| BROOKE CORP ITEM 1A RISK FACTORS Risks Related to Brooke Corporation A significant part of our business strategy involves adding new franchise locations, and our failure to grow may adversely affect our business, prospects, results of operations and financial condition |
| Our expansion strategy consists principally of adding new franchise locations |
| Our continued growth is dependent upon a number of factors, including the availability of adequate financing and suitable franchise locations on acceptable terms, experienced management employees, the ability to obtain required government permits and licenses and other factors, some of which are beyond our control |
| In addition, we compete for acquisition and expansion opportunities with entities that have substantially greater resources than us |
| We cannot assure you that we will be able to grow our business successfully through adding new franchise locations or by growing the operations of existing franchisees |
| Our failure to grow could have a material adverse effect on our business, prospects, results of operations and financial condition |
| Our franchisees’ financial performance may adversely affect their ability to repay amounts due to us |
| We have credit exposure with respect to loans made to our franchisees and with respect to our franchisees’ monthly statement balances |
| We lend money to our franchisees to acquire businesses and, in addition, we assist our franchisees by financing long-term producer development, cyclical fluctuations of revenues, receivables and payables |
| We make loans to help our franchisees with monthly fluctuations of revenues and record these advances on our franchisees’ monthly statements |
| We also grant temporary extensions of due dates for franchisee statement balances owed by franchisees to us |
| To fund long-term producer development of our franchisees, including hiring and training costs, we also extend credit to our franchisees which we refer to as “non-statement balances |
| ” Our franchisees depend on commission income to pay amounts due to us in respect of their loans, in respect of their statement balances, and in respect of their non-statement balances used to finance long-term producer development |
| If our franchisees’ businesses are not successful, they may be unable to pay statement or non-statement balances to us and may be unable to repay their loans, any of which would have a detrimental effect on us |
| As of December 2005, franchise statement balances totaled approximately dlra4 million, of which approximately dlra1dtta9 million we identified as “watch” balances because the balances were not repaid in full at least once in the previous four months |
| Non-statement balances totaled dlra3dtta3 million owed to us by our franchisees, of which dlra527cmam000 had been outstanding for more than 90 days |
| Our credit loss reserves are determined primarily by our watch statement balances |
| Other factors we consider in determining credit loss reserves are statement loss experience, management’s evaluation of the potential for future losses and management’s evaluation of the potential for future recoveries |
| We may not be able to accurately predict credit losses and, as a result, our credit reserves may not be sufficient to cover future losses, in which case, our financial condition and results of operations will be adversely affected |
| The ability of our borrowers to repay loans made to them by our finance subsidiary may be adversely affected by an increase in market interest rates |
| The loans we make to our franchisees and other borrowers through Brooke Credit typically bear interest at a variable or floating interest rate |
| The risk associated with rising interest rates will increase if coupled with a flattening or decreasing of property and casualty insurance premiums, and thus commissions |
| As well, an increase in interest rates could cause certain insurance companies to reduce their premium rates in an effort to sell more insurance 12 ______________________________________________________________________ [37]Table of Contents and invest the resulting premiums in fixed-income securities to get the benefit of these higher rates |
| In such event, the amount of commissions our franchisees earn could be adversely affected, further increasing the risk of default on loans made by us to our franchisees |
| See “Our business is dependent on the cyclical pricing of property and casualty insurance, which may adversely affect our franchisees’ performance and, thus, our financial performance |
| ” Our financial condition could be adversely affected if we are unable to fund our loans through sales to third parties |
| In an effort to broaden our funding sources and to provide an additional source of liquidity, we have sold participation interests in our loans and have accessed, and intend to attempt to continue to access, the asset-backed securitization markets |
| Under a typical asset-backed securitization, we sell a “pool” of secured loans to a special-purpose entity, generally a limited liability company |
| The special-purpose entity, in turn, typically issues securities that are collateralized by the pool and the holders of the securities are entitled to participate in certain pool cash flows |
| Several factors will affect our ability to sell participation interests in our loans and to complete securitizations, including: • conditions in the securities markets, generally; • conditions in the asset-backed securities markets; • the credit quality and performance of our financial instruments and loans; • our ability to adequately service our financial instruments and loans; • our ability to monitor our borrowers and to implement collateral preservation; and • the absence of any material downgrading or withdrawal of ratings given to securities previously issued in our securitizations |
