Arthur J. Gallagher & Co.

Good afternoon, and welcome to Arthur J. Gallagher and Company's second 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 statements 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-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 Jay Patrick Gallagher, Chairman, President, and CEO of Arthur J. Gallagher and Company. Mr. Gallagher, you may begin.

Thank you. Good afternoon, everyone. Thank you for joining us for our second quarter 2022 earnings call. On the call for you today is Doug Hall, our CFO, as well as the heads of our operating divisions. We had another excellent quarter of financial performance. For our combined brokerage and risk management segments, we posted 22% growth in revenue, 10.7% organic growth, net earnings growth of 35%, adjusted EBITDA growth of 23%, and adjusted earnings per share growth of 19%. I'm extremely proud of how our nearly 41,000 colleagues around the globe performed during the quarter and the first half of the year. So let me give you some more detail on our second quarter brokerage segment performance. During the quarter, reported revenue growth was 25%. Of that, 10.8% was organic. We did have a tailwind of about a point from an infrequent large life case that I'll touch on in a minute. Rollover revenues were about $240 million, consistent with our June IR Day expectations. Net earnings growth was 36%, and as expected, we posted adjusted EBITDA margins of 32%, an outstanding quarter for the brokerage team. Let me walk you around the world and break down our organic, starting with our PC operations. Our U.S. retail business posted 11% organic with strong new business, retention, and continued renewal premium increases. Risk placement services, our U.S. wholesale operations posted organic of 8%. This includes more than 15% organic in open brokerage and 4% organic in our MGA programs and binding businesses. New business was consistent with second quarter of 21, while retention was down just a bit from last year, as we noted in our June IR day. Shifting outside the U.S., our U.K. businesses posted organic of 8%, with excellent new business overall, and another double-digit organic growth quarter within specialty. Australia and New Zealand combined, organic was more than 11%. driven by strong new business, stable retention, and higher renewal premium increases. Canada was up more than 14% organically and continues to benefit from renewal premium increases, great new business, and great retention. Moving to our employee benefits, brokerage, and consulting business. As I mentioned earlier, we were helped this quarter from a large life case. Excluding this, our benefits business organic was about 9%, in line with our IR day expectations and driven by increased HR benefits consulting work and solid growth in our international and health and welfare businesses. Finally, our December reinsurance acquisition is right on target. After controlling for breakage prior to closing, second quarter organic was around 7%, just fantastic. And integration continues to progress nicely on budget and ahead of its original timeline. So reinsurance continues to be a really good story. So headline brokerage segment all in organic of 10.8% and upper 9% after controlling for the large life case. Either way, an excellent quarter. Next, let me give you some thoughts on the current PC market environment, starting in the primary insurance market. Overall global second quarter renewal premiums, that's both rate and exposure combined, were up 10.5%. That's higher than what our data showed for increases in renewal premiums in both the fourth quarter 21 and first quarter 22. When I look at our renewal premiums by line for nearly all coverages, second quarter increases were equal to or higher than first quarter One exception to this was professional liability, mostly D&O. By geography, renewal premiums were up double digits nearly everywhere. Again, that's a combination of both rate and exposure. So next to no slowdown in premium increases during the quarter. Additionally, we are not seeing any significant signs of economic slowdown. In fact, Second quarter midterm policy endorsements, audits, and cancellations continue to trend more favorable than a year ago. Thus far in July, midterm policy endorsements continue to move higher year over year, and renewal premium increases are consistent with second quarter. But remember, our job as brokers is to help our clients mitigate premium increases and find suitable insurance programs that fit their budgets. Moving to reinsurance. As we noted in our first view report published by our reinsurance professionals earlier this month, there are very real signs of hardening in the reinsurance market. Property reinsurance pricing is up across the board, and most notably for U.S. hurricane and Australian property risks are up anywhere from 15 to more than 40%. On the casualty side, reinsurance placements experienced more modest price increases and were a little bit less challenging. Regardless, a firm or hardening reinsurance market will naturally show up in primary market rate increases. And there are many other reasons for our carrier partners to maintain their cautious underwriting stance outside of reinsurance market conditions. Inflation, geopolitical tensions, and economic uncertainty, to