Arthur J. Gallagher & Co. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; the filing also reports fourth-quarter results. All dollar amounts are U.S. dollars.
Business context
Gallagher provides insurance brokerage and consulting, plus third-party claims administration and risk-management services. It generally does not assume insurance underwriting risk. Brokerage, risk management and corporate accounted for approximately 68%, 14% and 18% of 2019 reported revenue, respectively. The corporate segment includes clean-energy investments and debt-related and other corporate costs.
Financial performance and liquidity
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total revenue | $7,195.0 million | $6,934.0 million | +3.8% |
| Revenue before reimbursements | $7,056.4 million | $6,792.4 million | +3.9% |
| Earnings before income taxes | $626.1 million | $479.4 million | +30.6% |
| Net earnings attributable to controlling interests | $668.8 million | $633.5 million | +5.6% |
| Diluted EPS | $3.52 | $3.40 | +3.5% |
| Operating cash flow | $1,119.2 million | $765.1 million | +$354.1 million |
| Capital expenditures | $138.8 million | $124.4 million | +$14.4 million |
Revenue growth included acquisitions and a $75.3 million gain on divestitures, versus $10.2 million in 2018. Brokerage organic revenue increased 5.8%; risk-management organic fee revenue increased 4.4%. Brokerage adjusted EBITDAC margin improved to 28.6% from 27.8%; risk-management adjusted margin was 17.4% versus 17.3%. Adjusted diluted EPS was $3.65, up 6% from $3.43. These adjusted and EBITDAC measures are non-GAAP.
Fourth-quarter revenue was $1,721.4 million versus $1,657.4 million. Earnings attributable to controlling interests were $98.5 million versus $117.3 million, and diluted EPS was $0.51 versus $0.63.
At year-end, cash and cash equivalents were $604.8 million; restricted cash of $2,019.1 million was largely fiduciary/client-related and should not be treated as freely available. Total debt was $4,613.6 million before $6.9 million of unamortized debt issuance costs, compared with $3,617.0 million in 2018. The revolving credit facility had $663.8 million available. Total assets were $19,634.8 million and stockholders’ equity was $5,215.5 million. The filing states the company was in compliance with debt covenants.
Dividends declared were $1.72 per share for 2019. The board announced a first-quarter 2020 dividend of $0.45 per share; maintaining that rate for the year would imply approximately $338.4 million in annual cash dividends.
Material changes and unusual items
- Acquisition spending rose: cash paid, net of cash acquired, was $1,266.8 million, compared with $784.8 million in 2018. The company completed 49 acquisitions; annualized acquired revenue was approximately $468.2 million.
- Clean-energy results weakened: net after-tax earnings were $88.5 million versus $118.6 million in 2018. The segment recorded a $67.7 million net loss, while tax credits materially reduced the consolidated tax provision. Section 45 credits generated and recognized were $196.0 million, down from $252.9 million.
- The consolidated income-tax benefit was $89.7 million, producing a reported effective tax rate of negative 14.3%. This unusual result was driven principally by clean-energy tax credits; it is not a conventional recurring operating tax rate.
- The 14 plants whose Section 45 eligibility ran through 2019 expired at year-end; 20 plants may qualify through 2021. The company reported $937.0 million of unused Section 45 credits available to offset future U.S. federal tax liabilities.
- Operating cash flow increased, partly because of lower acquisition earnout payments, lower income-tax payments and the absence of the $30 million discretionary pension contribution made in 2018. Management cautions that working-capital and fiduciary-balance timing can cause substantial cash-flow variation.
- Lease accounting adoption added $393.5 million of right-of-use assets and $427.3 million of lease liabilities at year-end. The 2019 statements also reflect revenue-recognition estimates, including variable contingent revenue.
Outlook, risks and contingencies
Management expected 2020 property/casualty rates and exposures to rise more than the modest increases seen in 2019, citing firming insurance pricing, employment growth and demand for employee-benefit solutions. It expected international revenue mix to remain comparable to 2019 and planned to continue acquisition-led growth. Estimated 2020 clean-energy net after-tax earnings, including Section 45 credits, were $80 million to $100 million; this estimate is exposed to production, tax, regulatory and coal-market risks. Expected 2020 capital expenditures were approximately $146 million. Management said operating cash flow and available borrowing capacity should meet foreseeable liquidity needs.
Key risks include insurance-premium and commission cycles; acquisition pricing, financing and integration; international, currency and Brexit exposure; cybersecurity, privacy and talent retention; debt and refinancing needs; and the uncertain, variable timing of supplemental and contingent brokerage revenue. Clean-energy investments face coal-demand, environmental, intellectual-property and IRS audit risks. The IRS was investigating micro-captive advisory services and auditing more than 100 related captive entities; a related class action had been dismissed in favor of arbitration, with plaintiffs appealing. The filing also describes a patent-infringement case involving Chem-Mod and other defendants. Management said it could not reasonably estimate potential losses in the micro-captive matters; it considered a material loss in the patent case remote. The filing was signed February 7, 2020 and identified pandemics, including coronavirus, among potential risks.
Investor verification priorities
- Reconcile reported revenue and earnings growth with acquisitions, divestiture gains, clean-energy activity and the negative effective tax rate; review adjusted non-GAAP reconciliations.
- Assess the sustainability and usability of the $937 million in unused Section 45 credits, the post-2019 plant eligibility timetable and the assumptions behind the $80–$100 million 2020 clean-energy estimate.
- Review debt maturities, interest expense, credit-facility availability, acquisition funding needs and the effects of restricted fiduciary cash on usable liquidity.
- Track organic growth, margins and retention in brokerage and risk management separately from acquisition contributions and contingent revenues.
- Follow outcomes of IRS micro-captive examinations, the class-action appeal, refined-coal tax-credit audits and the Chem-Mod patent litigation.