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 September 30, 1997 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. ------------------------------------------------------ (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 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (630) 773-3800 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [_] The number of outstanding shares of the registrant's Common Stock, $1.00 par value, as of September 30, 1997 was 16,490,357.
ARTHUR J. GALLAGHER & CO. INDEX <TABLE> <CAPTION> Page No. <S> <C> Part I. Financial Information: Item 1. Financial Statements (Unaudited): Consolidated Statement of Earnings for the three-month and nine-month periods ended September 30, 1997 and 1996................................................... 3 Consolidated Balance Sheet at September 30, 1997 and December 31, 1996........................................................................... 4 Consolidated Statement of Cash Flows for the nine-month periods ended September 30, 1997 and 1996................................................................. 5 Notes to Consolidated Financial Statements...................................................... 6-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................... 8-10 Part II. Other Information: Item 6. Exhibits and Reports on Form 8-K................................................................ 11 Exhibit 11.0 - Computation of Net Earnings Per Common and Common Equivalent Share (Unaudited) Exhibit 27.0 - Financial Data Schedule (Unaudited) Signatures.............................................................................................. 12 </TABLE> -2-
ARTHUR J. GALLAGHER & CO. CONSOLIDATED STATEMENT OF EARNINGS (UNAUDITED) <TABLE> <CAPTION> Three-month period Nine-month period ended September 30, ended September 30, 1997 1996 1997 1996 -------- -------- -------- -------- (In thousands, except per share data) <S> <C> <C> <C> <C> Revenues: Commissions $ 72,702 $ 71,339 $199,197 $196,772 Fees 48,127 46,075 133,254 126,468 Investment income and other 9,572 5,702 26,005 17,894 -------- -------- -------- -------- Total revenues 130,401 123,116 358,456 341,134 Expenses: Salaries and employee benefits 63,547 61,207 182,745 181,391 Other operating expenses 38,726 36,909 114,204 109,148 -------- -------- -------- -------- Total expenses 102,273 98,116 296,949 290,539 -------- -------- -------- -------- Earnings before income taxes 28,128 25,000 61,507 50,595 Provision for income taxes 9,563 7,315 20,912 17,375 -------- -------- -------- -------- Net earnings $ 18,565 $ 17,685 $ 40,595 $ 33,220 ======== ======== ======== ======== Net earnings per common and common equivalent share $ 1.06 $ 1.00 $ 2.31 $ 1.89 Dividends declared per common share $ .31 $ .29 $ .93 $ .87 Weighted average number of common and common equivalent shares outstanding 17,740 17,938 17,880 17,863 </TABLE> See accompanying notes. -3-
ARTHUR J. GALLAGHER & CO. CONSOLIDATED BALANCE SHEET (UNAUDITED) <TABLE> <CAPTION> September 30, December 31, 1997 1996 ------------- ------------ <S> <C> <C> (In thousands) ASSETS Current assets: Cash and cash equivalents $ 53,877 $ 57,017 Restricted cash 95,241 87,224 Premiums and fees receivable 201,347 237,640 Investment strategies - trading 61,423 53,409 Other 34,670 30,003 -------- -------- Total current assets 446,558 465,293 Marketable securities - available for sale 40,884 36,881 Deferred income taxes and other noncurrent assets 68,412 52,783 Fixed assets 84,094 80,794 Accumulated depreciation and amortization (58,199) (54,556) -------- -------- Net fixed assets 25,895 26,238 Intangible assets - net 10,353 11,093 -------- -------- $592,102 $592,288 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Premiums payable to insurance companies $317,818 $323,867 Accrued salaries and bonuses 12,326 14,922 Accounts payable and other accrued liabilities 74,507 69,706 Unearned fees 12,770 13,043 Income taxes payable 1,345 4,965 Other 5,736 20,305 -------- -------- Total current liabilities 424,502 446,808 Other noncurrent liabilities 12,385 11,579 Stockholders' equity: Common stock - issued and outstanding 16,490 shares in 1997 and 16,457 shares in 1996 16,490 16,457 Capital in excess of par value 2,852 2,140 Retained earnings 133,731 114,415 Unrealized gain on available for sale securities - net of income taxes 2,142 889 -------- -------- Total stockholders' equity 155,215 133,901 -------- -------- $592,102 $592,288 ======== ======== </TABLE> See accompanying notes. -4-
