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JFGI > SEC Filings for JFGI > Form 10-Q on 22-Oct-2012All Recent SEC Filings

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Form 10-Q for JACOBS FINANCIAL GROUP, INC.


22-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

During fiscal 2012 and the three-month period ended August 31, 2012, the Company has focused its primary efforts on the development and marketing of its surety business in West Virginia and Ohio, arranging for potential strategic relationships that will accelerate the progression of the Company's business plan and raising additional capital to increase the capital base of its insurance subsidiary, First Surety Corporation ("FSC"), to facilitate entry into other state markets.

RESULTS OF OPERATIONS FOR THE THREE-MONTH PERIOD ENDED AUGUST 31, 2012

The Company experienced a loss from operations for the three-month period ended August 31, 2012 of $35,456 as compared with income from operations of $187,634 for the corresponding period ended August 31, 2011.

REVENUES

Revenues from operations for the three-month period ended August 31, 2012 were $384,377 as compared with $656,764 for the corresponding period ended August 31, 2011. The overall decrease in revenues is largely attributable to the previous year's receipt of a cumulative No Claims Bonus from its reinsurers for the years ended June 30, 2010 and June 30, 2011, and a decline in premium written by the surety business of FSC as well. For the three-month period ended August 31, 2012 net investment income declined due to the re-allocation of assets in the investment portfolio compared to the previous year. Some interest bearing mortgage backed securities were sold at various times during the previous twelve-month period and replaced with non-interest bearing, or zero coupon bonds. In addition, investment advisory fees declined due to the decrease in the size of the portfolios under management.

INVESTMENT ADVISORY REVENUES

Quarterly revenues from the Company's investment management segment (Jacobs & Company or J&C) net of advisory referral fees were $54,892 for the three-month period ended August 31, 2012 as compared with $74,970 for the corresponding period ended August 31, 2011. 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 quarter to quarter with any large fluctuations being attributable to the growth or decline of assets under management.

INSURANCE AND INVESTMENT REVENUES

Quarterly  revenues from the Company's surety insurance  segment,  consisting of
FSC and Triangle Surety Agency,  Inc ("TSA"),  were $325,455 for the three-month
period ended  August 31, 2012 as compared  with  $581,149 for the  corresponding
period ended August 31,  2011.  Revenues  attributable  to premium  earned,  net
investment income and commissions earned are as follows:

                                       3
                                                  Three-month Period Ended
                                                         August 31,
                                             -----------------------------------
                                                   2012              2011
                                             ----------------- -----------------

Premium earned                               $        140,175  $        267,544
Commissions earned                                     16,865            18,214
No Claims Bonus from Reinsurers                        98,000           213,281
Net investment income                                  58,989            70,017
Net realized investment gains                          11,426            12,093
                                             ----------------- -----------------
                                      Total  $        325,455  $        581,149
                                             ================= =================

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. The decrease in premium earned for the three-month period ended August 31, 2012, in comparison to the corresponding period from the prior year is a result of the losing two customers that were acquired by a multi-national company that chose to use their in-place bond capacity although at less favorable terms, resulting in less premium written, as well as the need to recognize additional ceded premium in order to meet the minimum amount set forth in the Reinsurance contract.

On August 31, 2011 the Company's insurance subsidiary, FSC, recorded receipt of $213,281 from its reinsurers representing cumulative No Claims Bonus under the terms of its reinsurance treaty for the claim years ending June 30, 2010 and June 30, 2011. For the three-month period ended August 31, 2012, the Company recorded $98,000 of No Claims Bonus receivable for the claim year ending June 30, 2012.

Investment income should remain relatively consistent but can fluctuate based on interest rates and market conditions in relation to the average assets held for investment. The decrease in corresponding periods reflects consistent average assets held for investment in FSC's investment portfolio, $7.653 million for the three-month period ended August 31, 2011 and $7.656 million for the three-month period ended August 31, 2012, but offset by a decrease in investment yield from approximately 3.47% for the three-month period ended August 31, 2011 to approximately 2.95% for the three-month period ended August 31, 2012. This decrease in investment yield is mostly attributable to the shifting of some invested assets from interest earning, mortgage backed securities to non-interest earning, or zero coupon, bonds. During the period, equity securities in the portfolio provided dividends and gains from the covered call strategy utilized on the equities.

