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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1998
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission file number 1-9761
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ARTHUR J. GALLAGHER & CO.
(Exact name of registrant as specified in its charter)
DELAWARE 36-2151613
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
Two Pierce Place 60143-3141
Itasca, Illinois (Zip Code)
(Address of principal executive
offices)
Registrant's telephone number, including area code (630) 773-3800
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange
Common Stock, par value on which registered
$1.00 per share
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant, computed by reference to the last reported price at which the
stock was sold on February 28, 1999 was $804,286,000.
The number of outstanding shares of the registrant's Common Stock, $1.00 par
value, as of February 28, 1999 was 18,100,066.
Portions of documents incorporated by Part of Form 10-K into which document
reference into this report is incorporated
ARTHUR J. GALLAGHER & CO. PART III
Proxy Statement dated March 30, 1999
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PART I
Item 1. Business.
Arthur J. Gallagher & Co. (the "Registrant") and its subsidiaries (the
Registrant and its subsidiaries are collectively referred to as the "Company"
unless the context otherwise requires) are engaged in providing insurance
brokerage, risk management, employee benefit and other related services to
clients in the United States and abroad. The Company's principal activity is
the negotiation and placement of insurance for its clients. The Company also
specializes in furnishing risk management services. Risk management involves
assisting clients in analyzing risks and determining whether proper protection
is best obtained through the purchase of insurance or through retention of all
or a portion of those risks and the adoption of corporate risk management
policies and cost-effective loss control and prevention programs. Risk
management services also include claims management, loss control consulting
and property appraisals and insurance related investigative services. The
Company believes that its ability to deliver a comprehensively structured risk
management and brokerage service is one of its major strengths.
The Company operates through a network of approximately 200 offices located
throughout the United States and six countries abroad and through a network of
correspondent brokers and consultants in more than 100 countries around the
world. Some of these offices are fully staffed with sales, marketing, claims
and other service personnel; others function as servicing offices for the
brokerage and risk management service operations of the Company. The Company's
international operations include a Lloyd's broker and affiliated companies in
London, England and other facilities in Australia, Bermuda, Canada, Scotland
and Papua New Guinea.
The Company was founded in 1927 and was reincorporated as a Delaware
corporation in 1972. The Company's executive offices are located at Two Pierce
Place, Itasca, Illinois 60143-3141, and its telephone number is (630) 773-
3800.
The Company has identified three operating segments in addition to its
corporate operations. Insurance Brokerage Services encompasses operations
that, for commission or fee compensation, place or arrange to place insurance
directly related to the clients' funding of risk. This segment also provides
consulting, for fee compensation, related to clients' risk financing programs.
Risk Management Services includes the Company's third party administration,
loss control and risk management consulting, workers' compensation
investigations and insurance property appraisal operations. Third party
administration is principally claims management services for the Company's
clients. Financial Services includes the Company's investment operations and
certain non-recurring events. Corporate consists primarily of unallocated
administrative costs and the provision for income taxes which is not allocated
to the Company's operating segments.
Insurance Brokerage Services
The Company places insurance for and services commercial, industrial,
institutional, governmental, religious and personal accounts throughout the
United States and abroad. The Company acts as an agent in soliciting,
negotiating and effecting contracts of insurance through insurance companies
worldwide, and also as a broker in procuring contracts of insurance on behalf
of insureds. Specific coverages include all forms of property and casualty,
marine, employee benefits, pension and life insurance products.
The Company places surplus lines coverages, which are coverages not
available from insurance companies licensed by the states in which the risks
are located, for various specialized risks. The Company also places
reinsurance coverages for its clients.
The Company's Gallagher Benefit Services ("GBS") division specializes in the
management of employee benefit programs through fully insured and self-insured
programs. GBS provides services in connection with the design, financing,
implementation, administration and communication of compensation and employee
benefit programs (including pension and profit-sharing plans, group life,
health, accident and disability insurance programs and tax deferral plans),
and provides other professional services in connection therewith. The services
provided by GBS are supported by an on-line data processing system provided by
an outside vendor.
Risk Management Services
Through its wholly-owned subsidiary, Gallagher Bassett Services, Inc.
("Gallagher Bassett"), the Company provides a variety of professional
consulting services to assist clients in analyzing risks and in determining
whether proper protection is best obtained through the purchase of insurance
or through retention of all or a portion of those risks and the adoption of
risk management policies and cost-effective loss control and prevention
programs. A full range of risk management services is offered including claims
management, risk control consulting services, information management, property
appraisals and insurance related investigative services on a totally
integrated or select, stand-alone basis. Gallagher Bassett provides these
services for the Company's clients through a network of over 100 offices
throughout the United States, Canada, England, Scotland, Australia and Papua
New Guinea.
The Company believes that its risk management services are an important
factor in securing new brokerage business and retaining brokerage clients. The
Company also markets these services directly to the client on an unbundled
basis independent of brokerage services in order to capitalize on the interest
in self-insurance created by market conditions. These services include
consulting on a wide range of risk management needs such as toxic waste
disposal, handling of dangerous cargo, workers' compensation, medical cost
containment, substance abuse, employment-related background investigations,
loss prevention, property appraisals and liability reserve reviews.
In connection with its risk management services, the Company provides self-
insurance programs for large institutions, risk sharing pools and
associations, and large commercial and industrial customers. Self-insurance,
as administered by the Company, is a program in which the client assumes a
manageable portion of its insurance risks, usually (although not always)
placing the less predictable and larger loss exposures with an excess carrier.
The Company's offices are staffed to provide services relating to claims,
property appraisals, loss control consulting and computerized record keeping
in administering the clients' programs.
Financial Services
Financial Services is responsible for all of the Company's investment
operations and certain non-recurring events. The Company's comprehensive and
diversified investment portfolio includes investment strategies, marketable
securities, tax advantaged investments, equity investments, real estate
partnerships and notes receivable from investees. Tax advantaged investments
represent amounts invested by the Company in limited partnerships that operate
qualified affordable housing or alternative energy projects. The Company
receives tax benefits in the form of tax deductions for operating losses and
tax credits from these investments. Investments in real estate partnerships
primarily represent an investment in a limited partnership that owns 10,000
acres of land to be developed near Orlando, Florida. Notes receivable from
investees represent secured loans made by the Company to several of its equity
and limited partnership investments. Financial Services is primarily
responsible for the management of the Company's own investments but is
expanding these investment management services in conjunction with the
insurance products the Company markets to its clients. These investments and
the associated returns are for the benefit of the Company.
International Operations
The Company's international operations are principally comprised of a
Lloyd's broker and a risk management services company in London, a risk
management services company in Australia and Papua New Guinea, and an
insurance brokerage operation and a rent-a-captive facility in Bermuda.
Arthur J. Gallagher (UK) Limited, a wholly-owned Lloyd's brokerage
subsidiary of the Company based in London, provides brokerage and other
services to clientele primarily located outside of the United Kingdom
("U.K."). The principal activity of Arthur J. Gallagher (UK) Limited is to
negotiate and place insurance and reinsurance with Lloyd's underwriters and
insurance companies worldwide. Its brokerage services encompass four major
categories: aviation, marine, reinsurance (treaty and facultative) and
property and casualty (risks predominantly located in North America).
Although Arthur J. Gallagher (UK) Limited is located in London, the thrust
of its business development has been with non-U.K. brokers, agents and
insurers rather than domestic U.K. retail business. Its clients are
2
primarily insurance and reinsurance companies, underwriters at Lloyd's, the
Company and its non-U.K. subsidiaries, other independent agents and brokers
and major business corporations requiring direct insurance and reinsurance
placement.
Wyatt Gallagher Bassett Pty Ltd ("Wyatt GB") is a 50% owned subsidiary of
Gallagher Bassett that is headquartered in Brisbane, Australia with facilities
located throughout Australia and Papua New Guinea. Wyatt GB is principally
engaged in providing claims adjusting and risk management services.
Arthur J. Gallagher & Co. (Bermuda) Limited provides clients with direct
access to the risk-taking capacity of Bermuda-based insurers for both direct
and reinsurance placements. It also acts as a wholesaler to the Company's
marketing efforts by accessing foreign insurance and reinsurance companies in
the placing of U.S. and foreign risks. In addition, it provides services
relating to the formation and management of offshore captive insurance
companies.
The Company has helped to develop Artex Insurance Company Ltd., a partially
owned, Bermuda-based insurance company that operates a "rent-a-captive"
facility. Rent-a-captives enable clients to receive the benefits of owning a
captive insurance company without the disadvantages of ownership. Captive
insurance companies are created to insure risk and capture underwriting profit
and investment income, which is then returned to the insured.
Gallagher Bassett International Ltd. (UK) ("GBI"), a subsidiary of Gallagher
Bassett, provides risk management services for foreign operations, as well as
U.S. operations that are foreign-controlled. Headquartered in London with
offices throughout England and Scotland, GBI works with insurance companies,
reinsurance companies, overseas brokers, and risk managers of overseas
organizations. Services are offered on an unbundled basis wherever applicable
and include consulting, claims management, information management, loss
control and property valuations.
The Company also has facilities in Canada that are not material to the
Company's consolidated operations. Additional information relating to the
Company's foreign operations is contained in Notes 12 and 14 to the
Consolidated Financial Statements.
Markets and Marketing
A substantial portion of the commission and fee business of the Company is
derived from institutions, not-for-profit organizations, municipal and other
governmental entities and associations. In addition, the Company's clients
include large United States and multinational corporations engaged in a broad
range of commercial and industrial businesses. The Company also places
insurance for individuals. The Company services its clients through its
network of approximately 200 offices in the United States and six countries
abroad. No material part of the Company's business is dependent upon a single
customer or on a few customers, the loss of any one or more of which would
have a materially adverse effect on the Company. In 1998, the largest single
customer represented approximately 1% of total revenues.
The Company believes that its ability to deliver comprehensively structured
risk management and brokerage services, including the placement of
reinsurance, is one of its major strengths. The Company also believes that its
risk management business enhances and attracts other brokerage business due to
the nature and strength of business relationships which it forms with clients
when providing a variety of risk management services on an on-going basis.
The Company requires its employees serving in a sales or marketing capacity,
including certain executive officers of the Company, to enter into agreements
with the Company restricting disclosure of confidential information and
solicitation of clients and prospects of the Company upon their termination of
employment. The confidentiality and non-solicitation provisions of such
agreements terminate in the event of a hostile change in control of the
Company, as defined therein.
3
Competition
The Company believes it is the fourth largest insurance broker worldwide in
terms of total revenues. The insurance brokerage and service business is
highly competitive and there are many insurance brokerage and service
organizations as well as individuals throughout the world who actively compete
with the Company in every area of its business. Three competing firms are
significantly larger and have many times the commission and/or fee revenues of
the Company. There are firms in a particular region or locality which are as
large or larger than the particular local office of the Company. The Company
believes that the primary factors determining its competitive position with
other organizations in its industry are the overall cost and the quality of
services rendered.
The Company is also in competition with certain insurance companies which
write insurance directly for their customers. Government benefits relating to
health, disability, and retirement are also alternatives to private insurance
and hence indirectly compete with the business of the Company. To date, such
direct writing and government benefits have had, in the opinion of the
Company, relatively little effect on its business and operations, but the
Company can make no prediction as to their effect in the future.
Regulation
In every state and foreign jurisdiction in which the Company does business,
the Company or an employee is required to be licensed or receive regulatory
approval in order for the Company to conduct business. In addition to
licensing requirements applicable to the Company, most jurisdictions require
that individuals who engage in brokerage and certain insurance service
activities be personally licensed.
The Company's operations depend on its continued good standing under the
licenses and approvals pursuant to which it operates. Licensing laws and
regulations vary from jurisdiction to jurisdiction. In all jurisdictions the
applicable licensing laws and regulations are subject to amendment or
interpretation by regulatory authorities, and generally such authorities are
vested with relatively broad and general discretion as to the granting,
renewing and revoking of licenses and approvals.
Commissions and Fees
The two major sources of operating revenues are commissions from brokerage
and risk management operations and service fees from risk management
operations. Information with respect to these two major sources as well as
investment income and other revenue, including non-recurring gains, are as
follows (in thousands):
Years Ended December 31,
--------------------------------------------
1998 1997* 1996*
-------------- -------------- --------------
% of % of % of
Amount Total Amount Total Amount Total
-------- ----- -------- ----- -------- -----
Commissions........................ $313,131 58 $285,189 57 $276,736 58
Fees............................... 209,017 39 182,147 36 172,965 37
Investment income and other........ 18,507 3 24,169 5 24,052 5
Non-recurring gains................ -- -- 8,993 2 -- --
-------- --- -------- --- -------- ---
$540,655 100 $500,498 100 $473,753 100
======== === ======== === ======== ===
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*Restated for poolings of interests
The primary source of the Company's compensation for its brokerage services
is commissions paid by insurance companies which are usually based on a
percentage of the premium paid by the insured. Commission rates are dependent
on a number of factors including the type of insurance, the particular
insurance company and the capacity in which the Company acts. In some cases
the Company is compensated for brokerage or advisory services directly by a
fee from a client, particularly when insurers do not pay commissions. The
Company may
4
also receive contingent commissions which are generally based on the profit
the insurance company makes on the overall volume of business placed by the
Company in a given period of time. Occasionally, the Company shares
commissions with other brokers who have participated with the Company in
placing insurance or servicing insureds.
