United States Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 2003.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to .
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Commission file number : 0-25679
FIRST AMERICAN CAPITAL CORPORATION
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(Name of small business issuer in its charter)
Kansas 48-1187574
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(State of incorporation) (I.R.S. Employer Identification Number)
1303 SW First American Place, Topeka, KS 66604
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(Address of principal executive offices)
Issuer's telephone number (785) 267-7077
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Securities registered under 12(b) of the Act:
Title of Each Class
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NONE
Securities registered under Section 12(g) of the Act:
Title of Each Class
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Common Stock, $.10 Par Value
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
periods 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B in this form, and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this form 10-KSB [ ]
State issuer's revenues for its most recent fiscal year: $4,313,969
State the aggregate market value of the voting equity held by non-affiliates:
Of the 5,449,578 shares of common stock of the registrant issued and 4,687,078
outstanding shares of common stock of the registrant as of March 17, 2004,
4,317,878 shares are held by non-affiliates. Because of the absence of an
established trading market for the common stock, the registrant is unable to
calculate the aggregate market value of the voting stock held by non-affiliates
as of a specified date within the past 60 days.
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
Common Stock, $.10 Par Value - 4,687,078 shares as of March 17, 2004.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
1
FORM 10-KSB
For the Fiscal Year Ended December 31, 2003
TABLE OF CONTENTS
Page
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Part I.
Item 1. Description of Business 3
Item 2. Description of Property 8
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 9
Part II.
Item 5. Market for Common Equity and Related Stockholder Matters 9
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations 10
Item 7. Financial Statements 15
Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure 15
Item 8a. Controls and Procedures 15
Part III.
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act 15
Item 10. Executive Compensation 19
Item 11. Security Ownership of Certain Beneficial Owners and Management 21
Item 12. Certain Relationships and Related Transactions 22
Item 13. Exhibits and Reports on Form 8-K 23
Item 14. Principal Accountant Fees and Services 24
Signatures 25
2
PART I
Item 1. Description of Business
First American Capital Corporation (the "Company") was incorporated on July 10,
1996 for the purpose of forming, owning and managing life insurance companies.
The Company sold 2,120,000 shares at $.10 per share to its organizing
shareholders in August of 1996 for total proceeds of $212,000. Also, in
September, 1996, the Company sold 600,000 shares of its common stock for $1.00
per share in a separate private placement. The initial capital was used to fund
the Company's efforts to register a $12,500,000 intra-state public offering with
the Office of the Kansas Securities Commissioner. Included in the registration
was a 10% over-sale provision. On March 11, 1996 the Office of the Kansas
Securities Commissioner declared the registration statement effective.
On January 11, 1999, the Company completed the intra-state public stock offering
raising approximately $13,750,000 of capital. The offering included a 10%
over-sale of $1,250,000. The Company capitalized the life insurance subsidiary,
First Life America Corporation ("FLAC"), with $3,000,000 of the proceeds from
the stock sale. Subsequent to the initial capitalization, the Company has
contributed an additional $700,000 to FLAC in the form of surplus contributions.
The venture capital subsidiary, First Capital Venture, Inc. ("FCVI"), was formed
in October of 1998. FCVI has not yet been capitalized. The remainder of the
proceeds are available to provide additional capital for the life insurance
subsidiary or for the possible acquisition of life insurance or insurance
related company(s) or to provide working capital.
First American Capital Corporation
The primary segment of the Company's operations is life insurance and annuities.
Accordingly, a significant portion of revenue will be generated by the Company's
wholly owned life insurance subsidiary, FLAC. Additional income is provided in
the form of investment and rental income. The Company has contracted with FLAC
to provide services, which are incident to the operations of FLAC. The Service
Agreement between the Company and FLAC ("Service Agreement") was amended and
restated effective January 1, 2002.
First Life America Corporation
On October 15, 1997, FLAC received a certificate of authority from the Kansas
Insurance Department ("KID") to transact its life insurance and annuity business
in the state of Kansas. On November 19, 1998, life insurance operations
commenced. Under the provisions of accounting principles generally accepted in
the United States of America, FLAC had $5,796,464 of shareholders' equity as of
December 31, 2003, and is wholly owned by the Company. FLAC has contracted with
the Company for policy administration and data processing services as discussed
below.
Administration
Under the terms of the Service Agreement, the Company provides personnel,
facilities, and services incident to the operations of FLAC. FLAC does not have
any employees. Services performed pursuant to the Service Agreement are
underwriting, claim processing, accounting, policy processing and other services
necessary for FLAC to operate. The Service Agreement is effective until either
party provides 90 days written notice of termination. FLAC pays fees equal to
the Company's cost of providing such services, including an appropriate
allocation of the Company's overhead expenses, in accordance with accounting
principles generally accepted in the United States of America. FLAC bears all of
its direct selling costs, which include agent recruiting, training and
licensing; agent commissions; any benefits or awards directly for or to agents
or management including any life or health insurance to be provided; and any
taxes (federal, state or county) directly related to the business of FLAC.
Additionally, FLAC is responsible for, among other things, any reinsurance
premiums; legal expenses related to settlement of claims; state examination
fees; interest on indebtedness; costs related to mergers or acquisitions and
costs related to fulfilling obligations of the life insurance and annuity
contracts written by the agents of FLAC.
3
Actuarial Services
On behalf of FLAC, the Company has retained the services of Miller & Newberg
Inc., consulting actuaries located in Olathe, Kansas. Mr. Eric Newberg of Miller
& Newberg Inc. has been appointed by the Board of Directors of FLAC to act as
its valuation and illustration actuary.
Products of FLAC
The various insurance products currently being marketed by FLAC are as follows:
First American 2000 is a modified payment whole life insurance policy with a
flexible premium deferred annuity rider. A modified payment whole life insurance
policy requires premium payments to be made for a certain number of years after
which time the policyholder is entitled to policy benefits without making future
payments. The product combines both a ten and twenty payment period based on the
issue age of the insured. Issue ages from age 0 (30 days) to 20 and 66 to 80 are
ten pay policies and issue ages from 21 to 65 are twenty pay policies. Premium
payments are split between life and annuity based on percentages established in
the product design. First year premium payments are allocated 100% to life
insurance and renewal payments are split 50% to life and 50% to annuity. The
product is sold in premium units with the ability to purchase either fractional
or multiple units. At the end of the required premium paying period, the
policyholder may continue to make full premium payments into the annuity rider
to provide for greater annuity accumulations.
Golden Eagle Whole Life is available on a simplified issue or graded death
benefit basis. The simplified issue product is issued from age 50 to 85 with
death benefit coverage ranging from a minimum of $2,500 to a maximum of $25,000.
The graded death benefit product is issued from age 50 to 80 with death benefit
coverage ranging from a minimum of $2,000 to a maximum of $10,000. The policy
includes a living benefit rider that pays the actuarial present value of death
benefit upon terminal illness or nursing home confinement. Premiums are level
for life and vary by risk class, sex and issue age.
First Step is a juvenile term product issued from age 0 (30 days) to age 15.
Coverage is sold in units. One unit, consisting of a single premium payment of
$100 purchases $5,000 of death benefit coverage, while two units, consisting of
a single premium payment of $200 purchases $10,000 of coverage. The product
contains a conversion provision allowing it to be converted to a whole life
policy prior to age 21.
FLAT 10 (First Life Affordable Term) is a ten year term product issued from age
20 to 70. It has a re-entry provision allowing the current insured to re-qualify
prior to each ten year period. The re-qualification is essentially
re-underwriting including medical exams and inspections to determine if the risk
has changed or remained the same. The policy expires automatically at age 95.
First Guard 10 is a ten year term product renewable to age 70 and convertible to
age 60. Renewable means the policy is kept inforce as long as the premiums are
paid, but the rates do change each 10 year period. Convertible means that prior
to age 60 the policy can be converted to a permanent plan of insurance. The
product is issued from age 18 to 60. The policy includes an accelerated death
benefit rider. This rider provides that in the event that certain ailments or
medical conditions occur, a 25% or 50% of the base policy coverage could be
paid. The maximum benefit under this rider is $250,000. Payment of an
accelerated benefit does reduce the future death benefit.
SPDA is a single premium deferred annuity contract. Additional deposits are
subject to maximum and minimum restrictions. The contract is issued as a
conventional deferred annuity that meets Federal requirements for tax deferred
accumulation of interest.
4
Product Marketing and Sales
The Company's marketing strategy is to provide life insurance and annuity
products that are beneficial to the consumer, are marketable by the sales force
and are profitable for the Company and its shareholders. The Company is
continually seeking new markets for its products. The Company sells its products
through independent agents. The independent agents receive commissions from the
Company based on premiums collected on the products sold by the independent
agents. The Company manages the independent agents directly or through
independent marketing organizations, referred to as IMOs. IMOs generally are
organizations that align multiple independent agents with specific insurers and
products. The IMOs receive a portion of the overall commissions paid by the
Company on products sold by the agents. The IMOs recruit, train, supervise and
provide other support functions to the independent agents.
FLAC is currently licensed to transact life and annuity business in the states
of Kansas, Texas, Ohio, Illinois, Oklahoma, North Dakota, Nebraska and Kentucky.
Due to the uncertainties involved, management cannot reasonably estimate the
time frame of marketing expansion into any additional states.
Insurance Inforce
The following table provides certain information about FLAC's volume of life
insurance coverage inforce for each of the last three years:
Amounts of Insurance (1) (shown in thousands)
2003 2002 2001
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Beginning of year $ 154,577 $ 112,302 $ 83,277
Issued during year 32,877 54,827 46,962
Reinsurance assumed 6,360 5,821 1,280
Revived during year 427 1,512 167
Lapse, surrender and decreased (30,817) (19,885) (19,384)
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In-force end of year $ 163,424 $ 154,577 $ 112,302
========= ========= =========
(1) Excludes accidental death benefits (shown in thousands) of $36,920,
$36,508, and $31,027 in 2003, 2002, and 2001, respectively.
Reinsurance
In order to reduce the financial exposure to adverse underwriting results,
insurance companies generally reinsure a portion of their risks with other
insurance companies. FLAC has entered into agreements with Generali USA Life
Reassurance Company ("Generali") of Kansas City, Missouri, as well as Optimum Re
Insurance Company ("Optimum Re") of Dallas, Texas, to reinsure portions of the
life insurance risks it underwrites. Pursuant to the terms of the reinsurance
agreements, FLAC retains a maximum coverage exposure of $50,000 on any one
insured. In the event that the reinsurance companies are unable to fulfill their
obligations under the reinsurance agreements, FLAC remains primarily liable for
the entire amount at risk. According to the reinsurance agreements, there are
generally no premiums due on first year business.
FLAC is party to an Automatic Retrocession Pool Agreement (the "Reinsurance
Pool") with Optimum Re, Catholic Order of Foresters, American Home Life
Insurance Company and Woodmen of the World. The agreement provides for automatic
retrocession of coverage in excess of Optimum Re's retention on business ceded
to Optimum Re by the other parties to the Reinsurance Pool. FLAC's maximum
exposure on any one insured under the Reinsurance Pool is $50,000.
5
Underwriting
FLAC follows underwriting procedures designed to assess and quantify insurance
risks before issuing life insurance policies. Such procedures require medical
examinations (including blood tests, where permitted) of applicants for policies
of life insurance in excess of certain policy limits. These requirements are
graduated according to the applicant's age and vary by policy type. The life
insurance subsidiary also relies upon medical records and upon each applicant's
written application for insurance, which is generally prepared under the
supervision of a trained agent.
Evaluating the impact of future Acquired Immune Deficiency Syndrome ("AIDS")
claims under life insurance policies issued is extremely difficult, in part due
to the insufficiency and conflicting data regarding the number of persons now
infected with the AIDS virus, uncertainty as to the speed at which the AIDS
virus has and may spread through the general population, and advancements in
medical treatment options. The life insurance subsidiary has implemented, where
legally permitted, underwriting procedures designed to assist in the detection
of the AIDS virus in applicants.
Investments
The Kansas Insurance Code restricts the investments of insurance companies by
the type of investment, the amount that an insurance company may invest in one
type of investment, and the amount that an insurance company may invest in the
securities of any one issuer. The restrictions of the Kansas Insurance Code are
not expected to have a material effect on the investment return of FLAC. The
Company is not subject to the limitations, which restrict the investments, made
by FLAC. Currently, investments are held in both short-term, highly liquid
securities and long-term, higher yield securities.
Competition
The life insurance industry is extremely competitive. There are a large number
of insurance companies that are substantially larger, have greater financial
resources, offer more diversified product lines and have larger selling
organizations than FLAC. Competition also is encountered from the expanding
number of banks and other financial intermediaries that offer competing
products. FLAC must also compete with other insurers to attract and retain
qualified agents to market FLAC's products.
Governmental Regulation
FLAC is subject to regulation and supervision by the KID. The insurance laws of
Kansas give KID broad regulatory authority, including powers to: (i) grant and
revoke licenses to transact business; (ii) regulate and supervise trade
practices and market conduct; (iii) establish guaranty associations; (iv)
license agents; (v) approve policy forms; (vi) approve premium rates for some
lines of business; (vii) establish reserve requirements; (viii) prescribe the
form and content of required financial statements and reports; (ix) determine
the reasonableness and adequacy of statutory capital and surplus; and (x)
regulate the type and amount of permitted investments.
Kansas has enacted legislation, which regulates insurance holding company
systems, including acquisitions, extraordinary dividends, the terms of affiliate
transactions, and other related matters. Currently, the Company and FLAC have
registered as a holding company system pursuant to the laws of the state of
Kansas.
