Business Context and Reporting Period
Company: Principal Financial Group, Inc. (PFG)
Filing Type: Form 10-Q (Unaudited)
Period Ended: June 30, 2005
Business Overview: PFG provides financial products and services through four primary segments: U.S. Asset Management and Accumulation, International Asset Management and Accumulation, Life and Health Insurance, and Corporate and Other. The company operates globally with significant presence in the U.S. and international markets including Brazil, Chile, Mexico, and Asia.
Key Financial Metrics
| Metric (in millions) | Three Months Ended June 30, 2005 |
Three Months Ended June 30, 2004 |
Six Months Ended June 30, 2005 |
Six Months Ended June 30, 2004 |
|---|---|---|---|---|
| Total Revenues | $2,200.7 | $1,979.7 | $4,344.6 | $3,975.5 |
| Net Income | $238.9 | $119.7 | $444.4 | $313.3 |
| Diluted EPS | $0.82 | $0.37 | $1.49 | $0.98 |
| Operating Cash Flow | N/A | N/A | $805.3 | $929.6 |
| Total Assets | $117,192.6 | N/A | N/A | N/A |
| Total Liabilities | $109,340.5 | N/A | N/A | N/A |
| Stockholders' Equity | $7,852.1 | N/A | N/A | N/A |
| Short-term Debt | $456.3 | N/A | N/A | N/A |
| Long-term Debt | $839.5 | N/A | N/A | N/A |
Note: Balance sheet data is as of June 30, 2005, compared to December 31, 2004 ($113,798.1M Total Assets). Cash and cash equivalents increased to $1,171.6 million from $451.9 million at year-end 2004.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 11% ($221.0M) for the quarter and 9% ($369.1M) for the six months compared to the prior year. This was driven by higher premiums in the Life and Health segment and increased fees in the U.S. Asset Management segment.
- Profitability Surge: Net income doubled (100% increase) for the quarter and rose 42% for the six months. A significant contributor was a $14.7 million gain on the sale of a real estate property classified as discontinued operations.
- Capital Gains: Net realized/unrealized capital gains improved significantly, turning from a $66.3M loss in Q2 2004 to a $10.2M gain in Q2 2005. This was largely due to fewer impairments and a $52.0M recovery from a litigation settlement regarding previously impaired securities.
- Investment Income: Net investment income increased 6% for the quarter and 4% for the six months, primarily due to a 6-7% increase in average invested assets, partially offset by slightly lower yields.
Guidance, Outlook, and Risks
Management Commentary and Transactions
- Capital Actions: In June 2005, PFG issued $542.0 million in perpetual preferred stock (Series A and B). Proceeds were used to fund an accelerated stock repurchase agreement for approximately 13.7 million common shares.
- Acquisitions: Completed the acquisition of Columbus Circle Investors (70% interest) in January 2005, adding $3.9 billion in assets under management. Acquired a 26% stake in PNB Principal Insurance Advisory Company in India in February 2005.
- Dispositions: Sold a real estate investment property in May 2005 (discontinued operations). Announced intent to liquidate the ING/Principal Pensions Company operation in Japan by year-end 2005.
Risks and Contingencies
- Tax Litigation: The IRS completed examinations for 1999-2001, resulting in deficiency notices totaling approximately $445.3 million (including interest). PFG paid these in Q1 2005 and plans to file refund claims. Management believes the ultimate resolution will not materially impact net income.
- Legal Proceedings: A lawsuit regarding the demutualization allocation of settlement costs was dismissed in July 2005. The company faces ongoing industry-wide inquiries regarding compensation arrangements and bid-rigging.
- Indemnifications: PFG indemnified Westpac Banking Corporation regarding the 2002 sale of BT Financial Group. Westpac lodged claims totaling approximately $38.0 million (AUD $50.0M) related to fund pricing and tax assets. PFG intends to defend vigorously.
- Market Risk: A 100 basis point increase in interest rates is estimated to decrease the net fair value of the portfolio by approximately $91.6 million. A 10% decline in equity markets would result in a $76.7 million unrealized loss on equity securities.
Investor Verification Checklist
- Discontinued Operations Impact: Verify the sustainability of earnings by excluding the $14.7M one-time gain from the real estate sale included in net income.
- Tax Refund Status: Monitor the status of the $445M+ IRS deficiency payment and the expected timeline for refund claims related to carrybacks of capital losses.
- BT Financial Group Indemnity: Track the resolution of the $38M warranty claim lodged by Westpac regarding BT Financial Group fund pricing.
- Preferred Stock Dividends: Note that dividends on the newly issued Series A and B preferred stock commence September 30, 2005, and are subject to capital adequacy restrictions.
- Investment Portfolio Quality: Review the composition of fixed maturity securities, noting that 94% are investment grade, but monitor the $89.1M in gross unrealized losses.