UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended May 31, 2011
Commission file number 0-21210
JACOBS FINANCIAL GROUP, INC.
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(Exact name of registrant as specified in its charter)
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DELAWARE 84-0922335
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation)
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300 SUMMERS STREET, SUITE 970, CHARLESTON, WV 25301
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (304) 343-8171
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Securities registered under Section 12 (b) of the Exchange Act:
NONE
Securities registered under Section 12 (g) of the Exchange Act:
COMMON STOCK $.0001 PAR VALUE
Indicate by check mark if registrant is a well-known seasoned insurer, as
defined in rule 405 of the Securities Act.
Yes[ ] No[X]
Indicate by check mark if registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
Yes[ ] No[X]
Indicated by a check mark whether the issuer (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the proceeding 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.
Yes[X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will
not be contained, to the best of the registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act).
Yes[ ] No[X]
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of the
last business day of the registrant's most recently completed second fiscal
quarter. As of November 30, 2010: $1,541,882 (226,747,282 shares at $.0068 /
share)
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 244,409,253 shares of common
stock as of September 9, 2011.
TABLE OF CONTENTS
Page
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PART I
Item 1 Business 4
Item 1A Risk Factors 5
Item 2 Properties 5
Item 3 Legal Proceedings 5
Item 4 Submission of Matters to a Vote of Security Holders 5
PART II
Item 5 Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities 6
Item 6 Selected Financial Data 8
Item 7 Management's Discussion and Analysis of Financial Condition and
Results of Operations 8
Item 7A Quantitative and Qualitative Disclosures About Market Risk 22
Item 8 Financial Statements and Supplementary Data 22
Item 9 Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 23
Item 9A(T) Controls and Procedures 23
Item 9B Other Information 24
PART III
Item 10 Directors, Executive Officers and Corporate Governance 25
Item 11 Executive Compensation 27
Item 12 Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 30
Item 13 Certain Relationships and Related Transactions and Director
Independence 33
Item 14 Principal Accounting Fees and Services 34
PART IV
Item 15 Exhibits, Financial Statement Schedules 35
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PART I
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Item 1. BUSINESS
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The predecessor of Jacobs Financial Group, Inc. (the "Registrant", "JFG" or the
"Company"), NELX, Inc., was incorporated in the State of Kansas in March 1983 as
Nelson Exploration, Inc. In October 1993 the Company changed its name to NELX,
Inc. On or about December 29, 2005, NELX was merged with and into its
newly-formed wholly-owned subsidiary, JFG, a Delaware corporation. JFG survived
the merger as the Registrant. The merger effected a change in the Registrant's
name, a change in the state of incorporation of the Registrant from Kansas to
Delaware, and amendments to the Articles of Incorporation and Bylaws of the
Registrant. The Company holds four wholly owned subsidiaries, FS Investments,
Inc. ("FSI"), Jacobs & Company ("Jacobs & Co."), First Surety Corporation
("FSC") and Crystal Mountain Water, Inc. ("CMW").
FSI, incorporated in 1997 in West Virginia, is a holding company that was
organized to develop surety business through the formation or acquisition of
subsidiaries engaged in the issuance of surety bonds collateralized by
investment accounts that are professionally managed by Jacobs & Co. Through its
wholly-owned subsidiary, Triangle Surety Agency, Inc. ("Triangle Surety" or
"TSA"), FSI is actively engaged in the placement with insurance companies of
surety bonds, with an emphasis on clients engaged in regulated industries.
Jacobs & Co., incorporated in 1988 in West Virginia, is a SEC registered
investment advisory firm whose executive offices are located in Charleston, West
Virginia. Jacobs & Co. provides fee based investment advisory services to
institutions, companies and individuals. In June 2001, the Jacobs & Company
Mutual Fund (the "Fund") was organized as a series of the Advisors Series Trust.
On June 27, 2005, the Fund was reorganized as a series of Northern Lights Fund
Trust. The Fund's assets were liquidated in November 2009 and distribution of
proceeds to the Fund's shareholders was made on December 1, 2009.
On December 31, 2005 the Company acquired the former West Virginia Fire and
Casualty Company (WVFC), subsequently renamed First Surety Corporation (FSC),
from The Celina Mutual Insurance Company (Celina). The acquisition consisted of
the purchase of marketable investments and insurance licenses and did not
include any existing policies or customer base as the insurance lines being
offered by WVFC were not insurance lines that new ownership intended to pursue.
FSC is a West Virginia domiciled property and casualty company with licenses
(multi-line) in West Virginia, Indiana and Ohio, targeting primarily coal and
oil & gas industry surety markets in the Eastern United States. In 2006, the
Company was licensed for the surety line of business in West Virginia. In 2008,
the Company's license for surety was expanded to include Ohio.
CMW has an undeveloped leasehold interest in a mineral water spring located near
Hot Springs, Arkansas.
The Company is headquartered in Charleston, West Virginia, and through its
wholly-owned subsidiaries, employs a total of seven (7) full-time employees.
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Item 1A. RISK FACTORS
----------------------
As the Registrant qualifies as a small reporting company as defined by
ss.229.10(f)(1) of Regulation S-K, the Registrant is not required to provide the
information required by this item.
Item 2. PROPERTIES
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Through its wholly-owned subsidiary, CMW, the Company has an undeveloped
leasehold interest in a mineral water spring located near Hot Springs, Arkansas.
Under this leasehold arrangement, CMW is obligated for minimum lease payments in
the amount of approximately $180 per month with automatic options to extend the
leasehold through October 2026. CMW has the right to cancel the lease upon sixty
(60) days written notice at any time. The property is presently not being
actively explored or developed. During the 2002 fiscal year, management
evaluated the lease and determined the development was not currently feasible.
Accordingly, the Company recorded an impairment of $116,661 to its investment in
the lease. Opportunities will continue to be explored as they arise with respect
to the development or sale of the leasehold interest. The stock of CMW has been
pledged to a group of lenders as collateral (See Item 7 "Bridge-financing,
Commitments and Material Agreements").
Item 3. LEGAL PROCEEDINGS
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None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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Three new members have been appointed to the JFG Board of Directors since the
last annual meeting, held in December 2005, and will serve until the next called
meeting of shareholders which is not yet scheduled.
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PART II
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Item 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER
PURCHASES OF EQUITY SECURITIES.
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The Company's common stock is traded in the over-the-counter market under the
symbol JFGI (OTC Bulletin Board Symbol). The table below sets forth the high and
low price information for the Company's common stock for the periods indicated.
Such prices are inter-dealer prices, without mark-up, mark-down or commission
and may not represent actual transactions.
HIGH LOW
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FISCAL YEAR ENDED MAY 31, 2011
4th Quarter .01 .005
3rd Quarter .01 .004
2nd Quarter .009 .006
1st Quarter .008 .003
FISCAL YEAR ENDED MAY 31, 2010
4th Quarter .012 .003
3rd Quarter .015 .005
2nd Quarter .026 .006
1st Quarter .04 .003
As of May 31, 2011, there were approximately 900 holders of record of the
Company's common stock.
The Company has neither declared nor paid any cash dividends on its common stock
during the last two fiscal years, and it is not anticipated that any such
dividend will be declared or paid in the foreseeable future.
Regulatory approval of the acquisition of FSC by JFG was provided under the
condition that no dividends or monies are to be paid to JFG from FSC without
regulatory approval. For further information, see Notes C and O to the
Consolidated Financial Statements and "Restrictions on Use of Assets" within the
section of "Capital Resources and Financial Condition" of Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in Part II Item 7 of this Annual Report on Form 10-K.
As of May 31, 2011, shares of the Company's common stock authorized for issuance
under the Registrant's 2005 Stock Incentive Plan, that was approved by the
stockholders of the Company on December 8, 2005, are as follows:
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EQUITY COMPENSATION PLAN INFORMATION
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Number of Shares to be Issued Weighted-Average Number of Shares
Upon Exercise of Exercise Price of Remaining Available
Outstanding Options Outstanding Options For Future Issuance
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11,800,000 .0400 23,200,000
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There are no other equity compensation plans not approved by stockholders of the
Company.
UNREGISTERED SALES OF EQUITY SECURITIES
The Certificate of Designations, Powers, Preferences and Rights of Series A
Preferred Stock adopted by the Board of Directors of the Company on December 22,
2005 is set forth as Exhibit 4.1
The Certificate of Designations, Powers, Preferences and Rights of Series B
Preferred Stock adopted by the Board of Directors of the Company on December 22,
2005 is set forth as Exhibit 4.2
The Certificate of Designations, Powers, Preferences and Rights of Series C
Preferred Stock adopted by the Board of Directors of the Company on October 29,
2009 is set forth as Exhibit 4.3.
In the year ended May 31, 2011, 5,719,499 common shares were issued as
additional consideration to various lenders in private placements pursuant to
short term borrowings. 8,359,326 common shares were issued to holders exercising
the company's warrants. 12,952,185 common shares were issued to the Bridge
lenders. 500,000 common shares were issued to an individual as compensation for
services instrumental to advancing the Company's business plan. 309,282 common
shares issued April 1, 2011 in connection with the additional 2% stock quarterly
dividend associated with Series B Preferred shares that have requested to be
redeemed upon maturity. Subsequent to May 31, 2011, 732,000 common shares have
been issued in private placements to various individuals pursuant to short term
borrowings and 1,372,949 common shares were issued July 1, 2011 in connection
with the additional 2% stock quarterly dividend associated with Series B
Preferred shares that have requested to be redeemed.
The Registrant's Common Shares are issued under the restrictions of Rule 144 and
bear a legend to that effect.
The issuance of the aforementioned securities is exempt from registration
provisions of the Securities Act of 1933, as amended (the "Securities Act"), by
reason of the provision of Section 4(2) of the Securities Act, as transactions
not involving any public offering, in reliance upon, among other things, the
representations made by the investors, including representations regarding their
status as accredited investors (as such term is defined under Rule 501
promulgated under the Securities Act), and their acquisition of the securities
for investment and not with a current view to distribution thereof. The
securities contain a legend to the effect that such securities are not
registered under the Securities Act pursuant to an exemption from such
registration. The issuance of the securities was not underwritten.
-7-
Item 6. SELECTED FINANCIAL DATA
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As the Registrant qualifies as a small reporting company as defined by
ss.229.10(f)(1) of Regulation S-K, the Registrant is not required to provide the
information required by this item.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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During fiscal 2011, the Company has focused its primary efforts on the
development and marketing of its surety business in West Virginia and Ohio,
securing potential strategic relationships that will accelerate the progression
of the Company's business plan and raising additional capital to increase the
capital base of its insurance subsidiary, First Surety Corporation (FSC), to
facilitate entry into other state markets.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION AS OF AND FOR THE YEAR ENDED MAY
31, 2011
RESULTS OF OPERATIONS
Total revenues increased from approximately $1,372,000 in fiscal 2010 to
approximately $1,561,000 in fiscal 2011, while total operating expenses
decreased from approximately $1,830,000 in fiscal 2010 to approximately
$1,583,000 in fiscal 2011. This resulted in a loss from operations of
approximately $22,000 in 2011 as compared with a loss from operations of
$458,000 in fiscal 2010, an improvement of approximately $436,000.
The increase in revenues is largely attributable to the continued growth of the
surety business of FSC and the recognition of gains on the sale of investments
held by the company. However, net investment income decreased due to the receipt
of large principal payments on mortgage backed securities, which resulted in
large amortization of premiums recognized in the current year. The reduction in
expenses is attributable to decreased general and administrative expenses,
mostly related to the award of stock options on June 30, 2009, a reduction in
professional legal fees incurred in the Company's ongoing efforts to raise
additional capital to expand its business and penetrate new markets, and the
elimination of expenses absorbed as part of the Jacobs & Company Mutual Fund
which was liquidated on December 1, 2009.
Interest expense decreased from approximately $957,000 in fiscal 2010 to
approximately $908,000 in fiscal 2011, due mainly to the expense of common
shares issued attributable to the June 5, 2009 forbearance of the bridge loan
holders and despite additional borrowings incurred in relation to the Company's
efforts to raise additional capital financing and to provide financing of
current operations.
In the twelve-month periods ending May 31, 2011 and May 31, 2010, the Company,
upon advice of legal counsel, removed certain dormant accounts payable in the
aggregate amount of $54,358 and $200,240 based upon the conclusion that none of
the accounts represented an obligation that is legally enforceable against the
Company. Such removal was recorded as a gain on debt extinguishment.
-8-
CAPITAL RESOURCES AND FINANCIAL CONDITION
MANDATORILY REDEEMABLE PREFERRED STOCK
In conjunction with the acquisition of FSC at December 31, 2005, a restructuring
of the Company's financing was accomplished through the private placement of 350
shares of Series A Preferred stock and 3,980 shares of Series B Preferred stock,
each accompanied by warrants to acquire common stock of the Company in exchange
for cash totaling $3,335,000. $2,860,000 was used in the acquisition and funding
of the insurance subsidiary, with the remaining funds used to pay expenses
attributable to the acquisition and the funding of on-going operations.
Additionally, approximately $3,668,000 of indebtedness of the Company was
converted into preferred stock and warrants reducing the Company's borrowings
under short-term financing arrangements to approximately $167,000 as of December
30, 2005.
The Series A designation was designed for issuance to principals desiring surety
bonds under FSC's partially collateralized bonding programs. As designed,
proceeds from the sale of Series A preferred stock is down-streamed to FSC to
increase its capital and insurance capacity, although to the extent that
proceeds from the sale of Series B preferred shares was used in the initial
acquisition and funding of FSC, the Company was allowed to use such proceeds to
redeem Series B preferred stock (Company option to redeem) or for funding of
on-going operations. Effective June 1, 2007, the Company agreed to the
requirement of the West Virginia Insurance Department to downstream all future
proceeds from sales of Series A preferred stock in order to increase capital and
reserves of the insurance subsidiary to more substantial levels.
The Series A designation contains a conditional redemption feature providing for
the redemption of the Series A shares at any time after the seventh (7th)
anniversary of the Issue Date, provided that the principal no longer requires
surety bonds issued by FSC. Surety bonds currently being issued by FSC are
primarily for coal mining and reclamation permits, which are long-term in nature
and continually evolving whereby outstanding bonds are periodically released as
properties are mined and reclaimed and new bonds issued for properties to be
mined in the future. Accordingly, this source of financing was designed to be
long-term by nature.
The Series B designation was designed for issuance to investors in JFG and
contains both conversion rights to common stock and redemption features. Each
share of the Series B preferred stock is convertible, at the option of the
holder, into 1,000 shares of JFG common stock and can be converted at any time.
The Series B preferred shares were issued at a twenty-five percent (25%)
discount to the stated face value of $1,000 per share or approximately
$2,217,650 in total. Additional shares of the Series B were subsequently sold at
a discount of approximately four and one-half percent (4.5%) or approximately
$36,000. Additionally, the Series B preferred stock can be redeemed, at the
option of the holder, at full-face value plus accrued and unpaid cumulative
dividends, commencing with the fifth (5th) anniversary of the original issue
date. The Company has the option to redeem the Series B preferred shares at any
time after the first (1st) anniversary of the original issue date, subject to
the holder choosing to exercise conversion privileges prior to the stated
redemption date
-9-
The Company's outstanding Series B Preferred stock matured on December 30, 2010,
meaning that the holders of the Series B Stock became entitled to request that
the Company redeem their Series B Shares. As of this report, the Company has
received requests for redemption of 2,141.341 shares of Series B Preferred. The
aggregate redemption amount to which the holders are entitled as of June 30,
2011, is $3,310,824.
Under the terms of the Series B Preferred Stock, receipt of a redemption request
required the Company's Board to make a good faith determination regarding (A)
whether the funds of the Company legally available for redemption of shares of
Series B Stock are sufficient to redeem the total number of shares of Series B
Stock to be redeemed on such date and (B) whether the amounts otherwise legally
available for redemption would, if used to effect the redemption, not result in
an impairment of the operations of the Insurance Subsidiary. If the Board
determines that there is a sufficiency of legally available funds to accomplish
the redemption and that the use of such funds to affect the redemption will not
result in an impairment of the operations of the Insurance Subsidiary, then the
redemption shall occur on the Redemption Date. If, however, the Board determines
either that there are not sufficient funds legally available to accomplish the
redemption or that the use of such funds to effect the redemption will result in
an impairment of the operations of the Insurance Subsidiary, then (X) the
Company shall notify the holders of shares that would otherwise have been
redeemed of such fact and the consequences as provided in this paragraph, (Y)
the Company will use those funds which are legally available therefor and which
would not result in an impairment of the operations of the Insurance Subsidiary
to redeem the maximum possible number of shares of Series B Stock for which
Redemption Notices have been received ratably among the holders of such shares
to be redeemed based upon their holdings of such shares, and (Z) thereafter,
until such shares are redeemed in full, the dividends accruing and payable on
such shares of Series B Stock to be redeemed shall be increased by 2% of the
Series B Face Amount, with the amount of such increase (I.E., 2% of the Series B
Face Amount) to be satisfied by distributions on each Dividend Payment Date of
shares of Common Stock having a value (determined by reference to the average
closing price of such Common Stock over the preceding 20 trading days) equal to
the amount of such increase. The shares of Series B Stock not redeemed shall
remain outstanding and entitled to all the rights and preferences provided
herein. At any time thereafter when additional funds of the Company are legally
available for the redemption of shares of Series B Stock and such redemption
will not result in an impairment of operations of the Insurance Subsidiary, such
funds will immediately be used to redeem the balance of the shares of Series B
Stock to be redeemed. No dividends or other distributions shall be declared or
paid on, nor shall the Company redeem, purchase or acquire any shares of, the
Common Stock or any other class or series of Junior Securities or Equal Ranking
Preferred of the Company unless the Redemption Price per share of all shares for
which Redemption Notices have been given shall have been paid in full, provided
that the redemption price of any Equal Ranking Preferred subject of redemption
shall be paid on a pari passu basis with the Redemption Price of the Series B
Stock subject of redemption in accordance herewith. Until the Redemption Price
for each share of Series B Stock elected to be redeemed shall have been paid in
full, such share of Series B Stock shall remain outstanding for all purposes and
entitle the holder thereof to all the rights and privileges provided herein, and
Dividends shall continue to accrue and, if unpaid prior to the date such shares
are redeemed, shall be included as part of the Redemption Price.
-10-
On March 8, 2011, the Company's Board of Directors determined, based on the
criteria established under the terms of the Series B Preferred Stock, that there
were insufficient funds available for the redemption of Series B Preferred
Stock.
As an inducement to the initial preferred stock shareholders, warrants to
purchase 45,402,996 shares of common stock at an exercise price of one-tenth of
one cent ($.001) per share were issued. Warrants issued to Series A Preferred
holders have a seven year expiration; warrants issued to Series B Preferred
holders had a five-year expiration period. Such warrants were valued at
approximately $533,000 using the Black-Scholes pricing model. 386,667 warrants
expired unexercised on December 31, 2010, while 600,000 warrants remain
outstanding with an expiration date of December 31, 2012.
The Company experienced a loss after accretion of mandatorily redeemable
convertible preferred stock, and accrued dividends on mandatorily redeemable
preferred stock of $1,440,090 in fiscal 2011 as compared with a loss after
accretion of mandatorily redeemable convertible preferred stock, and accrued
dividends on mandatorily redeemable preferred stock of $2,338,531 in fiscal
2010.
EQUITY PREFERRED STOCK
In November 2009, as a means of alleviating obligations associated with the
Company's Series B Preferred Stock, which by its terms matured at the end of
2010, management proposed a recapitalization to assist in stabilizing the
financial position of the Company. The Board deemed it advisable to designate a
Series C Preferred Stock, with 10,000 authorized shares. The Recapitalization
consisted of the exchange of 6,804.936 Series B Shares for a combination of
Series C Shares and Common Stock Shares. For each Series B Share, the
participating holder received (i) one Series C Share and (ii) 2,000 shares of
JFG Common Stock. The accumulated dividend rights and preferences associated
with the Series B Shares transferred undiminished to the corresponding Series C
Shares. This exchange amounted to $6,269,051 of carrying value of Series B stock
being exchanged for Series C and Common Stock. 13,609,872 shares of Common Stock
were issued to the Series C Stock holders at the rate of 2,000 Common shares for
each exchanged Series B Stock, with the related cost associated with the Common
issuance offsetting the Series C carrying value by $265,120. The shares were
valued at approximately $.01948 per share based on the average quoted closing
price of the Company's stock for the 20-day period proceeding the date of the
transaction. Series C stock may be redeemed by the Company but does not have a
fixed maturity date and is considered permanent equity. Holders of over 70% of
the outstanding Series B Preferred Shares elected to participate in the
recapitalization
Unlike the Series B Shares with their fixed maturity date, the Series C Shares
are permanent equity, with accruing dividends only increasing the preference
amount that must be satisfied before junior securities may participate in
dividends or on liquidation. Accordingly, the effect of the accrual of dividends
with respect to the Series C Shares on the Company's balance sheet is to
increase the aggregate claimbythe Series C Shares on the equity of the
corporation and to increase the deficit in common equity, while having no effect
on the net equity of the corporation as a whole. The entitlement of the Series C
Shares to a priority in relation to junior securities with respect to dividends
and on liquidation does not create an obligation by the Company and therefore no
liability is recorded until the dividends are declared by the Board of the
Company. The Series C Shares are pari passu with the Series A Shares and Series
-11-
B Shares and no dividends or other distributions will be paid upon Common Shares
or any other class of Shares that is junior in priority to the Series C Shares
while dividends are in arrears.
The accrual of dividends on the equity preferred stock resulted in a charge to
common stockholders' equity and a credit to the equity of equity preferred stock
of $781,062 in fiscal 2011 as compared with a charge to common stockholders'
equity of $374,662 in fiscal 2010.
DIVIDEND PREFERENCE AND ACCRETION
The carrying value of the Series B Preferred Shares that did not convert are
listed in the Liabilities section of the Balance Sheet, and therefore the
accretion and dividends associated with the Series B stock after November 30,
2009 are deductions from net income. Series C stock has no accretion. The
recorded values of the Series A preferred stock is being increased to their
stated liquidation values using the interest method over a period of five years
and such amounts are categorized as accretion of mandatorily redeemable
preferred stock in the consolidated statement of operations.
The Series A designation is entitled to receive cumulative dividends at the rate
of 4.00% per annum and the Series B and Series C designations are entitled to
receive cumulative dividends at the rate of 8.00% per annum, with the Series A,
B and C designations having equal ranking and preference as to dividends and
liquidation rights and in priority to the Company's common stockholders. The
accrued (but undeclared) dividends associated with the Series C exchange
amounted to $2,295,624 and are included in the total amount exchanged for Series
C Shares.
