The following selected consolidated financial data for each of the five years in the period ended December 31, 2011 have been derived from our consolidated financial statements. Such data should be read in conjunction with our consolidated financial statements and notes thereto in Item 8 of this annual report.
We are engaged in providing insurance brokerage and third-party property/casualty claims settlement and administration services to entities in the U.S. and abroad. We believe that one of our major strengths is our ability to deliver comprehensively structured insurance and risk management services to our clients. Our brokers, agents and administrators act as intermediaries between insurers and their customers and we do not assume underwriting risks. We are headquartered in Itasca, Illinois, have operations in 17 countries and offer client-service capabilities in more than 110 countries globally through a network of correspondent brokers and consultants. We generate approximately 81% of our revenues domestically, with the remaining 19% derived internationally, primarily in Australia, Bermuda, Canada, New Zealand and the U.K. We have three reporting segments: brokerage, risk management and corporate, which contributed approximately 73%, 26% and 1%, respectively, to 2011 revenues. Our major sources of operating revenues are commissions, fees and supplemental and contingent commissions from brokerage operations and fees from risk management operations. Investment income is generated from our investment portfolio, which includes invested cash and fiduciary funds, as well as clean energy and other investments.
Even though we generated positive organic growth in the year ended December 31, 2011 in both our brokerage and risk management segments, the uncertain economic environment continued to provide headwinds for our business in 2011. In first quarter 2011, surveys by the Council of Insurance Agents & Brokers (which we refer to as the CIAB) indicated that commercial property/casualty rates had again declined for the 29th consecutive quarter, although the rate of decrease slowed from that reported in fourth quarter 2010. The second quarter report indicated that rates remained stable with negligible declines. The third quarter report indicated that rates were up, on average, 0.9% across all sized accounts, with small accounts leading the way with an average 2.1% increase. The fourth quarter report indicated that rates were up, on average, 2.8% across all sized accounts, with medium accounts leading the way with an average 3.5% increase. The CIAB survey did not reveal any significant new emerging trends, but did note that rates appear to be moving towards positive territory. Although competition is still stiff in the marketplace, the fourth quarter survey indicated that property/casualty insurance carriers appear to be tightening their underwriting standards, particularly on accounts with poor loss experience. The survey also indicated that there is some upward rate pressure on workers’ compensation and property lines of business. However, the demand for insurance continues to be restrained due to the sluggish economy, which could offset the impact of the favorable pricing trend noted in the fourth quarter survey. The CIAB represents the leading domestic and international insurance brokers, who write approximately 80% of the commercial property/casualty premiums in the U.S.
In our combined brokerage and risk management segments, total revenues and adjusted total revenues were up 17% and 18%, respectively, organic commission, fee and supplemental commission revenues were up 4.8%, earnings from continuing operations were up 4% and adjusted EBITDAC was up 18%.
We achieved these results by demonstrating expense discipline and headcount control, continuing to pursue our acquisition strategy and generating organic growth in our core businesses. In 2011, we continued to expand our international operations through both acquisitions and organic growth. By the end of 2011, 19% of our revenues were generated internationally, compared with 13% in 2010. We expect this international revenue trend to continue in 2012.
Fluctuations in premiums charged by property/casualty insurance carriers have a direct and potentially material impact on the insurance brokerage industry. Commission revenues are generally based on a percentage of the premiums paid by insureds and normally follow premium levels. Insurance premiums are cyclical in nature and may vary widely based on market conditions. Various factors, including competition for market share among insurance carriers, increased underwriting capacity and improved economies of scale following consolidations, can result in flat or reduced property/casualty premium rates (a “soft” market). A soft market tends to put downward pressure on commission revenues. Various countervailing factors, such as greater than anticipated loss experience and capital shortages, can result in increasing property/casualty premium rates (a “hard” market). A hard market tends to favorably impact commission revenues. Hard and soft markets may be broad-based or more narrowly focused across individual product lines or geographic areas.
The deterioration in the economy that began in the fall of 2008 adversely impacted us in 2011, and could continue to do so in future years as a result of reductions in the overall amount of insurance coverage that our clients purchase due to reductions in, among other things, their headcount, payroll, properties and the market value of their assets. Such reductions could also adversely impact our commission revenues in future years if the property/casualty insurance carriers perform exposure audits that lead to subsequent downward premium adjustments. We record the income effects of subsequent premium adjustments when the adjustments become known and, as a result, any improvement in our results of operations and financial condition may lag an improvement in the economy. In addition, some of our clients may cease operations completely in the event of a prolonged deterioration in the economy.
During 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Affordability Reconciliation Act (which we refer to together as the 2010 Health Care Reform Legislation) were signed into law. The 2010 Health Care Reform Legislation, among other things, increases the level of regulatory complexity for companies that offer health and welfare benefits to their employees. Many clients of our brokerage segment purchase health and welfare products for their employees and, therefore, are impacted by the 2010 Health Care Reform Legislation. As a result, the potential exists for our employee benefits consultants to win new clients and generate additional revenue from existing clients by assisting them in navigating the increasingly complex regulations surrounding their benefits plans. In 2011, our employee benefits consulting operation generated approximately one quarter of the brokerage segment’s revenues. Although we believe that the 2010 Health Care Reform Legislation could be beneficial to our brokerage segment’s fee revenues, given the legislation’s broad scope and the uncertainties that exist regarding the interpretation and implementation of many of the legislation’s complex provisions, the potential impact of the legislation on us, beneficial or otherwise, is currently uncertain.
Clean energy investments - In 2009, we built and placed in service fourteen commercial clean coal production plants (2009 Era Plants). At December 31, 2011, we held non-controlling, minority interests in five limited liability companies that own twelve of the 2009 Era Plants. These plants are currently producing refined coal using Chem-Mod LLC’s technologies (see below) which reduce harmful emissions and that we believe qualify for IRC Section 45 tax credits. Collectively, these twelve plants’ operations could generate for us approximately $4.3 million of net after-tax earnings per quarter through 2019.
We continue to seek and negotiate long-term purchase commitments for the remaining ten 2011 Era Plants, all of which are currently idle. We have non-binding agreements in principle with a utility and co-investors for one of the 2011 Era Plants. However, these transactions are not expected to close, and the related production of refined coal at this utility is not expected to begin, until approximately second quarter of 2012. This plant could generate for us approximately $1.7 million of after-tax earnings per quarter through 2021. It is too early at this time to predict when negotiations and transactions will be complete and what the ultimate earnings potential will be from the remaining nine plants not currently under long-term purchase commitments.
Ultimately, we plan to sell majority ownership interests in all fifteen 2011 Era Plants and relinquish control of the plants under structures similar to the 2009 Era Plants, thereby becoming a non-controlling, minority investor.
We also own a 42% controlling interest in Chem-Mod LLC, which has been marketing its Chem-Mod™ Solution technologies principally to coal-fired power plants owned by utility companies, including those utilities that are operating with the IRC Section 45 clean coal production plants in which we hold investments. To date, permits to utilize Chem-Mod’s technologies have been permitted for coal-fired utilities in twelve states. Several other states are in the process of granting similar approvals, although we cannot predict the timing of such approvals or whether such approvals will be granted. Based on current production estimates provided by licensees, Chem-Mod could generate for us approximately $2.5 million of net after-tax earnings per quarter.
