As part of our acquisition of Kaye, we acquired Old Lyme, which we have sold to a subsidiary of Fairfax. Under U.S. GAAP, interest expense on debt we incurred to finance the purchase of Old Lyme is not charged to earnings. See note 18 to our audited consolidated financial statements for more information.
Under U.S. GAAP, the fair value of put options is recorded as a debit to shareholders’ equity, representing an unearned compensation expense which is amortized to earnings using the straight-line method over the period from the issue date to the put date. See note 18 to our audited consolidated financial statements for more information.
Includes long-term debt and capital leases (including current portion), bank debt and subordinated convertible notes.
Under U.S. GAAP, financial statements are translated using a current exchange rate. See note 18 to our audited consolidated financial statements for more information.
Under U.S. GAAP, the fair value of put options is recorded as a debit to shareholders’ equity, representing an unearned compensation expense which is amortized to earnings using the straight-line method over the period from the issue date to the put date. Further, the redemption value of the common shares to which the put options is attached has been reclassified as mezzanine equity outside of shareholders’ equity. See note 18 to our audited consolidated financial statements for more information.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and accompanying notes included elsewhere in this report. Certain information contained in “Management’s discussion and analysis of financial condition and results of operations” are forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements because of various factors, including those discussed below and elsewhere in this Form 10-K, particularly under the heading “Risk Factors”.
We have acquired 86 brokerages in Canada and the United States, with substantially all of our large acquisitions focused in the United States over the past four years. Accordingly our revenue base also has shifted increasingly into the United States. Listed in the chart below is a summary of our major acquisitions for the past four years:
We applied the purchase method of accounting for these acquisitions, and as a result, the acquired brokerages’ financial results are included only from the date of acquisition.
Industry Conditions. Insurance brokerages derive a significant portion of their revenue from commissions. Commissions are calculated and paid as a percentage of the total insurance premium and therefore vary directly with changes in premiums charged by the insurance companies.
In 2001, premium rates - the cost per dollar of insurance coverage - began rising. The terrorist attacks of 2001 accelerated this increase in premium rates. In 2002, premium rates increased an average of 12% - 17% over 2001. This substantial pattern of premium rate increase follows more than a decade of low premiums in the insurance market. Years of excess capacity and competitive market conditions resulted in a downward pressure on premiums and an increase in underwriting losses by insurance companies. These losses were at least partly offset by favorable investment portfolio returns fueled by a strong economy and robust capital markets. A combination of a stagnant economy, declining investment portfolio values and losses related to the events of September 11, 2001, resulted in additional underwriting losses, which forced insurance companies to dramatically accelerate the rate of premium increases and limit coverage availability.
Although the insurance industry is typically less sensitive to economic cycles than other industries, primarily because insurance is considered a necessity for most businesses, reductions in a client’s sales, inventories and employee head counts during a slow economy can lead to a reduction in total premiums for certain types of insurance. In addition, clients often respond to higher premium rates by adjusting coverage, increasing deductibles or making other changes to reduce their insurance costs. As a result, our commission revenue did not keep pace with premium rate increases.
We generate commission income from the sale of both personal and commercial insurance. As the charts (below) show, U.S. operations generate nearly 91% of commissions from commercial insurance, while commercial business is approximately 53% of commissions in Canada. Primary factors attributing to this difference include:
Contingent commissions are based on the profit an insurance company makes on the book of business a brokerage places with the insurance company.
Other income consists of fees and interest income, including income earned while we hold client premiums on behalf of insurance companies. In 2002, $7.7 million, or 3.5% of our total revenue, was derived from other income.
We are not dependent on any single client or on a few clients for our revenue, nor are we dependent on a single industry or client type for a substantial amount of our business. We place insurance policies with more than 150 different insurance companies in the United States and Canada and do not depend on any single insurance company or group of related insurance companies for the products we market to our clients or for any substantial amount of our revenue.