| We make certain assumptions regarding the profitability of our securitizations and loan participations which may not prove to be accurate |
| In a securitization or participation sale transaction, we may recognize a gain on sale resulting from related retained interest and/or servicing rights in the securitized pool or loan when we sell the assets |
| The value assigned to the retained interest and/or servicing asset depends upon certain assumptions we make about future performance of the securitized loan portfolio or participation loan, including the level of credit losses and the rate of prepayments |
| If actual credit losses or prepayment rates differ from the original assumptions, the value of the retained interest and/or servicing asset may decrease materially |
| The value of the retained interest and/or servicing asset may also decrease materially as a result of changes in market interest rates |
| In addition, changes in the volume of assets securitized or loan participations sold due to our inability to access the asset-backed securitization markets, or other funding sources, could have a material adverse effect on our business, financial condition and results of operations |
| Decreases in the value of the retained interests and/or servicing asset in securitizations that we have completed or loan participations we have sold due to market interest rate fluctuations or higher than expected credit losses on prepayments also could have a material adverse effect on our business, financial condition and results of operations |
| The value of the collateral securing our loans to borrowers may be adversely affected by our borrowers’ actions |
| We make loans to franchisees and other borrowers through Brooke Credit primarily for the purpose of allowing them to acquire insurance agencies |
| These loans are secured by, among other things, insurance agency assets |
| Insurance agency assets in most cases are intangible, and the value of these assets may rapidly deteriorate 13 ______________________________________________________________________ [38]Table of Contents if our borrowers do not adequately serve their customers or if the policies they offer are not competitively priced |
| Reduction in the value of such assets could result in these loans being inadequately secured, which could adversely affect us in the event of a default on these loans |
| Carrier override and contingent or profit sharing commissions are difficult to predict, and any decrease in our receipt of such payments will adversely affect us |
| We derive a portion of our revenues from carrier override and contingent or profit sharing commissions based upon the terms of the contractual relationships between our insurance companies and us |
| Carrier override commissions are commissions paid by insurance companies in excess of the standard commission rates on specific classes of business |
| These amounts may be, but are not always, contingent on achieving a specific premium volume or profitability of the business |
| Contingent or profit sharing commissions are commissions paid by insurance companies based on the estimated profit that the companies make on the overall volume of business that we place with such companies |
| We generally receive these contingent commissions in the first and second quarters of each year |
| We do not account for carrier overrides separately |
| However, contingent or profit sharing commissions accounted for approximately four percent of our total revenues for the year ended December 31, 2005 |
| Due to the nature of these commissions, it is difficult for us to predict their payment |
| Increases in loss ratios experienced by insurance companies will result in a decreased profit to them and may result in decreases in payments of contingent or profit sharing commissions to us |
| Furthermore, we have no control over insurance companies’ ability to estimate loss reserves, which affects our profit sharing calculation |
| In addition, tightening of underwriting criteria by certain insurance companies, due in part to high loss ratios, may result in a lower volume of business that we are able to place with them |
| Our company override and contingent or profit sharing commissions affect our revenues, and decreases in their payment to us may have an adverse effect on our results of operations |
| Potential litigation and regulatory proceedings regarding commissions, fees, contingency payments, profit sharing and other compensation paid to brokers or agents could materially adversely affect our financial condition |
| The insurance industry has in recent years come under a significant level of scrutiny by various regulatory bodies, including state Attorneys General and the departments of insurance for various states, with respect to contingent compensation and other volume or profit based compensation arrangements |
| Attorneys General have issued subpoenas to various insurance brokerages and insurance companies |
| Certain of these investigations have led to complaints being filed against brokerages and insurance companies and some brokerages and insurance companies have stated that they will discontinue accepting or making, respectively, volume based and profit based payments |
| In addition to government investigations, class action lawsuits relating to these business practices have been filed against various members of the insurance industry |
