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Hub Intl 10-Q 2005 Table of Contents
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended: June 30, 2005
Commission file number: 1-31310
HUB INTERNATIONAL LIMITED
(Exact name of registrant as specified in its Charter)
(877) 402-6601
Registrant’s telephone number, including area code
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act.)
Yes þ No o
Indicate the number of shares outstanding of each of the
issuer’s classes of common stock, as of the latest
practicable date.
HUB INTERNATIONAL LIMITED
INDEX
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Hub International Limited
Consolidated Balance Sheets
As of June 30, 2005 and December 31, 2004
(in thousands of U.S. dollars)
(the accompanying notes form an integral part of the interim
financial statements)
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Hub International Limited
Consolidated Statements of Earnings
For the three months and six months ended June 30, 2005
and 2004
(in thousands of U.S. dollars, except per share amounts)
(Unaudited)
(the accompanying notes form an integral part of the interim
financial statements)
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Hub International Limited
Consolidated Statements of Retained Earnings
For the six months ended June 30, 2005 and 2004
(in thousands of U.S. dollars)
(Unaudited)
(the accompanying notes form an integral part of the interim
financial statements)
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Hub International Limited
Consolidated Statements of Cash Flows
For the three months and six months ended June 30, 2005
and 2004
(in thousands of U.S. dollars)
(Unaudited)
(the accompanying notes form an integral part of the interim
financial statements)
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Hub International Limited
Notes to Interim Consolidated Financial Statements
For the three months and six months ended June 30, 2005
and 2004 (unaudited)
(in thousands of U.S. dollars, except per share amounts or as otherwise indicated)
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 the Toronto Stock Exchange
(TSX: HBG).
The interim consolidated financial statements do not include all
disclosures required by Canadian generally accepted accounting
principles (“Canadian GAAP”) for annual financial
statements and accordingly, should be read in conjunction with
the Company’s consolidated financial statements for
the year ended December 31, 2004 as set out on
pages 43 to 76 of the Company’s 2004 Annual
Report on Form 10-K. In the opinion of management, all
adjustments (consisting of items of a normal recurring nature)
considered necessary for a fair presentation of the accompanying
financial statements have been reflected therein. Certain
reclassifications have been made to the prior years’
financial statements to conform to the current year
presentation. These interim consolidated financial statements of
the Company are expressed in United States
(“U.S.”) dollars and have been prepared in
accordance with Canadian GAAP using the same accounting
principles as were used for the Company’s consolidated
financial statements for the year ended December 31, 2004.
These principles differ in certain respects from United States
generally accepted accounting principles
(“U.S. GAAP”) and, to the extent that they affect
the Company, the differences are described in Note 16,
“Reconciliation to U.S. GAAP.”
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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 very low capital to
earnings ratio. As a result, the Company records a substantial
amount of goodwill and other intangible assets in connection
with acquisitions.
During the second quarter 2005, the Company purchased all of the
issued and outstanding shares of THB Intermediaries, Inc.
(“THB”) a facultative reinsurance brokerage with
offices in New York, Los Angeles, Chicago and Dallas. This
acquisition allows us to expand into the reinsurance market. In
addition, the Company acquired the assets of three other
insurance brokerages in the second quarter 2005. All of the
acquisitions 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.
The preliminary allocation of the purchase price, including
goodwill and other identifiable intangible assets, and the cost
of the acquired brokerages in the second quarter 2005 are
summarized below:
Of the goodwill acquired $8.6 million is deductible for tax
purposes. Goodwill included under “Other” above, in
the amount of $4.0 million is associated with contingent
consideration relating to prior period acquisitions.
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Accounts and other receivables consist of the following:
As of June 30, 2005 and December 31, 2004 the gross
carrying amount and accumulated amortization of intangible
assets other than goodwill were as follows:
The Company is unable to estimate the useful life of certain
non-competition covenants. These indefinite life intangible
assets are reviewed annually for impairment. Once a
non-competition covenant is triggered, following the departure
of an employee from the Company, the Company’s policy is to
amortize the related intangible asset over the period of the
contractual obligation.
Additions to intangible assets during the six months ended
June 30, 2005 and 2004 were as follows:
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The changes in the carrying amount of goodwill for the six
months ended June 30, 2005 and the year ended
December 31, 2004, are as follows:
For the three months and six months ended June 30, 2005 and
2004 amortization has been comprised of the following:
The Company estimates the amortization charges for 2005 through
2009 for all acquisitions consummated through June 30, 2005
will be:
Accounts payable and accrued liabilities consist of the
following:
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Long-term debt and capital leases
Future repayments of long-term debt and capital leases are as
follows:
Notes:
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Demand U.S. dollar base rate loan
The Company has an undrawn $9.8 million facility which
bears interest at the bank’s U.S. base rate, which was
6.50% and 5.75% at June 30, 2005 and December 31,
2004, respectively, plus 50 basis points. Borrowings on the
facility are repayable on demand.
Subordinated convertible debentures
The Company has issued 8.5% convertible subordinated debentures
(“the Fairfax notes”) in the amount of
$35 million due June 28, 2007 to certain subsidiaries
of Fairfax Financial Holdings Limited (“Fairfax”). The
Fairfax notes are convertible by the holders at any time into
the Company’s common shares at Canadian (“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 32% of the
Company’s total outstanding common shares as of
June 30, 2005.
Share capital
At June 30, 2005 and December 31, 2004, 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
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issued. At June 30, 2005 and December 31, 2004, there
were an unlimited number of common shares authorized, of which
30,604 and 30,411 were issued and outstanding as at
June 30, 2005 and December 31, 2004, respectively.
Contributed surplus
Cumulative translation account
No options were issued in the six months ended June 30,
2005. The maximum option term is seven years, and the options
vest at one-third per year over three years of continuous
employment. The number of common shares that may be issued under
the Equity Incentive Plan is limited to 3,631,820 common shares.
A summary of the stock option activity and related information
for the six months ended June 30, 2005 consists of the
following:
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The following table summarizes information about the stock
options outstanding at:
Non-cash stock based compensation of $10,652 and $1,701 for the
three months ended June 30, 2005 and 2004, respectively and
$19,650 and $3,315 for the six months ended June 30, 2005
and 2004, respectively, was expensed with offsetting credits to
contributed surplus, and accounts payable and accrued
liabilities. The Company recognizes the fair value of non-cash
stock based compensation as an expense over the period in which
entitlement to the compensation vests.
Shares derived from the options are held in escrow and subject
to transfer restrictions for a period of five years from the
date the options are granted, subject to early release in
certain circumstances.
In the first quarter 2005, 226,000 restricted share units were
granted to the Company’s Executive Management Team
(“EMT”). In addition, 25,000 restricted share units
were granted in relation to employment agreements entered into
by the Company with other non-EMT employees. No restricted share
units were granted during the second quarter 2005.