ARTHUR J. GALLAGHER & CO. CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> Nine-month period ended September 30, 1997 1996 -------- -------- <S> <C> <C> (In thousands) Cash flows from operating activities: Net earnings $ 40,595 $ 33,220 Adjustments to reconcile net earnings to net cash provided by operating activities: Net gain on investments (3,449) (2,748) Depreciation and amortization 7,983 7,879 Increase in restricted cash (8,017) (6,698) Decrease in premiums receivable 32,830 32,439 Decrease in premiums payable (6,049) (6,947) Increase in trading investments - net (5,335) (3,258) Increase in other current assets (4,667) (3,276) Decrease in accrued salaries and bonuses (2,596) (5,636) Increase in accounts payable and other accrued liabilities 3,902 6,294 Decrease in income taxes payable (3,620) (243) Increase (decrease) in deferred income taxes 732 (1,198) Other 1,752 3,063 -------- -------- Net cash provided by operating activities 54,061 52,891 -------- -------- Cash flows from investing activities: Purchases of marketable securities (19,918) (18,353) Proceeds from sales of marketable securities 18,536 17,520 Proceeds from maturities of marketable securities 1,289 1,767 Additions to fixed assets (6,900) (7,613) Other (19,344) (9,185) -------- -------- Net cash used by investing activities (26,337) (15,864) -------- -------- Cash flows from financing activities: Proceeds from issuance of common stock 7,966 7,275 Tax benefit from issuance of common stock 1,747 1,809 Repurchases of common stock (14,536) (21,290) Dividends paid (14,873) (12,824) Retirement of long-term debt (1,130) (1,130) Borrowings on line of credit facilities 15,900 - Repayments on line of credit facilities (25,900) - Equity transactions of pooled companies prior to dates of acquisition (38) (8,449) -------- -------- Net cash used by financing activities (30,864) (34,609) -------- -------- Net (decrease) increase in cash and cash equivalents (3,140) 2,418 Cash and cash equivalents at beginning of period 57,017 58,917 -------- -------- Cash and cash equivalents at end of period $ 53,877 $ 61,335 ======== ======== Supplemental disclosures of cash flow information: Interest paid $ 792 $ 548 Income taxes paid $ 16,397 $ 12,789 </TABLE> See accompanying notes. -5-
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, 1996 and include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information set forth. Certain reclassifications have been made to the prior year financial statements in order to conform to the current year presentation. 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 1996 Annual Report to Stockholders. 2. Acquisitions - Poolings of Interests During the nine-month period ended September 30, 1997, the Company acquired substantially all of the net assets of Byerly & Company, Inc., Arnold & Company, Inc. and Trinder & Norwood, Inc. in exchange for 263,000 shares of its Common Stock. These acquisitions were accounted for as poolings of interests. The financial statements for all periods prior to the acquisition date (January 1, 1997) have been restated to include the operations of Byerly & Company, Inc.; Arnold & Company, Inc. and Trinder & Norwood, Inc. were not material to the Company individually or in the aggregate and accordingly, prior period financial statements were not restated. On April 2, 1997, the Company acquired a 50% interest in Wyatt Group Pty Ltd. and accounted for the acquisition as a purchase. This transaction was not material to the Company. The following summarizes the restatement to reflect the acquisition of Byerly & Company, Inc. (in thousands): <TABLE> <CAPTION> Attributable Three-month period Arthur J. to Pooled ended September 30, 1996 Gallagher Companies As Restated ------------------------ --------- ------------- ----------- <S> <C> <C> <C> Revenues $121,696 $ 1,420 $123,116 Net earnings (loss) 18,057 (372) 17,685 ======== ======= ======== </TABLE> <TABLE> <CAPTION> Nine-month period ended September 30, 1996 ------------------------ <S> <C> <C> <C> Revenues $337,135 $ 3,999 $341,134 Net earnings (loss) 34,534 (1,314) 33,220 ======== ======= ======== </TABLE> -6-
ARTHUR J. GALLAGHER & CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (CONTINUED) 3. Effect of New Pronouncements In February 1997, the Financial Accounting Standards Board ("FASB") issued Statement No. 128 "Earnings Per Share" ("SFAS 128"), which is required to be adopted on December 31, 1997. At that time, the Company will be required to change the method currently used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating primary earnings per share, the dilutive effect of stock options will be excluded. The impact is expected to result in an increase in primary earnings of $.07 and $.08 per share for the quarters ended September 30, 1997 and 1996, respectively, and $.16 and $.13 per share for the nine month periods ended September 30, 1997 and 1996, respectively. In addition, the impact of SFAS 128 is expected to result in an increase in fully diluted earnings