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<SEC-DOCUMENT>0000950131-03-001589.txt : 20030325
<SEC-HEADER>0000950131-03-001589.hdr.sgml : 20030325
<ACCEPTANCE-DATETIME>20030325121928
ACCESSION NUMBER: 0000950131-03-001589
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 8
CONFORMED PERIOD OF REPORT: 20021231
FILED AS OF DATE: 20030325
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: GALLAGHER ARTHUR J & CO
CENTRAL INDEX KEY: 0000354190
STANDARD INDUSTRIAL CLASSIFICATION: INSURANCE AGENTS BROKERS & SERVICES [6411]
IRS NUMBER: 362151613
STATE OF INCORPORATION: DE
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 001-09761
FILM NUMBER: 03615309
BUSINESS ADDRESS:
STREET 1: TWO PIERCE PL
CITY: ITASCA
STATE: IL
ZIP: 60143
BUSINESS PHONE: 7087733800
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>d10k.txt
<DESCRIPTION>FORM 10-K
<TEXT>
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 2002
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _________________ to __________________
Commission file number 1-9761
ARTHUR J. GALLAGHER & CO.
(Exact name of registrant as specified in its charter)
DELAWARE 36-2151613
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
Two Pierce Place 60143-3141
Itasca, Illinois (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code (630) 773-3800
--------------------------------
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange
------------------- on which registered
Common Stock, par value -------------------
$1.00 per share New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
---------------------------------
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]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No .
--- ---
The aggregate market value of the voting common equity held by non-affiliates of
the registrant, computed by reference to the last reported price at which the
stock was sold on June 28, 2002 (the last day of the registrant's most recently
completed second quarter) was $2,920,318,000.
The number of outstanding shares of the registrant's Common Stock, $1.00 par
value, as of February 28, 2003 was 88,809,000.
Documents incorporated by reference:
Portions of Arthur J. Gallagher & Co.'s Annual Report to Stockholders for the
year ended December 31, 2002 are incorporated by reference into this Form 10-K
in response to Parts I and II to the extent described herein.
Portions of Arthur J. Gallagher & Co.'s definitive 2003 Proxy Statement are
incorporated by reference into this Form 10-K in response to Part III to the
extent described herein.
<PAGE>
ARTHUR J. GALLAGHER & CO.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
INDEX
<TABLE>
<CAPTION>
Page No.
<S> <C>
Part I.
Item 1. Business ................................................................................................... 2
Item 2. Properties ................................................................................................. 8
Item 3. Legal Proceedings .......................................................................................... 8
Item 4. Submission of Matters to a Vote of Security Holders ........................................................ 8
Item 4A. Executive Officers of the Registrant ....................................................................... 9
Part II.
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters ................................... 9
Item 6. Selected Financial Data .................................................................................... 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ...................... 11
Item 7A. Quantitative and Qualitative Disclosure About Market Risk .................................................. 11
Item 8. Financial Statements and Supplementary Data ................................................................ 11
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ....................... 11
Part III.
Item 10. Directors and Executive Officers of the Registrant ......................................................... 11
Item 11. Executive Compensation ..................................................................................... 11
Item 12. Security Ownership of Certain Beneficial Owners and Management ............................................. 11
Item 13. Certain Relationships and Related Transactions ............................................................. 11
Item 14. Controls and Procedures .................................................................................... 11
Part IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K ............................................ 12
Signatures ................................................................................................................ 16
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 .................................................. 17
Schedule II--Valuation and Qualifying Accounts ............................................................................ 19
Exhibit Index ............................................................................................................. 20
</TABLE>
1
<PAGE>
PART I
Item 1. Business.
General
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 sales and service
offices located throughout the United States and six 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 England and other facilities in Australia, Bermuda,
Canada, Scotland and Singapore.
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.
Information Concerning Forward-Looking Statements
This annual report contains forward-looking statements within the meaning
of that term in the Private Securities Litigation Reform Act of 1995 (the "Act")
found at Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Additional
written or oral forward-looking statements may be made by Gallagher from time to
time in filings with the Securities and Exchange Commission (SEC), press
releases, or otherwise. Statements contained in this report that are not
historical facts are forward-looking statements made pursuant to the safe harbor
provisions of the Act. Forward-looking statements may include, but are not
limited to, discussions concerning revenues, expenses, earnings, cash flow,
capital structure, financial losses, as well as market and industry conditions,
premium rates, financial markets, interest rates, foreign exchange rates,
contingencies and matters relating to Gallagher's operations and income taxes.
In addition, when used in this report, the words "anticipates," "believes,"
"should," "estimates," "expects," "intends," "plans" and variations thereof and
similar expressions are intended to identify forward-looking statements. Such
forward-looking statements are based on available current market and industry
material, experts' reports and opinions and long-term trends, as well as
management's expectations concerning future events impacting Gallagher.
Forward-looking statements made by or on behalf of Gallagher are subject to
risks and uncertainties, including but not limited to the following: Gallagher's
commission revenues are highly dependent on premiums charged by insurers, which
are subject to fluctuation; lower interest rates reduce Gallagher's income
earned on invested funds; the alternative insurance market continues to grow
which could unfavorably impact commission and favorably impact fee revenue;
Gallagher's revenues vary significantly from period to period as a result of the
timing of policy inception dates and the net effect of new and lost business
production; the general level of economic activity can have a substantial impact
on Gallagher's renewal business; Gallagher's operating results, returns on
investments and financial position may be adversely impacted by exposure to
various market risks such as interest rate, equity pricing, foreign exchange
rates and the competitive environment, and changes in income tax laws.
Gallagher's ability to grow has been enhanced through acquisitions, which may or
may not be available on acceptable terms in the future and which, if
consummated, may or may not be advantageous to Gallagher. Accordingly, actual
results may differ materially from those set forth in the forward-looking
statements.
Readers are cautioned not to place undue reliance on any forward-looking
statements contained in this report, which speak only as of the date set forth
on the signature page hereto. Gallagher undertakes no obligation to publicly
release the result of any revisions to these forward-looking statements that may
be made to reflect events or circumstances after such date or to reflect the
occurrence of anticipated or unanticipated events.
2
<PAGE>
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' managing of risk. This segment also provides consulting
services, for fee compensation, related to clients' risk financing programs and
includes Gallagher's retail, reinsurance and wholesale insurance brokerage
operations. Risk Management Services includes Gallagher's third party
administration, loss control and risk management consulting and insurance
property appraisal operations. Third party administration is principally the
management and processing of claims for self insurance programs for Gallagher's
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. The invested assets of Gallagher are managed in
this segment in order to maximize the long-term after-tax return to Gallagher.
Corporate consists primarily of the operating results of Gallagher's investment
in the limited partnership that owns its corporate headquarters building,
unallocated administrative costs and the provision for income taxes which is not
allocated to Gallagher's operating segments. Only revenues not attributable to
one of the three operating segments are recorded in the Corporate segment.
The two major sources of operating revenues for Gallagher are commissions
from insurance brokerage operations and service fees primarily from risk
management operations. Information with respect to all sources of revenue, by
operating segment, for each of the three years in the period ended December 31,
2002, is as follows (in thousands):
<TABLE>
<CAPTION>
2002 2001 * 2000 *
------------------------- -------------------------- -------------------------
% of % of % of
Amount Total Amount Total Amount Total
------------- ------ ------------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Commissions
Insurance Brokerage Services $ 662,857 60% $ 537,933 58% $ 472,878 59%
Risk Management Services 613 - 1,090 - 1,204 -
Fees
Insurance Brokerage Services 109,046 10% 62,342 8% 51,678 7%
Risk Management Services 279,821 25% 262,522 28% 229,557 29%
Investment income and other
Insurance Brokerage Services 7,879 1% 11,457 1% 17,157 2%
Risk Management Services 817 - 1,084 - 1,534 -
Financial Services 33,024 3% 39,407 4% 24,318 3%
Corporate 7,165 1% 7,153 1% 2,254 -
------------- ----- ------------- ----- ----------- -----
Total revenues $ 1,101,222 100% $ 922,988 100% $ 800,580 100%
============= ===== ============= ===== =========== =====
</TABLE>
- --------------
* Restated to conform to the current year presentation. See Note 3 to the
Consolidated Financial Statements of Gallagher's 2002 Annual Report to
Stockholders on page 39, which is incorporated herein by reference.
See Note 18 to the Consolidated Financial Statements of Gallagher's 2002
Annual Report to Stockholders on pages 55 and 56, which is incorporated herein
by reference for additional financial information, including earnings before
income taxes and identifiable assets, by operating segment, for 2002, 2001 and
2000.
During 2002 and 2001, Gallagher's total revenues and expenses increased
sequentially from quarter-to-quarter within the calendar years, except for the
second quarter of 2001 and the third quarter of 2002, the latter of which was
negatively impacted by $28.9 million of investment write-downs. However,
commission and fee revenues and the related expenses can vary from
quarter-to-quarter as a result of the timing of policy inception dates that
traditionally are heaviest in the third and fourth quarters. On the other hand,
salaries and employee benefits, rent, depreciation and amortization expenses
tend to be more uniform throughout the year. In addition, the timing of
acquisitions accounted for as purchases will also impact the trends in
Gallagher's quarterly operating results. See Note 17 to the Consolidated
Financial Statements of Gallagher's 2002 Annual Report to Stockholders on page
54, which is incorporated herein by reference for unaudited quarterly operating
results for 2002 and 2001.
3
<PAGE>
Insurance Brokerage Services
The Insurance Brokerage Services segment comprises 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's reinsurance
intermediary operations place reinsurance coverages for its insurance company
clients.
GBS specializes in the management of employee benefit programs through
fully insured and self-insured programs. GBS provides services in connection
with the design, financing, implementation, administration and communication of
compensation and employee benefit programs (including pension and profit-sharing
plans, group life, health, accident and disability insurance programs and tax
deferral plans), and provides other professional services in connection
therewith.
The primary source of Gallagher's compensation for its Insurance Brokerage
Services segment is commissions paid by insurance companies which are usually
based upon a percentage of the premium paid by insureds. Commission rates are
dependent on a number of factors including the type of insurance, the particular
insurance company and the capacity in which Gallagher acts. In some cases,
Gallagher is compensated for brokerage or advisory services directly by fees
from clients. Gallagher may also receive contingent commissions which are based
on the estimated profit the underwriting insurance company earns and/or the
overall volume of business placed by Gallagher in a given period of time.
Occasionally, Gallagher shares commissions with other brokers who have
participated with Gallagher in placing insurance or servicing insureds. GBS
receives a fee for acting in the capacity of advisor and administrator with
respect to employee benefit programs and receives commissions in connection with
the placement of insurance under such programs.
Risk Management Services
The Risk Management Services segment comprises two wholly-owned
subsidiaries, Gallagher Bassett Services, Inc. (GB) and Gallagher Benefit
Administrators, Inc. (GBA).
GB provides a full range of risk management services including claims
management, risk control consulting services, information management, property
appraisals on a totally integrated or select, stand-alone basis. GB provides
these services for Gallagher's clients through a network of service offices
located throughout the United States, Canada, England, Scotland and Australia.
GB primarily markets its risk management services directly to clients on an
unbundled basis independent of Gallagher. GB also markets these services to
BSD's clients who are interested in P/C risk management related services.
In connection with its risk management services, GB provides
"self-insurance" programs for large institutions, risk sharing pools and
associations, and large commercial and industrial customers. Self-insurance, as
administered by GB, is a program in which the client assumes a manageable
portion of its insurance risks, usually (although not always) placing the less
predictable and larger loss exposures with an insurance carrier that specializes
in these less predictable exposures.
GBA is a third-party administrator that serves the self-funded employee
health benefit marketplace by integrating effective managed care and quality
assurance programs with claims administration services. The employee health
benefit services provided by GBA are, in many instances, directly supported by
GBS.
GB's and GBA's revenues for risk management services are substantially in
the form of fees. These fees are typically negotiated in advance on an annual
basis based upon the estimated volume of the services to be performed.
4
<PAGE>
Financial Services
Financial Services is primarily responsible for Gallagher's diversified
investment portfolio which includes investment strategies--trading, marketable
securities--trading, tax advantaged investments, real estate partnerships, an
investment in Allied World Assurance Holdings, Ltd., venture capital equity
investments, a minority investment in an alternative fund manager, notes
receivable from investees, and an investment in an airplane leasing company that
leases two cargo airplanes to the French postal service. Financial Services
manages the invested assets of Gallagher in order to maximize the long-term
after-tax return to Gallagher. See Note 4 to the Consolidated Financial
Statements of Gallagher's 2002 Annual Report to Stockholders on pages 40 to 43,
which is incorporated herein by reference for a summary of Gallagher's
investments and notes receivable and for a summary of the assets and liabilities
related to Gallagher's unconsolidated investment portfolio, accounted for using
the equity method.
Gallagher's equity investment philosophy generally consists of investing in
tax advantaged investments and venture capital equity projects which take a
long-term view toward private sale or public offering. Gallagher uses the
limited partnership or limited liability company forms of legal ownership to
fund many of its investments in order to obtain favorable tax treatment with
respect to gains, losses and distributions, while limiting its liability. Based
on the ownership structure of these investments, management believes that
Gallagher's exposure to losses related to these investments is limited to the
combination of its net carrying value, funding commitments, letters of credit
and financial guarantees. In the event that certain of these limited
partnerships or limited liability companies were to default on their debt
obligations and Gallagher's net carrying value became impaired, the amount to be
written-off could have a material effect on Gallagher's consolidated financial
position or operating results. See Note 4 (pages 40 to 43) and Note 15 (pages 51
and 52) to the Consolidated Financial Statements of Gallagher's 2002 Annual
Report to Stockholders, which is incorporated herein by reference for a summary
of outstanding letters of credit, financial guarantees and funding commitments
and Note 7 on page 45 for a summary of outstanding debt and contingent
commitments.
International Operations
Total revenues by geographic area for each of the three years in the period
ended December 31, 2002 are as follows (in thousands):
<TABLE>
<CAPTION>
2002 2001 * 2000 *
--------------------------- ---------------------------- ----------------------------
% of % of % of
Amount Total Amount Total Amount Total
----------------- ------- ----------------- -------- ----------------- --------
<S> <C> <C> <C> <C> <C> <C>
United States $ 995,656 90% $ 847,361 92% $ 734,731 92%
Foreign, principally United Kingdom,
Australia and Bermuda 105,566 10% 75,627 8% 65,849 8%
----------------- ----- ----------------- ----- ----------------- ------
Total revenues $ 1,101,222 100% $ 922,988 100% $ 800,580 100%
================= ===== ================= ===== ================= ======
</TABLE>
- --------------
* Restated to conform to the current year presentation. See Note 3 to the
Consolidated Financial Statements of Gallagher's 2002 Annual Report to
Stockholders on page 39, which is incorporated herein by reference.
The Insurance Brokerage Services segment's international operations
comprise the following: 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) is a wholly-owned London based
subsidiary of Gallagher. It provides brokerage and other services to clients
primarily located outside 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. AJG UK's brokerage services
encompass most classes of business within the general categories of aviation,
marine, reinsurance (treaty and facultative) and property/casualty. The thrust
of AJG UK's 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's non-United Kingdom subsidiaries, other
independent agents and brokers and major business corporations requiring direct
insurance and reinsurance placements.
5
<PAGE>
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 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.
Arthur J. Gallagher Pte Ltd is a 51% owned joint-venture of AJG UK that is
based in Singapore. It specializes in treaty and facultative reinsurance
placements for insurance companies located throughout Asia. These placements are
made directly with reinsurance companies or through Gallagher's subsidiaries and
encompass several lines of business.
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 and
Australia.
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. 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 Note 16 (pages 53 and 54) and Note 18 (pages 55 and 56) to the
Consolidated Financial Statements of Gallagher's 2002 Annual Report to
Stockholders which is incorporated herein by reference for additional financial
information related to Gallagher's foreign operations, including earnings before
income taxes and identifiable assets, by operating segment, for 2002, 2001 and
2000.
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 multi-national 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 sales and service offices in the United States and six 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 2002, the largest single customer
represented less than 2% of total revenues.
6
<PAGE>
Gallagher believes that its ability to deliver comprehensively structured
risk management and brokerage services, including the placement of insurance and
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 that it forms with clients
when providing a variety of risk management services on an ongoing basis.
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
(third largest in the United States) 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.
2002 Acquisitions
In 2002, Gallagher acquired the net assets of ten insurance brokerage and
risk management firms in exchange for its common stock and/or cash using the
purchase method for recording business combinations. See Note 2 to the
Consolidated Financial Statements of Gallagher's 2002 Annual Report to
Stockholders on pages 38 and 39, which is incorporated herein by reference for a
summary of the entities acquired, the amount and nature of the consideration
paid and the dates of acquisition.
2003 Acquisitions
The following acquisitions accounted for as purchases have occurred since
December 31, 2002:
Effective on January 1, 2003, Gallagher acquired substantially all of the
net assets of W. E. Kingsley Company, Inc., a Kentucky corporation engaged in
the wholesale insurance brokerage and services business, in exchange for 101,000
shares of Gallagher's common stock.
Effective on January 1, 2003, Gallagher acquired substantially all of the
net assets of McRory & Company and Harman & McRory Company, Washington
corporations engaged in the insurance brokerage and services business, in
exchange for 54,000 and 49,000 shares of Gallagher's common stock, respectively.
Effective on March 1, 2003, Gallagher acquired substantially all of the net
assets of Benefits Planning & Insurance Agency, Inc., a California corporation
engaged in the benefits insurance business, in exchange for 577,000 shares of
Gallagher's common stock and a contingent obligation of $8,500,000 that, if any
is earned, will be paid in additional shares of Gallagher common stock.
7
<PAGE>
Gallagher believes that the net effect of these acquisitions has been and
will be to expand 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, 2002, Gallagher employed approximately 7,100 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.
Available Information
Gallagher makes available free of charge on its website at www.ajg.com its
annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments to those reports filed or furnished pursuant to Section
13(a)or 15(d) of the Exchange Act, as soon as reasonably practicable after
electronically filing or furnishing such material to the Securities and Exchange
Commission.
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 264,000 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 (pages
40 to 43), Note 7 (page 45) and 15 (pages 51 and 52) to the Consolidated
Financial Statements of Gallagher's 2002 Annual Report to Stockholders which is
incorporated herein by reference for additional information with respect to this
ownership interest. 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 15 to the
Consolidated Financial Statements of Gallagher's 2002 Annual Report to
Stockholders on pages 51 and 52, which is incorporated herein by reference for
information with respect to Gallagher's lease commitments at December 31, 2002.
Item 3. Legal Proceedings.
Information regarding legal proceedings of Gallagher is included in Note 15
to the Consolidated Financial Statements on page 52 of Gallagher's 2002 Annual
Report to Stockholders and is incorporated herein by reference.
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, 2002.
8
<PAGE>
Item 4A. Executive Officers of the Registrant.
The executive officers of Gallagher are as follows:
<TABLE>
<CAPTION>
Name Age Position and Year First Elected
---- ------ -------------------------------
<S> <C> <C>
Robert E. Gallagher 80 Chairman since 1990, Chief Executive Officer from 1963 until 1995
J. Patrick Gallagher, Jr. 51 President since 1990, Chief Executive Officer since 1995
James J. Braniff III 63 Vice President since 1995, President and Chief Operating Officer of
BSD from 1999 to June 2002
Elizabeth J. Brinkerhoff 59 Vice President since 1993
Richard C. Cary 40 Chief Accounting Officer since 2001, Acting Chief Financial Officer
since September 2002
James W. Durkin, Jr. 53 Vice President since 1985, President of GBS since 1985
Nicholas M. Elsberg 60 Vice President since 1994
James S. Gault 51 Vice President since 1992, President and Chief Operating Officer of
BSD since June 2002
David E. McGurn, Jr. 49 Vice President from 1993, President--Specialty Marketing and
International Division since 2001
Richard J. McKenna 56 Vice President since 1994, President of GB since 2000
John C. Rosengren 56 Vice President and General Counsel since 1995
</TABLE>
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.
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, 2001
through December 31, 2002 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.
<TABLE>
<CAPTION>
Dividends
Declared
Per Common
High Low Share
-------- -------- ----------
<S> <C> <C> <C>
Quarterly Periods
- -----------------
2002
- ----
First $ 37.240 $ 31.000 $ .150
Second 37.200 32.150 .150
Third 34.900 21.700 .150
Fourth 29.800 22.100 .150
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
</TABLE>
As of February 28, 2003, there were approximately 700 holders of record of
Gallagher's common stock.
9
<PAGE>
Item 6. Selected Financial Data.
The following selected consolidated financial data for each of the five
years in the period ended December 31, 2002 have been derived from Gallagher's
consolidated financial statements. Such data should be read in conjunction with
Gallagher's audited Consolidated Financial Statements and related notes thereto,
which have been incorporated by reference in Item 8 of this annual report.
<TABLE>
<CAPTION>
Year Ended December 31, (1)
-----------------------------------------------------------------------------------
2002 2001 2000 1999 1998
---------------- ---------------- ---------------- ---------------- ----------------
(In thousands, except per share and employee data)
<S> <C> <C> <C> <C> <C>
Consolidated Statement of Earnings Data:
Commissions $ 663,470 $ 539,023 $ 474,082 $ 440,828 $ 421,256
Fees 388,867 324,864 281,235 235,879 213,360
Investment income and other 48,885 59,101 45,263 39,230 24,980
---------------- ---------------- ---------------- ---------------- ----------------
Total revenues 1,101,222 922,988 800,580 715,937 659,596
Total expenses 915,880 781,135 666,841 588,913 576,430
---------------- ---------------- ---------------- ---------------- ----------------
Earnings before income taxes 185,342 141,853 133,739 127,024 83,166
Provision for income taxes 55,603 16,597 40,784 43,784 16,287
---------------- ---------------- ---------------- ---------------- ----------------
Net earnings $ 129,739 $ 125,256 $ 92,955 $ 83,240 $ 66,879
================ ================ ================ ================ ================
Per Share Data:
Basic net earnings per share (2) $ 1.49 $ 1.48 $ 1.11 $ 1.02 $ .83
Diluted net earnings per share (3) 1.41 1.39 1.04 .97 .80
Dividends declared per common share (4) .60 .52 .46 .40 .35
Share Data:
Shares outstanding at year end 88,548 85,111 84,540 82,157 81,169
Weighted average number of common share
outstanding 87,303 84,795 83,558 81,678 80,757
Weighted average number of common and
common equivalent shares outstanding 91,861 90,127 88,967 85,606 83,973
Consolidated Balance Sheet Data:
Total assets $ 2,463,574 $ 2,145,342 $ 1,626,771 $ 1,364,302 $ 1,243,946
Long-term debt less current portion 128,349 96,698 103,856 13,900 15,500
Total stockholders' equity 528,155 371,613 328,900 260,801 268,668
Return on Beginning Stockholders'
Equity (5) 35% 38% 36% 31% 28%
Employee Data:
Number of employees at year end 7,111 6,499 5,714 5,344 5,128
Total revenue per employee (6) $ 155 $ 142 $ 140 $ 134 $ 129
Net earnings per employee (6) $ 18 $ 19 $ 16 $ 16 $ 13
</TABLE>
- ------------------------------------------------
(1) Restated to conform to the current year presentation. See Note 3 to the
Consolidated Financial Statements of Gallagher's 2002 Annual Report to
Stockholders on page 39, which is incorporated herein by reference.