| Negative publicity associated with these investigations, lawsuits and resulting settlements have precipitated increased volatility in the prices of securities issued by companies throughout the insurance industry |
| We have received inquiries from departments of insurance which are related to such compensation arrangements or are related to unethical or unlawful sales practices |
| These inquiries were not related to specific or general allegations of wrongdoing on our behalf |
| Rather, these inquiries were sent to numerous agents and brokers based upon their status as a licensed agent or broker, the volume of business they produce or other factors unrelated to allegations of wrongdoing |
| We cannot predict whether we will receive further inquiries or will receive subpoenas, or will become subject to investigations, regulatory actions, proceedings or lawsuits |
| The outcome of any such subpoena, investigation, regulatory action, proceeding or lawsuit could have a material adverse effect on our business or financial condition |
| The insurance industry has also recently come under a significant level of scrutiny by consumer advocacy groups, and certain media reports have advocated governmental action with respect to contingent and other volume or profit based compensation arrangements |
| The consumer groups and media reports typically 14 ______________________________________________________________________ [39]Table of Contents characterize these payments as creating an unacceptable conflict of interest and adding an unnecessary or even unfair consumer cost |
| If negative characterizations of such compensation arrangements become accepted by consumers, this could have a material adverse effect on the demand for our franchisees’ products and services and could materially adversely affect our results of operations and financial condition |
| Negative perception of such compensation arrangements or other activities could also result in us being subject to more restrictive laws and regulations as well as increased litigation, which may increase further our costs of doing business and adversely affect our profitability by impeding our ability to market our products and services, requiring us to change our marketing practices, products or services and increasing the regulatory burdens under which we operate |
| Our business is dependent on the cyclical pricing of property and casualty insurance, which may adversely affect our franchisees’ performance and, thus, our financial performance |
| Our franchisees are primarily engaged in insurance agency and brokerage activities and derive revenues from commissions paid by insurance companies, which commissions are based in large part on the amount of premiums paid by our franchisees’ customers to such insurance companies |
| In turn, we earn fees from our franchisees based upon the amount of such commissions payable by insurance companies, which fees make up a substantial portion of our revenues |
| Neither we nor our franchisees determine insurance premiums |
| Premium rates are determined by insurers based on a fluctuating market |
| Historically, property and casualty insurance premiums have been cyclical in nature, characterized by periods of severe price competition and excess underwriting capacity, or soft markets, which generally have an adverse effect upon the amount of commissions earned by our franchisees, followed by periods of high premium rates and shortages of underwriting capacity, or hard markets |
| The current insurance market generally may be characterized as “soft,” with a flattening or decreasing of premiums in most lines of insurance |
| As insurance carriers continue to outsource the production of premium revenue to independent brokers or agents, such as our franchisees, those insurance carriers may seek to reduce further their expenses by reducing the commission rates payable to our franchisees |
| The reduction of these commission rates, along with general volatility and/or declines in premiums, may significantly undermine our franchisees’ and our profitability |
| A reduction in commission rates may significantly undermine our borrowers’ ability to repay loans to us |
| Because we do not determine the timing and extent of premium pricing changes, we cannot accurately forecast our commission revenues, including whether they will significantly decline |
| As a result, our budgets for future acquisitions, capital expenditures, credit loss reserves, dividend payments, loan repayments and other expenditures may have to be adjusted to account for unexpected changes in revenues |
| We may not be able to successfully convert new franchises |
| Our ability to successfully identify suitable acquisition candidates, complete acquisitions, convert acquired businesses into our franchisees, and expand into new markets will require us to continue to implement and improve our operations, financial and management information systems |
| Our new franchises may not achieve levels of revenue, profitability, or productivity comparable to our existing franchises, or otherwise perform as expected |
| In addition, when we make an acquisition and effect a conversion, we are subject to a number of special risks, such as entry into unfamiliar markets and unanticipated problems or legal liabilities, some or all of which could have a material adverse effect on our results of operations and financial condition |
| We may be required to repurchase loans sold with recourse or make payments on guarantees |
| In some instances, Brooke Credit has sold loans to investors with full recourse, which may adversely affect our financial condition or results of operations in the event Brooke Credit is required to repurchase loans of poor quality |
