Arthur J. Gallagher & Co. quarterly report, Q3 FY2023

Arthur J. Gallagher & Co. — Q3 2023 Form 10-Q

Business context and reporting period

Quarter ended September 30, 2023; financial statements are unaudited. Gallagher provides insurance and reinsurance brokerage, consulting, and third-party claims services. Its reportable segments are brokerage, risk management, and corporate. Unless otherwise noted, financial amounts below are in millions of U.S. dollars.

Financial performance and liquidity

Metric	Q3 2023	Q3 2022	Nine months 2023	Nine months 2022
Total revenue, including reimbursements	$2,492.0	$2,044.0	$7,640.0	$6,522.3
Earnings before income taxes	$364.1	$315.0	$1,267.3	$1,205.0
Net earnings attributable to controlling interests	$280.7	$255.8	$1,001.7	$978.7
Diluted GAAP EPS	$1.28	$1.19	$4.58	$4.57
Cash provided by operating activities	Not reported for quarter	Not reported for quarter	$1,338.1	$782.1

Q3 revenue grew 22%; controlling-interest net earnings rose about 10%, and diluted GAAP EPS increased about 8%. Nine-month revenue increased about 17%, while controlling-interest earnings rose about 2% and GAAP EPS was essentially flat.
Management’s non-GAAP adjusted diluted EPS was $2.00 for Q3, up 19%, and $6.92 for nine months, up 14%. Adjusted measures exclude items including acquired-intangible amortization, acquisition integration expenses, earnout adjustments and certain legal/tax items; they are not GAAP results.
Q3 brokerage organic revenue growth was 9.3%; risk management organic fee growth was 17.9%. Adjusted EBITDAC margins were 32.4% for brokerage and 20.4% for risk management, compared with 31.9% and 18.2%, respectively, a year earlier.
Nine-month segment results: brokerage revenue was $6,585.7 and earnings before tax $1,535.4; risk management revenue was $1,053.8 and earnings before tax $151.8. Corporate reported a $419.9 pretax loss, versus $302.7 a year earlier.
Nine-month interest expense was $218.5, up from $192.9. Investment income increased to $242.2 from $79.1, primarily reflecting higher interest earned on funds.
Operating cash flow was $1,338.1; investing activities used $1,392.5, including $1,183.6 of net cash paid for acquisitions; financing activities provided $1,891.8. Operating cash flow comparisons are affected by working-capital timing and the reclassification of fiduciary cash flows to financing activities.
At September 30, cash and cash equivalents were $1,027.5, of which $857.6 was unrestricted and $169.9 restricted. Fiduciary assets and matching fiduciary liabilities were each $30,704.7; these client-related balances should not be treated as available corporate liquidity.
Net corporate and other debt was $6,727.6, including $279.0 of premium-financing debt; the company reported no borrowings under its revolving credit agreement at quarter-end, with $1,189.1 available after letters of credit. Total liabilities of $42,693.9 include substantial fiduciary liabilities.
Stockholders’ equity was $10,510.0. The company declared $0.55 per common share for Q3; nine-month dividends declared were $358.2.

Material changes versus prior periods

Growth reflected both organic expansion and acquisitions. Gallagher completed 37 acquisitions in the first nine months, with approximately $475.3 of annualized acquired revenue; the recorded aggregate purchase price was $1,657.8. The Buck acquisition closed in April.
Goodwill increased to $10,469.4 from $9,489.4 at year-end 2022, primarily due to acquisitions. Amortization expense rose to $385.3 for the nine months from $337.5.
In March, Gallagher issued $950.0 of unsecured senior notes: $350.0 at 5.50% due 2033 and $600.0 at 5.75% due 2053. The company also replaced its revolving credit agreement with a new five-year, $1,200.0 unsecured facility.
Q3 reported compensation expense increased to $1,424.5 from $1,181.8 and operating expense to $423.0 from $321.5, alongside higher revenue and acquisition-related costs. The brokerage segment’s nine-month reported net earnings margin declined to 17.4% from 18.9%, while its adjusted EBITDAC margin edged up to 35.2% from 34.9%.
Gallagher changed presentation of fiduciary assets and liabilities and moved their net cash-flow change from operating to financing activities. Prior periods were recast; the change did not affect earnings or total cash-flow change.

Outlook, commentary, risks and unusual items

Management cited continued strong brokerage retention, new business and renewal premiums, and expects favorable trends to continue into Q4, while warning that weaker economic conditions could soften growth. The latest available industry survey showed commercial P&C rates up 8.9% in Q2; management expected a similar Q3 trend and anticipated rate increases could continue through 2023 and potentially 2024.
Risk management reported stronger new claims arising from clients added in 2022 and 2023; management expected favorable trends to continue, subject to economic conditions and employment levels.
No specific consolidated earnings or revenue guidance was provided in the supplied filing text. Management said it expects sufficient capital and access to capital to meet short- and long-term needs, and projected approximately $200.0 in 2023 capital expenditures.
Management expected brokerage and risk management effective tax rates of approximately 24.5%–26.5% and 25%–27%, respectively. It anticipated positive net cash flow from legacy Section 45 tax-credit activity in 2023, but said the timing and amount are difficult to predict; the credit-generating program has expired.
Acquisition-related earnouts are a significant source of estimation volatility: maximum potential obligations were $1,915.7, of which $899.0 was recorded at fair value. Changes in earnout estimates affected earnings; nine-month corporate results also reflected higher interest and corporate costs.
After quarter-end, Gallagher agreed to acquire Cadence Insurance for approximately $749 and Eastern Insurance for approximately $510, subject to closing conditions and regulatory approval; both were expected to close in Q4 2023. Cadence integration and expected non-cash retention costs were estimated at $70 over three years.
Disclosed legal and regulatory matters include a DOJ investigation concerning insurance business with public entities in Ecuador, an IRS audit of the company’s micro-captive advisory business, and a patent litigation matter scheduled for trial in November 2023. Gallagher said it is cooperating or defending the matters and currently believes the proceedings will not materially harm its financial position, results or cash flows. It also disclosed $108.0 of exposure to previously earned tax credits, with no reserve recorded.
Other risks include acquisition integration and earnout estimates, debt and interest rates, currency movements, cyber incidents, talent and compensation costs, insurance-market conditions, and contingencies. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Reconcile GAAP EPS growth with adjusted EPS growth and assess the recurring nature of adjustments, especially amortization, integration costs, legal/tax items and earnout revaluations.
Track organic brokerage and risk-management growth, segment margins, compensation and operating-cost trends, and whether reported growth continues to depend materially on acquisitions.
Review acquisition integration progress, the Cadence and Eastern closing terms and costs, and the scale, settlement options and estimate sensitivity of earnout obligations.
Assess debt maturities, refinancing costs, covenant headroom and available liquidity; distinguish unrestricted cash from restricted and fiduciary balances.
Monitor cash conversion and working-capital movements, since fiduciary cash-flow presentation changed and reported operating cash flow can be affected by timing.
Follow the disclosed DOJ, IRS, patent, E&O reserve and legacy tax-credit matters for subsequent developments or changes in estimated exposure.