Revenue Recognition - We recognize commission revenues at the later of the billing or the effective date of the related insurance policies, net of an allowance for estimated policy cancellations. We recognize commission revenues related to installment premiums as the installments are billed. We recognize supplemental commission revenues using internal data and information received from insurance carriers that allows us to reasonably estimate the supplemental commissions earned in the period. A supplemental commission is a commission paid by an insurance carrier that is above the base commission paid, is determined by the insurance carrier based on historical performance criteria and is established annually in advance of the contractual period. We recognize contingent commissions and commissions on premiums directly billed by insurance carriers as revenue when we have obtained the data necessary to reasonably determine such amounts. Typically, we cannot reasonably determine these types of commission revenues until we have received the cash or the related policy detail or other carrier specific information from the insurance carrier. A contingent commission is a commission paid by an insurance carrier based on the overall profit and/or volume of the business placed with that insurance carrier during a particular calendar year and is determined after the contractual period. Commissions on premiums billed directly by insurance carriers to the insureds generally relate to a large number of property/casualty transactions, each with small premiums, and comprise a substantial portion of the revenues generated by our employee benefit brokerage operations. Under these direct bill arrangements, the insurance carrier controls the entire billing and policy issuance process. We record the income effects of subsequent premium adjustments when the adjustments become known. Fee revenues generated from the brokerage segment primarily relate to fees negotiated in lieu of commissions that we recognize in the same manner as commission revenues. Fee revenues generated from the risk management segment relate to third party claims administration, loss control and other risk management consulting services, that we provide over a period of time, typically one year. We recognize these fee revenues ratably as the services are rendered and record the income effects of subsequent fee adjustments when the adjustments become known.
Uncertain tax positions are measured based upon the facts and circumstances that exist at each reporting period and involve significant management judgment. Subsequent changes in judgment based upon new information may lead to changes in recognition, derecognition and measurement. Adjustments may result, for example, upon resolution of an issue with the taxing authorities, or expiration of a statute of limitations barring an assessment for an issue. We recognize interest and penalties, if any, related to unrecognized tax benefits in our provision for income taxes. See Note 14 to our consolidated financial statements for a discussion regarding the possibility that our gross unrecognized tax benefits balance may change within the next twelve months.
Intangible Assets/Earnout Obligations - Intangible assets represent the excess of cost over the estimated fair value of net tangible assets of acquired businesses. Our primary intangible assets are classified as either goodwill, expiration lists, non-compete agreements or trade names. Expiration lists, non-compete agreements and trade names are amortized using the straight-line method over their estimated useful lives (three to fifteen years for expiration lists, three to five years for non-compete agreements and ten to fifteen years for trade names), while goodwill is not subject to amortization. The establishment of goodwill, expiration lists, non-compete agreements and trade names and the determination of estimated useful lives are primarily based on valuations we receive from qualified independent appraisers. The calculations of these amounts are based on estimates and assumptions using historical and pro forma data and recognized valuation methods. Different estimates or assumptions could produce different results. We carry intangible assets at cost, less accumulated amortization in our consolidated balance sheet.
Effective January 1, 2009, we adopted, on a prospective basis, revised guidance to account for our acquisitions, including the estimation and recognition of the fair value of liabilities related to potential earnout obligations as of the acquisition dates for all of our acquisitions from 2009 and into the future, whose purchase agreements contain such provisions. Subsequent changes in these estimated earnout obligations are recorded in our consolidated statement of earnings when incurred. Potential earnout
obligations are typically based upon the estimated future operating results of the acquired businesses. For acquisitions made prior to January 1, 2009, we did not include such obligations in the purchase price recorded for each applicable acquisition at the acquisition date because such obligations are not fixed and determinable. We generally record future payments made under these 2008 and prior arrangements, if any, as additional goodwill when the earnouts are settled, which will have no impact on the amounts reported in our consolidated statement of earnings. See Note 3 to our consolidated financial statements for additional discussion on our 2011 business combinations.
See Note 3 to our consolidated financial statements for a discussion of our 2011 business combinations. We did not have any material dispositions in 2011, 2010 or 2009. Historically, we have used acquisitions to grow our brokerage segment’s commission and fee revenues. Acquisitions allow us to expand into desirable geographic locations and further extend our presence in the retail and wholesale insurance brokerage services industries. We expect that our brokerage segment’s commission and fee revenues will continue to grow from acquisitions. We intend to continue to consider from time to time, additional acquisitions for our brokerage and risk management segments on terms that we deem advantageous. At any particular time, we are generally engaged in discussions with multiple acquisition candidates. However, we can make no assurances that any additional acquisitions will be consummated, or, if consummated, that they will be advantageous to us.
In the discussion that follows regarding our results of operations, we provide information regarding EBITDAC, EBITDAC margin, adjusted EBITDAC, adjusted EBITDAC margin, adjusted EBITDAC margin excluding Heath Lambert, diluted earnings from continuing operations per share (as adjusted), organic change in commission, fee and supplemental commission revenues, adjusted revenues, expenses and earnings from continuing operations, adjusted compensation ratio and adjusted operating expense ratio. These measures are not in accordance with, or an alternative to, the GAAP information provided in this report. We believe that these presentations provide useful information to management, analysts and investors regarding financial and business trends relating to our results of operations and financial condition. Our industry peers may provide similar supplemental non-GAAP information, although they may not use the same or comparable terminology and may not make identical adjustments. The non-GAAP information we provide should be used in addition to, but not as a substitute for, the GAAP information provided. Certain reclassifications have been made to the prior-year amounts reported in this report in order to conform them to the current-year presentation.
Adjusted presentation - We believe that the adjusted presentation of our 2011, 2010 and 2009 statements of earnings, presented on the following pages, provides stockholders and other interested persons with useful information regarding certain of our financial metrics that may assist such persons in analyzing our operating results as they develop a future earnings outlook for us. The after-tax amounts related to the adjustments were computed using the effective tax rate for each respective period.
Adjusted revenues, expenses and earnings from continuing operations - We define these measures as revenues, expenses (including compensation expense and operating expense) and earnings from continuing operations, respectively, each adjusted to exclude gains realized from sales of books of business, supplemental commission timing amounts, workforce related charges, lease termination related charges, acquisition related integration costs, litigation settlements and adjustments to the change in estimated acquisition earnout payables, as applicable. Acquisition related integration costs include costs related to transactions not expected to occur on an ongoing basis in the future once we fully assimilate the applicable acquisition. These costs are typically associated with redundant workforce, extra lease space, duplicate services and external costs incurred to assimilate the acquisition on to our IT related systems.
Adjusted EBITDAC margin - We define this measure as adjusted EBITDAC divided by total revenues, as adjusted to exclude gains realized from sales of books of business and supplemental commission timing amounts.
Reconciliation of Non-GAAP Information Presented to GAAP Measures - This report includes tabular reconciliations to the most comparable GAAP measures for adjusted revenues, expenses and earnings from continuing operations, EBITDAC, EBITDAC margin, adjusted EBITDAC, adjusted EBITDAC margin, adjusted EBITDAC margin excluding Heath Lambert, diluted earnings from continuing operations per share (as adjusted) and organic change in commission, fee and supplemental commission revenues.
The brokerage segment accounted for 73% of our revenue from continuing operations in 2011. Our brokerage segment is primarily comprised of retail and wholesale brokerage operations. Our retail brokerage operations negotiate and place property/casualty, employer-provided health and welfare insurance and retirement solutions, principally for middle-market commercial, industrial, public entity, religious and not-for-profit entities. Many of our retail brokerage customers choose to place their insurance with insurance underwriters, while others choose to use alternative vehicles such as self-insurance pools, risk retention groups or captive insurance companies. Our wholesale brokerage operations assist our brokers and other unaffiliated brokers and agents in the placement of specialized, unique and hard-to-place insurance programs.
The following provides non-GAAP information that management believes is helpful when analyzing the impact of the Heath Lambert acquisition on our 2011 results. We expect that it could take up to two years to fully integrate the Heath Lambert operations into our existing operations (in millions):
Commissions and fees - The aggregate increase in commissions and fees for 2011 was principally due to revenues associated with acquisitions that were made during 2011 ($184.4 million). Commissions and fees in 2011 included new business production of $168.9 million, which was offset by renewal decreases and lost business of $134.0 million. The aggregate increase in commissions and fees for 2010 was principally due to revenues associated with acquisitions that were made during 2010 ($57.9 million). Commissions and fees in 2010 included new business production of $141.3 million, which was offset by renewal decreases and lost business of $162.0 million. The organic change in commission and fee revenues was 3% in 2011, (2%) in 2010 and (3%) in 2009. The organic change in commission, fee and supplemental commission revenues was 3% in 2011 and (2%) in 2010 and 2009. Commission revenues increased 18% and fee revenues increased 18% in 2011 compared to 2010. Commission revenues increased 5% and fee revenues decreased 3% in 2010 compared to 2009.
