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, 2012
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, 2011: $1,172,680 (254,930,437 shares at $.0046 /
share)
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date: 306,533,262 shares of common
stock as of September 13, 2012.
TABLE OF CONTENTS
PART I Page
----
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 23
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 25
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
3
PART I
ITEM 1. BUSINESS
----------------
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 Spring 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 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.
4
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
--------------------------
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.
5
PART II
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, 2012
4th Quarter $.004 $.003
3rd Quarter $.005 $.002
2nd Quarter $.007 $.005
1st Quarter $.009 $.005
FISCAL YEAR ENDED MAY 31, 2011
4th Quarter $.01 $.005
3rd Quarter $.01 $.004
2nd Quarter $.009 $.006
1st Quarter $.008 $.003
As of May 31, 2012, 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. This consent order was terminated on March 26, 2012 and
dividends in the amount of $380,000 were paid subsequent to that date and before
May 31, 2012. 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.
6
As of May 31, 2012, 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:
EQUITY COMPENSATION PLAN INFORMATION
------------------------------- ---------------------- -------------------------
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
------------------------------- ---------------------- -------------------------
10,000,000 .0400 25,000,000
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There are no other equity compensation plans 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, 2012, 3,545,000 common shares were issued as
additional consideration to various lenders in private placements pursuant to
short term borrowings. 14,473,727 common shares were issued to the Bridge
lenders. 1,000,000 common shares were issued to an individual as compensation
for services instrumental to advancing the Company's business plan. 9,029,800
common shares were issued 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, 2012, 1,161,000 common shares have
been issued in private placements to various individuals pursuant to short term
borrowings, 8,573,594 shares were issued to Bridge lenders, 22,600,000 shares
were issued to employees under the Company's stock incentive plan, and 3,845,837
common shares were issued July 1, 2012 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 the effect that such securities are not registered under the
Securities Act pursuant to an exemption from such registration.
7
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.
ITEM 6. SELECTED FINANCIAL DATA
--------------------------------
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 2012, 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, 2012
RESULTS OF OPERATIONS
Total revenues increased from approximately $1,561,000 in fiscal 2011 to
approximately $1,833,000 in fiscal 2012, while total operating expenses
increased from approximately $1,583,000 in fiscal 2011 to approximately
$1,817,000 in fiscal 2012. This resulted in net income from operations of
approximately $16,000 in 2012 as compared with a loss from operations of
approximately $22,000 in fiscal 2011, an improvement of approximately $38,000.
The increase in revenues is largely attributable to the continued growth of the
surety business of FSC as well as the receipt of a cumulative No Claims Bonus
from its reinsurers for the years ended June 30, 2010 and June 30, 2011. For the
twelve month period ended May 31, 2011 net investment income was less than
expected due to the receipt of large principal payments on mortgage backed
securities, which required larger amortization of premium in that period. The
increase in expenses is attributable to increased general and administrative
expenses, increased salaries and related costs, increased accounting and legal
fees and penalties in relation to unpaid federal payroll taxes.
8
Interest expense remained relatively consistent, from approximately $908,000 in
fiscal 2011 to approximately $905,000 in fiscal 2012.
In the years ending May 31, 2012 and May 31, 2011, the Company, upon advice of
legal counsel, removed certain dormant accounts payable in the aggregate amount
of $150,604 and $54,358. For the year ended May 31, 2012, removal was based upon
the vendor no longer requiring payment on a portion of the balance owed to them.
For the year ended May 31, 2011, the amount was removed based upon the
conclusion that the accounts represented an obligation that is not legally
enforceable against the Company. Such removals were recorded as gains on debt
extinguishment.
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.
9
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
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,
2012, is $3,713,966.
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
10
which Redemption Notices have been given shall have been paid in full, provided
that the redemption price of any Equal Ranking Preferred subject to 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 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
issued in connection with Series B Preferred Stock expired unexercised on
December 31, 2010, while 600,000 warrants issued in connection with Series A
Preferred Stock 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 $1,219,559 in fiscal 2012 as compared with 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.
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 Preferred for a
combination of Series C Preferred Shares and Common Stock Shares. For each
Series B Preferred Share, the participating holder received (i) one Series C
Preferred Share and (ii) 2,000 shares of JFG Common Stock. The accumulated
dividend rights and preferences associated with the Series B Preferred Shares
transferred undiminished to the corresponding Series C Preferred Shares. This
exchange amounted to $6,269,051 of carrying value of Series B Preferred stock
being exchanged for Series C Preferred and Common Stock. 13,609,872 shares of
Common Stock were issued to the Series C Preferred Stock holders at the rate of
2,000 Common shares for each exchanged Series B Preferred Stock, with the
related cost associated with the Common issuance offsetting the Series C
Preferred 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
Preferred 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
11
outstanding Series B Preferred Shares elected to participate in the
recapitalization
Unlike the Series B Preferred Shares with their fixed maturity date, the Series
C Preferred 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 Preferred Shares on the
Company's balance sheet is to increase the aggregate claim by the Series C
Preferred 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 Preferred 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
Preferred Shares are pari passu with the Series A Preferred Shares and Series B
Preferred 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 Preferred 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 $847,833 in fiscal 2012 as compared with a charge to common stockholders'
equity of $781,062 in fiscal 2011.
DIVIDEND PREFERENCE AND ACCRETION
During the year ended May 31, 2012, two holders of Series A Preferred stock
released all of their outstanding bonds held with FSC. The carrying value of
these shares of Series A Preferred Shareholders are listed in the Liability
section of the Balance Sheet, and therefore the dividends associated with these
shares of Series A Preferred stock after February 29, 2012 is a deduction from
net income. 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 Preferred
stock after November 30, 2009 are deductions from net income. Series C Preferred
stock has no accretion. The recorded values of the Series A preferred stock was
increased to their stated liquidation values using the interest method over a
period of five years and such amounts were categorized as accretion of
mandatorily redeemable preferred stock in the consolidated statement of
operations. This accretion was concluded in December 2010.
The Series A Preferred designation is entitled to receive cumulative dividends
at the rate of 4.00% per annum and the Series B Preferred and Series C Preferred
designations are entitled to receive cumulative dividends at the rate of 8.00%
per annum, with the Series A, B and C Preferred designations having equal
ranking and preference as to dividends, liquidation rights and priority to the
Company's common stockholders. The accrued (but undeclared) dividends associated
with the Series C Preferred exchange amounted to $2,295,624 and are included in
the total amount exchanged for Series C Preferred 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.
12
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
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.
13
In anticipation of a proposed financing and as a condition thereof, the Company
and each of the bridge lenders entered into a Loan Modification Agreement dated
February 25, 2012 which provided for modification of the Promissory Notes,
including an extension of the term of the Promissory Notes, and Subscription
Agreements in exchange for a partial cash payment to each bridge lender. To
date, the proposed financing has not closed, and the Company has been unable to
remit the partial payment. On August 10, 2012, the Company entered into an
agreement with the bridge lenders, pursuant to which the bridge lenders formally
agreed to forbear from exercising their rights and remedies arising from the
accumulated acknowledged events of default with respect to the bridge loans
until such date. As consideration for this forbearance, the Company entered into
an Amended and Restated General Hypothecation and Pledge Agreement dated August
9, 2012 (the "August 2012 Pledge"), but effective September 23, 2011, granting
to the bridge lenders as security for the repayment of the loans a lien and
security interest in all of the Company's shares of capital stock of First
Surety Corporation. Under the August 2012 Pledge, the bridge lenders acknowledge
that the effectiveness of certain of the rights and remedies provided by such
agreement may be subject to prior approval by the Office of the Commissioner of
Insurance for the State of West Virginia. To date, none of the bridge lenders
has elected to pursue legal remedies under the Promissory Notes or the August
2012 Pledge.
RESTRICTIONS ON USE OF ASSETS
Regulatory approval for the acquisition of FSC by JFG was provided by a Consent
Order issued December 23, 2005 by the Commissioner of Insurance of the State of
West Virginia and imposed several conditions for the operation of FSC, including
the condition that no dividends or monies were to be paid to JFG without
regulatory approval. On May 26, 2012, all conditions imposed by the Consent
Order were terminated by the Commissioner of Insurance. Accordingly, the payment
of ordinary dividends is no longer restricted but cash, marketable investments,
and other receivables held by FSC are restricted from the Company's use to fund
operations or meet cash needs outside of the insurance company's domain. As of
May 31, 2012, such assets amounted to approximately $7.83 million.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
INVESTMENTS
Management believes the Company has the ability to hold all fixed income
securities to maturity. However, 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 classifies 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.
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
14
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 but 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.
15
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, 2012.
