Arthur J. Gallagher & Co. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. Unless stated otherwise, dollar amounts are in millions. The company provides insurance brokerage and consulting, third-party claims administration, and clean-energy operations.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total revenue | $1,837.7 | $1,646.4 | +11.6% |
| Earnings before income taxes | $242.3 | $199.6 | +21.4% |
| Net earnings | $286.0 | $242.0 | +18.2% |
| Net earnings attributable to controlling interests | $273.7 | $228.8 | +19.6% |
| Diluted EPS | $1.48 | $1.27 | +16.5% |
| Operating cash flow | $(217.6) | $15.5 | — |
| Capital expenditures | $31.1 | $29.3 | — |
- The income tax line was a benefit of $43.7, versus a $42.4 benefit in Q1 2017; the reported effective consolidated tax rate was negative 18.0%, principally reflecting Section 45 clean-coal credits.
- Cash and cash equivalents were $697.9 at March 31; restricted cash was a further $1,410.8 and is not available for general liquidity. Total current assets were $8,533.3 and current liabilities $7,742.4, substantially reflecting fiduciary premiums and related balances.
- Net corporate and other debt was $3,273.1, including $2,798.0 under note purchase agreements, $360.0 under the credit agreement and $121.0 of premium-financing debt. The company had $422.8 available under its $800.0 credit facility and reported compliance with debt covenants.
- Operating cash flow was affected by timing of client fiduciary receipts and payments and payment of annual 2017 bonuses. Management cautions that cash flow varies substantially by quarter; restricted cash and related premiums receivable/payable should be considered separately from funds available to the company.
Material changes and operating trends
- Brokerage revenue was $1,195.6, up 10%; organic commissions and fees grew 5.1%. Brokerage net earnings were $239.2 versus $179.6, and adjusted EBITDAC was $415.2 versus $380.2, with adjusted margin of 34.8% versus 34.3%.
- Risk-management revenue before reimbursements was $195.1, up 10%; organic fees grew 7.7%. Net earnings rose to $15.9 from $13.8. Adjusted EBITDAC increased to $32.1 from $30.6, while adjusted margin declined to 16.5% from 17.2%.
- Corporate reported $412.2 of revenue, primarily from clean-coal activities, and $30.9 of net earnings versus $48.6. Clean-energy after-tax earnings were $52.5 versus $63.1.
- Management cited new business, renewal rate increases, acquisitions and favorable foreign-currency translation as contributors to brokerage growth. In brokerage, new business production and renewal rate increases added $141.2 of commissions and fees, partially offset by $72.3 of lost business.
- Revenue and the 2017 comparison reflect retrospective adoption of ASC 606. Adoption materially shifted some revenue and expense recognition into Q1, although management said the annual after-tax impact was not material. It also changed quarterly seasonality; reported comparisons should therefore be read alongside the restated 2017 figures and organic measures.
- Seven acquisitions were completed in Q1, with approximately $29.9 of annualized acquired revenue. Recorded purchase price was $88.2; maximum potential earnouts across acquisitions were $571.0, of which $270.9 was recorded at estimated fair value.
Outlook, commentary and risks
- Management expects 2018 clean-energy investments to generate $104–$112 of net earnings and anticipates positive net cash flow from these investments in 2018, while noting that production, tax-credit utilization, operating conditions, regulatory changes and relocation costs could alter outcomes. Section 45 credits substantially expire in 2019 for the 2009-era plants and 2021 for the 2011-era plants.
- Management described insurance pricing as generally stable, with modest property/casualty exposure growth, employment growth and employee-benefit opportunities. It noted improving markets in Australia and New Zealand and pricing bottoming in London Specialty; the Q1 industry pricing survey was not yet available.
- Management expects 2018 capital expenditures of approximately $125.0, anticipates using operating cash flow and debt to fund acquisitions, and stated that it believes capital is sufficient for short- and long-term needs. It declared a Q2 dividend of $0.41 per share; future dividends are not assured. No company-wide earnings or revenue guidance is provided in the supplied filing text.
- Key exposures include IRS investigation of micro-captive advisory services and audits of more than 100 client captives; potential consequences are not estimable. The company also disclosed $108.0 of exposure to previously earned tax credits from investments no longer held, with no reserve recorded.
- After quarter-end, Nalco filed patent-infringement suits against two unaffiliated refined-coal plants; Gallagher and Chem-Mod were not named, but the defense may be tendered to Chem-Mod. The filing also describes other litigation and regulatory matters whose outcomes cannot currently be determined, and uncertainty over clean-coal tax-credit eligibility and regulatory conditions.
- Other risks highlighted include acquisition integration and earnout estimates, foreign exchange, cybersecurity/business continuity, insurance-market conditions, personnel retention, and debt obligations. The company was still completing its accounting for certain Tax Act effects and could record future adjustments.
Most important facts for investors to verify
- Separate underlying operating growth from ASC 606 timing effects, acquisitions, foreign exchange and clean-coal revenue; review the restated comparison and segment organic growth.
- Assess cash conversion and seasonal fiduciary working-capital movements, distinguishing unrestricted cash from restricted client funds.
- Track corporate debt, near-term maturities, credit-facility availability, covenant compliance, and the potential cash requirements of earnouts.
- Monitor actual clean-coal production, tax-credit realization and expiration, as well as the IRS and patent litigation developments.
- Reconcile reported results with non-GAAP adjusted EBITDAC and adjusted EPS; these are supplemental measures, not substitutes for GAAP results.