10-K 1 jfgi10kvfinal.txt 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, 2009 Commission file number 0-21210 JACOBS FINANCIAL GROUP, INC. ---------------------------------------------- (Exact name of registrant as specified in its charter) ======================================== ===================================== DELAWARE 84-0922335 ---------------------------------------- ------------------------------------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation) ======================================== ===================================== 300 SUMMERS STREET, SUITE 970, CHARLESTON, WV 25301 -------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (304) 343-8171 -------------- 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, 2008: $783,348 (174,077,272 shares at $.0045 / share) Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date: 186,028,413 shares of common stock as of September 9, 2009. 2
TABLE OF CONTENTS PAGE PART I Item 1 Business 4 Item 1A Risk Factors 5 Item 2 Properties 5 Item 3 Legal Proceedings 5 Item 4 Submission of Matters to a Vote of Security Holders 5 PART II Item 5 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 6 Item 6 Selected Financial Data 7 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 7 Item 7A Quantitative and Qualitative Disclosures About Market Risk 18 Item 8 Financial Statements and Supplementary Data 18 Item 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 19 Item 9A(T) Controls and Procedures 19 Item 9B Other Information 20 PART III Item 10 Directors, Executive Officers and Corporate Governance 21 Item 11 Executive Compensation 23 Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 25 Item 13 Certain Relationships and Related Transactions and Director Independence 28 Item 14 Principal Accounting Fees and Services 29 PART IV Item 15 Exhibits, Financial Statement Schedules 32
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. for the purpose of acquiring, dealing in, and if warranted, developing oil and gas properties. In October 1993 the Company changed its name to NELX, Inc. Prior to May 2001, the Company owned certain non-producing oil and gas properties as well as various real estate properties. Due to continuing lack of capital partners for oil and gas exploration and/or real estate development, in fiscal year 1997 the Company turned its attention to divesting its interests in said properties. For the next three years, the principal activities of the Company involved disposing of assets, settling claims and liabilities and considering potential business combinations with related or complementary businesses. During fiscal year 2001, the Company's principal assets consisted of a leasehold interest in an undeveloped mineral spring in Arkansas and certain oil and gas properties located in West Virginia. The oil and gas properties were sold in May 2001. On May 29, 2001, the Company acquired two businesses, FS Investments, Inc. ("FSI") and Jacobs & Company ("Jacobs & Co." or "Jacobs"), in exchange for 75 million shares of common stock of NELX. The transaction was accounted for as a recapitalization of FSI and Jacobs & Co. effected by a reverse acquisition. For accounting purposes, NELX was treated as the acquiree, and no goodwill or other intangible asset was recorded. FSI, incorporated in 1997 in West Virginia, is a holding company that was organized to develop surety business through the formation or acquisition of subsidiaries engaged in the issuance of surety bonds collateralized by investment accounts that are professionally managed by Jacobs & Co. Through its wholly-owned subsidiary, Triangle Surety Agency, Inc. ("Triangle Surety" or "TSA"), FSI is actively engaged in the placement with insurance companies of surety bonds, with an emphasis on clients engaged in regulated industries. Jacobs & Co., incorporated in 1988 in West Virginia, is a SEC registered investment advisory firm whose executive offices are located in Charleston, West Virginia. Jacobs & Co. provides fee based investment advisory services to institutions, companies and individuals, including the Jacobs & Company Mutual Fund (the "J&C Fund" or the "Fund"), which was organized in June 2001 as a series of the Advisors Series Trust. On June 27, 2005, the Fund was reorganized as a series of Northern Lights Fund Trust. Since the May 29, 2001 business combination, the Company has expanded its focus to include the ongoing business and activities of FSI and Jacobs, namely the surety business and investment management and related services. On or about December 29, 2005, NELX was merged with and into its newly-formed wholly-owned subsidiary, Jacobs Financial Group, Inc., 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. 4 The Company is headquartered in Charleston, West Virginia, and through its wholly-owned subsidiaries, employs a total of seven (7) full-time employees. 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 Through its wholly-owned subsidiary, Crystal Mountain Water, Inc. ("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. Item 3. LEGAL PROCEEDINGS None Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 5 PART II Item 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES. 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 ---- --- FISCAL YEAR ENDED MAY 31, 2009 4th Quarter .045 .001 3rd Quarter .01 .003 2nd Quarter .01 .003 1st Quarter .01 .003 FISCAL YEAR ENDED MAY 31, 2008 4th Quarter .025 .00831 3rd Quarter .07 .006 2nd Quarter .03 .006 1st Quarter .03 .01 As of May 31, 2009, there were approximately 882 holders of record of the Company's common stock. The Company has neither declared nor paid any cash dividends on its common stock during the last two fiscal years, and it is not anticipated that any such dividend will be declared or paid in the foreseeable future. Regulatory approval of the acquisition of FSC by JFG was provided under the condition that no dividends or monies are to be paid to JFG from FSC without regulatory approval. For further information, see Notes C and O to the Consolidated Financial Statements and "Restrictions on Use of Assets" within the section of "Capital Resources and Financial Condition" of Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II Item 7 of this Annual Report on Form 10-K. 6 As of May 31, 2009, 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 -------------------------------------------- ------------------------------------------ ------------------------------------------ 23,100,000 .06652 11,900,000 -------------------------------------------- ------------------------------------------ ------------------------------------------
There are no other equity compensation plans not approved by stockholders of the Company. UNREGISTERED SALES OF EQUITY SECURITIES In the three-month period ended May 31, 2009, 232 shares of Series A Preferred Stock were issued pursuant to ongoing bonding programs of FSC in exchange for cash in the amount of $232,000. 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 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 During fiscal 2009, the Company has focused its primary efforts on the development and marketing of its surety business in West Virginia and Ohio, arranging for an increase in FSC's bonding capacity through a reinsurance relationship, raising additional capital to increase the capital base of FSC and facilitate entry into other state markets and other means of accelerating the progression of the Company's business plan. 7 RESULTS OF OPERATIONS AND FINANCIAL CONDITION AS OF AND FOR THE YEAR ENDED MAY 31, 2009 RESULTS OF OPERATIONS The Company experienced a loss (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) of $3,057,687 in fiscal 2009 as compared with a loss (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) of $3,332,942 in fiscal 2008. While total revenues increased from approximately $957,000 in fiscal 2008 to approximately $1,194,000 in fiscal 2009, total expenses decreased from approximately $2,465,000 in fiscal 2008 to approximately $2,039,000 in fiscal 2009, resulting in a decrease in the loss from operations of approximately $663,000. The increase in revenues is largely attributable to new business acquired by FSC and increased investment holdings of FSC. The decrease in expenses is attributable to decreased general and administrative expense related to reduction in personnel and reduction in professional fees incurred in the Company's negotiating and entering into acquisition agreements with respect to RSH and Unione in fiscal 2008 and ongoing efforts to raise additional capital to expand its business. Interest expense increased from approximately $479,000 in fiscal 2008 to approximately $605,000 in fiscal 2009 due to additional borrowings incurred to pay professional fees and expenses related to the Company's efforts to raise additional capital financing and to provide financing of current operations. Accretion and accrued dividends on preferred stock increased from approximately $1,471,000 in fiscal 2008 to approximately $1,609,000 in fiscal 2009. This increase is attributable the accrual of dividends associated with the issuance of the Company's Series A preferred stock in connection with its partially collateralized bonding programs and the compounding of accrued dividends on previously accrued but unpaid dividends. 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 preferred stock and 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 $167,000 as of December 30, 2005. As an inducement to the initial preferred stock shareholders, warrants to purchase 45,402,996 shares of common stock at an exercise price of one-tenth of one cent ($.001) per share were issued with a five-year expiration period. Such 8 warrants were valued at approximately $533,000 using the Black-Scholes pricing model. Additionally, 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. Accordingly, the recorded values of the Series A and B preferred stock are being increased to their stated liquidation values using the interest method over a period of five years and such amounts are categorized as accretion of mandatorily redeemable preferred stock in the consolidated statement of operations. The preferred stock issued consisted of non-voting Series A and Series B redeemable preferred stock; the Series A designation being entitled to receive cumulative dividends at the rate of 4.00% per annum and the Series B designation being entitled to receive cumulative dividends at the rate of 8.00% per annum, with both the Series A and B designations having equal ranking and preference as to dividends and liquidation rights and in priority to the Company's common stockholders. At this time, management has chosen to defer payment of dividends to the holders of the Series A and B preferred stock until the Company has sufficient cash flow from operations to service the obligation. 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 request by the West Virginia Insurance Department to downstream all future proceeds from the sale Series A preferred stock in order to build capital and surplus 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. Furthermore, once redeemed, the principal will no longer be eligible to participate in partially collateralized bonding programs offered 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. 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 exercising its conversion privileges prior to the stated redemption date. Management's ability to execute its business plan and increase the market value of its common stock will largely determine whether the Series B preferred shares are converted to common shares or eventually redeemed. 9 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 are fixed at 10.00%. Payments due December 2008 and March 2009 were not made by the Company as scheduled, but an agreement was subsequently entered into with the bridge lenders on June 5, 2009, modifying payment terms to cure the default and pledging the stock of the Company's subsidiary, CMW, as security for repayment of the loans. Certain equity inducements in the form of common stock of the Company were provided under the terms of the bridge loan documents. Upon issuance of the bridge notes, an aggregate of 7% of the outstanding common stock of the Company was issued to the bridge lenders. Upon retirement of the notes upon consummation of a qualified equity offering, the Company will issue to the bridge lenders a percentage of the outstanding common stock of the Company which, when added to the stock initially issued, may equal as much as 28% of the common stock of the Company that would otherwise have been retained by the holders of the Company's common shares immediately prior to the financing. Finally, because a qualified financing was not completed by September 10, 2008, the Company was required to issue to the bridge lenders under the terms of the loan documents a total of 2.8% of the Company's outstanding common shares at such date. An additional 2.8% of the Company's outstanding common shares are required to be issued upon each six-month anniversary date thereof until retirement of the notes. RESTRICTIONS ON USE OF ASSETS Regulatory approval of the acquisition of FSC by JFG was provided under the condition that no dividends or monies are to be paid to JFG from FSC without regulatory approval. Accordingly, cash, marketable investments, and other receivables held by FSC are restricted from use to fund operations or meet cash needs outside of the insurance company's domain. As of May 31, 2009, such assets amounted to approximately $6.78 million. 10 CRITICAL ACCOUNTING POLICIES AND ESTIMATES 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. 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, 2009. 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, the value of 11 the collateral accounts held for the benefit of FSC, along with industry averages and historical experience. Management has estimated such losses based on industry experience, adjusted for factors that are unique to the Company's approach, and in consultation with consulting actuaries experienced in the surety field. LIQUIDITY AND GOING CONCERN The Company has experienced operating losses (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) of approximately $3,058,000 and $3,333,000 for the fiscal years ended May 31, 2009 and 2008, respectively. The Company continues to face significant working capital deficiencies and cash flow concerns. This has resulted in the deferral of payments to professionals and others and an inability to pay its preferred stock dividend obligation. 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 allow FSC to expand its 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 matures at the end of 2010, management is considering a recapitalization. The goal of any such recapitalization will be to stabilize the financial position of the Company, which management believes will improve the Company's prospects for a relationship with potential capital sources, assist FSC as it applies to enter other state markets and be an impetus to the growth of the Company's business. Any such recapitalization is expected 12 to involve the voluntary participation of the holders of Series B Preferred Stock, and no assurance can be given that a recapitalization will be accomplished. 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 until its capital and surplus reserves reach more substantial levels. And while growth of the FSC business continues to provide additional cash flow to the Company's other subsidiaries, Jacobs and Triangle Surety, it is anticipated that working capital deficiencies will continue and will need to be met either through the raising of additional capital or borrowings. However, there can be no assurance that additional capital (or debt financing) will be available when and to the extent required or, if available, on terms acceptable to the Company. Accordingly, concerns as to the Company's ability to continue as a going concern are substantial. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. COMPARISON OF RESULTS OF OPERATIONS FOR FISCAL 2009 WITH 2008 The Company experienced a loss (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) of $3,057,687 in fiscal 2009 as compared with a loss of $3,332,942 (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) in fiscal 2008. REVENUES Revenues in fiscal 2009 amounted to $1,194,077 as compared with $957,142 in fiscal 2008. The increase in revenues is largely attributable to new business acquired by FSC and increased investment holdings of FSC. Revenue from the investment management segment, net of advisory referral fees, was $233,298 in fiscal 2009 as compared with $262,806 in fiscal 2008, representing a decrease of $29,503. As investment advisory fees are based on the market value of assets under management, some fluctuation will occur due to overall market conditions. For the most part, however, such revenues will remain relatively constant from year to year with any large fluctuations being attributable to the growth or loss of assets under management. The decrease in revenues is primarily attributable to a decrease in advisory fees received from the J&C Fund resulting from a decline in assets under management. Revenue from the surety insurance segment, consisting of FSC and TSA, was $957,067 for fiscal 2009 as compared with $694,336 for fiscal 2008. Revenues attributable to the insurance segment are as follows: Year Ended May 31, 2009 2008 --------------- -------------- Premiums and commissions $ 660,222 $ 465,286 Net investment income 288,747 225,461 Net realized investment gains 8,098 3,589 --------------- -------------- Total $ 957,067 $ 694,336 =============== ============== 13 Premium revenue is recognized ratably over the term of the policy period and thus is relatively stable from period to period with fluctuations for comparable periods generally reflecting the overall growth or loss of business. Whereas, commission revenue, which is dependent on the timing of issuance or renewal of bonds, is expected to be somewhat more "seasonable" from quarter-to-quarter with fluctuations for comparable periods largely reflecting the overall growth or loss of business. Investment income is expected to remain relatively consistent from period to period, but can fluctuate based on interest rates, market conditions, growth or loss of business, and investment funds expended in the payment of claims. The increase in revenues reflected above is attributable to increased surety business that has been secured in fiscal 2009. However, net premium written (written premium less deductions for ceded reinsurance) in fiscal 2009 amounted to $813,345 as compared with $586,498 in fiscal 2008, and is more reflective of the growth experienced in this segment of the business for the comparable periods. Commission income earned for the placement of bonds with outside insurers has remained relatively stagnant. Additionally, during fiscal 2009, in conjunction with the increased surety business written, proceeds amounting to $259,000 from the sale of Series A preferred stock were contributed to the surplus and capital of FSC. $176,000 in proceeds have been collected but not yet contributed to the surplus and capital of FSC. FSC's investment holdings in fiscal 2009 averaged $5.986 million as compared with $4.553 million for fiscal 2008, with investment yields remaining relatively unchanged at just below 5.00%. 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 since its acquisition in December 2005. Incurred policy losses for fiscal 2009 have been recorded as $186,007 or 28.5% of earned premium as compared to $135,867 or 30.0% of earned premium for fiscal 2008. IBNR loss estimates have been based on industry averages adjusted for factors that are unique to the FSC's underwriting approach. FSC has experienced no claims for losses as of May 31, 2009. 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 2009 such costs amounted to $153,263 or 23.5% of earned premium as compared with $126,386 or 27.9% in fiscal 2008. General and administrative expenses for fiscal 2009 were $1,564,224 as compared with $2,037,178 for fiscal 2008, representing a decrease of $472,954 and are comprised of the following: 14
