Total revenues decreased from $1,576,000 in fiscal 2015 to $1,336,000 in fiscal 2016, while total operating expenses decreased from $3,080,000 in fiscal 2015 to $1,907,000 in fiscal 2016. This resulted in a net loss from operations of $571,000 in 2016 as compared with a net loss from operations of $1,505,000 in fiscal 2015.
The decrease in revenues is largely attributable to a decrease in net investment income of approximately $490,000 in 2016, mainly due to an unrealized decline in market value of an investment account held as a result of a contractual arrangement, where the Company receives any appreciation and earning in excess of the initial deposit of collateral by a principal bondholder. The Company also realized losses of $79,000 on the sale of investments in 2016 compared to gains of $136,000 in 2015. Insurance premiums written for new and existing customers increased by approximately $100,000 in 2016. In addition, the Company recognized other income of approximately $287,000 from the removal of dormant account payable balances and commissions no longer payable on receivables that were written off as uncollectible, and approximately $81,000 in interest income on notes receivable issued during 2016.
During the years ending May 31, 2016 and May 31, 2015 the Company recorded gains on extinguishment of debt in the amount of $1,919,532 and $1,257,536 respectively. These gains resulted from the waived interest and forgiven principal on notes payables occurring upon the settlement of the bridge loans in 2016 and from the purchase of a majority interest in the bridge loans and the payoff of other notes payables in 2015.
The Company’s outstanding Series A Preferred stock matures on the seventh anniversary of the issuance date if the holder has no outstanding surety bonds with the Registrant. Thereafter holders of the Series A Stock are eligible to request that the Company redeem their Series A Shares. As of May 31, 2016, the Company has received requests for redemption of 1,026 shares of Series A Preferred. The aggregate amount to which the holders requesting redemption are entitled as of June 30, 2016, is $1,535,688.
(Y) the Company will use those funds which are legally available therefor and which would not result in an impairment of the operations of the Insurance Subsidiary to redeem the maximum possible number of shares of Series A Stock for which Redemption Notices have been received ratably among the holders of such shares to be redeemed based upon their holdings of such shares, and (Z) thereafter, until such shares are redeemed in full, the dividends accruing and payable on such shares of Series A Stock to be redeemed shall be increased by 2% of the Series A Face Amount, with the amount of such increase (i.e., 2% of the Series A Face Amount) to be satisfied by distributions on each Dividend Payment Date of shares of Common Stock having a value (determined by reference to the average closing price of such Common Stock over the preceding 20 trading days) equal to the amount of such increase. The shares of Series A Stock not redeemed shall remain outstanding and entitled to all the rights and preferences provided herein. At any time thereafter when additional funds of the Company are legally available for the redemption of shares of Series A Stock and such redemption will not result in an impairment of operations of the Insurance Subsidiary, such funds will immediately be used to redeem the balance of the shares of Series A Stock to be redeemed. No dividends or other distributions shall be declared or paid on, nor shall the Company redeem, purchase or acquire any shares of, the Common Stock or any other class or series of Junior Securities or Equal Ranking Preferred of the Company unless the Redemption Price per share of all shares for which Redemption Notices have been given shall have been paid in full, provided that the redemption price of any Equal Ranking Preferred subject to redemption shall be paid on a pari passu basis with the Redemption Price of the Series A Stock subject to redemption in accordance herewith. Until the Redemption Price for each share of Series A Stock elected to be redeemed shall have been paid in full, such share of Series A Stock shall remain outstanding for all purposes and entitle the holder thereof to all the rights and privileges provided herein, and Dividends shall continue to accrue and, if unpaid prior to the date such shares are redeemed, shall be included as part of the Redemption Price.
The Company’s outstanding Series B Preferred stock matured on December 30, 2010, meaning that the holders of the Series B Stock became entitled to request that the Company redeem their Series B Shares. As of May 31, 2016, the Company has received requests for redemption of 2,219
shares of Series B Preferred. The aggregate redemption amount to which the holders are entitled as of June 30, 2016, is $5,099,573.
