Through its wholly-owned subsidiary, 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 then 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.
During fiscal 2017, the Company has focused its primary efforts (i) on the development and marketing of its surety business in West Virginia and Ohio, (ii) securing potential strategic relationships that will accelerate the progression of the Company’s business plan, including by giving access to other state markets, (iii) strengthening its insurance subsidiary’s reserves for potential claims and (iv) raising additional capital to facilitate that subsidiary’s entry into other state markets.
Results of Operations and Financial Condition as of and for the Year Ended May 31, 2016
Total revenues increased from $1,336,000 in fiscal 2016 to $2,869,000 in fiscal 2017, while total operating expenses increased from $1,907,000 in fiscal 2016 to $2,362,000 in fiscal 2017. This resulted in net income from operations of $508,000 in 2017 as compared with a net loss from operations of $571,000 in fiscal 2016.
The increase in revenues is largely attributable to an increase in net investment income of approximately $709,000 in 2017, mainly due to the rebounding of a 2016 unrealized decline in market value of an investment account held as a result of a contractual arrangement, where the Company receives any appreciation and earning in excess of the initial deposit of collateral by the principal on a surety bond. The Company also realized gains of $138,000 on the sale of investments in 2017 compared to losses of $79,000 in 2016. Insurance premiums written for new and existing customers increased by approximately $762,000 in 2017, partially due to the recording of $329,000 in No Claims Bonus (recorded in 2017 for contract years 2015 and 2016) as part of the reinsurance contract. In addition, during 2016, the Company recognized other income of approximately $287,000 from the removal of dormant account payable balances and commissions no longer payable on receivables that were written off as uncollectible.
Interest expense decreased from $916,000 in fiscal 2016 to $575,000 in fiscal 2017, due to the discontinuance of the issuance of stock as consideration for the additional 2% dividend on Series A and B Preferred shares for those holders requesting to be redeemed, as well as an decrease in stock issued as incentive for lending and continuation of terms for previously lent funds.
During the year ending May 31, 2016, the Company recorded gains on extinguishment of debt in the amount of $1,919,532. These gains resulted from the waived interest and forgiven principal on notes payables occurring upon the settlement of the bridge loans in 2016.
During the year ending May 31, 2017, the Company recorded a settlement expense in the amount of $350,000 to be paid to a former employee as the result of a mediation.
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 350 shares of Series A Preferred
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 had 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 expired unexercised on 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 $1,357,656 in fiscal 2017 as compared to $108,386 in fiscal 2016.
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 6,805 Series B Preferred Shares 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 preceding 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 outstanding Series B Preferred Shares elected to participate in the recapitalization.
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
On August 5, 2015 the Company completed a $1,600,000 transaction which resulted in its acquisition of the remaining 49.3% ($1.725 million face amount) of the senior promissory notes of the $3.5 million financing dating from 2008, after waiving interest of approximately $1.8 million. Upon closing of the acquisition, the collateral securing the senior promissory notes, 1,000 shares (100%) of FSC and 1,000 shares (100%) of CMW, was released to the Company.
The transaction was funded through sale in a private offering of investment units (Units) that consisted of 5.00% of the outstanding shares of FSC and 500,000 common shares of the Company. $1,600,00 was raised through the sale of units in exchange for consideration that included a combination of the cash purchase of units, cancellation of indebtedness owed by the Company to the purchaser in exchange for units and loans to the Company by potential purchasers that are convertible into the purchase of Units. The Registrant’s Board of Directors has authorized the sale of Units, which, if completed, would include up to forty-nine percent (49%) of the outstanding stock of FSC.
bonds and of greater size for its coal reclamation bonding clients. Management expects this reinsurance arrangement to continue FSC’s expansion of market share and to result in increased cash flow for each of the Company’s operating subsidiaries.
Ceded reinsurance is treated as the risk and liability of the assuming companies. The Company cedes insurance to other companies but these reinsurance contracts do not relieve the Company from its obligations to policyholders. Ceded premiums, at a rate of 35% of written premium with a minimum of $490,000 (the newest contract effective March 1, 2017 ceded premium at a rate of 26.75% with a $842,610 minimum), are recognized as reductions in revenue ratably over the term of the related policies. Ceded unearned premiums represent the portion of ceded premiums written applicable to the unexpired terms of policies in force determined on a pro rata basis.
