Arthur J. Gallagher & Co. Q1 2022 Earnings Call Transcript

Quartr
Provided by Quartr
April 28, 2022

There are 10 speakers on the call.

Operator

Good afternoon, and welcome to the Arthur J. Gallagher and Company First 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.

Operator

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 ks, 10 Q and 8 ks 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.

Speaker 1

It is

Operator

now my pleasure to introduce J. Patrick Gallagher, Chairman, President and CEO of Arthur J. Gallagher and Company. Mr. Gallagher, you may begin.

Speaker 2

Thank you. Good afternoon, everyone, and thank you for joining us for our Q1 2022 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 a fantastic start to the year. For the Q1, our combined brokerage and risk management segments posted 30% growth in revenue, more than 10% organic growth, net earnings growth of 28%, Adjusted EBITDAC growth of 34% and adjusted earnings per share growth of 26%.

Speaker 2

And we were named a World's Most Ethical Company for the 11th year in a row, an outstanding achievement on its own and a testament to our nearly 40,000 As you can tell, I'm extremely proud of how the team performed during the quarter. So let me give you some more detail on our Q1 brokerage segment performance. During the quarter, reported revenue growth was 32%. Of that, 9.6 percent was organic, which is just excellent. Rollover revenues of $380,000,000 were pretty Consistent with our March IR Day expectations and mostly driven by the December reinsurance brokerage acquisition.

Speaker 2

Doug will have some further comments on rollover revenues in his prepared remarks. Net earnings growth was 27%. Adjusted EBITDA growth was 35% and we expanded our adjusted EBITDA margin by about 50 basis points, An outstanding all around quarter for the brokerage team. Let me walk you around the world and break down the 9.6% organic, Starting with our PC operations. 1st, our domestic retail business posted 11% organic driven by terrific new business, Strong retention and continued renewal premium increases.

Speaker 2

Risk placement services, our domestic wholesale operations Posted organic of 10%. This includes more than 20% organic in open brokerage and 6% organic in our MGA programs and binding businesses. New business was better than Q1 2021 levels and retention was consistent with prior year. Outside the U. S, our U.

Speaker 2

K. Business posted organic of 14%. Within retail, fantastic new business and continued renewal premium increases helped drive 10% organic. And our London Specialty business, including our legacy Gallagheri operations, saw 17% organic. Australia and New Zealand combined organic was nearly 10%, driven by strong new business, stable retention and higher renewal premium increases.

Speaker 2

And finally, Canada was up more than 12% organically and continues to benefit from renewal premium increases and great new business production. Moving to our employee benefit brokerage and consulting business. 1st quarter organic was up over 7%, more than a point better than our March IR Day Our core health and welfare organic was in line with our expectations of 5% and the Sight in the quarter was driven by our international operations and our HR consulting, pharmacy benefits and various other life insurance product sales. So 7% organic in benefits, 11% organic within our PC operations, an excellent quarter. Next, I'd like to make a few comments on the PC market.

Speaker 2

Overall, global first quarter renewal premium increases were 8%, consistent with the Q4 of 2021 after controlling for line of coverage mix differences. Recall the renewal premium change includes both rate and exposure, so let me break that down around the world. About 10% in U. S. Retail, including double digit increases in property, professional liability and casualty, somewhat offset by workers' comp and commercial auto.

Speaker 2

In Canada and New Zealand, renewal premiums were up about 8.5% with professional liability seeing the strongest increases. In Australia and UK Retail, renewal premiums were up mid single digits, driven by increases in casualty and package. Within RPS, wholesale open brokerage premium increases were up 11% and binding operations were up 6%. And in our London Specialty business, we saw 1st quarter rate increases around 7.5%. Moving to reinsurance.

Speaker 2

As we noted in January, our oneone renewals showed price increases that varied by geography and client loss experience. And while rate tended to be based on client Specific attributes and loss history, even loss free programs faced modest rate increases. Our April Gallagher Re First review report is more focused on Japanese renewals, which tend to dominate the April 1 renewal season. We saw pricing increases in property related classes, while casualty pricing was flattish despite inflation being a key topic of discussion. You can access our April reinsurance market report on our website for more information.

Speaker 2

So whether retail, wholesale or reinsurance, Premiums are still increasing almost everywhere. Looking forward, we expect our mix shift away from workers' compensation renewals in Q1 The U. S. Property cat renewals in Q2 will lead to premium increases in the Q2 very similar to full year 2021. We see these difficult PC market conditions continuing throughout the remainder of this year.

Speaker 2

Carriers will likely continue their cautious underwriting Stands due to rising loss costs and increases in reinsurance pricing. This comes at a time when the conflict in Ukraine is elevating geopolitical uncertainty, Courts are reopening and global monetary policy is tightening. So from our seat, it looks like carriers will continue to push for rate and don't see a dramatic change in the near term. Moving to our employee benefit brokerage and consulting business, I see domestic labor market Conditions in 2022 working in our favor. There are more than 11,000,000 job openings in the U.

Speaker 2

S. That's 5,000,000 more jobs available than people unemployed and looking for work. And that imbalance Lays the groundwork for robust demand for our HR and benefits consulting services as employers look to attract, Retain and motivate their workforce. So we finished first quarter with organic of 9.6%. Given our Q1 result and the current insurance market conditions, as we sit here today, we think 2022 organic Should end up even better than 2021.

Speaker 2

Moving on to mergers and acquisitions, starting with some comments on our recent reinsurance acquisition. Integration is progressing at a fast pace and is ahead of schedule. Alongside the speed that we are The pull forward of some of the future integration costs, which Doug will cover in his remarks. Also, we had a strong first Quarter with the legacy Gallagaree team growing 30% and our new reinsurance operations delivering towards $340,000,000 of revenue and over $170,000,000 in EBITDA and our reinsurance colleagues are melding together extremely well. So it continues to be a really good story.