The Company's compensation for risk management services is in the form of
fees and commissions. The Company typically negotiates fees in advance with
its risk management clients on an annual basis based on the estimated value of
the services to be performed. In some cases the Company receives a fee for
acting in the capacity of advisor and administrator with respect to employee
benefit programs and receives commissions in connection with the placement of
insurance under such programs.
See Note 14 to the Consolidated Financial Statements for revenue information
by operating segment for 1998, 1997 and 1996.
The Company's revenues vary significantly from quarter to quarter as a
result of the timing of policy inception dates which traditionally are
heaviest in the third quarter, whereas expenses are fairly uniform throughout
the year. See Note 13 to the Consolidated Financial Statements for unaudited
quarterly operating results for 1998 and 1997.
Acquisitions
From January 1, 1994 through December 31, 1998, the Company has acquired
forty-two insurance service businesses and disposed of seven insurance service
businesses. See Note 2 to the Consolidated Financial Statements for further
information concerning acquisitions in 1998 and 1997.
The following acquisitions have occurred since December 31, 1998:
On February 28, 1999, a wholly owned subsidiary of the Company acquired
substantially all of the assets of Goodman Insurance Agency, Inc., a
California corporation engaged in the insurance brokerage and services
business in exchange for 157,385 shares of the Company's Common Stock. This
acquisition was accounted for as a pooling of interests. The principal entered
into a three-year employment agreement with the Company.
On February 28, 1999, a wholly owned subsidiary of the Company acquired
substantially all of the assets of Dodson-Bateman & Company, a Texas
corporation engaged in the insurance brokerage and services business in
exchange for 147,480 shares of the Company's Common Stock. This acquisition
was accounted for as a pooling of interests. Two principals and one key
employee entered into three-year employment agreements with the Company.
On February 28, 1999, a wholly owned subsidiary of the Company acquired
substantially all of the assets of Associated Risk Managers of California,
Insurance Producers, a California corporation engaged in the insurance
brokerage and services business in exchange for 99,054 shares of the Company's
Common Stock. This acquisition was accounted for as a pooling of interests.
One principal entered into a three-year employment agreement with the Company.
The Company believes that the net effect of these acquisitions has been and
will be to expand significantly the volume of general services rendered by the
Company and the geographical areas in which the Company renders such services
and not to change substantially the nature of the services performed by the
Company.
The Company is considering and intends to consider from time to time
acquisitions and divestitures on terms it deems advantageous. The Company has
had preliminary discussions with a number of candidates for possible future
acquisitions and has executed a non-binding letter of intent with one
candidate. No assurances can be given that any additional acquisitions or
divestitures will be consummated or, if consummated, will be advantageous to
the Company.
Employees
As of December 31, 1998, the Company and its subsidiaries employed
approximately 4,300 employees, none of whom is represented by a labor union.
The Company continuously reviews benefits and other matters of interest to its
employees. The Company considers its relations with its employees to be
satisfactory.
5
Item 2. Properties.
The Company's executive offices and certain subsidiary and branch facilities
are located at Two Pierce Place, Itasca, Illinois, where the Company leases
approximately 200,000 square feet of space. The lease commitment on the above
mentioned property expires February 28, 2006. The Company operates virtually
all of its branch and service offices in leased premises. Certain of these
leases for office space have options permitting renewals for additional
periods. In addition to minimum fixed rentals, a number of leases contain
escalation clauses related to increases in the cost of living in future years.
See Note 11 to the Consolidated Financial Statements for information with
respect to the Company's lease commitments at December 31, 1998.
Item 3. Legal Proceedings.
The Company 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 the Company's consolidated financial position or
results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the Company's
fourth fiscal quarter ended December 31, 1998.
Item 4A. Executive Officers of the Registrant.
The executive officers of the Company are as follows:
Name Age Position and Year First Elected
---- --- -------------------------------
J. Patrick Gallagher, 47 President since 1990, Chief Executive Officer since 1995
Jr.....................
Michael J. Cloherty..... 51 Vice President--Finance 1981-1996, Executive Vice President since 1996
James J. Braniff III.... 59 Vice President since 1995
Peter J. Durkalski...... 48 Vice President since 1990
James W. Durkin, Jr..... 49 Vice President since 1985
David E. McGurn, Jr..... 45 Vice President since 1993
Each such person has been principally employed by the Company in management
capacities for more than the past five years. All executive officers are
elected annually and serve at the pleasure of the Board of Directors.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters.
The Company's common stock is listed on the New York Stock Exchange, trading
under the symbol "AJG." The following table sets forth information as to the
price range of the Company's common stock for the two-year period January 1,
1997 through December 31, 1998 and the dividends declared per share for such
period. The table reflects the range of high and low sales prices per share as
reported on the Consolidated Transaction Reporting System for securities
listed on the New York Stock Exchange.
Dividends
Declared
Quarterly Periods High Low Per Share
- ----------------- --------- -------- ---------
1998
- ----
First............................................ $46 1/8 $33 9/16 $.35
Second........................................... 46 9/16 41 7/8 .35
Third............................................ 45 25/32 36 5/8 .35
Fourth........................................... 46 3/4 34 7/8 .35
1997
- ----
First............................................ $33 1/2 $29 3/4 $.31
Second........................................... 37 3/4 30 3/8 .31
Third............................................ 37 5/8 34 1/4 .31
Fourth........................................... 38 1/4 34 3/8 .31
As of February 28, 1999, there were approximately 650 holders of record of
the Company's common stock.
6
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7
Item 6. Selected Financial Data.
ARTHUR J. GALLAGHER & CO.
GROWTH RECORD: 1989-1998(a)
Average
Annual ----------------------------
(in thousands, except per share and Growth 1998 1997 1996
employee data) ------- -------- -------- --------
Revenue Data
Commissions............................ $313,131 $285,189 $276,736
Fees................................... 209,017 182,147 172,965
Investment income and other (e)........ 18,507 33,162 24,052
-------- -------- --------
Total revenues......................... $540,655 $500,498 $473,753
Dollar growth.......................... $ 40,157 $ 26,745 $ 17,624
Percent growth......................... 9% 8% 6% 4%
------ -------- -------- --------
Pretax Earnings Data
Pretax earnings........................ $ 84,529 $ 82,622 $ 67,002
Dollar growth.......................... $ 1,907 $ 15,620 $ (1,936)
Percent growth......................... 12% 2% 23% (3%)
Pretax earnings as a percentage of
revenues.............................. 16% 17% 14%
------ -------- -------- --------
Net Earnings Data
Net earnings........................... $ 56,501 $ 54,900 $ 44,227
Dollar growth.......................... $ 1,601 $ 10,673 $ 1,216
Percent growth......................... 11% 3% 24% 3%
Net earnings as a percentage of
revenues.............................. 10% 11% 9%
------ -------- -------- --------
Net Earnings Per Share Data
Shares outstanding at year end......... 17,645 16,883 16,749
Net earnings per share (b)............. $ 3.10 $ 3.17 $ 2.54
Percent growth......................... 11% (2%) 25% 5%
------ -------- -------- --------
Employee Data
Number at year end..................... 4,288 3,975 4,104
Number growth.......................... 313 (129) 35
Percent growth......................... 5% 8% (3%) 1%
Total revenue per employee (c)......... $ 126 $ 126 $ 115
Net earnings per employee (c).......... $ 13 $ 14 $ 11
------ -------- -------- --------
Common Stock Dividend Data
Dividends declared per share (d)....... $ 1.40 $ 1.24 $ 1.16
Total dividends declared............... $ 24,218 $ 20,408 $ 18,399
Percent of net earnings................ 43% 37% 42%
------ -------- -------- --------
Balance Sheet Data
Total assets........................... $746,010 $652,080 $602,067
Long-term debt less current portion.... -- -- 1,130
Total stockholders' equity............. $202,468 $165,580 $134,566
------ -------- -------- --------
Return On Beginning Stockholders' Equity. 34% 41% 35%
Notes:
(a) The financial information for all periods prior to 1998 has been restated
for four 1998 acquisitions accounted for using the pooling of interests
method.
(b) Based on the weighted average number of common and common equivalent shares
outstanding during the year.
(c) Based on the number of employees at year end.
(d) Based on the total dividends declared on a share of common stock
outstanding during the entire year.
(e) Includes non-recurring gains.
8
Years Ended December 31,
- --------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989
- -------- -------- -------- -------- -------- -------- --------
$270,437 $251,344 $226,394 $209,287 $200,171 $193,097 $174,231
163,137 144,516 131,957 114,545 95,468 80,255 66,499
22,555 14,136 20,983 17,191 14,565 20,293 19,822
- -------- -------- -------- -------- -------- -------- --------
$456,129 $409,996 $379,334 $341,023 $310,204 $293,645 $260,552
$ 46,133 $ 30,662 $ 38,311 $ 30,819 $ 16,559 $ 33,093 $ 24,405
11% 8% 11% 10% 6% 13% 10%
- -------- -------- -------- -------- -------- -------- --------
$ 68,938 $ 59,542 $ 54,218 $ 40,534 $ 32,990 $ 36,057 $ 35,981
$ 9,396 $ 5,324 $ 13,684 $ 7,544 $ (3,067) $ 76 $ 6,542
16% 10% 34% 23% (9%) --% 22%
15% 15% 14% 12% 11% 12% 14%
- -------- -------- -------- -------- -------- -------- --------
$ 43,011 $ 37,712 $ 32,104 $ 25,353 $ 22,480 $ 24,424 $ 24,113
$ 5,299 $ 5,608 $ 6,751 $ 2,873 $ (1,944) $ 311 $ 2,835
14% 17% 27% 13% (8%) 1% 13%
9% 9% 8% 7% 7% 8% 9%
- -------- -------- -------- -------- -------- -------- --------
16,821 16,527 17,432 16,907 17,213 17,247 17,442
$ 2.43 $ 2.14 $ 1.76 $ 1.43 $ 1.25 $ 1.36 $ 1.33
14% 22% 23% 14% (8%) 2% 15%
- -------- -------- -------- -------- -------- -------- --------
4,069 3,730 3,562 3,304 3,104 2,979 2,801
339 168 258 200 125 178 139
9% 5% 8% 6% 4% 6% 5%
$ 112 $ 110 $ 106 $ 103 $ 100 $ 99 $ 93
$ 11 $ 10 $ 9 $ 8 $ 7 $ 8 $ 9
- -------- -------- -------- -------- -------- -------- --------
$ 1.00 $ .88 $ .72 $ .64 $ .64 $ .60 $ .52
$ 15,270 $ 13,209 $ 10,808 $ 8,767 $ 8,439 $ 6,999 $ 5, 905
36% 35% 34% 35% 38% 29% 24%
- -------- -------- -------- -------- -------- -------- --------
$577,067 $525,288 $553,753 $497,565 $478,189 $470,678 $423,601
2,260 3,390 28,166 23,888 24,432 24,723 24,775
$125,884 $105,344 $127,239 $100,040 $ 95,088 $ 94,278 $ 86,614
- -------- -------- -------- -------- -------- -------- --------
41% 30% 32% 27% 24% 28% 31%
9
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General
Fluctuations in premiums charged by insurance companies have a material
effect on the insurance brokerage industry. Commission revenues are based on a
percentage of the premiums paid by insureds and generally follow premium
levels. For more than a decade, lower premium rates have prevailed among
property/casualty insurance carriers resulting in heavy competition for market
share. This "soft market" (i.e., lower premium rates) has generally resulted
in flat or reduced renewal commissions.
In recent years insured losses have reached into the billions of dollars.
Substantial mergers, both domestically and internationally, have resulted in
fewer insurance companies. Increased underwriting losses and reduced
competition tend to raise premium rates. In spite of these forces, there have
been mitigating factors including a favorable equity market, increased
underwriting capital (more supply of insurance product) and economies of scale
after consolidations, all of which tend to lower premium rates. The net result
is that property/casualty premium rates have remained low. Management believes
these conditions in the insurance marketplace will continue and overall
premium pricing will remain under pressure and not improve in 1999.
Historically, increased property replacement costs due to inflation and
increasingly large litigation awards have caused some clients to seek higher
levels of insurance coverage. These factors generally have the effect of
generating higher premiums to clients and higher commissions to the Company.
In recent years, lower rates of inflation along with increased underwriting
capital have resulted in a highly competitive insurance marketplace and flat
to lower premiums. In general, the downward trend in premium rates has had a
greater effect on the Company's revenues than inflation.
Although the property/casualty insurance pricing environment has resulted in
some "risk" buyers returning to first-dollar coverage, management believes the
overall trend will continue to move toward the alternative insurance market,
which would tend to have a favorable effect on our Risk Management Services
segment. The Company 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 the Company's fee revenue growth during
1999.
The Company continues to look to the future and to explore not only the core
segments of Insurance Brokerage and Risk Management Services, but also
expansion within the alternative insurance markets and financial and related
investment services. Management believes these areas continue to hold
opportunities for diversification and profitable growth.