per share of $.02 and $.04 per share for each of the quarters ended September 30, 1997 and 1996, respectively, and $.08 and $.04 per share for each of the nine month periods ended September 30, 1997 and 1996, respectively. In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which is effective for years beginning after December 15, 1997. SFAS 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. SFAS 130 will require that enterprises (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in-capital in the equity section of the balance sheet. SFAS 130 will not have any impact on the Company's consolidated results of operations, financial position, or cash flows. In June 1997, the FASB issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"), which is effective for years beginning after December 15, 1997. SFAS 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company has not completed all of the analyses required to determine the full impact of the new statement. -7-
ARTHUR J. GALLAGHER & CO. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The Company's insurance commissions and risk management fees reflect the overall pricing pressure throughout the insurance premium marketplace. Although these conditions are partially offset by the increases in investment and other income, the Company does not anticipate any change in the near future in this extremely competitive environment. Commission revenues increased by 2% to $72.7 million in the third quarter of 1997 and by 1% to $199.2 million in the first nine months of 1997 over the respective periods in 1996. These increases are due principally to new business production partially offset by lost business. Fee revenues increased by 4% to $48.1 million in the third quarter of 1997 and by 5% to $133.3 million in the first nine months of 1997 over the respective periods in 1996. These increases reflect new business production and to a lesser extent renewal fee increases of self-insurance products generated primarily by Gallagher Bassett Services, Inc. (a Company subsidiary), partially offset by lost business. Investment income and other increased 68% to $9.6 million in the third quarter of 1997 over the same period in 1996 due primarily to a $3.6 million gain recognized on the sale of assets in the third quarter. Investment income and other increased by 45% to $26.0 million in the first nine months of 1997 over the first nine months of 1996 due primarily to gains in the second quarter of $1.8 million recognized on the restructuring of a long term lease for facilities in the U.K. and $1.1 million of capital gains recognized on the sale of assets, and a $1.6 million gain recognized in the first quarter of 1997 on the sale of assets and other investments. Total expenses increased by 4% or $4.2 million in the third quarter of 1997 from the same period in 1996 and increased by 2% or $6.4 million in the first nine months of 1997 over the same period in 1996. Salaries and employee benefits increased by $2.3 million or 4% to $63.5 million in the third quarter of 1997 and increased by $1.4 million or 1% to $182.7 million in the first nine months of 1997 from the respective periods in 1996. These increases are due primarily to salary increases and higher employee fringe benefit costs partially offset by a $4.8 million non-recurring gain recognized in the second quarter of 1997 from a restructuring and settlement of a defined benefit pension plan at one of the Company's London subsidiaries and a 4% reduction in employee head count to 3,900 employees at September 30, 1997 from 4,043 at September 30, 1996. Other operating expenses increased by $1.8 million or 5% to $38.7 million in the third quarter of 1997 and by 5% to $114.2 million in the first nine months of 1997 over the respective periods in 1996. These increases are due primarily to increases in rent and general office expenses related to office expansions and increased business insurance costs. In addition, travel and other direct employee expenses increased in 1997 due to the growth in sales volume. The effective income tax rate of 34% for the third quarter of 1997 is greater than the Company's effective tax rate of 29% for the third quarter of 1996 due primarily to an annualization adjustment made in the third quarter of 1996 resulting from tax benefits generated by certain investments. The effective income tax rate of 34% for the first nine months of 1997 is the same as the Company's effective tax rate of 34% for the first nine months of 1996. The effective income tax rates for the third quarter and first nine months of 1997 are less than the statutory federal rate of 35% due primarily to the effect of tax benefits generated by certain investments which are substantially offset by state and foreign taxes. Earnings per share for the third quarter of 1997 were $1.06 compared to $1.00 in 1996, a 6% increase. For the first nine months, earnings per share increased 22% from $1.89 in 1996 to $2.31 in 1997. These earnings per share increases reflect the non-recurring gains discussed above. -8-