Non-cash stock based compensation for the three months and six
months ended June 30, 2005 and 2004 is comprised of the
following:
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The Company estimates the non-cash stock based compensation
expense for 2005 through 2010 will be:
Basic earnings per share, excluding the dilutive effect of
common share equivalents, are calculated by dividing net
earnings by the weighted average number of common shares
outstanding for the period. Diluted earnings per share are
calculated using the treasury stock method and includes the
effects of all potentially dilutive securities. Earnings per
common share are calculated as follows:
Income taxes for the three months ended June 30, 2005 and
2004 amounted to $8,977 and $6,968 respectively, and for the six
months ended June 30, 2005 and 2004 amounted to $21,859 and
$12,237 respectively, resulting in an
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effective tax rate of 67.8% and 37.6% in the second quarter 2005
and 2004, respectively and 51.3% and 36.6% for the first six
months 2005 and 2004, respectively. This increase in the
effective tax rate is due to non-cash stock based compensation
related to the Talbot earnout which is not deductible for tax
purposes. The effective tax rate for the three months and six
months ended June 30, 2005, excluding the Talbot non-cash
stock based compensation, was 40.9% and 37.4% respectively.
Interest and income taxes paid for the three months and six
months ended June 30, 2005 and 2004 were:
The Company is an international insurance brokerage, which
provides a variety of property, casualty, life and health,
employee benefits, investment and risk management products and
services. In addition to its Corporate Operations, the Company
has identified two operating segments within its insurance
brokerage business: Canadian Operations and U.S. Operations.
Corporate Operations consist primarily of investment income,
non-cash stock based compensation, unallocated administrative
costs, interest expense and the income tax expense or benefit
which is not allocated to the Company’s operating segments.
The elimination of intra-segment revenue relates to
intra-company interest charges, management fees and dividends.
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Geographic revenue is determined based upon the functional
currency of the various subsidiaries. Financial information by
operating and geographic segment is as follows:
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In the three months and six months ended June 30, 2005 and
2004, respectively, the Company had transactions with and
recorded revenue from the following related parties:
The Company had accounts receivable and accounts payable
balances with the above related parties in the amounts of $7,001
and $19,955 respectively, at June 30, 2005 and $4,625 and
$17,848 respectively, at December 31, 2004. All revenue and
related accounts receivable and accounts payable are the result
of transactions in the normal course of business. The companies
above, except for OLIC, are related through common ownership by
Fairfax, which owns approximately 26% of the Company’s
common shares as of June 30, 2005. During the second
quarter 2004, Fairfax sold OLIC to Old Lyme Insurance Group,
Ltd, a company owned primarily by a group of Hub employees,
including Bruce Guthart, Chief Operating Officer and a director
of Hub, and Michael Sabanos, Chief Financial Officer of HUB
International Northeast Limited. The Company continues to place
insurance with OLIC. The compensation that Hub earns from the
business placed with OLIC and the fees it earns from managing
OLIC are substantially the same as if Fairfax continued to own
OLIC.
As of June 30, 2005 and December 31, 2004 subordinated
convertible debentures of $35,000 were due to related parties.
During the three months and six months ended June 30, 2005
and 2004, the Company incurred expenses related to rental of
premises from related parties in the amount of $792 and $1,308
for 2005 and $446 and $876 for the respective periods in 2004.
At June 30, 2005 and December 31, 2004 the Company
also had receivables due from related parties in the amount of
$1,871 and $2,613, respectively, of which the majority were
loans to employees to enable them to purchase the Company’s
common shares. Of these receivables, as of June 30, 2005
and December 31, 2004, $1,655 and $1,793, respectively,
were related to Company loans to employees to purchase shares
under the executive share purchase plan. As collateral, the
employees have pledged 133,000 and 143,000 common shares as of
June 30, 2005 and December 31, 2004, respectively,
which have a market value of $2,601 and $2,619 as of
June 30, 2005 and December 31, 2004, respectively.
The consolidated financial statements have been prepared in
accordance with Canadian GAAP, which differs in certain respects
from U.S. GAAP.
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Net earnings and comprehensive income
There were no differences between Canadian GAAP and U.S. GAAP
affecting net earnings, basic earnings per share and diluted
earnings per share. The table below presents comprehensive
income for the three months and six months ending June 30,
2005 and 2004.
Shareholders’ equity
The table below sets out the differences between Canadian GAAP
and U.S. GAAP that affect shareholders’ equity at
June 30, 2005 and December 31, 2004:
Notes:
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On August 1, 2005 the Company announced that it had signed
a definitive agreement to purchase the shares of Personal Lines
Insurance Brokerage, Inc., based in Warren, New Jersey. The
transaction is expected to close within 60 days.
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The following discussion and analysis should be read in
conjunction with our unaudited consolidated financial statements
and accompanying notes included elsewhere in this report.
Certain information contained in “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations” are forward-looking statements that involve
risks and uncertainties. Our actual results may differ
materially from the results discussed in the forward-looking
statements because of various factors, including those discussed
below and elsewhere in this Form 10-Q. Reference to
“Hub”, “we”, “us”, “our”
and the “registrant” refer to Hub International
Limited and its subsidiaries, unless otherwise expressly stated.
Unless otherwise indicated, all dollar amounts are expressed in,
and the term “dollars” and the symbol “$”
refer to, U.S. dollars. The term “Canadian dollars”
and the symbol “C$” refer to Canadian dollars. Our
financial statements are prepared in accordance with Canadian
generally accepted accounting principles (“Canadian
GAAP”). These principles differ in certain respects from
United States generally accepted accounting principles
(“U.S. GAAP”) and to the extent that they affect us
are described in Note 16 to our unaudited consolidated
financial statements.
Overview
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. Our acquisition pipeline
continues to be strong, although we cannot predict the timing or
size of future acquisitions.
As of June 30, 2005, our operations included
16 regional “hub” brokerages—eleven in the
United States and five in Canada — and nearly
200 offices staffed by approximately 3,300 people. Our
strategic plan calls for the addition of approximately four
additional U.S. hubs to extend our geographic footprint.
Brokerages large enough to be considered hubs will generally
have annual revenue in excess of $10 million. In addition
to larger, “hub” acquisitions by the parent
corporation, each regional hub is tasked with pursuing smaller,
fold-in acquisitions that either expand its geographic
penetration or add new specialization or expertise to the
regional operation.
We generally acquire larger “hub” brokerages for a
combination of cash and our common shares. Although there are
variations in the purchase terms for each hub, our goal is to
pay 30% – 70% of the “hub” purchase
price in our common shares, while setting escrow periods of up
to 10 years for the sellers to hold these shares. We
believe the use of escrowed stock in major acquisitions creates
increased alignment of interests between senior managers and the
public shareholders of the corporation. We have paid all cash
for the acquisition of certain brokerages, and may pay an all
cash purchase price for brokerages in the future. As of
June 30, 2005, senior managers of the company and its hubs
owned approximately 1.9 million shares, or 6.1%, of total
shares outstanding, while all employees as a group held
approximately 6.6 million shares, or 21.4% of total shares
outstanding.