Speaker 2

During the Q1, we completed 5 new tuck in brokerage mergers representing about $32,000,000 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 around 40 term sheets signed or being Prepared representing nearly $250,000,000 of annualized revenue. We know not all of these will close. However, we believe we will get our fair share.

Speaker 2

Next, I'd like to move to our Risk Management segment, Gallagher Bassett. 1st quarter organic growth was 15.2% better than our IR day expectation due to a strong March, some new business wins and higher than expected COVID claims. Adjusted EBITDA margin was 17.3% and would have been 18.5%, but we had a litigation settlement late in the quarter. Moving forward, we think the remaining 22 quarterly margins will be closer to our 19% expectation. We again saw increases in new arising claims across general liability, property and to a lesser extent core workers' compensation during the quarter.

Speaker 2

New arising COVID claims were well above what we saw during the Q4. However, core claim counts, which tend to have a greater impact on results, still have room to rebound fully to pre COVID levels. Looking forward, we see ample opportunity for organic revenue growth from existing clients, Growing claim counts and new business and expect organic to be around 10% per quarter for the remainder of the year. And let me finish with some thoughts on our Bedrock culture. I believe our outstanding financial results As I mentioned earlier, we were once again named a World's Most Ethical Company by Ethisphere, a truly global effort that reflects our colleagues' care and integrity to each other and our clients.

Speaker 2

Every day, I hear stories of our colleagues working together as one team to give our clients exactly what they need all around the world. That collaboration is possible because we genuinely want to deliver the best Possible service at all times. When one team wins, we all win. And then there's the way our people give back to their communities. In March, we announced a special matching donation to provide humanitarian relief to the people of Ukraine.

Speaker 2

Thanks to the generosity of my Gallagher colleagues, We're able to donate over $1,000,000 for necessities like food, water, supplies and first aid. I'm proud to stand together with my Gallagher colleagues Okay. I'll stop now and turn it over to Doug. Doug? Thanks,

Speaker 3

Pat, and hello, everyone. As Pat said, a fantastic Q1 and start to the year. Today, I'll get to my And I'll also do a financial recap of the Willis Re acquisition. But first, the modeling heads up regarding rollover revenues this quarter. We typically don't comment on consensus estimates, But this quarter looks like there is a large variance in brokerage segment rollover revenues relative to the guidance numbers we provided within our CFO commentary document during our March 16th IR Day.

Speaker 3

When we get to Page 6 of today's CFO commentary document, You'll see we've added a table that shows consensus overstates rollover revenues by approximately $40,000,000 versus the number we provided in March. That has an impact of overstating consensus EPS by $0.06 We hope you take this into consideration as you analyze our performance relative Okay. With that housekeeping behind us, let's shift to the earnings release to the brokerage segment organic table on Page 3. All in brokerage organic of 9.6 percent. We had a really strong finish to the quarter.

Speaker 3

Some nice new business wins by the P and C team and a terrific finished by our benefits consulting teams. You'll also see strong growth in both contingents and supplementals. The Ukraine Russia conflict Impact was small, about $5,000,000 of revenue, which is about a $0.01 hit this quarter. Looking forward, It's looking like it's small also, maybe another $5,000,000 revenue impact spread over the next three quarters. Given our strong start and given our current favorable outlook of the market as Pat discussed, we could be pushing nicely towards upper 8% to 9% Full year organic growth here in 2022.

Speaker 3

Next, let's turn to Page 5 to the brokerage segment adjusted EBITDAC margin table. Headline all in adjusted margin expansion for Q1 was 49 basis points, right in line with our March IR day expectation. Recall that expansion includes a favorable seasonal impact from reinsurance roll in offset in part by a return of expenses that we come out of the pandemic And it also has a little more incentive compensation given our stronger Q1 organic growth and full year expectations. Repeating what we said during March, we are well positioned to deliver around 10 to 20 basis points of full year adjusted margin expansion. But remember, as we discussed, here in 2022, there'll be margin change volatility quarter to quarter.

Speaker 3

That's due to expenses returning as we come out of the pandemic and the rolling impact of acquired reinsurance revenues. So let me walk through what we said in March. 50 basis points of expansion here in the Q1, then expecting second and third quarter margins to each be down around 100 basis points, But then that flips and we expect 4th quarter margins to be up around 100 basis points. The math given that we are seasonally larger in the Q1 Gets us back to that 10 to 20 basis points of full year margin expansion. Looking way out towards 2023, that quarterly margins Change volatility should go away with the pandemic behind us and reinsurance fully in our book.

Speaker 3

Okay. Let's move on to the risk management segment and the organic Table on the bottom of Page 5. You'll see 15.2% organic in the Q1. That's just terrific by the team. And with continued strong new business and rebounding claim counts, it's looking like organic revenue growth of about 10% each quarter for the rest of 2022.

Speaker 3

On the next page, you'll see that our risk management segment posted adjusted EBITDAC margin of 17.3%. That was compressed by about 120 basis points due to an unusual late quarter litigation settlement. As Pat said, moving forward, we would expect margins for the remainder of 2022 to be closer to 19%. Moving to Page 7 of the earnings release and the corporate segment shortcut table. Most adjusted Q1 items were in line with our March IR Day estimates.