As of December 31, 2002, we had placed insurance polices with seven insurance companies owned by Fairfax Financial Holdings Limited (Fairfax), which owns approximately 27% of our common shares, each of which offers competitively-priced products. All of our transactions with the Fairfax companies are conducted in the normal course of business, at fair market value and in the aggregate our brokerage subsidiaries generated approximately 10% of our total revenue in 2002 from these related parties.
Expenses. The majority of expenses we incur are compensation expenses related to salaries, management profitability bonuses and employee benefits, which accounted for approximately 67% of our total operating expenses in 2002. The next largest category of expenses are, selling, occupancy and administrative expenses. Selling includes marketing and advertising, but not commissions paid to our sales producers, occupancy includes rent and related operating costs and administration includes, among other expenses, office supplies, postage, telephone, training, technology, insurance and bad debts. The graph below shows that compensation expenses, and selling, occupancy and administrative expenses as a percentage of revenue both decreased by 300 basis points in 2002. These decreases were the result of changes to our management profitability bonus plan discussed below and maintaining fixed costs as our revenue grew.
During 2002, we changed our management bonus plan to require that half of certain earned bonuses be paid in the form of stock options. These options must be earned through achievement of specific earnings goals. We also began expensing stock options in 2002. This non-cash expense reduced our 2002 pre-tax income by $1,078, and diluted net earnings per share of $0.02.
Net Earnings. We increased net earnings at a growth rate compounded annually of 104% from $1.7 million in 1998 to $29.4 million in 2002. Net margin, which represents net earnings as a percentage of revenue, increased to 13% in 2002 from 4% in 1998, reflecting increases in revenue as well as operating efficiencies and economies of scale. On a diluted per share basis, net earnings increased at a growth rate compounded annually of 42% to $1.06 in 2002 from $0.26 in 1998. The growth rate of diluted earnings per share did not keep pace with the growth rate of net earnings due to a substantial increase in the number of shares outstanding over that time period as a result of shares issued in connection with acquisitions and our initial public offering in Canada in 1999, and most recently, our common shares outstanding grew by 6.9 million, due to the U.S. initial public offering in June of 2002.
Revenue. We increased total revenue by $66.0 million, or 43%, to $220.0 million in 2002 from $154.0 million in 2001. Of this increase, $46.2 million or 70% was attributable to acquisitions, primarily from the acquisitions of Kaye, Burnham and Flanagan in 2001, and $19.8 million or 30% was attributable to organic growth. Commission income increased by $57.7 million, or 40%, to $200.8 million in 2002, from $143.1 million in 2001. Excluding the effect of acquisitions, commission income increased by $18.4 million, or 13%, due to organic growth, including the continued firming of insurance premium rates. In 2002, revenue from contingent commissions and volume overrides increased by $5.6 million, or 94%, to $11.5 million from $5.9 million in 2001. Excluding the effects of acquisitions of $4.2 million, contingent commissions and volume overrides increased by $1.4 million or 23% as compared with the prior year. This increase resulted primarily from contingent commissions earned in the third and fourth quarters of 2002 from Fairfax related to premium volume placed with Old Lyme. In 2002, other income, which includes fees and interest income, increased by $2.7 million, or 53%, to $7.7 million from $5.0 million in 2001. Excluding the effects of acquisitions of $2.7 million, other income remained unchanged.
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 $7.9 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 $9.0 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,
Goodwill and other intangible asset amortization. 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.”
Gain on disposal of investment held for sale, property, equipment and investments. 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.
Net earnings. Net earnings in 2002 increased by $19.4 million, or 194%, to $29.4 million in 2002 compared with $10.0 million in 2001. Basic earnings per share increased 140% to $1.27 in 2002 compared with $0.53 per share in 2001. Diluted earnings per share increased 112% to $1.06 in 2002 from $0.50 in 2001.
Compensation. Compensation costs increased by $33.3 million, or 61%, to $88.0 million in 2001 from $54.7 million in 2000. Compensation costs as a percentage of total revenue remained unchanged at 57% for 2001 as compared to 2000.
Interest expense. Interest expense increased by $5.4 million, or 270%, to $7.4 million in 2001 from $2.0 million in 2000. This increase was largely attributable to our issuance of 8.5% convertible subordinated notes and new short-term bank loans incurred to fund the acquisitions of Kaye and other brokerages we acquired in 2001.
