SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
Current Report
Pursuant to Section 13 or 15 (D) of the Securities Exchange Act of 1934
June 25, 2003
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Date of Report (Date of earliest event reported)
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Arthur J. Gallagher & Co.
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(Exact name of registrant as specified in its charter)
Delaware 1-9761 36-2151613
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(State or other jurisdiction of (Commission File Number) (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)
Item 5. Other Events.
Beginning with the Form 10-Q filed by Arthur J. Gallagher & Co. (Gallagher)
for the quarterly period ended March 31, 2003 (the "First Quarter 10-Q"),
Gallagher has changed the way it reports segment information. For all periods
ending on or prior to December 31, 2002, Gallagher had reported financial
information for three operating segments, Brokerage, Risk Management and
Financial Services, and a Corporate segment. Beginning in 2003, Gallagher's
segment disclosures only report information for the three operating segments and
no longer include information for Corporate. The identifiable assets and income
and expense amounts that were previously reported in the Corporate segment are
now allocated to the three operating segments. Consistent with the requirements
of Statement of Financial Accounting Standards No. 131, "Disclosures About
Segments of an Enterprise and Related Information," and to enhance comparability
with prior periods, Gallagher is filing this Form 8-K for the purpose of
providing financial statement and other historical financial information that
show segment information as of and for the three year period ended December 31,
2002 on the new basis of segment reporting that was adopted by Gallagher in its
First Quarter 10-Q.
In addition to the foregoing, beginning with the First Quarter 10-Q,
Gallagher has changed the way it reports commissions paid to sub-brokers on its
retail property/casualty (P/C) brokerage business. Such commissions had been
reported as other operating expenses in Gallagher's consolidated statements of
earnings, but are now reported as offsets to gross revenues in the consolidated
statements of earnings in order to conform to a more common industry practice.
Accordingly, the consolidated financial statements included herein have been
reclassified to conform to the current year presentation. This reclassification
had no impact on the previously reported net earnings or stockholders' equity.
The impact on total revenues and expenses of this reclassification is presented
in the consolidated statements of earnings included herein.
Operating Segments
Gallagher has identified three operating segments: Brokerage, Risk
Management and Financial Services. The Brokerage segment represents three
operating divisions: Retail Brokerage Services, Wholesale Brokerage Services and
Gallagher Benefit Services. The Brokerage segment, for commission or fee
compensation, places commercial P/C and employee benefit-related insurance on
behalf of its customers. The Risk Management segment provides P/C and health
claim third-party administration, loss control and risk management consulting
and insurance property appraisals. Third-party administration is principally the
management and processing of claims for self-insurance programs of Gallagher's
clients or clients of other brokers. The Financial Services segment is
responsible for managing Gallagher's diversified investment portfolio to
maximize long-term after-tax returns.
The two major sources of operating revenues for Gallagher are commissions
from insurance brokerage operations and service fees primarily from risk
management operations. Information with respect to all sources of revenue, by
operating segment, for each of the three years in the period ended December 31,
2002, is as follows (in thousands):
2002 2001 * 2000 *
---------------------- ---------------------- ----------------------
% of % of % of
Amount Total Amount Total Amount Total
----------- ------- ----------- -------- ----------- -------
Commissions
Brokerage $ 662,857 63% $ 537,933 61% $ 472,878 61%
Fees
Brokerage 109,046 10% 62,342 7% 51,678 7%
Risk Management 280,434 26% 263,612 30% 230,761 30%
Investment income and other
Brokerage 9,240 1% 12,070 1% 17,333 2%
Risk Management 817 - 1,084 - 1,534 -
Financial Services 38,828 4% 45,947 5% 26,396 3%
----------- ------ ----------- ------ ----------- ------
Gross revenues 1,101,222 104% 922,988 104% 800,580 103%
Less brokerage (41,015) (4%) (34,959) (4%) (26,048) (3%)
----------- ------ ----------- ------ ----------- ------
Total revenues $ 1,060,207 100% $ 888,029 100% $ 774,532 100%
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* Restated to conform to the current year presentation. See Note 3 to the
Consolidated Financial Statements.
2
See Note 18 to the Consolidated Financial Statements for additional
financial information, including earnings before income taxes and identifiable
assets, by operating segment, for 2002, 2001 and 2000.
