Arthur J. Gallagher & Co.

Good afternoon. Welcome to Arthur J. Gallagher and Company's third quarter 2024 earnings conference call. Participants have been placed on 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 factors 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 investor relations section of the company's website. It is now my pleasure to introduce J. Patrick Gallagher, Jr., Chairman and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.

Thank you very much. Good afternoon, everyone, and thank you for joining us for our third quarter 24 earnings call. On the call for you today is Doug Howell, our CFO, other members of the management team, and 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 the recent storms and floods. Our thoughts are with those impacted by these events, including our own Gallagher colleagues. Our professionals are hard at work helping clients sort through their coverages, file claims, and ultimately get losses paid. I'm really honored to be part of a company in an industry with such an important responsibility, helping families, businesses, and communities rebuild and restore their lives. And that's a noble cause. Okay. Onto my comments regarding our financial performance. We had a great third quarter. For our combined brokerage and risk management segments, we posted 13% growth in revenue, 6% organic growth, which does not include interest income. Reported net earnings margin of 15.5%, adjusted EBITDA margin of 31.9%, up 123 basis points year over year. Gap earnings per share of $1.90 and adjusted earnings per share of $2.72, up 16% year over year. Another fantastic operating quarter by the team. Moving to results on a segment basis, starting with the brokerage segment. Reported revenue growth was 13%. Organic growth was right in line with our expectations at 6%, which, as we forecasted, reflects about a point of timing headwind from those large life cases we have highlighted over the past couple of quarters. Doug will provide you with some good news from October related to these sales in his remarks. Adjusted EBITDAG margin expanded 137 basis points to 33.6%, which was better than our IR day expectations. Let me give some insights behind our brokerage segment organic. Within our PC retail operations, we delivered 5% in the US and 7% outside the US. Internationally, Australia and New Zealand led the way with organic of more than 10%. The UK was up 6% and Canada was flattish. Our global employee benefit brokerage and consulting business posted organic of about 4%, and a few points higher, excluding the timing differences from the large life case sales. Shifting to our reinsurance, wholesale, and specialty businesses, overall organic of 8%. So very strong growth, whether retail, wholesale, or reinsurance. Next, let me provide some thoughts on the PC insurance pricing environment. starting with the primary insurance market. Global third quarter renewal premiums, which include both rate and exposure, were up 5% and little changed from the 6% we discussed at our September IR Day update a few weeks ago. Most lines and geographies had very similar renewal premium changes through all three months of the quarter, with a couple of exceptions. September casualty renewal increases outside the U.S. were lower relative to July and August, driven by changes in business mix. Additionally, large account and E&S property renewal premium increases were a bit less in September than the first two months of the quarter. But neither of these appear to be a trend. Thus far in October, we are seeing large account property and international casualty renewal premium increases higher than September. Breaking down third quarter renewal premium changes by product line, we saw the following. Property up 4%. General liability up 6%. Commercial auto up 7%. Umbrella up 10%. Workers' comp up 2%. D&O down about 5%. Cyber was flat. And personal lines up 11%. So overall, increases continue to be broad-based and rational in our view, with carriers still cautious and pushing for a rate where it's needed to generate an acceptable underwriting profit. we shine in this environment. Our job as brokers is to help clients find the best coverage while mitigating premium increases. So while not all the increases ultimately show up in our organic, a rational market allows us to further differentiate ourselves with our leading tools, data, and expertise. Let me shift to the reinsurance market. The July 1st renewal season saw modest property price declines concentrated at the top end of reinsurance towers, while casualty renewals saw terms and conditions tighten and some modest price increases concentrated in the U.S. Clearly, a lot has happened in the property market over the past month, which is now adding some complexity to January 1st property renewals. It's still early, but we now believe a flattish renewal is more likely than the downward pressure previously being discussed. And don't forget, US hurricane season is not over for another month. For casualty risks, we believe reinsurance will remain cautious heading into next year, especially if there is more noise related to US reserve adequacy. We think differentiating underwriting practices will likely be the key to a successful renewal for clients. Overall, The reinsurance industry remains adequately capitalized and is