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 March 31, 2002 or
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[_] 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)
________________________________________________________________________________
(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 March 31, 2002 was 86,087,701
ARTHUR J. GALLAGHER & CO.
INDEX
Page No.
Part I. Financial Information:
Item 1. Financial Statements (Unaudited):
Consolidated Statements of Earnings for the three-month
periods ended March 31, 2002 and 2001 ............................... 3
Consolidated Balance Sheets at March 31, 2002 and
December 31, 2001 ................................................... 4
Consolidated Statements of Cash Flows for the three-month
periods ended March 31, 2002 and 2001 ............................... 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 2. Changes in Securities .................................................. 19
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 March 31,
2002 2001
--------------- --------------
(in thousands, except per share data)
Operating Results
Revenues:
Commissions $ 143,216 $ 121,610
Fees 89,762 76,437
Investment income and other:
Investment income 3,601 6,092
Income from equity investments,
installment sales and partnerships 5,925 3,151
Income from real estate ventures 3,476 6,551
Other income 3,182 2,811
--------------- --------------
Total investment income and other 16,184 18,605
--------------- --------------
Total revenues 249,162 216,652
Expenses:
Salaries and employee benefits 126,322 110,923
Other operating expenses 63,767 60,227
Expenses of real estate ventures 1,810 2,520
Partnership investment expenses 1,718 3,246
Depreciation and amortization 6,740 5,663
--------------- --------------
Total expenses 200,357 182,579
--------------- --------------
Earnings before income taxes 48,805 34,073
Provision for income taxes 15,130 6,990
--------------- --------------
Net earnings $ 33,675 $ 27,083
=============== ==============
Net earnings per common share $ .39 $ .32
Net earnings per common and common equivalent share .37 .30
Dividends declared per common share .15 .13
See notes to consolidated financial statements.
-3-
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
March 31, December 31,
2002 2001
----------- -----------
(in thousands)
ASSETS
Current assets:
Cash and cash equivalents $ 103,197 $ 98,530
Restricted cash 246,829 209,509
Premiums and fees receivable 1,088,795 1,117,238
Investment strategies - trading 53,446 52,588
Other 84,724 85,142
----------- -----------
Total current assets 1,576,991 1,563,007
Marketable securities - available for sale 16,579 18,290
Deferred income taxes 99,367 99,263
Other noncurrent assets 217,822 216,196
Fixed assets 292,298 283,807
Accumulated depreciation and amortization (103,290) (100,562)
----------- -----------
Net fixed assets 189,008 183,245
Intangible assets - net 72,845 65,341
----------- -----------
$ 2,172,612 $ 2,145,342
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Premiums payable to insurance and reinsurance companies $ 1,352,045 $ 1,366,516
Accrued salaries and bonuses 60,995 56,572
Accounts payable and other accrued liabilities 114,208 111,618
Unearned fees 17,419 16,527
Income taxes payable 17,430 33,746
Borrowings on line of credit facilities 57,050 38,552
Other 8,936 11,273
----------- -----------
Total current liabilities 1,628,083 1,634,804
Long-term debt 99,683 99,850
Other noncurrent liabilities 40,272 39,075
Stockholders' equity:
Common stock - issued and outstanding 86,088 shares in
2002 and 85,111 shares in 2001 86,088 85,111
Capital in excess of par value 33,996 8,768
Retained earnings 304,623 283,796
Unearned deferred compensation (7,381) (3,438)
Unearned restricted stock (9,972) -
Accumulated other comprehensive earnings (loss) (2,780) (2,624)
----------- -----------
Total stockholders' equity 404,574 371,613
----------- -----------
$ 2,172,612 $ 2,145,342
=========== ===========
See notes to consolidated financial statements.
