United States Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the quarterly period ended June 30, 2006.
[ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the transition period from to
----------- ----------------.
Commission file number : 0-25679
FIRST AMERICAN CAPITAL CORPORATION
----------------------------------------------------
(Exact Name of small business issuer in its charter)
Kansas 48-1187574
------------------------ ---------------------------------------
(State of incorporation) (I.R.S. Employer Identification Number)
1303 S.W. First American Place Topeka, Kansas 66604
--------------------------------------------------------------------------------
(Address of principal executive offices)
Issuer's telephone number (785) 267-7077
-----------------------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ ] No [X]
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 - 4,257,057 shares as of August 1, 2006
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X ]
FIRST AMERICAN CAPITAL CORPORATION
INDEX TO FORM 10-QSB
Part I. FINANCIAL INFORMATION Page Numbers
------------------------------ ------------
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 2006
and December 31, 2005.................................................. 3
Condensed Consolidated Statements of Operations for the
three months ended June 30, 2006 and 2005 and for the
six months ended June 30, 2006 and 2005................................ 5
Condensed Consolidated Statements of Comprehensive Income for the
three months ended June, 2006 and 2005 and for the
six months ended June 30, 2006 and 2005................................ 6
Condensed Consolidated Statements of Cash Flows for the
six months ended June 30, 2006 and 2005................................ 7
Notes to Condensed Consolidated Financial Statements......................... 9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...............................................13
Item 3. Controls and Procedures.............................................20
Part II. OTHER INFORMATION
--------------------------
Item 4. Submission of Matters to a Vote of Security Holders.................21
Item 6. Exhibits and Reports on Form 8-K.....................................21
SIGNATURES...................................................................22
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FIRST AMERICAN CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, December 31,
Assets 2006 2005
-------------------- --------------------
Investments:
Securities available-for-sale, at fair value:
Fixed maturities (amortized cost, $11,773,264
in 2006 and $13,960,005 in 2005) $ 11,166,226 $ 13,854,375
Equity securities (cost of $258,400 in 2006
and $458,150 in 2005) 238,631 456,760
Investments in real estate 274,564 274,564
Policy loans 141,930 103,493
Mortgage loans on real estate 1,538,953 1,566,382
Other investments 2,854,364 1,656,866
-------------- --------------
Total investments 16,214,668 17,912,440
Cash and cash equivalents 1,076,457 249,109
Accrued investment income 226,508 250,984
Accounts receivable 203,937 272,200
Reinsurance receivables 112,775 78,725
Deferred policy acquisition costs (net of accumulated
amortization of $4,078,112 in 2006 and $3,712,369 in
2005) 5,204,752 5,133,244
Property and equipment (net of accumulated depreciation
of $474,692 in 2006 and $820,415 in 2005) 2,697,663 2,756,025
Other assets 122,748 24,935
-------------- --------------
Total assets $ 25,859,508 $ 26,677,662
============== ==============
See notes to condensed consolidated financial statements.
3
FIRST AMERICAN CAPITAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (continued)
(Unaudited)
June 30, December 31,
Liabilities and Shareholders' Equity 2006 2005
----------------- -----------------
Policy and contract liabilities:
Future annuity benefits $ 12,163,420 $ 10,301,546
Future policy benefits 5,703,130 5,267,805
Liability for policy claims 177,071 190,050
Policyholder premium deposits 132,245 146,354
Deposits on pending policy applications 16,481 9,361
Reinsurance premiums payable 66,197 107,334
Amounts held under reinsurance 95,429 219,079
----------------- -----------------
Total policy and contract liabilities 18,353,973 16,241,529
Commissions, salaries, wages and benefits payable 61,629 131,873
Other liabilities 236,609 180,086
Notes payable - 2,272,986
Deferred federal income taxes payable 424,744 527,941
----------------- -----------------
Total liabilities 19,076,508 19,354,415
Shareholders' equity:
Common stock, $.10 par value, 8,000,000 shares authorized;
5,449,578 shares issued and 4,257,057 shares
outstanding in 2006; and 5,449,578 issued and 4,257,057
shares outstanding in 2005 544,958 544,958
Additional paid in capital 12,478,903 12,478,903
Accumulated deficit (3,620,508) (3,496,404)
Accumulated other comprehensive income (loss) (501,452) (84,862)
Less: Treasury stock held at cost (1,192,521 shares in 2006
and 1,192,521 in 2005) (2,119,348) (2,119,348)
----------------- -----------------
Total shareholders' equity 6,782,553 7,323,247
----------------- -----------------
Total liabilities and shareholders' equity $ 25,859,508 $ 26,677,662
================= =================
See notes to condensed consolidated financial statements.