Under the terms of its reinsurance treaty, the Company is entitled to a No Claims Bonus from the reinsurers for each contract year in which no claims are received. The bonus is 20% of the contract year’s reinsurance premium. No claims had been made since the inception of the treaty that rose to the coverage level of the reinsurance agreement.
industry information but is largely dependent upon management’s experience and judgment since prior Company experience and industry data available are extremely limited.
Miscellaneous fixed-liability limit surety bonds are generally fully collateralized by the principal’s cash investment into a collateral investment account to mitigate FSC’s exposure to loss. Generally the collateral investment account is managed by the Company’s investment advisory subsidiary, Jacobs & Co. Losses can occur should the principal default on the performance required by the bond and the collateral in the investment account experiences deterioration in value.
Revenues increased 115% in fiscal 2017 to $2,869,316 as compared with $1,335,829 in fiscal 2016. The increase is largely attributable to the increase in net investment income of approximately $709,000, mainly due to the rebounding of a 2016 severe unrealized loss in market value of an investment account held as a result of a contractual arrangement, where the Company receives any appreciation and earning in excess of the initial deposit of collateral by the principal on a surety bond. The Company also realized gains of $138,000 on the sale of investments in 2017 compared to losses of $79,000 in 2016. Insurance premiums written for new and existing customers increased by approximately $762,000 in 2017.
In 2016 the Company recognized other income of approximately $287,000 from the removal of dormant accounts payable and commissions no longer payable on premium receivables that were written off as uncollectible. During 2017, the Company recognized approximately $109,000 in interest income on notes receivable issued during 2016, compared to approximately $81,000 in the previous year.
Revenue from the investment management segment, net of advisory referral fees, declined 25% with fiscal 2017 reporting $81,918 as compared to $109,194 in fiscal 2016. This decline in investment advisory fees related to the decrease in the market value of assets in portfolios under management. 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.
Revenue from the surety insurance segment, consisting of FSC and TSA, increased 204%, with $2,518,089 in fiscal 2017 as compared with $829,456 for the prior year. Revenues attributable to the insurance segment are as follows:
Premium revenue is recognized ratably over the term of the policy period and thus is relatively stable from period to period with fluctuations for comparable periods generally reflecting the overall growth or loss of business. Commission revenue, which is dependent on the timing of issuance or renewal of bonds, is expected to be more seasonal from quarter-to-quarter with fluctuations for comparable periods largely reflecting the overall growth or loss of business
December 31, 2015. However, during 2017, the claim, which was significantly less than the No Claim Bonus, was withdrawn in favor of receiving the applicable No Claims Bonus for the contract year ending December 31, 2015, in the amount of $106,578. The No Claims Bonus for the contract period ending March 31, 2017, in the amount of $222,470 was recorded on March 31, 2017 and this contract was commuted as well. The company also recorded a one-time additional other underwriting income premium of $80,000 from one client, associated with a special acceptance increasing certain reinsurance limits.
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. The Company reported $579,359 as IBNR for fiscal 2017, or 40% of earned premium (25% of gross earned premium before reinsurance), as compared to $179,334 or 18% of earned premium (13% of gross earned premium before reinsurance) for fiscal 2016. As an abundance of caution to reflect the change in FSC’s reinsurance treaty. with higher limits but increased underlying exposure, FSC increased the percentage of premium reserved for IBNR from 23% of earned premium to 26% for partially collateralized bonds beginning May 1, 2017. Due to overall concern for the coal industry brought about by substantial pricing competition from natural gas and resultant bankruptcies of publicly traded coal companies, FSC had previously agreed with its actuary and regulators to adjust the percentage of premium reserved for IBNR by increasing the reserve rate from 12% of earned premium for partially collateralized bonds to 23% beginning January 1, 2016. IBNR loss estimates have been based on actuarial recommendations and management’s judgment that are unique to the FSC’s underwriting approach. Prior to 2014, FSC had not received any claims for losses on any bonds underwritten since business began in 2006.
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 2017, such costs amounted to $590,260 or 40% of earned premium as compared with $284,127 or 29% in fiscal 2016.
The increase in commissions is partially attributable to FSC’s commission structure that pays a larger commission percentage on the origination of a policy but reduced for subsequent policy renewals, as well as to the timing of payment of commissions based upon collections. The increase in salaries and wages is attributable to the hiring of three new employees in June of 2016, and one additional employee in January of 2017. The increase in payroll taxes and fringe benefits is attributable to the additional employees and the increased cost of health insurance related to adding a new employees to the plan.
