UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2013
or
¨ | Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission File Number: 1-09761
ARTHUR J. GALLAGHER & CO.
(Exact name of registrant as specified in its charter)
Delaware | 36-2151613 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
Two Pierce Place, Itasca, Illinois 60143-3141
(Address of principal executive offices) (Zip code)
(630) 773-3800
(Registrants telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer | x | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ | Smaller reporting company | ¨ | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of outstanding shares of the registrants common stock, $1.00 par value, as of September 30, 2013 was 131,538,000.
Arthur J. Gallagher & Co.
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Part I - Financial Information
Item 1. Financial Statements (Unaudited)
Arthur J. Gallagher & Co.
Consolidated Statement of Earnings
(Unaudited - in millions, except per share data)
Three-month period ended September 30, |
Nine-month period ended September 30, |
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2013 | 2012 | 2013 | 2012 | |||||||||||||
Commissions |
$ | 399.1 | $ | 346.0 | $ | 1,126.8 | $ | 962.7 | ||||||||
Fees |
270.0 | 248.2 | 778.6 | 706.0 | ||||||||||||
Supplemental commissions |
17.8 | 16.6 | 53.4 | 50.3 | ||||||||||||
Contingent commissions |
6.5 | 7.7 | 43.5 | 37.0 | ||||||||||||
Investment income |
2.6 | 2.7 | 5.5 | 8.0 | ||||||||||||
Net gains on books of business sales |
| 0.7 | 3.3 | 1.4 | ||||||||||||
Revenues from clean coal activities |
134.9 | 28.4 | 264.1 | 80.3 | ||||||||||||
Other net revenues |
4.9 | 0.1 | 14.2 | 1.4 | ||||||||||||
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Total revenues |
835.8 | 650.4 | 2,289.4 | 1,847.1 | ||||||||||||
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Compensation |
412.5 | 373.9 | 1,211.9 | 1,082.4 | ||||||||||||
Operating |
133.1 | 121.6 | 404.7 | 353.6 | ||||||||||||
Cost of revenues from clean coal activities |
146.9 | 27.7 | 281.6 | 74.4 | ||||||||||||
Interest |
13.1 | 10.7 | 36.2 | 32.1 | ||||||||||||
Depreciation |
14.3 | 10.7 | 38.2 | 30.6 | ||||||||||||
Amortization |
30.8 | 25.8 | 90.1 | 73.1 | ||||||||||||
Change in estimated acquisition earnout payables |
(0.4 | ) | 3.7 | 1.5 | 1.0 | |||||||||||
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Total expenses |
750.3 | 574.1 | 2,064.2 | 1,647.2 | ||||||||||||
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Earnings before income taxes |
85.5 | 76.3 | 225.2 | 199.9 | ||||||||||||
Provision for income taxes |
10.9 | 14.6 | 16.6 | 38.4 | ||||||||||||
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Net earnings |
$ | 74.6 | $ | 61.7 | $ | 208.6 | $ | 161.5 | ||||||||
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Basic net earnings per share |
$ | 0.57 | $ | 0.50 | $ | 1.63 | $ | 1.35 | ||||||||
Diluted net earnings per share |
0.57 | 0.50 | 1.61 | 1.33 | ||||||||||||
Dividends declared per common share |
0.35 | 0.34 | 1.05 | 1.02 |
See notes to consolidated financial statements.
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Arthur J. Gallagher & Co.
Consolidated Statement of Comprehensive Earnings
(Unaudited - in millions)
Three-month period ended September 30, |
Nine-month period ended September 30, |
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2013 | 2012 | 2013 | 2012 | |||||||||||||
Net earnings |
$ | 74.6 | $ | 61.7 | $ | 208.6 | $ | 161.5 | ||||||||
Change in pension liability, net of taxes |
0.2 | 1.0 | 0.4 | 2.0 | ||||||||||||
Foreign currency translation |
29.1 | 19.6 | (9.9 | ) | 17.4 | |||||||||||
Change in fair value of derivative investments, net of taxes |
1.5 | 1.7 | 0.5 | 2.0 | ||||||||||||
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Comprehensive earnings |
$ | 105.4 | $ | 84.0 | $ | 199.6 | $ | 182.9 | ||||||||
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See notes to consolidated financial statements.
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Arthur J. Gallagher & Co.
(In millions)
September 30, 2013 |
December 31, 2012 |
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(Unaudited) | ||||||||
Cash and cash equivalents |
$ | 286.9 | $ | 302.1 | ||||
Restricted cash |
924.2 | 851.6 | ||||||
Premiums and fees receivable |
1,075.1 | 1,096.1 | ||||||
Other current assets |
260.5 | 179.7 | ||||||
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Total current assets |
2,546.7 | 2,429.5 | ||||||
Fixed assets - net |
148.1 | 105.4 | ||||||
Deferred income taxes |
283.6 | 251.8 | ||||||
Other noncurrent assets |
302.3 | 283.3 | ||||||
Goodwill - net |
1,771.5 | 1,472.7 | ||||||
Amortizable intangible assets - net |
918.0 | 809.6 | ||||||
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Total assets |
$ | 5,970.2 | $ | 5,352.3 | ||||
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Premiums payable to insurance and reinsurance companies |
$ | 1,875.9 | $ | 1,819.7 | ||||
Accrued compensation and other accrued liabilities |
361.3 | 306.7 | ||||||
Unearned fees |
69.7 | 70.6 | ||||||
Other current liabilities |
35.5 | 36.9 | ||||||
Corporate related borrowings - current |
235.5 | 129.0 | ||||||
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Total current liabilities |
2,577.9 | 2,362.9 | ||||||
Corporate related borrowings - noncurrent |
825.0 | 725.0 | ||||||
Other noncurrent liabilities |
635.1 | 605.8 | ||||||
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Total liabilities |
4,038.0 | 3,693.7 | ||||||
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Stockholders equity: |
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Common stock - issued and outstanding 131.5 shares in 2013 and 125.6 shares in 2012 |
131.5 | 125.6 | ||||||
Capital in excess of par value |
1,259.3 | 1,055.4 | ||||||
Retained earnings |
583.2 | 510.4 | ||||||
Accumulated other comprehensive loss |
(41.8 | ) | (32.8 | ) | ||||
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Total stockholders equity |
1,932.2 | 1,658.6 | ||||||
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Total liabilities and stockholders equity |
$ | 5,970.2 | $ | 5,352.3 | ||||
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See notes to consolidated financial statements.
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Arthur J. Gallagher & Co.
Consolidated Statement of Cash Flows
(Unaudited - in millions)
Nine-month period ended September 30, |
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2013 | 2012 | |||||||
Cash flows from operating activities: |
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Net earnings |
$ | 208.6 | $ | 161.5 | ||||
Adjustments to reconcile net earnings to net cash provided by operating activities: |
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Net gain on investments and other |
(17.6 | ) | (1.4 | ) | ||||
Depreciation and amortization |
128.3 | 103.7 | ||||||
Change in estimated acquisition earnout payables |
1.5 | 1.0 | ||||||
Amortization of deferred compensation and restricted stock |
10.6 | 6.4 | ||||||
Stock-based and other noncash compensation expense |
5.4 | 5.5 | ||||||
Effect of changes in foreign exchange rates |
| 0.9 | ||||||
Net change in restricted cash |
(29.3 | ) | (65.7 | ) | ||||
Net change in premiums receivable |
62.3 | 75.1 | ||||||
Net change in premiums payable |
(7.2 | ) | (55.5 | ) | ||||
Net change in other current assets |
(71.5 | ) | 12.2 | |||||
Net change in accrued compensation and other accrued liabilities |
50.1 | (42.6 | ) | |||||
Net change in fees receivable/unearned fees |
(11.3 | ) | (7.9 | ) | ||||
Net change in income taxes payable |
9.5 | 12.9 | ||||||
Net change in deferred income taxes |
(36.6 | ) | 3.3 | |||||
Net change in other noncurrent assets and liabilities |
(24.2 | ) | (30.0 | ) | ||||
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Net cash provided by operating activities |
278.6 | 179.4 | ||||||
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Cash flows from investing activities: |
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Net additions to fixed assets |
(69.8 | ) | (36.1 | ) | ||||
Cash paid for acquisitions, net of cash acquired |
(333.0 | ) | (137.9 | ) | ||||
Net proceeds from sales of operations/books of business |
3.3 | 8.9 | ||||||
Net (funding) proceeds of investment transactions |
(31.0 | ) | 10.7 | |||||
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Net cash used by investing activities |
(430.5 | ) | (154.4 | ) | ||||
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Cash flows from financing activities: |
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Proceeds from issuance of common stock |
64.5 | 60.9 | ||||||
Tax impact from issuance of common stock |
6.3 | 3.7 | ||||||
Dividends paid |
(136.0 | ) | (119.7 | ) | ||||
Borrowings on line of credit facility |
445.5 | 162.0 | ||||||
Repayments on line of credit facility |
(439.0 | ) | (172.0 | ) | ||||
Borrowings of corporate related long-term debt |
200.0 | 50.0 | ||||||
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Net cash provided (used) by financing activities |
141.3 | (15.1 | ) | |||||
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Effect of changes in foreign exchange rates on cash and cash equivalents |
(4.6 | ) | 4.1 | |||||
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Net (decrease) increase in cash and cash equivalents |
(15.2 | ) | 14.0 | |||||
Cash and cash equivalents at beginning of period |
302.1 | 291.2 | ||||||
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Cash and cash equivalents at end of period |
$ | 286.9 | $ | 305.2 | ||||
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Supplemental disclosures of cash flow information: |
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Interest paid |
$ | 40.4 | $ | 38.0 | ||||
Income taxes paid |
37.1 | 24.5 |
See notes to consolidated financial statements.
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Arthur J. Gallagher & Co.
Consolidated Statement of Stockholders Equity
(Unaudited - in millions)
Common Stock | Capital in Excess of |
Retained | Accumulated Other Comprehensive |
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Shares | Amount | Par Value | Earnings | Loss | Total | |||||||||||||||||||
Balance at December 31, 2012 |
125.6 | $ | 125.6 | $ | 1,055.4 | $ | 510.4 | $ | (32.8 | ) | $ | 1,658.6 | ||||||||||||
Net earnings |
| | | 208.6 | | 208.6 | ||||||||||||||||||
Change in pension liability, net of taxes of $0.2 million |
| | | | 0.4 | 0.4 | ||||||||||||||||||
Foreign currency translation |
| | | | (9.9 | ) | (9.9 | ) | ||||||||||||||||
Change in fair value of derivative instruments, net of taxes of $0.3 million |
| | | | 0.5 | 0.5 | ||||||||||||||||||
Compensation expense related to stock option plan grants |
| | 5.4 | | | 5.4 | ||||||||||||||||||
Tax impact from issuance of common stock |
| | 6.3 | | | 6.3 | ||||||||||||||||||
Common stock issued in: |
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Four purchase transactions |
3.4 | 3.4 | 147.8 | | | 151.2 | ||||||||||||||||||
Stock option plans |
2.1 | 2.1 | 54.4 | | | 56.5 | ||||||||||||||||||
Employee stock purchase plan |
0.2 | 0.2 | 7.8 | | | 8.0 | ||||||||||||||||||
Deferred compensation and restricted stock |
0.2 | 0.2 | (17.8 | ) | | | (17.6 | ) | ||||||||||||||||
Cash dividends declared on common stock |
| | | (135.8 | ) | | (135.8 | ) | ||||||||||||||||
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Balance at September 30, 2013 |
131.5 | $ | 131.5 | $ | 1,259.3 | $ | 583.2 | $ | (41.8 | ) | $ | 1,932.2 | ||||||||||||
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See notes to consolidated financial statements.
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Notes to September 30, 2013 Consolidated Financial Statements (Unaudited)
1. Nature of Operations and Basis of Presentation
Arthur J. Gallagher & Co. and its subsidiaries, collectively referred to herein as we, our, us or the company, provide insurance brokerage and risk management services to a wide variety of commercial, industrial, institutional and governmental organizations through three reportable segments. Commission and fee revenue generated by the brokerage segment is primarily related to the negotiation and placement of insurance for our clients. Fee revenue generated by the risk management segment is primarily related to claims management, information management, risk control consulting (loss control) services and appraisals in the property/casualty market. Investment income and other revenue are generated from our investment portfolio, which includes invested cash and restricted funds, as well as clean energy and other investments. We are headquartered in Itasca, Illinois, have operations in 20 countries and offer client-service capabilities in more than 140 countries globally through a network of correspondent insurance brokers and consultants.
We have prepared the accompanying unaudited consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements have been omitted pursuant to such rules and regulations. We believe the disclosures are adequate to make the information presented not misleading. The unaudited consolidated financial statements included herein are, in the opinion of management, prepared on a basis consistent with our audited consolidated financial statements for the year ended December 31, 2012 and include all normal recurring adjustments necessary for a fair presentation of the information set forth. The quarterly results of operations are not necessarily indicative of the results of operations to be reported for subsequent quarters or the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2012.
Certain reclassifications have been made to the amounts reported in the prior years unaudited consolidated financial statements in order to conform to the current year presentation.
In the preparation of our unaudited consolidated financial statements as of September 30, 2013, management evaluated all material subsequent events or transactions that occurred after the balance sheet date through the date on which the financial statements were issued, for potential recognition or disclosure therein.
2. Effect of New Accounting Pronouncements
Presentation of Unrecognized Tax Benefits
In July 2013, the Financial Accounting Standards Board (which we refer to as the FASB) issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which provides explicit guidance on the presentation of certain unrecognized tax benefits in the financial statements that did not previously exist. The ASU provides that a liability related to an unrecognized tax benefit would be offset against a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. In that case, the liability associated with the unrecognized tax benefit is presented in the financial statements as a reduction to the related deferred tax asset. In situations in which a net operating loss carryforward, a similar tax loss or a tax credit carryforward is not available at the reporting date under the tax law of the jurisdiction or the tax law of the jurisdiction does not require, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit will be presented in the financial statements as a liability and will not be combined with deferred tax assets. This new guidance is effective for annual and interim periods beginning after December 15, 2013. Early adoption is permitted. Management is currently evaluating whether or not to early adopt and the impact of the new guidance upon adoption, but believes that the impact on the financial statements will not be material.
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Other Comprehensive Income
In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220), Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which requires significant items reclassified out of accumulated other comprehensive income (which we refer to as AOCI) to net income in their entirety in the same reporting period, to be reported to show the effect of the reclassifications on the respective line items of the statement where net income is presented. These reclassifications can be presented either on the face of the statement where net income is presented or in the notes to the financial statements. For items that are not reclassified to net income in their entirety in the same reporting period, a cross reference to other disclosures currently required under U.S. GAAP is required in the notes to the consolidated financial statements. The new guidance also requires companies to report changes in the accumulated balances of each component of AOCI. This new guidance was effective for annual and interim periods beginning after December 15, 2012. We adopted the new guidance effective January 1, 2013. The adoption affected the disclosures made in our unaudited consolidated financial statements and notes thereto, but did not have any impact on our results of operations or financial position.