We have acquired 104 brokerages in Canada and the United
States, with substantially all of our large acquisitions over
the past four years focused in the United States. Accordingly,
U.S. revenue has grown to 70% of our total in the second
quarter 2005 from 13% in the second quarter 2000, reflecting
primarily acquisition growth but also organic growth. Organic
growth, a non-GAAP measure, is similar to the
same-store-sales calculation used by retailers. It
includes revenue growth from operations included in our
financial statements for at least 12 months. Because we
apply the purchase method of accounting for acquisitions,
acquired brokerages’ financial results are included only
from the date of acquisition.
We have a diverse mix of products, services, insurer
relationships and distribution channels, and as a result, our
revenue and profitability levels are not usually highly
susceptible to major changes as a result of a single product or
service. However, general economic trends may influence both
overall insurance rates, commissions and availability or costs
of individual types of coverage, which in turn may affect our
revenue and profitability levels. Our ability to achieve organic
revenue growth is not solely dependent on rising or declining
rates, but results from a more complex mixture of general
economic growth, access to coverage from insurers and
marketing/sales expertise.
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During the 1990s, for example, insurance rates were generally
considered low, or “soft,” as insurance companies
sought to maximize the flow of premium dollars that they could
invest profitably in a rising stock market and in other
investments. Beginning in 2000, as return on investment began to
shrink, insurance rates began to rise, or “harden,” a
pace that accelerated rapidly after the terrorist attacks of
September 11, 2001. During the two years after
September 11, 2001 premium rates remained firm for most
types of coverage, rising 10% to 15% per year in many cases.
During the latter part of 2003, the Canadian market remained
firm, but the U.S. market experienced some softening of premium
rates for property and casualty coverage. During 2004 insurance
rates in both Canada and in the U.S., for many types of
coverage, continued to decline. This trend continues in 2005.
For us, as for other brokers, falling rates can present both
positive and negative effects. Falling premiums usually yield
reduced commissions, if the insurance buyer maintains its
coverage levels. However, many insurance buyers will respond to
falling rates by increasing total coverage, often by lowering
deductibles, increasing limits of coverage, or by adding new
risks to those already insured. During the first six months
2005, we started to see modest evidence of insurance buyers
increasing coverage levels as a result of the softening of
insurance rates. In addition, the economic environment could
lead to higher or lower sales and employee headcounts at client
companies, leading in turn to increased or reduced demand for
employee benefits, liability and other types of coverage tied to
business activity levels.
Results of Operations
Three months ended June 30, 2005 compared with three
months ended June 30, 2004
Revenue
A significant portion of our revenue growth in 2005 was the
result of brokerages acquired in 2004. During 2004, we acquired
seven insurance brokerages, including Talbot Financial
Corporation (“Talbot”), and divested of three small
brokerages in Canada. In 2005 we sold assets of certain
brokerages with annual revenue of approximately
$2.5 million. Included in the second quarter 2005 revenue,
is $25.4 million attributable to the 2004 acquisitions and
$1.2 million attributable to the 2005 acquisitions, offset
by $1.9 million attributable to dispositions during 2004
and 2005. As a result of these acquisitions net of dispositions
and 7% organic growth, which includes the strengthening of the
Canadian dollar in 2005 compared to the U.S. dollar, we reported
a 37% increase in revenue to $112.7 million in the second
quarter 2005.
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The table below shows a breakdown of our revenue by segment and
type for the three months ended June 30, 2005 including
organic growth:
Of the $30.4 million in new revenue we reported,
$24.7 million, or 81%, reflected growth through
acquisitions net of dispositions, while $5.8 million, or
19%, resulted from organic growth. By comparison, acquired
brokerages added $3.8 million, or 47%, of second quarter
2004 sales growth, while organic growth contributed
$4.3 million, or 53%, 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 the second quarter 2005, the rise of the Canadian
dollar versus the U.S. dollar contributed 4 percentage
points of our 7% organic growth rate in revenue.
Commission income, which usually ranges from 5% to 20% of the
premium charged by insurers, provided approximately 93% of our
revenue in the second quarter 2005 compared to 94% in the second
quarter 2004. In addition to “core” commissions, the
company derives revenue from:
In addition to the variations that can result from changes in
organic growth rates, acquisitions and other variables related
to operations, the second quarter 2005 and 2004 results included
a number of factors that can complicate
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any efforts at direct comparisons. To increase investor
understanding the following chart shows the net earnings and
diluted earnings per share impact on specific items.
As shown above, our net earnings benefited more significantly
from a stronger Canadian dollar in the second quarter 2005 as
compared to 2004. The impact of foreign exchange on second
quarter 2005 earnings generated an increase of $0.4 million
as compared to an increase of $0.2 million in the second
quarter 2004. In the second quarter 2005, we recorded
$8.7 million of non-cash stock based compensation related
to the Talbot acquisition. See “Contractual Obligations
— Acquisitions.”
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. In the second quarter
2005, the strength of the Canadian dollar versus the U.S. dollar
had a more positive impact on our net earnings than in the
second quarter 2004 however, there was no impact on diluted
earnings per share. Any decline in the Canadian dollar versus
the U.S. dollar would have a negative effect on our results. See
“Market Risk.”
U.S.
Results
U.S. revenue grew 55% to $78.6 million, or 70% of
consolidated revenue, in the second quarter 2005 as compared to
2004, due to both acquisitions and to organic growth.
Acquisitions net of dispositions added $26.1 million to
revenue, or 94% of the increase, while organic growth provided
$1.7 million, or 6% of revenue growth. Our U.S. operations
posted an organic growth rate of 3% in the second quarter 2005,
a 25% decrease from 4% in the second quarter 2004, primarily due
to a lower organic growth rate on commission income as premium
rates continue to decline. Core commission income increased 55%
and organic growth was 2%. Meanwhile, contingent commissions and
volume overrides grew 58%, including organic growth of 19%,
while other income grew 37%, including organic growth of 23%.
Canadian
Results
Canadian revenue grew 8% to $34.1 million, or 30% of
consolidated revenue, in the second quarter 2005 as compared to
2004, primarily as a result of organic growth as well as a
strengthening of the Canadian dollar against the U.S. dollar.
Canadian brokerages posted organic growth of 13%, of which 9
percentage points reflected a stronger Canadian dollar.
Dispositions lowered revenue by $1.6 million while
acquisitions only added $0.1 million, for a net decrease of
$1.5 million. Canadian operations had a decrease in
contingent commissions and volume overrides of 8% in the second
quarter 2005, versus a growth of 22% in the second quarter 2004.
Compensation Expense
Cash compensation expense for the second quarter 2005 increased
46% to $61.4 million from $42.1 million, while
non-cash stock based compensation grew 526% to
$10.7 million in the second quarter 2005 from
$1.7 million in the second quarter of 2004 due to the
non-cash stock based compensation related to Talbot. As a
percentage of revenue, cash compensation expense increased to
55% primarily due to a relatively higher level of compensation
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cost as a percentage of revenue from Talbot as well as salaries
and bonuses increasing at a higher rate than revenue growth.
