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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, 2012

 

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
(State of incorporation)
74-2962475
(I.R.S. Employer ID no.)  
   
204 Woodhew Drive
Waco, Texas
(Address of Principal Executive Offices)  
76712
(Zip Code)  

 

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 ¨
(Do not check if a smaller
reporting company)
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 January 4, 2013: 18,647,468 (18,750,000 issued less 102,532 treasury shares)

 

 
 

 

LIFE PARTNERS HOLDINGS, INC.

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements  
     
  Consolidated Condensed Balance Sheets – November 30, 2012 (Unaudited) and February 29, 2012 3-4
     
  Consolidated Condensed Statements of Income - For the Three and Nine Months Ended November 30, 2012
and 2011 (Unaudited)
5
     
  Consolidated Condensed Statements of Cash Flows - For the Nine Months Ended November 30, 2012 and 2011 (Unaudited) 6
     
  Notes to Consolidated Condensed Financial Statements 7-19
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 19-28
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
     
Item 4. Controls and Procedures 28
     
PART II. OTHER INFORMATION  
     
Item 1. Legal Proceedings  29
     
Item 1A. Risk Factors 30
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 30
     
Item 3. Defaults upon Senior Securities 30
     
Item 4. Mine Safety Disclosures 30
     
Item 5. Other Information 30
     
Item 6. Exhibits 30
     
Signatures   31
     
Exhibit Index   32

 

2
 

 

PART I - FINANCIAL INFORMATION

 

LIFE PARTNERS HOLDINGS, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

NOVEMBER 30, 2012 (Unaudited) AND FEBRUARY 29, 2012

Page 1 of 2

 

ASSETS

 

CURRENT ASSETS:  Nov. 30,
2012
   Feb. 29,
2012
 
         
Cash and cash equivalents  $12,384,255   $11,362,688 
Certificates of deposit   101,086    100,848 
Investment in securities   -    400,000 
Accounts receivable – trade   -    99,363 
Accounts receivable – employees   16,149    15,949 
Accounts receivable – other   24,464    18,410 
Note receivable   -    581,096 
Current portion of income tax receivable   -    1,807,128 
Current portion of deferred tax assets   1,249,439    1,327,918 
Current portion of investment in policies   2,491,865    2,317,974 
Prepaid expenses   225,412    474,837 
Total current assets   16,492,670    18,506,211 
           
PROPERTY AND EQUIPMENT:          
Land and building   2,316,202    2,316,202 
Proprietary software   550,063    545,663 
Furniture, fixtures and equipment   1,552,063    1,478,885 
Transportation equipment   9,800    9,800 
Subtotal   4,428,128    4,350,550 
Accumulated depreciation   (2,301,769)   (2,070,316)
Net property and equipment   2,126,359    2,280,234 
           
OTHER ASSETS:          
Premium advances, net of reserve of $4,202,003 and $3,804,219 respectively   8,881,556    7,216,534 
Investments in policies   -    6,540,560 
Investment in life settlements trust   6,713,405    6,337,339 
Artifacts and other   834,700    834,700 
Income tax receivable   3,003,320    - 
Deferred tax assets   1,277,368    4,051,036 
          
        Total other assets   20,710,349    24,980,169 
           
Total assets  $39,329,378   $45,766,614 

 

See the accompanying notes to Consolidated Condensed Financial Statements.

 

3
 

 

LIFE PARTNERS HOLDINGS, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

NOVEMBER 30, 2012 (Unaudited) AND FEBRUARY 29, 2012

 

Page 2 of 2

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

CURRENT LIABILITIES:  Nov. 30,
2012
   Feb. 29,
2012
 
         
Accounts payable  $2,192,404   $710,148 
Accrued liabilities   271,585    605,299 
Dividends payable   1,869,145    1,872,399 
Accrued settlement expense   100,122    419,292 
Current deferred policy monitoring costs   382,941    398,689 
           
Total current liabilities   4,816,197    4,005,827 
           
Long-term portion of deferred policy monitoring costs   2,456,056    2,523,493 
Income taxes payable   59,187    77,678 
           
       Total long-term liabilities   2,515,243    2,601,171 
           
       Total liabilities   7,331,440    6,606,998 
           
SHAREHOLDERS' EQUITY:          
           
          
Common stock, $0.01 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   20,772,448    27,934,126 
Less: treasury stock – 102,532 shares as of November 30, and February 29, 2012   (385,064)   (385,064)
           
Total shareholders' equity   31,997,938    39,159,616 
           
Total liabilities and shareholders' equity  $39,329,378   $45,766,614 

 

See the accompanying notes to Consolidated Condensed Financial Statements.

 

4
 

 

LIFE PARTNERS HOLDINGS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

FOR THE THREE AND NINE MONTHS ENDED NOVEMBER 30, 2012 AND 2011

 

(Unaudited)

 

   Three Months
Ended Nov. 30,
   Nine Months
Ended Nov. 30,
 
   2012   2011   2012   2011 
REVENUES  $4,776,403   $6,666,795   $13,578,547   $27,311,539 
                     
BROKERAGE FEES   3,154,086    4,161,233    9,138,502    17,472,277 
                     
REVENUES, NET OF BROKERAGE FEES   1,622,317    2,505,562    4,440,045    9,839,262 
                     
OPERATING AND ADMINISTRATIVE EXPENSES:                    
                     
General and administrative   2,006,923    2,029,960    5,771,887    5,559,259 
Legal and professional expense   1,125,739    2,204,217    2,971,658    5,984,748 
Impairment of investments in policies   10,836    129,173    714,866    499,177 
Premium advances, net   526,241    236,138    1,043,522    1,088,191 
Settlement costs (recoveries)   (354,997)   -    (156,893)   613,374 
Depreciation   105,133    68,416    231,453    199,381 
                     
