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, 2014

 

or

 

¨ Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

 

Commission File Number: 0-07900

 

LIFE PARTNERS HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)

 

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

 

Registrant’s telephone number, including area code: 254-751-7797

 

Indicate by check mark whether the Registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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. x Yes ¨ 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). x Yes ¨ 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 the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨	Accelerated filer ¨	Non-accelerated filer ¨	Smaller reporting company x
		(Do not check if a smaller reporting company)

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes  x   No

 

Shares of Common Stock, $.01 par value, outstanding as of January 14, 2015: 18,647,468 outstanding (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, 2014 (Unaudited) and February 28, 2014	3-4
	Consolidated Condensed Statements of Income - For the Three and Nine Months Ended  November 30, 2014 and 2013 (Unaudited )	5
	Consolidated Condensed Statements of Cash Flows - For the Nine Months Ended  November 30, 2014 and 2013 (Unaudited)	6
	Notes to Consolidated Condensed Financial Statements	7-17
Item 2.	Management's Discussion and Analysis of Financial Condition  and Results of Operations	17-23
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	23
Item 4.	Controls and Procedures	23
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	23-26
Item 1A.	Risk Factors	26-28
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	28
Item 3.	Defaults upon Senior Securities	28
Item 4.	Mine Safety Disclosures	28
Item 5.	Other Information	28
Item 6.	Exhibits	28
Signatures		29
Exhibit Index		30

 

 

PART I - FINANCIAL INFORMATION

 

LIFE PARTNERS HOLDINGS, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

NOVEMBER 30, 2014 (Unaudited) AND FEBRUARY 28, 2014

Page 1 of 2

 

ASSETS

 

		Nov. 30, 2014				Feb. 28, 2014
CURRENT ASSETS:
Cash and cash equivalents		$	4,220,749			$	6,134,731
Certificates of deposit			352,008				351,588
Accounts receivable – trade			57,049				17,480
Accounts receivable – other			31,429				20,750
Note receivable			8,912				8,912
Current portion of investments in policies			363,995				1,075,205
Deferred income taxes			608,644				585,498
Prepaid expenses			596,916				224,233
Total current assets			6,239,702				8,418,397
PROPERTY AND EQUIPMENT:
Land and building			2,316,202				2,316,202
Proprietary software			559,879				554,211
Furniture, fixtures and equipment			1,546,753				1,536,390
Transportation equipment			9,800				9,800
			4,432,634				4,416,603
Accumulated depreciation			(2,645,888	)			(2,502,647	)
			1,786,746				1,913,956
OTHER ASSETS:
Premium advances, net of allowance of $5,080,077 and $4,661,953 respectively			7,300,062				7,043,680
Long term portion of investments in policies			130,811				1,165,941
Investment in life settlements trust			-				6,648,478
Artifacts and other			834,700				837,850
Deferred income tax asset			4,023,775				3,442,293
Total other assets			12,289,348				19,138,242
Total assets		$	20,315,796			$	29,470,595

 

See the accompanying notes to Consolidated Condensed Financial Statements.

 

 

LIFE PARTNERS HOLDINGS, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

NOVEMBER 30, 2014 (Unaudited) AND FEBRUARY 28, 2014

Page 2 of 2

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

		Nov. 30,				Feb. 28,
		2014				2014
CURRENT LIABILITIES:
Accounts payable		$	1,571,060			$	908,963
Accrued liabilities			473,318				353,604
Dividends payable			4,297				936,788
Current portion of note payable			237,518				-
Accrued settlement expense			45,499				45,499
Deferred policy monitoring costs - current			708,405				638,373
Total current liabilities			3,040,097				2,883,227
LONG-TERM LIABILITIES:
Long-term portion of deferred policy monitoring costs			4,319,110				3,892,130
Income taxes payable			52,028				56,726
Total long-term liabilities			4,371,138				3,948,856
Total liabilities			7,411,235				6,832,083
SHAREHOLDERS' EQUITY:
Common stock, $0.01 par value 18,750,000 shares authorized; 18,750,000 shares issued and 18,647,468 outstanding			187,500				187,500
Additional paid-in capital			11,423,054				11,423,054
Retained earnings			1,679,071				11,413,022
Less: treasury stock – 102,532 shares as of November 30 and February 28, 2014			(385,064	)			(385,064	)
Total shareholders' equity			12,904,561				22,638,512
Total liabilities and shareholders' equity		$	20,315,796			$	29,470,595

 

See the accompanying notes to Consolidated Condensed Financial Statements.