3. Business Combinations
During the nine-month period ended September 30, 2013, we acquired substantially all of the net assets of the following firms in exchange for our common stock and/or cash. These acquisitions have been accounted for using the acquisition method for recording business combinations (in millions except share data):
Name and Effective Date of Acquisition |
Common Shares Issued |
Common Share Value |
Cash Paid |
Accrued Liability |
Escrow Deposited |
Recorded Earnout Payable |
Total Recorded Purchase Price |
Maximum Potential Earnout Payable |
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Metzler Brothers Insurance February 1, 2013 |
| $ | | $ | 3.4 | $ | | $ | 0.4 | $ | 0.7 | $ | 4.5 | $ | 1.4 | |||||||||||||||||
Advanced Benefit Advisors, Inc. (ABA) April 1, 2013 |
| | 10.9 | | 0.1 | 1.8 | 12.8 | 7.0 | ||||||||||||||||||||||||
Property & Commercial Limited (PCL) April 1, 2013 |
| | 65.1 | | | | 65.1 | | ||||||||||||||||||||||||
Garza Long Group, LLC (GLG) May 1, 2013 |
| | 4.3 | | 0.1 | 0.5 | 4.9 | 6.7 | ||||||||||||||||||||||||
Bollinger, Inc. (BOL) August 1, 2013 |
3,177 | 140.0 | 155.1 | | 22.0 | | 317.1 | | ||||||||||||||||||||||||
Dickinson & Associates, Inc. (DA) August 1, 2013 |
| | 10.9 | | 0.1 | 0.5 | 11.5 | 4.8 | ||||||||||||||||||||||||
Belmont International (BEL) September 1, 2013 |
| | 21.7 | | 2.5 | 2.8 | 27.0 | 3.2 | ||||||||||||||||||||||||
R.W. Scobie, Inc. (RWS) September 1, 2013 |
223 | 9.5 | 4.4 | | | 2.4 | 16.3 | 5.0 | ||||||||||||||||||||||||
Jeffrey Haber & Michael Fischman (HF) September 20, 2013 |
| | 7.0 | | | 8.4 | 15.4 | 10.3 | ||||||||||||||||||||||||
Eight other acquisitions completed in 2013 |
30 | 1.4 | 8.4 | | 0.4 | 6.4 | 16.6 | 8.7 | ||||||||||||||||||||||||
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3,430 | $ | 150.9 | $ | 291.2 | $ | | $ | 25.6 | $ | 23.5 | $ | 491.2 | $ | 47.1 | ||||||||||||||||||
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On September 4, 2013 we signed an agreement to acquire the Giles Group of Companies (which we refer to as Giles) headquartered in London, England. Under the agreement, we agreed to purchase all of the outstanding shares of Giles for net cash consideration of approximately £233 million, or approximately $370 million. The transaction is subject to regulatory approval and is expected to close in early November 2013. Giles is the fifth largest independent retail insurance broker in the United Kingdom with over 1,100 employees operating out of 43 offices in England,
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Scotland, Wales, Northern Ireland, Isle of Man and the Channel Islands. In the nine-month period ended September 30, 2013, we recognized an unrealized fair value pretax gain of $5.0 million related to three foreign currency derivative investment contracts that we executed in September 2013 in connection with the signing of the agreement to acquire Giles. This unrealized gain was included in other net revenues in the consolidated statement of earnings. The derivative investment contracts will expire by October 31, 2013.
Common shares issued in connection with acquisitions are valued at closing market prices as of the effective date of the applicable acquisition. We record escrow deposits that are returned to us as a result of adjustments to net assets acquired as reductions of goodwill when the escrows are settled. The maximum potential earnout payables disclosed in the foregoing table represent the maximum amount of additional consideration that could be paid pursuant to the terms of the purchase agreement for the applicable acquisition. The amounts recorded as earnout payables, which are primarily based upon the estimated future operating results of the acquired entities over a two- to three-year period subsequent to the acquisition date, are measured at fair value as of the acquisition date and are included on that basis in the recorded purchase price consideration for the applicable acquisition. We will record subsequent changes in these estimated earnout obligations, including the accretion of discount, in our consolidated statement of earnings when incurred.
The fair value of these earnout obligations is based on the present value of the expected future payments to be made to the sellers of the acquired entities in accordance with the provisions outlined in the respective purchase agreements. In determining fair value, we estimated the acquired entitys future performance using financial projections developed by management for the acquired entity and market participant assumptions that were derived for revenue growth and/or profitability. Revenue growth rates generally ranged from 2.0% to 10.0% for our 2013 acquisitions. We estimated future payments using the earnout formula and performance targets specified in each purchase agreement and these financial projections. We then discounted these payments to present value using a risk-adjusted rate that takes into consideration market-based rates of return that reflect the ability of the acquired entity to achieve the targets. These discount rates generally ranged from 8.0% to 8.5% for all of our 2013 acquisitions. Changes in financial projections, market participant assumptions for revenue growth and/or profitability, or the risk-adjusted discount rate, would result in a change in the fair value of recorded earnout obligations.
During each of the three-month periods ended September 30, 2013 and 2012, we recognized $2.9 million and $2.4 million, respectively, of expense in our consolidated statement of earnings related to the accretion of the discount recorded for earnout obligations in connection with our acquisitions. During each of the nine-month periods ended September 30, 2013 and 2012, we recognized $8.7 million and $7.0 million, respectively, of expense in our consolidated statement of earnings related to the accretion of the discount recorded for earnout obligations in connection with our acquisitions. In addition, during the three-month periods ended September 30, 2013 and 2012, we recognized $3.3 million of income and $1.3 million of expense, respectively, related to net adjustments in the estimated fair value of earnout obligations in connection with revised projections of future performance for twenty and twelve acquisitions, respectively. In addition, during the nine-month periods ended September 30, 2013 and 2012, we recognized $7.2 million and $6.0 million of income, respectively, related to net adjustments in the estimated fair value of earnout obligations in connection with revised projections of future performance for fifty-three and thirty-one acquisitions, respectively. The aggregate amount of maximum earnout obligations related to acquisitions made in 2009 and subsequent years was $400.4 million as of September 30, 2013, of which $140.4 million was recorded in our consolidated balance sheet as of September 30, 2013, based on the estimated fair value of the expected future payments to be made.
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The following is a summary of the estimated fair values of the net assets acquired at the date of each acquisition made in the nine-month period ended September 30, 2013 (in millions):
ABA | PCL | GLG | BOL | DA | BEL | RWS | HF | Nine Other Acquisitions |
Total | |||||||||||||||||||||||||||||||
Cash |
$ | | $ | 2.4 | $ | | $ | 7.6 | $ | 0.6 | $ | 5.3 | $ | 0.2 | $ | | $ | 0.2 | $ | 16.3 | ||||||||||||||||||||
Other current assets |
| 32.9 | | 39.4 | | 19.1 | 8.2 | | 0.2 | 99.8 | ||||||||||||||||||||||||||||||
Fixed assets |
| 2.7 | | 3.1 | | 0.4 | 0.4 | | 0.2 | 6.8 | ||||||||||||||||||||||||||||||
Noncurrent assets |
| 0.4 | | 2.2 | | | | | | 2.6 | ||||||||||||||||||||||||||||||
Goodwill |
7.6 | 44.6 | 2.4 | 197.0 | 4.0 | 15.3 | 12.8 | 8.4 | 7.9 | 300.0 | ||||||||||||||||||||||||||||||
Expiration lists |
5.0 | 25.6 | 2.4 | 132.5 | 7.3 | 9.0 | 6.7 | 6.7 | 13.4 | 208.6 | ||||||||||||||||||||||||||||||
Non-compete agreements |
0.2 | | 0.1 | 0.4 | 0.2 | 0.2 | | 0.3 | 0.4 | 1.8 | ||||||||||||||||||||||||||||||
Trade names |
| 0.1 | | 1.7 | | | | | | 1.8 | ||||||||||||||||||||||||||||||
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Total assets acquired |
12.8 | 108.7 | 4.9 | 383.9 | 12.1 | 49.3 | 28.3 | 15.4 | 22.3 | 637.7 | ||||||||||||||||||||||||||||||
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Current liabilities |
| 35.5 | | 50.9 | 0.6 | 20.5 | 9.4 | | 0.7 | 117.6 | ||||||||||||||||||||||||||||||
Noncurrent liabilities |
| 8.1 | | 15.9 | | 1.8 | 2.6 | | 0.5 | 28.9 | ||||||||||||||||||||||||||||||
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Total liabilities assumed |
| 43.6 | | 66.8 | 0.6 | 22.3 | 12.0 | | 1.2 | 146.5 | ||||||||||||||||||||||||||||||
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Total net assets acquired |
$ | 12.8 | $ | 65.1 | $ | 4.9 | $ | 317.1 | $ | 11.5 | $ | 27.0 | $ | 16.3 | $ | 15.4 | $ | 21.1 | $ | 491.2 | ||||||||||||||||||||
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Among other things, these acquisitions allow us to expand into desirable geographic locations, further extend our presence in the retail and wholesale insurance brokerage services and risk management industries and/or increase the volume of general services currently provided. The excess of the purchase price over the estimated fair value of the tangible net assets acquired at the acquisition date was allocated to goodwill, expiration lists, non-compete agreements and trade names in the amounts of $300.0 million, $208.6 million, $1.8 million and $1.8 million, respectively, within the brokerage segment.
Provisional estimates of fair value are established at the time of the acquisition and are subsequently reviewed within the first year of operations subsequent to the acquisition date to determine the necessity for adjustments. The fair value of the tangible assets and liabilities for each applicable acquisition at the acquisition date approximated their carrying values. The fair value of expiration lists was established using the excess earnings method, which is an income approach based on estimated financial projections developed by management for each acquired entity using market participant assumptions. Revenue growth and attrition rates generally ranged from 2.0% to 10.0% and 5.0% to 15.0%, respectively, for our 2012 and 2013 acquisitions, for which a valuation was performed in the nine-month period ended September 30, 2013. We estimate the fair value as the present value of the benefits anticipated from ownership of the subject customer list in excess of returns required on the investment in contributory assets necessary to realize those benefits. The rate used to discount the net benefits was based on a risk-adjusted rate that takes into consideration market-based rates of return and reflects the risk of the asset relative to the acquired business. These discount rates generally ranged from 10.5% to 14.0% for our 2012 and 2013 acquisitions, for which a valuation was performed in the nine-month period ended September 30, 2013. The fair value of non-compete agreements was established using the profit differential method, which is an income approach based on estimated financial projections developed by management for the acquired company using market participant assumptions and various non-compete scenarios.
Expiration lists, non-compete agreements and trade names related to our acquisitions are amortized using the straight-line method over their estimated useful lives (three to fifteen years for expiration lists, three to five years for non-compete agreements and five to ten years for trade names), while goodwill is not subject to amortization. We use the straight-line method to amortize these intangible assets because the pattern of their economic benefits cannot be reasonably determined with any certainty. We review all of our intangible assets for impairment periodically (at least annually) and whenever events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. In reviewing intangible assets, if the fair value is less than the carrying amount of the respective (or underlying) asset, an indicator of impairment would exist and further analysis would be required to determine whether or not a loss would need to be charged against current period earnings. Based on the results of
- 11 -
impairment reviews during the nine-month period ended September 30, 2013, we wrote off $2.2 million of amortizable intangible assets related to the brokerage segment. Based on the results of impairment reviews during the three-month and nine-month periods ended September 30, 2012, we wrote off $0.3 million and $3.4 million, respectively, of amortizable intangible assets related to the brokerage segment.
Of the $208.6 million of expiration lists, $1.8 million of non-compete agreements and $1.8 million of trade names related to our acquisitions made during the nine-month period ended September 30, 2013, $174.9 million, $0.7 million and $1.8 million, respectively, is not expected to be deductible for income tax purposes. Accordingly, we recorded a deferred tax liability of $23.4 million, and a corresponding amount of goodwill, in the nine-month period ended September 30, 2013 related to nondeductible amortizable intangible assets.
During the nine-month period ended September 30, 2012, we issued 425,000 shares of our common stock and paid $3.4 million in cash related to earnout obligations of four acquisitions made prior to 2009 and recorded additional goodwill of $0.1 million.
Our consolidated financial statements for the nine-month period ended September 30, 2013 include the operations of the acquired entities from their respective acquisition dates. The following is a summary of the unaudited pro forma historical results, as if these entities had been acquired at January 1, 2012 (in millions, except per share data):
Three-month period ended September 30, |
Nine-month period ended September 30, |
|||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Total revenues |
$ | 850.9 | $ | 693.7 | $ | 2,385.9 | $ | 1,981.0 | ||||||||
Net earnings |
75.2 | 63.5 | 216.2 | 168.7 | ||||||||||||
Basic net earnings per share |
0.57 | 0.50 | 1.66 | 1.37 | ||||||||||||
Diluted net earnings per share |
0.57 | 0.50 | 1.64 | 1.35 |
The unaudited pro forma results above have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had these acquisitions occurred at January 1, 2012, nor are they necessarily indicative of future operating results. Annualized revenues of the businesses acquired during the nine-month period ended September 30, 2013 totaled approximately $176.4 million. For the nine-month period ended September 30, 2013, total revenues and net earnings recorded in our unaudited consolidated statement of earnings related to our acquisitions made during the nine-month period ended September 30, 2013 in the aggregate, were $41.5 million and $4.3 million, respectively.
4. Intangible Assets
The carrying amount of goodwill at September 30, 2013 and December 31, 2012 allocated by domestic and foreign operations is as follows (in millions):
Brokerage | Risk Management |
Corporate | Total | |||||||||||||
At September 30, 2013 |
||||||||||||||||
United States |
$ | 1,398.6 | $ | 19.3 | $ | | $ | 1,417.9 | ||||||||
Foreign, principally Australia, Canada and the U.K. |
351.6 | 2.0 | | 353.6 | ||||||||||||
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Total goodwill - net |
$ | 1,750.2 | $ | 21.3 | $ | | $ | 1,771.5 | ||||||||
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At December 31, 2012 |
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United States |
$ | 1,158.1 | $ | 19.2 | $ | | $ | 1,177.3 | ||||||||
Foreign, principally Australia, Canada and the U.K. |
293.3 | 2.1 | | 295.4 | ||||||||||||
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Total goodwill - net |
$ | 1,451.4 | $ | 21.3 | $ | | $ | 1,472.7 | ||||||||
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- 12 -
The changes in the carrying amount of goodwill for the nine-month period ended September 30, 2013 are as follows (in millions):
Risk | ||||||||||||||||
Brokerage | Management | Corporate | Total | |||||||||||||
Balance as of December 31, 2012 |
$ | 1,451.4 | $ | 21.3 | $ | | $ | 1,472.7 | ||||||||
Goodwill acquired during the period |
300.0 | | | 300.0 | ||||||||||||
Goodwill adjustments due to appraisals and other acquisition adjustments |
3.3 | | | 3.3 | ||||||||||||
Foreign currency translation adjustments during the period |
(4.5 | ) | | | (4.5 | ) | ||||||||||
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Balance as of September 30, 2013 |
$ | 1,750.2 | $ | 21.3 | $ | | $ | 1,771.5 | ||||||||
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Major classes of amortizable intangible assets at September 30, 2013 and December 31, 2012 consist of the following (in millions):
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
Expiration lists |
$ | 1,372.4 | $ | 1,175.0 | ||||
Accumulated amortization - expiration lists |
(477.1 | ) | (390.8 | ) | ||||
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895.3 | 784.2 | |||||||
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Non-compete agreements |
31.8 | 30.9 | ||||||
Accumulated amortization - non-compete agreements |
(25.0 | ) | (23.3 | ) | ||||
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6.8 | 7.6 | |||||||
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Trade names |
22.4 | 23.0 | ||||||
Accumulated amortization - trade names |
(6.5 | ) | (5.2 | ) | ||||
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15.9 | 17.8 | |||||||
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Net amortizable assets |
$ | 918.0 | $ | 809.6 | ||||
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Estimated aggregate amortization expense for each of the next five years is as follows:
2013 (remaining three months) |
$ | 32.6 | ||
2014 |
128.5 | |||
2015 |
123.4 | |||
2016 |
117.9 | |||
2017 |
109.8 | |||
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Total |
$ | 512.2 | ||
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5. Credit and Other Debt Agreements
Note Purchase Agreement - We are a party to an amended and restated note purchase agreement dated December 19, 2007, with certain accredited institutional investors, pursuant to which we issued and sold $100.0 million in aggregate principal amount of our 6.26% Senior Notes, Series A, due August 3, 2014 and $300.0 million in aggregate principal amount of our 6.44% Senior Notes, Series B, due August 3, 2017, in a private placement. These notes require semi-annual payments of interest that are due in February and August of each year.