4
FIRST AMERICAN CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (Unaudited)
Three months ended Six months ended
June 30, June30, June 30, June 30,
2006 2005 2006 2005
------------------ ------------------ ------------------ -------------------
Revenues:
Gross premium income $ 972,407 $ 945,015 $ 2,236,373 $ 2,101,212
Reinsurance premiums assumed 6,471 3,845 8,637 5,880
Reinsurance premiums ceded (150,520) (22,421) (312,873) (68,197)
------------------ ------------------ ------------------ -------------------
Net premium income 828,358 926,439 1,932,137 2,038,895
Net investment income 267,710 210,935 533,676 400,868
Net realized investment gain (loss) (68,293) 3,211 (70,017) 1,542
Rental income 59,057 45,779 118,114 91,558
Other income 1,054 50 1,305 50
------------------ ------------------ ------------------ -------------------
Total revenue 1,087,886 1,186,414 2,515,215 2,532,913
Benefits and expenses:
Increase in policy reserves 185,348 266,684 435,325 678,432
Policyholder surrender values 76,556 60,538 147,921 110,147
Interest credited on annuities
and premium deposits 142,943 98,768 269,247 184,594
Death claims 162,467 133,444 295,031 206,000
Commissions 175,299 393,422 425,620 694,382
Policy acquisition costs deferred (162,257) (457,127) (437,251) (779,330)
Amortization of deferred policy
acquisition costs 209,827 144,812 365,743 340,944
Salaries, wages, and employee
benefits 218,176 318,329 489,009 633,369
Miscellaneous taxes 32,223 45,990 59,351 77,969
Other operating costs and
expenses 230,230 372,937 589,323 793,869
------------------ ------------------ ------------------ -------------------
Total benefits and expenses 1,270,812 1,377,797 2,639,319 2,940,376
------------------ ------------------ ------------------ -------------------
Income (Loss) before income tax expense (182,926) (191,383) (124,104) (407,463)
------------------ ------------------ ------------------ -------------------
Income tax expense (benefit) - (290) - 14,951
------------------ ------------------ ------------------ -------------------
Net Income (Loss) $ (182,926) $ (191,093) $ (124,104) $ (422,414)
================== ================== ================== ===================
Net Income (Loss) per common
share - basic and diluted $ (0.04) $ (0.05) $ (0.03) $ (0.10)
================== ================== ================== ===================
See notes to condensed consolidated financial statements.
5
FIRST AMERICAN CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (Unaudited)
Three months ended Six months ended
June 30, June 30, June 30, June 30,
2006 2005 2006 2005
-------------- -------------- -------------- ---------------
Net income (loss) $ (182,927) $ (191,093) $ (124,104) $ (422,414)
Unrealized gain (loss) on available-for-sale
securities:
Unrealized holding gain (loss)
during the period (285,437) 333,262 (589,804) 75,582
Less: Reclassification for gains (loss)
included in net income (68,293) 3,211 (70,017) 1,542
Tax benefit (expense) 44,338 (66,361) 103,197 (15,059)
-------------- -------------- -------------- ---------------
Other comprehensive income (loss) (176,810) 263,690 (416,590) 58,981
-------------- -------------- -------------- ---------------
Comprehensive loss $ (359,737) $ 72,597 $ (540,694) $ (363,433)
============== ============== ============== ===============
Comprehensive loss per common
share-basic and diluted $ (0.08) $ 0.02 $ (0.13) $ (0.08)
============== ============== ============== ===============
See notes to condensed consolidated financial statements.
6
FIRST AMERICAN CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six months ended
June 30, June 30,
2006 2005
------------------- -------------------
Operating activities:
Net income (loss) $ (124,104) $ (422,414)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Interest credited on annuities and premium deposits 269,247 184,594
Net realized investment (gain) loss 70,017 (1,542)
Provision for depreciation 66,117 82,870
Settlement loss - 35,465
Amortization of premium and accretion of discount on
fixed maturity and short-term investments (42,505) 29,164
Provision for deferred federal income taxes - 14,951
Decrease in accrued investment income 24,476 (10,332)
(Increase) decrease in accounts receivable 68,263 (171,649)
Decrease in reinsurance receivables (34,050) -
Acquisition costs capitalized (437,251) (779,330)
Amortization of deferred acquisition costs 365,743 340,944
Increase in policy loans (38,437) (18,168)
Decrease in other assets (97,813) (3,092)
Increase in future policy benefits 435,325 678,432
Increase (decrease) in liability for policy claims (12,979) 12,797
Increase in deposits on pending policy applications 7,120 25,407
Decrease in reinsurance premiums payable (41,137) (3,061)
Decrease in amounts held under reinsurance (123,650) -
Increase (decrease) in commissions, salaries, wages
and benefits payable (70,244) 19,744
Increase in other liabilities 56,523 45,264
------------------- -------------------
Net cash provided by (used in) operating activities $ 340,661 $ 60,044
See notes to condensed consolidated financial statements.
7
FIRST AMERICAN CAPITAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
June 30, June 30,
2006 2005
------------------- --------------------
Investing activities:
Purchase of available-for-sale fixed maturities $ (664,852) $ (1,179,218)
Sale of available-for-sale fixed maturities 2,258,015 198,750
Maturity of available-for-sale fixed maturities 471,000 1,031,623
Purchase of available-for-sale equities - (247,750)
Sale of available-for-sale equities 222,699 25,000
Additions to property and equipment (7,755) (4,630)
Purchase of other investments (1,329,068) (606,850)
Maturity of other investments 203,687 58,333
Purchase of mortgage loans - (717,000)
Payments received on mortgage loans 27,429 7,979
------------------- --------------------
Net cash used in investing activities 1,181,155 (1,433,763)
Financing activities:
Proceeds from note payable - 570,355
Payments on notes payable (2,272,986) (41,828)
Deposits on annuity contracts 1,592,627 1,780,647
Surrenders on annuity contracts - (368,077)
Policyholder premium deposits - 23,938
Withdrawals on policyholder premium deposits (14,109) (33,220)
Purchase of treasury stock - (770,355)
------------------- --------------------
Net cash provided by financing activities (694,468) 1,161,460
------------------- --------------------
(Decrease) Increase in cash and cash equivalents 827,348 (212,259)
Cash and cash equivalents, beginning of period 249,109 527,028
Cash and cash equivalents, end of period $ 1,076,457 $ 314,769
=================== ====================
Supplemental disclosure of cash activities:
Interest paid $ 62,295 $ 65,335
=================== ====================
Income taxes paid $ - $ -
=================== ====================
See notes to condensed consolidated financial statements.