(2) Based on the weighted average number of common shares outstanding during
the year.
(3) Based on the weighted average number of common and common equivalent shares
outstanding during the year.
(4) Based on the total dividends declared on a share of common stock
outstanding during the entire year.
(5) Represents annual net earnings divided by stockholders' equity as of the
beginning of the year.
(6) Based on the number of employees at year end.
10
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Information regarding Management's Discussion and Analysis of Financial
Condition and Results of Operations is included in Gallagher's 2002 Annual
Report to Stockholders under the caption entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations" on pages 22 to 30 and
is incorporated herein by reference. All of such information should be read in
conjunction with Gallagher's Consolidated Financial Statements and related notes
thereto, which have been incorporated by reference in Item 8 of this annual
report.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Information regarding Quantitative and Qualitative Disclosures About Market
Risk is included in Gallagher's 2002 Annual Report to Stockholders under the
caption entitled "Market Risk Exposure" on page 30 and is incorporated herein by
reference.
Item 8. Financial Statements and Supplementary Data.
Gallagher's Consolidated Financial Statements, the related notes thereto,
Management's Report and Report of Independent Auditors are included in
Gallagher's 2002 Annual Report to Stockholders on pages 31 to 58 and are
incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
There were no changes in or disagreements with accountants on accounting
and financial disclosure.
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 2003 Proxy
Statement and is incorporated herein by reference. Information regarding
executive officers of Gallagher is included under the caption entitled
"Executive Officers of the Registrant" in Part I of this annual report.
Item 11. Executive Compensation.
Information regarding executive compensation of Gallagher's directors and
executive officers is included in the 2003 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 2003 Proxy Statement and is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
Not applicable.
Item 14. Controls and Procedures.
Within the 90-day period prior to filing this report, Gallagher management
carried out an evaluation, under the supervision and with the participation of
Gallagher's Chief Executive Officer ("CEO") and Acting Chief Financial Officer
("ACFO"), of the effectiveness of Gallagher's disclosure controls and procedures
pursuant to Exchange Act Rule 13a-14. Based on this evaluation, the CEO and ACFO
have concluded that Gallagher's disclosure controls and procedures were
effective as of the date of such evaluation.
There have been no significant changes in Gallagher's internal controls or
in other factors that could significantly affect the internal controls
subsequent to the date of Gallagher's evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
11
<PAGE>
PART IV
Item 15. 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 from Gallagher's 2002 Annual Report
to Stockholders which are incorporated herein by reference:
(a) Consolidated Statements of Earnings for each of the three years
in the period ended December 31, 2002 (page 31)
(b) Consolidated Balance Sheets as of December 31, 2002 and 2001
(page 32).
(c) Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 2002 (page 33).
(d) Consolidated Statements of Stockholders' Equity for each of the
three years in the period ended December 31, 2002 (page 34).
(e) Notes to Consolidated Financial Statements (pages 35 to 56).
(f) Management's Report (page 57).
(g) Report of Independent Auditors (page 58).
2. Consolidated Financial Statement Schedules required to be filed by
Item 8 of this Form:
(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.
3. Exhibits:
Included in this Form 10-K
10.8.9 Arthur J. Gallagher & Co. and AJG Financial Services, Inc. Ninth
Amendment to Credit Agreement Dated as of November 13, 2002.
13.0 Pages 21 to 58 of Gallagher's 2002 Annual Report to Stockholders
incorporated herein by reference.
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.
99.1 Certification of CEO Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
99.2 Certification of Acting CFO Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
Not included in this Form 10-K
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).
12
<PAGE>
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).
10.5 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).
10.7.1 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
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-K Annual Report for 2001, File No. 1-9761).
13
<PAGE>
10.8.6 Arthur J. Gallagher & Co. and AJG Financial Services, Inc. Sixth
Amendment to Credit Agreement Dated as of April 23, 2002
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly period
ended March 31, 2002, File No. 1-9761).
10.8.7 Arthur J. Gallagher & Co. and AJG Financial Services, Inc.
Seventh Amendment to Credit Agreement Dated as of August 9, 2002
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly period
ended June 30, 2002, File No. 1-9761).
10.8.8 Arthur J. Gallagher & Co. and AJG Financial Services, Inc.
Eighth Amendment to Credit Agreement Dated as of August 29, 2002
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly period
ended September 30, 2002, File No. 1-9761).
*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).
*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).
*10.22 Arthur J. Gallagher & Co. Brokerage Services Division Management
Bonus Plan Amended and Restated as of March 21, 2002
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly period
ended March 31, 2002, File No. 1-9761).
*10.22.1 Employment Agreement dated September 3, 2002 between Gallagher
and Michael J. Cloherty (incorporated by reference to the same
exhibit number to Gallagher's Form 10-Q Quarterly Report for the
quarterly period ended September 30, 2002, File No. 1-9761).
*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).
14
<PAGE>
*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).
*10.27.2 Amendment No. 2 to the Arthur J. Gallagher & Co. Restated 1988
Nonqualified Stock Option Plan, Amended as of January 18, 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).
*10.27.3 Amendment No. 3 to the Arthur J. Gallagher & Co. Restated 1988
Nonqualified Stock Option Plan, Amended as of January 17, 2002
(incorporated by reference to the same exhibit number to
Gallagher's Form 10-Q Quarterly Report for the quarterly period
ended June 30, 2002, 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).
*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).
*10.28.2 Amendment No. 3 to the Arthur J. Gallagher & Co. Restated 1989
Non-Employee Directors' Stock Option Plan, Amended as of
January 18, 2001 (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).
*10.28.3 Amendment No. 4 to the Arthur J. Gallagher & Co. Restated 1989
Non-Employee Directors' Stock Option Plan, Amended as of
January 17, 2002 (incorporated by reference to the same exhibit
number to Gallagher's Form 10-Q Quarterly Report for the
quarterly period ended June 30, 2002, File No. 1-9761).
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.
- -------
* 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.
15
<PAGE>
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 24th day of
March, 2003.
ARTHUR J. GALLAGHER & CO.
By /S/ J. PATRICK GALLAGHER, JR.
------------------------------------------
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 24th day of March, 2003 by the following
persons on behalf of the Registrant in the capacities indicated.
<TABLE>
<CAPTION>
Name Title
---- -----
<S> <C>
*ROBERT E. GALLAGHER Chairman and Director
- ----------------------------------------------------
Robert E. Gallagher
/S/ J. PATRICK GALLAGHER, JR. President and Director (Principal Executive Officer)
- ----------------------------------------------------
J. Patrick Gallagher, Jr.
/S/ RICHARD C. CARY Acting Chief Financial Officer and Controller
- ---------------------------------------------------- (Principal Financial and 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
*ELBERT O. HAND Director
- ----------------------------------------------------
Elbert O. Hand.
*DAVID E. MCGURN, JR. Director
- ----------------------------------------------------
David E. McGurn, Jr.
*RICHARD J. MCKENNA Director
- ----------------------------------------------------
Richard J. McKenna
*JAMES R. WIMMER Director
- ----------------------------------------------------
James R. Wimmer
*By: /S/ JOHN C. ROSENGREN
----------------------------------------------
John C. Rosengren, Attorney-in-Fact
</TABLE>
16
<PAGE>
ARTHUR J. GALLAGHER & CO.
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
I, J. Patrick Gallagher, Jr., certify that:
1. I have reviewed this annual report on Form 10-K of Arthur J. Gallagher &
Co.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a.) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b.) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c.) Presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a.) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b.) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 24, 2003
/s/ J. PATRICK GALLAGHER, JR.
---------------------------------------------
J. Patrick Gallagher, Jr.
President and Chief Executive Officer
(principal executive officer)
17
<PAGE>
ARTHUR J. GALLAGHER & CO.
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002 (Continued)
CERTIFICATION
I, Richard C. Cary, certify that:
1. I have reviewed this annual report on Form 10-K of Arthur J. Gallagher &
Co.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a.) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b.) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c.) Presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a.) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b.) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 24, 2003
/s/ RICHARD C. CARY
---------------------------------------------
Richard C. Cary
Acting Chief Financial Officer and Chief
Accounting Officer
(principal financial officer)
18
<PAGE>
SCHEDULE II
ARTHUR J. GALLAGHER & CO.
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Balance Additions Balance
at Charged at
Beginning to End
of Year Earnings Adjustments of Year
--------- --------- -------------- -------
(In thousands)
<S> <C> <C> <C> <C>
Year ended December 31, 2002
Allowance for doubtful accounts $ 1,730 $ 4,691 $(4,396)(1) $ 2,025
Allowance for estimated policy cancellations 2,500 500 - 3,000
Accumulated amortization of goodwill 7,129 - (9)(2) 7,120
Accumulated amortization of expiration
lists and noncompete agreements 1,602 6,647 (798)(3) 7,451
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 expiration
lists and noncompete agreements 4,089 881 (3,368)(3) 1,602
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 expiration
lists and noncompete agreements 3,118 1,283 (312)(3) 4,089
</TABLE>
- -----------------------------------------------------------
(1) Bad debt write-offs net of recoveries.
(2) Elimination of fully amortized goodwill and intangible asset/amortization
reclassifications.
(3) Elimination of fully amortized expiration lists and non-compete agreements
and intangible asset/amortization reclassifications.
19
<PAGE>
ARTHUR J. GALLAGHER & CO.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
EXHIBIT INDEX
10.8.9 Arthur J. Gallagher & Co. and AJG Financial Services, Inc. Ninth
Amendment to Credit Agreement Dated as of November 13, 2002.
13.0 Pages 21 to 58 of Gallagher's 2002 Annual Report to Stockholders
incorporated herein by reference.
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.
99.1 Certification of CEO Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Acting CFO Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
20
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-10.8.9
<SEQUENCE>3
<FILENAME>dex1089.txt
<DESCRIPTION>NINTH AMENDMENT TO CREDIT AGREEMENT
<TEXT>
<PAGE>
Exhibit 10.8.9
ARTHUR J. GALLAGHER & CO. AND AJG FINANCIAL SERVICES, INC.
NINTH AMENDMENT TO CREDIT AGREEMENT
Harris Trust and Savings Bank Citibank, N.A.
Chicago, Illinois New York, New York
Bank of America, N.A. LaSalle Bank National Association
Chicago, Illinois Chicago, Illinois
The Northern Trust Company
Chicago, Illinois
Ladies and Gentlemen:
This Ninth Amendment to Credit Agreement dated as of November 13, 2002
(herein, the "Amendment") is entered into by and between the undersigned, Arthur
J. Gallagher & Co, a Delaware corporation ("Gallagher"), AJG Financial Services,
Inc., a Delaware corporation ("AJG"; Gallagher and AJG being referred to herein
collectively as the "Borrowers" and individually as a "Borrower"), Citibank,
N.A., Bank of America, N.A., LaSalle Bank National Association, The Northern
Trust Company and Harris Trust and Savings Bank, individually and as Agent (the
"Agent"). Reference is hereby made to that certain Credit Agreement dated as of
September 11, 2000, as amended, between the Borrowers, the Banks and the Agent
(the "Credit Agreement"). All capitalized terms used herein without definition
shall have the same meanings herein as such terms have in the Credit Agreement.
The Borrowers desire to modify certain provisions with respect to the
issuance of Letters of Credit, and the Banks are willing to do so under the
terms and conditions set forth in this Amendment.
SECTION 1. AMENDMENTS.
Subject to the satisfaction of the conditions precedent set forth in
Section 2 below, the Credit Agreement shall be and hereby is amended as follows:
1.1. Section 1.3(b) of the Credit Agreement shall be amended and
restated in its entirety to read as follows:
"(b) Applications. At any time on or after the Effective Date and
before the Termination Date, the Agent shall, at the request of the
relevant Borrower, issue one or more Letters of Credit for the account
of such Borrower, in a form satisfactory to the Agent, with expiration
dates no later than the earliest of (i) 12 months from the date of
issuance or (ii) 365 days after the Termination Date, in an
<PAGE>
aggregate face amount as set forth above, upon the receipt of a duly
executed application for the relevant Letter of Credit in the form
customarily prescribed by the Agent for the type of Letter of Credit,
whether standby or commercial, requested (each an "Application");
provided, that with respect to any Letter of Credit with an expiration
date that is later than the Termination Date, the relevant Borrower
shall deliver to the Agent no later than 20 days prior to the
Termination Date cash collateral in an amount equal to the full amount
then available for drawing under such Letter of Credit. Any such cash
collateral required by this Section 1.3(b) shall be held by the Agent
pursuant to the terms of Section 10.4 hereof. Notwithstanding anything
contained in any Application to the contrary (i) the Borrowers'
obligation to pay fees in connection with each Letter of Credit shall
be as exclusively set forth in Section 5.1(b) hereof, (ii) except
during the continuance of an Event of Default, the Agent will not call
for the funding by the Borrowers of any amount under a Letter of
Credit before being presented with a drawing thereunder, and (iii) if
the Agent is not timely reimbursed for the amount of any drawing under
a Letter of Credit on the date such drawing is paid, the Borrowers'
obligation to reimburse the Agent for the amount of such drawing shall
bear interest (which the Borrowers hereby jointly and severally
promise to pay) from and after the date such drawing is paid until
payment in full thereof (i) in the case of a drawing under a Letter of
Credit denominated in U.S. Dollars, at a rate per annum equal to the
sum of 2% plus the Domestic Rate from time to time in effect and (ii)
in the case of a drawing under a Letter of Credit denominated in an
Alternative Currency, at a rate per annum equal to the sum of 2% plus
the Applicable Margin for Eurocurrency Loans under the Revolving
Credit plus the Overnight Eurocurrency Rate. The Agent will promptly
notify the Banks of each issuance by it of a Letter of Credit. If the
Agent issues any Letters of Credit with expiration dates that are
automatically extended under the terms set forth in such Letter of
Credit, then the Agent will give notice of non-renewal before the time
necessary to prevent such automatic extension if before such required
notice date (i) the expiration date of such Letter of Credit if so
extended would be later than 365 days after the Termination Date, (ii)
the Commitments have been terminated or (iii) an Event of Default
exists and the Required Banks have given the Agent instructions not to
so permit the extension of the expiration date of such Letter of
Credit. The Agent agrees to issue amendments to the Letters of Credit
increasing the amount, or extending the expiration date, thereof at
the request of the relevant Borrower subject to the conditions of
Section 8.2 and the other terms of this Section 1.3. Without limiting
the generality of the foregoing, the Agent's obligation to
-2-
<PAGE>
issue, amend or extend the expiration date of a Letter of Credit is
subject to the conditions of Section 8.2 and the other terms of this
Section 1.3 and the Agent will not issue, amend or extend the
expiration date of any Letter of Credit if any Bank notifies the Agent
of any failure to satisfy or otherwise comply with such conditions and
terms and directs the Agent not to take such action. Except as
specifically provided for in this Section 1.3(b), no amendment to a
Letter of Credit shall extend the expiration date of such Letter of
Credit beyond the Termination Date without the consent of each Bank
having a Revolving Credit Commitment."
1.2. Section 10.1(b) of the Credit Agreement shall be amended and
restated in its entirety to read as follows:
"(b) default in the observance or performance of any covenant set
forth in Sections 1.3(b), 9.5, 9.7, 9.8, 9.9, 9.10, 9.12, 9.13, 9.14,
9.15, 9.16 or 9.20 hereof; or"
SECTION 2. CONDITIONS PRECEDENT.
The effectiveness of this Amendment is subject to the satisfaction of all
of the following conditions precedent:
2.1. The Borrowers and the Banks shall have executed and delivered
this Amendment.
2.2. Legal matters incident to the execution and delivery of this
Amendment shall be satisfactory to the Agent and its counsel.
SECTION 3. REPRESENTATIONS.
In order to induce the Agent and the Banks to execute and deliver this
Amendment, the Borrowers hereby represent to the Agent and the Banks that as of
the date hereof the representations and warranties set forth in Section 7 of the
Credit Agreement are and shall be and remain true and correct (except that the
representations contained in Section 7.5 shall be deemed to refer to the most
recent financial statements of the Borrowers delivered to the Agent and the
Banks) and the Borrowers are in compliance with the terms and conditions of the
Credit Agreement and no Default or Event of Default has occurred and is
continuing under the Credit Agreement or shall result after giving effect to
this Amendment.
SECTION 4. MISCELLANEOUS.
4.1. Except as specifically amended herein, the Credit Agreement shall
continue in full force and effect in accordance with its original terms.
Reference to this specific Amendment need not be made in the Credit Agreement,
the Notes, or any other instrument or document executed in connection therewith,
or in any certificate, letter or communication issued or made
-3-
<PAGE>
pursuant to or with respect to the Credit Agreement, any reference in any of
such items to the Credit Agreement being sufficient to refer to the Credit
Agreement as amended hereby.
4.2. The Borrowers agree to pay on demand all costs and expenses of or
incurred by the Agent in connection with the negotiation, preparation, execution
and delivery of this Amendment, including the fees and expenses of counsel for
the Agent.
4.3. This Amendment may be executed in any number of counterparts, and by
the different parties on different counterpart signature pages, all of which
taken together shall constitute one and the same agreement. Any of the parties
hereto may execute this Amendment by signing any such counterpart and each of
such counterparts shall for all purposes be deemed to be an original. This
Amendment shall be governed by the internal laws of the State of Illinois.
-4-
<PAGE>
This Ninth Amendment to Credit Agreement is entered into as of the date and
year first above written.
ARTHUR J. GALLAGHER & CO.
By /s/ JACK H. LAZZARO
----------------------------------
Name: Jack H. Lazzaro
----------------------------
Title: Vice President & Treasurer
---------------------------
AJG FINANCIAL SERVICES, INC.
By /s/ JACK H. LAZZARO
-----------------------------------
Name: Jack H. Lazzaro
----------------------------
Title: Chief Financial Officer
---------------------------
-5-
<PAGE>
Accepted and agreed to.
HARRIS TRUST AND SAVINGS BANK,
individually and as Agent
By /s/ M. JAMES BARRY, III
--------------------------------
Name M. James Barry, III
---------------------------
Title Vice President
-------------------------
CITIBANK, N.A.
By /s/ PETER C. BICKFORD
--------------------------------
Name Peter C. Bickford
---------------------------
Title Vice President
-------------------------
BANK OF AMERICA, N.A.
By /s/ R. GUY STAPLETON
--------------------------------
Name R. Guy Stapleton
---------------------------
Title Managing Director
--------------------------
LASALLE BANK NATIONAL ASSOCIATION
By /s/ KYLE FREIMUTH
--------------------------------
Name Kyle Freimuth
---------------------------
Title Vice President
--------------------------
THE NORTHERN TRUST COMPANY
By /s/ ERIC DYBING
--------------------------------
Name Eric Dybing
---------------------------
Title Second Vice President
--------------------------
-6-
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-13.0
<SEQUENCE>4
<FILENAME>dex130.txt
<DESCRIPTION>PAGES 21 TO 58 OF GALLAGHER 2002 ANNUAL REPORT
<TEXT>
<PAGE>
EXHIBIT 13.0
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
21
FINANCIAL REVIEW
<TABLE>
<S> <C>
.. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Introduction ...............................................................22
Insurance Market Overview ..................................................22
Critical Accounting Policies ...............................................22
Effect Of New Pronouncements ...............................................23
Reclassifications Of Previously Reported Financial Statements ..............24
2002 Acquisitions ..........................................................24
Results Of Operations--Consolidated.........................................24
Results Of Operations--Segment Information .................................26
Financial Condition And Liquidity ..........................................28
Contractual Obligations And Commitments ....................................29
Market Risk Exposure .......................................................30
.. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements Of Earnings ........................................31
Consolidated Balance Sheets ................................................32
Consolidated Statements Of Cash Flows ......................................33
Consolidated Statements Of Stockholders' Equity ............................34
.. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Summary Of Significant Accounting Policies ........................35
Note 2: Business Combinations .............................................38
Note 3: Reclassifications Of Previously Reported Financial Statements .....39
Note 4: Investments .......................................................40
Note 5: Fixed Assets ......................................................44
Note 6: Intangible Assets .................................................44
Note 7: Credit And Other Debt Agreements ..................................45
Note 8: Capital Stock And Stockholders' Rights Plan .......................46
Note 9: Earnings Per Share ................................................46
Note 10: Stock Option Plans ................................................47
Note 11: Deferred Compensation .............................................48
Note 12: Restricted Stock Awards ...........................................48
Note 13: Retirement Plans ..................................................48
Note 14: Postretirement Benefits Other Than Pensions .......................50
Note 15: Commitments, Contingencies And Financial Guarantees ...............51
Note 16: Income Taxes ......................................................53
Note 17: Quarterly Operating Results .......................................54
Note 18: Segment Information ...............................................55
.. MANAGEMENT'S REPORT .............................................................57
.. REPORT OF INDEPENDENT AUDITORS ..................................................58
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
22
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
primarily 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 (P/C)
market or human resource/employee benefits market. Investment income and
other revenue 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
operations in seven countries and does business in more than 100 countries
around the world through a network of correspondent brokers and
consultants.
This Management's Discussion And Analysis Of Financial Condition And
Results Of Operations contains certain statements relating to future
results which are forward-looking statements as that term is defined in the
Private Securities Litigation Reform Act of 1995. See "Cautionary Language
Regarding Forward-Looking Statements" on page 68 of this annual report.
INSURANCE MARKET OVERVIEW
During the period from 1986 to 2000, heavy competition for market share
among P/C insurance carriers resulted in low premium rates. This "soft
market" (i.e., low premium rates) generally resulted in flat or reduced
renewal commissions. During this soft market period, natural catastrophes
and other losses 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 that P/C premium rates remained low through 1999.
Years of underwriting losses coupled with the downward turn in equity
markets and interest rates for the past three years, have placed insurers
in the position of having to replenish depleted reserves. In order to
restore reserves, many carriers began to increase premium rates in 2000 and
continued to do so throughout 2001 and 2002, particularly after the events
described below.
