Arthur J. Gallagher & Co. annual report, FY2021

Arthur J. Gallagher & Co. — FY2021 Form 10-K

Reporting period: Fiscal year ended December 31, 2021; comparisons are principally with FY2020. Gallagher provides insurance brokerage and consulting, and third-party claims administration. It reports brokerage, risk management and corporate segments. It generally does not assume net underwriting risk.

Financial performance

Metric	FY2021	FY2020	Change / context
Total revenue, including reimbursements	$8.209 billion	$7.004 billion	Up 17%
Revenue before reimbursements	$8.076 billion	$6.852 billion	Up 18%
Net earnings attributable to controlling interests	$906.8 million	$818.8 million	Up 11%
Diluted GAAP EPS	$4.37	$4.20	Up 4%
Adjusted diluted EPS (non-GAAP)	$5.48	$4.81	Up 14%
Cash provided by operating activities	$1.704 billion	$1.807 billion	Down $103 million
Capital expenditures	$128.6 million	$99.3 million	Up $29.3 million

• Brokerage: Revenue was $5.968 billion, up 15%; organic revenue growth was 8%. Net earnings were $1.017 billion, up 17%. Adjusted EBITDAC margin rose to 33.9% from 32.7%.
• Risk management: Revenue before reimbursements was $967.6 million, up 18%; organic growth was 12.2%. Net earnings rose 34% to $89.5 million. Adjusted EBITDAC margin before reimbursements improved to 19.1% from 18.2%.
• Corporate: Reported a $151.1 million net loss, compared with a $74.8 million loss in 2020. Segment results include debt costs, acquisition-related items and clean-energy operations.
• Margins and tax: Consolidated pretax earnings were $975.1 million, versus $870.9 million. The reported effective tax rate was unusually low at 2.1%, largely reflecting clean-energy tax credits; it is not representative of the brokerage segment’s 24.4% effective rate.

Balance sheet, debt and liquidity

• At year-end, total assets were $33.345 billion and total liabilities were $24.785 billion. Cash and cash equivalents were $402.6 million; an additional $4.064 billion of restricted cash was held principally in a fiduciary capacity and is not generally available for corporate use.
• Gross corporate and other debt was $6.321 billion ($6.284 billion net of specified discounts and issuance costs), up from $4.552 billion gross at year-end 2020. The increase primarily funded the Willis reinsurance acquisition. Interest expense increased to $226.1 million from $196.4 million.
• The company had $45 million drawn on its $1.2 billion revolving credit facility, with $1.141 billion available, and reported compliance with debt covenants. Management said it had sufficient capital and access to capital to meet short- and long-term cash needs.
• Dividends declared were $1.92 per share, or $396.2 million, compared with $1.80 per share in 2020. A first-quarter 2022 dividend of $0.51 per share was announced. No common shares were repurchased under the company’s repurchase plan in 2021.

Material changes and notable items

• On December 1, 2021, Gallagher acquired substantially all of Willis Towers Watson’s treaty reinsurance brokerage operations for initial gross consideration of $3.25 billion. Up to $750 million of additional consideration may be payable in 2025 based on 2024 revenue targets. Twelve international closings, representing about $180 million of initial consideration, remained subject to regulatory approvals and were expected in the first half of 2022.
• Gallagher financed the acquisition using cash, a May 2021 stock offering that generated $1.438 billion net, new senior notes and short-term borrowings. The acquisition’s purchase accounting remained provisional; acquired operations were included only from their respective closing dates.
• Gallagher completed 38 acquisitions in 2021, versus 27 in 2020. Acquired businesses had estimated annualized revenue of approximately $1.002 billion. Goodwill rose to $8.666 billion from $6.127 billion, and net amortizable intangible assets rose to $3.954 billion from $2.400 billion.
• Section 45 clean-energy tax-credit eligibility expired for the remaining plants on December 31, 2021. Gallagher generated $193.4 million of these credits in 2021 and reported $1.051 billion of unused credits available to offset future federal tax liabilities. Management did not expect clean-energy revenue or earnings in 2022 absent legislative reinstatement, but anticipated potential positive cash flow from using existing credits through at least 2027, subject to conditions.
• Operating cash flow declined despite higher earnings, reflecting, among other items, increased tax payments, acquisition earnout payments and debt interest, as well as working-capital timing. The company said approximately $106 million of 2021 tax prepayments related to tax-method changes represented payments otherwise expected in future periods, not additional taxes due.

Outlook, risks and contingencies

• Management expected continued organic growth opportunities, supported by improving client business conditions, new business, retention and a firming insurance pricing environment. It expected property/casualty rates to continue rising in 2022, but noted growth could soften if the recovery slowed or reversed.
• Management expected higher brokerage costs in 2022 than in 2021 as activity normalized and investments continued. It estimated 2021’s incremental brokerage costs from returning activity and other items at $15 million, $25 million and $30 million in the second, third and fourth quarters, respectively, compared with the corresponding 2020 quarters.
• Key risks include acquisition integration, client and employee retention, deferred regulatory approvals, higher debt and financing constraints, competition for acquisitions and talent, insurance pricing and premium cycles, variable contingent revenues, inflation, COVID-19 effects, cybersecurity and data privacy, foreign exchange, and international regulatory compliance.
• The filing describes ongoing IRS reviews of the company’s micro-captive advisory business, under audit since 2013; Gallagher said it was cooperating, was not a target of the related criminal investigation, and did not expect losses to be material. Several Section 45 operations were also under IRS audit, and the company disclosed a pending patent-infringement suit concerning clean-coal technology, which it said it was defending and considered unlikely to result in a material loss.
• Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management’s ICFR assessment excluded 24 of the 38 businesses acquired in 2021, which represented about 9.8% of year-end assets and 0.6% of revenue.

Investor verification priorities

• Track Gallagher Re integration, client and employee retention, final purchase accounting, deferred closings, and whether acquisition targets support the expected returns and potential earnout.
• Reconcile GAAP results with adjusted EPS and adjusted EBITDAC, reviewing the nature and recurrence of excluded acquisition, transaction, legal, tax and other adjustments.
• Assess debt service and refinancing needs alongside acquisition spending, dividends, available revolver capacity, and the distinction between unrestricted and fiduciary restricted cash.
• Verify the realization and timing of unused Section 45 credits, related IRS audit outcomes, and the business and cash-flow consequences of the credit program’s expiration.
• Monitor organic growth, insurance rate and exposure trends, contingent and supplemental revenue variability, operating-cost normalization, and cash conversion.
• Review legal and regulatory developments, including micro-captive matters, the patent litigation, cybersecurity and privacy exposure, and the acquired businesses’ controls and compliance.