MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL AND RESULTS OF OPERATIONS --------------------------------------------------------------------------------
Interest expense increased from approximately $906,000 in fiscal 2012 to approximately $1,073,000 in fiscal 2013, as a result of the rise in market value of the common stock used to calculate the price of shares to be issued for the semi-annual bridge loan issuance in September 2012.
In the years ending May 31, 2012 the Company, upon advice of legal counsel, removed certain dormant accounts payable in the aggregate amount of $150,604 based upon the vendor no longer requiring payment on a portion of the balance owed to them. These removals were recorded as gains on debt extinguishment.
The Series A designation was designed for issuance to principals desiring surety bonds under FSC's partially collateralized bonding programs. As designed, proceeds from the sale of Series A preferred stock is down-streamed to FSC to increase its capital and insurance capacity, although to the extent that proceeds from the sale of Series B preferred shares was used in the initial acquisition and funding of FSC, the Company was allowed to use such proceeds to redeem Series B preferred stock (Company option to redeem) or for funding of on-going operations. Effective June 1, 2007, the Company agreed to the requirement of the West Virginia Insurance Department to downstream all future proceeds from sales of Series A preferred stock in order to increase capital and reserves of the insurance subsidiary to more substantial levels.
The Company's outstanding Series A Preferred stock matures on the seventh anniversary of the issuance date and thereafter holders of the Series A Stock are eligible to request that the Company redeem their Series A Shares. As of this report, the Company has received requests for redemption of 291 shares of Series A Preferred. The aggregate amount to which the holders requesting redemption are entitled as of June 30, 2013, is $387,071.
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
On April 4, 2013, the Company's Board of Directors determined based on the criteria established under the terms of the Preferred Stocks that there were insufficient funds available for the redemption of Preferred Stocks.
Under the terms of the Series B Preferred Stock, receipt of a redemption request required the Company's Board to make a good faith determination regarding (A) whether the funds of the Company legally available for redemption of shares of Series B Stock are sufficient to redeem the total number of shares of Series B 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 B 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 B Stock to be redeemed shall be increased by 2% of the
In November 2009, as a means of alleviating obligations associated with the Company's Series B 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 Board deemed it advisable to designate a Series C Preferred Stock, with 10,000 authorized shares. The Recapitalization consisted of the exchange of 6,805 Series B Shares Preferred for a combination
Unlike the Series B Preferred Shares with their fixed maturity date, the Series C Preferred 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 Preferred Shares on the Company's balance sheet is to increase the aggregate claim by the Series C Preferred 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 Preferred 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 Preferred Shares are pari passu with the Series A Preferred Shares and Series B Preferred 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 Preferred Shares while dividends are in arrears.
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 $915,335 in fiscal 2013 as compared with a charge to common stockholders' equity of $847,833 in fiscal 2012.
Certain equity inducements in the form of common stock of the Company were provided under the terms of the bridge loan documents. Upon issuance of the
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 due to changes in interest rates, prepayments, tax and credit considerations, liquidity or regulatory capital requirements, or other similar factors. As a result, the Company classifies all of its fixed income securities (bonds) and equity securities as available-for-sale. These securities are reported at fair value, with unrealized gains and losses, net of deferred income taxes, reported in stockholders' equity as a separate component of accumulated other comprehensive income.
Under the terms of its reinsurance treaty, the Company is entitled to a No Claims Bonus from the reinsurers for each contract year in which no claims are received. The bonus is 20% of the contract year reinsurance premium and no claims have been made since the inception of the treaty.
Reserves for unpaid losses and loss adjustment expenses of the insurance subsidiary are estimated using information derived from Company experience in addition to management's estimate of expected future claims on those policies in force. Management's estimate considers relevant industry information but is largely dependent upon management's experience and judgment since prior Company experience and industry data available are extremely limited. FSC has experienced no claims for losses as of May 31, 2013.