6
Federal Income Taxation
FLAC is taxed under the life insurance company provisions of the Internal
Revenue Code of 1986, as amended (the "Code"). Under the Code, a life insurance
company's taxable income incorporates all income, including life and health
premiums, investment income, and certain decreases in reserves. The Code
currently establishes a maximum corporate tax rate of 35%. The Code currently
requires capitalization and amortization over a five year period of certain
policy acquisition costs incurred in connection with the sale of certain
insurance products. These provisions apply to life and annuity business. Certain
proposals to make additional changes in the federal income tax laws, including
increasing marginal tax rates, and regulations affecting insurance companies or
insurance products, continue to be considered at various times in the United
States Congress and by the Internal Revenue Service. The Company currently
cannot predict whether any additional changes will be adopted in the foreseeable
future or, if adopted, whether such measures will have a material effect on its
operations.
Commencing with the 2003 tax year, FLAC will file a consolidated income tax
return with the Company. In certain consolidated return years, the separate tax
liability of either FLAC or the Company may be reduced through the utilization
of net operating losses of the other company comprising the consolidated group.
In addition, the taxes payable by the consolidated group as a whole may be
reduced by tax credits generated or earned by one company of the consolidated
group, which are in effect used to reduce the separate tax liability of the
other company. The tax savings attributable to the use of such tax attributes
will inure generally to the benefit of the company of the consolidated group
that earned or generated the tax attribute in question. Members of the
consolidated group will reimburse one another for the value of the consolidated
tax attributes utilized in each consolidated return year.
Financial Information Relating to Industry Segments
Financial information related to specific segments of the Company's business are
presented below. All sales of life insurance by FLAC are to unaffiliated
customers.
2003 2002 2001
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Revenues:
Life and annuity insurance operations $ 3,988,400 $ 3,712,523 $ 2,704,352
Corporate operations 325,569 446,625 514,796
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Total $ 4,313,969 $ 4,159,148 $ 3,219,148
=========== =========== ===========
Income (loss) before income taxes:
Life and annuity insurance operations $ 368,682 $ 480,628 $ 532,626
Corporate operations (1,095,168) (625,386) (734,059)
----------- ----------- -----------
Total $ (726,486) $ (144,758) $ (201,433)
=========== =========== ===========
Depreciation and amortization expense:
Life and annuity insurance operations $ 629,068 $ 423,210 $ 459,124
Corporate operations 124,093 134,999 87,698
----------- ----------- -----------
Total $ 753,161 $ 558,209 $ 546,822
=========== =========== ===========
Assets:
Life and annuity insurance operations $15,053,265 $12,090,507 $ 8,795,709
Corporate operations 5,625,835 6,656,009 8,444,254
----------- ----------- -----------
Total $20,679,100 $18,746,516 $17,239,963
=========== =========== ===========
7
Employees
As of December 31, 2003, the Company had 14 full time and no part time
employees.
Item 2. Description of Property
The Company owns approximately six and one-half acres of land located in Topeka,
Kansas. A 20,000 square foot office building has been constructed on
approximately one-half of this land. The remaining land, including improvement
costs, is classified as real estate held for investment. The Company does not
intend to make any improvements, develop or renovate the property or building.
The Company occupies approximately 7,500 square feet of the building. The
remaining 12,500 square feet is leased. Approximately 10,000 square feet is
leased to the United States Department of Agriculture ("USDA") under a 10 year
inclusive non cancelable lease that commenced on July 1, 2001 and will end on
June 30, 2011. The USDA may terminate this lease after 5 years, on or after June
30, 2006 upon 90 days notification in writing to the Company. The average annual
rental of this lease is $18.20 per square foot or $181,990 per year. The
remaining 2,500 square feet is currently available for lease. The occupancy rate
based on the total square feet available for lease in 2003 was 98%. Management
believes that insurance coverage on the building is adequate. The building is
depreciated over 39 years using the straight-line method for book and tax
purposes. The annual taxes on the building are $72,765 or an assessed rate of
25%. The annual taxes on the land are $7,511 or an assessed rate of 12%.
A note from Western National Bank of Lenexa, Kansas secures the office building.
As of December 31, 2003, the remaining principal balance on the note was
$1,843,007. The note is payable in 120 monthly payments of $13,534 each with a
final payment of the unpaid principal balance and interest due on April 22,
2013. Interest will be accrued at 6% until April 22, 2008 at which time the rate
may change. The interest rate change will be the Wall Street Journal Prime Rate
of Interest, subject to a floor of 6% and a ceiling of 9.5%.
Item 3. Legal Proceedings
On November 12, 2003, the Company filed a petition in the District Court of
Shawnee County, Kansas asserting claims against Rickie D. Meyer, the Company's
former President, arising, in part, out of Mr. Meyer's employment with the
Company. Among other things, the Company is seeking to recover expense
reimbursements previously paid to Mr. Meyer and Company funds allegedly
misappropriated by Mr. Meyer. In this regard, the petition alleges that Mr.
Meyer abused Company policies related to claiming business- related expense
reimbursements by submitting expense reports for goods and services purchased
for personal use. The petition further alleges that Mr. Meyer misappropriated
funds from the Company by fraudulently altering a check made payable to the
Company. The Company is also seeking to have Mr. Meyer reimburse it for the
amount it paid another insurance company in settlement of a claim. On August 8,
2003, the Company settled a claim that it had breached various marketing
agreements with AF&L, a long-term care insurance company, and certain of its
affiliates, through the payment to AF&L of $150,000 plus $15,000 in attorney
fees. The petition asserts that Meyer entered into the marketing agreements
despite knowing that the Company could not perform on the financial requirements
of the agreements and without the knowledge, approval or authorization of the
Company's Board of Directors.
On December 12, 2003, Meyer filed an Answer and Counterclaim against FACC
asserting claims for defamation and breach of employment agreement. Meyer seeks
damages in excess of $75,000 plus interest and costs on his defamation claims.
Meyer seeks damages in the amount of $250,000 for an alleged breach of a
provision in his employment contract regarding severance pay; he seeks
additional damages in excess of $75,000 for an alleged breach of a provision in
the employment contract relating to payment of residual commissions.
FACC denies Meyer allegations and will defend against them as well as pursue its
lawsuit against Meyer.
8
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted during the fourth quarter of the fiscal year covered by
this Form 10-KSB to a vote of the Company's security holders, through the
solicitation of proxies or otherwise.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
(a.) Market Information
The Company's common stock became tradeable on October 11, 1999. The common
stock is not listed on any stock exchange. Trading of the Company's common stock
in the over-the-counter market is limited and sporadic and an established public
market does not exist.
(b.) Holders
As of March 17, 2004, there are approximately 4,949 shareholders of record of
the Company's outstanding common stock.
(c.) Dividends
The Company has not paid any cash dividends since inception (July 10, 1996).
Additionally, dividends are not anticipated in the foreseeable future.
9
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The Company makes forward-looking statements from time to time and desires to
take advantage of the "safe harbor" that is afforded such statements under the
Private Securities Litigation Reform Act of 1995 when they are accompanied by
meaningful cautionary statements identifying important factors that could cause
actual results to differ materially from those in the forward-looking
statements.
The statements contained in this report, which are not historical facts, are
forward-looking statements that involve risks and uncertainties that could cause
actual results to differ materially from those set forth in the forward-looking
statements. Any projections of financial performances or statements concerning
expectations as to future developments should not be construed in any manner as
a guarantee that such results or developments will, in fact, occur. There can be
no assurance that any forward-looking statement will be realized or that actual
results will not be significantly different from that set forth in such
forward-looking statement. In addition to the risks and uncertainties of
ordinary business operations, the forward-looking statements of the Company
referred to above are also subject to risks and uncertainties.
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto, beginning on page F-1 in this report.
Financial Position
Significant changes in the consolidated balance sheets from December 31, 2002 to
December 31, 2003 are highlighted below.
Total assets increased from $18,746,516 at December 31, 2002 to $20,679,100 at
December 31, 2003. The Company's available-for-sale fixed maturities had a fair
value of $12,032,106 and $10,760,529 at December 31, 2003 and 2002,
respectively. This investment portfolio is reported at market value with
unrealized gains and losses, net of applicable deferred taxes, reflected as a
separate component of accumulated other comprehensive income.
The Company limits credit risk by emphasizing investment grade securities and by
diversifying its investment portfolio between U.S. Government agency and
corporate bonds. Investing in certificates of deposit further minimizes credit
risk. As a result, management believes that significant concentrations of credit
risk do not exist.
Short-term investments increased from $416,801 at December 31, 2002 to $460,593
at December 31, 2003. The increase of short-term investments held by the Company
is attributable to bonds maturing during the year ended December 31, 2003, and
the proceeds were used to purchase available-for-sale securities and short-term
investments. This resulted in a $43,792 or 11% increase in short-term
investments.
Cash and cash equivalents decreased from $400,062 at December 31, 2002 to
$397,789 at December 31, 2003. Refer to the statement of cash flows for uses and
sources of cash during 2003.
Investments in related parties decreased $24,549 from $89,749 at December 31,
2002 to $65,200 at December 31, 2003. This decrease is due to the Company's 50%,
or $46,049, share of First Computer Services, LLC ("FCS") net loss from
operations offset by a capital contribution of $21,500. FCS owns the computer
hardware and software that runs the Company's policy administration,
underwriting, claim processing, and accounting functions. First Alliance
Corporation ("FAC") owns the remaining 50% interest in FCS.
Accounts receivable decreased $26,055 from $322,421 at December 31, 2002 to
$296,366 at December 31, 2003. The change is primarily due to an increase in
amounts due from agents of $11,267 that have been advanced commissions on
production of the Final Expense product, an increase in income tax recoverable
of $9,780, a decrease in due premiums of $28,327, and a decrease in due from
employees of $18,655.
Deferred policy acquisition costs, net of amortization, increased 26% from
$3,186,587 at December 31, 2002 to $4,010,959 at December 31, 2003 resulting
from the capitalization of acquisition expenses related to the increasing sales
of life insurance. These acquisition expenses include commissions on first year
business, medical exam and inspection report fees, and salaries of employees
directly involved in the marketing, underwriting and policy issuance functions.
10
Property and equipment decreased to $2,836,814 at December 31, 2003 from
$2,952,046 at December 31, 2002. The decrease is attributable to depreciation
expense of $124,093, capitalization of assets of $12,440 and the disposition of
assets with a book value of $3,579.
Other assets decreased $23,496 to $7,648 at December 31, 2003 from $31,144 at
December 31, 2002. The decrease is primarily due to the use of prepaid marketing
leads in 2003.
Liabilities increased to $11,249,639 at December 31, 2003 from $8,851,559 at
December 31, 2002. A significant portion of this increase is due to life
insurance related policy liabilities and annuity contract liabilities. Policy
reserves established due to the sale of life insurance increased approximately
$819,632 (35%) between 2002 and 2003. These reserves are actuarially determined
based on such factors as insured age, life expectancy, mortality and interest
assumptions. There was an increase in the amount of $2,010,808 (70%) for annuity
contract liabilities from 2002 to 2003. According to the design of FLAC's
primary life insurance product, first year premium payments are allocated 100%
to life insurance and renewal payments are split 50% to life and 50% to annuity.
In 2003, annuity contract liabilities increased as additional policies reached
the second policy year and the renewal policy base grew larger.
The liability for policy claims increased $29,347 from $78,671 at December 31,
2002 to $108,018 at December 31, 2003. The increase was due to an increase in
the number of unpaid claims at December 31, 2003.
Deposits on pending policy applications decreased to $32,491 at December 31,
2003 from $197,013 at December 31, 2002. Deposits on pending policy applications
represent money submitted with policy applications that have not yet been
approved. Any increases or decreases in this liability from year to year are due
to the timing of approval and delivery of the new business.
Other liabilities increased $66,202 from $108,075 at December 31, 2002 to
$174,277 at December 31, 2003. There was an increase of $40,037 in accounts
payable due to the timing of the receipt of significant invoices for legal and
auditing services. Advisory Board Member ("ABM") fees payable increased $29,336
during 2003. ABM fees are payable in common stock of the Company. The increase
in ABM fees payable during 2003 is the result of the stock having yet to be
issued for those fees incurred in 2002 and 2003.
Note payable has decreased $45,837 to $1,843,007 at December 31, 2003 from
$1,888,844 at December 31, 2002. The decrease represents the portion of the note
payments due Western National Bank that have been applied to the principal
amount of the note. During 2003 interest expense for the note was $120,278.
Deferred federal income taxes payable decreased to $760,881 at December 31, 2003
from $1,066,390 at December 31, 2002. Federal income taxes payable are due to
deferred taxes established based on timing differences between income recognized
for financial statements and taxable income for the Internal Revenue Service.
These deferred taxes are based on the operations of the Company and FLAC and on
unrealized gains of fixed maturities. The decrease in deferred income taxes
payable is primarily attributable to the reduction in the tax rate used to
calculate deferred taxes under a consolidated tax return approach from 35% to
34% for the Company and from 35% to 20% for FLAC.