name a few. These all translate into difficult PC market conditions continuing for our clients across retail, wholesale, and reinsurance for this foreseeable future. Moving to our employee benefit brokerage and consulting business, U.S. labor market conditions remain broadly favorable. Even with a decline in U.S. job postings in each of the last two months, there remain more than 11 million job openings, That's more than double the number of people unemployed and looking for work. We expect strong demand for our HR and benefits consulting services to continue as businesses prioritize attracting, retaining, and motivating their workforce. The timing of the large life case and covered life changes in the second half of 21 will cause the benefits business to post lumpy quarterly organic results this year. But that doesn't change the still favorable underlying environment. So let me wrap up on the brokerage segment organic. A great first half and looking like the second half will lead us to a full year 22 organic over 9%, which would be an absolutely terrific year. Moving on to mergers and acquisitions. During the second quarter, we completed eight new tuck-in brokerage mergers representing about $50 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 more than 40 term sheets signed or being prepared, representing nearly $350 million of annualized revenues. We know not all these will close, however, we believe we will get our fair share. Next, I would like to move to our risk management segment, Gallagher-Bastard. Second quarter organic growth was 10.3%, a bit better than our IR day expectation due to a strong June. Adjusted EBITDAG margin was 18.9%, which is in line with our expectations. For the year, we continue to see adjusted EBITDAG margins near that 19% level. We again saw increases in new arising claims across general liability, property and core workers' compensation during the quarter. Encouragingly, property and liability claim counts are back to pre-pandemic levels. Core workers' claim counts have yet to fully rebound to 2019 levels. which represents a nice opportunity for further growth. Looking towards the second half of the year, we think organic revenue growth will continue to push 10% due to growing claim counts and new business. I'll conclude my remarks with some thoughts on our bedrock culture. As I resume traveling to our Gallagher offices around the globe, I can report to you that our culture is as strong as ever, and that's a reflection of our people, our nearly 41,000 colleagues working together for a common goal, to serve our clients. As I've said before, our people underpin our culture, a culture that we believe is a true competitive advantage and drives our outstanding financial results. Okay, I'll stop now and turn it over to Doug. Doug?

Thanks, Pat, and hello, everyone. An excellent second quarter and terrific half. Today I'll touch on organic margins and the corporate segment using our earnings release. I'll then make some comments using our CFO commentary document posted on our website. I'll end then with my typical comments on M&A, debt, and cash. Okay, starting with the earnings release. To the brokerage segment organic table on page three. Fantastic headline, all-in brokerage organic of 10.8%. As Pat said, we did benefit by about a point or so because of a large group life case bound in late June. With or without that, a great quarter by our sales team. As for the rest of 22, during our June IR day, we said third and fourth quarter would be somewhere around 8% due to a tough benefits compare. As we sit today, we're still seeing third quarter around that 8%, reflecting about a point of that tough benefits compare, and we're becoming more bullish on fourth quarter. Call it nicely over 8% in the fourth quarter. That would lead to full year brokerage segment organic growth of over 9%. So today we're forecasting full year organic growth better than what we were seeing at our June IR day. Next, turning to page five to the brokerage segment adjusted EBITDA margin table. Headline all in adjusted EBITDA margin of 32%, right in line with our June IR day expectation. Recall what we've been saying all year. Because of the rolling impact of the acquired reinsurance operations, which has substantial quarterly seasonality, and because there are still expenses returning as we come out of the pandemic, those in combination create quarterly margin change volatility. As a recap, we posted adjusted margins up 50 basis points in the first quarter, down 97 basis points here in the second, and we're forecasting down 100 basis points in the third, then back up 100 basis points in the fourth. Because we are seasonally largest in the first quarter, those results would roll up to around 10 to 20 basis points of full-year margin expansion. These quarterly margin changes are right on what we've been saying all year. When I think of inflation impact, I just don't see much here in 22 on our expenses. And as we discussed in June, headline inflation doesn't significantly impact 80% of our expense base. And we have mitigation levers to pull on that other 20% if it comes to that. So even with rising CPI, we remain comfortable with our 2020 margin outlook. Looking towards 23, all that quarter margin change volatility should go away with the pandemic behind