NOTES: (a) The financial information for all periods prior to 1994 has been restated for acquisitions accounted for using the pooling-of-interests method. (b) Based on the weighted average number of common and common equivalent shares, if any, outstanding during the year. (c) Based on the number of employees at year end. (d) Based on the total dividends on a share of common stock outstanding during the entire year.
Within the past three years, the United States has experienced the devastation of hurricanes in the Southeast and Hawaii, suffered severe losses from flooding in the Midwest, and in California, witnessed earthquakes and more recently observed heavy damage from torrential rains, windstorms and flooding. In January, 1995, Japan was struck by its worst earthquake in more than 70 years. Extraordinarily high losses associated with these catastrophes appear to have had limited impact on the insurance industry, and the competitive environment continues. There remains an overabundance of risk-taking capital, interest rates have risen and a number of insurers are selling their product below cost. Although some forecasts anticipate premium increases, the prospect for overall rate increases in 1995 is unpredictable. The soft market appears to be the arena in which insurance brokers will do business in the foreseeable future.
Growth of the alternative insurance market has continued notwithstanding the soft market conditions. The Company believes this move from the traditional approach of purchasing insurance will continue regardless of the property/casualty pricing environment and anticipates that sales in the risk management, benefits and self-insurance services areas will again be a major contributor to fee revenue growth in 1995.
Historically, inflation has contributed to increased property replacement costs and higher litigation awards causing some clients to seek higher levels of insurance coverage. These factors have the effect of generating higher premiums to customers and higher commissions to the Company. More recently, however, the United States has experienced low rates of inflation along with business down-sizing, reduced sales and lower payrolls. These events have resulted in lower levels of exposure to insure. In general, premium rates have had a greater effect on the Company's revenues than inflation.
The Company's results of operations for all periods prior to December 31, 1994 have been restated to include the results of Donald P. Pipino and Associates, Inc. and The Steel Agency on a combined basis as if they had operated as part of the Company. The Company continues to search for merger partners which complement existing business and provide entry into new market niches and new geographic areas. For the effect of such restatements in the aggregate on year-to-year comparisons, see Note 2 of the Notes to Consolidated Financial Statements.
Salaries and employee benefits increased by $21.2 million or 13% in 1994 due principally to salary increases, the annualized effect of prior year hires, a 4% increase in year-end employee head count and a corresponding increase in employee benefit expenses and changes in certain benefit plan actuarial assumptions. Also contributing to this increase is a $4.6 million non-recurring gain from a restructuring and settlement of a defined benefit plan at the Company's London subsidiary, Arthur J. Gallagher (UK) Limited, recorded in 1993. See Note 10 of the Notes to Consolidated Financial Statements. Salaries and employee benefits increased by $9.7 million or 6% in 1993 due principally to salary increases, the annualized effect of prior year hires, an 8% increase in year-end employee head count and an increase of $1.1 million in postretirement benefits resulting from the adoption of Statement of Financial Accounting Standards No. 106. Prior to 1993, postretirement benefits had been recorded on a pay-as-you-go basis. See Note 11 of the Notes to Consolidated Financial Statements. This increase was partially offset by the $4.6 million gain from the benefit plan restructuring mentioned above. Without the effect of the benefit plan gain, the increase in salaries and employee benefits would have been $14.3 million or 9%. In 1994, 1993 and 1992, salaries and employee benefits have represented 53%, 51% and 53%, respectively, of total revenues.
In February, 1993, the Company entered into a $20 million unsecured revolving credit agreement (the "Credit Agreement") with two banks. Loans under the Credit Agreement are repayable no later than February, 1998, and bear floating interest rates over the term of the loan. In February, 1993, a loan was funded for $20 million. The Company simultaneously entered into interest rate exchange agreements which fixed the rate of interest payable on the loan. The Company retired the $20 million loan in the fourth quarter of 1994 and has fully satisfied all obligations associated with the loan. The Company also recognized a gain of $656,000 in closing out the interest rate exchange agreements. The Credit Agreement remains in effect and as of December 31, 1994, there are no borrowings currently existing under this agreement.
The Company also entered into two term loan agreements (the "Term Loan Agreements") with a bank for $3.2 million and $2.5 million in 1993. Loans under the Term Loan Agreements are repayable in equal annual installments no later than January 11, 1998, and June 15, 1998, respectively, and bear interest rates over the terms of the loans of 6.64% and 6.30%, respectively.
The Company has line of credit facilities of $17.5 million and $10.0 million which expire on April 30, 1995 and February 28, 1996, respectively. No borrowings currently exist under these facilities.
The Company operates in the insurance brokerage and risk management business and offers various services that are related to that activity. The accompanying consolidated financial statements include the accounts of the Company and all subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to the prior year balance sheet amounts in order to conform to the current year presentation.
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 recognized when received. Fee income is 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 $846,000 and $876,000 at December 31, 1994 and 1993, respectively.
