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EX-31.1 - CERTIFICATION - LIFE PARTNERS HOLDINGS INCv244538_ex31-1.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

x Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934
For the quarterly period ended: November 30, 2011
 
or
 
¨ Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

Commission File Number: 0-7900
 
LIFE PARTNERS HOLDINGS, INC.
(Exact name of Registrant as specified in its charter)

Texas
74-2962475
(State of incorporation)
(I.R.S. Employer ID no.)
   
204 Woodhew Drive
76712
Waco, Texas
(Zip Code)
(Address of Principal Executive Offices)
 
 
Registrant’s telephone number, including area code: 254-751-7797
 
Check whether the Registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to the filing requirements for at least the past 90 days.  Yes x No ¨
 
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  Yes x No ¨
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨
Accelerated filer x
Non-accelerated filer ¨
Smaller reporting company ¨
   
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
 
Shares of Common Stock, $.01 par value, outstanding as of November 30, 2011: 18,647,468 (18,750,000 issued less 102,532 treasury shares)

 
 

 
 
EXPLANATORY NOTE
 
In this Form 10-Q, we are restating our Consolidated Condensed Financial Statements for the three months and nine months ended November 30, 2010 (the “Third Quarter of last year” and the “First Nine Months of last year”).  Our Consolidated Condensed Financial Statements for three months and nine months ended November 30, 2011 (the “Third Quarter of this year” and the “First Nine Months of this year”) are not restated.  This Form 10-Q also revises “Management’s Discussion and Analysis of Financial Condition and Results of Operations” presented in our Form 10-Q for the Third Quarter of last year, as it relates to such quarter.

 
2

 
 
LIFE PARTNERS HOLDINGS, INC.
 
TABLE OF CONTENTS

PART I.
 
FINANCIAL INFORMATION
   
Item 1.
 
Financial Statements
   
   
Consolidated Balance Sheets – Nov. 30, 2011 (Unaudited) and February 28, 2011
 
4-5
   
Consolidated Statements of Income - For the Three and Nine Months Ended November 30, 2011 and 2010 (Unaudited)
 
6
   
Consolidated Statements of Cash Flows - For the Nine Months Ended November 30, 2011 and 2010 (Unaudited)
 
7
   
Notes to Consolidated Condensed Financial Statements
 
8-21
Item 2.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
21-30
Item 3.
 
Quantitative and Qualitative Disclosures about Market Risk
 
30
Item 4.
 
Controls and Procedures
 
30
         
PART II.  OTHER INFORMATION
   
Item 1.
 
Legal Proceedings
 
31
Item 1A.
 
Risk Factors
 
31
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
32
Item 3.
 
Defaults upon Senior Securities
 
32
Item 4.
 
(Removed and Reserved)
 
32
Item 5.
 
Other Information
 
32
Item 6.
 
Exhibits
 
32
         
Signatures
     
33
Exhibit Index
     
34
 
 
3

 
 
PART I - FINANCIAL INFORMATION
 

LIFE PARTNERS HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30, 2011 (Unaudited) AND FEBRUARY 28, 2011
Page 1 of 2
 
   
Nov. 30,
2011
   
Feb. 28,
2011
 
ASSETS
           
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 16,288,749     $ 27,610,564  
Certificates of deposit
    100,772       100,737  
Investment in securities
    1,900,000       5,110,677  
Accounts receivable – trade
    143,864       404,363  
Accounts receivable – other
    33,512       163,097  
Note receivable
    581,096       581,096  
Income tax receivable
    1,569,097       -  
Deferred income taxes
    1,234,592       1,312,215  
Prepaid expenses
    396,203       96,663  
Total current assets
    22,247,885       35,379,412  
                 
PROPERTY AND EQUIPMENT:
               
                 
Land and building
    2,316,202       2,312,002  
Proprietary software
    545,663       517,646  
Furniture, fixtures and equipment
    1,477,808       1,536,416  
Transportation equipment
    9,800       9,800  
Subtotal
    4,349,473       4,375,864  
                 
Accumulated depreciation
    (2,003,548 )     (1,876,771 )
Net property and equipment
    2,345,925       2,499,093  
                 
OTHER ASSETS:
               
Premium advances, net of reserve of $3,631,320 and $3,229,194, respectively
    7,225,851       6,504,201  
Investments in policies
    9,043,770       9,506,495  
Investment in life settlements trust
    6,349,773       6,202,193  
Artifacts and other
    834,700       834,700  
Deferred income taxes
    3,883,377       4,868,470  
Total other assets
    27,337,471       27,916,059  
Total assets
  $ 51,931,281     $ 65,794,564  
 
See the accompanying notes to Consolidated Condensed Financial Statements.

 
4

 

LIFE PARTNERS HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
NOVEMBER 30, 2011 (Unaudited) AND FEBRUARY 28, 2011
Page 2 of 2
 
    
Nov. 30, 
2011
   
Feb. 28,
2011
 
LIABILITIES AND SHAREHOLDERS' EQUITY
           
CURRENT LIABILITIES:
           
             
Accounts payable
  $ 2,142,603     $ 2,165,467  
Accrued liabilities
    796,709       204,901  
Dividends payable
    3,737,234       3,736,330  
Accrued settlement expense
    419,292       281,471  
Income taxes payable
    -       613,505  
Current deferred policy monitoring costs
    395,319       415,028  
                 
Total current liabilities
    7,491,157       7,416,702  
                 
Long-term portion of deferred policy monitoring costs
    2,506,391       2,703,739  
Income taxes payable
    66,068       424,156  
                 
Total long-term liabilities
    2,572,459       3,127,895  
Total liabilities
    10,063,616       10,544,597  
                 
SHAREHOLDERS' EQUITY:
               
                 
Common stock, $.01 par value 18,750,000 shares authorized; 18,647,468 shares issued
    187,500       187,500  
Additional paid-in capital
    11,423,054       11,423,054  
Retained earnings
    30,642,175       44,114,389  
Accumulated comprehensive income, net of taxes
    -       (89,912 )
Less: treasury stock – 102,532 shares as of November 30, and February 28, 2011
    (385,064 )     (385,064 )
Total shareholders' equity
    41,867,665       55,249,967  
                 
Total liabilities and shareholders' equity
  $ 51,931,281     $ 65,794,564  
 
See the accompanying notes to Consolidated Condensed Financial Statements.

 
5

 

LIFE PARTNERS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTHS ENDED NOVEMBER 30, 2011 AND 2010
(Unaudited)

   
Three Months
Ended Nov. 30,
   
Nine Months
Ended Nov. 30,
 
          
(Restated)
         
(Restated)
 
    
2011
   
2010
   
2011
   
2010
 
REVENUES
  $ 6,666,795     $ 20,159,650     $ 27,311,539     $ 84,548,210  
BROKERAGE FEES
    4,161,233       9,659,733       17,472,277       38,093,650  
REVENUES, NET OF BROKERAGE FEES
    2,505,562       10,499,917       9,839,262       46,454,560  
OPERATING AND ADMINISTRATIVE EXPENSES:
                               
                                 
General and administrative
    4,234,177       2,924,153       11,544,007       8,685,717  
Impairment of investments in policies
    129,173       1,553,038       499,177       4,659,114  
Premium advances, net
    236,138       208,435       1,088,191       663,521  
Settlement costs
    -       205,833       613,374       575,016  
Depreciation
    68,416       71,118       199,381       211,879  
                                 
Total operating and administrative expenses
    4,667,904       4,962,577       13,944,130       14,795,247  
INCOME (LOSS) FROM OPERATIONS
    (2,162,342 )     5,537,340       (4,104,868 )     31,659,313  
                                 
OTHER INCOME (EXPENSES):
                               
                                 
Interest and other income
    820,951       241,636       1,123,712       575,297  
Interest expense
    -       -       (5,694 )     (1,505 )
Realized gain (loss) on sales of securities
    (134,509 )     267,448       (185,456 )     119,914  
                                 
Total other income and expense
    686,442       509,084       932,562       693,706  
                                 
INCOME (LOSS) BEFORE INCOME TAXES
    (1,475,900 )     6,046,424       (3,172,306 )     32,353,019  
                                 
Total income taxes
    (393,052 )     2,085,736       (892,131 )     11,957,089  
                                 
NET (LOSS) INCOME
  $ (1,082,848 )   $ 3,960,688     $ (2,280,175 )   $ 20,395,930  
                                 
EARNINGS (LOSS):
                               
Per share – Basic and Diluted
  $ (0.05 )   $ 0.21     $  (0.12 )   $ 1.09  
                                 
AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING:  Basic and diluted
    18,647,468       18,644,058       18,647,468       18,640,735  
                                 
THE COMPONENTS OF COMPREHENSIVE (LOSS) INCOME:
                               
Net (loss) income
  $ (1,082,848 )   $ 3,960,688     $ (2,280,175 )   $ 20,395,930  
Unrealized (loss) gain on investment securities, net of taxes
    91,617       21,402       89,912       (178,896 )
COMPREHENSIVE (LOSS) INCOME
  $ (991,231 )   $ 3,982,090     $ (2,190,263 )   $ 20,217,034  
 
See the accompanying notes to Consolidated Condensed Financial Statements.

