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 June 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
-------------------------------- --------------------------------
(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 June 30, 2001 was 84,150,478.
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 six-month periods ended June 30, 2001
and 2000................................................. 3
Consolidated Balance Sheets at June 30, 2001 and
December 31, 2000........................................ 4
Consolidated Statements of Cash Flows for the six-
month periods ended June 30, 2001 and 2000............... 5
Notes to Consolidated Financial Statements.............. 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 11-16
Part II. Other Information:
Item 4. Submission of Matters to a Vote of Security Holders....... 17
Item 6. Exhibits and Reports on Form 8-K.......................... 17
Signatures......................................................... 18
-2-
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
Three-month period ended Six-month period ended
June 30, June 30,
2001 2000 2001 2000
---------- ---------- ---------- ----------
(in thousands, except per share data)
Operating Results
Revenues:
Commissions $122,768 $107,475 $240,460 $216,485
Fees 77,500 64,545 153,883 128,931
Investment income and other:
Investment income 7,058 5,946 13,104 11,666
Income from equity investments, partnerships
and joint ventures 974 2,907 7,732 4,287
Other income 792 105 3,603 723
-------- -------- -------- --------
Total investment income and other 8,824 8,958 24,439 16,676
-------- -------- -------- --------
Total revenues 209,092 180,978 418,782 362,092
Expenses:
Salaries and employee benefits 109,443 96,821 218,787 192,112
Other operating expenses 71,051 58,038 137,498 113,329
-------- -------- -------- --------
Total expenses 180,494 154,859 356,285 305,441
-------- -------- -------- --------
Earnings before income taxes 28,598 26,119 62,497 56,651
Provision for income taxes 5,542 9,035 12,499 20,027
-------- -------- -------- --------
Net earnings $ 23,056 $ 17,084 $ 49,998 $ 36,624
======== ======== ======== ========
Net earnings per common share $ .27 $ .21 $ .59 $ .44
Net earnings per common and common equivalent share .26 .19 .56 .42
Dividends declared per common share .130 .115 .260 .230
See notes to consolidated financial statements.
-3-
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
2001 2000
---------- ------------
(in thousands)
ASSETS
Current assets:
Cash and cash equivalents $ 100,930 $ 140,707
Restricted cash 178,498 158,228
Premiums and fees receivable 499,039 435,010
Investment strategies - trading 49,299 51,897
Other 54,050 56,078
---------- ----------
Total current assets 881,816 841,920
Marketable securities - available for sale 22,908 23,306
Deferred income taxes 48,295 47,824
Other noncurrent assets 196,087 159,649
Fixed assets 133,935 125,883
Accumulated depreciation and amortization (90,411) (83,961)
---------- ----------
Net fixed assets 43,524 41,922
Intangible assets - net 22,609 15,931
---------- ----------
$1,215,239 $1,130,552
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Premiums payable to insurance companies $ 672,251 $ 602,831
Accrued salaries and bonuses 23,224 37,643
Accounts payable and other accrued liabilities 114,309 109,030
Unearned fees 17,684 19,014
Income taxes payable 194 9,800
Other 26,493 5,165
---------- ----------
Total current liabilities 854,155 783,483
Other noncurrent liabilities 27,293 19,271
Stockholders' equity:
Common stock - issued and outstanding 84,150
shares in 2001 and 83,951 shares in 2000 84,150 83,951
Capital in excess of par value 24,541 21,809
Retained earnings 230,772 224,536
Unearned deferred compensation (3,813) --
Accumulated other comprehensive earnings (loss) (1,859) (2,498)
---------- ----------
Total stockholders' equity 333,791 327,798
---------- ----------
$1,215,239 $1,130,552
========== ==========
See notes to consolidated financial statements.