Compensation Comparison
For the three months ended June 30, 2005 and 2004
Our non-cash stock based compensation includes stock options and
restricted share units for senior employees as well as the
amortization of $8.7 million, or $0.25 per diluted share,
of non-cash stock based compensation for the second quarter 2005
related to the estimated earnout due to management of Talbot.
Our policy is to expense the fair value of non-cash stock based
compensation to employees over the period in which entitlement
to the compensation vests. The amount of expense recognized in
each year related to stock options will vary with respect to
exercise and forfeiture of options.
Non-cash stock based compensation for the three months ended
June 30, 2005 and 2004 is comprised of the following:
Selling, Occupancy and Administration Expense
Selling, occupancy and administration expense increased 29% to
$20.7 million in the second quarter 2005 as compared to
2004. As a percentage of revenue, selling, occupancy and
administration expense decreased to 18%, versus 20% in the
second quarter 2004. This decrease was due to controlling these
primarily fixed costs as revenue increased.
Depreciation
Depreciation remained consistent at 2% of revenue in the second
quarter 2005 and 2004.
Interest Expense
Interest expense increased 52% to $2.6 million in the
second quarter 2005, as compared to 2004, primarily as a result
of higher debt levels and higher interest rates in 2005.
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Intangible Asset Amortization
Intangible asset amortization increased 102% to
$1.9 million in the second quarter 2005 as compared to the
second quarter 2004, primarily as a result of the acquisition of
Talbot.
Provision for Income Tax Expense
Our effective tax rate increased in the second quarter 2005 to
67.8% from 37.6% in the second quarter 2004, due primarily to
non-cash stock based compensation expense related to the
acquisition of Talbot which is not deductible for tax purposes.
Excluding the Talbot non-cash stock based compensation, the
effective tax rate for second quarter 2005 was 40.9%. The
current year tax rate for the quarter, excluding the Talbot
non-cash stock based compensation, is higher than the prior year
as a result of adjustments made in the quarter to reflect actual
taxes paid versus amounts previously accrued.
Net Earnings and Earnings Per Share
Our net earnings decreased 63% to $4.3 million in the
second quarter 2005, primarily as a result of the increase in
non-cash stock based compensation related to Talbot. As a
percentage of revenue, net earnings decreased to 4% in the
second quarter 2005 from 14% in the second quarter 2004. Diluted
earnings per share decreased 66% to $0.12.
As shown in the table on page 25, net earnings increased
$0.4 million related to the strengthening Canadian dollar
versus the U.S. dollar while the effect on diluted earnings per
share was flat as compared to the second quarter 2004. Net
earnings decreased $8.7 million or $0.25 per diluted share
due to the impact of non-cash stock based compensation related
to the Talbot acquisition.
Results of Operations
Six months ended June 30, 2005 compared with six months
ended June 30, 2004
Revenue
As mentioned earlier, a significant portion of our revenue
growth in 2005 was the result of brokerages acquired in 2004,
mainly Talbot, and in 2005. In the first six months of 2005 we
sold assets of certain brokerages with an aggregate annual
revenue of approximately $2.5 million. Included in the
first six months 2005 revenue, is $61.7 million
attributable to the 2004 acquisitions and $1.2 million
attributable to the 2005 acquisitions, offset by
$3.6 million of dispositions during 2004 and 2005. Total
annualized revenue of brokerages acquired in 2004, as of their
respective acquisition dates, was $115.4 million:
$62.9 million of our first six months 2005 revenue was
attributable to these 2004 acquisitions. As a result of these
acquisitions and 8% organic growth, which includes the
strengthening of the Canadian dollar in 2005 compared to the
U.S. dollar, we reported a 45% increase in revenue to
$234.4 million in the first six months 2005.
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The table below shows a breakdown of our revenue by segment and
type for the six months ended June 30, 2005 including
organic growth:
Of the $72.8 million in new revenue we reported,
$59.3 million, or 82%, reflected growth through
acquisition, while $13.5 million, or 18%, resulted from
organic growth. By comparison, acquired brokerages added
$5.4 million, or 29%, of second quarter 2004 sales growth,
while organic growth contributed $13.1 million, or 71%, of
our revenue increases in the first six months 2004. Organic
growth figures for both revenue and earnings include the impact
of foreign exchange rate changes between the U.S. and Canadian
dollars. In the second quarter 2005, the rise of the Canadian
dollar versus the U.S. dollar contributed 3 percentage
points of our 8% organic growth rate in revenue.
Commission income, which usually ranges from 5% to 20% of the
premium charged by insurers, provided approximately 83% of our
revenue base in the first six months 2005 compared to 86% in the
first six months 2004. In addition to “core”
commissions, the company derives revenue from:
In addition to the variations that can result from changes in
organic growth rates, acquisitions and other variables related
to operations, the first six months 2005 and 2004 results
included a number of factors that can complicate
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any efforts at direct comparisons. To increase investor
understanding the following chart shows the net earnings and
diluted earnings per share impact on specific items.
As shown above, the benefit from a stronger Canadian dollar was
the same in the first six months 2005 and 2004, an increase of
$1.1 million. In the first six months 2005, we recorded
$15.9 million of non-cash stock based compensation related
to the Talbot acquisition. See “Contractual Obligations
— Acquisitions.” In addition, we benefited from the
gain on forgiveness of debt of $2.9 million, after tax, as
part of a settlement of an early payment of a term loan.
Included in the first six months of 2004, was the write-off of
trademarks of $1.7 million after tax. We further benefited
from the gain on disposition of assets of certain brokerages of
$1.9 million after tax, as compared to a gain of
$0.4 million in the first six months 2004.
Gains and losses on disposal of assets are not an unusual item,
but they are included here to highlight the difference between
the two reporting periods. Similarly, 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. In the first six months 2005, the
strength of the Canadian dollar versus the U.S. dollar had the
same impact on our results as in the first six months 2004. Any
decline in the Canadian dollar versus the U.S. dollar would have
a negative effect on our results. See “Market Risk.”
U.S.
Results
U.S. revenue grew 66% to $165.7 million, or 71% of
consolidated revenue, in the first six months 2005 as compared
to 2004, due to both acquisitions and organic growth.
Acquisitions net of dispositions added $62.2 million to
revenue — 94% of the increase while organic growth provided
$3.9 million or 6% of revenue growth. Our U.S. operations
posted an organic growth rate of 4% in the first six months 2005
remaining unchanged from 2004, primarily due to an increase in
contingent commissions offset by declining premium rates. Core
commission income increased 1% while contingent commissions and
volume overrides grew 23%.
