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 June 30, 1996
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 offices) (Zip Code)
Registrant's telephone number, including area code (212) 444-4500
-------------------
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 August 1,
1996 was 42,872,383.
The number of shares of Class A Common Stock, $.00001 par value, outstanding as
of August 1, 1996 was 1,811,120.
The number of shares of Class C Common Stock, $1 par value, outstanding as of
August 1, 1996 was 357,151.
No shares of Class D Common Stock, $1 par value, were outstanding as of August
1, 1996.
<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 Six Months Ended June 30, 1996 and 1995...............2
Condensed Consolidated Balance Sheets, as of
June 30, 1996(Unaudited) and December 31, 1995..................3
Unaudited Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1996 and 1995.........................5
Unaudited Notes to Financial Statements...........................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............21
Part II. Other Information:
Item 1. Legal Proceedings...........................................36
Item 4. Submission of Matters to a Vote of Security Holders.........36
Item 6. Exhibits....................................................37
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 Six Months Ended June 30, 1996 and 1995
---------------------------------------------------------
(in millions, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating revenues:
Commissions and fees $319.3 $311.4 $619.0 $619.7
Fiduciary investment income 15.9 16.7 30.5 32.6
------ ------ ------ ------
Total 335.2 328.1 649.5 652.3
------ ------ ------ ------
Operating expenses:
Salaries and benefits 191.2 186.4 375.0 368.5
Other 105.9 102.5 207.9 202.9
------ ------ ------ ------
Total 297.1 288.9 582.9 571.4
------ ------ ------ ------
Operating income 38.1 39.2 66.6 80.9
------ ------ ------ ------
Other income (expenses):
Investment income 3.0 4.4 7.1 9.3
Interest expense (3.9) (5.0) (7.9) (9.5)
Other (0.5) 2.4 (0.5) 32.8
------ ------ ------ ------
Total (1.4) 1.8 (1.3) 32.6
------ ------ ------ ------
Income before income taxes and
minority interest 36.7 41.0 65.3 113.5
Income taxes 14.7 17.2 26.0 43.7
------ ------ ------ ------
Income before minority interest 22.0 23.8 39.3 69.8
Minority interest (0.5) (1.1) (4.7) (5.4)
------ ------ ------ ------
Net income 21.5 22.7 34.6 64.4
Preferred stock dividends (6.6) (6.3) (13.2) (12.5)
------ ------ ------ ------
Earnings attributable to common
shareholders $ 14.9 $ 16.4 $ 21.4 $ 51.9
====== ====== ====== ======
PER SHARE INFORMATION:
- ----------------------
Primary earnings per share $ 0.33 $ 0.37 $ 0.48 $ 1.17
====== ====== ====== ======
Average common and common equivalent shares
outstanding 45.2 44.6 45.1 44.4
====== ====== ====== ======
Fully diluted earnings per share $ 0.33 $ 0.36 $ 0.48 $ 1.06
====== ====== ====== ======
Average common shares outstanding, assuming
full dilution 45.2 57.0 45.1 56.9
====== ====== ====== ======
Cash dividends per common share $0.025 $0.025 $0.050 $0.050
====== ====== ====== ======
</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
June 30, 1996 (Unaudited) and December 31, 1995
-----------------------------------------------
(in millions)
June 30, December 31,
1996 1995
-------- ------------
ASSETS
Current assets:
Cash and cash equivalents:
Operating $ 232.2 $ 241.2
Fiduciary 663.0 496.4
Short-term investments:
Operating 10.7 11.3
Fiduciary 261.2 224.9
Premiums and fees receivable (less
allowance for doubtful accounts
of $20.6 in 1996 and $20.5 in 1995) 1,375.9 1,292.8
Deferred income taxes 18.6 20.0
Other current assets 75.0 85.4
-------- --------
Total current assets 2,636.6 2,372.0
Property and equipment - net 119.9 126.4
Intangible assets - net 221.3 210.7
Deferred income taxes 107.1 102.1
Long-term operating investments 30.3 30.9
Other 116.8 100.3
-------- --------
$3,232.0 $2,942.4
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Premiums payable to insurance companies $2,075.6 $1,810.4
Short-term debt 11.2 19.1
Current portion of long-term debt 8.0 9.3
Deferred income taxes 9.3 9.4
Accrued compensation and related benefits 42.6 81.8
Income taxes payable 42.7 24.7
Other accrued expenses 146.9 165.8
-------- --------
Total current liabilities 2,336.3 2,120.5
-------- --------
Long-term liabilities:
Long-term debt 152.4 126.2
Deferred income taxes 18.7 15.6
Net liabilities of discontinued operations 30.3 33.4
Other 246.7 234.1
-------- --------
Total long-term liabilities 448.1 409.3
-------- --------
Commitments and contingent liabilities
(Notes 3, 6 and 9)
8% Series B cumulative convertible preferred
stock contingency (Note 9) 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)
June 30, 1996 (Unaudited) and December 31, 1995
-----------------------------------------------
(in millions)
<TABLE>
<CAPTION>
June 30, December 31,
1996 1995
------------ ------------
<S> <C> <C>
Stockholders' equity:
Preferred stock, authorized 15,000,000 shares, $1 par value:
Series A junior participating preferred
stock, issued and outstanding, none $ - $ -
$3.625 Series A convertible preferred stock,
issued and outstanding, 2,300,000 shares,
liquidation preference of $115 million 2.3 2.3
8% Series B cumulative convertible preferred
stock, issued and outstanding, 4,658,047 and
4,477,170 shares, respectively, liquidation
preference of $233 million and $224 million,
respectively 4.7 4.5
Common stock, authorized 200,000,000 shares, $1 par
value; issued and outstanding 42,872,279
and 42,259,282 shares, respectively 42.9 42.3
Class A common stock, authorized 26,000,000 shares,
$.00001 par value; issued and outstanding
1,811,121 and 1,920,821 shares, respectively - -
Class C common stock, authorized 11,000,000 shares,
$1 par value; issued and outstanding
357,151 and 361,092 shares, respectively 0.4 0.4
Class D common stock, authorized 40,000,000 shares,
$1 par value; issued and outstanding, none - -
Paid-in capital 650.1 638.1
Accumulated deficit (208.3) (227.5)
Unrealized investment gains - net of income taxes 5.4 5.6
Accumulated translation adjustments (59.9) (63.1)
-------- --------
Total stockholders' equity 437.6 402.6
-------- --------
$3,232.0 $2,942.4
======== ========
</TABLE>
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 Six Months Ended June 30, 1996 and 1995
-----------------------------------------------
(in millions)
Six Months Ended
June 30,
------------------
1996 1995
---- ----
Cash provided (used) by:
Operating activities:
Income from continuing operations $ 34.6 $ 64.4
Adjustments to reconcile to net cash
provided (used) by operating activities:
Depreciation and amortization 24.6 22.4
Deferred income taxes 1.0 17.1
Gains on dispositions of subsidiaries
and other assets - (32.0)
Other 7.2 6.3
Changes in assets and liabilities (net of
effects from acquisitions and
dispositions):
Premiums and fees receivable (79.9) (67.7)
Prepaid expenses and other current assets 15.7 (15.5)
Other non-current assets (12.7) (10.3)
Premiums payable to insurance companies 259.3 231.4
Accounts payable (2.1) (7.5)
Other current liabilities (50.2) (93.4)
Other long-term liabilities 17.9 (3.7)
Net fiduciary cash and cash equivalents
and short-term investments (201.4) (181.5)
Discontinued operations (6.2) (12.5)
------- -------
Net cash provided (used) by operating
activities 7.8 (82.5)
------- -------
Investing activities:
Net purchases of property and equipment (10.3) (7.5)
Purchases of businesses (20.7) (2.0)
Proceeds from sales of subsidiaries and
other assets 0.2 87.8
Purchases of operating investments (15.3) (85.8)
Sales and maturities of operating investments 16.9 89.2
------- -------
Net cash provided (used) by investing
activities (29.2) 81.7
------- -------
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 June 30, 1996 and 1995
-----------------------------------------------
(in millions)
Six Months Ended
June 30,
------------------
1996 1995
---- ----
Financing activities:
Cash dividends $ (6.4) $ (6.4)
Proceeds from issuance of short-term debt 4.9 0.1
Payments of short-term debt (10.7) (0.6)
Proceeds from issuance of long-term debt 30.1 0.4
Repayments of long-term debt (8.1) (30.2)
Issuance of common stock 1.2 0.1
------- -------
Net cash provided (used) by financing
activities 11.0 (36.6)
------- -------
Effect of exchange rate changes on operating
cash and cash equivalents 1.4 4.9
Operating cash and cash equivalents at
beginning of year 241.2 248.7
------- -------
Operating cash and cash equivalents at end
of period $ 232.2 $ 216.2
======= =======
Supplemental cash flow information:
Cash paid during the period for:
Interest $ 5.6 $ 9.1
Income taxes 2.3 59.9
Non-cash investing and financing activities:
Notes payable issued for contingency
settlements $ - $ 45.7
Series B cumulative convertible preferred
stock dividends-in-kind 9.0 8.4
Common stock issued for employee benefit and
stock plans 2.4 2.1
Common stock issued for non-employee stock
plans 0.2 0.3
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. In the opinion of the Company, all adjustments, consisting only of
normal recurring accruals, necessary for a fair presentation have been
included in the consolidated financial statements. The results of
operations for the first six months of the year are not necessarily
indicative of results for the year.
