UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________TO _____________________
COMMISSION FILE NUMBER: 000-31789
BROOKE CORPORATION
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
KANSAS 48-1009756
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
10895 GRANDVIEW DRIVE, SUITE 250, OVERLAND PARK, KANSAS 66210
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
ISSUER'S TELEPHONE NUMBER: (913) 661-0123
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days.
(Check One): Yes |X| No |_|
As of June 30, 2002 there were 763,123 shares of the registrant's sole class
of common stock outstanding.
Transitional Small Business Disclosure Format (Check One):
Yes |_| No |X|
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL INFORMATION
BROOKE CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
Contents
INDEPENDENT ACCOUNTANTS' REPORT 2
CONSOLIDATED FINANCIAL STATEMENTS 3
CONSOLIDATED BALANCE SHEETS........................................................................4-5
CONSOLIDATED STATEMENTS OF INCOME - THREE MONTHS ENDED.............................................6
CONSOLIDATED STATEMENTS OF INCOME - SIX MONTHS ENDED...............................................7
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY.........................................8
CONSOLIDATED STATEMENTS OF CASH FLOWS..............................................................9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.........................................................10-42
1
INDEPENDENT ACCOUNTANTS' REPORT
To the Board of Directors
Brooke Corporation:
We have reviewed the accompanying consolidated balance sheets of
BROOKE CORPORATION
as of June 30, 2002 and 2001, and the related consolidated statements of
income, changes in stockholders' equity and cash flows for the six month
periods then ended. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with auditing standards generally accepted in the
United States of America, the objective of which is the expression of an
opinion regarding the financial statements taken as a whole. Accordingly, we
do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying financial statements for them to be in
conformity with generally accepted accounting principles.
Summers, Spencer & Cavanaugh, CPAs, Chartered
Topeka, Kansas
August 15, 2002
2
BROOKE CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
3
BROOKE CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
JUNE 30, 2002 AND 2001
ASSETS
2002 2001
----------------- ------------------
CURRENT ASSETS
Cash $ 4,753,902 $ 3,853,166
Accounts and notes receivable, net 8,760,500 4,471,323
Note receivable, parent company 506,909 267,075
Other receivables 1,349,123 358,346
Securities 1,198 1,198
Interest-only strip receivable 896,466 144,343
Deposits 1,531,187 50,769
Prepaid expenses 312,486 102,707
----------------- ------------------
TOTAL CURRENT ASSETS 18,111,771 9,248,927
----------------- ------------------
INVESTMENT IN AGENCIES 594,446 -
----------------- ------------------
PROPERTY AND EQUIPMENT
Cost 3,108,394 2,351,501
Less: Accumulated depreciation (1,892,324) (1,705,446)
----------------- ------------------
NET PROPERTY AND EQUIPMENT 1,216,070 646,055
----------------- ------------------
OTHER ASSETS
Excess of cost over fair value of net assets 892,848 892,848
Less: Accumulated amortization (295,189) (215,749)
Prepaid commission guarantee 14,100 48,134
Covenants not to compete - 4,888
Goodwill - 3,174
Prepaid finders fee 14,086 14,594
Contract database 38,275 41,108
Servicing asset 715,769 146,779
Restricted cash 364,690 -
Deferred tax asset 67,665 480,716
----------------- ------------------
NET OTHER ASSETS 1,812,244 1,416,492
----------------- ------------------
TOTAL ASSETS $ 21,734,531 $ 11,311,474
================= ==================
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS AND INDEPENDENT ACCOUNTANTS'
REVIEW REPORT.
4
BROOKE CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
JUNE 30, 2002 AND 2001
LIABILITIES AND STOCKHOLDERS' EQUITY
2002 2001
---------------- ------------------
CURRENT LIABILITIES
Accounts payable $ 1,134,457 $ 1,012,229
Premiums payable to insurance companies 1,971,048 2,518,691
Unearned buyer assistance plan fees 1,270,697 100,846
Accrued commission refunds 326,306 267,217
Short-term debt 793,431 986,674
Current maturities of long-term debt 4,121,307 2,141,277
---------------- ------------------
TOTAL CURRENT LIABILITIES 9,557,246 7,026,934
NON-CURRENT LIABILITIES
Servicing liability 46,399 18,211
Long-term debt less current maturities 8,479,227 3,964,379
---------------- ------------------
TOTAL LIABILITIES 18,142,872 11,009,524
---------------- ------------------
STOCKHOLDERS' EQUITY
Common stock, $1 par value, 9,500,000 shares
authorized, 774,173 and 704,018 shares issued
and 763,123 and 692,968 shares outstanding 774,173 704,018
Preferred stock, $75 par value, 1,000 shares
authorized, 781 shares issued and outstanding 58,600 58,600
Preferred stock, $25 par value, 464,625 shares
authorized, 49,667 and 17,639 shares issued and outstanding 1,241,675 440,975
Preferred stock, $32 par value, 34,375 shares
authorized, 24,331 shares issued and outstanding 778,592 -
Less: Treasury stock, 11,050 shares at cost (39,500) (39,500)
Additional paid-in capital 2,105,839 951,989
Retained earnings (1,359,994) (1,820,194)
Accumulated other comprehensive income 32,274 6,062
---------------- ------------------
TOTAL STOCKHOLDERS' EQUITY 3,591,659 301,950
---------------- ------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 21,734,531 $ 11,311,474
================ ==================
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS AND INDEPENDENT ACCOUNTANTS'
REVIEW REPORT.
5
BROOKE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
THREE MONTHS ENDED JUNE 30, 2002 AND 2001
2002 2001
---------------- -----------------
OPERATING INCOME
Insurance commissions $ 7,441,079 $ 5,557,361
Interest income (net) 217,670 121,507
Finder's fee 336,106 -
Gain on sale of agencies 34,161 449,580
Buyer assistance plan fees 616,558 317,203
Gain on sale of notes receivable 530,607 100,955
Gain on extinguishment of debt 397,306 -
Other income 8,164 -
---------------- ----------------
TOTAL OPERATING INCOME 9,581,651 6,546,606
---------------- ----------------
OPERATING EXPENSES
Commissions expense 6,174,404 4,547,920
Payroll expense 1,525,640 968,148
Depreciation and amortization 160,365 118,565
Other operating expenses 1,154,096 451,130
Bond interest expense 122,574 78,518
---------------- ----------------
TOTAL OPERATING EXPENSES 9,137,079 6,164,281
---------------- ----------------
INCOME FROM OPERATIONS 444,572 382,325
---------------- ----------------
OTHER EXPENSES
Interest expense 29,946 32,205
---------------- ----------------
TOTAL OTHER EXPENSES 29,946 32,205
---------------- ----------------
INCOME BEFORE INCOME TAXES 414,626 350,120
Income tax expense 140,973 119,041
---------------- ----------------
NET INCOME $ 273,653 $ 231,079
================ ================
NET INCOME PER SHARE:
Basic .27 .32
Diluted .31 .31
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS AND INDEPENDENT ACCOUNTANTS'
REVIEW REPORT.
6
BROOKE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
2002 2001
---------------- ----------------
OPERATING INCOME
Insurance commissions $13,497,693 $10,252,831
Interest income (net) 436,198 119,939
Finder's fee 661,271 175,000
Gain on sale of agencies 128,103 449,580
Buyer assistance plan fees 1,677,627 317,203
Gain on sale of notes receivable 1,190,892 286,145
Gain on extinguishment of debt 397,306 -
Other income 14,030 -
---------------- ----------------
TOTAL OPERATING INCOME 18,003,120 11,600,698
---------------- ----------------
OPERATING EXPENSES
Commissions expense 11,210,737 7,377,527
Payroll expense 2,984,151 1,832,972
Depreciation and amortization 305,855 230,648
Other operating expenses 1,922,005 833,220
Bond interest expense 248,199 138,217
---------------- ----------------
TOTAL OPERATING EXPENSES 16,670,947 10,412,584
---------------- ----------------
INCOME FROM OPERATIONS 1,332,173 1,188,144
---------------- ----------------
OTHER EXPENSES
Interest expense 72,880 90,026
---------------- ----------------
TOTAL OTHER EXPENSES 72,880 90,026
---------------- ----------------
INCOME BEFORE INCOME TAXES 1,259,293 1,098,088
Income tax expense 428,160 373,350
---------------- ----------------
NET INCOME $ 831,133 $ 724,738
================ ================
NET INCOME PER SHARE:
Basic .98 1.03
Diluted .95 1.01
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS AND INDEPENDENT ACCOUNTANTS'
REVIEW REPORT.
7
BROOKE CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
<Table>
<Caption>
NOTES
COMMON PREFERRED TREASURY RECEIVABLE FOR ADD'L PAID-
STOCK STOCK STOCK COMMON STOCK IN CAPITAL
BALANCES, DECEMBER 31, 2000 $704,018 $ 58,600 $ (39,500) $ - $ 1,103,702
Dividends paid
Preferred stock issued 440,975
Fair market value of
contributed services 20,000
Deferred charges (171,713)
Comprehensive income:
Interest-only strip
receivable, fair
market value
Net income
-------- ---------- ---------- -------------- ------------
BALANCES, JUNE 30, 2001 $704,018 $ 499,575 $ (39,500) $ - $ 951,989
======== ========== ========== ============== ============
BALANCES, DECEMBER 31, 2001 $704,018 $ 1,899,850 $ (39,500) $ (8,193) $ 703,023
Dividends paid
Preferred stock issued 2,001,646
Fair market value of
contributed services 20,000
Equity conversion 70,155 (1,822,629) 1,752,474
Loan proceeds for common
stock issuances 8,193
Deferred charges (369,658)
Comprehensive income:
Interest-only strip
receivable, fair
market value
Net income
-------- ----------- ---------- -------------- ------------
BALANCES, JUNE 30, 2002 $774,173 $ 2,078,867 $ (39,500) $ - $ 2,105,839
======== =========== ========== =============== ===========
</Table>
<Table>
<Caption>
ACCUMULATED
RETAINED OTHER
EARNINGS COMPREHENSIVE
(DEFICIT) INCOME TOTAL
BALANCES, DECEMBER 31, 2000 $ (2,452,773) $ - $ (625,953)
Dividends paid (92,159) (92,159)
Preferred stock issued 440,975
Fair market value of
contributed services 20,000
Deferred charges (171,713)
Comprehensive income:
Interest-only strip
receivable, fair
market value 6,062 6,062
Net income 724,738 724,738
------------ --------------- -----------
BALANCES, JUNE 30, 2001 $ (1,820,194) $ 6,062 $ 301,950
============ ================ ===========
BALANCES, DECEMBER 31, 2001 $ (1,990,093) $ 7,311 $ 1,276,416
Dividends paid (201,034) (201,034)
Preferred stock issued 2,001,646
Fair market value of
contributed services 20,000
Equity conversion -
Loan proceeds for common
stock issuances 8,193
Deferred charges (369,658)
Comprehensive income:
Interest-only strip
receivable, fair
market value 24,963 24,963
Net income 831,133 831,133
------------ --------------- ----------
BALANCES, JUNE 30, 2002 $ (1,359,994) $ 32,274 $ 3,591,659
============ =============== ==========
</Table>
8
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS AND INDEPENDENT ACCOUNTANTS'
REVIEW REPORT.
BROOKE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
<Table>
<Caption>
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME $ 831,133 $ 724,738
ADJUSTMENTS TO RECONCILE NET INCOME TO
NET CASH FLOWS FROM OPERATING ACTIVITIES:
Depreciation 140,000 140,000
Amortization 165,855 90,648
Fair market value of contributed services 20,000 20,000
(Gain) loss on sale of inventory (128,103) (449,580)
Deferred income tax expense 428,160 373,350
Gain on sale of notes receivable (1,190,892) (286,145)
(INCREASE) DECREASE IN ASSETS:
Accounts and notes receivables, net (1,019,053) (1,766,506)
Other receivables (470,031) (338,818)
Prepaid expenses and other assets (1,514,761) (5,834)
INCREASE (DECREASE) IN
LIABILITIES:
Accounts and expenses payable 43,086 569,549
Other liabilities 86,245 686,293
---------- -----------
NET CASH USED IN OPERATING ACTIVITIES (2,608,361) (242,305)
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash payments for property and equipment (242,851) (84,406)
Purchases of insurance agency inventory (3,096,443) (3,343,642)
Proceeds from sales of insurance agency inventory 7,508,820 4,242,802
----------- ----------
NET CASH PROVIDED BY INVESTING ACTIVITIES 4,169,526 814,754
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Deferred charges (369,658) (171,713)
Dividends paid (201,034) (92,159)
Cash proceeds from bond issuance 580,000 1,575,000
Cash proceeds from preferred stock issuance 2,001,646 440,975
Payments on bond maturities (975,000) -
Advances on short-term borrowing - 898,649
Payments on short-term borrowing (78,890) (738,514)
Payments on long-term debt (2,552,196) (315,034)
----------- ----------
NET CASH PROVIDE BY (USED IN) FINANCING ACTIVITIES (1,595,132) 1,597,204
----------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (33,967) 2,169,653
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 4,787,869 1,683,513
----------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,753,902 $ 3,853,166
=========== ==========
</Table>
9
SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS AND INDEPENDENT ACCOUNTANTS'
REVIEW REPORT.
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) ORGANIZATION
Brooke Corporation was incorporated under the laws of the State of Kansas on
January 17, 1986. The Company's registered offices are located in Phillipsburg,
Kansas. Brooke Holdings, Inc. owns 67.87% of the Company's common stock. The
Company recruits fully vested franchise agents to sell insurance and financial
services. Most of the Company's revenues result from the sale of property and
casualty insurance, however, the Company also offers life and health insurance
services, investment services and credit services.
All of the Company's subsidiaries are 100% owned and controlled by the
Company. Other than Brooke Credit Corporation and Brooke Bancshares, Inc.,
the subsidiaries' financial statements are not separately prepared. Brooke
Credit Corporation, a Kansas corporation, is a licensed finance company that
originates loans primarily to the Company's agents. Separate financial
statements are regularly prepared for Brooke Credit Corporation, and Brooke
Credit Corporation borrows money in its own right through the issuance of
bonds.
The Company's other subsidiaries include:
BROOKE LIFE AND HEALTH, INC., is a licensed insurance agency that sells life and
health insurance through the Company's network of franchise agents, subagents
and insurance producers.
BROOKE AGENCY, INC., is a licensed insurance agency that sells property and
casualty insurance through the Company's network of franchise agents, subagents
and insurance producers.
BROOKE INVESTMENTS, INC., may offer insurance annuities and mutual funds for
sale through the Company's network of franchise agents, subagents and insurance
producers. Brooke Investments, Inc. will determine whether registration as a
broker-dealer is required and will register, if required, before investment
services and securities are offered.
