Business context and reporting period
Arthur J. Gallagher & Co. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2020. The company provides insurance brokerage and consulting, and third-party claims administration. Its reportable segments are brokerage, risk management and corporate. Corporate includes clean-energy investments and related refined-coal activities. Unless otherwise stated, amounts are in millions of dollars.
Financial results and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $1,584.0 | $1,657.8 | $3,450.9 | $3,648.4 |
| Earnings before income taxes | $171.7 | $105.5 | $527.7 | $427.3 |
| Net earnings attributable to controlling interests | $153.7 | $110.1 | $500.0 | $444.2 |
| Diluted EPS | $0.79 | $0.58 | $2.58 | $2.35 |
| Cash provided by operating activities | Not presented quarterly | Not presented quarterly | $802.2 | $419.6 |
- Q2 revenue fell 4.5% year over year; six-month revenue fell 5.4%. Q2 pretax margin was approximately 10.8%, versus 6.4% a year earlier.
- Six-month operating cash flow increased substantially, which management attributed primarily to working-capital timing, including client fiduciary-related receipts and payments. Investing cash flow was $(139.8) million and financing cash flow was $(252.5) million for the six months.
- At June 30, cash and cash equivalents were $349.7 million; restricted cash was $2,653.0 million and is not available for general use. Management reported approximately $1.3 billion of available liquidity, including credit availability.
- Corporate and other debt totaled $4,651.6 million, including $4,448.0 million under note purchase agreements, $100.0 million under the credit agreement and $103.6 million of premium-financing debt. The company reported compliance with its financial covenants.
- Dividends declared were $0.45 per share in Q2 and $0.90 per share for the first half, up 5% year over year for the half. A $0.45-per-share Q3 dividend was announced July 29, 2020.
Material changes versus prior comparable periods
- Brokerage remained the primary growth driver. Q2 brokerage revenue rose 6% to $1,201.1 million, while organic revenue increased 2.1%; six-month brokerage revenue rose 5%, with 2.7% organic growth. Q2 adjusted brokerage EBITDAC margin was 32.6%, compared with 26.3%.
- Risk management weakened: Q2 revenue before reimbursements declined 9% to $190.8 million and organic revenue fell 9.6%. Six-month organic revenue declined 2.8%. Management linked the pressure to fewer new claims during the pandemic; Q2 net earnings fell to $9.9 million from $15.5 million.
- Clean-coal activity materially reduced reported consolidated revenue: Q2 revenue from clean-coal activities was $159.5 million versus $284.4 million; first-half revenue was $341.3 million versus $656.7 million. The corporate segment recorded a Q2 pretax loss of $89.3 million.
- Six-month reported earnings included a $73.3 million benefit from changes in estimated acquisition earnout payables, versus $6.3 million of expense in the prior-year period. The company also wrote off approximately $46.0 million of amortizable intangible assets in the first half; it reported no goodwill impairment indicators in its June 30 review.
- Prior-year first-half results included a $59.0 million gain on divestitures, compared with $1.2 million in 2020. Consequently, reported consolidated revenue and earnings comparisons are affected by clean-coal activity, earnout revaluations, impairment charges and the prior-year divestiture gain.
Outlook, management commentary and risks
- Management said new property/casualty business generation remained near pre-pandemic levels in Q2, but retention, non-recurring business and exposure units weakened. It reported improving exposure units in June and early July and continued premium-rate increases, which it expected could partly or fully offset future exposure declines. Management cited a 9.3% average commercial property/casualty rate increase in the Q1 industry survey; the Q2 survey was not yet available.
- Employee-benefits consulting and covered lives weakened; management said the decline could persist or worsen if the economy recovers slowly. Risk-management claims improved from April lows through July but remained below pre-pandemic levels.
- Cost controls generated estimated Q2 pretax savings of approximately $74 million, offset by about $14 million of severance and lease-termination costs. Management estimated Q3 and Q4 savings of $60–$70 million per quarter, with possible additional quarterly severance and lease-termination costs of $5–$10 million. These are estimates, not guaranteed outcomes.
- Management estimated 2020 adjusted net earnings from clean-energy investments of $60–$70 million. It also noted that IRC Section 45 credits had expired for 14 plants at year-end 2019 and were scheduled to expire for the remaining 21 plants in December 2021; operations and tax-credit changes may affect reported revenue, earnings and cash flows.
- The company slowed acquisitions, reduced capital spending and discretionary costs, and said it believed liquidity was sufficient for operations. It warned that a prolonged downturn could reduce collections and business volumes. More than 90% of staff were working remotely at the time of the report.
- Material legal and regulatory matters include ongoing IRS and DOJ investigations concerning micro-captive arrangements. The company said it was cooperating, was not currently a DOJ investigation target, and could not reasonably estimate potential losses. A related class-action dismissal was on appeal. In a separate clean-coal patent case, the complaint was dismissed without prejudice and an amended complaint was filed; the company disputed the allegations and said it believed the likelihood of a material loss was remote.
- The filing also identifies risks from COVID-19, acquisition integration and earnout estimates, insurance-market and premium trends, cybersecurity, foreign exchange, debt and interest rates, clean-energy investments and litigation. No full-year revenue or EPS guidance was provided in the supplied filing text.
Important facts for investors to verify
- Separate underlying brokerage and risk-management trends from consolidated results, which include substantial clean-coal revenue and unusual tax-credit effects.
- Assess the sustainability of cash flow: restricted cash is fiduciary-related, and first-half operating cash flow benefited from working-capital timing and deferred or recovered tax payments.
- Review debt maturities, interest costs, available credit and covenant headroom, alongside the company’s acquisition and dividend commitments.
- Track COVID-related exposure units, employee-benefits covered lives, claims volumes, cost savings and restructuring charges against management’s estimates.
- Monitor earnout remeasurement, intangible-asset impairment, clean-energy production and tax-credit expiration, and developments in the micro-captive investigations and related litigation.