At this time, management has chosen to defer payment of dividends to the holders
of the Series A, B and C Preferred Shares until the Company has sufficient cash
flow from operations to service the obligation.
BRIDGE-FINANCING, COMMITMENTS AND MATERIAL AGREEMENTS
Of primary importance to the Company's ability to fully implement its business
plan is the expansion of that business into additional states. Regulatory
approval and licensing is required for each state where FSC seeks to conduct
business. Management found entry into additional states (as a surety) was
proving difficult without the benefit of more substantial capital and reserves
due to FSC's status as a recent entry into this market. Accordingly, management
began pursuing avenues that would provide additional capital to facilitate such
expansion.
Beginning in fiscal 2008 and completed during the first quarter of fiscal 2009,
the Company obtained two rounds of bridge financing totaling an aggregate of
$3,500,000. The purpose of the financing was to pay expenses of operations and
to pay fees and expenses incurred or expected to be incurred in connection with
a larger permanent financing and, in addition, to increase the capital surplus
of FSC to make possible the reactivation of FSC's surety license in the state of
Ohio. The terms of the bridge-financing arrangement provide for payment in full
upon consummation by the Company of a qualified equity offering providing net
proceeds of at least $15 million on or before September 10, 2013; and because
such a qualified equity offering was not consummated by September 10, 2008,
accrued interest-to-date was payable, and quarterly installments of principal
and interest became payable over five years commencing in December 2008. The
interest rates on such notes were fixed at 10.00%. Payments due December 2008
and March 2009 were not made by the Company as scheduled, but a forbearance
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agreement was subsequently entered into with the bridge lenders on June 5, 2009,
modifying payment terms to cure the default (including increasing the interest
rate on the loans to 17%), issuing additional common stock to the loan holders,
and pledging the stock of the Company's subsidiary, CMW, as security for
repayment of the loans. The modification required the Company to pay interest of
$224,515 on June 10, 2009 and increase the quarterly payments by $67,185 (to a
total of $291,700) for eight consecutive quarters beginning September 10, 2009
to satisfy the arrearage. Although the Company has failed to make the payment
that was due September 10, 2009 and the payments that were due in the ensuing
quarters, management has remained in close contact with the bridge lenders,
providing reports regarding its efforts to refinance or otherwise repay the
bridge loans. To date, none of the bridge lenders has elected to pursue legal
remedies.
Certain equity inducements in the form of common stock of the Company were
provided under the terms of the bridge loan documents. Upon issuance of the
bridge notes, an aggregate of 7% of the outstanding common stock of the Company
was issued to the bridge lenders. Upon retirement of the notes upon consummation
of a qualified equity offering, the Company will issue to the bridge lenders a
percentage of the outstanding common stock of the Company which, when added to
the stock initially issued, may equal as much as 28% of the common stock of the
Company that would otherwise have been retained by the holders of the Company's
common shares immediately prior to the financing. Finally, because a qualified
financing was not completed by September 10, 2008, the Company was required to
issue to the bridge lenders under the terms of the loan documents a total of
2.8% of the Company's outstanding common shares at such date. An additional 2.8%
of the Company's outstanding common shares are required to be issued upon each
six-month anniversary date thereof until retirement of the notes.
RESTRICTIONS ON USE OF ASSETS
Regulatory approval of the acquisition of FSC by JFG was provided under the
condition that no dividends or monies are to be paid to JFG from FSC without
regulatory approval. Accordingly, cash, marketable investments, and other
receivables held by FSC are restricted from use to fund operations or meet cash
needs outside of the insurance company's domain. As of May 31, 2011, such assets
amounted to approximately $7.79 million.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
INVESTMENTS
Management believes the Company has the ability to hold all fixed income
securities to maturity. However, during fiscal year 2010, the Company determined
it may dispose of securities prior to their scheduled maturity due to changes in
interest rates, prepayments, tax and credit considerations, liquidity or
regulatory capital requirements, or other similar factors. As a result, the
Company reclassified all of its fixed income securities (bonds) and equity
securities as available-for-sale. These securities are reported at fair value,
with unrealized gains and losses, net of deferred income taxes, reported in
stockholders' equity as a separate component of accumulated other comprehensive
income.
-13-
INSURANCE PREMIUMS
Insurance premiums are recognized as revenue ratably over the term of the
related policies in proportion to the insurance protection provided. Premium
revenues are net of amounts ceded to reinsurers. Unearned premiums represent the
portion of premiums written, before ceded reinsurance which is shown as an
asset, applicable to the unexpired terms of policies in force determined on a
pro rata basis.
Insurance premium receivables are presented net of an estimated allowance for
doubtful accounts, which is based on a periodic evaluation of the aging and
collectability of premium receivables.
REINSURANCE
The Company limits the maximum net loss that can arise from large risks by
reinsuring (ceding) certain levels of such risk with reinsurers. Ceded
reinsurance is treated as the risk and liability of the assuming companies. The
Company cedes insurance to other companies and these reinsurance contracts do
not relieve the Company from its obligations to policyholders. Ceded premiums,
at a rate of 35% of written premium, are recognized as revenue ratably over the
term of the related policies. Ceded unearned premiums represent the portion of
ceded premiums written applicable to the unexpired terms of policies in force
determined on a pro rata basis.
Under the terms of its reinsurance treaty, the Company is entitled to a No
Claims Bonus from the reinsurers for each claim year in which no claims are
received. The bonus is 20% of the annual reinsurance premium and no claims have
been made since the inception of the treaty.
DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs, consisting of commissions, premium taxes and other
underwriting expenses which vary with, and are primarily related to, the
production of business, are deferred and amortized as a charge to income as the
related premiums are earned. The Company periodically tests that deferred policy
acquisition costs are recoverable based on the expected profitability embedded
in the reserve for unearned premium. If the expected profitability is less than
the balance of deferred policy acquisition costs, a charge to income is taken
and the deferred policy acquisition cost balance is reduced to the amount
determined to be recoverable. Anticipated investment income is considered in the
determination of the recoverability of deferred policy acquisition costs.
INTANGIBLE ASSETS
In exchange for the purchase price of $2.9 million for the acquisition of FSC,
the Company received cash and investments held by FSC totaling $2.75 million,
with the difference being attributed to the property and casualty licenses of
FSC in the states of West Virginia, Ohio and Indiana. Such licenses have
indefinite lives and are evaluated annually for recoverability and impairment
loss. Impairment loss, if any, is measured by estimating future cash flows
attributable to such assets based on forecasts and projections and comparing
such discounted cash flow amounts to the carrying value of the asset. Should
actual results differ from such forecasts and projections, such assets may be
subject to future impairment charges.
-14-
RESERVE FOR LOSSES AND LOSS EXPENSES
Reserves for unpaid losses and loss adjustment expenses of the insurance
subsidiary are estimated using individual case-basis valuations in conjunction
with estimates derived from industry and company experience. FSC has experienced
no claims for losses as of May 31, 2011.
FSC is currently licensed to write coal permit and miscellaneous fixed-liability
limit surety bonds in West Virginia and Ohio. Coal permit bonds are required by
regulatory agencies to assure the reclamation of land that has been disturbed by
mining operations, and accordingly, is a highly regulated process by federal and
state agencies. Such bonds are generally long-term in nature with mining
operations and reclamation work being conducted in unison as the property is
mined. Additionally, no two principals and properties are alike due to varied
company structures and unique geography and geology of each site.
In underwriting coal reclamation bonds, management obtains estimates of costs to
reclaim the properties in accordance with the specifications of the mining
permit, prepared by independent outside professionals experienced in this field
of work. Such estimates are then periodically updated and compared with
marketable securities pledged, and held for the benefit of FSC as collateral for
the surety bond, to mitigate the exposure to significant loss. Should the
principal default in its obligation to reclaim the property as specified in the
mining permit, FSC would then use the funds held in the collateral account to
reclaim the property or forfeit the face amount of the surety bond. Losses can
occur if the costs of reclamation exceed the estimates obtained at the time the
bond was underwritten or upon subsequent re-evaluations, if sufficient
collateral is not obtained, or if the collateral held has experienced
significant deterioration in value and if FSC is not otherwise able to recover
under its contractual rights to indemnification.
Miscellaneous fixed-liability limit surety bonds are generally fully
collateralized by the principal's cash investment into a collateral investment
account, managed by the Company's investment advisory subsidiary (Jacobs & Co.)
that mitigates FSC's exposure to loss. Losses can occur should the principal
default on the performance required by the bond and the collateral held in the
investment account experience deterioration in value.
In establishing its reserves for losses and loss adjustment expense, management
continually reviews its exposure to loss based on reports provided in
conjunction with the periodic monitoring and inspections performed along with
industry averages and historical experience. Management has estimated such
losses based on industry experience, adjusted for factors that are unique to the
Company's approach, and in consultation with consulting actuaries experienced in
the surety field.
LIQUIDITY AND GOING CONCERN
The Company has experienced operating losses of approximately $22,000 and
$458,000 for the fiscal years ended May 31, 2011 and 2010, respectively. The
Company losses increase when accretion of mandatorily redeemable convertible
preferred stock, and accrued dividends on mandatorily redeemable preferred stock
are taken into account to approximately $1,440,090 and $2,338,531 for the fiscal
years ended May 31, 2011 and 2010, respectively. Despite increased revenue and
the continued decline of operating expenses, the Company has not been able to
pay certain amounts due to professionals and others and continues to be unable
to pay its preferred stock dividend obligation and to cure its defaults in
-15-
certain quarterly payments due its bridge-financing lenders. A substantial
portion of the Company's cash flow is generated by its insurance subsidiary and
is subject to certain withdrawal restrictions. While management expects revenue
growth and cash flow to increase significantly as its business plan is fully
implemented, it is anticipated that losses will continue and the Company will be
cash constrained until FSC is able to develop a substantial book of business.
Effective April 1, 2009, FSC entered into a reinsurance agreement with Lloyd's
of London for its coal reclamation surety bonding programs. This agreement has
provided additional bonding capacity to FSC and has enabled FSC to write more
bonds and of greater size for its coal reclamation bonding clients. Management
expects this reinsurance arrangement to continue FSC's expansion of market share
and to result in increased cash flow for each of the Company's operating
subsidiaries.
Expansion of FSC's business to other states is a key component to fully
implementing the Company's business plan. In fiscal 2009, the Company was able
to increase the capital of FSC and reactivate FSC's insurance license in Ohio
and obtain authority to issue surety bonds in that state. However, management
has found that entry into other states (as a surety) has been difficult without
the benefit of more substantial capital and reserves due to FSC's status as a
recent entry into this market and the financial condition of the Company. This
is the case notwithstanding the reinsurance agreement entered into by FSC with
Lloyd's of London and the resulting increase in bonding capacity. Management
believes that if FSC's capital and surplus reserves were significantly more
substantial and the financial condition of the Company was stabilized, entry
into other states would be less challenging. Accordingly, management continues
to pursue avenues that can provide additional capital to increase the capacity
of its insurance subsidiary and to fund continuing operations as the business is
being fully developed. In addition, as an alternative means of addressing access
to markets, management is seeking to establish a relationship with any one of
several possible sureties that are licensed in those states other than West
Virginia and Ohio that comprise significant markets for the bonding programs of
FSC and could issue surety bonds that are underwritten and reinsured by FSC.
Under such a "fronting" arrangement, the need for additional capital at the
level of FSC to facilitate entry to other state markets would become secondary,
since the payment of a fronting fee to the insurance company with active
licenses would provide access to the state market without formal entry.
As a means of alleviating obligations associated with the Company's Series B
Preferred Stock, which by its terms matured at the end of 2010, management
proposed a recapitalization to assist in stabilizing the financial position of
the Company. Holders of the Series B Preferred Stock were offered the
opportunity to exchange their Series B Shares for an equal number of shares of a
new series of JFG preferred stock designated as Series C Preferred Stock plus
2,000 shares of JFG Common Stock. Series C Preferred Stock is equal in priority
to the Series B Preferred Stock, is entitled to dividends at the same rate as
Series B Preferred Stock, is entitled to convert to common stock of the Company
at a conversion rate of $.10 per common share (in contrast to $1.00 per share
for Series B Preferred) and may be redeemed by the Company but does not have a
fixed maturity date and, thus, is classified as permanent equity. Holders of
over 70% of the outstanding Series B Preferred Shares elected to participate in
the recapitalization. Management believes the recapitalization will improve the
Company's prospects for engaging in a larger financing, will assist FSC as it
applies to enter other state markets, and will be an impetus to the growth of
the Company's business.
Through the sharing of resources (primarily personnel) to minimize operating
costs, the Company and its subsidiaries attempt to minimize operating expenses
and preserve resources. Although FSC is now cash flow positive, the use of its
-16-
assets and profits are restricted to its stand-alone operation by regulatory
authority until its capital and surplus reserves reach more substantial levels.
And while growth of the FSC business continues to provide additional cash flow
to the Company's other subsidiaries, Jacobs & Company and Triangle Surety, it is
anticipated that working capital deficiencies will continue and will need to be
met either through the raising of additional capital or borrowings. However,
there can be no assurance that additional capital (or debt financing) will be
available when and to the extent required or, if available, on terms acceptable
to the Company. Accordingly, concerns as to the Company's ability to continue as
a going concern are substantial. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
COMPARISON OF RESULTS OF OPERATIONS FOR FISCAL 2011 WITH 2010
The Company experienced a loss from operations of approximately $22,000 in 2011
as compared with a loss from operations of $458,000 in fiscal 2010, an
improvement of approximately $436,000. After accretion of mandatorily redeemable
convertible preferred stock, and accrued dividends on mandatorily redeemable
preferred stock, the Company experienced a loss of $1,440,090 in fiscal 2011 as
compared with a loss after accretion of mandatorily redeemable convertible
preferred stock, and accrued dividends on mandatorily redeemable preferred stock
of $2,338,531 in fiscal 2010.
REVENUES
Revenues in fiscal 2011 amounted to $1,561,475 as compared with $1,371,783 in
fiscal 2010. The increase in revenues is largely attributable to the continued
growth of the surety business of FSC and the recognition of gains on the sale of
investments held by the company.
Revenue from the investment management segment, net of advisory referral fees,
was $266,963 in fiscal 2011 as compared with $262,635 in fiscal 2010,
representing an increase of $4,328. As investment advisory fees are based on the
market value of assets under management, some fluctuation will occur due to
overall market conditions. For the most part, however, such revenues will remain
relatively constant from year to year with any large fluctuations being
attributable to the growth or loss of assets under management. The increase in
revenues is primarily attributable to growth in individually managed funds.
Revenue from the surety insurance segment, consisting of FSC and TSA, was
$1,275,319 for fiscal 2011 as compared with $1,095,213 for fiscal 2010. Revenues
attributable to the insurance segment are as follows:
Year Ended May 31,
2011 2010
----------------- -----------------
Premiums earned $ 910,940 $ 768,908
Commissions earned 18,415 11,900
Net investment income 229,777 273,577
Net realized investment gains 116,187 40,828
----------------- -----------------
Total $ 1,275,319 $ 1,095,213
================= =================
-17-
Premium revenue is recognized ratably over the term of the policy period and
thus is relatively stable from period to period with fluctuations for comparable
periods generally reflecting the overall growth or loss of business. Whereas,
commission revenue, which is dependent on the timing of issuance or renewal of
bonds, is expected to be somewhat more "seasonable" from quarter-to-quarter with
fluctuations for comparable periods largely reflecting the overall growth or
loss of business. Investment income is expected to remain relatively consistent
from period to period, but can fluctuate based on interest rates, market
conditions, growth or loss of business, and investment funds expended in the
payment of claims.
The increase in revenues reflected above is attributable to increased surety
business that has been secured in fiscal 2011. Gross premium written in fiscal
2011 amounted to $1,613,912 as compared to $1,114,197 in fiscal 2010 and is
reflective of the growth experienced in this segment of the business for the
comparable periods. Commission income earned for the placement of bonds with
outside insurers has remained relatively stagnant.
FSC's investment holdings in fiscal 2011 averaged $7.192 million as compared
with $6.553 million for fiscal 2010, with investment yields decreasing slightly
from 4.1% to 3.57%. In addition, the amortization of premium for larger than
usual principal payments on mortgage backed securities during fiscal 2011
resulted in decreased investment income.
EXPENSES
Incurred policy losses represent the provision for loss and loss adjustment
expense for "incurred but not reported" (IBNR) losses attributable to surety
bonds issued by FSC. Incurred policy losses for fiscal 2011 have been recorded
as $204,323 or 22% of earned premium as compared to $178,531 or 23.2% of earned
premium for fiscal 2010. IBNR loss estimates have been based on industry
averages adjusted for factors that are unique to the FSC's underwriting
approach. As of May 31, 2011 FSC has not received any claims for losses on any
bonds underwritten since business began in 2006, therefore its actuaries have
approved reducing the percentage of premiums reserved for IBNR due to this
historical pattern.
Insurance policy acquisition costs represent charges to operations for
underwriting, commissions and premium tax attributable to surety polices issued
by FSC and are recognized ratably over the period in which premiums are earned.
In fiscal 2011 such costs amounted to $313,223 or 34.38% of earned premium as
compared with $249,478 or 32.4% in fiscal 2010. The increase of $63,745 in
expenses is attributable to costs associated to the increase in gross premium
written, while the increase as a percentage is attributable to the increase
specifically in new gross premiums written, which pay a higher commission than
renewal premiums.
-18-
General and administrative expenses for fiscal 2011 were $1,050,486 as compared
with $1,316,211 for fiscal 2010, representing a decrease of $265,725 and are
comprised of the following:
Year Ended May 31,
2011 2010 Difference
---------------- ----------------- ----------------
Salaries and related costs $ 483,250 $ 710,750 $ (227,500)
General office expense 112,148 111,203 945
Legal and other professional fees 137,250 171,535 (34,285)
Audit, accounting and related services 87,851 110,431 (22,580)
Travel, meals and entertainment 69,828 49,214 20,614
Other general and administrative 160,159 163,078 (2,919)
---------------- ----------------- ----------------
Total general and administrative $ 1,050,486 $ 1,316,211 $ (265,725)
================ ================= ================
Salaries and related costs, net of deferred internal policy acquisition costs,
decreased $227,500 and are comprised of the following:
Year Ended May 31,
2011 2010 Difference
------------------ ------------------ ------------------
Salaries and wages $ 487,341 $ 469,341 $ 18,000
Commissions 113,324 44,374 68,950
Payroll taxes 50,763 42,372 8,391
Stock option expense 16,782 251,631 (234,849)
Fringe benefits 72,796 54,027 18,769
Key-man life insurance 53,099 54,994 (1,895)
Deferred policy acquisition costs (310,855) (205,989) (104,866)
------------------ ------------------ ------------------
Total salaries and related costs $ 483,250 $ 710,750 $ (227,500)
================== ================== ==================
The increase in salaries and taxes is attributable to year end bonuses paid to
certain employees in December 2010 which were not paid in the previous year. The
decrease in stock option expense is attributable to the awarding of 10,000,000
shares of incentive stock options on June 30, 2009. Group health benefits
increased due to more employees being covered in 2011 and the rising cost of
health isurance premiums. The increase in commissions is attributable to FSC's
commission structure that pays a larger commission percentage on the origination
of a policy but reduced for subsequent policy renewals.
During fiscal year 2010, the Company incurred costs in response to a triennial
SEC examination of its investment advisor subsidiary as well as costs in
response to a statutory examination of its insurance subsidiary, required by the
West Virginia Insurance Commission. Despite these costs, legal and professional
fees decreased due to the need for significantly less general corporate legal
services and reduced costs related to the Company's pending acquisitions and
on-going efforts to obtain financing necessary to expand the Company's business
and penetrate new markets. General corporate services were reduced in fiscal
2011 due primarily to costs incurred in the recapitalization and exchange of
Series B Preferred shares for Series C Preferred shares in fiscal 2010, as well
as less review and assistance required in connection with the filing of the
Company's annual and interim reports with the Securities and Exchange
Commission.
-19-
Travel, meals and entertainment expense increased during fiscal 2011 due to
expanded efforts by management obtain financing necessary to expand the
Company's business and penetrate new markets
Other less significant increases and decreases were experienced in other general
administrative expenses categories in fiscal 2011 as compared to fiscal 2010.
Jacobs & Co. was the investment advisor to the Jacobs & Company Mutual Fund (the
"Fund"). The Fund was initially established by Jacobs & Co. to provide the
ability to manage smaller accounts in a more efficient and diversified manner
and provide an investment vehicle that would fit within the Company's broader
business plan of issuing smaller bonds under its collateralized surety programs.
The delays incurred by the Company in accomplishing a financing that would make
possible the full implementation of the Company's business plan coupled with the
Fund's lackluster performance during the interim period contributed to a gradual
decline in assets and the fixed cost maintenance of the Fund was a significant
expense to the Company. The Fund's independent Board of Trustees had determined
that unless the Fund experienced a significant growth in assets it would be
necessary to liquidate the Fund. Growth in assets was not accomplished. As a
result, the Board of Trustees directed the liquidation of the Fund's assets in
November and the distribution of the proceeds to the Fund's shareholders on
December 1, 2009.
While the Fund was responsible for its own operating expenses, Jacobs & Co., as
the investment advisor, had agreed to limit the Fund's aggregate annual
operating expenses to 2% of the average net assets. Under this expense
limitation agreement, Jacobs & Co. absorbed $75,038 of the Fund's operating
expenses in 2010 as compared to having no revenue or expense attributable to the
fund during fiscal 2011. The cumulative reimbursement due the Fund by J&C as of
May 31, 2011 was $54,866.
GAIN ON EXTINGUISHMENT OF DEBT
During the years ended May 31, 2011 and May 31, 2010, the Company, upon advice
of legal counsel, removed certain dormant accounts payable in the aggregate
amounts of $54,358 and $200,240, based upon the conclusion that none of accounts
represented an obligation that is legally enforceable against the Company. Such
removal was recorded as a gain on debt extinguishment.
INTEREST EXPENSE AND INTEREST INCOME
Interest expense for fiscal 2011 was $908,375 as compared with $956,973 in
fiscal 2010. The increase in interest expense is primarily attributable to the
bridge-financing arrangement forbearance agreement and increased debt and stock
issued as incentive for debt in 2010. Components of interest expense are
comprised of the following:
-20-
Year Ended May 31,
2011 2010 Difference
------------------ ------------------ -------------------
Interest expense on bridge financing $ 595,000 $ 583,829 $ 11,171
Expense of common shares issued or to be issued in
connection with bridge financing and other arrangements 132,662 269,850 (137,188)
Interest expense on demand and term notes 129,844 95,599 34,245
Other finance charges 50,869 7,695 43,174
------------------ ------------------ -------------------
Total interest expense $ 908,375 $ 956,973 $ (48,598)
================== ================== ===================
The decrease in the expense of common shares issued (or to be issued) for fiscal
year 2010 as compared to fiscal year 2010 was largely attributable to the
issuance of common stock on June 5, 2009 in relation to the agreement with the
bridge loan holders. Interest expense on demand and term notes increased due to
increased borrowings and other finance charges increased due to incentive fees
paid to a note holder to obtain borrowings as well as interest paid upon the
satisfaction of the payroll tax withholding liability with the U.S. Treasury.
