Our principal executive offices and the administrative offices of Payments Inc. are located at 1158 Broadway, Hewlett, New York. Our central processing offices are located at 1762 Central Avenue, Albany, New York.
Our 12 Barry Scott offices and four Accurate Agency offices are located in upstate New York. Our three Atlantic Insurance offices are located in eastern Pennsylvania.
See Item 1 of this Annual Report for a discussion of a contemplated sale of our Barry Scott and Accurate Agency operations.
The stores also offer automobile club services for roadside assistance and some of our franchise locations offer income tax preparation services.
Franchise fee revenue on initial franchisee fees is recognized when substantially all of our contractual requirements under the franchise agreement are completed. Franchisees also pay a monthly franchise fee plus a monthly advertising fee. We are obligated to provide marketing and training support to each franchisee.
We recognize commission revenue from insurance policies at the beginning of the contract period. Refunds of commissions on the cancellation of insurance policies are reflected at the time of cancellation.
For our premium finance operations, we used the interest method to recognize interest income over the life of each loan in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.”
Upon completion of collection efforts, after cancellation of the underlying insurance policies, any uncollected earned interest or fees were charged off.
Our stock option and other equity-based compensation plans are accounted for in accordance with the recognition and measurement provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”). FAS 123(R) requires compensation costs related to share-based payment transactions, including employee stock options, to be recognized in the financial statements. In addition, we adhere to the guidance set forth within Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin (“SAB”) No. 107, which provides the Staff's views regarding the interaction between SFAS 123(R) and certain SEC rules and regulations and provides interpretations with respect to the valuation of share-based payments for public companies.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements about fair value measurements. SFAS 157 was effective for us on January 1, 2008. However, in February 2008, the FASB released FASB Staff Position (FSP FAS 157-2 - Effective Date of FASB Statement No. 157), which delayed the effective date of SFAS 157 for all nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of SFAS 157 for our financial assets and liabilities did not have a material impact on our consolidated financial statements. We do not believe the adoption of SFAS 157 for our nonfinancial assets and liabilities, effective January 1, 2009, will have a material impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”). The new standard changes the accounting and reporting of noncontrolling interests, which have historically been referred to as minority interests. SFAS 160 requires that noncontrolling interests be presented in the consolidated balance sheets within shareholders’ equity, but separate from the parent’s equity, and that the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented in the consolidated statements of income. Any losses in excess of the noncontrolling interest’s equity interest will continue to be allocated to the noncontrolling interest. Purchases or sales of equity interests that do not result in a change of control will be accounted for as equity transactions. Upon a loss of control, the interest sold, as well as any interest retained, will be measured at fair value, with any gain or loss recognized in earnings. In partial acquisitions, when control is obtained, the acquiring company will recognize, at fair value, 100% of the assets and liabilities, including goodwill, as if the entire target company had been acquired. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, with early adoption prohibited. The new standard will be applied prospectively, except for the presentation and disclosure requirements, which will be applied retrospectively for all periods presented. We have not yet determined the impact, if any, that this statement will have on our consolidated financial statements and we will adopt the standard at the beginning of fiscal 2009.
In April 2008, the FASB issued FASB Staff Position ("FSP") No. 142-3, “Determination of the Useful Life of Intangible Assets” ("FSP 142-3"). FSP 142-3 removes the requirement under SFAS 142 to consider whether an intangible asset can be renewed without substantial cost of material modifications to the existing terms and conditions, and replaces it with a requirement that an entity consider its own historical experience in renewing similar arrangements, or a consideration of market participant assumptions in the absence of historical experience. FSP 142-3 also requires entities to disclose information that enables users of financial statements to assess the extent to which the expected future cash flows associated with the asset are affected by the entity's intent and/or ability to renew or extend the arrangement. The guidance will become effective as of the beginning of our fiscal year beginning after December 15, 2008. We are currently evaluating the impact this standard will have on our financial statements.
In June 2008, the FASB ratified Emerging Issues Task Force (“EITF”) No. 07-5, “Determining Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity's Own Stock” ("EITF 07-5"). EITF 07-5 provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument's contingent exercise and settlement provisions. EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early application is not permitted. We are assessing the potential impact of this EITF on our financial condition and results of operations.
