Good afternoon, and welcome to Arthur J. Gallagher & Co.'s Second Quarter 2021 Earnings Conference Call. Participants have been placed on a listen-only mode. Today's call is being recorded. 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 security laws. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to the cautionary statement and risk factors contained in the company's 10-K, 10-Q and 8-K filings for more details on its forward-looking statements.

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 EBITDAC 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. We 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. Reported 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 EBITDAC margin expanded by 23 basis points, highlighting our continued expense discipline. Another excellent quarter from the Brokerage team.

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 of the 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 of 2020, we then adjusted that in the second quarter of 2020. So that creates a more difficult compare this year 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 EBITDAC table. You'll see that we expanded our EBITDAC 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 cost that came back this second quarter, what was the underlying margin expansion? The 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&E expenses and incentive compensation. 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 returned 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? Math 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.

Thanks Doug. Laura, I think we take some questions now.

Thank you. Our first question comes from the line of Elyse Greenspan with Wells Fargo. You may proceed with your question.

Hi. Thanks. Good evening.

Good evening.

My first question is on, Pat, your organic growth comments. I think you mentioned that you guys would get the full year to 8%. So, if my math is right, if you were sitting at 6.4% for the first half of the year, that would imply that you guys are expecting the back half to come close to 10%. Is there something wrong with that thinking, or are you thinking given the timing impact in the second quarter so we get close to double-digits in the second half a year within Brokerage?

Yeah. Elyse, I think you might be a little strong on that, based on the math. So, just take a look at it again. I think why are math produce more like, towards 9%.

Okay. So, 9%. Okay. Close. And then my second question, you guys announced a $1.5 billion share repurchase program, right, to effectively buyback the stock issued for the Willis deal. So I just wanted to get a sense of timing on the buybacks. Is that something you expect to complete this year? And then, is the expectation that you will buyback all those shares? Or is that also a little bit dependent upon some of the tuck-in deals if some of them come together pretty quickly?

No, I think as we sit right now, our intent is to repurchase the $1.5 billion. We think we can get that done in short order also and certainly by the end of the year. Now the point here is that we won't let excess capital sit idle by any means.

Okay. That's helpful. And then, on the margin side if you were, give us some helpful information and you were giving an example, right, that if you guys get to pull your data of 7%, that you could show a 100 basis points of margin improvement. So, is that with the costs coming back, or is that kind of after adjusting for the impact of days or the expectation that we'll be about 100 points of margin within Brokerage this year?

Yeah. I think, what I was doing is using the illustration of saying if we post 7% for the full year, you'd see about 100 basis points of margin expansion, even with those costs coming back into our structure. And clearly if we better 7%, we should be able to better that too.

Okay. That's helpful. Thanks for the color.

Sure.

Thanks, Elyse.

Our next question comes from the line of David Motemaden with Evercore ISI. You may proceed with your question.

Hi. Good evening. I had a question, just on the expense side. If I just look in Brokerage at the operating expenses, non-comp, non-D&A, just the OpEx line, if I take out the $15 million of incremental costs, it looks like expenses were roughly flat year-over-year. Doug, I think you spoke about this a little bit in your comments. But I guess I'm just wondering, is that sort of right that the underlying expenses in the business, or sort of flat year-over-year and would you expect that to continue for the rest of this year?

So, did you take the entire $15 million out of OpEx or did you spread some of that into comp and then also did you factor in M&A, but you're not far off of it, being pretty close to flat when you factor in M&A.

Yeah. I was just looking purely at OpEx. So, it was roughly flat, but that's something that you think can continue for the rest of the year, just given some of the changes you guys made over the course of last year.

I believe that $20 million will be reflected in our expenses for the third quarter, and $30 million will appear in the fourth quarter. This will be divided between operating expenses and compensation. Overall, aside from some IT-related areas, we are beginning to see savings in real estate and professional fees. There are increases in travel and entertainment costs because our clients expect us to be present, and we’re happy to accommodate that. However, we’re also gaining valuable insights from the pandemic. We have efficiently managed our incoming and outgoing mail, leading to cost savings through centralization, allowing us to manage mail globally with ease. We have several promising projects ongoing that we are leveraging from the operating expense line.

Got it. Yeah, that continues to come in a bit better than I would have thought. I guess, any update on the sustainable expense savings from COVID, which I believe was 150 to 175? Is that still a good level to consider, or are there any changes to that?

Let's clarify. During the pandemic, we were saving about $65 million each quarter. We believe we can maintain around $30 million to $35 million of that. As for your figure of 150, I'm not sure how you arrived at that number unless it was calculated based on 60 times four or five, then divided by two. Where did the 150 come from?

I was using more of a range, that you guys have given. But that makes sense.

Okay.

Thanks for that. Could you break down the 9% organic growth in Brokerage on a clean basis? Can you discuss the various components, such as rate, exposure, new business, and share gains, and how you expect each of those to trend throughout the year?

