Arthur J. Gallagher & Co. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; balance-sheet comparisons are with December 31, 2010. Gallagher provides insurance brokerage and risk-management services in 16 countries, with business conducted in more than 110. Interim financial statements are unaudited and were reviewed, not audited, by Ernst & Young.
Financial results and liquidity
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Total revenue | $447.4 million | $482.4 million |
| Operating expenses | $423.9 million | $439.5 million |
| Earnings before income taxes | $23.5 million | $42.9 million |
| Net earnings | $15.2 million | $29.2 million |
| Diluted EPS | $0.14 | $0.28 |
| Operating cash flow | $(7.3) million | $3.5 million |
- Reported revenue fell about 7%; pretax earnings declined about 45% and net earnings about 48%. Net margin was approximately 3.4%, versus 6.1% a year earlier.
- The filing does not provide a consolidated gross-margin measure. Compensation was $295.1 million and operating expense $94.0 million. Interest expense was $9.5 million.
- Cash and cash equivalents were $333.2 million, up from $249.8 million at year-end; an additional $580.1 million was restricted cash and should not be treated as freely available liquidity. Current assets were $1,749.8 million and current liabilities $1,485.3 million.
- Corporate debt was $675.0 million, all under fixed-rate note agreements, up from $550.0 million after issuing $125.0 million of new notes. No credit-facility borrowings were outstanding; $483.9 million remained available. The company was in compliance with debt covenants.
- Investing cash outflow was $27.3 million, including $19.1 million for acquisitions and $8.3 million of capital spending. Financing cash inflow was $118.0 million, principally reflecting the new notes and stock issuance, partly offset by $34.7 million of dividends paid.
Material changes versus the prior period
- The reported revenue decline largely reflects the absence of $62.7 million of clean-coal activity revenue reported in Q1 2010, following changes in ownership and consolidation. The prior period also included $64.0 million of related costs and a $4.8 million gain from sales of clean-coal interests.
- Brokerage revenue was $317.4 million versus $304.4 million; brokerage pretax earnings were $29.1 million versus $39.4 million. On management’s adjusted basis, brokerage revenue was $316.3 million versus $288.8 million and adjusted diluted EPS was $0.16 versus $0.14. Organic commissions and fees grew 1.6%; management cited acquisition contributions and new business, offset by renewal rate declines and lost business.
- Risk-management revenue rose to $130.6 million from $110.5 million, including $11.5 million from GAB Robins. Reported pretax earnings were $11.3 million versus $15.4 million, but management’s adjusted pretax earnings were $16.6 million versus $15.4 million after excluding integration-related charges. Organic fees grew 5.8%.
- Reported supplemental commissions fell to $13.5 million from $27.9 million. The prior-year figure included a $14.7 million timing item; management says most carriers now provide information that supports quarterly recognition. Contingent commissions were $16.8 million versus $15.5 million.
- Four brokerage acquisitions were completed in Q1, with approximately $27.2 million of annualized acquired revenue. Goodwill increased to $925.5 million from $883.7 million.
Outlook, commentary, risks and unusual items
- Management said it expects its historically favorable pretax-earnings trend to continue, based on organic growth and acquisitions, and believes capital is sufficient for short- and long-term needs. No specific consolidated earnings or revenue guidance was given.
- Management expects 2011 capital-improvement spending of approximately $30–$35 million. The quarterly dividend was $0.33 per share; a second-quarter dividend of $0.33 was announced, 3% above the year-earlier quarter.
- Management described continued economic and pricing pressure: commercial property/casualty rates had declined for 28 consecutive quarters through Q4 2010, and Gallagher had not seen overall rate increases in Q1 2011.
- Clean-coal operations faced permitting, production, partner and tax-credit uncertainty. Management described possible earnings at planned production levels, but emphasized that timing and qualification for IRC Section 45 credits were uncertain.
- Potential tax indemnifications related to previously sold tax-advantaged investments had a maximum exposure of approximately $195 million, net of applicable tax benefit; $148.8 million of previously claimed credits remained exposed. No liability was recorded. The company also disclosed $153.9 million of unrecorded earnout obligations for older acquisitions.
- Other risks include insurance-market cyclicality, acquisition integration and earnout estimates, foreign exchange, litigation, regulation, employee costs and retention, and the ability to borrow in future credit-market conditions. The company disclosed an errors-and-omissions reserve within its actuarial range and various pending legal matters whose outcomes could not be determined.
Important facts for investors to verify
- Reconcile the sharp reported revenue and earnings decline with the clean-coal comparison, supplemental-commission timing, and management’s non-GAAP adjusted measures.
- Assess whether organic brokerage growth can persist amid renewal-rate pressure, and whether GAB Robins integration and revenue expectations are achieved.
- Monitor operating cash flow, excluding the effects of fiduciary and restricted funds, against dividends, acquisition spending and planned capital expenditures.
- Review debt levels and covenant headroom, as well as the valuation and eventual settlement of acquisition earnouts.
- Track clean-coal permits, operating performance and tax-credit eligibility, alongside the disclosed tax-indemnity exposure.