    Total operating and administrative expenses   3,419,875    4,667,904    10,576,493    13,944,130 
                     
LOSS FROM OPERATIONS   (1,797,558)   (2,162,342)   (6,136,448)   (4,104,868)
                     
OTHER INCOME (EXPENSES):                    
                     
Interest and other income (expense)   497,241    129,462    615,062    426,529 
Gain (loss) on sale of assets   160,695    691,489    3,713,973    691,489 
Loss on settlement of note receivable   -    -    (231,096)   - 
Realized gain (loss) on sales of securities   -    (134,509)   -    (185,456)
Total other income and expense   657,936    686,442    4,097,939    932,562 
                     
LOSS BEFORE INCOME TAXES   (1,139,622)   (1,475,900)   (2,038,509)   (3,172,306)
    Total income tax expense (benefit)   (385,973)   (393,052)   (472,566)   (892,131) 
                     
NET LOSS  $(753,649)  $(1,082,848)  $(1,565,943)  $(2,280,175)
                     
LOSS:                    
                     
Per share – Basic and Diluted  $(0.04)  $(0.06)  $(0.08)  $(0.12)
                     
AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING:  Basic and diluted   18,647,468    18,647,468    18,647,468    18,647,468 
                     
THE COMPONENTS OF COMPREHENSIVE LOSSES:                    
Net loss  $(753,649)  $(1,082,848)  $(1,565,943)  $(2,280,175)
Unrealized gain on investment securities, net of taxes   -    91,617    -    89,912 
                     
COMPREHENSIVE LOSS  $(753,649)  $(991,231)  $(1,565,943)  $(2,190,263)

 

See the accompanying notes to Consolidated Condensed Financial Statements.

 

5
 

 

LIFE PARTNERS HOLDINGS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED NOVEMBER 30, 2012 AND 2011

(Unaudited)

 

   Nine Months Ended Nov. 30, 
CASH FLOWS FROM OPERATING ACTIVITIES:  2012   2011 
Net loss  $(1,565,943)  $(2,280,175)
Adjustments to reconcile net income (loss) to operating activities:          
Depreciation   231,453    199,381 
Impairment of investments in policies   714,866    499,177 
Gain on investment in life settlements trust   (458,377)   (22,531)
Increase in allowance for premium advances   401,250    402,126 
Gain on sale of investments in policies   (3,713,973)   (691,489)
Loss on settlement of note receivable   231,096    - 
Realized loss on sales of investments in securities   -    185,456 
Deferred income taxes   2,852,147    1,014,303 
(Increase) decrease in operating assets:          
Accounts receivable   93,109    390,084 
Note receivable   350,000    - 
Prepaid expenses   249,425    (299,540)
Premium advances   (2,066,272)   (1,123,777)
Income taxes payable and receivable    (1,214,683)   (2,540,690)
Increase (decrease) in operating liabilities:          
Accounts payable   1,482,256    (22,864)
Accrued liabilities   (333,714)   591,808 
Accrued settlement expense   (319,170)   137,821 
Deferred policy monitoring costs   (83,185)   (217,057)
Net cash (used in) provided by operating activities   (3,149,715)   (3,777,967)
           
CASH FLOWS FROM INVESTING ACTIVITIES:          
Investment in certificates of deposit   (238)   (35)
Proceeds from sales of marketable securities   400,000    3,163,547 
Purchases of property and equipment   (77,578)   (46,213)
Investment in life settlement trust   (609,371)   (190,782)
Proceeds from sales of investments in policies   9,534,236    906,225 
Proceeds from investment in life settlements trust   691,682    65,733 
Maturities of investments in policies   52,034    293,545 
Purchase of policies for investment purposes   (220,494)   (544,733)
Net cash provided by (used in) investing activities   9,770,271    3,647,287 
           
CASH FLOWS FROM FINANCING ACTIVITIES:          
Dividends paid   (5,598,989)   (11,191,135)
Net cash used in financing activities   (5,598,989)   (11,191,135)
           
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   1,021,567    (11,321,815)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD   11,362,688    27,610,564 
CASH AND CASH EQUIVALENTS, END OF PERIOD   12,384,255    16,288,749 
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:          
Interest paid   -    5,694 
Income taxes paid  $366,620   $634,865 

  

See accompanying notes to Consolidated Condensed Financial Statements.

 

6
 

 

Life Partners Holdings, Inc.

 

Notes to Consolidated Condensed Financial Statements

 

November 30, 2012

 

(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 for its clients at a discount to their face value for investment purposes.

 

(2) 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 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. These financial statements should be read in conjunction with the financial statements and the summary of significant accounting policies and the notes thereto included in the most recent Annual Report on Form 10-K.

 

Property and Equipment. Our property and equipment are depreciated over their estimated useful lives using the straight-line method. Depreciation expenses for the nine months ended November 30, 2012 and 2011 (the “First Nine Months of this year” and “First Nine Months of last year”, respectively) were $231,453 and $199,381, 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

 

7
 

 

Artifacts and Other. The artifacts and other assets are stated at cost. We have evaluated these assets, obtained a recent appraisal, and believe there is no impairment in their value as of November 30, 2012, and February 29, 2012.

 

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 $714,866 and $499,177, respectively.

 

Revenue Recognition. We recognize income at the time a settlement closes and we defer revenue to cover minor policy monitoring services provided after the settlement date and amortize this amount 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.

 

Brokerage Fees. This line item in the consolidated income statement covers costs of sales, which includes compensation paid to life settlement brokers for referrals of policy sellers, compensation paid to licensees for referrals of client purchasers, and medical review and related costs.

 

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.

