FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1995
----------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------------- -------------
Commission File Number 1-8282
------
Alexander & Alexander Services Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Maryland 52-0969822
- ---------------------------------- ---------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
1185 Avenue of the Americas
New York, New York 10036
- ---------------------------------- ---------------------------------------
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code (212) 840-8500
------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
The number of shares of Common Stock, $1 par value, outstanding as of November
1, 1995 was 42,125,623.
The number of shares of Class A Common Stock, $.00001 par value, outstanding as
of November 1, 1995 was 1,954,687.
The number of shares of Class C Common Stock, $1 par value, outstanding as of
November 1, 1995 was 361,774.
No shares of Class D Common Stock, $1 par value, were outstanding as of November
1, 1995.
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC. AND SUBSIDIARIES
INDEX
-----
Page No.
--------
Part I. Financial Information:
Item 1. Financial Statements:
Unaudited Consolidated Statements of Operations for the
Three and Nine Months Ended September 30, 1995 and 1994.........2
Condensed Consolidated Balance Sheets, as of
September 30, 1995 (Unaudited) and December 31, 1994............3
Unaudited Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1995 and 1994....................5
Unaudited Notes to Financial Statements............................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............24
Part II. Other Information:
Item 1. Legal Proceedings............................................44
Item 5. Other Information............................................44
Item 6. Exhibits.....................................................45
1
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries
PART I. FINANCIAL INFORMATION
-----------------------------
Item 1. Financial Statements
Unaudited Consolidated Statements of Operations
For the Three and Nine Months Ended September 30, 1995 and 1994
---------------------------------------------------------------
(in millions, except per share amounts)
<TABLE><CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1995 1994 1995 1994
------- ------ ------- -------
<S> <C> <C> <C> <C>
Operating revenues:
Commissions and fees $283.7 $318.7 $903.4 $953.3
Fiduciary investment income 16.0 13.9 48.6 37.4
------ ------ ------ ------
Total 299.7 332.6 952.0 990.7
------ ------ ------ ------
Operating expenses:
Salaries and benefits 175.4 200.3 543.9 601.5
Other 96.7 128.1 299.6 365.2
------ ------ ------ ------
Total 272.1 328.4 843.5 966.7
------ ------ ------ ------
Operating income 27.6 4.2 108.5 24.0
------ ------ ------ ------
Other income (expenses):
Investment income 4.6 3.0 13.9 6.5
Interest expense (4.6) (4.7) (14.1) (11.9)
Other 1.2 (2.0) 34.0 (8.5)
------ ------ ------ ------
Total 1.2 (3.7) 33.8 (13.9)
------ ------ ------ ------
Income before income taxes and
minority interest 28.8 0.5 142.3 10.1
Income taxes (11.0) (0.2) (54.7) (4.0)
------ ------ ------ ------
Income before minority interest 17.8 0.3 87.6 6.1
Minority interest (0.3) (0.2) (5.7) (4.0)
------ ------ ------ ------
Income from continuing operations 17.5 0.1 81.9 2.1
Loss from discontinued operations - (20.9) - (26.9)
------ ------ ------ ------
Income (loss) before cumulative effect of
change in accounting 17.5 (20.8) 81.9 (24.8)
Cumulative effect of change in
accounting - - - (2.6)
------ ------ ------ ------
Net income (loss) 17.5 (20.8) 81.9 (27.4)
Preferred stock dividends (6.4) (4.8) (18.9) (9.0)
------ ------ ------ ------
Earnings (loss) attributable to common
shareholders $ 11.1 $(25.6) $ 63.0 $(36.4)
====== ====== ====== ======
PER SHARE INFORMATION:
Primary earnings per share:
Income (loss) from continuing operations $ 0.25 $(0.11) $ 1.42 $(0.16)
Loss from discontinued operations - (0.47) - (0.61)
Cumulative effect of change in accounting - - - (0.06)
------ ------ ------ ------
Net income (loss) $ 0.25 $(0.58) $ 1.42 $(0.83)
====== ====== ====== ======
Average common and common equivalent shares
outstanding 44.6 43.9 44.5 43.7
====== ====== ====== ======
Fully diluted earnings per share:
Income (loss) from continuing operations $ 0.25 $(0.11) $ 1.33 $(0.16)
Loss from discontinued operations - (0.47) - (0.61)
Cumulative effect of change in accounting - - - (0.06)
------ ------ ------ ------
Net income (loss) $ 0.25 $(0.58) $ 1.33 $(0.83)
====== ====== ====== ======
Average common shares outstanding, assuming
full dilution 44.6 43.9 57.1 43.7
====== ====== ====== ======
Cash dividends per common share $0.025 $0.025 $0.075 $ 0.30
====== ====== ====== ======
</TABLE>
See accompanying notes to financial statements.
2
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Condensed Consolidated Balance Sheets
September 30, 1995 (Unaudited) and December 31, 1994
---------------------------------------------------------------
(in millions)
September 30, December 31,
1995 1994
ASSETS ------------- ------------
- ------
Current assets:
Cash and cash equivalents:
Operating $ 254.8 $ 248.7
Fiduciary 549.4 428.5
Short-term investments:
Operating 10.8 19.2
Fiduciary 228.1 292.2
Premiums and fees receivable (less
allowance for doubtful accounts
of $21.6 in 1995 and $23.7 in 1994) 1,173.4 1,206.1
Deferred income taxes 21.5 71.5
Other current assets 80.4 120.7
-------- --------
Total current assets 2,318.4 2,386.9
Property and equipment - net 121.9 138.0
Intangible assets - net 171.2 175.1
Deferred income taxes 109.6 87.1
Long-term operating investments 58.9 64.1
Other 101.5 94.5
-------- --------
$2,881.5 $2,945.7
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Premiums payable to insurance companies $1,749.8 $1,738.3
Short-term debt 0.8 1.0
Current portion of long-term debt 9.2 17.1
Deferred income taxes 9.0 8.5
Accrued compensation and related benefits 60.6 60.0
Income taxes payable 32.8 66.3
Other accrued expenses 172.6 258.1
-------- --------
Total current liabilities 2,034.8 2,149.3
-------- --------
Long-term liabilities:
Long-term debt 156.4 132.7
Deferred income taxes 17.9 13.4
Net liabilities of discontinued operations 34.0 56.8
Other 226.6 266.0
-------- --------
Total long-term liabilities 434.9 468.9
-------- --------
Commitments and contingent liabilities
(Notes 6, 7 and 11)
8% Series B cumulative convertible preferred
stock contingency (Note 11) 10.0 10.0
-------- --------
See accompanying notes to financial statements.
-Continued-
3
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Condensed Consolidated Balance Sheets (continued)
September 30, 1995 (Unaudited) and December 31, 1994
---------------------------------------------------------------
(in millions)
September 30, December 31,
1995 1994
------------ ------------
Stockholders' equity:
Preferred stock, authorized 15 shares, $1 par value:
Series A junior participating preferred
stock, issued and outstanding, none $ - $ -
$3.625 Series A convertible preferred stock,
issued and outstanding 2.3 and 2.3 shares,
respectively, liquidation preference of
$115 million 2.3 2.3
8% Series B cumulative convertible preferred
stock, issued and outstanding, 4.4 and 4.1
shares, respectively, liquidation preference
of $220 million and $205 million, respectively 4.4 4.1
Common stock, authorized 200 shares, $1 par
value; issued and outstanding 42
and 41.5 shares, respectively 42.0 41.5
Class A common stock, authorized 26 shares,
$.00001 par value; issued and outstanding
2.0 and 2.3 shares, respectively - -
Class C common stock, authorized 11 shares,
$1 par value; issued and outstanding
0.4 and 0.4 shares, respectively 0.4 0.4
Class D common stock, authorized 40 shares,
$1 par value; issued and outstanding,
none - -
Paid-in capital 630.9 615.0
Accumulated deficit (227.3) (287.1)
Net unrealized investment gains - net of
deferred income taxes 5.3 1.5
Accumulated translation adjustments (56.2) (60.2)
-------- --------
Total stockholders' equity 401.8 317.5
-------- --------
$2,881.5 $2,945.7
See accompanying notes to financial statements.
4
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 1995 and 1994
---------------------------------------------------------------
(in millions)
Nine Months Ended
September 30,
-----------------
1995 1994
---- ----
Cash provided (used) by:
Operating activities:
Income from continuing operations $ 81.9 $ 2.1
Adjustments to reconcile to net cash
used by operating activities:
Depreciation and amortization 33.3 38.8
Deferred income taxes 28.9 11.1
Gains on sales of subsidiaries (30.4) -
Other 7.8 8.9
Changes in assets and liabilities (net of
effects from acquisitions and dispositions):
Net fiduciary cash and cash equivalents and
short-term investments (44.7) (32.7)
Premiums and fees receivable 38.2 158.4
Other current assets (8.4) 17.6
Other assets (13.2) 0.7
Premiums payable to insurance companies (10.1) (116.3)
Other accrued expenses (104.2) (94.1)
Other long-term liabilities (8.5) 15.5
Discontinued operations (net) (12.8) (0.9)
Cumulative effect of change in accounting - (2.6)
------- -------
Net cash provided (used) by operating
activities (42.2) 6.5
------- -------
Investing activities:
Net purchases of property and equipment (15.1) (17.2)
Purchases of businesses (2.8) (2.3)
Proceeds from sales of subsidiaries and
other assets 88.1 0.4
Purchases of operating investments (180.2) (38.0)
Sales/maturities of operating investments 196.1 7.4
------- -------
Net cash provided (used) by investing
activities 86.1 (49.7)
------- -------
See accompanying notes to financial statements.
-Continued-
5
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Consolidated Statements of Cash Flows (Continued)
For the Six Months Ended September 30, 1995 and 1994
---------------------------------------------------------------
(in millions)
Nine Months Ended
September 30,
-----------------
1995 1994
---- ----
Financing activities:
Cash dividends $ (9.6) $ (19.3)
Proceeds from issuance of short-term debt 0.2 8.0
Payments of short-term debt (0.4) (24.8)
Proceeds from issuance of long-term debt 4.6 51.0
Payments of long-term debt (35.1) (7.9)
Payment for a finite risk contract - (80.0)
Issuance of common stock 0.1 196.5
------- -------
Net cash provided (used) by financing
activities (40.2) 123.5
------- -------
Effect of exchange rate changes on operating
cash and cash equivalents 2.4 5.2
Operating cash and cash equivalents at
beginning of year 248.7 151.5
------- ------
Operating cash and cash equivalents at end
of period $ 254.8 $237.0
======= ======
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 13.9 $ 9.6
Income taxes 67.5 30.8
Non-cash investing and financing activities:
Notes payable issued for contingency
settlements $ 45.7 $ -
Series B cumulative convertible preferred
stock dividends-in-kind 12.6 2.8
Common stock issued for employee benefit and
stock plans 3.6 2.3
Common stock issued for non-employee stock
plans 0.4 -
Note receivable established for contingency
settlement 1.3 -
Sale of direct financing lease and related
mortgage notes - 19.0
See accompanying notes to financial statements.
6
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
1. Interim Financial Presentation
Unless otherwise indicated, all amounts are stated in millions of U.S.
dollars. Certain prior period amounts have been reclassified to conform with
the current year presentation. In the opinion of the Company, all adjustments
necessary for a fair presentation have been included in the consolidated
financial statements. The results of operations for the first nine months of
the year are not necessarily indicative of results for the year.
2. Employees' Retirement Plans and Benefits
Effective January 1, 1994, the Company adopted SFAS No. 112, "Employers'
Accounting for Postemployment Benefits." This statement requires that
certain benefits provided to former or inactive employees after employment
but prior to retirement, including disability benefits and health care
continuation coverage, be accrued based upon the employees' services already
rendered. The cumulative effect of this accounting change was an after-tax
charge of $2.6 million or $0.06 per share in the first quarter of 1994.
3. Restructuring Charges
In the fourth quarter of 1994, management committed to a formal plan of
restructuring the Company's operations and recorded a $69 million pre-tax
charge ($45.1 million after-tax, or $1.03 per share). The restructuring
charge included $25.2 million to consolidate real estate space requirements
at 48 offices worldwide, and $43.8 million for voluntary early retirement
programs and involuntary workforce reductions involving approximately 1,100
positions, of which 650 were in the U.S.
The involuntary severance portion of the charge amounted to $22.9 million
and reflected the elimination of 898 positions worldwide. The voluntary
early retirement program was accepted by 208 employees prior to December 31,
1994 and amounted to $20.9 million of the charge. Of these amounts, $5.9
million will be paid from various pension plans of the Company. As of
September 30, 1995, the Company has paid $24.8 million of these liabilities.
The Company expects to pay $5.6 million of the remaining balance of $19
million throughout the remainder of 1995 with the remaining balance paid in
the form of annuities, generally over periods of fifteen years or less.