Okay. So, new business was stronger than where we were, same second quarter or for also say the year new business range stronger. Retention is about the same, getting lift from rate and exposure that when we combine that together, right now I think it's about 50/50. rate and 50% exposure.

Got it. Thank you.

Our next question comes from the line of Mark Hughes with Truist. You may proceed with your question.

Yeah. Thank you very much. Good afternoon.

Good afternoon, Mark.

I think some of your end markets have been a little slower getting ramped up, maybe compared to other more cyclical end markets. Could you expand on that just a little bit?

What do you mean end markets?

You're talking about your customers. If I heard you properly, tell me if I didn't, but your customers.

Our employee benefits business shows significant recovery in employment statistics, particularly in sectors like retail, hospitality, and transportation. However, our customer base is more diverse and not heavily concentrated in those areas. Consequently, the return to work for our clients is not quite matching the overall employment recovery rates. This is what you were referring to, Mark? It's primarily due to the mix of business we have in the benefits sector.

I understand your question. Pat, regarding pricing, I may have missed some details from your previous comments, but when I look at some of your specific numbers compared to last time, they seem to be as good or better in Q1. It appears there's a broader discussion about potential slowdown. Why do you think you're viewing the situation a bit more positively than others might?

No. From my perspective, when I talk to people in the field and our underwriting partners, there doesn't seem to be any interest in making cuts. While the rate of increase has slowed down, I'm not hearing anyone suggest that we have everything figured out and should proceed with full confidence.

We're noticing some trends. In the larger account market, we observed premium increases that were somewhat greater than those in the mid-market or smaller market toward the end of 2020 and into the first half of 2021. However, the growth rate in the large account market is not as rapid as it was previously. This trend is not as evident in the mid-market, where it remains steady compared to the first and fourth quarters. Did you catch that, Mark?

I'm back. I'm just curious if you would like to share any thoughts about the potential for adding some staff in light of the breakup of Willis Towers Watson and Aon. Are you noticing any significant movement in the market?

Well, no. We don't. But as you know, Mark, you follow us a long time. Our organic hiring is a big part of our strategy and there's no doubt that we're going to continue to hire production talent across all the lines of business that we've got. And our doors are open for production talent.

Very good. Thank you.

Thanks Mark.

Our next question comes from the line of Meyer Shields with KBW. You may proceed with your question.

Thanks. I wanted a little bit on capital management, I guess it's $850 million of the raised debt that you're keeping, is it interpret, Doug, your comments about M&A potential as being able to utilize that $850 million?

Yeah, definitely. That's cash we have on hand right now. We believe we may need to borrow a bit more toward the end of the year for part of next year, depending on how the M&A opportunities develop. The $650 million includes a special mandatory redemption feature, so we will pay that back. Regarding the $850 million we raised alongside that, we'll put it to use in the second half of the year.

Okay. I might be find you hard with this one. But if you're expecting an increase in potential sellers because of capital gains tax rates, is that likely to depress placing on these assets at all?

You might see a slight impact, but I believe it could result in stable pricing, possibly leading to earlier earnings being recognized rather than relying heavily on earn-outs. So, if we account for this in the current year, there might be some discomfort. It could potentially shift the multiple to accelerate things, reducing the reliance on earn-outs, but I wouldn’t anticipate a significant drop in pricing.

No, there's a lot of competition for deals out there.

Yeah. Fair enough. Okay. Thank you so much.

Our next question comes from the line of Alex Bolan with Raymond James. You may proceed with your question.

I am calling in on behalf of Greg Peters. Maybe kind of sticking with M&A, and the tuck-in conversation, when you're talking, I guess to potential is, as tuck-in up within the conversation as of now, or is that still a thought?

It's coming up every time.

Okay. And then, when looking at, I guess, M&A, I guess what is the size of acquisitions you're considering? Has that changed at all?

No. We're good at tuck-ins. By the way, looks also, Greg knows this very well. If in fact there's 39,000 agents and brokers in America, let's remember that business insurance that just brought out its July edition this month number 100 was $25 million in revenue. So the playing field is full of really, really good tuck-in players.

Okay. That makes sense. Can you share your thoughts on the deployment of T&E and how it might differ from 2019 in relation to margin expansion?

All right. Let me see if I can understand that again. I thought you had asked a question about India, or did I mishear you?

No, I didn't mention anything about India. It was about the impact of lower travel and entertainment on margin expansion and how you are thinking of using travel and entertainment in the future compared to 2019.

First of all, we have no hold on travel. If someone wants to visit their clients, they are free to do so, and we have no restrictions in place. People are managing this independently. We will meet our clients wherever they prefer to conduct business. We are accommodating their needs. In terms of financials, we likely have around $5 million more per quarter than we did in the past. This might translate to an additional $5 million in our first quarter, $10 million this quarter, $15 million next quarter, and $20 million the following quarter compared to the depths of the pandemic. The positive aspect is that we can now connect our experts to the point of sale virtually much more effectively than before. We have experts in every facet of insurance globally, allowing us to connect them directly to our customers' offices or homes virtually. Though there is less international travel, we can bring our experts from London to our clients in Des Moines, Iowa, with just a click. This is a significant competitive advantage. Most of the time, we compete against smaller firms that lack expertise. When we can provide our experts and their capabilities, it will result in more wins moving forward. Previously, traveling someone in for a half-hour meeting could take two or three days. Even if travel expenses rise again, the ability to ensure our experts are present at the virtual point of sale or to prospects is a fantastic outcome from the pandemic.

