ARTHUR J. GALLAGHER & CO. The discussion and analysis that follows relates to our financial condition and results of operations for the three-month and six-month periods endedJune 30, 2020 . Readers should review this information in conjunction with theJune 30, 2020 unaudited consolidated financial statements and notes included in Item 1 of Part I of this quarterly report on Form 10Q and the audited consolidated financial statements and notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations, contained in our annual report on Form 10-K for the year endingDecember 31, 2019 .
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 (adjusted EPS), adjusted revenues, adjusted compensation and operating expenses, adjusted compensation expense ratio, adjusted operating expense ratio and organic revenue. These measures are not in accordance with, or an alternative to, the GAAP information provided in this quarterly report on Form 10Q. 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 because they provide investors with measures that our chief operating decision maker uses when reviewing the company's performance, and for the other reasons described below. Our industry peers may provide similar supplemental non-GAAP information with respect to one or more of these measures, 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. We make determinations regarding certain elements of executive officer incentive compensation, performance share awards and annual cash incentive awards, partly on the basis of measures related to adjusted EBITDAC. Adjusted Non-GAAP presentation - We believe that the adjusted non-GAAP presentation of the current and prior period information presented on the following pages provides stockholders and other interested persons with useful information regarding certain financial metrics that may 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 measures - We define these measures as revenues (for the
brokerage segment), revenues before reimbursements (for the risk
management segment), net earnings, compensation expense and operating
expense, respectively, each adjusted to exclude the following, as
applicable:
• Net gains on divestitures, which are primarily net proceeds received
related to sales of books of business and other divestiture
transactions, such as the disposal of a business unit through sale or
closure.
• Costs related to divestitures, which include legal and other costs
related to certain operations that are being exited by us.
• Acquisition integration costs, which include costs related to certain
of our large acquisitions, outside the scope of our usualtuck-in
strategy, 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.
• Workforce related charges, which primarily include severance costs
(either accrued or paid) related to employee terminations and other
costs associated with redundant workforce.
• Lease termination related charges, which primarily include costs
related to terminations of real estate leases and abandonment of
leased space.
• Acquisition related adjustments, which include change in estimated
acquisition earnout payables adjustments, impairment charges and
acquisition related compensation charges. Prior to firstquarter 2019,
this adjustment also reflected impacts of acquisition valuation
true-ups.
• The impact of foreign currency translation, as applicable. The amounts
excluded with respect to foreign currency translation arecalculated
by applying current year foreign exchange rates to the same period in
the prior year.
• Effective income tax rate impact, which represents the impact related
to prior quarters in 2019 for the decrease in the effective income tax
rate used to compute the provision for income taxes in fourth quarter
2019.
• Adjusted ratios - Adjusted compensation expense and adjusted operating
expense, respectively, each divided by adjusted revenues.
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Non-GAAP Earnings Measures
We believe that the presentation of EBITDAC, EBITDAC margin, adjusted EBITDAC, adjusted EBITDAC margin and adjusted EPS for the brokerage and risk management segment, each as defined below, provides a meaningful representation of our operating performance. Adjusted EPS is a performance measure and should not be used as a measure of our liquidity. We also consider EBITDAC and EBITDAC margin as ways to measure financial performance on an ongoing basis. In addition, adjusted EBITDAC, adjusted EBITDAC margin and adjusted EPS 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 and EBITDAC Margin - EBITDAC is net earnings before interest,
income taxes, depreciation, amortization and the change in estimated
acquisition earnout payables and EBITDAC margin is EBITDAC divided by
total revenues (for the brokerage segment) and revenues before
reimbursements (for the risk management segment). These measures for the
brokerage and risk management segments provide a meaningful representation
of our operating performance for the overall business and provide a
meaningful way to measure its financial performance on an ongoing basis.
• Adjusted EBITDAC and Adjusted EBITDAC Margin - Adjusted EBITDAC is EBITDAC
adjusted to exclude net gains on divestitures, acquisition integration
costs, workforce related charges, lease termination related charges,
acquisition related adjustments, and the period-over-period impact of
foreign currency translation, as applicable, and Adjusted EBITDAC margin
is Adjusted EBITDAC divided by total adjusted revenues (defined above).
These measures for the brokerage and risk management segments provide a
meaningful representation of our operating performance and, are also
presented to improve the comparability of our results between periods by
eliminating the impact of the items that have a high degree of
variability.