Items excluded from organic revenue computations yet impacting revenue comparisons for 2011, 2010 and 2009 include the following (in millions):
Compensation expense - The increase in compensation expense in 2011 compared to 2010 was primarily due to an increase in the average number of employees, salary increases, one-time compensation payments and increases in incentive compensation linked to our overall operating results ($138.1 million in the aggregate), increases in employee benefits expense ($17.3 million), the $7.0 million earnout compensation charge discussed below.
These increases were partially offset by decreases in stock compensation expense ($8.4 million) and severance related costs ($2.7 million). The increase in employee headcount in 2011 compared to 2010 primarily relates to the addition of employees associated with the acquisitions that we completed in 2011 and new production hires.
The increase in compensation expense in 2010 compared to 2009 was primarily due to an increase in the average number of employees, salary increases, one-time compensation payments and increases in incentive compensation linked to our overall operating results ($34.3 million in the aggregate), increases in employee benefits expense ($3.9 million) and severance related costs ($1.0 million).
Operating expense - The increase in operating expenses in 2011 compared to 2010 was due primarily to increases in office expense ($11.8 million), professional fees ($10.1 million), net rent and utilities ($8.7 million), travel and entertainment expense ($6.7 million), business insurance ($4.2 million), licenses and fees ($4.2 million), sales development expense ($2.5 million) and other expense ($0.5 million). Also contributing to the increase in operating expenses in 2011 were increased expenses associated with the acquisitions completed in 2011. These increases were partially offset by a favorable foreign currency translation ($0.9 million) and decreases in litigation settlement expense ($3.5 million), bad debt expense ($0.6 million) and lease termination charges ($0.5 million).
The increase in operating expenses in 2010 compared to 2009 was due primarily to increases in professional fees ($2.8 million), travel and entertainment expense ($2.8 million), licenses and fees ($1.9 million), unfavorable foreign currency translation ($1.7 million), litigation settlement expense ($1.3 million), net rent and utilities ($1.2 million), sales development expenses ($0.3 million) and office expense ($0.2 million). Also contributing to the increase in operating expenses in 2010 were increased expenses associated with the acquisitions completed in 2010. These increases were partially offset by decreases in business insurance ($3.4 million), other expense ($2.4 million) and lease termination charges ($0.8 million).
Change in estimated acquisition earnout payables - The increase in income from the change in estimated acquisition earnout payables in 2011 compared to 2010 and 2010 compared to 2009 was due primarily to adjustments made to the estimated fair value of earnout obligations related to revised projections of future performance. During 2011, 2010 and 2009, we recognized $8.3 million, $6.2 million and $4.1 million, respectively, of expense related to the accretion of the discount recorded for earnout obligations in connection with our 2011, 2010 and 2009 acquisitions. During 2011 and 2010, we recognized $14.5 million and $8.8 million of income, respectively, related to net adjustments in the estimated fair market values of earnout obligations in connection with revised projections of future performance for 22 and 11 acquisitions, respectively.
Provision for income taxes - The brokerage segment’s effective tax rate in 2011, 2010 and 2009 was 38.7%, 39.3% and 38.9%, respectively. We anticipate reporting an effective tax rate of approximately 38.0% to 40.0% in our brokerage segment for the foreseeable future.
The following two tables provide GAAP (Reported) and non-GAAP information (see page 23), and a reconciliation to the most directly comparable GAAP measure, that management believes is helpful when comparing risk management segment results for 2011, 2010 and 2009 (in millions, except per share, percentage and workforce data):
Fees - The increase in fees for 2011 compared to 2010 was primarily due to revenues associated with our acquisition of GAB Robins and new business and the impact of increased claim counts (total of $68.4 million), which were partially offset by lost business of $14.7 million in 2011. The increase in fees for 2010 compared to 2009 was primarily due to revenues associated with the acquisition and new business of $39.0 million, which were partially offset by lost business and the impact of decreased claim counts of $30.6 million in 2010. Organic change in fee revenues was 9% in 2011, (3%) in 2010 and (1%) in 2009.
Operating expense - The increase in operating expenses in 2011 compared to 2010 was primarily due to GAB Robins integration costs ($3.8 million), increases in professional fees ($13.7 million), office expense ($3.3 million), business insurance ($2.2 million), sales development expense ($1.1million), travel and entertainment ($1.0 million), net rent and utilities ($0.9 million) and other expenses ($0.8 million). The decrease in operating expenses in 2010 compared to 2009 was primarily due to decreases in professional fees ($3.0 million), lease termination related charges ($1.2 million) and other expense ($0.7 million), partially offset by GAB Robins integration costs ($1.0 million) and increases in business insurance ($1.1 million), office expenses ($0.6 million), net rent and utilities ($0.2 million), bad debt expense ($0.4 million), sales development expense ($0.4 million) and travel and entertainment expense ($0.2 million).
Depreciation - Depreciation expense increased in 2011 compared to 2010 and reflects the impact of purchases of furniture, equipment and leasehold improvements related to office expansions and moves and expenditures related to upgrading computer systems. Depreciation expense increased in 2010 compared to 2009 and reflects the impact of purchases of furniture, equipment and leasehold improvements related to office expansions and moves and expenditures related to upgrading computer systems.
Provision for income taxes - The risk management segment’s effective tax rate in 2011, 2010 and 2009 was 36.5 %, 39.3% and 36.8%, respectively. We anticipate reporting an effective tax rate of approximately 38.0% to 40.0% in our risk management segment for the foreseeable future.
The following two tables provide GAAP (Reported) and non-GAAP information (see page 23), and a reconciliation to the most directly comparable GAAP measure, that management believes is helpful when comparing corporate segment results for 2011, 2010 and 2009 (in millions, except per share and percentage data):
Royalty income from clean coal licenses - This represents revenues related to Chem-Mod LLC. We have a 42% ownership interest in Chem-Mod and we are its manager. We therefore are required to consolidate its operations. The increased royalty income in 2011 and 2010 was due to increased production of refined coal by Chem-Mod’s licensees. Expenses related to the royalty income of Chem-Mod were $3.2 million, $2.1 million and $0.7 million in 2011, 2010 and 2009, respectively.
Income (loss) from unconsolidated clean coal production plants - This includes income (losses) related to our equity portion of the pretax results of the twelve clean coal production plants discussed above and the production based income from the investors in the twelve operations. The increased pretax loss in 2011 compared to 2010 was due to the nine high volume production plants incurring fixed expenses during the period that they were not producing refined coal, and as a result, we were not earning monetization income during that same time period. Only three low volume plants were in production during the first seven months of 2011. Production at the nine high volume plants did not start until August 5, 2011, after they received permanent operating permits.
Other net revenues (loss) - In 2011, other net revenues consist of the earnings from our equity investments in three venture capital funds ($0.5 million) offset by the net $0.3 million impairment write-down of our investment in a biomass energy venture. In 2010, other net revenues consists primarily of a $4.8 million net pretax gain from the sales of portions of our ownership in the twelve 2009 Era Plants discussed above, $1.2 million of equity earnings from one of our venture capital fund investments, offset by an $8.0 million impairment charge on our investment in a biomass energy venture, a $1.5 million loss, under equity method accounting, of an additional 3% investment in the global operations of C-Quest Technology LLC, and a $0.5 million write-down of our investment in an investment management company. The loss in 2009 primarily consisted of a $1.0 million write-down of our investment in an investment management company offset by $0.4 million of equity earnings from our venture capital fund investments.
