Arthur J. Gallagher & Co. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Gallagher provides insurance brokerage and consulting, claims administration and risk-management services. Its three segments are brokerage, risk management and corporate; corporate includes clean-energy investments. Financial statements are unaudited and interim comparisons for 2017 were restated for ASC 606.
Financial performance
Amounts below are in millions, except per-share data. Q2 means the three months ended June 30; first-half means the six months ended June 30.
| Metric | Q2 2018 | Q2 2017 | First-half 2018 | First-half 2017 |
|---|---|---|---|---|
| Total revenue | $1,660.4 | $1,489.5 | $3,498.1 | $3,135.9 |
| Net earnings | $123.7 | $78.3 | $409.7 | $320.3 |
| Net earnings attributable to controlling interests | $114.9 | $70.0 | $388.6 | $298.8 |
| Diluted EPS | $0.62 | $0.39 | $2.10 | $1.65 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $313.3 | $260.9 |
- Reported revenue increased about 11% year over year in both periods. Clean-coal activity contributed $422.4 million in Q2 and $834.6 million in the first half, making reported revenue growth an imperfect proxy for core brokerage and claims-services growth.
- Brokerage organic revenue growth was 5.9% in Q2 and 5.3% in the first half; risk-management organic fee growth was 10.1% and 8.9%, respectively. These are company-defined non-GAAP measures.
- Adjusted brokerage EBITDAC margin was 25.6% in Q2 and 30.6% in the first half; adjusted risk-management EBITDAC margin was 17.7% and 17.1%, respectively. Adjusted figures exclude specified items and are non-GAAP.
- Q2 comprehensive loss attributable to controlling interests was $31.5 million, principally reflecting a $150.7 million foreign-currency translation loss before noncontrolling interests and other comprehensive items.
Cash, debt and liquidity
- At June 30, cash and cash equivalents were $652.2 million; restricted cash was $1,692.5 million and is largely fiduciary/client-related, not available for general corporate use. Total assets were $16.23 billion.
- Net cash provided by operating activities was $313.3 million in the first half. Investing activities used $445.7 million, including $395.4 million net cash paid for acquisitions and $62.7 million of capital expenditures. Financing activities provided $201.6 million. Cash, cash equivalents and restricted cash rose $39.7 million in total.
- Net corporate and other debt was $3.487 billion at June 30, up from $3.133 billion at year-end 2017. The company reported $3.248 billion under note purchase agreements, $135 million drawn on its revolving credit agreement and $111.1 million of premium-financing debt. It had $648.5 million available under the revolving facility and was in compliance with debt covenants.
- First-half interest expense was $65.2 million, versus $61.5 million. Dividends declared were $0.41 per share for Q2; the company announced the same per-share quarterly dividend for Q3.
Changes, outlook and material matters
- Profit and EPS increased substantially year over year. Brokerage and risk-management segment earnings and margins improved; acquisition contributions, organic growth and lower effective tax rates were factors. The consolidated effective tax rate was negative 18.4% in the first half, mainly reflecting IRC Section 45 clean-energy tax credits.
- Gallagher completed 19 acquisitions in the first half, with recorded purchase prices totaling $506.8 million and estimated annualized acquired revenue of approximately $175.1 million. Cash paid for acquisitions was higher than in the prior-year period. The Pronto Insurance acquisition accounted for $313.5 million of recorded purchase price. A further acquisition agreement closed July 6, after quarter-end.
- Management described the insurance market as mostly positive, citing modest exposure growth, retail rate increases and employment growth, while noting uncertainty about economic conditions and whether insurance-rate trends would persist. It expects clean-energy investments to generate $112–$118 million of net earnings in 2018 and anticipates positive net cash flow from those investments in 2018. Management said available capital and operating cash flows should meet foreseeable liquidity needs; no company-wide earnings or revenue guidance is provided in the filing.
- ASC 606 was adopted retrospectively, with a $125.3 million increase to retained earnings on January 1, 2016. It changed revenue and expense timing, shifting some brokerage revenue recognition into the first quarter and affecting quarterly seasonality; management said annual after-tax earnings were not materially affected.
- Risks include integration and execution of acquisitions, debt and interest costs, foreign-exchange movements, and uncertainty in contingent brokerage revenues. The IRS was investigating micro-captive advisory services and auditing more than 100 client captives; Gallagher said it could not reasonably estimate potential losses. Nalco patent-infringement complaints against refined-coal facilities were amended July 16, 2018; neither Gallagher nor Chem-Mod was named, but the company expected defense to be tendered to Chem-Mod. Clean-energy earnings and tax credits also depend on production, regulation, tax law and other operating factors.
- The company reported approximately $108.2 million of exposure related to previously earned tax credits, with no reserve recorded, and approximately $91.6 million of AMT credit carryovers expected to be refunded by tax year 2021. Its accounting for Tax Act effects remained incomplete; no provisional adjustment was recorded in Q2.
- Following revocation of OFAC General License H on June 27, U.K. and Norwegian subsidiaries said they would discontinue relevant Iran-related brokerage activities before the wind-down period ended. Reported gross revenue and net profit from these activities were approximately $5,765 and $1,153, respectively.
Key facts for investors to verify
- Separate core brokerage and risk-management growth from clean-coal revenue and assess the sustainability and cash conversion of Section 45 credits.
- Review acquisition contribution, integration progress, goodwill and intangible-asset impairment risk, and the size and sensitivity of earnout obligations.
- Reconcile available corporate liquidity with restricted fiduciary cash, debt maturities, interest expense and planned acquisition spending.
- Monitor the IRS micro-captive investigation, refined-coal litigation and tax-credit exposures; outcomes and potential financial effects remain uncertain.
- Compare GAAP results with company-defined adjusted and organic measures, noting the ASC 606 timing changes and restated prior-year comparisons.