Arthur J. Gallagher & Co. — FY2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010. The filing is an annual report, not a standalone Q4 filing; quarterly figures are included. Gallagher provides insurance brokerage and third-party claims administration, primarily in the U.S., and does not assume insurance underwriting risk. Brokerage, risk management and corporate represented approximately 72%, 25% and 3% of 2010 revenue, respectively.
Key financial results
| Metric | 2010 | 2009 | Change / context |
|---|---|---|---|
| Total revenue | $1,864.2 million | $1,729.3 million | Up 7.8%; acquisitions and clean-energy activity contributed |
| Pretax earnings from continuing operations | $203.0 million | $211.1 million | Down 3.8% |
| Continuing-operations earnings | $163.3 million | $133.1 million | Up 22.7%; helped by a lower tax provision |
| Net earnings | $174.1 million | $128.6 million | Includes $10.8 million from discontinued operations in 2010 |
| Diluted EPS | $1.56 continuing; $1.66 net | $1.32 continuing; $1.28 net | Net EPS benefited from tax and discontinued-operation items |
| Operating cash flow | $231.8 million | $211.5 million | Cash used in investing was $91.7 million; financing used $96.2 million |
| Cash and cash equivalents | $249.8 million | $205.9 million | Excludes $599.7 million of restricted cash, largely fiduciary funds |
| Debt and equity | $550.0 million debt; $1,106.7 million equity | $550.0 million debt; $892.9 million equity | No credit-facility borrowings at year-end |
The 2010 continuing-operations effective tax rate was 19.6%, versus 36.9% in 2009. Resolution of tax matters and expiration of statutes reduced the tax provision by $30.7 million; the Q4 IRS examination resolution generated $29.3 million of net earnings related to prior-year tax positions. This materially boosted reported earnings and is not necessarily recurring.
Brokerage revenue was $1,340.6 million, up 5%; pretax earnings were $223.2 million, up 10%. Risk-management revenue was $462.1 million, up 2%; pretax earnings were $51.6 million, up 6%. Organic revenue declined in both segments: brokerage commissions, fees and supplemental commissions fell 1.7%, while risk-management organic fees fell 2.7%. Adjusted EBITDAC margins, a non-GAAP measure, were 21.9% for brokerage and 15.6% for risk management.
Q4 2010 revenue was $459.1 million versus $435.1 million in Q4 2009. Q4 pretax continuing earnings were $25.8 million versus $30.4 million; continuing-operations earnings were $46.0 million versus $19.4 million, and net earnings were $54.7 million versus $16.8 million. The substantial earnings increase reflects tax and discontinued-operation items as well as operations.
Material changes and operating developments
- Supplemental and contingent commissions rose to $97.6 million from $65.0 million. Reported supplemental commissions were affected by a change in the timing of carrier information and revenue recognition; management said the 2010 timing effect was not expected to recur in 2011.
- New brokerage business of $141.3 million was offset by $162.0 million of renewal decreases and lost business. Management attributed pressure to the weak economy and a soft insurance market; commercial property/casualty rates declined during each quarter of 2010.
- Gallagher completed 19 acquisitions, with approximately $145.1 million in annualized acquired revenue. Cash paid for acquisitions, net of cash acquired, was $78.9 million. The GAB Robins risk-management acquisition was expected to contribute about $50 million in annual revenue.
- International revenue rose to 13% of total from 11% in 2009. Shares outstanding increased to 108.4 million from 102.5 million, in part reflecting acquisition consideration issued in stock.
- The corporate segment reported a $71.8 million pretax loss and a $3.5 million after-tax loss. Clean-coal revenue and costs were material, while the segment also recorded an $8.0 million impairment of biomass-energy investments.
Liquidity, outlook and risks
Operating cash flow was $231.8 million and year-end cash was $249.8 million. The $500 million revolving credit agreement runs through July 2014; $483.9 million remained available after letters of credit, and Gallagher reported compliance with debt covenants. Long-term notes totaled $550 million, with scheduled principal payments beginning in 2014. The company declared $1.28 per share in 2010 dividends and announced a Q1 2011 dividend of $0.33 per share. Management expected about $30 million of 2011 capital expenditures and said operating cash flow and available borrowing capacity should meet foreseeable liquidity needs.
Management expected growth from existing operations and acquisitions and anticipated continued international expansion, but gave no specific consolidated revenue or earnings guidance. It expected soft-market conditions to persist until demand improves and insurance capacity diminishes. Gallagher stated that clean-coal operations could generate significant quarterly earnings if permits, tax-credit qualification and operating plans succeed; these are conditional estimates, not assured guidance. As of the filing, one of six partly owned facilities had received a permanent operating permit, the other five were awaiting permits, and two majority-owned facilities were not producing.
- Insurance-cycle and economic exposure: Falling premiums, reduced client exposures, lost clients or lower contingent commissions can pressure brokerage revenue; weaker claims volumes can affect risk-management fees.
- Clean-energy and tax contingencies: Permit, regulatory, operating, coal-demand and IRC Section 45 qualification uncertainties could prevent recovery of investments. Separately, tax indemnities tied to previously claimed Section 29 credits had a stated maximum potential exposure of approximately $195 million, net of tax benefit; no liability was recorded for these contingent indemnifications.
- Other risks: Acquisitions and integration, competition, regulation and healthcare reform, legal and E&O claims, employee-benefit and pension costs, foreign exchange, data security, and debt covenants. The filing describes legal proceedings and contingencies but does not provide a clear quantified aggregate loss estimate.
Investor verification priorities:
- Separate recurring operating performance from the $30.7 million tax-provision reduction, Q4 tax resolution benefit, discontinued operations and clean-energy activity.
- Check organic revenue trends, renewal pricing and retention, and the sustainability and timing of supplemental and contingent commissions.
- Track acquisition integration, earnout obligations and dilution; the filing reports $169.4 million of maximum unrecorded earnouts for pre-2009 acquisitions.
- Verify permanent permits, Section 45 eligibility, production and partner commitments for clean-coal facilities, and potential exposure under legacy tax-credit indemnities.
- Assess liquidity using unrestricted cash and operating cash flow, while distinguishing restricted fiduciary cash; monitor debt maturities, covenant headroom and dividend capacity.