Year Ended May 31, 2009 2008 DIFFERENCE ---------------- ----------------- ---------------- Salaries and related costs $ 550,646 $ 727,219 $ (176,573) General office expense 103,830 111,739 (7,909) Legal and other professional fees 486,878 804,512 (317,634) Audit, accounting and related services 126,359 118,595 7,764 Travel, meals and entertainment 58,589 73,668 (15,079) Other general and administrative 237,922 201,445 36,477 ---------------- ----------------- ---------------- Total general and administrative $ 1,564,224 $ 2,037,178 $ (472,954) ================ ================= ================
Salaries and related costs, net of deferred internal policy acquisition costs, decreased approximately $176,573 and are comprised of the following:
Year Ended May 31, 2009 2008 DIFFERENCE ------------------ ------------------ --------------- Salaries and wages $ 528,699 $ 567,522 $ (38,823) Commissions 26,131 37,147 (11,016) Payroll taxes 45,262 47,107 (1,845) Stock option expense 11,462 98,972 (87,510) Fringe benefits 63,531 61,764 1,767 Key-man life insurance 57,522 42,863 14,659 Deferred policy acquisition costs (181,961) (128,156) (53,805) ------------------ ------------------ --------------- Total salaries and related costs $ 550,646 $ 727,219 $(176,573) ================== ================== ===============
Decreases in salaries and wages relate to decreased staff and year-end bonuses paid to non-executive employees. The decrease in stock option expense is attributable to non-uniform vesting schedules under which options vest for certain key employees as well as the expiration of options for employees terminated in 2009. Group health benefits remained consistent with the previous year, but were offset by an increase in the Company's group life insurance cost of approximately $2,000. The increase in key-man life insurance is attributable to the increased debt the Company has incurred. In fiscal 2009, legal and professional fees of approximately $486,900 included approximately $305,500 relating to the Company's on-going efforts to raise additional capital for the expansion of the surety business into other states. Other less significant increases and decreases were experienced in audit, travel and other general administrative expenses categories in fiscal 2009 as compared to fiscal 2008. Jacobs & Co. is the investment advisor to the J&C Fund. While the Fund is responsible for its own operating expenses, Jacobs & Co., as the advisor, has agreed to limit the Fund's aggregate annual operating expenses to 2.00% of the average net assets. Under this expense limitation agreement, Jacobs & Co. absorbed $122,758 of the Fund's operating expenses in fiscal 2009 as compared to $157,269 in fiscal 2008. As the Fund grows in size of assets under management, expenses (in excess of the 2% level) absorbed by Jacobs & Co. will decrease 15 until the Fund reaches sufficient size to support its on-going operating costs. In contrast, as the Fund grows in size, revenues from investment advisory fees will increase. Additionally, should the Fund's operating expense ratio fall below the 2.00% level, the costs absorbed by the Company are reimbursable to it for a period of up to three years. In fiscal 2009, the Fund's investment advisory and distribution fee revenue amounted to $24,143 as compared to $39,535 in fiscal 2008. The Fund's average assets under management declined from approximately $3.25 million in fiscal 2008 to approximately $1.95 million in fiscal 2009. As of May 31, 2009, assets under management were approximately $1.81 million. The Fund was initially established by Jacobs to provide the ability to manage funds for smaller accounts in a more efficient and diversified manner than could be achieved on an individual account basis. Additionally, the Fund provided an investment vehicle that would fit within the Company's broader business plan of issuing smaller bonds under its collateralized surety programs. While the Fund's lackluster performance has contributed to its gradual decline in size, and the maintenance of the Fund continues to be a significant cost to the Company, it remains a key component in the Company's broader business plan. Moreover, if successful in these broader efforts, the opportunity exists to significantly increase the assets under management within the Fund. Should the Company be successful in increasing the size of the Fund to such a level that the Fund's operating expense ratio falls below the 2.00% level, the costs absorbed by Jacobs & Co. are currently reimbursable to it for a period of up to three years. Management continually evaluates the cost/benefit of maintaining the Fund. GAIN ON EXTINGUISHMENT OF DEBT The Company had been delinquent in paying certain of its payroll tax obligations for periods ending on or before December 31, 2005. In fiscal 2008, the Company entered into negotiations for the repayment and settlement of this obligation with the Internal Revenue Service. In conjunction with such negotiations, the Company made payments of approximately $402,000 towards the tax and interest portion of this obligation and requested abatement of all penalties relating to this matter. In February 2008, the Company received notification from the Internal Revenue Service granting its request for abatement of penalty with respect to this matter. Accordingly, the Company recognized a gain of $115,470 upon final settlement of this matter. INTEREST EXPENSE AND INTEREST INCOME Interest expense for fiscal 2009 was $605,045 as compared with $479,295 in fiscal 2008. The increase in interest expense is primarily attributable to the additional borrowings under the bridge-financing arrangement undertaken by the Company beginning in September 2007. Components of interest expense are comprised of the following: 16
Year Ended May 31, 2009 2008 DIFFERENCE ------------------ ------------------ ----------------- Interest expense on bridge financing $ 349,016 $ 170,931 $ 178,085 Expense of common shares issued or to be issued in connection with bridge financing arrangements 149,738 238,943 (89,205) Expense of common shares issued or to be issued in connection with issued debt 14,733 - 14,733 Interest expense on demand and term notes 77,460 47,920 29,540 Interest expense accrued on debt obligations subsequently settled and recorded as gain on debt extinguishment - 13,075 (13,075) Other finance charges 14,098 8,426 5,672 ------------------ ------------------ ------------------- Total interest expense $ 605,045 $ 479,295 $ 125,750 ================== ================== ===================
Interest income for fiscal 2009 was $4,819 as compared with $10,137 for fiscal 2008. Interest income for fiscal 2009 and 2008 is primarily related to the investment of the unexpended proceeds from the bridge-financing arrangement in short-term investment accounts PREFERRED STOCK ACCRETION AND DIVIDENDS Accretion of mandatorily redeemable convertible preferred stock is comprised of accretion of discount, accrued but unpaid dividends on preferred stock and amounts by which the redemption price exceeded the carrying value of redeemed shares of Series B preferred stock as follows: Year Ended May 31, 2009 2008 ----------------- ---------------- Accretion of discount $ 567,811 $ 529,273 Accrued dividends 1,041,499 942,044 Excess redemption price - - ----------------- ---------------- $ 1,609,310 $ 1,471,317 ================= ================ 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. 17 Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As the Registrant qualifies as a small reporting company as defined by ss.229.10(f)(1) of Regulation S-K, the Registrant is not required to provide the information required by this item. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are included herein in response to Item 8: Page -------------------- Table of Contents F-1 Report of Independent Registered Public Accounting Firm F-2 FINANCIAL STATEMENTS Consolidated Balance Sheets F-3 Consolidated Statements of Operations F-4 Consolidated Statements of Comprehensive Income (Loss) F-5 Consolidated Statements of Cash Flows F-6 Consolidated Statements of Mandatorily Redeemable Preferred Stock and Stockholders' Equity (Deficit) F-7 Notes to Consolidated Financial Statements F-8 SCHEDULES SCHEDULES Schedule I - Summary of Investments - Other than Investments in Related Parties F-45 Schedule II - Condensed Financial Information of Registrant F-46 Schedule III - Supplementary Insurance Information F-48 Schedule IV - Supplemental Insurance Information - Reinsurance F-49 Schedule VI - Supplemental Information F-50
18 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE In connection with the audits for the years ended May 31, 2009 and May 31, 2008, 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, 2009. Disclosure controls and procedures are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time frames specified in SEC rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures. During the evaluation of disclosure controls and procedures as of May 31, 2009, control deficiencies were identified that constitute a material weakness in internal control over financial reporting. Such control deficiencies relate to inadequate segregation of duties, lack of effective board of directors oversight, 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, 2009, JFG's disclosure controls and procedures were ineffective. Upon identification of the material weaknesses and under the direction of the Chief Executive Officer and Chief Financial Officer, JFG developed a plan to remediate the material weaknesses within the constraints of the Company's limited financial resources and the size of its accounting staff. Effective July 1, 2008, management implemented changes in the processing of transactions to remediate the inadequate segregation of duties weakness previously identified. Additionally, management identified steps to be implemented at both management and the board of directors' level to increase the effectiveness of review as it relates to the financial reporting process. Such changes were implemented during the first fiscal quarter of the Company's 2008-2009 fiscal year. Management continues to monitor changes made in fiscal 2008 and 2009 and will continue to implement improvements. Other 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, 2009 and 2008, and the results of its operations and cash flows for the years ended May 31, 2009 and 2008 in conformity with U.S. generally accepted accounting principals (GAAP). 19 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, 2009. 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, 2009. 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, 2009. Such control deficiencies relate to inadequate segregation of duties, lack of effective board of directors oversight, 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. Effective July 1, 2008, management implemented changes in the processing of transactions to remediate the inadequate segregation of duties weakness. Additionally, management identified steps to be implemented at both management and the board of directors' level to increase the effectiveness of review as it relates to the financial reporting process. Such changes were implemented during the first fiscal quarter of the Company's 2008-2009 fiscal year. Other changes are to be considered as additional financial resources and accounting staff become available. Management believes that the successful implementation of these changes will strengthen overall controls over financial reporting, 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 temporary 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 20 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 55 President and CEO/CFO Director Frederick E. Ferguson 75 Director C. David Thomas 56 Director Robert J. Kenney 62 Vice President JOHN M. JACOBS Mr. Jacobs is the founder of Jacobs & Co., an independent SEC registered investment advisor, a Certified Public Accountant, and is licensed as a property and casualty insurance agent in fifteen (15) states. Mr. Jacobs has served as a Director and President of both Jacobs & Co. and FS Investments, Inc. since their inception. Prior to establishing Jacobs & Co., in 1988, Mr. Jacobs was a practicing public accountant for over thirteen years, during which he was a managing partner of his accounting firm and a business and personal advisor to his clients. Mr. Jacobs has served as a director and President of JFG since May 2001. FREDERICK E. FERGUSON Mr. Ferguson is retired coal operator who has a diverse experience with respect to business and the coal industry. Mr. Ferguson spent the first half of his career as a state and federal mine inspector. During the later half of his career, Mr. Ferguson owned his own coal company and was involved in all facets of mining production. 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. C. DAVID THOMAS Mr. Thomas is a licensed resident insurance agent in West Virginia and holds non-resident agent licenses in several other states. Mr. Thomas began his surety career in 1976 with United States Fidelity and Guaranty Company and served as the surety underwriter in the Charleston, WV branch office until 1979. At that time he joined George Friedlander & Company, a regional insurance agency based in Charleston, WV, where he presently serves as Vice President and Manager of the Surety Department. Mr. Thomas is a shareholder and Director of George Friedlander & Company. He has served as a Director of FS Investments, Inc. since its inception in December 1997, and has served as a director of JFG since July 2002. 21 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. Previously, Mr. Kenney served as Senior Vice President of Triangle Surety Agency, Inc. In addition, he is a licensed resident insurance agent in West Virginia and also holds Series 63 and 65 securities licenses. Prior to joining Triangle Surety and Jacobs & Co., Mr. Kenney had over 20 years experience in the oil and gas industry with Columbia Energy Group. With Columbia, Mr. Kenney held various positions in Treasury, Human Resources, and Law Departments and served as both Manager of Risk Management and Special Projects Manager. There are no family relationships among any of the Company's directors and executive officers. During the past five years, there have been no filings of petitions under federal bankruptcy laws, or any state insolvency laws, by or against any business of which any director or executive officer of the Company was a general partner or executive officer at the time or within two years before the time of such filing. During the past five years, no director or executive officer of the Company has been convicted in a criminal proceeding or been subject to a pending criminal proceeding. During the past five years, no director or executive officer of the Company has been the subject of any order, judgment, or decree, not subsequently reversed, suspended or vacated by a court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities. During the past five years, no director or executive officer of the Company has been found by a court of competent jurisdiction (in a civil action), the Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law. COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT During the most recent fiscal year, the Company is not aware of any director, officer or beneficial owner of more than 10 percent of the Company's common stock at any time during the fiscal year that failed to file on a timely basis reports required by Section 16(a) of the Exchange Act. 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: 22 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 November 2004 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, 2009 and 2008 to the Principal Executive Officer and the two most highly compensated executive officers of the Company (the "Named Executive Officers").
------------------ ------- -------------- --------- ----------- -------------- ----------------- ------------------- ALL NAMES AND STOCK OPTION OTHER PRINCIPAL SALARY BONUS AWARDS AWARDS COMPENSATION TOTAL POSITION YEAR ($) ($) ($) ($) (1) ($) (2) ($) ------------------ ------- -------------- --------- ----------- -------------- ----------------- ------------------- John M. Jacobs, 2009 $150,000 - - $ 10,731 $ 23,235 $183,966 CEO 2008 $150,000 $ 49,164 $ 25,913 $225,077 ------------------ ------- -------------- --------- ----------- -------------- ----------------- ------------------- Robert J. 2009 $ 75,000 - - $ 6,336 - $ 81,336 Kenney, VP 2008 $ 75,000 $ 15,840 $ 90,840 ------------------ ------- -------------- --------- ----------- -------------- ----------------- -------------------
(1) On May 25, 2006, the compensation committee of the board of directors awarded 12,500,000, and 5,000,000 of incentive stock options to acquire common shares at an exercise price of seven cents ($.07) 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 expires in May 2011. 23 ------------------------- ------------------------------------------------- Vesting date Incentive Stock Option Awards ------------------------- ---------------------- ------------------------- John M. Jacobs Robert J. Kenney ------------------------- ---------------------- ------------------------- May 25, 2006 2,500,000 2,000,000 ------------------------- ---------------------- ------------------------- January 1, 2007 2,500,000 ------------------------- ---------------------- ------------------------- May 25, 2007 1,000,000 ------------------------- ---------------------- ------------------------- January 1, 2008 2,500,000 ------------------------- ---------------------- ------------------------- May 25, 2008 1,000,000 ------------------------- ---------------------- ------------------------- January 1, 2009 2,500,000 ------------------------- ---------------------- ------------------------- May 25, 2009 1,000,000 ------------------------- ---------------------- ------------------------- January 1, 2010 2,500,000 ------------------------- ---------------------- ------------------------- 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, 2009.