-4-
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Six-month period ended June 30,
2001 2000
------------ ------------
(in thousands)
Cash flows from operating activities:
Net earnings $ 49,998 $ 36,624
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Net gain on investments and other (2,716) (685)
Gain on sales of operations (2,375) --
Depreciation and amortization 9,195 8,588
Increase in restricted cash (20,270) (2,803)
Increase in premiums receivable (63,798) (19,594)
Increase in premiums payable 69,420 48,511
Decrease (increase) in trading investments - net 3,680 (329)
Decrease in other current assets 1,527 252
Decrease in accrued salaries and bonuses (14,232) (11,749)
Increase (decrease) in accounts payable and other accrued liabilities 4,075 (2,290)
Decrease in income taxes payable (9,606) (9,299)
Tax benefit from issuance of common stock 7,304 9,699
Net change in deferred income taxes (582) (27)
Other (8,043) 9,015
-------- --------
Net cash provided by operating activities 23,577 $ 65,913
-------- --------
Cash flows from investing activities:
Purchases of marketable securities (9,009) (14,566)
Proceeds from sales of marketable securities 15,603 13,725
Proceeds from maturities of marketable securities 76 330
Net additions to fixed assets (9,527) (9,428)
Proceeds from sales of operations 2,700 --
Other (20,735) (21,137)
-------- --------
Net cash used by investing activities (20,892) (31,076)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 6,735 17,910
Repurchases of common stock (25,110) (12,821)
Dividends paid (19,637) (15,932)
Borrowings on line of credit facilities 85,700 30,000
Repayments on line of credit facilities (77,200) (40,000)
Equity transactions of pooled companies prior to dates of acquisition (12,950) 1,421
-------- --------
Net cash used by financing activities (42,462) (19,422)
-------- --------
Net (decrease) increase in cash and cash equivalents (39,777) 15,415
Cash and cash equivalents at beginning of period 140,707 96,013
-------- --------
Cash and cash equivalents at end of period $100,930 $111,428
======== ========
Supplemental disclosures of cash flow information:
Interest paid $ 856 $ 499
Income taxes paid 11,489 17,524
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 are expected to be
completed prior to December 31, 2001 and be accounted for as poolings of
interests because they meet 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 December 15, 2001 (i.e.,
January 1, 2002 for calendar year companies). Because of the different
transition dates for goodwill and
-6-
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
2. Effect of New Pronouncements (Continued)
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 six-month period ended June 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; SKANCO International, Ltd., 263,000
shares; Nelson/Monarch Insurance Services, Ltd., 109,000 shares; and
Madison Scott & Associates, Inc., 34,000 shares. These acquisitions were
accounted for as poolings of interests and, except for one 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):
Three-month period ended As Previously Attributable to
June 30, 2000 Reported Pooled Companies As Restated
----------------------------- ------------- ---------------- -----------
Total revenues $169,625 $11,353 $180,978
Net earnings 15,933 1,151 17,084
Net earnings per common share .20 .01 .21
Net earnings per common and
common equivalent share .19 -- .19
Six-month period ended
June 30, 2000
-----------------------------
Total revenues $335,059 $27,033 $362,092
Net earnings 32,483 4,141 36,624
Net earnings per common share .42 .02 .44
Net earnings per common and
common equivalent share .39 .03 .42
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.
-7-
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
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):
June 30, December 31,
2001 2000
-------- ------------
Premiums and claims:
Receivable $418,645 $373,764
Payable 430,550 378,166
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.
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 Six-month period
ended June 30, ended June 30,
2001 2000 2001 2000
------- ------- ------- -------
Net earnings $23,056 $17,084 $49,998 $36,624
======= ======= ======= =======
Weighted average number of common shares
outstanding 84,028 82,924 84,076 82,341
Dilutive effect of stock options using
the treasury stock method 5,138 4,763 5,257 4,536
------- ------- ------- -------
Weighted average number of common and
common equivalent shares outstanding 89,166 87,687 89,333 86,877
======= ======= ======= =======
Net earnings per common share $ .27 $ .21 $ .59 $ .44
Net earnings per common and common
equivalent share .26 .19 .56 .42
Options to purchase 295,000 and 232,000 shares of common stock were
outstanding at June 30, 2001 and 2000, respectively, but were not included
in the computation of the dilutive effect of stock options for the
three-month period then ended. Options to purchase 220,000 and 125,000
shares of common stock were outstanding at June 30, 2001 and 2000,
respectively, but were not included in the computation of the dilutive
effect of stock options for the six-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.
