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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 2001
[ ] 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
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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 Identification Number)
incorporation or organization)
Two Pierce Place 60143-3141
Itasca, Illinois (Zip Code)
(Address of principal executive
offices)
Registrant's telephone number, including area code (630) 773-3800
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange
Common Stock, par value on which registered
$1.00 per share
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
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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 .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, computed by reference to the last reported price at which the stock
was sold on February 28, 2002 was $2,846,500,000.
The number of outstanding shares of the registrant's Common Stock, $1.00 par
value, as of February 28, 2002 was 85,577,000.
Portions of documents incorporated by Part of Form 10-K into which document
reference into this report is incorporated
ARTHUR J. GALLAGHER & CO. PART III
2002 Proxy Statement
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PART I
Item 1. Business.
Arthur J. Gallagher & Co. and its subsidiaries (collectively referred to as
"Gallagher" unless the context otherwise requires) are engaged in providing
insurance brokerage, risk management and related services to clients in the
United States and abroad. Gallagher's principal activity is the negotiation and
placement of insurance for its clients. Gallagher also specializes in
furnishing risk management services. Risk management involves assisting clients
in analyzing risks and determining whether proper protection is best obtained
through the purchase of insurance or through retention of all or a portion of
those risks and the adoption of corporate risk management policies and cost-
effective loss control and prevention programs. Risk management services also
include claims management, loss control consulting and property appraisals.
Gallagher believes that its ability to deliver comprehensively structured risk
management and brokerage services is one of its major strengths. In addition,
Gallagher has a financial services operation that manages Gallagher's
investment portfolio.
Gallagher operates through a network of more than 250 offices located
throughout the United States and eight countries abroad and through a network
of correspondent brokers and consultants in more than 100 countries around the
world. Some of these offices are fully staffed with sales, marketing, claims
and other service personnel; others function as servicing offices for the
brokerage and risk management service operations of Gallagher. Gallagher's
international operations include a Lloyd's of London broker and affiliated
companies in the United Kingdom and other facilities in Australia, Bermuda,
Canada, Scotland, Singapore, New Zealand and Papua New Guinea.
Gallagher was founded in 1927 and was reincorporated as a Delaware
corporation in 1972. Gallagher's executive offices are located at Two Pierce
Place, Itasca, Illinois 60143-3141, and its telephone number is (630) 773-3800.
Operating Segments
Gallagher has identified three operating segments in addition to its
corporate operations. Insurance Brokerage Services encompasses operations that,
for commission or fee compensation, place or arrange to place insurance
directly related to the clients' funding of risk. This segment also provides
consulting services, for fee compensation, related to clients' risk financing
programs. Risk Management Services 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
brokerage clients or clients of other brokers. Financial Services 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. It manages the invested assets of
Gallagher in order to maximize the return to the company. Corporate consists
primarily of unallocated administrative costs and the provision for income
taxes which is not allocated to Gallagher's operating segments.
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,
2001, is as follows (in thousands):
2001 2000* 1999*
--------------- --------------- --------------
% of % of % of
Amount Total Amount Total Amount Total
-------- ----- -------- ----- -------- -----
Commissions
Insurance Brokerage Services... $533,360 59 $469,040 59 $437,706 61
Risk Management Services....... 1,090 -- 1,204 -- -- --
Fees
Insurance Brokerage Services... 62,342 7 51,678 7 43,026 6
Risk Management Services....... 262,522 29 229,557 29 192,853 27
Investment income and other
Insurance Brokerage Services... 12,626 1 18,227 2 19,412 3
Risk Management Services....... 1,084 -- 1,534 -- 769 --
Financial Services............. 37,294 4 24,130 3 19,764 3
Corporate...................... (275) -- (97) -- -- --
-------- --- -------- --- -------- ---
Total revenues................. $910,043 100 $795,273 100 $713,530 100
======== === ======== === ======== ===
--------
*Restated for seven 2001 acquisitions accounted for as poolings of
interests. See Note 2 to the Consolidated Financial Statements for a summary
of the effects of these restatements on the 2000 and 1999 consolidated
financial statements.
See Note 15 to the Consolidated Financial Statements for additional financial
information, including earnings before income taxes and identifiable assets, by
operating segment, for 2001, 2000 and 1999.
Gallagher's revenues vary significantly from quarter to quarter as a result
of the timing of policy inception dates, which traditionally are heaviest in
the third quarter, whereas expenses are fairly uniform throughout the year. See
Note 14 to the Consolidated Financial Statements for unaudited quarterly
operating results for 2001 and 2000.
Insurance Brokerage Services
The Insurance Brokerage Services segment is principally comprised of two
divisions, the Brokerage Services Division (BSD) and Gallagher Benefit Services
(GBS).
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 places 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.
2
The primary source of Gallagher's compensation for its Insurance Brokerage
Services segment is commissions paid by insurance companies which are usually
based upon a percentage of the premium paid by the insured. 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 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 Services
The Risk Management Services segment is principally comprised of two wholly
owned subsidiaries, Gallagher Bassett Services, Inc. (GB) and Gallagher Benefit
Administrators, Inc. (GBA).
GB provides a variety of professional consulting services to assist clients
in analyzing risks and in determining whether proper protection is best
obtained through the purchase of insurance or through retention of all or a
portion of those risks and the adoption of risk management policies and cost-
effective loss control and prevention programs. A full range of risk management
services is offered including claims management, risk control consulting
services, information management, property appraisals and insurance related
investigative services on a totally integrated or select, stand-alone basis. GB
provides these services for Gallagher's clients through a network of over 140
service offices located throughout the United States, Canada, England,
Scotland, Australia, New Zealand and Papua New Guinea.
GB primarily markets its risk management services directly to clients on an
unbundled basis independent of Gallagher's Insurance Brokerage Services. GB
also markets these services to Insurance Brokerage Services' clients who are
interested in 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.
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 value 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--available for sale, 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 a leased commercial aircraft. It
manages the invested assets of Gallagher in order to maximize the return to the
company.
3
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. See Note 4 to the Consolidated Financial Statements.
The following is a summary of Gallagher's non cash and cash equivalent
investment portfolio (in thousands):
December 31,
-----------------
2001 2000
-------- --------
Investment strategies--trading............................... $ 52,588 $ 51,897
======== ========
Marketable securities--available for sale.................... $ 18,290 $ 23,306
======== ========
Tax advantaged investments................................... $ 18,656 $ 40,243
Real estate partnerships..................................... 29,036 26,563
Investment in Allied World Assurance Holdings, Ltd. (an
insurance company).......................................... 20,000 --
Venture capital equity investments........................... 34,891 34,092
Minority investment in alternative fund manager.............. 33,595 14,347
Notes receivable from investees.............................. 49,174 22,593
Leased commercial aircraft................................... 6,060 6,758
-------- --------
Total investments included in noncurrent assets.............. $191,412 $144,596
======== ========
Tax advantaged investments represent amounts invested by Gallagher in 36
limited partnerships (35 in 2000) that operate qualified affordable housing and
alternative energy projects that are generating tax benefits to Gallagher on an
ongoing basis. These benefits are in the form of both tax deductions for
operating losses and tax credits. The tax advantaged investments are primarily
accounted for using the effective yield method and are carried at amortized
cost in the consolidated balance sheets. Under the effective yield method,
Gallagher recognizes the tax credits as they are allocated by the partnerships,
which are included, net of amortization of the investment, as a component of
the provision for income taxes.
Real estate partnerships at December 31, 2001 and 2000 primarily represent an
investment in a limited partnership that owns the building that Gallagher
leases for its corporate headquarters and several of its subsidiary operations
and an investment in a limited partnership that owns 11,000 acres of land near
Orlando, Florida, that is currently under development. Investments in real
estate partnerships are carried on the equity basis in the consolidated balance
sheets, which approximated fair value at December 31, 2001 and 2000.
The investment in Allied World Assurance Holdings, Ltd. represents the
Company's minority investment in a newly formed Bermuda based insurance and
reinsurance company founded by American International Group, Inc., The Chubb
Corporation and affiliates of Goldman, Sachs & Co.
Venture capital equity investments at December 31, 2001 and 2000 consist of
minority investments in seventeen and thirteen, respectively, software, e-
commerce, insurance and financial services companies, none of which exceeds
$7,000,000 individually. Investments in partially owned entities in which
ownership is 20% to 50% are accounted for using the equity method. Accordingly,
Gallagher's share of the net earnings of these entities is included in
consolidated net earnings. Investments in partially owned entities in which
ownership is less than 20% are carried at cost.
Gallagher's 25% investment in an alternative fund manager is accounted for on
the equity method of accounting. Accordingly, Gallagher's share of the net
earnings of this entity is included in consolidated net earnings.
4
Notes receivable from investees primarily represent secured loans made by
Gallagher to twelve of its investments (five in 2000). Interest rates on the
loans at December 31, 2001 and 2000 ranged from 5.5% to 12.0%. The carrying
value of these loans at December 31, 2001 and 2000 approximated fair value.
The leased commercial aircraft represents Gallagher's 90% interest in a trust
which leases a commercial jet to a major domestic airline. There is no debt
remaining on the aircraft. The net carrying value of this investment
approximated fair value at December 31, 2001 and 2000.
International Operations
Total revenues by geographic area for each of the three years in the period
ended December 31, 2001 are as follows (in thousands):
2001 2000* 1999*
-------------- -------------- --------------
% of % of % of
Amount Total Amount Total Amount Total
-------- ----- -------- ----- -------- -----
United States..................... $837,820 92 $732,192 92 $664,573 93
Foreign, principally United
Kingdom, Australia and Bermuda... 72,223 8 63,081 8 48,957 7
-------- --- -------- --- -------- ---
Total revenues.................. $910,043 100 $795,273 100 $713,530 100
======== === ======== === ======== ===
--------
*Restated for seven 2001 acquisitions accounted for as poolings of interests.
The Insurance Brokerage Services segment's international operations are
principally comprised of a Lloyd's of London broker and an insurance brokerage
and risk management joint venture in the United Kingdom; an insurance brokerage
operation and a "rent-a-captive" insurance company facility in Bermuda;
reinsurance intermediary operations in Australia and Singapore; and a network
of correspondent brokers and consultants in more than 100 countries around the
world.
Arthur J. Gallagher (UK) Limited (AJG UK), a wholly owned Lloyd's of London
brokerage subsidiary of Gallagher based in London, provides brokerage and other
services to clientele primarily located outside of the United Kingdom. The
principal activity of AJG UK is to negotiate and place insurance and
reinsurance with Lloyd's of London underwriters and insurance companies
worldwide. Its brokerage services encompass four major categories: aviation,
marine, reinsurance (treaty and facultative) and property/casualty (risks
predominantly located in North America). Although AJG UK is located in London,
the thrust of its business development has been with non-United Kingdom
brokers, agents and insurers rather than domestic United Kingdom retail
business. Its clients are primarily insurance and reinsurance companies,
underwriters at Lloyd's of London, Gallagher and its non-United Kingdom
subsidiaries, other independent agents and brokers and major business
corporations requiring direct insurance and reinsurance placements.
Risk Management Partners Ltd. (RMP) is a 50% owned joint venture between
Gallagher and Munich-American Re Corporation that markets customized insurance
and risk management products and services to United Kingdom public entities
through offices in England and Scotland. RMP was formed in 1994 and Gallagher
believes that RMP is now the third largest provider of insurance brokerage
related services to the public entity market in the United Kingdom.
Arthur J. Gallagher & Co. (Bermuda) Limited provides clients with direct
access to the risk-taking capacity of foreign insurers for both direct and
reinsurance placements. It also acts as a wholesaler to Gallagher's marketing
efforts by accessing global insurance and reinsurance companies in the
placement of United States and foreign risks. In addition, it provides services
relating to the formation and management of offshore captive insurance
companies.
Gallagher has ownership interests in two Bermuda-based insurance companies
that operate "rent-a-captive" facilities; Artex Insurance Company Ltd., a
partially owned joint venture, and Protected Insurance
5
Company, a wholly owned subsidiary. Rent-a-captives enable clients to receive
the benefits of owning a captive insurance company without certain
disadvantages of ownership. Captive insurance companies are created to insure
risk and capture underwriting profit and investment income, which is then
available for use by the insured generally for reducing future costs of their
insurance programs.
Arthur J. Gallagher Australasia Pty Ltd. is a wholly owned subsidiary of
Gallagher that is headquartered in Sydney, Australia. This subsidiary provides
reinsurance placements for international or local Australian companies, and
specialty programs and coverages for Australian and other clients through
underwriting facilities with Lloyd's of London underwriters. Gallagher's
reinsurance intermediary operations in Singapore are not material to
Gallagher's Insurance Brokerage Services segment.
Insurance Brokerage Services also has strategic alliances with a variety of
international brokers in countries where Gallagher does not have a physical
presence. Through a network of correspondent brokers and consultants in more
than 100 countries around the world, Gallagher is able to fully serve its
clients' coverage and service needs wherever their operations are located.
The Risk Management Services segment's international operations are
principally comprised of risk management companies in the United Kingdom,
Australia, New Zealand and Papua New Guinea.
Gallagher Bassett International Ltd. (UK) (GB UK), a wholly owned subsidiary
of GB, provides risk management services for foreign operations, as well as
United States operations that are foreign controlled. Headquartered in London
with offices throughout England and Scotland, GB UK works with insurance
companies, reinsurance companies, overseas brokers, and risk managers of
overseas organizations. Services include consulting, claims management,
information management, loss control and property valuations.
Wyatt Gallagher Bassett Pty Ltd is a 50% owned joint venture of GB that is
headquartered in Brisbane, Australia with facilities located throughout
Australia, New Zealand and Papua New Guinea. Wyatt Gallagher Bassett is
principally engaged in providing claims adjusting and risk management services
in Australasia.
Gallagher also has risk management service facilities in Canada that are not
material to Gallagher's Risk Management Services segment.
See Notes 13 and 15 to the Consolidated Financial Statements for additional
financial information related to Gallagher's foreign operations, including
earnings before income taxes and identifiable assets, by operating segment, for
2001, 2000 and 1999.
Markets and Marketing
A large portion of the commission and fee business of Gallagher is derived
from all types of business institutions, not-for-profit organizations,
associations and municipal and other governmental entities. Gallagher's clients
include United States and multinational corporations engaged in a broad range
of commercial and industrial businesses. Gallagher also places insurance for
individuals, although this portion of the business is not material to
Gallagher's operations. Gallagher services its clients through its network of
more than 250 offices in the United States and eight countries abroad. No
material part of Gallagher's business is dependent upon a single customer or on
a few customers. The loss of any one customer would not have a materially
adverse effect on Gallagher. In 2001, the largest single customer represented
less than 3% of total revenues.
Gallagher believes that its ability to deliver comprehensively structured
risk management and brokerage services, including the placement of reinsurance,
is one of its major strengths. Gallagher also believes that its risk management
business enhances and attracts insurance brokerage business due to the nature
and strength of business relationships which it forms with clients when
providing a variety of risk management services on an on-going basis.
6
Gallagher requires its employees serving in a sales or marketing capacity,
including all executive officers of Gallagher, to enter into agreements with
Gallagher restricting disclosure of confidential information and solicitation
of clients and prospects of Gallagher upon their termination of employment. The
confidentiality and non-solicitation provisions of such agreements terminate in
the event of a hostile change in control of Gallagher, as defined therein.
Competition
Gallagher believes it is the fourth largest insurance broker worldwide in
terms of total revenues. The insurance brokerage and service business is highly
competitive and there are many insurance brokerage and service organizations as
well as individuals throughout the world who actively compete with Gallagher in
every area of its business. Two competing firms are significantly larger and
have several times the commission and/or fee revenues of Gallagher. There are
firms in a particular region or locality that are as large or larger than the
particular local office of Gallagher. Gallagher believes that the primary
factors determining its competitive position with other organizations in its
industry are the quality of the services rendered and the overall costs to its
clients.
Gallagher is also in competition with certain insurance companies that write
insurance directly for their customers. Government benefits relating to health,
disability, and retirement are also alternatives to private insurance and hence
indirectly compete with the business of Gallagher. To date, such direct writing
and government benefits have had, in the opinion of Gallagher, relatively
little effect on its business and operations, but Gallagher can make no
prediction as to their effect in the future.
Regulation
In every state and foreign jurisdiction in which Gallagher does business,
Gallagher or an employee is required to be licensed or receive regulatory
approval in order for Gallagher to conduct business. In addition to licensing
requirements applicable to Gallagher, most jurisdictions require that
individuals who engage in brokerage and certain insurance service activities be
personally licensed.
Gallagher's insurance brokerage and risk management operations depend on its
continued good standing under the licenses and approvals pursuant to which it
operates. Licensing laws and regulations vary from jurisdiction to
jurisdiction. In all jurisdictions, the applicable licensing laws and
regulations are subject to amendment or interpretation by regulatory
authorities. Generally such authorities are vested with relatively broad and
general discretion as to the granting, renewing and revoking of licenses and
approvals.
2001 Acquisitions
In 2001, Gallagher acquired thirteen insurance brokerage firms and three
benefits consulting companies.
On December 1, 2001, Gallagher acquired substantially all of the net assets
of Equity Insurance Managers, Inc., a Kentucky corporation engaged in the
insurance brokerage and services business, in exchange for an initial cash
payment of $9,200,000 and a contingent obligation of $800,000. This acquisition
was accounted for as a purchase. Three key employees entered into three-year
employment agreements with Gallagher.
On November 1, 2001, Gallagher acquired substantially all of the net assets
of MRS Holdings Limited, a United Kingdom company engaged in the insurance
brokerage and services business, in exchange for 280,000 shares of Gallagher's
common stock. This acquisition was accounted for as a purchase. Nine principals
entered into two-year employment agreements with Gallagher.
On October 31, 2001, Gallagher acquired substantially all of the net assets
of Cashan & Company, a New Jersey corporation engaged in the insurance
brokerage and services business, in exchange for 307,000 shares of Gallagher's
common stock. This acquisition was accounted for as a purchase. Three
principals entered into three-year employment agreements with Gallagher.
7
On October 31, 2001, Gallagher acquired substantially all of the net assets
of Hartstein Associates, Inc., a New Jersey corporation engaged in the benefits
insurance business, in exchange for 91,000 shares of Gallagher's common stock,
an initial cash payment of $3,000,000 and a contingent obligation of
$4,500,000. This acquisition was accounted for as a purchase. One principal and
two key employees entered into three-year employment agreements with Gallagher.
On September 1, 2001, Gallagher acquired substantially all of the net assets
of Henderson Philips Fine Arts, a Washington D.C. corporation engaged in the
insurance brokerage and services business, in exchange for an initial cash
payment of $350,000 and a contingent obligation of $1,150,000. This acquisition
was accounted for as a purchase. Two key employees entered into three-year
employment agreements with Gallagher.
On August 31, 2001, Gallagher acquired substantially all of the net assets of
Central Surety Agency, Inc., a Wisconsin corporation engaged in the insurance
brokerage and services business in exchange for 26,000 shares of Gallagher's
common stock. This acquisition was accounted for as a pooling of interests. One
principal entered into a three-year employment agreement with Gallagher.
On August 31, 2001, Gallagher acquired substantially all of the net assets of
Midwest Surety Services, Inc., a Wisconsin corporation engaged in the insurance
brokerage and services business in exchange for 32,000 shares of Gallagher's
common stock. This acquisition was accounted for as a pooling of interests. One
principal entered into a three-year employment agreement with Gallagher.
