Arthur J. Gallagher & Co. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted. Results are unaudited.
Business context
Gallagher provides insurance brokerage and consulting, third-party claims administration and risk management services. Its reportable segments are brokerage, risk management and corporate; corporate includes debt costs and clean-energy investments. The company operates internationally and generally does not assume insurance underwriting risk.
Financial results and key metrics
| Metric | Q1 2020 | Q1 2019 | Change / context |
|---|---|---|---|
| Total revenue | $1,866.9 | $1,990.6 | Down 6.2%; prior-year results included substantially higher clean-coal revenue and a $57.1 divestiture gain. |
| Revenue before reimbursements | $1,829.2 | $1,957.5 | Down 6.6%, largely reflecting clean-energy activity. |
| Net earnings attributable to controlling interests | $346.3 | $334.1 | Up 3.7%. |
| Diluted EPS | $1.79 | $1.77 | Up 1.1%. |
| Adjusted diluted EPS (non-GAAP) | $1.83 | $1.63 | Up 12%; management’s adjusted measure excludes specified items. |
| Operating cash flow | $108.6 | $(96.2) | Improved; cash flow is affected by timing of client fiduciary balances and other working-capital movements. |
| Cash and cash equivalents | $352.8 | $604.8 at Dec. 31, 2019 | Restricted cash of $2,280.4 is separately reported and is not available for general liquidity. |
| Corporate and other debt, net of issuance costs | $4,892.7 | $4,606.7 at Dec. 31, 2019 | Increased during the quarter; includes corporate borrowings and premium-financing debt. |
| Common dividend declared per share | $0.45 | $0.43 | Q1 declaration increased 5% year over year. |
Brokerage revenue was $1,435.6, up 4%; organic revenue grew 3.1%. Brokerage adjusted EBITDAC was $495.5, up 6%, while adjusted margin declined to 34.5% from 35.7%. Risk-management revenue before reimbursements was $211.8, up 4%; organic revenue grew 4.1%. Its adjusted EBITDAC was $35.3, up 3%, with adjusted margin of 16.7% versus 17.1%.
Consolidated interest expense rose to $50.5 from $40.2, and amortization increased to $135.6 from $76.5, including the effect of acquired intangibles and an impairment. The reported income-tax provision was $0.6, compared with a $29.9 benefit in Q1 2019; the unusually low consolidated effective tax rate reflected clean-energy tax credits.
Material changes and unusual items
- Clean-coal activity revenue fell to $181.8 from $372.3. Costs of that activity also fell, to $185.4 from $382.5. Q1 2019 additionally included the $57.1 divestiture gain.
- Brokerage commissions and fees benefited from acquisitions, new business and renewal rate increases. Organic base commission and fee growth was 3.8%, compared with 4.8% a year earlier; contingent revenues declined 9.6% organically.
- The company recorded $45.8 of amortizable-intangible write-offs following impairment reviews; none were reported in the comparable 2019 quarter.
- Changes in acquisition earnout estimates produced $99.6 of income, compared with $2.7 in Q1 2019, partly offset by discount-accretion expense. The filing attributes significant estimate changes to revised expectations related to COVID-19.
- Foreign-currency translation and derivative fair-value changes reduced comprehensive earnings attributable to controlling interests to a loss of $126.4, versus earnings of $397.8 in Q1 2019. These items were recorded in other comprehensive income, not net earnings.
- The company completed eight acquisitions, with estimated annualized acquired revenue of $124.2. It issued shares in connection with acquisitions and slowed its acquisition program amid economic uncertainty.
COVID-19, outlook and risks
- Management estimated a net $42.2 reduction in revenue and a $1.2 reduction in net earnings from COVID-19-related effects in Q1; the estimated EBITDAC effect was a $47.8 reduction. The estimate reflected lower expected commissions and fees, lower claims activity, increased bad-debt estimates, intangible impairment and revised earnout estimates. These are management estimates and may change.
- More than 99% of staff were working remotely; management said service levels were substantially unchanged. It planned discretionary-spending reductions, hiring and wage constraints, and workforce actions expected to affect less than 4% of global employees. Such actions could cost about $30 in the following three quarters; management estimated potential savings of $50–$75 per quarter.
- Management reported approximately $1.1 billion of available liquidity at April 30, 2020. It cited slightly slower April cash receipts and planned expense reductions, lower non-client-facing capital spending and working-capital measures. It also stated cash flows and borrowings were expected to support liquidity needs.
- No specific company-wide earnings or revenue guidance was provided. Management expected commercial property/casualty rate increases to continue through 2020, while warning that falling client exposure units, unemployment and economic contraction could weigh on revenues. It expected insurance-market capacity to remain adequate, based on conditions then observed.
- Management estimated 2020 adjusted net earnings from clean-energy investments of $70–$90, while noting lower coal-generated electricity use and low natural-gas prices could reduce production and earnings. Tax-credit eligibility for the 2009-era plants expired in 2019; the 2011-era plants’ eligibility was expected to expire in 2021.
- Key risks include the pandemic’s duration and economic effects, client solvency and collectability, premium grace periods or mandated coverage changes, reduced claims and exposure units, delayed acquisitions, cyber and work-from-home risks, clean-energy tax-credit and production uncertainty, and litigation and regulatory matters. The IRS was investigating the company’s micro-captive advisory services; related client audits and an appealed class-action matter were unresolved. The filing said potential losses could not be reasonably estimated.
Most important facts for investors to verify
- Whether COVID-19 revenue, bad-debt, impairment and earnout estimates prove accurate as the economic downturn develops.
- Whether organic brokerage growth, retention, pricing and client exposure trends sustain revenue, particularly in contingent commissions and affected industries.
- How much of reported earnings and cash flow depends on clean-energy operations and tax credits, and the timing of their expiration and related cash effects.
- Debt maturities, covenant headroom and liquidity: the filing reports $4.9 billion of net corporate and other debt, $352.8 million of unrestricted cash at quarter-end, and $903 million available under the credit agreement at March 31.
- Developments in the IRS micro-captive investigation, related litigation, and other legal or regulatory contingencies for which outcomes and potential losses remain uncertain.
- That adjusted EPS, adjusted EBITDAC and organic revenue are non-GAAP measures; compare them with GAAP results and review the company’s stated adjustments.