We commenced payment of dividends in the second quarter of 2000.
Effective October 1, 2001, we adopted the U.S. dollar as our reporting currency. Our financial results for all periods prior to October 1, 2001 have been restated from Canadian dollars to U.S. dollars using the exchange rate in effect at September 30, 2001 of C$1.00 = $0.6338.
Hub is a leading North American insurance brokerage that has grown rapidly since its formation in 1998 through mergers, acquisitions and organic growth. We provide a broad array of property and casualty, life and health, employee benefits, investment and risk management products and services through offices located in the United States and Canada. We are pursuing a growth strategy that includes expansion of our geographic footprint across the United States and deeper penetration of the insurance brokerage market in both the United States and Canada. Both acquisitions and internal growth are core components of our strategic plan for revenue expansion.
We anticipate that increases in revenue, higher revenue per employee, expense control and more advantageous commission arrangements with insurance firms will be instrumental in margin expansion efforts.
Our management believes pricing discipline is a key to successful acquisition efforts and did not complete potential acquisitions that did not meet our pricing criteria. During 2003, for example, we considered an acquisition of a large brokerage firm in Chicago, but decided against the potential transaction as a result of our due diligence process. This process led to diversion of a significant amount of management’s time, which weighed against other acquisition efforts. We still continue to have a goal of acquiring an average of 2 hub operations per year, increasing our base of U.S. hubs to 15 from the current six. Acquisitions will be driven by opportunity, pricing and fit, however, not by a rigid timetable.
Wholesale property and casualty insurance centers provide products, international risk solutions, captive management programs and specialty lines to independent brokers and corporations in North America and globally from offices in New York, Toronto, Montreal and Vancouver.
In addition, we are a member of the Worldwide Broker Network, a consortium of international brokerages which we can access to service U.S. or Canadian clients who require insurance internationally.
We achieved growth in revenue and profitability in 2003. Although the pace of acquisitions did not match that of 2002, we benefited from strong organic growth rates in most hubs, contributions from brokerages acquired in 2002 and the currency exchange benefits of a strengthening Canadian dollar. Overall, our management believes the company made strong progress on several fronts in 2003, including increased penetration of the commercial middle market in British Columbia, expansion of the professional liability practice in Chicago and growth of the wholesale brokerage business in New York and Toronto.
The table below shows a breakdown of our revenue by segment and type for 2003 including organic growth for 2003:
Of the $66.4 million in new revenue we reported, $40.0 million, or 60% reflected growth through acquisition, while $26.4 million, or 40% resulted from organic growth. By comparison, acquired units added $46.1 million, or 70% of 2002’s sales growth, while organic growth contributed $19.9 million, or 30% of our revenue increases. Organic growth figures for both revenue and earnings include the impact of foreign exchange rate changes between the U.S. and Canadian dollars. In 2003, the rise of the Canadian dollar versus the U.S. dollar contributed 5 percentage points of our 12% organic growth rate in revenue.
Volume overrides and contingent commissions are typically paid in the first or second quarter, based on prior-year performance. The sharp increase in contingent commissions and volume overrides in 2003 reflected increased profitability of business placed by us at higher premium rates and increased concentrations of some placements among a group of selected insurers.
direct comparisons. The following chart shows the net earnings and diluted per-share impacts that several of these factors had over the past two years. They are shown here as an added disclosure to increase investor understanding.
Changes in currency exchange rates are not an unusual item. Because we derive our revenue from both the United States and Canada and do not use derivatives to manage our Canadian pre-tax income, foreign exchange fluctuations will continue to impact our results. We have highlighted the impact of these changes because currency translation effects can lead to reported results that are less meaningful than local-currency results as an indicator of underlying operations. This year the strength of the Canadian dollar versus the U.S. dollar had a positive impact on our results. A decline would have a negative effect. See “Market Risk”.
During 2003, U.S. insurance premium rates remained strong - or hard - for most product lines, although rates for property coverage showed only modest increases as the year progressed. Hard insurance pricing in 2002 contributed strongly to a significant increase in contingent profitability income from insurers in 2003, as these insurers benefited from the near-term impact of higher rates implemented in 2002. Our management believes contingent commissions are likely to rise or decline only marginally in 2004 versus 2003 levels, reflecting a relative moderation in the pace of rate increases.