2. Acquisitions and Dispositions
Acquisitions
In the first six months of 1996, the Company acquired or invested in
several brokerage and consulting operations, primarily in the Asia/Pacific
region, for combined purchase prices approximating $26.5 million. The
Company paid a total of $20.4 million at closing and accounted for these
acquisitions as purchase transactions. The acquisitions are expected to
produce about $30 million in annualized revenues.
Dispositions
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 resulting in a pre-tax gain of $30.3 million, ($20.8 million
after-tax or $0.47 per share). Adjustments, including post closing
adjustments pursuant to the agreement, resulted in a final reported pre-tax
gain of $28.7 million, ($18.7 million after-tax or $0.42 per share) for the
year ended December 31, 1995.
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.
3. Income Taxes
On August 6, 1996, the Company received a technical advice memorandum
("TAM"), issued by the IRS National Office, favorable to the Company with
respect to the federal income tax consequences of certain 1991 intercompany
transactions involving the stock of a U.K. subsidiary. The Company and its
independent tax counsel expect that the IRS District Director's Office will
adopt the TAM and will withdraw its proposal to increase taxable income for
the year 1991 with respect to this issue. The potential additional tax
liability, excluding interest and penalties, associated with this issue had
been estimated by the Company at $50 million. The examination of the
Company's 1990 and 1991 federal income tax returns will come to a
conclusion with the disposition of this issue.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
3. Income Taxes (continued)
Based upon the favorable TAM relating to the 1991 transactions, the Company
does not expect IRS examiners to take issue with the Company's reporting of
a similar series of transactions that occurred in 1993. The IRS commenced
its examination of the tax years 1992 through 1994 in July 1996. The
potential additional tax liability, excluding interest and penalties,
associated with the 1993 transactions had been estimated by the Company at
$25 million.
No provision for any potential liability with respect to the 1991 and 1993
transactions had been made in the consolidated financial statements.
The Company believes that its current tax reserves are adequate to cover
its tax liabilities.
4. Employees' Retirement Plans and Benefits
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 123, "Accounting for Stock Based
Compensation". The Company has elected to continue to measure compensation
costs using APB Opinion No. 25 and accordingly will provide the disclosures
required by SFAS No. 123 in its Annual Report on Form 10-K for the year
ended December 31, 1996.
5. Stock Option and Incentive Plans
Worldwide Employee Savings-Related Stock Purchase Plan
The Company's Worldwide Employee Savings-Related Stock Purchase Plan
(Worldwide Employee Purchase Plan) was approved by the Board of Directors
and became effective as of May 16,1996. Under the Worldwide Employee
Purchase Plan eligible employees outside the U.S. may purchase up to an
aggregate 750,000 shares of the Company's Common Stock. At the end of the
5-year offering period, participants can elect to purchase from the
contributions saved, shares of the Company's Common Stock at a 15 percent
discount of the closing price of the Common Stock reported on the New York
Stock Exchange on the first date of the 5-year offering period. 534,000
shares have been subscribed to as of June 30, 1996. Non-U.S. employees who
are "executive officers" of the Company, as that term is defined pursuant
to Section 16 of the Securities Exchange Act of 1934, participate in a
subplan of the Employee Discount Stock Purchase Plan with similar terms.
1995 Long-Term Incentive Plan Amendment
On May 16, 1996 an amendment to the 1995 Long-Term Incentive Plan (1995
LTIP) was approved by stockholders. The 1995 LTIP provided that no more
than 940,000 restricted shares may be used for Restricted Stock Awards and
Bonus Equity Plan Awards (BEP). The amendment excluded BEP Awards from the
940,000 restricted share limitation, but does not increase the number of
shares authorized under the 1995 LTIP.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
6. 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 Limited (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.
A summary of the net liabilities of discontinued operations is as follows:
As of As of
June 30, 1996 December 31, 1995
------------- -----------------
Liabilities:
Insurance liabilities $251.3 $257.1
Other 13.8 14.9
------ ------
Total liabilities 265.1 272.0
------ ------
Assets:
Recoverable under finite risk contracts:
Insurance liabilities 125.2 126.4
Premium adjustment 9.8 9.8
Reinsurance recoverables 53.3 51.6
Cash and investments 27.4 27.2
Other 7.9 9.3
------ ------
Total assets 223.6 224.3
------ ------
Total net liabilities of discontinued
operations 41.5 47.7
Less current portion classified as
other accrued expenses 11.2 14.3
------ ------
Remainder classified as net liabilities
of discontinued operations $ 30.3 $ 33.4
====== ======
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.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
6. Discontinued Operations (continued)
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 clean-up (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 relevant industry 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 insurance pool 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.
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
June 30, 1996, based on an estimate by an independent actuarial firm, the
Company had accrued $12.9 million of the deductible.
On July 1, 1994, the Company entered into an insurance-based financing
contract (finite risk contract) with the reinsurance company providing
protection primarily for exposures relating to Orion, Syndicate 701 and
Swann & Everett. The contract provided for the payment by the Company of
$80 million, $50 million of which was borrowed from 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 June 30, 1996, recoveries were
limited to $118.9 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,
all of which are under the Company's control, 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.
<PAGE>
Alexander & Alexander Services Inc. and Subsidiaries (the Company)
PART I. FINANCIAL INFORMATION (continued)
-----------------------------
Item 1. Financial Statements (continued)
Unaudited Notes to Financial Statements (continued)
---------------------------------------------------
(in millions, except per share information)
6. Discontinued Operations (continued)
Changes in the total net liabilities of discontinued operations for the six
months ended June 30, 1996 are as follows:
Beginning balance $ 47.7
Claims and expense payments (6.2)
Other -
-----
Ending Balance $ 41.5
======
While the insurance liabilities set forth above represent the Company's
best estimate of the probable liabilities within a range of independent
actuarial estimates of reasonably probable loss amounts, there is no
assurance that further adverse developments may not occur due to variables
inherent in the estimation processes and other matters described above.
Based on independent actuarial estimates of a range of reasonably possible
loss amounts, liabilities could exceed recorded amounts by approximately
$170 million. However, in the event of such adverse developments, based on
independent actuarial estimates of pay-out patterns, up to approximately
$130 million of this excess would be recoverable under the finite risk
contracts.