Other general and administrative expense decreased by approximately $121,000 in 2017 compared to the corresponding 2016 period. This decrease is mainly due to the Company’s writing off accounts receivable of approximately $55,000 in 2017 compared to $156,000 as uncollectible in
Interest expense for fiscal 2017 was $574,971 compared to $915,098 in fiscal 2016. Components of interest expense are comprised of the following:
Interest expense decreased from $915,098 in fiscal 2016 to $571,971 in fiscal 2017, attributable to several factors; i) interest expense on bridge financing decreased due to elimination of the debt in July 2015, ii) an adjustment in 2016 to correctly record as interest expense part of a mineral asset (land) sale transaction made in 2015 iii) deferral of the issuance of stock as 2% dividend on Series A and B Preferred shares that have requested to be redeemed. In addition, there was a decrease in the market value of common stock used to calculate the price of shares issued as incentive for lending in the year ended 2016, as well as a decrease in the amount of borrowings in 2017 and the interest associated with those borrowings.
Accretion of mandatorily redeemable convertible preferred stock is comprised of accretion of discount and accrued but unpaid dividends on preferred stock as follows:
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, for the year ended May 31, 2017, dividends of $522,099 associated with the Series B outstanding after that date are deductions from net income and not included in the table above. For the year ended May 31, 2016, dividends of
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.
Management believes that the Company’s successful restructuring of the $3.5 million Bridge debt has been a substantial positive that will permit its insurance subsidiary to raise significant capital and more fully execute its business plan within the next 12 months. Additional capital will permit FSC to apply for licensing in additional states targeted for our coal reclamation surety program, plus file for approval with the U.S. Treasury to provide bonds for projects on federal lands.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note A to the financial statements, the Company has insufficient liquidity, financial resources, is in default with certain loan and preferred stock agreements, and has suffered significant recurring operating losses. These conditions, among others, raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans regarding these matters are also discussed in Note A. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Jacobs Financial Group, Inc. (the “Company” or “JFG”), formerly NELX, Inc., was incorporated in Kansas on March 25, 1983. In 2001, the Company acquired all the outstanding stock of two corporations located in Charleston, West Virginia: Jacobs & Company (“Jacobs”) and FS Investments, Inc. (“FSI”). Jacobs is a registered investment advisory firm that derives its revenue from asset-based investment advisory fees. FSI, through its wholly-owned subsidiary Triangle Surety Agency, Inc. (“Triangle”), is engaged in the business of placing surety bonds with insurance companies for clients engaged in regulated industries, such as the extraction of coal, oil and gas. Triangle receives commission income from the placement of these bonds and is licensed in five states primarily in the eastern United States. On December 30, 2005, the Company acquired all of the outstanding stock of West Virginia Fire & Casualty Company (“WVFCC”), an insurance company licensed to engage in business in West Virginia, Ohio and Indiana. The acquisition of WVFCC consisted of the purchase of marketable investments and insurance licenses and did not include any existing policies or customer base as the insurance lines of business offered by WVFCC were not insurance lines that the Company intended to pursue. Following the acquisition, the name of WVFCC was changed to First Surety Corporation (“FSC”). FSC receives insurance premium income in connection with the issuance of surety bonds. The Company and its subsidiaries are subject to the business risks inherent in the financial services industry.
These consolidated financial statements are presented on the basis that the Company is a going concern. Going concern contemplates the realization of assets and the satisfaction of liabilities in the normal course of business over a reasonable length of time. Presently, the Company has insufficient liquidity, financial resources, is in default with certain loan and preferred stock agreements, and has suffered significant recurring losses from operations. Losses are expected to continue until the Company develops a more substantial book of business. While improvement is anticipated as the Company’s business plan is implemented, other conditions, such as restrictions on the use of FSC’s assets (See Note C), and the Company’s significant deficiency in working capital and stockholders’ equity raise substantial doubt about the Company’s ability to continue as a going concern.
Policy acquisition costs include costs that vary with and are primarily related to the acquisition of new business. Such costs generally include commissions, underwriting expenses, and premium taxes and are deferred and amortized over the period in which the related premiums are earned. The deferred policy acquisition cost assets are reviewed for recoverability based on the profitability of the underlying surety policy. Investment income is not considered in the determination of recoverability of deferred policy acquisition costs.
Debt and equity securities that are bought and held principally for sale in the near future are classified as trading securities and are carried at fair value, with changes in fair value being recorded in current operations. Short-term investments consist primarily of debt securities having maturities of one year or less at date of purchase, and other similar investments that have immediate availability.
