Our 19 wholly-owned storefront locations and our executive and other offices are operated pursuant to lease agreements that expire from time to time through 2015. The current yearly aggregate base rental for the offices is approximately $414,000.
Until December 2008, our continuing operations primarily consisted of the ownership and operation of 19 storefronts, including 12 Barry Scott locations, three Atlantic Insurance locations, and four Accurate Agency locations. In December 2008, due to declining revenues and profits, we made a decision to restructure our network of retail offices (the “Retail Business”). The plan of restructuring called for the closing of seven of our least profitable locations during December 2008 and the sale of the remaining 19 Retail Business locations. On March 30, 2009, an asset purchase agreement (the “Purchase Agreement”) was fully executed pursuant to which we agreed to sell substantially all of the assets, including the book of business, of the 16 remaining Retail Business locations that we own in New York State (the “Assets”). The closing of the sale of the Assets is subject to a number of conditions. As a result of the restructuring in December 2008, and the Purchase Agreement on March 30, 2009, our Retail Business has been reclassified as discontinued operations and prior periods have been restated.
In our continuing operations, we receive fees from 33 franchised locations in connection with their use of the DCAP name.
In our Retail Business discontinued operations, the insurance storefronts serve as insurance agents or brokers and place various types of insurance on behalf of customers. Our Retail Business focuses on automobile, motorcycle and homeowner’s insurance and our customer base is primarily individuals rather than businesses.
The stores from our Retail Business discontinued operations receive commissions from insurance companies for their services. Neither we nor the stores have served as an insurance company and therefore we have not assumed underwriting risks; however, as discussed in Item 1(b) of this Annual Report, in March 2007, Commercial Mutual Insurance Company’s Board of Directors adopted a resolution to convert Commercial Mutual from an advance premium insurance company to a stock property and casualty insurance company. We hold surplus notes of Commercial Mutual in the aggregate principal amount of $3,750,000. Based upon the amount payable on the surplus notes and the statutory surplus of Commercial Mutual, the plan of conversion provides that, in the event of a conversion by Commercial Mutual into a stock corporation, in exchange for our relinquishing our rights to any unpaid principal and interest under the surplus notes, we would receive 100% of the stock of Commercial Mutual.
Our consolidated financial statements include accounts of DCAP Group, Inc. and all majority-owned and controlled subsidiaries. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related notes. In preparing these financial statements, our management has utilized information available including our past history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality. It is possible that the ultimate outcome as anticipated by our management in formulating its estimates inherent in these financial statements might not materialize. However, application of the critical accounting policies below involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. In addition, other companies may utilize different estimates, which may impact comparability of our results of operations to those of companies in similar businesses.
Customers who purchase insurance policies are often unable to pay the premium in a lump sum and, therefore, require extended payment terms. Premium finance involves making a loan to the customer that is backed by the unearned portion of the insurance premiums being financed. No credit checks were made prior to the decision to extend credit to a customer. Losses on finance receivables included an estimate of future credit losses on premium finance accounts. Credit losses on premium finance accounts occurred when the unearned premiums received from the insurer upon cancellation of a financed policy were inadequate to pay the balance of the premium finance account. After collection attempts were exhausted, the remaining account balance, including unrealized interest, was written off. We reviewed historical trends of such losses relative to finance receivable balances to develop estimates of future losses.
The carrying value of goodwill was initially reviewed for impairment as of January 1, 2002, and is reviewed annually or whenever events or changes in circumstances indicate that the carrying amount might not be recoverable. If the fair value of the reporting unit to which goodwill relates is less than the carrying amount of those operations, including unamortized goodwill, the carrying amount of goodwill is reduced accordingly with a charge to impairment expense. Based on our most recent analysis, our results of operations for the year ended December 31, 2008 include a charge to impairment expense of approximately $394,000.
In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141R “Business Combinations” (“SFAS 141R”). SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. SFAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for our fiscal year beginning January 1, 2009. We are currently evaluating this statement for the impact, if any, that SFAS 141R will have on our consolidated financial position and results of operations.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 permits companies to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Companies are not allowed to adopt SFAS 159 on a retrospective basis unless they choose early adoption. We adopted SFAS 159 in 2008, and did not elect the fair value option for eligible items that existed at the date of adoption.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 applies to all entities. SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. We are currently evaluating this statement for the impact, if any, that SFAS 161 will have on our consolidated financial position and results of operations.