We are a party to a note purchase agreement dated November 30, 2009, with certain accredited institutional investors, pursuant to which we issued and sold $150.0 million in aggregate principal amount of our 5.85% Senior Notes, Series C, due in three equal installments on November 30, 2016, November 30, 2018 and November 30, 2019, in a private placement. These notes require semi-annual payments of interest that are due in May and November of each year.
- 13 -
We are a party to a note purchase agreement dated February 10, 2011, with certain accredited institutional investors, pursuant to which we issued and sold $75.0 million in aggregate principal amount of our 5.18% Senior Notes, Series D, due February 10, 2021 and $50.0 million in aggregate principal amount of our 5.49% Senior Notes, Series E, due February 10, 2023, in a private placement. These notes require semi-annual payments of interest that are due in February and August of each year.
We are a party to a note purchase agreement dated July 10, 2012, with certain accredited institutional investors, pursuant to which we issued and sold $50.0 million in aggregate principal amount of our 3.99% Senior Notes, Series F, due July 10, 2020, in a private placement. These notes require semi-annual payments of interest that are due in January and July of each year.
We are a party to a note purchase agreement dated June 14, 2013, with certain accredited institutional investors, pursuant to which we issued and sold $200.0 million in aggregate principal amount of our 3.69% Senior Notes, Series G, due June 14, 2022, in a private placement. These notes require semi-annual payments of interest that are due in June and December of each year.
Under the terms of the note purchase agreements, we may redeem the notes at any time, in whole or in part, at 100% of the principal amount of such notes being redeemed, together with accrued and unpaid interest and a make-whole amount. The make-whole amount is derived from a net present value computation of the remaining scheduled payments of principal and interest using a discount rate based on U.S. Treasury yields plus 0.5% and is designed to compensate the purchasers of the notes for their investment risk in the event prevailing interest rates at the time of prepayment are less favorable than the interest rates under the notes. We do not currently intend to prepay any of the notes.
The note purchase agreements contain customary provisions for transactions of this type, including representations and warranties regarding us and our subsidiaries and various financial covenants, including covenants that require us to maintain specified financial ratios. We were in compliance with these covenants as of September 30, 2013. The note purchase agreements also provide customary events of default, generally with corresponding grace periods, including, without limitation, payment defaults with respect to the notes, covenant defaults, cross-defaults to other agreements evidencing our or our subsidiaries indebtedness, certain judgments against us or our subsidiaries and events of bankruptcy involving us or our material subsidiaries.
The notes issued under the note purchase agreements are senior unsecured obligations of ours and rank equal in right of payment with our Credit Agreement discussed below.
Credit Agreement - On September 19, 2013, we entered into a $600.0 million unsecured multicurrency credit agreement (which we refer to as the Credit Agreement), which expires on September 19, 2018, with a group of fifteen financial institutions. The Credit Agreement replaced a $500.0 million unsecured revolving credit facility (that was scheduled to expire on July 14, 2014), which was terminated upon the execution of the Credit Agreement. All indebtedness, liabilities and obligations outstanding under the previous facility were fully paid and satisfied, except for the letters of credit (which we refer to as LOCs) which became LOCs under the Credit Agreement. We incurred no early termination fees in connection with replacing the previous credit facility.
The Credit Agreement provides for a revolving credit commitment of up to $600.0 million, of which up to $75.0 million may be used for issuances of standby or commercial letters of credit and up to $50.0 million may be used for the making of swing loans, as defined in the Credit Agreement. We may from time to time request, subject to certain conditions, an increase in the revolving credit commitment up to a maximum aggregate revolving credit commitment of $850.0 million.
The Credit Agreement provides that we may elect that each borrowing in U.S. dollars be either base rate loans or Eurocurrency loans, as defined in the Credit Agreement. All loans denominated in currencies other than U.S. dollars will be Eurocurrency loans. Interest rates on base rate loans and outstanding drawings on letters of credit in U.S. dollars under the Credit Agreement are based on the base rate, as defined in the Credit Agreement. Interest rates on Eurocurrency loans or outstanding drawings on letters of credit in currencies other than U.S. dollars are based on an adjusted London Interbank Offered Rate (which we refer to as LIBOR), as defined in the Credit Agreement, plus a margin of 0.85%, 0.95%, 1.05%, 1.25% or 1.45%, depending on the financial leverage ratio we maintain. Interest rates on swing loans are based, at our election, on either the base rate, as defined in the Credit Agreement, or such alternate rate as may be quoted by the lead lender. The annual facility fee related to the Credit Agreement is .15%, .175%, .20%, .25% or .30% of the used and unused portions of the revolving credit commitment, depending on the financial leverage ratio we maintain. In connection with entering into the Credit Agreement, we incurred approximately $2.1 million of debt acquisition costs that were capitalized and will be amortized on a pro rata basis over the term of the Credit Agreement.
- 14 -
The terms of our Credit Agreement include various financial covenants, including covenants that require us to maintain specified levels of net worth and financial leverage ratios. We were in compliance with these covenants as of September 30, 2013. The Credit Agreement also includes customary events of default, with corresponding grace periods, including, without limitation, payment defaults, cross-defaults to other agreements evidencing indebtedness and bankruptcy-related defaults.
At September 30, 2013, $15.2 million of letters of credit (for which we had $8.7 million of liabilities recorded at September 30, 2013) were outstanding under the Credit Agreement. There were $135.5 million of borrowings outstanding under the Credit Agreement at September 30, 2013. Accordingly, as of September 30, 2013, $449.3 million remained available for potential borrowings under the Credit Agreement, of which $59.8 million may be in the form of additional letters of credit.
See Note 12 to these unaudited consolidated financial statements for additional discussion on our contractual obligations and commitments as of September 30, 2013.
The following is a summary of our corporate debt (in millions):
September 30, | December 31, | |||||||
2013 | 2012 | |||||||
Note Purchase Agreements: |
||||||||
Semi-annual payments of interest, fixed rate of 6.26%, balloon due 2014 |
$ | 100.0 | $ | 100.0 | ||||
Semi-annual payments of interest, fixed rate of 6.44%, balloon due 2017 |
300.0 | 300.0 | ||||||
Semi-annual payments of interest, fixed rate of 5.85%, $50 million due in 2016, 2018 and 2019 |
150.0 | 150.0 | ||||||
Semi-annual payments of interest, fixed rate of 5.18%, balloon due 2021 |
75.0 | 75.0 | ||||||
Semi-annual payments of interest, fixed rate of 5.49%, balloon due 2023 |
50.0 | 50.0 | ||||||
Semi-annual payments of interest, fixed rate of 3.99%, balloon due 2020 |
50.0 | 50.0 | ||||||
Semi-annual payments of interest, fixed rate of 3.69%, balloon due 2022 |
200.0 | | ||||||
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Total Note Purchase Agreements |
925.0 | 725.0 | ||||||
Credit Agreement: |
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Periodic payments of interest and principal, prime or LIBOR plus up to 1.45%, expires September 19, 2018 |
135.5 | 129.0 | ||||||
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$ | 1,060.5 | $ | 854.0 | |||||
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The fair value of the $925.0 million in debt under the note purchase agreements at September 30, 2013 was $985.2 million due to the long-term duration and fixed interest rates associated with these debt obligations. No active or observable market exists for our private placement long-term debt. Therefore, the estimated fair value of this debt is based on discounted future cash flows, which is a Level 3 fair value measurement, using current interest rates available for debt with similar terms and remaining maturities. To estimate an all-in interest rate for discounting, we obtain market quotes for notes with the same terms as ours, which we have deemed to be the closest approximation of current market rates. We have not adjusted this rate for risk profile changes, covenant issues or credit ratings changes.
- 15 -
6. Earnings Per Share
The following table sets forth the computation of basic and diluted net earnings per share (in millions, except per share data):
Three-month period ended September 30, |
Nine-month period ended September 30, |
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2013 | 2012 | 2013 | 2012 | |||||||||||||
Net earnings |
$ | 74.6 | $ | 61.7 | $ | 208.6 | $ | 161.5 | ||||||||
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Weighted average number of common shares outstanding |
129.8 | 123.1 | 127.7 | 119.7 | ||||||||||||
Dilutive effect of stock options using the treasury stock method |
1.5 | 1.4 | 1.6 | 1.5 | ||||||||||||
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Weighted average number of common and common equivalent shares outstanding |
131.3 | 124.5 | 129.3 | 121.2 | ||||||||||||
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Basic net earnings per share |
$ | 0.57 | $ | 0.50 | $ | 1.63 | $ | 1.35 | ||||||||
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Diluted net earnings per share |
$ | 0.57 | $ | 0.50 | $ | 1.61 | $ | 1.33 | ||||||||
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Options to purchase 1.7 million and 1.4 million shares of common stock were outstanding at September 30, 2013 and 2012, respectively, but were not included in the computation of the dilutive effect of stock options for the three-month periods then ended. Options to purchase 1.2 million and 1.0 million shares of common stock were outstanding at September 30, 2013 and 2012, respectively, but were not included in the computation of the dilutive effect of stock options for the nine-month periods then ended. These stock options were excluded from the computation because the options exercise prices were greater than the average market price of our common shares during the respective period, and therefore would be anti-dilutive to earnings per share under the treasury stock method.
7. Stock Option Plans
Long-Term Incentive Plan
On May 10, 2011, our stockholders approved the Arthur J. Gallagher 2011 Long-Term Incentive Plan (which we refer to as the LTIP), which replaced our previous stockholder-approved Arthur J. Gallagher & Co. 2009 Long-Term Incentive Plan (which we refer to as the 2009 LTIP). The LTIP term began May 10, 2011 and terminates on the date of the annual meeting of stockholders that occurs during 2018, unless terminated earlier by our board of directors. All of our officers, employees and non-employee directors are eligible to receive awards under the LTIP. The compensation committee of our board of directors determines the participants under the LTIP. The LTIP provides for non-qualified and incentive stock options, stock appreciation rights, restricted stock, restricted stock units and performance units, any or all of which may be made contingent upon the achievement of performance criteria. A stock appreciation right entitles the holder to receive, upon exercise and subject to withholding taxes, cash or shares of our common stock (which may be restricted stock) with a value equal to the difference between the fair market value of our common stock on the exercise date and the base price of the stock appreciation right. Subject to the LTIP limits, the compensation committee has the discretionary authority to determine the size of an award.
Shares of our common stock available for issuance under the LTIP include authorized and unissued shares of common stock or authorized and issued shares of common stock reacquired and held as treasury shares or otherwise, or a combination thereof. The number of available shares will be reduced by the aggregate number of shares that become subject to outstanding awards granted under the LTIP. To the extent that shares subject to an outstanding award granted under either the LTIP or the 2009 LTIP are not issued or delivered by reason of the expiration, termination, cancellation or forfeiture of such award or by reason of the settlement of such award in cash, then such shares will again be available for grant under the LTIP. Shares that are subject to a stock appreciation right and were not issued upon the net settlement or net exercise of such stock appreciation right, shares that are used to pay the exercise price of an option, delivered to or withheld by us to pay withholding taxes, and shares that are purchased on the open market with the proceeds of an option exercise, may not again be made available for issuance.
- 16 -
The maximum number of shares available under the LTIP for restricted stock, restricted stock unit awards and performance unit awards settled with stock (i.e., all awards other than stock options and stock appreciation rights) is 0.5 million at September 30, 2013. To the extent necessary to be qualified performance-based compensation under Section 162(m) of the Internal Revenue Code (which we refer to as the IRC): (i) the maximum number of shares with respect to which options or stock appreciation rights or a combination thereof that may be granted during any fiscal year to any person is 200,000; (ii) the maximum number of shares with respect to which performance-based restricted stock or restricted stock units that may be granted during any fiscal year to any person is 100,000; and (iii) the maximum amount that may be payable with respect to performance units granted during any fiscal year to any person is $3.0 million.
The LTIP provides for the grant of stock options, which may be either tax-qualified incentive stock options or non-qualified options and stock appreciation rights. The compensation committee determines the period for the exercise of a non-qualified stock option, tax-qualified incentive stock option or stock appreciation right, provided that no option can be exercised later than seven years after its date of grant. The exercise price of a non-qualified stock option or tax-qualified incentive stock option and the base price of a stock appreciation right cannot be less than 100% of the fair market value of a share of our common stock on the date of grant, provided that the base price of a stock appreciation right granted in tandem with an option will be the exercise price of the related option.
Upon exercise, the option exercise price may be paid in cash, by the delivery of previously owned shares of our common stock, through a net-exercise arrangement, or through a broker-assisted cashless exercise arrangement. The compensation committee determines all of the terms relating to the exercise, cancellation or other disposition of an option or stock appreciation right upon a termination of employment, whether by reason of disability, retirement, death or any other reason. Stock option and stock appreciation right awards under the LTIP are non-transferable.
On March 13, 2013, the compensation committee granted 1,665,000 options to our officers and key employees that become exercisable at the rate of 34%, 33% and 33% on the anniversary date of the grant in 2016, 2017 and 2018, respectively. On March 16, 2012, the compensation committee granted 1,355,000 options to our officers and key employees that become exercisable at the rate of 34%, 33% and 33% on the anniversary date of the grant in 2015, 2016 and 2017, respectively. The 2013 and 2012 options expire seven years from the date of grant, or earlier in the event of certain terminations of employment. For certain of our executive officers age 55 or older, stock options awarded in 2013 are no longer subject to forfeiture upon such officers departure from the company after two years from the date of grant.
Other Information
All of our stock option plans provide for the immediate vesting of all outstanding stock option grants in the event of a change in control of our company, as defined in the applicable plan documents.
During the three-month periods ended September 30, 2013 and 2012, we recognized $2.2 million and $2.2 million, respectively, of compensation expense related to our stock option grants. During the nine-month periods ended September 30, 2013 and 2012, we recognized $5.4 million and $5.2 million, respectively, of compensation expense related to our stock option grants.
For purposes of expense recognition, the estimated fair values of the stock option grants are amortized to expense over the options vesting period. We estimated the fair value of stock options at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:
2013 | 2012 | |||||||
Expected dividend yield |
3.5 | % | 4.0 | % | ||||
Expected risk-free interest rate |
1.2 | % | 1.2 | % | ||||
Volatility |
29.6 | % | 26.7 | % | ||||
Expected life (in years) |
6.0 | 5.0 |
- 17 -
Option valuation models require the input of highly subjective assumptions including the expected stock price volatility. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. Because our employee and director stock options have characteristics significantly different from those of traded options, and because changes in the selective input assumptions can materially affect the fair value estimate, in managements opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our employee and non-employee director stock options. The weighted average fair value per option for all options granted during the nine-month periods ended September 30, 2013 and 2012, as determined on the grant date using the Black-Scholes option pricing model, was $7.51 and $5.49, respectively.