Of primary importance to the Company's ability to fully implement its business plan is the expansion of that business into additional states. Regulatory approval and licensing is required for each state where FSC seeks to conduct business. Management found entry into additional states (as a surety) was proving difficult without the benefit of more substantial capital and reserves due to FSC's status as a recent entry into this market and due to the cyclical nature of the coal industry. Accordingly, management began pursuing avenues that would provide additional capital to facilitate such expansion.
the Company of a qualified equity offering providing net proceeds of at least $15 million on or before September 10, 2013. Because such a qualified equity offering was not consummated by September 10, 2008, accrued interest-to-date was payable, and quarterly installments of principal and interest became payable over five years commencing in December 2008. The interest rates on such notes were fixed at 10.00%. Payments due December 2008 and March 2009 were not made by the Company as scheduled, but a forbearance agreement was subsequently entered into with the bridge lenders on June 5, 2009, modifying payment terms to cure the default (including increasing the interest rate on the loans to 17%), issuing additional common stock to the loan holders, and pledging the stock of the Company’s subsidiary, CMW, as security for repayment of the loans. The modification required the Company to pay interest of $224,515 on June 10, 2009 and increase the quarterly payments by $67,185 beginning September 10, 2009 to satisfy the arrearage. The Company failed to make the payment that was due September 10, 2009 and the payments that were due in the ensuing quarters.
On July 9, 2014 the Company completed a $4,500,000 financing. In effect, FSI, a subsidiary of the Registrant, borrowed the funds at 8.00% interest with principal repayments on a ten year schedule. Proceeds of the borrowing were applied (i) to purchase from certain bridge lenders, after waiving interest of approximately $1.6 million, 50.7% ($1.775 million face amount) of the outstanding senior promissory notes comprising a $3.5 million financing dating from 2008, together with the associated collateral, (ii) to pay in full delinquent tax liabilities owed to the Internal Revenue Service and State of West Virginia, (iii) to pay an outstanding judgment, and (iv) to pay certain other current liabilities. FSI therefore became a member of the Bridge Loan and notified the Collateral Agent for the group of its purchase and majority holding. The transaction restored majority control of FSC to the Company and improved its balance sheet through waiver of accrued interest.
The transaction was funded through sale in a private offering of investment units (Units) that consisted of 5.00% of the outstanding shares of FSC and 500,000 common shares of the Company. $1,600,00 was raised through the sale of units in exchange for consideration that included a combination of the cash purchase of units, cancellation of indebtedness owed by the Company to the purchaser in exchange for units and loans to the Company by potential purchasers that are convertible into the purchase of Units. The Registrant’s Board of Directors has authorized the sale of up to nine Units, which, if completed, would include forty-five percent (45%) of the outstanding stock of FSC.
Regulatory approval for the acquisition of FSC by JFG was provided by a Consent Order issued December 23, 2005 by the Commissioner of Insurance of the State of West Virginia and imposed several conditions for the operation of FSC, including the condition that no dividends or monies were to be paid to JFG without regulatory approval. This consent order was terminated on March 26, 2012 and dividends in the amounts of $173,000 and $198,000 were paid during the years ended May 31, 2015 and May 31, 2014, respectively. For further information, see Notes C and O to the Consolidated Financial Statements.
Management believes the Company has the ability to hold all fixed income securities to maturity. However, the Company determined it may dispose of securities prior to their scheduled maturity
Ceded reinsurance is treated as the risk and liability of the assuming companies. The Company cedes insurance to other companies but these reinsurance contracts do not relieve the Company from its obligations to policyholders. Ceded premiums, at a rate of 35% of written premium with a minimum of $490,000, are recognized as reductions in revenue ratably over the term of the related policies. Ceded unearned premiums represent the portion of ceded premiums written applicable to the unexpired terms of policies in force determined on a pro rata basis.
In establishing its reserves for losses and loss adjustment expense, management continually reviews its exposure to loss based on reports provided in conjunction with the periodic monitoring and inspections performed along with industry averages and historical experience. Management has estimated such losses based on management’s experience, adjusted for factors that are unique to the Company’s approach, and in consultation with its consulting actuary experienced in the surety field. As a result of the limited Company and industry data and experience there is a significant risk that amounts reserved for future expected losses and loss adjustment expenses could vary from those amounts reserved and the variance could be material. Adjustments to reserves are reflected in earnings in the period of determination.
Through the sharing of resources (primarily personnel) to minimize operating costs, the Company and its subsidiaries attempt to minimize operating expenses and preserve resources. Although FSC is cash flow positive, the use of its assets and profits are restricted to its stand-alone operation by regulatory authority. While growth of the FSC business continues to provide additional revenue opportunities to the Company’s other subsidiaries, Jacobs & Company and Triangle Surety, it is anticipated that working capital deficiencies will continue to be met either through the raising of additional capital or borrowings. However, there can be no assurance that additional capital (or debt financing) will be available when and to the extent required or, if available, on terms acceptable to the Company. Accordingly, there is substantial doubt as to the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
$490,000, mainly due to the severe unrealized loss in market value of an investment account held as a result of a contractual arrangement, where the Company receives any appreciation and earning in excess of the initial deposit of collateral by a principal bondholder. The Company also had losses of $(79,000) in 2016 on the sale of investments compared to realized gains of $136,000 in 2015.