11
Results of Operations
Significant components of revenues include life insurance premiums, net of
reinsurance, and net investment income. The following table provides information
concerning net premium income for the years ended December 31, 2003, 2002, and
2001:
2003 2002 2001
----------- ----------- -----------
Whole life insurance:
First year $ 1,381,964 $ 1,815,415 $ 1,365,755
Renewal 2,247,022 1,595,159 1,034,091
Term insurance:
First year 1,352 4,524 11,814
Renewal 17,724 15,729 8,871
Single premium 9,800 10,580 30,386
----------- ----------- -----------
Gross premium income 3,657,862 3,441,407 2,450,917
Reinsurance premiums assumed 5,943 1,077 15
Reinsurance premiums ceded (126,531) (111,624) (78,203)
----------- ----------- -----------
Net premium income $ 3,537,274 $ 3,330,860 $ 2,372,729
=========== =========== ===========
Net premium income increased $206,414 (6%) from 2002 to 2003 and $958,131 (40%)
from 2001 to 2002. Total first year whole life premium decreased $433,451 (24%)
from 2002 to 2003 and increased $449,660 (33%) from 2001 to 2002. Total renewal
year whole life premiums increased $651,863 (41%) from 2002 to 2003 and $561,068
(54%) from 2001 to 2002. The increase in net premium income has been driven by
increased sales of the Company's Final Expense product and renewal year premiums
collected on the Company's FA2000 product. First year premiums collected on the
FA2000 product have decreased from prior year as a result of the disruptive
affect of the Company's 2003 proxy contest on its customers, shareholders and
its marketing agents used to market the Company's FA2000 product. The Company
anticipates a reduction in FA2000 production will continue in year 2004.
Management is presently reviewing its product portfolio in an effort to manage
production to both the needs and capacity of the Company.
Net investment income decreased $31,012 (5%) from 2002 to 2003 and decreased
$111,473 (16%) from 2001 to 2002. During 2002 short-term investments were
converted to investments in available-for-sale fixed maturity investments, with
lower yields as compared to bonds that have been purchased in prior years. The
decrease in yields resulted in the decrease in net investment income for the
year ended December 31, 2002. During 2003 excess cash was used to purchase
available-for-sale fixed maturity investments, with lower yields as compared to
bonds that have been purchased in prior years. The decrease in yields resulted
in the decrease in net investment income for the year ended December 31, 2003.
Rental income decreased from $214,676 in 2002 to $213,457 in 2003. The decrease
in rental income resulted from a month to month lease being cancelled in
December of 2003. Rental income increased from $106,963 in 2001 to $214,676 in
2002. The increase in rental income resulted from a whole year of leasing of
office space instead of a partial year in 2001. Rental income is earned by
leasing approximately 12,500 square feet of office space in the home office
building. The Company has executed a 10 year inclusive non cancelable lease on
10,000 square feet of the office space.
Benefits and expenses totaled $5,040,455, $4,303,906 and $3,420,581 for the
years ended December 31, 2003, 2002 and 2001, respectively. Included in total
benefits and expenses were policy reserve increases of $819,632, $786,064 and
$603,159 during 2003, 2002, and 2001, respectively. Life insurance reserves are
actuarially determined based on such factors as insured age, life expectancy,
mortality and interest assumptions. As more life insurance is written and
existing policies reach additional durations, it is reasonable for policy
reserves to continue to increase.
Policyholder surrender values increased $59,980 from 2002 to 2003 and $20,408
from 2001 to 2002. This increase is due to the maturation of policies.
12
Interest credited on annuities and premium deposits totaled $304,283, $171,866
and $78,989 for the years ended December 31, 2003, 2002 and 2001, respectively.
The increases during 2003 and 2002 ($132,417 and $92,877, respectively) are
primarily a result of the increase in annuity fund balances. Both interest
credited on annuities and premium deposits have increased as a result of the
increase in the number of policies inforce (6,582, 4,927 and 2,933 in 2003, 2002
and 2001, respectively).
Death claims increased $165,622 from 2002 to 2003 and $38,517 from 2001 to 2002.
The increase is due to the maturation of policies.
Commission expense was $1,235,074, $1,366,805 and $849,576 for the years ended
December 31, 2003, 2002, and 2001, respectively. Commission expense is based on
a percentage of premium and is determined in the product design. Additionally,
higher percentage commissions are paid for first year business than renewal
year. The increases and/or decreases in commission expenses are directly related
to the increases and/or decreases in first year premium income during each
respective period.
Acquisition costs related to the sale of insurance are capitalized and amortized
over the life of the associated policies. These costs include commissions on
first year business, medical exams and inspection report fees, and salaries of
employees directly involved in the marketing, underwriting and policy issuance
functions. During 2003, 2002 and 2001, $1,453,440, $1,680,977 and $1,115,390,
respectively, of these costs had been capitalized as deferred policy acquisition
costs. The related amortization for the same periods totaled $629,068, $423,210,
and $459,124, respectively.
Salaries, wages and employee benefits increased from $1,020,655 in 2001 to
$1,352,175 in 2002 and $1,150,230 in 2003. The increase in 2002 resulted from
the hiring of numerous employees that occupied new positions within the Company.
The decrease in 2003 resulted from a decrease in number of employees in 2003 as
compared to 2002.
Administrative fees - related party were paid to FAC for underwriting,
accounting and other policy services during 2002 and 2001. There were no
administrative fees - related party in 2003. During 2002 and 2001, respectively,
these fees totaled $288,936 and $142,785 and were calculated based on a
percentage of FLAC's premium income collected. The increase in the 2002 amount
is due to the buyout of the administrative agreement for a lump sum amount of
$212,000.
Other operating costs and expenses totaled $1,845,155, $1,394,120 and $1,235,769
for the years ended December 31, 2003, 2002, and 2001, respectively. The
significant increase in 2003 compared to 2002 is directly related to the
Company's 2003 proxy contest and the litigation surrounding the contest as well
as increased legal fees related to the lawsuit filed against the Company's
former President. Significant components of the $451,035 increase from 2002 to
2003 include the following: legal fees of $396,076, annual meeting expenses of
$143,549 and $165,000 in settlement amount paid to AF&L, Inc. in settlement of
its claim. These increases were offset by decreases in agency related expenses
of $106,055, EDP expenses of $35,777, interest expense of 22,948 and travel,
meals and entertainment expenses of $75,059. The decreases in expenses are the
result of management implementing tighter control over expenses during 2003.
Significant components of the $158,351 increase from 2001 to 2002 include the
following: interest expense of $49,593, travel related expenses of $71,253, EDP
consulting of $83,061 and depreciation expense of $47,301.
13
Liquidity and Capital Resources
During the years ended December 31, 2003, 2002, and 2001, the Company maintained
liquid assets sufficient to meet operating demands, while continuing to utilize
excess liquidity for fixed maturity investments. Net cash used in operating
activities during the years ended December 31, 2003, 2002 and 2001 totaled
$179,098, $280,699 and $226,170, respectively. Cash used in operating activities
was directly affected by the Company's 2003 proxy contest, the litigation
surrounding such contest, payment for the legal settlement to AF&L, and the
lawsuit against the Company's former President.
FLAC generally receives adequate cash flow from premium collections and
investment income to meet the obligations of its insurance operations. Insurance
policy liabilities are primarily long-term and generally are paid from future
cash flows. Cash collected from deposits on annuity contracts and policyholder
premium deposits are recorded as cash flows from financing activities. A
significant portion of the Company's invested assets are readily marketable and
highly liquid.
Management of the Company has identified that there may be a need for additional
capital in the long term. Such capital could be used on a working capital basis
or to grow the business. In the event that additional capital is deemed
necessary, the Company may seek to sell additional equity securities, debt
securities or to borrow monies.
The Company's former President and Chief Executive Officer has made a demand on
the Company for the payment of $250,000 in severance benefits under his
employment agreement. The Company denies any such obligation. See Item 3 for
other claims made by the former President and CEO. If these claims are found to
be meritorious, the Company's liquidity could be adversely affected.
14
Item 7. Financial Statements
The consolidated financial statements and related notes are included in this
report beginning on page F-1.
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
NONE
Item 8a. Controls and Procedures
The Company maintains controls and procedures designed to ensure that
information required to be disclosed in the reports that the Company files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission. Based upon their evaluation of those
controls and procedures performed within 90 days of the filing date of this
report, the Chief Executive Officer and Chief Financial Officer of the Company
concluded that the Company's disclosure controls and procedures were adequate.
The Company made no significant changes in its internal controls over financial
reporting or in other factors that could significantly affect these controls
subsequent to the date of the evaluation of those controls by the Chief
Executive Officer and Chief Financial Officer.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16 (a) of the Exchange Act
The current Executive Officers and Directors of the Company are as follows:
Name Age Position
---- --- --------
Harland E. Priddle 73 Chairman of the Board/Secretary/Treasurer
John F. Van Engelen 51 President and CEO
Vincent L. Rocereto 82 Executive Vice President
Paul E. Burke Jr. 70 Director
Edward C. Carter 61 Director
Thomas M. Fogt 58 Director
Kenneth L. Frahm 57 Director
Stephen J. Irsik Jr. 57 Director
John G. Montgomery 64 Director
Gary E. Yager 49 Director
The Directors serve until their successors are elected and qualified. Directors
are elected annually by the stockholders. The Executive Officers serve at the
discretion of the Board of Directors. The President, Secretary and Treasurer are
elected at the annual meeting of the Board, while the other officers are elected
by the Board from time to time as the Board deems advisable. The Executive
Officers and Directors also hold the same positions for the Company's
subsidiaries. The following is a brief description of the previous business
background of the Executive Officers and Directors:
15
Harland E. Priddle: Mr. Priddle has been a Director of the Company since its
inception and has been the Chairman of the Board since November 15, 2002. Mr.
Priddle is President of Priddle & Associates, a business consulting firm
specializing in business and economic development consulting. Mr. Priddle is the
former Kansas Secretary of Agriculture (1982-1986) and served as the first
Kansas Secretary of Commerce (1987-1991). As the first Secretary of Commerce, he
was directly involved in the creation of such programs as Kansas, Inc., Kansas
Technology Enterprise Corporation, Kansas Development Finance Authority and the
Kansas Venture Capital Corp. He was candidate for Lt. Governor of Kansas in 1986
and 1990. He was the Deputy Director of the White House Communications Agency
for the President for a period of four years (1970-1974) where he provided
support and accompanied the President on approximately 200 Presidential trips.
Mr. Priddle was the Vice President for Marketing and Customer Services for the
Hutchinson National Bank from 1978 to 1981. He also has served as Assistant
Manager of the Kansas State Fair (1974-1978) and Executive Director of the
Kansas Wildscape Foundation (1999-2002), a not for profit foundation dedicated
to creating outdoor opportunities in Kansas. He retired from the United States
Air Force in 1974, after 22 years, with the rank of Colonel. While in the Air
Force, he received 17 military decorations including the Bronze Star and two
Legions of Merit. He is a veteran of both Korea and Vietnam Campaigns. He
received a BS in Agriculture from Kansas State University in 1952.
John F. Van Engelen: Mr. Van Engelen was named President and CEO of the Company
on February 16, 2004. Mr. Van Engelen previously was the President of Western
United Life. Mr. Van Engelen joined Western United Life in 1984 as its
underwriting manager, and shortly thereafter he was appointed Vice
President--Underwriting. From 1987 to 1994, he was Vice President--Sales and a
Regional Sales Manager. During 1994, he was appointed President of Western
United Life. Prior to joining Western United Life, Mr. Van Engelen had worked in
the insurance industry and in corporate and public accounting. He holds the
following certifications: CPA, CFP, CLU, CHFC, and FLMI. He is also a member of
the American Institute of Certified Public Accountants, Society of Financial
Service Professionals, National Association of Insurance and Financial Advisors,
and a board member of the New Mexico Life and Health Guaranty Fund. Mr. Van
Engelen holds a Bachelor of Business Administration in Accounting from Boise
State University.
Vincent L. Rocereto: Mr. Rocereto was named Executive Vice President on February
16, 2004. Previously, Mr. Rocereto was the President of the Company since
February 28, 2003. Mr. Rocereto is the former President, CEO and Chairman of the
Board for American Home Life Insurance Company. He retired from American Home
Life Insurance Company in 1986. Mr. Rocereto was employed as a schoolteacher and
a coach between the years of 1946 to 1953. He started his career at American
Home Life as a part time agent while still teaching in 1953. He then became a
full time agent and was promoted to Field Supervisor. Mr. Rocereto eventually
became the Marketing Vice President and later was named Executive Vice
President. Mr. Rocereto has been the President of Kansas Life Insurance
Association. He has served on the International Board on Life Insurance and
Management Research Association. He served as a Board of Director for Merchant
Bank for 20 years. He served on the Kansas Life and Health Guarantee Association
Board. Mr. Rocereto is a Navy veteran of WWII.
Paul E. Burke, Jr.: Mr. Burke, who has been a Director of the Company since its
inception, is the President of Issues Management Group, Inc., a public relations
and governmental affairs consulting company. Mr. Burke served as a member of the
Kansas State Senate from 1975 to January 1997 and served as the President of the
Senate from 1989 until his retirement in 1997. During his tenure in the Kansas
Senate, Mr. Burke served as Chairman of the Organization, Calendar and Rules,
Legislative Coordinating Council and Interstate Cooperation Committees. Mr.
Burke was a majority leader of the Senate from 1985 to 1988. Mr. Burke has
served in numerous national, state and local leadership positions including past
positions as a member of the President's Advisory Commission on
Intergovernmental Relations. He is also the former owner of WEBBCO, Inc., an
industrial engineering and equipment company. Mr. Burke received his Bachelor of
Science degree in business from the University of Kansas in 1956.