The charge associated with real estate activities relates to the closure,
abandonment and downsizing of office space globally, including 34 locations
in the U.S. The Company anticipates that these actions will be completed by
the end of 1995. The costs include primarily remaining lease obligations and
write-offs of leasehold improvements and fixed assets. As of September 30,
1995, the Company has paid $8.4 million of these liabilities and written-off
assets of $2.2 million. The Company expects to pay $2.8 million of the
remaining $11.6 million cash portion of these liabilities throughout the
remainder of 1995. The cash portion of the remaining liabilities, excluding
the fixed asset and leasehold improvement write-offs of approximately $3
million, will be paid out over the remaining lease periods, which range from
one to ten years.
7
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
4. Dispositions
During the second quarter of 1995, the Company sold two small operations for
gross proceeds of $1.9 million and resulting pre-tax gains totaling $1.4
million.
On February 28, 1995 the Company completed the sale of Alexsis, Inc., its
U.S.-based third party claims administrator, for total cash proceeds of
$47.1 million. The previously reported pre-tax gain on this transaction was
$30.3 million. Pursuant to the terms of the purchase agreement, under
certain circumstances the transaction was subject to a post-closing
adjustment in the purchase price. During the third quarter of 1995, the
Company and the purchaser reached an agreement resulting in a final pre-tax
gain of $28.7 million ($19.8 million after-tax or $0.44 per share).
In January 1995, the Company sold its minority interest in a U.K. merchant
bank for cash proceeds of $7.2 million and a pre-tax gain of $0.3 million.
These gains are included in Other Income (Expenses) in the Consolidated
Statements of Operations.
5. Other Income and Expenses
Other non-operating income (expenses) is comprised of the following:
Three Months Ended Nine Months Ended
September 30, 1995 September 30, 1995
------------------ ------------------
1995 1994 1995 1994
---- ---- ---- ----
Gains on sales of subsidiaries
(See Note 4) $(1.6) $ - $30.4 $ -
Litigation costs - (2.3) (0.1) (7.7)
Other 2.8 0.3 3.7 (0.8)
----- ----- ----- -----
$ 1.2 $(2.0) $34.0 $(8.5)
===== ===== ===== =====
Litigation costs in 1994 are associated primarily with the Mutual Fire
lawsuit described in Note 11 of the Unaudited Notes to Financial Statements.
8
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
6. Income Taxes
During 1994, the Company was advised that the Joint Committee on Taxation
had approved the agreement reached in 1993 by the Company and the Appeals
Office of the Internal Revenue Service (IRS) on settlement of tax issues
with respect to years 1980 through 1986. Also during 1994, the Company
reached an agreement with the IRS on settlement of the examination of years
1987 through 1989. On February 28, 1995, the Company paid the amounts due
for such years and charged the tax and net interest totaling $35.6 million
against previously established reserves.
In 1994, the Company received a Notice of Proposed Adjustment from the IRS
in connection with the examination of its 1990 and 1991 U.S. federal income
tax returns, proposing an increase in taxable income for the 1991 year
which, if sustained, would result in additional tax liability estimated by
the Company at $50 million, excluding interest and penalties. This proposed
adjustment relates to intercompany transactions involving the stock of a
United Kingdom subsidiary.
The Company disagrees with the IRS position on this issue. Although the
ultimate outcome of the matter cannot be predicted with certainty, the
Company and its independent tax counsel believe there are meritorious
defenses to the proposed adjustment and substantial arguments to sustain the
Company's position and that the Company should prevail in the event this
issue is litigated.
A similar set of transactions occurred in 1993 for which the IRS could
propose an increase in taxable income which would result in an additional
tax liability estimated by the Company at $25 million, excluding interest
and penalties. The Company's 1993 tax return is not currently under
examination. The Company believes it should prevail in the event this
similar issue is raised by the IRS. Accordingly, no provision for any
liability with respect to the 1991 and 1993 transactions has been made in
the consolidated financial statements.
The Company believes that its current tax reserves are adequate to cover its
tax liabilities.
7. Discontinued Operations
In 1985, the Company discontinued its insurance underwriting operations. In
1987 the Company sold Sphere Drake Insurance Group (Sphere Drake). The
Sphere Drake sales agreement provides indemnities by the Company to the
purchaser for various potential liabilities including provisions covering
future losses on certain insurance pooling arrangements from 1953 to 1967
between Sphere Drake and Orion Insurance Company (Orion), a U.K.-based
insurance company, and future losses pursuant to a stop-loss reinsurance
contract between Sphere Drake and Lloyd's Syndicate 701 (Syndicate 701). In
addition, the sales agreement requires the Company to assume any losses in
respect of actions or omissions by Swann & Everett Underwriting Agency
(Swann & Everett), an underwriting management company previously managed by
Alexander Howden Group plc (Alexander Howden).
The net liabilities of discontinued operations shown in the accompanying
Consolidated Balance Sheets include insurance liabilities associated with
the above indemnities, liabilities of insurance underwriting subsidiaries
currently in run-off and other related liabilities.
9
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
7. Discontinued Operations
A summary of the net liabilities of discontinued operations is as follows:
As of As of
September 30, 1995 December 31, 1994
------------------ -----------------
Liabilities:
Insurance liabilities $273.1 $277.6
Other 17.5 31.4
------ ------
Total liabilities 290.6 309.0
------ ------
Assets:
Recoverable under finite risk contracts:
Insurance liabilities 133.6 135.7
Premium adjustment 10.8 10.8
Reinsurance recoverables 60.4 64.2
Cash and investments 23.3 23.6
Other 11.5 10.9
------ ------
Total assets 239.6 245.2
------ ------
Total net liabilities of discontinued
operations 51.0 63.8
Less current portion classified as
other accrued expenses 17.0 7.0
------ ------
Remainder classified as net liabilities
of discontinued operations $ 34.0 $ 56.8
====== ======
The insurance liabilities represent estimates of future claims expected to
be made under occurrence-based insurance policies and reinsurance business
written through Lloyd's and the London market covering primarily asbestosis,
environmental pollution, and latent disease risks in the United States which
are coupled with substantial litigation expenses. These claims are expected
to develop and be settled over the next twenty to thirty years.
Liabilities stemming from these claims cannot be estimated using
conventional actuarial reserving techniques because the available historical
experience is not adequate to support the use of such techniques and because
case law, as well as scientific standards for measuring the adequacy of site
cleanup (both of which have had, and will continue to have, a significant
bearing on the ultimate extent of the liabilities) is still evolving.
Accordingly, the Company's independent actuaries have combined available
exposure information with other data and have used various projection
techniques to estimate the insurance liabilities, consisting principally of
incurred but not reported losses.
In 1994, Orion, which has financial responsibility for sharing certain of
the indemnity liabilities, was placed in provisional liquidation by order of
the English Courts. Based on current facts and circumstances, the Company
believes that the provisional liquidation will not have a material adverse
effect on the net liabilities of discontinued operations.
10
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
7. Discontinued Operations (continued)
The Company has certain protection against adverse developments of the
insurance liabilities through two finite risk contracts issued by Centre
Reinsurance (Bermuda) Limited (reinsurance company). A contract entered into
in 1989 provides the insurance underwriting subsidiaries currently in
run-off with recoveries of recorded liabilities of $76 million, and for up
to $50 million of additional recoveries in excess of those liabilities
subject to a deductible for one of the run-off companies of $15 million. At
September 30, 1995, the Company had recorded $8 million of the deductible.
On July 1, 1994, the Company entered into an insurance-based financing
contract (finite risk contract) providing protection primarily for exposures
relating to Orion, Syndicate 701 and Swann & Everett. The contract provided
for a payment by the Company of $80 million ($50 million of which was
borrowed from the reinsurance company) to the reinsurance company and for
payment by the Company of the first $73 million of paid claims. The contract
entitles the Company to recover paid claims in excess of the Company's $73
million retention. At September 30, 1995, recoveries were limited to $113
million, which includes the Company's payment of $80 million. In addition,
commencing December 31, 1996, depending on the timing and amount of paid
loss recoveries under the contract, the Company may be entitled to receive a
payment from the reinsurance company in excess of the amounts recovered for
paid losses if the contract is terminated. The contract is accounted for
under the deposit method of accounting and the accounting requirements for
discontinued operations.
The Company's right to terminate the contract entered into in 1994 is
subject to the consent of American International Group, Inc. (AIG) as long
as AIG is the holder of certain shares of the Company's stock. In addition,
the reinsurance company also has the right, under certain circumstances, the
occurrence of which is currently considered to be remote by the Company, to
terminate that contract.
The insurance liabilities set forth above represent the Company's best
estimates of the probable liabilities based on independent actuarial
estimates. The recoverable amounts under the finite risk contracts, which
are considered probable of realization based on independent actuarial
estimates of losses and pay out patterns, represent the excess of such
liabilities over the Company's retention levels. The premium adjustment
represents the recoverable amount considered probable of realization at the
earliest date the Company can exercise its right to terminate the finite
risk contract covering the insurance underwriting subsidiaries currently in
run-off.
Insurance liabilities in excess of recorded liabilities could develop in
the future. Based on independent actuarial estimates of the amount and
timing of claim payments, it is reasonably possible that such additional
liabilities of $189 million, net of estimated amounts recoverable for paid
losses under the finite risk contracts of $117 million, could amount to $72
million. However, management currently believes that such additional
insurance liabilities are not likely to develop.
11
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
7. Discontinued Operations (continued)
Changes in the total net liabilities of discontinued operations for the nine
months ended September 30, 1995 are as follows:
Beginning balance $ 63.8
Claims and expense payments (12.5)
Other (0.3)
------
Ending balance $ 51.0
======
The Company believes that, based on current estimates, the established total
net liabilities of discontinued operations are sufficient to cover its
exposures. However, there is no assurance that further adverse development
may not occur due to variables inherent in the estimation processes and
other matters described above. The Company currently believes that the
effect of such adverse development, if any, will not be material to the
Company's financial position and results of operations.
8. Per Share Data
Primary earnings per share are computed by dividing earnings (loss)
attributable to common shareholders by the weighted average number of shares
of Common Stock and their equivalents (Class A and Class C Common Stock)
outstanding during the period and, if dilutive, shares issuable upon exercise
of stock options. The $3.625 Series A Convertible Preferred Stock and the 8%
Series B Cumulative Convertible Preferred Stock are not Common Stock
equivalents.
Fully diluted earnings per share are computed by dividing earnings
attributable to common shareholders plus preferred dividends and interest
expense, net of tax, on the convertible subordinated debentures by the
weighted average number of common shares outstanding during the period after
giving effect to the exercise of stock options, the conversion of preferred
stock and the conversion of convertible subordinated debentures (in each
instance if dilutive). The computations of fully diluted earnings per share
for the three months ended September 30, 1995 and three and nine months ended
September 30, 1994 were antidilutive; therefore, the amounts for primary and
fully diluted earnings per share were the same.
9. Investments
Effective January 1, 1994, the Company adopted SFAS No. 115, "Accounting
for Certain Investments in Debt and Equity Securities." In accordance with
the Statement, the Company has classified all debt and equity securities as
available for sale. At September 30, 1995, net unrealized holding gains
totaled $5.3 million, net of deferred income taxes of $1.8 million, and are
reported as a separate component of Stockholders' Equity. During the nine
months ended September 30, 1995, the net unrealized holding gains increased
by approximately $3.8 million and proceeds from sales/maturities of the
Company's operating investment securities totaled $196.1 million with gross
realized gains totaling $0.4 million.
12
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
9. Investments (continued)
The amortized cost and estimated fair value of the Company's debt and equity
securities and financial instruments used to hedge the existing and
anticipated fiduciary portion of such investments as of September 30, 1995
are summarized below:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- --------- --------- ---------
U.S. Government agencies/
state issuances $ 6.8 $ - $ - $ 6.8
Other interest-bearing
securities 131.1 - - 131.1
Mortgage-backed securities 6.5 - - 6.5
Equity securities 3.2 6.5 - 9.7
Financial instruments - used
as hedges - 1.0 (0.3) 0.7
--------- -------- --------- --------
Total $ 147.6 $ 7.5 $ (0.3) $ 154.8
========= ======== ========= ========
The above debt and equity securities and financial instruments used as
hedges are classified in the Consolidated Balance Sheet at September 30,
1995 as follows:
Cash and cash equivalents:
Operating $ 36.3
Fiduciary 75.5
Short-term investments:
Operating 0.9
Fiduciary 10.3
Long-term operating investments 31.8
--------
Total $ 154.8
========
The amortized cost and estimated fair value of debt securities at September
30, 1995 by contractual maturity are summarized below:
Estimated
Amortized Fair
Cost Value
--------- ---------
Due in one year or less $ 118.0 $ 118.0
Due after one year through five years 5.0 5.0
Due after five years through ten years 9.8 9.8
Due after ten years 5.1 5.1
--------- ---------
137.9 137.9
Mortgage-backed securities 6.5 6.5
--------- ---------
Total debt securities $ 144.4 $ 144.4
========= =========
Certain of the above investments with maturities greater than one year are
classified as short-term and included in current assets as they represent
fiduciary investments that will be utilized during the normal operating
cycle of the business to pay premiums payable to insurance companies that
are included in current liabilities.
