SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report under section 13 or 15 (d) of the Securities Exchange Act
of 1934 for the quarterly period ended March 31, 1999 or
[ ] Transition report pursuant to section 13 or 15 (d) of the Securities
Exchange Act of 1934 for the transition period
from
------------------ to -------------------------------
Commission File Number 1-9761
ARTHUR J. GALLAGHER & CO.
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(Exact name of registrant as specified in its charter)
DELAWARE 36-2151613
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Two Pierce Place, Itasca, Illinois 60143-3141
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(Address of principal executive offices) (Zip Code)
(630) 773-3800
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X] NO [ ]
The number of outstanding shares of the registrant's Common Stock, $1.00 par
value, as of March 31, 1999 was 17,989,797.
ARTHUR J. GALLAGHER & CO.
INDEX
Page No.
Part 1. Financial Information:
Item 1. Financial Statements (Unaudited):
Consolidated Statement of Earnings for the three-month
period ended March 31, 1999 and 1998............. 3
Consolidated Balance Sheet at March 31, 1999 and
December 31, 1998................................ 4
Consolidated Statement of Cash Flows for the three-month
period ended March 31, 1999 and 1998............. 5
Notes to Consolidated Financial Statements............ 6-7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.... 8-12
Part II. Other Information
Item 5. Other Information..................................... 13
Item 6. Exhibits and Reports on Form 8-K...................... 13
Signatures..................................................... 14
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ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENT OF EARNINGS
(UNAUDITED)
Three-month period ended
March 31,
1999 1998
---- ----
(In thousands, except per share data)
Operating Results
Revenues:
Commissions $ 77,880 $ 71,405
Fees 52,602 47,607
Investment income and other 4,633 7,201
-------- --------
Total revenues 135,115 126,213
Expenses:
Salaries and employee benefits 73,714 68,489
Other operating expenses 40,983 40,317
-------- --------
Total expenses 114,697 108,806
-------- --------
Earnings before income taxes 20,418 17,407
Provision for income taxes 7,146 5,721
-------- --------
Net earnings $ 13,272 $ 11,686
======== ========
Net earnings per common share $ .73 $ .67
Net earnings per common and
common equivalent share .70 .64
Dividends declared per common share .40 .35
See notes to consolidated financial statements.
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ARTHUR J. GALLAGHER & CO.
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
March 31, December 31,
1999 1998
--------- ------------
(In thousands)
ASSETS
Current assets:
Cash and cash equivalents $ 43,917 $ 64,469
Restricted cash 99,469 90,560
Premiums and fees receivable 256,894 292,979
Investment strategies - trading 57,874 57,368
Other 41,699 37,289
-------- --------
Total current assets 499,853 542,665
Marketable securities - available for sale 20,229 20,089
Deferred income taxes and other
noncurrent assets 154,900 151,336
Fixed assets 101,572 99,656
Accumulated depreciation and amortization (68,567) (67,852)
-------- --------
Net fixed assets 33,005 31,804
Intangible assets - net 12,451 12,541
-------- --------
$720,438 $758,435
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Premiums payable to insurance companies $364,480 $380,112
Accrued salaries and bonuses 11,941 21,940
Accounts payable and other accrued
liabilities 88,350 92,129
Unearned fees 18,227 13,616
Income taxes payable 5,480 12,621
Other 15,619 19,517
-------- --------
Total current liabilities 504,097 539,935
Other noncurrent liabilities 12,455 12,953
Stockholders' equity:
Common stock - issued and outstanding
17,990 shares in 1999 and 18,049
shares in 1998 17,990 18,049
Capital in excess of par value 7,151 12,885
Retained earnings 179,758 175,390
Accumulated other comprehensive
earnings (loss) (1,013) (777)
-------- --------
Total stockholders' equity 203,886 205,547
-------- --------
$720,438 $758,435
======== ========
See notes to consolidated financial statements.