8
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying condensed consolidated financial statements of First American
Capital Corporation and its Subsidiaries (the "Company") for the three month and
nine month periods ended September 30, 2005 and 2004 are unaudited. However, in
the opinion of the Company, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been reflected
therein.
Effective June 29, 2005, the Company formed and capitalized First Life
Brokerage, Inc. ("FLBI"). FLBI was capitalized with $25,000 and is a direct
subsidiary of First American Capital Corporation. FLBI will operate as an
insurance broker offering complementary products underwritten by other
companies.
Certain financial information which is normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America, but which is not required for interim reporting
purposes, has been omitted. The accompanying condensed consolidated financial
statements should be read in conjunction with the financial statements and notes
thereto included in the Company's Form 10-KSB for the fiscal year ended December
31, 2005. The results of operations for the period are not necessarily
indicative of the results to be expected for the full year.
2. Intercompany Sale of Building and Payoff of Related Mortgage Notes Payable
On May 1, 2006, the Company sold its home office building to First Life America
Corporation ("FLAC") for $2,800,000. No gain was recognized on this intercompany
sale. The Company paid $1,722,053 to Vision Bank to repay the mortgage note from
the proceeds resulting from the sale of the home office building. Also, the
Company paid $522,822 to Brooke Credit Corporation ("Brooke") to repay the
second mortgage from the proceeds from the sale of the home office building.
3. Net Earnings Per Common Share
Net loss per common share for basic and diluted earnings per share is based upon
the weighted average number of common shares outstanding during each period. On
March 2, 2005 the Company acquired 450,500 shares of its common stock from
Brooke. The weighted average number of common shares outstanding was 4,257,057
and 4,388,404 for the six months ended June 30, 2006 and June 30, 2005,
respectively. The weighted average number of common shares outstanding was
4,257,057 and 4,237,578 for the three months ended June 30, 2006 and June 30,
2005, respectively.
4. Federal Income Taxes
Current taxes are provided based on estimates of the projected effective annual
tax rate. Deferred taxes reflect the net effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The Company has elected
to file a consolidated federal income tax return with its subsidiaries, First
Life America Corporation ("FLAC") and First Life Brokerage, Inc. (FLBI). 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, which covers the period from November 1998 through December 31, 2002.
5. 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 ("Meyer"), the
Company's former President, arising, in part, out of Meyer's employment with the
Company. Among other things, the Company sought to recover expense
reimbursements previously paid to Meyer and Company funds allegedly
misappropriated by Meyer. 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.
On December 12, 2003, Meyer filed an Answer and Counterclaim against the Company
asserting claims for defamation and breach of employment agreement.
On August 1, 2005, the District Court of Shawnee County, Kansas entered an
order, by agreement, submitting the claims to binding arbitration. Following the
conclusion of the arbitration, the parties entered into a settlement agreement
in November of 2005, pursuant to which the Company agreed to pay Meyer $38,500
with Meyer and the Company agreeing to settle all claims. The Company paid the
amount to Meyer in February of 2006. This claim was accrued as of December 31,
2005.
6. Reinsurance
Effective September 29, 2005, the Company and Wilton Reassurance Company
("Wilton Re"), of Wilton, CT, executed a binding letter of intent whereby both
parties agreed that the Company would cede the simplified issue version of its
Golden Eagle Whole Life (Final Expense) product to Wilton Re on a 50/50 quota
share original term coinsurance basis. The letter of intent was executed on a
retroactive basis to cover all applicable business issued by the Company
subsequent to January 1, 2005. Wilton Re agreed to provide various commission
and expense allowances to the Company in exchange for the Company ceding 50% of
the applicable premiums to Wilton Re as they are collected. As of June 24, 2006,
Wilton Re terminated the reinsurance agreement, for new business issued after
the termination date.
7. Liquidity and Capital Resources
During the quarters ended June 30, 2006, and 2005, the Company maintained liquid
assets sufficient to meet operating demands, while continuing to utilize excess
liquidity to purchase various investments. Net cash provided by operating
activities during the quarters ended June 30, 2006 and 2005 totaled $486,125 and
$60,044, respectively.
As of June 30, 2006, the Company and its subsidiaries had consolidated cash
reserves and liquid investments of approximately $12,464,514, as compared with
$14,209,951 as of June 30, 2005. Of these amounts, cash reserves and liquid
investments at FLAC as of these dates were approximately $11,905,907 and
$13,358,036, respectively. 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. Due to insurance regulatory restrictions, as noted
above, cash generated by FLAC cannot necessarily be used to fund the cash needs
of the parent company on a stand-alone basis.
