Arthur J. Gallagher & Co. quarterly report, Q1 FY2023

Arthur J. Gallagher & Co. — Q1 2023 Form 10-Q

Business context and reporting period. The filing covers the three months ended March 31, 2023, compared with Q1 2022. Gallagher provides insurance and reinsurance brokerage, consulting, and third-party claims administration services. Brokerage generated about 88% of quarterly revenue and risk management about 12%. The company generally acts as an intermediary and does not assume material net insurance underwriting risk.

Financial results

Metric	Q1 2023	Q1 2022	Change
Total revenue	$2,706.1 million	$2,435.3 million	+11.1%
Revenue before reimbursements	$2,672.9 million	$2,404.5 million	+11.2%
Earnings before income taxes	$605.8 million	$537.7 million	+12.7%
Net earnings attributable to controlling interests	$486.5 million	$438.7 million	+10.9%
Diluted GAAP EPS	$2.24	$2.05	+9.3%
Operating cash flow	$428.5 million	$216.6 million	+$211.9 million
Interest expense	$67.9 million	$63.9 million	+$4.0 million

Revenue and segment trends: Brokerage revenue rose 12% to $2,375.2 million; organic revenue growth was 9.1%. Risk management revenue before reimbursements rose 15% to $297.6 million; organic growth was 14.3%.
Segment profitability: Brokerage reported net earnings of $515.3 million, up 11%; its reported net earnings margin was 21.7%, down 17 basis points. Risk management net earnings rose 40% to $33.5 million, and its margin before reimbursements increased to 11.3% from 9.2%. Adjusted EBITDAC and adjusted margins are non-GAAP measures: brokerage adjusted EBITDAC was $958.4 million, up 15%, with a 40.4% margin; risk management adjusted EBITDAC was $57.1 million, up 28%, with a 19.2% margin.
Adjusted EPS: Company adjusted diluted EPS, a non-GAAP measure, was $3.03 versus $2.76, up 10%. It excludes specified items including intangible amortization, acquisition-related costs and earnout adjustments; it is not a substitute for GAAP results or a liquidity measure.
Cash flow: Operating cash flow increased to $428.5 million, which management attributed primarily to business growth and timing differences in receivables and accrued liabilities. Investing cash flow was negative $256.6 million, including $311.4 million of net cash paid for acquisitions. Financing cash flow was positive $958.1 million, including net corporate long-term borrowings and the reported net change in fiduciary assets and liabilities. The fiduciary cash-flow presentation was revised; fiduciary balances are client-related.
Liquidity and debt: Cash and cash equivalents were $1,549.9 million at quarter-end, including $204.2 million of restricted cash. Separately reported fiduciary assets were $23,403.4 million and matched fiduciary liabilities; they should not be treated as available corporate liquidity. Net corporate and other debt was $6,856.8 million, versus $6,114.7 million at year-end 2022. The company issued $950 million of unsecured senior notes in March, and reported $1,189.1 million available under its credit agreement; no credit-agreement borrowings were outstanding at March 31. The company said it was in compliance with debt covenants.
Balance sheet: Total assets were $45,094.4 million and total stockholders’ equity was $9,858.3 million at March 31, 2023. Goodwill was $9,703.2 million and net amortizable intangible assets were $3,404.1 million.

Material changes and unusual items

Investment income increased to $66.0 million from $18.2 million, primarily reflecting higher interest income as rates rose. Clean coal activity revenue fell to zero from $22.7 million after the IRC Section 45 credit program expired.
Expense for changes in estimated acquisition earnout payables increased to $41.8 million from $20.9 million, reflecting discount accretion and updated fair-value assumptions and projections.
Q1 acquisitions included 10 firms, with approximately $69 million in estimated annualized revenue. Cash paid for acquisitions was $311.4 million; the company also issued shares as acquisition consideration.
The previously announced Buck acquisition closed April 3, 2023, after quarter-end, for gross consideration of $660 million (approximately $585 million net of agreed seller-funded expenses and net working capital). It was funded with free cash flow and senior-note proceeds. Estimated integration expense is approximately $125 million.
The company revised its balance-sheet and cash-flow presentation to separately identify fiduciary assets and liabilities. It said the reclassification had no effect on earnings, equity, or previously reported total cash movements.

Outlook, commentary and risks

Management expects continued firming in property/casualty insurance pricing, citing rising loss costs, higher reinsurance pricing, catastrophe frequency and social inflation. It noted potential for sharply higher prices and tighter terms in U.S. property catastrophe coverage. Management said worsening economic conditions or deteriorating loss trends could soften growth or make conditions more difficult.
Management reported strong retention and new-business generation and expected favorable brokerage trends to continue into Q2, while noting economic deterioration could slow revenue growth. Risk management’s favorable claims trends were expected to continue, but could weaken if economic conditions or employment trends reverse.
No specific full-year revenue or earnings guidance is provided in the supplied filing text. Management expects approximately $200 million of 2023 capital expenditures and stated it anticipates segment effective tax rates of about 24.5%–26.5% for brokerage and 25.0%–27.0% for risk management.
Management said it expects positive net cash flow overall from legacy IRC Section 45 tax-credit utilization, while noting period-specific cash flows are difficult to predict. It does not anticipate clean-energy investments producing after-tax earnings in 2023.
Key disclosed matters include a DOJ subpoena concerning insurance business with public entities in Ecuador; the company said it is cooperating. The IRS continues audits concerning its micro-captive advisory business; the company said it is cooperating and is not a target of a related criminal investigation. A patent-infringement case involving Midwest Energy was scheduled for trial in November 2023. The company stated it believes proceedings will not materially harm it, but warned outcomes remain uncertain.
Other notable risks include acquisition integration and earnout valuation, leverage and refinancing needs, economic and insurance-market changes, foreign exchange, cybersecurity and data privacy, talent and compensation costs, and potential adverse legal, regulatory or tax outcomes. The company disclosed $108 million of exposure relating to previously earned tax credits for which it recorded no reserve.

Important facts for investors to verify

How much of reported growth reflects organic expansion versus acquisitions, foreign exchange, interest income and other one-time or variable items; review the company’s non-GAAP reconciliations.
Whether cash conversion remains strong after considering seasonal receivables and accrued-liability timing, and distinguish corporate cash from restricted and fiduciary balances.
The level, settlement timing and cash-versus-stock mix of acquisition earnouts: maximum potential obligations were $1,748.3 million, with $901.8 million recorded at estimated fair value.
Actual Buck integration costs and realized benefits relative to the approximately $125 million integration-cost estimate.
Developments in the DOJ, IRS and patent litigation matters, as well as the unreserved tax-credit exposure.
Debt maturity and interest costs, acquisition funding, and whether the company sustains covenant compliance and its stated liquidity capacity.