Notes: (a) The financial information for all periods prior to 2000 has been restated for twelve 2000 acquisitions accounted for using the pooling of interests method. (b) All information relating to shares of common stock of Gallagher has been adjusted to reflect a two-for-one stock split, effected in the form of a 100% stock dividend, that was declared in November 2000 and paid on January 18, 2001. (c) Based on the weighted average number of common and common equivalent shares outstanding during the year. (d) Based on the number of employees at year end. (e) Based on the total dividends declared on a share of common stock outstanding during the entire year.
Though inflation tends to increase the levels of insured values and risk exposures, premium rates have historically had a greater effect on Gallagher's revenues than inflation.
Because of rising insurance costs, management believes there is a trend for certain "risk" buyers to move toward the alternative insurance market, which would tend to have a favorable effect on Gallagher's Risk Management Services segment. Gallagher anticipates that new sales in the areas of risk management, claims management, insurance captive and self-insurance services will continue to be a major factor in Gallagher's fee revenue growth during 2001. Gallagher continues to look to the future and to pursue expansion not only in the core segments of Insurance Brokerage and Risk Management Services, but also within Financial Services. Management believes these areas continue to hold opportunities for diversification and profitable growth.
Fee revenues increased by $45.1 million or 19% in 2000. This increase, generated primarily from the Risk Management Services segment, resulted from strong new business production of $41.4 million and renewal rate increases and favorable retention rates on existing business partially offset by lost business of $13.2 million.
Investment income and other increased by $11.3 million or 37% in 2000 due primarily to $9.2 million in income related to Gallagher's alternative energy related investments, and higher returns on fiduciary income investments. Investment income and other increased $9.2 million or 44% in 1999. This increase was due primarily to higher returns on Gallagher's independently managed investment portfolio which was positively affected by robust equity markets during 1999 and a gain of $3.0 million recognized in 1999 which resulted from the sale of a portion of its interests in limited partnerships that operate qualified affordable housing projects.
Salaries and employee benefits increased by $42.7 million or 13% in 2000 due primarily to a 6% increase in employee head count, salary increases, increases in incentive compensation linked to Gallagher's overall operating results and the performance of a portion of Gallagher's investment portfolio and the annualized effect of prior year new hires along with a corresponding increase in employee benefit expenses. In 1999, salaries and employee benefits increased by $23.0 million or 7% due to salary increases, the annualized effect of prior year new hires and a 4% increase in employee head count along with a corresponding increase in employee benefit expenses.
Other operating expenses increased by $24.1 million or 12% in 2000 due primarily to increases in professional fees related to acquisition activity and investment projects, management fees related to positive investment results, commissions paid to sub-brokers, write-off of doubtful accounts, increased leased space, temporary help needed to service the new risk management and claims business and travel and entertainment. Other operating expenses increased by $8.6 million or 4% in 1999 due primarily to temporary personnel costs for new business, technology upgrades, office consolidation expenses, commissions paid to sub-brokers and increases associated with travel and entertainment.
Gallagher's effective income tax rates were 30.0%, 35.0% and 32.5% in 2000, 1999 and 1998, respectively. These rates include the effect of benefits generated by tax advantaged investments which are partially offset by state and foreign taxes. See Note 12 to the Consolidated Financial Statements.
Gallagher's revenues vary from quarter-to-quarter generally as a result of the timing of policy inception dates which traditionally are heaviest in the third quarter. Expenses, on the other hand, are fairly uniform throughout the year. See Note 13 to the Consolidated Financial Statements.
As discussed in Note 14 to the Consolidated Financial Statements, Gallagher operates in three business segments; Insurance Brokerage Services, Risk Management Services and Financial Services, as well as a Corporate segment.
The Insurance Brokerage Services segment includes Gallagher's retail, reinsurance and wholesale brokerage operations. Total revenues in 2000 were $484.3 million, a 9% increase over 1999. This increase is due primarily to new business production offset by lost business. Domestic revenues of $443.7 million were up 8% over 1999. Revenues in 2000 from foreign operations, principally in the United Kingdom and Bermuda, were up 22% or $7.3 million over 1999 with $2.2 million attributable to the 2000 acquisition of MBR Pty
Limited. Earnings before income taxes in 2000 increased 17% over 1999 principally as a result of increased revenues. Total revenues in 1999 were $443.0 million, an increase of 5% over 1998. This increase again is due to new business production partially offset by lost business. Domestic revenues of $409.8 million were up 6% over 1998 mainly due to new business partially offset by lost business. Revenues in 1999 from foreign operations, primarily in the United Kingdom and Bermuda, were up 3% over 1998 mainly due to new business partially offset by lost business. Earnings before income taxes of $78.4 million in 1999 increased 12% over 1998 due mainly to increased revenues.