Goodwill and other intangible asset amortization. Goodwill and other intangible asset amortization increased by $1.6 million, or 48%, to $4.9 million in 2001 from $3.3 million in 2000. This increase is attributable to acquisitions in 2001 and 2000.
Net earnings. Net earnings increased by $3.9 million or 63% to $10.0 million in 2001 compared to $6.1 million in 2000. Basic earnings per share increased to $0.53 per share in 2001 from $0.34 per share in 2000. Diluted earnings per share increased to $0.50 per share in 2001 from $0.34 per share in 2000.
As of December 31, 2002, we had cash and cash equivalents of $40.6 million, an increase of $13.6 million from $27.0 million as of December 31, 2001. During 2002, $19.1 million of cash was provided by operating activities primarily as a result of net earnings adjusted for items not affecting working capital partially offset by an increase in trust cash of $3.2 million and the payment of the following other payables and accrued liabilities that existed at December 31, 2001: $2.4 million of deferred compensation related to the Kaye acquisition; $4.5 million of amounts owed by Kaye to Old Lyme; $1.5 million of tax liabilities related to the Flanagan acquisition; and $1.4 million related to the relocation of Kaye’s New York City office.
$7.6 million facility. Borrowings under this facility are at the bank’s U.S. Base rate which is currently 4.75%. Payment is due on demand. As of December 31, 2002 no amount had been drawn on this facility.
The Fairfax notes are convertible by the holders at any time into our common shares at C$17.00 per share. If Fairfax converted all of the Fairfax notes, Fairfax would own approximately 35% of our total outstanding common shares as of December 31, 2002. Net debt, defined as long-term debt, including the current portion of long-term debt, bank debt and subordinated convertible debentures less non-trust cash and the investment held for sale as of December 31, 2002, was $66.4 million compared with $129.2 million as of December 31, 2001. The decrease in net debt is due to the repayment of bank debt and a subordinated convertible debenture from the proceeds of the sale of Old Lyme and the U.S. initial public offering in the second quarter of 2002 partially offset by new borrowings for financing of acquisitions in 2002 and the release of the Burnham put option liability at December 31, 2002. Our net debt-to-equity ratio decreased to 0.23:1 at December 31, 2002 from 0.96:1 at December 31, 2001. As of December 31, 2002, we were in compliance with the financial covenants under our credit facilities.
As of December 31, 2002, we have an obligation to issue approximately $1.2 million of additional stock options related to our executive management bonuses.
In connection with our acquisition of C.S. Nenner Insurance Agency, Inc. (Nenner) the former owners of this company are entitled to contingent consideration based upon the acquired operations achieving profitability targets over a period of three years from the date of acquisition. As of December 31, 2002, we estimate the total contingent payment for Nenner to be approximately $4,500 of which 90% is payable in cash and 10% is payable in common shares.
As of December 31, 2002, we had not recorded any liabilities or the related adjustment to goodwill as it related to unpaid contingent consideration for acquisitions. In addition, diluted shares outstanding have not been increased for any contingent consideration that is payable in common shares.
In connection with our executive share purchase plan, under certain circumstances, we may be obligated to purchase loans previously received by certain of our officers, directors and employees from a Canadian chartered bank totaling $5,077 and $5,542 as of December 31, 2002 and December 31, 2001, respectively, to assist in purchasing common shares. As collateral, the employees have pledged 602 and 669 common shares as of December 31, 2002 and December 31, 2001, respectively, which have a market value of $7,677 and $6,389 as of December 31, 2002 and December 31, 2001, respectively. Interest on the loans in the amount of $264, $377, and $397 for the years ended December 31, 2002, 2001 and 2000, respectively, was paid by us and is included in compensation expense.
We have committed to award, under our equity incentive plan, an aggregate of 266 restricted shares that will be paid for by the participants with loans either from the Company or from a bank (guaranteed by us). In addition, we have committed to award an aggregate of 471 restricted share units that are exercisable for common shares, without payment of cash consideration. As of December 31, 2002 no restricted shares or restricted share units had been awarded or issued. See note 12 to our audited consolidated financial statements.