Factors considered in identifying OTTI include: 1) for debt securities, whether the Company intends to sell the investment or whether it is more likely than not that the Company will be required to sell the security prior to the anticipated recovery in value; 2) the likelihood of the recoverability of principal and interest for debt securities (i.e., whether there is a credit loss) or cost for equity securities; 3) the length of time and extent to which the fair value has been less than amortized cost for debt securities or carrying value for equity securities; and 4) the financial condition, near-term and long-term prospects for the issuer, including the relevant industry conditions and trends, and implications of rating agency actions and offering prices.
Furniture and equipment is recorded at cost. Maintenance and repairs are charged to operations when incurred. When property and equipment are sold or disposed of, the asset account and related accumulated depreciation account are relieved, and any gain or loss is included in operations. The cost of property and equipment is depreciated over the estimated useful lives of the related assets, ranging from three to seven years, using the straight-line or double-declining balance methods, which approximates estimated economic depreciation.
Interest and penalties associated with tax positions are recorded in the period assessed as general and administrative expenses. However, no interest or penalties have been assessed as of May 31, 2017 or 2016.
On December 22, 2017, the U.S. Tax Cuts and Jobs Act (the “Tax Act”) was enacted. The Tax Act, among other things, reduces the U. S. federal income tax rate from 35 percent to 21 percent, effective January 1, 2018. The Company has made a reasonable estimate of the effects of the Tax Act on existing deferred tax balances. These amounts are provisional and subject to change. The most significant impact of the legislation for the Company was a $2,050,000 reduction of the value of the Company’s net deferred tax assets (which represent future tax benefits).
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-09 (ASU 2014-09), Revenue from Contracts with Customers. The guidance in this Update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The standard's core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance. This may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The Update will be effective for the Company’s fiscal 2019 annual and interim financial statements. Companies have the option of using either a full or modified retrospective approach in applying this standard. The Company is in the process of assessing the impact of ASU 2014-09. We anticipate the impact will be quantitatively immaterial to our consolidated financial statements as a whole and expect the timing of our revenues to remain the same.
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments-Overall (Subtopic 825-10)”, which updated the accounting guidance related to the recognition and measurement of financial assets and financial liabilities. The updated accounting guidance, among other things, requires that all nonconsolidated equity investments, except those accounted for under the equity method, be measured at fair value and that the changes in fair value be recognized in net income. The Update will be effective for the Company’s fiscal 2019 annual and interim financial statements. The updated accounting guidance requires, with certain exceptions, a cumulative effect adjustment to beginning retained earnings when the guidance is adopted. The Company is currently in the process of evaluating the impact of adoption of the new rules.
In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments”. The guidance is intended to reduce the diversity in practice as to how certain cash receipts and cash payments are presented and classified in the statement of cash flows by providing guidance for several specific cash flow issues. In addition, in November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”. The amendment requires that amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The Update will be effective for the Company’s fiscal 2020 annual financial statements and interim periods thereafter.
In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business”. The update provides that when substantially all the fair value of the assets acquired is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. The new rules will be effective for the Company’s fiscal 2021 financial statements and interim periods thereafter.
In February 2016, the FASB issued ASU 2016-02, which amends the FASB Accounting Standards Codification and creates Topic 842, “Leases.” The new topic supersedes Topic 840, “Leases,” and increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosures of key information about leasing arrangements. The guidance is effective for the Company’s fiscal 2020 financial statements. ASU 2016-02 mandates a modified retrospective transition method. The Company is currently assessing the impact this guidance will have on its financial statements.
The Company held the following investments, by 	security type, that have been 	classified as available-for-sale and carried at fair value at May 31, 2016:
The Company had no assets or liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at either May 31, 2017 or at May 31, 2016.
At May 31, 2016, the Company’s insurance subsidiary had securities and short-term investment with a fair value of $1,153,324 on deposit with the State insurance department to satisfy regulatory requirements.
Principal repayments on U.S. government agency mortgage-backed securities held by the Company as of May 31, 2017 are estimated as follows:
As of May 31, 2017, the Company held twenty-two mortgage-backed securities with gross unrealized losses of $11,064, six of which have been in a continuous loss position for more than 12 months. These securities consist of fixed-rate securities issued by Government National Mortgage Association (GNMA) that are sensitive to movements in market interest rates.