PREFERRED STOCK ACCRETION AND DIVIDENDS
Accretion of mandatorily redeemable convertible preferred stock is comprised of
accretion of discount and accrued but unpaid dividends on preferred stock as
follows:
Year Ended May 31,
2011 2010
----------------- ---------------
Accretion of discount $ 10,888 $ 273,369
Accrued dividends - mandatorily redeemable
preferred stock 122,468 607,706
Accrued dividends - equity preferred stock 781,062 374,662
----------------- ---------------
$ 914,418 $ 1,255,737
================= ===============
The Series B class of stock is treated as a liability as of November 30, 2009
when the majority was exchanged for Series C equity stock. Therefore, accretion
of $106,366 and dividends of $324,455 associated with the Series B after that
date are deductions from net income and not included in the table above. The
decrease in the accretion of discount and accrued dividends on mandatorily
redeemable preferred stock results from this exclusion of Series B subsequent to
November 30, 2009, the application of the interest or constant yield method to
the initial discount recorded over a period of five years from the date of
issuance of the stock and the final month's accretion of the discount on Series
A Preferred stock recognized in December 2010. Series C equity stock accrues
dividends at the same rate as the Series B for which it was exchanged; however,
it is separated in the table above due to Series C not being mandatorily
redeemable. Series C does not accrete.
-21-
OFF BALANCE SHEET ARRANGEMENTS
The Company does not have any off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on the Company's financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources that is
material to investors.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-------------------------------------------------------------------
As the Registrant qualifies as a small reporting company as defined by
ss.229.10(f)(1) of Regulation S-K, the Registrant is not required to provide the
information required by this item.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
---------------------------------------------------
The following financial statements are included herein in response to Item 8:
Page
------------
Table of Contents F-1
Report of Independent Registered Public Accounting Firm F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Comprehensive Income (Loss) F-5
Consolidated Statements of Cash Flows F-6
Consolidated Statements of Mandatorily Redeemable Preferred
Stock and Stockholders' Equity (Deficit) F-7
Notes to Consolidated Financial Statements F-10
SCHEDULES
Schedule I - Summary of Investments - Other than
Investments in Related Parties F-45
Schedule II - Condensed Financial Information of Registrant F-46
Schedule III - Supplementary Insurance Information F-48
Schedule IV - Supplementary Insurance Information - Reinsurance F-49
Schedule VI - Supplemental Information F-50
-22-
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
--------------------------------------------------------------------------------
In connection with the audits for the years ended May 31, 2011 and May 31, 2010,
there have been no disagreements with independent accountants with respect to
any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure.
Item 9A(T). CONTROLS AND PROCEDURES
-----------------------------------
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
In connection with the preparation of this Annual Report on Form 10-K, an
evaluation was carried out by JFG's management, with the participation of JFG's
Chief Executive Officer and Chief Financial Officer, of the effectiveness of
JFG's disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934 (Exchange Act)) as of May
31, 2011. Disclosure controls and procedures are designed to ensure that
information required to be disclosed in reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported within the time
frames specified in SEC rules and forms and that such information is accumulated
and communicated to management, including the Chief Executive Officer and Chief
Financial Officer, to allow timely decisions regarding required disclosures.
During the evaluation of disclosure controls and procedures as of May 31, 2011,
control deficiencies were identified that constitute a material weakness in
internal control over financial reporting. Such control deficiencies relate to
the use of internally developed non-integrated accounting systems, lack of
internal review of account reconciliations, and lack of internal review of
general journal entries, elimination entries and the financial statement
consolidation process. As a result, JFG's Chief Executive Officer and Chief
Financial Officer concluded that as of May 31, 2011, JFG's disclosure controls
and procedures were ineffective. Changes will be considered as additional
financial resources and accounting staff become available.
Notwithstanding the above, JFG believes the consolidated financial statements in
this Annual Report on Form 10-K fairly present, in all material respects, JFG's
financial condition as of May 31, 2011 and 2010, and the results of its
operations and cash flows for the years ended May 31, 2011 and 2010 in
conformity with U.S. generally accepted accounting principals (GAAP).
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of JFG is responsible for establishing and maintaining adequate
internal control over financial reporting. JFG's internal control over financial
reporting is a process under the supervision of JFG's Chief Executive Officer
and Chief Financial Officer, designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of JFG's financial
statements for external purposes in accordance with GAAP.
-23-
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to risk that controls may become
inadequate because of change in conditions, or the degree of compliance with the
policies and procedures may deteriorate.
JFG management conducted an assessment of the effectiveness of the Company's
internal control over financial reporting as of May 31, 2011. In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control -
Integrated Framework. Based on this assessment, management concluded that the
Company's internal control over financial reporting was not effective as of May
31, 2011. A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of our annual or interim financial statements would not be
prevented or detected.
JFG management identified control deficiencies that, in the aggregate,
constitute a material weakness in internal control over financial reporting as
of May 31, 2011. Such control deficiencies relate to the use of internally
developed non-integrated accounting systems, lack of internal review of account
reconciliations, and lack of internal review of general journal entries,
elimination entries and the financial statement consolidation process.
Changes are to be considered as additional financial resources and accounting
staff become available. Management believes that overall controls over financial
reporting are in place, but may not, at this time, be sufficient to effectively
mitigate this material weakness.
This annual report does not include an attestation report of the company's
registered public accounting firm regarding internal control over financial
reporting. Management's report was not subject to attestation by the company's
registered public accounting firm pursuant to exemption rules of the Securities
and Exchange Commission that permit the company to provide only management's
report in this annual report.
Item 9B. OTHER INFORMATION
--------------------------
None
-24-
PART III
--------
Item 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERANCE
---------------------------------------------------------------
The directors and executive officers of the Company, their ages and positions
are as follows:
NAME AGE POSITION
---------------------- --- -------------------------------
John M. Jacobs 57 President and CEO/CFO, Director
C. David Thomas 58 Director
Mario J. Marra 57 Director
Bradley W. Tuckwiller 58 Director
Eric D. Ridenour 39 Director
Robert J. Kenney 64 Vice President
JOHN M. JACOBS
Mr. Jacobs is the founder of Jacobs & Co., an independent SEC registered
investment advisor, a Certified Public Accountant, and is licensed as a property
and casualty insurance agent in fifteen (15) states. Mr. Jacobs has served as a
Director and President of both Jacobs & Co. and FS Investments, Inc. since their
inception. Prior to establishing Jacobs & Co., in 1988, Mr. Jacobs was a
practicing public accountant for over thirteen years, during which he was a
managing partner of his accounting firm and a business and personal advisor to
his clients. Mr. Jacobs has served as a director and President of JFG since May
2001.
C. DAVID THOMAS
Mr. Thomas is a licensed resident insurance agent in West Virginia and holds
non-resident agent licenses in several other states. Mr. Thomas began his surety
career in 1976 with United States Fidelity and Guaranty Company and served as
the surety underwriter in the Charleston, WV branch office until 1979. At that
time he joined George Friedlander & Company, a regional insurance agency based
in Charleston, WV, where he presently serves as Vice President and Manager of
the Surety Department. Mr. Thomas is a shareholder and Director of George
Friedlander & Company. He has served as a Director of FS Investments, Inc. since
its inception in December 1997, and has served as a director of JFG since July
2002.
MARIO J. MARRA
Mr. Marra holds a Masters in Business Administration from the University of
Findlay and is the production supervisor for the Bridgeport WV facility of a
multinational aerospace and building industries company where he has been
employed since 1986. Mr. Marra joined the JFG board in June 2009.
BRADLEY W. TUCKWILLER
Mr. Tuckwiller is a licensed resident insurance agent in West Virginia. Mr.
Tuckwiller served in various bank management and credit administration
capacities for a small regional bank based in West Virginia from 1977 through
2001, concluding as Executive Vice President. Mr. Tuckwiller is the owner of a
-25-
consulting firm, providing assistance in financial and regulatory compliance
matters. He has served as a Director of Jacobs and Company since January 2008,
Director of First Surety Corporation since June 2010 and Director of JFG since
June 2009.
ERIC D. RIDENOUR
Mr. Ridenour is a Certified Public Accountant and has been employed since 2003
in the Charlotte, NC office of a national wealth management firm that serves
several hundred wealthy families. Mr. Ridenour serves as a Managing Director of
that firm. His prior employer was Deloitte & Touche from 1996 to 2003 where his
most recent position was Senior Manager. Mr. Ridenour was appointed as Director
of JFG in December 2009.
ROBERT J. KENNEY
Mr. Kenney has been Vice President of the Company since 2003. Mr. Kenney joined
FSI and Jacobs &Co. in 2000, and is President of First Surety Corporation and
Vice President and Assistant Portfolio Manager of Jacobs & Co. Mr. Kenney is a
licensed resident insurance agent in West Virginia and also holds Series 63 and
65 securities licenses. Prior to joining the Company Mr. Kenney had over 20
years experience in the oil and gas industry with Columbia Energy Group. With
Columbia, Mr. Kenney held various positions in Treasury, Human Resources, and
Law Departments and served as both Manager of Risk Management and Special
Projects Manager.
There are no family relationships among any of the Company's directors and
executive officers.
During the past five years, there have been no filings of petitions under
federal bankruptcy laws, or any state insolvency laws, by or against any
business of which any director or executive officer of the Company was a general
partner or executive officer at the time or within two years before the time of
such filing.
During the past five years, no director or executive officer of the Company has
been convicted in a criminal proceeding or been subject to a pending criminal
proceeding.
During the past five years, no director or executive officer of the Company has
been the subject of any order, judgment, or decree, not subsequently reversed,
suspended or vacated by a court of competent jurisdiction, permanently or
temporarily enjoining, barring, suspending or otherwise limiting his involvement
in any type of business, securities or banking activities.
During the past five years, no director or executive officer of the Company has
been found by a court of competent jurisdiction (in a civil action), the
Commission or the Commodity Futures Trading Commission to have violated a
federal or state securities or commodities law.
-26-
CODE OF ETHICS
The Company adopted a Code of Business Conduct and Ethics ("Code") that applies
to the Employees, Officers and Directors of Jacobs Financial Group, Inc.,
Triangle Surety Agency, Inc. and First Surety Corporation on November 13, 2007.
Further, the Code contains additional guidelines and standards for the Company's
principal executive officer and senior financial officer. A copy of the Code of
Business Conduct and Ethics can be obtained, without charge, upon written
request as follows:
Jacobs Financial Group, Inc.
Attn: Compliance Director
300 Summers Street, Suite 970
Charleston, WV 25301
Jacobs & Co., as an investment advisor, has its own compliance policy that was
revised and updated in September 2006 and is specifically designed to assure
compliance by Jacobs & Co. and its employees with the Investment Advisors Act of
1940 and the rules promulgated thereunder.
AUDIT (COMMITTEE) FINANCIAL EXPERT
The Board has determined that John M. Jacobs is the Audit (Committee) Financial
Expert as such term is defined in Item 407(d)(5)(ii) of Regulation SK. Mr.
Jacobs is not independent as that term is used in Item 7(d)(3)(iv) of Schedule
14A under the Securities Exchange Act.
Item 11. EXECUTIVE COMPENSATION
-------------------------------
SUMMARY COMPENSATION TABLE
The following table sets forth the compensation paid by the Company during the
fiscal years ended May 31, 2011 and 2010 to the Principal Executive Officer and
the two most highly compensated executive officers of the Company (the "Named
Executive Officers").
----------------- -------- -------------- ------------------- ---------- -------------- ----------------- ------------------
ALL
NAMES AND STOCK OPTION OTHER
PRINCIPAL SALARY BONUS/COMMISSIONS AWARDS AWARDS COMPENSATION TOTAL
POSITION YEAR ($) ($) ($) ($) (1) (2) ($) (3) ($)
----------------- -------- -------------- ------------------- ---------- -------------- ----------------- ------------------
John M. Jacobs, 2011 $150,000 $ 12,751 - $6,356 $ 28,652 $ 222,759
CEO 2010 $150,000 - - $ 147,311 $ 32,259 $ 304,750
----------------- -------- -------------- ------------------- ---------- -------------- ----------------- ------------------
Robert J. 2011 $ 75,000 $ 7,500 - $ 2,542 - $ 85,042
Kenney, VP 2010 $ 75,000 - - $ 55,830 - $ 130,830
----------------- -------- -------------- ------------------- ---------- -------------- ----------------- ------------------
(1) On June 30, 2009, the compensation committee of the board of directors
awarded 5,000,000, and 2,000,000 of incentive stock options to acquire
common shares at an exercise price of four cents ($.04) per share to Mr.
-27-
Jacobs and Mr. Kenney, respectively, which vest as set forth in the table
below. The term of the options is five years and they expire in June 2014.
------------------------- -----------------------------------------------
Vesting date Incentive Stock Option Awards
------------------------ ---------------------- -------------------------
John M. Jacobs Robert J. Kenney
------------------------- ---------------------- ------------------------
June 30, 2009 2,500,000 1,000,000
------------------------- ---------------------- ------------------------
June 30, 2010 2,500,000 1,000,000
------------------------- ---------------------- ------------------------
The amounts shown in this column represent the dollar amount recognized for
financial reporting purposes during the fiscal year for the fair value of
stock options received by the named individuals, excluding the effects of
forfeitures relating to service-based vesting conditions. The assumptions
used to compute the fair value are disclosed in "Note L, Stock-Based
Compensation", to the audited financial statements included herein under
Part II Item 8.
(2) Other compensation includes insurance premiums paid by the Registrant on
behalf of the named executive officer under verbal agreement with the
Executive Officer.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table sets forth for each of our Named Executive Officers certain
information regarding unexercised options and stock awards as of May 31, 2011.
---------------- -----------------------------------------------------------------------------------
OPTION AWARDS
---------------- -----------------------------------------------------------------------------------
EQUITY
NUMBER OF INCENTIVE PLAN
NUMBER OF SECURITIES AWARDS; NUMBER
SECURITIES UNDERLYING OF SECURITIES
UNDERLYING UNEXERCISED UNDERLYING
UNEXERCISED OPTIONS (#) UNEXERCISED OPTION
OPTIONS (#) UNEXERCISABLE UNEARNED EXERCISE OPTION
NAME EXERCISABLE OPTIONS (#) PRICE ($) EXPIRATION
DATE
---------------- ---------------- ----------------- ----------------- -------------- ---------------
John M. 5,000,000 - - $.04 06/30/2014
Jacobs, CEO
---------------- ---------------- ----------------- ----------------- -------------- ---------------
Robert J.
Kenney, VP 2,000,000 - - $.04 06/30/2014
---------------- ---------------- ----------------- ----------------- -------------- ---------------
OTHER EXECUTIVE COMPENSATION PLANS
The Company has no plans that provide for the payment of retirement benefits, or
benefits that will be paid primarily following retirement, including but not
limited to tax-qualified defined benefit plans, supplemental executive
retirement plans, tax-qualified defined contribution plans and nonqualified
defined contribution plans.
The Company has no contract, agreement, plan or arrangement, whether written or
unwritten, that provides for payment(s) to a named executive officer at,
following, or in connection with the resignation, retirement or other
-28-
termination of a named executive officer, or a change in control of the Company
or a change in the named executive officer's responsibilities following a change
in control.
DIRECTOR COMPENSATION
Directors of JFG are not compensated for board meetings or other duties as board
members.
Non-employee board members of FSC, which include some JFG board members, are
compensated at the rate of $150 per meeting.
The following table sets forth compensation received by non-employee directors
for the fiscal year ended May 31, 2011.
------------------------- ----------------------------------------- ------------
NAME FEES EARNED OR PAID IN CASH ($) TOTAL ($)
------------------------- ----------------------------------------- ------------
Brad Tuckwiller $1,350 $1,350
------------------------- ----------------------------------------- ------------
C. David Thomas $1,350 $1,350
------------------------- ----------------------------------------- ------------
Timothy Maddox $1,200 $1,200
------------------------- ----------------------------------------- ------------
Linda G. Aguilar $1,200 $1,200
------------------------- ----------------------------------------- ------------
-29-
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
--------------------------------------------------------------------------------
The following tables set forth the beneficial ownership of common stock of the
Company as of September 13, 2011 by (i) each person known by the Company to own
more than 5% of the Company's common stock, (ii) each of the directors, (iii)
the Named Executive Officers and (iv) all directors and executive officers as a
group. Unless otherwise noted, such persons have sole voting and investment
power with respect to such shares.
------------------------ ------------------------------------------- ------------------- ----- ---------------------
Amount and Nature
of
Name and Address of Beneficial Percent of
Title of Class Beneficial Owner Ownership (1) Class (2)
------------------------ ------------------------------------------- ------------------- ----- ---------------------
MORE THAN 5.00% BENEFICIAL OWNERSHIP
------------------------------------
Common John M. Jacobs 30,322,746 (3) 11.84%
300 Summers St. Suite 970
Charleston, WV 285301
Common Charles D. Ungurean 25,913,358 10.61%
8400 Dunsinane Drive
Dublin, OH 43017
Common Fay S. Alexander 12,796,931 (4) 5.24%
6318 Timarron Cove Lane
Burke, VA 22015-4073
Common William D. Jones 13,930,970 (5) 5.69%
513 Georgia Avenue
Chattanooga, TN 37403
Common Charles L. Stout 12,525,000 (6) 5.12%
Route 1, Box 41J
Bridgeport, WV 26330
Common A Thomas Falbo 12,351,937 (7) 5.06%
2700 E. DuPont Ave.
Belle, WV 25015
-30-
DIRECTORS AND NAMED EXECUTIVE OFFICERS
--------------------------------------
John M. Jacobs 30,322,746 (3) 11.84%
Common 300 Summers St. Suite 970
Charleston, WV 285301
Robert J. Kenney 2,920,000 (8) 1.19%
Common 809 Sherwood Drive
Charleston, WV 25314
Mario J. Marra 989,795 *
Common 204 Olive Street
Bridgeport, WV 26330
Eric D. Ridenour 9,421,761 (9) 3.80%
Common Two Morrocroft Centre
4064 Colony Road, Suite 195
Charlotte, NC 28211
C. David Thomas 992,295 *
Common P. O., Box 5157
Charleston, WV 25361
Bradley W. Tuckwiller 3,869,152 (10) 1.58%
Common P O Box 1294
Lewisburg, WV 24901
ALL DIRECTORS AND EXECUTIVE
Common OFFICERS AS A GROUP 48,515,749 18.47%
---------------------
* Represents beneficial ownership of less than one percent of the Company's
common stock.
1) Beneficial ownership is determined in accordance with the rules of the
Securities Exchange Commission and generally includes voting or investment
power with respect to securities. Shares of common stock issuable upon the
exercise of options or warrants currently exercisable within 60 days of
September 9, 2011 are deemed outstanding for computing the percentage
ownership of the person holding such options or warrants but are not deemed
outstanding for computing the percentage ownership of any other person.
-31-
2) Based on 244,409,253 shares of common stock issued and outstanding as of
September 9, 2011.
3) Includes 12,233,044 shares of common stock held in the name of FS Limited
Partnership ("FSLP") of which Mr. Jacobs is the sole general partner. Mr.
Jacobs has the power to vote and to direct the voting of and the power to
dispose and direct the disposition of the shares beneficially owned by
FSLP. Includes 785,000 shares of common stock held in the name of JF
Limited Partnership ("JFLP") of which Mr. Jacobs is the sole general
partner. Mr. Jacobs has the power to vote and to direct the voting of and
the power to dispose and direct the disposition of the shares beneficially
owned by JFLP. Includes 5,193,416 shares held in joint tenancy with spouse,
Kathleen M. Jacobs. Includes 5,000,000 in vested options to purchase
Company stock exercisable within 60 days of September 9, 2011. Includes the
right to convert Series C Preferred Stock holdings to 6,733,340 shares of
common stock exercisable within 60 days of September 9, 2011. John M.
Jacobs is the CEO and a member of the board of directors for the
Registrant.
4) Includes 11,425,111 shares of common stock held in the name of Graphite
Investment, LLC ("Graphite") and 1,157, 120 shares held in the name of
Southall Management Corporation ("Southall") of which Fay S. Alexander is
President (both entities). Includes the right to convert Series B Preferred
Stock holdings of Graphite and Southall to 2,141,341 shares of common stock
exercisable within 60 days of September 9, 2011. Includes 214,700 shares
held in joint tenancy with spouse, Dan C. Alexander.
5) Includes 9,970,578 shares of common stock held in joint tenancy with
spouse, Cynthia B. Jones. Includes the right to convert Series C Preferred
Stock holdings to 2,821,160 shares of common stock exercisable within 60
days of September 9, 2011.
6) Includes 25,000 shares of common stock held in the name of Applied
Mechanics Corporation of which Charles L. Stout is President and a
director. Includes 12,000,000 shares held in joint tenancy with spouse,
Marilyn J. Stout.
7) Includes 748,000 shares of common stock held in joint tenancy with spouse,
Vicke R. Falbo. Includes 6,518,667 shares of common stock held in
Montgomery Equipment Company, Inc., of which Mr. Falbo is President.
Includes the right to convert Series C Preferred Stock holdings to
4,666,670 shares of common stock exercisable within 60 days of September 9,
2011.
8) Includes 75,000 shares of common stock held in joint tenancy with spouse,
Lee Anne Kenney. Includes 335,000 shares of common stock held in the
Individual Retirement Account ("IRA") of, Robert J. Kenney. Includes
510,000 shares of common stock held in the Individual Retirement Account
("IRA") of spouse, Lee Anne Kenney. Includes 2,000,000 in vested options to
purchase Company stock exercisable within 60 days of September 9, 2011.
-32-
9) Includes 562,346 shares of common stock held in joint tenancy with spouse,
Mary K. Ridenour. Includes 937,504 shares of common stock held in the
Individual Retirement Account of Eric D. Ridenour. Includes the right to
convert Series C Preferred Stock holdings to 2,811,730 shares of common
stock held in joint tenancy with spouse. Includes the right to convert
Series C Preferred Stock holdings to 810,670 shares of common stock held in
the Individual Retirement Account of Eric D. Ridenour exercisable within 60
days of September 9, 2011.