The Company believes that, based on current estimates, the established
total net liabilities of discontinued operations are sufficient to cover
its exposures.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
7. Investments
At June 30, 1996, net unrealized holding gains totaled $5.4 million, net of
deferred income taxes of $1.8 million, and are reported as a separate
component of Stockholders' Equity.
At June 30, 1996 and December 31, 1995, the amortized cost and estimated
fair value of the Company's debt and equity securities and related
financial instruments used to hedge such investments are summarized below:
<TABLE>
<CAPTION>
June 30, 1996
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
U.S. Government agencies/
state issuances $ - $ - $ - $ -
Other interest-bearing
securities 171.4 - - 171.4
Mortgage-backed securities 5.8 - - 5.8
Equity securities 3.8 7.1 - 10.9
Financial instruments - used
as hedges - 0.7 (0.6) 0.1
--------- -------- --------- --------
Total $ 181.0 $ 7.8 $ (0.6) $ 188.2
========= ======== ========= ========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1995
--------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
U.S. Government agencies/
state issuances $ 2.7 $ - $ - $ 2.7
Other interest-bearing
securities 138.1 - - 138.1
Mortgage-backed securities - - - -
Equity securities 3.1 6.5 - 9.6
Financial instruments - used
as hedges - 1.3 (0.2) 1.1
--------- -------- --------- -------
Total $ 143.9 $ 7.8 $ (0.2) $ 151.5
========= ======== ========= =======
</TABLE>
The above debt and equity securities and financial instruments used as hedges
are classified in the Consolidated Balance Sheets as follows:
June 30, 1996 December 31, 1995
------------- -----------------
Cash and cash equivalents:
Operating $ 21.8 $ 34.1
Fiduciary 138.8 73.1
Short-term investments:
Operating - 0.3
Fiduciary 3.0 18.8
Long-term operating investments 24.6 25.2
------ ------
Total $188.2 $151.5
====== ======
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 (continued)
---------------------------------------------------
(in millions, except per share information)
7. Investments (continued)
At June 30, 1996 and December 31, 1995, the amortized cost and estimated
fair value of debt securities by contractual maturity are summarized below:
June 30, 1996
---------------------------
Estimated
Amortized Fair
Cost Value
--------- ---------
Due in one year or less $ 162.1 $ 162.1
Due after one year through five years 0.2 0.2
Due after five years through ten years 5.1 5.1
Due after ten years 4.0 4.0
--------- --------
171.4 171.4
Mortgage-backed securities 5.8 5.8
--------- --------
Total debt securities $ 177.2 $ 177.2
========= ========
December 31, 1995
---------------------------
Estimated
Amortized Fair
Cost Value
--------- ----------
Due in one year or less $ 120.8 $ 120.8
Due after one year through five years 4.8 4.8
Due after five years through ten years 10.2 10.2
Due after ten years 5.0 5.0
--------- --------
140.8 140.8
Mortgage-backed securities - -
--------- -------
Total debt securities $ 140.8 $ 140.8
========= ========
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.
8. Debt
The Company has a $200 million three year credit 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 net worth,
maximum leverage and minimum cash flow requirements. Interest rates charged
on amounts drawn on this credit agreement are dependent upon the Company's
credit ratings, the duration of the borrowings and the Company's choice of
one of a number of indices, including the prime lending rate, certificate
of deposit rates, the federal funds rate and LIBOR. As of June 30, 1996, a
$10 million letter of credit has been issued and $60 million of unsecured
borrowings were outstanding under the agreement. In July 1996, the $10
million letter of credit was cancelled.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
8. Debt (continued)
In March 1996, the Company obtained a $10 million, short term bank loan
which was subsequently repaid in April 1996.
As part of the October 1995 agreement for the purchase of JIB, the Company
paid a promissory note totaling $10.6 million in April, 1996. During the
second quarter of 1996, the October 1996 promissory note was revalued to $6
million in accordance with the revenue retention criteria for the former
JIB offices stipulated in the purchase agreement.
In April 1996, the Company paid the first installment of $5.8 million on
the Mutual Fire zero-coupon note. (See Note 9 of the Unaudited Notes to
Financial Statements).
In May 1996, the Company issued a $2.7 million, 9 percent two year note,
relating to an acquisition in the Asia/Pacific region. This note is
contingent upon future results of the acquired business. (See Note 2 of the
Unaudited Notes to Financial Statements).
9. 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 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. The remaining claim asserting
these allegations is pending in a suit filed in New York. In an 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 certain of the
plaintiffs for contribution. Discovery in this case remains to be concluded
and no trial date has been set. 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
action. This action is 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 this action,
if any, would not be material to the Company's financial position or
results of operations.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
9. Contingencies (continued)
In 1987, the Company sold Shand Morahan & Company (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 Marine & Inland
Insurance Company (Mutual Fire). Mutual Fire was placed in rehabilitation
by the Courts of the Commonwealth of Pennsylvania in December 1986. In
February 1991, the rehabilitator commenced an action captioned Foster v.
Alexander & Alexander Services Inc., 91 Civ. 1179 (E.D.Pa.). 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 sought damages estimated at approximately
$234 million.
On March 27, 1995, the Company, Shand and the rehabilitator entered into a
settlement agreement which was 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 and issued a $35 million six-year
zero-coupon note. In addition, in 1995 Shand 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. In April 1996 the Company paid the
first installment on the zero-coupon note in the amount of $5.8 million.
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 (Alexander &
Alexander Services Inc. and Alexander & Alexander Inc. v. Those Certain
Underwriters at Lloyd's of London, subscribing to insurance evidence by
policy numbers 879/P. 31356 and 879/P. 35349 and Assicurazioni Generali,
S.P.A., No. 92 Civ. 6319 (F.D.N.Y.)). All required documents in this case
have been submitted to the Court, and the Company is awaiting a decision on
the matter.
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.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
9. Contingencies (continued)
Starting in late 1992, the purchaser of Shand has asserted a number of
claims under both the Mutual Fire indemnification provision and the errors
and omissions indemnification provision of the sales agreement. During
1995, most of those claims have been resolved by a series of settlement
agreements, 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 potential
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 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 contingent obligation of $4.5 million.
In June 1995, the $14 million note payable was prepaid in whole. The
remaining contingent note payable of $4.5 million was paid in full in
September 1995.
Notwithstanding these settlements, 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.
In response to the second amended complaint, the Company filed a motion to
dismiss. On March 4, 1996, the Court entered an order granting the
Company's motion to dismiss the action and plaintiff was denied leave to
replead. Following plaintiff's filing a notice of appeal, the parties
entered into a stipulation withdrawing the appeal, which was entered by the
court on June 17, 1996, thereby terminating the litigation.
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.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
9. Contingencies (continued)
Under the Series B Convertible Preferred Stock Purchase Agreement, as
amended, the Company has agreed to make certain payments to the purchaser
pursuant to indemnifications given with respect to tax payments and
reserves in excess of recorded tax reserves as of March 31, 1994. The
Company's potential exposures under the indemnification, individually or in
the aggregate, are limited to $10 million. 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.
10. 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 with settlements 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 foreign exchange forward contracts 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
forward contracts at June 30, 1996 was an asset of $1.1 million and a
liability of $0.1 million as of December 31, 1995.
At June 30, 1996, the Company had $84.7 million notional principal of
forward exchange contracts outstanding, primarily to exchange U.S. dollars
into U.K. pounds sterling, and $30.2 million notional principal
outstanding, primarily to exchange U.K. pounds sterling into U.S. dollars.
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 June 30, 1996, the Company had
$20 million notional principal of written foreign exchange options
outstanding. Based on foreign exchange rates at June 30, 1996 and December
31, 1995, the Company recognized a current liability of $0.5 million and
$0.6 million, respectively, consisting of unamortized premiums and the
estimated cost to settle these options on those dates.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
10. Financial Instruments (continued)
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. 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 held as investments by the Company are marked to
market in accordance with SFAS No. 115. At June 30, 1996, an unrealized
gain of $0.1 million on interest rate swaps and forward rate agreements
which hedge existing fiduciary investments was reflected in fiduciary cash
and equivalents in the Consolidated Balance Sheet.