As of May 31, 2017, the Company held twenty-one equity security investments with gross unrealized losses of $146,775, seven of which have been in a continuous loss position for more than 12 months. These securities consist of common stock whose fair value is sensitive to movements in market interest rates.
Included in other assets as of May 31, 2017 and May 31, 2016 are $16,780 and $14,617 of prepaid expenses and deposits.
FSC maintains reinsurance agreements with various syndicates at Lloyd's of London. The reinsurance agreement is an excess of loss contract that protects FSC against losses up to certain limits over stipulated amounts. Each client’s cash is invested in investment collateral accounts managed by Jacobs utilizing investment strategies consistent with the state code governing investments of an insurance company.
Losses can occur if the costs of reclamation exceed estimates obtained at the time the bond was underwritten or upon subsequent re-evaluations, if sufficient collateral is not obtained and increased if necessary, or if collateral held has experienced a significant deterioration in value. FSC has experienced two claims for loss through May 31, 2017 as detailed below, and thus provisions for losses and loss adjustment expense have been based on management’s experience adjusted for other factors unique to the Company’s approach, and in consultation with actuaries experienced in the surety field.
In August 2015, the Company paid a claim on a called bond in the amount of $550,000, of which $75,000 was paid using collateral of the principal. The remaining $475,000 has been established as a salvage reserve to be repaid with the assignment of proceeds from sales of stock and an assignment of a promissory note as additional collateral with total assigned values in excess of the salvage reserve. As of May 31, 2017, the Company had received $45,000 in recovered salvage on this claim. As of June 2018, the unrecovered balance of this salvage was $280,000, with full recovery expected in future.
At May 31, 2017 and 2016, the Company had the following secured and unsecured notes payable to individuals:
During the year ended May 31, 2015, the Company borrowed $75,000 from a board member. Accrued related party interest of $5,000 is payable to this individual at May 31, 2017, with $0 and $3,068 interest expense for the years ended May 31,2017 and 2016, respectively.
During the year ended May 31, 2016, an individual who holds secured notes payables from the Company, became a greater than 10% owner of outstanding common stock of the Company. During the year ended May 31, 2016, the Company borrowed additional money from this individual and entities controlled by this individual. Amounts owed to this individual (and the individual’s companies and relatives) at May 31, 2017 consisted of $1,020,079 in demand notes, $1,248,920 in notes payable secured by FSC stock, and $26,853 in accrued interest.
On August 5, 2015 the Company completed a $1,600,000 transaction which resulted in its acquisition of the remaining 49.3% ($1.725 million face amount) senior promissory notes of the $3.5 million bridge loan financing dating from 2008, after waiving interest of approximately $1.8 million. Upon closing of the acquisition, the collateral securing the senior promissory notes, 1,000 shares (100%) of FSC and 1,000 shares (100%) of CMW, was released to the Company. This extinguishment of debt resulted in a gain from forgiven principal and interest in the amounts of $125,000 and $1,795,000, respectively for a total gain on debt extinguishment of approximately $1,920,000.
As of May 31, 2016, the Company had accrued and withheld approximately $44,000 in West Virginia payroll withholdings and approximately $7,000 in interest and penalties, which are reflected in the accompanying financial statements as other liabilities and accrued expenses and professional fees payable.
As of May 31, 2017 and May 31, 2016, the Company held $21,926,872 and $2,068,192, respectively, in its cash and investment accounts as collateral for clients surety bonding programs.
The Company’s outstanding Series A Preferred stock matures on the seventh anniversary of the issuance date and thereafter holders of the Series A Stock are eligible to request that the Company redeem their Series A Shares. As of May 31, 2017, the Company has received requests for redemption of 1,026 shares of Series A Preferred. The aggregate amount to which the holders requesting redemption are entitled as of June 30, 2017, is $1,598,043.