In the United States, our brokerages benefited from new business generation, additional revenue from businesses acquired during 2002 and moderate premium rate increases. While higher premium rates on most product lines
We have undertaken a number of initiatives to reduce or maintain compensation expense. During 2002, members of the executive management group agreed to accept 50% of their earned bonuses in the form of stock options, rather than cash. At the close of 2003, we obtained agreement from managers to restructure the company’s management bonus agreement. Under the new agreement the non-cash stock option component of the annual bonus was eliminated in exchange for restricted share units to be issued in the first quarter of 2004. In addition, whereas the management bonus agreement was previously contractual in nature, the restructured plan is no longer contractual and may be subject to change as we deem necessary. Management has estimated that approximately $16.9 million of restricted share units will be issued in connection with the modifications. The amount of restricted share units to be issued was based upon a multiple of the previous two years average bonus. The restricted share units will all vest in full on January 1, 2011 subject to continued employment. Although the impact of this change is
In total, as of December 31, 2003, we had issued and outstanding approximately 1.5 million stock options at a weighted average exercise price of $15.64. Our closing share price on the New York Stock Exchange was $16.76 on December 31, 2003.
In January 2004, we adopted a corporate marketing and positioning strategy to build awareness of the Hub brand across all of our markets and to encourage greater coordination and collegial identity among our employees. As part of this corporate consolidation and identity development program, we have reassigned a number of key executives to new or expanded areas of responsibility and determined that future marketing and communications will be conducted under the Hub International name, rather than the traditional corporate names of acquired brokerages. As a result, in the first quarter of 2004 certain of our subsidiaries changed their names and as a result, we will recognize a non-cash impairment expense of approximately $2.6 million before tax related to trademarks.
two subsidiaries, Old Lyme Insurance Company of Rhode Island Inc. and Old Lyme Insurance Company, Ltd. (collectively, “Old Lyme”) - were non-taxable, while $1 million of 2003 earnings - resulting from life insurance proceeds - were non-taxable. Absent these two items, the tax rates were unchanged at approximately 34.7% in both years. Based on existing operations, management anticipates that our effective tax rate will likely be in the range of 36% - 39% in 2004.
As shown in the table on page 25, net earnings increased $2.6 million or $0.09 per diluted share, in 2002 on the sale of two insurance subsidiaries and decreased $1.1 million or $0.04 per diluted share due to non-cash stock based compensation. In 2003, diluted earnings per share increased $0.03 per diluted share from life insurance proceeds and another $0.06 per diluted share from foreign exchange rates and net earnings decreased $4.8 million or $0.14 per diluted share due to non-cash stock based compensation. Excluding these effects our diluted earnings per share would have increased from $1.01 in 2002 to $1.19 in 2003 on a comparable basis.
Total revenue from Canadian Operations increased by $7.2 million, or 9%, to $85.8 million in 2002 from $78.6 million in 2001. Excluding the effect of net dispositions of $0.7 million, total revenue increased by $8.0 million or 10%. This increase was due to increases in commission income. Commission income increased by $8.3 million, or 12%, to $80.2 million in 2002 from $71.9 million in 2001. Excluding the effect of net dispositions of $0.7 million, commission income increased by $9.1 million, or 13%, the result of organic growth and higher premium rates. Contingent commissions and volume overrides decreased by $0.5 million, or 12%, to $3.7 million in 2002 from $4.2 million in 2001. This decrease was primarily attributable to deteriorating loss ratios on business placed with insurance companies during 2001. Other income, which includes fees and interest income, decreased by $0.6 million, or 24%, to $1.9 million in 2002 from $2.5 million in 2001. This decrease was attributable primarily to lower interest rates in 2002 compared with 2001.