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 experienced income from operation and operating losses of
approximately $16,000 and ($22,000) for the years ended May 31, 2012 and 2011,
respectively. The Company's income (or loss) decreases (or increases) when
accretion of mandatorily redeemable convertible preferred stock and accrued
16
dividends on mandatorily redeemable preferred stock are taken into account, to
losses of approximately $1,219,559 and $1,440,000 for the years ended May 31,
2012 and 2011. Despite increased revenue and the income from operations, 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 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 Preferred 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
17
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
assets and profits are restricted to its stand-alone operation by regulatory
authority. While growth of the FSC business continues to provide additional
revenue opportunities to the Company's other subsidiaries, Jacobs & Company and
Triangle Surety, it is anticipated that working capital deficiencies will
continue 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 2012 WITH 2011
The Company experienced income from operations of approximately $16,000 in 2012
as compared with a loss from operations of $22,000 in fiscal 2011, an
improvement of approximately $38,000. After accretion of mandatorily redeemable
convertible preferred stock, and accrued dividends on mandatorily redeemable
preferred stock, the Company experienced a loss of $1,219,559 in fiscal 2012 as
compared with 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.
REVENUES
Revenues increased 17% in fiscal 2012, $1,833,194 as compared with $1,561,475 in
fiscal 2011. The increase is largely attributable to the continued growth of the
surety business of FSC and the receipt of a cumulative No Claims Bonus from its
reinsurers for the years ended June 30, 2010 and June 30, 2011.
Revenue from the investment management segment, net of advisory referral fees,
declined 9% with fiscal 2012 reporting $242,472 as compared to $266,963 in
fiscal 2011, a decrease of $24,491. Investment advisory fees are based on the
market value of assets under management and some fluctuation will occur due to
overall market conditions. Generally such revenues will remain relatively
constant from year to year with large fluctuations attributable to the growth or
loss of assets under management.
Revenue from the surety insurance segment, consisting of FSC and TSA, increased
24%, with $1,576,107 in fiscal 2012 as compared with $1,275,319 for the prior
year. Revenues attributable to the insurance segment are as follows:
18
Year Ended May 31,
2012 2011
------------------ -----------------
Premiums earned $ 956,615 $ 910,940
Commissions earned 33,422 18,415
No Claims Bonus from Reinsurers 213,281 -
Net investment income 279,410 229,777
Net realized investment gains 93,379 116,187
------------------ -----------------
Total $ 1,576,107 $ 1,275,319
================== =================
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 mainly attributable to the recorded
receipt of $213,281 from the reinsurers of the Company's insurance subsidiary,
FSC, representing a cumulative No Claims Bonus under the terms of its
reinsurance agreement for the claim years ending June 30, 2010 and June 30,
2011. The Company has experienced no claims for losses as of May 31, 2012. Gross
premium written in fiscal 2012 amounted to $1,343,661 as compared to $1,613,912
in fiscal 2011 and is reflective of the loss of a major customer, although the
Company still experienced overall growth in bonds issued for new and existing
clients, as well as increased bonds written on contracts that are earned up
front as opposed to over the life of a bond. Commission income earned for the
placement of bonds with outside insurers has remained relatively stagnant.
FSC's investment holdings in fiscal 2012 averaged $7.749 million as compared
with $7.192 million for fiscal 2011, with investment yields increasing slightly
from 3.57% to 3.58%. In addition, the amortization of premium for larger than
usual principal payments on mortgage backed securities during fiscal 2011
resulted in decreased investment income for that year.
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 2012 have been recorded
as $210,977 or 22% of earned premium as compared to $204,323 or 22% of earned
premium for fiscal 2011. 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, 2012 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.
19
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 2012 such costs amounted to $311,385 or 32.55% of earned premium as
compared with $313,223 or 34.38% in fiscal 2011. The slight decrease of $1,838
in expenses is attributable to costs associated to the decrease in gross premium
written, while the decrease as a percentage is attributable to the decrease
specifically in new gross premiums written, which pay a higher commission than
renewal premiums.
General and administrative expenses for fiscal 2012 were $1,284,341 as compared
with $1,050,486 for fiscal 2011, representing an increase of $233,855 and are
comprised of the following:
Year Ended May 31,
2012 2011 Difference
---------------- ----------------- ----------------
Salaries and related costs $ 642,539 $ 483,250 $ 159,289
General office expense 111,816 112,148 (332)
Legal and other professional fees 156,460 137,250 19,210
Audit, accounting and related services 136,687 87,851 48,836
Travel, meals and entertainment 85,006 69,828 15,178
Other general and administrative 151,833 160,159 (8,326)
---------------- ----------------- ----------------
Total general and administrative $ 1,284,341 $ 1,050,486 $ 233,855
================ ================= ================
Salaries and related costs, net of deferred internal policy acquisition costs,
increased $159,289 and are comprised of the following:
Year Ended May 31,
2012 2011 Difference
---------------- ----------------- ----------------
Salaries and wages $ 528,871 $ 487,341 $ 41,530
Commissions 134,564 113,324 21,240
Payroll taxes 48,033 50,763 (2,730)
Stock option expense 370 16,782 (16,412)
Fringe benefits 89,266 72,796 16,470
Key-man life insurance 56,889 53,099 3,790
Deferred policy acquisition costs (215,454) (310,855) 95,401
---------------- ----------------- ----------------
Total salaries and related costs $ 642,539 $ 483,250 $ 159,289
================ ================= ================
The increase in salaries is attributable to increased salaries for certain
employees. The increase in commissions is attributable to the Company's
commission structure that pays a larger sales commission on the origination of a
policy but a reduced percentage for subsequent policy renewals. The decrease in
stock option expense is attributable to completion of vesting of stock options
awarded on June 30, 2009. The increase in fringe benefits is attributable to
increased cost of health insurance.
20
Legal and professional fees increased due to costs related to the Company's
on-going efforts to obtain financing necessary to expand the Company's business
and penetrate new markets. In the year ended May 31, 2012, the Company incurred
$27,500 in costs associated with the due diligence performed by third parties
for the benefit of potential investors. These costs, as well as increased costs
in coal reclamation consulting, offset the reduction in costs incurred in the
previous year from the triennial SEC examination of its investment advisor
subsidiary.
Travel, meals and entertainment expense increased during fiscal 2012 due to
expanded efforts by management to obtain financing necessary to expand the
Company's business and penetrate new markets.
Other general and administrative expense decreased approximately $8,000 for the
year May 31, 2012 as compared to the corresponding 2011 period. The decline this
year reflects termination of a corporate lease and decreased finance charges
associated with overdue payables while the prior year's expense included
expenses related to obtaining a U.S. Treasury Listing for FSC and non-recurring
use of temporary personnel for information technology projects in the prior
year. Other less significant increases and decreases were experienced in other
general administrative categories in fiscal 2012 as compared to fiscal 2011.
GAIN ON EXTINGUISHMENT OF DEBT
During the years ended May 31, 2012 and May 31, 2011, the Company removed
certain dormant accounts payable in the aggregate amounts of $150,604 and
$54,358. For the year ended May 31, 2012, the amount was removed based on the
vendor no longer requiring payment on a portion of the balance owed. For the
year ended May 31, 2011, the amount was removed based upon advice of legal
counsel that the accounts represented an obligation that is legally
unenforceable. Such removals were recorded as gains on debt extinguishment.
INTEREST EXPENSE AND INTEREST INCOME
Interest expense for fiscal 2012 was $905,601 as compared with $908,375 in
fiscal 2011. Components of interest expense are comprised of the following:
Year Ended May 31,
2012 2011 Difference
------------------ ------------------ -------------------
Interest expense on bridge financing $ 596,630 $ 595,000 $ 1,630
Expense of common shares issued or to be issued in
connection with bridge financing and other arrangements 122,621 132,662 (10,041)
Interest expense on demand and term notes 179,010 129,844 49,166
Other finance charges 7,340 50,869 (43,529)
------------------ ------------------ -------------------
Total interest expense $ 905,601 $ 908,375 $ (2,774)
================== ================== ===================
21
The decrease in the expense of common shares issued (or to be issued) for fiscal
year 2012 as compared to fiscal year 2011 was attributable to the Company's
slightly lower average stock price. Interest expense on demand and term notes
increased due to increased interest rates on some new borrowings taken during
the current year. Other finance charges in the prior year period reflected
incentive fees paid to a note holder to obtain borrowings and the recording of
additional interest on the settlement of an obligation with the IRS.
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,
2012 2011
-------------- -------------
Accretion of discount $ - $ 10,888
Accrued dividends - mandatorily redeemable
preferred stock 113,726 122,468
Accrued dividends - equity preferred stock 847,833 781,062
-------------- -------------
$ 961,559 $ 914,418
============== =============
The Series B class of stock became treated as a liability effective November 30,
2009 when the majority was exchanged for Series C equity stock. Therefore,
accretion of $251 and dividends of $352,271 associated with the Series B after
that date are deductions from net income and not included in the table above.
The decrease in accretion of discount on Series A Preferred stock results from
completion in December 2010 of the final month's accretion of discount on Series
A Preferred stock. During the year ended May 31, 2012, two holders of Series A
stock released all of their outstanding bonds held with FSC. Therefore these
shares of Series A Preferred Shareholders are listed in the liability section of
the Balance Sheet and the dividends after February 29, 2012 associated with
these shares are a deduction from net income in the amount of $14,069. Series C
equity stock is not mandatorily redeemable and does not accrete.
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.
22
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-9
Page
--------
SCHEDULES
Schedule I - Summary of Investments - Other than Investments
in Related Parties F-43
Schedule II - Condensed Financial Information of Registrant F-44
Schedule III - Supplementary Insurance Information F-46
Schedule IV - Supplementary Insurance Information - Reinsurance F-47
Schedule VI - Supplemental Information F-48
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
--------------------------------------------------------------------------------
In connection with the audits for the years ended May 31, 2012 and May 31, 2011,
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, 2012. 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
23
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, 2012,
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, 2012, 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, 2012 and 2011, and the results of its
operations and cash flows for the years ended May 31, 2012 and 2011 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.
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, 2012. 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, 2012. 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, 2012. 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.
24
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
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 58 President and CEO/CFO, Director
C. David Thomas 59 Director
Mario J. Marra 58 Director
Bradley W. Tuckwiller 59 Director
Eric D. Ridenour 40 Director
Robert J. Kenney 65 Vice President
JOHN M. JACOBS
Mr. Jacobs is a Certified Public Accountant, the founder of Jacobs & Co., a
Registered Investment Advisor and is licensed as a property and casualty
insurance agent in twelve (12) 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
25
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
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
26
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.
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, 2012 and 2011 to the Principal Executive Officer and
the two most highly compensated executive officers of the Company (the "Named
Executive Officers").
27
----------------- -------- -------------- ------------------- ---------- -------------- ----------------- ------------------
ALL
NAMES AND STOCK OPTION OTHER
PRINCIPAL SALARY BONUS/COMMISSIONS AWARDS AWARDS COMPENSATION TOTAL
POSITION YEAR ($) ($) ($) ($) (1) (2) ($) (3) ($)
----------------- -------- -------------- ------------------- ---------- -------------- ----------------- ------------------
John M. Jacobs, 2012 $ 150,000 $ 79,732 - $ - $ 29,952 $ 259,684
CEO 2011 $ 150,000 $ 12,751 - $ 6,356 $ 28,652 $ 222,759
----------------- -------- -------------- ------------------- ---------- -------------- ----------------- ------------------
Robert J. 2012 $ 91,000 $ 16,200 - $ - - $ 107,200
Kenney, VP 2011 $ 75,000 $ 7,500 - $ 2,542 - $ 85,042
----------------- -------- -------------- ------------------- ---------- -------------- ----------------- ------------------
(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.
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, 2012.
28
---------------- -----------------------------------------------------------------------------------
OPTION AWARDS
---------------- -----------------------------------------------------------------------------------
EQUITY
NUMBER OF INCENTIVE PLAN
NUMBER OF SECURITIES AWARDS; NUMBER
SECURITIES UNDERLYING OF SECURITIES
UNDERLYING UNEXERCISED UNDERLYING
UNEXERCISED OPTIONS (#) UNEXERCISED OPTION OPTION
OPTIONS (#) UNEXERCISABLE UNEARNED EXERCISE EXPIRATION
NAME EXERCISABLE OPTIONS (#) PRICE ($) 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
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 $150 per meeting.
The following table sets forth compensation received by non-employee directors
for the fiscal year ended May 31, 2012.
----------------------------- ---------------------------------- -------------
NAME FEES EARNED OR PAID IN CASH ($) TOTAL ($)
----------------------------- ---------------------------------- -------------
Brad Tuckwiller $1,800 $1,800
----------------------------- ---------------------------------- -------------
C. David Thomas $1,800 $1,800
----------------------------- ---------------------------------- -------------
Timothy Maddox $1,500 $1,500
----------------------------- ---------------------------------- -------------
Linda G. Aguilar $1,500 $1,500
----------------------------- ---------------------------------- -------------
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 42,775,746 (3) 13.82%
300 Summers St. Suite 970
Charleston, WV 285301
Common Ungurean, Charles D. 33,230,223 11.16%
8400 Dunsinane Drive
Dublin, OH 43017
Common Fay S. Alexander 27,201,911 (4) 9.07%
6318 Timarron Cove Lane
Burke, VA 22015-4073
DIRECTORS AND NAMED EXECUTIVE OFFICERS
John M. Jacobs 42,775,746 (3) 13.82%
Common 300 Summers St. Suite 970
Charleston, WV 285301
Robert J. Kenney 7,150,000 (5) 2.38%
Common 809 Sherwood Drive
Charleston, WV 25314
Mario J. Marra 989,795 (*)
Common 204 Olive Street
Bridgeport, WV 26330
Eric D. Ridenour 10,709,618 (6) 3.55%
Common Two Morrocroft Centre
4064 Colony Road, Suite 195
Charlotte, NC 28211
30
Amount and
Nature of
Name and Address of Beneficial Percent of
Title of Class Beneficial Owner Ownership(1) Class(2)
----------------------------------------------------------------------------------------------------------------------
C. David Thomas 917,295 (*)
Common P. O., Box 5157
Charleston, WV 25361
Bradley W. Tuckwiller 5,869,152 (7) 1.96%
Common P O Box 1294
Lewisburg, WV 24901
Common ALL DIRECTORS AND EXECUTIVE 68,411,606 21.71%
OFFICERS AS A GROUP
-----------------------------------
(*)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
August 30, 2012 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.
2) Based on 297,859,664 shares of common stock issued and outstanding as of
August 30, 2012.
31
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 August 30, 2012. Includes the
right to convert Series C Preferred Stock holdings to 6,733,340 shares of
common stock exercisable within 60 days of August 30, 2012. John M. Jacobs
is the CEO and a member of the board of directors for the Registrant.
4) Includes 21,641,869 shares of common stock held in the name of Graphite
Investment, LLC ("Graphite") and 2,204,001 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 August 30, 2012. Includes 1,214,700 shares
held in joint tenancy with spouse, Dan C. Alexander.
5) 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 August 30, 2012.
6) Includes 562,346 shares of common stock held in joint tenancy with spouse,
Mary K. Ridenour. Includes 1,211,763 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 August 30, 2012.
7) 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 August 30, 2012.
32
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 2012, advances to the Company from Mr. Jacobs amounted to
$1,124,925, which included assumption of company debt in the amount of $393,519,
and repayments to Mr. Jacobs amounted to $1,152,006. As of May 31, 2012, the
balance due the Company from Mr. Jacobs was $57,046. The largest aggregate
amount outstanding to Mr. Jacobs in fiscal 2012 was $18,003.
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 2012 and 2011 fiscal years.
As of September 13, 2012, $102,956 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
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.
33
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, 2012 amounted to
$102,080.
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.
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, 2012 amounted to $8,270.
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.
FEES FOR TAX PREPARATION SERVICES
During fiscal 2012, billings for tax preparation services were $8,919. During
fiscal 2011, billings for tax preparation services were $8,729.
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
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.
34
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-9
(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-43
Schedule II - Condensed Financial Information of Registrant F-44
Schedule III - Supplementary Insurance Information F-46
Schedule IV - Supplementary Insurance Information - Reinsurance F-47
Schedule VI - Supplemental Information F-48
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-9
Page
--------
SCHEDULES
Schedule I - Summary of Investments - Other than Investments
in Related Parties F-43
Schedule II - Condensed Financial Information of Registrant F-44
Schedule III - Supplementary Insurance Information F-46
Schedule IV - Supplementary Insurance Information - Reinsurance F-47
Schedule VI - Supplemental Information F-48
F-1
Malin, Bergquist & Company, LLP
------------------------------------------------
CERTIFIED PUBLIC ACCOUNTANTS & BUSINESS ADVISORS
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, 2012 and 2011, 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. The Company's management is
responsible for these consolidated financial statements and financial statement
schedules. 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, 2012 and 2011, 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
Pittsburgh, PA
September 13, 2012
F-2
JACOBS FINANCIAL GROUP, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
MAY 31, 2012 MAY 31, 2011
----------------- ----------------
ASSETS
INVESTMENTS AND CASH:
Bonds and mortgaged-back securities available for sale, at market value $ 6,098,648 $ 6,038,718
(amortized cost - 5/31/12 $5,915,428; 05/31/11 $5,858,595)
Equity investments available for sale, at market value, net 484,274 453,456
(amortized cost - 5/31/12 $519,120; 05/31/11 $450,908)
Short-term investments, at cost (approximates market value) 991,875 1,007,617
Cash 259,079 290,569
----------------- ----------------
TOTAL INVESTMENTS AND CASH 7,833,876 7,790,360
Investment income due and accrued 42,981 38,736
Premiums and other accounts receivable 289,463 171,702
Prepaid reinsurance premium 243,877 264,763
Funds deposited with Reinsurers 42,458 -
Deferred policy acquisition costs 167,010 190,711
Furniture, automobile, and equipment, net of accumulated
depreciation of $102,616 and $158,267, respectively 22,404 33,140
Other assets 96,370 21,986
Intangible assets 150,000 150,000
----------------- ----------------
TOTAL ASSETS $ 8,888,439 $ 8,661,398
================= ================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Reserve for losses and loss expenses $ 1,026,489 $ 815,512
Reserve for unearned premiums 771,089 851,783
Advanced premium 139,402 20,195
Accrued expenses and professional fees payable 473,540 573,568
Accounts payable 172,627 144,997
Ceded reinsurance payable - 77,635
Related party payable 109,309 99,209
Term and demand notes payable to related party 377,954 405,035
Notes payable 4,836,000 4,874,500
Accrued interest payable 1,716,884 1,148,730
Accrued interest payable to related party 209,069 140,181
Other liabilities 290,706 89,257
Mandatorily redeemable Series A Preferred Stock, $.0001 par value per share; 1
million shares authorized; 1,126 shares issued and outstanding at May 31, 2012
and May 31, 2011, respectively; stated liquidation value of $1,000 per share 1,424,863 -
Mandatorily redeemable Series B Preferred Stock, $.0001 par value per share;
3,136 shares authorized; 2,817 shares issued and outstanding at May 31, 2012 and
May 31, 2011; stated liquidation value of $1,000 per share 4,610,224 4,257,703
----------------- ----------------
TOTAL LIABILITIES 16,158,156 13,498,305
Series A Preferred Stock, $.0001 par value per share; 1 million shares
authorized; 1,549 shares issued and outstanding at May 31, 2012 and May 31,
2011, respectively; stated liquidation value of $1,000 per share 1,841,555 3,138,623
----------------- ----------------
TOTAL MANDATORILY REDEEMABLE PREFERRED STOCK 1,841,555 3,138,623
COMMITMENTS AND CONTINGENCIES (SEE NOTES)
STOCKHOLDERS' EQUITY (DEFICIT)
Series C Preferred Stock, $.0001 par value per share; 10,000 shares authorized;
6,805 shares issued and outstanding at May 31, 2012 and May 31, 2011,
respectively; includes $4,299,181 and $3,451,348 accrued Series C dividends,
respectively 10,330,112 9,482,279
Common stock, $.0001 par value per share; 490 million shares authorized;
270,352,831 and 242,304,304 shares issued and outstanding at May 31, 2012 and
May 31, 2011, respectively 27,035 24,230
Additional paid in capital 3,664,923 3,549,443
Accumulated deficit (23,281,717) (21,214,153)
Accumulated other comprehensive income (loss) 148,375 182,671
----------------- ----------------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) (9,111,272) (7,975,530)
----------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 8,888,439 $ 8,661,398
================= ================
See accompanying notes.