The Financial Services segment is responsible for the management of Gallagher's diversified investment portfolio, which includes fiduciary funds, marketable and other equity securities, and tax advantaged and other strategic investments. It combines the invested assets of Gallagher in order to maximize the return to the company. Revenues in 2000 were $24.1 million or 22% more than revenues in 1999. This increase is due primarily to $9.2 million of income related to Gallagher's alternative energy related investments, and higher returns on short-term investments. Earnings before income taxes decreased $532,000 or 4% from 1999 due primarily to increases in incentive compensation linked to the performance of a portion of Gallagher's investment portfolio and increased management fees associated with positive investment results for Gallagher's independently managed investment portfolio. Revenues in 1999 increased 116% over 1998 and earnings before income taxes in 1999 increased 184% over 1998. These increases were due primarily to more favorable returns on funds invested with independent managers and the effect of the $3.0 million gain recognized in 1999 which resulted from the sale of a portion of its interests in limited partnerships that operate qualified affordable housing projects.
The Corporate segment consists of unallocated administrative costs and the provision for income taxes which is not allocated to Gallagher's operating entities. Only revenues not attributable to one of the three operating segments are recorded in Corporate. All costs are generated in the United States.
The insurance brokerage industry is not capital intensive. Gallagher has historically been profitable, and cash flows from operations and short-term borrowings under various credit agreements have been sufficient to fund operating, investment and capital expenditure needs of the company. Cash generated from operating activities was $136.2 million, $73.0 million and $59.6 million in 2000, 1999 and 1998, respectively. Because of the variability related to the timing of premiums and fees receivable and premiums payable, net cash flows from operations vary substantially from year to year. Funds restricted as to Gallagher's use, primarily premiums held as fiduciary funds, have not been included in determining Gallagher's overall liquidity.
borrowed and repaid $10.0 million and $20.0 million, respectively, of short- term borrowings under the Credit Agreement. These borrowings were primarily used to finance a portion of Gallagher's operating and investment activity. In September 2000, Gallagher terminated this agreement.
Gallagher also had three line of credit facilities totaling $45.0 million that were to expire on April 30, 2001. Periodically, Gallagher made short-term borrowings under these facilities to meet short-term cash flow needs and had a balance of $15.0 million outstanding at December 31, 1999. During 2000, Gallagher borrowed $35.0 million and repaid $50.0 million of borrowings under these facilities. During 1999, Gallagher borrowed $78.5 million and repaid $78.5 million of short-term borrowings under these facilities. The repayments satisfied all remaining loan balances under these facilities and these agreements were terminated in September 2000. Borrowings under these facilities were primarily used to finance a portion of Gallagher's operating and investment activities.
Gallagher paid $33.8 million in cash dividends on its common stock in 2000. Gallagher's dividend policy is determined by the Board of Directors. Quarterly dividends are declared after considering Gallagher's available cash from earnings and its anticipated cash needs. In each quarter of 2000, Gallagher paid a dividend of $.115 per share which was $.015 or 15% greater than each quarterly dividend in 1999.
Net capital expenditures were $14.6 million, $17.0 million and $14.0 million in 2000, 1999 and 1998, respectively. In 2001, Gallagher expects to make expenditures for capital improvements of approximately $17.0 million. Capital expenditures by Gallagher are related primarily to office moves and expansions and updating computer systems and equipment.
In 1988, Gallagher adopted a common stock repurchase plan that has been extended through June 30, 2001. Under the plan, Gallagher has repurchased 1,500,000 shares at a cost of $31.3 million, 1,524,000 shares at a cost of $18.4 million and 860,000 shares at a cost of $8.7 million in 2000, 1999 and 1998, respectively. The repurchased shares are held for reissuance in connection with exercises of options under Gallagher's stock option plans. Gallagher is authorized to repurchase, under the provisions of the plan, approximately 3.2 million additional shares through June 30, 2001. Gallagher is under no commitment or obligation to repurchase any particular amount of common stock and at its discretion may suspend the repurchase plan at any time.