Cost of revenues - Cost of revenues from consolidated clean coal production plants in 2011 and 2010 includes the expenses incurred by the clean coal production plants to generate the consolidated revenues discussed above. In 2011, the cost of revenues also included the expenses incurred ($22.4 million) to run the IRC Section 45 leased facility discussed above.
Compensation expense - Compensation expense for 2011, 2010 and 2009, respectively, includes salary and benefit expenses of $6.2 million, $5.6 million and $4.0 million and incentive compensation of $7.4 million, $6.8 million and $3.7 million, respectively. The increased salary and benefit expenses for 2011 and 2010 were due to additional headcount, salary and benefits expense increases. The increases in incentive compensation for 2011 and 2010 were primarily related to the sales and operations of the facilities that qualify for tax credits under IRC Section 45.
Operating expense - Operating expense for 2011 includes professional fees of $0.9 million primarily related to clean coal activities, expense and minority interest totaling $3.2 million related to royalty income, other corporate operating expenses of $3.4 million, external professional fees and other external due diligence costs of $4.6 million related to 2011 acquisitions, $3.1 million of banking fees and $0.7 million of costs incurred for a company-wide award and sales meeting. Operating expense for 2010 includes professional fees of $1.2 million primarily related to clean coal activities, expense and minority interest totaling $2.1 million related to royalty income, other corporate operating expenses of $3.2 million, external professional fees and other external due diligence costs of $2.8 million related to 2010 acquisitions, $1.8 million of banking fees, an $8.1 million donation to the Arthur J. Gallagher charitable foundation and $2.7 million of costs incurred for a company-wide award and sales meeting. Operating expense for 2009 includes professional fees of $2.4 million primarily related to clean coal activities, expense of $0.7 million related to royalty income, other corporate operating expenses of $2.4 million and $1.5 million of banking fees.
Interest expense - The increase in interest expense in 2011 compared to 2010 is primarily due to interest on the $125.0 million note purchase agreement entered into on February 10, 2011 ($5.9 million). The increase in interest expense in 2010 compared to 2009 is due to interest on the $150.0 million note purchase agreement entered into on November 30, 2009 ($8.0 million), partially offset by a substantial reduction in the amount of borrowing under the prior credit agreement, plus a reduction in the interest rate of those borrowings ($2.0 million).
Congress extended the deadline for clean coal production plants to be “placed in service” by two years, from December 31, 2009 to December 31, 2011. Tax credits on these plants can be earned for ten years from the placed in service date if the clean coal production plants are placed in service by December 31, 2011. In conjunction with this extension and the marketing efforts of Chem-Mod, there is increased demand for IRC Section 45 projects and the Chem-Mod technologies. Accordingly, we have invested $33.4 million in fifteen commercial clean coal production plants that we placed in service, producing refined coal using Chem-Mod’s technologies, prior to December 31, 2011 (2011 Era Plants).
At December 31, 2011, we held controlling majority interests in seven limited liability companies that own the fifteen 2011 Era Plants. As of January 1, 2012, we sold majority portions of our investments in six limited liability companies that own five of the plants for $12.9 million. These plants are currently producing refined coal under long-term purchase commitments with utilities. Collectively, these five plants could generate for us approximately $8.0 million of net after-tax earnings per quarter through 2021.
We continue to seek and negotiate long-term purchase commitments for the remaining ten 2011 Era plants which are currently idle. Our net carrying value of these investments at December 31, 2011was $9.8 million. We estimate that we will invest an additional net $2.0 million to house each of these plants prior to the resumption of production.
We have non-binding agreements in principle with a utility and co-investors for one of the 2011 Era Plants. However, these transactions and the related resumption of production is not expected until the second quarter of 2012. This plant could generate for us approximately $1.7 million of after-tax earnings per quarter through 2021.
It is too early at this time to predict when negotiations and transactions will be complete and what the ultimate earnings potential will be from the remaining nine 2011 Era Plants not currently under long-term purchase commitments.
All estimates set forth above regarding the future quarterly earnings impact of our clean energy investments are subject to significant risks, including those set forth in the risk factors regarding our IRC Section 45 investments under Item 1A, “Risk Factors.” See Note 12 to the consolidated financial statements for additional information related to these investments.
Historically, we have depended on our ability to generate positive cash flow from operations to meet our cash requirements. We believe that our cash flow from operations and borrowings under our Credit Agreement will provide us with adequate resources to meet our liquidity needs for the foreseeable future. However, to fund acquisitions made during 2011 and 2009, we relied to a large extent on proceeds from borrowings, which were repaid before the end of fourth quarter, under our credit agreements.
Cash provided by operating activities was $283.1 million, $231.8 million and $211.5 million for 2011, 2010 and 2009, respectively. The increase in cash provided by operating activities in 2011 compared to 2010 was primarily due to favorable timing differences in the receipts and disbursements of fiduciary funds and in the payment of accrued liabilities and to an increased amount of non-cash charges in 2011 compared to 2010. The increase in cash provided by operating activities in 2010 compared to 2009 was primarily due to timing differences between periods related to cash collections of premiums and fees receivable and cash disbursements of premiums payable and improved operating results in 2010 compared to 2009. Our cash flows from operating activities are primarily derived from our earnings from operations, as adjusted for realized gains and losses, and our non-cash expenses, which include depreciation, amortization, change in estimated acquisition earnout payables, deferred compensation, restricted stock, and stock-based and other noncash compensation expenses.
Capital Expenditures - Net capital expenditures were $40.0 million, $25.4 million and $23.5 million for 2011, 2010 and 2009, respectively. In 2012, we expect total expenditures for capital improvements to be approximately $55.0 million, primarily related to office moves and expansions and updating computer systems and equipment. The increase in net capital expenditures in 2011 from 2010 primarily related to capitalized costs associated with the implementation of new accounting and financial reporting systems and several other system initiatives that occurred in 2011.
Acquisitions - Cash paid for acquisitions, net of cash acquired, was $264.3 million, $78.9 million and $44.6 million in 2011, 2010 and 2009, respectively. The increased use of cash for acquisitions made in 2011 compared to 2010 and 2009 was primarily due to the increase in the number of acquisitions made and the $164.0 million of net cash paid for the Heath Lambert acquisition. We completed 32, 19 and 15 acquisitions in 2011, 2010 and 2009, respectively. Annualized revenues of entities acquired in 2011, 2010 and 2009 totaled approximately $277.0 million, $145.1 million and $98.5 million, respectively.
During 2011, 2010 and 2009, we sold several books of business and recognized one-time gains of $5.5 million, $5.9 million and $11.6 million, respectively. We received cash proceeds of $14.0 million, $3.2 million and $11.6 million related to these transactions.
Clean Energy Investments - We have invested in clean energy operations capable of producing refined coal that we believe qualifies for tax credits under IRC Section 45. We believe these investments will increase our cash flows and liquidity by generating tax credits that reduce our tax payments in future periods. Please see “Clean energy investments” beginning on page 38 for a more detailed description of these investments (including the reference therein to risks and uncertainties)
Outlook - We believe that we have sufficient capital to meet our short- and long-term cash flow needs. Except for 2008 and 2005, our earnings from continuing operations before income taxes, adjusted for non-cash items (i.e., EBITDAC), have increased year over year since 1991. In 2008, earnings from continuing operations before income taxes were adversely impacted by charges related to real estate lease terminations, severance, litigation, impairments of intangible assets and the adverse impact of foreign currency translation. In 2005, earnings from continuing operations before income taxes were adversely impacted by charges incurred for litigation and retail contingent commission related matters and claims handling obligations. We expect the historically favorable trend in earnings from continuing operations before income taxes, adjusted for non-cash items, to continue in the foreseeable future because we intend to continue to expand our business through organic growth from existing operations and growth through acquisitions. Additionally, we anticipate a favorable impact on the amount we will pay the IRS in 2012 and in future years based on anticipated tax credits from IRC Section 45 investments. We also anticipate that we will continue to use cash flows from operations and, if needed, borrowings under the Credit Agreement (described below under “Cash Flows From Financing Activities”) and our common stock to fund acquisitions. In addition, we may from time to time consider other
The Credit Agreement provides for a revolving credit commitment of up to $500.0 million, of which up to $75.0 million may be used for issuances of standby or commercial letters of credit and up to $50.0 million may be used for the making of swing loans as defined in the Credit Agreement. We may from time to time request, subject to certain conditions, an increase in the revolving credit commitment up to a maximum aggregate revolving credit commitment of $600.0 million.