---------------- ----------------------------------------------------------------------------------- OPTION AWARDS ---------------- ---------------- ----------------- ----------------- -------------- --------------- EQUITY NUMBER OF INCENTIVE PLAN NUMBER OF SECURITIES AWARDS; NUMBER SECURITIES UNDERLYING OF SECURITIES UNDERLYING UNEXERCISED UNDERLYING UNEXERCISED OPTIONS (#) UNEXERCISED OPTION OPTIONS (#) UNEXERCISABLE UNEARNED EXERCISE OPTION NAME EXERCISABLE OPTIONS (#) PRICE ($) EXPIRATION DATE ---------------- ---------------- ----------------- ----------------- -------------- --------------- John M. 10,000,000 2,500,000 - $.07 05/25/2011 Jacobs, CEO ---------------- ---------------- ----------------- ----------------- -------------- --------------- Robert J. 5,000,000 - - $.07 05/25/2011 Kenney, VP ---------------- ---------------- ----------------- ----------------- -------------- ---------------
OTHER EXECUTIVE COMPENSATION PLANS The Company has no plans that provide for the payment of retirement benefits, or benefits that will be paid primarily following retirement, including but not limited to tax-qualified defined benefit plans, supplemental executive retirement plans, tax-qualified defined contribution plans and nonqualified defined contribution plans. 24 The Company has no contract, agreement, plan or arrangement, whether written or unwritten, that provides for payment(s) to a named executive officer at, following, or in connection with the resignation, retirement or other termination of a named executive officer, or a change in control of the Company or a change in the named executive officer's responsibilities following a change in control. DIRECTOR COMPENSATION The following table sets forth compensation received by our directors for the fiscal year ended May 31, 2009. --------------------------- ---------------------------------------- ----------- NAME FEES EARNED OR PAID IN CASH ($) (1) TOTAL ($) --------------------------- ---------------------------------------- ----------- Frederick E. Ferguson $750 $750 --------------------------- ---------------------------------------- ----------- C. David Thomas $750 $750 --------------------------- ---------------------------------------- ----------- Non-employee board members of JFG's wholly-owned subsidiary First Surety Corporation, which include JFG board members, are compensated at the rate of $150 per meeting. 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 August 22, 2008 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. 25
---------------------------------- ------------------------------- ------------------------------- ------------------------------- Amount and Nature of Name and Address of Beneficial Ownership (1) Percent of Title of Class Beneficial Owner Class (2) ---------------------------------- ------------------------------- ------------------------------- ------------------------------- MORE THAN 5.00% BENEFICIAL OWNERSHIP John M. Jacobs 300 Summers St. Suite 970 Common Charleston, WV 285301 28,956,405 (3) 15.57% Charles L. Stout Route 1, Box 41J Common Bridgeport, WV 26330 13,175,000 (4) 7.08% Fay S. Alexander 6318 Timarron Cove Lane Common Burke, VA 22015-4073 13,256,041 (5) 7.13% William D. Jones 513 Georgia Avenue Common Chattanooga, TN 37403 10,827,694 (6) 5.82% Sue C. Hunt 1508 Viewmont Drive Common Charleston, WV 25302 8,611,589 (7) 5.18% DIRECTORS AND NAMED EXECUTIVE OFFICERS John M. Jacobs 300 Summers St. Suite 970 Common Charleston, WV 285301 28,956,405 (3) 15.57% Frederick E. Ferguson Route 3, Box 408 Common Fayetteville, WV 25840 1,600,000 (8) * C. David Thomas P. O., Box 5157 Common Charleston, WV 25361 992,295 * Robert J. Kenney 809 Sherwood Drive Common Charleston, WV 25314 6,920,000 (9) 3.72% ALL DIRECTORS AND EXECUTIVE Common OFFICERS AS A GROUP 38,468,700 20.68%
* 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 26 power with respect to securities. Shares of common stock issuable upon the exercise of options or warrants currently exercisable within 60 days of August 18, 2009 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 186,028,413 shares of common stock issued and outstanding as of August 18, 2009. (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 5,271,694 shares held in joint tenancy with spouse, Kathleen M. Jacobs. Includes 7,500,000 in vested options to purchase Company stock exercisable within 60 days of August 18, 2009. Includes the right to convert Series B Preferred Stock holdings to 666,667 shares of common stock exercisable within 60 days of August 18, 2009. John M. Jacobs is the CEO and also a member of the board of directors for the Registrant. (4) Includes 25,000 shares of common stock held in the name of Applied Mechanics Corporation of which Charles L. Stout is President and a director, 12,150,000 shares held in joint tenancy with spouse, Marilyn J. Stout, and 1,000,000 shares beneficially owned by members of the immediate family. (5) Includes 9,900,000 shares of common stock held in the name of Graphite Investment, LLC ("Graphite") and 1,000,000 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 18, 2009. Includes 214,700 shares held in joint tenancy with spouse, Dan C. Alexander. (6) Includes 9,060,000 shares of common stock held in joint tenancy with spouse, Cynthia B. Jones. Includes the right to convert Series B Preferred Stock holdings to 282,116 shares of common stock (182,116 in joint tenancy with spouse) exercisable within 60 days of August 18, 2009. Includes the right to purchase 1,410,578 shares of common stock (910,578 in joint tenancy with spouse) pursuant to issued and outstanding stock warrants at an exercise price of one-tenth of one cent per share ("stock warrants") exercisable within 60 days of August 18, 2009. (7) Includes 2,243,302 shares of common stock held in the Individual Retirement Account ("IRA") of spouse, Douglas E. Hunt. Includes the right to convert Series B Preferred Stock holdings to 200,000 shares of common stock and the right to purchase 1,000,000 shares of common stock pursuant to issued and outstanding stock warrants exercisable within 60 days of August 18, 2009 and held in the IRA of Douglas E. Hunt. Includes the right to convert Series B Preferred Stock holdings to 33,679 shares of common stock and the right to purchase 168,395 shares of common stock pursuant to issued and outstanding stock warrants exercisable within 60 days of August 18, 2009 and held jointly with spouse. 27 (8) Includes 750,000 shares of common stock held in joint tenancy with spouse, Sandra B. Ferguson. Includes 130,000 shares held in the name of The Party Store, Inc. ("Party Store") of which Fred E. Ferguson is President and a director. Includes the right to convert Series B Preferred Stock holdings held in the name Party Store to 120,000 shares of common stock exercisable within 60 days of August 18, 2009. Includes the right to purchase 600,000 shares of common stock pursuant to issued and outstanding stock warrants held in the name of Party Store exercisable within 60 days of August 18, 2009. (9) 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 6,000,000 in vested options to purchase Company stock exercisable within 60 days of August 18, 2009. In accordance with the terms of the bridge-financing arrangement as set forth in Note H of the Audited Financial Statements contained in Item 8. of Part II herein, in the event that a qualified financing (as defined in said Note H) is not completed and such bridge-financing is extended to March 2012 for repayment, one of the participants providing part of the bridge-financing would acquire common shares of the Registrant through such arrangement equal to 10.96% of the common shares then outstanding. For each six-month period thereafter, such holdings would be increased by 1.40% and if extended to maturity (September 2013), such holdings would amount to 14.15%. 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. At the beginning of fiscal 2008, the balance due Mr. Jacobs from the Company was $15,763. During fiscal 2008, advances to the Company from Mr. Jacobs amounted to $132,200 and repayments to Mr. Jacobs amounted to $146,963. As of May 31, 2008, the balance due Mr. Jacobs was $1,000. The largest aggregate amount outstanding to Mr. Jacobs in fiscal 2008 was $127,200. Interest paid on such obligations to Mr. Jacobs in fiscal 2008 amounted to $1,387. 28 During fiscal 2009, advances to the Company from Mr. Jacobs amounted to $437,388 and repayments to Mr. Jacobs amounted to $454,777. As of May 31, 2009, the balance due to Mr. Jacobs from the Company was $2,281. The largest aggregate amount outstanding to Mr. Jacobs in fiscal 2009was $294,546. The rate of interest on such amounts due from and obligations due to Mr. Jacobs was 12% for both the 2008 and 2009 fiscal years. As of September 10, 2009, $27,806 was owed by the Company to Mr. Jacobs. DIRECTOR'S INDEPENDENCE The board of directors ("Board") is comprised of three members, John M. Jacobs, Frederick E. Ferguson and C. David Thomas. Only Mr. John M. Jacobs, who serves as Chief Executive Officer for the Company, is not independent within the meaning of The Nasdaq Stock Market, Inc. listing standards. There were no transactions, relationships or arrangements that were considered by the Board of Directors in determining that Mr. Ferguson or Mr. Thomas were independent. 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-QSB, and services provided by the accountant in connection with statutory and regulatory filings for the year ended May 31, 2009 amounted to $89,098. 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-QSB, and services provided by the accountant in connection with statutory and regulatory filings for the year ended May 31, 2008 amounted to $70,173. AUDIT-RELATED SERVICES There were no 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 years ended May 31, 2009 and 2008. FEES FOR TAX PREPARATION SERVICES During fiscal 2009, billings for tax preparation services were $10,666. During fiscal 2008, billings for tax preparation services were $12,584 29 ALL OTHER FEES Billings for other services related to potential financing transactions in amounted to $4,863 and $11,708 in fiscal 2009 and 2008 respectively. Billings for professional services related to the audit of the acquisition target, RSH Holdings, Inc. amounted to $21,659 during fiscal 2008. 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, with the exception of the billings for other services related to potential financing transactions amounting to $4,863 in fiscal 2009 which were approved by the Board of Directors prior to the completion of the audit for fiscal 2009 as provided by Rule 2-01(c)(7)(i)(C)(3) of Regulation S-X. 30 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 SCHEDULES Schedule I - Summary of Investments - Other than Investments in Related Parties F-45 Schedule II - Condensed Financial Information of Registrant F-46 Schedule III - Supplementary Insurance Information F-48 Schedule IV - Supplemental Insurance Information - Reinsurance F-49 Schedule VI - Supplemental Information F-50
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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-45 Schedule II - Condensed Financial Information of Registrant F-46 Schedule III - Supplementary Insurance Information F-48 Schedule IV - Supplemental Insurance Information - Reinsurance F-49 Schedule VI - Supplemental Information F-50
F-1 Report of Independent Registered Public Accounting Firm To the Board of Directors Jacobs Financial Group, Inc. Charleston, West Virginia We have audited the accompanying consolidated balance sheets of Jacobs Financial Group, Inc. and subsidiaries (the "Company") as of May 31, 2009 and 2008, and the related consolidated statements of operations, comprehensive income (loss), cash flows, and mandatorily redeemable preferred stock and stockholders' equity (deficit) for each of the years in the two-year period ended May 31, 2009. Our audits also included the financial statement schedules listed in the Index as Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of May 31, 2009 and 2008, and the results of its operations and its cash flows for each of the years in the two-year period ended May 31, 2009 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statement taken as a whole, present fairly, in all material respects, the information set forth therein. The accompanying consolidated financial statements have been prepared assuming that the company will continue as a going concern. As discussed in Note A to the financial statements, the company's significant net working capital deficit and operating losses raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/Malin, Bergquist & Company, LLP ----------------------------- Malin, Bergquist & Company, LLP Pittsburgh, PA September 14, 2009 F-2 JACOBS FINANCIAL GROUP, INC. CONSOLIDATED CONDENSED BALANCE SHEETS
MAY 31, 2009 MAY 31, 2008 --------------- --------------- ASSETS INVESTMENTS AND CASH: Bonds available for sale, at market value $ 908,766 $ 105,866 (amortized cost - 05/31/09 $866,855; 05/31/08 $98,774) Mortgage-back securities held to maturity, at amortized costs 5,085,300 3,826,688 (market value - 05/31/09 $5,157,936; 05/31/08 $3,800,909) Short-term investments, at cost (approximates market value) 387,753 1,176,056 Cash 80,038 48,640 --------------- --------------- TOTAL INVESTMENTS AND CASH 6,461,857 5,157,250 Investment income due and accrued 28,124 19,892 Premiums and other accounts receivable 61,184 47,353 Prepaid reinsurance premium 87,114 - Deferred policy acquisition costs 143,173 75,940 Furniture and equipment, net of accumulated depreciation of $133,493 and $120,931, respectively 23,169 29,168 Other assets 43,517 298,163 Intangible assets 150,000 150,000 --------------- --------------- TOTAL ASSETS $ 6,998,138 $ 5,777,766 =============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Reserve for losses and loss expenses $ 432,658 $ 246,651 Reserve for unearned premiums 530,795 277,208 Accrued expenses and professional fees payable 470,099 367,464 Accounts payable 268,066 299,585 Related party payable 75,009 60,567 Demand note payable to related party 3,081 1,000 Notes payable 4,049,791 2,967,016 Accrued interest payable 303,914 71,483 Ceded reinsurance payable 92,173 - Other liabilities 78,470 16,402 --------------- --------------- TOTAL LIABILITIES 6,304,056 4,307,376 SERIES A PREFERRED STOCK, $.0001 par value per share; 1 million shares authorized; 2,665 and 2,230 shares issued and outstanding at May 31, 2009 and May 31, 2008, respectively; stated liquidation value of $1,000 per share 2,860,670 2,308,933 SERIES B PREFERRED STOCK, $.0001 par value per share; 9,941.341 shares authorized; 9,621.940 shares issued and outstanding at May 31, 2009 and May 31, 2008; stated liquidation value of $1,000 per share 11,429,440 9,936,866 --------------- --------------- TOTAL MANDATORILY REDEEMABLE PREFERRED STOCK 14,290,110 12,245,799 COMMITMENTS AND CONTINGENCIES (SEE NOTES) STOCKHOLDERS' EQUITY (DEFICIT) Common stock, $.0001 par value per share; 490 million shares authorized; 179,682,912 and 166,091,242 shares issued and outstanding at May 31, 2009 and May 31, 2008, respectively 17,968 16,609 Additional paid in capital 2,626,236 2,423,537 Accumulated deficit (16,279,725) (13,222,038) Accumulated other comprehensive income (loss) 39,493 6,483 --------------- --------------- TOTAL STOCKHOLDERS' EQUITY (DEFICIT) (13,596,028) (10,775,409) --------------- --------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) $ 6,998,138 $ 5,777,766 =============== ===============
See accompanying notes. F-3 JACOBS FINANCIAL GROUP, INC, CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED MAY 31, -------------------------------- 2009 2008 ------------- ------------- REVENUES: Investment advisory services $ 233,298 $ 262,806 Insurance premiums and commissions 660,222 465,286 Net investment income 288,747 225,461 Net realized investment gains (losses) 8,098 3,589 Other income 3,712 - ------------- ------------- TOTAL REVENUES 1,194,077 957,142 EXPENSES: Incurred policy losses 186,007 135,867 Insurance policy acquisition costs 152,964 126,386 General and administrative 1,564,224 2,037,178 Mutual fund costs 122,758 157,269 Depreciation 12,562 8,379 ------------- ------------- TOTAL EXPENSES 2,038,515 2,465,079 ------------- ------------- NET INCOME (LOSS) FROM OPERATIONS (844,438) (1,507,937) Gain on debt extinguishment - 115,470 Interest expense (605,045) (479,295) Interest income 1,107 10,137 ------------- ------------- NET INCOME (LOSS) (1,448,376) (1,861,625) Accretion of Mandatorily Redeemable Convertible Preferred Stock, including accrued dividends (1,609,311) (1,471,317) ------------- ------------- NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (3,057,687) $(3,332,942) ============= ============= BASIC AND DILUTIVE NET INCOME (LOSS) PER SHARE: NET INCOME (LOSS) PER SHARE $ (0.02) $ (0.02) ============= ============= WEIGHTED-AVERAGE SHARES OUTSTANDING 173,788,315 159,130,160 ============= =============