As of June 30, 2006, cash reserves and nonliquid investments at the parent
company level were approximately $553,674 as compared with $828,790 as of June
30, 2005. Cash reserves for FLBI were $4,933 at June 30, 2006 and there $23,512
as of June 30, 2005. Based on the decreasing level of cash reserves and
nonliquid investments at the parent company level over the past few years, in
2005, management began to pursue all reasonable alternatives for increasing cash
reserves at the parent company level. As an initial step in this process, the
Board of Directors of each of the parent company and FLAC approved a transaction
pursuant to which FLAC agreed to purchase the Company's home office building and
the real property on which it is located from the parent company at its value of
$2,800,000, which was determined based on an independent appraisal.
On March 28, 2006, the Kansas Insurance Department (KID) approved this
transaction pursuant to a Form D (Prior Notice of a Transaction) filed by the
Company. Proceeds from the sale were used by the parent company to pay off the
two creditors that held mortgages on the building, which resulting in interest
savings of approximately $890,000 over the life of the loans. In addition, the
transaction provided the parent company with approximately $478,000 in cash.
This cash will be used to fund operations at the parent company.
Based on currently forecasted cash flow levels, management anticipates that the
$478,000 in cash provided to the parent company as a result of the
aforementioned transaction plus the parent company's existing cash reserves will
fund operations at the parent company level into mid 2007. Therefore, in the
interim, management will continue to explore all reasonable opportunities to
provide additional capital to the parent company through the sale of new equity
securities or debt securities, or through borrowed funds. Successful efforts in
this arena will not only help to remedy the parent company's current cash
situation, but also allow management to fully implement its business development
plan of expanding the Company's product lines and marketing efforts through the
infusion of additional capital into FLAC's insurance operations and FLBI's
brokerage operations. If these efforts are not successful, however, then the
Company will have no choice but to cease operations as a public company and
liquidate its assets, which primarily are the insurance operations of its
subsidiary FLAC. There is no assurance of what if any value could be realized by
the parent company in this event.
Pursuant to these efforts, on October 6, 2006, the Company executed a Stock
Purchase and Sale Agreement (the "Agreement") with Brooke Corporation ("Brooke")
pursuant to which, subject to the conditions stated in the Agreement, Brooke has
agreed to acquire newly issued shares of the common stock of FACC in a two step
transaction that will result in Brooke owning 55% of the then issued and
outstanding shares of common stock. In consideration therefor, Brooke will (i)
pay to FACC $3,000,000 in cash and (ii) enter into a Brokerage Agreement
pursuant to which, among other things, CJD & Associates, L.L.C., a Brooke
subsidiary, will cause all of its new managing general agent loan brokerage
business to be transacted through First Life Brokerage, Inc. ("FLB"), a FACC
subsidiary. In the Agreement, the pretax profits of FLB over a three year period
shall be not less than $6,000,000 in pretax profits or Brooke shall be obligated
to contribute funds FACC as additional consideration for the issuance of the
shares of FACC common stock acquired pursuant to the Agreement to the extent the
pretax profit goal is not made under such schedule. The closing of the
transactions contemplated under the Agreement are subject to a number of
conditions, including the approval of the Kansas Department of Insurance.
Although there is no assurrance that these conditions will be met and that the
closing of these transactions will occur, management currently anticipates that
the closing will occur in the fourth quarter of 2006.
8. Other Regulatory Matters
FLAC is licensed to transact life and annuity business in the states of Kansas,
Texas, Illinois, Oklahoma, North Dakota, Kentucky and Nebraska. Due to the
varied processes of obtaining admission to write business in new states,
management cannot reasonably estimate the time frame of expanding its marketing
presence.
FLAC was previously licensed to transact business in the state of Ohio. FLAC's
license in Ohio was suspended during the fourth quarter of 2005. The suspension
resulted from FLAC's statutory basis capital and surplus as of September 30,
2005 of $2,495,616 being less than the minimum required level in Ohio of
$2,500,000. As of June 30, 2006, FLAC's statutory basis capital and surplus was
$2,931,926, which is in excess of the aforementioned minimum requirement. FLAC
appealed the suspension and had its license reinstated on July 27, 2006.
9. Segment Information
The operations of the Company and its subsidiaries have been classified into two
operating segments as follows: life and annuity insurance operations and
corporate and brokerage operations. Segment information for the three and six
months ended June 30, 2006 and 2005 and as of June 30, 2006 and December 31,
2005 is as follows:
Three months ended Six months ended
June 30, June 30, June 30, June 30,
2006 2005 2006 2005
------------------- ------------------ ------------------ ------------------
Revenues:
Life and annuity insurance
operations $ 1,067,962 $ 1,131,169 $ 2,433,356 $ 2,422,448
Corporate and brokerage operations $ 19,924 55,245 81,859 110,465
------------------- ------------------ ------------------ ------------------
Total $ 1,087,886 $ 1,186,414 $ 2,515,215 $ 2,532,913
=================== ================== ================== ==================
Income (loss) before income taxes:
Life and annuity insurance
operations $ (67,691) $ 4 $ 176,776 $ 83,696
Corporate and brokerage operations (114,236) (191,387) (300,880) (491,159)
------------------- ------------------ ------------------ ------------------
Total $ (181,927) $ (191,383) $ (124,104) $ (407,463)
=================== ================== ================== ==================
Depreciation and amortization expense:
Life and annuity insurance
operations $ 221,793 $ 144,812 $ 377,709 $ 340,944
Corporate and brokerage operations 18,726 41,523 54,151 82,870
------------------- ------------------ ------------------ ------------------
Total $ 240,519 $ 186,335 $ 431,860 $ 423,814
=================== ================== ================== ==================
June 30, December 31,
2006 2005
------------------ -------------------
Assets:
Life and annuity insurance operations $ 25,091,285 23,337,149
Corporate and brokerage operations 768,223 3,340,513
------------------ -------------------
Total $ 25,859,508 $ 26,677,662
================== ===================
12
ITEM 2. 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 the following risks and uncertainties,
among others: (i) the strength of the United States economy in general and the
strength of the local economies in which the Company does business; (ii)
inflation, interest rates, market and monetary fluctuations and volatility;
(iii) the timely development of and acceptance of new products and services and
perceived overall value of these products and services by existing and potential
customers; (iv) the persistency of existing and future insurance policies sold
by the Company; (v) the effect of changes in laws and regulations with which the
Company must comply; and (vi) the cost and effects of litigation and of
unexpected or adverse outcomes in litigation.