In underwriting coal reclamation bonds, management obtains estimates of costs to reclaim the properties in accordance with the specifications of the mining permit, prepared by independent outside professionals experienced in this field of work. Such estimates are then periodically updated and compared with marketable securities pledged, and held for the benefit of FSC as collateral for the surety bond, to mitigate the exposure to significant loss. Should the principal default in its obligation to reclaim the property as specified in the mining permit, FSC would then use the funds held in the collateral account to
reclaim the property or forfeit the face amount of the surety bond. Losses can occur if the costs of reclamation exceed the estimates obtained at the time the bond was underwritten or upon subsequent re-evaluations, if sufficient collateral is not obtained, or if the collateral held has experienced significant deterioration in value and if FSC is not otherwise able to recover under its contractual rights to indemnification.
Miscellaneous fixed-liability limit surety bonds are generally fully collateralized by the principal's cash investment into a collateral investment account, managed by the Company's investment advisory subsidiary (Jacobs & Co.) that mitigates FSC's exposure to loss. Losses can occur should the principal default on the performance required by the bond and the collateral held in the investment account experience deterioration in value.
As a means of alleviating obligations associated with the Company's Series B 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. Holders of the Series B Preferred Stock were offered the opportunity to exchange their Series B Preferred 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.
The Company experienced a loss from operations of approximately $445,000 in 2013 as compared with income from operations of $16,000 in fiscal 2012. The net loss attributable to common stockholders was $2,946,806 in fiscal 2013 as compared $2,067,392 in fiscal 2012.
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. 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 receipt in 2012 of a cumulative No Claims Bonus from its reinsurers for the two years ending June 30, 2010 and June 30, 2011, as well as the need to recognize additional ceded premium in 2013 in order to meet the minimum amount set forth in the Reinsurance contract. The Company has experienced no claims for losses as of May 31, 2013. Gross premium written in fiscal 2013 amounted to $1,088,202 as compared to $1,343,661 in fiscal 2012 and is reflective of a decline in the volume of bonds required by a major customer, as well as overall decrease in new premium written for new and existing clients. Commission income earned for the placement of bonds with outside insurers has remained relatively stagnant.
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 2013 have been recorded as $181,414 or 24% of earned premium as compared to $210,977 or 22% of earned premium for fiscal 2012. The increase is due to the increased cost of reinsurance based upon the reduced volume of written premiums. IBNR loss estimates have been based on management's judgment that are unique to the FSC's underwriting approach. As of May 31, 2013 FSC has not received any claims for losses on any bonds underwritten since business began in 2006, therefore its actuary has adjusted the percentage of premiums reserved for IBNR due to this historical pattern.
Insurance policy acquisition costs represent charges to operations for underwriting, commissions and premium tax attributable to surety polices issued by FSC and are recognized ratably over the period in which premiums are earned. In fiscal 2013 such costs amounted to $267,587 or 36% of earned premium as compared with $311,385 or 33% in fiscal 2012. The decrease of $43,798 in expenses is attributable to costs associated to the decrease in gross premium written, while the increase as a percentage of earned premium for the current fiscal year is due to FSC's increased cost of ceded premiums required in the Reinsurance contract, without a corresponding increase in the premiums written.
General and administrative expenses for fiscal 2013 were $1,330,234 as compared with $1,284,341 for fiscal 2012, representing an increase of $45,893 and are comprised of the following:
Salaries and related costs $ 710,376 $ 642,539 $ 67,837 General office expense 108,257 111,816 (3,559) Legal and other professional fees 125,672 156,460 (30,788) Audit, accounting and related services 133,109 136,687 (3,578) Travel, meals and entertainment 83,483 85,006 (1,523) Other general and administrative 169,337 151,833 17,504 ------------- ------------ ------------- Total general and administrative $ 1,330,234 $ 1,284,341 $ 45,893 ============= ============ =============
Salaries and related costs, net of deferred internal policy acquisition costs, increased $67,837 and are comprised of the following:
Total salaries and related costs $ 710,376 $ 642,539 $ 67,837 ============= ============= =============
Legal and professional fees decreased compared to the prior year. In 2012 the Company incurred $27,500 in costs associated with the due diligence performed by third parties for the benefit of potential investors as well as costs associated with a statutory examination of its insurance subsidiary by the West Virginia Insurance Commission in that year. Costs related to the Company's on-going efforts to obtain financing necessary to expand the Company's business and penetrate new markets decreased in 2013, offset by increases in general corporate services, resulting primarily from increased legal and consulting expenses affecting the insurance subsidiary.