The insurance industry was jolted by the tragic terrorist attacks that
occurred on September 11, 2001. The devastation caused by those events
resulted in the largest insurance loss ever. Along with this historic loss,
larger than anticipated loss experience across most risks, the stock
market's steep decline, lower interest rates and diminished risk capacity
have led to the unprecedented acceleration of premium rate increases. A
higher premium rate environment is referred to as a "hard market" and
generally results 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. Since September
11th, the increased premium rates charged by insurance companies have had a
positive impact on Gallagher's 2001 and 2002 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 during 2003, the longevity of the hard market and its future
effect on Gallagher's operations is difficult to predict. However, the rate
of increase in premiums in the P/C marketplace has begun to level off, but
certain types of coverages, such as directors and officers and medical
malpractice liability, continue to have a high rate of increase.
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 is causing
some buyers to raise their deductibles and/or reduce the overall amount of
insurance coverage they purchase. In addition, some buyers are switching to
negotiated fee in lieu of commission arrangements with Gallagher for
placing their risks. Other buyers are moving toward the alternative
insurance market, which could have a favorable effect on Gallagher's Risk
Management Services segment. These factors tend to reduce commission
revenue to Gallagher. Gallagher anticipates that new sales and renewal
increases in the areas of risk management, claims management, captive
insurance and self-insurance services will continue to be a major factor in
Gallagher's fee revenue growth during 2003. 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.
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 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. 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. Commission on premiums billed directly
by insurance companies relates 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
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
23
revenues generated from the Risk Management 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.
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 deemed 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 that invest in common and preferred
stocks and bonds. 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 and preferred stocks and bonds that are primarily based
on quoted market prices.
Marketable securities consist primarily of common and preferred stocks and
bonds and are carried at fair value in the accompanying consolidated
balance sheets. Prior to September 30, 2002, these securities were
classified as available for sale and the unrealized gains and losses, less
related deferred income taxes, were excluded from net earnings and reported
as accumulated other comprehensive earnings (loss) in the stockholders'
equity section of the consolidated balance sheets. Effective September 30,
2002, Gallagher reclassified its marketable securities portfolio from
available for sale to trading. As a result of this reclassification,
changes in unrealized gains and losses are now recorded in investment
income in the consolidated statements of earnings. 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.
INTANGIBLE ASSETS
Intangible assets consist of the excess of cost over the value of net
tangible assets of acquired businesses, expiration lists and non-compete
agreements. Expiration lists and non-compete agreements are amortized
using the straight-line method over their estimated useful lives (5 to 15
years for expiration lists and 5 to 6 years for non-compete agreements).
Allocation of intangible assets between goodwill, expiration lists and
non-compete agreements and the determination of estimated useful lives are
based on valuations Gallagher received from qualified independent
appraisers. The calculations of these amounts are based on estimates and
assumptions using historical and pro forma data and recognized valuation
methods. The use of different estimates or assumptions could produce
different results.
In accordance with Statement of Financial Accounting Standards No. 142
(SFAS 142), "Goodwill and Other Intangible Assets," goodwill and indefinite
lived assets are not amortized, but are subject to periodic reviews for
impairment (at least annually or more frequently if impairment indicators
arise). Gallagher reviews goodwill and other intangible assets for
impairment periodically and whenever events or changes in business
circumstances indicate that the carrying value of the assets may not be
recoverable. Under those circumstances, if the fair value were less than
the carrying amount of the asset, a loss would be recognized for the
difference. The determinations of impairment indicators and fair value are
based on estimates and assumptions related to the amount and timing of
future cash flows and future interest rates. The use of different estimates
or assumptions could produce different results.
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 in the following areas to
calculate the liabilities and expenses recorded in the consolidated
financial statements and the amounts disclosed in the notes: defined
benefit pension plan, retiree health benefits plan, self-funded employee
benefit plans, self-funded professional liability and other insurance
programs and pro forma stock option information. The calculations of these
amounts 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 deemed necessary. The use of different estimates or
assumptions could produce different results.
EFFECT OF NEW PRONOUNCEMENTS
GUARANTEES
In November 2002, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 45 (Interpretation 45), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," which will significantly change current practice
in the accounting for, and disclosure of, guarantees. Interpretation 45
requires certain guarantees to initially be recorded as a liability at fair
value, which is different from the current practice of recording a
liability only when a loss is probable and estimable, as those terms are
defined in Statement of Financial Accounting Standards No. 5 (SFAS 5),
"Accounting for Contingencies." Interpretation 45 also requires a guarantor
to make significant new disclosures, even when the likelihood of making any
payments under the guarantee is remote, which is also a change from general
current practice.
The Interpretation's disclosure requirements are effective for all
guarantees, regardless of the initiation date, for financial statements of
interim or annual periods ending after December 15, 2002, while the initial
recognition and initial measurement provisions are applicable on a
prospective basis to guarantees issued, renewed or modified after December
31, 2002. Gallagher implemented the disclosure requirements of
Interpretation 45 in 2002, which is presented in Note 15 to the
Consolidated Financial Statements. Gallagher is currently evaluating the
impact Interpretation 45 will have on Gallagher's consolidated financial
statements for those current guarantees that are anticipated to renew in
2003. The adoption of Interpretation 45 could have a material effect on
Gallagher's consolidated operating results or financial position.
CONSOLIDATION OF PARTIALLY-OWNED ENTITIES
In January 2003, the FASB issued FASB Interpretation No. 46 (Interpretation
46), "Consolidation of Variable Interest Entities." Interpretation 46
generally defines a variable interest entity (VIE) as a corporation,
partnership, trust, or any other legal structure used for business purposes
that either (a) does not have equity investors with voting rights or (b)
has equity investors that do not provide sufficient financial resources for
the entity to support its own activities.
Prior to Interpretation 46, a partially owned entity was only consolidated
into the investor company's consolidated financial statements if it was
controlled by the investor company through voting interests. Regardless of
voting interests, Interpretation 46 generally requires a VIE to be
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Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
24
consolidated by an investor company if that VIE's equity is less than 10%
of its assets and the investor company is subject to a majority of the risk
of loss from the VIE's activities or entitled to receive a majority of the
VIE's residual returns or both. Interpretation 46 also requires disclosures
about VIEs in circumstances where the investor company is not required to
consolidate but in which it has a significant variable interest.
The consolidation requirements of Interpretation 46 apply immediately to
VIEs created or invested in after January 31, 2003. The consolidation
requirements apply to entities created or invested in as of January 31,
2003 or earlier, in the first fiscal year or interim period beginning after
June 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003, regardless of when the
VIE was created or invested in.
Gallagher has a number of investments it believes may be deemed to be VIEs.
These investments include qualified affordable housing and alternative
energy projects intended primarily to be income tax credit generators, a
synthetic fuel facility intended to produce both tax credits and pretax
income, real estate development projects intended to generate gains and
venture capital investees intended to generate equity income and realized
gains. Total assets of these investments approximates $650 million in the
aggregate. Gallagher's maximum exposure to losses related to these
investments is approximately $14 million including net book value, letters
of credit, financial guarantees and funding commitments. Management is
currently evaluating the impact Interpretation 46 will have on Gallagher's
consolidated financial statements. However, management anticipates that the
adoption of Interpretation 46 will not have a material effect on
Gallagher's consolidated net earnings or stockholders' equity.
INTANGIBLE ASSETS
In 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 141 (SFAS 141), "Business
Combinations," and SFAS 142. SFAS 141 requires that all business
combinations initiated after June 30, 2001 be accounted for using the
purchase method of accounting. In addition, SFAS 141 further clarifies the
criteria to recognize intangible assets separately from goodwill. The
requirements of SFAS 141 were effective for business combinations
accounted for by the purchase method completed after June 30, 2001.
Under SFAS 142, goodwill and indefinite lived intangible assets are no
longer amortized, but are 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 estimated useful lives. The
amortization provisions of SFAS 142 initially applied only to goodwill and
intangible assets related to business combinations accounted for by the
purchase method that were completed after June 30, 2001. With respect to
goodwill and intangible assets acquired prior to July 1, 2001, companies
were 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 before June 30, 2001 and those acquired after that date,
pre-existing goodwill and intangible assets were amortized during the
transition period from June 30 to December 31, 2001. Effective January 1,
2002, Gallagher adopted the remaining provisions of SFAS 142 with respect
to pre-existing goodwill and intangible assets, the effect of which was not
material to Gallagher's consolidated operating results or financial
position.
RECLASSIFICATIONS OF PREVIOUSLY REPORTED FINANCIAL STATEMENTS
During the first quarter of 2002, Gallagher undertook a review of how it
was accounting for all of its partially-owned entities. Given the current
environment regarding ownership/control relationships with respect to
partially-owned entities, Gallagher determined it would be appropriate to
consolidate three operations that were previously accounted for using the
equity method of accounting. In addition, prior to 2002, the premiums and
claims receivable and payable of a reinsurance intermediary subsidiary of
Gallagher were reported on a net basis in Gallagher's consolidated balance
sheets with the gross amounts disclosed in the Notes to the Consolidated
Financial Statements. During 2002, Gallagher determined it would be
appropriate to include these amounts on a gross basis in its consolidated
balance sheets in order to conform to a more common industry practice.
Reclassifications have been made to the previously reported financial
statements in order to conform them to the current year presentation. These
reclassifications had no impact on the previously reported net earnings or
stockholders' equity. For additional information, see Note 3 to the
Consolidated Financial Statements.
2002 ACQUISITIONS
During 2002, Gallagher acquired substantially all the net assets of 10
insurance brokerage and risk management firms in exchange for its common
stock and/or cash using the purchase method of accounting for recording
business combinations. Gallagher continues to search for merger partners
that complement existing operations, provide entry into new markets, add
new products and enhance local sales and service capabilities. See Note 2
to the Consolidated Financial Statements for a discussion of the 2002
business combinations.
In the second quarter of 2002, a 90% owned subsidiary of Gallagher acquired
a leasing company that leases two cargo airplanes to the French postal
service. As part of this acquisition, the subsidiary acquired assets of
$47.0 million and assumed non-recourse long-term debt of $38.2 million, in
exchange for $3.1 million of cash and $5.7 million of other assets. During
the second quarter of 2002, Gallagher consolidated the financial results of
this leasing company into its consolidated financial statements.
RESULTS OF OPERATIONS -- CONSOLIDATED
Commission revenues increased $124.4 million, or 23%, to $663.5 million in
2002. This increase generated by the Insurance Brokerage Services segment
was primarily the result of record new business of $145.9 million and above
average rate increases partially offset by lost business of $85.3 million.
Commission revenues increased $64.9 million, or 14%, to $539.0 million in
2001. This increase, also generated by the Insurance Brokerage Services
segment, was the result of new business production of $99.8 million and
rate increases partially offset by lost business of $60.3 million and a
reduction in contingent commission revenue. Organic growth represents the
increase in revenues before the impact of the 2002 and 2001 acquisitions
accounted for as purchases. Organic growth in commission revenues in 2002
was 17%. Commission revenues from purchase acquisitions completed in 2002
and 2001 totaled $29.5 million for 2002.
Fee revenues increased $64.0 million, or 20%, to $388.9 million in 2002.
This increase, generated primarily from the Insurance Brokerage Services
segment, resulted primarily from new business production of $65.1 million
and favorable retention rates on existing business, partially offset by
lost business of $34.2 million. Fee revenues increased $43.6 million, or
16%, to $324.9 million in 2001. This increase, generated primarily from the
Risk Management Services segment, resulted from new business production of
$55.3 million and favorable retention rates on existing business, partially
offset by lost business of $24.6 million. Organic growth in fee revenues in
2002 was 15%. Fee revenues from purchase acquisitions completed in 2002 and
2001 totaled $15.4 million for 2002.
Interest income from fiduciary funds, primarily interest on cash and
restricted funds, decreased $3.9 million, or 29%, to $9.3 million in 2002
and $6.3 million, or 32%, to $13.2 million in 2001 due to significant
declines in short-term interest rates during 2002 and 2001.
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Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
25
Rates of return on interest bearing accounts and certificates of deposit
were down over 40% and 70% in 2002 and 2001, respectively, putting
considerable pressure on short-term interest returns.
Income from investment strategies and marketable securities decreased
$14.1 million, or 171%, to a loss of $5.9 million in 2002. This decrease
was substantially due to other-than-temporary impairments that resulted
from a sharp decline in the equity markets in 2002, most of which occurred
during the third quarter. During 2002, Gallagher recognized
other-than-temporary impairments of $10.6 million in the consolidated
statement of earnings related to its marketable securities portfolio.
Effective September 30, 2002, Gallagher reclassified its marketable
securities portfolio from available for sale to trading. Changes in
unrealized gains and losses in this portfolio are now recorded in
investment income in the consolidated statements of earnings, instead of in
stockholders' equity as accumulated other comprehensive earnings (loss). As
a result of this reclassification, $425,000 of net unrealized losses,
previously classified in accumulated other comprehensive earnings (loss),
was recognized in earnings before income taxes in 2002. Income from
investment strategies and marketable securities increased $1.7 million, or
26%, to $8.3 million in 2001 due primarily to realized gains of $2.8
million generated from Gallagher's investment strategies and marketable
securities portfolios.
Income from equity investments and partnerships decreased $23.6 million, or
293%, to a loss of $15.5 million in 2002. This decrease was substantially
due to $19.6 million of write-downs of loans and equity holdings in five
venture capital investments recognized in 2002 and a $3.0 million loss
associated with Gallagher's equity investment in Asset Alliance Corporation
(AAC) that is discussed below. In addition, Gallagher incurred a $3.6
million loss in 2002 on the sale of a venture capital investment. Income
from equity investments and partnerships increased $4.8 million, or 148%,
to $8.0 million in 2001. This increase was due primarily to results
generated by Gallagher's unconsolidated equity investment portfolio and
income generated from commitment fees paid to Gallagher for providing
letters of credit and financial guarantees to three of its investees.
The $11.8 million gain on the sale of a portion of a minority interest in
an investment relates to the gain recognized on the sale of a portion of
Gallagher's minority equity position in AAC to an international financial
institution that was completed in the second quarter of 2002. After the
sale and subsequent equity transactions of AAC, Gallagher owns
approximately 25% of AAC, which is a holding company for alternative fund
managers.
On November 7, 2002, one of the major fund managers of AAC, Beacon Hill
Asset Management LLC (Beacon Hill), agreed to the entry of a preliminary
injunction in an action by the Securities and Exchange Commission (SEC). In
accordance with the court's order, Beacon Hill withdrew from managing its
hedge funds, which reported approximately $400 million in losses. AAC
reports that assets under management by AAC and its 14 affiliate fund
managers are currently in excess of $4.0 billion. While Gallagher does not
have a direct investment in Beacon Hill or its hedge funds, Gallagher
recognized a $3.0 million loss in the fourth quarter of 2002 using the
equity method of accounting for AAC's write-down of its investment in
Beacon Hill. Gallagher is monitoring these developments but there can be no
assurance that as the result of further SEC action against Beacon Hill or
otherwise, including investor claims, that there will not be further
negative developments which could be material to Gallagher.
Installment gains from alternative energy partnership sales primarily
relate to five sales of Gallagher's interests in limited partnerships that
operate synthetic fuel facilities discussed below. Installment gains from
alternative energy partnership sales increased $22.9 million, or 195%, to
$34.6 million in 2002, and $2.5 million, or 27%, to $11.7 million in 2001.
As discussed below, Gallagher expects to continue to recognize additional
installment gains over time through 2007 based on the amount of qualified
fuel processed by these facilities. Production at these facilities, which
ultimately determines the amount of the installment gains realized, did not
meet full expectations in 2002 due to the unusually mild winter in 2001 and
a short-term shut down of production in the first quarter of 2002 at one of
the major facilities, as the movable equipment was relocated to permanent
sites to accommodate the delivery of synthetic fuel.
During the third quarter of 2001, Gallagher completed 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 the amount of qualified fuel
processed by the facility. Gallagher retains a 5% partnership interest in
this synthetic fuel facility.
During the fourth quarter of 2001 and the first and fourth quarters of
2002, Gallagher completed a series of sales totaling 95% of its interest in
a partnership that owns a 59.9% interest in another South Carolina
synthetic fuel facility. Gallagher received aggregate down-payments of $4.5
million and will receive additional installment payments over time through
2007 based on the amount of qualified fuel processed by the facility. The
buyer has the option to put the purchased interest back to Gallagher if
certain adverse tax consequences occur through 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. Gallagher retains a 3%
partnership interest in this synthetic fuel facility.
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 and will receive
additional installment payments over time through 2007 based on qualified
fuel production generated by the facilities. This transaction had no impact
on Gallagher's 2000 results.
In 2000, Gallagher recognized $7.2 million 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 $2.0 million of income
related to an investment development fee generated from one of Gallagher's
alternative energy investments.
Income from real estate ventures represents revenue related to Gallagher's
consolidation of its investments in two real estate partnerships. These
real estate partnerships 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 Birchwood
Acres, a limited partnership that owns 11,000 acres of land under
development near Orlando, Florida. This residential, recreational and
commercial development is being marketed under the name of Harmony. Income
from real estate ventures decreased $2.8 million, or 23%, to $9.3 million
in 2002 due primarily to a one-time gain of $4.5 million generated from the
sale of land by Harmony that was reported in the first quarter of 2001.
Income from real estate ventures increased $9.0 million, or 288%, to $12.1
million in 2001, due primarily to the $4.5 million gain noted above and the
full year impact of Gallagher's fourth quarter 2000 investment in the
limited partnership that owns its corporate headquarters building.
Other income consists primarily of gains on the sales of books of insurance
brokerage and benefits business and interest income on employee loans and
compensation arrangements. Other income decreased $584,000, or 10%, to $5.2
million in 2002 and increased $2.2 million, or 59%, to $5.8 million in
2001. During 2002 and 2001, Gallagher recognized gains on sales of books of
business of $2.5 million
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
26
and $2.4 million, respectively. Given the nature of the items that comprise
other income, income levels will fluctuate from period to period due to
timing differences.
See Note 4 to the Consolidated Financial Statements for a summary of the
components of investment income and other.
Salaries and employee benefits increased $97.9 million, or 20%, to $576.5
million in 2002 and $63.2 million, or 15%, to $478.6 million in 2001. These
increases are higher than usual and are due primarily to a 9% and 14%
increase in employee headcount in 2002 and 2001, respectively, salary
increases, increases in incentive compensation linked to Gallagher's
overall operating results and the performance of Gallagher's investment
portfolio, the annualized effect of prior year new hires, a corresponding
increase in employee benefit expenses, and increases in pension and medical
insurance costs in 2002. The increase in employee headcount relates to the
hiring of additional production and support staff to generate the recent
and future new business growth and the addition of employees associated
with the acquisitions accounted for as purchases that were made in the last
15 months. Salaries and employee benefits as a percentage of commission and
fee revenues were 54.8%, 55.4% and 55.0% in 2002, 2001 and 2000,
respectively.
Other operating expenses increased $41.9 million, or 17%, to $293.6 million
in 2002 due primarily to increases in business insurance costs and shared
commissions paid to non-affiliated brokers on the retail P/C brokerage
business, both of which are due to the effects of the hard market. Also
contributing to the increase in other operating expenses are increases in
travel and entertainment costs, due primarily to new business development
from new producers, and interest expense due to higher levels of short-term
borrowings in 2002 and increased long-term debt related to the 2002
acquisition of the airplane leasing company. Other operating expenses
increased $21.6 million, or 9%, to $251.7 million in 2001, due primarily to
fees for professional services and business insurance related to
Gallagher's investments and to performance-related investment management
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 non-affiliated
brokers on the retail P/C brokerage business.
Operating expenses of alternative energy partnerships represent Gallagher's
portion of the production costs associated with the operations of the
synthetic fuel facilities owned by the partnerships. These expenses
decreased $14.9 million, or 71%, to $6.1 million in 2002 and increased
$21.1 million in 2001. The decrease in 2002 is directly attributable to
the sales of Gallagher's interests in limited partnerships that operate
these facilities that were completed in the third and fourth quarters of
2001 and the first and fourth quarters of 2002. Because of the sales,
Gallagher's portion of these expenses was substantially reduced. The
increase 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. There were no similar costs
incurred in 2000.
Expenses of real estate ventures represent expenses related to Gallagher's
consolidation of the two investments in real estate partnerships discussed
above. Expenses of real estate ventures increased $625,000, or 9%, to $7.3
million in 2002 due primarily to the development, marketing and operating
expenses of Harmony, partially offset by a decrease in minority interest
expense associated with the two investments in real estate partnerships.
Expenses of real estate ventures increased $4.7 million, or 238%, to $6.6
million in 2001 due primarily to the full-year impact of Gallagher's fourth
quarter 2000 investment in the limited partnership that owns its corporate
headquarters building and to an increase in minority interest expense.
Depreciation increased $6.1 million, or 31%, to $25.8 million in 2002 and
$3.9 million, or 24%, to $19.6 million in 2001. These increases are due
primarily to the purchases of furniture, equipment and leasehold
improvements related to office expansions and moves made during the
three-year period ended December 31, 2002. Also contributing to the
increase in depreciation expense in 2002 is the depreciation expense
associated with the acquisitions accounted for as purchases that were made
in the last 18 months and to the increase in fixed assets related to the
2002 acquisition of the airplane leasing company. In addition, a portion of
the increase in depreciation expense in 2001 was due to the full-year
impact of Gallagher's investment in the limited partnership that owns its
corporate headquarters building.
Amortization increased $3.1 million, or 90%, to $6.6 million in 2002 due
primarily to Gallagher's adoption of SFAS 141 and the amortization expenses
associated with acquisitions accounted for as purchases that were made in
the fourth quarter of 2001 and throughout 2002. Amortization expense for
2001 was relatively unchanged compared to 2000. See Note 2 to the
Consolidated Financial Statements for a discussion on the 2002 business
combinations.
Gallagher's effective income tax rates were 30.0%, 11.7% and 30.5% in 2002,
2001 and 2000, 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
amortization expense and state and foreign income taxes. The increase in
the effective income tax rate in 2002 is due primarily to a reduction in
the amount of tax credits earned in 2002. This decrease in tax credits is
directly attributable to the sales of Gallagher's interests in limited
partnerships that operate synthetic fuel facilities. These sales were
completed in the third and fourth quarters of 2001 and the first and fourth
quarters of 2002. The reduction in the effective income tax rate in 2001 is
due to a $23.4 million increase in tax credits earned in 2001, net of the
related amortization expense. This increase in the amount of tax credits
earned was generated from Gallagher's alternative energy related
partnerships. See Note 16 to the Consolidated Financial Statements. The
2003 effective income tax rate will be higher than the 2002 rate due to the
anticipated growth in pretax earnings the decrease in tax credits that will
be generated for Gallagher's use in 2003. Gallagher anticipates that the
2003 effective income tax rate will be in the mid-30% range.
Diluted net earnings per share increased $.02, or 1%, to $1.41 in 2002 and
$.35, or 34%, to $1.39 in 2001. Basic net earnings per share increased
$.01, or 1%, to $1.49 in 2002 and $.37, or 33%, to $1.48 in 2001. Earnings
per share in 2002 were negatively impacted by the investment impairments
and write-downs discussed above, an increase in the effective income tax
rate in 2002 and an increase in both the weighted average number of common
shares and common equivalent shares outstanding. The increase in earnings
per share in 2001 is primarily due to the increase in total revenues, which
was partially offset by moderate increases in expenses, and to the
reduction in the effective income tax rate in 2001.
