Arthur J. Gallagher & Co. — FY 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. The filing is an annual report, not a standalone fourth-quarter filing; it also provides unaudited quarterly results. Unless noted otherwise, financial amounts below are in U.S. dollars, millions.
Business context
Gallagher provides insurance brokerage and third-party claims administration services and does not assume insurance underwriting risk. In 2012, brokerage generated approximately 73% of revenue, risk management 22%, and corporate 5%. About 80% of revenue was domestic; international operations were principally in the U.K., Australia, Bermuda and Canada.
Financial results and liquidity
| Metric | 2012 | 2011 |
|---|---|---|
| Total revenue | $2,520.3 | $2,134.7 |
| Expenses | $2,275.0 | $1,926.9 |
| Pretax earnings | $245.3 | $207.8 |
| Net earnings from continuing operations | $195.0 | $144.1 |
| Diluted EPS from continuing operations | $1.59 | $1.28 |
| Operating cash flow | $343.0 | $284.0 |
| Capital expenditures | $51.0 | $45.9 |
| Cash and cash equivalents at year end | $302.1 | $291.2 |
| Total debt at year end | $854.0 | $685.0 |
| Stockholders’ equity | $1,658.6 | $1,243.6 |
- Revenue increased 18.1% and continuing-operations net earnings rose 35.3%; diluted continuing-operations EPS increased 24.2%.
- Operating cash flow improved by $59.0 million. The company attributed the increase mainly to timing of accrued-liability payments and realization of other current assets, as well as higher noncash charges.
- Reported segment operating results: brokerage revenue was $1,827.6 million and continuing-operations earnings were $155.8 million; risk management revenue was $571.7 million and earnings were $42.5 million. Corporate reported a $3.3 million continuing-operations loss after tax.
- Brokerage and risk management adjusted EBITDAC margins were 22.7% and 16.0%, respectively. These are company-defined non-GAAP measures, not GAAP operating margins.
- 2012 dividends declared were $1.36 per share. Five dividend payments were made during the calendar year because of a change in the payment schedule.
Changes versus the prior year
- Brokerage revenue rose 17%; base organic commissions and fees increased 4.4%. Management cited acquisitions, new business and renewal rate increases, partly offset by lost business. Acquisitions contributed materially to reported growth.
- Risk management revenue rose 4%; base organic fee revenue increased 3.7%. Earnings from continuing operations rose 28%, with adjusted EBITDAC up 11% and adjusted margin improving to 16.0%.
- Corporate revenue increased to $121.0 million from $29.4 million, principally reflecting higher clean-coal production and license royalties. Clean-energy investments contributed $32.7 million to net earnings, compared with $3.9 million in 2011.
- Revenue mix shifted further internationally: foreign revenue was $514.2 million, or about 20% of total, compared with $409.6 million, or about 19%, in 2011.
- Debt increased by $169.0 million, while year-end shares outstanding increased from 114.7 million to 125.6 million, reflecting acquisition-related stock issuance and other share issuances.
Outlook, management commentary and risks
- Management described the insurance market as “firming,” with moderate rate increases, but said the trend’s sustainability was uncertain. The sluggish economy could restrain coverage demand and offset pricing gains.
- Management expected 2013 capital expenditures of approximately $80 million and planned to continue acquisition-led growth. It was seeking an additional $200 million of long-term debt, expected to close by mid-2013; this was a plan, not a completed financing.
- Management estimated 2013 after-tax earnings of $75–$91 million from clean-coal plants expected to operate during the year. It said these estimates depended on production, contracts and eligibility for IRC Section 45 tax credits; several plants remained without long-term production contracts.
- Clean-energy tax credits materially reduced the consolidated effective tax rate to 20.5% in 2012, versus 30.7% in 2011. The underlying investments face tax qualification, regulatory, operational, environmental, coal-demand and counterparty risks. Prior Section 29 investments also carried indemnification exposure: maximum potential future payments were estimated at $160 million, with $130 million of previously earned tax credits exposed; no liability was recorded for those indemnifications.
- In the fourth quarter, Gallagher announced workforce reductions of about 400 positions, approximately 3% of global staff. It recorded $12.3 million of pretax charges and expected approximately $35 million in annual savings, partly offset by anticipated benefit, pension and compensation cost increases.
- Other key risks include insurance-premium cycles and commission pressure, acquisition integration and goodwill impairment, competition, employee retention and benefit costs, legal and regulatory matters, data security, foreign exchange exposure, and debt covenant and refinancing constraints. The company reported compliance with debt covenants at year end.
- Year-end liquidity included $129 million drawn under a $500 million revolving credit agreement, with $355.1 million available for potential borrowing after outstanding letters of credit. Management said operating cash flow and available borrowing capacity should meet foreseeable needs.
- The financial statement auditor issued an unqualified opinion, as did the auditor on internal control over financial reporting. The control assessment excluded 28 of the 60 entities acquired during 2012.
Important facts for investors to verify
- Reconcile acquisition counts: management’s highlights cite 58 acquisitions, while the cash-flow discussion and notes report 60 completed in 2012.
- Assess how much earnings and cash generation depend on IRC Section 45 tax credits, and verify plant production, long-term contract coverage, tax-credit qualification and future capital needs.
- Separate organic growth from acquisitions and market pricing; confirm integration progress, acquired-business profitability and the impact of acquisition-related share dilution.
- Review debt maturities, the planned additional $200 million borrowing, revolving-credit availability and the company’s ability to fund acquisitions, dividends and capital spending.
- Track workforce savings against the disclosed $12.3 million charge and expected increases in employee-benefit, pension and incentive-compensation costs.
- Review contingent exposures, including the $160 million maximum potential Section 29 indemnification payments, legal and errors-and-omissions claims, and clean-energy environmental liabilities.