-4-
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three-month period ended March 31,
2002 2001
------------- -------------
(in thousands)
Cash flows from operating activities:
Net earnings $ 33,675 $ 27,083
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Net gain on investments and other (543) (521)
Gain on sales of operations (2,500) (2,375)
Depreciation and amortization 6,740 5,663
(Increase) decrease in restricted cash (37,320) 790
Decrease in premiums receivable 32,807 30,241
Decrease in premiums payable (14,471) (14,754)
(Increase) decrease in trading investments - net (26) 3,775
Decrease in other current assets 418 2,802
Increase (decrease) in accrued salaries and bonuses 4,510 (18,491)
Increase (decrease) in accounts payable and other accrued liabilities 707 (3,353)
Decrease in income taxes payable (16,316) (1,862)
Tax benefit from issuance of common stock 3,907 4,471
Net change in deferred income taxes 6 (1,350)
Other (271) (15,293)
------------- -------------
Net cash provided by operating activities 11,323 16,826
------------- -------------
Cash flows from investing activities:
Purchases of marketable securities (3,499) (4,469)
Proceeds from sales of marketable securities 3,346 4,781
Proceeds from maturities of marketable securities 1,319 11
Net additions to fixed assets (11,243) (6,624)
Cash paid for acquisitions, net of cash acquired (3,641) -
Proceeds from sales of operations 2,500 2,700
Other (6,570) (11,694)
------------- -------------
Net cash used by investing activities (17,788) (15,295)
------------- -------------
Cash flows from financing activities:
Proceeds from issuance of common stock 3,865 4,258
Repurchases of common stock - (12,836)
Dividends paid (11,064) (9,148)
Borrowings on line of credit facilities 151,498 2,200
Repayments on line of credit facilities (133,000) (2,200)
Repayments of long term debt (167) (103)
Equity transactions of pooled companies prior to dates of acquisition - (4,446)
------------- -------------
Net cash provided (used) by financing activities 11,132 (22,275)
------------- -------------
Net increase (decrease) in cash and cash equivalents 4,667 (20,744)
Cash and cash equivalents at beginning of period 98,530 149,387
------------- -------------
Cash and cash equivalents at end of period $ 103,197 $ 128,643
============= =============
Supplemental disclosures of cash flow information:
Interest paid $ 2,230 $ 2,351
Income taxes paid 26,418 2,063
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
250 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, 2001,
except for the conforming reclassifications discussed in Note 3, 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 2001 Annual Report on Form 10-K.
2. Effect of New Pronouncements
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 requires that all business
combinations initiated after June 30, 2001 be accounted for using the
purchase method of accounting. In addition, SFAS 141 further clarifies the
criteria to recognize intangible assets separately from goodwill. The
requirements of SFAS 141 were effective for any business combination
accounted for by the purchase method that was completed after June 30,
2001.
Under SFAS 142, goodwill and indefinite lived intangible assets are no
longer amortized, but are 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 initially only applied to goodwill and intangible
assets related to business combinations accounted for by the purchase
method that were completed after June 30, 2001. With respect to goodwill
and intangible assets acquired prior to July 1, 2001, companies were
required to adopt SFAS 142 in their fiscal year beginning after 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 intangible assets were amortized during the transition period
(June 30 to December 31, 2001). Effective January 1, 2002, Gallagher
adopted the remaining provisions of SFAS 142 with respect to pre-existing
goodwill and intangible assets, the effect of which was not material to
Gallagher's consolidated operating results or financial position.
-6-
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
2. Effect of New Pronouncements (Continued)
In performing the impairment reviews, Statement No. 142 requires Gallagher
to compare the fair value of a reporting unit with its carrying amount on
an annual basis to determine if there is impairment of goodwill. If the
fair value of the reporting unit is less than its carrying value, an
impairment loss would be recorded to the extent that the fair value of the
goodwill within the reporting unit is less than its carrying value. While
Gallagher is still in the process of performing the initial goodwill
impairment review by reporting unit as of January 1, 2002, it is
management's preliminary assessment that a goodwill impairment charge will
not be recorded as of the date of adoption.
3. Reclassifications of Previously Reported Financial Statements
During the three-month period ended March 31, 2002, Gallagher undertook a
review of how it was accounting for all of its partially owned entities.