13
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
10. Debt
On March 27, 1995, the Company's then existing credit agreement was replaced
by a new $200 million three-year facility with various banks which expires
in March 1998. The agreement provides for unsecured borrowings and for the
issuance of up to $100 million of letters of credit, and contains various
covenants, including minimum consolidated tangible capital funds, minimum
consolidated tangible net worth, maximum leverage and minimum cash flow
requirements. The Company currently believes that the covenants regarding
minimum cash flow coverage and minimum consolidated tangible capital funds
are the most restrictive. The minimum cash flow covenant requires that the
ratio of earnings before interest, taxes, depreciation and amortization to
interest expense and cash dividends exceed 4.25 to 1. At September 30, 1995,
this ratio was 7.83 to 1. The minimum consolidated tangible capital funds
covenant requires that total stockholders' equity less intangible assets, as
defined by the agreement, plus subordinated debt must equal or exceed $240
million. At September 30, 1995 the Company's consolidated tangible capital
funds were $340 million. In addition, the occurrence of a "Special Event"
under the AIG Agreement, which, if not waived by AIG, would constitute an
event of default under the new agreement. Interest rates charged on amounts
drawn on this credit agreement are dependent upon numerous variables,
including the Company's credit ratings and the duration of the borrowings.
Interest rates are based upon various published rates, including the prime
lending rate, certificate of deposit rates, federal funds borrowing rates
and LIBOR.
During the second quarter of 1995, the Company arranged a $10 million letter
of credit under the agreement. On October 13, 1995, the Company borrowed $60
million under its long-term revolving credit agreement to fund the
redemption of its outstanding 11% Convertible Subordinated Debentures due
2007. (See Note 13 of the Unaudited Notes to Financial Statements.) The
Company has full and immediate access to the remaining $130 million credit
line.
On March 27, 1995, the Company, Shand Morahan and Company, Inc. (Shand) and
the rehabilitator of Mutual Fire Marine and Inland Insurance Company (Mutual
Fire) entered into a settlement agreement which was subsequently approved by
the courts and which terminated the rehabilitator's litigation and released
the Company and Shand from any further claims by the rehabilitator. Under
the terms of the settlement, the Company paid $12 million in cash into an
escrow account on April 1, 1995 and issued a $35 million six-year
zero-coupon note with a present value of $25.9 million on March 27, 1995,
secured by a letter of credit, using a discount rate of 9.3%. The cash and
note were released from escrow on June 9, 1995. The note is payable in six
equal, consecutive annual installments, commencing on or before the first
day of April 1996. A partial payment of $0.3 million was paid on the note in
June 1995. The carrying value of the outstanding principal balance,
including imputed interest, of the note payable at September 30, 1995 was
$26.9 million. (See Note 11 of the Unaudited Notes to Financial Statements.)
14
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
10. Debt (continued)
In March 1995, a U.S. subsidiary prepaid an unsecured $10 million term loan
with a bank which was due August 1995.
In January 1995, the Company negotiated the settlement of certain
obligations relating to the 1987 sale of Shand. Under the terms of the
settlement, the Company paid $14 million in cash, issued a five year
interest bearing note in the principal amount of $14 million and expected to
pay a net contingent obligation of $4.5 million ($5.8 million contingent
notes payable less $1.3 million contingent note receivable). In June 1995,
the $14 million note payable was prepaid in whole, as well as $1.8 million
of the contingent notes payable. In addition, $1.3 million of cash was
received for payment of the contingent note receivable. The remaining
contingent note payable of $4 million was paid in full in September 1995.
(See Note 11 of the Unaudited Notes to Financial Statements.)
11. Contingencies
The Company and its subsidiaries are subject to various claims and lawsuits
from both private and governmental parties, which include claims and
lawsuits in the ordinary course of business, consisting principally of
alleged errors and omissions in connection with the placement of insurance
and in rendering consulting services. In some of these cases, the remedies
that may be sought or damages claimed are substantial. Additionally, the
Company and its subsidiaries are subject to the risk of losses resulting
from the potential uncollectibility of insurance and reinsurance balances
and claims advances made on behalf of clients and indemnifications connected
with the sales of certain businesses.
Certain claims were asserted against the Company and certain of its
subsidiaries alleging, among other things, that certain Alexander Howden
subsidiaries accepted, on behalf of certain insurance companies, insurance
or reinsurance at premium levels not commensurate with the level of
underwriting risks assumed and retroceded or reinsured those risks with
financially unsound reinsurance companies.
15
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
11. Contingencies (continued)
Claims asserting these allegations are pending in suits filed in New York
and Ohio. In a New York action brought in 1985, claims were asserted against
the Company and certain subsidiaries (Pine Top Insurance Company, Ltd. v.
Alexander & Alexander Services Inc., et al., 85 Civ. 9860 (RPP) (S.D.N.Y.)).
The plaintiff sought compensatory and punitive, as well as treble damages
under RICO totalling approximately $87 million, arising from alleged RICO
violations, common law fraud, breach of contract and negligence. Two
subsidiaries counterclaimed for breach of certain reinsurance contracts with
the plaintiff. This action was settled as of January 12, 1995 and the action
was voluntarily dismissed in February 1995. The settlement amount was $4.5
million. The Company's portion was $2.1 million which was previously
reserved under its professional indemnity program. In a similar New York
action brought in 1988 against the Company and certain subsidiaries (Certain
Underwriters at Lloyd's of London Subscribing to Insurance Agreements
ML8055801, et al. v. Alexander & Alexander Services Inc., et al., formerly
captioned Dennis Edward Jennings v. Alexander & Alexander Europe plc, et
al., 88 CIV. 7060 (RO) (S.D.N.Y.)), plaintiffs seek compensatory and
punitive damages, as well as treble damages under RICO totaling $36 million.
The defendants have counterclaimed against some of the plaintiffs for
contribution. Discovery in this case remains to be concluded and no trial
date has been set. In the Ohio action brought in 1985 (The Highway Equipment
Company, et al. v. Alexander Howden Limited, et al. (Case No. 1-85-01667,
U.S. Bankruptcy Court, So. Dist. Ohio, Western Div.)), plaintiffs sought
compensatory and punitive damages, as well as treble damages under RICO
totaling $24 million. A directed verdict in the Company's favor was affirmed
on March 14, 1994 in a decision by the U.S. District Court for the Southern
District of Ohio and later affirmed on August 15, 1995 by the U.S. Court of
Appeals for the Sixth Circuit. Management of the Company believes there are
valid defenses to all the claims that have been made with respect to these
activities and the Company is vigorously defending the pending actions.
These actions are covered under the Company's professional indemnity
program, except for possible damages under RICO. The Company currently
believes the reasonably possible loss that might result from these actions,
if any, would not be material to the Company's financial position or results
of operations.
In 1987, the Company sold Shand, its domestic underwriting management
subsidiary. Prior to the sale, Shand and its subsidiaries had provided
underwriting management services for and placed insurance and reinsurance
with and on behalf of Mutual Fire. Mutual Fire was placed in rehabilitation
by the Courts of the Commonwealth of Pennsylvania in December 1986. In
February 1991, the rehabilitator filed a complaint in the Commonwealth court
against Shand and the Company. The case was subsequently removed to the U.S.
District Court for the Eastern District of Pennsylvania and is captioned
Foster v. Alexander & Alexander Services Inc., 91 Civ. 1179. The complaint,
which sought compensatory and punitive damages, alleged that Shand and, in
certain respects, the Company breached duties to and agreements with, Mutual
Fire. The rehabilitator, through an expert's report, indicated that the
alleged damages are approximately $234 million, a conclusion with which the
Company, based on substantial arguments, strongly disagreed.
16
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
11. Contingencies (continued)
On March 27, 1995, the Company, Shand and the rehabilitator entered into a
settlement agreement which was subsequently approved by the courts and which
terminated the rehabilitator's litigation and released the Company and Shand
from any further claims by the rehabilitator. Under the terms of the
settlement, the Company had paid $12 million in cash into an escrow account
on April 1, 1995 and issued a $35 million six-year zero-coupon note with a
present value of $25.9 million on March 27, 1995, secured by a letter of
credit, using a discount rate of 9.3%. The cash and note were released from
escrow on June 9, 1995. In addition, Shand has returned $4.6 million of
trusteed assets to the rehabilitator, and the rehabilitator has eliminated
any right of set-offs previously estimated to be $4.7 million. The Mutual
Fire settlement agreement includes certain features protecting the Company
from potential exposure to claims for contribution brought by third parties
and expenses arising out of such claims. Although the Company's professional
liability underwriters have denied coverage for the Mutual Fire lawsuit, the
Company has instituted a declaratory judgment action attempting to validate
coverage up to $32.5 million (Alexander & Alexander Services Inc. and
Alexander & Alexander Inc., plaintiffs, against those certain underwriters
at Lloyd's, London, England subscribing to insurance evidenced by policy
numbers 879/P. 31356 and 879/P. 35349 and Assicurazioni Generali, S.P.A.,
defendants No. 92 Civ. 6319 (S.D.N.Y.)). All required documents in this case
have been submitted to the court, and the Company is awaiting a decision on
this matter. In the fourth quarter of 1994, the Company increased its
previously established reserves of $10 million for Mutual Fire based on an
estimated settlement amount, and recorded a pre-tax charge of $37.2 million
($24.2 million after-tax or $0.55 per share).
Under the 1987 agreement with the purchaser of Shand, the Company agreed to
indemnify the purchaser against certain contingencies, including, among
others, (i) losses arising out of pre-sale transactions between Shand or
Shand's subsidiaries, on the one hand, and Mutual Fire, on the other, and
(ii) losses arising out of pre-sale errors or omissions by Shand or Shand's
subsidiaries. The Company's obligations under the indemnification provisions
in the 1987 sales agreement were not limited as to amount or duration.
17
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
11. Contingencies (continued)
Starting in late 1992, the purchaser of Shand had asserted a number of
claims under both the Mutual Fire indemnification provision and the
errors-and-omissions indemnification provision of the sales agreement. Most
of those claims have been resolved by a series of settlement agreements with
the purchasers of Shand, involving the settlement or release of (a) claims
relating to reinsurance recoverables due to Shand's subsidiaries from Mutual
Fire, (b) claims relating to deterioration of reserves for business written
by Mutual Fire and ceded to Shand's subsidiaries, and (c) a number of
errors-and-omissions claims by third-party reinsurers against Shand. Under
the settlement agreement entered into in January 1995, covering the
errors-and-omissions claims by third-party reinsurers, the Company obtained
from the purchasers of Shand a release and limitation of indemnification
obligations relating to certain third-party errors-and-omissions claims, and
restructured the contractual relationship with the purchaser so that the
parties' future interests as to third-party claims are more closely aligned.
The Company paid $14 million in cash, issued a five-year interest bearing
note in the principal amount of $14 million and expected to pay a net
contingent obligation of $4.5 million. In the fourth quarter of 1994, the
Company recorded a pre-tax charge of $32.5 million ($21.1 million after-tax,
or $0.48 per share) associated with this settlement. In June 1995, the $14
million note payable was prepaid in whole, as well as $1.8 million of the
contingent notes payable. In addition, $1.3 million of cash was received for
payment of the contingent note receivable. The remaining contingent note
payable of $4 million was paid in full in September 1995.
Notwithstanding these settlements with the purchasers of Shand, the
limitation of certain contract obligations and the restructuring of the
parties' relationship, some of the Company's indemnification provisions
under the 1987 agreement are still in effect. As a result, there remains the
possibility of substantial exposure under the indemnification provisions of
the 1987 agreement, although the Company, based on current facts and
circumstances, believes the possibility of a material loss resulting from
these exposures is remote.
In November 1993, a class action suit was filed against the Company and two
of its then directors and officers, Tinsley H. Irvin and Michael K. White,
in the United States District Court for the Southern District of New York
under the caption Harry Glickman v. Alexander & Alexander Services Inc., et
al. (Civil Action No. 93 Civ. 7594). On January 6, 1995, the plaintiff filed
a second amended complaint which, among other things, dropped Mr. White as a
defendant. The second amended complaint purports to assert claims on behalf
of a class of persons who purchased the Company's Common Stock during the
period May 1, 1991 to November 4, 1993, alleging that during this period the
Company's financial statements contained material misrepresentations as a
result of inadequate reserves established by the Company's subsidiary,
Alexander Consulting Group Inc., for unbillable work-in-progress. The second
amended complaint seeks damages in an unspecified amount, as well as
attorneys' fees and other costs, for alleged violations of Sections 10(b)
and 20(a) of the Securities Exchange Act of 1934. The defendants have filed
a motion to dismiss the second amended complaint and a hearing on the motion
has been set for January 26, 1996. Management of the Company believes that
there are valid defenses to the allegations set forth in the complaint and
the Company intends to vigorously dispute this claim. The Company currently
believes that this action is covered by the Company's insurance program and
that the reasonably possible loss that might result, if any, would not be
material to the Company's financial position or results of operations.
18
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
11. Contingencies (continued)
These contingent liabilities involve significant amounts. While it is not
possible to predict with certainty the outcome of such contingent
liabilities, the applicability or availability of coverage for such matters
under the Company's professional indemnity insurance program, or their
financial impact on the Company, management currently believes that such
impact will not be material to the Company's financial position. However, it
is possible that future developments with respect to these matters could
have a material effect on future interim or annual results of operations.