-8-
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 Six-month period
ended June 30, ended June 30,
2001 2000 2001 2000
------- ------- ------- -------
Net earnings $23,056 $17,084 $49,998 $36,624
Net change in unrealized gain (loss) on available
for sale securities, net of income taxes of
($322), $140, $426 and $108, respectively (483) 210 639 162
------- ------- ------- -------
Comprehensive earnings $22,573 $17,294 $50,637 $36,786
======= ======= ======= =======
Accumulated other comprehensive earnings (loss)
at beginning of period $(1,376) $(2,717) $(2,498) $(2,669)
Net change in unrealized gain (loss) on available
for sale securities, net of income taxes (483) 210 639 162
------- ------- ------- -------
Accumulated other comprehensive earnings (loss)
at end of period $(1,859) $(2,507) $(1,859) $(2,507)
======= ======= ======= =======
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 to 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 three-month period
ended June 30, 2001, $187,000 was charged to expense related to this plan.
-9-
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 $109,010 $107,475 $119,227 $128,004
Fees 64,386 64,545 73,491 78,651
Investment income and other:
Investment income 5,720 5,946 8,217 5,812
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 7,718 8,958 14,535 12,326
-------- -------- -------- --------
Total revenues 181,114 180,978 207,253 218,981
Expenses:
Salaries and employee benefits 95,291 96,821 101,891 115,350
Other operating expenses 55,291 58,038 59,822 71,970
-------- -------- -------- --------
Total expenses 150,582 154,859 161,713 187,320
-------- -------- -------- --------
Earnings before income taxes 30,532 26,119 45,540 31,661
Provision for income taxes 10,992 9,035 13,552 7,102
-------- -------- -------- --------
Net earnings $ 19,540 $ 17,084 $ 31,988 $ 24,559
======== ======== ======== ========
Net earnings per common share $ .24 $ .21 $ .38 $ .29
Net earnings per common and common equivalent share .23 .19 .36 .27
-10-
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. Underwriting losses and the
downward turn in equity markets in 2000 and 2001 have placed insurers in the
situation of having to replenish depleted reserves. To accomplish this, many
carriers began to increase premium rates in 2000 and have continued this trend
into 2001 across many sectors of the insurance marketplace. These increases are
viewed as a "hardening of the market" (i.e., higher premium rates), and
generally result in increased commission revenues. Gallagher is generally seeing
this trend in higher premium rates, which have contributed to the overall
revenue growth in the second quarter and year to date 2001 operating results.
Although a hardening of the market overall contributes positively to Gallagher's
results, the longevity of a hard market and its effect on Gallagher's business
are difficult to predict.
Because of rising insurance costs, management believes there is a trend for
certain "risk" buyers to 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 captive 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 six-month period ended June 30, 2001, Gallagher acquired
substantially all of the net assets of six insurance brokerage firms, five of
which were accounted for as poolings of interests. For four 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 has initiated
several business combinations prior to July 1, 2001 that are expected to be
completed prior to December 31, 2001 and be accounted for as poolings of
interests because they meet the qualifying criteria of SFAS 141. See Note 2 to
the Consolidated Financial Statements.
Commission revenues increased by 14% to $122.8 million in the second quarter of
2001 and by 11% to $240.5 million in the first half of 2001 over the respective
periods in 2000. These increases are due principally to new business production
of $23.5 million in the second quarter of 2001 and $40.8 million in the first
six 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 20% or $13.0 million to $77.5 million in the second
quarter of 2001 and by 19% or $25.0 million to $153.9 million in the first six
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 $14.0 million in the second quarter of 2001 and
$27.2 million in the first six months of 2001, and renewal rate increases
partially offset by lost business.
-11-
ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS - CONSOLIDATED (Continued)
Investment income and other in the second quarter of 2001 of $8.8 million was
essentially flat compared to the same period in 2000. In the first six months of
2001, investment income and other increased 47% % or $7.8 million to $24.4
million over the respective period in 2000. This increase is due primarily to
the results generated by Gallagher's unconsolidated equity investment portfolio
and to realized gains generated from Gallagher's marketable securities portfolio
and two 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. This land development project completed its first real estate
transaction earlier in the year. 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.
