SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to section 13 or 15 (d) of the Securities
Exchange Act of 1934 for the quarterly period ended September 30, 2001 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 1-9761
ARTHUR J. GALLAGHER & CO.
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(Exact name of registrant as specified in its charter)
DELAWARE 36-2151613
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Two Pierce Place, Itasca, Illinois 60143-3141
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(Address of principal executive offices) (Zip code)
(630) 773-3800
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(Registrant's telephone number, including area code)
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(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 [_]
The number of outstanding shares of the registrant's Common Stock, $1.00 par
value, as of September 30, 2001 was 84,700,220.
ARTHUR J. GALLAGHER & CO.
INDEX
Page No.
Part I. Financial Information:
Item 1. Financial Statements (Unaudited):
Consolidated Statements of Earnings for the three-month and
nine-month periods ended September 30, 2001 and 2000.............. 3
Consolidated Balance Sheets at September 30, 2001 and
December 31, 2000................................................. 4
Consolidated Statements of Cash Flows for the nine-month
periods ended September 30, 2001 and 2000......................... 5
Notes to Consolidated Financial Statements....................... 6-11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 12-18
Part II. Other Information:
Item 6. Exhibits and Reports on Form 8-K................................... 19
Signatures................................................................. 20
- 2 -
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
Three-month period ended Nine-month period ended
September 30, September 30,
2001 2000 2001 2000
--------- --------- --------- ---------
(in thousands, except per share data)
Operating Results
Revenues:
Commissions $ 136,180 $ 120,985 $ 380,504 $ 340,486
Fees 84,422 73,533 238,413 202,548
Investment income and other:
Investment income 4,330 8,283 17,470 20,081
Income from equity investments,
partnerships and joint ventures 6,907 5,686 14,639 9,973
Other income 1,458 632 5,061 1,355
--------- --------- --------- ---------
Total investment income and other 12,695 14,601 37,170 31,409
--------- --------- --------- ---------
Total revenues 233,297 209,119 656,087 574,443
Expenses:
Salaries and employee benefits 114,843 103,145 336,180 297,765
Other operating expenses 68,176 60,332 196,072 174,681
Partnership investment expenses 8,259 - 18,971 -
--------- --------- --------- ---------
Total expenses 191,278 163,477 551,223 472,446
--------- --------- --------- ---------
Earnings before income taxes 42,019 45,642 104,864 101,997
Provision for income taxes 116 13,579 12,681 33,660
--------- --------- --------- ---------
Net earnings $ 41,903 $ 32,063 $ 92,183 $ 68,337
========= ========= ========= =========
Net earnings per common share $ .49 $ .38 $ 1.09 $ .82
Net earnings per common and
common equivalent share
.47 .36 1.03 .77
Dividends declared per common share
.130 .115 .390 .345
See notes to consolidated financial statements.
-3-
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
September 30, December 31,
2001 2000
------------- ------------
(in thousands)
ASSETS
Current assets:
Cash and cash equivalents $ 124,238 $ 141,831
Restricted cash 189,916 158,646
Premiums and fees receivable 402,756 436,542
Investment strategies - trading 48,712 51,897
Other 83,580 56,447
------------ -----------
Total current assets 849,202 845,363
Marketable securities - available for sale 18,493 23,306
Deferred income taxes 48,925 47,824
Other noncurrent assets 180,406 160,360
Fixed assets 139,694 126,933
Accumulated depreciation and amortization (93,677) (84,387)
------------ -----------
Net fixed assets 46,017 42,546
Intangible assets - net 22,867 16,089
------------ -----------
$ 1,165,910 $ 1,135,488
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Premiums payable to insurance companies $ 618,185 $ 604,979
Accrued salaries and bonuses 32,946 38,650
Accounts payable and other accrued liabilities 106,675 109,214
Unearned fees 18,074 19,014
Income taxes payable 474 9,867
Other 19,444 5,197
------------ -----------
Total current liabilities 795,798 786,921
Other noncurrent liabilities 26,948 19,667
Stockholders' equity:
Common stock - issued and outstanding 84,700 shares in
2001 and 84,540 shares in 2000 84,700 84,540
Capital in excess of par value 2,973 21,762
Retained earnings 261,920 225,096
Unearned deferred compensation (3,625) -
Accumulated other comprehensive earnings (loss) (2,804) (2,498)
------------ -----------
Total stockholders' equity 343,164 328,900
------------ -----------
$ 1,165,910 $ 1,135,488
============ ===========
See notes to consolidated financial statements.