likely to meet capacity demands at the upcoming January 1 renewals. We continue to believe Gallagher Re will perform very well in 2025, regardless of how the market environment unfolds in the near term. Moving to some comments on our customers' business activity. Our daily revenue indications from audits, endorsements, and cancellations were again in positive territory for the third quarter. While the amount of upward revenue adjustments isn't as much as 2023, they are running in line with 2022. So client business activity remains solid, and we are not seeing any signs of a meaningful global economic slowdown. Within the U.S., the labor market is on solid footing. In fact, the number of open jobs increased in August and remained well above the number of unemployed people looking for work. Overall job growth, upward wage pressure, and rising medical cost inflation continue to challenge employers looking for ways to grow their workforce and control their benefits costs. Regardless of market or economic conditions, I believe we are well positioned to take market share across our brokerage business. Remember, about 90% of the time we are competing against the smaller local broker that cannot match our client value proposition, niche expertise, outstanding service, and our extensive data and analytics offerings. Putting this all together, we continue to see full year 24 brokerage organic around 7.5%, and that would be another outstanding year. Moving on to our risk management segment, Gallagher Bassett. Revenue growth was 12%, including organic of 6%. We continue to benefit from excellent client retention, increases in customer business activity, rising claim counts, and new business wins. Adjusted EBITDAG margin was 20.8%, 35 basis points higher than last year, and a bit above our September IR day expectation. Looking ahead, We see organic in the fourth quarter around 7% and full year organic pushing 9%. Margins for fourth quarter and full year should be in the 20.5% range, as that too would be another outstanding year. Shifting to mergers and acquisitions. During the third quarter, we remained disciplined, completing four new mergers at fair prices representing $47 million of estimated annualized revenue. For those new partners joining us, I'd like to extend a very warm welcome to the Gallagher family of professionals. Looking ahead, we have more than 100 mergers in our pipeline, representing approximately $1.5 billion of annualized revenue. Of these 100 potential partners, we have about 60 turn sheets signed or being prepared, representing around $700 million of annualized revenue. Good firms always have a choice and it would be terrific if they chose to partner with Gallagher. Let me conclude with some comments regarding our culture. As we passed our 40th anniversary as a public company, I believe our greatest differentiator continues to be our bedrock culture. It's a culture that runs towards problems not away from them. A culture that supports one another and embraces teamwork. A culture that is grounded in the highest standards of moral and ethical behavior. It's a culture that will continue to guide our success for many years to come. Frankly, we love this business. We enjoy taking care of our customers. And that is the Gallagher way. Okay, I'll stop now and turn it over to Doug. Doug?

Thanks, Pat, and hello, everyone. Today I'll walk you through our earnings release. First, I'll comment on third quarter organic growth and margins by segment. Then I'll provide an update on how we are seeing organic growth and margins shape up for fourth quarter earnings. and provide an early look on 25. Next, I'll move to the CFO commentary document that we post on our IR website and walk you through our typical modeling helpers. And I'll conclude my prepared remarks with my usual comments on cash, M&A, and capital management. Okay, let's flip to page three of the earnings release. Headline brokerage segment third quarter organic growth of 6% without interest income. That's right in line with our September IR day forecast, during which we signaled about a point of headwind due to the timing of large life sales. Recall that these live products are interest rate sensitive. So as we've been discussing, clients were waiting for lower interest rates. Well, the good news Pat mentioned happened over the last month or so. We are now seeing clients fund their policies. In fact, here in October, we have already caught up more than half of what had slipped from earlier quarters. So the quarterly lumpiness that we have been highlighting throughout the year is starting to swing the other way here in October. And thus, we are currently seeing fourth quarter organic towards 8% and full year pushing 7.5%. As we start to budget for 25, our early thinking is brokerage segment full year organic growth might be in the 6% to 8% range. If so, that could mean A 25 similar to how 24 might ultimately play out. We'll provide some more on our 2025 thinking at our December IR day. But an early read-through is we remain upbeat on our ability to grow given the investments we have been making in the business. From adding niche experts to rolling out new sales and support tools to expanding our data and analytics offerings. We believe these actions are leading to higher new business production and strong client retention