Results of Operations--Consolidated
The Company's results of operations for periods prior to 1998 have been
restated for four acquisitions as if they had operated as part of the Company
prior to their joining the Company. The Company continues to search for merger
partners which complement existing operations, provide entry into new markets,
add new products and enhance local sales and service capabilities. For the
effect of these restatements, in the aggregate, on year-to-year comparisons,
see Note 2 to the Consolidated Financial Statements.
Commission revenues increased by $27.9 million or 10% in 1998. This increase
is the result of new business production of $54.1 million, significantly
offset by lost business of $35.2 million, with the balance coming from net
increases on renewals and contingent commissions. Commission revenues
increased by $8.5 million or 3% in 1997. This increase is the result of new
business production partially offset by lost business.
Fee revenues increased by $26.9 million or 15% in 1998. This increase,
generated primarily from the Risk Management Services segment, resulted from
strong new business production of $39.0 million and favorable retention rates
on existing business. Fee revenues increased by $9.2 million or 5% in 1997.
This increase, also generated primarily from Risk Management Services,
resulted from new business production partially offset by lost business.
Investment income and other decreased by $5.7 million or 23% in 1998. This
decrease is due primarily to lower returns on funds invested with outside fund
managers which were adversely affected by volatility in global
10
equity markets during 1998. In addition, the Company liquidated a portion of
its investment portfolio, thereby reducing the aggregate value of these
portfolios by $24.0 million during 1998. Investment income and other was
virtually unchanged in 1997 from the same period in 1996.
In 1997, the Company recognized non-recurring pretax gains of $7.2 million
on the sale of underperforming or geographically undesirable operations and
$1.8 million on a real estate transaction. There were no material non-
recurring pretax gains recorded in either 1998 or 1996.
Salaries and employee benefits increased by $27.1 million or 11% in 1998 due
primarily to an 8% increase in employee head count, salary increases, the
annualized effect of prior year new hires along with a corresponding increase
in employee benefit expenses, and a $4.8 million non-recurring gain recognized
in 1997 from the settlement of a defined benefit pension plan at one of the
Company's United Kingdom subsidiaries. Salaries and employee benefits
increased by $4.8 million or 2% in 1997 due to salary increases and the
annualized effect of prior year new hires substantially offset by a 3%
reduction in employee head count in 1997, the non-recurring pension gain
mentioned above and a wage freeze for certain management employees in 1997.
Other operating expenses increased by $11.2 million or 7% in 1998. This
increase is due primarily to increases associated with travel, entertainment
and temporary personnel costs for new business, technology upgrades, office
consolidation expenses and commissions paid to sub-brokers. Other operating
expenses increased by $6.4 million or 4% in 1997. This increase is due
primarily to higher business insurance costs, additional rent and utility
expenses resulting from leasing new office space, expanding and upgrading
existing office facilities and the costs associated with closing certain
underperforming operations.
The Company's effective income tax rates of 33.2%, 33.6% and 34.0% in 1998,
1997 and 1996, respectively, are less than the statutory federal income tax
rate of 35% due primarily to the effect of tax benefits generated by certain
investments which are substantially offset by state and foreign taxes. See
Note 12 to the Consolidated Financial Statements.
The Company's foreign operations recorded earnings before income taxes of
$5.4 million, $6.6 million and $5.2 million in 1998, 1997 and 1996,
respectively. The decrease in 1998 is due to the non-recurring gains
recognized in 1997 associated with the pension and real estate transactions
mentioned above, substantially offset by growth in operating results generated
by new business. The 1997 increase is due to the non-recurring gains
associated with the pension and real estate transactions mentioned above. See
Notes 12 and 14 to the Consolidated Financial Statements.
The Company'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.
Results of Operations--Segment Information
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 (SFAS 131), "Disclosure about Segments
of an Enterprise and Related Information." SFAS 131 establishes standards for
the way that public business enterprises report information about operating
segments and related disclosures. The following discussion describes and
compares the results of operations and geographic data between 1998, 1997 and
1996 with respect to the way the Company views its operating segments.
Insurance Brokerage Services includes the Company's retail, reinsurance and
wholesale brokerage operations. Total revenues in 1998 were $362.5 million, a
9% increase over 1997. This increase is due primarily to new business
production and the positive effect of acquisitions, significantly offset by
lost business. U.S. revenues of $330.2 million were up 9% over 1997. Revenues
in 1998 from foreign operations, principally in the United Kingdom were up 8%
or $2.3 million over 1997 due mainly to new business partially offset by lost
business. Earnings before income taxes in 1998 increased 19% over 1997 as a
result of increased revenues. Total revenues in 1997 were $333.8 million, an
increase of 4% over 1996. This increase again is due to new business
production partially offset by lost business. U.S. revenues of $303.8 million
were up 4% over 1996. Revenues in
11
1997 from foreign operations, primarily in the United Kingdom, were virtually
flat with 1996. Earnings before income taxes of $57.4 million in 1997
increased 9% over 1996 due mainly to increased revenues.
Risk Management Services includes the Company's third party claims
administration operations which are principally engaged in providing claims
management services for the Company's clients. Total revenues in 1998 were
$168.8 million or 18% over 1997 due to strong new business production and
favorable retention rates on existing business. U.S. revenues of $156.8
million in 1998 were up 15% over 1997 due primarily to new business. In 1998,
foreign revenues of $12.0 million, principally from the United Kingdom and
Australia, increased 107% over 1997 due mainly to new business and significant
revenues from Australian operations for claim work performed as a result of a
pervasive and extended power outage in New Zealand. Earnings before income
taxes in 1998 increased 50% over 1997 due primarily to large revenue
increases. Total revenues in 1997 were $142.7 million or 3% over 1996 due to
new business production partially offset by lost business. In 1997, U.S.
revenues increased 1% over 1996 due primarily to new business partially offset
by lost business. Earnings before income taxes in 1997 decreased 18% from 1996
due primarily to lost business partially offset by new business.
Financial Services is responsible for investments and certain non-recurring
events. The Company's comprehensive investment portfolio includes investment
strategies held as trading, marketable securities held as available for sale,
tax advantaged investments, investments on the equity method of accounting,
real estate partnerships and notes receivable from investees. Revenues in 1998
were $9.3 million or $14.7 million less than revenues in 1997 and earnings
before income taxes decreased $16.9 million or 76% from 1997. These decreases
relate to $9.0 million and $13.8 million of non-recurring gains in revenues
and earnings before taxes, respectively, recognized in 1997 and less favorable
returns on funds invested with outside fund managers due to equity market
conditions in 1998. Revenues in 1997 increased 80% over 1996 and earnings
before income taxes in 1997 increased 166% over 1996 due primarily to the non-
recurring gains mentioned above and favorable returns on funds invested with
outside fund managers. Financial Services' revenues are generated principally
in the U.S.
Corporate consists of unallocated administrative costs and the provision for
income taxes which is not allocated to the Company's operating entities.
Revenues are not recorded in this segment and all costs are generated in the
U.S. See Note 14 to the Consolidated Financial Statements.
Financial Condition and Liquidity
The insurance brokerage industry is not capital intensive. The Company 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 $56.4 million, $67.0 million and $45.6
million in 1998, 1997 and 1996, 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 the Company's use, primarily premiums held as fiduciary
funds, have not been included in determining the Company's overall liquidity.
The Company maintains a $20.0 million unsecured revolving credit agreement
(the "Credit Agreement") requiring repayment of any loans under the agreement
no later than June 30, 2001. During 1998, the Company borrowed and repaid
$15.0 million of short-term borrowings under the Credit Agreement. These
borrowings were primarily used on a short-term basis to finance a portion of
the Company's expanded investment activity. As of December 31, 1998, there
were no borrowings outstanding under this agreement. During 1997, the Company
made no borrowings under this agreement. The Credit Agreement requires the
maintenance of certain financial covenants. The Company is currently in
compliance with these covenants. The Company also had two term loan
agreements. In 1998, the Company retired the remaining loan balances on these
term loan agreements.
The Company also has line of credit facilities of $27.5 million which expire
on April 30, 1999. Periodically, the Company will make short-term borrowings
under these credit facilities to meet short-term cash flow needs. During 1998
and 1997, the Company borrowed $60.0 million and $30.9 million and repaid
$60.0 million and $25.9 million of short-term borrowings, respectively, under
these facilities. As of December 31, 1998 and 1997,
12
$15.0 million was outstanding under these facilities. These borrowings were
primarily used on a short-term basis to finance a portion of the Company's
expanded investment activity.
At December 31, 1997, the Company had commitments to invest $26.0 million in
several of its equity and tax advantaged investments. In addition, the Company
had contingently committed to invest an additional $3.0 million in 1998
related to a line of credit arrangement with one of its equity investments. As
of December 31, 1998, approximately $29.0 million had been invested under
these arrangements, which were funded primarily from the $24.0 million of
proceeds from the sales and maturities of trading and marketable securities
investments. At December 31, 1998, the Company has committed to invest an
additional $7.5 million related to two letter of credit arrangements with one
of its equity investments and to unconditionally guarantee $30.0 million of
debt that will be incurred by another of its equity investments. In addition,
the Company has guaranteed an aggregate $8.7 million of funds through letters
of credit or other arrangements related to several investments and insurance
programs of the Company.
The Company paid $23.2 million in cash dividends on its common stock in
1998. The Company's dividend policy is determined by the Board of Directors
and payments are fixed after considering the Company's available cash from
earnings and its known or anticipated cash needs. In each quarter of 1998, the
Company's Board of Directors declared a dividend of $.35 per share which was
$.04 or 13% greater than each quarterly dividend in 1997. In January 1999, the
Company announced a first quarter dividend of $.40 per share, a 14% increase
over the first quarter dividend in 1998.
Net capital expenditures were $14.0 million, $11.4 million and $10.4 million
in 1998, 1997 and 1996, respectively. In 1999, the Company expects to make
expenditures for capital improvements of approximately $14.5 million. Capital
expenditures by the Company are related primarily to office moves and
expansions and updating computer systems and equipment.
In 1988, the Company adopted a plan which has been extended through June 30,
1999 to repurchase its common stock. Under the plan, the Company repurchased
215,000 shares at a cost of $8.7 million, 522,000 shares at a cost of $17.1
million and 645,000 shares at a cost of $21.3 million in 1998, 1997 and 1996,
respectively. The repurchased shares are held for reissuance in connection
with exercises of options under the Company's stock option plans. Under the
provisions of the plan, the Company is authorized to repurchase approximately
535,000 additional shares through June 30, 1999. The Company 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.
Effective with changes in the United States federal income tax laws in 1997,
the Company no longer provides for U.S. income taxes on the undistributed
earnings of its foreign subsidiaries which are considered permanently invested
outside the United States. At December 31, 1998, the Company had $21.8 million
of undistributed earnings from its foreign subsidiaries which is a decrease of
$5.4 million from the undistributed earnings at December 31, 1997. This
decrease is due primarily to $7.7 million of aggregate dividend payments
received by the Company from two of its foreign subsidiaries partially offset
by the 1998 net earnings of its foreign subsidiaries. These dividend payments
are subject to United States federal income tax which have been provided for
by the Company. See Note 12 to the Consolidated Financial Statements. Although
not considered available for domestic needs, the undistributed earnings
generated by certain foreign subsidiaries referred to above may be used to
finance foreign operations and acquisitions.
Year 2000 Compliance
Computer programs that have time sensitive software may recognize the date
"00" as the Year 1900, rather than the Year 2000 which could result in system
failures or miscalculations causing disruptions of operations. With respect to
this issue, the Company has completed an assessment of its computer systems
and software and has substantially completed the necessary modifications or
replacements of its existing software so that its computer systems will
function properly in the Year 2000 and beyond. Testing and live use have taken
place and will continue into 1999. Any additional modifications found
necessary will be made at that time. No contingency plans are deemed
necessary.
13
The Company has evaluated the impact on operations of the Year 2000 on non-
information technology systems and has determined that any potential impact
would not be material to the Company's operations.
Generally, system modifications and replacements and the associated costs
were contemplated with normal enhancements and improvements being made in
conjunction with updating financial reporting and operating systems. To date,
the cost of compliance has not been material and is not expected to be
material in the future.
The Company also has an ongoing program to review the status of Year 2000
compliance efforts of its business partners and vendors. While the Company
believes it is taking the appropriate steps to assure the Company's Year 2000
compliance, it is also dependent on business partner, vendor and client
compliance to some extent. Consequently, any Year 2000 compliance problems
that may be experienced by the Company's business partners, vendors or clients
could have a material adverse effect on the Company's future financial
condition and future operating results. No assurance can be given that the
Company's and these other entities' efforts will completely address the Year
2000 issue.
Market Risk Exposure
The Company is exposed to various market risks, including changes in
interest rates and foreign currency exchange rates. Market risk is the
potential loss arising from adverse changes in market rates and prices, such
as interest and foreign currency exchange rates and equity prices. The Company
does not enter into derivatives or other similar financial instruments for
trading or speculative purposes. The following analysis presents the
hypothetical loss in fair value of the financial instruments held by the
Company at December 31, 1998 that are sensitive to changes in interest rates
and equity prices. The range of changes in interest rates used in the analysis
reflects the Company's view of changes that are reasonably possible over a one
year period. This discussion of market risks related to the Company's
consolidated balance sheet includes estimates of future economic environments
caused by changes in market risks. The effect of actual changes in these risk
factors may differ materially from the Company's estimates. In the ordinary
course of business, the Company also faces risks that are either nonfinancial
or nonquantifiable, including credit risk and legal risk. These risks are not
included in the following analysis.
