AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 22, 2002
REGISTRATION NO. 333-
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------------------
FORM S-1
REGISTRATION STATEMENT
UNDER THE
SECURITIES ACT OF 1933
------------------------------------
HUB INTERNATIONAL LIMITED
(Exact name of Registrant as specified in its Charter)
<Table>
ONTARIO, CANADA 6411 NOT APPLICABLE
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employee Identification
incorporation or organization) Classification Code Number) Number)
</Table>
------------------------------------
HUB INTERNATIONAL LIMITED
55 EAST JACKSON BOULEVARD
CHICAGO, ILLINOIS 60604
(877) 402-6601
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
------------------------------------
W. KIRK JAMES
VICE PRESIDENT AND GENERAL COUNSEL
HUB INTERNATIONAL LIMITED
55 EAST JACKSON BOULEVARD
CHICAGO, ILLINOIS 60604
(312) 279-4881
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
------------------------------------
COPIES TO:
<Table>
BRICE T. VORAN, ESQ. LUCIANA FATO, ESQ.
SHEARMAN & STERLING DAVIS POLK & WARDWELL
199 BAY STREET 450 LEXINGTON AVENUE
COMMERCE COURT WEST, SUITE 4405 NEW YORK, NY 10017
TORONTO, ONTARIO CANADA M5L 1E8 (212) 450-4000
(416) 360-8484
</Table>
------------------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, please check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, please check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act, please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM
TITLE OF EACH CLASS AGGREGATE AMOUNT OF
OF SECURITIES TO BE REGISTERED OFFERING PRICE(1) REGISTRATION FEE
- ------------------------------------------------------------------------------------------------------------------
Common Shares............................................... $75,000,000 $6,900
- ------------------------------------------------------------------------------------------------------------------
</Table>
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(o) under the Securities Act.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PART I
INFORMATION REQUIRED TO BE DELIVERED TO OFFEREES OR PURCHASERS
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES, AND WE ARE NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED MARCH 22, 2002
PROSPECTUS
SHARES
(HUB INTERNATIONAL LOGO)
COMMON SHARES
Hub International Limited is selling common shares. Our common
shares are listed on The Toronto Stock Exchange under the symbol HBG. On March
21, 2002, the closing sale price of our common shares as reported on the TSE was
C$19.00 per share. This is our initial public offering in the United States. We
anticipate that the initial public offering price will be between $ and
$ per share.
We intend to apply to list our common shares on the New York Stock Exchange
under the symbol HBG.
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------
PER SHARE TOTAL
- -------------------------------------------------------------------------------------------------------
Initial public offering price $ $
Underwriting commissions $ $
Proceeds to Hub, before expenses $ $
- -------------------------------------------------------------------------------------------------------
</Table>
We have granted the underwriters an option for a period of 30 days to purchase
up to additional common shares.
INVESTING IN OUR COMMON SHARES INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING ON PAGE 8.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
JPMORGAN
COCHRAN, CARONIA & CO.
STEPHENS INC.
BMO NESBITT BURNS
FERRIS, BAKER WATTS
Incorporated
, 2002
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
Exchange rate information................................... ii
Prospectus summary.......................................... 1
Risk factors................................................ 8
Forward-looking statements.................................. 18
Use of proceeds............................................. 19
Capitalization.............................................. 20
Dilution.................................................... 21
Market price of our common shares........................... 22
Dividend policy............................................. 22
Unaudited pro forma consolidated statement of earnings...... 23
Selected historical consolidated financial data............. 25
Management's discussion and analysis of financial condition
and results of operations................................. 28
Industry.................................................... 44
Business.................................................... 47
Management.................................................. 56
Certain relationships and related party transactions........ 64
Principal shareholders...................................... 67
Description of share capital................................ 69
Shares eligible for future sale............................. 70
Certain United States and Canadian federal income tax
considerations............................................ 72
Underwriting................................................ 78
Legal matters............................................... 81
Experts..................................................... 81
Where you can find more information......................... 81
Index to consolidated financial statements.................. F-1
</Table>
------------------------------------
NO SECURITIES COMMISSION OR SIMILAR AUTHORITY IN CANADA HAS IN ANY WAY PASSED
UPON THE MERITS OF THE COMMON SHARES OFFERED BY THIS PROSPECTUS AND ANY
REPRESENTATION TO THE CONTRARY IS AN OFFENCE. THE COMMON SHARES OFFERED BY THIS
PROSPECTUS HAVE NOT BEEN AND WILL NOT BE QUALIFIED FOR SALE UNDER THE SECURITIES
LAWS OF CANADA OR ANY PROVINCE OR TERRITORY OF CANADA AND ARE NOT BEING OFFERED
FOR SALE IN CANADA OR TO ANY RESIDENT OF CANADA AND MAY NOT BE OFFERED OR SOLD,
DIRECTLY OR INDIRECTLY, IN CANADA, OR TO OR FOR THE ACCOUNT OF ANY RESIDENT OF
CANADA.
i
EXCHANGE RATE INFORMATION
We publish our consolidated financial statements in U.S. dollars. All references
in this prospectus to "dollars" or "$" are to U.S. dollars and all references to
"C$" are to Canadian dollars, unless otherwise noted. The following table
presents, in U.S. dollars, the exchange rates for the Canadian dollar,
determined based on the inverse of the noon buying rate in New York City for
cable transfers in U.S. dollars as certified for customs purposes by the Federal
Reserve Bank of New York (the "noon buying rate") for the periods indicated.
<Table>
<Caption>
- -----------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2001 2000 1999 1998 1997
- -----------------------------------------------------------------------------------
High........................ $0.6697 $0.6969 $0.6925 $0.7105 $0.7487
Low......................... 0.6241 0.6410 0.6535 0.6341 0.6945
End of period............... 0.6279 0.6669 0.6925 0.6504 0.6999
Average..................... 0.6444 0.6724 0.6744 0.6714 0.7197
- -----------------------------------------------------------------------------------
</Table>
The average exchange rate is calculated on the last business day of each month
for the applicable period. On March 21, 2002, the noon buying rate was C$1.00 =
$0.6326.
------------------------------------
Unless the context requires otherwise, "Hub," "we," "our" and "us" refer to Hub
International Limited and our consolidated subsidiaries.
Except as otherwise indicated, all financial statements and financial data
contained in this prospectus and in the documents incorporated by reference in
this prospectus have been prepared in accordance with generally accepted
accounting principles in Canada, or Canadian GAAP, which differs in certain
significant respects from generally accepted accounting principles in the United
States of America, or U.S. GAAP. Please see note 17 to our consolidated
financial statements for a description of the material differences between
Canadian GAAP and U.S. GAAP.
ii
PROSPECTUS SUMMARY
This summary highlights selected information contained elsewhere in this
prospectus. This summary does not contain all of the information you should
consider before investing in our common shares. You should read the entire
prospectus carefully, including "Risk factors" beginning on page 8, our
consolidated financial statements and the accompanying notes, as well as our
unaudited pro forma consolidated statement of earnings and the accompanying
notes, included elsewhere in this prospectus, before making an investment
decision.
Unless otherwise indicated, all dollar amounts are expressed in, and the term
"dollars" and the symbol "$" refer to, U.S. dollars. The term "Canadian dollars"
and the symbol "C$" refer to Canadian dollars.
HUB INTERNATIONAL LIMITED
We are a leading North American insurance brokerage providing a broad array of
property and casualty, life and health, employee benefits, investment and risk
management products and services. We focus primarily on middle-market commercial
accounts in the United States and Canada, which we serve through our
approximately 1,900 employees in 130 locations, using a variety of retail and
wholesale distribution channels. We define the middle-market as those clients
that generate annual commissions and fees ranging from $2,500 to $250,000. We
generate commissions and other revenue from placing insurance. Since our company
was formed in 1998 through the merger of 11 Canadian insurance brokerages, we
have acquired an additional 78 brokerages and have established a strong presence
in the northeastern and midwestern United States and in the Canadian provinces
of Ontario, Quebec and British Columbia. Through a combination of organic growth
and acquiring quality brokerages with proven track records, we have grown our
revenue from $38.7 million in 1998 to $154.0 million in 2001, representing a
compound annual growth rate of 58%. In addition, our EBITDA has increased from
$6.2 million in 1998 to $30.7 million in 2001, representing a compound annual
growth rate of 70%.
We operate through an organizational structure comprised of our head office,
larger regional brokerages that we call "hub" brokerages and smaller brokerages
that we call "fold-ins." We have nine hub brokerages, four operating in the
United States and five in Canada. Each hub brokerage has a significant market
presence in a geographic region in the United States or Canada. A hub brokerage
is responsible not only for the development of its own business, but also the
identification of fold-ins that can be acquired by and integrated into the
operations of the hub brokerage. This process allows each hub brokerage an
opportunity to strengthen its regional market presence by acquiring new or
complementary products and services and management talent, while improving
profit margins through the reduction or elimination of redundant administrative
functions, premises and systems. Our structure enables our hub brokerages to
more effectively and quickly meet the changing needs of our clients in various
markets, while benefiting from the operating efficiencies and leverage of a
large brokerage.
We offer commercial and specialized insurance products and services to
businesses, personal insurance products and services to individuals and program
products to affinity groups and associations. We offer three categories of
commercial products and services:
1
property and casualty products, employee benefits and risk management services.
We offer two categories of personal products and services: property and casualty
products and life, health and financial products and services. Our program
products involve the development, in collaboration with insurance companies, of
baskets of insurance products for members of affinity groups or associations,
such as bar associations, medical associations and other professional groups.
Our specialized risk products cover diverse exposures such as environmental,
professional liability and directors' and officers' liability. We utilize
retail, wholesale and call-center distribution channels, and have the ability to
employ these distribution channels for specific market segments.
Our primary goals are to further develop our position as a leading North
American middle-market insurance broker and to generate significant sustained
shareholder value. We plan to achieve these objectives by executing the
following strategies:
FOCUS ON MIDDLE-MARKET COMMERCIAL ACCOUNTS. We focus our sales efforts on
middle-market companies because we believe the insurance needs of these
companies are underserved and that middle-market commercial accounts generally
generate higher profit margins than personal accounts and provide us with
greater cross-selling opportunities.
GROW ORGANICALLY. We intend to increase profitability per customer and attract
new customers by leveraging our existing infrastructure to sell a broad range of
products and services through multiple distribution channels, target profitable
client segments and maximize cross-selling opportunities.
GROW THROUGH SELECTED ACQUISITIONS. We acquire brokerages to grow our revenue,
complement and supplement our existing products and services and add experienced
management.
STANDARDIZE PROCEDURES TO INCREASE OPERATING EFFICIENCY AND REDUCE COSTS. We
strive to implement the best operating and sales practices of our brokerages
across our company to increase operating efficiencies and reduce costs by
eliminating administrative redundancies.
RECRUIT, TRAIN AND RETAIN QUALIFIED PERSONNEL. We are formalizing our recruiting
and training program to continue to build and sustain a sales and service team
with a wide variety of experience and capabilities.
We believe the following competitive advantages will enable us to achieve our
objectives:
DECENTRALIZED HUB APPROACH. Our decentralized hub approach allows us to react to
regional market conditions while still centrally managing the growth and
profitability of our business with consistent standards.
BROAD ARRAY OF PRODUCTS AND SERVICES OFFERED THROUGH MULTIPLE DISTRIBUTION
CHANNELS. We offer a broad array of products and services through a variety of
distribution channels, which allows us to maintain and maximize existing client
relationships and attract new clients.
BENEFITS OF SCALE. Our scale, relative to smaller brokerages, provides insurers
with greater incentives to work with us, which enables us to generate increased
volume overrides and contingent commissions, based on the volume and
profitability of the business we place, favorable commission rates, exclusive
distribution rights for certain
2
territories and products, and, in some cases, have expanded authority to price
and approve insurance policies on behalf of insurance companies. We believe our
scale also makes us attractive to smaller brokerages as a potential acquiror.
COMMITTED AND EXPERIENCED MANAGEMENT. Most of the senior managers of our
brokerages have over 20 years of experience in the industry and also have
significant shareholdings in our company, typically with transfer restrictions
for up to ten years.
Our executive office is located at 55 East Jackson Boulevard, Chicago, Illinois
60604, and our telephone number is (877) 402-6601. Our web site is located at
www.hubinternational.com. Information contained on our website is not part of
this prospectus.
3
THE OFFERING
Common shares offered by us: shares
Common shares to be outstanding after this offering: shares
USE OF PROCEEDS
We estimate that the net proceeds from this offering will be approximately
$ million. We intend to use approximately $47 million of the net proceeds
from this offering to repay existing indebtedness and the balance for working
capital and other general corporate purposes, which may include acquisitions.
See "Use of proceeds" on page 19 for more information regarding our use of the
proceeds from this offering.
DIVIDEND POLICY
We have paid a dividend of C$0.07 per common share for each quarter commencing
June 30, 2000. We have no formal dividend policy other than the board of
directors considers the payment of dividends as quarterly financial information
becomes available. In the future, dividends will be paid at the discretion of
our board of directors depending on our financial position and capital
requirements, general business conditions, contractual restrictions and other
factors.
Proposed New York Stock Exchange symbol: HBG
Toronto Stock Exchange symbol: HBG
------------------------
The share information above is based on shares outstanding as of ,
2002.
------------------------
Unless otherwise noted, the information in this prospectus assumes that the
underwriters' over-allotment option will not be exercised.
4
SUMMARY CONSOLIDATED FINANCIAL DATA
Our summary consolidated financial data has been derived from our historical
consolidated financial statements as of and for the three years ended December
31, 2001 which are included elsewhere in this prospectus.
Our historical consolidated financial statements are prepared in accordance with
Canadian GAAP, which differs in certain significant respects from U.S. GAAP. For
a discussion of the principal differences between Canadian GAAP and U.S. GAAP
see note 17 to our historical consolidated financial statements beginning on
page F-1. Historical results of operations are not necessarily indicative of
future results.
It is important that you read this information together with "Management's
discussion and analysis of financial condition and results of operations"
beginning on page 28 and our consolidated financial statements and the
accompanying notes, included elsewhere in this prospectus. You should also read
our "Unaudited pro forma consolidated statement of earnings" for the year ended
December 31, 2001 and the accompanying notes, beginning on page 23 of this
prospectus. Our unaudited pro forma consolidated statement of earnings gives
effect to our June 28, 2001 acquisition of Kaye Group Inc. as if it had occurred
on January 1, 2001.
5
<Table>
<Caption>
- -----------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)(1) 2001 2000 1999
- -----------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF EARNINGS DATA:
Revenue:
Commission income............................ $142,851 $ 86,410 $ 47,964
Contingent commissions and
volume overrides.......................... 5,946 4,909 2,824
Other........................................ 5,196 3,921 3,309
--------------------------------
153,993 95,240 54,097
--------------------------------
Expenses:
Remuneration................................. 88,015 54,701 29,519
Selling...................................... 8,359 4,840 3,036
Occupancy.................................... 9,061 5,756 3,393
Depreciation................................. 3,940 1,885 1,275
Administration............................... 17,856 11,182 6,806
--------------------------------
127,231 78,364 44,029
--------------------------------
Net earnings before the following.............. 26,762 16,876 10,068
Interest expense............................. 7,447 1,981 632
Goodwill and other
intangible asset amortization............. 4,940 3,260 1,626
(Gain) loss on disposal of capital assets and
investments............................... (173) 127 14
Other income -- put option liability......... (719) -- --
--------------------------------
Net earnings before income taxes............... 15,267 11,508 7,796
Provision for income tax
expense...................................... 5,262 5,370 4,052
--------------------------------
Net earnings................................... $ 10,005 $ 6,138 $ 3,744
--------------------------------
Net earnings per share:
Basic........................................ $ 0.53 $ 0.34 $ 0.22
Diluted...................................... $ 0.50 $ 0.34 $ 0.22
Weighted average shares:
Basic........................................ 19,012 18,327 16,941
Diluted...................................... 20,105 18,327 16,941
Dividends per share(2)......................... $ 0.18 $ 0.13 --
Reconciliation to U.S. GAAP:
Net earnings................................. $ 10,005 $ 6,138 $ 3,744
Adjustment to investment
held for sale(3)........................ 520 -- --
Change in reporting currency(4)........... 158 366 233
--------------------------------
Net earnings (U.S. GAAP)..................... $ 10,683 $ 6,504 $ 3,977
- -----------------------------------------------------------------------------------
</Table>
(1) Effective September 30, 2001, we adopted the U.S. dollar as our reporting
currency. Our financial results for all periods prior to October 1, 2001 have
been restated from Canadian dollars to U.S. dollars using the exchange rate in
effect at September 30, 2001 of C$1.00 = $0.6338.
(2) We commenced payment of dividends in the second quarter of 2000.
(3) As part of our acquisition of Kaye, we acquired Old Lyme Insurance Company
of Rhode Island, Inc. and Old Lyme Insurance Company, Ltd., which we refer to
collectively as Old Lyme, and which we have agreed to sell to a subsidiary of
Fairfax Financial Holdings Limited. See "Certain relationships and related party
transactions." Under U.S. GAAP, interest expense on debt we incurred to finance
the purchase of Old Lyme is not charged to earnings. See note 17 to our
consolidated financial statements for more information.
(4) Under U.S. GAAP, financial statements are translated using the average
exchange rate for the period. See note 17 to our consolidated financial
statements for more information.
6
<Table>
<Caption>
- ------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PERCENTAGES)(1) 2001 2000 1999
- ------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET DATA (AT PERIOD END):
Cash and cash equivalents(2)................. $ 26,979 $ 19,919 $ 21,368
Total assets................................. $ 502,296 $ 206,157 $ 171,202
Total debt(3)................................ $ 196,952 $ 34,665 $ 20,562
Total shareholders' equity................... $ 135,271 $ 112,212 $ 105,562
OTHER FINANCIAL DATA:
EBITDA(4).................................... $ 30,702 $ 18,761 $ 11,343
EBITDA margin(5)............................. 19.9% 19.6% 20.9%
Net cash flow provided by operating
activities................................. $ 46,912 $ 12,807 $ 5,103
Net cash flow provided by financing
activities................................. $ 132,431 $ 5,613 $ 58,494
Net cash flow (used in) investing
activities................................. $(134,213) $ (17,983) $ (34,655)
- ------------------------------------------------------------------------------------
</Table>
(1) Effective September 30, 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 = $0.6338.
(2) Excludes trust cash, which includes premiums collected (less commissions and
other deductions) not yet remitted to insurance companies.
(3) Long-term debt and capital leases (including current portion), bank debt and
subordinated convertible notes.
(4) EBITDA is defined as earnings before interest, income taxes, depreciation
and goodwill and other intangible asset amortization, but excluding gains or
losses from the sale of capital assets and investments and other income -- put
option liability. EBITDA is not a measure of financial performance under either
U.S. or Canadian GAAP, and should not be considered in isolation or as a
substitute for net income, cash flows from operating activities or other income
or cash flow statement data prepared in accordance with generally accepted
accounting principles as a measure of profitability or liquidity. We believe the
presentation of EBITDA is relevant because EBITDA is a measurement that industry
analysts use when evaluating our operating performance. Investors should be
aware that our presentation of EBITDA may not be comparable with similarly
titled measures presented by other companies.
(5) EBITDA margin represents EBITDA as a percentage of total revenue. EBITDA
margin is presented because we believe that it is a useful indicator to
investors of our profitability. EBITDA margin should not be considered by
investors as an alternative to operating margin as an indicator of our
profitability. Investors should be aware that our presentation of EBITDA margin
may not be comparable with similarly titled measures presented by other
companies.
7
RISK FACTORS
You should carefully consider the risks described below and all other
information contained in this prospectus before making an investment decision.
If any of the following risks, as well as additional risks and uncertainties
that are not yet known to us or that we currently think are immaterial, actually
occur, our business, financial condition and results of operations could be
materially adversely affected. In that event, the trading price of our shares
could decline, and you may lose part or all of your investment.
RISKS RELATED TO OUR BUSINESS
WE MAY BE UNSUCCESSFUL IN IDENTIFYING AND ACQUIRING SUITABLE ACQUISITION
CANDIDATES, WHICH COULD IMPEDE OUR GROWTH AND ABILITY TO REMAIN COMPETITIVE IN
OUR INDUSTRY.
Our strategic plan includes the regular and systematic evaluation and
acquisition of insurance brokerages in new and existing markets. There can be no
assurance, however, that we will successfully identify suitable acquisition
candidates. We are unable to predict whether or when any prospective acquisition
candidate will become available or the likelihood that any acquisition will be
completed once negotiations have commenced. We compete for acquisition and
expansion opportunities with entities that have substantially greater resources
than we do and these entities may be able to outbid us for these acquisition
targets. If we fail to execute our acquisition strategy, our revenue growth is
likely to suffer and we may be unable to remain competitive.
OUR CONTINUED GROWTH IS PARTLY BASED ON OUR ABILITY TO ACQUIRE ADDITIONAL
BROKERAGES AND OUR FAILURE TO INTEGRATE THESE BROKERAGES SUCCESSFULLY MAY HAVE
AN ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS.
A significant element of our strategy is to acquire additional insurance
brokerages. We cannot assure you that we will successfully integrate brokerages
we may acquire in the future. The integration of an acquisition involves a
number of factors that may affect our operations. These factors include:
- - diversion of management's attention;
- - difficulties in the integration of acquired operations and retention of
personnel;
- - entry into unfamiliar markets;
- - unanticipated problems or legal liabilities; and
- - tax and accounting issues.
A failure to integrate acquired brokerages may be disruptive to our operations
and negatively impact our revenue or increase our expenses.
INSURANCE BROKERAGES THAT WE HAVE ACQUIRED MAY HAVE LIABILITIES THAT WE ARE NOT
AWARE OF AND MAY NOT BE AS PROFITABLE AS WE EXPECT THEM TO BE.
Since our formation in November 1998 through the merger of 11 insurance
brokerages, we have acquired an additional 78 brokerages. Although we conduct
due diligence in respect of the business and operations of each of the
brokerages we acquire, we cannot assure you that we have identified all material
facts concerning these
8
brokerages. Unanticipated events or liabilities relating to these companies
could have a material adverse effect on our results of operations and financial
condition. Furthermore, once we have integrated an acquired brokerage, it may
not achieve levels of revenue, profitability, or productivity comparable to our
existing locations, or otherwise perform as expected. Our failure to integrate
one or more acquired brokerages so that they achieve our performance goals may
have a material adverse effect on our results of operations and financial
condition.
IF WE FAIL TO OBTAIN ADDITIONAL FINANCING FOR ACQUISITIONS, WE MAY BE UNABLE TO
EXPAND OUR BUSINESS.
Our acquisition strategy may require us to seek additional financing. If we are
unable to obtain sufficient financing on satisfactory terms and conditions, we
may not be able to maintain or increase our market share or expand our business
through acquisitions. Our ability to obtain additional financing will depend
upon a number of factors, many of which are beyond our control. For example, we
may not be able to obtain additional satisfactory financing because we already
have debt outstanding and because we may not have sufficient cash flow to
service or repay our existing or additional debt.
WE CANNOT ACCURATELY FORECAST OUR COMMISSION REVENUE BECAUSE OUR COMMISSIONS
DEPEND ON PREMIUM RATES CHARGED BY INSURANCE COMPANIES, WHICH HISTORICALLY HAVE
VARIED AND ARE DIFFICULT TO PREDICT. ANY DECLINES IN PREMIUMS MAY ADVERSELY
IMPACT OUR PROFITABILITY.
In 2001, we derived approximately 93% of our revenue from commissions paid by
insurance companies on the sale of their insurance products to our clients. Our
revenue from commissions fluctuates with premiums charged by insurers, as
commissions typically are determined as a percentage of premiums. When premiums
decline, we experience downward pressure on our revenue and earnings.
Historically, property and casualty premiums have been cyclical in nature and
have varied widely based on market conditions. Significant reductions in premium
rates occurred during the years 1988 through 2000 as a result of expanded
underwriting capacity of property and casualty insurance companies and increased
competition. In some cases, property and casualty insurance companies lowered
commission rates. Because we cannot determine the timing and extent of premium
pricing changes, we cannot accurately forecast our commission revenue, including
whether it will significantly decline. If premiums decline or commission rates
are reduced, our revenue, earnings and cash flow could decline. In addition, our
budgets for future acquisitions, capital expenditures, dividend payments, loan
repayments and other expenditures may have to be adjusted to account for
unexpected changes in revenue.
INSURANCE COMPANY CONTINGENT COMMISSIONS AND VOLUME OVERRIDES ARE LESS
PREDICTABLE THAN NORMAL COMMISSIONS, WHICH IMPAIRS OUR ABILITY TO FORECAST THE
AMOUNT OF SUCH REVENUE THAT WE WILL RECEIVE AND MAY NEGATIVELY IMPACT OUR
OPERATING RESULTS.
We derive a portion of our revenue from contingent commissions and volume
overrides. The aggregate of these sources of revenue generally has accounted for
4% to 5% of our total revenue. Contingent commissions may be paid by an
insurance company based on the profit it makes on the overall volume of business
that we place with it. We generally receive these commissions in the first and
second quarters of each year. Volume overrides are paid by an insurance company
based on the volume of
9
business that we place with it and are generally paid over the course of the
year. As a result of recent developments in the property and casualty insurance
industry, including changes in underwriting criteria due in part to the higher
numbers and dollar value of claims as compared to the premiums collected by
insurance companies, we cannot predict the payment of these performance-based
revenues as accurately as we have been able to in the past. Further, we have no
control over the process by which insurance companies estimate their own loss
reserves, which affects our ability to forecast contingent commissions. Because
these contingent commissions affect our revenue, any decrease in their payment
to us could adversely affect our results of operations.
PROPOSED TORT REFORM LEGISLATION IN THE UNITED STATES, IF ENACTED, COULD
DECREASE DEMAND FOR LIABILITY INSURANCE, THEREBY REDUCING OUR COMMISSION
REVENUE.
Legislation concerning tort reform is currently being considered in the United
States Congress and in several states. Among the provisions being considered for
inclusion in such legislation are limitations on damage awards, including
punitive damages, and various restrictions applicable to class action lawsuits,
including lawsuits asserting professional liability of the kind for which
insurance is offered under certain policies we sell. Enactment of these or
similar provisions by Congress, or by states or countries in which we sell
insurance, could result in a reduction in the demand for liability insurance
policies or a decrease in policy limits of such policies sold, thereby reducing
our commission revenue.
WE HAVE ENTERED INTO PUT OPTION ARRANGEMENTS WITH FORMER SHAREHOLDERS OF OUR
ACQUIRED BROKERAGES, J.P. FLANAGAN CORPORATION AND BURNHAM INSURANCE GROUP,
INC., WHICH MAY REQUIRE US TO PAY SUBSTANTIAL AMOUNTS TO REPURCHASE OUR COMMON
SHARES FROM THESE SHAREHOLDERS. THOSE PAYMENTS WOULD REDUCE OUR CASH FLOW AND
THE FUNDS AVAILABLE TO GROW OUR BUSINESS.
In connection with our acquisitions of Flanagan and Burnham, we entered into put
option arrangements with the former shareholders of those companies whereby we
gave them the right to require us to repurchase their shares of Hub that were
issued in consideration of the acquisitions. The rights under the put
arrangements may be exercised between 2006 and 2011, and if exercised, we could
be required to buy back our common shares at C$17.00 per share at specific
exercise dates set out under the heading "Certain relationships and related
party transactions -- Put options." We may not have sufficient cash on hand on
the exercise dates to satisfy our obligations under these put arrangements and
as a consequence we may have to obtain additional financing. However, we may not
be able to incur additional debt at such time. Our inability to satisfy our
obligations under the put options may adversely affect our relationship with the
management team at Flanagan and Burnham and may result in the loss of key
management personnel from these subsidiaries and, in turn, the loss of
customers, which would adversely affect our business and financial condition. In
addition, our failure to satisfy our obligations under the put options may cause
us to breach our agreements with those shareholders.
10
A SUBSTANTIAL PORTION OF OUR TOTAL ASSETS ARE REPRESENTED BY GOODWILL AS A
RESULT OF OUR ACQUISITIONS AND UNDER NEW ACCOUNTING STANDARDS, WE MAY BE
REQUIRED TO WRITE DOWN THE VALUE OF OUR GOODWILL.
When we acquire a brokerage, virtually the entire purchase price for the
acquisition is allocated to goodwill and other identifiable intangible assets.
The amount of purchase price allocated to goodwill is determined by the excess
of the purchase price over the net identifiable assets paid by us to acquire the
brokerage.
On July 1, 2001, we adopted the Canadian Institute of Chartered Accountants
(CICA) Accounting Standards Board Handbook Section 1581, "Business
Combinations". These new rules require that all business combinations after June
30, 2001 be accounted for in accordance with the purchase method of accounting
and expand the definition of other identifiable intangible assets acquired in a
business combination using the purchase method.
On January 1, 2002, we adopted CICA's Section 3062, "Goodwill and Other
Intangible Assets". For all business combinations accounted for using the
purchase method prior to June 30, 2001, Section 3062 eliminates the amortization
of goodwill, requires annual impairment testing of goodwill and introduces the
concept of definite life and indefinite life intangible assets. Indefinite life
intangible assets, similar to goodwill, will no longer be amortized and will be
tested at least annually for impairment. We can give no assurance that the
carrying value of our goodwill and other indefinite life intangible assets will
not be affected by this new accounting standard.
THE LOSS OF MEMBERS OF OUR SENIOR MANAGEMENT OR A SIGNIFICANT NUMBER OF OUR
BROKERS COULD NEGATIVELY AFFECT OUR FINANCIAL PLANS, MARKETING AND OTHER
OBJECTIVES.
The loss of or failure to attract key personnel could significantly impede our
financial plans, growth, marketing and other objectives. Our success depends to
a substantial extent not only on the ability and experience of our senior
management but also on the individual brokers and teams that service our clients
and maintain client relationships. Our operations are not generally dependent on
any one individual; however, the loss of Martin Hughes, our Chairman and Chief
Executive Officer, or Bruce Guthart, our President, U.S. Operations, could
negatively impact our acquisition strategy in the United States due to their
significant relationships and expertise in the insurance industry.
The insurance brokerage industry has in the past experienced intense competition
for the services of leading individual brokers and brokerage teams. We believe
that our future success will depend in large part on our ability to attract and
retain additional highly skilled and qualified personnel and to expand, train
and manage our employee base. We may not be successful in doing so because the
competition for qualified personnel in our industry is intense. If we fail to
recruit and retain top producers, our organic growth may be adversely affected.
COMPETITION IN OUR INDUSTRY IS INTENSE, AND IF WE ARE UNABLE TO COMPETE
EFFECTIVELY, WE MAY LOSE MARKET SHARE AND OUR BUSINESS MAY BE MATERIALLY
ADVERSELY AFFECTED.
The insurance brokerage business is highly competitive and we actively compete
with other insurance brokerages for customers and insurance company markets,
many of which have existing relationships with insurance companies or have a
significant
11
presence in niche insurance markets that may give them an advantage over us.
Because relationships between insurance brokers and insurance companies or
clients are often local or regional in nature, this potential competitive
disadvantage is particularly pronounced. See "Business--Competition" for a
further discussion of the level of competition in our industry.
We face competition in all markets in which we operate, based on product
breadth, innovation, quality of service and price. We compete with a number of
brokerages, such as Arthur J. Gallagher & Co., Hilb, Rogal and Hamilton Company
and Brown & Brown, Inc. in the United States, who may have greater resources
than we do, as well as with numerous Internet-based, specialist and regional
firms in the United States and Canada. If we are unable to compete effectively
against our competitors, we will suffer a loss of market share, decreased
revenue and reduced operating margins.
In addition, regulatory changes in the financial services industry in the United
States and Canada have permitted banks, securities firms and insurance companies
to affiliate, causing rapid consolidation in the insurance industry. Some
insurance companies are engaged in the direct sale of insurance, primarily to
individuals, and do not pay commissions to agents and brokers on policies they
sell directly. Increasing competition from insurance companies and from within
the financial services industry, generally, could have a negative effect on our
operations.
WE DO BUSINESS WITH CERTAIN SUBSIDIARIES OF OUR LARGEST SHAREHOLDER AND IF A
CONFLICT OF INTEREST WERE TO ARISE IT MAY NOT BE RESOLVED IN OUR FAVOR AND COULD
ADVERSELY AFFECT OUR REVENUE.
Fairfax Financial Holdings Limited owns 37% of our common shares. We do business
with certain subsidiaries of Fairfax which represented approximately 4.9% of our
revenue in 2001. We expect that this percentage will increase as a result of our
sale of Old Lyme to Fairfax, as we will continue to do a significant amount of
business with Old Lyme as described under "Certain relationships and related
party transactions." If a conflict of interest were to arise between us and
Fairfax or one of its subsidiaries, we cannot assure you that this conflict
would be resolved in a manner that would favor us. In addition, if Fairfax were
to sell our common shares that it owns, it may no longer be as interested in
providing us with financial assistance or continuing to do business with us
which could have a material adverse effect on our financial condition.
WE DEPEND ON OUR INFORMATION PROCESSING SYSTEMS. INTERRUPTION OR LOSS OF OUR
INFORMATION PROCESSING SYSTEMS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR
BUSINESS.
Our ability to provide administrative services depends on our capacity to store,
retrieve, process and manage significant databases and expand and upgrade
periodically our information processing capabilities. Interruption or loss of
our information processing capabilities through loss of stored data, breakdown
or malfunctioning of computer equipment and software systems, telecommunications
failure, or damage caused by fire, tornadoes, lightning, electrical power outage
or other disruption could have a material adverse effect on our business,
financial condition and results of operations. Although we have disaster
recovery procedures in place for all our hub brokerages and insurance to protect
against such contingencies, we cannot assure you that such procedures will be
effective or that such insurance or recovery procedures will continue to be
available
12
at reasonable prices, address all such losses or compensate us for the possible
loss of clients occurring during any period that we are unable to provide
services.
PRIVACY LEGISLATION MAY IMPEDE OUR ABILITY TO UTILIZE OUR CUSTOMER DATABASE AS A
MEANS TO GENERATE NEW SALES.
We intend to utilize our extensive customer databases for marketing and sales
purposes, which we believe will enhance our ability to meet our organic growth
targets. However, new privacy legislation, such as the Gramm-Leach-Bliley Act
and the Health Insurance Portability and Accountability Act of 1996 in the
United States and the Personal Information Protection and Electronic Documents
Act in Canada, as well as other regulatory changes, may restrict our ability to
utilize personal information that we have collected in our normal course of
operations to generate new sales. If we become subject to new restrictions, or
other regulatory restrictions which we are not aware of, our ability to grow our
business may be adversely affected.
THE SECURITY OF THE DATABASES THAT CONTAIN OUR CUSTOMERS' PERSONAL INFORMATION
MAY BE BREACHED WHICH COULD SUBJECT US TO LITIGATION OR ADVERSE PUBLICITY.
Our technology may fail to adequately secure personal information we maintain in
our databases and protect it from inadvertent leakage or theft. In such
circumstances, we may be held liable to our customers, which could result in
litigation or adverse publicity that could have a material adverse effect on our
business.
OUR CORPORATE STRUCTURE AND STRATEGY OF OPERATING THROUGH DECENTRALIZED
BROKERAGES MAY MAKE IT MORE DIFFICULT FOR US TO BECOME AWARE OF AND RESPOND TO
ADVERSE OPERATING OR FINANCIAL DEVELOPMENTS AT OUR BROKERAGES.
We depend on timely and accurate reporting of business conditions and financial
results from our brokerages to affect our business plan and determine and report
our operating results. We receive end of month reports from each of our
brokerages regarding their financial condition and operating results. If an
adverse business or financial development occurs at one or more of our
brokerages near the beginning of a month, we may not become aware of the
occurrence for several weeks which could make it more difficult for us to
effectively respond to that development. In addition, if one of our brokerages
were to report inaccurate financial information, we might not learn of these
inaccuracies for several weeks, if at all, which could adversely affect our
ability to determine and report our financial results. We are investigating the
purchase of enterprise reporting software that would enable us to extract
financial and operating data from our brokerages electronically and on a real
time basis. We anticipate that such a system will be implemented in 2003.
However, we cannot assure you that it can be implemented within this time frame
or whether it will be effective.
OUR BUSINESS, RESULTS OF OPERATIONS, FINANCIAL CONDITION OR LIQUIDITY MAY BE
MATERIALLY ADVERSELY AFFECTED BY ERRORS AND OMISSIONS.
We have extensive operations and are subject to claims and litigation in the
ordinary course of business resulting from alleged errors and omissions. Errors
and omissions claims can involve significant defense costs and may result in
large damage awards against us. Errors and omissions could include, for example,
our employees or sub-agents failing, whether negligently or intentionally, to
place coverage or to notify
13
insurance companies of claims on behalf of clients, to provide insurance
companies with complete and accurate information relating to the risks being
insured or to appropriately apply funds that we hold for our clients on a
fiduciary basis. It is not always possible to prevent and detect errors and
omissions and the precautions we take may not be effective in all cases.
Our results of operations, financial condition or liquidity may be adversely
affected if in the future our insurance coverage proves to be inadequate or
unavailable or there is an increase in liabilities for which we self-insure. In
addition, errors and omissions claims may harm our reputation or divert
management resources away from operating our business.
IF WE FAIL TO COMPLY WITH REGULATORY REQUIREMENTS FOR INSURANCE BROKERAGES, WE
MAY NOT BE ABLE TO CONDUCT OUR BUSINESS.
Our business is subject to legal requirements and governmental regulatory
supervision in the jurisdictions in which we operate. These requirements are
designed to protect our clients by establishing minimum standards of conduct and
practice, particularly regarding the provision of advice and product information
as well as financial criteria.
Our activities in the United States and Canada are subject to regulation and
supervision by state and provincial authorities. Although the scope of
regulation and form of supervision by state and provincial authorities may vary
from jurisdiction to jurisdiction, insurance laws in the United States and
Canada are often complex and generally grant broad discretion to supervisory
authorities in adopting regulations and supervising regulated activities. This
supervision generally includes the licensing of insurance brokers and agents and
the regulation of the handling and investment of client funds held in a
fiduciary capacity. Our ability to conduct our business in the jurisdictions in
which we currently operate depends on our compliance with the rules and
regulations promulgated from time to time by the regulatory authorities in each
of these jurisdictions.
Our clients have the right to file complaints with the regulators about our
services, and the regulators may investigate or require us to address these
complaints. Our failure to satisfy the regulators that we are in compliance with
their requirements or the legal requirements governing our activities can result
in disciplinary action, fines, reputational damage and financial harm.
In addition, changes in legislation or regulations and actions by regulators,
including changes in administration and enforcement policies, could from time to
time require operational improvements or modifications at various locations
which could result in higher costs or hinder our ability to operate our
business. See "Business--Government regulation."
OUR SIGNIFICANT CANADIAN OPERATIONS EXPOSE US TO EXCHANGE RATE FLUCTUATIONS, AND
OUR NET INCOME MAY SUFFER IF THE CANADIAN DOLLAR DECLINES IN VALUE.
We report our results in U.S. dollars. However, our Canadian Operations, which
accounted for 51% of our revenue in 2001, earn revenue and incur expenses in
Canadian dollars. The Canadian dollar has suffered a decline in value compared
to the U.S. dollar in recent years. For example, at December 31, 1999, C$1.00
was equivalent to $0.6925, at December 31, 2001, C$1.00 was equivalent to only
$0.6279, a decline of
14
more than 9%. A decline in the value of the Canadian dollar compared to the U.S.
dollar would reduce our reported revenue, which could have a material adverse
effect on our business, financial condition, cash flow and results of
operations.
RISKS RELATED TO OUR COMMON SHARES
OUR COMMON SHARES HAVE NO PRIOR TRADING HISTORY IN THE UNITED STATES AND AN
ACTIVE TRADING MARKET MAY NOT DEVELOP.
We are a reporting issuer in Ontario, Canada under the Securities Act (Ontario)
and in the other provinces and territories of Canada under similar legislation.
Our common shares are currently listed on the TSE but are not listed on any U.S.
stock exchange or quoted on any U.S. quotation system. Accordingly, prior to
this offering, there has been no public market for our common shares in the
United States and we cannot assure you that an active trading market will
develop or be sustained in the United States after this offering. Furthermore,
there can be no assurance that an active trading market will be sustained in
Canada. The public offering price negotiated among us and the underwriters may
not be indicative of prices that will prevail in any trading market.
THE PRICE OF OUR COMMON SHARES MAY FLUCTUATE SUBSTANTIALLY, WHICH COULD
NEGATIVELY AFFECT THE HOLDERS OF OUR COMMON SHARES.
The price of our common shares may fluctuate substantially due to the following
factors: (1) fluctuations in the price of the shares of the small number of
public companies in the insurance brokerage business, (2) announcements of
acquisitions as part of our growth strategy, (3) additions or departures of key
personnel, (4) announcements of legal proceedings or regulatory matters and (5)
the general volatility in the stock market. The market price of our common
shares could also fluctuate substantially if we fail to meet or exceed
securities analysts' expectations of our financial results or if there is a
change in financial estimates or securities analysts' recommendations.
In addition, the stock market has experienced volatility that has affected the
market prices of equity securities of many companies, and that has often been
unrelated to the operating performance of these companies. A number of other
factors, many of which are beyond our control, could also cause the market price
of our common shares to fluctuate substantially. As a result, you may not be
able to resell your shares at or above the offering price, or at all.
SIGNIFICANT FLUCTUATION IN THE MARKET PRICE OF OUR COMMON SHARES COULD RESULT IN
SECURITIES CLASS ACTION CLAIMS AGAINST US.
Significant price and value fluctuations have occurred with respect to the
securities of insurance and insurance-related companies. Our common share price
is likely to be volatile in the future. In the past, following periods of
downward volatility in the market price of a company's securities, class action
litigation has often been pursued against the respective company. If similar
litigation was pursued against us, it could result in substantial costs and a
diversion of our management's attention and resources.
15
OUR CONTROLLING SHAREHOLDERS, EXECUTIVE OFFICERS AND DIRECTORS MAY SUBSTANTIALLY
INFLUENCE CERTAIN ACTIONS REQUIRING SHAREHOLDERS APPROVAL.
As of December 31, 2001, Fairfax and our executive officers and directors owned
37% and 10%, respectively, of our common shares. After giving effect to the
sales of our common shares contemplated in this offering, Fairfax will own
% of our common shares and our executive officers and directors will own
approximately % of our common shares. Fairfax also holds $35 million of
subordinated convertible notes which it can convert at any time into our common
shares at C$17.00 per share. If Fairfax converts the notes, after giving effect
to this offering, it would hold % of our common shares. Under our by-laws
and articles of incorporation, Fairfax and our executive officers and directors
have the ability to substantially influence certain actions requiring
shareholder approval, including:
- - electing members of our board of directors;
- - adopting amendments to our articles and by-laws; and
- - approving a merger or consolidation, liquidation or sale of all or
substantially all of our assets.
FUTURE SALES OR THE POSSIBILITY OF FUTURE SALES OF A SUBSTANTIAL AMOUNT OF OUR
COMMON SHARES MAY DEPRESS THE PRICE OF YOUR COMMON SHARES.
Future sales of a substantial number of our common shares by us from treasury or
by one of our shareholders in the public market could adversely affect
prevailing market prices and the price of your common shares. It may also impair
our ability to raise capital through future sales of, or pay for acquisitions
using, our equity securities. Upon completion of this offering, we will have
common shares issued and outstanding of which common shares
will be freely tradeable without restrictions under the Securities Act. All of
the shares offered pursuant to this offering, plus any shares sold pursuant to
the exercise of the underwriters' option to purchase additional common shares,
will be freely tradeable without restriction under the Securities Act, unless
purchased by our affiliates.
Upon completion of this offering, shares will be restricted securities
within the meaning of Rule 144. The rules affecting the sale of these securities
are summarized under "Shares eligible for future sale."
We expect we will continue to acquire brokerages to grow our business. We intend
to pay for acquisitions using, at least in part, our common shares. In the event
any such acquisition is significant, the number of shares that we may issue may
in turn be significant. In addition, we may also grant registration rights
covering shares issued in connection with any acquisition. Any significant share
issuance by us will dilute your equity interest in our company.
INVESTORS WILL INCUR IMMEDIATE DILUTION AND MAY EXPERIENCE FURTHER DILUTION.
The initial public offering price of our common shares will be substantially
higher than the net tangible book value per share of the outstanding common
shares immediately after this offering. If you purchase common shares in this
offering, based upon the issuance and sale of common shares at the
initial public offering price of
16
$ per share, you will incur immediate dilution of approximately
$ in the net tangible book value per common share.
WE ARE INCORPORATED IN ONTARIO, CANADA, AND, AS A RESULT, IT MAY NOT BE POSSIBLE
FOR SHAREHOLDERS TO ENFORCE CIVIL LIABILITY PROVISIONS OF THE SECURITIES LAWS OF
THE UNITED STATES.
We are organized under the laws of Ontario, Canada and some of our assets are
located outside the United States. As a result, it may not be possible for the
holders of our common shares to enforce against us in United States courts
judgments based on the civil liability provisions of the securities laws of the
United States. In addition, there is doubt as to whether the courts of Canada
would recognize or enforce judgments of United States courts obtained against us
or our directors or officers based on the civil liability provisions of the
securities laws of the United States or any state or hear actions brought in
Canada against us or those persons based on those laws.
17
FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Any written or oral statements made by us or on
our behalf may include 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 (which we
describe in more detail elsewhere in this prospectus) include, but are not
limited to:
- - risks associated with implementing our business strategies;
- - failure to identify or consummate acquisitions;
- - failure to successfully integrate acquired businesses;
- - decrease in the level of demand for insurance products;
- - decrease in the premiums charged by insurance companies (which may result in a
corresponding decrease in our revenue);
- - loss of services of key executive officers;
- - failure to successfully recruit and retain qualified employees;
- - actions of our competitors, including industry consolidation and increased
competition in the industry;
- - inability to develop and implement effective information technology systems;
and
- - the passage of legislation subjecting our business to supervision or
regulation in the jurisdictions in which we operate.
------------------------
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. We have
described some important factors that could cause our actual results to differ
materially from our expectations in this prospectus, including in the section
titled "Risk factors." We undertake no obligation to publicly update or revise
any forward-looking statements, whether as a result of new information, future
events or otherwise.
18
USE OF PROCEEDS
We estimate that we will receive net proceeds from this offering of
approximately $ million, or $ million if the underwriters'
over-allotment option is exercised in full, assuming an initial public offering
price of $ per share and after deducting the estimated underwriting
commissions and estimated offering expenses payable by us.
We expect to use the net proceeds from this offering to repay (1) the C$42.5
million, or approximately $26.6 million, of 8.5% convertible subordinated notes
due June 28, 2006, issued to Zurich Insurance Company in connection with our
acquisition of Kaye, and (2) $20 million outstanding under one of our credit
facilities incurred on July 19, 2001 in connection with our acquisition of Kaye,
which expires on July 17, 2002 and bears interest at LIBOR plus 150 basis
points. See "Management's discussion and analysis of financial condition and
operating results--Liquidity and capital resources" for a more detailed
description of our outstanding debt. The remaining proceeds will be used for
working capital and general corporate purposes, which may include acquisitions.