10) Includes 75,000 shares of common stock held in joint tenancy with spouse,
Lynn D. Tuckwiller. Includes 1,000,000 in vested options to purchase
Company stock exercisable within 60 days of September 9, 2011.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
--------------------------------------------------------------------------------
For the past several years the Company's operating expenses were partially
funded by advances from its largest shareholder and chief executive officer,
John M. Jacobs. The source of funding for these advances originated with
obligations incurred by Mr. Jacobs with third parties (such obligations together
with the loans by Mr. Jacobs to the Company, "back-to-back loans") with interest
rates ranging from 6.75% to 12%.
To assure that repayments of the various borrowings by the Company that were
either guaranteed by Mr. Jacobs or loaned to the Company by Mr. Jacobs via such
back-to-back loan arrangements did not result in a deemed loan to Mr. Jacobs,
Mr. Jacobs entered into an Assumption Agreement with the Company, pursuant to
which Mr. Jacobs assumes, and agrees to hold the Company harmless from,
principal of specified indebtedness of the Company as and when necessary to
fully offset what might otherwise be deemed an advance of funds arising out of
the Company's financing activities.
During fiscal 2011, advances to the Company from Mr. Jacobs amounted to
$1,125,113, which included assumption of company debt in the amount of $624,303,
and repayments to Mr. Jacobs amounted to $1,162,182. As of May 31, 2011, the
balance due the Company from Mr. Jacobs was $29,965. The largest aggregate
amount outstanding to Mr. Jacobs in fiscal 2011 was $143,460.
During fiscal 2010, advances to the Company from Mr. Jacobs amounted to
$710,435, which included assumption of company debt in the amount of $185,652
and repayments to Mr. Jacobs amounted to $706,412. As of May 31, 2010, the
balance due to Mr. Jacobs from the Company was $7,104. The largest aggregate
amount outstanding to Mr. Jacobs in fiscal 2010 was $178,444.
The rate of interest on such amounts due from and obligations due to Mr. Jacobs
was 12% for both the 2010 and 2011 fiscal years.
As of September 13, 2011, $16,746 was owed by the Company to Mr. Jacobs.
DIRECTOR'S INDEPENDENCE
The board of directors ("Board") is comprised of five members, John M. Jacobs,
Bradley W. Tuckwiller, Mario J. Marra, Eric D. Ridenour, and C. David Thomas.
Mr. John M. Jacobs, who serves as Chief Executive Officer for the Company, Eric
-33-
D. Ridenour, who is the holder of notes from the Company, and Bradley W
Tuckwiller, who is owed fees for consulting services, are not independent within
the meaning of The Nasdaq Stock Market, Inc. listing standards.
There were no transactions, relationships or arrangements with Mr. Marra or Mr.
Thomas that would affect their independence.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
-----------------------------------------------
AUDIT FEES
Billings for principal accounting fees and services related to the annual audit
of financial statements, review of financial statements included in the
Company's Forms 10-Q, and services provided by the accountant in connection with
statutory and regulatory filings for the year ended May 31, 2011 amounted to
$99,894.
Billings for principal accounting fees and services related to the annual audit
of financial statements, review of financial statements included in the
Company's Forms 10-Q, and services provided by the accountant in connection with
statutory and regulatory filings for the year ended May 31, 2010 amounted to
$108,824.
AUDIT-RELATED SERVICES
Billings for assurance and related services by the principal accountant that are
reasonably related to the performance of the annual audit or review of financial
statements for the year ended May 31, 2011 amounted to $10,038.
Billings for assurance and related services by the principal accountant that are
reasonably related to the performance of the annual audit or review of financial
statements for the year ended May 31, 2010 amounted to $3,164.
FEES FOR TAX PREPARATION SERVICES
During fiscal 2011, billings for tax preparation services were $8,729. During
fiscal 2010, billings for tax preparation services were $9,221.
ADMINISTRATION OF AUDIT AND NON-AUDIT ENGAGEMENTS
The Company does not have a standing audit committee. The full Board of
Directors is performing the functions of the audit committee. The Board of
Director's policy is to pre-approve all audit and permissible non-audit services
provided by the independent auditors. These services may include audit services,
audit-related services, tax services and other services. Pre-approval is
generally provided for up to one year and any pre-approval is detailed as to the
particular service or category of services and is generally subject to a
specific budget. The independent auditors and management are required to
periodically report to the Board of Directors regarding the extent of services
provided by the independent auditors in accordance with this pre-approval, and
-34-
the fees for the services performed to date. The Board of Directors may also
pre-approve particular services on a case-by-case basis. The Board of Directors
pre-approved each audit and non-audit service rendered to the Company by its
independent Auditors as set forth above.
PART IV
-------
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
------------------------------------------------
(a)(1 The following financial statements are included in response to Item 8
herein:
Page
------------
Report of Independent Registered Public Accounting Firm F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Comprehensive Income (Loss) F-5
Consolidated Statements of Cash Flows F-6
Consolidated Statements of Mandatorily Redeemable Preferred
Stock and Stockholders Equity (Deficit) F-7
Notes to Consolidated Financial Statements F-10
(a)(2) The following financial statement schedules are included in response
to Item 8 herein:
Page
------------
SCHEDULES
Schedule I - Summary of Investments - Other than
Investments in Related Parties F-45
Schedule II - Condensed Financial Information of Registrant F-46
Schedule III - Supplementary Insurance Information F-48
Schedule IV - Supplementary Insurance Information - Reinsurance F-49
Schedule VI - Supplemental Information F-50
-35-
JACOBS FINANCIAL GROUP, INC.
TABLE OF CONTENTS
Page
------------
Report of Independent Registered Public Accounting Firm F-2
FINANCIAL STATEMENTS
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Comprehensive Income (Loss) F-5
Consolidated Statements of Cash Flows F-6
Consolidated Statements of Mandatorily Redeemable Preferred
Stock and Stockholders Equity (Deficit) F-7
Notes to Consolidated Financial Statements F-10
Page
------------
SCHEDULES
Schedule I - Summary of Investments - Other than
Investments in Related Parties F-45
Schedule II - Condensed Financial Information of Registrant F-46
Schedule III - Supplementary Insurance Information F-48
Schedule IV - Supplementary Insurance Information - Reinsurance F-49
Schedule VI - Supplemental Information F-50
F-1
Report of Independent Registered Public Accounting Firm
To the Board of Directors
Jacobs Financial Group, Inc.
Charleston, West Virginia
We have audited the accompanying consolidated balance sheets of Jacobs Financial
Group, Inc. and subsidiaries (the "Company") as of May 31, 2011 and 2010, and
the related consolidated statements of operations, comprehensive income (loss),
cash flows, and mandatorily redeemable preferred stock and stockholders' equity
(deficit) for the years then ended. Our audits also included the financial
statement schedules listed in the Index as Item 15. These consolidated financial
statements and financial statement schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedules based on our
audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company as of May 31, 2011 and 2010, and the results of its operations and its
cash flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, such
financial statement schedules, when considered in relation to the basic
consolidated financial statement taken as a whole, present fairly, in all
material respects, the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the company will continue as a going concern. As discussed in Note A to the
financial statements, the company's significant net working capital deficit and
operating losses raise substantial doubt about its ability to continue as a
going concern. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
/s/Malin, Bergquist & Company, LLP
-----------------------------
Malin, Bergquist & Co., LLP
Pittsburgh, PA
September 13, 2011
F-2
JACOBS FINANCIAL GROUP, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
MAY 31, 2011 MAY 31, 2010
--------------- -----------------
ASSETS
INVESTMENTS AND CASH:
Bonds and mortgaged-back securities available for sale, at market value $ 6,038,718 $ 6,618,472
(amortized cost - 05/31/11 $5,858,595; 05/31/10 $6,413,857)
Equity investments available for sale, at market value, net 453,456 -
(amortized cost - 05/31/11 $450,908; 05/31/10 $0)
Short-term investments, at cost (approximates market value) 1,007,617 264,079
Cash 290,569 74,571
--------------- -----------------
TOTAL INVESTMENTS AND CASH 7,790,360 6,957,122
Investment income due and accrued 38,736 31,833
Premiums and other accounts receivable 171,702 147,466
Prepaid reinsurance premium 264,763 214,385
Funds deposited with Reinsurers - 122,568
Deferred policy acquisition costs 190,711 128,453
Furniture, Automobile, and equipment, net of accumulated depreciation
of $158,267 and $144,102 respectively 33,140 18,380
Other assets 21,986 27,832
Intangible assets 150,000 150,000
--------------- -----------------
TOTAL ASSETS $ 8,661,398 % 7,798,039
=============== =================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Reserve for losses and loss expenses $ 815,512 $611,190
Reserve for unearned premiums 851,783 618,095
Advanced premium 20,195 -
Accrued expenses and professional fees payable 573,568 613,301
Accounts payable 144,997 141,287
Ceded reinsurance payable 77,635 -
Related party payable 99,209 96,160
Term note payable to related party 360,000 360,000
Demand notes payable to related party 45,035 91,490
Notes payable 4,874,500 4,159,119
Accrued interest payable 1,148,730 651,983
Accrued interest payable to related party 140,181 71,481
Other liabilities 89,257 212,995
Mandatorily redeemable Series B Preferred Stock, $.0001 par value
per share; 3,136.405 shares authorized; 2,817.004
shares issued and outstanding at May 31, 2011 and May 31,
2010; stated liquidation value of $1,000 per share 4,257,703 3,826,882
--------------- -----------------
TOTAL LIABILITIES 13,498,305 11,453,983
Series A Preferred Stock, $.0001 par value per share;
1 million shares authorized; 2,675 shares issued and outstanding
at May 31, 2011 and May 31, 2010, respectively; stated liquidation
value of $1,000 per share 3,138,623 3,005,266
--------------- -----------------
TOTAL MANDATORILY REDEEMABLE PREFERRED STOCK 3,138,623 3,005,266
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
STOCKHOLDERS' EQUITY (DEFICIT)
Series C Preferred Stock, $.0001 par value per share;
10,000 shares authorized; 6,804.936 shares issued and outstanding
at May 31, 2011 and May 31, 2010, respectively; includes $3,451,348
and $2,670,286 accrued Series C dividends, respectively 9,482,279 8,701,217
Common stock, $.0001 par value per share; 490 million shares authorized;
242,304,304 and 214,464,012 shares issued and outstanding
at May 31, 2011 and May 31, 2010, respectively 24,230 21,446
Additional paid in capital 3,549,443 3,404,431
Accumulated deficit (21,214,153) (18,992,919)
Accumulated other comprehensive income (loss) 182,671 204,615
--------------- -----------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) (7,975,530) (6,661,210)
--------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 8,661,398 $ 7,798,039
=============== =================
See accompanying notes.
F-3
JACOBS FINANCIAL GROUP, INC,
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
YEAR ENDED MAY 31,
2011 2010
--------------- ---------------
REVENUES:
Investment advisory services $ 266,963 $ 262,635
Insurance premiums and commissions 929,355 780,808
Net investment income 229,777 273,577
Net realized investment gains (losses) 116,187 40,828
Other income 19,193 13,935
--------------- ---------------
TOTAL REVENUES 1,561,475 1,371,783
OPERATING EXPENSES:
Incurred policy losses 204,323 178,531
Insurance policy acquisition costs 313,223 249,478
General and administrative 1,050,486 1,316,211
Mutual fund costs - 75,038
Depreciation 15,339 10,609
--------------- ---------------
TOTAL OPERATING EXPENSES 1,583,371 1,829,867
--------------- ---------------
NET INCOME (LOSS) FROM OPERATIONS (21,896) (458,084)
Gain on debt extinguishment 54,358 200,240
Accrued dividends and accretion of Series B Mandatorily
Redeemable Preferred Stock (430,821) (242,639)
Interest expense (908,375) (956,973)
--------------- ---------------
NET INCOME (LOSS) (1,306,734) (1,457,456)
Accretion of Mandatorily Redeemable Convertible
Preferred Stock, including accrued dividends (133,356) (881,075)
Accrued dividends on Series C Preferred Stock equity (781,062) (374,662)
--------------- ---------------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (2,221,152) $ (2,713,193)
=============== ===============
BASIC AND DILUTIVE NET INCOME (LOSS) PER SHARE:
NET INCOME (LOSS) PER SHARE $ (0.01) $ (0.01)
=============== ===============
WEIGHTED-AVERAGE SHARES OUTSTANDING 227,839,197 200,089,422
=============== ===============
See accompanying notes.
F-4
JACOBS FINANCIAL GROUP, INC,
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEAR MONTHS ENDED
MAY 31,
2011 2010
--------------- -----------------
COMPREHENSIVE INCOME (LOSS):
Net income (loss) attributable to common stockholders $ (2,221,152) $ (2,713,193)
OTHER COMPREHENSIVE INCOME (LOSS):
Reclassification of investments from Held to Maturity to Avaialble for Sale - 175,479
Net unrealized gain (loss) of available-for-sale investments arising during period 39,007 15,794
Reclassification adjustment for realized (gain) loss included in net income (60,951) (26,151)
--------------- -----------------
Net unrealized gain (loss) attributable to available-for-sale investments recognized
in other comprehensive income (21,944) 165,122
--------------- -----------------
COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (2,243,096) $ (2,548,071)
=============== =================
See accompanying notes.
F-5
JACOBS FINANCIAL GROUP, INC,
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
YEARS ENDED MAY 31,
2011 2010
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (Loss) $ (1,306,734) $ (1,457,456)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Unearned premium 203,505 (39,971)
Stock option expense 16,782 251,632
Stock issued (or to be issued) in connection with financing arrangements 124,197 261,958
Stock issued (or to be issued) in connection with dividend arrangements 1,877 -
Accrual of Series B preferred stock dividends and accretion 430,821 242,639
Provision for loss reserves 204,322 178,532
Amortization of premium 118,580 71,996
Depreciation 15,339 10,609
Accretion of discount (14,478) (9,217)
Realized (gain) loss on sale of securities (116,187) (42,926)
Gain on extinguishment of debt (54,358) (200,239)
Loss on disposal of equipment 336 -
Change in operating assets and liabilities:
Other assets 5,848 18,103
Premium and other receivables (24,236) (86,282)
Investment income due and accrued (6,152) (2,860)
Deferred policy acquisition costs (62,258) 14,720
Related party accounts payable 3,050 21,150
Accounts payable and cash overdraft (1,318) 82,846
Accrued expenses and other liabilities 652,181 482,536
-------------- --------------
NET CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES 191,117 (202,230)
CASH FLOWS FROM INVESTING ACTIVITIES
(Increase) decrease in short-term investments (743,538) 123,674
Costs of bonds acquired (2,623,919) -
Costs of mortgaged-backed securities acquired (1,977,132) (2,378,290)
Purchase of equity securities (448,992) -
Sale of securities available for sale 3,542,943 404,958
Repayment of mortgage-backed securities 1,622,788 1,490,926
Purchase of furniture and equipment (30,435) (5,819)
-------------- --------------
NET CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES (658,285) (364,551)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from related party debt 1,125,113 691,764
Repayment of related party debt (1,162,183) (687,741)
Proceeds from borrowings 1,762,000 1,017,500
Repayment of borrowings (1,046,619) (473,172)
Proceeds from issuance of Series A preferred stock - 10,000
Proceeds from exercise of common stock warrants 4,855 2,963
-------------- --------------
NET CASH FLOWS FROM FINANCING ACTIVITIES 683,166 561,314
NET INCREASE (DECREASE) IN CASH 215,998 (5,467)
CASH AT BEGINNING OF PERIOD 74,571 80,038
-------------- --------------
CASH AT END OF PERIOD $ 290,569 $ 74,571
============== ==============
SUPPLEMENTAL DISCLOSURES
Interest paid $ 210,266 $ 292,689
Income taxes paid - -
Non-cash investing and financing transaction:
Additional consideration paid for issuance of debt 124,201 261,958
See accompanying notes.
F-6
JACOBS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENT OF MANDATORILY REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE TWELVE MONTH PERIOD ENDED MAY 31, 2010
SERIES A SERIES B
MANDATORILY REDEEMABLE MANDATORILY REDEEMABLE
CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK
SHARES AMOUNT SHARES AMOUNT
----------------------------------------------
-------- ----------- --------- ------------
BALANCE,
MAY 31, 2009 2,665 $ 2,860,670 9,621.940 $11,429,440
Issuance of
Series A and B Preferred
Stock and common stock 10 10,000 - -
Issuance of common stock
as additional consideration
for financing arrangements - - - -
Exercise of warrants - - - -
Accretion of mandatorily
redeemable convertible
preferred stock - 17,881 - 255,487
Accrued dividends
of mandatorily
redeemable convertible
preferred stock - 116,715 - 490,991
Accrued dividends
of Series C equity
preferred stock - - - -
Exchange of Series C Preferred
Stock for Series B
Mandatorily Redeemable
Convertible Preferred Stock - - (6,804.936) (8,591,675)
Reclassification of Series B
from temporary equity
to liabilities - - (2,817.004) (3,584,243)
Increase (Decrease)
in accrual of common
shares to be issued in
connection with
financing arrangements - - - -
Common stock
option expense - - - -
Unrealized net gain
(loss) on available for
sale securities - - - -
Net income (loss), year
ended May 31, 2010 - - - -
------- ----------- --------- ------------
BALANCE,
MAY 31, 2010 2,675 $ 3,005,266 0.000 $ -
---------------------------------------------
(CONTINUED)
See accompanying notes.
F-7
JACOBS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENT OF MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE TWELVE MONTH PERIOD ENDED MAY 31, 2010 (CONTINUED)
----------------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY (DEFICIT)
----------------------------------------------------------------------------------------------------
SERIES C
COMMON SHARES PREFERRED STOCK
------------------------------------- --------------------
ACCUMULATED
ADDITIONAL OTHER
PAID-IN AMOUNT ACCUMULATED COMPREHENSIVE
SHARES AMOUNT CAPITAL SHARES AND APIC DEFICIT INCOME TOTAL
(LOSS)
----------------------------------------------------------------------------------------------------
BALANCE,
MAY 31, 2009 179,682,912 17,968 $ 2,626,236 - $ - $(16,279,725) $ 39,493 $(13,596,028)
Issuance of Series A and B
Preferred Stock and common stock - - - - - - - -
Issuance of common stock as
additional consideration for
financing arrangements 18,207,560 1,820 348,184 - - - - 350,004
Exercise of warrants 2,963,668 297 2,668 - - - - 2,965
Accretion of mandatorily
redeemable convertible
preferred stock - - - - - (273,368) - (273,368)
Accrued dividends of mandatorily
redeemable convertible
preferred stock - - - - - (607,706) - (607,706)
Accrued dividends of Series C
equity preferred stock - - - - 374,664 (374,664) - -
Exchange of Series C Preferred
Stock for Series B Mandatorily
Redeemable Convertible
Preferred Stock 13,609,872 1,361 263,759 6,804.936 8,326,553 - - 8,591,673
Reclassification of Series B
from temporary equity
to liabilities - - - - - - - -
Increase (Decrease) in accrual
of common shares to be issued in
connection with financing
arrangements - - (88,047) - - - - (88,047)
Common stock option expense - - 251,631 - - - - 251,631
Unrealized net gain (loss) on
available for sale securities - - - - - - 165,122 165,122
Net income (loss), year
ended May 31, 2010 - - - - - (1,457,456) - (1,457,456)
----------------------------------------------------------------------------------------------------
BALANCE,
MAY 31, 2010 214,464,012 $ 21,446 $ 3,404,431 6,804.936 $ 8,701,217 $(18,992,919) $ 204,615 $ (6,661,210)
----------------------------------------------------------------------------------------------------
See accompanying notes.
F-8
JACOBS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENT OF MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE TWELVE MONTH PERIOD ENDED MAY 31, 2011
-----------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY (DEFICIT)
SERIES A -----------------------------------------------------------------------------------------
MANDATORILY REDEEMABLE COMMON STOCK SERIES C PREFERRED ACCUMULATED
------------------------------ --------------------- OTHER
ADDITIONAL COMPREHENSIVE
PREFERRED STOCK PAID-IN AMOUNT ACCUMULATED INCOME
SHARES AMOUNT SHARES AMOUNT CAPITAL SHARES AND APIC DEFICIT (LOSS) TOTAL
----- ---------- ----------- ------- ---------- --------- ----------- ------------ -------- ------------
BALANCE, MAY 31, 2010 2,675 $3,005,266 214,464,012 $21,446 $3,404,431 6,804.936 $ 8,701,217 $(18,992,919) $204,615 $(6,661,210)
Issuance of common
stock as compensation
for services - - 500,000 50 1,998 - - - - 2,048
Issuance of common
stock as additional
consideration for
financing arrangements - - 18,980,966 1,898 117,386 - - - - 119,284
Exercise of warrants - - 8,359,326 836 4,019 - - - - 4,855
Accretion of Series A
mandatorily redeemable
convertible preferred
stock - 10,889 - - - - - (10,889) - (10,889)
Accrued dividends of
Series A mandatorily
redeemable convertible
preferred stock - 122,468 - - - - - (122,549) - (122,549)
Accrued dividends of
Series C equity
preferred stock - - - - - - 781,062 (781,062) - -
Increase (Decrease) in
accrual of common
shares to be issued
in connection with
financing arrangements - - - - 4,827 - - - - 4,827
Common stock option
expense - - - - 16,782 - - - - 16,782
Unrealized net gain
(loss) on available
for sale securities - - - - - - - - (21,944) (21,944)
Net income (loss),
year ended
May 31, 2011 - - - - - - - (1,306,734) - (1,306,734)
----- ---------- ----------- ------- ---------- --------- ----------- ------------ -------- ------------
BALANCE, MAY 31, 2011 2,675 $3,138,623 242,304,304 $24,230 $3,549,443 6,804.936 $ 9,482,279 $(21,214,153) $182,671 $(7,975,530)
See accompanying notes.
F-9
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - ORGANIZATION AND BUSINESS
----------------------------------
ORGANIZATION AND NATURE OF BUSINESS
Jacobs Financial Group, Inc. (the "Company" or "JFG"), formerly NELX, Inc., was
incorporated in Kansas on March 25, 1983. In 2001, the Company acquired all the
outstanding stock of two corporations located in Charleston, West Virginia:
Jacobs & Company ("Jacobs") and FS Investments, Inc. ("FSI"). Jacobs is a
registered investment advisory firm that derives its revenue from asset-based
investment advisory fees. FSI, through its wholly-owned subsidiary Triangle
Surety Agency, Inc. ("Triangle"), is engaged in the business of placing surety
bonds with insurance companies for clients engaged in regulated industries, such
as the extraction of coal, oil and gas. FSI receives commission income from the
placement of these bonds and is licensed in ten states primarily in the eastern
United States. On December 30, 2005, the Company acquired all of the outstanding
stock of West Virginia Fire & Casualty Company ("WVFCC"), an insurance company
licensed to engage in business in West Virginia, Ohio and Indiana. The
acquisition of WVFCC consisted of the purchase of marketable investments and
insurance licenses and did not include any existing policies or customer base as
the insurance lines of business offered by WVFCC were not insurance lines that
the Company intended to pursue. Following the acquisition, the name of WVFCC was
changed to First Surety Corporation ("FSC"). FSC receives insurance premium
income in connection with the issuance of surety bonds. The Company and its
subsidiaries are subject to the business risks inherent in the financial
services industry.