Gallagher's foreign operations recorded earnings before income taxes of
$13.8 million, $8.5 million and $7.9 million in 2002, 2001 and 2000,
respectively. The increases in 2002 and 2001 are due primarily to new
business production partially offset by lost business. Also contributing to
the increase in 2002 was the effect of a United Kingdom-based acquisition
accounted for as a purchase that was made in the fourth quarter of 2001.
See Notes 16 and 18 to the Consolidated Financial Statements.
During 2002 and 2001, Gallagher's total revenues and expenses increased
sequentially from quarter-to-quarter within the calendar years, except for
the second quarter of 2001 and the third quarter of 2002, the latter of
which was negatively impacted by $28.9 million of investment write-downs.
However, commission and fee revenues and the related expenses can vary from
quarter-to-quarter as a result of
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
27
the timing of policy inception dates that traditionally are heaviest in the
third and fourth quarters. On the other hand, salaries and employee
benefits, rent, depreciation and amortization expenses tend to be more
uniform throughout the year. In addition, the timing of acquisitions
accounted for as purchases will also impact the trends in Gallagher's
quarterly operating results. See Note 17 to the Consolidated Financial
Statements.
RESULTS OF OPERATIONS -- SEGMENT INFORMATION
As discussed in Note 18 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 segment also
provides consulting, for fee compensation, related to the clients' risk
financing programs and includes Gallagher's retail, reinsurance and
wholesale insurance brokerage operations.
Total revenues for this segment increased $168.1 million, or 27%, to $779.8
million in 2002. Total domestic revenues were up $140.2 million, or 25%, to
$700.6 million in 2002 and total foreign revenues, principally in the
United Kingdom, Australia and Bermuda, were up $27.8 million, or 54%, to
$79.2 million in 2002. These increases are due principally to new
business, renewal rate increases and the effect of acquisitions accounted
for as purchases that were made in the fourth quarter of 2001 and
throughout 2002, partially offset by lost business. Earnings before income
taxes increased $38.9 million, or 33%, to $155.4 million in 2002 due
primarily to the new business production and rate increases mentioned
above.
Total revenues increased $70.0 million, or 13%, to $611.7 million in 2001.
This increase is due primarily to new business production offset partially
by lost business and a $5.6 million reduction in interest income generated
from the float on fiduciary funds in 2001. The decrease in the fiduciary
interest income is due to the decrease in short-term interest rates during
2001. Total domestic revenues were up $62.0 million, or 12%, to $560.4
million in 2001 and total foreign revenues, principally in the United
Kingdom, Australia and Bermuda, were up $8.0 million, or 18%, to $51.3
million in 2001. These increases are due primarily to new business
production offset partially by lost business. Earnings before income taxes
increased $16.2 million, or 16%, to $116.5 million in 2001 principally as a
result of increased revenues.
RISK MANAGEMENT SERVICES
The Risk Management Services segment primarily represents Gallagher Bassett
(GB), which is Gallagher's P/C third-party administration, loss control and
risk management consulting and insurance property appraisal operation. The
Risk Management Services segment also includes the operations of Gallagher
Benefit Administrators, which is Gallagher's third-party administrator of
health claims. Third-party administration is principally the management and
processing of claims for self-insurance programs of Gallagher's clients or
clients of other brokers.
Total revenues for this segment increased $16.6 million, or 6%, to $281.3
million in 2002 due primarily to new business production substantially
offset by reductions in existing business volume and by lost business.
Total domestic revenues were up $14.3 million, or 6%, to $256.7 million in
2002 and total foreign revenues, principally from the United Kingdom and
Australia, were up $2.2 million, or 10% to $24.5 million in 2002. The
slowdown in total revenue growth from historical double-digit percentages
to recent single-digit percentages, is primarily the result of the events
of September 11, 2001, combined with a general economic slowdown in the
United States. GB provides services to several airline, hospitality and
restaurant-related clients, all of whose businesses were particularly hard
hit following September 11th. Because those clients experienced declines in
their business, including reductions in their headcount, the rate of
increase in new GB claim counts slowed, and for some clients, actual claim
counts decreased from the same period in 2001. In addition, the hard
market had an unfavorable impact on GB as several of its managing general
agent programs were unable to renew their coverages in the reinsurance
marketplace during 2002. GB's 2002 operating results were also negatively
impacted by several insurance carrier insolvencies in 2002 and 2001. As
GB's revenues are generally based on the number of new claims it handles,
the reduction in claims has had a direct impact on revenue. As revenues
slow, expenses in the short-term do not experience the same immediate
reduction. The net result of the above is that earnings before income taxes
for the segment were down $2.7 million, or 8%, to $32.6 million in 2002.
Total revenues were up $32.4 million, or 14%, to $264.7 million in 2001
due to strong new business production and favorable retention rates on
existing business. Total domestic revenues were up $32.0 million, or 15%,
to $242.4 million in 2001 and total foreign revenues, principally from the
United Kingdom and Australia, were up $382,000, or 2%, to $22.3 million in
2001 due primarily to new business and substantially less lost business
than in 2000. Earnings before income taxes increased $2.1 million, or 6%,
to $35.3 million in 2001 due primarily to revenue increases, which were
partially offset by moderate increases 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 long-term after-tax return to Gallagher.
Total revenues for this segment decreased $6.4 million, or 16%, to $33.0
million in 2002. This decrease is primarily due to the following previously
discussed items:
. Other-than-temporary impairments that resulted from the sharp decline in
the equity markets during 2002, most of which occurred in the third
quarter. During 2002, Gallagher recognized other-than-temporary
impairments of $10.6 million in the consolidated statements of earnings
related to its marketable securities portfolio.
. An unrealized loss of $425,000 that was recognized in the third quarter
of 2002 related to reclassifying the marketable securities portfolio
from available for sale to trading.
. Aggregate write-downs of loans and equity holdings of $19.6 million
related to venture capital investments that were recognized in 2002. In
addition, Gallagher incurred a $3.6 million loss in 2002 on the sale of
a venture capital investment.
. The $3.0 million loss that was recognized by Gallagher in the fourth
quarter of 2002 through the equity method of accounting for AAC's
write-down of its investment in Beacon Hill.
. A one-time gain of $4.5 million generated from the sale of land by
Harmony that was recognized in the first quarter of 2001.
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Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
28
These decreases are partially offset by installment gains from the sales of
Gallagher's interests in limited partnerships that operate synthetic fuel
facilities that were completed in the third and fourth quarters of 2001 and
the first and fourth quarters of 2002. These installment gains increased
$22.9 million, or 195%, to $34.6 million in 2002. In addition, the $11.8
million gain on the sale of a portion of Gallagher's minority interest in
AAC also offset the 2002 decreases discussed above.
Earnings before income taxes increased $1.6 million, or 28%, to $7.1
million in 2002. This increase is primarily due to the $14.9 million
reduction in the operating expenses of alternative energy partnerships, the
$22.9 million increase in installment gains and the $11.8 million gain on
the sale of a portion of Gallagher's minority interest in AAC, all of which
were significantly offset by the impairments and write-downs discussed
above.
Total revenues increased $15.1 million, or 62%, to $39.4 million in 2001
due primarily to realized gains of $2.8 million generated from Gallagher's
investment strategies and marketable securities portfolios, increased
installment gains on the alternative energy sale transactions 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 three of its investees. Also
contributing to the increase in total revenues was income from real estate
ventures related to the $4.5 million gain from Harmony mentioned above and
the $2.4 million gain recognized on the sale of a benefits administration
book of business in 2001.
Earnings before income taxes decreased $7.5 million, or 58%, to $5.5
million in 2001 due primarily to the increase in operating expenses of
alternative energy partnerships of $21.1 million in 2001, which represents
Gallagher's portion of the production costs associated with the operations
of the synthetic fuel facilities. The increase in these expenses in 2001
relates to the production costs incurred by the alternative energy
partnerships that generated a substantial portion of the tax credits earned
by Gallagher in 2001. The tax credits generated by these investments are
included in the provision for income taxes, which is not allocated to
Gallagher's operating entities. The impact of the increase in operating
expenses of alternative energy partnerships on 2001 earnings before income
taxes was partially offset by the revenue increases discussed above.
CORPORATE
The Corporate segment consists of the operating results of Gallagher's
investment in the limited partnership that owns its corporate headquarters
building, unallocated administrative costs and the provision for income
taxes which is not allocated to Gallagher's operating entities. Only
revenues not attributable to one of the three operating segments are
recorded in the Corporate segment. All costs are generated in the United
States.
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, including tax credits generated
from tax advantaged investments. Cash generated from operating activities
was $149.7 million, $131.5 million and $169.4 million in 2002, 2001 and
2000, respectively. Because of the variability related to the timing of
premiums and fees receivable and premiums payable, net cash flows from
operations vary substantially from quarter to quarter and 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 may 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, historically
Gallagher has 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
foreseeable future.
In 2000, Gallagher and its financial services subsidiary entered into an
unsecured Revolving Credit Agreement (the 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 $100.0 million and $50.0 million, respectively. The Credit
Agreement 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 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 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. Interest rates on borrowings under
the Eurocurrency Loan option are based on LIBOR plus .40% for short-term
and long-term revolving credit commitments. The facility fee related to the
Credit Agreement is .10% of the used and unused portions of the short-term
and long-term revolving credit commitments. Terms of the Credit Agreement
include various covenants that require Gallagher to maintain specified
levels of net worth and restrict the amount of payments on certain
expenditures and debt outside the facility. Gallagher was in compliance
with these covenants as of December 31, 2002.
As of December 31, 2002, under the Credit Agreement, Gallagher has
contingently committed to funding $54.3 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, 2002,
there were $25.0 million of short-term borrowings outstanding under the
Credit Agreement. Accordingly, Gallagher had $70.7 million available at
December 31, 2002 for future borrowing. In 2002, Gallagher borrowed $258.0
million and repaid $268.0 million of short-term borrowings under the Credit
Agreement. In 2001, Gallagher borrowed $206.7 million and repaid $171.7
million of short-term borrowings under the Credit Agreement. The 2002 and
2001 borrowings were used on a short-term basis to finance a portion of
Gallagher's operating and investment activities and common stock
repurchases. There were $35.0 million in short-term borrowings outstanding
under the Credit Agreement as of December 31, 2001.
As of December 31, 2002, there were $17.0 million of borrowings on a line
of credit facility and $134.1 million of long-term debt (of which $5.8
million is current) related to the previously discussed airplane leasing
company and two real estate partnerships. In 2002, these partnerships
borrowed $13.4 million on the line of credit facility and $500,000 of
long-term debt and repaid $4.4 million of long-term debt. In 2001, these
partnerships borrowed $3.5 million on the line of credit facility and
repaid $4.0 million of long-term debt. These borrowings were used by the
partnerships (three in 2002 and two in 2001) for their own operating,
investing and financing activities. Borrowings under these facilities are
not available to Gallagher and as such have not been included in
determining Gallagher's
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
29
overall liquidity. Based on the ownership structure of these three
investments, management believes that Gallagher's exposure to losses
related to these investments is limited to the combination of its net
carrying value of its investments, funding commitments, letters of credit
and financial guarantees.
In the event that any of these operations 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. For additional information, see
Note 4 to the Consolidated Financial Statements.
The issue of off-balance sheet financing is a concern of many investors.
Gallagher's unconsolidated investment portfolio includes investments in
limited partnerships and venture capital equity projects where Gallagher's
ownership is between 3% and 50%. As a result, these investments are
accounted for using either the lower of amortized cost/cost or fair value,
or the equity method, whichever is appropriate depending on the legal form
of Gallagher's ownership interest and the applicable percentage of the
entity owned. As such, the balance sheets of these investees are not
consolidated in Gallagher's consolidated balance sheets as of December 31,
2002 and 2001. The December 31, 2002 and 2001 balance sheets of several of
these unconsolidated investments contain outstanding debt, which is not
required to be included in Gallagher's consolidated balance sheets. See
Note 4 to the Consolidated Financial Statements for a summary of the
outstanding debt and contingent commitments related to Gallagher's
unconsolidated investment portfolio, 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 7 and 15 to the
Consolidated Financial Statements for additional commitments and
contingencies.
Gallagher paid $50.4 million in cash dividends on its common stock in 2002.
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
2002, Gallagher paid a dividend of $.15 per share that was $.02 or 15%
greater than each quarterly dividend declared in 2001. On January 23, 2003,
Gallagher declared a 20% increase in its quarterly cash dividend to $.18,
payable on April 15, 2003 to Shareholders of Record as of March 31, 2003.
Net capital expenditures were $45.4 million, $31.5 million and $20.6
million in 2002, 2001 and 2000, respectively. These amounts include net
capital expenditures of the two previously discussed real estate
partnerships of $11.5 million, $7.2 million and $5.4 million in 2002, 2001
and 2000, respectively, the majority of which are related to the Harmony
land development project. In 2003, exclusive of the net capital
expenditures of the two real estate partnerships, Gallagher expects total
capital expenditures to be approximately $30.0 million. Capital
expenditures by Gallagher are related primarily to office moves and
expansions and updating computer systems and equipment. The capital
expenditures related to office moves and expansions in 2002 were higher
than originally anticipated due to the increase in employee headcount
related to the hiring of additional production personnel and to the
acquisitions that were made in the last 15 months.
In 1988, Gallagher adopted a common stock repurchase plan that has been
extended through June 30, 2003. Under the plan, Gallagher has repurchased
478,000 shares at a cost of $11.7 million, 3.4 million shares at a cost of
$104.1 million and 1.5 million shares at a cost of $31.3 million in 2002,
2001 and 2000, 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 4.5 million additional shares through June 30,
2003. 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, 2002,
Gallagher had $42.0 million of undistributed earnings from its foreign
subsidiaries. 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. See
Note 16 to the Consolidated Financial Statements.
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, 7 and 15 to the Consolidated
Financial Statements for an additional discussion of these obligations
and commitments.
Gallagher's future cash payments, excluding interest, associated with its
contractual obligations pursuant to the Credit Agreement, limited
partnership and airplane leasing company debt obligations and operating
leases as of December 31, 2002 are as follows (in thousands):
<TABLE>
<CAPTION>
PAYMENTS DUE BY PERIOD
----------------------------------------------------
CONTRACTUAL OBLIGATIONS 2003 2004 TO 2005 2006 TO 2007 THEREAFTER TOTAL
------------------------------------------------------- --------- ------------ ------------ ---------- ----------
<S> <C> <C> <C> <C> <C>
Revolving Credit Agreement $ 25,000 $ -- $ -- $ -- $ 25,000
Florida real estate limited partnership debt 7,857 15,260 -- 12,410 35,527
Corporate headquarters limited partnership mortgage loan 746 1,693 1,999 74,145 78,583
Airplane leasing company debt 2,180 4,904 29,937 -- 37,021
--------- ------------ ------------ ---------- ----------
Total debt obligations 35,783 21,857 31,936 86,555 176,131
Operating leases 51,006 86,830 52,049 41,019 230,904
--------- ------------ ------------ ---------- ----------
Total contractual obligations $ 86,789 $ 108,687 $ 83,985 $ 127,574 $ 407,035
========= ============ ============ ========== ==========
</TABLE>
The debt of the limited partnerships and the airplane leasing company
disclosed in the table above represents the debt directly associated with
three of Gallagher's investments that are accounted for on a consolidated
basis in the accompanying consolidated balance sheets. This debt is secured
by the partnerships' assets and supports their operations. Approximately
$32.4 million of the limited partnership debt is recourse to Gallagher
through the letters of credit and financial guarantees, which are included
in the amounts disclosed below.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
30
Gallagher's total commitments associated with outstanding letters of
credit, financial guarantees and funding commitments as of December 31,
2002 are as follows (in thousands):
<TABLE>
<CAPTION>
AMOUNT OF COMMITMENT EXPIRATION BY PERIOD TOTAL
---------------------------------------------------- AMOUNTS
OTHER COMMITMENTS 2003 2004 TO 2005 2006 TO 2007 THEREAFTER COMMITTED
------------------------------------------------------- --------- ------------ ------------ ---------- ---------
<S> <C> <C> <C> <C> <C>
Letters of credit $ 1,025 $ 8,883 $ 561 $ 43,781 $ 54,250
Financial guarantees 16,500 20,000 -- 5,100 41,600
Funding commitments 200 18,481 -- -- 18,681
--------- ------------ ------------ ---------- ---------
Total other commitments $ 17,725 $ 47,364 $ 561 $ 48,881 $ 114,531
========= ============ ============ ========== =========
</TABLE>
Since commitments may expire unused, the amounts presented in the table
above do not necessarily reflect the actual future cash funding
requirements of Gallagher.
MARKET RISK EXPOSURE
Gallagher is exposed to various market risks in its day-to-day operations.
Market risk is the potential loss arising from adverse changes in market
rates and prices, such 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, 2002 and 2001 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 -- trading.
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, 2002 and 2001 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 values were not
materially different from the carrying values at December 31, 2002 and
2001.
At December 31, 2002 and 2001, the fair value of Gallagher's investment
strategies -- trading portfolio was $55.9 million and $52.6 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 $6.1 million and $6.9 million
and an alternative investment strategies portfolio of $49.8 million and
$45.7 million at December 31, 2002 and 2001, respectively.
The equity portfolio is subject to equity price risk. It is not hedged,
consists primarily of common and preferred stocks and is 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 $610,000 and
$690,000 at December 31, 2002 and 2001, 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" 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, 2002 and 2001, 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 portfolio was $14.6
million (trading basis) and $18.3 million (available for sale basis, which
was $4.4 million less than its aggregate amortized cost) at December 31,
2002 and 2001, respectively. The overall objective of this portfolio is to
provide Gallagher with a stable after-tax yield. This unhedged portfolio
consists primarily of dividend-yielding preferred stocks, and accordingly,
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 $1.7 million and $2.1 million at December 31, 2002 and 2001,
respectively.
At December 31, 2002 and 2001, Gallagher had $25.0 million and $35.0
million, respectively, in short-term borrowings outstanding under the
Credit Agreement. The fair value of these borrowings approximated their
carrying value due to their short-term duration and variable interest
rates. 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, 2002
and 2001 and the resulting fair values were not materially different from
the year-end carrying values.
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 a substantial portion of
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 2002 and 2001 (a weakening of the U.S.