Share repurchases. For the year ended December 31, 2002, no common shares were repurchased by us.
Shares reserved for issuance. As of December 31, 2002, 2.1 million common shares were reserved for issuance under our equity incentive plan.
Shareholders’ equity increased by $149.0 million, or 110%, to $284.3 million as of December 31, 2002 from $135.3 million as of December 31, 2001. This increase resulted from net earnings of $29.4 million, an increase in
share capital of $90.6 million related to the U.S. initial public offering, an increase in contributed surplus of $1.2 million related primarily to non-cash stock option expense, an increase in share capital of $7.4 million related to shares issued in acquisitions, an increase in share capital of $11.8 million related to the release of the Burnham put option liability and an increase in contingently issuable shares of $13.7 million related to the Burnham contingent consideration earned as at December 31, 2002. The increase in shareholders’ equity was offset by the payment of dividends of $4.5 million and a decrease in the cumulative translation account of $0.6 million.
Shareholders’ equity increased by $23.1 million or 21% to $135.3 million as of December 31, 2001 from $112.2 million as of December 31, 2000. This increase resulted from net earnings of $10.0 million, an increase in the cumulative translation account of $2.6 million and an increase in share capital of $14.1 million primarily related to issuance of our common shares in connection with acquisitions. The increase in shareholders’ equity was offset by the payment of dividends of $3.6 million.
The Canadian dollar is subject to volatility and has experienced a significant decline in its value compared to the U.S. dollar in recent years. The table below summarizes the effect that a $0.01 decline or increase in the value of the Canadian dollar would have had on our revenue, cumulative translation account and net earnings for the years ended December 31, 2002, 2001 and 2000.
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 under the new accounting standards as discussed under “- Effects of new accounting pronouncements. When an employee leaves the Company, the non-competition covenant becomes effective and the value assigned is then amortized over the life of covenant.” We have historically amortized goodwill primarily over a period of forty years. Under the new accounting standards, goodwill is not amortized and is evaluated annually for impairment. For the past three years ended December 31, 2002, our amortization has been comprised of the following:
We estimate that our amortization charges for intangible assets from 2003 through 2007 for all acquisitions consummated to date will be:
The Company had transactions with and recorded revenue from the following related parties:
As of December 31, 2002 and 2001, the Company had accounts receivable and accounts payable balances with the above related parties in the amounts of $2,104 and $12,180, for 2002, respectively, and $666 and $7,494 for 2001, 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 27% of the Company’s common shares as of December 31, 2002.
As of December 31, 2002 and 2001, long-term debt related to put options of $5,940 and $17,274, respectively, and subordinated convertible debentures of $35,000 at the end of both years, are due to related parties.
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 independent valuators to assist us in conducting asset valuations.
The fair value of assets, including intangible assets, and liabilities may be determined using a number of valuation methods including net realizable values, market prices and discounted cash flows. The use of assumptions and estimates is inherent in each of these valuation methods. Valuation methods and their underlying assumptions and estimates are based on management’s judgment. The use of different judgments, estimates, or assumptions could produce different allocations of the purchase price and, as a result, different results of operations.
Effective January 1, 2002, we concurrently adopted the Canadian Institute of Chartered Accountants (CICA) Accounting Standards Board Handbook Section 3062, “Goodwill and Other Intangible Assets” for reporting under Canadian GAAP and the Financial Accounting Standards Board’s SFAS No. 142, “Goodwill and Other Intangible Assets” for reporting under U.S. GAAP. Section 3062 was applicable for fiscal years commencing on or after January 1, 2002 and SFAS No. 142 was applicable for fiscal years beginning on or after December 31, 2001.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, effective for fiscal years beginning after December 15, 2001. This Statement supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”, and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 “Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (APB No. 30).
Canadian GAAP has been harmonized with U.S. GAAP related to the provisions of SFAS No. 144, with the issuance of the CICA Accounting Standards Board Handbook Section 3063, “Impairment of Long-Lived Assets” in September 2002 and Section 3475, “Disposal of Long-Lived assets and Discontinued Operations” in January 2003.