 

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. Regarding compensation paid to licensees for referrals of client purchasers, during the three months ended November 30, 2012, (the “Third Quarter of this year”), no single licensee accounted for more than 10% of referral fees paid during the period. For the three months ended November 30, 2011 (the “Third Quarter of last year”), no single licensee accounted for more than 10% of referral fees paid during the period. In the First Nine Months of this year and last year, there was no compensation to any licensee that represented more than 10% of total referral fees. Regarding compensation paid to life settlement brokers for referrals of policy sellers, during the Third Quarter of this year, three brokers accounted for more than 10% of the face value of all completed transactions, and constituted 57% of the total face value of completed transactions. For the First Nine Months of this year, three brokers, who each accounted for more than 10% of the face value of all completed transactions, constituted 52% of the total face value of completed transactions. For the Third Quarter of last year, six brokers accounted for more than 10% of the face value of all completed transactions, and constituted 94% 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 25% of the total face value of completed transactions.

 

8
 

 

(3) NEW ACCOUNTING PRONOUNCEMENTS 

 

In January 2011, the FASB issued ASU 2011-06, Improving Disclosures about Fair Value Measurements. ASU 2011-06 amends the Fair Value Measurements and Disclosures Topic to require additional disclosure and clarify existing disclosure requirements about fair value measurements. ASU 2011-06 requires entities to provide fair value disclosures by each class of assets and liabilities, which may be a subset of assets and liabilities within a line item in the statement of financial position. The additional requirements also include disclosure regarding the amounts and reasons for significant transfers in and out of Level 1 and 2 of the fair value hierarchy and separate presentation of purchases, sales, issuances and settlements of items within Level 3 of the fair value hierarchy. ASU 2011-06 is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements, which is effective for fiscal years beginning after December 15, 2011, and for interim periods within those fiscal years. We adopted ASU 2011-06 on March 1, 2012. The adoption of ASU 2011-06 did not have a material impact on our footnote disclosures.

 

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820) — Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, which amends ASC 820 providing consistent guidance on fair value measurement and disclosure requirements between GAAP and International Financial Reporting Standards. ASU 2011-04 became effective for us beginning March 1, 2012, and has no material impact on our Consolidated Condensed Financial Statements.

 

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income. ASU 2011-05 requires the components of net income and other comprehensive income to be either presented in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive statements. The current option to report other comprehensive income and its components in the statement of shareholders’ equity will be eliminated. While ASU 2011-05 changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. This new guidance became effective for us beginning March 1, 2012, and requires retrospective application. As this guidance only amends the presentation of the components of comprehensive income (loss), the adoption does not have an impact on our Consolidated Condensed Financial Statements.

 

In September 2011, the FASB issued ASU 2011-08, “Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment”. The new guidance provides the option to perform a qualitative assessment by applying a more likely than not scenario to determine whether the fair value of a reporting unit is less than its carrying amount, which may then allow a company to skip the annual two-step quantitative goodwill impairment test depending on the determination. This guidance is effective for goodwill impairment tests performed in interim and annual periods for fiscal years beginning after December 15, 2011. The adoption of this guidance does not have a material impact on our Consolidated Condensed Financial Statements.

 

In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU 2011-12 indefinitely defers the new provisions under ASU 2011-05, which required entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented for both interim and annual financial statements. This ASU became effective for us on March 1, 2012, and had no material impact on our Consolidated Condensed Financial Statements.

 

9
 

 

In July 2012, FASB issued ASU 2012-02, Intangibles—Goodwill and Other (Topic 350)—Testing Indefinite-Lived Intangible Assets for Impairment (ASU 2012-02), to allow entities to use a qualitative approach to test indefinite-lived intangible assets for impairment. ASU 2012-02 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed quantitative impairment test by comparing the fair value of the indefinite-lived intangible asset with its carrying value. Otherwise, the quantitative impairment test is not required. ASU 2012-02 is effective for us in our fiscal 2014 and earlier adoption is permitted. We are currently evaluating the impact of our pending adoption of ASU 2012-02 on our Consolidated Condensed Financial Statements.

 

Other recent authoritative guidance issued by the FASB (including technical corrections to the Codification), the American Institute of Certified Public Accountants, and the Securities and Exchange Commission did not, or are not expected to have a material effect on our Consolidated Condensed Financial Statements.

 

(4) 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. Until January 1, 2013, the Federal Deposit Insurance Corporation (“FDIC”) provided unlimited coverage on non-interest-bearing accounts and insured all other bank accounts up to $250,000. After January 1, 2013, the unlimited coverage on non-interest-bearing accounts ceased and only accounts up to $250,000 are insured. 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.

 

(5) 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, 2012, or February 29, 2012.

 

(6) 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 February 29, 2012:

 

   Cost
Basis
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
Municipal and corporate bonds  $400,000   $-   $-   $400,000 
     Total at Feb. 29, 2012  $400,000   $-   $-   $400,000 

 

As of November 30, 2012, we had no investment securities.

 

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(7) 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, 2012, and February 29, 2012, were $0 and $99,363, respectively.

 

(8) ACCOUNTS RECEIVABLE – EMPLOYEES AND OTHER

 

The amount shown on the balance sheet at November 30, 2012, termed Accounts Receivable – Employees, is composed of $16,149 due us from loans to two, non-officer employees. The amounts at November 30, 2012, termed Accounts Receivable – Other, is composed of $24,464 due to us from maturities of policies. The amount for February 29, 2012, termed Accounts Receivable – Employees, reflects loans of $15,949 to two, non-officer employees. The amount at February 29, 2012, termed Accounts Receivable – Other, is composed of $18,410 due us from maturities of policies. We consider all receivables to be current and collectible.

 

(9) NOTE RECEIVABLE

 

The amount of $581,096 shown on the consolidated balance sheet at February 29, 2012, termed Note Receivable represented 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. 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. On May 15, 2012, we received a payment of $350,000 and settled this note, which resulted in a loss of $231,096.

