01—Abstract
Summary
Summary of the 10-K filed March 25, 2003. Cited figures are marked; the original filing is the authoritative source.
Arthur J.
Gallagher & Co. (AJG), the NYSE-listed insurance broker, reported 2002 total revenues of $1.101 billiona, up 19% from $923 million in 2001, and net earnings of $129.7 million, up about 4%. Diluted EPS was $1.41 versus $1.39. Growth came mainly from the Insurance Brokerage Services segment, where commissions rose 23% to $663.5 million on record new business of $145.9 million and above-average rate increases in the post-September 11 hard market.
Organic commission growth was 17%b and organic fee growth was 15%. Management expects the hard market to continue in 2003, though it notes that the pace of premium increases is leveling off. Earnings quality was weaker than the top line suggests.
Pre-tax earnings rose only 31% to $185.3 millionc, and the effective tax rate jumped to 30.0% from 11.7% as tax credits from synthetic fuel partnerships shrank. Financial Services absorbed about $29 million of investment write-downs in 2002, including $10.6 million of other-than-temporary impairments on marketable securities and $19.6 million on venture capital holdings. Gallagher also took a $3.0 million equity-method loss tied to Beacon Hill, a fund manager at its 25%-owned Asset Alliance affiliate that was hit by an SEC injunction.
Installment gains from synthetic fuel sales, which run through 2007, partly offset these charges. Management guided to a mid-30%d effective tax rate for 2003. Balance sheet and capital activity were significant.
Total assets grew to $2.46 billion and stockholders' equity rose to $528 million, driven by seven purchase acquisitions paid largely in stock and the 2002 consolidation of an airplane leasing company. Long-term debt related to limited partnerships reached $128 million, and short-term borrowings on the $150 million unsecured credit facility stood at $25 million, expiring September 2003. The company also raised its quarterly dividend 20% to $0.18 and disclosed contingent exposure through letters of credit, guarantees, and investment funding commitments totaling about $114.5 million.
02—Key points
Key Highlights
- Total revenues rose 19% to $1.101 billion, led by commissions up 23% to $663.5 million and fees up 20% to $388.9 million.
- Organic growth was strong, at 17% for commissions and 15% for fees, driven by $145.9 million of record new business in 2002.
- Net earnings grew about 4% to $129.7 million, and diluted EPS rose to $1.41 from $1.39. The effective tax rate increased to 30.0% from 11.7% as synthetic fuel tax credits declined.
- Financial Services recorded roughly $29 million of investment write-downs and impairments in 2002, including $10.6 million on marketable securities and $19.6 million on venture capital holdings, along with a $3.0 million equity loss tied to Beacon Hill.
- Acquisitions were a major driver of growth: ten firms were acquired in 2002, and seven purchase acquisitions were completed with stock valued at about $50.8 million. Further 2003 deals, including Benefits Planning & Insurance Agency, were disclosed.
- The quarterly dividend was raised 20% to $0.18 per share, and the company repurchased only 478,000 shares in 2002 versus 3.4 million in 2001.
- Management expects the hard insurance market to continue in 2003, but notes that premium rate increases are beginning to level off, and it expects the 2003 effective tax rate to be in the mid-30% range.
03—Questions
Frequently Asked Questions
Why did net earnings grow only about 4% when revenues rose 19%?
Several factors absorbed much of the revenue gain. Other operating expenses rose 17% due to hard-market business insurance and shared commissions, and salaries and employee benefits rose 20% with headcount growth of 9%. The effective tax rate also increased to 30.0% from 11.7% because fewer synthetic fuel tax credits were generated. Investment write-downs of roughly $29 million further reduced 2002 results.
How much of the growth came from acquisitions versus organic expansion?
Organic growth was 17% for commissions and 15% for fees, which is most of the increase. Commissions from purchase acquisitions completed in 2002 and 2001 totaled only $29.5 million, and fees from those acquisitions totaled $15.4 million. Acquisitions contributed meaningfully but were not the primary driver.
Is the hard insurance market expected to continue, and how does that affect AJG?
Management believes the hard market will continue through 2003, supporting commission revenue because commissions track premium levels. It also noted that the pace of premium increases is leveling off and that some insurers are trying to cut commission rates. Management acknowledged that the longevity of the hard market is difficult to predict.
What are the main risks in Gallagher's investment portfolio?
The portfolio includes tax-advantaged partnerships, venture capital holdings, a 25% stake in Asset Alliance Corporation, and an investment in Allied World Assurance. Management says it has limited exposure beyond carrying value, funding commitments, and letters of credit, but total commitments of about $114.5 million are disclosed. The company also noted a $3.0 million equity loss from Beacon Hill, and a lawsuit related to its synthetic fuel investments could have a material adverse effect if decided against the company.
Does the company have liquidity concerns?
Management said it has sufficient capital to meet cash needs. Operating cash flow was $149.7 million in 2002. Gallagher had $70.7 million of available borrowing capacity at year-end. Its $150 million credit facility expires in September 2003, and it was in compliance with covenants. Short-term borrowings were $25 million.
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