Speaker 3

Within the corporate line, we did also benefit from an FX remeasurement gain and a larger tax benefit related to employee stock option Given the strong performance of our stock late in the quarter. You'll also see a couple of non GAAP adjustments. The first relates to transaction costs and professional fees associated with buying Willis Re. And the second was a state tax benefit related to the revaluation of our deferred income tax balances. All right.

Speaker 3

Let's now go to the CFO commentary document. Page 3 has our typical brokerage and risk management modeling helpers. We've updated our outlook for integration. I'll get to that more in a minute. We've updated FX and you'll see a slight tick up in our expected brokerage segment tax rate, call it 0.5 percentage point.

Speaker 3

In addition, the amortization lines in both brokerage and risk management are now highlighted in yellow. This means the item is now being treated as a non GAAP adjustment. If you missed our March IR day, we did a vignette on how this change and how we are on this change and how we're reporting adjusted EPS. This is the Q1 reporting under that revised method. On Page 4 of the CFO commentary, that's our corporate segment outlook.

Speaker 3

You'll see there is no change in our outlook for 2nd, 3rd and 4th quarters. When you turn to Page 5 to Clean Energy, the purpose of this page is to highlight that we have over $1,000,000,000 of credit carry forwards and we are now in the cash harvesting era of these investments. There's no GAAP earnings anymore other than a little bit of overhead expense, but rather now substantial cash flows. You'll see in the pinkish column that the 22 cash flow increase should be substantial. We should be able to harvest $125,000,000 to $150,000,000 a year of cash flows and perhaps more in 2023 and beyond.

Speaker 3

At that rate, a really nice 7 year cash flow sweetener. And there still is a possibility of an extension in the law, So we remain well positioned to restart production if that happens. Okay. Flipping to Page 6 of the CFO commentary document. Top table is the rollover revenue table.

Speaker 3

Recall that we update this each earnings release day and also each quarter during our late quarter IR meetings. The next box highlighted in yellow is the math behind the $0.06 impact of consensus versus our March guidance that I touched on in my opening. Then at the bottom table is an update on our December reinsurance acquisition. Revenue this quarter was $337,000,000 and EBITDAC $172,000,000 The very small difference to the numbers we provided during our March IR Day reflects 2 items. First, the quarterly timing related to further refinement in our ASC 606 accounting for both revenue expense And second, some further movement in FX rates.

Speaker 3

In the end, if you go all the way back to our original August 2021 projections, There is very little change to our 1st year of ownership expectations other than a small impact from Russia, Ukraine and FX. As for integration, the good news is that our original estimate of around a total of $250,000,000 for integration charges through the end of 2024 as holding close. Even better news is we're making progress at a faster pace than we originally thought. Integration efforts around people, real estate, back office transition services, etcetera are targeted to be mostly done by late 2022 versus mid to late 2023 as originally planned. When it comes to technology rebuilds, we think most of it will be done by the end of 20 20 3 or early 2024.

Speaker 3

So what that means is that we will see integration costs lumped more into 2022 and 2023 then spreading deep into 2024. You'll see the bump up of our 2022 quarterly integration estimates back on Page 3 of the CFO commentary, But it's important to remember it isn't changing our in total view. So that continues to be a really good story. As for cash, capital management and future M and A, at March 31, available cash on hand was about $450,000,000 and no outstanding borrowing on our line of credit. With strong operating cash flows expected in 2022 and a nice bump in cash flow from our clean energy investments, We are extremely well positioned to fund future tuck in M and A using cash and debt.

Speaker 3

We continue to see our M and A capacity at more than $4,000,000,000 through the end of 2023 without using any stock. So those are my comments. We're off to a great start in 20 22. Back to you, Pat.

Speaker 2

Thank you, Doug. Daryl, I think we're ready to open up for questions, please.

Operator

Thank you. The call is now open for questions. Our first question comes from the line of Paul Dusan with Piper Sandler. Please proceed with your questions.

Speaker 4

Good morning. Congratulations good afternoon, pardon me. Congratulations on the quarter. I was going to ask about the guidance for organic growth is at a deceleration pace. Maybe you could talk about sort of the factors that go into what might be decelerating prospectively from a macro basis that's having an effect on your business.

Speaker 3

Well, listen, I think we posted 9.6% this quarter and I think that we're guiding upper 8% to 9%. I wouldn't call that a deceleration. I think There's a reality looking towards where we were in 3rd Q4 as the compares get a little more difficult to have. But I don't know if I'd

Speaker 2

Well, in fact, Paul, we looked at the stats before this call. And over the last eight quarters, The renewal rates across our book, including, I should add, the exposure units About flat around 8.5% to 9%. So I mean it varies up to 9%, 9.5% it comes down to 8%, but I would say any kind of a wholesale drop off is not what we're seeing to Doug's point.

Speaker 5

My

Speaker 4

second question is to interest rates. We're finally seeing some rising interest rates. I was wondering what your thoughts are on how that affects your earnings as well as frankly M and A. I wonder if we'll see Any change in the competitive environment for M and A with interest rate changing as well. So I guess that's I was sneaking in essentially two questions.

Speaker 3

Right. Let me take the investment income for our fiduciary funds that we keep on hand. We would think that a one point rise And interest rates would be about another $40,000,000 a year of investment income versus what we've been showing so far. That might tick up a little bit more as we get reinsurance completely rolled into our books. In terms of What that means in terms of other pressures inside of our organization, we're just not all that sensitive Interest rates internally in our operating model.

Speaker 2

But we do know, Paul, I mean, let's face it, a lot of the competition from our Private Equity Competitors for Acquisitions has been driven by free money. And if they got to start paying for it, I think that bodes well for us.

Speaker 4

That makes sense. You haven't seen any of that yet. I've seen it's just too soon With interest rate change in mind.