16
Edward C. Carter: Mr. Carter, who has been a Director of the Company since its
inception, is an entrepreneur and real estate developer. Mr. Carter is a retired
senior executive (1963-1992) with the Kansas Southwestern Bell Telephone
Company. He served in numerous senior executive positions including Division
Manager Regulatory Relations, Regional Vice President Southwestern Bell Telecom,
a start up company serving a four state area, and Kansas Director of Marketing
and District Manager Residence Service Centers. Mr. Carter served as City
Commissioner and Mayor of Lawrence, Kansas from 1977 to 1981. He was a director
and President of the Lawrence, Kansas Rotary Club, past Executive Board Member
of the Kansas State Chamber of Commerce, past Chairman of the Douglas County
United Fund and Director and President of Junior Achievement. He is a
Co-Recipient of the Outstanding Kansan Award for Civic Service and received the
Lifetime Meritorious Achievement Award from Pittsburgh State University in 2001.
Mr. Carter was a member and All Conference guard on the Pittsburgh State
University National Championship Football Team. He received his B.A. in Business
Administration from Pittsburgh State University in 1963.
Thomas M. Fogt: Mr. Fogt has been a director of the Company since March 31,
2003. Mr. Fogt has over twenty-five years of experience in insurance, financial
management, accounting, corporate development and business planning. He has a
master's degree from Xavier University in business and is a member of the
American Institute of Certified Public Accountants. Mr. Fogt has served as
Executive Vice President for AmerUs Annuity Group Co., a subsidiary of AmerUs
Group, since 1994 with responsibilities for finance and accounting, as well as
mergers and acquisitions. Prior to joining AmerUs, Mr. Fogt was a partner with
the accounting firm of Deloitte & Touche.
Kenneth L. Frahm: Mr. Frahm, who has been a Director of the Company since its
inception, has been a self-employed farmer since 1975. He currently owns 1,200
acres of irrigated corn and dryland wheat production land and is a member of a
family partnership, which produces over 500,000 bushels of corn and wheat
annually on 6,500 acres of western Kansas farm land. Mr. Frahm's operating
entities include Allied Family Farm and Grain Management, Inc. He is past
President of the Kansas Development Finance Authority. He is past Chairman of
21st Century Grain Processing Cooperative, and a former member of the Board of
Directors of Bank IV Community Bank in Colby. In addition, Mr. Frahm is a member
of the Kansas Farm Service Agency State Committee appointed by US Agriculture
Secretary Ann Veneman. He is a member of the Agricultural Use Value Committee of
the Kansas Department of Revenue, an Executive Committee member of the Fort Hays
State University Endowment Association, a past member of the Board of Directors
of the Kansas Area United Methodist Foundation and Chairman of its Investment
Committee, Past President and Paul Harris Fellow of Rotary, a member of the
Kansas Farm Bureau, Kansas Livestock Association, Kansas Corn Growers
Association, Kansas Association of Wheat Growers and serves on the Boards of
Directors of the Ogallala Aquifer Institute and the Kansas Water Congress. Mr.
Frahm is married to Sheila Frahm, a former Kansas United States Senator and has
three daughters. Mr. Frahm received his B.A. in Economics in 1968 from Fort Hays
Kansas State College and his M.B.A. in Finance in 1969 from the University of
Texas at Austin.
Stephen J. Irsik Jr.: Mr. Irsik, who has been a Director of the Company since
its inception, is one of the owners of a multi faceted agri-business centered in
western Kansas. The business deals with identity preserved grain production,
angus beef and the dairy industry. Mr. Irsik is one of the owners of Irsik &
Doll Company, a grain storage, merchandising and full feeding cattle operation
with facilities across the State of Kansas. Mr. Irsik is serving his 16th year
on the Gray County Commission. He currently serves on the 21 Century Alliance
Board, 21Century Grain Processing board and Home National Bank Board of Garden
City, Kansas. Mr. Irsik has served as a past Board member of the Southwest
Kansas Irrigation Association, Upper Ark Basin Advisory committee and Ground
Water Management District #3. He is a graduate of Kansas State University and a
veteran of the United States Air Force.
17
John G. Montgomery: Mr. Montgomery, who has been a Director of the Company since
its inception, is the President of Montgomery Communications, Inc. of Junction
City, Kansas. He is a newspaper publisher and TV station owner. He is also
President of the Junction City Housing and Development Corporation. From 1964 to
1973 he was the Assistant to the President at the San Francisco Newspaper
Printing Company. Mr. Montgomery is a member of the InterAmerican Press
Association, Inland Daily Press Association and the Kansas Press Association. He
was Civilian Aid to the Secretary of the Army of Kansas from 1979-1981 and has
again served in that role since 1995. He has extensive state government service
including Past Chairman of the Kansas Board of Regents, Past member of the
Washburn University Board of Regents, and 1986 Democratic nominee for Lieutenant
Governor. His considerable civic involvement, in part, includes being past
President of the Junction City Chamber of Commerce, Director and past President
of the United Way, past Board member of the Boy Scouts of America, Coronado
Council, past Director of the armed service YMCA, Trustee of the William Allen
White Foundation, Co-chair of Economic Lifelines, Board member of Kansas
Wildscape and the Kansas 4-H and a member of the Rotary Club. Mr. Montgomery has
received the 1975 Jaycees Outstanding Young Man of Kansas Award, 1975 Junction
City Jaycees Distinguished Service Award and the Department of the Army,
Patriotic Civilian Service Award. He graduated from the Philips Academy,
Andover, Massachusetts, in 1958, Yale University in 1962, receiving a Bachelor
of Arts Degree, and from Stanford University in 1964, where he received his MBA
Degree.
Gary E. Yager: Mr. Yager, who has been a Director of the Company since its
inception, became the Vice Chairman of Western National Bank in September of
2002. From December 1995 to September of 2002 Mr. Yager was the Executive Vice
President and Chief Executive Officer and Senior Lender of the Columbian Bank of
Topeka, Kansas. From October 1986 to December 1995, Mr. Yager served as either
the Vice President and Branch Manager or the Vice President of Commercial Loans
for the Commerce Bank and Trust of Topeka, Kansas. From 1976 to 1986, he served
in various management positions with Bank IV of Topeka including Assistant
Vice-President of Correspondent Banking and Branch Manager. Mr. Yager is
currently a member of the Topeka Housing Authority, Topeka Chamber of Commerce,
Art Council of Topeka, the Washburn University Ichabod Club and the Washburn
University Moore Bowl Renovation Committee. Additionally, he currently serves as
President of Downtown Topeka, Inc. and as Chairman of the Business Improvement
District of Topeka. He is a former member of the Board of Directors of the
Topeka Family Service and Guidance Center and former advisor of Junior
Achievement. He is a past member of the Topeka Active 20-30 Club, where he
served in numerous leadership roles including President and Treasurer. Mr. Yager
received his BA degree in Business Administration from Washburn University of
Topeka in 1976.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16 of the Securities Exchange Act of 1934, as amended, requires the
Company's directors and officers, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file initial reports of
ownership and reports of change in ownership with the SEC. Such persons are
required by SEC regulations to furnish the Company with copies of all forms
under Section 16(a). To the Company's knowledge, all filings were made on a
timely basis, other than Thomas M. Fogt, who acquired 200 shares of Company
common stock during 2003. Mr. Fogt has not filed a Form 4 or Form 5 reporting
such acquisition.
Audit Committee
The Board of Directors has a standing Audit Committee established in accordance
with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended. The
Audit Committee is responsible for the selection, review and oversight of the
Company's independent accountants, the approval of all audit, review and attest
services provided by the independent accountants, the integrity of the Company's
reporting practices and the evaluation of the Company's internal controls and
accounting procedures. It also periodically reviews audit reports with the
Company's independent auditors. The Audit Committee is currently comprised of
Gary Yager, John Montgomery and Thomas Fogt. Each of the members of the Audit
Committee are "independent" as that term is defined in Rule 4200(a)(14) of the
Nasdaq Marketplace Rules. The Board of Directors has adopted a written charter
for the Audit Committee. The Board of Directors has determined that Mr. Fogt is
an "audit committee financial expert" as defined under regulations of the SEC.
18
Code of Ethics
The Company has adopted a code of ethics that applies to all executive officers
and directors. A copy of the code of ethics has been filed as an exhibit to this
report.
Item 10. Executive Compensation
The following table sets forth amounts earned by executive officers as
compensation over the past three years:
Annual Compensation
Other Annual All Other
Name and Principal Position Year Salary ($) Bonus ($) (1) Compensation ($) (2) Compensation
-----------------------------------------------------------------------------------------------------------------------------------
Harland E. Priddle 2003 76,154 1,385 - 17,141(3)
Chairman / Treasurer / Secretary and Director 2002 3,600 - - -
2001 - - - -
Vincent L. Rocereto 2003 73,038 1,731 - -
Executive Vice President and Former President / CEO 2002 - - - -
2001 - - - -
Rickie D. Meyer 2003 20,348 30,786 3,500 61,466(4)
Former President / CEO and Director 2002 105,301 104,651 8,131 -
2001 96,271 79,080 5,983 -
Michael N. Fink 2003 - - - 20,269(5)
Former Chairman and Director 2002 64,748 86,199 3,554 -
2001 77,017 63,264 2,792 -
Phillip M. Donnelly 2003 - - - -
Former Treasurer / Secretary and Director 2002 74,895 31,957 - -
2001 72,838 19,783 - -
(1) Bonus amounts for Messrs. Meyer, Fink and Donnelly include incentive
compensation paid in accordance with their Executive Employment Agreements.
Incentive compensation was calculated based on a set percentage of the
first year and renewal year premium collected by the Company. Bonus amounts
for Messrs. Priddle and Rocereto include holiday bonuses paid during the
year. Bonus amounts were calculated as one week's gross pay.
(2) Other Annual Compensation consists of automobile allowances. The aggregate
cost to the Company of such personal benefits did not exceed the lesser of
$50,000 or 10% of the total annual salary and bonus received by the
applicable executive officers.
(3) All Other Compensation for Mr. Priddle includes travel and lodging expenses
paid by the Company for Mr. Priddle to commute between his home in Burrton,
Kansas and the Company's home office in Topeka, Kansas.
(4) All Other Compensation for Mr. Meyer includes $46,689 in severance benefits
paid subsequent to his departure from the Company. Severance benefits were
provided for a three-month period commencing on February 28, 2003. All
Other Compensation also includes $14,777 paid to Mr. Meyer subsequent to
his departure from the Company for vested renewal incentives in accordance
with his Executive Employment Agreement. Vested renewal incentives were
calculated based on a set percentage of the renewal premium collected by
the Company.
(5) All Other Compensation for Mr. Fink includes amounts paid subsequent to his
departure from the Company for vested renewal incentives in accordance with
his Executive Employment Agreement. Vested renewal incentives were
calculated based on a set percentage of the renewal premium collected by
the Company.
19
Compensation of Directors
Each non-employee director is paid $750 per regular meeting attended for the
Company and its subsidiaries, $75 per telephonic meeting and $250 per committee
meeting. In addition, as an annual retainer for non-employee directors, an
attendance pool fee has been established. This pool consists of 1% of the
premiums delivered in each calendar year and is paid to each non-employee
director on a pro-rata basis determined by his attendance of board meetings.
This fee was payable in cash for calendar years 2001 and 2002. No fee was
payable for calendar year 2003 as the pool was terminated during that year.
Executive Employment Agreements
The Company had entered into an Executive Employment Agreement with Mr. Meyer.
The employment agreement for Mr. Meyer was for a term of four years beginning
November 1, 1998. The employment agreement for Mr. Meyer expired on November 1,
2002, but was reinstated for a period of time before lapsing.
On November 15, 2002, Mr. Harland E. Priddle became an at-will employee serving
as the Chairman of the Board, Secretary and Treasurer of the Company and its
subsidiaries. On February 28, 2003, Mr. Vincent L. Rocereto became an at-will
employee serving as President and Chief Executive Officer of the Company and its
subsidiaries. The gross annual base salary under the at-will agreements is
$90,000 and $72,000 for Messrs. Rocereto and Priddle, respectively. Mr. Rocereto
performed the duties of President and Chief Executive Officer until February 16,
2004, at which time he was named Executive Vice President.
On February 16, 2004, the Company entered into an Employment Agreement with Mr.
John F. Van Engelen to serve as President and Chief Executive Officer of the
Company and its subsidiaries. The agreement is for an initial term of one year.
Subsequent to the expiration of the initial term, the agreement becomes an
at-will employment agreement. The agreement calls for a gross annual base salary
of $140,000. In addition, a performance bonus of not less than 20% of the gross
annual base salary will be paid at the end of any calendar year of employment
under the agreement if Mr. Van Engelen's performance is determined to be
satisfactory by the Company's Board of Directors. The performance bonus will be
paid either in cash or shares of the Company's common stock (with the number of
shares determined on the basis of the book value of the stock on the last day of
the calendar year). The agreement also includes an option to purchase 10,000
shares of the Company's common stock at the current book value for a period of
90 days from the effective date of the agreement. In the event that there is a
change in control of the Company, whether during the initial term or during
at-will employment, Mr. Van Engelen may terminate his employment with the
Company within a period of 60 days after the change in control becomes
effective. In such event, Mr. Van Engelen will receive a lump sum cash payment
in the amount of $280,000 within 30 days of his last day of employment. In
addition, if Mr. Van Engelen elects, pursuant to applicable federal or state
law, continuation coverage under the Company's health, major medical or dental
plans, the Company will pay for the same portion or percentage of such coverage
as it was paying prior to his termination of employment, for the first 12 months
of such period of continuation coverage or such lesser period of time as he
remains eligible for and continues to purchase such continuation coverage.