• Adjusted EPS and Adjusted Net Earnings - Adjusted net earnings have been
adjusted to exclude the after-tax impact of net gains on divestitures,
acquisition integration costs, workforce related charges, lease
termination related charges and acquisition related adjustments and the
period-over-period impact of foreign currency translation and effective
income tax rate impact, as applicable. Adjusted EPS is Adjusted Net
Earnings divided by diluted weighted average shares outstanding. This
measure provides a meaningful representation of our operating performance
(and as such should not be used as a measure of our liquidity), and for
the overall business is also presented to improve the comparability of our
results between periods by eliminating the impact of the items that have a
high degree of variability.
Organic Revenues (a non-GAAP measure) - For the brokerage segment, organic
change in base commission and fee revenues, supplemental revenues and contingent
revenues excludes the first twelve months of such revenues generated from
acquisitions and such revenues related to divested operations in each year
presented. These revenues 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 period. In
addition, organic change in base commission and fee revenues, supplemental
revenues and contingent revenues exclude the periodoverperiod impact of
foreign currency translation. For the risk management segment, organic change in
fee revenues excludes the first twelve months of fee revenues generated from
acquisitions and the fee revenues related to operations disposed of in each year
presented. In addition, change in organic growth excludes 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, but non-GAAP, 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 nonGAAP 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 10Q 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, adjusted EBITDAC (before acquisitions), diluted net
earnings per share (as adjusted) and organic revenue measures.
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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 using local statutory rates. As a result,
the provision for income taxes for the corporate segment reflects the entire
benefit to us of the IRC Section 45 credits produced, because that is the
segment which generated the credits. The law that provides for IRC Section 45
credits expired in December 2019 for our fourteen 2009 Era Plants and will
expire in December 2021 for our twenty-one 2011 Era Plants. We anticipate
reporting an effective tax rate of approximately 23.0% to 25.0% in the brokerage
segment and 24.0% to 26.0% in the risk management segment for the foreseeable
future. Reported operating results by segment would change if different
allocation methods were applied. When the law governing IRC Section 45 credits
expires, reported GAAP revenues and net earnings will decrease, yet our net cash
flow will increase as a result of not having to pay expenses to operate the
clean coal facilities and also from an increase in the use of credits against
our U.S. federal income tax obligations.
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 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 Second Quarter 2020 Highlights
We are engaged in providing insurance brokerage and consulting services, and third-party property/casualty claims settlement and administration services to entities in theU.S. and abroad. In the six-month period endedJune 30, 2020 , we generated approximately 69% of our revenues for the combined brokerage and risk management segments domestically and 31% internationally, primarily inAustralia ,Bermuda ,Canada , theCaribbean ,New Zealand and theU.K. We have three reportable segments: brokerage, risk management and corporate, which contributed approximately 76%, 14% and 10%, respectively, to revenues during the sixmonth period endedJune 30, 2020 . Our major sources of operating revenues are commissions, fees and supplemental and contingent revenues from brokerage operations and fees from risk management operations. Investment income is generated from invested cash and fiduciary funds, clean energy and other investments, and interest income from premium financing. We typically cite theCouncil of Insurance Agents and Brokers (which we refer to as CIAB) insurance pricing quarterly survey at this time as an indicator of the current insurance rate environment. The first quarter 2020 survey indicated that commercial property/casualty rates increased by 9.3% on average. The second quarter 2020 survey had not been published as of the filing date of this report. The CIAB represents the leading domestic and international insurance brokers, who write approximately 85% of the commercial property/casualty premiums in theU.S. We believe increases in property/casualty rates will continue for the remainder of 2020; however, loss trends could deteriorate over the next year, leading to a more difficult rate and conditions environment in certain lines. The economies of theU.S. and other countries around the world have rapidly contracted as a result of COVID-19. The decreased level of economic activity is leading to, and is likely to continue to lead to, a decline in exposure units and rising unemployment. However, we expect that our history of strong new business generation, solid retentions and enhanced value-added services for our carrier partners should help offset, to a degree, softer economic conditions around the world. Overall, we believe that in a positive rate environment with declining exposure units, our professionals can demonstrate their expertise and high-quality, value-added capabilities by strengthening our clients' insurance portfolios and delivering insurance and risk management solutions within our clients' budget. Based on our experience, there is adequate capacity in the insurance market, most insurance carriers appear to be making rational pricing decisions and clients can broadly still obtain coverage. Please also refer to the section entitled "COVID-19 Impact" below see pages 43 and 44. - 38 -
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Summary of Financial Results - Three-Month Periods Ended
See the reconciliations of non-GAAP measures on page 40.