| In addition, in connection with our activities of matching business purchasers and sellers, we have sometimes guaranteed payments from purchasers to sellers, which may adversely affect us in the event such a purchaser defaults on its obligations to such a seller |
| 15 ______________________________________________________________________ [40]Table of Contents We will be adversely affected if we do not have alternative sources of funds to repay our obligations as they mature |
| Loans made by Brooke Credit are usually amortized for a period of between twelve years and fifteen years |
| We have funded a portion of our loan portfolio with a funding facility which will require all or partial repayment by us prior to the time that loans made by us are scheduled to be repaid, and we will be adversely affected if we do not have alternative sources of funds to repay these obligations as they mature |
| We are dependent on key personnel |
| We are dependent upon the continued services of senior management, particularly the services of Robert D Orr, Leland G Orr, Shawn T Lowry, Michael S Lowry, Kyle L Garst and Anita F Larson |
| We have entered into an employment agreement with each of them |
| The loss of the services of any of these key personnel, by termination, death or disability, or our inability to identify, hire and retain other highly qualified personnel in the future, could have a material adverse effect on us |
| We currently do not maintain key employee insurance with respect to any of our officers or employees |
| Because we intend to change our method of funding our loans, our leverage will increase |
| Our goal is to recognize fewer gains on loan sales and more net interest revenue |
| As a result, our current liabilities are expected to increase because more loans will be funded through sales of participations that do not qualify as true sales and through our warehouse facility with DZ Bank AG Deutsche Zentral-Genossenschaftsbank |
| Our network of participating lenders may become uncomfortable with such an increase in current liabilities |
| As a result, we may not be able to sell participation interests in loans we originate on terms acceptable to us or at all, which would have a material adverse effect on our operations and prospects for growth |
| Our business, results of operations, financial condition or liquidity may be materially adversely affected by errors and omissions |
| Our franchisees are subject to claims and litigation in the ordinary course of business resulting from alleged errors and omissions |
| Because we are agent of record on policies written through our franchisees, claims against our franchisees may also allege liability against us for all or part of the amounts in question |
| Claimants may seek large damage awards and these claims may involve potentially significant defense costs |
| Errors and omissions could include, for example, our employees or sub-agents failing, whether negligently or intentionally, to place coverage or to notify insurance companies of claims on behalf of clients, to provide insurance companies with complete and accurate information relating to the risks being insured or to appropriately apply funds that we hold for our clients |
| It is not always possible to prevent and detect errors and omissions and the precautions we take may not be effective in all cases |
| While most of the errors and omissions claims made against us have been covered by our professional liability insurance, subject to our self-insured deductibles, our results of operations, financial condition or liquidity may be adversely affected if in the future our insurance coverage proves to be inadequate or unavailable or there is an increase in liabilities for which we self-insure |
| In addition, errors and omissions claims may harm our reputation or divert management resources away from operating our business |
| Termination of our professional liability insurance policy would adversely impact our financial prospects and our ability to continue our relationships with insurance companies |
| Without professional liability insurance, it is unlikely that we would be able to continue our relationships with insurance companies, which would adversely impact our financial prospects |
| Although we have an acceptable claims history, there can be no assurance that we will be able to maintain our professional liability insurance and in the event of the termination or non-renewal of our professional liability insurance policy, we may be unable to acquire this insurance on acceptable terms, or at all |
| 16 ______________________________________________________________________ [41]Table of Contents Efforts to comply with the Sarbanes-Oxley Act will involve significant expenditures; non-compliance with the Sarbanes-Oxley Act may adversely affect us |
| The Sarbanes-Oxley Act of 2002 that became law in July 2002 and rules subsequently implemented by the Securities and Exchange Commission and the National Association of Securities Dealers, Inc |
| require changes to some of our accounting and corporate governance practices, including the requirement that we issue a report on our internal controls as required by Section 404 of the Sarbanes-Oxley Act |
| If we are an accelerated filer (as defined in Exchange Act Rule 12b-2) as of June 30, 2006, we will be required to comply with Section 404 of the Sarbanes-Oxley Act with respect to the year ended December 31, 2006, and if not an accelerated filer, with respect to the year ended December 31, 2007 |
| We expect these new rules and regulations to continue to increase our accounting, legal and other costs, and to make some activities more difficult, time consuming and/or costly |
