Brooke Corporation Q4 2007 Earnings Call Transcript

Brooke Corporation (BXXX)

Q4 2007 Earnings Call

March 17, 2008 1:00 pm ET

Executives

Leland G. Orr – President & Chief Executive Officer

Robert D. Orr – Founder & Chairman of the Board

Analysts

Herb Buchbinder – Wachovia Securities

Joe [Amarfio] – [J. Hoff]

Ritchie Russell – Oppenheimer

Presentation

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2007 Brooke Corporation earnings conference call. My name is Melanie and I’ll be your coordinator today. At this time all participants are in listen only mode. We will conduct a question and answer session at the end of this conference. (Operator Instructions) I would now like to turn the call over to Mr. Leland Orr, President and Chief Executive Officer. Please proceed.

Leland G. Orr

Good afternoon everyone. Thank you for listening to our annual earnings call. I am Leland Orr, President and Chief Executive Officer of Brooke Corporation. With me today is Robert Orr, Chairman of Brooke Corporation and our largest shareholder. The agenda for today’s call is as follows: I will start with some brief remarks on Brooke Corporation’s fundamental, Rob will follow me with his perspective of 2007. Finally, we will conduct a question and answer session for participants on the live call.

Before I begin I’d like to remind everyone that some of the information we’ll discuss today constitutes forward-looking statements. Actual results could differ materially from our current expectations. Some factors and uncertainties that could cause actual results to differ from those indicated in the forward-looking statements include the uncertainty that the company will achieve short term and long term profitability and goal growth, uncertainties associated with market acceptance and the demand for the company’s products and services, the impact of competitive products and pricing, the availability of funding sources, the exposure to market risk, uncertainties associated with the development of technology, changes in the law and economic, political and regulatory environment, changes in management, the dependence on intellectual property rights, the effectiveness of internal controls and risk factors described from time-to-time in the reports and registration statements filed by the company with the Securities & Exchange Commission.

Brooke undertakes no obligation to publically release any revisions to forward-looking statements to reflect the events or expectations after these remarks. Brooke provides a detail description of risk factors in periodic SEC filings and you’re encouraged to review these filings. The annual 10K was planned to be filed prior to the earnings call but we had a printing glitch and it should be filed shortly.

I want to reiterate something Rob said in this morning’s press release. We were a better managed, better capitalized and better organized company on December 31, 2007 than we were on December 31, 2006. Management delivered or is delivering on its 2007 plan to acquire an agent bank network to transfer ownership of its lending subsidiaries into a separate public company and to improve the quality of agents and its insurance network. The consolidated total network of Brooke Corporation including minority shareholders’ interest was approximately $116,547,000 on December 31, 2007 as compared to consolidated total equity of approximately $61,992,000 on December 31, 2006. Brooke Corporation book value per share of common stock increased to $3.66 from $3.24, a 13% increase from December 31, 2006. Brooke Corporation has been organized to provide more clarity and flexibility to investors by consolidating lending into a Aleritas Capital, a separate public company consolidating most insurance activities into Brooke Capital Corporation, another separate public company and focusing Brooke Corporation operations on agent banking.

We were profitable in 2007. Brooke Corporation reported a 2007 consolidated profit of $1,595,000 as compared to a 2006 consolidated profit of $10,742,000. Brooke Corporation reported 2007 consolidated revenues of $214,070,000 as compared to 2006 consolidated revenue of $177,081,000. Although Brooke Corporation was profitable in 2007 its earnings per share for the year were a -$0.10 per common share after accounting for preferred stock treatment. Brooke Corporation reported fourth quarter 2007 consolidated loss of $7,257,000 or $0.56 per share as compared to fourth quarter 2006 consolidated profit of $1,689,000. Brooke Corporation reported fourth quarter 2007 consolidated revenues of $39,333,000 as compared to fourth quarter 2006 consolidated revenues of $41,635,000. Primarily as a result of impairment and credit losses the earnings of our specialty finance company were about $9 million less than expected which had a significant adverse affect on our consolidated earnings.

Additionally, the new Aleritas initiatives implemented by Brooke Capital Corporation in the fourth quarter of 2007 which included a reduction of franchises royalties and slower location growth has had an adverse affect on our consolidated earnings. I want to again reiterate something Rob mentioned in this morning’s press release. Aleritas Capital and Brooke Capital have combined 2007 profits of $8.6 million and combined revenues of $205 million which demonstrates that are publically held shares in these companies hold significant value.

