During fiscal 2012, the Company has focused its primary efforts on the development and marketing of its surety business in West Virginia and Ohio, securing potential strategic relationships that will accelerate the progression of the Company's business plan and raising additional capital to increase the capital base of its insurance subsidiary, First Surety Corporation (FSC), to facilitate entry into other state markets.
RESULTS OF OPERATIONS AND FINANCIAL CONDITION AS OF AND FOR THE YEAR ENDED MAY 31, 2012
Total revenues increased from approximately $1,561,000 in fiscal 2011 to approximately $1,833,000 in fiscal 2012, while total operating expenses increased from approximately $1,583,000 in fiscal 2011 to approximately $1,817,000 in fiscal 2012. This resulted in net income from operations of approximately $16,000 in 2012 as compared with a loss from operations of approximately $22,000 in fiscal 2011, an improvement of approximately $38,000.
The Series A designation contains a conditional redemption feature providing for the redemption of the Series A shares at any time after the seventh (7th) anniversary of the Issue Date, provided that the principal no longer requires surety bonds issued by FSC. Surety bonds currently being issued by FSC are primarily for coal mining and reclamation permits, which are long-term in nature and continually evolving whereby outstanding bonds are periodically released as properties are mined and reclaimed and new bonds issued for properties to be mined in the future. Accordingly, this source of financing was designed to be long-term by nature.
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 this report, the Company has received requests for redemption of 2,141.341 shares of Series B Preferred. The aggregate redemption amount to which the holders are entitled as of June 30, 2012, is $3,713,966.
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 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 of 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.
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. Warrants issued to Series A Preferred holders have a seven year expiration; warrants issued to Series B Preferred holders had a five-year expiration period. Such warrants were valued at approximately $533,000 using the Black-Scholes pricing model. 386,667 warrants issued in connection with Series B Preferred Stock expired unexercised on December 31, 2010, while 600,000 warrants issued in connection with Series A Preferred Stock remain outstanding with an expiration date of December 31, 2012.
The Company experienced a loss after accretion of mandatorily redeemable convertible preferred stock, and accrued dividends on mandatorily redeemable preferred stock of $1,219,559 in fiscal 2012 as compared with a loss after accretion of mandatorily redeemable convertible preferred stock, and accrued dividends on mandatorily redeemable preferred stock of $1,440,090 in fiscal 2011.
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 6,804.936 Series B Shares Preferred for a combination of Series C Preferred Shares and Common Stock Shares. For each Series B Preferred Share, the participating holder received (i) one Series C Preferred Share and (ii) 2,000 shares of JFG Common Stock. The accumulated dividend rights and preferences associated with the Series B Preferred Shares transferred undiminished to the corresponding Series C Preferred Shares. This exchange amounted to $6,269,051 of carrying value of Series B Preferred stock being exchanged for Series C Preferred and Common Stock. 13,609,872 shares of Common Stock were issued to the Series C Preferred Stock holders at the rate of 2,000 Common shares for each exchanged Series B Preferred Stock, with the related cost associated with the Common issuance offsetting the Series C Preferred carrying value by $265,120. The shares were valued at approximately $.01948 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. Series C Preferred stock may be redeemed by the Company but does not have a fixed maturity date and is considered permanent equity. Holders of over 70% of the
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 $847,833 in fiscal 2012 as compared with a charge to common stockholders' equity of $781,062 in fiscal 2011.
During the year ended May 31, 2012, two holders of Series A Preferred stock released all of their outstanding bonds held with FSC. The carrying value of these shares of Series A Preferred Shareholders are listed in the Liability section of the Balance Sheet, and therefore the dividends associated with these shares of Series A Preferred stock after February 29, 2012 is a deduction from net income. The carrying value of the Series B Preferred Shares that did not convert are listed in the Liabilities section of the Balance Sheet, and therefore the accretion and dividends associated with the Series B Preferred stock after November 30, 2009 are deductions from net income. Series C Preferred stock has no accretion. The recorded values of the Series A preferred stock was increased to their stated liquidation values using the interest method over a period of five years and such amounts were categorized as accretion of mandatorily redeemable preferred stock in the consolidated statement of operations. This accretion was concluded in December 2010.
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. To date, the proposed financing has not closed, and the Company has been unable to remit the partial payment. 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 acknowledge that the effectiveness of certain of the rights and remedies provided by such agreement may be subject to prior approval by the Office of the Commissioner of Insurance for the State of West Virginia. To date, none of the bridge lenders has elected to pursue legal remedies under the Promissory Notes or the August 2012 Pledge.