dollar), earnings before income taxes would decrease by approximately $6.1
million and $3.3 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.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
31
CONSOLIDATED
STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
(in thousands, except per share data) 2002 2001 2000
- ------------------------------------------------------------------------ ----------- ----------- -----------
<S> <C> <C> <C>
OPERATING RESULTS
Revenues:
Commissions $ 663,470 $ 539,023 $ 474,082
Fees 388,867 324,864 281,235
Investment income and other:
Interest income from fiduciary funds 9,289 13,166 19,468
Income (loss) from investment strategies and marketable securities (5,851) 8,255 6,574
Income (loss) from equity investments and partnerships (15,534) 8,049 3,243
Gain on sale of portion of minority interest in investment 11,848 -- --
Installment gains from alternative energy partnership sales 34,580 11,703 9,200
Income from real estate ventures 9,324 12,115 3,121
Other income 5,229 5,813 3,657
----------- ----------- -----------
Total investment income and other 48,885 59,101 45,263
----------- ----------- -----------
Total revenues 1,101,222 922,988 800,580
----------- ----------- -----------
Expenses:
Salaries and employee benefits 576,497 478,563 415,348
Other operating expenses 293,557 251,707 230,100
Operating expenses of alternative energy partnerships 6,131 21,079 --
Expenses of real estate ventures 7,265 6,640 1,967
Depreciation 25,784 19,641 15,780
Amortization 6,646 3,505 3,646
----------- ----------- -----------
Total expenses 915,880 781,135 666,841
----------- ----------- -----------
Earnings before income taxes 185,342 141,853 133,739
Provision for income taxes 55,603 16,597 40,784
----------- ----------- -----------
Net earnings $ 129,739 $ 125,256 $ 92,955
=========== =========== ===========
Basic net earnings per share $ 1.49 $ 1.48 $ 1.11
Diluted net earnings per share 1.41 1.39 1.04
Dividends declared per common share .60 .52 .46
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
32
CONSOLIDATED
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
(in thousands) 2002 2001
- ------------------------------------------------------------------------ ----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 152,536 $ 98,530
Restricted cash 256,323 209,509
Premiums and fees receivable 1,183,737 1,117,238
Investment strategies -- trading 55,937 52,588
Marketable securities -- trading 14,619 --
Other 110,458 85,142
----------- -----------
Total current assets 1,773,610 1,563,007
Marketable securities -- available for sale -- 18,290
Deferred income taxes 102,361 99,263
Other investments and notes receivable 168,413 192,002
Other noncurrent assets 33,133 24,194
Fixed assets 367,273 283,807
Accumulated depreciation and amortization (116,278) (100,562)
----------- -----------
Net fixed assets 250,995 183,245
Goodwill -- net 84,217 55,475
Amortizable intangible assets -- net 50,845 9,866
----------- -----------
$ 2,463,574 $ 2,145,342
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Premiums payable to insurance and reinsurance companies $ 1,488,222 $ 1,366,516
Accrued salaries and bonuses 58,066 56,572
Accounts payable and other accrued liabilities 107,542 111,618
Unearned fees 19,427 16,527
Income taxes payable 11,036 33,746
Borrowings on line of credit facility 25,000 35,000
Borrowings on line of credit facilities -- limited partnerships 16,996 3,552
Current portion of long-term debt -- limited partnerships 5,786 3,152
Other 17,529 11,273
----------- -----------
Total current liabilities 1,749,604 1,637,956
Long-term debt -- limited partnerships 128,349 96,698
Other noncurrent liabilities 57,466 39,075
Commitments and contingencies -- Note 15
Stockholders' equity:
Common stock -- issued and outstanding 88,548 shares in 2002
and 85,111 shares in 2001 88,548 85,111
Capital in excess of par value 92,716 8,768
Retained earnings 360,958 283,796
Unearned deferred compensation (6,544) (3,438)
Unearned restricted stock (7,523) --
Accumulated other comprehensive earnings (loss) -- (2,624)
----------- -----------
Total stockholders' equity 528,155 371,613
----------- -----------
$ 2,463,574 $ 2,145,342
=========== ===========
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
33
CONSOLIDATED
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
(in thousands) 2002 2001 2000
- ------------------------------------------------------------------------ ----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 129,739 $ 125,256 $ 92,955
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Net loss (gain) on investments and other 13,562 (2,895) (2,006)
Gain on sales of operations (2,500) (2,375) (1,823)
Depreciation and amortization 32,430 23,146 19,426
Increase in restricted cash (46,814) (50,863) (29,350)
Increase in premiums receivable (57,705) (297,758) (53,395)
Increase in premiums payable 103,000 380,464 97,105
(Increase) decrease in trading investments -- net (1,758) 1,051 6,498
(Increase) decrease in other current assets (21,787) (9,160) 7,876
Increase in accrued salaries and bonuses 4,534 18,094 14,073
Decrease in accounts payable and other accrued liabilities (8,795) (1,478) (1,479)
(Decrease) increase in income taxes payable (22,842) 23,456 105
Tax benefit from issuance of common stock 18,683 24,806 20,027
Net change in deferred income taxes (6,577) (77,751) (30,613)
Other 16,513 (22,452) 30,019
----------- ----------- -----------
Net cash provided by operating activities 149,683 131,541 169,418
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (16,004) (13,957) (25,832)
Proceeds from sales of marketable securities 10,568 23,051 22,471
Proceeds from maturities of marketable securities 3,185 398 762
Net additions to fixed assets (45,430) (31,457) (20,649)
Cash paid for acquisitions, net of cash acquired (5,443) (17,893) (14,801)
Proceeds from sales of operations 2,500 2,700 2,334
Other 1,897 (47,804) (35,632)
----------- ----------- -----------
Net cash used by investing activities (48,727) (84,962) (71,347)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 15,546 27,255 27,837
Repurchases of common stock (11,662) (104,122) (31,344)
Dividends paid (50,359) (41,618) (33,759)
Borrowings on line of credit facilities 271,444 210,252 45,000
Repayments on line of credit facilities (268,000) (171,700) (60,000)
Borrowings of long-term debt 500 -- 12,410
Repayments of long-term debt (4,419) (4,006) (2,315)
Equity transactions of pooled companies prior to dates of acquisition -- (13,497) (4,937)
----------- ----------- -----------
Net cash used by financing activities (46,950) (97,436) (47,108)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 54,006 (50,857) 50,963
Cash and cash equivalents at beginning of year 98,530 149,387 98,424
----------- ----------- -----------
Cash and cash equivalents at end of year $ 152,536 $ 98,530 $ 149,387
=========== =========== ===========
Supplemental disclosures of cash flow information:
Interest paid $ 10,743 $ 10,477 $ 4,937
Income taxes paid 63,067 36,470 25,371
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
34
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK CAPITAL IN UNEARNED UNEARNED
-------------------- EXCESS OF RETAINED DEFERRED RESTRICTED
(in thousands) SHARES AMOUNT PAR VALUE EARNINGS COMPENSATION STOCK
- ------------------------------------------ ------ ----------- ----------- --------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1999 82,157 $ 82,157 $ 8,847 $ 172,466 $ -- $ --
Net earnings -- -- -- 92,955 -- --
Net change in unrealized gain (loss)
on available for sale securities -- -- -- -- -- --
COMPREHENSIVE EARNINGS
Cash dividends declared on
common stock -- -- -- (35,539) -- --
Common stock issued under stock
option plans 3,811 3,811 24,026 -- -- --
Tax benefit from issuance of
common stock -- -- 20,027 -- -- --
Common stock repurchases (1,500) (1,500) (30,987) -- -- --
Common stock issued in two
pooling acquisitions 72 72 -- -- -- --
Equity transactions of pooled companies
prior to dates of acquisition -- -- (151) (4,786) -- --
------ ----------- ---------- --------- ------------ -----------
Balance at December 31, 2000 84,540 84,540 21,762 225,096 -- --
Net earnings -- -- -- 125,256 -- --
Net change in unrealized gain (loss)
on available for sale securities -- -- -- -- -- --
COMPREHENSIVE EARNINGS
Cash dividends declared on
common stock -- -- -- (43,534) -- --
Common stock issued under stock
option plans 3,007 3,007 24,248 -- -- --
Tax benefit from issuance of
common stock -- -- 24,806 -- -- --
Common stock repurchases (3,359) (3,359) (90,151) (9,470) -- --
Common stock issued in three
pooling acquisitions 93 93 -- -- -- --
Common stock issued in three
purchase acquisitions 678 678 24,200 -- -- --
Common stock issued under
deferred compensation 152 152 3,848 -- (3,438) --
Equity transactions of pooled companies
prior to dates of acquisition -- -- 55 (13,552) -- --
------ ----------- ---------- --------- ------------ -----------
Balance at December 31, 2001 85,111 85,111 8,768 283,796 (3,438) --
Net earnings -- -- -- 129,739 -- --
Net change in unrealized gain (loss)
on available for sale securities -- -- -- -- -- --
COMPREHENSIVE EARNINGS
Cash dividends declared on
common stock -- -- -- (52,577) -- --
Common stock issued under stock
option plans 1,896 1,896 13,650 -- -- --
Tax benefit from issuance of
common stock -- -- 18,683 -- -- --
Common stock repurchases (478) (478) (11,184) -- -- --
Common stock issued in seven
purchase acquisitions 1,590 1,590 49,166 -- -- --
Common stock issued under
deferred compensation 123 123 3,908 -- (3,106) --
Common stock issued under
restricted stock 306 306 9,725 -- -- (7,523)
------ ----------- ---------- --------- ------------ -----------
Balance at December 31, 2002 88,548 $ 88,548 $ 92,716 $ 360,958 $ (6,544) $ (7,523)
====== =========== ========== ========= ============ ===========
<CAPTION>
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE STOCKHOLDERS'
(IN THOUSANDS) EARNINGS (LOSS) EQUITY
- ---------------------------------------- ----------------- -------------
<S> <C> <C>
Balance at December 31, 1999 $ (2,669) $ 260,801
-------------
Net earnings -- 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)
Common stock issued under stock
option plans -- 27,837
Tax benefits from issuance of
common stock -- 20,027
Common stock repurchases -- (32,487)
Common stock issued in two
pooling acquisitions -- 72
Equity transactions of pooled companies
prior to dates of acquisition -- (4,937)
---------------- -------------
Balance at December 31, 2000 (2,498) 328,900
-------------
Net earnings -- 125,256
Net change in unrealized gain (loss)
on available for sale securities (126) (126)
-------------
125,130
COMPREHENSIVE EARNINGS
Cash dividends declared on
common stock -- (43,534)
Common stock issued under stock
option plans -- 27,255
Tax benefit from issuance of
common stock -- 24,806
Common stock repurchases -- (102,980)
Common stock issued in three
pooling acquisitions -- 93
Common stock issued in three
purchase acquisitions -- 24,878
Common stock issued under
deferred compensation -- 562
Equity transactions of pooled companies
prior to dates of acquisition -- (13,497)
--------------- -------------
Balance at December 31, 2001 (2,624) 371,613
-------------
Net earnings -- 129,739
Net change in unrealized gain (loss)
on available for sale securities 2,624 2,624
-------------
132,363
COMPREHENSIVE EARNINGS
Cash dividends declared on
common stock -- (52,577)
Common stock issued under stock
option plans -- 15,546
Tax benefit from issuance of
common stock -- 18,683
Common stock repurchases -- (11,662)
Common stock issued in seven
purchase acquisitions -- 50,756
Common stock issued under
deferred compensation -- 925
Common stock issued under
restricted stock -- 2,508
---------------- -------------
Balance at December 31, 2002 $ -- $ 528,155
================ =============
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
35
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
revenue 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 operations
in seven 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 (50% or greater
ownership). Investments in partially owned entities in which Gallagher's
ownership is less than 50% are accounted for using either the lower of
amortized cost/cost or fair value, or the equity method, whichever is
appropriate depending on the legal form of Gallagher's ownership interest
and the applicable percentage of the entity owned. For partially owned
entities accounted for using the equity method, Gallagher's share of the
net earnings of these entities is included in consolidated net earnings.
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 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 relates 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 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.
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
$3,000,000 and $2,500,000 at December 31, 2002 and 2001, respectively,
which represents a reserve for future reversals in commission and fee
revenues related to the potential cancellation of client insurance policies
that were in force as of year end. The allowance for doubtful accounts was
$2,025,000 and $1,730,000 at December 31, 2002 and 2001, respectively.
Gallagher periodically reviews the adequacy of the allowances for estimated
policy cancellations and doubtful accounts and adjusts them as deemed
necessary.
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."
For revenue recognition policies pertaining to net realized and unrealized
gains (losses), see the accounting policy on investments below. 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
Basic net earnings per share is computed by dividing net earnings by the
weighted average number of common shares outstanding during the respective
period. Diluted net earnings per share is computed by dividing net earnings
by 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 that have a maturity of 90 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
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
36
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 interest income from
fiduciary funds in the accompanying consolidated statements of earnings.
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 and marketable securities are considered trading
securities. Investment strategies consist primarily of limited
partnerships, which invest in common and preferred stocks and bonds.
Marketable securities consist primarily of common and preferred stocks and
bonds. Investments 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 and preferred stocks and bonds, which are based primarily
on quoted market prices. The fair value of marketable securities is based
primarily on quoted market prices.
Effective September 30, 2002, Gallagher reclassified its marketable
securities portfolio which consists primarily of common and preferred
stocks and bonds, from available for sale to trading based on changes in
its investment philosophy. Prior to September 30, 2002, marketable
securities were considered available for sale and were 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).
Gains and losses were recognized in net earnings when realized using the
specific identification method. The fair value of marketable securities
held as available for sale were based primarily on quoted market prices. As
a result of this reclassification, $425,000 of net pretax unrealized
losses, previously classified in accumulated other comprehensive earnings
(loss), was recognized in earnings before income taxes in the third quarter
of 2002.
FIXED ASSETS
Fixed assets are carried at cost in the accompanying consolidated balance
sheets. 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. Under those
circumstances, if the fair value were less than the carrying amount of the
asset, a loss would be recognized for the difference. Depreciation for
fixed assets is computed using the straight-line method over the following
estimated useful lives:
YEARS
---------------------------------------------------------------------------
Furniture and equipment 3-10 years
Buildings and improvements 3-40 years
Airplanes of the leasing company 15 years
Leasehold improvements Lesser of remaining life of
the asset or life of lease
INTANGIBLE ASSETS
Intangible assets consist of the excess of cost over the value of net
tangible assets of acquired businesses, expiration lists and non-compete
agreements. Expiration lists and non-compete agreements are amortized using
the straight-line method over their estimated useful lives (5 to 15 years
for expiration lists and 5 to 6 years for non-compete agreements). In
accordance with Statement of Financial Accounting Standards No. 142 (SFAS
142), "Goodwill and Other Intangible Assets," goodwill and indefinite lived
assets are not amortized, but are subject to periodic reviews for
impairment (at least annually or more frequently if impairment indicators
arise). Gallagher reviews goodwill and other intangible assets for
impairment periodically and whenever events or changes in business
circumstances indicate that the carrying value of the assets may not be
recoverable. Under those circumstances, if the fair value were less than
the carrying amount of the asset, a loss would be recognized for the
difference.
STOCK-BASED COMPENSATION
At December 31, 2002, Gallagher has four stock-based employee compensation
plans, which are described more fully in Note 10. Gallagher primarily
grants stock options for a fixed number of shares to employees, with an
exercise price equal to the fair value of the underlying shares at the date
of grant. Gallagher accounts for stock option grants under the recognition
and measurement principles of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations
and, accordingly, recognizes no compensation expense for these stock
options granted to employees. The following table illustrates the effect on
net earnings and net earnings per share if Gallagher had applied the fair
value recognition provisions of Statement of Financial Accounting Standards
Board No. 123 (SFAS 123), "Accounting for Stock-Based Compensation," to
stock-based employee compensation.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
2002 2001 2000
------------------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Net earnings, as reported $ 129,739 $ 125,256 $ 92,955
Deduct: Total stock-based employee compensation
expense determined under fair value based method for
all awards (see Note 10), net of related tax effects (4,013) (6,232) (2,046)
---------- ---------- ----------
Pro forma net earnings $ 125,726 $ 119,024 $ 90,909
========== ========== ==========
Basic net earnings per share -- as reported $ 1.49 $ 1.48 $ 1.11
Basic net earnings per share -- pro forma 1.44 1.40 1.09
Diluted net earnings per share -- as reported 1.41 1.39 1.04
Diluted net earnings per share -- pro forma 1.38 1.33 1.03
</TABLE>
As presented in the table above, had Gallagher applied the fair value
recognition provisions of SFAS 123, diluted net earnings per share as
reported would have been reduced by $.03 in 2002, $.06 in 2001 and $.01 in
2000. 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.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
37
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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, 2002 and 2001, 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
investments and notes receivable are disclosed in Note 4. The carrying
amount of borrowings outstanding under Gallagher's credit agreement
approximates fair value at December 31, 2002 because the borrowings are at
floating interest rates.
EFFECT OF NEW PRONOUNCEMENTS
GUARANTEES
In November 2002, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation No. 45 (Interpretation 45), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," which will significantly change current practice
in the accounting for, and disclosure of, guarantees. Interpretation 45
requires certain guarantees to initially be recorded as a liability at fair
value, which is different from the current practice of recording a
liability only when a loss is probable and estimable, as those terms are
defined in Statement of Financial Accounting Standards No. 5 (SFAS 5),
"Accounting for Contingencies." Interpretation 45 also requires a guarantor
to make significant new disclosures, even when the likelihood of making any
payments under the guarantee is remote, which is also a change from general
current practice.
The Interpretation's disclosure requirements are effective for all
guarantees, regardless of the initiation date, for financial statements of
interim or annual periods ending after December 15, 2002, while the initial
recognition and initial measurement provisions are applicable on a
prospective basis to guarantees issued, renewed or modified after December
31, 2002. Gallagher implemented the disclosure requirements of
Interpretation 45 in 2002, which is presented in Note 15. Gallagher is
currently evaluating the impact Interpretation 45 will have on Gallagher's
consolidated financial statements for those current guarantees that are
anticipated to renew in 2003. The adoption of Interpretation 45 could have
a material effect on Gallagher's consolidated operating results or
financial position.
CONSOLIDATION OF PARTIALLY-OWNED ENTITIES
In January 2003, the FASB issued FASB Interpretation No. 46 (Interpretation
46), "Consolidation of Variable Interest Entities." Interpretation 46
generally defines a variable interest entity (VIE) as a corporation,
partnership, trust, or any other legal structure used for business purposes
that either (a) does not have equity investors with voting rights or (b)
has equity investors that do not provide sufficient financial resources for
the entity to support its own activities.
Prior to Interpretation 46, a partially owned entity was only consolidated
into the investor company's consolidated financial statements if it was
controlled by the investor company through voting interests. Regardless of
voting interests, Interpretation 46 generally requires a VIE to be
consolidated by an investor company if that VIE's equity is less than 10%
of its assets and the investor company is subject to a majority of the risk
of loss from the VIE's activities or entitled to receive a majority of the
VIE's residual returns or both. Interpretation 46 also requires disclosures
about VIEs in circumstances where the investor company is not required to
consolidate but in which it has a significant variable interest.
The consolidation requirements of Interpretation 46 apply immediately to
VIEs created or invested in after January 31, 2003. The consolidation
requirements apply to entities created or invested in as of January 31,
2003 or earlier, in the first fiscal year or interim period beginning after
June 15, 2003. Certain of the disclosure requirements apply in all
financial statements issued after January 31, 2003, regardless of when the
VIE was created or invested in.
Gallagher has a number of investments it believes may be deemed to be VIEs.
These investments include qualified affordable housing and alternative
energy projects intended primarily to be income tax credit generators, a
synthetic fuel facility intended to produce both tax credits and pretax
income, real estate development projects intended to generate gains and
venture capital investees intended to generate equity income and realized
gains. Total assets of these investments approximates $650,000,000 in the
aggregate. Gallagher's maximum exposure to losses related to these
investments is approximately $14,000,000 including net book value, letters
of credit, financial guarantees and funding commitments. Management is
currently evaluating the impact Interpretation 46 will have on Gallagher's
consolidated financial statements. However, management anticipates that the
adoption of Interpretation 46 will not have a material effect on
Gallagher's consolidated net earnings or stockholders' equity.
INTANGIBLE ASSETS
In 2001, the FASB issued Statement of Financial Accounting Standards No.
141 (SFAS 141), "Business Combinations," and SFAS 142. SFAS 141 requires
that all business combinations initiated after June 30, 2001 be accounted
for using the purchase method of accounting. In addition, SFAS 141 further
clarifies the criteria to recognize intangible assets separately from
goodwill. The requirements of SFAS 141 were effective for business
combinations accounted for by the purchase method completed after June 30,
2001.
Under SFAS 142, goodwill and indefinite lived intangible assets are no
longer amortized, but are 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 estimated useful lives. The
amortization provisions of SFAS 142 initially applied only to goodwill and
intangible assets related to business combinations accounted for by the
purchase method that were completed after June 30, 2001. With respect to
goodwill and intangible assets acquired prior to July 1, 2001, companies
were 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 before June 30, 2001 and those acquired after that date,
pre-existing goodwill and intangible assets were amortized during the
transition period from June 30 to December 31, 2001. Effective January 1,
2002, Gallagher adopted the remaining provisions of SFAS 142 with respect
to pre-existing goodwill and intangible assets, the effect of which was not
material to Gallagher's consolidated operating results or financial
position.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
38
2. BUSINESS COMBINATIONS
PURCHASE ACQUISITIONS
In 2002, Gallagher acquired substantially all of the net assets of the
following insurance brokerage and risk management firms for its common
stock and/or cash using the purchase accounting method for recording
business combinations (in thousands):
<TABLE>
<CAPTION>
COMMON COMMON RECORDED
SHARES SHARE ESCROW PURCHASE CONTINGENT
2002 PURCHASE ACQUISITIONS ISSUED VALUE CASH PAID DEPOSITED PRICE PAYABLE
- ---------------------------------------- ------ -------- --------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Life Plans Unlimited, Inc.
(LPUI), February 28, 2002 127 $ 3,987 $ -- $ 443 $ 4,430 $ 3,000
Tom Sherwin Insurance Agency,
February 28, 2002 -- -- 720 80 800 600
NiiS/Apex Group Holdings, Inc.
(NAGH), April 1, 2002 643 18,968 -- 2,108 21,076 2,000
Cornwall & Stevens Co., Inc.,
April 30, 2002 -- -- 1,800 200 2,000 --
Manning & Smith Insurance, Inc.
(MSII), May 31, 2002 274 8,664 -- 992 9,656 7,500
Roberts & Roberts Insurance
Agency, Inc. (RRIA), May 31, 2002 87 2,773 -- 308 3,081 1,700
Mountain View Software Corporation,
May 31, 2002 15 491 -- 55 546 1,100
Craig M. Ferguson & Co., Inc.,
July 31, 2002 -- -- 2,600 100 2,700 2,300
Grandy Pratt Co.
(GPC), October 31, 2002 393 9,470 -- 1,052 10,522 800
Encore Insurance & Bonding, Inc.
(EIBI), November 30, 2002 51 1,340 1,375 105 2,820 1,500
------ -------- --------- --------- ---------- ----------
1,590 $ 45,693 $ 6,495 $ 5,443 $ 57,631 $ 20,500
====== ======== ========= ========= ========== ==========
</TABLE>
Common shares exchanged in connection with these acquisitions were valued
at closing market prices as of the effective date of the respective
acquisition. Escrow deposits returned to Gallagher as a result of purchase
price adjustment provisions are recorded as downward adjustments to
intangible assets when the escrows are settled. The contingent payables
that are disclosed in the foregoing table represent the maximum amount of
additional consideration that could be paid per the purchase agreements.
These contingent obligations are primarily based upon future earnings of
the acquired entities and were not included in the purchase price that was
recorded for these acquisitions at their respective dates of acquisition.
Future payments made under these arrangements will be recorded as upward
adjustments to goodwill 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):
<TABLE>
<CAPTION>
FOUR OTHER
LPUI NAGH MSII RRIA GPC EIBI ACQUISITIONS TOTAL
- ---------------------------- -------- -------- --------- ------- -------- --------- ------------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Current assets $ 107 $ 2,626 $ 7,185 $ 52 $ 5,250 $ 1,230 $ 6,424 $ 22,874
Other noncurrent assets -- -- -- -- 15 -- 320 335
Fixed assets 7 307 196 53 341 -- 153 1,057
Goodwill 2,866 13,455 2,381 2,176 4,915 1,107 3,797 30,697
Expiration lists 1,046 4,480 4,113 691 6,143 1,384 2,343 20,200
Non-compete agreements 504 3,030 2,808 333 1,229 277 603 8,784
-------- -------- --------- ------- -------- --------- ------------ ---------
Total assets acquired 4,530 23,898 16,683 3,305 17,893 3,998 13,640 83,947
Current liabilities 100 2,617 7,027 224 5,991 1,178 7,594 24,731
Other noncurrent liabilities -- 205 -- -- 1,380 -- -- 1,585
-------- -------- --------- ------- -------- --------- ------------ ---------
Total liabilities assumed 100 2,822 7,027 224 7,371 1,178 7,594 26,316
-------- -------- --------- ------- -------- --------- ------------ ---------
Total net assets acquired $ 4,430 $ 21,076 $ 9,656 $ 3,081 $ 10,522 $ 2,820 $ 6,046 $ 57,631
======== ======== ========= ======= ======== ========= ============ =========
</TABLE>
These acquisitions allow Gallagher to expand into desirable geographic
locations, further extend its presence in the retail insurance brokerage
services and risk management industries and increase the volume of general
services currently provided. The excess of the purchase price over the
estimated fair value of the tangible net assets acquired at the acquisition
date for the 2002 acquisitions was allocated to goodwill, expiration lists
and non-compete agreements in the amounts of $30,697,000, $20,200,000 and
$8,784,000, respectively. With the exception of the intangible assets
related to the MountainView Software Corporation acquisition, which were
allocated to the Risk Management Services segment, all of the goodwill,
expiration lists, and non-compete agreements were allocated to the
Insurance Brokerage Services segment. Purchase price allocations are
preliminarily established at the time of the acquisition and are
subsequently reviewed within the first year of operation to determine the
necessity for allocation adjustments. Expiration lists and non-compete
agreements related to the 2002 acquisitions are currently being amortized
on a straight-line basis over a weighted average useful life of 14 years
and 6 years, respectively. Of the $20,200,000 of expiration lists and
$8,784,000 of non-compete agreements related to the 2002 acquisitions,
Gallagher expects $3,727,000 and $880,000, respectively, to be deductible
for tax purposes. Accordingly, $10,530,000 of goodwill and a corresponding
deferred tax liability related to the nondeductible amortizable intangible
assets were established in the Corporate segment, which is not included
in the above table.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
39
2. BUSINESS COMBINATIONS (CONTINUED)
Gallagher's consolidated financial statements for the years ended December
31, 2002 include the operations of these companies from the dates of their
respective acquisitions. The following is a summary of the unaudited
proforma historical results, as if these entities had been acquired at
January 1, 2002 and 2001, respectively (in thousands, except per share
data):
YEARS ENDED DECEMBER 31,
------------------------
2002 2001
------------------------------------------------ ----------- -----------
Total revenues $ 1,119,978 $ 968,442
Net earnings 130,321 128,028
Basic net earnings per share 1.48 1.48
Diluted net earnings per share 1.41 1.40
The unaudited proforma results above have been prepared for comparative
purposes only and do not purport to be indicative of the results of
operations, which actually would have resulted had the acquisitions
occurred as of January 1, 2002 and 2001, respectively, nor is it
necessarily indicative of future operating results.