The accompanying notes are an integral part of these consolidated financial statements F-4 JACOBS FINANCIAL GROUP, INC, CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEAR MONTHS ENDED MAY 31 -------------------------------- 2009 2008 --------------- --------------- COMPREHENSIVE INCOME (LOSS): Net income (loss) attributable to common stockholders $ (3,057,687) $ (3,332,942) OTHER COMPREHENSIVE INCOME (LOSS): Net unrealized gain (loss) of available-for-sale investments arising during period 41,108 7,318 Reclassification adjustment for realized (gain) loss included in net income (8,098) (835) --------------- --------------- Net unrealized gain (loss) attributable to available-for-sale investments recognized in other comprehensive income 33,010 6,483 --------------- --------------- COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDERS $ (3,024,677) $ (3,326,459) --------------- ---------------
See accompanying notes. F-5 JACOBS FINANCIAL GROUP, INC, CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS
YEAR ENDED MAY 31 ------------------------------ 2009 2008 -------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES Net Income (Loss) $ (1,448,376) $(1,861,625) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Unearned premium 166,473 5,986 Stock option expense 11,451 98,972 Stock issued (or to be issued) in connection with financing arrangements 192,607 242,003 Provision for loss reserves 186,007 135,867 Amortization of premium 44,286 23,496 Depreciation 12,562 8,379 Write off of bad debts - 985 Premium and other receivables (13,831) (9,670) Accretion of discount (13,072) (11,565) Investment income due and accrued (7,770) 15,858 Realized (gain) loss on sale of securities (12,511) (3,589) Deferred policy acquisition costs (67,233) (23,575) (Gain) on extinguishment of debt - (115,470) Loss on disposal of furniture and equipment - 684 Change in operating assets and liabilities: Other assets 252,837 (125,531) Related party accounts payable 14,442 60,567 Accounts payable and cash overdraft (31,519) (46,310) Accrued expenses and other liabilities 489,307 (504,992) -------------- -------------- NET CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES (224,340) (2,109,530) CASH FLOWS FROM INVESTING ACTIVITIES Short-term loan - (50,000) Repayment of short-term loan - 50,000 (Increase) decrease in short-term investments 788,303 (835,305) Cost of bonds acquired (356,101) (97,582) Costs of mortgaged-backed securities acquired (2,851,803) (2,956,145) Purchase of equity securities - (25,438) Sale of securities held to maturity - 169,330 Sale of securities available for sale 107,639 - Escrow deposits for pending acquisitions - (125,000) Redemption of available for sale securities upon call 20,000 - Repayment of mortgage-backed securities 1,034,407 476,400 Redemption of bonds upon call or at maturity - 2,155,000 Purchase of furniture and equipment (6,563) (14,603) -------------- -------------- NET CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES (1,264,118) (1,253,343) CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from related party debt 456,858 132,200 Repayment of related party debt (454,777) (146,963) Proceeds from borrowings 1,402,500 2,842,000 Repayment of borrowings (319,725) (269,357) Proceeds from issuance of Series A preferred stock 435,000 803,000 Proceeds from issuance of Series B preferred stock - 25,000 Proceeds from exercise of common stock warrants - 335 -------------- -------------- NET CASH FLOWS FROM FINANCING ACTIVITIES 1,519,856 3,386,215 NET INCREASE (DECREASE) IN CASH 31,398 23,342 CASH AT BEGINNING OF PERIOD 48,640 25,298 -------------- -------------- CASH AT END OF PERIOD $ 80,038 $ 48,640 ============== ============== SUPPLEMENTAL DISCLOSURES Interest paid $ 181,037 $ 171,889 Income taxes paid - - Non-cash investing and financing transaction: Additional consideration paid for issuance of debt 192,607 - Reclassification of bonds held-to-maturity to bonds available for sale - -
See accompanying notes. F-6
JACOBS FINANCIAL GROUP, INC. CONSOLIDATED STATEMENT OF MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEAR ENDED MAY 31, 2008 ------------------------------------------------------------------- STOCKHOLDERS' EQUITY (DEFICIT) ------------------------------------------------------------------- ACCUM. SERIES B OTHER SERIES A MANDATORILY REDEEMABLE COMPRE- MANDATORILY REDEEMABLE CONVERTIBLE ADDITIONAL HENSIVE PREFERRED STOCK PREFERRED STOCK PAID-IN ACCUMULATED INCOME SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT (LOSS) TOTAL ------ ----------- --------- ---------- ----------- ------- ---------- ------------ ------ ------------ BALANCE, MAY 31, 2007 1,427 $ 1,420,913 9,596.940 $8,526,059 156,997,836 $15,700 $2,082,647 $(9,889,098) $ - $(7,790,751) Issuance of Series A and B Preferred Stock and common stock 803 803,000 25.000 24,510 25,000 2 488 - - 490 Issuance of common stock as additional consideration for financing arrange- ments - - - - 8,735,304 874 223,330 - - 224,204 Issuance of common stock upon exercise of warrants - - - - 333,102 34 301 - - 335 Accretion of mandatorily redeemable convertible preferred stock - 16,045 - 513,228 - - - (529,273) - (529,273) Accrued dividends of mandatorily redeemable convertible preferred stock - 68,975 - 873,069 - - - (942,044) - (942,044) Expense of common shares to be issued in connection with financing arrangements - - - - - - 17,799 - - 17,799 Common stock option expense - - - - - - 98,972 - - 98,972 Unrealized net gain on available for sale securities - - - - - - - - 6,483 6,483 Net income (loss), year ended May 31, 2008 - - - - - - - (1,861,624) - (1,861,624) ------ ----------- --------- ---------- ----------- ------- ---------- ------------- ------ ------------- BALANCE, MAY 31, 2008 2,230 $ 2,308,933 9,621.940 $9,936,866 166,091,242 $16,610 $2,423,537 $(13,222,039) $6,483 $(10,775,409) ------ ----------- --------- ---------- ----------- ------- ---------- ------------- ------ ------------- ------------------------------------------- -------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. F-7 JACOBS FINANCIAL GROUP, INC. CONSOLIDATED STATEMENT OF MANDATORILY REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEAR ENDED MAY 31, 2009
---------------------------------------------------------------------- STOCKHOLDERS' EQUITY (DEFICIT) ---------------------------------------------------------------------- SERIES A SERIES B MANDATORILY REDEEMABLE MANDATORILY REDEEMABLE ACCUMULATED CONVERTIBLE ADDITIONAL OTHER PREFERRED STOCK PREFERRED STOCK PAID-IN ACCUMULATED COMPREHENSIVE SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT INCOME TOTAL (LOSS) ---------------------------------------------- ---------------------------------------------------------------------- -------- ----------- --------- ----------- ----------- ------- ----------- ------------- ------- ------------- BALANCE, MAY 31, 2008 2,230 $ 2,308,933 9,621.940 $ 9,936,866 166,091,242 $16,610 $ 2,423,537 $(13,222,039) $ 6,483 $(10,775,409) Issuance of Series A 435 435,000 - - - - - - - - and B Preferred Stock and common stock Issuance of common stock - - - - 13,591,670 1,358 104,684 - - 106,042 stock as additional consideration for financing arrangement Less expense previously recognized - - - - - - (38,958) - - (38,958) Accretion of mandatorily redeemable convertible preferred stock - 16,939 - 550,874 - - - (567,812) - (567,812) Accrued dividends of mandatorily redeemable convertible preferred stock - 99,798 - 941,700 - - - (1,041,498) - (1,041,498) Expense of common shares to be issued in connection with financing arrangements - - - - - - 125,511 - - 125,511 Common stock option expense - - - - - - 11,462 - - 11,462 Unrealized net gain on available for sale securities - - - - - - - - 33,010 33,010 Net income (loss), year ended May 31, 2009 - - - - - - - (1,448,376) - (1,448,376) -------- ----------- --------- ----------- ----------- ------- ----------- ------------- ------- ------------- BALANCE, MAY 31, 2009 2,665 $ 2,860,670 9,621.940 $11,429,440 179,682,912 $17,968 $ 2,626,236 $(16,279,725) $39,493 $(13,596,028) ---------------------------------------------- ----------------------------------------------------------------------
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 incurred losses (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) of approximately $3,058,000 and $3,333,000 for the years ended May 31, 2009 and 2008. Losses are expected to continue until FSC develops substantial 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. F-9 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Jacobs Financial Group, Inc. and its majority owned subsidiaries, after the elimination of intercompany transactions. USE OF ESTIMATES Preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant areas requiring the use of management estimates are loss reserves, stock options and the valuation of deferred tax benefits. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. REVENUE RECOGNITION Fees for investment advisory services are based on an agreed percentage of the value of client assets under management and are accrued monthly based on the market value of client assets. Surety premiums are recorded as receivables when due and are earned pro rata over the term of the policies. Thereserve 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 representrenewal premiums paid in advance of the effective renewal date. F-10 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 is 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 carried at current market values, with changes in market value being recorded in current operations. Debt and equity securities that the Company may not have a positive intent to hold until maturity and not classified as trading, are considered to be available for sale and carried at current market values, with unrealized gains and losses reflected as a separate component of other comprehensive income in consolidated shareholders' equity currently. 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. F-11 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Realized gains and losses are determined by specific identification of the security sold. ALLOWANCE FOR UNCOLLECTIBLE PREMIUM AND OTHER RECEIVABLES The majority of our fee revenue is generated by services provided to companies and individuals throughout the Eastern United States. We evaluate the need for a reserve for the amount of these receivables that may be uncollectible, based on historical collection activity adjusted for current conditions. Premium and other receivables are charged-off when deemed uncollectible. Based on this evaluation, management believes that substantially all accounts receivable are collectible, and therefore has not established an allowance for estimated uncollectible accounts. IMPAIRMENT We evaluate long-lived assets for impairment annually, or whenever events or changes in circumstances indicate that the assets may not be recoverable. The impairment is measured by discounting estimated future cash flows expected to be generated, and comparing this amount to the carrying value of the asset. Cash flows are calculated utilizing forecasts and projections and estimated lives of the assets being analyzed. Should actual results differ from those forecasted and projected, we are subject to future impairment charges related to these long-lived assets. FURNITURE AND EQUIPMENT Furniture and equipment is recorded at cost. Maintenance and repairs are charged to operations when incurred. When property and equipment are sold or disposed of, the asset account and related accumulated depreciation account are relieved, and any gain or loss is included in operations. The cost of property and equipment is depreciated over the estimated useful lives of the related assets, ranging from three to seven years, using the straight-line and double-declining balance methods, which approximates estimated economic depreciation. F-12 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 recommended by SFAS No. 123R, Accounting for Stock-based Compensation. The fair value of stock options is estimated at the grant date using the Black Scholes Option Pricing Model. This model requires the input of a number of assumptions, including expected dividend yields, expected stock price risk- free interest rates, and an expected life of the options. Although the assumptions used reflect management's best estimate, they involve inherent uncertainties based on market conditions generally outside the control of the Company. If future market conditions are different than the assumptions used, stock-based compensation expense could be significantly different. INCOME TAXES We currently have net operating loss ("NOL") carry-forwards that can be utilized to offset future income for federal and state tax purposes. These NOLs generate a significant deferred tax asset. However, we have recorded a valuation allowance against this deferred tax asset as we have determined that it is more likely than not that we will not be able to fully utilize the NOLs. Should our assumptions regarding the utilization of these NOLs change, we may reduce some or all of this valuation allowance, which would result in the recording of a deferred income tax benefit. EARNINGS (LOSS) PER SHARE Basic earnings (loss) per share of common stock are computed using the weighted average number of shares outstanding during each period. Diluted earnings per share are computed on the basis of the average number of common shares outstanding plus the dilutive effect of convertible debt, stock options and warrants. In periods of net loss, there are no diluted earnings per share since the result would be anti-dilutive. F-13 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS RECLASSIFICATIONS Certain amounts in the 2008 Consolidated Financial Statements have been reclassified to be consistent with the presentation in the Consolidated Financial Statements as of May 31, 2009 and for the year then ended. These reclassifications had no impact on previously reported net income, cash flow from operations or changes in shareholder equity. RECENT ACCOUNTING PRONOUNCEMENTS In December 2007, the FASB issued a revised Statement No. 141 (revised 2007) "Business Combinations" and Statement No. 160 "Non-controlling Interests in Consolidated Financial Statements - an amendment of Accounting Research Bulletin No. 51". Statement No. 141 was revised to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial report about a business combination and its effects. The Statement establishes principles and requirements for how the acquirer: a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. While the Statement retains the fundamental requirement that the acquisition or purchase method of accounting be used for all business combinations, it replaces the cost-allocation process that resulted in not recognizing some assets and liabilities at the acquisition date and measuring some assets and liabilities at amounts other than fair market value at the acquisition date. Among other matters, the revised Statement requires that acquisition-related and restructuring costs be recognized separately from the business combination as expenses in the periods in which the costs are incurred and provides that "bargain purchases" (those business combinations in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any non-controlling, or minority, interest in the acquiree) be recognized in the earnings of the acquirer as a gain. This Statement applies prospectively to business combinations for which the F-14 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited. Application of FAS 141R would be effective for any acquisitions that are consummated by the Company after May 31, 2009. Statement No. 160 was issued to improve the relevance, comparability, and transparency of financial information for the reporting entity by establishing accounting and reporting standards attributable to noncontrolling, or minority, interests in subsidiaries included in the reporting entity's consolidated financial statements. This Statement clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and requires consolidated net income to be reported at amounts that include amounts attributable to both the parent and the noncontrolling interest. The Statement also provides a single method for accounting for changes in the parent's ownership interest in a subsidiary that does not result in deconsolidation, as well as recognition of gain or loss when a subsidiary is deconsolidated as a result of an ownership change in which the parent ceases to have a controlling financial interest in the subsidiary, and expanded disclosures to clearly identify and distinguish between the interests of the parent's owners and the interests of the noncontrolling owners of a subsidiary. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. This Statement shall be applied prospectively as of the beginning of the fiscal year in which this Statement is initially applied, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. Management does not expect the application of Statement No. 160 to have a material impact on the Company's results of operations or financialposition. In March 2008, the FASB issued Statement No. 161 "Disclosures about Derivative Instruments and Hedging Activities--an amendment of FASB Statement No. 133". This Statement changes the disclosure requirements for derivative instruments and hedging activities in order to provide improved transparency of financial reporting with respect to derivative instruments and hedging activities. This .Statement is effective for financial statements issued for fiscal years and interim periods F-15 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS beginning after November 15, 2008, with early adoption encouraged. The Company does not currently employ the use of derivative instruments or engage in hedging activities and thus the issuance of this Statement is not expected to have any impact on the Company's current financial statement disclosure requirements. In May 2008, the FASB issued Statement No. 163 "Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60". This Statement clarifies how Statement No. 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. A financial guarantee insurance contract within the scope of this Statement generally insures investment securities in the form of municipal bonds or asset-backed securities. FASB's intent in setting the scope of this Statement was to address the narrow issue relating to those contracts for which diversity existed in the accounting for claim losses. This Statement is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years, except for some disclosures about the insurance enterprise's risk management activities, which are effective for the first interim period after issuance to the Statement. Except for those disclosures, earlier application is not permitted. Management does not expect the application of Statement No. 163 to have a material impact on the Company's results of operations or financial position. In June 2009, the Financial Accounting Standards Board ("FASB") issued SFAS No. 168, "The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles - A Replacement of FASB Statement No. 162." This SFAS establishes the FASB Accounting Standards Codification as the single source of authoritative US generally accepted accounting principles. SFAS No. 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. Management does not expect the application of Statement No. 163 to have a material impact on the Company's results of operations or financial position. In June 2009, the FASB issued SFAS No. 167, "Amendments to FASB Interpretation No. 46(R)." This statement changes how a reporting entity determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. New disclosures will be required regarding involvement with variable interest entities and any significant changes in risk exposure due to that involvement. SFAS No. 167 will be effective for F-16 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the start of the first fiscal year beginning after November 15, 2009 (June 1, 2010 for the Company). This SFAS is not expected to have a material impact on the Company's financial statements. In June 2009, the FASB issued SFAS No. 166, "Accounting for Transfers of Financial Assets." This is a revision to SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," and will require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a "qualifying special-purpose entity," and changes the requirements for derecognizing financial assets, and requires additional disclosures. SFAS No. 166 will be effective for the start of the first fiscal year beginning after November 15, 2009 (June 1, 2009 for the Company). This SFAS is not expected to have a material impact on the Company's financial statements. In May 2009, the FASB issued SFAS No. 165, "Subsequent Events." This statement establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS No. 165 is effective for interim and annual financial periods ending after June 15, 2009, and shall be applied prospectively. In April 2009, the FASB issued FASB Staff Position ("FSP") FAS 157-4, "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly." This FSP provides additional clarification on the determination of fair value, including illustrative examples. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. This FSP did not have a material impact on the Company's financial statements. In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, "Recognition and Presentation of Other-Than-Temporary Impairments." This FSP provides guidance on determining whether an impairment is other than temporary, provides examples to be considered and identifies reporting requirements related to such impairments. FSP FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March F-17 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 15, 2009. This FSP did not have a material impact on the Company's financial statements. In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "Interim Disclosures about Fair Value of Financial Instruments." This FSP requires disclosure about the fair value of financial instruments whenever summarized financial information for interim periods is issued, and requires disclosure of the fair value of all financial instruments (where practicable) in the body or accompanying notes of interim and annual financial statements. FSP FAS 107-1 and APB 28-1 is effective for interim periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. In April 2009, the FASB issued FSP FAS 141(R)-1, "Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies." This FSP requires that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value if fair value can be reasonably estimated, and eliminates the requirement to disclose an estimate of the range of outcomes of recognized contingencies at the acquisition date. This FSP is effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. In December 2008, the FASB issued FSP 132(R)-1, "Employers' Disclosure about Postretirement Benefit Plan Assets." This FSP provides guidance on an employer's disclosures regarding plan assets of a defined benefit pension or other postretirement plan. The objectives of the disclosures required under this FSP are to provide users of financial statements with an understanding of: a) How investment allocation decisions are made; b) The major categories of plan assets; c) The inputs and valuation techniques used to measure the fair value of plan assets; d) The effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period; and e) Significant concentrations of risk within plan assets. The disclosures about plan assets required by this FSP are required for fiscal years ending after December 15, 2009, and earlier application is permitted. F-18 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In April 2008, the FASB issued FSP 142-3, "Determination of the Useful Life of Intangible Assets." This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, "Goodwill and Other Intangible Assets." The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R), "Business Combinations," and other U.S. generally accepted accounting principles. FSP 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. 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, 2009:
Gross Unrealized Gross Unrealized Amortized Cost Gains Losses Fair Market Value ---------------------- ---------------------- ---------------------- ---------------------- State and municipal $ 352,816 $ 28,570 $ - $ 381,386 securities Equity securities 10,280 - 2,418 7,862 Mortgage Backed Securities $ 514,039 $ 13,342 $ - $ 527,381 ---------------------- ---------------------- ---------------------- ---------------------- $ 877,135 $ 41,912 $ 2,418 $ 916,629 ====================== ====================== ====================== ======================
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, 2008:
Gross Unrealized Gross Unrealized Amortized Cost Gains Losses Fair Market Value ---------------------- ---------------------- ---------------------- ---------------------- State and municipal $ 98,774 $ 7,092 $ - $ 105,866 securities Equity securities 25,438 - 609 24,829 ---------------------- ---------------------- ---------------------- ---------------------- $ 124,212 $ 7,092 $ 609 $ 130,695 ====================== ====================== ====================== ======================
In September, 2007, an equity investment in the amount of $25,000 was made in the Jacobs & Company Mutual Fund by its investment advisor, Jacobs & Company, and is recorded in other assets at market value. Dividends paid by the Fund at calendar year-end were reinvested. In March 2009, $15,412 of the equity investment was sold for $11,000 resulting in a loss of $4,413. F-19 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company held the following investments, by security type, with the positive intent and ability to hold to maturity:
MAY 31, 2009 ------------------------------------------------------------------------------------------- Amortized Cost Gross Unrealized Gross Unrealized Fair Market Value Gains Losses ---------------------- ---------------------- ---------------------- ---------------------- U.S Government agency $ 5,085,300 $ 79,739 $ 7,103 $ 5,157,936 mortgage-backed securities ====================== ====================== ====================== ======================
MAY 31, 2008 ------------------------------------------------------------------------------------------- Amortized Cost Gross Unrealized Gross Unrealized Fair Market Value Gains Losses ---------------------- ---------------------- ---------------------- ---------------------- U.S Government agency $ 3,826,688 $ 23,206 $ 48,985 $ 3,800,909 mortgage-backed securities ====================== ====================== ====================== ======================
Invested assets are exposed to various risks, such as interest rate, market and credit risks. Due to the level of risk associated with certain of these invested assets and the level of uncertainty related to changes in the value of these assets, it is possible that changes in risks in the near term may significantly affect the amounts reported in the Consolidated Condensed Balance Sheets and Statements of Income. 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. F-20 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. Assets measured at fair value on a recurring basis are summarized below:
May 31, 2009 --------------------------------------------------------------------- Fair Value Measurements Using Assets At Level 1 Level 2 Level 3 Fair Value ----------------- ---------------- ----------------- ---------------- Assets: Fixed income securities at fair value $ - $908,766 $ - $ 908,766 Equity securities at fair value 7,862 - - 7,862 Short-term investments at fair value 387,753 - - 387,753 ----------------- ---------------- ----------------- ---------------- Total Assets $ 395,615 $908,766 $ - $1,304,381
The Company had no assets or liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at either the adoption of SFAS 157 on June 1, 2008 or at May 31, 2009. F-21 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Statutory deposits consisting of securities with a carrying value of $1,056,245 were deposited by the Company's insurance subsidiary under requirements of regulatory authority. 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 $ 6,440,387 and $ 5,142,101 as of May 31, 2009 and 2008, respectively, are restricted to the use of FSC. The amortized cost and estimated market values of investments with fixed- maturities available-for-sale as of May 31, 2009, by contractual maturity, are as follows: Amortized Cost Fair Market Value ---------------------- ------------------- Due after ten years $ 352,816 $ 381,386 ====================== =================== Principal repayments on U.S. government agency mortgaged-backed securities held by the Company as of May 31, 2009 are estimated as follows: Amortized Cost Fair Market Value ----------------- ------------------ Due in one year or less $1,098,337 $1,112,857 Due after one year through five years 2,284,503 2,320,319 Due after five years through ten years 1,051,586 1,069,507 Due after ten years 650,874 655,253 ----------------- ------------------ $ 5,085,300 $ 5,157,936 ================= ================== Estimated repayments are forecast based on varying prepayment speeds for each particular security held assuming that interest rates remain constant. Expected repayments will differ from actual repayments because borrowers of the underlying mortgages have a right to prepay obligations. An analysis of net investment income follows: 2009 2008 -------------- ------------------ Bonds - fixed maturities $ 15,006 $ 76,185 Mortgage-backed securities 267,993 111,115 Short-term investments 7,842 39,377 -------------- ------------------ 290,841 226,677 Total investment income -------------- ------------------ Investment expense 2,094 1,216 -------------- ------------------ Net investment income $288,747 $225,461 ============== ================== In the three-month period ended November 30, 2007, the Company sold one of its investments in debt securities of Federal National Mortgage Association ("FNMA" or "Fannie Mae") previously classified as held-to-maturity (carrying value of $169,881) and reclassified its remaining FNMA securities aggregating $828,653 to the available-for-sale classification in response to uncertainties attributable to the slumping U.S. mortgage and housing markets and its potential effect on the issuer's financial condition. Such remaining FNMA securities, which were subject to call by the issuer, were called in the three-month period ended February 29, 2008. F-22 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Realized gains from held-to-maturity securities resulted from certain securities subject to call being called by the issuer.Net realized investment gains (losses) were as follows: 2009 2008 ---------------- -------------- Bonds-fixed maturities $ - $ 2,754 Mortgage-backed securities (46) - Equity securities - - Short-term investments - - ----------------- ------------- Net realized gain $ (46) $ 2,754 ================ ============== The increases (decrease) in unrealized appreciation of investments were as follows: 2009 2008 --------------- --------------- Bonds-fixed maturities $ 21,478 $ 15,964 Mortgage-backed securities 111,757 (23,732) Equity securities (1,810) (609) --------------- --------------- Increase (decrease) in unrealized appreciation $ 131,425 $ (8,377) =============== =============== The gross gains and gross losses realized on available-for-sale securities were as follows: Gross Gross Gross Realized Realized Proceeds Gains Losses ------------ ------------- --------------- 2009 Bonds-fixed maturities $ 107,639 $ 12,577 $ - Mortgage-backed securities - - - Equity securities 11,000 - (4,413) ------------ ------------- --------------- Total $ 118,639 $ 12,577 $ (4,413) ============ ============= =============== F-23 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2008 Bonds-fixed maturities $ 830,000 $ 835 $ - Mortgage-backed securities - - - Equity securities - - - ------------ ------------- -------------- Total $ 830,000 $ 835 $ - ============ ============= ============== 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, 2009 and May 31, 2008.
