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 $170 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 increase in revenues is largely attributable to new business acquired by FSC and increased investment holdings of FSC. The increase in expenses is attributable to increased expense related to the growth in business within the insurance segment and increased general and administrative expense related to professional fees incurred in the Company's ongoing efforts to raise additional capital to expand its business.
Interest expense increased from approximately $153,000 in fiscal 2007 to approximately $479,000 in fiscal 2008 due to additional borrowings incurred to pay professional fees and expenses related to the Company's efforts to raise additional capital financing and to provide financing of current operations. Such increase was partially offset by the recognition of a gain of approximately $115,500 relating to the settlement of the Company's delinquent pre-2006 payroll tax obligations and largely represents the waiver of accrued penalties in connection with payment of the obligation in full.
In conjunction with the acquisition of FSC at December 31, 2005, a restructuring of the Company's financing was accomplished through the private placement of preferred stock and warrants to acquire common stock of the Company in exchange for cash totaling $3,335,000. $2,860,000 was used in the acquisition and funding of the insurance subsidiary, with the remaining funds used to pay expenses attributable to the acquisition and the funding of on-going operations. Additionally, approximately $3,668,000 of indebtedness of the Company was converted into preferred stock and warrants reducing the Company's borrowings under short-term financing arrangements to approximately $167,000 as of December 30, 2005.
BRIDGE-FINANCING, COMMITMENTS AND MATERIAL AGREEMENTS - ----------------------------------------------------- Of primary importance to the Company's ability to fully implement its business plan is the expansion of that business into additional states. Regulatory approval and licensing is required for each state where FSC seeks to conduct business. Management found entry into additional states (as a surety) was proving difficult without the benefit of more substantial capital and reserves due to FSC's status as new entry into this market. Accordingly, management began pursuing avenues that would provide additional capital to facilitate such expansion.
INTANGIBLE ASSETS - ----------------- 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 attributable to such assets based on forecasts and projections and comparing such discounted cash flow amounts to the carrying value of the asset. Should actual results differ from such forecasts and projections, such assets may be subject to future impairment charges.
RESERVE FOR LOSSES AND LOSS EXPENSES - ------------------------------------ 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, 2008.
In underwriting such bonds, management obtains estimates of costs to reclaim such 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.
accrued dividends) and $2,661,000 for the fiscal years ended May 31, 2008 and 2007, respectively. The Company continues to face significant working capital deficiencies and has not had adequate funds to pay its preferred stock dividend obligation. 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 until FSC is able to develop a substantial book of business.
Revenue from the investment management segment, net of advisory referral fees, was $262,806 in fiscal 2008 as compared with $275,328 in fiscal 2007, representing a decrease of $12,522. 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 decrease in revenues is primarily attributable to a decrease in advisory fees received from the J&C Fund resulting from a decline in assets under management. Investment advisory fees for management of individual and corporate investment accounts
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 2008 such costs amounted to $126,386 or 27.9% of earned premium as compared with $108,065 or 34.1% in fiscal 2007.
Salaries and related costs, net of deferred internal policy acquisition costs, decreased approximately $63,500 and are comprised of the following:
Increases in salaries and wages relate to increased sales staff, salary increases and year-end bonuses paid to non-executive employees. The increase in commissions and deferred policy acquisition costs is attributable to the increase in insurance business written in fiscal 2008 as compared to fiscal 2007. The decrease in stock option expense is attributable to non-uniform vesting schedules under which options vest for certain key employees. Group health benefits increased approximately $8,300 or 16.46% from the previous year, but were offset by a decrease in the Company's group life insurance cost of approximately $2,600. The increase in key-man life insurance is attributable to the increased debt the Company has incurred.
In fiscal 2008, legal and professional fees of approximately $804,500 included approximately $748,000 relating to the Company's on-going efforts to raise additional capital for the expansion of the surety business into other states. In fiscal 2007, legal and professional fees of approximately $306,000 included approximately $197,000 relating to the Company's on-going efforts to raise
additional capital for the expansion of the surety business into other states. Other legal and professional fees incurred in the respective years were for other corporate matters.
The Fund was initially established by Jacobs to provide the ability to manage funds for smaller accounts in a more efficient and diversified manner than could be achieved on an individual account basis. Additionally, the Fund provided an investment vehicle that would fit within the Company's broader business plan of issuing smaller bonds under its collateralized surety programs. While the Fund's lackluster performance has contributed to its gradual decline in size, and the maintenance of the Fund continues to be a significant cost to the Company, it remains a key component in the Company's broader business plan. Moreover, if successful in these broader efforts, the opportunity exists to significantly increase the assets under management within the Fund. Should the Company be successful in increasing the size of the Fund to such a level that the Fund's operating expense ratio falls below the 2.00% level, the costs absorbed by Jacobs & Co. are currently reimbursable to it for a period of up to three years. Management continually evaluates the cost/benefit of maintaining the Fund.
GAIN ON EXTINGUISHMENT OF DEBT - ------------------------------ 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.
In December 2006, the Company repaid an obligation to a creditor relating to professional fees incurred in the Company's 2002 fiscal year in connection with litigation resulting from a failed business combination transaction. Under the terms of an agreement reached in October 2006, the creditor agreed to waive payment of any accrued interest on the obligation provided the obligation was
INTEREST EXPENSE AND INTEREST INCOME - ------------------------------------ Interest expense for fiscal 2008 was $479,295 as compared with $153,020 in fiscal 2007. 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:
Interest income for fiscal 2008 was $10,137 as compared with $1,176 for fiscal 2007. Interest income for fiscal 2008 is primarily related to the investment of the unexpended proceeds from the bridge-financing arrangement in short-term investment accounts. Interest income for fiscal 2007 relates to interest earned on amounts due from a related party.
Year Ended May 31, 2008 2007 ----------------- ---------------- Accretion of discount $ 529,273 $ 494,651 Accrued dividends 942,044 827,797 Excess redemption price 10,717 - ----------------- ---------------- $1,471,317 $1,333,165 ================= ================