Canadian
Results
Canadian revenue grew 11% to $68.7 million, or 29% of
consolidated revenue, in the first six months of 2005 as
compared to 2004, primarily as a result of a strengthening of
the Canadian dollar against the U.S. dollar as well as organic
growth. Canadian brokerages posted organic growth of 15% of
which nine percentage points reflected a stronger Canadian
dollar. Dispositions net of acquisitions lowered revenue by
$2.9 million reflecting the sale of certain fold-ins
acquired in prior years. In addition, Canadian operations
benefited from an increase in contingent commissions and volume
overrides, which grew 49% in the first six months 2005, versus a
46% growth rate in the first six months 2004.
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Compensation Expense
Cash compensation expense for the first six months 2005
increased 51% to $125.3 million from $82.8 million,
while non-cash stock based compensation grew 493% to
$19.7 million from $3.3 million in the first six
months 2004. As a percentage of revenue, cash compensation
expense increased to 54% from 51% a year earlier, due to a
relatively higher level of compensation cost as a percentage of
revenue from Talbot and to salaries and bonuses increasing at a
higher rate than revenue growth.
Compensation Comparison
For the six months ended June 30,
Our non-cash compensation includes stock options and restricted
share units for senior employees as well as the amortization of
$15.9 million, or $0.43 per diluted share, of non-cash
stock based compensation for the first six months 2005 related
to the estimated earnout due to management of Talbot. Our policy
is to expense the fair value of non-cash stock based
compensation to employees over the period in which entitlement
to the compensation vests. The amount of expense recognized in
each quarter related to stock options will vary with respect to
exercise and forfeiture of options.
Non-cash stock based compensation for the six months ended
June 30, 2005 and 2004 is comprised of the following:
Selling, Occupancy and Administration Expense
Selling, occupancy and administration expense increased 29% to
$40.7 million in the first six months 2005 as compared to
2004. As a percentage of revenue, selling, occupancy and
administration expense decreased to 17% versus 20% in the first
six months 2004. This decrease was due to controlling these
primarily fixed costs as revenue increased.
Depreciation
Depreciation remained consistent at 2% of revenue in the first
six months 2005 and 2004.
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Interest Expense
Interest expense increased 48% to $5.0 million from
$3.4 million in the first six months 2005, primarily as a
result of higher debt levels and higher interest rates in 2005.
Gain on Forgiveness of Debt
During the first quarter 2005 an early payment settlement was
negotiated in respect of our $7.5 million loan from an
insurance carrier. The early settlement negotiations resulted in
the $7.5 million principal amount of the term loan being
reduced to $3.0 million and interest payments for the first
quarter 2005 being reduced to zero.
(Gain) Loss on Disposal of Subsidiaries, Property, Equipment
and Other Assets
During the first six months 2005, we sold assets of certain
insurance brokerages in Canada resulting in a gain of
$2.4 million as compared to $0.6 million in 2004.
Intangible Asset Amortization
Intangible asset amortization increased 118% to
$3.7 million in the first six months 2005 as compared to
the first six months 2004 primarily as a result of the
acquisitions of Talbot and Bush, Cotton and Scott LLC.
Loss on Write-Off of Trademarks
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 identity 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,
certain of our subsidiaries changed their names and we
recognized a non-cash pre-tax expense of approximately
$2.6 million related to the write-offs of trademarks.
Provision for Income Tax Expense
Our effective tax rate increased in the first six months 2005 to
51.3% compared to 36.6% for the same prior year period, due
primarily to non-cash stock based compensation related to the
acquisition of Talbot which is not deductible for tax purposes.
Excluding Talbot non-cash stock based compensation, the
effective tax rate for the first six months 2005 was 37.4%.
Net Earnings and Earnings Per Share
Our net earnings decreased 2% to $20.7 million in the first
six months 2005, primarily as a result of the increase in
non-cash stock based compensation related to Talbot offset by
growth in revenue, the gain on forgiveness of debt and gains on
disposal of assets. As a percentage of revenue, net earnings
decreased to 9% in the first six months 2005 from 13% in the
first six months 2004. Diluted earnings per share decreased 8%
to $0.59 in the first six months 2004 compared to $0.64 in the
first six months 2004.
As shown in the table on page 29, net earnings increased
$1.1 million or $0.03 per diluted share, related to the
strengthening Canadian dollar versus the U.S. dollar,
$2.9 million or $0.08 per diluted share related to the gain
on forgiveness of debt and $1.9 million or $0.05 per
diluted share related to the gain on disposal of assets of
certain brokerages. Also, net earnings decreased
$15.9 million or $0.43 per diluted share due to the impact
of non-cash stock based compensation related to the Talbot
acquisition.
Cash Flow, Liquidity and Capital Resources
As of June 30, 2005, we had cash and cash equivalents of
$114.6 million, an increase of 17% from $98.2 million
as of December 31, 2004. Operating activities generated
$27.8 million of cash in the six months ended June 30,
2005
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compared to $17.1 million in the six months ended
June 20, 2004. The amount of cash provided by operating
activities is affected by net earnings for the period, non-cash
income and expenses, the change in trust cash, the collection of
accounts and other receivables and the payment of accounts
payable and accrued liabilities. In the six months ended
June 30, 2005, $2.3 million of cash was used in
investing activities, primarily from the acquisition of
subsidiaries compared to $10.5 million used in the six
months ended June 30, 2004. Also in the six months ended
June 30, 2005, $8.2 million of cash was used for
financing activities, primarily resulting from the repayment of
long-term debt and capital leases and the payment of dividends,
compared to $57.7 million generated in the six months ended
June 30, 2004. In the six months ended June 30, 2005,
the effect of exchange rate changes on cash and cash equivalents
was a decrease of $0.9 million compared to a decrease of
$2.0 million in the six months ended June 30, 2004.
Net debt, defined as long-term debt ($142.1 million) and
subordinated convertible debentures ($35.0 million) less
non-trust cash (cash and cash equivalents of
$114.6 million) as of June 30, 2005, was
$62.5 million compared with $88.6 million as of
December 31, 2004.
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 under the caption
“Trust Cash.” 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.
In addition to internally generated cash, we maintain two
separate credit facilities:
As of June 30, 2005 we had outstanding $65 million
aggregate principal amount of unsecured senior notes issued
June 10, 2002. The senior notes were issued in two series.
Series A represents $10 million aggregate principal
amount of 5.71% senior notes with interest due semi-annually,
and principal of $3.3 million due annually, June 15,
2008 through June 15, 2010. Series B represents
$55 million aggregate principal amount of 6.16% senior
notes with interest due semi-annually, and principal of
$11 million due annually, June 15, 2009 through
June 15, 2013. The senior notes were sold on a private
basis in the United States to institutional accredited
investors. We incurred approximately $0.7 million in fees
and expenses related to the offering of these notes which were
capitalized and are being amortized to expense over the term of
the notes. As of June 30, 2005 we were in compliance with
all financial covenants governing the senior notes.