During the year ended May 31, 2012, the Company removed certain dormant accounts payable in the aggregate amount of $150,604 based on the vendor no longer requiring payment on a portion of the balance owed.
Interest expense for fiscal 2013 was $1,073,338 compared to $905,601 in fiscal 2012. Components of interest expense are comprised of the following:
Year Ended May 31, 2013 2012 ----------------- ---------------- Accrued dividends - mandatorily redeemable preferred stock $ 74,774 $ 113,726 Accrued dividends - equity preferred stock 915,335 847,833 ----------------- ----------------
shares are a deduction from net income in the amounts of $57,855 and $14,069, for the years ended May 31, 2013 and 2012, and not included in the table above. Series C equity stock is not mandatorily redeemable and does not accrete.
Schedule I - Summary of Investments - Other than Investments in Related Parties
We have audited the accompanying consolidated balance sheet of Jacobs Financial Group, Inc. and subsidiaries (the "Company") as of May 31, 2013, and the related consolidated statements of operations, comprehensive loss, cash flows, and Series A redeemable preferred stock and stockholders' deficit for the year then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
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.
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, is in default with respect to certain loan and preferred stock agreements and has suffered recurring losses from operations. 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 consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
MALIN, BERGQUIST & COMPANY, LLP CERTIFIED PUBLIC ACCOUNTANTS & BUSINESS ADVISORS
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note A to the financial statements, the Company's significant net working capital deficit and operating losses raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Management intends to improve cash flow through the implementation of its business plan. Additionally, management continues to seek to raise additional funds for operations through private placements of stock, other long-term or permanent financing, or short-term borrowings. However, the Company cannot be certain that it will be able to continue to obtain adequate funding in order to reasonably predict whether it will be able to continue as a going concern. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Management has determined it may dispose of securities prior to their scheduled maturity due to changes in interest rates, prepayments, tax and credit considerations, liquidity or regulatory capital requirements, or other similar factors. As a result, the Company classifies all of its fixed income securities (bonds) and equity securities as available-for-sale. These securities are reported at fair value, with unrealized gains and losses, net of deferred income taxes, reported in stockholders' equity as a separate component of accumulated other comprehensive income.
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 cost 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 majority of the Company's fee revenue is generated by services provided to companies and individuals throughout the Eastern United States. Management evaluates the need for a reserve for the amount of these receivables that may be uncollectible, based on historical collection activity adjusted for current conditions. Premium and other receivables are charged-off when deemed uncollectible. Based on this evaluation, management believes that substantially all accounts receivable are collectible, and therefore has not established an allowance for estimated uncollectible accounts.
The fair value of stock options is estimated at the grant date using the Black Scholes Option Pricing Model. This model requires the input of a number of assumptions, including expected volatility and dividend yields, expected stock price, risk-free interest rates, and an expected life of the options. Although the assumptions used reflect management's best estimate, they involve inherent uncertainties based on market conditions generally outside the control of the Company.
The Company currently has net operating loss ("NOL") carry-forwards that can be utilized to offset future income for federal and state tax purposes. These NOLs generate a significant deferred tax asset. However, the Company has recorded a valuation allowance against this deferred tax asset as it has determined that it is more likely than not that it will not be able to fully utilize the NOLs. Should assumptions regarding the utilization of these NOLs change, the Company may reduce some or all of this valuation allowance, which would result in the recording of a deferred income tax benefit.
The Company prescribes a more-likely-than-not measurement methodology to reflect the financial statement impact of uncertain tax positions taken or expected to be taken in a tax return. If taxing authorities were to disallow any tax positions taken by the Company, the additional income taxes, if any, would be imposed on the stockholders rather than the Company.
In December 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2011-11 (ASU 2011-11), DISCLOSURES ABOUT OFFSETTING ASSETS AND LIABILITIES. The amendments in this Update will enhance disclosures required by U.S. GAAP by requiring improved information about financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The amendments are effective for fiscal years beginning after January 1, 2013 and for interim periods within those fiscal years. The amendments of ASU 2011-11 did not have a material impact on the Company's consolidated financial statements.