During 2002 and 2001, Gallagher's total revenues and expenses increased
sequentially from quarter-to-quarter within the calendar years, except for the
second quarter of 2001 and the third quarter of 2002, the latter of which was
negatively impacted by $28.9 million of investment write-downs. However,
commission and fee revenues and the related expenses can vary from
quarter-to-quarter as a result of the timing of policy inception dates that
traditionally are heaviest in the third and fourth quarters. On the other hand,
salaries and employee benefits, rent, depreciation and amortization expenses
tend to be more uniform throughout the year. In addition, the timing of
acquisitions accounted for as purchases will also impact the trends in
Gallagher's quarterly operating results. See Note 17 to the Consolidated
Financial Statements for unaudited quarterly operating results for 2002 and
2001.
Brokerage
The Brokerage segment comprises the following operations: the Brokerage
Services Division (BSD) and Gallagher Benefit Services (GBS). BSD encompasses
two operating divisions: Retail Brokerage Services, Wholesale Brokerage Services
BSD places insurance for and services commercial, industrial,
institutional, governmental, religious and personal accounts throughout the
United States and abroad. BSD acts as an agent in soliciting, negotiating and
effecting contracts of insurance through insurance companies worldwide, as a
broker in procuring contracts of insurance on behalf of insureds, and in setting
up and managing self-insured programs. BSD has the capability to handle
insurable risks and related coverages for all forms of property/casualty
products. BSD also places surplus lines coverages, which are coverages for
various specialized risks not available from insurance companies licensed by the
states in which the risks are located. In addition, BSD's reinsurance
intermediary operations place reinsurance coverages for its insurance company
clients.
GBS specializes in the management of employee benefit programs through
fully insured and self-insured programs. GBS provides services in connection
with the design, financing, implementation, administration and communication of
compensation and employee benefit programs (including pension and profit-sharing
plans, group life, health, accident and disability insurance programs and tax
deferral plans), and provides other professional services in connection
therewith.
The primary source of Gallagher's compensation for its Brokerage segment is
commissions paid by insurance companies which are usually based upon a
percentage of the premium paid by insureds. Commission rates are dependent on a
number of factors including the type of insurance, the particular insurance
company and the capacity in which Gallagher acts. In some cases, Gallagher is
compensated for brokerage or advisory services directly by fees from clients.
Gallagher may also receive contingent commissions which are based on the
estimated profit the underwriting insurance company earns and/or the overall
volume of business placed by Gallagher in a given period of time. Occasionally,
Gallagher shares commissions with other brokers who have participated with
Gallagher in placing insurance or servicing insureds. GBS receives a fee for
acting in the capacity of advisor and administrator with respect to employee
benefit programs and receives commissions in connection with the placement of
insurance under such programs.
Risk Management
The Risk Management segment comprises two wholly-owned subsidiaries,
Gallagher Bassett Services, Inc. (GB) and Gallagher Benefit Administrators, Inc.
(GBA).
GB provides a full range of risk management services including claims
management, risk control consulting services, information management, property
appraisals on a totally integrated or select, stand-alone basis. GB provides
these services for Gallagher's clients through a network of service offices
located throughout the United States, Canada, England, Scotland and Australia.
GB primarily markets its risk management services directly to clients on an
unbundled basis independent of Gallagher. GB also markets these services to
BSD's clients who are interested in P/C risk management related services.
In connection with its risk management services, GB provides
"self-insurance" programs for large institutions, risk sharing pools and
associations, and large commercial and industrial customers. Self-insurance, as
administered by GB, is a program in which the client assumes a manageable
portion of its insurance risks, usually (although not always) placing the less
predictable and larger loss exposures with an insurance carrier that specializes
in these less predictable exposures.
GBA is a third-party administrator that serves the self-funded employee
health benefit marketplace by integrating effective managed care and quality
assurance programs with claims administration services. The employee health
benefit services provided by GBA are, in many instances, directly supported by
GBS.
3
GB's and GBA's revenues for risk management services are substantially in
the form of fees. These fees are typically negotiated in advance on an annual
basis based upon the estimated volume of the services to be performed.