 

(10) 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 29, 2012  $11,020,753 
Advances   4,155,699 
Reimbursements and adjustments   (2,092,893)
Total premium advance balance at November 30, 2012   13,083,559 
Allowance for doubtful accounts   (4,202,003)
Net premium advance balance at November 30, 2012  $8,881,556 

 

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(11) INVESTMENTS IN POLICIES

 

From time to time, we have purchased 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, 2012.

 

Policies With Remaining Life
Expectancy

(in years)
  Number of
Contracts
   Carrying
Value
   Face
Value
 
0-1   3   $12,272   $63,636 
1-2   -    -    - 
2-3   20    769,093    1,208,147 
3-4   7    142,639    236,014 
4-5   3    982,846    2,014,456 
Thereafter   88    585,015    2,884,513 
Total   121   $2,491,865   $6,406,766 

 

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 $714,866 and $499,177 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, 2012, and February 29, 2012, were $121,634 and $1,201,561, 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, 2012, are as follows.

 

Year 1  $48,587 
Year 2   167,011 
Year 3   204,208 
Year 4   235,070 
Year 5   212,277 
Thereafter   1,392,030 
Total estimated premiums  $2,259,183 

 

The majority of our Investments in Policies were purchased as part of settlement agreements and goodwill purchases from existing clients, which we refer to as tertiary purchases. Due to the capital requirements, we do not intend to buy large amounts of policies for investment purposes, and we shall likely resell any policies that we purchase instead of holding the policies for investment. 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 discount rates.

 

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We sold the viatical portion of our Investments in Policies to an unrelated party on May 1, 2012, for $3,829,849, and a significant portion of the life settlements portion of our Investment in Policies to two unrelated parties on May 23, 2012, for $4,056,214. Within the Second and Third Quarter of this year, we also sold several life settlement interests, to various unrelated buyers, for $1,648,173. The remainder of the carrying value of the investment, $2,491,865, net of impairment, is classified as a current asset, as we anticipate selling the policy interests within the next twelve months.

 

(12) 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, 2012, and February 29, 2012, we owned 19.9% of the trust, which we carried at $6.7 million and the $6.3 million, respectively, accounted for on the equity method of accounting. At November 30, 2012, the Trust owned a portfolio of 236 life insurance settlements with a face value of $621 million, of which LPI originally 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.

 

(13) INCOME TAXES

 

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

 

   Nine Months Ended Nov. 30, 
   2012   2011 
Income tax (benefit) expense from continuing operations  $(472,566)  $(892,131)

 

Income tax expense was made up of the following components:

 

   Nine Months Ended Nov. 30, 
   2012   2011 
Current income taxes  $(3,324,713)  $(1,906,434)
Deferred tax expense (benefit)   2,852,147    1,014,303 
Total income tax expense  $(472,566)  $(892,131)

 

Income tax expense differed from amounts computed by applying the Federal income tax rate to pre-tax earnings for the First Nine Months of this year and last year as a result of the following:

 

   Nine Months Ended Nov. 30, 
   2012   2011 
United States statutory rate   35.0%   35.0%
State income taxes   (1.9)%   (2.1)%
Permanent differences   (9.9)%   (4.8)%
Combined effective tax rate   23.2%   28.1%

 

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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, 2012   Feb. 29, 2012 
Deferred tax assets:        
Impairment of investment in policies  $322,863   $3,706,127 
Premium advances allowance   1,471,915    1,331,477 
Deferred policy monitoring costs   967,295    980,597 
Investment in securities   672,115    672,115 
Contingency costs   35,042    146,752 
Charitable contributions   270,202    176,199 
Compensated absences   26,185    40,932 
State taxes   20,715    27,188 
    3,786,332    7,081,387 
Valuation allowance   (643,403)   (643,403)
Net deferred tax assets   3,142,929    6,437,984 
           
Deferred tax liabilities:          
Settlement costs   (78,072)   (861,080)
Depreciation   (106,286)   (140,860)
Prepaid expenses   (70,000)   (43,750)
Unrealized revenues and brokerage fees   (348,424)   - 
Loss in investment in trust   (13,340)   (13,340)
Net deferred tax liabilities   (616,122)   (1,059,030)
Total deferred tax asset, net  $2,526,807   $5,378,954 
Summary of deferred tax assets:          
Current  $1,249,439   $1,327,918 
Non-current   1,277,368    4,051,036 
Total deferred tax asset, net  $2,526,807   $5,378,954 

 

Income Tax Receivable. As a result of our operating losses for fiscal 2012 and in the current fiscal 2013, we recorded an income tax receivable for overpayment of federal income taxes in prior years. As of August 31, 2012, we recorded $2,477,600 as the current portion of our income tax receivables and received this amount during the Third Quarter of this year. In addition, as of November 30, 2012, we have recorded $3,003,320 as the non-current portion of our income tax receivables.

 

Valuation Allowance. 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 and 2012, we had net capital losses of $91,729. This increased the valuation allowance to $643,403 at February 29, 2012, and November 30, 2012.

 

With few exceptions, we are no longer subject to U.S. federal, state or local examinations by tax authorities for fiscal years 2009 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.

 

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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 29, 2012, 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, 2012, and February 29, 2012, was $123,374.

 

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

 

Balance at February 29, 2012  $123,374 
Reductions based on tax positions related to the current period   - 
Balance at November 30, 2012  $123,374 

 

(14) COMPREHENSIVE INCOME PER SHARE, SHAREHOLDERS’ EQUITY, STOCK TRANSACTIONS AND COMMON STOCK OPTIONS

 

Comprehensive losses for Third Quarter of this year and last year were $(753,649) and $(991,231), respectively. Comprehensive losses income for the First Nine Months of this year and last year were $(1,565,943) and $(2,190,263), respectively. Basic and diluted losses per share for comprehensive income for the Third Quarter of this year and last year were $(0.04) and $(0.06), respectively. Basic and diluted losses per share for comprehensive losses for the First Nine Months of this year and last year were $(0.08) and $(0.12), 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
01/21/11 03/15/11 $0.20
05/4/11 06/15/11 $0.20
08/11/11 09/15/11 $0.20
11/23/11 12/15/11 $0.20
02/27/12 03/15/12 $0.10
05/23/12 06/15/12 $0.10
08/8/12 09/26/12 $0.10
12/03/12 12/17/12 $0.10

 

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.