On August 31, 2001, Gallagher acquired substantially all of the net assets of
E.S. Susanin, Inc., a Connecticut corporation engaged in the insurance
brokerage and services business in exchange for 109,000 shares of Gallagher's
common stock. This acquisition was accounted for as a pooling of interests. One
principal entered into a two-year employment agreement with Gallagher and two
key employees entered into three-year employment agreements with Gallagher.
On July 31, 2001, Gallagher acquired substantially all of the net assets of
Burgess & Associates, Inc., a Kansas corporation engaged in the benefits
insurance business in exchange for 73,000 shares of Gallagher's common stock.
This acquisition was accounted for as a pooling of interests. Four principals
entered into three-year employment agreements with Gallagher and two key
employees entered into two-year employment agreements with Gallagher.
On July 31, 2001, Gallagher acquired substantially all of the net assets of
The InWest Group, Inc., a Texas corporation engaged in the insurance brokerage
and services business in exchange for 407,000 shares of Gallagher's common
stock. This acquisition was accounted for as a pooling of interests. Four
principals and two key employees entered into three-year employment agreements
with Gallagher.
On May 31, 2001, Gallagher acquired substantially all of the net assets of
The Galtney Group, Inc. dba Healthcare Insurance Services, a Texas corporation
engaged in the insurance brokerage and services business in exchange for
3,330,000 shares of Gallagher's common stock. This acquisition was accounted
for as a pooling of interests. One principal entered into a five-year
employment agreement with Gallagher, three key employees entered into three-
year employment agreements with Gallagher and thirty-eight key employees
entered into two-year employment agreements with Gallagher.
On May 31, 2001, Gallagher acquired substantially all of the net assets of
Nelson/Monarch Insurance Services, Ltd., a Kentucky corporation engaged in the
insurance brokerage and services business in exchange for 109,000 shares of
Gallagher's common stock. This acquisition was accounted for as a pooling of
interests. One principal entered into a three-year employment agreement with
Gallagher and one key employee entered into a two-year employment agreement
with Gallagher.
On May 1, 2001, Gallagher acquired substantially all of the net assets of
Texas Insurance Agency, Inc.-Houston, a Texas corporation engaged in the
insurance brokerage and services business, in exchange for an
8
initial cash payment of $4,565,000 and a contingent obligation of $1,500,000.
This acquisition was accounted for as a purchase. Two principals entered into
three-year employment agreements with Gallagher and six key employees entered
into two-year employment agreements with Gallagher.
On February 28, 2001, Gallagher acquired substantially all of the net assets
of MDM Insurance Associates, Inc., a California corporation engaged in the
insurance brokerage and services business in exchange for 752,000 shares of
Gallagher's common stock. This acquisition was accounted for as a pooling of
interests. Three principals entered into three-year employment agreements with
Gallagher and ten key employees entered into two-year employment agreements
with Gallagher.
On February 28, 2001, Gallagher acquired substantially all of the net assets
of SKANCO International, Ltd., an Arizona corporation engaged in the insurance
brokerage and services business in exchange for 263,000 shares of Gallagher's
common stock. This acquisition was accounted for as a pooling of interests. Two
principals entered into three-year employment agreements with Gallagher.
On February 28, 2001, Gallagher acquired substantially all of the net assets
of Madison Scott & Associates, Inc., a Texas corporation engaged in the
benefits insurance business in exchange for 34,000 shares of Gallagher's common
stock. This acquisition was accounted for as a pooling of interests. The
principal entered into a three-year employment agreement with Gallagher.
2002 Acquisitions
The following acquisitions have occurred since December 31, 2001:
On February 28, 2002, Gallagher acquired substantially all of the net assets
of Life Plans Unlimited, Inc., a Connecticut corporation engaged in the
benefits insurance business, in exchange for 127,000 shares of Gallagher's
common stock and a contingent obligation of $3,000,000 that, if earned, will be
paid in additional shares of Gallagher common stock. This acquisition was
accounted for as a purchase. Two principals entered into three-year employment
agreements with Gallagher and two key employees entered into two-year
employment agreements with Gallagher.
On February 28, 2002, Gallagher acquired substantially all of the net assets
of Thomas Sherwin Insurance Agency, Inc., a New Jersey company engaged in the
insurance brokerage and services business, in exchange for an initial cash
payment of $800,000 and a contingent obligation of $600,000. This acquisition
was accounted for as a purchase. The principal entered into a three-year
employment agreement with Gallagher and one key employee entered into a one-
year employment agreement with Gallagher.
Gallagher believes that the net effect of these acquisitions has been and
will be to expand significantly the volume of general services rendered by
Gallagher and the geographical areas in which Gallagher renders such services
and not to change substantially the nature of the services performed by
Gallagher.
Gallagher is considering and intends to consider from time to time additional
acquisitions and divestitures on terms that it deems advantageous. Gallagher at
this time is engaged in preliminary discussions with a number of candidates for
possible future acquisitions and has received signed, non-binding letters of
intent from three acquisition candidates. No assurances can be given that any
additional acquisitions or divestitures will be consummated, or, if
consummated, will be advantageous to Gallagher.
Employees
As of December 31, 2001, Gallagher employed approximately 6,500 employees,
none of whom is represented by a labor union. Gallagher continuously reviews
benefits and other matters of interest to its employees and considers its
relations with its employees to be satisfactory.
9
Item 2. Properties.
Gallagher's executive offices and certain subsidiary and branch facilities
are located at Two Pierce Place, Itasca, Illinois, where Gallagher leases
approximately 245,000 square feet of space. The lease commitment on this
property expires February 28, 2006. Gallagher has an equity interest in the
limited partnership that owns the Two Pierce Place property. See Note 4 to the
Consolidated Financial Statements. Gallagher generally operates in leased
premises. Certain office space leases have options permitting renewals for
additional periods. In addition to minimum fixed rentals, a number of leases
contain annual escalation clauses generally related to increases in an
inflation index. See Note 12 to the Consolidated Financial Statements for
information with respect to Gallagher's lease commitments at December 31, 2001.
Item 3. Legal Proceedings.
Gallagher is engaged in various legal actions incident to the nature of its
business. Management is of the opinion that none of the litigation will have a
material effect, individually or in the aggregate, on Gallagher's consolidated
financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during Gallagher's
fourth fiscal quarter ended December 31, 2001.
Item 4A. Executive Officers of the Registrant.
The executive officers of Gallagher are as follows:
Name Age Position and Year First Elected
---- --- -------------------------------
J. Patrick Gallagher, Jr.. 50 President since 1990, Chief Executive Officer since 1995
Michael J. Cloherty....... 54 Executive Vice President since 1996, Chief Financial Officer since 1981
and Vice President--Finance 1981-1996
James J. Braniff III...... 62 Vice President since 1995, President and Chief Operating Officer of BSD
since 1999
James W. Durkin, Jr....... 52 Vice President since 1985, President of GBS since 1985
David E. McGurn, Jr....... 48 Vice President--Specialty Marketing & International since 1996,
Vice President from 1993 to 1996
Richard J. McKenna........ 55 Vice President since 1994, President of GB since 2000
Each such person has been principally employed by Gallagher in management
capacities for more than the past five years. All executive officers are
elected annually and serve at the pleasure of the Board of Directors.
10
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters.
Gallagher's common stock is listed on the New York Stock Exchange, trading
under the symbol "AJG." The following table sets forth information as to the
price range of Gallagher's common stock for the two-year period January 1, 2000
through December 31, 2001 and the dividends declared per common share for such
period. The table reflects the range of high and low sales prices per share as
reported on the New York Stock Exchange composite listing.
Dividends
Declared
Per Common
Quarterly Periods High Low Share
----------------- ------- ------- ----------
2001
----
First.............................................. $32.094 $21.875 $.130
Second............................................. 29.200 22.230 .130
Third.............................................. 34.000 25.370 .130
Fourth............................................. 38.820 32.900 .130
2000
----
First.............................................. $16.438 $11.531 $.115
Second............................................. 21.719 14.938 .115
Third.............................................. 30.250 20.063 .115
Fourth............................................. 34.250 25.219 .115
As of February 28, 2002, there were approximately 700 holders of record of
Gallagher's common stock.
11
Item 6. Selected Financial Data.
ARTHUR J. GALLAGHER & CO.
GROWTH RECORD: 1992-2001(a)
Average
Annual ------------------------------
(in thousands, except per share and Growth 2001 2000 1999
employee data) ------- ---------- ---------- --------
Revenue Data
Commissions............................ $ 534,450 $ 470,244 $437,706
Fees................................... 324,864 281,235 235,879
Investment income and other............ 50,729 43,794 39,945
---------- ---------- --------
Total revenues......................... $ 910,043 $ 795,273 $713,530
Dollar growth.......................... $ 114,770 $ 81,743 $ 55,421
Percent growth......................... 9% 14% 11% 8%
------ ---------- ---------- --------
Pretax Earnings Data
Pretax earnings........................ $ 141,853 $ 133,739 $127,024
Dollar growth.......................... $ 8,114 $ 6,715 $ 43,858
Percent growth......................... 18% 6% 5% 53%
Pretax earnings as a percentage of
total revenues........................ 16% 17% 18%
------ ---------- ---------- --------
Net Earnings Data
Net earnings........................... $ 125,256 $ 92,955 $ 83,240
Dollar growth.......................... $ 32,301 $ 9,715 $ 16,361
Percent growth......................... 19% 35% 12% 24%
Net earnings as a percentage of total
revenues.............................. 14% 12% 12%
------ ---------- ---------- --------
Net Earnings Per Share Data
Shares outstanding at year end......... 85,111 84,540 82,157
Net earnings per common and common
equivalent share (b).................. $ 1.39 $ 1.04 $ .97
Percent growth......................... 18% 34% 7% 21%
------ ---------- ---------- --------
Employee Data
Number at year end..................... 6,488 5,703 5,333
Number growth.......................... 785 370 216
Percent growth......................... 6% 14% 7% 4%
Total revenues per employee (c)........ $ 140 $ 139 $ 134
Net earnings per employee (c).......... $ 19 $ 16 $ 16
------ ---------- ---------- --------
Common Stock Dividend Data
Dividends declared per common share (d) $ .52 $ .46 $ .40
Total dividends declared............... $ 43,534 $ 35,539 $ 29,202
Percent of same year net earnings...... 35% 38% 35%
------ ---------- ---------- --------
Balance Sheet Data
Total assets........................... $1,471,823 $1,135,488 $990,608
Long-term debt less current portion.... -- -- --
Total stockholders' equity............. $ 371,613 $ 328,900 $260,801
------ ---------- ---------- --------
Return On Beginning Stockholders' Equity. 38% 36% 31%
Notes:
(a) The financial information for all periods prior to 2001 has been restated
for seven 2001 acquisitions accounted for using the pooling of interests
method.
(b) Based on the weighted average number of common and common equivalent
shares outstanding during the year.
(c) Based on the number of employees at year end.
(d) Based on the total dividends declared on a share of common stock
outstanding during the entire year.
12
Years Ended December 31,
--------------------------------------------------------------------------------------
1998 1997 1996 1995 1994 1993 1992
-------- -------- -------- -------- -------- -------- --------
$419,460 $392,427 $376,083 $362,259 $330,169 $295,329 $270,452
213,360 186,014 176,411 166,111 147,265 134,422 115,390
25,289 40,452 34,214 26,929 17,137 23,223 19,392
-------- -------- -------- -------- -------- -------- --------
$658,109 $618,893 $586,708 $555,299 $494,571 $452,974 $405,234
$ 39,216 $ 32,185 $ 31,409 $ 60,728 $ 41,597 $ 47,740 $ 32,475
6% 5% 6% 12% 9% 12% 9%
-------- -------- -------- -------- -------- -------- --------
$ 83,166 $ 94,672 $ 79,974 $ 77,599 $ 67,802 $ 59,607 $ 44,645
$(11,506) $ 14,698 $ 2,375 $ 9,797 $ 8,195 $ 14,962 $ 12,650
(12%) 18% 3% 14% 14% 34% 40%
13% 15% 14% 14% 14% 13% 11%
-------- -------- -------- -------- -------- -------- --------
$ 66,879 $ 63,388 $ 52,985 $ 48,437 $ 43,536 $ 36,068 $ 28,030
$ 3,491 $ 10,403 $ 4,548 $ 4,901 $ 7,468 $ 8,038 $ 5,825
6% 20% 9% 11% 21% 29% 26%
10% 10% 9% 9% 9% 8% 7%
-------- -------- -------- -------- -------- -------- --------
81,169 79,257 78,612 78,900 79,724 81,344 79,124
$ .80 $ .78 $ .65 $ .59 $ .53 $ .43 $ .34
3% 20% 10% 11% 23% 26% 27%
-------- -------- -------- -------- -------- -------- --------
5,117 4,907 4,872 4,794 4,382 4,158 3,889
210 35 78 412 224 269 224
4% 1% 2% 9% 5% 7% 6%
$ 129 $ 126 $ 120 $ 116 $ 113 $ 109 $ 104
$ 13 $ 13 $ 11 $ 10 $ 10 $ 9 $ 7
-------- -------- -------- -------- -------- -------- --------
$ .35 $ .31 $ .29 $ .25 $ .22 $ .18 $ .16
$ 24,218 $ 20,408 $ 18,399 $ 15,270 $ 13,209 $ 10,808 $ 8,767
36% 32% 35% 32% 30% 30% 31%
-------- -------- -------- -------- -------- -------- --------
$914,461 $848,746 $747,829 $692,305 $620,652 $647,051 $572,238
-- -- 1,130 2,260 3,390 28,166 23,888
$268,668 $239,455 $201,795 $183,651 $157,307 $177,859 $144,227
-------- -------- -------- -------- -------- -------- --------
28% 31% 29% 31% 24% 25% 23%
13
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Introduction
The following discussion and analysis should be read in conjunction with
Arthur J. Gallagher & Co.'s Consolidated Financial Statements and the related
notes thereto that are included elsewhere in this annual report.
Arthur J. Gallagher & Co. (Gallagher) provides insurance brokerage and risk
management services to a wide variety of commercial, industrial, institutional
and governmental organizations. Commission revenue is principally generated
through the negotiation and placement of insurance for its clients. Fee revenue
is primarily generated by providing other risk management services including
claims management, information management, risk control services and appraisals
in either the property/casualty market or human resource/employee benefit
market. Investment income and other is generated from Gallagher's investment
portfolio, which includes fiduciary funds, equity securities, and tax
advantaged and other strategic investments. Gallagher is headquartered in
Itasca, Illinois, has more than 250 offices in nine countries and does business
in more than 100 countries around the world through a network of correspondent
brokers and consultants.
Insurance Market Overview
For more than a decade prior to 2000, heavy competition for market share
resulted in low premium rates among property/casualty insurance carriers. This
"soft market" (i.e., low premium rates) generally resulted in flat or reduced
renewal commissions. During this soft market period, natural catastrophes
resulted in billions of dollars in underwriting losses to the insurance market.
Substantial mergers, both domestically and internationally, resulted in fewer
insurance companies. Increased property replacement costs and increasingly
large litigation awards caused some clients to seek higher levels of insurance
coverage. These factors would generally have the effect of generating higher
premiums to clients and higher commissions to Gallagher. In spite of these
forces, there were opposing factors including favorable equity markets,
increased underwriting capital causing heavy competition for market share and
improved economies of scale following consolidations, all of which tended to
lower premium rates. The net result was property/casualty premium rates
remained low through 1999. Years of underwriting losses and the downward turn
in equity markets in 2000 and 2001 placed insurers in the situation of having
to replenish depleted reserves. Many carriers began to increase premium rates
in 2000 and continued to do so throughout 2001.
The insurance industry was jolted by the tragic terrorist attacks that
occurred on September 11, 2001. The destruction and devastation of those events
have resulted in the largest insurance loss in America's history and have
reshaped the insurance marketplace more rapidly than expected. Along with this
historic loss, larger than anticipated loss experience across all risks, stock
market declines, lower interest rates and diminished risk capacity have led to
unprecedented short-term premium rate increases. Higher premium rates are
referred to as a "hard market" and generally result in increased commission
revenues. Fluctuations in premiums charged by insurance companies have a direct
and potentially material impact on the insurance brokerage industry. Commission
revenues are generally based on a percentage of the premiums paid by insureds
and normally follow premium levels. Thus, a hard market will generally
contribute positively to Gallagher's operating results, and since September
11th, the premium rates charged by insurance companies have soared having a
positive impact on Gallagher's 2001 operating results in spite of some
insurance companies' efforts to reduce commission rates during the upturn in
premium pricing. Although, management believes this hard market will continue
for the foreseeable future, the longevity of the hard market and its future
effect on Gallagher's business is difficult to predict.
In a period of rising insurance costs, there is resistance among certain
"risk" buyers (Gallagher's clients) to pay increased premiums and the higher
commissions generated by these premiums. Such resistance may cause some buyers
to raise their deductibles and/or reduce the overall amount of insurance
coverage that they purchase. In addition, some buyers will switch to negotiated
fee in lieu of commission arrangements with the
14
broker for placing the risk. These factors will reduce commission revenue to
Gallagher. Other buyers will move toward the alternative insurance market,
which would tend to have a favorable effect on Gallagher's Risk Management
Services segment. Gallagher anticipates that new sales and renewal increases in
the areas of risk management, claims management, insurance captive and self-
insurance services will continue to be a major factor in Gallagher's fee
revenue growth during 2002. Though inflation tends to increase the levels of
insured values and risk exposures, premium rates charged by insurance companies
have had a greater impact on Gallagher's revenues than inflation.
Gallagher continues to look to the future and to pursue expansion not only in
the core business segments of Insurance Brokerage and Risk Management Services,
but also within Financial Services. Management believes these areas continue to
hold opportunities for diversification and profitable growth.
Critical Accounting Policies
Gallagher's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States (GAAP), which
require management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. See Note 1 to the
Consolidated Financial Statements for a complete summary of the significant
accounting policies used to prepare Gallagher's consolidated financial
statements. Gallagher believes that of the significant accounting policies
disclosed in Note 1, the following may involve a higher degree of judgment and
complexity.
Revenue Recognition
Commission revenues are recognized at the latter of the billing or the
effective date of the related insurance policies, net of an allowance for
estimated policy cancellations. Commission revenues related to installment
premiums are recognized periodically as billed. Contingent commissions and
commissions on premiums directly billed by insurance companies are recognized
as revenue when the data necessary to reasonably determine such amounts has
been obtained by Gallagher. The income effects of subsequent premium
adjustments are recorded when the adjustments become known. Fee revenues are
recognized ratably as the services are rendered. The income effects of
subsequent fee adjustments are recorded when the adjustments become known.
Premiums and fees receivable in the consolidated balance sheets are net of
allowances for estimated policy cancellations and doubtful accounts. The
allowance for estimated policy cancellations is established through a charge to
revenues, while the allowance for doubtful accounts is established through a
charge to other operating expenses. Both of these allowances are based on
estimates and assumptions using historical data to project future experience.
Gallagher periodically reviews the adequacy of these allowances and makes
adjustments as necessary. The use of different estimates or assumptions could
produce different results.