LIQUIDITY AND GOING CONCERN
These financial statements are presented on the basis that the Company is a
going concern. Going concern contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business over a reasonable
length of time. The Company incurred operating losses of approximately $22,000
and $458,000 for the years ended May 31, 2011 and 2010. The Company's losses
increase when accretion of mandatorily redeemable convertible preferred stock
and accrued dividends on mandatorily redeemable preferred stock are taken into
account to approximately $1,440,000 and $2,339,000 for the years ended May 31,
2011 and 2010. Losses are expected to continue until FSC develops a more
substantial book of business. While improvement is anticipated as the Company's
business plan is implemented, restrictions on the use of FSC's assets (See Note
C), the company's significant deficiency in working capital and stockholders'
equity raise substantial doubt about the Company's ability to continue as a
going concern.
Management intends to improve cash flow through the implementation of its
business plan. Additionally, management continues to seek to raise additional
funds for operations through private placements of stock, other long-term or
permanent financing, or short-term borrowings. However, the Company cannot be
certain that it will be able to continue to obtain adequate funding in order to
reasonably predict whether it will be able to continue as a going concern. The
accompanying financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
F-10
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
---------------------------------------------------
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Jacobs Financial
Group, Inc. and its wholly owned subsidiaries, after the elimination of
intercompany transactions.
USE OF ESTIMATES
Preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Significant areas requiring the use of
management estimates are loss reserves, stock options and the valuation of
deferred tax benefits. Actual results inevitably will differ from those
estimates, and such differences may be material to the financial statements.
REVENUE RECOGNITION
Fees for investment advisory services are based on an agreed percentage of the
value of client assets under management and are accrued monthly based on the
market value of client assets.
Surety premiums are recorded as receivables when due and are earned pro rata
over the term of the policies. The reserve for unearned premiums represents the
portion of premiums written relating to the unexpired terms of coverage. The
reserve for unearned premium is determined using the monthly pro rata method.
Advance premiums represent renewal premiums paid in advance of the effective
renewal date.
Agency commissions for surety bond services are based on a percentage of
premiums charged for bonds placed with insurance companies, and are recorded
upon issuance or effective renewal date of the bonds. No significant continuing
services subsequent to the issuance or renewal of surety bonds are required.
Policy acquisition costs include costs that vary with and are primarily related
to the acquisition of new business. Such costs generally include commissions,
underwriting expenses, and premium taxes and are deferred and amortized over the
period in which the related premiums are earned. The deferred policy acquisition
cost assets are reviewed for recoverability based on the profitability of the
underlying surety policy. Investment income is not anticipated in the
recoverability of deferred policy acquisition costs.
INVESTMENTS
Debt securities are designated at purchase as held-to-maturity, trading or
available for sale. Held-to-maturity debt securities are carried at amortized
cost where the Company has the ability and intent to hold these securities until
F-11
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
maturity. Premiums and discounts arising from the purchase of debt securities
are treated as yield adjustments over the estimated lives or call date, if
applicable.
Debt and equity securities that are bought and held principally for sale in the
near future are classified as trading securities and are carried at current
market values, with changes in market value being recorded in current
operations.
Debt and equity securities that the Company may not have a positive intent to
hold until maturity and not classified as trading, are considered to be
available for sale and carried at current market values, with unrealized gains
and losses reflected as a separate component of other comprehensive income in
consolidated shareholders' equity currently.
Management believes the Company has the ability to hold all fixed income
securities to maturity. However, during the current fiscal year, the Company
determined it may dispose of securities prior to their scheduled maturity due to
changes in interest rates, prepayments, tax and credit considerations, liquidity
or regulatory capital requirements, or other similar factors. As a result, the
Company reclassified all of its fixed income securities (bonds) and equity
securities as available-for-sale. These securities are reported at fair value,
with unrealized gains and losses, net of deferred income taxes, reported in
stockholders' equity as a separate component of accumulated other comprehensive
income.
Short-term investments consist primarily of debt securities having maturities of
one year or less at date of purchase, money-market investment funds and other
similar investments that have immediate availability.
Interest income with respect to fixed maturity securities is accrued as earned.
Dividend income is generally recognized when receivable.
Realized gains and losses are determined by specific identification of the
security sold.
DERIVATIVES
The Company uses derivatives in the form of covered call options sold to
generate additional income and provide limited downside protection in the event
of a market correction.
These transactions expose the Company to potential market risk for which the
Company receives a premium up front. The market risk relates to the requirement
to deliver the underlying security to the purchaser of the call within a
definite time at an agreed price regardless of the then current price of the
security. As a result the Company takes the risk that it may be required to sell
the security at the strike price, which could be a price less than the then
market price. Should the security decline in price over the holding period of
the call option, the Company realizes the option premium received as income and
the Company lessens or mitigates this risk which may be eliminated by a closing
transaction for the covered call and sale of the underlying security.
The Company invests in large capitalized US securities traded on major US
exchanges and writes standardized covered calls only against these positions
(covered calls), which are openly traded on major US exchanges. The use of such
underlying securities and standardized calls lessens the credit risk to the
furthest extent possible.
The Company is not exposed to significant cash requirements through the use of
covered calls in that it sells a call for a premium and may use these proceeds
to enter a closing transaction for the call at a later date.
F-12
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ALLOWANCE FOR UNCOLLECTIBLE PREMIUM AND OTHER RECEIVABLES
The majority of our fee revenue is generated by services provided to companies
and individuals throughout the Eastern United States. We evaluate the need for a
reserve for the amount of these receivables that may be uncollectible, based on
historical collection activity adjusted for current conditions. Premium and
other receivables are charged-off when deemed uncollectible. Based on this
evaluation, management believes that substantially all accounts receivable are
collectible, and therefore has not established an allowance for estimated
uncollectible accounts.
IMPAIRMENT
We evaluate long-lived assets for impairment annually, or whenever events or
changes in circumstances indicate that the assets may not be recoverable. The
impairment is measured by discounting estimated future cash flows expected to be
generated, and comparing this amount to the carrying value of the asset. Cash
flows are calculated utilizing forecasts and projections and estimated lives of
the assets being analyzed. Should actual results differ from those forecasted
and projected, we are subject to future impairment charges related to these
long-lived assets.
FURNITURE AND EQUIPMENT
Furniture and equipment is recorded at cost. Maintenance and repairs are charged
to operations when incurred. When property and equipment are sold or disposed
of, the asset account and related accumulated depreciation account are relieved,
and any gain or loss is included in operations. The cost of property and
equipment is depreciated over the estimated useful lives of the related assets,
ranging from three to seven years, using the straight-line and double-declining
balance methods, which approximates estimated economic depreciation.
RESERVE FOR LOSSES AND LOSS EXPENSES
Losses and loss adjustment expenses represent management's best estimate of the
ultimate net cost of all reported and unreported losses incurred. Reserves for
unpaid losses and loss adjustment expenses are estimated using individual
case-basis valuations in conjunction with estimates derived from industry and
Company historical experience. These estimates and methods of establishing
reserves are continually reviewed and updated.
STOCK-BASED COMPENSATION
We have adopted the fair value method of accounting for stock-based compensation
required by ASC 718, Accounting for Stock-based Compensation.
F-13
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of stock options is estimated at the grant date using the Black
Scholes Option Pricing Model. This model requires the input of a number of
assumptions, including expected dividend yields, expected stock price risk- free
interest rates, and an expected life of the options. Although the assumptions
used reflect management's best estimate, they involve inherent uncertainties
based on market conditions generally outside the control of the Company. If
future market conditions are different than the assumptions used, stock-based
compensation expense could be significantly different.
INCOME TAXES
We currently have net operating loss ("NOL") carry-forwards that can be utilized
to offset future income for federal and state tax purposes. These NOLs generate
a significant deferred tax asset. However, we have recorded a valuation
allowance against this deferred tax asset as we have determined that it is more
likely than not that we will not be able to fully utilize the NOLs. Should our
assumptions regarding the utilization of these NOLs change, we may reduce some
or all of this valuation allowance, which would result in the recording of a
deferred income tax benefit.
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share of common stock are computed using the weighted
average number of shares outstanding during each period. Diluted earnings per
share are computed on the basis of the average number of common shares
outstanding plus the dilutive effect of convertible debt, stock options and
warrants. In periods of net loss, there are no diluted earnings per share since
the result would be anti-dilutive.
RECLASSIFICATIONS
Certain amounts in the 2010 Consolidated Financial Statements have been
reclassified to be consistent with the presentation in the Consolidated
Financial Statements as of May 31, 2011 and for the year then ended. These
reclassifications had no impact on previously reported net income, cash flow
from operations or changes in shareholder equity.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2011, the FASB issued Accounting Standards Update 2011-05,
"Comprehensive Income: Presentation of Comprehensive Income". This object of
this Update is to improve the comparability, consistency, and transparency of
financial reporting and to increase the prominence of items reported in other
comprehensive income. This update is effective for annual reporting periods
beginning on or after December 15, 2011 and interim periods within that fiscal
year. Management does not expect this update to have a material effect on the
Company's financial statements.
In May 2011, the FASB issued Accounting Standards Update 2011-04,"Fair Value
Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure
Requirements in U.S. GAAP and AFRSs". The amendments in this Update will improve
the comparability of fair value measurements presented and disclosed in
F-14
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
financial statements prepared in accordance with U.S. generally accepted
accounting principles and International Financial Reporting Standards. This
update is effective for annual reporting periods beginning on or after December
15, 2011 and interim periods within that fiscal year. Management does not expect
this update to have a material effect on the Company's financial statements.
In October 2010, the FASB issued Accounting Standards Update 2010-26, "Financial
Services - Insurance: Accounting for Costs Associated with Acquiring or Renewing
Insurance Contracts." This FASB is intended to specify costs incurred in the
acquisition of new and renewal contracts that should be capitalized as deferred
acquisition costs and amortized over time using amortization methods dependent
upon the nature of the underlying insurance contract. This update is effective
for annual reporting periods beginning on or after December 15, 2011 and interim
periods within that fiscal year. Management does not expect this update to have
a material effect on the Company's financial statements.
In August 2010, the FASB issued Accounting Standards Update 2010-21, "Accounting
for Technical Amendments to Various SEC Rules and Schedules". This Accounting
Standards Update amends various SEC paragraphs pursuant to the issuance of
Release No. 33-9026; Technical Amendments to Rules, Forms, Schedules and
Codifications of Financial Reporting Policies. This update has no material
effect on the Company's financial statements.
In July 2010, the FASB issued Accounting Standards Update 2010-20, "Disclosures
about the Credit Quality of Financing Receivables and the Allowance for Credit
Losses." This FASB is intended to provide additional information to assist
financial statement users in assessing an entity's credit risk exposure and
evaluating the adequacy of its allowance for credit losses. This update affects
all entities with financing receivables, excluding short-term trade accounts
receivable or receivables measured at fair value or lower of cost or fair value.
The effective date of this update is deferred by ASU-2011-01, "Deferral of the
Effective Date of Disclosures about Troubled Debt Restructuring". It is now
effective for interim and annual reporting periods beginning on or after June
15, 2011. Management does not expect this update to have a material effect on
the Company's financial statements.
In February 2010, the FASB issued Accounting Standards Update 2010-09,
"Subsequent Events: Amendments to Certain Recognition and Disclosure
Requirements." This FASB retracts the requirement to disclose the date through
which subsequent events have been evaluated and whether that date is the date
the financial statements were issued or were available to be issued. ASU 2010-09
is effective for interim and annual financial periods ending after February 24,
2010, and has been applied with no material impact on the Company's financial
statements.
In February 2010, the FASB issued Accounting Standards Update 2010-08,
"Technical Corrections to Various Topics." This FASB eliminates inconsistencies
and outdated provisions in GAAP and provides needed clarification on others. ASU
2010-08 is effective for interim and annual financial periods ending after
February 2010, and has been applied with no material impact on the Company's
financial statements.
In January 2010, the FASB issued Accounting Standards Update 2010-06, "Fair
Value Measurements and Disclosures: Improving Disclosures About Fair Value
Measurements." This FASB requires additional disclosures about the fair value
measurements including transfers in and out of Levels 1 and 2 and a higher level
F-15
of disaggregation for the different types of financial instruments. For the
reconciliation of Level 3 fair value measurements, information about purchases,
sales, issuances and settlements should be presented separately. ASU 2010-06 is
effective for interim and annual financial periods beginning after December
2009, and is not expected to have a material impact on the Company's financial
statements.
In August 2009, the Financial Accounting Standards Board ("FASB") issued
Accounting Standards Update 2009-04, "Accounting for Redeemable Equity
Instruments - Amendment to Section 480-10-S99". This updates Section 480-10-S99,
"Distinguishing Liabilities from Equity", to reflect the SEC staff's views
regarding the application of Accounting Series Release No. 268, "Presentation in
Financial Statements of "Redeemable Preferred Stocks." The exchange for Series B
Preferred shares into Series C shares as elected by those shareholders utilizes
the view of the SEC in classifying the Series C Preferred shares as equity.
There is no stated maturity on the Series C Preferred shares and at the time of
redemption the Company will accrete changes in the redemption value at the
appropriate time. These amounts will be adjusted at the end of each reporting
period as applicable.
In August 2009, the FASB issued Accounting Standards Update 2009-05, "Fair Value
Measurements and Disclosures (Topic 820) - Measuring Liabilities at Fair Value".
This update includes amendments to Subtopic 820-10 "Fair Value Measurements and
Disclosures - Overall" for the fair value measurements of liabilities and
provides clarification that in circumstances in which quoted price in an active
market for the identical liability is not available, a reporting entity is
required to measure fair value using one or more of the techniques provided for
in this update. This Statement is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after August 26, 2009. The
application of this update did not have a material impact on the Company's
results of operations or financial position.
In September 2009, the FASB issued Accounting Standards Update 2009-08,
"Earnings Per Share-Amendments to Section 260-10-S99". This update includes
technical corrections to Topic 260-10-S99, "Earnings Per Share", based on EITF
Topic D-53, "Computation of Earnings Per Share for a Period that Includes a
Redemption or an Induced Conversion of a Portion of a Class of Preferred Stock"
and EITF Topic D-42, "The Effect of the Calculation of Earnings Per Share for
the Redemption or Induced Conversion of Preferred Stock". The application of
this update did not have an impact on the Company's results of operations,
therefore not requiring additional earnings per share computation.
F-16
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE C - INVESTMENTS
--------------------
The Company held the following investments, by security type, that have been
classified as available-for-sale and carried at market value at May 31, 2011:
Gross Unrealized Gross Unrealized
Amortized Cost Gains Losses Fair Market Value
---------------------- ---------------------- ---------------------- ----------------------
State and municipal $ 1,073,724 $ - $ 26,955 $ 1,046,769
securities
Equity securities 461,524 11,685 7,002 466,207
Derivatives (10,616) (3,010) (875) (12,751)
Mortgage Backed
Securities 4,784,871 208,356 1,278 4,991,949
---------------------- ---------------------- ---------------------- ----------------------
$ 6,309,503 $ 217,031 $ 34,360 $ 6,492,174
====================== ====================== ====================== ======================
The Company held the following investments, by security type, that were
classified as available-for-sale and carried at market value at May 31, 2010:
Amortized Cost Gross Unrealized Gross Unrealized Fair Market Value
Gains Losses
---------------------- ---------------------- ---------------------- ----------------------
Mortgage Backed $ 6,413,856 $ 208,315 $ 3,700 $ 6,818,472
Securities
---------------------- ---------------------- ---------------------- ----------------------
$ 6,413,856 $ 208,315 $ 3,700 $ 6,818,472
====================== ====================== ====================== ======================
Management believes the Company has the ability to hold all fixed income
securities to maturity. However, during fiscal year 2010, the Company determined
it may dispose of securities prior to their scheduled maturity due to changes in
interest rates, prepayments, tax and credit considerations, liquidity or
regulatory capital requirements, or other similar factors. As a result, the
Company reclassified all of its fixed income securities (bonds) and equity
securities as available-for-sale. These securities are reported at fair value,
with unrealized gains and losses, net of deferred income taxes, reported in
stockholders' equity as a separate component of accumulated other comprehensive
income.
There are no securities classified as held to maturity at May 31, 2011 or May
31, 2010.
The Company held the following investments, by security type, with the positive
intent and ability to hold to maturity:
Invested assets are exposed to various risks, such as interest rate, market and
credit risks. Due to the level of risk associated with certain of these invested
assets and the level of uncertainty related to changes in the value of these
assets, it is possible that changes in risks in the near term may significantly
affect the amounts reported in the Consolidated Condensed Balance Sheets and
Statements of Income.
F-17
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date. The Company uses the following fair value hierarchy in
selecting inputs, with the highest priority given to Level 1, as these are the
most transparent or reliable:
O Level 1 - Quoted prices for identical instruments in active markets.
O Level 2 - Quoted prices for similar instruments in active markets;
quoted prices for identical or similar instruments in markets that are
not active; and model-derived valuations in which all significant
inputs are observable in active markets.
O Level 3 - Valuations derived from valuation techniques in which one or
more significant inputs are unobservable.
Fair market values are provided by the Company's independent investment
custodians that utilize third-party quotation services for the valuation of the
fixed-income investment securities and money-market funds held. The Company's
investment custodians are large money-center banks. The Company's equity
investment is valued using quoted market prices.
The following section describes the valuation methodologies used to measure
different financial instruments at fair value, including an indication of the
level in the fair value hierarchy in which the instrument is generally
classified.
FIXED INCOME SECURITIES
Securities valued using Level 1 inputs include highly liquid government bonds
for which quoted market prices are available. Securities using Level 2 inputs
are valued using pricing for similar securities, recently executed transactions,
cash flow models with yield curves and other pricing models utilizing observable
inputs. Most fixed income securities are valued using Level 2 inputs. Level 2
includes corporate bonds, municipal bonds, asset-backed securities and mortgage
pass-through securities.
EQUITY SECURITIES
Level 1 includes publicly traded securities valued using quoted market prices.
SHORT-TERM INVESTMENTS
The valuation of securities that are actively traded or have quoted prices are
classified as Level 1. These securities include money market funds and U.S.
Treasury bills. Level 2 includes commercial paper, for which all significant
inputs are observable.
F-18
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS ARE SUMMARIZED BELOW:
May 31, 2011
--------------------------------------------------------------------
Fair Value Measurements Using
Assets At
Level 1 Level 2 Level 3 Fair Value
----------------- ---------------- ---------------- ----------------
Assets:
Fixed income securities at fair value $ - $ 6,038,718 $ - $ 6,038,718
Equity securities at fair value (includes 453,456 - - 453,456
derivatives)
Short-term investments at fair value 1,007,617 - - 1,007,617
----------------- ---------------- ---------------- ----------------
Total Assets $ 1,461,073 $ 6,038,718 $ - $ 7,499,791
May 31, 2010
---------------------------------------------------------------------
Fair Value Measurements Using
Assets At
Level 1 Level 2 Level 3 Fair Value
--------------- ------------------ --------------- ------------------
Assets:
Fixed income securities at fair value $ - $ 6,618,472 $ - $ 6,618,472
Short-term investments at fair value 264,079 - - 264,079
--------------- ------------------ --------------- ------------------
Total Assets $ 264,079 $ 6,618,472 $ - $ 6,882,551
The Company had no assets or liabilities measured at fair value on a recurring
basis using significant unobservable inputs (Level 3) at either May 31, 2011 or
at May 31, 2010.
At May 31, 2011, the Company's insurance subsidiary had securities and short
term investment with a fair value of $1,093,368 on deposit with the State
insurance department to satisfy regulatory requirements. In connection with
regulatory approval of the Company's acquisition of its insurance subsidiary,
certain restrictions were imposed on the ability of the Company to withdraw
funds from FSC without prior approval of the Insurance Commissioner.
Accordingly, investments and cash in the amount of $7,789,441 and $6,956,987 as
of May 31, 2011 and 2010, respectively, are restricted to the use of FSC.
F-19
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Principal repayments on U.S. government agency mortgage-backed securities held
by the Company as of May 31, 2011 are estimated as follows:
Fair Market
Amortized Cost Value
------------------ -----------------
Due in one year or less $ 840,527 $ $ 880,586
Due after one year through five years 2,078,869 2,173,974
Due after five years through ten years 1,131,350 1,180,987
Due after ten years 734,125 756,402
------------------ -----------------
$ 4,784,871 $ 4,991,949
================== =================
Estimated repayments are forecast based on varying prepayment speeds for each
particular security held assuming that interest rates remain constant. Expected
repayments will differ from actual repayments because borrowers of the
underlying mortgages have a right to prepay obligations.
An analysis of net investment income follows:
2011 2010
------------------ ------------------
Bonds - fixed maturities $ 59,516 $ 9,217
Mortgage-backed securities 170,129 264,508
Short-term investments 132 146
------------------ ------------------
229,777 273,871
Total investment income
------------------ ------------------
Investment expense - 294
------------------ ------------------
Net investment income $ 229,777 $ 273,577
================== ==================
The increases (decrease) in unrealized appreciation of investments were as
follows:
2011 2010
----------- ----------
Bonds-fixed maturities $ (26,955) $(28,570)
Mortgage-backed securities 2,463 118,637
Equity securities 2,548 2,418
----------- ----------
Increase (decrease) in unrealized
appreciation $ (21,944) $ 92,485
=========== ==========
F-20
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The gross gains and gross losses realized on available-for-sale securities were
as follows:
Gross Gross
Gross Realized Realized
Proceeds Gains Losses
------------- ------------- -------------
2011
Bonds-fixed maturities $ 1,592,745 $ 32,187 $ -
Mortgage-backed securities 1,952,133 84,017 -
Equity securities (derivatives) 1,916 - (17)
------------- ------------- -------------
Total $ 3,546,794 $ 116,204 $ (17)
============= ============= =============
2010
Bonds-fixed maturities $ 404,958 $ 42,926 $ -
Mortgage-backed securities - - -
Equity securities 8,182 - 2,098
------------- ------------- -------------
Total $ 413,140 $ 42,926 $ 2,098
============= ============= =============
The following table summarizes the gross unrealized losses and fair value on
investment securities aggregated by major investment category and length of time
that individual securities have been in a continuous loss position at May 31,
2011 and May 31, 2010.