At June 30, 1996 and December 31, 1995 the Company had the following
interest rate swaps and forward rate agreements in effect, by year of final
maturity:
June 30, 1996
------------------------------------------------------
Gross Net Weighted Gross Net Weighted
Receiving Average Paying Average
Year Fixed Interest Rate Fixed Interest Rate
---- --------- ------------- ------ -------------
1996 $ 161.0 6.07% $111.0 5.54%
1997 553.0 6.55 65.0 6.03
1998 238.5 6.97 - -
1999 65.4 6.37 - -
-------- ---- ------ ----
Total $1,017.9 6.56% $176.0 5.72%
======== ==== ====== ====
December 31, 1995
------------------------------------------------------
Gross Net Weighted Gross Net Weighted
Receiving Average Paying Average
Year Fixed Interest Rate Fixed Interest Rate
---- --------- ------------- ------ -------------
1996 $390.3 7.38% $471.7 6.27%
1997 203.2 6.68 40.0 5.90
1998 182.9 7.08 - -
------ ---- ------ ----
Total $776.4 7.13% $511.7 6.24%
====== ==== ====== ====
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
reset dates. Forward rate agreements generally have a final maturity date
that is less than two years, and use six-month LIBOR as the floating rate
index.
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.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
10. Financial Instruments (continued)
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 $0.7 million and $0.3 million, representing the estimated cost to settle
these options at June 30, 1996 and December 31, 1995, 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.
At June 30, 1996 and December 31, 1995, the Company had the following
written interest rate option agreements outstanding, by year of final
maturity:
June 30, 1996
------------------------------------------------------
Gross Net Weighted Gross Net Weighted
Receiving Average Paying Average
Year Fixed Interest Rate Fixed Interest Rate
---- --------- ------------- ------ -------------
1996 $ 33.2 5.66% $ - - %
1997 71.0 6.68 - -
1998 61.0 7.05 - -
------ ---- ----- ----
Total $165.2 6.61% $ - - %
====== ==== ===== ====
December 31, 1995
-----------------------------------------------------
Gross Net Weighted Gross Net Weighted
Receiving Average Paying Average
Year Fixed Interest Rate Fixed Interest Rate
---- --------- ------------- ------ -------------
1996 $43.2 5.41% $10.0 4.60%
1997 15.5 8.50 - -
1998 10.0 8.50 - -
----- ---- ----- ----
Total $68.7 6.54% $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 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.
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 (continued)
---------------------------------------------------
(in millions, except per share information)
10. 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.
<TABLE>
<CAPTION>
As of June 30, 1996 As of December 31, 1995
------------------- -----------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Long-term debt, including
current portion $160.4 $158.5 $135.6 $135.8
Interest rate swaps and
forward rate agreements - 2.1 - 5.1
</TABLE>
20
<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
--------
Alexander & Alexander Services Inc. (the "Company") provides professional
risk management consulting, insurance brokerage and human resource
management consulting services from offices in more than 80 countries. The
Company's principal industry segments are (i) insurance services, comprised
of risk management and insurance broking services and specialist and
reinsurance broking, and (ii) human resource management consulting.
The Company's insurance services revenues are generally derived from
commissions and fees and can be affected by pricing and seasonality. The
Company's insurance broking revenues are generally impacted by overall
available market capacity and premium rates charged by insurance companies.
Insurance broking commissions and fee growth continue to be constrained,
particularly in North America and the London-based specialist and
reinsurance operations, due to soft pricing and excess market capacity and
the resultant intense competition among insurance carriers and brokers for
market share. These market conditions are becoming increasingly evident in
the risk management and insurance broking operations in the U.K.,
Continental Europe and in other parts of the world. Soft market conditions
were prevalent in the first half of 1996 and are expected to continue in
most insurance coverages throughout 1996. In addition, an increasing number
of companies are securing competitive bids for their insurance needs
resulting in higher account turnover rates.
Moderate revenue growth is expected from the Company's human resource
management consulting operations during 1996, excluding the impact of the
transfer of a business unit to the insurance services segment.
The timing and realization of revenues are also affected by the timing of
renewal cycles in different parts of the world and lines of business. This
produces a degree of seasonality in the Company's results. Broking revenues
for risk management and insurance broking services are strongest during the
first quarter for Continental Europe and strongest in the U.S. and
Asia-Pacific during the fourth quarter. Specialist and reinsurance broking
revenues are strongest in the first and second quarters. Revenues for human
resource management consulting are typically strongest in the fourth
quarter and weakest in the first quarter.
In addition to commissions and fees, the Company derives revenues from
investment income earned on fiduciary funds. Contributing to the decline in
investment income is lower average interest rates during the second quarter
of 1996 versus the same period in 1995. There is also pressure from
insurance companies to shorten the time that fiduciary funds are held prior
to remittance to carriers. The approximate six percent decline in
investment income earned on fiduciary funds during the first six months of
1996 compared to 1995 is anticipated to continue for the full year.
The Company anticipates operating margins for its insurance broking
operations to remain under considerable pressure and are unlikely to
improve for the foreseeable future. Future earnings growth will be
dependent on both revenue growth from the development of new products and
services, new business generation and selective acquisitions, and the
continued emphasis on expense reductions.
21
<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)
------------------------------------------------------------------
OVERVIEW (CONTINUED)
--------------------
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. Nor can the Company
predict, if any such transaction is consummated, what the financial
benefit, if any, will be to the Company.
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 JUNE 30, 1996 VS. 1995
-----------------------------------------
CONSOLIDATED RESULTS
--------------------
The Company reported net income of $21.5 million, or $0.33 per share on
consolidated operating revenues of $335.2 million for the three months
ended June 30, 1996. Fully diluted earnings per share for the quarter were
also $0.33.
For the same period of 1995, the Company reported net income of $22.7
million, or $0.37 per share on consolidated operating revenues of $328.1
million. Fully diluted earnings per share for the quarter were $0.36.
Operating Revenues
------------------
Consolidated operating revenues for the second quarter of 1996 were $335.2
million compared to $328.1 million for the same period in 1995, an increase
of $7.1 million or 2.2 percent. Excluding the impact of foreign exchange
fluctuations, total revenues increased by $12.4 million, or 3.8 percent,
primarily due to acquisitions.
Commissions and Fees
Total commissions and fees for the second quarter of 1996 were $319.3
million compared to $311.4 million for the same period in 1995, an increase
of $7.9 million or 2.5 percent. Excluding the negative impact of foreign
exchange rates, total commissions and fees increased by $12.9 million, or
4.1 percent, of which approximately $16 million is attributable to
acquisitions. The offsetting decrease is due primarily to weak pricing
conditions.
Fiduciary Investment Income
Investment income earned on fiduciary funds for the second quarter of 1996
decreased by $0.8 million, or 4.8 percent, versus 1995 levels primarily due
to lower average interest rates, particularly in the U.K. and Canada.
22
<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 JUNE 30, 1996 VS. 1995 (CONTINUED)
-----------------------------------------------------
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 $1.2 million
in the second quarter of 1996 and $0.2 million in the same period in 1995.
For additional information relating to the Company's interest rate
financial instruments, see Note 10 of Unaudited Notes to Financial
Statements and Note 12 of Audited Notes to Financial Statements in the
Company's Annual Report on Form 10-K for the year ended December 31, 1995.
Operating Expenses
Consolidated operating expenses for the second quarter of 1996 were $297.1
million compared to $288.9 million for the same period in 1995, an increase
of $8.2 million or 2.8 percent. Excluding the impact of favorable foreign
exchange fluctuations of $6.3 million, total operating expenses increased
$14.5 million or 5 percent, primarily due to acquisitions. Total expenses
were essentially flat compared to the prior year quarter after adjusting
for the estimated impact of these acquisitions.