Given the current environment regarding ownership/control relationships
with respect to partially owned entities, Gallagher determined that it
would be appropriate to consolidate three operations that were previously
accounted for using the equity method of accounting. In addition, prior to
2002, the premiums and claims receivable and payable relating to a
reinsurance intermediary subsidiary of Gallagher were reported on a net
basis in Gallagher's consolidated balance sheets with the gross amounts
disclosed in the notes to the consolidated financial statements. During
2002, Gallagher determined that it would be appropriate to include these
amounts on a gross basis in its consolidated balance sheets in order to
conform to a more common industry practice. Reclassifications have been
made to the previously reported financial statements in order to conform
them to the current year presentation. These reclassifications had no
impact on the previously reported net earnings or stockholders' equity. The
following summarizes the reclassifications that were made to the 2001
consolidated financial statements (in thousands, except per share data):
Three-month period ended As Previously Amounts
March 31, 2001 Reported Reclassified As Reclassified
-------------- -------- ------------ ---------------
Total revenue $ 211,694 $ 4,958 $ 216,652
Total expenses 177,621 4,958 182,579
Earnings before income taxes 34,073 -- 34,073
Net earnings 27,083 -- 27,083
Net earnings per common share .32 -- .32
Net earnings per common and
common equivalent share .30 -- .30
December 31, 2001
-----------------
Premiums and fees receivable $ 555,276 $ 561,962 $1,117,238
Net fixed assets 51,246 131,999 183,245
Total assets 1,471,823 673,519 2,145,342
Premiums payable to insurance and
reinsurance companies 805,595 560,921 1,366,516
Long-term debt -- 99,850 99,850
Total stockholders' equity 371,613 -- 371,613
-7-
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
4. Business Combinations
During the three-month period ended March 31, 2002, Gallagher acquired
substantially all of the net assets of the following insurance brokerage
firms in exchange for its common stock and/or cash using the purchase
accounting method for recording business combinations (in thousands):
Common Common Total
Name and Date of Shares Share Cash Contingent Escrow Purchase
Acquisitions Issued Value Paid Payable Deposited Price
--------------------------- -------- -------- ------ ---------- --------- --------
Life Plans Unlimited, Inc.
February 28, 2002 127 $ 3,987 $ - $ - $ 443 $ 4,430
Tom Sherwin Insurance
Agency, Inc.
February 28, 2002 - - 720 600 80 1,400
-------- -------- ------ ---------- --------- --------
127 $ 3,987 $ 720 $ 600 $ 523 $ 5,830
======== ======== ====== ========== ========= ========
Common shares exchanged in connection with these acquisitions were valued
at closing market prices as of the effective date of the respective
acquisition. Contingent obligations, which are primarily based upon future
earnings of the acquired entities, were included in the purchase price
recorded for these acquisitions at the maximum amount per the purchase
agreements. Contingent consideration or escrow deposits that are returned
to Gallagher as a result of purchase price adjustment provisions are
recorded as adjustments to intangibles when the contingencies are settled.
These acquisitions allow Gallagher to expand into desirable geographic
locations, further extend its presence in the retail and wholesale
insurance brokerage services industry and increase the volume of general
services currently provided. The excess of the purchase price over the
estimated fair value of the tangible net assets acquired at the acquisition
date was allocated to goodwill and expiration lists of the Insurance
Brokerage Services segment. Purchase price allocations are preliminarily
established at the time of the acquisition and are subsequently reviewed
within the first year of operations to determine the necessity for
allocation adjustments. Expiration lists, related to these acquisitions,
will be amortized on a straight-line basis over an estimated useful life of
10 years. Gallagher's consolidated financial statements for the three-month
period ended March 31, 2002 include the operations of these companies from
the date of their respective acquisitions. The historical operating results
of these purchase acquisitions for the three-month periods ended March 31,
2002 and 2001 were not material to Gallagher's consolidated statements of
earnings.