Compensation expense in 2002 increased by $30.7 million, or 35%, to $118.7 million from $88.0 million in 2001. Compensation expense as a percentage of total revenue decreased 3% to 54% from 57% in 2001. This proportional decrease resulted largely from revenue growth as certain fixed compensation expense remained constant, and from a decrease in the accrual of executive management profitability bonuses (approximately $4.7 million or 2.1% of revenue) associated with the granting of stock options. In 2002 we changed our executive management bonus plan to require that 50% of earned bonuses be paid with stock option awards.
Intangible asset amortization decreased by $3.2 million, or 66%, to $1.7 million in 2002 from $4.9 million in 2001. This decrease is attributable to the elimination of goodwill amortization, effective January 1, 2002, in accordance with The Canadian Institute of Chartered Accountants Accounting Standards Board Handbook Section 3062, “Goodwill and Other Intangible Assets.”
These gains have increased by $2.5 million, or 1449%, to $2.7 million in 2002 from $0.2 million in 2001. Included in 2002 is a $2.6 million, non-taxable gain on the sale of Old Lyme. This gain increased basic and diluted earnings per share by $0.11 and $0.09, respectively. As part of our acquisition of Kaye in 2001, we acquired Old Lyme, with the intent to sell the operation and have since sold it to a subsidiary of Fairfax at a purchase price equivalent to its U.S. GAAP book value as of December 31, 2001 of approximately $43.5 million. The sale of Old Lyme was completed on May 30, 2002. As of December 31, 2002, Fairfax owned 27% of our common shares. Prior to the sale, we recorded Old Lyme as an investment available for sale, and accordingly, its results of operations are not included in our consolidated earnings.
The gain on put option liability of $0.2 million in 2002, as compared to $0.7 million in 2001, reflect changes in the fair value of put options granted by us. We issued put options as consideration for certain businesses acquired in the second and third quarters of 2001. The related put option liability is classified as long-term debt at fair value until such time as the options are exercised or expire. Factors affecting the fair market value of the put option are the stock price, stock volatility, and interest rates.
Income taxes in 2002 and 2001 amounted to $14.3 million and $5.3 million, respectively, resulting in an effective tax rate of 33% and 34% in 2002 and 2001, respectively. This decrease in effective tax rate was primarily the result of the non-taxable gain of $2.6 million on the sale of Old Lyme.
We improved our financial position and capacity for acquisitions in 2003 through positive cash flow from operations and a private debt offering. As a result of these factors, as of December 31, 2003, we had cash and cash equivalents of $82.1 million, an increase of 102%, from $40.6 million as of December 31, 2002. Operating activities generated $53.9 million of cash in 2003 compared to $19.1 million in 2002. The amount of cash provided by operating activities is affected by net earnings for the period, non-cash income and expenses, the collection of accounts and other receivables and the payment of accounts payable and accrued liabilities. In 2003, $20.1 million of cash was used in investing activities, primarily for the acquisitions of property and equipment and the purchase of subsidiaries compared to $8.4 million in 2002. Also in 2003, $4.6 million of cash was provided from financing activities, primarily resulting from our private debt offering, of $65.0 million, and offset by the repayment of long-term debt and capital leases, and the payment of dividends. In 2003, the effect of exchange rate changes on cash and cash equivalents was an increase of $3.1 million compared to $0.1 million in 2002. Net debt, defined as long-term debt ($78.8 million) and subordinated convertible debentures ($35.0 million) less non-trust cash (cash and cash equivalents of $82.1 million) as of December 31, 2003, was $31.7 million compared with $66.4 million as of December 31, 2002.
As a broker, we collect and hold premiums paid by clients, deduct commissions and other expenses from these payments, and hold the remainder in trust, which we remit to the insurers who provide coverage to clients. We earn interest on these funds during the time between receipt of the cash and the time the cash is paid to insurers. The cash held in trust is shown separately on our balance sheet. On the statement of cash flows, changes in trust cash are included as part of the change in non-cash working capital and the determination of cash provided from operating activities.