Salaries and Benefits
Consolidated salaries and benefits for the second quarter of 1996 were
$191.2 million compared to $186.4 million for the same period in 1995, an
increase of $4.8 million or 2.6 percent. After adjusting for changes in
foreign exchange rates, consolidated salaries and benefits increased by $8
million, or 4.3 percent, versus the comparable quarter in 1995.
Acquisitions increased salaries and benefits by approximately $10 million.
Offsetting this increase was the decline in headcount from approximately
11,700 at June 30, 1995 to approximately 11,300 at June 30, 1996, excluding
an increase of approximately 700 people due to acquisitions in the fourth
quarter of 1995 and first half of 1996, as well as a reduction in employee
benefit costs and lower incentive compensation, primarily in the U.S. and
U.K.
Other Operating Expenses
Consolidated other operating expenses increased by $3.4 million, or 3.3
percent in the second quarter of 1996 compared to 1995. Excluding the
favorable impact of changes in foreign currency rates, including hedging
contract gains and losses, total other operating expenses increased $6.5
million, or 6.3 percent, for the comparable period, including approximately
$5 million from acquisitions.
Contributing to this increase is higher goodwill amortization and other
expenses relating to the acquisitions and increased costs associated with
the Company's ongoing investment in information technology. Partially
offsetting this increase was a decrease in insurance costs primarily
relating to the Company's professional indemnity programs.
OTHER INCOME (EXPENSES)
Investment Income
Investment income earned on operating funds decreased in the second quarter
of 1996 by $1.4 million, or 31.8 percent over the comparable period in
1995. The decrease is primarily due to a reduction in average investment
balances and lower interest rates, particularly in the U.S.
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 (continued)
------------------------------------------------------------------
THREE MONTHS ENDED JUNE 30, 1996 VS. 1995 (CONTINUED)
-----------------------------------------------------
Interest Expense
Interest expense decreased by $1.1 million, or 22 percent, in the second
quarter of 1996 versus 1995. The decrease is primarily due to the Company's
redemption and subsequent funding of the 11% convertible subordinated
debentures with borrowings at more favorable rates under the long term
credit facility.
Other
Other Income (expense) decreased by $2.9 million for the second quarter of
1996 versus 1995. The 1995 results include pre-tax gains of $1.4 million
for the sale of two small operations.
Income Taxes
The Company's effective tax rate for the second quarter was 40.1 percent of
income before taxes in 1996 and 41.9 percent in 1995. The effective tax
rates are higher than the U.S. statutory rate of 35 percent primarily due
to U.S. state and local income taxes and to the nondeductibility of certain
expenses, including entertainment and amortization of goodwill, in various
jurisdictions in which the Company does business. Partially offsetting
these factors was the favorable impact of foreign tax rates which were
lower than the U.S. statutory rate.
SEGMENT INFORMATION
INSURANCE SERVICES
Operating results for the Insurance Services segment of the Company's
operations are summarized below:
Three Months Ended June 30,
---------------------------
1996 1995
---- ----
Operating revenues:
Risk management and insurance services
broking $196.5 $187.2
Specialist insurance and reinsurance
broking 69.1 70.8
Fiduciary investment income 15.8 16.6
------ ------
Total operating revenues 281.4 274.6
Operating expenses 241.3 229.9
------ ------
Operating income $ 40.1 $ 44.7
====== ======
Risk Management and Insurance Services Broking Revenues
Worldwide risk management and insurance services broking commissions and
fees were $196.5, an increase of $9.3 million, or 5 percent, for the second
quarter of 1996 versus 1995. Excluding the impact of an unfavorable foreign
exchange rate variance of $3.3 million, revenues increased by $12.6 million
or 6.7 percent.
The increase is primarily due to the effect of acquisitions, which
approximated $16 million, and revenue gains in the Company's U.K.
operations and Asia/Pacific regions. Excluding acquisitions, revenues were
lower in the North American operations.
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 JUNE 30, 1996 VS. 1995 (CONTINUED)
-----------------------------------------------------
Specialist Insurance and Reinsurance Broking Revenues
-----------------------------------------------------
Total second quarter 1996 broking commissions and fees for the specialist
insurance and reinsurance broking operations decreased $1.7 million, or 2.4
percent, versus 1995 levels. Changes in foreign exchange rates decreased
second quarter broking revenues by $1.1 million. After adjusting for the
effect of changes in foreign exchange rates, commissions and fees decreased
$0.6 million or 0.8 percent. This decrease was primarily due to shortfalls
in the U.K. due to lower premium rates.
Fiduciary Investment Income
For the second quarter of 1996 investment income earned on fiduciary funds
held by the Company was $15.8 million versus $16.6 million for the
comparable period in 1995, a decrease of $0.8 million, or 4.8 percent. The
decrease was primarily due to lower average interest rates, particularly in
the U.K. and Canada.
Operating Expenses
Operating expenses were $241.3 million for the second quarter of 1996, an
increase of $11.4 million versus the comparable period in 1995. Excluding
the impact of foreign exchange rate changes, including hedging and
contracts gains and losses of $5.8 million, operating expenses increased
$17.2 million, or 7.5 percent on a comparable basis due mainly to an
approximate $14 million impact from acquisitions.
HUMAN RESOURCE MANAGEMENT CONSULTING
Operating results for the Human Resource Management Consulting segment of
the Company's operations are summarized below:
Three Months Ended
June 30,
------------------
1996 1995
-------- --------
Operating revenues:
Commissions and fees $ 53.7 $ 53.4
Fiduciary investment income 0.1 0.1
-------- --------
Total operating revenues 53.8 53.5
Operating expenses 49.1 50.5
-------- --------
Operating income $ 4.7 $ 3.0
======== ========
Human resource management consulting commissions and fees of $53.7 million
increased by $0.3 million, or 0.6 percent, in the second quarter of 1996
compared to the same period in 1995. After adjusting for the effects of
changes in foreign exchange rates and the impact of the transfer of a
business unit to the U.S. risk management and insurance services
operations, these revenues increased by $2.5 million, or 4.8 percent. This
increase is primarily attributable to revenue gains in the U.S. and U.K.
operations and the 1996 acquisitions of two small operations in Australia
and Sweden.
Operating expenses decreased by $1.4 million, or 2.8 percent, for the
second quarter of 1996 compared to 1995. After adjusting for the effect of
changes in foreign exchange rates and the transfer of a business unit,
operating expenses increased by $1.1 million or 2.3 percent. This increase
was primarily attributable to the U.K. operations and the 1996
acquisitions.
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)
------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 1996 VS. 1995
---------------------------------------
CONSOLIDATED RESULTS
The Company reported net income of $34.6 million, or $0.48 per share on
consolidated operating revenues of $649.5 million for the six months ended
June 30, 1996. Fully diluted earnings per share for the six months ended
June 30, 1996 were also $0.48.
For the six months ended June 30, 1995, the Company reported net income of
$64.4 million, or $1.17 per share, on consolidated operating revenues of
$652.3 million. Fully diluted earnings per share for the six months ended
June 30, 1995 were $1.06. Included in the results is an after-tax gain of
$20.8 million, or $0.47 per share, from the sale of Alexsis, the Company's
U.S.-based third party administrator operation.
Operating Revenues
Consolidated operating revenues were $649.5 million for the first half of
1996, a decrease of $2.8 million, or 0.4 percent, from the corresponding
period in 1995. Revenue comparisons were impacted by both foreign currency
fluctuations and the effect of dispositions. After adjusting for the effect
of these items, total revenues increased $15 million, or 2.3 percent,
primarily due to acquisitions.
Commissions and Fees
Total commissions and fees were $619 million for the first half of 1996, a
decrease of $0.7 million, or 0.1 percent, compared to the same period in
1995. After adjusting for the negative impact of foreign exchange rates and
the impact of operations sold in 1995, total commissions and fees increased
by $16.5 million, or 2.7 percent. This increase is due primarily to the
addition of approximately $26 million from acquisitions offset by the
impact of soft market conditions.