F-3
JACOBS FINANCIAL GROUP, INC,
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
YEAR ENDED MAY 31,
------------------------------
2012 2011
-------------- --------------
REVENUES:
Investment advisory services $ 242,472 $ 266,963
Insurance premiums and commissions 1,203,318 929,355
Net investment income 279,410 229,777
Net realized investment gains 93,379 116,187
Other income 14,615 19,193
-------------- --------------
TOTAL REVENUES 1,833,194 1,561,475
OPERATING EXPENSES:
Incurred policy losses 210,977 204,323
Insurance policy acquisition costs 311,385 313,223
General and administrative 1,284,341 1,050,486
Depreciation 10,736 15,339
-------------- --------------
TOTAL OPERATING EXPENSES 1,817,439 1,583,371
-------------- --------------
NET INCOME (LOSS) FROM OPERATIONS 15,755 (21,896)
Gain on debt extinguishment 150,604 54,358
Accrued dividends of Series A Mandatorily Redeemable
Preferred Stock (14,069) -
Accrued dividends and accretion of Series B Mandatorily
Redeemable Preferred Stock (352,522) (430,821)
Interest expense (905,601) (908,375)
-------------- --------------
NET INCOME (LOSS) (1,105,833) (1,306,734)
Accretion of Mandatorily Redeemable Convertible
Preferred Stock, including accrued dividends (113,726) (133,356)
Accrued dividends on Series C Preferred Stock equity (847,833) (781,062)
-------------- --------------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (2,067,392) $ (2,221,152)
============== ==============
BASIC AND DILUTIVE NET INCOME (LOSS) PER SHARE:
NET INCOME (LOSS) PER SHARE $ (0.01) $ (0.01)
============== ==============
WEIGHTED-AVERAGE SHARES OUTSTANDING 255,549,409 227,839,197
============== ==============
See accompanying notes.
F-4
JACOBS FINANCIAL GROUP, INC.
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEAR ENDED MAY 31,
-------------------------------
2012 2011
------------- --------------
COMPREHENSIVE INCOME (LOSS):
Net loss attributable to common stockholders $ (2,067,392) $ (2,221,152)
OTHER COMPREHENSIVE INCOME (LOSS):
Net unrealized gain of available-for-sale investments arising during period 19,320 39,007
Reclassification adjustment for realized loss included in net loss (53,616) (60,951)
------------- --------------
Net unrealized loss attributable to available-for-sale investments recognized
in other comprehensive income (loss) (34,296) (21,944)
------------- --------------
COMPREHENSIVE LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (2,101,688) $ (2,243,096)
============= ==============
See accompanying notes.
F-5
JACOBS FINANCIAL GROUP, INC,
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
YEAR ENDED MAY 31,
------------------------------
2012 2011
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss $ (1,105,833) $ (1,306,734)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Unearned premium 59,399 203,505
Stock option expense 370 16,782
Stock issued in connection with financing arrangements 70,175 124,197
Stock issued in connection with dividend arrangements 43,098 1,877
Accrual of Series A preferred stock dividends 14,069 -
Accrual of Series B preferred stock dividends and accretion 352,521 430,821
Stock issued in connection with services rendered 4,470 -
Provision for loss reserves 210,977 204,322
Amortization of premium 81,247 118,580
Depreciation 10,736 15,339
Accretion of discount (104) (14,478)
Realized gain on sale of securities (93,379) (116,187)
Gain on extinguishment of debt (150,604) (54,358)
Loss on disposal of equipment - 336
Change in operating assets and liabilities:
Other assets (74,384) 5,848
Premium and other receivables (117,761) (24,236)
Investment income due and accrued (5,831) (6,152)
Deferred policy acquisition costs 23,701 (62,258)
Related party accounts payable 10,100 3,050
Accounts payable and cash overdraft 27,630 (1,318)
Accrued expenses and other liabilities 768,973 652,181
------------- -------------
NET CASH FLOWS FROM OPERATING ACTIVITIES 129,570 191,117
CASH FLOWS FROM INVESTING ACTIVITIES
(Increase) decrease in short-term investments 15,742 (743,538)
Costs of bonds acquired (1,883,581) (2,623,919)
Costs of mortgaged-backed securities acquired (634,182) (1,976,383)
Purchase of equity securities (247,056) (448,992)
Proceeds from sale of securities available for sale 1,757,718 3,542,943
Repayment of mortgage-backed securities 894,294 1,622,788
(Purchase)/Collection - accrued interest 1,586 (749)
Purchase of furniture and equipment - (30,435)
------------- -------------
NET CASH FLOWS USED IN INVESTING ACTIVITIES (95,479) (658,285)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from related party debt 1,124,925 1,125,113
Repayment of related party debt (1,152,006) (1,162,183)
Proceeds from borrowings 849,000 1,762,000
Repayment of borrowings (887,500) (1,046,619)
Proceeds from exercise of common stock warrants - 4,855
------------- -------------
NET CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES (65,581) 683,166
NET INCREASE (DECREASE) IN CASH (31,490) 215,998
CASH AT BEGINNING OF PERIOD 290,569 74,571
------------- -------------
CASH AT END OF PERIOD $ 259,079 $ 290,569
============= =============
SUPPLEMENTAL DISCLOSURES
Interest paid $ 145,398 $ 210,266
Income taxes paid - -
Non-cash investing and financing transaction:
Additional consideration paid for issuance of debt 70,347 124,201
See accompanying notes.
F-6
JACOBS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENT OF MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
YEAR 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 6,805 $ 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 loss
on available for
sale securities - - - - - - - - (21,944) (21,944)
Net 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 6,805 $ 9,482,279 $(21,214,153) $182,671 $(7,975,530)
===== ========== =========== ======= ========== ========= =========== ============ ======== ============
See accompanying notes.
F-7
JACOBS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENT OF MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
YEAR ENDED MAY 31, 2012
-----------------------------------------------------------------------------------------
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, 2011 2,675 $3,138,623 242,304,304 $24,230 $3,549,443 6,805 $ 9,482,279 $(21,214,153) $182,671 $(7,975,530)
Issuance of common
stock as compensation
for services - - 1,000,000 100 4,370 - - - - 4,470
Issuance of common
stock as additional
consideration for
financing arrangements - - 27,048,527 2,705 120,818 - - - - 123,523
Accrued dividends of
Series A mandatorily
redeemable convertible
preferred stock - 113,726 - - - - - (113,726) - (113,726)
Accrued dividends of
Series C equity
preferred stock - - - - - - 847,833 (848,005) - (172)
Reclassification of
Series A from
temporary equity
to liabilities (1,126) (1,410,794) - - - - - - - -
Increase (Decrease) in
accrual of common
shares to be issued
in connection with
financing arrangements - - - - (10,078) - - - - (10,078)
Common stock option
expense - - - - 370 - - - - 370
Unrealized net loss
on available for
sale securities - - - - - - - - (34,296) (34,296)
Net loss, year ended
May 31, 2012 - - - - - - - (1,105,833) - (1,105,833)
----- ---------- ----------- ------- ---------- --------- ----------- ------------ -------- ------------
BALANCE, MAY 31, 2012 1,549 $1,841,555 270,352,831 $27,035 $3,664,923 6,805 $10,330,112 $(23,281,717) $148,375 $(9,111,272)
===== ========== =========== ======= ========== ========= =========== ============ ======== ============
See accompanying notes.