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ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Three-month period ended
March 31,
1999 1998
----- ------
(In thousands)
Cash flows from operating
activities:
Net earnings $ 13,272 $ 11,686
Adjustments to reconcile
net earnings to net cash provided
by operating activities:
Net gain on investments and
other (63) (1,780)
Depreciation and amortization 3,252 2,950
Increase in restricted cash (8,909) (22,334)
Decrease in premiums receivable 36,939 31,107
Decrease in premiums payable (15,632) (2,635)
Increase in trading
investments - net (528) (894)
(Increase) decrease in other
current assets (4,410) 587
Decrease in accrued salaries
and bonuses (9,999) (8,297)
Decrease in accounts payable
and other accrued liabilities (6,063) (1,888)
Decrease in income taxes payable (7,141) (4,551)
Net change in deferred income
taxes 1,416 786
Other 4,868 1,534
-------- --------
Net cash provided by operating
activities 7,002 6,271
-------- --------
Cash flows from investing activities:
Purchases of marketable securities (13,604) (8,819)
Proceeds from sales of marketable
securities 13,058 9,081
Proceeds from maturities of marketable
securities 68 237
Net additions to fixed assets (4,198) (1,928)
Other (5,465) (15,263)
-------- --------
Net cash used by investing
activities (10,141) (16,692)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 5,499 6,800
Tax benefit from issuance of common stock 1,491 1,793
Repurchases of common stock (11,530) (15)
Dividends paid (6,176) (5,143)
Retirement of long-term debt - (630)
Borrowings on line of credit facilities 5,000 -
Repayments on line of credit facilities (10,000) (15,000)
Equity transactions of pooled companies
prior to dates of acquisition (1,697) 570
-------- --------
Net cash used by financing activities (17,413) (11,625)
-------- --------
Net decrease in cash and cash equivalents (20,552) (22,046)
Cash and cash equivalents at
beginning of period 64,469 76,568
-------- --------
Cash and cash equivalents
at end of period $ 43,917 $ 54,522
======== ========
Supplemental disclosures of
cash flow information:
Interest paid $ 197 $ 257
Income taxes paid 10,699 5,482
See notes to consolidated financial statements.
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ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared by the Company 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. The Company 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, 1998 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
the Company's 1998 Annual Report to Stockholders.
2. Business Combinations
During the three-month period ended March 31, 1999, the Company acquired
substantially all of the net assets of the following companies in exchange
for its common stock: Goodman Insurance Agency, Inc., 157,385 shares;
Dodson-Bateman & Company, 147,480 shares; and Associated Risk Managers of
California, Insurance Producers, dba ARM of California, 99,054 shares.
These acquisitions were accounted for as poolings of interests. 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 1998 consolidated financial
statements to reflect the operations of these acquisitions (in thousands,
except per share data):
Attributable
Three-month period Arthur J. to Pooled
ended March 31, 1998 Gallagher & Co. Companies As Restated
- -------------------- --------------- ------------- -----------
Revenues $123,702 $2,511 $126,213
Net earnings 11,494 192 11,686
Net earnings per common share .68 (.01) .67
Net earnings per common and
common equvalent share .65 (.01) .64
On May 1, 1999, the Company acquired substantially all of the net assets of
R. W. Thom & Company, a California corporation engaged in the retail
insurance brokerage business. The Company paid cash in this transaction
which was not material to the consolidated financial statements.
3. 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,
1999 1998
------- -------
Net earnings $13,272 $11,686
======= =======
Weighted average number of common
shares outstanding 18,085 17,420
Dilutive effect of stock options
using the treasury stock method 922 750
------- -------
Weighted average number of common
and common equivalent shares outstanding 19,007 18,170
======= =======
Net earnings per common share $ .73 $ .67
Net earnings per common and common
equivalent share .70 .64
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ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (Continued)
3. Earnings Per Share (continued)
Options to purchase 33,000 and 4,000 shares of common stock were
outstanding during the three-month period ended March 31, 1999, and 1998,
respectively, but were not included in the computation of the dilutive
effect of stock options. These options were excluded from the computation
because the options' exercise prices were greater than the average market
price of the common shares and, therefore, would be antidilutive.