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. On May 26, 2012, all conditions imposed by the Consent Order were terminated by the Commissioner of Insurance. Accordingly, the payment of ordinary dividends is no longer restricted but cash, marketable investments, and other receivables held by FSC are restricted from the Company's use to fund operations or meet cash needs outside of the insurance company's domain. As of May 31, 2012, such assets amounted to approximately $7.83 million.
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 industry experience, adjusted for factors that are unique to the Company's approach, and in consultation with consulting actuaries experienced in the surety field.
dividends on mandatorily redeemable preferred stock are taken into account, to losses of approximately $1,219,559 and $1,440,000 for the years ended May 31, 2012 and 2011. Despite increased revenue and the income from operations, the Company has not been able to pay certain amounts due to professionals and others and continues to be unable to pay its preferred stock dividend obligation and to cure its defaults in certain quarterly payments due its bridge-financing lenders. A substantial portion of the Company's cash flow is generated by its insurance subsidiary and is subject to certain withdrawal restrictions. While management expects revenue growth and cash flow to increase significantly as its business plan is fully implemented, it is anticipated that losses will continue and the Company will be cash constrained until FSC is able to develop a substantial book of business.
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
The Company experienced income from operations of approximately $16,000 in 2012 as compared with a loss from operations of $22,000 in fiscal 2011, an improvement of approximately $38,000. After accretion of mandatorily redeemable convertible preferred stock, and accrued dividends on mandatorily redeemable preferred stock, the Company experienced a loss of $1,219,559 in fiscal 2012 as compared with a loss after accretion of mandatorily redeemable convertible preferred stock, and accrued dividends on mandatorily redeemable preferred stock of $1,440,090 in fiscal 2011.
Revenues increased 17% in fiscal 2012, $1,833,194 as compared with $1,561,475 in fiscal 2011. The increase is largely attributable to the continued growth of the surety business of FSC and the receipt of a cumulative No Claims Bonus from its reinsurers for the years ended June 30, 2010 and June 30, 2011.
Revenue from the investment management segment, net of advisory referral fees, declined 9% with fiscal 2012 reporting $242,472 as compared to $266,963 in fiscal 2011, a decrease of $24,491. Investment advisory fees are based on the market value of assets under management and some fluctuation will occur due to overall market conditions. Generally such revenues will remain relatively constant from year to year with large fluctuations attributable to the growth or loss of assets under management.
FSC's investment holdings in fiscal 2012 averaged $7.749 million as compared with $7.192 million for fiscal 2011, with investment yields increasing slightly from 3.57% to 3.58%. In addition, the amortization of premium for larger than usual principal payments on mortgage backed securities during fiscal 2011 resulted in decreased investment income for that year.
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 2012 have been recorded as $210,977 or 22% of earned premium as compared to $204,323 or 22% of earned premium for fiscal 2011. 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, 2012 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.
The increase in salaries is attributable to increased salaries for certain employees. The increase in commissions is attributable to the Company's commission structure that pays a larger sales commission on the origination of a policy but a reduced percentage for subsequent policy renewals. The decrease in stock option expense is attributable to completion of vesting of stock options awarded on June 30, 2009. The increase in fringe benefits is attributable to increased cost of health insurance.
Legal and professional fees increased due to costs related to the Company's on-going efforts to obtain financing necessary to expand the Company's business and penetrate new markets. In the year ended May 31, 2012, the Company incurred $27,500 in costs associated with the due diligence performed by third parties for the benefit of potential investors. These costs, as well as increased costs in coal reclamation consulting, offset the reduction in costs incurred in the previous year from the triennial SEC examination of its investment advisor subsidiary.
The decrease in the expense of common shares issued (or to be issued) for fiscal year 2012 as compared to fiscal year 2011 was attributable to the Company's slightly lower average stock price. Interest expense on demand and term notes increased due to increased interest rates on some new borrowings taken during the current year. Other finance charges in the prior year period reflected incentive fees paid to a note holder to obtain borrowings and the recording of additional interest on the settlement of an obligation with the IRS.
The Series B class of stock became treated as a liability effective November 30, 2009 when the majority was exchanged for Series C equity stock. Therefore, accretion of $251 and dividends of $352,271 associated with the Series B after that date are deductions from net income and not included in the table above. The decrease in accretion of discount on Series A Preferred stock results from completion in December 2010 of the final month's accretion of discount on Series A Preferred stock. During the year ended May 31, 2012, two holders of Series A stock released all of their outstanding bonds held with FSC. Therefore these shares of Series A Preferred Shareholders are listed in the liability section of the Balance Sheet and the dividends after February 29, 2012 associated with these shares are a deduction from net income in the amount of $14,069. Series C equity stock is not mandatorily redeemable and does not accrete.