Less than 12 Months 12 Months or More Total ------------------------------- ---------------------------- -------------------------------- Cost Unrealized Cost Unrealized Fair Unrealized (a) Losses (a) Losses Value Losses --------------- --------------- ------------ --------------- --------------- ---------------- 2009 Mortgage-backed securities $ 686,543 $ 7,103 $ - $ - $ 679,440 $ 7,103 Equity - - 10,290 2,418 7,861 2,418 --------------- --------------- ------------ --------------- --------------- ---------------- Total $ 686,543 $ 7,103 $ 10,290 $ 2,418 $ 687,301 $ 9,521 =============== =============== ============ =============== =============== ================ 2008 Mortgage-backed securities $2,525,173 $48,985 $ - $ - $ 2,476,188 $ 48,985 Equity securities 25,438 609 - - 24,829 609 --------------- --------------- ------------ --------------- --------------- ---------------- Total $2,550,611 $ 49,594 $ - $ - $ 2,501,217 $ 49,594 =============== =============== ============ =============== =============== ================
(a) For bonds-fixed maturities and mortgage-backed securities, represents amortized costs. As of May 31, 2009, the company held 3 mortgage-backed securities with gross unrealized losses of $7,103, all of which have been in a continuous loss position for less than 12 months. These securities consist of fixed-rate securities issued by Government National Mortgage Association (GNMA) that are sensitive to movements in market interest rates. The unrealized losses are considered temporary since the Company has the ability and intent to hold the securities until maturity. F-24 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity securities consist of the company's investment in the Jacobs & Company Mutual Fund with an unrealized loss of $2,418 which has been in a continuous loss position for more than 12 months. The fair value of such investment will fluctuate based on the underlying values of the investments held within the mutual fund, which are sensitive to overall economic market conditions. Accordingly, the unrealized loss was considered temporary at May 31, 2009 and has not been reduced to their fair value through the income statement. 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. 2009 2008 ------------------ ------------------ Balance at beginning of year $ 75,940 $ 52,365 Acquisition costs deferred 220,496 149,961 Amortization charged to operations (153,263) (126,386) ------------------ ------------------ Total $ 143,173 $ 75,940 ================== ================== NOTE E - OTHER ASSETS Included in other assets are escrow deposits relating to pending acquisitions and advance deposits for professional fees relating to such acquisitions and certain equity financing matters (see Note P-Commitments) the Company has endeavored to undertake in fiscal 2009. As of May 31, 2009 and 2008, such balances are comprised of the following: 2009 2008 ------------- ---------- Advance deposits for professional fees $ 1,311 $ 133,498 Escrow deposits for proposed acquisitions - 125,000 Mutual fund investment at market 7,862 24,829 Prepaid expense and other deposits 34,344 14,836 ------------- ---------- Total $ 43,517 $ 298,163 ============= ========== F-25 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE F - INTANGIBLES As the result of the acquisition of the stock of FSC on December 30, 2005, in exchange for the purchase price of $2,900,000, the Company received cash and investments held by FSC with a fair market value of $2,750,000, with the difference of $150,000 being attributed to the property and casualty licenses of FSC in the states of West Virginia, Ohio and Indiana. Such licenses have indefinite lives and are evaluated annually, or more frequently if circumstances indicate that a possible impairment has occurred, for recoverability and possible impairment loss. No impairment has been recorded in fiscal years ended May 31, 2009 and 2008. 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, 2009, the Company's insurance subsidiary, FSC, is only licensed to write surety in West Virginia and Ohio and has focused its primary efforts towards coal permit bonds while also providing other miscellaneous surety bonds that are substantially secured by collateral consisting of investment accounts that are managed by Jacobs. Reclamation of land that has been disturbed by mining operations is highly regulated by federal and state agencies and the required bonds are generally long-term in nature with mining operations and reclamation work being conducted in unison as the property is being mined. Additionally, no two principals or properties are alike due to varied company structures and unique geography and geology of each site. In underwriting such bonds, management obtains estimates of costs to reclaim the properties subject of the permit(s) in accordance with those mining permit(s), as prepared by independent outside professionals experienced in this field of work, and hired by FSC, in addition to other underwriting and financial risk considerations. FSC requires the principal to provide collateral in amounts deemed to be sufficient to reclaim the disturbed land and thus mitigate the exposure to significant loss. Such collateral 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, 2009 and thus provisions for losses and loss adjustment expense have been based on industry averages adjusted for other factors unique to the Company's approach, and in consultation with consulting actuaries experienced in the surety field. F-26 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At May 31, the reserve for losses and loss expenses consisted of: 2009 2008 -------------- ------------ Balance at beginning of year $ 246,651 $ 110,784 Incurred policy losses-current year 186,007 135,867 Incurred policy losses-prior year - Amounts paid-current year losses - - Amounts paid-prior year losses - - -------------- ------------ Balance at end of year $ 432,658 $ 246,651 ============== ============ NOTE H - NOTES PAYABLE At May 31, 2009 and 2008, the Company had the following unsecured notes payable to individuals and a commercial bank:
2009 2008 ------------- -------------- Unsecured demand notes payable to individuals and others; interest rate fixed @ 10.00% $ 380,000 $ 127,000 Unsecured short-term advances from principal shareholder and chief executive officer; interest rate fixed @ 12.00% (Also See Note T - Related Party Transactions) 3,081 1,000 Unsecured note(s)payable to individual(s) under a bridge- financing arrangement described below 3,500,000 2,635,000 Unsecured term note payable to commercial bank in the original amount of $250,000 and payable in equal monthly payments of $5,738; interest rate fixed @ 13.25% maturing January 31, 2012 169,791 205,016 ------------- -------------- Total $ 4,052,872 $ 2,968,016 ============= ==============
F-27 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In September 2007, the Company borrowed $2,100,000 in the aggregate from a group of individuals to provide interim bridge-financing of operations until a larger, more permanent financing the Company endeavored to undertake was consummated and to pay fees and expenses in connection with the larger financing. Additionally, terms of the $25,000 note payable outstanding as of May 31, 2007 were modified to correspond to the terms of the $2,100,000 bridge-financing. Additional borrowings with similar terms were transacted in November 2007 in the amount of $275,000 and in February 2008 for $100,000. Such borrowings totaling $2,500,000 are referred to as the "first round" bridge financing. Additional borrowings in the amount of $75,000, $60,000 and $865,000 were transacted in April, May and June 2008, respectively, in conjunction with additional bridge- financing (referred to as "second round" bridge-financing in the aggregate amount of $1,000,000) that was finalized July 2, 2008. Terms of the bridge-financing arrangements were amended (first round) and structured (second round) to provide similar terms and conditions. The terms of the cumulative $3,500,0000 bridge-financing arrangement, as revised, 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 if such a qualified equity offering was not consummated by September 10, 2008, accrued interest-to-date became payable, with quarterly installments of principal and interest in the aggregate amount of $169,028 ($224,515 based on the full $3.5 million bridge-financing) commencing December 2008. The interest rates on such notes are fixed at 10.00%. In accordance with the terms of the first round bridge-financing, 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 received 2.00% of the Company's common shares. Upon retirement of the notes upon 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 noteholder's 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 F-28 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS upon each six-month anniversary date thereof until retirement of the notes. On September 10, 2008 and March 10, 2009, 4,870,449 and 5,010,640 common shares, respectively, were issued to those noteholders. 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. The Company asked the Holders to forbear from exercising their rights and remedies arising from the Acknowledged Events of Default and reached agreement subsequent to May 31, 2009. The Holders agreed that the Company may satisfy its obligation to make the Initial Amortization Payments by making 8 consecutive quarterly payments of $67,185 each, commencing September 10, 2009, and within a 14 day grace period after the same, and continuing on the payment dates (and 14 day grace periods) prescribed by the Amortization Schedule for the Promissory Notes and ending on June 10, 2011 (collectively, the "PAYMENTS"), it being understood that the Payments shall result in the payment of the principal of and interest on the unpaid portion of the Initial Amortization Payments at the rate of 10% per annum from and after the originally scheduled payment dates. The Payments shall be allocated among and paid to the Holders in accordance with the balances due to each. The Company may at any time prepay the balance remaining due with respect to the principal of the Initial Amortization Payments by paying the amount thereof, together with interest accrued through the date of such prepayment. Scheduled maturities and principal payments for each of the next five years are as follows: 2009 ------------- Fiscal year 2009-2010 (including demand notes) $ 1,028,539 Fiscal year 2010-2011 958,809 Fiscal year 2011-2012 832,668 Fiscal year 2012-2013 801,035 Fiscal year 2013-2014 431,821 Fiscal year 2014-2015 - -------------- Total $ 4,052,872 ============== F-29 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE I - OTHER LIABILITIES The Company had been delinquent in paying certain of its payroll tax obligations for periods ending on or before December 31, 2005. The Company's accrued liability, including estimates for penalties and interest, approximated $517,600 of which $500,625 was recorded as of May 31, 2007. In September, 2007, the Company entered into negotiations for the repayment and settlement of this obligation with the Internal Revenue Service. In conjunction with such negotiations, the Company made payments of approximately $402,130 towards the tax and interest due and requested abatement of all penalties relating to this matter. In February 2008, the Company received notification from the Internal Revenue Service granting its request for abatement of penalty with respect to this matter. Accordingly, in fiscal 2008 the Company recognized a gain of $115,470 upon final settlement of this matter. NOTE J - 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 the 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 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-30 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, 2009, the Company has issued 2,665 shares of Series A Preferred Stock in exchange for cash investments in the amount of $2,665,000, of which 435 shares were issued in fiscal 2009 and 803 shares were issued in fiscal 2008. As of May 31, 2009 the Company has chosen to defer payment of dividends on the Series A Preferred Stock with such accrued and unpaid dividends amounting to $224,437 through May 31, 2009. On December 30, 2005, through a private placement, the Company issued 3,980 shares of 8% Non-Voting Series B Convertible Preferred Stock (Series B Preferred Stock), along with 19,900,000 warrants for common shares of Company stock as additional consideration, for a cash investment in the amount of $2,985,000; and issued 4,890.599 shares of Series B Preferred Stock, along with 24,452,996 warrants for common shares of Company stock as additional consideration, for a conversion of $3,667,949 of indebtedness of the Company, in connection with the 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 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 nonassessable 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. During fiscal year 2008, 25 shares of Series B Preferred Stock and 25,000 shares of the Company's common stock were issued as additional consideration, in exchange for cash investments of $25,000. As of May 31, 2009 the Company has chosen to defer payment of dividends on the Series B Preferred Stock with such accrued and unpaid dividends amounting to $2,767,946 through May 31, 2009. F-31 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Management consulted Statement of Financial Accounting Standards (SFAS) Number 133, "Accounting for Derivative Instruments and Hedging Activity", Emerging Issues Task Force (EITF) Number 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock", and SFAS 150, "Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity" in evaluating the accounting for preferred securities. Management determined that SFAS 150 is the appropriate accounting literature. SFAS 150 requires that an entity classify as liabilities certain financial instruments with characteristics of both liabilities and equity. SFAS 150 applies to certain freestanding financial instruments that embody an obligation for the entity that may require the entity to issue shares, redeem or repurchase its shares. The Company's Series A and B preferred stock each have mandatory redemption features that subject the Company to the analysis of equity versus liability. In accordance with SFAS 150, both Series A and B have features that embody a conditional obligation to redeem the instrument upon events not certain to occur and accordingly, are not classified as liabilities until such events are certain to occur. With respect to the Series A Preferred Stock, such condition is contingent upon the holder having no further need for surety bonds issued by the Company's insurance subsidiary (FSC) under its partially collateralized bonding programs and, having no such surety bonds then outstanding. With respect to the Series B Preferred Stock, in accordance with SFAS 150, if the stock provides an option to the holder to convert to common shares at a rate equivalent to fair value, then the financial instruments are not mandatorily redeemable during the period in which the holder can convert the shares into common shares. Accordingly, the Company has determined that both the Series A and B preferred stocks should not be classified as liabilities. However, in accordance with Securities and Exchange Commission (SEC) Issued Topic No. D- 98, SEC Staff Announcement, "Classification and Measurement of Redeemable Securities", a company that issues preferred shares that are conditionally redeemable (i.e., the shares are not within the scope of SFAS 150 because there is no unconditional obligation to redeem the shares at a specified or determinable date or upon an event certain to occur) is required to account for the conditionally redeemable preferred shares in accordance with Accounting Series Release 268, which states that the shares are to be reflected on the company's balance sheet between total liabilities and stockholders' equity as temporary equity. NOTE K - STOCK WARRANTS At May 31, 2009, the Company had issued and outstanding warrants to purchase 13,071,564 shares of common stock. F-32 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 of which 13,071,564 remain outstanding. The exercise price of the warrants is one-tenth of one cent ($.001) per share. The warrants expire on December 30, 2010. 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 $449,972. NOTE L-STOCK-BASED COMPENSATION On October 12, 2005, the board of directors adopted its 2005 Stock Incentive Plan (the "Plan") to allow the Company to make awards of stock options as part of the Company's compensation to key employees, non-employee directors, contractors and consultants. The Plan was approved by the stockholders on December 8, 2005. The aggregate number of shares of Common Stock issuable under all awards under the Plan is 35,000,000. No awards may be granted under the Plan after December 8, 2015. On May 25, 2006, the compensation committee of the board of directors awarded 23,400,000 of incentive stock options to acquire common shares at an exercise price of seven cents ($.07) per share, of which 5,500,000 shares vested immediately and the remaining 17,900,000 options vesting over the next four years ending in May 2010. The term of the options is five years and expires in May 2011. As of May 31, 2009, the awarded options had been reduced to 21,300,000 due to changes in employment status for two employees. Subsequent to May 31, 2009, 1,500,000 vested options expired, leaving 19,800,000 options awarded, of which 17,300,000 are vested. On December 28, 2006, the compensation committee of the board of directors awarded 2,100,000 of incentive stock options to acquire common shares at an exercise price of four cents ($.04) per share, of which 450,000 shares vested immediately and the remaining 1,650,000 options vesting over the next three years ending in December 2009. The term of the options is five years and expires in December 2011. As of May 31, 2009, the awarded options had been reduced to 1,800,000 due to changes in employment status. As of May 31, 2009, 1,550,000 in options have vested. Subsequent to May 31, 2009, on June 30, 2009 the compensation committee of the board of directors awarded 10,000,000 of incentive stock options to acquire common shares at an exercise price of four cents ($.04) per share, of which 4,700,000 shares vested immediately and the remaining 5,300,000 options vesting over the next three years ending in June 2011. The term of the options is five years and expires in June 2014. The following table summarizes option activity under the Plan for the fiscal year ended May 31, 2009. F-33 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2009 ------------------------------------------------------------- Number Weighted-Avg. Weighted-Avg. Of Shares Remaining Aggregate Exercise Under Life Intrinsic Price Option (Years) Value -------------- ----------------- ----------- -------------- Balance at June 1, 2008 $ .06649 26,500,000 Options granted - - Options exercised - - Options canceled/expired .06625 2,400,000 -------------- ---------------- Balance, May 31, 2009 $ .06652 24,100,000 ============== ================ Exercisable at May 31, 2009 $ .06642 21,350,000 2.00 $ - ============== ================ Expected to vest $ .06727 2,750,000 2.04 $ - ============== ================