Okay. That makes sense. I appreciate the answers.

Thanks, Alex.

Our next question comes from the line of Ryan Tunis with Autonomous Research. You may proceed with your question.

Good evening, guys.

Good evening.

First question, considering the second half of the year, you mentioned about 9% organic growth, and it's likely to see a 4% increase in employee benefits. Can you elaborate on how you envision this fitting into the 9% for the latter half of the year?

I think we're seeing a continued increase in employee benefits as more people return, and recently our HR consulting units have been receiving more inquiries. With the rise in covered lives, the number of participants in medical and dental plans is also increasing. It has moved from four to six and then to eight over the next couple of quarters, and I wouldn't be surprised if it continues to grow in our employee benefits sector.

Got it. Pat, could you remind us why you do 40 deals a year, but very few appear to be related to wholesale? What do you mean by wholesale M&A? Why aren't there more of those?

We're very active there. Ryan, I think it's just opportunistic. We've built RPS over the last 20 plus years in large part with acquisitions, and we've done some nice acquisitions over the last 12 months at RPS. One of the areas we built out, of course, we're the country's largest MGA. We also have a program business that's really strong, but open market brokers, we built the typical Gallagher way. We've recruited our own and built our own young people out of hardship. And we've done some very nice acquisitions there. So, no, there's no hold back there. And actually there's no real shortage of opportunities, a lot of competition, one of which had a very successful IPO this month.

Gotcha. Okay. Cool. Thanks, guys.

Thanks, Ryan.

Our last question comes from the line of Phil Stefano with Deutsche Bank. You may proceed with your question.

Thank you, good evening. Congratulations on the quarter. I'm not quite sure how to phrase this, but I hope it's taken the right way. I anticipate that the main concern I'll hear tonight and tomorrow is that our organic growth appears to be behind that of our competitors. I recognize the timing factors and the issues with the contingent and 606, but even with a 9% growth, it seems like there will be questions about this. How would you like me to address this in my conversations over the next day?

I think Doug can provide you with the tactical details, Phil, since he's skilled at that. However, I want to emphasize how proud I am of our team. We had an excellent quarter, and so did our competitors, which I commend. When you compare our results over the years to anyone else, our team consistently shows up and actively sells a significant amount of insurance. I firmly believe this quarter was remarkable, and one quarter's comparison doesn’t concern me. Doug can give you a more technical explanation, but I truly believe our people excelled in selling insurance and retaining clients. I'm very pleased with our performance this quarter. Other companies may appear stronger on a comparable basis, and I'm fine with that.

I think, Phil, it would be beneficial for you to compare last year's second quarter with this year’s second quarter. When you add them up, you'll see that the difference isn't significant. As Pat mentioned, over the past two years, we've experienced about 10% organic growth in our Brokerage segment. If you analyze the data from those who have reported, you'll notice that the numbers for both quarters are quite similar. I believe that approaching 9% is our strongest performance since the fourth quarter of 2003. Additionally, this level of organic growth is not just a one-off for a few of us; the whole industry is experiencing strong organic growth, significantly outpacing GDP. I would also express that our expectations for the second half of the year are optimistic. So, to summarize, if you look at the two quarters together, the results will be fairly close, assuming similar business conditions.

Part of this relates to the two-year period you're mentioning, reflecting that your clients were more consistent. Therefore, we are not experiencing the fluctuations that occurred during last year's recovery. Would you say that's a reasonable way to connect that observation to the numbers?

The other way I might put it, Phil, is we're doing a better job than our competition to mitigating the impact of rates for our clients.

When I consider your comment about keeping the door open for talent, I want to know if there were any non-compete or no-shop provisions in the agreement for the Willis businesses being acquired that could prevent you from attracting certain talent that might be looking around.

Yeah. We have some limitations. We've agreed, of course, that we intend to honor those and they're not extensive. But generally speaking, we're not limited in our ability to hire general production talent. But of course, in that discussion, that transaction, there are some limitations which we intend on honoring.

Thank you, and congratulations. I believe the margin expansion story over the past few years has been exceptional. I hope you take that away from my comments tonight. I appreciate it.

All right. Thanks Phil.

Thank you, Laura. I want to make a few comments here. We delivered an excellent second quarter, and I'm extremely proud of our team. I believe we are in the best business in the world, providing significant value to our clients globally every day. Thank you all for joining us this evening, and we look forward to speaking with you next quarter. Thank you very much. Thank you, Laura.

This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation for the rest of your evening.