During fiscal 2008, the Company has focused its primary efforts on the development and marketing of its surety business in West Virginia, arranging for strategic acquisitions to accelerate the progression of the Company's business plan, and raising additional capital to increase the capital base of FSC and facilitate entry into other state markets.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION AS OF AND FOR THE YEAR ENDED MAY 31, 2008
The Company experienced a loss of $3,332,942 (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) in fiscal 2008 as compared with a loss of $2,661,431 in fiscal 2007. While total revenues increased from approximately $823,000 in fiscal 2007 to approximately $957,000 in fiscal 2008, total expenses increased from approximately $2,042,000 in fiscal 2007 to approximately $2,465,000 in fiscal 2008, resulting in an increase in the loss from operations of approximately $289,000.
Accretion and accrued dividends on preferred stock increased from approximately $1,333,000 in fiscal 2007 to approximately $1,471,000 in fiscal 2008. This increase is attributable the accrual of dividends associated with the issuance of the Company's Series A preferred stock in connection with its partially collateralized bonding programs and the compounding of accrued dividends on previously accrued but unpaid dividends.
As an inducement to the initial preferred stock shareholders, warrants to purchase 45,402,996 shares of common stock at an exercise price of one-tenth of one cent ($.001) per share were issued with a five-year expiration period. Such warrants were valued at approximately $533,000 using the Black-Scholes pricing model. Additionally, the Series B preferred shares were issued at a twenty-five percent (25%) discount to the stated face value of $1,000 per share or
approximately $2,217,650 in total. Additional shares of the Series B were subsequently sold at a discount of approximately four and one-half percent (4.5%) or approximately $36,000. Accordingly, the recorded values of the Series A and B preferred stock are being increased to their stated liquidation values using the interest method over a period of five years and such amounts are categorized as accretion of mandatorily redeemable preferred stock in the consolidated statement of operations.
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. In the fiscal year ended May 31, 2007, proceeds from the sale of Series A preferred stock amounted to $318,000 of which $62,000 was used to redeem Series B preferred shares, $79,000 was retained for use in funding of on-going operations and $177,000 being down-streamed to FSC to increase its capital and surplus. Effective June1, 2007, the Company agreed to the request by the West Virginia Insurance Department to downstream all future proceeds from the sale Series A preferred stock in order to build capital and surplus reserves of the insurance subsidiary to more substantial levels. In fiscal 2008, proceeds from the sale of Series A preferred stock amounted to $803,000 that was contributed to the surplus and capital of FSC.
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 exercising its 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.
Beginning in September 2007, the Company secured loans totaling $2.5 million to provide interim bridge-financing until the Company was able to accomplish a larger, more permanent financing, and engaged an investment bank to serve as financial advisor to assist in accomplishing the larger financing. Additionally, the Company entered into letters of intent to acquire two additional companies, Unione Italiana Insurance Company ("Unione"), a New York domiciled insurance company with licenses in 24 states for a purchase price of $2.75 million plus the surplus of Unione; and Reclamation Surety Holding Company ("RSH") for a purchase price of $3.4 million, an acquisition that would provide marketing, underwriting and coal reclamation engineering capabilities. The proposed acquisitions, when coupled with the proposed financing, would provide the ability for the Company to enhance and accelerate its business plan. The Company's accomplishing the permanent financing and consummation of the acquisitions of Unione and RSH are mutually dependent and remain substantial contingencies.
The terms of the bridge-financing arrangement, as revised (See Note H to Financial Statements), provide for payment in full upon consummation by the Company of a qualified equity offering providing net proceeds of at least $15 million by September 10, 2013; and if such a qualified equity offering is not consummated by September 10, 2008, then accrued interest-to-date shall be payable, with quarterly installments of principal and interest based on a five-year term payout beginning in December 2008.
RESTRICTIONS ON USE OF ASSETS - ----------------------------- Regulatory approval of the acquisition of FSC by JFG was provided under the condition that no dividends or monies are to be paid to JFG from FSC without regulatory approval. Accordingly, cash, marketable investments, and other receivables held by FSC are restricted from use to fund operations or meet cash needs outside of the insurance company's domain. As of May 31, 2008, such assets amounted to approximately $5.14 million.