INTERSTATE INSURANCE GROUP, LTD, is a licensed insurance agency that may sell
insurance programs and "targeted market" policies through the Company's
network of agents and through agents not necessarily affiliated with the
Company under the trade name of American Interstate Insurance Agency.
THE AMERICAN AGENCY, INC., consults with agent sellers and brokers agency
sales under the trade name of Agency Business Brokers. This subsidiary is
also a licensed insurance agency that may sell insurance programs and
"targeted market" policies through the Company's network of agents and
through agents not necessarily affiliated with the Company under the trade
name of American Insurance Agency.
THE AMERICAN HERITAGE, INC., consults with and otherwise assists agent buyers
under the trade name of Heritage Agency Consultants. This subsidiary is also a
licensed insurance agency that sells insurance programs and "targeted market"
policies through the Company's network of agents and through agents not
necessarily affiliated with the Company under the trade name of American
Heritage Insurance Agency.
10
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
BROOKE CORPORATION OF NEVADA, is a licensed Nevada insurance agency that sells
insurance through the Company's network of franchise agents, subagents and
insurance producers. This subsidiary may also sell the programs and "targeted
market" policies in Nevada through the Company's network of agents and through
agents not necessarily affiliated with the Company.
BROOKE BANCSHARES, INC. was incorporated in January of 2002 for the specific
purpose of acquiring and owning one or more commercial banks that will
distribute banking services and products through the Company's agents. If the
Company is successful in acquiring a bank, this subsidiary will become a bank
holding company as defined pursuant to the Bank Holding Company Act of 1956, as
amended.
BROOKE AGENCY SERVICES COMPANY LLC (BASC) is a limited liability company
organized under the laws of the state of Delaware on June 24, 2002. It is a
bankruptcy-remote special purpose entity, is licensed as an insurance agency and
was created to offer property, casualty, life and health insurance through
certain agents with loans originated by Brooke Credit Corporation.
FIRST BROOKE INSURANCE AND FINANCIAL SERVICES, INC. is a Texas corporation
controlled through a contractual agreement with stockholders. The corporation is
used for licensing purposes. The corporation is consolidated with Brooke
Corporation for financial statement reporting.
(b) USE OF ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of certain assets, liabilities and disclosures.
Accordingly, the actual amounts could differ from those estimates. Any
adjustments applied to estimated amounts are recognized in the year in which
such adjustments are determined.
The following are significant estimates made by management: accrued commission
refund obligations, reimbursement from agents for commission refund obligations,
Buyers Assistance Program unearned and earned percentages, and the fair value
assumptions utilized for interest-only strip receivables. It is at least
reasonably possible these estimates will change in the near term.
(c) CASH EQUIVALENTS
For purposes of the statements of cash flows, the Company considers all cash on
hand, cash in banks and short-term investments purchased with a maturity of
three months or less to be cash and cash equivalents.
(d) ALLOWANCE FOR BAD DEBTS
The Company considers all accounts and notes receivable to be fully collectible,
therefore no allowance has been recognized for uncollectible amounts.
11
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
(e) REVENUE RECOGNITION
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 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 the event of cancellation or reduction in premiums, for policies billed by an
insurance carrier, a percentage of the commission revenue is often returned to
the insurance carrier. The commission refunds are calculated by the insurance
carriers and are typically deducted from amounts due to the Company from
insurance carriers. The Company has estimated and accrued a liability for
commission refunds of $326,306 and $267,217 as of June 30, 2002 and 2001,
respectively.
The Company provides consulting, marketing and cash flow assistance to agency
owners during the first year of agency ownership through a Buyers Assistance
Plan ("BAP") program. The Company has allocated the fees paid by agents for BAP
assistance to each of the services provided by the Company and the fee
associated with a particular service is recognized as revenue using the
percentage of completion accounting method by referencing the costs incurred to
date. Many of the BAP services (inspection reports, operations analysis,
marketing plan development) are provided by the Company before, or within thirty
days after, agency acquisition so approximately 58% of BAP fees are immediately
recognized as revenue. An additional 20% of BAP and related fees are recognized
during the first year of agency ownership leaving approximately 22% of related
fees unearned, and the revenue recognized, after the BAP period expires. The
allocation of fees may change if the nature, or timing, of BAP related services
change. Unearned BAP fees were $1,270,697 and $100,846 at June 30, 2002 and
2001, respectively.
Revenues from finders fees, gains on sale of agencies and seller discounts are
recognized immediately because the Company has no continuing obligation.
(f) PROPERTY AND EQUIPMENT
Depreciable assets are stated at cost less accumulated depreciation.
Depreciation is charged to expense using the straight-line method over the
estimated useful lives of the assets.
(g) EXCESS COST OF PURCHASED SUBSIDIARY
Included in other assets are unamortized costs of purchased subsidiaries (Brooke
Life and Health, Inc. and The American Agency, Inc.) in excess of the fair value
of underlying net tangible assets acquired. The balance is being amortized over
a 15-year period using an accelerated 150% declining balance switching to
straight-line method. Amortization expense (excluding servicing asset
amortization expense of $109,079) was $56,776 for the period ended June 30,
2002. The "excess cost of purchased subsidiary" resulted from the purchase of a
subsidiary corporation. In 2001, management elected to reclassify Investment in
Agencies of $316,520 to this account because management's intention was no
longer to sell these agencies, which, primarily consisted of an agency doing
business as Brooke Life/Health.
12
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
In the third and fourth quarters of 2000, Interstate Insurance Group, LTD's
primary supplier began exiting the limousine insurance market, which comprised
virtually all of Interstate's insurance business, and revenues began decreasing.
Based on these circumstances, revenue and cash flow projections were revised,
resulting in the recognition of impairment losses in the Interstate unit of the
insurance agency business segment of $300,000 and $162,877, in 2000 and 2001,
respectively. The amount of the Interstate impairment losses corresponds to the
amounts recorded as Excess Cost of Purchased Subsidiary as disclosed in footnote
15.
(h) INCOME TAXES
Income taxes are provided for the tax effect of transactions reported in the
financial statements and consist of taxes currently due plus deferred taxes
related to net operating loss carryforwards that are available to offset future
taxable income. The Company files its federal income tax return on a
consolidated basis with its subsidiaries.
(i) INVESTMENT IN AGENCIES
The assets included in the "Investment in Agencies" category is the purchase
price paid for agency assets. These assets are available for sale and are
carried at the lower of cost or market. The Company acquires insurance agency
assets to hold in inventory for sale to its agents. The number of agencies
purchased for this purpose for the period ending June 30, 2002 and 2001 was
15 and 10, respectively. Correspondingly, the number of agencies sold from
inventory for the period ending June 30, 2002 and 2001 was 16 and 10,
respectively. At June 30, 2002 the "Investment in Agencies" inventory
consisted of a Texas agency purchased during 2001, at a total cost of
$594,446.
In 2001, management elected to reclassify Investment in Agencies of $316,520 to
other assets because management's intention was no longer to sell these
agencies, which primarily consists of an agency doing business as Brooke
Life/Health.
(j) GAIN OR LOSS ON SALE OF ASSETS
"Investment in Agencies" gains or losses are the difference between the
insurance agency's sales price and the insurance agency's book value, which is
carried at the lower of cost or fair value. Insurance agencies are typically
sold in the same units as purchased. However, in instances where a part, or
segment, of an insurance agency unit is sold, then management estimates the fair
value of the segment of the insurance agency unit being sold and the difference
between the sales price and the resulting fair value estimation is the amount of
the gain or loss. Any such fair value estimation is evaluated for reasonableness
by comparing the market value estimation of the segment to the book value for
the entire insurance agency unit. Fair value estimations are based on comparable
sales information that takes into consideration agency characteristics such as
customer type, customer account size, supplier size and billing methods.
(k) CONTRACTS DATABASE
This asset consists of standardized loan documents which have been developed by
Brooke Corporation. These contracts are available for sale to others that make
these types of loans, by first purchasing a license from Brooke Corporation. A
complete review and revision is scheduled for all loan documents every five
years, therefore, the asset is being amortized over a five year period.
13
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
(l) DEFERRED CHARGES
Deferred charges relate to costs associated with the public offering of
preferred stock and bonds. Selling expenses, auditor fees, legal costs and
filing charges associated with the Company's public offering of stock totaled
$810,337 and have been offset against stock proceeds. Similar costs associated
with the Company's public offering of bonds totaled $291,371 and are classified
as prepaid expenses that are amortized over a period ending at bond maturity.
Net of amortization, the balance of all such prepaid expenses as of June 30,
2002 was $189,323.
(m) EQUITY RIGHTS AND PRIVILEGES
Convertible preferred stockholders shall be entitled to a 9% cumulative dividend
in cash of the liquidation value of such stock per share per annum, as
determined by the Board of Directors. Convertible preferred stock may convert to
common stock at a rate of 13 shares of common stock for 1 share of preferred
stock. Convertible preferred stock has no voting rights. Holders of convertible
preferred stock, upon liquidation or dissolution of the Company, are entitled to
be paid an amount equal to $75 for each share of preferred stock not converted
into common stock before any amount may be paid to holders of common stock. In
addition to the convertible preferred stock, the Company is authorized to issue
499,000 shares of preferred stock. The authorized shares consist of 100,000
shares of 2002 convertible preferred stock, 10,000 shares of 2002A convertible
preferred stock, and 34,375 shares of 2002B convertible preferred stock. The
remaining 354,625 shares are "undesignated" preferred stock. The holders of the
2002 and 2002A convertible preferred stock are entitled to receive a cumulative
dividend in cash at the rate of 10% of the liquidation value of such stock per
share per annum if determined by the Board of Directors. Prior to April 1, 2002,
the holders of 2002 and 2002A convertible preferred stock converted 60,333 of
their preferred shares into 60,333 shares of common stock. The holders of 2002
and 2002A convertible preferred stock that did not convert their shares to
common shares prior to April 1, 2002 have no conversion rights. In the case of
liquidation or dissolution of the Company, the holders of the 2002 or 2002A
convertible preferred stock shall be entitled to be paid in full the liquidation
value, $25 per share, after payment of full liquidation value to the holders of
convertible preferred stock and before the holders of common stock. The holders
of 2002B convertible preferred stock are entitled to receive a cumulative
dividend in cash at the rate of 9% of the liquidation value of such stock per
share per annum if determined by the Board of Directors. On or prior to May 15,
2002, the holders of 2002B convertible stock converted 9,822 of their preferred
shares into 9,822 shares of common stock. The holders of 2002B convertible
preferred stock that did not convert their shares to common shares on or prior
to May 15, 2002 have no conversion rights. In the case of liquidation or
dissolution of the Company, the holders of the 2002B convertible preferred stock
shall be entitled to be paid in full the liquidation value, $32 per share, after
payment of full liquidation value to the holders of convertible preferred stock,
2002 convertible preferred stock, 2002A convertible preferred stock, and before
the holders of common stock. The common stockholders shall possess all rights
and privileges afforded to capital stock by law, subject to holders of
convertible preferred stock.
14
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
(n) PER SHARE DATA
Basic net income per share is calculated by dividing net income, less preferred
stock dividends declared in the period (whether or not paid) and the dividends
accumulated for the period on cumulative preferred stock (whether or not
earned), by the average number of shares of the Company's common stock
outstanding. Total preferred stock dividends declared during the periods ended
June 30, 2002 and 2001 were $114,299 and $8,979, respectively. Diluted net
income per share is calculated by including the probable conversion of preferred
stock to common stock, and then dividing net income, less preferred stock
dividends declared on non-convertible stock during the period (whether or not
paid) and the dividends accumulated for the period on non-convertible cumulative
preferred stock (whether or not earned), by the adjusted average number of
shares of the Company's common stock outstanding.
<Table>
<Caption>
2002 2001
---- ----
BASIC EARNINGS PER SHARE
Net Income $ 831,133 $ 724,738
Less: Preferred Stock Dividends (114,299) (8,979)
----------------------------
Income Available to Common Stockholders 716,834 715,759
Average 2002 Common Stock Shares 739,431
Less: 2002 Treasure Stock Shares (11,050) 728,381 692,968
-------------------------------------------
Basic Earnings Per Share $ .98 $ 1.03
=================================
<Caption>
DILUTED EARNINGS PER SHARE 2002 2001
---- ----
Net Income $ 831,133 $ 724,738
Less: 2002 Preferred Stock Dividends on Non-Convertible Shares (48,828) -
---------------------------
Income Available to Common Stockholders 782,305 724,738
Average 2002 Common Stock Shares 739,431
Less: 2002 Treasure Stock Shares (11,050)
Plus: Allowance for Shares Converted During 2002 34,742
Plus: Assumed Conversion of Convertible Preferred Shares in
2002 10,153
Plus: Assumed Exercise of 47,500 Stock Options Shares in 2002 47,500 820,776 721,437
------------------------------------------
Diluted Earnings Per Share $ .95 $ 1.01
================================
</Table>
15
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT.)
(o) BUYER ASSISTANCE PLAN
The Company introduced a consulting program (Buyer Assistance Plan or "BAP") to
provide assistance to agency buyers during the first months of insurance agency
ownership. Although most of the BAP services provided by the Company are
performed in the first month of agency ownership, some of the BAP services are
performed later and a portion of BAP fees are therefore deferred until the cost
of providing the service is incurred. Unearned buyer assistance plan fees are
$1,270,697 and $100,846 at June 30, 2002 and 2001, respectively.
(p) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation of the financial statements.
(q) ACCOUNTS AND NOTES RECEIVABLE, NET
The net notes receivable included as part of the "Accounts and Notes Receivable,
Net" asset category are available for sale and are carried at the lower of cost
or market. Accordingly, any changes in the net notes receivable balances are
classified as an operating activity.
(r) OTHER RECEIVABLES
Included in this category are reimbursements due from agents for possible
cancellation of policies, advances of commission to agents, receivables from
sellers on contracts of services and advances to vendors on behalf of franchise
agents. Most of these amounts are collected within 30 days from borrowers or
agents and all amounts are collected within 12 months from date of recording.
(s) ADVERTISING
The Company expenses the costs of advertising as they are incurred. Total
advertising expense for the period ending June 30, 2002 and 2001 was $266,072
and $40,515, respectively.
16
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
2. NOTES RECEIVABLE
At June 30, 2002 and 2001, notes receivable consist of the following:
06/30/2002 06/30/2001
---------- ----------
Agency loans $46,912,632 $ 29,941,485
Less: Agency loan participation (44,468,620) (29,497,403)
Equipment loans 0 941
Less: Equipment loan participation 0 (941)
Consumer loans 156,017 154,783
Less: Consumer loan participation (78,419) (154,783)
---------------- ------------------
Total notes receivable, net 2,521,610 444,082
Interest earned not collected on notes * 376,762 509,531
Customer receivables 5,862,128 3,517,710
---------------- ------------------
Total accounts and notes receivable, net $ 8,760,500 $ 4,471,323
================ ==================
*The Company has a corresponding liability for interest payable to participating
lenders in the amounts of $306,330 and $317,236 at June 30, 2002 and 2001,
respectively.