Revolving U.S. dollar LIBOR loan - This undrawn facility was renegotiated in December 2003 subject to completion of the definitive amended agreement. Under the new terms, the unsecured facility totals $50 million and bears interest at a floating rate of prime plus 1% or 112.5 basis points above LIBOR, which were 1.12% and 1.42% at December 31, 2003 and 2002, respectively. The facility is available on a revolving basis for one year and expires on December 13, 2004; however if the revolving period is not extended, we may convert the outstanding balance under the facility to a three year non-revolving term loan repayable at the end of three years with an interest rate of 137.5 basis points above the Canadian dollar interest swap rate. An annual commitment fee of 20 basis points is assessed on the unused balance. Borrowings under this facility totaled $NIL and $50 million at December 31, 2003 and 2002, respectively. We are in compliance with all financial covenants governing this facility as of December 31, 2003 and 2002.
Demand U.S. dollar base rate loan - We have an undrawn $9.3 million facility which expires on July 18, 2004 and bears interest at the bank’s U.S. base rate plus 50 bonus points. Borrowings under this facility are repayable on demand.
Also at December 31, 2003 we had outstanding a $7.5 million term loan from an insurance carrier. The terms of the loan provide for an incentive arrangement whereby a credit can be earned that will reduce annual interest payments under the loan (based on target premiums placed with the carrier) and reduces the principal repayment due in February 2007 (based on both target premiums placed with the carrier as well as the loss ratio on premiums placed with the carrier). Credits were earned for 2003 and 2002 which reduced interest payments to zero from $750 and $229, respectively.
In addition to these primary credit sources, we ended 2003 with $6.3 million of subsidiary debt comprised of various notes payable, term loans and capital leases. We intend to repay these liabilities from internally generated cash flow, existing cash balances and/or borrowings under our credit facilities as the subsidiary debt becomes due during 2003 through 2010. Of the outstanding subsidiary debt, $0.5 million is secured by liens on certain assets of our subsidiaries.
The table below summarizes our contractual obligations and commercial commitments as of December 31, 2003:
In connection with other various acquisitions completed through December 31, 2003, we may be obligated to pay contingent consideration up to a maximum sum of approximately $8.2 million cash and $0.2 million in common shares based upon the acquired brokerages achieving certain targets. The contingent payments are payable on various dates through September, 2006 according to the terms and conditions of each purchase agreement. Any additional consideration will be recorded as an adjustment to goodwill once the contingency is resolved. In connection with contingent consideration earned as at December 31, 2003, the financial statements reflect a liability to pay cash of $71 and to issue common shares valued at approximately $635 as of December 31, 2003.
In connection with our executive share purchase plan, under certain circumstances, we may be obligated to purchase loans for officers, directors and employees from a Canadian chartered bank totaling $4,513 and $5,077 as of December 31, 2003 and 2002 respectively, to assist in purchasing our common shares. As collateral, the employees have pledged 478,000 and 602,000 common shares as of December 31, 2003 and 2002, respectively, which have a market value of $8,105 and $7,677 as of December 31, 2003 and 2002, respectively. Interest on the loans in the amount of $279, $264 and $377 for the years ended December 31, 2003, 2002 and 2001, respectively, was paid by us and is included in compensation expense. We no longer make loans to our executive officers and directors.
We have undertaken a number of initiatives to reduce and maintain compensation expense. During 2002, members of the executive management group agreed to accept 50% of their earned bonuses in the form of stock options, rather than cash. At the close of 2003, we obtained agreement from managers to restructure the company’s management bonus agreement to reduce total compensation expense over the long term. Under the new agreement the non-cash stock option component of the annual bonus was eliminated in exchange for restricted
Restricted share units. We committed to award, under our equity incentive plan, an aggregate of 266,000 restricted shares that would be paid for by the participants (none of whom are members of our senior management or directors) with loans either from us or from a bank (guaranteed by us). In addition, we committed to award an aggregate of 471,000 restricted share units that would be exercisable for common shares, without payment of cash consideration. On June 30, 2003, we awarded 610,000 restricted share units in satisfaction of substantially all of the above-mentioned commitments. The restricted share units vest over periods ranging from 68 months to 95 months. In the first quarter of 2004, 1,005,690 restricted share units were issued in connection with the restructure of our management bonus agreement and 84,375 restricted share units were issued in connection with the renegotiation of contingent consideration for Flanagan.
