Arthur J. Gallagher & Co. quarterly report, Q2 FY2023

Arthur J. Gallagher & Co. — Q2 2023 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2023; unaudited. Gallagher provides insurance and reinsurance brokerage, consulting, and third-party claims administration services. Its reportable segments are brokerage, risk management, and corporate. Amounts below are in millions of dollars except per-share data.

Financial performance and key metrics

Metric	Q2 2023	Q2 2022	Six months 2023	Six months 2022
Total revenue	$2,441.9	$2,043.0	$5,148.0	$4,478.3
Net earnings	$235.8	$285.1	$722.4	$724.2
Net earnings attributable to controlling interests	$234.5	$284.2	$721.0	$722.9
Diluted EPS	$1.07	$1.33	$3.31	$3.38
Operating cash flow	Not presented quarterly	Not presented quarterly	$440.9	$140.4

Q2 revenue grew 19% (approximately 20% before reimbursements), while net earnings attributable to controlling interests fell about 18% and diluted EPS fell about 20%. Calculated GAAP net margin was approximately 9.7%, versus 14.0% a year earlier.
For the first half, revenue increased 15%, while net earnings attributable to controlling interests were nearly flat and diluted EPS declined 2%.
Management’s adjusted non-GAAP diluted EPS was $1.90 for Q2, up 17%, and $4.93 for the first half, up 11%. Adjusted results exclude specified items, including intangible amortization, acquisition integration and transaction costs, earnout adjustments, and certain other costs; they are not GAAP measures.
Q2 adjusted EBITDAC margin was 32.1% for brokerage, up 49 basis points, and 19.4% for risk management, up 63 basis points. First-half adjusted margins were 36.5% for brokerage and 19.3% for risk management.
First-half operating cash flow was $440.9, compared with $140.4. Investing cash outflow was $1,065.1, mainly reflecting $1,049.5 of net cash paid for acquisitions. Financing cash inflow was $2,560.3. Cash flow comparisons reflect the revised presentation of fiduciary-related cash flows described below.
At June 30, cash and cash equivalents were $952.3, including $174.4 of restricted cash. Fiduciary assets of $31,759.1 were matched by fiduciary liabilities and should not be treated as freely available company liquidity.
Net corporate and other debt was $7,134.1, including $191.2 of premium-financing debt. The balance sheet reported $920.0 of current and $6,022.9 of noncurrent corporate borrowings. The new $1.2 billion revolving facility had $495.0 drawn and $705.0 available after letters of credit. The company reported compliance with debt covenants.

Material changes and notable items

Brokerage produced 87% of first-half revenue; risk management produced 13%. First-half organic revenue growth was 9.4% in brokerage and 16.2% in risk management.
Gallagher acquired Buck on April 3, 2023, for a recorded purchase price of $645.0, and completed 25 acquisitions in the first half. Acquired businesses represented approximately $418.1 of annualized revenue. Buck’s expected integration expense is approximately $125.0.
Q2 compensation expense rose $251.9 companywide, and operating expense rose $109.7. Brokerage reported increased acquisition-related costs, higher compensation and operating costs, and a $43.2 million year-over-year swing in the change in estimated acquisition earnout payables—from income in Q2 2022 to expense in Q2 2023. Amortization also increased.
Gallagher issued $950.0 of senior notes in March: $350.0 at 5.50% due 2033 and $600.0 at 5.75% due 2053. Interest expense increased to $77.8 in Q2 from $64.6 a year earlier.
The company revised balance-sheet and cash-flow presentation in 2023 to separately identify fiduciary assets and liabilities and moved the net change in those balances from operating to financing cash flows. The filing says the change did not affect earnings or total cash; prior periods were revised for comparability.

Outlook, risks, and contingencies

Management expects commercial property/casualty rates to continue increasing through the remainder of 2023 and potentially into 2024, citing loss-cost inflation, higher reinsurance pricing, catastrophe losses, and social inflation. It reported an 8.8% average rate increase in the Q1 2023 industry survey and expected a similar Q2 trend; the Q2 survey was not yet available.
Management cited strong brokerage retention and new business, and expected favorable trends to continue, while cautioning that weaker economic conditions could soften revenue growth. Risk management’s favorable claims trends were also expected to continue, subject to economic and employment conditions.
The company expects approximately $200.0 of 2023 capital expenditures. It said cash flows and borrowings under its credit facility should provide adequate resources for foreseeable liquidity needs. The $0.55 per-share Q3 dividend was announced July 26, 2023; future dividends are not assured.
Principal risks include acquisition integration and earnout estimates, economic and insurance-market conditions, talent and compensation costs, cybersecurity, foreign-exchange and interest-rate exposure, debt and refinancing needs, and regulatory or legal outcomes. The filing describes an ongoing DOJ investigation concerning public-entity insurance business in Ecuador, an IRS audit of its micro-captive advisory business, and a patent-infringement case scheduled for trial in November 2023. Gallagher says it is cooperating with investigations and vigorously defending the lawsuit.
The company disclosed $108.0 of exposure relating to previously earned tax credits, with no reserve recorded. Its errors-and-omissions reserve is within the actuarially estimated range, but future claims could change the estimate. Management said it believes disclosed legal matters are not expected to materially harm results or financial position, while acknowledging uncertainty.

Most important facts for investors to verify

How much of revenue growth and adjusted EPS growth is organic versus acquisition-driven, and whether Buck integration costs and benefits track management’s expectations.
Why GAAP Q2 earnings and margin declined despite strong revenue growth, including the effect of earnout remeasurement, amortization, integration expenses, and compensation and operating costs.
Debt maturities, interest expense, revolving-facility availability, covenant headroom, and the funding mix for further acquisitions and dividends.
The conversion of reported operating cash flow into recurring cash generation, considering working-capital timing, fiduciary cash-flow presentation, acquisitions, and capital spending.
Developments in the DOJ, IRS, and patent matters; potential exposure from previously claimed tax credits; and changes in E&O reserves.
Whether pricing, retention, claims activity, and economic conditions support management’s outlook. The filing does not provide specific full-year revenue or earnings guidance.