The following table summarizes activity and pricing information for the non- vested shares under the Plan for the year ended May 31, 2009. 2009 ------------------------------- Weighted-Average Number Grant Date Of Fair Value Non-vested Shares ---------------- -------------- Balance at June 1, 2008 $ .01804 8,916,666 Options granted - - Options vested .01804 ( 5,166,666) Options canceled/expired .01810 ( 1,000,000) ---------------- -------------- Balance at May 31, 2009 $ .01818 2,750,000 ================ ============== No options were granted in fiscal 2009 or 2008. There were no options exercised in fiscal 2009 or 2008. The total fair value of shares vested amounted to approximately $93,000 and $101,000 in fiscal 2009 and 2008 respectively. Stock-based compensation expense attributable to such awards amounted to approximately $11,000 and $99,000 in fiscal years ended May 31, 2009 and 2008 respectively. Unrecognized compensation expense related to non-vested awards at May 31, 2009 was approximately $8,200 and is expected to be recognized over the next year. The company estimates the fair value of stock options using a Black-Scholes valuation model, consistent with the provisions of SFAS 123R. Key inputs and assumptions used to estimate the fair value of stock options include the grant price of the award, the expected option term, volatility of the company's stock, the risk-free interest rate and the company's dividend yield. F-34 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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, 2009, the Company had operating loss carry forwards of approximately $15 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 $5.1 million tax benefit of the operating loss carry forward, by a valuation allowance of the same amount, because the likelihood of realization of the tax benefit cannot be determined. NOTE N-STOCKHOLDERS EQUITY In fiscal 2009, the Company issued 595,000 shares of the Company's common stock as additional consideration in connection with short-term and demand borrowing arrangements totaling $435,000. The shares were valued at approximately $.024761 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 $14,733. In fiscal 2009, the Company issued 3,115,581 shares of the Company's common stock in connection with the second round of bridge-financing arrangements (see Note H) totaling $940,000. The shares were valued at approximately $.009027 per share based on the average quoted closing price of the Company's stock for the 20-day period proceeding the date of the transaction and totaled $28,126. In fiscal 2009, the Company issued 5,010,640 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 $.004350 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 $21,796. In fiscal 2009, the Company issued 4,870,449 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 $.008498 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 $41,389. In fiscal 2008, the Company issued 25,000 of the Company's common stock as additional consideration in connection with the sale of 25 shares of Series B Preferred Stock, in exchange for a cash investment in the F-35 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS amount of $25,000. The shares were valued at approximately $.0196 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 $490. In fiscal 2008, the Company issued 270,000 shares of the Company's common stock as additional consideration in connection with short-term and demand borrowing arrangements totaling $145,000. The shares were valued at approximately $.0171 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 $4,610. In fiscal 2008, the Company issued 8,266,437 shares of the Company's common stock in connection with the first round of bridge-financing arrangements (see Note H) totaling $2,500,000. The shares were valued at approximately $.0263 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 $217,314. In fiscal 2008, the Company issued 198,867 shares of the Company's common stock in connection with the second round of bridge-financing arrangements (see Note H) totaling $60,000. The shares were valued at approximately $.0115 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 $2,280. 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, 2009 and 2008 and net income for the Company's insurance subsidiary the calendar year ended December 31, 2008 and 2007 and five-month periods ended May 31, 2009 and 2008 are as follows: F-36 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Statutory Surplus May 31, 2009 $ 5,439,269 Statutory Surplus May 31, 2008 4,564,352 Net Income Calendar year 2008 177,018 Net Income Calendar year 2007 54,173 Net Income Five-month period 2009 76,395 Net Income Five-month period 2008 108,957 Statutory surplus exceeds the minimum capital requirements provided by West Virginia state law of $2.0 million. Under the Consent Order issued by the Commissioner of the State of West Virginia for the acquisition of the insurance subsidiary by the Company, no dividends can be declared or paid from the insurance subsidiary without the prior written approval of the Insurance Commissioner. NOTE P - COMMITMENTS AND CONTINGENCIES ACQUISITION COMMITMENTS AND MATERIAL AGREEMENTS On December 3, 2007, the Company entered into an agreement (the "December 3 Agreement) with National Indemnity Company ("National Indemnity") to purchase all of the outstanding shares of Unione Italiana Insurance Company of America ("Unione") for a purchase price of $2.75 million plus the surplus of Unione on the date of the closing. Unione is a New York Corporation with insurance licenses in 26 states. Prior to closing, National Indemnity will enter into a reinsurance agreement with Unione under which National Indemnity will reinsure all liabilities of Unione under contracts of insurance and reinsurance arising prior to closing. Among other conditions, closing is subject to applicable regulatory approvals, including approval by the New York Superintendent of Insurance. Either party may terminate the December 3 Agreement if the closing does not take place on or prior to June 30, 2008. The Company has made a nonrefundable deposit (except for failure by National Indemnity or Unione to meet certain required conditions for closing) to National Indemnity in the amount of $75,000 which amount will be applied towards the purchase price at closing. On February 8, 2008, the Company entered into an agreement and plan of merger with Reclamation Surety Holding Company ("RSH") pursuant to which the Company will acquire by merger all of the business and assets of RSH, including the stock of its subsidiaries Cumberland Surety, Inc. and NewBridge Services, Inc. for a purchase price of $3,400,000, less certain indebtedness. The Company made a $50,000 deposit that was to be applied toward the purchase price. RSH and subsidiaries perform surety underwriting services and service surety bonding programs. The acquisition was expected to add a substantial depth of experience and expertise to the Company. F-37 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS On August 20, 2008, the Company entered into a stock purchase agreement with National Indemnity Company ("NICO"), pursuant to which the Company agreed to acquire all of the outstanding stock of Unione Italiana Reinsurance Company of America ("Unione"). Unione is a New York domiciled insurer licensed in 24 states and has license applications pending with the Commonwealth of Kentucky and with the Financial Management Service of the United States Department of Treasury. The purchase price for the acquisition of Unione (the "Transaction") is equal to the sum of (i) $2,750,000 plus (ii) an amount in cash equal to Unione's New York statutory policyholders' surplus as of the closing date of the transaction. The Company made a $75,000 deposit that was to be applied toward the purchase price. The Company's acquisition of Unione, when coupled with a reinsurance agreement with NICO that is to be executed simultaneously with closing, will consist of the purchase of marketable investments and insurance licenses and will not include any existing policies or customer base as the insurance lines of business offered by Unione are not insurance lines that the Company intends to pursue. The insurance licenses of Unione were expected to enable the Company to more rapidly enter and penetrate the various state markets that it has targeted in its business plan. The acquisition of Unione remains contingent upon necessary regulatory approvals, and both the acquisition of RSH and the acquisition of Unione were and are contingent upon the Company's obtaining necessary financing. Based on the dislocation in the capital markets that began in the fall of 2007 and has continued through the present, the Company has not been able to obtain the financing necessary to complete the acquisitions of RSH and Unione. Each acquisition agreement as become terminable by the parties by reason of the Company's inability to meet the financing conditions within the time frames provided in the acquisition agreements. The Company has released its $50,000 purchase money deposit to the shareholders of RSH. NICO continues to hold the Company's $75,000 deposit made with respect to the Unione acquisition. Neither agreement has been formally terminated. On February 8, 2008, the Company entered into an agreement (the "Merger Agreement") with Reclamation Surety Holding Company, Inc. ("RSH") to acquire by merger (the "Merger") all of the business and assets of RSH, including the stock of RSH's subsidiaries, Cumberland Surety, Inc. ("Cumberland") and NewBridge Services, Inc. ("NewBridge") for a purchase price of $3,400,000, less certain indebtedness of RSH (the "Merger Consideration"). The Merger Consideration is payable in stock of the Company or, at the election of certain non-employee shareholders, cash. Currently, NewBridge performs certain surety underwriting services for the Company's subsidiary, First Surety Corporation. Among other conditions, closing is subject to, and will take place following, the closing by the Company of an equity financing. Either party may terminate the Merger Agreement if the closing does not take place on or prior October 31, 2008. Upon execution of the Merger Agreement, the Company made a nonrefundable deposit in the amount of $50,000 for the benefit of the RSH shareholders, which amount will be applied toward the Merger Consideration at closing. F-38 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS LEASE COMMITMENTS The Company leases certain office equipment with combined monthly payments of approximately $840 that have varying remaining terms of less than five years. The Company leases office, parking and storage space under month-to-month lease arrangements that approximate $3,905 each month. The Company leases an apartment for corporate use that has a remaining term of 6 months at a monthly rate of $545.00 plus electric utilities. The Company holds an undeveloped leasehold interest in a mineral water spring located near Hot Springs, Arkansas. Under the leasehold arrangement, the Company makes minimum lease payments of $180 per month. The Company has options to extend the leasehold arrangement through October 2026 and also has a right to cancel the lease at any time upon sixty (60) days written notice. Rental expense for these lease commitments totaled approximately $66,092 and $65,650 during 2009 and 2008. Minimum future lease payments under non-cancelable operating leases having remaining terms in excess of one year as of May 31, 2009 are: Fiscal year 2009-2010 11,839 Fiscal year 2010-2011 6,944 Fiscal year 2011-2012 6,944 ------------ Total $ 25,727 ============ CONTINGENCIES On May 15, 2009, the Company sold shares of Series A Preferred Stock in conjunction with the sale of surety bonds. As of September 14th, the Company has not transferred the monies received from the sale of stock to FSC to be applied towards its surplus. The amount of Preferred A Stock was $176,000. Pursuant to the terms of the Consent Order dated December 23, 2005 (Consent Order) and the Amended Consent Order dated June 8, 2007 (Amended Consent Order), each with the West Virginia Insurance Commissioner (Commissioner) , all money received from the sale of Series A Preferred Stock shall be placed into the surplus accounts of FSC. The monies received from the above described transaction were not placed with FSC but were retained by the Company. This action is viewed by the Commissioner to be a violation of the Consent Order and Amended Consent Order. Under the terms of the Amended Consent Order any knowing or intentional violation of the conditions of the Order shall constitute grounds for the Commissioner to issue a Confidential Order immediately suspending FSC from doing business in West Virginia. FSC advised the Commissioner of this violation. Presently the Commissioner has advised FSC that no action will be taken by the Commissioner with respect to this violation. FSC has submitted a plan to correct this violation as expeditiously as possible, and the Company has agreed with this plan. F-39 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE Q - FINANCIAL INSTRUMENTS FAIR VALUE The following methods and assumptions were used to estimate fair market value of each class of financial instruments for which it is practicable to estimate that value: INVESTMENT SECURITIES Fair values for investment securities (U.S. Government, government agencies, government agency mortgage-backed securities, state and municipal securities, and equity securities) held for investment purposes (available-for-sale and held-to-maturity) 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, 2009 and 2008 are as follows:
2009 2008 ------------------------------------------------------------------------ Carrying Fair Carrying Fair Amount Value Amount Value ----------------- ------------------ ----------------- ----------------- ASSETS Bonds available for sale $ 908,766 $ 908,766 $ 105,866 $ 105,866 Mortgage-backed securities held to maturity 5,085,300 5,157,936 3,826,688 3,800,909 Cash and short-term investments 467,791 467,791 1,224,696 1,224,696 Premiums and other receivables 89,308 89,308 67,245 67,245 Equity securities (included in other assets) 7,862 7,862 24,829 24,829 LIABILITIES Notes payable 4,052,872 4,052,872 2,968,016 2,968,016 Accounts payable and advance premiums 268,066 268,066 299,585 299,585 Accrued expenses and other liabilities 1,019,665 1,019,665 515,916 515,916
F-40 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE R - OTHER RISKS, UNCERTAINTIES AND CONCENTRATIONS CONCENTRATION OF CREDIT RISK Statement of Financial Accounting Standards No. 105, "Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk", requires disclosure of significant concentration of credit risk regardless of the degree of such risk. As of May 31, 2009 the Company's investment securities of approximately $6,382,000 are solely comprised of mortgage-backed securities and defeased municipal bonds that are guaranteed by U.S government agencies, 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 four financial institutions, two for commercial banking services and the others for brokerage and custodial services. Periodically, the amount on deposit in financial institutions providing commercial banking services exceeds the $250,000 federally insured limit. Management believes these financial institutions are financially sound. With respect to the financial institutions providing brokerage and custodial services, amounts on deposit are invested in money market funds that invest principally in obligations issued by the U.S government, its agencies or instrumentalities. Management believes that substantially all receivables are collectible, and therefore has not established an allowance for estimated uncollectible accounts. CONCENTRATION IN PRODUCTS, MARKETS AND CUSTOMERS The Company's insurance subsidiary currently writes only the surety line of business, is licensed to write surety only in West Virginia and Ohio and has focused its primary efforts towards coal permit bonds. Such business, including investment advisory fees from managed collateral accounts, accounted for approximately 65% and 58% of the Company's fiscal 2009 and 2008 revenues, respectively. Furthermore, the Company provides surety bonds to companies that share common ownership interests that constitute 52% and 48% of the Company's fiscal 2009 and 2008 revenues, respectively, as follows:
2009 2008 ------------------------------------------------------------------------ Investment Investment Surety Advisory Surety Advisory Premium Fees Premium Fees ------------------ ----------------- ----------------- ----------------- Customer group # 1 $ 259,000 $ 71,000 $ 270,000 $ 80,000 Customer group # 2 248,000 40,000 96,000 11,000 ------------------ ----------------- ----------------- ----------------- TOTAL 507,000 111,000 366,000 91,000 ================== ================= ================= =================