The following discussion should be read in conjunction with the consolidated
financial statements and notes thereto.
Critical Accounting Policies and Estimates
------------------------------------------
The accounting policies below have been identified as critical to the
understanding of the results of operations and financial position. The
application of these critical accounting policies in preparing the financial
statements requires management to use significant judgments and estimates
concerning future results or other developments, including the likelihood,
timing or amount of one or more future transactions. Actual results may differ
from these estimates under different assumptions or conditions. On an ongoing
basis, estimates, assumptions and judgments are evaluated based on historical
experience and various other information believed to be reasonable under the
circumstances.
13
Investments
-----------
The Company's principal investments are in fixed maturity securities.
Investments are exposed to three primary sources of investment risk: credit,
interest rate and liquidity. The fixed maturity securities, which are all
classified as available for sale, are carried at their fair value in the
Company's balance sheet. The investment portfolio is monitored regularly to
ensure that investments which may be other than temporarily impaired are
identified in a timely fashion and properly valued, and that impairments are
charged against earnings as realized investment losses. The valuation of the
investment portfolio involves a variety of assumptions and estimates, especially
for investments that are not actively traded. Fair values are obtained from
broker statements.
Deferred Policy Acquisition Costs
---------------------------------
Deferred policy acquisition costs, principally agent commissions and other
selling, selection and issue costs, which vary with and are directly related to
the production of new business, are capitalized as incurred. These deferred
costs are then amortized in proportion to future premium revenues or the
expected future profits of the business, depending upon the type of product.
Profit expectations are based upon assumptions of future interest spreads,
mortality margins, expense margins and policy and premium persistency
experience. These assumptions involve judgment and are compared to actual
experience on an ongoing basis.
Future Policy Benefits
----------------------
The Company establishes liabilities for amounts payable under insurance
policies. Generally, benefits are payable over an extended period of time and
the reserves established for future policy benefits are dependent on the
assumptions used in the pricing of the products. Principal assumptions used in
pricing policies and in the establishment of reserves for future policy benefits
are mortality, morbidity, expenses, persistency, investment returns and
inflation. Differences between actual experience and assumptions used in the
pricing of these policies and in the establishment of liabilities may result in
variability of net income in amounts which may be material.
Future Annuity Benefits
-----------------------
Future annuity benefits relate to deferred annuity contracts. The account
balances for deferred annuity contracts are equal to the cumulative deposits
less any applicable contract charges plus interest credited. The profitability
of these products is also dependent on principal assumptions similar to
traditional insurance products, and differences between actual experience and
pricing assumptions may result in variability of net income in amounts which may
be material.
Premiums
--------
Premiums for traditional life insurance products are reported as revenue when
due. Traditional insurance products include whole life and term life. Deposits
relate to deferred annuity products. The cash flows from deposits are credited
to policyholder account balances. Deposits are not recorded as revenue.
Income Taxes
------------
Deferred income taxes are recorded on the differences between the tax bases of
assets and liabilities and the amounts at which they are reported in the
consolidated financial statements. Recorded amounts are adjusted to reflect
changes in income tax rates and other tax law provisions as they become enacted.
Reinsurance
-----------
Reinsurance is one of the tools that the Company uses to accomplish its business
objectives. A variety of reinsurance vehicles are currently in use. Reinsurance
supports a multitude of corporate objectives including managing statutory
14
capital, reducing volatility and reducing surplus strain. At the customer level
it increases the Company's capacity, provides access to additional underwriting
expertise, and generally makes it possible for the Company to offer products at
competitive levels that the Company could not otherwise bring to market without
reinsurance support.
Financial Condition
-------------------
Significant changes in the condensed consolidated balance sheets from December
31, 2005 to June 30, 2006 are highlighted below.
Total assets decreased from $26,677,662 at December 31, 2005 to $25,859,508 at
June 30, 2006. The decrease in total assets is primarily attributable to the
sale of FLAC available-for sale fixed maturity securities to facilitate the
purchase of the home office building from the Company.
The Company's available-for-sale fixed maturity securities had a fair value of
$11,166,226 and $13,854,375 at June 30, 2006 and December 31, 2005,
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 decrease is
attributable to the sale of FLAC owned investments to facilitate the purchase of
the building from the Company. Credit risk is limited by emphasizing investment
grade securities and by diversifying the investment portfolio among various
investment instruments. Certain cash balances exceed the maximum insurance
protection of $100,000 provided by the Federal Deposit Insurance Corporation.
However, cash balances exceeding this maximum are protected through additional
insurance. As a result, management believes that significant concentrations of
credit risk do not exist.