In 2007, 2009 and 2011 we entered into separate note purchase agreements, with certain accredited institutional investors, pursuant to which we issued and sold to the investors $400.0 million, $150.0 million and $125.0 million in aggregate debt, respectively. At December 31, 2011, we had $675.0 million of corporate-related borrowings outstanding under the three note purchase agreements and a cash and cash equivalent balance of $291.2 million. We also use our Credit Agreement from time to time to borrow funds to supplement operating cash flows. See Note 6 to our consolidated financial statements for a discussion of the terms of the note purchase agreements and the Credit Agreement. There were $10.0 million of borrowings outstanding under the Credit Agreement at December 31, 2011. Due to the outstanding borrowing and letters of credit, $474.1 million remained available for potential borrowings under the Credit Agreement at December 31, 2011.
During 2011, we borrowed $151.0 million and repaid $141.0 million under the Credit Agreement. Principal uses of the 2011 borrowings under the Credit Agreement were to fund acquisitions, earnout payments related to acquisitions and general corporate purposes. During 2010, we borrowed and repaid $48.0 million under the Credit Agreement. Principal uses of the 2010 borrowings under the Credit Agreement were to fund acquisitions, earnout payments related to acquisitions and general corporate purposes. During 2009, we borrowed and repaid $154.0 million and $286.0 million, respectively, under a previous credit agreement. Principal uses of the 2009 borrowings under a previous credit agreement were to fund acquisitions completed in 2009, earnout payments related to acquisitions completed prior to 2009 and general corporate purposes.
The note purchase agreements and the Credit Agreement contain various covenants that require us to maintain specified levels of net worth and financial leverage ratios. We were in compliance with these covenants as of December 31, 2011.
Dividends - Our board of directors determines our dividend policy. Our board of directors declares dividends on a quarterly basis after considering our available cash from earnings, our anticipated cash needs and current conditions in the economy and financial markets.
In 2011, we declared $149.5 million in cash dividends on our common stock, or $1.32 per common share. On January 13, 2012, we paid a fourth quarter dividend of $.33 per common share to shareholders of record as of December 31, 2011. On January 26, 2012, we announced a quarterly dividend for first quarter 2012 of $.34 per common share, a 3% increase over the prior quarter. If the dividend is maintained at $.34 per common share throughout 2012, this dividend level would result in an annualized net cash used by financing activities in 2012 of approximately $156.0 million (based on the outstanding shares as of December 31, 2011), or an increase in cash used of approximately $6.5 million. We can make no assurances regarding the amount of any future dividend payments.
Common Stock Issuances - Another source of liquidity to us is the issuance of our common stock pursuant to our stock option and employee stock purchase plans. Proceeds from the issuance of common stock under these plans were $73.9 million in 2011, $36.7 million in 2010 and $8.3 million in 2009. Prior to 2009, we issued stock options under four stock option-based employee compensation plans. The options were primarily granted at the fair value of the underlying shares at the date of grant and generally become exercisable at the rate of 10% per year beginning the calendar year after the date of grant. On May 10, 2011, our stockholders approved the 2011 Long-Term Incentive Plan (which we refer to as the LTIP), which replaced our previous stockholder-approved 2009 Long-Term Incentive Plan. All of our officers, employees and non-employee directors are eligible to receive awards under the LTIP. Awards which may be granted under the LTIP include non-qualified and incentive stock options, stock appreciation rights, restricted stock units and performance units any or all of which may be made contingent upon the achievement of performance criteria. Stock options with respect to 6.1 million shares (less any shares of restricted stock issued under the LTIP - 1.2 million shares of our common stock were available for this purpose) were available for grant under the LTIP at December 31, 2011. In addition, we have an employee stock purchase plan which allows our employees to purchase our common stock at 95% of its fair market value. Proceeds from the issuance of our common stock related to these plans have contributed favorably to net cash provided by financing activities in 2011 and we believe this favorable trend will continue in the foreseeable future.
In connection with our investing and operating activities, we have entered into certain contractual obligations and commitments. See Notes 6, 12 and 13 to our consolidated financial statements for additional discussion of these obligations and commitments. Our future minimum cash payments, excluding interest, associated with our contractual obligations pursuant to our note purchase agreements and Credit Agreement, operating leases and purchase commitments as of December 31, 2011 are as follows (in millions):
See Note 6 to our consolidated financial statements for a discussion of the terms of the note purchase agreements.
Credit Agreement - We have a $500.0 million Credit Agreement, which expires on July 14, 2014, with a group of twelve financial institutions. We use the Credit Agreement to post letters of credit and to borrow funds to supplement our operating cash flows from time to time. At December 31, 2011, $15.9 million of letters of credit (for which we have $8.1 million of liabilities recorded at December 31, 2011) were outstanding under the Credit Agreement. There were $10.0 million of borrowings outstanding under the Credit Agreement at December 31, 2011. Accordingly, at December 31, 2011, $474.1 million remained available for potential borrowings, of which $59.1 million may be in the form of additional letters of credit. We are under no obligation to use the Credit Agreement in performing our normal business operations. See Note 6 to our consolidated financial statements for a discussion of the terms of the Credit Agreement.
Since commitments may expire unused, the amounts presented in the table above do not necessarily reflect our actual future cash funding requirements. See Note 13 to our consolidated financial statements for a discussion of our funding commitments related to our corporate segment and the Off-Balance Sheet Debt section below for a discussion of other letters of credit. All of the letters of credit represent multiple year commitments that have annual, automatic renewing provisions and are classified by the latest commitment date.
Nature of Operations - Arthur J. Gallagher & Co. and its subsidiaries, collectively referred to herein as we, our or us, provide insurance brokerage and risk management services to a wide variety of commercial, industrial, institutional and governmental organizations through two reportable operating segments. Commission and fee revenue generated by the brokerage segment is primarily related to the negotiation and placement of insurance for our clients. Fee revenue generated by the risk management segment is primarily related to claims management, information management, risk control consulting (loss control) services and appraisals in the property/casualty market. Investment income and other revenue is generated from our investment portfolio, which includes invested cash and restricted funds, as well as tax-advantaged, clean energy and other investments. We are headquartered in Itasca, Illinois, have operations in 17 countries and offer client-service capabilities in more than 110 countries globally through a network of correspondent insurance brokers and consultants.
We recognize commission revenues at the later of the billing or the effective date of the related insurance policies, net of an allowance for estimated policy cancellations. We recognize commission revenues related to installment premiums as the installments are billed. We recognize supplemental commission revenues using internal data and information received from insurance carriers that allows us to reasonably estimate the supplemental commissions earned in the period. A supplemental commission is a commission paid by an insurance carrier that is above the base commission paid, is determined by the insurance carrier based on historical performance criteria, and is established annually in advance of the contractual period. We recognize contingent commissions and commissions on premiums directly billed by insurance carriers as revenue when we have obtained the data necessary to reasonably determine such amounts. Typically, we cannot reasonably determine these types of commission revenues until we have received the cash or the related policy detail or other carrier specific information from the insurance carrier. A contingent commission is a commission paid by an insurance carrier based on the overall profit and/or volume of the business placed with that insurance carrier during a particular calendar year and is determined after the contractual period. Commissions on premiums billed directly by insurance carriers to the insureds generally relate to a large number of property/casualty transactions, each with small premiums, and comprise a substantial portion of the revenues generated by our employee benefit brokerage operations. Under these direct bill arrangements, the insurance carrier controls the entire billing and policy issuance process. We record the income effects of subsequent premium adjustments when the adjustments become known.