We adopted SFAS No. 144 effective January 1, 2002 for our U.S. GAAP reporting. The transitional guidance of SFAS No. 144 generally permits long-lived assets classified as held for disposal as a result of disposal activities that were initiated prior to SFAS No. 144’s initial application to continue to be accounted for in accordance with the prior pronouncement applicable for that disposal. As such, our investment in Old Lyme, which was classified as held for disposal at December 31, 2001, continued to be accounted for in accordance with Canadian and U.S. generally accepted accounting principles applicable at the date that the disposal activities were initiated until the sale on May 30, 2002. We do not anticipate that the provisions of Sections 3063 and 3475 will have a material impact on our financial position or results of operations as reported under Canadian GAAP.
Section 3870 requires that stock-based payments to non-employees and direct awards of stock to employees and non-employees be accounted for using a fair value-based method of accounting and recommends that all other stock-based transactions with employees, including the granting of stock options, be accounted for in the same way. In accordance with this Section, we have incurred an expense of $1,078 in 2002 in relation to the stock options issued.
Concurrent with the adoption of Section 3870 for its Canadian GAAP reporting, we adopted SFAS No. 123, “Accounting for Stock-based Compensation” for our reporting under U.S. GAAP. Accounting under SFAS No. 123 under U.S. GAAP is the same as Section 3870 under Canadian GAAP.
Report of the Independent Accountants to the Board of Directors and Shareholders of Hub International Limited:
We have audited the accompanying consolidated balance sheets of Hub International Limited and its subsidiaries as of December 31, 2002 and 2001 and the related consolidated statements of earnings, retained earnings (deficit) and cash flows for each of the years in the three year period ended December 31, 2002, all expressed in United States of America dollars. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements schedules based on our audits.
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, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2002, in accordance with accounting principles generally accepted in Canada.
As discussed in Note 2 to the financial statements, the Company changed the method of accounting for goodwill and other intangible assets in 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.
These consolidated financial statements of the Company are expressed in United States (U.S.) dollars and have been prepared in accordance with Canadian generally accepted accounting principles (Canadian GAAP). These principles differ in certain respects from U.S. GAAP and to the extent that they affect the Company, the differences are described in note 18 “Reconciliation to U.S. GAAP.” The more significant of the accounting policies are as follows:
The operations of the Company’s subsidiaries outside of the U.S. are self-sustaining. The assets and liabilities of these subsidiaries as at December 31, 2002 were translated to U.S. dollars at the year end exchange rate. Revenue and expenses for 2002, were translated to U.S. dollars at the average exchange rate for the period. Accordingly, the unrealized gains and losses which result from this translation are deferred and included in shareholders’ equity under the caption “Cumulative translation account.”
Commission income and fees, (including commission income related to installment billing arrangements) are recognized as of the effective date of the policy unless information is not available relating to the determination of the client’s policy premiums, in which case commission income and fees related to that policy are recognized when that information becomes available and the revenue can be reasonably determined. Commission income is reported net of sub-broker commission expense. Commission and other adjustments are recorded when they occur and the Company maintains an allowance for estimated policy cancellations and commission returns based upon applying historical policy cancellation and commission return rates to the current year revenue, adjusted for any known deviations. The Company is entitled to contingent commissions and volume overrides from insurance companies which are recorded in the earlier of the period in which amounts can be reasonably estimated or the period in which the amounts are received. Amounts related to contingent commissions and volume overrides can be reasonably estimated when information pertaining to the calculation, such as premium volumes, loss ratios and expenses, can be obtained from the insurance companies. Other revenue primarily includes investment income, policy service fees and income earned related to the financing of client premiums. Investment income is recorded when earned. Policy service fees are recorded on the effective date of the policy, at which time the service has been provided. Income earned related to the financing of client premiums is recorded when known.
Premiums collected (less commissions and other deductions) but not yet remitted to insurance companies are included in trust cash. Trust cash is restricted as to use by contractual obligations and by laws in certain states and provinces in which the Company operates.