The Company's available-for-sale equity securities had a fair value of $238,631
and $456,760 at June 30, 2006 and December 31, 2005, 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 decrease is attributable to a FLAC
owned investment was sold to facilitate the purchase of the home office building
from the Company.
Mortgage loans on real estate decreased from $1,566,382 at December 31, 2005 to
$1,538,953 at June 30, 2006. The slight decrease is attributable to the payments
received during the quarter on mortgage loans held during the quarter. No
additional mortgage loans have been purchased during the period. The Company
currently owns six mortgage loans. The Company may purchase more of these types
of investments in the future in limited quantities in an effort to enhance the
Company's investment portfolio yield.
Other investments increased from $1,656,866 at December 31, 2005 to $2,854,364
at June 30, 2006. The increase is attributable to the purchase of additional
investments in lottery prize cash flows during the year. These other investments
involve purchasing assignments of the future payment rights from lottery winners
at a discounted price sufficient to meet the Company's yield requirements.
Payments on these other investments will be made by state run lotteries and as
such are backed by the general credit of the respective state. The Company may
purchase more of these types of investments in the future in limited quantities
in an effort to enhance the Company's investment portfolio yield.
Cash and cash equivalents increased to $1,076,457 at June 30, 2006 from $249,109
at December 31, 2005. Refer to the statement of cash flows for sources and uses
of cash.
Accounts receivable decreased 25% from $272,200 at December 31, 2005 to $203,937
at June 30, 2006. The decrease is primarily due to a decrease of $121,190 in
amounts due from agents and an increase in income tax recoverable of $57,706. An
allowance for uncollectible items is not deemed necessary with respect to these
receivables.
Deferred policy acquisition costs, net of amortization, increased from
$5,133,244 at December 31, 2005 to $5,204,752 at June 30, 2006 resulting from
the capitalization of acquisition expenses related to the 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.
Management of the Company reviews the recoverability of deferred acquisition
costs on a quarterly basis based on current trends as to persistency, mortality
and interest. These trends are compared to the assumptions used in the
establishment of the original asset in order to assess the need for impairment.
Based on the results of the aforementioned procedures performed by management,
no impairments have been recorded against the balance of deferred acquisition
costs. Liabilities decreased to $19,076,955 at June 30, 2006 from $19,354,415 at
December 31, 2005. Reserves for future policy benefits, established from the
sale of life insurance increased $435,325, or 8% from December 31, 2005 to June
30, 2006. These reserves are actuarially determined based on such factors as
insured age, life expectancy, mortality and interest assumptions. Reserves for
future annuity benefits increased $1,861,874 or 18% from December 31, 2005 to
June 30, 2006. In 2005 and 2006, annuity contract liabilities increased due to
the introduction of three new annuity products to the marketing force and
continued considerations received on the Company's FA2000 product.
Other liabilities increased $56,524 from $180,086 at December 31, 2005 to
$236,609 at March 31, 2006. The increase is attributable to timing factors
associated with the payment of significant invoices for professional services
and property taxes.
Notes payable stood at $0 at June 31, 2006, a decrease from $2,272,986 at
December 31, 2005. The decrease is due to the Company paying off Vision Bank and
Brooke Credit Corporation notes from proceeds of the sale of the home office
building to FLAC.
Deferred federal income taxes payable decreased to $424,744 at June 30, 2006
from $527,941 at December 31, 2005. Deferred federal income taxes payable are
established based on timing differences between income recognized for financial
statement purposes and taxable income for the Internal Revenue Service. These
deferred taxes are based on the operations of the Company and FLAC and on
unrealized losses on available-for-sale securities. The decrease in deferred
taxes payable is primarily attributable to the increase in unrealized losses in
the investment portfolio at June 30, 2006 compared to December 31, 2005.
16
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 three and six months ended June 30, 2006
and 2005:
Three months ended Six months ended
June 30, June 30, June 30, June 30,
2006 2005 2006 2005
------------------ ---------------- ---------------- -----------------
Whole life insurance:
First year $ 179,297 $ 278,879 $ 414,819 $ 500,014
Renewal 778,123 650,435 1,796,164 1,578,015
Term insurance:
First year 868 937 2,311 977
Renewal 11,320 11,264 13,280 12,986
Single premium 2,800 3,500 9,800 9,220
------------------ ---------------- ---------------- -----------------
Gross premium income 972,408 945,015 2,236,374 2,101,212
Reinsurance premiums assumed 6,471 3,845 8,637 5,880
Reinsurance premiums ceded (150,520) (22,421) (312,873) (68,197)
------------------ ---------------- ---------------- -----------------
Net premium income $ 828,358 $ 926,439 $ 1,932,137 $ 2,038,895
================== ================ ================ =================
Net premium income decreased $106,758 or 5% from the six months ended June 30,
2006 to the same period during 2005. Total first year whole life premium
decreased $85,195 or 17% from 2005 to 2006. The decrease is attributable to
17
a decrease in the production of the Company's Golden Eagle Whole Life (Final
Expense) product and the coinsurance allowance paid to Wilton Re for business
written in the prior year.
Management released several new annuity, term and whole life products during
2005. The Company's goal in introducing these new products is to diversify the
Company's product mix and to manage its first year production to both the needs
and capacity of the Company.