The Company has a comprehensive and diversified investment portfolio. The
Company's invested assets are held as cash and cash equivalents, investment
strategies held as trading and marketable securities held as available for
sale. Accordingly, these assets are subject to various market risk exposures
such as interest rate risk and equity price risk.
The fair value of the Company's cash and cash equivalents investment
portfolio at December 31, 1998 approximated its carrying value due to its
short-term duration. Market risk was estimated as the potential decrease in
fair value resulting from a hypothetical one percentage point increase in
interest rates for the instruments contained in the cash and cash equivalents
investment portfolio and the resulting fair value was not materially different
from the December 31, 1998 carrying value.
At December 31, 1998, the fair value of the Company's investment strategies
portfolio was $57.4 million. From an investment management perspective, this
portfolio, which is managed by several outside fund managers, consists of two
different components: an equity portfolio of $7.3 million and an alternative
investment strategies portfolio of $50.1 million. The equity portfolio is
subject to equity price risk. This portfolio, which is not hedged, consists of
common stocks and is primarily managed to produce realized gains for the
Company. The estimated potential loss in fair value of this equity component
at December 31, 1998 resulting from a hypothetical decrease in prices quoted
by stock exchanges of 10% would be approximately $730,000. The Company's
alternative investment strategies portfolio is also subject to equity pricing
risk. However, these investments are actively managed in order to minimize the
Company's exposure to equity pricing risk. The objective of this portfolio is
to maximize the overall return to the Company, while minimizing the downward
price risk in order to preserve the investment's underlying principal balance.
The outside fund managers for these alternative investment
14
strategies hedge their strategies by "selling short" common equity securities
in order to mitigate the effects of changes in equity prices thereby making
any such fluctuations immaterial. Accordingly, hypothetical changes in equity
prices would not cause the resulting fair value to be materially different
from the December 31, 1998 carrying value for this portfolio.
At December 31, 1998, the fair value of the Company's marketable securities
portfolio was $20.1 million, which was $1.3 million less than its aggregate
amortized cost. The overall objective of this portfolio is to provide the
Company with a stable after tax yield. This portfolio, which is not hedged,
primarily consists of dividend yielding preferred stocks. Accordingly, this
portfolio is more sensitive to interest rate risk than it is to equity pricing
risk. The estimated potential loss in fair value resulting from a hypothetical
one percentage point increase in short-term interest rates at December 31,
1998 would be approximately $2.1 million.
At December 31, 1998, the fair value of the Company's borrowings under the
line of credit facilities approximated the carrying value due to their short-
term duration and variable interest rates. Market risk was estimated as the
potential increase in the fair value resulting from a hypothetical one
percentage point decrease in the Company's weighted average short-term
borrowing rate at December 31, 1998 and the resulting fair value was not
materially different from the year end carrying value.
The Company is subject to foreign currency exchange rate risk primarily due
to the fact that its United Kingdom based subsidiaries incur expenses
denominated in British pounds while receiving their revenues in U.S. dollars.
The Company does not hedge this foreign currency exchange rate risk. The
foreign currency gains (losses) related to this market risk are recorded in
earnings before income taxes as they are incurred. Assuming a hypothetical
adverse change of 10% in the average foreign currency exchange rate for 1998
(a weakening of the U.S. dollar), earnings before income taxes would decrease
by approximately $2.0 million. The Company is also subject to foreign currency
exchange rate risk associated with the translation of its foreign subsidiaries
into U.S. dollars. However, it is management's opinion that this foreign
currency exchange risk is not material to the Company's consolidated operating
results or financial position. The Company manages the balance sheets of its
foreign subsidiaries such that foreign liabilities are matched with equal
foreign assets thereby maintaining a "balanced book" which minimizes the
effects of currency fluctuations.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of
1995
This annual report contains forward-looking statements. Forward-looking
statements made by or on behalf of the Company are subject to risks and
uncertainties, including but not limited to the following: the Company's
commission revenues are highly dependent on premiums charged by insurers,
which are subject to fluctuation; the property/casualty insurance industry
continues to experience a prolonged soft market (low premium rates) thereby
reducing commissions; lower interest rates will reduce the Company's income
earned on invested funds; the insurance brokerage and service businesses are
extremely competitive with three competitors being substantially larger than
the Company; the alternative insurance market continues to grow which could
unfavorably impact commission and favorably impact fee revenue; the Company's
revenues vary significantly from period to period as a result of the timing of
policy inception dates and the net effect of new and lost business production;
the general level of economic activity can have a substantial impact on the
Company's renewal business; the Company's operating results and financial
position may be adversely impacted by exposure to various market risks such as
interest rate, equity pricing and foreign exchange rates; and the Company's
Year 2000 compliance efforts depend upon compliance efforts of the Company's
business partners, vendors and clients. The Company's ability to grow has been
enhanced through acquisitions, which may or may not be available on acceptable
terms in the future and which, if consummated, may or may not be advantageous
to the Company. Accordingly, actual results may differ materially from those
set forth in the forward-looking statements. Attention is also directed to
other risk factors set forth in documents filed by the Company with the
Securities and Exchange Commission.
15
Item 8. Financial Statements and Supplementary Data.
INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Pages
-----
Consolidated Financial Statements:
Consolidated Statement of Earnings...................................... 17
Consolidated Balance Sheet.............................................. 18
Consolidated Statement of Cash Flows.................................... 19
Consolidated Statement of Stockholders' Equity.......................... 20
Notes to Consolidated Financial Statements.............................. 21-37
Management's Report....................................................... 38
Report of Independent Auditors............................................ 39
16
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENT OF EARNINGS
Year Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
(in thousands, except per
share data)
Operating Results
Revenues:
Commissions....................................... $313,131 $285,189 $276,736
Fees.............................................. 209,017 182,147 172,965
Investment income and other....................... 18,507 24,169 24,052
Non-recurring gains............................... -- 8,993 --
-------- -------- --------
Total revenues.................................. 540,655 500,498 473,753
-------- -------- --------
Expenses:
Salaries and employee benefits.................... 281,509 254,424 249,674
Other operating expenses.......................... 174,617 163,452 157,077
-------- -------- --------
Total expenses.................................. 456,126 417,876 406,751
-------- -------- --------
Earnings before income taxes........................ 84,529 82,622 67,002
Provision for income taxes.......................... 28,028 27,722 22,775
-------- -------- --------
Net earnings.................................... $ 56,501 $ 54,900 $ 44,227
======== ======== ========
Net earnings per common share....................... $ 3.25 $ 3.28 $ 2.64
Net earnings per common and common equivalent share. 3.10 3.17 2.54
Dividends declared per common share................. 1.40 1.24 1.16
See notes to consolidated financial statements.
17
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED BALANCE SHEET
December 31,
------------------
1998 1997
-------- --------
(in thousands)
ASSETS
------
Current assets:
Cash and cash equivalents................................ $ 61,518 $ 72,021
Restricted cash.......................................... 86,622 81,160
Premiums and fees receivable............................. 288,276 220,972
Investment strategies--trading........................... 57,368 62,681
Other.................................................... 37,172 40,655
-------- --------
Total current assets................................... 530,956 477,489
Marketable securities--available for sale.................. 20,089 39,203
Deferred income taxes and other noncurrent assets.......... 151,033 96,748
Fixed assets............................................... 98,262 88,029
Accumulated depreciation and amortization.................. (66,801) (59,784)
-------- --------
Net fixed assets....................................... 31,461 28,245
Intangible assets--net..................................... 12,471 10,395
-------- --------
$746,010 $652,080
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Premiums payable to insurance companies.................. $372,626 $318,007
Accrued salaries and bonuses............................. 21,940 18,585
Accounts payable and other accrued liabilities........... 90,336 90,731
Unearned fees............................................ 13,616 11,778
Income taxes payable..................................... 12,621 10,799
Other.................................................... 19,517 23,260
-------- --------
Total current liabilities.............................. 530,656 473,160
Other noncurrent liabilities............................... 12,886 13,340
Stockholders' equity:
Common stock--issued and outstanding 17,645 shares in
1998 and
16,883 shares in 1997.................................. 17,645 16,883
Capital in excess of par value........................... 13,219 4,696
Retained earnings........................................ 172,381 142,343
Accumulated other comprehensive earnings (loss).......... (777) 1,658
-------- --------
Total stockholders' equity............................. 202,468 165,580
-------- --------
$746,010 $652,080
======== ========
See notes to consolidated financial statements.
18
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENT OF CASH FLOWS
Years Ended December 31,
----------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
Cash flows from operating activities:
Net earnings................................... $ 56,501 $ 54,900 $ 44,227
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Net gain on investments and other............ (4,144) (13,931) (3,928)
Depreciation and amortization................ 11,728 11,240 10,712
(Increase) decrease in restricted cash....... (5,462) 6,064 8,164
(Increase) decrease in premiums receivable... (58,782) 15,790 (5,775)
Increase (decrease) in premiums payable...... 54,619 (11,570) 3,280
Decrease (increase) in trading investments--
net......................................... 6,963 (6,217) (4,128)
Decrease (increase) in other current assets.. 5,583 (6,490) (8,000)
Increase in accrued salaries and bonuses..... 3,355 3,512 1,326
(Decrease) increase in accounts payable and
other accrued liabilities................. (1,428) 19,675 8,404
Increase (decrease) in income taxes payable.. 1,822 5,760 (5,575)
Net change in deferred income taxes.......... (5,474) (9,604) (2,502)
Other........................................ (8,914) (2,163) (650)
-------- -------- --------
Net cash provided by operating activities.. 56,367 66,966 45,555
-------- -------- --------
Cash flows from investing activities:
Purchases of marketable securities............. (33,331) (30,170) (23,679)
Proceeds from sales of marketable securities... 47,665 30,368 28,747
Proceeds from maturities of marketable
securities.................................... 2,600 1,645 1,958
Net additions to fixed assets.................. (13,994) (11,381) (10,363)
Other.......................................... (52,146) (25,698) (16,969)
-------- -------- --------
Net cash used by investing activities...... (49,206) (35,236) (20,306)
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock......... 13,655 10,964 7,966
Tax benefit from issuance of common stock...... 4,273 2,429 1,955
Repurchases of common stock.................... (8,651) (17,126) (21,290)
Dividends paid................................. (23,185) (19,990) (17,530)
Retirement of long-term debt................... (1,130) (1,130) (1,130)
Borrowings on line of credit facilities........ 75,000 30,900 10,000
Repayments on line of credit facilities........ (75,000) (25,900) --
Equity transactions of pooled companies prior
to dates of acquisition....................... (2,626) (613) (6,807)
-------- -------- --------
Net cash used by financing activities...... (17,664) (20,466) (26,836)
-------- -------- --------
Net (decrease) increase in cash and cash
equivalents..................................... (10,503) 11,264 (1,587)
Cash and cash equivalents at beginning of year... 72,021 60,757 62,344
-------- -------- --------
Cash and cash equivalents at end of year......... $61,518 $ 72,021 $ 60,757
======== ======== ========
Supplemental disclosures of cash flow
information:
Interest paid.................................. $ 1,289 $ 1,018 $ 885
Income taxes paid.............................. 20,337 24,158 25,874
See notes to consolidated financial statements.
19
ARTHUR J. GALLAGHER & CO.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Accumulated
Capital Other
Common Stock In Excess Comprehensive Total
--------------- Of Retained Earnings Stockholders'
Shares Amount Par Value Earnings (Loss) Equity
------ ------- --------- -------- ------------- -------------
(in thousands)
Balance at December 31,
1995 as previously
reported............... 16,529 $16,529 $ -- $109,616 $ 34 $ 126,179
Acquisition of pooled
companies............. 292 292 267 (854) -- (295)
------ ------- --------- -------- ------------- -------------
Balance at December 31,
1995................... 16,821 16,821 267 108,762 34 125,884
-------------
Net earnings........... -- -- -- 44,227 -- 44,227
Net change in
unrealized gain (loss)
on available for sale
securities............ -- -- -- -- 855 855
-------------
Comprehensive earnings 45,082
Cash dividends declared
on common stock....... -- -- -- (18,399) -- (18,399)
Common stock issued
under stock option
plans................. 398 398 7,568 -- -- 7,966
Tax benefit from
issuance of common
stock................. -- -- 1,955 -- -- 1,955
Common stock
repurchases........... (645) (645) (7,383) (13,262) -- (21,290)
Common stock issued in
three pooling
acquisitions.......... 175 175 -- -- -- 175
Equity transactions of
pooled companies prior
to dates of
acquisition........... -- -- -- (6,807) -- (6,807)
------ ------- --------- -------- ------------- -------------
Balance at December 31,
1996................... 16,749 16,749 2,407 114,521 889 134,566
-------------
Net earnings........... -- -- -- 54,900 -- 54,900
Net change in
unrealized gain (loss)
on available for sale
securities............ -- -- -- -- 769 769
-------------
Comprehensive earnings 55,669
Cash dividends declared
on common stock....... -- -- -- (20,408) -- (20,408)
Common stock issued
under stock option
plans................. 557 557 10,407 -- -- 10,964
Tax benefit from
issuance of common
stock................. -- -- 2,429 -- -- 2,429
Common stock
repurchases........... (522) (522) (10,627) (5,977) -- (17,126)
Common stock issued in
two pooling
acquisitions.......... 99 99 -- -- -- 99
Equity transactions of
pooled companies prior
to dates of
acquisition........... -- -- 80 (693) -- (613)
------ ------- --------- -------- ------------- -------------
Balance at December 31,
1997................... 16,883 16,883 4,696 142,343 1,658 165,580
-------------
Net earnings........... -- -- -- 56,501 -- 56,501
Net change in
unrealized gain (loss)
on available for sale
securities............ -- -- -- -- (2,435) (2,435)
-------------
Comprehensive earnings 54,066
Cash dividends declared
on common stock....... -- -- -- (24,218) -- (24,218)
Common stock issued
under stock option
plans................. 588 588 13,067 -- -- 13,655
Tax benefit from
issuance of common
stock................. -- -- 4,273 -- -- 4,273
Common stock
repurchases........... (215) (215) (8,436) -- -- (8,651)
Common stock issued in
nine pooling
acquisitions.......... 389 389 -- -- -- 389
Equity transactions of
pooled companies prior
to dates of
acquisition........... -- -- (381) (2,245) -- (2,626)
------ ------- --------- -------- ------------- -------------
Balance at December 31,
1998................... 17,645 $17,645 $ 13,219 $172,381 $ (777) $ 202,468
====== ======= ========= ======== ============= =============
See notes to consolidated financial statements.