- 4 -
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Nine-month period ended September 30,
2001 2000
-------------------------------------
(in thousands)
Cash flows from operating activities:
Net earnings $ 92,183 $ 68,337
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Net gain on investments and other (2,940) (6,998)
Gain on sales of operations (2,375) -
Depreciation and amortization 13,977 13,183
Increase in restricted cash (31,270) (23,063)
Decrease in premiums receivable 38,229 48,881
Increase in premiums payable 13,206 16,723
Decrease in trading investments - net 4,524 5,986
(Increase) decrease in other current assets 27,634) 730
Decrease in accrued salaries and bonuses (5,329) (6,080)
Decrease in accounts payable and other accrued liabilities (10,055) (7,960)
Decrease in income taxes payable (9,393) (9,035)
Tax benefit from issuance of common stock 18,560 11,099
Net change in deferred income taxes (583) (96)
Other 1,286 (3,200)
--------- ---------
Net cash provided by operating activities 92,386 108,507
--------- ---------
Cash flows from investing activities:
Purchases of marketable securities (10,286) (23,551)
Proceeds from sales of marketable securities 19,470 21,272
Proceeds from maturities of marketable securities 271 655
Net additions to fixed assets (15,557) (12,291)
Proceeds from sales of operations 2,700 -
Other (22,455) (21,715)
--------- ---------
Net cash used by investing activities (25,857) (35,630)
--------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 22,102 19,869
Repurchases of common stock (67,147) (13,200)
Dividends paid (30,580) (24,708)
Borrowings on line of credit facilities 95,700 45,000
Repayments on line of credit facilities (90,700) (60,000)
Equity transactions of pooled companies prior to dates of acquisition (13,497) 837
--------- ---------
Net cash used by financing activities (84,122) (32,202)
--------- ---------
Net (decrease) increase in cash and cash equivalents (17,593) 40,675
Cash and cash equivalents at beginning of period 141,831 97,531
--------- ---------
Cash and cash equivalents at end of period $ 124,238 $ 38,206
========= =========
Supplemental disclosures of cash flow information:
Interest paid $ 955 $ 696
Income taxes paid 12,627 17,539
See notes to consolidated financial statements.
- 5 -
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Nature of Operations and Basis of Presentation
Arthur J. Gallagher & Co. (Gallagher) provides insurance brokerage and risk
management services to a wide variety of commercial, industrial,
institutional and governmental organizations. Commission revenue is
principally generated through the negotiation and placement of insurance
for its clients. Fee revenue is primarily generated by providing other risk
management services including claims management, information management,
risk control services and appraisals in either the property/casualty market
or human resource/employee benefit market. Investment income and other is
generated from Gallagher's investment portfolio, which includes fiduciary
funds, equity securities, and tax advantaged and other strategic
investments. Gallagher is headquartered in Itasca, Illinois, has more than
200 offices in nine countries and does business in more than 100 countries
around the world through a network of correspondent brokers and
consultants.
The accompanying unaudited consolidated financial statements have been
prepared by Gallagher 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. Gallagher believes 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 the audited
consolidated financial statements for the year ended December 31, 2000 and
include all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the information set forth. The
quarterly results of operations are not necessarily indicative of results
of operations 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
Gallagher's 2000 Annual Report on Form 10-K.
2. Effect of New Pronouncements
In 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for
Derivative Instruments and Hedging Activities," as amended, which was
effective for fiscal years beginning after June 15, 2000. Because of
Gallagher's minimal use of derivatives, the effect of the adoption of SFAS
133 in the first quarter of 2001 was not material to Gallagher's
consolidated operating results or financial position.
In June 2001, the FASB issued Statements of Financial Accounting Standards
No. 141 (SFAS 141), "Business Combinations," and No. 142 (SFAS 142),
"Goodwill and Other Intangible Assets."
SFAS 141 eliminates the pooling of interests method of accounting for
business combinations except for qualifying business combinations that were
initiated prior to July 1, 2001. In addition, SFAS 141 further clarifies
the criteria to recognize intangible assets separately from goodwill. The
requirements of SFAS 141 are effective for any business combination
accounted for by the purchase method that is completed after June 30, 2001
(i.e., the acquisition date is July 1, 2001 or after). Gallagher initiated
several business combinations prior to July 1, 2001 that were completed in
the third quarter of 2001 and were accounted for as poolings of interests
because they met the qualifying criteria of SFAS 141.
Under SFAS 142, goodwill and indefinite lived intangible assets will no
longer be amortized, but will be subject to periodic review for impairment
(at least annually or more frequently if impairment indicators arise).
Separable intangible assets that are not deemed to have an indefinite life
will continue to be amortized over their useful lives. The amortization
provisions of SFAS 142 will apply to goodwill and intangible assets
acquired after June 30, 2001. With respect to goodwill and intangible
assets acquired prior to July 1, 2001, companies will be required to adopt
SFAS 142 in their fiscal year beginning after
- 6 -
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
2. Effect of New Pronouncements (Continued)
December 15, 2001 (i.e., January 1, 2002 for calendar year companies).