Under the terms of the Series A Preferred Stock, upon receipt of such a request, the Company’s Board was required to make a good faith determination regarding (A) whether the funds of the Company legally available for redemption of shares of Series A Stock are sufficient to redeem the total number of shares of Series A 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
On December 30, 2005, through a private placement, the Company issued 3,980 shares of 8% Non-Voting Series B Convertible Preferred Stock (Series B Preferred Stock), along with 19,900,000 warrants for common shares of Company stock as additional consideration, for a cash investment in the amount of $2,985,000; and issued 4,891 shares of Series B Preferred Stock, along with 24,452,996 warrants for common shares of Company stock as additional consideration, for a conversion of $3,667,949 of indebtedness of the Company, in connection with the Company's acquisition of FSC. Holders of the Series B Preferred Stock are entitled to receive, when and as declared by the board of directors, cumulative preferential cash dividends at a rate of eight percent of the $1,000 liquidation preference per annum (equivalent to a fixed annual rate of $80 per share). The Series B Preferred
Stock ranks senior to the Company's common stock and pari passu with the Company's Series A Preferred and Series C Preferred Stock with respect to dividend rights and rights upon liquidation, dissolution or winding up of the Company. Each share of the Series B Preferred Stock is convertible at the option of the holder, at any time after the original issue date, into 1,000 fully paid and non-assessable shares of the Company's common stock at a conversion price of $1.00 per common share. The Company may redeem the Series B Preferred Stock at any time after the first anniversary of the Original Issue Date at a price per share equal to the Series B Preferred Stock Face Amount plus all accrued and unpaid dividends with respect to the shares of the Series B Preferred Stock of such holder to be redeemed. To the extent that the Series B Preferred Stock has not been redeemed by the Company, the holder may redeem the Series B Preferred Stock on or after the fifth anniversary of the Original Issue Date at a price per share equal to the Series B Preferred Stock Face Amount plus all accrued and unpaid dividends with respect to the shares of the Series B Preferred Stock of such holder to be redeemed. The Company is authorized to issue up to 10,000 shares of the Series B Preferred Stock. The Company did not issue any additional shares of Series B Preferred Stock during fiscal 2017.
The Company’s outstanding Series B Preferred stock matured on December 30, 2010, meaning that the holders of the Series B Stock that had not requested exchange to the Company’s Series C Preferred stock became entitled to request that the Company redeem their Series B Shares. As part of the exchange to Series C Preferred Stock in September 2009, the shares that did not exchange were treated as a liability on the balance sheet. As of May 31, 2017, of the 2,817 shares of Series B Preferred that remained outstanding, the Company has received requests for redemption of 2,219 shares of Series B Preferred. The aggregate amount to which the holders requesting redemption are entitled as of June 30, 2017, is $5,519,942.
Under the terms of the Series B Preferred Stock, upon receipt of such a request, the Company’s Board was required 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
As of May 31, 2017 the Company has chosen to defer payment of dividends on Series B and Series C Preferred Stock with such accrued and unpaid dividends amounting to $4,038,772 and $9,698,738 through May 31, 2017, respectively. These dividends are included in the amounts reported on the face of the balance sheet for each respective classification of stock.
On October 12, 2005, the board of directors adopted its 2005 Stock Incentive Plan (the "Plan") to allow the Company to make awards of stock options as part of the Company's compensation to key employees, non-employee directors, contractors and consultants. The Plan was approved by the stockholders on December 8, 2005. The aggregate number of shares of Common Stock issuable under
all awards under the Plan is 35,000,000. No awards may be granted under the Plan after December 8, 2015.
The Company has fully reserved the $3.3 million tax benefit of the operating loss carry forward, adjusted for the Tax Cuts and Jobs Act enacted December 22, 2017, by a valuation allowance of the same amount, because the likelihood of realization of the tax benefit is doubtful.
In fiscal 2017, the Company issued 300,000 shares of the Company’s common stock as additional consideration in connection with new and continued borrowings totaling $75,000. The shares were valued at approximately $.002520 per share based on the average quoted closing price of the Company’s stock for the 20-day period preceding the date of the transaction and totaled $756.
In fiscal 2017, the Company issued 500,000 shares of the Company’s common stock as additional consideration for the purchase and loans convertible into the purchase of 5% of FSC subsidiary stock. The shares were valued at approximately $.002705 per share based on the average quoted closing price of the Company’s stock for the 20-day period preceding the date of the transaction and totaled $1,353.
In fiscal 2016, the Company issued 2,500,000 shares of the Company's common stock as additional consideration for the purchase and loans convertible into the purchase of 25% of FSC subsidiary stock.
The Company’s insurance subsidiary files calendar year financial statements prepared in accordance with statutory accounting practices prescribed or permitted by regulatory authorities. The principal differences between statutory financial statements and financial statements prepared in accordance with generally accepted accounting principles are that statutory financial statements do not reflect deferred policy acquisition costs and certain assets.
Statutory surplus exceeds the West Virginia state law minimum capital requirements of $2.0 million.