Total renewal year whole life premiums increased $218,148 or 14% from the six
months ended June 30, 2005 to the same period during 2006. Renewal premiums
reflect the premium collected in the current year for those policies that have
surpassed their first anniversary. Renewal premiums will continue to increase
unless premiums lost from surrenders, lapses, settlement options or application
of the non-forfeiture options, exceed prior year's first year premium, other
than single premium.
Reinsurance premiums ceded increased $244,676 or 359% for the six months ended
June 30, 2006, compared to the same period in 2005. The increase is primarily
attributable to premiums paid to Wilton Re in conjunction with the reinsurance
of the Company's Golden Eagle Whole Life (Final Expense) product.
Net premium income decreased $98,081 or 11% from the three months ended June 30,
2006 to the same period during 2005. Total first year whole life premium
decreased $99,582 or 36% from 2005 to 2006. The decrease is attributable to a
decrease in the production of the Company's Golden Eagle Whole Life (Final
Expense) product.
Total renewal year whole life premiums increased $127,687 or 20% from the three
months ended June 30, 2005 to the same period during 2006.
Reinsurance premiums ceded increased $128,099 or 571% for the three months ended
June 30, 2006, compared to the same period in 2005. The increase is primarily
attributable to premiums paid to Wilton Re in conjunction with the reinsurance
of the Company's Golden Eagle Whole Life (Final Expense) product.
Net investment income increased $132,808 or 33% for the six months ended June
30, 2006, compared to the same period for 2005. The increase is due to an
increase of average yields on the Company's portfolio. The Company revised its
investment strategy and is now focused primarily on matching maturities to the
anticipated cash needs of the Company, but also attempts to match the investment
mix to others within the Company's industry peer group.
Net realized investment gain (loss) decreased $71,559 from the six months ended
June 30, 2006 to the same period during 2005. The decrease is attributable to
the sale of a significant portion of the Company's investment portfolio during
the six months ended June 30, 2006. Losses totaling $92,968 were realized upon
the sale of these bonds and gains of $22,949 were realized on the sale of stock.
Benefits and expenses totaled $2,639,319 and $2,940,376 during the six months
ended June 30, 2006 and 2005, respectively. Included in total benefits and
expenses were policy reserve increases of $435,325 and $678,432 during three
months ended June 30, 2006 and 2005, respectively. Benefits and expenses totaled
$1,270,814 and $1,377,797 during the three months ended June 30, 2006 and 2005,
respectively. Included in total benefits and expenses were policy reserve
increases of $185,348 and $266,684 during three months ended June 30, 2006 and
2005, 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, policy reserves will continue to increase.
Policyholder surrender values increased $37,774 from $110,147 during the six
months ended June 30, 2005 to $147,921 during the same period in 2006. This
increase is attributable to the maturation of policies.
Interest credited on annuities and premium deposits totaled $269,247 and 184,594
for the six months ended June 30, 2006 and 2005, respectively. The increase
during 2006 of $84,653or 46% is primarily a result of the increase in annuity
18
fund balances. Both interest credited on annuities and premium deposits have
increased as a result of the increase in the number of policies inforce. The
average interest credit rate on annuities and premium deposits has increased
from 4.7% to 5.1% during the six months ended June 30, 2005 and 2006,
respectively.
Death claims increased $89,031, or 43%, for the six months ended June 30, 2006,
compared to the same period for 2005. The increase is attributable to the
increase in the number of policies inforce and the continued maturation of those
policies. Mortality experienced by the Company to date is within management's
expectations.
Commission expense totaled $425,620 and $694,382 for the six months ended June
30, 2006 and 2005, respectively. Commission expense is based on a percentage and
is determined in the product design. Additionally higher percentage commissions
are paid for first year business rather than the renewal year. Commission
expense decreased $268,762 primarily due to commission allowances received on
reinsured business due from Wilton Re of $222,017 during the quarter being
netted against the commission expense. Commission allowances received on
reinsurance business essentially serve as a reimbursement to the Company for
acquisition costs incurred to write business.
Salaries, wages and employee benefits decreased $144,360 from $633,369 for the
six months ended June 30, 2005, to $489,009 for the same period in 2006. The
decrease in 2006 is primarily attributable to a decrease in employee headcount
along with decreased employee benefit expenses.
Other operating costs and expenses totaled $589,323 and $793,869 for the six
months ended June 30, 2006 and 2005, respectively. The net decrease of $204,546,
or 26%, was primarily due to a decrease in Wilton Re expense allowances of
$72,877, and a loss on a Treasury Stock transaction of $35,465 recognized in
March 31, 2005. The Company had no Treasury Stock transactions for the same
period in 2006.
As a result of the items noted above the Company had a net loss before income
tax expense of $124,104 and 407,463 for the six months ended June 30, 2006 and
2005, respectively.
Liquidity and Capital Resources
-------------------------------
During the quarters ended June 30, 2006, and 2005, the Company maintained liquid
assets sufficient to meet operating demands, while continuing to utilize excess
liquidity to purchase various investments. Net cash provided by operating
activities during the quarters ended June 30, 2006 and 2005 totaled $486,125 and
$60,044, respectively.
As of June 30, 2006, the Company and its subsidiaries had consolidated cash
reserves and liquid investments of approximately $12,464,514, as compared with
$14,209,951 as of June 30, 2005. Of these amounts, cash reserves and liquid
investments at FLAC as of these dates were approximately $11,905,907 and
$13,358,036, respectively. 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. Due to insurance regulatory restrictions, as noted
above, cash generated by FLAC cannot necessarily be used to fund the cash needs
of the parent company on a stand-alone basis.