Because of the different transition dates for goodwill and intangible
assets acquired on or before June 30, 2001 and those acquired after that
date, pre-existing goodwill and intangibles will be amortized during this
transition period (June 30, to December 31, 2001) until adoption whereas
new goodwill and indefinite lived intangible assets acquired after June 30,
2001 will not be amortized.
Gallagher will apply the new rules on accounting for pre-existing goodwill
and other intangible assets beginning in the first quarter of 2002.
Management has not yet determined the effect on net earnings of the
application of the nonamortization provisions of SFAS 142. During 2002,
Gallagher will perform the first of the required impairment tests of
goodwill and indefinite lived intangible assets as of January 1, 2002 and
has not yet determined what the effect of these tests will be on
Gallagher's operating results or financial position.
3. Business Combinations
During the nine-month period ended September 30, 2001, Gallagher acquired
substantially all of the net assets of the following insurance brokerage
firms in exchange for shares of its common stock: The Galtney Group, Inc.
dba Healthcare Insurance Services, 3,330,000 shares; MDM Insurance
Associates, Inc., 752,000 shares; The InWest Group, Inc., 407,000 shares;
SKANCO International, Ltd., 263,000 shares; Nelson/Monarch Insurance
Services, Ltd., 109,000 shares; E.S. Susanin, Inc., 109,000 shares; Burgess
& Associates, Inc., 73,000 shares; Madison Scott & Associates, Inc., 34,000
shares; Midwest Surety Services, Inc., 32,000 shares; and Central Surety
Agency, Inc., 26,000 shares. These acquisitions were accounted for as
poolings of interests and, except for three of these acquisitions whose
results were not significant, the consolidated financial statements for all
periods prior to the acquisition dates have been restated to include the
operations of these companies. The following summarizes the restatement of
the 2000 consolidated financial statements to reflect the operations of the
2001 acquisitions (in thousands, except per share data):
Attributable
Three-month period ended As Previously to Pooled
September 30, 2000 Reported Companies As Restated
----------------------------- ------------- ------------ -----------
Total revenues $ 197,078 $ 12,041 $ 209,119
Net earnings 31,341 722 32,063
Net earnings per common share .40 (.02) .38
Net earnings per common and
common equivalent share .37 (.01) .36
Nine-month period ended
September 30, 2000
-----------------------------
Total revenues $ 532,137 $ 42,306 $ 574,443
Net earnings 63,824 4,513 68,337
Net earnings per common share .82 - .82
Net earnings per common and
common equivalent share .77 - .77
- 7 -
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
3. Business Combinations (Continued)
Effective May 1, 2001, Gallagher acquired substantially all of the net
assets of Texas Insurance Agency, Inc.-Houston, an insurance brokerage
firm, in exchange for an initial cash payment of $4.6 million and a
contingent obligation of $1.5 million. This acquisition was accounted for
as a purchase and was not material to the consolidated financial
statements.
4. Insurance Company Receivables and Payables
A reinsurance intermediary subsidiary of Gallagher includes only amounts
relating to brokerage commission revenue in premiums and fees receivable in
the accompanying consolidated balance sheets. The premiums and claims
receivable and payable, as well as the related excise taxes payable,
associated with the reinsurance brokerage commission revenue, are not
included in the accompanying consolidated balance sheets because they are
not assets and liabilities of Gallagher. The excluded amounts are as
follows (in thousands):
September 30, December 31,
2001 2000
------------- ------------
Premiums and claims:
Receivable $ 446,832 $ 373,764
Payable 452,887 378,166
The differences between the receivable and payable balances represent fiduciary
funds received by the reinsurance intermediary subsidiary, which are included in
restricted cash and premiums payable to insurance companies in the accompanying
consolidated balance sheets.
- 8 -
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
5. Earnings Per Share
The following table sets forth the computation of net earnings per common
share and net earnings per common and common equivalent share (in
thousands, except per share data):
Three-month period ended Nine-month period ended
September 30, September 30,
2001 2000 2001 2000
--------- --------- --------- ---------
Net earnings $ 41,903 $ 32,063 $ 92,183 $ 68,337
========= ========= ========= =========
Weighted average number of common shares
outstanding 84,785 84,001 84,705 83,287
Dilutive effect of stock options using the
treasury stock method 5,289 5,662 5,218 4,995
--------- --------- --------- ---------
Weighted average number of common and common equivalent
shares outstanding 90,074 89,663 89,923 88,282
========= ========= ========= =========
Net earnings per common share $ .49 $ .38 $ 1.09 $ .82
Net earnings per common and common equivalent share .47 .36 1.03 .77
Options to purchase 141,000 shares of common stock were outstanding at September
30, 2001, but were not included in the computation of the dilutive effect of
stock options for the three-month period then ended. Options to purchase 345,000
and 134,000 shares of common stock were outstanding at September 30, 2001 and
2000, respectively, but were not included in the computation of the dilutive
effect of stock options for the nine-month period then ended. These options were
excluded from the computations because the options' exercise prices were greater
than the average market price of the common shares during the respective periods
and, therefore, would be antidilutive to earnings per share under the treasury
stock method.
