Talbot Earnout. As previously disclosed, on July 1, 2004, we acquired Talbot Financial Corporation (“Talbot”). As part of the Talbot acquisition we purchased 100% of the common shares of Satellite Acquisition Corporation (“Satellite”), a corporation formed by the senior management of Talbot, which we refer to as the “Talbot Management Group”. In turn, Satellite purchased 100% of the issued and outstanding common shares of Talbot from Safeco Corporation. The special shares of Satellite were retained by the Talbot Management Group as a mechanism through which these individuals could be rewarded for retention and future performance. We agreed to purchase one-third of the special shares of Satellite each during the 2005, 2006, and 2007 at a price contingent on Talbot’s earnings during the preceding calendar year (the “Talbot earnout”). Under the agreement, we have the discretion to pay the Talbot earnout, if payable, with cash, issuances of our common shares or a combination thereof. Individual members of the Management Group who are no longer employed by Talbot, for any reason, as of the date that a Talbot earnout payment is due are not entitled to share in that or any future earnout payments. No member of the Talbot Management Group was a shareholder of Talbot or received any portion of the purchase price paid to Safeco Corporation. Accordingly, we determined that the Talbot earnout arrangement is, in substance, a performance-based contingent compensation arrangement, and, thus, have recorded the Talbot earnout payments as a charge to compensation expense over the period that the payments are earned. In accordance with the Talbot earnout, the Talbot Management Group is being compensated for future services based on remaining with Talbot and achieving certain performance targets during each of the applicable three years. Upon our distribution of the final Talbot earnout payment on March 31, 2007, we will have purchased 100% of the special shares of Satellite from the Talbot Management Group. Total compensation expense to be incurred in accordance with the Talbot earnout agreement will be approximately $57.3 million.
The final Talbot earnout payment of approximately $21.8 million will be made on March 31, 2007, and will be based upon Talbot’s earnings for the year ended December 31, 2006. The final Talbot earnout payment will most likely be paid in cash.
During 2006, we acquired 21 insurance brokerages, including five hub brokerages located in the U.S., as discussed under the caption “Acquisitions” included herein.
During 2005, we recorded goodwill of $43.9 million in connection with various acquisitions. Of the total goodwill recorded during 2005, $18.0 million was recorded in connection with our acquisition of PLI, which is a personal lines insurance brokerage, and $2.5 million was recorded in connection with our acquisition of THB, which is a facultative reinsurance brokerage. PLI and THB represented our only hub brokerage acquisitions during 2005. In addition, during 2005 we acquired the assets of 13 other insurance brokerages, which were not significant, individually or in the aggregate, to our consolidated financial statements and recorded total goodwill of $23.4 million related to these acquisitions. The goodwill recorded in connection with our acquisitions of PLI and THB, relative to the significance of these acquisitions, is less than the amount of goodwill we have historically recorded for acquisitions of this magnitude due to (1) the fact that we allocated approximately 10% of the total purchase price of PLI to identifiable non-competition covenants, which is greater than our historical allocation percentage for insurance brokerage acquisitions, related to significant employee retention agreements in place prior to our acquisition, and (2) because of the unique nature of and unique risks related to THB’s business, we structured our acquisition of THB in a manner that minimized our initial purchase price, thus, minimizing the amount of goodwill recorded in connection with our acquisition of THB during 2005. We may be required to record additional goodwill in future periods as a result of contingent consideration arrangements in connection with our acquisition of THB.