The following is a summary of our stock option activity and related information for 2013 (in millions, except exercise price and year data):
Nine-month period ended September 30, 2013 | ||||||||||||||||
Weighted | ||||||||||||||||
Average | ||||||||||||||||
Weighted | Remaining | |||||||||||||||
Shares | Average | Contractual | Aggregate | |||||||||||||
Under | Exercise | Term | Intrinsic | |||||||||||||
Option | Price | (in years) | Value | |||||||||||||
Beginning balance |
9.0 | $ | 28.80 | |||||||||||||
Granted |
1.6 | 39.17 | ||||||||||||||
Exercised |
(2.1 | ) | 27.00 | |||||||||||||
Forfeited or canceled |
| | ||||||||||||||
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Ending balance |
8.5 | $ | 31.29 | 3.83 | $ | 105.0 | ||||||||||
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Exercisable at end of period |
3.9 | $ | 27.67 | 2.38 | $ | 62.9 | ||||||||||
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Ending vested and expected to vest |
8.4 | $ | 31.20 | 3.80 | $ | 104.2 | ||||||||||
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Options with respect to 8.0 million shares (less any shares of restricted stock issued under the LTIPsee Note 9 to these unaudited consolidated financial statements) were available for grant under the LTIP at September 30, 2013.
The total intrinsic value of options exercised during the nine-month periods ended September 30, 2013 and 2012 was $28.8 million and $19.1 million, respectively. As of September 30, 2013, we had approximately $23.0 million of total unrecognized compensation expense related to nonvested options. We expect to recognize that expense over a weighted average period of approximately four years.
Other information regarding stock options outstanding and exercisable at September 30, 2013 is summarized as follows (in millions, except exercise price and year data):
Options Outstanding | Options Exercisable | |||||||||||||||||||||
Range of Exercise Prices |
Number Outstanding |
Weighted Average Remaining Contractual Term (in years) |
Weighted Average Exercise Price |
Number Exercisable |
Weighted Average Exercise Price |
|||||||||||||||||
$ 10.58 - $ 27.25 |
2.9 | 2.78 | $ | 25.87 | 2.1 | $ | 25.88 | |||||||||||||||
27.35 - 30.95 |
2.4 | 2.56 | 29.73 | 1.7 | 29.44 | |||||||||||||||||
31.24 - 35.71 |
1.5 | 4.92 | 35.40 | 0.1 | 32.95 | |||||||||||||||||
35.95 - 35.95 |
| 5.84 | 35.95 | | | |||||||||||||||||
39.17 - 39.17 |
1.7 | 6.45 | 39.17 | | | |||||||||||||||||
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$ 10.58 - $ 39.17 |
8.5 | 3.83 | $ | 31.29 | 3.9 | $ | 27.67 | |||||||||||||||
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8. Deferred Compensation
We have a Deferred Equity Participation Plan, which is a non-qualified plan that generally provides for distributions to certain of our key executives when they reach age 62 (or the one-year anniversary of the date of the grant for participants over the age of 61 as of the grant date) or upon or after their actual retirement. Under the provisions of the plan, we typically contribute shares of our common stock or cash, in an amount approved by the compensation committee, to a rabbi trust on behalf of the executives participating in the plan. Alternatively, we may contribute cash to the rabbi trust and instruct the trustee to acquire a specified number of shares of our common stock on the open market or in privately negotiated transactions. Distributions under the plan may not normally be made until the participant reaches age 62 (or the one-year anniversary of the date of the grant for participants over the age of 61 as of the grant date) and are subject to forfeiture in the event of voluntary termination of employment prior to then. All contributions to the plan deemed to be invested in shares of our common stock are distributed in the form of our common stock and all other distributions are paid in cash.
Our common stock that is issued to or purchased by the rabbi trust as a contribution under the Plan is valued at historical cost, which equals its fair market value at the date of grant or date of purchase. When common stock is issued or purchased, we record an unearned deferred compensation obligation as a reduction of capital in excess of par value in the accompanying consolidated balance sheet, which is amortized to compensation expense ratably over the vesting period of the participants. Future changes in the fair market value of our common stock owed to the participants do not have any impact on the amounts recorded in our consolidated financial statements.
In the first quarter of each of 2013 and 2012, the compensation committee approved $8.0 million and $7.3 million, respectively, of cash awards in the aggregate to certain key executives under the Deferred Equity Participation Plan that were contributed to the rabbi trust in second quarter 2013 and first quarter 2012, respectively. The fair value of the funded cash award assets at December 31, 2012 was $41.6 million and has been included in other noncurrent assets in the accompanying consolidated balance sheet. In the second quarter of 2013, we instructed the trustee for the Plan to liquidate all investments held under the Plan, other than our common stock, and use the proceeds to purchase additional shares of our common stock on the open market. As a result, the Plan sold all of the funded cash award assets and purchased 1.2 million shares of our common stock at an aggregate cost of $52.4 million during the second quarter of 2013. During the three-month periods ended September 30, 2013 and 2012, we charged $2.0 million and $1.5 million, respectively, to compensation expense related to these awards. During the nine-month periods ended September 30, 2013 and 2012, we charged $5.3 million and $4.1 million, respectively, to compensation expense related to these awards.
At September 30, 2013 and December 31, 2012, we recorded $30.0 million (related to 2.0 million shares) and $5.6 million (related to 0.8 million shares), respectively, of unearned deferred compensation as a reduction of capital in excess of par value in the accompanying consolidated balance sheet. The total intrinsic value of our unvested equity based awards under the plan at September 30, 2013 and December 31, 2012 was $89.2 million and $21.1 million, respectively. During each of the nine-month periods ended September 30, 2013 and 2012, cash and equity awards with an aggregate fair value of $0.7 million were vested and distributed to executives under this plan.
9. Restricted Stock and Cash Awards
Restricted Stock Awards
As discussed in Note 7 to these unaudited consolidated financial statements, on May 10, 2011, our stockholders approved the LTIP, which replaced our previous stockholder-approved 2009 LTIP. The LTIP provides for the grant of a stock award either as restricted stock or as restricted stock units. In either case, the compensation committee may determine that the award will be subject to the attainment of performance measures over an established performance period. Stock awards are non-transferable and subject to forfeiture if the holder does not remain continuously employed with us during the applicable restriction period or, in the case of a performance-based award, if applicable performance measures are not attained. The compensation committee will determine all of the terms relating to the satisfaction of performance measures and the termination of a restriction period, or the forfeiture and cancellation of a restricted stock award upon a termination of employment, whether by reason of disability, retirement, death or any other reason. The compensation committee may grant unrestricted shares of common stock or units representing the right to receive shares of common stock to employees who have attained age 62.
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The agreements awarding restricted stock units will specify whether such award may be settled in shares of our common stock, cash or a combination of shares and cash and whether the holder will be entitled to receive dividend equivalents, on a current or deferred basis, with respect to such award. Prior to the settlement of a restricted stock unit, the holder of a restricted stock unit will have no rights as a stockholder of the company. The maximum number of shares available under the LTIP for restricted stock, restricted stock units and performance unit awards settled with stock (i.e., all awards other than stock options and stock appreciation rights) is 1.2 million. At September 30, 2013, 0.5 million shares were available for grant under the LTIP for such awards.
In the first quarter of each of 2013 and 2012, we granted 345,000 and 332,000 restricted stock units, respectively, to employees under the LTIP, with an aggregate fair value of $13.5 million and $11.9 million, respectively, at the date of grant. These 2013 and 2012 awards of restricted stock units vest as follows: 345,000 units granted in first quarter 2013 and 332,000 units granted in first quarter 2012, vest in full based on continued employment through March 13, 2017 and March 16, 2016, respectively. In the second quarter of each of 2013 and 2012, we granted 17,500 and 20,000 restricted stock units, respectively, to non-employee Board of Directors under the LTIP, with an aggregate fair value of $0.8 million and $0.7 million, respectively, at the date of grant. These grants vest in full one year from the date of grant. For certain of our executive officers age 55 or older, restricted stock units awarded in 2013 are no longer subject to forfeiture upon such officers departure from the company after two years from the date of grant.
We account for restricted stock awards at historical cost, which equals their fair market value at the date of grant. When restricted stock units are granted, no amounts are recorded in the accompanying consolidated financial statements. The grant date fair market value is amortized to compensation expense ratably over the vesting period of the participants with the offsetting amount recorded in capital in excess of par in the consolidated balance sheet. Future changes in the fair value of our common stock that is owed to the participants do not have any direct impact on the amounts recorded in our consolidated financial statements. During the three-month periods ended September 30, 2013 and 2012, we charged $2.3 million and $1.7 million, respectively, to compensation expense related to restricted stock unit awards granted in 2006 through 2013. During the nine-month periods ended September 30, 2013 and 2012, we charged $7.4 million and $5.5 million, respectively, to compensation expense related to restricted stock unit awards granted in 2006 through 2013. The total intrinsic value of unvested restricted stock units at September 30, 2013 and 2012 was $46.4 million and $33.8 million, respectively. During the nine-month periods ended September 30, 2013 and 2012, equity awards (including accrued dividends) with an aggregate fair value of $8.4 million and $7.2 million were vested and distributed to employees under this plan.
Cash Awards
On March 13, 2013, pursuant to our Performance Unit Program (which we refer to as the Program), the compensation committee approved provisional cash awards of $10.5 million in the aggregate for future grant to our officers and key employees that are denominated in units (269,000 units in the aggregate), each of which was equivalent to the value of one share of our common stock on the date the provisional award was approved. The Program consists of a one-year performance period based on our financial performance and a two-year vesting period. At the discretion of the compensation committee and determined based on our performance, the eligible officer or key employee will be granted a percentage of the provisional cash award units that equates to the EBITAC growth achieved (as defined in the Program). At the end of the performance period, eligible participants will be granted a number of units based on achievement of the performance goal and subject to approval by the compensation committee. Granted units for the 2013 provisional award will fully vest based on continuous employment through January 1, 2016. For certain of our executive officers age 55 or older, awards granted under the Program in 2013 are no longer subject to forfeiture upon such officers departure from the company after two years from the date of grant. The ultimate award value will be equal to the trailing twelve-month stock price on December 31, 2015, multiplied by the number of units subject to the award, but limited to between 0.5 and 1.5 times the original value of the units determined as of the grant date. The fair value of the awarded units will be paid out in cash as soon as practicable in 2016. If an eligible employee leaves us prior to the vesting date, the entire award will be forfeited. We did not recognize any compensation expense during the nine-month period ended September 30, 2013 related to the 2013 provisional award under the Program.
On March 16, 2012, pursuant to the Program, the compensation committee approved provisional cash awards of $13.1 million in the aggregate for future grant to our officers and key employees that are denominated in units (368,000 units in the aggregate), each of which was equivalent to the value of one share of our common stock on the date the provisional award was approved. Terms of the 2012 provisional award were similar to the terms for the 2013 provisional award. Based on our performance for 2012, we granted 365,000 units under the Program in first quarter 2013 that will fully vest on January 1, 2015. During the three-month period ended September 30, 2013, we charged $2.0 million to compensation expense related to these awards. During the nine-month period ended September 30, 2013, we charged $5.4 million to compensation expense related to the 2012 awards.
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On March 8, 2011, pursuant to the Program, the compensation committee approved provisional cash awards of $14.4 million in the aggregate for future grant to our officers and key employees that are denominated in units (464,000 units in the aggregate), each of which was equivalent to the value of one share of our common stock on the date the provisional award was approved. Terms of the 2011 provisional award were similar to the terms for the 2013 provisional award. Based on our performance for 2011, we granted 432,000 units under the Program in first quarter 2012 that will fully vest on January 1, 2014. During the three-month periods ended September 30, 2013 and 2012, we charged $2.6 million and $1.9 million, respectively, to compensation expense related to these awards. During the nine-month periods ended September 30, 2013 and 2012, we charged $6.9 million and $5.7 million, respectively, to compensation expense related to the 2011 awards.
On March 2, 2010, pursuant to the Program, the compensation committee approved provisional cash awards of $17.0 million in the aggregate for future grant to our officers and key employees that are denominated in units (706,000 units in the aggregate), each of which was equivalent to the value of one share of our common stock on the date the provisional award was approved. Terms of the 2010 provisional award were similar to the terms for the 2013 provisional award. However, based on company performance for 2010, we did not grant any units in 2011 related to the 2010 provisional award under the Program. We did not recognize any compensation expense during 2013 or 2012 related to the 2010 provisional award.
During the nine-month period ended September 30, 2012, cash awards related to the 2009 provisional award with an aggregate fair value of $26.5 million (1.1 million units in the aggregate) were vested and distributed to employees under the Program.
10. Retirement Plans
We have a noncontributory defined benefit pension plan that, prior to July 1, 2005, covered substantially all of our domestic employees who had attained a specified age and one year of employment. Benefits under the plan were based on years of service and salary history. In 2005, we amended our defined benefit pension plan to freeze the accrual of future benefits for all U.S. employees, effective on July 1, 2005. In the table below, the service cost component represents plan administration costs that are incurred directly by the plan.
The components of the net periodic pension benefit cost for the plan consists of the following (in millions):
Three-month period ended September 30, |
Nine-month period ended September 30, |
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2013 | 2012 | 2013 | 2012 | |||||||||||||
Service cost |
$ | 0.2 | $ | 0.1 | $ | 0.4 | $ | 0.3 | ||||||||
Interest cost on benefit obligation |
2.9 | 3.0 | 8.8 | 9.0 | ||||||||||||
Expected return on plan assets |
(4.2 | ) | (3.8 | ) | (12.8 | ) | (11.4 | ) | ||||||||
Amortization of net actuarial loss |
2.0 | 1.8 | 5.9 | 5.4 | ||||||||||||
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Net periodic benefit cost |
$ | 0.9 | $ | 1.1 | $ | 2.3 | $ | 3.3 | ||||||||
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We are not required under the IRC to make any minimum contributions to the plan for the 2013 plan year. We were also not required under the IRC to make any minimum contributions for the 2012 plan year. This level of required funding is based on the plan being frozen and the aggregate amount of our historical funding. During the nine-month periods ended September 30, 2013 and 2012, we made discretionary contributions of $6.3 million and $5.4 million to the plan.
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11. Investments
The following is a summary of our investments and the related funding commitments (in millions):
September 30, 2013 | December 31, | |||||||||||
Funding | 2012 | |||||||||||
Assets | Commitments | Assets | ||||||||||
Chem-Mod LLC |
$ | 4.0 | $ | | $ | 4.0 | ||||||
Chem-Mod International LLC |
2.0 | | 2.0 | |||||||||
C-Quest Technology LLC |
2.0 | | | |||||||||
Clean-coal investments |
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Non-controlling interest in four limited liability companies that own nine 2009 Era Clean Coal Plants |
8.2 | 1.8 | 2.8 | |||||||||
Controlling interest in two limited liability companies that own five 2009 Era Clean Coal Plants |
6.8 | 0.9 | 6.3 | |||||||||
Non-controlling interest in six limited liability companies that own five 2011 Era Clean Coal Plants |
12.1 | | 13.2 | |||||||||
Controlling interest in five limited liability companies that own nine 2011 Era Clean Coal Plants |
41.4 | 2.2 | 9.2 | |||||||||
Controlling interest in a limited liability company that owns six 2011 Era Clean Coal Plants |
7.4 | 0.7 | 5.1 | |||||||||
Notes receivable and interest from co-investor related to the sales of three 2009 Era Plants |
| | 8.5 | |||||||||
Other investments |
3.6 | 5.0 | 3.0 | |||||||||
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Total investments |
$ | 87.5 | $ | 10.6 | $ | 54.1 | ||||||
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Chem-Mod LLC - At September 30, 2013, we held a 46.54% controlling interest in Chem-Mod LLC. Chem-Mod LLC possesses the exclusive marketing rights, in the U.S. and Canada, for technologies used to reduce emissions created during the combustion of coal. The refined coal production plants discussed below, as well as those owned by other unrelated parties, license and use Chem-Mods proprietary technologies, The Chem-Mod Solution, in the production of refined coal. The Chem-Mod Solution uses a dual injection sorbent system to reduce mercury, sulfur dioxide and other emissions at coal-fired power plants.