Financial Services
Financial Services is primarily responsible for Gallagher's diversified
investment portfolio which includes investment strategies--trading, marketable
securities--trading, tax advantaged investments, real estate partnerships, an
investment in Allied World Assurance Holdings, Ltd., venture capital equity
investments, a minority investment in an alternative fund manager, notes
receivable from investees, and an investment in an airplane leasing company that
leases two cargo airplanes to the French postal service. Financial Services
manages the invested assets of Gallagher in order to maximize the long-term
after-tax return to Gallagher. See Note 4 to the Consolidated Financial
Statements of Gallagher's for a summary of Gallagher's investments and notes
receivable and for a summary of the assets and liabilities related to
Gallagher's unconsolidated investment portfolio, accounted for using the equity
method.
Gallagher's equity investment philosophy generally consists of investing in
tax advantaged investments and venture capital equity projects which take a
long-term view toward private sale or public offering. Gallagher uses the
limited partnership or limited liability company forms of legal ownership to
fund many of its investments in order to obtain favorable tax treatment with
respect to gains, losses and distributions, while limiting its liability. Based
on the ownership structure of these investments, management believes that
Gallagher's exposure to losses related to these investments is limited to the
combination of its net carrying value, funding commitments, letters of credit
and financial guarantees. In the event that certain of these limited
partnerships or limited liability companies 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. See Note 4 and Note 15 to the Consolidated
Financial Statements for a summary of outstanding letters of credit, financial
guarantees and funding commitments and Note 7 for a summary of outstanding debt
and contingent commitments.
4
Selected Financial Data
The following selected consolidated financial data for each of the five
years in the period ended December 31, 2002 have been derived from Gallagher's
consolidated financial statements. Such data should be read in conjunction with
Gallagher's audited Consolidated Financial Statements and related notes thereto.
Year Ended December 31, (1)
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2002 2001 2000 1999 1998
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(In thousands, except per share and employee data)
Consolidated Statement of Earnings Data:
Commissions $ 662,857 $ 537,933 $ 472,878 $ 440,828 $ 421,256
Fees 389,480 325,954 282,439 235,879 213,360
Investment income and other 48,885 59,101 45,263 39,230 24,980
----------- ----------- ----------- ----------- -----------
Gross revenues 1,101,222 922,988 800,580 715,937 659,596
Less brokerage (41,015) (34,959) (26,048) (16,735) (15,517)
----------- ----------- ----------- ----------- -----------
Total revenues 1,060,207 888,029 774,532 699,202 644,079
Total expenses 874,865 746,176 640,793 572,178 560,913
----------- ----------- ----------- ----------- -----------
Earnings before income taxes 185,342 141,853 133,739 127,024 83,166
Provision for income taxes 55,603 16,597 40,784 43,784 16,287
----------- ----------- ----------- ----------- -----------
Net earnings $ 129,739 $ 125,256 $ 92,955 $ 83,240 $ 66,879
=========== =========== =========== =========== ===========
Per Share Data:
Basic net earnings per share (2) $ 1.49 $ 1.48 $ 1.11 $ 1.02 $ .83
Diluted net earnings per share (3) 1.41 1.39 1.04 .97 .80
Dividends declared per common share (4) .60 .52 .46 .40 .35
Share Data:
Shares outstanding at year end 88,548 85,111 84,540 82,157 81,169
Weighted average number of common shares
outstanding 87,303 84,795 83,558 81,678 80,757
Weighted average number of common and
common equivalent shares outstanding 91,861 90,127 88,967 85,606 83,973
Consolidated Balance Sheet Data:
Total assets $ 2,463,574 $ 2,145,342 $ 1,626,771 $ 1,364,302 $ 1,243,946
Long-term debt less current portion 128,349 96,698 103,856 13,900 15,500
Total stockholders' equity 528,155 371,613 328,900 260,801 268,668
Return on Beginning Stockholders'
Equity (5) 35% 38% 36% 31% 28%
Employee Data:
Number of employees at year end 7,111 6,499 5,714 5,344 5,128
Total gross revenue per employee (6) $ 155 $ 142 $ 140 $ 134 $ 129
Net earnings per employee (6) $ 18 $ 19 $ 16 $ 16 $ 13
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(1) Restated to conform to the current year presentation. See Note 3 to the
Consolidated Financial Statements.
(2) Based on the weighted average number of common shares outstanding during
the year.
(3) Based on the weighted average number of common and common equivalent shares
outstanding during the year.
(4) Based on the total dividends declared on a share of common stock
outstanding during the entire year.
(5) Represents annual net earnings divided by stockholders' equity as of the
beginning of the year.