Fair Value of Financial Instruments
Investment strategies are considered trading securities and consist primarily
of limited partnerships which invest in common stocks. These securities are
carried at fair value in the accompanying consolidated balance sheets, with
unrealized gains and losses included in the consolidated statements of
earnings. The fair value of investment strategies is determined by reference to
the fair values of the underlying common stocks which are primarily based on
quoted market prices. Marketable securities are considered available for sale
and consist primarily of preferred and common stocks. These securities are
carried at fair value in the accompanying consolidated balance sheets, with
unrealized gains and losses, less related deferred income taxes, excluded from
net earnings and reported as accumulated other comprehensive earnings (loss) in
stockholders' equity section of the consolidated balance sheets. The fair value
for marketable securities is primarily based on quoted market prices. To the
extent that quoted market prices are not available, fair value is determined
based on other relevant factors including dealer price quotations, price
quotations for similar instruments in different markets and pricing models.
Pricing models and their underlying assumptions impact the amount and timing of
unrealized gains and losses recognized and the use of different pricing models
or assumptions could produce different results.
15
Use of Estimates
In the preparation of Gallagher's consolidated financial statements in
accordance with GAAP, certain estimates and assumptions are made that affect
the amounts reported in the financial statements and accompanying notes.
Estimates and assumptions are used to calculate liabilities and expenses in
several areas including the following: defined benefit pension plan, retiree
health benefits plan, self-funded employee benefit plans, self-funded insurance
programs and stock options. The calculation of these liabilities and expenses
are based on estimates and assumptions using historical data and recognized
actuarial methods to project future experience. Gallagher periodically reviews
the adequacy of the assumptions used and makes adjustments as necessary. The
use of different estimates or assumptions could produce different results.
Results of Operations--Consolidated
During 2001, Gallagher acquired substantially all of the net assets of
sixteen insurance brokerage firms, ten of which were accounted for as poolings
of interests. For seven 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
2 to the Consolidated Financial Statements.
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (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 initiated five business combinations prior to July 1, 2001 that were
completed in the third quarter of 2001 and were accounted for as poolings of
interests because they met the qualifying criteria of SFAS 141. In June 2001,
the FASB also issued SFAS 142 which no longer permits the amortization of
goodwill and indefinite lived intangible assets. Instead, these assets will be
subject to periodic review for impairment (at least annually or more frequently
if impairment indicators arise). Gallagher will apply the new rules on
accounting for pre-existing goodwill and other intangible assets beginning in
the first quarter of 2002. Application of the nonamortization provisions of
SFAS 142 is expected to result in an increase in pretax earnings of $1.3
million per year. During 2002, Gallagher will perform the first of the required
tests of goodwill and indefinite lived intangible assets as of January 1, 2002.
Exclusive of the nonamortization provisions of goodwill and indefinite lived
intangible assets, management does not expect the adoption of SFAS 142 will
have a material effect on Gallagher's consolidated operating results or
financial position. See Note 1 to the Consolidated Financial Statements.
Commission revenues increased by $64.2 million or 14% in 2001. This increase
generated by the Insurance Brokerage Services segment is the result of record
new business of $99.8 million and rate increases partially offset by lost
business of $60.3 million and a reduction in revenue from national insurance
revenue sharing programs. Commission revenues increased by $32.5 million or 7%
in 2000. This increase, also generated by the Insurance Brokerage Services
segment was the result of new business production and rate increases partially
offset by lost business and a reduction in revenue from national insurance
revenue sharing programs.
Fee revenues increased by $43.6 million or 16% in 2001. This increase,
generated primarily from the Risk Management Services segment, resulted from
strong new business production of $55.3 million and renewal rate increases and
favorable retention rates on existing business partially offset by lost
business of $24.6 million. Fee revenues increased by $45.4 million or 19% in
2000. This increase, also generated primarily from Risk Management Services,
resulted from new business production of $41.4 million and favorable retention
rates on existing business partially offset by lost business of $13.2 million.
Investment income and other increased by $6.9 million or 16% in 2001 due
primarily to results generated by Gallagher's unconsolidated equity investment
portfolio, realized gains generated from Gallagher's
16
marketable securities portfolio, installment gains of $11.9 million on the
three alternative energy sale transactions discussed below and income generated
from commitment fees paid to Gallagher for providing letters of credit and
financial guarantees to several of its tax advantaged investments, real estate
partnerships and venture capital equity projects. Gallagher also recognized a
gain in 2001 of $2.4 million on the sale of a benefits administration book of
business. Income from Gallagher's unconsolidated equity investment portfolio
increased in 2001 by $2.5 million due primarily to $3.0 million of income that
was generated from Gallagher recording its proportionate share of income from
an equity investment in a real estate partnership that is currently developing
land in Florida. See Note 4 to the Consolidated Financial Statements for a
summary of the components of investment income and other.
Income from tax advantaged investments in 2001 relates to the sales of
interests in three alternative energy related limited partnerships. During the
third quarter of 2001, Gallagher entered into a transaction for the sale of a
95% interest in one of its synthetic fuel facilities located in South Carolina.
Under the sale agreement, Gallagher received an initial nonrefundable down
payment of $6.7 million and will receive additional installment payments over
time through 2007 based on qualified fuel production generated by the facility.
The buyer has the option to put the purchased interest back to Gallagher if
favorable tax rulings are not received by March 1, 2003. In the event of a put,
Gallagher would retain the down payment and installment payments made through
the put date. The aggregate pretax installment gain on the transaction is
expected to range from $36.0 million to $106.0 million and will be recognized
on an installment basis through December 31, 2007. In 2001, Gallagher
recognized an installment gain of $8.6 million on this sale transaction.
During the fourth quarter of 2001, Gallagher completed the sale of a two-
thirds interest in a partnership that owns a 59.9% interest in a synthetic fuel
facility also located in South Carolina. Gallagher received an initial down
payment of $3.2 million with additional installment payments over time through
2007 based on qualified fuel production generated by the facility. The buyer
has the option to put the purchased interest back to Gallagher if certain
adverse tax consequences occur through December 31, 2007. In the event of a
put, Gallagher would retain all installment payments made through the put date
and a pro-rated portion of the initial down payment. The aggregate pretax
installment gain on the transaction is expected to range from $48.0 million to
$70.0 million and will be recognized on an installment basis through December
31, 2007. In 2001, Gallagher recognized an installment gain of $2.0 million on
this sale transaction. The buyer also had the option, through March 31, 2002,
to acquire from Gallagher another one-sixth interest in the partnership at
proportionally equivalent terms. In January 2002, the buyer exercised this
option, which had no impact on Gallagher's 2001 results.
Effective December 31, 2000, Gallagher completed the sale of its interests in
several partnerships that operate landfill gas facilities. Gallagher received
an initial down payment of $8.7 million with additional installment payments
over time through 2007 based on qualified fuel production generated by the
facilities. The aggregate pretax installment gain on the transaction is
expected to range from $12.0 million to $22.0 million and will be recognized on
an installment basis through December 31, 2007. In 2001, Gallagher recognized
an installment gain of $1.3 million on this sale transaction. This transaction
had no impact on Gallagher's 2000 results.
The increases in investment income discussed above were partially offset by
the $9.2 million in income related to Gallagher's alternative energy related
investments recognized in 2000 and to a $6.0 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
between 2000 and 2001.
Investment income and other increased $3.8 million or 10% in 2000. This
increase was due primarily to $9.2 million in income related to Gallagher's
alternative energy related investments, and higher returns on fiduciary income
investments which was partially offset by other income recognized in 1999 by an
acquisition accounted for as a pooling of interests.
Salaries and employee benefits increased by $62.9 million or 15% in 2001.
This increase is higher than usual and is due primarily to a 14% increase in
employee headcount, salary increases, increases in incentive
17
compensation linked to Gallagher's overall operating results and the
performance of Gallagher's investment portfolio, the annualized effect of prior
year new hires, and a corresponding increase in employee benefit expenses. The
increase in employee headcount relates to the hiring of additional staff to
support the new business growth previously discussed and to an ongoing
initiative to hire additional production personnel to generate future revenue
growth. In 2000, salaries and employee benefits increased by $48.7 million or
13% due to a 7% increase in employee headcount, salary increases, increases in
incentive compensation linked to Gallagher's overall operating results and the
performance of a portion of Gallagher's investments portfolio, the annualized
effect of prior year new hires and a corresponding increase in employee benefit
expenses.
Other operating expenses increased by $22.7 million or 9% in 2001 due
primarily to fees for professional services and business insurance related to
Gallagher's tax advantaged investments, real estate partnerships and venture
capital equity projects 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. Other operating
expenses increased by $26.3 million or 12% in 2000 due primarily to increases
in professional fees related to acquisition activity and investment projects,
management fees related to positive investment results, commissions paid to
sub-brokers, write-off of doubtful accounts, increased leased space, temporary
help needed to service the new risk management and claims business and travel
and entertainment.
Partnership investment expenses of $21.1 million in 2001 represent the
ongoing expenses associated with the operations of 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.
Gallagher's effective income tax rates were 11.7%, 30.5% and 34.5% in 2001,
2000 and 1999, respectively. These rates are net of the effect of tax credits
generated by investments in alternative energy related partnerships that
operate synthetic fuel facilities and limited partnerships that operate
qualified affordable housing, which are partially offset by state and foreign
taxes. The reduction in the effective income tax rate in 2001 from the prior
year is due to a $23.4 million increase in tax credits earned, net of
amortization expense in 2001. This increase in the amount of tax credits earned
was generated from Gallagher's alternative energy related partnerships. See
Note 13 to the Consolidated Financial Statements. As a result of these sales of
interests in alternative energy facilities, Gallagher expects its income tax
rate to increase to a more normalized level in 2002.
Gallagher's foreign operations recorded earnings before income taxes of $8.4
million, $7.9 million and $5.0 million in 2001, 2000 and 1999, respectively.
The increase in 2001 is due primarily to new business production partially
offset by lost business. The increase in 2000 is due primarily to new business
and the $1.2 million write-off in 1999 of intangible assets associated with
lost business. See Notes 13 and 15 to the Consolidated Financial Statements.
Gallagher's revenues vary from quarter-to-quarter generally as a result of
the timing of policy inception dates which traditionally are heaviest in the
third quarter. Expenses, on the other hand, are fairly uniform throughout the
year. See Note 14 to the Consolidated Financial Statements.
Results of Operations--Segment Information
As discussed in Note 15 to the Consolidated Financial Statements, Gallagher
operates in three business segments; Insurance Brokerage Services, Risk
Management Services and Financial Services, as well as a Corporate segment.
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
18
segment also provides consulting services, for fee compensation, related to the
clients' risk financing programs and includes Gallagher's retail, reinsurance
and wholesale insurance brokerage operations.
Total revenues in 2001 were $608.3 million, a 13% increase over 2000. 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 between 2000 and 2001.
Total domestic revenues of $560.4 million were up 12% over 2000. Revenues in
2001 from foreign operations, principally in the United Kingdom, Australia and
Bermuda, were up 18% or $7.4 million over 2000. This increase is due primarily
to new business production offset partially by lost business. Earnings before
income taxes in 2001 increased 16% over 2000 principally as a result of
increased revenues. Total revenues in 2000 were $538.9 million, an increase of
8% over 1999. This increase again is due to new business production partially
offset by lost business. Total domestic revenues of $498.4 million were up 7%
over 1999. Revenues in 2000 from foreign operations, primarily in the United
Kingdom, Australia and Bermuda, were up 22% over 1999 mainly due to $2.2
million attributable to the 2000 acquisition of MBR Pty Limited. Earnings
before income taxes of $100.3 million in 2000 increased 3% over 1999 due mainly
to increased revenues.
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 in 2001 were $264.7 million or 14% over 2000 due to strong new
business production and favorable retention rates on existing business. Total
domestic revenues of $242.4 million in 2001 were up 15% over 2000 due primarily
to new business and substantially less lost business than in 2000. In 2001,
foreign revenues of $22.3 million, principally from the United Kingdom and
Australia, increased 2% over 2000 due to new business production. Earnings
before income taxes in 2001 of $35.3 million increased 6% over 2000 due
primarily to revenue increases, which were partially offset by moderate
increases in expenses. Total revenues in 2000 were $232.3 million or 20% over
1999 due to strong new business production and favorable retention rates on
existing business. Total domestic revenues of $210.4 million increased 17% over
1999 due primarily to new business and substantially less lost business than in
1999. In 2000, foreign revenues of $21.9 million, principally from the United
Kingdom and Australia, increased 57% over 1999 due to new business production
and a significant increase in revenues from Australian operations for claims
work performed as a result of tainted aviation fuel in Australia. Earnings
before income taxes in 2000 increased 43% over 1999 due primarily to increased
revenues, which were partially offset by a moderate increase in expenses.
Financial Services
The Financial Services segment is responsible for the management of
Gallagher's diversified investment portfolio, which includes fiduciary funds,
marketable and other equity securities, and tax advantaged and other strategic
investments. The invested assets of Gallagher are managed in this segment in
order to maximize the return to the company.
Total revenues in 2001 were $37.3 million or 55% more than total revenues in
2000 due primarily to results generated by Gallagher's unconsolidated equity
investment portfolio, realized gains generated from Gallagher's marketable
securities portfolio, installment gains of $11.9 million on the three
alternative energy sale transactions previously discussed in "Results Of
Operations--Consolidated" and to income generated from commitment fees paid to
Gallagher for providing letters of credit and financial guarantees to several
of its tax advantaged investments, real estate partnerships and venture capital
equity projects. Gallagher also recognized a gain in 2001 of $2.4 million on
the sale of a benefits administration book of business. Income from Gallagher's
unconsolidated equity investment portfolio increased in 2001 by $2.5 million
due primarily to
19
$3.0 million of income that was generated from Gallagher recording its
proportionate share of income from an equity investment in a real estate
partnership that is currently developing land in Florida.
In 2001, earnings before income taxes decreased $7.5 million or 58% from 2000
due primarily to the increase in partnership investment expenses of $21.1
million in 2001 which represent the ongoing expenses associated with the
operations of synthetic fuel facilities. The increase in these expenses in 2001
relates to the production costs that were incurred by the alternative energy
partnerships in order to generate the tax credits that were 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.
Total revenues in 2000 increased 22% over 1999. This increase is due
primarily to $9.2 million of income related to Gallagher's alternative energy
related investments and higher returns on short-term investments. Earnings
before income taxes in 2000 decreased $532,000 or 4% from 1999 due primarily to
increases in incentive compensation linked to the performance of Gallagher's
investment portfolio and increased management fees associated with positive
investment results for Gallagher's independently managed investment portfolio.
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 Corporate. All costs are generated in the United States.
Financial Condition and Liquidity
The insurance brokerage industry is not capital intensive. The capital used
to fund Gallagher's investment portfolio has been primarily generated from the
excess cash provided by its operations. Cash generated from operating
activities was $130.3 million, $155.0 million and $93.1 million in 2001, 2000
and 1999, 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 year to year. Funds restricted as to
Gallagher's use, primarily premiums held as fiduciary funds, have not been
included in determining Gallagher's overall liquidity. Currently, Gallagher
believes it has sufficient capital to meet its cash flow needs. However, in the
event that Gallagher needs capital to fund its operations and investing
requirements, it would use borrowings under its credit agreement to meet its
short-term needs and would consider other alternatives for its long-term needs.
Such alternatives would include raising capital through public markets or
restructuring its operations in the event that cash flows from operations are
reduced dramatically due to lost business. However, Gallagher has historically
been profitable, and cash flows from operations and short-term borrowings under
its credit agreements have been sufficient to fund Gallagher's operating,
investment and capital expenditure needs. Gallagher expects this favorable cash
flow trend to continue in the future.
In 2000, Gallagher and one of its significant subsidiaries entered into an
unsecured Revolving Credit Agreement (the Revolving Credit Agreement), which
expires on September 10, 2003, with a group of five financial institutions. The
Revolving Credit Agreement provides for short-term and long-term revolving
credit commitments of $100.0 million and $50.0 million, respectively. The
facility provides for loans and letters of credit. 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. The Revolving Credit Agreement provides for borrowings to be
denominated in either U.S. dollars or Alternative Currencies, as defined in the
credit agreement. In addition, the credit agreement has two borrowing options,
Domestic Rate Loans and Eurocurrency Loans, as defined in the credit agreement.
Interest rates on borrowings under the Domestic Rate Loan option are based on
the prime commercial rate and interest rates on borrowings under the
Eurocurrency Loan option are based on LIBOR plus .400% for short-term and long-
term revolving credit commitments. The facility fee related to this credit
agreement is based on .100% of the used and unused portions of the short-term
and long-term revolving credit commitments.
20
As of December 31, 2001, under the long-term credit facility, Gallagher has
contingently committed to funding $45.9 million through letter of credit
arrangements related to its corporate insurance programs and several of its
equity and other strategic investments. Also, as of December 31, 2001, there
were $35.0 million of borrowings outstanding under the Revolving Credit
Agreement. Accordingly, Gallagher had $69.1 million available for future
borrowing. In 2001, Gallagher borrowed $206.7 million and repaid $171.7 million
of short-term borrowings under this facility. These borrowings were used on a
short-term basis to finance a portion of Gallagher's operating and investment
activities and stock repurchases. There were no borrowings under this facility
in 2000. Terms of the Revolving Credit Agreement include various covenants that
require Gallagher to maintain specified levels of tangible net worth and
restrict the amount of payments on certain expenditures. Gallagher was in
compliance with these covenants, in all material respects, as of December 31,
2001.
Gallagher had 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. During 2000 and 1999, Gallagher borrowed and repaid
$10.0 million and $20.0 million, respectively, of short-term borrowings under
the Credit Agreement. These borrowings were primarily used to finance a portion
of Gallagher's operating and investment activity. In September 2000, Gallagher
terminated this agreement.
Gallagher also had three line of credit facilities totaling $45.0 million
that were to expire on April 30, 2001. Periodically, Gallagher made short-term
borrowings under these facilities to meet short-term cash flow needs and had a
balance of $15.0 million outstanding at December 31, 1999. During 2000,
Gallagher borrowed $35.0 million and repaid $50.0 million of borrowings under
these facilities. During 1999, Gallagher borrowed $78.5 million and repaid
$78.5 million of short-term borrowings under these facilities. The repayments
satisfied all remaining loan balances under these facilities and these
agreements were terminated in September 2000. Borrowings under these facilities
were primarily used to finance a portion of Gallagher's operating and
investment activities.
Recently, the issue of off-balance sheet financing has been prominent in the
news and has become a topic of concern among many investors. Gallagher's
investment portfolio includes investments in real estate partnerships and
venture capital equity projects where Gallagher's ownership is between 20% to
50%. As a result, these investments are accounted for using the equity method
and as such, the balance sheets of the investees are not consolidated in
Gallagher's consolidated balance sheet as of December 31, 2001 and 2000. The
December 31, 2001 and 2000 balance sheets of several of the unconsolidated
equity investments contain outstanding debt, which is not required to be
included in Gallagher's consolidated balance sheet. See Note 4 to the
Consolidated Financial Statements for a summary of the outstanding debt of
Gallagher's unconsolidated investments accounted for using the equity method.
In addition, Note 4 to the Consolidated Financial Statements also contains a
summary of Gallagher's contingent commitments related to its investments
accounted for using the equity method.
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 Notes 5
and 12 to the Consolidated Financial Statements for additional commitments and
contingencies.
Gallagher paid $41.6 million in cash dividends on its common stock in 2001.
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. In each quarter of 2001, Gallagher
paid a dividend of $.13 per share which was $.015 or 13% greater than each
quarterly dividend in 2000. On January 24, 2002, Gallagher declared a 15%
increase in its quarterly cash dividend to $.15 payable on April 15, 2002 to
Shareholders of Record as of March 29, 2002.
