Customer receivables primarily include amounts owed to Brooke Franchise by our franchisees and, to a lesser extent, amounts owed to Brooke Brokerage for premiums billed by agents. Customer receivables increased in 2004 primarily from continued expansion of our franchise operations and decreased in 2003 primarily because Brooke Credit began to provide working capital financing to franchisees, which increased notes receivables and decreased customer receivables. A loss allowance was established for Brooke Franchise’s credit loss exposure to customer receivables (See Franchise Services Segment).
The following tables provide information regarding our Notes Receivables, Notes Participations, Notes Payables and Bonds & Debentures Payables principal balances and the corresponding weighted interest rates as of
the end of each quarter in 2004, 2003 and 2002 (excluding capitalized lease balances). Notes Receivables balances include the loans originated by Brooke Credit to our franchisees and others, even though the notes may no longer be on our balance sheet. Notes Participations are comprised of loan participation interests that we have sold to our funding institutions and that we typically no longer carry on our balance sheet. Notes Payables balances are comprised of borrowings to fund the loans that we have made to our franchisees and others and include primarily notes issued to sellers of agencies we have purchased, borrowings under our lines of credit and bank borrowings. Bonds and debentures payable include bonds and debentures that we have issued to primarily fund our lending and commission advance activities.
Gains on Debt Extinguishment. In the event that we repay the deferred portion of the purchase price to the seller before maturity for an amount less than our carrying value, we recognize the difference between our
loan payments generally are deducted from commissions received by Brooke Franchise prior to payment of commissions to the borrower and most other creditors. We believe that credit problems on recourse and securitized loans are more likely to be identified when Brooke Franchise collects franchisees’ monthly statement account balance than by monitoring Brooke Credit’s loan delinquencies.
If necessary, we believe that we can increase cash flow from operating activities within a relatively short period of time by liquidating our notes receivable portfolio through the sale of note, or loan, participations. Gains on sale of inventory have been excluded as an operating source of cash because changes in inventory have been classified as an investing activity. We believe that we can increase cash flow from investing activities within a relatively short period of time by liquidating our business inventory.
DB Indemnity, LTD was incorporated under the laws of Bermuda and is licensed as a Class 1 insurer under the Insurance Act 1978 of Bermuda and related regulations for the purpose of self-insuring a portion of the professional insurance agents’ liability exposure of Brooke Franchise Corporation, its affiliated companies and its franchisees and for the purpose of self-insuring financial guaranty policies to Brooke Credit Corporation and its participating lenders.
Commission revenue on insurance policy premiums is generally recognized as of the effective date of the policies or, in certain cases, as of the effective date or billing date, whichever is later. Contingent and profit sharing commissions are generally paid based on prior year performance and recognized when received. Premiums due from the insured to the Company are reported as assets of the Company and as corresponding liabilities, net of commissions, to the insurance carriers.
In February 2003, the Company acquired the rights to the web-site “Agencies4Sale.com” for $25,000.
Subsequent to the initial recording at fair value, the amortizable intangible asset is evaluated and measured annually for impairment. The impairment testing is performed by two different methods of analysis. The first method is a cash flow analysis to determine if there is sufficient operating cash flows. The second method is a fair market value analysis based primarily on comparative sales data. If analysis indicates that operating cash flows are insufficient or the asset’s fair value is less than its book value, then an impairment has occurred and the Company writes down the asset to the estimated fair value. No impairment was recognized for the years ended December 31, 2004, 2003 or 2002.
The amount of assets included in the “Investment in Businesses” category is the total of purchase prices paid, or market prices if lower, for business assets that Brooke Franchise Corporation acquires to hold in inventory for sale to its franchisees. These assets are carried at the lower of cost or market because they are available for sale and not held for investment. Typically the Company acquires and sells the business assets simultaneously. If the assets are not sold simultaneously then the Company operates the business until sold and records the income and expense associated with the business. The number of businesses purchased for this purpose for the years ended December 31, 2004 and 2003 was 51 and 50, respectively. Correspondingly, the number of businesses sold from inventory for the year ended December 31, 2004 and 2003 was 50 and 50, respectively. At December 31, 2004 and 2003, the “Investment in Businesses” inventory consisted of 2 businesses and 1 business, respectively, with fair market values totaling $1,022,000 and $367,000, respectively.
The value of the “Servicing Asset” is calculated by estimating the net present value of net servicing income (or expense) on loans sold using the discount rate and prepayment speeds noted in the following table. At December 31, 2004 and 2003, the value of the servicing asset recorded by the Company was $2,909,000 and $1,723,000, respectively. Subsequent to the initial recording at fair value, the servicing asset is amortized in proportion to and over the period of estimated net servicing income.
The following illustrate how the changes in fair values were calculated for 10% and 20% adverse changes in key economic assumptions.
The Company offered unsecured debentures (Series A and Series B) for sale to the public in denominations of $1,000 with a minimum purchase amount of $5,000. The bonds were issued in book-entry form and registered in the name of The Depository Trust Company or its nominee. Interest is paid semi-annually on December 1st and June 1st. The Series B debentures are callable on the third anniversary of the date of issuance of the debentures. The Company used the debenture sale proceeds to acquire insurance agencies for inventory, make corporate acquisitions, purchase loan participation certificates and make short-term working capital loans to insurance agents or other Company subsidiaries.
For the year ended December 31, 2004, income of $323,000 was earned in Bermuda and is excluded from the U.S. Federal Tax. Under current Bermuda law, DB Indemnity, LTD and DB Group, LTD are not required to pay any taxes in Bermuda on either income or capital gains. They have received an undertaking from the
Robert D. Orr and Leland G. Orr own 100% of the voting stock of GI Agency, Inc. Although GI Agency was a franchise agent for the Company in previous years, it is not currently a franchise agent and its business operations do not include insurance sales. Brooke Credit Corporation made loans to GI Agency upon the same general terms as loans made to franchise agencies. During the fourth quarter of 2004, GI Agency repaid its loans in full to Brooke Credit Corporation and, at December 31, 2004, Brooke Credit Corporation had no loans outstanding to GI Agency.
Pursuant to an announced personal financial planning process, in July, 2004 Robert D. Orr transferred Brooke Corporation stock into Brooke Holdings, Inc. and in September, 2004 Brooke Holdings, Inc. transferred Brooke Corporation stock to a Brooke Holdings, Inc. minority shareholder. The Securities Exchange Act of 1934, Rule 16(b) interprets these transfers by Brooke Holdings, Inc. as “purchases” and “sales” and the resulting short-swing profit of $196,000 was paid by Brooke Holdings, Inc. to Brooke Corporation in the fourth quarter of 2004.
DB Indemnity, LTD. is also required to maintain a minimum liquidity ratio whereby the value of its relevant assets are not less than 75% of the amount of its relevant liabilities. Relevant assets include cash and deposits, investment income accrued and insurance balances receivable. Certain categories of assets do not qualify as relevant assets under the statute. The relevant liabilities are total general business insurance reserves and total other liabilities, less sundry liabilities. DB Indemnity, LTD. was required to maintain relevant assets of at least $587,000 and $120,000 at December 31, 2004, and 2003 respectively. At December 31, 2004 and 2003, relevant assets were $1,790,000 and $448,000, respectively. The minimum liquidity ratio was therefore met.
Certain accounts in the prior year financial statements have been reclassified for comparative purposes to conform with the presentation in the current year financial statements.