Investment income is expected to remain relatively consistent from period to period, but can fluctuate based on interest rates, market conditions, growth or loss of business, and investment funds expended in the payment of claims. The decrease in revenues reflected above is mainly attributable to the severe drop in market value of an investment account held as a result of a contractual arrangement, where the Company receives any appreciation and earning in excess of
the initial deposit of collateral by a principal bondholder as well as realized losses of ($79,060) in 2016 compared to realized gains of $136,000 in 2015 on the sale of investments. Gross premium written in fiscal 2016 amounted to $1,386,837 as compared to $1,382,725 in fiscal 2015 and is reflective of a slight increase in the volume of bonds required for new and existing clients. Commission income earned for the placement of bonds with outside insurers also increased from $9,483 in 2015 to $134,346 in 2016. This increase in commission revenue for 2016 is derived from one subsidiary’s facilitation of a contract with an outside company and a separate subsidiary to provide replacement bonding for premium income. The Company did not record a No Claims Bonus for the year ended May 31, 2016 due to the recording of a claim reserve in excess of the minimum amount specified in the reinsurance contract period covering October 1, 2014 through December 31, 2015.
Incurred policy losses represent the provision for loss and loss adjustment expense for “incurred but not reported” (IBNR) losses attributable to surety bonds issued by FSC. Due to overall concern for the coal industry brought about by substantial pricing competition from natural gas and resultant bankruptcies of publicly traded coal companies, the Company has agreed with its actuary and regulators to increase FSC’s reserves in 2015 and 2016 by recording $179,334 as IBNR for fiscal 2016, or 18% of earned premium, as compared to $968,017 or 106% of earned premium for fiscal 2015, strengthening its reserves by a net of approximately $820,000. In addition, FSC has adjusted the percentage of premium reserved for IBNR by increasing the reserve rate from 12% of earned premium to 23% for partially collateralized bonds beginning January 1, 2016. IBNR loss estimates have been based on actuarial recommendations and management’s judgment that are unique to the FSC’s underwriting approach. Prior to 2014, FSC had not received any claims for losses on any bonds underwritten since business began in 2006.
General and administrative expenses for fiscal 2016 were $1,442,606 as compared with $1,809,121 for fiscal 2015, representing an decrease of $366,515 and are comprised of the following:
The increase in commissions is partially attributable to FSC’s commission structure that pays a larger commission percentage on the origination of a policy but reduced for subsequent policy, as well as to the timing of payment of commissions based upon collections. The decrease in fringe benefits is attributable to decreased cost of health insurance for employees after changing insurance providers.
Legal and professional fees decreased in 2016 compared to the prior year due to the Company’s above normal efforts and related expenses in 2015 to expand the Company’s business, remove debt of the Company via refinancing and sale of subsidiary stock, and penetrate new markets. In 2015 the Company reclassified an $80,000 deposit from prior years as legal expense for work on a financing arrangement that was not completed. Audit, accounting and related services decreased in 2016 due to a change in accounting and audit service provider in 2015 for the Company which resulted in the delay of audit related expenses for all of 2016.
Other general and administrative expense decreased by approximately $117,000 in 2016 compared to the corresponding 2015 period. This decrease is mainly due to the Company’s writing off accounts receivable of approximately $300,000 as uncollectible in 2015. The Company anticipates that some of these accounts receivable will be paid by an obligor in the future based on verbal agreements with this obligor.
Interest expense for fiscal 2016 was $915,098 compared to $833,242 in fiscal 2015. Components of interest expense are comprised of the following:
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note A to the financial statements, the Company has insufficient liquidity and capitalization, and has suffered recurring operating losses. These conditions, among others, raise substantial doubt about the Company's ability to continue as a going concern. Management's plans regarding these matters are also described in Note A. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Debt securities are designated at purchase as held-to-maturity, trading or available for sale. Held-to-maturity debt securities are carried at amortized cost where the Company has the ability and intent to hold these securities until maturity. Premiums and discounts arising from the purchase of debt securities are treated as yield adjustments over the estimated lives or call date, if applicable.