Now, I will turn it over to Rob Orr who will provide his perspective on 2007.

Robert D. Orr

Our strategy and philosophy remains unchanged. We own a 49% interest in specialty finance company Aleritas Capital, we own 82% of an insurance company, Brooke Capital Corporation and 100% of a bank, Brooke Savings Bank. In recent 10Q and 10K filings we noted that we prefer to hold investments in small public companies for the purpose of diversifying risk and increasing liquidity.

Let’s first discuss our investment in Aleritas Capital. We reduced our investment risk in Aleritas by selling approximately 40% of the company in 2007 as a result of a merger with Oakmont Acquisition Corporation. Our investment risk in Aleritas Capital has also been reduced because Aleritas is a public company which makes it easier to sell part or all of our investment. To further increase the liquidity of Aleritas Capital stock and to reduce our investment risk we recently assisted Aleritas with a stock exchange listing application and we’ve declared a dividend of approximately 2,300,000 shares of Aleritas Capital stock to Brooke Corporation shareholders. We view our holdings in Aleritas as a Brooke Corporation investment and not a Brooke Corporation operation. We are not represented on the Aleritas board of directors and after the Aleritas stock dividend our ownership will be less than 50%. As such, for accounting purposes we do not expect to consolidate Aleritas results with Brooke Corporation results in future accounting periods.

We’ve retained an investment banker to assist us in selling the remainder of our ownership in Aleritas Capital and to reinvest the proceeds in our agent mark banking program and also to invest a portion of the proceeds in the purchase of BXXX stock. The book value of our investment in Aleritas is currently approximately $74 million and we have issued debt secured by our stock in Aleritas totaling approximately $16 million. This sale will obviously generate significant cash for Brooke Corporation even after payment of a stock dividend to shareholders. We view our investment in Brooke Capital Corporation as a long term investment. As noted in Brooke Capital’s earnings call Brooke Capital’s management was pleased with the 2007 results. Excluding lender assistance expenses Brooke Capital Corporation enjoyed the most profitable year in their history.

We believe that the insurance company activities of Brooke Capital Corporation particularly to regards to non-standard auto insurance represents a promising opportunity because of our experience in this area. We also believe that the insurance agency or franchisee activities of Brooke Capital Corporation represent value that is often unnoticed. The Brooke Capital Corporation franchise activities generate nearly $1 billion in annual premium yet this insurance agency asset is carried on Brooke Capital Corporation books with little or no book value and there is no debt secured by the insurance agency. Brooke Capital Corporation obtained sufficient scale in 2007 that it implemented a new era initiative whereby the insurance agency that a) emphasized improvement in the quality of agents that are granted franchises and b) emphasized franchise growth. As a result of the new era initiative Brooke Capital Corporation has become less reliant on credit availability.

We believe that Brooke Corporation’s banker agent activity represent a promising future opportunity. Leland will directly responsible for banking operations. We recently completed the acquisition of a banker agent network and the assets of our agent bank now total approximately $140 million. We believe that our independent banker agent network will challenge traditional banks. As a result of reducing our ownership interest in Aleritas Capital to 49% we will no longer be required to consolidated Aleritas Capital assets and liabilities in the Brooke Corporation consolidated balance sheet. This reduction in Brooke Corporation consolidated assets and liabilities is therefore expected to increase overall capital to asset ratios and Brooke Corporation is therefore, not expected to require additional capital for banking activities.

The BXXX stock price has been trading near its book value of $3.56. Now, ordinarily I don’t pay much attention to our stock price as I believe in the long run if we run a good company the stock price will take care of itself. However, the clatter about our stock price in recent weeks has distracted management, its distracted investors, its distracted our customers so I feel obligated to comment. The overall credit environment has apparently impacted the market’s perception of our company particularly with regard to our specialty finance company. Our specialty company had a tough fourth quarter partially as a result of increased nervousness by regulators, rating agencies and auditors related to the current credit environment. Our hedge fund investors have also been affected by the current credit environment which is surly affected their perception of our company. Implementation of the new era initiative by our insurance agency has caused tension as poor performing franchisees are feeling performance pressure. Leland and I are working our tail off to make this company successful. Most of our net worths are in this company and we believe in it.