On July 15, 2003, we 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 0.47% and 1.98% for the three months ended
June 30, 2005 and 2004, respectively and 0.72% and 2.19%
for the six months ended June 30, 2005 and 2004,
respectively. We account 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
June 30, 2005, we estimate the fair value of the swap to be
$2.2 million, which is not recognized in
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our financial statements. Accordingly, $2.2 million is the
estimated amount that we would need to pay to terminate the swap
as of June 30, 2005.
During the first quarter 2005 an early payment settlement was
negotiated in respect of our $7.5 million loan from an
insurance carrier. The loan agreement provided for an incentive
agreement whereby a credit could be earned to reduce interest
payments (based on target premiums placed with the carrier) and
principal amounts (based on target premiums placed with the
carrier as well as loss ratios on those premiums). The early
settlement negotiations resulted in the $7.5 million
principal amount of the term loan being reduced to
$3.0 million and interest payments for the first quarter
2005 being reduced to zero. We paid $3.0 million in March
2005 and recorded a gain on forgiveness of debt of
$4.5 million for the first quarter 2005.
In addition to these primary credit sources, we ended
June 30, 2005 with $11.9 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 2005 through 2011. Of the outstanding subsidiary debt,
$7.3 million is secured by liens on certain assets of our
subsidiaries.
Also at June 30, 2005, we had outstanding $35 million
aggregate principal amount of 8.5% convertible subordinated
notes due June 28, 2007 held by certain subsidiaries of
Fairfax Financial Holdings Limited (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
C$19.00 per share. If converted, Fairfax would have owned
approximately 32% of our total outstanding common shares as of
June 30, 2005, versus the 26% of outstanding shares which
it held on that date.
At June 30, 2005, our cash position included approximately
$47.1 million of working capital and approximately
$67.5 million available for acquisitions. This amount
combined with available lines of credit leaves us with a total
amount of $87.3 million available for acquisitions compared
to the $61.1 million available at December 31, 2004.
It is impossible to define exactly how many acquisitions or how
much new revenue could be acquired through the use of this cash,
additional cash flow from operations and application of credit
facilities, as acquisition pricing and other factors vary during
the course of the year. However, we intend to use common shares
as consideration for approximately 30%-70% of the value of a hub
acquisition, and generally have paid a multiple of 5-8 times
earnings before interest, taxes, depreciation and amortization
(frequently referred to as EBITDA) for acquired brokerages.
We believe that our capital resources, including existing cash,
funds generated from operations and borrowings available under
credit facilities, will be sufficient to satisfy the
company’s financial requirements, including some strategic
acquisitions, during the next twelve months, as well as the
Talbot payment, if paid in cash on September 1, 2005. We
may finance acquisitions with available cash or an existing
credit facility, but may, depending on the number and size of
future acquisitions, need to supplement our finance requirements
with the proceeds from debt financing, the issuance of
additional equity securities, or a combination of both.
Our debt to capitalization ratio (defined as debt as a
percentage of debt and shareholders’ equity) decreased to
30% at June 30, 2005, compared with 33% at
December 31, 2004. If all lines of credit and other loan
facilities were fully utilized by the company at June 30,
2005 our ratio of debt to capitalization would have been 33%,
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 45%. As of June 30, 2005, we were in compliance
with the financial covenants under all of our debt instruments.
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Contractual Obligations
The table below summarizes our contractual obligations as of
June 30, 2005:
Acquisitions
On July 1, 2004, we purchased all of the common shares of
Satellite Acquisition Corporation (“Satellite”) a
corporation formed by senior management at Talbot. In turn,
Satellite purchased 100% of Talbot from Safeco Corporation. We
will purchase special shares of Satellite owned by the
management of Talbot using a combination of both restricted and
unrestricted common shares of Hub. Payments will be made on
September 1, 2005, March 31, 2006 and March 31,
2007 based upon Talbot’s earnings for the 12 month
periods ending December 31, 2004, 2005 and 2006,
respectively. The contingent payment to Talbot management is
recorded as a charge to earnings in the form of non-cash stock
based compensation expense over the period in which the payments
are earned. We estimate that the aggregate value of compensation
which will be recognized under this arrangement will be
$52 — $55 million, of which $8.7 million was
recognized in the second quarter 2005 and $30.3 million has
been recognized in total from the date of acquisition through
June 30, 2005 as an expense with an offsetting credit to
accounts payable and accrued liabilities. A payment of
$16.4 million will be paid to Talbot management on
September 1, 2005 in the form of cash or our common shares.
In connection with other various acquisitions completed through
June 30, 2005, we may be obligated to pay contingent
consideration up to a maximum sum of approximately
$14.9 million in cash and $8.8 million in common
shares based upon management’s best estimate of acquired
brokerages achieving certain targets. The contingent payments
are payable on various dates through July 2009 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 June 30, 2005, the financial
statements reflect a liability to pay cash of $2.2 million
and to issue common shares valued at approximately
$0.1 million.
Other
In connection with our executive share purchase plan, under
certain circumstances, we may be obligated to purchase loans for
certain employees from a Canadian chartered bank totaling
$3.9 million and $4.3 million as of June 30, 2005
and December 31, 2004, respectively, to assist in
purchasing our common shares. As collateral, the employees have
pledged 407,000 and 431,000 of our common shares as of
June 30, 2005 and December 31, 2004, respectively,
which have a market value of $7.9 million as of
June 30, 2005 and December 31, 2004. Interest on the
loans in the amount of $96,000 for the six months ended
June 30, 2005 and 2004 was paid by us and is included in
cash compensation expense.
In the ordinary course of business, we 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 our management, the ultimate resolution of all
asserted and potential claims and lawsuits will not have a
material adverse effect on our consolidated financial position
or results of operations.
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Shareholders’ equity
Restricted share units. During the first six months 2005,
226,000 restricted share units were granted to our Executive
Management Team (“EMT”). In addition 25,000 restricted
share units were granted in relation to employment agreements
entered into with other non-EMT employees.
Share repurchases. For the six months ended June 30,
2005, no common shares were repurchased by us.
Shares reserved for issuance. As of June 30, 2005,
3.6 million common shares were reserved for issuance under
our equity incentive plan. As of June 30, 2005, an
aggregate of approximately 3.2 million stock options and
restricted share units were outstanding which would reduce such
shares reserved for issuance.
Shareholders’ equity increased by $21.8 million, or
6%, to $403.6 million as of June 30, 2005 from
$381.8 million as of December 31, 2004. This increase
resulted from net earnings of $20.8 million, an increase in
contributed surplus of $3.3 million related primarily to
non-cash stock based compensation expense, $1.7 million for
shares issued for contingent consideration, $0.4 million
for shares issued for acquisitions, $0.6 million for
exercise of stock options, $0.5 million for the release of
restricted share units and $0.1 million for the repayment
of loans under our employee stock purchase plan. The increase in
shareholders’ equity was offset by dividends of
$3.7 million in the second quarter 2005, and a decrease in
the cumulative translation account of $1.9 million, due
mainly to the weakening of the Canadian dollar compared to the
U.S. dollar since December 31, 2004.