F-8
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 experienced
income from operation and operating losses of approximately $16,000 and
($22,000) for the years ended May 31, 2012 and 2011, respectively. The
Company's income (or loss) decreases (or increases) when accretion of
mandatorily redeemable convertible preferred stock and accrued
dividends on mandatorily redeemable preferred stock are taken into
account, to losses of approximately $1,219,559 and $1,440,000 for the
years ended May 31, 2012 and 2011. 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-9
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities. Significant areas requiring the use of management
estimates are loss reserves, stock options, valuation of investments,
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 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
F-10
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Management believes the Company has the ability to hold all fixed
income securities to maturity. However, 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 classifies 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 market price regardless
of the then current market 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 market 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-11
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ALLOWANCE FOR UNCOLLECTIBLE PREMIUM AND OTHER RECEIVABLES
The majority of the Company's fee revenue is generated by services
provided to companies and individuals throughout the Eastern United
States. Management evaluates 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
The Company evaluates 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, The Company may be 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-12
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
The Company currently has 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, the Company has recorded a valuation allowance against this
deferred tax asset as it has determined that it is more likely than not
that it will not be able to fully utilize the NOLs. Should assumptions
regarding the utilization of these NOLs change, the Company 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 2011 Consolidated Financial Statements have been
reclassified to be consistent with the presentation in the Consolidated
Financial Statements as of May 31, 2012 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.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
---------------------------------------------------
In December 2011, the FASB issued Accounting Standards Update 2011-12,
"Comprehensive Income: Deferral of the Effective Date for Amendments to
the Presentation of Reclassifications of Items Out of Accumulated Other
Comprehensive Income in Accounting Standards Update No. 2011-05". The
object of this Update is to defer only those changes in ASU No. 2011-05
that relate to the presentation of reclassifications adjustments. 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 December 2011, the FASB issued Accounting Standards Update 2011-11,
"Balance Sheet: Disclosures about Offsetting Assets and Liabilities".
The differences in the requirements for offsetting assets and
liabilities in the presentation of financial statements prepared in
accordance with U.S. GAAP and financial statements prepared in
accordance with International Financial Reporting Standards (IFRS)
makes the comparability of those statements difficult. The objective of
F-13
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
this Update is to facilitate comparison between those financial
statements, specifically within the scope of instruments and
transactions eligible for offset in the form of derivatives, sale and
repurchase agreements and reverse sale and repurchase agreements, and
securities borrowing and securities lending arrangements. This update
is effective for annual reporting periods beginning on or after January
1, 2013 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 June 2011, the FASB issued Accounting Standards Update 2011-05,
"Comprehensive Income: Presentation of Comprehensive Income". The
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 IFRSs". The amendments in
this Update will improve the comparability of fair value measurements
presented and disclosed in financial statements prepared in accordance
with U.S. GAAP and InFRS. 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 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.
F-14
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, 2012:
Gross Unrealized Gross Unrealized
Amortized Cost Gains Losses Fair Market Value
--------------------- --------------------- --------------------- ---------------------
State and municipal securities $ 2,077,399 $ 16,051 $ 6,110 $ 2,087,340
Equity securities 533,669 15,176 52,377 496,468
Derivatives (14,549) (2,344) (4,699) (12,194)
Foreign Obligations 205,247 - 9,997 195,250
Mortgage Backed Securities 3,632,782 185,140 1,864 3,816,058
--------------------- --------------------- --------------------- ---------------------
$ 6,434,548 $ 214,023 $ 65,649 $ 6,582,922
===================== ===================== ===================== =====================
The Company held the following investments, by security type, that were
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 securities $ 1,073,724 $ - $ 26,955 $ 1,046,769
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
===================== ===================== ===================== =====================
Management believes the Company has the ability to hold all fixed
income securities to maturity. However, 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 classifies 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, 2012
or May 31, 2011.
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 Operations.
F-15
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-16
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS ARE SUMMARIZED
BELOW:
May 31, 2012
------------------------------------------------------------------
Fair Value Measurements Using
-------------------------------------------------- Assets At
Level 1 Level 2 Level 3 Fair Value
---------------- ---------------- ---------------- ---------------
Assets:
Fixed income securities at fair value $ - $ 6,098,648 $ - $ 6,098,648
Equity securities at fair value (includes
derivatives) 484,274 - - 484,274
Short-term investments at fair value 991,875 - - 991,875
---------------- ---------------- ---------------- ---------------
Total Assets $ 1,476,149 $ 6,098,648 $ - $ 7,574,797
================ ================ ================ ===============
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
derivatives) 453,456 - - 453,456
Short-term investments at fair value 1,007,617 - - 1,007,617
---------------- ---------------- ---------------- ---------------
Total Assets $ 1,461,073 $ 6,038,718 $ - $ 7,499,791
================ ================ ================ ===============
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, 2012 or at May 31, 2011.
At May 31, 2011, the Company's insurance subsidiary had securities and
short term investment with a fair value of $1,090,186 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 $7,833,825 and $7,789,441 as of May 31, 2012 and 2011, respectively,
are restricted to the use of FSC.
Principal repayments on U.S. government agency mortgage-backed
securities held by the Company as of May 31, 2012 are estimated as
follows:
Amortized Fair Market
Cost Value
-------------- --------------
Due in one year or less $ 248,353 $ 262,210
Due after one year through five years 277,323 292,504
Due after five years through ten years 250,688 263,924
Due after ten years 2,856,418 2,997,420
-------------- --------------
$ 3,632,782 $ 3,816,058
============== ==============
Estimated repayments are forecast based on varying prepayment speeds
for each particular security held assuming that interest rates remain
F-17
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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:
2012 2011
------------- --------------
Bonds - fixed maturities $ 76,424 $ 59,516
Mortgage-backed securities 190,949 170,129
Equity investments 11,960 -
Short-term investments 77 132
------------- --------------
Total investment income 279,410 229,777
------------- --------------
Investment expense - -
------------- --------------
Net investment income $ 279,410 $ 229,777
============= ==============
The increases (decrease) in unrealized appreciation of investments were
as follows:
2012 2011
-------------- ------------
Bonds-fixed maturities $ 26,899 $ (26,955)
Mortgage-backed securities (23,802) 2,463
Equity securities (37,393) 2,548
-------------- ------------
Increase (decrease) in
unrealized appreciation $ (34,296) $ (21,944)
============== ============
The gross gains and gross losses realized on available-for-sale
securities were as follows:
Gross Gross
Gross Realized Realized
Proceeds Gains Losses
---------------- -------------- ---------------
2012
Bonds-fixed maturities $ 688,281 $ 26,439 $ -
Mortgage-backed securities 874,051 50,399 -
Equity securities 112,876 2,168 (2,976)
Derivatives (equity securities) 78,578 26,676 (9,327)
---------------- -------------- ---------------
Total $ 1,753,786 $ 105,682 $ (12,303)
================ ============== ===============
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)
================ ============== ===============
F-18
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2012 and May 31, 2011.
Less than 12 Months 12 Months or More Total
--------------------------------- ------------------------------ --------------------------------
Cost Unrealized Cost Unrealized Fair Unrealized
(a) Losses (a) Losses Value Losses
---------------- ---------------- ------------- ---------------- --------------- ----------------
2012
Equity securities $ 266,036 $ 36,909 $ 81,169 $ 15,468 $ 294,828 $ 52,377
Bonds- Fixed Maturities 888,501 13,734 523,068 2,373 1,395,462 16,107
Mortgage-backed
securities 272,548 1,362 38,189 503 308,872 1,865
---------------- ---------------- ------------- ---------------- --------------- ----------------
Total $ 1,427,085 $ 52,005 $ 642,426 $ 18,344 $ 1,999,162 $ 70,349
================ ================ ============= ================ =============== ================
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
================ ================ ============= ================ =============== ================
(a) For bonds-fixed maturities and mortgage-backed securities,
represents amortized costs.
As of May 31, 2012, the Company held four mortgage-backed securities
with gross unrealized losses of $1,865, two of which have been in a
continuous loss position for more 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, 2012, the Company held four fixed maturity bonds with
gross unrealized losses of $16,107, one of which has been in a
continuous loss position for more than 12 months.
As of May 31, 2012, the Company held fourteen equity security
investments with gross unrealized losses of $52,377, three of which has
F-19
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
been in a continuous loss position for more 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.
2012 2011
-------------- -------------
Balance at beginning of year
$ 190,711 $ 128,453
Acquisition costs deferred
287,684 372,678
Amortization charged to operations
(311,385) (310,420)
-------------- -------------
Total $ 167,010 $ 190,711
============== =============
NOTE E - OTHER ASSETS
---------------------
Included in other assets as of May 31, 2012 and May 31, 2011 are
$96,370 and $21,986 of prepaid expenses and deposits. The balance on
May 31, 2012 includes an $80,000 deposit for legal fees.