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. The Company has historically been profitable and positive cash flow from operations and funds available under various loan agreements have been sufficient to finance the operations and capital expenditures of the Company. Cash generated from operating activities was $54.1 million and $52.9 million for the nine months ended September 30, 1997 and 1996, respectively. Because of the variability related to the timing of fees receivable and premiums receivable and payable, cash from operations for the Company can 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 liquidity. The Company maintains a $20 million unsecured revolving credit agreement (the "Credit Agreement") requiring repayment of any loans under the agreement no later than June 30, 2001. As of September 30, 1997, there were no borrowings existing under this agreement. The Company also has two term loan agreements (the "Term Loan Agreements") that have outstanding balances of $630,000 and $500,000 at September 30, 1997. Loans under the Term Loan Agreements are repayable in equal annual installments no later than January 11, 1998 and June 15, 1998, respectively. These borrowings were used to finance some of the Company's alternative investments. The Credit Agreement and Term Loan Agreements require the maintenance of certain financial requirements. The Company is currently in compliance with these requirements. The Company has line of credit facilities of $27.5 million which expire on April 30, 1998. Periodically, the Company will make short-term borrowings under these credit facilities to meet short-term cash flow needs. During the nine months ended September 30, 1997, the Company borrowed funds under these facilities with total outstanding balances remaining less than $11.0 million at any one time during the period. The Company repaid these funds and as of September 30, 1997, no short-term borrowings exist under these facilities. Through the first nine months of 1997, the Company paid $14.9 million in cash dividends on its common stock. On July 18, 1997, the Company declared a regular quarterly cash dividend of $.31 per share payable on October 15, 1997 to Shareholders of Record as of September 30, 1997. This is a 7% increase over the quarterly dividend in 1996. Net capital expenditures were $6.9 million and $7.6 million for the nine months ended September 30, 1997 and 1996, respectively. In 1997, the Company expects to make expenditures for capital improvements at least equal to the $10.2 million spent in 1996. Capital expenditures by the Company are related primarily to expanded offices and updating computer systems and equipment. In 1988, the Company adopted a plan which has been extended through June 30, 1998, to repurchase its common stock. Through the first nine months of 1997 and 1996, the Company repurchased 465,000 shares at a cost of $14.5 million and 645,000 shares at a cost of $21.3 million, respectively. The repurchases 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 350,000 additional shares through June 30, 1998. 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. -9-
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 and casualty insurance industry continues to experience a prolonged soft market despite high losses; continued low interest rates will reduce income earned on invested funds; the insurance brokerage and service businesses are extremely competitive with a number of competitors being substantially larger than the Company; the alternative insurance market continues to grow; the Company's revenues vary significantly from quarter to quarter as a result of the timing of policy renewals 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 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. Attention is also directed to other risk factors set forth in documents filed by the Company with the Securities and Exchange Commission. -10-
ARTHUR J. GALLAGHER & CO. PART II - OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K a. Exhibit 11.0 - Computation of Net Earnings Per Common and Common Equivalent Share (Unaudited). Exhibit 27.0 - Financial Data Schedule (Unaudited). b. Reports on Form 8-K. No Reports on Form 8-K were filed during the three-month period ended September 30, 1997. -11-
SIGNATURES Pursuant to the requirements 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. ARTHUR J. GALLAGHER & CO. Date: November 5, 1997 /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 -12-