Intangible Asset Amortization. For the years ended December 31, 2006, 2005 and 2004, we recognized amortization for customer relationships and non-competition covenants as follows (in thousands):
We have identified the accounting estimates listed below as those that we believe require management’s most subjective and complex judgments in estimating the effect of inherent uncertainties. These accounting estimates are based on, among other things, our historical experience, terms of existing contracts and policies, our observance of trends in the insurance industry, information provided by our clients and other outside sources, as appropriate, and other factors that management believes to be relevant. Management has reviewed these critical accounting estimates and related disclosures with our independent auditor and the Audit Committee of our Board of Directors. This section should be read in conjunction with Note 2 “Summary of Significant Accounting Policies” of the notes to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K, which includes a discussion of these and other significant accounting policies.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006 is fairly stated, in all material respects, based on criteria established in Internal Control - Integrated Framework issued by the COSO. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006 based on criteria established in Internal Control - Integrated Framework issued by the COSO.
As used in these financial statements, the terms “Hub,” “we,” “us,” and “our” refer to Hub International Limited and our wholly-owned subsidiaries, unless otherwise expressly stated.
Hub is a leading insurance broker in North America, providing a broad array of products and services to our clients, including, but not limited to, property and casualty, life and health, employee benefits, and risk management. We focus on both commercial and personal client accounts in the U.S. and Canada, which we serve through our approximately 3,820 employees in approximately 200 offices, using a variety of retail and wholesale distribution channels. Since our founding in 1998 through the merger of 11 Canadian insurance brokerages, we have acquired approximately 135 insurance brokerages, establishing a strong presence in the northeastern, midwestern, and western U.S. and in the Canadian provinces of Ontario, Quebec, and British Columbia. We have increased our revenue from $38.7 million during 1998 to $543.9 million during 2006. Approximately 78% of our revenue increase during this period was attributable to acquired brokerages. Approximately 72% of our total revenue during 2006 was attributable to our U.S. based operations. Our common shares are listed under the symbol HBG on both the New York Stock Exchange (“NYSE”) and the Toronto Stock Exchange (“TSX”).
Unremitted insurance premiums and claims are held in a fiduciary capacity as trust cash. The obligation to remit these funds is recorded as accounts payable on our consolidated balance sheets. The period for which we hold these funds is dependant upon the time between the date the client remits to us the payment and the date we are required to forward such payment to the insurance carrier.
We expect that approximately $67.8 million of the goodwill identified in the table above will be deductible for income tax purposes.
Hogan Marren, Ltd. v. Hub International Limited, et al. As previously disclosed, on January 21, 2005, we and our affiliates were named as defendants in a class action filed in the Circuit Court of Cook County, Illinois. The named plaintiff is a Chicago law firm that obtained its professional liability insurance through the Chicago office of what is now Hub Midwest and claims that an undisclosed contingent commission was received with respect to its policy. We dispute the allegations of this lawsuit and are vigorously defending this case.
Talbot Earnout. As previously disclosed, and as discussed in Note 3 “Business Acquisitions and Dispositions,” in these notes to our consolidated financial statements, on July 1, 2004, we completed the acquisition of Talbot. The special shares of Satellite were retained by the Talbot Management Group as a mechanism through which these individuals could be rewarded for retention and future performance. We agreed to purchase one-third of the special shares of Satellite each during 2005, 2006, and 2007 at a price contingent on Talbot’s financial performance during the preceding calendar year (the “Talbot earnout”). Under the agreement, we have the discretion to pay the Talbot earnout, if payable, with cash, issuances of our common shares or a combination thereof. Individual members of the Talbot Management Group who are no longer employed by Talbot, for any reason, as of the date
we paid Interest on these loans in the amount of $0.3 million, $0.2 million, and $0.2 million, respectively, which we recognize as compensation expense.
A summary of the activity for our Share Capital, Issuable Shares, Contributed Surplus, and Cumulative Translation accounts as of and for the years ending December 31, 2006, 2005 and 2004, is as follows (in thousands):
The original vesting term for RSUs granted during 2005 ranges from 46 months to 60 months. Approximately 12,000 of the total RSUs granted during 2005 were awarded in connection with a fold-in acquisition and approximately 26,000 of the total RSUs granted during 2005 were awarded in connection with the execution of employment agreements between us and non-EMT employees.