During the three-month period ending August, 31, 2012, the Company sold certain equity investments for $59,412, resulting in realized gains of $11,426. During the three-month period ending August 31, 2011, the Company sold certain US Government agency mortgage backed securities and equity investments for $120,908, resulting in realized gains of $12,093.

EXPENSES

INCURRED POLICY LOSSES

The Company has experienced no claims for losses as of August 31, 2012. However, "incurred but not reported" (IBNR) policy losses for the three-month period ended August 31, 2012 and 2011 amounted to $49,373 and $60,413 respectively. Such amounts represent the provision for loss and loss adjustment expense attributable to surety bonds issued by FSC. Such estimates are based on industry averages adjusted for factors that are unique to FSC's underwriting approach and are constantly reviewed for adequacy based on current market conditions and other factors unique to FSC's business. For each of these periods, IBNR provisional losses were approximately 35% and 23% of earned premium. The increase as a percentage of earned premium for the current quarter is due to FSC's need to recognize the minimum ceded premium amount required in the Reinsurance contract without offsetting premium written.

POLICY ACQUISITION COSTS

Insurance policy acquisition costs of $69,724 and $84,919 for the three-month periods ended August 31, 2012 and 2011, respectively, represent charges to operations for policy acquisition expense and premium tax attributable to surety polices issued by FSC and are recognized ratably over the period in which premiums are earned. Such cost as a percentage of earned premium was approximately 50% and 32% for the periods ended August 31, 2012 and 2011 respectively. The increase as a percentage of earned premium for the current quarter is due to FSC's need to recognize the minimum ceded premium amount set forth in the Reinsurance contract, without offsetting premium written.

GENERAL AND ADMINISTRATION

General and administrative expenses for the three-month periods ended August 31,
2012 and 2011 were $298,065 and $321,105 respectively,  representing an decrease
of $23,040, and were comprised of the following:
                                                       Three-month Period Ended
                                                              August 31,
                                                 -------------------------------------
                                                        2012               2011             Difference
                                                 ------------------ ------------------ -------------------
Salaries and related costs                       $         130,829  $         145,730  $         (14,901)
General office expense                                      27,243             28,301             (1,058)
Legal and other professional fees and costs                 60,111             54,602              5,509
Audit, accounting and related services                      29,450             34,307             (4,857)
Travel, meals and entertainment                             18,011             22,891             (4,880)
Other general and administrative                            32,421             35,274             (2,853)
                                                 ------------------ ------------------ -------------------
        Total general and administrative         $         298,065  $         321,105  $         (23,040)
                                                 ================== ================== ===================

Salaries and related costs, net of deferred internal policy acquisition costs, decreased approximately $15,000 and are comprised of the following:

                                                       Three-month Period Ended
                                                              August 31,
                                                 --------------------------------------
                                                         2012               2011             Difference
                                                 ------------------- ------------------- ------------------
Salaries and taxes                               $          136,800  $         132,766   $           4,034
Commissions                                                   9,719             50,047             (40,328)
Stock option expense                                              -                370                (370)
Fringe benefits                                              22,276             21,341                 935
Key-man insurance                                            14,751             12,224               2,527
Deferred payroll costs                                      (52,717)           (71,018)             18,301
                                                 ------------------- ------------------- ------------------
        Total salaries and related costs         $          130,829  $         145,730   $         (14,901)
                                                 =================== =================== ==================

The decrease in commissions is partially attributable to FSC's commission structure that pays a larger commission percentage on the origination of a policy but reduced for subsequent policy renewals. In addition, the loss of two customers and the timing of some commission payments contributed to the decrease.

Legal and other professional fees and costs were comprised of the following:

                                                                Three-month Period Ended
                                                                       August 31,
                                                          --------------------------------------
                                                                   2012               2011            Difference
                                                          -------------------- ------------------- -----------------
General corporate services                                $           11,250   $          3,866    $          7,384
Coal reclamation consulting                                           18,238              7,916              10,322
Statutory examination costs                                                -              7,675              (7,675)
Acquisition and financing related costs                               30,623              7,645              22,978
Acquisition and financing related costs - due diligence                    -             27,500             (27,500)
                                                          -------------------- ------------------- -----------------
        Total legal and other professional fees           $           60,111   $         54,602    $          5,509
                                                          ==================== =================== =================

