Arthur J. Gallagher & Co. quarterly report, Q2 FY2013

Arthur J. Gallagher & Co. — Q2 2013 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2013; financial statements are unaudited. Gallagher provides insurance brokerage and risk-management services, with a corporate segment that includes clean-energy investments. Ernst & Young reviewed the interim statements; this was not an audit.

Financial performance and position

Amounts below are in millions, except per-share data. Comparisons are with the corresponding 2012 period.

Metric	Q2 2013	Q2 2012	Six months 2013	Six months 2012
Total revenue	$779.5	$649.9	$1,453.6	$1,196.7
Earnings before income taxes	$97.4	$91.1	$139.7	$123.6
Net earnings	$93.5	$71.7	$134.0	$99.8
Diluted earnings per share	$0.73	$0.59	$1.04	$0.83
Operating cash flow	—	$73.8	$63.0

Q2 revenue increased about 20% and net earnings about 30%; six-month revenue increased about 21% and net earnings about 34%.
Reported Q2 net margin was approximately 12.0% versus 11.0% a year earlier; six-month net margin was approximately 9.2% versus 8.3%. These are calculated from reported net earnings and revenue.
Six-month brokerage revenue was $1,005.3, up from $858.8; risk-management revenue was $309.8, up from $284.7. Corporate revenue rose to $138.5 from $53.2, substantially reflecting clean-coal activity.
Management reported Q2 organic growth of 5.9% in brokerage base commissions and fees and 10.4% in risk-management fees. Adjusted EBITDAC increased 20% in brokerage and 14% in risk management; adjusted EBITDAC margins were 27.2% and 16.3%, respectively. These are non-GAAP measures.
Cash and cash equivalents were $240.0 at June 30, down from $302.1 at year-end 2012. Restricted cash was $913.5 and is fiduciary/restricted, not freely available liquidity.
Corporate debt was $925.0, all under private-placement note agreements, versus $854.0 at year-end. No credit-facility borrowings were outstanding; $484.1 remained available under the $500.0 revolving facility after letters of credit. Equity was $1,702.0; total assets were $5,562.1.

Changes and notable items

Brokerage and risk-management results improved, supported by acquisitions, new business, renewal pricing, and organic growth. Acquisitions contributed $46.4 of Q2 brokerage commission and fee revenue; management cited $62.2 of new production and renewal-rate increases, partly offset by $38.6 of lost business.
Gallagher completed nine acquisitions in the first half, with annualized acquired revenue of approximately $40.9. Cash paid, net of acquired cash, was $113.4. Goodwill rose to $1,506.1.
The company issued $200.0 of 3.69% senior notes due 2022 in June. It paid $90.1 in dividends in the first half and declared $0.35 per share for Q3. Shares outstanding were 127.7 million at June 30.
Clean-coal revenues and costs both increased sharply. The corporate segment recorded $24.1 of clean-energy net earnings in Q2 and $37.3 for the first half, largely reflecting tax benefits. The consolidated effective tax rate was 4.0% in Q2 and 4.1% for the first half, versus 21.3% and 19.3% in 2012; management attributed the low rates primarily to IRC Section 45 credits.
Foreign-currency translation reduced comprehensive earnings by $39.0 in the first half. Accumulated other comprehensive loss increased to $72.6 from $32.8 at year-end.

Outlook, risks and contingencies

Management expected clean-energy investments to generate $67–$71 of 2013 after-tax earnings and anticipated using positive tax-related cash flows to support acquisitions. It forecast brokerage and risk-management effective tax rates of approximately 37%–39% for the foreseeable future; the much lower consolidated rate reflects clean-energy credits.
Management said it had sufficient capital for short- and long-term needs and expected continued expansion through organic growth and acquisitions. No specific consolidated revenue or earnings guidance was provided. It expected approximately $80 of 2013 capital improvements.
Clean-coal operations carry execution and regulatory risk: six of 29 plants were still seeking contracts, permits, or deployment; management estimated further redeployment investment of $30–$35 after 2013, before co-investor contributions. Certain plants could be idle for 12–18 months if host utilities switch fuels or close.
Potential indemnification related to previously sold tax-advantaged investments was approximately $160, net of tax benefit; Gallagher also cited exposure on $130 of previously earned tax credits. No liability was recorded for those indemnifications. Adverse tax rulings or audits could create losses or repayment obligations.
Gallagher disclosed ordinary-course litigation and stated outcomes could not be determined. Its errors-and-omissions reserve was within the actuarial range, but future claims could materially change estimates. Other risks include acquisition integration and impairment, insurance-market conditions, competition, international operations, regulation, currency, and contingent commissions.
The company was in compliance with debt covenants at June 30. Its contractual-obligations table reported $1,554.1 total, including debt, interest, leases, and purchase obligations; off-balance-sheet commitments totaled $44.9.

Key facts for investors to verify

How much reported growth and earnings depend on acquisitions, contingent commissions, and clean-energy tax credits versus recurring organic brokerage and risk-management performance.
Whether clean-coal production, host-utility contracts, redeployment schedules, and required capital spending support management’s $67–$71 full-year earnings estimate.
The sustainability of the unusually low consolidated tax rate and the potential exposure from previously claimed tax credits and indemnities.
Acquisition integration, goodwill and intangible-asset impairment risk, earnout obligations, and the effect of rising debt and acquisition funding on cash generation.
Liquidity excluding restricted cash, dividend funding, and progress against management’s 2013 capital-expenditure and acquisition plans.