Less than 12 Months 12 Months or More Total
-------------------------------- ---------------------------- --------------------------------
Cost Unrealized Cost Unrealized Fair Unrealized
(a) Losses (a) Losses Value Losses
---------------- --------------- ------------ --------------- --------------- ----------------
2011
Equity securities $ 186,825 $ 7,002 $ - $ - $ 179,823 $ 7,002
Bonds- Fixed Maturities 1,073,724 26,955 - - 1,046,769 26,955
Mortgage-backed
securities 136,269 1,278 - - 134,991 1,278
---------------- --------------- ------------ --------------- --------------- ----------------
Total $ 1,396,818 $ 35,235 $ - $ - $ 1,361,583 $ 35,235
================ =============== ============ =============== =============== ================
F-21
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2010
Mortgage-backed
securities $ 945,394 $ 3,699 $ - $ - $ 941,685 $ 3,699
---------------- --------------- ------------ --------------- --------------- ----------------
Total $ 945,394 $ 3,699 $ - $ - $ 941,685 $ 3,699
================ =============== ============ =============== =============== ================
(a) For bonds-fixed maturities and mortgage-backed securities, represents
amortized costs.
As of May 31, 2011, the company held 4 mortgage-backed securities with gross
unrealized losses of $1,278, all of which have been in a continuous loss
position for less than 12 months. These securities consist of fixed-rate
securities issued by Government National Mortgage Association (GNMA) that are
sensitive to movements in market interest rates.
As of May 31, 2011, the company held 3 fixed maturity municipal bonds with gross
unrealized losses of $26,955, all of which have been in a continuous loss
position for less than 12 months.
As of May 31, 2011, the company held 6 equity security investments with gross
unrealized losses of $7,002, all of which have been in a continuous loss
position for less than 12 months. These securities consist of common stock whose
fair value is sensitive to movements in market interest rates.
All unrealized losses are considered temporary since the Company has the ability
to hold the securities until maturity if needed.
NOTE D-DEFERRED POLICY ACQUISITION COSTS
----------------------------------------
The following reflects the policy acquisition costs deferred for amortization
against future income and the related amortization charged to operations.
2011 2010
------------------ --------------
Balance at beginning of year $ 128,453 $ 143,173
Acquisition costs deferred 372,678 242,090
Amortization charged to operations (310,420) (256,810)
------------------ --------------
Total $ 190,711 $ 128,453
================== ==============
NOTE E - OTHER ASSETS
---------------------
Included in other assets as of May 31, 2011 and May 31, 2010 are $21,986 and
$27,832 of prepaid expenses and deposits.
F-22
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE F - INTANGIBLES
--------------------
As the result of the acquisition of the stock of FSC on December 30, 2005, in
exchange for the purchase price of $2,900,000, the Company received cash and
investments held by FSC with a fair market value of $2,750,000, with the
difference of $150,000 being attributed to the property and casualty licenses of
FSC in the states of West Virginia, Ohio and Indiana. Such licenses have
indefinite lives and are evaluated annually, or more frequently if circumstances
indicate that a possible impairment has occurred, for recoverability and
possible impairment loss. No impairment has been recorded in fiscal years ended
May 31, 2011 and 2010.
NOTE G-RESERVE FOR LOSSES AND LOSS EXPENSE
------------------------------------------
Reserves for unpaid losses and loss adjustment expenses are estimated using
individual case-basis valuations in conjunction with estimates derived from
industry and Company historical experience. As of May 31, 2011, the Company's
insurance subsidiary, FSC, is only licensed to write surety in West Virginia and
Ohio and has focused its primary efforts towards coal permit bonds while also
providing other miscellaneous surety bonds that are substantially secured by
collateral consisting of investment accounts that are managed by Jacobs.
Reclamation of land that has been disturbed by mining operations is highly
regulated by federal and state agencies and the required bonds are generally
long-term in nature with mining operations and reclamation work conducted in
unison as the property is being mined. Additionally, no two principals or
properties are alike due to varied company structures and unique geography and
geology of each site. In underwriting such bonds, management obtains estimates
of costs to reclaim the properties subject of the permit(s) in accordance with
those mining permit(s), as prepared by independent outside professionals
experienced in this field of work and hired by FSC, in addition to other
underwriting and financial risk considerations. FSC requires the principal to
provide cash in amounts deemed sufficient to reclaim the disturbed land and thus
mitigate the exposure to significant loss. Such cash is invested in investment
collateral accounts managed by Jacobs utilizing conservative investment
strategies. Inspections of mining activity and reclamation work are performed on
a regular basis with initial costs estimates being updated periodically. Should
the principal default in the obligation to reclaim the property in accordance
with the mining permit, FSC would then use the funds held in the collateral
account to reclaim the property or would be required to forfeit the face amount
of the bond to the agency to which the bond is issued. Losses can occur if the
costs of reclamation exceed estimates obtained at the time the bond was
underwritten or upon subsequent re-evaluations, if sufficient collateral is not
obtained and increased if necessary, or if collateral held has experienced a
significant deterioration in value. FSC has experienced no claims for losses as
of May 31, 2011 and thus provisions for losses and loss adjustment expense have
been based on industry averages adjusted for other factors unique to the
Company's approach, and in consultation with consulting actuaries experienced in
the surety field.
F-23
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At May 31, 2011 and May 31, 2010, the reserve for losses and loss expenses
consisted of:
2011 2010
------------------ -----------------
Balance at beginning of year $ 611,190 $ 432,658
Incurred policy losses-current year 204,322 178,532
Incurred policy losses-prior year - -
Amounts paid-current year losses - -
Amounts paid-prior year losses - -
------------------ -----------------
Balance at end of year $ 815,512 $ 611,190
================== =================
NOTE H - NOTES PAYABLE
----------------------
At May 31, 2011 and 2010, the Company had the following unsecured notes payable
to individuals and a commercial bank:
2011 2010
------------------ ------------------
Unsecured demand notes payable to individuals and
others; interest rate fixed @ 10.00% ($75,000 to
related party) $ 1,492,500 $ 1,057,000
Unsecured demand notes payable to individuals and
others 103,000 -
Secured demand note payable to individuals; interest
rate fixed @ 14%; secured by accounts receivable for
investment advisory fees for the quarter ending June
30, 2011 45,000 -
Secured demand note payable to individuals; interest
rate fixed @ 12%; secured by accounts receivable for
investment advisory fees for the quarter ending June
30, 2011 40,000 -
Secured demand note payable to individuals; interest
rate fixed @ 12%; secured by accounts receivable for
investment advisory fees for the quarters ending
September 30 and December 2011 129,000 -
F-24
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unsecured short-term advances from principal
shareholder and chief executive officer; interest rate
fixed @ 12.00% (Also See Note T -
Related Party Transactions) (29,965) 7,104
Unsecured note(s)payable to individual(s) under a
bridge- financing arrangement described below
($360,000 to related party) 3,500,000 3,500,000
Unsecured term note payable to commercial bank in the
original amount of $250,000 and payable in equal
monthly payments of $5,738; interest rate
fixed @ 13.25% maturing January 31, 2012 - 37,119
------------------ ------------------
Total $ 5,279,535 $ 4,601,223
================== ==================
In accordance with the terms of the first round bridge-financing of $2.5 million
on March 10, 2008, the holders of such notes were paid accrued interest-to date
and issued 5.00% of the Company's common shares. Holders of the second round of
bridge-financing notes of $1.0 million received 2.00% of the Company's common
shares. Upon retirement of the notes subsequent to consummation of a qualified
equity offering, the Company shall issue to the holders of the bridge financing
notes additional Company common stock that when added to the stock initially
issued to the holders of the notes, will equal the note holders' pro rata share
of the applicable percentage of the outstanding common stock of the Company as
follows: If the qualified financing consists of $50 million or more, the holders
of such notes will receive 28% of the common stock of the Company that would
otherwise be retained by the holders of the Company's common shares immediately
prior to the financing; if the qualified financing is for an amount less than
$50 million, the percentage will be reduced on a sliding scale to a fraction of
28% of the amount retained by the holders of the Company's common shares (where
the numerator is the amount of financing and the denominator is $50 million).
Beginning September 10, 2008, because a qualified financing had not been
completed, the Company became required under the terms of the bridge financing
to issue 2.80% of the Company's outstanding common shares and shall issue 2.80%
of the Company's outstanding common shares upon each six-month anniversary date
thereof until retirement of the notes. The following table summarizes the common
shares issued to those note holders.
Date of Issuance Shares Issued
--------------------------------------- ---------------
September 10, 2008 4,870,449
March 10, 2009 5,010,640
September 10, 2009 5,354,642
March 10, 2010 6,005,925
September 10, 2010 6,213,285
March 10, 2011 6,738,900
---------------
34,193,841
===============
F-25
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Pursuant to the terms of the Promissory Notes, the first two of 20 equal
quarterly installments of principal and interest payable thereunder were to have
been paid on December 10, 2008 and March 10, 2009 (the "INITIAL AMORTIZATION
PAYMENTS"). As the result of upheavals and dislocations in the capital markets,
the Company was unable to either refinance the indebtedness evidenced by the
Promissory Notes or make the Initial Amortization Payments to the Holders when
due; and an Event of Default (as defined in the Promissory Notes) occurred under
the Promissory Notes as a result of the Company's failure to pay the Initial
Amortization Payments within 14 days after same became due and payable.
On June 5, 2009 the Company entered into an agreement with the bridge lenders to
forbear from exercising their rights and remedies arising from the Acknowledged
Events of Default. As consideration for the forbearance, the Company issued
5,171,993 shares of Common stock, and pledged the stock of the Company's
subsidiary, Crystal Mountain Water (CMW), as security for repayment of the
loans. The original repayment schedule called for quarterly payments of
$224,515. The Holders agreed that under the forbearance the Company may satisfy
its obligation by increasing the quarterly payments by $67,185, (to a total of
$291,700) for eight consecutive quarters beginning September 10, 2009 to satisfy
the arrearage. In addition, the interest rate was increased to 17.00%. Although
the Company has failed to make the payment that was due September 10, 2009 and
the payments that were due in the ensuing quarters, management has remained in
close contact with the bridge lenders, providing reports regarding its efforts
to refinance or otherwise repay the bridge loans. To date, none of the bridge
lenders has elected to pursue legal remedies.
Scheduled maturities and principal payments for each of the next five years are
as follows:
2011
------------------
Fiscal year 2011-2012 (including demand notes) $ 5,279,535
Fiscal year 2012-2013 -
Fiscal year 2013-2014 -
Fiscal year 2014-2015 -
Fiscal year 2015-2016 -
Fiscal year 2016-2017 -
------------------
Total $ 5,279,535
==================
NOTE I - OTHER LIABILITIES
--------------------------
In the twelve-month periods ending May 31, 2011 and May 31, 2010, the Company,
upon advice of legal counsel, removed certain dormant accounts payable in the
aggregate amount of $54,358 and $200,240, based upon the conclusion that none of
accounts represented an obligation that is legally enforceable against the
Company. Such removal was recorded as a gain on debt extinguishment.
As of May 31, 2011, the Company had accrued and withheld approximately $17,000
in West Virginia payroll withholdings, of which $12,000 was non current and is
being remitted as part of a monthly payment plan negotiated with the State of
F-26
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
West Virginia. This 12 month plan runs through November 2011 and will result in
the full payment of all non current withholding taxes, including interest and
penalties of approximately $5,000 which are reflected in the accompanying
financial statements as accrued expenses.
During the fiscal year 2011, the Company satisfied its obligation with the U.S.
Treasury concerning Federal payroll taxes accrued and withheld in previous years
of approximately $155,000.
NOTE J - PREFERRED STOCK
------------------------
REDEEMABLE PREFERRED STOCK
On December 30, 2005, through a private placement, the Company issued 350 shares
of 4% Non-Voting Series A Preferred Stock (Series A Preferred Stock), along with
1,050,000 warrants for common shares of Company stock as additional
consideration, for a cash investment in the amount of $350,000, in connection
with the Company's acquisition of FSC. Holders of Series A Preferred Stock are
entitled to participate in FSC's partially collateralized bonding programs,
subject to continuing satisfaction of underwriting criteria, based upon the
bonding capacity of FSC attributable to capital reserves of FSC established with
the subscription proceeds (i.e., bonding capacity equal to ten times
subscription proceeds) and for so long as the subscriber holds the Series A
shares. Holders of the Series A Preferred Stock are entitled to receive, when
and as declared by the board of directors, cumulative preferential cash
dividends at a rate of four percent of the $1,000 liquidation preference per
annum (equivalent to a fixed annual rate of $40 per share). The Series A
Preferred Stock ranks senior to the Company's common stock and pari passu with
the Company's Series B Preferred and Series C Preferred Stock with respect to
dividend rights and rights upon liquidation, dissolution or winding up of the
Company. The holder may redeem the Series A Preferred Stock on or after the
seventh anniversary of the Issue Date, if the holder provides a written
statement to the Company that it will no longer require surety bonds issued by
the Company's insurance subsidiary (FSC) under its partially collateralized
bonding programs and, if no such surety bonds are then outstanding, the Company,
at the option of the holder, will redeem all or any portion of the Series A
Preferred Stock of such holder at a price per share equal to the Series A
Preferred Stock Issue Price plus all accrued and unpaid dividends with respect
to the shares of the Series A Preferred Stock of such holder to be redeemed. The
conditional redemption shall not be available to any holder of Series A
Preferred Stock for so long as surety bonds of the Company's insurance
subsidiary issued on a partially collateralized basis remain outstanding for the
benefit of such holder, and upon redemption, such holder shall no longer be
eligible to participate in the partially collateralized bonding programs of the
insurance subsidiary. The Company is authorized to issue up to 1,000,000 shares
of the Series A Preferred Stock. As of May 31, 2011, the Company has issued
2,675 shares of Series A Preferred Stock in exchange for cash investments in the
amount of $2,675,000, of which no shares were issued in fiscal 2011 and 10
shares were issued in fiscal 2010.
On December 30, 2005, through a private placement, the Company issued 3,980
shares of 8% Non-Voting Series B Convertible Preferred Stock (Series B Preferred
Stock), along with 19,900,000 warrants for common shares of Company stock as
additional consideration, for a cash investment in the amount of $2,985,000; and
issued 4,890.599 shares of Series B Preferred Stock, along with 24,452,996
warrants for common shares of Company stock as additional consideration, for a
conversion of $3,667,949 of indebtedness of the Company, in connection with the
F-27
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company's acquisition of FSC. Holders of the Series B Preferred Stock are
entitled to receive, when and as declared by the board of directors, cumulative
preferential cash dividends at a rate of eight percent of the $1,000 liquidation
preference per annum (equivalent to a fixed annual rate of $80 per share). The
Series B Preferred Stock ranks senior to the Company's common stock and pari
passu with the Company's Series A Preferred and Series C Preferred Stock with
respect to dividend rights and rights upon liquidation, dissolution or winding
up of the Company. Each share of the Series B Preferred Stock is convertible at
the option of the holder, at any time after the original issue date, into 1,000
fully paid and non-assessable shares of the Company's common stock at a
conversion price of $1.00 per common share. The Company may redeem the Series B
Preferred Stock at any time after the first anniversary of the Original Issue
Date at a price per share equal to the Series B Preferred Stock Face Amount plus
all accrued and unpaid dividends with respect to the shares of the Series B
Preferred Stock of such holder to be redeemed. To the extent that the Series B
Preferred Stock has not been redeemed by the Company, the holder may redeem the
Series B Preferred Stock on or after the fifth anniversary of the Original Issue
Date at a price per share equal to the Series B Preferred Stock Face Amount plus
all accrued and unpaid dividends with respect to the shares of the Series B
Preferred Stock of such holder to be redeemed. The Company is authorized to
issue up to 10,000 shares of the Series B Preferred Stock. The Company has not
issued any additional shares of Series B Preferred Stock during this fiscal
year.
The Company's outstanding Series B Preferred stock matured on December 30, 2010,
meaning that the holders of the Series B Stock became entitled to request that
the Company redeem their Series B Shares. As of this report, the Company has
received requests for redemption of 2,141.341 shares of Series B Preferred. The
aggregate amount to which the holders requesting redemption are entitled as of
June 30, 2011, is $3,310,824.
Under the terms of the Series B Preferred Stock, upon receipt of such a request,
the Company's Board was required to make a good faith determination regarding
(A) whether the funds of the Company legally available for redemption of shares
of Series B Stock are sufficient to redeem the total number of shares of Series
B Stock to be redeemed on such date and (B) whether the amounts otherwise
legally available for redemption would, if used to effect the redemption, not
result in an impairment of the operations of the Insurance Subsidiary. If the
Board determines that there is a sufficiency of legally available funds to
accomplish the redemption and that the use of such funds to affect the
redemption will not result in an impairment of the operations of the Insurance
Subsidiary, then the redemption shall occur on the Redemption Date. If, however,
the Board determines either that there are not sufficient funds legally
available to accomplish the redemption or that the use of such funds to effect
the redemption will result in an impairment of the operations of the Insurance
Subsidiary, then (X) the Company shall notify the holders of shares that would
otherwise have been redeemed of such fact and the consequences as provided in
this paragraph, (Y) the Company will use those funds which are legally available
therefor and which would not result in an impairment of the operations of the
Insurance Subsidiary to redeem the maximum possible number of shares of Series B
Stock for which Redemption Notices have been received ratably among the holders
of such shares to be redeemed based upon their holdings of such shares, and (Z)
thereafter, until such shares are redeemed in full, the dividends accruing and
payable on such shares of Series B Stock to be redeemed shall be increased by 2%
of the Series B Face Amount, with the amount of such increase (I.E., 2% of the
Series B Face Amount) to be satisfied by distributions on each Dividend Payment
Date of shares of Common Stock having a value (determined by reference to the
average closing price of such Common Stock over the preceding 20 trading days)
equal to the amount of such increase. The shares of Series B Stock not redeemed
shall remain outstanding and entitled to all the rights and preferences provided
F-28
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
herein. At any time thereafter when additional funds of the Company are legally
available for the redemption of shares of Series B Stock and such redemption
will not result in an impairment of operations of the Insurance Subsidiary, such
funds will immediately be used to redeem the balance of the shares of Series B
Stock to be redeemed. No dividends or other distributions shall be declared or
paid on, nor shall the Company redeem, purchase or acquire any shares of, the
Common Stock or any other class or series of Junior Securities or Equal Ranking
Preferred of the Company unless the Redemption Price per share of all shares for
which Redemption Notices have been given shall have been paid in full, provided
that the redemption price of any Equal Ranking Preferred subject of redemption
shall be paid on a pari passu basis with the Redemption Price of the Series B
Stock subject of redemption in accordance herewith. Until the Redemption Price
for each share of Series B Stock elected to be redeemed shall have been paid in
full, such share of Series B Stock shall remain outstanding for all purposes and
entitle the holder thereof to all the rights and privileges provided herein, and
Dividends shall continue to accrue and, if unpaid prior to the date such shares
are redeemed, shall be included as part of the Redemption Price.
On March 8, 2011, the Company's Board of Directors determined based on the
criteria established under the terms of the Series B Preferred Stock that there
were insufficient funds available for the redemption of Series B Stock.
The Company experienced a loss after accretion of mandatorily redeemable
convertible preferred stock, and accrued dividends on mandatorily redeemable
preferred stock of $1,440,090 in fiscal 2011 as compared with a loss after
accretion of mandatorily redeemable convertible preferred stock, and accrued
dividends on mandatorily redeemable preferred stock of $2,338,531 in fiscal
2010.
EQUITY PREFERRED STOCK
As a means of alleviating obligations associated with the Company's Series B
Preferred Stock, which by its terms matured at the end of 2010, management
proposed a recapitalization to assist in stabilizing the financial position of
the Company. The Company's Certificate of Incorporation provides for two classes
of capital stock, known as common stock, $0.0001 par value per share (the
"COMMON STOCK"), and preferred stock, $0.0001 par value per share (the
"PREFERRED STOCK"). The Company's Board is authorized by the Certificate of
Incorporation to provide for the issuance of the shares of Preferred Stock in
series, and by filing a certificate pursuant to the applicable law of the State
of Delaware, to establish from time to time the number of shares to be included
in such series and to fix the designations, preferences and rights of the shares
of each such series and the qualifications, limitations and restrictions
thereof. The Board deemed it advisable to designate a Series C Preferred Stock
and fixed and determined the preferences, rights, qualifications, limitations
and restrictions relating to the Series C Preferred Stock as follows:
1. Designation. The shares of such series of Preferred Stock are designated
"Series C Preferred Stock" (referred to herein as the "SERIES C STOCK").
F-29
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The date on which the first share of Series C Stock is issued shall
hereinafter be referred to as the "ORIGINAL ISSUE DATE".
2. Authorized Number. The number of shares constituting the Series C Stock is
10,000.
3. Ranking. The Series C Stock ranks, (a) as to dividends and upon Liquidation
senior and prior to the Common Stock and all other equity securities to
which the Series C ranks prior, with respect to dividends and upon
Liquidation (collectively, "JUNIOR SECURITIES"), (b) pari passu with the
Corporation's Series A Preferred Stock, par value $0.0001 per share (the
"SERIES A STOCK"), the Corporation's Series B Stock, and any other series
of Preferred Stock subsequently established by the Board with equal ranking
(any such other series of Preferred Stock, together with the Series C
Stock, the Series B Stock and Series A Stock are collectively referred to
as the "EQUAL RANKING PREFERRED") and (c) junior to any other series of
Preferred Stock subsequently established by the Board with senior ranking.
4. Dividends.
(a) DIVIDEND ACCRUAL AND PAYMENT. The holders of the Series C Stock shall be
entitled to receive, in preference to the holders of Junior Securities,
dividends ("DIVIDENDS") on each outstanding share of Series C Stock at the
rate of 8% per annum of the sum of (i) the Series C Face Amount plus (ii)
an amount equal to any accrued, but unpaid, dividends on such Series C
Stock, including for this purpose the exchanged Series B Amount outstanding
with respect to such Series C Stock. For purposes hereof, the "SERIES B
AMOUNT" means an amount equal to the dividend that would have accrued on
such Series C Stock held by such holder from and after the Series B
Original Issue Date applicable to such share of Series C Stock, through the
Original Issue Date as if such Series C Stock had been issued on such
Series B Original Issue Date, less all amounts thereof distributed by the
Corporation with respect to such Series C Stock. Dividends shall be payable
quarterly in arrears on each January 1, April 1, July 1 and October 1
following the Original Issue Date, or, if any such date is a Saturday,
Sunday or legal holiday, then on the next day which is not a Saturday,
Sunday or legal holiday (each a "DIVIDEND PAYMENT DATE"), as declared by
the Board and, if not paid on the Dividend Payment Date, shall accrue.