 
6

 

LIFE PARTNERS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED NOVEMBER 30, 2011 AND 2010
(Unaudited)
   
Nine Months
Ended Nov. 30,
 
          
(Restated)
 
    
2011
   
2010
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net (loss) income
  $ (2,280,175 )   $ 20,395,930  
Adjustments to reconcile net income (loss) to operating activities:
               
Depreciation
    199,381       211,879  
Impairment of investments in policies
    499,177       4,659,114  
Gain on investment in life settlements trust
    (22,531 )     (104,272 )
Increase in allowance for premium advances
    402,126       170,719  
Gain on sales of investments in policies
    (691,489 )     -  
Realized loss (gain) on sales of investments in securities
    185,456       (119,914 )
Deferred income taxes
    1,014,303       (426,707 )
(Increase) decrease in operating assets:
               
Accounts receivable
    390,084       630,552  
Prepaid expenses
    (299,540 )     237,383  
Premium advances
    (1,123,777 )     (1,520,617 )
Increase (decrease) in operating liabilities:
               
Accounts payable
    (22,864 )     587,475  
Accrued liabilities
    591,808       (514,559 )
Accrued settlement expense
    137,821       (248,196 )
Income taxes payable
    (2,540,690 )     (138,943 )
Deferred policy monitoring costs
    (217,057 )     (39,255 )
Net cash (used in) provided by operating activities
    (3,777,967 )     23,780,589  
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Investment in certificates of deposit
    (35 )     (190 )
Proceeds from sales of marketable securities
    3,163,547       9,946,605  
Purchases of  marketable securities
    -       (12,160,678 )
Purchases of  property and equipment
    (46,213 )     (98,906 )
Investment in life settlements trust
    (190,782 )     -  
Proceeds from  investment in life settlements trust
    65,733       311,367  
Maturities of investment in policies
    293,545       83,469  
Proceeds from sales of investments in policies
    906,225       -  
Purchase of  policies for investment purposes
    (544,733 )     (2,338,021 )
Net cash provided by (used in) investing activities
    3,647,287       (4,256,354 )
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Dividends paid
    (11,191,135 )     (14,901,102 )
Net cash used in financing activities
    (11,191,135 )     (14,901,102 )
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    (11,321,815 )     4,623,133  
                 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    27,610,564       19,868,728  
                 
CASH AND CASH EQUIVALENTS, END OF PERIOD
  $ 16,288,749     $ 24,491,861  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
               
Interest paid
  $ 5,694     $ 1,505  
Income taxes paid
  $ 634,865     $ 13,015,000  
 
See accompanying notes to Consolidated Condensed Financial Statements.

 
7

 
 
Life Partners Holdings, Inc.
 
Notes to Consolidated Condensed Financial Statements
 
November 30, 2011
 
(Unaudited)
 
(1) DESCRIPTION OF BUSINESS
 
Life Partners Holdings, Inc. (“we” or “Life Partners”) is a specialty financial services company and the parent company of Life Partners, Inc. (“LPI”).  LPI is the oldest and one of the most active companies in the United States engaged in the secondary market for life insurance known generally as “life settlements”.  LPI facilitates the sale of life settlements between sellers and purchasers, but does not take possession or control of the policies.  The purchasers acquire the life insurance policies at a discount to their face value for investment purposes.
 
(2) RESTATEMENT
 
The accompanying Consolidated Condensed Financial Statements reflect adjustments made to previously reported consolidated condensed statements of income and cash flows for the three months and nine months ended November 30, 2010 (the “Third Quarter of last year”, and the “First Nine Months of last year”, respectively).  The restatements address timing issues related to revenue and related brokerage fees, impairment expense for investments in policies, deferred policy monitoring costs and the timing of state income taxes, the gain from the investment in the life settlement trust and executive bonus expense.  The deferred income tax provision related to these adjustments was also restated.  The restatement decreased reported earnings before income taxes by $5.1 million for the Third Quarter of last year, and by $3.3 million for the First Nine Months of last year.
 
Revenue and Brokerage Fees.  The revenue and brokerage fees adjustments resulted from changing the date of revenue recognition from the date that purchasers commit to buy policies to the date that policy closings are funded.  This adjustment decreased reported earnings before income taxes by $2.9 million for the Third Quarter of last year, and  increased reported earnings before income taxes by $3.1 million for the First Nine Months of last year.
 
Impairment Expense.  We improved the method by which we calculate impairment on Investment in Policies.  Impaired value is based on estimates of life expectancy and the effect of those estimates on the cost of future premiums and the receipt of proceeds from policy maturities.  We increased the amount of actuarial data to improve our methodology for estimating life expectancy.  In general, life expectancies increased with the addition of more data.  This adjustment reduced reported earnings before income taxes by $1.5 million for the Third Quarter of last year, and by $4.5 million for the First Nine Months of last year.
 
Deferred Policy Monitoring Costs.  We improved the method by which we calculate deferred policy monitoring costs.  Deferred policy monitoring costs is based on estimates of life expectancy and the effect of those estimates on the cost of monitoring policies over those life expectancies.  As we increased the amount of actuarial and historical data when estimating life expectancies, the life expectancies increased generally, which in turn increased our estimates of future monitoring costs.  The adjustment decreased reported earnings before income taxes by $0.7 million for the Third Quarter of last year and by $2.2 million for the First Nine Months of last year.
 
Executive Bonus Expense.  Before fiscal 2011, we recognized executive bonus expense when paid.  The restatement is only an issue of timing and increased reported earnings before income taxes by $0.3 million for the First Nine Months of last year.

 
8

 
 
Tax Adjustments.  The restatement includes the tax effects of the aforementioned adjustments by adjusting the deferred tax expense/benefit and deferred tax asset balance at the end of each fiscal period.
 
Balance Sheet Adjustments.  We have restated amounts within the balance sheet accounts to appropriately calculate and classify the proper balances in Accounts Receivable - Trade, Investments in Policies, Accounts Payable, Accrued Liabilities, Deferred Policy Monitoring Costs, State Income Taxes Payable, Deferred Income Tax Assets and Retained Earnings.
 
The following table shows the effect of the restatement on our previously issued financial statements as of and for the periods ended November 30, 2010:

   
November 30, 2010
 
   
As Reported
   
Restated
 
Balance Sheet:
           
Accounts receivable
  $ 11,893,089     $ 812,339  
Current deferred income taxes
    670,236       1,974,167  
Total current assets
    47,455,779       37,678,960  
Investments in policies
    18,603,572       9,743,369  
Long-term deferred income taxes
    370,808       4,203,531  
Total assets
    80,964,760       66,160,461  
Accounts payable
    5,743,050       807,406  
Current deferred policy monitoring costs
    954,728       415,028  
Total current liabilities
    11,797,278       6,451,476  
Long-term deferred policy monitoring costs
    -       2,716,822  
Total long-term liabilities
    385,201       3,102,023  
Total liabilities
    12,182,479       9,553,499  
Retained earnings
    57,735,687       45,560,368  
Total shareholders’ equity
    68,782,281       56,606,962  
Total liabilities and shareholders’ equity
  $ 80,964,760     $ 66,160,461  
 
   
Three Months Ended
November 30, 2010
   
Nine Months Ended
November 30, 2010
 
   
As Reported
   
Restated
   
As Reported
   
Restated
 
Income Statement:
                       
Revenues
  $ 26,241,865       20,159,650     $ 83,282,026     $ 84,548,210  
Brokerage fees
    12,109,403       9,659,733       37,758,450       38,093,650  
Revenue, net of brokerage fees
    14,132,462       10,499,917       45,523,576       46,454,560  
General and administrative expense
    2,900,658       2,924,153       8,990,891       8,685,717  
Impairment investments in policies
    56,471       1,553,038       111,333       4,659,114  
Total expenses
    3,466,010       4,962,577       10,552,640       14,795,247  
Income from operations
    10,666,452       5,537,340       34,970,936       31,659,313  
Earnings before income taxes
    11,175,536       6,046,424       35,664,642       32,353,019  
Income taxes
    4,108,138       2,085,736       12,886,281       11,957,089  
Net income
  $ 7,067,398     $ 3,960,688     $ 22,778,361     $ 20,395,930  
Earnings per share
  $ 0.38     $ 0.21     $ 1.22     $ 1.09  
 
 
9

 

   
Three Months Ended
November 30, 2010
    Nine Months Ended
November 30, 2010
 
   
As Reported
   
Restated
   
As Reported
    Restated  
Statement of Shareholders' Equity:
                       
Balance, Beginning
  $ 69,151,908     $ 60,083,300     $ 59,849,656     $ 50,056,768  
Net income
    7,067,398       3,960,688       22,778,361       20,395,930  
Balance, Ending
  $ 68,782,281     $ 56,606,962     $ 68,782,281     $ 56,606,962  
 
   
Nine Months Ended
November 30, 2010
 
   
As Reported
   
Restated
 
Cash Flow:
           
Net income
  $ 22,778,361     $ 20,395,930  
Impairment of investments in policies
    111,333       4,659,114  
Deferred income taxes
    180,666       (426,707 )
Accounts receivable
    1,143,697       630,552  
Accounts payable
    228,779       587,475  
Accrued liabilities
    (185,890 )     (514,559 )
Income taxes payable
    182,882       (138,943 )
Deferred policy monitoring costs
    713,778       (39,255 )
Net cash flow provided by operating activities
  $ 25,130,486     $ 23,780,589  
 
The notes to these Consolidated Condensed Financial Statements have been restated, as applicable, to reflect the restatement adjustments shown above.
 
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Presentation.  The accompanying Consolidated Condensed Financial Statements include the accounts of Life Partners and its wholly owned subsidiary, LPI.  All significant intercompany balances and transactions have been eliminated in consolidation.  The balance sheet for February 28, 2011, is derived from audited financial statements.  The Consolidated Condensed Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).  The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period in the normal course of business.  Actual results inevitably will differ from those estimates and such differences may be material to the financial statements.
 
These Consolidated Condensed Financial Statements have been prepared without audit, pursuant to the rules and regulations of the SEC, and reflect all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim periods, on a basis consistent with the annual audited financial statements.  All such adjustments are of a normal recurring nature.  Certain information, accounting policies, and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations, although we believe that the disclosures are adequate to make the financial statements and information presented not misleading.  It is suggested that these condensed financial statements be read in conjunction with the financial statements and the notes thereto included in the most recent Annual Report on Form 10-K.

 
10

 
 
Reclassifications.  Certain prior period amounts have been reclassified to conform to the current year’s presentation.  Investment in securities is shown as a current asset as opposed to the prior period when it was classified as a long-term asset.  Certain investments in securities are also shown as an investment in securities on the Statements of Cash Flows, when previously it was included in cash.  State income tax expense is shown on the statements of income in all periods as deducted from pre-tax earnings to arrive at net income (loss).  Payments for state income taxes are now presented as a component of income taxes paid on the Statements of Cash Flows.  These reclassifications had no impact on our results of operation or financial condition.  It is management’s opinion that all adjustments necessary for a fair statement of the results for the interim period have been made and that all adjustments are of a normal recurring nature.
 