| In the event that we are unable to maintain or achieve compliance with the Sarbanes-Oxley Act and related rules, we may be adversely affected |
| If we fail to maintain an effective system of internal controls over financial reporting, we may not be able to accurately report our financial results or prevent fraud |
| As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm the value of our common stock |
| Effective internal controls over financial reporting are necessary for us to provide reliable financial reports, effectively prevent fraud and operate successfully as a public company |
| If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results will be harmed |
| In the last two years, we have made significant changes to our operations to improve our internal controls and have hired several individuals who have accounting experience, have accounting degrees and/or are certified public accountants |
| As a result of these improvements, our independent auditor’s letters to our audit committee in connection with the audits of our 2004 and 2005 results did not note any material weaknesses |
| We have, in the past, discovered and may in the future discover areas of our internal controls over financial reporting that need improvement |
| For example, during the audit of our 2003 financial statements, our independent auditors noted certain reportable conditions involving our internal controls and operations, primarily relating to accounting oversight, and indicated that our lack of accounting personnel was a material weakness |
| In connection with our 2004 audit, our independent auditor noted reportable conditions relating to accounting staff shortages and the need for additional documentation in support of estimates related to revenue recognition |
| No reportable conditions were noted by our independent auditor in connection with the audit of our financial statements for 2005 |
| To address past reportable conditions, we are continuing to take steps to improve our internal controls |
| For example, in addition to the hiring additional accounting staff, we have engaged independent accounting firms to assist our internal accounting staff with financial reporting and other accounting related matters |
| We cannot be certain that these measures, and any other steps we may take, will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future |
| Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operations or results or cause us to fail to meet our reporting obligations |
| As a public company we are subject to the reporting requirements of the Sarbanes-Oxley Act of 2002 |
| Beginning with the year ending December 31, 2006 (or December 31, 2007, depending upon the value of our common stock held by non-affiliates as of June 30, 2006), our management will be required to annually assess and report on our internal controls over financial reporting |
| We cannot assure you that our management will be able to complete its required assessment by our reporting deadline |
| If we are unable to adequately establish or improve our internal controls over financial reporting, we may report that our internal controls are ineffective and our independent auditors will not be able to issue an unqualified opinion on the effectiveness of our internal controls |
| Ineffective internal controls over financial reporting could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our common stock or could affect our ability to access the capital markets, and which could result in regulatory proceedings against us by, among others, the US Securities and Exchange Commission |
| 17 ______________________________________________________________________ [42]Table of Contents Our dependence on initial franchise fees creates an incentive for us to extend credit to borrowers that may not meet our stringent underwriting guidelines |
| A significant part of our revenues are derived from one-time initial fees we receive from assisting franchisees and others with the acquisition of businesses |
| Generating fees is largely dependent on our franchisees’ and others’ ability to obtain acquisition financing from Brooke Credit |
| Our dependence on these initial fees creates an incentive for us to extend credit to borrowers that may not meet our stringent underwriting criteria |
| Our failure to follow stringent underwriting guidelines could adversely affect the quality of the loans we make and adversely affect our financial condition and results of operations |
| Because a significant part of our loans and insurance-related revenues derive from operations located in five states, our business may be adversely affected by conditions in these states |
| A substantial portion of our loans and insurance-related revenues derive from operations located in the states of Texas, Kansas, Florida, California and Missouri |
| Our franchisees’ and our revenues and profitability are affected by the prevailing regulatory, economic, demographic, weather, competitive, industry and other conditions in these states |
| Changes in any of these conditions could make it more costly or difficult for our franchisees and us to conduct our business |
| Adverse regulatory or industry developments in these states, which could include fundamental changes to the design or implementation of the insurance regulatory framework, could have a material adverse effect on our results of operations and financial condition |
| Losses sustained by our Bermuda captive insurance companies may adversely affect us |
| Our captive insurance company subsidiary, DB Indemnity, Ltd, domiciled in Bermuda, is directly liable for losses and loss adjustment expenses under the terms of the insurance policies that it writes |