In February 2013, the FASB issued Accounting Standards Update 2013-02 (ASU 2013-02), REPORTING OF AMOUNTS RECLASSIFIED OUT OF ACCUMULATED OTHER COMPREHENSIVE INCOME. The objective of this Update is to improve the reporting of reclassifications out of accumulated other comprehensive income. The amendments in this Update seek to attain that objective by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments are effective prospectively for annual reporting periods beginning after December 15, 2012 and interim periods within those annual periods. The amendments of ASU 2013-02 did not have a material impact on the Company's consolidated financial statements.
The Company held the following investments, by security type, that were classified as available-for-sale and carried at fair value at May 31, 2012:
The Company had no assets or liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at either May 31, 2013 or at May 31, 2012.
At May 31, 2013, the Company's insurance subsidiary had securities and short term investment with a fair value of $1,068,225 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 $7,495,538 and $7,833,825 as of May 31, 2013 and 2012, respectively, are restricted to the use of FSC.
Principal repayments on U.S. government agency mortgage-backed securities held by the Company as of May 31, 2013 are estimated as follows:
2013 2012 ------------------- --------------------- Bonds - fixed maturities $ 85,761 $ 76,424 Mortgage-backed securities 117,696 190,949 Equity investments 15,929 11,960 Short-term investments 88 77 Other investment income 20,175 - ------------------- --------------------- Total investment income 239,649 279,410 ------------------- --------------------- Investment expense 9,276 - ------------------- --------------------- Net investment income $ 230,373 $ 279,410 =================== =====================
Mortgage-backed securities 28,581 - (1,627) Equity securities 381,580 14,833 (5,054) Derivatives (equity securities) 72,967 27,695 (8,036) ------------ ----------- ------------ Total $ 1,970,739 $ 65,468 $ (22,229) ============ =========== ============ Bonds-fixed maturities $ 688,281 $ 26,439 $ -
Mortgage-backed securities 874,051 50,399 - Equity securities 112,876 2,168 (2,976) Derivatives (equity securities) 78,578 26,676 (9,327) ------------ ----------- ------------ Total $ 1,753,786 $ 105,682 $ (12,303) ============ =========== ============
As of May 31, 2013, the Company held five equity security investments with gross unrealized losses of $21,979, three of which has 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, 2013 and May 31, 2012 are $99,187 and $96,370 of prepaid expenses and deposits. The balance on May 31, 2013 includes an $80,000 deposit for legal fees.
Balance at end of year $ 1,207,903 $ 1,026,489 =============== =============
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 featured was analyzed and determined to be an embedded derivative, but the value was considered to be immaterial.
Date of Issuance Shares Issued -------------------- -------------- September 10, 2008 4,870,449 March 10, 2009 5,010,640 September 10, 2009 5,354,642 March 10, 2010 6,005,925 September 10, 2010 6,213,285 March 10, 2011 6,738,900 September 10, 2011 7,043,710 March 10, 2012 7,430,017 September 10, 2012 8,573,594 March 10, 2013 8,947,444 -------------- 66,188,606 ==============
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. The original repayment schedule called for quarterly payments of $224,515. The Holders agreed that under the forbearance the Company may satisfy its obligation by increasing the quarterly payments by $67,185, (to a total of $291,700) for eight consecutive quarters beginning September 10, 2009 to satisfy the arrearage. In addition, the interest rate was increased to 17.00%. Although the Company failed to make the payment that was due September 10, 2009 and the payments that were due in the ensuing quarters,
As of May 31, 2013, the Company had accrued and withheld approximately $319,000 in Federal payroll taxes and approximately $45,000 in estimated penalties and interest, which are reflected in the financial statements as other liabilities. Subsequent to the year ended May 31, 2013, the Company satisfied its obligation to the IRS in full.