20
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of operations
Arthur J. Gallagher & Co. (the Company) 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 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. The Company operates through approximately
200 offices throughout the United States and six countries abroad.
Basis of presentation
The accompanying consolidated financial statements include the accounts of
the Company and all of its majority owned subsidiaries. Investments in
partially owned entities in which ownership is 20% to 50% are accounted for
using the equity method. Accordingly, the Company's share of the net earnings
of these entities is included in consolidated net earnings. Investments in
partially owned entities in which ownership is less than 20% are carried at
cost. All material intercompany accounts and transactions have been eliminated
in consolidation. Certain reclassifications have been made to the prior years'
financial statements in order to conform to the current year presentation.
Use of estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements
and accompanying notes. Such estimates and assumptions could change in the
future as more information becomes known which could impact the amounts
reported and disclosed herein.
Revenue recognition
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 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 $1,500,000 and $860,000 at December
31, 1998 and 1997, respectively.
Comprehensive earnings
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130 (SFAS 130), "Reporting Comprehensive Income." SFAS 130
establishes new rules for the reporting and display of comprehensive earnings
and its components; however, the adoption of SFAS 130 had no impact on the
Company's consolidated net earnings or total stockholders' equity. SFAS 130
requires unrealized gains or losses on the Company's available for sale
securities, which prior to adoption were reported separately in stockholders'
equity, to be included in other comprehensive earnings. Prior year
consolidated financial statements have been reclassified to conform to the
requirements of SFAS 130.
Earnings per share
Earnings per share are computed based on the weighted average number of
common and common equivalent shares outstanding during the respective period.
Common equivalent shares include incremental shares from dilutive stock
options, which are calculated from the date of grant under the treasury stock
method using the average market price for the period.
21
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1. Summary of Significant Accounting Policies--(Continued)
Segment information
As of December 31, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131 (SFAS 131), "Disclosure about Segments of an
Enterprise and Related Information," which superseded Statement of Financial
Accounting Standards No. 14, "Financial Reporting for Segments of a Business
Enterprise." SFAS 131 establishes standards for the way that public business
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information
about operating segments in interim financial reports issued to stockholders.
SFAS 131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. The adoption of SFAS 131 had
no impact on the Company's consolidated operating results or financial
position, but did affect the disclosure of segment information. Prior year
segment information has been reclassified to conform to the requirements of
SFAS 131. See Note 14 to the consolidated financial statements.
Consolidated statement of cash flows
Short-term investments, consisting principally of commercial paper and
certificates of deposit which have a maturity of ninety days or less at date
of purchase, are considered cash equivalents.
Premium trust funds
Premiums collected from insureds but not yet remitted to insurance carriers
are restricted as to use by laws in certain states and foreign jurisdictions
in which the Company's subsidiaries operate. Additionally, the Company's
United Kingdom subsidiaries are required by Lloyd's of London to meet certain
liquidity requirements.
Investments
Investment strategies are considered trading securities and consist
primarily of limited partnerships which invest in common stocks. Securities
designated as trading are carried at fair value in the accompanying
consolidated balance sheet, with unrealized gains and losses included in the
consolidated statement of earnings. The fair value of investment strategies is
determined by reference to the fair values of the underlying common stocks
which are based on quoted market prices.
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
sheet, with unrealized gains and losses, less related deferred income taxes,
excluded from net earnings and reported as accumulated other comprehensive
earnings. 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.
Fixed assets
Fixed assets are carried at cost in the accompanying consolidated balance
sheet. Furniture and equipment with a cost of $86,862,000 and $78,839,000 at
December 31, 1998 and 1997, respectively, are depreciated using the straight-
line method over the estimated useful lives of the assets. Leasehold
improvements with a cost of $11,400,000 and $9,190,000 at December 31, 1998
and 1997, respectively, are amortized using the straight-line method over the
shorter of the estimated useful lives of the assets or the lease terms.
22
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1. Summary of Significant Accounting Policies--(Continued)
Intangible assets
Intangible assets consist of the excess of cost over the value of net
tangible assets of acquired businesses, non-compete agreements and expiration
lists. The excess of cost over the value of net tangible assets is amortized
over twenty to forty years using the straight-line method. Non-compete
agreements and expiration lists are amortized principally over ten years using
the straight-line method. Accumulated amortization at December 31, 1998 and
1997 was $4,618,000 and $6,487,000, respectively.
Stock based compensation
The Company primarily grants stock options for a fixed number of shares to
employees with an exercise price equal to the fair value of the shares at the
date of grant. The Company accounts for stock option grants in accordance with
Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock
Issued to Employees," and, accordingly, recognizes no compensation expense for
these stock options granted to employees.
Effect of new pronouncement
In 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities," which is effective for fiscal years
beginning after June 15, 1999. Because of the Company's minimal use of
derivatives, management does not anticipate that the adoption of SFAS 133 will
have a significant effect on the Company's consolidated operating results or
financial position.
2. Business Combinations
In 1998, the Company acquired substantially all of the net assets of twelve
insurance brokerage firms and one benefits consulting company in exchange for
681,000 shares of its common stock. In 1997, the Company acquired
substantially all of the net assets of one insurance brokerage firm and two
benefits consulting companies in exchange for 263,000 shares of its common
stock. These acquisitions were accounted for as poolings of interests and,
except for nine of the 1998 acquisitions and two of the 1997 acquisitions
whose results were not significant, the consolidated financial statements for
all periods prior to the acquisition dates have been restated to include the
operations of these companies.
The following summarizes the restatement of the 1997 and 1996 consolidated
financial statements to reflect the operations of the 1998 acquisitions (in
thousands, except per share data):
As Attributable
Previously to Pooled As
1997 Reported Companies Restated
- ---- ---------- ------------ --------
Total revenues................................ $488,028 $ 12,470 $500,498
Net earnings.................................. 53,316 1,584 54,900
Net earnings per common share................. 3.24 .04 3.28
Net earnings per common and common equivalent
share........................................ 3.13 .04 3.17
1996
- ----
Total revenues................................ $462,022 $ 11,731 $473,753
Net earnings.................................. 43,144 1,083 44,227
Net earnings per common share................. 2.62 .02 2.64
Net earnings per common and common equivalent
share........................................ 2.52 .02 2.54
In 1998, the Company acquired the net assets of three insurance brokerage
firms in exchange for cash and notes payable. These acquisitions were
accounted for as purchases. In 1997, the Company acquired a majority equity
interest in a risk management company which was also accounted for as a
purchase. The Company paid cash in this transaction. These purchase
transactions were not material to either the 1998 or 1997 consolidated
financial statements.
23
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Investments
The following is a summary of available for sale marketable securities (in
thousands):
Cost or Gross Gross
Amortized Unrealized Unrealized Fair
December 31, 1998 Cost Gains Losses Value
- ----------------- --------- ---------- ---------- -------
Preferred stocks........................ $ 14,487 $ 529 $ 646 $14,370
Common stocks........................... 4,735 57 1,218 3,574
Fixed maturities........................ 2,161 71 87 2,145
--------- ---------- ---------- -------
$ 21,383 $ 657 $ 1,951 $20,089
========= ========== ========== =======
December 31, 1997
- -----------------
Preferred stocks........................ $ 20,776 $ 1,264 $ 162 $21,878
Common stocks........................... 12,139 2,420 766 13,793
Fixed maturities........................ 3,525 161 154 3,532
--------- ---------- ---------- -------
$ 36,440 $ 3,845 $ 1,082 $39,203
========= ========== ========== =======
The gross realized gains on sales of marketable securities totaled
$3,054,000, $2,257,000 and $1,652,000 for 1998, 1997 and 1996, respectively.
The gross realized losses totaled $1,179,000, $346,000 and $881,000 for 1998,
1997 and 1996, respectively.
The cost or amortized cost and fair value of fixed maturities at December
31, 1998, by contractual maturity, are as follows (in thousands):
Cost or
Amortized Fair
Cost Value
---------- -------
Due in 1999.................................................. $ -- $ --
Due in 2000 through 2003..................................... 1,540 1,524
Due in 2004 through 2008..................................... 152 152
Due in 2009 and thereafter................................... 469 469
---------- -------
$ 2,161 $ 2,145
========== =======
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.
The following is a summary of deferred income taxes and other noncurrent
assets (in thousands):
December 31,
------------------
1998 1997
---------- -------
Tax advantaged investments................................... $ 51,400 $34,413
Investments on equity method of accounting................... 20,017 15,736
Real estate partnerships..................................... 10,732 405
Notes receivable from investees.............................. 30,855 12,545
Noncurrent deferred income taxes............................. 21,669 19,349
Other investments............................................ 9,466 8,656
Other........................................................ 6,894 5,644
---------- -------
$151,033 $96,748
========== =======
24
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
3. Investments--(Continued)
Tax advantaged investments represent amounts invested by the Company in
limited partnerships that operate qualified affordable housing or alternative
energy projects. The Company receives tax benefits in the form of tax
deductions for operating losses and tax credits from these investments. The
tax advantaged investments are primarily accounted for using the effective
yield method and are carried at amortized cost in the consolidated balance
sheet. Under the effective yield method, the Company recognizes the tax
credits as they are allocated by the partnerships, which are included, net of
amortization of the investment, as a component of the provision for income
taxes. During 1998 and 1997, the Company received tax benefits related to
$20,159,000 and $21,934,000 of the aggregate amount invested in the tax
advantaged investments at December 31, 1998 and 1997, respectively.
Investments in real estate partnerships primarily represent an investment in a
limited partnership that owns 10,000 acres of land to be developed near
Orlando, Florida. Investments in real estate partnerships are carried at cost
in the consolidated balance sheet, which approximated fair value at December
31, 1998. Notes receivable from investees represent secured loans made by the
Company to several of its equity and limited partnership investments. Interest
rates on the loans at December 31, 1998 ranged from 6% to 9.75%. The carrying
value of these loans at December 31, 1998 approximated fair value.
Significant components of investment income and other, including non-
recurring gains, are as follows (in thousands):
Years Ended December 31,
-------------------------
1998 1997 1996
------- ------- -------
Interest............................................ $11,112 $13,993 $15,817
Dividends........................................... 2,809 3,814 4,229
Net realized and unrealized gains................... 4,144 4,938 3,928
Other income........................................ 1,206 1,155 189
Income (loss) from equity investments............... (764) 269 (111)
Non-recurring gains................................. -- 8,993 --
------- ------- -------
Total investment income and other................... $18,507 $33,162 $24,052
======= ======= =======
The net change in unrealized gain (loss) on investment strategies included
in the above table amounted to ($611,000) in 1998, ($1,813,000) in 1997 and
$3,905,000 in 1996. In 1997, the Company sold several underperforming or
geographically undesirable operations and recorded aggregate gains on these
sales of $7,203,000. The gains on these sales of operations have been included
in non-recurring gains in the foregoing table. The net assets sold and the
operating results included in the consolidated statement of earnings related
to these operations were not material to the consolidated financial
statements. Also in 1997, the Company recorded a gain on a real estate
transaction of $1,790,000, which has also been included in non-recurring gains
in the foregoing table.
The components of other comprehensive earnings, including the related income
tax effects, consist of the following (in thousands):
Years Ended December 31,
-------------------------
1998 1997 1996
------- ------- -------
Change in unrealized gain (loss) on available for
sale securities during the
year, net of income taxes of ($844), $872 and $830,
respectively....................................... $(1,267) $ 1,308 $ 1,245
Reclassification adjustment for gains realized in
net earnings during the
year, net of income taxes of ($778), ($360) and
($259), respectively............................... (1,168) (539) (390)
------- ------- -------
Net change in unrealized gain (loss) on available
for sale securities during the year, net of income
taxes of ($1,622), $512 and $571, respectively..... $(2,435) $ 769 $ 855
======= ======= =======
25
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Securities Sold Under Agreements to Repurchase
At December 31, 1998, securities sold under agreements to repurchase the
identical securities are collateralized by government backed small business
administration loans and government securities with a carrying value of
$21,714,000 and a fair value of $21,817,000. The securities collateralizing
the agreements were held by two primary dealers. At December 31, 1997, these
securities had a carrying value of $22,121,000 and a fair value of
$22,360,000.