On March 26, 2012 the Commissioner of the State of West Virginia (WVOIC) terminated in its entirety the Amended Consent Order of June 7, 2007 and terminated the restrictive conditions of the Consent Order issued December 23, 2005 which approved acquisition of FSC by the Company. Among other consequences, removal of these restrictions allowed dividends to be declared by and paid from FSC to the Company. No dividends were declared or paid for the twelve month periods ended May 31, 2017 or May 31, 2016.
During 2013, the Company and one of its surety principals entered into a contractual arrangement whereby the Company would hold collateral for use in paying future claims and expenses and upon the Company’s determination that its liability had been fully extinguished, the Company would return the amount of the deposits less any paid claims or expenses. While the Company holds the collateral, the Company will pay 1.35% annual simple interest to the principal. The Company receives any appreciation and earnings in excess of the contractual deposit, less payments, and interest paid to the principal. This deposit and the earning or expenses associated with the deposit are included in the calculation of the Company’s investment income.
The carrying amount of cash, short-term investments, receivables, prepaid expenses, short-term and demand notes payable, accounts payable, accrued expenses and other liabilities approximate fair value because of the immediate or relatively short-term maturity of these financial instruments. Fair value of term notes payable, including notes payable under the bridge-financing arrangement, were deemed to approximate their carrying value based on the Company’s incremental borrowing rates for similar types of borrowings with maturities consistent with those remaining for the debt being valued.
The Company transacts the majority of its business with three financial institutions, one for commercial banking services and the others for brokerage and custodial services. Periodically, the amount on deposit in financial institutions providing commercial banking services exceeds federally insured limits. Management believes these financial institutions are financially sound. With respect to the financial institutions providing brokerage and custodial services, amounts on deposit are invested in money market funds that invest principally in obligations issued by the U.S government, its agencies or instrumentalities.
During fiscal 2016, advances to the Company from Mr. Jacobs amounted to $1,088,758, and repayments to Mr. Jacobs amounted to $971,207. As of May 31, 2016, the balance due from Mr. Jacobs was $515,488. The largest aggregate amount outstanding from Mr. Jacobs in fiscal 2016 was $549,143.
During the years ended May 31, 2017 and May 31, 2016, a company owned by a board member provided consulting services. This company provided services totaling $66,100 and $62,100 in 2017 and 2016. Amounts owed to this company at year end are treated as related party payables in the amounts $124,323 and $124,723 at May 31, 2017 and 2016 respectively.
During the year ended May 31, 2016, an individual who holds secured notes payables from the Company, became a greater than 10% owner of outstanding common stock of the Company. During the year ended May 31, 2016, the Company borrowed additional money from this individual and entities controlled by this individual. Amounts owed to this individual (and the individual’s companies and relatives) at May 31, 2017 consisted of $1,020,079 in demand notes, $1,248,920 in notes payable secured by FSC stock, and $26,853 in accrued interest (with $122,766 and $124,444 of interest expense for the periods ending
The Company limits the maximum net loss that can arise from large risks by reinsuring (ceding) certain levels of such risk with reinsurers. Ceded reinsurance is treated as the risk and liability of the assuming companies. The Company cedes insurance to other companies and these reinsurance contracts do not relieve the Company from its obligations to policyholders.
There were no ceded Loss and Loss Adjustment Expenses for the years ended May 31, 2017 or 2016.
Subsequent to May 31, 2017, the Company obtained various borrowings from individuals and businesses through May 31, 2018 totaling $120,600 at rates varying from 10% to 14%, which mature at various dates subsequent to this filing, and made repayments on notes in the amount of $290,218. These borrowings, and the renewal of other borrowings, included no issuances of shares of its common stock as additional consideration. Additionally, the Company obtained borrowings of $730,693, including $388,788 assumption of Company debt, from its principal shareholder and chief executive officer under a pre-approved financing arrangement bearing interest at the rate of 12% and made repayments totaling $158,883. After
taking into account the net accrued payroll owed, reimbursement of company expenses, and the personal assumption of Company debt that is to be offset against these borrowings, the balance owed to the principal shareholder from the Company is $23,393 at May 31, 2018.
Subsequent to May 31, 2017, the Registrant sold 15.50% interest in First Surety Corporation to various individuals for $1,550,000. This sale also resulted in the issuance of 1,550,000 shares of common stock of the Company. In addition, the Company converted a note payable from a lender for 3% interest in First Surety Corporation.