us and reinsurance fully rolled into our books. Moving to the risk management segment on pages 5 and 6, Pat hit the highlights, 10.3% organic and 18.9% adjusted margins, an excellent quarter. This unit continues to show momentum with rebounding claim counts and a large new business win coming on next quarter. It's looking now like organic revenue growth of around 10% in each of third and fourth quarters 22. Now remember, that's on top of 17% growth in third quarter 21 and 13% growth in fourth quarter 21. That would be a terrific outcome to overcome such a difficult compare. Moving to page seven of the earnings release to the corporate segment shortcut table. Interest in banking is within our June IR day range. Adjusted M&A costs and clean energy, those combine also within our range. And corporate, after adjusting for some favorable tax item, is slightly better than our June IR day range. Call it about a penny due to favorable FX remeasurement gains given the strengthening in the dollar. Let's leave the earnings release and go to the CFO commentary document. On page three, these are our typical brokerage and risk management modeling helpers. With the rally in the US dollar since our June IR day, please take a look at our updated FX guidance for the remainder of 22. This late June strengthening also caused an extra penny headwind here in the second quarter versus our IR day guidance. Next, you'll see our current estimate of integration costs. Most of this is related to Willis-Rhee. The punchline is no change to our original estimate of $250 million for integration charges through the end of 2024. As I mentioned last quarter, the team is making excellent progress and is executing at a faster pace than our original plan. Integration efforts around people, real estate, back office transition services are targeted to be mostly done by late 22. In fact, our new reinsurance colleagues are now moving into our combined Gallagher locations around the world and there's an excitement of coming together. As for technology and system rebuilds, we still see having that done by the end of 23, early 24. So continue good news on the reinsurance integration front. Next, please take a look at the amortization of intangibles line. Recall we now adjust that out of our non-GAAP results. Also, take a look at footnote number two. That will help you reconcile this number to what we're showing on the face of our GAAP financial statements. Next, the change in estimated earn-out payables. This quarter, a subtle component of the earn-out payable adjustment has become more pronounced. The punchline is found in footnote 5. The note, admittedly, is a little accountant-ese, but it's saying that the large non-cash gain in our results this quarter is mostly due to increases in interest rates and market volatility. When these increase, the value of our earn-out liability declines, thus creating gap income. This gain does not reflect any meaningful change to our expectations of the acquired brokerages, nor does it change our view of what we'll ultimately pay and earn out. The accounting is a bit like the change in interest rate assumptions in pension accounting, except for this change in earn-out liability goes to the P&L, not through OCI, as does pensions. In our view, this is a no-never mind, but can dramatically impact comparability, so we adjust it out. Turning now to page four, our corporate segment outlook. No changes to third and fourth quarter estimates. Clipping to page five, clean energy. This page is here to highlight that we have around a billion dollars of tax credit carryovers. And with the sunset of the program late last year, we're now in the cash harvesting era of these investments. You'll see in the pinkish column that the 2022 cash flow increase should be $125 to $150 million, and perhaps more in 23 and beyond. At this rate, these investments will be a really nice seven-year cash flow sweetener. The possibility of an extension of the law still exists, so we have idled our plans rather than decommissioning them. It costs us a little to carry them, but it lets us remain well-positioned to restart production if an extension happens. Turning to page six, the top of the page is the rollover revenue table that we've spoken about in detail. We appreciate all those that have incorporated this disclosure into their models. Moving down the page, the bottom table is an update on our December reinsurance acquisition. You'll see that these numbers are almost spot on to our June IR Day estimates. Delivering $730 million of revenue and nearly $260 million of adjusted EBITDA here in 22 would be very close to our performance when we inked the deal. That would be a really good outcome. Moving on, as to cash and capital management and future M&A, at June 30, available cash on hand was about $450 million. Our operations continue to perform very well, and we expect strong operating cash flows. You know, add to that the cash flow sweetener from our clean energy investments and additional borrowing capacity, it adds up to more than $4 billion of tuck-in M&A capacity here in 22 and 23 combined. So those are my comments. An excellent quarter and first half, and we're extremely well positioned for another terrific year. Back to you, Pat. Thanks, Doug. Daryl, I think we're ready to open it up to questions.