 

(15) 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.

 

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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

 

·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.

 

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Following is a table of Investment in Securities measured at fair value on a recurring basis as of February 29, 2012, 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  $400,000    -    -   $400,000 
Total at Feb. 29, 2012  $400,000    -    -   $400,000 

 

As of November 30, 2012, we had no investment securities.

 

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 4 through 8. Before settlement of the note receivable in the First Quarter of this year, the recorded value of the note receivable was the original note amount plus accrued interest. Its fair value was not readily determinable; the note is discussed in Note 9. 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 12.

 

The carrying value of our investments in policies at November 30, 2012, totaled $2,491,865, which includes $373,045 of capitalized premiums, and has an estimated fair value, net of the present value of estimated premiums, of $1,312,517. 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 11. The roll forward of the fair value of the investment is as follows:

 

Fair Value at February 29, 2012  $4,483,039 
Purchases of Policies   (26,117)
Maturity of Policies   (14,642)
Sales of Policies   (2,812,422)
Change in Unrealized Gains   (317,341)
Fair Value at November 30, 2012  $1,312,517 

 

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.

 

(16) 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.

 

In connection with the promotion of licensee relations, 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). In the First Nine Months of this year and last year, we reimbursed costs of $524,984 and $301,604, respectively, for such use. We believe the reimbursed cost is well below the fair rental value for such use. We also periodically use a motoryacht owned by our Chairman and CEO in order to promote licensee relations and we reimburse him for the direct costs of our use. In the First Nine Months of this year and last year, we reimbursed costs of $29,015 and $136,497, respectively, for such use. We believe the reimbursed cost is well below the fair rental value for such use.

 

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(17) CONTINGENCIES

 

LPI is aware of certain instances in which 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 $152,279 and our estimated liability is recorded in accrued liabilities at November 30, 2012. During the First Nine Months of this year, we accrued an additional $68,000 for future claims that might arise in relation to these policies and paid $37,050 of settlements, which had been accrued in the current and previous periods. In addition, during the First Nine Months of this year, we adjusted an accrual due primarily to the settlement of a previously reserved contingency resulting in a net recovery of $354,997 during the Third Quarter of this year and a credit balance of $156,893 for the First Nine Months of this year.

 

Except as described above, there have been no material contingencies during the current quarter. During the current quarter, there have been no material developments for legal proceedings apart from those legal proceedings that are disclosed in Part II, Item 1, of this Quarterly Report or were disclosed in our Quarterly Reports for the First and Second Quarters of this year (collectively, the “2013 Quarterly Reports”), and in our Annual Report on Form 10-K for the year ended February 29, 2012 (the “2012 Annual Report”). For a full disclosure of legal proceedings, please reference our 2013 Quarterly Reports and 2012 Annual Report.

 

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.

 

(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 $59,136 and $58,447, respectively.

 

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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 29, 2012 (“Fiscal 2012”), 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.

 

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 a settlement closes and the purchasers have made the obligation to make the purchase. 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, 2012, and February 29, 2012, our investments in life settlements held for our own account were carried at $2,491,865 and $8,858,534, respectively.

 

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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 $714,866 and $499,177 during the First Nine Months of this year and last year, respectively.

 

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 2011, 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.

 

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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 2 of our Consolidated Condensed Financial Statements.

 

New Accounting Pronouncements

 

Recent accounting pronouncements have been issued including ASU 2011-04, 2011-05, 2011-06, 2011-08, 2011-12 and 2012-02. For a discussion of these pronouncements, refer to Note 3 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 145,000 purchaser transactions involving over 6,500 policies totaling over $3.1 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.

 

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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 Third Quarter and First Nine Months of this year and last year:

 

   Three Months Ended Nov. 30,   Nine Months Ended Nov. 30, 
   2012   2011   2012   2011 
Number of settlements   12    10    25    44 
Face value of policies  $30,508,150   $35,000,000   $77,158,150   $147,044,000 
Avg. revenue per settlement  $398,034   $666,680   $543,142   $620,717 
Net revenues derived*  $1,622,317   $2,505,562   $4,440,045   $9,839,262 

__________________

 

*      Net revenues derived are exclusive of brokerage and referral fees.

 

Comparison of the Three Months Ended November 30, 2012 and 2011

 

We reported a net loss of $753,649 for the three months ended November 30, 2012 (the “Third Quarter of this year”), compared to a net loss of $1,082,848 for the three months ended November 30, 2011 (the “Third Quarter of last year”). Our lower net loss resulted primarily from a 27% decrease in total operating and administrative expenses and a $354,997 credit balance against previously recognized settlement costs. The number of life settlement transactions we brokered increased from 10 to 12, while the average revenue per settlement decreased by 40%, from $666,680 in the Third Quarter of last year to $398,034 in the Third Quarter of this year. The decrease in average revenue per settlement during the Third Quarter of this year is due primarily to a larger number of smaller faced policies transacted during this period as well as higher brokerage and referral fees due to a policy resale accommodation to institutional clients, in which we cover their resale fees to encourage reinvestment of the sale proceeds, and to promotional bonuses paid to licensees.