- 9 -
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
6. Comprehensive Earnings
The components of comprehensive earnings and accumulated other
comprehensive earnings (loss) are as follows (in thousands):
Three-month period ended Nine-month period ended
September 30, September 30,
2001 2000 2001 2000
-------- -------- -------- ---------
Net earnings $ 41,903 $ 32,063 $ 92,183 $ 68,337
Net change in unrealized gain (loss)
on available for sale securities, net
of income taxes of ($630), $362,
($204) and $470, respectively (945) 543 (306) 705
-------- -------- -------- ---------
Comprehensive earnings $ 40,958 $ 32,606 $ 91,877 $ 69,042
======== ======== ======== =========
Accumulated other comprehensive
earnings (loss) at beginning of
period $ (1,859) $ (2,507) $ (2,498) $ (2,669)
Net change in unrealized gain (loss)
on available for sale securities, net
of income taxes (945) 543 (306) 705
-------- -------- -------- ---------
Accumulated other comprehensive
earnings (loss) at end of period $ (2,804) $ (1,964) $ (2,804) $ (1,964)
======== ======== ======== =========
7. Deferred Compensation
In 2001, Gallagher adopted the Deferred Equity Participation Plan, which is
a non-qualified plan that provides for distributions to certain key
executives of Gallagher upon their normal retirement. Under the provisions
of the plan, Gallagher contributes shares of its common stock, in an amount
approved by Gallagher's Board of Directors, to a rabbi trust on behalf of
the executives participating in the plan. Distributions under the plan
normally may not be made until the participant retires after reaching age
62 and are subject to forfeiture in the event of voluntary termination of
employment prior to age 62. All distributions from the plan are made in the
form of Gallagher's common stock.
In June 2001, Gallagher contributed $4.0 million to the plan through the
issuance of 152,000 shares of Gallagher common stock. Gallagher accounts
for the common stock issued to the plan in accordance with the provisions
of Emerging Issues Task Force (EITF) Issue No. 97-14, "Accounting for
Deferred Compensation Arrangements Where Amounts Earned are Held in a Rabbi
Trust and Invested." EITF 97-14 requires that the Gallagher common stock
issued to the trust be valued at historical cost (fair market value at the
date of grant) and the unearned deferred compensation obligation be
classified as an equity instrument, with no recognition of changes in the
fair value of the amount owed to the participants. The unearned deferred
compensation balance is shown as a reduction of stockholders' equity in the
accompanying 2001 consolidated balance sheet and is being amortized ratably
over the vesting period of the participants. During the nine-month period
ended September 30, 2001, $375,000 was charged to expense related to this
plan.
- 10 -
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
8. Quarterly Operating Results
Quarterly operating results for 2000, as restated for the 2001 acquisitions
accounted for as poolings of interests, were as follows (in thousands,
except per share data):
1st 2nd 3rd 4th
-------- -------- -------- --------
Revenues:
Commissions $110,268 $109,233 $120,985 $129,758
Fees 64,428 64,587 73,533 78,687
Investment income and other:
Investment income 5,786 6,012 8,283 5,871
Income from equity
investments, partnerships
and joint ventures 1,380 2,907 5,686 4,212
Other income 618 105 632 2,302
-------- -------- -------- --------
Total investment income
and other 7,784 9,024 14,601 12,385
-------- -------- -------- --------
Total revenues 182,480 182,844 209,119 220,830
Expenses:
Salaries and employee
benefits 96,545 98,075 103,145 116,607
Other operating expenses 55,801 58,548 60,332 72,481
Partnership investment
expenses - - - -
-------- -------- -------- --------
Total expenses 152,346 156,623 163,477 189,088
-------- -------- -------- --------
Earnings before income
taxes 30,134 26,221 45,642 31,742
Provision for income
taxes 11,019 9,062 13,579 7,124
-------- -------- -------- --------
Net earnings $ 19,115 $ 17,159 $ 32,063 $ 24,618
======== ======== ======== ========
Net earnings per common share $ .23 $ .21 $ .38 $ .29
Net earnings per common and
common equivalent share .22 .19 .36 .27
- 11 -
Item 2.
ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS - CONSOLIDATED
Fluctuations in premiums charged by insurance companies have a direct and
potentially material effect on the insurance brokerage industry. Commission
revenues are generally based on a percentage of the premiums paid by insureds
and therefore, normally follow premium levels. The tragic events in the United
States on September 11, 2001 have reshaped the insurance marketplace much faster
than expected. Larger than anticipated loss experience, stock market declines,
lower interest rates and diminished risk capacity have led to unprecedented
short term premium rate increases across all lines. Higher premium rates are
referred to as a "hardening of the market" and generally result in increased
commission revenues. Since the beginning of the year, Gallagher has seen a trend
toward higher premium rates which has contributed to its overall revenue growth
in the third quarter and year-to-date 2001. Management believes a hard market
will continue for the foreseeable future. Although a hardening of the market
overall contributes positively to Gallagher's results, its future effect on
Gallagher's business is difficult to predict.
In a period of rising insurance costs, certain "risk" buyers will move toward
the alternative insurance market, which would tend to have a favorable effect on
Gallagher's Risk Management Services segment. Gallagher anticipates that new
sales and renewal increases in areas of risk management, claims management,
insurance captives and self-insurance will continue to be a major factor in
Gallagher's fee revenue growth during 2001, which could adversely impact the
growth in commission revenues.
During the nine-month period ended September 30, 2001, Gallagher acquired
substantially all of the net assets of eleven insurance brokerage firms, ten of
which were accounted for as poolings of interests. For seven of the acquisitions
that were accounted for as poolings of interests, Gallagher's results of
operations for all periods presented have been restated as if they had operated
as part of Gallagher prior to their acquisition dates. Gallagher continues to
search for merger partners which complement existing operations, provide entry
into new markets, add new products and enhance local sales and service
capabilities. For the effect of these restatements, in the aggregate, on period
to period comparisons, see Note 3 to the Consolidated Financial Statements. In
June 2001, the FASB issued SFAS 141 which eliminates the pooling-of-interests
method of accounting for business combinations except for qualifying business
combinations that were initiated prior to July 1, 2001. Gallagher initiated
several business combinations prior to July 1, 2001 that were completed in the
third quarter of 2001 and were accounted for as poolings of interests because
they met the qualifying criteria of SFAS 141. See Note 2 to the Consolidated
Financial Statements.
Commission revenues increased by 13% to $136.2 million in the third quarter of
2001 and by 12% to $380.5 million in the first nine months of 2001 over the
respective periods in 2000. These increases are due principally to new business
production of $28.4 million in the third quarter of 2001 and $69.2 million in
the first nine months of 2001, and to renewal increases from increased premiums
partially offset by lost business and a reduction in revenue from national
insurance revenue-sharing programs.
Fee revenues increased by 15% or $10.9 million to $84.4 million in the third
quarter of 2001 and by 18% or $35.9 million to $238.4 million in the first nine
months of 2001 over the respective periods in 2000. These increases, generated
primarily by the Risk Management Services segment, reflect new business
production of approximately $11.0 million in the third quarter of 2001 and $38.2
million in the first nine months of 2001, and renewal rate increases partially
offset by lost business.
Investment income and other in the third quarter of 2001 decreased $1.9 million
or 13% to $12.7 million from the same period in 2000. This decrease is due
primarily to a $5.4 million net gain on the installment sale of a synthetic fuel
facility recognized in the third quarter of 2000, which was partially offset by
a $4.0 million dollar installment gain recognized on the sale of a synthetic
fuel facility in the third quarter of 2001.
- 12 -
ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS - CONSOLIDATED (Continued)
During the third quarter of 2001, Gallagher entered into a transaction for the
sale of a 95% interest in one of its synthetic fuel facilities located in South
Carolina. Under the sale agreement, Gallagher received an initial nonrefundable
down payment of $6.7 million and will receive further installment payments over
time through 2007 based on qualified fuel production generated by the facility.
The buyer has the option to put the purchased interest back to Gallagher if
favorable tax rulings are not received by March 1, 2003. In such case, Gallagher
would retain the down payment and installment payments made through the put
date. The aggregate pretax gain on the transaction is expected to range from
$36.0 million to $106.0 million and will be recognized on an installment basis
through December 31, 2007.
In October 2001, Gallagher completed the sale of a two-thirds interest in a
partnership that owns a 59.9% interest in a synthetic fuel facility located in
South Carolina. The sale agreement provides for an initial down payment of $3.2
million with further installment payments over time through 2007 based on
qualified fuel production generated by the facility. The buyer has the option to
put the purchased interest back to Gallagher if favorable tax rulings are not
received by March 30, 2002 or if certain adverse tax consequences occur through
December 31, 2007. In such case, Gallagher would retain all installment payments
made through the put date and a pro-rated portion of the initial down payment.
