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United States Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
| þ | Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the fiscal year ended December 31, 2006.
| o | 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
(Name of small business issuer in its charter)
| Kansas | 48-1187574 | |
| (State of incorporation) | (I.R.S. Employer Identification Number) |
1303 SW First American Place, Topeka, KS 66604
(Address of principal executive offices)
(Address of principal executive offices)
| Issuer’s telephone number | (785) 267-7077 | |||
Securities registered under 12(b) of the Act:
Title of Each Class
NONE
Title of Each Class
NONE
Securities registered under Section 12(g) of the Act:
Title of Each Class
Common Stock, $.01 Par Value
Title of Each Class
Common Stock, $.01 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 þ No o
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 o
State issuer’s revenues for its most recent fiscal year: $6,162,196.
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by
reference to the price at which the common equity was sold, or the average bid and asked price of such common equity,
as of a specified date within the last 60 days:
Of the 9,643,460 shares of common stock of the registrant issued and outstanding as of February 22, 2007, 4,206,057
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, $.01 Par Value — 9,643,460 shares as of February 22, 2007.
Transitional Small Business Disclosure Format (check one): Yes o No þ
FORM 10-KSB
For the Fiscal Year Ended December 31, 2006
For the Fiscal Year Ended December 31, 2006
TABLE OF CONTENTS
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PART I
This Annual Report on Form 10-KSB for the fiscal year ended December 31, 2006 (“report”) contains forward-looking
statements within the meaning of federal securities law. Words such as “may,” “will,” “expect,” “anticipate,”
“believe,” “estimate,” “continue,” “predict,” or other similar words, identify forward-looking statements.
Forward-looking statements appear in a number of places in this report and include statements regarding our intent,
belief or current expectation about, among other things, trends affecting the markets in which the company operates,
the Company’s business, financial condition and growth strategies. Although the Company believes that the expectations
reflected in these forward-looking statements are based on reasonable assumptions, forward-looking statements are not
guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those
predicted in the forward-looking statements as a result of various factors, including the uncertainties that all
regulatory approvals will be obtained, that all closing conditions will be met, that the closing of the transaction
will occur, and that any closing will occur when expected, the uncertainty that plans relating to the Company’s
acquisition of a federal savings bank will be successfully implemented, the uncertainty as to the effect of the
potential transaction on the earnings and operations of the Company; the uncertainty that the Company will achieve
short-term and long-term profitability and growth goals, uncertainties associated with market acceptance of and demand
for the products and services of the Company, or its subsidiaries, the impact of competitive products and pricing, the
dependence on third-party suppliers and their pricing, the ability of the parties to the transaction to meet product
demand, the availability of capital and funding sources, the exposure to market risks, uncertainties associated with
the development of technology, changes in the law and in economic, political and regulatory environments, the impact of
inflation and general economic conditions on the Company’s liquidity and capital resources, changes in management, the
dependence on intellectual property rights, the effectiveness of internal controls, and risks and factors described
from time to time in reports and registration statements filed by the Company with the Securities and Exchange
Commission. When considering forward-looking statements, you should keep these factors in mind as well as the other
cautionary statements in this report. You should not place undue reliance on any forward-looking statement. The
Company is not obligated to update forward-looking statements.
| Item 1. | Description of Business |
Overview
In this report, references to the “Company,” “FACC,” and “we,” “our,” or “us” refers to First American Capital
Corporation, a Kansas corporation, and the Company’s subsidiaries First Life America Corporation, a Kansas life
insurance company (“FLAC”), and Brooke Capital Advisors, Inc., a Kansas corporation (“BCA”).
The Company is a Topeka, Kansas-based financial Services Company incorporated in the State of Kansas on July 10, 1996.
The Company sells proprietary life insurance and annuity products in eight states through the Company’s wholly owned
subsidiary FLAC. The Company brokers life, health, disability and annuity products underwritten by other insurance
companies through its wholly owned subsidiary BCA.
As a result of recent change of control transactions, see “Description of Business — - Recent Developments”, the
Company recently began offering loan brokerage services through BCA. In addition, the Company recently announced that
it had entered into a definitive agreement to acquire a federal savings bank. See “Descriptions of Business — Recent
Developments”.
Sale of Proprietary Life Insurance and Annuity Products
The Company underwrites and sells proprietary life insurance and annuity products through FLAC. 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 $7,659,130 of
shareholders’ equity as of December 31, 2006.
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Products of FLAC
The primary insurance products currently being marketed by FLAC are as follows:
Golden Eagle Whole Life (Final Expense) 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 Whole Life is a permanent whole life insurance product with guaranteed level premiums and death benefits. Issue
ages are 0 (30 days) to age 80. Rate classes include preferred non-tobacco, non-tobacco and tobacco. The product is
non-participating. Available riders include accidental death, accelerated living benefit, waiver of premium, terminal
illness and long-term care.
First Term is a level term life insurance product with term periods of 10, 15, 20 and 30 years. Both fully guaranteed
and partially guaranteed premium options are available. For the partially guaranteed option, premiums are level for 5
years on the 10 year term, 10 years on the 15 year term, 13 years on the 20 year term and 17 years on the 30 year term,
increasing annually thereafter. Rate classes include non-tobacco, preferred tobacco and tobacco. Issue ages for the
10, 15 and 20 are 18 to 60 for all classes. Issue ages for 30 year non-tobacco are 18 to 50, and issue ages for 30
year preferred tobacco and tobacco are 18 to 45. Available riders include return of premium, accidental death,
accelerated death benefit and waiver of premium.
Value Builder is a modified payment whole life insurance policy with a flexible premium deferred annuity rider. The
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.
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.
First Flex I is a flexible premium deferred annuity for ages 0 to 84. The initial interest rate is guaranteed for one
contract year with a minimum guaranteed interest rate of 3%. The surrender charge period is seven years and up to 15%
of the account value can be withdrawn each year without incurring a surrender charge. If the owner becomes confined to
an extended care facility or hospital, the surrender charge may be waived up to a certain limit. The minimum deposit
is $100.
First Max I is a single premium deferred annuity for ages 0 to 90. The initial interest rate is guaranteed for one
contract year with a minimum guaranteed interest rate of 3%. The surrender charge period is five years and up to 15%
of the account value can be withdrawn each year without incurring a surrender charge. If the owner becomes confined to
an extended care facility or hospital, the surrender charge may be waived up to a certain limit. The minimum deposit
is $500.
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First Max III is a single premium deferred annuity for ages 0 to 90. The initial interest rate is guaranteed for three
contract years with a minimum guaranteed interest rate of 3%. The surrender charge period is three years. If the
owner becomes confined to an extended care facility or hospital, the surrender charge may be waived up to a certain
limit. The minimum deposit is $500.
Easy Pack contains short form applications for simplified underwriting and quick issue. Products included in the Easy
Pack are First Whole Life, First Term, First Step, Golden Eagle Final Expense and First Flex I, First Max I and First
Max III. The Easy Pack is designed for the agent and consumer to receive quick underwriting decisions on the small
face policies.
Product Marketing and Sales
The Company’s marketing strategy is to provide life insurance and annuity products that are beneficial to the consumer
and profitable for the Company and its shareholders. As such, FLAC is continually seeking new markets for its products
primarily by utilizing its existing and new insurance agents to promote the sales of its products. FLAC sells its
products through agents. These agents receive commissions and, subject to qualification, promotional incentives from
FLAC based on premiums collected on the products sold. FLAC contracts 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
FLAC on products sold by the agents. The IMOs recruit, train, contract 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, 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.
Insurance Inforce
The following table provides certain information about FLAC’s volume of life insurance coverage inforce for each of the
last three years:
| (shown in thousands) | ||||||||||||
| Amounts of Insurance | 2006 | 2005 | 2004 | |||||||||
Beginning of the year |
$ | 163,353 | $ | 160,123 | $ | 163,424 | ||||||
Issued during year |
9,937 | 26,306 | 16,854 | |||||||||
Reinsurance assumed |
4,651 | 1,096 | 3,169 | |||||||||
Revived during year |
2,168 | 2,147 | 694 | |||||||||
Lapse, surrender and decreased |
(25,435 | ) | (26,319 | ) | (24,018 | ) | ||||||
In-force end of year |
$ | 154,674 | $ | 163,353 | $ | 160,123 | ||||||
(1) Excludes accidental death benefits (shown in thousands) of $31,184, $33,235, and $35,695 in 2006, 2005, and 2004,
respectively.
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The following table provides certain information about FLAC’s policy count for each of the last three years:
| (Number of Policies) | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Beginning of the year |
9,856 | 8,318 | 6,582 | |||||||||
Issued during year |
1,137 | 2,516 | 1,676 | |||||||||
Reinsurance assumed |
135 | 55 | 726 | |||||||||
Revived during year |
143 | 110 | 50 | |||||||||
Lapse, surrender and decreased |
(1,297 | ) | (1,143 | ) | (716 | ) | ||||||
In-force end of year |
9,974 | 9,856 | 8,318 | |||||||||
As is evidenced by the tables above, the average face amount per policy issued has approximated $9,000 to $10,000
during 2004, 2005 and 2006. The relatively small face amount issued is directly related to increased focus being
placed on production of the Company’s Final Expense product over the past three years. The Final Expense product has a
maximum face amount of $25,000, a level significantly less than the other products historically marketed by the
Company.
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, Optimum Re Insurance Company (“Optimum Re”) of Dallas,
Texas, and Wilton Reassurance Company (“Wilton Re”) of Wilton, CT, 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.
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.
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.
Actuarial Services
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.
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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. FACC is not subject to the limitations, which restrict the investments made by FLAC.
Currently, investments of FLAC are held in both short-term, highly liquid securities and long-term, higher yield
securities. The investment strategy is focused primarily on matching maturities to the anticipated cash needs of FLAC,
but also attempts to match the investment mix to others within FLAC’s industry peer group.
Insurance Brokerage Operations
Effective June 29, 2005, FACC formed and capitalized BCA under the name First Life Brokerage, Inc., as a Kansas
Corporation. BCA was capitalized with $25,000 and is a direct subsidiary of FACC. First Life Brokerage, Inc. recently
amended its Articles of Incorporation to reflect its new name, Brooke Capital Advisors, Inc. underscoring the company’s
addition of loan brokerage services to its insurance agency activities.
BCA operates as a licensed insurance agency, offering life, health, disability, and annuity products underwritten by
other insurance companies. BCA’s strategy is to make use of the Company’s existing infrastructure, equipment and
personnel by selling other companies’ insurance products to the Company’s shareholders, FLAC policyholders and the
general public. BCA will also solicit business from independent agents who may need specialized coverage or service
offered through BCA and its insurance contacts. Income will be derived from commissions and fees generated through the
sale of insurance products. Although much work has been done to create BCA and lay a foundation for future growth, the
sale of products and recruiting of agents is only beginning. BCA has secured appointment contracts with several
well-known insurance companies including AFLAC, Standard, AIG, and Mutual of Omaha and is licensed to transact business
in Kansas, Illinois, Ohio and Missouri.
Loan Brokerage Operations
As a part of the change of control transactions with Brooke Corporation, a Kansas corporation (“Brooke”), discussed in
“Recent Events”, CJD & Associates, L.L.C. (“CJD”), an indirect, wholly owned subsidiary of Brooke, and BCA entered into
a Brokerage Agreement by which, as of that date, BCA began operating a business of (1) consulting with managing general
agents and managing agencies regarding (a) acquisitions of managing general agencies, (b) financing of such
acquisitions or other activities or needs of managing general agencies, and (c) other borrower’s assistance services:
(2) referring such managing general agents and managing general agencies to Brooke Credit Corporation (`Brooke
Credit”), a wholly owned subsidiary of Brooke, for the purpose of obtaining commercial loans from Brooke Credit for
such acquisitions, activities or needs, and (3) providing collateral preservation services to Brooke Credit through its
MGA and Funeral Loan Programs with respect to such loans, for which BCA receives a fee from the borrowers that may be
funded by Brooke Credit’s loans to the borrowers and/or compensation from Brooke Credit for collateral preservation
services.
BCA’s Loan Programs originated its first loans in December 2006. Revenue from this business segment is derived from
commissions and fees generated through the loan brokerage and collateral preservation activities. Although much work
has been done to create BCA and lay a foundation for future growth, the sale of products, recruiting of agents and
marketing of the Loan Programs are relatively new segments for the Company. Income received by BCA in 2006 was
$1,199,339 of which $1,196,882 was generated through the Loan Brokerage segment. Based on these recent revenues,
management anticipates that revenues from BCA will continue to grow and add to the Company’s financial results in 2007.
Administration
FACC has contracted with FLAC to provide services, which are incident to the operations of FLAC. Under the terms of
the Service Agreement, that was amended and restated effective January 1, 2002, FACC provides personnel, facilities,
and services incident to the operations of FLAC. FLAC does not have any employees.
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Services performed pursuant to the
Service Agreement are underwriting, claim processing, accounting, policy administration and data 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 FACC’s cost of
providing such services, including an appropriate allocation of FACC’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.
As a cost savings measure for the Company, Brooke has agreed in a servicing agreement (the “Brooke Servicing
Agreement”) to provide many administrative and public-company compliance services to the Company, including, but not
limited to, human resource services, payroll accounting, legal services, accounting, tax and auditing services, risk
management, and corporate marketing services. The $5,000 monthly cost for these services should provide material cost
savings to the Company. The Brooke Servicing Agreement terminates on December 31, 2007.
Competition
The life insurance industry is extremely competitive. FLAC faces significant competition from insurance companies that
have greater financial resources, offer more diversified product lines and have larger selling organizations and
customer bases. Competition also is encountered from the expanding number of banks and other financial intermediaries
that offer competing products. FLAC must compete with other insurers to attract and retain qualified agents to market
FLAC’s products.
In connection with its insurance brokerage business, BCA primarily competes against independent insurance agencies
against the locally placed “captive” insurance agencies of large insurance companies, and against large insurance
agencies and brokers. BCA competes against these companies for the insurance business of the individual and small
business end-customers. The popularity of Internet sales and the passage of the Financial Services Modernization Act
also have increased the number of potential insurance and financial services competitors.
BCA’s insurance brokerage product line competes for business with a large number of brokerage companies, some of which
are independently owned and others of which are owned by major retail insurance agency companies. Many independent
insurance agents and insurance brokers have developed insurance programs for specific market niches and provide
significant competition.
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. Without limiting the foregoing,
the effect of the regulatory powers of the KID over FLAC may restrict the ability of FLAC to dividend or otherwise
transfer funds from FLAC to FACC even if FLAC’s operations are profitable and creating positive cash flow, restrict the
ability of FLAC to raise capital other than by contributions from FACC, and require that FACC contribute additional
capital to FLAC.
Kansas has enacted legislation that regulates insurance holding company systems, including acquisitions, extraordinary
dividends, the terms of affiliate transactions, and other related matters. Currently, FACC and FLAC have registered as
a holding company system pursuant to the laws of the state of Kansas.
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BCA is subject to licensing or regulatory approval by the state insurance department in each state in which it does
business. The Company’s operations depend on the validity of and our continued good standing under the licenses and
approvals under which we operate. Licensing laws and regulations vary from jurisdiction to jurisdiction. In all
jurisdictions, the applicable licensing laws and regulations are subject to amendment or interpretation by regulatory
authorities, and generally, these authorities are vested with broad discretion as to grant, renewal and revocation of
licenses and approvals.
The Company is subject to state laws and regulations pertaining to the charging of fees by insurance agents and brokers
and the rebating of premiums and/or commissions. The charging of fees and/or rebating may be prohibited in some states
or permitted in others with or without certain limitations. Where permitted, the charging of fees may require that
certain disclosures be given to customers and/or that customers agree to the fees in writing. The regulation of
rebating can extend to an agent giving anything of value to a customer to induce the purchase of a policy or in
connection with the purchase of a policy.
The Company is subject to the unfair trade practices acts of the various states in which it does business. They each
define and prohibit unfair methods of competition or unfair or deceptive acts or practices, including misrepresentation
of policy terms, false advertising, making false statements, and defamation. Failure to comply with such acts or
insurance regulations could have a material adverse effect on the Company.
There are many states that have statutes regulating the activities of brokering loans or providing credit services to
individuals or businesses. Such laws may pertain to the receipt of advance fees, misrepresentations or omissions to
state any material facts in connection with loans or services, engagement in fraud or deception or registration.
If the acquisition of Brooke Savings Bank closes, the Company will be regulated by the United States Office of Thrift
Supervision, which has the authority to regulate, examine and take enforcement action against banks with respect to
their financial condition and deposit, lending, investment and other operations.
