Arthur J. Gallagher & Co. — Q1 2015 Form 10-Q
Business context and period. The filing covers the three months ended March 31, 2015. Gallagher provides insurance brokerage and risk-management services, alongside corporate clean-energy investments. Its brokerage, risk-management and corporate segments represented approximately 61%, 14% and 25% of reported revenue, respectively. The interim financial statements were reviewed, not audited.
Financial results and liquidity
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Total revenue | $1,231.3 million | $915.0 million |
| Earnings before income taxes | $30.9 million | $54.7 million |
| Net earnings attributable to controlling interests | $21.9 million | $49.3 million |
| Diluted earnings per share | $0.13 | $0.36 |
| Operating cash flow | $113.3 million | $84.1 million |
| Capital expenditures | $17.8 million | $19.8 million |
| Dividends declared per share | $0.37 | $0.36 |
- Reported revenue rose 35%, but included $303.9 million of clean-coal revenue versus $166.4 million a year earlier, with related costs of $309.3 million versus $171.0 million. Brokerage and risk-management revenue combined was $928.3 million, up from $728.6 million.
- Brokerage revenue increased 33%; base organic commissions and fees grew 4.5%. Risk-management revenue increased 8%, with organic fees up 10.9%. Management reported improved segment earnings and adjusted EBITDAC, while consolidated earnings attributable to controlling interests and EPS declined.
- Consolidated EBITDAC, a company-defined non-GAAP measure, was $143.3 million versus $128.9 million. Adjusted EBITDAC for brokerage and risk management combined increased 46% to $196.7 million; these adjusted measures exclude specified items and are not GAAP results.
- Operating cash flow improved year over year, primarily due to timing of accrued-liability payments and fiduciary-fund receipts and disbursements. Cash and cash equivalents were $276.8 million at quarter-end, down from $314.4 million at December 31, 2014. Restricted cash of $1,186.6 million is held for fiduciary purposes and is not available for general liquidity.
- Total corporate and other debt was $2,335.8 million: $2,125.0 million of fixed-rate notes, $115.0 million drawn under the revolving credit agreement and $95.8 million under the premium-financing facility. The company reported $462.4 million available under its $600 million revolving facility after borrowings and letters of credit; it was in compliance with debt covenants.
- Current assets were $3,594.8 million and current liabilities $3,438.7 million. Goodwill was $3,418.0 million and net amortizable intangible assets $1,723.6 million. Long-term debt fair value was estimated at $2,321.5 million, above its $2,125.0 million carrying value.
Material changes versus the prior period
- Revenue growth reflected acquisitions, including substantial contributions from businesses acquired in 2014, as well as clean-energy consolidation. Eleven acquisitions closed in Q1 2015, with $88.9 million of recorded purchase consideration and approximately $33.6 million of annualized acquired revenue. Acquisition-related stock issuance contributed to dilution.
- Despite stronger brokerage and risk-management operations, consolidated controlling-interest earnings fell, reflecting the corporate segment’s $29.7 million attributable loss versus $4.6 million of income a year earlier. Corporate pretax loss widened to $53.7 million from $14.3 million, including higher interest expense and clean-energy operating costs; Q1 2014 also included a non-cash gain from changes in clean-energy ownership.
- Foreign-currency translation reduced comprehensive earnings by $134.8 million and increased accumulated other comprehensive loss. Management attributed the translation effect principally to movements in currencies of foreign operations.
- Interest expense rose to $25.6 million from $16.2 million, principally reflecting debt issued in 2014. The company also recorded $10.6 million of expense for changes in estimated acquisition earnout payables, versus $5.1 million.
Outlook, commentary and risks
- Management said it expected organic growth and acquisitions to support continued growth in earnings before income taxes adjusted for non-cash items, and stated it had sufficient capital for anticipated needs. The filing gives no consolidated revenue or EPS guidance.
- Management estimated 2015 after-tax earnings from clean-energy investments, including Section 45 tax credits, of $92.5 million to $107.5 million and anticipated positive net cash flow in 2015, while noting that timing and amounts are uncertain. Clean-energy tax-credit eligibility, plant production and utilization, and tax-credit usage are material assumptions.
- Management expected approximately $120 million of 2015 capital expenditures, mainly for the new headquarters, office moves and expansions, and technology. If the quarterly dividend remained at $0.37 per share through 2015, estimated annual cash use for dividends was approximately $246.2 million.
- The IRS was investigating the company’s micro-captive advisory services and auditing more than 100 client micro-captive insurers for 2012. The company said it could not estimate a potential loss; adverse findings could affect clients, the captive business and earnings.
- Five senior employees, including the CEO, CFO and chief risk officer, left the U.K.-based international brokerage operation during the quarter. The U.K. regulator planned a review of governance and controls; possible penalties, restrictions or remedial requirements had not been determined.
- Other risks include litigation and regulatory matters, clean-energy patent and tax-credit exposure, foreign-exchange changes, acquisition integration and earnout estimates, and contingent commissions. A patent complaint was refiled after the court granted an earlier motion to dismiss; Gallagher disputed the allegations. The company disclosed up to $32 million of potential indemnification payments relating to former tax-advantaged investments, net of applicable tax benefit, and $117 million of exposure on previously earned tax credits; no liability was recorded for those indemnifications.
Key facts for investors to verify
- How much of reported growth and future earnings is attributable to acquired businesses versus organic brokerage and risk-management growth.
- Whether clean-energy plant output, tax-credit eligibility and management’s $92.5–$107.5 million earnings estimate are realized, and how these affect cash flow.
- Developments in the IRS micro-captive investigation and the FCA review, including any quantified financial or operating consequences.
- Acquisition integration costs, earnout remeasurements and potential dilution from acquisition-related share issuance.
- Usable liquidity after excluding restricted fiduciary cash, and funding needs for debt service, dividends, capital spending and acquisitions.