Arthur J. Gallagher & Co.

Good afternoon and welcome to Arthur J. Gallagher and Co.' 's second quarter 2021 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 statements and risk factors contained in the company's 10-K statement. 10Q and 8K 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 & Co. Mr. Gallagher, you may begin.

Thank you, Laura. Good afternoon, and thank you for joining us for our second quarter 2021 earnings call. On the call with me today is Doug Howell, our Chief Financial Officer, as well as the heads of our operating divisions. We had an excellent second quarter. The team delivered on all four of our long-term operating priorities to drive shareholder value. We grew organically. We grew through acquisitions, improved our productivity, all while raising our quality and maintaining our unique Gallagher culture. For our combined brokerage and risk management segments, we posted 17% growth in revenue, 8.6% organic growth, but it's over 10% when adjusted for timing, which Doug will spend some time on in a few minutes. Net earnings margin expansion of 107 basis points, adjusted EBITDA margin expansion of 30 basis points, and we completed eight new mergers in the quarter with more than $70 million of estimated annualized revenue. Most importantly, our Gallagher culture continues to thrive. Just a fantastic quarter on all measures. Now before I discuss how each of our businesses performed in more detail, let me comment briefly about the termination of our agreement to purchase certain Willis Towers Watson brokerage operations. We were excited about the opportunity and would have loved to complete the transaction. There are a lot of great people at Willis, and they would have been a great addition to our team. But here's the key point. With or without this, we remain very well positioned to support our clients, compete for new ones, and ultimately drive value for all of our stakeholders. We're in the greatest business on earth, our culture is stronger than ever, and I'm excited about our future. Okay, back to our quarterly results, starting with our brokerage segment. Purported revenue growth was strong at 16%. Of that, 6.8 was organic revenue growth, a little better than our June IR day expectation and closer to 9% adjusted for timing. Our net earnings margin moved higher by 53 basis points, and our adjusted EBITDAG margin expanded by 23 basis points, highlighting our continued expense discipline. Another excellent quarter from the brokerage team. Let me walk you around the world and break down our organization by geography, starting with our PC operations. First, our domestic retail operations were very strong with more than 8% organic. New business was excellent, nicely above second quarter 2020 levels. Risk placement services, our domestic wholesale operations, grew 12%. This includes nearly 25% organic in open brokerage and 6% organic in our MGA programs and binding businesses. New business and retention were both better than 2020 levels. Outside the U.S., our U.K. operations posted more than 9% organic. Specialty was 10% and retail was excellent at 9% bolstered by new business production. Pardon me. Canada was up an outstanding 16% fueled by rate and exposure growth on top of solid new business and retention. And finally, Australia and New Zealand combined grew nearly 4%, benefiting from good new business and stable retention. Moving to our employee benefit brokerage and consulting business, second quarter organic was up about 4%, which is also ahead of our June IR Day commentary, and another sequential step up over first quarter 2021 and the second half of 2020. As business activity improves, we're seeing more favorable growth in our core health and welfare fee-for-service and retirement consulting businesses. which is an encouraging sign for the second half of the year. So when I combined PC at 9 plus percent and benefits around 4 percent, total brokerage segment organic was pushing 9 percent, but with timing reported 6.8 percent. Either way, another really strong performance. Next, I'd like to make a few comments on the PC market. Global PC rates remain firm overall, and at the same time, we are seeing increased economic activity across our client base. Customers are adding coverages and exposures to their existing policies, and monthly positive policy endorsements are trending higher than pre-pandemic levels. And overall, second quarter renewal premium increases were similar with the first quarter. Moving around the world, U.S. retail was up about 8%, including double-digit increases in professional liability. Canada was up 9%, driven by increases in professional liability and package. New Zealand was flat, and Australia up 6%. Moving to the U.K., retail was up about 8%, with most classes of specialty business over 10%. And finally, within RPS, wholesale open brokerage was up 12% while our binding operations were up 4%. So clearly, premiums are still increasing across nearly all geographies. Looking forward, it feels that the current renewal environment will persist for some time. Carriers that cut back capacity