We have no commitments or agreements concerning any acquisitions as of the date
of this prospectus. Pending the use of the net proceeds, we intend to invest
these funds in short-term, interest-bearing, investment grade securities.
19
CAPITALIZATION
The following table sets forth our capitalization as of December 31, 2001:
- - on an actual basis; and
- - on an as adjusted basis to give effect to (1) the sale by us of
common shares at an assumed initial public offering price of $ per
share, after deducting underwriting commissions and estimated offering expenses,
and (2) the application of the proceeds therefrom. See "Use of proceeds" on page
19 for more information regarding our use of the net proceeds from this
offering.
This table should be read in conjunction with "Management's discussion and
analysis of financial condition and results of operations," our consolidated
financial statements and our unaudited pro forma consolidated statement of
earnings and the accompanying notes, appearing elsewhere in this prospectus.
<Table>
<Caption>
- -------------------------------------------------------------------------------------
AT DECEMBER 31, 2001
(IN THOUSANDS, EXCEPT SHARE AMOUNTS) ACTUAL AS ADJUSTED
- -------------------------------------------------------------------------------------
Cash and cash equivalents(1)......................... $ 26,979 $
----------------------------
Short-term debt(2)................................... 59,169
----------------------------
Long-term debt and capital leases.................... 137,783
----------------------------
Shareholders' equity:
Preferred shares, unlimited authorized, none issued
and outstanding at December 31, 2001 (actual and
as adjusted).................................... --
Common shares, unlimited authorized, 21,655,748
issued and outstanding at December 31, 2001,
(actual) and shares issued and
outstanding (as adjusted)....................... 125,506
Cumulative translation account..................... 2,770
Retained earnings.................................. 6,995
----------------------------
Total shareholders' equity...................... 135,271
----------------------------
Total capitalization....................... $332,223 $
- -------------------------------------------------------------------------------------
</Table>
(1) Excludes trust cash, which includes premiums collected (less commissions and
other deductions) not yet remitted to insurance companies.
(2) Includes bank debt and current portion of long-term debt and capital leases.
20
DILUTION
At December 31, 2001, our net tangible book value was $(110.9) million, or
$(5.12) per common share. Net tangible book value represents the amount of our
total tangible assets less our total liabilities.
After giving effect to the sale of shares at an assumed initial public
offering price of $ per share, our net tangible book value after this
offering as of December 31, 2001 would have been $ million, or $
per share. The net tangible book value after this offering assumes that the
proceeds to us, net of underwriting commissions and offering expenses, will be
approximately $ million. Based on the foregoing, there would be as at
December 31, 2001 an immediate increase in net tangible book value of $ per
share to existing stockholders and an immediate dilution of $ per share to
new investors. The following table illustrates this per share dilution:
<Table>
- ------------------------------------------------------------------------------------
Assumed initial public offering price per share........... $
Net tangible book value per share at December 31, 2001.. $(5.12)
Increase per share attributable to new investors........
---------
Net tangible book value per share after this offering.....
---------
Dilution per share to new investors....................... $
---------
</Table>
The following table summarizes, as of December 31, 2001, the differences between
our officers, directors and affiliates and new investors with respect to:
- - the number of common shares purchased from us;
- - the total consideration paid to us; and
- - the average price paid per share.
The table below is based on an assumed initial public offering price of
$ per share and is calculated before deducting estimated underwriting
commissions and estimated offering expenses payable by us.
<Table>
<Caption>
- ---------------------------------------------------------------------------------------
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
--------------------- ---------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
- ---------------------------------------------------------------------------------------
Affiliated shareholders... 21,655,748 % $125,505,172 % $5.80
New investors.............
-----------------------------------------------------------
Total................ 100.0% $ 100.0% $
- ---------------------------------------------------------------------------------------
</Table>
21
MARKET PRICE OF OUR COMMON SHARES
Our common shares are listed and posted for trading on the TSE under the symbol
HBG. The following table sets forth the high and low closing prices for our
common shares on the TSE and the quarterly dividends paid for the periods
indicated:
<Table>
<Caption>
- ------------------------------------------------------------------------------------
HIGH LOW DIVIDENDS
- ------------------------------------------------------------------------------------
2000
First Quarter.................................. C$18.00 C$13.50 C$ --
Second Quarter................................. 16.00 13.00 0.07
Third Quarter.................................. 14.75 10.00 0.07
Fourth Quarter................................. 13.00 9.50 0.07
2001
First Quarter.................................. C$20.00 C$12.00 C$0.07
Second Quarter................................. 18.00 15.75 0.07
Third Quarter.................................. 17.25 13.75 0.07
Fourth Quarter................................. 15.75 13.00 0.07
2002
First Quarter (through March 20)............... C$19.25 C$15.50 C$0.07
- ------------------------------------------------------------------------------------
</Table>
Source: Dow Jones & Company, Inc. and the TSE.
On March 21, 2002 the closing price of our common shares on the TSE was C$19.00
and the inverse of the noon buying rate quoted by the Federal Reserve Bank of
New York was C$1.00 per $0.6326. As of March 12, 2002, there were 21,655,748 of
our common shares issued and outstanding. As of the close of business March 12,
2002, we had approximately 1,040 holders of record of our common shares.
DIVIDEND POLICY
We have paid a dividend of C$0.07 per common share for each quarter commencing
June 30, 2000. We have no formal dividend policy other than the board of
directors considers the payment of dividends as quarterly financial information
becomes available. In the future, dividends will be paid at the discretion of
our board of directors depending on our financial position and capital
requirements, general business conditions, contractual restrictions and other
factors.
22
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT
OF EARNINGS
We have set forth below our unaudited pro forma consolidated statement of
earnings for the year ended December 31, 2001, which is prepared in accordance
with U.S. GAAP. Our unaudited pro forma consolidated statement of earnings gives
effect to the acquisition of Kaye as if it had occurred on January 1, 2001. We
acquired Kaye on June 28, 2001, for cash consideration of $125.1 million. We
accounted for the acquisition under the purchase method. Accordingly, $59.8
million of the purchase price was allocated to goodwill. For information as to
the basis on which the unaudited pro forma consolidated statement of earnings
are presented, see the accompanying notes to the unaudited pro forma
consolidated statement of earnings.
The unaudited pro forma consolidated statement of earnings is presented for
illustrative purposes only and does not purport to represent what our actual
performance or financial position would have been if the acquisition of Kaye had
occurred at an earlier date. The pro forma adjustments are based upon currently
available information and our estimates and assumptions. Actual adjustments may
differ from the pro forma adjustments. Our future operating results may differ
materially from the unaudited pro forma consolidated statement of earnings
presented below due to various factors, including those described under "Risk
factors" included elsewhere in this prospectus.
You should read the unaudited pro forma consolidated statement of earnings
including the accompanying notes, in conjunction with our historical
consolidated financial statements and the accompanying notes, the audited
financial statements of Kaye and "Management's discussion and analysis of
financial condition and results of operations" included elsewhere in this
prospectus.
23
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2001 HUB
(IN THOUSANDS, EXCEPT INTERNATIONAL KAYE PRO FORMA
PER SHARE AMOUNTS) LIMITED GROUP INC.(1) ADJUSTMENTS PRO FORMA
- ---------------------------------------------------------------------------------------------
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF EARNINGS(2):
Revenue:
Commission income................ $145,413 $20,174 -- $165,587
Contingent commissions and volume
overrides...................... 6,073 448 -- 6,521
Other............................ 5,295 6,599 -- 11,894
--------------------------------------------------------
156,781 27,221 -- 184,002
--------------------------------------------------------
Expenses:
Remuneration..................... 89,627 13,290 -- 102,917
Other operating expenses......... 39,925 8,639 -- 48,564
--------------------------------------------------------
129,552 21,929 -- 151,481
--------------------------------------------------------
Net earnings before the
following........................ 27,229 5,292 -- 32,521
Interest expense................. 7,060 452 4,200(3) 11,712
Goodwill and intangible asset
amortization................... 5,026 676 505(4) 6,207
(Gain) loss on disposal of
capital assets and
investments.................... (180) -- -- (180)
Other income -- put option
liability...................... (719) -- -- (719)
Non-recurring expenses........... -- 13,263(5) (13,263)(6) --
--------------------------------------------------------
Net earnings (loss) before income
taxes............................ 16,042 (9,099) 8,558 15,501
Provision for income tax expense
(benefit)........................ 5,359 (4,326) 3,423(7) 4,456
--------------------------------------------------------
Net earnings from operations....... $ 10,683 $ 4,773 $ 5,135 $ 11,045
--------------------------------------------------------
Net earnings from operations per
share:
Basic............................ $ 0.56 $ 0.57
Diluted.......................... $ 0.53 $ 0.54
Average shares outstanding:
Basic............................ 19,012 19,232
Diluted.......................... 20,105 20,325
- ---------------------------------------------------------------------------------------------
</Table>
(1) Results for the period January 1, 2001 to June 28, 2001, excluding the
results of Old Lyme.
(2) Amounts presented in our unaudited pro forma consolidated statement of
earnings are in accordance with U.S. GAAP.
(3) Represents interest on convertible subordinated notes and short-term bank
debt issued in connection with the acquisition of Kaye. The convertible
subordinated notes issued in aggregate principal amounts of $35 million and
$26.6 million bear interest at 8.5%. In addition, bank debt of $67 million
accrues interest at an average rate of 6.7% for the six month period ended June
30, 2001.
(4) Represents amortization of goodwill and other identifiable intangible assets
resulting from the acquisition of Kaye. Goodwill in the amount of $59.8 million
is amortized over 40 years. Definite-lived intangible assets in the amount of
$13.0 million are amortized over 15 years.
(5) Includes non-recurring costs incurred by Kaye in connection with our
acquisition of Kaye in the amount of $13.2 million, including payments of
approximately $10.6 million to retire Kaye's obligation under stock-based
compensation plans.
(6) Represents a reversal of non-recurring costs incurred by Kaye, as a result
of our acquisition of Kaye.
(7) Current tax benefit of 40.0% of the above adjustments excluding amortization
of goodwill.
24
SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA
The following selected historical consolidated financial data should be read
with "Management's discussion and analysis of financial condition and results of
operations" and our historical consolidated financial statements and the
accompanying notes included elsewhere in this prospectus. The consolidated
statement of earnings data relating to the three years ended December 31, 2001
and the balance sheet data as of December 31, 2001 and 2000 are derived from our
historical consolidated financial statements for the three year period ended
December 31, 2001 and as of December 31, 2001 and 2000 audited by
PricewaterhouseCoopers LLP, our independent auditors, beginning on page F-1. The
financial data relating to the year ended December 31, 1999 is derived from our
historical audited consolidated financial statements for that year. The
financial data for the years ended December 31, 1998 and 1997 is derived from
our audited combined financial statements for those years. Historical results of
operations are not necessarily indicative of future results.
We were formed in November 1998 through the merger of 11 independent insurance
brokerages into a new company. The merger was accounted for using the
pooling-of-interests method. Accordingly, our results for the years ended
December 31, 1998 and 1999 include the assets, liabilities, shareholders equity,
revenue and expenses of the combined companies, without adjustments. Our results
for the year ended December 31, 1999 reflect the results of TOS Insurance
Services Ltd. and Mack and Parker, Inc. from September 1, 1999 and October 28,
1999, respectively, the dates on which we acquired each brokerage. Our results
for the year ended December 31, 2000 reflect the results of C.J. McCarthy
Insurance Agency, Inc. from July 1, 2000, the dates on which we acquired it. Our
results for the year ended December 31, 2001 reflect the results of Flanagan,
Kaye and Burnham from June 1, 2001, June 29, 2001 and July 2, 2001,
respectively, the dates on which we acquired each brokerage. In addition to the
acquisition of these larger brokerages, our results also reflect the acquisition
of smaller brokerages that occurred in each respective period. As a result of
our acquisitions, the results in each period are not directly comparable.
Our historical consolidated financial statements are prepared in accordance with
Canadian GAAP, which differs in certain significant respects from U.S. GAAP. For
a discussion of the principal differences between Canadian GAAP and U.S. GAAP
see note 17 to our historical consolidated financial statements included
elsewhere in this prospectus.
25
<Table>
<Caption>
- ----------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)(1) 2001 2000 1999 1998 1997
- ----------------------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF EARNINGS DATA:
Revenue:
Commission income................... $142,851 $86,410 $47,964 $35,177 $27,390
Contingent commissions and volume
overrides........................ 5,946 4,909 2,824 2,604 1,528
Other............................... 5,196 3,921 3,309 942 882
------------------------------------------------
153,993 95,240 54,097 38,723 29,800
------------------------------------------------
Expenses:
Remuneration........................ 88,015 54,701 29,519 21,847 16,099
Selling............................. 8,359 4,840 3,036 2,810 2,622
Occupancy........................... 9,061 5,756 3,393 2,364 1,596
Depreciation........................ 3,940 1,885 1,275 897 658
Administration...................... 17,856 11,182 6,806 5,461 4,151
------------------------------------------------
127,231 78,364 44,029 33,379 25,126
------------------------------------------------
Net earnings before the following..... 26,762 16,876 10,068 5,344 4,674
Interest expense.................... 7,447 1,981 632 805 567
Goodwill and other intangible asset
amortization..................... 4,940 3,260 1,626 1,087 807
(Gain) loss on disposal of capital
assets and investments........... (173) 127 14 (84) --
Other income -- put option
liability........................ (719) -- -- -- --
------------------------------------------------
Net earnings before income taxes...... 15,267 11,508 7,796 3,536 3,300
Provision for income tax expense...... 5,262 5,370 4,052 1,848 1,319
------------------------------------------------
Net earnings.......................... $ 10,005 $ 6,138 $ 3,744 $ 1,688 $ 1,981
------------------------------------------------
Net earnings per share:
Basic............................... $ 0.53 $ 0.34 $ 0.22 $ 0.26
Diluted............................. $ 0.50 $ 0.34 $ 0.22 $ 0.26
Weighted average shares:
Basic............................... 19,012 18,327 16,941 6,448
Diluted............................. 20,105 18,327 16,941 6,448
Dividends per share(2)................ $ 0.18 $ 0.13 -- --
Reconciliation to U.S. GAAP:
Net earnings........................ $ 10,005 $ 6,138 $ 3,744 $ 1,688 $ 1,981
Adjustment to investment held
for sale(3)................. 520 -- -- -- --
Change in reporting
currency(4)................. 158 366 233 -- --
------------------------------------------------
Net earnings (U.S. GAAP)............ $ 10,683 $ 6,504 $ 3,977 $ 1,688 $ 1,981
- ----------------------------------------------------------------------------------------
</Table>
(1) Effective September 30, 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 = $0.6338.
(2) We commenced payment of dividends in the second quarter of 2000.
(3) As part of our acquisition of Kaye, we acquired Old Lyme, which we have
agreed to sell to a subsidiary of Fairfax as described under "Certain
relationships and related party transactions." Under U.S. GAAP, interest expense
on debt we incurred to finance the purchase of Old Lyme is not charged to
earnings. See note 17 to our consolidated financial statements for more
information.
(4) Under U.S. GAAP, financial statements are translated using the average
exchange rate for the period. See note 17 to our consolidated financial
statements for more information.
26
<Table>
<Caption>
- ------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PERCENTAGES)(1) 2001 2000 1999 1998 1997
- ------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEET DATA (AT PERIOD END):
Cash and cash equivalents(2)........ $ 26,979 $ 19,919 $ 21,368 $ 308 $ 563
Total assets........................ $ 502,296 $206,157 $171,202 $49,128 $39,741
Total debt(3)....................... $ 196,952 $ 34,665 $ 20,562 $14,388 $15,724
Total shareholders' equity.......... $ 135,271 $112,212 $105,562 $13,463 $ 6,297
OTHER FINANCIAL DATA:
EBITDA(4)........................... $ 30,702 $ 18,761 $ 11,343 $ 6,241 $ 5,332
EBITDA margin(5).................... 19.9% 19.6% 20.9% 16.1% 17.8%
Net cash flow provided by
operating activities.............. $ 46,912 $ 12,807 $ 5,103 $ 3,545 $ 1,214
Net cash flow provided by
financing activities.............. $ 132,431 $ 5,613 $ 58,494 $ 4,075 $ 3,250
Net cash flow (used in) investing
activities........................ $(134,213) $(17,983) $(34,655) $(8,931) $(4,100)
- ------------------------------------------------------------------------------------------
</Table>
(1) Effective September 30, 2001, we adopted the U.S. dollar as our reporting
currency. Our financial results for all periods prior to October 1, 2001 have
been restated from Canadian dollars to U.S. dollars using the exchange rate in
effect at September 30, 2001 of C$1.00 = $0.6338.
(2) Excludes trust cash, which includes premiums collected (less commissions and
other deductions) not yet remitted to insurance companies.
(3) Includes long-term debt and capital leases (including current portion), bank
debt and subordinated convertible notes.
(4) EBITDA is defined as earnings before interest, income taxes, depreciation
and goodwill and other intangible asset amortization, but excluding gains or
losses from the sale of capital assets and investments and other income -- put
option liability. EBITDA is not a measure of financial performance under either
U.S. or Canadian GAAP, and should not be considered in isolation or as a
substitute for net income, cash flows from operating activities or other income
or cash flow statement data prepared in accordance with generally accepted
accounting principles as a measure of profitability or liquidity. We believe the
presentation of EBITDA is relevant because EBITDA is a measurement that industry
analysts use when evaluating our operating performance. Investors should be
aware that our presentation of EBITDA may not be comparable with similarly
titled measures presented by other companies.
(5) EBITDA margin represents EBITDA as a percentage of total revenue. EBITDA
margin is presented because we believe that it is a useful indicator to
investors of our profitability. EBITDA margin should not be considered by
investors as an alternative to operating margin as an indicator of our
profitability. Investors should be aware that our presentation of EBITDA margin
may not be comparable with similarly titled measures presented by other
companies.
27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our
consolidated financial statements and accompanying notes. 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 prospectus, particularly
under the heading "Risk factors." 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.
OVERVIEW
We are a leading North American insurance brokerage providing a wide variety of
property and casualty, life and health, employee benefits, investment and risk
management products and services from 130 locations across North America. We
were formed in November 1998 through the merger of 11 Canadian independent,
privately-held insurance brokers.
In 1999, we acquired 44 brokerages, including Mack and Parker, Inc., our first
acquisition in the United States. In 2000, we acquired 18 brokerages in the
United States and Canada, including C.J. McCarthy Insurance Agency, Inc. In
2001, we acquired 16 brokerages, including Kaye Group Inc. on June 28, Burnham
Stewart Group Inc. on July 1 and Flanagan Corporation on May 31. We apply the
purchase method of accounting to our acquisitions and, as a result, the acquired
brokerages' financial results are included only from the date of purchase.
Revenue generated by Kaye, which was previously listed on NASDAQ, represented
17% of our revenue for the year ended December 31, 2001 on an actual basis, and
30% on a pro forma basis.
As part of our acquisition of Kaye, we acquired Old Lyme Insurance Company of
Rhode Island, Inc. and Old Lyme Insurance Company Ltd., primary insurance
companies, which together we call Old Lyme. We acquired Kaye with the intent to
sell Old Lyme and have since entered into an agreement to sell Old Lyme to a
subsidiary of Fairfax Financial Holdings Limited at a purchase price equivalent
to its U.S. GAAP book value as of December 31, 2001 of approximately $42.8
million. As of December 31, 2001, Fairfax owned 37% of our common shares. As of
June 28, 2001, we recorded Old Lyme as an investment available for sale.
Accordingly, Old Lyme is shown separately on our balance sheet at cost, which is
at or below market value, and its results of operations are not included in our
consolidated earnings.
We generate our revenue in the United States and Canada. As the table below
shows, historically we derived a large percentage of our revenue from our
Canadian Operations. However, after our acquisitions of Kaye, Burnham and
Flanagan, and our other acquisitions in 2001, revenue from our U.S. Operations
increased to almost half of our total revenue for 2001. We expect that in the
future, a greater percentage of our revenue will be derived from our U.S.
Operations and generated in U.S. dollars.
28
<Table>
<Caption>
- --------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT % OF % OF % OF
PERCENTAGES) 2001 TOTAL 2000 TOTAL 1999 TOTAL
- --------------------------------------------------------------------------------------
Revenue
U.S. Operations............ $ 75,429 49.0% $20,004 21.0% $ 1,535 2.8%
Canadian Operations........ 78,564 51.0% 75,236 79.0% 52,562 97.2%
-------------------------------------------------------
Total...................... $153,993 100.0% $95,240 100.0% $54,097 100.0%
- --------------------------------------------------------------------------------------
</Table>
We have demonstrated growth in revenue and EBITDA (which we define as earnings
before interest, income taxes, depreciation and goodwill and other intangible
asset amortization, but excluding gains or losses from the sale of capital
assets and investments and other income -- put option liability) over the past
three years. From December 31, 1998 to December 31, 2001, our revenue increased
from $38.7 million to $154.0 million representing a compounded annual growth
rate of 58%. This growth in revenue is primarily attributable to the additional
78 brokerages we have acquired since our formation in 1998 and has been
supplemented by our consistent organic growth, which has ranged from 5% to 6%
per year. We define organic growth as an increase in revenue for one period as
compared to a prior period, including net new business and net increases in
commissions from existing business. Revenue from a brokerage we acquire is
excluded from the calculation of organic growth for the first 12 months
subsequent to the acquisition of the brokerage.
From December 31, 1998 to December 31, 2001, EBITDA improved from $6.2 million
to $30.7 million, representing a compounded annual growth rate of 70%. EBITDA is
not a measure of financial performance under either U.S. or Canadian GAAP, and
should not be considered in isolation or as a substitute for net income, cash
flows from operating activities or other income or cash flow statement data
prepared in accordance with generally accepted accounting principles as a
measure of profitability or liquidity. We believe the presentation of EBITDA is
relevant because EBITDA is a measurement that industry analysts use when
evaluating our operating performance. Investors should be aware that our
presentation of EBITDA may not be comparable with similarly titled measures
presented by other companies.
Though the insurance brokerage industry is highly sensitive to changes in the
property and casualty insurance industry, it is relatively less sensitive to
economic cycles than other industries. Insurance coverage, products and services
are essential to businesses, governmental agencies and consumers, and are
typically a fixed cost that is difficult to eliminate even in periods of
economic weakness. The commissions that we receive from primary insurers,
however, fluctuate with premium levels within the insurance market.
During the 1990's and into 2000, the property and casualty insurance industry
experienced excess capacity which resulted in highly competitive market
conditions, declining premium levels and a corresponding reduction in
commissions paid to brokers. However, market participants, particularly in the
United States, have recently reported significant increases in property and
casualty premium levels. This change is the result of several years of reduced
profitability for property and casualty insurance companies and a subsequent
contraction of capacity. In the United States, premium levels for property and
casualty insurance policy renewals generally increased throughout 2001, while in
Canada prices did not begin to increase until the fourth quarter of 2001. We
29
believe that the events of September 11, 2001 have caused property and casualty
insurance companies to increase premium levels even further. We also believe
that the publicity surrounding these events has led to widespread acceptance of
rate increases by middle-market companies. While we cannot predict the timing or
extent of premium pricing changes or their effect on our operations in the
future, we believe that premium rates will continue to increase at least through
2003.
REVENUE
We derive our revenue primarily from commissions on the sale of insurance
products and services to our clients. Commissions, which represented
approximately 93% of our revenue for 2001, are calculated as a percentage of and
paid from premiums. The insurance companies determine insurance premium rates
based upon their underwriting analyses, while the percentage of commission is
negotiated between us and the insurers. Typically commission rates fall within a
range of industry norms based on lines of business. For example, basic
commissions for property and casualty insurance typically average approximately
15% of premiums.
For the year ended December 31, 2001, approximately 65% of our revenue was
derived from commercial accounts and approximately 28% from personal accounts,
in both cases, excluding related contingent commissions and volume overrides.
In addition to revenue from commissions on premiums, we derive a portion of our
revenue from volume overrides, contingent commissions and fees. Volume overrides
are additional compensation paid by insurance companies based upon the overall
volume of business that an insurance broker places with an insurance company.
Contingent commissions are based on the profit an insurance company makes on the
overall volume of business we place with it. Contingent commissions are
typically received in the first or second quarter. In 2001, 3.8% of our total
revenue was derived from contingent commissions and volume overrides.
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, 2001, we placed insurance policies with six insurance
companies owned by Fairfax, each of which offers competitively-priced products.
All of our transactions with the Fairfax companies are in the normal course of
business, at fair market value and, in the aggregate, generated approximately
4.9% of our total revenue in 2001. This percentage will increase in 2002 as a
result of the sale of Old Lyme. See "Certain relationships and related party
transactions" for a more detailed description of these transactions.
EXPENSES
The majority of expenses we incur are remuneration expenses related to
compensation and employee benefits, which typically account for approximately
70% of our total operating expenses. In addition to salaries, we also pay
bonuses pursuant to our performance bonus program whereby each brokerage has an
opportunity to achieve an annual bonus ranging from 50% to 65% of its brokerage
pre-bonus operating profit in
30
excess of 20% of the brokerage's prior year revenue. The bonus percentage earned
is based upon the respective brokerage's operating profit margin. In 2001,
salary, bonuses and benefits equaled approximately 57% of our total revenue.
Other expenses include selling (which includes marketing and advertising, but
not commissions paid to our sales producers), occupancy (which includes rent and
related operating costs), administration (which includes office supplies,
postage, telephone, training, technology and bad debts) and depreciation.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Revenue. Total revenue for the year ended December 31, 2001 increased by $58.8
million or 62% to $154.0 million from $95.2 million for the year ended December
31, 2000. Of this increase, $55.6 million or 95% was attributable to
acquisitions and reflects the inclusion of the results of each brokerage we
acquired during the year from the respective date of each acquisition. For the
year ended December 31, 2001, commission income increased by $56.5 million or
65% to $142.9 million from $86.4 million for the year ended December 31, 2000.
Excluding the effects of acquisitions, commission income increased $4.3 million
or 5%. This increase was mainly due to organic growth including premium rate
increases. For the year ended December 31, 2001, revenue from contingent
commissions and volume overrides increased by $1.0 million or 20% to $5.9
million from $4.9 million for the year ended December 31, 2000. This increase
was primarily attributable to acquisitions. For the year ended December 31, 2001
other income, which includes fees and interest income, increased by $1.3 million
or 33% to $5.2 million from $3.9 million for the year ended December 31, 2000.
This increase was primarily attributable to acquisitions.
For the year ended December 31, 2001, total revenue from U.S. Operations
increased by $55.4 million or 277% to $75.4 million from $20.0 million for the
year ended December 31, 2000. This increase was primarily due to acquisitions.
Excluding the effect of acquisitions, total revenue increased $2.1 million or
11% primarily due to organic growth.
For the year ended December 31, 2001, total revenue from Canadian Operations
increased by $3.4 million or 5% to $78.6 million from $75.2 million for the year
ended December 31, 2000. Excluding the effect of acquisitions, total revenue
increased $1.1 million or 1.0%.
Remuneration. Remuneration costs for the year ended December 31, 2001 increased
by $33.3 million or 61% to $88.0 million from $54.7 million for the year ended
December 31, 2000. Remuneration costs as a percentage of total revenue remained
unchanged at 57% for 2001 as compared to 2000.
Selling. Selling expenses for the year ended December 31, 2001 increased by $3.6
million or 75% to $8.4 million from $4.8 million for the year ended December 31,
2000. Selling expenses as a percentage of total revenue of 5% remained unchanged
for 2001 as compared to 2000.
Occupancy. Occupancy expenses for the year ended December 31, 2001 increased by
$3.3 million or 57% to $9.1 million from $5.8 million for the year ended
December 31, 2000. Occupancy expenses as a percentage of total revenue of 6%
remained unchanged for 2001 as compared to 2000.
31
Depreciation. Depreciation expenses for the year ended December 31, 2001
increased by $2.0 million or 105% to $3.9 million from $1.9 million for the year
ended December 31, 2000. Depreciation expenses as a percentage of total revenue
increased to 3% in 2001 from 2% in 2000. This increase was primarily due to
capital assets that we acquired with our brokerage acquisitions.
Administration. Administration expenses for the year ended December 31, 2001
increased by $6.7 million or 60% to $17.9 million from $11.2 million for the
year ended December 31, 2000. Administration expenses as a percentage of total
revenue of 12%, remained unchanged for 2001 as compared to 2000. This decrease
was primarily due to increased cost efficiencies and the slower rate of increase
of certain administrative costs versus the rate of growth of commission income.
Interest expense. Interest expense for the year ended December 31, 2001
increased by $5.4 million or 270% to $7.4 million from $2.0 million for the year
ended December 31, 2000. This increase was largely attributable to our issuance
of 8.5% convertible subordinated notes to Fairfax and Zurich Insurance Company
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 for the year ended December 31, 2001 increased by $1.6
million or 48% to $4.9 million from $3.3 million for the year ended December 31,
2000. This increase is attributable to acquisitions in 2001 and 2000. For more
information, see "--Goodwill and other intangible assets" below.
Provision for income tax expense. Income taxes for the year ended December 31,
2001 and 2000 amounted to $5.3 million and $5.4 million, respectively, resulting
in an effective tax rate of 34% and 47% for 2001 and 2000, respectively. The
decrease in our effective income tax rate was the result of more efficient tax
planning, including the manner in which we have structured certain of our
acquisitions in the United States.
Net earnings. Net earnings for the year ended December 31, 2001 increased by
$3.9 million or 63% to $10.0 million compared to $6.1 million in 2000. Basic
earnings per share increased to $0.53 per share for 2001 from $0.34 per share
for 2000. Diluted earnings per share increased to $0.50 per share for 2001 from
$0.34 per share for 2000.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
Revenue. Total revenue for the year ended December 31, 2000 increased by $41.1
million or 76% to $95.2 million from $54.1 million for the year ended December
31, 1999. Of this increase, $39.5 million or 96% was attributable to
acquisitions. For the year ended December 31, 2000, commission income increased
by $38.4 million or 80% to $86.4 million from $48.0 million for the year ended
December 31, 1999. Excluding the effects of acquisitions, commission income
increased $2.8 million or 6%. This increase was mainly due to organic growth.
For the year ended December 31, 2000, revenue from contingent commissions and
volume overrides increased by $2.1 million or 75% to $4.9 million from $2.8
million for the year ended December 31, 1999. This increase was primarily
attributable to acquisitions. For the year ended December 31, 2000, other
income, which includes fees and interest income, increased by $0.6 million or
18% to $3.9 million from $3.3 million for the year ended December 31, 1999. This
increase was primarily attributable to acquisitions.
32
For the year ended December 31, 2000, total revenue from U.S. Operations
increased by $18.5 million or 1,233% to $20.0 million from $1.5 million for the
year ended December 31, 1999. This increase was primarily due to acquisitions.
Total revenue from our U.S. Operations increased to 21% of our consolidated
total revenue in 2000 from 3% in 1999.
For the year ended December 31, 2000, total revenue from Canadian Operations
increased $22.6 million or 43% to $75.2 million from $52.6 million for the year
ended December 31, 1999 primarily due to acquisitions. Total revenue from our
Canadian Operations decreased to 79% of consolidated total revenue in 2000 from
97% in 1999.
Remuneration. Remuneration costs for the year ended December 31, 2000 increased
by $25.2 million or 85% to $54.7 million from $29.5 million for the year ended
December 31, 1999. Remuneration costs as a percentage of total revenue increased
to 57% in 2000 from 55% in 1999. This increase was primarily a result of
increases in brokerage performance bonuses. Brokerage performance bonuses were
4% of total revenue in 2000 compared to 1% in 1999. Due to the timing of our
acquisitions, many of the brokerages did not qualify for an operating bonus in
1999. In 2000 however, all but three brokerages achieved a pre-bonus operating
profit in excess of 20%.
Selling. Selling expenses for the year ended December 31, 2000 increased by $1.8
million or 60% to $4.8 million from $3.0 million for the year ended December 31,
1999. Selling expenses as a percentage of total revenue decreased to 5% in 2000
from 6% in 1999. This decrease was mainly due to increased cost reductions.
Occupancy. Occupancy expenses for the year ended December 31, 2000 increased by
$2.4 million or 71% to $5.8 million from $3.4 million for the year ended
December 31, 1999. Occupancy expenses as a percentage of total revenue of 6%
remained unchanged for 2000 as compared with 1999.
Depreciation. Depreciation expenses for the year ended December 31, 2000
increased by $0.6 million or 46% to $1.9 million from $1.3 million for the year
ended December 31, 1999. Depreciation expenses as a percentage of total revenue
of 2% remained unchanged for 2000 as compared to 1999.
Administration. Administration expenses for the year ended December 31, 2000
increased by $4.4 million or 65% to $11.2 million from $6.8 million for the year
ended December 31, 1999. Administration expenses as a percentage of total
revenue decreased to 12% in 2000 from 13% in 1999. This decrease was primarily
due to our continuous effort to reduce overhead costs.
Interest expense. Interest expense for the year ended December 31, 2000
increased by $1.4 million or 233% to $2.0 million from $0.6 million for the year
ended December 31, 1999. This increase is attributable to the increase in
long-term debt incurred to fund our acquisitions.
Goodwill and other intangible asset amortization. Goodwill and other intangible
asset amortization for the year ended December 31, 2000 increased by $1.7
million or 106% to $3.3 million from $1.6 million for the year ended December
31, 1999. This increase is attributable to the 62 acquisitions we completed
during 2000 and 1999.
Provision for income tax expense. Income taxes for the year ended December 31,
2000 and 1999 amounted to $5.4 million and $4.1 million, respectively, resulting
in an effective tax rate of 47% and 52% for 2000 and 1999, respectively. The
decrease in our
33
effective income tax rate is the result of more efficient tax planning,
including the manner in which we have structured certain of our acquisitions in
the United States.
Net earnings. Net earnings for the year ended December 31, 2000 increased by
$2.4 million or 65% to $6.1 million compared to $3.7 million for 1999. Basic and
diluted earnings per share increased to $0.34 per share for 2000 from $0.22 per
share for 1999.
CASH FLOW, LIQUIDITY AND CAPITAL RESOURCES
We act as an intermediary between insurance companies and their insured
customers. As such, we collect and hold premiums paid by customers on behalf of
the insurers. We deduct commissions and other expenses from these payments and
hold the remainder in trust for the insurers. We earn interest on those funds
during the time between receipt of the cash and the time the cash is paid out to
the insurers. However, we may not use the funds for any purpose and we must
remit the funds within a specified period after the effective date of the
respective policy. The cash we hold in trust is shown separately on our balance
sheet.
As of December 31, 2001, we had cash and cash equivalents of $77.4 million, of
which $50.4 million was trust cash, an increase of $45.1 million from $32.3
million as of December 31, 2000. During 2001, $46.9 million of cash was provided
by operating activities, primarily as a result of timing differences between the
payment of accounts payable and the collection of accounts receivable. The
remainder was the result of increased net earnings adjusted for items affecting
working capital. Long-term debt financing and bank debt financing generated
$137.8 million of cash. Share capital issued generated cash of $3.3 million, net
of repurchases. From these amounts and existing cash balances, $148.8 million
(including gross of $25.4 million cash received) was used to acquire businesses
and $5.2 million was used to repay long-term debt and capital leases, $3.6
million was used to pay dividends, and $10.9 million was used for additions to
capital assets and other assets.
As of December 31, 2000, we had cash and cash equivalents of $32.3 million, of
which $12.4 million was trust cash, an increase of $0.5 million from $31.8
million as of December 31, 1999. During 2000, $12.8 million of cash was provided
from operating activities primarily as a result of timing differences between
the payment of accounts payable and the collection of accounts receivable. The
remainder was the result of increased net earnings adjusted for items affecting
working capital. Long-term debt financing generated $29.8 million of cash. In
addition, the executive share purchase plan and the sale of other assets
generated $2.8 million of cash. From these amounts and existing cash balances,
$18.9 million was used to acquire brokerages, $2.8 million was used to
repurchase our common shares, $18.9 million was used to repay long-term debt,
capital leases, and bank debt, $2.5 million was used to pay dividends, and $2.1
million was used for additions to capital assets.
As of December 31, 2001, we had client premiums receivable outstanding of $80.5
million, of which 1.7% were over 90 days old. We monitor these receivables on a
regular and timely basis and have controls in place to manage aging accounts. In
addition, we can mitigate the risk of loss related to client premiums receivable
by requesting that the insurance company cancel the contract for insurance where
payment is overdue, thereby reducing the related premiums payable to insurance
companies and the related amounts to be collected from the client. Therefore, we
do
34
not believe that the aging of our accounts receivable presents a material
liquidity risk. As of December 31, 2001, we had related premiums payable to
insurance companies of $122.7 million.
We require that our brokerages submit to head office on a monthly basis all
excess cash on hand in excess of a working capital ratio of 1:1. All brokerages
with trust reporting requirements are required to submit to head office on a
quarterly basis trust reconciliation calculations stating whether or not they
are in compliance with applicable insurance broker regulations.
We maintain four separate credit facilities:
- - $50 million facility. Borrowings under this facility are accessed at a
floating rate of 112.5 basis points above LIBOR, which was 2.09% as of December
31, 2001. This facility expires on June 20, 2002 and requires us to maintain
certain financial ratios. We intend to extend this facility for a further period
of one year, but if the revolving period is not extended, any amounts
outstanding will automatically convert into a three-year term loan at a fixed
interest rate equal to the Canadian dollar interest swap rate quoted by the
lender plus 1.375%. As of December 31, 2001, $49.5 million had been drawn on
this facility. We intend to pay down approximately $5 million of this facility
with the proceeds from the sale of Old Lyme.
- - $25 million facility. Borrowings under this facility are accessed at a
floating rate of 135 basis points above LIBOR. This facility is guaranteed by
certain of our subsidiaries and by Fairfax. It expires on July 18, 2002 and
contains covenants that, among other things, require us to maintain certain
financial ratios, restrict our ability to incur additional debt and limit our
quarterly dividend payments to C$0.07 per share. As of December 31, 2001, $25
million was drawn on this facility. We intend to fully repay and terminate this
facility with proceeds from the sale of Old Lyme.
- - $25 million facility. Borrowings under this facility are accessed either at a
floating rate of 150 basis points above LIBOR or at a fixed interest rate of 9%.
This facility is guaranteed by certain of our subsidiaries. The floating rate
portion of this facility expires on July 17, 2002 and contains covenants that,
among other things, require us to maintain certain financial ratios, restrict
our ability to incur additional debt and limit our quarterly dividend payments
to C$0.07 per share. As of December 31, 2001, $24.5 million was drawn on this
facility, of which $23 million was drawn at a floating interest rate, and $1.5
million was drawn at a fixed interest rate, which is included in long-term debt
and is due October 31, 2005. We intend to repay $4.5 million of this facility
with proceeds from the sale of Old Lyme and to repay $20 million and terminate
both the fixed and floating portions of this facility with proceeds from this
offering.
- - $7.5 million facility. Borrowings under this facility are at an interest rate
of prime, which was 4.75% as of December 31, 2001, plus 1%. Payment is due on
demand. As of December 31, 2001, $7.0 million had been drawn on this facility.
We intend to fully repay and terminate this facility with the proceeds from the
sale of Old Lyme.
As of September 30, 2001, we were not in compliance with certain financial
covenants relating to the maintenance of our financial ratios under both of our
$25 million credit facilities. Our non-compliance was the direct result of a
delay in reaching a final agreement for the sale of Old Lyme, the proceeds of
which would have been used to repay debt. Our lenders have granted us waivers
with respect to our non-compliance with these covenants. In addition, we have
negotiated amended agreements with these
35
lenders as of December 31, 2001. Under the amended agreements, we are in
compliance with all of the financial covenants governing the respective credit
facilities as of December 31, 2001.
As of December 31, 2001, we had $13.6 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
2002 through 2010. Of the outstanding subsidiary debt, $8.6 million is secured
by liens on certain assets of our subsidiaries.
In connection with our acquisition of Kaye on June 28, 2001, we issued: (1)
$26.6 million aggregate principal amount of 8.5% convertible subordinated notes
due June 28, 2006 to Zurich Insurance Company, the Zurich notes; and (2) $35
million aggregate principal amount of 8.5% convertible subordinated notes due
June 28, 2007 to certain subsidiaries of Fairfax, the Fairfax notes. These
convertible notes were anti-dilutive to earnings per share as of December 31,
2001.
The Zurich notes are convertible by Zurich at any time into our common shares at
C$17.00 per share, subject to mandatory conversion on June 30, 2006. Zurich has
agreed not to convert the Zurich notes into common shares before June 30, 2002
and also has agreed to allow us to repay the Zurich notes, in whole or in part,
on or before June 30, 2002, without penalty. We intend to repay the Zurich notes
using proceeds from this offering.
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 Fairfax to
convert the Fairfax notes into our common shares at C$17.00 per share if, at any
time, the weighted average closing price of our common shares for 20 consecutive
trading days equals or exceeds C$19.00 per share. If Fairfax converted all of
the Fairfax notes, Fairfax would own approximately 45.1% of our total
outstanding common shares as of December 31, 2001 or % after giving effect
to this offering.
Net debt, defined as, long-term debt, including the current portion, bank debt
and subordinated convertible notes, less non-trust cash and the investment held
for sale, as of December 31, 2001, was $129.2 million, compared to $14.7 million
as of December 31, 2000. The increase in debt is largely associated with debt
incurred to finance acquisitions we made in 2001. In connection with our
acquisition of Kaye for $130.4 million, we issued $61.6 million in convertible
subordinated notes to Fairfax and Zurich, as described above, as well, $54.0
million was financed with bank debt and $14.8 million was paid with cash.
Similarly, the cash portion of our purchase of Burnham was financed with a
short-term bank loan of $11.9 million.
As a result of financing of these acquisitions with debt, our net debt-to-equity
ratio has increased. As of December 31, 2001, our net debt-to-equity ratio was
0.96:1, up from 0.13:1 as of December 31, 2000. We may incur additional debt to
pay for future acquisitions. However, we intend to continue our practice of
using our common shares to pay for acquisitions. To the extent we issue
additional common shares to pay for future acquisitions, your equity interest in
us will be diluted.
36
The table below summarizes our contractual obligations and commercial
commitments as of December 31, 2001:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------
PAYMENTS DUE BY PERIOD ON LESS THAN 1 - 3 4 - 5 AFTER
(IN THOUSANDS) TOTAL DEMAND 1 YEAR YEARS YEARS 5 YEARS
- -----------------------------------------------------------------------------------------
Bank borrowings............. $ 55,000 $7,000 $48,000 -- -- --
Long-term debt and capital
lease obligations......... 80,328 -- 4,169 $ 5,272 $62,381 $ 8,506
Operating lease
obligations............... 53,766 -- 9,061 14,877 11,991 17,837
-----------------------------------------------------------
Total..................... $189,094 $7,000 $61,230 $20,149 $74,372 $26,343
- -----------------------------------------------------------------------------------------
</Table>
We intend to repay approximately $41.5 million of bank borrowings with the
proceeds from the sale of Old Lyme. We intend to repay $20 million of our
remaining bank borrowings and the Zurich notes with the net proceeds from this
offering. It is our intention to pay for operating lease obligations with cash
flows generated from our operating activities.
We believe that our existing cash, funds generated from operations and
borrowings available under our credit facilities, together with the proceeds
from the sale of Old Lyme and the net proceeds from this offering, will be
sufficient to satisfy our financial requirements, including strategic
acquisitions, during the next twelve months. We may also raise debt or equity
capital in the public or private markets in the future. If we issue additional
common shares, your equity interest in us will be diluted.
CONTINGENT OBLIGATIONS
As part of our executive share purchase plan, we guaranteed loans made by a
Canadian chartered bank to executives and employees to acquire our common
shares. We may be required under certain circumstances to repay up to $5.5
million in loans incurred under the plan. The loans are secured by 669,000 of
our common shares, which had a market value of $6.4 million as of December 31,
2001. See "Management--Indebtedness of directors, executive officers and senior
officers" for a more detailed discussion of the loans outstanding.
Additionally, in conjunction with our acquisitions of Flanagan and Burnham in
2001, we issued our common shares to the former owners of each brokerage in
consideration of the purchase price paid and granted to them the option to
require us to repurchase our shares, approximately 2.1 million common shares in
total, upon certain triggering events. The estimated financial liability
associated with these put options totaled $17.3 million as of December 31, 2001
and is included in long-term debt. See note 8 to our consolidated financial
statements and the section entitled "Certain relationships and related party
transactions--Put options" for more detail regarding the put options.
We paid for the acquisition of Burnham and Flanagan with a combination of cash
and our common shares. The former shareholders of Burnham and Flanagan are also
entitled to receive contingent consideration if their respective brokerages meet
specified performance targets, based on revenue and operating profit.
37
FLANAGAN
The following table summarizes the contingent consideration that will be issued
to the former shareholders of Flanagan if Flanagan meets certain performance
criteria:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------
CONTINGENT CONTINGENT CONSIDERATION
YEAR CONSIDERATION TARGET CRITERIA
- ---------------------------------------------------------------------------------------
2002.................................. 38,000 shares Revenue
2002.................................. 38,000 shares Profitability
2003.................................. 88,000 shares Revenue
2003.................................. 37,000 shares Profitability
- ---------------------------------------------------------------------------------------
</Table>
Flanagan met its contingent consideration criteria for 2001. Accordingly, as of
December 31, 2001, we have an obligation to issue 50,000 shares in the amount of
$478,000. The additional purchase consideration has been recorded in goodwill
and share capital as of December 31, 2001.
BURNHAM
The former shareholders of Burnham are entitled to contingent consideration in
the event that the acquired Burnham operations meet certain profitability
targets for the twelve-month period ended June 30, 2002. The contingent
consideration to be issued, if the profitability criteria are met, will be a
portion of actual profitability in excess of the target. Any contingent
consideration issued by us will be paid 38% in cash, 51% in our restricted
shares, and 11% in our unrestricted shares.
OTHERS
An additional $400,000 of contingent consideration, based primarily on revenue
targets, may also be issued in connection with acquisitions we made in 2001.
SHAREHOLDERS' EQUITY
Share repurchases. In 2001, no common shares were purchased and cancelled. As of
December 31, 2001, 8,000 common shares were reserved in respect of our executive
stock purchase plan.
In 2000, we purchased and cancelled 226,000 of our common shares for an
aggregate cost of $2.0 million of which $0.6 million was charged to retained
earnings. In addition, we reserved 62,000 common shares in respect of our
executive stock purchase plan. Of the aggregate cost of $0.8 million, retained
earnings was charged with $0.4 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 $10.1 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.
Shareholders' equity increased by $6.7 million or 6% to $112.2 million as of
December 31, 2000 from $105.5 million as of December 31, 1999. This increase
resulted from net earnings of $6.1 million, an increase in the currency
translation account of $1.0 million and an increase in share capital of $3.1
million, which was offset by the payment of dividends of $2.5 million and excess
over stated value of shares purchased of $1.0 million.
38
MARKET RISK
INTEREST RATE RISK
We are exposed to interest rate risk in connection with our credit facilities.