Speaker 2

No, gosh. No, we haven't seen anything.

Speaker 4

Great. Thanks, guys. Appreciate the help.

Speaker 3

Thanks, Paul.

Speaker 5

Thank

Operator

you. Our next question is from the line of Mark Hughes with Truist. Please proceed with your question.

Speaker 2

Mark.

Speaker 1

Yes. Hello, Pat. Good afternoon. Did you give the margin and brokerage if you back out Will it 3, I suppose you've given us the inputs, but do you have that handy, Doug?

Speaker 3

I can take it out here for you here in a second.

Speaker 2

We've got it at the table somewhere, Mark. You have another question?

Speaker 1

Yes. Pat, you talked about Risk management being helped by an uptick in GL Property Workers' Comp claims, anything you see in either GL or comp that Influences your view of what's going to happen in terms of the cycle if in fact courts are opening and you're seeing the pickup in GL, does that Tell you anything or

Speaker 3

is there

Speaker 2

2 things? Well, there's 2 things I'd comment on, Mark, really. One is it's been in very interesting hard market. And as you know, looking over the past what is now almost 4 years, comp hasn't moved. COP has not been a big rate driver up and it's not coming down.

Speaker 2

So it's been an interesting line. And as the economy becomes more robust and frankly when we pick up when we start to fill some of those 11,000,000 jobs, I think that the natural increase in claim activity is going to really benefit Gallagher Bassett. We clearly can track back That when our economy is humming, it's just a natural outcome. You don't like to see people get hurt, but we have more claim volume. That's number 1.

Speaker 2

Number 2, What I continue to be astounded by and I'm sure everybody on this call reads it every week as well. When I look at our social inflation around Tort, It's incredible. And so I think what you're seeing is number 1 case settlements at levels that never Any of us would have predicted, but also what that does is it drives our clients to be much more cautious and concerned about claims that frankly in the past They might have said, pay the $50, let's move on or let's not settle that. It doesn't look like that big a deal. Not to get anecdotal on you all, but it is late in the evening and you probably saw the settlement last week for some guy got $450,000 Because this company threw a surprise party for him.

Speaker 2

I mean, I keep asking the folks for a surprise party. But it's just it's So that I do think is beneficial to GB and GB continues to invest and I think capable of proving That if in fact you use our services with all that we bring to the table, our outcomes are better. So all of a sudden, if you're used to getting a lot of claims, but one of them every 5 years tends to pop and now you're looking at it, you go, man, oh man, what's happening? I'm starting to get 2 a year, 3 year. Now who pays those claims makes a bigger and bigger difference and I think that bodes well for the long term.

Speaker 3

Mark, Mark, I can

Speaker 2

give you the answer

Speaker 5

to the market.

Speaker 3

If you want to follow-up with that, then I'll come back to

Speaker 5

that. Okay.

Speaker 1

I was just going to ask on the June 1 Reinsurance renewals, so what kind of rate increases are you seeing? How much dislocation there is in Kent property?

Speaker 2

Really, not that much dislocation on the reinsurance side. And I would say back to my prepared remarks, Depending on the carrier, depending on the carrier's experience, that's what's driving the renewals. Okay. And Doug, go ahead.

Speaker 3

Yes. On the margin, Mark, we will be somewhere around high 37% margins in the brokerage Business without Willis Re. And there is some variability around that because of allocations between the units, right? Second of all, I just think that when in the context of margin as you're looking at what's changed since last year. This quarter, I know that we're ahead on our bonus accrual relative to where we were last year because we started off We are with considerably better organic growth, so that has a little bit of a margin compression impact, but I would consider that timing.

Speaker 3

We are in the Q1 and recall we give our raises out mid year. So raise impact rolling in versus Q1 As organic develops throughout the year, you grow into your raises. And then when it comes back to cost returning into the business. So if you break it down, let's say that expenses year over year on an apples to apples basis are $25,000,000 up, dollars 10,000,000 of that's bonus. You probably can call it $6,000,000 is raise impact and then you get down About $8,000,000 left over.

Speaker 3

That's probably take a third of that and call it increased professional fees that we're spending, a third of that would be T and E travel and a third of that would The client entertainment. So when you look at the pieces of being up, let's say $25,000,000 of expenses year over year, the way we look at it, Call it, 10 of it's timing and 15 of spread between raises that we'll work ourselves into for the year and then the other piece of it, T and E entertainment and some professional fees. Does that help?

Speaker 1

Yes. Appreciate the detail.

Speaker 3

Yes. And let me throw in too is that we're I went back while you're doing that. I looked at in Q1 of 2019, We posted 35. This is where the supplement really helps that we post not the CFO commentary, but the 5 year supplement we put out there. We posted 35.6 percent EBITDAC margin in Q1 of 2019.

Speaker 3

And this quarter in the brokerage segment, we're at 39.8s were up 4 20 basis points. If we hit our target this year of being up 10 basis points to 20 basis points for full year, We'd be up 5.40 basis points over 2019. So that's 180 basis points Margin expansion a year over the last 3 years, each year 180 basis points. And truthfully, our reinsurance business is rolling in While seasonally a little better this quarter, when you put full year in, it's not all that different than our combined brokerage operation margins. So the margin story is we believe is pretty darn good.

Speaker 3

And when we're running somewhere around 34 points of margin for full year if we hit our targets this year. That's pretty darn good versus the 28% and change in 2019.

Speaker 1

Appreciate it.

Speaker 2

Thanks, Mark.

Operator

Thank you. Our next questions come from the line of Greg Peters With Raymond James, please proceed with your questions. Hey, Greg.

