Arthur J. Gallagher & Co. — 2015 Form 10-K
Business context and reporting period
Fiscal year ended December 31, 2015; the filing was signed February 10, 2016. Gallagher provides insurance brokerage and consulting, and third-party claims administration. Brokerage and risk management are its core operating businesses; the corporate segment includes debt and clean-energy investments. Reported revenue mix was approximately 62% brokerage, 13% risk management and 25% corporate, with corporate revenue substantially tied to refined-coal activities.
Financial performance and position
| Metric | 2015 | 2014 |
|---|---|---|
| Total revenue | $5,392.4 million | $4,626.5 million |
| Earnings before income taxes | $293.5 million | $291.5 million |
| Net earnings attributable to controlling interests | $356.8 million | $303.4 million |
| Diluted earnings per share | $2.06 | $1.97 |
| Cash from operating activities | $652.6 million | $436.6 million |
| Cash and cash equivalents at year-end | $480.4 million | $314.4 million |
| Total debt at year-end | $2,457.0 million | $2,392.9 million |
| Total assets / stockholders’ equity | $10,913.8 million / $3,688.2 million | $10,010.0 million / $3,305.1 million |
Revenue increased 17%; controlling-interest net earnings rose 18%, while pretax earnings were nearly flat. The unusually low consolidated effective tax rate, a 32.6% tax benefit, reflected $181.3 million of recognized tax credits, principally from IRC Section 45 clean-energy investments. Cash flow from operations improved, partly because of payment timing and noncash items; the filing also reports significant cash use in refined-coal operations. Of $1,892.5 million of total cash and restricted cash, $1,412.1 million was restricted, primarily for fiduciary funds, and is not generally available for corporate liquidity.
Core-segment performance improved: brokerage organic base commission and fee growth was 3.3%, with adjusted EBITDAC of $866.8 million and adjusted margin of 26.1% (up 70 basis points). Risk management organic fee growth was 11.3%, with adjusted EBITDAC of $126.0 million and adjusted margin of 17.3% (up 130 basis points). These are non-GAAP measures.
Fourth-quarter revenue was $1,334.9 million versus $1,245.4 million in 2014; controlling-interest net earnings were $62.3 million versus $51.5 million, and diluted EPS was $0.35 versus $0.31. Fourth-quarter pretax earnings were $28.4 million versus $30.3 million, underscoring the effect of tax items on reported net income.
Changes versus prior year
- Acquisitions remained a major growth driver: Gallagher completed 44 acquisitions in 2015, with annualized revenue of $230.8 million, compared with 60 acquisitions and $761.2 million of annualized revenue in 2014. Cash paid for acquisitions fell to $342.3 million from $1,918.3 million.
- Combined brokerage and risk management reported revenue rose 13%; adjusted revenue rose 17%. Combined organic growth was 5.1%, and adjusted EBITDAC increased 22%, with adjusted margin up 92 basis points.
- Reported corporate-segment revenue rose to $1,341.3 million from $1,047.9 million, largely because of consolidated clean-coal operations. Clean-energy earnings after tax were $100.9 million, versus $90.5 million in 2014.
- Outstanding shares increased, including shares issued for acquisitions and through the at-the-market equity program. Gallagher sold 3.1 million shares under that program in 2015 for net proceeds of $149.2 million. Annual dividends declared rose to $1.48 per share from $1.44.
- Foreign-currency translation reduced accumulated other comprehensive income by $261.1 million in 2015; accumulated other comprehensive loss reached $522.5 million.
Outlook, risks and unusual items
- Management expected 2016 clean-energy investments to generate $110–$124 million of net earnings after tax, but cautioned that production, plant deployment, utility demand, tax-credit eligibility and partner funding make estimates uncertain. The credits are expected to phase out by 2019 for 2009-era plants and 2021 for 2011-era plants.
- Management expected modestly declining property/casualty rates to be a headwind, partly offset by exposure growth, new business, employee-benefit demand and continued acquisition activity. It anticipated international revenue to remain approximately the same share of combined brokerage and risk-management revenue in 2016.
- Gallagher planned $225 million of 2016 capital expenditures, including about $103 million for its new headquarters, and estimated total redevelopment and relocation costs of about $145 million. Potential state and local incentives were estimated at $60–$80 million, conditional on job requirements.
- Management anticipated raising an additional $200–$300 million of debt in late second-quarter 2016. It reported $383.5 million available under its $600 million revolving credit agreement at year-end and compliance with debt covenants. The board announced a first-quarter 2016 dividend of $0.38 per share.
- Clean-energy earnings depend materially on Section 45 tax-credit qualification and coal-plant operations. Risks include reduced coal use, plant outages or relocation, environmental and product liability, tax-credit disallowance and pending patent litigation brought by Nalco. The IRS had not yet released 2016 phase-out factors.
- The IRS was investigating Gallagher’s micro-captive advisory services and auditing more than 100 related captive insurers for 2012; the company said it could not reasonably estimate potential losses. The company also disclosed a separate IRS inquiry into previously claimed Section 29 credits and related indemnification exposure.
- In 2015, Gallagher settled litigation involving former U.K. executives for approximately $31 million, recorded as a pretax gain. Related retention and other charges are expected to continue through June 2017. Gallagher also reported $11.5 million of amortizable-intangible impairment charges, primarily tied to prior acquisitions.
- Other risks include acquisition integration and goodwill impairment, soft insurance pricing and commission pressure, foreign-exchange exposure, cyber and data-security events, regulatory compliance, litigation and the ability to service debt. Brokerage and risk-management revenues and expenses are seasonal.
Important facts for investors to verify
- How much of earnings and cash generation depends on Section 45 credits, and whether production, tax eligibility and expected 2016 earnings are being realized.
- Underlying organic growth and margins in brokerage and risk management, separately from acquisitions, currency effects and the non-GAAP adjustments used by management.
- The quality and sustainability of operating cash flow, considering timing-related working-capital movements, restricted cash and refined-coal cash requirements.
- Debt maturities, planned 2016 borrowing, covenant headroom, acquisition funding needs and the effect of share issuance on per-share results.
- Developments in the micro-captive investigation, Section 29 tax exposure and Nalco patent case, including any changes to estimated liabilities or disclosures.
- Progress on headquarters costs and incentives, and whether the assumptions underlying clean-energy earnings and plant redeployment remain achievable.