In December 2008, due to declining revenues and profits, we made a decision to restructure our network of retail offices (the “Retail Business”). The plan of restructuring called for the closing of seven of our least profitable locations during December 2008 and the sale of the remaining 19 Retail Business locations. On March 30, 2009, an asset purchase agreement (the “Purchase Agreement”) was fully executed pursuant to which we agreed to sell substantially all of the assets, including the book of business, of the 16 remaining Retail Business locations that we own in New York State (the “Assets”). The closing of the sale of the Assets is subject to a number of conditions. As a result of the restructuring in December 2008, and the Purchase Agreement on March 30, 2009, our Retail Business has been reclassified as discontinued operations and prior periods have been restated.
Separate discussions follow for results of continuing operations and discontinued operations.
The following table summarizes the changes in the significant components of the results of continuing operations (in thousands) for the periods indicated:
The following table summarizes the changes in the results of our premium finance discontinued operations (in thousands) for the periods indicated:
Our general and administrative expenses from discontinued operations decreased $1,250,000 in 2008 as compared to 2007. The 87% decrease is due to only including one month of operating expenses related to revenue in 2008 compared to 12 months in 2007.
Our provision for finance receivable losses for 2008 was $383,000 less than for 2007. The 81% decrease was due to the discontinuance of loan originations offset by a provision for losses from loans originated in the prior year.
Loss on sale of premium financing portfolio was $102,000 in 2008, compared to no such loss in 2007. The 2008 loss was primarily due to $83,000 in fees related to the sale of our premium finance portfolio, and an adjustment to the selling price as a result of a change in the estimated collectible amount of the portfolio.
Our discontinued premium finance operations, on a stand-alone basis, generated a net loss before income taxes of $240,000 in 2008 as compared to a net profit before income taxes of $517,000 in 2007. The decrease in profit of $757,000 in 2008 was primarily due to: (i) the cessation of revenues as of January 31, 2008, and (ii) the loss on sale of our premium financing portfolio, offset by the elimination and reductions in operating expenses.
Our discontinued Retail Business operations, on a stand-alone basis, generated a net loss before income taxes of $500,000 in 2008 as compared to a net profit before income taxes of $340,000 in 2007. The decrease in profit of $840,000 in 2008 was primarily due to the $1,054,000 decrease in revenues, and increase in impairment of intangibles, offset by a decrease in general and administrative expenses.
The following table summarizes our change in net loss for the periods indicated.
As of December 31, 2008, we had $142,949 in cash and cash equivalents and a working capital deficit of $175,105. As of December 31, 2007, we had $1,030,822 in cash and cash equivalents and a working capital deficit of $1,603,288.
During 2007, the holders of $1,500,000 outstanding principal amount of notes payable (the “Notes Payable”) agreed to extend the maturity date of the debt from September 30, 2007 to September 30, 2008. In August 2008, the maturity date of the Notes Payable was further extended from September 30, 2008 to the earlier of July 10, 2009 or 90 days following the conversion of Commercial Mutual to a stock property and casualty insurance company and the issuance to us of a controlling interest in Commercial Mutual (subject to acceleration under certain circumstances). In exchange for this extension, the holders are entitled to receive an aggregate incentive payment equal to $10,000 times the number of months (or partial months) the debt is outstanding after September 30, 2008 through the maturity date. If a prepayment of principal reduces the debt below $1,500,000, the incentive payment for all subsequent months will be reduced in proportion to any such reduction to the debt. The aggregate incentive payment is due upon full repayment of the debt. The $1,500,000 principal balance of the Notes Payable is included in our December 31, 2008 balance sheet under “Current portion of long-term debt.”
Effective April 16, 2008, the holder of our Series B preferred shares (which provided for dividends at the rate of 5% per annum and an outside mandatory redemption date of April 30, 2008) exchanged such shares for an equal number of Series C preferred shares (which provided for dividends at the rate of 10% per annum and an outside mandatory redemption date of April 30, 2009). Effective August 23, 2008, the outside mandatory redemption date for the preferred shares was further extended to July 31, 2009 through the issuance of Series D preferred shares in exchange for the Series C preferred shares. The mandatorily redeemable balance of $780,000 is included in our December 31, 2008 balance sheet under “Current Liabilities”.