Restricted Cash - In our capacity as an insurance broker, we collect premiums from insureds and, after deducting our commissions and/or fees, remit these premiums to insurance carriers. We hold unremitted insurance premiums in a fiduciary capacity until we disburse them, and the use of such funds is restricted by laws in certain states and foreign jurisdictions in which our subsidiaries operate. Various state and foreign agencies regulate insurance brokers and provide specific requirements that limit the type of investments that may be made with such funds. Accordingly, we invest these funds in cash and U.S. Treasury fund accounts. We can earn interest income on these unremitted funds, which is included in investment income in the accompanying consolidated statement of earnings. These unremitted amounts are reported as restricted cash in the accompanying consolidated balance sheet, with the related liability reported as premiums payable to insurance carriers. Additionally, several of our foreign subsidiaries are required by various foreign agencies to meet certain liquidity and solvency requirements. We were in compliance with these requirements at December 31, 2011.
instruments are reflected other comprehensive earnings in the accompanying consolidated balance sheet. The impact of the hedge at maturity is recognized in the income statement as a component of compensation and operating expenses. We do not use derivatives for trading or speculative purposes.
Because of the inherent risk of investments, we can make no assurances that there will not be impairments in the future should economic and other conditions change.
Intangible Assets - Intangible assets represent the excess of cost over the estimated fair value of net tangible assets of acquired businesses. Our primary intangible assets are classified as either goodwill, expiration lists, non-compete agreements or trade names. Expiration lists, non-compete agreements and trade names are amortized using the straight-line method over their estimated useful lives (three to fifteen years for expiration lists, three to five years for non-compete agreements and ten to fifteen years for trade names), while goodwill is not subject to amortization. The establishment of goodwill, expiration lists, non-compete agreements and trade names and the determination of estimated useful lives are primarily based on valuations we receive from qualified independent appraisers. The calculations of these amounts are based on estimates and assumptions using historical and pro forma data and recognized valuation methods. Different estimates or assumptions could produce different results. We carry intangible assets at cost, less accumulated amortization, in the accompanying consolidated balance sheet.
We review all of our intangible assets for impairment periodically (at least annually for goodwill) and whenever events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. We perform such impairment reviews at the division (i.e., reporting unit) level with respect to goodwill and at the business unit level for amortizable intangible assets. In reviewing intangible assets, if the fair value were less than the carrying amount of the respective
(or underlying) asset, an indicator of impairment would exist and further analysis would be required to determine whether or not a loss would need to be charged against current period earnings as a component of amortization expense. Based on the results of impairment reviews in 2011 and 2010, we wrote-off $4.6 million and $2.3 million, respectively, of amortizable intangible assets related to prior year acquisitions of our brokerage segment. No such indicators were noted in 2009. The determinations of impairment indicators and fair value are based on estimates and assumptions related to the amount and timing of future cash flows and future interest rates. Such estimates and assumptions could change in the future as more information becomes known which could impact the amounts reported and disclosed herein.
The carrying amounts of financial assets and liabilities reported in the accompanying consolidated balance sheet for cash and cash equivalents, restricted cash, premiums and fees receivable, premiums payable to insurance carriers, accrued salaries and bonuses, accounts payable and other accrued liabilities, unearned fees and income taxes payable, at December 31, 2011 and 2010, approximate fair value because of the short-term duration of these instruments. See Note 3 to our consolidated financial statements for the fair values related to the establishment and adjustment of intangible assets and earnout payables. See Note 6 to our consolidated financial statements for the fair values related to borrowings outstanding at December 31, 2011 and 2010 under our debt agreements. See Note 11 to our consolidated financial statements for the fair values related to investments at December 31, 2011 and 2010 under our defined benefit pension plan.
During 2011, we acquired substantially all of the net assets of the following firms in exchange for our common stock and/or cash. These acquisitions have been accounted for using the acquisition method for recording business combinations (in millions except share data):
For all acquisitions made prior to January 1, 2009, we did not include potential earnout obligations in the recorded purchase price for each applicable acquisition at its respective acquisition date because such obligations were not fixed and determinable as of the acquisition date. We will generally record future payments made under these arrangements, if any, as additional goodwill when the earnouts are settled. The aggregate amount recorded in the consolidated balance sheet as of December 31, 2011 related to earnout payables for acquisitions we made prior to January 1, 2009 was $18.3 million. There were no unrecorded earnout payables outstanding at December 31, 2011 related to acquisitions we made prior to January 1, 2009.
The following is a summary of the estimated fair values of the net assets acquired at the date of each acquisition made in 2011 (in millions):
Provisional estimates of fair value are established at the time of the acquisition and are subsequently reviewed within the first year of operations to determine the necessity for adjustments. The fair value of the current assets and current liabilities for each applicable acquisition at the acquisition date approximated their carrying values due to their short-term duration. The fair value of expiration lists was established using the excess earnings method, which is an income approach based on estimated financial projections developed by management for each acquired entity using market participant assumptions. We estimate the fair value as the present value of the benefits anticipated from ownership of the subject customer list in excess of returns required on the investment in contributory assets necessary to realize those benefits. The rate used to discount the net benefits was based on a risk-adjusted rate that takes into consideration market-based rates of return and reflects the risk of the asset relative to the acquired business. The fair value of non-compete agreements was established using the profit differential method, which is an income approach on estimated financial projections developed by management for the acquired company using market participant assumptions and various non-compete scenarios.
Of the $11.1 million of trade names, $160.9 million of expiration lists and $2.7 million of non-compete agreements related to the 2011 acquisitions, $10.9 million, $50.5 million and $0.4 million, respectively, is not expected to be deductible for income tax purposes. Accordingly, we recorded a deferred tax liability of $18.4 million, and a corresponding amount of goodwill, in 2011 related to the nondeductible amortizable intangible assets.
Our consolidated financial statements for the year ended December 31, 2011 include the operations of the acquired entities from their respective acquisition dates. The following is a summary of the unaudited pro forma historical results, as if these entities had been acquired at January 1, 2010 (in millions, except per share data):
The unaudited pro forma results above have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which actually would have resulted had these acquisitions occurred at January 1, 2010, nor are they necessarily indicative of future operating results. Annualized revenues of entities acquired in 2011 totaled approximately $277.0 million. In 2011, total revenues and earnings (loss) from continuing operations recorded in our consolidated statement of earnings related to the 2011 acquisitions in the aggregate were $135.9 million and $(4.7 million), respectively.
The carrying amount of goodwill at December 31, 2011 and 2010 allocated by domestic and foreign operations is as follows (in millions):
Under the terms of the note purchase agreements, we may redeem the notes at any time, in whole or in part, at 100% of the principal amount of such notes being redeemed, together with accrued and unpaid interest and a “make-whole amount”. The “make-whole amount” is derived from a net present value computation of the remaining scheduled payments of principal and interest using a discount rate based on the U.S. Treasury yield plus 0.5% and is designed to compensate the purchasers of the notes for their investment risk in the event prevailing interest rates at the time of prepayment are less favorable than the interest rates under the notes. We do not currently intend to prepay the notes.
The notes issued under the note purchase agreement are senior unsecured obligations of ours and rank equal in right of payment with our Credit Agreement discussed below.
The Credit Agreement provides for a revolving credit commitment of up to $500.0 million, of which up to $75.0 million may be used for issuances of standby or commercial letters of credit and up to $50.0 million may be used for the making of swing loans, as defined in the Credit Agreement. We may from time to time request, subject to certain conditions, an increase in the revolving credit commitment up to a maximum aggregate revolving credit commitment of $600.0 million.
The following is a summary of our corporate debt (in millions):
Options to purchase 3.8 million, 9.2 million and 12.5 million shares of our common stock were outstanding at December 31, 2011, 2010 and 2009, respectively, but were not included in the computation of the dilutive effect of stock options for the year then ended. These stock options were excluded from the computation because the options’ exercise prices were greater than the average market price of our common shares during the respective period and, therefore, would be anti-dilutive to earnings per share under the treasury stock method.