Property and Equipment.  Our property and equipment are depreciated over their estimated useful lives using the straight-line method.  Depreciation expenses for the First Nine Months of this year and last year were $199,381 and $211,879, respectively.  The useful lives of property and equipment for purposes of computing depreciation are:
 
Building and components
7 to 39 years
 
Machinery and equipment
5 to 7 years
 
Software
3 to 7 years
 
Transportation equipment
5 years
 
 
Artifacts and Other.  The artifacts and other assets are stated at cost.  We have evaluated these assets and believe there is no impairment in their value as of November 30, 2011, and February 28, 2011.
 
Impairment of Long-Lived Assets.  We account for the impairment and disposition of long-lived assets in accordance with ASC 360-10, Accounting for the Impairment or Disposal of Long-Lived Assets.  We review the carrying value for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition.  In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss would be recognized equal to an amount by which the carrying value exceeds the fair value of assets.  The factors considered by management in performing this assessment include current operating results, trends and prospects, the manner in which the property is used, and the effects of obsolescence, demand, competition and other economic factors.  Based on our analysis, Investments in Policies is the only balance sheet item that has been impaired.  During the First Nine Months of this year and last year, we recorded impairments of $499,177 and $4,659,114, respectively.
 
Revenue Recognition.  We recognize income at the time a settlement closes.  In fiscal 2011, we improved our methodology for estimating deferred revenue.  We now do a more comprehensive estimate, based on future monitoring costs, amortized over the anticipated life expectancy of the insureds.  This amount is shown as Deferred Policy Monitoring Costs within current and long-term liabilities on the Consolidated Balance Sheets.
 
Income Taxes.  We recognize deferred tax assets and liabilities for the expected future tax consequences of transactions and events.  Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  Timing differences between the reporting of income and expenses for financial statement and income tax reporting purposes are reported as deferred tax assets, net of valuation allowances, or as deferred tax liabilities depending on the cumulative effect of all timing differences, recorded at amounts expected to be more likely than not recoverable.

 
11

 
 
Earnings Per Share.  Basic earnings per share computations are calculated on the weighted-average of common shares and common share equivalents outstanding during the year, reduced by the treasury stock.  Common stock options and warrants are considered to be common share equivalents and are used to calculate diluted earnings per common and common share equivalents except when they are anti-dilutive.
 
Concentrations of Credit Risk and Major Customers.  In the First Nine Months of this year and last year, there was no compensation to any single licensee or broker organization that represented more than 10% of brokerage fees.  For the Third Quarter of this year, six brokers who each accounted for more than 10% of the face value of all completed transactions, constituted 94.3% of the total face value of completed transactions.  For the First Nine Months of this year, two brokers, who each accounted for more than 10% of the face value of all completed transactions, constituted 25.4% of the total face value of completed transactions.  For the Third Quarter of last year, two brokers accounted for more than 10% of the face value of all completed transactions, and constituted 32.5% of the total face value of completed transactions.  For the First Nine Months of last year, two brokers, who each accounted for more than 10% of the face value of all completed transactions, constituted 31.4% of the total face value of completed transactions.
 
(4) NEW ACCOUNTING PRONOUNCEMENTS
 
ASU 2010-06 – Improving Disclosures about Fair Value Measurements, amended ASC 820 to clarify certain existing fair value disclosures and requires a number of additional disclosures.  The guidance in ASU 2010-06 clarified that disclosures should be presented separately for each class of assets and liabilities measured at fair value and provided guidance on how to determine the appropriate classes of assets and liabilities to be presented.  ASU 2010-06 also clarified the requirements for entities to disclose information about both the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements.  ASU 2010-06 introduced new requirements to disclose the amounts (on a gross basis) and reason for any significant transfers between Levels 1, 2, and 3 of the fair value hierarchy and present information regarding the purchases, sales, issuances and settlements of Level 3 assets and liabilities on a gross basis.  With the exception of the requirement to present changes in Level 3 measurements on a gross basis, which is delayed until 2011, the guidance in ASU 2010-06 became effective for reporting periods beginning after December 15, 2009.  Adoption of ASU 2010-06 during our Fiscal 2011 had no impact on our financial condition, results of operations or cash flows.
 
(5) CASH AND CASH EQUIVALENTS
 
For purposes of the balance sheets and statements of cash flows, we consider all highly liquid investments available for current use with an original maturity of three months or less to be cash equivalents.  The average balance of our operating checking account balance is generally in excess of $250,000.  The Federal Deposit Insurance Corporation (“FDIC”) currently insures all bank accounts up to $250,000, with unlimited coverage on non-interest-bearing accounts.  Amounts in interest-bearing accounts in excess of $250,000, with the exception of amounts in FDIC sweep accounts, are at risk to the extent that their balances exceed FDIC coverage.  Money market investments generally do not have FDIC protection.  We believe we have mitigated our exposure to loss with deposits in a combination of five smaller, community banks and four of the largest national financial institutions.
 
(6) CERTIFICATES OF DEPOSIT
 
A certificate of deposit with an original maturity of greater than three months, but less than a year, is held in one banking institution.  The certificate of deposit was not in excess of the FDIC insurance limit at November 30, 2011, and February 28, 2011.

 
12

 
 
(7) INVESTMENTS IN SECURITIES
 
Securities investments not classified as either held-to-maturity or trading securities are classified as available-for-sale securities.  Our securities investments consist of common stocks, municipal and corporate bonds, and commodity, index and foreign currency funds and are classified as available-for-sale securities.
 
The table below shows the cost and estimated fair value of the investment securities classified as available-for-sale as of November 30, 2011, and February 28, 2011:
 
   
Cost
Basis
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair Value
 
Municipal and corporate bonds
  $ 1,900,000     $ -     $ -     $ 1,900,000  
Total at November 30, 2011
  $ 1,900,000     $ -     $ -     $ 1,900,000  
Municipal and corporate bonds
  $ 4,569,850     $ -     $ (82,463 )   $ 4,487,387  
U.S. common stocks
    521,731       -       (47,955 )     473,776  
Commodity and index funds
    157,421       -       (7,907 )     149,514  
Total at February 28, 2011
  $ 5,249,002     $ -     $ (138,325 )   $ 5,110,677  
 
The unrealized loss at February 28, 2011 was considered temporary in nature and the securities are recorded at fair value in Investment in Securities on the balance sheet, with the change in fair value during the current period included in equity through Other Comprehensive Income.
 
(8) ACCOUNTS RECEIVABLE – TRADE
 
The amounts shown on the balance sheet termed Accounts Receivable – Trade are amounts reflecting non-interest bearing advances to facilitate a settlement transaction.  We collect the advances generally within 30 days after the transactions close, and we receive payment before any of the parties involved in the transaction receive funds.  Our business model does not use leverage, which minimizes issues of collectability or adverse effects due to the credit environment.  The receivable amounts at November 30, 2011, and February 28, 2011, were $143,864 and $404,363, respectively.
 
(9) ACCOUNTS RECEIVABLE – OTHER
 
The amount shown on the balance sheet at November 30, 2011, termed Accounts Receivable – Other, is composed of $18,423 due us from maturities of policies and loans of $15,089 to various employees for a total of $33,512.  The amount for February 28, 2011, is composed of $150,350 due us from maturities of policies and loans of $12,747 to various employees for a total of $163,097.  We consider all receivables to be current and collectible.
 
(10) NOTE RECEIVABLE
 
The amounts shown on the balance sheet termed Note Receivable represent a note, including interest at 5%, with a non-related partnership originally dated January 8, 2008, and renewed with a guaranty and security agreement on January 23, 2009.  The original due date was February 28, 2009.  This note is substantially collateralized and we instituted collection proceedings, which resulted in an agreed final judgment being entered against the debtor on April 7, 2010, for the full amount of the note plus accrued interest on that date, attorney’s fees, costs, all taxable costs of court and post judgment interest at the highest rate allowable by law.  Our counsel in this matter is seeking collection of this judgment and is investigating the available collateral to foreclose upon to satisfy the judgment.  The amount of interest we may be able to collect is not certain.  As a result, we stopped accruing interest income on this Note in the Second Quarter of fiscal 2011.  We believe we will collect the full amount, including accrued interest, in the near term.  The amount, including accrued interest, at November 30, 2011, and February 28, 2011, was $581,096.

 
13

 
 
(11) PREMIUM ADVANCES
 
We make advances on policy premiums to maintain certain policies.  When the future premium amounts in escrow are exhausted, purchasers are contractually obligated to pay the additional policy premiums.  In some instances, purchasers have failed to pay the premiums and we have acquired the policy or advanced the premiums to maintain the policies.  While we have no contractual or other legal obligation to do so, and do not do so in every instance, we have made premium advances as an accommodation based on our assumptions that we will ultimately recoup the advances.  Although we expect ultimate repayment, we make estimates of the collectability of these premium advances.
 
The table below shows the changes in the premium advances account.

Total premium advance balance at February 28, 2011
  $ 9,733,395  
Advances
    3,959,581  
Reimbursements and adjustments
    (2,835,805 )
Total premium advance balance at November 30, 2011
    10,857,171  
Allowance for doubtful accounts
    (3,631,320 )
Net premium advance balance at November 30, 2011
  $ 7,225,851  
 
(12) INVESTMENTS IN POLICIES
 
From time to time, we purchase interests in policies to hold for investment purposes.  ASC 325-30, Investments in Insurance Contracts, provides that a purchaser may elect to account for its investments in life settlement contracts based on the initial investment at the purchase price plus all initial direct costs.  Continuing costs (e.g., policy premiums, statutory interest, and direct external costs, if any) to keep the policy in force are capitalized.  We have historically elected to use the investment method, and refer to the recorded amount as the carrying value of the policies.
 
The table below describes the Investments in Policies account at November 30, 2011.
 

Policies With Remaining Life
Expectancy
(in years)
 
Number of
Contracts
   
Carrying
Value
   
Face
Value
 
0-1
    6     $ 26,753     $ 52,339  
1-2
    15       743,491       1,020,641  
2-3
    46       802,578       1,153,616  
3-4
    63       1,100,328       2,191,203  
4-5
    125       1,799,784       4,580,089  
Thereafter
    1,092       4,570,836       21,263,601  
Total
    1,347     $ 9,043,770     $ 30,261,489  
 
Before fiscal 2004, our business model focused on viatical settlements, in which the insured is terminally ill.  At that time, most viaticals involved insureds with HIV.  Subsequent advances in medical science and health care greatly extended the life expectancies of these insureds, and we and the industry switched to life settlements.  Our current business model, since fiscal 2004, has focused on facilitating the purchase of life settlements for our clients.  The bulk of policies that we own that have exceeded life expectancy are viaticals.