4. Comprehensive Earnings
The components of comprehensive earnings and accumulated other
comprehensive earnings (loss) are as follows (in thousands):
Three-month period ended
March 31,
1999 1998
------- -------
Net earnings $13,272 $11,686
Net change in unrealized gain on available for
sale securities, net of income taxes
of ($158) and $96, respectively (236) 144
------- -------
Comprehensive earnings $13,036 $11,830
======= =======
Accumulated other comprehensive earnings (loss)
at beginning of period $ (777) $ 1,658
Net change in unrealized gain on available for
sale securities, net of income taxes (236) 144
------- -------
Accumulated other comprehensive earnings (loss)
at end of period $(1,013) $ 1,802
======= =======
5. Effect of New pronouncements
In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for
Derivative Instruments and Hedging Activities," which is effective for
fiscal years beginning after June 15, 1999. Because of the Company's
minimal use of derivatives, management does not anticipate that the
adoption of SFAS 133 will have a significant effect on the Company's
consolidated operating results or financial position.
In 1998, the Accounting Standards Executive Committee of the AICPA issued
Statement of Position 98-1 (SOP 98-1), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1, which
has been adopted prospectively as of January 1, 1999, requires the
capitalization of certain costs incurred in connection with developing or
obtaining internal use software. Prior to the adoption of SOP 98-1, the
Company expensed all internal use software related costs as incurred. The
effect of adopting SOP 98-1 was not material to the Company's consolidated
operating results.
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ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS - CONSOLIDATED
Insurance premiums and risk management income reflect the overall pricing
pressure throughout the insurance premium marketplace, and the Company does not
anticipate any change in the near future in this extremely competitive
environment.
Commission revenues increased by 9% to $77.9 million in the first quarter of
1999 over the same period in 1998. This increase is due principally to new
business production and the results of a strong niche marketing plan partially
offset by lost business.
Fee revenues increased by 10% to $52.6 million in the first quarter of 1999 over
the same period in 1998. This increase reflects strong new business production
of approximately $10.4 million generated primarily by Gallagher Bassett
Services, Inc. through the sale of self-insurance products, substantially offset
by lost business.
Investment income and other decreased 36% to $4.6 million in the first quarter
of 1999 from the same period in 1998. This decrease is due primarily to lower
returns from several investment strategies which are invested with outside fund
managers, and reduced interest income on lower average cash balances in the
first quarter of 1999.
Salaries and employee benefits increased by $5.2 million or 8%, to $73.7 million
in the first quarter of 1999 over the same period in 1998. This increase is due
principally to an 8% increase in the number of employees in the first quarter of
1999 over the same period in 1998, and to salary increases and associated
employee fringe benefit costs.
Other operating expenses increased by $.7 million or 2% to $41.0 million in the
first quarter of 1999 over the same period in 1998. This increase is due
primarily to increases in rent and general office expenses related to new leases
and office expansions and outside brokerage expense.
The effective income tax rate of 35% for the first quarter of 1999 is equal to
the statutory federal rate. The effective income tax rate of 33% for the first
quarter of 1998 is less than the statutory federal rate due primarily to the
effects of tax benefits generated by certain investments which are substantially
offset by state and foreign taxes.
Net earnings per common and common equivalent share for the first quarter of
1999 were $.70 compared to $.64 for the same period in 1998, a 9% increase. This
increase primarily reflects the growth in revenues, partially offset by a
smaller growth in expenses and a 5% increase in the weighted average number of
common and common equivalent shares outstanding.