21
Net capital expenditures were $24.3 million, $15.2 million and $18.1 million
in 2001, 2000 and 1999, respectively. In 2002, Gallagher expects to make
expenditures for capital improvements of approximately $25.0 million. Capital
expenditures by Gallagher are related primarily to office moves and expansions
and updating computer systems and equipment.
In 1988, Gallagher adopted a common stock repurchase plan that has been
extended through June 30, 2002. Under the plan, Gallagher has repurchased
3,359,000 shares at a cost of $104.1 million, 1,500,000 shares at a cost of
$31.3 million, and 1,524,000 shares at a cost of $18.4 million in 2001, 2000
and 1999, respectively. The repurchased shares are held for reissuance in
connection with exercises of options under Gallagher's stock option plans.
Under the provisions of the repurchase plan, Gallagher is authorized to
repurchase approximately 2.3 million additional shares through June 30, 2002.
Gallagher is under no commitment or obligation to repurchase any particular
amount of common stock and at its discretion may suspend the repurchase plan at
any time.
Effective with changes in the United States federal income tax laws in 1997,
Gallagher no longer provides for federal income taxes on the undistributed
earnings of its foreign subsidiaries which are considered permanently invested
outside the United States. At December 31, 2001, Gallagher had $32.0 million of
undistributed earnings from its foreign subsidiaries. See Note 13 to the
Consolidated Financial Statements. Although not considered available for
domestic needs, the undistributed earnings generated by certain foreign
subsidiaries referred to above may be used to finance foreign operations and
acquisitions.
Contractual Obligations and Commitments
In connection with its operating and investing activities, Gallagher has
entered into certain contractual obligations, as well as commitments to fund
certain investments. See Notes 4, 5 and 12 to the Consolidated Financial
Statements for a discussion on these obligations and commitments.
Gallagher's future cash payments associated with its contractual obligations
pursuant to the Revolving Credit Agreement and operating leases as of December
31, 2001 are as follows (in thousands):
Payments Due by Period
--------------------------------------------
Contractual Obligations 2002 2003 to 2004 2005 to 2006 Thereafter Total
----------------------- ------- ------------ ------------ ---------- --------
Revolving credit
agreement............... $35,000 $ -- $ -- $ -- $ 35,000
Operating leases......... 41,533 60,897 36,962 45,905 185,297
------- ------- ------- ------- --------
Total contractual
obligations........... $76,533 $60,897 $36,962 $45,905 $220,297
======= ======= ======= ======= ========
Gallagher's commitments associated with outstanding letters of credit,
financial guarantees and funding commitments as of December 31, 2001 are as
follows (in thousands):
Amount of Commitment Expiration by Period Total
-------------------------------------------- Amounts
Other Commitments 2002 2003 to 2004 2005 to 2006 Thereafter Committed
----------------- ------- ------------ ------------ ---------- ---------
Letters of credit....... $ 645 $ 7,252 $3,530 $34,504 $ 45,931
Financial guarantees.... 6,250 27,250 -- 5,100 38,600
Funding commitments..... 15,600 -- -- -- 15,600
------- ------- ------ ------- --------
Total other
commitments.......... $22,495 $34,502 $3,530 $39,604 $100,131
======= ======= ====== ======= ========
Since commitments may expire unused, the amounts presented in the table above
do not necessarily reflect the actual future cash funding requirements of
Gallagher.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Gallagher is exposed to various market risks, including changes in interest
rates and foreign currency exchange rates. Market risk is the potential loss
arising from adverse changes in market rates and prices, such
22
as interest and foreign currency exchange rates and equity prices. Gallagher
does not enter into derivatives or other similar financial instruments for
trading or speculative purposes. The following analyses present the
hypothetical loss in fair value of the financial instruments held by Gallagher
at December 31, 2001 and 2000, that are sensitive to changes in interest rates
and equity prices. The range of changes in interest rates used in the analyses
reflects Gallagher's view of changes that are reasonably possible over a one
year period. This discussion of market risks related to Gallagher's
consolidated balance sheets includes estimates of future economic environments
caused by changes in market risks. The effect of actual changes in these risk
factors may differ materially from Gallagher's estimates. In the ordinary
course of business, Gallagher also faces risks that are either nonfinancial or
unquantifiable, including credit risk and legal risk. These risks are not
included in the following analyses.
Gallagher has a comprehensive and diversified investment portfolio.
Gallagher's invested assets are held as cash and cash equivalents, investment
strategies--trading and marketable securities--available for sale. Accordingly,
these assets are subject to various market risk exposures such as interest rate
risk and equity price risk.
The fair value of Gallagher's cash and cash equivalents investment portfolio
at December 31, 2001 and 2000 approximated its carrying value due to its short-
term duration. Market risk was estimated as the potential decrease in fair
value resulting from a hypothetical one percentage point increase in interest
rates for the instruments contained in the cash and cash equivalents investment
portfolio. The resulting fair value was not materially different from the
carrying values at December 31, 2001 and 2000, respectively.
At December 31, 2001 and 2000, the fair value of Gallagher's investment
strategies--trading portfolio was $52.6 million and $51.9 million,
respectively. From an investment management perspective, this portfolio, which
is managed by several independent fund managers, consists of two different
components: an equity portfolio of $6.9 million and $7.2 million and an
alternative investment strategies portfolio of $45.7 million and $44.7 million
at December 31, 2001 and 2000, respectively.
The equity portfolio is subject to equity price risk. It is not hedged,
consists of common stocks and is primarily managed to produce realized gains
for Gallagher. The estimated potential loss in fair value of this equity
component resulting from a hypothetical decrease in prices quoted by stock
exchanges of 10% would be approximately $690,000 and $720,000 at December 31,
2001 and 2000, respectively.
Gallagher's alternative investment strategies portfolio is also subject to
equity pricing risk. However, these investments are actively managed in order
to minimize Gallagher's exposure to equity pricing risk. The objective of this
portfolio is to maximize the overall return to Gallagher, while minimizing the
downward price risk in order to preserve the investments' underlying principal
balances. The independent fund managers for these alternative investment
strategies hedge their strategies by "selling short" common equity securities
in order to mitigate the effects of changes in equity prices thereby making any
such fluctuations immaterial. Accordingly, hypothetical changes in equity
prices would not cause the resulting fair value to be materially different from
the carrying value for this portfolio at December 31, 2001 and 2000,
respectively. While these fund managers attempt to perfectly hedge their
investment strategies, equity pricing risk cannot be completely eliminated.
The fair value of Gallagher's marketable securities--available for sale
portfolio was $18.3 million ($4.4 million less than its aggregate amortized
cost) and $23.3 million ($4.2 million less than its aggregate amortized cost)
at December 31, 2001 and 2000, respectively. The overall objective of this
portfolio is to provide Gallagher with a stable after tax yield. This
portfolio, which is not hedged, consists primarily of dividend yielding
preferred stocks. Accordingly, this portfolio is more sensitive to interest
rate risk than it is to equity pricing risk. The estimated potential loss in
fair value resulting from a hypothetical one percentage point increase in
short-term interest rates would be approximately $2.1 million and $2.7 million
at December 31, 2001 and 2000, respectively.
23
At December 31, 2001, Gallagher had $35.0 million in short-term borrowings
outstanding under the Revolving Credit Agreement. The fair value of these
borrowings approximated their carrying value due to their short-term duration
and variable interest rates. At December 31, 2000, there were no borrowings
outstanding under the Revolving Credit Agreement. Market risk was estimated as
the potential increase in the fair value resulting from a hypothetical one
percentage point decrease in Gallagher's weighted average short-term borrowing
rate at December 31, 2001 and the resulting fair value was not materially
different from the year end carrying value.
Gallagher is subject to foreign currency exchange rate risk primarily due to
the fact that its United Kingdom based subsidiaries incur expenses denominated
in British pounds while receiving their revenues in U.S. dollars. Gallagher
does not hedge this foreign currency exchange rate risk. The foreign currency
gains (losses) related to this market risk are recorded in earnings before
income taxes as they are incurred. Assuming a hypothetical adverse change of
10% in the average foreign currency exchange rate for 2001 and 2000 (a
weakening of the U.S. dollar), earnings before income taxes would decrease by
approximately $3.3 million and $2.8 million, respectively. Gallagher is also
subject to foreign currency exchange rate risk associated with the translation
of its foreign subsidiaries into U.S. dollars. However, it is management's
opinion that this foreign currency exchange risk is not material to Gallagher's
consolidated operating results or financial position. Gallagher manages the
balance sheets of its foreign subsidiaries such that foreign liabilities are
matched with equal foreign assets thereby maintaining a "balanced book" which
minimizes the effects of currency fluctuations.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of
1995
This annual 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.
24
Item 8. Financial Statements and Supplementary Data.
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Pages
-----
Consolidated Financial Statements:
Consolidated Statements of Earnings..................................... 26
Consolidated Balance Sheets............................................. 27
Consolidated Statements of Cash Flows................................... 28
Consolidated Statements of Stockholders' Equity......................... 29
Notes to Consolidated Financial Statements.............................. 30-54
Management's Report....................................................... 55
Report of Independent Auditors............................................ 56
25
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENTS OF EARNINGS
Years Ended December 31,
--------------------------
2001 2000 1999
-------- -------- --------
(in thousands, except per
share data)
Operating Results
Revenues:
Commissions....................................... $534,450 $470,244 $437,706
Fees.............................................. 324,864 281,235 235,879
Investment income and other:
Investment income................................ 21,335 25,952 28,736
Income from equity investments, partnerships and
joint ventures.................................. 23,581 14,185 8,939
Other income..................................... 5,813 3,657 2,270
-------- -------- --------
Total investment income and other................. 50,729 43,794 39,945
-------- -------- --------
Total revenues.................................. 910,043 795,273 713,530
-------- -------- --------
Expenses:
Salaries and employee benefits.................... 477,279 414,372 365,689
Other operating expenses.......................... 269,832 247,162 220,817
Partnership investment expenses................... 21,079 -- --
-------- -------- --------
Total expenses.................................. 768,190 661,534 586,506
-------- -------- --------
Earnings before income taxes........................ 141,853 133,739 127,024
Provision for income taxes.......................... 16,597 40,784 43,784
-------- -------- --------
Net earnings.................................... $125,256 $ 92,955 $ 83,240
======== ======== ========
Net earnings per common share....................... $ 1.48 $ 1.11 $ 1.02
Net earnings per common and common equivalent share. 1.39 1.04 .97
Dividends declared per common share................. .52 .46 .40
See notes to consolidated financial statements.
26
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED BALANCE SHEETS
December 31,
----------------------
2001 2000
---------- ----------
(in thousands)
ASSETS
------
Current assets:
Cash and cash equivalents............................ $ 97,334 $ 141,831
Restricted cash...................................... 209,509 158,646
Premiums and fees receivable......................... 555,276 436,542
Investment strategies--trading....................... 52,588 51,897
Other................................................ 109,559 56,447
---------- ----------
Total current assets............................... 1,024,266 845,363
Marketable securities--available for sale.............. 18,290 23,306
Deferred income taxes.................................. 99,263 47,824
Other noncurrent assets................................ 213,417 160,360
Fixed assets........................................... 143,344 126,933
Accumulated depreciation and amortization.............. (92,098) (84,387)
---------- ----------
Net fixed assets................................... 51,246 42,546
Intangible assets--net................................. 65,341 16,089
---------- ----------
$1,471,823 $1,135,488
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Premiums payable to insurance companies.............. $ 805,595 $ 604,979
Accrued salaries and bonuses......................... 56,270 38,650
Accounts payable and other accrued liabilities....... 109,853 109,214
Unearned fees........................................ 16,527 19,014
Income taxes payable................................. 33,226 9,867
Other................................................ 45,084 5,197
---------- ----------
Total current liabilities.......................... 1,066,555 786,921
Other noncurrent liabilities........................... 33,655 19,667
Stockholders' equity:
Common stock--issued and outstanding 85,111 shares in
2001 and
84,540 shares in 2000.............................. 85,111 84,540
Capital in excess of par value....................... 8,768 21,762
Retained earnings.................................... 283,796 225,096
Unearned deferred compensation....................... (3,438) --
Accumulated other comprehensive earnings (loss)...... (2,624) (2,498)
---------- ----------
Total stockholders' equity......................... 371,613 328,900
---------- ----------
$1,471,823 $1,135,488
========== ==========
See notes to consolidated financial statements.
27
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
-----------------------------
2001 2000 1999
--------- -------- --------
(in thousands)
Cash flows from operating activities:
Net earnings.................................. $ 125,256 $ 92,955 $ 83,240
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Net gain on investments and other........... (2,895) (2,006) (2,996)
Gain on sales of operations................. (2,375) (1,823) --
Depreciation and amortization............... 20,042 18,611 17,676
Increase in restricted cash................. (50,863) (29,350) (31,057)
Increase in premiums receivable............. (111,602) (31,701) (78,691)
Increase in premiums payable................ 193,307 76,972 95,439
Decrease (increase) in trading investments--
net........................................ 1,051 6,498 (3,678)
Increase in other current assets............ (25,026) (2,274) (419)
Increase (decrease) in accrued salaries and
bonuses.................................... 18,027 14,032 (456)
Decrease in accounts payable and other
accrued liabilities........................ (401) (571) (12,443)
Increase (decrease) in income taxes payable. 23,359 25 (2,929)
Tax benefit from issuance of common stock... 24,806 20,027 5,502
Net change in deferred income taxes......... (77,751) (30,613) (2,842)
Other....................................... (4,626) 24,227 26,779
--------- -------- --------
Net cash provided by operating activities. 130,309 155,009 93,125
--------- -------- --------
Cash flows from investing activities:
Purchases of marketable securities............ (13,957) (25,832) (44,009)
Proceeds from sales of marketable securities.. 23,051 22,471 39,778
Proceeds from maturities of marketable
securities.................................. 398 762 1,495
Net additions to fixed assets................. (24,319) (15,169) (18,088)
Cash paid for acquisitions, net of cash
acquired.................................... (17,893) (2,440) (250)
Proceeds from sales of operations............. 2,700 2,334 --
Other......................................... (47,803) (35,632) (20,537)
--------- -------- --------
Net cash used by investing activities..... (77,823) (53,506) (41,611)
--------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock........ 27,255 27,837 16,029
Repurchases of common stock................... (104,123) (31,344) (18,428)
Dividends paid................................ (41,618) (33,759) (28,010)
Borrowings on line of credit facilities....... 206,700 45,000 98,500
Repayments on line of credit facilities....... (171,700) (60,000) (98,500)
Equity transactions of pooled companies prior
to dates of acquisition..................... (13,497) (4,937) (63,116)
--------- -------- --------
Net cash used by financing activities..... (96,983) (57,203) (93,525)
--------- -------- --------
Net (decrease) increase in cash and cash
equivalents................................... (44,497) 44,300 (42,011)
Cash and cash equivalents at beginning of year.. 141,831 97,531 139,542
--------- -------- --------
Cash and cash equivalents at end of year........ $ 97,334 $141,831 $ 97,531
========= ======== ========
Supplemental disclosures of cash flow
information:
Interest paid................................. $ 1,236 $ 1,212 $ 2,048
Income taxes paid............................. 35,750 24,643 30,153
See notes to consolidated financial statements.
28
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Other
Common Stock Capital In Unearned Comprehensive Total
--------------- Excess Of Retained Deferred Earnings Stockholders'
Shares Amount Par Value Earnings Compensation (Loss) Equity
------ ------- ---------- -------- ------------- -------------- -------------
(in thousands)
Balance at December 31,
1998 as previously
reported............... 76,126 $76,126 $ (15,566) $150,619 $ -- $ (777) $ 210,402
Acquisition of pooled
companies............. 5,043 5,043 7,224 45,999 -- -- 58,266
------ ------- ---------- -------- ------------- -------------- -------------
Balance at December 31,
1998................... 81,169 81,169 (8,342) 196,618 -- (777) 268,668
-------------
Net earnings........... -- -- -- 83,240 -- -- 83,240
Net change in
unrealized gain (loss)
on available for sale
securities............ -- -- -- -- -- (1,892) (1,892)
-------------
Comprehensive earnings 81,348
Cash dividends declared
on common stock....... -- -- -- (29,202) -- -- (29,202)
Common stock issued
under stock option
plans................. 2,512 2,512 13,517 -- -- -- 16,029
Tax benefit from
issuance of common
stock................. -- -- 5,502 -- -- -- 5,502
Common stock
repurchases........... (1,524) (1,524) (16,904) -- -- -- (18,428)
Equity transactions of
pooled companies prior
to dates of
acquisition........... -- -- 15,074 (78,190) -- -- (63,116)
------ ------- ---------- -------- ------------- -------------- -------------
Balance at December 31,
1999................... 82,157 82,157 8,847 172,466 -- (2,669) 260,801
-------------
Net earnings........... -- -- -- 92,955 -- -- 92,955
Net change in
unrealized gain (loss)
on available for sale
securities............ -- -- -- -- -- 171 171
-------------
Comprehensive earnings 93,126
Cash dividends declared
on common stock....... -- -- -- (35,539) -- -- (35,539)
Common stock issued
under stock option
plans................. 3,811 3,811 24,026 -- -- -- 27,837
Tax benefit from
issuance of common
stock................. -- -- 20,027 -- -- -- 20,027
Common stock
repurchases........... (1,500) (1,500) (30,987) -- -- -- (32,487)
Common stock issued in
two pooling
acquisitions.......... 72 72 -- -- -- -- 72
Equity transactions of
pooled companies prior
to dates of
acquisition........... -- -- (151) (4,786) -- -- (4,937)
------ ------- ---------- -------- ------------- -------------- -------------
Balance at December 31,
2000................... 84,540 84,540 21,762 225,096 -- (2,498) 328,900
-------------
Net earnings........... -- -- -- 125,256 -- -- 125,256
Net change in
unrealized gain (loss)
on available for sale
securities............ -- -- -- -- -- (126) (126)
-------------
Comprehensive earnings 125,130
Cash dividends declared
on common stock....... -- -- -- (43,534) -- -- (43,534)
Common stock issued
under stock option
plans................. 3,007 3,007 24,248 -- -- -- 27,255
Tax benefit from
issuance of common
stock................. -- -- 24,806 -- -- -- 24,806
Common stock
repurchases........... (3,359) (3,359) (90,151) (9,470) -- -- (102,980)
Common stock issued in
three pooling
acquisitions.......... 93 93 -- -- -- -- 93
Common stock issued in
three purchase
acquisitions.......... 678 678 24,200 -- -- -- 24,878
Common stock issued
under deferred
compensation.......... 152 152 3,848 -- (3,438) -- 562
Equity transactions of
pooled companies prior
to dates of
acquisition........... -- -- 55 (13,552) -- -- (13,497)
------ ------- ---------- -------- ------------- -------------- -------------
Balance at December 31,
2001................... 85,111 $85,111 $ 8,768 $283,796 $ (3,438) $ (2,624) $ 371,613
====== ======= ========== ======== ============= ============== =============
See notes to consolidated financial statements.