 
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Remaining life expectancy is based on original life expectancy estimates and is not an indication of expected maturity.  Actual maturity dates in any category may vary significantly (either earlier or later) from the remaining life expectancies reported above.
 
We evaluate the carrying value of our investments in owned policies on a regular basis, and adjust our total basis in the policies using new or updated information that affects our assumptions about remaining life expectancy, credit worthiness of the policy issuer, funds needed to maintain the asset until maturity, capitalization rates and potential return.  We recognize impairment on individual policies if the expected discounted cash flows are less than the carrying amount of the investment, plus anticipated undiscounted future premiums and capitalizable direct external costs, if any.  Impairment of policies is generally caused by the insured significantly exceeding the estimate of the original life expectancy, which causes the original policy costs and projected future premiums to exceed the estimated maturity value.  We recorded $499,177 and $4,659,114 of impairment for the First Nine Months of this year and the First Nine Months of last year, respectively.  The fair values of the impaired policies at November 30, 2011, and February 28, 2011, were $1,121,115 and $1,172,608, respectively.
 
Estimated premiums to be paid for each of the five succeeding fiscal years to keep the life settlement contracts in force as of November 30, 2011, are as follows.

Year 1
  $ 633,830  
Year 2
    666,510  
Year 3
    802,990  
Year 4
    757,924  
Year 5
    779,006  
Thereafter
    10,222,317  
Total estimated premiums
  $ 13,862,577  
 
The majority of our Investments in Policies was purchased as part of settlement agreements and purchases from existing clients, which we refer to as tertiary purchases.  We do not currently have a strategy of buying large amounts of policies for investment purposes, but we expect to continue to make purchases as they may be presented to us and if the purchases can be made with benefit to both parties.  Since the purchases for our own account are motivated by settlements and tertiary purchases, the supply of available policies in the secondary market does not affect our purchases.  The risks that we might experience as a result of investing in policies are unknown remaining life expectancy, a change in credit worthiness of the policy issuer, funds needed to maintain the asset until maturity and changes in capitalization rates.
 
(13) INVESTMENT IN LIFE SETTLEMENTS TRUST
 
The amount shown on the balance sheet termed Investment in Life Settlements Trust is an investment in an unaffiliated corporation, Life Assets Trust, S.A., (the “Trust”) created for the acquisition of life settlements.  As of November 30, 2011, and February 28, 2011, we owned 19.9% of the trust, carried at $6,349,773 and $6,202,193, respectively, accounted for on the equity method of accounting.  At November 30, 2011, the Trust owned a portfolio of 262 life insurance settlements with a face value of $683 million, of which LPI supplied settlements with a face value of approximately $278 million.  We anticipate the policies will mature over the next few years, although we cannot determine the exact time of the policy maturities and the distribution of the underlying assets.  We have considered any potential impairment to the investment and believe no impairment to our investment value is warranted.

 
15

 
 
(14) INCOME TAXES
 
Total income tax expense was allocated for the First Nine Months of this year and last year is as follows:

   
2011
   
2010
 
Income tax (benefit) expense from continuing operations
  $ (892,131 )   $ 11,957,089  
 
Income tax expense was made up of the following components:

   
Nine Months Ended Nov. 30,
 
    
2011
   
2010
 
Current income taxes
  $ (1,906,434 )   $ 12,383,796  
Deferred tax expense (benefit)
    1,014,303       (426,707 )
Total income tax expense
  $ (892,131 )   $ 11,957,089  
 
Income tax expense differed from amounts computed by applying the Federal income tax rate to pre-tax earnings for the nine months ended November 30, 2011, and 2010, as a result of the following:

   
Nine Months Ended Nov. 30,
 
    
2011
   
2010
 
United States statutory rate
    35.0 %     35.0 %
State income taxes
    (2.1 )%     0.3 %
Permanent differences
    (4.8 )%     1.7 %
Combined effective tax rate
    28.1 %     37.0 %
 
The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows:

   
Nov. 30, 2011
   
Feb. 28, 2011
 
Deferred tax assets:
           
Impairment of investment in policies
  $ 3,690,845     $ 3,737,353  
Premium advances allowance
    1,270,962       1,130,218  
Deferred policy monitoring costs
    968,161       1,112,651  
Investment in securities
    676,209       611,298  
Contingency costs
    146,752       98,514  
Charitable contributions
    127,549       -  
Compensated absences
    39,004       40,095  
State taxes
    23,124       148,455  
Unrealized revenues and brokerage fees
    -       998,716  
Unrealized loss on marketable securities
    -       48,414  
      6,942,606       7,925,714  
Valuation allowance
    (647,947 )     (582,587 )
Net deferred tax assets
    6,295,109       7,343,127  

 
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Deferred tax liabilities:
           
Settlement costs
    (883,332 )     (945,259 )
Depreciation
    (150,436 )     (185,905 )
Prepaid expenses
    (70,000 )     (17,938 )
Unrealized revenues and brokerage fees
    (60,032 )     -  
Loss in investment in trust
    (13,340 )     (13,340 )
Net deferred tax liabilities
    (1,177,140 )     (1,162,442 )
Total deferred tax asset, net
  $ 5,117,969     $ 6,180,685  
                 
Summary of deferred tax assets:
               
Current
  $ 1,234,592     $ 1,312,215  
Non-current
    3,883,377       4,868,470  
Total deferred tax asset, net
  $ 5,117,969     $ 6,180,685  
 
In fiscal 2010, we recorded a valuation allowance of $611,298 for capital losses resulting from other-than-temporary impairments.  This amount represents capital losses that we were not able to deduct until we had corresponding capital gains to apply the losses against.  In fiscal 2011, we had capital gains of $82,031.  This reduced the valuation allowance to $582,587 at February 28, 2011.  In fiscal 2012, we incurred additional capital losses of $185,456 that we are not able to deduct until we have corresponding capital gains to apply the losses against.  This increased the valuation allowance to $647,947 at November 30, 2011.
 
With few exceptions, we are no longer subject to U.S. federal, state or local examinations by tax authorities for fiscal years 2008 and prior.
 
Accounting for Uncertainty in Income Taxes.  In June 2006, the FASB issued guidance contained in ASC 740, Income Taxes (formerly FIN 48).  The guidance is intended to clarify the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes the recognition and measurement of a tax position taken or expected to be taken in a tax return.  ASC 740 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
 
Under ASC 740, evaluation of a tax position is a two-step process.  The first step is to determine whether it is more likely than not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position.  The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements.  A tax position is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.
 
At February 28, 2010, we determined that it is more likely than not that we will be assessed additional Texas Margin Tax for non-deductibility of certain payments in past and current periods included in our calculation of the Texas Margin Tax taxable basis.  The amount accrued for this uncertain tax position at November 30, 2011, and February 28, 2011, was $123,374.

 
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A reconciliation of the beginning and ending amount of unrecognized tax expense for the current period is as follows.

Balance at February 28, 2011
  $ 123,374  
Reductions based on tax positions related to the current period
    -  
Balance at November 30, 2011
  $ 123,374  
 
(15)
COMPREHENSIVE INCOME PER SHARE, SHAREHOLDERS’ EQUITY, STOCK  TRANSACTIONS AND COMMON STOCK OPTIONS
 
Comprehensive (loss) income for Third Quarter of this year and last year was $(991,231) and $3,982,090, respectively.  Comprehensive (loss) income for the First Nine Months of this year and last year was $(2,190,263) and $20,217,034, respectively,  Basic and diluted earnings (loss) per share for comprehensive income for the Third Quarter of this year and last year were $(0.05) and $0.21, respectively.  Basic and diluted earnings (loss) per share for comprehensive income (loss) for the First Nine Months of this year and last year were $(0.12) and $1.09, respectively.
 
Dividends. We declared and paid dividends in the amounts as set forth in the following table for the First Nine Months of last year and this year:

Date Declared
 
Date Paid
 
Dividend Amount
04/26/10
 
06/15/10
 
$0.20
08/06/10
 
09/15/10
 
$0.20
09/03/10
 
10/29/10
 
$0.20
10/21/10
 
12/15/10
 
$0.20
05/04/11
 
06/15/11
 
$0.20
08/11/11
 
09/15/11
 
$0.20
11/23/11
 
12/15/11
 
$0.20
 
We had no share based awards that were granted, modified or outstanding for the First Nine Months of this year or last year, and as a result, we had no share based compensation expense in any quarter.
 
(16)
FAIR VALUE MEASUREMENTS
 
ASC 820, Fair Value Measurements and Disclosures, addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under GAAP.  ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.
 
In February 2008, the FASB agreed to defer the effective date of ASC 820 for one year for certain nonfinancial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  Examples of these items include:
 
 
·
Nonfinancial assets and nonfinancial liabilities that initially are measured at fair value in a business combination or other new basis event, but are not measured at fair value in subsequent periods;
 
 
·
Asset retirement obligations that are measured at fair value at initial recognition, but are not measured at fair value in subsequent periods; or

 
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·
Nonfinancial liabilities for exit or disposal activities that are measured at fair value at initial recognition, but are not measured at fair value in subsequent periods.
 
We determined the fair values of our financial instruments based on the fair value hierarchy established in ASC 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The standard defines fair value, describes three levels of inputs that may be used to measure fair value, and expands disclosures about fair value measurements.
 
The term inputs refers to the assumptions that market participants use in pricing the asset or liability.  ASC 820 distinguishes between observable inputs and unobservable inputs.  Observable inputs reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from independent sources.  Unobservable inputs reflect an entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability.  ASC 820 indicates that valuation techniques should maximize the use of observable inputs and minimize the use of unobservable inputs.  ASC 820 establishes a fair value hierarchy that prioritizes the inputs used in valuation techniques and creates the following three broad levels, with Level 1 being the highest priority:
 
 
·
Level 1 inputs: Level 1 inputs are quoted market prices in active markets for identical assets or liabilities that are accessible at the measurement date (e.g., equity securities traded on the New York Stock Exchange).
 