The Company believes that it is currently in material compliance with all state, federal and foreign regulations to
which the Company is subject and the Company is unaware of any pending or threatened investigation. action or
proceeding by any state federal or foreign regulatory agency involving the Company that would have a material adverse
effect on the Company’s operations. In the fourth quarter 2005, Ohio suspended FLAC’s license because its statutory
capital and surplus fell below the minimum amount of $2,500,000 as of September 30, 2005. This shortfall was
corrected as of December 31, 2005 and Ohio reinstated FLAC’s license in 2006. FLAC continues to operate under a
Confidential Memorandum of Understanding which restricts its ability to write new business in Ohio, however, management
believes this restriction will be removed in 2007 because of FLAC’s profitable operations in 2006 and its 46% increase
in its capital and surplus since the end of 2005.
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.
FLAC and BCA file a consolidated income tax return with FACC. In certain consolidated return years, the separate tax
liability of FLAC, BCA or FACC may be reduced through the utilization of net operating losses of the other companies
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 companies. 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.
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Assuming that the acquisition of Brooke Savings Bank is consummated, Brooke Corporation’s direct and indirect ownership
interest in the Company will increase to approximately 72% of its outstanding common stock. Under these circumstances,
it is anticipated that the Company will continue to file a separate consolidated income tax return with its
subsidiaries. Existing net operating losses will be utilized by the Company in its consolidated returns to the extent
possible subject to certain limitations. Certain limitations (with respect to the utilization of existing net
operating loss carryforwards) will apply when a change in ownership is deemed to have occurred for tax purposes. A
change in ownership typically occurs when more than 50% of a Company’s stock changes hands. In connection with the
2006 Stock Purchase Agreement, Brooke’s ownership in the Company did not exceed 50% until Brooke was able to exercise
its warrant on January 31, 2007. Accordingly, the Company believes that a change in ownership did not occur until that
date and expects to utilize existing net operating losses without limitation through January 31, 2007, the date when
Brooke was able to exercise the warrant and obtain more than 50% ownership of the Company’s issued and outstanding
common stock.
Financial Information Relating to Industry Segments
The operations of the Company and its subsidiaries have been classified into three operating segments as follows: life
and annuity insurance operations (conducted by FLAC and by FACC pursuant to the Services Agreement); brokerage
operations conducted by BCA; and corporate operations. All sales of life insurance by FLAC are to unaffiliated
customers. Financial information related to these three segments of the Company’s business is presented below.
| 2006 | 2005 | 2004 | ||||||||||
Revenues: |
||||||||||||
Life and annuity insurance operations |
$ | 4,880,259 | 4,628,936 | $ | 4,293,633 | |||||||
Brokerage operations |
1,199,210 | 765 | — | |||||||||
Corporate |
82,727 | 230,801 | 403,843 | |||||||||
Total |
$ | 6,162,196 | $ | 4,860,502 | $ | 4,697,476 | ||||||
Income (loss) before income taxes: |
||||||||||||
Life and annuity insurance operations |
$ | 254,517 | $ | 271,992 | $ | 464,114 | ||||||
Brokerage operations |
1,083,796 | (13,965 | ) | — | ||||||||
Corporate |
(570,598 | ) | (958,656 | ) | (761,430 | ) | ||||||
Total |
$ | 767,715 | $ | (700,629 | ) | $ | (297,316 | ) | ||||
Depreciation and amortization expense: |
||||||||||||
Life and annuity insurance operations |
$ | 737,908 | 630,737 | 769,611 | ||||||||
Brokerage operations |
584 | 438 | — | |||||||||
Corporate |
142,767 | 153,863 | 132,902 | |||||||||
| $ | 881,259 | $ | 785,038 | $ | 902,513 | |||||||
Assets: |
||||||||||||
Life and annuity insurance operations |
28,570,332 | 23,337,149 | $ | 18,305,111 | ||||||||
Brokerage operations |
1,198,212 | 11,903 | — | |||||||||
Corporate |
1,488,199 | 3,328,610 | 4,649,885 | |||||||||
Total |
$ | 31,256,743 | $ | 26,677,662 | $ | 22,954,996 | ||||||
Employees
As of December 31, 2006, the Company had 11 full time employees.
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Recent Developments
As the result of consummation of a series of transactions contemplated by the terms of a Stock Purchase and Sale
Agreement between FACC and Brooke dated October 6, 2006 (the “2006 Stock Purchase Agreement”), Brooke has acquired a
majority of FACC’s outstanding common stock. See “Item 5—Market for Common Equity and Related Stockholders Matters —
Sales of Unregistered Securities”.
Brooke is listed on the Nasdaq Global Market under the symbol “BXXX”. Its wholly owned subsidiary, Brooke Franchise
Corporation, distributes insurance and banking services through a network of more than 700 franchise locations. Brooke
Franchise was named the 22nd largest U.S. insurance agency by Business Insurance magazine (2006) and the country’s No.
37 top franchise opportunity by Entrepreneur magazine (2007).
Among other things, the 2006 Stock Purchase Agreement provided for (1) FACC to submit to a shareholder vote approvals
of (a) amendments to its Articles of Incorporation to (i) increase the number of shares of authorized common stock that
FACC is authorized to issue from 8,000,000 shares to 25,000,000 shares, (ii) increase the number of shares of
authorized preferred stock that FACC is authorized to issue from 550,000 shares to 1,550,000 shares, and (iii) reduce
the par value of each share of common. stock from $.10 to $.01, and (b) a reverse stock split of FACC’s common stock
whereby every three shares of common stock will be reverse split into one share of common stock and fractional shares
will be cashed out at the equivalent of $1.72 per whole share; (2) FACC to obtain, and Brooke to use its reasonable
best efforts to cause FACC to obtain, a listing of FACC’s common stock on the American Stock Exchange or the Nasdaq
Capital Markets, if such shares are eligible to be so listed; (3) the commencement of a modified “Dutch Auction” style
tender offer by FACC within three months after the December 8, 2006 closing for up to $500,000 of outstanding shares of
FACC’s common stock subject to certain adjustments; (4) the Company to have, and Brooke to use its best efforts to
cause the Company to have, capital and surplus reasonably sufficient to fund the projected capital needs of FACC
operations for the first three years after the closing, subject to certain conditions: (5) certain limitations on
Brooke’s ability to transfer its shares of the FACC’s common stock during that three-year period, (6) the formation and
maintenance of a committee of FACC’s Board of Directors consisting of independent directors for a limited term to
approve or disapprove certain specified types of actions and transactions; and (7) the entry by FACC and Brooke into
the Brooke Servicing Agreement with a term through December 31, 2007, by which certain human resources, accounting
compliance and communications services would be provided by Brooke to the Company in exchange for a $5,000 monthly fee.
The Brokerage Agreement and Brooke Servicing Agreement became effective on December 8, 2006.
On February 14, 2007, the Company announced that it had entered into a definitive agreement (the “2007 Stock Purchase
Agreement”) with Brooke Brokerage Corporation, a Kansas corporation (“BBC”) pursuant to which the Company will acquire
all of the issued and outstanding shares of capital stock of Brooke Savings Bank from BBC in exchange for 6,047,904
shares of the Company’s common stock, subject to adjustment in the event of certain changes to the Company’s
capitalization. See “Market for Common Equity and Related Stockholder Matters — Sales of Unregistered Securities”.
The closing of the transaction is subject to its approval by the United States Office of Thrift Supervision, the
Commissioner of Insurance for the State of Kansas, any other regulatory approvals, and other standard closing
conditions, and is expected within 12 months. Either party may terminate this agreement after 365 days following the
date of the 2007 Stock Purchase Agreement if the transaction contemplated thereby has not been consummated. The
Company can provide no assurance that the transaction will be consummated.
| Item 2. | Description of Property |
FLAC owns approximately six and one-half acres of land located in Topeka, Kansas, which it acquired from the Company on
May 1, 2006. The land is comprised of two parcels, the first of which includes a 20,000 square foot office building
which was constructed on approximately one-half of this land. The remaining land, including improvement costs, is
classified as real estate held for investment. Under the transaction the Company sold and FLAC purchased the Company’s
office building and the real property on which it is located for $2,800,000, which value was determined based upon an
independent appraisal.
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On May 1, 2006 the Company entered into a month-to-month commercial lease agreement with FLAC under which the Company
leases 1,400 square feet of office space. Under the lease agreement, the Company pays $2,566.67 per month or $22 per
square foot for the space leased. The lease payment is an all inclusive rate, which includes taxes, maintenance,
utilities, and insurance that is attributable to the space leased.
The Company does not intend to make any improvements, develop or renovate the property or building and believes the
occupied space is adequate for use as the Company’s offices. The Company occupies approximately 7,500 square feet of
the building. Approximately 10,000 square feet is leased to the United States Department of Agriculture (“USDA”) under
a lease that commenced on July 1, 2001 and will end on June 30, 2011. The remaining 2,500 square feet is leased to the
United States Department of Transportation (“USDOT”) under a lease that commenced on September 1, 2005 and will end on
August 31, 2010. The lease will automatically renew if not terminated on or after August 15, 2010 for another five
years.
The average effective annual rental of the total leased space during 2006, assuming no vacancy, was $19.17 per square
foot or $239,678 per year. The occupancy rate based on the total square feet available for lease in 2006 was 100%.
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 $75,053 or an assessed
rate of 25%. The annual taxes on the land are $8,766 or an assessed rate of 12%.
| Item 3. | Legal Proceedings |
The Company has been from time to time a party to claims and lawsuits that are incidental to the Company’s business
operations. While ultimate liability with respect to these claims and litigation is difficult to predict, the Company
believes that the amount, if any, that we are required to pay in the discharge of liabilities or settlements in these
matters will not have a material adverse effect on our consolidated results of operations or financial position. As of
February 22, 2007, the Company was not, to its knowledge, a named party in any legal proceeding.
| 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 report to a vote of the Company’s
security holders, through the solicitation of proxies or otherwise.
Subsequent to year end at a special meeting of shareholders held on January 31, 2007, a majority of the shareholders
approved (a) amendments to the Company’s Articles of incorporation to (i) increase the number of shares of authorized
common stock that the Company is authorized to issue from 8,000,000 shares to 25,000,000 shares, (ii) increase the
number of shares of authorized preferred stock that the Company is authorized to issue from 550,000 shares to 1,550,000
shares, and (iii) reduce the par value of each share of common stock from $.10 to $.01, and (b) a reverse stock split
of the Company’s common stock and fractional shares will be cashed out at the equivalent of $1.72 per whole share.
PART II
| Item 5. | Market for Common Equity and Related Stockholder Matters |
Market Information
The Company’s common stock is not traded on an established public market.
Holders
As of February 22, 2007, there were approximately 4,945 shareholders of record of the Company’s outstanding common
stock.
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Dividends
The Company has not paid any cash dividends since inception (July 10, 1996). Management anticipates that for the
foreseeable future any and all earnings will be retained to fund the growth of FLAC’s business and for other working
capital purposes and that as a result no dividends are currently planned. As noted above, the regulatory requirements
of the KID may practically restrict the ability of the Company to transfer any operating profits produced by FLAC’s
insurance operations to the Company for use in paying dividends on the Company’s stock.
Sales of Unregistered Securities
Pursuant to the 2006 Stock Purchase Agreement between Brooke and the Company, Brooke initially acquired 3,742,943
shares of common stock of the Company (approximately 46.8% of the then issued and outstanding FACC common stock) on
December 8, 2006. Pursuant to the same agreement, Brooke also acquired a warrant to purchase an additional 1,643,460
shares of such common stock. On January 31, 2007, the date that the Company’s Articles of Incorporation were amended
to increase the number of authorized shares of common stock from 8,000,000 shares of such common stock to 25,000,000,
Brooke exercised its warrant to purchase such additional shares and, as of such date, increased its total ownership of
FACC common stock to 5,386,403 shares. This amount represents approximately 55% of the issued and outstanding shares,
on a fully diluted basis. Brooke paid a total of $3 million in cash for the common stock and is required to pay up to
$6 million in additional consideration to the Company should BCA, not meet a three-year, $6 mullion pretax profit goal
in accordance, with an agreed upon schedule set forth in the 2006 Stock Purchase Agreement.
On February 14, 2007, the Company entered into the 2007 Stock Purchase Agreement with Brooke Brokerage Corporation
(“BBC”), a Kansas corporation and wholly owned subsidiary of Brooke, pursuant to which the Company will acquire all of
the issued and outstanding shares of capital stock of Brooke Savings Bank from BBC in exchange for 6,047,904 shares of
the Company’s common stock, subject to adjustment in the event of certain changes to the Company’s capitalization. The
closing of the transaction is subject to its approval by the United States Office of Thrift Supervision, the
Commissioner of Insurance for the State of Kansas, any other regulatory approvals, and other standard closing
conditions, and is expected to occur by February 2008. Either party may terminate the 2007 Stock Purchase Agreement
after 365 days following the date of the agreement if the transaction contemplated thereby has not been consummated.
BBC is a wholly owned subsidiary of Brooke. Robert D. Orr and Michael S. Hess are both directors and officers of each
of BBC and the Company; Mr. Orr is also a director and Chairman of the Board and Chief Executive Officer of Brooke
Corporation; and Mr. Hess is a director of Brooke Savings Bank. BBC acquired all of the capital stock of Brooke Savings
Bank, previously Generations Bank, on January 8, 2007, and Brooke became a majority owner of the Company on January 31,
2007.
| Item 6. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto,
beginning on page F-1 in this report.
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. For a detailed discussion of other significant accounting policies, see Note 2 — Significant
Accounting Policies in the Notes to the Consolidated Financial Statements.
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Investments. The Company’s principal investments are held by FLAC 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 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 consolidated balance sheets from December 31, 2005 to December 31, 2006 are highlighted
below.
Total assets increased from $26,677,662 at December 31, 2005 to $31,256,743 at December 31, 2006 primarily as the
result of a $3,293,819 increase in cash balances partially resulting from an increase in equity of approximately
$2,261,000 from the sale of stock and warrants to Brooke Corporation.
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Primarily as the result of regular analysis and repositioning of the Company’s investment portfolio, available for sale
fixed maturities investments decreased from $13,854,375 at December 31, 2005 to $12,298,780 at December 31, 2006 and
available for sale equity securities decreased from $456,760 at December 31, 2005 to $283,060 at December 31, 2006
Mortgage loans on real estate increased from $1,566,382 at December 31, 2005 to $1,937,281 at December 31, 2006 as the
result of management’s decision to invest and reallocate a larger share of the Company’s investment portfolio to
mortgage loans on real estate to increase overall yields.
Other investments increased from $1,656,866 at December 31, 2005 to $3,067,369 at December 31, 2006 as the result of
management’s decision to invest and reallocate a larger share of the Company’s investment portfolio to lottery prize
cash flows to increase overall yields. These investments involve purchasing assignments of the future payment rights
from the 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.
Reinsurance receivables increased from $78,725 at December 31, 2005 to $112,145 at December 31, 2006. The increase
during the year represents the balance due from Wilton Re in conjunction with the reinsurance of the Company’s Golden
Eagle Whole Life (Final Expense) product (see Note 11 to the Consolidated Financial Statements). Of the $112,145
balance due, $2,476 is attributable to commission allowances, $4,567 is attributable to expense allowances, and
$105,102 represents a recovery for paid claims.
Deferred policy acquisition costs, net of amortization, increased marginally from $5,133,244 at December 31, 2005 to
$5,209,693 at December 31, 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.
Other assets increased from $24,935 at December 31, 2005 to $1,221,559 at December 31, 2006. The increase is primarily
due to a $1,196,182 receivable from a Brooke Corporation subsidiary for loan brokerage loan fees generated during the
fourth quarter transition of loan brokerage activities from the Brooke Corporation subsidiary to BCA.
Policy and contract liabilities increased to $20,184,040 at December 31, 2006 from $16,241,529 at December 31, 2005. A
significant portion of this increase is attributable to future policy and annuity benefits related to sales of the
Company’s various life insurance products. Reserves for future policy benefits established due to the sale of life
insurance increased $841,250 or 16% from December 31, 2005 to December 31, 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 $3,356,628 or 33% from December 31, 2005 to December 31, 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. According to the design of the Company’s FA2000
product, first year premium payments are allocated 100% to life insurance and renewal payments are split 50% to life
and 50% to annuity.
Reinsurance premiums payable decreased from $107,334 at December 31, 2005 to $54,732 at December 31, 2006. The
decrease was due to the termination of the reinsurance treaty on June 24, 2006.
Amounts held under reinsurance decreased from $219,079 at December 31, 2005 to $18,321 at December 31, 2006. Amounts
held under reinsurance represents the unearned portion of commission allowances due to the Company by Wilton Re in
conjunction with the reinsurance of our final expense product. Commission allowances are paid to the Company on an
annualized basis and initially recorded by the Company as a liability. The liability is subsequently
released and applied against policy acquisition costs over the first policy year as premiums are paid on the applicable
business.