(6) Based on the number of employees at year end.
5
Results Of Operations -- Segment Information
As discussed in Note 18 to the Consolidated Financial Statements, Gallagher
operates in three business segments; Brokerage, Risk Management and Financial
Services.
Brokerage
Total revenues for this segment increased $162.7 million, or 28%, to $740.1
million in 2002. Total domestic revenues were up $134.9 million, or 26%, to
$661.0 million in 2002 and total foreign revenues, principally in the United
Kingdom, Australia and Bermuda, were up $27.8 million, or 54%, to $79.2 million
in 2002. These increases are due principally to new business, renewal rate
increases and the effect of acquisitions accounted for as purchases that were
made in the fourth quarter of 2001 and throughout 2002, partially offset by lost
business. Earnings before income taxes increased $31.2 million, or 27%, to
$148.7 million in 2002 due primarily to the new business production and rate
increases mentioned above.
Total revenues increased $61.5 million, or 12%, to $577.4 million in 2001.
This increase is due primarily to new business production offset partially by
lost business and a $5.6 million reduction in interest income generated from the
float on fiduciary funds in 2001. The decrease in the fiduciary interest income
is due to the decrease in short-term interest rates during 2001. Total domestic
revenues were up $53.6 million, or 11%, to $526.1 million in 2001 and total
foreign revenues, principally in the United Kingdom, Australia and Bermuda, were
up $8.0 million, or 18%, to $51.3 million in 2001. These increases are due
primarily to new business production offset partially by lost business. Earnings
before income taxes increased $20.0 million, or 21%, to $117.5 million in 2001
principally as a result of increased revenues.
Risk Management
Total revenues for this segment increased $16.6 million, or 6%, to $281.3
million in 2002 due primarily to new business production substantially offset by
reductions in existing business volume and by lost business. Total domestic
revenues were up $14.3 million, or 6%, to $256.7 million in 2002 and total
foreign revenues, principally from the United Kingdom and Australia, were up
$2.2 million, or 10% to $24.5 million in 2002. The slowdown in total revenue
growth from historical double-digit percentages to recent single-digit
percentages, is primarily the result of the events of September 11, 2001,
combined with a general economic slowdown in the United States. GB provides
services to several airline, hospitality and restaurant-related clients, all of
whose businesses were particularly hard hit following September 11th. Because
those clients experienced declines in their business, including reductions in
their headcount, the rate of increase in new GB claim counts slowed, and for
some clients, actual claim counts decreased from the same period in 2001. In
addition, the hard market had an unfavorable impact on GB as several of its
managing general agent programs were unable to renew their coverages in the
reinsurance marketplace during 2002. GB's 2002 operating results were also
negatively impacted by several insurance carrier insolvencies in 2002 and 2001.
As GB's revenues are generally based on the number of new claims it handles, the
reduction in claims has had a direct impact on revenue. As revenues slow,
expenses in the short-term do not experience the same immediate reduction. The
net result of the above is that earnings before income taxes for the segment of
$31.5 million in 2002 were flat compared to 2001.
Total revenues were up $32.4 million, or 14%, to $264.7 million in 2001 due
to strong new business production and favorable retention rates on existing
business. Total domestic revenues were up $32.0 million, or 15%, to $242.4
million in 2001 and total foreign revenues, principally from the United Kingdom
and Australia, were up $382,000, or 2%, to $22.3 million in 2001 due primarily
to new business and substantially less lost business than in 2000. Earnings
before income taxes of $31.3 million in 2001 were flat compared to 2000.
6
Financial Services
Total revenues for this segment decreased $7.1 million, or 15%, to $38.8
million in 2002. This decrease is primarily due to the following previously
discussed items:
. Other-than-temporary impairments that resulted from the sharp decline in
the equity markets during 2002, most of which occurred in the third
quarter. During 2002, Gallagher recognized other-than-temporary impairments
of $10.6 million in the consolidated statements of earnings related to its
marketable securities portfolio.
. An unrealized loss of $425,000 that was recognized in the third quarter of
2002 related to reclassifying the marketable securities portfolio from
available for sale to trading.
. Aggregate write-downs of loans and equity holdings of $19.6 million related
to venture capital investments that were recognized in 2002. In addition,
Gallagher incurred a $3.6 million loss in 2002 on the sale of a venture
capital investment.