 
·
Level 2 inputs: Level 2 inputs are from other than quoted market prices included in Level 1 that are observable for the asset or liability, either directly or indirectly (e.g., quoted market prices of similar assets or liabilities in active markets, or quoted market prices for identical or similar assets or liabilities in markets that are not active).
 
 
·
Level 3 inputs: Level 3 inputs are unobservable (e.g., a company’s own data) and should be used to measure fair value to the extent that observable inputs are not available.
 
Following is a table of Investment in Securities measured at fair value on a recurring basis as of November 30, 2011, and February 28, 2011, using quoted prices in active markets for identical assets (Level 1).
 
Description
 
Level 1:
Quoted Prices in
Active Markets for
Identical Assets
   
Level 2:
Significant Other
Observable Inputs
   
Level 3:
Significant
Unobservable Inputs
   
Total
 
Municipal and corporate bonds
  $ 1,900,000       -       -     $ 1,900,000  
Total at Nov. 30, 2011
  $ 1,900,000       -       -     $ 1,900,000  
Municipal and corporate bonds
  $ 4,487,387       -       -     $ 4,487,387  
U.S. common stocks
    473,776       -       -       473,776  
Commodity, index and foreign currency funds
    149,514       -       -       149,514  
Total at Feb. 28, 2011
  $ 5,110,677       -       -     $ 5,110,677  

 
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Our financial assets and liabilities are cash and cash equivalents, certificates of deposit, accounts receivable, note receivable, investments in securities, investments in policies, investment in a life settlements trust, accounts payable and accrued liabilities.  The recorded values of cash and cash equivalents, certificates of deposit, investment in securities, accounts receivable, accounts payable, and accrued liabilities approximate their fair values based on their short-term nature and are discussed in Notes 5 through 9.  The recorded value of the note receivable is the original note amount plus accrued interest.  Fair value is not readily determinable; the note is discussed in Note 10.  The investment in the trust is accounted for using the equity method of accounting.  Fair value is not readily determinable; the investment is discussed in Note 13.
 
The carrying value of our investments in policies at November 30, 2011, totaled $9,043,770, which includes $1,034,223 of capitalized premiums, and has an estimated fair value, net of the present value of estimated premiums, of $4,596,072.  Fair value of the investment in policies was determined using unobservable Level 3 inputs and was calculated by performing a net present value calculation of the face amount of the life policies less premiums for the total portfolio.  The unobservable Level 3 inputs use new or updated information that affects our assumptions about remaining life expectancy, credit worthiness of the policy issuer, funds needed to maintain the asset until maturity, and discount rates.  The investment in policies is discussed more fully in Note 12.  The roll forward of the fair value of the investment is as follows:
Fair Value at February 28, 2011
  $ 4,681,176  
Purchases of Policies
    39,777  
Maturity of Policies
    1,378  
Sales of Policies
    (125,636 )
Change in Unrealized Gains
    (623 )
Fair Value at November 30, 2011
  $ 4,596,072  
 
In April 2009, the FASB issued ASC 820-10, Fair Value Measurements and Disclosures, that provides additional guidance for estimating fair value in accordance with ASC 820 when the volume and level of activity for the asset or liability have significantly decreased.  ASC 820-10 also includes guidance on identifying circumstances that indicate a transaction is not orderly.  ASC 820-10 has had no impact on our financial condition, results of operations or cash flows.
 
(17) CONTINGENCIES
 
LPI is aware of certain instances wherein the insurance companies denied payment on policies in which LPI arranged the settlement with purchasers.  Most of these denials are related to unforeseeable reductions in face value.  Face value of the policies in question total $541,665 and our estimated liability is recorded in accrued liabilities at November 30, 2011.  During the First Nine Months of this year, we accrued an additional $356,120 for future claims that might arise in relation to these policies and paid $19,546 of settlements, which had been accrued in the current and previous periods.
 
We record provisions in the Consolidated Condensed Financial Statements for pending litigation when we determine that an unfavorable outcome is probable and the amount of the loss can be reasonably estimated.  Except as discussed elsewhere in this note: (i) management has not concluded that it is probable that a loss has been incurred in any pending litigation; or (ii) management is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome of any pending litigation; and (iii) accordingly, management has not provided any amounts in the Consolidated Condensed Financial Statements for unfavorable outcomes, if any.
 
It is possible that our consolidated results of operations, cash flows or financial position could be materially affected in a particular fiscal quarter or fiscal year by an unfavorable outcome or settlement of any pending litigation.  Nevertheless, although litigation is subject to uncertainty, management believes and we have been so advised by counsel handling the respective cases that we have a number of valid claims and defenses in all pending litigation to which we are a party, as well as valid bases for appeal of adverse verdicts against us.  All such cases are, and will continue to be, vigorously defended and all valid counterclaims pursued.  However, we may enter into settlement discussions in particular cases if we believe it is in the best interests of our shareholders to do so.

 
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(18) DEFINED CONTRIBUTION PLAN
 
All employees are eligible to participate in our 401(k) retirement plan once they have met specified employment and age requirements.  The 401(k) has a matching feature whereby we will make an annual matching contribution to each participant’s plan account equal to 100% of the lesser of the participant’s contribution to the plan for the year or 4% of the participant’s eligible compensation for that year.  The contribution expenses for our matching contributions to the 401(k) plan for the First Nine Months of this year and last year were $58,447 and $116,975, respectively.
 
(19) RELATED PARTY TRANSACTIONS
 
We currently operate under an agreement with ESP Communications, Inc. (“ESP”), which is owned by the spouse of our Chief Executive Officer.  Under the agreement, ESP performs certain post-settlement services for us, which include periodic contact with insureds and their health care providers, monthly record checks to determine an insured’s status, and working with the outside escrow agent in the filing of death claims.  Either party may cancel the agreement with a 30-day written notice.  We currently pay ESP $7,500 on a semi-monthly basis for its services.  We recorded management services expense concerning this agreement with ESP of $135,000 in each of the First Nine Months of this year and last year.
 
We periodically use an aircraft owned by our Chairman and CEO, and reimburse him for the incremental costs of our use, as described in applicable Federal Aviation Administration regulations (FAA Part 91, subpart F).  We believe the reimbursed cost is well below the fair rental value for such use.  In the First Nine Months of this year and last year, we reimbursed costs of $301,604 and $143,786, respectively, for such use.  We also periodically use a motoryacht owned by our Chairman and CEO, and reimburse him for the direct costs of our use.  We believe the reimbursed cost is well below the fair rental value for such use.  In the First Nine Months of this year and last year, we reimbursed costs of $136,497 and $127,100, respectively, for such use.
 
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Special Note:  Certain statements in this quarterly report on Form 10-Q concerning our business prospects or future financial performance, anticipated revenues, expenses, profitability or other financial items, estimates as to size, growth in or projected revenues from the life settlement market, developments in industry regulations and the application of such regulations, expected outcomes of pending or potential litigation and regulatory actions, and our strategies, plans and objectives, together with other statements that are not historical facts, are “forward-looking statements” as that term is defined under the federal securities laws.  All of these forward-looking statements are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements.  You should carefully review the risks described herein and in other documents we file from time to time with the Securities and Exchange Commission, (“SEC”), including our Annual Report on Form 10-K for the year ended February 28, 2011 (“Fiscal 2011”), particularly in the sections entitled “Item 1A – Risk Factors” and “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  We do not undertake any obligation to release publicly any revisions to such forward-looking statements to reflect events or uncertainties after the date hereof or reflect the occurrence of unanticipated events.

 
21

 
 
Critical Accounting Estimates, Assumptions and Policies
 
Our discussion and analysis of financial condition and results of operations are based on our Consolidated Condensed Financial Statements that were prepared in accordance with accounting principles generally accepted in the United States of America.  To guide our preparation, we follow accounting policies, some of which represent critical accounting policies as defined by the SEC.  The SEC defines critical accounting policies as those that are both most important to the portrayal of a company’s financial condition and results and require management’s most difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.  Certain accounting estimates involve significant judgments, assumptions and estimates by management that may have a material impact on the carrying value of certain assets and liabilities, disclosures of contingent liabilities, and the reported amounts of income and expenses during the reporting period that management considers critical accounting estimates.  The judgments, assumptions and estimates used by management are based on historical experience, management’s experience, knowledge of the accounts and other factors that are believed to be reasonable.  Because of the nature of the judgments and assumptions made by management, actual results may differ materially from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of our operations.  Areas affected by our estimates and assumptions are identified below.
 
We recognize income at the time the purchasers have made the obligation to make the purchase and policy closings are funded.  We defer revenue equal to the estimated costs to monitor policies into the future, and we amortize this deferred cost over the anticipated life expectancy of the insureds.
 
We sometimes make short-term advances to facilitate a life settlement transaction.  These amounts are included in “Accounts receivable – trade”, and are collected as the life settlement transactions close.  All amounts are considered collectible as we are repaid the advance before any of the other parties involved in the transaction receive funds.
 
We follow the guidance contained in ASC 325-30, Investments in Insurance Contracts, to account for our investments in life settlement contracts.  ASC 325-30 states that a purchaser may elect to account for its investments in life settlement contracts using either the investment method or the fair value method.  The election is made on an instrument-by instrument basis and is irrevocable.  Under the investment method, a purchaser recognizes the initial investment at the purchase price plus all initial direct costs.  Continuing costs (e.g., policy premiums and direct external costs, if any) to keep the policy in force are capitalized.  Under the fair value method, a purchaser recognizes the initial investment at the purchase price.  In subsequent periods, the purchaser re-measures the investment at fair value in its entirety at each reporting period and recognizes changes in fair value earnings (or other performance indicators for entities that do not report earnings) in the period in which the changes occur.  We elected to value our investments in life settlement contracts using the investment method.  As of November 30, 2011, and February 28, 2011, our investments in life settlements held for our own account were carried at $9,043,770 and $9,506,495, respectively.
 
We review the carrying value of our investments in policies for impairment whenever events and circumstances indicate that we might not recover the carrying value of the policies from future maturities.  In cases where undiscounted expected proceeds from future maturities are less than the carrying value, we recognize an impairment loss equal to an amount by which the carrying value (including expected future costs to maintain the policies) exceeds the expected proceeds.  Based on this assessment, we recorded impairment costs for investments in policies of $499,177 and $4,659,114 during the First Nine Months of this year and last year, respectively.

