Arthur J. Gallagher & Co. — Q1 2021 Form 10-Q
Reporting period: Three months ended March 31, 2021; comparisons are with Q1 2020 unless stated otherwise. The company provides insurance brokerage, consulting, and third-party claims administration services. Amounts are in U.S. dollars; financial-statement amounts are generally in millions.
Financial performance and position
| Metric | Q1 2021 | Q1 2020 / prior date |
|---|---|---|
| Total revenue | $2,165.0 | $1,866.9 (+16%) |
| Revenue before reimbursements | $2,132.6 | $1,829.2 |
| Earnings before income taxes | $408.4 | $356.0 |
| Net earnings attributable to controlling interests | $382.1 | $346.3 (+10%) |
| Diluted EPS | $1.92 | $1.79 (+7%); adjusted EPS was $2.02 vs. $1.86 |
| Operating cash flow | $286.3 | $108.6 |
| Capital expenditures | $27.2 | $29.5 |
| Net corporate and other debt | $4,517.6 | $4,544.6 at Dec. 31, 2020 |
| Cash and cash equivalents | $526.3 | $664.6 at Dec. 31, 2020 |
| Current assets / current liabilities | $12,667.5 / $11,516.0 | $11,124.2 / $10,135.0 at Dec. 31, 2020 |
Restricted cash was $2,834.6 million and is held for client and other restricted purposes; the company excludes it when assessing its available liquidity. Management reported $1.6 billion of available liquidity and $1,185.8 million available under its credit agreement. No credit-agreement borrowings were outstanding at quarter-end. The company was in compliance with debt covenants.
Revenue and earnings comparisons include a substantial clean-energy component: clean-coal revenues were $300.6 million versus $181.8 million, with related costs of $309.1 million versus $185.4 million. Consolidated effective tax rates were 3.6% and 0.2%, respectively, largely reflecting Section 45 tax credits. Consolidated pretax margin was approximately 18.9%, compared with 19.1%; clean-energy activity and its tax effects make this comparison less indicative of core brokerage performance.
Material changes and segment trends
- Brokerage: Revenue rose 12% to $1,610.2 million; organic revenue growth was 6.0%. Adjusted EBITDAC increased 24% to $629.7 million, and adjusted EBITDAC margin expanded to 39.2% from 34.4%. Reported diluted segment EPS rose 13% to $1.82; adjusted segment EPS rose 14% to $1.91.
- Risk management: Revenue before reimbursements increased 4% to $220.3 million, but organic fee growth was 0.6%. Net earnings fell 6% to $18.0 million; adjusted EBITDAC rose 12% to $40.5 million, with adjusted margin of 18.4% versus 16.6%.
- Corporate: Pretax loss widened to $96.0 million from $80.4 million. Net earnings attributable to controlling interests were $1.5 million versus $16.5 million. Clean-energy after-tax earnings were $33.4 million versus $52.5 million.
- Q1 included six acquisitions, with total recorded purchase price of $501.9 million and annualized acquired revenue of approximately $103.7 million. Cash paid for acquisitions, net of cash and restricted cash acquired, was $395.6 million. Goodwill increased to $6.51 billion from $6.13 billion at year-end.
- Acquisition earnout changes were a $15.0 million expense in Q1 2021, versus an $89.0 million benefit in Q1 2020. The company recorded $623.0 million of earnout liabilities against maximum potential obligations of $1.146 billion.
Outlook, commentary, and risks
- Management expects continued property/casualty rate increases during 2021 and noted that improving economic activity was supporting higher exposure units. It cautioned that deteriorating loss trends could make pricing and coverage conditions more difficult in some lines.
- Management said early Q2 trends in brokerage new business, retention, policy changes, and rates were similar to or better than Q1; benefits covered lives and consulting activity showed modest improvement. These expectations depend on continued economic recovery.
- The company estimated 2021 clean-energy adjusted net earnings of $70 million to $80 million, including Section 45 tax credits. Credits for the 21 plants placed in service before the end of 2011 were scheduled to expire in December 2021. Production, regulatory, tax-law, and energy-market changes could affect results and cash flows.
- Management expected approximately $140 million of 2021 capital expenditures and anticipated positive net cash flow from clean-energy investments in 2021, while noting that cash-flow timing is uncertain. No company-wide earnings or revenue guidance was provided.
- The quarterly dividend was $0.48 per share, up 7% year over year. The board declared another $0.48 quarterly dividend on April 28, 2021.
- COVID-19 remained a risk to client activity, claims volumes, employee benefits revenue, clean-energy production, and liquidity. Management reported approximately $64 million of Q1 cost savings versus the comparable pre-pandemic period, offset in part by severance and lease-termination costs.
- The September 2020 ransomware incident was contained and critical systems were restored. The investigation remained ongoing; the company reported no known actual or attempted misuse of information and did not expect a material adverse effect, but noted potential claims or government action and possible insurance-coverage disputes.
- The IRS micro-captive investigation, a related DOJ criminal investigation, and litigation remained unresolved. Gallagher said it was cooperating, was advised it was not currently a DOJ target, and could not reasonably estimate potential losses. A separate clean-coal patent lawsuit was being defended; the company considered material loss remote.
Key facts for investors to verify
- How much of reported revenue and earnings growth reflects core brokerage operations versus acquisitions, clean-energy activity, tax credits, and earnout remeasurement; review the company’s non-GAAP reconciliations.
- Whether brokerage organic growth, margin expansion, and favorable insurance pricing persist, and whether risk-management claims volumes recover without weakening margins.
- Clean-energy earnings and cash-flow assumptions, including the effect of the December 2021 tax-credit expiration and potential regulatory, operating, or tax changes.
- Acquisition integration, goodwill and intangible-asset recoverability, and the eventual cash or stock settlement of the $623.0 million recorded earnout liability.
- Liquidity excluding restricted client funds, debt maturities and interest costs, and the impact of acquisition spending and dividends on financing needs.
- Developments and potential financial exposure from the micro-captive investigations and litigation, cybersecurity matters, and other legal contingencies.