In May 1993, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 115, "Accounting for Certain Investments in Debt and Equity Securities". The new standard requires that securities designated as available for sale be carried at fair value, with unrealized gains and losses, less related deferred income taxes, excluded from earnings and reported as a separate component of stockholders' equity. In addition, securities designated as trading are required to be carried at fair value, with unrealized gains and losses included in the statement of earnings. Previously, the Company carried these investments at either the lower of cost or fair value, or at amortized cost. As of January 1, 1994, the Company adopted the provisions of the new standard for investments held as of or acquired after that date. In accordance with Statement 115, prior period financial statements have not been restated to reflect the change in accounting principle. The cumulative effect as of January 1, 1994 of adopting Statement 115 increased the opening balance of stockholders' equity by $1,456,000 (net of deferred income taxes of $970,000) to reflect the net unrealized holding gains on securities classified as available for sale previously carried at the lower of cost or fair value, or at amortized cost. There was no cumulative effect on net earnings as a result of the adoption of Statement 115 because the securities classified as trading were carried as a current asset and had a fair value below cost at January 1, 1994. Accordingly, such unrealized losses were recorded in prior period earnings.
Fixed assets are carried at cost. Furniture and equipment with a cost of $52,246,000 at December 31, 1994 ($45,903,000 at December 31, 1993) are depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements with a cost of $6,684,000 at December 31, 1994 ($6,294,000 at December 31, 1993) are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the lease terms.
Intangible assets consist primarily of the excess of cost over the value of net tangible assets of acquired businesses and are amortized over forty years using the straight-line method. Accumulated amortization at December 31, 1994 was $7,145,000 ($4,616,000 at December 31, 1993).
The gross realized gains on sales of marketable securities totaled $2,004,000, $1,719,000 and $1,475,000 for the years ended December 31, 1994, 1993, and 1992, respectively. The gross realized losses totaled $312,000, $929,000, and $340,000 for the years ended December 31, 1994, 1993, and 1992, respectively.
The net unrealized gains (losses) on investment strategies included in income amounted to $83,000 in 1994, $1,908,000 in 1993, and ($1,573,000) in 1992.
In November, 1994, the Company retired its variable-rate unsecured revolving credit agreement that was due in 1998. In connection with the retirement, the Company also recognized a gain of $656,000 on the settlement of interest rate exchange agreements that had been entered into in 1993 to fix the rate of interest payable on the revolving credit agreement. The credit agreement remains in effect and, as of December 31, 1994, there were no borrowings outstanding under this agreement.
Non-voting Rights, authorized by the Board of Directors on March 10, 1987 and approved by stockholders on May 12, 1987, were distributed May 12, 1987 as a dividend to holders of the Company's
The Company has two sets of incentive and nonqualified stock option plans for officers and key employees of the Company and its subsidiaries adopted in 1983 and 1988, respectively. Options granted under the 1983 plans become exercisable at the rate of 10% per year beginning the calendar year after the date of grant and expire ten years from the date of grant, or earlier in the event of death or termination of the employee. The terms of options under the 1988 plans are determined by the Company's Option Committee on the date of grant. Incentive stock options are granted at the fair market value of the underlying shares at the date of grant. The excess of fair market value at the date of grant over the option price for the nonqualified stock options is considered compensation and is charged against earnings ratably over the vesting period. No options may be granted under any plan ten years after its inception.
The Company has a contributory savings & thrift plan covering the majority of its employees. Company contributions are at the discretion of the Company's Board of Directors and may not exceed the maximum amount deductible for federal income tax purposes. The Company contributed $879,000, $773,000 and $640,000 in 1994, 1993 and 1992, respectively.
The following table sets forth the plan's estimated funded status and amounts recognized in the Company's consolidated financial statements:
In 1992, the Company amended its health benefits plan to eliminate retiree coverage, except for current retirees and those employees who had already attained a specified age and length of service. The retiree health plan is contributory, with contributions adjusted annually, and is funded on a pay-as- you-go basis.
The discount rate used to measure the accumulated postretirement benefit obligation was 8.0% and 7.0% at December 31, 1994 and 1993, respectively. The transition obligation is being amortized over 20 years. Prior to 1993, postretirement benefits were recorded on a pay-as-you-go basis.
Total rent expense, including rent relating to cancelable leases and leases with initial terms of less than one year, amounted to $24,811,000 in 1994, $24,122,000 in 1993 and $23,957,000 in 1992.
Due to changes in the U.S. federal income tax laws, effective in 1994, the Company began providing for U.S. income taxes on the undistributed earnings of its foreign subsidiaries. Prior to 1994, the Company did not provide for U.S. income taxes on the undistributed earnings ($19,200,000 at December 31, 1994) of certain foreign subsidiaries which are considered permanently invested outside of the U.S. The amount of unrecognized deferred tax liability on these undistributed earnings is $5,300,000.
Ernst & Young LLP, independent auditors, has audited the Company's financial statements and their report is presented herein.
We have audited the accompanying consolidated balance sheet of Arthur J. Gallagher & Co. as of December 31, 1994 and 1993, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Arthur J. Gallagher & Co. at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.