5. Credit and Debt Agreements
The Company maintains a $20,000,000 variable rate (based on LIBOR plus .4%)
unsecured revolving credit agreement which expires on June 30, 2001. As of
December 31, 1998 and 1997, there were no borrowings outstanding under this
agreement. Terms of the revolving credit agreement include various covenants
which require the Company to maintain specified levels of tangible net worth
and restrict the amount of payments on certain expenditures.
The Company also has line of credit facilities of $27,500,000 which expire
on April 30, 1999. Short-term borrowings under these facilities totaled
$15,000,000 at December 31, 1998 and 1997. The weighted average interest rate
on the short-term borrowings were 5.9% and 6.5% during 1998 and 1997,
respectively.
At December 31, 1997, the Company had two unsecured term loan agreements
with outstanding balances of $630,000 and $500,000 and stated interest rates
of 6.64% and 6.30%, respectively. In 1998, the Company retired the remaining
balances on these term loan agreements.
6. Capital Stock and Stockholders' Rights Plan
Capital Stock
The table below summarizes certain information about the Company's capital
stock at December 31, 1998 and 1997 (in thousands, except per share data):
Par Authorized
Class Value Shares
- ----- ------ ----------
Preferred stock............................................... No par 1,000
Common stock.................................................. $ 1.00 100,000
Stockholders' Rights Plan
Non-voting Rights, authorized by the Board of Directors on March 10, 1987
and approved by stockholders on May 12, 1987, are outstanding on each share of
outstanding common stock. Under certain conditions, each Right may be
exercised to purchase one share of common stock at an exercise price of $100.
The Rights become exercisable and transferable after a public announcement
that a person or group has acquired 20% or more of the common stock or after
commencement or public announcement of a tender offer for 30% or more of the
common stock. If the Company is acquired in a merger or business combination,
each Right exercised gives the holder the right to purchase $200 of market
value of common stock of the surviving company for the $100 exercise price.
The Rights Plan was amended in 1996 to extend the expiration of the Rights to
May 12, 2007. The Rights may be redeemed by the Company at five cents per
Right at any time prior to the public announcement of the acquisition of 20%
of the common stock. At December 31, 1998 and 1997, 25,000,000 shares of
common stock were reserved for potential exercise of the Rights.
26
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
7. Earnings Per Share
The following table sets forth the computation of net earnings per common
share and net earnings per common and common equivalent share (in thousands,
except per share data):
Years Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
Net earnings........................................ $ 56,501 $ 54,900 $ 44,227
======== ======== ========
Weighted average number of common shares
outstanding........................................ 17,402 16,746 16,739
Dilutive effect of stock options using the treasury
stock method....................................... 804 584 681
-------- -------- --------
Weighted average number of common and common
equivalent shares outstanding...................... 18,206 17,330 17,420
======== ======== ========
Net earnings per common share....................... $ 3.25 $ 3.28 $ 2.64
Net earnings per common and common equivalent share. 3.10 3.17 2.54
Options to purchase 20,000, 644,000 and 1,313,000 shares of common stock
were outstanding during 1998, 1997 and 1996, 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 and,
therefore, would be antidilutive.
8. Stock Option Plans
The Company has incentive and nonqualified stock option plans for officers
and key employees of the Company and its subsidiaries. The options are
primarily granted at the fair value of the underlying shares at the date of
grant. Options granted under the nonqualified plan primarily become
exercisable at the rate of 10% per year beginning the calendar year after the
date of grant or earlier in the event of death, disability or retirement.
Options expire ten years from the date of grant, or earlier in the event of
termination of the employee.
In addition, the Company has a non-employee directors' stock option plan
which currently authorizes 200,000 shares for grant, with Discretionary
Options granted at the direction of the Option Committee and Retainer Options
granted in lieu of the directors' annual retainer. Discretionary Options shall
be exercisable at such rates as shall be determined by the Committee on the
date of grant. Retainer Options shall be cumulatively exercisable at the rate
of 25% of the total Retainer Option at the end of each full fiscal quarter
succeeding the date of grant. The excess of fair value at the date of grant
over the option price for these nonqualified stock options is considered
compensation and is charged against earnings ratably over the vesting period.
The Company 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 the Company'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.
In 1998, all of the aforementioned stock option plans were modified to
provide for the immediate vesting of all outstanding stock option grants in
the event of a change in control of the Company. A change in control of the
Company is defined as the acquisition by a person (or entity) of the
beneficial ownership of 50% or more of the Company's common stock; the
cessation, for any reason, of a majority of directors of the Company to serve
as directors during any two year period; or the approval by the stockholders
of the Company of the sale of substantially all of the assets of the Company.
27
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Stock Option Plans--(Continued)
The Company accounts for stock option grants in accordance with APB 25 and,
accordingly, recognizes no compensation expense for stock options that are
granted to employees at the fair value of the underlying shares at the date of
grant. Statement of Financial Accounting Standards No. 123 (SFAS 123),
"Accounting for Stock-Based Compensation," requires disclosure of pro forma
information regarding net earnings and net earnings per share, using pricing
models to estimate the fair value of stock option grants. Had compensation
expense for the Company's stock option plans been determined based on the
estimated fair value at the date of grant consistent with the methodology
prescribed under SFAS 123, approximate net earnings and net earnings per share
would have been as follows (in thousands, except per share data):
Years Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
Pro forma net earnings.............................. $ 55,449 $ 54,009 $ 43,583
Pro forma net earnings per common share............. 3.19 3.23 2.60
Pro forma net earnings per common and common
equivalent share................................... 3.08 3.15 2.53
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:
Years Ended December 31,
--------------------------
1998 1997 1996
-------- -------- --------
Dividend yield...................................... 3.1% 3.0% 2.9%
Risk-free interest rate............................. 4.9% 5.7% 6.3%
Volatility.......................................... 24.1% 23.9% 24.1%
Expected life (years)............................... 8.0 8.0 8.0
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee and director stock options have characteristics
significantly different from those of traded options, and because changes in
the selective input assumptions can materially affect the fair value estimate,
in management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee and director stock
options.
The pro forma disclosures above only include the effect of options granted
subsequent to January 1, 1995. Accordingly, the effects of applying the SFAS
123 pro forma disclosures to future periods may not be indicative of future
effects.
28
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Stock Option Plans--(Continued)
The following is a summary of all of the Company's stock option activity and
related information (in thousands, except exercise price data):
Years Ended December 31,
-----------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Under Exercise Under Exercise Under Exercise
Option Price Option Price Option Price
------ -------- ------ -------- ------ --------
Beginning balance........ 4,327 $28.26 4,910 $27.18 4,770 $25.87
Granted.................. 761 37.91 149 33.18 714 32.05
Exercised................ (588) 23.20 (557) 19.69 (398) 20.02
Canceled................. (39) 32.83 (175) 29.44 (176) 28.44
------ ------ ------ ------ ------ ------
Ending balance........... 4,461 $30.52 4,327 $28.26 4,910 $27.18
====== ====== ====== ====== ====== ======
Exercisable at end of
year.................... 1,743 1,780 1,728
====== ====== ======
Options with respect to 1,328,000 shares were available for grant at
December 31, 1998.
Other information regarding stock options outstanding and exercisable at
December 31, 1998 is summarized as follows (in thousands, except exercise
price data):
Options Outstanding Options Exercisable
-------------------------------- --------------------
Weighted
Average
Remaining Weighted Weighted
Contractual Average Average
Range of Exercise Prices Number Life Exercise Number Exercise
- ------------------------ Outstanding (in years) Price Exercisable Price
----------- ----------- -------- ----------- --------
$ 7.13 - $22.38.......... 1,078 2.25 $20.70 703 $20.59
22.81 - 31.88.......... 1,262 6.44 30.50 434 30.05
32.00 - 34.38.......... 1,170 5.33 33.87 534 33.74
34.75 - 44.06.......... 897 9.18 37.08 72 36.10
45.13 - 45.38.......... 54 9.91 45.35 -- --
-------- -------- -------- -------- --------
$ 7.13 - $45.38.......... 4,461 5.73 $30.52 1,743 $27.62
======== ======== ======== ======== ========
9. Retirement Plans
The Company has a noncontributory defined benefit pension plan which covers
substantially all domestic employees who have attained a specified age and one
year of employment. Benefits under the plan are based on years of service and
salary history. Plan assets consist primarily of common stocks and bonds
invested under the terms of a group annuity contract managed by a life
insurance company.
The Company accounts for the defined benefit pension plan in accordance with
Statement of Financial Accounting Standards No. 87 (SFAS 87), "Employers'
Accounting for Pensions." The difference between the present value of the
pension benefit obligation at the date of adoption of SFAS 87 and the fair
value of plan assets at that date is being amortized on a straight-line basis
over the average remaining service period of employees expected to receive
benefits.
29
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Retirement Plans--(Continued)
A reconciliation of the beginning and ending balances of the pension benefit
obligation and fair value of plan assets and the funded status of the plan is
as follows (in thousands):
Years Ended December 31,
--------------------------
1998 1997
------------ ------------
Change in pension benefit obligation:
Pension benefit obligation at beginning of
year........................................ $ 63,747 $ 52,931
Service cost................................. 7,355 7,046
Interest cost................................ 4,560 3,985
Actuarial (gain) loss........................ (9,141) 657
Benefits paid................................ (1,206) (872)
------------ ------------
Pension benefit obligation at end of year.... 65,315 63,747
------------ ------------
Change in plan assets:
Fair value of plan assets at beginning of
year........................................ 45,560 39,045
Actual return on plan assets................. 5,832 5,802
Company contributions........................ 4,868 1,585
Benefits paid................................ (1,206) (872)
------------ ------------
Fair value of plan assets at end of year..... 55,054 45,560
------------ ------------
Funded status of the plan (underfunded)...... (10,261) (18,187)
Unrecognized net actuarial gain.............. (13,433) (2,628)
Unrecognized prior service cost.............. 1,102 1,212
Unrecognized transition obligation........... 443 499
------------ ------------
Accrued pension benefit cost................. $ (22,149) $ (19,104)
============ ============
The components of the net periodic pension benefit cost for the plan
consists of the following (in thousands):
Years Ended December 31,
-----------------------------------
1998 1997 1996
------- ------------ ------------
Service cost--benefits earned during
the year............................ $ 7,355 $ 7,046 $ 5,790
Interest cost on benefit obligation.. 4,560 3,985 3,322
Expected return on plan assets....... (4,168) (3,550) (3,057)
Amortization of prior service cost... 110 110 110
Amortization of transition
obligation.......................... 56 56 56
Other................................ 26 26 52
------- ------------ ------------
Net periodic pension benefit cost.... $ 7,939 $ 7,673 $ 6,273
======= ============ ============
The following assumptions were used in determining the plan's pension
benefit obligation for 1998, 1997 and 1996:
Discount rate............................................. 7.5%
Rate of increase in future compensation levels............ 6.5%
Expected long-term rate of return on assets............... 9.0%
The Company has a contributory savings and 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
30
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
9. Retirement Plans--(Continued)
amount deductible for federal income tax purposes. The Company contributed
$2,823,000, $2,760,000 and $3,220,000 in 1998, 1997 and 1996, respectively.
The Company also has a foreign defined contribution plan which provides for
basic contributions by the Company and voluntary contributions by employees
which are matched 100% by the Company, up to a maximum of 5% of salary, as
defined. Net expense (income) for foreign retirement plans amounted to
$3,128,000 in 1998, ($2,922,000) in 1997 and $1,485,000 in 1996.
In 1997, the Company settled a foreign defined benefit plan and enrolled the
participants into a foreign defined contribution plan. At the time of the
settlement of the foreign plan, there was a surplus of plan assets in excess
of benefit obligations. Previously vested benefits of the plan participants
were settled by the purchase of annuity policies with a life insurance
company. As a result of the defined benefit plan settlement, the Company
recognized a $4,830,000 gain in 1997 which was recorded as a reduction of
salaries and employee benefits expense.
10. Postretirement Benefits Other Than Pensions
In 1992, the Company amended its health benefits plan to eliminate retiree
coverage, except for retirees at the time of the amendment 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.