The aggregate pretax gain on the transaction is expected to range from $48.0
million to $70.0 million and will be recognized on an installment basis through
December 31, 2007. The buyer also has the option, through March 31, 2002, to
acquire from Gallagher another one-sixth interest in the partnership at
proportionally equivalent terms. This sale transaction had no impact on
Gallagher's third quarter results.
The United States Treasury Department is continuing its review of the Internal
Revenue Code Section that governs qualified synthetic production, and no
assurance can be given that such review will not result in changes that could
adversely affect the two installment sale transactions discussed above.
In the first nine months of 2001, investment income and other increased 18% or
$5.8 million to $37.2 million over the respective period in 2000. This increase
is due primarily to the results generated by Gallagher's unconsolidated equity
investment portfolio, realized gains generated from Gallagher's marketable
securities portfolio and the sale transactions discussed below. In 2001,
Gallagher recorded $3.0 million of income related to its proportionate share of
income from an equity investment in a real estate partnership that is currently
developing land in Florida. Gallagher also recognized gains in 2001 of $800,000
on the sale of an interest in a limited partnership that operates qualified
affordable housing projects and $2.4 million on the sale of a benefit
administration book of business. These increases were partially offset by the
$1.4 million net difference in gains on the installment sales of the synthetic
fuel facilities discussed above.
Salaries and employee benefits increased by 11% or $11.7 million to $114.8
million in the third quarter of 2001 and increased by 13% or $38.4 million to
$336.2 million in the first nine months of 2001 over the respective periods in
2000. These increases are higher than usual and reflect salary increases and
associated employee benefit costs, increases in incentive compensation linked to
Gallagher's overall operating results and the performance of Gallagher's
investment portfolio, and a 9% increase in employee headcount in the period from
September 30, 2000 to September 30, 2001. The increase in employee headcount
relates to the hiring of additional staff to support the new business growth
previously discussed and to an ongoing initiative to hire additional production
personnel to generate future revenue growth.
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ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS - CONSOLIDATED (Continued)
Other operating expenses increased by 27% or $16.1 million to $76.4 million in
the third quarter of 2001 and by 23% or $40.4 million to $215.0 million in the
first nine months of 2001 over the respective periods in 2000. These increases
are due primarily to start up costs, fees for professional services, business
insurance and ongoing expenses related to the operations of synthetic fuel
facilities (partnership investment expenses) and to performance-related
investment fees. In addition, Gallagher experienced increases in expenses in
2001 related to increased leased space, temporary help needed to service new
risk management and claims business and commissions paid to sub-brokers.
The effective income tax rate was essentially 0% for the third quarter and 12%
for the first nine months of 2001 and 30% for the third quarter and 33% for the
first nine months of 2000. These rates are net of the effect of tax credits
generated by investments in alternative energy related partnerships that operate
synthetic fuel facilities and limited partnerships that operate qualified
affordable housing, which are partially offset by state and foreign taxes. The
reductions in the effective income tax rates in 2001 from the prior year reflect
an increase in tax credits earned in 2001 from the alternative energy projects.
Net earnings per common and common equivalent share increased by 31% or $.11 to
$.47 in the third quarter of 2001 and by 34% or $.26 to $1.03 in the first nine
months of 2001 over the respective periods in 2000. These increases are
primarily due to the decrease in the effective income tax rate in 2001 from the
same period in 2000 and also reflect the previously discussed, revenue increases
and investment gains.
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ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS - SEGMENT INFORMATION
Financial information relating to Gallagher's operating segments is as follows
(in thousands):
Insurance
Brokerage Risk Management Financial
Services Services Services Corporate Total
--------- --------------- --------- --------- ---------
Three-month period ended
------------------------
September 30, 2001
------------------
Total revenues $ 155,407 $ 67,812 $10,078 $ - $ 233,297
Earnings (loss) before
income taxes 35,878 10,079 (2,052) (1,886) 42,019
September 30, 2000
------------------
Total revenues 138,591 60,682 9,846 - 209,119
Earnings (loss) before
income taxes 30,759 9,939 5,367 (423) 45,642
Nine-month period ended
-----------------------
September 30, 2001
------------------
Total revenues 431,080 198,900 26,258 (151) 656,087
Earnings (loss) before
income taxes 84,916 28,003 (1,788) (6,267) 104,864
September 30, 2000
------------------
Total revenues 386,280 171,528 16,635 - 574,443
Earnings (loss) before
income taxes 68,010 27,310 8,756 (2,079) 101,997
Total Identifiable Assets at
----------------------------
September 30, 2001 733,877 72,901 245,574 113,558 1,165,910
September 30, 2000 669,848 58,991 245,111 63,788 1,037,738
Insurance Brokerage Services
The Insurance Brokerage Services segment encompasses operations that, for
commission or fee compensation, place or arrange to place insurance directly
related to the clients' managing of risk. This segment also provides consulting,
for fee compensation related to the clients' risk financing programs and
includes Gallagher's retail, reinsurance and wholesale insurance brokerage
operations.