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The Company sold its home office building to FLAC during 2006 resulting in the repayment of all notes payable balances
and a decrease of $2,272,986 from the balance outstanding at December 31, 2005.
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.
Results of Operations
The Company reported net income of $755,848 during 2006 and net losses of $700,629 and $232,936 during 2005 and 2004,
respectively. After losses in the previous two years, the Company was profitable during 2006 because the Company’s
brokerage subsidiary began brokering loans to managing general insurance agencies in the fourth quarter of 2006
pursuant to a brokerage agreement with a Brooke Corporation subsidiary.
In addition to consulting fees from loan brokerage activities in 2006, significant components of revenues include life
insurance premiums (net of reinsurance), net investment income, and net realized investment gain. The following table
provides information concerning net premium income for the years ended December 31, 2006, 2005, and 2004:
| 2006 | 2005 | 2004 | ||||||||||
Whole life insurance: |
||||||||||||
First year |
$ | 671,152 | $ | 1,091,667 | $ | 899,629 | ||||||
Renewal |
3,544,584 | 3,069,155 | 2,701,813 | |||||||||
Term insurance: |
||||||||||||
First year |
3,543 | 3,932 | 1,099 | |||||||||
Renewal |
19,277 | 18,305 | 20,296 | |||||||||
Single premium |
14,800 | 17,520 | 17,720 | |||||||||
Gross premium income |
4,253,356 | 4,200,579 | 3,640,557 | |||||||||
Reinsurance premiums
assumed |
12,425 | 12,240 | 10,816 | |||||||||
Reinsurance premiums ceded |
(588,544 | ) | (419,660 | ) | (117,761 | ) | ||||||
Net premium income |
$ | 3,677,237 | $ | 3,793,159 | $ | 3,533,612 | ||||||
Gross premium income increased by 1%, while net premium income decreased by 3% between 2005 and 2006 as a result of
greater reinsurance premiums ceded in the amount of $185,839 to Wilton Re for our final expense product. Total first
year whole life premium decreased $420,515 or 39% from 2005 to 2006. The decrease is attributable to management’s
decision to reduce the issuance of final expense products of 2006 because of capital limitations. Net premium income
increased $259,547 or 7% between 2004 and 2005 and total first year whole life premium
increased $192,038 or 21% from 2004 to 2005. The increase is attributable primarily to an increase in the production
of the Company’s final expense product.
Total renewal year whole life premiums increased $475,429 or 15% from 2005 to 2006 and $367,342 or 14% from 2004 to
2005. Renewal premiums reflect the premium collected in the current year for those policies that have surpassed their
first policy 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.
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Net investment income increased $218,594 or 25% from 2005 to 2006 and increased $349,817 or 68% from 2004 to 2005.
During the first quarter of 2004, the Company sold a significant portion of its bond portfolio in order to realize
market gains and reinvest the resulting proceeds using a new investment strategy. The new strategy is focused
primarily on matching maturities to the anticipated cash needs of the Company, but also attempted to more closely
duplicate the investment mix of others within the Company’s industry peer group.
Net investment losses of $39,955 were realized in 2006 as compared to net losses of $1,836 in 2005. The variance is
primarily attributable to the sale of a significant portion of the Company’s bond portfolio during 2006 to generate the
cash required by FLAC to acquire the Company’s home office. Net realized investment gains of $463,787 were recorded in
2004. As described above, the Company sold a significant portion of its bond portfolio during the three months ended
March 31, 2004. Gains totaling $464,363 were realized upon the sale of these bonds.
Benefits and expenses totaled $5,394,481, $5,561,131 and $4,994,792 for the years ended December 31, 2006, 2005 and
2004, respectively. Included in total benefits and expenses were policy reserve increases of $841,250, $1,118,501, and
$1,020,812 for the years ended December 31, 2006, 2005 and 2004, 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 $33,519 from 2005 to 2006 and $101,076 from 2004 to 2005. The increase is
attributable to the increase in the number of policies inforce and the continued maturation of those policies.
Interest credited on annuities and premium deposits totaled $579,074, $405,778, and $344,918 for the years ended
December 31, 2006, 2005 and 2004, respectively. The increases 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 (9,974, 9,856, and 8,318 in 2006, 2005 and 2004, respectively). The average interest credit
rate on annuities and premium deposits has decreased from 5.7% and 4.7% during 2004 and 2005, respectively, to 4.7%
during 2006. The decrease is attributable to management’s attempt to more effectively manage the interest spread
between the rate the Company earns on its investment portfolio and the rate being credited to policyholder accounts
combined with the introduction of several new annuity products marketed during 2005 and 2006 which are deemed to be
shorter in duration and thus credit interest at a lesser rate than other annuities which have historically been offered
by the Company.
Death claims increased $230,080 from 2005 to 2006 and $218,009 from 2004 to 2005. The increase is attributable to the
increase in the number of policies inforce and the continued maturation of the final expense policies, which are
generally purchased by consumers in their senior years.
Commission expense totaled $809,549, $1,200,741, and $1,059,798 for the years ended December 31, 2006, 2005 and 2004,
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 decrease in
commission expense during 2006 is directly related to the decrease in first year whole life premium in 2006. The
increase in commission expense during 2005 is directly related to the increase in first year whole life premium in
2005. The increase during 2005 was partially offset by commission allowances of $335,931 from Wilton Re being netted
against the balance of commission expense. Commission allowances received on reinsured business essentially serve as a
reimbursement to the Company for acquisition costs incurred to write business.
Salaries, wages and employee benefits decreased from $1,234,824 and $1,119,185 in 2005 and 2004, respectively, to
$933,707 in 2006. The decrease during 2006 is primarily attributable to a decrease in employee headcount combined with
decreased employee benefit expenses. Management elected not to replace several positions that became vacant because of
its intent to reduce expenses and make FLAC profitable. The increase during 2005 is primarily attributable to an
increase in employee headcount combined with increased employee benefit expenses.
Other operating costs and expenses totaled $1,176,769, $1,336,307, and $1,359,969 for the years ended December 31,
2006, 2005 and 2004, respectively. The balance of other operating costs and expenses during 2006 and 2005,
respectively, is comprised of gross costs totaling $1,278,131 and $1,492,972, offset by expense allowances received
from Wilton Re totaling $101,362 and $156,665. Expense allowances received on reinsured business essentially
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serve as
a reimbursement to the Company for acquisition costs incurred to write business. Significant components of the
$214,841 decrease in gross other operating costs and expenses from 2005 to 2006 include the following. Agency expenses
decreased $50,412 and travel expense decreased $23,645 due to FACC not conducting an agent incentive trip in 2006.
FACC conducted an agent incentive trip in 2005. Miscellaneous losses decreased $73,965. Interest expense decreased by
$95,120 due to the payoff of the notes payables in 2006. The aforementioned decreases were offset by an increase in
professional fees of $70,565 during 2006.
Significant components of the $133,003 increase in gross other operating costs and expenses from 2004 to 2005 include
the following. EDP (Electronic Data Processing) costs increased $63,268 in conjunction with conversion process
consulting related to the Company’s two life insurance administration systems. Agency expenses increased $27,710 in
conjunction with an agency incentive contest. Miscellaneous losses increased $73,965 resulting from a $35,465 loss
incurred on a transaction with Brooke (see Item 12 Certain Relationships, Related Transactions, and Director
Independence — Related Person Transactions) and a $38,500 loss on the settlement of pending litigation. Other
increases realized during 2005 included building operations ($43,732), interest ($33,370) and depreciation ($20,961).
The aforementioned increases were offset by reductions in actuarial and legal fees of $73,858 and $60,965,
respectively. These decreases are primarily attributable to the nonrecurrence of the professional fees and expenses
incurred in 2004 in support of the activities of a special committee of the Board of Directors of the Company,
described as follows.
Liquidity and Capital Resources
During the years ended December 31, 2006, 2005, and 2004, 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 years ended December 31, 2006, 2005 and 2004 totaled $634,874, $768,938 and $404,894,
respectively.
As of December 31, 2006, the Company and its subsidiaries had consolidated cash reserves and liquid investments of
approximately $16,107,968, as compared with $14,543,444 at the end of 2005 and $14,200,958 at the end of 2004. Of
these amounts, cash reserves and liquid investments at FLAC as of these dates were approximately $14,128,536,
$14,112,878, and $12,812,107, 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 December 31, 2006, cash reserves and liquid investments
at the parent company level were approximately $1,978,394 as compared with $419,540 at the end of 2005 and $1,388,851
at the end of 2004. Cash balances at the parent company level as of December 31, 2006 increased from the net proceeds
of approximately $478,000 resulting from the sale of the Company’s home office building to FLAC and net proceeds of
approximately $2,261,000 resulting from the sale of warrants and common stock to Brooke Corporation. Cash balances at
the parent company level as of December 31, 2006 decreased from a $1,000,000 capital contribution to FLAC. Cash
balances at the parent company level, combined with additional proceeds from exercise of warrants in 2007 by Brooke,
the expected cash flows from its brokerage subsidiary, income tax sharing arrangements and administrative services
reimbursements from FLAC is believed by management to be sufficient to fund the parent company’s normal operations and
pay its corporate expenses, income taxes and dividends.
The Company received additional capital of approximately $448,000 from the exercise of warrants by Brooke Corporation
on February 1, 2007. The Company may also receive additional capital contributions from Brooke Corporation during the
next three years resulting from an agreement by Brooke Corporation to contribute up to an additional $6,000,000 to the
Company’s capital if the Company’s brokerage subsidiary does not achieve $6,000,000 in pre tax income over the next
three years in accordance with an agreed upon schedule.
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If FLAC is successful in implementing its marketing plans and its premiums increase significantly as a result, then
FLAC may require additional capital contributions in 2007 from the parent company. In this event, capital
contributions are not expected to exceed $1,000,000 and any such required contributions are expected to be funded from
the parent company’s cash reserves.
BCA is the Company’s brokerage subsidiary. The nature of BCA’s operations is such that it is not expected to require
any capital contributions in 2007 from the parent company. Instead, if BCA is successful in implementing its
marketing plans, it will likely be a source of cash to the parent company.
The Company recently announced an agreement to acquire all of the outstanding common stock of Brooke Savings Bank in
exchange for 6,047,904 shares of the Company’s stock with a value of approximately $10,100,000. Although the
transaction, if consummated, will not affect the parent company’s cash balances, it will increase the Company’s total
equity capital. If Brooke Savings Bank is acquired and it is successful in implementation of its business plans, then
the bank may require additional capital contributions in 2007 from the parent company. In this event, capital
contributions are not expected to exceed $10,000,000 and any such required contributions are expected to be funded from
the sale by the parent company of common or preferred equity to public or private investors.
If another suitable bank, life insurance or brokerage acquisition opportunity arises, the Company may require
additional capital to fund an acquisition. In this event, the required capital for an acquisition is expected to be
funded from the sale by the parent company of common or preferred equity to public or private investors.
The Company plans to seek a listing of its common stock on either the American Stock Exchange or the Nasdaq Capital
Market, once those shares are eligible for listing. Management believes that a stock exchange listing will improve the
Company’s prospects for selling additional equity, acquiring a business by merger or issuing debt.
Capital Commitments
Substantially all of the Company’s contractual commitments are future annuity and policy benefits. The following table
summarizes the Company’s estimated contractual obligations for its annuity and insurance liabilities by due date and
expiration as of December 31, 2006:
Due within one year |
$ | 1,937.000 | ||
Due in one to three years |
4,507,000 | |||
Due in three to five years |
5,416,000 | |||
Due after five years |
7,907,000 | |||
Total |
$ | 19,767,000 | ||
While annuity contracts have scheduled payments, the timing of the cash flows associated with life insurance policies
is uncertain and can vary significantly.
Recently Issued Accounting Principles
See Note 2 (Significant Accounting Policies) to the Company’s consolidated financial statements for a discussion of the
effects of the adoption of new accounting pronouncements.
Impact of Inflation and General Economic Conditions
The Company’s liquidity and capital resources are subject to inflation and general market conditions. The Company is
primarily invested in fixed maturity securities. A majority of these assets are debt securities and are considered
fixed income investments. In addition, the Company has investments in mortgage loans. Both of these investments are
exposed to three primary sources of investment risk: credit, interest rate and liquidity. In addition, the Company’s
investments are subject, in varying degrees, to market risk that can affect their return and their fair market value.
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Interest rate risk arises from the price sensitivity of investments to change in interest rates. Coupon and dividend
income represents the greatest portion of an investment’s total return for most fixed income instruments in stable
interest rate environments. The changes in the fair market price of such investments are inversely related to changes
in market interest rates. As interest rates fall, the coupon and dividend streams of existing fixed rate investments
become more valuable and the market values rise. As interest rates rise, the opposite effect occurs.
The Company’s mortgage loan investments are also particularly sensitive to interest rate changes. As long-term rates
fall, borrowers become more likely to refinance their mortgages causing a prepayment of outstanding mortgage principal
that requires reinvestment at lower rates.
As interest rates rise, policyholders may become more likely to surrender policies or to borrow against cash values,
often to meet sudden needs in an inflationary environment or to invest in higher yielding opportunities elsewhere.
This risk of disintermediation may force the Company to liquidate part of its portfolio at a time when the fair market
value of fixed income investments is falling.
A majority of the Company’s investments are exposed to varying degrees of credit risk. Credit risk is the risk that
the value of the investment may decline due to the deterioration of the financial strength of the issuer and that the
timely or ultimate payment of principal or interest may occur. The Company mitigates credit risk by diversifying the
investment portfolio across a broad range of issuers, investment sectors and security types and by timing the amount of
investments in any particular entity.
| 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 |
On November 1, 2006, the Company’s independent accountant, BKD, LLP, (“BKD”) notified the Company that it was
resigning as the Company’s independent certified public accounting firm. BKD stated that its resignation was not a
result of any disagreements with either the management or audit committee of the Company. BKD’s accountant’s reports
for the Company’s financial statements for the Company’s two most recent fiscal years, or any later interim period, did
not contain adverse opinions or disclaimers of opinion, nor were any reports modified as to uncertainty, audit scope or
accounting principles. BKD’s resignation was of its own volition and a change of accountants was not recommended or
approved by the board of directors or an audit or similar committee of the board of directors.
At no time during the two most recent fiscal years or the interim period through November 1, 2006 did the Company have
any disagreements with BKD on any matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedure, which, if not resolved to BKD’s satisfaction, would have caused BKD to make reference to
the subject matter of the disagreement in connection with its accountant’s report.
During the two fiscal years prior to the change and through November 1, 2006, there were no reportable events (as
defined in Regulation S-B Item 304(a)(1)(iv)(B)).
The Company requested that BKD furnish it with a letter addressed to the SEC stating whether or not it agrees with the
above statements. A copy of such letter, dated November 14, 2006, was filed as Exhibit 16.1 to the Company’s Form
8-K/A filed November 15, 2006.
On November 6, 2006, the Company engaged Summers, Spencer & Callison, CPAs, Chartered (“SSC”), of Topeka, Kansas, to be
the Company’s new independent certified public accounting firm. SSC was selected by the Company due to, among other
factors, its proximity to the Company’s location in Topeka, Kansas and the familiarity of SSC with the industry within
which the Company operates. During the two most recent fiscal years and through November 6, 2006, the Company did not
consult with SSC regarding either (i) the application of accounting principles to a specific completed or contemplated
transaction, or the type of audit opinion that might be rendered on the Company’s financial statements and either
written or oral advice was provided that SSC concluded was an important factor considered by the Company in reaching a
decision as to the accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of
a disagreement, as that term is defined in Item 304(a)(1)(iv)(A) of Regulation S-B and the related instructions to Item
304 of Regulation S-B, or a reportable event, as that term is defined in Item 304(a)(1)(iv)(B) of
Regulation S-B.
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| 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 and the
information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive
Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. The Company’s Chief
Executive Officer and Chief Financial Officer 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 these controls and
procedures, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls
and procedures are effective in alerting management on a timely basis, of material information required to be disclosed
in the Company’s reports, except as set forth in this section.
In connection with its review of the financial statements filed with the Company’s Annual Report on Form 10-KSB for the
year ended December 31, 2005, the Company’s independent public accounting firm advised management that it had noted
certain matters that it considered to be a “material weakness”. A material weakness is a significant deficiency, or a
combination of significant deficiencies, in the Company’s internal financial procedures or controls, that results in
more than a remote likelihood that a material misstatement of the Company’s financial statements will not be prevented
or detected. The auditors noted that due to the resignation of the Chief Financial Officer of the Company effective
March 31, 2006, the Company did not then have adequate review procedures in place to ensure the development of timely,
complete and accurate financial statements and related footnotes.