On December 30, 2005, through a private placement, the Company issued 350 shares of 4% Non-Voting Series A Preferred Stock (Series A Preferred Stock), along with 1,050,000 warrants for common shares of Company stock as additional consideration, for a cash investment in the amount of $350,000, in connection with the Company's acquisition of FSC. Holders of Series A Preferred Stock are entitled to participate in FSC's partially collateralized bonding programs, subject to continuing satisfaction of underwriting criteria, based upon the bonding capacity of FSC attributable to capital reserves of FSC established with the subscription proceeds (i.e., bonding capacity equal to ten times subscription proceeds) and for so long as the subscriber holds the Series A shares. Holders of the Series A Preferred Stock are entitled to receive, when and as declared by the board of directors, cumulative preferential cash dividends at a rate of four percent of the $1,000 liquidation preference per annum (equivalent to a fixed annual rate of $40 per share). The Series A Preferred Stock ranks senior to the Company's common stock and pari passu with the Company's Series B Preferred and Series C Preferred Stock with respect to dividend rights and rights upon liquidation, dissolution or winding up of the Company. The holder may redeem the Series A Preferred Stock on or after the seventh anniversary of the Issue Date, if the holder provides a written statement to the Company that it will no longer require surety bonds issued by the Company's insurance subsidiary (FSC) under its partially collateralized bonding programs and, if no such surety bonds are then outstanding, the Company, at the option of the holder, will redeem all or any portion of the Series A Preferred Stock of such holder at a price per share equal to the Series A Preferred Stock Issue Price plus all accrued and unpaid dividends with respect to the shares of the Series A Preferred Stock of such holder to be redeemed. The conditional redemption shall not be available to any holder of Series A Preferred Stock for so long as surety bonds of the Company's insurance subsidiary issued on a partially collateralized basis remain outstanding for the benefit of such holder, and upon redemption, such holder shall no longer be eligible to participate in the partially collateralized bonding programs of the insurance subsidiary. The Company is authorized to issue up to 1,000,000 shares of the Series A Preferred Stock. As of May 31, 2013, the Company has issued 2,675 shares of Series A Preferred Stock in exchange for cash investments in the amount of $2,675,000, of which no shares were issued in fiscal 2013 or 2012.
The Company's outstanding Series A Preferred stock matures on the seventh anniversary of the issuance date and thereafter holders of the Series A Stock are eligible to request that the Company redeem their Series A Shares. As of May 31, 2013, the Company has received requests for redemption of 100 shares of Series A Preferred. The aggregate amount to which the holders requesting redemption are entitled as of May 31, 2013, is $1,482,718.
Under the terms of the Series B 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 B Stock are sufficient to redeem the total number of shares of Series B 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 B 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 B Stock to be redeemed shall be increased by 2% of the Series B Face Amount, with the amount of such increase (I.E., 2% of the Series B 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 B 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 B 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 B 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 B Stock subject to redemption in accordance herewith. Until the Redemption Price for each share of Series B Stock elected to be redeemed shall have been paid in full, such share of Series B 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 Board of Directors determined based on the criteria established under the terms of the Series B Preferred Stock that there were insufficient funds available for the redemption of Series B Stock.
1. Designation. The shares of such series of Preferred Stock are designated "Series C Preferred Stock" (referred to herein as the "SERIES C STOCK"). The date on which the first share of Series C Stock is issued shall hereinafter be referred to as the "ORIGINAL ISSUE DATE".
3. Ranking. The Series C Stock ranks, (a) as to dividends and upon Liquidation senior and prior to the Common Stock and all other equity securities to which the Series C ranks prior, with respect to dividends and upon Liquidation (collectively, "JUNIOR SECURITIES"), (b) pari passu with the Corporation's Series A Preferred Stock, par value $0.0001 per share (the "SERIES A STOCK"), the Corporation's Series B Stock, and any other series of Preferred Stock subsequently established by the Board with equal ranking (any such other series of Preferred Stock, together with the Series C Stock, the Series B Stock and Series A Stock are collectively referred to as the "EQUAL RANKING PREFERRED") and (c) junior to any other series of Preferred Stock subsequently established by the Board with senior ranking.
4. Dividends. (a) DIVIDEND ACCRUAL AND PAYMENT. The holders of the Series C Stock shall be entitled to receive, in preference to the holders of Junior Securities, dividends ("DIVIDENDS") on each outstanding share of Series C Stock at the rate of 8% per annum of the sum of (i) the Series C Face Amount plus (ii) an amount equal to any accrued, but unpaid, dividends on such Series C Stock, including for this purpose the exchanged Series B Amount outstanding with respect to such Series C Stock. For purposes hereof, the "SERIES B AMOUNT" means an amount equal to the dividend that would have accrued on such Series C Stock held by such holder from and after the Series B Original Issue Date applicable to such share of Series C Stock, through the Original Issue Date as if such Series C Stock had been issued on such Series B Original Issue Date, less all amounts thereof distributed by the Corporation with respect to such Series C Stock. Dividends shall be payable quarterly in arrears on each January 1, April 1, July 1 and October 1 following the Original Issue Date, or, if any such date is a Saturday, Sunday or legal holiday, then on the next day which is not a Saturday, Sunday or legal holiday (each a "DIVIDEND PAYMENT DATE"), as declared by the Board and, if not paid on the Dividend Payment Date, shall accrue. Amounts available for payment of Dividends (including for
this purpose the Series 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.