NOTE F - INTANGIBLES
--------------------
As the result of the acquisition 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,
2012 and 2011.
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,
2012, 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 & Company.
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
F-20
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2012 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.
At May 31, 2012 and May 31, 2011, the reserve for losses and loss
expenses consisted of:
2012 2011
-------------- ----------------
Balance at beginning of year
$ 815,512 $ 611,190
Incurred policy losses-current year 210,977 204,322
Incurred policy losses-prior year - -
Amounts paid-current year losses - -
Amounts paid-prior year losses - -
-------------- ----------------
Balance at end of year $ 1,026,489 $ 815,512
============== ================
F-21
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - NOTES PAYABLE
----------------------
At May 31, 2012 and 2011, the Company had the following unsecured notes
payable to individuals and a commercial bank:
2012 2011
------------- -------------
Unsecured demand notes payable to individuals and
others; interest rate fixed @ 10% ($75,000 to
related party) $ 1,589,000 $ 1,492,500
Unsecured demand notes payable to individuals and
others - 103,000
Unsecured demand notes payable to individuals and
others; interest rate fixed @ 12% 15,000 -
Secured demand note payable to individuals; interest
rate fixed @ 14%; secured by accounts receivable for
investment advisory fees 62,000 45,000
Secured demand note payable to individuals; interest
rate fixed @ 10%; secured by accounts receivable for
investment advisory fees 105,000 -
Secured demand note payable to individuals; interest
rate fixed @ 12%; secured by accounts receivable for
investment advisory fees - 40,000
Secured demand note payable to individuals; interest
rate fixed @ 12%; secured by accounts receivable for
investment advisory fees - 129,000
Unsecured short-term advances from principal
shareholder and chief executive officer; interest rate
fixed @ 12% (Also See Note T - Related Party
Transactions) (57,046) (29,965)
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
------------- -------------
Total $ 5,213,954 $ 5,279,535
============= =============
F-22
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
September 10, 2011 7,043,710
March 10, 2012 7,430,017
--------------
48,667,568
==============
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.
F-23
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. The Original forbearance was
amended October 13, 2009. 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 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.
In anticipation of a proposed financing and as a condition thereof, the
Company and each of the bridge lenders entered into a Loan Modification
Agreement dated February 25, 2012 which provided for modification of
the Promissory Notes, including an extension of the term of the
Promissory Notes, and Subscription Agreements in exchange for a partial
cash payment to each bridge lender. To date, the proposed financing has
not closed, and the Company has been unable to remit the partial
payment. On August 10, 2012, the Company entered into an agreement with
the bridge lenders, pursuant to which the bridge lenders formally
agreed to forbear from exercising their rights and remedies arising
from the accumulated acknowledged events of default with respect to the
bridge loans until such date. As consideration for this forbearance,
the Company entered into an Amended and Restated General Hypothecation
and Pledge Agreement dated August 9, 2012 (the "August 2012 Pledge"),
but effective September 23, 2011, granting to the bridge lenders as
security for the repayment of the loans a lien and security interest in
all of the Company's shares of capital stock of First Surety
Corporation. Under the August 2012 Pledge, the bridge lenders
acknowledge that the effectiveness of certain of the rights and
remedies provided by such agreement may be subject to prior approval by
the Office of the Commissioner of Insurance for the State of West
Virginia. To date, none of the bridge lenders has elected to pursue
legal remedies under the Promissory Notes or the August 2012 Pledge.
Scheduled maturities and principal payments for each of the next five
years are as follows:
2012
-------------
Fiscal year 2012-2013 (including demand notes) $ 5,213,954
Fiscal year 2013-2014 -
Fiscal year 2014-2015 -
Fiscal year 2015-2016 -
Fiscal year 2016-2017 -
Fiscal year 2017-2018 -
-------------
Total $ 5,213,954
=============
F-24
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - OTHER LIABILITIES
--------------------------
In the years ended May 31, 2012 and May 31, 2011, the Company, upon
advice of legal counsel, removed certain dormant accounts payable in
the aggregate amount of $150,604 and $54,358. For the year ended May
31, 2012, the amount was removed based on the vendor no longer
requiring payment on that portion of the balance owed to them. For the
year ended May 31, 2011, the amount was removed based upon the
conclusion that none of accounts represented an obligation that is
legally enforceable against the Company. Such removals were recorded as
gains on debt extinguishment.
As of May 31, 2012, the Company had accrued and withheld approximately
$202,000 in Federal payroll taxes and approximately $24,000 in
estimated penalties and interest, which are reflected in the financial
statements as other liabilities. Management is in discussions with the
IRS and intends to satisfy this obligation as soon as possible.
As of May 31, 2012, the Company had accrued and withheld approximately
$53,000 in West Virginia payroll withholdings and approximately $8,000
in interest and penalties, which are reflected in the accompanying
financial statements as other liabilities. Subsequent to year end,
management entered into a payment plan to satisfy this obligation in
full over a 15 month payment period.
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
F-25
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2012, 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 2012 or 2011.
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 4,891 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
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
2,219 shares of Series B Preferred. The aggregate amount to which the
holders requesting redemption are entitled as of June 30, 2012, is
$3,713,966.
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
F-26
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 to redemption shall be paid on a pari passu basis with the
Redemption Price of the Series B Stock subject to 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 $1,219,559 in fiscal 2012 as
compared with 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.
EQUITY PREFERRED STOCK
As a means of alleviating obligations associated with the Company's
F-27
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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"). 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
F-28
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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).
For the year ending May 31, 2010, 6,805 shares of Series B Stock were
surrendered and exchanged for 6,805 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 $847,833 in fiscal 2012 as compared with a
charge to common stockholders' equity of $781,062 in fiscal 2011.
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 the 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
F-29
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 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 $251 and $352,271 for the year ended May 31, 2012. 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 year ended May 31, 2012.
During the year ended May 31, 2012, two holders of Series A stock
released all of their outstanding bonds held with FSC. These shares of
Series A Preferred Shareholders are listed in the liability section of
the Balance Sheet in the amount of $1,424,863, which consists of
$1,126,000 face value of stock and $298,863 in dividends payable. The
dividends associated with these shares of Series A stock after February
29, 2012 is a deduction from net income in the amount of $14,069. There
was no accretion on these shares of Series A stock.
As of May 31, 2012 the Company has chosen to defer payment of dividends
on Series A Preferred Stock with such accrued and unpaid dividends
amounting to $591,416 through May 31, 2012.
As of May 31, 2012 the Company has chosen to defer payment of dividends
on Series B and Series C Preferred Stock with such accrued and unpaid
dividends amounting to $1,795,746 and $4,299,181 through May 31, 2012.
ACCOUNTING TREATMENT
U.S. GAAP requires that an entity classify as liabilities certain
financial instruments with characteristics of both liabilities and
equity. 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. 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
F-30
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Preferred Stock, such condition is contingent upon the holder having no
further need for surety bonds issued by the 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, 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 held by principals with outstanding surety bonds
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 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 $.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 year ended 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 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 $.07 per share, of which 5,500,000 shares
vested immediately and the remaining 17,900,000 options vesting over
the next four years ending in May 2010. Due to changes in employment
F-31
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 $.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. As of May 31, 2010,
the awarded options had been reduced to 1,800,000 due to changes in
employment status, all of which expired in December 2011.
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 $.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, all 10,000,000
options were vested.
The following table summarizes option activity under the Plan for the
fiscal year ended May 31, 2012.
Number Weighted-Avg.
Weighted-Avg. Of Shares Remaining Aggregate
Exercise Under Life Intrinsic
Price Option (Years) Value
------------- ------------ ------------ ---------
Balance at June 1, 2011 $ .0400 11,800,000
Options granted - -
Options exercised - -
Options canceled/expired .0400 1,800,000
------------- ------------
Balance, May 31, 2012 $ .04000 10,000,000
============= ============
Exercisable at May 31, 2012 $ .04000 10,000,000 2.08 $ -
============= ============
Expected to vest $ - - - $ -
============= ============
The following table summarizes activity and pricing information for the
non- vested shares under the Plan for the year ended May 31, 2012.
F-32
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Weighted- Number
Average Of
Grant Date Non-vested
Fair Value Shares
---------------- --------------------
Balance at June 1, 2012
$ .02962 300,000
Options granted - -
Options vested .02962 ( 300,000)
Options canceled/expired - -
---------------- --------------------
Balance at May 31, 2012 $ - -
================ ====================
There were no options exercised in fiscal 2012 or 2011. The total fair
value of shares vested amounted to approximately $9,000 and $148,000 in
fiscal 2012 and 2011, respectively.
Stock-based compensation expense attributable to such awards amounted
to $370 and $16,780 in fiscal years ended May 31, 2012 and 2011
respectively. There is no unrecognized compensation expense related to
non-vested awards at May 31, 2012 as all awards are fully vested.
The Company estimates the fair value of stock options using a
Black-Scholes valuation model. 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,
2012, the Company had operating loss carry forwards of approximately
$18.9 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.