Total revenues for this segment in the three and nine-month periods ended
September 30, 2001 increased 12% to $155.4 million and 12% to $431.1 million,
respectively, over the same periods in 2000. These increases are due principally
to new business of approximately $28.4 million and $69.2 million, respectively,
and renewal rate increases partially offset by lost business and a reduction in
revenue from national insurance revenue-sharing programs. Earnings before income
taxes for this segment in the three and nine-month periods ended
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ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS - SEGMENT INFORMATION (Continued)
Insurance Brokerage Services (Continued)
September 30, 2001 increased 17% to $35.9 million and 25% to $84.9 million,
respectively, over the same periods in 2000. These increases are due primarily
to the new business production and rate increases mentioned above.
Risk Management Services
The Risk Management Services segment includes Gallagher's third party
administration, loss control and risk management consulting, workers'
compensation investigations and insurance property appraisal operations. Third
party administration is principally claims management programs for Gallagher's
clients or clients of other brokers.
Total revenues for this segment in the three and nine-month periods ended
September 30, 2001 increased 12% to $67.8 million and 16% to $198.9 million over
the respective periods in 2000 due primarily to new business production of
approximately $11.0 million and $38.2 million, respectively, and renewal rate
increases partially offset by lost business. Earnings before income taxes for
this segment in the three and nine-month periods ended September 30, 2001
increased 1% to $10.1 million and 3% to $28.0 million, respectively, over the
same periods in 2000. These increases are due primarily to the earnings leverage
created by the increased revenues discussed above significantly offset by
increased costs for personnel and systems conversions.
Financial Services
The Financial Services segment is responsible for the management of Gallagher's
diversified investment portfolio, which includes fiduciary funds, marketable and
other equity securities, and tax advantaged and other strategic investments. The
non-fiduciary invested assets of Gallagher are combined in this segment in order
to maximize the return to the company.
Total revenues for this segment in the three-month period ended September 30,
2001 were essentially flat compared to the prior year due primarily to the $1.4
million net difference in gains on the installment sales of the synthetic fuel
facilities mentioned above. Total revenues for this segment in the nine-month
period ended September 30, 2001 increased 58% to $26.3 million over the
respective period in 2000. This increase is due primarily to the results
generated by Gallagher's unconsolidated equity investment portfolio, realized
gains generated from Gallagher's marketable securities portfolio and sale
transactions discussed below. In 2001, Gallagher recorded $3.0 million of income
related to its proportionate share of income from an equity investment in a real
estate partnership that is currently developing land in Florida. Gallagher also
recognized gains in 2001 of $800,000 on the sale of an interest in a limited
partnership that operates qualified affordable housing projects and $2.4 million
on the sale of a benefit administration book of business. Earnings (loss) before
taxes for this segment in the three and nine-month periods ended September 30,
2001 decreased $7.4 million to a loss of $2.1 million and $10.5 million to a
loss of $1.8 million, respectively. These decreases are due primarily to
increases in start up costs, fees for professional services, business insurance
and ongoing expenses related to the operations of synthetic fuel facilities
(partnership investment expenses); incentive compensation linked to the
performance of Gallagher's investment portfolio; and performance-related
investment fees. The tax credits earned by Gallagher from these facilities have
increased significantly in 2001, which resulted in a reduction of Gallagher's
effective income tax rates in 2001 from the prior year.
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ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS - SEGMENT INFORMATION (Continued)
Corporate
The Corporate segment consists of unallocated administrative costs and the
provision for income taxes which is not allocated to Gallagher's operating
entities. Only revenues not attributable to one of the three operating segments
are recorded in the Corporate segment. All costs are generated in the United
States.
FINANCIAL CONDITION AND LIQUIDITY
The insurance brokerage industry is not capital intensive. Gallagher has
historically been profitable and cash flows from operations and short-term
borrowings under various credit agreements have been sufficient to fund
Gallagher's operating, investment and capital expenditure needs. Cash generated
from operating activities was $92.4 million and $108.5 million for the nine
months ended September 30, 2001 and 2000, respectively. Because of the
variability related to the timing of premiums and fees receivable and premiums
payable, net cash flows from operations vary substantially from quarter to
quarter. Funds restricted as to Gallagher's use, primarily premiums held as
fiduciary funds, have not been included in determining Gallagher's overall
liquidity.