We completed our impairment testing on the balance of goodwill and intangible assets as of January 1, 2004, 2003 and 2002. Based on the testing performed, no impairment losses were incurred.
Customer relationships are amortized on a straight-line basis over their periods of duration, normally fifteen years. Many factors outside our control determine the persistency of our customer relationships and we cannot be sure that the value we have allocated will ultimately be realized. Non-competition covenants and trademarks are intangible assets that have an indefinite life and accordingly, are not amortized but are evaluated for impairment. When an employee leaves Hub, the non-competition covenant becomes effective and the value assigned is then amortized over the life of covenant. Prior to 2002 we amortized goodwill primarily over a period of forty years. Under the new accounting standards adopted in 2002, goodwill is not amortized and is evaluated annually for
We estimate that our amortization charges for intangible assets from 2004 through 2008 for all acquisitions consummated to date will be:
As of December 31, 2003 and 2002, we had accounts receivable and accounts payable balances with the above related parties in the amounts of $3,185 and $17,999, for 2003, respectively, and $2,104 and $12,180 for 2002, respectively. All revenue and related accounts receivable and accounts payable are the result of transactions in the normal course of business. The companies above are related through common ownership by Fairfax, which owns approximately 26% of our common shares as of December 31, 2003.
Our significant accounting polices are more fully described in Note 2 to our consolidated financial statements. Certain of our accounting policies are particularly important to the portrayal of our financial position and results of operations and require the application of significant judgment by our management; as a result they are subject to an inherent degree of uncertainty. In applying those policies, our management uses its judgment to determine the appropriate assumptions to be used in the determination of certain estimates. Those estimates are based on our historical experience, terms of existing contracts and policies, our observance of trends in the insurance industry, information provided by our clients and information provided by outside sources, as appropriate. Our critical accounting policies include the recognition of commission income, the allocation of the purchase price of an acquisition, the measurement of goodwill and other intangibles and related impairment evaluation, and the valuation of stock-based compensation. These policies are discussed below.
The acquisition of new brokerages is a fundamental component of our strategy. When we acquire a business, the cost of the purchase is allocated to all of the assets acquired and liabilities assumed based on their fair values. Any excess of the cost of purchase over the net of the allocated amounts is recognized as goodwill. For significant acquisitions, we engage qualified third party valuators to assist us in conducting asset valuations.
Intangible assets primarily represent goodwill, associated with our acquisitions. Goodwill represents the excess of the cost of purchase of acquired businesses over the fair market value of their identifiable net assets. The fair value of our subsidiary brokerages has been increasing primarily due to recent increases in premium rates and organic growth as previously discussed which has generally increased the commission earned by us.
The cost of definite lived intangible assets is amortized over the estimated remaining useful life of the assets. We regularly evaluate whether events or changes in circumstances indicate that the carrying amount of intangibles, other than goodwill and intangible assets with indefinite useful lives, may warrant revision or may not be recoverable. The estimation of the useful economic lives and the selection of estimates and assumptions used in conducting impairment tests require the exercise of judgment. The use of different judgments, estimates and assumptions could produce different results in the application of the impairment tests of the assets and, as a result, significantly different results of operations.
We are not aware of any new accounting pronouncements which will impact on our financial reporting.
We conducted our audits in accordance with auditing standards generally accepted in Canada and in the United States of America. Those standards require that we plan and perform an audit to obtain reasonable assurance 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 financial position of Hub International Limited and its subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2003, in accordance with accounting principles generally accepted in Canada.
Hub International Limited (the “Company”) is an international insurance brokerage that provides a variety of property and casualty, life and health, employee benefits, investment and risk management products and services. The Company’s shares are listed on both the New York Stock Exchange (NYSE: HBG) and Toronto Stock Exchange (TSX: HBG).
In June 2002, the Company completed its initial U.S. public offering (“U.S. IPO”) of 6.9 million common shares at a price of $14 per share. The cash proceeds of the offering, net of issue costs of $8.5 million, were approximately $88.1 million of which approximately $86.0 million was used to repay bank debt, long-term debt and a convertible subordinated debenture during the second quarter of 2002.