Since March 31, 2006, the Company has taken significant steps to remediate this material weakness, including enhancing
the knowledge and skills of the existing staff, hiring outside consultants and independent contractors to assist the
staff in handling financial statement matters, and engaging as a full-time consultant an individual who had previously
served as the Company’s controller and who during that tenure was primarily responsible for preparing both the
Company’s statutory and GAAP financial statements. The Company has not yet hired a full time Chief Financial
Officer. However, John Van Engelen was appointed on January 31, 2007 to serve in this position on an interim basis.
In addition, in connection with the Brooke Servicing Agreement, the Company now has access to additional resources in
connection with its accounting and financial and regulatory reporting. Accordingly, management believes that the
material weakness that existed with respect to the preparation of the Company’s financial statements for the quarter
ended March 31, 2006, remained at June 30, 2006, but was substantially remediated prior to the preparation of the
financial statements for the year ended December 31, 2006.
With these remediation steps remaining in place and the addition of the functional financial support to be provided by
Brooke pursuant to the Brooke Servicing Agreement referred to above, management believes that the material weakness
will continue to be remediated and that the Company’s internal control over financial reporting as of the date of this
report is effective at a reasonable assurance level and has been for a period of time prior hereto. In connection with
its review of the financial statements filed with this report, the Company’s independent public accounting firm has
advised management that its has not identified any matters that it considered to represent material weaknesses.
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PART III
| Item 9. | Directors, Executive Officers, Promoters, Control Persons, and Corporate Governance; Compliance
With Section 16 (a) of the Exchange Act |
As a result of the consummation of the change of control transactions contemplated by the 2006 Stock Purchase
Agreement, the Company has experienced significant turnover in its Board of Directors. As previously agreed, six
members of the Board tendered their resignations for the Board upon occurrence of the change of control transactions.
The remaining two directors accepted these resignations, reduced by board resolution the number of directors comprising
the Board to six members, and designated four individuals to fill the vacant board positions. The current officers and
directors of FACC are as follows:
| Name | Age | Position | ||||
Robert D. Orr
|
53 | Chairman of the Board, President, Chief Executive Officer and Director | ||||
John F. Van Engelen
|
54 | Chief Financial Officer, Director and President of FLAC | ||||
Paul E. Burke Jr.
|
73 | Director | ||||
Keith E. Bouchey
|
56 | Director | ||||
Richard E. Gill
|
52 | Director | ||||
Michael S. Hess
|
51 | Vice President, Director, and President of FLAC | ||||
The directors serve until their successors are elected and qualified or until their earlier resignation or removal.
Directors are elected annually by the shareholders. The Chairman of the Board, Chief Executive Officer, President,
Secretary and Treasurer are elected at the annual meeting of the Board and serve for a term of one year. Any such
officer may, however, be removed, with or without cause, at any time by the Board. Other officers are elected by the
Board from time to time as the Board deems advisable and serve at the discretion of the Board. The following is a
brief description of the business background of the executive officers and directors:
Robert D. Orr: Mr. Orr was named Chairman of the Board, President, Chief Executive Officer and Director on
January 31, 2007. Mr. Orr is the founder of Brooke and has been a Brooke director and its Chief Executive Officer
since its inception in 1986. Mr. Orr was Brooke’s President from 1986 until 1991. Mr. Orr has been a director of
Brooke Brokerage Corporation, a wholly owned subsidiary of Brooke, since December 2005, has been its Chairman of the
Board and Chief Executive Officer since March 2006, and was its President from December 2005 until March 2006. Mr.
Orr served as President of Farmers State Bank, Phillipsburg, Kansas, Chairman of the Board of Brooke State Bank,
Jewell, Kansas, President of First National Bank, Smith Center, Kansas, and a self-employed insurance agent for
American Family Insurance Company. Mr. Orr is an honors graduate from Fort Hays State University in Hays, Kansas, with
a Bachelor of Arts Degree in Political Science. He also completed the Graduate School of Banking program at the
University of Colorado. Mr. Orr is the author of a book published in 2000 about the sale of insurance and financial
services in the Internet age entitled Death of an Insurance Salesman?.
John F. Van Engelen: Mr. Van Engelen has been a director of FACC since February 2004 and was named FACC’s Chief
Financial Officer on January 31, 2007. Mr. Van Engelen served as President and Chief Executive Officer of FACC from
February 16, 2004 until January 31, 2007. Mr. Van Engelen has also been a director and President of FLAC since
February 2004 and a director of BCA since its inception in 2005. He was elected Chief Executive Officer of FLAC on
January 31, 2007. He served as President of BCA from July 2005 through December 31, 2006. 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, 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.
Paul E. Burke, Jr.: Mr. Burke has been a director of FACC since its inception. Mr. Burke 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.
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Keith E. Bouchey: Mr. Bouchey has been a Director of the Company since January 31, 2007. Mr. Bouchey is a
director of the First Community Bancshares, Inc., Overland Park, Kansas, and serves as Senior Executive Vice President
and Chief Financial Officer of such corporation and its wholly owned subsidiary bank, First Community Bank, Lee’s
Summit, Missouri. Mr. Bouchey served five years as the Executive Financial Officer of Gold Banc Corporation, Inc.,
Leawood, Kansas, a publicly traded multi-bank holding company, from November 1995 until he joined First Community
Bankshares, Inc. in 2000. Previously, Mr. Bouchey was employed as a principal of GRA, Thompson, White & Co., P.C., a
regional bank accounting and consulting firm. Mr. Bouchey served for seventeen years as managing director of the
firm’s regulatory services practice. Mr. Bouchey is also a director, officer and shareholder of Holyrood Bancshares,
Inc., a closely-held, one-bank holding company located in Holyrood, Kansas; and a director and shareholder of UBT
Bancshares Inc., a $365 million closely-held, one-bank holding company located in Marysville, Kansas, which own United
Bank & Trust. Mr. Bouchey has also served as a director of Brooke Credit Corporation, a wholly owned subsidiary of
Brooke since February 2006. He has a Bachelor’s Degree in Corporate Finance from Kansas State University.
Richard Gill: Mr. Gill has been a Director of the Company since January 31, 2007. Mr. Gill is the owner of
Gill Agency, Inc. in Cherryvale, Kansas. Although the Cherryvale office serves as his principal place of business, Mr.
Gill has several insurance agency locations in Southeast Kansas. Prior to his ownership of the agency, Mr. Gill was
Superintendent of Customer Accounting for Union Gas Company where he supervised thirteen district offices. Preceding
his tenure at Union Gas Company, Mr. Gill was the credit manager for B&R Tire Company in Parsons, Kansas. Mr. Gill has
a Bachelors Degree in Business Administration from Pittsburg State University.
Michael Hess: Mr. Hess has served as a director and Vice President of FACC since January 31, 2007 and as
President of BCA since January 1, 2007. He was an original investor in Brooke and served on its Board of Directors
from 1990 until January 2005, as its President from 1996 until 2003, and as its Vice President from 1988 until 1996.
From its acquisition by Brooke in 2002 until January 2007, Mr. Hess was president and a director of CJD & Associates,
L.L.C., a wholesale insurance broker that later also began providing loan brokerage and consulting services to managing
general agencies and funeral homes. He was a director and President of Brooke Brokerage Corporation, a wholly owned
subsidiary of Brooke and the parent corporation of CJD from December 2004 until December 2005 and has been its Vice
President since December 2005. Mr. Hess has been a director of Brooke Savings Bank, a federal savings bank, since
January 8, 2007. Prior to joining the Brooke organization, Mr. Hess was employed by Western Resources, Inc. (now
Westar Energy, Inc.), a utility company in Topeka, Kansas. Mr. Hess also previously served as director of Patrons
Insurance Company and Great Plains Mutual Insurance Companies.
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 filed pursuant to Section 16(a). Based solely on a review of the copies of those
forms furnished to the Company and those filed with the SEC, the Company believes that during the fiscal year ended
December 31, 2006, all required filings applicable to the Company’s directors, executive officers and persons who own
more than ten percent of a registered class of the Company’s equity securities were timely met, except for the
following: (1) a late filing on Form 3 relating to the acquisition of common stock of the Company by Kyle L. Garst,
Robert D. Orr, Michael Lowry, Shawn Lowry, Anita Larson, Leland Orr, and Brooke Holdings, Inc., which was filed on
February 2, 2007; (2) a late filing on Form 3 relating to the acquisition of common stock of the Company by Robert D.
Orr, which was filed on February 7, 2007; (3) a late filing on Form 4 relating to a single
transaction by Robert D. Orr, which was filed on February 12, 2007; (4) a failure to file Form 4 relating to a single
transaction by Thomas Fogt, which was remediated by the filing of a Form 5 by Mr. Fogt on February 14, 2007; and (5) a
failure to file Form 4 relating to a single transaction by John Van Engelen, which was remediated by the filing of a
Form 5 by Mr. Van Engelen on February 12, 2007.
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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 Paul Burke, Keith Bouchey and Richard Gill. 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. As a result of the recent
restructuring of the Board following the consummation of the transactions contemplated by the 2006 Stock Purchase
Agreement, the Board of Directors has been unable to determine at this time if the audit committee has at least one
member who qualifies to serve as an “audit committee financial expert” as defined under regulations of the SEC.
Code of Ethics
The Company has adopted a code of ethics that applies to all executive officers and directors.
| Item 10. | Executive Compensation |
The following table sets forth the total compensation earned by the principal executive officer during the 2006 fiscal
year. No other executive officers’ total compensation exceeded $100,000 for service as an executive officer of the
Company during the 2006 fiscal year.
Summary Compensation Table
| Non-Equity | ||||||||||||||
| Option | Incentive Plan | All Other | ||||||||||||
| Salary | Bonus | Awards | Compensation | Compensation | Total | |||||||||
| Name and Principal Position | Year | ($) | ($) | ($) (1) | ($) | ($) | ($) | |||||||
| John Van Engelen, Chief Financial Officer (2) | 2006 | 144,800 | 25,000 | 32,210 | 28,000 | 5,496 | 235,506 |
| (1) | The assumptions made in the valuation of this award are discussed in Note 10 of the Notes to Consolidated
Financial Statements at Item 7 “Financial Statements.” |
|
| (2) | Mr. Van Engelen was President and Chief Executive Officer of FACC until January 31, 2007. |
On September 21, 2006, upon the recommendation of the compensation committee, the Board of Directors authorized the
grant of a success award to Mr. Van Engelen, consisting of a cash portion and a non-cash portion for the successful
negotiation and closing of the transactions contemplated by the 2006 Stock Purchase Agreement. The cash portion of the
success award consisted of a $25,000 bonus payable to Mr. Van Engelen at the time of the closing of such transactions
and was received by Mr. Van Engelen on December 8, 2006. The non-cash portion of the success award consisted of a
Warrant To Purchase Shares of Common Stock (the “Van Engelen Warrant”), dated October 5, 2006, providing Mr. Van
Engelen the right to purchase 50,000 shares of common stock of FACC upon its exercise. The warrant became exercisable
on December 8, 2006. Under the terms of the Van Engelen Warrant, Mr. Van Engelen may exercise his right to purchase up
to 50,000 shares, in one or in multiple exercises at an exercise price of $1.72 per share. The exercise period extends
until December 8, 2016. The Van Engelen Warrant additionally provides for adjustments of the number of shares and the
exercise price in accordance with any changes in the outstanding common stock by reason of stock dividends, split-ups,
recapitalizations and
conversions, combinations or exchanges of shares, separations, reorganizations, liquidations, or the like. Shares
received upon exercise of the Van Engelen Warrant may be subject to transfer restrictions as unregistered securities.
The amount disclosed in the table above as “non-equity incentive plan compensation” was paid to Mr. Van Engelen on
December 8, 2006, as a cash performance award pursuant to the terms of Mr. Van Engelen’s Employment Agreement, entered
into on July 1, 2006 (the “2006 Employment Agreement”). The terms of the 2006 Employment Agreement provided that Mr.
Van Engelen would be entitled to a performance-based bonus equal to 20% of his
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gross annual base salary, if the Board
of Directors’ determined that Mr. Van Engelen’s performance as Chief Executive Officer and President was satisfactory
(the “Performance Award”). Effective December 8, 2006, the Company entered into an Employment Agreement with Mr. John
F. Van Engelen to serve as President and Chief Executive Officer of First Life America (the “2007 Agreement”). The
2007 Agreement replaced and superseded the 2006 Employment Agreement but preserved Mr. Van Engelen’s eligibility to
receive the Performance Award as provided by the 2006 Employment Agreement.
The dollar value representing “all other compensation” in the summary compensation table represents the amount that the
Company paid to Mr. Van Engelen’s SIMPLE IRA plan in matching contributions.
Outstanding Equity Awards at Fiscal Year-End
| Number of | Number | |||||||
| Securities | of Securities | |||||||
| Underlying | Underlying | Option | ||||||
| Unexercised | Unexercised | Exercise | ||||||
| Options (#) | Options (#) | Price | ||||||
| Name | Exercisable | Unexercisable | ($) | Option Expiration Date | ||||
| John Van Engelen | 50,000 (1) | 0 | 1.72 | December 8, 2016 |
| (1) | FACC granted Mr. Van Engelen a warrant for the right to purchase 50,000 shares of the Company’s common
stock on October 5, 2006, which became exercisable on December 8, 2006. |
Compensation of Directors
The following table sets forth the total compensation of non-employee directors during the 2006 fiscal year. The
Company does not compensate employees for their service as members of the Board.
Directors Compensation Table
| Fees Earned or | ||||||||||||||||
| Paid in | All Other | |||||||||||||||
| Cash | Option Awards | Compensation | Total | |||||||||||||
| Name | ($) | ($) | ($) | ($) | ||||||||||||
Paul E. Burke, Jr. |
3,075 | 0 | — | 3,075 | ||||||||||||
Edward Carter |
3,400 | 0 | — | 3,658 | ||||||||||||
Thomas Fogt |
5,125 | 64,420 | (1) | 50,000 | 119,545 | |||||||||||
Kenneth Frahm |
4,125 | 0 | — | 4,125 | ||||||||||||
Stephen Irsik |
750 | 0 | — | 750 | ||||||||||||
John Montgomery |
3,975 | 0 | — | 3,975 | ||||||||||||
Gary Yager |
4,950 | 0 | — | 4,950 | ||||||||||||
| (1) | The assumptions made in the valuation of this award are discussed in Note 10 of the Notes to
Consolidated Financial Statements at Item 7 “Financial Statements.” |
On September 21, 2006, upon the recommendation of the compensation committee, the Board of Directors authorized the
grant of a success award to Mr. Fogt, consisting of a cash portion and a non-cash portion for his contribution to the
successful negotiation and closing of the transactions contemplated by the 2006 Stock Purchase
Agreement. The cash portion of the success award consisted of a $50,000 bonus payable to Mr. Fogt at the time of the
closing of such transactions and was received by Mr. Fogt on December 8, 2006. The non-cash portion of the success
award consisted of a Warrant To Purchase Shares of Common Stock (the “Fogt Warrant”), dated October 5, 2006, providing
Mr. Fogt the right to purchase 100,000 shares of common stock of FACC upon its exercise. The warrant became
exercisable on December 8, 2006. Under the terms of the Fogt Warrant, Mr. Fogt may exercise his
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right to purchase up
to 100,000 shares, in one or in multiple exercises at an exercise price of $1.72 per share. The exercise period
extends until December 8, 2016. The Fogt Warrant additionally provides for adjustments of the number of shares and
the exercise price in accordance with any changes in the outstanding common stock by reason of stock dividends,
split-ups, recapitalizations and conversions, combinations or exchanges of shares, separations, reorganizations,
liquidations, or the like. Shares received upon exercise of the Fogt Warrant may be subject to transfer restrictions
as unregistered securities.
During the 2006 fiscal year, each non-employee director was paid $750 per regular quarterly meeting attended for the
Company and its subsidiaries, $75 per telephonic meeting attended and $250 per committee meeting attended.
The Company has revised its director compensation policy for the 2007 fiscal year. Under the revised policy current
directors receive a $500 monthly retainer, $500 per regular meeting attended for the Company and its subsidiaries, $250
per telephonic meeting attended and $250 per committee meeting attended.