Speaker 6

Hey, good afternoon, everyone. I can say listening to your comments, Pat, that I'm sure a number of us, myself included, would take a piece of the action on your surprise party. Keep us in mind. So, hey, I guess, From a macro perspective, I'm going to come at Paul tried to ask a question and I'm going to come at it from a different way. I know You've mapped out a pretty robust outlook for the remainder of the year.

Speaker 6

There are a number of economists and other reports out there that are Speculating about the potential oncoming of a recession. And obviously, the data is not showing it yet, at least your data isn't. But I'm just curious from an enterprise risk management perspective, when you think about that type of risk, what are you doing at the corporate level to prepare for something like that if you think that might be in the cards.

Speaker 2

Well, first of all, Mark or Craig, I'm not going to sit here and predict a recession. Unfortunately, we've lived through them before. And I think we do know how to react to those. And when you're in a recession, a couple of things happen that are very, very negative. Exposure units drop, companies go broke, expenses become even more important, not that they're ever Not important and shopping can go up.

Speaker 2

Now when shopping goes up for our strength in particular in the middle Good. I think we show well, so we hold our own there. But when you've got a robust economy falling off, you end up with negative audits And you've got lesser exposure units. And depending on the depth of that recession, it's not a pretty picture. So when you talk about what are we doing relative to Our risk management approach, we talk about it every quarter.

Speaker 2

We take a look at where we are. We've got Significant margins and we're prepared to say here's what we have to do to make sure that And on the one of the things I really like about our model is we basically pay our production force on how their book of business performs. So we're all in this together and if it's if the business is sinking. Now in previous recessions, If I don't go back too far, we've not had the benefit of inflation. So inflation may in fact help Cause a recession and I don't know whether that will be a point, 2 points.

Speaker 2

I know the Q1 GDP was down. But if you're talking 5% to 8% inflation, that has the exact opposite impact. As you know, Payrolls go up. We're all seeing that. I mean, I can't go a day without somebody stopping me and saying, we're getting whacked.

Speaker 2

I've got a mid level Service person and it's a problem and what am I going to do about it and every customer is coming to Bill Zabel's team and saying how am I going to hold on to my people, everybody wants them. You go to a restaurant, they don't have people that can serve you. I mean, there's just huge demand and that's pushing payrolls up. And our contractors book, they bid everything out. Now they got to deliver at inflation rates they never anticipated when they made the bid.

Speaker 2

Well, if there's other business to bid, those rates are going up, so sales will go up. So there's offsetting factors there and I think our business holds up pretty darn well in

Speaker 3

Yes. So a couple of things. We look at daily endorsements, cancellations audits. We get that as a daily feed. And this was the biggest month of positive audits that we've seen.

Speaker 3

And again, that's a historical that's a rearview mirror metric, I'm not seeing that trail off at all. So I'm not seeing any early signs of a recession happen because the first thing a customer will do is They'll bring up the phone and they'll adjust their expected payrolls down. So we're not seeing that. We're not seeing it in our exposure unit and our rate Monitoring that we look at renewals every day also. So we're just not seeing it happen.

Speaker 3

But what we've proven Throughout the COVID is that we've got a pretty resilient model that we have a lot of levers to pull, should we get into a situation where growth becomes More difficult. And I think that we've proven we can do that. So we think the model is resilient. We think that inflation is going to help us on Top line when it comes to revenues for the business that's there. But we do have levers that we can pull in order to help us get through a recession.

Speaker 2

Well, and also let me remind you back in 2007, 2008, 2009, 2009, and this is just an incredible support of this bottle again. You'd think, oh my god, it's going to be true. Our clients will stop paying their people before they stop paying their insurance bill. That's how important we are to them. That's a good spot to be.

Speaker 6

Indeed. Thanks for the color on that. Pivot to perhaps a little bit more detailed question. And Doug, Your guidance and commentary on the various parts and your CFO commentary quite helpful. And I guess what I wanted to ask about was the free cash flow excluding clean energy, Because you talked about the integration expense and some other things.

Speaker 6

I'm just wondering what you think the cadence of that looks like now For 2022, has there been a change versus previous expectations? And how you would suggest we look at that?

Speaker 3

All right. Let's see if I can break it down. Let's start with $4,000,000,000 that we have left over for M and A in 2022 and 2023. Cash Clean Energy provides $250,000,000 of Integration is already net in that number, all right. So I've already given you a number net of integration.

Speaker 3

Also when we talk about integration, you've got to look at it as half of it being non cash and half of it being cash. You recall that integration expenses are the sign up bonuses that we delivered in mostly, equity plans. So that's amortizing as a non cash item against that. So I would say that integration won't consume an excessive amount of cash. I would say that the clean energy maybe you think about it this way, the clean energy basically offsets the cash portion of that And all that has all washed out in our $4,000,000,000 expectation for M and A over the during 2022 and 2023.

Speaker 3

Does that help you give a thought on it?

Speaker 6

It does. I know you've given me similar answers like that in the past. It feels like that should be your voicemail, but thanks. Thanks for reminding me of all that pieces there.

Speaker 3

Yes. Listen, it generates a lot of cash. Like I say around here, I don't make the money, I just count it and there's a lot of it coming in.

Speaker 6

Got it. Thanks guys for the answers.

Speaker 2

Thanks, Greg.

Operator

Thank you. Our next questions come from the line of Elyse Greenspan with Wells Fargo. Please proceed with your question.

Speaker 2

Hi, Elyse.