FSC is currently licensed to write coal permit and miscellaneous fixed-liability limit surety bonds in West Virginia (and Ohio effective August 5, 2008). Coal permit bonds are required by regulatory agencies to assure the reclamation of land that has been disturbed by mining operations, and accordingly, is a highly regulated process by federal and state agencies. Such bonds are generally long-term in nature with mining operations and reclamation work being conducted in unison as the property is mined. Additionally, no two principals and properties are alike due to varied company structures and unique geography and geology of each site.
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, the value of the collateral accounts held for the benefit of FSC, along with industry averages and historical experience. Management has estimated such losses based on industry experience, adjusted for factors that are unique to the Company's approach, and in consultation with consulting actuaries experienced in the surety field.
The Company has experienced operating losses of approximately $3,333,000 (after accretion of mandatorily redeemable convertible preferred stock, including
Expansion of FSC's business to other states is a key component to fully implementing the Company's business plan. However, management has found that entry into other states (as a surety) has been difficult without the benefit of more substantial capital and reserves due to FSC's status as new entry into this market. Management believes that if FSC's capital and surplus reserves were significantly more substantial, entry into other states would be less challenging. Accordingly, management continues to pursue avenues that can provide additional capital to increase the capacity of its insurance subsidiary and to fund continuing operations as the business is being fully developed.
REVENUES - -------- Revenues in fiscal 2008 amounted to $957,142 as compared with $823,339 in fiscal 2007. The increase in revenues is largely attributable to new business acquired by FSC and increased investment holdings of FSC.
increased by approximately $11,000 from the addition of new clients and were offset by a decrease of approximately $18,000 in advisory and distribution fees received from the Fund. The remaining decrease is attributable to fees received in fiscal year 2007 relating to other advisory services provided.
Additionally, in conjunction with the increased surety business written in fiscal 2008, proceeds amounting to $803,000 from the sale of Series A preferred stock, a requirement for issuing partially collateralized bonds, were contributed to the surplus and capital of FSC. FSC's investment holdings in fiscal 2008 averaged $4.553 million as compared with $3.837 for fiscal 2007 with investment yields remaining relatively unchanged at just below 5.00%. Net realized gains from investments resulted primarily from higher rate investment bonds with call features being called and redeemed prior to maturity.
EXPENSES - -------- 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 since its acquisition in December 2005. Incurred policy losses for fiscal 2008 have been recorded as $135,867 or 30.0% of earned premium as compared to $98,873 or 31.5% of earned premium for fiscal 2007. IBNR loss estimates have been based on industry averages adjusted for factors that are unique to the FSC's underwriting approach. FSC has experienced no claims for losses as of May 31, 2008.
General and administrative expenses for fiscal 2008 were $2,037,178 as compared with $1,641,237 for fiscal 2007, representing an increase of $395,941 and are comprised of the following:
Other less significant decreases were experienced in audit, travel and other general administrative expenses categories in fiscal 2008 as compared to fiscal 2007.
Jacobs & Co. is the investment advisor to the J&C Fund. While the Fund is responsible for its own operating expenses, Jacobs & Co., as the advisor, has agreed to limit the Fund's aggregate annual operating expenses to 2.00% of the average net assets. Under this expense limitation agreement, Jacobs & Co. absorbed $157,269 of the Fund's operating expenses in fiscal 2008 as compared to $181,612 in fiscal 2007. As the Fund grows in size (of assets under management), expenses (in excess of the 2% level) absorbed by Jacobs & Co. will decrease until the Fund reaches sufficient size to support its on-going operating costs. In contrast, as the Fund grows in size, revenues from investment advisory fees will increase. Additionally, should the Fund's operating expense ratio fall below the 2.00% level, the costs absorbed by the Company are now reimbursable to it for a period of up to three years. In fiscal 2008, the Fund's investment advisory and distribution fees amounted to $39,535 as compared to $58,055 in fiscal 2007. The Fund's average assets under management declined from approximately $4.68 million for fiscal 2007 to approximately $3.25 million for fiscal 2008. As of May 31, 2008, assets under management were approximately $2.5 million.
paid by a certain agreed-upon date. At the time of repayment, accrued interest on this obligation totaled $42,445, and accordingly, upon satisfaction of the debt in accordance with such agreement, a gain on the extinguishment of debt was recognized.
PREFERRED STOCK ACCRETION AND DIVIDENDS - --------------------------------------- Accretion of mandatorily redeemable convertible preferred stock is comprised of accretion of discount, accrued but unpaid dividends on preferred stock and amounts by which the redemption price exceeded the carrying value of redeemed shares of Series B preferred stock as follows: