Arthur J. Gallagher & Co.

Good afternoon, and welcome to Arthur J. Gallagher & Company's second 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 the information concerning forward-looking statements and risk factor sections contained in the company's most recent 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, President, and CEO of Arthur J. Gallagher & Company. Mr. Gallagher, you may begin.

Thank you very much. Good afternoon, everyone. Thank you for joining us for our second quarter 23 earnings call. On the call today is Doug Howell, our CFO, as well as the heads of our operating divisions. We had a fantastic second quarter. For our combined brokerage and risk management segments, we posted 20% revenue growth, 10.8% organic growth. And recall, we don't include interest income in our organic. If we did, our headline number would be 13.4% and over 14% if you levelized for last year's large life product sale. Gap earnings per share of $1.48. Adjusted earnings per share of $2.28, up 21% year over year. Reported net earnings margin of 13.6%. Adjusted EBITDA margin of 30.4%, up 52 basis points. We also completed 15 mergers totaling $349 million of estimated annualized revenue. We had a terrific month to finish the quarter that fueled the upside versus our June IR debut. I could not be more pleased with our second quarter performance and how our teams all around the globe continue to deliver incredible value for our clients. On a segment basis, let me give you some more detail on our second quarter performance starting with our brokerage segment. Reported revenue growth was 20%. Organic was 9.7% or 12.3% if we include interest income, and about 13% when levelizing for the large life product sale. Acquisition rollover revenues were $151 million. Adjusted EBITDA growth was 23%, and we posted adjusted EBITDA margin expansion of about 50 basis points. Let me walk you around the world and provide some more detailed commentary on our brokerage organic. Again, the following figures do not include interest income. Starting with our retail brokerage operations, our USPC business posted 13% organic. New business production was up year over year, while retention was similar to last year's second quarter. Our UK PC business posted 11% organic due to strong new business production. Canada was up 6% organically, reflecting solid new business, similar retention versus last year, and continued but somewhat more modest renewal premium increases. Rounding out the retail PC business, our combined operations in Australia and New Zealand posted more than 10% organic. Core new business wins were excellent, and renewal premium increases were ahead of second quarter 22 levels. Our global employee benefit brokerage and consulting business posted organic of about 2%. That includes a three-point headwind from last year's life product sale. Excluding the tough compare, organic would have been about 5%. With core health and welfare up low single digits, then many of our consulting practice groups showed continued strength. Shifting to our reinsurance, wholesale, and specialty businesses, Gallagher Re posted 11% organic, another outstanding quarter by the team, building upon their excellent first quarter results. Displacement services, our U.S. wholesale operations posted organic of 10%. This includes 19% growth in open brokerage and about 6% organic in our MGA programs and binding businesses. And finally, U.K. specialty posted organic of 19%, benefiting from excellent new business production and fantastic retention and a firm rate environment. Next, let me provide some thoughts on the PC insurance pricing environment, starting with the primary insurance market. Global second quarter renewal premiums, which include both rate and exposure changes, were up 12%. That's ahead of the 8% to 10% renewal premium change we were reporting throughout 22 and the first quarter of 23. Renewal premium increases remain broad-based and are up across all of our major geographies. We're also seeing increases across most product lines. Property is up more than 20%. General liability is up about 8%. Workers' comp is up about 3%. Umbrella and package are up about 11%. And most lines are trending similar or higher relative to previous quarters, with two exceptions. First is public company D&O, where renewal premiums are lower versus last year. And second, cyber, which has flattened down slightly year over year. But to put this all in perspective, these two lines combined represent around 5% of our year-to-date brokerage revenues and thus don't have much of an impact. So I believe the market continues to be rational. still pushing for a rate where it's needed to generate an acceptable underwriting profit. Remember, though, our job as brokers is to help our clients find the best coverage while mitigating price increases to ensure their risk management programs fit their budgets. So not all these renewal premium increases show up in our organic. Shifting to the reinsurance market. Overall, the June and July reinsurance renewals resulted in similar outcomes to what we saw during January renewals, with most global reinsurance lines continuing to harden. Property continues to experience the most hardening, especially cat-exposed treaties. Within the US, Florida property cat renewals were more orderly than January due to an early start and well-defined reinsurer appetites. Regardless, price increases were in the 25% to 40% range, causing many seasons to increase their retentions. While property capacity isn't abundant, we ultimately were able to place risk for most all of our seasons. As for casualty reinsurance