 

Revenues: Revenue decreased by $1,890,392, or 28%, from $6,666,795 in the Third Quarter of last year to $4,776,403 in the Third Quarter of this year. Brokerage fees declined by $1,007,147 or 24%, but increased 4% as a percentage of gross revenues. These factors resulted in a 35% decrease in the net revenues derived in the Third Quarter of this year compared to the Third Quarter of last year.

 

Although the general market for life settlements appears to have reduced among all industry participants, we continued to experience a decreased demand for our services due to negative publicity from news articles and the filing of a civil action by the Securities and Exchange Commission. We believe these articles portrayed us in a false light, and we have devoted substantial resources and the personal time of our senior management to improve licensee relations, develop new clients and work to rebuild confidence in our company. Since the start of our current fiscal year (March 1, 2012), approximately 2,200 of our clients have been paid approximately $50 million in proceeds from their life settlement transactions, and we believe the amount of payouts will increase during the remainder of this fiscal year. Since many of our life settlement purchasers are repeat purchasers, we believe the payouts will restore some demand in the remainder of this fiscal year and the following fiscal year and will enable us to gradually rebuild our markets. We have observed an increase in new clients and deposits into escrow as well as a generally increased positive interest in our services. We intend to continue devoting resources to rebuild our client base and increase demand for our services during the remainder of fiscal 2013. However, restoration of demand approaching levels we recorded in fiscal 2011 may not occur, until and unless we are able to resolve the civil actions filed by the Securities and Exchange Commission and other private litigants favorably.

 

Brokerage and Referral Fees: Brokerage and referral fees decreased 24% or $1,007,147 from $4,161,233 in the Third Quarter of last year to $3,154,086 in the Third Quarter of this year. Brokerage and referral fees as a percentage of gross revenue increased from 62% in the Third Quarter of last year to 66% in the Third Quarter of this year. We believe the increase was due primarily to a policy resale accommodation to institutional clients, in which we cover their resale fees to encourage reinvestment of the sale proceeds and to promotional bonuses paid to licensees. In the Third Quarter of this year, broker referrals accounted for 67% of the total face value of policies transacted, compared to 100% in the Third Quarter of last year. For the Third Quarter of this year, three brokers accounted for more than 10% of the face value of all completed transactions, constituted 57% of the total face value of completed transactions. For the Third Quarter of last year, six brokers who each accounted for more than 10% of the face value of all completed transactions, and constituted 94% of the total face value of completed transactions. No one licensee accounted for more than 10% of the licensee referral fees expense.

 

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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.

 

Expenses: Operating and administrative expenses decreased by 27% or $1,248,029 from $4,667,904 in the Third Quarter of last year to $3,419,875 in the Third Quarter of this year. The decrease is primarily due to 49% decrease in legal and professional fees. Legal and professional fees were $1,125,739 and $2,204,217 in the Third Quarter of this year and last year, respectively. A significant amount of legal and professional fees were incurred in this quarter in defending ourselves against an action filed by the Texas Attorney General. See Part II. Item13. Legal Proceedings. This action, which was resolved in our favor in the district court, required incurring substantial legal fees in a concentrated period of time. Because of the nature of the action and our success in the district court, we do not anticipate incurring further substantial legal fees in that matter. Other legal and professional fees are a result of the legal fees associated with the SEC investigation and the shareholder suits and have declined due to insurance coverage and a reduction in legal activity.

 

Impairment of investments in policies in the Third Quarter of this year declined to $10,836 as compared to $129,173 in the Third Quarter of last year primarily due the sale of affected policies.

 

During the Third Quarter of this year and last year, we made premium advances of $2,033,352 and $754,427, respectively, and were reimbursed $1,021,841 and $639,996, 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 $526,241 and $236,138, 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 19.

 

Total other income decreased slightly from $686,442 in the Third Quarter of last year to $657,936 in the Third Quarter of this year, primarily due to a $425,589 gain from investment in life settlements trust during the Third Quarter of this year compared to other income comprised primarily of $530,794 in additional sales of investments in policies, offset by a realized loss on sales of investment securities of $134,509 in the Third Quarter of last year.

 

Income Taxes: As a result of our losses in fiscal 2012 and in the current fiscal 2013, we have accrued net operating losses, which can be used to offset future taxable income and recorded as income tax benefit. Our income tax benefit decreased from $393,052 in the Third Quarter of last year to $385,973 in the Third Quarter of this year, primarily due to $425,589 gain from investment in life settlements trust.

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Comparison of the Nine months Ended November 30, 2012 and 2011

 

We reported a net loss of $1,565,943 for the nine months ended November 30, 2012 (the “First Nine Months of this year”), compared to a net loss of $2,280,175 for the nine months ended November 30, 2011 (the “First Nine Months of last year”). The reduction in net loss resulted primarily from a 24% decrease in total operating and administrative expenses and a 339% increase in other income arising from the one-time sale of most of our viatical and life settlement interests held for our own account. The number of life settlement transactions we brokered decreased from 44 to 25, while the average revenue per settlement decreased from $620,717 during the First Nine Months of last year to $543,142 during the First Nine Months of this year. The decrease in average revenue per settlement during the quarter may have been due in part to a larger number of smaller faced policies transacted during this period as well as higher brokerage and referral fees due to a policy resale accommodation to institutional clients.

 

Revenues: Revenues decreased by $13,732,992, or 50%, from $27,311,539 in the First Nine Months of last year to $13,578,547 in the First Nine Months of this year. Brokerage fees declined by $8,333,775 or 48%, but increased 3% as a percentage of gross revenues. These factors resulted in a 55% decrease in the net revenues derived in the Third Quarter of this year compared to the Third Quarter of last year.

