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 at the exchange rate in effect at September 30, 2001 of C$1.00 = $0.63.
U.S. revenue grew 32% to $233.3 million, or 66% of consolidated revenue in 2004. Acquisitions in 2004 added $55.7 million to revenue. Our U.S. operations posted an organic growth rate of 0% in 2004, as compared to 3% in 2003, primarily as a result of the rapid softening of premium rates for property and casualty coverage in the third and fourth quarters of 2004. Core commission income increased 34%, while contingent commissions and volume overrides grew 10%. Higher premium rates in 2003 contributed strongly to a significant increase in contingent profitability income from insurance companies in 2004.
Depreciation increased 16% to $7.2 million in 2004 but remained constant at 2% of revenue.
Net debt, defined as long-term debt ($140.3 million) and subordinated convertible debentures ($35.0 million) less non-trust cash (cash and cash equivalents of $70.1 million) as of December 31, 2005, was $105.2 million compared with $88.6 million as of December 31, 2004. Our debt to capitalization ratio (debt as a percentage of debt and shareholders’ equity) decreased to 29% at December 31, 2005, compared with 33% at December 31, 2004. If we had fully utilized all lines of credit and other loan facilities at December 31, 2005, our ratio of debt to capitalization would have been 32%, which is below the range of 35% to 38% that our management believes is suitably conservative for our business model. Under our loan covenants, our debt to capitalization ratio must be less than the 45%. As of December 31, 2005, we were in compliance with the financial covenants under all of our debt instruments.
In addition to these primary credit sources, we ended 2005 with $10.0 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 2006 through 2011. Of the outstanding subsidiary debt, $4.1 million is secured by liens on certain assets of our subsidiaries.
Also at December 31, 2005, we had outstanding 8.5% subordinated convertible debentures in the amount of $35.0 million due June 28, 2007 held by certain subsidiaries of Fairfax (the “Fairfax notes”). The Fairfax notes are convertible by the holders at any time into our common shares at C$17.00 per share. Beginning June 28, 2006, we 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 our common shares on the TSX for twenty consecutive trading days equals or exceeds
(the accompanying notes form an integral part of the financial statements)
During 2004, the Company purchased Talbot (as described above), all of the issued and outstanding membership interests of Bush, Cotton & Scott, LLC, now known as “HUB Northwest,” located in the State of Washington, as well as the assets of five other insurance brokerages, all of which were accounted for 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.
In the ordinary course of business, the Company and its subsidiaries are subject to various claims and lawsuits consisting primarily of alleged errors and omissions in connection with the placement of insurance. In the opinion of management, the ultimate resolution of all such asserted and potential claims and lawsuits will not have a material adverse effect on the consolidated financial position or results of operations of the Company. The Company self insures for certain losses related to errors or omission claims, certain general insurance deductibles and a portion of its group medical insurance. The amounts in excess of self-insured levels are fully insured by third parties, subject to certain limitations and exclusions. Reserves for all self-insurance at December 31, 2005 were approximately $7.1 million and are included in accounts payable and accrued liabilities on the Company’s consolidated balance sheet.
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 resulting in a savings of approximately $0.2 million and $1.3 million for the years ended December 31, 2005 and 2004, 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, 2005, the Company estimated the fair value of the swap to be $4.0 million, which is not recognized in these financial statements. Accordingly, $4.0 million is the estimated amount that the Company would need to pay to terminate the swap as of December 31, 2005.
Other non-cash stock based compensation for the years ended December 31, 2005, 2004 and 2003 is comprised of the following:
Basic earnings per share, excluding the dilutive effect of common share equivalents, is calculated by dividing net earnings by the weighted average number of common shares outstanding for the period. Diluted earnings per share is calculated using the if-converted method for the subordinated convertible debentures and the treasury stock
Also under U.S. GAAP, the fair value of the put options at the date of issuance was also recorded as a debit and credit to shareholders’ equity, representing an unearned compensation expense, as the put options require the selling shareholders to remain employed by the Company in order to be able to exercise the put options. Compensation expense was recognized using the straight-line method over the period from the issue date to the exercise date.