20
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth information as of March 17, 2004, regarding
ownership of Common Stock of the Company by (i) the only persons known by the
Company to own beneficially more than 5% thereof; (ii) the executive officers
and directors individually; and (iii) all officers and directors as a group.
Name and Address of Amount and Nature of
Beneficial Owner Class of Stock Beneficial Ownership Percent of Class
------------------------------------------------------------------------------------------------------------------
Brooke Corporation
10950 Grandview St, Ste 600
Overland Park, KS 66210 Common 450,500 9.61%
Paul E. Burke, Jr.
2009 Camelback Drive
Lawrence, KS 66047 Common 50,000 1.07%
Edward C. Carter
4100 Wimbledon Drive
Lawrence, KS 66047 Common 85,000 1.81%
Thomas M. Fogt
8200 W 101st Ter Common 200 *
Overland Park, KS 66212
Kenneth L. Frahm
Box 849
Colby, KS 67701 Common 40,000 *
Stephen J. Irsik, Jr.
05405 Six Road
Ingalls, KS 67853 Common 69,000 1.47%
Rickie D. Meyer
2955 SW McClure Road, Apt 308 256,000 5.46%
Topeka, KS 66614 Common
John G. Montgomery
510 Redbud Lane
Junction City, KS 66441 Common 45,000 *
Harland E. Priddle
8214 South Haven Rd.
Burrton, KS 67020 Common 40,000 *
Vincent L. Rocereto
1821 Campbell Ave
Topeka, KS 66604 Common - *
John F. Van Engelen
4410 W. Excell
Spokane, WA 99208 Common -(1) *
Gary E. Yager
3521 SW Lincolnshire
Topeka, KS 66614 Common 40,000 *
All Directors and Officers as a Group 369,200 7.88%
* Indicates less than 1% ownership.
(1) Does not include an option to purchase 10,000 shares of Company common
stock at the current book value prior to May 16, 2004.
21
Item 12. Certain Relationships and Related Transactions
The Company contracted with First Alliance Corporation ("FAC"), a Lexington,
Kentucky based insurance holding company and a former 5% or greater shareholder
of the Company, to provide accounting services for FLAC and the Company. Under
the terms of the management agreement, the Company paid fees based on a
percentage of delivered premiums of FLAC. The percentages were 5.5% of first
year premiums; 4% of second year premiums; 3% of third year premiums; 2% of
fourth year premiums; 1% of fifth year premiums; 1% for years six through ten
for ten year policies and .5% in years six through twenty for twenty year
policies. Pursuant to the agreement, the Company incurred $288,936 and $142,785
of fees during 2002 and 2001, respectively.
Effective September 30, 2002 the Company acquired 525,000 shares of its common
stock held by FAC for an aggregate purchase price of $1,002,750. In conjunction
with the agreement to repurchase the stock, the Company also acquired 72,500
shares of its common stock held by six individuals associated with FAC for an
aggregate purchase price of $138,475. In a related agreement, the Company and
FAC agreed to terminate the management agreement between the parties through
which the Company received administrative, reporting and underwriting services
from FAC. Termination of the agreement occurred by the Company making a lump-sum
payment of $212,000 to FAC on September 30, 2002. This amount represented the
then present value of fees anticipated to be earned by FAC under the agreement
which would otherwise have been payable over time. These agreements effectively
severed FAC's financial interest in the Company.
In the past the Company leased approximately 2,500 square feet of the Company's
home office building to Montgomery Communications on a month to month basis.
This lease was cancelable upon the lessor or lessee providing the other party
written notice 60 days prior to termination of the lease. Montgomery
Communications gave the Company written notice to cancel the lease effective
December 2003, at which time the lease was terminated. John Montgomery, a
Director of the Company, is the President of Montgomery Communications.
The Company's note payable was obtained through Western National Bank. Gary
Yager, a Director of the Company, is the Vice Chairman of Western National Bank.
The terms of the note payable were determined by competitive bid.
22
Item 13. Exhibits and Reports on Form 8-K
The following documents are filed as part of this Form 10-KSB:
(a) Financial Statements are attached hereto and included herein on pages F-1
through F-23.
(b) Index to Exhibits
Exhibit No. Description
---------- -----------
3.1 Articles of Incorporation of First American Capital Corporation
(Incorporated by reference from Exhibit 2.1 to the Registrant's
amended Form 10-SB filed August 13, 1999)
3.2 Amendment II To Bylaws of First American Capital Corporation
(Incorporated by reference from Exhibit 3.2 to the Registrant's
Form 10-KSB filed March 31, 2003)
4 Certificate of Designations, Preferences and Relative,
Participating, Optional and Other Special Rights of Preferred
Stock and Qualifications, Limitations, and Restrictions
Thereof of 6% Non-Cumulative, Convertible, Callable Preferred
Stock (Incorporated by reference from Exhibit 3 to the
Registrant's amended Form 10-SB filed August 13, 1999)
10.1 Form of Advisory Board Contract (Incorporated by reference from
Exhibit 6.2 to the Registrant's amended Form 10-SB filed
August 13, 1999)
10.2 Service Agreement amended and restated effective January 1,
2002 between First American Capital Corporation and First Life
America Corporation (Incorporated by reference from Exhibit
10.3 to the Registrant's Form 10-KSB filed March 31, 2003)
10.3 Operating Agreement of First Computer Services, LLC dated
December 1, 2001 (Incorporated by reference from Exhibit 10.10 to
the Registrant's Form 10-KSB filed March 31, 2003)
10.4 Automatic Umbrella and Bulk ADB Reinsurance Agreements
effective September 1, 1998 between First Life America
Corporation and Business Men's Assurance Company of America
(Incorporated by reference from Exhibit 6.8 to the
Registrant's Form 10-SB filed August 13, 1999)
10.5 Employment Agreement effective February 16, 2004 between First
American Capital Corporation and John F. Van Engelen (*)
10.6 Intercompany Tax Sharing Agreement dated December 31, 2003
between First American Capital Corporation and First Life America
Corporation (*)
14.1 First American Capital Corporation Code of Ethics for Executive
Management and Board of Directors (*)
21 Subsidiaries of First American Capital Corporation (Incorporated
by reference from Exhibit 21 to the Registrant's Form 10-KSB filed
March 31, 2003)
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002. (*)
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002. (*)
32.1 Certificate of Chief Executive Officer pursuant to Section 18 U.S.C.
Section 1350 (*)
23
Item 13. Exhibits and Reports on Form 8-K (continued)
Exhibit No. Description
----------- -----------
32.2 Certificate of Chief Financial Officer pursuant to Section 18
U.S.C. Section 1350 (*)
(*) Filed herewith
(c) Reports on Form 8-K.
The Company filed a current report on Form 8-K dated November 12, 2003
announcing the Company's initiation of a lawsuit against its former President
and Director, Rickie D. Meyer, seeking damages for, among other things, abuse of
the Company's expense reimbursement policy, misappropriation of funds,
indemnification, and breach of fiduciary duty. The Company filed a current
report on Form 8-K dated December 19, 2003 disclosing its issuance of a press
release announcing current developments. Subsequent to the year ended December
31, 2003, the Company filed a current report on Form 8-K dated January 29, 2004
announcing current developments. Subsequent to the year ended December 31, 2003,
the Company filed a current report on Form 8-K dated February 23, 2004
announcing that John Van Engelen was named President of the Company. Subsequent
to the year ended December 31, 2003, the Company filed a current report on Form
8-K dated March 16, 2004 announcing current developments.
Item 14. Principal Accountant Fees and Services
All audit related services were pre-approved by the Audit Committee, which
concluded that the provision of such services by Kerber, Eck, & Braeckel LLP was
compatible with the maintenance of that firm's independence in the conduct of
its auditing functions.
The following table represents fees for professional audit services rendered by
Kerber, Eck, & Braeckel LLP for the audit of our annual financial statements and
review of the financial statements included in our quarterly reports.
Years Ended December 31,
2003 2002
-------- --------
Audit fees (1) $ 78,929 $ 45,058
Audit related fees (2) - -
Tax fees (3) - -
All other fees (4) - -
-------- --------
$ 78,929 $ 45,058
======== ========
(1) Audit fees - Consists of fees billed for professional services rendered
for the audit of the Company's annual financial statements and review
of the interim financial statements included in quarterly reports, and
services that are normally provided by Kerber, Eck, & Braeckel LLP in
connection with statutory and regulatory filings or engagements.
(2) Audit related fees - Consists of fees billed for assurance and related
services that are reasonably related to the performance of the audit or
review of financial statements and are not reported under "Audit Fees."
These services include consultations concerning financial accounting
and reporting standards.
(3) Tax fees - Consists of fees billed for professional services for
federal and state tax compliance, tax advice and tax planning.
(4) All other fees - Consists of fees for products and services other than
the services reported above.
24
SIGNATURES
In accordance with Section 13 or 15 (d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
FIRST AMERICAN CAPITAL CORPORATION
By /s/ John F. Van Engelen Date 03/29/04
-------------------------------------------------------- --------------------
John F. Van Engelen, President & Chief Executive Officer
25
SIGNATURES
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By /s/ John F. Van Engelen Date 03/29/04
-------------------------------------------------------- --------------------
John F. Van Engelen, President & Chief Executive Officer
By /s/ Harland E. Priddle Date 03/29/04
-------------------------------------------------------- --------------------
Harland E. Priddle, Chairman/Secretary/Treasurer/
Principal Financial Officer/
Principal Accounting Officer/Director
By /s/ Vincent L. Rocereto Date 03/29/04
-------------------------------------------------------- --------------------
Vincent L. Rocereto, Executive Vice President
By /s/ Thomas M. Fogt Date 03/29/04
-------------------------------------------------------- --------------------
Thomas M. Fogt, Director
By /s/ John G. Montgomery Date 03/29/04
-------------------------------------------------------- --------------------
John G. Montgomery, Director
By /s/ Gary E. Yager Date 03/29/04
-------------------------------------------------------- --------------------
Gary E. Yager, Director
By /s/ Kenneth L. Frahm Date 03/29/04
-------------------------------------------------------- --------------------
Kenneth L. Frahm, Director
By /s/ Edward C. Carter Date 03/29/04
-------------------------------------------------------- --------------------
Edward C. Carter, Director
By /s/ Stephen J. Irsik Jr. Date 03/29/04
-------------------------------------------------------- --------------------
Stephen J. Irsik, Director Jr.
26
FIRST AMERICAN CAPITAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Consolidated Financial Statements Numbers
--------------------------------- -------
Independent Auditors' Report.............................................................. F-2
Consolidated Balance Sheets as of December 31, 2003 and 2002.............................. F-3
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001.................................................... F-5
Consolidated Statements of Comprehensive Income for the years
ended December 31, 2003, 2002 and 2001.............................................. F-6
Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 2003, 2002, and 2001............................................. F-7
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002, and 2001................................................... F-8
Notes to Consolidated Financial Statements................................................ F-10
Independent Auditors' Report
Board of Directors and Shareholders
First American Capital Corporation
We have audited the accompanying consolidated balance sheets of First
American Capital Corporation (a Kansas corporation) and subsidiary as of
December 31, 2003 and 2002, and the related consolidated statements of
operations, comprehensive income, changes in shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 2003. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes 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 financial statements referred to above present
fairly, in all material respects, the consolidated financial position of First
American Capital Corporation and subsidiary as of December 31, 2003 and 2002,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States of America.
KERBER, ECK & BRAECKEL LLP
Springfield, Illinois
March 18, 2004
F-2
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
2003 2002
------------ ------------
ASSETS
Investments:
Securities available for sale, at fair value:
Fixed maturities (amortized cost, $11,432,605
in 2003 and $10,096,482 in 2002) $ 12,032,106 $ 10,760,529
Equity securities (cost of $41,800 in 2003 and 2002) 41,800 41,800
Investments in real estate 274,564 274,564
Policy loans 60,451 65,011
Notes receivable (net of valuation allowance
of $0 in 2003 and $2,368 in 2002) 13,741 28,204
Short-term investments 460,593 416,801
------------ ------------
Total investments 12,883,255 11,586,909
Cash and cash equivalents 397,789 400,062
Investments in related parties 65,200 89,749
Accrued investment income 181,069 177,598
Accounts receivable 296,366 322,421
Deferred policy acquisition costs (net of accumulated
amortization of $2,312,021 in 2003 and $1,682,954 in 2002) 4,010,959 3,186,587
Property and equipment (net of accumulated depreciation
of $383,199 in 2003 and $264,976 in 2002) 2,836,814 2,952,046
Other assets 7,648 31,144
------------ ------------
Total assets $ 20,679,100 $ 18,746,516
============ ============
See notes to consolidated financial statements.
