AJG

Arthur J. Gallagher & Co. - Q1 2009 10-Q Summary

Business Context and Reporting Period

This filing covers the quarterly period ended March 31, 2009. Arthur J. Gallagher & Co. is a global provider of insurance brokerage and risk management services. The company operates through three segments: Brokerage (72% of revenue), Risk Management (28% of revenue), and Financial Services and Corporate (<1% of revenue). The company is headquartered in Itasca, Illinois, with operations in 15 countries.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 6.7% year-over-year, driven primarily by the Brokerage segment which saw a 12% revenue increase. This growth was largely due to acquisitions ($38.0 million in new revenue) rather than organic growth, which declined 1.4% in the Brokerage segment due to renewal rate decreases and lost business.
• Profitability: Earnings from continuing operations increased significantly from $16.3 million to $28.3 million. The Brokerage segment's pretax profit margin improved from 8% to 14%.
• Discontinued Operations: The company reported a loss from discontinued operations of $1.9 million in Q1 2009, a significant improvement from the $22.3 million loss in Q1 2008. This improvement is attributed to the sale of the U.S. reinsurance brokerage run-off obligations in January 2009.
• Debt Levels: Total corporate borrowings increased by $90.0 million to $622.0 million, primarily due to increased borrowings under the Credit Agreement to fund acquisitions and earnout payments.
• Investment Losses: The Financial Services segment recorded a $1.0 million impairment loss on its investment in Asset Alliance Corporation (AAC) following a third-party offer to purchase the remaining interest.

Guidance, Outlook, and Risks

• Market Conditions: Management notes the P/C insurance market remains "soft" with declining premium rates, which puts downward pressure on commission revenues. However, the company continues to pursue acquisitions to offset organic headwinds.
• Acquisition Strategy: The company completed three acquisitions in Q1 2009. While it intends to continue seeking acquisitions, management cautions that current economic and credit market conditions may inhibit the ability to fund acquisitions with cash.
• Liquidity: The company maintains $214.4 million in available borrowing capacity under its $450.0 million Credit Agreement. Management believes resources are adequate to meet liquidity needs.
• Tax Rate: The consolidated effective tax rate for Q1 2009 was 34.9%, lower than the statutory rate due to the resolution of prior tax examinations. Management anticipates a future effective tax rate of approximately 40.0% to 42.0%.
• Risks: Key risks include the potential for insurer failures reducing industry capacity, the impact of the global credit crisis on financing costs and access, and ongoing litigation regarding contingent commission arrangements (MDL settlement appeal pending).

Investor Verification Checklist

• Organic Growth vs. Acquisitions: Verify the sustainability of revenue growth given the 1.4% decline in organic Brokerage revenue and reliance on acquisitions.
• Discontinued Operations: Confirm the finalization of the reinsurance brokerage sale and the status of any remaining contingent proceeds or liabilities.
• Investment Impairments: Monitor the status of the Asset Alliance Corporation (AAC) sale and potential further impairments in the Financial Services segment's alternative energy and venture capital portfolio.
• Debt Covenants: Review compliance with financial covenants in the Note Purchase Agreement and Credit Agreement, particularly given the increased debt load.
• MDL Settlement: Track the outcome of the appeal regarding the Multi-District Litigation (MDL) settlement concerning contingent commissions, as a ruling is expected by year-end 2009.