| In 2006, The DB Group, Ltd, also domiciled in Bermuda, will write some insurance policies relating to our errors and omissions coverage |
| DB Indemnity and The DB Group are required by Bermuda law to maintain minimum levels of statutory capital and surplus |
| In addition, each of DB Indemnity and The DB Group is required to maintain a minimum liquidity ratio whereby the value of its relevant assets is not less than a specified percentage of the amount of its relevant liabilities |
| If DB Indemnity and The DB Group fail to accurately assess the risks they assume, they may fail to establish appropriate premium rates and their reserves may be inadequate to cover their losses |
| Claim reserves represent estimates involving actuarial and statistical projections at a given point in time of expectations of the ultimate settlement and administrative costs of claims incurred |
| Captives use actuarial models as well as historical industry loss development patterns to assist in the establishment of appropriate claim reserves |
| For both casualty and property losses, actual claims and claim expenses paid may deviate, perhaps substantially, from the reserve estimates of DB Indemnity and The DB Group |
| If the claim reserves of DB Indemnity and/or The DB Group are determined to be inadequate, one or both of them will be required to increase claim reserves with a corresponding reduction in net income in the period in which the deficiency is rectified |
| Even though most insurance contracts have policy limits, the nature of property and casualty insurance and reinsurance is that losses can exceed policy limits for a variety of reasons and could significantly exceed the premiums received on the underlying policies |
| Our captives have not incurred any claims or claims expenses; however, claims, claims settlement patterns, legislative activity, social and economic patterns, and litigation and regulatory trends, all of which are difficult to predict, may have a substantial impact on the future loss experience of DB Indemnity and/or The DB Group |
| If the reserves of DB Indemnity and/or The DB Group are insufficient to cover claims, this could have a material adverse effect on future earnings DB Indemnity and/or The DB Group contribute to the Company and, accordingly, could have a material adverse effect on our prospects |
| In addition, if the reserves of DB Indemnity or The DB Group are insufficient to cover claims, because the risks insured are risks of the Company and its franchisees, in some instances, we may have to pay losses for which the reserves of DB Indemnity or The DB Group were not adequate to cover |
| 18 ______________________________________________________________________ [43]Table of Contents Our reliance on the Internet could have a material adverse effect on our operations and our ability to meet customer expectations |
| We rely heavily on the Internet in conducting our operations |
| A main component of our franchise program is providing franchisees and their personnel access to documents and other data over the Internet |
| This service requires efficient operation of Internet connections from franchisees and franchisee personnel to our system |
| These connections, in turn, depend on efficient operation of web browsers, Internet service providers and Internet backbone service providers, all of which have experienced periodic operational problems or outages in the past and over which we have no control |
| Any system delays, failures or loss of data, whatever the cause, could reduce customer satisfaction with our services and products |
| Moreover, despite the implementation of security measures, our computer system may be vulnerable to computer viruses, program errors, attacks by third parties or similar disruptive problems |
| These events could have a material adverse effect on our operations and our ability to meet customer expectations |
| Our network may be vulnerable to security breaches and inappropriate use by Internet users, which could disrupt or deter future use of our services |
| Concerns over the security of transactions conducted on the Internet and the privacy of users may inhibit the growth of the Internet and other online services |
| Our failure to successfully prevent security breaches could significantly harm our business, reputation and results of operations and could expose us to lawsuits by state and federal consumer protection agencies, by governmental authorities in the jurisdictions in which we operate, and by consumers |
| Anyone who is able to circumvent our security measures could misappropriate proprietary information, including personal customer data, cause interruptions in our operations or damage our brand and reputation |
| A breach of our security measures could involve the disclosure of personally identifiable information and could expose us to a material risk of litigation, liability or governmental enforcement proceedings |
| We cannot assure you that our financial systems and other technology resources are completely secure from security breaches, password lapses or sabotage, and we have occasionally experienced attempts at “hacking |
| ” We may be required to incur significant additional costs to protect against security breaches or to alleviate problems caused by any of these types of breaches |
| Any well publicized compromise of our security or the security of any other Internet provider could deter people from using our services or the Internet to conduct transactions that involve transmitting confidential information or downloading sensitive materials, which could have a detrimental impact on our franchise network |