across the globe. And as Pat described, the market environment is still a tailwind for us. Flipping now to page five of the earnings release to the brokerage segment adjusted EBITDA table. Third quarter adjusted EBITDA margin was 33.6%, up 137 basis points over last year and above the upper end of our September IR day expectations. Let me walk you through a bridge from last year. First, if you pull out last year's 2023 third quarter earnings release, you would see we reported back then adjusted EBITDA margin of 32.4%. But now using current period FX rates, that would have been 32.2%. Then organic and interest gave us nearly 150 basis points of expansion this quarter. Finally, the impact of M&A and divestitures used about 10 basis points of margin this quarter. You follow that, and that will get you to third quarter 24 margin of 33.6%. And that's the 137 basis points of brokerage margin expansion. That is really, really great work by the team. As we look ahead to fourth quarter 24, we are still expecting margin expansion in the 90 to 100 basis point range. And again, that would be off of fourth quarter 23 adjusted margin for FX. which currently is estimated to be about 20 basis points lower than last year's headline margin of 31.6%. If we do that, that would mean full year 24 could show about 70 basis points of margin expansion and 90 basis points excluding the first quarter impact from the roll-in of the buck merger. Okay, let's move on to the risk management segment and the organic and EBITDA tables on pages 5 and 6. It was another solid quarter. We posted organic of 6%. That's a point lower than our IR day guidance because we just missed qualifying for a full revenue bonus related to one large account. That said, Gallagher Bassett continues to see excellent client retention and strong new business production and still delivers an adjusted EBITDA margin of 20.8%, which is up 35 basis points over prior year and ahead of our IR day expectation. Looking forward, we see organic of 7% and margins around 20.5% in the fourth quarter. If we were to post that, we would finish the year with organic pushing 9% and margins of approximately 20.5%. That too would be great work by the team. As for 25, our early thinking is for organic growth similar to the brokerage segment. Call it in that 6% to 8% range. Turning now to page six of the earnings release in the corporate segment shortcut table. In total, adjusted third quarter numbers for interest in banking, clean energy, and acquisition costs came in within our September IR day expectations. The corporate line of the corporate segment was below our expectations due to approximately $9 million of additional unrealized non-cash foreign exchange remeasurement expense that developed during September and wasn't included in our IRD forecast. After tax, call it about three cents. That has already reversed here in October, so it really is a non-cash nothing in our opinion, but the accounting does cause some noise. Let's now move to the CFO commentary document. Starting on page three, modeling helpers. There's no new news here other than FX, so just consider these updated revenue and EPS impacts as you update your models. Turning to the corporate segment on page four of the CFO commentary document, no change to our outlook for fourth quarter. Flipping now to page five to our tax credit carry forwards shows $796 million at September 30th. While this benefit won't show up in the P&L, it does benefit our cash flow for the next few years, which helps us fund future M&A. Turning to page six, the investment income table. We are now embedding two 25 basis point rate cuts in the fourth quarter of 24 and have updated our estimates in this table for current FX rates. Punchline here is our fourth quarter estimate does not change much from what we provided at our September IR day. Shifting down that page to the rollover revenue table, the third quarter 24 column subtotal is $111 million and $141 million before divestitures. These are consistent with our September IRD expectations. Looking forward, the pinkish columns to the right include estimated revenues for brokerage M&A through closed through yesterday. So just a reminder, you'll need to make a pick for future M&A. And when you move down on that page, you'll see the risk management segment rollover revenues for fourth quarter 24 are expected to be approximately $15 million. So moving to cash capital management and M&A funding. Available cash on hand at September 30 was about $1.2 billion. Considering this balance and our strong expected free cash flow, we are in an excellent position to fund our robust pipeline of M&A opportunities here in 24. We currently estimate capacity of around $3 billion for M&A here in 24 and it's looking like we could have another $4 billion to fund M&A in 25. all while maintaining a solid investment grade rating. So it's another excellent quarter in the books. Through the first nine months of the year for our combined brokerage and risk management segments, we have delivered revenues up 16%, organic growth of 8%, net earnings up 20%, adjusted EBITDA up 18%, and adjusted EPS up 17%. Those are terrific numbers and reflect an unstoppable culture. We are well on our way to another great year of financial results. Hats off to the team for all of their hard work. So back to you, Pat.