F-3
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS (continued)
DECEMBER 31, 2003 AND 2002
2003 2002
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Policy and contract liabilities:
Future annuity benefits $ 4,899,770 $ 2,888,962
Future policy benefits 3,128,491 2,308,859
Liability for policy claims 108,018 78,671
Policyholder premium deposits 217,976 219,629
Deposits on pending policy applications 32,491 197,013
Reinsurance premiums payable 31,713 39,886
------------ ------------
Total policy and contract liabilities 8,418,459 5,733,020
Commissions, salaries, wages and benefits payable 53,015 55,230
Other liabilities 174,277 108,075
Note payable 1,843,007 1,888,844
Deferred federal income taxes payable 760,881 1,066,390
------------ ------------
Total liabilities 11,249,639 8,851,559
Shareholders' equity:
Common stock, $.10 par value, 8,000,000 shares authorized; 5,449,578 shares
issued and 4,687,078 shares outstanding
in 2003 and 2002 544,958 544,958
Additional paid in capital 12,380,523 12,380,523
Accumulated deficit (2,562,839) (2,076,839)
Accumulated other comprehensive income 452,302 431,798
Less: Treasury stock held at cost (762,500 shares in 2003 and 2002) (1,385,483) (1,385,483)
------------ ------------
Total shareholders' equity 9,429,461 9,894,957
------------ ------------
Total liabilities and shareholders' equity $ 20,679,100 $ 18,746,516
============ ============
See notes to consolidated financial statements.
F-4
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
----------- ----------- -----------
Revenues:
Gross premium income $ 3,657,862 $ 3,441,407 $ 2,450,917
Reinsurance premiums assumed 5,943 1,077 15
Reinsurance premiums ceded (126,531) (111,624) (78,203)
----------- ----------- -----------
Net premium income 3,537,274 3,330,860 2,372,729
Net investment income 558,418 589,430 700,903
Net realized investment gain 4,820 22,848 24,584
Rental income 213,457 214,676 106,963
Other income - 1,334 13,969
----------- ----------- -----------
Total revenue 4,313,969 4,159,148 3,219,148
Benefits and expenses:
Increase in policy reserves 819,632 786,064 603,159
Policyholder surrender values 127,142 67,162 46,754
Interest credited on annuities and
premium deposits 304,283 171,866 78,989
Death claims 251,389 85,767 47,250
Commissions 1,235,074 1,336,805 849,576
Policy acquisition costs deferred (1,453,440) (1,680,977) (1,115,390)
Amortization of deferred policy
acquisition costs 629,068 423,210 459,124
Salaries, wages, and employee benefits 1,150,230 1,352,175 1,020,655
Miscellaneous taxes 131,922 78,778 51,910
Administrative fees - related party - 288,936 142,785
Other operating costs and expenses 1,845,155 1,394,120 1,235,769
----------- ----------- -----------
Total benefits and expenses 5,040,455 4,303,906 3,420,581
----------- ----------- -----------
Loss before income tax expense (726,486) (144,758) (201,433)
----------- ----------- -----------
Income tax (benefit) expense (240,486) 402,468 151,395
----------- ----------- -----------
Net loss $ (486,000) $ (547,226) $ (352,828)
=========== =========== ===========
Net loss per common
share - basic and diluted $ (0.10) $ (0.11) $ (0.07)
=========== =========== ===========
See notes to consolidated financial statements.
F-5
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
---------- ---------- ----------
Net loss $ (486,000) $ (547,226) $ (352,828)
Unrealized (loss) gain on available-for-sale securities:
Unrealized holding (loss) gain during the period (60,789) 392,883 100,335
Less: Reclassification for gains included in net income 4,820 22,848 24,584
Tax benefit (expense) 86,113 (129,514) (28,700)
---------- ---------- ----------
Other comprehensive income 20,504 240,521 47,051
---------- ---------- ----------
Comprehensive loss $ (465,496) $ (306,705) $ (305,777)
========== ========== ==========
Net loss per common share-basic and diluted $ (0.10) $ (0.06) $ (0.06)
========== ========== ==========
See notes to consolidated financial statements.
F-6
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
----------- ----------- -----------
COMMON STOCK:
Balance, beginning of year $ 544,958 $ 543,899 $ 541,886
Common shares issued 0 1,059 2,013
----------- ----------- -----------
Balance, end of year 544,958 544,958 543,899
ADDITIONAL PAID IN CAPITAL:
Balance, beginning of year 12,380,523 12,328,617 12,230,005
Common shares issued 0 51,906 98,612
----------- ----------- -----------
Balance, end of year 12,380,523 12,380,523 12,328,617
ACCUMULATED DEFICIT:
Balance, beginning of year (2,076,839) (1,529,613) (1,176,785)
Net loss (486,000) (547,226) (352,828)
----------- ----------- -----------
Balance, end of year (2,562,839) (2,076,839) (1,529,613)
ACCUMULATED OTHER COMPREHENSIVE INCOME:
Balance, beginning of year 431,798 191,277 144,226
Other comprehensive income 20,504 240,521 47,051
----------- ----------- -----------
Balance, end of year 452,302 431,798 191,277
TREASURY STOCK:
Balance, beginning of year (1,385,483) (244,258) (186,758)
Purchase of 50,000 common shares at $1.15 per share - - (57,500)
Purchase of 597,500 common shares at $1.91 per share - (1,141,225) -
----------- ----------- -----------
Balance, end of year (1,385,483) (1,385,483) (244,258)
----------- ----------- -----------
Total shareholders' equity $ 9,429,461 $ 9,894,957 $11,289,922
=========== =========== ===========
See notes to consolidated financial statements.
F-7
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
---------- ---------- ----------
OPERATING ACTIVITIES:
Net loss $ (486,000) $ (547,226) $ (352,828)
Adjustments to reconcile net loss to net cash
used in operating activities:
Interest credited on annuities and premium deposits 304,283 77,189 82,838
Net realized investment gain (4,820) (22,848) (25,618)
Provision for depreciation 124,093 134,999 87,698
Equity loss in investment in affiliate 46,049 28,832 -
Amortization of premium and accretion of discount on
fixed maturity and short-term investments 87,980 53,849 (6,033)
Interest credited to certificates of deposit balances - (7,018) (47,909)
Realized net loss on disposal of assets 2,179 - 1,034
Provision for deferred federal income taxes (219,401) 403,089 143,692
(Increase) decrease in accrued investment income (3,471) 4,121 (33,232)
Decrease (increase) in accounts receivable 26,055 (217,974) (11,280)
Decrease (increase) in accounts receivable from affiliate - 124,881 (124,881)
Increase in deferred policy acquisition costs, net (824,372) (1,257,767) (656,266)
Decrease (increase) in policy loans 4,560 (31,833) (27,188)
Decrease (increase) in other assets 23,496 (5,072) (7,685)
Increase in future policy benefits 819,632 786,065 603,159
Increase (decrease) in liability for policy claims 29,347 78,671 (22,306)
(Decrease) increase in deposits on pending policy applications (164,522) 24,397 96,237
(Decrease) increase in reinsurance premiums payable (8,173) 7,744 3,581
(Decrease) increase in commissions, salaries, wages and
benefits payable (2,215) 87,131 70,645
Decrease in accounts payable to affiliate - (18,022) (25)
Increase in other liabilities 66,202 16,093 197
---------- ---------- ----------
Net cash used in operating activities $ (179,098) $ (280,699) $ (226,170)
See notes to consolidated financial statements.
F-8
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
------------ ------------ ------------
INVESTING ACTIVITIES:
Purchase of available-for-sale fixed maturities $ (2,816,821) $ (5,152,880) $ (4,537,224)
Sale or maturity of available-for-sale fixed maturities 1,404,000 3,373,352 2,014,503
Additions to property and equipment (12,440) (26,698) (1,865,557)
Dispositions of property and equipment 1,400 - -
Purchases of real estate held for investment - - (274,564)
Purchase of investments in affiliates (21,500) (9,805) (133,776)
Payments on notes receivable 14,463 2,796 44,270
Additions to notes receivable - (31,000) (14,008)
Purchases of short-term investments (466,312) (697,403) (4,031,526)
Sales or maturity of short-term investments 415,000 2,537,643 6,496,662
------------ ------------ ------------
Net cash used in investing activities (1,482,210) (3,995) (2,301,220)
FINANCING ACTIVITIES:
Proceeds from note payable - - 1,301,982
Payments on note payable (45,837) (78,484) (32,672)
Purchase of treasury stock - (1,141,225) (57,500)
Deposits on annuity contracts 1,840,681 1,477,447 886,817
Surrenders on annuity contracts (120,606) (78,540) (24,520)
Policyholder premium deposits 46,858 109,519 96,219
Withdrawals on policyholder premium deposits (62,061) (67,324) (12,058)
------------ ------------ ------------
Net cash provided by financing activities 1,659,035 221,393 2,158,268
------------ ------------ ------------
Decrease in cash and cash equivalents (2,273) (63,301) (369,122)
Cash and cash equivalents, beginning of period 400,062 463,363 832,485
------------ ------------ ------------
Cash and cash equivalents, end of period $ 397,789 $ 400,062 $ 463,363
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH ACTIVITIES :
Interest paid $ 123,449 $ 143,227 $ 93,634
============ ============ ============
Income taxes paid $ - $ 10,500 $ -
============ ============ ============
SCHEDULE OF NON-CASH FINANCING TRANSACTIONS:
Common stock issued to Advisory Board Members $ - $ 52,965 $ 100,625
============ ============ ============
See notes to consolidated financial statements.
F-9
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
First American Capital Corporation (the "Company") is a holding company whose
subsidiary, First Life America Corporation ("FLAC") is primarily engaged in the
business of marketing, underwriting and distributing a broad range of individual
life and annuity insurance products to individuals in eight states.
The Company formed First Capital Venture Inc. ("FCVI"), a venture capital
subsidiary in October of 1998. FCVI has yet to be capitalized.
The various insurance products currently being marketed by FLAC are as follows:
First American 2000 is a modified payment whole life insurance policy with a
flexible premium deferred annuity rider. A modified payment whole life insurance
policy requires premium payments to be made for a certain number of years after
which time the policyholder is entitled to policy benefits without making future
payments. The product combines both a ten and twenty payment period based on the
issue age of the insured. Issue ages from age 0 (30 days) to 20 and 66 to 80 are
ten pay policies and issue ages from 21 to 65 are twenty pay policies. Premium
payments are split between life and annuity based on percentages established in
the product design. First year premium payments are allocated 100% to life
insurance and renewal payments are split 50% to life and 50% to annuity. The
product is being sold in premium units with the ability to purchase either
fractional or multiple units. At the end of the required premium paying period,
the policyholder may continue to make full premium payments into the annuity
rider to provide for greater annuity accumulations.
Golden Eagle Whole Life is available on a simplified issue or graded death
benefit basis. The simplified issue product is issued from age 50 to 85 with
death benefit coverage ranging from a minimum of $2,500 to a maximum of $25,000.
The graded death benefit product is issued from age 50 to 80 with death benefit
coverage ranging from a minimum of $2,000 to a maximum of $10,000. The policy
includes a living benefit rider that pays the actuarial present value of death
benefit upon terminal illness or nursing home confinement. Premiums are level
for life and vary by risk class, sex and issue age.
First Step is a juvenile term product issued from age 0 (30 days) to age 15.
Coverage is sold in units. One unit, consisting of a single premium payment of
$100 purchases $5,000 of death benefit coverage, while two units, consisting of
a single premium payment of $200 purchases $10,000 of coverage. The product
contains a conversion provision allowing it to be converted to a whole life
policy prior to age 21.
FLAT 10 (First Life Affordable Term) is a ten year term product issued from age
20 to 70. It has a re-entry provision allowing the current insured to re-qualify
prior to each ten year period. The re-qualification is essentially
re-underwriting including medical exams and inspections to determine if the risk
has changed or remained the same. The policy expires automatically at age 95.
First Guard 10 is a ten year term product renewable to age 70 and convertible to
age 60. Renewable means the policy is kept inforce as long as the premiums are
paid, but the rates do change each 10 year period. Convertible means that prior
to age 60 the policy can be converted to a permanent plan of insurance. The
product is issued from age 18 to 60. The policy includes an accelerated death
benefit rider. This rider provides that in the event that certain ailments or
medical conditions occur, a 25% or 50% of the base policy coverage could be
paid. The maximum benefit under this rider is $250,000. Payment of an
accelerated benefit does reduce the future death benefit.
SPDA is a single premium deferred annuity contract. Additional deposits are
subject to maximum and minimum restrictions. The contract is issued as a
conventional deferred annuity that meets Federal requirements for tax deferred
accumulation of interest.
F-10
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP"), which for FLAC, differ from statutory accounting practices
prescribed or permitted by the Kansas Insurance Department ("KID").
Certain amounts from prior years have been reclassified to conform with the
current year's presentation. These reclassifications had no effect on previously
reported net income or shareholders' equity.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts and
operations of the Company and its subsidiary, FLAC. All intercompany accounts
and transactions are eliminated in consolidation.
Management's Estimates
The 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 amounts reported in the financial
statements and accompanying notes. As more information becomes known, actual
results could differ from those estimates.
Investments
The Company classifies all of its fixed maturity investments as
available-for-sale. Available-for-sale fixed maturities are carried at fair
value with unrealized gains and losses, net of applicable taxes, reported in
other comprehensive income. Equity securities are carried at fair value with
unrealized gains and losses, net of applicable taxes, reported in other
comprehensive income. Policy loans are carried at unpaid balances. Cash
equivalents consist of highly liquid investments with maturities of three months
or less at the date of purchase and are carried at cost, which approximates fair
value. Notes receivable are reported at unpaid principal balance, net of
allowance for uncollectible amounts. Short-term investments consist of
investments with original maturities of three months to one year and are carried
at cost, which approximates fair value. Realized gains and losses on sales of
investments are recognized in operations on the specific identification basis.
Interest earned on investments is included in net investment income. Investments
in related parties are reported using the equity method (see Note 5).