Factors considered in identifying OTTI include: 1) for debt securities, whether the Company intends to sell the investment or whether it is more likely than not that the Company will be required to sell the security prior to the anticipated recovery in value; 2) the likelihood of the recoverability of principal and interest for debt securities (i.e., whether there is a credit loss) or cost for equity securities; 3) the length of time and extent to which
the fair value has been less than amortized cost for debt securities or carrying value for equity securities; and 4) the financial condition, near-term and long-term prospects for the issuer, including the relevant industry conditions and trends, and implications of rating agency actions and offering prices.
The Company invests in large capitalized US securities traded on major US exchanges and writes standardized covered calls only against these positions (covered calls), which are openly traded on major US exchanges. The use of such underlying securities and standardized calls lessens the credit risk to the furthest extent possible.
Losses and loss adjustment expenses represent management’s best estimate of the ultimate net cost of all reported and unreported losses incurred. Reserves for unpaid losses and loss adjustment expenses are estimated using industry averages, however, will include individual case-basis valuations in the event if claims are received. These estimates and methods of establishing reserves are continually reviewed and updated.
doubt about an organization's ability to continue as a going concern and to provide related footnote disclosures. This guidance is effective for us for the annual period ending May 31, 2017 and interim and annual periods thereafter. We do not expect the adoption of this standard to have a material impact on our consolidated financial position, results of operations and cash flows.
In April 2015, the FASB issued ASU 2015-03, “Interest - Imputation of Interest”, which require debt issuance costs to be presented in the balance sheet as a direct deduction from the associated debt liability. The new rules were effective for the Company in the first quarter of 2016. In August 2015, the FASB issued ASU 2015-15, “Interest - Imputation of Interest (Subtopic 835-30) - Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements”. The guidance clarifies accounting for debt issuance costs related to line-of-credit arrangements. The standard states that the FASB deems deferring debt issuance costs related to line-of-credit arrangements as an asset and amortizing over the term of the agreement to be appropriate. The adoption of these accounting rules did not have a material impact on the Company’s financial condition, results of operations or cash flows.
In March 2016, the FASB issued ASU No. 2016-07, “Investments - Equity Method and Joint Ventures (Topic 323)”, that eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an adjustment must be made to the investment, results of operations and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. The new standard will be effective for the Company on January 1, 2017. The adoption of the new accounting rule is not expected to have a material impact on the Company’s financial condition, results of operations or cash flows.
In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting”, which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The new rules are effective for the Company in the first quarter of 2017. The Company does not expect the adoption of the new accounting rules to have a material impact on the Company’s financial condition, results of operations or cash flows.
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments-Overall (Subtopic 825-10)”, which updated the accounting guidance related to the recognition and measurement of financial assets and financial liabilities. The updated accounting guidance, among other things, requires that all nonconsolidated equity investments, except those accounted for under the equity method, be measured at fair value and that the changes in fair value be recognized in net income. The updated guidance will be effective for the Company as of January 1, 2018. The updated accounting guidance requires, with certain exceptions, a cumulative effect adjustment to beginning retained earnings when the guidance is adopted. The Company is currently in the process of evaluating the impact of adoption of the new rules on the Company’s financial condition, results of operations and cash flows.
presented and classified in the statement of cash flows by providing guidance for several specific cash flow issues. In addition, in November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. The amendment requires that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new rules will be effective for the Company in the first quarter of 2018. The Company does not expect the adoption of the new accounting rules to have a material impact on the Company’s cash flows.
At May 31, 2016, the Company’s insurance subsidiary had securities and short-term investment with a fair value of $1,171,307 on deposit with the State insurance department to satisfy regulatory requirements. In connection with regulatory approval of the Company’s acquisition of its insurance subsidiary, certain restrictions were imposed on the ability of the Company to withdraw funds from FSC without prior approval of the state Insurance Commissioner. Accordingly, investments and cash in the amount of $9,386,503 and $10,100,908 as of May 31, 2016 and 2015, respectively, are restricted to the use of FSC.
At May 31, 2016, the Company’s insurance subsidiary had cash, securities and short term investments held as collateral for their bonding program in the amount of $2,068,252.
Principal repayments on U.S. government agency mortgage-backed securities held by the Company as of December 31, 2016 are estimated as follows:
The following table summarizes the gross unrealized losses and fair value on investment securities aggregated by major investment category and length of time that individual securities have been in a continuous loss position at May 31, 2016 and May 31, 2015.
As of May 31, 2016, the Company held fifteen fixed maturity bonds with gross unrealized losses of $58,217, seven of which have been in a continuous loss position for more than 12 months.
