Our results for the five year period ended December 31, 2004 reflect the acquisition of brokerages that occurred in each respective period. These acquisitions were accounted for using the purchase method. Thus, results of acquisitions are only included from the date of acquisition forward. Accordingly, the results in each period are not directly comparable.
compensation expense increased to 55% from 54% in 2003, primarily due to a relatively higher level of compensation costs as a percentage of revenue at Talbot.
2004 included gains of $1.9 million on the sale of investments and assets and shares of certain brokerages compared with a gain of $0.2 million in 2003. Approximately $1.6 million of the 2004 gain is non-taxable.
Volume overrides - additional compensation paid by insurance companies to brokerages on the basis of the overall volume of business a brokerage places with the insurance company.
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. Approximately $16.9 million of restricted share units were issued in connection with the modifications. The amount of restricted share units 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 expected to be earnings-neutral in 2004, the long-term effect is to reduce compensation costs as a percentage of revenue.
Our net earnings increased 24% to $36.5 million in 2003, primarily as a result of growth in revenue. As a percentage of revenue, net earnings declined approximately 0.6 percentage points to 12.8% in 2003 from 13.4% in 2002. Diluted earnings per share increased at a somewhat slower rate than net earnings - 8% to $1.14 - due primarily to a larger number of shares outstanding.
We have audited the accompanying consolidated balance sheets of Hub International Limited (the “Company”) as at December 31, 2004 and 2003 and the related consolidated statements of earnings, retained earnings and cash flows for each of the years in the three-year period ended December 31, 2004. We have also audited the effectiveness of the Company’s internal control over financial reporting as at December 31, 2004, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and management’s assessment thereof included in Management’s Annual Report on Internal Control over Financial Reporting appearing under Item 8. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audits.
Included in computer equipment is computer software with a net book value of $6,331 and $5,137 at December 31, 2004 and 2003, respectively. Depreciation expense of $1,906, $1,538 and $1,087 was charged against these assets for the years ended December 31, 2004, 2003 and 2002, respectively.
On July 15, 2003, the Company entered into an interest rate swap agreement. The effect of the swap is to convert the fixed rate interest payments on the 5.71% senior notes and 6.16% senior notes in amounts of $10 million and $55 million, respectively, to a floating rate of approximately 2.00% and 2.40% for 2004 and 2003, respectively. The Company accounts for the swap transaction using the synthetic instruments method under which the net interest expense on the swap and associated debt is reported in earnings as if it were a single, synthetic, financial instrument. As at December 31, 2004, the Company estimated the fair value of the swap to be $2.4 million, which is not recognized in these financial statements. Accordingly, $2.4 million is the estimated amount that the Company would need to pay to terminate the swap as of December 31, 2004.
The following table summarizes information about the stock options outstanding at December 31, 2004, 2003 and 2002:
In connection with the acquisition of HUB Northeast in 2001, the Company issued 8.5% subordinated convertible debentures due June 28, 2007 with a carrying amount and aggregate principal of $35 million. These debentures remain outstanding at December 31, 2004. The Company believes it is not practicable to estimate the fair value of its subordinated convertible debentures due to the conversion features.