Through its wholly-owned subsidiary, CMW, the Company has an undeveloped leasehold interest in a mineral water spring located near Hot Springs, Arkansas. Under this leasehold arrangement, CMW is obligated for minimum lease payments in the amount of approximately $180 per month with automatic options to extend the leasehold through October 2026. CMW has the right to cancel the lease upon sixty (60) days written notice at any time. The property is presently not being actively explored or developed. During the 2002 fiscal year, management evaluated the lease and determined the development was not currently feasible. Accordingly, the Company recorded an impairment of $116,661 to its investment in the lease. Opportunities will continue to be explored as they arise with respect to the development or sale of the leasehold interest. The stock of CMW has been pledged to a group of lenders as collateral (See Item 7 "Bridge-financing, Commitments and Material Agreements").
RESULTS OF OPERATIONS AND FINANCIAL CONDITION AS OF AND FOR THE YEAR ENDED MAY 31, 2010
The increase in revenues is largely attributable to new business acquired by FSC and increased investment holdings and the gain on sales of investments of FSC. The decrease in expenses is attributable to decreased general and administrative expense related to reduction in professional legal fees incurred in the Company's pending acquisition agreements and ongoing efforts to raise additional capital to expand its business and penetrate new markets.
The Series B designation was designed for issuance to investors in JFG and contains both conversion rights to common stock and redemption features. Each share of the Series B preferred stock is convertible, at the option of the holder, into 1,000 shares of JFG common stock and can be converted at any time. Additionally, the Series B preferred stock can be redeemed, at the option of the holder, at full-face value plus accrued and unpaid cumulative dividends, commencing with the fifth (5th) anniversary of the original issue date. The Company has the option to redeem the Series B preferred shares at any time after the first (1st) anniversary of the original issue date, subject to the holder choosing to exercise conversion privileges prior to the stated redemption date. Management's ability to execute its business plan and increase the market value of its common stock will largely determine whether the Series B preferred shares are converted to common shares or eventually redeemed.
The Series A designation is entitled to receive cumulative dividends at the rate of 4.00% per annum and the Series B and Series C designations are entitled to receive cumulative dividends at the rate of 8.00% per annum, with the Series A, B and C designations having equal ranking and preference as to dividends and liquidation rights and in priority to the Company's common stockholders. The accrued (but undeclared) dividends associated with the Series C exchange amounted to $2,295,624 and are included in the total amount exchanged for Series C Shares.
Unlike the Series B Shares with their fixed maturity date, the Series C Shares are permanent equity, with accruing dividends only increasing the preference amount that must be satisfied before junior securities may participate in dividends or on liquidation. Accordingly, the effect of the accrual of dividends with respect to the Series C Shares on the Company's balance sheet is to increase the aggregate claim of the Series C Shares on the equity of the corporation and to increase the deficit in common equity, while having no effect on the net equity of the corporation as a whole. The entitlement of the Series C Shares to a priority in relation to junior securities with respect to dividends and on liquidation does not create an obligation by the Company and therefore no liability is recorded until the dividends are declared by the Board of the Company. The Series C Shares are pari passu with the Series A Shares and Series B Shares and no dividends or other distributions will be paid upon Common Shares or any other class of Shares that is junior in priority to the Series C Shares while dividends are in arrears. At this time, management has chosen to defer
Beginning in fiscal 2008 and completed during the first quarter of fiscal 2009, the Company obtained two rounds of bridge financing totaling an aggregate of $3,500,000. The purpose of the financing was to pay expenses of operations and to pay fees and expenses incurred or expected to be incurred in connection with a larger permanent financing and, in addition, to increase the capital surplus of FSC to make possible the reactivation of FSC's surety license in the state of Ohio. The terms of the bridge-financing arrangement provide for payment in full upon consummation by the Company of a qualified equity offering providing net proceeds of at least $15 million on or before September 10, 2013; and 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 (to a total of $291,700) for eight consecutive quarters beginning September 10, 2009 to satisfy the arrearage. Although the Company has failed to make the payment that was due September 10, 2009 and the payments that were due in the ensuing quarters, management has remained in close contact with the bridge lenders, providing reports regarding its efforts to refinance or otherwise repay the bridge loans. To date, none of the bridge lenders has elected to pursue legal remedies.
attributable to such assets based on forecasts and projections and comparing such discounted cash flow amounts to the carrying value of the asset. Should actual results differ from such forecasts and projections, such assets may be subject to future impairment charges.
Effective April 1, 2009, FSC entered into a reinsurance agreement with Lloyd's of London for its coal reclamation surety bonding programs. This agreement has provided additional bonding capacity to FSC and has enabled FSC to write more bonds and of greater size for its coal reclamation bonding clients. Management expects this reinsurance arrangement to continue FSC's expansion of market share and to result in increased cash flow for each of the Company's operating subsidiaries.
As a means of alleviating obligations associated with the Company's Series B Preferred Stock, which by its terms matures at the end of 2010, management proposed a recapitalization to assist in stabilizing the financial position of the Company. Holders of the Series B Preferred Stock were offered the opportunity to exchange their Series B Shares for an equal number of shares of a new series of JFG preferred stock designated as Series C Preferred Stock plus 2,000 shares of JFG Common Stock. Series C Preferred Stock is equal in priority to the Series B Preferred Stock, is entitled to dividends at the same rate as Series B Preferred Stock, is entitled to convert to common stock of the Company at a conversion rate of $.10 per common share (in contrast to $1.00 per share for Series B Preferred) and may be redeemed by the Company but does not have a fixed maturity date and, thus, is classified as permanent equity. Holders of over 70% of the outstanding Series B Preferred Shares elected to participate in the recapitalization. Management believes the recapitalization will improve the
Company's prospects for engaging in a larger financing, will assist FSC as it applies to enter other state markets, and will be an impetus to the growth of the Company's business.