F-41 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, 2009 MAY 31, 2008 ---------------- ------------------- ----------------- Investment advisory $ 232,853 $ 263,250 Surety insurance 961,480 694,336 Corporate 851 9,693 ------------------- ----------------- Total revenues $ 1,195,184 $ 967,279 =================== ================= OPERATING INCOME (LOSS): Investment advisory $ (136,830) $ (200,009) Surety insurance 313,556 92,368 Corporate (1,625,102) (1,753,984) ------------------- ----------------- Total operating income (loss) $ (1,448,376) $ (1,861,625) =================== ================= IDENTIFIABLE ASSETS: Investment advisory $ 49,752 $ 69,112 Surety insurance 6,828,127 5,420,727 Corporate 107,345 287,927 ------------------- ----------------- Total assets $ 6,985,224 $ 5,777,766 =================== ================= CAPITAL ACQUISITIONS: Investment advisory $ - $ - Surety insurance - 13,093 Corporate 6,563 1,510 ------------------- ----------------- Total capital acquisitions $ 6,563 $ 14,603 =================== ================= DEPRECIATION CHARGED TO IDENTIFIABLE ASSETS: Investment advisory $ 50 $ 45 Surety insurance 7,513 3,311 Corporate 4,999 5,023 ------------------- ----------------- Total Depreciation $ 12,562 $ 8,379 =================== ================= INTEREST EXPENSE: Investment advisory $ 1,023 $ 13,892 Surety insurance 23 - Corporate 603,999 465,403 ------------------- ----------------- Total interest expense $ 605,045 $ 479,295 =================== ================= F-42 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE T - RELATED PARTY TRANSACTIONS BORROWING AND OTHER TRANSACTIONS OF LARGEST SHAREHOLDER AND CEO For the past several years the Company's operating expenses were partially funded by advances from its largest shareholder and chief executive officer, John M. Jacobs. The source of funding for these advances originated with obligations incurred by Mr. Jacobs with third parties (such obligations together with the loans by Mr. Jacobs to the Company, "back-to-back loans") with interest rates ranging from 6.75% to 12%. To assure that repayments of the various borrowings by the Company that were either guaranteed by Mr. Jacobs or loaned to the Company by Mr. Jacobs via such back-to-back loan arrangements did not result in a deemed loan to Mr. Jacobs, Mr. Jacobs entered into an Assumption Agreement with the Company, pursuant to which Mr. Jacobs assumes, and agrees to hold the Company harmless from, principal of specified indebtedness of the Company as and when necessary to fully offset what might otherwise be deemed an advance of funds arising out of the Company's financing activities. During fiscal 2008, advances to the Company from Mr. Jacobs amounted to $132,200 and repayments to Mr. Jacobs amounted to $146,962. As of May 31, 2008, the balance due Mr. Jacobs was $1,000. During 2009, advances to the Company from Mr. Jacobs amounted to $456,858 and repayments amounted to $454,777. As of May 31, 2009 the balance due Mr. Jacobs was $3,081. During the years ended May 31, 2009 and May 31, 2008, a company owned by a board member provided consulting services. This company provided services totalling $62,531 and $102,488 in 2009 and 2008. Amounts owed to this company at year end are treated as related party payables in the amounts $75,009 and $60,567 at May 31, 2009 and 2008. NOTE U - REINSURANCE On March 23, 2009, the Company announced that FSC has entered into a reinsurance agreement with Lloyd's of London ("Reinsurer") for its coal reclamation surety bonding programs that took effect April 1, 2009. 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 three years and can be terminated by either party by written notice of at least 90 days prior to any April 1. The contract calls for a minimum premium to be paid to the Reinsurer of $490,000 per year. At May 31, 2009 The Company had prepaid reinsurance premiums of $87,114 and ceded reinsurance payable of $92,173. The Company limits the maximum net loss that can arise from large risks by reinsuring (ceding) certain levels of risks with reinsurers. The Company's reinsurer is comprised of five syndicates. 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-43 JACOBS FINANCIAL GROUP INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The effect of reinsurance on premiums written and earned for fiscal 2009 is as follows: 2009 2009 Written Earned Direct $ 905,519 $ 651,933 Ceded $ 92,174 $ 5,060 ----------- ----------- Net $ 813,345 $ 646,873 =========== =========== NOTE V - EVENTS SUBSEQUENT TO MAY 31, 2009 Subsequent events have been evaluated through September 14, 2009, the date these financial statements were issued. Subsequent to May 31, 2009, the Company obtained borrowings of $157,500 from individuals to fund ongoing operation and made repayments of $32,000. Such borrowings were obtained under demand notes bearing interest at the rate of 10%. Additionally, the Company borrowed $250,000 at the rate of 10%, which matures on December 31, 2009. This borrowing included the issuance of 500,000 shares of its common stock as additional consideration. Additionally, advances to the Company from its largest shareholder and CEO amounting to $100,025, with repayments totaling $75,300. On June 5, 2009 the Company asked the Holders of the Bridge loans to forbear from exercising their rights and remedies arising from the Acknowledged Events of Default and reached agreement. The Holders agreed that the Company may satisfy its obligation to make the Initial Amortization Payments by making 8 consecutive quarterly payments of $67,185 each, commencing September 10, 2009, and within a 14 day grace period after the due date, and continuing on the payment dates prescribed by the Amortization Schedule for the Promissory Notes and ending on June 10, 2011 (collectively, the "PAYMENTS"), it being understood that the Payments shall result in the payment of the principal of and interest on the unpaid portion of the Initial Amortization Payments at the rate of 10% per annum from and after the originally scheduled payment dates. On September 10, 2009, in accordance with the Bridge financing agreement, the Company became obligated to issue in the aggregate 5,354,642 shares of its common stock to the holders of such notes. Subsequent to May 31, 2009, warrants totaling 1,795,273 were exercised for cash and the issuance 1,795,273 common shares of the Company. On June 30, 2009, the Board of Directors of the Registrant voted to expand the number of Directors comprising the Board from three to five. The Board then elected two new members to fill the vacancies created. The new Directors so elected are Mario J. Marra and Bradley W. Tuckwiller. Each will serve until the next meeting of the shareholders of the Registrant at which there is an election of members of the Board of Directors (and until his successor is elected and qualified) and, if nominated, may stand for reelection. On June 30, 2009, the Company elected to continue to defer payment of dividends on its Series A Preferred Stock and Series B Preferred stock with such accumulated accrued and unpaid dividends amounting to $251,458 and $3,011,518 as of June 30, 2009. F-44 JACOBS FINANCIAL GROUP, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------ SUMMARY OF INVESTMENTS- OTHER THAN INVESTMENTS IN RELATED PARTIES SCHEDULE I ------------------------------------------------------------------------------------------------------------------------------------ AMOUNT AT WHICH AT MAY 31, 2009 SHOWN IN THE COST* VALUE BALANCE SHEET ---------------- ---------------- ------------------ Fixed maturities: Bonds: United States Government and government agencies and authorities $ - $ - $ - States, municipalities, and political subdivisions 352,816 381,386 381,386 ---------------- ---------------- ------------------ Total fixed maturities 352,816 381,386 381,386 Equity securities: - - - ---------------- ---------------- ------------------ Total equity securities - - - Mortgage-backed securities guaranteed by U.S. government agency 5,599,339 5,685,317 5,612,681 Short-term investments, at cost (approximates market value) 387,753 387,753 387,753 ---------------- ---------------- ------------------ Total investments $ 6,339,908 $ 6,454,456 $ 6,381,820 ================ ================ ==================
* Original cost of equity securities and, as to fixed maturities, original cost reduced by repayments and adjusted for amortization of premiums and accrual of discounts F-45 JACOBS FINANCIAL GROUP, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------ CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II ------------------------------------------------------------------------------------------------------------ BALANCE SHEETS - PARENT COMPANY ONLY MAY 31, 2009 MAY 31, 2008 ------------ ------------ Assets: Cash $ (2,028) $ 12,385 Accounts receivable from affiliates - 2,740 Prepaid expense and other assets 24,822 264,816 Furniture and equipment, net 9,551 7,987 Investment in subsidiaries, equity method 4,661,611 3,807,434 Due from affiliates, net 989,836 772,966 ------------ ------------ Total assets $ 5,683,792 $ 4,868,328 ============ ============ LIABILITIES: Accounts payable $ 6,460 $ 8,339 Accrued expenses and professional fees 365,859 289,584 Related party payable 67,275 52,192 Notes payable 4,049,791 2,967,017 Related party notes payable 2,281 1,000 Due to affiliates 176,000 - Other liabilities 361,538 86,289 ------------ ------------ Total liabilities 5,029,204 3,404,421 MANDATORILY REDEEMABLE PREFERRED STOCK 14,290,109 12,245,799 STOCKHOLDERS EQUITY: Common stock 17,968 16,609 Additional paid in capital 2,626,236 2,423,537 Accumulated deficit (16,279,725) (13,222,038) ------------ ------------ Total stockholders equity (deficit) (13,635,521) (10,781,892) ------------ ------------ Total liabilities and stockholders equity $ 5,683,792 $ 4,868,328 ============ ============
F-46 JACOBS FINANCIAL GROUP, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------ CONDENSED FINANCIAL INFORMATION OF REGISTRANT SCHEDULE II ------------------------------------------------------------------------------------------------------------ STATEMENTS OF CASH FLOWS - PARENT COMPANY ONLY YEAR ENDED MAY 31, 2009 2008 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (1,448,376) $(1,861,625) Adjustments to reconcile net (loss) to net cash provided by operating activities: Equity in undistributed net loss of consolidated subsidiaries (95,177) (7,829) Stock option compensation expense 11,462 98,972 Stock issued in connection with financing arrangements 231,554 242,003 Depreciation 4,999 5,023 Loss on disposal of equipment - 684 Change in other assets, accounts payable and accrued expense, net 568,504 (398,549) ------------- ------------- TOTAL CASH USED IN OPERATIONS (727,034) (1,921,321) CASH FLOWS FROM INVESTING ACTIVITIES: Contributions to insurance company subsidiary (759,000) (804,000) Funds provided to affiliates for operations (40,871) (659,377) Purchase of furniture and equipment (6,563) (1,510) ------------- ------------- TOTAL CASH USED IN INVESTING ACTIVITIES (806,434) (1,464,887) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of mandatorily redeemable preferred stock 435,000 828,000 Proceeds from exercise of stock warrants - 335 Redemption of mandatorily redeemable preferred stock - - Proceeds from borrowings 1,402,500 2,842,000 Repayment of borrowings (319,725) (269,357) Proceeds from short-term borrowings from related party 456,057 132,200 Repayment of short-term borrowings to related party (454,777) (146,963) ------------- ------------- TOTAL CASH PROVIDED BY FINANCING ACTIVITIES 1,519,055 3,386,215 ------------- ------------- CHANGE IN CASH (14,413) 7 Cash at beginning of year 12,385 12,378 ------------- ------------- Cash at end of year $ (2,028) $ 12,385 ============= =============
F-47 JACOBS FINANCIAL GROUP, INC. AND SUBSIDIARIES
-------------------------------------------------------------------------------------------------------------------------------- SUPPLEMENTARY INSURANCE INFORMATION AS OF MAY 31, 2009 AND 2008 AND FOR THE YEARS THEN ENDED SCHEDULE III -------------------------------------------------------------------------------------------------------------------------------- RESERVE FOR LOSSES OTHER AMORTIZATION AND POLICY CLAIMS OF DEFERRED LOSS 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 -------- ------------ ------------ ---------- --------- --------- ---------- ---------- ------------ --------- ----------- 2009 Surety $ 143,173 $ 432,658 $ 530,794 $ - $ 646,873 $ 288,747 $ 186,007 $ 153,263 $ - $ 813,345 ------------------------------------------------------------------------------------------------------------------------------------ 2008 Surety $ 75,940 $ 246,651 $ 277,208 $ - $ 453,478 $ 225,461 $ 135,867 $ 126,386 $ - $ 586,498
F-48
------------------------------------------------------------------------------------------------------------------------------------ SUPPLEMENTAL INSURANCE INFORMATION - REINSURANCE AS OF MAY 31, 2009 AND 2008 AND FOR THE YEARS THEN ENDED SCHEDULE IV ------------------------------------------------------------------------------------------------------------------------------------ CEDED TO OTHER 2009 GROSS AMOUNT COMPANIES NET AMOUNT Premiums written: Property and casualty insurance $ 905,519 $ 92,174 $ 813,345 --------------------- ------------------- ------------------- Total premiums written $ 905,519 $ 92,174 $ 813,345 ===================== =================== =================== Premiums earned: Property and casualty insurance $ 651,933 $ 5,060 $ 646,873 --------------------- ------------------- ------------------- Total premiums earned $ 651,933 $ 5,060 $ 646,873 ===================== =================== =================== There were no premiums ceded to other companies for the year ended May 31, 2008.
F-49 JACOBS FINANCIAL GROUP, INC. AND SUBSIDIARIES
------------------------------------------------------------------------------------------------------------------------------------ SUPPLEMENTAL INFORMATION AS OF MAY 31, 2009 AND 2008 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 DISCOUNT CLAIMS, LOSSES AMORTIZATION AND IF ANY, AND SETTLEMENT OF DEFERRED LOSS EXPENSES, DEDUCTED EXPENSES IN- DEFERRED PAID CLAIMS POLICY FUTURE IN NET CURRED RELATED TO POLICY AND CLAIMS NET AFFILIATION ACQUISITION POLICY COLUMN UNEARNED PREMIUM INVESTMENT CURRENT PRIOR ACQUISITION ADJUSTMENT PREMIUMS WITH REGISTRANT COSTS CLAIMS C PREMIUMS REVENUE INCOME YEAR YEARS COSTS EXPENSES WRITTEN --------------- ----------- ------------- --------- --------- -------- ---------- ----------------- ----------- ----------- -------- 2009 Consolidated property- casualty entities $ 143,173 $ 432,658 $ - $ 530,794 $ 646,873 $ 288,747 $ 186,007 $ - $ 153,263 $ - $ 813,345 ------------------------------------------------------------------------------------------------------------------------------------ 2008 Consolidated property- casualty entities $ 75,940 $ 246,651 $ - $ 277,208 $ 453,478 $ 225,461 $ 135,867 $ - $ 126,386 $ - $ 586,498
F-50
(b) The following exhibits are filed as a part of this Annual Report. EXHIBITS 2.1 Agreement and Plan of Merger dated as of May 18, 2001 by and among NELX, Inc., FSI Acquisition Corp. and FS Investments, Inc. (1) 2.2 Agreement and Plan of Merger dated as of May 18, 2001 by and among NELX, Inc., J&C Acquisition Corp. and Jacobs & Company (1) 2.3 Agreement and Plan of Merger dated as of December 8, 2006 by and among NELX, Inc. and Jacobs Financial Group, Inc. (2) 3.1 Company's Articles of Incorporation (3) 3.2 Company's By-laws (3) 3.3 Certificate of the Designations, Powers, Preferences and Rights of Series A Preferred Stock of Jacobs Financial Group (3) 3.4 Certificate of the Designations, Powers, Preferences and Rights of Series B Preferred Stock of Jacobs Financial Group (3) 4.1 Certificate of the Designations, Powers, Preferences and Rights of Series A Preferred Stock of Jacobs Financial Group (3) 4.2 Certificate of the Designations, Powers, Preferences and Rights of Series B Preferred Stock of Jacobs Financial Group (3) 10.1 Stock Purchase Agreement with National Indemnity Company to purchase Unione Italiana Insurance Company of America dated August 20, 2008 (11) 10.2 Engagement Agreement between Friedman, Billings, Ramsey & Co., Inc. and Jacobs Financial Group, Inc. dated December 5, 2007 (7) (9) 10.3 Agreement to acquire by merger Reclamation Surety Holding, Inc. (5) (6) (10) 21.1 Subsidiaries of the Registrant 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) promulgated under the Securities Exchange Act of 1934 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) promulgated under the Securities Exchange Act of 1934 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.1 Form of Subscription Agreement and Promissory Note (4) 99.2 Form of Amended Subscription Agreement and Promissory Note (8) 99.3 Form of Subscription Agreement and Promissory Note (Second Round) (8) (1) Incorporated by reference to the Company's Current Report On Form 8-K dated May 29, 2001. (2) Incorporated by reference to the Company's Definitive Proxy Statement dated November 7, 2005. (3) Incorporated by reference to the Company's Current Report on Form 8-K dated December 29, 2005. (4) Incorporated by reference to the Company's Current Report on Form 8-K dated September 10, 2007. (5) Incorporated by reference to the Company's Current Report on Form 8-K dated December 14, 2007. (6) Incorporated by reference to the Company's Current Report on Form 8-K dated February 8, 2008. (7) Incorporated by reference to the Company's Quarterly Report on Form 10-QSB for the quarterly period ended February 29, 2008 (8) Incorporated by reference to the Company's Current Report on Form 8-K dated May 30, 2008 (9) Incorporated by reference to the Company's Current Report on Form 8-K dated April 15, 2008 (10) Incorporated by reference to the Company's Current Report on Form 8-K dated June 24, 2008 (11) Incorporated by reference to the Company's Current Report on Form 8-K dated August 26, 2008 (12) Incorporated by reference to the Company's Current Report on Form 8-K dated November 20, 2008 (13) Incorporated by reference to the Company's Current Report on Form 8-K dated March 23, 2009 (14) Incorporated by reference to the Company's Current Report on Form 8-K dated June 16, 2009 (15) Incorporated by reference to the Company's Current Report on Form 8-K dated July 7, 2009
32 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 14, 2009 By: /s/ John M. Jacobs ------------------------------------------- John M. Jacobs President and CEO Director 33 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 14, 2009 By:/s/John M. Jacobs ------------------------ ---------------------------- John M. Jacobs President and CEO Director Dated: September 14, 2009 By:/s/ John M. Jacobs ------------------------ ---------------------------- John M. Jacobs Chief Financial Officer Dated: September 14, 2009 By:/s/ Mario J. Marra ------------------------ ---------------------------- Mario J. Marra Director Dated: September 14, 2009 By:/s/ C. David Thomas ------------------------ ---------------------------- C. David Thomas Director Dated: September 14, 2009 By:/s/ Frederick E. Ferguson ------------------------ ---------------------------- Frederick E. Ferguson Director Dated: September 14, 2009 By:/s/ Bradley W. Tuckwiller ------------------------ ---------------------------- Bradley W. Tuckwiller Director 34