We believe that the application of The Chem-Mod Solution qualifies for refined coal tax credits under IRC Section 45 when used with refined coal production plants placed in service by December 31, 2011 or 2009. Chem-Mod has been marketing its technologies principally to coal-fired power plants owned by utility companies, including those utilities that are operating with the IRC Section 45 refined coal production plants in which we hold an investment.
Chem-Mod is determined to be a variable interest entity (which we refer to as a VIE). We are the controlling manager of Chem-Mod and therefore consolidate its operations into our consolidated financial statements. At September 30, 2013, total assets and total liabilities of this VIE included in our consolidated balance sheet were $6.1 million and $0.6 million, respectively. For the nine-month period ended September 30, 2013, total revenues and expenses were $27.1 million and $15.2 million (including non-controlling interest of $13.7 million), respectively. We are under no obligation to fund Chem-Mods operations in the future.
Chem-Mod International LLC - At September 30, 2013, we held a 31.52% non- controlling interest in Chem-Mod International LLC. Chem-Mod International LLC has the rights to market The Chem-Mod Solution in countries other than the U.S. and Canada. Such marketing activity has been limited to date.
C-Quest Technology LLC - At September 30, 2013, we held a non-controlling 8% interest in C-Quests global operation. C-Quest possesses rights, information and technology for the reduction of carbon dioxide emissions created by burning fossil fuels. Thus far, C-Quests operations have been limited to laboratory testing. C-Quest is determined to be a VIE, but due to our lack of control over the operation of C-Quest, we do not consolidate this investment into our consolidated financial statements. We also have options to acquire an additional 19% interest in C-Quests global operations for $9.5 million at any time on or prior to August 15, 2016. On August 1, 2013, we
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loaned the majority owner $2.0 million at a 2% interest rate, which matures on May 15, 2014. The loan can be paid in cash or by delivery of an additional 4% ownership interest in C-Quests global operations. If the loan is paid by delivery of the additional 4% ownership interest, our option would be reduced to 15% and the remaining purchase price would be reduced to $7.5 million.
Clean Coal Investments -
| We have investments in limited liability companies that own 34 refined coal production plants which produce refined coal using propriety technologies owned by Chem-Mod. We believe the production and sale of refined coal at these plants is qualified to receive refined coal tax credits under IRC Section 45. The fourteen plants placed in service prior to December 31, 2009 (which we refer to as the 2009 Era Plants) can receive tax credits through 2019 and the twenty plants placed in service prior to December 31, 2011 (which we refer to as the 2011 Era Plants) can receive tax credits through 2021. |
| On March 1, 2013, we purchased an additional ownership interest in twelve of the 2009 Era Plants from one of the co-investors. For nine of the plants, our ownership increased from 24.5% to 49.5%. Our investment in these plants had been accounted for under the equity method of accounting and will continue to be accounted for under the equity method. For three of the plants, our ownership went from 25.0% to 60.0%. Our investment in these plants had been accounted for under the equity method of accounting. As of March 1, 2013, we consolidated the operations of the limited liability company that owns these three plants. Total revenues and expenses recorded in our unaudited consolidated statement of earnings for the nine-month period ended September 30, 2013 related to this acquisition were $68.4 million and $72.3 million, respectively. |
| Our purchase price for the additional ownership interests in these twelve plants was the assumption of the promissory note that we received as consideration for the co-investors purchase of ownership interests in three of the 2009 Era Plants on March 1, 2010, which had a carrying value, including accrued interest, of $8.0 million at March 1, 2013, plus the payment of cash and other consideration of $5.0 million. We recognized a gain of $9.6 million, which included the increase in fair value of our prior 25% equity interest in the limited liability company upon the acquisition of the additional 35% equity interest, and recorded $26.3 million of fixed and other amortizable intangible assets and $5.0 million of other assets in connection with this transaction. The carrying value of our prior non-controlling interest in the limited liability company was $4.8 million as of the acquisition date. The fair value of our prior non-controlling interest in the limited liability company was determined by allocating, on a pro rata basis, the fair value of the limited liability company as adjusted for our lack of control in our prior ownership position. We determined the fair value of the limited liability company based on provisional estimates of fair value using similar valuation techniques to those discussed in Note 3 to these unaudited consolidated financial statements. |
| On September 1, 2013, we purchased a 99% interest in a limited liability company that has ownership interests in four limited liability companies that own five 2011 Era Plants. The purchase price was $4.0 million in cash plus a $10.0 million note with 3% interest due in installments through December 19, 2021. Total revenues and expenses recorded in our unaudited consolidated statement of earnings, for the nine-month period ended September 30, 2013 related to the acquisition, were $6.3 million and $6.9 million, respectively. |
| As of September 30, 2013: |
| Twenty-eight of the plants have long-term production contracts. |
| The remaining six plants are in various stages of seeking and negotiating long-term production contracts, permitting and construction of permanent deployment facilities. |
| We have a non-controlling, minority interest in fourteen plants. We also have agreements in principle with co-investors for the sale of majority ownership interests in six additional plants. We may sell ownership interests in some or all of the remaining plants to co-investors. |
| Nine of the 2009 Era Plants and five of the 2011 Era Plants are owned by limited liability companies, which we have determined to be VIEs, for which we are not the primary beneficiary. At September 30, 2013, total assets and total liabilities of these VIEs were $80.4 million and $37.8 million, respectively. For the nine-month period ended September 30, 2013, total revenues and expenses of these VIEs were $255.7 million and $291.9 million, respectively. |
| In all limited liability companies where we are a non-controlling, minority investor, the membership agreements for the operations of each of these entities contain provisions that preclude an individual member from being able to make major decisions that would denote control. As of the date we became a non-controlling, minority investor, we deconsolidated these entities and subsequently accounted for the investments using equity method accounting. |
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| For all plants that are not under long-term production contracts, we estimate that we will invest, on average, an additional $5.0 million per plant to connect and house each of them. For those plants that will have majority ownership co-investors, the average additional investment will be $2.5 million. We plan to sell majority ownership interests in such plants to co-investors and relinquish control of the plants, thereby becoming a non-controlling, minority investor. We are currently committed to fund an additional $5.6 million under engineering and construction contracts related to moving, connecting and housing the refined coal plants that we plan to redeploy during the remainder of 2013. Subsequent to 2013, we estimate that we will invest an additional $30.0 million to $35.0 million to redeploy the remainder of the refined coal plants before co-investor contributions. |
| Each investor funds its portion of the on-going operations of the limited liability companies in proportion to its investment ownership percentage. Other than our portion of the on-going operational funding, there are no additional amounts that we are committed to related to funding these investments. |
| We are aware that some of the coal-fired power plants that purchase the refined coal are considering changing to burning natural gas or shutting down completely for economic reasons. We and our partners are prepared to move the refined coal productions plants to other, generally higher volume, coal-fired power plants. If these potential developments were to occur, we estimate those plants will not operate for 12 to 18 months during their movement and redeployment, which could have a material impact on the amount of tax credits that are generated by these plants. |
| Until March 1, 2013, we had a promissory note from a co-investor that was received as part of the consideration for the March 1, 2010 sale of ownership interests in three of the 2009 Era Plants. This note was assumed by us as part of our purchase of additional ownership interests in twelve of the 2009 Era Plants as described above. |
Other Investments - At September 30, 2013, we owned a non-controlling, minority interest in five venture capital funds totaling $3.2 million, a 20% non-controlling interest in an investment management company totaling $0.5 million, twelve certified low-income housing developments with zero carrying value and two real estate entities with zero carrying value. The low-income housing developments and real estate entities have been determined to be VIEs, but are not required to be consolidated due to our lack of control over their respective operations. At September 30, 2013, total assets and total debt of these VIEs were approximately $60.0 million and $20.0 million, respectively.
12. Commitments, Contingencies and Off-Balance Sheet Arrangements
In connection with our investing and operating activities, we have entered into certain contractual obligations and commitments. See Notes 5 and 11 to these unaudited consolidated financial statements for additional discussion of these obligations and commitments. Our future minimum cash payments, including interest, associated with our contractual obligations pursuant to the note purchase agreements and Credit Agreement, operating leases and purchase commitments at September 30, 2013 were as follows (in millions):
Payments Due by Period | ||||||||||||||||||||||||||||
Contractual Obligations |
2013 | 2014 | 2015 | 2016 | 2017 | Thereafter | Total | |||||||||||||||||||||
Note purchase agreements |
$ | | $ | 100.0 | $ | | $ | 50.0 | $ | 300.0 | $ | 475.0 | $ | 925.0 | ||||||||||||||
Credit Agreement |
135.5 | | | | | | 135.5 | |||||||||||||||||||||
Interest on debt |
8.1 | 50.4 | 44.1 | 44.1 | 41.2 | 76.6 | 264.5 | |||||||||||||||||||||
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Total debt obligations |
143.6 | 150.4 | 44.1 | 94.1 | 341.2 | 551.6 | 1,325.0 | |||||||||||||||||||||
Operating lease obligations |
18.8 | 69.4 | 61.8 | 50.6 | 40.2 | 109.3 | 350.1 | |||||||||||||||||||||
Less sublease arrangements |
(2.1 | ) | (1.8 | ) | (0.8 | ) | (0.1 | ) | | | (4.8 | ) | ||||||||||||||||
Outstanding purchase obligations |
4.1 | 9.4 | 7.0 | 1.3 | 0.3 | | 22.1 | |||||||||||||||||||||
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Total contractual obligations |
$ | 164.4 | $ | 227.4 | $ | 112.1 | $ | 145.9 | $ | 381.7 | $ | 660.9 | $ | 1,692.4 | ||||||||||||||
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The amounts presented in the table above may not necessarily reflect our actual future cash funding requirements, because the actual timing of the future payments made may vary from the stated contractual obligation.
Note Purchase Agreements and Credit Agreement - See Note 5 to these unaudited consolidated financial statements for a discussion of the terms of the note purchase agreements and the Credit Agreement.
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Operating Lease Obligations - Our corporate segments executive offices and certain subsidiary and branch facilities of our brokerage and risk management segments are located at Two Pierce Place, Itasca, Illinois, where we lease approximately 306,000 square feet of space, or approximately 60% of the building. The lease commitment on this property expires February 28, 2018.
We generally operate in leased premises at our other locations. Certain of these leases have options permitting renewals for additional periods. In addition to minimum fixed rentals, a number of leases contain annual escalation clauses which are generally related to increases in an inflation index.
We have leased certain office space to several non-affiliated tenants under operating sublease arrangements. In the normal course of business, we expect that the leases will not be renewed or replaced. We adjust charges for real estate taxes and common area maintenance annually based on actual expenses, and we recognize the related revenues in the year in which the expenses are incurred. These amounts are not included in the minimum future rentals to be received in the contractual obligations table above.
Outstanding Purchase Obligations - As a service company, we typically do not have a material amount of outstanding purchase obligations at any point in time. The amount disclosed in the contractual obligations table above represents the aggregate amount of unrecorded purchase obligations that we had outstanding at September 30, 2013. These obligations represent agreements to purchase goods or services that were executed in the normal course of business.
Off-Balance Sheet Commitments - Our total unrecorded commitments associated with outstanding letters of credit, financial guarantees and funding commitments as of September 30, 2013 were as follows (in millions):
Total | ||||||||||||||||||||||||||||
Amount of Commitment Expiration by Period | Amounts | |||||||||||||||||||||||||||
Off-Balance Sheet Commitments |
2013 | 2014 | 2015 | 2016 | 2017 | Thereafter | Committed | |||||||||||||||||||||
Letters of credit |
$ | | $ | | $ | | $ | | $ | | $ | 15.2 | $ | 15.2 | ||||||||||||||
Financial guarantees |
| | | | | 9.3 | 9.3 | |||||||||||||||||||||
Funding commitments |
7.0 | 0.7 | | | | 2.9 | 10.6 | |||||||||||||||||||||
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Total commitments |
$ | 7.0 | $ | 0.7 | $ | | $ | | $ | | $ | 27.4 | $ | 35.1 | ||||||||||||||
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Since commitments may expire unused, the amounts presented in the table above do not necessarily reflect our actual future cash funding requirements. See Note 11 to these unaudited consolidated financial statements for a discussion of our funding commitments related to our corporate segment and the Off-Balance Sheet Debt section below for a discussion of our letters of credit. All of the letters of credit represent multiple year commitments that have annual, automatic renewing provisions and are classified by the latest commitment date.
Since January 1, 2002, we have acquired 265 companies, all of which were accounted for using the acquisition method for recording business combinations. Substantially all of the purchase agreements related to these acquisitions contain provisions for potential earnout obligations. For all of our acquisitions made in the period from 2009 to 2013 that contain potential earnout obligations, such obligations are measured at fair value as of the acquisition date and are included on that basis in the recorded purchase price consideration for the respective acquisition. The amounts recorded as earnout payables are primarily based upon estimated future operating results of the acquired entities over a two- to three-year period subsequent to the acquisition date. The aggregate amount of the maximum earnout obligations related to these acquisitions was $400.4 million, of which $140.4 million was recorded in our consolidated balance sheet as of September 30, 2013 based on the estimated fair value of the expected future payments to be made.
Off-Balance Sheet Debt - Our unconsolidated investment portfolio includes investments in enterprises where our ownership interest is between 1% and 50%, in which management has determined that our level of influence and economic interest is not sufficient to require consolidation. As a result, these investments are accounted for under the equity method. None of these unconsolidated investments had any outstanding debt at September 30, 2013 or December 31, 2012 that was recourse to us.
At September 30, 2013, we had posted two letters of credit totaling $9.5 million, in the aggregate, related to our self-insurance deductibles, for which we had a recorded liability of $8.7 million. We have an equity investment in a rent-a-captive facility, which we use as a placement facility for certain of our insurance brokerage operations. At September 30, 2013, we had posted two letters of credit totaling $5.7 million to allow the rent-a-captive facility to meet minimum statutory surplus requirements and for additional collateral related to premium and claim funds held in a fiduciary capacity. These letters of credit have never been drawn upon.
- 25 -
Litigation - We are the defendant in various legal actions related to employment matters and otherwise incidental to the nature of our business. We believe we have meritorious defenses and intend to defend ourselves vigorously in all unresolved legal actions. In addition, we are the plaintiff in certain legal actions with and relating to former employees regarding alleged breaches of non-compete or other restrictive covenants, theft of trade secrets, breaches of fiduciary duties and related causes of action. Neither the outcomes of these legal actions nor their effect upon our business, financial condition or results of operations can be determined at this time.