The Company’s consolidated financial statements historically have been expressed in Canadian dollars. Effective October 1, 2001, the Company adopted the U.S. dollar as its reporting currency. Comparative financial information has been restated in United States (U.S.) dollars using the translation of convenience method. Accordingly, the financial results for the first nine months of the year ended December 31, 2001 and the entire year ended 2000, were converted from Canadian to U.S. dollars at the exchange rate in effect at September 30, 2001 of one Canadian dollar (C$) to 0.6338 U.S. dollar.
Effective June 28, 2001, the Company acquired Kaye Group Inc. (Kaye). Kaye, primarily an insurance broker, also underwrote insurance risks through its subsidiaries Old Lyme Insurance Company of Rhode Island Inc. and Old Lyme Insurance Company, Ltd. (collectively Old Lyme). The Company indicated prior to the effective date of the acquisition that it intended to find a purchaser for the Old Lyme operations as soon as possible after closing.
Preparation of the financial statements in conformity with Canadian GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and the reported amount of revenue and expense during the reporting period. The principal estimates used in the preparation of these financial statements are the determination of the provision for cancelled policies relating to revenue renegotiation, the allocation of the purchase price on acquisitions, the valuation of reporting units when testing the recoverability of goodwill and other intangible assets, the estimation of the useful lives of definite life intangible assets, and the measurement of stock based compensation. Actual results could differ from those estimated.
The Company’s financial instruments that are exposed to concentration of credit risk consist primarily of cash and cash equivalents and accounts receivable. The Company maintains cash with banks in excess of federally insured limits and is exposed to the credit risk from this concentration of cash. The Company performs ongoing credit evaluations of its customers financial condition and generally requires no collateral. No single client accounted for more than ten percent of total client premiums nor more than ten percent of revenue for the years ended December 31, 2003, 2002 and 2001, respectively.
Acquisitions of subsidiaries have been accounted for using the purchase method, whereby the results of acquired companies are included only from the date of acquisition. Consideration which is contingent on maintaining or achieving specified earnings levels in future periods is recognized as an additional cost of the purchase when the contingency is resolved and the additional consideration is issued or becomes issuable.
Effective January 1, 2002, the Company adopted the Canadian Institute of Chartered Accountants (CICA) Accounting Standards Board Handbook Section 3062, “Goodwill and Other Intangible Assets” (Section 3062) without restatement of prior periods.
Intangible assets other than goodwill which do not have indefinite lives are amortized on a straight-line basis over their useful lives. These intangible assets are subject to an annual impairment test comparing carrying values to net recoverable amounts.
No goodwill amortization expense was incurred for the year ended December 31, 2003 and 2002. For the year ended December 31, 2001 the Company incurred goodwill amortization expense of $4,125 before tax and approximately $3,996 after tax ($0.20 per diluted share).
During 2003, the Company acquired 9 insurance brokerages for total consideration of approximately $8,674, of which $8,136 was cash and the remainder of $538 in 32,000 common shares of the Company. These acquisitions were accounted for under the purchase method. The allocation of aggregate purchase prices to the fair value of the assets acquired was as follows: goodwill - $6,389, customer relationships - $1,352, non-competition covenants - $337, current assets - $4,298, capital assets - $24, current liabilities - $3,726.
Of the goodwill acquired $1,367 is deductible for tax purposes. In addition the Company also recognized $1,800 of goodwill associated with contingent consideration relating to prior year acquisitions.
As part of the negotiations of the contingent consideration for J.P. Flanagan Corporation (“Flanagan”) total additional consideration of 37,500 of our common shares were earned at December 31, 2003 valued at approximately $635, based on the closing price of the shares at December 31, 2003 on the NYSE. The common shares have been recorded as “issuable shares” and included in shareholders’ equity and goodwill has been increased by the same amount at December 31, 2003. Also as part of the negotiations the former owner agreed to relinquish his rights to put options on the 730,000 shares previously issued as well as on shares issued as contingent consideration. In addition we expect to issue non-cash stock based compensation in the form of 84,375 restricted share units in the first quarter of 2004. Half of these restricted share units will vest in 4 years and the balance will vest in 7 years.