In the second quarter of 2002, a 90% owned subsidiary of Gallagher acquired
a leasing company that leases two cargo airplanes to the French postal
service. As part of this acquisition, the subsidiary acquired assets of
$47.0 million and assumed non-recourse long-term debt of $38.2 million, in
exchange for $3.1 million of cash and $5.7 million of other assets. During
the second quarter of 2002, Gallagher consolidated the financial results of
this leasing company into its consolidated financial statements.
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.
These acquisitions were accounted for as poolings of interests and, except
for three of these acquisitions whose results were not significant, the
consolidated financial statements for all periods prior to the acquisition
dates were restated in 2001 to include the operations of these companies.
3. RECLASSIFICATIONS OF PREVIOUSLY REPORTED FINANCIAL STATEMENTS
During the first quarter of 2002, Gallagher undertook a review of how it
was accounting for all of its partially owned entities. Given the current
environment regarding ownership/control relationships with respect to
partially owned entities, Gallagher determined that it would be appropriate
to consolidate three operations that were previously accounted for using
the equity method of accounting. In addition, prior to 2002, the premiums
and claims receivable and payable of a reinsurance intermediary subsidiary
of Gallagher were reported on a net basis in Gallagher's consolidated
balance sheets, with the gross amounts disclosed in the notes to the
consolidated financial statements. During 2002, Gallagher determined that
it would be appropriate to include these amounts on a gross basis in its
consolidated balance sheets in order to conform to a more common industry
practice. Reclassifications have been made to the previously reported
financial statements in order to conform them to the current year
presentation. These reclassifications had no impact on the previously
reported net earnings or stockholders' equity. The following summarizes the
reclassifications that were made to the 2001 consolidated financial
statements (in thousands, except per share data):
<TABLE>
<CAPTION>
AS PREVIOUSLY AMOUNTS AS
DECEMBER 31, 2002 REPORTED RECLASSIFIED RECLASSIFIED
- --------------------------------------------------------------- ------------- ------------ ------------
<S> <C> <C> <C>
Premiums and fees receivable $ 555,276 $ 561,962 $ 1,117,238
Net fixed assets 51,246 131,999 183,245
Total assets 1,471,823 673,519 2,145,342
Premiums payable to insurance and
reinsurance companies 805,595 560,921 1,366,516
Borrowings on line of credit facilities -- limited partnerships -- 3,552 3,552
Total long-term debt -- limited partnerships -- 99,850 99,850
Total stockholders' equity 371,613 -- 371,613
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
40
4. INVESTMENTS
EQUITY INVESTMENTS
Gallagher's equity investment philosophy generally consists of investing in
tax advantaged and other investment projects that 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, letters of credit, financial
guarantees and funding commitments.
The following is a summary of Gallagher's investments and notes receivable
and the related outstanding letters of credit, financial guarantees and
funding commitments (in thousands):
<TABLE>
<CAPTION>
LETTERS OF
INVESTMENTS CREDIT AND
AND FINANCIAL FUNDING
DECEMBER 31, 2002 RECEIVABLES GUARANTEES COMMITMENTS
- ------------------------------------------------------ -------------- ---------- -----------
<S> <C> <C> <C>
Investment strategies -- trading $ 55,937(1) $ -- $ 6,516
===========
Marketable securities -- trading 14,619(1) -- --
===========
Other investments and notes receivable:
Tax advantaged investments:
Partnership interest $ 56,700 5,880 2,600
Notes receivable 20,752 -- --
Equity investment in Asset Alliance
Corporation 45,526 15,000 --
Venture capital investments:
Equity and partnership interests 27,911 14,931 2,565
Notes receivable 19,966 -- --
Equity investment in Allied World
Assurance Holdings, Ltd. 20,000 -- --
Other Notes receivable 1,251 -- --
----------- ---------- -----------
192,106(1) 35,811 5,165
Less amounts included in other current assets (23,693)
-----------
Total other investments and notes receivable
per the consolidated balance sheet $ 168,413
===========
Net investment assets, letters of credit, financial
guarantees and funding commitments related to
investments accounted for on a consolidated basis 33,166(1) 45,675 7,000
----------- ---------- -----------
Total net investment assets, letters of credit,
financial guarantees and funding commitments
related to Gallagher's investment portfolios $ 295,828(2) $ 81,486 18,681
=========== ========== ===========
DECEMBER 31, 2001
- ---------------------------------------------------------------------------------------------------
Investment strategies -- trading $ 52,588(1) $ -- $ 6,650
===========
Marketable securities -- available for sale $ 18,290(1) -- --
===========
Other investments and notes receivable:
Tax advantaged investments:
Partnership interests $ 47,219 4,380 --
Notes receivable 16,956 -- --
Equity investment in Assets Alliance
Corporation 33,595 25,000 --
Venture capital investments:
Equity and partnership interests 45,328 10,495 5,900
Notes receivable 31,303 -- --
Equity investment in Allied World
Assurance Holdings, Ltd. 20,000 -- --
Other notes receivable 1,417 -- --
----------- ---------- -----------
195,818(1) 39,875 5,900
Less amounts included in other current assets (3,816)
-----------
Total other investments and notes receivable
per the consolidated balance sheet $ 192,002
===========
Net invested assets, letters of credit, financial
guarantees and funding commitments related to
investments accounted for on a consolidated basis 25,431(1) 34,175 --
----------- ---------- -----------
Total net invested assets, letters of credit,
financial guarantees and funding commitments
related to Gallagher's investment portfolios $ 292,127(2) $ 74,050 $ 12,550
=========== ========== ===========
</TABLE>
- --------------------------------------------------------------------------------
(2) Equals sum of (1)'s above.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
41
4. INVESTMENTS (CONTINUED)
Tax advantaged investments represents amounts invested by Gallagher in 32
limited partnerships (36 in 2001) 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 investments as a component of the provision for income taxes.
Gallagher's 25% equity investment in Asset Alliance Corporation, an
alternative fund manager, is accounted for using the equity method of
accounting. Accordingly, Gallagher's share of net earnings of this entity
is included in consolidated net earnings.
Venture capital investments at December 31, 2002 and 2001 consist primarily
of minority investments in 14 and 17, respectively, real estate, asset
management, insurance, energy, software and e-commerce companies, only one
of which exceeded $5,000,000 individually at December 31, 2002. Venture
capital investments included limited partnerships and other equity projects
where Gallagher's ownership is between 3% and 50%. As a result, these
investments are accounted for using either the lower of amortized cost/cost
or fair value, or the equity method, whichever is appropriate, depending on
the legal form of Gallagher's ownership interest and the applicable
percentage of the entity owned. For the investments accounted for using the
equity method, Gallagher's share of the net earnings of these entities is
included in consolidated net earnings.
The equity investment in Allied World Assurance Holding, Ltd, represents
Gallagher's minority investment in a Bermuda based insurance and
reinsurance company founded in 2001 by American International Group Inc.,
The Chubb Corporation and affiliates of Goldman, Sachs & Co.
Notes receivable from investees primarily represent secured loans made by
Gallagher of 10 of its investees (12 in 2001). Interest rates on the loans
at December 31, 2002 and 2001 ranged form 4.75% to 10.0%. The carrying
value of these loans at December 31, 2002 and 2001 approximated fair value.
Investments accounted for on a consolidated basis include two real estate
partnerships and an leasing company (2002 only). The real estate
partnerships 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 under development near Orlando, Florida
(Harmony). The airplane leasing company is a 90% owned subsidiary that owns
the net assets of a leasing company that leases two cargo airplanes to the
French postal service. These three investments are consolidated into
Gallagher's consolidated financial statements because Gallagher's voting
control in each of these investments is greater than 50%.
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,
---------------------------
2002 2001
--------------------------------------------- ------------ ------------
Net current assets $ 84,321 $ 98,241
Other noncurrent assets 315,859 249,110
Net fixed assets 31,438 25,182
Net intangible assets 86,454 135,104
Debt outstanding (306,711) (327,281)
Other noncurrent liabilities (120,901) (78,735)
Interests of other shareholders (32,864) (45,778)
------------ ------------
Gallagher's net carrying value $ 57,596 $ 55,843
============ ============
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
42
4. INVESTMENTS (CONTINUED)
The following is a summary of the total debt outstanding and Gallagher's
commitments related to Gallagher's unconsolidated investments accounted for
using the equity method (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------------------
2002 2001
--------------------------------- ---------------------------------
LETTERS OF LETTERS OF
DEBT CREDIT GUARANTEES DEBT CREDIT GUARANTEES
- ----------------------------------------------------------- --------- ---------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Convertible subordinated debentures payable:
Issued in connection with various
acquisitions made by Asset Alliance, fixed
rates of 3.09% to 6.58%, mature 2003 to 2006 $ 40,108 $ -- $ -- $ 42,605 $ -- $ --
Mortgage loan on commercial (office and retail) real
estate complex, secured by the commercial real estate:
Monthly installments through 2011, 30-year
amortization period, fixed rate of 7.40%, balloon
payment in 2011 12,763 -- -- 12,873 -- --
Line of credit facility on commercial (hotel) real
estate complex, secured by the commercial real estate:
Permits borrowing up to $8,750,000, interest only,
variable rate of LIBOR plus 4.00%, floor of 8.00%,
balloon payment April 2003 8,536 500 -- 8,037 500 --
"Warehouse" line of credit facilities of equity
investee, secured by loan portfolio:
Monthly interest-only payments, variable rates of
commercial paper rate plus 1.06%, commercial paper
rate plus .95%, LIBOR plus 3.00%, maturities in
2003 and five-day call 226,481 5,000 -- 238,824 5,000 --
Unsecured bank credit agreement of Asset Alliance:
Due in periodic equal installments through June
2003, variable rate of LIBOR plus 1.00% 14,957 -- 15,000 24,942 -- 25,000
Redevelopment loan on golf course, secured by the
property:
Interest-only, variable rate of LIBOR plus 2.25%,
balloon payment June 2004 3,866 -- -- -- -- --
Other -- 250 -- -- 250 --
--------- ---------- ---------- --------- ---------- ----------
Total debt and Gallagher's contingent commitments for
Gallagher's investments accounted for using the equity
method $ 306,711 $ 5,750 $ 15,000 $ 327,281 $ 5,750 $ 25,000
========= ========== ========== ========= ========== ==========
</TABLE>
See Notes 7 and 15 for additional commitments and contingencies.
INVESTMENT INCOME AND OTHER
Significant components of investment income and other are as follows (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------
2002 2001 2000
- ----------------------------------------------------------------------------- -------------- -------------- --------------
<S> <C> <C> <C>
Interest $ 15,525 $ 18,267 $ 24,148
Dividends 1,839 2,923 2,955
Net change in unrealized gain (loss) on investment strategies 32 (110) 628
Net realized gain on investment strategies 1,518 1,852 1,244
Net realized (loss) gain on marketable securities (10,458) 1,153 134
Net change in unrealized gain (loss) on marketable securities -- trading 194 -- --
Gain on sale of portion of minority interest in investment 11,848 -- --
Realized loss on sale of equity interest in start-up venture (3,547) -- --
Income (loss) from equity investments (8,002) (332) (709)
Write-downs of notes receivables from equity investments (13,149) -- --
Income from tax advantaged investments 35,391 13,591 9,200
Income from consolidated investments 11,147 12,115 3,121
Gains on sales of operations 2,500 2,375 1,823
Other income 4,047 7,267 2,719
-------------- -------------- --------------
Total investment income and other $ 48,885 $ 59,101 $ 45,263
============== ============== ==============
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
43
4. INVESTMENTS (CONTINUED)
INCOME FROM TAX ADVANTAGED INVESTMENTS
Income from tax advantaged investments in 2002 and 2001 primarily relates
to the sales of interests in three alternative energy related limited
partnerships.
During the third quarter of 2001, Gallagher completed 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. Gallagher recognized installment gains of $18,208,000 and
$8,242,000 on this sale transaction in 2002 and 2001 respectively.
Gallagher retains a 5% partnership interest in this synthetic fuel
facility.
During the fourth quarter of 2001 and the first and fourth quarters of
2002, Gallagher completed the sales of 95% of its interest in a partnership
that owns a 59.9% interest in a synthetic fuel facility also located in
South Carolina. Gallagher received aggregate down-payments of $4,493,000
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 interests back to Gallagher if certain
adverse tax consequences occur through 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-payments. Gallagher recognized
installment gains of $15,360,000 and $2,050,000 respectively on this sale
transaction in 2002 and 2001 respectively. Gallagher retains a 3%
partnership interest in this synthetic fuel facility.
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 and will receive additional
installment payments over time through 2007 based on qualified fuel
production generated by the facilities. Gallagher recognized installment
gains of $1,012,000 and $1,411,000 on this sale transaction in 2002 and
2001 respectively. 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.
INCOME FROM CONSOLIDATED INVESTMENTS
Income from consolidated investments in 2002, 2001 and 2000 primarily
represents rental income related to die airplane leasing company (2002
only) and the two real estate partnerships previously discussed. Rental
income of the corporate headquarters limited partnership was $7,165,000,
$7,428,000 and $2,351,000 in 2002, 2001 and 2000, respectively. Total
expenses associated with this income, including interest and depreciation
expenses, were $7,479,000, $7,712,000 and $2,508,000 in 2002, 2001 and
2000, respectively. In 2002, rental income of the airplane leasing company
was $1,943,000 and total expenses associated with this income, including
interest and depreciation expenses, was $2,904,000.
GAINS ON SALES OF OPERATIONS
In 2002, Gallagher sold a P/C book of business and recorded a gain on the
sale of $2,500,000. 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
Other income in 2002 and 2001 consists primarily of investment related fees
paid to Gallagher for providing letters of credit and financial guarantees
to its investees. Other income in 2000 consists primarily of other income
attributable to the restatement effects of the 2001 and 2000 acquisitions
accounted for as poolings of interests.
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
=========== ============ ============ =========
The gross realized gains on sales of marketable securities -- available for
sale totaled $527,000, $2,420,000 and $884,000 for 2002,2001 and 2000,
respectively. The gross realized losses totaled $414,000, $690,000 and
$750,000 for 2002,2001 and 2000, respectively. In addition, in 2002 and
2001, Gallagher recognized other-than-temporary impairment losses of
$10,571,000 and $577,000, respectively, related to its marketable
securities -- available for sale portfolio. Effective September 30, 2002,
Gallagher reclassified its marketable securities portfolio from available
for sale to trading based on changes in investment philosophy.
The components of other comprehensive earnings (loss), including the
related income tax effects, consist of the following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
2002 2001 2000
---------------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Change in unrealized gain (loss) on available for
sale securities during the year, net of income
taxes of ($481) and $95, respectively $ -- $ (722) $ 143
Reclassifications adjustment for losses (gains)
realized in net earnings during the year, net of
income taxes of $1,749, $397 and $19, respectively 2,624 596 28
---------- ---------- ----------
Net change in unrealized gain (loss) on available
for sale securities during the year, net of income
taxes of $1,749, ($84) and $114, respectively $ 2,624 $ (126) $ 171
========== ========== ==========
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
44
5. FIXED ASSETS
Major classes of fixed assets consist of the following (in thousands):
DECEMBER 31,
------------------------------
2002 2001
--------------------------------------------- ------------- -------------
Furniture and equipment $ 137,837 $ 122,325
Buildings and improvements 96,678 96,647
Land and improvements 54,306 43,254
Airplanes of leasing company 51,793 --
Leasehold improvements 26,659 21,581
------------- -------------
$ 367,273 $ 283,807
============= =============
6. INTANGIBLE ASSETS
Major classes of amortizable intangible assets of the following (in
thousands):
DECEMBER 31,
------------------------------
2002 2001
- ---------------------------------------------- ------------- -------------
Expiration lists $ 45,150 $ 11,233
Accumulated amortization --
Expiration lists (5,686) (1,444)
------------- -------------
39,464 9,789
Non-compete agreements 13,146 235
Accumulated amortization --
Non-compete agreements (1,765) (158)
------------- -------------
11,381 77
------------- -------------
$ 50,845 $ 9,866
============= =============
Estimated aggregate amortization expense for each of the next five years is
as follows:
2003 $ 7,745
2004 7,576
2005 7,244
2006 6,300
2007 5,625
-------------
Total $ 34,490
=============
The changes in the carrying amount of goodwill for the year ended
December 31, 2002 are as follows (in thousands):
<TABLE>
<CAPTION>
INSURANCE RISK
BROKERAGE MANAGEMENT
SERVICES SERVICES CORPORATE TOTAL
- ------------------------------------------------------ --------- ---------- --------- ---------
<S> <C> <C> <C> <C>
Balance as of January 1, 2002 $ 52,475 $ 1,882 $ 1,118 $ 55,475
Goodwill acquired during the year 30,007 690 10,530 41,227
Adjustments related to independent appraisals
and other purchase accounting adjustments (12,849) -- 450 (12,399)
Goodwill written off related to sales of business
units during the year (29) (57) -- (86)
--------- ---------- --------- ---------
Balance as of December 31, 2002 $ 69,604 $ 2,515 $ 12,098 $ 84,217
========= ========== ========= =========
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
45
7. CREDIT AND OTHER DEBT AGREEMENTS
In 2000, Gallagher and its financial services subsidiary entered into an
unsecured Revolving Credit Agreement (the 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 Credit
Agreement 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 facility and up to $25,000,000 may be issued under the short-term
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 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 .40% for short-term and
long-term revolving credit commitments. The facility fee related to the
Credit Agreement is .10% of the used and unused portions of the short-term
and long-term revolving credit commitments. Terms of the Credit Agreement
include various covenants that require Gallagher to maintain specified
levels of net worth and restrict the amount of payments on certain
expenditures and debt outside the facility. Gallagher was in compliance
with these covenants as of December 31, 2002.
As of December 31, 2002, under the Credit Agreement, Gallagher has
contingently committed to funding $54,250,000 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, 2002 and
2001 respectively, there were $25,000,000 and $35,000,000 of short-term
borrowings outstanding under the Credit Agreement. Accordingly, Gallagher
had $70,750,000 available at December 31, 2002 for future borrowing.
The following is a summary of Gallagher's Credit Agreement and limited
partnership consolidated debt (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------------------
2002 2001
------------------------------------- ------------------------------------
LETTERS OF FINANCIAL LETTERS OF FINANCIAL
DEBT CREDIT GUARANTEES DEBT CREDIT GUARANTEES
- ----------------------------------------- ----------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Gallagher's line of credit facility:
Periodic payments of interest and
principal, prime for daily borrowings,
.40% plus LIBOR for 30 day plus
borrowings, expires September 2003 $ 25,000 $ -- $ -- $ 35,000 $ -- $ --
Line of credit facility on Harmony:
Permits borrowings up to $17,000,000,
monthly interest-only payments,
variable rate of LIBOR plus 1.45%,
expires 2004 16,996 -- 17,000 3,552 -- 8,500
Line of credit facility on Harmony:
Permits borrowings up to $3,000,000,
quarterly interest-only, rate of prime
with a collar of 3.00% and 6.00%,
expires 2004 -- -- 3,000 -- -- --
Bonds payable on Harmony:
Monthly interest-only payments through
2010, variable rate based on
commercial paper rate, balloon payment
2010 12,410 12,575 -- 12,410 12,575 --
Mortgage loan on Harmony:
Annual installments, fixed rate of
8.00%, expires 2004 5,700 -- -- 8,165 -- --
Equipment loan on Harmony:
Fixed monthly payments, fixed rate of
7.00%, expires 2005 421 -- -- -- -- --
Government-issued community development
bonds on Harmony:
Guaranteed through 2032 -- 5,000 5,100 -- 5,000 5,100
Loan on airplanes leased to French postal
service:
Monthly principal and interest
payments, variable rate of LIBOR plus
1.62%, balloon payment 2006 37,021 -- -- -- -- --
Mortgage loan on Gallagher's corporate
headquarters building:
Monthly installments of principal and
interest, fixed rate of 8.35%, 30 year
amortization, balloon payment 2008 78,583 3,000 -- 79,275 3,000 --
----------- ---------- ---------- ---------- ---------- ----------
$ 176,131 $ 20,575 $ 25,100 $ 138,402 $ 20,575 $ 13,600
=========== ========== ========== ========== ========== ==========
</TABLE>
See Note 15 for additional discussion on commitments and contingencies.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
46
8. CAPITAL STOCK AND STOCKHOLDERS' RIGHTS PLAN
CAPITAL STOCK
The table below summarizes certain information about Gallagher's capital
stock at December 31, 2002 and 2001 (in thousands, except par value data):
AUTHORIZED
CLASS PAR 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 Gallagher's 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 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.
9. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted net
earnings per share (in thousands, except per share data):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------
2002 2001 2000
------------------------------------------------------- ------------ ------------ ------------
<S> <C> <C> <C>
Net earnings $ 129,739 $ 125,256 $ 92,955
============ ============ ============
Weighted average number of common shares outstanding 87,303 84,795 83,558
Dilutive effect of stock options using the treasury
stock method 4,558 5,332 5,409
------------ ------------ ------------
Weighted average number of common and common equivalent
shares outstanding 91,861 90,127 88,967
============ ============ ============
Basic net earnings per share $ 1.49 $ 1.48 $ 1.11
Diluted net earnings per share 1.41 1.39 1.04
</TABLE>
Options to purchase 252,000, 231,000 and 313,000 shares of common stock
were outstanding at December 31, 2002, 2001 and 2000, 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.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
47
10. 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 10 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 Compensation 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.