29
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Operations
Arthur J. Gallagher & Co. (Gallagher) provides insurance brokerage and risk
management services to a wide variety of commercial, industrial, institutional
and governmental organizations. Commission revenue is principally generated
through the negotiation and placement of insurance for its clients. Fee revenue
is primarily generated by providing other risk management services including
claims management, information management, risk control services and appraisals
in either the property/casualty market or human resource/employee benefit
market. Investment income and other is generated from Gallagher's investment
portfolio, which includes fiduciary funds, equity securities, and tax
advantaged and other strategic investments. Gallagher is headquartered in
Itasca, Illinois, has more than 250 offices in nine countries and does business
in more than 100 countries around the world through a network of correspondent
brokers and consultants.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
Gallagher and all of its majority owned subsidiaries (greater than 50%
ownership). Investments in partially owned entities in which ownership is 20%
to 50% are accounted for using the equity method. Accordingly, Gallagher's
share of the net earnings of these entities is included in consolidated net
earnings. Investments in partially owned entities in which ownership is less
than 20% are carried at cost. All material intercompany accounts and
transactions have been eliminated in consolidation. Certain reclassifications
have been made to the prior years' financial statements in order to conform to
the current year presentation.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes. Such estimates and
assumptions could change in the future as more information becomes known which
could impact the amounts reported and disclosed herein.
Revenue Recognition
Gallagher's revenues are derived from commissions, fees and investment
income.
Commission revenues, as well as the related premiums receivable and premiums
payable to insurance companies, are recognized at the latter of the billing or
the effective date of the related insurance policies, net of an allowance for
estimated policy cancellations. Commission revenues related to installment
premiums are recognized periodically as billed. Contingent commissions and
commissions on premiums directly billed by insurance companies are recognized
as revenue when the data necessary to reasonably determine such amounts has
been obtained by Gallagher. Typically, these types of commission revenues
cannot be reasonably determined until the cash or the related policy detail is
received by Gallagher from the insurance company. A contingent commission is a
commission paid by an insurance company that is based on the overall estimated
profit and/or volume of the business placed with that insurance company.
Commissions on premiums billed directly by insurance companies relate to a
large number of small premium transactions, whereby the billing and policy
issuance process is controlled entirely by the insurance company. The income
effects of subsequent premium adjustments are recorded when the adjustments
become known.
Fee revenues are recognized ratably as the services are rendered. Fee
revenues generated from the Insurance Brokerage Services segment primarily
relate to fees negotiated in lieu of commissions, which are recognized in the
same manner as commission revenues. Fee revenues generated from the Risk
Management
30
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1. Summary of Significant Accounting Policies--(Continued)
Services segment relate to third party claims administration, loss control and
other risk management consulting services, which are provided over a period of
time, typically one year. The income effects of subsequent fee adjustments are
recorded when the adjustments become known.
In 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial Statements," as
amended, which was effective for fiscal years beginning after December 15,
1999. SAB 101 summarizes the SEC staff's views regarding the recognition and
reporting of revenues in financial statements for certain types of
transactions. Accordingly, during 2000, Gallagher changed its method of
accounting for cancellations of client insurance policies to establish an
allowance for estimated policy cancellations. Previously, Gallagher did not
specifically record an allowance for such cancellations. The adoption of the
applicable provisions of SAB 101 by Gallagher in 2000 was not material to
Gallagher's consolidated operating results or financial position. Gallagher
will periodically review the adequacy of the allowance for estimated policy
cancellations and adjust it as necessary.
Premiums and fees receivable in the accompanying consolidated balance sheets
are net of allowances for estimated policy cancellations and doubtful accounts.
The allowance for estimated policy cancellations was $2,500,000 and $2,000,000
at December 31, 2001 and 2000, respectively. The allowance for doubtful
accounts was $1,730,000 and $3,132,000 at December 31, 2001 and 2000,
respectively.
Investment income and other primarily includes interest income, dividend
income, net realized and unrealized gains (losses), income (loss) from equity
investments, and gains on sales of operations and invested assets. Interest
income is recorded as earned. Dividend income is recognized as income based on
the date that the underlying security trades "ex-dividend." See the accounting
policy on investments for revenue recognition policies pertaining to net
realized and unrealized gains (losses). Income (loss) from equity investments
represents Gallagher's proportionate share of income or losses from investments
accounted for using the equity method.
Earnings per Share
Earnings per share is computed based on the weighted average number of common
and common equivalent shares outstanding during the respective period. Common
equivalent shares include incremental shares from dilutive stock options, which
are calculated from the date of grant under the treasury stock method using the
average market price for the period.
Cash and Cash Equivalents
Short-term investments, consisting principally of commercial paper and
certificates of deposit which have a maturity of ninety days or less at date of
purchase, are considered cash equivalents.
Restricted Cash
In its capacity as an insurance broker, Gallagher collects premiums from
insureds and, after deducting its commissions and/or fees, remits these
premiums to insurance carriers. Unremitted insurance premiums are held in a
fiduciary capacity until disbursed by Gallagher. Various state and foreign
agencies that regulate insurance brokers provide specific requirements that
limit the type of investments that may be made with such funds. Accordingly
Gallagher invests these funds in cash, money market accounts, commercial paper
and certificates of deposit. Gallagher earns interest income on these
unremitted funds, which is reported as investment income and other in the
accompanying consolidated statements of earnings.
31
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1. Summary of Significant Accounting Policies--(Continued)
Premiums collected from insureds but not yet remitted to insurance carriers
are restricted as to use by laws in certain states and foreign jurisdictions in
which Gallagher's subsidiaries operate. These unremitted amounts are reported
as restricted cash in the accompanying consolidated balance sheets, with the
related liability reported as premiums payable to insurance companies.
Additionally, one of Gallagher's United Kingdom subsidiaries is required by
Lloyd's of London to meet certain liquidity requirements.
Investments
Investment strategies are considered trading securities and consist primarily
of limited partnerships which invest in common stocks. Securities designated as
trading are carried at fair value in the accompanying consolidated balance
sheets, with unrealized gains and losses included in the consolidated
statements of earnings. The fair value of investment strategies is determined
by reference to the fair values of the underlying common stocks which are based
primarily on quoted market prices.
Marketable securities are considered available for sale and consist primarily
of preferred and common stocks. Securities designated as available for sale are
carried at fair value in the accompanying consolidated balance sheets, with
unrealized gains and losses, less related deferred income taxes, excluded from
net earnings and reported as accumulated other comprehensive earnings or loss.
Gains and losses are recognized in net earnings when realized using the
specific identification method. The fair value for marketable securities is
based primarily on quoted market prices.
Fixed Assets
Fixed assets are carried at cost in the accompanying consolidated balance
sheets. Furniture and equipment with a cost of $121,763,000 and $110,614,000 at
December 31, 2001 and 2000, respectively, are depreciated using the straight-
line method over the estimated useful lives (three to ten years) of the assets.
Leasehold improvements with a cost of $21,581,000 and $16,319,000 at December
31, 2001 and 2000, respectively, are amortized using the straight-line method
over the shorter of the estimated useful lives of the assets or the lease
terms. Gallagher periodically reviews long-lived assets for impairment whenever
events or changes in business circumstances indicate that the carrying value of
the assets may not be recoverable. If the fair value is less than the carrying
amount of the asset, a loss would be recognized for the difference.
Intangible Assets
Intangible assets consist of the excess of cost over the value of net
tangible assets of acquired businesses, non-compete agreements and expiration
lists. The excess of cost over the value of net tangible assets is amortized
over fifteen to forty years using the straight-line method. Non-compete
agreements and expiration lists are amortized over two to ten years using the
straight-line method. Accumulated amortization at December 31, 2001 and 2000
was $8,730,000 and $9,925,000, respectively. Amortization expense was
$3,505,000, $3,646,000 and $3,559,000 for 2001, 2000 and 1999, respectively.
Gallagher periodically reviews intangible assets for impairment whenever events
or changes in business circumstances indicate that the carrying value of the
assets may not be recoverable. If the fair value is less than the carrying
amount of the asset, a loss would be recognized for the difference.
Stock Based Compensation
Gallagher primarily grants stock options for a fixed number of shares to
employees with an exercise price equal to the fair value of the shares at the
date of grant. Gallagher accounts for stock option grants in
32
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1. Summary of Significant Accounting Policies--(Continued)
accordance with Accounting Principles Board Opinion No. 25 (APB 25),
"Accounting for Stock Issued to Employees," and, accordingly, recognizes no
compensation expense for these stock options granted to employees.
Fair Value of Financial Instruments
The carrying amounts of financial assets and liabilities reported in the
accompanying consolidated balance sheets for cash and cash equivalents,
restricted cash, premiums and fees receivable, premiums payable to insurance
companies, accrued salaries and bonuses, accounts payable and other accrued
liabilities, unearned fees and income taxes payable, at December 31, 2001 and
2000, approximate fair value because of the short maturity of these
instruments. The financial assets that comprise investment strategies and
marketable securities are carried at fair value in the accompanying
consolidated balance sheets. Fair values for other noncurrent assets are
disclosed in Note 4. The carrying amount of borrowings outstanding under
Gallagher's credit agreement approximates fair value at December 31, 2001
because the borrowings are at floating rates.
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 five business
combinations prior to July 1, 2001 that were completed in the third quarter of
2001 and were accounted for as poolings of interests because they met 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 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. Application
of the nonamortization provisions of SFAS 142 is expected to result in an
increase in pretax earnings of $1,300,000 per year. During 2002, Gallagher will
perform the first
33
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1. Summary of Significant Accounting Policies--(Continued)
of the required impairment tests of goodwill and indefinite lived intangible
assets as of January 1, 2002. Exclusive of the nonamortization of goodwill and
indefinite lived intangible assets, management does not expect the adoption of
SFAS 142 will have a material effect on Gallagher's consolidated operating
results or financial position.
2. Business Combinations
Poolings of Interests Acquisitions
In 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; The InWest Group, Inc., 407,000
shares; SKANCO International, Ltd., 263,000 shares; Nelson/Monarch Insurance
Services, Ltd., 109,000 shares; E.S. Susanin, Inc., 109,000 shares; Burgess &
Associates, Inc., 73,000 shares; Madison Scott & Associates, Inc., 34,000
shares; Midwest Surety Services, Inc., 32,000 shares; and Central Surety
Agency, Inc., 26,000 shares.
In 2000, Gallagher acquired substantially all of the net assets of the
following insurance brokerage firms in exchange for shares of its common stock:
John P. Woods Co., Inc., 1,816,000 shares; Universico Group, Ltd., 292,000
shares; Persing, Dyckman & Toynbee, Inc., 246,000 shares; Atlantic Risk
Management Corporation, 208,000 shares; Davis-Poston & Associates, Inc.,
150,000 shares; Castle Insurance Associates, Inc., 144,000 shares; R. L.
Youngdahl & Associates, Inc., 138,000 shares; Bultman/Bell Associates, Inc.,
136,000 shares; R. G. Speno, Inc., 88,000 shares; Rebholz Insurance Agency,
Inc., 84,000 shares; Towle Agency, Inc., 74,000 shares; Murphy Consultants,
58,000 shares; Powell Insurance Services, Inc., 39,000 shares; and
SiliconInsurance, Inc., 33,000 shares.
These acquisitions were accounted for as poolings of interests and, except
for three of the 2001 acquisitions and two of the 2000 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 and 1999 consolidated financial statements to reflect the operations of
the 2001 acquisitions (in thousands, except per share data):
As Attributable
Previously to Pooled As
2000 Reported Companies Restated
---- ---------- ------------ --------
Total revenues................................ $740,596 $54,677 $795,273
Net earnings.................................. 87,776 5,179 92,955
Net earnings per common share................. 1.12 (.01) 1.11
Net earnings per common and common equivalent
share........................................ 1.05 (.01) 1.04
1999
----
Total revenues................................ $656,404 $57,126 $713,530
Net earnings.................................. 70,250 12,990 83,240
Net earnings per common share................. .92 .10 1.02
Net earnings per common and common equivalent
share........................................ .87 .10 .97
34
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2. Business Combinations--(Continued)
Purchase Acquisitions
In 2001, Gallagher acquired substantially all of the net assets of the
following insurance brokerage firms in exchange for its common stock and/or
cash using the purchase accounting method for recording business combinations
(in thousands):
Common Common Total
2001 Purchase Shares Share Contingent Escrow Purchase
Acquisitions Issued Value Cash Paid Payable Deposited Price
------------- ------- ------- --------- ---------- --------- --------
Cashan & Company
(Cashan),
October 31, 2001...... 307 $10,213 $ -- $ -- $1,000 $11,213
Hartstein Associates,
Inc. (HAI),
October 31, 2001...... 91 2,598 3,000 4,500 734 10,832
MRS Holdings Limited
(MRS),
November 1, 2001...... 280 8,266 290 -- 2,067 10,623
Equity Insurance
Managers, Inc. (EIM),
December 1, 2001...... -- -- 8,400 800 800 10,000
Texas Insurance Agency,
Inc. - Houston (TIA),
May 1, 2001........... -- -- 4,340 1,500 225 6,065
Henderson Philips Fine
Arts (HPFA),
September 1, 2001..... -- -- 350 1,150 -- 1,500
------- ------- ------- -------- ------ -------
678 $21,077 $16,380 $ 7,950 $4,826 $50,233
======= ======= ======= ======== ====== =======
Common shares exchanged in connection with these acquisitions were valued at
closing market prices as of the effective date of the respective acquisition.
Contingent obligations, which are primarily based upon future earnings of the
acquired entities, were included in the purchase price recorded for these
acquisitions at the maximum amount per the purchase agreements. Contingent
consideration or escrow deposits that are returned to Gallagher as a result of
purchase price adjustment provisions are recorded as adjustments to intangibles
when the contingencies are settled.
The following is a summary of the estimated fair values of the assets
acquired at the date of each acquisition based on preliminary purchase price
allocations (in thousands):
Cashan HAI MRS EIM TIA HPFA Total
------- ------- ------- ------- ------ ------ --------
Current assets.......... $ 885 $ 542 $57,242 $ 7,849 $ -- $ -- $ 66,518
Other noncurrent assets. 54 -- 12 7 -- -- 73
Fixed assets............ 57 130 602 717 127 -- 1,633
Intangible assets....... 11,248 10,352 10,623 9,465 5,938 1,500 49,126
------- ------- ------- ------- ------ ------ --------
Total assets acquired. 12,244 11,024 68,479 18,038 6,065 1,500 117,350
Current liabilities..... 1,031 192 57,835 8,038 -- -- 67,096
Other noncurrent
liabilities............ -- -- 21 -- -- -- 21
------- ------- ------- ------- ------ ------ --------
Total liabilities
assumed.............. 1,031 192 57,856 8,038 -- -- 67,117
------- ------- ------- ------- ------ ------ --------
Total net assets
acquired............... $11,213 $10,832 $10,623 $10,000 $6,065 $1,500 $ 50,233
======= ======= ======= ======= ====== ====== ========
These acquisitions allow Gallagher to expand into desirable geographic
locations, further extend its presence in the retail and wholesale insurance
brokerage services industry and increase the volume of general services
currently provided. The excess of the purchase price over the estimated fair
value of the tangible net
35
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
2. Business Combinations--(Continued)
assets acquired at the acquisition date was allocated to goodwill and
expiration lists of the Insurance Brokerage Services segment in the amounts of
$44,813,000 and $4,313,000, respectively. Purchase price allocations are
preliminarily established at the time of the acquisition and are subsequently
reviewed within the first year of operations to determine the necessity for
allocation adjustments. Expiration lists, related to these acquisitions, will
be amortized on a straight-line basis over an estimated useful life of 10
years. Of the $44,813,000 of goodwill related to the 2001 acquisitions,
$34,682,000 is expected to be deductible for tax purposes. SFAS 142, "Goodwill
and Other Intangible Assets," prohibits amortization of goodwill acquired
subsequent to June 30, 2001. Gallagher completed five acquisitions under the
purchase method subsequent to June 30, 2001 and as a result of the application
of SFAS 142, $299,000 of goodwill that would have been amortized in 2001 under
the pre-SFAS 142 rule was not amortized (see Note 1). As the acquisition of TIA
occurred prior to the effective date of SFAS 142, goodwill related to this
acquisition was amortized from the acquisition date to December 31, 2001 on a
straight-line method using a 20 year estimated life. In accordance with SFAS
142, no goodwill amortization will be recorded in the 2002 consolidated
statement of earnings.
The 2001 consolidated financial statements reflect the operations of these
entities from the date of their respective acquisitions. The following is a
summary of the unaudited proforma historical results, as if these purchase
acquisitions had been acquired at the beginning of January 1, 2001 and 2000,
respectively (in thousands, except per share data):
Years Ended
December 31,
-----------------
2001 2000
-------- --------
Total revenues............................................... $938,850 $825,986
Net earnings................................................. 124,600 94,178
Net earnings per common share................................ 1.46 1.12
Net earnings per common and common equivalent share.......... 1.37 1.05
The unaudited proforma results above have been prepared for comparative
purposes only and do not purport to be indicative of the results of operation
which actually would have resulted had the acquisitions occurred as of January
1, 2001 and 2000, respectively, nor is it necessarily indicative of future
operating results.
In 2000, Gallagher acquired 60% of the net assets of MBR Pty Limited, an
Australian company engaged in the reinsurance brokerage and services business
in exchange for an initial cash payment of $2,100,000. Also in 2000, Gallagher
acquired substantially all of the net assets of Joe E. Martin, Inc., an
employee benefits broker and consultant, in exchange for an initial cash
payment of $340,000. These acquisitions were accounted for as purchases. These
purchase acquisitions were not material to the 2000 consolidated financial
statements.
3. 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):
December 31,
-----------------
2001 2000
-------- --------
Premium and Claims:
Receivable.................................................. $560,921 $373,764
Payable..................................................... 572,964 378,166
36
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Insurance Company Receivables and Payables--(Continued)
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.
4. Investments
Equity Investments
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.
The following is a summary of other noncurrent assets, including equity
investments (in thousands):
December 31,
-----------------
2001 2000
-------- --------
Tax advantaged investments................................... $ 18,656 $ 40,243
Real estate partnerships..................................... 29,036 26,563
Investment in Allied World Assurance Holdings, Ltd. (an
insurance company).......................................... 20,000 --
Venture capital equity investments........................... 34,891 34,092
Minority investment in alternative fund manager.............. 33,595 14,347
Notes receivable from investees.............................. 49,174 22,593
Leased commercial aircraft................................... 6,060 6,758
Other........................................................ 9,544 8,399
Deferred compensation plan assets (see Note 10).............. 12,461 7,365
-------- --------
$213,417 $160,360
======== ========
Tax advantaged investments represent amounts invested by Gallagher in 36
limited partnerships (35 in 2000) that operate qualified affordable housing and
alternative energy projects that are generating tax benefits to Gallagher on an
ongoing basis. These benefits are in the form of both tax deductions for
operating losses and tax credits. The tax advantaged investments are primarily
accounted for using the effective yield method and are carried at amortized
cost in the consolidated balance sheets. Under the effective yield method,
Gallagher recognizes the tax credits as they are allocated by the partnerships,
which are included, net of amortization of the investment, as a component of
the provision for income taxes.
Real estate partnerships at December 31, 2001 and 2000 primarily represent an
investment in a limited partnership that owns the building that Gallagher
leases for its corporate headquarters and several of its subsidiary operations
and an investment in a limited partnership that owns 11,000 acres of land near
Orlando, Florida, that is currently under development. Investments in real
estate partnerships are carried on the equity basis in the consolidated balance
sheets, which approximated fair value at December 31, 2001 and 2000.