Property and Equipment
Property and equipment, including the home office building (see Note 6), are
carried at cost less accumulated depreciation. Accumulated depreciation on the
office building and land improvements is calculated using the straight-line
method over the estimated useful lives of the respective assets. Accumulated
depreciation on furniture, fixtures and equipment is calculated using the 200%
declining balance method over the estimated useful lives of the respective
assets. The estimated useful lives are generally as follows:
Building and capitalized interest 39 years
Land improvements 15 years
Furniture, fixtures and equipment 3 to 7 years
F-11
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Office Lease
The Company is currently located in a new office building owned by the Company
in Topeka, Kansas. During 2001, the Company terminated the previous office
lease. Rent expense incurred under this previous agreement for the year ended
December 31, 2001 totaled $16,995.
Deferred Policy Acquisition Costs
Commissions and other costs of acquiring life insurance, which vary with, and
are primarily related to, the production of new business have been deferred to
the extent recoverable from future policy revenues and gross profits. The
acquisition costs are being amortized over the premium paying period of the
related policies using assumptions consistent with those used in computing
policy reserves.
Future Policy Benefits
The liabilities for future policy benefits on the Company's life insurance
products are computed using the net level premium method and assumptions as to
investment yields, mortality, withdrawals and other assumptions, modified as
necessary to reflect anticipated trends and to include provisions for possible
adverse deviations. Reserve interest assumptions ranged from 6.50 to 7.25
percent.
Future Annuity Benefits
Annuity contract liabilities are computed using the retrospective deposit method
and consist of policy account balances before deduction of surrender charges,
which accrue to the benefit of policyholders. Premiums received on annuity
contracts are recognized as an increase in a liability rather than premium
income. Interest credited on annuity contracts is recognized as an expense. The
range of interest crediting rates for annuity products was 4.75 to 7.88 percent
in 2003 and 2002 and 7.50 to 7.75 in 2001.
Liability for Policy Claims
Policy claim liabilities are based on reported death claims.
Policyholder Premium Deposits
Policyholder premium deposits represent premiums received for the payment of
future premiums on existing policyholder contracts. Interest is credited on
these deposits at the rate of 6%. The premium deposits are recognized as an
increase in a liability rather than premium income. Interest credited on the
premium deposits is recognized as an expense.
Premiums
Life insurance premiums for limited payment contracts are recorded according to
Statement of Financial Accounting Standard ("SFAS") No. 97. "Accounting and
Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for
Realized Gains and Losses from the Sale of Investments." Any gross premium in
excess of net premium is deferred and recognized in income in a constant
relationship with insurance in force.
F-12
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Federal Income Taxes
The Company uses the liability method of accounting for income taxes. Deferred
income taxes are provided for cumulative temporary differences between balances
of assets and liabilities determined under accounting principles generally
accepted in the United States of America and balances determined for tax
reporting purposes.
Reinsurance
Estimated reinsurance receivables are reported as assets and are recognized in a
manner consistent with the liabilities related to the underlying reinsured
contracts, in accordance with SFAS No. 113, "Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts."
Net Earnings (Loss) Per Common Share
Net income (loss) per common share for basic and diluted earnings per share is
based upon the weighted average number of common shares outstanding during each
year. The weighted average outstanding common shares were 4,687,078, 5,120,804
and 5,294,418 for the years ended December 31, 2003, 2002 and 2001,
respectively.
Comprehensive Income
SFAS No. 130 requires unrealized gains and losses on the Company's
available-for-sale securities to be recorded as a component of accumulated other
comprehensive income. Unrealized gains and losses recognized in accumulated
other comprehensive income that are later recognized in net income through a
reclassification adjustment are identified on the specific identification
method.
F-13
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. INVESTMENTS
The amortized cost and fair value of investments in fixed maturities at December
31, 2003 and 2002 are summarized as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
December 31, 2003:
------------------
U.S. Government Agency $ 3,428,817 $ 115,827 $ 4,882 $ 3,539,762
Corporate bonds 8,003,788 495,637 7,081 8,492,344
----------- --------- -------- -----------
Total $11,432,605 $ 611,464 $ 11,963 $12,032,106
=========== ========= ======== ===========
Equity securities $ 41,800 $ - $ - $ 41,800
=========== ========= ======== ===========
December 31, 2002:
------------------
U.S. Government Agency $ 3,976,796 $ 199,142 $ - $4,175,938
Corporate bonds 6,119,687 468,801 3,896 6,584,592
----------- --------- -------- -----------
Total $10,096,482 $ 667,943 $ 3,896 $10,760,529
=========== ========= ======== ===========
Equity securities $ 41,800 $ - $ - $ 41,800
=========== ========= ======== ===========
The amortized cost and fair value of fixed maturities at December 31, 2003, by
contractual maturity, are shown below. Actual maturities may differ from
contractual maturities because certain borrowers may have the right to call or
prepay obligations.
Amortized Cost Fair Value
-------------- -----------
Due in one year or less $ 1,576,336 $ 1,603,312
Due after one year through five years 5,511,889 5,818,544
Due after five years through ten years 3,589,673 3,860,000
Due after ten years 754,707 750,250
----------- -----------
$11,432,605 $12,032,106
=========== ===========
The fair values for investments in fixed maturities are based on quoted market
prices.
On June 20, 2000, the Company purchased, through a private placement, 168,000
shares of the common stock of Mid-Atlantic Capital Corporation ("MCC") of
Charleston, West Virginia for $16,800. On August 16, 2001, the Company
purchased, through a private placement, 250,000 shares of the common stock of
Arkansas Security Capital Corporation ("ASCC") of Springdale, Arkansas for
$25,000. These investments are restricted under Rule 144 of the Securities Act
of 1933. There are no quoted market prices for these investments as these
companies are still in the developmental stage.
Included in investments are securities, which have been pledged to various state
insurance departments. The fair value of these securities were $2,172,541 and
$2,199,038 at December 31, 2003 and 2002, respectively.
F-14
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. INVESTMENTS (CONTINUED)
During 2003, the Company had gross realized investment gains of $4,820.
Investment gains were $39,454 and $26,746 during 2002 and 2001, respectively.
During 2003, the Company did not have any gross realized investment losses.
Gross realized investment losses totaled $16,606 and $2,162 in 2002 and 2001,
respectively.
During 2002, the Company issued a $31,000 note to an employee of the Company.
The note was to be payable in 36 equal monthly installments and bear interest at
8% per annum. During 2003, the note was called as a result of the employee
failing to pay one of the monthly installments when due. Subsequent to the note
being called, demand payments have been recovered from both the employee and the
guarantor of the note. The remaining principal balance of the note was $13,741
and $28,204 at December 31, 2003, and 2002, respectively. No valuation allowance
was assessed against the note at December 31, 2003 and 2002.
During July of 2000, advances to agents in the amount of $60,053 were converted
to notes receivable to be collected over a three-year term. The notes accrued
interest at 9.5% per annum. Total payments of $2,038 were received against these
notes during 2002. The principal balance due on the notes at December 31, 2003
and 2002 was $0 (net of valuation allowance of $0) and $0 (net of valuation
allowance of $2,368), respectively.
The carrying value of short-term investments approximates their fair value. At
December 31, 2003 and 2002 the fair value of short-term investments was $460,593
and $416,801, respectively.
Interest income consists of interest earned on notes receivable, policy loans,
available-for-sale securities and short-term investments, which include
certificates of deposit.
Following are the components of net investment income for the years ended
December 31, 2003, 2002 and 2001:
Years ended December 31,
2003 2002 2001
--------- --------- ---------
Fixed maturities $ 549,369 $ 545,051 $ 482,201
Notes receivables 1,697 2,051 3,065
Short-term and other investments 10,970 44,718 218,936
--------- --------- ---------
Gross investment income 562,036 591,820 704,202
Investment expenses (3,618) (2,390) (3,299)
--------- --------- ---------
Net investment income $ 558,418 $ 589,430 $ 700,903
========= ========= =========
4. CONCENTRATIONS OF CREDIT RISK
Credit risk is limited by emphasizing investment grade securities and by
diversifying the investment portfolio among U.S. Government Agency and Corporate
bonds. Credit risk is further minimized by investing in certificates of deposit.
Certain certificates of deposit and cash balances exceed the maximum insurance
protection of $100,000 provided by the Federal Deposit Insurance Corporation
("FDIC"). However, both certificates of deposit balances and cash balances
exceeding this maximum are protected through additional insurance. The Company
has not experienced any losses in such accounts and believes it is not exposed
to any significant credit risk on cash and cash equivalents.
F-15
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. INVESTMENTS IN RELATED PARTIES
During 2001, the Company purchased a 50% interest in First Computer Services,
LLC ("FCS"). FCS owns the computer hardware and software that operates the
Company's policy administration, underwriting, claim processing, and accounting
system. The company uses the equity method to account for this investment, which
is owned jointly by the Company and First Alliance Corporation ("FAC") of
Lexington, Kentucky. As of December 31, 2003 and 2002, the carrying value of the
FCS investment was $65,200 and $89,749, respectively. The current year amount
represents an investment of $146,500 reduced by cumulative net operating losses
totaling $81,300. Selected financial data for FCS for the year ended December
31, 2003 is listed below.
Total Assets: $ 130,400
Total Liabilities: -
Total Liabilities and Equity: 130,400
Loss from Operations: (92,099)
6. PROPERTY AND EQUIPMENT
The Company owns approximately six and one-half acres of land located in Topeka,
Kansas. A 20,000 square foot office building has been constructed on
approximately one-half of this land. The remaining land, including improvement
costs, is classified as real estate held for investment. On May 1, 2001, the
Company relocated its home office facilities to the newly constructed building.
The Company occupies approximately 7,500 square feet of the building and the
remaining 12,500 square feet is leased (see Note 7).
2003 2002
---------- ----------
Land and improvements $ 357,675 $ 357,675
Building and capitalized interest 2,605,330 2,605,330
Furniture, fixtures and equipment 257,008 254,017
---------- ----------
Total property and equipment 3,220,013 3,217,022
Less - accumulated depreciation and amortization (383,199) (264,976)
---------- ----------
Net property and equipment $2,836,814 $2,952,046
========== ==========
7. LEASES
The Company owns a 20,000 square foot office building and occupies approximately
7,500 square feet. The company has leased the remaining 12,500 square feet to
two separate entities. The Company has leased approximately 2,500 square feet on
a month to month basis. This lease was cancelled in December 2003. The remaining
10,000 square feet is leased under a 10 year inclusive non cancelable lease that
commenced on July 1, 2001 and will end on June 30, 2011. The lessee may
terminate this lease after 5 years, on or after June 30, 2006 upon 90 days
notification in writing to the lessor. The future minimum lease payments to be
received under non cancelable lease agreements at December 31, 2003 are
approximately as follows:
Year Ending
December 31, Amount
------------ --------
2004 $181,990
2005 181,990
2006 90,995
--------
Total $454,974
========
F-16
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. FEDERAL INCOME TAXES
Effective June 30, 2003, the Company commenced calculating deferred taxes based
on a consolidated income tax return approach. The impact of this change in
accounting estimate is reflected in the year ended December 31, 2003 summary of
operations. Income tax expense was reduced by $347,412, or $.07 per share, for
the year ended December 31, 2003, resulting in an income tax benefit of $240,486
for the year ended December 31, 2003.
The Company has elected to file a consolidated federal income tax return with
FLAC for the year ended December 31, 2003. FLAC is taxed as a life insurance
company under the provisions of the Internal Revenue Code and had to file a
separate tax return for its initial five years of existence. Federal income tax
expense for the years ended December 31, 2003, 2002, and 2001 consisted of the
following:
Years ended December 31,
2003 2002 2001
--------- -------- --------
Current $ (21,089) $ - $ 7,703
Deferred (219,397) 402,468 143,692
--------- -------- --------
Federal income tax (benefit) expense $(240,486) $402,468 $151,395
========= ======== ========
Federal income tax expense differs from the amount computed by applying the
statutory federal income tax rate for 2003, 2002 and 2001 as follows:
Years ended December 31,
2003 2002 2001
--------- -------- --------
Federal income tax expense (benefit) at statutory rate $(247,005) $(50,665) $ (70,502)
Small life insurance company deduction (51,616) - (29,936)
Increase in valuation allowance 234,152 480,683 254,674
Surtax exemptions - - (9,650)
Income tax recoverable from NOL carryback (21,089) - -
Other (154,928) (27,550) 6,809
--------- -------- --------
Federal income tax (benefit) expense $(240,486) $402,468 $151,395
========= ======== ========
F-17
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. FEDERAL INCOME TAXES (CONTINUED)
Deferred federal income taxes reflect the impact of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and such amounts as measured by tax laws and regulations. Significant components
of the Company's net deferred tax liability are as follows:
December 31,
2003 2002
------------ -----------
Deferred tax liability:
Due and deferred premiums $ 16,153 $ 38,150
Deferred policy acquisition costs 675,324 937,917
Accrual of discount 11,387 -
Net unrealized investment gains 146,395 232,508
---------- -----------
Total deferred tax liability 849,259 1,208,575
Deferred tax asset:
Policy reserves 82,035 128,705
Reinsurance premiums 6,343 13,480
Net operating loss carryforward 1,602,890 1,370,274
Capital loss carryforward 1,536 -
---------- -----------
Total deferred tax asset 1,692,804 1,512,459
Valuation allowance (1,604,426) (1,370,274)
---------- -----------
Net deferred tax asset 88,378 142,185
---------- -----------
Net deferred tax liability $ 760,881 $ 1.066.390
========== ===========
The Company has net operating loss carryforwards of approximately $4,261,838
expiring in 2011 through 2023. The Company can offset $3,462,597 of the total
net operating loss carryforwards against 35% of FLAC's taxable income. FLAC has
approximately $769,325 of net operating loss carryforwards expiring in 2022 and
2023.