Speaker 7

Hi, thanks. Good evening. Maybe my first question is kind of going back to the earlier discussion on organic. Pat, when you give us the initial Outlook for 2022, you had said that the full year would be about 1% above the Q1. So is it just that the and I think that was maybe based off of the benefits business perhaps being a little lighter and heavier in concentration in the Q1.

Speaker 7

But Is there something that changed or is there just I understand that the rest of the year outlook is close to the Q1. Is there something that perhaps Cause that view to change or is it just that just as simple as the Q1 being better than you expected when you made that comment?

Speaker 2

I'll let Doug Answer the actual number piece on that because a lot of that's mathematical. But in terms of what I'm seeing for the year, I'm not seeing I'm not anticipating significant change in the operating environment over the next 3 quarters.

Speaker 3

Yes. I think that our cautious guidance in January and then again in March, really was talking about The fact that you're not we're not getting rate lift from workers' comp, which is heavier in the Q1 and then also, You're not really seeing rate and benefits yet. Now it's interesting since that guidance, There is medical inflation that's coming back fast and furious. And I think that give us another quarter on that and might become a little bit more bullish because I think that and of course that will eventually translate into workers' comp to absent frequency Declining or holding in there. But I think our cautiousness on the benefits business might have been overly cautious.

Speaker 3

But again, we just need to Another quarter of that before I we get into a position of declaring that there's true medical inflation that's going to affect next Cheers, grow too. But I don't see it as a headwind. I see it as a tailwind or organic.

Speaker 7

Great. And then my second question, You guys have mentioned having around $4,000,000,000 of capital over the next couple of years to spend on M and A. The tuck ins, right, were just around $30,000,000 this quarter. So maybe a little bit light relative to some historical averages. So as we think about just kind of deal flows, it sounds like interest rates could impact private equity interest, so maybe that helps with the pipeline.

Speaker 7

Is there a certain point and maybe we have to wait till next year where if deals don't materialize, since that's a pretty high level of capital, Gallagher might consider using some buybacks as well with the excess capital?

Speaker 3

I think an answer to that is yes, let's clarify. I think that Q1 is already seasonally the smallest when it comes to M and A. It's historically been that 5 out of the last 6 years. So I think that there's just a natural little push towards year end and then there's a little pause in the Q1. So I think there could be a rebound in opportunities through the rest of the year.

Speaker 3

If those rebounds don't materialize and we're not seeing opportunities for it, then our next place that we would go is to make sure that our debt is clearly within a solid investment grade rating and then use it for stock buybacks next And then maybe even consideration on the dividend. So those are the 3 or 4 things that we're seeing. How's deal flow look? Next thing is what do we do with the excess cash if the

Speaker 7

Okay. And one last one on Willis Re. I recognize the revenue was close to what you guys had laid out at the Investor Day. Can you give us a sense of just client retention and new business and how that's been trending in your 1st full quarter of owning the business?

Speaker 2

Yes, I will do that, please. It's really been an amazing and let's remember as we finished the quarter, we're 4 months in. So as we have this call, we're close to 5 months. But I will tell you that the team, we are not losing people, we are not losing clients. Our renewals have been fantastic.

Speaker 2

Tom, myself, others at the table I've had a chance to meet with reinsurance clients. They continue to be very open about the fact that they're glad That there are there's not one less competitor in the marketplace. They're also very clear with us that the reason That the business held together over the years of discussion as to where this business was going to land is because of the people handling their business And those people are still in place. Our losses in terms of people out the door are minimal to 0. And so when I look at it, I'm really, really happy about it.

Speaker 2

And new business pipeline is strong. What I'm Very excited about is the integration that we're seeing or the sharing of information from our retail. Everybody said at the beginning, why is this good for retail? And people also would ask, why does reinsurance care what you're doing as a retailer? Well, I'll tell you what, there is so much going back and forth right now in Terms of data relative to the business we're doing with all kinds of carriers with things that our reinsurance people are seeing can help our retailers And they're melding.

Speaker 2

So the business is strong. We are absolutely nailing it when it comes to what we hope the pro form a would be. And I think it's going to continue to just be a great business for us.

Speaker 3

Yes. I can give you some numbers behind that flavor is that and I'll give it to you Is net new? Our net new was over 5% this quarter if you control for those people that Put on a different jersey before we bought it. And our overall organic is nicely, let's call it 8% first quarter plus or minus a point. So organic really, I got to give it to the team for what they went through for 3 years for them to be out there, battling the way they have holding Clients writing new business, I mean, it's really a terrific, terrific story.

Speaker 3

So when you're Posting organic nicely in that upper single digits after what they've been through, I couldn't be more pleased with the team.

Speaker 7

Great. Thanks for all the color.

Speaker 2

Thanks, Elyse.

Operator

Thank you. Our next question comes from the line of David Motemaden with Evercore. Please proceed with your questions.

Speaker 8

Hi, David. Hi, David. Hi, good evening. How is it going guys? Great.

Speaker 8

So great to hear the outlook on organic in the brokerage segment, But obviously still keeping the 10 to 20 basis points full year margin expansion outlook. I guess I'm wondering, it definitely sounds like it's a bit more Positive on the organic growth side. So I guess I'm wondering why I guess we're not expecting or why you guys aren't expecting more margin improvement than the 10 to 20 basis points. Is it additional investments that you're making? Is it the bonus accruals?

Speaker 8

Is it something in addition? I think you had called out $60,000,000 of Incremental costs coming back in this year, is that higher now that sort of keeps it at 10 to 20 basis points of margin expansion?