We have approximately $104.5 million of floating rate bank debt. However, we
intend to pay down approximately $41.5 million of such debt with proceeds from
the sale of Old Lyme and $20 million of such debt with proceeds from this
offering. Accordingly, upon completion of this offering and the application of
the proceeds, we will be subject to interest rate risk on $43 million. Each 100
basis point increase in the interest rates charged on the balance of our
outstanding floating rate debt after the offering will result in a $0.3 million
decrease in our net earnings. We currently do not engage in any derivatives or
hedging transactions. However, we are investigating and may enter into an
interest rate swap for our outstanding foreign currency debentures.
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 our 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
decline in its value compared to the U.S. dollar in recent years. As shown in
the table under "Exchange rate information," the value of the Canadian dollar as
of December 31, 1999 was $0.6925 compared to $0.6279 as of December 31, 2001, a
decline of more than 9%.
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 and net earnings in
prior years.
<Table>
<Caption>
- ------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PERCENTAGES) 2001 2000 1999
- ------------------------------------------------------------------------------------
Canadian Operations revenue........................ $78,564 $75,236 $52,562
Percentage of total.............................. 51.0% 79.0% 97.2%
Canadian Operations net earnings................... $ 9,163 $ 6,446 $ 3,969
Percentage of total.............................. 91.6% 100.0% 100.0%
$0.01 change in value of C$ results in change in:
Revenue.......................................... +/-$785 +/-$752 +/-$ 525
Net earnings..................................... +/- 92 +/- 64 +/- 40
- ------------------------------------------------------------------------------------
</Table>
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. We have not entered into, and do not intend to enter into,
foreign currency forward exchange agreements.
39
GOODWILL AND OTHER INTANGIBLE ASSETS
Intangible assets arising from acquisitions consist of the following:
<Table>
<Caption>
- ------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS) 2001 2000
- ------------------------------------------------------------------------------------
Customer relationships...................................... $ 21,720 $ --
Non-competition covenants................................... 2,587 --
Trademarks.................................................. 1,839 --
Goodwill.................................................... 235,670 128,226
Accumulated amortization.................................... (15,637) (10,482)
--------------------
Total..................................................... $246,179 $117,744
- ------------------------------------------------------------------------------------
</Table>
The amounts allocated to customer relationships, non-competition covenants and
trademarks are determined by discounting the net cash flow of future commissions
adjusted for expected persistency, mortality and associated costs. The balance
of the excess purchase price is allocated to goodwill.
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." 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, 2001, our amortization has been
comprised of the following:
<Table>
<Caption>
- ------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS) 2001 2000 1999
- ------------------------------------------------------------------------------------
Customer relationships................................ $ 759 $ -- $ --
Non-competition covenants............................. 56 -- --
Goodwill.............................................. 4,125 3,260 1,626
--------------------------
Total............................................... $4,940 $3,260 $1,626
- ------------------------------------------------------------------------------------
</Table>
We estimate that our amortization charges for 2002 through 2006 for all
acquisitions consummated to date will be:
<Table>
<Caption>
- ------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS) 2002 2003 2004 2005 2006
- ------------------------------------------------------------------------------------
Customer relationships................. $1,487 $1,487 $1,487 $1,487 $1,487
Non-competition covenants.............. 80 24 -- -- --
------------------------------------------
Total................................ $1,567 $1,511 $1,487 $1,487 $1,487
- ------------------------------------------------------------------------------------
</Table>
40
EFFECTS OF NEW ACCOUNTING PRONOUNCEMENTS
BUSINESS COMBINATIONS, GOODWILL AND OTHER INTANGIBLE ASSETS
In July 2001, we adopted the Canadian Institute of Chartered Accountants (CICA)
Accounting Standards Board Handbook Sections 1581, "Business Combinations" and
Section 3062, "Goodwill and Other Intangible Assets" (Section 1581 and Section
3062, respectively) for all business combinations accounted for using the
purchase method consummated after that date. These sections harmonize Canadian
standards with Financial Accounting Standards Boards Statement of Financial
Accounting Standards No. 141 and No. 142 (SFAS No. 141 and SFAS No. 142,
respectively). Section 1581 and SFAS No. 141 require that all business
combinations be accounted for in accordance with the purchase method of
accounting. We have historically used the purchase method to record
acquisitions, with the exception of the initial 11 acquisitions in 1998, which
was accounted for as a pooling-of-interests. Section 1581 and SFAS No. 141 also
expand the definition of intangible assets acquired in a business combination
accounted for using the purchase method. As a result, the purchase price
allocation of future business combinations may be different than the allocation
that would have resulted under the old rules. Business combinations must be
accounted for using Section 1581 and SFAS No. 141 beginning on July 1, 2001. Our
acquisition of the Burnham, effective July 1, 2001, was accounted for under the
provisions of Section 1581 and SFAS No. 141.
In accordance with the above, we completed valuations of our 2001 acquisitions
and separately identified definite and indefinite life intangible assets apart
from goodwill acquired as a result of our business combinations accounted for
using the purchase method.
Prior to 2001, we allocated the entire excess of the purchase price over net
assets acquired to goodwill and primarily amortized that amount over a period of
40 years. Accordingly, there were no attempts to value and separately identify
other intangible assets apart from goodwill associated with business
combinations accounted for using the purchase method prior to 2001. For business
combinations with a date of acquisition before July 1, 2001, accounted for by
the purchase method, the transitional guidance of CICA Section 1581 and SFAS No.
141 require that the carrying amount of any recognized intangible assets, that
meet the recognition criteria in paragraph 1581.48 (SFAS No. 141 paragraph 61),
and has been included in an amount reported as goodwill (or as goodwill and
intangible assets) should be reclassified and accounted for as an asset, apart
from goodwill, upon initial application of CICA Section 3062 and SFAS No. 142 to
the entire financial statements.
For acquisitions prior to 2001, we did not separately identify and recognize
intangible assets apart from goodwill in our accounting records. Therefore, we
intend to continue to report the carrying value of the excess of purchase price
over net assets acquired as goodwill for purchase business combinations prior to
2001. We believe that this treatment is in accordance with the transitional
provisions of CICA Section 1581 and SFAS No. 141.
In January 2002, we adopted CICA Section 3062 and SFAS No. 142 "Goodwill and
Other Intangible Assets" for all business combinations accounted for using the
purchase method prior to June 30, 2001. CICA Section 3062 and SFAS No. 142
eliminate the amortization of goodwill, require annual impairment testing of
goodwill, and introduces the concept of definite and indefinite life intangible
assets. Indefinite life
41
intangible assets, similar to goodwill, will no longer be amortized and will be
tested at least annually for impairment. Definite life intangible assets will be
amortized over the estimated useful life of the asset. CICA Section 3062 and
SFAS No. 142 must be adopted on January 1, 2002.
These new requirements will increase our future net earnings by an amount equal
to the amount of goodwill amortization that has been discontinued, offset by any
goodwill impairment charges and additional amortization as a result of
reclassification of other intangible assets as goodwill. An initial impairment
test must be performed as of January 1, 2002. Any resulting impairment charge
from this initial test will be reported as a change in accounting principle, and
charged to opening retained earnings, net of tax.
Although we have not completed our assessment of the impact of the new
impairment testing rules or the reclassification rules, based on current
conditions, we do not expect to incur a material transition goodwill impairment
charge as of January 1, 2002. We do, however, expect that because goodwill will
no longer be amortized and charged to earnings that there will be a significant
impact on our consolidated earnings in 2002 when compared to consolidated
earnings for prior years. Amortization expense related to goodwill and other
intangible assets for the years ended December 31, 2001 was $4.9 million
compared to $3.3 million and $1.6 million in 2000 and 1999, respectively.
ACCOUNTING FOR THE DISPOSAL OF LONG-LIVED ASSETS
In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No.
144). SFAS No. 144 addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. 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 Principal 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).
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.
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 is classified as held for
disposal at December 31, 2001, will continue to be accounted for in accordance
with generally accepted accounting principles applicable at the date that the
disposal activities were initiated.
42
As of the time of this filing, the CICA has not harmonized Canadian GAAP with
the provisions of SFAS No. 144. Accordingly, any impact related to the adoption
of the provisions of SFAS No. 144 will be treated as a reconciling item between
U.S. and Canadian GAAP. However, we do not anticipate that the provisions of
SFAS No. 144 will have a material impact on our financial position or results of
operations as reported under U.S. GAAP.
43
INDUSTRY
OVERVIEW
An insurance broker is an intermediary that places and negotiates insurance
contracts for an insured. The broker works with the insured to assess its risk,
determine the amount and type of coverage it needs, and select insurance
providers. An insurance broker does not typically assume underwriting risk.
There are three main sub-sectors of the insurance brokerage industry: (a) retail
brokering, (b) wholesale brokering and (c) reinsurance brokering. Retail
brokering involves placing insurance on behalf of the insured. The retail broker
handles the majority of traditional risk placement services. Wholesale brokering
involves placing insurance on behalf of another insurance broker. Reinsurance
brokering involves placing reinsurance on behalf of an insurance company or
reinsurance company.
Typically, a broker is compensated for its services through commissions, which
are calculated and paid as a percentage of the total insurance premium, and
through fees for management and consulting services. The insured submits the
premium to the broker who then deducts its commission and remits the remaining
premium to the insurance company. The broker has the opportunity to earn
investment income on premiums held in trust, pending remittance to the insurance
company. Premiums are typically held in trust for less than 60 days and are
invested in short-term securities. Insurance brokers may also earn fees for
other risk management and consulting services that they perform for clients.
Volume overrides and contingent commissions can also be negotiated with an
insurance company based on the volume, type and profitability of the coverage
placed with that insurance company. Payments for volume overrides are received
from insurance companies throughout the year while payments for contingent
commissions are typically received in the first or second quarter of the
subsequent year.
TRENDS AFFECTING THE INSURANCE BROKERAGE INDUSTRY
Correlation with the property and casualty insurance underwriting industry. The
insurance brokerage industry is highly sensitive to changes in the property and
casualty insurance industry. The property and casualty insurance industry has
undergone a substantial restructuring in recent years, including significant
consolidation of insurers and until recently significant downward pressure on
premiums. In an effort to improve profitability, insurance companies began to
take steps to reduce their costs, including their distribution costs. As a
result, insurance companies have demanded increased service and efficiency from
insurance brokers. For example, brokers are expected to be fully automated in
order to provide additional administrative services and to gain efficiencies in
processing insurance applications. In addition, many insurers have redesigned
the insurer/broker relationship by replacing loyalty with demands for minimum
volume levels and requiring that the ratio between the claims paid and the
premiums collected be reduced on policies being sold by brokerages. Beginning in
2001, and accelerated by the events of September 11, 2001, insurance premiums
have risen. Increased premiums are now pervasive in the marketplace. Insurers
have also become more selective in underwriting risks, causing brokers to expend
greater resources to place coverages. In some cases, higher premium levels and
more selective underwriting have caused brokers to lose clients due to
unavailable or non-competitively priced products.
44
Consolidation. The soft pricing conditions that, until recently, characterized
the insurance market for more than a decade resulted in downward pressure on
margins in the insurance brokerage industry. Moreover, insurance brokers were
only able to achieve a relatively low level of organic growth, typically
tracking overall economic growth, because of the maturity of this industry.
These two factors resulted in increasing consolidation within the insurance
brokerage industry during the 1990s as insurance brokers sought to supplement
their organic growth with growth from acquisitions. Some of the larger
acquisitions in the 1990s included Marsh & McLennan Companies, Inc.'s purchases
of Johnson & Higgins and Sedgwick and Aon Corporation's purchases of Alexander &
Alexander and Frank B. Hall. In addition, a number of smaller insurance brokers
have employed acquisition strategies, such as Arthur J. Gallagher, Hilb, Rogal
and Hamilton, Brown & Brown, Acordia and USI, to develop a regional or national
presence.
This period of rapid consolidation has led to the emergence of two dominant
participants in the North American insurance brokerage market: Marsh & McLennan
and Aon Corporation, each of which primarily serve Fortune 1000 companies and
other large companies. In the middle-market, the insurance brokerage industry
tends to be fragmented and continues to be dominated by regional insurance
brokerages.
Despite consolidation, the insurance brokerage industry still features a large
number of small, independent brokers, that often lack sophisticated succession
plans. As the principals of small brokerages approach retirement, there is often
an opportunity for larger, better capitalized brokers to acquire the smaller
brokerages, providing the principals with liquidity for their ownership stake
and providing the consolidators with attractive acquisition targets.
Consolidators attempt to improve the efficiency of acquired brokerages by
providing new technology, centralizing certain key management and administrative
functions and providing a greater depth of products and services.
Non-traditional sources of competition. Additional competitive pressures have
arisen in the insurance brokerage industry from the entry of new market
participants, such as banks, mid-sized accounting firms and insurance companies.
In the United States certain banks have implemented aggressive insurance
brokerage acquisition strategies in an attempt to augment their non-interest
income and to capitalize on existing lending relationships with middle-market
customers. Some mid-sized accounting firms have also sought to expand their
existing relationships with middle-market customers by acquiring insurance
brokerages, although the success of this strategy has generally been limited.
Insurance companies also compete with brokers by directly soliciting insureds
without the assistance of an independent broker or agent. In addition, both
insurers and brokers have turned to the Internet as a direct marketing strategy.
Despite these trends we believe that traditional insurance brokers will continue
to have a significant role in the placement of larger, more complicated policies
and to function as risk managers on behalf of many small to medium-sized
clients.
Diversification. Another trend in the insurance brokerage industry is the
increasing diversification of products and services offered by larger regional
and national brokers. Brokers specializing in commercial lines traditionally
have focused on offering one or two niche products targeted to a particular
industry. In recent years, larger brokers have added a variety of new products
and services in order to meet the increasingly
45
complex risk management needs of their clients and to address the decision by
clients to retain more of the risk themselves to better manage premium levels.
Client demands. Clients generally have an increasing level of awareness of their
risk management options and are demanding improved coverage and services without
commensurate increases in price. Brokers no longer can adopt a uniform strategy
to attract and satisfy clients. Clients are more segmented, with certain groups
emphasizing price and others emphasizing personal service and efficiencies in
the insurance purchasing process. In this new environment, brokers must employ
different strategies and offer a broader range of products, services and
distribution channels to attract and satisfy different client segments.
RESULTING EFFECTS ON INSURANCE BROKERS
Property and casualty insurers are becoming more selective about the brokers
that distribute their products. Brokers must demonstrate to insurers
productivity (by meeting minimum volume levels and not exceeding specified loss
ratios), efficiency (by having the capability to process insurance applications
on behalf of the insurer) and sophistication (by having information technology,
aggressive marketing strategies and client retention systems). To meet these
high standards, brokers are changing the way they traditionally have operated
their businesses by making greater investments in technology, preparing
comprehensive business, marketing and succession plans and generally
transforming themselves into more sophisticated operations.
Many large brokers have established multiple distribution channels to attract
different market segments and to compete on a cost-effective basis with new
entrants into the market. In addition, many brokers now offer multiple types of
insurance products and services in an effort to provide one-stop shopping.
We believe that smaller brokers may be unable to invest in improving technology
or to further broaden their products and services. We also believe that
consolidation of the brokerage industry will continue as smaller brokers seek
access to the resources of larger partners and their economies of scale.
DIFFERENCES BETWEEN THE U.S. AND CANADIAN MARKETS
The trends in the insurance brokerage industry tend to be similar in the United
States and Canada. However, there are a few distinctions. For example:
- - premiums generally began to increase in the United States in the early part of
2001, but did not generally begin to increase in Canada until the latter part of
2001;
- - provincial governments in Canada provide publicly funded, government-managed
health insurance to all residents and some provincial governments have assumed
the role of the exclusive provider of primary liability automobile insurance,
which they sell through designated independent brokers; and
- - the Canadian market for insurance brokerage products and services is much
smaller than the U.S. market.
46
BUSINESS
OVERVIEW
We are a leading North American insurance brokerage providing a broad array of
property and casualty, life and health, employee benefits, investment and risk
management products and services. We focus primarily on middle-market commercial
accounts in the United States and Canada, which we serve through our
approximately 1,900 employees in 130 locations, using a variety of retail and
wholesale distribution channels. We define the middle-market as those clients
that generate annual commissions and fees ranging from $2,500 to $250,000. Since
our company was formed in 1998 through the merger of 11 Canadian insurance
brokerages, we have acquired an additional 78 brokerages and have established a
strong presence in the northeastern and midwestern United States and in the
Canadian provinces of Ontario, Quebec and British Columbia. Through a
combination of acquiring quality brokerages with proven track records and
organic growth, we have grown our revenue from $38.7 million in 1998 to $154.0
million in 2001, representing a compound annual growth rate of 58%. In addition,
our EBITDA has increased from $6.2 million in 1998 to $30.7 million in 2001,
representing a compound annual growth rate of 70%.
We operate through an organizational structure comprised of our head office,
larger regional brokerages that we call "hub" brokerages and smaller brokerages
that we call "fold-ins." Our head office coordinates selling and marketing
efforts, identifies cross-selling opportunities among our brokerages, negotiates
significant contracts with insurers and handles general administrative
functions. We have nine hub brokerages, four operating in the United States and
five in Canada. Each hub brokerage has a significant market presence in a
geographic region of the United States or Canada.
We operate our hub brokerages in a decentralized manner so they may more
effectively address their local market conditions. A hub brokerage is
responsible not only for the development of its own business, but also the
identification of fold-ins that can be acquired by and integrated into the
operations of the hub brokerage. This process allows each hub brokerage an
opportunity to strengthen its regional market presence by acquiring new or
complementary products and services and management talent and improve profit
margins through the reduction or elimination of redundant administrative
functions, premises and systems. Our structure enables our hub brokerages to
more effectively and quickly meet the changing needs of our clients in various
markets, while benefiting from the operating efficiencies and leverage of a
large brokerage.
OUR PRODUCTS AND SERVICES
We offer commercial and specialized insurance products and services to
businesses, personal insurance products and services to individuals and program
products to affinity groups and associations. We offer three categories of
commercial products and services: property and casualty products, employee
benefits and risk management services. We offer two categories of personal
products and services: property and casualty products and life, health and
financial products and services. Our program products involve the development,
in collaboration with insurance companies, of baskets of insurance products for
members of affinity groups or associations, such as bar associations, medical
associations and other professional groups. Our specialized risk products cover
47
diverse exposures such as environmental, professional liability and directors'
and officers' liability.
The chart below lists a selection of our commercial and personal insurance
products and services.
COMMERCIAL INSURANCE
<Table>
<Caption>
- -----------------------------------------------------------------------------------
PROPERTY AND CASUALTY EMPLOYEE BENEFITS RISK MANAGEMENT SERVICES
- -----------------------------------------------------------------------------------
- - Business property - Group life and health - Claims management
- - Auto and trucking fleets - Employment issues - Risk finance structuring
- - Technology - Human resources - Exposure evaluation
- - Intellectual property - Retirement plans - Coverage analysis
- - Natural disaster - Contract review - Contract review
- - Workers' compensation
- - Liability
- - Surety bonds
- - Business income
- - Accounts receivable
- - Environmental risks
- -----------------------------------------------------------------------------------
</Table>
PERSONAL INSURANCE
<Table>
<Caption>
- --------------------------------------------------------------------------------------------
PROPERTY AND CASUALTY LIFE, HEALTH AND FINANCIAL
- --------------------------------------------------------------------------------------------
- - Home - Disability
- - Personal property - Life
- - Auto and recreational vehicles - Investments
- - Travel accident and trip cancellation - Financial planning
- --------------------------------------------------------------------------------------------
</Table>
The mix of products and services we offer in the United States differs from
those we offer in Canada. Our product mix in the United States is comprised of
more commercial products and services as compared to more personal products and
services in Canada. In the United States in 2001, 83.6% of our commission income
was generated from the sale of commercial lines and 10.0% from personal lines.
In Canada in 2001, 47.1% of our commission income was generated from the sale of
commercial lines and 44.5% from personal lines.
STRATEGY
Our primary goals are to further develop our position as a leading North
American middle-market insurance brokerage and to generate significant sustained
shareholder value. We plan to achieve these objectives by executing the
following strategies:
Focus on middle-market commercial accounts. We focus our sales efforts on
middle-market companies. We estimate that there are more than 1.2 million
middle-market companies in the United States and more than 50,000 middle-market
companies in Canada. We believe that the insurance and risk management needs of
these companies are underserved because many of the brokers that target them
have limited capital
48
resources and lack the breadth of products and services that we are able to
offer due to our scale and strong insurer relationships. We primarily target
commercial accounts because they generally generate higher profit margins than
personal accounts. Commercial accounts also provide us with the opportunity to
sell personal insurance products and employee benefits to the employees of those
businesses.
Grow organically. We intend to increase profitability per customer and attract
new customers by leveraging our existing infrastructure to:
- - sell a broad range of products and services through the efficient use of a
variety of distribution channels;
- - effectively and efficiently identify and target profitable client segments by
employing technology to capitalize on our extensive customer databases; and
- - maximize cross-selling opportunities among our brokerages.
Grow through selected acquisitions. The introduction of new brokerages through
acquisitions is a fundamental component of our strategy. We have acquired an
additional 78 brokerages since our formation in 1998. We acquire brokerages to
grow our revenue, complement and supplement our existing products and services
and add experienced management. In addition, acquisitions of larger brokerages
allow us to further expand our hub platform and geographic reach. We believe
that we are well positioned to compete for quality brokerages and that our
proven success in consolidating brokerages in the past will make us attractive
to regional brokerages seeking to join with and share in the resources of a
larger North American brokerage.
Standardize procedures to increase operating efficiency and reduce costs. We
strive to implement the best operating and sales practices of our brokerages
across our company. We provide centralized marketing support to our brokers for
many specialized risk programs and group home and auto plans and we are
integrating promotional programs across our brokerage offices. Our brokerages
share certain systems, such as accounting and payroll, which reduce redundancies
and increase operating efficiencies. In addition, we are developing a
comprehensive quality control program and a standardized approach to our sales
and marketing efforts across our brokerages.
Recruit, train and retain qualified personnel. We are formalizing our recruiting
and training program to continue to build and sustain a sales and service team
with a wide variety of experience and capabilities. We intend to recruit
directly from college campuses and provide graduates with effective training and
attractive compensation packages. In addition, we are making a concerted effort
to develop a company-wide sales culture by promoting the techniques and results
of our most successful producers through regular newsletters, sales meetings,
sales tracking, awards, recognition programs and training.
We are implementing a formal internship program designed to groom selected
candidates to be successful producers within our company. We anticipate
commencing the program in the second half of 2002. Candidates will be selected
by our hub brokerages and typically will have a university education or relevant
work experience. Participants will spend several weeks learning about the
insurance industry, our company, quality standards, products and services and
leading sales techniques from our leading producers, members of management,
representatives of insurance compa-
49
nies and other members of the industry. Upon completion of the curriculum,
successful trainees will be designated for an area of specialization.
COMPETITIVE ADVANTAGES
We believe the following competitive advantages will enable us to achieve our
objectives:
Decentralized hub approach. Our decentralized hub approach allows us to react to
regional market conditions while still centrally managing the growth and
profitability of our business with consistent standards. Our geographic
diversity allows us to balance our revenue stream across markets and better
insulate us from regional adverse developments. Our hub structure provides us
with strong local name recognition and a ready platform, capable of reacting
quickly to smaller brokerage acquisition opportunities, and to assimilate
fold-ins once acquired.
Broad array of products and services offered through multiple distribution
channels. We offer a broad array of products and services, which allows us to
maintain and maximize existing client relationships and attract new clients. We
offer these insurance products and services through four distribution channels:
retail, wholesale property and casualty, wholesale life and financial and
call-centers. Our diversity provides us with the flexibility to determine the
most appropriate product and service and which distribution channel to employ
for particular market segments. We are exploring the implementation of Internet
strategies to reach a growing on-line market segment and to reduce costs in
processing insurance quotes and applications. See "--Distribution channels" for
a more detailed discussion about distribution.
Benefits of scale. Our scale, relative to smaller brokerages, provides insurers
with greater incentives to work with us. Enhanced insurer relationships often
result in mutual cost savings, increased volume overrides and contingent
commissions, favorable commission rates, collaborative marketing arrangements
and product design, exclusive distribution rights for certain territories and
products, and, in some cases, expanded authority to price and approve insurance
policies on behalf of insurance companies, thus eliminating the time and expense
required for the broker to solicit numerous price quotes. Our scale also makes
us attractive to smaller brokerages as a potential acquiror.
Committed and experienced management. Most of the senior managers of our
brokerages have over 20 years of experience in the industry and also have
significant shareholdings in our company, typically with transfer restrictions
for up to ten years. In addition, designated key employees in each brokerage are
rewarded for their contribution to their brokerage's success through a bonus
program that recognizes brokerage performance in excess of specified targets.
We believe that these strategies encourage loyalty and align the interests of
management of our brokerages with our corporate goals and the interests of our
shareholders, combining to create a powerful incentive to maximize financial
results. Most of our senior managers have extensive contacts in the insurance
brokerage industry, including participation in prominent industry associations,
brokerage networks and insurance company broker councils.
50
OUR OPERATIONS
We were created in November 1998 when 11 Canadian brokerages merged to form Hub.
Significant events that have occurred since our formation in the last four years
include:
- - January 1999--Fairfax purchased 5.4 million common shares of Hub for $35
million cash.
- - January 1999--We completed a financing whereby we issued a total of 2,838,080
common shares, on a private placement basis at a price of $8.60 per common share
or approximately $24.4 million in the aggregate. Fairfax purchased, through
certain of its wholly-owned subsidiaries, 1,185,184 of the common shares.
- - February 1999--We completed a public offering in Canada of 865,624 common
shares at a price of $8.60 per share for total proceeds of approximately $7.4
million and listed our common shares on the TSE.
- - During 1999--We acquired 44 brokerages in Canada and completed our first
acquisition in the United States (Mack and Parker, Chicago, Illinois).
- - During 2000--We acquired 18 brokerages in Canada and the United States
(including McCarthy).
- - During 2001--We acquired 16 brokerages in Canada and the United States
(including Flanagan, Kaye and Burnham).
Our activities are currently conducted from principal offices located in
Chicago, New York, Boston, Toronto, Vancouver and Montreal. The following table
lists our nine hub brokerages.
<Table>
<Caption>
- ------------------------------------------------------------------------------------------
NAME LOCATIONS DATE ACQUIRED
- ------------------------------------------------------------------------------------------
Burnham Battle Creek, Michigan, and other July 2001
locations in Michigan, Chicago,
Cleveland, Dallas
Kaye New York, Rhode Island, Connecticut, June 2001
California
C.J. McCarthy Boston June 2000
Mack and Parker Chicago, New York, Baltimore, October 1999
(includes Flanagan Cleveland, Denver
acquired in June 2001)
TOS Insurance Services Vancouver, British Columbia August 1999
Barton Insurance British Columbia November 1998
The Hub Group (Ontario) Southern and central Ontario November 1998
Martin Assurance & Gestion de Montreal, Quebec November 1998
Risques
Hub Financial Toronto, Calgary, Vancouver, Edmonton November 1998
- ------------------------------------------------------------------------------------------
</Table>
51
ACQUISITION PROCESS
Our senior management is responsible for identifying and negotiating the
acquisition of hub brokerages that are strategically suited to our growth
strategy. Typically we are familiar with the owners and management of the
acquisition target well before we initiate discussions. Most of the hub
brokerages we acquire are owner operated. We perform extensive diligence on
potential targets and we determine what the budget of the acquired brokerage
will be, including payroll and other adjustments, prior to completing the
acquisition.
We anticipate that we will selectively acquire more hub brokerages in geographic
regions where we currently have a limited presence, most notably the
southeastern, southwestern and western United States. There are many more
brokerages in the United States that we would consider suitable hub brokerage
acquisition candidates than in Canada due to the market size of the United
States. Each new hub will be characterized by the following attributes:
- - an experienced and talented management team prepared to make a long-term
commitment to executing our strategic business plan;
- - the ability to identify, acquire and seamlessly integrate smaller brokerages
(fold-ins) in its region;
- - specialization in certain products or services that may be beneficial to or
complement our other brokerages; and
- - a demonstrated record of organic growth and profitability, operating at, or
capable of achieving in the near term, minimum financial performance targets.
The retention of existing management at the hub brokerages we acquire is
important to the successful integration and subsequent operation of acquired
brokerages. We encourage existing management to stay with the acquired hub
brokerage by using our common shares to pay a large majority of the acquisition
price. The shares the owner/management receive are subject to transfer
restrictions for up to ten years, with 10% being released from these
restrictions on the third, fourth and fifth anniversaries of the acquisition.
DISTRIBUTION CHANNELS
We utilize retail, wholesale and call-center distribution channels, and have the
ability to employ these distribution channels for specific market segments. Each
brokerage uses a combination of different distribution channels:
- - Retail sales and service centers that target middle-market companies provide a
broad range of property and casualty insurance, life and health insurance, risk
management and financial services from traditional office locations leased by
our brokerages in local communities. All of our brokerages utilize this
distribution channel;
- - Retail call-centers provide sales and services by telephone to individuals or
members of employee groups, associations, affinity groups and specific
communities. We operate call-centers in Chicago, Toronto, Saint John, New
Brunswick and Chilliwack, British Columbia;
52
- - Wholesale life and financial services centers, known as managing general
agents, provide life and financial products and expertise to independent agents
on a wholesale basis from our locations in Vancouver, Calgary and Toronto; and
- - Wholesale property and casualty insurance centers provide products,
international risk solutions, captive management programs and specialty lines to
independent brokers and corporations in North America and internationally from
our locations in New York, Toronto and Vancouver.
In addition, we are a member of the Worldwide Broker Network, a consortium of
international brokerages which we can access to service clients resident in the
United States and Canada who require insurance internationally.
DECISION-MAKING PROCESS
We have established an executive committee that consists of our senior executive
officers and the heads of each of our hub brokerages. The executive committee is
comprised of two subcommittees that meet independently of each other, one
comprised of U.S. representatives (chaired by Bruce Guthart, our President, U.S.
Operations), and the other comprised of Canadian representatives (chaired by
Craig Barton, our President, Canadian Operations). The mandate of the
sub-committees is to discuss topics of common concern and opportunity for the
brokerages of each respective country and to make recommendations to the
executive committee and to implement and report to the executive committee
regarding initiatives that are undertaken. The executive committee convenes
monthly to discuss company-wide strategies and developments.
COMPETITION
The insurance brokerage industry is highly competitive. We face several sources
of competition including other brokerages, insurance companies, banks and other
financial services companies. Brokerage consolidators have been active in the
market over several years. Consolidators, often publicly traded corporations,
consolidate small to medium size independent brokerages with a view to
strengthening their competitive position and increasing their market share. In
addition to direct competition from the insurance companies, new sources of
competition are emerging as banks in the United States accelerate their efforts
to diversify their financial services to include insurance brokerage services
(often through the acquisition of established insurance brokerages) and as the
Canadian chartered banks lobby for greater flexibility to create and market
insurance products.
We compete for clients in both the United States and in Canada on the basis of
reputation, client service, program and product offerings and the ability to
tailor our products and risk management services to the specific needs of a
client. We believe that we are in a favorable competitive position in most of
the meaningful aspects of our business, because of our broad array of products
and services, diversity of distribution channels, industry focus and expertise,
and management experience. We believe that our most serious competitive threat
in the United States will likely come from brokerages such as Arthur J.
Gallagher, Brown & Brown and Hilb, Rogal and Hamilton, who pursue an acquisition
or consolidation strategy similar to ours. We believe that our primary
competitors in Canada are local retail brokers.
53
GOVERNMENT REGULATION
LICENSES
In every state, province and territory in which we do business, the relevant
brokerage is required to be licensed or to have received regulatory approval to
conduct business. In addition to licensing requirements, most jurisdictions
require individuals who engage in brokerage and certain insurance service
activities to be licensed personally.
Our operations depend on the validity of and continued good standing under the
licenses and approvals pursuant to which we operate. Licensing laws and
regulations vary from jurisdiction to jurisdiction and are always subject to
amendment or interpretation by regulatory authorities. Such authorities are
generally vested with general discretion as to the grant, renewal and revocation
of licenses and approvals.
PRIVACY
The management and dissemination of information is critical to our business. We
gather information from our customers to assess and address their insurance
needs. We share information both internally, among our employees, and, where
appropriate and permitted, between our brokerages, as well as externally, with
insurers. We believe we have taken appropriate steps to safeguard our customers'
information.
A recent trend in both the United States and Canada has been the introduction of
more comprehensive privacy laws designed to protect the privacy of individuals
from the undisclosed or non-consensual sharing of sensitive information for
commercial purposes. As the gathering and use of information is such an integral
component of our business, we must always be alert for changes in the
information regulatory environment. For example, in response to the recent
effectiveness of the privacy provisions of the Gramm-Leach-Bliley Act, our
U.S.-based brokerages have developed or refined written privacy policies that,
together with appropriate opt-out elections, have been sent to all of our
customers who are resident in the United States.
In Canada, the federal Personal Information Protection and Electronic Documents
Act and similar proposed provincial legislation will affect our operations as of
January 1, 2004, and possibly sooner. This new legislation will require us to
obtain the consent of our customers before their personal information can be
collected, used or disclosed. Furthermore, to the extent we share information
with federally regulated Canadian organizations or disclose personal information
between provinces or internationally for consideration, we are already subject
to the federal legislation. We do not believe that these regulatory changes will
have any significant effect on our operations.
EMPLOYEES
As of December 31, 2001, we employed 1,932 persons on a full-time basis, 1,544
of whom were employed in sales and customer service and 388 of whom were
employed in corporate finance and administration. None of our employees are
represented by a labor union and we have never experienced a work stoppage. We
believe our relationship with our employees is good.
54
FACILITIES
We maintain our corporate headquarters at premises that we sublet from Mack and
Parker in Chicago, Illinois. This facility, totaling approximately 3,500 square
feet, contains corporate, finance, administration, sales and customer support
functions. The lease on the premises expires on October 1, 2011. We also lease
the following premises:
<Table>
<Caption>
- -------------------------------------------------------------------------------------
SPACE NUMBER OF LEASE EXPIRATION OF
FACILITY (SQUARE FEET) LOCATIONS REGIONAL HEAD OFFICE
- -------------------------------------------------------------------------------------
California....................... 7,200 1 September 30, 2007
Connecticut...................... 10,400 1 November 30, 2002
Illinois......................... 50,200 4 October 1, 2011
Massachusetts.................... 32,800 6 July 1, 2002
Michigan......................... 25,000 8 June 30, 2011
New York......................... 82,600 3 August 31, 2010
Rhode Island..................... 7,500 1 April 30, 2007
Texas............................ 15,000 2 September 30, 2006
Alberta.......................... 21,800 5 December 31, 2006
British Columbia................. 175,300 68 December 31, 2010
New Brunswick.................... 2,200 1 May 31, 2004
Ontario.......................... 106,400 24 August 31, 2010
Quebec........................... 62,300 4 August 31, 2010
- -------------------------------------------------------------------------------------
</Table>
Total annual base rent for all of these locations is approximately $7.9 million.
We believe that our facilities are well maintained and in good condition and are
adequate for our current needs. We expect that suitable additional space will be
available as required.
LEGAL PROCEEDINGS
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.
55
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following persons are our executive officers and directors as of December
31, 2001:
<Table>
<Caption>
- --------------------------------------------------------------------------------------------
NAME AGE POSITION
- --------------------------------------------------------------------------------------------
Martin P. Hughes 53 Chairman, Chief Executive Officer and
Director
Richard A. Gulliver 46 President, Chief Operating Officer and
Director
John Varnell(1) 45 Vice-Chairman and Director
Bruce D. Guthart 46 President, U.S. Operations and Director
R. Craig Barton 48 President, Canadian Operations and
Director
W. Kirk James 46 Vice President, Secretary and General
Counsel
Dennis J. Pauls 41 Vice President and Chief Financial Officer
Peter L. Scavetta 41 Vice President, Finance
Jean Martin 55 Vice President and Director
Anthony F. Griffiths(1)(2) 71 Director
Paul Murray(1)(2) 70 Director
Bradley P. Martin(3) 42 Director
- --------------------------------------------------------------------------------------------
</Table>
(1) Member of audit committee.
(2) Member of compensation committee.
(3) Will stand for election to our board of directors at our annual general
meeting in May 2002 and will be appointed to our audit committee and
compensation committee.
Martin P. Hughes has served as our Chairman, Chief Executive Officer and a
director since December 1999. Mr. Hughes has 28 years of experience in the
insurance brokerage industry. In 1973, Mr. Hughes joined Mack and Parker for
which he served as Chairman from 1999 to 2001 and as President from 1990 to
1999. Mr. Hughes previously served as Chairman of Assurex International, a
worldwide insurance service organization, as director of the Assurex Marketing
Group and as a director of the Council of Insurance Agents and Brokers.
Richard A. Gulliver has served as our President and a director since November
1998, and as our Chief Operating Officer from December 1999 to the present and
as our Chief Executive Officer from January 1999 to December 1999. Mr. Gulliver
has 25 years of marketing, sales and management experience in the insurance
brokerage industry. Prior to joining us, Mr. Gulliver served as President of The
Hub Group (Ontario) from 1997 to 1998 and of its subsidiary, Gulliver Insurance
Brokers Ltd., from 1986 to 1998. In 1995, Mr. Gulliver and others collaborated
to form Insurance Network Solutions Inc., a company for which Mr. Gulliver
served as President from 1995 to 1997. Mr. Gulliver holds his designation from
the Insurance Institute of Canada and is a Canadian Certified Insurance Broker.
56
John Varnell has served as a director since November 1998 and as our Vice
Chairman since December 1999. Prior to December 1999, Mr. Varnell served as our
Chairman and until February 1999 as our Chief Financial Officer. Mr. Varnell has
been a senior officer of Fairfax since 1986 and was involved in most of
Fairfax's acquisitions and investments from then until 2001. Mr. Varnell is a
chartered accountant.
Bruce D. Guthart has served as our President, U.S. Operations and a director
since August 2001. Prior to joining us, Mr. Guthart held the position of
President of Kaye since its formation in 1993. He was appointed Chief Executive
Officer of Kaye in 1996 and its Chairman in 1997. Mr. Guthart is a Director of
the Council of Insurance Agents and Brokers.
R. Craig Barton has served as our President, Canadian Operations since November
2001, and as a director since November 1998. Mr. Barton has been involved in the
insurance brokerage industry for approximately 29 years. He has been the
President and Chief Executive Officer of Barton Insurance since 1988.
W. Kirk James has served as our Vice President, Secretary and General Counsel
since December 1999. Mr. James has practiced law for 20 years and is a member of
the Law Society of Upper Canada (Ontario). Prior to joining us, Mr. James was a
corporate lawyer and partner with the law firm McKenzie, Lake, in London,
Ontario from 1991 to 1999.
Dennis J. Pauls has served as our Chief Financial Officer and as Vice President
since February 1999 and December 1999, respectively. Mr. Pauls served as Chief
Financial Officer of The Hub Group (Ontario) and its subsidiary, Gulliver
Insurance, from 1991 to 1999, where he participated in planning the initial
organization and structure of our company. Mr. Pauls is a chartered accountant.
Peter L. Scavetta, has served as our Vice President, Finance, since December 1,
2001. Prior to that, since September 1992, Mr. Scavetta was Vice President,
Finance of Kaye. Mr. Scavetta has been a certified public accountant since 1985
and is a member of the American Institute of Certified Public Accountants. Prior
to joining Kaye, Mr. Scavetta held positions in both the audit and tax
departments at Coopers & Lybrand, Certified Public Accountants.
Jean Martin has been our Vice President and a director since November 1998. Mr.
Martin has been involved in the insurance brokerage industry for approximately
30 years. He has served as President of Martin Assurance (and its predecessor
companies) for the past 20 years.
Anthony F. Griffiths has served as a director since December 1998. He is
currently an independent business consultant and corporate director. Mr.
Griffiths became the Chairman of Mitel Corporation, a telecommunications
company, in 1987 and also assumed the positions of President and Chief Executive
Officer in addition to that of Chairman from 1991 to 1993. He is currently a
director of various operating subsidiaries of Fairfax and of Alliance Atlantis
Communications Inc., Leitch Technology Corporation, QLT Inc. and Russel Metals
Inc.
Paul Murray has served as a director since January 1999. He has been President
of Pinesmoke Investments Ltd. of Toronto, Ontario, since 1985. From 1990 to 1998
Mr. Murray served as President, Secretary and Treasurer of Lockwood
Manufacturing Inc. of Brantford, Ontario. Mr. Murray is a chartered accountant.
57
Bradley P. Martin will stand for election to our board of directors at our
annual general meeting in May 2002. He has served as a Vice President of Fairfax
since June 1998. Prior to that, Mr. Martin had been a partner at the law firm of
Torys LLP in Toronto, Ontario since 1995.
BOARD COMMITTEES
Our board of directors has an audit committee, a compensation committee and an
executive committee.
AUDIT COMMITTEE
Our board of directors has established an audit committee to be comprised of
three independent directors. The audit committee's primary responsibilities
include:
- - engaging independent accountants;
- - approving independent audit fees;
- - reviewing quarterly and annual financial statements, audit results and
reports, including management comments and recommendations thereto;
- - reviewing our system of controls and policies, including those covering
conflicts of interest and business ethics;
- - evaluating reports of actual or threatened litigation;
- - considering significant changes in accounting practices; and
- - examining improprieties or suspected improprieties, with the authority to
retain outside counsel or experts.
Our audit committee is currently comprised of Anthony F. Griffiths, Paul Murray
and John Varnell. We intend to appoint Bradley P. Martin to our audit committee
after he is elected to our board of directors at our next annual general
meeting.
COMPENSATION COMMITTEE
Our board of directors has established a compensation committee to be comprised
of three independent directors. The compensation committee's primary
responsibilities include reviewing and making recommendations to our board of
directors regarding our restricted share plan, share purchase plans and
compensation to our officers. The compensation committee also establishes and
reviews general policies relating to compensation and benefits of our employees.
Our compensation committee is currently comprised of Anthony F. Griffiths and
Paul Murray. We intend to appoint Bradley P. Martin to our compensation
committee after he is elected to our board of directors at our next annual
general meeting.
EXECUTIVE COMMITTEE
We also have an executive committee, appointed by our board of directors,
comprised of certain of our senior executive officers identified in the table
under the heading "--Executive officers and directors" as well as the following,
each of whom are the heads of hub brokerages: Charles C. Burnham (Burnham),
Nelson Tilander (Hub Ontario), Edward Mack (Mack and Parker), Joseph P. Flanagan
(Mack and Parker),
58
Cornelius J. McCarthy (McCarthy) and Larry Lineker (TOS). The executive
committee meets on a monthly basis and assists management in assessing,
developing and exploiting company-wide brokerage opportunities and initiatives.
See "Business--Our operations--Decision making process" for a more detailed
description of the executive committee.
DIRECTOR COMPENSATION
Directors other than directors who are officers of Hub or of any of Hub's
subsidiaries ("outside directors") are paid an annual retainer of approximately
$3,100 for their services. Additional amounts may be paid to outside directors
for special assignments. In 2001 three outside directors were entitled to
receive an aggregate of $9,300 pursuant to these arrangements. Directors other
than outside directors are not compensated for their services. Directors are
reimbursed for travel and other out-of-pocket expenses incurred in attending
board or committee meetings or in otherwise being engaged on Hub's business.
EXECUTIVE COMPENSATION
The following table sets forth compensation information for our Chief Executive
Officer and our five other most highly compensated executive officers, referred
to as our named executive officers, during the year ended December 31, 2001.
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------------------
ANNUAL COMPENSATION
------------------------------------- LONG-TERM
NAME AND PRINCIPAL OTHER ANNUAL ALL OTHER COMPENSATION
POSITION YEAR SALARY BONUS COMPENSATION(1) COMPENSATION(2) AWARDS
- ---------------------------------------------------------------------------------------------------------
Martin P. Hughes........... 2001 $350,000 $350,000 $45,989 $ -- --
Chairman and Chief
Executive Officer
Richard A. Gulliver........ 2001 250,000 250,000 42,635 -- --
President and Chief
Operating Officer
Bruce D. Guthart(3)........ 2001 250,000 296,000 13,700 2,550 --
President, U.S. Operations
R. Craig Barton(4)......... 2001 258,715 538,452 39,097 4,366 --
President, Canadian
Operations
Dennis J. Pauls............ 2001 200,000 100,000 14,272 -- --
Vice President and Chief
Financial Officer
W. Kirk James.............. 2001 200,000 100,000 17,764 -- --
Vice President, Secretary
and General Counsel
- ---------------------------------------------------------------------------------------------------------
</Table>
(1) The amounts quoted in this column includes the taxable benefits represented
by automobile allowances, memberships, participation in group medical and life
insurance plans, relocation expenses, an interest free loan to R.C. Barton Ltd.
(now repaid in full) and interest or deemed interest with respect to 10 year
interest free loans granted in connection with our executive share purchase plan
described under "Executive share purchase plan" and "Indebtedness of directors,
executive officers and senior officers." The shares issued under the plan vest
at 10% per year while the participant remains employed by us. Until the
principal of the loan has been repaid, these shares continue to be held as
collateral for the outstanding loan. We have agreed to forgive the $0.5 million
and $0.4 million loans made by us to each of Mr. Hughes and Mr. Gulliver,
respectively, after each has been continuously employed by us for ten years from
the original date of the respective loan. When we implement our restricted share
plan, Mr. Hughes and Mr. James will no longer participate in our executive share
purchase plan.
(2) The amounts quoted in this column include our contribution to Mr. Guthart's
401(k) plan and a contribution to the Barton Insurance retirement plans on
behalf of Mr. Barton.
59
(3) Employed and paid by Hub's subsidiary, Kaye (which was acquired by us
effective June 2001) for six months in 2001.
(4) Salary and Bonus until December 31, 2001 were paid in the form of fees to
Librico Properties Ltd., a corporation controlled by R. Craig Barton, by Hub's
subsidiary, Barton Insurance. Pursuant to the employment agreement we entered
into with Mr. Barton on January 1, 2002, salary and bonus will now be paid by
Barton Insurance directly to Mr. Barton.
MANAGEMENT AND EMPLOYMENT CONTRACTS
We have entered into employment agreements with Martin Hughes, our Chairman and
Chief Executive Officer, Richard Gulliver, our President and Chief Operating
Officer, Dennis J. Pauls, our Vice President and Chief Financial Officer, and W.
Kirk James, our Vice President, Secretary and General Counsel. The agreements
provide Mr. Hughes, Mr. Gulliver, Mr. Pauls and Mr. James with an annual salary
of $350,000, $300,000, $200,000 and $200,000, respectively, participation in our
401(k) plan, in which we provide a matching contribution of 60% of the
participant's contribution, up to a maximum of three percent of the
participant's salary, and an annual bonus of up to $350,000, $200,000, $100,000
and $100,000, respectively, to be declared at the discretion of our compensation
committee. Our compensation committee determines the amount of the annual
bonuses of Mr. Hughes, Mr. Gulliver, Mr. Pauls and Mr. James taking into
consideration not only individual performance, but also our performance as a
company relative to our growth and profitability targets for the applicable
year. Under our agreement with Mr. Hughes, he is provided with use of a company
car. Under our respective agreements with Mr. Gulliver, Mr. Pauls and Mr. James,
each is provided with a car allowance. In the event of termination of Mr.