Severance and Change in Control Agreements
Notwithstanding that the employment relationship between Mr. Van Engelen and the Company is characterized as “at will”
employment, the 2007 Employment Agreement provides that if before June 30, 2007, (a) the Company terminates Mr. Van
Engelen’s employment without “Cause” (as defined by the 2007 Employment Agreement) or (b) Mr. Van Engelen resigns, the
Company will pay Mr. Van Engelen a lump sum cash payment of $144,800. If the Company terminates Mr. Van Engelen for
any reason after June 30, 2007, the Company will pay Mr. Van Engelen an amount equal to three months of his base salary
at the annual rate specified by the 2007 Employment Agreement.
| Item 11. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
The following table sets forth information as of February 22, 2007, regarding ownership of common stock of the Company
by (i) the only persons known by management 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 of | |||||||||
| Beneficial Owner | Status of Holder | Beneficial Ownership | Percent of Class(1) | |||||||
Brooke Corporation(2) |
Beneficial Owner | 5,386,403 | 55 | % | ||||||
10959 Grandview, Suite 600 Overland Park, KS 66210 |
||||||||||
Robert Orr(3) |
Director, Officer, | 5,386,403 | 55 | % | ||||||
210 W. State Street |
Beneficial Owner | |||||||||
Phillipsburg, KS 67661 |
||||||||||
John F. Van Engelen(4) |
Director, Officer | 51,000 | * | |||||||
1303 SW First America Place |
||||||||||
Topeka, KS 66604 |
||||||||||
Paul E. Burke, Jr. |
Director | 50,000 | * | |||||||
2009 Camelback Drive Lenexa, KS 66047 |
||||||||||
Keith E. Bouchey |
Director | -0- | * | |||||||
9820 Metcalf, Suite 110 Overland Park, KS 66212 |
||||||||||
Richard E. Gill |
Director | -0- | * | |||||||
215 West Main Street Cherryvale, KS 67335 |
||||||||||
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| Name and Address of | Amount of | |||||||||
| Beneficial Owner | Status of Holder | Beneficial Ownership | Percent of Class(1) | |||||||
Michael S. Hess |
Director, Officer | -0- | * | |||||||
10950 Grandview Drive, Suite 500 |
||||||||||
Overland Park, KS 66210 |
||||||||||
All Directors and Officers as a |
5,487,403 | 56 | % | |||||||
Group (6 persons) |
||||||||||
* Indicates less than 1% ownership.
(1) All percentages represent the total number of shares as beneficially owned by the individual, group, or entity or
as a percentage of (i) 9,643,460 shares of common stock issued and outstanding as of February 22, 2007, plus (ii) any
shares that the individual, group, or entity has the right to purchase within 60 days after such date pursuant to the
exercise of a vested stock option, warrants, conversion privileges or other rights.
(2) As of February 22, 2007, Brooke owned directly 5,386,403 shares of FACC common stock that represents approximately
55% of the shares of common stock then outstanding. As of that date, a group consisting of Brooke Holdings, Inc.,
Robert D. Orr, Leland S. Orr, Anita F. Larson, Shawn T. Lowry, Michael S, Lowry, and Kyle T. Garst beneficially owned
these shares.
(3) As of February 22, 2007, Robert D. Orr owned 65.45% of the common stock of Brooke Holdings, Inc. Brooke Holdings,
Inc. in turn owned, as of that date, 46.53% of Brooke. Brooke Holdings, Inc. and the following executive officers of
Brooke and/or its subsidiaries: Robert D. Orr, Leland S. Orr, Anita F. Larson, Shawn T. Lowry, Michael S. Lowry and
Kyle L. Garst have orally agreed to vote their shares of Brooke common stock together and, as a group, beneficially
owned 52.57% of the shares of Brooke common stock on February 22, 2007. Based on Robert D. Orr’s ownership of Brooke
Holdings, Inc. and his and Brooke Holdings, Inc.’s participation in the group, Robert D. Orr is deemed to beneficially
own 5,336,403 shares of FACC common stock.
(4) Includes shares issuable pursuant to a warrant to purchase 50,000 shares of FACC common stock at $1.72 per share,
which was issued on October 6, 2006 and is currently exercisable.
| Item 12. | Certain Relationships, Related Transactions, and Director Independence |
Related Person Transactions
On March 2, 2005, the Company entered into a Stock Repurchase Agreement with Brooke under which the Company repurchased
450,500 shares of Company common stock from Brooke. Brooke had previously acquired the shares from a third party for a
total purchase price of $772,255. The privately negotiated transaction involved approximately 9.7 % of Company common
stock then outstanding. The shares were purchased at a price of $1.71 per share for a total purchase price of
$770,355. The Company paid the purchase price using $200,000 of its working capital and financed the remaining amount
with a loan from Brooke Credit at a fixed rate of 8% over a ten-year period. The repurchase agreement also granted
Brooke warrants to purchase up to 150,000 shares of Company common stock at prices ranging from $1.71 to $5.00 per
share. These warrants were cancelled as part of the 2006 Stock Purchase Agreement.
The mortgage note on the commercial property and office building that the Company owned was financed by Vision Bank of
Topeka, Kansas. Gary Yager, a former Director of the Company, is the President and CEO of Vision Bank. As of December
31, 2006 the mortgage note was paid in full. Management believes that the terms obtained from Vision Bank at the time
of financing were no less favorable to the Company than those available from an independent lender.
The Boards of Directors of the Company and FLAC and KID authorized the parent company to sell its office building and
related real estate to FLAC. The proceeds were used in part to repay the notes to Vision Bank and Brooke described
above. Closing of this transaction occurred May 1, 2006.
27
Table of Contents
On October 5, 2006, Mr. Van Engelen was awarded a warrant to purchase up to 50,000 shares of Company common stock at an
exercise price of $1.72 per share. The warrant was awarded to Mr. Van Engelen in exchange for his
services in successfully negotiating and closing the transactions contemplated by the 2006 Stock Purchase Agreement.
Mr. Van Engelen entered into an employment agreement with the Company effective December 8, 2006 to serve as President
and CEO of First Life America Corporation. See Item 10 Executive Compensation above.
On October 5, 2006, Thomas Fogt, a then director of the Company, was awarded a warrant to purchase up to 100,000 shares
of Company common stock at an exercise price of $1.72 per share. Mr. Fogt was awarded the warrant in exchange for his
services in successfully negotiating and closing the transactions proposed by the 2006 Stock Purchase Agreement.
As more fully discussed in “Description of Business — Recent Developments” and “Market for Common Equity and Related
Stockholder Matters — Sales of Unregistered Securities”, Brooke had or has a direct and/or indirect material interest
in the 2006 Stock Purchase Agreement, the Brokerage Agreement and the Brooke Servicing Agreement. Brooke also has an
indirect interest in the Company’s proposed acquisition of Brooke Savings Bank under the terms of the 2007 Stock
Purchase Agreement. As a result of his relationship with Brooke, Robert Orr, a Company director and the Company’s
Chairman of the Board, President and Chief Executive Officer, has an indirect material interest in these transactions.
Michael Hess, a Company director and one of its executive officers, is a director and executive officer of BBC and a
director of Brooke Savings Bank.
With respect to the Company’s proposed acquisition of Brooke Savings Bank from BBC, the Company will exchange 6,047,904
shares of its common stock, with a value of approximately $10.1 million, for all of the stock of Brooke Savings Bank.
The agreed upon purchase price of approximately $10.1 million equals the price paid by BBC to acquire Brooke Savings
Bank on January 8, 2007. For the purpose of the proposed transaction, the shares of Company common stock have been
valued at $1.67 per share. This valuation equals the approximate price per share paid by Brooke for it 55% ownership
interest in the Company in the change of control transactions that occurred in December 2006 and January 2007. Based
on the number of Company shares of common stock currently outstanding, the proposed transaction would result in an
increase in Brooke’s combined direct and indirect ownership of the Company from 55% to approximately 72%. The proposed
transaction, after adjustments, would also reduce Brooke’s indirect ownership of Brooke Savings Bank from 100% to
approximately 72%.
For additional information regarding related transactions, see Note 12 to the Company’s consolidated financial
statements.
Director Independence
The following members, and former members, of the Board of Directors are “independent” as that term is defined in Rule
4200(a)(14) of the Nasdaq Marketplace Rules:
Current Directors:
|
Former Directors Who Served in 2006 | |
Paul E. Burke
|
Edward Carter | |
Keith E. Bouchey
|
Thomas Fogt | |
Richard E. Gill
|
Kenneth Frahm | |
| Stephen Irsik | ||
| John Montgomery | ||
| Harland Priddle | ||
| Gary Yager |
All members of the Company’s compensation committee and nominating and governance committee are independent in
accordance with Nasdaq independence standards for members of these committees.
28
Table of Contents
| Item 13. | Exhibits |
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-27.
(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 | Certificate of Amendment of Articles of Incorporation of First American Capital Corporation adopted January 31, 2007 (Incorporated by reference from Exhibit 3.1 to the Registrant’s S-K filed on February 2, 2007) | |
| 3.3 | Copy of Articles of Incorporation, as amended by the Certificate of Amendment adopted January 31, 2007 (*) | |
| 3.4 | Amended and Restated Bylaws of First American Capital Corporation adopted April 7, 2005 (Incorporated by reference from Exhibit 3.2 to the Registrant’s Form 8-K filed April 11, 2005) | |
| 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 | 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) | |
| 10.2 | 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) | |
| 10.3 | Intercompany Tax Sharing Agreement dated December 31, 2003 between First American Capital Corporation and First Life America Corporation (Incorporated by reference from Exhibit 10.6 to the Registrant’s Form 10-KSB filed March 29, 2004) | |
| 10.4 | Automatic Reinsurance Agreement between First Life America Corporation and Wilton Reassurance Company effective January 1, 2005 (Incorporated by reference from Exhibit 10.13 to the Registrant’s Form 10-KSB filed March 31, 2006) | |
| 10.5 | Stock Purchase and Sale Agreement between First American Capital Corporation and Brooke Corporation dated October 6, 2006 (Incorporated by reference from Exhibit 7a to the Registrant’s Schedule 13 D/A filed December 19, 2006) | |
| 10.6 | Stock Purchase Agreement between First American Capital Corporation and Brooke Brokerage Corporation dated February 14, 2007 (Incorporated by reference from Exhibit 10.1 to the Registrant’s Form 8-K filed February 15, 2007) | |
| 10.7 | Brokerage Agreement between First Life Brokerage, Inc. and CJD Associates, L.L.C. dated December 8, 2006 (*) |
29
Table of Contents
| Exhibit No. | Description | |
| 10.8 | Servicing Agreement between First American Capital Corporation and Brooke Corporation dated December 8, 2006 (*) | |
| 10.9 | Employment Agreement dated December 8, 2006 between First Life America Corporation and John F. Van Engelen (*) | |
| 10.10 | Employment Agreement dated December 8, 2006 between First American Capital Corporation and Michael S. Hess (*) | |
| 10.11 | Warrant for 50,000 shares of First American Capital Corporation common stock for $1.72 per share issued on October 5, 2006 to John F. Van Engelen. (*) | |
| 10.12 | Warrant for 100,000 shares of First American Capital Corporation common stock for $1.72 per share issued on October 5, 2006 to Thomas M. Fogt. (*) | |
| 10.13 | Warrant for 1,643,460 shares of First American Capital Corporation common stock for an aggregate exercise price of $447,818.00 issued December 8, 2006 to Brooke Corporation. (*) | |
| 10.14 | Commercial Lease Agreement between First Life America Corporation and First American Capital Corporation dated May 1, 2006 (*) | |
| 14.1 | First American Capital Corporation Code of Ethics for Executive Management and Board of Directors (Incorporated by reference from Exhibit 14.1 to the Registrant’s Form 10-KSB filed March 29, 2004) | |
| 16.1 | Letter on Change in Certifying Accountant (Incorporated by reference from Exhibit 16.1 to the Registrant’s Form 8-K/A filed November 15, 2006) | |
| 21 | Subsidiaries of First American Capital Corporation (*) | |
| 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 (*) | |
| 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 current reports on Forms 8-K dated October 8, 2006, November 1, 2006 (as amended by a Form 8-K/A
filed November 15, 2006) and December 8, 2006 reporting recent 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 Summers, Spencer & Callison, CPAs, Chartered was compatible with the maintenance of this firm’s
independence in the conduct of its auditing functions.
30
Table of Contents
The following table represents fees for professional audit services rendered by Summers, Spencer & Callison, CPAs,
Chartered for the audit of the Company’s annual financial statements and for the review of the financial statements
included in our quarterly reports.
| Years Ended December 31, | ||||||||
| 2006 | 2005 | |||||||
Audit Fees |
$ | 68,206 | $ | — | ||||
| $ | 68,206 | $ | — | |||||
| (1) | Audit fees — Consists of fees billed and anticipated fees 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 Summers, Spencer & Callison, CPAs, Chartered in connection
with statutory and regulatory filings or engagements. |
31
Table of Contents
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/ Robert D. Orr | Date | March 1, 2007 | |||
| Robert D. Orr, Chairman of the Board, President, Chief Executive Officer and Director |
||||||
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/ Robert D. Orr
|
Date | March 1, 2007
|
|||
| Robert D. Orr, Chairman of the Board, President, Chief Executive Officer and Director | ||||||
| By | /s/ John F. Van Engelen | Date | March 1, 2007 | |||
| John F. Van Engelen, Chief Financial Officer and Director | ||||||
| By | /s/ Michael Hess | Date | March 1, 2007 | |||
| Michael Hess, Director | ||||||
| By | /s/ Keith E. Bouchey | Date | March 1, 2007 | |||
| Keith E. Bouchey, Director | ||||||
| By | /s/ Paul E. Burke, Jr. | Date | March 1, 2007 | |||
| Paul E. Burke, Jr., Director | ||||||
| By | /s/ Richard E. Gill | Date | March 1, 2007 | |||
| Richard E. Gill, Director |
32
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| Page | ||||
| Consolidated Financial Statements | Numbers | |||
| F-2 | ||||
| F-3 | ||||
| F-4 | ||||
| F-6 | ||||
| F-7 | ||||
| F-8 | ||||
| F-9 | ||||
| F-11 | ||||
F-1
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
First American Capital Corporation:
First American Capital Corporation:
We have audited the accompanying consolidated balance sheet of
FIRST AMERICAN CAPITAL CORPORATION
as of December 31, 2006, and the related consolidated statements of operations, comprehensive
income, changes in stockholders’ equity and cash flows for the year then ended. 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 audit. The consolidated financial statements of
First American Capital Corporation as of December 31, 2005 and 2004 were audited by other auditors,
whose report thereon, dated March 21, 2006, expressed an unqualified opinion.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. The
company is not required to have, nor were we engaged to perform, an audit of its internal control
over financial reporting. Our audit included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the company’s internal control
over financial reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of First American Capital Corporation as of December 31,
2006, and the results of its operations and its cash flows for the year then ended in conformity
with accounting principles generally accepted in the United States of America.
Topeka, Kansas
February 27, 2007
February 27, 2007
F-2
Table of Contents
Report of Independent Registered Public Accounting Firm
Audit Committee, Board of Directors and Stockholders
First American Capital Corporation
First American Capital Corporation
We have audited the accompanying consolidated balance sheet of First American Capital Corporation
(a Kansas corporation) as of December 31, 2005 and the related consolidated statements of
operations, comprehensive income, changes in shareholders’ equity and cash flows for each of the
two years in the period ended December 31, 2005. 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 the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. 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 consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of First American Capital Corporation as of
December 31, 2005 and the consolidated results of its operations and its cash flows for each of the
two years in the period ended December 31, 2005, in conformity with accounting principles generally
accepted in the United States of America.
/s/ BKD, LLP
Kansas City, Missouri
March 21, 2006, except for Note 15 as
to which the date is March 28, 2006
March 21, 2006, except for Note 15 as
to which the date is March 28, 2006
F-3
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
| December 31, | December 31, | |||||||
| 2006 | 2005 | |||||||
Assets |
||||||||
Investments: |
||||||||
Securities available-for-sale, at fair value: |
||||||||
Fixed maturities (amortized cost, $12,532,067
in 2006 and $13,960,005 in 2005) |
$ | 12,298,780 | $ | 13,854,375 | ||||
Equity securities (cost of $258,400 in 2006
and $458,150 in 2005) |
283,060 | 456,760 | ||||||
Investments in real estate |
274,564 | 274,564 | ||||||
Policy loans |
166,026 | 103,493 | ||||||
Mortgage loans on real estate |
1,937,281 | 1,566,382 | ||||||
Other Investments |
3,067,369 | 1,656,866 | ||||||
Total investments |
18,027,080 | 17,912,440 | ||||||
Cash and cash equivalents |
3,542,928 | 249,109 | ||||||
Accrued investment income |
233,858 | 250,984 | ||||||
Accounts receivable |
281,894 | 272,200 | ||||||
Reinsurance receivables |
112,145 | 78,725 | ||||||
Deferred policy acquisition costs (net of accumulated
amortization of $4,444,081 in 2006 and $3,712,369 in 2005) |
5,209,693 | 5,133,244 | ||||||
Property and equipment (net of accumulated depreciation
of $945,228 in 2006 and $820,415 in 2005) |
2,627,586 | 2,756,025 | ||||||
Other assets |
1,221,559 | 24,935 | ||||||
Total assets |
$ | 31,256,743 | $ | 26,677,662 | ||||
See notes to consolidated financial statements.