Arthur J. Gallagher & Co. (Gallagher) provides insurance brokerage and risk management services to a wide variety of commercial, industrial, institutional and governmental organizations. Commission revenue is principally generated through the negotiation and placement of insurance for its clients. Fee revenue is primarily generated by providing other risk management services including claims management, information management, risk control services and appraisals in either the property/casualty market or human resource/employee benefit market. Investment income and other is generated from Gallagher's investment portfolio, which includes fiduciary funds, equity securities, and tax advantaged and other strategic investments. Gallagher is headquartered in Itasca, Illinois, has more than 200 offices in nine countries and does business in more than 100 countries around the world through a network of correspondent brokers and consultants.
Commission income is generally recognized as of the effective date of insurance policies except for commissions on installment premiums which are recognized periodically as billed. Contingent commissions are generally recognized when received. Fee income is primarily recognized ratably as services are rendered. The income effects of subsequent premium and fee adjustments are recorded when the adjustments become known. Premiums and fees receivable are net of allowance for doubtful accounts of $2,939,000 and $1,153,000 at December 31, 2000 and 1999, respectively.
Marketable securities are considered available for sale and consist primarily of preferred and common stocks. Securities designated as available for sale are carried at fair value in the accompanying consolidated balance sheets, with unrealized gains and losses, less related deferred income taxes, excluded from net earnings and reported as accumulated other comprehensive earnings or loss. Gains and losses are recognized in net earnings when realized using the specific identification method. The fair value for marketable securities is based on quoted market prices.
$2,150,000, $3,444,000 and $1,491,000 for 2000, 1999 and 1998, respectively. Gallagher periodically reviews intangible assets for impairment whenever events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. If the fair value is less than the carrying amount of the asset, a loss would be recognized for the difference.
In November 2000, the Board of Directors declared a two-for-one stock split of Gallagher's common stock, effected in the form of a 100% stock dividend paid on January 18, 2001 to shareholders of record as of January 2, 2001. As a result of this action, par value of the common stock remains at $1.00 per share. All information relating to the number of common shares and per common share amounts in the accompanying consolidated financial statements and notes thereto have been restated to give retroactive effect to the stock split for all periods presented. Accordingly, $39,749,000 in the aggregate was transferred to common stock from capital in excess of par value ($14,032,000) and retained earnings ($25,717,000) in the accompanying December 31, 2000 consolidated balance sheet.
In March 2000, the FASB issued FASB Interpretation No. 44 (Interpretation 44), "Accounting for Certain Transactions Involving Stock Compensation," which was effective July 1, 2000. Interpretation 44 clarifies the application of APB 25. Because Gallagher historically has not modified the terms of its outstanding stock option grants, management anticipates that the adoption of Interpretation 44 will not have a significant effect on Gallagher's consolidated operating results or financial position.
In 2000, Gallagher acquired substantially all of the net assets of the following insurance brokerage firms in exchange for its common stock: John P. Woods Co., Inc., 1,816,000 shares; Universico Group, Ltd., 292,000 shares; Persing, Dyckman & Toynbee, Inc., 246,000 shares; Atlantic Risk Management Corporation, 208,000 shares; Davis-Poston & Associates, Inc., 150,000 shares; Castle Insurance Associates, Inc., 144,000 shares; R. L. Youngdahl & Associates, Inc., 138,000 shares; Bultman/Bell Associates, Inc., 136,000 shares; R. G. Speno, Inc., 88,000 shares; Rebholz Insurance Agency, Inc., 84,000 shares; Towle Agency, Inc., 74,000 shares; Powell Insurance Services, Inc., 39,000 shares; and SiliconInsurance, Inc., 33,000 shares. In addition, Gallagher acquired substantially all of the net assets of Murphy Consultants, a benefits consulting firm, in exchange for 58,000 shares of its common stock.
In 1999, Gallagher acquired substantially all of the net assets of the following insurance brokerage firms in exchange for its common stock: Goodman Insurance Agency, Inc., 630,000 shares; Dodson-Bateman & Company, 590,000 shares; Associated Risk Managers of California, Insurance Producers, dba ARM of California, 396,000 shares; and Sternfels Insurance Agency, Inc., 192,000 shares. In addition, Gallagher acquired substantially all of the net assets of the following benefit consulting firms in 1999 in exchange for its common stock: Group Benefit Concepts, Inc., 182,000 shares; and Stanley E. Clarke & Associates, Inc., 122,000 shares.