(Dollars in millions, except per
share data) 2nd Quarter 2020 2nd Quarter 2019 Change
Reported Adjusted Reported Adjusted Reported Adjusted
GAAP Non-GAAP GAAP Non-GAAP GAAP Non-GAAP
Brokerage Segment
Revenues $ 1,201.1 $ 1,200.1 $ 1,131.2 $ 1,113.8 6 % 8 %
Organic revenues $ 1,112.3 $ 1,089.1 2.1 %
Net earnings $ 190.2 $ 138.0 38 %
Net earnings margin 15.8 % 12.2 % + 364 bpts
Adjusted EBITDAC $ 391.3 $ 292.4 34 %
Adjusted EBITDAC margin 32.6 % 26.3 % + 636 bpts
Diluted net earnings per share
$ 0.75 39 % 45 % Risk Management Segment Revenues before reimbursements$ 190.8 $ 190.8 $ 209.1 $ 207.3 (9 )% (8 )% Organic revenues$ 187.0 $ 206.8 (9.6 )% Net earnings$ 9.9 $ 15.5 (36 )%
Net earnings margin (before reimbursements) 5.2 % 7.4 % - 222 bpts Adjusted EBITDAC$ 33.5 $ 36.2 (7 )% Adjusted EBITDAC margin (before reimbursements) 17.6 % 17.5 % + 10 bpts
Diluted net earnings per share
$ 0.09 (38 )% (11 )% Corporate Segment Diluted net loss per share$ (0.23 ) $ (0.23 ) $ (0.20 ) $ (0.21 ) Total Company Diluted net earnings per share$ 0.79 $ 0.94 $ 0.58 $ 0.63 36 % 49 % Total Brokerage and Risk Management Segment Diluted net earnings per share$ 1.02 $ 1.17 $ 0.78 $ 0.84 31 % 39 %
Summary of Financial Results - Six-Month Periods Ended
See the reconciliations of non-GAAP measures on page 41.
(Dollars in millions, except
per share data) Six Months 2020 Six Months 2019 Change
Reported Adjusted Reported Adjusted Reported Adjusted
GAAP Non-GAAP GAAP Non-GAAP GAAP Non-GAAP
Brokerage Segment
Revenues $ 2,636.7 $ 2,635.5 $ 2,513.1 $ 2,424.5 5 % 9 %
Organic revenues $ 2,434.1 $ 2,370.9 2.7 %
Net earnings $ 501.6 $ 447.5 12 %
Net earnings margin 19.0 % 17.8 % + 121 bpts
Adjusted EBITDAC $ 886.8 $ 760.8 17 %
Adjusted EBITDAC margin 33.7 % 31.4 % + 227 bpts
Diluted net earnings per
share $ 2.58 $ 2.75 $ 2.29 $ 2.19 13 % 26 %
Risk Management Segment
Revenues before
reimbursements $ 402.6 $ 402.6 $ 412.4 $ 408.0 (2 )% (1 )%
Organic revenues $ 395.6 $ 407.1 (2.8 )%
Net earnings $ 29.0 $ 31.7 (9 )%
Net earnings margin (before
reimbursements) 7.2 % 7.7 % - 49 bpts
Adjusted EBITDAC $ 68.8 $ 70.5 (2 )%
Adjusted EBITDAC margin
(before reimbursements) 17.1 % 17.3 % - 19 bpts
Diluted net earnings per
share $ 0.15 $ 0.17 $ 0.17 $ 0.18 (12 )% (6 )%
Corporate Segment
Diluted net loss per share $ (0.15 ) $ (0.15 ) $ (0.11 ) $ (0.12 )
Total Company
Diluted net earnings per
share $ 2.58 $ 2.77 $ 2.35 $ 2.25 10 % 23 %
Total Brokerage and Risk
Management Segment
Diluted net earnings per
share $ 2.73 $ 2.92 $ 2.46 $ 2.37 11 % 23 %
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-------------------------------------------------------------------------------- In our corporate segment, net after-tax earnings from our clean energy investments were$5.0 million and$8.2 million , as adjusted, in the threemonth periods endedJune 30, 2020 and 2019, respectively. In our corporate segment, net after-tax earnings from our clean energy investments were$57.5 million and$69.7 million , as adjusted, in the sixmonth periods endedJune 30, 2020 and 2019, respectively. We anticipate our clean energy investments to generate between$60.0 million and$70.0 million in adjusted net earnings in 2020. See "COVID-19 Impact" on pages 43 and 44. We expect to