Salaries and employee benefits increased by 13% or $12.6 million to $109.4
million in the second quarter of 2001 and increased by 14% or $26.7 million to
$218.8 million in the first six 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
June 30, 2000 to June 30, 2001. The increase in employee headcount relates to
the hiring of additional staff to support the new business growth previously
discussed and to a recent initiative to hire additional production personnel to
generate future revenue growth.
Other operating expenses increased by 22% or $13.0 million to $71.1 million in
the second quarter of 2001 and by 21% or $24.2 million to $137.5 million in the
first six months of 2001 over the respective periods in 2000. These increases
are due primarily to start up, professional services and ongoing expenses
related to the operations of synthetic fuel facilities 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 19.4% for the second quarter and 20.0% for the
first six months of 2001 and 34.6% for the second quarter and 35.4% for the
first six months of 2000. These rates are net of the effect of tax credits
generated by investments in limited partnerships that operate qualified
affordable housing and alternative energy related partnerships that operate
synthetic fuel facilities, 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 37% or $.07 to
$.26 in the second quarter of 2001 and by 33% or $.14 to $.56 in the first six
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 investment gains.
-12-
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
- ------------------------
June 30, 2001
- -------------
Total revenues $138,568 $ 65,328 $ 5,196 $ -- $ 209,092
Earnings (loss) before income taxes 26,848 8,476 (3,701) (3,025) 28,598
June 30, 2000
- -------------
Total revenues 121,657 55,643 3,678 -- 180,978
Earnings (loss) before income taxes 17,296 8,317 1,778 (1,272) 26,119
Six-month period ended
- ----------------------
June 30, 2001
- -------------
Total revenues 271,665 131,088 16,180 (151) 418,782
Earnings (loss) before income taxes 48,690 17,924 264 (4,381) 62,497
June 30, 2000
- -------------
Total revenues 244,457 110,846 6,789 -- 362,092
Earnings (loss) before income taxes 37,547 17,371 3,389 (1,656) 56,651
Total Identifiable Assets at
- ----------------------------
June 30, 2001 800,808 63,688 242,714 108,029 1,215,239
June 30, 2000 697,194 58,839 241,619 41,482 1,039,134
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 six-month periods ended June
30, 2001 increased 14% to $138.6 million and 11% to $271.7 million,
respectively, over the same periods in 2000. These increases are due principally
to new business of approximately $23.5 and $40.8 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 six-month periods ended June 30, 2001
increased
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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)
55% to $26.8 million and 30% to $48.7 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 six-month periods ended June
30, 2001 increased 17% to $65.3 million and 18% to $131.1 million over the
respective periods in 2000 due primarily to new business production of
approximately $14.0 and $27.2 million, respectively, and renewal rate increases
partially offset by lost business. Earnings before income taxes for this segment
in the three and six-month periods ended June 30, 2001 increased 2% to $8.5
million and 3% to $17.9 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 and six-month periods ended June
30, 2001 increased 41% to $5.2 million and 138% to $16.2 million over the
respective periods in 2000. These increases are due primarily to the results
generated by Gallagher's unconsolidated equity investment portfolio and to
realized gains generated from Gallagher's marketable securities portfolio and
two 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. This
land development project completed its first real estate transaction earlier in
the year. 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
six-month periods ended June 30, 2001 decreased $5.5 million to a loss of $3.7
million and $3.1 million to earnings of $264,000, respectively. These decreases
are due primarily to increases in start up, professional services and ongoing
expenses related to the operations of synthetic fuel facilities; incentive
compensation linked to the performance of Gallagher's investment portfolio; and
performance-related investment fees. Gallagher incurred expenses of
approximately $7.5 million and $10.7 million in the three and six-month periods
ended June 30, 2001 related to the operations of the synthetic fuel facilities.
The tax credits earned by Gallagher from these facilities have increased
significantly in 2001, which resulted in a reduction of Gallagher's to effective
income tax rates in 2001 from the prior year.
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.
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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
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 $23.6 million and $65.9 million for the six months
ended June 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
June 30, 2001, under the long-term credit facility, Gallagher has contingently
committed to funding $44.2 million through letter of credit arrangements related
to its corporate insurance programs and several of its equity and other
strategic investments. During the six-month period ended June 30, 2001,
Gallagher borrowed $85.7 million and repaid $77.2 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
June 30, 2001, $8.5 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
June 30, 2001.
