MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - --------------------------------------------------------------------------------
During fiscal 2010, the Company has focused its primary efforts on the development and marketing of its surety business in West Virginia and Ohio, arranging reinsurance and other 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.
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 (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) of $3,057,687 in fiscal 2009. While total revenues increased from approximately $1,194,000 in fiscal 2009 to approximately $1,372,000 in fiscal 2010, total operating expenses decreased from approximately $2,039,000 in fiscal 2009 to approximately $1,830,000 in fiscal 2010, resulting in a decrease in the loss from operations of approximately $386,000.
Interest expense increased from approximately $605,000 in fiscal 2009 to approximately $957,000 in fiscal 2010. This was mainly due to additional borrowings incurred in relation to the Company's efforts to raise additional capital financing and to provide financing of current operations, as well as the increased expense of common shares issued in connection with bridge loans and other financing arrangements, and the higher interest rate on bridge loans due to the forbearance agreement.
In the twelve-month period ending May 31, 2010, the Company, upon advice of legal counsel, removed certain dormant accounts payable in the aggregate amount of $200,240 based upon the conclusion that none of the accounts represented an obligation that is legally enforceable against the Company. Such removal was recorded as a gain on debt extinguishment.
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. Furthermore, once redeemed, the principal will no longer be eligible to participate in partially collateralized bonding programs offered 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.
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.
In November 2009, 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. 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 for a combination of Series C Shares and Common Stock Shares. For each Series B Share, the participating holder received (i) one Series C Share and (ii) 2,000 shares of JFG Common Stock. The accumulated dividend rights and preferences associated with the Series B Shares transferred undiminished to the corresponding Series C Shares. This exchange amounted to $6,269,051 of carrying value of Series B stock being exchanged for Series C and Common Stock. 13,609,872 shares of Common Stock were issued to the Series C Stock holders at the rate of 2,000 Common shares for each exchanged Series B Stock, with the related cost associated with the Common issuance offsetting the Series C 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 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 outstanding Series B Preferred Shares elected to participate in the recapitalization. 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 stock after November 30, 2009 are deductions from net income. The remaining Series B shares are continuing to be accreted from carrying value to the face amount for the 5 year period from the date of issuance. Series C stock has no accretion. The recorded values of the Series A preferred stock is 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.
payment of dividends to the holders of the Series A, B and C Preferred Shares until the Company has sufficient cash flow from operations to service the obligation.
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, 2010, such assets amounted to approximately $6.96 million.
Management believes the Company has the ability to hold all fixed income securities to maturity. However, during the current fiscal year, 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 reclassified 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.
In exchange for the purchase price of $2.9 million for the acquisition of FSC, the Company received cash and investments held by FSC totaling $2.75 million, with the difference being attributed to the property and casualty licenses of FSC in the states of West Virginia, Ohio and Indiana. Such licenses have indefinite lives and are evaluated annually for recoverability and impairment loss. Impairment loss, if any, is measured by estimating future cash flows
Reserves for unpaid losses and loss adjustment expenses of the insurance subsidiary are estimated using individual case-basis valuations in conjunction with estimates derived from industry and company experience. FSC has experienced no claims for losses as of May 31, 2010.
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.
expenses, 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, certain payroll taxes and withholdings from 2009, 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.
Revenues in fiscal 2010 amounted to $1,371,783 as compared with $1,194,077 in fiscal 2009. The increase in revenues is largely attributable to new business acquired by FSC and increased investment holdings of FSC and gains on sales of those investment holdings.
Salaries and related costs, net of deferred internal policy acquisition costs, increased approximately $160,104 and are comprised of the following:
Decreases in salaries and wages relate to decreased staff and lower salary for staff replaced during the last month of 2009. The increase in stock option expense is attributable to the awarding of 10,000,000 shares of incentive stock options on June 30, 2009. Group health benefits decreased slightly due to less employees being covered in 2010. Commissions increase due to a large number of new bonds being written in 2010.
The decrease in legal and professional fees of $315,343 is due to fewer resources expended in 2010 in the areas of acquisition and expansion.
Other less significant decreases were experienced in audit, travel and other general administrative expenses categories in fiscal 2010 as compared to fiscal 2009, also due to fewer resources expended in acquisition efforts.
Jacobs & Co. was the investment advisor to the Jacobs & Company Mutual Fund (the "Fund"). The Fund was initially established by Jacobs & Co. to provide the ability to manage smaller accounts in a more efficient and diversified manner and provide an investment vehicle that would fit within the Company's broader business plan of issuing smaller bonds under its collateralized surety programs. The delays incurred by the Company in accomplishing a financing that would make possible the full implementation of the Company's business plan coupled with the
During the year ended May 31, 2010, the Company, upon advice of legal counsel, removed certain dormant accounts payable in the aggregate amount of $200,240, based upon the conclusion that none of accounts represented an obligation that is legally enforceable against the Company. Such removal was recorded as a gain on debt extinguishment.
The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.