F-4
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS (continued)
DECEMBER 31, 2006 AND 2005
| 2006 | 2005 | |||||||
Liabilities and Shareholders’ Equity |
||||||||
Policy and contract liabilities: |
||||||||
Future annuity benefits |
$ | 13,658,174 | $ | 10,301,546 | ||||
Future policy benefits |
6,109,055 | 5,267,805 | ||||||
Liability for policy claims |
211,932 | 190,050 | ||||||
Policyholder premium deposits |
104,038 | 146,354 | ||||||
Deposits on pending policy applications |
27,788 | 9,361 | ||||||
Reinsurance premiums payable |
54,732 | 107,334 | ||||||
Amounts held under reinsurance |
18,321 | 219,079 | ||||||
Total policy and contract liabilities |
20,184,040 | 16,241,529 | ||||||
Commissions, salaries, wages and benefits payable |
49,661 | 131,873 | ||||||
Other liabilities |
257,085 | 180,086 | ||||||
Notes payable |
— | 2,272,986 | ||||||
Deferred federal income taxes payable |
508,380 | 527,941 | ||||||
Total liabilities |
20,999,166 | 19,354,415 | ||||||
Shareholders’ equity: |
||||||||
Common stock, $.10 par value, 8,000,000 shares authorized,
issued and outstanding in 2006; and 5,449,578 shares issued
and 4,257,057 shares outstanding in 2005 |
800,000 | 544,958 | ||||||
Additional paid in capital |
13,757,298 | 12,478,903 | ||||||
Accumulated deficit |
(4,132,804 | ) | (3,496,404 | ) | ||||
Accumulated other comprehensive loss |
(166,917 | ) | (84,862 | ) | ||||
Less: Treasury stock held at cost (0 shares in 2006
and 1,192,521 in 2005) |
— | (2,119,348 | ) | |||||
Total shareholders’ equity |
10,257,577 | 7,323,247 | ||||||
Total liabilities and shareholders’ equity |
$ | 31,256,743 | $ | 26,677,662 | ||||
See notes to consolidated financial statements.
F-5
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
| 2006 | 2005 | 2004 | ||||||||||
Revenues: |
||||||||||||
Gross premium income |
$ | 4,253,356 | $ | 4,200,579 | $ | 3,640,557 | ||||||
Reinsurance premiums assumed |
12,425 | 12,240 | 10,816 | |||||||||
Reinsurance premiums ceded |
(588,544 | ) | (419,660 | ) | (117,761 | ) | ||||||
Net premium income |
3,677,237 | 3,793,159 | 3,533,612 | |||||||||
Net investment income |
1,085,897 | 867,303 | 517,486 | |||||||||
Net realized investment gain (loss) |
(39,955 | ) | (1,836 | ) | 463,787 | |||||||
Rental income |
239,678 | 201,008 | 182,553 | |||||||||
Consulting fees |
1,199,339 | 868 | 38 | |||||||||
Total revenue |
6,162,196 | 4,860,502 | 4,697,476 | |||||||||
Benefits and expenses: |
||||||||||||
Increase in policy reserves |
841,250 | 1,118,501 | 1,020,812 | |||||||||
Policyholder surrender values |
270,113 | 236,594 | 135,518 | |||||||||
Interest credited on annuities and
premium deposits |
579,074 | 405,778 | 344,918 | |||||||||
Death claims |
736,830 | 506,750 | 288,741 | |||||||||
Commissions |
809,549 | 1,200,741 | 1,059,798 | |||||||||
Policy acquisition costs deferred |
(814,016 | ) | (1,246,987 | ) | (1,275,646 | ) | ||||||
Amortization of deferred policy
acquisition costs |
737,567 | 630,737 | 769,611 | |||||||||
Salaries, wages, and employee benefits |
933,707 | 1,234,824 | 1,119,185 | |||||||||
Miscellaneous taxes |
123,638 | 137,886 | 171,886 | |||||||||
Other operating costs and expenses |
1,176,769 | 1,336,307 | 1,359,969 | |||||||||
Total benefits and expenses |
5,394,481 | 5,561,131 | 4,994,792 | |||||||||
Income (Loss) before income tax expense |
767,715 | (700,629 | ) | (297,316 | ) | |||||||
Income tax expense (benefit) |
11,867 | — | (64,380 | ) | ||||||||
Net Income (Loss) |
$ | 755,848 | $ | (700,629 | ) | $ | (232,936 | ) | ||||
Net Income (Loss) per common share: |
||||||||||||
Basic |
$ | 0.50 | $ | (0.49 | ) | $ | (0.15 | ) | ||||
Diluted |
$ | 0.39 | $ | (0.49 | ) | $ | (0.15 | ) | ||||
See notes to consolidated financial statements.
F-6
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
| 2006 | 2005 | 2004 | ||||||||||
Net income (loss) |
$ | 755,848 | $ | (700,629 | ) | $ | (232,936 | ) | ||||
Unrealized gain (loss) on available-for-sale securities: |
||||||||||||
Unrealized holding gain (loss) during the period |
(141,563 | ) | (382,700 | ) | 138,928 | |||||||
Less: Reclassification for gains (loss) included in net income |
(39,955 | ) | (1,836 | ) | 463,787 | |||||||
Tax benefit (expense) |
19,553 | 75,548 | 93,011 | |||||||||
Other comprehensive loss |
(82,055 | ) | (305,316 | ) | (231,848 | ) | ||||||
Comprehensive income (loss) |
$ | 673,793 | $ | (1,005,945 | ) | $ | (464,784 | ) | ||||
See notes to consolidated financial statements.
F-7
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF
CHANGES IN SHAREHOLDERS’ EQUITY
CHANGES IN SHAREHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
| 2006 | 2005 | 2004 | ||||||||||
Common stock: |
||||||||||||
Balance, beginning of year |
$ | 544,958 | $ | 544,958 | $ | 544,958 | ||||||
Common shares issued |
255,042 | — | — | |||||||||
Balance, end of year |
800,000 | 544,958 | 544,958 | |||||||||
Additional paid in capital: |
||||||||||||
Balance, beginning of year |
12,478,903 | 12,380,716 | 12,380,523 | |||||||||
Stock warrants issued |
564,150 | 35,465 | — | |||||||||
Additional paid in capital on issuance of common stock |
714,245 | 62,722 | — | |||||||||
Additional paid in capital on sale of treasury stock |
— | — | 193 | |||||||||
Balance, end of year |
13,757,298 | 12,478,903 | 12,380,716 | |||||||||
Accumulated deficit: |
||||||||||||
Balance, beginning of year |
(3,496,404 | ) | (2,795,775 | ) | (2,562,839 | ) | ||||||
Loss on sale of treasury stock |
(1,392,248 | ) | — | — | ||||||||
Net income (loss) |
755,848 | (700,629 | ) | (232,936 | ) | |||||||
Balance, end of year |
(4,132,804 | ) | (3,496,404 | ) | (2,795,775 | ) | ||||||
Accumulated other comprehensive income: |
||||||||||||
Balance, beginning of year |
(84,862 | ) | 220,454 | 452,302 | ||||||||
Other comprehensive income |
(82,055 | ) | (305,316 | ) | (231,848 | ) | ||||||
Balance, end of year |
(166,917 | ) | (84,862 | ) | 220,454 | |||||||
Treasury stock: |
||||||||||||
Balance, beginning of year |
(2,119,348 | ) | (1,383,666 | ) | (1,385,483 | ) | ||||||
Sale of 1,192,521 shares at a cost of $1.78 per share |
2,119,348 | — | — | |||||||||
Purchase of 450,500 common shares at $1.71 per share |
— | (770,355 | ) | — | ||||||||
Issuance of 19,479 shares at cost of $1.78 per share |
— | 34,673 | — | |||||||||
Sale of 1,000 shares at cost of $1.82 per share |
— | — | 1,817 | |||||||||
Balance, end of year |
— | (2,119,348 | ) | (1,383,666 | ) | |||||||
Total shareholders’ equity |
$ | 10,257,577 | $ | 7,323,247 | $ | 8,966,687 | ||||||
See notes to consolidated financial statements.
F-8
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
| 2006 | 2005 | 2004 | ||||||||||
Operating activities: |
||||||||||||
Net income (loss) |
$ | 755,848 | $ | (700,629 | ) | $ | (232,936 | ) | ||||
Adjustments to reconcile net loss to net cash
provided by operating activities: |
||||||||||||
Interest credited on annuities and premium deposits |
579,074 | 405,778 | 344,918 | |||||||||
Net realized investment (gain) loss |
39,955 | 1,836 | (463,787 | ) | ||||||||
Provision for depreciation |
143,692 | 154,301 | 132,902 | |||||||||
Equity loss in investment in affiliate |
— | — | 28,516 | |||||||||
Settlement loss |
— | 35,465 | — | |||||||||
Amortization of premium and accretion of discount on
fixed maturity and short-term investments |
(145,087 | ) | 25,958 | 138,001 | ||||||||
Provision for deferred federal income taxes |
— | — | (64,380 | ) | ||||||||
Acquisition costs capitalized |
(814,016 | ) | (1,246,987 | ) | (1,275,646 | ) | ||||||
Amortization of deferred acquisition costs |
737,567 | 630,737 | 769,611 | |||||||||
(Increase) decrease in assets: |
||||||||||||
Accrued investment income |
17,126 | (36,844 | ) | (33,071 | ) | |||||||
Accounts receivable |
(9,694 | ) | (14,006 | ) | 38,172 | |||||||
Reinsurance receivables |
(33,420 | ) | (78,725 | ) | — | |||||||
Policy loans |
(62,533 | ) | (16,547 | ) | (26,495 | ) | ||||||
Other assets |
(1,196,624 | ) | 5,430 | (22,717 | ) | |||||||
Increase (decrease) in liabilities: |
||||||||||||
Future policy benefits |
841,250 | 1,118,501 | 1,020,812 | |||||||||
Liability for policy claims |
21,882 | 77,144 | 4,888 | |||||||||
Deposits on pending policy applications |
18,427 | (307 | ) | (22,823 | ) | |||||||
Reinsurance premiums payable |
(52,602 | ) | 84,214 | (8,593 | ) | |||||||
Amounts held under reinsurance |
(200,758 | ) | 219,079 | — | ||||||||
Commissions, salaries, wages and benefits payable |
(82,212 | ) | 27,929 | 50,929 | ||||||||
Other liabilities |
76,999 | 76,611 | 26,593 | |||||||||
Net cash provided by operating activities |
$ | 634,874 | $ | 768,938 | $ | 404,894 | ||||||
See notes to consolidated financial statements.
F-9
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
| 2006 | 2005 | 2004 | ||||||||||
Investing activities: |
||||||||||||
Purchase of available-for-sale fixed maturities |
$ | (2,670,727 | ) | $ | (2,748,760 | ) | $ | (10,022,949 | ) | |||
Sale of available-for-sale fixed maturities |
3,409,932 | 400,080 | 6,732,704 | |||||||||
Maturity of available-for-sale fixed maturities |
576,046 | 1,502,624 | 1,850,000 | |||||||||
Purchase of available-for-sale equities |
— | (247,750 | ) | (193,600 | ) | |||||||
Sale of available-for-sale equities |
222,699 | 25,000 | — | |||||||||
Additions to property and equipment |
(15,253 | ) | (135,140 | ) | (71,275 | ) | ||||||
Purchase of other investments |
(1,593,368 | ) | (1,520,232 | ) | (202,760 | ) | ||||||
Maturity of other investments |
377,726 | 134,416 | — | |||||||||
Purchase of investments in affiliate |
— | — | (11,500 | ) | ||||||||
Dispositions of investment in affiliate |
— | — | 48,184 | |||||||||
Purchase of mortgage loans |
(429,500 | ) | (1,244,600 | ) | (350,000 | ) | ||||||
Payments received on mortgage loans |
58,601 | 27,760 | 458 | |||||||||
Payment on notes receivable |
— | — | 13,741 | |||||||||
Purchases of short-term investments |
— | — | (3,925,512 | ) | ||||||||
Sale or maturity of short term investments |
— | — | 4,375,507 | |||||||||
Net cash used in investing activities |
(63,844 | ) | (3,806,602 | ) | (1,757,002 | ) | ||||||
Financing activities: |
||||||||||||
Proceeds from note payable |
— | 570,355 | — | |||||||||
Payments on notes payable |
(2,272,986 | ) | (88,976 | ) | (51,400 | ) | ||||||
Deposits on annuity contracts |
3,548,635 | 3,754,742 | 1,839,573 | |||||||||
Surrenders on annuity contracts |
(766,138 | ) | (658,617 | ) | (269,794 | ) | ||||||
Policyholder premium deposits |
9,486 | 23,938 | 22,472 | |||||||||
Withdrawals on policyholder premium deposits |
(56,745 | ) | (71,342 | ) | (61,514 | ) | ||||||
Proceeds from issuance of warrants |
564,150 | — | — | |||||||||
Proceeds from sale of common stock |
969,287 | — | — | |||||||||
Proceeds from sale of treasury stock |
727,100 | — | 2,010 | |||||||||
Purchase of treasury stock |
— | (770,355 | ) | — | ||||||||
Net cash provided by financing activities |
2,722,789 | 2,759,745 | 1,481,347 | |||||||||
Increase (decrease) in cash and cash equivalents |
3,293,819 | (277,919 | ) | 129,239 | ||||||||
Cash and cash equivalents, beginning of period |
249,109 | 527,028 | 397,789 | |||||||||
Cash and cash equivalents, end of period |
$ | 3,542,928 | $ | 249,109 | $ | 527,028 | ||||||
Supplemental disclosure of cash activities: |
||||||||||||
Interest paid |
$ | 62,295 | $ | 105,084 | $ | 111,104 | ||||||
Income taxes paid |
$ | — | $ | — | $ | — | ||||||
Schedule of non-cash investing transactions: |
||||||||||||
Issuance of treasury stock |
$ | — | $ | 97,935 | $ | — | ||||||
See notes to consolidated financial statements.
F-10
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Operations
First American Capital Corporation (the “Company”) is a financial services holding company located
in Topeka, Kansas. Subsidiaries of the Company include First Life America Corporation (“FLAC”) and
Brooke Capital Advisors, Inc. (“BCA”) formerly First Life Brokerage, Inc. 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. BCA operates as an insurance
broker offering products underwritten by other companies and complementary to those offered by
FLAC.
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 subsidiaries, FLAC and BCA. 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. Significant assumptions are
made by management to develop estimates of the Company’s policy and contract liabilities and
related deferred acquisition costs. As more information becomes known, actual results could differ
from those estimates.
Investments
The Company classifies all of its fixed maturity and equity 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. Mortgage loans on real estate are carried at cost less principal payments. Other
investments are carried at amortized cost. Discounts originating at the time of purchase, net of
capitalized acquisition costs, are amortized using the level yield method on an individual basis
over the remaining contractual term of the investment. 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. 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.
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.
F-11
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Significant Accounting Policies (continued)
Property and Equipment
Property and equipment, including the home office building (see Note 5), are carried at cost less
accumulated depreciation. Depreciation on the office building and land improvements is calculated
using the straight-line method over the estimated useful lives of the respective assets.
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 | |||
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 4.25 to 5.35 percent in 2006 and
4.25 to 5.35 percent in 2005.
Future Policy Benefits
Traditional life insurance policy benefit liabilities are computed on a net level premium method
using assumptions with respect to current yield, mortality, withdrawal rates, and other assumptions
deemed appropriate by the Company. Reserve interest assumptions, including the impact of grading
for possible adverse deviations, ranged from 4.50 to 7.25 percent.
Liability for Policy Claims
Policy claim liabilities represent the estimated liabilities for claims reported plus claims
incurred but not yet reported. The liabilities are subject to the impact of actual payments and
future changes in claim factors.
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 4% in 2006
and 2005. 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.
Treasury Stock
Treasury stock is held at cost. Issuances of treasury stock are recorded based on the average cost
method.
Premiums
For limited payment and other traditional life insurance policies, premium income is reported as
earned when due. Profits are recognized over the life of these contracts by associating benefits
and expenses with insurance in force for limited payment policies and with earned premiums for
other traditional life policies. This association is accomplished by a provision for liability for
future policy benefits and the amortization of policy acquisition costs.
F-12
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Significant Accounting Policies (continued)
Consulting Fees
Beginning in December 2006, BCA began using its industry contacts and expertise in insurance
brokerage to broker loans for, and consult with, managing general agencies and managing general
agencies that own insurance companies, specializing in hard-to-place insurance sales, captive
insurance agencies and funeral homes. The Company receives consulting fees for these activities.