In accordance with the purchase agreement, the former owners of Burnham Stewart Group, Inc. (Burnham), were entitled to additional consideration based upon certain acquired operations of Burnham achieving 2002 profitability targets. The additional consideration to be issued was a multiple of the final adjusted profitability as of December 31, 2002 for those operations. The total additional consideration was $22,166 of which $8,423 was cash and the remainder of $13,743 in 1,228 common shares of the Company. The Company issued the common shares in March 2003. As of December 31, 2002, the Company had accrued the cash portion of the contingent consideration and the share portion of the contingent consideration had been recorded as “issuable shares” and included in shareholders’ equity. As part of the negotiations of the contingent consideration, the former owners of Burnham agreed to relinquish their rights to put options on all of the 1,423 common shares issued as part of the 2002 acquisition, as well as on shares issued as contingent consideration in exchange for release from escrow provisions on those same common shares. The total additional consideration of $22,794 is shown as an addition to goodwill and customer relationships in the table below.
The allocation of the purchase price, including goodwill and other identifiable intangible assets, and the cost of the acquired brokerages in 2002 are summarized as follows:
Losses relating to the non-collection of client premium receivables, may be mitigated by cancellation of the underlying insurance policy.
The changes in the carrying amount of goodwill for the years ended December 31, 2003 and 2002, are as follows:
The Company estimates the amortization charges for 2004 through 2008 for all acquisitions consummated to date will be:
Revolving U.S. dollar LIBOR loan - This undrawn facility was renegotiated in December 2003, subject to completion of the definitive amended agreement. Under the new terms, the unsecured facility totals $50 million, bears interest at a floating rate of prime plus 1% or 112.5 basis points above LIBOR, which were 1.12% and 1.42% at December 31, 2003 and 2002, respectively. The facility is available on a revolving basis for one year and expires on December 13, 2004; however if the revolving period is not extended, the Company may convert the outstanding balance under the facility to a three year non-revolving term loan repayable at the end of three years with an interest rate of 137.5 basis points above the Canadian dollar interest swap rate. An annual commitment fee of 20 basis points is assessed on the unused balance. Borrowings under this facility totaled $NIL and $50 million at December 31, 2003 and 2002, respectively. The Company was in compliance with all financial covenants governing this facility as of December 31, 2003 and 2002.
Put Options - as discussed in note 3(a), the former owner of Flanagan has relinquished his right to put options on 730,000 commons shares of the Company. Accordingly, an amount of $5,940, previously classified as long-term debt, has been reclassed as share capital (see note 11).
This term loan is from an insurance carrier. The terms of the loan provide for an incentive arrangement whereby a credit can be earned that will reduce annual interest payments under the loan (based on target premiums placed with the carrier) which reduces the principal repayment due in February 2007 (based on both target premiums placed with the carrier as well as the loss ratio on premiums placed with the carrier). Under this incentive arrangement, both the annual interest payments as well as the principal payment can be reduced to zero. Credits were earned for 2003 and 2002 which reduced interest payments to zero from $750 and $229, respectively.
Certain property and equipment have been pledged as collateral in amounts not less than the outstanding balance of the loan at December 31, 2003 and December 31, 2002, respectively.
Substantially all officers and employees of the Company in the United States are entitled to participate in a qualified retirement savings plan (defined contribution plan). The cost to the Company was $1,781, $1,425, and $648 for 2003, 2002 and 2001 respectively. Subsequent to year-end a defined contribution plan was put in place for Canadian employees.
The Company is committed under lease agreements for office premises and computer equipment. At December 31, 2003, aggregate minimum rental commitments (net of expected sub-lease receipts) under operating leases are as follows:
On December 24, 2003 executive management profitability bonuses were restructured. Under the new agreement, the stock option component of the annual bonus was eliminated in exchange for restricted share units to be issued in the first quarter of 2004. Management has estimated that approximately $16.9 million of restricted share units will be issued. These restricted share units will all vest on January 1, 2011 subject to continued employment. Hub’s policy is to expense the fair value of non-cash stock based compensation evenly over the period they are earned. Non-cash stock based compensation expense related to the 2003 bonuses was $1,405 and is included in non-cash stock based compensation.