-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 March 31,
2002 2001
--------- ---------
Net earnings $ 33,675 $ 27,083
========= =========
Weighted average number of common shares outstanding 85,405 84,713
Dilutive effect of stock options using the treasury stock method 5,190 5,378
--------- ---------
Weighted average number of common and common equivalent
shares outstanding 90,595 90,091
========= =========
Net earnings per common share $ .39 $ .32
Net earnings per common and common equivalent share .37 .30
Options to purchase 83,000 and 144,000 shares of common stock were
outstanding at March 31, 2002 and 2001, respectively, but were not included
in the computation of the dilutive effect of stock options for the
three-month period then ended. These options were excluded from the
computation because the options' exercise prices were greater than the
average market price of the common shares during the respective period and,
therefore, would be antidilutive to earnings per share under the treasury
stock method.
6. Comprehensive Earnings
The components of comprehensive earnings and accumulated other
comprehensive earnings (loss) are as follows (in thousands):
Three-month period
ended March 31,
2002 2001
--------- ---------
Net earnings $ 33,675 $ 27,083
Net change in unrealized gain (loss) on available for sale
securities, net of income taxes of $(104) and $748, respectively (156) 1,122
--------- ---------
Comprehensive earnings $ 33,519 $ 28,205
========= =========
Accumulated other comprehensive earnings (loss) at beginning of period $ (2,624) $ (2,498)
Net change in unrealized gain (loss) on available for sale
securities, net of income taxes (156) 1,122
--------- ---------
Accumulated other comprehensive earnings (loss) at end of period $ (2,780) $ (1,376)
========= =========
-9-
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
7. Restricted Stock Awards
In 2001, Gallagher adopted an incentive compensation plan for several of
its key executives and management personnel. The compensation under this
plan is determined by a formula applied to the pretax profitability of
certain operating divisions and may include an equity award as part of such
incentive compensation.
Effective on March 31, 2002, Gallagher contributed $8.9 million to the plan
through the issuance of 274,000 shares of Gallagher common stock. Also,
effective on March 31, 2002, Gallagher granted a restricted stock award of
32,000 shares of Gallagher common stock to its Chief Executive Officer,
with an aggregate value of $1.1 million. All of the 2002 restricted stock
awards vest over a three year period at the rate of 33 1/3% per year
beginning on March 31, 2003. Gallagher accounts for restricted stock at
historical cost which equals its fair market value at the date of grant.
When restricted shares are issued, an unearned restricted stock obligation
is recorded as a reduction of stockholders' equity which will be ratably
charged to expense over the vesting period of the participants. During the
three-month period ended March 31, 2002, no amounts were charged to expense
related to these awards.
-10-
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
8. Quarterly Operating Results
Quarterly operating results for 2001 were reclassified to conform to the
current year presentation, which had no impact on previously reported net
earnings. The reclassified results were as follows (in thousands, except
per share data):
1st 2nd 3rd 4th
--------- --------- ---------- ----------
Revenues:
Commissions $ 121,610 $ 125,963 $ 136,653 $ 154,797
Fees 76,437 77,554 84,422 86,451
Investment income and other:
Investment income 6,092 7,098 4,350 3,881
Income from equity investments,
installment sales and partnerships 3,151 685 6,806 9,110
Income from real estate ventures 6,551 1,855 1,975 1,734
Other income 2,811 792 1,458 752
--------- --------- ---------- ----------
Total investment income and other 18,605 10,430 14,589 15,477
--------- --------- ---------- ----------
Total revenues 216,652 213,947 235,664 256,725
Expenses:
Salaries and employee benefits 110,923 111,001 115,139 141,500
Other operating expenses 60,227 59,943 63,530 68,007
Expenses of real estate ventures 2,520 1,348 1,320 1,452
Partnership investment expenses 3,246 7,466 8,259 2,108
Depreciation and amortization 5,663 5,417 5,397 6,669
--------- --------- ---------- ----------
Total expenses 182,579 185,175 193,645 219,736
--------- --------- ---------- ----------
Earnings before income taxes 34,073 28,772 42,019 36,989
Provision for income taxes 6,990 5,575 116 3,916
--------- --------- ---------- ----------
Net earnings $ 27,083 $ 23,197 $ 41,903 $ 33,073
========= ========= ========== ==========
Net earnings per common share $ .32 $ .27 $ .49 $ .39
Net earnings per common and common
equivalent share
.30 .26 .47 .36
-11-
Item 2.
ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS - CONSOLIDATED
The insurance industry was jolted by the tragic terrorist attacks that occurred
on September 11, 2001. The destruction and devastation of those events have
resulted in the largest insurance loss in America's history and have reshaped
the insurance marketplace more rapidly than expected. Along with this historic
loss, larger than anticipated loss experience across all risks, stock market
declines, lower interest rates and diminished risk capacity have led to
unprecedented premium rate increases. Higher premium rates are referred to as a
"hard market" and generally result in increased commission revenues.
Fluctuations in premiums charged by insurance companies have a direct and
potentially material impact on the insurance brokerage industry. Commission
revenues are generally based on a percentage of the premiums paid by insureds
and normally follow premium levels. Thus, a hard market will generally
contribute positively to Gallagher's operating results, and since September
11th, the premium rates charged by insurance companies have soared having a
positive impact on Gallagher's 2002 operating results in spite of some insurance
companies' efforts to reduce commission rates during the upturn in premium
pricing. Although, management believes this hard market will continue for the
foreseeable future, the longevity of the hard market and its future effect on
Gallagher's business is difficult to predict.
In a period of rising insurance costs, there is resistance among certain "risk"
buyers (Gallagher's clients) to pay increased premiums and the higher
commissions generated by these premiums. Such resistance may cause some buyers
to raise their deductibles and/or reduce the overall amount of insurance
coverage that they purchase. In addition, some buyers will switch to negotiated
fee in lieu of commission arrangements with the broker for placing the risk.
These factors will reduce commission revenue to Gallagher. Other 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 the areas of risk
management, claims management, insurance captive and self-insurance services
will continue to be a major factor in Gallagher's fee revenue growth during
2002.
During the first quarter of 2002, Gallagher acquired two companies which were
accounted for as purchases. 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 information
concerning business combinations, see Note 4 to the Consolidated Financial
Statements.
Commission revenues increased by 18% to $143.2 million in the first quarter of
2002 over the respective period in 2001. This increase is due principally to new
business of approximately $28.5 million and renewal rate increases partially
offset by lost business of $18.1 million and a reduction in revenue from
national insurance revenue-sharing programs.
Fee revenues increased by 17% or $13.3 million to $89.8 million in the first
quarter of 2002 over the respective period in 2001. This increase, generated
primarily by the Risk Management Services segment, resulted from new business
production of approximately $14.4 million, renewal rate increases and favorable
retention rates on existing business partially offset by lost business of $7.4
million.
Investment income, primarily interest on cash and restricted funds, was down
$2.5 million or 41% from the same period in 2001 due primarily to lower interest
income as a result of declining short term interest rates and lower returns on
invested funds managed by external fund managers. Rates of return on interest
bearing accounts and certificates are down in excess of 60% on a
quarter-over-quarter basis putting considerable pressure on short term interest
returns.
-12-
ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS - CONSOLIDATED (Continued)
In the first quarter of 2002, income from equity investments, installment sales
and partnerships increased 88% to $5.9 million over the same period in 2001 due
primarily to installment gains recognized in 2002 from sales of a portion of its
interests in two limited partnerships that operate synthetic fuel facilities
which were completed in the third and fourth quarters of 2001. Gallagher will
continue to recognize additional installment gains over time through 2007 based
on qualified fuel production generated by these facilities. Production at these
facilities, which ultimately determines the amount of the gains realized, did
not meet full expectations in the first quarter of 2002 due to the unusually
mild winter and a short term shut down of production as the facilities were
moved to more permanent sites to accommodate the ultimate purchaser.