The fees associated with this service are recognized upon loan closing as all of the consulting
services related to the transaction have been provided by the Company (prior to closing).
The Company will also use its expertise in the hard to place and niche insurance industry to
preserve collateral and monitor insurance agency borrowers on behalf of lenders. Fees are received
for this collateral preservation activity. An initial fee is received and recognized upon loan
closing. Ongoing fees are received monthly from these activities and are recognized as services
are provided.
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 Statement of
Financial Accounting Standards (“SFAS”) No. 113, “Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts.”
Net Earnings (Loss) Per Common Share
Basic net income (loss) per common share is calculated by dividing net income (loss) by the
weighted average number of shares of the Company’s common stock outstanding. Diluted net income
(loss) is calculated by including the weighted average effect of dilutive warrants outstanding
during the periods. The weighted average number of shares issuable upon the exercise of
outstanding warrants assumes that the applicable proceeds from such exercises are used to acquire
treasury shares at the average price of common stock during the periods. Basic and diluted earnings
per share for 2006, 2005 and 2004, were determined as follows (adjusted for the 3-for-1 reverse
stock split approved on January 31, 2007):
F-13
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Significant Accounting Policies (continued)
| Years ended December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Numerator: |
||||||||||||
Net income (loss) — numerator for basic earnings per share |
$ | 755,848 | $ | (700,629 | ) | $ | (232,936 | ) | ||||
Effect of dilutive securities |
— | — | — | |||||||||
Numerator for diluted earnings per share |
$ | 755,848 | $ | (700,629 | ) | $ | (232,936 | ) | ||||
Denominator: |
||||||||||||
Average common shares outstanding |
4,492,914 | 4,313,774 | 4,687,078 | |||||||||
Effect of 3-for-1 reverse stock split |
(2,995,276 | ) | (2,875,849 | ) | (3,124,719 | ) | ||||||
Shares used for basic earnings per share |
1,497,638 | 1,437,925 | 1,562,359 | |||||||||
Effect of diluted warrant outstanding (adjusted for split) |
547,820 | — | — | |||||||||
Assumed repurchase of shares with procceds of exercise |
(86,786 | ) | — | — | ||||||||
Shares used for diluted earnings per share |
1,958,672 | 1,437,925 | 1,562,359 | |||||||||
Earnings per share: |
||||||||||||
Basic |
$ | 0.50 | $ | (0.49 | ) | $ | (0.15 | ) | ||||
Diluted |
$ | 0.39 | $ | (0.49 | ) | $ | (0.15 | ) | ||||
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.
New Accounting Pronouncements
In September 2005, the Accounting Standards Executive Committee of the American Institute of
Certified Public Accountants (AcSEC) issued Statement of Position 05-1 (SOP 05-1), “Accounting by
Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges
of Insurance Contracts”. SOP 05-1 provides guidance on accounting by insurance enterprises for
deferred acquisition costs on internal replacements of insurance contracts other than those
specifically described in Statement of Financial Accounting Standards (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”. SOP 05-1 defines an internal replacement as a
modification in product benefits, features, rights, or coverages that occurs by exchange of a
contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the
election of a feature or coverage within a contract. SOP 05-1 is effective for internal
replacements occurring in fiscal years beginning after December 31, 2006. Retrospective application
of SOP 05-1 to previously issued consolidated financial statements is not permitted. The Company is
continuing to evaluate SOP 05-1 but does not believe that it will have a material impact on the
consolidated financial statements.
F-14
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Significant Accounting Policies (continued)
On July 14, 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in
Income Taxes,” an Interpretation of SFAS 109, “Accounting for Income Taxes.” FIN 48 prescribes
guidance to address inconsistencies among entities with the measurement and recognition in
accounting for income tax positions for financial statement purposes. Specifically, FIN 48
addresses the timing of the recognition of income tax benefits. FIN 48 requires the financial
statement recognition of an income tax benefit when a company determines that it is
more-likely-than-not that the tax position will be ultimately sustained. FIN 48 is effective for
fiscal years beginning after December 15, 2006, which, for the Company, is fiscal year 2007.
Management is currently evaluating the impact that the adoption of this interpretation could have
on the Company’s financial position and results of operation.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which provides enhanced
guidance for using fair value measurements in financial reporting. While the standard does not
expand the use of fair value in any new circumstance, it has applicability to several current
accounting standards that require or permit entities to measure assets and liabilities at fair
value. This standard defines fair value, establishes a framework for measuring fair value in GAAP
and expands disclosures about fair value measurements. Application of this standard is required for
the Company beginning in 2008. Management is currently assessing what impact, if any, the
application of this standard could have on the Company’s results of operations and financial
position.
All other Standards and Interpretations of those Standards issued during 2006 did not relate to
accounting policies and procedures pertinent to the Company at this time.
F-15
Table of Contents
3. Investments
The amortized cost and fair value of investments at December 31, 2006 and 2005 are summarized as
follows:
| Gross | Gross | |||||||||||||||
| Amortized | Unrealized | Unrealized | Fair | |||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
December 31, 2006: |
||||||||||||||||
U.S. Government Agency |
$ | 1,559,006 | $ | 9,879 | $ | 18,414 | $ | 1,550,471 | ||||||||
Corporate bonds |
10,973,061 | 75,128 | 299,880 | 10,748,309 | ||||||||||||
Total |
$ | 12,532,067 | $ | 85,007 | $ | 318,294 | $ | 12,298,780 | ||||||||
Equity securities |
$ | 258,400 | $ | 28,960 | $ | 4,300 | $ | 283,060 | ||||||||
December 31, 2005: |
||||||||||||||||
U.S. Government Agency |
$ | 1,408,079 | $ | 16,891 | $ | 14,026 | $ | 1,410,944 | ||||||||
Corporate bonds |
12,551,926 | 223,559 | 332,054 | 12,443,431 | ||||||||||||
Total |
$ | 13,960,005 | $ | 240,450 | $ | 346,080 | $ | 13,854,375 | ||||||||
Equity securities |
$ | 458,150 | $ | 22,005 | $ | 23,395 | $ | 456,760 | ||||||||
The amortized cost and fair value of fixed maturities at December 31, 2006, 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 through five years |
$ | 2,454,322 | $ | 2,470,426 | ||||
Due after five years through ten years |
5,176,566 | 5,064,874 | ||||||
Due after ten years |
4,901,179 | 4,763,480 | ||||||
| $ | 12,532,067 | $ | 12,298,780 | |||||
The fair values for investments in fixed maturities are based on quoted market prices.
Included in investments are securities, which have been pledged to various state insurance
departments. The fair values of these securities were $2,060,964 and $2,120,855 at December 31,
2006 and 2005, respectively.
During 2006, the Company had gross realized investment gains of $53,502. Investment gains were
$3,211 and $464,363 during 2005 and 2004, respectively. During 2006, the Company had gross
realized investment losses of $93,457. Gross realized investment losses totaled $5,047 and $576 in
2005 and 2004, respectively.
Since 2004, the Company has purchased investments in lottery prize cash flows. These other
investments involve purchasing assignments of the future payment rights from the 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 states. At December 31, 2006 and 2005 the carrying value of other investments was
$3,067,369 and $1,656,866 respectively.
F-16
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investments (continued)
Investment income consists of dividends and interest earned on notes receivable, policy loans,
available-for-sale securities, mortgage loans, and other investments.
Following are the components of net investment income for the years ended December 31, 2006, 2005
and 2004:
| Years ended December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Fixed maturities |
$ | 720,022 | $ | 713,645 | $ | 509,933 | ||||||
Equity securities |
25,929 | 18,666 | 70 | |||||||||
Notes receivables |
— | — | 238 | |||||||||
Mortgage loans on real estate |
116,584 | 66,625 | 2,275 | |||||||||
Equity loss on investment in related parties |
— | — | (28,516 | ) | ||||||||
Short-term and other investments |
249,418 | 90,007 | 43,798 | |||||||||
Gross investment income |
1,111,953 | 888,943 | 527,798 | |||||||||
Investment expenses |
(26,056 | ) | (21,640 | ) | (10,312 | ) | ||||||
Net investment income |
$ | 1,085,897 | $ | 867,303 | $ | 517,486 | ||||||
The Company has a policy and process in place to identify securities that could potentially have an
impairment that is other-than-temporary. This process involves monitoring market events that could
impact issuers’ credit ratings, business climate, management changes, litigation and government
actions, and other similar factors. At the end of each quarter, all securities are reviewed in an
effort to determine each issuer’s ability to service its debts and the length of time the security
has been trading below cost. This quarterly process includes an assessment of the credit quality
of each investment in the entire securities portfolio. The Company considers relevant
facts and circumstances in evaluating whether the impairment of a security is other-than-temporary.
Relevant facts and circumstances considered include: (1) the length of time the fair value has been
below cost; (2) the financial position of the issuer, including the current and future impact of
any specific events; and (3) the Company’s ability and intent to hold the security to maturity or
until it recovers in value. Based on the performance of these procedures, no securities are deemed
to be other-than-temporarily impaired by the Company.
There are a number of significant risks and uncertainties inherent in the process of monitoring
impairments and determining if an impairment is other-than-temporary. These risks and uncertainties
include: (1) the risk that the Company’s assessment of an issuer’s ability to meet all of its
contractual obligations will change based on changes in the credit characteristics of that issuer,
(2) the risk that the economic outlook will be worse than expected or have more of an impact on the
issuer than anticipated, (3) the risk that fraudulent information could be provided to the
Company’s investment professionals who determine the fair value estimates and other-than-temporary
impairments, and (4) the risk that new information obtained by the Company or changes in other
facts and circumstances lead the Company to change its intent to hold the security to maturity or
until it recovers in value. Any of these situations could result in a charge to income in a future
period.
F-17
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Investments (continued)
The Company owned 68 securities that were in an unrealized loss position at December 31, 2006. The
following tables provide information regarding unrealized losses on investments available for sale,
as of December 31, 2006 and 2005.
| Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
December 31, 2006: |
||||||||||||||||||||||||
U.S. Government
Agency |
$ | — | $ | — | $ | 694,830 | $ | 18,414 | $ | 694,830 | $ | 18,414 | ||||||||||||
Corporate bonds |
4,360,312 | 77,558 | 4,743,034 | 222,322 | 9,103,346 | 299,880 | ||||||||||||||||||
Total |
$ | 4,360,312 | $ | 77,558 | $ | 5,437,864 | $ | 240,736 | $ | 9,798,176 | $ | 318,294 | ||||||||||||
Equity securities |
$ | 2,300 | $ | 50 | $ | 95,750 | $ | 4,250 | $ | 98,050 | $ | 4,300 | ||||||||||||
| Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||
| Fair | Unrealized | Fair | Unrealized | Fair | Unrealized | |||||||||||||||||||
| Value | Losses | Value | Losses | Value | Losses | |||||||||||||||||||
December 31, 2005: |
||||||||||||||||||||||||
U.S. Government
Agency |
$ | 598,965 | $ | 11,324 | $ | 96,879 | $ | 2,702 | $ | 695,844 | $ | 14,026 | ||||||||||||
Corporate bonds |
6,047,377 | 212,041 | 1,414,230 | 120,013 | 7,461,607 | 332,054 | ||||||||||||||||||
Total |
$ | 6,646,342 | $ | 223,365 | $ | 1,511,109 | $ | 122,715 | $ | 8,157,451 | $ | 346,080 | ||||||||||||
Equity securities |
$ | 47,980 | $ | 20 | $ | 126,275 | $ | 23,375 | $ | 174,255 | $ | 23,395 | ||||||||||||
4. Concentrations of Credit Risk
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, the 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.
5. 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. The
Company occupies approximately 7,500 square feet of the building and the remaining 12,500 square
feet is leased (see Note 6).
| 2006 | 2005 | |||||||
Land and improvements |
$ | 357,675 | $ | 357,675 | ||||
Building and capitalized interest |
2,605,330 | 2,605,330 | ||||||
Furniture, fixtures and equipment |
500,939 | 510,063 | ||||||
Tenant improvements |
108,870 | 103,372 | ||||||
Total property and equipment |
3,572,814 | 3,576,440 | ||||||
Less — accumulated depreciation and amortization |
(945,228 | ) | (820,415 | ) | ||||
Net property and equipment |
$ | 2,627,586 | $ | 2,756,025 | ||||
F-18
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Leases
As noted above, the Company occupies approximately 7,500 square feet of its building in Topeka,
Kansas. The Company has leased 10,000 square feet under a lease that was renewed during 2006 to
run through June 30, 2011. The lease agreement calls for minimum monthly base lease payments of
$15,500.
Effective August 29, 2005, the Company executed a lease agreement with a tenant for the remaining
2,500 square feet. The base lease period commenced on September 1, 2005 and will end on August 31,
2010. The lease will automatically renew if not terminated on or after August 15, 2010 for another
five years. The lease agreement calls for minimum monthly base lease payments of $4,366 for the
period September 1, 2005 through August 31, 2010. The lease payments will decrease to $3,100 per
month for the period September 1, 2010 through August 31, 2015. In conjunction with the execution
of the lease agreement, the Company incurred $103,372 in tenant improvement costs to prepare the
space for lease. These costs are being depreciated on a straight line basis over the base lease
term of five years.
The future minimum lease payments to be received under non cancelable lease agreements at December
31, 2006 are approximately as follows:
| Year Ending | ||||
| December 31, | Amount | |||
2007 |
238,385 | |||
2008 |
238,385 | |||
2009 |
238,385 | |||
2010 |
220,919 | |||
2011 |
185,988 | |||
Total |
$ | 936,073 | ||
7. Federal Income Taxes
The Company has elected to file a consolidated federal income tax return with FLAC and BCA for the
years ended December 31, 2006 and 2005 and filed a consolidated federal income tax return with FLAC
for the year ended December 31, 2004. 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, 2006, 2005, and
2004 consisted of the following:
| Years ended December 31, | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
Current |
$ | 11,867 | $ | — | $ | — | ||||||
Deferred |
— | — | (64,380 | ) | ||||||||
Federal income tax (benefit) expense |
$ | 11,867 | $ | — | $ | (64,380 | ) | |||||
Federal income tax expense differs from the amount computed by applying the statutory federal
income tax rate for 2006, 2005 and 2004 as follows:
| 2006 | 2005 | 2004 | ||||||||||
Federal income tax expense (benefit) at
statutory rate |
$ | 261,023 | $ | (238,213 | ) | $ | (101,088 | ) | ||||
Small life insurance company deduction |
(32,165 | ) | (36,106 | ) | (64,975 | ) | ||||||
Increase (decrease) in valuation allowance |
(289,533 | ) | 273,190 | 100,202 | ||||||||
Other |
72,542 | 1,129 | 1,481 | |||||||||
Federal income tax (benefit) expense |
$ | 11,867 | — | $ | (64,380 | ) | ||||||
F-19
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. 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, | ||||||||
| 2006 | 2005 | |||||||
Deferred tax liability: |
||||||||
Due premiums |
$ | 10,571 | $ | 11,832 | ||||
Policy reserves |
4,069 | — | ||||||
Deferred policy acquisition costs |
873,841 | 868,699 | ||||||
Accrual of discount |
8,524 | 5,387 | ||||||
Premium deposit |
8,463 | — | ||||||
Total deferred tax liability |
905,468 | 885,918 | ||||||
Deferred tax asset: |
||||||||
Policy reserves |
— | 92,810 | ||||||
Capital loss carryforward |
9,948 | — | ||||||
AMT credit carryforward |
11,867 | — | ||||||
Reinsurance premiums |
2,298 | 3,514 | ||||||
Net operating loss carryforward |
2,019,534 | 2,217,307 | ||||||
Net unrealized investment loss |
41,726 | 22,164 | ||||||
Total deferred tax asset |
2,085,373 | 2,335,795 | ||||||
Valuation allowance |
(1,688,285 | ) | (1,977,818 | ) | ||||
Net deferred tax asset |
397,088 | 357,977 | ||||||
Net deferred tax liability |
$ | 508,380 | $ | 527,941 | ||||
The Company has net operating loss carryforwards of approximately $6,312,734 on a consolidated
basis. Net operating loss carryforwards of $799,241 resulted from non-life insurance operations and
were generated prior to the base period for tax consolidation purposes. These loss carryforwards
expire in 2011 and 2012 and can only be used to offset taxable income resulting from non-life
insurance operations. Net operating loss carryforwards of $4,607,808 resulted from non-life
insurance operations and were generated either during or subsequent to the base period for tax
consolidation purposes. These loss carryforwards expire in 2018 through 2025 and can be used to
offset either taxable income resulting from non-life insurance operations or 35% of taxable income
resulting from life insurance operations subject to certain limitations. Net operating loss
carryforwards of $905,685 resulted from life insurance operations and were generated either during
or subsequent to the base period for tax consolidation purposes. These loss carryforwards expire in
2022 through 2025. Capital loss carryforwards of $45,002 will expire in 2009 and 2010.