Investment in Allied World Assurance Holdings, Ltd. represents Gallagher's
minority investment in a newly formed Bermuda based insurance and reinsurance
company founded by American International Group, Inc., The Chubb Corporation
and affiliates of Goldman, Sachs & Co.
37
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Investments--(Continued)
Venture capital equity investments at December 31, 2001 and 2000 consist of
minority investments in seventeen and thirteen, respectively, software, e-
commerce, insurance and financial services companies, none of which exceeds
$7,000,000 individually. Investments in partially owned entities in which
ownership is 20% to 50% are accounted for using the equity method. Accordingly,
Gallagher's share of the net earnings of these entities is included in
consolidated net earnings. Investments in partially owned entities in which
ownership is less than 20% are carried at cost.
Gallagher's 25% investment in an alternative fund manager is accounted for
using the equity method of accounting. Accordingly, Gallagher's share of the
net earnings of this entity is included in consolidated net earnings.
Notes receivable from investees primarily represent secured loans made by
Gallagher to twelve of its investments (five in 2000). Interest rates on the
loans at December 31, 2001 and 2000 ranged from 5.5% to 12.0%. The carrying
value of these loans at December 31, 2001 and 2000 approximated fair value.
The leased commercial aircraft represents Gallagher's 90% interest in a trust
which leases a commercial jet to a major domestic airline. There is no debt
remaining on the aircraft. The net carrying value of this investment
approximated fair value at December 31, 2001 and 2000.
Other noncurrent assets consist primarily of prepaid compensation related to
a 2001 acquisition, company owned real estate and rental deposits on
Gallagher's leased premises.
The following is a summary of the assets and liabilities of Gallagher's
unconsolidated investments accounted for using the equity method reconciled to
Gallagher's net carrying value (in thousands):
December 31,
--------------------
2001 2000
--------- ---------
Net current assets........................................ $ 42,402 $ 47,972
Other noncurrrent assets.................................. 41,192 316,707
Net fixed assets.......................................... 122,149 123,028
Net intangible assets..................................... 135,700 115,899
Debt outstanding.......................................... (191,859) (480,405)
Other noncurrent liabilities.............................. (6,773) (4,284)
Interests of other shareholders........................... (66,375) (59,333)
--------- ---------
Gallagher's net carrying value............................ $ 76,436 $ 59,584
========= =========
38
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Investments--(Continued)
The following is a summary of the total debt outstanding of Gallagher's
unconsolidated investments accounted for using the equity method (in
thousands):
December 31,
-----------------
2001 2000
-------- --------
Nonrecourse to Gallagher:
Mortgage loan on Gallagher's corporate headquarters
building, secured by building:
Monthly installments through 2008 based on 30 year
amortization, remaining balloon payment in 2008, fixed
rate of 8.35%........................................... $ 79,275 $ 79,861
Unsecured bank credit agreement of alternative fund manager
with bank:
Variable rate based on LIBOR plus 2.00%, secured by the
net assets of alternative fund manager.................. -- 51,348
Convertible subordinated debentures payable:
Issued in connection with various acquisitions made by
alternative fund manager, mature in 2003 to 2005, fixed
rates of 3.09% to 6.58%................................. 42,605 30,324
Mortgage loan on Florida real estate project, secured by
land:
Annual installments through 2004, fixed rate of 8.00%.... 8,165 11,585
Mortgage loan on commercial (office and retail) real estate
complex, secured by the commercial real estate:
Monthly installments through 2011 based on 30 year
amortization period, remaining balloon payment in 2011,
fixed rate of 7.40%..................................... 12,873 11,244
Line of credit facility on commercial (hotel) real estate
complex, secured by the commercial real estate:
Permits borrowings up to $8,750,000, variable rate based
on LIBOR plus 4.00%..................................... 8,037 7,547
"Warehouse" line of credit facilities of equity investee,
secured by loan portfolio:
Monthly interest only payments, variable rate based on
commercial paper rate plus 1.06%........................ -- 276,086
-------- --------
150,955 467,995
-------- --------
Recourse to Gallagher--see contingent commitments below:
Unsecured bank credit agreement of alternative fund
manager:
Due in four periodic equal installments through 2003,
variable rate based on LIBOR plus 1.00%................. 24,942 --
Bonds payable on Florida real estate project:
Monthly interest only payments through 2010, variable
rate based on commercial paper rate, balloon payment in
2010.................................................... 12,410 12,410
Line of credit facility on Florida real estate project:
Permits borrowings up to $8,500,000, monthly interest
only payments, variable rate based on LIBOR plus 1.15%.. 3,552 --
-------- --------
40,904 12,410
-------- --------
Total debt of Gallagher's investments accounted for using
the equity method......................................... $191,859 $480,405
======== ========
39
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Investments--(Continued)
The following is a summary of Gallagher's contingent commitments related to
its investments accounted for using the equity method (in thousands):
December 31,
---------------
2001 2000
------- -------
Letter of credit commitments:
Gallagher's corporate headquarters building.................. $ 3,000 $ 3,000
Commercial (hotel) real estate complex....................... 500 --
"Warehouse" lines of credit facilities....................... -- 7,200
Bonds payable on Florida real estate project................. 12,575 12,575
Community development bonds payable on Florida real estate
project..................................................... 5,000 5,000
Other ....................................................... 250 250
------- -------
$21,325 $28,025
======= =======
Financial guarantees:
Unsecured bank credit agreement of alternative fund manager.. $25,000 $ --
Line of credit facility on Florida real estate project....... 8,500 --
Community development bonds payable on Florida real estate
project..................................................... 5,100 --
------- -------
$38,600 $ --
======= =======
See Notes 5 and 12 for additional commitments and contingencies.
Investment Income and Other
Significant components of investment income and other are as follows (in
thousands):
Years Ended December 31,
------------------------
2001 2000 1999
------- ------- -------
Interest.............................................. $18,181 $24,057 $19,618
Dividends............................................. 2,923 2,955 2,345
Net change in unrealized gain (loss) on investment
strategies........................................... (110) 628 889
Net realized gain on investment strategies............ 1,852 1,244 1,579
Net realized gain on marketable securities............ 1,153 134 528
Income from tax advantaged investments................ 13,591 9,200 3,015
Gains on sales of operations.......................... 2,375 1,823 --
Other income.......................................... 7,267 2,719 9,913
Income (loss) from equity investments................. 3,497 1,034 2,058
------- ------- -------
Total investment income and other..................... $50,729 $43,794 $39,945
======= ======= =======
Income from tax advantaged investments in 2001 primarily relates to the sales
of interests in three alternative energy related limited partnerships.
During the third quarter of 2001, Gallagher entered into a transaction for
the sale of a 95% interest in one of its synthetic fuel facilities located in
South Carolina. Under the sale agreement, Gallagher received an initial
nonrefundable down payment of $6,700,000 and will receive additional
installment payments over time through 2007 based on qualified fuel production
generated by the facility. The buyer has the option to put the purchased
interest back to Gallagher if favorable tax rulings are not received by March
1, 2003. In the event of a put, Gallagher would retain the down payment and
installment payments made through the put date. The aggregate
40
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Investments--(Continued)
pretax installment gain on the transaction is expected to range from
$36,000,000 to $106,000,000 and will be recognized on an installment basis
through December 31, 2007. In 2001, Gallagher recognized an installment gain of
$8,550,000 on this sale transaction.
During the fourth quarter of 2001, Gallagher completed the sale of a two-
thirds interest in a partnership that owns a 59.9% interest in a synthetic fuel
facility also located in South Carolina. Gallagher received an initial down
payment of $3,200,000 with additional installment payments over time through
2007 based on qualified fuel production generated by the facility. The buyer
has the option to put the purchased interest back to Gallagher if certain
adverse tax consequences occur through December 31, 2007. In the event of a
put, Gallagher would retain all installment payments made through the put date
and a pro-rated portion of the initial down payment. The aggregate pretax
installment gain on the transaction is expected to range from $48,000,000 to
$70,000,000 and will be recognized on an installment basis through December 31,
2007. In 2001, Gallagher recognized an installment gain of $2,050,000 on this
sale transaction. The buyer also had the option, through March 31, 2002, to
acquire from Gallagher another one-sixth interest in the partnership at
proportionally equivalent terms. In January 2002, the buyer exercised this
option which had no impact on Gallagher's 2001 results.
Effective December 31, 2000, Gallagher completed the sale of its interests in
several partnerships that operate landfill gas facilities. Gallagher received
an initial down payment of $8,706,000 with additional installment payments over
time through 2007 based on qualified fuel production generated by the
facilities. The aggregate pretax installment gain on the transaction is
expected to range from $12,000,000 to $22,000,000 and will be recognized on an
installment basis through December 31, 2007. In 2001, Gallagher recognized an
installment gain of $1,289,000 on this sale transaction. This transaction had
no impact on Gallagher's 2000 results.
In 2000, Gallagher recognized $7,200,000 of income related to the forfeiture
of a non-refundable down payment from the termination of an installment sale of
a synthetic fuel facility and $2,000,000 of income related to an investment
development fee generated from one of Gallagher's alternative energy
investments. In 1999, Gallagher sold a portion of its interests in limited
partnerships that operate qualified affordable housing projects for cash
proceeds of $6,264,000. The gain recognized in 1999 on this sale of limited
partnership interests was $3,015,000. This 2000 and 1999 income has been
included in income from tax advantaged investments in the foregoing table.
In 2001, Gallagher sold a benefits administration book of business that was
underperforming and recorded a gain on the sale of $2,375,000. In 2000,
Gallagher sold several underperforming or geographically undesirable operations
and recorded aggregate gains on these sales of $1,823,000. The net assets sold
and the operating results included in the consolidated statements of earnings
related to these operations were not material to the consolidated financial
statements.
Other income in 2001 consists primarily of investment related fees paid to
Gallagher for providing letters of credit and financial guarantees to its tax
advantaged investments, real estate partnerships and venture capital equity
projects. Other income in 2000 and 1999 consists primarily of other income
attributable to the restatement effects of the 2001 and 2000 acquisitions
accounted for as poolings of interests.
41
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Investments--(Continued)
Marketable Securities
The following is a summary of marketable securities--available for sale (in
thousands):
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 2001 Cost Gains Losses Value
----------------- --------- ---------- ---------- --------
Preferred stocks....................... $ 11,567 $ 215 $ 991 $ 10,791
Common stocks.......................... 6,635 228 2,161 4,702
Fixed maturities....................... 4,461 20 1,684 2,797
-------- -------- -------- --------
$ 22,663 $ 463 $ 4,836 $ 18,290
======== ======== ======== ========
December 31, 2000
-----------------
Preferred stocks....................... $ 15,127 $ 615 $ 1,525 $ 14,217
Common stocks.......................... 8,423 593 3,079 5,937
Fixed maturities....................... 3,919 10 777 3,152
-------- -------- -------- --------
$ 27,469 $ 1,218 $ 5,381 $ 23,306
======== ======== ======== ========
The gross realized gains on sales of marketable securities totaled
$2,420,000, $884,000, and $1,579,000, for 2001, 2000 and 1999, respectively.
The gross realized losses totaled $1,267,000, $750,000, and $1,051,000, for
2001, 2000 and 1999, respectively.
The cost or amortized cost and fair value of fixed maturities at December 31,
2001, by contractual maturity, are as follows (in thousands):
Cost or
Amortized Fair
Cost Value
---------- --------
Due in 2002................................................. $ 649 $ 350
Due in 2003 through 2006.................................... 485 436
Due in 2007 through 2011.................................... 92 92
Due in 2012 and thereafter.................................. 3,235 1,919
-------- --------
$ 4,461 $ 2,797
======== ========
The expected maturities may differ from contractual maturities in the
foregoing table because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
The components of other comprehensive earnings, including the related income
tax effects, consist of the following (in thousands):
Years Ended December 31,
-------------------------
2001 2000 1999
------- ------- --------
Change in unrealized gain (loss) on available for
sale securities during the
year, net of income taxes of ($481), $95 and
($1,251), respectively.............................. $ (722) $ 143 $(1,877)
Reclassification adjustment for losses (gains)
realized in net earnings during the
year, net of income taxes of $397, $19 and ($10),
respectively........................................ 596 28 (15)
------- ------- -------
Net change in unrealized gain (loss) on available for
sale securities during the year, net of income taxes
of ($84), $114 and ($1,261), respectively........... $ (126) $ 171 $(1,892)
======= ======= =======
42
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Credit Agreements
In 2000, Gallagher and one of its significant subsidiaries entered into an
unsecured revolving credit agreement, which expires on September 10, 2003, with
a group of five financial institutions. The credit agreement provides for
short-term and long-term revolving credit commitments of $100,000,000 and
$50,000,000, respectively. The facility provides for loans and letters of
credit. Letters of credit are limited to $75,000,000 of which up to $50,000,000
may be issued under the long-term credit facility and up to $25,000,000 may be
issued under the short-term credit facility in the determination of net funds
available for future borrowing. The credit agreement provides for borrowings to
be denominated in either U.S. dollars or Alternative Currencies, as defined in
the credit agreement. In addition, the credit agreement has two borrowing
options, Domestic Rate Loans, or Eurocurrency Loans, as defined in the credit
agreement. Interest rates on borrowings under the Domestic Rate Loan option are
based on the prime commercial rate and interest rates on borrowings under the
Eurocurrency Loan option are based on LIBOR plus .400% for short-term and long-
term revolving credit commitments. The facility fee related to this credit
agreement is based on .100% of the used and unused portions of the short-term
and long-term revolving credit commitments.
As of December 31, 2001, under this credit facility, Gallagher has
contingently committed to funding $45,931,000 through letter of credit
arrangements related to its corporate insurance programs and several of its
equity and other strategic investments of which $21,325,000 was previously
disclosed in Note 4. Also, as of December 31, 2001, there were $35,000,000 of
short-term borrowings outstanding under the credit agreement. There were no
borrowings under this credit agreement in 2000. Terms of the credit agreement
include various covenants that require Gallagher to maintain specified levels
of tangible net worth and restrict the amount of payments on certain
expenditures. Gallagher was in compliance with these covenants, in all material
respects, as of December 31, 2001.
6. Capital Stock and Stockholders' Rights Plan
Capital Stock
The table below summarizes certain information about Gallagher's capital
stock at December 31, 2001 and 2000 (in thousands, except per share data):
Par Authorized
Class Value Shares
----- ------ ----------
Preferred stock............................................... No par 1,000
Common stock.................................................. $ 1.00 400,000
Stockholders' Rights Plan
Non-voting Rights, authorized by the Board of Directors on March 10, 1987 and
approved by stockholders on May 12, 1987, are outstanding on each share of
outstanding common stock. The Rights Plan was amended in 1996 to extend the
expiration of the Rights to May 12, 2007. Under certain conditions, each Right
may be exercised to purchase one share of common stock at an exercise price of
$25. The Rights become exercisable and transferable after a public announcement
that a person or group (as defined) has acquired 20% or more of the common
stock or after commencement or public announcement of a tender offer for 30% or
more of the common stock. If Gallagher is acquired in a merger or business
combination, each Right exercised gives the holder the right to purchase $50 of
market value of common stock of the surviving company for the $25 exercise
price. The Rights may be redeemed by Gallagher at $.0125 per Right at any time
prior to the public announcement of the acquisition of 20% of the common stock.
43
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. 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):
Years Ended December 31,
--------------------------
2001 2000 1999
-------- -------- --------
Net earnings........................................ $125,256 $ 92,955 $ 83,240
======== ======== ========
Weighted average number of common shares
outstanding........................................ 84,795 83,558 81,678
Dilutive effect of stock options using the treasury
stock method....................................... 5,332 5,409 3,928
-------- -------- --------
Weighted average number of common and common
equivalent shares outstanding...................... 90,127 88,967 85,606
======== ======== ========
Net earnings per common share....................... $ 1.48 $ 1.11 $ 1.02
Net earnings per common and common equivalent share. 1.39 1.04 .97
Options to purchase 231,000, 313,000 and 40,000 shares of common stock were
outstanding at December 31, 2001, 2000 and 1999, 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 during the
respective year and, therefore, would be antidilutive to earnings per share
under the treasury stock method.
8. Stock Option Plans
Gallagher has incentive and nonqualified stock option plans for officers and
key employees of Gallagher and its subsidiaries. The options are primarily
granted at the fair value of the underlying shares at the date of grant.
Options granted under the nonqualified plan primarily become exercisable at the
rate of 10% per year beginning the calendar year after the date of grant or
earlier in the event of death, disability or retirement. Options expire ten
years from the date of grant, or earlier in the event of termination of the
employee.
In addition, Gallagher has a non-employee directors' stock option plan which
currently authorizes 1,025,000 shares for grant, with Discretionary Options
granted at the direction of the Option Committee and Retainer Options granted
in lieu of the directors' annual retainer. Discretionary Options shall be
exercisable at such rates as shall be determined by the Committee on the date
of grant. Retainer Options shall be cumulatively exercisable at the rate of 25%
of the total Retainer Option at the end of each full fiscal quarter succeeding
the date of grant. The excess of fair value at the date of grant over the
option price for these nonqualified stock options is considered compensation
and is charged against earnings ratably over the vesting period.
Gallagher also has an incentive stock option plan for its officers and key
employees resident in the United Kingdom. The United Kingdom plan is
essentially the same as Gallagher's domestic employee stock option plans, with
certain modifications to comply with United Kingdom law and to provide
potentially favorable tax treatment for grantees resident in the United
Kingdom.
All of the aforementioned stock option plans provide for the immediate
vesting of all outstanding stock option grants in the event of a change in
control of Gallagher. A change in control of Gallagher is defined as the
acquisition by a person (or entity) of the beneficial ownership of 50% or more
of Gallagher's common stock; the cessation, for any reason, of a majority of
directors of Gallagher to serve as directors during any two year period; or the
approval by the stockholders of Gallagher of the sale of substantially all of
the assets of Gallagher.
44
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Stock Option Plans--(Continued)
Gallagher accounts for stock option grants in accordance with APB 25 and,
accordingly, recognizes no compensation expense for stock options that are
granted to employees at the fair value of the underlying shares at the date of
grant. Statement of Financial Accounting Standards No. 123 (SFAS 123),
"Accounting for Stock-Based Compensation," requires disclosure of pro forma
information regarding net earnings and net earnings per share, using pricing
models to estimate the fair value of stock option grants. Had compensation
expense for Gallagher's stock option plans been determined based on the
estimated fair value at the date of grant consistent with the methodology
prescribed under SFAS 123, approximate net earnings and net earnings per share
would have been as follows (in thousands, except per share data):
Years Ended December 31,
--------------------------
2001 2000 1999
-------- -------- --------
Pro forma net earnings.............................. $119,024 $ 90,909 $ 81,765
Pro forma net earnings per common share............. 1.40 1.09 1.00
Pro forma net earnings per common and common
equivalent share................................... 1.33 1.03 .96
For purposes of the pro forma disclosures, the estimated fair values of the
stock option grants are amortized to expense over the options' expected lives.
The fair value of stock options at the date of grant was estimated using the
Black-Scholes option pricing model with the following weighted-average
assumptions:
Years Ended December 31,
--------------------------
2001 2000 1999
-------- -------- --------
Dividend yield....................................... 3.0% 2.5% 3.1%
Risk-free interest rate.............................. 5.0% 5.1% 6.6%
Volatility........................................... 24.5% 24.6% 22.9%
Weighted average expected life (in years)............ 5.3 6.0 8.0
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because Gallagher's employee and director stock options have characteristics
significantly different from those of traded options, and because changes in
the selective input assumptions can materially affect the fair value estimate,
in management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee and director stock
options.