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 now cash flow positive, the use of its assets and profits are restricted to its stand-alone operation by regulatory authority until its capital and surplus reserves reach more substantial levels. And while growth of the FSC business continues to provide additional cash flow to the Company's other subsidiaries, Jacobs and Triangle Surety, it is anticipated that working capital deficiencies will continue and will need to be met either through the raising of additional capital or borrowings. However, there can be no assurance that additional capital (or debt financing) will be available when and to the extent required or, if available, on terms acceptable to the Company. Accordingly, concerns as to the Company's ability to continue as a going concern are substantial. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The Company experienced a loss (after accretion of mandatorily redeemable convertible preferred stock, and accrued dividends on mandatorily redeemable preferred stock and equity preferred stock) of $2,713,193 in fiscal 2010 as compared with a loss of $3,057,687 (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) in fiscal 2009.
Revenue from the investment management segment, net of advisory referral fees, was $262,635 in fiscal 2010 as compared with $233,297 in fiscal 2009, representing an increase of $29,337. As investment advisory fees are based on the market value of assets under management, some fluctuation will occur due to overall market conditions. For the most part, however, such revenues will remain relatively constant from year to year with any large fluctuations being attributable to the growth or loss of assets under management. The increase in revenues is primarily attributable to growth in individually managed funds...
Revenue from the surety insurance segment, consisting of FSC and TSA, was $1,095,213 for fiscal 2010 as compared with $957,067 for fiscal 2009. Revenues attributable to the insurance segment are as follows:
Premiums and commissions $ 780,808 $ 660,222 Net investment income 273,577 288,747 Net realized investment gains 40,828 8,098 --------------- ---------------
Premium revenue is recognized ratably over the term of the policy period and thus is relatively stable from period to period with fluctuations for comparable periods generally reflecting the overall growth or loss of business. Whereas, commission revenue, which is dependent on the timing of issuance or renewal of bonds, is expected to be somewhat more "seasonable" from quarter-to-quarter with fluctuations for comparable periods largely reflecting the overall growth or loss of business. Commission income for the year ending 2010 was $11,900 compared to $13,349 for 2009. 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 increase in revenues reflected above is attributable to increased surety business that has been secured in fiscal 2010. Gross premium written in fiscal 2010 amounted to $1,114,197 as compared to $905,519 and is reflective of the growth experienced in this segment of the business for the comparable periods. However, net premium written (written premium less deductions ceded reinsurance) in fiscal 2010 amounted to $728,938 as compared with $813,345 in fiscal 2009, due to a full year of ceded premium in 2010 compared to 2 months in 2009. Commission income earned for the placement of bonds with outside insurers has remained relatively stagnant.
FSC's investment holdings in fiscal 2010 averaged $6.553 million as compared with $5.986 million for fiscal 2009, with investment yields decreasing slightly from 5.0% to 4.1%.
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. Incurred policy losses for fiscal 2010 have been recorded as $178,531 or 23.2% of earned premium as compared to $186,007 or 28.5% of earned premium for fiscal 2009. IBNR loss estimates have been based on industry averages adjusted for factors that are unique to the FSC's underwriting approach. As of May 31, 2010 FSC has not received any claims for losses on any bonds underwritten since business began in 2006, therefore its actuaries have approved reducing the percentage of premiums reserved for IBNR due to this historical pattern.
General and administrative expenses for fiscal 2010 were $1,316,211 as compared with $1,564,224 for fiscal 2009, representing a decrease of $248,013 and are comprised of the following:
Fund's lackluster performance during the interim period contributed to a gradual decline in assets and the fixed cost maintenance of the Fund was a significant expense to the Company. The Fund's independent Board of Trustees had determined that unless the Fund experienced a significant growth in assets it would be necessary to liquidate the Fund. Growth in assets was not accomplished. As a result, the Board of Trustees directed the liquidation of the Fund's assets in November and the distribution of the proceeds to the Fund's shareholders on December 1, 2009.
While the Fund was responsible for its own operating expenses, Jacobs & Co., as the investment advisor, had agreed to limit the Fund's aggregate annual operating expenses to 2% of the average net assets. Under this expense limitation agreement, Jacobs & Co. absorbed $75,038 of the Fund's operating expenses in 2010 as compared to $122,758 in 2009. Due to the Fund's liquidation, there were no revenues and minimal expenses attributable to the fund subsequent to December 1, 2009. The cumulative reimbursement due the Fund by J&C as of May 31, 2010 was $54,866.
Year Ended May 31, 2010 2009 ----------------- ---------------- Accretion of discount $ 273,369 $ 567,811 Accrued dividends - mandatorily redeemable preferred stock 607,706 1,041,499 Accrued dividends - equity preferred stock 374,662 - ----------------- ----------------
The Series B class of stock is treated as a liability as of November 30, 2009 when the majority was exchanged for Series C equity stock. Therefore, accretion of $86,932 and dividends of $155,708 associated with the Series B after that date are deductions from net income and not included in the table above. The decrease in the accretion of discount results from this exclusion of Series B subsequent to November 30, 2009 as well as the application of the interest or constant yield method to the initial discount recorded with respect to the mandatorily redeemable preferred stock over a period of five years from the date of issuance of the stock. Series C equity stock accrues dividends at the same rate as the Series B it was exchanged for, however it is separated in the table above due to Series C not being mandatorily redeemable. Series C does not accrete.