F-33
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE N - STOCKHOLDERS EQUITY
----------------------------
In fiscal 2012, the Company issued 3,545,000 shares of the Company's
common stock as additional consideration in connection with new and
continued borrowings totaling $2,798,000. The shares were valued at
approximately $.005088 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 $18,036.
In fiscal 2012, the Company issued 9,029,800 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 $.00444 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 $40,098.
In fiscal 2012, the Company issued 7,043,710 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 $.00506 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 $35,561.
In fiscal 2012, the Company issued 7,430,017 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 $.00360 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 $26,748.
In fiscal 2012, the Company awarded 1,000,000 shares to an individual
as compensation for services rendered. The shares were valued at
approximately $.004447 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 $4,470.
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 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
F-34
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 not reflect
deferred policy acquisition costs and certain assets are non-admitted.
Statutory surplus as of May 31, 2012 and 2011 and net income for the
Company's insurance subsidiary for the calendar year ended December 31,
2011 and 2010 and five-month periods ended May 31, 2012 and 2011 are as
follows:
Statutory Surplus May 31, 2012 $ 6,075,541
Statutory Surplus May 31, 2011 6,105,504
Net Income Calendar year 2011 378,455
Net Income Calendar year 2010 201,683
Net Income Five-month period 2012 167,043
Net Income Five-month period 2011 86,700
Statutory surplus exceeds the minimum capital requirements provided by
West Virginia state law of $2.0 million.
F-35
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On March 26, 2012 the Commissioner of the State of West Virginia
terminated in its entirety the Amended Consent Order of June 7, 2007
and terminated the restrictive conditions of the Consent Order issued
December 23, 2005 which approved acquisition of the insurance
subsidiary by the Company. Among other consequences, removal of these
restrictions allowed dividends to be declared by the insurance
subsidiary in the amount of $380,000 as of May 31, 2012 and paid from
the insurance subsidiary to the Company.
NOTE P - COMMITMENTS AND CONTINGENCIES
--------------------------------------
LEASE COMMITMENTS
The Company leases certain office equipment with combined monthly
payments of approximately $460 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 leased an apartment for corporate use at a monthly rate of
$560 plus electric utilities. This lease ended in August 2011.
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
$56,112 and $63,291 during fiscal years 2012 and 2011.
Minimum future lease payments under non-cancelable operating leases
having remaining terms in excess of one year as of May 31, 2012 are:
Fiscal year 2012-2013 $ 5,514
Fiscal year 2013-2014 5,514
Fiscal year 2014-2015 5,514
Fiscal year 2015-2016 5,514
--------------
Total $ 22,056
==============
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
F-36
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
purposes (available-for-sale) 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, 2012 and 2011 are as follows:
2012 2011
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ ------------ ------------ ------------
ASSETS
Bonds available for sale $ 6,098,648 $ 6,098,648 $ 6,038,718 $ 6,038,718
Cash and short-term investments 1,250,954 1,250,954 1,291,186 1,291,186
Premiums and other receivables 332,444 332,444 210,438 210,438
Equity securities (including derivatives) 484,274 484,274 453,456 453,456
LIABILITIES
Notes payable 5,213,954 5,213,954 5,279,535 5,279,535
Accounts payable and advance premiums 421,338 421,338 342,036 342,036
Accrued expenses and other liabilities 2,690,199 2,690,199 1,951,736 1,951,736
NOTE R - OTHER RISKS, UNCERTAINTIES AND CONCENTRATIONS
------------------------------------------------------
CONCENTRATION OF CREDIT RISK
As of May 31, 2012 the Company's investment securities of approximately
$7,600,000 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.
F-37
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 63% and 74% of the
Company's fiscal 2012 and 2011 revenues, respectively. Furthermore, the
Company provides surety bonds to companies that share common ownership
interests that constitute 38% and 54% of the Company's fiscal 2012 and
2011 revenues, respectively, as follows:
2012 2011
Investment Investment
Surety Advisory Surety Advisory
Premium Fees Premium Fees
---------- ---------- ---------- ----------
Customer group # 1 $ - $ 2,400 $ 267,000 $ 75,000
Customer group # 2 567,000 104,000 462,000 83,000
Customer group # 3 195,000 3,000 203,000 2,800
---------- ---------- ---------- ----------
TOTAL $ 762,000 $ 109,400 $ 932,000 $ 160,800
========== ========== ========== ==========
F-38
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
YEAR ENDED
INDUSTRY SEGMENT MAY 31, 2012 MAY 31, 2011
------------------------- ------------------ ----------------
REVENUES:
Investment advisory $ 257,087 $ 286,695
Surety insurance 1,576,107 1,279,138
Corporate 150,604 50,000
------------------ ----------------
Total revenues $ 1,983,798 $ 1,615,833
================== ================
OPERATING INCOME (LOSS):
Investment advisory $ 73,432 $ 70,222
Surety insurance 613,377 475,455
Corporate (1,792,642) (1,852,411)
------------------ ----------------
Total operating income (loss) $ (1,105,833) $ (1,306,734)
================== ================
IDENTIFIABLE ASSETS:
Investment advisory $ 60,932 $ 59,949
Surety insurance 8,739,074 8,584,860
Corporate 88,433 16,589
------------------ ----------------
Total assets $ 8,888,439 $ 8,661,398
================== ================
CAPITAL ACQUISITIONS:
Investment advisory $ - $ -
Surety insurance - 25,919
Corporate - 4,516
------------------ ----------------
Total capital acquisitions $ - $ 30,435
================== ================
DEPRECIATION CHARGED TO
IDENTIFIABLE ASSETS:
Investment advisory $ 45 $ 45
Surety insurance 7,874 12,229
Corporate 2,817 3,065
------------------ ----------------
Total Depreciation $ 10,736 $ 15,339
================== ================
INTEREST EXPENSE:
Investment advisory $ - $ 5
Surety insurance - -
Corporate 905,601 908,370
------------------ ----------------
Total interest expense $ 905,601 $ 908,375
================== ================
F-39
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, because Mr. Jacobs entered into an
Assumption Agreement with the Company. Pursuant to the assumption
agreement Mr. Jacobs assumes, and agrees to hold the Company harmless
from, principal of specified indebtedness of the Company and to fully
offset when necessary what might otherwise be deemed an advance of
funds arising out of the Company's financing activities.
During fiscal 2012, advances to the Company from Mr. Jacobs amounted to
$1,124,925, which included assumption of company debt in the amount of
$393,519, and repayments to Mr. Jacobs amounted to $1,152,006. As of
May 31, 2012, the balance due the Company was $57,046. The largest
aggregate amount outstanding to Mr. Jacobs in fiscal 2012 was $18,003.
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 2012 and 2011 fiscal years.
As of September 13, 2012, $102,956 was owed by the Company to Mr.
Jacobs.
OTHER RELATED PARTIES
During the years ended May 31, 2012 and May 31, 2011, a company owned
by a board member provided consulting services. This company provided
services totaling $62,100 and $62,100 in 2012 and 2011. Amounts owed to
this company at year end are treated as related party payables in the
amounts $109,309 and $99,209 at May 31, 2012 and 2011 respectively.
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, 2012 and May 31, 2011 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 Company cedes insurance to other companies and these
reinsurance contracts do not relieve the Company from its obligations
to policyholders.
F-40
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. For the third
agreement year, which covers the twelve months beginning July 1, 2011,
the premium rate remains the same at 35% with the premium due within 30
days of the close of the agreement year, subject to a minimum premium
of $490,000. Deposits are made to the reinsurers quarterly in arrears
in equal amounts of $140,000. At May 31, 2012 and 2011, the Company had
prepaid reinsurance premiums of $243,877 and $264,763 and ceded
reinsurance payable/ (deposited) of ($42,458) and $77,635. During 2012,
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,
2012 or 2011.
The effects of reinsurance on premium written and earned for fiscal
2012 and 2011 are as follows;
2012 Written 2012 Earned 2011 Written 2011 Earned
-------------- --------------- ---------------- ---------------
Direct $ 1,343,661 $ 1,424,355 $ 1,613,912 $ 1,380,225
Ceded 446,853 467,739 519,663 469,285
-------------- --------------- ---------------- ---------------
Net $ 896,808 $ 956,616 $ 1,094,249 $ 910,940
============== =============== ================ ===============
NOTE V - EVENTS SUBSEQUENT TO MAY 31, 2012
------------------------------------------
Subsequent to May 31, 2012, the Company obtained various borrowings
from individuals and businesses totaling $160,000 at rates varying from
10% to 14%, which mature at various dates subsequent to this filing,
and made repayments on notes in the amount of $60,000. These
borrowings, and the renewal of other borrowings, included the issuance
of 1,161,000 shares of its common stock as additional consideration.
Additionally, there were advances to the Company from its largest
shareholder and CEO amounting to $569,017, with repayments totaling
$409,015.
On September 10, 2012, in accordance with the Bridge financing
agreement, the Company became obligated to issue in the aggregate
8,573,594 shares of its common stock to the holders of such notes.
F-41
JACOBS FINANCIAL GROUP INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On June 30, 2012, 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 $609,921, $1,918,283, and $4,520,655 as of June
30, 2012.