Loan participation represents the transfer of notes receivable, by sale, to
"participating" banks and finance companies. The Company receives
consideration from the participating entities. In accordance with SFAS 140
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES, these transfers are accounted for as sales.
The transferred assets (i.e. notes receivable) are isolated from the Company.
The participating companies obtain the right, free of conditions that
constrain it from taking advantage of that right, to pledge or exchange the
notes receivables. In addition, the Company does not maintain control over
the transferred assets and the transfer agreements do not entitle the Company
or obligate the Company to repurchase or redeem the notes receivable before
their maturity. Based on management's experience the carrying value for notes
receivable approximates the fair value.
When the Company sells participation in notes receivable to investors, it
retains servicing rights and interest income which are retained interests in the
loan participations. Gain or loss on sales of the notes receivable depends in
part on the previous carrying amount of the financial assets involved in the
transfer, allocated between the assets sold and the retained interests based on
their relative fair value at the date of transfer.
In all loan participation sales, the Company retains servicing responsibilities
for which it typically receives annual servicing fees ranging from .25% to
1.375% of the outstanding balance. In those instances whereby annual service
fees received by the Company are less than the cost of servicing, which is
estimated at .25% of the outstanding balance, a servicing liability is recorded.
Additionally, the Company often retains interest income. The Company's right to
interest income is not subordinate to the investor's interests and the Company
shares interest income with investors on a prorata basis. Although not
subordinate to investor's interests, the Company's retained interest is subject
to credit and prepayment risks on the transferred financial assets.
17
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
2. NOTES RECEIVABLE (CONT.)
During the period ended June 30, 2002, the Company sold $27,564,256 (138) loan
participations for which servicing rights and interest receivable was retained.
Corresponding pre-tax gains of $1,190,892 were recorded for the period ending
June 30, 2002. During the period ended June 30, 2001, the Company sold
$9,055,783 (47) loan participations for which servicing rights and interest
receivable was retained. Corresponding pre-tax gains of $286,145 were recorded
for the period ending June 30, 2001. 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. Additionally, impairment of the servicing asset
is subsequently evaluated and measured. Subsequent to the initial recording at
fair value, interest only receivables are measured as debt securities classified
as available for sale.
Of the agency loans at June 30, 2002 and 2001, $9,993,743 and $7,993,732,
respectively, are sold to various participating lenders with recourse to Brooke
Credit Corporation. Such recourse is limited to the amount of actual principal
and interest loss incurred and any such loss is not due for payment to the
participating lender until such time as all collateral is liquidated, all
actions against the borrower are completed and all liquidation proceeds applied.
However, participating lenders may be entitled to periodic advances from Brooke
Credit Corporation against liquidation proceeds in the amount of regular loan
payments. Brooke Credit Corporation is not obligated, under any circumstances,
to repurchase any loans sold to participating lenders prior to maturity or final
resolution. All such recourse loans: a) have no balances more than 60 days past
due; b) have adequate collateral; c) and are not in default.
The expense provision associated with the Company's recourse obligation is based
on the estimated fair value of the obligation. During the periods ended June 30,
2002 and June 30, 2001, the Company sold $2,191,074 and $2,804,385,
respectively, of loan participations for which the Company provided recourse.
To obtain fair values of retained interests and recourse obligations, quoted
market prices are used if available. However, quotes are generally not
available for retained interests, so the Company typically estimates fair
value based on the present value of future expected cash flows estimated
using management's best estimates of key assumptions, credit losses,
prepayment speed and discount rates commensurate with the risks involved.
The predominant risk characteristics of the underlying loans of the Company's
servicing assets have been analyzed by management to identify how to stratify
servicing assets for the purpose of evaluating and measuring impairment. The
underlying loans are very similar in virtually all respects, however management
has concluded that those underlying loans with adjustable interest rates should
be evaluated separately from loans with fixed interest rates. Accordingly,
different key economic assumptions would be used when determining the fair value
of fixed rate loans than have been used for adjustable rate loans. However, the
total amount of underlying loans that are fixed rate is not material so no
evaluation of fair value has been made for the fixed rate loan stratum. As such,
all underlying loans are part of the same stratum and have been evaluated using
the key economic assumptions identified for adjustable rate loans. No valuation
allowance has been established because the fair value for the adjustable rate
loan stratum is not less than the carrying amount of the servicing assets.
18
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
2. NOTES RECEIVABLE (CONT.)
Although substantially all of the company's loans are adjustable, a discount
rate has been applied to reflect the net present value of future revenue
streams. As such, changes in the net present value rate, or discount rate,
resulting from interest rate variations, would adversely affect the asset's fair
value.
The fair value of the interest-only strip receivable is calculated by estimating
the net present value of interest income on loans sold using the discount rate
and prepayment speeds noted in the following table. The fair value of the
interest-only strip receivable is reduced by the amount of estimated credit
losses, which are calculated using the estimated credit loss percentage noted in
the following table. On June 30, 2002 and 2001, the fair value of the
interest-only strip receivable recorded by the Company was $896,466 and
$144,343, respectively. The Company has classified the interest-only receivable
asset as available for sale.
The fair value of the "Servicing Asset" (or liability) 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.
On June 30, 2002 and 2001, the fair value of the servicing asset recorded by the
Company was $715,769 and $146,779, respectively.
Key economic assumptions used in measuring the retained interests and recourse
obligations at the date of loan participation sales completed during the year
were as follows (rates per annum):
Agency Loans (Adjustable Rate Agency Loans (Fixed-Rate Stratum)
Stratum)*
Prepayment speed 10% 10%
Weighted average life (MONTHS) 101.18 N/A
Expected credit losses 5% 5%
Discount rate 8.5% 11.00%
*Rates for these loans are adjusted based on an index (for most loans, the New
York prime rate plus 3.50%). Contract terms vary but, for most loans, the rate
is adjusted annually on December 31st.
At June 30, 2002, key economic assumptions and the sensitivity of the current
fair value of residual cash flows to immediate 10 percent and 20 percent adverse
changes in those assumptions are as follows:
Agency Loans Agency Loans
(Adjustable Rate (Fixed Rate
Stratum) Stratum)
PREPAYMENT SPEED ASSUMPTION (ANNUAL RATE) 10% N/A
Impact on fair value of 10% adverse change $(51,304) N/A
Impact on fair value of 20% adverse change $(88,501) N/A
EXPECTED CREDIT LOSSES (ANNUAL RATE) 5% N/A
Impact on fair value of 10% adverse change $(10,382) N/A
Impact on fair value of 20% adverse change $(21,049) N/A
DISCOUNT RATE (ANNUAL) 8.5% N/A
Impact on fair value of 10% adverse change $(53,118) N/A
Impact on fair value of 20% adverse change $(92,341) N/A
19
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
2. NOTES RECEIVABLE (CONT.)
These sensitivities are hypothetical and should be used with caution. The effect
of a variation in a particular assumption on the fair value of the servicing
asset and recourse liability is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another,
which might magnify or counteract the sensitivities. The numbers used above are
actual dollar amounts and not listed in the thousands.
The above adverse changes are calculated on the Company's retained interests in
loans sold to participating lenders totaling $44,547,040 and excludes unsold
loans totaling $2,521,609. The above adverse changes for expected credit losses
are calculated on the Company's retained interests in loans sold with recourse
to participating lenders totaling $9,993,743 and excludes unsold and
non-recourse loans totaling $37,074,906.
The following illustrate how the changes in fair values were calculated for 10%
and 20% adverse changes in key economic assumptions (prepayment speed of 10%,
credit loss rate of 5% and discount rate of 8.5%).
10% ADVERSE CHANGE IN PREPAYMENT SPEED ON RETAINED SERVICING INTEREST:
- ----------------------------------------------------------------------
Estimated cash flows from loan servicing fees @ 11% prepay speed $ 1,425,129
Servicing expense @ 11% prepay speed 373,150
Discount of estimated cash flows to present value @ 8.5% discount rate 365,575
Carrying value of retained servicing interest in loan participations (adverse) 686,404
Carrying value of retained servicing interest in loan participations (normal) 715,769
Decrease of carrying value due to adverse change $ 29,365
20% ADVERSE CHANGE IN PREPAYMENT SPEED ON RETAINED SERVICING INTEREST
- ---------------------------------------------------------------------
Estimated cash flows from loan servicing fees @ 12% prepay speed $ 1,388,350
Servicing expense @ 12% prepay speed 362,587
Discount of estimated cash flows to present value @ 8.5% discount rate 357,267
Carrying value of retained servicing interest in loan participations (adverse) 668,496
Carrying value of retained servicing interest in loan participations (normal) 715,769
Decrease of carrying value due to adverse change $ 47,273
20
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
2. NOTES RECEIVABLE (CONT.)
10% ADVERSE CHANGE IN PREPAYMENT SPEED ON RETAINED INTEREST (STRIP RECEIVABLE):
- -------------------------------------------------------------------------------
Estimated cash flows from interest income @ 11% prepay speed $ 1,347,240
Estimated credit loss on recourse loans @ 5% credit loss/11% prepay speed 187,782
Discount of estimated cash flows to present value @ 8.5% discount rate 284,931
Carrying value of retained interest in loan participations (adverse) 874,527
Carrying value of retained interest in loan participations (normal) 896,466
Decrease of carrying value due to adverse change $ 21,939
20% ADVERSE CHANGE IN PREPAYMENT SPEED ON RETAINED INTEREST (STRIP RECEIVABLE):
- -------------------------------------------------------------------------------
Estimated cash flows from interest income @ 12% prepay speed $ 1,313,005
Estimated credit loss on recourse loans @ 5% credit loss/12% prepay speed 182,189
Discount of estimated cash flows to present value @ 8.5% discount rate 275,578
Carrying value of retained interest in loan participations (adverse) 855,238
Carrying value of retained interest in loan participations (normal) 896,466
Decrease of carrying value due to adverse change $ 41,228
10% ADVERSE CHANGE IN CREDIT LOSS RATE ON RETAINED INTEREST (STRIP RECEIVABLE):
- -------------------------------------------------------------------------------
Estimated cash flows from interest income @ 10% prepay speed $ 1,383,320
Estimated credit loss on recourse loans @ 5.5% credit loss/10% prepay sp 207,138
Discount of estimated cash flows to present value @ 8.5% discount rate 290,098
Carrying value of retained interest in loan participations (adverse) 886,084
Carrying value of retained interest in loan participations (normal) 896,466
Decrease of carrying value due to adverse change $ 10,382
20% ADVERSE CHANGE IN CREDIT LOSS RATE ON RETAINED INTEREST (STRIP RECEIVABLE):
- -------------------------------------------------------------------------------
Estimated cash flows from interest income @ 10% prepay speed $ 1,383,320
Estimated credit losses on recourse loans @ 6% credit loss /10% prepay sp 220,605
Discount of estimated cash flows to present value @ 8.5% discount rate 287,298
Carrying value of retained interest in loan participations (adverse) 875,417
Carrying value of retained interest in loan participations (normal) 896,466
Decrease of carrying value due to adverse change $ 21,049
21
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
2. NOTES RECEIVABLE (CONT.)
10% ADVERSE CHANGE IN DISCOUNT RATE ON RETAINED SERVICING INTEREST:
- -------------------------------------------------------------------
Estimated cash flows from loan servicing fees @ 10% prepay speed $ 1,463,888
Servicing expense @ 10% prepay speed 384,292
Discount of estimated cash flows to present value @ 9.35% discount rate 393,710
Carrying value of retained servicing interest in loan participations (adverse) 685,886
Carrying value of retained servicing interest in loan participations (normal) 715,769
Decrease of carrying value due to adverse change $ 29,883
20% ADVERSE CHANGE IN DISCOUNT RATE ON RETAINED SERVICING INTEREST:
- --------------------------------------------------------------------
Estimated cash flows from loan servicing fees @ 10% prepay speed $ 1,463,888
Servicing expense at 10% prepay speed 384,292
Discount of estimated cash flows to present value @ 10.2% discount rate 412,256
Carrying value of retained servicing interest in loan participations (adverse) 667,340
Carrying value of retained servicing interest in loan participations (normal) 715,769
Decrease of carrying value due to adverse change $ 48,429
10% ADVERSE CHANGE IN DISCOUNT RATE ON RETAINED INTEREST (STRIP RECEIVABLE):
- ----------------------------------------------------------------------------
Estimated cash flows from interest income @ 10% prepay speed $ 1,383,320
Estimated credit losses on recourse loans @ 5% loss rate 193,670
Discount of estimated cash flows to present value @ 9.35% discount rate 316,419
Carrying value of retained interest in loan participations (adverse) 873,231
Carrying value of retained interest in loan participations (normal) 896,466
Decrease of carrying value due to adverse change $ 23,235
20% ADVERSE CHANGE IN DISCOUNT RATE ON RETAINED INTEREST (STRIP RECEIVABLE):
- ----------------------------------------------------------------------------
Estimated cash flows from interest income @ 10% prepay speed $ 1,383,320
Estimated credit losses on recourse loans @ 5% loss rate 193,670
Discount of estimated cash flows to present value @ 10.2% discount rate 337,096
Carrying value of retained interest in loan participations (adverse) 852,554
Carrying value of retained interest in loan participations (normal) 896,466
Decrease of carrying value due to adverse change $ 43,912
22
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
2. NOTES RECEIVABLE (CONT.)
The following is an illustration of disclosure of expected static pool credit
losses for loan participations sold with recourse to the Company. "Static pool
credit loss" is an analytical tool that matches credit losses with the
corresponding loans so that loan growth does not distort or minimize actual loss
rates. The Company discloses static pool loss rates by measuring credit losses
for loans originated in each of the last three years.
AGENCY RECOURSE LOANS SOLD IN
ACTUAL & PROJECTED CREDIT LOSSES (%) AS OF: 1999 2000 2001
December 31, 2001 0 0 0
December 31, 2000 0 0
December 31, 1999 0
The following table presents quantitative information about delinquencies, net
credit losses and components of loan participations sold with recourse as of and
for the period ended June 30:
TOTAL PRINCIPAL AMOUNT PRINCIPAL AMOUNTS NET CREDIT
OF LOANS 60 OR MORE DAYS LOSSES***
PAST DUE*
TYPE OF LOAN 2002 2001 2002 2001 2002 2001
Participations Sold with Recourse $9,993,743 $7,993,732 $0 $0 $0 $0
Portfolio Loans 2,521,609 444,082 $0 $0 $0 $0
---------------- --------------- -- -- -- --
Total Loans Managed** $12,515,352 $8,437,814 $0 $0 $0 $0
================= ===============
*Loans 60 days or more past due are based on end of period total loans.