use the additional cash flow generated by these earnings to continue our mergers and acquisition strategy in our core brokerage and risk management operations. The following provides information that management believes is helpful when comparing revenues before reimbursements, net earnings, EBITDAC and diluted net earnings per share for the three-month and six-month periods endedJune 30, 2020 with the same periods in 2019. In addition, these tables provide reconciliations to the most comparable GAAP measures for adjusted revenues, adjusted EBITDAC and adjusted diluted net earnings per share. Reconciliations of EBITDAC for the brokerage and risk management segments are provided on pages 46 and 52, respectively, of this filing. For the Three-Month Periods EndedJune 30 Reported GAAP to Adjusted Non-GAAP Reconciliation: Revenues Before Diluted Net Reimbursements Net Earnings EBITDAC Earnings Per Share Segment 2020 2019 2020 2019 2020 2019 2020 2019 Chg (in millions) (in millions) (in millions) Brokerage, as reported$ 1,201.1 $ 1,131.2 $ 190.2 $ 138.0 $ 366.5 $ 280.9 $ 0.97 $ 0.70 39 % Net gains on divestitures (1.0 ) (1.9 ) (0.8 ) (1.4 ) (1.0 ) (1.9 ) - (0.01 ) Acquisition integration - 5.1 2.5 6.7 3.4 0.02 0.01 Workforce and lease termination - - 11.5 7.2 15.0 9.5 0.06 0.04 Acquisition related adjustments - - 8.3 3.0 4.1 6.1 0.04 0.02 Levelized foreign currency translation - (15.5 ) - (3.2 ) - (5.6 ) - (0.02 ) Effective income tax rate impact - - - 0.6 - - - 0.01 Brokerage, as adjusted * 1,200.1 1,113.8 214.3 146.7
391.3 292.4 1.09 0.75 45 % Risk Management, as reported
190.8 209.1 9.9 15.5 28.5 33.8 0.05 0.08 (38 )% Workforce and lease termination
- - 3.7 2.1 5.0 2.8 0.02 0.01
Acquisition related
adjustments - - 1.1 (0.2 ) - - 0.01 -
Levelized foreign
currency
translation - (1.8 ) - (0.2 ) - (0.4 ) - -
Effective income tax
rate impact - - - 0.2 - - - -
Risk Management, as
adjusted * 190.8 207.3 14.7 17.4 33.5 36.2 0.08 0.09 (11 )% Corporate, as reported 159.7 284.5 (38.3 ) (32.1 )
(35.0 ) (45.9 ) (0.23 ) (0.20 )
Effective income tax
rate impact - - - (1.0 ) - - - (0.01 )
Corporate, as adjusted
* 159.7 284.5 (38.3 ) (33.1 ) (35.0 ) (45.9 ) (0.23 ) (0.21 )
Total Company , as
reported $ 1,551.6 $ 1,624.8 $ 161.8 $ 121.4 $ 1,550.6 $ 1,605.6 $ 190.7 $ 131.0 $ 389.8 $ 282.7 $ 0.94 $ 0.63 49 % Total Brokerage & Risk Management, as reported$ 1,391.9 $ 1,340.3 $ 200.1 $ 153.5 $ 395.0 $ 314.7 $ 1.02 $ 0.78 31 % Total Brokerage & Risk Management, as adjusted *$ 1,390.9 $ 1,321.1 $ 229.0 $ 164.1 $ 424.8 $ 328.6 $ 1.17 $ 0.84 39 %
* For the three-month period ended
brokerage segment adjustments totals
adjustment to the provision for income taxes of
these items. For the three-month period ended
impact of the risk management segment adjustments totals
corresponding adjustment to the provision for income taxes of
relating to these items. A detailed reconciliation of the 2020 provision for
income taxes is shown on page 42.
* For the three-month period ended
brokerage segment adjustments totals
adjustment to the provision for income taxes of
these items. The pretax impact of the risk management segment adjustments
totals
income taxes of
reconciliation of the 2019 provision for income taxes is shown on page 42.
