Arthur J. Gallagher & Co. — FY 2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011; comparisons are primarily with FY 2010. The company provides insurance brokerage and third-party claims administration, without assuming insurance underwriting risk. Brokerage, risk management and corporate contributed approximately 73%, 26% and 1% of 2011 revenue, respectively.
Financial performance and liquidity
| Metric | FY 2011 | FY 2010 | Change |
|---|---|---|---|
| Revenue | $2,134.7 million | $1,864.2 million | +14.5% |
| Expenses | $1,926.9 million | $1,661.2 million | +16.0% |
| Pretax earnings | $207.8 million | $203.0 million | +2.4% |
| Earnings from continuing operations | $144.1 million | $163.3 million | -11.8% |
| Net earnings | $144.1 million | $174.1 million | -17.2% |
| Diluted EPS from continuing operations | $1.28 | $1.56 | -17.9% |
| Cash provided by operations | $283.1 million | $231.8 million | +22.1% |
Revenue growth included acquisitions and organic improvement. The company reported 3.1% organic growth in brokerage commissions, fees and supplemental commissions, and 9.4% organic growth in risk management revenue. Combined brokerage and risk management adjusted EBITDAC rose 18%; these are non-GAAP measures. Pretax margin was approximately 9.7%, versus 10.9% in 2010.
- Revenue mix: Brokerage revenue was $1,556.5 million, up 16%; risk management revenue was $548.8 million, up 19%. Corporate revenue fell to $29.4 million from $61.5 million, primarily reflecting lower clean-coal activity.
- Cash and debt: Cash and cash equivalents were $291.2 million; restricted cash of $692.5 million is held in fiduciary or otherwise restricted capacity. Debt was $685 million, including $675 million under fixed-rate note agreements and $10 million under the revolving credit facility. Revolver availability was $474.1 million; the company reported compliance with debt covenants.
- Balance sheet: Total assets were $4,483.5 million and stockholders’ equity was $1,243.6 million. Goodwill and net amortizable intangible assets totaled approximately $1,716.8 million.
- Investment and distributions: Capital expenditures were $40.0 million; management expected approximately $55.0 million in 2012. Cash dividends declared were $1.32 per share for 2011; a $0.34 quarterly dividend for Q1 2012 was announced.
Material changes versus FY 2010
- Acquisition activity increased: 32 acquisitions in 2011, with approximately $277 million in acquired annualized revenue; cash paid for acquisitions was $264.3 million. Heath Lambert, acquired in May, added $85.8 million of 2011 revenue and had $12.3 million of adjusted EBITDAC excluding integration costs.
- International revenue share increased to 19% from 13%, principally reflecting U.K. operations and acquisitions.
- Continuing-operations earnings declined despite higher revenue and pretax earnings. The reported consolidated effective tax rate rose to 30.7% from 19.6%; FY 2010 benefited from $30.7 million of reductions in unrecognized tax benefits, including a $29.3 million net earnings benefit following completion of IRS examinations.
- Operating cash flow increased, while investing cash use rose sharply due mainly to acquisitions. Long-term debt increased by $125 million following a 2011 note issuance.
- The pension plan’s underfunding worsened: the obligation was $267.1 million against plan assets of $202.9 million, a $64.2 million shortfall versus $20.3 million in 2010. The principal reported driver was a lower discount rate.
Outlook, risks and unusual items
Management provided no specific consolidated revenue or earnings guidance. It expected continued growth from organic activity and acquisitions, anticipated further international revenue growth in 2012, and projected segment effective tax rates of approximately 38%–40% for the foreseeable future. Management also expected Section 45 clean-energy tax credits to reduce tax payments and cited a favorable long-term earnings trend; these expectations are subject to significant execution, regulatory and tax uncertainties.
- Insurance-market and economic exposure: Brokerage commissions depend in part on premiums, which are cyclical. Management noted improving commercial property/casualty pricing late in 2011, but sluggish demand and economic weakness could constrain coverage purchases, claims volumes and future revenues.
- Clean-energy investments: Tax-credit eligibility depends on statutory and operating conditions, utility purchase commitments, permits, coal demand and successful plant operations. Several plants were idle at year-end; the company’s estimated future quarterly earnings from projects are not assured. Environmental, product-liability and regulatory risks also apply.
- Legacy tax exposure: The filing disclosed maximum potential payments of approximately $195 million, net of tax benefit, under indemnifications relating to previously sold Section 29 investments, and exposure on $129.2 million of previously claimed credits. No liability was recorded for these contingent indemnification exposures.
- Other risks and items: Acquisition integration and earnout estimates, competition, contingent commissions, employee-benefit costs, international currency and regulatory risks, litigation/E&O claims, cybersecurity, and debt covenants may affect results. Brokerage intangible-asset write-offs were $4.6 million in 2011. The filing disclosed a prior attempted unauthorized system access that was prevented; management said it was unaware of a cybersecurity incident with a material operational effect.
- Controls and audit: The independent auditor issued unqualified opinions on the financial statements and internal control. Management’s control assessment excluded 13 of 32 acquired entities, which represented approximately 17.2% of year-end assets and 4.4% of revenue.
Important facts for investors to verify
- Whether organic growth and margins persist after separating acquisition contributions, integration costs and other non-GAAP adjustments.
- Whether Heath Lambert integration progresses as planned and the acquired operations deliver sustainable profitability.
- Whether clean-energy plants secure operating permits and long-term utility commitments, and whether Section 45 credits withstand tax and regulatory scrutiny.
- The potential cash, earnings and covenant implications of debt maturities, acquisition spending, dividends and the substantially underfunded pension plan.
- Developments in the legacy Section 29 tax indemnities and other legal, tax and E&O contingencies.