Amounts available for payment of Dividends (including for this purpose the
Series B Amount) shall be allocated and paid with respect to the shares of
Series C Preferred and any other Equal Ranking Preferred, FIRST, among the
shares of Equal Ranking Preferred pro rata in accordance with the amounts
of dividends accruing with respect to such shares at the current Dividend
Payment Date, and, THEN, any additional amounts available for distribution
in accordance with the accrued, but unpaid, dividends (and the Series B
Amount then outstanding) at each prior Dividend Payment Date, in reverse
chronological order, with respect to all shares of the Equal Ranking
Preferred then outstanding in accordance with amounts accrued, but unpaid.
For purposes hereof, the term "SERIES B ORIGINAL ISSUE DATE" shall mean,
with respect to any share of Series C Stock issued by the Corporation in
exchange for a share of Series B Stock, the date on which the Corporation
originally issued such share of Series B Stock.
The Recapitalization consisted of the exchange of Series B Shares for a
combination of Series C Shares and Common Stock. For each Series B Share, the
participating holder received (i) one Series C Share and (ii) 2,000 shares of
JFG Common Stock (for no additional consideration).
F-30
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the year ending May 31, 2010, 6,804.936 shares of Series B Stock were
surrendered and exchanged for 6,804.936 shares of Series C Stock. This exchange
amounted to $6,269,051 of carrying value of Series B stock being exchanged for
Series C and Common Stock. 13,609,872 shares of Common Stock were issued to the
Series C Stock holders at the rate of 2,000 Common shares for each exchanged
Series B Stock, with the related cost associated with the Common issuance
offsetting the Series C carrying value by $265,120. The shares were valued at
approximately $.01948 per share based on the average quoted closing price of the
Company's stock for the 20-day period proceeding the date of the transaction.
Series C stock may be redeemed by the Company but does not have a fixed maturity
date and, thus, is classified as permanent equity.
The accrual of dividends on the equity preferred stock resulted in a charge to
common stockholders' equity and a credit to the equity of equity preferred stock
of $781,062 in fiscal 2011 as compared with a a charge to common stockholders'
equity of $374,662 in fiscal 2010.
DIVIDEND PREFERENCE AND ACCRETION
The Series A Shares are entitled to receive cumulative dividends at the rate of
4.00% per annum.
The Series B Shares have an 8.0% per annum compounding dividend preference, are
convertible into Common Shares of JFG at the option of the holders at a
conversion price of $1.00 per Share (as adjusted for dilution) and, to the
extent not converted, must be redeemed by the Corporation at any time after
December 31, 2010 at the option of the holder. Any such redemption is subject to
legal constraints, such as the availability of capital or surplus out of which
to pay the redemption, and to a determination by our Board of Directors that the
redemption will not impair the operations of First Surety.
The Series C Shares issued in the Recapitalization have the same 8.0% per annum
compounding dividend preference and carry over from the Series B Shares the same
accrued but unpaid dividends. While dividends had never been declared on the
Series B shares, they had been accrued, increasing the dividend preference and
the redemption price and liquidity preference of such shares and increasing the
liability represented thereby based upon the Series B Shares fixed maturity
date. The accrued (but undeclared) dividends associated with the Series C
exchange amounted to $2,295,624 and are included in the total amount exchanged
for Series C Shares. Unlike the Series B Shares with their fixed maturity date,
the Series C Shares are permanent equity, with accruing dividends only
increasing the preference amount that must be satisfied before junior securities
may participate in dividends or on liquidation. Accordingly, the effect of the
accrual of dividends with respect to the Series C Shares on the Company's
balance sheet is to increase the aggregate claim of the Series C Shares on the
equity of the corporation and to increase the deficit in common equity, while
having no effect on the net equity of the corporation as a whole. The
entitlement of the Series C Shares to a priority in relation to junior
securities with respect to dividends and on liquidation does not create an
obligation to the Company and therefore no liability is recorded until the
F-31
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
dividends are declared by the Board of the Company. The Series C Shares are pari
passu with the Corporation's Series A Preferred Stock and Series B Shares (to
the extent any remain outstanding following the Recapitalization) and no
dividends or other distributions will be paid upon Common Shares or any other
class of Shares that is junior in priority to the Series C Preferred while
dividends are in arrears. In addition, the Series C Shares are convertible into
Common Shares of JFG at the option of the holders at a conversion price of $0.10
per Share. The Series C Shares may be redeemed by the Corporation, at its
option, when it is in a financial position to do so.
Holders of over 70% of the outstanding Series B Preferred Shares elected to
participate in the recapitalization. The shares of Series B Preferred
Shareholders that chose not to convert are listed in the Liabilities section of
the Balance Sheet, and therefore the accretion and dividends associated with the
Series B stock after November 30, 2009 are deductions from net income. Accretion
and dividends on Series B mandatorily redeemable preferred stock deducted from
net income amounted to $106,366 and $324,455 for the twelve month period ended
May 31, 2011. The remaining Series B shares not converted were accreted from
carrying value to the face amount for the 5 year period from the date of
issuance. Series C stock has no accretion. There were no shares of Series B
Stock surrendered or exchanged in the twelve month periods ending May 31, 2011.
As of May 31, 2011 the Company has chosen to defer payment of dividends on the
Series A Preferred Stock with such accrued and unpaid dividends amounting to
$463,621 through May 31, 2011.
As of May 31, 2011 the Company has chosen to defer payment of dividends on the
Series B and Series C Preferred Stock with such accrued and unpaid dividends
amounting to $1,443,475 and $3,451,348 through May 31, 2011.
ACCOUNTING TREATMENT
Management consulted Statement of Financial Accounting Standards (SFAS) Number
133, "Accounting for Derivative Instruments and Hedging Activity", Emerging
Issues Task Force (EITF) Number 00-19, "Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company's Own Stock", and
SFAS 150, "Accounting for Certain Instruments with Characteristics of Both
Liabilities and Equity" in evaluating the accounting for preferred securities.
Management determined that SFAS 150 is the appropriate accounting literature.
SFAS 150 requires that an entity classify as liabilities certain financial
instruments with characteristics of both liabilities and equity. SFAS 150
applies to certain freestanding financial instruments that embody an obligation
for the entity that may require the entity to issue shares, redeem or repurchase
its shares.
The Company's Series A and B preferred stock each have mandatory redemption
features that subject the Company to the analysis of equity versus liability. In
accordance with SFAS 150, both Series A and B have features that embody a
conditional obligation to redeem the instrument upon events not certain to occur
and accordingly, are not classified as liabilities until such events are certain
to occur. With respect to the Series A Preferred Stock, such condition is
contingent upon the holder having no further need for surety bonds issued by the
F-32
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company's insurance subsidiary (FSC) under its partially collateralized bonding
programs and, having no such surety bonds then outstanding. With respect to the
Series B Preferred Stock, in accordance with SFAS 150, if the stock provides an
option to the holder to convert to common shares at a rate equivalent to fair
value, then the financial instruments are not mandatorily redeemable during the
period in which the holder can convert the shares into common shares.
Accordingly, the Company has determined that only the Series A preferred stocks
should not be classified as liabilities. However, in accordance with Securities
and Exchange Commission (SEC) Issued Topic No. D- 98, SEC Staff Announcement,
"Classification and Measurement of Redeemable Securities", a company that issues
preferred shares that are conditionally redeemable (i.e., the shares are not
within the scope of SFAS 150 because there is no unconditional obligation to
redeem the shares at a specified or determinable date or upon an event certain
to occur) is required to account for the conditionally redeemable preferred
shares in accordance with Accounting Series Release 268, which states that the
shares are to be reflected on the company's balance sheet between total
liabilities and stockholders' equity as temporary equity.
NOTE K - STOCK WARRANTS
-----------------------
On December 30, 2005, the Company issued warrants to purchase 45,402,996 shares
of common stock in connection with the Series A and B Preferred Stock private
placements. The exercise price of the warrants is one-tenth of one cent ($.001)
per share. The warrants were valued using the Black-Scholes pricing model. The
warrants issued in connection with the Series A Preferred Stock were valued at
$.08 per share or $83,043. The warrants issued in connection with the Series B
Preferred Stock were valued at $.01 per share or $449,972.
In the twelve month period ending May 31, 2011, warrants totaling 4,854,564 were
exercised for cash and 4,854,564 common shares of the Company were issued at a
price of $.001 per share. In addition, warrants totaling 4,266,666 (gross) were
exercised under the cashless exercise option, resulting in 761,904 warrants
surrendered at the market price of $.0056 to effect those holders' purchase of
3,504,762 net common shares. 386,667 warrants issued in connection with Series B
Preferred Stock expired unexercised on the fifth anniversary at December 31,
2010; 600,000 warrants issued in connection with Series A Preferred Stock remain
outstanding with an expiration on the seventh anniversary of their issuance.
NOTE L-STOCK-BASED COMPENSATION
-------------------------------
On October 12, 2005, the board of directors adopted its 2005 Stock Incentive
Plan (the "Plan") to allow the Company to make awards of stock options as part
of the Company's compensation to key employees, non-employee directors,
contractors and consultants. The Plan was approved by the stockholders on
December 8, 2005. The aggregate number of shares of Common Stock issuable under
all awards under the Plan is 35,000,000. No awards may be granted under the Plan
after December 8, 2015.
On May 25, 2006, the compensation committee of the board of directors awarded
23,400,000 of incentive stock options to acquire common shares at an exercise
price of seven cents ($.07) per share, of which 5,500,000 shares vested
F-33
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
immediately and the remaining 17,900,000 options vesting over the next four
years ending in May 2010. Due to changes in employment status for two employees
during fiscal year 2010, the awarded options had been reduced to 19,800,000, all
of which expired in May 2011.
On December 28, 2006, the compensation committee of the board of directors
awarded 2,100,000 of incentive stock options to acquire common shares at an
exercise price of four cents ($.04) per share, of which 450,000 shares vested
immediately and the remaining 1,650,000 options vesting over the next three
years ending in December 2009. The term of the options is five years and expires
in December 2011. As of May 31, 2010, the awarded options had been reduced to
1,800,000 due to changes in employment status. As of May 31, 2011, all of these
options have vested.
On June 30, 2009 the compensation committee of the board of directors awarded
10,000,000 of incentive stock options to acquire common shares at an exercise
price of four cents ($.04) per share, of which 4,700,000 shares vested
immediately and the remaining 5,300,000 options vesting over the next three
years ending in June 2011. The term of the options is five years and expires in
June 2014. As of May 31, 2011, 9,700,000 options were vested and 300,000 were
unvested.
The following table summarizes option activity under the Plan for the fiscal
year ended May 31, 2011.
2011
Number Weighted-Avg.
Weighted-Avg. Of Shares Remaining Aggregate
Exercise Under Life Intrinsic
Price Option (Years) Value
------------- ---------------- ------------ ------------
Balance at June 1, 2010 $ .05822 32,600,000
Options granted - -
Options exercised - -
Options canceled/expired .06856 20,800,000
------------- ----------------
Balance, May 31, 2011 $ .04000 11,800,000
============= ================
Exercisable at May 31, 2011 $ .04000 11,500,000 2.69 $ -
============= ================
Expected to vest $ .04000 300,000 3.08 $ -
============= ================
The following table summarizes activity and pricing information for the non-
vested shares under the Plan for the year ended May 31, 2011.
F-34
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2011
Number
Weighted-Average Of
Grant Date Non-vested
Fair Value Shares
---------------- -----------------
Balance at June 1, 2010
$ .02962 5,300,000
Options granted - -
Options vested .02962 ( 5,000,000)
Options canceled/expired - -
---------------- -----------------
Balance at May 31, 2011 $ .02962 300,000
================ =================
There were no options exercised in fiscal 2011 or 2010. The total fair value of
shares vested amounted to approximately $148,000 and $189,000 in fiscal 2011 and
2010 respectively.
Stock-based compensation expense attributable to such awards amounted to
approximately $17,000 and $252,000 in fiscal years ended May 31, 2011 and 2010
respectively. Unrecognized compensation expense related to non-vested awards at
May 31, 2011 was approximately $400 and is expected to be recognized over the
next year.
The company estimates the fair value of stock options using a Black-Scholes
valuation model, consistent with the provisions of SFAS 123R. Key inputs and
assumptions used to estimate the fair value of stock options include the grant
price of the award, the expected option term, volatility of the company's stock,
the risk-free interest rate and the company's dividend yield.
NOTE M - INCOME TAXES
---------------------
Deferred tax assets and liabilities are recorded for the effects of temporary
differences between the tax basis of an asset or liability and its reported
amount in the consolidated financial statement. Such differences include the
income recognition of a portion of the unearned premium reserve, accruals not
currently deductible relating to stock option expense and certain accrued
expenses that are not paid within specified time frames by the Internal Revenue
Service, and the deductibility of deferred policy acquisition costs paid. As of
May 31, 2011, the Company had operating loss carry forwards of approximately
$17.8 million. These carry forwards begin expiring in 2015 and, as a result of
the ownership change resulting from the 2001 acquisitions of FSI and Jacobs, the
utilization of approximately $6.4 million of the operating loss carry forwards
are substantially limited.
The Company has fully reserved the $5.6 million tax benefit of the operating
loss carry forward, by a valuation allowance of the same amount, because the
likelihood of realization of the tax benefit cannot be determined.
NOTE N-STOCKHOLDERS EQUITY
--------------------------
In fiscal 2011, the Company issued 5,719,499 shares of the Company's common
stock as additional consideration in connection with new and continued
borrowings totaling $4,912,500. The shares were valued at approximately $.00619
F-35
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
per share based on the average quoted closing price of the Company's stock for
the 20-day period proceeding the date of the transaction and totaled $35,405.
In fiscal 2011, warrants totaling 4,854,564 were exercised for cash and
4,854,564 common shares of the Company were issued at a price of $.001 per
share. In addition, warrants totaling 4,266,666 (gross) were exercised under the
cashless exercise option, resulting in 761,904 warrants surrendered at the
market price of $.0056 to effect those holders' purchase of 3,504,762 net common
shares. 386,667 warrants issued in connection with Series B Preferred Stock
expired unexercised on the fifth anniversary at December 31, 2010; 600,000
warrants issued in connection with Series A Preferred Stock remain outstanding
with an expiration of December 31, 2012.
On March 31, 2011 the Company issued 309,282 shares of the Company's common
stock in connection with the additional 2% stock dividend associated with Series
B Preferred shares that were requested to be redeemed upon maturity (see Note
J). The shares were valued at approximately $.00607 per share based on the
average quoted closing price of the Company's stock for the 20-day period
proceeding the date of the transaction and totaled $1,877.
In fiscal 2011, the Company issued 6,213,285 shares of the Company's common
stock in connection with the semi-annual issuance of shares under terms of the
bridge-financing arrangement. The shares were valued at approximately $.00607
per share based on the average quoted closing price of the Company's stock for
the 20-day period proceeding the date of the transaction and totaled $37,715.
In fiscal 2011, the Company issued 6,738,900 shares of the Company's common
stock in connection with the semi-annual issuance of shares under terms of the
bridge-financing arrangement. The shares were valued at approximately $.006790
per share based on the average quoted closing price of the Company's stock for
the 20-day period proceeding the date of the transaction and totaled $45,757.
In fiscal 2011, the Company awarded 500,000 shares to an individual as
compensation for services instrumental to advancing the Company's business plan,
including introductions and negotiations with reinsurers, investors and insurers
with the potential to provide license authority in additional states. The shares
were valued at approximately $.004095 per share based on the average quoted
closing price of the Company's stock for the 20-day period proceeding the date
of the transaction and totaled $2,048
In fiscal 2010, the Company issued 1,675,000 shares of the Company's common
stock as additional consideration in connection with short-term and demand
borrowing arrangements totaling $500,000. The shares were valued at
approximately $.0169 per share based on the average quoted closing price of the
Company's stock for the 20-day period proceeding the date of the transaction and
totaled $28,275.
In fiscal 2010, warrants totaling 2,963,668 were exercised for cash and issuance
of 2,963,668 common shares of the Company.
In fiscal 2010, the Company issued 5,354,642 shares of the Company's common
stock in connection with the semi-annual issuance of shares under terms of the
bridge-financing arrangement. The shares were valued at approximately $.0146 per
share based on the average quoted closing price of the Company's stock for the
20-day period proceeding the date of the transaction and totaled $78,178.
F-36
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In fiscal 2010, the Company issued 6,005,925 shares of the Company's common
stock in connection with the semi-annual issuance of shares under terms of the
bridge-financing arrangement. The shares were valued at approximately $.00912
per share based on the average quoted closing price of the Company's stock for
the 20-day period proceeding the date of the transaction and totaled $54,774.
In fiscal 2010, the Company issued 5,171,993 shares of the Company's common
stock in connection with the forbearance agreement of the bridge-financing
arrangement (See Note H). The shares were valued at approximately $.0365 per
share based on the average quoted closing price of the Company's stock for the
20-day period proceeding the date of the transaction and totaled $188,778.
In fiscal 2010, the Company issued 13,609,872 shares of the Company's common
stock in connection with the exchange of Series B Preferred Shares for Series C
Preferred Shares (See Note J).
NOTE O-STATUTORY FINANCIAL DATA (UNAUDITED)
-------------------------------------------
The Company's insurance subsidiary files calendar year financial statements
prepared in accordance with statutory accounting practices prescribed or
permitted by regulatory authorities. The principal differences between statutory
financial statements and financial statements prepared in accordance with
generally accepted accounting principals are that statutory financial statements
do notreflect deferred policy acquisition costs and certain assets are
non-admitted.
Statutory surplus as of May 31, 2011 and 2010 and net income for the Company's
insurance subsidiary the calendar year ended December 31, 2010 and 2009 and
five-month periods ended May 31, 2011 and 2010 are as follows:
Statutory Surplus May 31, 2011 $ 6,105,504
Statutory Surplus May 31, 2010 5,869,182
Net Income Calendar year 2010 201,683
Net Income Calendar year 2009 279,136
Net Income Five-month period 2011 86,700
Net Income Five-month period 2010 72,782
Statutory surplus exceeds the minimum capital requirements provided by West
Virginia state law of $2.0 million.
Under the Consent Order issued by the Commissioner of the State of West Virginia
for the acquisition of the insurance subsidiary by the Company, no dividends can
be declared or paid from the insurance subsidiary without the prior written
approval of the Insurance Commissioner.
F-37
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE P - COMMITMENTS AND CONTINGENCIES
--------------------------------------
LEASE COMMITMENTS
The Company leases certain office equipment with combined monthly payments of
approximately $615 that have varying remaining terms of less than five years.
The Company leases office, parking and storage space under month-to-month lease
arrangements that approximate $3,905 each month.
The Company leases an apartment for corporate use that has a remaining term of 3
months at a monthly rate of $560.00 plus electric utilities.
The Company holds an undeveloped leasehold interest in a mineral water spring
located near Hot Springs, Arkansas. Under the leasehold arrangement, the Company
makes minimum lease payments of $180 per month. The Company has options to
extend the leasehold arrangement through October 2026 and also has a right to
cancel the lease at any time upon sixty (60) days written notice.
Rental expense for these lease commitments totaled approximately $63,291 and
$63,452 during 2011 and 2010.
Minimum future lease payments under non-cancelable operating leases having
remaining terms in excess of one year as of May 31, 2011 are:
Fiscal year 2011-2012 $ 8,682
---------
Total $ 8,682
=========
NOTE Q - FINANCIAL INSTRUMENTS
------------------------------
FAIR VALUE
The following methods and assumptions were used to estimate fair market value of
each class of financial instruments for which it is practicable to estimate that
value:
INVESTMENT SECURITIES
Fair values for investment securities (U.S. Government, government agencies,
government agency mortgage-backed securities, state and municipal securities,
and equity securities) held for investment purposes (available-for-) are based
on quoted market prices or dealer quotes. If a quoted market price is not
available, fair value is estimated using quoted market prices for similar
securities.
OTHER FINANCIAL INSTRUMENTS
The carrying amount of cash, short-term investments, receivables, prepaid
expenses, short-term and demand notes payable, accounts payable, accrued
expenses and other liabilities approximate fair value because of the immediate
or relatively short-term maturity of these financial instruments. Fair value of
term notes payable, including notes payable under the bridge-financing
arrangement, were deemed to approximate their carrying value based on the
Company's incremental borrowing rates for similar types of borrowings with
maturities consistent with those remaining for the debt being valued.
The carrying values and fair values of the Company's financial instruments at
May 31, 2011 and 2010 are as follows:
F-38
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2011 2010
Carrying Fair Carrying Fair
Amount Value Amount Value
----------------- ------------------ ----------------- -----------------
ASSETS
Bonds available for sale $ 5,858,595 $ 6,038,718 $ 6,618,472 $ 6,618,472
Cash and short-term investments 1,291,186 1,291,186 338,650 338,650
Premiums and other receivables 210,438 210,438 179,299 179,299
Equity securities (including derivatives) 450,908 453,456 - -
LIABILITIES
Notes payable 5,279,535 5,279,535 4,610,609 4,610,609
Accounts payable and advance premiums 342,036 342,036 237,447 237,447
Accrued expenses and other liabilities 1,951,736 1,951,736 1,549,760 1,549,760
NOTE R - OTHER RISKS, UNCERTAINTIES AND CONCENTRATIONS
------------------------------------------------------
CONCENTRATION OF CREDIT RISK
As of May 31, 2011 the Company's investment securities of approximately
$7,500,000 are solely comprised of mortgage-backed securities, fixed maturity
municipal bonds, equity investments, and money-market mutual funds that invest
principally in obligations issued by the U.S government, its agencies or
instrumentalities. Such instruments are generally considered to be of the
highest credit quality investment available.
The Company transacts the majority of its business with three financial
institutions, one for commercial banking services and the others for brokerage
and custodial services. Periodically, the amount on deposit in financial
institutions providing commercial banking services exceeds the $250,000
federally insured limit. Management believes these financial institutions are
financially sound. With respect to the financial institutions providing
brokerage and custodial services, amounts on deposit are invested in money
market funds that invest principally in obligations issued by the U.S
government, its agencies or instrumentalities.
Management believes that substantially all receivables are collectible, and
therefore has not established an allowance for estimated uncollectible accounts.
CONCENTRATION IN PRODUCTS, MARKETS AND CUSTOMERS
The Company's insurance subsidiary currently writes only the surety line of
business, is licensed to write surety only in West Virginia and Ohio and has
focused its primary efforts towards coal permit bonds. Such business, including
investment advisory fees from managed collateral accounts, accounted for
approximately 74% and 69% of the Company's fiscal 2011 and 2010 revenues,
respectively. Furthermore, the Company provides surety bonds to companies that
share common ownership interests that constitute 54% and 51% of the Company's
fiscal 2011 and 2010 revenues, respectively, as follows:
F-39
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2011 2010
Investment Investment
Surety Advisory Surety Advisory
Premium Fees Premium Fees
------------------ ----------------- ----------------- -----------------
Customer group # 1 $ 267,000 $ 75,000 $ 277,000 $ 73,000
Customer group # 2 462,000 83,000 262,000 46,000
Customer group # 3 203,000 2,800 167,000 1,400
------------------ ----------------- ----------------- -----------------
TOTAL 932,000 160,800 706,000 120,400
================== ================= ================= =================
NOTE S - SEGMENT REPORTING
--------------------------
The Company has two reportable segments, investment advisory services and surety
insurance products and services. The following table presents revenue and other
financial information by industry segment.