| Furthermore, computer viruses may affect our ability to provide our services and adversely affect our revenues |
| Moreover, if a computer virus affecting our system were highly publicized, our reputation could be significantly damaged, resulting in the loss of current and future franchisees and customers |
| We are in a highly competitive market, which could result in reduced profitability |
| Our franchisees face significant competition |
| The popularity of Internet sales and enactment of the Financial Services Modernization Act have increased the number of potential competitors and allow highly capitalized competitors, like banks, to offer certain kinds of insurance services which are competitive with the products of our franchisees |
| If our prediction that the number of agents will increase is accurate, we will face greater competition for the services we provide to our franchisees |
| Our funeral services franchisees face competition for sales of funeral services from independent, regional and multinational operators, including large publicly traded owners and discount funeral service providers who provide products and services on discount or “a la carte” bases |
| In addition, they face significant competition with respect to pre-need insurance policies, pre-need trusts and other products |
| Many of our potential competitors have greater financial resources and market acceptance than we do |
| Our management, facilities and labor force may be insufficient to accommodate expected growth |
| If we grow more quickly than anticipated, our management, facilities and labor force may become insufficient to accommodate our expected growth |
| Also, although we have safeguards for emergencies and have 19 ______________________________________________________________________ [44]Table of Contents arranged for back-up facilities to process information if the processing center in Phillipsburg, Kansas is not functioning, the occurrence of a major catastrophic event or other system failure at our processing center could interrupt document processing or result in the loss of stored data |
| We compete in a highly regulated industry, which may result in increased expenses or restrictions in our operations |
| We conduct business in a number of states and are subject to comprehensive regulation and supervision by government agencies in many of the states in which we do business |
| The primary purpose of such regulation and supervision is to provide safeguards for policyholders rather than to protect the interests of shareholders |
| The laws of the various state jurisdictions establish supervisory agencies with broad administrative powers with respect to, among other things, licensing to transact business, licensing of agents and unfair trade practices |
| Although we believe that we are currently in material compliance with statutes and regulations applicable to our business, we cannot assure you that we will be able to maintain compliance without incurring significant expense, or at all |
| In addition, our franchisees are also subject to comprehensive regulations and supervision and we cannot ensure their material compliance with statutes and regulations applicable to our business |
| Our failure to comply, or the failure of our franchisees to comply, with any current or subsequently enacted statutes and regulations could have a material adverse effect on us |
| Furthermore, the adoption of additional statutes and regulations, changes in the interpretation and enforcement of current statutes and regulations, or the expansion of our business into jurisdictions that have adopted more stringent regulatory requirements than those in which we currently conduct business, could have a material adverse effect on us |
| We are subject to franchise law and regulations that govern our status as a franchisor and regulate some aspects of our franchise relationships |
| Our ability to develop new franchise locations and to enforce contractual rights against franchisees may be adversely affected by these laws and regulations, which could cause our franchise revenues to decline and adversely affect our growth strategy |
| We are subject to federal and state laws and regulations, including the regulations of the Federal Trade Commission as well as similar authorities in individual states, in connection with the offer, sale and termination of franchises and the regulation of the franchisor-franchisee relationship |
| Our failure to comply with these laws could subject us to liability to franchisees and to fines or other penalties imposed by governmental authorities |
| In addition, we may become subject to litigation with, or other claims filed with state or federal authorities by, franchisees based on alleged unfair trade practices, implied covenants of good faith and fair dealing, payment of royalties, location of stores, advertising expenditures, franchise renewal criteria or express violations of franchise agreements |
| We cannot assure you that we will not encounter compliance problems from time to time, or that material disputes will not arise with one or more franchisees |
| Accordingly, our failure to comply with applicable franchise laws and regulations, or disputes with franchisees, could have a material adverse effect on our results of operations, financial condition and growth strategy |
| Risks Related to Our Common Stock Our Chairman of the Board and Chief Executive Officer, Robert D Orr, is able to exert significant control over us and may act in a manner that is adverse to our other shareholders’ interests |
| As of December 31, 2005, Robert D Orr, our Chairman of the Board and Chief Executive Officer, beneficially owned approximately 47prca of our outstanding common stock and is the designated representative of the controlling group of shareholders that owns approximately 53prca of our outstanding common stock |