 
22

 
 
We establish litigation and policy analysis loss accruals based on our best estimates as to the ultimate outcome of contingent liabilities.  This loss analysis is necessary to properly match current expenses to currently recognized revenues and to recognize that there is a certain amount of liability associated with litigation and policy losses.  Through these accruals, we recognize the estimated cost to settle pending litigation as an expense.  These estimates are reviewed on a quarterly basis and adjusted to management’s best estimate of the anticipated liability on a case-by-case basis.  A high degree of judgment is required in determining these estimated accrual amounts since the outcomes are affected by numerous factors, many of which are beyond our control.  As a result, there is a risk that the estimates of future litigation and policy analysis loss costs could differ from our currently estimated amounts.  Any difference between estimates and actual final outcomes could have a material impact on our financial statements.
 
We must make estimates of the collectability of accounts and notes receivable and premium advances.  The accounts associated with these areas are critical to recognizing the correct amount of revenue and expenses in the proper period.  Within the last quarter of fiscal 2010, issues were resolved which have enabled us to better estimate the collectability of premium advances.  The agreement with the State of Texas allowed us to specifically identify a class of investors for whom we made premium advances, and which, under the terms of the agreement, will be uncollectible.  Our historical success of collecting premium advances enabled us to build a body of evidence by which we can demonstrate full collectability of the remaining balance of advanced premiums.  As a result of the resolution of the suit, the reserve for uncollectible premium advances is based on our best estimate and historical data and premium advances are no longer fully reserved.
 
We review the carrying value of our property and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition.  In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of assets.  The factors considered by management in performing this assessment includes current operating results, trends and prospects, the manner in which the property is used, and the effects of obsolescence, demand, competition and other economic factors.  Based on this assessment, there were no impairments during the First Nine Months of this year and last year.
 
We must evaluate the useful lives of our property and equipment to assure that an adequate amount of depreciation is being charged to operations.  Useful lives are based generally on specific knowledge of life for specific types of assets.
 
We are required to estimate our income taxes.  This process involves estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes.  These differences result in deferred tax assets and liabilities.  We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and, to the extent we believe that recovery is not likely, we must establish a valuation allowance.  To the extent we establish a valuation allowance or increase this allowance in a period, we must include a tax provision or reduce our tax benefit in the statements of income.  We use our judgment to determine our provision or benefit for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets.
 
We cannot predict what future laws and regulations might be passed that could have a material effect on our results of operations.  We assess the impact of significant changes in laws and regulations on a regular basis and update the assumptions and estimates used to prepare our financial statements when we deem it necessary.
 
We have not made any material changes to our critical accounting estimates or assumptions or the judgments affecting the application of those estimates or assumptions.  We discuss our significant accounting policies, including those policies that are not critical, in Note 3 of our Consolidated Condensed Financial Statements.

 
23

 
 
New Accounting Pronouncements
 
Recent accounting pronouncements have been issued including ASU 2010-06.  For a discussion of these pronouncements, refer to Note 4 of our Consolidated Condensed Financial Statements.
 
Life Partners
 
General.  Life Partners Holdings, Inc. (“we” or “Life Partners”) is a specialty financial services company and the parent company of Life Partners, Inc. (“LPI”).  LPI is the oldest and one of the most active companies in the United States engaged in the secondary market for life insurance known generally as “life settlements”.  LPI facilitates the sale of life settlements between sellers and purchasers, but does not take possession or control of the policies.  The purchasers acquire the life insurance policies at a discount to their face value for investment purposes.
 
The Secondary Market for Life Insurance Policies.  LPI was incorporated in 1991 and has conducted business under the registered service mark “Life Partners” since 1992.  Our operating revenues are derived from fees for facilitating life settlement transactions.  Life settlement transactions involve the sale of an existing life insurance policy to another party.  By selling the policy, the policyholder receives an immediate cash payment.  The purchaser takes an ownership interest in the policy at a discount to its face value and receives the death benefit under the policy when the insured dies.
 
We are a specialty financial services company, providing purchasing services for life settlements to our client base.  We facilitate these transactions by identifying, examining, and purchasing the policies as agent for the purchasers.  To meet market demand and maximize our value to our clients, we have made significant investments in proprietary software and processes that enable us to facilitate a higher volume of transactions while maintaining our quality controls.  Since our inception, we have facilitated over 136,000 purchaser transactions involving over 6,400 policies totaling over $3.0 billion in face value.  We believe our experience, infrastructure and intellectual capital provide us a unique market position and will enable us to maintain sustainable growth within the life settlement market.
 
The following table shows the number of settlement contracts we have transacted, the aggregate face values of those contracts, and the revenues we derived, for the three and nine months ended November 30, 2011 and 2010:
 
   
Three Months Ended Nov. 30,
   
Nine Months Ended Nov. 30,
 
   
2011
   
2010
   
2011
   
2010
 
Number of settlements
    10       37       44       136  
Face value of policies
  $ 35,000,000     $ 109,925,000     $ 147,044,000     $ 416,410,000  
Avg. revenue per settlement
  $ 666,680     $ 544,855     $ 620,717     $ 621,678  
Net revenues derived*
  $ 2,505,562     $ 10,499,917     $ 9,839,262     $ 46,454,560  

*      Net revenues derived are exclusive of brokerage and referral fees.
 
Comparison of the Three Months Ended November 30, 2011 and 2010
 
We reported a net loss of $1,082,848 for the three months ended November 30, 2011 (the “Third Quarter of this year”), compared to net income of $3,960,688 for the three months ended November 30, 2010 (the “Third Quarter of last year”).  Our lower net income resulted primarily from a 66.9% decrease in revenues, a 76.1% decrease in revenues net of brokerage fees, and a 6.0% decrease in total operating and administrative expenses.  The number of life settlement transactions we brokered decreased from 37 to 10, while the average revenue per settlement increased by 22.3%, from $544,855 in the Third Quarter of last year to $666,680 in the Third Quarter of this year, furthering a trend of fewer transactions and a higher face value per settlement.

 
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The dramatic decrease in revenue was due to two factors.  First, we believe the life settlement market declined from approximately $8 billion in face value transactions in calendar 2009 to approximately $4 billion in calendar 2010 and the market has continued to perform at this lower level.  A second contributing factor was the publication of news articles criticizing our operations coupled with our disclosure of a pending SEC investigation, both of which occurred in the fourth quarter of fiscal 2011.  The articles and disclosure of the pending investigation resulted in a significant drop in the price of our common stock and were followed by civil suits based generally on alleged false disclosures or omissions.  These developments significantly impacted our operations.  Compared to the Third Quarter of last year, we closed a lower number of settlements (10 from 37), lower aggregate face values ($35.0 million from $109.9 million) and lower total net revenues derived ($2.5 million from $10.5 million).  The stability, and increase, in the average revenue per settlement reflects the fact that our revenue decreases result generally from decreases in purchaser demand for life settlements and not in the availability of policies for life settlement transactions.
 
Revenues: Revenue decreased by $13,492,855, or 66.9%, from $20,159,650 in the Third Quarter of last year to $6,666,795 in the Third Quarter of this year.  Brokerage fees declined by $5,498,500, resulting in a 76.1% decrease in the net revenues derived.
 
It is difficult to discern the respective impacts of the general decline in the life settlement markets and the specific adverse developments affecting us.  The general decline in the market followed the 2008 financial crisis.  In reports issued in 2010 and 2011, the insurance research group, Conning & Co. (the “Conning reports”), estimated that the life settlement industry completed $11.8 billion in face value of transactions in 2008, but dropped to $7.6 billion in 2009 and $3.8 billion in 2010.  Demand for our services remained relatively strong during these periods, although weakened somewhat in the latter half of fiscal 2011.  Revenues for the First Quarter of last year reflect this demand.
 
The greater impact upon demand for our services appears to have come from the critical news articles and the uncertainty related to the SEC investigations.  These developments have especially hurt our licensee network and purchaser base.  Our business model is somewhat unique in the industry in that we are the only publicly held, life settlement company and the only prominent company with a broad, retail base.  We believe the publicity from the news articles affected our client base more acutely than the articles might have affected a company with an institutional-oriented base.  We believe the articles portrayed us in a false light, and we have worked with our licensees and clients to restore lost confidence and rebut the charges in the articles.  We expect that we can gradually repair our client base and restore demand, but anticipate that the declines from these events will continue to adversely affect our operating results in fiscal 2012.  Restoration of demand approaching levels we recorded in fiscal 2010 may not occur, however, until and unless we are able to resolve the SEC investigation favorably and the life settlement market strengthens.
 
Brokerage and Referral Fees: Brokerage and referral fees decreased 56.9% or $5,498,500 from $9,659,733 in the Third Quarter of last year to $4,161,233 in the Third Quarter of this year.  Brokerage and referral fees as a percentage of gross revenue increased from 47.9% in the Third Quarter of last year to 62.4% in the Third Quarter of this year.  In the Third Quarter of this year, broker referrals accounted for 100% of the total face value of policies transacted, which is unchanged from the Third Quarter of last year.  For the Third Quarter of this year, six brokers who each accounted for more than 10% of the face value of all completed transactions, constituted 94.3% of the total face value of completed transactions.  For the Third Quarter of last year, two brokers accounted for more than 10% of the face value of all completed transactions, and constituted 32.6% of the total face value of completed transactions.
 
Brokerage and referral fees generally increase or decrease with revenues, face values of policies transacted, and the volume of transactions, although the exact ratio of fees may vary.  Brokers may adjust their fees with the individual policyholders whom they represent.  In some instances, several brokers may compete for representation of the same seller, which may result in lower broker fees.  Referral fees also vary depending on factors such as varying contractual obligations, market demand for a particular kind of policy or life expectancy category and individual agreements between clients and their referring financial planners.  No broker fees are paid when a life settlor presents a policy to us directly.

 
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Many states now license life settlement brokerage activity, which may result in the capping of fees or the increased disclosure of fees.  Industry analysts have suggested that these regulations could tend to lower the fees, although we have yet to see such result.
 