The pro forma disclosures above only include the effect of options granted
subsequent to January 1, 1995. Accordingly, the effects of applying the SFAS
123 pro forma disclosures to future periods may not be indicative of future
effects.
45
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Stock Option Plans--(Continued)
The following is a summary of all of Gallagher's stock option activity and
related information (in thousands, except exercise price data):
Years Ended December 31,
-----------------------------------------------------
2001 2000 1999
----------------- ----------------- -----------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Under Exercise Under Exercise Under Exercise
Option Price Option Price Option Price
------ -------- ------ -------- ------ --------
Beginning balance........ 14,419 $ 10.43 15,800 $ 8.05 17,844 $ 7.63
Granted.................. 2,842 24.95 2,642 19.98 944 12.44
Exercised................ (3,007) 9.00 (3,811) 7.22 (2,512) 6.36
Canceled................. (137) 14.17 (212) 9.68 (476) 8.46
------ ------ ------ ------ ------ ------
Ending balance........... 14,117 $ 13.63 14,419 $ 10.43 15,800 $ 8.05
====== ====== ====== ====== ====== ======
Exercisable at end of
year.................... 4,808 5,229 6,736
====== ====== ======
Options with respect to 5,615,000 shares were available for grant at
December 31, 2001.
Other information regarding stock options outstanding and exercisable at
December 31, 2001 is summarized as follows (in thousands, except exercise price
data):
Options Outstanding Options Exercisable
-------------------------------- --------------------
Weighted
Average
Remaining Weighted Weighted
Contractual Average Average
Range of Exercise Prices Number Life Exercise Number Exercise
------------------------ Outstanding (in years) Price Exercisable Price
----------- ----------- -------- ----------- --------
$ .25 - $ 7.97.......... 3,546 3.18 $ 7.22 1,867 $ 7.06
8.00 - 9.25.......... 4,751 4.22 8.82 2,189 8.67
9.31 - 26.11.......... 3,639 8.14 18.11 725 15.66
26.50 - 36.94.......... 2,181 9.51 27.01 27 30.06
------ ---- ------ ----- ------
$ .25 - $36.94.......... 14,117 5.79 $13.63 4,808 $ 9.22
====== ==== ====== ===== ======
9. Deferred Compensation
In 2001, Gallagher implemented the Deferred Equity Participation Plan, which
is a nonqualified 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 reaches 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 $4,000,000 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)
46
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Deferred Compensation--(Continued)
and the unearned deferred compensation obligation 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 2001, $562,000 was charged to expense related to this
plan.
10. Retirement Plans
Gallagher has a noncontributory defined benefit pension plan which covers
substantially all domestic employees who have attained a specified age and one
year of employment. Benefits under the plan are based on years of service and
salary history. Plan assets consist primarily of common stocks and bonds
invested under the terms of a group annuity contract managed by a life
insurance company.
Gallagher accounts for the defined benefit pension plan in accordance with
Statement of Financial Accounting Standards No. 87 (SFAS 87), "Employers'
Accounting for Pensions." The difference between the present value of the
pension benefit obligation at the date of adoption of SFAS 87 and the fair
value of plan assets at that date is being amortized on a straight-line basis
over the average remaining service period of employees expected to receive
benefits.
A reconciliation of the beginning and ending balances of the pension benefit
obligation and fair value of plan assets and the funded status of the plan is
as follows (in thousands):
Years Ended December 31,
--------------------------
2001 2000
------------ ------------
Change in pension benefit obligation:
Pension benefit obligation at beginning of year..... $ 92,792 $ 80,728
Service cost........................................ 9,108 7,754
Interest cost....................................... 6,316 6,002
Net actuarial (gain) loss........................... (7,711) (82)
Benefits paid....................................... (1,718) (1,610)
------------ ------------
Pension benefit obligation at end of year........... 98,787 92,792
------------ ------------
Change in plan assets:
Fair value of plan assets at beginning of year...... 66,137 63,148
Actual return on plan assets........................ (3,481) (1,742)
Company contributions............................... 5,293 6,341
Benefits paid....................................... (1,718) (1,610)
------------ ------------
Fair value of plan assets at end of year............ 66,231 66,137
------------ ------------
Funded status of the plan (underfunded)............. (32,556) (26,655)
Unrecognized net actuarial gain..................... (3,069) (5,162)
Unrecognized prior service cost..................... 772 882
Unrecognized transition obligation.................. 275 331
------------ ------------
Accrued pension benefit cost........................ $ (34,578) $ (30,604)
============ ============
47
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Retirement Plans--(Continued)
The components of the net periodic pension benefit cost for the plan consists
of the following (in thousands):
Years Ended December 31,
-------------------------
2001 2000 1999
------- ------- -------
Service cost--benefits earned during the year........ $ 9,108 $ 7,754 $ 7,058
Interest cost on benefit obligation.................. 6,316 6,002 5,176
Expected return on plan assets....................... (5,911) (5,935) (4,897)
Recognized net actuarial gain........................ (412) (495) (199)
Amortization of prior service cost................... 110 110 110
Amortization of transition obligation................ 56 56 56
Other................................................ 26 26 26
------- ------- -------
Net periodic pension benefit cost.................... $ 9,293 $ 7,518 $ 7,330
======= ======= =======
The following assumptions were used in determining the plan's pension benefit
obligation for 2001, 2000 and 1999:
Discount rate........................................................ 7.5%
Rate of increase in future compensation levels....................... 6.5%
Expected long-term rate of return on assets.......................... 9.0%
Gallagher has a qualified contributory savings and thrift (401(k)) plan
covering the majority of its employees. Gallagher's matching contributions (up
to a maximum of 2% of eligible compensation) are at the discretion of
Gallagher's Board of Directors and may not exceed the maximum amount deductible
for federal income tax purposes. Gallagher contributed $4,605,000, $4,638,000
and $4,165,000 in 2001, 2000 and 1999, respectively. Effective January 1, 1999,
Gallagher implemented a nonqualified deferred compensation plan for certain
employees, who due to Internal Revenue Service rules, cannot take full
advantage of the Gallagher matching contributions under the savings and thrift
plan. The plan permits these employees to annually elect to defer a portion of
their compensation until their retirement. Gallagher's matching contributions
to this plan are also at the discretion of Gallagher's Board of Directors.
Gallagher contributed $471,000, $316,000 and $236,000 to the plan in 2001, 2000
and 1999, respectively. The fair value of the plan's assets as of December 31,
2001 and 2000, including employee contributions and investment earnings
thereon, was $12,461,000 and $7,365,000, respectively, and has been included in
other noncurrent assets and the corresponding liability has been included in
other noncurrent liabilities in the accompanying consolidated balance sheets.
Gallagher also has a foreign defined contribution plan which provides for
basic contributions by Gallagher and voluntary contributions by employees
resident in the United Kingdom which are matched 100% by Gallagher, up to a
maximum of 5% of eligible compensation. Net expense for foreign retirement
plans amounted to $2,879,000 in 2001, $2,465,000 in 2000 and $2,253,000 in
1999.
11. Postretirement Benefits Other Than Pensions
In 1992, Gallagher amended its health benefits plan to eliminate retiree
coverage, except for retirees and those employees who had already attained a
specified age and length of service at the time of the amendment. The retiree
health plan is contributory, with contributions adjusted annually and is funded
on a pay-as-you-go basis.
48
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Postretirement Benefits Other Than Pensions--(Continued)
A reconciliation of the beginning and ending balances of the postretirement
benefit obligation and the funded status of the plan is as follows (in
thousands):
Years Ended December 31,
--------------------------
2001 2000
------------ ------------
Change in postretirement benefit obligation:
Postretirement benefit obligation at beginning of
year.............................................. $ 6,852 $ 7,883
Service cost....................................... -- --
Interest cost...................................... 493 491
Net actuarial gain................................. (280) (1,238)
Benefits paid...................................... (204) (284)
------------ ------------
Postretirement benefit obligation at end of year... 6,861 6,852
Fair value of plan assets at beginning and end of
year.............................................. -- --
------------ ------------
Funded status of the plan (underfunded)............ (6,861) (6,852)
Unrecognized net actuarial gain.................... (5,306) (5,357)
Unrecognized prior service cost.................... -- --
Unrecognized transition obligation................. 5,628 6,140
------------ ------------
Accrued postretirement benefit cost................ $ (6,539) $ (6,069)
============ ============
The components of the net periodic postretirement benefit cost include the
following (in thousands):
Years Ended December 31,
-------------------------
2001 2000 1999
------- ------- -------
Service cost--benefits earned during the year....... $ -- $ -- $ --
Interest cost on benefit obligation................. 493 491 563
Amortization of transition obligation............... 512 512 512
Amortization of net actuarial gain.................. (331) (325) (253)
------- ------- -------
Net periodic postretirement benefit cost............ $ 674 $ 678 $ 822
======= ======= =======
The discount rate used to measure the postretirement benefit obligation was
7.5% at December 31, 2001, 2000 and 1999. The transition obligation is being
amortized over a 20 year period. For measurement purposes, a 7.5% annual rate
of increase in the per capita cost of covered health care benefits was assumed
for 2002. This rate was assumed to gradually scale down to 4.5% for 2009 and
remain at that level thereafter. The assumed health care cost trend rate has a
significant effect on the amounts reported and disclosed herein. A one
percentage point change in the assumed health care cost trend rate would have
the following effects (in thousands):
One Percentage Point
-----------------------
Increase (Decrease)
---------- -----------
Effect on the net periodic postretirement benefit
cost in 2001........................................ $ 54 $ (45)
Effect on the postretirement benefit obligation at
December 31, 2001................................... 748 (647)
12. Commitments and Contingencies
Gallagher is engaged in various legal actions incident to the nature of its
business. Management is of the opinion that none of the litigation will have a
material effect on Gallagher's consolidated financial position or operating
results.
49
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. Commitments and Contingencies--(Continued)
Gallagher generally operates in leased premises. Certain office space leases
have options permitting renewals for additional periods. In addition to minimum
fixed rentals, a number of leases contain annual escalation clauses generally
related to increases in an inflation index.
Minimum aggregate rental commitments at December 31, 2001 under noncancelable
operating leases having an initial term of more than one year are as follows
(in thousands):
Total
--------
2002.................................................................. $ 41,533
2003.................................................................. 33,738
2004.................................................................. 27,159
2005.................................................................. 22,212
2006.................................................................. 14,750
Subsequent years...................................................... 45,905
--------
$185,297
========
Total rent expense, including rent relating to cancelable leases and leases
with initial terms of less than one year, amounted to $53,575,000 in 2001,
$46,243,000 in 2000 and $41,198,000 in 1999.
As of December 31, 2001, Gallagher had funding commitments of $15,600,000
related to several of its venture capital equity investments.
13. Income Taxes
Significant components of earnings before income taxes and the provision for
income taxes are as follows (in thousands):
Years Ended December 31,
----------------------------
2001 2000 1999
-------- -------- --------
Earnings before income taxes:
Domestic........................................ $133,414 $125,874 $122,050
Foreign, principally United Kingdom, Australia
and Bermuda.................................... 8,439 7,865 4,974
-------- -------- --------
$141,853 $133,739 $127,024
======== ======== ========
Provision for income taxes:
Federal:
Current........................................ $ 87,599 $ 67,774 $ 39,338
Deferred....................................... (73,552) (33,305) (1,935)
-------- -------- --------
14,047 34,469 37,403
-------- -------- --------
State and local:
Current........................................ 11,636 6,685 6,281
Deferred....................................... (10,507) (4,683) (316)
-------- -------- --------
1,129 2,002 5,965
-------- -------- --------
Foreign:
Current........................................ 1,518 4,787 1,196
Deferred....................................... (97) (474) (780)
-------- -------- --------
1,421 4,313 416
-------- -------- --------
Total provision for income taxes................. $ 16,597 $ 40,784 $ 43,784
======== ======== ========
50
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
13. Income Taxes--(Continued)
A reconciliation of the provision for income taxes with the United States
federal income tax rate is as follows (in thousands):
Years Ended December 31,
---------------------------------------------------
2001 2000 1999
---------------- ---------------- ----------------
% of % of % of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
-------- ------ -------- ------ -------- ------
Federal statutory rate.... $ 49,649 35.0 $ 46,809 35.0 $ 44,458 35.0
State income taxes--net of
federal benefit ......... 890 0.6 2,102 1.6 4,179 3.3
Pre-acquisition earnings
of pooled companies taxed
to previous owners....... (699) (0.5) (293) (0.2) (200) (0.1)
Foreign taxes............. (1,561) (1.1) 1,570 1.2 (712) (0.6)
Affordable housing and
alternative energy tax
credits, net of
amortization expense..... (35,304) (24.9) (11,879) (8.9) (4,990) (3.9)
Other--net................ 3,622 2.6 2,475 1.8 1,049 0.8
-------- ----- -------- ---- -------- ----
Provision for income
taxes.................... $ 16,597 11.7 $ 40,784 30.5 $ 43,784 34.5
======== ===== ======== ==== ======== ====
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of Gallagher's deferred tax liabilities and assets are as follows (in
thousands):
December 31,
-----------------
2001 2000
-------- --------
Deferred tax assets:
Accrued and unfunded compensation and employee benefits...... $ 41,885 $ 29,326
Accrued liabilities.......................................... 11,044 12,395
Alternative minimum tax (AMT) credit carryforward............ 42,724 11,949
Investment-related partnerships.............................. 43,656 7,926
Unrealized investment loss................................... 1,749 1,665
Other........................................................ 4,526 4,402
-------- --------
Total deferred tax assets................................... 145,584 67,663
Valuation allowance for deferred tax assets................. -- --
-------- --------
Deferred tax assets......................................... 145,584 67,663
Deferred tax liabilities...................................... 3,587 3,479
-------- --------
Net deferred tax assets....................................... $141,997 $ 64,184
======== ========
At December 31, 2001 and 2000, $46,321,000 and $19,839,000, respectively, of
deferred tax assets have been included in other current assets in the
accompanying consolidated balance sheets. AMT credits have an indefinite life
and Gallagher expects to fully utilize the amounts carried forward. During the
period from 1994 to 1996, Gallagher provided for United States federal income
taxes on the undistributed earnings of its foreign subsidiaries. Due to changes
in the United States federal income tax laws effective in 1997, Gallagher no
longer provides for United States federal income taxes on the undistributed
earnings ($32,000,000 at December 31, 2001) of certain foreign subsidiaries
which are considered permanently invested outside of the United States. The
amount of unrecognized deferred tax liability on these undistributed earnings
is $6,000,000 at December 31, 2001.
51
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
14. Quarterly Operating Results (unaudited)
Quarterly operating results for 2001 and 2000 were as follows (in thousands,
except per share data):
1st 2nd 3rd 4th
-------- -------- -------- --------
2001
----
Total revenues............................. $211,694 $211,096 $233,297 $253,956
Earnings before income taxes............... 34,073 28,772 42,019 36,989
Net earnings............................... 27,083 23,197 41,903 33,073
Net earnings per common share.............. .32 .27 .49 .39
Net earnings per common and common
equivalent share.......................... .30 .26 .47 .36
2000
----
Total revenues............................. $182,480 $182,844 $209,119 $220,830
Earnings before income taxes............... 30,134 26,221 45,642 31,742
Net earnings............................... 19,115 17,159 32,063 24,618
Net earnings per common share.............. .23 .21 .38 .29
Net earnings per common and common
equivalent share.......................... .22 .19 .36 .27
15. Segment Information
Gallagher has identified three operating segments in addition to its
corporate operations. Insurance Brokerage Services encompasses operations that,
for commission or fee compensation, place or arrange to place insurance
directly related to the clients' funding of risk. This segment also provides
consulting services, for fee compensation, related to clients' risk financing
programs. Risk Management Services 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 services for Gallagher's
brokerage clients or clients of other brokers. Financial Services 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. It manages the invested assets of
Gallagher in order to maximize the return to the company. Corporate consists
primarily of unallocated administrative costs and the provision for income
taxes which is not allocated to Gallagher's operating segments.