Income from real estate ventures represents revenue related to Gallagher's
consolidation of its investments in two real estate partnerships. These real
estate partnerships represent an investment in a limited partnership that owns
the building that Gallagher leases for its corporate headquarters and several of
its subsidiary operations and an investment in a limited partnership that owns
11,000 acres of land near Orlando, Florida, that is currently under development.
In the first quarter of 2002, income from real estate ventures decreased 47% to
$3.5 million primarily due to a one-time gain of $3.0 million generated from the
sale of land by the Florida real estate partnership that was reported in the
first quarter of 2001.
Other income consists primarily of gains on the sales of books of business. In
the first quarter of 2002, Gallagher recognized a $2.5 million gain on the sale
of a book of business compared to a $2.4 million gain that was recorded on the
sale of a book of business in 2001.
Salaries and employee benefits increased by $15.4 million or 14% to $126.3
million in the first quarter of 2002. This increase was higher than usual and
reflects a 13% increase in employee headcount in the period from March 31, 2001
to March 31, 2002, salary increases and associated employee benefit costs. The
increase in employee headcount relates to the hiring of additional staff to
support the new business growth previously discussed, to an ongoing initiative
to hire additional production personnel to generate future revenue growth, and
to employees associated with the acquisitions accounted for as purchases that
were made in the fourth quarter of 2001 and the first quarter of 2002.
Other operating expenses increased from $60.2 million to $63.8 million or 6% in
the first quarter of 2002 over the first quarter of 2001 due primarily to an
increase in business insurance costs and commissions paid to sub-brokers. For
the first quarter of 2002, expenses of real estate ventures decreased $700,000
or 28% to $1.8 million from the same period in 2001 due to a decrease in
minority interest expense associated with the two investments in real estate
partnerships previously discussed.
Partnership investment expenses represent Gallagher's portion of the ongoing
expenses associated with the operations of the synthetic fuel facilities. In the
first quarter of 2002, these expenses decreased $1.5 million or 47% to $1.7
million from the same period in 2001 due to the two sales of interests in
limited partnerships that operate synthetic fuel facilities discussed above.
Depreciation and amortization increased 19% to $6.7 million in the first three
months of 2002 over the same period in 2001 due primarily to amortization
expense associated with acquisitions accounted for as purchases that were made
in the fourth quarter of 2001 and the first quarter of 2002.
-13-
ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS - CONSOLIDATED (Continued)
The effective income tax rate was 31% for the first quarter of 2002 and 21% for
the first quarter of 2001. These rates are net of the effect of tax credits
generated by investments in limited partnerships that operate qualified
affordable housing and alternative energy projects, which are partially offset
by state and foreign taxes. The increase in the effective income tax rate in
2002 over the prior year is due to a reduction in the tax credits earned in
2002. This decrease in the amount of tax credits earned was due to the two sales
of interests in limited partnerships that operate synthetic fuel facilities.
Net earnings per common and common equivalent share for the first quarter of
2002 were $.37 compared to $.30 in 2001, a 23% increase. This increase is
primarily due to the previously discussed revenue growth in 2002 which was
partially offset by increased expenses and by an increase in the effective
income tax rate in 2002.
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
------------------------
March 31, 2002
--------------
Total revenues $ 164,566 $ 70,059 $ 12,544 $ 1,993 $ 249,162
Earnings (loss) before
income taxes 31,730 11,947 6,590 (1,462) 48,805
March 31, 2001
--------------
Total revenues 136,399 65,760 12,553 1,940 216,652
Earnings (loss) before
income taxes 22,016 9,448 3,965 (1,356) 34,073
Total Identifiable Assets at
----------------------------
March 31, 2002 1,520,960 72,327 292,351 286,974 2,172,612
March 31, 2001 1,075,620 60,366 272,821 194,144 1,602,951
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' management of risk. This segment also provides
consulting, for fee compensation, related to clients' risk financing programs
and includes Gallagher's retail, reinsurance and wholesale brokerage operations.