8. 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. Proceeds from the sale
were used by the Company to repay outstanding notes with Vision Bank (first mortgage of $1,722,053)
and Brooke Credit Corporation (second mortgage of $522,822).
F-20
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. 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.
Net income for 2006, 2005, and 2004 and capital and surplus at December 31, 2006, 2005, and 2004
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 | |||||||||||||
2006 |
254,517 | 7,659,130 | 216,259 | 3,966,233 | ||||||||||||
2005 |
271,995 | 6,490,251 | (64,575 | ) | 2,724,980 | |||||||||||
2004 |
528,494 | 6,251,955 | (54,205 | ) | 2,539,348 | |||||||||||
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. Enterprise’s 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, the
Company’s management believes that FLAC meets the RBC requirements.
F-21
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Shareholders’ Equity Transactions
On December 8, 2006 the Company closed on a Stock Purchase and Sale Agreement (“2006 Stock Purchase
Agreement”) with Brooke Corporation (Brooke). Pursuant to the agreement, the Company committed,
through a series of steps, to sell shares of common stock that equate to 55% of the outstanding
shares of the Company to Brooke in exchange for $3,000,000 in cash and execution of a Brokerage
Agreement. At closing the Company issued 3,742,943 shares of common stock to Brooke, representing
approximately 46.8% of the Company’s authorized and issued common stock, for $2,552,182 and
executed and delivered the Brokerage Agreement. As part of the closing, the Company issued Brooke
a warrant to purchase an additional 1,643,460 shares of common stock for $447,818, such shares to
be authorized for issuance pursuant to forthcoming amendments to the Company’s Articles of
Incorporation. The Articles of Incorporation were amended on January 31, 2007. Brooke exercised
the Warrant on the same day.
As part of the consideration under the 2006 Stock Purchase Agreement, BCA, a subsidiary of the
Company, and CJD & Associates, L.L.C. (“CJD”), Brooke’s brokerage subsidiary, entered into an
agreement by which, as of that date, BCA began transacting all new managing general agent loan
brokerage business (formerly operated by CJD). CJD operated such a business prior to Closing and,
as part of the Brokerage Agreement, agreed not to engage in any new managing general agent loan
brokerage business. Pursuant to the terms of the 2006 Stock Purchase Agreement, Brooke will
contribute funds to the Company as additional consideration for the issuance of the shares of the
Company’s common stock acquired, to the extent the pretax profits of BCA do not meet a three-year
$6 million pretax profit goal in accordance with an agreed upon schedule set forth in the 2007
Stock Purchase Agreement.
The Warrant issued in connection with the above Agreement has been reported as a part of the
Company’s additional paid in capital as of December 31, 2006. As previously noted, this Warrant
was exercised by Brooke on January 31, 2007. Other warrants outstanding at December 31, 2006
include one issued to an officer and another to an outside Director of the Company for 50,000 and
100,000 shares, respectively. These warrants were authorized on September 21, 2006 in recognition
of those individuals’ efforts in connection with the successful closing of the 2006 Stock Purchase
Agreement. The warrants became exercisable on December 8, 2006 either in whole or in part for a
period of 10 years from that date at an exercise price of $1.72 per share, the assumed market price
of the Company’s stock at the date of grant. The fair value of these warrants was estimated as of
the grant date using an accepted valuation model in accordance with SFAS No. 123R, “Share-Based
Payment”. Significant assumptions included a risk-free rate of 4.56%, and expected volatility of
10% and a dividend rate of 0%. In the case of the officer, the estimated value of the warrant,
$32,210, was recorded as compensation expense. In the case of the Director, the estimated value of
the warrant, $64,420, was recorded as a reduction of related stock issuance costs. The Warrant
held by Brooke at December 31, 2006 is considered in the Company’s diluted earnings per share
reported for 2006. The other warrants are not considered to have a dilutive effect on reported
earnings as their exercise price is equal to or greater than the per share prices reflected in
recent transactions involving the Company’s stock.
On March 2, 2005 the Company acquired 450,500 shares of its common stock previously held by Brooke.
In that transaction, the Company negotiated a purchase price of $770,355 ($1.71 per share) to
include $200,000 cash at closing, with Brooke Credit Corporation, the finance subsidiary of Brooke,
financing the remainder at a fixed interest rate of 8% over a ten year period (see Note 9). The
agreement also granted Brooke three separate warrants to purchase up to 50,000 shares of common
stock (for each warrant) at prices of $1.71, $3.35 and $5.00, respectively. The warrants were
exercisable in 2012 or immediately prior to any earlier change of control involving the Company and
were due to expire no later than 2015. The Company incurred a loss on the transaction in the
amount of $35,465 which is included in other operating costs and expenses for the year ended
December 31, 2005. The note to Brooke was paid in full during 2006. The warrants issued to
Brooke in 2005 were cancelled on December 8, 2006 as a result of the execution of the Stock
Purchase and Sale Agreement on that date.
F-22
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. 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,
Optimum Re Insurance Company (“Optimum Re”) of Dallas, Texas, and Wilton Reassurance Company
(“Wilton Re”) of Wilton, CT, 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. At December 31, 2006 and 2005, respectively, FLAC ceded inforce amounts totaling
$27,346,000 and $32,617,000 of ordinary business and $31,184,000 and $33,235,000 of accidental
death benefit risk.
Pursuant to the terms of the agreement with Generali, 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, 2006 and 2005, respectively, the unpaid reinsurance premiums net of amortization
totaled $11,489 and $17,570. 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.
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. During 2006 and 2005, respectively, FLAC
assumed inforce amounts totaling $22,377,000 and $17,726,000.
Effective September 29, 2005, the Company and Wilton Re 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 has 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.
12. Related Party Transactions
On March 2, 2005, the Company entered into a Stock Repurchase Agreement with Brooke under which the
Company repurchased 450,500 shares of Company common stock from Brooke. Brooke had previously
acquired the shares from a third party for a total purchase price of $772,255. The privately
negotiated transaction involved approximately 9.7% of Company common stock then outstanding. The
shares were purchased at a price of $1.71 per share for a total purchase price of $770,355. The
Company paid the purchase price using $200,000 of its working capital and financed the remaining
amount with a loan from Brooke Credit at a fixed rate of 8% over a ten-year period. The repurchase
agreement also granted Brooke warrants to purchase up to 150,000 shares of Company common stock at
prices ranging from $1.71 to $5.00 per share. These warrants were cancelled as part of the 2006
Stock Purchase Agreement.
A mortgage note on the commercial property and office building that the Company owned was financed
by Vision Bank of Topeka, Kansas. Gary Yager, a former Director of the Company, is the President
and CEO of Vision Bank. Management believes that the terms obtained from Vision Bank at the time
of financing were no less favorable to the Company than those available from an independent lender.
The terms of the note payable were determined by competitive bid. As of December 31, 2006 the
mortgage note was paid in full. One of the Company’s notes payable was financed by Vision Bank of
Topeka, Kansas.
F-23
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Boards of Directors of the Company and FLAC and the Kansas Insurance Department (KID)
authorized the parent company to sell its office building and related real estate to FLAC. The
proceeds were used in part to repay outstanding notes to Vision Bank and Brooke. Closing of this
transaction occurred May 1, 2006.
On October 5, 2006, Mr. Van Engelen was awarded a warrant to purchase up to 50,000 shares of
Company common stock at an exercise price of $1.72 per share. The warrant was awarded to Mr. Van
Engelen in exchange for his services in successfully negotiating and closing the transactions
contemplated by the 2006 Stock Purchase Agreement. Mr. Van Engelen entered into an employment
agreement with the Company effective December 8, 2006 to serve as President and CEO of First Life
America Corporation. See Item 10 Executive Compensation above.
On October 5, 2006, Thomas Fogt, a then director of the Company, was awarded a warrant to purchase
up to 100,000 shares of Company common stock at an exercise price of $1.72 per share. Mr. Fogt was
awarded the warrant in exchange for his services in successfully negotiating and closing the
transactions proposed by the 2006 Stock Purchase Agreement.
On December 8, 2006, contemporaneously with the closing of the 2006 Stock Purchase Agreement, the
Company entered into a Servicing Agreement with Brooke, pursuant to which Brooke will provide
certain administrative and public-company compliance services to the Company, including, but not
limited to, human resource services, payroll accounting, legal services, accounting, tax and
auditing services, risk management, and corporate marketing services. These services are being
provided for a monthly cost of $5,000. The Servicing Agreement terminates December 31, 2007.
As discussed in Note 10, pursuant to the transfer of certain loan brokerage and other business from
CJD to BCA, a receivable in the amount of $1,196,882 was recorded by BCA (amount due from CJD)
representing fees and other income collected by CJD on BCA’s behalf in connection with transactions
closed by BCA during December 2006. In addition, BCA recorded a payable to CJD in the amount of
$102,531 representing commissions and other expenses related to the December 2006 transactions.
These amounts receivable/payable were outstanding at the balance sheet date and are reported as
other assets/other liabilities, respectively. These amounts were collected/paid by BCA subsequent
to December 31, 2006.
With respect to the Company’s proposed acquisition of Brooke Savings Bank from BBC, the Company
will exchange 6,047,904 shares of its common stock, with a value of approximately $10.1 million,
for all of the stock of Brooke Savings Bank. The agreed upon purchase price of approximately $10.1
million equals the price paid by BBC to acquire Brooke Savings Bank on January 8, 2007. For the
purpose of the proposed transaction, the shares of Company common stock have been valued at $1.67
per share. This valuation equals the approximate price per share paid by Brooke for its 55%
ownership interest in the Company in the change of control transactions that occurred in December
2006 and January 2007. Based on the number of Company shares of common stock currently
outstanding, the proposed transaction would result in an increase in Brooke’s combined direct and
indirect ownership of the Company from 55% to approximately 72%. The proposed transaction would
also reduce Brooke’s indirect ownership of Brooke Savings Bank from 100% to approximately 72%.
Brooke had or has a direct and/or indirect material interest in 2006 Stock Purchase Agreement, the
Brokerage Agreement and the Brooke Servicing Agreement. Brooke also has an indirect interest in
the Company’s proposed acquisition of Brooke Servicing Agreement. Brooke also has an indirect
interest in the Company’s proposed acquisition of Brooke Savings Bank under the terms of the 2007
Stock Purchase Agreement. As a result of his relationship with Brooke, Robert Orr, a Company
director and the Company’s Chairman of the Board, President and Chief Executive Officer, has an
indirect material interest in these transactions. Michael Hess, a Company director and one of its
executive officers, is a director and executive officer of BBC and a director of Brooke Savings
Bank.
F-24
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Fair Values of Financial Instruments
The fair values of financial instruments, and the methods and assumptions used in estimating their
fair values, are described below. In all cases, these financial instruments represent assets of
the Company and their carrying values represent or approximate their fair values 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, 2006 and 2005,
the fair value of fixed maturities was $12,298,780 and $13,854,375, 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. At December 31, 2006 and 2005,
the fair value of equity securities was $283,060 and $456,760, respectively.
Policy Loans
The carrying value of policy loans approximates their fair value. At December 31, 2006 and 2005,
the fair value of policy loans was $166,026 and $103,493, respectively.
Mortgage Loans on Real Estate
The carrying value of mortgage loans on real estate approximates their fair value. At December 31,
2006 and 2005, the fair value of mortgage loans on real estate was $1,937,281 and $1,566,382,
respectively.
Other Investments
The carrying value of other investments approximates their fair value. At December 31, 2006 and
2005, the fair value of other investments was $3,067,369 and $1,656,866, respectively.
Cash and Cash Equivalents
The carrying value of cash and cash equivalents approximates their fair value. At December 31,
2006 and 2005, the fair value of cash and cash equivalents was $3,542,928 and $249,109,
respectively.
F-25
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. Segment Information
The operations of the Company and its subsidiaries have been classified into three operating
segments as follows: life and annuity insurance operations (conducted by FLAC and by the Company
pursuant to the Services Agreement); brokerage operations conducted by BCA and corporate
operations. All sales of life insurance by FLAC are to unaffiliated customers. Segment
information as of December 31, 2006, 2005 and 2004 and for the years then ended is as follows:
| 2006 | 2005 | 2004 | ||||||||||
Revenues: |
||||||||||||
Life and annuity insurance operations |
$ | 4,880,259 | $ | 4,628,936 | $ | 4,293,633 | ||||||
Brokerage operations |
1,199,210 | 765 | — | |||||||||
Corporate |
82,727 | 230,801 | 403,843 | |||||||||
Total |
$ | 6,162,196 | $ | 4,860,502 | $ | 4,697,476 | ||||||
Income (loss) before income taxes: |
||||||||||||
Life and annuity insurance operations |
$ | 254,517 | $ | 271,992 | $ | 464,114 | ||||||
Brokerage operations |
1,083,796 | (13,965 | ) | — | ||||||||
Corporate |
(570,598 | ) | (958,656 | ) | (761,430 | ) | ||||||
Total |
$ | 767,715 | $ | (700,629 | ) | $ | (297,316 | ) | ||||
Depreciation and amortization expense: |
||||||||||||
Life and annuity insurance operations |
$ | 737,908 | $ | 630,737 | $ | 769,611 | ||||||
Brokerage operations |
584 | 438 | — | |||||||||
Corporate |
142,767 | 153,863 | 132,902 | |||||||||
Total |
$ | 881,259 | $ | 785,038 | $ | 902,513 | ||||||
Assets: |
||||||||||||
Life and annuity insurance operations |
$ | 28,570,332 | $ | 23,337,149 | $ | 18,305,111 | ||||||
Brokerage operations |
1,198,212 | 11,903 | — | |||||||||
Corporate |
1,488,199 | 3,328,610 | 4,649,885 | |||||||||
Total |
$ | 31,256,743 | $ | 26,677,662 | $ | 22,954,996 | ||||||
F-26
Table of Contents
FIRST AMERICAN CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Liquidity and Capital Resources
As of December 31, 2005 cash reserves and liquid investments at the parent company level were
approximately $419,540 compared to $1,388,851 at the end of 2004. Based on the decreasing level of cash reserves and liquid investments at the parent company level
over the previous 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 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, resulting in expected interest savings of approximately $890,000 over the life of the loans. In addition, the transaction provided
the parent company approximately $478,000 in cash. This cash was available to fund operations at the parent company.
16. Other Regulatory Matters
FLAC is currently 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’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. FLAC appealed the suspension and had its
license reinstated on July 27, 2006. As of December 31, 2006, FLAC’s statutory basis capital and
surplus was $3,966,233, which is in excess of the aforementioned minimum requirement.
17. Subsequent Events
On January 31, 2007, the Company’s shareholders approved certain amendments to First American’s
Articles of Incorporation to: (1) increase its authorized shares of common stock from 8,000,000 to
25,000,000 shares; (2) increase its authorized shares of preferred stock from 550,000 to 1,550,000;
and (3) reduce the par value of its common stock from $.10 to $.01 per share. In addition, the
shareholders approved a 3-for-1 reverse stock split by which each three shares of outstanding
common stock will be reverse split into one share of common stock. The reverse split is expected
to occur during the second quarter of 2007. Further, the Company has committed up to $500,000
(subject to adjustment) to repurchase shares of its common stock through a modified Dutch auction
tender offer for a price not to exceed $1.72 per share. The tender offer is expected to be
commenced during the first quarter of 2007.
On January 31, 2007, Brooke exercised its warrant to purchase an additional 1,643,460 shares of the
Company’s common stock for $447,818.
On February 14, 2007, the Company and Brooke Brokerage Corporation, a wholly owned subsidiary of
Brooke, announced that they had entered into a definitive agreement by which the Company would
acquire all of the outstanding capital stock of Brooke Savings Bank from Brooke Brokerage
Corporation in exchange for 6,047,904 shares of the Company’s common stock with a value of
approximately $10.1 million. Consummation of the transaction is subject to regulatory approvals
and other closing conditions and is expected to close within 12 months.
The agreed upon purchase price for the Bank of $10.1 million is the price paid by Brooke Brokerage
Corporation to acquire Brooke Savings Bank on January 8, 2007. Furthermore, the number of shares
of the Company’s common stock to be issued is based on a price per share of $1.67. Based on
current outstanding shares of the Company’s common stock, the proposed transaction would result in
an increase of Brooke’s direct and indirect ownership of the Company from its current level of
approximately 55 percent to approximately 72 percent.
F-27