In connection with the acquisition of Hooper Hayes and Associates, Inc., in 2002 the Company issued 196,000 shares (the “Retractable Shares”) that are being held in escrow subject to release over a period of three years upon the satisfaction of certain performance targets. As of December 31, 2003, 63,000 shares have been released from escrow.
A summary of the stock option activity and related information for the years ended December 31, 2003 and 2002 consists of the following (no stock options were issued prior to 2002):
The following table summarizes information about the stock options outstanding at December 31, 2003 and 2002:
Non-cash stock based compensation related to stock options of $2,309 and $1,089 for the year ended December 31, 2003 and 2002, respectively, was expensed with offsetting credits to contributed surplus.
Shares derived from the options are held in escrow and subject to transfer restrictions for the period of five years from the date the options are granted, subject to early release in certain circumstances.
On June 30, 2003, the Company awarded 605,000 restricted share units to employees of the Company. The restricted share units are exercisable for common shares without payment of cash consideration and vest over periods ranging from 68 months to 95 months. In addition, in December 2003, the Company agreed to award approximately $16.9 million of restricted share units in connection with the restructure of executive management profitability bonuses - see note 10(c).
The carrying amounts of the Company’s financial assets and liabilities, including cash and cash equivalents, accounts and other receivables, accounts payable and accrued liabilities at December 31, 2003 and 2002, approximate fair value because of the short -term nature of these instruments. The carrying value of the Company’s variable rate debt at December 31, 2003 and 2002, of $385 and $50,587 respectively, approximates fair market value.
outstanding at December 31, 2003. The Company believes it is not practicable to estimate the fair value of its subordinated convertible debentures due to the conversion features.
As of December 31, 2003 and 2002, long-term debt related to put options of $NIL and $5,940, respectively, and subordinated convertible debentures of $35,000 at the end of both years, are due to related parties.
During 2003, 2002 and 2001, the Company incurred expenses related to rental of premises from related parties in the amount of $2,102, $1,691 and $1,373, respectively. At December 31, 2003 and 2002, the Company also had accounts receivable due from related parties in the amount of $3,530 and $3,801, respectively, of which the majority were loans to employees to enable them to purchase shares of the Company. Of these accounts receivable, as of December 31, 2003 and 2002, $1,918 and $2,207, respectively, were related to Company loans to employees to purchase shares under the executive share purchase plan. As collateral, the employees have pledged 153,000 and 177,000 common shares as of December 31, 2003 and 2002, respectively, which have a market value of $2,590 and $2,263 as of December 31, 2003 and 2002, respectively.
The table below sets out the differences between Canadian GAAP and U.S. GAAP that affect shareholders’ equity at December 31, 2003 and 2002:
Under U.S. GAAP, Old Lyme was recorded as an investment held for sale at its fair value of $40,938. Between acquisition and completion of the sale the carrying value of the investment was adjusted for increases in fair value due to changes in its U.S. GAAP net asset value and interest accretion. Such adjustments were reflected as changes in goodwill arising on the Kaye acquisition. Interest on debt financing the purchase of Old Lyme was debited to the carrying value of the investment and did not impact earnings. The difference between the carrying value of the investment as of the date of completion of the sale and the sale proceeds was reflected as an adjustment to goodwill arising on the Kaye acquisition and accordingly no gain or loss was recorded in income.
As part of the negotiations of contingent consideration the former owners of certain 2001 acquisitions agreed to relinquish their rights to put options on 730,000 common shares at December 31, 2003 and on 1,423,000 common shares at December 31, 2002. Accordingly at December 31, 2003 no put options were outstanding on our common shares.
have not been included as such disclosures related to the Company’s investments in debt and equity securities are immaterial to the overall financial statement presentation.
In the first quarter of 2004 certain of the Company’s subsidiaries changed their names and as a result, the Company will recognize a non-cash impairment expense of approximately $2.6 million before tax related to trademarks.