Under the AIG Agreement, the Company has agreed to make certain payments to
AIG pursuant to indemnifications given with respect to the Company's balance
sheet as of March 31, 1994. Pursuant to an amendment to the AIG Agreement,
dated November 10, 1994, the Company's potential exposures under the
indemnification, individually or in the aggregate, were limited to $10
million. Pursuant to a second amendment, dated March 16, 1995, the
indemnification was further limited to cover only tax payments and reserves
in excess of recorded tax reserves as of March 31, 1994. As a result of this
indemnification, the Company has classified $10 million of the proceeds from
the issuance of the Series B Convertible Preferred Shares outside
stockholders' equity until such time as the indemnification, if any, is
satisfied or terminated.
12. Financial Instruments
The Company enters into foreign exchange forward contracts and foreign
exchange option agreements primarily to provide risk management against
existing firm commitments as well as anticipated future exposures that will
arise at its London-based specialist insurance and reinsurance broking
operations. The exposures arise because a significant portion of the
revenues of these operations are denominated in U.S. dollars, while their
expenses are primarily denominated in U.K. pounds sterling.
The Company generally sells forward U.S. dollars and purchases U.K. pounds
sterling for periods of up to two years in the future. Such contracts
provide risk management against future anticipated transactions which are
not firm commitments. In addition, the Company enters into foreign exchange
contracts to manage market risk associated with foreign exchange volatility
on intercompany loans and expected intercompany dividends. Finally, the
Company enters into foreign exchange contracts to effectively offset
existing contracts when anticipated exchange rate movements would benefit
the Company.
Gains and losses on contracts which are designated as hedges of firm
commitments are deferred until the settlement dates. Contracts which are not
designated as hedges are marked to market at each balance sheet date and are
included in other current assets or liabilities, with the resulting gain or
loss recorded as a component of other operating expenses. The fair market
value of all foreign exchange contracts at September 30, 1995 was $0.7
million.
19
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
12. Financial Instruments (continued)
Foreign exchange options written by the Company are marked to market at each
balance sheet date and the resulting gain or loss is recorded as a
component of other operating expenses. Future cash requirements may exist if
the option is exercised by the holder. At September 30, 1995, the Company
had $20 million notional principal of written foreign exchange options
outstanding. Based on foreign exchange rates at September 30, 1995, the
Company recognized a current liability of $0.5 million, consisting of
unamortized premiums, representing the estimated cost to settle these
options at that date. At December 31, 1994, the Company's foreign exchange
options could have been exercised at a nominal cost to the Company.
At September 30, 1995, the Company had approximately $83.4 million notional
principal of forward exchange contracts outstanding, primarily to exchange
U.S. dollars into U.K. pounds sterling, and approximately $29.7 million
notional principal outstanding, primarily to exchange U.K. pounds sterling
into U.S. dollars. In addition, at September 30, 1995, the Company had no
foreign exchange contracts outstanding related to intercompany loans.
The Company has entered into interest rate swaps and forward rate
agreements, which are accounted for as hedges, as a means to limit the
earnings volatility associated with changes in short-term interest rates on
its existing and anticipated fiduciary investments with maturities of three
months or less. These instruments are contractual agreements between the
Company and financial institutions which exchange fixed and floating
interest rate payments periodically over the life of the agreements without
exchanges of the underlying principal amounts. The notional principal
amounts of such agreements are used to measure the interest to be paid or
received and do not represent the amount of exposure to credit loss. The
Company records the difference between the fixed and floating rates of such
agreements as a component of its fiduciary investment income. Interest rate
swaps and forward rate agreements which relate to debt securities are marked
to market in accordance with SFAS No. 115. At September 30, 1995, an
unrealized gain of $0.7 million on interest rate swaps and forward rate
agreements which hedge existing and anticipated fiduciary investments with
maturities of three months or less was reflected in fiduciary cash and
equivalents in the Consolidated Balance Sheet.
20
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
12. Financial Instruments (continued)
At September 30, 1995 and December 31, 1994 the Company had the following
interest rate swaps and forward rate agreements in effect, by year of final
maturity:
September 30, 1995
------------------------------------------------------
Gross Net Weighted Gross Net Weighted
Receiving Average Paying Average
Year Fixed Interest Rate Fixed Interest Rate
---- --------- ------------- ------ -------------
1995 $137.4 8.11% $251.9 6.75%
1996 416.6 7.27 285.8 6.61
1997 208.7 6.68 - -
1998 107.4 7.16 - -
------ ---- ------ ---
Total $870.1 7.25% $537.7 6.67%
====== ==== ====== ====
December 31, 1994
------------------------------------------------------
Gross Net Weighted Gross Net Weighted
Receiving Average Paying Average
Year Fixed Interest Rate Fixed Interest Rate
---- --------- ------------- ------ -------------
1995 $457.0 6.84% $257.0 6.83%
1996 291.9 7.30 31.2 8.85
1997 97.8 6.65 - -
------ ---- ------ --
Total $846.7 6.98% $288.2 7.05%
====== ==== ====== ====
The Company generally enters into interest rate swap agreements with a
final maturity of three years or less. The floating rate on these agreements
is generally based upon the six-month LIBOR rate on the relevant six-month
reset dates. The Company also generally uses six-month LIBOR as the floating
rate index for its forward rate agreements. Forward rate agreements
generally have a final maturity date that is less than two years.
In addition, as part of its interest rate management program, the Company
utilizes various types of interest rate options, including caps, collars,
floors and interest rate guarantees. The Company generally writes covered
interest rate options under which the Company receives a fixed interest
rate.
The options are marked to market at each balance sheet date, based on the
Company's estimated cost to settle the options. The estimated cost to settle
the options, less any premium deferred by the Company, is recognized as a
reduction to fiduciary investment income in the period when such changes in
market value occur. The Company recognized a current liability of $0.4
million and $1.3 million, representing the estimated cost to settle these
options at September 30, 1995 and December 31, 1994, respectively. The
estimated cost to settle these agreements was determined by obtaining quotes
from banks and other financial institutions which make a market in these
instruments.
21
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
12. Financial Instruments (continued)
At September 30, 1995 and December 31, 1994, the Company had the following
written interest rate option agreements outstanding, by year of final
maturity:
September 30, 1995
------------------------------------------------------
Gross Net Weighted Gross Net Weighted
Receiving Average Paying Average
Year Fixed Interest Rate Fixed Interest Rate
---- --------- ------------- ------ -------------
1996 $43.7 5.43% $10.0 4.60%
1997 15.8 8.50 - -
1998 10.0 8.50 - -
----- ---- ----- ---
Total $69.5 6.57% $10.0 4.60%
===== ==== ===== ====
December 31, 1994
------------------------------------------------------
Gross Net Weighted Gross Net Weighted
Receiving Average Paying Average
Year Fixed Interest Rate Fixed Interest Rate
---- --------- ------------- ------ -------------
1995 $15.6 5.27% $ - - %
1996 43.4 5.42 10.0 4.60
----- ---- ----- ----
Total $59.0 5.38% $10.0 4.60%
===== ==== ===== ====
The above financial instruments are purchased from large international
banks and financial institutions with strong credit ratings. Credit limits
are established based on such credit ratings and are monitored on a regular
basis. Management does not anticipate incurring any losses due to
non-performance by these institutions. In addition, the Company monitors the
market risk associated with these agreements by using probability analyses,
external pricing systems and information from banks and brokers. The
following methods and assumptions were used in estimating the fair value of
each class of financial instrument. The fair values of short-term and
long-term investments were estimated based upon quoted market prices for the
same or similar instruments. The fair value of long-term debt, including the
current portion, was estimated on the basis of market prices for similar
issues at current interest rates for the applicable period. The fair value
of interest rate swaps and forward rate agreements was estimated by
discounting the future cash flows using rates currently available for
agreements of similar terms and maturities. The fair value of foreign
exchange forward contracts and foreign exchange option agreements was
estimated based upon applicable period-end exchange rates. The fair value of
interest rate options was estimated based upon market quotes of the cost to
settle these agreements. The carrying amounts of the Company's other
financial instruments approximate fair value due to their short-term
maturities.
22
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements
---------------------------------------
(in millions, except per share information)
12. Financial Instruments (continued)
The following table presents the carrying amounts and the estimated fair
value of the Company's financial instruments that are not carried at fair
value.
As of September 30, 1995 As of December 31, 1994
------------------------ -----------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
Long-term debt, including
current portion $165.6 $166.2 $149.8 $146.4
Foreign exchange forward
contracts 0.7 0.7 1.6 2.6
Interest rate swaps and
forward rate agreements 0.7 4.1 (2.8) (8.2)
13. Subsequent Events
On October 12, 1995, the Company completed its previously announced plan to
acquire most of the U.S. retail insurance broking and consulting business of
Jardine Insurance Brokers Inc. (JIB) for a purchase price not to exceed
approximately $48.3 million. The Company paid $21.1 million at closing and
issued two 6.375% promissory notes totaling $21.2 million with payments of
$10.6 million due on April 9 and October 12, 1996, respectively. The latter
payment is subject to adjustment based on certain revenue retention criteria
at the former JIB offices. The remaining purchase price of approximately $6
million is contingent on the retention of specific accounts over a four year
period ending October 12, 1999. The acquired offices generated revenues of
approximately $53 million in 1994.
This acquisition will be accounted for under the purchase method in the
fourth quarter of 1995. A substantial majority of the purchase price will be
allocated to identifiable intangible assets (expiration lists) and goodwill.
In addition, the Company expects to complete its integration plans before
year-end and, as a result, it is probable that the Company would incur a
one-time charge in the fourth quarter of 1995 relating to closing certain of
its offices and workforce reductions. Based on currently available
information, the specific amount of the charge cannot be determined at this
time. However, the Company currently expects that the amount of the pre-tax
charge will range from $10 million to $15 million.
On August 23, 1995, the Company announced its intention to redeem its
outstanding 11% Convertible Subordinated Debentures due 2007. All $60.2
million of outstanding securities were redeemed on October 13, 1995,
together with accrued interest and a $0.9 million redemption premium. This
redemption was primarily funded by the Company through the borrowing of $60
million under its revolving long-term credit facility. The current interest
rate on these borrowings is 6.44% which is based on LIBOR.
23
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
--------------------------------------------------------------------------
OVERVIEW
The Company's insurance broking revenues are generally affected by premium
rates charged by insurance companies in the property and casualty markets
and the overall available market capacity. Since the mid-to-late 1980s,
commission and fee growth has been constrained due to soft pricing and
excess capacity and the resultant intense competition among insurance
carriers and brokers for market share. Furthermore, the market conditions
that have prevailed in the U.S. over the last decade are increasingly
evident in the U.K. retail business and spreading to Continental Europe and
elsewhere.
The Company's investment income earned on fiduciary funds is generally
affected by short-term interest rate levels. A downward trend in interest
rates occurred in the early 1990's. However, short-term interest rates have
risen since the latter half of 1994 and are generally expected to remain at
these levels in the near future.
The Company's 1994 restructuring and related initiatives reflect, in part,
management's view that insurance premium pricing will not improve
significantly in the foreseeable future. Revenue growth will depend
increasingly on the development of new products and services, new business
generation and selective acquisitions, such as the October 1995 purchase of
most of the U.S. insurance broking and consulting business of Jardine
Insurance Brokers, Inc.
Revenue growth from the Company's human resource management consulting
operations was impacted by uncertainty over health care reform in the U.S.
Many clients postponed or reduced planned employee benefit reviews while
waiting to analyze the impact of the potential governmental health care
proposals. The Company anticipates slightly lower revenues in 1995 as a
result of the restructuring program, including a decline in the number of
consultants.
Overall comparable operating expenses are expected to continue to decline
throughout 1995, resulting from implementing the plan of restructuring and
other expense initiatives, including certain employee benefit cost
reductions, tightening of travel and entertainment practices, elimination of
certain employee perquisites and the consolidation of vendor and supply
management. The Company has estimated that approximately $100 million of
expense savings will be realized from these efforts; however, approximately
one-half of such savings will be offset by investments in new technology,
products and personnel to support revenue growth, as well as normal
inflationary increases.
The following discussion and analysis of significant factors affecting the
Company's operating results and liquidity and capital resources should be
read in conjunction with the accompanying consolidated financial statements
and related notes.
THREE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994
----------------------------------------------
CONSOLIDATED
The Company reported net income of $17.5 million, or $0.25 per share on
consolidated operating revenues of $299.7 million for the three months ended
September 30, 1995. Fully diluted earnings per share for the quarter were
also $0.25.
24
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
----------------------------------------------
CONSOLIDATED (CONTINUED)
For the three months ended September 30, 1994, the Company reported a net
loss of $20.8 million, or $0.58 per share on a primary and fully diluted
basis, on consolidated operating revenues of $332.6 million. These results
include a $20.9 million after-tax, or $0.47 per share, charge to
discontinued operations.
OPERATING REVENUES
Consolidated operating revenues were $299.7 million for the third quarter of
1995 compared to $332.6 million for the same period in 1994. Revenue
comparisons were impacted by both foreign currency fluctuations and
dispositions of non-core businesses. After adjusting for the effect of these
items, total revenues decreased $1.1 million, or 0.4 percent, compared to
the 1994 third quarter.