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For the Six-Month Periods Ended June 30 Reported GAAP to Adjusted Non-GAAP
Reconciliation:
Revenues Before Diluted Net
Reimbursements Net Earnings EBITDAC Earnings Per Share
Segment 2020 2019 2020 2019 2020 2019 2020 2019 Chg
(in millions) (in millions) (in millions)
Brokerage, as reported $ 2,636.7 $ 2,513.1 $ 501.6 $ 447.5 $ 844.4 $ 787.6 2.58 $ 2.29 13 %
Net gains on
divestitures (1.2 ) (59.0 ) (1.0 ) (34.5 ) (1.2 ) (46.0 ) - (0.18 )
Acquisition
integration - - 10.2 2.8 13.4 3.8 0.05 0.01
Workforce and lease
termination - - 16.5 11.9 21.5 15.8 0.09 0.06
Acquisition related
adjustments - - 6.2 2.9 8.7 8.7 0.03 0.02
Levelized foreign
currency
translation - (29.6 ) - (4.7 ) - (9.1 ) - (0.03 )
Effective income tax
rate impact - - - 2.9 - - - 0.02
Brokerage, as adjusted
* 2,635.5 2,424.5 533.5 428.8 886.8 760.8 2.75 2.19 26 %
Risk Management, as
reported 402.6 412.4 29.0 31.7 63.5 67.9 0.15 0.17 (12 )%
Workforce and lease
termination - - 3.9 2.4 5.3 3.2 0.02 0.01
Acquisition related
adjustments - - 0.9 (0.2 ) - - - -
Levelized foreign
currency
translation - (4.4 ) - (0.3 ) - (0.6 ) - -
Effective income tax
rate impact - - - 0.4 - - - -
Risk Management, as
adjusted * 402.6 408.0 33.8 34.0 68.8 70.5 0.17 0.18 (6 )%
Corporate, as reported 341.5 656.8 (13.4 ) (6.1 ) (58.0 ) (111.3 ) (0.15 ) (0.11 )
Effective income tax
rate impact - - - (2.0 ) - - - (0.01 )
Corporate, as adjusted
* 341.5 656.8 (13.4 ) (8.1 ) (58.0 ) (111.3 ) (0.15 ) (0.12 )
Total Company , as
reported $ 3,380.8 $ 3,582.3 $ 517.2 $ 473.1 $ 849.9 $ 744.2 $ 2.58 $ 2.35 10 %
Total Company , as
adjusted * $ 3,379.6 $ 3,489.3 $ 553.9 $ 454.7 $ 897.6 $ 720.0 $ 2.77 $ 2.25 23 %
Total Brokerage & Risk
Management, as
reported $ 3,039.3 $ 2,925.5 $ 530.6 $ 479.2 $ 907.9 $ 855.5 $ 2.73 $ 2.46 11 %
Total Brokerage & Risk
Management, as
adjusted * $ 3,038.1 $ 2,832.5 $ 567.3 $ 462.8 $ 955.6 $ 831.3 $ 2.92 $ 2.37 23 %
* For the six-month period ended
brokerage segment adjustments totals
adjustment to the provision for income taxes of
these items. For the six-month period ended
of the risk management segment adjustments totals
corresponding adjustment to the provision for income taxes of
relating to these items. A detailed reconciliation of the 2020 provision for
income taxes is shown on page 43.
For the six-month period endedJune 30, 2019 , the pretax impact of the brokerage segment adjustments totals$28.7 million , with a corresponding adjustment to the provision for income taxes of$10.0 million relating to these items. The pretax impact of the risk management segment adjustments totals$2.5 million , with a corresponding adjustment to the provision for income taxes of$0.2 million relating to these items. A detailed reconciliation of the 2019 provision for income taxes is shown on page 43. - 41 - -------------------------------------------------------------------------------- Reconciliation of Non-GAAP Measures - Pre-tax Earnings and Diluted Net Earnings per Share (In millions except share and per share data) Earnings Provision Net Earnings Net Earnings Before (Benefit) Attributable to Attributable to Diluted Net Income for Income Net Noncontrolling Controlling Earnings Taxes Taxes Earnings Interests Interests per Share
Quarter EndedJune 30, 2020 Brokerage, as reported$ 247.8 $ 57.6 $ 190.2 $ 1.5 $ 188.7 $ 0.97 Net gains on divestitures (1.0 ) (0.2 ) (0.8 ) - (0.8 ) - Acquisition integration 6.7 1.6 5.1 - 5.1 0.02 Workforce and lease termination 15.0 3.5 11.5 - 11.5 0.06 Acquisition related adjustments 10.8 2.5 8.3 - 8.3 0.04 Brokerage, as adjusted$ 279.3 $ 65.0 $ 214.3 $ 1.5 $ 212.8 $ 1.09 Risk Management, as reported$ 13.2 $ 3.3 $ 9.9 $ - $ 9.9 $ 0.05 Workforce and lease termination 5.0 1.3 3.7 - 3.7 0.02 Acquisition related adjustments 1.5 0.4 1.1 - 1.1 0.01 Risk Management, as adjusted$ 19.7 $ 5.0 $ 14.7 $ - $ 14.7 $ 0.08 Quarter EndedJune 30, 2019 Brokerage, as reported$ 182.3 $ 44.3 $ 138.0 $ 5.1 $ 132.9 $ 0.70 Net gains on divestitures (1.9 ) (0.5 ) (1.4 ) - (1.4 ) (0.01 ) Acquisition integration 3.4 0.9 2.5 - 2.5 0.01 Workforce and lease termination 9.5 2.3 7.2 - 7.2 0.04 Acquisition related adjustments 4.0 1.0 3.0 - 3.0 0.02 Effective income tax rate impact - (0.6 ) 0.6 - 0.6 0.01 Levelized foreign currency translation (4.2 ) (1.0 ) (3.2 ) - (3.2 ) (0.02 ) Brokerage, as adjusted$ 193.1 $ 46.4 $ 146.7 $ 5.1 $ 141.6 $ 0.75 Risk Management, as reported$ 21.0 $ 5.5 $ 15.5 $ - $ 15.5 $ 0.08 Workforce and lease termination 2.8 0.7 2.1 - 2.1 0.01 Acquisition related adjustments (0.3 ) (0.1 ) (0.2 ) - (0.2 ) - Effective income tax rate impact - (0.2 ) 0.2 - 0.2 - Levelized foreign currency translation (0.3 ) (0.1 ) (0.2 ) - (0.2 ) - Risk Management, as adjusted$ 23.2 $ 5.8 $ 17.4 $ - $ 17.4 $ 0.09 Corporate, as reported$ (97.8 ) $ (65.7 ) $ (32.1 ) $ 6.2 $ (38.3 )$ (0.20 ) Effective income tax rate impact - 1.0 (1.0 ) - (1.0 ) (0.01 ) Corporate, as adjusted$ (97.8 ) $ (64.7 ) $ (33.1 ) $ 6.2 $ (39.3 )$ (0.21 ) - 42 -
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Reconciliation of Non-GAAP Measures - Pre-tax Earnings and Diluted Net Earnings
per Share
(In millions except share
and per share data)
Earnings Provision Net Earnings Net Earnings
Before (Benefit) Attributable to Attributable to Diluted Net
Income for Income Net Noncontrolling Controlling Earnings
Taxes Taxes Earnings Interests Interests per ShareSix-Months EndedJune 30, 2020 Brokerage, as reported$ 658.6 $ 157.0 $ 501.6 $ 2.2 $ 499.4 $ 2.58 Net gains on divestitures (1.2 ) (0.2 ) (1.0 ) - (1.0 ) - Acquisition integration 13.4 3.2 10.2 - 10.2 0.05 Workforce and lease termination 21.5 5.0 16.5 - 16.5 0.09 Acquisition related adjustments 8.0 1.8 6.2 - 6.2 0.03 Brokerage, as adjusted$ 700.3 $ 166.8 $ 533.5 $ 2.2 $ 531.3 $ 2.75 Risk Management, as reported$ 38.8 $ 9.8 $ 29.0 $ - $ 29.0 $ 0.15 Workforce and lease termination 5.3 1.4 3.9 - 3.9 0.02 Acquisition related adjustments 1.2 0.3 0.9 - 0.9 - Risk Management, as adjusted$ 45.3 $ 11.5 $ 33.8 $ - $ 33.8 $ 0.17 Six-Months Ended June 30, 2019 Brokerage, as reported$ 594.7 $ 147.2 $ 447.5 $ 14.9 $ 432.6 $ 2.29 Net gains on divestitures (46.0 ) (11.5 ) (34.5 ) - (34.5 ) (0.18 ) Acquisition integration 3.8 1.0 2.8 - 2.8 0.01 Workforce and lease termination 15.8 3.9 11.9 - 11.9 0.06 Acquisition related adjustments 3.9 1.0 2.9 - 2.9 0.02 Effective income tax rate impact - (2.9 ) 2.9 - 2.9 0.02 Levelized foreign currency translation (6.2 ) (1.5 ) (4.7 ) - (4.7 ) (0.03 ) Brokerage, as adjusted$ 566.0 $ 137.2 $ 428.8 $ 14.9 $ 413.9 $ 2.19 Risk Management, as reported$ 43.0 $ 11.3 $ 31.7 $ - $ 31.7 $ 0.17 Workforce and lease termination 3.2 0.8 2.4 - 2.4 0.01 Acquisition related adjustments (0.3 ) (0.1 ) (0.2 ) - (0.2 ) - Effective income tax rate impact - (0.4 ) 0.4 - 0.4 - Levelized foreign currency translation (0.4 ) (0.1 ) (0.3 ) - (0.3 ) - Risk Management, as adjusted$ 45.5 $ 11.5 $ 34.0 $ - $ 34.0 $ 0.18 Corporate, as reported$ (210.4 ) $ (204.3 ) $ (6.1 ) $ 14.0 $ (20.1 )$ (0.11 ) Effective income tax rate impact - 2.0 (2.0 ) - (2.0 ) (0.01 ) Corporate, as adjusted$ (210.4 ) $ (202.3 ) $ (8.1 ) $ 14.0 $ (22.1 )$ (0.12 ) COVID-19 Impact In our property/casualty brokerage operations, during the second quarter 2020, our (a) new business generation remained at pre-pandemic levels, (b) retention and non-recurring business were both lower than pre-pandemic levels, (c) renewal customer exposure units (i.e., insured values, payrolls, employees, miles driven, etc.) showed some decline; however, premium rates across most geographies and lines of coverage have continued to increase, effectively mitigating the decline, and (d) net positive mid-term policy modifications were also lower. In June and thus far in July, renewal customer exposure units showed improvements compared to lows seen in April and May as our customers restarted and reopened their businesses, full policy cancellations have remained similar to pre-pandemic levels, and we continue to see property/casualty premium rates move higher overall which may partially, or fully, offset future declines in exposure units, if any. In our employee benefits brokerage operations, during the second quarter 2020, and thus far in July, we saw a decrease in new consulting and special project work and a decrease in covered lives on renewal business, but not to the same level as increases in unemployment claims. We believe the decline in covered lives could persist over the next few quarters, and deteriorate further, if the economy is slow to recover. In our risk management operations, we began seeing a meaningful decline in new claims arising during the last two weeks of March, which persisted into April. In each of May, June and July we did see an improved level of claims; however, new claims arising are - 43 - --------------------------------------------------------------------------------
