Arthur J. Gallagher & Co. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; fourth-quarter figures below are unaudited. Gallagher provides insurance brokerage and consulting, and third-party claims administration. Its reported segments are brokerage, risk management and corporate. Corporate revenue is primarily from clean-energy investments; Gallagher says it generally does not retain net insurance underwriting risk.
Financial performance
| Metric | 2017 | 2016 | Change / context |
|---|---|---|---|
| Total revenue | $6.160 billion | $5.595 billion | +10.1%; includes $1.561 billion from clean-coal activities |
| Earnings before income taxes | $378.1 million | $356.9 million | +5.9% |
| Net earnings attributable to controlling interests | $463.1 million | $414.4 million | +11.8% |
| Diluted EPS | $2.54 | $2.32 | +9.5% |
| Cash from operating activities | $854.2 million | $649.6 million | Increase attributed mainly to stronger cash generation in core brokerage and risk management |
| Capital expenditures | $129.2 million | $217.8 million | 2016 included substantial headquarters construction spending |
| Debt, net of debt issuance costs | $3.133 billion | $2.848 billion | Cash and cash equivalents were $681.2 million |
Brokerage revenue was $3.831 billion, up 9%; organic revenue growth was 4.4%. Brokerage net earnings rose 19% to $424.0 million, with an 11.1% net earnings margin versus 10.1%. Risk management revenue grew 7% to $768.6 million, with 5.2% organic growth; net earnings increased 5% to $59.9 million and its margin was 7.8%, down from 8.0%.
Fourth-quarter revenue was $1.599 billion versus $1.385 billion; earnings before tax were $82.1 million versus $68.8 million; net earnings attributable to controlling interests were $105.1 million versus $95.1 million; diluted EPS was $0.57 versus $0.53.
At year-end, total assets were $12.897 billion and stockholders’ equity was $4.165 billion. Cash and cash equivalents were $681.2 million; restricted cash of $1.624 billion is largely fiduciary funds and should not be treated as freely available liquidity. The $800 million revolving credit facility had $592.8 million available. The company reported compliance with debt covenants.
Changes, unusual items and outlook
- Growth reflected acquisitions as well as organic expansion. Gallagher completed 39 acquisitions and reported $376.1 million of acquisition cash outlays, net of cash acquired. Acquired businesses contributed $112.6 million of 2017 revenue.
- Clean-energy investments materially affect reported results and taxes. Gallagher reported $229.7 million of IRC Section 45 tax credits produced and recognized. Corporate segment earnings attributable to controlling interests shifted to a $12.7 million loss from $3.7 million of earnings; clean-energy investments generated $132.7 million of net after-tax earnings, including noncontrolling interests.
- The 2017 tax benefit was $121.1 million, contributing to a consolidated effective tax rate of negative 32.0%. Tax reform produced a provisional $40.0 million repatriation-tax expense and a $1.0 million deferred-tax revaluation benefit; estimates remained subject to refinement.
- Management estimated 2018 clean-energy after-tax earnings of $105 million to $115 million and expected positive net cash flow from these investments, subject to operating, regulatory, tax-credit and coal-demand risks. Section 45 credits are scheduled to expire in 2019 for 14 plants and 2021 for 20 plants. Management expected approximately $125 million of 2018 capital expenditures and planned to continue acquisitions.
- Management described insurance pricing as broadly stable to improving, with increasing exposures in certain lines and geographies; it expected stable U.S. retail property/casualty rates and continued international expansion.
- Gallagher planned to adopt the new revenue-recognition standard retrospectively from January 1, 2018. It anticipated a $100 million to $180 million increase to retained earnings as of January 1, 2016, changes to quarterly revenue timing and presentation, and limited impact on annual results overall.
- Key risks include insurance-market pricing and competition, acquisition integration and goodwill impairment, foreign exchange and Brexit exposure, cybersecurity and privacy compliance, and reliance on contingent revenues and clean-energy tax credits. The IRS was investigating micro-captive advisory services and auditing more than 100 related entities; the company could not estimate potential losses. A patent dispute involving Nalco was on appeal, with Gallagher stating material loss was remote.
The board declared dividends of $1.56 per share for 2017 and announced a first-quarter 2018 dividend of $0.41 per share. The auditor gave unqualified opinions on the financial statements and internal control over financial reporting; controls for 15 of 39 businesses acquired in 2017 were excluded from management’s assessment.
Investor verification priorities
- Separate core brokerage and risk-management growth from acquisition effects and corporate clean-coal revenue; review the company’s non-GAAP reconciliations.
- Assess the sustainability and cash conversion of clean-energy earnings, the value and timing of Section 45 credits, plant contracts and scheduled credit expirations.
- Review debt maturities, interest costs, covenant headroom and cash available after excluding restricted fiduciary balances.
- Track final Tax Act accounting and the retrospective revenue-standard restatement, including effects on quarterly comparability.
- Monitor outcomes of the IRS micro-captive investigation and audits, the Nalco appeal, and other tax and legal contingencies.