52
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
15. Segment Information--(Continued)
Allocations of investment income and certain expenses are based on
assumptions and estimates, and reported operating results by segment would
change if different methods were applied. Certain assets are not individually
identifiable by segment and, accordingly, have been allocated based on
formulas. Financial information relating to Gallagher's operating segments for
2001, 2000 and 1999 is as follows (in thousands):
Insurance Risk
Brokerage Management Financial
Services Services Services Corporate Total
--------- ---------- --------- --------- ----------
Year Ended December 31, 2001
----------------------------
Revenues:
Commissions................. $533,360 $ 1,090 $ -- $ -- $ 534,450
Fees........................ 62,342 262,522 -- -- 324,864
Investment income and other. 12,626 1,084 37,294 (275) 50,729
-------- -------- -------- -------- ----------
Total revenues............ $608,328 $264,696 $ 37,294 $ (275) $ 910,043
======== ======== ======== ======== ==========
Earnings (loss) before income
taxes........................ $116,498 $ 35,314 $ 5,513 $(15,472) $ 141,853
Provision for income taxes.... -- -- -- 16,597 16,597
-------- -------- -------- -------- ----------
Net earnings (loss)....... $116,498 $ 35,314 $ 5,513 $(32,069) $ 125,256
======== ======== ======== ======== ==========
Income (loss) from equity
investments.................. $ 785 $ -- $ 2,987 $ (275) $ 3,497
Depreciation and amortization
expense...................... 12,068 7,367 -- 607 20,042
Interest expense.............. 199 150 204 683 1,236
Net foreign exchange gain
(loss)....................... (451) (32) -- (13) (496)
------------------------------------------------------
Revenues:
United States............... $560,429 $242,403 $ 35,263 $ (275) $ 837,820
Foreign, principally United
Kingdom, Australia and
Bermuda.................... 47,899 22,293 2,031 -- 72,223
-------- -------- -------- -------- ----------
Total revenues............ $608,328 $264,696 $ 37,294 $ (275) $ 910,043
======== ======== ======== ======== ==========
At December 31, 2001
--------------------
Identifiable assets:
United States............... $603,215 $ 47,203 $256,459 $170,942 $1,077,819
Foreign, principally United
Kingdom, Australia and
Bermuda.................... 374,174 16,481 3,349 -- 394,004
-------- -------- -------- -------- ----------
Total identifiable assets. $977,389 $ 63,684 $259,808 $170,942 $1,471,823
======== ======== ======== ======== ==========
Identifiable assets related
to equity investments...... $ 1,690 $ -- $ 61,560 $ 13,186 $ 76,436
53
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
15. Segment Information--(Continued)
Insurance Risk
Brokerage Management Financial
Services Services Services Corporate Total
--------- ---------- --------- --------- ----------
Year Ended December 31, 2000
----------------------------
Revenues:
Commissions................ $469,040 $ 1,204 $ -- $ -- $ 470,244
Fees....................... 51,678 229,557 -- -- 281,235
Investment income and
other..................... 18,227 1,534 24,130 (97) 43,794
-------- --------- --------- --------- ----------
Total revenues........... $538,945 $ 232,295 $ 24,130 $ (97) $ 795,273
======== ========= ========= ========= ==========
Earnings (loss) before income
taxes....................... $100,265 $ 33,216 $ 12,997 $ (12,739) $ 133,739
Provision for income taxes... -- -- -- 40,784 40,784
-------- --------- --------- --------- ----------
Net earnings (loss)...... $100,265 $ 33,216 $ 12,997 $ (53,523) $ 92,955
======== ========= ========= ========= ==========
Income from equity
investments................. $ 777 $ -- $ 354 $ (97) $ 1,034
Depreciation and amortization
expense..................... 12,318 5,913 -- 380 18,611
Interest expense............. 517 174 212 309 1,212
Net foreign exchange gain
(loss)...................... (290) 20 -- (23) (293)
------------------------------------------------------
Revenues:
United States.............. $498,400 $ 210,384 $ 23,505 $ (97) $ 732,192
Foreign, principally United
Kingdom, Australia and
Bermuda................... 40,545 21,911 625 -- 63,081
-------- --------- --------- --------- ----------
Total revenues........... $538,945 $ 232,295 $ 24,130 $ (97) $ 795,273
======== ========= ========= ========= ==========
At December 31, 2000
--------------------
Identifiable assets:
United States.............. $502,112 $ 47,919 $ 213,640 $ 96,696 $ 860,367
Foreign, principally United
Kingdom, Australia and
Bermuda................... 254,938 13,744 6,439 -- 275,121
-------- --------- --------- --------- ----------
Total identifiable assets. $757,050 $ 61,663 $ 220,079 $ 96,696 $1,135,488
======== ========= ========= ========= ==========
Identifiable assets related
to equity investments..... $ 2,079 $ -- $ 44,044 $ 13,461 $ 59,584
Year Ended December 31, 1999
----------------------------
Revenues:
Commissions................ $437,706 $ -- $ -- $ -- $ 437,706
Fees....................... 43,026 192,853 -- -- 235,879
Investment income and
other..................... 19,412 769 19,764 -- 39,945
-------- --------- --------- --------- ----------
Total revenues........... $500,144 $ 193,622 $ 19,764 $ -- $ 713,530
======== ========= ========= ========= ==========
Earnings (loss) before income
taxes....................... $ 97,377 $ 23,188 $ 13,529 $ (7,070) $ 127,024
Provision for income taxes... -- -- -- 43,784 43,784
-------- --------- --------- --------- ----------
Net earnings (loss)...... $ 97,377 $ 23,188 $ 13,529 $ (50,854) $ 83,240
======== ========= ========= ========= ==========
Income (loss) from equity
investments................. $ 746 $ -- $ 1,312 $ -- $ 2,058
Depreciation and amortization
expense..................... 11,990 4,553 -- 1,133 17,676
Interest expense............. 980 159 226 683 2,048
Net foreign exchange gain
(loss)...................... (83) (37) -- 28 (92)
------------------------------------------------------
Revenues:
United States.............. $466,940 $ 179,678 $ 17,955 $ -- $ 664,573
Foreign, principally United
Kingdom, Australia and
Bermuda................... 33,204 13,944 1,809 -- 48,957
-------- --------- --------- --------- ----------
Total revenues........... $500,144 $ 193,622 $ 19,764 $ -- $ 713,530
======== ========= ========= ========= ==========
At December 31, 1999
--------------------
Identifiable assets:
United States.............. $455,175 $ 36,498 $ 231,652 $ 51,698 $ 775,023
Foreign, principally United
Kingdom, Australia and
Bermuda................... 199,046 10,466 6,073 -- 215,585
-------- --------- --------- --------- ----------
Total identifiable assets. $654,221 $ 46,964 $ 237,725 $ 51,698 $ 990,608
======== ========= ========= ========= ==========
Identifiable assets related
to equity investments..... $ 907 $ -- $ 37,438 $ -- $ 38,345
54
MANAGEMENT'S REPORT
The management of Arthur J. Gallagher & Co. (Gallagher) is responsible for
the preparation and integrity of the consolidated financial statements and the
related financial comments appearing in this annual report. The consolidated
financial statements were prepared in accordance with accounting principles
generally accepted in the United States and include certain amounts based on
management's best estimates and judgments. Other financial information
presented in this annual report is consistent with the consolidated financial
statements.
Gallagher maintains a system of internal accounting controls designed to
provide reasonable assurance that assets are safeguarded and that transactions
are executed as authorized and are recorded and reported properly. This system
of controls is based on written policies and procedures, appropriate divisions
of responsibility and authority, careful selection and training of personnel
and the utilization of an internal audit function. Policies and procedures
prescribe that Gallagher and all employees are to maintain the highest ethical
standards and that business practices throughout the world are to be conducted
in a manner which is above reproach.
Ernst & Young LLP, independent auditors, has audited Gallagher's consolidated
financial statements and their report is presented herein.
The Board of Directors has an Audit Committee composed entirely of outside
directors. Ernst & Young LLP has direct access to the Audit Committee and
periodically meets with the Committee to discuss accounting, auditing and
financial reporting matters.
Arthur J. Gallagher & Co.
Itasca, Illinois
January 23, 2002
/s/ J. Patrick Gallagher, Jr.
-------------------------------------
J. Patrick Gallagher, Jr.
President and Chief Executive
Officer
/s/ Michael J. Cloherty
-------------------------------------
Michael J. Cloherty
Executive Vice President and
Chief Financial Officer
55
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Arthur J. Gallagher & Co.
We have audited the accompanying consolidated balance sheets of Arthur J.
Gallagher & Co. (Gallagher) as of December 31, 2001 and 2000, and the related
consolidated statements of earnings, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 2001. These financial
statements are the responsibility of Gallagher's management. Our responsibility
is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Arthur J. Gallagher & Co. at December 31, 2001 and 2000, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States.
/s/ Ernst & Young LLP
-------------------------------------
Ernst & Young LLP
Chicago, Illinois
January 23, 2002
56
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
57
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information regarding directors and nominees for directors of Gallagher is
included under the caption entitled "Election of Directors" in the 2002 Proxy
Statement and is incorporated herein by reference.
Item 11. Executive Compensation.
Information regarding executive compensation of Gallagher's directors and
executive officers is included in the 2002 Proxy Statement under the caption
entitled "Compensation of Executive Officers and Directors," and is
incorporated herein by reference; provided, however, the report of the
Compensation Committee on executive compensation and the stock performance
graph shall not be deemed to be incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information regarding beneficial ownership of the Common Stock by certain
beneficial owners and by management of Gallagher is included under the caption
entitled "Principal Holders of Securities" in the 2002 Proxy Statement and is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
Information regarding transactions between Gallagher and Mr. James J.
Braniff III and Mr. Michael J. Cloherty is included under the caption entitled
"Summary Compensation Table" in the 2002 Proxy Statement and is incorporated
herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as a part of this report:
1. Consolidated Financial Statements of Arthur J. Gallagher & Co.
consisting of:
(a) Consolidated Statements of Earnings for each of the three years
in the period ended December 31, 2001.
(b) Consolidated Balance Sheets as of December 31, 2001 and 2000.
(c) Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2001.
(d) Consolidated Statements of Stockholders' Equity for each of the
three years in the period ended December 31, 2001.
(e) Notes to Consolidated Financial Statements.
(f) Management's Report.
(g) Report of Independent Auditors.
2. Consolidated Financial Statement Schedules consisting of:
(a) Schedule II--Valuation and Qualifying Accounts.
All other schedules are omitted because they are not applicable,
or not required, or because the required information is included in
the Consolidated Financial Statements or the Notes thereto.
58
3. Exhibits:
3.1 Restated Certificate of Incorporation of Gallagher
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly
period ended June 30, 1996, File No. 1-9761).
3.1.1 Certificate of Amendment of Restated Certificate of
Incorporation of Arthur J. Gallagher & Co., Amended as of May
18, 2000 (incorporated by reference to the same exhibit number
to Gallagher's Form 10-Q Quarterly Report for the quarterly
period ended June 30, 2000, File No. 1-9761).
3.1.2 Certificate of Amendment of Restated Certificate of
Incorporation of Arthur J. Gallagher & Co., Amended as of May
23, 2001 (incorporated by reference to the same exhibit number
to Gallagher's Form 10-Q Quarterly Report for the quarterly
period ended June 30, 2001, File No. 1-9761).
3.2 By-Laws of Gallagher (incorporated by reference to the same
exhibit number to Gallagher's Form S-1 Registration Statement
No. 33-10447).
3.3 Rights Agreement between Gallagher and Bank of America
Illinois (formerly Continental Illinois National Bank and
Trust Company of Chicago) (incorporated by reference to
Exhibits 1 and 2 to Gallagher's Form 8-A Registration
Statement filed May 12, 1987, File No. 0-13480).
3.4 Assignment and Assumption Agreement of Rights Agreement by and
among Bank of America Illinois (formerly Continental Illinois
National Bank and Trust Company of Chicago), Harris Trust and
Savings Bank and Gallagher (incorporated by reference to the
same exhibit number to Gallagher's Form S-8 Registration
Statement No. 33-38031).
3.5 Amendment No. 1 to Exhibit 3.3 (incorporated by reference to
the same exhibit number to Gallagher's Form 10-Q Quarterly
Report for the quarterly period ended June 30, 1996, File No.
1-9761).
4.1 Instruments defining the rights of security holders (relevant
portions contained in the Restated Certificate of
Incorporation and By-Laws of Gallagher and the Rights
Agreement in Exhibits 3.1, 3.2, and 3.3, respectively, hereby
incorporated by reference).
**10.25 Arthur J. Gallagher & Co. United Kingdom Incentive Stock
Option Plan, Amended and restated as of January 22, 1998 and
approved by the Inland Revenue on June 12, 1998 (incorporated
by reference to the same exhibit number to Gallagher's Form
10-Q Quarterly Report for the quarterly period ended June 30,
1998, File No. 1-9761).
**10.26 Arthur J. Gallagher & Co. 1988 Incentive Stock Option Plan,
Amended and restated as of May 19, 1998 (incorporated by
reference to the same exhibit number to Gallagher's Form 10-Q
Quarterly Report for the quarterly period ended June 30, 1998,
File No. 1-9761).
**10.27 Arthur J. Gallagher & Co. 1988 Nonqualified Stock Option Plan,
Amended and restated as of January 22, 1998 (incorporated by
reference to the same exhibit number to Gallagher's Form 10-Q
Quarterly Report for the quarterly period ended June 30, 1998,
File No. 1-9761).
**10.27.1 Amendment No. 1 to the Arthur J. Gallagher & Co. Restated 1988
Nonqualified Stock Option Plan, Amended as of January 20, 2000
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly
period ended June 30, 2000, File No. 1-9761).
**10.28 Arthur J. Gallagher & Co. 1989 Non-Employee Directors' Stock
Option Plan, Amended and restated as of January 22, 1998
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly
period ended June 30, 1998, File No. 1-9761).
59
**10.28.1 Amendment No. 2 to the Arthur J. Gallagher & Co. Restated 1989
Non-Employee Directors' Stock Option Plan, Amended as of
January 20, 2000 (incorporated by reference to the same
exhibit number to Gallagher's Form 10-Q Quarterly Report for
the quarterly period ended June 30, 2000, File No. 1-9761).
10.5 Lease Agreement between Arthur J. Gallagher & Co. and Itasca
Center III Limited Partnership, a Texas limited partnership,
dated July 26, 1989 (incorporated by reference to the same
exhibit number to Gallagher's Form 10-K Annual Report for
1989, File No. 1-9761).
10.7 Letter dated December 31, 1983 from Arthur J. Gallagher & Co.
to Bank of America Illinois (formerly Continental Illinois
National Bank and Trust Company of Chicago) regarding Common
Stock Purchase Financing Program including exhibits thereto
and related letters (incorporated by reference to the same
exhibit number to Gallagher's Form S-1 Registration Statement
No. 2-89195).
10.71 Amendment to Exhibit No. 10.7 dated September 11, 1985
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-K Annual Report for 1985, File No.
0-13480).
10.8 Credit Agreement Dated as of September 11, 2000 Among Arthur
J. Gallagher & Co., AJG Financial Services, Inc., The Banks
Party Thereto, Harris Trust and Savings Bank, as Agent and
Lead Arranger, Citibank, N.A., as Co-Lead Arranger and
Syndication Agent, and Bank of America, N.A. as Co-Lead
Arranger and Documentation Agent (incorporated by reference to
the same exhibit number to Gallagher's Form 10-Q Quarterly
Report for the quarterly period ended September 30, 2000, File
No. 1-9761).
10.8.1 Arthur J. Gallagher & Co. and AJG Financial Services, Inc.
First Amendment to Credit Agreement Dated as of November 10,
2000 (incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly
period ended September 30, 2000, File No. 1-9761).
10.8.2 Arthur J. Gallagher & Co. and AJG Financial Services, Inc.
Second Amendment to Credit Agreement Dated as of May 31, 2001
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly
period ended June 30, 2001, File No. 1-9761).
10.8.3 Arthur J. Gallagher & Co. and AJG Financial Services, Inc.
Third Amendment to Credit Agreement Dated as of September 7,
2001 (incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly
period ended September 30, 2001, File No. 1-9761).
10.8.4 Arthur J. Gallagher & Co. and AJG Financial Services, Inc.
Fourth Amendment to Credit Agreement Dated as of November 7,
2001 (incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly
period ended September 30, 2001, File No. 1-9761).
*10.8.5 Arthur J. Gallagher & Co. and AJG Financial Services, Inc.
Fifth Amendment to Credit Agreement Dated as of February 21,
2002.
**10.10 Board of Directors' Resolution from meeting on January 26,
1984 relating to consulting and retirement benefits for
certain directors (incorporated by reference to the same
exhibit number to Gallagher's Form S-1 Registration Statement
No. 2-89195).
**10.11 Form of Indemnity Agreement between Gallagher and each of its
directors and corporate officers (incorporated by reference to
Attachment A to Gallagher's Proxy Statement dated April 10,
1987 for its Annual Meeting of Stockholders, File No. 0-
13480).
60
**10.14 Form of Change in Control Agreement between Gallagher and each
of its Executive Officers (incorporated by reference to the
same exhibit number to Gallagher's Form 10-K Annual Report for
1998, File No. 1-9761).
**10.15 Arthur J. Gallagher & Co. Supplemental Savings and Thrift Plan
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-K Annual Report for 1999, File No. 1-9761).
**10.16 Arthur J. Gallagher & Co. Deferred Equity Participation Plan
and Deferred Equity Trust Agreement dated March 22, 2001
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-K Annual Report for 2000, File No. 1-9761).
**10.17 Executive Bonus Agreement dated June 2, 2000 between Gallagher
and Michael J. Cloherty (incorporated by reference to the same
exhibit number to Gallagher's Form 10-K Annual Report for 2000,
File No. 1-9761).
**10.18 Promissory Note dated March 15, 2001 in the principal amount of
$2,382,900 from Michael J. Cloherty, payable to Gallagher
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-K Annual Report for 2000, File No. 1-9761).
**10.19 Employment Agreement dated January 1, 1999 between Gallagher
and James J. Braniff III (incorporated by reference to the same
exhibit number to Gallagher's Form 10-K Annual Report for 2000,
File No. 1-9761).
**10.20 Secured Promissory Note dated June 19, 1996 in the principal
amount of $1,155,000 from James J. Braniff III, payable to
Gallagher (incorporated by reference to the same exhibit number
to Gallagher's Form 10-K Annual Report for 2000, File No. 1-
9761).
**10.21 Promissory Note dated February 1, 1999 in the principal amount
of $100,000 from James J. Braniff III, payable to Gallagher
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-K Annual Report for 2000, File No. 1-9761).
*21.0 Subsidiaries of Gallagher, including state or other
jurisdiction of incorporation or organization and the names
under which each does business.
*23.1 Consent of Ernst & Young LLP, independent auditors.
*24.0 Powers of Attorney.
All other exhibits are omitted because they are not applicable, or not
required, or because the required information is included in the
Consolidated Financial Statements or Notes thereto.
--------
*Filed as exhibits to this Form 10-K with the Securities and Exchange
Commission.
**Such exhibit is a management contract or compensatory plan or
arrangement required to be filed as an exhibit to this form pursuant
to item 601 of Regulation S-K.
(b) Reports on Form 8-K
Not applicable.
61
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 22nd day of
March, 2002.
Arthur J. Gallagher & Co.
/s/ J. Patrick Gallagher, Jr.
By___________________________________
J. Patrick Gallagher, Jr.
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the 22nd day of March, 2002 by the following
persons on behalf of the Registrant in the capacities indicated.
Name Title
---- -----
*Robert E. Gallagher Chairman and Director
___________________________________________
Robert E. Gallagher
/s/ J. Patrick Gallagher, Jr. President and Director (Chief Executive
___________________________________________ Officer)
J. Patrick Gallagher, Jr.
/s/ Michael J. Cloherty Executive Vice President and Director
___________________________________________ (Chief Financial Officer)
Michael J. Cloherty
/s/ Richard C. Cary Controller (Chief Accounting Officer)
___________________________________________
Richard C. Cary
*James J. Braniff III Director
___________________________________________
James J. Braniff III
*T. Kimball Brooker Director
___________________________________________
T. Kimball Brooker
*Gary P. Coughlan Director
___________________________________________
Gary P. Coughlan
*James W. Durkin, Jr. Director
___________________________________________
James W. Durkin, Jr.
*Ilene S. Gordon Director
___________________________________________
Ilene S. Gordon
*David E. McGurn, Jr. Director
___________________________________________
David E. McGurn, Jr.
*Richard J. McKenna Director
___________________________________________
Richard J. McKenna
*Robert Ripp Director
___________________________________________
Robert Ripp
*James R. Wimmer Director
___________________________________________
James R. Wimmer
/s/ John C. Rosengren
*By: ________________________________
John C. Rosengren, Attorney-in-
Fact
62
SCHEDULE II
ARTHUR J. GALLAGHER & CO.
VALUATION AND QUALIFYING ACCOUNTS
Balance Additions
at Charged Balance
Beginning to at End
of Year Earnings Adjustments of Year
--------- --------- ----------- -------
(in thousands)
Year ended December 31, 2001
Allowance for doubtful accounts.... $3,132 $1,657 $(3,059)(1) $1,730
Allowance for estimated policy
cancellations..................... 2,000 500 -- 2,500
Accumulated amortization of
goodwill.......................... 5,836 2,624 (1,331)(2) 7,129
Accumulated amortization of non-
compete agreements and expiration
lists............................. 4,089 881 (3,369)(3) 1,601
Year ended December 31, 2000
Allowance for doubtful accounts.... $1,531 $4,456 $(2,855)(1) $3,132
Allowance for estimated policy
cancellations..................... -- 2,000 -- 2,000
Accumulated amortization of
goodwill.......................... 5,588 2,363 (2,115)(2) 5,836
Accumulated amortization of non-
compete agreements and expiration
lists............................. 3,118 1,283 (312)(3) 4,089
Year ended December 31, 1999
Allowance for doubtful accounts.... $2,151 $ 36 $ (656)(1) $1,531
Allowance for estimated policy
cancellations..................... -- -- -- --
Accumulated amortization of
goodwill.......................... 4,895 1,545 (852)(2) 5,588
Accumulated amortization of non-
compete agreements and expiration
lists............................. 1,135 2,014 (31)(3) 3,118
--------
(1) Bad debt write-offs net of recoveries.
(2) Elimination of fully amortized goodwill and intangible asset/amortization
reclassifications.
(3) Elimination of fully amortized non-compete agreements and expiration lists
and intangible asset/amortization reclassifications.