in some of the less profitable lines of business like property, professional liability, umbrella, and cyber have yet to budge on terms or conditions or haven't reverted back to offering more limits or lower attachment points. And elevated natural catastrophes, continued impacts of the pandemic, social inflation, and low investment returns are all continuing to pressure rates. Add on top of this the potential for increased claim frequency as economies recover and carriers are making a strong case that rate increases are likely to persist for some time. We, too, see the global PC environment remaining difficult for our clients and that is likely to remain for the foreseeable future. Moving to our benefits business, our customer base is returning towards pre-pandemic levels a little more slowly than headline-grabbing sectors like retail, leisure, and hospitality. So we were expecting even better organic in the second half. Further, our HR consulting units are very well positioned to deliver solutions as clients and prospects pivot away from controlling costs to growing their businesses and attracting, motivating, and retaining their workforce in 2021 and beyond. So as I sit here today, I think second half brokerage organic will be better than the first half and could take full year 2020 organic towards 8%. That would be a terrific step up from the 3.2% organic we reported in 2020. Moving on to mergers and acquisitions. We completed seven brokerage and one risk management merger during the second quarter, representing over $70 million of estimated annualized revenues. I'd like to thank all of our new partners for joining us, and I 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 more than 40 term sheets signed or being prepared, representing around $300 million of annualized revenues. Our platform continues to attract entrepreneurial owners looking to leverage our data, expertise, tools, and market relationships to grow their businesses. And we expect that our U.S. pipeline will grow in the second half of the year, given the potential changes in capital gains, taxes, So 2021 is setting up to be another successful year for our merger strategy. Next, I'd like to move to our risk management segment, Gallagher Bassett. Second quarter organic growth was pushing 20%, better than our June IR day expectations of mid-teens, and our adjusted EBITDA margin exceeded 19%. We benefited from a revenue lift related to our 2020 new business wins, increased new arising claims within core workers' compensation, and an easier pandemic-era comparison. Looking forward, the rebound in employment, economic activity, and our solid new business should lead to third and fourth quarter organic nicely in double digits. For the year, we expect organic to be just over 10% and our EBITDA margin to remain above 19%. So what an exciting time to be part of Gallagher. And that's because of our 35,000 plus employees and our unique Gallagher culture. It's our culture that keeps us together during the depths of the pandemic. And as we open offices around the globe, yet preserving the flexibility we've mastered over the last 16 months, I'm hearing the excitement about being back together. Ultimately, it's our employees that wake up every day and decide to do things the right way, the Gallagher way. That's what makes us different. It makes us special as a franchise. It attracts the very best people and merger partners and ultimately clients. I believe our culture has never been stronger. So with two quarters in the books, 2021 is shaping up to be an excellent year. Okay, I'll stop now and turn it over to Doug. Doug?

Thanks, Pat, and hello, everyone. As Pat said, an excellent quarter and first half of the year. Today I'll spend a little extra time on organic and then give you our current thinking on expenses and margins. Then I'll walk you through some items on our CFO commentary document, and I'll finish up with some comments on cash, liquidity, and capital management. Okay, let's move to page four of the earnings release and the brokerage segment organic table. Headline all in organic of 6.8%. Excellent on its own, but as Pat said, really running closer to 9%. There's two reasons for that. First, recall that we had some favorable timing in our first quarter related to contingent commissions that caused a little unfavorable timing here in the second quarter. Call that 70 basis points. Second, also recall that we took our 606 revenue accounting adjustment in the first quarter 2020. We then adjusted that in the second quarter of 2020. So that creates a more difficult compare of this year's second quarter. Call that about 150 basis points. These two items combined for about 220 basis points of a headwind here in the second quarter. We don't expect similar headwinds in the second half. Okay, let's go to page six to the brokerage-adjusted EBITDA table. You'll see that we expanded our EBITDA margin by 23 basis points here in the second quarter. Considering last year's second quarter was in the depth of the pandemic and our brokerage segment saved $60 million in that quarter, to post