RESULTS OF OPERATIONS - SEGMENT INFORMATION
Financial information relating to the Company's operating segments is as follows
(in thousands):
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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 Risk
Brokerage Management Financial
Services Services Services Corporate Total
--------- ---------- --------- ---------- --------
Three-month period ended
March 31, 1999
Total revenues $ 87,886 $44,618 $ 2,611 $ - $135,115
Earnings (loss) before income taxes 13,763 6,685 1,369 (1,399) 20,418
Total identifiable assets 415,252 48,959 208,105 48,122 720,438
Three-month period ended
March 31, 1998
Total revenues 82,583 39,120 4,510 - 126,213
Earnings (loss) before income taxes 10,391 4,349 3,663 (996) 17,407
Total identifiable assets 383,072 38,164 190,405 40,095 651,736
Insurance Brokerage Services
Insurance Brokerage Services includes the Company's retail, reinsurance and
wholesale brokerage operations. Total revenues in the first three months of 1999
were $87.9 million, a 6% increase over the same period in 1998. This increase is
due primarily to new business production and the positive effect of the 1998
acquisitions, significantly offset by lost business. Earnings before income
taxes in the first quarter of 1999 increased $3.4 million or 32% over the same
period in 1998 due mainly to increased revenues.
Risk Management Services
Risk Management Services includes the Company's third party claims
administration operations which are principally engaged in providing claims
management services for the Company's clients. Total revenues in the first three
months of 1999 were $44.6 million or 14% over the same period in 1998 due to
strong new business production and favorable retention rates on existing
business. Earnings before income taxes in the first quarter of 1999 increased
54% to $6.7 million over the same period in 1998 due primarily to increased
revenues.
Financial Services
Financial Services is primarily responsible for the Company's comprehensive
investment portfolio which includes investment strategies held as trading,
marketable securities held as available for sale, tax advantaged investments,
investments on the equity method of accounting, real estate partnerships and
notes receivable from investees.
-9-
ARTHUR J. GALLAGHER & CO.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS - SEGMENT INFORMATION (Continued)
Financial Services (Continued)
Revenues in the first quarter of 1999 were $2.6 million or $1.9 million less
than revenues in the same period in 1998 and earnings before income taxes
decreased $2.3 million or 63% from the same period in 1998. These decreases
relate to lower returns on funds invested with outside fund managers and lower
interest income on reduced cash and investment balances from the same period in
1998.
Corporate
Corporate consists of unallocated administrative costs and the provision for
income taxes which is not allocated to the Company's operating entities.
Revenues are not normally recorded in this segment.
FINANCIAL CONDITION AND LIQUIDITY
The insurance brokerage industry is not capital intensive. The Company has
historically been profitable and cash flows from operations and short-term
borrowings under various credit agreements have been sufficient to fund
operating, investment and capital expenditure needs of the Company. Cash
generated from operating activities was $7.0 million and $6.3 million for the
three months ended March 31, 1999 and 1998 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 the Company's use, primarily premiums held as
fiduciary funds, have not been included in determining the Company's overall
liquidity.
The Company maintains a $20.0 million unsecured revolving credit agreement (the
"Credit Agreement") requiring repayment of any loans under the agreement no
later than June 30, 2001. As of March 31, 1999, there were no borrowings
outstanding under this agreement. The Credit Agreement requires the maintenance
of certain financial covenants and the Company is currently in compliance with
these covenants.
The Company has line of credit agreements which have been increased from $27.5
million to $40.0 million. Agreements totaling $30.0 million expire on April 29,
2000, and another agreement for $10.0 million expires on May 21, 1999.
Periodically, the Company will make short-term borrowings under these facilities
to meet short-term cash flow needs. During the three months ended March 31,
1999, the Company borrowed $5.0 million and repaid $10.0 million of short-term
borrowings under these facilities, which was primarily used on a short-term
basis to finance a portion of the Company's operations. As of March 31, 1999,
there was $10.0 million outstanding under these facilities.
As of March 31, 1999, the Company has committed to invest $7.5 million related
to two letter of credit arrangements with one of its equity investments and has
unconditionally guaranteed $30.0 million of debt that was incurred by another of
its investments. In addition, the Company has guaranteed an aggregate $7.9
million of funds through letters of credit or other arrangements related to
several investments and insurance programs of the Company. No funds have been
expended related to these guarantees.
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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)
Through the first three months of 1999, the Company paid $6.2 million in cash
dividends on its common stock. The Company's dividend policy is determined by
the Board of Directors and payments are fixed after considering the Company's
available cash from earnings and its known or anticipated cash needs. In January
1999, the Company announced a first quarter dividend of $.40 per share, a 14%
increase over the first quarter dividend in 1998.