With that, I’d like to open up this call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Herb Buchbinder with Wachovia.

Herb Buchbinder – Wachovia Securities

Can you just comment on a couple of things, I’m a little confused about the transferring of some expenses and obligations from BCP to BRCR and there’s quite a bit of money involved and it does theoretically increase the earnings of one and reduce the earnings of the other. It relates I guess collateral whatever, I think you used it as collateral but can you kind of explain what’s being done with these two companies and what the effect is? And also I’d like you to just comment on the balance sheet of BXXX to see what you have on your balance sheet in the way of debt and equity. That’s two questions for you.

Robert D. Orr

Okay. Let’s start with the discussion regarding the insurance agency versus the financing company. As a result Herb of last year when we separated these companies that was obviously a very good thing to do. Our timing was very good when it comes to the finance company and taking it public and getting an additional $40 million in equity. But, now each the finance company and the insurance agency both have a different set of shareholders where in the past we were one big happy family the separation of expenses was not that important. However, the insurance agency assists the lender and what we call collateral preservation which is what you’re referring to but really it’s lender servicing. And, this is exemplified by collateral preservation agreement that is executed for each of the loans that is made and then solid either to participating lenders or in the asset backed securities to private investors. Now that we’re separate companies we have to make sure those expenses are allocated properly. Those collateral preservation agreements provide for a payment of these loan servicing expenses up until, and we disclosed this in our September filing, is up until we actually did the merger on November 15^th those loan servicing expenses were paid by the insurance agency and not by the lender. Now, that they’re two separate companies Herb we have to go back with what the collateral preservation agreement provide for and that is the payment of these lender expenses.

Herb Buchbinder – Wachovia Securities

Okay. So, these are actual cash expenses?

Robert D. Orr

Yes, they’re actually cash expenses.

Herb Buchbinder – Wachovia Securities

Okay. So, it will penalize the earnings then of Aleritas and benefit BCP?

Robert D. Orr

That seems to be what’s going to be the outcome here, Herb.

Herb Buchbinder – Wachovia Securities

Okay. When Aleritas had their call they expressed confidence in the earnings this year but I assume they took into account the additional expenses they’re going to have from changing the way this is allocated.

Robert D. Orr

Now, Herb what I would get is that they’re going to be pretty aggressive about reducing these loan servicing expenses which means that I think they would probably be more than likely get rid of poor performing franchisees instead of trying to rehabilitate them which obviously would reduce what we call collateral preservation expense. I’d imagine they’re going to be more aggressive about doing that.

Herb Buchbinder – Wachovia Securities

Okay. Next question was the actual balance sheet of BXXX after you’ve reduced your ownership in Aleritas to 49%, what kind of debt do you show on your balance sheet right now.

Robert D. Orr

After we sell Aleritas there will be no debt. We only have about gosh I can’t remember the exact number but I believe we have $15 million of debt, $16 million of debt that is tied to or secured by Aleritas stock. We sell our Aleritas stock and we’ll pay off all $26 million of our holding company debt. Part of that debt is also secured by our bank holding company stock but Herb, our total holding company debt is approximately $26 million which is secured by BRCR stock which has book value of about $72 million and our bank holding company which has a book value of about $15 million.

Herb Buchbinder – Wachovia Securities

Okay so most of the debt was incurred to pay the dividend. You haven’t made any comments yet about the dividend but you’re having a board meeting next month, correct?

Robert D. Orr

Yes, we are but let me give you a little perspective about that Herb because it brings up something that I’ve been quizzed about a lot. What happens with the dividend? If we liquidate our Aleritas stock then we will continue to pay out our dividend in cash because basically that’s a return of some of this money to our shareholders. If Aleritas stock price is not such that we feel like we want to sell it, in other words today’s environment, gosh you look at the headlines, Bear Stearns, whatever else is going on, if indeed today is not a real good time for us to be selling our finance company stock then what we’ll probably do is dividend out the rest of our shares in Aleritas to our shareholders and let them decide when they want to sell their stock. In that case, if we were to do that then obviously we would not be paying dividends in the future. However, that is not what we plan on doing at this point. We plan to liquidate our BRCR shares, having engaged an investment banker to help us do that and then use the proceeds to pay off our debt and to continue our dividend payments.