** Owned and participated loans in which the Company has a risk of loss.
*** Net credit losses are charge-offs and are based on total loans outstanding.
****Represents the principal amount of the loan. Interest receivable and
servicing rights held for participation loans are excluded from this table
because they are recognized separately.
As an employment incentive, Brooke Credit Corporation has loaned money to
certain employees for the purpose of acquiring the Company's common stock. Of
the consumer loans at June 30, 2002 and 2001, $84,712 and $175,463,
respectively, have been made to employees for this purpose. All such loans have
been sold to unaffiliated third parties without recourse.
23
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
3. PROPERTY AND EQUIPMENT
A summary of property and equipment and depreciation is as follows:
2002 2001
---- ----
Furniture and fixtures $ 368,825 $ 304,855
Office and computer equipment 1,561,602 1,460,891
Automobiles 714,525 585,755
Building, construction in process 463,442 -
------------ ------------
3,108,394 2,351,501
Less: Accumulated depreciation (1,892,324) (1,705,446)
------------ ------------
Property and equipment, net $ 1,216,070 $ 646,055
============ ============
Depreciation expense $ 140,000 $ 140,000
============ ============
24
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
4. BANK LOANS, NOTES PAYABLE, AND OTHER LONG-TERM OBLIGATIONS
2002 2001
---- ----
First National Bank & Trust, Phillipsburg, KS, line of credit, $960,000
available, $0 not utilized. Due January 2003. Interest rate is 8%.
Collateralized by accounts receivable. $ 960,000 $ 600,000
State Bank of Colwich, Colwich, KS, due August 2004. Interest rate is 11.75%,
payable $1,435 monthly. Collateralized by insurance agency assets. 31,475 44,173
Chrysler Financial, Overland Park, KS, due February 2001 to December 2003.
Interest rates are 7.80% to 8.94%, payable monthly. Collateralized by
automobiles. 159,490 145,213
Colonial Pacific, Portland, OR, due December 2001. Interest rate is 14.811%
payable $2,083 monthly. Collateralized by personal guaranty of certain
officers of Brooke Corporation. - 11,766
Brooke Investments, Inc., Phillipsburg, KS, due February 2007. Interest rate
is 10.00%, payable $1,718 monthly. Note is sold to participating bank.
Collateralized by certain agency assets acquired by Brooke Investments, Inc. 76,457 88,751
David Patterson, Sr., Phoenix, AZ, due March 2008. Interest rate is 0%,
payable $1,112 monthly. Unsecured deferred compensation agreement provided by
The American Agency, Inc. - 6,672
Premier Insurance Agency, Poplar Bluff, MO. Interest rate is 5.00%, balance
due January 2002. Collateralized by certain agency assets acquired by Brooke
Corporation. - 639,737
Stewart Insurance, Monroe, LA, due August 2001. Interest rate is 0%, entire
balance is due at maturity. Collateralized by certain agency assets acquired
by Brooke Corporation. - 252,245
APB Insurers, Crane, MO, due July 2001. Interest rate is 0%, entire balance
is due at maturity. Collateralized by certain agency assets acquired by
Brooke Corporation. - 77,445
McCrory & Associates, due October 2005. Interest rate is 0%, payable $30,000
annually. Collaterized by certain agency assets by Brooke Corporation. 10,000
Anderson Insurance Agency, Inc., Ballwin, MO, due June 2006. Interest rate
is 7%, first installment of $146,805 due July 2001, and annual installments of
$133,250 thereafter. Collaterized by certain agency assets acquired by Brooke
Corporation. 693,225
Anderson Insurance Agency, Inc., Ballwin, MO, due June 2006. Interest rate is
7%, first installment of $7,543 due July 2001, and annual installments of
$6,708 thereafter. Collaterized by certain agency assets acquired by Brooke
Corporation. 35,000
Ely Insurance Services, Inc., Tampa, FL, due June 2002. Interest rate is 0%,
entire balance is due at maturity. Collaterized by certain agency assets
acquired by Brooke Corporation. 82,549
Roppolo Insurance, Shreveport, LA, due July 2001. Interest rate is 0%, entire
balance is due at maturity. Collateralized by certain agency assets acquired
by Brooke Corporation. - 115,285
25
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
4. BANK LOANS, NOTES PAYABLE, AND OTHER LONG-TERM OBLIGATIONS (CONT.)
Dawn Insurance Agency, Inc. Strasburg, CO, due May 2003. Interest rate is 0%,
payable $43,322 annually. Collateralized by certain agency assets acquired by
Brooke Corporation. $ 43,322 $ 86,644
Phares and Lites Agency, Inc., Many, LA, due June 2001. Interest rate is 0%,
entire balance is due at maturity. Collaterized by certain agency assets
acquired by Brooke Corporation. 207,825
Bruner Insurance Agency, Marianna, FL, due June 2004. Interest rate is 5%,
payable $101,900 annually. Collaterized by certain agency assets acquired by
Brooke Corporation. 277,500
Lalumondier Insurance, Inc., Kearney, MO, due September 1, 2004. Interest
rate is 5%, annual installments of $68,219 thereafter. Collateralized by
certain agency assets acquired by Brooke Corporation. 204,656 -
Anderson Insurance Agency, Inc, Ballwin, MO, due May 2002. Interest rate is
7.5%, entire balance is due at maturity. Collateralized by certain agency
assets acquired by Brooke Corporation. - 163,300
Bond-Pyatt Insurance Agency, Inc., St. Louis, MO, due August 2006. Interest
rate at prime rate, first installment of $89,465 due January 2002, and annual
installments of $89,465 thereafter. Collateralized by certain agency assets
acquired by Brooke Corporation. 447,326 -
All Drivers Insurance Inc., Colorado Springs, CO, due September 2003.
Interest rate is 5%, annual payments of $112,500. Collateralized by certain
agency assets acquired by Brooke Corporation. 225,000 -
Gateway Realty of Columbus, Inc., Columbus, NE, due September 2010. Interest
rate is 7%, annual principal payments of $67,345. Collateralized by certain
agency assets acquired by Brooke Corporation. 606,109 -
Gary Karch & Associates A-1 Insurance, Mt. Vernon, IL, due December 2002.
Interest rate is 0%. Collaterized by certain agency assets acquired by Brooke
Corporation. 67,500 -
Kohn-Senf Insurance Agency, Inc., St. Louis, MO, due December 2002. Interest
rate is 5%, entire balance due at maturity. Collaterized by certain agency
assets acquired by Brooke Corporation. 80,500 -
Sun Century Insurance Agency, Inc., Phoenix, AZ, due December 2003. Interest
rate is 5%, annual principal payments of $67,333. Collaterized by certain
agency assets acquired by Brooke Corporation. 134,667 -
W.I. of Florida, Inc., Tampa, FL, due December 2003. Interest rate is 0%,
annual payments of $73,176. Collaterized by certain agency assets acquired
by Brooke Corporation. 146,352 -
26
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
4. BANK LOANS, NOTES PAYABLE, AND OTHER LONG-TERM OBLIGATIONS (CONT.)
Auto Insurors, due October, 2002. Interest rate is 0%, and one payment of
remaining balance is due October, 2002. Collaterized by certain agency assets
acquired by Brooke Corporation. $ 60,000 -
Barry James Christensen, due January 2005. Interest rate is 0%, annual
payments of $93,333. Collaterized by certain agency assets acquired by Brooke
Corporation. 210,667 -
Service First Insurance, due January 2005. Interest rate is 0%, annual
payments of $281,375. Collaterized by certain agency assets acquired by
Brooke Corporation. 636,305 -
Goodman Insurance, due February 2004. Interest rate is 0%, annual payments of
$186,063. Collaterized by certain agency assets acquired by Brooke
Corporation. 293,710 -
JD Failla & Associates, due February 2003. Interest rate is 0%, quarterly
payments of $127,188. Collaterized by certain agency assets acquired by
Brooke Corporation. 395,431 -
Donna Sue Saffel, due March 2003. Interest rate is 0%, annual payments of
$62,500. Collaterized by certain agency assets acquired by Brooke Corporation. 62,500 -
All Insurance, due March 2005. Interest rate is 0%, annual payments of
$25,196. Collaterized by certain agency assets acquired by Brooke Corporation. 75,589 -
Jim Bob Nation Insurance, due March 2005. Interest rate is 0%, annual
payments of $116,746. Collaterized by certain agency assets acquired by
Brooke Corporation. 260,000 -
Able Insurance, due March 2006. Interest rate is 0%, annual payments of
$45,867. Collaterized by certain agency assets acquired by Brooke Corporation. 183,469 -
Rebel Auto Insurance, Inc., due May, 2003. Interest rate is 0% and one
payment of remaining balance is due May, 2003. Collaterized by certain agency
assets acquired by Brooke Corporation. 87,500 -
Crouch Insurance Agency, LLC due May 2004. Interest rate is 0%, annual pay
payments of $97,970. Collaterized by certain agency assets acquired by Brooke
Corporation. 195,940 -
Turner Insurance, Inc., due May, 2003. Interest rate is 0% and one payment of
remaining balance is due May, 2003. Collaterized by certain agency assets
acquired by Brooke Corporation. 40,000 -
NCMIC Finance Corporation, due August, 2002. Interest rate is 7.75% and one
payment of remaining balance is due August, 2002. Loan is unsecured. 1,500,000 -
--------------- ---------------
Total bank loans and notes payable 7,183,965 3,537,330
Bonds payable (See Note 5) and Capital lease obligation (See Note 6) 6,210,000 3,555,000
--------------- ---------------
Total bank loans, notes payable and other long-term obligations 13,393,965 7,092,330
Less: Current maturities and short-term debt (4,914,738) (3,127,951)
--------------- ---------------
Total long-term debt $8,479,227 $3,964,379
=============== ===============
27
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
4. BANK LOANS, NOTES PAYABLE, AND OTHER LONG-TERM OBLIGATIONS (CONT.)
None of the bank loans, notes payable and other long term obligations contain
covenants that: require the Company to maintain minimum financial ratios or
net worth; restrict management's ability to pay dividends; restrict
management's ability to buy or sell assets; restrict management's ability to
incur additional debt; or contain any subjective acceleration clauses.
Interest incurred on bank loans, notes payable and other long-term
obligations for the period ended June 30, 2002 and 2001 is $321,079 and
$228,243, respectively. Short-term debt represents the non-cash investing
transactions utilized to purchase agency assets.
Bank loans, notes payable and other long-term obligations mature as follows:
<Table>
<Caption>
BANK LOANS
TWELVE MONTHS ENDING & NOTES CAPITAL BONDS
JUNE 30 PAYABLE LEASE PAYABLE TOTAL
2003 $ 4,489,738 $ 60,000 $ 365,000 $ 4,914,738
2004 1,692,099 65,000 - 1,757,099
2005 329,419 70,000 5,020,000 5,419,419
2006 225,036 75,000 - 300,036
2007 178,289 80,000 - 258,289
Thereafter 269,384 475,000 - 744,384
------------- ------------ ------------- ---------------
$ 7,183,965 $825,000 $5,385,000 $13,393,965
============= ============ ============= ===============
</Table>
28
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
5. LONG-TERM DEBT, BONDS PAYABLE
Brooke Credit Corporation has offered bonds (series 1997A, 1997B and 1997C)
for sale to institutional investors in $5,000 denominations. Brooke Credit
Corporation has also offered bonds (series 1997D, 1998E, and 2001F) for sale
to the public in $5,000 denominations. These bonds are issued in registered
form with interest payable semi-annually on January 1st and July 1st of each
year. These bonds are not callable by Brooke Credit Corporation and are not
redeemable by the bondholder until maturity.
Brooke Credit Corporation covenants to use all bond proceeds for the purposes
of funding loans or purchasing receivables. Brooke Credit Corporation has no
debt and covenants not to incur obligations superior to its obligations to
bondholders. Therefore, the obligation to bondholders is guaranteed by the
assets and the equity of Brooke Credit Corporation.
At June 30, 2002 and 2001, the bonds payable consist of:
<Table>
<Caption>
2002 2001
PRINCIPAL PRINCIPAL
BOND SERIES RATE MATURITY VALUE VALUE
----------- ---- -------- ----- -----
1997B 10.250% January 1, 2002 - $ 155,000
1997C 10.500% January 1, 2003 365,000 245,000
1997D 10.125% July 1, 2001 - 715,000
1998E 10.125% January 1, 2002 - 820,000
2001F 9.125% July 1, 2004 5,020,000 890,000
------------ ------------
Total $5,385,000 $ 2,825,000
============ ============
</Table>
Interest payable is $248,199 and $138,217 at June 30, 2002 and 2001,
respectively.
29
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
6. LONG-TERM DEBT, CAPITAL LEASES
Phillips County, Kansas has issued Industrial Revenue Bonds for the purpose
of purchasing, renovating, and equipping an office building in Phillipsburg,
Kansas. The total bonds issued were $825,000 with various maturities through
2012.
The Company leases the building from Phillips County, Kansas which may be
purchased for a nominal amount at the expiration of the lease agreement. The
Company is required to provide insurance coverage on the building as
specified by the lessor. Under the criteria established by SFAS 13, this
asset has been capitalized in the Company's financial statements.
RESTRICTED CASH Cash restricted at June 30, 2002 represents proceeds received
from the issuance of Industrial Revenue Bonds that are to be used for the
purpose of purchasing, renovating and equipping a processing facility in
Phillipsburg, Kansas. The restricted cash at June 30, 2002 was $364,690.
Interest earned on the restricted cash totaled $3,132.
BUILDING UNDER CONSTRUCTION The total cash used for the purchase and
renovation of the building at June 30, 2002 was $463,442.
