Arthur J. Gallagher & Co. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparative period is Q1 2013. The company provides insurance brokerage and risk-management services and reports brokerage, risk management, and corporate segments. Financial statement amounts below are in millions of dollars unless stated otherwise. Interim statements were reviewed by Ernst & Young, not audited.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Total revenue | $915.0 | $674.1 | +35.7% |
| Earnings before income taxes | $46.3 | $42.3 | +9.5% |
| Income tax provision (benefit) | $(3.0) | $1.8 | — |
| Net earnings | $49.3 | $40.5 | +21.7% |
| Diluted EPS | $0.36 | $0.32 | +12.5% |
| Operating cash flow | $76.1 | $51.2 | +$24.9 |
| Dividends declared per share | $0.36 | $0.35 | +2.9% |
Revenue growth included a large increase in clean-coal activity following consolidation of additional plants; clean-coal revenue was $166.4 versus $57.0, with related costs of $171.0 versus $58.1. Accordingly, consolidated revenue growth does not by itself indicate comparable growth in the core brokerage and risk-management businesses. Consolidated EBITDAC, a company-defined non-GAAP measure, was $120.5 versus $98.3.
Segments and margins
- Brokerage: Revenue of $568.6, up 25%; net earnings of $32.6, up 33%. Organic base commissions and fees grew 3.3%, down from 4.8%. Adjusted EBITDAC rose 34% to $110.7, and adjusted EBITDAC margin increased to 19.5% from 18.0%. Reported compensation and operating expense ratios were 63% and 19%, respectively, both unchanged.
- Risk management: Revenue of $160.0, up 4%; organic fees grew 6.0%, versus 10.8%. Net earnings fell 13% to $12.1, and reported EBITDAC fell 7% to $24.6. Adjusted EBITDAC increased 8% to $26.0 and adjusted margin was 16.3%, versus 16.2%. Higher compensation contributed to the lower reported earnings.
- Corporate: Revenue of $186.4 versus $66.1; pretax loss widened to $23.1 from $19.8, while net earnings were $4.6 versus $2.0. The corporate segment included clean-energy activity, company debt and related tax credits.
The filing reports adjusted measures that exclude specified items; these are non-GAAP measures and should be considered alongside reported results.
Cash, debt and liquidity
- Cash and cash equivalents were $739.2 at March 31, up from $298.1 at year-end; restricted cash was $915.9, down from $1,027.4. Restricted cash is fiduciary/client-related and is not freely available for general liquidity.
- Operating cash flow was $76.1; investing activities used $44.5 and financing activities provided $409.5. The company attributed the higher operating cash flow mainly to timing of accrued-liability payments and fiduciary cash receipts and disbursements.
- Corporate borrowings totaled $1,892.4, versus $1,455.5 at December 31: $1,525.0 of fixed-rate notes and $367.4 drawn on the revolving credit facility. The $600.0 of notes funded in February 2014 contributed to the increase. The company had $211.5 of facility capacity available, including limits applicable to letters of credit, and reported compliance with debt covenants.
- Total liabilities were $5,131.4 and stockholders’ equity was $2,144.2. The company had $100.0 of notes due in August 2014. It reported $2,455.0 of total debt obligations, including scheduled interest, in its contractual-obligations table.
Material changes, outlook and risks
- The company completed nine Q1 acquisitions, with annualized revenues of approximately $17.8. Acquisition-related amortization and integration costs increased; reported earnout-payable expense was $5.1. Maximum earnouts related to acquisitions from 2009 onward totaled $460.2, of which $156.8 was recorded as a liability.
- On April 1, the company closed the Oval acquisition for approximately $331.0 in net cash consideration. On April 6, it agreed to acquire Wesfarmers’ insurance brokerage operations for approximately $933.0, subject to regulatory approvals and other conditions, with closing expected in Q2 or Q3. On April 16, it issued 21.85 million shares for net proceeds of $911.9, primarily intended to fund Wesfarmers; if that deal does not close, proceeds may be used for Oval-related borrowings and other corporate purposes.
- Management expected 2014 clean-energy investments to contribute $90–$100 of after-tax earnings and anticipated positive net cash flow from those investments. It also expected capital-improvement spending of approximately $90 in 2014. Management stated it believed available capital was sufficient for short- and long-term needs, while noting that acquisition funding may include operating cash, debt and equity.
- Clean-energy earnings depend on Section 45 tax credits and plant production. As of March 31, 28 of 34 plants had long-term production contracts; the other six were seeking or negotiating contracts. Management estimated $30–$35 of additional redeployment investment later in 2014 and 2015, before co-investor contributions, and warned that plant moves could interrupt production for 12–18 months. Tax-credit disallowance, utility plant closures or lower production could materially affect results and cash flows.
- Other disclosed risks include acquisition integration and completion risk, insurance-market pricing and competition, contingent-commission variability, foreign-currency exposure, and legal, regulatory and tax matters. The company disclosed potential indemnification payments of approximately $45 relating to previously sold tax-advantaged investments and exposure on $130 of previously earned tax credits; no related liability was recorded. Outcomes of litigation and regulatory matters were not determinable.
- The company reported effective disclosure controls as of March 31 and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- How much reported revenue and earnings growth reflects core organic performance versus acquisitions, clean-coal consolidation, tax credits and one-time remeasurement gains.
- Whether the Wesfarmers acquisition received required approvals, closed on expected terms, and delivered the anticipated integration benefits; also how the equity proceeds and acquisition financing affected dilution and debt.
- Actual clean-energy production, contract coverage, redeployment spending, tax-credit realization and any changes to management’s $90–$100 after-tax earnings estimate.
- Debt repayment and liquidity after the August 2014 note maturity, acquisitions, dividends and planned capital spending; distinguish unrestricted cash from restricted fiduciary cash.
- Subsequent changes in acquisition earnouts, contingent liabilities, tax-credit exposures and legal or regulatory proceedings.