Hughes, Mr. Gulliver, Mr. Pauls or Mr. James by us without cause, or by Mr.
Hughes, Mr. Gulliver, Mr. Pauls or Mr. James for good reason (including any
significant alteration in the nature of his duties), each is entitled to payment
of an amount equal to one year's salary plus a ratable portion of an amount
equal to his bonus for the prior year. Each of Mr. Hughes, Mr. Gulliver, Mr.
Pauls and Mr. James is obligated not to compete with us through employment or
other arrangements with any insurance brokerage in the United States or Canada
(except in the case of termination by us without cause or by him for good
reason) or to solicit any of our clients or employees for a period of two years
following the cessation of his employment.
Our agreements with Mr. Hughes, Mr. Gulliver, Mr. Pauls and Mr. James provide
that once we implement our restricted share plan each will be awarded 44,130
shares, 35,817 shares, 25,000 shares and 30,000 shares, respectively, under the
plan. The shares will be awarded without payment of any cash consideration and
to be free from transfer restrictions, other than securities laws restrictions,
as to 50% after five years and the balance after 10 years of employment.
Our hub brokerage, Kaye, has entered into an employment agreement with Bruce
Guthart, our President, U.S. Operations, as President and Chief Executive
Officer of Kaye. Under the agreement, Mr. Guthart is entitled to an annual
salary of $500,000, a car allowance, participation in our 401(k) plan and an
annual bonus representing 50% of the aggregate of any bonuses earned by senior
management under Kaye's management bonus agreement. In the event of termination
by us without cause, or by Mr. Guthart for good reason (including significant
alteration in the nature of his duties), Mr. Guthart is entitled to payment of
an amount equal to one year's salary plus a ratable portion of his share of
Kaye's management bonus for the year. Mr. Guthart is
60
obligated not to compete with us through employment or other arrangements with
any insurance brokerage in the United States (except in the case of termination
by us without cause or by him for good reason) or to solicit any of our clients
or employees for a period of two years following the cessation of his
employment. In connection with the acquisition of Kaye, we agreed to award Mr.
Guthart 88,261 restricted shares when we implement our restricted share plan, to
be issued without payment of any cash consideration and to be free from transfer
restrictions, other than securities laws restrictions, as to 50% after five
years and the balance after 10 years of employment.
Our hub brokerage, Barton Insurance, has entered into an employment contract
with Craig Barton, our President, Canadian Operations, as President and Chief
Executive Officer of Barton. Under the agreement, Mr. Barton is entitled to an
annual salary of C$400,000, and an annual bonus representing his share, as
determined by him, of the aggregate of any bonuses earned by senior management
under Barton's management bonus agreement. In the event of termination by us
without cause, Mr. Barton is entitled to payment of an amount equal to one
year's salary plus a ratable portion of his share of Barton's management bonus
for the year. Mr. Barton is obligated not to compete in any insurance brokerage
in the Province of British Columbia (except in the case of termination by us
without cause) or to solicit any of our clients or employees for a period of two
years following the cessation of his employment.
Each member of senior management of our brokerages is subject to an employment
agreement that sets out the terms of his or her employment. These agreements
typically include non-competition covenants, which continue for two years
following the cessation of employment, except in the case of termination by us
without cause, and generally provide for a payment equal to one year's salary in
the event they are terminated without cause. Members of senior management of our
brokerages also may be entitled to bonuses pursuant to the management bonus
agreement for the respective brokerage if operating targets are achieved.
We believe that the compensation we provide to our senior management is
commensurate with that provided to senior management of similar sized insurance
brokerages.
EXECUTIVE SHARE PURCHASE PLAN
We have an executive share purchase plan under which we may from time to time
grant or guarantee loans to our designated employees, officers and service
providers to purchase common shares. Our board of directors determines who may
participate in the plan. Participation in the plan is entirely voluntary. A loan
advanced or arranged under the plan is repayable by the participant ten years
from the date of the loan. We pay interest on behalf of the employee. A
participant's entitlement to shares allocated under the plan vests at the rate
of 10% per year while employed. All shares purchased pursuant to the plan are
held as security for the outstanding loans of the participant. Common shares
purchased under the plan may be purchased from treasury at market values or in
the open market without any discount from fair market value. The maximum number
of shares authorized for issuance from treasury under such plan is 1,000,000.
There is no limit on the number of shares, which may be purchased in the open
market under the plan. The plan is administered by Computershare Trust Company
of Canada. We have arranged and made loans under the plan. See "--Indebtedness
of directors, executive officers and senior officers."
61
EMPLOYEE SHARE PURCHASE PLAN
We have an employee share purchase plan under which our employees and service
providers who have completed three months of continuous service may purchase our
common shares by contributing to the plan up to a maximum of 10% of his or her
annual compensation. We do not make any loan or other contribution in respect of
such purchase. Participation in the plan is entirely voluntary and transfers of
shares acquired under this plan are not restricted by the terms of the plan.
Common shares purchased under the plan are to be made by the trustee of the plan
either from treasury at market values or in the open market without any discount
from fair market value. The maximum number of shares authorized for issuance
from treasury under such plan is 1,000,000. There is no limit on the number of
shares which may be purchased in the open market under the plan. The plan is
administered by Computershare Trust Company of Canada.
401(K) PLAN
We have established a 401(k) retirement savings plan that is intended to qualify
as a profit-sharing plan under Internal Revenue Code Section 401(a), and
includes a cash or deferred arrangement that is intended to qualify under Code
Section 401(k). The plan was established and is maintained for the exclusive
benefit of our eligible employees and their beneficiaries. The plan was
effective as of January 1, 2002 and merged the 401(k) plan and related assets
previously administered by each of Mack and Parker, McCarthy, Kaye and Flanagan.
We make matching contributions for active participants equal to 60% of their
permitted contributions, up to a maximum of three percent of the participant's
salary. One-third of our contribution will be used by the trustee that
administers the plan to fund the purchase of our common shares on the open
market.
EQUITY-BASED AND OTHER COMPENSATION PLANS
We intend to adopt plans that provide for awards of restricted shares and
options to purchase our common shares, and a long-term incentive compensation
plan prior to the completion of this offering. The terms of these proposed plans
have not been finalized.
INDEBTEDNESS OF DIRECTORS, EXECUTIVE OFFICERS AND SENIOR OFFICERS
The aggregate outstanding indebtedness represented by loans made under our
executive share purchase plan to our current and former officers, directors and
employees as at December 31, 2001 was $5,542,341 and $2,141,823 to a Canadian
chartered bank and our company, respectively. We pay the interest on the loans
provided by the bank, calculated at rates ranging from prime plus one-half
percent to prime plus one-and-a-half percent per annum. We have guaranteed the
loans provided by the bank and may, under certain circumstances, be obligated to
purchase the loans from the bank.
62
The following table summarizes indebtedness of certain officers and directors
represented by loans made under our executive share purchase plan:
<Table>
<Caption>
- ------------------------------------------------------------------------------------------
LARGEST AMOUNT FINANCIALLY
OUTSTANDING AMOUNT ASSISTED SECURITIES
DURING FISCAL OUTSTANDING PURCHASED DURING SHARES
YEAR ENDED AS OF FISCAL YEAR ENDED HELD AS
NAME AND PRINCIPAL DECEMBER 31, DECEMBER 31, DECEMBER 31, SECURITY FOR
POSITION 2001 2001 2001 INDEBTEDNESS
- ------------------------------------------------------------------------------------------
Martin P. Hughes(1)... $463,177 $463,177 -- 36,883
Chairman and Chief
Executive Officer
Richard A. Gulliver... 397,147 397,147 -- 52,444
President and Chief
Operating Officer
R. Craig Barton....... 545,877 545,877 -- 86,937
President, Canadian
Operations
W. Kirk James(1)...... 125,580 125,580 -- 11,765
Vice President,
Secretary and General
Counsel
Jean Martin........... 52,445 52,445 -- 6,187
Vice President
- ------------------------------------------------------------------------------------------
</Table>
(1) When we implement our restricted share plan, Mr. Hughes and Mr. James will
no longer participate in our executive share purchase plan.
The aggregate indebtedness of our directors, executive officers and senior
officers, other than under our executive share purchase plan is $50,801 as at
December 31, 2001, and is summarized in the following table:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------
LARGEST AMOUNT AMOUNT
OUTSTANDING DURING AMOUNT OUTSTANDING AS
FISCAL YEAR ENDED OUTSTANDING AS OF OF
NAME AND PRINCIPAL POSITION DECEMBER 31, 2001 DECEMBER 31, 2001 MARCH 15, 2002
- -----------------------------------------------------------------------------------------
R. Craig Barton(1)........... $22,187 $18,684 --
President, Canadian
Operations
W. Kirk James(2)............. 37,674 32,117 --
Vice President, Secretary and
General Counsel
- -----------------------------------------------------------------------------------------
</Table>
(1) A non-interest bearing loan made by our subsidiary Barton Insurance to R.C.
Barton Ltd., a corporation controlled by Mr. Barton, to facilitate the
acquisition of shares in the capital of Barton Insurance.
(2) A non-interest bearing loan made by us to Mr. James to facilitate the
relocation of his principal residence from Toronto, Ontario to Chicago,
Illinois.
63
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
BUSINESS RELATIONSHIPS
RELATIONSHIPS WITH INSURANCE COMPANIES OWNED BY FAIRFAX
Most of the founding 11 brokerages have generated a significant portion of their
revenue from the sale of insurance policies issued by Lombard Canada Ltd., a
property and casualty insurer which is a wholly-owned subsidiary of Fairfax.
Certain of the founding 11 brokerages and their principals have in the past
received financial support from Lombard in accordance with standard practice
between insurance companies and their significant brokers. Such financial
support was primarily in the form of loans and equity investments negotiated at
arms length between the parties. Certain of the former shareholders of the
founding 11 brokerages who are officers or employees of the founding 11
brokerages or Hub or associates of such individuals remain indebted to Lombard
in an aggregate amount of approximately C$5.2 million.
We also had transactions with and recorded commission income from the following
Fairfax insurance companies which represented approximately 4.9%, 8.6% and 12.1%
of our total revenue in 2001, 2000 and 1999, respectively.
<Table>
<Caption>
- ----------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
(IN THOUSANDS) 2001 2000 1999
- ----------------------------------------------------------------------------------------
Lombard General Insurance Company of Canada................. $6,123 $7,527 $6,077
Commonwealth Insurance Company.............................. 374 351 353
Federated Insurance Company of Canada....................... 28 10 1
Markel Insurance Company of Canada.......................... 88 72 61
Crum & Forster Insurance.................................... 745 291 67
TIG Specialty Insurance..................................... 150 -- --
--------------------------
$7,508 $8,251 $6,559
- ----------------------------------------------------------------------------------------
</Table>
As of December 31, 2001, we had accounts receivable and accounts payable
balances with the Fairfax insurance companies in the amounts of $0.3 million and
$6.8 million, respectively. All revenue and related accounts receivable and
accounts payable are the result of transactions in the normal course of business
and were transacted at fair market value.
As part of our acquisition of Kaye, we acquired Old Lyme but have since entered
into an agreement to sell Old Lyme to a subsidiary of Fairfax, at a purchase
price equivalent to its U.S. GAAP book value as of December 31, 2001 of
approximately $42.8 million.
In connection with the sale of Old Lyme, we entered into three agreements with
Old Lyme under which some of our subsidiaries will continue to provide services
that they had previously provided to Old Lyme. As a result of our sale of Old
Lyme the amount of our revenue generated from transactions with insurance
companies owned by Fairfax will increase in 2002.
Claims settlement agreement. We will provide claims settlement and
administration services to Old Lyme. Such services will include analysis,
investigation, adjustment, settlement and denial of claims. Compensation will be
based on a schedule.
64
Underwriting agreement. Two of our subsidiaries will provide
underwriting-related services to Old Lyme, including, but not limited to,
receiving and reviewing applications submitted by producing brokers and
determining the premium to be charged. We will be compensated on a commission
basis and will also be eligible to receive a contingent commission equal to a
percentage of Old Lyme's underwriting profit generated from new business we
place. Although, we will not incur underwriting risk, under the agreement Old
Lyme will be entitled to offset a percentage of underwriting losses resulting
from new business we place against our future contingent commissions.
Administration agreement. We will provide certain administrative services to Old
Lyme, including actuarial, audit, executive, legal, personnel, accounting and
other financial services. In addition, we will also provide office space and
office equipment. Compensation will be based on the actual cost we incur to
provide the services.
FAIRFAX INSURANCE COVERAGE
Fairfax has purchased an insurance policy from Lloyd's of London and various
other insurance companies covering comprehensive crime insurance, insurance
companies professional liability insurance, directors' and officers' liability
and company reimbursement insurance, employment practices liability insurance
and fiduciary liability insurance. Fairfax's coverage under the policy is
subject to an overall aggregate limit of $250 million combined during the policy
period which runs from May 31, 2000 to May 31, 2003, subject to various single
loss limits, deductibles, retentions, and other exclusions, adjustments and
limitations. The comprehensive crime insurance portion of the policy covers
specified losses sustained by Fairfax and certain entities in which more than
50% of the outstanding voting shares are owned directly or indirectly by
Fairfax, and other entities in which Fairfax maintains an ownership interest,
including us. The professional liability insurance, directors' and officers'
liability and company reimbursement insurance, employment practices liability
insurance and fiduciary liability insurance portion of the policy cover
specified losses sustained by the companies and their officers and directors in
respect of claims made during the policy period. Coverage includes directors and
officers and company liability coverage, employment practices coverage,
fiduciary liability coverage, and errors and omissions coverage. Our share of
the premiums for this policy for the year ended December 31, 2001 was $350,000.
RELATIONSHIPS WITH SENIOR OFFICERS AND DIRECTORS
When we acquire a brokerage we only purchase the brokerage operations and not
other assets such as a building from which a brokerage operates. In
circumstances where the former principal of an acquired brokerage owns the
office space, we frequently enter into an agreement to lease the premises from
the former principal at fair market value. R. Craig Barton, President of our
Canadian Operations and President of Barton Insurance, leases four premises to
us through a company he controls. The following table lists the annual base rent
and expiry date of each lease.
<Table>
<Caption>
- ---------------------------------------------------------------------------------
ANNUAL BASE RENT EXPIRY DATE
- ---------------------------------------------------------------------------------
C$138,000................................................... December 31, 2010
C$59,400.................................................... November 30, 2008
C$21,450.................................................... November 30, 2008
C$285,524................................................... December 31, 2007
- ---------------------------------------------------------------------------------
</Table>
65
In addition, we lease one of our locations from Mr. Barton's brother, at an
annual rent of C$45,320. This lease expires on November 30, 2008. Under the
terms of the leases, after five years the annual base rent will increase by 20%.
We believe that each of these leases represents the fair market value of the
associated premises.
PUT OPTIONS
In conjunction with our acquisition of Flanagan and Burnham in 2001, we granted
to the former owners of the brokerages the right to require us to repurchase our
shares issued in consideration of the purchase price of the respective
brokerage, in accordance with the schedule set out below, if the trading price
of our shares is below C$17.00 per share at these specified exercise dates.
FLANAGAN
<Table>
<Caption>
- --------------------------------------------------------------------------------
EXERCISE DATE NUMBER OF SHARES
- --------------------------------------------------------------------------------
June 18, 2006............................................... 340,000 (50.0%)
June 18, 2007............................................... 68,000 (10.0%)
June 18, 2011............................................... 272,000 (40.0%)
------------------
Total..................................................... 680,000 (100.0%)
- --------------------------------------------------------------------------------
</Table>
BURNHAM
<Table>
<Caption>
- ----------------------------------------------------------------------------------
EXERCISE DATE NUMBER OF SHARES
- ----------------------------------------------------------------------------------
July 1, 2006................................................ 873,062 (61.4%)
July 1, 2011................................................ 549,772 (38.6%)
--------------------
Total..................................................... 1,422,834 (100.0%)
- ----------------------------------------------------------------------------------
</Table>
In the event of special circumstances, such as attaining age 60, death,
disability or dismissal without cause, the put options are exercisable relative
to all of the shares held by the respective individuals. In addition, the put
options are effective with respect to any shares that such individuals may
receive as contingent consideration in connection with the Flanagan acquisition
and the Burnham acquisition (estimated at about an aggregate maximum of 420,000
shares). See "Management's discussion and analysis of financial conditions and
results of operations--Contingent obligations."
In the event that any put options are exercised, we have the option to require
the Flanagan and Burnham shareholders to sell their shares on the open market.
We would then be required to make a payment to the selling shareholders equal to
the difference between the sale price of the shares being sold and C$17.00 per
share.
66
PRINCIPAL SHAREHOLDERS
The following tables sets forth information with respect to the beneficial
ownership of our issued share capital, comprised solely of common shares, as of
December 31, 2001 and as adjusted to reflect our sale of common shares in this
offering by:
- - all those known by us to be beneficial owners of more than five percent of the
outstanding common shares;
- - our top five most highly compensated named executive officers;
- - each of our directors; and
- - all executive officers and directors as a group.
Beneficial ownership is determined in accordance with the rules of the SEC that
deem shares to be beneficially owned by any person or group who has or shares
voting or investment power with respect to such shares. Unless otherwise
indicated, the persons names on this table have sole voting and investment
control with respect to all shares beneficially owned.
<Table>
<Caption>
- --------------------------------------------------------------------------------------
COMMON SHARES COMMON SHARES
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO THE OFFERING AFTER THE OFFERING
--------------------- ---------------------
NAME OF BENEFICIAL OWNER AMOUNT PERCENT AMOUNT PERCENT
- --------------------------------------------------------------------------------------
Fairfax Financial Holdings
Limited(1).......................... 11,232,870 45.1% 11,232,870
Zurich Insurance Company(2)........... 2,500,000 10.4% 2,500,000
R. Craig Barton(3).................... 598,666 2.8% 598,666
Martin P. Hughes(4)................... 489,048 2.3% 489,048
Bruce D. Guthart(5)................... 439,526 2.0% 439,526
Richard A. Gulliver(6)................ 321,844 1.5% 321,844
Jean Martin(7)........................ 226,345 1.0% 226,345
Dennis J. Pauls(8).................... 29,323 * 29,323
W. Kirk James(9)...................... 12,015 * 12,015
Paul Murray........................... 2,000 * 2,000
Anthony F. Griffiths.................. -- -- --
John Varnell.......................... -- -- --
Bradley P. Martin(10)................. -- -- --
----------------------------------------------
Executive officers and directors as a
group............................... 2,118,767 9.8% 2,118,767
Total............................... 15,851,637 57.9% 15,851,637
- --------------------------------------------------------------------------------------
</Table>
* Indicates less than 1%.
(1) Includes 3,278,904 shares issuable upon the conversion of the Fairfax notes
and 638,273 shares subject to escrow releasable as to 70,920 shares on each of
November 30, 2002 and 2003 and 496,433 shares on November 30, 2008. The Sixty
Two Investment Company Limited, a company controlled by V. Prem Watsa, owns
subordinate and multiple voting shares representing 55.8% of the total votes
attached to all classes of shares of Fairfax. Mr. Watsa himself beneficially
owns and controls additional subordinate voting shares which, together with the
shares owned by Sixty Two, represent 56.3% of the total votes attached to all
classes of Fairfax's shares.
(2) Represents the shares that are issuable upon the conversion of the Zurich
notes. Zurich has agreed to allow us to redeem the Zurich notes at our option
and without penalty until June 30, 2002. Zurich has also agreed not to convert
the Zurich notes until after June 30, 2002.
67
(3) Includes 86,937 shares allocated under our executive share purchase plan of
which 69,550 are not vested and which vest as to 10% of the allocated amount per
year while employed and includes 356,183 shares subject to escrow restrictions,
which release 62,854 shares on each of November 30, 2002 and 2004, 46,096 shares
on each of November 30, 2003, 2005, 2006 and 2007 and 46,091 shares on November
30, 2008.
(4) Includes 36,883 shares allocated under our executive share purchase plan of
which 33,195 are not vested and which vest as to 10% of the allocated amount per
year while employed and includes 452,165 shares subject to escrow restrictions,
which release 45,217 shares on each of October 27, 2002, 2003 and 2004 and
316,514 shares on September 8, 2008.
(5) Represents 439,526 shares subject to escrow restrictions, which release
43,953 shares on each of June 30, 2004, 2005 and 2006 and 307,667 shares on June
30, 2011.
(6) Includes 52,444 shares allocated under our executive share purchase plan of
which 41,955 are not vested and which vest as to 10% of the allocated amount per
year while employed and includes 242,460 shares subject to escrow restrictions,
which release 26,940 shares on each of November 30, 2002 and 2003 and 188,580
shares on November 30, 2008.
(7) Includes 6,187 shares allocated under our executive share purchase plan of
which 4,950 are not vested and which vest as to 10% of the allocated amount per
year while employed and includes 198,142 shares subject to escrow restrictions,
which release 22,016 shares on each of November 30, 2002 and 2003 and 154,110
shares on December 6, 2006.
(8) Includes 26,091 shares subject to escrow restrictions, which release 3,232
shares on November 30, 2002, 2,804 shares on November 30, 2003, 428 shares on
November 30, 2004 and 19,627 shares on November 30, 2008.
(9) Represents shares allocated under our executive share purchase plan of which
10,588 are not vested and which vest as to 10% of the allocated amount per year
while employed.
(10) Will stand for election to our board of directors at our annual general
meeting in May 2002.
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DESCRIPTION OF SHARE CAPITAL
Our authorized capital consists of an unlimited number of preference shares,
issuable in series, and an unlimited number of common shares. After giving
effect to the offering, no preference shares and common shares will be
issued and outstanding.
The following is a summary of the material provisions of the share capital of
Hub.
COMMON SHARES
The holders of our common shares are entitled to one vote per share at meetings
of our shareholders other than those meetings where only the holders of the
preference shares as a class or the holders of one or more series of the
preference shares are entitled to vote. The holders of common shares will be
entitled to such dividends as may be declared by the directors out of funds
legally available therefore, subject to the preferential rights of the
preference shares. In the event of our liquidation, dissolution or winding-up,
the holders of our common shares will be entitled to receive all of the our
assets remaining after the payment of all of our liabilities, subject to the
preferential right of the preference shares or any other shares which may rank
prior to the common shares.
PREFERENCE SHARES
Preference shares may be issued at any time and from time to time in one or more
series, each series comprising the number of shares, and having the designation,
rights, privileges, restrictions and conditions, which our board of directors
determines by resolution. Our preference shares rank prior to our common shares
with respect to the payment of dividends and distribution of assets in the event
of our liquidation, dissolution or winding-up. Except as required by law or
where the rights privileges, restrictions and conditions attaching to a series
of preference shares provide for voting rights for the holders of that series of
preference shares, the holders of the preference shares as a class are not
entitled as such to receive notice of, to attend or to vote at any meeting of
our shareholders.
INDEMNIFICATION OF OFFICERS AND DIRECTORS
Our by-laws provide that we will indemnify our current and former directors and
officers to the fullest extent permitted by Ontario law. The by-laws also
provide that we will purchase and maintain insurance for the benefit of our
directors and officers to the extent permitted by Ontario law. We believe that
the provisions in our by-laws are necessary to attract and retain qualified
persons as directors and officers.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common shares is CIBC Mellon Trust
Company.
69
SHARES ELIGIBLE FOR FUTURE SALE
If our shareholders sell substantial amounts of common shares in the public
market following this offering, the market price of our common shares could
fall. These sales also might make it more difficult for us to sell equity or
equity-related securities in the future and at a time and price that we consider
appropriate.
Upon completion of this offering, we will have outstanding an aggregate of
common shares. All of the common shares sold in this offering will be
freely tradeable without restriction or further registration under the
Securities Act, unless these common shares are purchased by our affiliates, or
persons who directly or indirectly control, are controlled by or are under
common control with us. Common shares held by affiliates generally may be sold
only in compliance with the limitations of Rule 144 of the Securities Act
described below. Upon completion of this offering, of our outstanding
shares will be restricted securities and shares will be eligible for
sale in the public market at various times after days from the date of this
prospectus.
LOCK-UP AGREEMENTS
All of our officers, directors and certain of our shareholders have signed
lock-up agreements with the underwriters under which they agreed, subject to
certain limitations, not to offer, pledge, announce the intention to sell, sell,
contract to sell, sell any option or contract to purchase, purchase any option
or contract to sell, grant any option, right or warrant to purchase, or
otherwise transfer or dispose of, directly or indirectly, (or enter into any
swap or other agreement that transfers, in whole or part, any of the economic
consequences of ownership of), any shares of our common shares, or any
securities convertible into or exercisable or exchangeable for our common shares
(including, common shares which may be deemed to beneficially owned by them in
accordance with the rules, of the SEC) for a period of 180 days after the date
of this prospectus, without the prior written consent of J.P. Morgan Securities
Inc.
RULE 144
In general, under Rule 144 as currently in effect, beginning 90 days after the
date of this prospectus, a person who has beneficially owned restricted
securities for at least one year would be entitled to sell within any
three-month period a number of shares that does not exceed the greater of:
- - 1% of the number of our common shares then outstanding, which will equal
approximately shares immediately after this offering; or
- - the average weekly trading volume of our common shares on the NYSE during the
four calendar weeks preceding the filing of a notice on Form 144 concerning that
sale.
Sales under Rule 144 are also subject to manner of sale provisions and notice
requirements and to the availability of current public information about us.
RULE 144(K)
Under Rule 144(k) as currently in effect, a person who has not been one of our
affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned restricted securities proposed to be sold for at least two
years, including the
70
holding period of any prior owner other than an affiliate, is entitled to sell
those shares without complying with the manner of sale, public information,
volume limitation or notice provisions of Rule 144. Therefore, unless otherwise
restricted, Rule 144(k) shares may be sold immediately upon the completion of
this offering.
RULE 701
In general, under Rule 701 of the Securities Act as currently in effect, any of
our employees, consultants or advisors who purchases our common shares from us
in connection with a compensatory stock plan or other written agreement is
eligible to resell those shares 90 days after the effective date of this
prospectus in reliance on Rule 144.
RESTRICTED SHARE PURCHASE PLAN
Shortly after this offering, we intend to file a registration statement on Form
S-8 covering the common shares reserved for issuance under our plans that will
provide for awards of units representing our restricted shares and options to
purchase or common shares. The shares covered by the Form S-8 registration
statement will be freely tradeable, subject to volume restrictions applicable to
affiliates.
71
CERTAIN UNITED STATES AND CANADIAN
FEDERAL INCOME TAX CONSIDERATIONS
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
This section describes the material United States federal income tax
consequences of the purchase, ownership and disposition of the common shares,
subject to the limitations provided herein. This section assumes that you will
hold your common shares as capital assets for United States federal income tax
purposes. This section does not discuss special rules that may apply to you if
you are a member of a class of holders subject to special rules, including if
you are:
- - a bank;
- - a dealer in securities or currencies;
- - a trader in securities that elects to use a mark-to-market method of
accounting for your securities holdings;
- - a tax-exempt organization;
- - a life insurance company;
- - a person liable for alternative minimum tax;
- - a person that actually or constructively owns 10% or more of our voting
shares;
- - a person that holds common shares as part of a straddle, hedging or conversion
transaction; or
- - a person whose functional currency is not the U.S. dollar.
This section is based on the Internal Revenue Code of 1986, as amended, its
legislative history, existing and proposed regulations, published rulings and
court decisions, all as currently in effect. These laws are subject to change,
possibly on a retroactive basis.
For purposes of this discussion, you are a U.S. holder if you are a beneficial
owner of common shares and you are:
- - a citizen or resident of the United States;
- - a corporation, partnership or other entity organized under the laws of the
United States or any state thereof;
- - an estate whose income is subject to United States federal income tax
regardless of its source; or
- - a trust (a) if a United States court can exercise primary supervision over the
trust's administration and one or more United States persons are authorized to
control all substantial decisions of the trust or (b) that has elected to be
treated as a United States person under applicable Treasury regulations.
You should consult your own tax advisor regarding the United States federal,
state and local and other tax consequences of owning and disposing of common
shares in your particular circumstances.
72
TAXATION OF DIVIDENDS
U.S. holders. Subject to the passive foreign investment company rules discussed
below, if you are a U.S. holder, you must include in your gross income as
ordinary income the gross amount of any dividend paid by us out of our current
or accumulated earnings and profits (as determined for United States federal
income tax purposes). You must include the dividend in income when you receive
the dividend, actually or constructively. The dividend will not be eligible for
the dividends-received deduction generally allowed to United States corporations
in respect of dividends received from other United States corporations. The
amount of the dividend distribution that you must include in your income will be
the U.S. dollar value of the Canadian dollar payments made, determined at the
Canadian dollar to U.S. dollar "spot rate" on the date the dividend distribution
is includible in your income, regardless of whether the payment is in fact
converted into U.S. dollars. Generally, any gain or loss resulting from currency
exchange fluctuations during the period from the date you include the dividend
payment in income to the date you convert the payment into U.S. dollars will be
treated as ordinary income or loss. This income or loss generally will be income
or loss from sources within the United States for foreign tax credit limitation
purposes. Distributions in excess of our current and accumulated earnings and
profits (as determined for United States federal income tax purposes) will be
treated as a non-taxable return of capital to the extent of your basis in the
common shares and thereafter as capital gain. We do not maintain calculations of
earnings and profits (as determined for United States federal income tax
purposes).
For purposes of this discussion, the "spot rate" generally means a rate that
reflects a fair market rate of exchange available to the public for currency
under a "spot contract" in a free market and involving representative amounts. A
"spot contract" is a contract to buy or sell a currency on or before two
business days following the date of the execution of the contract. If such a
spot rate cannot be demonstrated, the Internal Revenue Service has the authority
to determine the "spot rate."
A portion of dividends paid by us, as a foreign corporation which is engaged in
a U.S. trade or business, will be treated as domestic source income because 25%
or more of our worldwide gross income over a three-year testing period (ending
with the close of the our taxable year immediately preceding the declaration of
a dividend) is effectively connected with our U.S. business or is treated as
effectively connected. The dividends will be U.S. source income to the extent
our gross income for the testing period is effectively connected income, or
treated as such, in relation to our gross income from all sources for such
period. The remainder of the dividends from the common shares will be classified
as foreign source income. The foreign source income generally will be "passive
income" or "financial services income" which will be treated separately from
other types of income for purposes of computing the foreign tax credit allowable
to you. The rules relating to foreign tax credits are extremely complex and the
availability of a foreign tax credit depends on numerous factors. You should
consult your own tax advisors concerning the application of the U.S. foreign tax
credit rules to your particular situation.
TAXATION OF CAPITAL GAINS
U.S. holders. Subject to the passive foreign investment company rules discussed
below, if you are a U.S. holder and you sell or otherwise dispose of your common
shares, you
73
will recognize capital gain or loss for United States federal income tax
purposes equal to the difference between the U.S. dollar value of the amount
that you realize and your tax basis, determined in U.S. dollars, in your common
shares. Capital gain of a non-corporate U.S. holder is generally taxed at a
maximum rate of 20% if the property has been held more than one year and 18% if
the property has been held for more than five years. The deductibility of
capital losses is subject to limitations. The gain or loss will generally be
gain or loss from sources within the United States for foreign tax credit
limitation purposes.
PASSIVE FOREIGN INVESTMENT COMPANY RULES
We do not expect to be considered a passive foreign investment company, but this
conclusion is a factual determination that is made annually and this may be
subject to change. In general, if you are a United States holder, we will be a
passive foreign investment company with respect to you if, for any taxable year
in which you held our common shares:
- - 75% or more of our gross income for the taxable year is "passive income"; or
- - 50% or more of the average quarterly value of our assets consists of assets
that produce, or are held for the production of, passive income.
Passive income generally includes dividends, interest, royalties, rents (other
than certain rents and royalties derived in the active conduct of a trade or
business) and net gains from the disposition of assets that produce passive
income. For purposes of determining whether we will be treated as a passive
foreign investment company, we will be treated as holding our proportionate
share of the assets of any corporation in which we owned, directly or
indirectly, 25%, by value, of the corporation's stock and we will be treated as
receiving directly our proportionate share of the corporation's income.
If we are treated as a passive foreign investment company, and you are a U.S.
holder that does not make a mark-to-market election, as described below, you
will be subject to special rules with respect to:
- - any gain you realize on the sale or other disposition of your common shares;
and
- - any excess distribution that we make to you (generally, any distributions to
you during a single taxable year that are greater than 125% of the average
annual distributions received by you in respect of the ordinary shares during
the three preceding taxable years or, if shorter, your holding period for the
common shares).
Under these rules:
- - the gain or excess distribution will be allocated ratably over your holding
period for the common shares;
- - the amount allocated to the taxable year in which you realized the gain or
excess distribution or to any years prior to our being treated as a passive
foreign investment company will be taxed as ordinary income;
- - the amount allocated to each prior year other than a year prior to the first
year in which we were a passive foreign investment company, with certain
exceptions, will be taxed at the highest federal income tax rate in effect for
that year with respect to ordinary income; and
74
- - the interest charge generally applicable to underpayments of tax will be
imposed in respect of the tax attributable to each such year.
These rules apply even if we would not be considered a passive foreign
investment company in a subsequent year, unless you make an election to be taxed
under these rules on any gain that would be recognized if you sold your common
shares on the last day of the last taxable year in which we were a passive
foreign investment company.
Special rules apply for calculating the amount of the foreign tax credit with
respect to excess distributions by a passive foreign investment company.
The foregoing rules with respect to distribution and dispositions may be avoided
if you are eligible for and timely make either a valid "qualifying electing
fund" election, in which case you would be required to include in income on a
current basis your pro rata share of our ordinary income and net capital gains.
We do not currently intend to complete the actions necessary for U.S. holders to
make a qualifying electing fund election in the event that we are considered a
passive foreign investment company for any taxable year.
If we are a passive foreign investment company and the common shares are treated
as "marketable stock" under applicable Treasury regulations, you may make a
mark-to-market election. With respect to your common shares, if you make this
election, you will not be subject to the passive foreign investment company
rules described above. Instead, in general, you will include as ordinary income
each year the excess, if any, of the fair market value of your common shares at
the end of the taxable year over your adjusted basis in your common shares. You
will also be allowed to take an ordinary loss in respect of the excess, if any,
of the adjusted basis of your common shares over their fair market value at the
end of the taxable year (but only to the extent of the net amount of previously
included income as a result of the mark-to-market election). Your basis in the
common shares will be adjusted to reflect any such income or loss amounts. The
mark-to-market election is made on a shareholder-by-shareholder basis and, once
made, can only be revoked with the consent of the Internal Revenue Service.
Under applicable Treasury regulations, the term "marketable stock" includes
stock of a passive foreign investment company that is "regularly traded" on a
qualified exchange or other market. For these purposes, a class of stock is
regularly traded on a qualified exchange or other market for any calendar year
during which such class of stock is traded (other than in de minimis quantities)
on at least 15 days during each calendar quarter. The New York Stock Exchange is
a qualified exchange and it is expected that there will be sufficient trading in
the shares so that any will be treated as "regularly traded", but no assurances
can be given.
If you own common shares during any year that we are a passive foreign
investment company, you must file Internal Revenue Service Form 8621 with your
annual United States federal income tax return for each year in which you own
common shares even if we subsequently would not be considered a passive foreign
investment company. If we are a passive foreign investment company, U.S. holders
who acquire common shares from decedents could be denied the step-up of the
income tax basis for such common shares, which would otherwise have been
available.
75
INFORMATION REPORTING AND BACK-UP WITHHOLDING
You may be subject to information reporting on dividends or sales proceeds on
the common shares unless you establish that you are an "exempt recipient" for
purposes of the information reporting rules. If you do not establish that you
are an exempt recipient, you may be subject to backup withholding on these
amounts if you do not provide a correct taxpayer identification number.
You generally may obtain a credit against your United States federal income tax
liability for any amounts withheld under the backup withholding rules and a
refund for amounts that exceed your income tax liability by filing the required
information with the United States Internal Revenue Service.
CERTAIN CANADIAN FEDERAL INCOME TAX CONSIDERATIONS
In the opinion of Torys LLP, our Canadian counsel, the following is a summary of
the principal Canadian federal income tax considerations generally applicable to
the holders described below. This summary is based on the current provisions of
the Income Tax Act, the regulations thereunder, all specific proposals to amend
the Income Tax Act or the regulations publicly announced by the Minister of
Finance (Canada) prior to the date hereof, and counsel's understanding of the
current administrative practices of the Canada Customs and Revenue Agency.
This summary is not exhaustive of all possible Canadian federal income tax
considerations and, except as mentioned above, does not take into account or
anticipate any changes in law, whether by legislative, administrative or
judicial decision or action, nor does it take into account provincial,
territorial or foreign tax legislation or considerations, which may differ from
the federal income tax considerations described herein.
THIS SUMMARY IS OF A GENERAL NATURE ONLY AND IS NOT INTENDED TO BE, NOR SHOULD
IT BE CONSTRUED TO BE, LEGAL OR TAX ADVICE TO ANY PARTICULAR HOLDER, AND NO
REPRESENTATION WITH RESPECT TO THE INCOME TAX CONSEQUENCES TO ANY PARTICULAR
HOLDER IS MADE. CONSEQUENTLY, PROSPECTIVE PURCHASERS SHOULD CONSULT THEIR OWN
TAX ADVISORS WITH RESPECT TO THEIR PARTICULAR CIRCUMSTANCES.
The following summary is generally applicable to a person (a "Non-Resident
Holder"): (1) who acquires common shares under this offering, (2) who holds such
common shares as capital property, (3) who, at all relevant times, for purposes
of the Income Tax Act and any applicable tax treaty or convention, is not a
resident of Canada, (4) who does not use or hold (and will not use or hold) and
is not deemed to use or hold the common shares in, or in the course of, carrying
on a business in Canada and does not carry on an insurance business in Canada
and elsewhere, and (5) whose shares do not constitute "taxable Canadian
property" for purposes of the Income Tax Act. Provided that the common shares
are listed on a prescribed stock exchange (which includes the TSE and the NYSE)
at a particular time, the common shares will generally not constitute taxable
Canadian property to a Non-Resident Holder at that time. This rule applies
unless, at any time during the five-year period immediately preceding that time,
25% or more of the issued shares of any class or series of a class of Hub
capital stock was owned by the Non-Resident Holder, persons with whom the
Non-Resident Holder did not deal at arm's length or any combination thereof. For
this purpose, the Non-Resident Holder and persons with whom the Non-Resident
Holder did not deal at arm's length are considered to own any shares which such
Non-Resident Holder or such
76
persons have an interest in or an option in respect of. A Non-Resident Holder's
common shares can be deemed to be taxable Canadian property in certain
circumstances set out in the Income Tax Act.
Dividends on common shares paid or credited or deemed under the Income Tax Act
to be paid or credited to a Non-Resident Holder generally will be subject to
Canadian withholding tax at the rate of 25%, subject to any applicable reduction
in the rate of withholding in an applicable tax treaty where the Non-Resident
Holder is a resident of a country with which Canada has an income tax treaty.
Where the Non-Resident Holder is a U.S. resident entitled to benefits under the
Canada--U.S. Income Tax Convention, dividends on common shares generally will be
subject to Canadian withholding tax at the rate of 15%.
A Non-Resident Holder will not be subject to tax under the Income Tax Act in
respect of any capital gain realized on the disposition of common shares.
THE ABOVE SUMMARY IS NOT INTENDED TO CONSTITUTE A COMPLETE ANALYSIS OF ALL TAX
CONSEQUENCES RELATING TO ACQUISITION, OWNERSHIP AND DISPOSITION OF COMMON
SHARES. PROSPECTIVE PURCHASERS OF COMMON SHARES SHOULD CONSULT THEIR OWN TAX
ADVISORS CONCERNING THE TAX CONSEQUENCES OF THEIR PARTICULAR SITUATIONS.
77
UNDERWRITING
Subject to the terms and conditions of an underwriting agreement, dated the date
of this prospectus, the underwriters named below, who are represented by J.P.
Morgan Securities Inc., have severally agreed to purchase from us the respective
number of common shares shown opposite their names below.
<Table>
<Caption>
- ------------------------------------------------------------------------------
NAME NUMBER OF SHARES
- ------------------------------------------------------------------------------
J.P. Morgan Securities Inc. ................................
Cochran, Caronia Securities LLC ............................
Stephens Inc. ..............................................
BMO Nesbitt Burns Corp. ....................................
Ferris, Baker Watts, Incorporated...........................
-----------
Total.......................................................
- ------------------------------------------------------------------------------
</Table>
The underwriting agreement provides that the obligations of the underwriters are
subject to certain conditions precedent, including the absence of any material
adverse change in our business and the receipt of certain certificates, opinions
and letters from us, our counsel and our independent auditors. The underwriters
are committed to purchase all of our common shares if they purchase any shares.
The following table shows the underwriting fees to be paid to the underwriters
by us in connection with this offering. These amounts are shown assuming both no
exercise and full exercise of the underwriters' option to purchase additional
common shares.
UNDERWRITING COMMISSIONS
<Table>
<Caption>
- -----------------------------------------------------------------------------------------
WITHOUT OVER- WITH OVER-
ALLOTMENT EXERCISE ALLOTMENT EXERCISE
- -----------------------------------------------------------------------------------------
Per share...................................... $ $
Total.......................................... $ $
- -----------------------------------------------------------------------------------------
</Table>
We will pay the offering expenses, estimated to be $ , excluding
underwriting commissions.
The underwriters propose to initially offer some of the common shares directly
to the public at the public offering price on the cover page of this prospectus
and some of the shares to dealers at the public offering price less a concession
not in excess of $ per share. The underwriters may allow, and these dealers
may re-allow, a concession not in excess of $ per share on sales to other
dealers. After the initial offering of the shares to the public, the
representative of the underwriters may change the public offering price and such
concessions. The underwriters do not intend to confirm sales to any accounts
over which they exercise discretionary authority.
We have granted to the underwriters an option, exercisable for 30 days after the
date of the underwriting agreement, to purchase up to additional
common shares at the initial public offering price less the underwriting fees.
The underwriters may exercise this option solely to cover over-allotments, if
any, made in connection with this
78
offering. To the extent that the underwriters exercise this option, each of the
underwriters will have a firm commitment to purchase approximately the same
percentage thereof which the number of common shares to be purchased by it shown
in the above table bears to the total number of common shares offered hereby. We
will be obligated, pursuant to the option, to sell shares to the underwriters to
the extent the option is exercised. The underwriters may exercise this option
only to cover over-allotments made in connection with the sale of common shares
offered hereby. The offering of our common shares is made for delivery when, as
and if accepted by the underwriters and subject to prior sale and to withdrawal,
cancellation, or modification of the offering without notice. The underwriters
reserve the right to reject an order for the purchase of common shares in whole
or in part.
We have agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act, or to contribute the payments
that the underwriters may be required to make in respect of these liabilities.
We, our executive officers and directors and certain of our shareholders have
agreed, subject to limited exceptions, for a period of 180 days after the date
of this prospectus, not to, without the prior written consent of J.P. Morgan
Securities Inc.:
- - offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option, right or
warrant to purchase or otherwise transfer or dispose of, directly or indirectly,
any common shares or any securities convertible into or exercisable or
exchangeable for common shares; or
- - enter into any swap or other arrangement that transfers all or a portion of
the economic consequences associated with the ownership of any common shares.
Either of the foregoing transfer restrictions will apply regardless of whether a
covered transaction is to be settled by the delivery of common shares or such
other securities, in cash or otherwise. In addition, during this 180-day period,
we have also agreed not to file any registration statement for, and each of our
executive officers, directors and several shareholders have agreed not to make
any demand for, or exercise any right of, the registration of any shares of
common shares or any securities convertible into or exercisable or exchangeable
for common shares without the prior written consent of J.P. Morgan Securities
Inc.
We intend to apply to list our common shares on the NYSE under the symbol HBG.
The common shares to be sold in the offering have not been and will not be
qualified for sale under the securities laws of Canada or any province or
territory of Canada. The common shares to be sold in the offering may not be
offered or sold, directly or indirectly, in Canada, or to or for the benefit of
any resident thereof, in violation of the securities laws of Canada or any
province or territory of Canada. Each underwriter has agreed that it will:
a) not, directly or indirectly, offer, sell or deliver common shares in Canada
or to persons who are residents of Canada or acting on the behalf of residents
of Canada or to any person whom it believes intends to reoffer, resell or
deliver the shares in Canada or to any persons who are residents of Canada or
acting on the behalf of residents of Canada; and
b) cause any dealer to whom it may sell such shares at any concession to agree
to observe a similar restriction.
79
We have been advised by the representative that, pursuant to Regulation M under
the Securities Act, some persons participating in the offering may engage in
transactions, including syndicate covering transactions, stabilizing bids or the
imposition of penalty bids, that may have the effect of stabilizing or
maintaining the market price of our common shares at a level above that which
might otherwise prevail in the open market.
A "syndicate covering transaction" is a bid for or the purchase of common shares
on behalf of the underwriters to reduce a syndicate short position incurred by
the underwriters in connection with the offering. The underwriters may create a
syndicate short position by making short sales of our common shares and may
purchase our common shares in the open market to cover syndicate short positions
created by short sales. Short sales involve the sale by the underwriters of a
greater number of common shares than they are required to purchase in the
offering. Short sales can be either "covered" or "naked." "Covered" short sales
are sales made in an amount not greater than the underwriters' over-allotment
option to purchase additional shares from us in the offering. "Naked" short
sales are sales in excess of the over-allotment option. A naked short position
is more likely to be created if the underwriters are concerned that there may be
downward pressure on the price of our common shares in the open market after
pricing that could adversely affect investors who purchase in the offering. If
the underwriters create a syndicate short portion, they may choose to reduce or
"cover" this position by either exercising all or part of the over-allotment
option to purchase additional shares from us or by engaging in "syndicate
covering transactions." The underwriters may close out any covered short
position by either exercising their over-allotment option or purchasing shares
in the open market. The underwriters must close out any naked short position by
purchasing shares in the open market. In determining the source of shares to
close out the covered short position, the underwriters will consider, among
other things, the price of shares available for purchase in the open market as
compared to the price at which they may purchase shares through the
over-allotment option.
A "stabilizing bid" is a bid for, or the purchase of, common shares on behalf of
the underwriters for the purpose of fixing or maintaining the price of our
common shares. A "penalty bid" is an arrangement that permits the representative
to reclaim the selling concession from an underwriter or a syndicate member when
our common shares sold by such underwriter or syndicate member are purchased by
the representative in the syndicate covering transaction and therefore have not
been effectively placed by the underwriter or syndicate member.
We have been advised by the representative that these transactions may be
effected on the NYSE or otherwise and, if commenced, may be discontinued at any
time. Similar to other purchase activities, these activities may have the effect
of raising or maintaining the market price of our common shares or preventing or
retarding the decline in the market price of our common shares. As a result, the
price of our common shares may be higher than the price that might otherwise
exist in the open market.