Future capital lease payments and long term operating lease payments are as
follows:
<Table>
<Caption>
CAPITAL OPERATING
REAL REAL
PERIOD ESTATE ESTATE TOTAL
--------- --------- --------
2002.......................................................... $ 54,063 $260,296 $314,359
2003.......................................................... 115,163 327,159 442,322
2004.......................................................... 121,450 139,858 261,308
2005.......................................................... 117,119 83,368 200,487
2006.......................................................... 122,450 80,764 203,214
2007.......................................................... 117,100 20,339 137,439
2008 and thereafter........................................ 521,843 - 521,843
--------- --------- ----------
Total minimum lease payments 1,169,188 $911,784 $2,080,972
========= ==========
Less amount representing interest (344,188)
---------
Total obligations under capital leases 825,000
Less current maturities of obligations under capital leases (60,000)
---------
Obligations under capital leases payable after one year $ 765,000
=========
</Table>
30
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
7. INCOME TAXES
The elements of income tax expense (benefit) are as follows:
<Table>
<Caption>
2002 2001
---- ----
Current $ 0 $ 0
Deferred 428,160 373,350
---------- ----------
$428,160 $373,350
========== ==========
</Table>
The Company's net operating loss carryforwards are used to offset the current
tax expense by decreasing the deferred tax asset
Reconciliation of the U.S. federal statutory tax rate to Brooke Corporation's
effective tax rate on pretax income, based on the dollar impact of this major
component on the current income tax expense:
<Table>
<Caption>
2002 2001
---- ----
U.S. federal statutory tax rate 34% 34%
State statutory tax rate 4% 4%
Effect of the utilization of net operating loss carryforwards (3)% (3)%
Miscellaneous (1)% (1)%
------- -------
Effective tax rate 34% 34%
======= =======
</Table>
Reconciliation of deferred tax asset:
<Table>
<Caption>
2002 2001
---- ----
Beginning balance, January 1 $ 495,825 $ 854,066
Deferred income tax (expense) benefit (428,160) (373,350)
------------ ------------
Balance, June 30 $ 67,665 $ 480,716
============ ============
</Table>
Expiration dates of net operating loss carryforwards:
2020 $ 199,015
31
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
8. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution retirement plan covering substantially
all employees. Employees may contribute up to 15% of their compensation. The
Company may contribute an additional amount to the plan at the discretion of
the Board of Directors. No employer contributions were charged to expense for
periods ended June 30, 2002 and 2001.
9. CONCENTRATION OF CREDIT RISK
The Company maintains cash balances at several banks. On June 30, 2002 and
2001, the Company had account balances of $330,465 and $2,803,085,
respectively, with one bank which exceeds the $100,000 insurance limit of the
Federal Deposit Insurance Corporation.
The Company sells participation loans to several banks. On June 30, 2002, the
Company had participation loans sold of $22,401,435 to one bank. This
represents 50.4% of participations sold at June 30, 2002.
10. SEGMENT AND RELATED INFORMATION
The Company's two reportable segments as of and for the years ended June 30,
2002 and 2001 consisted of its insurance agency business and its financial
services business. The insurance agency business includes the Company's
wholly-owned subsidiaries which are licensed insurance agencies operating in
the states of Arizona, Colorado, Florida, Iowa, Illinois, Kansas, Louisiana,
Missouri, Nebraska, Nevada, New Mexico, Oklahoma, Texas, and Utah. The
Company sells insurance through its network of exclusive franchise agents,
franchise sub-agents, non-exclusive brokers and insurance producers. The
finance services business includes the Company's wholly-owned subsidiary,
which is a licensed finance company. The Company originates loans to Brooke
Corporation's franchise agents, franchise sub-agents, insurance producers and
insurance policyholders. Unallocated corporate-level expenses are reported in
the reconciliation of the segment totals to the related consolidated totals
as "other corporate expenses". Management evaluates the performance of its
segments and allocates resources to them based on the net income before
income taxes. The segments' accounting policies are the same as those
described in the summary of significant accounting policies.
The table below reflects summarized financial information concerning the
Company's reportable segments for the years ended June 30, 2002 and 2001:
<Table>
<Caption>
INSURANCE FINANCIAL ELIMINATION OF
AGENCY SERVICES INTERSEGMENT CONSOLIDATED
BUSINESS BUSINESS ACTIVITY TOTALS
-------- --------- -------------- ------------
2002
Insurance commissions $ 13,497,693 $ - $ - $ 13,497,693
Interest income 23,268 654,652 (241,722) 436,198
Gain on sale of notes receivable 1,190,892 1,190,892
Interest expense 72,880 248,199 - 321,079
Commissions expense 11,210,737 - - 11,210,737
Depreciation and amortization 226,656 79,199 - 305,855
Segment assets 19,541,976 7,132,555 (4,940,000) 21,734,531
Expenditures for segment assets 739,547 - - 739,547
</Table>
32
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
10. SEGMENT AND RELATED INFORMATION (CONT.)
<Table>
<Caption>
INSURANCE FINANCIAL ELIMINATION OF
AGENCY SERVICES INTERSEGMENT CONSOLIDATED
BUSINESS BUSINESS ACTIVITY TOTALS
--------- --------- ------------- ------------
2001
Insurance commissions $10,252,831 $ - $ - $10,252,831
Interest income 19,077 252,291 (151,429) 119,939
Gain on sale of notes receivable - 286,145 - 286,145
Interest expense 90,026 138,217 - 228,243
Commissions expense 7,377,527 - - 7,377,527
Depreciation and amortization 211,352 19,296 - 230,648
Segment assets 11,437,843 3,818,629 (3,944,998) 11,311,474
Expenditures for segment assets 84,406 - - 84,406
</Table>
<Table>
<Caption>
PROFIT (LOSS) 2002 2001
---- ----
Insurance Agency profit $2,010,688 $2,593,003
Financial Services profit 1,276,424 229,494
-------------- -------------
Total segment profit 3,287,112 2,822,497
Unallocated amounts:
Finders fees 661,271 175,000
Buyer assistance plan fees 1,677,627 317,203
Gain on sale of agencies 128,103 449,580
Gain on extinguishment of debt 397,306 -
Other corporate expenses (4,892,126) (2,666,192)
-------------- -------------
Income before income taxes $1,259,293 $ 1,098,088
============== =============
</Table>
33
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
11. NEW ACCOUNTING STANDARD
In June 2001, the FASB issued SFAS No. 143, "ACCOUNTING FOR ASSET RETIREMENT
OBLIGATIONS" which amends SFAS No. 19 "FINANCIAL ACCOUNTING AND REPORTING BY
OIL AND GAS PRODUCING COMPANIES". This statement applies to all entities. It
applies to legal obligations associated with the retirement of long-lived
assets that result from the acquisition, construction, development and (or)
the normal operation of a long-lived asset, except for certain obligations of
lessees. SFAS 143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred if
a reasonable estimate of fair value can be made. The associated asset
retirement costs are capitalized as part of the carrying amount of the
long-lived asset. The provisions of SFAS 143 are required to be applied
starting with fiscal years beginning after June 15, 2002. Management
continues to evaluate the impact that adoption of SFAS 143 will have on its
consolidated financial statements.
In August 2001, the FASB issued SFAS No. 144, "ACCOUNTING FOR THE IMPAIRMENT
OR DISPOSAL OF LONG-LIVED ASSETS" which supersedes FASB 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 APB 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". SFAS 144 also amends ARB No. 51
"Consolidated Financial Statements". SFAS 144 has been applied to the second
quarter 2002 financial statements.
12. SUBSEQUENT EVENTS
Brooke Bancshares did not receive regulatory approval to consummate its
agreement of February 22, 2002 to purchase a Kansas bank prior to the
agreement termination date of June 30, 2002, so Brooke Bancshares withdrew
its regulatory application in July 2002.
Brooke Acceptance Company LLC is a limited liability company organized under
the laws of the state of Delaware on July 31, 2002. It is a bankruptcy-remote
special purpose entity of Brooke Credit Corporation and is the anticipated
purchaser of Brooke Credit Corporation loans and issuer of certain floating
rate asset backed notes. Its registered office is in Wilmington, Delaware and
its principal office is in Overland Park, Kansas.
CJD & Associates, L.L.C., of which 100% ownership interest was acquired by
the Company on July 1, 2002, is a limited liability company organized under
the laws of the state of Kansas on June 11, 1997. It is a licensed insurance
agency that sells insurance programs and "targeted market" policies though
the Company's network of agents and through agents not necessarily affiliated
with the Company under the trade name of Davidson-Babcock. Its registered and
principal offices are in Overland Park, Kansas.
34
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
13. RELATED PARTY INFORMATION
Robert D. Orr, Leland G. Orr and Michael Hess (the principals) own 100% of
the voting stock of GI Agency, Inc. GI Agency, Inc. owns franchise agencies
which purchase Master Agent services and obtain loans from the Company at the
same general prices and general terms as provided to other unaffiliated
franchise agents. As of June 30, 2002, the total outstanding balance of all
loans made to GI Agency, Inc. by the Company's finance subsidiary, Brooke
Credit Corporation, was $1,285,849. Except for retained principal loan
balances totaling $76,616, all GI Agency, Inc. loans made by Brooke Credit
Corporation have been sold without recourse to an unaffiliated lender. As
such, the total loss exposure to the Company for loans made to GI Agency
totals $76,616. All GI Agency, Inc. borrowings are secured by hypothecation
of certain shares of the Company's common stock owned by Brooke Holdings,
Inc. which currently represents 67.87% of the total shares outstanding.
Because of the relationships described above, certain conflicts of interest
may arise between the Company and its agents in attempting to resolve
disputes that occur as a result of such relationships.
In its role of matching agency buyers and sellers, the Company from time to
time executes purchase agreements to acquire agency assets and assigns them
to prospective or existing franchise agents. On occasion, the Company has
assigned all of its rights, title and interest in agreements to purchase
insurance agencies to GI Agency, Inc., without consideration from GI Agency,
Inc. From January 1, 2002 through June 30, 2002, GI Agency collected no
commissions on assets subject to such assignments.
Robert D. Orr, Leland G. Orr and Michael Hess have, in some cases, each
guaranteed amounts due suppliers under certain agency agreements. The amounts
guaranteed under such agency agreements varies depending on the value of
premiums to be collected under such agency agreements. The continuance of
these guarantees is important to the Company's prospects.
The Company has extended a $495,000 line of credit loan to Brooke Holdings,
Inc. which owns 67.87% of the Company's common stock. This line of credit is
unsecured and was renewed on December 31, 2001 bearing interest at a rate of
9.5% per annum and maturing on December 31, 2002. The outstanding principal
balance on the line of credit as of June 30, 2002 was $495,000. An additional
loan bearing interest at 9.5% per annum, and maturing on December 31, 2002,
in the amount of $11,909 was made to Brooke Holdings, Inc. during the quarter
ending June 30, 2002.
Robert Orr, Leland Orr, Michael Hess, and Shawn Lowry have each guaranteed
the promissory note of Austin Agency, Inc., of Brownsville, Texas, to Brooke
Credit Corporation. The four guarantors have each acquired 5% of the
outstanding stock of Austin Agency, Inc. as consideration for their
guarantees. The loan to Austin Agency, Inc. was executed on May 15, 2000 for
$1,200,000 and is scheduled to mature on August 1, 2010. As of June 30, 2002
the principal balance of the loan was $1,080,926. This loan is sold to an
unaffiliated lender without recourse so the Company does not have a loss
exposure on this loan.
Mr. Hess has one loan with Brooke Credit Corporation in the amount of $10,000
bearing interest at 9.50%. This loan was executed on January 2, 2002 and is
scheduled to mature on January 2, 2003. The outstanding principal balance as
of June 30, 2002 was $10,000.
35
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
13. RELATED PARTY INFORMATION (CONT.)
Shawn Lowry is the sole manager of First Financial Group, L.C., a Kansas
limited liability company. Michael Lowry is the sole member of First
Financial Group, L.C. The business purpose of First Financial includes
investing in agencies and guaranteeing loans made by Brooke Credit
Corporation to franchise agents who have bought agencies from the Company. On
June 1, 2001, First Financial Group, L.C., guaranteed 65% of the Brooke
Credit Corporation loan to Palmer, L.L.C. of Baxter Springs, Kansas. In
consideration for this guaranty, First Financial Group, L.C. received a 15%
profit interest in Palmer, L.L.C. The loan was executed on June 1, 2001 and
is scheduled to mature on September 1, 2011. As of June 30, 2002, the loan
principal balance was $731,005. The Company maintains retained principal loan
balances totaling $2,068. Of the amounts sold, $595,290 is sold with recourse
and $133,645 is sold without recourse. As such, the Company's exposure to
loss is limited to the retained loan balance and its recourse obligation.
First Financial Group's obligation with regards to Palmer, L.L.C. loans is
indirect and the Company believes its exposure to loss from First Financial
Group's failure to honor its guarantee is limited.
On September 28, 2001, First Financial Group, L.C. guaranteed 25% of the
outstanding principal balance of two Brooke Credit Corporation loans to R&F,
L.L.C. of Kansas City, Missouri. In consideration for these guarantees, First
Financial Group received 5% profit interest in R&F, L.L.C. Both loans were
executed on September 28, 2001 and both mature on December 1, 2013. As of
June 30, 2002 the principal balances of both loans totaled $636,458. The
Company maintains retained principal loan balances totaling $73,586. Of the
amounts sold, $461,896 is sold with recourse and $100,975 is sold without
recourse. As such, the Company's exposure to loss is limited to its recourse
obligation. First Financial Group's obligation with regards to R&F,
L.L.C. loans is indirect and the Company believes its exposure to loss from
First Financial Group's failure to honor its guarantee is limited.
Kyle Garst is the sole manager and sole member of American Financial Group,
L.C., a Kansas limited liability company. The business purpose of American
Financial Group, L.C., includes investing in agencies and guaranteeing loans
made by Brooke Credit Corporation to franchise agents who have bought
agencies from the Company. On October 15, 2001 American Financial Group, L.C.
and First Financial Group, L.C. each guaranteed 50% of the outstanding
principal balance of The Wallace Agency, L.L.C. of Wanette, Oklahoma. In
consideration of this guarantee, First Financial Group receives a 7.5% profit
interest in The Wallace Agency, L.L.C. and American Financial Group, L.C.
receives a 7.5% profit interest in The Wallace Agency, L.L.C. This loan was
executed on October 15, 2001 and matures on January 1, 2014. As of June 30,
2002 the loan principal balance was $433,872. This loan is sold to an
unaffiliated lender without recourse so the Company does not have a loss
exposure on this loan.
36
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
13. RELATED PARTY INFORMATION (CONT.)
Anita Larson is married to John Arensberg, a partner in Arensberg Insurance
of Lawrence, Kansas and Overland Park, Kansas. The Company and Arensberg
Insurance have entered into a franchise agreement pursuant to which Arensberg
Insurance participates in the Company's Master Agent program. In addition,
the Company's finance subsidiary, Brooke Credit Corporation, has made one
loan to Arensberg Insurance. As of June 30, 2002, the total outstanding
balance of such loan was $750,994. This loan bears interest at a rate
adjusted annually and equal to 3.0% per annum over the New York prime rate.