Contingent Liabilities - We purchase insurance to provide protection from errors and omissions (which we refer to as E&O) claims that may arise during the ordinary course of business. We currently retain the first $5.0 million of each and every E&O claim. Our E&O insurance provides aggregate coverage for E&O losses up to $175.0 million in excess of our retained amounts. We have historically maintained self-insurance reserves for the portion of our E&O exposure that is not insured. We periodically determine a range of possible reserve levels using actuarial techniques that rely heavily on projecting historical claim data into the future. Our E&O reserve in the September 30, 2013 consolidated balance sheet is above the lower end of the most recently determined actuarial range by $1.7 million and below the upper end of the actuarial range by $4.9 million. We can make no assurances that the historical claim data used to project the current reserve levels will be indicative of future claim activity. Thus, the E&O reserve level and corresponding actuarial range could change in the future as more information becomes known, which could materially impact the amounts reported and disclosed herein.
Tax-advantaged Investments No Longer Held - Between 1996 and 2007, we developed and then sold portions of our ownership in various energy related investments, many of which qualified for tax credits under IRC Section 29. In connection with the sales to other investors, we provided various indemnities. At September 30, 2013, the maximum potential amount of future payments that we could be required to make under these indemnification totaled approximately $45.0 million, net of the applicable income tax benefit. In addition, we recorded tax benefits in connection with our ownership in these investments. At September 30, 2013, we had exposure on $130.0 million of previously earned tax credits. In 2004, 2007 and 2009, the IRS examined several of these investments and all examinations were closed without any changes being proposed by the IRS. However, any future adverse tax audits, administrative rulings or judicial decisions could disallow previously claimed tax credits or cause us to be subject to liability under our indemnification obligations. Because of the contingent nature of these exposures, no liabilities have been recorded in our September 30, 2013 consolidated balance sheet related to these indemnification obligations.
13. Accumulated Other Comprehensive Loss
The after-tax components of our accumulated other comprehensive loss consist of the following:
Pension Liability |
Foreign Currency Translation |
Fair Value of Derivative Investments |
Accumulated Comprehensive Loss |
|||||||||||||
Balance as of December 31, 2012 |
$ | (52.4 | ) | $ | 20.5 | $ | (0.9 | ) | $ | (32.8 | ) | |||||
Net change in period |
0.4 | (9.9 | ) | 0.5 | (9.0 | ) | ||||||||||
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Balance as of September 30, 2013 |
$ | (52.0 | ) | $ | 10.6 | $ | (0.4 | ) | $ | (41.8 | ) | |||||
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The foreign currency translation during the nine-month period ended September 30, 2013 primarily relates to the net impact of changes in the value of the local currencies relative to the U.S. dollar for our operations in Australia, Canada, the Caribbean, India, Singapore, New Zealand and the U.K.
During the nine-month periods ended September 30, 2013 and 2012, $5.9 million and $5.4 million, respectively, of expense related to the pension liability was reclassified from accumulated other comprehensive loss to compensation expense in the statement of earnings. During the nine-month period ended September 30, 2013, $0.6 million of expense related to the fair value of derivative investments was reclassified from accumulated other comprehensive loss to the statement of earnings. During the nine-month period ended September 30, 2012, $0.1 million of expense related to the fair value of derivative investments was reclassified from accumulated other comprehensive loss to the statement of earnings. During the nine-month periods ended September 30, 2013 and 2012, no amounts related to foreign currency translation were reclassified from accumulated other comprehensive loss to the statement of earnings.
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14. Segment Information
We have three reportable segments: brokerage, risk management and corporate.
The brokerage segment is primarily comprised of our retail and wholesale insurance brokerage operations. The brokerage segment generates revenues through commissions paid by insurance underwriters and through fees charged to our clients. Our brokers, agents and administrators act as intermediaries between insurers and their customers and we do not assume underwriting risks.
The risk management segment provides contract claim settlement and administration services for enterprises that choose to self-insure some or all of their property/casualty coverages and for insurance companies that choose to outsource some or all of their property/casualty claims departments. These operations also provide claims management, loss control consulting and insurance property appraisal services. Revenues are principally generated on a negotiated per-claim or per-service fee basis.
The corporate segment manages our clean energy and other investments. This segment also holds all of our corporate debt.
Allocations of investment income and certain expenses are based on reasonable assumptions and estimates primarily using revenue, headcount and other information. We allocate the provision for income taxes to the brokerage and risk management segments as if those segments were preparing income tax provisions on a separate company basis. Reported operating results by segment would change if different methods were applied.
Financial information relating to our segments for the three-month and nine-month periods ended September 30, 2013 and 2012 is as follows (in millions):
Three-month period | Nine-month period | |||||||||||||||
ended September 30, | ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Brokerage |
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Total revenues |
$ | 546.3 | $ | 479.7 | $ | 1,551.6 | $ | 1,338.5 | ||||||||
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Earnings before income taxes |
$ | 97.3 | $ | 82.0 | $ | 250.5 | $ | 203.8 | ||||||||
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Identifiable assets at September 30, 2013 and 2012 |
$ | 4,661.9 | $ | 3,835.0 | ||||||||||||
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Risk Management |
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Total revenues |
$ | 149.7 | $ | 142.2 | $ | 459.5 | $ | 426.9 | ||||||||
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Earnings before income taxes |
$ | 17.9 | $ | 18.2 | $ | 59.6 | $ | 54.9 | ||||||||
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Identifiable assets at September 30, 2013 and 2012 |
$ | 546.2 | $ | 547.9 | ||||||||||||
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Corporate |
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Total revenues |
$ | 139.8 | $ | 28.5 | $ | 278.3 | $ | 81.7 | ||||||||
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Loss before income taxes |
$ | (29.7 | ) | $ | (23.9 | ) | $ | (84.9 | ) | $ | (58.8 | ) | ||||
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Identifiable assets at September 30, 2013 and 2012 |
$ | 762.1 | $ | 626.4 | ||||||||||||
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Review by Independent Registered Public Accounting Firm
The interim consolidated financial statements at September 30, 2013 and for the three-month and nine-month periods ended September 30, 2013 and 2012 have been reviewed by Ernst & Young LLP, our independent registered public accounting firm, and their report is included herein.
Review Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Arthur J. Gallagher & Co.
We have reviewed the consolidated balance sheet of Arthur J. Gallagher & Co. as of September 30, 2013, and the related consolidated statements of earnings and comprehensive earnings for the three-month and nine-month periods ended September 30, 2013 and 2012, the consolidated statement of cash flows for the nine-month periods ended September 30, 2013 and 2012, and the consolidated statement of stockholders equity for the nine-month period ended September 30, 2013. These financial statements are the responsibility of the Companys management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Arthur J. Gallagher & Co. as of December 31, 2012, and the related consolidated statements of earnings and comprehensive earnings, stockholders equity, and cash flows for the year then ended, not presented herein, and we expressed an unqualified audit opinion on those consolidated financial statements in our report dated February 8, 2013. In our opinion, the accompanying consolidated balance sheet of Arthur J. Gallagher & Co. as of December 31, 2012, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP |
Ernst & Young LLP |
Chicago, Illinois
October 30, 2013
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The discussion and analysis that follows relates to our financial condition and results of operations for the nine-month period ended September 30, 2013. Readers should review this information in conjunction with the unaudited consolidated financial statements and notes included in Item 1 of Part I of this quarterly report on Form 10-Q and the audited consolidated financial statements and notes, and Managements Discussion and Analysis of Financial Condition and Results of Operations, contained in our annual report on Form 10-K for the year ending December 31, 2012.
Information Concerning Forward-Looking Statements
This report contains certain statements related to future results, or states our intentions, beliefs and expectations or predictions for the future, which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements relate to expectations or forecasts of future events. They use words such as anticipate, believe, estimate, expect, contemplate, forecast, project, intend, plan, potential, and other similar terms, and future or conditional tense verbs like could, may, might, see, should, will and would. You can also identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. For example, we may use forward-looking statements when addressing topics such as: market and industry conditions, including competitive and pricing trends; acquisition strategy; the expected impact of acquisitions and dispositions; the development and performance of our services and products; changes in the composition or level of our revenues or earnings; our cost structure and the outcome of cost-saving or restructuring initiatives; the outcome of contingencies; dividend policy; pension obligations; cash flow and liquidity; capital structure and financial losses; future actions by regulators; the impact of changes in accounting rules; financial markets; interest rates; foreign exchange rates; matters relating to our operations; income taxes; and expectations regarding our investments, including our clean energy investments. These forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from either historical or anticipated results depending on a variety of factors. Potential factors that could impact results include:
| Volatility or declines in premiums or other adverse trends in the insurance industry; |
| An economic downturn, including one caused by the U.S. government shutdown and potential default, as well as uncertainty regarding the European debt crisis and market perceptions concerning the instability of the Euro; |
| Competitive pressures in each of our businesses; |
| Risks that could negatively affect the success of our acquisition strategy, including continuing consolidation in our industry, which could make it more difficult to identify targets and could make them more expensive, execution risks, integration risks, the risk of post-acquisition deterioration leading to intangible asset impairment charges, and the risk we could incur or assume unanticipated regulatory liabilities such as those relating to violations of anti-corruption and sanctions laws; |
| Failure to attract and retain experienced and qualified personnel; |
| Risks arising from our growing international operations, including the risks posed by political and economic uncertainty in certain countries, risks related to maintaining regulatory and legal compliance across multiple jurisdictions (such as those relating to violations of anti-corruption, sanctions and privacy laws), and risks arising from the complexity of managing businesses across different time zones, geographies, cultures and legal regimes; |
| Risks particular to our risk management segment; |
| The lower level of predictability inherent in contingent and supplemental commissions versus standard commissions; |
| Sustained increases in the cost of employee benefits; |
| Failure to apply technology effectively in driving value for our clients through technology-based solutions, or failure to gain internal efficiencies and effective internal controls through the application of technology and related tools; |
| Inability to recover successfully should we experience a disaster, material cybersecurity attack or other significant disruption to business continuity; |
| Failure to comply with regulatory requirements, including those related to international sanctions, or a change in regulations that adversely affects our operations; |
| Violations of the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act or other anti-corruption laws; |
- 29 -
| Failure to adapt our services to changes resulting from the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act; |
| Unfavorable determinations related to contingencies and legal proceedings; |
| Improper disclosure of personal data; |
| Significant changes in foreign exchange rates; |
| Changes in our accounting estimates and assumptions; |
| Risks related to our clean energy investments, including the risk of environmental and product liability claims and environmental compliance costs; |
| Disallowance of Internal Revenue Code of 1986, as amended, (which we refer to as IRC) Section 29 or IRC Section 45 tax credits; |
| Risks related to losses on other investments held by our corporate segment; |
| Restrictions and limitations in the agreements and instruments governing our debt; |
| The risk of share ownership dilution when we issue common stock as consideration for acquisitions; and |
| Volatility of the price of our common stock. |
Any or all of our forward-looking statements may turn out to be inaccurate, and there are no guarantees about our performance. The factors identified above are not exhaustive. Gallagher and its subsidiaries operate in a dynamic business environment in which new risks may emerge frequently. Accordingly, readers should not place undue reliance on forward-looking statements, which speak only as of the dates on which they are made. Except as required by law, we expressly disclaim any obligation to update or alter any forward-looking statement that we may make from time to time, whether as a result of new information, future events or otherwise. Further information about factors that could materially affect Gallagher, including our results of operations and financial condition, is contained in the Risk Factors section in our Annual Report on Form 10-K for the year ended December 31, 2012.
Information Regarding Non-GAAP Measures and Other
In the discussion and analysis of our results of operations that follows, in addition to reporting financial results in accordance with GAAP, we provide information regarding EBITDAC, EBITDAC margin, adjusted EBITDAC, adjusted EBITDAC margin, diluted net earnings per share (as adjusted) for the brokerage and risk management segments, adjusted revenues, adjusted compensation and operating expenses, adjusted compensation expense ratio, adjusted operating expense ratio and organic revenue measures for each operating segment. These measures are not in accordance with, or an alternative to, the GAAP information provided in this quarterly report on Form 10-Q. We believe that these presentations provide useful information to management, analysts and investors regarding financial and business trends relating to our results of operations and financial condition. Our industry peers may provide similar supplemental non-GAAP information related to organic revenues and EBITDAC, although they may not use the same or comparable terminology and may not make identical adjustments. The non-GAAP information we provide should be used in addition to, but not as a substitute for, the GAAP information provided. Certain reclassifications have been made to the prior-year amounts reported in this quarterly report on Form 10-Q in order to conform them to the current-year presentation.
Adjusted presentation - We believe that the adjusted presentations of the current and prior year information presented on the following pages, provides stockholders and other interested persons with useful information regarding certain of our financial metrics that will assist such persons in analyzing our operating results as they develop a future earnings outlook for us. The after-tax amounts related to the adjustments were computed using the normalized effective tax rate for each respective period.
| Adjusted revenues and expenses - We define these measures as revenues, compensation expense and operating expense, respectively, each adjusted to exclude net gains realized from sales of books of business, acquisition integration costs, New Zealand earthquake claims administration, South Australia ramp up fees/costs, workforce related charges, lease termination related charges, acquisition related adjustments and the impact of foreign currency translation, as applicable. Integration costs include costs related to transactions not expected to occur on an ongoing basis in the future once we fully assimilate the applicable acquisition. These costs are typically associated with redundant workforce, extra lease space, duplicate services and external costs incurred to assimilate the acquisition with our IT related systems. |
- 30 -
| Adjusted ratios - Adjusted compensation expense ratio and operating expense ratio are defined as adjusted compensation expense and adjusted operating expense, respectively, each divided by adjusted revenues. |
Earnings Measures - We believe that the presentation of EBITDAC, EBITDAC margin, adjusted EBITDAC, adjusted EBITDAC margin and diluted net earnings per share (as adjusted) for the brokerage and risk management segments, each as defined below, provides a meaningful representation of our operating performance. We consider EBITDAC and EBITDAC margin as a way to measure financial performance on an ongoing basis. Adjusted EBITDAC, adjusted EBITDAC margin and diluted net earnings per share (as adjusted) for the brokerage and risk management segments are presented to improve the comparability of our results between periods by eliminating the impact of the items that have a high degree of variability.
| EBITDAC - We define this measure as net earnings before interest, income taxes, depreciation, amortization and the change in estimated acquisition earnout payables. |
| EBITDAC margin - We define this measure as EBITDAC divided by total revenues. |
| Adjusted EBITDAC - We define this measure as EBITDAC adjusted to exclude net gains realized from sales of books of business, acquisition integration costs, workforce related charges, lease termination related charges, New Zealand earthquake claims administration, South Australia ramp up fees/costs, acquisition related adjustments, and the period-over-period impact of foreign currency translation, as applicable. |
| Adjusted EBITDAC margin - We define this measure as adjusted EBITDAC divided by total adjusted revenues (defined above). |
| Diluted net earnings per share (as adjusted) - We define this measure as net earnings adjusted to exclude the after-tax impact of net gains realized from sales of books of business, acquisition integration costs, New Zealand earthquake claims administration, South Australia ramp up fees/costs, the impact of foreign currency translation, workforce related charges, lease termination related charges and acquisition related adjustments, divided by diluted weighted average shares outstanding. |
Organic Revenues - For the brokerage segment, organic change in base commission and fee revenues excludes the first twelve months of net commission and fee revenues generated from acquisitions accounted for as purchases and the net commission and fee revenues related to operations disposed of in each year presented. These commissions and fees are excluded from organic revenues in order to help interested persons analyze the revenue growth associated with the operations that were a part of our business in both the current and prior year. In addition, change in organic revenues excludes the impact of supplemental and contingent commission revenues and the period-over-period impact of foreign currency translation. The amounts excluded with respect to foreign currency translation are calculated by applying current year foreign exchange rates to the same prior year periods. For the risk management segment, organic change in fee revenues excludes the first twelve months of fee revenues generated from acquisitions accounted for as purchases and the fee revenues related to operations disposed of in each year presented. In addition, organic change in fees excludes the impact of South Australia ramp up fees, New Zealand earthquake claims administration and the period-over-period impact of foreign currency translation to improve the comparability of our results between periods by eliminating the impact of the items that have a high degree of variability or are due to the limited-time nature of these revenue sources.