One or more members of the underwriting selling group may make copies of the
preliminary prospectus available over the Internet to customers or through its
or their websites.
80
LEGAL MATTERS
Legal matters relating United States law will be passed upon for us by Shearman
& Sterling, Toronto, Canada. The validity of the issuance of the common shares
to be sold in the offering and other legal matters relating to Canadian law will
be passed upon for us by Torys LLP, Toronto, Canada. Legal matters relating to
United States law will be passed upon for the underwriters by Davis Polk &
Wardwell, New York, New York.
EXPERTS
The consolidated financial statements of Hub International Limited as of
December 31, 2001 and 2000 and for each of the three years in the period ended
December 31, 2001 included in this prospectus have been so included in reliance
on the report of PricewaterhouseCoopers LLP, independent accountants, given on
the authority of said firm as experts in auditing and accounting. The
consolidated financial statements of Kaye Group Inc. as of June 28, 2001, and
December 31, 2000 and 1999, and for the period January 1, 2001 through June 28,
2001, and for each of the three years in the period ended December 31, 2000
included in this prospectus have been so included in reliance on the reports of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-1 under the
Securities Act, and the rules and regulations promulgated thereunder, with
respect to our common shares offered by this prospectus. This prospectus, which
constitutes a part of the registration statement, does not contain all of the
information set forth in the registration statement and the exhibits thereto.
Statements contained in this prospectus as to the contents of any contract or
other document that is filed as an exhibit to the registration statement are not
necessarily complete and each such statement is qualified in all respects by
reference to the full text of such contract or document.
You may read and copy all or any portion of the registration statement and the
exhibits at the SEC's public reference room at 450 Fifth Street N.W.,
Washington, D.C. 20549, and at the regional offices of the SEC located at 233
Broadway Avenue, New York, New York 10279 and Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. You can request copies of these
documents, upon payment of a duplication fee, by writing to the SEC. Please call
the SEC at 1-800-SEC-0330 for further information on the operation of the SEC's
public reference rooms. Also, the SEC maintains a World Wide Web site on the
Internet at http://www.sec.gov that contains reports, proxy and information
statements and other information regarding registrants that file electronically
with the SEC.
As a result of this offering, we will become subject to the information and
periodic reporting requirements of the Exchange Act and, in accordance
therewith, will file periodic reports, proxy and information statements and
other information with the SEC. These periodic reports, proxy, and information
statements and other information will be available for inspection and copying at
the public reference facilities, regional offices and SEC's Web site referred to
above.
81
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<Table>
<Caption>
HUB INTERNATIONAL LIMITED PAGE
Auditors' Report to the Board of Directors and Shareholders
of Hub International Limited.............................. F-2
Consolidated Balance Sheets as of December 31, 2001 and
2000...................................................... F-3
Consolidated Statements of Earnings for the Years Ended
December 31, 2001, 2000 and 1999.......................... F-4
Consolidated Statements of Retained Earnings (Deficit) for
the Years Ended
December 31, 2001, 2000 and 1999.......................... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999.......................... F-6
Notes to Consolidated Financial Statements.................. F-7
KAYE GROUP INC.
Report of Independent Accountants to the Board of Directors
of Kaye Group Inc......................................... F-31
Consolidated Balance Sheet as of June 28, 2001.............. F-32
Consolidated Statement of Operations for the period January
1, 2001 through June 28, 2001............................. F-34
Consolidated Statement of Stockholders' Equity for the
period January 1, 2001 through June 28, 2001.............. F-35
Consolidated Statements of Comprehensive Loss for the period
January 1, 2001 through June 28, 2001..................... F-36
Consolidated Statements of Cash Flows for the period January
1, 2001 through June 28, 2001............................. F-37
Notes to Consolidated Financial Statements.................. F-38
KAYE GROUP INC.
Report of Independent Accountants to the Board of Directors
and Stockholders of Kaye Group Inc........................ F-54
Consolidated Balance Sheets as of December 31, 2000 and
1999...................................................... F-55
Consolidated Statements of Income for the years ended
December 31, 2000, 1999 and 1998.......................... F-57
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998.......................... F-58
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 2000, 1999 and 1998.............. F-59
Consolidated Statements of Comprehensive Income for the
years ended December 31, 2000, 1999 and 1998.............. F-60
Notes to Consolidated Financial Statements.................. F-61
Financial Statement Schedules:
Schedule II -- Condensed Financial Information of
Registrant:
Balance Sheets as of December 31, 2000 and 1999........... F-82
Statements of Income for the years ended December 31,
2000, 1999 and 1998.................................... F-83
Statements of Cash Flows for the years ended December 31,
2000, 1999 and 1998.................................... F-84
Notes to Condensed Financial Statements................... F-85
Schedule IV -- Reinsurance for the years ended December 31,
2000, 1999 and 1998....................................... F-86
Schedule VI -- Supplemental Information Concerning
Property-Casualty Insurance Operations for the years ended
December 31, 2000, 1999 and 1998.......................... F-87
</Table>
The information for Schedule I is contained in the Notes to the Consolidated
Financial Statements. The information for Schedule III is included in Schedule
VI. The information required for Schedule V is not applicable.
F-1
AUDITORS' REPORT 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, 2001 and 2000 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,
2001, 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 based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in Canada and in the United States of America. Those standards require that we
plan and perform an audit to obtain reasonable assurance whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, these 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, 2001 and 2000, and
the results of their operations and their cash flows for each of the years in
the three year period ended December 31, 2001, in accordance with accounting
principles generally accepted in Canada.
LOGO
Chartered Accountants
Toronto, Ontario, Canada
March 18, 2002
F-2
HUB INTERNATIONAL LIMITED
CONSOLIDATED BALANCE SHEETS
As of December 31, 2001 and 2000
(in thousands of U.S. dollars)
<Table>
<Caption>
2001 2000
-------- ------------
(AS RESTATED
SEE NOTE 2)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 26,979 $ 19,919
Trust cash 50,426 12,356
Accounts and other receivables 101,313 41,975
Investment held for sale 40,772 --
Income taxes receivable 1,460 2,382
Future income taxes 1,999 --
Prepaid expenses 2,471 872
-------- --------
TOTAL CURRENT ASSETS 225,420 77,504
Capital assets 20,935 7,208
Other intangible assets 25,331 --
Goodwill 220,848 117,744
Future income taxes 2,671 368
Other assets 7,091 3,333
-------- --------
TOTAL ASSETS $502,296 $206,157
-------- ------------
LIABILITIES
CURRENT LIABILITIES:
Bank debt $ 55,000 $ --
Accounts payable and accrued liabilities 164,094 57,601
Income taxes payable -- 927
Future income taxes 1,387 --
Current portion long-term debt and capital leases 4,169 2,167
-------- --------
TOTAL CURRENT LIABILITIES 224,650 60,695
Long-term debt and capital leases 76,159 32,498
Subordinated convertible debentures 61,624 --
Future income taxes 4,592 752
-------- --------
TOTAL LIABILITIES 367,025 93,945
-------- --------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Share capital 125,506 111,430
Cumulative translation account 2,770 195
Retained earnings 6,995 587
-------- --------
TOTAL SHAREHOLDERS' EQUITY 135,271 112,212
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $502,296 $206,157
-------- ------------
</Table>
(the accompanying notes form an integral part of the financial statements)
F-3
HUB INTERNATIONAL LIMITED
CONSOLIDATED STATEMENTS OF EARNINGS
For the years ended December 31, 2001, 2000 and 1999
(in thousands of U.S. dollars, except per share amounts)
<Table>
<Caption>
2001 2000 1999
-------- ------------ ------------
(AS RESTATED (AS RESTATED
SEE NOTE 2) SEE NOTE 2)
REVENUE
Commission income $142,851 $86,410 $47,964
Contingent commissions and volume overrides 5,946 4,909 2,824
Other 5,196 3,921 3,309
-------- ------- -------
153,993 95,240 54,097
-------- ------- -------
EXPENSES
Remuneration 88,015 54,701 29,519
Selling 8,359 4,840 3,036
Occupancy 9,061 5,756 3,393
Depreciation 3,940 1,885 1,275
Administration 17,856 11,182 6,806
-------- ------- -------
127,231 78,364 44,029
-------- ------- -------
NET EARNINGS BEFORE THE FOLLOWING 26,762 16,876 10,068
Interest expense 7,447 1,981 632
Goodwill and other intangible asset
amortization 4,940 3,260 1,626
(Gain) loss on disposal of capital assets
and investments (173) 127 14
Other income -- put option liability (719) -- --
-------- ------- -------
NET EARNINGS BEFORE INCOME TAXES 15,267 11,508 7,796
-------- ------- -------
PROVISION FOR INCOME TAX EXPENSE (BENEFIT)
Current 4,967 4,907 4,260
Future 295 463 (208)
-------- ------- -------
5,262 5,370 4,052
-------- ------- -------
NET EARNINGS $ 10,005 $ 6,138 $ 3,744
-------- ------------ ------------
EARNINGS PER SHARE
BASIC $ 0.53 $ 0.34 $ 0.22
DILUTED $ 0.50 $ 0.34 $ 0.22
WEIGHTED AVERAGE SHARES OUTSTANDING -- BASIC
(000'S) 19,012 18,327 16,941
WEIGHTED AVERAGE SHARES OUTSTANDING --
DILUTED (000'S) 20,105 18,327 16,941
</Table>
(the accompanying notes form an integral part of the financial statements)
F-4
HUB INTERNATIONAL LIMITED
CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (DEFICIT)
For the years ended December 31, 2001, 2000 and 1999
(in thousands of U.S. dollars)
<Table>
<Caption>
2001 2000 1999
------- ------------ ------------
(AS RESTATED (AS RESTATED
SEE NOTE 2) SEE NOTE 2)
RETAINED EARNINGS (DEFICIT) -- BEGINNING OF
YEAR $ 587 $(2,049) $(3,159)
Net earnings 10,005 6,138 3,744
Excess over stated value of shares purchased -- (1,046) (2,634)
Dividends (3,597) (2,456) --
------- ------- -------
RETAINED EARNINGS (DEFICIT) -- END OF YEAR $ 6,995 $ 587 $(2,049)
------- ------------ ------------
</Table>
(the accompanying notes form an integral part of the financial statements)
F-5
HUB INTERNATIONAL LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2001, 2000 and 1999
(in thousands of U.S. dollars)
<Table>
<Caption>
2001 2000 1999
--------- ------------ ------------
(AS RESTATED (AS RESTATED
SEE NOTE 2) SEE NOTE 2)
OPERATING ACTIVITIES
Net earnings $ 10,005 $ 6,138 $ 3,744
Items not affecting working capital
Amortization and depreciation 8,880 5,145 2,901
(Gain) loss on disposal of capital assets and
investments (173) 127 14
Other income -- put option liability (719) -- --
Future income taxes 295 463 (208)
--------- -------- --------
18,288 11,873 6,451
Non-cash working capital items
Accounts and other receivables (5,511) (2,330) (3,331)
Prepaid expenses (299) (283) 128
Accounts payable and accrued liabilities 32,571 6,122 1,953
Income taxes 1,863 (2,575) (98)
--------- -------- --------
46,912 12,807 5,103
--------- -------- --------
FINANCING ACTIVITIES
Bank debt 55,122 (16,425) 14,178
Long-term debt -- advances 21,096 29,835 92
Subordinated convertible debentures 61,624 -- --
Long-term debt and capital leases -- repayments (5,154) (2,501) (14,529)
Share capital -- issued for cash, net of issue
costs 3,621 -- 65,534
Share capital -- repurchases (281) (2,840) (6,781)
Dividends (3,597) (2,456) --
--------- -------- --------
132,431 5,613 58,494
--------- -------- --------
INVESTING ACTIVITIES
Capital assets -- purchases (10,298) (2,050) (1,243)
Capital assets -- proceeds on sale 96 222 76
Purchase of subsidiaries, net of cash received (123,365) (18,932) (29,203)
Other assets (646) 2,777 (4,285)
--------- -------- --------
(134,213) (17,983) (34,655)
--------- -------- --------
CHANGE IN CASH AND CASH EQUIVALENTS AND TRUST
CASH 45,130 437 28,942
CASH AND CASH EQUIVALENTS AND TRUST CASH --
BEGINNING OF YEAR 32,275 31,838 2,896
--------- -------- --------
CASH AND CASH EQUIVALENTS AND TRUST CASH -- END
OF YEAR $ 77,405 $ 32,275 $ 31,838
--------- ----------- -----------
</Table>
(the accompanying notes form an integral part of the financial statements)
F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the years ended December 31, 2001, 2000 and 1999
(in thousands, except per share amounts or as otherwise indicated)
1. NATURE OF OPERATIONS
Business operations
Hub International Limited (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.
Business combinations
Acquisitions of subsidiaries have been accounted for using the purchase method,
whereby the results of acquired companies are included only from the date of
acquisition.
Effective June 28, 2001, the Company acquired Kaye Group Inc. (Kaye). Kaye,
primarily an insurance broker, also underwrote insurance risks through its
subsidiaries, Old Lyme Insurance Company of Rhode Island Inc. and Old Lyme
Insurance Company, Ltd. (collectively Old Lyme). The Company did not want to
retain the underwriting risk associated with Old Lyme, and indicated prior to
the effective date of the acquisition that it intended to find a purchaser for
the Old Lyme operations as soon as possible after closing.
At December 31, 2001, the net assets and liabilities of Old Lyme are recorded at
their original cost as an investment held for sale in the Company's consolidated
balance sheet. The net earnings of the Old Lyme operations from the date of
acquisition to December 31, 2001 have been excluded from the Company's 2001
consolidated statement of earnings and, accordingly, transactions with Old Lyme
have not been eliminated on consolidation. The amount of Old Lyme net earnings
excluded from consolidated net earnings for the period ended December 31, 2001
was approximately $1,833.
On December 31, 2001, Kaye entered into a stock purchase agreement with Fairfax
Inc. to sell all of the issued and outstanding shares of Old Lyme, pending
regulatory approval. Fairfax Inc. is a subsidiary of Fairfax Financial Holdings
Limited (Fairfax), which currently owns approximately 37% of the Company's
outstanding shares. The agreed-upon purchase price (which is considered to be
fair market value) is Old Lyme's December 31, 2001 stockholder's equity of
approximately $42,800 determined in accordance with accounting principles
generally accepted in the United States of America (U.S. GAAP). The purchase
price will be increased by four percent, compounded annually, from January 1,
2002, until the closing date. Any difference between the actual purchase price
at the closing date and the carrying amount of the investment held for sale in
the Company's consolidated balance sheet will be recorded as a gain or loss on
the sale of investment at the closing date.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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
F-7
described in note 17 "Reconciliation to U.S. GAAP." The more significant of the
accounting policies are as follows:
Basis of presentation
The consolidated financial statements include the accounts of the Company and
all of its subsidiaries. All material inter-company accounts and transactions
have been eliminated. Certain reclassifications have been made to prior years'
financial statements to conform to the current year presentation.
Change in reporting currency
The Company's consolidated financial statements have historically been expressed
in Canadian dollars. Effective September 30, 2001, the Company adopted the U.S.
dollar as its reporting currency. Comparative financial information has been
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.
Foreign currency translation
The assets and liabilities of these subsidiaries as at December 31, 2001 were
translated to U.S. dollars at the year end exchange rate. Revenue and expenses
subsequent to September 30, 2001 were translated to U.S. dollars at the average
exchange rate for the period. The operations of the Company's subsidiaries
outside of the U.S. are self-sustaining. Accordingly, the unrealized gains and
losses which result from this translation are deferred and included in
shareholders' equity under the caption "Cumulative translation account."
Revenue Recognition
Commission income and fees, (including commission income related to installment
billing arrangements) are generally recognized as of the latter of the effective
date of the policy or the date at which the amount can be reasonably estimated.
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. The Company
is entitled to contingent commissions and volume overrides from insurance
companies and are recorded in the earlier of the period in which amounts can be
reasonably estimated or the period in which amounts are received.
Cash and cash equivalents and trust cash
Cash and cash equivalents consist of cash, highly-liquid investments having
maturities of three months or less and trust cash. The carrying amounts on the
balance sheet approximate fair value.
Premiums collected (less commissions and other deductions) but not yet remitted
to insurance carriers 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.
F-8
Capital assets
Capital assets are stated at cost less accumulated depreciation and
amortization. Depreciation is recorded based on useful economic lives, using
principally the declining balance method at a rate which ranges between 20% and
30%. Leasehold improvements are amortized on the straight-line method over the
term of the related lease. Upon sale or retirement, the cost and related
accumulated depreciation or amortization are removed from the accounts and any
gain or loss is reflected in earnings.
Goodwill
Goodwill, equal to the excess of the purchase price over the fair value of net
identifiable assets acquired, relating to acquisitions which took place before
July 1, 2001, is amortized to earnings on a straight-line basis over 40 years.
Goodwill relating to acquisitions which took place on or after July 1, 2001 is
carried at cost and reviewed annually for impairment.
In June 2001, the Canadian Institute of Chartered Accountants approved a new
Handbook Section 3062, Goodwill and Other Intangible Assets. From January 1,
2002, goodwill will no longer be amortized but will be subject to regular review
for impairment. The impact of ceasing the amortization of goodwill on the year
ended December 31, 2002 will likely be to increase net earnings before income
taxes by approximately $3,400. The Company does not anticipate any other
material impact on the financial statements as a result of implementation of
this new accounting standard.
The new rule harmonizes Canadian GAAP with U.S. GAAP.
Other intangible assets
Intangible assets arising from purchase acquisitions principally represent the
fair value of customer relationships, company trademarks and non-competition
covenants. Definite life intangible assets are amortized to earnings on a
straight-line basis over the estimated useful life of the asset, averaging 15
years. Indefinite life intangible assets are carried at cost and reviewed
annually for impairment.
Investment held for sale
The investment held for sale (Old Lyme) is recorded at cost, which is at or
below market value.
Future income taxes
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 carryforwards is
recognized as an asset to the extent that it is more likely than not to be
recoverable from future profitable operations. The principal temporary
differences are related to loss carryforwards, goodwill and other intangible
asset amortization and reserves.
Estimates and assumptions
Preparation of the financial statements in conformity with Canadian GAAP
requires management to make estimates and assumptions that affect the reported
amount of
F-9
assets and liabilities and the reported amount of revenue and expense during the
reporting period. Actual results could differ from those estimated.
Earnings per share
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 year. Diluted earnings per share are
calculated using the treasury stock method and include the effects of all
potentially dilutive securities. Earnings per common share has been compiled
below:
<Table>
<Caption>
2001 2000 1999
------- ------ ------
Net income (numerator) $10,005 $6,138 $3,744
------- ------ ------
Weighted average common shares and effect of dilutive
shares used in the computation of earnings per share:
Average shares outstanding -- basic (denominator) 19,012 18,327 16,941
Effect of dilutive shares* 1,093 -- --
------- ------ ------
Average shares outstanding -- diluted (denominator) 20,105 18,327 16,941
------- ------ ------
Earnings per common share:
Basic $ 0.53 $ 0.34 $ 0.22
Diluted $ 0.50 $ 0.34 $ 0.22
</Table>
* Reflects dilutive effect of all put options issued in connection with certain
2001 acquisitions. The subordinated convertible debentures are anti-dilutive.
Written put options
The fair value of put options issued by the Company as consideration for
businesses acquired is classified as long-term debt until such time as the
option is exercised or expires. Changes in the fair value of these options are
recorded in earnings.
3. ACQUISITIONS
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.
The Company typically pays a portion of the consideration for an acquired
brokerage in cash. Consideration for the remainder of the purchase price is
normally in the form of the Company's common shares. The Company's common shares
issued in consideration for acquired brokerages are valued based on the quoted
market price, on the Toronto Stock Exchange, for a short period before and after
the closing date of the business combination.
a) During 2001, the Company purchased all of the issued and outstanding shares
of Kaye, Burnham Stewart Group, Inc. (Burnham) and J.P. Flanagan Corporation
(Flanagan), as well as the outstanding shares or net assets of 13 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.
F-10
The allocation of the purchase price, including goodwill and other identifiable
intangible assets, and the cost of the acquired brokerages are summarized as
follows:
<Table>
<Caption>
KAYE BURNHAM FLANAGAN OTHERS TOTAL
------------- ------------ ------------ ------- --------
Acquisition Date June 28, 2001 July 1, 2001 May 31, 2001 Various
Working capital $ 43,141 $ 3,002 $ (703) $ (216) $ 45,224
Capital and other
assets 7,413 1,580 79 (244) 8,828
Long-term debt and
capital leases
assumed (1,449) (8,200) (1,339) (70) (11,058)
-------- ------- ------- ------- --------
Net assets
(liabilities), at
fair value $ 49,105 $(3,618) $(1,963) $ (530) $ 42,994
------------- ------------ ------------ ------- --------
Consideration
Cash $125,131 $11,533 $ 776 $ 3,950 $141,390
Debt -- 12,435 7,210 1,760 21,405
Shares -- 6,191 1,821 557 8,569
-------- ------- ------- ------- --------
$125,131 $30,159 $ 9,807 $ 6,267 $171,364
------------- ------------ ------------ ------- --------
Goodwill $ 59,816 $27,269 $ 8,838 $ 6,001 $101,924
Customer relationships 12,992 5,690 2,242 796 21,720
Trademarks 1,714 623 250 -- 2,587
Non-competition
covenants 1,204 195 440 -- 1,839
-------- ------- ------- ------- --------
$ 75,726 $33,777 $11,770 $ 6,797 $128,070
------------- ------------ ------------ ------- --------
Number of shares
issued as
consideration
(000's) -- 1,743 730 51 2,524
------------- ------------ ------------ ------- --------
</Table>
Contingent Consideration
In addition to the consideration shown above, the previous owners of Burnham,
Flanagan and other subsidiaries are entitled to contingent consideration if
certain revenue and profitability targets are met. Purchase price allocations
for Flanagan and Burnham are subject to adjustment for future consideration
issued.
F-11
Flanagan
The following table summarizes the contingent consideration that may be issued
in connection with the acquisition of Flanagan:
<Table>
<Caption>
CONTINGENT
CONSIDERATION CONTINGENT CONSIDERATION
YEAR (000'S) TARGET CRITERIA
- ---- ------------- -------------------------
2001 50 shares Revenue and Profitability
2002 38 shares Revenue
2002 38 shares Profitability
2003 88 shares Revenue
2003 37 shares Profitability
</Table>
As of December 31, 2001, the contingent consideration criteria for 2001 were
met. Accordingly, the Company has an obligation to issue 50 shares in the amount
of $478. The additional purchase consideration has been recorded in goodwill and
share capital as of December 31, 2001.
Burnham
The owners of Burnham shall be entitled to contingent consideration in the event
that the acquired Burnham operations meet certain profitability targets for the
twelve-month period ended June 30, 2002. The contingent consideration to be
issued, if the profitability criteria are met, shall be a portion of actual
profitability in excess of the target. Any contingent consideration issued by
the Company shall be paid 38% in cash, 51% in restricted shares of the Company's
common stock, and 11% in unrestricted shares of the Company's common shares.
Others
An additional $400 of contingent consideration, based primarily on revenue
targets, may also be issued in connection with other acquisitions made by the
Company in 2001.
F-12
b) During 2000, the Company purchased all of the issued and outstanding shares
of C.J. McCarthy Insurance Agency Inc. (McCarthy), as well as the
outstanding shares or net assets of 17 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 allocation of the purchase price, including goodwill, and the cost of the
acquired brokerages are summarized as follows:
<Table>
<Caption>
MCCARTHY OTHERS TOTAL
------------- ------- -------
Acquisition date June 30, 2000 Various
Working capital $ 3,033 $(1,600) $ 1,433
Capital and other assets 487 363 850
Long-term debt and capital leases
assumed (899) (24) (923)
------- ------- -------
Net assets (liabilities), at fair
value $ 2,621 $(1,261) $ 1,360
------------ ------- -------
Consideration
Cash $18,236 $ 6,710 $24,946
Debt -- 1,951 1,951
Shares 4,415 466 4,881
------- ------- -------
$22,651 $ 9,127 $31,778
------------ ------- -------
Goodwill $20,030 $10,388 $30,418
------------ ------- -------
Number of shares issued as
consideration (000's) 465 43 508
------------ ------- -------
</Table>
F-13
c) During 1999, the Company purchased all of the issued and outstanding shares
of 44 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 allocation of the purchase price, including goodwill, and the cost of the
acquired brokerages are summarized as follows:
<Table>
<Caption>
TOS
MACK AND INSURANCE
PARKER, INC. SERVICES LTD. OTHERS TOTAL
---------------- --------------- ------- -------
Acquisition date October 27, 1999 August 31, 1999 Various
Working capital $ 3,283 $ 441 $ (632) $ 3,092
Capital and other assets 793 1,296 1,246 3,335
Long-term debt and capital
leases assumed (251) (2,219) (3,825) (6,295)
------- ------- ------- -------
Net assets (liabilities), at
fair value $ 3,825 $ (482) $(3,211) $ 132
-------------- ------------- ------- -------
Consideration
Cash $10,082 $ 4,376 $22,097 $36,555
Shares 13,249 4,496 12,586 30,331
------- ------- ------- -------
$23,331 $ 8,872 $34,683 $66,886
-------------- ------------- ------- -------
Goodwill $19,506 $ 9,354 $37,894 $66,754
-------------- ------------- ------- -------
Number of shares issued as
consideration (000's) 1,103 417 1,185 2,705
-------------- ------------- ------- -------
</Table>
F-14
4. ACCOUNTS AND OTHER RECEIVABLES
Accounts and other receivables consist of the following:
<Table>
<Caption>
DECEMBER 31,
------------------
2001 2000
-------- -------
Client premiums receivable $ 80,488 $33,430
Commissions receivable 18,214 5,870
Less: Allowance for doubtful accounts and policy
cancellations (1,427) (502)
-------- -------
97,275 38,798
Other receivables 4,038 3,177
-------- -------
$101,313 $41,975
-------- -------
</Table>
Allowance for doubtful accounts and policy cancellations:
<Table>
<Caption>
DECEMBER 31,
--------------------
2001 2000 1999
------ ---- ----
Balance, January 1 $ 502 $309 $110
Charged to net earnings before income taxes 340 26 188
Acquired through acquisitions 585 167 11
------ ---- ----
Balance, December 31 $1,427 $502 $309
====== ==== ====
</Table>
5. CAPITAL ASSETS
<Table>
<Caption>
DECEMBER 31,
-------------------
2001 2000
-------- --------
Leasehold improvements $ 10,043 $ 1,929
Office equipment 11,140 6,570
Computer equipment 13,620 8,900
-------- --------
34,803 17,399
Accumulated depreciation and amortization (13,868) (10,191)
-------- --------
Net book value $ 20,935 $ 7,208
-------- --------
</Table>
During 2001 and 2000, capital assets were acquired at an aggregate cost of
$11,534 and $2,395, respectively, of which $1,236 and $345, respectively, were
acquired by means of capital leases.
The cost above reflects certain capital assets held under capital leases of
which the remaining liability at December 31, 2001 and 2000 was $1,470 and $667,
respectively.
F-15
6. OTHER INTANGIBLE ASSETS AND GOODWILL
As of December 31, 2001, the gross carrying amount and accumulated amortization
of intangible assets were as follows:
<Table>
<Caption>
GROSS
CARRYING ACCUMULATED
AMOUNT AMORTIZATION TOTAL
-------- ------------ -------
Definite life intangible assets:
Customer relationships $21,720 $759 $20,961
Indefinite life intangible assets:
Non-competition covenants 2,587 56 2,531
Trademarks 1,839 -- 1,839
------- ---- -------
Total $26,146 $815 $25,331
------- --------- -------
</Table>
The Company is unable to estimate the useful life of non-competition covenants
and trademarks. These indefinite life intangible assets will be reviewed
annually for impairment. Once a non-competition covenant is triggered, the
Company's policy is to amortize the related intangible asset over the period of
the remaining contractual obligation.
The changes in the carrying amount of goodwill for the years ended December 31,
2001 and 2000, are as follows:
<Table>
<Caption>
OPERATIONS OPERATIONS
IN CANADA IN U.S. TOTAL
---------- ---------- --------
Balance as of January 1, 2000 $67,760 $ 22,051 $ 89,811
Goodwill acquired during 2000 10,388 20,030 30,418
Amortization of goodwill during
2000 (2,501) (759) (3,260)
Cumulative translation adjustment -- 775 775
------- -------- --------
Balance as of December 31, 2000 $75,647 $ 42,097 $117,744
Goodwill acquired during the period
January 1, 2001 to June 30, 2001 1,255 67,848 69,103
Goodwill acquired during the period
July 1, 2001 to December 31, 2001 556 32,265 32,821
Amortization of goodwill during
2001 (2,292) (1,833) (4,125)
Cumulative translation adjustment (884) 6,189 5,305
------- -------- --------
Balance as of December 31, 2001 $74,282 $146,566 $220,848
-------- --------- --------
</Table>
Goodwill acquired prior to July 1, 2001 is amortized on a straight-line basis
over a period of 40 years. Accumulated amortization was $14,822 and $10,482 at
December 31, 2001 and 2000, respectively.
F-16
For the years ended December 31, 2001, 2000 and 1999, amortization has been
comprised of the following:
<Table>
<Caption>
2001 2000 1999
------ ------ ------
Customer relationships $ 759 $ -- $ --
Non-competition covenants 56 -- --
Goodwill 4,125 3,260 1,626
------ ------ ------
Total $4,940 $3,260 $1,626
------ ------ ------
</Table>
7. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consist of the following:
<Table>
<Caption>
DECEMBER 31, DECEMBER 31,
2001 2000
------------- -------------
Insurance premiums payable $122,668 $42,472
Accrued liabilities 41,426 15,129
-------- -------
$164,094 $57,601
------------- ------------
</Table>
8. DEBT
Bank debt
At December 31, 2001, the Company had bank debt consisting of three separate
credit facilities:
- $25 million facility. Borrowings under this facility are accessed at a
floating rate of 135 basis points above LIBOR, which was 2.09% as of
December 31, 2001. This facility is guaranteed by certain of the
Company's subsidiaries and by Fairfax. It expires on July 18, 2002 and
contains covenants that, among other things, require the Company to
maintain certain financial ratios, restrict its ability to incur
additional debt, and limit quarterly dividends to C$.07 per share. As of
December 31, 2001, $25 million was drawn on this facility. The Company
intends to fully repay and terminate this facility with proceeds from the
sale of Old Lyme.
- $25 million facility. Borrowings under this facility are accessed either
at a floating rate of 150 basis points above LIBOR, which was 2.09% as of
December 31, 2001, or at a fixed interest rate of 9%. This facility is
guaranteed by certain of the Company's subsidiaries. It expires on July
17, 2002 and contains covenants that, among other things, require the
Company to maintain certain financial ratios, restrict its ability to
incur additional debt and limit quarterly dividend payments to C$0.07 per
share. As of December 31, 2001, $24.5 million was drawn on this facility,
$23 million at a floating interest rate and $1.5 million at a fixed
interest rate, which is included in long-term debt and is due October 31,
2005. We intend to repay approximately $4.5 million of this facility with
the proceeds from the sale of Old Lyme.
- $7.5 million facility. Borrowings under this facility are at an interest
rate of prime, which was 4.75% as of December 31, 2001, plus 1%. Payment
is due on demand. As of December 31, 2001, $7.0 million had been drawn on
this facility. The Company intends to fully repay and terminate this
facility with the proceeds from the sale of Old Lyme.
F-17
The Company has agreed to sell Old Lyme to a subsidiary of Fairfax for
approximately $42.8 million, subject to obtaining regulatory approval. The
Company intends to use the proceeds from the sale of Old Lyme to repay debt.
As of September 30, 2001, the Company was not in compliance with certain
financial covenants relating to the maintenance of certain ratios under both of
the $25 million credit facilities. The non-compliance was the direct result of a
delay in reaching a final agreement for the sale of Old Lyme, the proceeds of
which would have been used to repay debt. The Company's lenders have granted
waivers with respect to the non-compliance with these covenants. In addition,
the Company has negotiated amended agreements, with respect to these covenants,
with these lenders as of December 31, 2001. The amendments are for the remaining
life of the loans. Under the amended agreements, the Company is in compliance
with all the financial covenants governing the respective credit facilities as
of December 31, 2001.
Long-term debt and capital leases
<Table>
<Caption>
2001 2000
------- -------
Revolving U.S. Dollar LIBOR loans at 3.2% $49,454 $29,835
Put options (see below) 17,274 --
Term loan with interest at prime plus 3/4%, repayable at
$22 monthly, due August, 2005* 849 1,130
Term loan with interest at 9%, repayable at $46 monthly, due
October, 2005* 1,533 --
Term loan with interest at 7.8%, repayable at $367
quarterly, due June 2002* 728 --
Term loan with interest at 7.75% repayable at $13 monthly,
due March 2002* 38 --
Note payable with interest at 5.92%, repayable at $272
annually, due November 2005 953 1,103
Term loan with interest at 8.25%, repayable at $364
semi-annually, due June 2007* 4,007 --
Term loan with interest at 8%, repayable at $18 monthly, due
July 2010 1,353 --
Various other unsecured notes payable and debt 2,669 1,702
Capital leases* 1,470 667
Term loans repaid during the year -- 228
------- -------
Long-term debt and capital leases 80,328 34,665
Less current portion (4,169) (2,167)
------- -------
$76,159 $32,498
------- -------
</Table>
- ---------------
* Certain capital assets have been pledged as collateral in amounts not less
than the outstanding balance at December 31, 2001.
Revolving U.S. dollar LIBOR loans
Borrowings under this facility total $50 million and are accessed at a floating
rate of 112.5 basis points above LIBOR, which was 2.09% as of December 31, 2001.
This facility expires on June 20, 2002 and requires the Company to maintain
certain financial ratios. The Company intends to extend the facility for a
further period of one year; however,
F-18
if the revolving period is not extended, any amounts outstanding will
automatically convert into a three-year term loan at a fixed interest rate equal
to the Canadian dollar interest swap rate quoted by the lender plus 1.375%. As
of December 31, 2001 $49.5 million had been drawn on this facility. The Company
intends to pay down approximately $5 million of this facility with the proceeds
from the sale of Old Lyme.
Put options
Long-term debt includes the estimated value of the financial liability of
$17,274 relating to written put option agreements on 2,103 common shares,
exercisable at a price of C$17.00 per share, issued to former owners of
brokerages acquired who are officers and employees of the Company. The put
options are exercisable as follows:
<Table>
<Caption>
NUMBER
OF SHARES
DATE (000'S)
- ---- ---------
June 18, 2006 340
July 1, 2006 873
June 18, 2007 68
June 18, 2011 272
July 1, 2011 550
</Table>
The Company will not be required to settle the liabilities in cash if the common
share price exceeds C$17.00 on each of the above mentioned exercise dates. Any
options not exercised on the exercise date immediately expire.
Subordinated convertible debentures
In connection with the acquisition of Kaye on June 28, 2001, we issued: (1)
$26.6 million aggregate principal amount of 8.5% convertible subordinated notes
due June 28, 2006 to a third-party, the third-party notes; and (2) $35 million
aggregate principal amount of 8.5% convertible subordinated notes due June 28,
2007 to certain subsidiaries of Fairfax, the Fairfax notes. These convertible
notes were anti-dilutive to earnings per share as of December 31, 2001.
The third-party notes are convertible at any time into the Company's common
shares at C$17.00 per share, subject to mandatory conversion at June 28, 2006.
The Company subsequently entered into an agreement whereby the third-party
agreed not to convert the notes into common shares before June 30, 2002 and also
agreed to allow the Company to repay the notes, in whole or in part, on or
before June 30, 2002 without penalty.
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 for twenty consecutive trading days equals or exceeds C$19.00 per share.
If converted, Fairfax would own approximately 45% of the total outstanding
common shares as of December 31, 2001.
F-19
Future repayment of long-term debt and capital leases is as follows:
<Table>
Year ending December 31, 2002 $ 4,169
2003 2,794
2004 2,478
2005 51,365
2006 11,016
2007 and thereafter 8,506
-------
$80,328
-------
</Table>
9. COMMITMENTS AND CONTINGENCIES
a) The Company is committed under lease agreements for office premises and
computer equipment. At December 31, 2001, aggregate minimum rental
commitments (net of expected sub-lease receipts) under operating leases of
$53,766 are summarized as follows:
<Table>
2002 $ 9,061
2003 $ 7,909
2004 $ 6,968
2005 $ 6,311
2006 $ 5,680
2007 and thereafter $17,837
</Table>
b) The Company may, under certain circumstances be obligated to purchase loans
for officers, directors and employees from a Canadian chartered bank
totaling $5,542 (2000 -- $5,896) to assist in purchasing common shares of
the Company. As collateral, the employees have pledged 669 (2000 -- 690)
common shares which have a year-end market value of $6,389 (2000 -- $5,683).
Interest in the amount of $377 (2000 -- $397) on the loans was paid by the
Company.
c) 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 asserted and
potential claims and lawsuits will not have a material effect on the
consolidated financial position or results of operations of the Company.
10. SHAREHOLDERS' EQUITY
At December 31, 2001 and 2000, 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,
2001 and 2000, there were an unlimited number of common shares authorized, of
which 21,656 in 2001 and 18,528 in 2000 were issued and outstanding.
F-20
<Table>
<Caption>
COMMON SHARES
----------------------
OUTSTANDING
(000'S) AMOUNT
----------- --------
Balance, January 1, 1999 7,077 $ 16,624
Repurchase (577) (4,147)
Issued for cash 9,104 65,534
Purchase of subsidiaries 2,704 30,331
------ --------
Balance, December 31, 1999 18,308 108,342
Repurchase (288) (1,794)
Purchase of subsidiaries 508 4,882
------ --------
Balance, December 31, 2000 18,528 111,430
Issued for cash 440 3,621
Issued for executive stock purchase plan (net
of repurchases) 164 1,886
Purchase of subsidiaries 2,474 8,091
Issuable for contingent consideration 50 478
------ --------
Balance, December 31, 2001 21,656 $125,506
----------- --------
</Table>
During 2000, under terms of normal course issuer bids approved by The Toronto
Stock Exchange, the Company purchased and cancelled 226 common shares for an
aggregate cost of $1,996, of which $649 was charged to retained earnings.
On January 22, 1999, the Company issued 2,838 Special Warrants for cash of
$24,282. Holders of Special Warrants were entitled to receive, upon exercise and
without payment of any further consideration, one common share of the Company
for each Special Warrant held. These warrants were exercised on February 10,
1999.
On January 29, 1999, the Company filed a prospectus with applicable regulatory
authorities in each of the provinces of Canada for the offering and issuance of
866 common shares of the Company for cash of $7,406. The offering closed on
February 10, 1999. Shares issued for cash of $65,534 is net of issue costs of
$376.
Cumulative translation account
<Table>
<Caption>
2001 2000
------- ------
Balance at January 1 $ 195 $ (831)
Translation of self-sustaining foreign operations 9,479 1,335
Translation of debt financing self-sustaining foreign
operations (6,904) (309)
------- ------
Balance at December 31 $ 2,770 $ 195
------- ------
</Table>
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial assets and liabilities,
including cash and cash equivalents, accounts and other receivables, accounts
payable and accrued liabilities at December 31, 2001 and 2000, approximate fair
value because of the short maturity of these instruments. The carrying value of
the Company's variable rate debt of $105,300 approximates fair market value.
F-21
The fair value of the Company's subordinated convertible debentures is not
determinable. The carrying values of put options and other long-term debt
approximate fair values.
12. INCOME TAXES
The provision for income tax expense differs from the result that would have
been obtained by applying the combined Canadian statutory federal and provincial
income tax rate of 41.7% for 2001, 44.0% for 2000 and 44.5% for 1999, as
follows:
<Table>
<Caption>
2001 2000 1999
------- ------- ------
Provision for tax at statutory rates $ 6,366 $ 5,058 $3,467
Non-deductible amortization of goodwill 1,579 994 588
Income earned outside Canada (3,170) (1,148) (44)
Other 487 466 41
------- ------- ------
Provision for tax $ 5,262 $ 5,370 $4,052
------- ------- ------
</Table>
The components of the future tax assets and liabilities at December 31, 2001 and
2000, were as follows:
<Table>
<Caption>
2001 2000
------- -----
Future income tax assets
Loss carryforwards $ 1,886 $ 166
Non-deductible book reserves 1,602 --
Deferred compensation 879 --
Other 303 202
------- -----
Total future income tax assets 4,670 368
Less: current portion future income tax assets (1,999) --
------- -----
Future income tax assets $ 2,671 $ 368
------- -----
Future income tax liabilities
Goodwill and other intangible asset amortization $ 3,663 $ 712
Other accrual adjustments 1,309 --
Capital asset depreciation 169 181
Other 838 (141)
------- -----
Total future income tax liabilities 5,979 752
Less: current portion future income tax liabilities (1,387) --
------- -----
Future income tax liabilities $(4,592) $ 752
------- -----
</Table>
The Company has Canadian net operating loss carryforwards of $2,425 at December
31, 2001 that expire 2007 through 2008. In addition, the Company has various
state and local net operating loss carryforwards in the U.S. of approximately
$9,100, which expire 2016 through 2021. 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 these losses and, accordingly, a valuation allowance in the
amount of approximately $1,400 has been established where we do not believe the
net operating losses will be realized.
F-22
<Table>
Valuation allowance January 1, 2001 $ --
Acquired through acquisitions 1,461
Valuation allowance December 31, 2001 1,400
------
Change in the period $ 61
Average state and local tax rate 10%
------
Charged to provision for income tax expense for the year
ended December 31, 2001 $ 6
------
</Table>
13. INTEREST AND INCOME TAXES PAID
Interest and income taxes paid were for the years ending December 31 were:
<Table>
<Caption>
2001 2000 1999
------ ------ ------
Interest paid $6,818 $2,606 $ 632
Income taxes paid $3,444 $7,528 $4,264
</Table>
14. PRO FORMA RESULTS OF ACQUISITIONS (UNAUDITED)
The following table reflects the results of our operations, on a pro forma
basis, as if the 2001 acquisitions of Burnham, Flanagan and Kaye had been
completed on January 1, 2000, and the 2000 acquisition of McCarthy had been
completed on January 1, 2000. The 1999 acquisitions have not been presented due
to the significant number of individually immaterial acquisitions.
<Table>
<Caption>
2001 2000
-------- --------
Total revenue $197,786 $172,541
Net earnings (loss) before income taxes $ 16,321 $ (2,287)
Net earnings (loss) from operations $ 11,440 $ (3,388)
Net earnings (loss) from operations per share
Basic $ 0.56 $ (0.18)
Diluted $ 0.53 $ (0.16)
Weighted average shares outstanding
Basic (000's) 20,387 19,231
Diluted (000's) 21,480 21,654
</Table>
The pro forma adjustments for 2001 and 2000 include adjustments to remove non-
recurring expenses incurred by the brokerages acquired in connection with the
purchase transactions by the Company, adjustments to amortization of goodwill
and other identifiable intangible assets, as well as adjustments to reflect the
Company's cost of borrowings as if the 2001 acquisitions of Burnham, Flanagan
and Kaye had been completed on January 1, 2000, and the 2000 acquisition of
McCarthy had been completed on January 1, 2000.
15. SEGMENTED INFORMATION
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
F-23
income, 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 and management fees.
Geographic revenue is determined based upon the functional currency of the
various subsidiaries. Financial information by operating and geographic segment
for 2001, 2000 and 1999 is as follows:
<Table>
<Caption>
2001 2000
---------------------------------- ---------------------------------
CANADA U.S. CONSOLIDATED CANADA U.S. CONSOLIDATED
-------- -------- ------------ -------- ------- ------------
REVENUE
Brokerage $ 78,488 $ 75,458 $153,946 $ 74,710 $19,864 $ 94,574
Corporate and other 16,960 237 17,197 7,953 5,142 13,095
Elimination of intra-segment
revenue (16,884) (266) (17,150) (7,427) (5,002) (12,429)
-------- -------- -------- -------- ------- --------
$ 78,564 $ 75,429 $153,993 $ 75,236 $20,004 $ 95,240
-------- -------- ---------- -------- ------- ----------
NET EARNINGS BEFORE INCOME
TAXES
Brokerage $ 6,625 $ 13,200 $ 19,825 $ 8,017 $ 3,242 $ 11,259
Corporate and other 6,126 (10,684) (4,558) 3,771 (3,522) 249
-------- -------- -------- -------- ------- --------
$ 12,751 $ 2,516 $ 15,267 $ 11,788 ($280) $ 11,508
-------- -------- ---------- -------- ------- ----------
INCOME TAXES
Brokerage $ 3,910 $ 5,793 $ 9,703 $ 4,930 $ 1,339 $ 6,269
Corporate and other (322) (4,119) (4,441) 412 (1,311) (899)
-------- -------- -------- -------- ------- --------
$ 3,588 $ 1,674 $ 5,262 $ 5,342 $ 28 $ 5,370
-------- -------- ---------- -------- ------- ----------
NET EARNINGS
Brokerage $ 2,715 $ 7,505 $ 10,122 $ 3,087 $ 1,903 $ 4,990
Corporate and other 6,448 (6,565) (117) 3,359 (2,211) 1,148
-------- -------- -------- -------- ------- --------
$ 9,163 $ 842 $ 10,005 $ 6,446 ($308) $ 6,138
-------- -------- ---------- -------- ------- ----------
IDENTIFIABLE ASSETS
Brokerage $109,896 $319,989 $429,885 $129,899 $63,116 $193,015
Investment held for sale -- 40,772 40,772 -- -- --
Corporate and other 28,212 3,427 31,639 8,309 4,833 13,142
-------- -------- -------- -------- ------- --------
$138,108 $364,188 $502,296 $138,208 $67,949 $206,157
-------- -------- ---------- -------- ------- ----------
AMORTIZATION $ 2,316 $ 2,624 $ 4,940 $ 2,482 $ 778 $ 3,260
ADDITIONS TO CAPITAL ASSETS $ 1,624 $ 9,910 $ 11,534 $ 2,190 $ 205 $ 2,395
DEPRECIATION $ 1,755 $ 2,185 $ 3,940 $ 1,619 $ 266 $ 1,885
INTEREST REVENUE $ 805 $ 1,188 $ 1,993 $ 977 $ 704 $ 1,681
INTEREST EXPENSE $ 6,337 $ 1,110 $ 7,447 $ 1,920 $ 61 $ 1,981
</Table>
F-24
<Table>
<Caption>
1999
---------------------------------
CANADA U.S. CONSOLIDATED
-------- ------- ------------
REVENUE
Brokerage $ 50,944 $ 1,535 $ 52,479
Corporate and other 4,029 -- 4,029
Elimination of intra-segment revenue (2,411) -- (2,411)
-------- ------- --------
$ 52,562 $ 1,535 $ 54,097
-------- ------- -----------
NET EARNINGS BEFORE INCOME TAXES
Brokerage $ 5,727 $ (236) $ 5,491
Corporate and other 2,510 (205) 2,305
-------- ------- --------
$ 8,237 $ (441) $ 7,796
-------- ------- -----------
INCOME TAXES
Brokerage $ 3,274 $ (65) $ 3,209
Corporate and other 994 (151) 843
-------- ------- --------
$ 4,268 $ (216) $ 4,052
-------- ------- -----------
NET EARNINGS
Brokerage $ 2,453 $ (171) $ 2,282
Corporate and other 1,516 (54) 1,462
-------- ------- --------
$ 3,969 $ (255) $ 3,744
-------- ------- -----------
IDENTIFIABLE ASSETS
Brokerage $117,038 $32,070 $149,108
Corporate and other 20,247 1,847 22,094
-------- ------- --------
$137,285 $33,917 $171,202
-------- ------- -----------
AMORTIZATION $ 1,547 $ 79 $ 1,626
ADDITIONS TO CAPITAL ASSETS $ 1,225 $ 83 $ 1,308
DEPRECIATION $ 1,211 $ 64 $ 1,275
INTEREST REVENUE $ 724 $ 83 $ 807
INTEREST EXPENSE $ 425 $ 207 $ 632
</Table>
16. RELATED PARTY TRANSACTIONS
The Company had transactions with and recorded commission income from the
following related parties:
<Table>
<Caption>
2001 2000 1999
------ ------ ------
Lombard General Insurance Company of Canada $6,123 $7,527 $6,077
Commonwealth Insurance Company 374 351 353
Federated Insurance Company of Canada 28 10 1
Markel Insurance Company of Canada 88 72 61
Crum & Forster Insurance 745 291 67
TIG Specialty Insurance 150 -- --
------ ------ ------
$7,508 $8,251 $6,559
------ ------ ------
</Table>
As of December 31, 2001, the Company had accounts receivable and accounts
payable balances with the above related parties in the amounts of $271 and
$6,839 (2000 --
F-25
$269 and $3,605), 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 37% of the Company's common shares.
