As the Registrant qualifies as a small reporting company as defined by ss.229.10(f)(1) of Regulation S-K, the Registrant is not required to provide the information required by this item.
In the twelve-month periods ending May 31, 2011 and May 31, 2010, the Company, upon advice of legal counsel, removed certain dormant accounts payable in the aggregate amount of $54,358 and $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.
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 of 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.
On March 8, 2011, 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 Preferred Stock.
Unlike the Series B Shares with their fixed maturity date, the Series C 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 Shares on the Company's balance sheet is to increase the aggregate claimbythe Series C 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 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 Shares are pari passu with the Series A Shares and Series
B 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 Shares while dividends are in arrears.
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. 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.
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 were fixed at 10.00%. Payments due December 2008 and March 2009 were not made by the Company as scheduled, but a forbearance
agreement was subsequently entered into with the bridge lenders on June 5, 2009, modifying payment terms to cure the default (including increasing the interest rate on the loans to 17%), issuing additional common stock to the loan holders, and pledging the stock of the Company's subsidiary, CMW, as security for repayment of the loans. The modification required the Company to pay interest of $224,515 on June 10, 2009 and increase the quarterly payments by $67,185 (to a total of $291,700) for eight consecutive quarters beginning September 10, 2009 to satisfy the arrearage. Although the Company has failed to make the payment that was due September 10, 2009 and the payments that were due in the ensuing quarters, management has remained in close contact with the bridge lenders, providing reports regarding its efforts to refinance or otherwise repay the bridge loans. To date, none of the bridge lenders has elected to pursue legal remedies.
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, 2011, such assets amounted to approximately $7.79 million.
Under the terms of its reinsurance treaty, the Company is entitled to a No Claims Bonus from the reinsurers for each claim year in which no claims are received. The bonus is 20% of the annual reinsurance premium and no claims have been made since the inception of the treaty.
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.
Expansion of FSC's business to other states is a key component to fully implementing the Company's business plan. In fiscal 2009, the Company was able to increase the capital of FSC and reactivate FSC's insurance license in Ohio and obtain authority to issue surety bonds in that state. 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 a recent entry into this market and the financial condition of the Company. This is the case notwithstanding the reinsurance agreement entered into by FSC with Lloyd's of London and the resulting increase in bonding capacity. Management believes that if FSC's capital and surplus reserves were significantly more substantial and the financial condition of the Company was stabilized, 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. In addition, as an alternative means of addressing access to markets, management is seeking to establish a relationship with any one of several possible sureties that are licensed in those states other than West Virginia and Ohio that comprise significant markets for the bonding programs of FSC and could issue surety bonds that are underwritten and reinsured by FSC. Under such a "fronting" arrangement, the need for additional capital at the level of FSC to facilitate entry to other state markets would become secondary, since the payment of a fronting fee to the insurance company with active licenses would provide access to the state market without formal entry.
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 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.
Through the sharing of resources (primarily personnel) to minimize operating costs, the Company and its subsidiaries attempt to minimize operating expenses and preserve resources. Although FSC is now cash flow positive, the use of its
assets and profits are restricted to its stand-alone operation by regulatory authority until its capital and surplus reserves reach more substantial levels. And while growth of the FSC business continues to provide additional cash flow to the Company's other subsidiaries, Jacobs & Company and Triangle Surety, it is anticipated that working capital deficiencies will continue and will need to be met either through the raising of additional capital or borrowings. However, there can be no assurance that additional capital (or debt financing) will be available when and to the extent required or, if available, on terms acceptable to the Company. Accordingly, concerns as to the Company's ability to continue as a going concern are substantial. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Revenues in fiscal 2011 amounted to $1,561,475 as compared with $1,371,783 in fiscal 2010. The increase in revenues is largely attributable to the continued growth of the surety business of FSC and the recognition of gains on the sale of investments held by the company.
Revenue from the investment management segment, net of advisory referral fees, was $266,963 in fiscal 2011 as compared with $262,635 in fiscal 2010, representing an increase of $4,328. As investment advisory fees are based on the market value of assets under management, some fluctuation will occur due to overall market conditions. For the most part, however, such revenues will remain relatively constant from year to year with any large fluctuations being attributable to the growth or loss of assets under management. The increase in revenues is primarily attributable to growth in individually managed funds.