Commissions and Fees
Total commissions and fees were $283.7 million for the third quarter of 1995
compared to $318.7 million for the same period in 1994. The sale of non-core
operations reduced revenues in the third quarter of 1995 by $29.4 million
and changes in foreign exchange rates had a negative impact of $1.6 million.
When adjusted for the effect of these items, total commissions and fees
decreased by $4 million, or 1.4 percent.
Fiduciary Investment Income
Investment income earned on fiduciary funds for the third quarter of 1995
increased by $2.1 million, or 15.1 percent, versus 1994 levels primarily due
to higher average investment levels, particularly in the U.K. and higher
worldwide interest rates, particularly in the U.S. and U.K.
The Company enters into interest rate swaps and forward rate agreements to
limit the earnings volatility associated with changes in short-term interest
rates on its existing and anticipated fiduciary investments with maturities
of three months or less. In addition, as part of its interest rate
management program, the Company utilizes various types of interest rate
options, including caps, collars, floors and interest rate guarantees. The
effect of these interest rate swap and forward rate agreements and interest
rate options on the Company's fiduciary investment income was not
significant in the third quarters of 1995 and 1994, respectively. For
additional information relating to the Company's interest rate financial
instruments, see Note 12 of Unaudited Notes to Financial Statements.
OPERATING EXPENSES
Consolidated operating expenses were $272.1 million for the third quarter of
1995, a decrease of $56.3 million or 17.1 percent, versus the comparable
quarter of 1994. After adjusting for a $29.1 million decrease resulting from
the sale of non-core operations and the impact of changes in foreign
exchange rates, including hedging contracts gains and losses, operating
expenses decreased $27.1 million, or 9.1 percent, on a comparable basis.
25
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
----------------------------------------------
OPERATING EXPENSES (CONTINUED)
Salaries and Benefits
Consolidated salaries and benefits decreased by $24.9 million, or 12.4
percent, in the third quarter of 1995 versus the same period in 1994.
Excluding the effect of changes in foreign exchange rates and a $16.8
million decrease resulting from operations sold, total salaries and benefits
decreased $8.3 million, or 4.5 percent, versus the comparable quarter of
1994. Contributing to this decrease was a 7.5 percent decline in headcount,
excluding the impact of sold operations, primarily due to early retirement
programs and worldwide workforce reductions pursuant to the 1994 plan of
restructuring. Also reflected in the third quarter decrease were lower
employee benefit costs resulting from the Company's expense reduction
initiatives. Somewhat offsetting these items was an increase in incentives
attributable to improved sales and profit performance coupled with new
long-term incentive compensation plans.
Other Operating Expenses
Consolidated other operating expenses decreased by $31.4 million, or 24.5
percent, in the third quarter of 1995 compared to 1994. Excluding the effect
of changes in foreign exchange rates, including hedging contracts gains and
losses, and reductions resulting from the disposition of non-core
businesses, other operating expenses decreased by $18.8 million, or 16.2
percent, in 1995 versus 1994. Contributing to this decline was the
implementation of the 1994 plan of restructuring and other expense
initiatives, including tightening of travel and entertainment practices,
elimination of certain employee perquisites and the consolidation of vendor
supply management. Additionally, this decrease reflects lower insurance
costs primarily related to the Company's professional indemnity programs.
OTHER INCOME (EXPENSES)
Investment Income
Investment income earned on operating funds increased in the third quarter
of 1995 by $1.6 million, or 53.3 percent versus the comparable period in
1994. Contributing to this increase were higher average operating cash and
investments levels during 1995 primarily resulting from the Company's
improved operating performance and slightly higher worldwide interest rates.
Interest Expense
Interest expense decreased by $0.1 million, or 2.1 percent, in the third
quarter of 1995 versus 1994. Although the 1995 average debt level has
increased slightly over the 1994 level, interest expense has remained
relatively flat due to the more favorable financing terms of recently issued
debt and the repayment of certain higher interest bearing debt obligations.
26
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
----------------------------------------------
OTHER INCOME (EXPENSES) (CONTINUED)
Other
Other non-operating income (expenses) consists of the following:
Three Months Ended September 30,
--------------------------------
1995 1994
Gains on sales of businesses $ (1.6) $ -
Litigation costs - (2.3)
Other 2.8 0.3
------ -----
$ 1.2 $(2.0)
====== =====
Litigation costs in 1994 are associated primarily with the Mutual Fire
lawsuit described in Note 11 of the Unaudited Notes to Financial Statements.
INCOME TAXES
The Company reported income tax expense of $11 million on pre-tax income of
$28.8 million in the third quarter of 1995. The expense is higher than the
expected tax expense of $10.1 million based on the U.S. statutory rate of 35
percent, primarily due to U.S. taxes on income earned by foreign
subsidiaries and to state and local income taxes. Certain expenses which are
not deductible, including amortization of goodwill also negatively affected
the tax rate.
The Company reported income tax expense of $0.2 million on pre-tax income of
$0.5 million in the third quarter of 1994. The effective tax rate was 40
percent compared to the U.S. statutory rate of 35 percent. The tax rate was
negatively impacted by the non-deductibility of certain expenses for tax
purposes, including amortization of goodwill, and entertainment expenses.
Partially offsetting these factors were foreign tax rates which were lower
than the U.S. statutory rate.
27
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
----------------------------------------------
SEGMENT INFORMATION
INSURANCE SERVICES
Operating results for the Insurance Services segment of the Company's
operations are summarized below:
Three Months Ended September 30,
--------------------------------
1995 1994
Operating revenues:
Risk management and insurance services
broking $166.1 $201.0
Specialist insurance and reinsurance
broking 66.2 61.6
Fiduciary investment income 15.9 13.8
------ ------
Total operating revenues 248.2 276.4
Operating expenses 215.7 262.0
------ ------
Operating income $ 32.5 $ 14.4
====== ======
RISK MANAGEMENT AND INSURANCE SERVICES BROKING REVENUES
Worldwide risk management and insurance services broking commissions and
fees decreased $34.9 million, or 17.4 percent, for the third quarter of 1995
compared to 1994. Reflected in this decrease are the impact of sold
operations which reduced such revenues by $29.4 million and an unfavorable
foreign exchange rate variance of $1.4 million. Excluding the effect of
these items, commissions and fees decreased $4.1 million, or 2.4 percent.
The U.S. and European operations, particularly in the U.K., reported
decreased commissions and fees of $2 million and $3.4 million, respectively.
These decreases reflect weakened pricing resulting from continued softness
in certain U.S. insurance markets and evidence of similar market conditions
in the U.K. and Continental Europe. Partially offsetting these reductions
was an increase of $1.3 million for the Latin America operations primarily
attributable to new business production.
SPECIALIST INSURANCE AND REINSURANCE BROKING REVENUES
Total third quarter 1995 broking commissions and fees for the specialist
insurance and reinsurance operations increased $4.6 million, or 7.5 percent,
versus 1994 levels. Changes in foreign exchange rates decreased third
quarter 1995 broking revenues by $0.4 million. After adjusting for the
effect of changes in foreign exchange rates, commissions and fees increased
$5 million or 8.1 percent. This increase was primarily due to reported
increases of $4.2 million and $0.8 million in the U.S. and U.K. operations,
respectively.
The Company enters into foreign exchange forward contracts and foreign
exchange option agreements primarily to provide risk management against
future exposures that arise at its London-based specialist insurance and
reinsurance broking operations. The exposures arise because a significant
portion of the revenues of these operations are denominated in U.S. dollars,
while their expenses are primarily denominated in U.K. pounds sterling. For
additional information relating to the Company's foreign exchange financial
instruments, see Note 12 of the Unaudited Notes to Financial Statements.
28
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
----------------------------------------------
FIDUCIARY INVESTMENT INCOME
For the third quarter of 1995 investment income earned on fiduciary funds,
held by the Company in connection with its broking services for the risk
management and insurance services broking and the specialist and reinsurance
broking operations was $8.3 million and $7.6 million, respectively, versus
$7.8 million and $6 million, respectively, for the comparable period in
1994. Total Insurance Services investment income increased by $2.1 million,
or 15.2 percent, versus 1994 levels. The increase was primarily due to
higher average investment levels, particularly in the U.K., and higher
worldwide interest rates, particularly in the U.S. and U.K.
OPERATING EXPENSES
Worldwide risk management and insurance services operating expenses for the
third quarter of 1995 decreased $46 million, or 22.3 percent, versus the
same period in 1994. Foreign exchange rate changes, including hedging
contracts gains and losses decreased expenses by $0.8 million in 1995. The
effect of sold operations reduced operating expenses by $29.1 million in
1995. After adjusting for the effect of these items, total operating
expenses decreased $16.1 million, or 9.1 percent.
The U.S. and European operations, particularly in the U.K., reported
decreased expenses of $15 million and $1.7 million, respectively. These
decreases primarily resulted from the aforementioned restructuring and other
expense initiatives undertaken in 1994. Partially offsetting these
reductions was an increase reported by the Asia-Pacific operations of $0.9
million primarily due to the acquisition of a small brokerage business.
Third quarter of 1995 operating expenses for the specialist and reinsurance
operations decreased $0.3 million, or 0.5 percent, versus 1994 levels.
Foreign exchange rate variances, including hedging gains and losses,
negatively impacted expenses by $0.5 million in 1995. Excluding the impact
of foreign exchange rate variances, total operating expenses decreased $0.8
million, or 1.4 percent. Contributing to this decrease were reduced expenses
of $1.9 million in the U.K. operations partially offset by a slight increase
of $0.5 million for the U.S. operations.
HUMAN RESOURCE MANAGEMENT CONSULTING
Operating results for the Human Resource Management Consulting segment of
the Company's operations are summarized below:
For the Three Months Ended
September 30,
---------------------------
1995 1994
-------- ---------
Operating revenues:
Commissions and fees $ 51.4 $ 56.1
Fiduciary investment income 0.1 0.1
-------- --------
Total operating revenues 51.5 56.2
-------- --------
Operating expenses 49.4 55.0
-------- --------
Operating income $ 2.1 $ 1.2
======== ========
29
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
----------------------------------------------
HUMAN RESOURCE MANAGEMENT CONSULTING (CONTINUED)
Human resource management consulting commissions and fees decreased by $4.7
million, or 8.4 percent, in the third quarter of 1995 compared to the same
period in 1994. After adjusting for the effect of changes in foreign
exchange rates, commissions and fees decreased by $4.9 million, or 8.7
percent. This decrease is primarily attributable to consulting revenue
shortfalls in the U.S. and U.K. operations of $4.1 million and $1 million,
respectively, resulting from the Company's restructuring program which
included declines in the number of consultants based in these operations.
Operating expenses decreased by $5.6 million, or 10.2 percent, for the third
quarter of 1995 compared to 1994. After adjusting for the effect of changes
in foreign exchange rates, operating expenses decreased by $5.8 million, or
10.5 percent. Reflected in this decrease were operating expense reductions
of $4.8 million, $0.7 million and $0.4 million in the U.S., U.K. and
Canadian operations, respectively, as a result of the aforementioned
restructuring and other expense initiatives undertaken in 1994.
30
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994
---------------------------------------------
CONSOLIDATED
The Company reported net income of $81.9 million, or $1.42 per share on
consolidated operating revenues of $952 million for the nine months ended
September 30, 1995. Fully diluted earnings per share for the period were
$1.33. Included in the results is an after-tax gain of $19.8 million, or
$0.44 per share, from the sale of Alexsis, the Company's U.S.-based third
party administrator operation.
For the nine months ended September 30, 1994, the Company reported a net
loss of $27.4 million, or $0.83 per share on a primary and fully diluted
basis, on consolidated operating revenues of $990.7 million. These results
included a $26.9 million, or $0.61 per share, loss from discontinued
operations and a $2.6 million after-tax charge, or $0.06 per share, for the
cumulative effect of a change in accounting principle relating to the
adoption of SFAS No. 112, "Employers' Accounting for Postemployment
Benefits."
OPERATING REVENUES
Consolidated operating revenues were $952 million for the first nine months
of 1995 compared to $990.7 million for the same period in 1994. Revenue
comparisons were impacted by both foreign currency fluctuations and
dispositions of non-core businesses. After adjusting for the effect of these
items, total revenues increased $31.1 million, or 3.5 percent.
Commissions and Fees
Total commissions and fees were $903.4 million for the first nine months of
1995 compared to $953.3 million for the same period in 1994. The sale of
non-core operations reduced revenues in the comparable periods by $78
million and changes in foreign exchange rates had a favorable impact of $9.2
million. When adjusted for the effect of these items, total commissions and
fees increased by $18.9 million, or 2.2 percent.
Fiduciary Investment Income
Investment income earned on fiduciary funds for the first nine months of
1995 increased by $11.2 million, or 29.9 percent, versus 1994 levels
primarily due to higher average investment levels, particularly in the U.K.
and higher worldwide interest rates, particularly in the U.S. and U.K.