still well below pre-pandemic levels. A slower recovery in the number of workers employed could cause fewer claims arising in future quarters.
Our clean energy investments saw lower electricity consumption in theU.S. due to reduced economic activity, milder temperatures and falling natural gas prices. These conditions, which began in mid-to-late March, continued throughJune 30 . Thus far in July, production has increased due to warmer weather in our operating locations; however, we expect a reduced level of production for the remainder of 2020. We activated our business continuity plan in mid-March. Over 90% of our staff is still working remotely and approximately 20% of our nearly 1,000 locations are open; but most of which are only partially open. We believe our service levels are unchanged from pre-pandemic levels. We have not had any office-wide outbreaks of COVID-19, and fewer than 100 confirmed cases amongst our 33,000 employees - all of which we believe contracted the virus outside of our office locations. Given the deterioration in economic conditions, we are actively managing costs by limiting discretionary spending such as travel, entertainment and advertising expenses, adjusting our real estate footprint, reducing capital expenditures, limiting use of outside labor and consultants, increasing utilization of our centers of excellence, and implementing a support-layer hiring and wage freeze. In addition, we have adjusted portions of our workforce where volumes have declined significantly and normal attrition is not sufficient; which, to date has impacted less than 3%, and may impact an additional 1%, in 2020, of our global workforce. The impact of these actions in the second quarter of 2020 was substantial; with estimated savings of approximately$74 million pretax compared to second quarter 2019, as adjusted for pro forma full-quarter costs related to acquisitions closed afterMarch 31, 2019 . Offsetting these savings were severance and lease termination costs of approximately$14 million pretax related to these actions. We believe savings in the third and fourth quarters compared to the same quarters in 2019, could total between$60 million and$70 million pretax per quarter after adjusting for pro forma full-quarter costs related to acquisitions. Offsetting possible future savings would be additional severance and lease termination costs, which we estimate could total approximately$5 million to$10 million pretax per quarter related to these actions. Future net savings may be lower if the economy recovers faster than our forecasts or our costs to implement changes exceed our estimates. We have not seen any meaningful decline of cash receipts from our clients to date and we have approximately$1.3 billion of available liquidity. A prolonged economic downturn may cause a deterioration of future cash collections but we believe our cost savings, reduced non-client facing capital expenditures and working capital improvements could mitigate a potential decline in our cash flows over the nearterm. For a discussion of risk and uncertainties relating to COVID19 for our business, results of operations and financial condition, see Part II, Item 1A. Risk Factors in our Quarterly Report on Form 10-Q for the three-monthsMarch 31, 2020 . Results of Operations Brokerage
The brokerage segment accounted for 76% of our revenues during the six-month
period ended
(i) Identifying, negotiating and placing all forms of insurance or reinsurance
coverage, as well as providing risk-shifting, risk-sharing and
risk-mitigation consulting services, principally related to
property/casualty, life, health, welfare and disability insurance. We also
provide these services through, or in conjunction with, other unrelated
agents and brokers, consultants and management advisors.