The increase in general corporate services results primarily from increased legal and consulting expenses affecting the insurance subsidiary. Legal and other professional services and costs related to the Company's pending acquisitions and on-going efforts to obtain financing necessary to expand the Company's business and penetrate new markets amounted to $30,623 and $7,645 for the three-month periods ended August 31, 2012 and 2011, respectively. In the three-month period ending August 31, 2011, the Company incurred costs associated with a statutory examination of its insurance subsidiary by the West Virginia Insurance Commission. In the three-month period ending August 31, 2011, the Company incurred $27,500 in costs associated with the performance of due diligence by third parties for the benefit of an investor considering a substantial investment in the Company.

INTEREST EXPENSE

Interest  expense for the three-month  period ended August 31, 2012 was $311,920
as compared  with $229,573 for the  corresponding  period ended August 31, 2011.
Components of interest expense are comprised of the following:
                                                                    Three-month Period Ended
                                                                           August 31,
                                                               -----------------------------------
                                                                      2012              2011           Difference
                                                               ----------------- ----------------- -----------------
Interest expense on bridge-financing                           $        149,973  $        149,973  $              -
Expense of common shares issued or to be issued in
 connection with bridge financing and other arrangements                112,972            32,308            80,664
Interest expense on demand and term notes                                43,860            47,292            (3,432)
Other finance charges                                                     5,115                 -             5,115
                                                               ----------------- ----------------- -----------------
                                       Total interest expense  $        311,920  $        229,573  $         82,347
                                                               ================= ================= =================

The increase in the expense of common shares issued (or to be issued) for the three-month period ended August 31, 2012, as compared to the corresponding period of the previous year is attributable to rise in market value of the common stock used to calculate the price of shares to be issued for the semi-annual bridge loan issuance. Other finance charges for the three-month period ended August 31, 2012 consists of interest charged on past due accounts payable balances and Federal and State payroll taxes.

ACCRETION AND DIVIDENDS

Accretion of  mandatorily  redeemable  convertible  preferred  stock issued at a
discount and accrued dividends for three-month periods ended August 31, 2012 and
2011 are as follows:
                                                                  Three-month Period Ended
                                                                         August 31,
                                                            --------------------------------------
                                                                   2012                2011            Difference
                                                            -------------------- ------------------ ------------------

Accrued dividends - mandatorily redeemable preferred stock              18,365             31,300            (12,935)
Accrued dividends - equity preferred stock                             221,474            204,564             16,910
                                                            --------------------------------------- ------------------
                            Total accretion and dividends   $          239,839   $        235,864   $          3,975
                                                            ==================== ================== ==================

The Series B class of stock is treated as a liability as of November 30, 2009 after the majority was exchanged for Series C equity stock. Therefore, for the three-month period ending August 31, 2012, dividends of $92,002 associated with the Series B remaining after November 30, 2009 are deductions from net income and not included in the table above. During the year ended May 31, 2012, two holders of Series A stock released all of their outstanding bonds held with FSC. Therefore, these shares of Series A Preferred Shareholders are listed in the liability section of the Consolidated Condensed Balance Sheet and the dividends after February 29, 2012 associated with these shares are a deduction from net income in the amount of $14,210 and not included in the table above. Series C equity stock is not mandatorily redeemable and does not accrete.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

INTANGIBLE ASSETS

In exchange for the purchase price of $2.9 million for the 2005 acquisition of FSC, the Company received cash and investments held by FSC totaling $2.75 million, with the difference being attributed to the multi-line 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 August 31, 2012.

FSC holds license 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 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 relevant properties in accordance with the specifications of the mining permit prepared by independent outside professionals experienced in this field of work. Such estimates are updated periodically and contrasted to the principal's pledged asset account, which FSC requires to mitigate risk exposure. Should the principal default in its obligation to reclaim the property as specified in the mining permit, FSC could then use the collateral account to reclaim the property or as an offset in forfeiting the face amount of the surety bond. Losses can occur if the costs of reclamation exceed the estimates obtained at the time the initial bond was issued or upon subsequent re-evaluations if sufficient collateral is not obtained or if the collateral has experienced significant deterioration in value and FSC is not otherwise able to recover under its contractual rights to indemnification.

In general, miscellaneous fixed-liability surety bonds are collateralized in full by the principal's cash investment in 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 investment account experiences deterioration in value.