Expenses: Operating and administrative expenses decreased by 5.9% or $294,673 from $4,962,577 in the Third Quarter of last year to $4,667,904 in the Third Quarter of this year.  The decrease is primarily due to decreased impairment and bonuses less an increase in legal and professional fees.  Bonuses were $2,607 and $561,799 in the Third Quarter of this year and last year, respectively.  No executive bonuses were paid this year.  Legal and professional fees were $2,204,217 and $365,147 in the Third Quarter of this year and last year, respectively.  Legal and professional fees are a result of the legal fees associated with the SEC investigation and the shareholder suits and the fees for auditing fiscal years 2009 through 2011.
 
Impairment of investments in policies in the Third Quarter of this year was $129,173 as compared to $1,553,038 in the Third Quarter of last year.
 
During the Third Quarter of this year and last year, we made premium advances of $754,427 and $1,001,356, respectively, and were reimbursed $639,996 and $345,929, respectively.  In a typical life settlement, policy premiums for the insured’s projected life expectancy are added to the purchase price and those future premium amounts are set aside in an escrow account to pay future premiums.  When the future premium amounts are exhausted, purchasers are contractually obligated to pay the additional policy premiums.  In some instances, purchasers have failed to pay the premiums and we have repurchased the policy or advanced the premiums to maintain the policies.  While we have no contractual or other legal obligation to do so, and do not do so in every instance, we have made premium advances as an accommodation to certain purchasers based on our assumptions that we will ultimately recoup the advances.  While some purchasers repay the advances directly, reimbursements of these premiums will come most likely as a priority payment from the policy proceeds when an insured dies.  Net premium advance expense for the Third Quarter of this year and last year was $236,138 and $208,435, respectively, primarily as a result of the increased number of policies exhausting escrow.  See the discussion of Policy Advances within Critical Accounting Estimates, Assumptions and Policies on page 22.
 
Total other income increased from $509,084 in the Third Quarter of last year to $686,442 in the Third Quarter of this year, primarily due to a gain on sales of investments in policies of $691,489.  There was a realized loss on sales of investment securities of $134,509 in the Third Quarter of this year and a realized gain on sales of investment securities of $267,448 in the Third Quarter of last year.
 
Income Taxes: Income tax declined from $2,085,736 in the Third Quarter of last year to $(393,052) in the Third Quarter of this year, due to a loss in the current year versus pretax income in the previous year.
 
Comparison of the Nine months Ended November 30, 2011 and 2010
 
We reported a net loss of $2,280,175 for the nine months ended November 30, 2011 (the “First Nine Months of this year”), compared to net income of $20,395,930 for the nine months ended November 30, 2010 (the “First Nine Months of last year”).  Our lower net income resulted primarily from a 67.7% decrease in revenues, a 78.8% decrease in revenues net of brokerage fees, and a 5.8% decrease in total operating and administrative expenses.  The number of life settlement transactions we brokered decreased from 136 to 44, while the average revenue per settlement was essentially unchanged; $621,678 last year and $620,717 this year.

 
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The dramatic decrease in revenue was due to two factors.  First, we believe the life settlement market declined from approximately $8 billion in face value transactions in calendar 2009 to approximately $4 billion in calendar 2010 and the market has continued to perform at this lower level.  A second contributing factor was the publication of news articles criticizing our operations coupled with our disclosure of a pending SEC investigation, both of which occurred in the fourth quarter of fiscal 2011.  The articles and disclosure of the pending investigation resulted in a significant drop in the price of our common stock and were followed by civil suits based generally on alleged false disclosures or omissions.  These developments significantly impacted our operations.  Compared to the First Nine Months of last year, we closed a lower number of settlements (44 from 136), lower aggregate face values ($147.0 million from $416.4 million) and lower total net revenues derived ($9.8 million from $46.5 million).  No change in the average revenue per settlement reflects the fact that our revenue decreases result generally from decreases in purchaser demand for life settlements and not in the availability of policies for life settlement transactions.
 
Revenues: Revenues decreased by $57,236,671, or 67.7%, from $84,548,210 in the First Nine Months of last year to $27,311,539 in the First Nine Months of this year.  Brokerage fees declined by $20,621,373, resulting in a 78.8% decrease in the net revenues derived.
 
It is difficult to discern the respective impacts of the general decline in the life settlement markets and the specific adverse developments affecting us.  The general decline in the market followed the 2008 financial crisis.  In reports issued in 2010 and 2011, the insurance research group, Conning & Co. (the “Conning reports”), estimated that the life settlement industry completed $11.8 billion in face value of transactions in 2008, but dropped to $7.6 billion in 2009 and $3.8 billion in 2010.  Demand for our services remained relatively strong during these periods, although weakened somewhat in the latter half of fiscal 2011.  Revenues for the First Quarter of last year reflect this demand.
 
The greater impact upon demand for our services appears to have come from the critical new articles and the uncertainty related to the SEC investigations.  These developments have especially hurt our licensee network and purchaser base.  Our business model is somewhat unique in the industry in that we are the only publicly held, life settlement company and the only prominent company with a broad, retail base.  We believe the publicity from the news articles affected our client base more acutely than the articles might have affected a company with an institutional-oriented base.  We believe the articles portrayed us in a false light, and we have worked with our licensees and clients to restore lost confidence and rebut the charges in the articles.  We expect that we can gradually repair our client base and restore demand, but anticipate that the declines from these events will continue to adversely affect our operating results in fiscal 2012.  Restoration of demand approaching levels we recorded in fiscal 2010 may not occur, however, until and unless we are able to resolve the SEC investigation favorably and the life settlement market strengthens.
 
Brokerage and Referral Fees: Brokerage and referral fees decreased 54.1% or $20,621,373 from $38,093,650 in the First Nine Months of last year to $17,472,277 in the First Nine Months of this year.  Brokerage and referral fees as a percentage of gross revenue increased from 45.1% in the First Nine Months of last year to 64.0% in the First Nine Months of this year.  We paid a $600,000 termination fee to our former escrow services provider when we transitioned to a new provider in the quarter ended August 31, 2011.  In the First Nine Months of this year, broker referrals accounted for 100% of the total face value of policies transacted, which is unchanged from the First Nine Months of last year.  For the First Nine Months of this year, two brokers who each accounted for more than 10% of the face value of all completed transactions, constituted 25.4% of the total face value of completed transactions.  For the First Nine Months of last year, two brokers accounted for more than 10% of the face value of all completed transactions, and constituted 31.4% of the total face value of completed transactions.

 
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Brokerage and referral fees generally increase or decrease with revenues, face values of policies transacted, and the volume of transactions, although the exact ratio of fees may vary.  Brokers may adjust their fees with the individual policyholders whom they represent.  In some instances, several brokers may compete for representation of the same seller, which may result in lower broker fees.  Referral fees also vary depending on factors such as varying contractual obligations, market demand for a particular kind of policy or life expectancy category and individual agreements between clients and their referring financial planners.  No broker fees are paid when a life settlor presents a policy to us directly.
 
Many states now license life settlement brokerage activity, which may result in the capping of fees or the increased disclosure of fees.  Industry analysts have suggested that these regulations could tend to lower the fees, although we have yet to see such result.
 
Expenses: Total operating and administrative expenses decreased by 5.8% or $851,117 from $14,795,247 in the First Nine Months of last year to $13,944,130 in the First Nine Months of this year.  The decrease is primarily due to decreased impairment and bonuses less an increase in legal and professional fees.  Bonuses were $13,468 and $1,905,569 in the First Nine Months of this year and last year, respectively.  No executive bonuses were paid this year.  Legal and professional fees were $5,984,748 and $1,134,376 in the First Nine Months of this year and last year, respectively.  Legal and professional fees are a result of the legal fees associated with the SEC investigation, the shareholder suits and the fees to audit fiscal years 2009 through 2011.
 
Impairment of owned policies in the First Nine Months of this year was $499,177, vs. $4,659,114 in the First Nine Months of last year.
 
During the First Nine Months of this year and last year, we made premium advances of $3,959,582 and $2,250,183, respectively, and were reimbursed $2,835,805 and $1,071,004, respectively.  In a typical life settlement, policy premiums for the insured’s projected life expectancy are added to the purchase price and those future premium amounts are set aside in an escrow account to pay future premiums.  When the future premium amounts are exhausted, purchasers are contractually obligated to pay the additional policy premiums.  In some instances, purchasers have failed to pay the premiums and we have repurchased the policy or advanced the premiums to maintain the policies.  While we have no contractual or other legal obligation to do so, and do not do so in every instance, we have made premium advances as an accommodation to certain purchasers based on our assumptions that we will ultimately recoup the advances.  While some purchasers repay the advances directly, reimbursements of these premiums will come most likely as a priority payment from the policy proceeds when an insured dies.  Net premium advance expense for the First Nine Months of this year and last year was $1,088,191 and $663,521, respectively, primarily as a result of the increased number of policies exhausting escrow.  See the discussion of Policy Advances within Critical Accounting Estimates, Assumptions and Policies on page 22.
 
Total other income increased from $693,706 in the First Nine Months of last year to $932,562 in the First Nine Months of this year, primarily due to a gain on sales of investments in policies of $691,489.  There was a realized loss on sales of investment securities of $185,456 in the First Nine Months of this year and a realized gain on sales of investment securities of $119,914 the First Nine Months of last year.
 
Income Taxes: Income tax expense declined from $11,957,089 in the First Nine Months of last year to $(892,131) in the First Nine Months of this year, due to a loss in the current year versus pretax earnings in the previous year.

 
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Contractual Obligations and Commitments
 
Our outstanding contractual obligations and commitments as of November 30, 2011 were:
 
   
Total
   
Due in less
than 1 year
   
Due in
1 to 3 years
   
Due in
4 to 5 years
   
Due after
5 years
 
Operating leases
  $ 198,749     $ 74,438     $ 113,189     $ 11,122     $ -  
Total obligations
  $ 198,749     $ 74,438     $ 113,189     $ 11,122     $ -  
 
Liquidity and Capital Resources
 
Operating Activities: Net cash flows used by operating activities for the First Nine Months of this year were $3,777,967.  Uses of cash flow resulted primarily from a net loss of $2,280,175, a reduction of net income taxes payable of $2,540,690, net premium advances of $1,123,777 and the gain on sales of investments in policies of $691,489.  The primary sources of cash flow were from a decrease in deferred income taxes of $1,014,303, an increase in accrued liabilities of $591,808, impairment of investment in policies of $499,177, an increase in the premiums allowance account of $402,126, and a reduction of accounts receivable of $390,084.  Net cash flows provided by operating activities for the First Nine Months of last year were $23,780,589.  The cash flows from operating activities for last year resulted primarily from net income of $20,395,930, impairment of investments in policies of $4,659,114, a decrease in accounts receivable of $630,552 and an increase in accounts payable of $587,475. The primary use of cash flow was premium advances of $1,520,617.
 