As of May 31, 2016, the Company held seventeen equity security investments with gross unrealized losses of $155,300, two of which have been in a continuous loss position for more than 12 months. These securities consist of common stock whose fair value is sensitive to movements in market interest rates.
Included in other assets as of May 31, 2016 and May 31, 2015 are $14,617 and $14,550 of prepaid expenses and deposits.
Losses can occur if the costs of reclamation exceed estimates obtained at the time the bond was underwritten or upon subsequent re-evaluations, if sufficient collateral is not obtained and increased if necessary, or if collateral held has experienced a significant deterioration in value. FSC has experienced two claims for loss through May 31, 2016 (one fiscal 2016, detailed below) and thus provisions for losses and loss adjustment expense have been based on management’s experience adjusted for other factors unique to the Company’s approach, and in consultation with actuaries experienced in the surety field. In August 2015, the Company paid a claim on a called bond in the amount of $550,000, of which $75,000 was paid using collateral of the principal. The remaining $475,000 has been established as a salvage reserve to be repaid with the assignment of proceeds from sales of stock and an assignment of a promissory note as additional collateral with total assigned values in excess of the salvage reserve.
The Company incurred loss adjustment expenses of $26,590 ($25,000 in Fiscal 2014) related to costs of engaging experts, attorney fees, and consultants for potential claims. These costs were charged against established case reserves and bulk reserves.
As a result of an examination by the West Virginia Insurance Commissioner, a reserve strengthening in the form of an increase to the Loss Reserve was recorded in Fiscal 2015 and 2016 in the amounts of approximately $800,000 and $20,402.
During the year ended May 31, 2015, the Company borrowed $75,000 from a board member. Accrued related party interest of $9,452 is payable to this individual at May 31, 2016.
During the year ended May 31, 2016, an individual who holds secured notes payables from the Company, became a greater than 10% owner of outstanding common stock of the Company. During the year ended May 31, 2016, the Company borrowed additional money from this individual and entities controlled by this individual. Amounts owed to this individual (and the individual’s companies and relatives) at May 31, 2016 consisted of $868,900 in demand notes, $1,387,573 in notes payable secured by FSC stock, and $14,621 in accrued interest.
In accordance with the terms of the first round bridge-financing of $2.5 million on March 10, 2008, the holders of such notes were paid accrued interest-to date and issued 5.00% of the Company's common shares. During 2009, holders of the second round of bridge-financing notes of $1.0 million received 2.00% of the Company's common shares. Upon retirement of the notes subsequent to consummation of a qualified equity offering, the Company was to issue to the holders of the bridge financing notes additional Company common stock that when added to the stock initially issued to the holders of the notes, would equal the note holders’ pro rata share of the applicable percentage of the outstanding common stock of the Company as follows: If the qualified financing consists of $50 million or more, the holders of such notes will receive 28% of the common stock of the Company that would otherwise be retained by the holders of the Company's common shares immediately prior to the financing; if the qualified financing is for an amount less than $50 million, the percentage will be reduced on a sliding scale to a fraction of 28% of the amount retained by the holders of the Company's common shares (where the numerator is the amount of financing and the denominator is $50 million). This feature was analyzed and determined to be an embedded derivative, but the value was considered to be immaterial, and therefore was not recorded.
Beginning September 10, 2008, because a qualified financing had not been completed, the Company became required under the terms of the bridge financing to issue 2.80% of the Company's outstanding common shares and shall issue 2.80% of the Company's outstanding common shares upon each six-month anniversary date thereof until retirement of the notes. This feature was analyzed and determined to be an embedded derivative, but the value was considered to be immaterial and therefore was not recorded for the remaining shares to be issued. Pursuant to the terms of the Promissory Notes, the first two of 20 equal quarterly installments of principal and interest payable thereunder were to have been paid on December 10, 2008 and March 10, 2009 (the “Initial Amortization Payments”). As the result of upheavals and dislocations in the capital markets, the Company was unable to either refinance the indebtedness evidenced by the Promissory Notes or make the Initial
On June 5, 2009 the Company entered into an agreement with the bridge lenders to forbear from exercising their rights and remedies arising from the Acknowledged Events of Default. The Original forbearance was amended October 13, 2009. As consideration for the forbearance, the Company issued 5,171,993 shares of Common stock, and pledged the stock of an inactive subsidiary of the Company, Crystal Mountain Water (CMW), as security for repayment of the loans.