| As a result, he is able to exert significant influence over: • the nomination, election and removal of our board of directors; • the adoption of amendments to our charter documents; 20 ______________________________________________________________________ [45]Table of Contents • our management and policies; and • the outcome of any corporate transaction or other matter submitted to our shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets |
| Orr’s interests may conflict with the interests of other holders of our common stock and he may take actions affecting us with which other shareholders may disagree |
| For example, in order to retain control in the controlling group, Mr |
| Orr may decide not to enter into a transaction in which our shareholders would receive consideration for their shares that is much higher than the cost of their investment in our common stock or than the then current market price of our common stock |
| Orr may make at some future time will be in his absolute discretion |
| We are a controlled company that is exempt from certain stock exchange corporate governance requirements |
| Our common stock is currently listed on the Nasdaq National Market |
| Nasdaq generally requires a majority of directors to be independent and requires audit, compensation and nominating committees to be composed solely of independent directors |
| However, under the rules applicable to Nasdaq, if a group of shareholders owns more than 50prca of the voting power of a listed company, that company is considered a “controlled company” and, except for the rules relating to independence of the audit committee and meetings of the independent directors in executive sessions, is exempt from these independence requirements |
| We are a controlled company because Brooke Holdings, Inc, Robert D Orr, Leland G Orr, Shawn T Lowry, Michael S Lowry, Anita F Larson and Kyle L Garst, together own approximately 53prca of our outstanding common stock, and have orally agreed to vote their shares of common stock together as a group |
| The right to nominate, elect and remove directors rests solely with the representative of our controlling shareholder group |
| A majority of our directors are not independent and our shareholders do not have, and may never have, all the protections that these rules are intended to provide |
| If we become unable to continue to be deemed a controlled company, we would be required to meet these independence requirements and, if we are not able to do so, our common stock could be delisted from the stock exchange on which it is listed |
| Although shares of our common stock are listed on the Nasdaq National Market, our average daily trading volume has been approximately 10cmam000 shares during the three months ended February 28, 2006 |
| As a result of this low trading volume, shareholders may have difficulty selling a large number of shares of our common stock in the manner or at the price that might be attainable if our common stock were more actively traded |
| The price of our common stock may fluctuate significantly, which may make it difficult for shareholders to resell common stock when they want or at a price they find attractive |
| Since January 1, 2005, our common stock has traded at prices ranging between dlra9dtta75 and dlra26dtta25 on the American Stock Exchange (until June 17, 2005) or the Nasdaq National Market (on and after June 20, 2005) |
| We expect that the market price of our common stock will continue to fluctuate |
| Our common stock price can fluctuate as a result of a variety of factors, many of which are beyond our control |
| These factors include: • actual or anticipated variations in our quarterly operating results; • actual or anticipated changes in the dividends we pay on our common stock; • recommendations by securities analysts; • changes in interest rates and other general economic conditions; 21 ______________________________________________________________________ [46]Table of Contents • significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors; • operating and stock price performance of other companies that investors deem comparable to us; • news reports relating to trends, concerns, litigation, regulatory changes and other issues in our industry; • geopolitical conditions such as acts or threats of terrorism or military conflicts; and • relatively low trading volume |
| Kansas law and our articles of incorporation and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that shareholders may consider favorable |
| Certain provisions of our articles of incorporation and our bylaws and of Kansas law may discourage, delay or prevent transactions that our shareholders may consider favorable, including transactions that could provide for payment of a premium over the prevailing market price of our common stock, and also may limit the price that investors are willing to pay in the future for our common stock |
| For example, our articles of incorporation contain provisions, such as allowing our board of directors to issue preferred stock with rights superior to those of our common stock without the consent of our shareholders, which could make it more difficult for a third party to acquire us without the consent of our board of directors |
| In addition, our bylaws establish that our independent directors have neither the right nor the obligation to vote for the nomination, election or removal of directors of our company; those rights and obligations rest solely with the representative of our controlling shareholder group |