The loan is scheduled to mature on October 1, 2009. Except for retained
principal loan balances totaling $55,925, the Arensberg Insurance loan made
by Brooke Credit Corporation has been sold to unaffiliated lenders, including
$245,940 without recourse and $449,128 with recourse. As such, the Company's
exposure to loss is limited to the retained loan balance and its recourse
obligation. The Company entered into a franchise agreement and made loan
advances to Arensberg Insurance partnership well before Anita Larson was
employed by the Company. Anita Larson is not a partner of Arensberg
Insurance. The partners of Arensberg Insurance are established and credible
businessmen so the Company's believes its exposure to loss from its retained
loan balance and recourse obligation is limited.
Brooke Credit Corporation made a loan to Anita Larson for the purpose of
acquiring stock in the Company. The loan bears interest at a rate adjusted
annually and equal to 2.5% per annum over the New York prime rate, which as
of June 30, 2002 was 12%. The loan is scheduled to mature on August 1, 2005.
The outstanding balance of this loan as of June 30, 2002 was $24,526. The
entire loan balance has been sold without recourse to an unaffiliated lender
so the Company does not have any loss exposure.
Anita Lowry is a sister to Robert D. Orr and Leland G. Orr and the mother of
Shawn Lowry and Michael Lowry and is married to Don Lowry who is a
franchisee. Don & Anita Lowry are shareholders of American Heritage Agency,
Inc. which owns an agency in Hays, Kansas and previously owned agencies in
Great Bend, Kansas and Omaha, Nebraska. The Company and American Heritage
Agency, Inc. entered into a franchise agreement on February 28, 1999 pursuant
to which American Heritage Agency, Inc. participates in the Company's Master
Agent program. As of June 30, 2002, American Heritage Agency had four loans
outstanding to Brooke Credit Corporation with total outstanding balances of
$503,779. The outstanding loans to American Heritage Agency currently have
maturity dates of September 1, 2010, January 16, 2005, April 1, 2014, and
February 1, 2014. All of the loans bear interest at a rate adjusted annually
to 3.5% over the New York prime rate. Except for retained principal loan
balances totaling $68,088, all American Heritage Agency loans made by Brooke
Credit Corporation have been sold to unaffiliated lenders, including $173,500
without recourse and $262,191 with recourse. As such, the Company's exposure
to loss is limited to the retained loan balance and its recourse obligation.
Don Lowry is an experienced businessman with proven insurance sales skills,
so the Company believes its exposure to loss from its retained loan balance
and recourse obligation is limited.
37
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
13. RELATED PARTY INFORMATION (CONT.)
Brooke Credit Corporation made an unsecured loan to American Financial Group,
L.C. The loan bears interest at a fixed rate of 9%. The loan is scheduled to
mature on January 16, 2008. The outstanding balance of this loan as of June
30, 2002 was $32,355. The entire loan balance has been sold without recourse
to an unaffiliated lender so the Company does not have any loss exposure.
Anita Lowry is a sister of Robert D. Orr and Leland G. Orr and the mother of
Shawn Lowry and Michael Lowry. Brooke Credit Corporation made an unsecured
loan to Anita Lowry. The loan bears interest at a fixed rate of 9%. The loan
is scheduled to mature on January 16, 2005. The outstanding balance of this
loan as of June 30, 2002 was $2,191. The entire loan balance has been sold
without recourse to an unaffiliated lender so the Company does not have any
loss exposure.
Shawn Harding is the son-in-law of Michael Hess. Brooke Credit Corporation
made an unsecured loan to Shawn Harding. The loan bears interest at a fixed
rate of 9.5%. The loan is scheduled to mature on July 1, 2003. The
outstanding balance of this loan as of June 30, 2002 was $10,000. The entire
loan balance has been sold without recourse to an unaffiliated lender so the
Company does not have any loss exposure.
Principals and their immediate family have purchased Brooke Credit
Corporation Bonds totaling $140,000. Members of this group have also
purchased loan participations totaling $114,494.
The Company sells insurance to its Board of Directors and its employees. The
aggregate of these transactions is not significant to the financial
statements.
The fair value of Robert Orr's services was estimated at $40,000, or (one
half) of the compensation of the Company's most senior managers (Leland Orr
and Mike Hess). This value was established after analysis of the time Robert
Orr spent on Company activities and not necessarily the amount of
contribution made by Robert Orr, the importance of Robert Orr's
contributions, or the Company's dependence on Robert Orr. Robert Orr is an
author and is currently working on a revised addition of his previous
reference book. Additionally, Robert Orr maintains a secondary residence in
Boulder, CO and is absent from the company's offices on a frequent basis.
The Company's employee handbook contains conflict of interest guidelines
which are applicable to Company management and employees. The purpose of the
guidelines is to prevent an employee in a position to influence a decision
regarding the Company to use such influence for personal gain. Pursuant to
the guidelines, an employee in such a position is required to notify an
officer of the Company of the existence of such a situation.
14. CONTINGENCY
The Company is filing voluntarily with the SEC (Securities and Exchange
Commission). The Company has not received notice of clearing comments,
therefore, it is possible future SEC comments could have an effect on this
review report.
38
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
15. ACQUISITIONS AND DIVESTITURES
On June 30, 2000, the Company acquired 900 shares of Interstate Insurance
Group, LTD from Gerald Lanio and William Tyer. These shares represented 100%
of the shares outstanding. The total purchase price was estimated to be
$1,200,000 plus Interstate's net tangible book value. However, that portion
of the purchase price exceeding net tangible book value was contingent upon
future revenues. Therefore, in accordance with paragraph 80 of APB 16, the
purchase price was recorded as an asset when cash payments were made to the
sellers. Cash payments of $300,000 and $162,877 were recorded in 2000 and
2001, respectively, as Excess Cost of Purchased Subsidiary. As disclosed in
footnote 1 (g) to these financial statements, these amounts were subsequently
written off as impaired.
16. COMPENSATED ABSENCES
The Company has not accrued compensated absences, however, the total amount
is not deemed to be material.
17. STOCK-BASED COMPENSATION
The Company's net income and net income per common share would have been
reduced to the pro forma amounts indicated below if compensation cost for the
Company's stock option plan had been determined based on the fair value at
the grant date for awards in accordance with the provisions of SFAS No. 123:
2002
----------
Net income:
As reported $ 831,133
Pro forma 647,736
Basic earnings per share:
As reported .98
Pro forma .73
Diluted earnings per share:
As reported .95
Pro forma .73
The fair value of the options granted during 2002 is estimated on the
date of grant using the binomial option pricing model. The
weighted-average assumptions used and the estimated fair value are as
follows:
2002
---------
Expected term 2.7 years
Expected stock volatility 30%
Risk-free interest rate 5%
Dividend 1%
Fair value per share $ 5.85
39
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
17. STOCK-BASED COMPENSATION (CONT.)
The Company has granted stock options to officers, certain key employees, and
directors for the purchase of its common stock under a shareholder-approved
plan. The Brooke Corporation 2001 Compensatory Stock Option Plan authorizes
the issuance of up to 47,500 shares of the Company's common stock, for use in
paying incentive compensation awards in the form of stock options. Unless
otherwise required by law, the options are granted at fair value at the date
of grant and become partially exercisable immediately. The options expire
five to ten years from the date of grant. At June 30, 2002, there were 42,500
additional shares available for granting stock options under the stock plan.
SHARES UNDER WEIGHTED AVERAGE
OPTION EXERCISE PRICE
----------------------------------------------------------------------------------------
Outstanding, Jan. 1, 2002 - $ -
Granted 47,500 25.32
Exercised - -
Terminated and expired - -
-----------------------------------------------------------------------------------------
Outstanding, June. 30, 2002 47,500 $ 25.32
=========================================================================================
Options to purchase 2,100 shares were exercisable at June 30, 2002. The
following table summarizes information concerning outstanding and
exercisable options at June 30, 2002.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------------------------------------------------------------
REMAINING WEIGHTED WEIGHTED
CONTRACTUAL AVERAGE AVERAGE
NUMBER LIFE EXERCISE NUMBER EXERCISE
RANGE OF EXERCISABLE PRICES OUTSTANDING IN YEARS PRICE EXERCISABLE PRICE
-------------------------------------------------------------------------------------------------------
$ 25-27.50 47,500 2.7 $ 25.32 2,100 $ 25
40
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
18. GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the FASB issued SFAS No. 141, "BUSINESS COMBINATIONS," and SFAS
No. 142, "GOODWILL AND OTHER INTANGIBLE ASSETS", collectively referred to as
the "Standards," which were effective for the Company as of January 1, 2002.
SFAS No. 141 supercedes APB No. 16, "BUSINESS COMBINATIONS." The provisions
of SFAS No. 141 (1) require that the purchase method of accounting be used
for all business combinations initiated after June 30, 2001, (2) provide
specific criteria for the initial recognition and measurement of intangible
assets apart from goodwill, and (3) required that un-amortized negative
goodwill be written off immediately as an extraordinary gain instead of being
deferred and amortized. SFAS No. 141 also requires that, upon adoption of
SFAS No. 142, the Company reclassify the carrying amounts of certain
intangible assets into or out of goodwill, based on certain criteria. SFAS
No. 142 supercedes APB No. 17, "INTANGIBLE ASSETS," and is effective for
fiscal years beginning after December 15, 2001. SFAS No. 142 primarily
addresses the accounting for goodwill and intangible assets subsequent to
their initial recognition. The provisions of SFAS No. 142 (1) prohibit the
amortization of goodwill and indefinite-lived intangible assets, (2) require
that goodwill and indefinite-lived intangible assets be tested annually for
impairment (and in interim periods if certain events occur indicating that
the carrying value of goodwill and/or indefinite-lived intangible assets may
be impaired), (3) require that reporting units be identified for the purpose
of assessing potential future impairments of goodwill, and (4) remove the
forty-year limitation on the amortization period of intangible assets that
have finite lives.
The following table adjusts reported net income and earnings per share for
the six months ended June 30, 2001 (prior to the adoption date) to exclude
amortization of goodwill and other intangible assets with indefinite useful
lives:
Net Income Basic EPS Diluted EPS
As reported $724,738 1.03 1.01
Amortization of goodwill 1,890 .00 .00
------------ --------------- ---------------
$726,628 1.03 1.01
============ =============== ===============
There are no intangible assets with indefinite useful lives, other than
goodwill, as of June 30, 2002, and June 30, 2001. The intangible assets with
definite useful lives have a value of $1,379,887 and $932,602 as of June 30,
2002, and June 30, 2001, respectively. These assets are included in "Other
Assets" in the balance sheet. Amortization expense was $165,855 and $90,648
for the period ended June 30, 2002 and 2001, respectively.
41
BROOKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
19. SUPPLEMENTAL CASH FLOW DISCLOSURES
SUPPLEMENTAL DISCLOSURES:
Cash paid for interest $ 321,079 $ 228,243
================= ==================
Cash paid for income tax $ - $ -
================= ==================
Non cash financing activity - additional paid in
Capital for contributed services $ 20,000 $ 20,000
================= ==================
During the six month period ending June 30, 2002, the statement of cash flows
reflect the purchase of agencies into inventory totaling $3,096,443 and the
sale of agencies from inventory totaling $7,508,820. Agency inventory
decreased $272,874 from the December 31, 2001 to June 30, 2002, however net
cash of $4,412,377 was provided by the Company's agency inventory activities
because $4,139,503 of the purchase price of agency inventory was provided by
sellers per table below.
June 30, 2002
Purchase of insurance agency inventory $ (3,096,443)
Sale of insurance agency inventory $ 7,508,820
--------------------
Net cash provided (used) from sale of agency inventory $ 4,412,377
Cash (provided) by sellers of agency inventory $ ( 4,139,503)
--------------------
Decrease in inventory on balance sheet $ 272,874
====================
42
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Brooke Corporation's (the "Company") discussion of its financial
condition and operating results and plan of operations includes
forward-looking statements. Forward-looking statements are necessarily based
upon estimates and assumptions that are inherently subject to significant
business, economic and competitive uncertainties and contingencies, many of
which are beyond the Company's control and are subject to change. Actual
operating and financial results of the Company and the Company's actual plan
of operations may differ materially from the stated plan of operations.
CAUTIONS ABOUT FORWARD LOOKING STATEMENTS
The following cautionary statement is made for the purpose of taking
advantage of any defenses that may exist under the law, including common law.
Forward-looking statements include statements concerning plans, objectives,
goals, strategies, expectations, future events or performance and underlying
assumptions and other statements that are not statements of historical facts.
This document contains forward-looking statements which can be identified by
the use of words such as "intend," "anticipate," "believe," "estimate,"
"project," or "expect" or other similar statements. These forward-looking
statements involve risks and uncertainties which could cause actual results
or outcomes to differ materially from those expressed in the forward-looking
statements. Brooke Corporation's (the "Company") expectations, beliefs and
projections are expressed in good faith and are believed by the Company to
have a reasonable basis, including without limitation, management's
examination of historical operating trends, data contained in the Company's
records and data available from third parties. However, there can be no
assurance that management's expectations, beliefs or projections will occur
or be achieved or accomplished.
RESULTS OF OPERATIONS
The Company's consolidated results of operations have been
significantly impacted by the Company's expansion of territory and personnel
in recent years. Revenues are expected to continue to increase in 2002 as a
result of the foregoing.
Although the Company plans to eventually market its Master Agent,
facilitator and programs services to other financial services professionals,
currently virtually all of the Company's financial activity results from
insurance sales or lending to insurance agents. As such, management has
organized a portion of its discussion and analysis into an insurance agency
segment and a finance company segment.
The Company's revenues are comprised primarily of commissions paid
by insurance companies in connection with the Company's insurance agency
operations. Commission revenues typically represent a percentage of insurance
premiums paid by policyholders. Premium amounts and commission percentage
rates are established by insurance companies, so the Company has little or no
control of the commission amount
43
generated from the sale of a specific insurance policy. The Company primarily
relies on the recruitment of additional agents to increase commission revenue.
The Company's finance subsidiary generates most of its revenues from
interest margins resulting from the origination of loans to the Company's
agents and from gains on the sale of agent loan participations. The finance
subsidiary funds its loan portfolio primarily through the sale of loan
participation interests to other lenders and the sale of bonds to investors.
The finance subsidiary also expects to issue asset backed notes and has
recently organized two special purpose entities for this purpose. Covenants
related to the issue of bonds by the finance company restrict the payment of
dividends by the finance company subsidiary.
On February 22, 2002, the Company, through a wholly-owned
subsidiary, entered into an agreement to purchase Centerville State Bank in
Centerville, Kansas. However, regulatory approval of the proposed acquisition
was not obtained prior to the agreement termination date of June 30, 2002 so
the acquisition was not consummated. The Company continues to explore ways,
such as bank acquisitions, to offer banking services through its agents.