Net capital expenditures were $4.2 million and $1.9 million for each of the
three month periods ended March 31, 1999 and 1998 respectively. The $1.3 million
increase is due primarily to expansion of facilities at the Company's
headquarters building in Itasca, Illinois. In 1999, the Company expects to make
expenditures for capital improvements of approximately $14.5 million. Capital
expenditures by the Company are related primarily to office moves and expansions
and updating computer systems and equipment.
In 1988, the Company adopted a plan, which has been extended through June 30,
1999, to repurchase its common stock. Through the first three months of 1999,
the Company repurchased 273,000 shares at a cost of $11.5 million. The
repurchased shares are held for reissuance in connection with exercises of
options under its stock option plans. Under the provisions of the plan, the
Company is authorized to repurchase approximately 260,000 additional shares
through June 30, 1999. The Company 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.
YEAR 2000 COMPLIANCE
Computer programs that have time sensitive software may recognize the date "00"
as the Year 1900, rather than the Year 2000 which could result in system
failures or miscalculations causing disruptions of operations. With respect to
this issue, the Company has completed an assessment of its computer systems and
software and has substantially completed the necessary modifications or
replacements of its existing software so that its computer systems will function
properly in the Year 2000 and beyond. Testing and live use have taken place and
will continue in 1999. Any additional modifications found necessary will be made
at that time. No contingency plans are deemed necessary.
The Company has evaluated the impact on operations of the Year 2000 on non-
information technology systems and has determined that any potential impact
would not be material to the Company's operations.
Generally, system modifications and replacements and the associated costs were
contemplated with normal enhancements and improvements being made in conjunction
with updating financial reporting and operating systems. To date, the cost of
compliance has not been material and is not expected to be material in the
future.
The Company also has an ongoing program to review the status of Year 2000
compliance efforts of its business partners and vendors. While the Company
believes it is taking the appropriate steps to assure the Company's Year 2000
compliance, it is also dependent on business partner, vendor and client
compliance to some extent. Consequently, any Year 2000 compliance problems that
may be experienced by the Company's business partners, vendors or clients could
have a material adverse effect on the Company's future financial condition and
future operating results. No assurance can be given that the Company's and these
other entities' efforts will completely address the Year 2000 issue.
-11-
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 the Company are subject to risks and
uncertainties, including but not limited to the following: the Company's
commission revenues are highly dependent on premiums charged by insurers, which
are subject to fluctuation; the property/casualty insurance industry continues
to experience a prolonged soft market (low premium rates) thereby reducing
commissions; lower interest rates will reduce the Company's income earned on
invested funds; the alternative insurance market continues to grow which could
unfavorably impact commission and favorably impact fee revenue; the Company'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 the
Company's renewal business; the Company's operating results and financial
position may be adversely impacted by exposure to various market risks such as
interest rate, equity pricing and foreign exchange rates; and the Company's Year
2000 compliance efforts depend upon compliance efforts of the Company's business
partners, vendors and clients. The Company'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 the
Company. Accordingly, actual results may differ materially from those set forth
in the forward-looking statements.
-12-
ARTHUR J. GALLAGHER & CO.
PART II - OTHER INFORMATION
Item 5. Other Information
a. Exhibit 99 is incorporated herein by reference.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibit 27.0 - Financial Data Schedule (Unaudited).
b. Exhibit 99 - Press Release of Arthur J. Gallagher & Co. dated
April 22, 1999.
c. Reports on Form 8-K. No Reports on Form 8-K were filed during the
three-month period ended March 31, 1999.
-13-
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, 1999.
ARTHUR J. GALLAGHER & CO.
/s/Michael J. Cloherty
---------------------------------------
Michael J. Cloherty
Executive Vice President
Chief Financial Officer
/s/Jack H. Lazzaro
---------------------------------------
Jack H. Lazzaro
Vice President - Finance
Chief Accounting Officer
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