Arthur J. Gallagher & Co. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with Q1 2018 unless stated otherwise. Gallagher provides insurance brokerage, consulting and third-party claims administration services. The filing is unaudited.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenues | $1,990.6 million | $1,837.7 million | +8.3% |
| Revenues before reimbursements | $1,957.5 million | $1,802.9 million | +8.6% |
| Net earnings | $351.7 million | $286.0 million | +23.0% |
| Net earnings attributable to controlling interests | $334.1 million | $273.7 million | +22.1% |
| Diluted EPS | $1.77 | $1.48 | +19.6% |
| Cash used by operating activities | $96.2 million | $217.6 million | Use decreased |
| Capital expenditures | $39.3 million | $31.1 million | +$8.2 million |
| Net corporate and other debt | $4,185.1 million | $3,610.4 million | +$574.7 million |
Brokerage revenues were $1,381.9 million, up 16%; organic revenue growth was 5.7%. Brokerage adjusted EBITDAC was $471.9 million, up 15%, and its adjusted margin was 35.6%, compared with 35.0%. Risk management revenues before reimbursements were $203.3 million, up 4%; organic growth was 4.1%. Adjusted EBITDAC was $34.5 million, up 10%, and adjusted margin was 17.0%, compared with 16.4%. These segment EBITDAC and adjusted measures are non-GAAP.
Reported operating cash flow was negative, as is typical in the first quarter, partly due to timing of fiduciary receipts and payments, receivables, incentive compensation and benefits. Cash and cash equivalents were $871.5 million at March 31; an additional $1,669.3 million was restricted cash and should not be treated as available corporate liquidity. The company reported $260.0 million drawn on its credit agreement, with $523.0 million available, and stated it was in compliance with debt covenants.
Material changes and unusual items
- Brokerage commissions rose $101.0 million; supplemental revenues increased 9.0% and contingent revenues 37.5%. Organic base commissions and fees grew 4.8%. Management attributed growth to new business, renewal rate increases and acquisitions; new business and renewal increases were partly offset by lost business.
- A $57.1 million net gain on divestitures, versus $2.9 million a year earlier, included a one-time gain equivalent to $0.17 of diluted EPS from the sale of a travel insurance brokerage and four smaller operations. This materially benefited reported results.
- Clean-coal activity generated $372.3 million of revenue, down from $412.2 million, and had costs of $382.5 million. The corporate segment reported a pretax loss of $112.6 million. Clean-energy investments produced $61.5 million of after-tax net earnings, versus $52.5 million.
- The consolidated income tax benefit was $29.9 million. Gallagher reported $101.1 million of IRC Section 45 tax credits recognized in Q1, compared with $94.6 million; it said the credits were a principal reason for the unusually low consolidated effective tax rate.
- Debt increased following $600 million of senior note issuance in February and March. Total corporate and other debt was $4,192.8 million before unamortized debt costs, including $3,798.0 million under note purchase agreements. Interest expense rose to $40.2 million from $31.3 million.
- Gallagher completed 11 acquisitions in Q1, with recorded purchase consideration of $267.8 million and approximately $71.2 million in annualized acquired revenues. It issued about 452,000 shares in connection with the acquisitions.
Outlook, commentary and risks
- Management expected modest increases in U.S. retail property/casualty rates and exposures in 2019, with improving conditions in London Specialty, Australia and New Zealand. It cited employment growth and benefits complexity as supportive of employee-benefits demand. The Q1 industry pricing survey was not yet available.
- Management estimated 2019 after-tax earnings from clean-energy investments of $104.5 million to $114.5 million and anticipated positive net cash flow for 2019; it cautioned that production, utility demand, operating costs, weather, regulation and tax law could change results. Section 45 credits substantially expire in 2019 for 2009-era plants and in 2021 for 2011-era plants.
- Management expected approximately $125 million of 2019 capital expenditures and said operating cash flow and credit facilities should provide adequate liquidity. It anticipated annualized 2019 dividend cash use of approximately $318 million; the board announced a Q2 dividend of $0.43 per share. No broader earnings or EPS guidance was provided in the filing.
- Stackhouse Poland, for approximately $350 million cash, closed on April 5, 2019. The planned acquisition of JLT’s global aerospace operations for £130 million upfront plus up to £60 million contingent consideration was subject to regulatory approval and expected to close in Q2 2019.
- Key disclosed exposures include the IRS investigation of micro-captive services and audits of more than 100 client captives, a related class-action lawsuit seeking unspecified damages, and patent litigation involving refined-coal facilities. Gallagher said outcomes and potential financial effects could not be determined. It also disclosed $108.0 million of exposure relating to previously earned tax credits; no reserve was recorded.
- Other stated risks include acquisition integration and earnout obligations, insurance-market and competitive conditions, foreign exchange, cybersecurity, regulation and litigation, clean-energy tax-credit eligibility, and the company’s substantial debt. The filing cautions that quarterly results may not indicate full-year results.
Important facts for investors to verify
- How much earnings and EPS growth came from the $57.1 million divestiture gain and clean-energy tax credits, versus recurring brokerage and risk-management operations.
- Whether brokerage organic growth and risk-management fee growth continue, and how contingent and supplemental revenue variability affects results.
- Acquisition integration, financing and earnout performance, including the completed Stackhouse Poland deal and the pending JLT aerospace transaction.
- Cash conversion and debt-service capacity: operating cash flow was negative in Q1, net debt rose, and restricted client cash is not freely available.
- Developments in the micro-captive IRS investigation and class action, refined-coal patent litigation, and the $108.0 million tax-credit exposure.
- Clean-energy production, tax-credit utilization and expiry assumptions underpinning management’s 2019 earnings and cash-flow estimates.