Holders of over 70% of the outstanding Series B Preferred Shares elected to participate in the recapitalization. The shares of Series B Preferred Shareholders that chose not to convert are listed in the Liabilities section of the Balance Sheet, and therefore the accretion and dividends associated with the Series B stock after November 30, 2009 are deductions from net income. Dividends on Series B mandatorily redeemable preferred stock deducted from net income amounted to $380,239 for the year ended May 31, 2013. The remaining Series B shares not converted were accreted from carrying value to the face amount for the 5 year period from the date of issuance. Series C stock has no accretion. There were no shares of Series B Stock surrendered or exchanged in the year ended May 31, 2013.
During the year ended May 31, 2012, two holders of Series A stock released all of their outstanding bonds held with FSC. These shares of Series A Preferred Shareholders are listed in the liability section of the Balance Sheet as of May 31, 2013, in the amount of $1,482,718, which consists of $1,126,000 face value of stock and $356,718 in dividends payable. The dividends associated with these shares of Series A stock for the year ended May 31, 2013, is a deduction from net income in the amount of $57,855. There was no accretion on these shares of Series A stock.
As of May 31, 2013 the Company has chosen to defer payment of dividends on Series A Preferred Stock with such accrued and unpaid dividends amounting to $724,048 through May 31, 2013.
As of May 31, 2013 the Company has chosen to defer payment of dividends on Series B and Series C Preferred Stock with such accrued and unpaid dividends amounting to $2,175,985 and $5,214,516 through May 31, 2013.
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.
386,667 warrants issued in connection with Series B Preferred Stock expired unexercised on the fifth anniversary at December 31, 2010; 600,000 warrants issued in connection with Series A Preferred Stock expired unexercised on the seventh anniversary at December 31, 2012.
The following table summarizes option activity under the Plan for the fiscal year ended May 31, 2013.
There were no options exercised in fiscal 2013 or 2012. The total fair value of shares vested amounted to approximately $9,000 in fiscal 2012. All shares were vested as of May 31, 2012.
compensation expense related to non-vested awards at May 31, 2013 or May 31, 2012 as all awards are fully vested.
In fiscal 2013, the Company issued 8,573,594 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 $.01874 per share based on the average quoted closing price of the Company's stock for the 20-day period proceeding the date of the transaction and totaled $160,669.
The Company's insurance subsidiary files calendar year financial statements prepared in accordance with statutory accounting practices prescribed or permitted by regulatory authorities. The principal
-------------------- ------------------------ ---------------- Statutory Surplus May 31, 2013 $5,804,785 -------------------- ------------------------ ---------------- Statutory Surplus May 31, 2012 6,075,541 ==================== ======================== ================ Net Income Calendar year 2012 350,214 -------------------- ------------------------ ---------------- Net Income Calendar year 2011 378,455 ==================== ======================== ================ Net Income Five-month period 2013 75,003 -------------------- ------------------------ ---------------- Net Income Five-month period 2012 167,043 -------------------- ------------------------ ----------------
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 does not exceed the lesser of 10% of the insurance subsidiary's (FSC's) surplus as regards to policyholders as of December 31st of the preceding year-end or net income from the insurance subsidiary's (FSC's) 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.
The Company leases certain office equipment with combined monthly payments of approximately $465 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 $3,844 each month.
