Through its wholly-owned subsidiary, Crystal Mountain Water, Inc. ("CMW"), the Company has an undeveloped leasehold interest in a mineral water spring located near Hot Springs, Arkansas. Under this leasehold arrangement, CMW is obligated for minimum lease payments in the amount of approximately $180 per month with automatic options to extend the leasehold through October 2026. CMW has the right to cancel the lease upon sixty (60) days written notice at any time. The property is presently not being actively explored or developed. During the 2002 fiscal year, management evaluated the lease and determined the development was not currently feasible. Accordingly, the Company recorded an impairment of $116,661 to its investment in the lease. Opportunities will continue to be explored as they arise with respect to the development or sale of the leasehold interest.
The Company experienced a loss (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) of $3,057,687 in fiscal 2009 as compared with a loss (after accretion of mandatorily redeemable convertible preferred stock, including accrued dividends) of $3,332,942 in fiscal 2008. While total revenues increased from approximately $957,000 in fiscal 2008 to approximately $1,194,000 in fiscal 2009, total expenses decreased from approximately $2,465,000 in fiscal 2008 to approximately $2,039,000 in fiscal 2009, resulting in a decrease in the loss from operations of approximately $663,000.
Accretion and accrued dividends on preferred stock increased from approximately $1,471,000 in fiscal 2008 to approximately $1,609,000 in fiscal 2009. 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.
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. Effective June 1, 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.
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 fiscal 2008 and completed during the first quarter of fiscal 2009, the Company obtained two rounds of bridge financing totaling an aggregate of $3,500,000. The purpose of the financing was to pay expenses of operations and to pay fees and expenses incurred or expected to be incurred in connection with a larger permanent financing and, in addition, to increase the capital surplus of FSC to make possible the reactivation of FSC's surety license in the state of Ohio. The terms of the bridge-financing arrangement provide for payment in full upon consummation by the Company of a qualified equity offering providing net proceeds of at least $15 million on or before September 10, 2013; and because such a qualified equity offering was not consummated by September 10, 2008, accrued interest-to-date was payable, and quarterly installments of principal and interest became payable over five years commencing in December 2008. The interest rates on such notes are fixed at 10.00%. Payments due December 2008 and March 2009 were not made by the Company as scheduled, but an agreement was subsequently entered into with the bridge lenders on June 5, 2009, modifying payment terms to cure the default and pledging the stock of the Company's subsidiary, CMW, as security for repayment of the loans.
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, 2009, such assets amounted to approximately $6.78 million.
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, 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 is considering a recapitalization. The goal of any such recapitalization will be to stabilize the financial position of the Company, which management believes will improve the Company's prospects for a relationship with potential capital sources, assist FSC as it applies to enter other state markets and be an impetus to the growth of the Company's business. Any such recapitalization is expected
to involve the voluntary participation of the holders of Series B Preferred Stock, and no assurance can be given that a recapitalization will be accomplished.
Revenues in fiscal 2009 amounted to $1,194,077 as compared with $957,142 in fiscal 2008. The increase in revenues is largely attributable to new business acquired by FSC and increased investment holdings of FSC.
Premiums and commissions $ 660,222 $ 465,286 Net investment income 288,747 225,461 Net realized investment gains 8,098 3,589 --------------- --------------
The increase in revenues reflected above is attributable to increased surety business that has been secured in fiscal 2009. However, net premium written (written premium less deductions for ceded reinsurance) in fiscal 2009 amounted to $813,345 as compared with $586,498 in fiscal 2008, and is more reflective of the growth experienced in this segment of the business for the comparable periods. Commission income earned for the placement of bonds with outside insurers has remained relatively stagnant.
General and administrative expenses for fiscal 2009 were $1,564,224 as compared with $2,037,178 for fiscal 2008, representing a decrease of $472,954 and are comprised of the following:
In fiscal 2009, legal and professional fees of approximately $486,900 included approximately $305,500 relating to the Company's on-going efforts to raise additional capital for the expansion of the surety business into other states.
Other less significant increases and decreases were experienced in audit, travel and other general administrative expenses categories in fiscal 2009 as compared to fiscal 2008.
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 $122,758 of the Fund's operating expenses in fiscal 2009 as compared to $157,269 in fiscal 2008. 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 reimbursable to it for a period of up to three years. In fiscal 2009, the Fund's investment advisory and distribution fee revenue amounted to $24,143 as compared to $39,535 in fiscal 2008. The Fund's average assets under management declined from approximately $3.25 million in fiscal 2008 to approximately $1.95 million in fiscal 2009. As of May 31, 2009, assets under management were approximately $1.81 million.
The Company had been delinquent in paying certain of its payroll tax obligations for periods ending on or before December 31, 2005. In fiscal 2008, the Company entered into negotiations for the repayment and settlement of this obligation with the Internal Revenue Service. In conjunction with such negotiations, the Company made payments of approximately $402,000 towards the tax and interest portion of this obligation and requested abatement of all penalties relating to this matter. In February 2008, the Company received notification from the Internal Revenue Service granting its request for abatement of penalty with respect to this matter. Accordingly, the Company recognized a gain of $115,470 upon final settlement of this matter.
Interest expense for fiscal 2009 was $605,045 as compared with $479,295 in fiscal 2008. The increase in interest expense is primarily attributable to the additional borrowings under the bridge-financing arrangement undertaken by the Company beginning in September 2007. Components of interest expense are comprised of the following:
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:
Year Ended May 31, 2009 2008 ----------------- ---------------- Accretion of discount $ 567,811 $ 529,273 Accrued dividends 1,041,499 942,044 Excess redemption price - - ----------------- ----------------