Speaker 3

Yes. I think that we're just a little reluctant right now to push that up when it really comes down to it. I think that there's a lot of things that we'd really like to do. And I'll segue into some The exciting stuff. When you look at what's going on with and you listen to our March our mid our late quarter IR days, we talk about all the great things When you look at what's going on with our electronic delivery platform, when you're looking at the automation that we're doing That we're writing 6,000 policies a month with hardly anybody involved on cyber, the Gallagher Drive, The Advantage Programs, the smart market, then you look at the advertising and the brand building that we're doing and spending money on that Systems, we're spending money on hardening the environment and delivering more point of sale capabilities to the sales force.

Speaker 3

When you look at all those things posting another 10, 20, 30 basis of margin expansion on top of already Posting 540 basis points of expansion since 2019, I think we'd just like to spend a little money this year. When you get to 2023, as a lot of this levelizes between the pandemic and between and the roll in of the reinsurance M and A. You might see a little bit more expansion in that if we're still posted in that 9% range. But right now, this is a great opportunity for us to invest in the future organic growth of the company. So that's where we are on it.

Speaker 3

You want to pull that voluntary spend, call it voluntary spend, but it's not a must spend.

Speaker 8

No, no, it makes sense. No, that makes sense. And I guess just maybe, It sounded like the international business did quite well in the Q1. So I guess I'm wondering, Pat, Just specifically, could you just talk about what you're seeing on the ground in Europe and in the U. K?

Speaker 8

If there's any sign Of any wobbles there in terms of exposure growth or demand, as I think some of the leading indicators are pointing towards economic Slow down there.

Speaker 2

Well, let me go around the world again as I did in my prepared remarks. Let me take a look at what we're seeing in Canada and it's Our team in terms of new business is on fire. When we closed on Neuraxxus years ago and the Canadian economy was a little Flush record was a little slow. We weren't together with Nuraxxus was 7 separate businesses kind of operating separately. Now that business Totally together.

Speaker 2

The Gallagher branding is working extremely well. People are pumped up. We're using Salesforce. Our pipeline is growing and the 10% organic, Yes, it's helped by rate, but new business is much better than it's ever been. When you go to the U.

Speaker 2

K, that same timeframe, we Added new we recall we bought Heath, Lambert, Giles, etcetera. Again, a lot of time on integration. Today, We'll do an acquisition of Seys in the UK and frankly we've got that thing integrated in 5 to 7 months and they are putting on a Gallagher jersey, they're excited about it And our team just gets stronger and stronger there. Now I can't tell you that economic events aren't going to impact us. Recessions are terrible.

Speaker 2

They're bad for our clients, they're bad for us, and they're bad for our business. But I'll tell you that where we are from a team perspective is fantastic. So you're right to look The numbers and say it seems like international is doing really well because as we walked around the world and told you the organic, they're just they're killing it everywhere. Latin America is Strong, New Zealand is strong, Australia is strong and all of that is not just rate driven. That's the thing I want to make sure everybody realizes is It's not just because rates are moving.

Speaker 2

We are getting our fair share of our new business opportunities. And in fact, we're seeing hit ratios improve And we're being helped by our clients' business expansions and just blocking and tackling. So it's a very good spot to be.

Speaker 3

Yes. I can't predict the trickle on effect, but remember we're primarily in the UK. We do have inflow from the rest of Europe, not heavily based in by any means in Eastern Europe. So we don't have that. And I think at one point we looked at and our inflows from Europe might have been in that $40,000,000 range in total revenues.

Speaker 3

So if you think about it in the context of what it means to Gallagher, if all of Europe would stop sending any business to London. It's $50,000,000 of lost revenue to us. And pushing $8,000,000,000 of revenue as a total organization, we'd feel it, but it wouldn't register at all.

Speaker 2

David, I think it's fair to say too. What we've done in the United States in terms of the things you've seen here, Smart Market, Gallagher Drive, Those things are impacting our new business with carriers, our retention and clearly our new business So hit ratios using smart market. We're taking those internationally now. So that was born and bred here in the U. S, But those are our products that are going to be available in Canada and the U.

Speaker 2

K. To start and they're difference makers. And really remember when we compete and this is one of the things about again kind of being in a lucky spot. 90% of the time when our people go out the door to compete, Story. But every other time when I talk to our sales force, I think we should win.

Speaker 2

We don't obviously, but I think that's having an impact. Yes. Our people go out the door thinking they're going to win, I'll tell you that. Yes,

Speaker 8

yes. It definitely looks like you guys are getting your fair share of wins. And I know in the past, You've broken out the brokerage organic in terms of drivers by exposure, pricing and net new. I think in the past you said it's about a third, a third, a third. Is that changed at all this quarter?

Speaker 3

I think rates might be feeling that just a little bit more, but we probably need a little more time to peel it apart. We'll see if I can give you something and we can get back together in June on that. But right now, rates probably used to be a third, a third, a third and I think rates might More 40% than thirty-thirty something like that. Yes.

Speaker 5

Okay, great. Thank you.

Speaker 2

Thanks, David.

Operator

Thank you. Our next question comes from the line of Meyer Shields

Speaker 9

One, I guess, dumb question. When I look at Page 3 of the CFO commentary, it still anticipates a full year margin of 19% in risk management. Is that does that mean that we're going to unwind some of the Q1 underperformance or is that assuming is that based on like the 18.5 I

Speaker 3

think we'll be somewhere nicely in the 2018s for full year. So I think that if we post 3 quarters of 19%, We'll claw back into that 17.3 for this quarter. And again, we get an unusual legal settlement probably once every 4 or 5 years. So it's unfortunate it happened this quarter, but that business is really doing well.

Speaker 9

Okay. That's helpful. Second issue, and I know these are small numbers, but does the call withdrawal from Russia on the reinsurance business, does that have any impact on the earn out?