As of June 30, 2006, cash reserves and nonliquid investments at the parent
company level were approximately $553,674 as compared with $828,790 as of June
30, 2005. Cash reserves for FLBI were $4,933 at June 30, 2006 and there $23,512
as of June 30, 2005. Based on the decreasing level of cash reserves and
nonliquid investments at the parent company level over the past few years, in
2005, management began to pursue all reasonable alternatives for increasing cash
reserves at the parent company level. As an initial step in this process, the
Board of Directors of each of the parent company and FLAC approved a transaction
pursuant to which FLAC agreed to purchase the Company's home office building and
the real property on which it is located from the parent company at its value of
$2,800,000, which was determined based on an independent appraisal.
On March 28, 2006, the Kansas Insurance Department (KID) approved this
transaction pursuant to a Form D (Prior Notice of a Transaction) filed by the
Company. Proceeds from the sale were used by the parent company to pay off the
19
two creditors that held mortgages on the building, which resulting in interest
savings of approximately $890,000 over the life of the loans. In addition, the
transaction provided the parent company with approximately $478,000 in cash.
This cash will be used to fund operations at the parent company.
Based on currently forecasted cash flow levels, management anticipates that the
$478,000 in cash provided to the parent company as a result of the
aforementioned transaction plus the parent company's existing cash reserves will
fund operations at the parent company level into mid 2007. Therefore, in the
interim, management will continue to explore all reasonable opportunities to
provide additional capital to the parent company through the sale of new equity
securities or debt securities, or through borrowed funds. Successful efforts in
this arena will not only help to remedy the parent company's current cash
situation, but also allow management to fully implement its business development
plan of expanding the Company's product lines and marketing efforts through the
infusion of additional capital into FLAC's insurance operations and FLBI's
brokerage operations. If these efforts are not successful, however, then the
Company will have no choice but to cease operations as a public company and
liquidate its assets, which primarily are the insurance operations of its
subsidiary FLAC. There is no assurance of what if any value could be realized by
the parent company in this event.
Pursuant to these efforts, on October 6, 2006, the Company executed a Stock
Purchase and Sale Agreement (the "Agreement") with Brooke Corporation ("Brooke")
pursuant to which, subject to the conditions stated in the Agreement, Brooke has
agreed to acquire newly issued shares of the common stock of FACC in a two step
transaction that will result in Brooke owning 55% of the then issued and
outstanding shares of common stock. In consideration therefor, Brooke will (i)
pay to FACC $3,000,000 in cash and (ii) enter into a Brokerage Agreement
pursuant to which, among other things, CJD & Associates, L.L.C., a Brooke
subsidiary, will cause all of its new managing general agent loan brokerage
business to be transacted through First Life Brokerage, Inc. ("FLB"), a FACC
subsidiary. In the Agreement, the pretax profits of FLB over a three year period
shall be not less than $6,000,000 in pretax profits or Brooke shall be obligated
to contribute funds FACC as additional consideration for the issuance of the
shares of FACC common stock acquired pursuant to the Agreement to the extent the
pretax profit goal is not made under such schedule. The closing of the
transactions contemplated under the Agreement are subject to a number of
conditions, including the approval of the Kansas Department of Insurance.
Although there is no assurrance that these conditions will be met and that the
closing of these transactions will occur, management currently anticipates that
the closing will occur in the fourth quarter of 2006.
ITEM 3. 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. This information is accumulated and
communicated to the Company's management to allow timely decisions regarding
disclosure. The Company's Chief Executive Officer and President conducted an
evaluation of the Company's disclosure controls and procedures as of the end of
the period covered by this report. Based upon the evaluation of those controls
and procedures, the Chief Executive Officer and President of the Company
concluded that the Company's disclosure controls and procedures are effective in
alerting on a timely basis, material information required to be disclosed in the
Company's periodic filings.
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 President.
20
PART II
OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company attempted to hold its regularly scheduled annual meeting of
shareholders on June 5, 2006 for the purpose of electing directors and ratifying
the appointment of independent auditors. However, shareholder attendance (in
person and by proxy) did not constitute quorum to transact business pursuant to
the Company's bylaws. Therefore, no business was transacted. Accordingly, the
following existing directors remain in office: Thomas Fogt; Paul "Bud" Burke,
Jr.; Harland Priddle; Gary Yager; Edward Carter; Kenneth Frahm; John Montgomery;
and John Van Engelen.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Index to Exhibits
Exhibit No. Description
----------- -----------
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002. (*)
31.2 Certification of Treasurer and 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 (*)
32.2 Certificate of Treasurer and Chief Financial Officer pursuant to
Section 18 U.S.C. Section 1350 (*)
(*) Filed herewith
b) Reports on Form 8-K
The Company filed current reports on Forms 8-K dated February 16,
2006, March 13, 2006, and June 5, 2006, announcing current
developments.
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
FIRST AMERICAN CAPITAL CORPORATION
Date: October 6, 2006 By: /s/ John F. Van Engelen
------------------------ ---------------------------------------------
John F. Van Engelen
President & Chief Executive Officer
Date: October 6, 2006 By: /s/ Harland E. Priddle
------------------------ ---------------------------------------------
Harland E. Priddle
Chairman & Secretary of the Board of Directors
22