In anticipation of a proposed financing and as a condition thereof, the Company and each of the bridge lenders entered into a loan modification agreement dated February 25, 2012 which provided for modification of the Promissory Notes, including an extension of the term of the promissory notes, and subscription agreements in exchange for a partial cash payment to each bridge lender. On August 10, 2012, the Company entered into an agreement with the bridge lenders, pursuant to which the bridge lenders formally agreed to forbear from exercising their rights and remedies arising from the accumulated acknowledged events of default with respect to the bridge loans until such date. As consideration for this forbearance, the Company entered into an Amended and Restated General Hypothecation and Pledge Agreement dated August 9, 2012 (the “August 2012 Pledge”), but effective September 23, 2011, granting to the bridge lenders as security for the repayment of the loans a lien and security interest in all of the Company’s shares of capital stock of First Surety Corporation. Under the August 2012 Pledge, the bridge lenders acknowledged that the effectiveness of certain of the rights and remedies provided by such agreement would be subject to prior approval by the Office of the Commissioner of Insurance for the State of West Virginia.
interest in the amounts of $125,000 and $1,795,000, respectively for a total gain of $1,920,000.
The transaction was funded through sale in a private offering of investment units (Units) that consisted of 5.00% of the outstanding shares of FSC and 500,000 common shares of the Company. $1,600,000 was raised through a combination of cash, partial assignments of loans back to the Company that were debt of the Company and loans that are convertible into purchase of Units. The Registrant’s Board of Directors has authorized the sale of up to nine Units, which, if completed, would include forty-five percent (45%) of the outstanding stock of FSC.
As of May 31, 2016 and May 31, 2015 the Company held approximately $2,068,192 and $2,352,427 respectively in its cash and investment accounts that was for the benefit of clients as collateral for their surety bonding program.
Under the terms of the Series A Preferred Stock, upon receipt of such a request, the Company’s Board was required to make a good faith determination regarding (A) whether the funds of the Company legally available for redemption of shares of Series A Stock are sufficient to redeem the total number of shares of Series A Stock to be redeemed on such date and (B) whether the amounts otherwise legally available for redemption would, if used to effect the redemption, not result in an impairment of the operations of the Insurance Subsidiary. If the Board determines that there is a sufficiency of legally available funds to accomplish the redemption and that the use of such funds to affect the redemption will not result in an impairment of the operations of the Insurance Subsidiary, then the redemption shall occur on the Redemption Date. If, however, the Board determines either that there are not sufficient funds legally available to accomplish the redemption or that the use of such funds to effect the redemption will result in an impairment of the operations of the
Insurance Subsidiary, then (X) the Company shall notify the holders of shares that would otherwise have been redeemed of such fact and the consequences as provided in this paragraph, (Y) the Company will use those funds which are legally available therefor and which would not result in an impairment of the operations of the Insurance Subsidiary to redeem the maximum possible number of shares of Series A Stock for which Redemption Notices have been received ratably among the holders of such shares to be redeemed based upon their holdings of such shares, and (Z) thereafter, until such shares are redeemed in full, the dividends accruing and payable on such shares of Series A Stock to be redeemed shall be increased by 2% of the Series A Face Amount, with the amount of such increase (i.e., 2% of the Series A Face Amount) to be satisfied by distributions on each Dividend Payment Date of shares of Common Stock having a value (determined by reference to the average closing price of such Common Stock over the preceding 20 trading days) equal to the amount of such increase. The shares of Series A Stock not redeemed shall remain outstanding and entitled to all the rights and preferences provided herein. At any time thereafter when additional funds of the Company are legally available for the redemption of shares of Series A Stock and such redemption will not result in an impairment of operations of the Insurance Subsidiary, such funds will immediately be used to redeem the balance of the shares of Series A Stock to be redeemed. No dividends or other distributions shall be declared or paid on, nor shall the Company redeem, purchase or acquire any shares of, the Common Stock or any other class or series of Junior Securities or Equal Ranking Preferred of the Company unless the Redemption Price per share of all shares for which Redemption Notices have been given shall have been paid in full, provided that the redemption price of any Equal Ranking Preferred subject to redemption shall be paid on a pari passu basis with the Redemption Price of the Series A Stock subject to redemption in accordance herewith. Until the Redemption Price for each share of Series A Stock elected to be redeemed shall have been paid in full, such share of Series A Stock shall remain outstanding for all purposes and entitle the holder thereof to all the rights and privileges provided herein, and Dividends shall continue to accrue and, if unpaid prior to the date such shares are redeemed, shall be included as part of the Redemption Price.
