Principal Financial Group, Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Unaudited consolidated results; amounts are in millions except per-share data. Principal provides retirement and investment services, asset management, international savings and insurance, and U.S. insurance products.
Financial results
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $2,606.7 | $2,210.6 | $5,085.3 | $4,377.3 |
| Income before taxes | $407.5 | $265.6 | $783.9 | $493.8 |
| Net income | $319.2 | $236.6 | $643.3 | $426.6 |
| Net income available to common stockholders | $306.3 | $222.3 | $600.0 | $400.6 |
| Diluted EPS | $1.03 | $0.75 | $1.98 | $1.35 |
| Segment operating earnings | $323.1 | $271.4 | $640.2 | $504.7 |
| Operating cash flow | — | $1,377.3 | $783.6 |
- Revenue rose approximately 18% in Q2 and 16% in the first half year over year. Common-stockholder income rose approximately 38% and 50%, respectively.
- Reported earnings benefited from improved realized investment results: net realized capital gains were $86.8 in Q2 and $87.4 in H1, compared with losses of $80.1 and $131.0 in the comparable 2013 periods.
- Q2 segment operating earnings increased to $323.1, led by Retirement and Investor Services ($212.1 versus $172.3) and Principal International ($68.0 versus $58.3). Principal Global Investors declined to $27.4 from $29.0; U.S. Insurance Solutions increased to $49.0 from $47.2.
- At June 30, total assets were $218.3 billion and total stockholders’ equity was $10.5 billion. Separate-account assets and liabilities were each $139.1 billion; clients direct those investments and bear their investment risk.
- Cash and cash equivalents were $1.7 billion, down from $2.4 billion at year-end 2013. Total debt was $2.68 billion, down from $2.75 billion; debt-to-equity excluding AOCI was 27%, versus 29%.
- H1 operating, investing and financing cash flows were respectively $1.38 billion provided, $496.6 million used and $1.51 billion used. Operating cash generation improved year over year; financing outflows included $176.8 million of common dividends and $149.8 million of share repurchases.
- Investment income was $829.0 in Q2 and $1.67 billion in H1. Net investment yield was 4.9% and 5.0%, respectively, compared with 4.4% and 4.5% a year earlier.
Material changes and management commentary
- Management attributed revenue and earnings growth to business expansion, positive equity-market effects on accumulation fees, growth in payout annuities, the Cuprum acquisition, and higher Chilean inflation-linked investment returns. Realized gains also reflected derivatives and real-estate sales.
- Higher benefits and claims partly offset revenue growth, including increased payout-annuity reserves, higher inflation-linked crediting in Chile, and higher mortality in U.S. insurance. Operating costs also rose in several businesses, including distribution and sub-advisory expenses.
- Foreign-exchange movements reduced Principal International operating earnings by $8.7 in Q2 and $17.7 in H1. A 10% adverse currency move was estimated to reduce international operating earnings by $7.6 for Q2 and $14.6 for H1.
- Management reported no material change to the risk factors in the 2013 Form 10-K and did not provide a specific earnings or revenue forecast in the supplied filing text. It said available operating cash, borrowing facilities and capital-market access were expected to meet current liquidity needs and reasonably foreseeable contingencies.
Outlook, risks and unusual items
- Tax ruling: A May 2014 court ruling against Principal Life on timing of gains and losses from principal-only certificates prompted a reassessment of uncertain tax positions and reduced Q2 net income by $47.5. Unrecognized tax benefits were $171.8 at June 30, with $99.8 of accumulated pre-tax interest and penalties.
- Investment and market risk: A hypothetical immediate 100-basis-point rise in rates indicated a $2.24 billion net fair-value loss at June 30, versus $1.85 billion at year-end; management said this sensitivity is not a forecast and excludes some insurance liabilities. A hypothetical 10% equity-market decline followed by 2% quarterly recovery was estimated to reduce annual operating earnings by 4%–6%.
- Liquidity and capital: $900 million of committed revolving facilities backstop the commercial-paper program; $148.6 million was drawn at quarter-end. Principal Life’s 2014 dividend limit was approximately $687.2 million, of which $300 million had been paid by June 30. Holding companies had $390.9 million of cash and highly liquid assets.
- Benefits: Expected 2014 pension expense was $85.1, down from $143.3 in 2013. The qualified-plan minimum required contribution for 2014 was zero, although the company said it might contribute a combined $125–$175 million to qualified and nonqualified plans.
- Legal and contingent exposures: The filing describes ERISA and investment-fee lawsuits and a stayed Lehman bankruptcy claim seeking approximately $500 million from Principal Life. No losses were accrued for the discussed matters because management considered losses not probable and not reasonably estimable. Guarantees to third parties had maximum exposure of approximately $284 million; the future maximum exposure under Chile’s regulatory pension-fund return guarantee was indeterminable.
- Management cited low interest rates, rising-rate-driven withdrawals, credit and valuation uncertainty, equity-market declines, foreign-exchange changes, insurance guarantees, litigation, regulation, tax matters, and reinsurer or operational risks as potential sources of adverse results. Fitch affirmed ratings and revised its outlook to stable; S&P affirmed ratings with a stable outlook.
Investor verification priorities
- Separate recurring segment operating performance from volatile realized gains and the $47.5 tax-related charge; reconcile these items to reported common earnings.
- Review the court ruling, uncertain-tax-position balance and interest and penalties, including any appeal or subsequent developments.
- Assess investment portfolio credit quality, long-duration unrealized losses, mortgage exposures, and the assumptions behind fair values and impairment estimates.
- Confirm holding-company liquidity, insurance-subsidiary dividend capacity, debt maturities, and the potential pension contributions.
- Track the Lehman claim, ERISA and fee litigation, and the Chilean minimum-return guarantee for changes in probability, estimability or exposure.