Investing Activities: Net cash flow provided by investing activities was $3,647,287 during the First Nine Months of this year.  This amount consists of $3,163,547 of proceeds from sales of securities, $906,225 of proceeds from sales of investments in policies, $293,545 proceeds from maturities of investments in policies and $65,733 proceeds from the life settlement trust, less $544,733 for purchases of owned policies, $190,782 for an additional investment in the life settlements trust and $46,213 for purchases of property and equipment.  In comparison, in the First Nine Months of last year, net cash flow used by investing activities was $4,256,354.  This amounts consisted of $9,946,605 provided from proceeds of sales of investment securities, $311,367 proceeds from the investment in the life settlement trust and $83,469 from maturities of owned policies, minus $12,160,678 used for purchases of marketable securities, $2,338,021 for the purchase of policies, and $98,906 for purchases of property and equipment.
 
Financing Activities: For the First Nine Months of this year and last year, we used $11,191,135 and $14,901,102, respectively, to pay dividends.
 
Working Capital and Capital Availability: As of November 30, 2011, we had working capital of $14,601,025.  While we believe our existing working capital and future cash flows from operating activities will allow us to fund our short and long-term operations, our working capital decreased $13.2 million during the First Nine Months of this year due primarily to the payment of dividends and, to a lesser extent, operating losses.  Our cash and cash equivalents decreased from $27.6 million as of February 28, 2011, to $16.3 million as of November 30, 2011.  To fund our short and long-term operations at current levels, we may not be able to continue to pay dividends at the historical rate and may need to significantly reduce or eliminate dividends to conserve working capital until we can realize improved operating results.

 
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Outlook
 
We anticipate that our revenues, cash flows and recurring expenses for the remaining quarter of fiscal 2012 will be consistent with those of the First Nine Months of this year.  We believe that life settlements as an asset class are attractive alternatives for persons seeking to diversify investment portfolios and avoid economically sensitive investments.  Since the returns on life settlements are based on policy maturities, they are not correlated to traditional equity and debt markets and commodity investments.  We believe the life settlement market will rebound, which will help our operating results.
 
Our operating results are also impacted by the SEC investigation, which adversely affects our relationships within the licensee network and our purchaser base.  We believe our future results would be aided considerably if we were able to resolve the SEC investigation in a favorable manner.
 
Until we can realize improved operating results, we shall rely on our working capital position, which is strong, and we believe we have sufficient cash and cash equivalents to support our short and long-term operations.  We do not anticipate a need for future borrowings or stock sales.
 
Off-Balance Sheet Arrangements
 
We do not engage in any off-balance sheet arrangements or transactions.
 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Our risk exposure in the financial markets consists of exposure to interest rate changes and changes in the fair values of our investments.  Our risk exposure to changes in interest rates relates primarily to our investment portfolio.  We invest our excess cash in depository accounts with financial institutions and in income and equity-oriented investment funds.  We attempt to protect and preserve our invested funds by limiting default, market, and reinvestment risk through portfolio diversification and review of the financial stability of the institutions with which we deposit funds.  We do not hold derivative financial instruments or financial instruments such as credit default swaps, auction rate securities, mortgage-backed securities or collateralized debt obligations in our investment portfolio.
 
Investments in both fixed-rate and floating-rate interest earning instruments carry a degree of interest rate risk.  Because our business strategy does not rely on generating material returns from our investment portfolio or cash holdings, we do not expect our market risk exposure on our interest-bearing assets to be material.
 
Some of our investment funds may have investments in derivative instruments or other structured securities resulting in indirect exposure for us.  But, any indirect exposure that we might have to these financial instruments through our holdings in these funds is relatively small and thus immaterial.  Fixed-rate securities may have their fair value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall.  Due in part to these factors, our future investment income may fluctuate due to changes in interest rates.  We may suffer losses in principal if forced to sell securities that have declined in fair value due to negative market fluctuations and this potential loss may have a material impact on our financial condition, results of operations or cash flows.
 
ITEM 4.  CONTROLS AND PROCEDURES
 
Disclosure Controls and Procedures.  With the participation of our Chief Executive Officer and Chief Accounting Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report.  Based upon such evaluation, our Chief Executive Officer and Chief Accounting Officer have concluded that, as of the end of such periods, our disclosure controls and procedures were effective in ensuring that (i) information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 
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Internal Control over Financial Reporting.  For the year ended February 28, 2011, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were not effective as a result of reported material weaknesses.  To remediate these weaknesses, we have taken the following steps:
 
 
·
We have changed the date at which we recognize revenue from life settlement transactions,
 
 
·
We have improved the methodology for estimating life expectancies, which affects our calculation of possible impairment of the life settlements in which we have invested and our determination of deferred policy monitoring costs,
 
 
·
We have changed the date at which we recognize executive bonus expense, and,
 
 
·
We have amended our formal written policies and procedures regarding internal controls to reflect these changes.
 
We have implemented these changes.  We believe that testing of our internal controls and review of our financial statements will determine that the enhanced controls are operating effectively.
 
Management is committed to a strong internal control environment and believes that, when fully implemented and tested, the measures described above will improve our internal control over financial reporting. We will continue to assess the effectiveness of our remediation efforts in connection with our future assessments of the effectiveness of internal control over financial reporting.
 
PART II – OTHER INFORMATION
 
ITEM 1.  LEGAL PROCEEDINGS
 
On January 3, 2012, we and certain of our directors and officers were sued by the Securities and Exchange Commission (the “SEC”).  The suit alleges that we, our Chairman and CEO Brian Pardo, General Counsel Scott Peden, and Chief Financial Officer David Martin had knowledge of, but failed to disclose to our shareholders, the alleged underestimation of the life expectancies of settlors of viatical and life settlement policies.  The suit further claims that we prematurely recognized revenues from the sale of the settlements and that we understated the impairment of our investments in policies.  The suit also claims that Pardo and Peden sold shares while possessing inside information.  In addition, the suit alleges that the defendants misled our auditors about our revenue recognition policy.  The suit contains claims for violations of various federal securities statutes and regulations, including violations of the antifraud provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934, and seeks various forms of relief, including injunctive relief, disgorgement, and civil penalties.
 
We believe our internal data along with applicable industry trends and practices refute the claims about the underestimation of life expectancies and that our revenue recognition practices, which were addressed in our most recent Form 10-K, did not result in violations of the Federal securities laws.  No claims were asserted against our subsidiary, Life Partners, Inc., and the suit has no effect on any of Life Partners, Inc.’s life settlements or its life settlement clients.
 
While we plan to defend ourselves vigorously in this suit, and believe we have valid defenses to the suit, as with all litigation, the defense of such proceedings is subject to inherent uncertainties.  The costs of defense will depend upon numerous factors, many of which are as yet unknown and unascertainable due to the early stage of the suit.  Likewise, the outcome of any litigation is necessarily uncertain.  We may be forced to expend considerable funds in connection with attorneys’ fees, costs, and litigation-related expenses associated with the defense, and management’s time and attention will also be taxed during the pendency of the suit.
 
There have been no other developments during the current quarter for our legal proceedings that were not disclosed in our Annual Report on Form 10-K for the year ended February 28, 2011 (the “2011 Annual Report.  For a full disclosure of legal proceedings, please reference our 2011 Annual Report.
 
We are subject to other legal proceedings in the ordinary course of business.  When we determine that an unfavorable outcome is probable, and the amount of the loss can be reasonably estimated, we reserve for such losses.  Except as discussed above:  (i) management has not concluded that it is probable that a loss has been incurred in any of our pending litigation; (ii) management is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome of any pending litigation; and (iii) accordingly, management has not provided any amounts in the Consolidated Condensed Financial Statements for unfavorable outcomes, if any.
 
It is possible that our consolidated results of operations, cash flows or financial position could be materially affected in a particular fiscal quarter or fiscal year by an unfavorable outcome or settlement of any pending litigation.  Nevertheless, although litigation is subject to uncertainty, management believes, and we have been so advised by counsel handling the respective cases, that we have a number of valid legal defenses in all pending litigation to which we are a party, as well as valid bases for appeal of potential adverse rulings that may be rendered against us.  All such cases are, and will continue to be, vigorously defended, and, to the extent available, all valid counterclaims pursued.  Notwithstanding this fact, we may enter into settlement discussions in particular cases if we believe it is in the best interests of our shareholders to do so.
 
ITEM 1A.       RISK FACTORS
 
See “Risk Factors” in our 2011 Annual Report for a detailed discussion of the risk factors affecting us.

 
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ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
None
 
ITEM 3.          DEFAULTS UPON SENIOR SECURITIES
 
None
 
ITEM 4.          (Removed and Reserved)
 
ITEM 5.          OTHER INFORMATION
 
None
 
ITEM 6.  EXHIBITS
 
 
31.1 
Rule 13a-14(a) Certification of CEO
 
31.2 
Rule 13a-14(a) Certification of CFO
 
32 
Section 1350 Certification

 
32

 
 
SIGNATURES
 
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
Date:    January 6, 2012
 
Life Partners Holdings, Inc.
 
By:  /s/ Brian D. Pardo
Brian D. Pardo
President and Chief Executive Officer
(Signing on behalf of the registrant and as principal
executive officer)
 
By:  /s/ David M. Martin
David M. Martin
Chief Financial Officer and Principal Financial and
Accounting Officer

 
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EXHIBIT INDEX
 
DESCRIPTION OF EXHIBITS
 
Number
 
Description
 
Page
         
31.1
 
Rule 13a-14(a) Certification of CEO
 
35
31.2
 
Rule 13a-14(a) Certification of CFO
 
36
32.1
  
Section 1350 Certification
  
37

 
34