For purposes of the pro forma disclosures (see Note 1), 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-Schcles option pricing model with the
following weighted average assumptions:
YEARS ENDED DECEMBER 31,
-----------------------------------
2002 2001 2000
-------------------------------- ------ ------ ------
Dividend yield 3.0% 3.0% 2.5%
Risk-free interest rate 3.8% 5.0% 5.1%
Volatility 26.1% 24.5% 24.6%
Expected life (in years) 6.0 5.3 6.0
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 following is a summary of Gallagher's stock option activity and related
information (in thousands, except exercise price data):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
2002 2001 2000
----------------- ----------------- -----------------
WEIGHTED WEIGHTED WEIGHTED
SHARES AVERAGE SHARES AVERAGE SHARES AVERAGE
UNDER EXERCISE UNDER EXERCISE UNDER EXERCISE
OPTION PRICE OPTION PRICE OPTION PRICE
----------------------------------- ------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Beginning balance 14,117 $ 13.63 14,419 $ 10.43 15,800 $ 8.05
Granted 2,342 24.30 2,842 24.95 2,642 19.98
Exercised (1,896) 8.16 (3,007) 9.00 (3,811) 7.22
Canceled (113) 17.15 (137) 14.17 (212) 9.68
------ -------- ------ -------- ------ --------
Ending balance 14,450 $ 16.05 14,117 $ 13.63 14,419 $ 10.43
====== ======== ====== ======== ====== ========
Exercisable at end of year 5,107 4,808 5,229
====== ====== ======
</TABLE>
Options with respect to 6,686,000 shares were available for grant at
December 31, 2002.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
48
10. STOCK OPTION PLANS (CONTINUED)
Other information regarding stock options outstanding and exercisable at
December 31, 2002 is summarized as follows (in thousands, except exercise
price data):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (IN YEARS) PRICE EXERCISABLE PRICE
------------------------------------ ----------- --------------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
$ 1.11 -- $ 8.44 3,627 2.09 $ 7.87 2,353 $ 7.89
8.56 -- 12.36 3,661 4.75 9.52 1,709 9.61
12.56 -- 22.70 3,834 8.47 20.41 468 17.51
22.87 -- 36.94 3,328 8.43 27.10 577 26.01
-------- ------- ----------- --------------- -------- ----------- --------
$ 1.11 -- $ 36.94 14,450 5.91 $ 16.05 5,107 $ 11.39
=========== =============== ======== =========== ========
</TABLE>
11. 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 2002 and 2001, Gallagher contributed $4,031,000 and $4,000,000,
respectively, to the plan through the issuance of 123,000 and 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
Arrangement Where Amounts Earned are Held in Rabbi Trust and Invested."
EITF 97-14 requires that the Gallagher common stock issued to the trust be
value at historical cost (fair market value at the date of grant) 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 2002 and
2001 consolidated balance sheets and is being amortized ratably over the
vesting period of the participants. During 2002 and 2001, $925,000 and
$562,000, respectively, were charged to expense related to this plan.
12. RESTRICTED STOCK AWARDS
In 2001, Gallagher adopted an incentive compensation plan for several of
its key executives and management personnel. The compensation under this
plan is determined by a formula applied to the pretax profitability of
certain operating divisions and may include an equity award as part of such
incentive compensation.
Effective on March 31, 2002 Gallagher contributed 274,000 shares of
Gallagher common stock to the plan, with an aggregate value of $8,972,000
as of that date. Also, effective on March 31, 2002, Gallagher granted, to
its Chief Executive Officer, a restricted stock award of 32,000 shares of
Gallagher common stock with an aggregate value of $1,059,000 at the time of
grant. All of the 2002 restricted stock awards vest over a three-year
period at the rate of 33 1/3% per year beginning on March 31, 2003.
Gallagher accounts for restricted stock at historical cost, which equals
its fair market value at the date of grant. When restricted shares are
issued, an unearned restricted stock obligation is recorded as a reduction
of stockholders' equity, which will be ratably charged to salary expense
over the vesting period of the participants. During 2002, $2,508,000 was
charged to expense related to these awards.
13. RETIREMENT PLANS
Gallagher has a noncontributory defined benefit pension plan that 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 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 service period of employees expected to receive benefits.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
49
13. RETIREMENT PLANS (CONTINUED)
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,
-------------------------
2002 2001
----------------------------------------------- ----------- -----------
CHANGE IN PENSION BENEFIT OBLIGATION:
Pension benefit obligation at beginning of year $ 98,787 $ 92,792
Service cost 11,368 9,108
Interest cost 7,575 6,316
Plan amendments 2,958 --
Net actuarial loss (gain) 4,558 (7,711)
Benefits paid (1,960) (1,718)
----------- -----------
Pension benefit obligation at end of year 123,286 98,787
----------- -----------
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year 66,231 66,137
Actual return on plan assets (6,129) (3,481)
Company contributions 24,573 5,293
Benefits paid (1,960) (1,718)
----------- -----------
Fair value of plan assets at end of year 82,715 66,231
----------- -----------
Funded status of the plan (underfunded) (40,571) (32,556)
Unrecognized net actuarial loss (gain) 14,080 (3,069)
Unrecognized prior service cost 3,345 772
Unrecognized transition obligation 219 275
----------- -----------
Accrued pension benefit cost $ (22,927) $ (34,578)
=========== ===========
The components of the net periodic pension benefit cost for the plan
consists of the following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
2002 2001 2000
------------------------------------------ ----------- ----------- -----------
<S> <C> <C> <C>
Service cost -- benefits earned during the
year $ 11,368 $ 9,108 $ 7,754
Interest cost on benefit obligation 7,575 6,316 6,002
Expected return on plan assets (6,462) (5,911) (5,935)
Recognized net actuarial gain -- (412) (495)
Amortization of prior service cost 385 110 110
Amortization of transition obligation 56 56 56
Other 26 26 26
----------- ----------- -----------
Net periodic pension benefit cost $ 12,948 $ 9,293 $ 7,518
=========== =========== ===========
</TABLE>
The following assumptions were used in determining the plan's pension
benefit obligation:
<TABLE>
<CAPTION>
2002 2001 2000
---------------------------------------------- ---- ---- ----
<S> <C> <C> <C>
Discount rate 6.75% 7.50% 7.50%
Weighted average rate of increase in
future compensation levels 6.30% 6.50% 6.50%
Expected long-term rate of return on assets 8.50% 9.00% 9.00%
</TABLE>
Gallagher has a qualified contributory savings and thrift (401(k)) plan
covering the majority of its domestic 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
$5,347,000, $4,605,000, and $4,638,000 in 2002, 2001 and 2000,
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 $430,000, $471,000 and $316,000 to the plan in 2002, 2001, and
2000, respectively. The fair value of the plan's assets as of December 31,
2002, and 2001 respectively, including employee contributions and
investment earnings thereon, was $16,040,000 and $12,461,000, 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 that 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 $4,332,000 in 2002, $3,392,000 in 2001 and
$2,921,000 in 2000.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
50
14. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
In 1992, Gallagher amended its health plan to eliminate retiree coverage,
except for retirees and those employees who had already attained as
specified age and length of services 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.
A reconciliation of the beginning and ending balance of the postretirement
benefit obligation and the funded status of the plan is as follows (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
2002 2001
------------------------------------------------------- ------------- -------------
<S> <C> <C>
CHANGE IN POSTRETIREMENT BENEFIT OBLIGATION:
Postretirement benefit obligation at beginning of year $ 6,861 $ 6,852
Service cost -- --
Interest cost 416 493
Net actuarial gain (798) (280)
Benefits paid (299) (204)
------------- ------------
Postretirement benefit obligation at end of year 6,180 6,861
Fair value of plan assets at beginning and end of year -- --
------------- ------------
Funded status of the plan (underfunded) (6,180) (6,861)
Unrecognized net actuarial gain (5,685) (5,306)
Unrecognized prior service cost -- --
Unrecognized transition obligation 5,116 5,628
------------- ------------
Accrued postretirement benefit cost $ (6,749) $ (6,539)
============= ============
</TABLE>
The components of the net periodic postretirement benefit cost include the
following (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
2002 2001 2000
------------------------------------------ ------------ ------------- ------------
<S> <C> <C> <C>
Service cost -- benefits earned during the
year $ -- $ -- $ --
Interest cost on benefit obligation 416 493 491
Amortization of transition obligation 512 512 512
Amortization of net actuarial gain (419) (331) (325)
------------ ------------- ------------
Net periodic postretirement benefit cost $ 509 $ 674 $ 678
============ ============= ============
</TABLE>
The discount rate used to measure the postretirement benefit obligation was
6.75% at December 31, 2002, and 7.50% at December 31,2001 and 2000. The
transition obligation is being amortized over a 20-year period. For
measurement purposes, a 6.50% annual rate of increase in the per capita
cost of covered healthcare benefits was assumed for 2003. This rate was
assumed to gradually scale down to 4.50% for 2009 and remain at that level
thereafter. The assumed healthcare cost trend rate has a significant effect
on the amounts reported and disclosed herein. A one percentage point change
in the assumed healthcare cost trend rate would have the following effects
(in thousands):
<TABLE>
<CAPTION>
ONE PERCENTAGE POINT
-----------------------------
INCREASE (DECREASE)
------------------------------------------------------- ------------- ------------
<S> <C> <C>
Effect on the net periodic postretirement benefit cost
in 2002 $ 44 $ (37)
Effect on the postretirement benefit obligation at
December 31, 2002 681 (590)
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
51
15. COMMITMENTS, CONTINGENCIES AND FINANCIAL GUARANTEES
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.
Total rent expense, including rent relating to cancelable leases and leases
with initial terms of less than one year, amounted to $49,900,000 in 2002,
$46,721,000 in 2001 and $40,231,000 in 2000.
In connection with its investing and operating activities, Gallagher has
entered into certain contractual obligations as well as commitments to fund
certain investments. Gallagher's future cash payments, excluding interest,
associated with its contractual obligations pursuant to the Credit
Agreement, limited partnership debt obligations and operating leases as of
December 31, 2002 are as follows (in thousands):
<TABLE>
<CAPTION>
PAYMENTS DUE BY PERIOD
----------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS 2003 2004 2005 2006 2007 THEREAFTER TOTAL
------------------------------ ---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Credit Agreement $ 25,000 $ - $ - $ - $ - $ - $ 25,000
Florida real estate limited
partnership debt 7,857 15,161 99 - - 12,410 35,527
Corporate headquarters limited
partnership mortgage loan 746 811 882 958 1,041 74,145 78,583
Airplane leasing company debt 2,180 2,351 2,553 29,937 - - 37,021
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total debt obligations 35,783 18,323 3,534 30,895 1,041 86,555 176,131
Operating leases 51,006 46,237 40,593 27,008 25,041 41,019 230,904
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total contractual obligations $ 86,789 $ 64,560 $ 44,127 $ 57,903 $ 26,082 $ 127,574 $ 407,035
========== ========== ========== ========== ========== ========== ==========
</TABLE>
The debt of the limited partnerships and the airplane leasing company
disclosed in the table above represents the debt of three of Gallagher's
investments that are accounted for on a consolidated basis in the
accompanying consolidated balance sheets. This debt is secured by the
partnerships' assets and supports their operations. Approximately $32.4
million of the limited partnership debt is recourse to Gallagher through
the letters of credit and financial guarantees which are included below.
Gallagher's commitments associated with outstanding letters of credit
(LOC), financial guarantees and funding commitments as of December 31, 2002
are as follows (all dollar amounts in table and related footnotes are in
thousands):
<TABLE>
<CAPTION>
COMPENSATION
DESCRIPTION AND PURPOSE TYPE MATURITY TRIGGER COLLATERAL TO GALLAGHER
- -------------------------------------- ---------- ---------- ---------------------------- ---------- ------------------
<S> <C> <C> <C> <C> <C>
INVESTMENTS
Investment strategies -- trading
Funding commitments to Commitment 2004 Agreed conditions met None None
two funds
Marketable securities -- trading
Funding commitment to investee Commitment 2004 Agreed conditions met None None
Tax advantaged investments
Credit support for investee's loan Guarantee 2003 Investee defaults on loan None None
to develop landfill gas projects
"Reclamation" collateral for land LOC After 2007 Activities cease and (3) None
owned by Gallagher Gallagher does not proceed
with the reclamation process
Funding commitments to two Commitment 2004 Agreed conditions met None None
synthetic fuel facilities
Asset Alliance Corporation Guarantee 2003 Asset Alliance None $2,000 fee
Credit support for Asset Alliance's defaults on loan received in the
loan used for acquisitions second quarter
of 2002
Venture capital investments
Credit support for investee's debt LOC 2003 and Investee defaults on loan (4) None
facility used to acquire and after 2007
develop landfill gas sites
Collateral for investee's debt LOC 2003 Investee defaults on loan None None
on landfill gas site capital
improvement projects
Credit support for e-commerce LOC 2003 Investee defaults None None
investee office space lease on rent payments
Credit support for franchise finance LOC after 2007 Investee defaults on loan None 1.75% per year
investee "warehouse" loans on amount of
guarantee
Credit support for property 3 LOCs 2004 Investee defaults on loan (4) 18.5% of two
developer investee loans used projects and 37.0%
to purchase and develop retail of one project
properties, two of which are
anchored by a large, national,
well-known retailer
Credit support for investee's LOC after 2007 Investee defaults on mortgage None None
mortgage on hotel
Funding commitment to investee Commitment 2003 Agreed conditions met None None
<CAPTION>
MAXIMUM LIABILITY
DESCRIPTION AND PURPOSE EXPOSURE RECORDED
- -------------------------------------- ------------------- ----------------
<S> <C> <C>
INVESTMENTS
Investment strategies -- trading
Funding commitments to $ 6,516 $ --
two funds
Marketable securities -- trading
Funding commitment to investee 2,365 --
Tax advantaged investments
Credit support for investee's loan 1,500(1) --
to develop landfill gas projects
"Reclamation" collateral for land 4,380 --
owned by Gallagher
Funding commitments to two 2,600 --
synthetic fuel facilities
Asset Alliance Corporation
Credit support for Asset Alliance's 15,000 --
loan used for acquisitions
Venture capital investments
Credit support for investee's debt 4,100 --
facility used to acquire and
develop landfill gas sites
Collateral for investee's debt 645 --
on landfill gas site capital
improvement projects
Credit support for e-commerce 250 250
investee office space lease
Credit support for franchise finance
investee "warehouse" loans 5,000 --
Credit support for property 4,450 --
developer investee loans used
to purchase and develop retail
properties, two of which are
anchored by a large, national,
well-known retailer
Credit support for investee's 500 --
mortgage on hotel
Funding commitment to investee 200 --
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
52
15. COMMITMENTS, CONTINGENCIES AND FINANCIAL GUARANTEES (CONTINUED)
<TABLE>
<CAPTION>
COMPENSATION
DESCRIPTION AND PURPOSE TYPE MATURITY TRIGGER COLLATERAL TO GALLAGHER
- --------------------------------------- ------------ ---------- ---------------------------- ---------- ------------------
<S> <C> <C> <C> <C> <C>
Investments accounted for on a
consolidated basis
Credit support for Gallagher's LOC 2005 Manager (partial owner) None None
corporate headquarters defaults on mortgage payment
building mortgage
Credit support for Harmony 3 LOCs and 2004 Harmony or Community (5) (6)
property development bonds, 2 Guarantees through Development District
loans and lines of credit used 2032 default on payments
for project development
Funding commitment to Harmony Commitment 2004 Agreed conditions met None None
OTHER
Credit support for deductibles due LOC After 2007 Gallagher does not reimburse None None
by Gallagher on its own the insurance company for
insurance coverages deductibles the insurance
company advances on
behalf of Gallagher
Credit support for deductibles due 2 LOCs 2004 and Client does not fund its (7) Outstanding
by client of Gallagher on the after 2007 deductibles guarantee
client's insurance plan multiplied by
the current prime
interest rate
Credit enhancement for two of 2 LOCs 2003 and Dissolution or catastrophic (8) Reimbursement
Gallagher's Bermuda captive after 2007 financial results of the of LOC fees
insurance operations to meet operations
minimum statutory capital
requirements
Credit support for Gallagher's LOC 2006 Subsidiary defaults on its None None
subsidiary's line of credit payments
<CAPTION>
MAXIMUM LIABILITY
DESCRIPTION AND PURPOSE EXPOSURE RECORDED
- -------------------------------------- ------------ ----------
<S> <C> <C>
Investments accounted for on a
consolidated basis
Credit support for Gallagher's $ 3,000 $ --
corporate headquarters
building mortgage
Credit support for Harmony 42,675(2) --
property development bonds,
loans and lines of credit used
for project development
Funding commitment to Harmony 7,000 --
OTHER
Credit support for deductibles due 5,197 3,200
by Gallagher on its own
insurance coverages
Credit support for deductibles due 5,263 --
by client of Gallagher on the
client's insurance plan
Credit enhancement for two of 3,330 --
Gallagher's Bermuda captive
insurance operations to meet
minimum statutory capital
requirements
Credit support for Gallagher's 560 560
subsidiary's line of credit
------------ ----------
$ 114,531 $ 4,010
============ ==========
</TABLE>
(1) Plus interest and collection expenses.
(2) Plus interest and collection expenses on $20,000 of the total.
(3) The land.
(4) The property secures the loan.
(5) A portion of the property secures one of the lines of credit and the
two bond issues.
(6) Gallagher is in the process of negotiating a retroactive, annual,
cumulative fee for $30,100 of the LOCs and guarantees. The remaining
$12,575 LOC has a fee of $750 plus an interest rate differential.
(7) Lien on real property with an appraised value of approximately
$12,500.
(8) The majority owners of the operation that has $3,100 of the LOCs
pledge their percentage ownership portion of any draw.
Since commitments may expire unused, the amounts presented in the table
above do not necessarily reflect the actual future cash funding
requirements of Gallagher.
LITIGATION
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. Gallagher's financial services subsidiary is party to a
lawsuit relating to its investment in the synthetic fuel industry which, if
determined adversely to the subsidiary on substantially all claims and for
a substantial amount of the damages asserted, could have a material adverse
effect on Gallagher. However, Gallagher believes that the plaintiff's
claims lack merit. The subsidiary is vigorously defending such claims and
has asserted counterclaims against the plaintiff.
See Notes 4 and 7 for additional discussion on commitments and
contingencies.
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
53
16. INCOME TAXES
Significant components of earnings before income taxes and the provision
for income taxes are as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
2002 2001 2000
---------------------------------------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Earnings before income taxes:
Domestic $ 171,528 $ 133,350 $ 125,874
Foreign, principally United Kingdom, Australia and
Bermuda 13,814 8,503 7,865
---------- ---------- ----------
$ 185,342 $ 141,853 $ 133,739
========== ========== ==========
Provision for income taxes:
Federal:
Current $ 44,950 $ 78,995 $ 63,919
Deferred (5,691) (73,552) (33,305)
---------- ---------- ----------
39,259 5,443 30,614
---------- ---------- ----------
State and local:
Current 14,213 20,240 10,540
Deferred (1,203) (10,507) (4,683)
---------- ---------- ----------
13,010 9,733 5,857
---------- ---------- ----------
Foreign:
Current 2,731 1,518 4,787
Deferred 603 (97) (474)
---------- ---------- ----------
3,334 1,421 4,313
---------- ---------- ----------
Total provision for income taxes $ 55,603 $ 16,597 $ 40,784
========== ========== ==========
</TABLE>
A reconciliation of the provision for income taxes with the United States
federal income tax rate is as follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------ ------------------------
% OF % OF % OF
PRETAX PRETAX PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
---------------------------------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Federal statutory rate $ 64,870 35.0 $ 49,649 35.0 $ 46,809 35.0
State income taxes --
net of federal benefit 8,456 4.6 6,326 4.5 3,807 2.8
Pre-acquisition earnings of
pooled companies taxed
to previous owners -- -- (699) (0.5) (293) (0.2)
Foreign taxes (1,509) (0.8) (1,561) (1.1) 1,570 1.2
Affordable housing and
alternative energy tax credits (19,059) (10.3) (40,125) (28.3) (26,341) (19.7)
Amortization expense of affordable
housing and alternative energy
investment, net of tax benefit 2,421 1.3 4,821 3.4 14,462 10.8
Other -- net 424 0.2 (1,814) (1.3) 770 0.6
---------- ---------- ---------- ---------- ---------- ----------
Provision for income taxes $ 55,603 30.0 $ 16,597 11.7 $ 40,784 30.5
========== ========== ========== ========== ========== ==========
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
54
16. INCOME TAXES (CONTINUED)
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):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
2002 2001
-------------------------------------------------------------- ---------- ----------
<S> <C> <C>
Deferred tax assets:
Alternative minimum tax (AMT) and other credit carryforwards $ 46,617 $ 42,724
Accrued and unfunded compensation and employee benefits 44,265 41,968
Investment-related partnerships 40,319 46,370
Accrued liabilities 23,960 13,922
Unrealized investment loss -- 1,749
Other 4,822 5,675
---------- ----------
Total deferred tax assets 159,983 152,408
Valuation allowance for deferred tax assets -- --
---------- ----------
Deferred tax assets 159,983 152,408
---------- ----------
Deferred tax liabilities:
Nondeductible amortizable intangible assets 10,277 450
Accrued and unfunded compensation and employee benefits 956 1,209
Accrued liabilities 5,095 2,900
Investment-related partnerships 7,811 5,852
---------- ----------
Total deferred tax liabilities 24,139 10,411
---------- ----------
Net deferred tax assets $ 135,844 $ 141,997
========== ==========
</TABLE>
At December 31, 2002 and 2001, $57,622,000 and $53,145,000 respectively, of
deferred tax assets have been included in other current assets in the
accompanying consolidated balance sheets. AMT credits and other have an
indefinite and 20 year life, respectively. 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 ($42,000,000 at December 31, 2002) 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 $9,000,000 at December 31, 2002.
17. QUARTERLY OPERATING RESULTS (UNAUDITED)
Quarterly operating results for 2002 and 2001 were as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
1ST 2ND 3RD 4TH
- ----------------------------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
2002
Total revenues $ 249,162 $ 277,091 $ 268,187 $ 306,782
Total expenses 200,357 228,559 234,887 252,077
Earnings before income taxes 48,805 48,532 33,300 54,705
Net earnings 33,675 34,461 23,310 38,293
Basic earnings per share .39 .39 .26 .43
Diluted net earnings per share .37 .37 .25 .42
2001
Total revenues $ 216,652 $ 213,947 $ 235,664 $ 256,725
Total expenses 182,579 185,175 193,645 219,736
Earnings before income taxes 34,073 28,772 42,019 36,989
Net earnings 27,083 23,197 41,903 33,073
Basic earnings per share .32 .27 .49 .39
Diluted net earnings per share .30 .26 .47 .36
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
55
18. 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 clients' managing of risk. This segment also
provides consulting, for fee compensation, related to the clients' risk
financing programs and includes Gallagher's retail, reinsurance and
wholesale insurance brokerage operations. Risk Management Services
primarily represents Gallagher's third-party administration, loss control
and risk management consulting and insurance property appraisal operations.
Third-party administration is principally the management and processing of
claims for self insurance programs of Gallagher's 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. The invested assets of Gallagher are managed in this
segment in order to maximize the long-term after-tax return to Gallagher.
Corporate consists primarily of the operating results of Gallagher's
investment in the limited partnership that owns its corporate headquarters
building, unallocated administrative costs and the provision for income
taxes which is not allocated to Gallagher's operating segments. Only
revenues not attributable to one of the three operating segments are
recorded in the Corporate segment.