The Company enters into interest rate swaps and forward rate agreements to
limit the earnings volatility associated with changes in short-term interest
rates on its existing and anticipated fiduciary investments with maturities
of three months or less. In addition, as part of its interest rate
management program, the Company utilizes various types of interest rate
options, including caps, collars, floors and interest rate guarantees. These
interest rate swap and forward rate agreements and interest rate options
increased the Company's fiduciary investment income by $0.9 million in the
first nine months of 1995 and had a nominal effect on the same period in
1994. For additional information relating to the Company's interest rate
financial instruments, see Note 12 of Unaudited Notes to Financial
Statements.
31
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
---------------------------------------------
OPERATING EXPENSES
Consolidated operating expenses were $843.5 million for the first nine
months of 1995, a decrease of $123.2 million or 12.7 percent, versus the
comparable 1994 period. After adjusting for a $78.2 million decrease
resulting from the sale of non-core operations and the impact of changes in
foreign exchange rates, including hedging contracts gains and losses,
operating expenses decreased $55.4 million, or 6.3 percent, on a comparable
basis.
Salaries and Benefits
Consolidated salaries and benefits decreased by $57.6 million, or 9.6
percent in the first nine months of 1995 versus the same period in 1994.
Excluding the effect of changes in foreign exchange rates and a $44.9
million decrease resulting from operations sold, total salaries and benefits
decreased $20.2 million, or 3.7 percent, versus the comparable 1994 period.
Contributing to this decrease was a 7.5 percent decline in headcount,
excluding the impact of sold operations, primarily due to early retirement
programs and worldwide workforce reductions pursuant to the 1994 plan of
restructuring. Also reflected in the first nine months decrease were lower
employee benefit costs resulting from the Company's expense reduction
initiatives. Somewhat offsetting these items was an increase in incentives
attributable to improved sales and profit performance coupled with the
implementation of several new long-term incentive compensation plans.
Other Operating Expenses
Consolidated other operating expenses decreased by $65.6 million, or 18
percent, in the first nine months of 1995 compared to 1994. Excluding the
effect of changes in foreign exchange rates, including hedging contracts
gains and losses, and reductions resulting from the disposition of non-core
businesses, other operating expenses decreased by $29.4 million, or 8.9
percent, in 1995 versus 1994. Contributing to this decline was the
implementation of the 1994 plan of restructuring and other expense
initiatives, including tightening of travel and entertainment practices,
elimination of certain employee perquisites and the consolidation of vendor
supply management. Additionally, this decrease reflects lower insurance
costs primarily related to the Company's professional indemnity programs.
OTHER INCOME (EXPENSES)
Investment Income
Investment income earned on operating funds increased for the first nine
months of 1995 by $7.4 million, or 113.8 percent versus the comparable
period in 1994. Contributing to this increase were higher average operating
cash and investments levels during 1995 primarily resulting from the
Company's improved operating performance and the remaining proceeds from the
July 1994 issuance and sale of the Company's 8% Series B cumulative
convertible preferred stock coupled with slightly higher worldwide interest
rates.
32
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
---------------------------------------------
OTHER INCOME (EXPENSES) (CONTINUED)
Interest Expense
Interest expense increased by $2.2 million, or 18.5 percent, in the first
nine months of 1995 versus 1994. The increase is due to a higher average
debt level resulting from the $50 million borrowing in mid-1994 relating to
a contract with a reinsurance company and the issuance of long-term notes
payable upon settlement of the Shand and Mutual Fire contingencies during
the first quarter of 1995.
Other
Other non-operating income (expenses) consists of the following:
Nine Months Ended September 30,
-------------------------------
1995 1994
---- ----
Gains on sales of businesses $ 30.4 $ -
Litigation costs (0.1) (7.7)
Other 3.7 (0.8)
------ -----
$ 34.0 $(8.5)
====== =====
During the second quarter of 1995, the Company sold two small operations for
gross proceeds of $1.9 million and resulting pre-tax gains totaling $1.4
million.
On February 28, 1995 the Company completed the sale of Alexsis, Inc., its
U.S.-based third party claims administrator, for total cash proceeds of
$47.1 million. The previously reported pre-tax gain on this transaction was
$30.3 million. Pursuant to the terms of the purchase agreement, under
certain circumstances the transaction was subject to a post-closing
adjustment in the purchase price. During the third quarter of 1995 the
Company and the purchaser reached an agreement resulting in a final pre-tax
gain of $28.7 million ($19.8 million after-tax or $0.44 per share).
In January 1995, the Company sold its minority interest in a U.K. merchant
bank for cash proceeds of $7.2 million and a pre-tax gain of $0.3 million.
Litigation costs in 1994 are associated primarily with the Mutual Fire
lawsuit described in Note 11 of the Unaudited Notes to Financial Statements.
INCOME TAXES
The Company reported income tax expense of $54.7 million on pre-tax income
of $142.3 million in the first nine months of 1995. The expense is higher
than the expected tax expense of $49.8 million based on the U.S. statutory
rate of 35 percent, primarily due to U.S. taxes on income earned by foreign
subsidiaries and to state and local income taxes. Certain expenses which are
not deductible, including amortization of goodwill also negatively affected
the tax rate. Partially offsetting these factors is the favorable impact of
the amount of gain recognized on the sale of Alexsis for tax purposes as
well as foreign tax rates which were lower than the U.S. statutory rate.
33
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
---------------------------------------------
INCOME TAXES (CONTINUED)
The Company's effective tax rate in the first nine months of 1994 was 39.6%.
The rate was higher than the U.S. statutory rate of 35% primarily due to
amortization of goodwill, and certain other non-deductible expenses. These
factors were offset in part by the favorable impact of state and local tax
benefits on losses generated in the U.S. operations as well as foreign tax
rates which were lower than the U.S. statutory rate.
As discussed in Note 6 of the Unaudited Notes to Financial Statements,
during 1994, the Company was advised that the Joint Committee on Taxation
had approved the agreement reached in 1993 by the Company and the Appeals
Office of the Internal Revenue Service (IRS) on settlement of tax issues
with respect to years 1980 through 1986. Also during 1994, the Company
reached an agreement with the IRS on settlement of the examination of years
1987 through 1989. On February 28, 1995, the Company paid the amounts due
for such years and charged the tax and net interest totaling $ 35.6 million
against previously established reserves.
In 1994, the Company received a Notice of Proposed Adjustment from the IRS
in connection with the examination of its 1990 and 1991 U.S. federal income
tax returns, proposing an increase in taxable income for the 1991 year
which, if sustained, would result in additional tax liability estimated by
the Company at $50 million, excluding interest and penalties. This proposed
adjustment relates to intercompany transactions involving the stock of a
United Kingdom subsidiary.
As discussed in Note 6 of the Unaudited Notes to Financial Statements, the
Company disagrees with the IRS position on this issue. Although the ultimate
outcome of the matter cannot be predicted with certainty, the Company and
its independent tax counsel believe there are meritorious defenses to the
proposed adjustment and substantial arguments to sustain the Company's
position and that the Company should prevail in the event this issue is
litigated.
A similar set of transactions occurred in 1993 for which the IRS could
propose an increase in taxable income which would result in an additional
tax liability estimated by the Company at $25 million, excluding interest
and penalties. The Company's 1993 tax return is not currently under
examination. The Company believes it should prevail in the event this
similar issue is raised by the IRS. Accordingly, no provision for any
liability with respect to the 1991 and 1993 transactions has been made in
the consolidated financial statements.
The Company believes that its current tax reserves are adequate to cover its
tax liabilities.
34
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
---------------------------------------------
DISCONTINUED OPERATIONS
In 1985, the Company discontinued its insurance underwriting operations. In
1987 the Company sold Sphere Drake Insurance Group (Sphere Drake). The
Sphere Drake sales agreement provides indemnities by the Company to the
purchaser for various potential liabilities including provisions covering
future losses on certain insurance pooling arrangements from 1953 to 1967
between Sphere Drake and Orion Insurance Company (Orion), a U.K.-based
insurance company, and future losses pursuant to a stop-loss reinsurance
contract between Sphere Drake and Lloyd's Syndicate 701 (Syndicate 701). In
addition, the sales agreement requires the Company to assume any losses in
respect of actions or omissions by Swann & Everett Underwriting Agency
(Swann & Everett), an underwriting management company previously managed by
Alexander Howden Group plc (Alexander Howden).
The net liabilities of discontinued operations shown in the accompanying
Consolidated Balance Sheets include insurance liabilities associated with
the above indemnities, liabilities of insurance underwriting subsidiaries
currently in run-off and other related liabilities.
The insurance liabilities represent estimates of future claims expected to
be made under occurrence-based insurance policies and reinsurance business
written through Lloyd's and the London market covering primarily asbestosis,
environmental pollution, and latent disease risks in the United States which
are coupled with substantial litigation expenses. These claims are expected
to develop and be settled over the next twenty to thirty years.
Liabilities stemming from these claims cannot be estimated using
conventional actuarial reserving techniques because the available historical
experience is not adequate to support the use of such techniques and because
case law, as well as scientific standards for measuring the adequacy of site
cleanup (both of which have had, and will continue to have, a significant
bearing on the ultimate extent of the liabilities) is still evolving.
Accordingly, the Company's independent actuaries have combined available
exposure information with other data and have used various projection
techniques to estimate the insurance liabilities, consisting principally of
incurred but not reported losses.
On July 1, 1994, the Company entered into a finite risk contract providing
protection primarily for exposures relating to Orion, Syndicate 701 and
Swann & Everett. The contract provided for a payment by the Company of $80
million ($50 million of which was borrowed from the reinsurance company) to
the reinsurance company and for payment by the Company of the first $73
million of paid claims. The contract entitles the Company to recover paid
claims in excess of the Company's $73 million retention. At September 30,
1995, the recoveries were limited to $113 million, which includes the
Company's payment of $80 million. In addition, commencing December 31, 1996,
depending on the timing and amount of paid loss recoveries under the
contract, the Company may be entitled to receive a payment from the
reinsurance company in excess of the amounts recovered for paid losses if
the contract is terminated. The contract is accounted for under the deposit
method of accounting and the accounting requirements for discontinued
operations. As a result of this transaction, the Company recorded a $6
million charge in the second quarter of 1994 which represented the cost of
the premium and deductible that exceeded existing reserves for covered
exposures at that time.
35
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
---------------------------------------------
DISCONTINUED OPERATIONS (CONTINUED)
During the third quarter of 1994, the Company recorded a $20.9 million
charge relating to an agreement that resolved certain indemnity obligations
to Sphere Drake. Under terms of the Sphere Drake agreement, the Company
received a cash payment of $5 million in settlement of the zero coupon notes
receivable and related indemnities as well as certain income tax
liabilities.
Insurance liabilities in excess of recorded liabilities could develop in
the future. Based on independent actuarial estimates of the amount and
timing of claim payments, it is reasonably possible that such additional
liabilities of $189 million, net of estimated amounts recoverable for paid
losses under the finite risk contracts of $117 million, could amount to $72
million. However, management currently believes that such additional
insurance liabilities are not likely to develop.
The Company believes that, based on current estimates, the established total
net liabilities of discontinued operations are sufficient to cover its
exposures. However, there is no assurance that further adverse development
may not occur due to variables inherent in the estimation processes and
other matters described above. The Company currently believes that the
effect of such adverse development, if any, will not be material to the
Company's financial position and results of operations.
CUMULATIVE EFFECT ADJUSTMENTS
Effective January 1, 1994, the Company adopted SFAS No. 112, "Employers'
Accounting for Postemployment Benefits." This statement requires that
certain benefits provided to former or inactive employees after employment
but prior to retirement, including disability benefits and health care
continuation coverage, be accrued based upon the employees' service already
rendered. The cumulative effect of this accounting change was an after-tax
charge of $2.6 million or $0.06 per share in the first quarter of 1994. The
increase to the annual cost of providing such benefits will not be
significant.
36
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
---------------------------------------------
SEGMENT INFORMATION
INSURANCE SERVICES
Operating results for the Insurance Services segment of the Company's
operations are summarized below:
Nine Months Ended September 30,
-------------------------------
1995 1994
---- ----
Operating revenues:
Risk management and insurance services
broking $542.1 $602.4
Specialist insurance and reinsurance
broking 205.7 190.2
Fiduciary investment income 48.3 37.2
------ ------
Total operating revenues 796.1 829.8
Operating expenses 672.4 771.5
------ ------
Operating income $123.7 $ 58.3
====== ======
RISK MANAGEMENT AND INSURANCE SERVICES BROKING REVENUES
Worldwide risk management and insurance services broking commissions and
fees decreased $60.3 million, or 10 percent, for the first nine months of
1995 compared to 1994. Reflected in this decrease are the net impact of sold
operations which reduced revenues by $78 million and a favorable foreign
exchange rate variance of $5.3 million. Excluding the effect of these items,
commissions and fees increased $12.4 million, or 2.4 percent.
The European, Latin America, U.S., Canada and Asia-Pacific operations
reported increased commissions and fees of $1.6 million, $5.2 million, $1
million, $2 million and $2.6 million, respectively. The European operations
favorable variance reflects increased commissions and fees of $5.1 million
in Continental Europe, particularly in Germany, the Netherlands and France,
partially offset by a $3.5 million decrease for such revenues in the U.K.