In 2000, Gallagher and one of its significant subsidiaries entered into an
unsecured revolving credit agreement (the Revolving Credit Agreement), which
expires on September 10, 2003, with a group of five financial institutions. The
Revolving Credit Agreement provides for short-term and long-term revolving
credit commitments of $100.0 million and $50.0 million, respectively. The
facility provides for loans and letters of credit. Letters of credit are limited
to $75.0 million of which up to $50.0 million may be issued under the long-term
facility and up to $25.0 million may be issued under the short-term credit
facility in the determination of net funds available for future borrowing. As of
September 30, 2001, under the long-term credit facility, Gallagher has
contingently committed to funding $52.3 million through letter of credit
arrangements related to its corporate insurance programs and several of its
equity and other strategic investments. During the nine-month period ended
September 30, 2001, Gallagher borrowed $95.7 million and repaid $90.7 million of
short-term borrowings under this facility. These borrowings were used on a
short-term basis to finance a portion of Gallagher's operating and investment
activity. As of September 30, 2001, $5.0 million was outstanding under the
short-term credit facility. The Revolving Credit Agreement requires the
maintenance of certain financial covenants and Gallagher was in compliance with
these covenants as of September 30, 2001.
Through the first nine months of 2001, Gallagher paid $30.6 million in cash
dividends on its common stock. Gallagher's dividend policy is determined by the
Board of Directors. Quarterly dividends are declared after considering
Gallagher's available cash from earnings and its anticipated cash needs. On
October 15, 2001, Gallagher paid a third quarter dividend of $.13 per share to
shareholders of record as of September 28, 2001, a 13% increase over the third
quarter dividend per share in 2000.
Net capital expenditures were $15.6 million and $12.3 million for each of the
nine-month periods ended September 30, 2001 and 2000, respectively. Gallagher
expects to make total capital expenditures of approximately $17.0 million in
2001. Capital expenditures by Gallagher are related primarily to office moves
and expansions and updating computer systems and equipment.
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ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
FINANCIAL CONDITION AND LIQUIDITY (Continued)
In 1988, Gallagher adopted a common stock repurchase plan that has been extended
through June 30, 2002. Under the plan, Gallagher has repurchased 2.5 million
shares at a cost of $72.8 million in the first nine months of 2001. The
repurchased shares are held for reissuance in connection with exercises of
options under its stock option plans. Under the provisions of the repurchase
plan, Gallagher is authorized to repurchase approximately 3.2 million additional
shares through June 30, 2002. Gallagher is under no commitment or obligation to
repurchase any particular amount of common stock and at its discretion may
suspend the repurchase plan at any time.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995
This report contains forward-looking statements. Forward-looking statements made
by or on behalf of Gallagher are subject to risks and uncertainties, including
but not limited to the following: Gallagher's commission revenues are highly
dependent on premiums charged by insurers, which are subject to fluctuation;
lower interest rates reduce Gallagher's income earned on invested funds; the
alternative insurance market continues to grow which could unfavorably impact
commission and favorably impact fee revenue; Gallagher's revenues vary
significantly from period to period as a result of the timing of policy
inception dates and the net effect of new and lost business production; the
general level of economic activity can have a substantial impact on Gallagher's
renewal business; Gallagher's operating results, return on investment and
financial position may be adversely impacted by exposure to various market risks
such as interest rate, equity pricing, foreign exchange rates and the
competitive environment, and changes in income tax laws. Gallagher's ability to
grow has been enhanced through acquisitions, which may or may not be available
on acceptable terms in the future and which, if consummated, may or may not be
advantageous to Gallagher. Accordingly, actual results may differ materially
from those set forth in the forward-looking statements.
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ARTHUR J. GALLAGHER & CO.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
a. Exhibit 10.8.3 - Arthur J. Gallagher & Co. and AJG Financial
Services, Inc. Third Amendment to Credit
Agreement Dated as of September 7, 2001.
Exhibit 10.8.4 - Arthur J. Gallagher & Co. and AJG Financial
Services, Inc. Fourth Amendment to Credit
Agreement Dated as of November 7, 2001.
b. Reports on Form 8-K. No Reports on Form 8-K were filed during the
three-month period ended September 30, 2001.
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ARTHUR J. GALLAGHER & CO.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized on the 13th day of
November, 2001.
ARTHUR J. GALLAGHER & CO.
/s/ Michael J. Cloherty
---------------------------------------------
Michael J. Cloherty
Executive Vice President
Chief Financial Officer
/s/ Richard C. Cary
----------------------------------------------
Richard C. Cary
Controller
Chief Accounting Officer
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