The differences between the receivable and payable balances represent fiduciary funds received by the reinsurance intermediary subsidiary, which are included in restricted cash and premiums payable to insurance companies in the accompanying consolidated balance sheets.
The following is a summary of marketable securities--available for sale (in thousands):
The gross realized gains on sales of marketable securities totaled $884,000, $1,579,000, and $3,054,000 for 2000, 1999 and 1998, respectively. The gross realized losses totaled $750,000, $1,051,000, and $1,179,000 for 2000, 1999 and 1998, respectively.
The expected maturities may differ from contractual maturities in the foregoing table because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Significant components of investment income and other are as follows (in thousands):
The net change in unrealized gain (loss) on investment strategies included in the foregoing table amounted to $628,000 in 2000, $889,000 in 1999 and ($611,000) in 1998. In 2000, Gallagher recognized $7,200,000 of
income related to the forfeiture of a non-refundable down payment from the termination of an installment sale of a synthetic fuel facility and $2,000,000 of income related to an investment development fee generated from one of Gallagher's alternative energy investments. This income has been included in other income in the foregoing table. In 2000, Gallagher sold several underperforming or geographically undesirable operations and recorded aggregate gains on these sales of $1,823,000. The net assets sold and the operating results included in the consolidated statements of earnings related to these operations were not material to the consolidated financial statements. In 1999, Gallagher sold a portion of its interests in limited partnerships that operate qualified affordable housing projects for cash proceeds of $6,264,000. The gain recognized in 1999 on this sale of limited partnership interests was $3,015,000, which has been included in net realized and unrealized gains in the foregoing table.
Options to purchase 313,000, 40,000 and 80,000 shares of common stock were outstanding at December 31, 2000, 1999 and 1998, respectively, but were not included in the computation of the dilutive effect of stock options. These options were excluded from the computation because the options' exercise prices were greater than the average market price of the common shares during the respective year and, therefore, would be antidilutive to earnings per share under the treasury stock method.
Gallagher also has an incentive stock option plan for its officers and key employees resident in the United Kingdom. The United Kingdom plan is essentially the same as Gallagher's domestic employee stock option plans, with certain modifications to comply with United Kingdom law and to provide potentially favorable tax treatment for grantees resident in the United Kingdom.
For purposes of the pro forma disclosures, the estimated fair values of the stock option grants are amortized to expense over the options' expected lives. The fair value of stock options at the date of grant was estimated using the Black-Scholes option pricing model with the following weighted-average assumptions:
Options with respect to 4,553,000 shares were available for grant at December 31, 2000.
Other information regarding stock options outstanding and exercisable at December 31, 2000 is summarized as follows (in thousands, except exercise price data):
Gallagher also has a foreign defined contribution plan which provides for basic contributions by Gallagher and voluntary contributions by employees resident in the United Kingdom which are matched 100% by Gallagher, up to a maximum of 5% of eligible compensation. Net expense for foreign retirement plans amounted to $2,465,000 in 2000, $2,253,000 in 1999 and $3,128,000 in 1998.
Gallagher is engaged in various legal actions incident to the nature of its business. Management is of the opinion that none of the litigation will have a material effect on Gallagher's consolidated financial position or operating results.
Minimum aggregate rental commitments at December 31, 2000 under noncancelable operating leases having an initial term of more than one year are as follows (in thousands):
Total rent expense, including rent relating to cancelable leases and leases with initial terms of less than one year, amounted to $44,455,000 in 2000, $39,424,000 in 1999 and $34,656,000 in 1998.
Allocations of investment income and certain expenses are based on assumptions and estimates, and reported operating results by segment would change if different methods were applied. Certain assets are not individually identifiable by segment and, accordingly, have been allocated based on formulas. Financial information relating to Gallagher's operating segments for 2000, 1999 and 1998 is as follows (in thousands):
We have audited the accompanying consolidated balance sheets of Arthur J. Gallagher & Co. (Gallagher) as of December 31, 2000 and 1999, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of Gallagher's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Arthur J. Gallagher & Co. at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States.