These revenue items are excluded from organic revenues in order to determine a comparable measurement of revenue growth that is associated with the revenue sources that are expected to continue in the current year and beyond. We have historically viewed organic revenue growth as an important indicator when assessing and evaluating the performance of our brokerage and risk management segments. We also believe that using this measure allows readers of our financial statements to measure, analyze and compare the growth from our brokerage and risk management segments in a meaningful and consistent manner.
Reconciliation of Non-GAAP Information Presented to GAAP Measures - This quarterly report on Form 10-Q includes tabular reconciliations to the most comparable GAAP measures for adjusted revenues, adjusted compensation expense and adjusted operating expense, EBITDAC, EBITDAC margin, adjusted EBITDAC, adjusted EBITDAC margin, diluted net earnings per share (as adjusted) and organic revenue measures.
- 31 -
Other Information - Allocations of investment income and certain expenses are based on reasonable assumptions and estimates primarily using revenue, headcount and other information. We allocate the provision for income taxes to the brokerage and risk management segments as if those segments were computing income tax provisions on a separate company basis. As a result, the provision for income taxes for the corporate segment reflects the entire benefit to us of the IRC Section 45 credits generated, because that is the segment which produced the credits. The law that provides for IRC Section 45 credits substantially expires in December 2019 for our fourteen 2009 Era Plants and in December 2021 for our twenty 2011 Era Plants. We anticipate reporting an effective tax rate of approximately 37.0% to 39.0% in both our brokerage and risk management segments for the foreseeable future. Reported operating results by segment would change if different allocation methods were applied.
In the discussion that follows regarding our results of operations, we also provide the following ratios with respect to our operating results: pretax profit margin, compensation expense ratio and operating expense ratio. Pretax profit margin represents pretax earnings from continuing operations divided by total revenues. The compensation expense ratio is compensation expense divided by total revenues. The operating expense ratio is operating expense divided by total revenues.
Overview and Third Quarter 2013 Highlights
We are engaged in providing insurance brokerage and third-party property/casualty claims settlement and administration services to entities in the U.S. and abroad. Throughout 2012 and into 2013, we have expanded and expect to continue to expand our international operations through both acquisitions and organic growth. We generate approximately 80% of our revenues domestically, with the remaining 20% derived internationally, primarily in Australia, Bermuda, Canada, the Caribbean, Singapore, New Zealand and the U.K. (based on third quarter 2013 reported revenues). We expect that our international revenue will continue to grow as a percentage of our total revenues in 2013 compared to 2012. We have three reportable segments: brokerage, risk management and corporate, which contributed approximately 68%, 20% and 12%, respectively, to revenues during the nine-month period ended September 30, 2013. Our major sources of operating revenues are commissions, fees and supplemental and contingent commissions from brokerage operations and fees from risk management operations. Investment income is generated from our investment portfolio, which includes invested cash and fiduciary funds, as well as clean energy and other investments.
We have generated positive organic growth in the last eleven quarterly periods in both the brokerage and risk management segments. Based on our experience with customers, we believe we are seeing further evidence of market firming and our customers are being cautiously optimistic about their business prospects. The first quarter 2013 Council of Insurance Agents and Brokers (which we refer to as CIAB) survey indicated that rates were up, on average 5.2% across all sized accounts. The second quarter 2013 CIAB survey indicated that rates were up, on average 4.3% across all sized accounts. The third quarter 2013 CIAB survey indicated that rates were up, on average 3.4% across all sized accounts. Rates are continuing to rise as insurance carriers tighten their underwriting standards and press for higher pricing and deductibles on renewals in critical areas such as property and workers compensation. In addition, insurance carriers are still trying to reduce their exposure to property risks with catastrophic-loss exposure on the eastern coast of the U.S due to the on-going Superstorm Sandy impact. The survey also indicated that carriers have pulled back terms and conditions and lowered limits for exposures, such as storm surge, flood and off-site power, among others. However, the overall market hardening appears to have moderated in the second and third quarters. The CIAB represents the leading domestic and international insurance brokers, who write approximately 80% of the commercial property/casualty premiums in the U.S.
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Our operating results improved in third quarter 2013 compared to the same period in 2012 in both our brokerage and risk management segments:
| In our brokerage segment, total revenues and adjusted total revenues were both up 14% and 15%, respectively, base organic commission and fee revenues were up 5.5%, net earnings were up 23%, adjusted EBITDAC was up 20% and adjusted EBITDAC margins were up 120 basis points. In addition, we completed eight acquisitions with annualized revenues totaling $135.5 million in third quarter 2013. |
| In our risk management segment, total revenues and adjusted total revenues were up 5% and 7%, respectively, organic fees were up 8.5%, net earnings were flat, adjusted EBITDAC was up 5% and adjusted EBITDAC margins decreased by 20 basis points. |
| In our combined brokerage and risk management segments, total revenues and adjusted total revenues were both up 12% and 13%, respectively, organic commissions and fee revenues were up 6.2%, net earnings were up 19%, adjusted EBITDAC was up 17% and improved adjusted EBITDAC margins by 96 basis points. |
On August 12, 2013, we completed our acquisition of Bollinger, Inc., (which we refer to as Bollinger) headquartered in New Jersey. Bollinger was the 21st largest insurance broker in the U.S. with over 500 employees operating out of eight offices in New Jersey, New York, Pennsylvania and Connecticut. In September, we announced the signing of an agreement to acquire the Giles Group of Companies (which we refer to as Giles) headquartered in London, England, which is the fifth largest independent retail insurance broker in the U.K. with over 1,100 employees operating out of 43 offices in England, Scotland, Wales, Northern Ireland, Isle of Man and the Channel Islands. Together, these market-leading organizations could annually generate over $240.0 million in revenues.
In our corporate segment, third quarter 2013 earnings from our clean energy investments contributed $10.6 million to net earnings in the third quarter of 2013. We anticipate our clean energy investments to generate between $61.0 million and $63.0 million to net earnings for all of 2013. We expect to use these additional earnings to continue our mergers and acquisition strategy in our core brokerage and risk management operations.
The following provides non-GAAP information that management believes is helpful when comparing revenues, EBITDAC and diluted net earnings per share for the three-month and nine-month periods ended September 30, 2013 with the same periods in 2012:
For the Three-Month Periods Ended September 30, | Diluted Net Earnings | |||||||||||||||||||||||||||||||||||
Revenues | EBITDAC | Per Share | ||||||||||||||||||||||||||||||||||
Segment |
2013 | 2012 | Chg | 2013 | 2012 | Chg | 2013 | 2012 | Chg | |||||||||||||||||||||||||||
(in millions) | (in millions) | |||||||||||||||||||||||||||||||||||
Brokerage, as adjusted |
$ | 546.3 | $ | 476.8 | 15 | % | $ | 145.6 | $ | 121.7 | 20 | % | $ | 0.50 | $ | 0.43 | 16 | % | ||||||||||||||||||
Net gains on book sales |
| 0.7 | | 0.7 | | | ||||||||||||||||||||||||||||||
Acquisition integration |
| | (9.3 | ) | (4.2 | ) | (0.04 | ) | (0.02 | ) | ||||||||||||||||||||||||||
Workforce & lease termination |
| | (0.9 | ) | (1.1 | ) | (0.01 | ) | (0.01 | ) | ||||||||||||||||||||||||||
Acquisition related adjustments |
| | | | 0.02 | | ||||||||||||||||||||||||||||||
Levelized foreign currency translation |
| 2.2 | | 0.3 | | | ||||||||||||||||||||||||||||||
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Brokerage, as reported |
546.3 | 479.7 | 135.4 | 117.4 | 0.47 | 0.40 | ||||||||||||||||||||||||||||||
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Risk Management, as adjusted |
149.7 | 140.3 | 7 | % | 23.8 | 22.6 | 5 | % | 0.09 | 0.09 | 0 | % | ||||||||||||||||||||||||
New Zealand earthquake claims administration |
| 1.9 | | 0.3 | | | ||||||||||||||||||||||||||||||
Workforce & lease termination |
| | (0.2 | ) | (0.1 | ) | | | ||||||||||||||||||||||||||||
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Risk Management, as reported |
149.7 | 142.2 | 23.6 | 22.8 | 0.09 | 0.09 | ||||||||||||||||||||||||||||||
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Total Brokerage & Risk Management, as reported |
696.0 | 621.9 | 159.0 | 140.2 | 0.56 | 0.49 | ||||||||||||||||||||||||||||||
Corporate, as reported |
139.8 | 28.5 | (15.7 | ) | (13.0 | ) | 0.01 | 0.01 | ||||||||||||||||||||||||||||
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Total Company, as reported |
$ | 835.8 | $ | 650.4 | $ | 143.3 | $ | 127.2 | $ | 0.57 | $ | 0.50 | ||||||||||||||||||||||||
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Total Brokerage & Risk Management, as adjusted |
$ | 696.0 | $ | 617.1 | 13 | % | $ | 169.4 | $ | 144.3 | 17 | % | $ | 0.59 | $ | 0.52 | 13 | % | ||||||||||||||||||
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- 33 -
For the Nine-Month Periods Ended September 30, | Diluted Net Earnings | |||||||||||||||||||||||||||||||||||
Revenues | EBITDAC | Per Share | ||||||||||||||||||||||||||||||||||
Segment |
2013 | 2012 | Chg | 2013 | 2012 | Chg | 2013 | 2012 | Chg | |||||||||||||||||||||||||||
(in millions) | (in millions) | |||||||||||||||||||||||||||||||||||
Brokerage, as adjusted |
$ | 1,548.3 | $ | 1,330.7 | 16 | % | $ | 377.6 | $ | 310.5 | 22 | % | $ | 1.24 | $ | 1.07 | 16 | % | ||||||||||||||||||
Net gains on book sales |
3.3 | 1.4 | 3.3 | 1.4 | 0.01 | 0.01 | ||||||||||||||||||||||||||||||
Acquisition integration costs |
| | (17.3 | ) | (12.3 | ) | (0.08 | ) | (0.06 | ) | ||||||||||||||||||||||||||
Workforce & lease termination |
| | (1.2 | ) | (4.7 | ) | | (0.02 | ) | |||||||||||||||||||||||||||
Acquisition related adjustments |
| | | | 0.02 | 0.03 | ||||||||||||||||||||||||||||||
Levelized foreign currency translation |
| 6.4 | | (0.7 | ) | | | |||||||||||||||||||||||||||||
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Brokerage, as reported |
1,551.6 | 1,338.5 | 362.4 | 294.2 | 1.19 | 1.03 | ||||||||||||||||||||||||||||||
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Risk Management, as adjusted |
458.0 | 419.3 | 9 | % | 74.5 | 67.3 | 11 | % | 0.28 | 0.27 | 4 | % | ||||||||||||||||||||||||
New Zealand earthquake claims administration |
0.1 | 7.6 | | 1.5 | | 0.01 | ||||||||||||||||||||||||||||||
South Australia ramp up |
1.4 | | 1.3 | | 0.01 | | ||||||||||||||||||||||||||||||
Workforce & lease termination |
| | (0.2 | ) | (0.1 | ) | | | ||||||||||||||||||||||||||||
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Risk Management, as reported |
459.5 | 426.9 | 75.6 | 68.7 | 0.29 | 0.28 | ||||||||||||||||||||||||||||||
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Total Brokerage & Risk Management, as reported |
2,011.1 | 1,765.4 | 438.0 | 362.9 | 1.48 | 1.31 | ||||||||||||||||||||||||||||||
Corporate, as reported |
278.3 | 81.7 | (46.8 | ) | (26.2 | ) | 0.13 | 0.02 | ||||||||||||||||||||||||||||
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Total Company, as reported |
$ | 2,289.4 | $ | 1,847.1 | $ | 391.2 | $ | 336.7 | $ | 1.61 | $ | 1.33 | ||||||||||||||||||||||||
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Total Brokerage & Risk Management, as adjusted |
$ | 2,006.3 | $ | 1,750.0 | 15 | % | $ | 452.1 | $ | 377.8 | 20 | % | $ | 1.52 | $ | 1.34 | 13 | % | ||||||||||||||||||
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Results of Operations
Brokerage
The brokerage segment accounted for 68% of our revenues during the nine-month period ended September 30, 2013. Our brokerage segment is primarily comprised of retail and wholesale brokerage operations. Our retail brokerage operations negotiate and place property/casualty, employer-provided health and welfare insurance and retirement solutions, principally for middle-market commercial, industrial, public entity, religious and not-for-profit entities. Many of our retail brokerage customers choose to place their insurance with insurance underwriters, while others choose to use alternative vehicles such as self-insurance pools, risk retention groups or captive insurance companies. Our wholesale brokerage operations assist our brokers and other unaffiliated brokers and agents in the placement of specialized, unique and hard-to-place insurance programs.
Our primary sources of compensation for our retail brokerage services are commissions paid by insurance companies, which are usually based upon a percentage of the premium paid by insureds, and brokerage and advisory fees paid directly by our clients. For wholesale brokerage services, we generally receive a share of the commission paid to the retail broker from the insurer. Commission rates are dependent on a number of factors, including the type of insurance, the particular insurance company underwriting the policy and whether we act as a retail or wholesale broker. Advisory fees are dependent on the extent and value of services we provide. In addition, under certain circumstances, both retail brokerage and wholesale brokerage services receive supplemental and contingent commissions. A supplemental commission is a commission paid by an insurance carrier that is above the base commissions paid, is determined by the insurance carrier and is established annually in advance of the contractual period based on historical performance criteria. A contingent commission is a commission paid by an insurance carrier based on the overall profit and/or volume of the business placed with that insurance carrier during a particular calendar year and is determined after the contractual period.