F-18
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. NOTE PAYABLE
On July 20, 2001, the Company borrowed $2 million from Columbian Bank and Trust
Company secured by its home office building (See Note 6). The note was scheduled
to mature on July 15, 2016. The note was payable in 120 monthly payments of
$18,000 each and 59 monthly payments of $18,444 each and a final payment of the
balance due. The lender could, when an increase occurred in the interest rate,
increase the amount of the monthly payment or increase the number of payments
required. Interest was payable monthly based on the 5-year T-Bill rate (4.40% at
the date of the loan) plus a margin of 2.60 percentage points. The interest rate
would have been recomputed at the end of 5 years and 10 years based on the
current 5-year T-Bill rate at that time.
On April 22, 2003, the Company refinanced the note to Columbian Bank and Trust
Company with a note from Western National Bank (See Note 13). The note is
secured by the home office building. The note will mature on April 22, 2013. The
note is payable in 120 monthly payments of $13,534 each with a final payment of
the unpaid principal balance and interest on April 22, 2013. Interest will be
accrued at 6% until April 22, 2008 at which time the rate may change. The
interest rate change will be the Wall Street Journal Prime Rate of Interest,
subject to a floor of 6% and a ceiling of 9.5%.
Required future principle payments are as follows:
Principal
Year Payment
-------------- -----------
2004 51,400
2005 54,936
2006 58,373
2007 62,024
2008 65,624
Thereafter 1,550,650
---------
Total 1,843,007
=========
10. SHAREHOLDERS' EQUITY AND STATUTORY ACCOUNTING PRACTICES
FLAC prepares its statutory-basis financial statements in accordance with
statutory accounting practices ("SAP") prescribed or permitted by the KID.
Currently, "prescribed" statutory accounting practices include state insurance
laws, regulations, and general administrative rules, as well as the National
Association of Insurance Commissioners ("NAIC") Accounting Practices and
Procedures Manual and a variety of other NAIC publications. "Permitted"
statutory accounting practices encompass all accounting practices that are not
prescribed; such practices may differ from state to state, may differ from
company to company within a state, and may change in the future. During 1998,
the NAIC adopted codified statutory accounting principles ("Codification").
Codification replaced the NAIC Accounting Practices and Procedures Manual and
was effective January 1, 2001. The impact of Codification was not material to
FLAC's statutory-basis financial statements.
F-19
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. SHAREHOLDERS' EQUITY AND STATUTORY ACCOUNTING PRACTICES (CONTINUED)
Net income for 2003, 2002, and 2001 and capital and surplus at December 31,
2003, 2002, and 2001 for the Company's insurance operations as reported in these
financial statements prepared in accordance with GAAP as compared to amounts
reported in accordance with SAP prescribed or permitted by the KID are as
follows:
GAAP SAP
-------------------------------------- --------------------------------------
Net Income Capital and Net Income Capital and
(loss) Surplus (loss) Surplus
------------------- ------------------ ----------------- -----------------
2003 609,166 5,796,464 (253,955) 2,615,342
2002 78,160 5,190,658 (671,551) 2,879,079
2001 381,230 4,922,152 17,465 3,698,742
Principal differences between GAAP and SAP include: a) costs of acquiring new
policies are deferred and amortized for GAAP; b) benefit reserves are calculated
using more realistic investment, mortality and withdrawal assumptions for GAAP;
c) statutory asset valuation reserves are not required for GAAP; and d)
available-for-sale fixed maturity investments are reported at fair value with
unrealized gains and losses reported as a separate component of shareholders'
equity for GAAP.
Statutory restrictions limit the amount of dividends, which may be paid by FLAC
to the Company. Generally, dividends during any year may not be paid without
prior regulatory approval, in excess of the lesser of (a) 10% of statutory
shareholders' surplus as of the preceding December 31, or (b) statutory net
operating income for the preceding year. In addition, FLAC must maintain the
minimum statutory capital and surplus required for life insurance companies in
those states in which it is licensed to transact life insurance business.
The KID imposes on insurance enterprises minimum risk-based capital ("RBC")
requirements that were developed by the NAIC. The formulas for determining the
amount of RBC specify various weighing factors that are applied to financial
balances or various levels of activity based on the perceived degree of risk.
Regulatory compliance is determined by ratio (the "Ratio") of the enterprises
regulatory total adjusted capital, as defined by the NAIC, to its authorized
control level RBC, as defined by the NAIC. Enterprises below specific trigger
points or ratios are classified within certain levels, each of which requires
specified corrective action. FLAC has a ratio that is in excess of the minimum
RBC requirements; accordingly, FLAC meets the RBC requirements.
11. COMMITMENTS AND CONTINGENCIES
On November 12, 2003, the Company filed a petition in the District Court of
Shawnee County, Kansas asserting claims against Rickie D. Meyer, the Company's
former President, arising, in part, out of Mr. Meyer's employment with the
Company. Among other things, the Company is seeking to recover expense
reimbursements previously paid to Mr. Meyer and Company funds allegedly
misappropriated by Mr. Meyer. In this regard, the petition alleges that Mr.
Meyer abused Company policies related to claiming business- related expense
reimbursements by submitting expense reports for goods and services purchased
for personal use. The petition further alleges that Mr. Meyer misappropriated
funds from the Company by fraudulently altering a check made payable to the
Company. The Company is also seeking to have Mr. Meyer reimburse it for the
amount it paid another insurance company in settlement of a claim. On August 8,
2003, the Company settled a claim that it had breached various marketing
agreements with AF&L, a long-term care insurance company, and certain of its
affiliates, through the payment to AF&L of $150,000 plus $15,000 in attorney
fees. The petition asserts that Meyer entered into the marketing agreements
despite knowing that the Company could not perform on the financial requirements
of the agreements and without the knowledge, approval or authorization of the
Company's Board of Directors.
F-20
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. COMMITMENTS AND CONTINGENCIES (CONTINUED)
On December 12, 2003, Meyer filed an Answer and Counterclaim against FACC
asserting claims for defamation and breach of employment agreement. Meyer seeks
damages in excess of $75,000 plus interest and costs on his defamation claims.
Meyer seeks damages in the amount of $250,000 for an alleged breach of a
provision in his employment contract regarding severance pay; he seeks
additional damages in excess of $75,000 for an alleged breach of a provision in
the employment contract relating to payment of residual commissions.
FACC denies Meyer allegations and will defend against them as well as pursue its
lawsuit against Meyer.
12. REINSURANCE
In order to reduce the risk of financial exposure to adverse underwriting
results, insurance companies reinsure a portion of their risks with other
insurance companies. FLAC has entered into agreements with Generali USA Life
Reassurance Company ("Generali") of Kansas City, Missouri, as well as Optimum Re
Insurance Company ("Optimum Re") of Dallas, Texas, to reinsure portions of the
life insurance risks it underwrites. Pursuant to the terms of the agreements,
FLAC retains a maximum coverage exposure of $50,000 on any one insured.
Currently, insurance ceded to Optimum Re is limited to the 10-year term
policies. At December 31, 2003 and 2002, respectively, FLAC ceded inforce
amounts totaling $35,734,200 and $37,665,863 of ordinary business and
$36,920,000 and $36,508,000 of accidental death benefit risk.
Pursuant to the terms of the agreement with BMA, FLAC generally pays no
reinsurance premiums on first year individual business. However, SFAS No. 113
requires the unpaid premium to be recognized as a first year expense and
amortized over the estimated life of the reinsurance policies. FLAC records this
unpaid premium as "reinsurance premiums payable" in the accompanying balance
sheet and as "reinsurance premiums ceded" in the accompanying income statement.
At December 31, 2003 and 2002, respectively, the unpaid reinsurance premiums net
of amortization totaled $ 31,713 and $39,886. To the extent that the reinsurance
companies are unable to fulfill their obligations under the reinsurance
agreements, FLAC remains primarily liable for the entire amount at risk.
Effective April 1, 2001, FLAC entered into an Automatic Retrocession Pool
Agreement (the "Reinsurance Pool") with Optimum Re, Catholic Order of Foresters,
American Home Life Insurance Company and Woodmen of the World. The agreement
provides for automatic retrocession of coverage in excess of Optimum Re's
retention on business ceded to Optimum Re by the other parties to the
Reinsurance Pool. FLAC's maximum exposure on any one insured under the
Reinsurance Pool is $50,000. During 2003 and 2002, respectively, FLAC assumed
inforce amounts totaling $13,460,796 and $7,101,312.
13. RELATED PARTY TRANSACTIONS
The Company contracted with FAC to provide underwriting and accounting services
for FLAC and the Company. Under the terms of the management agreement, the
Company paid fees based on a percentage of delivered premiums of FLAC. The
percentages were 5.5% of first year premiums; 4% of second year premiums; 3% of
third year premiums; 2% of fourth year premiums, 1% of fifth year premiums, and
1% for years six through ten for ten year policies and .5% in years six through
twenty for twenty year policies. Pursuant to the agreement, the Company incurred
$288,936 and $142,785 of fees during 2002 and 2001, respectively.
F-21
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. RELATED PARTY TRANSACTIONS (CONTINUED)
Effective September 30, 2002 the Company acquired 525,000 shares of its common
stock held by FAC for an aggregate purchase price of $1,002,750. In conjunction
with the agreement to repurchase the stock, the Company also acquired 72,500
shares of its common stock held by six individuals associated with FAC for an
aggregate purchase price of $138,475. In a related agreement, the Company and
FAC agreed to terminate the management agreement between the parties through
which the Company received administrative, reporting and underwriting services
from FAC. Termination of the agreement occurred by the Company making a lump-sum
payment of $212,000 to FAC on September 30, 2002. This amount represented the
then present value of fees anticipated to be earned by FAC under the agreement
which would otherwise have been payable over time. These agreements effectively
severed FAC's financial interest in the Company.
The Company's note payable (See Note 9) was obtained through Western National
Bank. A Director of the Company is the Vice Chairman of Western National Bank.
The terms of the note payable were determined by competitive bid.
14. FAIR VALUES OF FINANCIAL INSTRUMENTS
The fair values of financial instruments, and the methods and assumptions used
in estimating their fair values, are as follows:
Fixed Maturities
Fixed maturities are carried at fair value in the accompanying consolidated
balance sheets. The fair value of fixed maturities are based on quoted market
prices. At December 31, 2003 and 2002, the fair value of fixed maturities was
$12,032,106 and $10,760,529, respectively.
Equity Securities
Equity securities are carried at fair value in the accompanying consolidated
balance sheets. The fair value of equity securities are based on quoted market
prices, however there are no quoted market prices for these investments as these
companies are still in the developmental stage. At December 31, 2003 and 2002,
the fair value of fixed maturities was $41,800.
Short-term Investments
The carrying value of short-term investments approximates their fair value. At
December 31, 2003 and 2002, the fair value of short-term investments was
$460,593 and $416,801, respectively.
Cash and Cash Equivalents
The carrying value of cash and cash equivalents approximates their fair value.
At December 31, 2003 and 2002, the fair value of cash and cash equivalents was
$397,789 and $400,062, respectively.
Policy Loans
The carrying value of policy loans approximates their fair value. At December
31, 2003 and 2002, the fair value of policy loans was $60,451 and $65,011,
respectively.
Investments in Related Parties
The Company holds investments in related parties of $65,200 and $89,749 at
December 31, 2003 and 2002, respectively. The balance represents the Company's
investment in First Computer Services, LLC ("FCS"). The company uses the equity
method to account for this investment. Refer to Note 5 for more information.
F-22
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED)
Notes Receivable
The carrying value of notes receivable approximates their fair value. At
December 31, 2003 and 2002, the fair value of notes receivable was $13,741 and
$28,204 respectively.
15. SEGMENT INFORMATION
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," became effective for 1998 and superseded SFAS No. 14. SFAS No. 131
requires a "management approach" (how management internally evaluates the
operating performance of its business units) in the presentation of business
segments. The segment data that follows has been prepared in accordance with
SFAS No. 131. The operations of the Company and its subsidiaries have been
classified into two operating segments as follows: life and annuity insurance
operations and corporate operations. Segment information as of December 31,
2003, 2002 and 2001 and for the years then ended is as follows:
2003 2002 2001
----------- ----------- ------------
Revenues:
Life and annuity insurance operations $ 3,988,400 $ 3,712,523 $ 2,704,352
Corporate operations 325,569 446,625 514,796
----------- ----------- -----------
Total $ 4,313,969 $ 4,159,148 $ 3,219,148
=========== =========== ===========
Income (loss) before income taxes:
Life and annuity insurance operations $ 368,682 $ 480,628 $ 532,626
Corporate operations (1,095,168) (625,386) (734,059)
----------- ----------- -----------
Total $ (726,486) $ (144,758) $ (201,433)
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Depreciation and amortization expense:
Life and annuity insurance operations $ 629,068 $ 423,210 $ 459,124
Corporate operations 124,093 134,999 87,698
----------- ----------- -----------
Total $ 753,161 $ 558,209 $ 546,822
=========== =========== ===========
Assets:
Life and annuity insurance operations $15,053,265 $12,090,507 $ 8,795,709
Corporate operations 5,625,835 6,656,009 8,444,254
----------- ----------- -----------
Total $20,679,100 $18,746,516 $17,239,963
=========== =========== ===========
F-23