On March 8, 2011, the compensation committee granted options to purchase 851,000 shares of our common stock under the 2009 LTIP to our officers and key employees that become exercisable at the rate of 20% per year on the anniversary date of the grant. On March 2, 2010, the compensation committee granted options to purchase 858,000 shares of our common stock under the 2009 LTIP to our officers and key employees that become exercisable at the rate of 20% per year on the anniversary date of the grant. The 2011 and 2010 options expire seven years from the date of grant, or earlier in the event of termination of the employee.
Options with respect to 6.1 million shares (less any shares of restricted stock issued under the LTIP-see Note 10 to our consolidated financial statements) were available for grant under the LTIP at December 31, 2011.
We have a Deferred Equity Participation Plan, which is a non-qualified plan that generally provides for distributions to certain of our key executives when they reach age 62 or upon or after their actual retirement. Under the provisions of the plan, we contribute shares of our common stock or cash, in an amount approved by the compensation committee, to a rabbi trust on behalf of the executives participating in the plan. Distributions under the plan may not normally be made until the participant reaches age 62 and are subject to forfeiture in the event of voluntary termination of employment prior to age 62. All distributions of stock contributions from the plan, except for accumulated non-invested dividends, are made in the form of our common stock and all distributions of cash contributions are distributed in cash.
Our common stock that is issued under the plan to the rabbi trust is valued at historical cost, which equals its fair market value at the date of grant. When common stock is issued, we record an unearned deferred compensation obligation as a reduction of capital in excess of par value in the accompanying consolidated balance sheet, which is being amortized to compensation expense ratably over the vesting period of the participants. Future changes in the fair market value of our common stock owed to the participants do not have any impact on the amounts recorded in our consolidated financial statements. During 2011, 2010 and 2009, we charged $1.3 million, $1.4 million and $1.9 million, respectively, to compensation expense related to this plan. During 2011, 2010 and 2009, 17,000 shares, 40,000 shares and 28,000 shares of our common stock, respectively, were vested and distributed to employees under this plan, with an aggregate fair value of $0.5 million, $1.0 million and $0.6 million, respectively. At December 31, 2011, and 2010, we recorded $6.8 million (related to 629,000 shares) and $8.1 million (related to 646,000 shares), respectively, of unearned deferred compensation as an offset to capital in excess of par value in the accompanying consolidated balance sheet. The total intrinsic value of our unvested common stock under the plan at December 31, 2011 and 2010 was $21.0 million and $18.8 million, respectively.
The vesting periods of the 2011, 2010 and 2009 restricted stock awards are as follows (in actual shares):
We account for restricted stock at historical cost, which equals its fair market value at the date of grant. When restricted shares are issued, we record an unearned restricted stock obligation as a reduction of capital in excess of par value in the accompanying consolidated balance sheet, which is amortized to compensation expense ratably over the vesting period of the participants. Future changes in the fair value of our common stock that is owed to the participants do not have any impact on the amounts recorded in our consolidated financial statements. During 2011, 2010 and 2009, we charged $5.5 million, $5.2 million and $4.3 million, respectively, to compensation expense related to restricted stock awards granted in 2006 through 2011. At December 31, 2011 and 2010, we recorded $1.3 million (related to 87,000 shares) and $2.1 million (related to 188,000 shares), respectively, of unearned restricted stock outstanding as an offset to capital in excess of par value in the accompanying consolidated balance sheet. The total intrinsic value of unvested restricted stock at December 31, 2011 and 2010 was $26.9 million and $23.9 million, respectively.
On March 8, 2011, pursuant to our Performance Unit Program (which we refer to as the Program), the compensation committee approved the future grant of provisional cash awards of $14.4 million in the aggregate to our officers and key employees that are denominated in units (464,000 units in the aggregate), each of which was equivalent to the value of one share of our common stock on the date the provisional award was approved. The Program consists of a one-year performance period based on our financial performance and a two-year vesting period. At the discretion of the compensation committee and determined based on our performance, each participant will be granted a number of provisional cash award units. At the end of the one-year performance period, participants will be awarded a number of units based on achievement of the EBITAC performance goal (as defined in the Program) and subject to approval by the compensation committee. Awarded units for the 2011 provisional award will fully vest based on continuous employment through January 1, 2014. The ultimate award value will be equal to the trailing twelve-month stock price on December 31, 2013, multiplied by the number of units subject to the award, but limited to between 0.5 and 1.5 times the original value of the units determined as of the grant date. The fair value of the awarded units will be paid out in cash as soon as practicable in 2014. If an eligible employee leaves us prior to the vesting date, the entire award will be forfeited. We did not recognize any compensation expense during 2011 related to the 2011 provisional award under the Program. Based on company performance for 2011, we expect to grant 433,000 units under the Program in first quarter 2012 that will fully vest on January 1, 2014.
On March 2, 2010, pursuant to the Program, the compensation committee approved the future grant of provisional cash awards of $17.0 million in the aggregate to our officers and key employees that are denominated in units (706,000 units in the aggregate), each of which is equivalent to the value of one share of our common stock on the date the provisional award was approved. Terms of the 2010 provisional award were similar to the terms discussed above for the 2011 provisional award. However, based on company performance for 2010, we did not grant any units in 2011 related to the 2010 provisional award under the Program. We did not recognize any compensation expense during 2011 or 2010 related to this provisional award.
We have a noncontributory defined benefit pension plan that, prior to July 1, 2005, covered substantially all of our domestic employees who had attained a specified age and one year of employment. Benefits under the plan were based on years of service and salary history. In 2005, we amended our defined benefit pension plan to freeze the accrual of future benefits for all domestic employees, effective on July 1, 2005. Since the plan is frozen, there is no difference between the projected benefit obligation and accumulated benefit obligation at December 31, 2011 and 2010. In the table below, the service cost component represents plan administration costs that are incurred directly by the plan.
The following weighted average assumptions were used at January 1 in determining the plan’s net periodic pension benefit cost:
The following benefit payments are expected to be paid by the plan (in millions):
Plan assets are invested in various pooled separate accounts under annuity contracts managed by two life insurance carriers. The plan’s investment policy provides that investments will be allocated in a manner designed to provide a long-term investment return greater than the actuarial assumptions, maximize investment return commensurate with risk and to comply with the Employee Retirement Security Act of 1974, as amended (which we refer to as ERISA), by investing the funds in a manner consistent with ERISA’s fiduciary standards. The weighted average expected long-term rate of return on plan assets assumption was determined based on a review of the asset allocation strategy of the plan using expected ten-year return assumptions for all of the asset classes in which the plan was invested at December 31, 2011 and 2010. The ten-year return assumptions used in the valuation were based on data provided by the plan’s external investment advisors.
We were required under the Internal Revenue Code (which we refer to as IRC) to make minimum contributions of $0.3 million to the plan for each of the 2010 and 2011 plan years. We were not required to make a minimum contribution to the plan for the 2009 plan year. This level of required funding is based on the plan being frozen and the aggregate amount of our historical funding. During 2011, 2010 and 2009, we made discretionary contributions of $7.2 million, $6.5 million and $4.0 million, respectively, to the plan. We are considering making additional discretionary contributions to the plan in 2012 and may be required to make significantly larger minimum contributions to the plan in future periods.
We also have a nonqualified deferred compensation plan for certain employees who, due to Internal Revenue Service (which we refer to as the IRS) rules, cannot take full advantage of our matching contributions under the 401(k) plan. The plan permits these employees to annually elect to defer a portion of their compensation until their retirement or a future date. Our matching contributions to this plan (up to a maximum of 5.0% of eligible compensation, less matching amounts contributed under the 401(k) plan) are also at the discretion of our board of directors. We contributed $2.1 million, $2.0 million and $1.9 million to a rabbi trust maintained under the plan in 2011, 2010 and 2009, respectively. The fair value of the assets in the plan’s rabbi trust at December 31, 2011 and 2010, including employee contributions and investment earnings, was $95.5 million and $86.6 million, respectively, and has been included in other noncurrent assets and the corresponding liability has been included in other noncurrent liabilities in the accompanying consolidated balance sheet.
