Arthur J. Gallagher & Co. — Q2 2021 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2021; unaudited. Gallagher provides insurance brokerage and consulting, claims administration and risk-management services, and operates clean-energy investments. Comparisons are with the corresponding 2020 periods. Dollar amounts are in millions unless noted.
Financial performance
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Total revenue | $1,933.5 | $1,584.0 | $4,098.5 | $3,450.9 |
| Earnings attributable to controlling interests | $190.2 | $153.7 | $572.3 | $500.0 |
| Diluted EPS | $0.92 | $0.79 | $2.83 | $2.58 |
| Operating cash flow | — | $688.3 | $802.2 |
- Q2 revenue increased 22% and controlling-interest earnings increased 24%; diluted EPS rose 16%. For the first half, revenue increased 19%, controlling-interest earnings 14%, and diluted EPS 10%.
- Management’s adjusted non-GAAP diluted EPS was $1.17 for Q2, up 18%, and $3.18 for the first half, up 12%. Adjustments include acquisition-related items, transaction costs, and other specified items; these figures are not GAAP measures.
- Q2 segment trends: Brokerage revenue was $1,390.2 million, up 16%, with organic revenue growth of 6.8%; adjusted EBITDAC margin was 32.9% versus 32.7%. Risk management revenue before reimbursements was $245.0 million, up 28%, with organic growth of 19.6%; adjusted margin was 19.7% versus 17.5%.
- Cash flow: First-half operating cash flow was down $113.9 million year over year, primarily reflecting higher income taxes and interest paid; timing of client fiduciary receipts and disbursements also affected cash flow. Capital expenditures were $59.2 million.
- Balance sheet and debt at June 30: Cash and cash equivalents were $3,204.1 million; restricted cash was an additional $3,170.9 million and is not generally available for company use. Gross corporate and other debt was $6,114.1 million ($6,078.3 million net of specified unamortized costs and discount), compared with $4,551.6 million gross at year-end 2020. The company reported $1,185.8 million available under its credit agreement and was in compliance with debt covenants.
- May equity issuance generated $1,437.9 million net proceeds; $1,500 million of senior notes were also issued. These financings helped drive the increase in cash and equity, while shares outstanding rose to 206.8 million from 193.7 million at year-end.
Material changes and unusual items
- Growth reflected stronger organic brokerage and claims-management activity, acquisitions, improving client business conditions, and higher clean-coal activity. First-half acquisitions had annualized revenue of approximately $173.8 million; cash paid for acquisitions, net of cash acquired, was $551.6 million.
- Clean-energy revenues rose, but related production costs exceeded revenues: in Q2, the corporate segment recorded $261.6 million revenue and a $110.8 million pretax loss. Section 45 tax credits substantially lowered the consolidated effective tax rate to 9.2% for Q2 and 5.6% for the first half.
- Q2 included one-time U.K. tax expense following enactment of a rate increase from 19% to 25% effective in 2023, as well as $10.2 million of pretax costs related to the proposed Willis Towers Watson transaction. The transaction-related agreement was terminated after quarter-end.
- Acquisition earnout changes were volatile: the first half of 2021 included $10.6 million of expense from revised earnout estimates, versus $91.6 million of income in the first half of 2020. Amortizable intangible-asset impairment write-offs were $13.1 million in the first half of 2021, compared with $46.0 million in 2020.
Outlook, risks and contingencies
- Management expected commercial property/casualty pricing to remain firm through the rest of 2021 and anticipated continued organic growth if economic recovery and insured exposures improved. It cautioned that slower recovery or deteriorating loss trends could weaken growth or make insurance conditions more difficult. The filing does not provide a consolidated full-year revenue or EPS forecast.
- Management estimated 2021 adjusted net earnings from clean-energy investments of $75–$85 million and expected positive net cash flow from these investments in 2021. It noted that tax-credit eligibility for the 21 plants from the 2011-era group was scheduled to expire in December 2021; expiration is expected to reduce reported revenue and earnings but may increase net cash flow.
- After the WTW-related agreement ended, Gallagher said it was evaluating uses for the financing proceeds, including acquisitions, share repurchases and general corporate purposes. It exercised the special redemption option on the $650 million 2031 notes; redemption was scheduled for August 13, 2021, with an estimated after-tax loss of $12–$14 million in Q3. The $850 million 2051 notes are not subject to that option.
- Effective July 29, the board authorized a new $1.5 billion share-repurchase program, replacing the prior program. Repurchases are discretionary and have no stated expiration date. The board also announced a Q3 dividend of $0.48 per share.
- Management anticipated higher operating costs as business activity normalized: estimated incremental brokerage costs versus 2020 were approximately $20 million in Q3 and $30 million in Q4, subject to economic recovery. Earlier pandemic-related expense savings had been approximately $60–$75 million per quarter.
- Material uncertainties include COVID-19 and economic conditions; acquisition integration and goodwill/intangible valuation; cybersecurity, including the previously disclosed ransomware incident; and insurance-market pricing and competition. The IRS has investigated the company’s micro-captive advisory business since 2013, and the DOJ is conducting a related criminal investigation; Gallagher stated it was not then a DOJ target, is cooperating, and cannot reasonably estimate potential loss. A patent infringement case remained pending, with the company describing the probability of material loss as remote. A related micro-captive class action concluded in Gallagher’s favor after the Supreme Court denied review in June 2021.
Important facts for investors to verify
- How much of reported growth and earnings improvement is recurring organic brokerage and risk-management performance versus acquisitions, clean-energy tax credits, and other non-GAAP adjustments.
- Deployment of the equity and debt proceeds after termination of the WTW transaction, including completion of the 2031-note redemption and any share repurchases or acquisitions.
- Cash available for corporate purposes after excluding restricted fiduciary cash, alongside debt levels, interest costs, and upcoming maturities.
- Clean-energy earnings and cash-flow assumptions, the December 2021 tax-credit expiration, and any resulting change in reported results.
- Developments and potential financial exposure from the IRS/DOJ micro-captive investigations, the patent litigation, and acquisition earnout and impairment estimates.