 

Although the general market for life settlements appears to have reduced among all industry participants, we continued to experience a decreased demand for our services due to negative publicity from news articles and the filing of a civil action by the Securities and Exchange Commission. We believe these articles portrayed us in a false light, and we have devoted substantial resources and the personal time of our senior management to improve licensee relations, develop new clients and work to rebuild confidence in our company. Since the start of our current fiscal year (March 1, 2012), some 2,200 of our clients have been paid approximately $50 million in proceeds from their life settlement transactions, and we believe the amount of payouts will increase during the remainder of this fiscal year. Since many of our life settlement purchasers are repeat purchasers, we believe the payouts will restore some demand in the remainder of this fiscal year and the following fiscal year and will enable us to gradually rebuild our markets. We have observed an increase in new clients and deposits into escrow as well as a generally increased positive interest in our services. We intend to continue devoting resources to rebuild our client base and increase demand for our services during the remainder of fiscal 2013. However, restoration of demand approaching levels we recorded in fiscal 2011 may not occur, until and unless we are able to resolve the civil actions filed by the Securities and Exchange Commission and other private litigants favorably.

 

Brokerage and Referral Fees: Brokerage and referral fees decreased 48% or $8,333,775 from $17,472,277 in the First Nine Months of last year to $9,138,502 in the First Nine Months of this year. Brokerage and referral fees as a percentage of gross revenue increased from 64% in the First Nine Months of last year to 67% in the First Nine Months of this year due primarily to a policy resale accommodation to institutional clients. In the First Nine Months of this year, broker referrals accounted for 87% of the total face value of policies transacted, compared to 100% in the First Nine Months of last year. For the First Nine Months of this year, three brokers who each accounted for more than 10% of the face value of all completed transactions, constituted 52% 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 25% of the total face value of completed transactions. No one licensee accounted for more than 10% of the licensee referral fees expense during the period.

 

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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Expenses: Total operating and administrative expenses decreased by 24% or $3,367,637 from $13,944,130 in the First Nine Months of last year to $10,576,493 in the First Nine Months of this year. The decrease is primarily due to 50% decrease in legal and professional fees. Legal and professional fees were $2,971,658 and $5,984,748 in the Third Quarter of this year and last year, respectively. A significant amount of these legal and professional fees were incurred in the Third Quarter of this year in defending ourselves against an action filed by the Texas Attorney General. See Part II. Item 1. Legal Proceedings. This action, which was resolved in our favor in the district court, required incurring substantial legal fees in a concentrated period of time. Because of the nature of the action and our success in the district court, we do not anticipate incurring further substantial legal fees in that matter. Other legal and professional fees are largely a result of the legal fees associated with the SEC investigation and the shareholder suits and these amounts have declined due to insurance coverage and a reduction in legal activity.

 

Impairment of owned policies in the First Nine Months of this year was $714,866 compared to $499,177 in the First Nine Months of last year.

 

During the First Nine Months of this year and last year, we made premium advances of $4,155,699 and $3,959,582, respectively, and were reimbursed $2,092,893 and $2,835,805, 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 $1,043,522 and $1,088,191, 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 19.

 

Total other income and expense increased from $932,562 in the First Nine Months of last year to $4,097,939 in the First Nine Months of this year, primarily due to a gain on sales of investments in policies of $3,713,973. There was a realized loss on sales of investment securities of $185,456 in the First Nine Months of last year, but no sale of securities during the First Nine Months of this year.

 

Income Taxes: Our income tax benefit decreased 47% from $892,131 in the First Nine Months of last year to $472,566 in the First Nine Months of this year, due to the substantial increase in other income from the sale of life settlement interests owned for our own account and a 5% decrease in our deferred tax cost compared to greater losses in income before income taxes in the previous year.

 

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Contractual Obligations and Commitments

 

Our outstanding contractual obligations and commitments as of November 30, 2012 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   $ 164,873     $ 79,388     $ 140,195     $ 6,486     $ -  
Total obligations   $ 164,873     $ 79,388     $ 140,195     $ 6,486     $ -  

 

Liquidity and Capital Resources

 

Operating Activities: Net cash flows used by operating activities for the First Nine Months of this year were $3,149,715. Uses of cash flow resulted primarily from a net loss of $1,565,943, an increase of income taxes receivable of $1,214,683, net premium advances of $2,066,272, gain on sales of investments in policies of $3,713,973 and the gain on investment in life settlements trust of $458,377. The primary sources of cash flow were from a decrease in deferred income taxes of $2,852,147, an increase in accounts payable of $1,482,256, impairment of investment in policies of $714,866, an increase in the premiums allowance account of $401,250, repayment of a note receivable of $350,000, and a reduction of prepaid expenses of $249,425. Net cash flows used by operating activities for the First Nine Months of last 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.

 

Investing Activities: Net cash flow provided by investing activities was $9,770,271 during the First Nine Months of this year. This amount consists of $9,534,236 of proceeds from sales of investments in policies, $400,000 of proceeds from sales of investments in securities, $691,682 of proceeds from our investment in the life settlements trust and offset by $220,494 purchases of policies for investment purposes, and $609,371 investment in life settlement trust. In comparison, net cash flow provided by investing activities was $3,647,287 during the First Nine Months of last 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.

 

Financing Activities: For the First Nine Months of this year and last year, we used $5,598,989 and $11,191,135, respectively, to pay dividends.

 

Working Capital and Capital Availability: As of November 30, 2012, we had working capital of $11,676,473. 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 $5.3 million during the First Nine Months of this year due primarily to decreases in our current assets including our note receivable, income tax, deferred tax and investment in policies. To fund our short and long-term operations at current levels and to continue to pay dividends, we have liquidated much of our investment portfolio, including most of our investments in policies and our investments in securities. We believe our investment in the life settlement trust has substantial unrealized value, but there is no ready market for the investment. Except for our cash and cash equivalents, we have few sources of additional liquidity. As a result, 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.