On March 30, 2009, an asset purchase agreement (the “Purchase Agreement”) was fully executed pursuant to which our wholly-owned subsidiaries, Barry Scott Agency, Inc. and DCAP Accurate, Inc. agreed to sell substantially all of their assets, including the book of business, of the 16 Retail Business locations that we own in New York State (the “Assets”). The closing of the sale of the Assets is subject to a number of conditions. We expect to satisfy the conditions and complete the sale of the Assets in April 2009. The purchase price for the Assets is approximately $2,337,000, of which approximately $1,786,000 is to be paid to us at closing, and the remainder of the purchase price is to be satisfied by the delivery of promissory notes in the aggregate principal amount of $551,000. As additional consideration, we will be entitled to receive through September 2010 an amount equal to 60% of the net commissions derived from the book of business of six retail locations that were closed in 2008. The proceeds from the sale of the Assets that we expect to receive in April 2009 will not be sufficient to fully satisfy the Notes Payable and preferred stock obligations on their respective maturity dates. We plan to seek to further extend the maturity dates and/or refinance the Notes Payable and preferred stock obligations.
We believe that, based on our present cash resources, and assuming that our efforts to further extend the maturity dates of the Notes Payable and preferred stock obligations, as discussed above, are successful and that we complete the sale of the Assets as contemplated, including the collection of the $551,000 of promissory notes discussed above in accordance with their terms, we will have sufficient cash on a short-term basis and over the next 12 months to fund our working capital needs. No definitive arrangements are in place with regard to any further extension of the maturity dates and/or refinancing the Notes Payable and preferred stock obligations and no assurances can be given that any will occur on commercially reasonable terms or otherwise. No assurances can be given that we will complete the sale of the Assets as contemplated.
All of our revenue is derived from sources located in the states of New York and Pennsylvania and, accordingly, is affected by the prevailing regulatory, economic, demographic, competitive and other conditions in these states. Changes in any of these conditions could make it more costly or difficult for us to conduct our business. Adverse regulatory developments in New York or Pennsylvania, which could include fundamental changes to the design or implementation of the automobile insurance regulatory framework, could have a material adverse effect on our results of operations and financial condition.
We are a holding company and a legal entity separate and distinct from our operating subsidiaries. As a holding company without significant operations of our own, the principal sources of our funds are dividends and other payments from our operating subsidiaries. Consequently, we must rely on our subsidiaries for our ability to repay debts, pay expenses and pay cash dividends to our shareholders. In connection with the plan of conversion of Commercial Mutual, we have agreed with the New York State Insurance Department that, for a period of two years following the conversion, without the approval of the Insurance Department, no dividend may be paid by Commercial Mutual to us.
We have determined to close or sell our Retail Business locations and such operations are reflected as discontinued operations in our financial statements. Such action has taken in anticipation of a change in business strategy from operating storefront insurance agencies to operating an insurance company through Commercial Mutual. To date, the conditions to the conversion of Commercial Mutual to a stock property and casualty insurance company, namely the approval of the plan of conversion by the Insurance Department and Commercial Mutual’s policyholders, have not yet been satisfied. No assurances can be given that the conversion will occur.
The volatility of premium pricing and commission rates could adversely affect our operations.
We currently derive revenue from commissions paid by insurance companies. In addition, our franchisees rely on such revenue. The commission is usually a percentage of the premium billed to an insured. Historically, property and casualty premiums have been cyclical in nature and have displayed a high degree of volatility based on economic and competitive conditions. Because such commission revenue is based on insurance premiums, a decline in premium levels will have an adverse effect on our discontinued operations and our franchisees. In addition, in many cases, insurance companies may seek to reduce their expenses by reducing the commission rates payable to insurance agents or brokers and generally reserve the right to make such reductions. We cannot predict the timing or extent of future changes in commission rates or premiums and therefore cannot predict the effect, if any, that such changes would have on our discontinued operations or our franchisees.
In addition, there are currently 33 DCAP franchises. The offering of franchises is regulated by both the federal government and some states, including New York.
We may seek to expand through acquisitions of complementary businesses or other assets which involve additional risks that may adversely affect us.