Through the first six months of 2001, Gallagher paid $19.6 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 July
13, 2001, Gallagher paid a second quarter dividend of $.13 per share to
shareholders of record as of June 29, 2001, a 13% increase over the second
quarter dividend per share in 2000.
Net capital expenditures were $9.5 million and $9.4 million for each of the
six-month periods ended June 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.
In 1988, Gallagher adopted a common stock repurchase plan that has been extended
through June 30, 2002. Under the plan, Gallagher has repurchased 914,000 shares
at a cost of $25.1 million in the first six months of 2001. The repurchased
shares are held for reissuance in connection with exercises of options under its
stock option plans. Gallagher is authorized to repurchase under the provisions
of the plan, approximately 4.8 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 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 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Stockholders of Arthur J. Gallagher & Co.
held on May 22, 2001, 74,623,357 shares of Gallagher's Common Stock,
or 92.44% of the total Common Stock outstanding on the record date for
such meeting, were represented.
Among other things, the Stockholders of Gallagher elected Mr. T.
Kimball Brooker, Mr. Robert E. Gallagher, Mr. David E. McGurn, Jr.,
and Mr. Richard J. McKenna as Class II directors with terms expiring
in 2004, Mr. James W. Durkin, Jr., as a Class I director with a term
expiring in 2003, Mr. James J. Braniff III as a Class III director
with a term expiring in 2002, and ratified the appointment of Mr. Gary
P. Coughlan as a Class III director with a term expiring in 2002. Of
the shares voted with respect to the election of Mr. Brooker,
71,637,870 were voted in favor and 2,985,487 were withheld. Of the
shares voted with respect to the election of Mr. Gallagher, 68,307,130
were voted in favor and 6,316,227 were withheld. Of the shares voted
with respect to the election of Mr. McGurn, 71,208,957 were voted in
favor and 3,414,400 were withheld. Of the shares voted with respect to
the election of Mr. McKenna, 71,111,869 were voted in favor and
3,511,488 were withheld. Of the shares voted with respect to the
election of Mr. Durkin, 71,109,161 were voted in favor and 3,514,196
were withheld. Of the shares voted with respect to the election of Mr.
Braniff, 71,206,669 were voted in favor and 3,416,688 were withheld.
Of the shares voted with respect to the ratification of Mr. Coughlan,
71,633,623 were voted in favor and 2,989,734 were withheld.
In addition to Mr. Coughlan, continuing as Class III directors with
terms expiring in 2002 are Michael J. Cloherty and Robert Ripp.
Continuing as Class I directors with terms expiring in 2003 are J.
Patrick Gallagher, Jr., Ilene S. Gordon, and James R. Wimmer.
The Stockholders of Gallagher also approved an Amendment to Clause (A)
of Article FOURTH of Gallagher's Restated Certificate of Incorporation
increasing Gallagher's authorized common stock, from 200,000,000 to
400,000,000 shares. Of the shares voted with respect to the amendment,
62,247,299 were voted in favor, 9,309,833 were voted against, and
66,225 were withheld.
The Stockholders of Gallagher also ratified the appointment of Ernst &
Young LLP as independent auditors for the fiscal year ending December
31, 2001.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibit 3.1.2 - Certificate of Amendment of Restated Certificate of
Incorporation of Arthur J. Gallagher & Co. (Amended
as of May 23, 2001).
Exhibit 10.8.2 - Arthur J. Gallagher & Co. and AJG Financial
Services, Inc. Second Amendment to Credit Agreement
Dated as of May 31, 2001.
Exhibit 10.27.2 - Amendment No. 2 to the Arthur J. Gallagher & Co
Restated 1988 Nonqualified Stock Option Plan
(Amended as of January 18, 2001).
Exhibit 10.28.2 - Amendment No. 3 to the Arthur J. Gallagher & Co
Restated 1989 Non-Employee Directors' Stock Option
Plan (Amended as of January 18, 2001).
b. Reports on Form 8-K. No Reports on Form 8-K were filed during the three-
month period ended June 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 August,
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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