In establishing its reserves for losses and loss adjustment expense, management routinely reviews its exposure to loss based on periodic monitoring and inspection reports, along with industry averages and historical experience. Management estimates such losses based on industry experience adjusted for factors that are unique to the Company's approach, and in consultation with actuaries experienced in the surety field.

ANALYSIS OF LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION AND RECENT DEVELOPMENTS AND FUTURE DIRECTION OF COMPANY

The Company experienced income (losses) from operation of approximately $16,000 and ($22,000) for the years ended May 31, 2012 and 2011, respectively. The Company's income decreases (or loss increases) when accretion of mandatorily redeemable convertible preferred stock and accrued dividends on mandatorily redeemable preferred stock are taken into account, to approximately ($1,220,000) and ($1,440,000) for the years ended May 31, 2012 and 2011, respectively.

For the three-month period ended August 31, 2012 the Company had a loss from operations of approximately $35,000, which, when accretion of mandatorily redeemable convertible preferred stock and accrued dividends on mandatorily redeemable preferred stock are taken into account, results in a loss of approximately $472,000. The Company reported cash flow used in operations of approximately $36,000 for the three-month period ended August 31, 2012. A substantial portion of the Company's cash flow is generated by its insurance subsidiary and subject to certain withdrawal restrictions. Despite the continued reduction of operating expenses, the Company has not been able to pay certain amounts due to professionals and others, continues to be unable to pay its preferred stock dividend obligation or cure its default in certain quarterly payments due its bridge-financing lenders. While management expects revenue growth and cash flow to increase significantly when its business plan is fully implemented, it is anticipated that losses will continue and the Company will be cash constrained until FSC develops a more substantial book of business.

The Company is restricted in its ability to withdraw monies from FSC without prior approval of the Insurance Commissioner. Of the Company's investments and cash of $7,752,772 as of August 31, 2012, $7,751,310 is restricted to FSC.

By Order dated March 26, 2012 the West Virginia Insurance Commissioner terminated the conditions imposed upon FSC by Consent Order dated December 23, 2005 and the Amended Consent Order dated June 8, 2007, which, among other conditions, included limitations before seeking license or Extension of its Authority in other states without obtaining prior approval of the Commissioner.

Beginning April 1, 2009, and continuing through annual renewals, the most recent of which was July 1, 2012, various syndicates of Lloyd's of London have reinsured FSC for its coal reclamation surety bonding programs. This agreement has provided additional bonding capacity to FSC and has enabled the underwriting of more and greater size bonds for its coal reclamation bonding clients. Management expects this reinsurance arrangement to expand FSC's market share and increase 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, 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 due to FSC's relatively small capital base and the financial condition of the Company. Management believes that if FSC's capital and surplus reserves were more substantial and the financial condition of the Company stabilized, entry into other states would be less challenging. Accordingly, management continues to pursue investor relationships that will provide additional capital to its insurance subsidiary and fund operations as the business fully develops.

As a means of alleviating obligations associated with the Company's Series B Preferred Stock, which by its terms matured at the end of 2010, management proposed a recapitalization to assist in stabilizing the financial position of the Company. Holders of the Series B Preferred Stock were offered the opportunity to exchange their Series B Shares for an equal number of shares of a new series of JFG preferred stock designated as Series C Preferred Stock plus 2,000 shares of JFG Common Stock. Series C Preferred Stock is equal in priority to the Series B Preferred Stock, entitled to dividends at the same rate as Series B Preferred Stock, entitled to convert to common stock of the Company at a conversion rate of $ .10 per common share (in contrast to $1.00 per share for Series B Preferred) and may be redeemed by the Company but does not have a fixed maturity date and thus, is classified as permanent equity. Holders of over 70% of the outstanding Series B Preferred Shares elected to participate in the recapitalization.

Through the sharing of resources (primarily personnel) to minimize operating costs, the Company and its subsidiaries minimize operating expenses and preserve resources. Although FSC is cash flow positive, its assets and profits are restricted to its stand-alone operation by regulatory authority until capital and surplus reserves reaches a more substantial level. Although the growth of FSC provides additional unrestricted cash flow to the Company's other subsidiaries, Jacobs and Triangle Surety, it is anticipated that working capital deficiencies will continue and 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, . . .

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