any expansion at all this quarter is terrific work by the team. Shows we are indeed holding a lot of our savings. So the natural question is, when you levelize for the $60 million of pandemic savings last year's second quarter and about $15 million of costs that came back this second quarter, what was the underlying margin expansion? Answer to that is about 125 basis points, which on 6.8% organic feels about right. That $15 million mostly relates to higher utilization of our self-insurance medical plans, a modest pickup in T&A expenses, and incentive comp. So we held $45 million of cost savings this quarter, and that's really terrific. Looking forward, we continue to think we can hold a lot of our pandemic period savings, perhaps more than half, but naturally some of those costs will come back. As of now, we think about $20 million of costs return in the third quarter and $30 million return in the fourth quarter. Both of those numbers are relative to last year's same quarters. So, again, the natural question might be, what organic do you need to post third and fourth quarter to overcome those expenses and still have margin expansion? Matt would say about 7%. which is really the real story. Recall at the beginning of the year, after expanding margins, 420 basis points in 2020, we were looking at just holding margins flat. Now we're looking at a full year margin expansion story. So even with the return of the expenses, and again, let's say, assuming for illustration, a full year organic of 7%, math would show another full point of margin expansion in 2021. That would mean our cumulative two-year margin expansion would be well over 500 basis points. That really highlights the improvements in productivity that are now ingrained in how we do business and how we operate. What a great story. Let's move on to the risk management segment EBITDA table on page seven. Adjusted EBITDA margin of 19.7% in the quarter is fantastic. And we continue to expect the team to deliver margins above 19% for the full year, showing that our risk management segment can also hold some of the pandemic induced cost savings, meaning that the 2020 step up in margin can be sustained in 2021. Let's move now to page four of the CFO commentary document that we post on our website. Comparing second quarter results in the blue section to our June IR day estimate in the gray section. Interest in banking was in line. Clean energy came in better than our estimate thanks to a hot late June, less wind energy production in certain areas of the country, and higher natural gas prices. Accordingly, we are increasing our full year net earnings range to $75 to $85 million on the back of the second quarter upside. You'll also notice two non-GAAP adjustments. one related to the cost associated with the terminated Willis-Towers Watson acquisition, and the other is a one-time deferred tax revaluation charge related to the statutory increase in the U.K.' 's 2023 corporate tax rate. When you control for those two items, it shows that adjusted M&A and corporate lines were both pretty close to our June 17th estimates. Looking ahead to the third quarter, and that's in the pinkish section, you'll see non-GAAP after-tax adjustment for $12 to $14 million. This charge is mostly related to redeeming $650 million of debt. That's the 10-year senior notes we issued in mid-May. You'll read that also on page three of the earnings release. This should also lead to lower third and fourth quarter adjusted interest and banking expense, savings maybe of $2 to $3 million after-tax each quarter. If you turn now to page five of the CFO commentary, go to the peach-colored section. Just another reminder of what we've been discussing in these calls and during our IR days for the last couple of years. 2021 is the last year our clean energy investments will show GAAP P&L earnings. Rather, beginning in 2022, we will show substantial cash flows through our cash flow statement. Call it $125 to $150 million a year for, say, six to seven years. I know I've highlighted this a lot, but I just want to make sure you consider this as you build your 2022 models and beyond. So next, let's go to the balance sheet on page 14, the top line cash. At June 30, cash on hand was $3.2 billion, and we have no outstanding borrowings on our credit facility. We'll use that first to redeem the $650 million of debt I just discussed, and also today we announced a $1.5 billion share repurchase program. That would leave us with about a billion of cash. Then add to that about $650 million of net cash generation in the second half. That's after dividends, CapEx, interest taxes, et cetera. And we would also have another $600 to $700 million of borrowing capacity. It means we have upwards of $2.5 billion for M&A. When I look at the pipeline, and if a capital gains tax rate change gets momentum, I think we'll have plenty of opportunities to put that capital to work at really fair multiples. Okay, those are my comments. An excellent quarter, an excellent first half, a bright outlook for the second half, and a really terrific cash position. Back to you, Pat.