On May 23, 2002, the Company entered into an agreement with Colin
and Julie Davidson to acquire on July 1, 2002 a 100% ownership interest in
CJD & Associates, L.L.C. for $2,024,816 and additional undetermined amounts
that are contingent upon the acquired company's future agency revenues. CJD &
Associates, L.L.C. operates an insurance agency wholesaler that sells
insurance programs and excess surplus lines insurance.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
Net income for the second quarter of 2002 was $273,653 or $.27 per
share, compared with net income in the second quarter of 2001 of $231,079 or
$.32 per share. Total revenues for the second quarter of 2002 were
$9,581,651, which is an increase of approximately 46% from total revenues of
$6,546,606 during the comparable period of the prior year.
Payroll and other operating expenses also increased primarily as a
result of the Company's expansion of its insurance agency operations. Payroll
expenses increased to $1,525,640 in the second quarter of 2002 from $968,148
in the second quarter of 2001, which is an increase of approximately 58%.
Other operating expenses increased to $1,154,096 in the second quarter of
2002 from $451,130 in the second quarter of 2001, which is an increase of
approximately 156%.
Depreciation and amortization expenses increased to $160,365 in the
second quarter of 2002 from $118,565 in the second quarter of 2001, which is
an increase of approximately 35%.
44
The Company's effective tax rate on income was 34.0% in the second
quarter of 2002 and 34.0% in the second quarter of 2001. The Company has
recorded deferred tax assets of $67,665 and $480,716 as of June 30, 2002 and
June 30, 2001 respectively. Based on the Company's recent profitability and
management's projections of continued profitability in 2002, the Company
expects the deferred tax asset to be fully realized.
On June 30, 2002, the Company's largest asset category was accounts
and notes receivables, which totaled $8,760,500 and was comprised of notes
receivable balances, accrued interest on notes receivables and customer
receivable balances. Although a loss allowance was made for the Company's
long-term loss exposure related to its recourse liability on loans sold to
participating lenders, no loss allowance has been made for the Company's
accounts and notes receivables because these assets have a short term
exposure to loss and the Company has experienced minimal credit losses. All
of the Company's notes receivables are held for sale and typically sold
within a short period of time. Most of the Company's accounts receivables are
agent obligations that are paid at the next monthly statement settlement so
accounts receivables are typically paid within 30 days.
On June 30, 2002, customer receivables were $5,862,128, which is an
increase of approximately 67% from $3,517,710 at June 30, 2001. Customer
receivables increased at a slightly lower rate than the rate at which
Company's revenues increased. On June 30, 2002, notes receivables were
$2,521,610, which is an increase of approximately 468% from $444,082 at June
30, 2001. Notes receivables increased significantly, primarily as a result of
management's decision to temporarily retain more loans in its "held for sale"
portfolio. On June 30, 2002, accrued interest on notes receivables was
$376,762, which is a decrease of approximately 26% from $509,531 at June 30,
2001.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
Net income for the six months ended June 30, 2002 was $831,133 or
$.98 per share, compared with net income for the comparable period of the
prior year of $724,738 or $1.03 per share. Total revenues for the six months
ended June 30, 2002 were $18,003,120, which is an increase of approximately
55% from total revenues of $11,600,698 during the comparable period of the
prior year. This increase is primarily the result of the Company's recent
expansion of its insurance agency operations.
Payroll and other operating expenses also increased primarily as a
result of the Company's expansion of its insurance agency operations. Payroll
expenses increased to $2,984,151 for the six months ended June 30, 2002 from
$1,832,972 in the comparable period of the prior year, which is an increase
of approximately 63%. Other operating expenses increased to $1,922,005 for
the six months ended June 30, 2002 from $833,220 in the comparable period of
the prior year, which is an increase of approximately 131%. Other operating
expenses increased much faster than revenues largely as a result of opening
additional insurance service center locations.
45
Depreciation and amortization expenses increased to $305,855 for the
six months ended June 30, 2002 from $230,648 in the comparable period of the
prior year, which is an increase of approximately 33%. The increase is
primarily attributable to amortization expense associated with the Company's
recent loan participation sales activity.
ANALYSIS BY SEGMENT
The Company separates insurance agency operations from finance
company operations when analyzing performance. In the first six months of
2002 and 2001, most of the Company's revenues were generated from its
insurance agency operations. However, most of the profits for the first six
months of 2002 were generated from finance company operations.
INSURANCE AGENCY SEGMENT
For performance comparisons of insurance agency operations, the
Company typically analyzes operating profits and operating profit margins.
Operating profits for the Company's insurance agency operations are defined
as earnings before interest, taxes, depreciation and amortization. The
Company typically expects operating profit margins, including insurance
related facilitator profits, from insurance agency operations in excess of
10%. For the three months ending June 30, 2002, the Company's insurance
agency operating profits, including insurance related facilitator profits,
were $62,570 on insurance commissions and fees of $8,833,374, resulting in an
operating profit margin of approximately 1%. During the comparable period of
2001, insurance agency operating profits, including insurance related
facilitator profits, were $356,946 on insurance commissions and fees of
$6,324,144, resulting in an operating profit margin of approximately 6%. For
the six months ending June 30, 2002, the Company's insurance agency operating
profits, including insurance related facilitator profits, were $342,473 on
insurance commissions and fees of $16,376,030, resulting in an operating
profit margin of approximately 2%. During the comparable period of 2001,
insurance agency operating profits, including insurance related facilitator
profits, were $1,150,895 on insurance commissions and fees of $11,194,614,
resulting in an operating profit margin of approximately 10%. The significant
decrease of operating profit margins in the first six months of 2002 from the
comparable period in 2001 occurred because insurance commission income
increased at a much slower rate than expenses for this segment, especially
other operating expenses and commissions expense paid to agents.
Insurance commission income in the second quarter of 2002 increased to
$7,441,079 or approximately 34%, from $5,557,361 in the second quarter of 2001.
Insurance commissions increased primarily as a result of the Company's recent
expansion. Commissions expense paid to the Company's agents in the second
quarter of 2002 increased to $6,174,404 or approximately 36%, from $4,547,920 in
the second quarter of 2001. Insurance commission income in the first six months
of 2002 increased to $13,497,693 or approximately 32%, from $10,252,831 in the
comparable period of 2001. Commissions expense paid to the Company's agents in
the first six months of 2002 increased to $11,210,737, or approximately 52%,
from $7,377,527 in the comparable period of the prior year. Commissions expense
paid to agents increased at a faster rate
46
<Page>
than insurance commission income because the Company has increased the share
of sales commissions paid to agents and because a smaller share of the
Company's insurance commissions result from the sales of "targeted market"
policies for which the commission rates paid to agents are generally less.
Included in insurance commission income are profit sharing
commissions, which are the Company's share of insurance company profits on
policies written by the Company's agents. Profit sharing commissions were
$54,807 for the three-month period ending June 30, 2002 or approximately 1%
of insurance commission income. During the comparable period of 2001, profit
sharing commissions were $158,064 or approximately 3% of insurance commission
income. Profit sharing commissions were $497,349 for the six-month period
ending June 30, 2002 or approximately 4% of insurance commission income.
During the comparable period of 2001, profit sharing commissions were
$632,552 or approximately 6% of insurance commission income.
Insurance commission income is reduced by the estimated amount of
commission refunds resulting from future policy cancellations and revenue was
correspondingly reduced by $13,307 and $13,844 for the quarters ending June
30, 2002 and June 30, 2001, respectively and reduced by $29,464 and $33,651
for the six month periods ending June 30, 2002 and June 30, 2001,
respectively. A corresponding liability has been accrued in the amounts of
$326,306 and $267,217 as of June 30, 2002 and June 30, 2001 respectively.
Fee income from the Company's insurance related facilitator
activities, such as consulting, agency finders fees, gains on agency sales
and agency seller discounts increased to $1,392,295 in the second quarter of
2002 from $766,783 in the comparable period of the prior year and increased
to $2,878,337 for the first six months of 2002 from $941,783 in the
comparable period of the prior year. Revenues from buyer's finder fees have
been differentiated from revenues for gains on sale of agencies because
finder's fees represent amounts received from prospective agency buyers for
the Company's efforts in locating an agency to acquire from an unaffiliated
third party seller. In these instances, the Company does not purchase the
agency into inventory. On the other hand, gains on sale of agencies represent
the net gains received for the sale of agencies directly acquired by the
Company and held in its inventory. Revenues from finders fees, gains on sale
of agencies and seller discounts are recognized immediately because the
Company has no continuing obligation. The Company provides consulting and
other assistance to agency owners during the first months of agency ownership
through a Buyers Assistance Plan ("BAP") program. The Company records BAP
income using the percentage of completion accounting method, so $1,270,697 of
BAP fees were deferred as of June 30, 2002 and a corresponding liability was
recorded by the Company.
During the first six months of 2002, William Tyer and Gerald Lanio
agreed to cancel any debt owed to them by the Company resulting from the
Company's acquisition of Interstate Insurance Group, LTD in June 2000.
Messrs. Tyer and Lanio were motivated to cancel this debt because the
purchase agreement structure resulted in some potential adverse income tax
consequences to the sellers. As consideration for the
47
cancellation of debt, the Company amended Messrs. Tyer's and Lanio's
employment agreements to provide for bonus payments equal to a percentage of
net commissions received.
FINANCE COMPANY SEGMENT
Finance company operations consist primarily of lending to insurance
agents. Agent loans are typically annually adjustable rate loans made for the
purpose of acquiring insurance agencies. Net interest income and gross
servicing income for the quarters ending June 30, 2002 and June 30, 2001 were
$217,670 and $121,507 respectively. Net interest income and gross servicing
income for the six months ending June 30, 2002 and June 30, 2001 were
$436,198 and $119,939 respectively.
The increase in net interest margins and gross servicing income is
primarily the result of a larger loan portfolio and the resulting loan
participation sales. When analyzing the impact that net interest margins and
gross servicing income have on the Company's overall finance company
operations, consideration should be given to amortization of the Company's
servicing asset and subsequent adjustments to the Company's interest
receivable asset referenced in the following discussion on loan participation
sales.
Revenues of $542,367 and $143,944 were recorded during the quarters
ending June 30, 2002 and June 30, 2001 to realize a gain on the sale of notes
receivables from recognition of the servicing asset and interest receivable
asset resulting from the sale of loan participation. Revenues of $1,295,555
and $267,867 were recorded during the six month periods ending June 30, 2002
and June 30, 2001 to realize a gain on the sale of notes receivables from
recognition of the servicing asset and interest receivable asset resulting
from the sale of loan participation.
As part of its finance company's operations, the Company typically
sells most of the insurance agent loans it originates to participating
lenders. As such, gains or losses were recognized, loans were removed from
the balance sheet and residual assets, representing the present value of
future cash flows, were recorded. Loan participation sales have made a
significant impact on the Company's financial condition and results of
operations. The following discussion describes this impact on the
Consolidated Statements of Income, Consolidated Balance Sheets and the credit
quality of the off-balance sheet loans sold with recourse.
In all sales of participations in insurance agent loans, the Company
retains servicing responsibilities for which it typically receives annual
servicing fees ranging from .25% to 1.375% of the outstanding balance. A gain
is recognized immediately upon the sale of a loan participation when the
annual servicing fees exceed the cost of servicing, which is estimated at
..25% of the outstanding loan balance. In those instances where annual service
fees received by the Company are less than the cost of servicing, a loss is
immediately recorded. The gain or loss associated with loan servicing is
determined based on a present value calculation of future cash flows from
servicing the underlying loans, net of prepayment assumptions. For the
quarters ending June 30, 2002
48
and June 30, 2001, the net gains from loan servicing totaled $212,537 and
$37,632 respectively which included gains from servicing benefits of $216,233
and $56,735 respectively and losses from servicing liabilities of $3,696 and
$19,103 respectively. For the six month periods ending June 30, 2002 and June
30, 2001, the net gains from loan servicing totaled $527,433 and $147,864
respectively which included gains from servicing benefits of $535,278 and
$166,967 respectively and losses from servicing liabilities of $7,845 and
$19,103 respectively.
In addition to loan servicing fees, the Company often retains
interest income when participations in insurance agent loans are sold. The
Company records a gain on sale for the interest benefit based on a present
value calculation of future cash flows of the underlying loans. The Company's
right to interest income is not subordinate to the investor's interests and
the Company shares interest income with investors on a prorata basis.
Although not subordinate to investor's interests, the Company's retained
interest is subject to credit and prepayment risks on the transferred
financial assets. In those instances where the Company provides recourse, a
loss is recorded based on a present value calculation of future cash flows of
the underlying loans. For the quarters ending June 30, 2002 and June 30,
2001, the net gains from interest benefits totaled $285,815 and $63,323
respectively which included gross gains from interest benefits of $297,329
and $108,503 respectively and losses from recourse liabilities of $11,514 and
$45,180 respectively. For the six month periods ending June 30, 2002 and June
30, 2001, the net gains from interest benefits totaled $663,459 and $138,281
respectively which included gross gains from interest benefits of $684,618
and $234,939 respectively and losses from recourse liabilities of $21,159 and
$96,658 respectively. Gains from servicing and interest benefits are
typically non-cash gains as the Company receives cash equal to the carrying
value of the loans sold. The Company has allocated the previous carrying
amount between the assets sold and the corresponding retained interests,
however cash in excess of the previous carrying amount is not generated by
loan sales. A corresponding adjustment has been made on the Statement of Cash
Flows to reconcile net income to net cash flows from operating activities.
Underlying assumptions used in the initial determination of future
cash flows on the participation loans accounted for as sales include the
following:
Agency Loans Agency Loans
(Adjustable Rate Stratum) (Fixed-Rate Stratum)
Prepayment speed* 10% 10%
Weighted average life* 101.18 months N/A
Expected credit losses* 5.0% 5.0%
Discount Rate* 8.5% 11.00%
*Annual rates
Gain-on-sale accounting requires management to make assumptions regarding
prepayment speeds and credit losses for the participated loans. The performances
of
49
these loans are extensively monitored, and adjustments to these assumptions
will be made if necessary.
The impact from the sale of loan participations can be seen in
several areas of the Company's balance sheet. The most significant has been
the removal of insurance agent loans that the Company continues to service.
On June 30, 2002 and June 30, 2001, the balances of those off-balance sheet
managed assets totaled $44,547,040 and $29,653,127 respectively. During the
quarters ending June 30, 2002 and June 30, 2001, the Company sold $16,069,194
and $4,801,451, respectively, of participations in insurance agent loans.
During the six month periods ending June 30, 2002 and June 30, 2001, the
Company sold $27,564,256 and $9,055,783, respectively, of participations in
insurance agent loans.