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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)
Total revenues for this segment in the three-month period ended March 31, 2002
increased 21% to $164.6 million over the same period in 2001. This increase is
due principally to new business of approximately $28.5 million and renewal rate
increases partially offset by lost business of $18.1 million and a reduction in
revenue from national insurance revenue-sharing programs. Earnings before income
taxes for this segment in the three-month period ended March 31, 2002 increased
44% to $31.7 million over the same period in 2001. This increase is 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-month period ended March 31, 2002
increased 7% to $70.1 million over the respective period in 2001 due primarily
to new business production of approximately $14.4 million, renewal rate
increases and favorable retention rates on existing business partially offset by
lost business of $7.4 million. Earnings before income taxes for this segment in
the first quarter of 2002 increased over the first quarter of 2001 by 26% to
$11.9 million. This increase is due primarily to the earnings leverage created
by the increased revenues discussed above.
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
invested assets of Gallagher are managed in this segment in order to maximize
the return to the company.
In the first quarter of 2002, revenues for this segment were $12.5 million,
which were flat to the prior year. Revenue in 2002 for this segment includes
installment gains from sales of interests in two limited partnerships that
operate synthetic fuel facilities that were completed in the third and fourth
quarters of 2001. However, the increase in income generated by these installment
gains was substantially offset by the $3.1 million decrease in income from real
estate ventures during the first quarter of 2002 and a reduction in income
generated from Gallagher's unconsolidated equity portfolio. As previously
discussed, the decrease in income from real estate ventures was primarily due to
a one-time gain of $3.0 million generated from the sale of land by the Florida
real estate partnership that was reported in the first quarter of 2001. Earnings
before income taxes for this segment increased $2.6 million or 66% to $6.6
million in the first quarter of 2002. This increase is due primarily to a
reduction in ongoing expenses related to the operations of synthetic fuel
facilities.
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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 the operating results of the real estate
limited partnership that owns the building that Gallagher leases for its
corporate headquarters and several of its subsidiary operations, 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. The capital used to
fund Gallagher's investment portfolio has been primarily generated from the
excess cash provided by its operations. Cash generated from operating activities
was $11.3 million and $16.8 million for the three months ended March 31, 2002
and 2001, 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 period to period. Funds restricted as to
Gallagher's use, primarily premiums held as fiduciary funds, have not been
included in determining Gallagher's overall liquidity. Currently, Gallagher
believes it has sufficient capital to meet its cash flow needs. However, in the
event that Gallagher needs capital to fund its operations and investing
requirements, it would use borrowings under its credit agreement to meet its
short-term needs and would consider other alternatives for its long-term needs.
Such alternatives would include raising capital through public markets or
restructuring its operations in the event that cash flows from operations are
reduced dramatically due to lost business. However, Gallagher has historically
been profitable and cash flows from operations and short-term borrowings under
its credit agreements have been sufficient to fund Gallagher's operating,
investment and capital expenditure needs. Gallagher expects this favorable cash
flow trend to continue in the future.
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. Letter of credits 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. The
Revolving Credit Agreement provides for borrowings to be denominated in either
U.S. dollars or Alternative Currencies, as defined in the credit agreement. In
addition, the credit agreement has two borrowing options, Domestic Rate Loans
and Eurocurrency Loans, as defined in the credit agreement. Interest rates on
borrowings under the Domestic Rate Loan option are based on the prime commercial
rate and interest rates on borrowings under the Eurocurrency Loan option are
based on LIBOR plus .400% for short-term and long-term revolving credit
commitments. The facility fee related to this credit agreement is based on .100%
of the used and unused portions of the short-term and long-term revolving credit
commitments.
As of March 31, 2002, under the long-term credit facility, Gallagher has
contingently committed to funding $47.3 million through letter of credit
arrangements related to its corporate insurance programs and several of its
equity and other strategic investments. Also, as of March 31, 2002, there were
$50.0 million of borrowings outstanding under the Revolving Credit Agreement.