Fiduciary Investment Income
Investment income earned on fiduciary funds for the first half of 1996
decreased by $2.1 million, or 6.4 percent, versus 1995 levels primarily due
to lower average investment levels, particularly in the U.K. and lower
worldwide interest rates, particularly in the U.K. and Canada.
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 $1.7 million
in the first six months of 1996 and $1.2 million in the same period in
1995. For additional information relating to the Company's interest rate
financial instruments, see Note 10 of Unaudited Notes to Financial
Statements and Note 12 of Audited Notes to Financial Statements in the
Company's Annual Report on Form 10-K for the year ended December 31, 1995.
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)
------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 1996 VS. 1995 (CONTINUED)
---------------------------------------------------
Operating Expenses
Consolidated operating expenses were $582.9 million for the first half of
1996, an increase of $11.5 million or 2 percent, versus the comparable
first six months of 1995. After adjusting for the $6.5 million favorable
effect of changes in foreign currency rates, including hedging and
contracts gains and losses, and the impact of operations sold in 1995,
operating expenses increased by $25.8 million, or 4.6 percent. The increase
is attributable to acquisitions which increased operating expenses by
approximately $26 million.
Salaries and Benefits
Consolidated salaries and benefits increased by $6.5 million, or 1.8
percent in the first six months of 1996 versus the same period in 1995.
Excluding the $3.9 million favorable effect of changes in foreign exchange
rates and the 1995 dispositions, total salaries and benefits increased $15
million, or 4.1 percent, versus 1995 levels. This increase is primarily due
to the impact of acquisitions of approximately $17 million.
Offsetting this increase was a decline of 3.3 percent in headcount, from
approximately 11,700 at June 30, 1995 to approximately 11,300 at June 30,
1996 after excluding an increase of approximately 700 people due to
acquisitions in the fourth quarter of 1995 and first half of 1996, as well
as a reduction in employee benefit costs primarily in the U.S. and U.K. and
a decrease in incentives attributable to profit performance.
Other Operating Expenses
Consolidated other operating expenses increased by $5 million, or 2.5
percent, in the first six months of 1996 compared to 1995. Excluding the
favorable impact of changes in foreign exchange rates, including hedging
contracts gains and losses, and operations sold in 1995, other operating
expenses increased $10.8 million, or 5.4 percent, in 1996 versus 1995. This
increase is attributable to the effect of acquisitions, which increased
expenses approximately $9 million and additional costs associated with the
Company's ongoing investment in information and technology.
OTHER INCOME (EXPENSES)
Investment Income
Investment income earned on operating funds decreased for the first half of
1996 by $2.2 million, or 23.7 percent. The decrease is primarily
attributable to lower interest rates and a reduction in the average
investment balances.
Interest Expense
Interest expense decreased by $1.6 million, or 16.8 percent, in the first
six months of 1996 versus 1995. The decrease is primarily due to the
Company's redemption and subsequent funding of the 11% convertible
subordinated debentures with borrowings at more favorable rates under the
long term credit facility.
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)
------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 1996 VS. 1995 (CONTINUED)
---------------------------------------------------
Other
Other non-operating income (expenses) consists of the following:
Six Months Ended June 30,
-------------------------
1996 1995
---- ----
Gains on sales of businesses $ - $32.0
Other (0.5) 0.8
----- -----
$(0.5) $32.8
Other non-operating income (expense) decreased $33.3 million for the first
six months of 1996. The 1995 results include the pre-tax gain on the sale
of Alexsis, Inc., the Company's U.S.-based third party claims
administrator, totaling $30.3 million ($20.8 million after-tax or $0.47 per
share). In addition, the 1995 results include gains resulting from the sale
of two small operations and a U.K. merchant bank, totaling $1.4 million and
$0.3 million, respectively.
Income Taxes
The Company's effective tax rate for the first half of the year was 39.8
percent in 1996 and 38.5 percent in 1995. The effective tax rates are
higher than the U.S. statutory rate of 35 percent primarily due to U.S.
state and local income taxes and to the nondeductibility of certain
expenses, including entertainment and amortization of goodwill, in the
various jurisdictions in which the Company does business. Partially
offsetting these factors in the first half of both 1996 and 1995 was the
favorable impact of foreign tax rates which were lower than the U.S.
statutory rate. In the first half of 1995 the rate was also favorably
affected by the amount of gain recognized for tax purposes on the sale of
Alexsis.
As discussed in Note 3 of Unaudited Notes to Financial Statements, the
Company expects the Internal Revenue Service to withdraw a previously
proposed adjustment to the Company's 1991 taxable income with respect to
certain intercompany transactions involving the stock of a United Kingdom
subsidiary.
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 Limited (Alexander Howden).
In 1994, Orion, which has financial responsibility for sharing certain of
the insurance pool 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.
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.
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)
------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 1996 VS. 1995 (CONTINUED)
---------------------------------------------------
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 relevant industry 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 with a
reinsurance company, 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, 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 June 30,
1996, the recoveries were limited to $118.9 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.
While the insurance liabilities represent the Company's best estimate of
the probable liabilities within a range of independent actuarial estimates
of reasonably probable loss amounts, there is no assurance that further
adverse developments may not occur due to variables inherent in the
estimation processes and other matters described above. Based on
independent actuarial estimates of a range of reasonably possible loss
amounts, liabilities could exceed recorded amounts by approximately $170
million. However, in the event of such adverse developments, based on the
independent actuarial estimate of pay out patterns, up to approximately
$130 million of this excess would be recoverable under the finite risk
contracts.
The Company believes that, based on current estimates, the established
total net liabilities of discontinued operations are sufficient to cover
its exposures.
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)
------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 1996 VS. 1995 (CONTINUED)
---------------------------------------------------
SEGMENT INFORMATION
INSURANCE SERVICES
Operating results for the Insurance Services segment of the Company's
operations are summarized below:
Six Months Ended June 30,
-------------------------
1996 1995
---- ----
Operating revenues:
Risk management and insurance services
broking $380.3 $376.0
Specialist insurance and reinsurance
broking 135.9 139.5
Fiduciary investment income 30.4 32.4
------ ------
Total operating revenues 546.6 547.9
Operating expenses 474.6 456.7
------ ------
Operating income $ 72.0 $ 91.2
====== ======
Risk Management and Insurance Services Broking Revenues
Worldwide risk management and insurance services broking commissions and
fees increased $4.3 million, or 1.1 percent, for the first half of 1996
compared to 1995. After adjusting for the unfavorable foreign exchange rate
variance of $3.2 million and the impact of operations sold in 1995,
commissions and fees increased $19 million, or 5.2 percent.
This increase was due to an approximate increase of $26 million for
acquisitions and revenue gains in the U.K. and Asia/Pacific operations. The
U.K. increase was a result of higher overrider commissions and the
Asia/Pacific increase was a result of strong new business. Offsetting these
increases were lower revenues due to soft pricing, particularly in the
North American operations.
Specialist Insurance and Reinsurance Broking Revenues
For the first six months of 1996 total broking commissions and fees for the
specialist insurance and reinsurance broking operations decreased $3.6
million, or 2.6 percent, versus 1995 levels. Changes in foreign exchange
rates decreased 1996 broking revenues by $1.6 million. After adjusting for
the effect of foreign exchange rates, commissions and fees decreased $2
million, or 1.4 percent. Decreased revenues of $3.1 million in the
Company's international operations were partially offset by a $1.1 million
increase in the U.S. operations. The international operations decrease
included a revenue shortfall of $2.8 primarily due to unfavorable market
conditions resulting in premium rate reductions on most classes of
business.
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 10 of the Unaudited Notes to
Financial Statements.
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)
------------------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 1996 VS. 1995 (CONTINUED)
---------------------------------------------------
Fiduciary Investment Income
For the first six months of 1996 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 $30.4 million versus $32.4 million for
the comparable period in 1995, a decrease of $2 million, or 6.2 percent.
