Principal Financial Group, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; unaudited. Comparisons are with Q1 2012 unless noted. Amounts are in millions of dollars except per-share data.
Business context
Principal provides retirement and investor services, asset management, international retirement and financial products, and U.S. insurance. Its reportable segments are Retirement and Investor Services, Principal Global Investors, Principal International, U.S. Insurance Solutions, and Corporate.
Financial results and position
| Metric | Q1 2013 | Q1 2012 / prior date |
|---|---|---|
| Total revenue | $2,166.7 | $2,095.9 |
| Income before tax | $228.2 | $278.0 |
| Net income | $190.0 | $221.3 |
| Net income available to common stockholders | $178.3 | $203.9 |
| Diluted EPS | $0.61 | $0.68 |
| Operating cash flow | $595.9 | $901.7 |
| Cash and cash equivalents, March 31 | $1,661.2 | $4,177.2 at Dec. 31, 2012 |
| Total assets, March 31 | $200,762.9 | $161,830.2 at Dec. 31, 2012 |
| Total debt, March 31 | $2,837.0 | $2,712.1 at Dec. 31, 2012 |
| Stockholders’ equity, March 31 | $9,826.6 | $9,703.4 at Dec. 31, 2012 |
Total revenue increased 3.4%, while net income available to common stockholders declined 12.6%. Income before tax as a percentage of revenue was approximately 10.5%, versus 13.3% a year earlier. Net investment income was $789.3, down from $824.8; net realized capital losses were $50.9, versus $6.7. Benefits and claims expenses fell to $1,094.5 from $1,212.5, while operating expenses rose to $795.7 from $555.1.
Management-defined segment operating earnings totaled $233.3, up from $215.3. Retirement and Investor Services earned $170.0 (up from $143.6); Principal Global Investors $20.3 (up from $16.2); Principal International $44.6 (up from $44.1); U.S. Insurance Solutions $35.7 (down from $50.2); and Corporate recorded a loss of $37.3 (versus $38.8). Segment operating earnings are a non-GAAP measure and do not equal consolidated net income.
Operating cash flow was positive, but investing activities used $1,525.4 and financing activities used $1,586.5. The net cash decrease of $2,516.0 primarily reflects the Cuprum acquisition, investment activity, and net investment-contract withdrawals. Total assets rose substantially, largely because the acquisition brought in consolidated Chilean retirement savings funds: $33,892.2 of separate account assets and an equal liability. These pass-through balances do not represent equivalent freely available corporate assets.
Long-term debt was $2,790.5 and short-term debt $46.5. Debt was 31% of equity excluding accumulated other comprehensive income, versus 30% at year-end. Management reported $386.7 of excess capital in the holding companies. Available short-term credit facilities totaled $613.0; $46.5 was outstanding. The filing says the $800 million commercial-paper backstop was fully supportive of the program; commercial paper outstanding was zero.
Material changes and unusual items
- Principal acquired a 91.55% interest in Chilean pension manager AFP Cuprum on February 4 for approximately $1.3 billion. Cuprum added $34.3 billion of assets under management and contributed $18.3 of revenue and $9.3 of net income from acquisition through March 31. Acquisition cash outflow, net of cash acquired, was $1,268.3. The purchase accounting included $646.3 of goodwill and $678.7 of other intangibles.
- Principal Global Investors’ assets under management increased to $273.0 billion from $242.2 billion a year earlier. Principal International AUM increased to $107.4 billion from $59.2 billion, including $34.3 billion from Cuprum.
- Reported U.S. Insurance Solutions comparisons were affected by a 2012 change in individual-life deferred acquisition cost and actuarial-balance amortization. The prior-year unlocking reduced fees by $46.6, increased benefits by $87.9, and reduced operating expenses by $139.6; the net after-tax gain was $3.3. This makes the year-over-year expense and fee movements less directly comparable.
- The company revised prior-period accounting for Mexico’s AFORE retirement accumulation business, changing it from insurance accounting to long-term service-contract accounting. Management said prior-period effects were not material and did not require amendments to previously filed reports.
- Quarterly common dividend paid was $0.23 per share, up from $0.18 a year earlier. The company repurchased $90.9 of common stock in the quarter.
Outlook, risks, and contingencies
The filing provides no specific earnings or revenue guidance. Management cautions that first-quarter results are not necessarily indicative of full-year results. It cites sustained low interest rates, equity and credit-market volatility, investment impairments and valuation uncertainty, policyholder behavior, foreign currency movements, acquisition and integration risks, and regulatory, tax, litigation, and operational risks.
A hypothetical immediate 100-basis-point parallel increase in interest rates produced an estimated net fair-value loss of $1,897.1, compared with $1,773.2 at year-end; this is a sensitivity illustration, not a forecast. Management estimated that a 10% immediate equity-market decline followed by 2% quarterly recovery would reduce annual operating earnings by approximately 4%–6%. A 10% adverse currency movement was estimated to reduce international operations’ equity by $327.9 and quarterly international operating earnings by $5.0.
Fitch affirmed Principal Life and Principal National Life’s financial strength ratings after the Cuprum deal but changed the outlook to negative, citing pressure on cash-coverage and debt metrics and acquisition-integration risk. Moody’s maintained a negative sector outlook; other cited agency outlooks varied.
Material disclosed matters include an investment-advisory fee lawsuit set for trial in June 2013, litigation concerning a U.S. property separate account, and a stayed Lehman-related claim seeking an unspecified amount, potentially up to approximately $440 million plus interest. No losses were accrued for the discussed legal matters because management considered loss not probable and not reasonably estimable; possible outcomes remain uncertain. Guarantees to third parties had maximum exposure of approximately $256 million, with material payment considered remote. The filing states there were no material changes to the risk factors in the 2012 Form 10-K and that disclosure controls were effective.
Investor verification priorities
- Review the Cuprum purchase accounting, integration progress, funding, and Fitch’s negative outlook rationale.
- Assess underlying earnings apart from realized investment and derivative losses, and account for the prior-year insurance-amortization unlocking when comparing expenses and fees.
- Monitor investment portfolio credit quality, long-duration unrealized losses, mortgage exposures, and assumptions used for impairments and Level 3 valuations.
- Reconcile the sharp cash decline with acquisition spending, investment-contract withdrawals, and available holding-company liquidity and credit facilities.
- Track interest-rate, equity-market, foreign-currency, and policyholder-withdrawal sensitivities, alongside legal and tax developments that the filing says cannot be reliably quantified.