As of December 31, 2001, long-term debt related to put options and certain
subordinated convertible debentures are due to related parties.
During 2001 and 2000, the Company incurred expenses related to rental of
premises from related parties in the amount of $1,373 and $993, respectively. At
December 31, 2001 and 2000, the Company also had accounts receivable due from
related parties in the amount of $4,586 (2000 -- $2,320), of which the majority
were loans to employees to enable them to purchase shares of the Company.
17. RECONCILIATION TO U.S. GAAP
The consolidated financial statements have been prepared in accordance with
Canadian GAAP which differs in certain respects from United States GAAP. The
following represents the differences affecting net earnings:
<Table>
<Caption>
2001 2000 1999
------- ------- ------
Net earnings for the year based on Canadian
GAAP $10,005 $ 6,138 $3,744
Adjustment to investment held for sale(1) 520 -- --
Change in reporting currency(2) 158 366 233
------- ------- ------
NET EARNINGS FOR THE YEAR BASED ON U.S.
GAAP(3) 10,683 6,504 3,977
Other comprehensive income
Unrealized gains (losses), net of tax of
$226 -- 2001, ($112) -- 2000,
($25) -- 1999 (370) 183 41
Less: reclassification adjustment, net of
tax of ($112) -- 2001, $0 -- 2000 (182) (1) --
Foreign currency translation adjustment,
net of tax of ($2,478) -- 2001,
$1,294 -- 2000, ($1,514) -- 1999(2) 3,718 (1,940) 2,272
------- ------- ------
Comprehensive income based on U.S. GAAP(4) $13,849 $ 4,746 $6,290
------- ------- ------
Basic earnings per share based on U.S. GAAP $ 0.56 $ 0.35 $ 0.23
Diluted earnings per share based on U.S.
GAAP $ 0.53 $ 0.35 $ 0.23
</Table>
F-26
The effect of these adjustments on shareholders' equity is as follows:
<Table>
<Caption>
2001 2000
-------- --------
Shareholders' equity based on Canadian GAAP $135,271 $112,212
Adjustment to investment held for sale(1) 520 --
Accumulated other comprehensive income:
Unrealized gains (losses), net of tax of
($89) -- 2001, $136 -- 2000 (146) 224
Cumulative translation account(2) (1,864) 5,582
Executive share purchase plan loan(5) (2,142) --
-------- --------
Shareholders' equity based on U.S. GAAP(3) $131,639 $118,023
-------- --------
</Table>
- ---------------
(1) Under Canadian GAAP, Old Lyme is treated as an investment held for sale at
its June 28, 2001 cost of $40,772. Under U.S. GAAP, Old Lyme is reflected at
its fair market value, which is equal to its U.S. GAAP shareholder's equity
at December 31, 2001 pursuant to the pending sale of Old Lyme. Accordingly,
under U.S. GAAP, the investment in Old Lyme has been increased to reflect
the net increase in its shareholder's equity from the date of acquisition.
This adjustment is treated as a purchase price adjustment to the Kaye
acquisition and results in an increase of $2,075 in the investment in Old
Lyme and a corresponding decrease in goodwill, with no effect on net
earnings or shareholders' equity. Under Canadian GAAP, interest on debt used
to finance the Old Lyme acquisition in the amount of $520 (net of tax) is
charged to earnings. Under U.S. GAAP, the interest expense on the debt
incurred to finance the purchase of Old Lyme is applied to the carrying
value of the investment and does not affect the net earnings of the Company.
(2) Under Canadian GAAP, the Company's consolidated financial statements have
historically been expressed in Canadian dollars. Effective September 30,
2001, the Company adopted the U.S. dollar as its reporting currency.
Comparative financial information has been 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
current 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 share capital accounts is the
historical exchange rate.
In addition, foreign exchange differences under U.S. GAAP are included in
the cumulative translation account net of tax. The aggregate impact of
these differences has been presented in the reconciliation of shareholders'
equity for Canadian to U.S. GAAP under the caption "cumulative translation
account."
F-27
(3) The consolidated statements of earnings and cash flows for the years ended
December 31, 2001, 2000 and 1999 and the condensed balance sheets as at
December 31, 2001 and 2000 under U.S. GAAP are as follows:
<Table>
<Caption>
2001 2000 1999
--------- -------- --------
Revenue $ 156,781 $100,919 $ 57,458
Net earnings before income taxes $ 16,042 $ 12,195 $ 8,281
Net earnings $ 10,683 $ 6,504 $ 3,977
Cash provided by operating
activities $ 44,980 $ 13,563 $ 5,377
Cash used in investing activities $(130,687) $(18,914) $(37,886)
Cash provided by financing
activities $ 130,881 $ 5,904 $ 63,949
Total current assets $ 225,485 $ 81,518
Total assets $ 499,381 $216,834
Total current liabilities $ 224,968 $ 63,839
Total liabilities $ 367,742 $ 98,811
Total shareholders' equity $ 131,639 $118,023
</Table>
(4) Comprehensive income is measured in accordance with Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income" (SFAS
130). This standard defines comprehensive income as all changes in equity
other than those resulting from investments by owners and distributions to
owners and includes the change in unrealized gains (losses) and foreign
currency translation adjustments, which under Canadian GAAP are not
recognized and recorded as a separate component of shareholders' equity,
respectively. Certain disclosures required by SFAS 115, Accounting for
Certain Investments in Debt and Equity Securities, have not been included as
such disclosures related to the Company's investments in debt and equity
securities are immaterial to the overall financial statement presentation.
(5) Under Canadian GAAP, loans granted by the Company to employees under the
executive share purchase plan are treated as a receivable and included in
the balance sheet caption "Accounts and other receivables." Under U.S. GAAP,
those loans receivables must be included as a reduction to shareholders'
equity.
18. EFFECTS OF NEW U.S. GAAP ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that all business combinations subsequent to June
30, 2001 be accounted for in accordance with the purchase method of accounting,
as well as specifies criteria for recognizing intangible assets acquired in a
purchase business combination. SFAS No. 142 eliminates the amortization of
goodwill, requires annual impairment testing of goodwill, and introduces the
concept of definite and indefinite life intangible assets. Indefinite life
intangible assets, similar to goodwill, will no longer be amortized and will be
tested at least annually for impairment. Definite life intangible assets will be
amortized over the estimated useful life of the asset. SFAS No. 142 must be
adopted on January 1, 2002.
Although the Company has not completed its assessment of these new accounting
standards, it expects that the provisions of SFAS No. 142 related to accounting
for
F-28
goodwill and other intangible assets will have a significant impact on its
consolidated earnings in 2002, as goodwill will no longer be amortized and
charged to income, when compared to consolidated earnings for years prior to
2002. The Company is reviewing the impairment testing provisions of these
standards, and based on current conditions, does not expect to incur a material
transition goodwill impairment charge as of January 1, 2002.
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).
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.
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 is classified as held for
disposal at December 31, 2001, will continue 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. In the event that the sale
of Old Lyme is not completed by December 31, 2002, the investment will be
reclassified as held for use in operations, in accordance with the provisions of
SFAS No. 144.
Canadian GAAP has not been harmonized with U.S. GAAP related to the provisions
of SFAS No. 144. Accordingly, any impact related to the adoption of the
provisions of SFAS No. 144 will be treated as a reconciling item between U.S.
and Canadian GAAP. However, we do not anticipate that the provisions of SFAS No.
144 will have a material impact on our financial position or results of
operations as reported under U.S. GAAP.
F-29
19. QUARTERLY DATA (UNAUDITED)
<Table>
<Caption>
FIRST SECOND THIRD FOURTH FULL
QUARTER QUARTER QUARTER QUARTER YEAR
------- ------- ------- ------- --------
YEAR ENDED DECEMBER 31, 2001
Revenue $28,096 $29,342 $43,601 $52,954 $153,993
Net earnings $2,467 $2,558 $2,029 $2,951 $10,005
Net earnings per share -- Basic $0.13 $0.14 $0.11 $0.15 $0.53
Net earnings per share -- Diluted $0.13 $0.14 $0.09 $0.14 $0.50
YEAR ENDED DECEMBER 31, 2000
Revenue $23,205 $23,080 $24,504 $24,451 $95,240
Net earnings $2,302 $2,093 $1,184 $559 $6,138
Net earnings per share -- Basic $0.13 $0.12 $0.06 $0.03 $0.34
Net earnings per share -- Diluted $0.13 $0.12 $0.06 $0.03 $0.34
</Table>
F-30
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS OF KAYE GROUP INC.:
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, of cash flows, of stockholders' equity
and comprehensive loss present fairly, in all material respects, the financial
position of Kaye Group Inc. and its subsidiaries at June 28, 2001, and the
results of their operations and their cash flows for the period from January 1,
2001 through June 28, 2001 in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audit. We conducted our audit
of these statements in accordance with auditing standards generally accepted in
the United States of America, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
LOGO
PricewaterhouseCoopers LLP
New York, New York
March 12, 2002
F-31
KAYE GROUP INC.
CONSOLIDATED BALANCE SHEET
As of June 28, 2001
(in thousands, except par value per share)
<Table>
ASSETS
INSURANCE BROKERAGE COMPANIES:
CURRENT ASSETS
Cash and cash equivalents (including short term
investments, and funds held in a fiduciary capacity of
$16,618) $ 18,053
Premiums and other receivables 36,857
Prepaid expenses and other assets 1,251
Deferred income taxes 1,363
--------
TOTAL CURRENT ASSETS 57,524
--------
Fixed assets (net of accumulated depreciation of $7,950) 5,256
Intangible assets (net of accumulated amortization of
$5,485) 12,128
Deferred income taxes 1,287
Other assets 518
--------
TOTAL ASSETS -- INSURANCE BROKERAGE COMPANIES 76,713
--------
PROPERTY AND CASUALTY COMPANIES:
Investments available-for-sale
Fixed maturities, at market value (amortized cost $50,038) 50,261
Equity securities, at market value (cost $350) 350
--------
TOTAL INVESTMENTS 50,611
--------
Cash and cash equivalents 8,998
Accrued interest and dividends 1,107
Premiums receivable 3,429
Reinsurance recoverable on paid and unpaid losses 7,430
Prepaid reinsurance premiums 1,248
Deferred acquisition costs 3,376
Deferred income taxes 3,120
Other assets 5,092
--------
TOTAL ASSETS -- PROPERTY AND CASUALTY COMPANIES 84,411
--------
CORPORATE:
Cash and cash equivalents 107
Cash, restricted 2,445
Prepaid income taxes 1,176
Prepaid expenses and other assets 10
Investment -- Equity securities, at market value (cost $308) 359
Deferred income taxes 71
--------
TOTAL ASSETS -- CORPORATE 4,168
--------
TOTAL ASSETS $165,292
--------
</Table>
See notes to consolidated financial statements.
F-32
KAYE GROUP INC.
CONSOLIDATED BALANCE SHEET
As of June 28, 2001 (in thousands, except par value per share)
<Table>
LIABILITIES
INSURANCE BROKERAGE COMPANIES:
Current liabilities
Premiums payable and unearned commissions $ 42,657
Accounts payable and accrued liabilities 6,625
Notes payable 488
Advance from Hub International Limited 10,585
Deferred income taxes 1,069
--------
TOTAL CURRENT LIABILITIES 61,424
Notes payable 94
Deferred income taxes 288
--------
TOTAL LIABILITIES -- INSURANCE BROKERAGE COMPANIES 61,806
--------
PROPERTY AND CASUALTY COMPANIES:
Liabilities
Unpaid losses and loss expenses 30,366
Unearned premium reserves 11,875
Accounts payable and accrued liabilities 375
Deferred income taxes 1,442
Other liabilities 954
--------
TOTAL LIABILITIES -- PROPERTY AND CASUALTY COMPANIES 45,012
--------
CORPORATE:
Current liabilities
Accounts payable and accrued liabilities 2,482
Loan payable 1,412
Deferred income taxes 17
--------
TOTAL CURRENT LIABILITIES -- CORPORATE 3,911
--------
TOTAL LIABILITIES 110,729
--------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par value; 1,000 shares authorized;
none issued or outstanding
Common stock, $.01 par value; 20,000 shares authorized;
8,507 shares issued and outstanding 85
Paid-in capital 17,995
Accumulated other comprehensive income, net of deferred
income tax liability of $93 181
Retained earnings 36,302
--------
TOTAL STOCKHOLDERS' EQUITY 54,563
--------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $165,292
--------
</Table>
See notes to consolidated financial statements.
F-33
KAYE GROUP INC.
CONSOLIDATED STATEMENT OF OPERATIONS
For the period January 1, 2001 through June 28, 2001
(in thousands)
<Table>
INSURANCE BROKERAGE COMPANIES:
Revenues
Commissions and fees -- net $20,174
Net investment income 448
Net realized loss on investments (364)
-------
TOTAL REVENUES 20,258
-------
Expenses
Compensation and benefits 12,089
Amortization of intangibles 676
Other operating expenses 7,795
-------
TOTAL OPERATING EXPENSES 20,560
-------
Interest expense 377
-------
LOSS BEFORE MERGER EXPENSES -- INSURANCE BROKERAGE COMPANIES (679)
-------
PROPERTY AND CASUALTY COMPANIES
Revenues
Net premiums written 14,671
Change in unearned premiums 2,121
-------
Net premiums earned 16,792
Net investment income 1,768
Net realized loss on investments (713)
Other income 6,480
-------
TOTAL REVENUES 24,327
-------
Expenses
Losses and loss expenses 7,258
Acquisition costs and general and administrative expenses 6,701
-------
TOTAL EXPENSES 13,959
-------
INCOME BEFORE MERGER EXPENSES -- PROPERTY AND CASUALTY
COMPANIES 10,368
-------
CORPORATE:
Revenues -- Net investment income 16
Expenses
Other operating expenses 247
Interest expense 75
-------
LOSS BEFORE MERGER EXPENSES -- CORPORATE (306)
-------
Income before merger expenses 9,383
Merger expenses 13,263
-------
LOSS BEFORE INCOME TAXES (3,880)
-------
(Benefit) provision for income taxes
Current 703
Deferred (2,735)
-------
TOTAL BENEFIT FOR INCOME TAXES (2,032)
-------
Loss before cumulative effect of change in accounting
principle (1,848)
Cumulative effect of change in accounting principle (net of
tax effect) 158
-------
NET LOSS $(1,690)
-------
</Table>
See notes to consolidated financial statements.
F-34
KAYE GROUP INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For the period January 1, 2001 through June 28, 2001 (in thousands)
<Table>
<Caption>
COMMON STOCK ACCUMULATED
------------------- COMMON UNEARNED OTHER TOTAL
OUTSTANDING PAR STOCK STOCK GRANT PAID-IN COMPREHENSIVE RETAINED STOCKHOLDERS'
SHARES VALUE IN TREASURY COMPENSATION CAPITAL INCOME EARNINGS EQUITY
----------- ----- ----------- ------------ ------- ------------- -------- -------------
Balance, January 1,
2001 8,481 $85 $(37) $(235) $18,019 $(207) $38,417 $56,042
Change in unrealized
appreciation, net of
deferred income tax
of $200 388 388
Amortization of
unearned restricted
stock 9 9
Net loss (1,690) (1,690)
Shares issued -- SRW
acquisition 21 171 171
Shares issued --
employee stock
option plan 4 31 31
Dividends declared
(per share -- $0.05) (425) (425)
Write off balance of
unearned restricted
stock 226 (226) --
Shares forfeited --
stock performance
plan (3) --
Reissuance of
treasury stock 4 37 37
----- --- ---- ----- ------- ----- ------- -------
Balance, June 28,
2001 8,507 $85 $ -- $ -- $17,995 $ 181 $36,302 $54,563
------- --- ------- -------- ------ -------- ------- ---------
</Table>
See notes to consolidated financial statements.
F-35
KAYE GROUP INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE LOSS
For the period January 1, 2001 through June 28, 2001
(in thousands)
<Table>
Net loss $(1,690)
Other comprehensive income
Unrealized investment holding losses arising during the
period, net of deferred income tax benefit of $22 (42)
Reclassification adjustment for realized investment loss
included in net income, net of deferred income tax
benefit of $222 430
-------
TOTAL OTHER COMPREHENSIVE INCOME 388
-------
Comprehensive loss $(1,302)
-------
</Table>
See notes to consolidated financial statements.
F-36
KAYE GROUP INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
For the period January 1, 2001 through June 28, 2001
(in thousands)
<Table>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,690)
Adjustments to reconcile net loss to net cash used in
operating activities
Deferred acquisition costs 677
Amortization of bond premium -- net 344
Deferred income taxes (2,735)
Net realized loss on investments 1,077
Depreciation and amortization 1,816
Change in assets and liabilities
Accrued interest and dividends (245)
Premiums and other receivables 234
Prepaid expenses and other assets 1,414
Premiums payable and unearned commissions (10,158)
Accounts payable and accrued liabilities (7,752)
Unpaid losses and loss expenses 2,382
Unearned premium reserves (1,822)
Income taxes payable (1,363)
--------
NET CASH USED IN OPERATING ACTIVITIES (17,821)
--------
CASH FLOWS FROM INVESTING ACTIVITIES
Investments available - for - sale
Purchase of fixed maturities (22,844)
Purchase of equity securities (477)
Maturities of fixed securities 2,320
Sales of fixed securities 13,553
Sales of equity securities 7,929
Purchase of fixed assets (615)
Acquisition payments (1,124)
--------
NET CASH USED IN INVESTING ACTIVITIES (1,258)
--------
CASH FLOWS FROM FINANCING ACTIVITIES
Acquisition debt-repayment (187)
Notes and loan payable-repayment (731)
Payment of dividends (636)
Proceeds from issuance of common stock 31
Advanced proceeds from Hub International Limited 10,585
Receipts under deposit contracts 107
--------
NET CASH PROVIDED BY FINANCING ACTIVITIES 9,169
--------
Net change in cash and cash equivalents (9,910)
Cash and cash equivalents at beginning of period 39,513
--------
Cash and cash equivalents at end of period $ 29,603
--------
</Table>
See notes to consolidated financial statements.
F-37
KAYE GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Kaye Group Inc. (the "Company"), a Delaware corporation, is a holding company
which, through its subsidiaries, is engaged in a broad range of insurance
brokerage, underwriting and related activities. The Company operates in two
insurance business segments -- the Insurance Brokerage Companies Operations
("Brokerage Operations"), comprised of the Retail Brokerage Business and the
Program Brokerage Business, and the Property and Casualty Companies Operations.
In addition, Corporate Operations includes those activities that benefit the
Company in its entirety and cannot be specifically identified to either the
Brokerage Operations or the Property and Casualty Companies Operations. Such
activities include debt servicing and public company expenses, including
investor relations' costs.
The Company's activities are conducted from offices in New York, New York,
Arcadia, California, Westport, Connecticut, Woodbury, New York and Warwick,
Rhode Island.
Sale of the company
On January 20, 2001, the Company reported that Hub International Limited ("HUB")
had entered into a definitive agreement (the "Agreement") to acquire the Company
through a merger transaction. Under the terms of the Agreement, shares of Kaye's
common stock not held by affiliates or shareholders perfecting appraisal rights
were converted to a right to receive $14 in cash. On June 28, 2001, the Company
and HUB completed the merger, which has not been given effect in the
accompanying consolidated financial statements. Prior to June 28, 2001 HUB had,
however, transferred cash of $10,585,000 to the Company to settle payments for
vested stock options and restricted stock held by employees; the cash is
reflected in the accompanying financial statements as restricted cash and an
advance from HUB, as well as recorded as a merger expense and as a payable to
the employees. On June 27, 2001, all stock options issued by the Company became
vested and were purchased with the payment of $8,140,000 in restricted cash
advanced by HUB. Restricted stock was converted to the right to receive $14 in
cash per share, totaling $2,445,000, which will be paid to stockholders upon the
first anniversary of the merger. Additionally, with the merger the advances by
HUB were contributed to the paid-in capital of the Company.
Proposed sale of property and casualty companies
On December 31, 2001, HUB, on behalf of the Company, announced that it had
agreed to sell the Company's underwriting subsidiaries Old Lyme Insurance
Company of Rhode Island, Inc. ("OLRI") and Old Lyme Insurance Ltd. ("OLB") to
Fairfax Inc. ("Fairfax"), effective January 1, 2002. Completion of the
transaction is subject to receipt of approval from and compliance with the
requirements of applicable regulatory authorities. Fairfax is a subsidiary of
Fairfax Financial Holdings Limited, and is HUB's largest shareholder with a 37%
interest in HUB's common stock.
Insurance brokerage companies operations
The Retail Brokerage Business operates insurance brokerage businesses through
four subsidiaries of the Company, the "Retail Brokerage Companies". The Retail
Brokerage Companies offer commercial clients a full range of insurance brokerage
services
F-38
including procurement of property/casualty insurance, risk management
consulting, bonding, loss prevention engineering, and group employee benefit
consulting services. In addition, personal lines and life and health insurance
coverage are placed on behalf of individual clients.
The Retail Brokerage Business' primary strategy is to service middle market
companies and organizations just below the Fortune 500 level for which other
national brokers intensely compete. Within this middle market, the Retail
Brokerage Business has developed particular expertise and knowledge of the risks
facing a number of industry sectors including health care, real estate, retail,
manufacturing, houses of worship, law firms, homes for the aged and fine arts.
The Retail Brokerage Business services approximately 14,000 insureds. The Retail
Brokerage Business is compensated for its services primarily in the form of
commissions paid by insurance companies. The commission is usually a percentage
of the premium paid by the insured. Commission rates depend upon the type of
insurance, the particular insurance company, and the role in which the Retail
Brokerage Business acts. In some cases a commission is shared with other agents
or brokers who have acted jointly with the Retail Brokerage Business in
connection with the transaction. The Retail Brokerage Business may also receive
from an insurance company a contingent commission that is generally based on the
profitability and volume of business placed with it by the Retail Brokerage
Business over a given period of time. The Retail Brokerage Business may also
receive fees from insureds in connection with consulting services relating to
the marketing of insurance.
Program Brokerage Corporation ("PBC" or the "Program Brokerage Business") is a
subsidiary of the Company and operates a wholesale insurance brokerage business
which offers retail insurance agents and brokers innovative solutions to the
twin insurance problems of price and availability of coverage. It accomplishes
this by organizing pools of similar risks into specially designed alternative
distribution programs through which it places insurance for affinity groups (the
"Programs").
The Program Brokerage Business is one of the leaders in the application of
purchasing groups in the commercial insurance market. Approximately 82% of PBC's
premium volume was generated by its own producers and approximately 1,000
unrelated retail insurance agent and broker producers serving approximately
14,000 insureds. The remaining 18% was derived from the Retail Brokerage
Business. Approximately 35% of PBC's premium volume is directly or indirectly
placed with two affiliates, OLRI and Old Lyme Insurance Company, Ltd. (Bermuda)
("OLB").
Property and casualty companies operations
The Company conducts its property and casualty underwriting business through two
insurance company subsidiaries (the "Insurance Companies"), OLRI and OLB. OLRI
is a property and casualty insurance company licensed in Rhode Island and
eligible as a surplus lines insurer in New York and New Jersey. OLB is a
property and casualty insurance company organized and licensed under the laws of
Bermuda. In states where the Insurance Companies are not admitted insurers or
surplus lines insurers, the Insurance Companies underwrite risks through various
reinsurance agreements.
The Insurance Companies underwrite property risks (loss or physical damage to
property) and OLRI underwrites casualty risks (legal liability for personal
injury or damaged property of others) for insureds in the United States.
Insurance is sold
F-39
principally through the Programs marketed by PBC which insure various types of
businesses and properties that have similar risk characteristics, such as
apartments, condominiums, cooperatives, restaurants, building maintenance
companies, automobile service stations, retail stores, funeral homes and
pharmacies, among others.
The Insurance Companies' strategy is to underwrite only the first "layer" of the
property and casualty insurance provided under the Programs. Exposure to
individual insureds on individual losses is thereby generally limited to between
$10,000 and $25,000 per claim, depending on the Program. Under the Programs, the
Insurance Companies' policies are sold in conjunction with policies issued by
unaffiliated Program insurers that provide coverage for losses above the first
layer of risk underwritten by the Insurance Companies. In addition, OLRI has
issued policies on a selected basis with limits up to $1,000,000, with net
retention of $50,000 of exposure and has reinsured the remaining limits with
unaffiliated reinsurers rated A or better by A.M. Best Company ("A.M. Best"), a
major rating agency for insurers.
The Property and Casualty Companies Operations includes Claims Administration
Corporation ("CAC"), a subsidiary of the Company which is responsible for the
administration of a large majority of the claims submitted to the Insurance
Companies. The administration of claims includes investigation, engagement of
legal counsel, approval of settlements and the making of payments to, or on
behalf of insureds. The Insurance Companies pay CAC for its services. CAC also
provides claims administration service to certain unaffiliated Program insurers
for a fee.
2. SIGNIFICANT ACCOUNTING POLICIES
a. Basis of presentation
The accompanying Consolidated Balance Sheet, Statement of Operations, Cash
Flows, Stockholders' Equity and Comprehensive Loss (the "financial statements")
have been prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP") and predominant industry practice.
The Consolidated Balance Sheet is presented on a segmented basis with
inter-company balances eliminated. Identifiable assets by segment are those
assets used in the Company's operations in each business segment. Corporate
assets are principally cash and cash equivalents and an equity security
investment.
The Statement of Operations is segmented and presents the consolidated results
of the Insurance Brokerage Companies segment, the Property and Casualty
Companies segment and the Corporate segment. Intersegment transactions have not
been eliminated. However, transactions within each segment are eliminated.
Income or loss before income taxes of the two operating segments includes
expenses incurred by Corporate on behalf of the segments, which are allocated to
operations of the segments. The allocation is based upon total revenues of each
segment except for the allocation of incentive compensation which is allocated
based on the percentage of profits contributed to the Company.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.
F-40
b. Commission income
Commission income is generally recognized on the effective date of the related
policies. Unearned commissions represent commission income that is earned in
installments on multiyear policies. Contingent commissions are recorded when
collected or known. Commission and other adjustments are recorded when they
occur and the Company maintains an allowance for estimated policy cancellations
and commission returns which is periodically evaluated and adjusted as
necessary.
Effective May 31, 2001, the Company changed its method of accounting for
commission income. Prior to that date, commission income was recorded when
earned which was principally as of the billing date. Under the new method of
accounting, adopted retroactive to January 1, 2001, the Company now records
commission income generally on the effective date of insurance policies. The
cumulative effect of the change on prior years resulted in additional income of
$158,000 (net of income taxes of $82,000). For each of the three years ended
December 31, 2000 the effect of this change on net income (loss) was not
significant. This change was effected due to the pending merger with HUB (see
Note 1) and the Company's desire to move to a methodology consistent with HUB's
policy, which is considered preferable by management. As a result of the change,
the Company's commission and fees-net was reduced by $1,196,000 during the
period January 1, 2001 through June 28, 2001.
c. Fixed assets
Furniture, equipment, computer hardware and software, and leasehold improvements
are carried at cost, less accumulated depreciation and amortization computed
using the straight-line method. Fixed assets are depreciated over periods
ranging from three to ten years, and leasehold improvements are amortized over
the remaining terms of the leases which expire through 2010 or useful life,
whichever is shorter.
d. Intangible assets
Acquired expiration lists, covenants not to compete and goodwill are carried at
cost, less accumulated amortization which is computed using the straight-line
method over the estimated useful life of the asset not to exceed twenty years.
e. Investments
Investments are stated at fair value. The difference between the cost and fair
value is reflected as unrealized appreciation or depreciation, net of applicable
deferred income taxes, as a separate component of stockholders' equity. Realized
gains or losses from the sale of investments are determined on the basis of
specific identification and are reflected as a component of revenues. Investment
income is recognized when earned. The fair value of fixed maturities and equity
securities is based on the closing price of the investments on June 28, 2001.
If a decline in fair value of an investment is considered to be other than
temporary, the investment is reduced to its net realizable value and the
reduction is accounted for as a realized investment loss. In evaluating whether
a decline is other than temporary, management considers the duration and extent
to which the market value has been less than cost, the financial condition and
near-term prospects of the issuer, including events that may impact the issuer's
operations and impair the earnings potential of the investment, and management's
ability and intent to hold an investment for a sufficient period to allow for an
anticipated recovery in fair value.
F-41
Investments in equity securities in which the Company does not exert significant
influence and there is no readily determinable fair value are carried at the
lower of cost or market.
f. Insurance premiums earned
Insurance premiums are recognized as revenues ratably over the terms of the
related policies in force. Unearned premiums are established to cover the
unexpired portion of premiums written and are calculated using the daily pro
rata method. Premiums earned are net of reinsurance ceded.
g. Deferred acquisition costs
Deferred acquisition costs include commissions incurred by the Insurance
Companies that vary with and are attributed to new and renewal insurance
policies or contracts. These costs are deferred and amortized over the
applicable premium recognition period, generally one year. These deferred costs
have been limited to the amount expected to be recovered from future earned
premiums. Acquisition costs of $5,118,000, were amortized to expense for the
period January 1, 2001 through June 28, 2001.
h. Unpaid losses and loss expenses
The estimated liability for unpaid losses and loss expenses is based on an
evaluation of claims reported by policyholders. A provision which is based on
historical experience and modified for current trends, is also included for
losses and loss expenses which have been incurred but not reported. The methods
of determining such estimates and establishing the resulting reserves are
continually reviewed and modified to reflect current conditions, and any
adjustments are reflected currently in results of operations.
i. Reinsurance
Assumed reinsurance premiums written, commission, and unpaid losses are
accounted for based principally on the reports received from the ceding
insurance companies and in a manner consistent with the terms of the related
reinsurance agreements. Liabilities for unpaid losses, loss expenses and
unearned premiums are stated gross of ceded reinsurance recoverables. Deferred
acquisition costs are stated net of the amounts of reinsurance ceded, as are
premiums written and earned, losses and loss expenses incurred, and amortized
acquisition costs.
j. Income taxes
The Company recognizes deferred tax assets or liabilities for temporary
differences between the financial reporting and tax basis of assets and
liabilities based on enacted tax rates. The principal temporary differences
relate to deferred acquisition costs, unearned premiums, discount for tax
purposes of the unpaid losses and loss expense reserves, amortization of
expiration lists, accrual adjustment for commission income and unrealized gains
or losses on investments (see Note 9).
k. Cash and cash equivalents
Cash and cash equivalents include money market funds and certificates of
deposit, including funds held in a fiduciary capacity for the Insurance
Brokerage Companies, with a maturity of three months or less. The Company
maintains cash with banks in excess of federally insured limits and is exposed
to the credit risk from this concentration of cash. The Corporate restricted
cash balance represents cash advanced
F-42
from HUB and maintained in an escrow account for the purpose of paying
compensation to participants of the terminated stock performance plan on the
first anniversary of the Company's merger with HUB (see Note 1).
l. Other income
Property and Casualty Companies' other income includes non-recurring revenue
from the discontinuation of agreements for claims administration relating to
warranty contracts issued by a third party for which cash has already been
received.
m. Capitalized software policy
Capitalized computer software costs (included in fixed assets on the
Consolidated Balance Sheet) consist of costs to purchase software. All
capitalized software costs are amortized on a straight line method over a period
of three or five years. Amortization expense charged to operations was $307,000
for the period January 1, 2001 through June 28, 2001.
n. Fair value of financial instruments
The carrying amounts reported in the Consolidated Balance Sheet for cash and
cash equivalents, receivables and premiums payable approximate those assets and
liabilities fair values due to the short-term nature of the instruments.
3. CHANGES IN ACCOUNTING POLICIES
a. Newly adopted accounting standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133 (as amended), Accounting for
Derivative Instruments and Hedging Activities. This statement requires all
derivatives to be recognized as either assets or liabilities in the statement of
financial position and to be measured at fair value. This statement is effective
for all fiscal quarters and fiscal years beginning after December 31, 2000. The
Company does not have any derivative instruments and therefore SFAS No. 133 has
no impact on the Company's financial statements.
b. Accounting standards not yet adopted
In June 2001, the FASB issued SFAS No. 141, "Business Combinations", and SFAS
No. 142, "Goodwill and Other Intangible Assets". Statement 141 requires that the
purchase method of accounting be used for all business combinations subsequent
to June 30, 2001 and specifies criteria for recognizing intangible assets
acquired in a business combination. Statement 142 requires that goodwill and
certain intangible assets with indefinite useful lives no longer be amortized,
but instead be tested for impairment at least annually. Intangible assets with
definite useful lives will continue to be amortized over their respective
estimated useful lives. Statement No. 142 is effective for fiscal years
beginning after December 15, 2001. The Company does not expect the adoption of
SFAS No. 141 and 142 to have a material impact on the Company's consolidated
financial statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Disposal or
Impairment of Long-Lived Assets". This statement requires a single accounting
model for long-lived assets to be disposed of by sale, whether previously held
or newly acquired. The statement provides guidance related to the disposal of
long-lived assets
F-43
and broadens the presentation of discontinued operations to include a component
of an entity where the operations and cash flows are clearly distinguishable.
SFAS No. 144 is effective for fiscal years beginning after December 15, 2001.
The Company does not expect the adoption of SFAS No. 144 to have a material
impact on the Company's consolidated financial statements.
4. ACQUISITIONS
Effective January 1, 1999, the Company, through one of its insurance brokerage
subsidiaries, Kaye Insurance Associates, Inc. ("KIA"), purchased the assets,
including customer lists, and certain liabilities of Woodbury, N.Y. -- based
broker Seaman, Ross & Wiener, Inc. and related entities for an initial purchase
price of $2,422,000 in cash and $500,000 in stock of the Company. During the
period January 1, 2001 through June 28, 2001, earn out payments totaling
$1,124,000 in cash and $208,000 in stock of the Company were recorded as
customer lists of $993,000 and goodwill of $340,000.
5. FUNDS HELD IN FIDUCIARY CAPACITY
Premiums collected by the Insurance Brokerage Companies but not yet remitted to
insurance carriers were approximately $16,618,000 at June 28, 2001, some of
which are restricted as to use by law in certain states in which the Insurance
Brokerage Companies operate. These balances are held in cash and cash
equivalents. The offsetting obligation is recorded in premiums payable.
6. INVESTMENTS
Net investment income for the period January 1, 2001 through June 28, 2001 was
derived from the following sources (in thousands):
<Table>
Insurance Brokerage Companies
Cash and cash equivalents $ 448
------
Property and Casualty Companies
Fixed maturities 1,256
Equity securities 2
Cash and cash equivalents 337
Other 210
------
Total investment income 1,805
Investment expenses (37)
------
1,768
Corporate
Cash and cash equivalents 16
------
NET INVESTMENT INCOME $2,232
------
</Table>
F-44
Net realized gains or losses and the change in unrealized appreciation or
depreciation on investments included in the Statement of Operations and the
Statement of Stockholders Equity, respectively, are summarized below (in
thousands):
<Table>
Net realized gains (losses)
Fixed maturities
Gross realized gains $ 259
Gross realized losses (4)
Equity securities
Gross realized gains 157
Gross realized losses (1,043)
Other investments
Gross realized losses (446)
-------
NET REALIZED LOSS ON INVESTMENTS $(1,077)
-------
Changes in unrealized appreciation
Fixed maturities $ 148
Equity securities 440
-------
NET CHANGE IN UNREALIZED APPRECIATION $ 588
-------
</Table>
Included in net realized loss on investments are write downs related to other
than temporary impairments in equity securities of $530,000 and limited
partnership investments of $446,000.
The composition cost (amortized cost for fixed maturities) and estimated fair
value of the Company's investments at June 28, 2001 are presented below (in
thousands):
<Table>
<Caption>
GROSS
UNREALIZED
HOLDING AGGREGATE
AMORTIZED -------------- FAIR
COST/COST GAINS LOSSES VALUE
--------- ----- ------ ---------
Fixed Maturities
U.S. Government agencies and authorities $23,157 $135 $ (61) $23,231
States municipalities and subdivisions 26,781 317 (103) 26,995
Corporate 100 -- (65) 35
------- ---- ----- -------
TOTAL FIXED MATURITIES $50,038 $452 $(229) $50,261
-------- ---- ----- --------
Equity Securities
Common Stock $ 608 $ 51 $ -- $ 659
Preferred Stock 50 -- -- 50
------- ---- ----- -------
TOTAL EQUITY SECURITIES $ 658 $ 51 $ -- $ 709
-------- ---- ----- --------
</Table>
F-45
The amortized cost and estimated fair value of fixed maturities at June 28,
2001, by contractual maturity date, are listed below (in thousands). Expected
maturities may differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without penalties.
<Table>
<Caption>
AGGREGATE
AMORTIZED FAIR
COST VALUE
--------- ---------
Due in one year or less $ 3,208 $ 3,163
Due after one year through five years 27,761 28,058
Due after five years through ten years 17,241 17,212
Due after ten years 1,828 1,828
------- -------
TOTAL $50,038 $50,261
-------- --------
</Table>
Fixed maturities and cash and cash equivalents carried at fair value of
$3,404,000 were on deposit for governmental authorities, as required by law.
Fixed maturities and cash equivalents carried at fair value of $30,163,000 have
been deposited in trust funds or pledged to collateralize the obligations of
OLRI to ceding companies under reinsurance agreements. In addition, OLB
maintained bank letters of credit in the amount of $3,200,000. The Company's
short-term investment of cash is maintained principally with seven banks and
three institutional money market funds. To control this risk, the Company
utilizes only high credit quality financial institutions. Additionally, under
the insurance laws of the State of Rhode Island, where OLRI is domiciled,
insurers and reinsurers are restricted as to the types of investments they may
purchase and the concentration of risk they may accept in any one issuer or
group of issuers. The Company complies with such laws which insure that the
concentration of risk in its investment portfolio is at an acceptable and
authorized level.
7. NOTES PAYABLE
Notes payable consist of the following at June 28, 2001 (in thousands):
<Table>
Insurance Brokerage
Note payable, due through 7/1/2002, interest at prime $ 469
Finance company note, due through 3/24/2002, interest at
7.75% 113
Current portion (488)
-------
NOTES PAYABLE -- LONG TERM $ 94
-------
Corporate
Term loan, due through 6/24/2002, interest at 7.8% $ 1,412
Current portion (1,412)
-------
NOTES PAYABLE -- LONG TERM $ --
-------
</Table>
The note payable, at prime, due through July 1, 2002, represents debt incurred
related to a 1998 acquisition.
The 7.8% Term Loan due through June 24, 2002 is secured by the stock of OLRI.
Certain covenants exist on this loan, the most significant being the requirement
to maintain a minimum GAAP net worth, minimum statutory surplus in the Insurance
Companies, a
F-46
fixed ratio of net premiums to surplus and a minimum debt service coverage. At
June 28, 2001, the Company was in compliance with the covenants under the loan
agreement.
Based on the borrowing rates currently available to the Company for bank loans
with similar terms and average maturities, the fair value of the notes payable
at June 28, 2001 approximates their carrying value.
Interest expense in the accompanying consolidated statement of operations, was
$452,000.
8. INTANGIBLE ASSETS
Intangible assets at June 28, 2001 consisted of the following (in thousands):
<Table>
Customer lists $14,760
Goodwill 2,453
Covenant not to compete 400
-------
17,613
Less accumulated amortization (5,485)
-------
Intangible assets $12,128
-------
</Table>
9. INCOME TAXES
The Company and its wholly owned domestic subsidiaries are party to a Tax
Allocation Agreement (the "Agreement"). The Agreement requires these companies
to file a U.S. consolidated income tax return. The Agreement also provides that
each member of the group will compute its separate tax liability or benefit on a
separate return basis and pay or receive such amounts to or from the Company.
The Company's effective income tax rate included in the Statement of Operations
differs from the statutory rate on ordinary income before income taxes as
follows (in thousands, except percentages):
<Table>
<Caption>
% OF PRETAX
AMOUNT INCOME
------- -----------
Income tax benefit computed at the statutory
rate $(1,319) (34.0)%
Increase (decrease) in taxes resulting from
Tax-exempt investment income (318) (8.2)%
Merger expenses 599 15.4 %
State and local income taxes (652) (16.8)%
Other (342) (8.8)%
------- -------
INCOME TAX BENEFIT $(2,032) (52.4)%
------ -----------
</Table>
F-47
The source of the significant temporary differences and the related deferred tax
effects are as follows (in thousands):
<Table>
Expiration lists $ 172
Unearned premium reserves 145
Accrual adjustment 82
Accrued incentive compensation (1,251)
State and local income taxes (900)
Non-deductible reserves (532)
Deferred acquisition costs (230)
Loss reserve discount (67)
Other (154)
-------
DEFERRED TAX BENEFIT $(2,735)
-------
</Table>
The components of the net deferred tax assets and liabilities, in the
accompanying consolidated balance sheet at June 28, 2001, are as follows (in
thousands):
<Table>
Deferred tax assets:
Loss and loss expense reserves $ 1,936
Accrued incentive compensation 1,251
State and local income taxes 1,002
Non-deductible reserves 878
Unearned premium reserves 722
Other 154
-------
DEFERRED TAX ASSET BEFORE VALUATION ALLOWANCE 5,943
Valuation allowance 102
-------
TOTAL DEFERRED TAX ASSET 5,841
-------
Deferred tax liabilities:
Deferred acquisition costs 1,148
Other accrual adjustments 1,288
Expiration lists 288
Unrealized gains on investments 92
-------
TOTAL DEFERRED TAX LIABILITY 2,816
-------
NET DEFERRED TAX ASSET $ 3,025
-------
</Table>
The Company has state net operating loss carryforwards totaling $9,401,000 at
June 28, 2001. Such net operating losses are currently available to offset our
future state taxable income and begin to expire in 2016. A valuation allowance
in the amount of $1,461,000 has been established for net operating losses in
states where management does not believe the net operating losses will be
realized. Management believes it is more likely than not that all remaining
deferred tax assets are realizable based upon the past earnings history of the
Company.
OLB, as a Bermuda domiciled company, is not subject to federal income taxes but,
rather, the Company is subject to federal income taxes based on OLB's taxable
income for the entire year. Accordingly, the Company includes the taxable income
of OLB in its separate company income for tax purposes, but for segment
reporting the income is
F-48
included with the Property and Casualty Companies. OLB has received an
undertaking from the Bermuda Government exempting it from all taxes computed on
profit or income, or computed on any capital asset gain or appreciation until
2016.
10. LEASE COMMITMENTS AND RENTALS
Minimum annual rental commitments under various non-cancelable operating leases
for office space and equipment are as follows (in thousands) for years ending
June 28,
<Table>
2002 $1,308
2003 982
2004 974
2005 959
2006 918
Thereafter 3,850
------
8,991
Sub-lease rental income (156)
------
Net rental commitments $8,835
------
</Table>
Effective August 1, 2001, the Company entered into a lease for office space for
its main office in Manhattan, New York. The lease expires on August 31, 2010.
The minimum rental commitment for the period August 1, 2001 to June 28, 2002 is
$1,228,000, and thereafter is $12,565,000.
Leases for office space include various escalation clauses, none of which
individually or in the aggregate are material. Escalation clauses are accounted
for on a straight-line basis over the remaining life of the lease. The leases
also contain provisions for the payment of certain operating expenses and real
estate taxes.
Rent expense included in the Statement of Operations amounted to $2,219,000, net
of sublease rental income of $204,000.
11. DEFINED CONTRIBUTION PLAN
Substantially all officers and employees of the Company are entitled to
participate in a qualified retirement savings plan (defined contribution plan).
The cost to the Company was $281,000 for 2001.
12. COMMITMENTS AND CONTINGENCIES
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 asserted and potential claims and
lawsuits will not have a material effect on the consolidated financial position
and results of operations of the Company.
F-49
13. REINSURANCE
The components of net written and net earned insurance premiums included in the
Statement of Operations were as follows (in thousands):
<Table>
Written premiums
Direct $ 3,212
Assumed 13,112
Ceded (1,653)
-------
NET WRITTEN PREMIUMS $14,671
-------
Earned premiums
Direct 4,831
Assumed 13,315
Ceded (1,354)
-------
NET EARNED PREMIUMS $16,792
-------
</Table>
OLRI assumes reinsurance under arrangements with unaffiliated insurance
companies. The Insurance Brokerage Companies produce the business assumed under
these arrangements. The business has limits varying from $25,000 to $100,000 per
occurrence. Claim liabilities under these agreements are secured with fixed
maturity securities and cash and cash equivalents, which are deposited in trust
funds. Approximately $30,163,000 as of June 28, 2001 is held in these trust
funds. In addition, OLB maintained bank letters of credit in the amount of
$3,200,000 at June 28, 2001 to satisfy the reinsurance collateral requirement.
OLRI underwrites a small book of business with limits up to $1,000,000 retaining
the first $50,000 of exposure and reinsuring the balance on an excess of loss
basis to other insurers or re-insurers. Under the terms of the reinsurance
agreements, loss and loss adjustment expenses recovered (incurred) during the
period January 1, 2001 through June 28, 2001 was $3,360,000. Commissions earned
on reinsurance ceded for the period January 1, 2001 through June 28, 2001 was
$337,000. Reinsurance has been placed with PXRE Reinsurance Company and The
Hartford Steam Boiler Inspection and Insurance Co. which are rated A or better
by A.M. Best.
A contingent liability exists with respect to reinsurance ceded, which would
become an ultimate liability of OLRI in the event that the assuming companies
were unable to meet their obligations under the reinsurance agreements in force
at June 28, 2001.
