Business context and reporting period
Principal Financial Group, Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2014. The company provides retirement and investment services, asset management, international financial products, and U.S. insurance products. Comparisons below are with the three months ended March 31, 2013, or with December 31, 2013, for balance-sheet figures.
Separate-account assets and liabilities were each $132.8 billion; the filing says clients direct these investments and bear the investment risk.
Key financial metrics
| Metric | Q1 2014 | Q1 2013 / prior year-end |
|---|---|---|
| Total revenue | $2,478.6 million | $2,166.7 million |
| Income before income taxes | $376.4 million | $228.2 million |
| Net income | $324.1 million | $190.0 million |
| Net income attributable to PFG | $301.9 million | $186.5 million |
| Net income available to common stockholders | $293.7 million | $178.3 million |
| Diluted earnings per share | $0.95 | $0.61 |
| Operating cash flow | $591.3 million | $595.9 million |
| Cash and cash equivalents | $1,393.1 million | $2,371.8 million at December 31, 2013 |
| Total assets | $211.2 billion | $208.2 billion at December 31, 2013 |
| Total stockholders’ equity | $10.1 billion | $9.8 billion at December 31, 2013 |
| Total debt | $2,664.8 million | $2,752.0 million at December 31, 2013 |
Revenue grew 14.4% year over year; net income available to common stockholders increased 64.7%. Approximate common-income margin was 11.8%, compared with 8.2% a year earlier. These are calculated as net income available to common stockholders divided by total revenue.
Net cash used in investing activities was $835.3 million, versus $1,525.4 million in Q1 2013. Net cash used in financing activities was $734.7 million, versus $1,586.5 million. The resulting decrease in cash was $978.7 million, compared with $2,516.0 million in Q1 2013. Financing cash flows included $1.32 billion of investment-contract deposits and $1.75 billion of withdrawals.
At March 31, debt to equity excluding accumulated other comprehensive income was 28%, versus 29% at year-end; debt to capitalization excluding that income was 22% at both dates. The company reported $380.3 million of cash and highly liquid assets readily deployable at the holding companies. It had $148.8 million of short-term debt and $2,516.0 million of long-term debt.
Material changes and operating performance
- All four operating segments reported higher operating earnings: Retirement and Investor Services, $216.5 million versus $170.0 million; Principal Global Investors, $26.9 million versus $20.3 million; Principal International, $63.3 million versus $44.6 million; and U.S. Insurance Solutions, $43.4 million versus $35.7 million. Corporate operating loss narrowed to $33.0 million from $37.3 million.
- Segment operating earnings totaled $317.1 million, up from $233.3 million. This non-GAAP measure is reconciled in the filing to common-stockholder income of $293.7 million; the filing adjusts for realized capital items and other items management considers not indicative of operating trends.
- Growth in Retirement and Investor Services reflected higher fees from increased account values and business growth, plus higher payout-annuity premiums. Principal Global Investors benefited from higher average assets under management (AUM); quarter-end AUM was $297.9 billion, up from $273.0 billion a year earlier.
- Principal International earnings benefited from the 2013 Cuprum acquisition and higher inflation-linked investment returns, partly offset by weaker Latin American currencies. The company estimated foreign-exchange movements reduced this segment’s operating earnings by $9.0 million in Q1 2014.
- U.S. Insurance Solutions earnings increased with specialty-benefits growth, lower staff-related costs, and higher investment yields. Benefits and claims expenses rose company-wide, primarily due to growth in payout annuities and specialty benefits.
- Net investment income rose to $844.7 million from $789.3 million. Management cited inflation-linked returns in Chile, the Cuprum acquisition, real-estate sale gains, and higher prepayment fees, partly offset by lower U.S. yields and currency weakness.
- Net realized capital gains were $0.6 million, versus a $50.9 million loss. Management attributed the improvement largely to the absence of 2013 foreign-currency translation losses on cash held for the Cuprum acquisition and lower credit-related losses.
Outlook, risks, contingencies, and unusual items
- The filing gives no specific consolidated earnings or revenue guidance. Management said 2014 pension expense was expected to be $85.1 million pre-tax, down from $143.3 million in 2013, largely due to a higher discount rate and better-than-expected 2013 asset returns. The company contributed $40.3 million to pension plans in Q1 and said it might contribute $125 million to $175 million to qualified and nonqualified plans in 2014, although the qualified plan’s minimum required contribution was zero.
- Management stated that operating cash flows, borrowing capacity, and capital-market access were expected to meet current liquidity needs and reasonably foreseeable contingencies. The company maintained committed revolving credit facilities totaling $900 million after refinancing in March 2014; these backstop its commercial-paper program.
- Principal Life redeemed $100 million of surplus notes on March 1, 2014, at 102.3% of par. The company also paid $82.7 million in common dividends and repurchased $89.0 million of common stock during the quarter. A new $200 million share-repurchase authorization was approved in February 2014.
- Market and investment risks include sustained low interest rates, interest-rate or credit-spread changes, equity and real-estate market declines, credit impairment, foreign-exchange movements, valuation assumptions, and possible policy surrenders or withdrawals. A hypothetical immediate 100-basis-point rise in rates produced an estimated $2.02 billion net fair-value loss at March 31, 2014; this is a sensitivity scenario, not a forecast. A hypothetical 10% equity-market decline was estimated to reduce annual operating earnings by approximately 4% to 6% under the assumptions described in the filing.
- Pending matters include a new putative ERISA class action filed in March 2014 and the Lehman bankruptcy estate’s claim seeking approximately $500 million, including interest. The company reported no accrual for these matters because management considered loss not probable and not reasonably estimable; management said litigation outcomes remain uncertain and estimates generally could not be made.
- Guarantees to third parties had a stated maximum exposure of approximately $252 million, with management describing the likelihood of material payment as remote. The filing also describes indemnifications whose maximum exposure could not reasonably be estimated.
- Moody’s had downgraded Principal Life’s financial-strength rating to A1 in November 2013, with a stable outlook; S&P affirmed Principal Life’s A+ rating and stable outlook in April 2014. Fitch’s outlook remained negative, citing Cuprum integration execution risk and leverage.
- The company converted to a new consolidation reporting tool during the quarter and called the change material to internal control over financial reporting. Management reported that implementation controls and testing were performed and concluded disclosure controls were effective. The filing reported no material changes to the stated risk factors.
Important facts for investors to verify
- Review whether earnings growth persists after separating segment operating performance from realized investment gains and other adjustments, and assess the effects of the prior-year Cuprum acquisition.
- Track cash balances, investment-contract withdrawals and deposits, committed credit availability, and holding-company liquidity relative to debt service, dividends, and repurchases.
- Assess portfolio credit quality and unrealized losses: available-for-sale fixed maturities had $534.6 million of gross unrealized losses at quarter-end, down from $806.6 million at year-end; management attributed the decrease to lower rates and spread improvement.
- Monitor Latin American currency exposure, Chilean inflation-linked returns, and the performance and integration of Cuprum.
- Follow developments in the ERISA and Lehman matters, as well as any changes to litigation estimates, guarantee exposure, or regulatory requirements.
- Confirm the assumptions behind pension contributions, rate and equity sensitivity estimates, and fair-value measurements, particularly those using significant unobservable inputs.