Speaker 3

Yes. It would technically have an impact if we don't reach some of our milestones in it that loss of $10,000,000 over the course of a year? Yes, that might have a it would have an impact on it.

Speaker 2

They're going to overdo That's not my prediction is it will not.

Speaker 9

Okay. Because of other businesses compensating?

Speaker 2

Correct.

Speaker 9

Okay. And then one final question on the reinsurance side. And Pat, you talked a lot about the fact that Some of the people there were under some strain over the past couple of years. Did that depress what Willettry was able to charge, is there an opportunity for revenue growth, now that simply because it's a more stable platform where you can invest in it more heavily?

Speaker 2

Well, I got to understand the question. I mean, our reinsurance clients pay us very, very well And very fairly and now a stable environment is not going to give us the ability to charge our clients. Does it give us the ability to invest more favorably? Absolutely, because you now have people and our old business is people. To be perfectly blunt, there were people who were going to join them before.

Speaker 2

Why join them in the middle of a sale? Nobody knows. And by the way, remember, I'm not making this up. It was public. I mean they couldn't tell the people at Willis, Baird, they're going to sit, who they're going to work for.

Speaker 2

That's not easy to recruit into, is it? So there's lots of opportunities to invest. There's lots of at the same time reinsurance buyers You're kind of frozen in the headlights. We want to see competition in the market. We don't want Willis frankly to disappear, We're not going to build the problem bigger.

Speaker 2

So yes, there's opportunities for us to go back to those clients and say, hey, We think we've got something to tell you now. So I think once it settles down and we all get Again, 4 months into the quarter, 5 months in total, a year from now, I'll have a much better feel for the individuals.

Speaker 3

Yes, I'll add to it. The thirst for information from our reinsurance Partners is there. And if we can bring them the information that they're looking for, That maybe they haven't been able to get in the past. I believe that that will help them Attract more new clients and perhaps broaden out the book of business they're doing with their existing clients. I do believe that our ability to provide Real time data like we do for our retail business to them be a compelling advantage for them in the marketplace.

Speaker 9

Okay. That was very helpful. Thank you so much.

Speaker 3

Thanks, Aaron.

Operator

Thank you. Our final questions come from the line of Weston Blumer with UBS. Please proceed with your questions.

Speaker 2

Weston?

Speaker 5

All right. Thanks for taking my questions. My first one is just a follow-up on the investments that you guys described around the systems and point of sales. Yes. What's the pipeline and timing for that?

Speaker 5

Does that extend into 2023? And just curious because in 2023, can we go back to a world where The pre pandemic commentary was we expand margins if organic is over 4%. Is that baseline potentially still the same or could it be lower given the higher investments that you're making? We recognize that the 34% and 19% margins are still impressive, but curious how to think about that in 2023?

Speaker 3

Well, some other things I'd like to say about it. So we've been investing in these technologies all along the way. So when we're talking about investing another $3,000,000 or 4 dollars a quarter. I mean, this is a smart market advantage, better works, 360, all the things that we're doing, we're continuing to invest in them and we really didn't slow that down much. It's the incremental spend, Adam, to make them even better and more competitive.

Speaker 3

That's what we want to do. I mean, if you looked at our GB GO, I'm just talking to risk management right now. What they can do to adjust a claim on your phone with you, track it, monitor it, help you get back to work. It's impressive. So these are the type of enhancements that we have on the table.

Speaker 3

How do we make that better? How do we make Gallagher Drive Better. Right now RPS has 24 different products on their quote and buying system that's basically a no touch system. We're doing 6,000 policies a month. What happens if we took that out to 48 policies?

Speaker 3

And our investment spend on that illustratively is about $2,000,000 a year. What if we could get 48 different lines of cover on that and then go to 72 and then go to 100. It's those are the type of incremental investments that we'd like to make because I think they're powerful. I say this all the time. What we're doing on the RPS automation Side alone is a $1,000,000,000 business.

Speaker 3

And I think that we'd like to do that across 20 different things inside of the company. So where are margins going to be in 2023? We're going to I think that we're going to be over the Turn of expenses from the pandemic, the real question is how much are we going to spend on investment on that. But it would stand to reason that if we post at least 4% organic growth, There'll be opportunities to expand on that.

Speaker 5

Got it. That's helpful color. And then My second question is to follow-up to Elyse's on M and A. I just want to clarify, was all of the term sheet Disclosure, is all of that seasonal or is there any of that strategic around Willis Re? The reason I'm asking is I'm trying to frame the Potential for maybe a pickup in that number in the second half as you annualize the deal?

Speaker 2

No, The numbers we were talking about in the pipeline in our prepared remarks are totally outside of Willis Re. Willis Re is Right. What I

Speaker 5

meant was is the pipeline what I meant is, yes, so is the pipeline potentially lighter as you focus on integrating Willis Re?

Speaker 2

No. Our retail operations have zero distraction by the Willis Re folks.

Speaker 3

And actually, we're starting to see some small little boutique reinsurance opportunities pipe up on our deals for you too already.

Speaker 5

Okay. That's great to hear. Thank you.

Speaker 2

Thanks, Weston. Thanks, Weston. Joe, I think that's all our questions for tonight. So I'd like to just say thank you again for joining us. Obviously, we had a fantastic start to 2022.

Speaker 2

I'd like to thank our colleagues around the globe for their hard work. We're a people business and our results directly reflect your efforts. Thank you. We look forward to speaking with you again at our June Investor Day, and thanks for being with us everybody.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and enjoy the rest of your day.

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Earnings Conference Call
Arthur J. Gallagher & Co. Q1 2022
00:00 / 00:00