 

Outlook

 

It is difficult to discern the respective impacts of the general decline in the life settlement markets as compared to the adverse publicity affecting us specifically. The general decline in the market followed the 2008 financial crisis. In a report issued in 2012, the insurance research group, Conning & Co. (the “Conning report”), 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, $3.8 billion in 2010 and $1.25 billion in 2011. The 2012 Conning report focuses primarily on market participants that, unlike our transactions, are organized in a fund structure and suggests the decrease in the life settlement market generally results from a lack of capital due primarily to fund investor’s concern regarding liquidity. While liquidity is a risk factor to be considered by any purchaser of life settlements, we believe our clients, as direct fractional owners of policies, are in a better position to evaluate their own individual liquidity needs, benefit from the fact that we do not charge annual management fees, and benefit from the fact that they are not required to share profits above a certain target level with us. Our challenge throughout fiscal 2013 has been to rebuild confidence in our company among our licensees and clients and to expand our client base. We have expended significant amounts of time and resources in this rebuilding effort and believe we have made substantial progress in restoring the confidence and interest of our clients. We intend to continue these efforts throughout the remaining fiscal quarter of 2013 and into fiscal 2014. A significant element of our rebuilding effort has been the fact that, during the 2012 calendar year, approximately $60 million in payouts from transactions were experienced. We believe the experience of these payouts will help restore client confidence and aid in rebuilding our corporate reputation that was damaged by the institution of the SEC action and other private litigation previously reported in our Annual Report on Form 10K for Fiscal 2012.

 

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The Conning report forecasts that the life settlement market overall will remain relatively flat for the next few years. We concur with Conning’s predictions about the 2013 market and we believe that the total market is likely to remain relatively flat for the next year at about $1.25 billion in face value. However, the Conning report also notes, and we agree that the supply of qualified life settlements is expected to remain strong and that life settlements remain an attractive alternative investment because the asset class has a low correlation to fixed-income and equity securities and offers investors the potential to generate competitive returns. We believe that life settlements should be appealing as an asset class, especially given the low interest rate environment for fixed income investments and equity market volatility. Based on the reduction in predicted transaction volume for the entire industry, our focus will be on increasing our share of the projected $1.25 billion total market by capitalizing on the strength of our client base and transaction structure, and by utilizing our proprietary software and processes to provide competitive bids and a high level of responsiveness and service to those who present policies to us.

 

We anticipate that our revenues, cash flows and recurring expenses will continue to improve during the remainder of fiscal 2013. We believe that life settlements as an asset class will remain an attractive alternative for persons seeking to diversify investment portfolios and avoid economically sensitive investments. Since the returns on life settlements are a function of the discount at which policies are purchased, future premium payments and the passage of time, they are not correlated to traditional equity and debt markets and commodity investments. Essentially, life settlements create value in a way that is different than market-based investments.

 

Despite the progress we have made in our efforts to rebuild confidence in our company, the large drops in revenues, the significant legal and professional fees, and operating losses we have experienced over the First Nine Months of this year have eroded the strength of our financial condition. The SEC suit and other litigation have been highly damaging to our business, and we do not anticipate a substantial recovery in our revenues and net income while the SEC suit and the other private litigation continues. To mitigate these developments, we continue to invest significantly in programs to develop and strengthen our relationships with new and inactive licensees. We are conserving our cash in anticipation that the suit will not be quickly resolved. We have decreased our cash dividends and may make further cuts and could eliminate the dividends. We have sold the majority of our portfolio of investments in policies and are reducing our investments, including investments in policies.

 

Until we can realize improved operating results, we shall rely on our working capital position, which is still relatively 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.

 

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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.

 

Changes in Internal Control over Financial Reporting. With the participation of our Chief Executive Officer and our Chief Accounting Officer, we have concluded that there were no changes to our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the period covered by this Quarterly Report on Form 10-Q (the fiscal quarter ended November 30, 2012). As we reported on a Form 8-K filed on October 25, 2012, we appointed a new Chief Financial Officer, Colette Pieper, to replace our former Chief Financial officer, David M. Martin, who resigned on July 12, 2012, to pursue another employment opportunity. Ms. Pieper joined us on November 19, 2012.

 

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Part II – other information

 

Item 1. Legal Proceedings

 

Other than as stated below, there have been no material 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 29, 2012 (the “2012 Annual Report”). For a full disclosure of legal proceedings, please reference our 2012 Annual Report.

 

We are party to a class action suit filed in the 191st Judicial District Court of Dallas County, Texas, and styled Helen Z. McDermott, Individually and on Behalf of all Others Similarly Situated v. Life Partners, Inc., Cause No. 11-02966. On November 20, 2012, the court certified this action as a class action with a class consisting of 38 persons. LPI has appealed this ruling and intends to vigorously defend the allegations in the suit, including opposing certification of the purported class. Because of the appeal regarding the certification of the class, the trial setting may be further postponed.

 

On August 16, 2012, the Texas Attorney General, acting for the State Securities Board, filed suit against Life Partners Holdings, Inc., Life Partners, Inc., its Chairman and President, Brian Pardo, and its General Counsel, Scott Peden. The suit sought a temporary restraining order preventing us from doing business and appointment of receiver based generally on allegations that our life settlements are securities under Texas law and that we made various misrepresentations in the sale of the life settlements, including misrepresentations about the life expectancies of the insureds. At the conclusion of a hearing held September 24 and 25, 2012, the court ruled that the life settlement transactions that we facilitate are not securities under Texas law. Since the claims were based on the premise that the life settlements were securities, the ruling effectively terminated the Attorney General’s case. The Attorney General has filed notice of an appeal in the case.

 

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 2012 Annual Report for a detailed discussion of the risk factors affecting us.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

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

 

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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 9, 2013    
     
  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/ Colette Pieper  
  Colette Pieper  
  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 33
31.2 Rule 13a-14(a) Certification of CFO 34
32 Section 1350 Certification 35

 

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