In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“EITF 03-6-1”). EITF 03-6-1 clarifies that all outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends participate in undistributed earnings with common shareholders. Awards of this nature are considered participating securities and the two-class method of computing basic and diluted earnings per share must be applied. EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008. We are currently evaluating the potential impact, if any; the new pronouncement will have on our consolidated financial statements.
On February 1, 2008, we sold our outstanding premium finance loan portfolio. As a result of the sale, our premium financing operations have been reclassified as discontinued operations.
Our general and administrative expenses in 2008 were $1,860,000, as compared to $2,275,000 in 2007. The 18% decrease of $415,000 was primarily attributable to decreases in: (i) franchise advertising costs, (ii) executive compensation, and (iii) fees paid to consultants.
Our interest expense in 2008 was $271,000, as compared to $432,000 in 2007. The 37% decrease of $161,000 was primarily due to: (i) a reduction in the principal balance of our debt and (ii) our no longer allocating a portion of the interest on our revolving credit line from our discontinued premium finance business to continuing operations.
Our interest income from notes receivable in 2008 was $765,000, as compared to $1,288,000 in 2007. The 41% decrease of $523,000 was primarily due to: (i) the discount on surplus notes and the accrued interest at the time of acquisition being fully accreted in July 2008, and (ii) a reduction in the variable interest rate in 2008 due to a decrease in the prime rate.
Our continuing operations generated a net loss before income taxes of $587,000 in 2008 as compared to a net loss before income taxes of $885,000 in 2007. The 34% decrease of $298,000 was primarily due to the inception of earning premium finance placement fees in 2008 and reductions in general and administrative and interest expenses, offset by a decrease in interest income from our surplus notes.
* Our premium finance portfolio was sold on February 1, 2008. Premium finance revenue for 2008 only includes the period from January 1, 2008 through January 31, 2008.
Our premium finance revenue decreased $2,942,000 in 2008 as compared to 2007. The 93% decrease is due to only including one month of revenue in 2008 compared to 12 months in 2007.
Our premium finance interest expense for 2008 was $601,000 less than for 2007. The 93% decrease was due to the payment in full of the outstanding balance of our revolving credit line on February 1, 2008.
The following table summarizes the changes in the results of our Retail Business discontinued operations (in thousands) for the periods indicated:
Our Retail Business revenue was $4,042,000 in 2008 as compared to $5,096,000 in 2007. The 21% revenue decrease of $1,054,000 was primarily attributable to a reduction in commissions and fees earned due to the sale of fewer insurance policies in 2008 than in 2007. Such reduction in sales was generally caused by the continued heightened competition from the voluntary insurance market, which is offering lower premium rates to our main customer, the non-standard insured.
Our Retail Business general and administrative expenses in 2008 were $3,895,000, as compared to $4,479,000 in 2007. The 13% net decrease of $584,000 was primarily attributable to decreases in fixed and variable compensation paid to employees due to a reduction in policies sold at our stores, and a reduction in advertising expenses, offset by an increase in occupancy costs due to rent increases and escalations.
Our Retail Business impairment of goodwill and intangibles for 2008 was $299,000 greater than for 2007. The increase in 2008 was due to goodwill impairment of $394,000 in 2008, compared to the cessation of utilization of the vanity telephone number included in intangible assets in 2007.
Our gain on sale of book of business in 2008 was $-0-, as compared to $66,000 in 2007. The $66,000 decrease in 2008 was due to a sale in 2007, compared to no such sales in 2008.
During 2008, we recorded a benefit from income taxes of $28,000 compared to a provision for income taxes of $193,000 in 2007. The change of $221,000 is due to an $840,000 decrease in income before taxes in 2008 as compared to 2007.
Our net loss for the year ended December 31, 2008 was $977,000 as compared to a net loss of $47,000 for the year ended December 31, 2007.
During 2008, cash and cash equivalents decreased by approximately $888,000 primarily due to the following:
Net cash used in operating activities during 2008 was $753,000 due primarily to the net loss of $977,000. Non-cash items totaling $820,000 increased the net cash used in operating activities to $1,797,000. These non-cash items included depreciation and amortization, bad debt expense, accretion of discount on notes receivable, amortization of warrants, stock-based payments, and deferred income taxes. The use of cash was offset by: (i) the receipt of a $368,000 Federal tax refund claim resulting from the carry-back of our 2007 net operating loss, (ii) an increase in accounts payable and accrued expenses of $252,000, and (iii) cash provided by the operating activities of our discontinued operations of $498,000.