- 34 -
Financial information relating to our brokerage segment results for the three-month and nine-month periods ended September 30, 2013 as compared to the same periods in 2012, is as follows: (in millions, except per share, percentages and workforce data):
Three-month period | Nine-month period | |||||||||||||||||||||||
ended September 30, | ended September 30, | |||||||||||||||||||||||
Statement of Earnings |
2013 | 2012 | Change | 2013 | 2012 | Change | ||||||||||||||||||
Commissions |
$ | 399.1 | $ | 346.0 | $ | 53.1 | $ | 1,126.8 | $ | 962.7 | $ | 164.1 | ||||||||||||
Fees |
120.5 | 106.8 | 13.7 | 320.5 | 281.4 | 39.1 | ||||||||||||||||||
Supplemental commissions |
17.8 | 16.6 | 1.2 | 53.4 | 50.3 | 3.1 | ||||||||||||||||||
Contingent commissions |
6.5 | 7.7 | (1.2 | ) | 43.5 | 37.0 | 6.5 | |||||||||||||||||
Investment income |
2.4 | 1.9 | 0.5 | 4.1 | 5.7 | (1.6 | ) | |||||||||||||||||
Gains realized on books of business sales |
| 0.7 | (0.7 | ) | 3.3 | 1.4 | 1.9 | |||||||||||||||||
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Total revenues |
546.3 | 479.7 | 66.6 | 1,551.6 | 1,338.5 | 213.1 | ||||||||||||||||||
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Compensation |
318.6 | 282.7 | 35.9 | 920.3 | 814.7 | 105.6 | ||||||||||||||||||
Operating |
92.3 | 79.6 | 12.7 | 268.9 | 229.6 | 39.3 | ||||||||||||||||||
Depreciation |
8.3 | 6.5 | 1.8 | 22.1 | 18.3 | 3.8 | ||||||||||||||||||
Amortization |
30.1 | 25.2 | 4.9 | 88.2 | 71.1 | 17.1 | ||||||||||||||||||
Change in estimated acquisition earnout payables |
(0.3 | ) | 3.7 | (4.0 | ) | 1.6 | 1.0 | 0.6 | ||||||||||||||||
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Total expenses |
449.0 | 397.7 | 51.3 | 1,301.1 | 1,134.7 | 166.4 | ||||||||||||||||||
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Earnings before income taxes |
97.3 | 82.0 | 15.3 | 250.5 | 203.8 | 46.7 | ||||||||||||||||||
Provision for income taxes |
36.1 | 32.4 | 3.7 | 96.2 | 79.5 | 16.7 | ||||||||||||||||||
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Net earnings |
$ | 61.2 | $ | 49.6 | $ | 11.6 | $ | 154.3 | $ | 124.3 | $ | 30.0 | ||||||||||||
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Diluted net earnings per share |
$ | 0.47 | $ | 0.40 | $ | 0.07 | $ | 1.19 | $ | 1.03 | $ | 0.16 | ||||||||||||
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Other Information |
||||||||||||||||||||||||
Change in diluted net earnings per share |
18 | % | (2 | %) | 16 | % | 6 | % | ||||||||||||||||
Growth in revenues |
14 | % | 14 | % | 16 | % | 17 | % | ||||||||||||||||
Organic change in commissions and fees |
6 | % | 4 | % | 6 | % | 4 | % | ||||||||||||||||
Compensation expense ratio |
58 | % | 59 | % | 59 | % | 61 | % | ||||||||||||||||
Operating expense ratio |
17 | % | 17 | % | 17 | % | 17 | % | ||||||||||||||||
Effective income tax rate |
37 | % | 40 | % | 38 | % | 39 | % | ||||||||||||||||
Workforce at end of period (includes acquisitions) |
9,890 | 8,683 | ||||||||||||||||||||||
Identifiable assets at September 30 |
$ | 4,661.9 | $ | 3,835.0 | ||||||||||||||||||||
EBITDAC |
||||||||||||||||||||||||
Net earnings |
$ | 61.2 | $ | 49.6 | $ | 11.6 | $ | 154.3 | $ | 124.3 | $ | 30.0 | ||||||||||||
Provision for income taxes |
36.1 | 32.4 | 3.7 | 96.2 | 79.5 | 16.7 | ||||||||||||||||||
Depreciation |
8.3 | 6.5 | 1.8 | 22.1 | 18.3 | 3.8 | ||||||||||||||||||
Amortization |
30.1 | 25.2 | 4.9 | 88.2 | 71.1 | 17.1 | ||||||||||||||||||
Change in estimated acquisition earnout payables |
(0.3 | ) | 3.7 | (4.0 | ) | 1.6 | 1.0 | 0.6 | ||||||||||||||||
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EBITDAC |
$ | 135.4 | $ | 117.4 | $ | 18.0 | $ | 362.4 | $ | 294.2 | $ | 68.2 | ||||||||||||
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EBITDAC margin |
25 | % | 24 | % | 23 | % | 22 | % | ||||||||||||||||
EBITDAC growth |
15 | % | 23 | % | 23 | % | 22 | % |
- 35 -
The following provides non-GAAP information that management believes is helpful when comparing EBITDAC and adjusted EBITDAC for the three-month and nine-month periods ended September 30, 2013 to the same periods in 2012 (in millions):
Three-month period | Nine-month period | |||||||||||||||
ended September 30, | ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Total EBITDAC - see computation above |
$ | 135.4 | $ | 117.4 | $ | 362.4 | $ | 294.2 | ||||||||
Net gains from books of business sales |
| (0.7 | ) | (3.3 | ) | (1.4 | ) | |||||||||
Acquisition integration |
9.3 | 4.2 | 17.3 | 12.3 | ||||||||||||
Workforce and lease termination related charges |
0.9 | 1.1 | 1.2 | 4.7 | ||||||||||||
Levelized foreign currency translation |
| (0.3 | ) | | 0.7 | |||||||||||
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Adjusted EBITDAC |
$ | 145.6 | $ | 121.7 | $ | 377.6 | $ | 310.5 | ||||||||
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Adjusted EBITDAC change |
19.6 | % | 20.4 | % | 21.6 | % | 22.0 | % | ||||||||
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Adjusted EBITDAC margin |
26.7 | % | 25.5 | % | 24.4 | % | 23.3 | % | ||||||||
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Acquisition integration costs include costs related to our May 12, 2011 acquisition of HLG Holdings, Ltd. (which we refer to as Heath Lambert) and to our August 12, 2013 acquisition of Bollinger that are not expected to occur on an ongoing basis in the future once we fully assimilate these acquisitions. These costs relate to redundant workforce, extra lease space, duplicate services and external costs incurred to assimilate the acquired businesses with our IT related systems. The Heath Lambert integration costs in the three-month period ended September 30, 2013 totaled $7.7 million and were primarily related to the consolidation of offices in London. The Bollinger integration costs in the three-month period ended September 30, 2013 totaled $1.6 million and were primarily related to technology costs, the onboarding of over 500 employees and incentive compensation. The prior period integration costs relate to the Heath Lambert acquisition only. The full integration of the Heath Lambert operations into our existing operations was completed in the third quarter of 2013. Integration costs related to the Bollinger acquisition are expected to range between $2.0 million to $3.0 million per quarter through 2014.
Commissions and fees - The aggregate increase in commissions and fees for the three-month period ended September 30, 2013 compared to the same period in 2012, was principally due to revenues associated with acquisitions that were made in the twelve-month period ended September 30, 2013 ($46.8 million). Commissions and fees in the three-month period ended September 30, 2013 included new business production and renewal rate increases of $59.1 million, which was partially offset by lost business of $39.1 million. Commissions increased 15% and fees increased 13% in the three-month period ended September 30, 2013 compared to the same period in 2012. Organic growth in commissions and fee revenues for the three-month period ended September 30, 2013 was 5.5% compared to 4.0% for the same period in 2012, principally due to net new business production and premium rate increases.
The aggregate increase in commissions and fees for the nine-month period ended September 30, 2013 compared to the same period in 2012, was principally due to revenues associated with acquisitions that were made in the twelve-month period ended September 30, 2013 ($144.7 million). Commissions and fees in the nine-month period ended September 30, 2013 included new business production and renewal rate increases of $177.4 million, which was partially offset by lost business of $118.9 million. Commissions increased 17% and fees increased 14% in the nine-month period ended September 30, 2013 compared to the same period in 2012. Organic growth in commissions and fee revenues for the nine-month period ended September 30, 2013 was 5.5% compared to 4.1% for the same period in 2012, principally due to net new business production and premium rate increases.
- 36 -
Items excluded from organic revenue computations yet impacting revenue comparisons for the three-month and nine-month periods ended September 30, 2013 and 2012 include the following (in millions):
2013 Organic Revenue | 2012 Organic Revenue | |||||||||||||||
For the Three-Month Periods Ended September 30, |
2013 | 2012 | 2012 | 2011 | ||||||||||||
Base Commissions and Fees |
||||||||||||||||
Commission revenues as reported |
$ | 399.1 | $ | 346.0 | $ | 346.0 | $ | 308.0 | ||||||||
Fee revenues as reported |
120.5 | 106.8 | 106.8 | 86.8 | ||||||||||||
Less commission and fee revenues from acquisitions |
(46.8 | ) | | (45.0 | ) | | ||||||||||
Less disposed of operations |
| (2.5 | ) | | (1.5 | ) | ||||||||||
Levelized foreign currency translation |
| (2.1 | ) | | (1.0 | ) | ||||||||||
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Organic base commission and fee revenues |
$ | 472.8 | $ | 448.2 | $ | 407.8 | $ | 392.3 | ||||||||
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Organic change in base commission and fee revenues |
5.5 | % | 4.0 | % | ||||||||||||
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Supplemental Commissions |
||||||||||||||||
Supplemental commissions as reported |
$ | 17.8 | $ | 16.6 | $ | 16.6 | $ | 14.5 | ||||||||
Less supplemental commissions from acquisitions |
(1.3 | ) | | (2.8 | ) | | ||||||||||
Less disposed of operations |
| | | (0.1 | ) | |||||||||||
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Organic supplemental commissions |
$ | 16.5 | $ | 16.6 | $ | 13.8 | $ | 14.4 | ||||||||
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Organic change in supplemental commissions |
(0.6 | %) | (4.2 | %) | ||||||||||||
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Contingent Commissions |
||||||||||||||||
Contingent commissions as reported |
$ | 6.5 | $ | 7.7 | $ | 7.7 | $ | 9.9 | ||||||||
Less contingent commissions from acquisitions |
(1.0 | ) | | (1.3 | ) | | ||||||||||
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Organic contingent commissions |
$ | 5.5 | $ | 7.7 | $ | 6.4 | $ | 9.9 | ||||||||
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Organic change in contingent commissions |
(28.6 | %) | (35.4 | %) | ||||||||||||
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2013 Organic Revenue | 2012 Organic Revenue | |||||||||||||||
For the Nine-Month Periods Ended September 30, |
2013 | 2012 | 2012 | 2011 | ||||||||||||
Base Commissions and Fees |
||||||||||||||||
Commission revenues as reported |
$ | 1,126.8 | $ | 962.7 | $ | 962.7 | $ | 829.7 | ||||||||
Fee revenues as reported |
320.5 | 281.4 | 281.4 | 227.7 | ||||||||||||
Less commission and fee revenues from acquisitions |
(144.7 | ) | | (153.7 | ) | | ||||||||||
Less disposed of operations |
| (3.0 | ) | | (7.2 | ) | ||||||||||
Levelized foreign currency translation |
| (5.8 | ) | | (3.0 | ) | ||||||||||
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Organic base commission and fee revenues |
$ | 1,302.6 | $ | 1,235.3 | $ | 1,090.4 | $ | 1,047.2 | ||||||||
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Organic change in base commission and fee revenues |
5.5 | % | 4.1 | % | ||||||||||||
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Supplemental Commissions |
||||||||||||||||
Supplemental commissions as reported |
$ | 53.4 | $ | 50.3 | $ | 50.3 | $ | 42.0 | ||||||||
Less supplemental commissions from acquisitions |
(3.3 | ) | | (8.3 | ) | | ||||||||||
Less disposed of operations |
| | | (0.5 | ) | |||||||||||
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Organic supplemental commissions |
$ | 50.1 | $ | 50.3 | $ | 42.0 | $ | 41.5 | ||||||||
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Organic change in supplemental commissions |
(0.4 | %) | 1.2 | % | ||||||||||||
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Contingent Commissions |
||||||||||||||||
Contingent commissions as reported |
$ | 43.5 | $ | 37.0 | $ | 37.0 | $ | 34.6 | ||||||||
Less contingent commissions from acquisitions |
(7.8 | ) | | (4.7 | ) | | ||||||||||
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Organic contingent commissions |
$ | 35.7 | $ | 37.0 | $ | 32.3 | $ | 34.6 | ||||||||
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Organic change in contingent commissions |
(3.5 | %) | (6.7 | %) | ||||||||||||
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- 37 -
Supplemental and contingent commissions - Reported supplemental and contingent commission revenues recognized in 2013, 2012 and 2011 by quarter are as follows (in millions):
First | Second | Third | Fourth | |||||||||||||||||
Quarter | Quarter | Quarter | Quarter | YTD | ||||||||||||||||
2013 |
||||||||||||||||||||
Reported supplemental commissions |
$ | 17.3 | $ | 18.3 | $ | 17.8 | $ | 53.4 | ||||||||||||
Reported contingent commissions |
22.5 | 14.5 | 6.5 | 43.5 | ||||||||||||||||
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Reported supplemental and contingent commissions |
$ | 39.8 | $ | 32.8 | $ | 24.3 | $ | 96.9 | ||||||||||||
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2012 |
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Reported supplemental commissions |
$ | 17.1 | $ | 16.6 | $ | 16.6 | $ | 17.6 | $ | 67.9 | ||||||||||
Reported contingent commissions |
19.0 | 10.3 | 7.7 | 5.9 | 42.9 | |||||||||||||||
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Reported supplemental and contingent commissions |
$ | 36.1 | $ | 26.9 | $ | 24.3 | $ | 23.5 | $ | 110.8 | ||||||||||
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2011 |
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Reported supplemental commissions |
$ | 13.5 | $ | 14.0 | $ | 14.5 | $ | 14.0 | $ | 56.0 | ||||||||||
Reported contingent commissions |
16.8 | 7.9 | 9.9 | 3.5 | 38.1 | |||||||||||||||
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Reported supplemental and contingent commissions |
$ | 30.3 | $ | 21.9 | $ | 24.4 | $ | 17.5 | $ | 94.1 | ||||||||||
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Investment income and net gains realized on books of business sales - This primarily represents interest income earned on cash, cash equivalents and restricted funds and one-time gains related to sales of books of business, which were zero and $0.7 million, respectively, for the three-month periods ended September 30, 2013 and 2012 and $3.3 million and $4.9 million, respectively, for the nine-month periods ended September 30, 2013 and 2012. Offsetting the one-time gains related to sales of books of business for the three-month and nine-month periods ended September 30, 2012, was a non-cash loss of $3.5 million we recognized related to our acquisition of an additional 41.5% equity interest in CGM Gallagher Group Limited (which we refer to as CGM), which increased our ownership in CGM to 80%. The loss represents the decrease in fair value of our initial 38.5% equity interest in CGM based on the purchase price paid to acquire the additional 41.5% equity interest in CGM. Investment income in the three-month and nine-month periods ended September 30, 2013 decreased slightly compared to the same period in 2012.
Compensation expense - The following provides non-GAAP information that management believes is helpful when comparing compensation expense for the three-month and nine-month periods ended September 30, 2013 with the same periods in 2012 (in millions):
Three-month period | Nine-month period | |||||||||||||||
ended September 30, | ended September 30, | |||||||||||||||
2013 | 2012 | 2013 | 2012 | |||||||||||||
Reported amounts |
$ | 318.6 | $ | 282.7 | $ | 920.3 | $ | 814.7 | ||||||||
Acquisition integration |
(2.9 | ) | (2.3 | ) | (6.4 | ) | (7.1 | ) | ||||||||
Workforce related charges |
(0.8 | ) | (1.1 | ) | (1.1 | ) | (4.7 | ) | ||||||||
Levelized foreign currency translation |
| (1.5 | ) | | (5.0 | ) | ||||||||||
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Adjusted amounts |
$ | 314.9 | $ | 277.8 | $ | 912.8 | $ | 797.9 | ||||||||
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Adjusted revenues - see pages 33 and 34 |
$ | 546.3 | $ | 476.8 | $ | 1,548.3 | $ | 1,330.7 | ||||||||
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