renewals, the second quarter showed more stable supply versus demand dynamics, resulting in price increases based on product or risk-specific factors. Looking forward, carriers are likely to continue their cautious underwriting posture given the frequency and severity of weather events, replacement cost increases, and social inflation, all of which can impact current and prior accident year profitability. Add to that rising insurance costs, and it's easy to make the case for pricing increases on most lines to continue here in 23 and perhaps throughout 24. Despite these and other inflationary cost pressures, our customers' business activity remains strong. During the second quarter, our daily indications of client business showed positive endorsements and audits. These positive policy adjustments have continued thus far in July. At the same time, labor market imbalances remain. 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. And medical cost trends are on the rise. We anticipate these costs to accelerate into 24 due to increased costs of services, more frequent high dollar claims, and the impact of new therapies and specialty medications. So I see demand for our HR consulting and other benefits offerings remaining strong. So when I bring this all together, as we sit here today, we are more confident with full year brokerage organic in the 8% to 9% range. And with an excellent second quarter in the books, more towards the upper end of that range. Posting that would be another fantastic year. Moving on to mergers and acquisitions, we had a very active second quarter. In addition to the buck acquisition, which I will discuss in a moment, we completed 14 new tuck-in brokerage mergers. Combined, these 15 mergers represent about $349 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. Moving to the buck merger, which was completed in early April. Our integration efforts have begun and the combined business is off to a great start. While it's still early, I'm extremely pleased with how the teams are working together and excited about our combined prospects. Looking ahead, we have a very strong merger pipeline, including nearly 55 term sheets signed or being prepared, representing more than $700 million of annualized revenue. We know that not all of these will ultimately close, but we believe we will get our fair share. Moving on to our risk management segment, Gallagher Bassett. Second quarter organic growth was 18.1% ahead of our expectations due to rising claim counts and continued growth from recent new business wins. These wins have been broad-based and across all of various client segments, including large corporate enterprises, public entities, insurance carriers, and captives. Growth in each of our client verticals is great affirmation in our ability to tailor our client offerings, utilize industry-leading technology, and ultimately deliver superior outcomes for clients across the globe. Second quarter, adjusted EBITDAG margin of 19.4% was very strong and at the upper end of our June expectation. Looking forward, we see full year 23 organic around 13%, and adjusted EBITDAG margins pushing 20%. That would be another outstanding year. And I'll conclude with some comments regarding our bedrock culture. This past quarter, I was on the road for a month, visiting employees around the globe, traveling to New Zealand, Ireland, the UK, and the Czech Republic. And I can say that our culture is thriving, which makes me incredibly proud. Some of those conversations included the more than 500 young people in our 58th class of the Gallagher summer internship. This rigorous two-month program is an essential investment in our future, ensuring our unique culture remains strong for years to come. As we continue welcoming new colleagues and merger partners into the Gallagher fold, I'm confident that each new addition will uphold the expertise, excellence, and ethical conduct that make Gallagher the name so trusted worldwide. And that is the Gallagher way. All right, I'll stop now and turn it over to Doug.

Doug? Thanks, Pat. Hello, everyone. What a terrific quarter on all measures. Today, I'll walk through organic and margins by segment, including how we see the remainder of the year playing out. Then I'll provide some comments on our typical modeling helpers using the CFO commentary document that we post on our website. And I'll conclude my prepared remarks with a few comments on cash, M&A capacity, and capital management. Okay, let's flip to page three of the earnings release. All-in brokerage organic of 9.7%. That'd be 12.3% if we include interest income and a little over 13% when further levelizing for last year's large live product sales. That's a bit better than what we forecasted at our IR day in June due to a fantastic finish of the quarter across all of our divisions, especially U.S. retail and London specialty. You'll also see that contingents were up more than 20% organically. Probably a better way to look at it is in combination with supplementals because contracts can flip from time to time. Together, up 12% is much more in line with our base commission and fee organic growth. So no matter which way you look at it, a fantastic organic growth quarter by the team. Looking forward, we see headline brokerage organic around 9% for third quarter and about 8% for fourth quarter. It's important to recall that fourth quarter will have a tough compare because in Q4 22, we booked a change in estimate related to our 606 deferred revenue accounting. Controlling for that, Fourth quarter 23 organic would be towards 9%. We highlighted this matter last year and again