A reconciliation of the beginning and ending balances of the postretirement
benefit obligation and the funded status of the plan is as follows (in
thousands):
Years Ended December 31,
--------------------------
1998 1997
------------ ------------
Change in postretirement benefit obligation:
Postretirement benefit obligation at beginning of
year.............................................. $ 11,280 $ 10,112
Service cost....................................... -- --
Interest cost...................................... 803 763
Actuarial (gain) loss.............................. (346) 793
Benefits paid...................................... (460) (388)
------------ ------------
Postretirement benefit obligation at end of year... 11,277 11,280
Fair value of plan assets at beginning and end of
year.............................................. -- --
------------ ------------
Funded status of the plan (underfunded)............ (11,277) (11,280)
Unrecognized net actuarial gain.................... (1,075) (729)
Unrecognized prior service cost.................... -- --
Unrecognized transition obligation................. 7,164 7,676
------------ ------------
Accrued postretirement benefit cost................ $ (5,188) $ (4,333)
============ ============
31
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
10. Postretirement Benefits Other Than Pensions--(Continued)
The components of the net periodic postretirement benefit cost include the
following (in thousands):
Years Ended December 31,
------------------------
1998 1997 1996
------- ------- -------
Service cost--benefits earned during the year........ $ -- $ -- $ --
Interest cost on benefit obligation.................. 803 763 717
Amortization of transition obligation................ 512 512 512
Amortization of gain................................. -- (89) (209)
------- ------- -------
Net periodic postretirement benefit cost............. $ 1,315 $ 1,186 $ 1,020
======= ======= =======
The discount rate used to measure the postretirement benefit obligation was
7.5% at December 31, 1998 and 1997. The transition obligation is being
amortized over a 20 year period. For measurement purposes, an 8.5% annual rate
of increase in the per capita cost of covered health care benefits was assumed
for 1999. This rate was assumed to gradually scale down to 4.5% for 2009 and
remain at that level thereafter. The assumed health care cost trend rate has a
significant effect on the amounts reported and disclosed herein. A one
percentage point change in the assumed health care cost trend rate would have
the following effects (in thousands):
One Percentage Point
-----------------------
Increase (Decrease)
---------- -----------
Effect on the net periodic postretirement benefit
cost in 1998........................................ $ 96 $ (342)
Effect on the postretirement benefit obligation at
December 31, 1998................................... 1,377 (4,900)
11. Commitments and Contingencies
The Company 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 the Company's consolidated financial position or
operating results.
The Company generally operates in leased premises. Certain office space
leases have options permitting renewals for additional periods. In addition to
minimum fixed rentals, a number of leases contain escalation clauses related
to increases in the cost of living in future years.
Minimum aggregate rental commitments at December 31, 1998 under
noncancelable operating leases having an initial term of more than one year
are as follows (in thousands):
Total
--------
1999.................................................................. $ 27,757
2000.................................................................. 22,729
2001.................................................................. 18,719
2002.................................................................. 15,462
2003.................................................................. 11,733
Subsequent years...................................................... 34,337
--------
$130,737
========
Total rent expense, including rent relating to cancelable leases and leases
with initial terms of less than one year, amounted to $32,057,000 in 1998,
$30,724,000 in 1997 and $28,796,000 in 1996.
32
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
11. Commitments and Contingencies--(Continued)
At December 31, 1998, the Company has contingently committed to invest an
additional $7,500,000 in 1999 related to two letter of credit arrangements
with one of its equity investments. At December 31, 1998, the Company has
agreed to unconditionally guarantee $30,000,000 of debt that will be incurred
by one of the Company's equity investments in 1999. In addition, the Company
has guaranteed an aggregate $8,700,000 of funds through letters of credit or
other arrangements related to several investment and insurance programs of the
Company.
12. Income Taxes
Significant components of earnings before income taxes and the provision for
income taxes are as follows (in thousands):
Years Ended December 31,
--------------------------
1998 1997 1996
------- -------- -------
Earnings before income taxes:
Domestic........................................... $79,087 $ 75,987 $61,838
Foreign............................................ 5,442 6,635 5,164
------- -------- -------
$84,529 $ 82,622 $67,002
======= ======== =======
Provision for income taxes:
Federal:
Current........................................... $27,314 $ 30,514 $19,953
Deferred.......................................... (7,049) (10,284) (3,737)
------- -------- -------
20,265 20,230 16,216
------- -------- -------
State and local:
Current........................................... 7,081 6,306 5,340
Deferred.......................................... (1,007) (1,469) (415)
------- -------- -------
6,074 4,837 4,925
------- -------- -------
Foreign:
Current........................................... 2,629 1,318 729
Deferred.......................................... (940) 1,337 905
------- -------- -------
1,689 2,655 1,634
------- -------- -------
Total provision for income taxes.................... $28,028 $ 27,722 $22,775
======= ======== =======
33
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
12. Income Taxes--(Continued)
A reconciliation of the provision for income taxes with the U.S. federal
income tax rate is as follows (in thousands):
Years Ended December 31,
-------------------------------------------------
1998 1997 1996
--------------- --------------- ---------------
% of % of % of
Pretax Pretax Pretax
Amount Income Amount Income Amount Income
------- ------ ------- ------ ------- ------
Federal statutory rate...... $29,585 35.0 $28,918 35.0 $23,451 35.0
State income taxes--net of
federal.................... 3,731 4.4 2,925 3.6 3,151 4.7
Pre-acquisition earnings of
pooled companies taxed to
previous owners............ (509) (0.6) (84) (0.1) (468) (0.7)
Foreign taxes............... 349 0.4 592 0.7 208 0.3
General business credits.... (4,866) (5.8) (2,697) (3.3) (2,242) (3.3)
Other--net.................. (262) (0.2) (1,932) (2.3) (1,325) (2.0)
------- ------ ------- ------ ------- ------
Provision for income taxes.. $28,028 33.2 $27,722 33.6 $22,775 34.0
======= ====== ======= ====== ======= ======
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components
of the Company's deferred tax liabilities and assets are as follows (in
thousands):
December 31,
---------------
1998 1997
------- -------
Deferred tax liabilities:
Leveraged leases............................................... $ 444 $ 444
Unrealized investment gain..................................... -- 1,105
Other.......................................................... 2,104 1,124
------- -------
Deferred tax liabilities...................................... 2,548 2,673
------- -------
Deferred tax assets:
Accrued and unfunded compensation and employee benefits........ 20,706 15,138
Accrued liabilities............................................ 13,305 13,938
Unrealized investment loss..................................... 517 --
Other.......................................................... 1,968 2,079
------- -------
Total deferred tax assets..................................... 36,496 31,155
Valuation allowance for deferred tax assets................... -- --
------- -------
Deferred tax assets........................................... 36,496 31,155
------- -------
Net deferred tax assets......................................... $33,948 $28,482
======= =======
During the period from 1994 to 1996, the Company provided for U.S. income
taxes on the undistributed earnings of its foreign subsidiaries. Due to
changes in the U.S. federal income tax laws effective in 1997, the Company no
longer provides for U.S. income taxes on the undistributed earnings
($21,800,000 at December 31, 1998) 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 $6,100,000 at
December 31, 1998.
34
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
13. Quarterly Operating Results (unaudited)
Quarterly operating results for 1998 and 1997 were as follows (in thousands,
except per share data):
1st 2nd 3rd 4th
-------- -------- -------- --------
1998
- ----
Total revenues............................. $123,702 $124,417 $143,538 $148,998
Earnings before income taxes............... 17,215 14,788 29,132 23,394
Net earnings............................... 11,494 9,892 19,859 15,256
Net earnings per common share.............. .68 .57 1.13 .87
Net earnings per common and common
equivalent share.......................... .65 .54 1.08 .83
1997
- ----
Total revenues............................. $114,594 $119,695 $133,518 $132,691
Earnings before income taxes............... 14,457 19,840 28,587 19,738
Net earnings............................... 9,631 13,185 18,958 13,126
Net earnings per common share.............. .57 .79 1.13 .78
Net earnings per common and common
equivalent share.......................... .56 .77 1.09 .75
14. Segment Information
The Company has identified three operating segments in addition to its
corporate operations. Insurance Brokerage Services encompasses operations
that, for commission or fee compensation, place or arrange to place insurance
directly related to the clients' funding of risk. This segment also provides
consulting, for fee compensation, related to clients' risk financing programs.
Risk Management Services includes the Company's third party administration,
loss control and risk management consulting, workers' compensation
investigations and insurance property appraisal operations. Third party
administration is principally claims management services for the Company's
clients. Financial Services includes alternative investment strategies and tax
advantaged investments. It manages the Company's own investment portfolio
while expanding these services in conjunction with the insurance products the
Company markets. Corporate consists primarily of unallocated administrative
costs and the provision for income taxes which is not allocated to the
Company's operating segments.
35
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
14. Segment Information--(Continued)
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 the Company's operating segments
for 1998, 1997 and 1996 is as follows (in thousands):
Insurance Risk
Brokerage Management Financial
Services Services Services Corporate Total
--------- ---------- --------- --------- --------
Year Ended December 31, 1998
- ----------------------------
Revenues:
Commissions............... $312,664 $ 467 $ -- $ -- $313,131
Fees...................... 41,640 167,377 -- -- 209,017
Investment income and
other.................... 8,179 1,000 9,328 -- 18,507
-------- --------- -------- -------- --------
Total revenues.......... $362,483 $ 168,844 $ 9,328 $ -- $540,655
======== ========= ======== ======== ========
Earnings before income
taxes...................... $ 68,268 $ 15,427 $ 5,270 $ (4,436) $ 84,529
Provision for income taxes.. -- -- -- 28,028 28,028
-------- --------- -------- -------- --------
Net earnings............ $ 68,268 $ 15,427 $ 5,270 $(32,464) $ 56,501
======== ========= ======== ======== ========
Income (loss) from equity
investments................ $ 215 $ -- $ (979) $ -- $ (764)
Depreciation and
amortization expense....... 7,660 3,732 -- 336 11,728
Interest expense............ 136 88 11 1,054 1,289
Net foreign exchange gain
(loss)..................... (176) 126 -- 2 (48)
- ---------------------------------------------------------------------------------
Revenues:
United States............. $330,153 $ 156,836 $ 8,902 $ -- $495,891
Foreign, principally
United Kingdom........... 32,330 12,008 426 -- 44,764
-------- --------- -------- -------- --------
Total revenues.......... $362,483 $ 168,844 $ 9,328 $ -- $540,655
======== ========= ======== ======== ========
At December 31, 1998
- --------------------
Identifiable assets:
United States............. $301,471 $ 40,774 $195,302 $ 40,006 $577,553
Foreign, principally
United Kingdom........... 156,701 7,373 4,383 -- 168,457
-------- --------- -------- -------- --------
Total identifiable
assets................. $458,172 $ 48,147 $199,685 $ 40,006 $746,010
======== ========= ======== ======== ========
Identifiable assets
related to equity
investments.............. $ (120) $ -- $ 20,137 $ -- $ 20,017
36
ARTHUR J. GALLAGHER & CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
14. Segment Information--(Continued)
Insurance Risk
Brokerage Management Financial
Services Services Services Corporate Total
--------- ---------- --------- --------- --------
Year Ended December 31, 1997
- ----------------------------
Revenues:
Commissions................... $284,808 $ 381 $ -- $ -- $285,189
Fees.......................... 40,744 141,403 -- -- 182,147
Investment income and other... 8,253 912 15,004 -- 24,169
Non-recurring gains........... -- -- 8,993 -- 8,993
-------- --------- -------- -------- --------
Total revenues.............. $333,805 $ 142,696 $ 23,997 $ -- $500,498
======== ========= ======== ======== ========
Earnings before income taxes.... $ 57,384 $ 10,273 $ 22,129 $ (7,164) $ 82,622
Provision for income taxes...... -- -- -- 27,722 27,722
-------- --------- -------- -------- --------
Net earnings................ $ 57,384 $ 10,273 $ 22,129 $(34,886) $ 54,900
======== ========= ======== ======== ========
Income (loss) from equity
investments.................... $ (154) $ -- $ 423 $ -- $ 269
Depreciation and amortization
expense........................ 7,486 3,425 -- 329 11,240
Interest expense................ 178 69 561 210 1,018
Net foreign exchange gain
(loss)......................... 75 1 -- -- 76
-------- --------- -------- -------- --------
Revenues:
United States................. $303,824 $ 136,899 $ 21,609 $ -- $462,332
Foreign, principally United
Kingdom...................... 29,981 5,797 2,388 -- 38,166
-------- --------- -------- -------- --------
Total revenues.............. $333,805 $ 142,696 $ 23,997 $ -- $500,498
======== ========= ======== ======== ========
At December 31, 1997
- --------------------
Identifiable assets:
United States................. $245,817 $ 34,084 $168,907 $ 44,928 $493,736
Foreign, principally United
Kingdom...................... 148,967 5,054 4,323 -- 158,344
-------- --------- -------- -------- --------
Total identifiable assets... $394,784 $ 39,138 $173,230 $ 44,928 $652,080
======== ========= ======== ======== ========
Identifiable assets related to
equity investments........... $ (627) $ -- $ 16,363 $ -- $ 15,736
Year Ended December 31, 1996
- ----------------------------
Revenues:
Commissions................... $276,295 $ 441 $ -- $ -- $276,736
Fees.......................... 36,458 136,507 -- -- 172,965
Investment income and other... 9,742 943 13,367 -- 24,052
-------- --------- -------- -------- --------
Total revenues.............. $322,495 $ 137,891 $ 13,367 $ -- $473,753
======== ========= ======== ======== ========
Earnings before income taxes.... $ 52,705 $ 12,494 $ 8,317 $ (6,514) $ 67,002
Provision for income taxes...... -- -- -- 22,775 22,775
-------- --------- -------- -------- --------
Net earnings................ $ 52,705 $ 12,494 $ 8,317 $(29,289) $ 44,227
======== ========= ======== ======== ========
Income (loss) from equity
investments.................... $ (204) $ -- $ 93 $ -- $ (111)
Depreciation and amortization
expense........................ 7,270 3,080 -- 362 10,712
Interest expense................ 485 5 362 33 885
Net foreign exchange gain
(loss)......................... (267) 72 -- 14 (181)
-------- --------- -------- -------- --------
Revenues:
United States................. $292,538 $ 135,044 $ 12,925 $ -- $440,507
Foreign, principally United
Kingdom...................... 29,957 2,847 442 -- 33,246
-------- --------- -------- -------- --------
Total revenues.............. $322,495 $ 137,891 $ 13,367 $ -- $473,753
======== ========= ======== ======== ========
At December 31, 1996
- --------------------
Identifiable assets:
United States................. $290,663 $ 36,595 $117,352 $ 21,163 $465,773
Foreign, principally United
Kingdom...................... 129,727 2,926 3,641 -- 136,294
-------- --------- -------- -------- --------
Total identifiable assets... $420,390 $ 39,521 $120,993 $ 21,163 $602,067
======== ========= ======== ======== ========
Identifiable assets related to
equity investments........... $ (473) $ -- $ 6,065 $ -- $ 5,592
37
MANAGEMENT'S REPORT
The Management of Arthur J. Gallagher & Co. is responsible for the
preparation and integrity of the consolidated financial statements and the
related financial comments appearing in this annual report. The consolidated
financial statements were prepared in accordance with generally accepted
accounting principles and include certain amounts based on management's best
estimates and judgments. Other financial information presented in this annual
report is consistent with the consolidated financial statements.