Allocations of investment income and certain expenses are based on
assumptions and estimates. 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 2002, 2001 and 2000 is as follows (in thousands):
<TABLE>
<CAPTION>
INSURANCE RISK
BROKERAGE MANAGEMENT FINANCIAL
SERVICES SERVICES SERVICES CORPORATE TOTAL
- ------------------------------------------ -------------- -------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 2002
Revenues:
Commissions $ 662,857 $ 613 $ -- $ -- $ 663,470
Fees 109,046 279,821 -- -- 388,867
Investment income and other 7,879 817 33,024 7,165 48,885
-------------- -------------- -------------- -------------- --------------
Total revenues $ 779,782 $ 281,251 $ 33,024 $ 7,165 $ 1,101,222
============== ============== ============== ============== ==============
Earnings (loss) before income taxes $ 155,438 $ 32,574 $ 7,073 $ (9,743) $ 185,342
Provision for income taxes -- -- -- 55,603 55,603
-------------- -------------- -------------- -------------- --------------
Net earnings (loss) $ 155,438 $ 32,574 $ 7,073 $ (65,346) $ 129,739
============== ============== ============== ============== ==============
Income (loss) from equity investments $ (581) $ -- $ (7,421) $ -- $ (8,002)
Depreciation expense 10,570 9,173 2,114 3,927 25,784
Amortization expense 6,606 40 -- -- 6,646
Interest expense 183 123 757 8,425 9,488
Net foreign exchange gain (loss) 282 (10) -- (17) 255
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues:
United States $ 700,630 $ 256,726 $ 31,135 $ 7,165 $ 995,656
Foreign, principally United Kingdom,
Australia and Bermuda 79,152 24,525 1,889 -- 105,566
-------------- -------------- -------------- -------------- --------------
Total revenues $ 779,782 $ 281,251 $ 33,024 $ 7,165 $ 1,101,222
============== ============== ============== ============== ==============
AT DECEMBER 31, 2002
Identifiable assets:
United States $ 1,259,675 $ 53,500 $ 294,217 $ 303,845 $ 1,911,237
Foreign, principally United Kingdom,
Australia and Bermuda 483,464 20,079 48,794 -- 552,337
-------------- -------------- -------------- -------------- --------------
Total Identifiable assets $ 1,743,139 $ 73,579 $ 343,011 $ 303,845 $ 2,463,574
============== ============== ============== ============== ==============
Goodwill -- net $ 69,604 $ 2,515 $ -- $ 12,098 $ 84,217
Amortizable Intangible assets -- net 50,195 650 -- -- 50,845
Identifiable assets related to equity
investments 375 -- 57,222 1,200 58,797
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
56
18. SEGMENT INFORMATION (CONTINUED)
<TABLE>
<CAPTION>
INSURANCE RISK
BROKERAGE MANAGEMENT FINANCIAL
SERVICES SERVICES SERVICES CORPORATE TOTAL
- ------------------------------------------ -------------- -------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 2001
Revenues:
Commissions $ 537,933 $ 1,090 $ -- $ -- $ 539,023
Fees 62,342 262,522 -- -- 324,864
Investment income and other 11,457 1,084 39,407 7,153 59,101
-------------- -------------- -------------- -------------- --------------
Total revenues $ 611,732 $ 264,696 $ 39,407 $ 7,153 $ 922,988
============== ============== ============== ============== ==============
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 $ (470) $ -- $ 138 $ -- $ (332)
Depreciation expense 8,954 7,127 5 3,555 19,641
Amortization expense 3,265 240 -- -- 3,505
Interest expense 199 150 2,747 7,381 10,477
Net foreign exchange gain (loss) (451) (32) -- (13) (496)
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues:
United States $ 560,429 $ 242,403 $ 37,376 $ 7,153 $ 847,361
Foreign, principally United Kingdom,
Australia and Bermuda 51,303 22,293 2,031 -- 75,627
-------------- -------------- -------------- -------------- --------------
Total revenues $ 611,732 $ 264,696 $ 39,407 $ 7,153 $ 922,988
============== ============== ============== ============== ==============
AT DECEMBER 31, 2001
Identifiable assets:
United States $ 1,164,136 $ 47,203 $ 283,433 $ 255,209 $ 1,749,981
Foreign, principally United Kingdom,
Australia and Bermuda 375,531 16,481 3,349 -- 395,361
-------------- -------------- -------------- -------------- --------------
Total Identifiable assets $ 1,539,667 $ 63,684 $ 286,782 $ 255,209 $ 2,145,342
============== ============== ============== ============== ==============
Goodwill -- net $ 52,475 $ 1,882 $ -- $ 1,118 $ 55,475
Amortizable Intagible assets - net 9,866 -- -- -- 9,866
Identifiable assets related to equity
investments 1,175 -- 48,115 1,200 50,490
YEAR ENDED DECEMBER 31, 2000
Revenues:
Commissions $ 472,878 $ 1,204 $ -- $ -- $ 474,082
Fees 51,678 229,557 -- -- 281,235
Investment income and other 17,157 1,534 24,318 2,254 45,263
-------------- -------------- -------------- -------------- --------------
Total revenues $ 541,713 $ 232,295 $ 24,318 $ 2,254 $ 800,580
============== ============== ============== ============== ==============
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 $ (384) $ -- $ (325) $ -- $ (709)
Depreciation expense 8,879 5,814 11 1,076 15,780
Amortization expense 3,547 99 -- -- 3,646
Interest expense 517 174 212 2,175 3,078
Net foreign exchange gain (loss) (290) 20 -- (23) (293)
- ------------------------------------------------------------------------------------------------------------------------------------
Revenues:
United States $ 498,400 $ 210,384 $ 23,693 $ 2,254 $ 734,731
Foreign, principally United Kingdom,
Australia and Bermuda 43,313 21,911 625 -- 65,849
-------------- -------------- -------------- -------------- --------------
Total revenues $ 541,713 $ 232,295 $ 24,318 $ 2,254 $ 800,580
============== ============== ============== ============== ==============
AT DECEMBER 31,2000
Identifiable assets:
United States $ 875,876 $ 47,919 $ 242,969 $ 183,194 $ 1,349,958
Foreign, principally United Kingdom,
Australia and Bermuda 256,630 13,744 6,439 -- 276,813
-------------- -------------- -------------- -------------- --------------
Total identifiable assets $ 1,132,506 $ 61,663 $ 249,408 $ 183,194 $ 1,626,771
============== ============== ============== ============== ==============
Goodwill -- net $ 9,602 $ 2,122 $ -- $ 1,373 $ 13,097
Amortizable intangible assets -- net 2,992 -- -- -- 2,992
Identifiable assets related to equity
investments 945 -- 33,396 1,200 35,541
</TABLE>
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
57
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, have 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 29, 2003
/s/ J. PATRICK GALLAGHER, JR. /s/ RICHARD C. CARY
J. Patrick Gallagher, Jr. Richard C. Cary
President and Chief Executive Acting Chief Financial Officer
Officer and Chief Accounting Officer
<PAGE>
Arthur J. Gallagher & Co. 2002 ANNUAL REPORT
58
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, 2002 and 2001, and the
related consolidated statements of earnings, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2002.
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, 2002 and 2001, and
the consolidated results of its operations and its cash flows for each of
the three years in the period ended December 31, 2002, in conformity with
accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
Chicago, Illinois
January 29, 2003
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-21.0
<SEQUENCE>5
<FILENAME>dex210.txt
<DESCRIPTION>SUBSIDIARIES OF GALLGHER
<TEXT>
<PAGE>
EXHIBIT 21.0
SUBSIDIARIES OF GALLAGHER
In the following list of subsidiaries of Gallagher, those companies that
are indented represent subsidiaries of the corporation under which they are
indented. Except for directors' qualifying shares, 100% of the voting stock of
each of the subsidiaries listed below, other than those indicated by footnote,
is owned of record or beneficially by its indicated parent./(1)/
<TABLE>
<CAPTION>
State or Other
Jurisdiction of
Name Incorporation
- ---- ----------------
<S> <C>
Arthur J. Gallagher & Co. (Registrant) Delaware
Arthur J. Gallagher & Co. (Illinois) Illinois
Arthur J. Gallagher & Co. of Oklahoma, Inc. Oklahoma
Arthur J. Gallagher Risk Management Services, Inc. Illinois
Arthur J. Gallagher & Co. of Wisconsin, Inc. Wisconsin
Arthur J. Gallagher & Co. of Pennsylvania, Inc. Pennsylvania
Gallagher Captive Services, Inc. Delaware
Arthur J. Gallagher & Co.--Chicago Metro Illinois
Arthur J. Gallagher & Co. (St. Louis) Delaware
Gallagher Holt, Inc. Texas
Arthur J. Gallagher, Inc. Texas
Arthur J. Gallagher & Co. of Texas, Inc. Texas
Arthur J. Gallagher & Co. (Florida) Florida
Arthur J. Gallagher & Co. of New York, Inc. New York
Colonial Alternative Risk Services, Inc. New York
Arthur J. Gallagher & Co. Ohio Agency, Inc. Ohio
Risk Placement Services, Inc. Illinois
Risk Placement Services of Texas, Inc. Texas
Risk Placement Services of Arkansas, Inc. Arkansas
Risk Placement Insurance Services of Massachusetts, Inc. Massachusetts
Risk Placement Services of Louisiana, Inc. Louisiana
Risk Placement Services of Pennsylvania, Inc. Pennsylvania
Arthur J. Gallagher & Co.--Greenville South Carolina
Arthur J. Gallagher and Co. of Massachusetts, Inc. Massachusetts
Gallagher Insurance Advisors, Inc. Massachusetts
Arthur J. Gallagher & Co. of Rhode Island, Inc. Rhode Island
Arthur J. Gallagher International, Inc. Delaware
Arthur J. Gallagher & Co. (Bermuda) Limited Bermuda
Arthur J. Gallagher Intermediaries (Bermuda) Limited Bermuda
Arthur J. Gallagher Management (Bermuda) Limited Bermuda
Gallagher Captive Services (Cayman) Limited Cayman Islands
Scholastic Risk Services Limited Bermuda
Artex Insurance Company Ltd/(2)/ Bermuda
Artex Underwriting Managers Ltd Bermuda
Protected Insurance Company Bermuda
Arthur J. Gallagher & Co.--Little Rock Arkansas
Arthur J. Gallagher & Co. of Georgia, Inc. Georgia
Arthur J. Gallagher (UK) Limited England
Risk Management Partners Ltd./(3)/ England
John Plumer & Company Limited England
Morgan Insurance Services Limited England
MRS Holdings Limited England
Morgan Read & Sharman Limited England
Arthur J. Gallagher Asia Pte Ltd/(4)/ Singapore
Arthur J. Gallagher Asia Limited Hong Kong
</TABLE>
1
<PAGE>
<TABLE>
<CAPTION>
State or Other
Jurisdiction of
Name Incorporation
- ---- ----------------
<S> <C>
Gallagher Bassett Services, Inc. Delaware
Gallagher Bassett of New York, Inc. New York
Gallagher Bassett International Ltd. Delaware
Gallagher Bassett International Ltd. (UK) England
Gallagher Bassett Canada Inc. Canada
Gallagher Benefit Administrators, Inc. Illinois
Gallagher Bassett Investigative Services, Inc. Delaware
Wyatt Gallagher Bassett Pty Ltd/(3)/ Australia
Gallagher Bassett Australia Pty Ltd Australia
Wyatt Gallagher Bassett (NSW) Ptd Ltd Australia
Wyatt Group (PNG) Pty Ltd New Guinea
Gallagher Bassett International S.A. France
Arthur J. Gallagher & Co. Insurance Brokers
of California, Inc. California
Charity First Insurance Services, Inc. California
Arthur J. Gallagher & Co. of Connecticut, Inc. Connecticut
Craig M. Ferguson & Co., Inc. Connecticut
C. W. Excess Incorporated New York
Arthur J. Gallagher Intermediaries, Inc. New York
Arthur J. Gallagher & Co.--Denver Colorado
Arthur J. Gallagher & Co. of Michigan, Inc. Michigan
Arthur J. Gallagher & Co. of Washington, Inc. Washington
Gallagher Louisiana, Inc. Louisiana
Arthur J. Gallagher of Louisiana, Inc. Louisiana
Arthur J. Gallagher & Co. of Mississippi, Inc. Mississippi
Arthur J. Gallagher & Co.--Kansas City, Inc. Missouri
IMC Insurance Management Corporation Missouri
IMC Services Corporation Missouri
Arthur J. Gallagher & Co. of New Jersey, Inc. New Jersey
Arthur J. Gallagher & Co. Ohio Life Agency, Inc. Ohio
Gallagher Pipino, Inc. Ohio
Arthur J. Gallagher & Co. of Minnesota, Inc. Minnesota
Risk Placement Services of Arizona, Inc. Arizona
AJG Financial Services, Inc. Delaware
AJG Capital, Inc./(5)/ Illinois
Aviacargo Leasing Limited Ireland
AJG Investments, Inc. Delaware
AJG Premium Finance, Inc. Illinois
AJG Coal, Inc. Delaware
Lamberson Koster & Company California
Arthur J. Gallagher & Co. of Tennessee, Inc. Tennessee
Arthur J. Gallagher & Co. of Kentucky, Inc. Kentucky
Gallagher Benefit Services, Inc. Delaware
Gallagher Benefit Services of Michigan, Inc. Michigan
Gallagher Benefit Services of the Carolinas, Inc. North Carolina
Gallagher Benefit Services of Colorado, Inc. Colorado
Gallagher Benefit Services of Kansas City, Inc. Delaware
Gallagher Benefit Services of New York, Inc. New York
Gallagher Benefit Services of Texas, Inc. Texas
Gallagher Benefit Services of Washington, D.C. Delaware
GBS Retirement Services, Inc. New York
Gallagher Benefit Services of Alabama Alabama
GBS Insurance and Financial Services Delaware
</TABLE>
2
<PAGE>
<TABLE>
<CAPTION>
State or Other
Jurisdiction of
Name Incorporation
- ---- ----------------
<S> <C>
Generation 2000 Loss Control Services, Inc. Tennessee
Arthur J. Gallagher Service Company Delaware
Arthur J. Gallagher Australasia Pty Ltd. Australia
Arthur J. Gallagher Professional Services
Australasia Pty Ltd Australia
Arthur J. Gallagher Reinsurance
Australasia Pty Ltd Australia
AJG Two Pierce, Inc. Delaware
John P. Woods Co., Inc. Delaware
Gallagher Healthcare Insurance Services, Inc. Texas
Gallagher Healthcare Insurance Services of
Kansas City, LLC/(6)/ Missouri
Specialty Catastrophe Services, Inc. New Jersey
Manning & Smith Insurance, Inc. Kansas
Arthur J. Gallagher & Co. of Iowa, Inc. Iowa
</TABLE>
(1) Gallagher conducts some of its operations under the following names:
Gallagher Bassett Information Services, Gallagher Risk Management Services,
Pacific Atlantic Administrators, The Boston Insurance Center, Gallagher
Heffernan, Broussard, Bush & Hurst, Henley, Williams & Associates, Bryce
Insurance, CMC Claims Management Corporation, Gallagher Byerly, Inc.,
Innovative Risk Services, Inc. and International Special Risk Services, Inc.
(2) 76% of the Common Stock of this subsidiary is owned by two third parties.
(3) 50% of the Common Stock of each of these subsidiaries is owned by an
unrelated party.
(4) 30% of the Common Stock of this subsidiary is owned by a third party.
(5) 10% of the Common Stock of this subsidiary is owned by an unrelated party.
(6) 49% of the Common Stock of this subsidiary is owned by a third party.
3
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-23.1
<SEQUENCE>6
<FILENAME>dex231.txt
<DESCRIPTION>CONSENT OF ERNST YOUNG LLP
<TEXT>
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report on Form
10-K of Arthur J. Gallagher & Co. (Gallagher) of our report dated January 29,
2003, included in Gallagher's 2002 Annual Report to Stockholders.
Our audits also included the consolidated financial statement schedule of
Gallagher listed in Item 15(a)(2). This schedule is the responsibility of
Gallagher's management. Our responsibility is to express an opinion based on our
audits. In our opinion, the consolidated financial statement schedule referred
to above, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
We consent to the incorporation by reference in the Registration Statements
(Form S-8, No. 33-604 and Form S-8, No. 33-14625) pertaining to the Arthur J.
Gallagher & Co. Incentive and United Kingdom Incentive Plans, in the
Registration Statements (Form S-8, No. 33-24251, Form S-8, No. 33-38031 and Form
S-8, No. 333-57155) pertaining to the Arthur J. Gallagher & Co. 1988 Incentive
and 1988 Nonqualified Stock Option Plans, in the Registration Statement (Form
S-8, No. 33-30816) pertaining to the Arthur J. Gallagher & Co. Non-Employee
Directors' Stock Option Plan, in the Registration Statements (Form S-8, No.
33-64614 and Form S-8, No. 33-80648) pertaining to the Arthur J. Gallagher & Co.
1988 Incentive, 1988 Nonqualified, and Non-Employee Directors' Stock Option
Plans, in the Registration Statements (Form S-8, No. 333-06359, Form S-8, No.
333-40000 and Form S-8, No. 333-87320) pertaining to the Arthur J. Gallagher &
Co. 1988 Nonqualified and Non-Employee Directors' Stock Option Plans, in the
Registration Statement (Form S-8, No. 333-62930) pertaining to the Arthur J.
Gallagher & Co. 1988 Nonqualified and Non-Employee Directors' Stock Option Plans
and the Gallagher Healthcare Insurance Services, Inc. 2001 Nonqualified Stock
Option Plan, in the Registration Statements (Form S-4, No. 333-75197, Form S-3,
No. 333-84139 and Form S-4, No. 333-55254), and in the related Prospectuses, of
our report dated January 29, 2003 with respect to the consolidated financial
statements of Gallagher incorporated by reference herein, and our report
included in the preceding paragraph with respect to the consolidated financial
statement schedule included in this Annual Report on Form 10-K for the year
ended December 31, 2002.
/S/ ERNST & YOUNG LLP
---------------------------
Ernst & Young LLP
Chicago, Illinois
March 24, 2003
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-24.0
<SEQUENCE>7
<FILENAME>dex240.txt
<DESCRIPTION>POWERS OF ATTORNEY
<TEXT>
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren his true and lawful attorney-in-fact and agent, for
him, and in his name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ ROBERT E. GALLAGHER
----------------------------
Robert E. Gallagher
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren his true and lawful attorney-in-fact and agent, for
him, and in his name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ JAMES J. BRANIFF III
----------------------------
James J. Braniff III
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren his true and lawful attorney-in-fact and agent, for
him, and in his name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ T. KIMBALL BROOKER
----------------------------
T. Kimball Brooker
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren his true and lawful attorney-in-fact and agent, for
him, and in his name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ GARY P. COUGHLAN
----------------------------
Gary P. Coughlan
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren his true and lawful attorney-in-fact and agent, for
him, and in his name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ JAMES W. DURKIN, JR.
----------------------------
James W. Durkin, Jr.
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren her true and lawful attorney-in-fact and agent, for
her, and in her name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ ILENE S. GORDON
----------------------------
Ilene S. Gordon
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren his true and lawful attorney-in-fact and agent, for
him, and in his name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ ELBERT O. HAND
----------------------------
Elbert O. Hand
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren his true and lawful attorney-in-fact and agent, for
him, and in his name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ DAVID E. McGURN, JR.
----------------------------
David E. McGurn, Jr.
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren his true and lawful attorney-in-fact and agent, for
him, and in his name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ RICHARD J. McKENNA
----------------------------
Richard J. McKenna
<PAGE>
EXHIBIT 24.0
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that the undersigned hereby constitutes and
appoints John C. Rosengren his true and lawful attorney-in-fact and agent, for
him, and in his name, place and stead, in any and all capacities (i) to sign the
Arthur J. Gallagher & Co. Annual Report on Form 10-K for the fiscal year ending
December 31, 2002 and any and all amendments thereto and (ii) to file the same,
with all exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorney-in-fact and
agent full power and authority to do and perform each and every act and thing
requisite and necessary to be done in such connection, as fully to all intents
and purposes as the undersigned might or could do in person, hereby ratifying
and confirming all that said attorney-in-fact and agent, may lawfully do or
cause to be done by virtue hereof.
IN WITNESS WHEREOF, the undersigned has duly executed this instrument as of
this 20th day of March, 2003.
/s/ JAMES R. WIMMER
----------------------------
James R. Wimmer
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-99.1
<SEQUENCE>8
<FILENAME>dex991.txt
<DESCRIPTION>CERTIFICATION OF CEO
<TEXT>
<PAGE>
EXHIBIT 99.1
Certificate Pursuant to Section 1350 of Chapter 63
--------------------------------------------------
of Title 18 of the United States Code
-------------------------------------
I, J. Patrick Gallagher, Jr., the chief executive officer of Arthur J.
Gallagher & Co., certify that (i) the Annual Report on Form 10-K of Arthur J.
Gallagher & Co. for the year ended December 31, 2002 (the "Form 10-K") fully
complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and (ii) the information contained in the Form 10-K fairly
presents, in all material respects, the financial condition and results of
operations of Arthur J. Gallagher & Co. and its subsidiaries.
Date: March 24, 2003
/s/ J. PATRICK GALLAGHER, JR.
---------------------------------------------
J. Patrick Gallagher, Jr.
President and Chief Executive Officer
(principal executive officer)
A signed original of this written statement required by Secton 906 has been
provided to Arthur J. Gallagher & Co. and will be retained by Arthur J.
Gallagher & Co. and furnished to the Securities and Exchange Commission or its
staff upon request.
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-99.2
<SEQUENCE>9
<FILENAME>dex992.txt
<DESCRIPTION>CERTIFICATION OF ACTING CFO
<TEXT>
<PAGE>
EXHIBIT 99.2
Certificate Pursuant to Section 1350 of Chapter 63
--------------------------------------------------
of Title 18 of the United States Code
-------------------------------------
I, Richard C. Cary, the acting chief financial officer of Arthur J.
Gallagher & Co., certify that (i) the Annual Report on Form 10-K of Arthur J.
Gallagher & Co. for the year ended December 31, 2002 (the "Form 10-K") fully
complies with the requirements of Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 and (ii) the information contained in the Form 10-K fairly
presents, in all material respects, the financial condition and results of
operations of Arthur J. Gallagher & Co. and its subsidiaries.
Date: March 24, 2003
/s/ RICHARD C. CARY
---------------------------------------------
Richard C. Cary
Acting Chief Financial Officer and Chief
Accounting Officer
(principal financial officer)
A signed original of this written statement required by Secton 906 has been
provided to Arthur J. Gallagher & Co. and will be retained by Arthur J.
Gallagher & Co. and furnished to the Securities and Exchange Commission or its
staff upon request.
</TEXT>
</DOCUMENT>
</SEC-DOCUMENT>
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