. The $3.0 million loss that was recognized by Gallagher in the fourth
quarter of 2002 through the equity method of accounting for Asset Alliance
Corporation's (AAC) write-down of its investment in Beacon Hill.
. A one-time gain of $4.5 million generated from the sale of land by Harmony
that was recognized in the first quarter of 2001.
These decreases are partially offset by installment gains from the sales of
Gallagher's interests in limited partnerships that operate synthetic fuel
facilities that were completed in the third and fourth quarters of 2001 and the
first and fourth quarters of 2002. These installment gains increased $22.9
million, or 195%, to $34.6 million in 2002. In addition, the $11.8 million gain
on the sale of a portion of Gallagher's minority interest in AAC also offset the
2002 decreases discussed above.
Earnings before income taxes increased $12.2 million, or 175%, to $5.2
million in 2002. This increase is primarily due to the $14.9 million reduction
in the operating expenses of alternative energy partnerships, the $22.9 million
increase in installment gains and the $11.8 million gain on the sale of a
portion of Gallagher's minority interest in AAC, all of which were significantly
offset by the impairments and write-downs discussed above.
Total revenues increased $19.6 million, or 74%, to $45.9 million in 2001
due primarily to realized gains of $2.8 million generated from Gallagher's
investment strategies and marketable securities portfolios, increased
installment gains on the alternative energy sale transactions discussed above
and to income generated from commitment fees paid to Gallagher for providing
letters of credit and financial guarantees to three of its investees. Also
contributing to the increase in total revenues was income from real estate
ventures related to the $4.5 million gain from Harmony mentioned above and the
$2.4 million gain recognized on the sale of a benefits administration book of
business in 2001.
Earnings before income taxes decreased $11.5 million, or 255%, to a loss of
$7.0 million in 2001 due primarily to the increase in operating expenses of
alternative energy partnerships of $21.1 million in 2001, which represents
Gallagher's portion of the production costs associated with the operations of
the synthetic fuel facilities. The increase in these expenses in 2001 relates to
the production costs incurred by the alternative energy partnerships that
generated a substantial portion of the tax credits earned by Gallagher in 2001.
The tax credits generated by these investments are included in the provision for
income taxes, which is not allocated to Gallagher's operating entities. The
impact of the increase in operating expenses of alternative energy partnerships
on 2001 earnings before income taxes was partially offset by the revenue
increases discussed above.
Information Concerning Forward-Looking Statements
This current report contains forward-looking statements within the meaning
of that term in the Private Securities Litigation Reform Act of 1995 (the "Act")
found at Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Additional
written or oral forward-looking statements may be made by Gallagher from time to
time in filings with the Securities and Exchange Commission (SEC), press
releases, or otherwise. Statements contained in this report that are not
historical facts are forward-looking statements made pursuant to the safe harbor
provisions of the Act. Forward-looking statements may include, but are not
limited to, discussions concerning revenues, expenses, earnings, cash flow,
capital structure, financial losses, as well as market and industry conditions,
premium rates, financial markets, interest rates, foreign exchange rates,
contingencies and matters relating to Gallagher's operations and income taxes.
In addition, when used in this report, the words "anticipates," "believes,"
"should," "estimates," "expects," "intends," "plans" and variations thereof and
similar expressions are intended to identify forward-looking statements. Such
forward-looking statements are based on available current market and industry
material, experts' reports and opinions and long-term trends, as well as
management's expectations concerning future events impacting Gallagher.
7
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, returns on
investments 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.
Readers are cautioned not to place undue reliance on any forward-looking
statements contained in this report, which speak only as of the date set forth
on the signature page hereto. Gallagher undertakes no obligation to publicly
release the result of any revisions to these forward-looking statements that may
be made to reflect events or circumstances after such date or to reflect the
occurrence of anticipated or unanticipated events.
Item 7. Exhibits.
23.1 Consent of Ernst & Young LLP, independent auditors.
99.1 Gallagher's 2002 Audited Financial Statements.
8
Signature
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 25th day of
June, 2003.
Arthur J. Gallagher & Co.
/s/ Richard C. Cary
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Richard C. Cary
Controller and Chief Accounting Officer
9
Arthur J. Gallagher & Co.
Current Report on Form 8-K
Exhibit Index
23.1 Consent of Ernst & Young LLP, independent auditors.
99.1 Gallagher's 2002 Audited Financial Statements.
10