The Company maintains a system of internal accounting controls designed to
provide reasonable assurance that assets are safeguarded and that transactions
are executed as authorized and are recorded and reported properly. This system
of controls is based on written policies and procedures, appropriate divisions
of responsibility and authority, careful selection and training of personnel
and the utilization of an internal audit function. Policies and procedures
prescribe that the Company and all employees are to maintain the highest
ethical standards and that business practices throughout the world are to be
conducted in a manner which is above reproach.
Ernst & Young LLP, independent auditors, has audited the Company's
consolidated financial statements and their report is presented herein.
The Board of Directors has an Audit Committee composed entirely of outside
directors. Ernst & Young LLP has direct access to the Audit Committee and
periodically meets with the Committee to discuss accounting, auditing and
financial reporting matters.
Arthur J. Gallagher & Co.
Itasca, Illinois
January 19, 1999
/s/ J. Patrick Gallagher, Jr.
-------------------------------------
J. Patrick Gallagher, Jr.
President and Chief Executive
Officer
/s/ Michael J. Cloherty
-------------------------------------
Michael J. Cloherty
Executive Vice President and
Chief Financial Officer
38
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Arthur J. Gallagher & Co.
We have audited the accompanying consolidated balance sheet of Arthur J.
Gallagher & Co. as of December 31, 1998 and 1997, and the related consolidated
statements of earnings, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. 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.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
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, 1998 and 1997, and the
consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
-------------------------------------
Ernst & Young LLP
Chicago, Illinois
January 19, 1999
39
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
40
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information regarding directors and nominees for directors of the Company is
included under the caption entitled "Election of Directors" in the Proxy
Statement dated March 30, 1999 and is incorporated herein by reference.
Item 11. Executive Compensation.
Information regarding executive compensation of the Company's directors and
executive officers is included in the Proxy Statement dated March 30, 1999
under the caption entitled "Compensation of Executive Officers and Directors,"
and is incorporated herein by reference; provided, however, the report of the
Compensation Committee on executive compensation and the stock performance
graph shall not be deemed to be incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information regarding beneficial ownership of the Common Stock by certain
beneficial owners and by management of the Company is included under the
caption entitled "Principal Holders of Securities" in the Proxy Statement
dated March 30, 1999 and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
Not applicable.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as a part of this report:
1. Consolidated Financial Statements of Arthur J. Gallagher & Co.
consisting of:
(a) Consolidated Statement of Earnings for each of the three years
in the period ended December 31, 1998.
(b) Consolidated Balance Sheet as of December 31, 1998 and 1997.
(c) Consolidated Statement of Cash Flows for each of the three years
in the period ended December 31, 1998.
(d) Consolidated Statement of Stockholders' Equity for each of the
three years in the period ended December 31, 1998.
(e) Notes to Consolidated Financial Statements.
(f) Report of Independent Auditors.
2. Consolidated Financial Statement Schedules consisting of:
(a) Schedule II--Valuation and Qualifying Accounts.
All other schedules are omitted because they are not applicable,
or not required, or because the required information is included in
the Consolidated Financial Statements or the Notes thereto.
3. Exhibits:
3.1 Restated Certificate of Incorporation of the Company
(incorporated by reference to the same exhibit number to
Company's Form 10-Q Quarterly Report for the quarterly period
ended June 30, 1996, File No. 1-9761).
41
3.2 By-Laws of the Company (incorporated by reference to the same
exhibit number to Company's Form S-1 Registration Statement No.
33-10447).
3.3 Rights Agreement between the Company and Bank of America
Illinois (formerly Continental Illinois National Bank and Trust
Company of Chicago) (incorporated by reference to Exhibits 1
and 2 to Company's Form 8-A Registration Statement filed May
12, 1987, File No. 0-13480).
3.4 Assignment and Assumption Agreement of Rights Agreement by and
among Bank of America Illinois (formerly Continental Illinois
National Bank and Trust Company of Chicago), Harris Trust and
Savings Bank and the Company (incorporated by reference to the
same exhibit number to Company's Form S-8 Registration
Statement No. 33-38031).
3.5 Amendment No. 1 to Exhibit 3.3 (incorporated by reference to
the same exhibit number to Company's Form 10-Q Quarterly Report
for the quarterly period ended June 30, 1996, File No. 1-9761).
4.1 Instruments defining the rights of security holders (relevant
portions contained in the Restated Certificate of Incorporation
and By-Laws of the Company and the Rights Agreement in Exhibits
3.1, 3.2, and 3.3, respectively, hereby incorporated by
reference).
4.4 Credit Agreement dated February 16, 1993 (incorporated by
reference to the same exhibit number to the Company's Form 10-K
Annual Report for 1992, File No. 1-9761).
**10.1 Arthur J. Gallagher & Co. Incentive Stock Option Plan and
related form of stock option agreement (incorporated by
reference to the same exhibit number to Company's Form S-1
Registration Statement No. 2-89195).
**10.1.1 Amendment No. 1 to Exhibit No. 10.1 (incorporated by reference
to Exhibit No. 10.3 to Company's Form S-8 Registration
Statement No. 33-604).
**10.1.2 Amendment No. 2 to Exhibit No. 10.1 (incorporated by reference
to Exhibit No. 10.3.1 to Company's Form S-8 Registration
Statement No. 33-14625).
**10.25 Arthur J. Gallagher & Co. United Kingdom Incentive Stock Option
Plan, Amended and restated as of January 22, 1998 and approved
by the Inland Revenue on June 12, 1998 (incorporated by
reference to the same exhibit number to the Company's Form 10-Q
Quarterly Report for the quarterly period ended June 30, 1998,
File No. 1-9761).
**10.26 Arthur J. Gallagher & Co. 1988 Incentive Stock Option Plan,
Amended and restated as of May 19, 1998 (incorporated by
reference to the same exhibit number to the Company's Form 10-Q
Quarterly Report for the quarterly period ended June 30, 1998,
File No. 1-9761).
**10.27 Arthur J. Gallagher & Co. 1988 Nonqualified Stock Option Plan,
Amended and restated as of January 22, 1998 (incorporated by
reference to the same exhibit number to the Company's Form 10-Q
Quarterly Report for the quarterly period ended June 30, 1998,
File No. 1-9761).
**10.28 Arthur J. Gallagher & Co. 1989 Non-Employee Directors' Stock
Option Plan, Amended and restated as of January 22, 1998
(incorporated by reference to the same exhibit number to the
Company's Form 10-Q Quarterly Report for the quarterly period
ended June 30, 1998, File No. 1-9761).
10.5 Lease Agreement between Arthur J. Gallagher & Co. and Itasca
Center III Limited Partnership, a Texas limited partnership,
dated July 26, 1989 (incorporated by reference to the same
exhibit number to Company's Form 10-K Annual Report for 1989,
File No. 1-9761).
10.7 Letter dated December 31, 1983 from Arthur J. Gallagher & Co.
to Bank of America Illinois (formerly Continental Illinois
National Bank and Trust Company of Chicago) regarding Common
Stock Purchase Financing Program including exhibits thereto and
related letters (incorporated by reference to the same exhibit
number to Company's Form S-1 Registration Statement No. 2-
89195).
42
10.71 Amendment to Exhibit No. 10.7 dated September 11, 1985
(incorporated by reference to the same exhibit number to
Company's Form 10-K Annual Report for 1985, File No. 0-13480).
**10.10 Board of Directors' Resolution from meeting on January 26, 1984
relating to consulting and retirement benefits for certain
directors (incorporated by reference to the same exhibit number
to Company's Form S-1 Registration Statement No. 2-89195).
**10.11 Form of Indemnity Agreement between the Company and each of its
directors and corporate officers (incorporated by reference to
Attachment A to the Company's Proxy Statement dated April 10,
1987 for its Annual Meeting of Stockholders, File No.
0-13480).
**10.13 Arthur J. Gallagher & Co. Stock Option Agreements dated May 10,
1988 between the Company and each of Robert H. B. Baldwin, Jack
M. Greenberg and James R. Wimmer (incorporated by reference to
the same exhibit number to Company's Form 10-K Annual Report
for 1988, File No. 1-9761).
*10.14 Form of Change in Control Agreement between the Company and
each of its Executive Officers.
*21.0 Subsidiaries of the Company, including state or other
jurisdiction of incorporation or organization and the names
under which each does business.
*23.1 Consent of Ernst & Young LLP, as independent auditors.
*24.0 Powers of Attorney.
*27.0 Financial Data Schedule.
All other exhibits are omitted because they are not applicable, or not
required, or because the required information is included in the
Consolidated Financial Statements or Notes thereto.
- --------
*Filed as exhibits to this Form 10-K with the Securities and Exchange
Commission.
**Such exhibit is a management contract or compensatory plan or arrangement
required to be filed as an exhibit to this form pursuant to item 601 of
Regulation S-K.
(b) Reports on Form 8-K
Not applicable
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized on the 26th day of
March, 1999.
Arthur J. Gallagher & Co.
/s/ J. Patrick Gallagher, Jr.
By___________________________________
J. Patrick Gallagher, Jr.
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on the 26th day of March, 1999 by the following
persons on behalf of the Registrant in the capacities indicated.
Name Title
---- -----
*Robert E. Gallagher Chairman and Director
_________________________________________
Robert E. Gallagher
/s/ J. Patrick Gallagher, Jr. President and Director (Chief Executive
___________________________________________ Officer)
J. Patrick Gallagher, Jr.
/s/ Michael J. Cloherty Executive Vice President and Director
___________________________________________ (Chief Financial Officer)
Michael J. Cloherty
/s/ Jack H. Lazzaro Vice President--Finance (Chief Accounting
___________________________________________ Officer)
Jack H. Lazzaro
*T. Kimball Brooker Director
_________________________________________
T. Kimball Brooker
*Peter J. Durkalski Director
_________________________________________
Peter J. Durkalski
*Jack M. Greenberg Director
___________________________________________
Jack M. Greenberg
*Frank M. Heffernan, Jr. Director
___________________________________________
Frank M. Heffernan, Jr.
*Philip A. Marineau Director
___________________________________________
Philip A. Marineau
*Walter F. McClure Director
___________________________________________
Walter F. McClure
*James R. Wimmer Director
___________________________________________
James R. Wimmer
/s/ John C. Rosengren
*By: ________________________________
John C. Rosengren, Attorney-in-
Fact
44
SCHEDULE II
ARTHUR J. GALLAGHER & CO.
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Balance Additions
at Charged Balance
Beginning to at End
of Year Expense Adjustments of Year
--------- --------- ----------- -------
Year ended December 31, 1998
Allowance for doubtful accounts... $ 860 $ 241 $ 399 (1) $ 1,500
Accumulated amortization of
goodwill......................... 3,377 285 (43)(2) 3,619
Accumulated amortization of non-
compete agreements and expiration
lists............................ 3,110 665 (2,776)(3) 999
Year ended December 31, 1997
Allowance for doubtful accounts... $ 889 $ 636 $ (665)(1) $ 860
Accumulated amortization of
goodwill......................... 3,419 237 (279)(2) 3,377
Accumulated amortization of non-
compete agreements and expiration
lists............................ 3,314 816 (1,020)(3) 3,110
Year ended December 31, 1996
Allowance for doubtful accounts... $ 729 $2,111 $(1,951)(1) $ 889
Accumulated amortization of
goodwill......................... 4,006 361 (948)(2) 3,419
Accumulated amortization of non-
compete agreements and expiration
lists............................ 4,189 759 (1,634)(3) 3,314
- --------
(1) Bad debt write-offs net of recoveries.
(2)Reversal of fully amortized goodwill.
(3) Reversal of fully amortized non-compete agreements and expiration lists.