The Company’s outstanding Series B Preferred stock matured on December 30, 2010, meaning that the holders of the Series B Stock that had not requested exchange to the Company’s Series C Preferred stock became entitled to request that the Company redeem their Series B Shares. As part of the exchange to Series C Preferred Stock in September 2009, the shares that did not exchange were treated as a liability on the balance sheet. As of May 31, 2016, of the 2,817 shares of Series B Preferred that remained outstanding, the Company has received requests for redemption of 2,219 shares of Series B Preferred. The aggregate amount to which the holders requesting redemption are entitled as of June 30, 2016, is $5,099,573.
Preferred Stock, which by its terms matured at the end of 2010, management proposed a recapitalization to assist in stabilizing the financial position of the Company. The Company’s Certificate of Incorporation provides for two classes of capital stock, known as common stock, $0.0001 par value per share (the “Common Stock”), and preferred stock, $0.0001 par value per share (the “Preferred Stock”). The Company’s Board is authorized by the Certificate of Incorporation to provide for the issuance of the shares of Preferred Stock in series, and by filing a certificate pursuant to the applicable law of the State of Delaware, to establish from time to time the number of shares to be included in such series and to fix the designations, preferences and rights of the shares of each such series and the qualifications, limitations and restrictions thereof. The Board deemed it advisable to designate a Series C Preferred Stock and fixed and determined the preferences, rights, qualifications, limitations and restrictions relating to the Series C Preferred Stock as follows:
B Amount) shall be allocated and paid with respect to the shares of Series C Preferred and any other Equal Ranking Preferred, first, among the shares of Equal Ranking Preferred pro rata in accordance with the amounts of dividends accruing with respect to such shares at the current Dividend Payment Date, and, then, any additional amounts available for distribution in accordance with the accrued, but unpaid, dividends (and the Series B Amount then outstanding) at each prior Dividend Payment Date, in reverse chronological order, with respect to all shares of the Equal Ranking Preferred then outstanding in accordance with amounts accrued, but unpaid. For purposes hereof, the term “Series B Original Issue Date” shall mean, with respect to any share of Series C Stock issued by the Corporation in exchange for a share of Series B Stock, the date on which the Corporation originally issued such share of Series B Stock.
The Recapitalization consisted of the exchange of Series B Shares for a combination of Series C Shares and Common Stock. For each Series B Share, the participating holder received (i) one Series C Share and (ii) 2,000 shares of JFG Common Stock (for no additional consideration).
The accrual of dividends on the equity preferred stock resulted in a charge to common stockholders’ equity and a credit to the equity of equity preferred stock of $1,164,143 in fiscal 2016 as compared with a charge to common stockholders’ equity of $1,072,461 in fiscal 2015.
The Series B Shares have an 8.0% per annum compounding dividend preference, are convertible into Common Shares of JFG at the option of the holders at a conversion price of $1.00 per Share (as adjusted for dilution) and, to the extent not converted, must be redeemed by the Corporation at any time after December 31, 2010 at the option of the holder. Any such redemption is subject to legal constraints, such as the availability of capital or surplus out of which to pay the redemption, and to a determination by the Board of Directors that the redemption will not impair the operations of First Surety Corporation.
As of May 31, 2016 the Company has chosen to defer payment of dividends on Series A Preferred Stock with such accrued and unpaid dividends amounting to $1,155,545 through May 31, 2016. These dividends are included in the amounts reported on the face of the balance sheet for each classification of Series A stock.
U.S. GAAP requires that an entity classify as liabilities certain financial instruments with characteristics of both liabilities and equity. The Company's Series A and B Preferred stock each have mandatory redemption features that subject the Company to the analysis of equity versus liability. Both Series A and B have features that embody a conditional obligation to redeem the instrument upon events not certain to occur and accordingly, are not classified as liabilities until such events are certain to occur. With respect to the Series A Preferred Stock, such condition is contingent upon the holder having no further need for surety bonds issued by the Company's insurance subsidiary (FSC) under its partially collateralized bonding programs and, having no such surety bonds then outstanding. With respect to the Series B Preferred Stock, if the stock provides an option to the holder to convert to common shares at a rate equivalent to fair value, then the financial instruments are not mandatorily redeemable during the period in which the holder can convert the shares into common shares. Accordingly, the Company has determined that only the Series A preferred stocks held by principals with outstanding surety bonds should not be classified as liabilities. However, in accordance with Securities and Exchange Commission (SEC) Issued Topic No. D- 98, SEC Staff Announcement, "Classification and Measurement of Redeemable Securities", a company that issues preferred shares that are conditionally redeemable is required to account for the conditionally redeemable preferred shares in accordance with Accounting Series Release 268, which states that the shares are to be reflected on the Company's balance sheet between total liabilities and stockholders' equity as temporary equity.