The Continental Europe increases are primarily attributable to increased
commission rates and the acquisition of a small brokerage business. The U.K.
decrease reflects weakened pricing resulting from their softening market.
The increases in the Latin America and U.S. operations are primarily due to
new business production and favorable client retention levels. The increase
in the Canada operations reflects increased commission rates and new
business production. Furthermore, the increase in the Asia-Pacific
operations reflects the acquisition of a small brokerage business.
SPECIALIST INSURANCE AND REINSURANCE BROKING REVENUES
For the first nine months of 1995 total broking commissions and fees for the
specialist insurance and reinsurance operations increased $15.5 million, or
8.1 percent, versus 1994 levels. Changes in foreign exchange rates increased
1995 broking revenues by $1.9 million. After adjusting for the effect of
changes in foreign exchange rates, commissions and fees increased $13.6
million, or 7.2 percent. This increase was primarily due to reported
increases of $13.1 million and $0.3 million in the U.S. and U.K. operations,
respectively.
37
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
---------------------------------------------
SPECIALIST INSURANCE AND REINSURANCE BROKING REVENUES (CONTINUED)
The Company enters into foreign exchange forward contracts and foreign
exchange option agreements primarily to provide risk management against
future exposures that arise at its London-based specialist insurance and
reinsurance broking operations. The exposures arise because a significant
portion of the revenues of these operations are denominated in U.S. dollars,
while their expenses are primarily denominated in U.K. pounds sterling. For
additional information relating to the Company's foreign exchange financial
instruments, see Note 12 of the Unaudited Notes to Financial Statements.
FIDUCIARY INVESTMENT INCOME
For the first nine months of 1995 investment income earned on fiduciary
funds, held by the Company in connection with its broking services for the
risk management and insurance services broking and the specialist and
reinsurance broking operations was $23.9 million and $24.4 million,
respectively, versus $21 million and $16.2 million, respectively, for the
comparable period in 1994. Total Insurance Services investment income
increased by $11.1 million, or 29.8 percent, versus 1994 levels. The
increase was primarily due to higher average investment levels, particularly
in the U.K., and higher worldwide interest rates, particularly in the U.S.
and U.K.
OPERATING EXPENSES
Worldwide risk management and insurance services operating expenses for the
first nine months of 1995 decreased $107.2 million, or 17.6 percent, versus
the same period in 1994. Foreign exchange rate changes, including hedging
contracts gains and losses, increased expenses by $2.7 million in 1995. The
net effect of sold operations reduced operating expenses by $78.2 million in
the comparable periods. After adjusting for the effect of these items, total
operating expenses decreased $31.7 million, or 6.1 percent.
The U.S. and European operations reported decreased operating expenses of
$34.1 million and $0.6 million, respectively. The European operations
favorable variance reflects reduced operating expenses of $2.7 million in
the U.K. substantially offset by increased operating expenses of $2.1
million in Continental Europe, particularly in France. Furthermore,
increased operating expenses of $2.9 million and $2.1 million were reported
in the Asia-Pacific and Latin America operations, respectively. The reported
reductions were primarily the result of the aforementioned restructuring and
other expense initiatives undertaken in 1994 somewhat offset by an increase
in incentives attributable to improved sales and profit performance coupled
with the implementation of several new long-term incentive compensation
plans. The reported increases in the Continental Europe and Asia-Pacific
operations were primarily due to acquisitions of small brokerage businesses.
38
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1995 VS. 1994 (CONTINUED)
---------------------------------------------
OPERATING EXPENSES (CONTINUED)
First nine months of 1995 operating expenses for the specialist and
reinsurance broking operations increased $8.1 million, or 5 percent, versus
1994 levels. Foreign exchange rate variances, including hedging gains and
losses, negatively impacted expenses by $5.8 million in 1995. Excluding the
impact of foreign exchange rate variances, total operating expenses
increased $2.3 million, or 1.4 percent. Contributing to this increase were
higher expenses of $3.2 million in the U.S. operations partially offset by
reduced expenses of $1.5 million in the U.K. operations. The reported
reduction in the U.K. operations was primarily the result of the
aforementioned restructuring and other expense initiatives undertaken in
1994. Both of these variances reflect additional incentives during 1995 due
to improved operating performance.
HUMAN RESOURCE MANAGEMENT CONSULTING
Operating results for the Human Resource Management Consulting segment of
the Company's operations are summarized below:
For the Nine Months Ended
September 30,
------------------------
1995 1994
-------- --------
Operating revenues:
Commissions and fees $ 155.6 $ 160.7
Fiduciary investment income 0.3 0.2
-------- --------
Total operating revenues 155.9 160.9
-------- --------
Operating expenses 149.7 162.9
-------- --------
Operating income (loss) $ 6.2 $ (2.0)
======== ========
Human resource management consulting commissions and fees decreased by $5.1
million, or 3.2 percent, in the first nine months of 1995 compared to 1994.
After adjusting for the effect of changes in foreign exchange rates, these
revenues decreased $7.1 million, or 4.4 percent. This decrease is primarily
attributable to consulting revenue shortfalls of $7.5 million and $1.7
million in the U.S. and U.K. operations, respectively, resulting from the
Company's restructuring program which included declines in the number of
consultants based in these operations. Partially offsetting these decreases
were increased commissions and fees of $1.5 million in the Canadian
operations.
Operating expenses decreased by $13.2 million, or 8.1 percent, for the first
nine months of 1995 compared to 1994. After adjusting for the effect of
changes in foreign exchange rates, operating expenses decreased $15.1
million, or 9.3 percent. Reflected in this decrease were reductions of $11.9
million, $1.8 million and $1.7 million in the operating expenses of the
U.S., U.K. and Canadian operations, respectively, primarily as a result of
the aforementioned restructuring and other expense initiatives undertaken in
1994.
39
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1995, the Company's operating cash and cash equivalents
totaled $254.8 million, a $6.1 million increase over the 1994 year-end
balance. In addition, the Company had $69.7 million of operating funds
invested in short-term and long-term investments at September 30, 1995, a
$13.6 million decrease compared to December 31, 1994.
Operating Activities
The Company's funds from operating activities consist primarily of net
income adjusted for non-cash items, including depreciation and amortization,
deferred income taxes, gains on sales of business and changes in working
capital balances. In addition, the net cash flows relating to discontinued
operations are included. In the first nine months of 1995, the Company's
operating activities used $42.2 million of operating funds, including the
following items.
The 1994 charges for restructuring required $20.8 million of cash payments
during the first nine months of 1995. The Company anticipates that
approximately $8.4 million of the remaining balance of $33.6 million will be
funded during the fourth quarter of 1995.
As described in Note 6 of the Unaudited Notes to Financial Statements,
during 1994, the Company was advised that the Joint Committee on Taxation
had approved the agreement reached in 1993 by the Company and the Appeals
Office of the IRS on settlement of tax issues with respect to the years 1980
through 1986. Also during 1994, the Company reached an agreement with the
IRS on settlement of the examination of years 1987 through 1989. In February
1995, the Company paid the amounts due for such years and charged the tax
and net interest totaling $35.6 million against previously established
reserves.
During the first quarter of 1995, the Company made a cash payment of $14
million under the terms of the settlement relating to Shand. A $12 million
cash payment was made on April 1, 1995 in accordance with the Mutual Fire
settlement agreement. These payments were applied against the 1994 special
charges reserve and the Company's previously established reserves.
During the first quarter of 1995, the Company made cash payments of
approximately $19.5 million relating to the settlement of certain large
litigation matters. These payments were applied against the Company's
previously established reserves.
Investing Activities
The Company's net capital expenditures for property and equipment were $15.1
million and $17.2 million during the nine months ended September 30, 1995
and 1994, respectively. These expenditures decreased as a result of the
Company's restructuring and other expense initiatives undertaken in 1994.
In January 1995, the Company received the remaining proceeds of $29.2
million from the November 1994 sale of the U.S.-based personal lines
business. In addition, the Company received $7.2 million in January 1995
from the sale of its minority interest in a U.K. merchant bank and $47.1
million in February 1995 from the sale of Alexsis.
40
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Investing Activities (continued)
On October 12, 1995, the Company completed its previously announced plan to
acquire most of the U.S. retail insurance broking and consulting business of
Jardine Insurance Brokers Inc. (JIB) for a purchase price not to exceed
approximately $48.3 million. The Company paid $21.1 million at closing and
issued two 6.375% promissory notes totaling $21.2 million with payments of
$10.6 million due on April 9 and October 12, 1996, respectively. The latter
payment is subject to adjustment based on certain revenue retention criteria
at the former JIB offices. The remaining purchase price of approximately $6
million is cotingent on the retention of specific accounts over a four year
period ending October 12, 1999. The acquired offices generated revenues of
approximately $53 million in 1994.
This acquisition will be accounted for under the purchase method in the
fourth quarter of 1995. A substantial majority of the purchase price will be
allocated to identifiable intangible assets (expiration lists) and goodwill.
In addition, the Company expects to complete its integration plans before
year-end and, as a result, it is probable that the Company would incur a
one-time charge in the fourth quarter of 1995 relating to closing certain of
its offices and workforce reductions. Based on currently available
information, the specific amount of the charge cannot be determined at this
time. However, the Company currently expects that the amount of the pre-tax
charge will range from $10 million to $15 million.
The Company will continue to evaluate domestic and international
geographical market expansion possibilities and further industry
specialization. Furthermore, the Company is considering additional possible
niche and substantial strategic acquisitions relating to its core
businesses, as well as other opportunities in the financial services
industry. As part of its evaluation of opportunities, the Company engages
with interested parties in discussions concerning possible transactions. The
Company will continue to evaluate such opportunities and prospects. However,
the Company cannot predict if any transaction will be consummated, nor the
terms or form of consideration required.
Financing Activities
During the first quarter of 1995, the Company increased long-term debt by
$19.8 million and recorded a note receivable of $1.3 million under the terms
of the settlement relating to Shand. In the second quarter of 1995, $15.8
million of this long-term debt was prepaid and $1.3 million of cash was
received in payment of the note receivable. The remaining contingent note
payable of $4 million was paid in full in September 1995. In accordance with
the Mutual Fire settlement agreement, the Company increased long-term debt
in the first quarter of 1995 by $25.9 million, representing the present
value of a $35 million zero coupon note on March 27, 1995, secured by a
letter of credit, using a discount rate of 9.3%. A partial payment of $0.3
million was made on this note in June 1995. The first quarter activity was
applied against the 1994 special charges reserve and the Company's
previously established reserves. The present value of the outstanding
principal balance of the note payable at September 30, 1995 was $26.9
million.
41
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Financing Activities (continued)
The decline in cash dividend payments reflects the reduction in the
Company's Common Stock dividend by 90 percent in 1994, resulting in
annualized cash flow improvement of $40 million. The 1995 cash flow
improvement from this action will be approximately $10 million. In addition,
dividends on the Company's Series B Cumulative Convertible Preferred Shares
(Series B Convertible Preferred Shares) are payable in kind (additional
preferred shares) until December 15, 1996 and thereafter, at the election of
the Board of Directors, until December 15, 1999.
Under the terms of the AIG Agreement, the declaration or payment of
dividends on Common Stock in excess of prescribed amounts may require the
Company to purchase all or part of the then outstanding Series B Convertible
Preferred Shares. Dividends on the Series B Convertible Preferred Shares
will reduce the amount of earnings otherwise available for common
stockholders by approximately $17 million in the first year after issuance,
and by approximately $23 million in the fifth year after issuance, assuming
dividends on the Series B Convertible Preferred Shares were to be paid in
kind throughout the first five years after issuance.
On March 27, 1995, the Company's then existing credit agreement was replaced
by a new $200 million three-year facility with various banks which expires
in March 1998. The agreement provides for unsecured borrowings and for the
issuance of up to $100 million of letters of credit. During the second
quarter of 1995, the Company arranged a $10 million letter of credit under
this agreement. On August 23, 1995, the Company announced its intention to
redeem its outstanding 11% Convertible Subordinated Debentures due 2007. All
$60.2 million of outstanding securities were redeemed on October 13, 1995,
together with accrued interest and a $0.9 million redemption premium. This
redemption was primarily funded by the Company through the borrowing of $60
million under its revolving credit facility. The interest rate on these
borrowings is 6.44% which is based on LIBOR. The Company has full and
immediate access to the remaining $130 million credit line. See Note 10 of
the Unaudited Notes to Financial Statements for further information
regarding this credit agreement.
Supplementing the credit agreement, the Company has unsecured lines of
credit available for general corporate purposes totaling $91.9 million, of
which $91.4 million were unused at September 30, 1995. These lines consist
of uncommitted cancellable facilities in foreign countries. If drawn, the
lines bear interest at market rates and carry annual commitment fees of not
greater than 1/2 percent of the line.
In March 1995, a U.S. subsidiary prepaid an unsecured $10 million term loan
which was due August 1995.