On September 25, 2001, PXRE Reinsurance Company, a primary re-insurer of OLRI,
has sent a notice of termination on all of the reinsurance contacts between Old
Lyme Insurance Company of Rhode Island, Inc. and PXRE Reinsurance Corporation,
effective on December 31, 2001 and March 31, 2002. The Company estimates the
loss exposure due to cancellation of these contracts could vary from $500,000 to
$800,000 for the calendar year 2002. The exposure is primarily related to
certain reinsurance liability business.
F-50
14. UNPAID LOSSES AND LOSS EXPENSES
The following table sets forth a reconciliation of the changes in the reserves
for losses and loss expenses for the period January 1, 2001 through June 28,
2001 (in thousands):
<Table>
Balance at January 1, 2001 $27,984
Less reinsurance recoverables (4,600)
-------
Net balance 23,384
-------
Incurred related to
Current year 7,298
Prior years (40)
-------
TOTAL INCURRED 7,258
-------
Paid related to
Current year 1,624
Prior years 6,082
-------
TOTAL PAID 7,706
-------
Net balance at June 28, 2001 22,936
Add reinsurance recoverables 7,430
-------
BALANCE $30,366
-------
</Table>
Increased provision reductions relating to prior years were due to redundant
property reserves.
15. STATUTORY FINANCIAL INFORMATION AND DIVIDEND RESTRICTIONS
The Insurance Companies file separate financial statements in accordance with
accounting practices prescribed or permitted by the insurance regulatory
authorities where they are domiciled. These statutory accounting practices
("SAP") differ in certain respects from GAAP. These differences are primarily
comprised of the accounting for prepaid acquisition costs, deferred income
taxes, and fixed maturity and equity investments.
F-51
The following is a reconciliation of statutory surplus and net income (loss) in
accordance with SAP as of June 30, 2001 as reported to the Rhode Island and
Bermuda insurance regulatory authorities to stockholder's equity and net income
(loss) as determined in conformity with GAAP.
<Table>
<Caption>
NET INCOME (LOSS)
STOCKHOLDER'S EQUITY/ FOR THE
STATUTORY SURPLUS SIX MONTHS
AS OF ENDED
JUNE 30, 2001 JUNE 30, 2001
--------------------- -----------------
Consolidated amount in accordance with GAAP $ 64,950 $(1,690)
(Equity) in net assets and net loss of
non-insurance companies (24,012) 4,676
-------- -------
Combined insurance companies amount in
accordance with GAAP 40,938 2,986
Deferred acquisition costs (3,376) 677
Non-admitted assets, deferred income taxes
and other (952) (237)
-------- -------
Combined amount in accordance with SAP $ 36,610 $ 3,426
---------------- -------------
</Table>
The Insurance Companies are currently subject to various regulations that limit
the maximum amount of dividends ultimately available to the Company without
prior approval of insurance regulatory authorities.
Accounting changes adopted to conform with the provisions of the NAIC Accounting
Practices and Procedures manual -- version effective January 1, 2001 are
reported as changes in SAP. The cumulative effect of changes in SAP is reported
as an adjustment to unassigned funds in the period of the change in SAP. The
cumulative effect is the difference between the amount of capital and surplus at
the beginning of the year and the amount of capital and surplus that would have
been reported at the date if the new SAP had been applied retrospectively for
all prior periods. As a result of these changes, OLRI reported a change in SAP
from the adoption of codification that increased unassigned funds (surplus) by
$986,457 as of January 1, 2001. This surplus increase adjustment was related to
deferred tax assets.
16. RELATED PARTY TRANSACTIONS
The administrative support for OLB is provided by International Advisory
Services, Ltd. ("IAS"), an insurance management company located in Bermuda. A
director of IAS is an officer of OLB and is a director of the Company.
Management fees paid to IAS under a service contract for the period January 1,
2001 through June 28, 2001 was $15,000.
17. STOCK PERFORMANCE AND STOCK OPTION PLANS
In 1997, the Company adopted a stock Performance Plan, under which up to 350,000
shares of the Company's common stock could have been granted and awarded to key
employees. In addition, the Company had a stock option plan. In connection with
the Company's merger with HUB, all outstanding options and restricted stock
became vested and the plans were terminated. On June 27, 2001, restricted cash
advanced from HUB totaling $8,140,000 was paid to the stock option holders at an
amount equal to
F-52
the purchase price of $14 per share less the grant price of the related options.
Additionally, HUB advanced restricted cash of $2,445,000 for amounts payable to
the holders of restricted stock on the first anniversary of the acquisition
date. Total compensation expense related to these plans of $10,585,000 has been
included in merger expenses in the accompanying Consolidated Statement of
Operations.
18. SUPPLEMENTAL CASH FLOW DISCLOSURES
Supplemental cash flow disclosures for the period January 1, 2001 through June
28, 2001 are as follows (in thousands):
<Table>
Cash paid during the period for
Interest expense $ 509
Income taxes 2,148
Non cash financing activity
Reissuance of treasury stock 208
</Table>
F-53
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF KAYE GROUP INC.:
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of Kaye
Group Inc. and its subsidiaries at December 31, 2000 and 1999, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedules listed in the accompanying index present
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedules are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedules based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
LOGO
PricewaterhouseCoopers LLP
New York, New York
February 26, 2001
F-54
KAYE GROUP INC.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2000 and December 31, 1999
(in thousands, except par value per share)
<Table>
2000 1999
-------- --------
ASSETS
INSURANCE BROKERAGE COMPANIES:
Current assets:
Cash and cash equivalents (including short term
investments, and funds held in a fiduciary capacity of
$25,374 and $25,610) $ 26,591 $ 27,678
Premiums and other receivables 41,744 27,265
Prepaid expenses and other assets 2,025 1,717
-------- --------
Total current assets 70,360 56,660
Fixed assets (net of accumulated depreciation of $6,827 and
$6,922) 5,816 3,770
Intangible assets (net of accumulated amortization of $4,808
and $3,845) 11,472 10,228
Other assets 665 195
-------- --------
Total assets 88,313 70,853
-------- --------
PROPERTY AND CASUALTY COMPANIES:
Investments available-for-sale:
Fixed maturities, at market value (amortized cost: 2000,
$43,157; 1999, $42,273) 43,232 41,304
Equity securities, at market value (cost: 2000, $8,610;
1999, $3,873) 8,209 4,496
-------- --------
Total investments 51,441 45,800
Cash and cash equivalents 12,784 14,327
Accrued interest and dividends 862 873
Premiums receivable 1,985 2,333
Reinsurance recoverable on paid and unpaid losses 4,600 2,747
Prepaid reinsurance premiums 949 488
Deferred acquisition costs 4,053 4,313
Deferred income taxes 1,505 1,236
Other assets 5,935 4,520
-------- --------
Total assets 84,114 76,637
-------- --------
CORPORATE:
Cash and cash equivalents 138 1,233
Prepaid expenses and other assets 59 153
Investments:
Equity securities, at market value (cost: 2000, $308, and
1999, $243) 320 243
Deferred income taxes 67 93
-------- --------
Total assets 584 1,722
-------- --------
Total assets $173,011 $149,212
-------- --------
</Table>
See notes to consolidated financial statements.
F-55
KAYE GROUP INC.
CONSOLIDATED BALANCE SHEETS
As of December 31, 2000 and December 31, 1999
(in thousands, except par value per share)
<Table>
<Caption>
2000 1999
-------- --------
LIABILITIES
INSURANCE BROKERAGE COMPANIES:
Current liabilities:
Premiums payable and unearned commissions $ 53,095 $ 42,161
Accounts payable and accrued liabilities 9,658 8,103
Notes payable 521 527
-------- --------
Total current liabilities 63,274 50,791
Notes payable 320 841
Deferred income taxes 1,083 491
-------- --------
Total liabilities 64,677 52,123
-------- --------
PROPERTY AND CASUALTY COMPANIES:
Liabilities:
Unpaid losses and loss expenses 27,984 23,969
Unearned premium reserves 13,697 13,694
Accounts payable and accrued liabilities 7,532 7,953
Other liabilities 567 245
-------- --------
Total liabilities 49,780 45,861
-------- --------
CORPORATE:
Current liabilities:
Accounts payable and accrued liabilities 254 300
Loan payable 1,343 1,241
Income taxes payable 187 366
-------- --------
Total current liabilities 1,784 1,907
Loan payable-long-term 728 2,070
-------- --------
Total liabilities 2,512 3,977
-------- --------
Total liabilities 116,969 101,961
-------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par value; 1,000 shares authorized;
none issued or outstanding
Common stock, $.01 par value; 20,000 shares authorized;
shares issued and outstanding (2000, 8,481; 1999,
8,458) 85 85
Paid -- in capital 18,019 18,019
Accumulated other comprehensive loss, net of deferred
income tax benefit (2000, $107; 1999, $118) (207) (228)
Unearned stock grant compensation (235) (254)
Retained earnings 38,417 29,858
Common stock in Treasury, shares at cost (2000, 4; 1999,
28) (37) (229)
-------- --------
Total stockholders' equity 56,042 47,251
-------- --------
Total liabilities and stockholders' equity $173,011 $149,212
-------- --------
</Table>
See notes to consolidated financial statements.
F-56
KAYE GROUP INC.
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31, 2000, 1999 and 1998
(in thousands, except per share amounts)
<Table>
<Caption>
2000 1999 1998
------- ------- -------
INSURANCE BROKERAGE COMPANIES:
Revenues:
Commissions and fees -- net $42,066 $37,379 $35,356
Investment income 1,339 1,374 1,846
------- ------- -------
Total revenues 43,405 38,753 37,202
------- ------- -------
Expenses:
Compensation and benefits 23,676 22,346 21,323
Amortization of intangibles 1,161 1,095 679
Other operating expenses 13,463 12,215 13,446
------- ------- -------
Total operating expenses 38,300 35,656 35,448
------- ------- -------
Interest expense 870 775 49
------- ------- -------
Income before income taxes 4,235 2,322 1,705
------- ------- -------
PROPERTY AND CASUALTY COMPANIES:
Revenues:
Net premiums written 30,028 27,821 24,538
Change in unearned premiums 458 (1,041) 151
------- ------- -------
Net premiums earned 30,486 26,780 24,689
Net investment income 3,127 2,949 2,920
Net realized gain (loss) on investments 804 (16) 85
Other income 469 72 146
------- ------- -------
Total revenues 34,886 29,785 27,840
------- ------- -------
Expenses:
Losses and loss expenses 12,270 9,754 8,496
Acquisition costs and general and administrative
expenses 12,615 11,205 9,707
Total expenses 24,885 20,959 18,203
------- ------- -------
Income before income taxes 10,001 8,826 9,637
------- ------- -------
CORPORATE:
Revenues -- Net investment income (loss) 107 206 (31)
Expenses:
Other operating expenses 480 309 314
Interest expense 234 316 443
------- ------- -------
Net expenses before income taxes (607) (419) (788)
------- ------- -------
INCOME BEFORE INCOME TAXES 13,629 10,729 10,554
------- ------- -------
Provision (benefit) for income taxes
Current 3,887 3,261 3,422
Deferred 338 (36) (150)
------- ------- -------
Total provision for income taxes 4,225 3,225 3,272
------- ------- -------
NET INCOME $ 9,404 $ 7,504 $ 7,282
------- ------- -------
EARNINGS PER SHARE
Basic $ 1.11 $ 0.89 $ 0.86
Diluted $ 1.09 $ 0.87 $ 0.85
Weighted average of shares outstanding -- basic 8,470 8,460 8,474
Weighted average shares outstanding and share
equivalents outstanding -- diluted 8,613 8,630 8,593
</Table>
See notes to consolidated financial statements.
F-57
KAYE GROUP INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2000, 1999 and 1998
(in thousands)
<Table>
<Caption>
2000 1999 1998
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 9,404 $ 7,504 $ 7,282
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Deferred acquisition costs 260 (392) 18
Amortization of bond premium -- net 685 695 599
Deferred income taxes 338 (36) (150)
Net realized loss (gains) on investments (868) 290 (85)
Depreciation and amortization expense 2,892 2,381 1,813
Change in assets and liabilities:
Accrued interest and dividends 11 88 (79)
Premiums and other receivables (16,077) 14,071 (8,125)
Prepaid expenses and other assets (1,646) (2,263) (1,253)
Premiums payable and unearned commissions 10,952 (17,235) 18,371
Accounts payable and accrued liabilities 1,633 (311) 2,055
Unpaid losses and loss expenses 4,015 2,402 2,441
Unearned premium reserves 3 1,367 (251)
Income taxes payable (179) (202) 552
-------- -------- --------
Net cash provided by operating activities 11,423 8,359 23,188
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments available -- for -- sale :
Purchase of fixed maturities (10,270) (11,560) (15,012)
Purchase of equity securities (7,589) (4,049) (200)
Maturities of fixed securities 5,109 5,474 4,861
Sales of fixed securities 3,498 6,094 8,158
Sales of equity securities 3,280 832 425
Purchase of fixed assets (3,866) (1,347) (2,089)
Acquisition payments (3,002) (5,203) (1,239)
Funds held under deposit contracts:
Sales of short-term investments 173
-------- -------- --------
Net cash used in investing activities (12,840) (9,759) (4,923)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Acquisition debt-repayment (375) (375) (657)
Notes and loan payable-repayment (1,392) (1,489) (7,981)
Proceeds from issuance of common stock 35
Acquisition of treasury stock (1,079)
Payment of dividends (845) (847) (849)
Proceeds from borrowings 5,000
Receipts (payments) under deposit contracts 304 (122)
-------- -------- --------
Net cash used in financing activities (2,308) (3,755) (4,609)
-------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS (3,725) (5,155) 13,656
Cash and cash equivalents at beginning of period 43,238 48,393 34,737
-------- -------- --------
Cash and cash equivalents at end of period $ 39,513 $ 43,238 $ 48,393
-------- -------- --------
</Table>
See notes to consolidated financial statements.
F-58
KAYE GROUP INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31, 2000, 1999 and 1998
(in thousands, except per share amounts)
<Table>
<Caption>
COMMON STOCK ACCUMULATED
------------------- COMMON UNEARNED OTHER TOTAL
OUTSTANDING PAR STOCK STOCK GRANT PAID-IN COMPREHENSIVE RETAINED STOCKHOLDERS'
SHARES VALUE IN TREASURY COMPENSATION CAPITAL (LOSS) EARNINGS EQUITY
----------- ----- ----------- ------------ ------- ------------- -------- -------------
Balance, January 1, 1998 8,474 $85 $17,942 $ 373 $16,768 $35,168
Change in unrealized
appreciation, net of
deferred income tax of
($88) 168 168
Net income 7,282 7,282
Dividends declared (per
share -- $0.10) (849) (849)
----- --- ----- ----- ------- ----- ------- -------
Balance, December 31,
1998 8,474 85 17,942 541 23,201 41,769
Change in unrealized
depreciation, net of
deferred income tax of
$398 (769) (769)
Shares issued --
employee stock option
plan 7 35 35
Shares issued -- stock
performance plan 5 $(264) 42 (222)
Amortization of unearned
restricted stock 10 10
Net income 7,504 7,504
Dividends declared (per
share -- $0.10) (847) (847)
Acquisition of treasury
stock net of
reissuances (28) $(229) (229)
----- --- ----- ----- ------- ----- ------- -------
Balance, December 31,
1999 8,458 85 (229) (254) 18,019 (228) 29,858 47,251
Change in unrealized
appreciation, net of
deferred income tax of
($11) 21 21
Amortization of unearned
restricted stock 19 19
Net income 9,404 9,404
Dividends declared (per
share -- $0.10) (845) (845)
Reissuance of treasury
stock 23 192 192
----- --- ----- ----- ------- ----- ------- -------
Balance, December 31,
2000 8,481 $85 $ (37) $(235) $18,019 $(207) $38,417 $56,042
------- --- ------- -------- ------ -------- ------- ---------
</Table>
F-59
KAYE GROUP INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the years ended December 31, 2000, 1999 and 1998
(in thousands)
<Table>
<Caption>
2000 1999 1998
------ ------ ------
NET INCOME $9,404 $7,504 $7,282
------ ------ ------
Other comprehensive income:
Unrealized holding gains (losses) arising during the
period, net of deferred income tax (benefit)
liability (2000, $255; 1999, ($482); 1998, $116) 496 (932) 221
Less: reclassification adjustment for loss (gains)
included in net income, net of deferred income tax
(benefit) liability (2000, $244; 1999, ($84); 1998,
$28) (475) 163 (53)
------ ------ ------
Total other comprehensive income 21 (769) 168
------ ------ ------
COMPREHENSIVE INCOME $9,425 $6,735 $7,450
------ ------ ------
</Table>
See notes to consolidated financial statements.
F-60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2000, 1999 and 1998
1) BUSINESS
Kaye Group Inc. (the "Company"), a Delaware corporation, is a holding company
which, through its subsidiaries, is engaged in a broad range of insurance
brokerage, underwriting and related activities. The Company operates in two
insurance business segments -- the Insurance Brokerage Companies Operations
("Brokerage Operations"), comprised of the Retail Brokerage Business and the
Program Brokerage Business, and the Property and Casualty Companies Operations.
In addition, Corporate Operations includes those activities that benefit the
Company in its entirety and cannot be specifically identified to either the
Brokerage Operations or the Property and Casualty Companies Operations. Such
activities include debt servicing and public company expenses, including
investor relations costs.
The Company's activities are conducted from offices in New York, New York,
Arcadia, California, Westport, Connecticut, Woodbury, New York and Warwick,
Rhode Island.
Insurance Brokerage Companies Operations
The Retail Brokerage Business operates insurance brokerage businesses through
four subsidiaries of the Company, the "Retail Brokerage Companies". The Retail
Brokerage Companies offers commercial clients a full range of insurance
brokerage services including procurement of property/casualty insurance, risk
management consulting, bonding, loss prevention engineering, and group employee
benefit consulting services. In addition, personal lines and life and health
insurance coverage are placed on behalf of individual clients.
The Retail Brokerage Business' primary strategy is to service middle market
companies and organizations just below the Fortune 500 level for which other
national brokers intensely compete. Within this middle market, the Retail
Brokerage Business has developed particular expertise and knowledge of the risks
facing a number of industry sectors including health care, real estate, retail,
manufacturing, houses of worship, law firms, homes for the aged and fine arts.
During 2000, the Retail Brokerage Business serviced approximately 15,000
insureds. The Retail Brokerage Business is compensated for its services
primarily in the form of commissions paid by insurance companies. The commission
is usually a percentage of the premium paid by the insured. Commission rates
depend upon the type of insurance, the particular insurance company, and the
role in which the Retail Brokerage Business acts. In some cases a commission is
shared with other agents or brokers who have acted jointly with the Retail
Brokerage Business in connection with the transaction. The Retail Brokerage
Business may also receive from an insurance company a contingent commission that
is generally based on the profitability and volume of business placed with it by
the Retail Brokerage Business over a given period of time. The Retail Brokerage
Business may also receive fees from insureds in connection with consulting
services relating to the marketing of insurance.
Program Brokerage Corporation ("PBC" or the "Program Brokerage Business") is a
subsidiary of the Company and operates a wholesale insurance brokerage business
which offers retail insurance agents and brokers innovative solutions to the
twin insurance problems of price and availability of coverage. It accomplishes
this by
F-61
organizing pools of similar risks into specially designed alternative
distribution programs through which it places insurance for affinity groups (the
"Programs").
The Program Brokerage Business is one of the leaders in the application of
purchasing groups in the commercial insurance market. Approximately 73% of PBC's
premium volume was generated by its own producers and approximately 800
unrelated retail insurance agent and broker producers serving approximately
10,500 insureds during 2000. The remaining 27% was derived from the Retail
Brokerage Business. Approximately 35% of PBC's premium volume is directly or
indirectly placed with two affiliates, Old Lyme Insurance Company of Rhode
Island, Inc. ("OLRI") and Old Lyme Insurance Company, Ltd. (Bermuda) ("OLB").
Property and Casualty Companies Operations
The Company conducts its property and casualty underwriting business through two
insurance company subsidiaries (the "Insurance Companies"), OLRI and OLB. OLRI
is a property and casualty insurance company licensed in Rhode Island and
eligible as a surplus lines insurer in New York and New Jersey. OLB is a
property and casualty insurance company organized and licensed under the laws of
Bermuda. In states where the Insurance Companies are not admitted insurers or
surplus lines insurers, the Insurance Companies underwrite risks through various
reinsurance agreements.
The Insurance Companies underwrite property risks (loss or physical damage to
property) and OLRI underwrites casualty risks (legal liability for personal
injury or damaged property of others) for insureds in the United States.
Insurance is sold principally through the Programs marketed by PBC which insure
various types of businesses and properties that have similar risk
characteristics, such as apartments, condominiums, cooperatives, restaurants,
building maintenance companies, automobile service stations, retail stores,
funeral homes and pharmacies, among others.
The Insurance Companies' strategy is to underwrite only the first "layer" of the
property and casualty insurance provided under the Programs. Exposure to
individual insureds on individual losses is thereby generally limited to between
$10,000 and $25,000 per claim, depending on the Program. Under the Programs, the
Insurance Companies' policies are sold in conjunction with policies issued by
unaffiliated Program insurers that provide coverage for losses above the first
layer of risk underwritten by the Insurance Companies. In addition, OLRI has
issued policies on a selected basis with limits up to $3,500,000, with net
retention on one policy of $100,000 of exposure and reinsuring the remaining
limits with unaffiliated reinsurers rated A or better by A.M. Best Company
("A.M. Best"), a major rating agency for insurers.
The Property and Casualty Companies Operations includes Claims Administration
Corporation ("CAC"), a subsidiary of the Company which is responsible for the
administration of a large majority of the claims submitted to the Insurance
Companies. The administration of claims includes investigation, engagement of
legal counsel, approval of settlements and the making of payments to, or on
behalf of insureds. The Insurance Companies pay CAC for its services. CAC also
provides claims administration service to certain of the unaffiliated Program
insurers for a fee.
F-62
2) SIGNIFICANT ACCOUNTING POLICIES
(a) Basis of Presentation
The accompanying Consolidated Balance Sheets, Statements of Income, Cash Flows,
Stockholders' Equity and Comprehensive Income (the "financial statements") have
been prepared in accordance with generally accepted accounting principles
("GAAP") and predominant industry practice.
The Consolidated Balance Sheets are presented on a segmented basis with inter-
company balances eliminated.
The Statements of Income are segmented and present the consolidated results of
the Insurance Brokerage Companies segment, the Property and Casualty Companies
segment and the Corporate segment. Intersegment transactions have not been
eliminated. However, transactions within each segment are eliminated. For
details on segment activity refer to Note 19.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those
estimates.
Certain prior year information has been reclassified to conform with the 2000
presentation.
(b) Segment Reporting
The accompanying consolidated financial statements have been prepared on a
segmented basis. See Note 1 for segments and their respective operations. Income
before income taxes of the two operating segments includes expenses incurred by
Corporate on behalf of the segments, which are allocated to operations of the
segments. The allocation is based upon total revenues of each segment except for
the allocation of incentive compensation which is allocated based on the
percentage of profits contributed to the Company. Identifiable assets by segment
are those assets used in the Company's operations in each business segment.
Corporate assets are principally cash and cash equivalents and an equity
security investment.
(c) Commission Income
Commission income, together with the related accounts receivable from clients
and premiums payable to insurance carriers, is recorded when earned which is
principally as of the billing date. Commission income related to installment
billing arrangements is recorded at the date of the initial billing. Unearned
commissions represent commission income that is earned in installments on
multiyear policies. Contingent commissions and commissions on premiums billed
directly by insurance carriers are recorded when collected or known. Commission
and other adjustments are recorded when they occur and the Company maintains an
allowance for estimated policy cancellations and commission returns.
(d) Fixed Assets
Furniture, equipment, computer hardware and software, and leasehold improvements
are carried at cost, less accumulated depreciation and amortization computed
using the straight-line method. Fixed assets are depreciated over periods
ranging from three to
F-63
ten years, and leasehold improvements are amortized over the remaining terms of
the leases which expire through 2010 or useful life which ever is shorter.
(e) Intangible Assets
Acquired expiration lists, covenants not to compete and goodwill are carried at
cost, less accumulated amortization which is computed using the straight-line
method over the estimated useful life of the asset not to exceed twenty years.
(f) Investments
Investments are stated at fair value. The difference between the cost and fair
value is reflected as unrealized appreciation or depreciation, net of applicable
deferred income taxes, as a separate component of stockholders' equity. Realized
gains or losses from the sale of investments are determined on the basis of
specific identification and are reflected as a component of revenues. Investment
income is recognized when earned. The fair value of fixed maturities and equity
securities is based on the closing price of the investments on December 31.
If a decline in fair value of an investment is considered to be other than
temporary, the investment is reduced to its net realizable value and the
reduction is accounted for as a realized investment loss. In evaluating whether
a decline is other than temporary, management considers the duration and extent
to which the market value has been less than cost, the financial condition and
near-term prospects of the issuer, including events that may impact the issuer's
operations and impair the earnings potential of the investment, and management's
ability and intent to hold an investment for a sufficient period to allow for an
anticipated recovery in fair value.
Investments in equity securities in which the Company does not exert significant
influence and there is no readily determinable fair value are carried at the
lower of cost or market.
(g) Insurance Premiums Earned
Insurance premiums are recognized as revenues ratably over the terms of the
related policies in force. Unearned premiums are established to cover the
unexpired portion of premiums written and are calculated using the daily pro
rata method. Premiums earned are net of reinsurance ceded.
(h) Deferred Acquisition Costs
Deferred acquisition costs include commissions incurred by the Insurance
Companies that vary with and are attributed to new and renewal insurance
policies or contracts. These costs are deferred and amortized over the
applicable premium recognition period, generally one year. These deferred costs
have been limited to the amount expected to be recovered from future earned
premiums. Acquisition costs of $9,450,000, $8,292,000, and $7,630,000 were
amortized to expense in 2000, 1999 and 1998, respectively.
(i) Unpaid Losses and Loss Expenses
The estimated liability for unpaid losses and loss expenses is based on an
evaluation of claims reported by policyholders. A provision which is based on
historical experience and modified for current trends, is also included for
losses and loss expenses which have been incurred but not reported. The methods
of determining such estimates and
F-64
establishing the resulting reserves are continually reviewed and modified to
reflect current conditions, and any adjustments are reflected currently in
results of operations.
(j) Reinsurance
Assumed reinsurance premiums written, commission, and unpaid losses are
accounted for based principally on the reports received from the ceding
insurance companies and in a manner consistent with the terms of the related
reinsurance agreements. Liabilities for unpaid losses, loss expenses and
unearned premiums are stated gross of ceded reinsurance recoverables. Deferred
acquisition costs are stated net of the amounts of reinsurance ceded, as are
premiums written and earned, losses and loss expenses incurred, and amortized
acquisition costs.
(k) Income Taxes
The Company recognizes deferred tax assets or liabilities for temporary
differences between the financial reporting and tax basis of assets and
liabilities based on enacted tax rates. The principal temporary differences
relate to deferred acquisition costs, unearned premiums, discount for tax
purposes of the unpaid losses and loss expense reserves, amortization of
expiration lists, accrual adjustment for commission income and unrealized gains
or losses on investments (see Note 8).
(l) Cash and Cash Equivalents
Cash and cash equivalents include money market funds and certificates of
deposit, including funds held in a fiduciary capacity for the Insurance
Brokerage Companies, with a maturity of three months or less. The Company
maintains cash with banks in excess of federally insured limits and is exposed
to the credit risk from this concentration of cash.
(m) Earnings Per Share
Basic earnings per share are calculated by dividing net income by the weighted
average number of common shares outstanding. Diluted earnings per share include
the effect of all potentially dilutive securities. Earnings per common share has
been compiled below (in thousands, except per share amounts):
<Table>
<Caption>
2000 1999 1998
------ ------ ------
Net income (numerator) $9,404 $7,504 $7,282
------ ------ ------
Weighted average common shares and effect of dilutive
shares used in the computation of earnings per
share:
Average shares outstanding -- basic 8,470 8,460 8,474
Effect of dilutive shares 143 170 119
------ ------ ------
Average shares outstanding -- diluted (denominator) 8,613 8,630 8,593
------ ------ ------
Earnings per common share:
Basic $ 1.11 $ 0.89 $ 0.86
Diluted $ 1.09 $ 0.87 $ 0.85
</Table>
Options to purchase 594,250, 219,250 and 161,450, common shares at prices from
$7.50 to $11.63, $7.88 to $11.63 and $7.06 to $11.63 per share were outstanding
at December 31, 2000, 1999 and 1998, respectively, but were not included in the
computation of earnings per diluted share for the respective years, because
their exercise price was greater than the average market price of the common
shares. These
F-65
options expire through November 16, 2009, December 10, 2008 and December 31,
2007, respectively.
(n) Capitalized Software Policy
Capitalized computer software costs (included in fixed assets on the
Consolidated Balance Sheets) consist of costs to purchase software. All
capitalized software costs are amortized on a straight line method over a period
of three or five years. Amortization expense charged to operations was $547,630
in 2000, $425,265 in 1999 and $199,272 in 1998.
(o) Accounting Policy for Stock Compensation Plans
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" and related interpretations in accounting for its
stock based compensation plans. Accordingly, no compensation expense has been
recognized for its Stock Option Plan as the exercise price of the options
equaled the market price of the stock at the date of grant. Compensation expense
has been recognized for the Stock Performance Plan based on the market price at
the date of the award.
(p) Fair Value of Financial Instruments
The carrying amounts reported in the Consolidated Balance Sheets for cash and
cash equivalents, receivables and premiums payable approximate those assets and
liabilities fair values due to the short-term nature of the instruments.
3) CHANGES IN ACCOUNTING POLICIES
(a) Newly Adopted Accounting Standards
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 101 which provides guidance for applying
generally accepted accounting principles relating to the timing of revenue
recognition in financial statements filed with the SEC. The Company is
recognizing revenue in accordance with SAB No. 101 and maintains an allowance
for policy cancellations and commission returns.
(b) Accounting Standards Not Yet Adopted
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133 (as amended), Accounting for
Derivative Instruments and Hedging Activities. This statement requires all
derivatives to be recognized as either assets or liabilities in the statement of
financial position and to be measured at fair value. This statement is effective
for all fiscal quarters and fiscal years beginning after December 31, 2000. The
statement is not expected to have a material impact on the financial position of
the Company.
4) ACQUISITIONS
Effective January 1, 1999, the Company, through one of its insurance brokerage
subsidiaries, Kaye Insurance Associates, Inc. ("KIA"), purchased the assets,
including customer lists, and certain liabilities of Woodbury, N.Y.-based broker
Seaman, Ross & Wiener, Inc. ("SRW") and related entities for an initial purchase
price of $2,422,000 in cash and $500,000 in stock of the Company. Additional
payments of $4,458,000 in cash and $292,000 in stock of the Company have been
made through December 31, 2000.
F-66
The total purchase price is contingent on future billings related to the
acquired customer lists and will increase significantly from the initial
purchase price. This acquisition is being accounted for using the purchase
method of accounting. Accordingly, intangible assets (including customer lists)
of approximately $7,700,000 resulting from the allocation of the preliminary
purchase price and payments made through December 31, 2000, are being amortized
by using the straight-line method over a period of not more than twenty years.
During 1998, the Company acquired certain assets and liabilities of Florida
Insurance Associates, Inc. ("FIA"), Daniel V. Keane Agency, Inc. ("DVK"), and
Laub Group of Florida, Inc. ("LGF") for cash of $275,000, $1,452,0000 and
$201,000, respectively, paid through December 31, 2000 and estimated amounts
payable in future periods of $656,000 (DVK). The total acquired intangible
assets (including expiration lists) was $2,108,000 for DVK. These acquisitions
were accounted for under the purchase method. During the first half of 2000, the
Brokerage Operations sold the majority of the operations of LGF at no gain or
loss, as well as certain assets and liabilities of FIA.
5) FUNDS HELD IN FIDUCIARY CAPACITY
Premiums collected by the Insurance Brokerage Companies but not yet remitted to
insurance carriers are approximately $25,374,000 and $25,610,000 at December 31,
2000 and 1999, respectively, some of which are restricted as to use by law in
certain states in which the Insurance Brokerage Companies operate. These
balances are held in cash and cash equivalents. The offsetting obligation is
recorded in premiums payable.
6) INVESTMENTS
Net investment income for the years ended December 31, 2000, 1999 and 1998 is
derived from the following sources (in thousands):
<Table>
<Caption>
2000 1999 1998
------ ------ ------
INSURANCE BROKERAGE COMPANIES
Cash and cash equivalents $1,339 $1,374 $1,846
------ ------ ------
PROPERTY AND CASUALTY COMPANIES
Fixed maturities 2,089 2,176 2,031
Equity securities 34 45 67
Cash and cash equivalents 729 532 791
Other 340 259 98
------ ------ ------
Total investment income 3,192 3,012 2,987
Investment expenses (65) (63) (67)
------ ------ ------
3,127 2,949 2,920
------ ------ ------
CORPORATE
Cash and cash equivalents 107 206 (31)
------ ------ ------
NET INVESTMENT INCOME $4,573 $4,529 $4,735
------ ------ ------
</Table>
F-67
Net realized gains or losses and the change in unrealized appreciation or
depreciation on investments for the years ended December 31, 2000, 1999 and 1998
are summarized below (in thousands):
<Table>
<Caption>
2000 1999 1998
------- ------- -------
Net realized gains (losses):
Fixed maturities:
Gross realized gains $ 14 $ 37 $ 85
Gross realized losses (108) (13)
Equity securities:
Gross realized gains 1,142 4
Gross realized losses (244) (44)
------- ------- -------
NET REALIZED GAIN (LOSS) ON INVESTMENTS $ 804 $ (16) $ 85
------- ------- -------
Change in unrealized appreciation (depreciation):
Fixed maturities $ 1,044 $(1,586) $ 47
Equity securities (1,012) 419 209
------- ------- -------
NET CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) $ 32 $(1,167) $ 256
------- ------- -------
</Table>
The composition, cost (amortized cost for fixed maturities) and estimated market
values of the Company's investments at December 31, 2000 and 1999 are presented
below.
<Table>
<Caption>
GROSS
UNREALIZED
HOLDING AGGREGATE
-------------- FAIR
COST GAINS LOSSES VALUE
------- ----- ------ ---------
(in thousands)
2000
Fixed Maturities:
U.S. Government(a) $ 3,792 $ 48 $ (6) $ 3,834
States(b) 35,804 287 (263) 35,828
Corporate 3,561 39 (30) 3,570
------- ---- ----- -------
Total fixed maturities $43,157 $374 $(299) $43,232
------- ---- ----- --------
Equity Securities:
Common Stock $ 8,648 $ 12 $(594) $ 8,066
Preferred Stock 270 193 463
------- ---- ----- -------
Total equity securities $ 8,918 $205 $(594) $ 8,529
------- ---- ----- --------
</Table>
F-68
<Table>
<Caption>
GROSS
UNREALIZED
HOLDING AGGREGATE
--------------- FAIR
COST GAINS LOSSES VALUE
------- ----- ------- ---------
(in thousands)
1999
Fixed Maturities:
U.S. Government(a) $ 3,351 $ 6 $ (132) $ 3,225
States(b) 35,247 53 (836) 34,464
Corporate 3,675 7 (67) 3,615
------- ---- ------- -------
Total fixed maturities $42,273 $ 66 $(1,035) $41,304
------- ---- ------- --------
Equity Securities:
Common Stock $ 4,066 $838 $ (215) $ 4,689
Preferred Stock 50 50
------- ---- ------- -------
Total equity securities $ 4,116 $838 $ (215) $ 4,739
------- ---- ------- --------
</Table>
- ---------------
(a) Includes U.S. Government agencies and authorities
(b) Includes municipalities and subdivisions
The amortized cost and estimated market value of fixed maturities at December
31, 2000, by contractual maturity date, are listed below. Expected maturities
may differ from contractual maturities because borrowers may have the right to
call or prepay obligations with or without penalties.
<Table>
<Caption>
AMORTIZED AGGREGATE
COST FAIR VALUE
--------- ----------
(in thousands)
Due in one year or less $ 3,030 $ 3,035
Due after one year through five years 19,497 19,683
Due after five years through ten years 18,898 18,790
Due after ten years 1,732 1,724
------- -------
TOTAL $43,157 $43,232
-------- --------
</Table>
Fixed maturities and cash and cash equivalents carried at market value of
$3,510,000 and $3,422,000, in 2000 and 1999, respectively, were on deposit for
governmental authorities, as required by law. Fixed maturities and cash
equivalents carried at market value of $27,328,000 and $22,270,000 in 2000 and
1999, respectively, have been deposited in trust funds or pledged to
collateralize the obligations of OLRI to ceding companies under reinsurance
agreements. In addition, OLB maintained a bank letter of credit in the amount of
$700,000 at December 31, 2000 and 1999. The Company's short term investment of
cash is maintained principally with seven banks and three institutional money
market funds. To control this risk, the Company utilizes only high credit
quality financial institutions. Additionally, under the insurance laws of the
State of Rhode Island, where OLRI is domiciled, insurers and reinsurers are
restricted as to the types of investments they may purchase and the
concentration of risk they may accept in any one issuer or group of issuers. The
Company complies with such laws which insure that the concentration of risk in
its investment portfolio is at an acceptable and authorized level.
F-69
7) NOTES PAYABLE
Notes payable consist of the following in thousands at December 31:
<Table>
<Caption>
2000 1999
------- -------
INSURANCE BROKERAGE:
Note payable, due through 7/1/2002, interest at prime $ 656 $ 1,031
Finance company note, due through 6/24/02, interest at 7.75% 185 320
Finance company note, due through 2000, interest at Prime
rate plus 1/2% -- 17
Current portion (521) (527)
------- -------
NOTES PAYABLE -- LONG TERM $ 320 $ 841
------- -------
CORPORATE:
Term loan, due through 6/24/2002, interest at 7.8% $ 2,071 $ 3,311
Current portion (1,343) (1,241)
------- -------
NOTES PAYABLE -- LONG TERM $ 728 $ 2,070
------- -------
</Table>
The note payable, at 9%, due through July 1, 2002, represents debt incurred
related to the DVK acquisition.
The 7.8% Term Loan due through June 24, 2002 is secured by the stock of the
Property and Casualty Companies. Certain covenants exist on this loan, the most
significant being the requirement to maintain a minimum GAAP net worth, minimum
statutory surplus in the Insurance Companies, a fixed ratio of net premiums to
surplus and a minimum debt service coverage. At December 31, 2000, the Company
was in compliance with the convenants under the loan agreement.
In addition, the Company has available a $4,500,000 revolving line of credit
through April 30, 2001 at LIBOR plus 175 basis points or the bank's base rate.
The line is also secured by the stock of the Property and Casualty Companies.
The proceeds are available for general operating needs and acquisitions. At
December 31, 2000, no amount was outstanding on the revolving line of credit. A
quarterly fee is assessed in the amount of .05% on the unused balance.
The Company maintains a $700,000 letter of credit and has established trust
funds in order to satisfy the collateral requirements of certain reinsurance
agreements as of December 31, 2000 and 1999. The letter of credit is secured by
certain cash deposits.
Based on the borrowing rates currently available to the Company for bank loans
with similar terms and average maturities, the fair value of the notes payable
at December 31, 2000 and 1999 approximates their carrying value.
Interest expense in the accompanying consolidated statements of income for the
years ended December 31, 2000, 1999 and 1998 was $1,104,000, $1,091,000 and
$492,000, respectively.
8) INCOME TAXES
The Company and its wholly owned domestic subsidiaries are party to a Tax
Allocation Agreement (the "Agreement"). The Agreement requires these companies
to file a U.S. consolidated income tax return. The Agreement also provides that
each member of the group will compute its separate tax liability or benefit on a
separate return basis and pay or receive such amounts to or from the Company.
F-70
The Company's effective income tax rate for the years ended December 31, 2000,
1999 and 1998 differs from the statutory rate on ordinary income before income
taxes as follows (in thousands, except percentages):
<Table>
<Caption>
2000 1999 1998
--------------- --------------- ---------------
% OF % OF % OF
PRETAX PRETAX PRETAX
AMOUNT INCOME AMOUNT INCOME AMOUNT INCOME
------ ------ ------ ------ ------ ------
Income taxes computed at
the statutory rate $4,634 34.0% $3,648 34.0% $3,588 34.0%
Increase (decrease) in
taxes resulting from:
Tax-exempt investment
income (519) (3.8) (507) (4.7) (456) (4.3)
State and local income
taxes and other 110 0.8 84 0.8 140 1.3
------ ----- ------ ----- ------ -----
PROVISION FOR INCOME
TAXES $4,225 31.0% $3,225 30.1% $3,272 31.0%
----- ------ ----- ------ ----- ------
</Table>
The source of the significant temporary differences and the related deferred tax
effects are as follows:
<Table>
<Caption>
2000 1999 1998
----- ----- -----
(in thousands)
Expiration lists $ 268 $ 395 $ 394
Accrual adjustment 167 60 (85)
Unearned premium reserves 31 (71) 10
Deferred acquisition costs (88) 133 (6)
Loss reserve discount (220) (353) (246)
Other 180 (200) (217)
----- ----- -----
DEFERRED TAX EXPENSE (BENEFIT) $ 338 $ (36) $(150)
----- ----- -----
</Table>
The components of the net deferred tax assets and liabilities, in the
accompanying consolidated balance sheets at December 31, 2000 and 1999, are as
follows:
<Table>
<Caption>
2000 1999
------ ------
(in thousands)
Deferred tax assets:
Loss and loss expense reserves $1,869 $1,649
Unearned premium reserves 867 898
Other 346 525
Unrealized losses on investments 107 118
Expiration lists (116) 152
------ ------
Total deferred tax asset 3,073 3,342
------ ------
Deferred tax liabilities:
Deferred acquisition costs 1,378 1,466
Other accrual adjustments 1,206 1,038
------ ------
Total deferred tax liability 2,584 2,504
------ ------
NET DEFERRED TAX ASSET $ 489 $ 838
------ ------
</Table>
F-71
Management believes it is more likely than not that all deferred tax assets are
realizable based upon the past earnings history of the Company.
OLB, as a Bermuda domiciled company, is not subject to federal income taxes but,
rather, the Company is subject to federal income taxes based on OLB's taxable
income for the entire year. Accordingly, the Company includes the taxable income
of OLB in its separate company income for tax purposes, but for segment
reporting the income is included with the Property and Casualty Companies. OLB
has received an undertaking from the Bermuda Government exempting it from all
taxes computed on profit or income, or computed on any capital asset gain or
appreciation until 2016.
9) LEASE COMMITMENTS AND RENTALS
Minimum annual rental commitments under various non-cancelable operating leases
for office space and equipment are as follows (in thousands):
<Table>
<Caption>
YEARS ENDING DECEMBER 31,
- -------------------------
2001 $ 3,329
2002 1,324
2003 982
2004 949
2005 923
Thereafter 4,311
-------
11,818
Sub-lease rental income (491)
-------
NET RENTAL COMMITMENTS $11,327
-------
</Table>
Leases for office space include various escalation clauses, none of which
individually or in the aggregate are material. Escalation clauses are accounted
for on a straight-line basis over the remaining life of the lease. The leases
also contain provisions for the payment of certain operating expenses and real
estate taxes.
Rent expense for the years ended December 31, 2000, 1999 and 1998 amounted to
$3,324,000, $3,242,000 and $2,928,000, respectively, net of sublease rental
income of $174,000, $48,000 and $48,000, respectively.
10) DEFINED CONTRIBUTION PLAN
Substantially all officers and employees of the Company are entitled to
participate in a qualified retirement savings plan (defined contribution plan).
The cost to the Company was $434,000 $406,000 and $255,000 for 2000, 1999 and
1998, respectively.
11) COMMITMENTS AND CONTINGENCIES
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 asserted and potential claims and
lawsuits will not have a material effect on the consolidated financial position
and results of operations of the Company.
As licensed brokers, the Insurance Brokerage Companies are or may become party
to administrative inquiries and at times to administrative proceedings commenced
by state insurance regulatory bodies. Certain subsidiaries were involved in an
administrative investigation commenced in 1992 by the New York Insurance
Department ("Depart-
F-72
ment") relating to how property insurance policies were issued for the
Residential Real Estate Program. As a result, the manner in which policies are
structured for certain clients in this Program was altered, which has not had a
material adverse effect on this Program. While the Company had discussions with
the Department regarding settlement of such investigation, this matter has not
been pursued for several years. If the matter is not closed or settled, the
Department could institute formal proceedings against the subsidiaries seeking
fines or license revocation. Management does not believe the resolution of this
issue will have a material adverse effect on the Company.
12) REINSURANCE
The components of net written and net earned insurance premiums were as follows
for the years ended December 31, 2000, 1999 and 1998:
<Table>
<Caption>
2000 1999 1998
------- ------- -------
(in thousands)
WRITTEN PREMIUMS:
Direct $ 8,988 $12,120 $11,586
Assumed 23,139 16,668 13,207
Ceded (2,099) (967) (255)
------- ------- -------
Net written premiums $30,028 $27,821 $24,538
------- ------- -------
EARNED PREMIUMS:
Direct $11,070 $11,576 $11,652
Assumed 21,054 15,846 13,392
Ceded (1,638) (642) (355)
------- ------- -------
Net earned premiums $30,486 $26,780 $24,689
------- ------- -------
</Table>
OLRI assumes reinsurance under arrangements with unaffiliated insurance
companies. The Insurance Brokerage Companies produce the business assumed under
these arrangements. The business has limits varying from $25,000 to $100,000 per
occurrence. Claim liabilities under these agreements are secured with fixed
maturity securities and cash and cash equivalents, which are deposited in trust
funds. Approximately $27,328,000 and $22,270,000 as of December 31, 2000 and
1999, respectively, are held in these trust funds. In addition, OLB maintained a
bank letter of credit in the amount of $700,000 at December 31, 2000 and 1999 to
satisfy the reinsurance collateral requirement. OLRI underwrites a small book of
business with limits up to $3,500,000 with net retention on one policy of
$100,000 and reinsures the balance on an excess of loss basis to other insurers
or reinsurers.
Under the terms of the reinsurance agreements, loss and loss adjustment expenses
recovered (incurred) in 2000, 1999 and 1998 were $2,174,857, $(451,000), and
$409,000, respectively. Commissions earned on reinsurance ceded in 2000, 1999
and 1998 were $347,000, $148,000 and $45,000, respectively. Reinsurance has been
placed with PXRE Reinsurance Company and The Hartford Stream and Boiler
Inspection and Insurance Co. which are rated A or better by A.M. Best.
A contingent liability exists with respect to reinsurance ceded, which would
become an ultimate liability of OLRI in the event that the assuming companies
were unable to meet their obligations under the reinsurance agreements in force
at December 31, 2000.