We also have several foreign benefit plans, the largest of which is a defined contribution plan that provides for us to make contributions of 5.0% of eligible compensation. In addition, the plan allows for voluntary contributions by U.K. employees, which we match 100%, up to a maximum of an additional 5.0% of eligible compensation. Net expense for foreign retirement plans amounted to $12.3 million, $7.8 million and $6.4 million in 2011, 2010 and 2009, respectively.
Chem-Mod LLC - At December 31, 2011, we held a 42% controlling interest in Chem-Mod LLC, which has the rights to market The Chem-ModTM Solution in the U.S and Canada. Chem-Mod, a multi-pollutant reduction venture, possesses rights, information and technologies for the reduction of unwanted emissions created during the combustion of coal. Chem-Mod has developed and is the exclusive licensee of proprietary emissions technologies it refers to as The Chem-Mod™ Solution, which uses a dual injection sorbent system to reduce mercury, sulfur dioxide and other toxic emissions at coal-fired power plants.
Chem-Mod has been determined to be a VIE. We are the manager of Chem-Mod, and consolidate its operations into our consolidated financial statements. At December 31, 2011, total assets and total liabilities of this investment that were included in our consolidated balance sheet were each less than $3.0 million. We are under no obligation to fund Chem-Mod’s operations in the future and Chem-Mod has no debt that is recourse to us.
Chem-Mod International LLC - At December 31, 2011, we held a non-controlling 20% interest in Chem-Mod International LLC, which has the rights to market The Chem-Mod™ Solution in countries other than the U.S. and Canada. Such marketing activity has been limited to date.
Twelve 2009 Era Clean Coal Production Plants - At December 31, 2011, we held non-controlling, minority interests in five limited liability companies that own twelve commercial clean coal production plants that were placed in service in 2009. These 2009 Era Plants are currently producing refined coal using Chem-Mod’s technologies, which reduce harmful emissions. We believe the production and sale of refined coal at these plants and the reduction of harmful emissions qualifies for IRC Section 45 tax credits through 2019. These limited liability companies are considered to be VIEs. The membership agreements for each of these operations require the unanimous consent of the owners for every action that would denote control. Because we do not control the operations of these entities, we account for the investments using equity method accounting. At December 31, 2011, total assets and total liabilities of these five limited liability companies were $94.2 million and $64.9 million, respectively. For 2011 and 2010, total revenues were $380.8 million and $572.0 million, respectively. For 2011 and 2010, total expenses were $405.7 million and $609.0 million, respectively. Each investor funds their portion of the obligations of the limited liability companies, in proportion to their investment ownership percentage. There are no additional debts or other obligations that we are committed to fund related to these investments.
Fifteen 2011 Era Clean Coal Production Plants - We built and placed into service fifteen commercial clean coal production plants prior to December 31, 2011. The operations of these plants are consolidated into our consolidated financial statements for 2011. These plants have produced refined coal using Chem-Mod’s technologies, which reduce harmful emissions. We believe the production and sale of refined coal at these 2011 Era Plants and the reduction of harmful emissions qualifies for IRC Section 45 tax credits through 2021. Ultimately, we plan to sell majority ownership interests in all fifteen plants to co-investors and relinquish control of the plants under structures similar to the 2009 Era plants, thereby becoming a non-controlling, minority investor. The total original construction cost was $33.4 million.
As of January 1, 2012, we sold ownership interests in six limited liability companies that own five of the fifteen 2011 Era Plants, for a total of $12.9 million. These plants are producing and selling refined coal to coal-fired power plants. Because we have become non-controlling, minority investors of these investments as of January 1, 2012, we will account for them using equity method accounting as of that date.
Gallagher has non-binding agreements in principle with a utility and co-investors for one of the 2011 Era Plants. However, this plant is not expected to resume production of refined coal until after signing the agreements with the utility and completion of moving the IRC Section 45 plant to the site, or approximately second quarter of 2012. The sale to the co-investors is anticipated to occur after the plant begins production. At December 31, 2011, Gallagher’s carrying value of this investment was $1.0 million. Until the sale to the co-investors is complete, we will consolidate its operations into our consolidated financial statements. Because we anticipate becoming a non-controlling, minority investor after a completed transaction, we then plan to account for this investment using equity method accounting.
Gallagher is currently seeking co-investors and long-term utility customers for the other nine 2011 Era Plants. After co-investors’ investments, Gallagher intends on holding non-controlling, minority investment positions in these investments. At December 31, 2011, Gallagher’s net carrying value of these investments was $8.8 million. These plants are currently idle.
Biomass Energy Ventures - We sold our entire interest in this biomass company as of October 12, 2011, for $0.1 million.
In connection with our investing and operating activities, we have entered into certain contractual obligations and commitments. See Notes 6 and 12 to our consolidated financial statements for additional discussion of these obligations and commitments. Our future minimum cash payments, excluding interest, associated with our contractual obligations pursuant to the note purchase agreements and Credit Agreement, operating leases and purchase commitments at December 31, 2011 were as follows (in millions):
Total rent expense, including rent relating to cancelable leases and leases with initial terms of less than one year, amounted to $91.0 million in 2011, $81.5 million in 2010 and $82.0 million in 2009.
We have leased certain office space to several non-affiliated tenants under operating sublease arrangements. In the normal course of business, we expect that the leases will not be renewed or replaced. We adjust charges for real estate taxes and common area maintenance annually based on actual expenses, and we recognize the related revenues in the year in which the expenses are incurred. These amounts are not included in the minimum future rentals to be received in the contractual obligations table above.
Outstanding Purchase Obligations - As a service company, we typically do not have a material amount of outstanding purchase obligations at any point in time. The amount disclosed in the contractual obligations table above represents the aggregate amount of unrecorded purchase obligations that we had outstanding at December 31, 2011. These obligations represent agreements to purchase goods or services that were executed in the normal course of business.
Off-Balance Sheet Debt - Our unconsolidated investment portfolio includes investments in enterprises where our ownership interest is between 1% and 50%, in which management has determined that our level of influence and economic interest is not sufficient to require consolidation. As a result, these investments are accounted for using the equity method. None of these unconsolidated investments had any outstanding debt at December 31, 2011 or 2010 that was recourse to us.
(1) The majority owners of the operation pledge their percentage ownership portion of any draw.
At December 31, 2011 and 2010, $66.5 million and $49.2 million, respectively, of deferred tax assets have been included in other current assets in the accompanying consolidated balance sheet. At December 31, 2011 and 2010, $4.7 million and $4.1 million, respectively, of deferred tax liabilities have been included in other current liabilities and $110.4 million and $79.1 million, respectively, have been included in noncurrent liabilities in the accompanying consolidated balance sheet. Alternative minimum tax credits have an indefinite life and other credits have a ten-year or twenty-year life. We expect to make full use of the amounts carried forward.
The after-tax components of our comprehensive earnings consist of the following:
The foreign currency translation in 2011, 2010 and 2009 primarily relates to the net impact of changes in the value of the local currencies relative to the U.S. dollar for our operations in Australia, Canada and the U.K.
We have audited the accompanying consolidated balance sheet of Arthur J. Gallagher & Co. (Gallagher) as of December 31, 2011 and 2010, and the related consolidated statements of earnings, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the financial statement schedule listed in the Index at Item 15(2)(a). These financial statements and schedule are the responsibility of Gallagher’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Gallagher’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report, dated February 14, 2012, expressed an unqualified opinion thereon.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on our evaluation under the framework in Internal Control - Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2011. In addition, the effectiveness of our internal control over financial reporting as of December 31, 2011 has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their attestation report which is included herein.
In our opinion, Arthur J. Gallagher & Co. maintained in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.