42
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
--------------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Other
As a result of the devaluation of the Mexican peso in late 1994, the
Company's accumulated translation adjustment balance for its Mexican
operation reflected an unrealized loss of $6.2 million at December 31, 1994.
Further devaluation of the Mexican peso during the first nine months of 1995
has increased this unrealized loss to $9.3 million at September 30, 1995.
However, the Company expects to maintain its strategic investment in Mexico
for the long-term and further anticipates that its Mexican operation will
remain profitable. Accordingly, the Company does not consider its investment
in Mexico to be permanently impaired.
In the first nine months of 1995, the Accumulated Translation Adjustments,
which represent the cumulative effect of translating the Company's
international operations to U.S. dollars, positively impacted total
Stockholders' Equity by $4 million. The increase reflects the strengthening
of most of the major European currencies and the Canadian dollar against the
U.S. dollar.
At September 30, 1995, the Company has an accumulated deficit of $227.3
million. The Company's current financial position satisfies Maryland law
requirements for the payment of dividends. At September 30, 1995, the
current maximum amount of unrestricted funds the Company has available to
pay Common Stock dividends under Maryland law equaled approximately $286.8
million. The Board of Directors will continue to take into consideration the
Company's financial performance and projections, as well as the provisions
of the AIG Agreement pertaining to dividends described in Note 11 of the
Unaudited Notes to Financial Statements, in connection with future decisions
with respect to dividend declarations. In addition, no dividends may be
declared or paid on the Company's Common Stock unless an equivalent amount
per share is declared and paid on the dividend-paying shares associated with
the Class A and Class C Common stock.
As described in Notes 7 and 11 of the Unaudited Notes to Financial
Statements, the Company believes its most significant litigation matters and
other contingencies have been settled.
The Company believes that cash flow from operations, along with current cash
balances, will be sufficient to fund working capital as well as all other
obligations on a timely basis. In the event additional funds are required,
the Company believes it will have sufficient resources, including borrowing
capacity, to meet such requirements.
43
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries
PART II. OTHER INFORMATION
--------------------------
ITEM 1. LEGAL PROCEEDINGS
Reference is made to Part I, Note 11 of the Unaudited Notes to Financial
Statements and to MD&A hereof as to the Company's discussion of contingencies
which is incorporated herein by reference in its entirety.
ITEM 5. OTHER INFORMATION
ACQUISITIONS
On October 12, 1995, the Company completed its previously announced plan to
acquire most of the U.S. retail insurance broking and consulting business of
Jardine Insurance Brokers Inc. (JIB) for a purchase price not to exceed
approximately $48.3 million. The Company paid $21.1 million at closing and
issued two 6.375% promissory notes totaling $21.2 million with payments of $10.6
million due on April 9 and October 12, 1996, respectively. The latter payment is
subject to adjustment based on certain revenue retention criteria at the former
JIB offices. The remaining purchase price of approximately $6 million is
contingent on the retention of specific accounts over a four year period ending
October 12, 1999. The acquired offices generated revenues of approximately $53
million in 1994. This acquisition will be accounted for under the purchase
method in the fourth quarter of 1995. Reference is made to Part I, Note 13 of
the Unaudited Notes to Financial Statements hereof which is incorporated herein
by reference in its entirety.
BOARD ACTIONS
At its regular meeting of the Board of Directors of the Company held on October
24, 1995, the Board of Directors elected Ronald A. Iles as Deputy Chairman of
the Board of Directors. Mr. Iles serves as Chairman of Alexander & Alexander
Services UK plc, the parent company of the Company's European operations and
Chairman of Alexander Howden Group Ltd. (AHG), the Company's primary reinsurance
and specialist subsidiary. He formerly served as Senior Vice President of the
Company.
At the same meeting, the Board of Directors also made the following
appointments:
- - Edward F. Kosnik, Chief Financial Officer of the Company, was appointed
Senior Executive Vice President of the Company. He formerly served as
Executive Vice President of the Company.
- - Elliot S. Cooperstone, Chief Administrative Officer of the Company and
Executive Vice President and Chief Operating Officer of Alexander &
Alexander Inc., the Company's United States retail subsidiary, was
appointed Executive Vice President of the Company. He formerly served as
Senior Vice President of the Company.
- - Kenneth J. Davis, Chief Executive Officer of Alexander & Alexander Europe,
the Company's United Kingdom and European retail broking subsidiary, was
appointed Executive Vice President of the Company.
- - Dennis L. Mahoney, Deputy Chairman of AHG responsible for the Company's
global specialist operations, was appointed Executive Vice President of
the Company.
Also, on October 24, 1995, at its regular meeting of the Board of Directors of
the Company, pursuant to Article XI of the Company's Bylaws, the Board of
Directors amended the Company's Bylaws to provide for the position of senior
executive vice president of the Company.
44
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries
PART II. OTHER INFORMATION (continued)
--------------------------------------
ITEM 6. EXHIBITS
(a) Exhibits
Exhibit No. Item
----------- ----
3.0 Amendment to Bylaws of the Company,
dated October 24, 1995
11.0 Statement Re: Computation of per Common
Share Earnings
27.0 Financial Data Schedule
(b) Current Reports on Form 8-K
Current Report on Form 8-K was filed on September 11, 1995,
noticing the proposed acquisition of a majority of Jardine
Insurance Brokers Inc. U.S. Retail Operations.
Current Report on Form 8-K was filed on October 16, 1995,
noticing: (1) the completion on October 12, 1995 of the
acquisition of a majority of Jardine Insurance Brokers Inc.
U.S. Retail Operations; and (2) the redemption on October 13,
1995, of the Company's 11% Convertible Subordinated Debentures
due 2007 which was primarily funded by the Company through the
borrowing of $60 million under its long-term revolving credit
facility.
45
<PAGE>
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on the 14th day of November, 1995.
ALEXANDER & ALEXANDER SERVICES INC.
(Registrant)
BY: /s/Edward F. Kosnik November 14, 1995
----------------------------------------------------
Edward F. Kosnik Date
Senior Executive Vice
President & Chief
Financial Officer
46
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC.
Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 1995
INDEX TO EXHIBITS
Certain exhibits to this Report on Form 10-Q have been incorporated by
reference. For a list of these Exhibits see Item 6 hereof. The following
exhibits are being filed herewith:
Exhibit Page No.
- ------- --------
3.0 Amendment to Bylaws of the Company, dated
October 24, 1995 48
11.0 Statement Re: Computation of per Common Share
Earnings 51
27.0 Financial Data Schedule 52
47
EXHIBIT 3.0
SECRETARY'S CERTIFICATE
I, the undersigned, Secretary of Alexander & Alexander Services Inc., a
corporation organized under the laws of the State of Maryland, DO HEREBY CERTIFY
that at a meeting of the Board of Directors of said corporation duly held on the
24th day of October, 1995, a quorum being present, the following resolution was
duly adopted and has not been modified or rescinded, and is now in full force
and effect; and that the same is not in contravention of or in conflict with the
By-Laws of Charter or Articles of Incorporation and is in accord therewith and
pursuant thereto:
WHEREAS, the Board deems it appropriate to make certain amendments to
Article III of the By-Laws providing for the position of Senior
Executive Vice President;
NOW, THEREFORE, BE IT
RESOLVED, that Sections 1 and 8 or Article III of the By-Laws of the
Company are amended as shown in the attachment to the minutes marked
"Amendment to By-Laws."
I DO FURTHER CERTIFY that attached hereto and made a part hereof is a
true, complete and correct copy of the attachment referred to in the above
resolution.
WITNESS my hand and the seal of said Corporation this 8th day of
November, 1995.
CORPORATE SEAL
/s/ Alice L. Russell
-----------------------
Secretary
48
<PAGE>
AMENDMENT TO BY-LAWS
ARTICLE III. OFFICERS
---------------------
SECTION 1. Officers of the Corporation
The officers of the Corporation (hereinafter in this Article III being
referred to as "officers") may consist of a Chief Executive Officer, a
President, a Chief Financial Officer, one or more Senior Executive Vice
Presidents, one or more Executive Vice Presidents, one or more Senior Vice
Presidents, one or more Vice Presidents, one or more Assistant Vice Presidents,
a Controller, one or more Assistant Controllers, a Treasurer, one or more
Assistant Treasurers, a Secretary, and one or more Assistant Secretaries. All of
said officers shall be elected by the Board of Directors and, except officers
holding contracts for fixed terms, shall hold office only during the pleasure of
the Board or until their successors are chosen and qualify. Any two or more of
the above offices, except those of President and Vice President, may be held by
the same person, but no officer shall execute, acknowledge or verify any
instrument in more than one capacity, when such instrument is required to be
executed, acknowledged or verified by any two or more officers. The Chief
Executive Officer and the President may be chosen from among the directors. The
Board of Directors may from time to time appoint such other agents and
employees, with such powers and duties as they may deem proper. In its
discretion, the Board of Directors may leave unfilled any offices except those
of President, Treasury and Secretary.
49
<PAGE>
SECTION 8. Senior Executive Vice President and Executive Vice President.
The Senior Executive Vice President or Senior Executive Vice Presidents
shall be vested with all the powers and perform all the duties of the President
in his absence. He or they may sign certificates of stock, and shall perform
such other duties as may be prescribed by the Board of Directors, the Executive
Committee, the Chairman, the Chief Executive Officer or the President. The
Executive Vice President or Executive Vice Presidents shall be vested with all
the powers and perform all of the duties of the Senior Executive Vice President
in his absence, and shall perform such other duties as may be prescribed by the
Board of Directors, the Executive Committee, the Chairman, the Chief Executive
Officer, or the President.
50
<TABLE><CAPTION>
EXHIBIT 11.0
(UNAUDITED)
Alexander & Alexander Services Inc.
Computation of per Common Share Earnings
Three and Nine Months Ended September 30, 1995 and 1994
(in millions)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------- ------------------
1995 1994 1995 1994
---- ---- ---- ----
<S> <C> <C> <C> <C>
PRIMARY
- -------
Earnings (Loss) Attributable to Common
--------------------------------------
Shareholders:
-------------
Income (loss) before cumulative effect of
change in accounting $ 17.5 $(20.8) $ 81.9 $(24.8)
Cumulative effect of change in accounting 0.0 0.0 0.0 (2.6)
------ ------ ------ ------
Net income (loss) 17.5 (20.8) 81.9 (27.4)
Less: Preferred stock dividends (6.4) (4.8) (18.9) (9.0)
------ ------ ------ ------
Earnings (loss) attributable to common
shareholders $ 11.1 $(25.6) $ 63.0 $(36.4)
====== ====== ====== ======
Average Common and Common Equivalent Shares
-------------------------------------------
Outstanding:
------------
Average common shares outstanding 44.3 43.9 44.3 43.7
Add shares of common stock assumed issued on
exercise of stock options 0.3 0.0 0.2 0.0
------ ------ ------ ------
Average common and common equivalent shares
outstanding 44.6 43.9 44.5 43.7
====== ====== ====== ======
FULLY DILUTED
- -------------
Fully Diluted Earnings Per Share:
---------------------------------
Income (loss) before cumulative effect of
change in accounting $ 17.5 $(20.8) $ 81.9 $(24.8)
Cumulative effect of change in accounting 0.0 0.0 0.0 (2.6)
------ ------ ------ ------
Net income (loss) 17.5 (20.8) 81.9 (27.4)
Less: Preferred stock dividends (6.4) (4.8) (18.9) (9.0)
------ ------ ------ ------
Earnings (loss) attributable to common
shareholders 11.1 (25.6) 63.0 (36.4)
Add: Series B preferred stock dividends 0.0 0.0 12.7 0.0
------ ------ ------ ------
Net income (loss) available to common
shareholders $ 11.1 $(25.6) $ 75.7 $(36.4)
====== ====== ====== ======
Average Common Shares Outstanding, Assuming
-------------------------------------------
Full Dilution:
--------------
Average common shares outstanding 44.3 43.9 44.3 43.7
Add shares of common stock assumed issued on:
Exercise of stock options 0.3 0.0 0.3 0.0
Conversion of Series B preferred stock 0.0 0.0 12.5 0.0
------ ------ ------ ------
Average common shares outstanding, assuming
full dilution 44.6 43.9 57.1 43.7
====== ====== ====== ======
</TABLE>
51
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000003449
<NAME> ALEXANDER & ALEXANDER SERVICES INC.
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> SEP-30-1995
<CASH> 804
<SECURITIES> 239
<RECEIVABLES> 1,173
<ALLOWANCES> 24
<INVENTORY> 0
<CURRENT-ASSETS> 2,318
<PP&E> 408
<DEPRECIATION> 286
<TOTAL-ASSETS> 2,882
<CURRENT-LIABILITIES> 2,035
<BONDS> 0
<COMMON> 42
0
7
<OTHER-SE> 353
<TOTAL-LIABILITY-AND-EQUITY> 2,882
<SALES> 0
<TOTAL-REVENUES> 952
<CGS> 0
<TOTAL-COSTS> 844
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 10
<INCOME-PRETAX> 114
<INCOME-TAX> 44
<INCOME-CONTINUING> 64
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 64
<EPS-PRIMARY> 1.17
<EPS-DILUTED> 1.06
</TABLE>
