Arthur J. Gallagher & Co. quarterly report, Q2 FY2022

Arthur J. Gallagher & Co. — Q2 2022 Form 10-Q

Reporting period: Three and six months ended June 30, 2022; unaudited. Gallagher provides insurance brokerage, consulting, and third-party claims administration services. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.

Key financial results

Metric	Q2 2022	Q2 2021	Six months 2022	Six months 2021
Total revenue	$2,043.0	$1,933.5	$4,478.3	$4,098.5
Earnings before income taxes	$352.3	$222.3	$890.0	$630.7
Net earnings attributable to controlling interests	$284.2	$190.2	$722.9	$572.3
Diluted earnings per share	$1.33	$0.92	$3.38	$2.83
Cash provided by operating activities	Not presented quarterly	Not presented quarterly	$768.3	$688.9

Revenue increased 5.7% in Q2 and 9.3% for the first half; controlling-interest earnings rose about 49% and 26%, respectively. Results include acquisition effects and significant prior-year clean-energy revenue.
Brokerage was the main operating engine: Q2 revenue was $1,740.7, up 25%; organic revenue growth was 10.8%. Six-month brokerage revenue was $3,863.3, up 29%, with 10.1% organic growth. Q2 adjusted EBITDAC margin was 32.0%, down 97 basis points year over year.
Risk management Q2 revenue before reimbursements was $267.4, up 9%; organic growth was 10.3%. Six-month revenue before reimbursements rose 13%, with 12.6% organic growth. Adjusted EBITDAC margin was 18.9% in Q2, down 70 basis points.
Reported consolidated pretax margin was approximately 17.2% in Q2 versus 11.5% in Q2 2021. Consolidated effective tax rates were 19.1% and 9.2%, respectively; the comparison reflects unusual tax and clean-energy items.
First-half operating cash flow was $768.3. Capital expenditures were $91.1; operating cash flow less capital expenditures was $677.2, a simple calculation rather than a company-defined measure. Acquisition cash payments, net of cash acquired, were $321.3.
At June 30, cash and cash equivalents were $523.6; restricted cash was $4,266.1, primarily fiduciary funds unavailable for general corporate use. Total cash, cash equivalents and restricted cash were $4,789.7.
Net corporate and other debt, as reported, was $6,448.7, compared with $6,283.6 at year-end 2021. This includes premium-financing debt. The company had $460.0 outstanding under its credit agreement and $729.3 available for potential borrowing; it reported compliance with debt covenants.
Dividends declared were $0.51 per share in Q2, versus $0.48 a year earlier. The company announced a Q3 dividend of $0.51 per share.

Material changes and notable items

Core brokerage growth was strong, but total reported revenue growth was moderated by the end of the IRC Section 45 clean-coal tax-credit program. Clean-coal revenue was $0.3 in Q2 2022 versus $261.0 in Q2 2021; related costs were $0.0 versus $268.8. No tax credits were produced in the first half of 2022, compared with $101.8 of credits in the first half of 2021.
The company recorded $47.8 of income from net fair-value adjustments to acquisition earnout liabilities in Q2 2022. The filing says the favorable adjustment primarily reflected rising interest rates and market volatility in the Willis Re earnout assumptions, not a material improvement in underlying performance or a changed ultimate earnout expectation.
Willis Towers Watson’s treaty reinsurance brokerage operations were acquired in December 2021 for initial gross consideration of $3.25 billion, with up to $750 million of additional consideration tied to third-year revenue targets. One deferred international closing remained subject to regulatory approval and was expected in Q3 2022.
Willis Re purchase accounting remained provisional. Valuation and working-capital adjustments increased goodwill by a net $425.9 during the first half; the final valuation was expected in Q3 2022. Goodwill was $9,036.4 and net amortizable intangible assets were $3,190.9 at June 30.
Foreign-currency translation reduced first-half comprehensive earnings: the six-month translation loss was $403.0, and Q2 translation loss was $417.9. These are reflected in other comprehensive income, not as operating expense.
First-half interest expense was $128.5, up from $104.3. The company repaid a $200.0 note maturity in June and received $52.7 from settling interest-rate hedges, which will be amortized into interest expense in future periods.

Outlook, risks and contingencies

Management expected continued firming in insurance pricing and anticipated a similar trend in the then-unpublished Q2 industry survey. It cited strong retention, new business generation, and increased insured exposures, while warning that a slower or reversing economic recovery could soften revenue growth.
Management said it expected favorable brokerage and risk-management trends to continue into the second half of 2022, but identified inflation, labor-market conditions, Russia’s invasion of Ukraine, and deterioration in insurance loss trends as uncertainties. It stated that capital and access to additional capital should meet foreseeable liquidity needs.
Expected 2022 capital expenditures were approximately $185.0, including office moves and technology and software development. Management expected to fund remaining acquisitions through operating cash, credit facilities, new debt, stock, or a combination.
Management did not anticipate after-tax earnings from clean-energy investments in 2022. It anticipated positive net cash flow from tax-credit utilization, potentially through at least 2027, subject to taxable income and other variables.
Risk exposures include acquisition integration and client or employee retention, competition and talent costs, cybersecurity and data privacy, foreign exchange, debt and refinancing, and regulatory and legal matters. The company cited inflation, economic uncertainty, international tensions, and potential insurance-market volatility as additional risks.
The IRS had audited Gallagher’s IRC 831(b) micro-captive advisory business since 2013 and was conducting a related criminal investigation. Gallagher said it was not a target of the criminal investigation, was cooperating, and did not expect a material loss, although it could not reasonably estimate any potential loss.
A patent-infringement case involving Midwest Energy Emissions was in discovery; Gallagher said it was defending the matter and considered a material loss remote. Other legal and regulatory matters were described as incidental or not estimable. The filing also notes uncertainty in errors-and-omissions reserves and possible exposure related to previously claimed energy tax credits.

Most important facts for investors to verify

How much reported growth reflects organic expansion versus acquisitions, foreign exchange, and the Willis Re integration.
Whether brokerage and risk-management organic growth continues and whether adjusted margins stabilize after Q2 declines.
The final Willis Re purchase-price allocation, remaining regulatory closing, integration costs, and eventual earnout payment relative to the $750 million contingent maximum.
Debt levels, borrowing costs, upcoming maturities, credit-facility availability, and covenant headroom; restricted fiduciary cash should not be treated as available liquidity.
The cash-flow consequences of clean-energy tax-credit utilization after the program’s expiration, and the effect of the associated earnings decline.
Developments in the IRS micro-captive matters, the patent case, E&O reserves, and other contingencies.