In fiscal 2016, the Company issued 1,878,000 shares of the Company's common stock as additional consideration in connection with new and continued borrowings totaling $1,878,000. The shares were valued at approximately $.002887 per share based on the average quoted closing price of the Company's stock for the 20-day period preceding the date of the transaction and totaled $5,422.
In fiscal 2015, the Company issued 10,221,845 shares of the Company's common stock in connection with the semi-annual issuance of shares under terms of the bridge-financing arrangement. The shares were valued at approximately $.005525 per share based on the average quoted closing price of the Company's stock for the 20-day period preceding the date of the transaction and totaled $56,476. Of
In fiscal 2015, the Company issued 5,183,936 shares of the Company's common stock in connection with the semi-annual issuance of shares under terms of the bridge-financing arrangement. The shares were valued at approximately $.005525 per share based on the average quoted closing price of the Company's stock for the 20-day period preceding the date of the transaction and totaled $(28,641).
Under the West Virginia insurance code, ordinary dividends to stockholders are allowed to be paid only from that part of the insurance subsidiary’s (FSC’s) available surplus funds
which constitutes realized net profits from the business and whereby all such dividends or distributions made within the preceding twelve months do not exceed the lesser of 10% of FSC’s surplus as regards to policyholders as of December 31st of the preceding year-end or net income from operations from the previous two calendar years, not including capital gains. Any payment of extraordinary dividends requires prior approval from the WV state insurance commissioner.
On March 26, 2012 the Commissioner of the State of West Virginia (WVOIC) terminated in its entirety the Amended Consent Order of June 7, 2007 and terminated the restrictive conditions of the Consent Order issued December 23, 2005 which approved acquisition of FSC by the Company. Among other consequences, removal of these restrictions allowed dividends to be declared by and paid from FSC to the Company. Dividends in the amounts of $173,000 were declared and paid for the twelve month period ending May 31, 2015. No dividends were declared or paid for the twelve month period ending May 31, 2016.
The Company leases certain office equipment with combined monthly payments of approximately $545 that have varying remaining terms of less than five years. The Company leases office, parking and storage space under month-to-month lease arrangements that approximate $6,897 each month.
Minimum future lease payments under non-cancelable operating leases having remaining terms in excess of one year as of May 31, 2016 are:
As of May 31, 2016 the Company’s investment securities of approximately $8,900,000 are comprised solely of mortgage-backed securities, fixed maturity municipal bonds, equity investments, and money-market mutual funds that invest principally in obligations issued by the U.S government, its agencies or instrumentalities. Such instruments are generally considered to be of the highest credit quality investment available.
For the past several years the Company’s operating expenses were partially funded by advances from its largest shareholder and chief executive officer, John M. Jacobs. The source of funding for these advances originated with obligations incurred by Mr. Jacobs with third parties (such obligations together with the loans by Mr. Jacobs to the Company, “back-to-back loans”) with interest rates ranging from 6% to 12%. This amount is unsecured and payable on demand.
To assure that repayments of the various borrowings by the Company that were either guaranteed by Mr. Jacobs or loaned to the Company by Mr. Jacobs via such back-to-back loan arrangements did not result in a deemed loan to Mr. Jacobs, because Mr. Jacobs entered into an Assumption Agreement with the Company. Pursuant to the assumption agreement Mr. Jacobs assumes, and agrees to hold the Company harmless from, principal of specified indebtedness of the Company and to fully offset when necessary what might otherwise be deemed an advance of funds arising out of the Company’s financing activities.
The rate of interest on such amounts due from and obligations due to Mr. Jacobs was 6% and 12% respectively for both the 2016 and 2015 fiscal years.
During the year ended May 31, 2016, an individual who holds secured notes payables from the Company, became a greater than 10% owner of outstanding common stock of the Company. During the year ended May 31, 2016, the Company borrowed additional money from this individual and entities controlled by this individual. Amounts owed to this individual (and the individual’s companies and relatives) at May 31, 2016 consisted of $868,900 in demand notes, $1,387,573 in notes payable secured by FSC stock, and $14,621 in accrued interest. This individual also arranged to purchase a 15.00% interest in First Surety Corporation for $1,500,000 through a combination of cash and a Promissory Note for $1,250,000 secured by assignment of debt payable by the Company.
The effects of reinsurance on premium written and earned for fiscal 2016 and 2015 are as follows;