Arthur J. Gallagher & Co. quarterly report, Q1 FY2022

Arthur J. Gallagher & Co. — Q1 2022 Form 10-Q

Reporting period: Three months ended March 31, 2022; comparisons are with Q1 2021. Amounts are in millions of dollars except per-share data. Gallagher provides insurance brokerage and consulting, and third-party claims administration services. Its reportable segments are brokerage, risk management and corporate.

Financial performance

Metric	Q1 2022	Q1 2021	Change
Total revenue	$2,435.3	$2,165.0	+12.5%
Revenue before reimbursements	$2,404.5	$2,132.6	+12.7%
Earnings before income taxes	$537.7	$408.4	+31.7%
Net earnings attributable to controlling interests	$438.7	$382.1	+14.8%
Diluted EPS	$2.05	$1.92	+6.8%
Operating cash flow	$434.6	$218.7	+$215.9

Revenue drivers: Brokerage revenue rose 32% to $2,122.6 million, including acquisition contributions; organic revenue growth was 9.6%. Risk management revenue before reimbursements rose 18% to $259.1 million, with 15.2% organic growth.
Profitability: Brokerage reported net earnings margin was 21.9%, down from 22.6%; adjusted EBITDAC margin increased to 39.8% from 39.3%. Risk management net earnings margin rose to 9.2% from 8.2%, while adjusted EBITDAC margin declined to 17.3% from 18.4%.
Taxes and earnings quality: The consolidated effective tax rate was 18.3%, versus 3.6% in Q1 2021. The prior-year rate benefited from $52.6 million of clean-energy tax credits. Q1 2022 also included a one-time tax benefit from revaluing certain deferred tax assets. Adjusted diluted EPS was $2.81 versus $2.39, up 18%; the company began excluding intangible amortization from adjusted EPS and restated the comparison accordingly.
Cash flow: Management attributed the operating cash flow increase mainly to timing differences in current assets and liabilities. Changes in premiums receivable and premiums payable together used $496.0 million of cash, compared with $483.1 million in Q1 2021.

Balance sheet, debt and liquidity

At March 31, 2022, cash and cash equivalents were $528.6 million; restricted cash was $4,110.1 million and primarily represents fiduciary funds, not cash available for general corporate use.
Total assets were $43,161.5 million, up from $33,345.0 million at year-end 2021. The filing attributes growth in fiduciary balances and related receivables and payables primarily to the December 2021 Willis Re acquisition.
Net corporate and other debt was $6,184.3 million, including $6,048.0 million of senior notes and note purchase agreements and $173.4 million under the premium financing facility. A $200 million note purchase agreement matures in June 2022. There were no borrowings under the revolving credit agreement; $1,185.6 million remained available.
Management said operating cash flow and available borrowing capacity should provide adequate resources for foreseeable liquidity needs, and reported compliance with debt covenants.
Q1 interest expense was $63.9 million, versus $48.1 million a year earlier. Capital expenditures were $37.7 million; management expected approximately $185 million of 2022 capital expenditures.

Material changes and management outlook

Reported revenue comparisons include a sharp reduction in corporate clean-coal revenue: $22.7 million in Q1 2022 versus $300.6 million in Q1 2021. The IRC Section 45 credit program expired at year-end 2021; no credits were produced in Q1 2022. Gallagher does not anticipate clean-energy after-tax earnings in 2022, but expects positive net cash flow from the investments in 2022 and potentially through at least 2027 as existing credits are used.
The Willis Towers Watson treaty reinsurance brokerage operations were acquired in December 2021 for initial gross consideration of $3.25 billion, with up to $750 million of additional consideration tied to third-year revenue targets. One deferred international closing remained subject to regulatory approval and was expected in Q2 2022. Acquisition integration costs and other acquisition-related adjustments were significant in Q1.
Management described a firming insurance pricing environment, continued growth in exposure units, strong retention and new business activity, and expected favorable organic growth trends to continue during 2022. It cautioned that an economic slowdown or reversal could weaken revenue growth. The Q1 2022 industry pricing survey cited by management was not yet available at filing.
Gallagher estimated that suspending services to Russia-based clients and complying with sanctions could reduce full-year 2022 brokerage revenue by up to $10 million and net after-tax earnings by up to $0.03 per share, including a $0.01-per-share Q1 impact. The indirect effects of the conflict were considered difficult to estimate.
The quarterly dividend declared was $0.51 per share, up 6% year over year; the same amount was announced for Q2 2022. No shares were repurchased under the company’s repurchase plan during the quarter.

Risks, contingencies and unusual items

Risks highlighted include acquisition integration and client or employee retention, inflation and labor costs, economic and insurance-market conditions, competition, cybersecurity, foreign exchange, regulation and sanctions, and the company’s debt burden.
The IRS has audited Gallagher’s IRC 831(b) micro-captive advisory business since 2013 and is investigating whether the company acted as a tax-shelter promoter. Gallagher said it is cooperating, is not a target of a related criminal investigation, and does not expect a loss to be material, although it cannot reasonably estimate a potential loss.
Other matters include a patent infringement lawsuit concerning clean-coal technology, described as in discovery with a material loss considered remote, and ordinary-course litigation and regulatory inquiries whose outcomes cannot be determined. Gallagher also disclosed $108.0 million of exposure to previously earned tax credits, with no reserve recorded.
Acquisition earnout obligations had a maximum potential amount of $1,823.0 million; $962.3 million was recorded at estimated fair value. Changes in performance estimates can affect earnings. Goodwill was $8,727.7 million and net amortizable intangible assets were $3,877.6 million.
Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Most important facts for investors to verify

How much of brokerage growth and earnings reflects organic performance versus Willis Re and other acquisitions, and whether the anticipated integration benefits are being realized.
Whether adjusted earnings growth remains strong after considering the size and recurring nature of excluded acquisition costs, earnout adjustments and amortization; review the company’s non-GAAP definitions and reconciliations.
How the expiration of clean-energy tax credits affects future reported revenue, earnings, cash flow and tax rates, including the timing and usability of remaining credits.
Liquidity available after excluding restricted fiduciary cash, and the company’s plan for the June 2022 $200 million maturity and other debt obligations.
Progress on the remaining deferred Willis Re closing, the contingent purchase consideration, and material legal, tax, sanctions and acquisition-related exposures.