Market Risk
Interest rate risk
We are exposed to interest rate risk in connection with our
$65 million revolving U.S. dollar LIBOR loan and senior
notes due to the interest rate swap entered into in July 2003,
which converted the fixed rate interest payments on the
$65 million aggregate principal amount of senior notes into
floating rate payments. As a result, each 100 basis point
increase in interest rates charged on the balance of our
outstanding floating rate debt as of June 30, 2005 will
result in a decrease of approximately $0.8 million in our
quarterly earnings.
Exchange rate sensitivity
We report our revenue in U.S. dollars. Our Canadian operations
earn revenue and incur expenses in Canadian dollars. Given our
significant Canadian dollar revenue, we are sensitive to the
fluctuations in the value of the Canadian dollar and are
therefore exposed to foreign currency exchange risk. Foreign
currency exchange risk is the potential for loss in revenue and
net income as a result of a decline in the U.S. dollar value of
Canadian dollar revenue due to a decline in the value of the
Canadian dollar compared to the U.S. dollar.
The Canadian dollar is subject to volatility and has experienced
significant changes in its value compared to the U.S. dollar
during 2001 through 2004. At June 30, 2005 and 2004 one
U.S. dollar equaled $1.2256 and $1.3404 Canadian dollars,
respectively. 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, net earnings and cumulative translation
account for the three months ended June 30, 2005 and 2004.
The increasing proportion of our revenue derived from our U.S.
operations and earned in U.S. dollars has, in part, offset the
potential risk of a decline in the Canadian dollar. We expect
that the proportion of revenue earned in U.S. dollars will
continue to increase, further mitigating our foreign currency
exchange sensitivity.
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Goodwill and Other Intangible Assets
Intangible assets arising from acquisitions consist of the
following:
We completed our impairment testing on the balance of goodwill
and intangible assets as of January 1, 2005 and 2004. Based
on the testing performed, no impairment losses were incurred.
The amounts allocated to customer relationships were determined
by discounting the expected future net cash flows from
commissions with consideration given to remaining economic
lives, renewals, and associated expenses. The amounts allocated
to non-competition covenants were determined using an income
approach with consideration given to economic benefits
associated with having the covenants in place versus damages
that would ensue absent the agreements. The balance of the
excess purchase price is allocated to goodwill.
Customer relationships are amortized on a straight-line basis
over their estimated useful life, typically ten to 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 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 the covenant. During
the second quarter of 2004 certain of our subsidiaries changed
their names and as a result we recognized a non-cash loss on the
write-off of trademarks of $2.6 million before tax. For the
three months and six months ended June 30, 2005 and 2004,
our amortization has been comprised of the following:
We estimate that our amortization charges for intangible assets
for 2005 through 2009 for all acquisitions consummated through
June 30, 2005 will be:
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Related Party Transactions
We had transactions with, and recorded revenue from, the
following related parties:
We had accounts receivable and accounts payable balances with
the above related parties in the amounts of $7.0 million
and $20.0 million, respectively, at June 30, 2005 and
$4.6 million and $17.8 million, respectively, at
December 31, 2004. All revenue and related accounts
receivable and accounts payable are the result of transactions
in the normal course of business. The companies above, except
for OLIC, are related through common ownership by Fairfax, which
owns approximately 26% of our common shares as of June 30,
2005. During the second quarter 2004, Fairfax sold OLIC to Old
Lyme Insurance Group, Ltd, a company owned primarily by a group
of Hub employees, including Bruce Guthart, Chief Operating
Officer and a director of Hub, and Michael Sabanos, Chief
Financial Officer of HUB International Northeast Limited
(“HUB Northeast”). We continue to place insurance with
OLIC. The compensation that Hub earns from the business placed
with OLIC and the fees it earns from managing OLIC are
substantially the same as if Fairfax continued to own OLIC.
As of June 30, 2005 and December 31, 2004,
subordinated convertible debentures of $35.0 million were
due to related parties.
During the second quarter of 2005 and 2004, we incurred expenses
related to rental of premises from related parties in the amount
of $0.8 million and $1.3 million for 2005 and
$0.4 million and $0.9 million for the respective
periods in 2004. At June 30, 2005 and December 31,
2004, we also had receivables due from related parties in the
amount of $1.9 million and $2.6 million, respectively,
of which the majority were loans to employees to enable them to
purchase our common shares. Of these receivables, as of
June 30, 2005 and December 31, 2004, $1.7 million
and $1.8 million, respectively, were related to company
loans to employees to purchase shares under our executive share
purchase plan. As collateral, the employees have pledged 133,000
and 143,000 common shares as of June 30, 2005 and
December 31, 2004, respectively, which have a market value
of $2.6 million as of June 30, 2005 and
December 31, 2004.
Off-Balance Sheet Transactions
Under Canadian GAAP, we use the synthetic instruments method to
account for the interest rate swap transaction — which
converted fixed rate interest payments of 5.71% and 6.16% on the
senior notes of $10 million and $55 million,
respectively to a floating rate resulting in a savings of
approximately 0.47% and 1.98% for the second quarter 2005 and
2004, respectively. Under this method, we report in earnings the
net interest expense on the swap and associated debt as if it
were a single, synthetic, financial instrument. The fair value
of the swap, estimated at $2.2 million, is not recognized
in our Canadian GAAP financial statements. Under U.S. GAAP, we
have designated the swap transaction as a hedge of changes in
the fair value of our fixed rate debt caused by changes in
interest rates and record the swap on our U.S. GAAP balance
sheet at its fair value. Changes in the fair value of the swap
are reported in earnings. Changes in the fair value of the debt
being hedged which are attributable to changes in interest rates
are recognized in earnings by adjustment of the carrying amount
of the debt. We have no other material off-balance sheet
arrangements.
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Item 3. Quantitative and Qualitative Disclosures
about Market Risk
See “Management’s Discussion and Analysis of Financial
Condition and Results of Operations — Market
Risk.”
Item 4. Controls and Procedures
Under SEC rules, we are required to maintain disclosure controls
and procedures designed to ensure that information required to
be disclosed by us in the reports that we file or submit under
the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the
SEC’s rules and forms.
Our chief executive officer and chief financial officer
conducted an evaluation of our disclosure controls and
procedures, as such term is defined under Rules 13a-15(e)
and 15d-15(e) promulgated under the Securities Exchange Act of
1934, as amended (the Exchange Act) as of June 30, 2005
(the Evaluation Date). Based on that evaluation, our chief
executive officer and chief financial officer concluded that as
of the Evaluation Date, our disclosure controls and procedures
were effective in timely alerting them to material information
relating to us required to be disclosed in our reports filed or
submitted under the Exchange Act. In addition, there have been
no changes in our internal control over financial reporting
during the second quarter 2005 that have materially affected, or
are reasonably likely to materially affect, our internal control
over financial reporting. Notwithstanding the foregoing, there
can be no assurance that our disclosure controls and procedures
will detect or uncover all failures within our company to
disclose all material information otherwise required to be set
forth in our periodic reports.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The insurance industry in general, and certain of our hubs,
continue to be the subject of a significant level of scrutiny by
various regulatory bodies, including State Attorneys General and
the departments of insurance for various states, with respect to
certain contingent commission arrangements between insurance
companies and brokers.