Revenue from the surety insurance segment, consisting of FSC and TSA, was $1,275,319 for fiscal 2011 as compared with $1,095,213 for fiscal 2010. Revenues attributable to the insurance segment are as follows:
The increase in revenues reflected above is attributable to increased surety business that has been secured in fiscal 2011. Gross premium written in fiscal 2011 amounted to $1,613,912 as compared to $1,114,197 in fiscal 2010 and is 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.
FSC's investment holdings in fiscal 2011 averaged $7.192 million as compared with $6.553 million for fiscal 2010, with investment yields decreasing slightly from 4.1% to 3.57%. In addition, the amortization of premium for larger than usual principal payments on mortgage backed securities during fiscal 2011 resulted in decreased investment income.
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 2011 have been recorded as $204,323 or 22% of earned premium as compared to $178,531 or 23.2% of earned premium for fiscal 2010. 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, 2011 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.
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 2011 such costs amounted to $313,223 or 34.38% of earned premium as compared with $249,478 or 32.4% in fiscal 2010. The increase of $63,745 in expenses is attributable to costs associated to the increase in gross premium written, while the increase as a percentage is attributable to the increase specifically in new gross premiums written, which pay a higher commission than renewal premiums.
Salaries and related costs, net of deferred internal policy acquisition costs, decreased $227,500 and are comprised of the following:
The increase in salaries and taxes is attributable to year end bonuses paid to certain employees in December 2010 which were not paid in the previous year. The decrease 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 increased due to more employees being covered in 2011 and the rising cost of health isurance premiums. The increase in commissions is attributable to FSC's commission structure that pays a larger commission percentage on the origination of a policy but reduced for subsequent policy renewals.
During fiscal year 2010, the Company incurred costs in response to a triennial SEC examination of its investment advisor subsidiary as well as costs in response to a statutory examination of its insurance subsidiary, required by the West Virginia Insurance Commission. Despite these costs, legal and professional fees decreased due to the need for significantly less general corporate legal services and reduced costs related to the Company's pending acquisitions and on-going efforts to obtain financing necessary to expand the Company's business and penetrate new markets. General corporate services were reduced in fiscal 2011 due primarily to costs incurred in the recapitalization and exchange of Series B Preferred shares for Series C Preferred shares in fiscal 2010, as well as less review and assistance required in connection with the filing of the Company's annual and interim reports with the Securities and Exchange Commission.
Travel, meals and entertainment expense increased during fiscal 2011 due to expanded efforts by management obtain financing necessary to expand the Company's business and penetrate new markets
Other less significant increases and decreases were experienced in other general administrative expenses categories in fiscal 2011 as compared to fiscal 2010.
While the Fund was responsible for its own operating expenses, Jacobs & Co., as the investment advisor, had agreed to limit the Fund's aggregate annual operating expenses to 2% of the average net assets. Under this expense limitation agreement, Jacobs & Co. absorbed $75,038 of the Fund's operating expenses in 2010 as compared to having no revenue or expense attributable to the fund during fiscal 2011. The cumulative reimbursement due the Fund by J&C as of May 31, 2011 was $54,866.
During the years ended May 31, 2011 and May 31, 2010, the Company, upon advice of legal counsel, removed certain dormant accounts payable in the aggregate amounts of $54,358 and $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 decrease in the expense of common shares issued (or to be issued) for fiscal year 2010 as compared to fiscal year 2010 was largely attributable to the issuance of common stock on June 5, 2009 in relation to the agreement with the bridge loan holders. Interest expense on demand and term notes increased due to increased borrowings and other finance charges increased due to incentive fees paid to a note holder to obtain borrowings as well as interest paid upon the satisfaction of the payroll tax withholding liability with the U.S. Treasury.
Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Comprehensive Income (Loss) Consolidated Statements of Cash Flows Consolidated Statements of Mandatorily Redeemable Preferred Stock and Stockholders' Equity (Deficit) Notes to Consolidated Financial Statements