The Company issued stock options for the first time in the second quarter of 2002. The Company’s accounting policy is to recognize the fair value of stock based compensation as an expense over the period in which entitlement to the compensation vests.
Income taxes reflect the expected future tax consequences of temporary differences between the carrying amounts of assets or liabilities and their tax bases. Future income tax assets and liabilities are determined for each temporary
difference based on the tax rates which are expected to be in effect when the asset or liability is settled. The benefit of loss carry forwards is recognized as an asset to the extent that it is more likely than not to be realized. The principal temporary differences are related to loss carry forwards, goodwill and other intangible asset amortization, IPO costs and reserves.
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. Actual results could differ from those estimated.
The Company’s strategic business plan includes the regular and systematic evaluation and acquisition of insurance brokerages in new and existing markets. Insurance brokerages, due to their nature, typically maintain a very low capital to earnings ratio. As a result, the Company recorded a substantial amount of goodwill and other intangible assets in connection with these acquisitions.
During 2002, the Company purchased all of the issued and outstanding shares of Hooper Hayes & Associates, Inc. (Hooper Hayes), and Fifth Third Insurance Services, Inc. renamed Hub International of Indiana Limited (Hub Indiana), as well as outstanding shares or net assets of 6 other brokerages, all of which were acquired using the purchase method of accounting. Accordingly, the results of operations and cash flows of the acquired companies have been included in the Company’s consolidated results from their respective acquisition dates.
The consideration shown in the table immediately above, does not reflect the Burnham contingent consideration which has been accrued at December 31, 2002.
During 2002 and 2001, property and equipment were acquired at an aggregate cost of $4,494 and $11,534 respectively, of which $25 and $1,236, respectively, were acquired by means of capital leases.
The cost above reflects certain property and equipment held under capital leases of which the remaining liability at December 31, 2002 and 2001 was $993 and $1,470, respectively.
Borrowings under this $7.6 million facility totaled $NIL and $7.0 million at December 31, 2002 and 2001 respectively, and are accessed at the bank’s U.S. base rate which was 4.75% and 6.25% at December 31, 2002 and 2001 respectively. Payment is due on demand.
The third-party note was fully repaid with the proceeds of the U.S. IPO on June 28, 2002. As of December 31, 2002, the $35 million Fairfax notes remain outstanding.
The Fairfax notes are convertible by the holders at any time into the Company’s common shares at C$17.00 per share. Beginning June 28, 2006, the Company may require conversion of the Fairfax notes into common shares at C$17.00 per share if, at any time, the weighted average closing price of the Company’s common shares on the TSX for twenty consecutive trading days equals or exceeds C$19.00 per share. If converted, Fairfax would have owned approximately 35% of the total outstanding common shares as of December 31, 2002.
In connection with the Company’s executive share purchase plan, under certain circumstances, the Company may be obligated to purchase loans for officers, directors and employees from a Canadian chartered bank totaling $5,077 and $5,542 as of December 31, 2002 and 2001 respectively, to assist in purchasing common shares of the Company. As collateral, the employees have pledged 602 and 669 common shares as of December 31, 2002 and 2001, respectively, which have a market value of $7,677 and $6,389 as of December 31, 2002 and 2001, respectively. Interest on the loans in the amount of $264, $377 and $397 for the years ended December 31, 2002, 2001 and 2000, respectively, was paid by the Company and is included in compensation expense.
At December 31, 2002 and 2001, there were an unlimited number of non-voting, preferred shares authorized, issuable in series on such terms and conditions as set by the Board of Directors, of which no shares were issued. At December 31, 2002 and 2001, there were an unlimited number of common shares authorized, of which 29,025 and 21,656 were issued and outstanding as at December 31, 2002 and December 31, 2001 respectively.
Contributed surplus at December 31, 2002 of $1,234 is primarily comprised of $1,078 related to non-cash stock option compensation, incurred for the first time in 2002.
Restricted share units are exercisable for common shares, without payment of cash consideration. Common shares derived from restricted share units will be subject to transfer restrictions that will cease to apply with respect to 50% of the shares after five years and the balance of the shares after ten years of continuous employment. As of December 31, 2002, no restricted shares or restricted share units have been awarded or issued.
On June 17, 2002 the Company granted options exercisable for 1,270 common shares at an exercise price of $15.67 per share, the U.S. dollar equivalent of the closing price of the Company’s common shares on the TSX on that date. The maximum option term is seven years, and the options vest as to one-third per year over three years of continuous employment. No options were exercised or forfeited and none expired from the date of grant through December 31, 2002. Accordingly, at December 31, 2002, 1,270 options were outstanding at a weighted average exercise price of $15.67. The remaining average contract life of the options at December 31, 2002 was 6.45 years. None of the options are exercisable at December 31, 2002.
8.5% subordinated convertible debenture due June 28, 2006 with a carrying amount and aggregate principal of $28.2 million. This debenture was fully repaid with the proceeds of the U.S. IPO on June 28, 2002.
8.5% subordinated convertible debentures due June 28, 2007 with a carrying amount and aggregate principal of $35.0 million. These debentures remain outstanding at December 31, 2002.
The carrying values of put options and other long-term debt approximate fair values.
The Company has Canadian net operating loss carryforwards of $4,737 at December 31, 2002 that expire 2007 through 2009 resulting in a future tax asset of $1,714. In addition, the Company has various state and local net operating loss carryforwards in the U.S. of approximately $9,792 relating primarily to acquisitions, which expire 2004 through 2022 resulting in a future tax asset of $749 before valuation allowance. Such net operating losses are currently available to offset certain future state and local taxable income. As a result of an ownership change, there are annual limitations imposed upon the utilization of some of these losses and, accordingly, a valuation allowance in the amount of approximately $228 has been established where we do not believe the net operating losses will be realized.
The table below presents the differences between Canadian and U.S. GAAP affecting net earnings and comprehensive income for the years ending December 31, 2002, 2001 and 2000.
The table below sets out the differences between Canadian GAAP and U.S. GAAP that affect shareholders’ equity at December 31, 2002 and 2001:
Under Canadian GAAP, Old Lyme was recorded as an investment held for sale at its cost, which was equivalent to its fair value, of $40,938 on June 28, 2001. No further adjustments were made to the carrying value of the investment until Old Lyme was sold on May 30, 2002, when the Company recorded a gain of $2,613, equal to the difference between the sale proceeds (which were agreed to be its net asset value under U.S. GAAP as of December 31, 2001 plus interest at 4% per annum from December 31, 2001 until closing) and its carrying value. Interest on debt financing the purchase of Old Lyme was charged to income as it accrued.
The Company’s consolidated financial statements were historically expressed in Canadian dollars. Effective October 1, 2001, the Company adopted the U.S. dollar as its reporting currency. Under Canadian GAAP, comparative financial information was restated in U.S. dollars using the translation of convenience method. At September 30, 2001 all historical financial statements, were converted from Canadian to U.S. dollars at the exchange rate in effect at September 30, 2001 of one Canadian dollar to 0.6338 U.S. dollar. Revenue and expenses subsequent to September 30, 2001 were translated to U.S. dollars at the average exchange rate for the period.
Under U.S. GAAP, historical financial statements are translated using a different exchange rate, which: for assets and liabilities is the exchange rate at the balance sheet date; for the income statement is the average exchange rate for the period; and for the share capital accounts is the historical exchange rate.
The Condensed consolidated statements of earnings and cash flows for the years ended December 31, 2002, 2001 and 2000 and the condensed consolidated balance sheets as at December 31, 2002 and 2001, under U.S. GAAP are as follows:
Effective January 1, 2002, the Company concurrently adopted the Canadian Institute of Chartered Accountants (CICA) Accounting Standards Board Handbook Section 3062, “Goodwill and Other Intangible Assets” for reporting under Canadian GAAP and the Financial Accounting Standards Board’s SFAS No. 142, “Goodwill and Other Intangible Assets” for reporting under U.S. GAAP. Section 3062 was applicable for fiscal years commencing on or after January 1, 2002 and SFAS No. 142 was applicable for fiscal years beginning on or after December 31, 2001. Both Section 3062 and SFAS No. 142 eliminate the amortization of goodwill, require annual impairment testing of goodwill and introduce the concept of definite and indefinite life intangible assets. Indefinite life intangible assets are no longer amortized and are tested at least annually for impairment. Definite life intangible assets are amortized over the estimated useful life of the asset.