On July 1, 2012 the Company issued 3,845,837 Common shares representing
the additional 2% stock dividend for the quarter ending June 30, 2012
to the holders of Series B Preferred shares that had requested to be
redeemed upon maturity (see Note J).
On June 19, 2012, the compensation committee of the board of directors
awarded 22,600,000 of stock to its employees under the Company's stock
incentive plan adopted October 12, 2005 (See Note L).
F-42
--------------------------------------------------------------------------------------------------------------------------
SUMMARY OF INVESTMENTS-
OTHER THAN INVESTMENTS IN RELATED PARTIES SCHEDULE I
--------------------------------------------------------------------------------------------------------------------------
Amount
at which
AT MAY 31, 2012 shown in the
Cost* Value Balance Sheet
------------- ------------- ---------------
Fixed maturities:
Bonds:
United States Government and government agencies and authorities $ - $ - $ -
Foreign obligations 205,246 195,250 195,250
States, municipalities, and political subdivisions 2,077,399 2,087,340 2,087,340
------------- ------------- ---------------
Total fixed maturities 2,282,645 2,282,590 2,282,590
Equity securities (including derivatives):
Common stock and derivatives 519,119 484,274 484,274
------------- ------------- ---------------
Total equity securities 519,119 484,274 484,274
Mortgage-backed securities guaranteed by U.S. government agency 3,632,782 3,816,058 3,816,058
Short-term investments, at cost (approximates market value) 991,875 991,875 991,875
------------- ------------- ---------------
Total investments $ 7,426,421 $ 7,574,797 $ 7,574,797
============= ============= ===============
* 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-43
JACOBS FINANCIAL GROUP, INC.
AND SUBSIDIARIES
--------------------------------------------------------------------------------------------------
CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II
--------------------------------------------------------------------------------------------------
BALANCE SHEETS - PARENT COMPANY ONLY
MAY 31, 2012 MAY 31, 2011
-------------- ---------------
Assets:
Cash $ (22,407) $ (27,461)
Accounts receivable from affiliates - -
Prepaid expense and other assets 83,864 9,192
Furniture and equipment, net 4,568 7,385
Investment in subsidiaries, equity method 5,907,389 5,798,422
Due from affiliates, net 555,000 677,801
-------------- ---------------
Total assets $ 6,528,414 $ 6,465,339
============== ===============
LIABILITIES:
Accounts payable $ 46,661 $ 20,922
Accrued expenses and professional fees 367,572 495,169
Related party payable 310,644 231,656
Notes payable 4,836,000 4,874,500
Related party note payable 377,954 405,035
Due to affiliates - -
Other liabilities 1,972,588 1,199,932
Series A Preferred Stock 1,424,863 -
Series B Preferred Stock 4,610,224 4,257,703
-------------- ---------------
Total liabilities 13,946,506 11,484,917
MANDATORILY REDEEMABLE PREFERRED STOCK 1,841,555 3,138,623
STOCKHOLDERS EQUITY:
Common stock 27,035 24,230
Additional paid in capital 3,664,923 3,549,443
Series C Stock 10,330,112 9,482,279
Accumulated deficit (23,281,717) (21,214,153)
-------------- ---------------
Total stockholders equity (deficit) (9,259,647) (8,158,201)
-------------- ---------------
Total liabilities and stockholders equity $ 6,528,414 $ 6,465,339
============== ===============
STATEMENTS OF INCOME - PARENT COMPANY ONLY
YEAR ENDED MAY 31,
2012 2011
-------------- ---------------
REVENUES
Equity in undistributed net income (loss) of consolidated
subsidiaries $ 109,064 $ 437,671
Tax benefit to parent from subsidiary attributable to
utilization of net operating loss carryforwards 197,745 108,006
Dividends paid to parent from subsidiary 380,000 -
Gain on extinguishment of debt 150,604 50,000
-------------- ---------------
Total revenues 837,413 595,677
EXPENSES:
General and administrative 668,238 560,155
Interest 905,601 908,370
Accrued dividends on stock liability 366,591 430,821
Depreciation 2,816 3,065
-------------- ---------------
Total expenses 1,943,246 1,902,411
-------------- ---------------
Net income (loss) (1,105,833) (1,306,734)
Accrued dividends on equity stock (847,833) (781,062)
Accretion of mandatorily redeemable convertible preferred
stock, including accrued dividends (113,726) (133,356)
-------------- ---------------
Net income (loss) attributable to common stockholders $ (2,067,392) $ (2,221,152)
============== ===============
F-44
JACOBS FINANCIAL GROUP, INC.
AND SUBSIDIARIES
-----------------------------------------------------------------------------------------------------
CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II
-----------------------------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS - PARENT COMPANY ONLY
YEAR ENDED MAY 31,
2012 2010
------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (1,105,833) $ (1,306,734)
Adjustments to reconcile net (loss) to net cash provided
by operating activities:
Equity in undistributed net loss of consolidated subsidiaries (108,967) (437,672)
Accrual of preferred stock dividend 366,339 324,455
Accretion of preferred stock 251 106,366
Stock option compensation expense 370 16,782
Stock issued in connection with financing arrangements 117,743 126,074
Depreciation 2,817 3,065
Loss on disposal of equipment - 335
Gain on extinguishment of debt (150,604) (50,000)
Change in other assets, accounts payable and accrued expense, net 825,718 461,011
------------- --------------
TOTAL CASH USED IN OPERATIONS (52,166) (756,318)
CASH FLOWS FROM INVESTING ACTIVITIES:
Funds provided to affiliates for operations 122,801 76,118
Purchase of furniture and equipment - (4,516)
------------- --------------
TOTAL CASH USED IN INVESTING ACTIVITIES 122,801 71,602
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock warrants - 4,855
Proceeds from borrowings 849,000 1,762,000
Repayment of borrowings (887,500) (1,046,619)
Proceeds from short-term borrowings from related party 1,124,925 1,125,113
Repayment of short-term borrowings to related party (1,152,006) (1,171,568)
------------- --------------
TOTAL CASH PROVIDED BY FINANCING ACTIVITIES (65,581) 673,781
------------- --------------
CHANGE IN CASH 5,054 (10,935)
Cash at beginning of year (27,461) (16,526)
------------- --------------
Cash at end of year $ (22,407) $ (27,461)
============= ==============
F-45
JACOBS FINANCIAL GROUP, INC.
AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTARY INSURANCE INFORMATION
AS OF MAY 31, 2012 AND 2011 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
--------- ----------- ----------- --------- -------- --------- ---------- ---------- ----------- --------- ---------
2012
Surety $ 167,010 $1,026,489 $ 771,089 $ - $1,169,897 $ 279,410 $ 210,977 $ 311,385 $ - $ 896,808
------------------------------------------------------------------------------------------------------------------------------------
2011
Surety $ 190,711 $ 815,512 $ 851,783 $ - $ 910,940 $ 229,777 $ 204,323 $ 310,420 $ - $1,094,249
F-46
------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL INSURANCE INFORMATION - REINSURANCE
AS OF MAY 31, 2012 AND 2011 AND FOR THE YEARS THEN ENDED SCHEDULE IV
------------------------------------------------------------------------------------------------------------------------------
CEDED TO OTHER
2012 GROSS AMOUNT COMPANIES NET AMOUNT
--------------------- ------------------- -------------------
Premiums written:
Property and casualty insurance $ 1,343,661 $ 446,853 $ 896,808
--------------------- ------------------- -------------------
Total premiums written $ 1,343,661 $ 446,853 $ 896,808
===================== =================== ===================
Premiums earned:
Property and casualty insurance $ 1,424,355 $ 467,739 $ 956,616
--------------------- ------------------- -------------------
Total premiums earned $ 1,424,355 $ 467,739 $ 956,616
===================== =================== ===================
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
===================== =================== ===================
F-47
JACOBS FINANCIAL GROUP, INC.
AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL INFORMATION
AS OF MAY 31, 2012 AND 2011 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
----------------- ----------- ---------- -------- --------- -------- ---------- --------- ------- --------- ----------- --------
2012
Consolidated
property-casualty
entities $167,010 $1,026,489 $ - $771,089 $ 956,616 $ 279,410 $ 210,977 $ - $ 311,385 $ - $ 896,808
------------------------------------------------------------------------------------------------------------------------------------
2011
Consolidated
property-casualty
entities $190,711 $ 815,512 $ - $851,783 $ 910,940 $ 229,777 $ 204,323 $ - $ 310,420 $ - $1,094,249
F-48
(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, 2012 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, 2012 BY: /s/ John M. Jacobs
----------------------------------
John M. Jacobs
President and CEO
Director
Dated: September 13, 2012 BY: /s/ John M. Jacobs
----------------------------------
John M. Jacobs
Chief Financial Officer
Dated: September 13, 2012 BY: /s/ Mario J. Marra
----------------------------------
Mario J. Marra
Director
Dated: September 13, 2012 BY: /s/ C. David Thomas
----------------------------------
C. David Thomas
Director
Dated: September 13, 2012 BY: /s/ Eric D. Ridenour
----------------------------------
Eric D. Ridenour
Director
Dated: September 13, 2012 BY: /s/ Bradley W. Tuckwiller
----------------------------------
Bradley W. Tuckwiller
Director
37