The decrease was primarily due to lower average investment levels and lower
worldwide interest rates, particularly in the U.S., U.K. and Canada.
Operating Expenses
Worldwide risk management and insurance services operating expenses for the
first half of 1996 increased $18.9 million, or 5.5 percent, versus the same
period in 1995. After adjusting for foreign exchange rate changes,
including hedging contracts gains and losses, and the 1995 dispositions,
total operating expenses increased $29.1 million, or 8.7 percent, primarily
due to acquisitions which increased expenses approximately $26 million.
Additionally, increases were reported in the Latin American and
Asia/Pacific operations, $1.7 million and $9.9 million, respectively. The
increase in Latin America was primarily due to increased staff costs in
Mexico and Brazil. The Asia/Pacific variance included the impact of
inflation and higher costs related to the expansion of operations.
For the first six months of 1996 operating expenses for the specialist and
reinsurance broking operations decreased $1 million, or 0.9 percent, versus
1995. Foreign exchange rate variances, including hedging gains and losses,
negatively impacted expenses by $3.4 million in 1996. After adjusting for
foreign exchange rate variances, total operating expenses increased $2.4
million, or 2.1 percent. Contributing to the 1996 increase were the
international operations primarily due to increased staff costs. Partially
offsetting the increase was a decrease in the U.K. operations primarily due
to a reduction in incentives.
HUMAN RESOURCE MANAGEMENT CONSULTING
Operating results for the Human Resource Management Consulting segment of
the Company's operations are summarized below:
For the Six Months Ended
June 30,
------------------------
1996 1995
------ ------
Operating revenues:
Commissions and fees $ 102.8 $ 104.2
Fiduciary investment income 0.1 0.2
-------- --------
Total operating revenues 102.9 104.4
Operating expenses 96.3 100.3
-------- --------
Operating income $ 6.6 $ 4.1
======== ========
Human resource management consulting commissions and fees decreased by $1.4
million, or 1.3 percent, in the first half of 1996 compared to 1995.
Excluding the impact of changes in foreign exchange rates and the impact of
the transfer of a business unit to the U.S. risk management and insurance
services operations, commissions and fees increased $2.9 million, or 2.9
percent. The increased revenues were spread throughout geographic regions
with $1.1 million, $1 million and $0.5 million in the U.K., U.S. and other
international operations, respectively.
Operating expenses decreased by $4 million, or 4 percent, for the first six
months of 1996 compared to 1995. After adjusting for the effect of changes
in foreign exchange rates and the transfer of a business unit, operating
expenses increased $0.6 million or 0.6 percent. This increase was
primarily attributable to the 1996 acquisitions of two small operations in
Australia and Sweden.
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)
------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
At June 30, 1996, the Company's operating cash and cash equivalents totaled
$232.2 million, a $9 million decrease compared to the 1995 year-end
balance. In addition, the Company had $41 million of operating funds
invested in short-term and long-term investments at June 30, 1996, a $1.2
million decrease compared to December 31, 1995.
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, and gains on sales of business. The
net cash flows relating to discontinued operations and changes in working
capital balances are also included. In the first six months of 1996, the
Company's operating activities provided $7.8 million of operating funds.
The Company paid approximately $71 million for the 1995 performance year
and $47 million for the 1994 performance year of incentives in the first
six months of 1996 and 1995, respectively.
Investing Activities
The Company's net capital expenditures for property and equipment were
$10.3 million and $7.5 million during the six months ended June 30, 1996
and 1995, respectively. These expenditures increased primarily as a result
of the Company's worldwide investment in technology, particularly in the
U.S. and Asia/Pacific region, coupled with leasehold improvements in the
U.S. due to the consolidation of real estate space.
In the first six months of 1996, the Company acquired or invested in
several brokerage and consulting operations, primarily in the Asia/Pacific
region, with a total of $20.4 million paid at closing.
Financing Activities
On June 11, 1996 in accordance with the terms of the 1995 Jardine purchase
agreement, the Company reduced the remaining $8.1 million note payable due
in October 1996 to $6 million.
In May 1996, the Company issued a $2.7 million, 9 percent two year note,
relating to an acquisition in the Asia/Pacific region. (See Note 2 of the
Unaudited Notes to Financial Statements).
In April 1996, the Company announced a stock repurchase program which
allows for the repurchase of up to two million shares of the Company's
common stock that will be used to fund the Company's equity based
compensation and employee benefit plans. No shares have been repurchased
under this program.
During the first quarter of 1996, the Company borrowed $30 million under
its long-term revolving credit agreement.
Other
The Company's accumulated translation adjustment balance for its Mexican
operations reflected an unrealized loss of $8.1 million at June 30, 1996.
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 impaired.
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)
------------------------------------------------------------------
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
-------------------------------------------
During the first six months of 1996, 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 $3.2 million. The increase reflects the
strengthening of the U.K. pound against the U.S. dollar.
At June 30, 1996, the Company had an accumulated deficit of $208.3 million.
The Company's current financial position satisfies Maryland law
requirements for the payment of dividends. At June 30, 1996, the current
maximum amount of unrestricted funds the Company has available to pay
Common Stock dividends under Maryland law equaled approximately $322.6
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 9
of 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.
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.
INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS
-------------------------------------------------
The Company has made and may from time to time make forward-looking
statements concerning future financial results or events or conditions that
may affect its future financial results. Forward-looking statements are
made based upon management's expectations, assumptions, judgments and
beliefs concerning future developments and global economic, industry and
financial market conditions, and their potential effect upon the Company.
There can be no assurance that these future conditions and developments
will be in accordance with management's expectations or that the effect of
future conditions and developments on the Company will be those anticipated
by management.
The Company cautions that the assumptions that form the basis for
forward-looking statements concerning future financial results, or events
or conditions that may affect such results, are based on many factors that
are beyond the Company's ability to control or estimate precisely,
including future market conditions and the behavior of competitors and
other market participants. Among the factors, in addition to other possible
factors not listed, that could affect actual results and cause such results
to differ materially from those anticipated in such forward-looking
statements are the following:
ECONOMIC CONDITIONS
The insurance brokerage industry is affected by changes in national,
international and local economic conditions as well as in client
preferences and spending patterns. Factors such as inflation and changes in
worldwide interest rates and monetary fluctuations may affect the Company's
clients and the markets in which the Company operates and its ability to
finance needed capital expenditures.
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)
------------------------------------------------------------------
INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS (CONTINUED)
-------------------------------------------------------------
GOVERNMENT REGULATION AND LICENSING
The global insurance brokerage industry is affected by the adoption of new,
and by changes in, trade, monetary, accounting and fiscal policies, laws
and regulations such as trade restrictions and prohibitions, as well as
other activities of federal and local governments, agencies and similar
organizations. The Company's ability to conduct business may be precluded,
temporarily suspended or otherwise adversely affected as a result of any
such changes or activities.
In addition, the activities of the Company related to insurance broking and
human resource management consulting services are subject to licensing
requirements and extensive regulation under the laws of the United States
and its states, territories and possessions, as well as the laws of other
countries in which the Company's subsidiaries conduct business. These laws
and regulations vary from jurisdiction to jurisdiction. The appropriate
regulatory authorities generally have wide discretionary authority in
adopting, amending and implementing such regulations. In addition, certain
of the Company's activities are governed by the rules of the Lloyd's of
London insurance market and other similar organizations. Compliance with
such licensing and regulatory requirements and the restructuring and
reorganization of Lloyd's of London may increase the Company's cost of
doing business or change the manner in which the Company is permitted to
operate.
COMPETITION
The insurance brokerage industry is intensely competitive with respect to
broking commissions, fee growth, personnel and the quality of service
provided. There is keen competition within the industry on a local,
national and international level, not only to gain new clients but also to
retain existing clients. In addition, the Company is subject to loss of
business due to the growing alternative markets and to loss of personnel to
its competitors.