In connection with the recognition of non-cash gains for the
servicing benefits of loan participation sales, the present value of future
cash flows were recorded as a servicing asset. Components of the servicing
asset as of June 30, 2002 were as follows:
Estimated cash flows from loan servicing fees $1,463,888
Less:
Servicing Expense (384,292)
Discount to Present Value (363,827)
-------------
Carrying Value of Retained Servicing Interest in Loan Participations $715,769
In connection with the recognition of non-cash losses for the
servicing liabilities of loan participation sales, the present value of
future cash flows were recorded as a servicing liabilities. Components of the
servicing liability as of June 30, 2002 were as follows:
Estimated cash flows from loan servicing fees $ -0-
Less:
Servicing expense 70,327
Discount to present value (23,928)
-------------
Carrying Value of Retained Servicing Liability in Loan Participations $46,399
In connection with the recognition of non-cash gains for the
interest benefits of loan participation sales, the present value of future
cash flows were recorded as an interest receivable asset and included in
investment securities. Components of the interest receivable asset as of June
30, 2002 were as follows:
Estimated cash flows from interest income $1,383,320
Less:
Estimated credit losses * (193,670)
Discount to present value (293,184)
-------------
50
Carrying Value of Retained Interest in Loan Participations $896,466
* Estimated credit losses from liability on sold recourse loans with balances
totaling $9,993,743 on June 30, 2002. Credit loss estimates are based upon
experience, delinquency rates, collateral adequacy, market conditions and
other pertinent factors.
The following table presents a summary of various indicators of the
credit quality of off-balance sheet recourse loans at June 30, 2002:
Net charge offs* $-0-
Recourse loans sold $9,993,743
Estimated credit losses provided for $193,670
Estimated credit losses to recourse loans sold at period end 1.94%
Estimated Credit Loss Rates:
Annual basis 5.00%
Percentage of original balance 1.69%
Delinquency rates:
30 to 89 days* 0%
90 days or more* 0%
*Although no amounts of recourse loans were charged off for the three month
and six month periods ending June 30, 2002 and no loans were delinquent 30
days or more as of June 30, 2002, it is likely that loan delinquencies and
loan charge offs will occur during the life of the sold recourse loans.
LIQUIDITY AND CAPITAL RESOURCES
The balances of the Company's cash and cash equivalents were
$4,753,902 and $3,853,166 at June 30, 2002 and June 30, 2001 respectively.
The Company's current ratios (current assets to current liabilities) were
1.90 and 1.32 at June 30, 2002 and June 30, 2001 respectively. The Company
has improved its current ratio and increased its cash balances to take
advantage of business opportunities such as increasing agency inventory,
negotiating seller discounts and attracting suppliers. Correspondingly, the
Company's current ratio and cash balances will be adversely affected if
agency inventory increases or seller loan balances are prepaid.
For the six-month period ending June 30, 2002, net cash of
$2,608,361 was used in operating activities. Cash of $1,534,584 was used to
fund an increase in customer receivables and cash of $1,500,000 was used to
fund an increase in prepaid expenses and other assets for a deposit made
towards the purchase of CJD & Associates, L.L.C. Although the Company's
business includes the buying and selling of insurance agencies held in
inventory, a $128,103 gain on the sale of inventory was excluded as an
operating source of cash because changes in inventory have been classified as
an investing activity. For the six-month period ending June 30, 2002, net
cash of $4,169,526 was provided by investing activities. A large net cash
inflow of $4,412,377 resulted from insurance agency inventory transactions.
Cash proceeds of $7,508,820 from sales of agency inventory exceeded cash
payments of $3,096,443 for purchases of agency inventory primarily because
cash payments for part of the agency purchase prices were deferred. For the
six-month period ending June 30, 2002, net cash of $1,595,132 was used in
51
financing activities, with the most significant portion of the cash used for
payments on long-term seller debt. The Company's cash balances decreased by
$33,967 from December 31, 2001 to June 30, 2002.
For the six-month period ending June 30, 2001, net cash of $242,305
was provided by operating activities. The largest use of operating cash was
$1,766,506, which was used to fund an increase in accounts and notes
receivables. For the six-month period ending June 30, 2001, net cash of
$814,754 was provided by investing activities and net cash of $1,597,204 was
provided by financing activities primarily from the issuance of bonds by the
Company's finance company subsidiary. The Company's cash balances increased
by $2,169,653 from December 31, 2000 to June 30, 2001.
If necessary, the Company believes it can increase cash flow within
a relatively short period of time by liquidating its notes receivable
inventory or by liquidating its insurance agency inventory.
The Company's "Other Assets" account balance totaled $1,812,244 and
$1,416,492 on June 30, 2002 and June 30, 2001 respectively. Included in Other
Assets are intangible accounts such as goodwill, excess of cost over fair
value of net asset, deferred tax assets and servicing assets. If the
Company's total assets are adjusted to exclude Other Assets, then the
Company's adjusted total assets exceeded its total liabilities by $1,779,415
on June 30, 2002, and the Company's total liabilities exceeded adjusted total
assets by $1,114,542 on June 30, 2001. Future Company acquisitions will
likely increase the Other Assets account balances and could result in total
liabilities exceeding adjusted total assets in future periods. The Company's
"Investment in Agencies" account balances of $594,446 and $-0- represent the
cost, or market value if lower, of insurance agencies held in inventory for
resale to franchise agents on June 30, 2002 and June 30, 2001, respectively.
Although intangible, the Company believes that agency inventory assets differ
from other intangible assets, such as goodwill, because agency inventory is
held for a relatively short period of time and has a recently demonstrated
value.
The Company believes that its existing cash, cash equivalents and
funds generated from operating, investing and financing activities will be
sufficient to satisfy its normal financial needs. Additionally, the Company
believes that funds generated from future operating, investing and financing
activities will be sufficient to satisfy its future financing needs,
including the required annual principal payments of its long-term debt and
any potential future tax liabilities.
RELATED PARTY LOANS
The Company's related party loans and other information are
summarized in footnote number 13 to the Company's Consolidated Financial
Statements for the fiscal quarter ended June 30, 2002.
52
CRITICAL ACCOUNTING POLICIES
The Company established accounting policies are summarized in
footnote number 1 to the Company's Consolidated Financial Statements for the
fiscal quarter ended June 30, 2002. As part of its oversight
responsibilities, management continually evaluates the propriety of its
accounting methods as new events occur. Management believes that its policies
are applied in a manner which is intended to provide the user of the
company's financial statements a current, accurate and complete presentation
of information in accordance with Generally Accepted Accounting Principles.
When recognizing insurance commission revenues, management makes
assumptions regarding future policy cancellations which may result in
commission refunds and sets up a corresponding reserve. When recognizing
consulting and other revenues associated with the assistance provided to
agent buyers, management makes assumptions regarding when service is
performed and the amount of assistance provided. When recognizing the gain on
sale revenues associated with the sale of loan participations, management
makes key economic assumptions regarding loan prepayment speeds, credit
losses and discount rates as required by SFAS 140. "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities."
Although the Company has not made any recent acquisitions, the
Company applies the purchase method of accounting to its acquisitions. Under
this method, the purchase price is allocated to the underlying tangible and
intangible assets acquired and liabilities assumed based upon their
respective fair market values, with the excess recorded as goodwill. Such
fair market value assessments require judgments and estimates. Pursuant to
SFAS No. 142, "Goodwill and Other Intangible Assets", amounts recorded as
goodwill will be subject to annual evaluation of impairment which can result
in declines in the carrying value of assets recorded as goodwill.
With respect to the previously described critical accounting
policies, management believes that the application of judgments and
assumptions is consistently applied and produces financial information which
fairly depicts the results of operations for all years presented.
EFFECT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Footnote numbers 11 and 18 to the Company's Consolidated Financial
Statements for the fiscal quarter ended June 30, 2002 provide additional
information on the effect to the Company of the following recently issued
accounting pronouncements: SFAS No. 141, "Business Combinations", SFAS No.
142, "Goodwill and Other Intangible Assets", SFAS 143, "Accounting for Asset
Retirement Obligations" and SFAS No 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets".
53
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On February 27, 2001, the Company commenced the offering of 100,000
shares of its 2002 Convertible Preferred Stock, par value $25.00 per share
(the "2002 Convertible Preferred Stock"). For the first quarter period ending
March 31, 2002, the Company sold 26,350 shares of 2002 Convertible Preferred
Stock for an aggregate purchase price of $658,750. The sale of these
securities did not involve an underwriter and were sold in transactions
exempt from registration under the Securities Act of 1933 under Section
3(a)(11) and Rule 147. The facts that the Company relied upon to claim the
exemption were that the securities were only offered and sold to residents of
the State of Kansas, including business entities whose principal place of
business is within the State of Kansas. The Company's offering of 2002
Convertible Preferred Stock was terminated on February 14, 2002 and therefore
no shares were sold during the second quarter period ending June 30, 2002.
Prior to April 1, 2002, the holders of 2002 Convertible Preferred
Stock had the right, at their option, to convert all or part of their 2002
Convertible Preferred Stock to common stock of the Company ("Common Stock").
In the event that a holder of 2002 Convertible Preferred Stock elected to
convert its shares to Common Stock, one share of 2002 Convertible Preferred
Stock would be exchanged for one share of Common Stock. The conversion of
shares would occur immediately upon written notice to the Company. At any
time after April 1, 2002, the Company has the option to redeem its 2002
Convertible Preferred Stock by paying $27.50 for each share held. As of March
31, 2002 51,153 shares of 2002 Convertible Preferred Stock had been converted
to Common Stock. No shares were converted during the period ending June 30,
2002. The sale of these securities did not involve an underwriter and were
sold in transactions exempt from registration under the Securities Act of
1933 under Section 3(a)(11 ) and Rule 147. The facts that the Company relied
upon to claim the exemption were that the securities were only offered and
sold to residents of the State of Kansas, including business entities whose
principal places of business are within the State of Kansas.
On January 31, 2002, the Company commenced the offering of 10,000
shares of its 2002A Convertible Preferred Stock, par value $25.00 per share
(the "2002A Convertible Preferred Stock"). For the first quarter period
ending March 31, 2002, the Company sold 10,000 shares of 2002A Convertible
Preferred Stock for an aggregate purchase price of $250,000. The sale of
these securities did not involve an underwriter and were sold in transactions
exempt from registration under the Securities Act of 1933 under Section
3(a)(11) and Rule 147. The facts that the Company relied upon to claim the
exemption were that the securities were only offered and sold to residents of
the State of Kansas, including business entities whose principal place of
business is within the State of Kansas. The Company's offering of 2002A
Convertible Preferred Stock was terminated on February 15, 2002, accordingly
no shares were sold during the period ending June 30, 2002.
54
On or prior to April 1, 2002, the holders of 2002A Convertible
Preferred Stock had the right, at their option, to convert all or part of
their 2002A Convertible Preferred Stock to Common Stock. In the event that a
holder of 2002A Convertible Preferred Stock elected to convert its shares to
Common Stock, one share of 2002A Convertible Preferred Stock would be
exchanged for one share of Common Stock. The conversion of shares would occur
immediately upon written notice to the Company. At any time after April 1,
2002, the Company has the option to redeem its 2002A Convertible Preferred
Stock by paying $27.50 for each share held. As of March 31, 2002, 9,180
shares of 2002A Convertible Preferred Stock had been converted to Common
Stock. There were no 2002A Convertible Preferred Stock shares converted into
Common Stock during the second quarter ending June 30, 2002.
On March 4, 2002, the Company commenced the offering of 34,375
shares of its 2002B Convertible Preferred Stock, par value $32.00 per share
(the "2002B Convertible Preferred Stock"). For the first quarter period
ending March 31, 2002, the Company sold 13,663 shares of 2002B Convertible
Preferred Stock for an aggregate purchase price of $437,216. For the second
quarter period ending June 30, 2002, the Company sold 20,490 shares 2002B
Convertible Preferred Stock at $32.00 per share for an aggregate purchase
price of $655,680. The sale of these securities did not involve an
underwriter and were sold in transactions exempt from registration under the
Securities Act of 1933 under Section 3(a)(11) and Rule 147. The facts that
the Company relied upon to claim the exemption were that the securities were
only offered and sold to residents of the State of Kansas, including business
entities whose principal place of business is within the State of Kansas. The
Company's offering of 2002B Convertible Preferred Stock was terminated on
April 30, 2002.
On or prior to May 15, 2002, the holders of 2002B Convertible
Preferred Stock have the right, at their option, to convert all or part of
their 2002B Convertible Preferred Stock to Common Stock. In the event that a
holder of 2002B Convertible Preferred Stock elected to convert its shares to
Common Stock, one share of 2002B Convertible Preferred Stock would be
exchanged for one share of Common Stock. The conversion of shares would occur
immediately upon written notice to the Company. At any time after May 15,
2002, the Company has the option to redeem its 2002B Convertible Preferred
Stock by paying $35.20 for each share held. As of March 31, 2002, no shares
of 2002B Convertible Preferred Stock had been converted to Common Stock. As
of June 30, 2002 9,822 shares of 2002B Convertible Preferred Stock had been
converted to Common Stock.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's annual shareholders' meeting was held on April 30,
2002. The following table sets forth each of the proposals the stockholders
were asked to vote upon and the results of the meeting:
55
PROPOSAL RESULTS
-------- -------
1. Proposal for election of Robert D. Orr, Michael Hess, For 550,768
Leland G. Orr, John Allen, and Derrol Hubbard as Against 0
Board of Directors Abstain 0
2. Proposal to ratify the selection of Summers, For 550,768
Spencer, & Cavanaugh, CPA's, Chartered as the Against 0
Company's independent auditors for the fiscal Abstain 0
Year ending December 31, 2002.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS. The following exhibits are filed as part of this report. Exhibit
numbers correspond to the numbers in the exhibit table in Item 601 of Regulation
S-B:
EXHIBIT NO. DESCRIPTION
----------- -----------
23.1 Consent of Accountants(1)
- ---------------------------------
(1) Filed herewith.
(b) REPORTS ON FORM 8-K. During the second quarter of 2002, no reports on Form
8-K were filed.
56
SIGNATURES
In accordance with requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: August 19, 2002 BROOKE CORPORATION
By: /s/ Robert D. Orr
--------------------------------------------
Robert D. Orr, Chief Executive Officer
By: /s/ Leland G. Orr
---------------------------------------------
Leland G. Orr, Chief Financial Officer
57
EXHIBIT LIST
EXHIBIT NO. DESCRIPTION
2.0 Stock Purchase Agreement dated February 22, 2002, by and
between Brooke Bancshares and 1st Financial Bancshares, Inc.(2)
10.1 Waiver and Release dated March 28, 2002, by and between the
Company and William Tyer(3)
10.2 Waiver and Release dated April 18, 2002, by and between the
Company and Gerald Lanio(3)
23.1 Consent of Accountants(1)
- --------------------
(1) Filed herewith.
(2) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 2001.
(3) Filed previously.
58