As previously reported, HUB Northeast, formerly known as Kaye
Insurance Associates, Inc., a subsidiary of Hub, received three
subpoenas from the Office of the Attorney General of the State
of New York seeking information regarding certain contingent
agreements and other business practices. Since August 2004,
various other subsidiaries of Hub have received and responded to
letters of inquiry and subpoenas from authorities in California,
Connecticut, Texas, Illinois, Delaware, Pennsylvania, New
Hampshire and Quebec. We retained external counsel to assist us
in responding to the New York Attorney General’s and other
inquiries and, among other things, requested that such external
counsel conduct an investigation of HUB Northeast and of our
other hubs to determine whether any current or former employee
engaged in the practice of falsifying or inflating insurance
quotes. Such investigation is substantially complete. To date,
management is unaware of any incidents of falsifying or
inflating insurance quotes. State Attorneys General and
insurance departments continue their investigations of various
industry practices. We continue to review our practices in light
of these investigations and resulting charges brought against
other brokers.
We continue to fully cooperate with the Attorney General and
department of insurance inquiries. While it is not possible to
predict the outcome of these investigations, if contingent
compensation agreements were to be restricted or no longer
permitted, our financial condition, results of operation and
liquidity may be materially adversely affected.
In October 2004, we were named as a defendant in a class action
lawsuit (the “Opticare case”) filed in Federal
District Court in New York against 30 different insurance
brokers and insurance companies. The lawsuit alleges that the
defendants used the contingent commission structure to deprive
policyholders of “independent and unbiased brokerage
services, as well as free and open competition in the market for
insurance.” In December, 2004, we were also named as one of
multiple defendants in two identical class actions filed in
Federal District Court in Illinois, with allegations
substantially similar to those in the Opticare case. In January
2005 we were named as one of several defendants in a third class
action filed in Federal District Court in Illinois, containing
allegations substantially similar to those in the Opticare case
and other Illinois federal class actions. None of the complaints
contain any specific factual allegations against us, but rather
generally assert that all of the broker defendants engaged in
the types of conduct of
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which the New York Attorney General charged the Marsh &
McLennan companies in his suit against them. On
February 17, 2005 the Federal Judicial Panel on
Multidistrict Litigation transferred the Opticare case as well
as three other class actions in which we are not named to the
District of New Jersey. We expect that the three class actions
filed in Federal District Court in Illinois will also be
transferred to New Jersey. We dispute the allegations made in
these lawsuits and intend to vigorously defend these cases.
In January, 2005 we and our affiliates were named as defendants
in a class action filed in the Circuit Court of Cook County,
Illinois. The named plaintiff is a Chicago law firm that
obtained its professional liability insurance through our HUB
International of Illinois Limited (“HUB Illinois”)
subsidiary and claims that an undisclosed contingent commission
was received with respect to its policy. We dispute the
allegations of this lawsuit and are vigorously defending this
case.
The cost of defending against the lawsuits, and diversion of
management’s attention, are significant and could have a
material adverse effect on our results of operations. In
addition, an adverse finding in a regulatory investigation or a
class action or similar lawsuit or a similar suit could result
in a significant judgment or imposition of liability against us
that could have a material adverse effect on our financial
condition, results of operation and liquidity.
In the normal course of business, we are involved in various
claims and legal proceedings relating to insurance placed by us
and other contractual matters. Our management does not believe
that any such pending or threatened proceedings will have a
material adverse effect on our consolidated financial position
or future results of operations.
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds
On April 14, 2005, we issued 1,731 common shares to former
shareholders of C.S. Nenner, Inc. as contingent consideration
for contingent obligations payable in connection with the
acquisition of that brokerage. On May 2, 2005, we issued
19,974 common shares to former shareholders of THB
Intermediaries, Inc. in connection with our acquisition of the
shares of that brokerage. On June 10, 2005, we issued
94,125 common shares to former owners of Bush, Cotton &
Scott, LLC as contingent consideration for contingent
obligations payable in connection with the acquisition of that
brokerage.
All of the shares issued in transactions described above were
issued in transactions exempt from registration pursuant to
section 4(2) of the Securities Act of 1933.
Item 4. Submission of Matters to a Vote of Security
Holders
The Annual and Special Meeting of Shareholders of Hub
International Limited (the “Meeting”) was held on
May 11, 2005. At the meeting, 21,581,436 common shares, or
70.6% of the 30,589,835 common shares outstanding on the record
date of the Meeting, were represented.
Election of Directors. The following ten nominees were
elected as directors of Hub for terms of one year expiring on
the date of Hub’s Annual Meeting of Shareholders to be held
in 2006, by a resolution passed by a majority of the votes cast
in person or by proxy at the Meeting.
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The results were as follows:
Approval of the 2005 Hub International Limited Equity
Incentive Plan. A resolution of shareholders was voted on to
approve the adoption of the 2005 Hub International Limited
Equity Incentive Plan (the “2005 Equity Incentive
Plan”) as previously approved by our Board of Directors.
To become effective, the approval of at least a majority of the
votes cast in person or proxy at the Meeting was required. The
requisite approval of shareholders was obtained at the Meeting
and the 2005 Equity Incentive Plan was approved and adopted. The
results of the vote were as follows: 12,971,010 common shares
were voted in favor of the approval, 7,337,334 common shares
voted against the approval, and 42,494 common shares withheld
their votes.
Appointment of Auditors. PricewaterhouseCoopers LLP was
appointed as our auditors to serve until our annual meeting of
Shareholders to be held in 2006, at a remuneration to be fixed
by our Board of Directors, with a favorable vote of 20,713,160
of the common shares represented at the Meeting and 404,816
common shares withholding their votes on the appointment.
Item 5. Other Information
Information Concerning Forward-Looking Statements
This Form 10-Q includes, and from time to time management
may make, forward-looking statements which reflect our current
views with respect to future events and financial performance.
These forward-looking statements relate, among other things, to
our plans and objectives for future operations. These
forward-looking statements are subject to uncertainties and
other factors that could cause actual results to differ
materially from such statements. These uncertainties and other
factors include, but are not limited to, risks associated with:
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The words “believe,” “anticipate,”
“project,” “expect,” “intend,”
“will likely result” or “will continue” and
similar expressions identify forward-looking statements. We
caution readers not to place undue reliance on these
forward-looking statements, which speak only as of their dates.
Except as otherwise required by federal securities laws, we
undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new
information, future events or otherwise.
Dividends
On April 26, 2005 the Board of Directors declared a
dividend of $0.06 on our common shares, payable June 30,
2005 for the second quarter 2005 to shareholders of record on
June 15, 2005.
Item 6. Exhibits
Exhibits
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
DATE: August 9, 2005
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