MARKET CONDITIONS
The insurance brokerage industry is affected by periods of soft pricing and
excess market capacity which, in recent years, has resulted in a downward
pressure on premium rates and intense competition among insurance carriers
and brokers for market share. The occurrence of catastrophic events can
change loss ratios and, subsequently, pricing, thereby affecting a broker's
contingent commissions and overriders. The Company's revenues, expenses and
associated hedging programs are also affected by the general level of
interest rates and the income earned on fiduciary funds as well as changes
in foreign currency exchange rates. The timing of renewal cycles in
different parts of the world and lines of business produces seasonality in
its results.
CONTINGENCIES
The Company's financial results are affected by the costs and other effects
of claims and lawsuits from both private and governmental parties, which
may 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, as well as
claims relating to the Company's discontinued operations and tax matters,
which may affect its operations and administrative expenses. The Company is
also subject to the risk of losses from the potential uncollectibility of
insurance and reinsurance claims and advances on behalf of clients and
indemnifications connected with the sales of certain businesses.
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)
------------------------------------------------------------------
INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS (CONTINUED)
-------------------------------------------------------------
GROWTH PLANS
The Company plans to explore geographical market expansion as well as
strategic and niche acquisitions relating to its core business. There can
be no assurance that the Company will be able to achieve its growth
objectives or consummate any acquisition or joint venture opportunities it
may pursue or if a transaction is consummated, what the financial benefit,
if any, will be to the Company. Growth in certain markets or products can
impact the historical quarterly comparisons of earnings based on insurance
renewal cycles.
RESTRUCTURING/COST SAVING EFFORTS
The Company's future earnings will be affected by its ability to effectuate
additional internal consolidation and other cost savings initiatives and
its investment in new technology, products and personnel.
While the Company periodically reassesses material trends and uncertainties
affecting its results of operations and financial condition in connection
with its preparation of management's discussion and analysis of results of
operations and financial condition contained in its quarterly and annual
reports, the Company undertakes no obligation to publicly update or revise
any particular forward-looking statement in light of future events.
35
<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 the Glickman
litigation and related contingencies which is incorporated herein by
reference in its entirety.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on May 18, 1996. At the
meeting, the Company's stockholders acted upon the following matters:
All fourteen nominees for director named in the Company's Proxy Statement,
dated April 11, 1996, were elected to the Board of Directors to hold office
until the next Annual Meeting of Stockholders and until their respective
successors are elected and qualified. The vote for election of directors was
as follows:
FOR WITHHELD
--- --------
H. Furlong Baldwin 39,670,956 567,088
Robert E. Boni 39,666,147 571,897
W. Peter Cooke 39,645,000 593,044
E. Gerald Corrigan 39,639,417 598,627
Joseph L. Dionne 39,683,815 554,229
Gerald R. Ford 39,620,633 617,411
Peter C. Godsoe 39,638,271 599,773
Angus M.M. Grossart 39,645,721 592,323
Maurice H. Hartigan II 39,671,974 566,070
James B. Hurlock 39,668,462 569,582
Ronald A. Iles 39,660,805 577,239
Edward F. Kosnik 39,679,249 558,795
Vincent R. McLean 39,637,754 600,290
James D. Robinson III 37,575,881 2,662,163
Frank G. Zarb 39,663,723 574,321
There were no abstentions or broker non-votes with respect to the election
of directors.
The proposal to ratify the appointment of Deloitte & Touche LLP as
independent auditors of the Company for 1996 was duly adopted. The vote was
as follows: 39,891,983 votes were cast for adoption of the proposal; 277,405
votes were cast against the adoption of the proposal; and there were 68,656
abstentions and broker non-votes with respect to the proposal.
The proposal to approve and adopt the First Amendment to the Company's 1995
Long-Term Incentive Plan was duly adopted. The vote was as follows:
33,465,964 votes were cast for adoption of the proposal; 6,530,609 votes were
cast against the adoption of the proposal; and there were 241,471 abstentions
and broker non-votes with respect to the proposal.
36
<PAGE>
Alexander & Alexander Services Inc. & Subsidiaries
PART II. OTHER INFORMATION (continued)
--------------------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Item
----------- ----
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 July 16, 1996 containing the
Company's information concerning its forward looking statements.
37
<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 August, 1996.
ALEXANDER & ALEXANDER SERVICES INC.
-----------------------------------
(Registrant)
BY: /s/ Richard P. Sneeder, Jr. August 14, 1996
-----------------------------------------------
Richard P. Sneeder, Jr. Date
Vice President & Controller
38
<PAGE>
ALEXANDER & ALEXANDER SERVICES INC.
Quarterly Report on Form 10-Q
For the Quarter Ended June 30, 1996
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.
- ------- --------
11.0 Statement Re: Computation of per Common Share
Earnings 40
27.0 Financial Data Schedule 41
39
EXHIBIT 11
(UNAUDITED)
Alexander & Alexander Services Inc.
Computation of per Common Share Earnings
Three and Six Months Ended June 30, 1996 and 1995
(in millions except per share information)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------- --------------
1996 1995 1996 1995
---- ---- ---- ----
PRIMARY
- -------
Earnings Attributable to Common
--------------------------------------
Shareholders:
-------------
<S> <C> <C> <C> <C>
Net income $ 21.5 $ 22.7 $ 34.6 $ 64.4
Less: Preferred stock dividends (6.6) (6.3) (13.2) (12.5)
------ ------ ------ ------
Earnings attributable to common
shareholders $ 14.9 $ 16.4 $ 21.4 $ 51.9
====== ====== ====== ======
Average Common and Common Equivalent Shares
-------------------------------------------
Outstanding:
------------
Average common shares outstanding 45.1 44.3 45.0 44.3
Add shares of common stock assumed issued on
exercise of stock options 0.1 0.3 0.1 0.1
------ ------ ------ ------
Average common and common equivalent shares
outstanding 45.2 44.6 45.1 44.4
====== ====== ====== ======
FULLY DILUTED
- -------------
Fully Diluted Earnings Per Share:
---------------------------------
Net income $ 21.5 $ 22.7 $ 34.6 $ 64.4
Less: Preferred stock dividends (6.6) (6.3) (13.2) (12.5)
------ ------ ------ ------
Earnings attributable to common
shareholders 14.9 16.4 21.4 51.9
Add: Series B preferred stock dividends 0.0 4.2 0.0 8.4
------ ------ ------ ------
Net income available to common shareholders $ 14.9 $ 20.6 $ 21.4 $ 60.3
====== ====== ====== ======
Average Common Shares Outstanding, Assuming
-------------------------------------------
Full Dilution:
--------------
Average common shares outstanding 45.1 44.3 45.0 44.3
Add shares of common stock assumed issued on:
Exercise of stock options 0.1 0.3 0.1 0.3
Conversion of Series B preferred stock 0.0 12.4 0.0 12.3
------ ------ ------ ------
Average common shares outstanding, assuming
full dilution 45.2 57.0 45.1 56.9
====== ====== ====== ======
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 895
<SECURITIES> 0
<RECEIVABLES> 1,376
<ALLOWANCES> 25
<INVENTORY> 0
<CURRENT-ASSETS> 2,637
<PP&E> 389
<DEPRECIATION> 269
<TOTAL-ASSETS> 3,232
<CURRENT-LIABILITIES> 2,336
<BONDS> 0
0
7
<COMMON> 43
<OTHER-SE> 387
<TOTAL-LIABILITY-AND-EQUITY> 3,232
<SALES> 0
<TOTAL-REVENUES> 650
<CGS> 0
<TOTAL-COSTS> 583
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8
<INCOME-PRETAX> 65
<INCOME-TAX> 26
<INCOME-CONTINUING> 35
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 35
<EPS-PRIMARY> 0.48
<EPS-DILUTED> 0.48
</TABLE>