Minimum future lease payments under non-cancelable operating leases having remaining terms in excess of one year as of May 31, 2013 are:
Fiscal year 2013-2014 $ 5,580 ----------------------- ----------- Fiscal year 2014-2015 5,580 ----------------------- ----------- Fiscal year 2015-2016 5,580 ----------------------- ----------- Total $ 16,740
INVESTMENT SECURITIES Fair values for investment securities (U.S. Government, government agencies, government agency mortgage-backed securities, state and municipal securities, and equity securities) held for investment purposes (available-for-sale) are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
The carrying values and fair values of the Company's financial instruments at May 31, 2013 and 2012 are as follows:
The Company's insurance subsidiary currently writes only the surety line of business, is licensed to write surety only in West Virginia and Ohio and has focused its primary efforts towards coal permit bonds. Such business, including investment advisory fees from managed collateral accounts, accounted for approximately 56% and 63% of the Company's fiscal 2013 and 2012 revenues, respectively. Furthermore, the Company provides surety bonds to companies that share common ownership
------------------------------- ---------------------- ---------------------- Investment Investment Surety Advisory Surety Advisory Premium Fees Premium Fees ------------------------------- ---------- ----------- ---------- ----------- Customer group # 1 $ 133,000 $ - $ 77,000 $ 2,900 ------------------------------- ---------- ----------- ---------- ----------- Customer group # 2 117,000 40,000 567,000 104,000 ------------------------------- ---------- ----------- ---------- ----------- Customer group # 3 242,000 3,000 195,000 3,000 ------------------------------- ---------- ----------- ---------- ----------- Customer group # 4 138,000 3,700 94,000 3,400 ------------------------------- ---------- ----------- ---------- ----------- TOTAL $ 630,000 $ 46,700 $ 933,000 $ 113,300 ------------------------------- ---------- ----------- ---------- -----------
IDENTIFIABLE ASSETS: Investment advisory $ 51,017 $ 60,932 Surety insurance 8,349,897 8,739,074 Corporate 83,219 88,433 --------------- --------------- Total assets $ 8,484,133 $ 8,888,439 =============== ===============
CAPITAL ACQUISITIONS: Investment advisory $ - $ - Surety insurance - - Corporate - - --------------- --------------- Total capital acquisitions $ - $ - =============== ===============
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 12% for both the 2013 and 2012 fiscal years.
During the years ended May 31, 2013 and May 31, 2012, a company owned by a board member provided consulting services. This company provided services totaling $62,100 and $62,100 in 2013 and 2012. Amounts owed to this company at year end are treated as related party payables in the amounts $124,409 and $109,309 at May 31, 2013 and 2012 respectively.
During the year ended May 31, 2009, the Company borrowed money from an individual that became a board member during 2010. On March 22, 2013 this individual resigned his duties as a board member. Total amounts owed to this individual at May 31, 2013 and May 31, 2012 consisted of $75,000 in demand notes and $360,000 in bridge financing.
companies. The Company cedes insurance to other companies and these reinsurance contracts do not relieve the Company from its obligations to policyholders.
Effective April 1, 2009, FSC entered into a reinsurance agreement with various syndicates at Lloyd's of London ("Reinsurer") for its coal reclamation surety bonding programs. The agreement has been renewed annually with the Reinsurer, with the most recent renewal effective July 1, 2012. The reinsurance agreement is an excess of loss contract which protects the Company against losses up to certain limits over stipulated amounts and can be terminated by either party by written notice of at least 90 days prior to any July 1. The contract calls for a premium rate of 35% subject to a minimum premium $490,000. Deposits are made to the reinsurers quarterly in arrears in equal amounts of $140,000. At May 31, 2013 and May 31, 2012, the Company had prepaid reinsurance premiums of $196,565 and $243,877 and ceded reinsurance deposited of $41,605 and $42,458.
On May 10, 2014, in accordance with the Bridge financing agreement, the Company became obligated to issue in the aggregate 9,630,856 shares of its common stock to the holders of such notes.
On October 1, 2013 the Company issued 1,463,551 Common shares representing the additional 2% stock dividend for the quarter ending September 30, 2013 to the holders of Series A and B Preferred shares that had requested to be redeemed upon maturity (see Note J).
On October 1, 2014 the Company issued 3,193,319 Common shares representing the additional 2% stock dividend for the quarter ending September 30, 2014 to the holders of Series A and B Preferred shares that had requested to be redeemed upon maturity (see Note J).
* Original cost of equity securities and, as to fixed maturities, original cost reduced by repayments and adjusted for amortization of premiums and accrual of discounts