Arthur J. Gallagher & Co. — Q3 2022 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2022. Gallagher provides insurance brokerage and consulting, and third-party claims management services, through brokerage, risk management and corporate segments. Brokerage generated about 86% of nine-month revenue and risk management about 14%.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Total revenue | $2,044.0 million | $2,138.2 million | $6,522.3 million | $6,236.7 million |
| Earnings before income taxes | $315.0 million | $231.4 million | $1,205.0 million | $862.1 million |
| Net earnings attributable to controlling interests | $255.8 million | $225.1 million | $978.7 million | $797.4 million |
| Diluted GAAP EPS | $1.19 | $1.06 | $4.57 | $3.88 |
| Operating cash flow | — | — | $1,925.0 million | $1,210.3 million |
- Q3 revenue declined 4.4%, while pretax earnings rose 36.2% and controlling-interest earnings rose 13.6%. Diluted GAAP EPS increased 12.3%. The company reported adjusted diluted EPS of $1.72, up 4% year over year.
- Nine-month revenue increased 4.6%; controlling-interest earnings rose 22.7% and diluted GAAP EPS rose 17.8%. Adjusted diluted EPS was $6.22, up 13%. Adjusted measures are non-GAAP and exclude selected items, including integration costs and intangible amortization.
- Brokerage Q3 organic revenue grew 7.8%; risk management organic revenue grew 12.2%. Brokerage adjusted EBITDAC margin declined to 32.2% from 33.5%; risk management adjusted margin declined to 18.2% from 19.5%. Risk management’s reported net earnings margin improved to 9.8% from 8.9%.
- Q3 GAAP revenue was weighed down by the prior-year clean coal comparison: corporate-segment revenue was $0.3 million versus $357.9 million in Q3 2021. The tax-credit program had expired, and no IRC Section 45 credits were produced in the 2022 nine-month period.
Cash, debt and liquidity
- At September 30, 2022, cash and cash equivalents were $553.7 million; restricted cash was $4,723.1 million, primarily fiduciary funds not available for general use. Total cash, cash equivalents and restricted cash was $5,276.8 million.
- Net corporate and other debt was approximately $6,247.5 million, including $190.0 million drawn on the credit agreement and $245.4 million of premium-financing debt. The company reported $1,010.0 million available under its credit agreement and compliance with debt covenants.
- Operating cash flow for the first nine months was $1,925.0 million, up from $1,210.3 million. Management attributed the increase primarily to timing of receipts and payments, including fiduciary balances; the net cash contribution from changes in premiums receivable and payable was $423.3 million, versus $47.0 million in 2021.
- Investing cash outflow was $562.1 million, including $418.9 million of net acquisition payments and $140.3 million of capital expenditures. Financing cash outflow was $269.7 million; dividends paid were $321.5 million.
- Management expects 2022 capital expenditures of approximately $185 million. The board declared a Q4 dividend of $0.51 per share. Management stated that operating cash flows and borrowing capacity should provide adequate resources for foreseeable liquidity needs.
Material changes, outlook and notable items
- Acquisition-related growth was substantial: acquisitions completed in the preceding 12 months contributed $161.2 million of Q3 brokerage commissions and fees and $777.9 million for the nine-month period. Gallagher completed 20 acquisitions in the first nine months of 2022. The Willis Re acquisition continued to generate integration costs; one international deferred closing remained subject to local regulatory approval and was expected in Q4 2022.
- The company signed an agreement to acquire M&T Insurance Agency for approximately $170 million cash plus a potential $22.5 million earnout; the acquisition closed October 31, 2022, after quarter-end.
- Management cited firm insurance pricing, higher insured exposures, strong client retention and new business generation as growth supports. It expected property/casualty rate increases to continue through the remainder of 2022 and into 2023, while noting potential softer growth if economic conditions worsen and possible significant price increases and tighter terms in U.S. property catastrophe coverage during 2023 renewals. No company-wide numerical earnings or revenue guidance was provided.
- Management expects segment effective tax rates of approximately 24.0%–25.5% for brokerage and 25.0%–27.0% for risk management. Gallagher also said clean-energy tax-credit expiration reduces reported revenue and earnings but can increase cash flow as credits are used against tax obligations. It expected to record an approximately $150 million acceleration in use of tax credits in Q4 2022.
- An October 2022 settlement of lawsuits brought by Gallagher produced $55 million cash; the company expected to recognize approximately $35 million net of litigation costs and taxes in Q4 and use the proceeds over five to nine quarters for production hires and technology investment.
- In Q3, Gallagher received a DOJ subpoena seeking information about insurance business with public entities in Ecuador. It is cooperating and stated that a material loss, if any, was not considered probable. The IRS continues audits concerning its micro-captive advisory business; the company says it is not a target of the related criminal investigation and does not expect a material loss. Other litigation and regulatory matters remain uncertain.
- Foreign currency translation reduced nine-month comprehensive earnings by $801.9 million and contributed to accumulated other comprehensive loss of $1,478.7 million at quarter-end. Q3 comprehensive loss attributable to controlling interests was $165.4 million despite positive net earnings.
Key facts for investors to verify
- How much organic brokerage and risk-management growth persists after separating acquisition contributions, currency effects and insurance pricing/exposure changes.
- Whether integration costs, employee compensation and operating expenses moderate, and how margin trends develop.
- Completion and integration of Willis Re, including the deferred international closing, and the ultimate cost and settlement of acquisition earnouts.
- Underlying operating cash generation after accounting for timing swings in fiduciary premiums receivable and payable; restricted cash should not be treated as freely available liquidity.
- Use and cash-flow effects of remaining clean-energy tax credits, including the expected Q4 tax-credit acceleration and the end of new credit production.
- Developments in the DOJ subpoena, IRS matters, E&O claims and other litigation; the filing says outcomes for several matters cannot be determined.
- Effects of foreign exchange movements, interest rates, debt maturities and the company’s ability to maintain liquidity and covenant compliance.