F-73
13) UNPAID LOSSES AND LOSS EXPENSES
The following table sets forth a reconciliation of the changes in the reserves
for losses and loss expenses, including paid losses and loss expenses:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
-----------------------------
2000 1999 1998
------- ------- -------
(in thousands)
Balance at January 1, $23,969 $21,567 $19,126
Less: reinsurance recoverables (2,678) (3,220) (2,811)
------- ------- -------
Net balance 21,291 18,347 16,315
------- ------- -------
Incurred related to:
Current year 13,340 10,410 8,461
Prior years (1,070) (656) 35
------- ------- -------
Total incurred 12,270 9,754 8,496
------- ------- -------
Paid related to:
Current year 2,809 2,188 1,877
Prior years 7,368 4,622 4,587
------- ------- -------
Total paid 10,177 6,810 6,464
------- ------- -------
Net balance at December 31, 23,384 21,291 18,347
Add: reinsurance recoverables 4,600 2,678 3,220
------- ------- -------
BALANCE $27,984 $23,969 $21,567
------- ------- -------
</Table>
2000 and 1999 incurred provisions increased over prior year's amounts due to the
growth of liability business. Incurred provision reductions in 2000 and 1999
relating to prior years were due to redundant property and liability reserves
established in those years. Paid losses in 2000 and 1999 for both current and
prior years increased over the prior year's amount due to the overall growth in
business.
14) STATUTORY FINANCIAL INFORMATION AND DIVIDEND RESTRICTIONS
The Insurance Companies file separate financial statements in accordance with
accounting practices prescribed or permitted by the insurance regulatory
authorities where they are domiciled. These statutory accounting practices
("SAP") differ in certain respects from GAAP. These differences are primarily
comprised of the accounting for prepaid acquisition costs, deferred income
taxes, and fixed maturity and equity investments.
F-74
The following is a reconciliation of net income and surplus regarding
policyholders in accordance with SAP as reported to the Rhode Island and Bermuda
insurance regulatory authorities to net income and capital as determined in
conformity with GAAP.
<Table>
<Caption>
STATUTORY SURPLUS/ NET INCOME FOR YEARS
STOCKHOLDERS' EQUITY ENDED
AS OF DECEMBER 31, DECEMBER 31,
--------------------- -------------------------
2000 1999 2000 1999 1998
--------- --------- ------- ------ ------
(in thousands)
Consolidated amount in accordance
with GAAP $ 56,042 $ 47,251 $ 9,404 $7,504 $7,282
Deficit (equity) in net assets and
net loss (income) of non-
insurance companies (14,782) (10,083) (1,658) (226) (141)
-------- -------- ------- ------ ------
Combined amount in accordance with
GAAP 41,260 37,168 7,746 7,278 7,141
Deferred acquisition costs (4,053) (4,313) 260 (392) 18
Non-admitted assets, deferred
income taxes and other (1,898) (341) (278) (292) (241)
-------- -------- ------- ------ ------
COMBINED AMOUNT IN ACCORDANCE WITH
SAP $ 35,309 $ 32,514 $ 7,728 $6,594 $6,918
-------- -------- ------- ------ ------
</Table>
The Insurance Companies are currently subject to various regulations that limit
the maximum amount of dividends ultimately available to the Company without
prior approval of insurance regulatory authorities. Under SAP, approximately
$3,811,000 of statutory surplus is available for distribution in 2001 without
prior regulatory approval.
In 1998, the National Association of Insurance Commissioners ("NAIC") adopted
the Codification of Statutory Accounting Principles guidance, which will replace
the current Accounting Practices and Procedures manual as the NAIC's primary
guidance on statutory accounting. The new accounting guidance becomes effective
January 1, 2001 and has been adopted by the State of Rhode Island.
15) RELATED PARTY TRANSACTIONS
The administrative support for OLB is provided by International Advisory
Services, Ltd. ("IAS"), an insurance management company located in Bermuda. A
director of IAS is an officer of OLB and is a director of the Company.
Management fees paid to IAS under a service contract for the years ended
December 31, 2000, 1999 and 1998 were $20,000, $20,000 and $30,000,
respectively.
A director of the Company is also a director of, and had shared beneficial
ownership of more than ten percent of the outstanding common stock of Sun
Television and Appliances, Inc. ("Sun TV"). In 1994, Sun TV and a subsidiary of
the Company entered into two agreements whereby the Company's subsidiary agreed
to assume certain service contracts that were sold by Sun TV to its retail
customers (the "Agreement") and contracted with Sun TV to have Sun TV provide
repair services under certain service contracts. The Board of Directors believes
that the agreements were commercially reasonable. On September 11, 1998, Sun TV
filed bankruptcy petitions under Chapter 11 of the Bankruptcy Code. The
Company's subsidiary filed a proof of claim on March 11, 1999 for any and all
amounts that are due and owing under the Agreement.
F-75
16) DIVIDENDS AND TREASURY STOCK
The Board of Directors of the Company declared annual dividends of $845,000 and
$847,000 for the years ended December 2000 and 1999, respectively, of which
$212,000 was unpaid at December 31, 2000 and 1999.
In December 1998, the Board of Directors authorized for a two year period the
repurchase, at management's discretion, of up to 300,000 shares of the Company's
Common Stock. The Company's repurchases of shares of Common Stock are recorded
as treasury stock and result in a reduction of stockholders' equity. When
treasury shares are reissued the Company uses a first-in, first-out method and
the excess of re-issuance price over repurchase cost is treated as an increase
of paid-in capital. Net issuances/ (purchases) of treasury stock for the years
ended December 31, 2000 and 1999 amounted to 23,176 shares and (27,657) shares,
respectively. Treasury shares at December 31, 2000 and 1999 amounted to 4,481
and 27,657 shares, respectively at a cost of approximately $37,000 and $229,000.
17) STOCK PERFORMANCE AND STOCK OPTION PLANS
On December 30, 1997, the Company adopted a Stock Performance Plan, under which
up to 350,000 shares of the Company's common stock may be granted and awarded to
key employees. The grant of stock under this plan is contingent upon criteria
established by the Compensation Committee of the Company's Board of Directors.
Awards are based on performance targets of the Company's stock based on
increases in the market value of the Company's common stock from the price on
the date the stock is initially granted by the Company. Shares must be granted,
awarded, and vested before participants take full title to the performance
stock. Awards vest on the occurrence of any of the following events, (i) fifteen
years of continuous service with the Company from the date shares are granted to
the participant, (ii) death or disability of the participant, (iii) immediately
before a change of control (as defined under the plan), (iv) attaining the age
of 65, or (v) immediately before a sale or merger (as defined under the plan).
During 2000 and 1999, $0 and 26,016 shares of performance stock were granted
under this plan, respectively. During July 1999, the Company awarded 33,844
shares of restricted stock from shares previously granted under the Stock
Performance Plan to certain key employees. The market value of these shares
awarded totaled approximately $264,000 and has been recorded as unearned stock
grant compensation (net of amortization) as a separate component of
stockholders' equity. Unearned compensation is being amortized to expense on a
straight-line basis over the remaining vesting period. At December 31, 2000 and
1999, no performance stock under this plan was vested.
F-76
In addition to the Stock Performance Plan, the Company has a stock option plan.
Under the option plan a total of 1,350,000 shares of common stock are reserved
for issuance. The option plan provides for the granting to directors, executives
or other key employees (including officers) of the Company non-qualified stock
options (NQO's) or incentive stock options (ISO's) within the meaning of Section
422 of the Internal Revenue Code of 1986, as amended. The Compensation Committee
determines the terms of the options including the exercise price, number of
shares subject to option and exercisability. The exercise price of all ISO's and
NQO's under the plan is generally at least the fair market value of the common
stock of the Company on the date of grant. A summary of the stock option
activity and related information consists of the following:
<Table>
<Caption>
2000 1999 1998
---------------------- -------------------- --------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- --------- -------- --------- -------- ---------
Outstanding at
beginning of year 993,000 $6.70 659,200 $6.15 624,850 $6.12
Granted 144,250 7.41 361,800 7.63 54,500 6.46
Exercised (6,900) 5.06
Forfeited (7,540) 5.94 (21,100) 5.93 (20,150) 7.88
---------- -------- --------
Outstanding at end of
year 1,129,710 $7.55 993,000 $6.70 659,200 $6.15
---------- -------- --------
Options exercisable at
year-end 544,060 341,300 232,900
---------- -------- --------
Weighted-average fair
value of options
granted during the
year $ 3.09 $ 2.34 $ 2.17
---------- -------- --------
</Table>
F-77
The following table summarizes information about the stock options outstanding
at December 31, 2000:
<Table>
<Caption>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- ----------------------------
NUMBER WEIGHTED-AVERAGE WEIGHTED- NUMBER WEIGHTED-
EXERCISE OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
PRICES AT 12/31/00 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/00 EXERCISE PRICE
- -------- ----------- ---------------- -------------- ----------- --------------
$11.63 500 3.09 years $11.63 500 $11.63
$10.91 5,000 3.06 $10.91 5,000 $10.91
$10.00 75,500 2.62 $10.00 75,500 $10.00
$8.43 39,750 4.81 $ 8.43 39,750 $ 8.43
$8.24 20,000 8.82 $ 8.24 4,000 $ 8.24
$8.24 48,500 8.83 $ 8.24 9,700 $ 8.24
$8.03 15,000 6.83 $ 8.03 9,000 $ 8.03
$7.88 15,000 4.70 $ 7.88 15,000 $ 7.88
$7.50 252,500 8.95 $ 7.50 50,500 $ 7.50
$7.50 122,500 9.37 $ 7.50 24,500 $ 7.50
$7.50 750 9.88 $ 7.50
$7.41 160 8.12 $ 7.41 160 $ 7.41
$7.38 40,000 8.15 $ 7.38 8,000 $ 7.38
$7.07 1,000 9.78 $ 7.07
$7.06 10,000 5.37 $ 7.06 8,000 $ 7.06
$6.90 20,000 9.83 $ 6.90
$6.64 5,000 7.00 $ 6.64 3,000 $ 6.64
$6.60 21,800 7.94 $ 6.60 8,900 $ 6.60
$6.17 20,000 7.83 $ 6.17 8,000 $ 6.17
$5.06 156,750 6.15 $ 5.06 95,550 $ 5.06
$5.00 250,000 6.12 $ 5.00 173,000 $ 5.00
$4.97 10,000 6.50 $ 4.97 6,000 $ 4.97
--------- -------
1,129,710 6.99 years $ 7.55 544,060 $ 6.58
---------- -----------
</Table>
Unless otherwise specified, the options vest and are exercisable at the rate of
20% per year and terminate ten years from date of grant. At December 31, 2000,
1999 and 1998, 544,060, 341,300 and 232,900 options were exercisable and there
were 220,290, 0, and 40,800 options available for future grants, respectively.
Had the compensation cost for the Company's stock based compensation plans been
determined based on the fair value at the grant date for awards under those
plans consistent with the method of SFAS No. 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below (in thousands, except per share amounts):
<Table>
<Caption>
2000 1999 1998
------ ------ ------
Net Income As reported $9,404 $7,504 $7,282
Pro forma 9,159 7,361 7,167
Earnings per share -- basic As reported 1.11 .89 .86
Pro forma 1.08 .87 .85
Earnings per share -- diluted As reported 1.09 .87 .85
Pro forma 1.06 .85 .84
</Table>
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions: (i) dividend
yield of 1.3%,
F-78
(ii) expected volatility range of 45%, (iii) risk-free interest rate of 6.63%,
and (iv) expected life of 5 years.
18) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following quarterly financial information for each of the three months ended
March 31, June 30, September 30 and December 31, 2000 and 1999 is unaudited.
However, in the opinion of management, all adjustments (consisting of normal
recurring adjustments) necessary for a fair presentation of the results of
operations for such periods, have been made.
<Table>
<Caption>
FOR THE THREE MONTHS ENDED
-----------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
----------------- ----------------- ----------------- -----------------
2000 1999 2000 1999 2000 1999 2000 1999
------- ------- ------- ------- ------- ------- ------- -------
(in thousands, except for per share)
Revenues $17,375 $16,083 $20,644 $17,739 $18,937 $16,599 $21,442 $18,323
------- ------- ------- ------- ------- ------- ------- -------
Net income $ 1,622 $ 1,359 $ 2,917 $ 2,123 $ 2,349 $ 1,723 $ 2,516 $ 2,299
------- ------- ------- ------- ------- ------- ------- -------
Earnings per share:
Basic $ 0.19 $ 0.16 $ 0.34 $ 0.25 $ 0.28 $ 0.20 $ 0.30 $ 0.27
Diluted 0.19 0.16 0.34 0.25 0.27 0.20 0.29 0.27
------- ------- ------- ------- ------- ------- ------- -------
Weighted average shares
outstanding:
Basic 8,461 8,460 8,466 8,448 8,473 8,460 8,479 8,464
Diluted 8,669 8,605 8,570 8,590 8,610 8,655 8,625 8,667
------- ------- ------- ------- ------- ------- ------- -------
</Table>
19) BUSINESS SEGMENTS
The Company operates in two insurance business segments, the Insurance Brokerage
Companies and the Property and Casualty Companies. In addition, Corporate
Operations include those activities that benefit the Company in its entirety and
cannot be specifically identified to either the Insurance Brokerage Companies or
the Property and Casualty Companies. Such activities include debt servicing and
public company expenses, including investor relations costs. The identifiable
segment assets, operating profits and income before income taxes and minority
interests are shown on the accompanying consolidated balance sheets and
statements of income.
The following table is a summary of certain other segment information for the
years ended December 31, 2000, 1999 and 1998:
<Table>
<Caption>
BUSINESS SEGMENTS -- 2000
-------------------------
INSURANCE PROPERTY &
BROKERAGE CASUALTY
--------- ----------
(in thousands)
Revenue from external sources $38,935 $30,486
Revenue from other segments 3,131 76
Depreciation and amortization expense 2,857 9,466
Interest income from other segments 275
Capital expenditures 3,866
</Table>
F-79
<Table>
<Caption>
BUSINESS SEGMENTS -- 1999
-------------------------
INSURANCE PROPERTY &
BROKERAGE CASUALTY
--------- ----------
(in thousands)
Revenue from external sources $33,158 $26,780
Revenue from other segments 4,221 72
Depreciation and amortization expense 2,355 8,309
Interest income from other segments 192
Capital expenditures 1,347
</Table>
<Table>
<Caption>
BUSINESS SEGMENTS -- 1998
-------------------------
INSURANCE PROPERTY &
BROKERAGE CASUALTY
--------- ----------
(in thousands)
Revenue from external sources $31,324 $24,689
Revenue from other segments 4,032 69
Depreciation and amortization expense 1,792 7,651
Capital expenditures 2,089
</Table>
The foreign operations set forth below, relate solely to the operations of OLB,
and its wholly owned subsidiary Park Brokerage, and business assumed from third
party insurance companies. All such risks assumed originate in the United
States.
<Table>
<Caption>
2000
-------------------------------
FOREIGN DOMESTIC TOTAL
------- -------- --------
(in thousands)
Consolidated Revenues $1,589 $76,809 $ 78,398
Income before income taxes 805 12,824 13,629
Identifiable assets 3,063 169,948 173,011
</Table>
<Table>
<Caption>
1999 1998
----------------------------- -----------------------------
FOREIGN DOMESTIC TOTAL FOREIGN DOMESTIC TOTAL
------- -------- -------- ------- -------- --------
(in thousands)
Consolidated Revenues $1,717 $67,027 $ 68,744 $2,092 $62,919 $ 65,011
Income before income
taxes 1,055 9,674 10,729 1,169 9,385 10,554
Identifiable assets 2,648 146,564 149,212 2,936 157,647 160,583
</Table>
There were no material inter-company revenue transactions between OLB and OLRI.
F-80
20) SUPPLEMENTAL CASH FLOW DISCLOSURES
<Table>
<Caption>
2000 1999 1998
------ ------- -------
(in thousands)
CASH PAID DURING THE PERIOD FOR:
Interest expense $1,097 $ 968 $ 501
Income taxes $4,066 $ 3,463 $ 2,870
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Stock issued under Stock Performance Plan $ 222
DETAILS OF ACQUISITIONS:
Purchase payments including outstanding payable $4,225 $ 7,784 $ 5,196
Amounts contingently payable (656) (1,578) (3,300)
Reissuance of treasury stock (192) (628)
Acquisition debt repayment (375) (375) (657)
------ ------- -------
Cash paid for acquisitions $3,002 $ 5,203 $ 1,239
------ ------- -------
</Table>
21) SUBSEQUENT EVENT
On January 20, 2001, the Company reported that Hub International Limited ("Hub")
had entered into a definitive agreement to acquire the Company through a merger
transaction.
Upon the merger, each holder of the Company's shares will receive $14.00 per
share consisting of cash of $9.33 and $4.67 principal amount of 5 year 8.50%
subordinate convertible debentures of Hub. Hub has the right to amend the merger
consideration by replacing any or all of the convertible debentures with an
equal amount of cash.
Completion of this transaction, anticipated to occur in the second quarter of
2001, is subject to the receipt of satisfactory applicable regulatory approvals,
approval of the merger by the shareholders of the Company, compliance with
applicable legal and regulatory requirements and standard closing conditions.
The holders of approximately 55% of the shares of the Company, under individual
agreements, have agreed to vote in favor of the merger, and have granted Hub an
irrevocable option to purchase their shares of the Company in the event that the
merger is not completed.
Immediately prior to the transaction all outstanding stock options shall become
vested, and in return for their cancellation, the holders of options will
receive a cash payment; and in return for the cancellation of all outstanding
and awarded Performance Stock Shares, the holders will receive a cash payment at
a later date. On completion of the transaction, the Company will record an
expense of approximately $2,400,000 related to the cancellation of the awarded
shares of the Stock Performance Plan.
In addition, as a result of the transaction, the Company will incur related
expenses of approximately $2.5 million during the period January 1, 2001 through
completion of the transaction.
F-81
SCHEDULE II
KAYE GROUP INC.
(PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
As of December 31, 2000 and 1999
(in thousands, except par value per share)
<Table>
<Caption>
2000 1999
------- -------
ASSETS
Cash and cash equivalents $ 138 $ 1,233
Prepaid expenses and other assets 59 153
Investments:
Equity securities, at market (cost: 2000, $308, and 1999,
$243) 320 243
Deferred income taxes 67 93
Due from subsidiaries 2,427 890
Investment in subsidiaries 55,543 48,616
------- -------
Total assets $58,554 $51,228
------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Accounts payable and other liabilities $ 254 $ 300
Note payable 1,343 1,241
Income taxes payable 187 366
------- -------
Total current liabilities 1,784 1,907
Note payable -- long term 728 2,070
------- -------
Total liabilities 2,512 3,977
------- -------
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par value; 1,000 shares authorized;
none issued or outstanding
Common stock, $.01 par value; 20,000 shares authorized;
(2000, 8,481; 1999, 8,458 shares issued and outstanding) 85 85
Paid-in capital 18,019 18,019
Unearned stock grant compensation (235) (254)
Common stock in Treasury, shares at cost (2000, 4; 1999, 28) (37) (229)
Unrealized appreciation (depreciation) of investments, net
of deferred income tax provision (benefit), (2000, ($107);
1999, ($118)) (207) (228)
Retained earnings 38,417 29,858
------- -------
Total stockholders' equity 56,042 47,251
------- -------
Total liabilities and stockholders' equity $58,554 $51,228
------- -------
</Table>
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto and the accompanying notes.
F-82
SCHEDULE II
KAYE GROUP INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF INCOME
For the years ended December 31, 2000, 1999 and 1998
(in thousands)
<Table>
<Caption>
2000 1999 1998
------- ------- -------
REVENUES:
Net investment income (loss) $ 107 $ 206 $ (31)
Equity in income of subsidiaries 14,236 11,148 11,342
EXPENSES:
Other operating expenses 480 309 314
Interest expense 234 316 443
------- ------- -------
Income before income taxes 13,629 10,729 10,554
Provision for income taxes 4,225 3,225 3,272
------- ------- -------
NET INCOME $ 9,404 $ 7,504 $ 7,282
------- ------- -------
</Table>
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto and the accompanying notes.
F-83
SCHEDULE II
KAYE GROUP INC.
(PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2000, 1999 and 1998
(in thousands)
<Table>
<Caption>
2000 1999 1998
-------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 9,404 $ 7,504 $ 7,282
Adjustment to reconcile net income to net cash
provided by (used in) operating activities:
Deferred income tax benefit 21 (93) (150)
Restricted stock compensation 19 10
Equity in net income of subsidiaries (10,214) (8,115) (7,826)
Dividends received from subsidiaries 3,900 3,886 4,060
Realized (gain) loss on investment (64) 274
Change in assets and liabilities:
Prepaid expenses and other assets 94 95 (20)
Due from subsidiaries (1,537) 1,228 1,294
Accounts payable and other liabilities (46) (211) (263)
Income taxes payable (179) (202) 552
-------- ------- -------
Net cash provided by operating activities 1,398 4,376 4,929
-------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of dividends (845) (847) (849)
Notes payable-repayment (1,240) (1,145) (7,575)
Reissuance (acquisition) of treasury stock 192 (571)
Proceeds from borrowing 5,000
Capital contribution to subsidiary (600) (950) (1,200)
-------- ------- -------
Net cash used in financing activities (2,493) (3,513) (4,624)
-------- ------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS (1,095) 863 305
Cash and cash equivalents at beginning of period 1,233 370 65
-------- ------- -------
Cash and cash equivalents at end of period $ 138 $ 1,233 $ 370
-------- ------- -------
SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid during the period for:
Interest expense $ 234 $ 316 $ 480
Income taxes $ 4,066 $ 3,463 $ 2,870
</Table>
The condensed financial statements should be read in conjunction with the
consolidated financial statements and notes thereto and the accompanying notes.
F-84
SCHEDULE II
KAYE GROUP INC.
(PARENT COMPANY ONLY)
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. CONDENSED FINANCIAL STATEMENTS
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested that these condensed financial
statements be read in conjunction with the Company's consolidated financial
statements and the notes thereto.
2. SIGNIFICANT ACCOUNTING POLICIES
The Company carries its investment in subsidiaries under the equity method. All
other accounting policies are consistent with those of the Company on a
consolidated basis.
F-85
SCHEDULE IV
KAYE GROUP INC.
REINSURANCE
For The Years Ended December 31, 2000, 1999 and 1998
(in thousands)
<Table>
<Caption>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F
- --------------- -------- -------------- --------------- ---------- --------------
PERCENTAGE
INSURANCE GROSS CEDED TO OTHER ASSUMED FROM OF AMOUNT
PREMIUMS EARNED AMOUNT COMPANIES OTHER COMPANIES NET AMOUNT ASSUMED TO NET
- --------------- -------- -------------- --------------- ---------- --------------
2000 $11,070 $1,638 $21,054 $30,486 69%
1999 $11,576 $ 642 $15,846 $26,780 59%
1998 $11,652 $ 355 $13,392 $24,689 54%
</Table>
F-86
SCHEDULE VI
KAYE GROUP INC.
SUPPLEMENTAL INFORMATION CONCERNING INSURANCE COMPANIES OPERATIONS
For the years ended December 31, 2000, 1999 and 1998
(in thousands)
<Table>
<Caption>
COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H COLUMN I
COLUMN A ----------- ------------- -------- -------- -------- ---------- ----------------- ------------
- ---------------
CLAIMS AND CLAIM
ADJUSTMENT
EXPENSES INCURRED
RESERVES FOR DISCOUNT RELATED TO
UNPAID CLAIMS IF ANY ----------------- AMORTIZATION
DEFERRED AND CLAIM DEDUCTED NET (1) (2) OF DEFERRED
AFFILIATION WITH ACQUISITION ADJUSTMENT IN UNEARNED EARNED INVESTMENT CURRENT PRIOR ACQUISITION
REGISTRANT COSTS EXPENSES COLUMN C PREMIUMS PREMIUMS INCOME YEAR YEARS COSTS
- ---------------- ----------- ------------- -------- -------- -------- ---------- ------- ------- ------------
Foreign $ 149 $ 246 N/A $ 709 $ 1,459 $ 130 $ 348 $ (88) $ 307
Domestic 3,904 27,738 N/A 12,988 29,027 2,924 12,992 (982) 9,143
------ ------- --- ------- ------- ------ ------- ------- ------
2000 $4,053 $27,984 N/A $13,697 $30,486 $3,054 $13,340 $(1,070) $9,450
-------- --------- ----- ------- ------- ------- ------ ------ --------
Foreign $ 152 $ 260 N/A $ 725 $ 1,598 $ 119 $ 375 $ (144) $ 335
Domestic 4,161 23,709 N/A 12,969 25,182 2,678 10,035 (542) 7,957
------ ------- --- ------- ------- ------ ------- ------- ------
1999 $4,313 $23,969 N/A $13,694 $26,780 $2,797 $10,410 $ (656) $8,292
-------- --------- ----- ------- ------- ------- ------ ------ --------
Foreign $ 193 $ 295 N/A $ 916 $ 1,957 $ 135 $ 313 $ 95 $ 414
Domestic 3,728 21,272 N/A 11,411 22,732 2,453 8,148 (60) 7,216
------ ------- --- ------- ------- ------ ------- ------- ------
1998 $3,921 $21,567 N/A $12,327 $24,689 $2,588 $ 8,461 $ 35 $7,630
-------- --------- ----- ------- ------- ------- ------ ------ --------
<Caption>
COLUMN J COLUMN K COLUMN L
COLUMN A ----------- -------- ---------
- ---------------
PAID CLAIMS
AND CLAIM OTHER
AFFILIATION WITH ADJUSTMENT PREMIUMS OPERATING
REGISTRANT EXPENSES WRITTEN EXPENSES
- ---------------- ----------- -------- ---------
Foreign $ 272 $ 1,443 $ 218
Domestic 9,905 28,584 2,947
------- ------- ------
2000 $10,177 $30,027 $3,165
-------- ------- -------
Foreign $ 296 $ 1,408 $ 66
Domestic 6,514 26,414 2,847
------- ------- ------
1999 $ 6,810 $27,822 $2,913
-------- ------- -------
Foreign $ 317 $ 1,742 $ 102
Domestic 6,147 22,796 2,178
------- ------- ------
1998 $ 6,464 $24,538 $2,280
-------- ------- -------
</Table>
F-87
SHARES
(HUB LOGO)
COMMON SHARES
PROSPECTUS
JPMORGAN
COCHRAN, CARONIA & CO.
STEPHENS INC.
BMO NESBITT BURNS
FERRIS, BAKER WATTS
Incorporated
, 2002
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE
NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT
CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO
BUY, COMMON SHARES ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE PERMITTED.
THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF THE DATE OF
THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS PROSPECTUS OR OF ANY
SALE OF OUR COMMON SHARES.
NO ACTION IS BEING TAKEN IN ANY JURISDICTION OUTSIDE THE UNITED STATES TO PERMIT
A PUBLIC OFFERING OF THE COMMON SHARES OR POSSESSION OR DISTRIBUTION OF THIS
PROSPECTUS IN THAT JURISDICTION. PERSONS WHO COME INTO POSSESSION OF THIS
PROSPECTUS IN JURISDICTION OUTSIDE THE UNITED STATES ARE REQUIRED TO INFORM
THEMSELVES ABOUT AND TO OBSERVE ANY RESTRICTIONS AS TO THIS OFFERING AND THE
DISTRIBUTION OF THIS PROSPECTUS APPLICABLE TO THAT JURISDICTION.
UNTIL , ALL DEALERS THAT BUY, SELL OR TRADE IN OUR COMMON SHARES,
WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE DEALER'S OBLIGATION TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
<Table>
- ------------------------------------------------------------------------
SEC registration fee........................................ $ 6,900.00
NASD filing fee............................................. 8,000.00
NYSE listing fee............................................ *
Blue Sky fees and expenses.................................. *
Printing and engraving expenses............................. *
Attorneys' fees and expenses................................ *
Accountants' fees and expenses.............................. *
Transfer agent's and registrar's fees and expenses.......... *
Miscellaneous............................................... *
Total....................................................... $ *
- ------------------------------------------------------------------------
</Table>
* To be filed by amendment.
The amounts set forth above are estimates except for the SEC registration fee,
the NASD filing fee and the NYSE listing fee.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Under the Business Corporations Act (Ontario), the Corporation may indemnify a
present or former director or officer or a person who acts or acted at the
Corporation's request as a director or officer of another corporation of which
the Corporation is or was a shareholder or creditor, and his or her heirs and
legal representatives, against all costs, charges and expenses, including an
amount paid to settle an action or satisfy a judgment, reasonably incurred by
him or her in respect of any civil, criminal or administrative action or
proceeding to which he or she is made a party by reason of being or having been
a director or officer of the Corporation of such other corporation and provided
that the director or officer acted honestly and in good faith with a view to the
best interests of the Corporation, and, in the case of a criminal or
administrative action or proceeding that is enforced by a monetary penalty, such
director or officer had reasonable grounds for believing that his or her conduct
was lawful. Such indemnification may be made in connection with an action by or
on behalf of the Corporation or such other corporation to procure a judgment in
its favor only with court approval. A director or officer is entitled to
indemnification from the Corporation as a matter of right if he or she was
substantially successful on the merits in his or her defense of the action or
proceeding and fulfilled the conditions set forth above.
The by-laws of the Corporation provide that the Corporation shall indemnify a
director or officer, a former director or officer or a person who acts or acted
at the Corporation's request as a director or officer of a body corporate of
which the Corporation is or was a shareholder or creditor, and the heirs and
legal representatives of such a person to the extent permitted by the Business
Corporations Act (Ontario).
The by-laws of the Corporation further provide that the Corporation may, to the
extent permitted by the Business Corporations Act (Ontario), purchase and
maintain insurance for the benefit of any director or officer, a former director
or officer or a person who acts or acted at the Corporation's request as a
director or officer of a body corporate of which the Corporation is or was a
shareholder or creditor.
II-1
A policy of directors' and officers' liability insurance is maintained by the
Corporation which insures, subject to certain exclusions, directors and officers
for losses as a result of claims against the directors and officers of the
Corporation in their capacity as directors and officers and also reimburses the
Corporation for payments made pursuant to the indemnity provided by the
Corporation pursuant to the Business Corporations Act (Ontario) and the by-laws
of the Corporation.
Insofar as indemnification for liabilities under the Securities Act may be
permitted to directors, officers or persons controlling the Registrant pursuant
to the foregoing provisions, the Registrant has been advised that in the opinion
of the SEC such indemnification is against public policy as expressed in the
Securities Act and is, therefore unenforceable.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
The following information reflects sales by the registrant of unregistered
securities within the past three years:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------
NUMBER OF PRICE PER
DATE ISSUED TO (NUMBER OF HOLDERS) SHARES SOLD SHARE
- -------------------------------------------------------------------------------------------------------
1/20/99................ Fairfax and wholly-owned subsidiaries for cash 5,400,000 C$10.00
1/20/99................ In exchange for 2,838,080 special warrants* 2,838,080 13.50
2/10/99................ Initial Public Offering in Canada 865,624 13.50
4/30/99................ Group Five Planned Insurance Services Inc. and The 247,857 14.00
Independent Brokerage Group Inc.**
5/31/99................ P. Moauro & Associates Inc.** 11,765 17.00
5/31/99................ Paul Ayotte Insurance Broker Ltd.** 52,941 17.00
5/31/99................ Paul Ayotte Insurance Brokers (Kapuskasing) Ltd.** 61,441 17.00
6/30/99................ Page Insurance Ltd.** 11,764 17.00
6/30/99................ Pro-Form Insurance Services Inc.** 24,264 17.00
6/30/99................ Evans-Bastion Insurance Agencies Ltd.** 63,000 17.00
6/30/99................ Mointra Services Inc. and Cambridge Insurance 82,353 17.00
Brokers Ltd.**
7/8/99................. Assurance Murdoch Crevier Inc.** 57,584 17.00
7/31/99................ Affinity Brokerage Network Inc., Segger & Associates 130,853 17.00
Ltd., APS Financial Corporation and APS Financial
Brokerage Inc.**
7/31/99................ Revelstoke Agencies Ltd. and Ken Magnes Agencies 9,189 18.50
Ltd.**
7/31/99................ KMS Insurance Services Ltd. and Underwriting 55,985 17.00
Alliance Group Inc.**
7/31/99................ Allan Tolsma Agencies Ltd. and Allan Tolsma Agencies 41,000 17.00
(Colwood) Ltd.**
7/31/99................ Feder & Associates Insurance Brokers Ltd. and 20,000 17.00
Canadian Block Managers Inc.**
8/3/99................. Assurances Cloutier & Cloutier Inc.** 13,889 18.00
8/3/99................. Gestion S. Lamanque Inc.** 2,673 17.00
8/31/99................ Parson Brown & Company Limited** 126,555 17.00
8/31/99................ TOS Insurance Services Ltd.*** 417,358 17.00
9/30/99................ Tenax Employee Benefits and Consulting Inc.** 26,176 17.00
</Table>
II-2
<Table>
<Caption>
- -------------------------------------------------------------------------------------------------------
NUMBER OF PRICE PER
DATE ISSUED TO (NUMBER OF HOLDERS) SHARES SOLD SHARE
- -------------------------------------------------------------------------------------------------------
10/27/99............... Mack & Parker, Inc.** 1,102,593 C$19.00
10/31/99............... Salmon Arm Insurance Agency Ltd.**** 74,510 20.00
11/1/99................ NILA Financial & Insurance Services Inc.** 42,500 20.00
11/20/99............... S & P Agencies (1980) Ltd. and G. B. Ventures Ltd.** 8,700 20.00
11/30/99............... Bytown Insurance Brokers Inc.** 15,000 20.00
12/31/99............... McIntosh Insurance Services Inc.** 4,620 20.00
12/31/99............... Executive Share Purchase Plan 41,992 20.00
6/30/00 3,258
1/14/00................ Executive Share Purchase Plan 5,882 17.00
2/2/00................. Executive Share Purchase Plan 5,000 20.00
4/1/00................. Blais, Chalifour, Couillard, McCarthy, Thabet inc. 18,640 18.00
and Les Placements Stefrasco Inc.**
4/3/00................. Executive Share Purchase Plan 5,000 20.00
6/30/00................ C. J. McCarthy Insurance Agency, Inc.** 464,470 15.00
7/1/00................. NILA Financial Group Inc.** 20,000 20.00
7/12/00................ Executive Share Purchase Plan 99,748 20.00
7/12/00................ Executive Share Purchase Plan 1,851 13.50
7/27/00................ Executive Share Purchase Plan 1,750 20.00
11/6/00................ Price adjustment pursuant to November 30, 1998 4,564 10.00
Merger Agreement
1/1/01................. Assurances Dumas & Associes Inc.** 50,879 17.00
6/18/01................ J. P. Flanagan Corporation** 680,000 17.00
6/26/01................ Executive Share Purchase Plan 186,999 17.00
7/19/01................ Bruce Guthart for cash 439,526 13.00
7/20/01................ Burnham Stewart Group, Inc.** 1,422,834 17.00
320,266 16.28
7/26/01................ Executive Share Purchase Plan 500 10.00
7/30/01................ Executive Share Purchase Plan 150 10.00
8/15/01................ Executive Share Purchase Plan 600 10.00
9/27/01................ Executive Share Purchase Plan 2,353 17.00
9/28/01................ Executive Share Purchase Plan 800 10.00
10/9/01................ Executive Share Purchase Plan 258 13.50
10/30/01............... Executive Share Purchase Plan 289 13.50
12/28/01............... Executive Share Purchase Plan 11,765 17.00
- -------------------------------------------------------------------------------------------------------
</Table>
* The 2,838,080 special warrants (exchangeable into one share each) were issued
on a private placement basis at a price of C$13.50 per special warrant. Fairfax
purchased, through certain of its wholly-owned subsidiaries, 1,185,184 special
warrants.
** Shares issued from treasury in partial consideration of the acquisition of
the indicated brokerage(s).
*** Shares issued from treasury in partial consideration of the acquisition of
the TOS Insurance Services Ltd., Lakeview Insurance Services Ltd., Colwood
Insurance Services Inc., Defieux Saxelby Insurance Services Inc., Smallwood
Insurance Services Ltd. (50% ownership) and Brentwood Insurance Agencies Ltd.
(50% ownership).
**** Shares issued from treasury in partial consideration of the acquisition of
the Salmon Arm Insurance Agency Ltd., Revelstoke Insurance Services Ltd., Habaro
Management Ltd., Habaro Leasing Corporation, Beacon Underwriting Ltd., BMI
Holdings Ltd., Healthy Holdings Ltd., Freedom Holdings Canada Ltd., 382407 B. C.
Ltd., Maribrook Investments Ltd. and Bencan Investments Ltd.
The sales of the above securities were deemed to be exempt from registration
under the Securities Act, with respect to offshore transactions, in reliance on
Regulation S and, with respect to sales to
II-3
U.S. persons, in reliance on Section 4(2) of the Securities Act, or Regulation D
promulgated under Section 4(2) of the Securities Act, or, with respect to
issuances to employees, Rule 701 promulgated under Section 3(b) of the
Securities Act as transactions by an issuer not involving a public offering or
transactions pursuant to compensatory benefit plans and contracts relating to
compensation as provided under Rule 701. The recipients of securities in each
transaction represented their intentions to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution of the securities and appropriate legends were affixed to the
instruments representing the securities issued in these transactions. All
recipients had adequate access, through their relationships with us, to
information about us.
ITEM 1. EXHIBITS.
<Table>
<Caption>
- ---------------------------------------------------------------------------
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ---------------------------------------------------------------------------
1.1 -- Form of Underwriting Agreement.*
3.1 -- Articles of Incorporation of the Registrant.
3.2 -- By-laws of the Registrant.
4.1 -- Specimen Certificate representing Common Shares.
5.1 -- Opinion of Torys LLP as to the legality of the Common
Shares.*
10.1 -- Agreement and Plan of Merger between Hub International
Limited, 416 Acquisition Inc. and Kaye Group Inc. dated
January 19, 2001.
10.2 -- Executive Share Purchase Plan.
10.3 -- Employee Share Purchase Plan.
10.4 -- Employment Agreement dated as of March 19, 2002 between Hub
International Limited and Martin P. Hughes.
10.5 -- Executive confidentiality, non-solicitation and insider
agreement dated as of March 19, 2001 between Hub
International Limited and its subsidiaries and Martin P.
Hughes.
10.6 -- Employment Agreement dated as of March 19, 2002 between Hub
International Limited and Richard A. Gulliver.
10.7 -- Executive confidentiality, non-solicitation and insider
agreement dated as of March 19, 2001 between Hub
International Limited and its subsidiaries and Richard A.
Gulliver.
10.8 -- Employment Agreement dated as of March 19, 2002 between Hub
International Limited and Dennis J. Pauls.
10.9 -- Executive confidentiality, non-solicitation and insider
agreement dated as of March 19, 2001 between Hub
International Limited and its subsidiaries and Dennis J.
Pauls.
10.10 -- Employment Agreement dated as of March 19, 2002 between Hub
International Limited and W. Kirk James.
10.11 -- Executive confidentiality, non-solicitation and insider
agreement dated as of March 19, 2001 between Hub
International Limited and its subsidiaries and W. Kirk
James.
10.12 -- Employment Agreement dated as of June 28, 2001 among Kaye
Group Inc., Hub International Limited and Bruce D. Guthart.
10.13 -- Employment Agreement dated as of January 1, 2002 among
Barton Insurance Brokers Ltd., Hub International Limited and
R. Craig Barton.
10.14 -- Form of Restricted Share Purchase Plan.*
10.15 -- Amended and Restated Credit Agreement dated as of June 21,
2001 between Hub International Limited and Bank of Montreal.
</Table>
II-4
<Table>
<Caption>
- ---------------------------------------------------------------------------
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ---------------------------------------------------------------------------
10.16 -- Debenture dated as of June 28, 2001 between Hub
International Limited and Royal Trust Corporation of Canada
as Trustee for Zurich Insurance Company, as amended.
10.17 -- Debenture dated as of June 28, 2001 between Hub
International Limited and Odyssey Reinsurance Corporation.
10.18 -- Debenture dated as of June 28, 2001 between Hub
International Limited and United States Fire Insurance
Company.
10.19 -- Credit Agreement dated as of July 19, 2001, as amended,
between Hub International Limited and Bank of America, N.A.
10.20 -- Credit Agreement dated as of July 19, 2001, as amended,
between Hub International Limited and LaSalle Bank National
Association.
21.1 -- List of Registrant's subsidiaries.
23.1 -- Consent of PricewaterhouseCoopers LLP.
23.2 -- Consent of PricewaterhouseCoopers LLP.
23.3 -- Consent of Torys LLP (included in its opinion in Exhibit
5.1).*
24.1 -- Powers of Attorney (included on the signature page of this
Registration Statement).
- ---------------------------------------------------------------------------
</Table>
* To be filed by amendment.
ITEM 2. UNDERTAKINGS.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers and controlling persons of the registrant
pursuant to the foregoing provisions or otherwise, the Registrant has been
advised that in the opinion of the SEC such indemnification is against public
policy as expressed in the Securities Act of 1933 and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(2) For the purposes of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
The undersigned Registrant hereby undertakes to provide to the Underwriters at
the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such name as required by the Underwriters to
permit prompt delivery to each purchaser.
II-5
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has duly caused the Registration Statement on Form S-1 to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Chicago in the State of Illinois on March 21, 2002.
Hub International Limited
By: /s/ MARTIN P. HUGHES
--------------------------------------
Name: Martin P. Hughes
Title: Chairman and Chief
Executive Officer
II-6
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints, jointly and severally, Martin P. Hughes and Richard A.
Gulliver his true and lawful attorneys-in-fact and agents, each of whom may act
alone, with full powers of substitution and resubstitution, for him or her and
in his or her name, place and stead, in any and all capacities, to sign any or
all amendments (including post-effective amendments) to this Registration
Statement, and to sign any related registration statement that is to be
effective upon filing pursuant to Rule 462(b) promulgated under the Securities
Act of 1933, and all post-effective amendments thereto, and to file the same,
with all exhibits thereto and all documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he or she might or could do in
person, and hereby ratifying and confirming all that such attorneys-in-fact and
agents or any of them, or his or their substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this Registration
Statement has been signed by the following persons in the capacities and on the
date indicated.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ MARTIN P. HUGHES Director and Principal March 21, 2002
- ----------------------------------------------------- Executive Officer
Martin P. Hughes
/s/ DENNIS J. PAULS Principal Financial and March 21, 2002
- ----------------------------------------------------- Accounting Officer
Dennis J. Pauls
/s/ RICHARD A. GULLIVER Director March 21, 2002
- -----------------------------------------------------
Richard A. Gulliver
/s/ R. CRAIG BARTON Director March 21, 2002
- -----------------------------------------------------
R. Craig Barton
/s/ ANTHONY F. GRIFFITHS Director March 21, 2002
- -----------------------------------------------------
Anthony F. Griffiths
/s/ BRUCE D. GUTHART Director March 21, 2002
- -----------------------------------------------------
Bruce D. Guthart
/s/ JEAN MARTIN Director March 21, 2002
- -----------------------------------------------------
Jean Martin
/s/ PAUL MURRAY Director March 21, 2002
- -----------------------------------------------------
Paul Murray
/s/ JOHN VARNELL Director March 21, 2002
- -----------------------------------------------------
John Varnell
</Table>
II-7
AUTHORIZED REPRESENTATIVE
Pursuant to the requirements of Section 6(a) of the Securities Act of 1933, the
Authorized Representative has duly signed this registration statement below on
March 21, 2002.
HUB U.S. HOLDINGS, INC.
By: /s/ W. KIRK JAMES
--------------------------------------
Name: W. Kirk James
Title: Secretary
II-8
INDEX OF EXHIBITS
<Table>
<Caption>
- -------------------------------------------------------------------------------------------
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF EXHIBIT NUMBERED PAGES
- -------------------------------------------------------------------------------------------
1.1 -- Form of Underwriting Agreement.*
3.1 -- Articles of Incorporation of the Registrant.
3.2 -- By-laws of the Registrant.
4.1 -- Specimen Certificate representing Common Shares.
5.1 -- Opinion of Torys LLP as to the legality of the Common
Shares.*
10.1 -- Agreement and Plan of Merger between Hub International
Limited, 416 Acquisition Inc. and Kaye Group Inc. dated
January 19, 2001.
10.2 -- Executive Share Purchase Plan.
10.3 -- Employee Share Purchase Plan.
10.4 -- Employment Agreement dated as of March 19, 2002 between Hub
International Limited and Martin P. Hughes.
10.5 -- Executive confidentiality, non-solicitation and insider
agreement dated as of March 19, 2001 between Hub
International Limited and its subsidiaries and Martin P.
Hughes.
10.6 -- Employment Agreement dated as of March 19, 2002 between Hub
International Limited and Richard A. Gulliver.
10.7 -- Executive confidentiality, non-solicitation and insider
agreement dated as of March 19, 2001 between Hub
International Limited and its subsidiaries and Richard A.
Gulliver.
10.8 -- Employment Agreement dated as of March 19, 2002 between Hub
International Limited and Dennis J. Pauls.
10.9 -- Executive confidentiality, non-solicitation and insider
agreement dated as of March 19, 2001 between Hub
International Limited and its subsidiaries and Dennis J.
Pauls.
10.10 -- Employment Agreement dated as of March 19, 2002 between Hub
International Limited and W. Kirk James.
10.11 -- Executive confidentiality, non-solicitation and insider
agreement dated as of March 19, 2001 between Hub
International Limited and its subsidiaries and W. Kirk
James.
10.12 -- Employment Agreement dated as of June 28, 2001 among Kaye
Group Inc., Hub International Limited and Bruce D. Guthart.
10.13 -- Employment Agreement dated as of January 1, 2002 among
Barton Insurance Brokers Ltd., Hub International Limited and
R. Craig Barton.
10.14 -- Form of Restricted Share Purchase Plan.*
10.15 -- Amended and Restated Credit Agreement dated as of June 21,
2001 between Hub International Limited and Bank of Montreal.
10.16 -- Debenture dated as of June 28, 2001 between Hub
International Limited and Royal Trust Corporation of Canada
as Trustee for Zurich Insurance Company, as amended.
</Table>
II-9
<Table>
<Caption>
- -------------------------------------------------------------------------------------------
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF EXHIBIT NUMBERED PAGES
- -------------------------------------------------------------------------------------------
10.17 -- Debenture dated as of June 28, 2001 between Hub
International Limited and Odyssey Reinsurance Corporation.
10.18 -- Debenture dated as of June 28, 2001 between Hub
International Limited and United States Fire Insurance
Company.
10.19 -- Credit Agreement dated as of July 19, 2001, as amended,
between Hub International Limited and Bank of America, N.A.
10.20 -- Credit Agreement dated as of July 19, 2001, as amended,
between Hub International Limited and LaSalle Bank National
Association.
21.1 -- List of Registrant's subsidiaries.
23.1 -- Consent of PricewaterhouseCoopers LLP.
23.2 -- Consent of PricewaterhouseCoopers LLP.
23.3 -- Consent of Torys LLP (included in its opinion in Exhibit
5.1).*
24.1 -- Powers of Attorney (included on the signature page of this
Registration Statement).
- -------------------------------------------------------------------------------------------
</Table>
* To be filed by amendment.
II-10