(ii) Acting as an agent or broker for multiple underwriting enterprises byproviding services such as sales, marketing, selecting, negotiating,
underwriting, servicing and placing insurance coverage on their behalf.
(iii) Providing consulting services related to health and welfare benefits,
voluntary benefits, executive benefits, compensation, retirement
planning, institutional investment and fiduciary, actuarial, compliance,
private insurance exchange, human resource technology, communications
and benefits administration.
(iv) Providing management and administrative services to captives, pools,
risk-retention groups, healthcare exchanges, small underwriting
enterprises, such as accounting, claims and loss processing assistance,
feasibility studies, actuarial studies, data analytics and other
administrative services.
- 44 -
-------------------------------------------------------------------------------- The primary source of revenues for our brokerage services is commissions from underwriting enterprises, based on a percentage of premiums paid by our clients, or fees received from clients based on an agreed level of service usually in lieu of commissions. Commissions are fixed at the contract effective date and generally are based on a percentage of premiums for insurance coverage or employee headcount for employer sponsored benefit plans. Commissions depend upon a large number of factors, including the type of risk being placed, the particular underwriting enterprise's demand, the expected loss experience of the particular risk of coverage, and historical benchmarks surrounding the level of effort necessary for us to place and service the insurance contract. Rather than being tied to the amount of premiums, fees are most often based on an expected level of effort to provide our services. In addition, under certain circumstances, both retail brokerage and wholesale brokerage services receive supplemental and contingent revenues. Supplemental revenue is revenue paid by an underwriting enterprise that is above the base commission paid, is determined by the underwriting enterprise and is established annually in advance of the contractual period based on historical performance criteria. Contingent revenue is revenue paid by an underwriting enterprise based on the overall profit and/or volume of the business placed with that underwriting enterprise during a particular calendar year and is determined after the contractual period.
Litigation, Regulatory and Taxation Matters
IRS andDOJ investigations - As previously disclosed, our IRC 831(b) (or "micro-captive") advisory services business has been under investigation by theIRS since 2013. Among other matters, theIRS is investigating whether we have been acting as a tax shelter promoter in connection with these operations. Additionally, theIRS has initiated audits for the 2012 tax year, and subsequent tax years, of over 100 of the micro-captive underwriting enterprises organized and/or managed by us. InMay 2020 we learned that theDepartment of Justice is conducting a criminal investigation related to IRC 831(b) micro-captive underwriting enterprises. We have been advised that we are not currently a target of the investigation. InJune 2020 our subsidiaryArtex Risk Solutions, Inc. (which we refer to as Artex) received a grand jury subpoena requesting documents relating to its micro-captive advisory business. We are in the process of responding to the subpoena. We are fully cooperating with both theIRS investigation and theDepartment of Justice investigation. We are not able to reasonably estimate the amount of any potential loss in connection with these investigations. Class action lawsuit - OnDecember 7, 2018 , a class action lawsuit was filed against us, Artex and other defendants, in theUnited States District Court for the District of Arizona . The named plaintiffs are micro-captives and their related entities and owners who had IRC Section 831(b) tax benefits disallowed by theIRS . The named plaintiffs are seeking to certify a class of all persons who were assessed back taxes, penalties or interest by theIRS as a result of their ownership of or involvement in anIRS Section 831(b) microcaptive during the time periodJanuary 1, 2005 to the present. The complaint does not specify the amount of damages sought by the named plaintiffs or the putative class. OnAugust 5, 2019 , the trial court granted the defendants' motion to compel arbitration and dismissed the class action lawsuit. Plaintiffs appealed this ruling to theUnited States Court of Appeals for the Ninth Circuit , which held an oral argument on the appeal onJuly 7, 2020 . We will continue to defend against the lawsuit vigorously. Litigation is inherently uncertain, however, and it is not possible for us to predict the ultimate outcome of this matter and the financial impact to us, nor are we able to reasonably estimate the amount of any potential loss in connection with this lawsuit. - 45 -
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Financial information relating to our brokerage segment results for the three-month and six-month periods endedJune 30, 2020 as compared to the same periods in 2019, is as follows (in millions, except per share, percentages and workforce data):
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