Accordingly, Gallagher had $52.7 million available for future borrowing. In
2002, Gallagher borrowed $148.0 million and repaid $133.0 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 activities. Terms
of the Revolving Credit Agreement include various
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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)
covenants that require Gallagher to maintain specified levels of tangible net
worth and restrict the amount of payments on certain expenditures. Gallagher was
in compliance with these covenants as of March 31, 2002. As of March 31, 2002,
there were $7.1 million of borrowings on a line of credit facility and $99.7
million of long term debt outstanding related to Gallagher's investments in the
two real estate partnerships previously discussed. These borrowing were used by
the two real estate partnerships for their own operating and finance investment
activities. Borrowings under these facilities are not available to Gallagher and
as such have not been included in determining Gallagher's overall liquidity.
Based on the ownership structure of these two investments, management believes
that Gallagher's exposure to losses related to these investments is limited to
the combination of its net carrying value, letters of credit and financial
guarantees. There have been no material changes in Gallagher's exposure to
losses for these investments since December 31, 2001. For additional
information, see Note 4 to the Consolidated Financial Statements included in
Gallagher's 2001 Annual Report on Form 10-K. In the event that these limited
partnerships were to default on their debt obligations and Gallagher's net
carrying value became impaired, the amount to be written-off could have a
material effect on Gallagher's consolidated financial position or operating
results.
Through the first three months of 2002, Gallagher paid $11.1 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
April 15, 2002, Gallagher paid a first quarter dividend of $.15 per share to
shareholders of record as of March 29, 2002, a 15% increase over the first
quarter dividend per share in 2001.
Net capital expenditures were $11.2 million and $6.6 million for each of the
three-month periods ended March 31, 2002 and 2001, respectively. These amounts
include net capital expenditures related to Gallagher's investments in the two
real estate partnerships previously discussed. In the first quarter of 2002, the
Florida real estate partnership made net capital expenditures of $3.4 million
related to its land development project. In 2002, exclusive of the net capital
expenditures related to the two real estate partnerships, Gallagher expects to
make total expenditures for capital improvements of approximately $25.0 million.
Capital expenditures by Gallagher are related primarily to office moves and
expansions and updating computer systems and equipment.
In 1988, Gallagher adopted a common stock repurchase plan that has been extended
through June 30, 2002. Under the plan, Gallagher repurchased 470,000 shares at a
cost of $12.8 million in the first three months of 2001, while there were no
repurchases made in the first three months of 2002. 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 2.3 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.
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ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM
ACT OF 1995
This quarterly 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.
-18-
ARTHUR J. GALLAGHER & CO.
PART II - OTHER INFORMATION
Item 2. Changes in Securities
Effective March 31, 2002, Gallagher contributed $8.9 million to an
incentive plan through the issuance of 274,000 shares of Gallagher
common stock. Also, effective on March 31, 2002, Gallagher granted
a restricted stock award of 32,000 shares of Gallagher common
stock to its Chief Executive Officer, with an aggregate value of
$1.1 million. These 2002 restricted stock awards vest over a three
year period at the rate of 33 1/3% per year beginning on March 31,
2003.
Effective March 21, 2002, Gallagher contributed $4.0 million to
the Deferred Equity Participation Plan through the issuance of
122,000 shares of Gallagher common stock. 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.
Exemption from registration is provided under Section 4(2) of the
Securities Act of 1933, as amended, regarding transactions by an
issuer not involving any public offering.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibit 10.8.6 - Arthur J. Gallagher & Co. and AJG Financial
Services, Inc. Sixth Amendment to Credit
Agreement Dated as of April 23, 2002.
Exhibit 10.22 - Arthur J. Gallagher & Co. Brokerage Services
Division Management Bonus Plan Amended and
Restated as of March 21, 2002.
b. Reports on Form 8-K. No Reports on Form 8-K were filed during the
three-month period ended March 31, 2002.
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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 14th day of May,
2002.
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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