Herb Buchbinder – Wachovia Securities

Alright so the dividend will continue for the short run while you’re in this transition period?

Robert D. Orr

It will continue as we liquidate our Aleritas Capital shares.

Herb Buchbinder – Wachovia Securities

But, if you find out reasonably quick that it is very difficult to sell Aleritas then you’ll distribute those shares and then ultimately discontinue the dividend?

Robert D. Orr

Yeah. If we were to do that then we’re going to leave it up to our shareholders to decide if they want to sell those shares. But, I don’t know that’s going to be the case. We have a board meeting next month as you talked about here and we’ll have a better indication by then of whether or not we’re going to be dividending or whether we’re going to be selling.

Herb Buchbinder – Wachovia Securities

Last question, you originally projected that you’d earn $2 million from BXXX and the earnings came out to $1.5 but where was that $.5 million shortfall?

Leland G. Orr

That was just potentially an estimation at that time.

Herb Buchbinder – Wachovia Securities

Okay. But, you’re off by almost $.5 million dollars.

Robert D. Orr

Well yeah but Herb, as we walk through the consolidation process here sometimes it’s a little bit difficult and we didn’t get numbers from several of our subsidiaries until late so we made the best guess we could at the time.

Operator

(Operator Instructions) Our next question comes from the line of Joe [Amarfio] with [J. Hoff]. Go ahead.

Joe [Amarfio] – [J. Hoff]

I guess one of my questions comes from kind of similar to I think I talked to you a little bit about before but deals with BXXX guaranteeing some of those franchise loan payments, etcetera. Is that a payment that goes to BCP, is that correct? Or, does that go to Brooke Credit?

Leland G. Orr

That payment goes to Brooke Capital Corporation.

Joe [Amarfio] – [J. Hoff]

Brooke Capital, okay. That’s good. Rob, Kent wasn’t able to get on the phone but he wanted me to get on and let you know that he knows its been a tough time but we’re standing behind you guys and we’re sticking with it and we think there’s lots of good opportunity going forward. So, just keep up the good work and we’ll stay in touch.

Robert D. Orr

Joe, I appreciate that. We’re working our tails off here, we’re making hard decisions to try to make sure that everybody here is taken care of. Our investors, just like with you and Kent, we’ve gotten to be pretty good friends with and the recent decline in stock prices, we’re going to do our darnedest to reverse those declines and explain to our investors just how we got here in way of a company so we don’t run into this again. Joe, we’ve got a good company and I’m glad that you recognize that, it’s just been a little bit frustrating over the last couple of weeks to see what’s happening with our stock price because dog gone it, this is a good company, a good concept with good management, well capitalized as Leland talked about here so it’s been extremely frustrating to see us get bounced around like we have in recent weeks. So, thank you very much for saying that Joe.

Joe [Amarfio] – [J. Hoff]

My other question was beyond that cash payment to BCP, any other large cash payment outstanding that you foresee going forward other than the dividend?

Leland G. Orr

Between BXXX but from the standpoint of any collateral preservation between the two subsidiaries.

Operator

Our next question comes from the line of Ritchie Russell with Oppenheimer. Go ahead.

Ritchie Russell – Oppenheimer

Could you comment on what type of outlet that you see on kind of the merger and acquisition side of going out and purchasing these independent agencies?

Robert D. Orr

Ritchie, first of all one of the points that I tried to make in my comments was that we’re going to be, our insurance agency is going to be much more particular about the quality of franchisees. As a result, I think that you’re probably going to see less activity both on the merger and acquisition side as well as the startup side of our insurance agency operation. I think that these guys are probably going to be doing [inaudible] but they’re going to try to be doing it with franchisees and agents that are a lot better. Now, from an M&A standpoint I don’t know what the overall market is going to look like, I know that our take on it is going to probably not be as aggressive as what it has been in the past. That just based on some of the things that’s going on today and probably the restriction of available credit. I would imagine that having an impact in the overall M&A perspective and the overall M&A market.

Operator

Ladies and gentlemen that does conclude our question and answer session. I’d like to turn the call back over to Leland Orr for closing remarks. Please proceed.

Leland G. Orr

Thank you. I would like to thank everyone for participating in today’s call. We look forward to talking to you next quarter. Thank you.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. That does conclude the presentation, you may disconnect. Have a wonderful day.

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