F-40
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEAR ENDED
INDUSTRY SEGMENT MAY 31, 2011 MAY 31, 2010
---------------- ---------------- ---------------
REVENUES:
Investment advisory $ 286,695 $ 361,412
Surety insurance 1,279,138 1,210,611
Corporate 50,000 -
---------------- ---------------
Total revenues $ 1,615,833 $ 1,572,023
================ ===============
OPERATING INCOME (LOSS):
Investment advisory $ 70,222 $ 113,005
Surety insurance 475,455 536,938
Corporate (1,852,411) (2,107,399)
---------------- ---------------
Total operating income (loss) $ (1,306,734) $ (1,457,456)
================ ===============
IDENTIFIABLE ASSETS:
Investment advisory $ 59,949 $ 51,097
Surety insurance 8,584,860 7,724,941
Corporate 16,589 22,001
---------------- ---------------
Total assets $ 8,661,398 $ 7,798,039
================ ===============
CAPITAL ACQUISITIONS:
Investment advisory $ - $ -
Surety insurance 25,919 5,819
Corporate 4,516 -
---------------- ---------------
Total capital acquisitions $ 30,435 $ 5,819
================ ===============
DEPRECIATION CHARGED TO
IDENTIFIABLE ASSETS:
Investment advisory $ 45 $ 45
Surety insurance 12,229 7,282
Corporate 3,065 3,282
---------------- ---------------
Total Depreciation $ 15,339 $ 10,609
================ ===============
INTEREST EXPENSE:
Investment advisory $ 5 $ -
Surety insurance - -
Corporate 908,370 956,973
---------------- ---------------
Total interest expense $ 908,375 $ 956,973
================ ===============
F-41
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE T - RELATED PARTY TRANSACTIONS
-----------------------------------
BORROWING AND OTHER TRANSACTIONS OF LARGEST SHAREHOLDER AND CEO
For the past several years the Company's operating expenses were partially
funded by advances from its largest shareholder and chief executive officer,
John M. Jacobs. The source of funding for these advances originated with
obligations incurred by Mr. Jacobs with third parties (such obligations together
with the loans by Mr. Jacobs to the Company, "back-to-back loans") with interest
rates ranging from 6.75% to 12%.
To assure that repayments of the various borrowings by the Company that were
either guaranteed by Mr. Jacobs or loaned to the Company by Mr. Jacobs via such
back-to-back loan arrangements did not result in a deemed loan to Mr. Jacobs,
Mr. Jacobs entered into an Assumption Agreement with the Company, pursuant to
which Mr. Jacobs assumes, and agrees to hold the Company harmless from,
principal of specified indebtedness of the Company as and when necessary to
fully offset what might otherwise be deemed an advance of funds arising out of
the Company's financing activities.
During fiscal 2010, advances to the Company from Mr. Jacobs amounted to
$710,435, which included assumption of company debt in the amount of $185,652,
and repayments to Mr. Jacobs amounted to $706,412. As of May 31, 2010, the
balance due Mr. Jacobs was $7,104. The largest aggregate amount outstanding to
Mr. Jacobs in fiscal 2010 was $178,444.
During fiscal 2011, advances to the Company from Mr. Jacobs amounted to
$1,125,113, which included assumption of company debt in the amount of $624,303,
and repayments to Mr. Jacobs amounted to $1,162,182. As of May 31, 2011, the
balance due the Company from Mr. Jacobs was $29,965. The largest aggregate
amount outstanding to Mr. Jacobs in fiscal 2011 was $143,460.
The rate of interest on such amounts due from and obligations due to Mr. Jacobs
was 12% for both the 2011 and 2010 fiscal years.
As of September 13, 2011, $16,746 was owed by the Company to Mr. Jacobs.
OTHER RELATED PARTIES
During the years ended May 31, 2011 and May 31, 2010, a company owned by a board
member provided consulting services. This company provided services totaling
$62,100 and $62,100 in 2011 and 2010. Amounts owed to this company at year end
are treated as related party payables in the amounts $99,209 and $96,160 at May
31, 2011 and 2010.
During the year ended May 31, 2009, the company borrowed money from an
individual that became a board member during 2010. Total amounts owed to this
board member at May 31, 2011 and May 31, 2010 consisted of $75,000 in demand
notes and $360,000 in bridge financing.
NOTE U - REINSURANCE
--------------------
The Company limits the maximum net loss that can arise from large risks by
reinsuring (ceding) certain levels of such risk with reinsurers. Ceded
reinsurance is treated as the risk and liability of the assuming companies. The
F-42
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company cedes insurance to other companies and these reinsurance contracts do
not relieve the Company from its obligations to policyholders.
Effective April 1, 2009, FSC entered into a reinsurance agreement with various
syndicates at Lloyd's of London and one Bermuda based reinsurer ("Reinsurer")
for its coal reclamation surety bonding programs. The reinsurance agreement is
an excess of loss contract which protects the Company against losses up to
certain limits over stipulated amounts, has an initial term of 39 months and can
be terminated by either party by written notice of at least 90 days prior to any
July 1. The contract calls for the first year of the agreement to consist of 15
months with premium due within 30 days of the end of the first Agreement Year,
June 1, 2010, at a rate of 35% of gross written premium, subject to a minimum
premium $490,000. For the second agreement year, which covers twelve months
beginning July 1, 2010, the premium rate remains the same at 35% with the
premium due within 30 days of the close of the second agreement year, subject to
a minimum premium of $490,000. Deposits are made to the reinsurers quarterly in
arrears in equal amounts of $122,500. At May 31, 2011 and 2010, the Company had
prepaid reinsurance premiums of $264,763 and $214,385 and ceded reinsurance
payable/(deposited) of $77,635 and ($122,568). During 2010, the amounts
deposited with the Reinsurer were greater than the ceded premium written,
resulting in a net deposit instead of a payable.
There were no ceded Loss and LAE expenses for the years ended May 31, 2011 or
2010.
The effects of reinsurance on premium written and earned for fiscal 2011 and
2010 are as follows;
2011 Written 2011 Earned 2010 Written 2010 Earned
------------- ------------ ------------- ------------
Direct $ 1,613,912 $ 1,380,225 $ 1,114,197 $ 1,026,896
Ceded $ 519,663 $ 469,285 $ 385,259 $ 257,987
------------- ------------ ------------- ------------
Net $ 1,094,249 $ 910,940 $ 728,938 $ 768,909
NOTE V - EVENTS SUBSEQUENT TO MAY 31, 2011
------------------------------------------
Subsequent to May 31, 2011, the Company obtained new borrowings of $35,000 from
individuals to fund ongoing operation and made repayments of $65,000. Such
borrowings were obtained under demand notes bearing interest at the rate of 10%.
These borrowings included the issuance of 35,000 shares of its common stock as
additional consideration. Additionally, the company obtained short term
borrowings from a business totaling $170,000 and made repayments on these
borrowing of $141,000 as well as $7,500 in interest.
Subsequent to May 31, 2011, the Company obtained various borrowings from
individuals and businesses totaling $82,000 at the rate of 10%, which mature in
October 2011. These borrowings, and the renewal of other borrowings, included
the issuance of 697,000 shares of its common stock as additional consideration.
Additionally, there were advances to the Company from its largest shareholder
and CEO amounting to $247,284, with repayments totaling $200,573.
On September 10, 2011, in accordance with the Bridge financing agreement, the
Company became obligated to issue in the aggregate 7,043,710 shares of its
common stock to the holders of such notes.
F-43
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On June 30, 2011, the Company elected to continue to defer payment of dividends
on its Series A Preferred Stock, Series B Preferred Stock, and Series C
Preferred Stock with such accumulated accrued and unpaid dividends amounting to
$494,921, $1,528,451, and $3,655,912 as of June 30, 2011.
On July 6, 2011 the Company issued 1,372,949 Common shares representing the
additional 2% stock dividend for the quarter ending June 30, 2011 to the holders
of Series B Preferred shares that had requested to be redeemed upon maturity
(see Note J).
On August 31, 2011 the Company's insurance subsidiary, FSC, recorded receipt of
$213,281 from its reinsurers representing cumulative No Claims Bonus under the
terms of its reinsurance treaty for the claim years ending June 30, 2010 and
June 30, 2011.
F-44
------------------------------------------------------------------------------------------------------------------------------------
SUMMARY OF INVESTMENTS-
OTHER THAN INVESTMENTS IN RELATED PARTIES SCHEDULE I
------------------------------------------------------------------------------------------------------------------------------------
AMOUNT
AT WHICH
AT MAY 31, 2011 SHOWN IN THE
COST* VALUE BALANCE SHEET
------------ ------------ ---------------
Fixed maturities:
Bonds:
United States Government and government agencies and authorities $ - $ - $ -
States, municipalities, and political subdivisions 1,073,724 1,046,769 1,046,769
------------ ------------ ---------------
Total fixed maturities 1,073,724 1,046,769 1,046,769
Equity securities (including derivatives):
Common stock and derivatives 450,908 453,456 453,456
------------ ------------ ---------------
Total equity securities 450,908 453,456 453,456
Mortgage-backed securities guaranteed by U.S. government agency 4,784,871 4,991,949 4,991,949
Short-term investments, at cost (approximates market value) 1,007,617 1,007,617 1,007,617
------------ ------------ ---------------
Total investments $ 7,317,120 $ 7,499,791 $ 7,499,791
============ ============ ===============
* Original cost of equity securities and, as to fixed maturities, original cost
reduced by repayments and adjusted for amortization of premiums and accrual of
discounts
F-45
------------------------------------------------------------------------------------------------------------------------------------
CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II
------------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEETS - PARENT COMPANY ONLY
MAY 31, 2011 MAY 31, 2010
------------ ------------
Assets:
Cash $ (27,461) $ (16,526)
Accounts receivable from affiliates - -
Prepaid expense and other assets 9,192 15,696
Furniture and equipment, net 7,385 6,269
Investment in subsidiaries, equity method 5,798,422 5,360,750
Due from affiliates, net 677,801 753,919
------------ ------------
Total assets $ 6,465,339 $ 6,120,108
============ ============
LIABILITIES:
Accounts payable $ 20,922 $ 33,189
Accrued expenses and professional fees 495,169 519,187
Related party payable 231,656 159,907
Notes payable 4,874,500 4,159,119
Related party note payable 405,035 451,490
Due to affiliates - -
Other liabilities 1,199,932 830,893
Series B Preferred Stock 4,257,703 3,826,882
------------ ------------
Total liabilities 11,484,917 9,980,667
MANDATORILY REDEEMABLE PREFERRED STOCK 3,138,623 3,005,266
STOCKHOLDERS EQUITY:
Common stock 24,230 21,446
Additional paid in capital 3,549,443 3,404,431
Series C Stock 9,482,279 8,701,217
Accumulated deficit (21,214,153) (18,992,919)
------------ ------------
Total stockholders equity (deficit) (8,158,201) (6,865,825)
------------ ------------
Total liabilities and stockholders equity $ 6,465,339 $ 6,120,108
============ ============
STATEMENTS OF INCOME - PARENT COMPANY ONLY
YEAR ENDED MAY 31,
2011 2010
------------ ------------
REVENUES
Equity in undistributed net income (loss) of consolidated subsidiaries $ 437,671 $ 513,139
Tax benefit to parent from subsidiary attributable to utilization of net
operating loss carryforwards 108,006 148,174
Gain on extinguishment of debt 50,000 -
------------ ------------
Total revenues 595,677 661,313
EXPENSES:
General and administrative 560,155 904,505
Interest 908,370 968,343
Accrued dividends on stock liability 430,821 242,639
Depreciation 3,065 3,282
------------ ------------
Total expenses 1,902,411 2,118,769
------------ ------------
Net income (loss) (1,306,734) (1,457,456)
Accrued dividends on equity stock (781,062) (374,662)
Accretion of mandatorily redeemable convertible preferred stock,
including accrued dividends (133,356) (881,075)
------------ ------------
Net income (loss) attributable to common stockholders $(2,221,152) $(2,713,193)
============ ============
F-46
------------------------------------------------------------------------------------------------------------------------------------
CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II
------------------------------------------------------------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS - PARENT COMPANY ONLY
YEAR ENDED MAY 31,
2011 2010
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(1,306,734) $(1,457,456)
Adjustments to reconcile net (loss) to net cash provided by operating
activities:
Equity in undistributed net loss of consolidated subsidiaries (437,672) (513,139)
Accrual of preferred stock dividend 324,455 155,708
Accretion of preferred stock 106,366 86,931
Stock option compensation expense 16,782 251,632
Stock issued in connection with financing arrangements 126,074 261,958
Depreciation 3,065 3,282
Loss on disposal of equipment 335 -
Gain on extinguishment of debt (50,000) -
Change in other assets, accounts payable and accrued expense, net 461,011 724,690
------------ ------------
TOTAL CASH USED IN OPERATIONS (756,318) (486,394)
CASH FLOWS FROM INVESTING ACTIVITIES:
Contributions to insurance company subsidiary - (186,000)
Funds provided to affiliates for operations 76,118 95,782
Purchase of furniture and equipment (4,516) -
------------ ------------
TOTAL CASH USED IN INVESTING ACTIVITIES 71,602 (90,218)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of mandatorily redeemable preferred stock - 10,000
Proceeds from exercise of stock warrants 4,855 2,963
Proceeds from borrowings 1,762,000 1,017,500
Repayment of borrowings (1,046,619) (473,172)
Proceeds from short-term borrowings from related party 1,125,113 691,764
Repayment of short-term borrowings to related party (1,171,568) (686,941)
------------ ------------
TOTAL CASH PROVIDED BY FINANCING ACTIVITIES 673,781 562,114
------------ ------------
CHANGE IN CASH (10,935) (14,498)
Cash at beginning of year (16,526) (2,028)
------------ ------------
Cash at end of year $ (27,461) $ (16,526)
============ ============
F-47
JACOBS FINANCIAL GROUP, INC.
AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTARY INSURANCE INFORMATION
AS OF MAY 31, 2011 AND 2010 AND FOR THE YEARS THEN ENDED SCHEDULE III
------------------------------------------------------------------------------------------------------------------------------------
RESERVE FOR
LOSSES
AND OTHER AMORTIZATION
LOSS POLICY CLAIMS OF
DEFERRED EXPENSES, AND LOSSES AND DEFERRED
POLICY FUTURE CONTRACT NET SETTLEMENT POLICY OTHER NET
ACQUISITION POLICY UNEARNED CLAIMS PREMIUM INVESTMENT EXPENSES ACQUISITION OPERATING PREMIUMS
SEGMENT COSTS CLAIMS PREMIUMS PAYABLE REVENUE INCOME INCURRED COSTS EXPENSES WRITTEN
--------- ----------- ----------- --------- -------- --------- ---------- ---------- ----------- --------- ---------
2011
Surety $ 190,711 $ 815,512 $ 851,783 $ - $ 910,940 $ 229,777 $ 204,323 $ 310,420 $ - $1,094,249
-----------------------------------------------------------------------------------------------------------------------------------
2010
Surety $ 128,453 $ 611,190 $ 618,095 $ - $ 768,909 $ 273,577 $ 178,531 $ 256,810 $ - $ 728,938
F-48
------------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL INSURANCE INFORMATION - REINSURANCE
AS OF MAY 31, 2011 AND 2010 AND FOR THE YEARS THEN ENDED SCHEDULE IV
------------------------------------------------------------------------------------------------------------------------------------
CEDED TO OTHER
2011 GROSS AMOUNT COMPANIES NET AMOUNT
----------------- --------------- -------------
Premiums written:
Property and casualty insurance $ 1,613,912 $ 519,663 $ 1,094,249
----------------- --------------- -------------
Total premiums written $ 1,613,912 $ 519,663 $ 1,094,249
================= =============== =============
Premiums earned:
Property and casualty insurance $ 1,380,225 $ 469,285 $ 910,940
----------------- --------------- -------------
Total premiums earned $ 1,380,225 $ 469,285 $ 910,940
================= =============== =============
CEDED TO OTHER
2010 GROSS AMOUNT COMPANIES NET AMOUNT
----------------- --------------- -------------
Premiums written:
Property and casualty insurance $ 1,114,197 $ 385,259 $ 728,938
----------------- --------------- -------------
Total premiums written $ 1,114,197 $ 385,259 $ 728,938
================= =============== =============
Premiums earned:
Property and casualty insurance $ 1,026,896 $ 257,987 $ 768,909
----------------- --------------- -------------
Total premiums earned $ 1,026,896 $ 257,987 $ 768,909
================= =============== =============
F-49
JACOBS FINANCIAL GROUP, INC.
AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL INFORMATION
AS OF MAY 31, 2011 AND 2010 AND FOR THE YEARS THEN ENDED SCHEDULE VI
------------------------------------------------------------------------------------------------------------------------------------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E COLUMN F COLUMN G COLUMN H COLUMN I COLUMN J COLUMN K
RESERVE
FOR
LOSSES CLAIMS, LOSSES
AND DISCOUNT AND SETTLEMENT AMORTIZATION
LOSS IF ANY, EXPENSES INCURRED OF
DEFERRED EXPENSES, DEDUCTED RELATED TO DEFERRED PAID CLAIMS
POLICY FUTURE IN NET POLICY AND CLAIMS NET
AFFILIATION WITH ACQUISITION POLICY COLUMN UNEARNED PREMIUM INVESTMENT CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS
REGISTRANT COSTS CLAIMS C PREMIUMS REVENUE INCOME YEAR YEARS COSTS EXPENSES WRITTEN
----------------- ----------- ---------- -------- --------- -------- ---------- --------- ------- --------- ----------- --------
2011
Consolidated
property-casualty
entities $190,711 $ 815,512 $ - $851,783 $ 910,940 $ 229,777 $ 204,323 $ - $ 310,420 $ - $1,094,249
2010
Consolidated
property-casualty
entities $128,453 $ 611,190 $ - $618,095 $ 768,909 $ 273,577 $ 178,531 $ - $ 256,810 $ - $728,938
------------------------------------------------------------------------------------------------------------------------------------
F-50
(b) The following exhibits are filed as a part of this Annual Report.
EXHIBITS
2.1 Agreement and Plan of Merger dated as of May 18, 2001 by and among NELX, Inc., FSI Acquisition Corp. and FS
Investments, Inc. (1)
2.2 Agreement and Plan of Merger dated as of May 18, 2001 by and among NELX, Inc., J&C Acquisition Corp. and Jacobs & Company (1)
2.3 Agreement and Plan of Merger dated as of December 8, 2006 by and among NELX, Inc. and Jacobs Financial Group, Inc. (2)
3.1 Company's Articles of Incorporation (3)
3.2 Company's By-laws (3)
3.3 Certificate of the Designations, Powers, Preferences and Rights of Series A Preferred Stock of Jacobs Financial Group (3)
3.4 Certificate of the Designations, Powers, Preferences and Rights of Series B Preferred Stock of Jacobs Financial Group (3)
4.1 Certificate of the Designations, Powers, Preferences and Rights of Series A Preferred Stock of Jacobs Financial Group (3)
4.2 Certificate of the Designations, Powers, Preferences and Rights of Series B Preferred Stock of Jacobs Financial Group (3)
10.1 Stock Purchase Agreement with National Indemnity Company to purchase Unione Italiana Insurance Company of
America dated August 20, 2008 (11)
10.2 Engagement Agreement between Friedman, Billings, Ramsey & Co., Inc. and Jacobs Financial Group, Inc. dated
December 5, 2007 (7) (9)
10.3 Agreement to acquire by merger Reclamation Surety Holding, Inc. (5) (6) (10)
21.1 Subsidiaries of the Registrant
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) promulgated under the
Securities Exchange Act of 1934
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) promulgated under the
Securities Exchange Act of 1934
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
99.1 Form of Subscription Agreement and Promissory Note (4)
99.2 Form of Amended Subscription Agreement and Promissory Note (8)
99.3 Form of Subscription Agreement and Promissory Note (Second Round) (8)
----------
(1) Incorporated by reference to the Company's Current Report On Form 8-K dated May 29, 2001.
(2) Incorporated by reference to the Company's Definitive Proxy Statement dated November 7, 2005.
(3) Incorporated by reference to the Company's Current Report on Form 8-K dated December 29, 2005.
(4) Incorporated by reference to the Company's Current Report on Form 8-K dated September 10, 2007.
(5) Incorporated by reference to the Company's Current Report on Form 8-K dated December 14, 2007.
(6) Incorporated by reference to the Company's Current Report on Form 8-K dated February 8, 2008.
(7) Incorporated by reference to the Company's Quarterly Report on Form 10-QSB for the quarterly period
ended February 29, 2008
(8) Incorporated by reference to the Company's Current Report on Form 8-K dated May 30, 2008
(9) Incorporated by reference to the Company's Current Report on Form 8-K dated April 15, 2008
(10) Incorporated by reference to the Company's Current Report on Form 8-K dated June 24, 2008
(11) Incorporated by reference to the Company's Current Report on Form 8-K dated August 26, 2008
(12) Incorporated by reference to the Company's Current Report on Form 8-K dated November 20, 2008
(13) Incorporated by reference to the Company's Current Report on Form 8-K dated March 23, 2009
(14) Incorporated by reference to the Company's Current Report on Form 8-K dated June 16, 2009
(15) Incorporated by reference to the Company's Current Report on Form 8-K dated July 7, 2009
-36-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
JACOBS FINANCIAL GROUP, INC.
Dated: September 13, 2011 By: /s/ John M. Jacobs
-------------------------------------------
John M. Jacobs
President and CEO
Director
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Dated: September 13, 2011 By:/s/ John M. Jacobs
------------------------ ----------------------------
John M. Jacobs
President and CEO
Director
Dated: September 13, 2011 By:/s/ John M. Jacobs
------------------------ ----------------------------
John M. Jacobs
Chief Financial Officer
Dated: September 13, 2011 By:/s/ Mario J. Marra
------------------------ ----------------------------
Mario J. Marra
Director
Dated: September 13, 2011 By:/s/ C. David Thomas
------------------------ ----------------------------
C. David Thomas
Director
Dated: September 13, 2011 By:/s/ Eric D. Ridenour
------------------------ ----------------------------
Eric D. Ridenour
Director
Dated: September 13, 2011 By:/s/ Bradley W. Tuckwiller
------------------------ ----------------------------
Bradley W. Tuckwiller
Director
-37-