at our June IR day, so there's nothing new here. It's just a reminder as you update your models. With all that said, we remain bullish on our organic prospects for the second half. Accordingly, we now believe full year brokerage organic is looking like at the higher end of that 8% to 9% range. Again, these percentages do not include interest income. flipping to page five of their earnings release to the brokerage segment adjusted EBITDA table. We posted adjusted EBITDA margin of 32.1% for the quarter. That's up about 50 basis points over second quarter 22's FX adjusted margin. And that came in better than our June IR day expectation of expanding 10 basis points, mostly due to the incremental organic growth. Looking at it like a bridge from Q2 22, organic gave us 100 basis points of expansion. Incremental interest income gave us 90 basis points of margin expansion. The impact rolling of M&A, which is mostly buck, uses about 80 basis points. And then we also made some incremental technology investments, call that around $7 million, and some continued inflation on T&E, call that about $5 million, which in total used about 60 basis points. Follow that bridge, and the math gets you close to that 50 basis points of FX adjusted expansion in the quarter. As for our margin outlook, we expect about 40 to 50 basis points of expansion for each of the next two quarters. So for the year, we're a bit more optimistic than our April and June views, and now see full year margin expansion of 30 to 40 basis points, or that would be 70 to 90 basis points, levelizing for the role and impact of Buck. Again, both those percentages are increases relative to prior year FX adjusted margins. We talked about that during our June IR day when we provided a vignette on how to model margins. Let me give you 22 margins recomputed at current FX levels for your starting points. In Q3 22 EBITDA margins would have been around 31.7% versus the 32.3% we reported. And as for fourth quarter 22, not nearly as much impact. Call it around 31.3%. So now if you move to the risk management segment and the organic table at the bottom of page five of the earnings release. Also had an excellent finish to the second quarter, 18.1% organic growth. As Pat mentioned, we continue to benefit from new business wins from the second half of 22. Looking forward, we see organic in the third quarter on 14% and fourth quarter about 10%, which reflects the lapping of last year's larger new business wins. As for margins, when you flip to page six and the adjusted margin EBITDA table, risk management posted 19.4%. That was on the upper end of our 19 to 19.5% June expectation. Looking forward, we see margins above 19.5% in each of the last two quarters of 23. So full-year double-digit organic and margins approaching 20%. That would lead to a record year for Gallagher Bassett. Now let's turn to page seven of the earnings release and the corporate segment shortcut table. In total, adjusted second quarter came in right at the midpoint of the range we provided during our June IR day. Even though we did experience a further $5 million of FX-related remeasurement headwinds, that cost us a couple pennies in the quarter. Now let's move to the CFO commentary document. On page three, you'll see most of the second quarter results were in line with our June commentary. And looking ahead, you'll see that we've updated our outlook to reflect current FX rates and provide our usual modeling helpers for the second half of the year. Moving to page four of the CFO commentary document and our corporate segment outlook for the second half, the punchline here is not much change other than a modest week corporate expense and interest in banking costs, as we've assumed a slightly higher balance on our credit line, giving our robust M&A activity. Then on page five of the CFO commentary, that shows our tax credit carry forwards. As of June 30, we have about $700 million, which will be used over the next few years, and that sweetens our cash flow and helps us fund future M&A. Shifting to rollover M&A revenues on page six of the CFO commentary document, $151 million in the quarter with Buck contributing nearly half of that. Remember, numbers in this table only include estimates for M&A closed through yesterday. So you need to make a pick for future M&A and you should also increase interest expense if you assume we borrow for a portion of the purchase price. One other call out and that's back at the bottom of page three of the earnings release. We did use a higher than normal amount of stock for tax-free exchange mergers this quarter. That can be a little lumpy, but we do like doing them. It's attractive to the sellers that are looking to defer the full tax consequence of selling their firm. And it's also attractive to us because it fully aligns our new partners with our long term shareholders. As for future M&A, we remain very well positioned. At June 30, available cash on hand was more than $400 million. Our cash flows are strongest in the second half of the year, and we have room for incremental borrowing all the while maintaining our strong investment grade ratings. We continue to see our full year 23 M&A capacity upwards of 3 billion and another 3 billion or more in 24 without using any equity. So another outstanding quarter by the team. From my position as CFO sitting halfway through the year, our full year 23 outlook on all measures continues to improve. better organic, better margins, and a more robust M&A pipeline. Bottom line, we're in a great spot to deliver another record year of financial performance. Okay, back to you, Pat. Thanks, Doug.