Net cash provided by investing activities during 2008 was $1,034,000 primarily due to the $1,008,000 cash flow from finance contracts receivable included in discontinued operations.
We have no current commitments for capital expenditures. However, we may, from time to time, consider acquisitions of complementary businesses, products or technologies.
Because our core revenue is derived from personal automobile insurance, our business may be adversely affected by negative developments in the conditions in this industry.
All of our revenues from continuing operations for 2008 related to the sale of personal automobile and other property and casualty insurance policies. As a result of our concentration in this line of business, negative developments in the economic, competitive or regulatory conditions affecting the personal automobile insurance industry could have a material adverse effect on our results of operations and financial condition.
Our future success will depend, in part, upon the efforts of Barry Goldstein, our Chief Executive Officer. The loss of Mr. Goldstein or other key personnel could prevent us from fully implementing our business strategies and could materially and adversely affect our business, financial condition and results of operations. We have an employment agreement with Mr. Goldstein that expires on June 30, 2009. As we continue to grow, we will need to recruit and retain additional qualified management personnel, but we may not be able to do so. Our ability to recruit and retain such personnel will depend upon a number of factors, such as our results of operations and prospects and the level of competition then prevailing in the market for qualified personnel.
As discussed in Item 1 hereof, 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. We have never operated as an insurance company and would face all of the risks and uncertainties that come with operating such a company, including underwriting risks.
As a holding company, we are dependent on the results of operations of our operating subsidiaries; there would be restrictions on the payment of dividends by Commercial Mutual.
We have determined to discontinue our Retail Business operations prior to our obtaining a controlling interest in Commercial Mutual.
Reductions in the New York involuntary automobile insurance market may adversely affect our premium finance revenue.
Prior to the sale of our premium finance loan portfolio, our primary source of premium finance loans had been the assigned risk, or involuntary, automobile insurance market. In New York, since mid-2003, there has been a significant decline in the number of new applications for coverage at the New York Auto Insurance Plan. This has led to a reduction in the number of loans where policies of this type are the collateral. Beginning in 2004, we began to finance certain voluntary auto insurance policies. We are now entitled to a placement fee based upon the amount of new premium finance loans made by the purchaser of our loan portfolio in the states of New York and Pennsylvania. There is no guaranty that the number or size of the loans in the voluntary marketplace will offset the declines experienced in the involuntary market.
We are subject to regulation that may restrict our ability to earn profits.
Our premium finance subsidiary is subject to regulation and supervision by the financial institution departments in the states where it offers to finance premiums. Certain regulatory restrictions, including restrictions on the maximum permissible rates of interest for premium financing, and prior approval requirements may affect its ability to place premium contracts and generate placement fees.
We continually evaluate the possible expansion of our operations through the acquisition of businesses or other assets which we believe will complement or enhance our business. We may also acquire or make investments in complementary businesses, products, services or technologies. In the event we effect any such acquisition, we may not be able to successfully integrate any acquired business, asset, product, service or technology in our operations without substantial costs, delays or other problems or otherwise successfully expand our operations. In addition, efforts expended in connection with such acquisitions may divert our management’s attention from other business concerns. We also may have to borrow money to pay for future acquisitions and we may not be able to do so at all or on terms favorable to us. Additional borrowings and liabilities may have a materially adverse effect on our liquidity and capital resources.
We have incurred, and will continue to incur, increased costs as a result of being an SEC reporting company.
The Sarbanes-Oxley Act of 2002, as well as a variety of related rules implemented by the SEC, have required changes in corporate governance practices and generally increased the disclosure requirements of public companies. As a reporting company, we incur significant legal, accounting and other expenses in connection with our public disclosure and other obligations. Based upon SEC regulations currently in effect, we are required to establish, evaluate and report on our internal control over financial reporting and will be required to have our registered independent public accounting firm issue an attestation as to such reports commencing with our financial statements for the year ending December 31, 2009. We believe that, based upon SEC regulations currently in effect, our general and administrative expenses, including amounts that will be spent on outside legal counsel, accountants and professionals and other professional assistance, will increase in 2009 over 2008, which could require us to allocate what may be limited cash resources away from our operations and business growth plans. We also believe that compliance with the myriad of rules and regulations applicable to reporting companies and related compliance issues will divert time and attention of management away from operating and growing our business.