SFAS No. 144 generally retains the basic accounting model for the identification and measurement of impairments to long-lived assets to be held, and long-lived assets to be disposed. SFAS No. 144 broadens the definition of “discontinued operations,” as previously defined by APB No. 30, but does not allow for the accrual of future operating losses, as was previously permitted under that standard. SFAS No. 144 also addresses several implementation and financial statement presentation issues not previously addressed under U.S. GAAP. SFAS No. 144 excludes from its scope financial accounting and reporting for the impairment of goodwill and other intangible assets.
Canadian GAAP requirements have been harmonized with U.S. GAAP related to the provisions of SFAS No. 144, with the issuance of the CICA Accounting Standards Board Handbook Section 3063, “Impairment of Long-Lived Assets” in September 2002 and Section 3475, “Disposal of Long-Lived assets and Discontinued Operations” in January 2003.
Section 3063 is effective for fiscal years beginning on or after April 1, 2003 (although earlier adoption is encouraged) and establishes standards for the recognition, measurement and disclosure of the impairment of long-lived assets and replaces the write-down provisions of Section 3061, “Property, Plant and Equipment”. The Company will adopt Section 3063 prospectively effective January 1, 2003 and does not anticipate that the provisions of Sections 3063 will have a material impact on its financial position or results of operations.
In November 2001, the CICA Accounting Standards Board issued Handbook Section 3870, “Stock-based Compensation and Other Stock-based Payments”, effective for fiscal years beginning on or after January 1, 2002 for public enterprises. The Company issued stock-based compensation for the first time and adopted Section 3870 in 2002.
Concurrent with the adoption of Section 3870 for reporting under Canadian GAAP, the Company adopted SFAS No. 123, “Accounting for Stock-based Compensation” for its reporting under U.S. GAAP. Accounting under SFAS No. 123 under U.S. GAAP is the same as Section 3870 under Canadian GAAP.
SFAS No. 145 - Recission of FAS Nos. 4, 44 and 64, Amendment of FAS 13 and Technical Corrections In April 2002, the Financial Accounting Standards Board issued SFAS No. 145, “Recission of FAS Nos. 4, 44 and 64, Amendment of FAS 13 and Technical Corrections”, effective for fiscal years beginning after May 15, 2002.
This Statement amends FASB Statement No. 13, Accounting for Leases, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions.
SFAS No. 146 - Accounting for costs associated with exit or disposal activities
The Company will adopt SFAS No. 146 prospectively effective January 1, 2003 and does not anticipate that the provisions of SFAS No. 146 will have a material impact on its financial position or results of operations as reported under U.S. GAAP.
In December 2001, the CICA Accounting Standards Board issued Accounting Guideline 13, “Hedging Relationships” (AcG 13), which is applicable to fiscal years beginning on or after July 1, 2003.
The Company will adopt AcG 13 prospectively effective January 1, 2004. However, since the Company does not engage in hedging transactions, it does not anticipate that the guidance of AcG 13 will have an impact on its financial position or results of operations.
In November 25, 2002, the Financial Accounting Standards Board issued FIN No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB”, with disclosure requirements effective for years ending after December 15, 2002 and recognition and measurement requirements effective on a prospective basis for guarantees that are issued or modified after December 31, 2002.
FIN No. 45 clarifies the requirements of SFAS No. 6, “Accounting for Contingencies”, relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. It requires that the guarantor recognize a liability for the guarantee at its inception equal to its fair value at that time and that the liability is reduced as the risk under the guarantee reduces. The liability may be reduced at the end of the guarantee period, on a systematic amortization basis or as the fair value changes as appropriate.