 

 

LIFE PARTNERS HOLDINGS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

FOR THE THREE AND NINE MONTHS ENDED NOVEMBER 30, 2014 AND 2013

(Unaudited)

 

		Three Months Ended Nov. 30,								Nine Months Ended Nov. 30,
		2014				2013				2014				2013
REVENUES		$	6,181,572			$	4,485,284			$	14,306,149			$	11,586,368
BROKERAGE FEES			931,911				2,907,918				5,564,911				9,037,800
REVENUES, NET OF BROKERAGE FEES			5,249,661				1,577,366				8,741,238				2,548,568
OPERATING AND ADMINISTRATIVE EXPENSES:
General and administrative			2,254,764				2,038,832				6,288,906				6,248,261
Legal and professional expense			663,690				594,098				3,164,727				2,235,110
Premium advances, net			229,822				266,578				618,457				627,522
Impairment of investments in policies			6,814				59,266				38,150				282,830
Settlement costs			13,000				20,809				13,600				36,322
Depreciation			47,908				52,602				143,241				150,582
Total operating and administrative expenses			3,215,998				3,032,185				10,267,081				9,580,627
INCOME (LOSS) FROM OPERATIONS			2,033,663				(1,454,819	)			(1,525,843	)			(7,032,059	)
OTHER INCOME (EXPENSES):
Interest and other income			13,110				24,638				43,717				79,045
Interest expense			(2,402	)			-				(2,583	)			(65	)
Income from assignment of income stream			-				-				-				5,254,500
Impairment of investment in life settlements trust			-				-				(6,648,478	)			-
Earnings from life settlements trust			-				-				-				114,886
Loss from accounts receivable- other			(257,395	)			-				(257,395	)			-
Income (loss) from investments in policies			(75,104	)			7,256				(31,224	)			26,534
Total other income (expense)			(321,791	)			31,894				(6,895,963	)			5,474,900
INCOME (LOSS) BEFORE INCOME TAXES			1,711,872				(1,422,925	)			(8,421,806	)			(1,557,159	)
Total income tax expense (benefit)			633,927				(484,159	)			(552,600	)			(504,268	)
NET INCOME (LOSS)		$	1,077,945			$	(938,766	)		$	(7,869,206	)		$	(1,052,891	)
EARNINGS (LOSS): per share – basic and diluted		$	0.06			$	(0.05	)		$	(0.42	)		$	(0.06	)
AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING: basic and diluted			18,647,468				18,647,468				18,647,468				18,647,468

  

See the accompanying notes to Consolidated Condensed Financial Statements.

 

 

LIFE PARTNERS HOLDINGS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED NOVEMBER 30, 2014 AND 2013

(Unaudited)

 

		Nine Months Ended Nov. 30,
		2014				2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(7,869,206	)		$	(1,052,891	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation			143,241				150,582
Impairment of investments in policies			38,150				282,830
Earnings from investment in life settlements trust			-				(114,886	)
Deferred income taxes			(604,628	)			(551,210	)
Premium advances and bad debt expense			418,124				199,774
Loss (gain) from investments in policies			31,224				(26,534	)
Income from assignment of income stream			-				(5,254,500	)
Impairment of investment in life settlements trust			6,648,478				-
(Increase) decrease in operating assets:
Accounts receivable			(50,248	)			(166,050	)
Note receivable			-				1,088
Income taxes receivable (payable)			(4,698	)			(5,138	)
Prepaid expenses			(33,720	)			(43,383	)
Premium advances, net			(674,506	)			1,497,813
Artifacts and other			3,150				(3,150	)
Increase (decrease) in operating liabilities:
Accounts payable			662,097				(982,251	)
Accrued liabilities			119,714				(38,155	)
Accrued settlement expense			-				(28,623	)
Deferred policy monitoring costs			497,012				701,244
Net cash used in operating activities			(675,816	)			(5,433,440	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in certificates of deposit			(420	)			(250,000	)
Proceeds from certificate of deposit			-				500,931
Purchases of property and equipment			(16,031	)			(2,366	)
Proceeds from life settlements trust			-				227,508
Proceeds from assignment of income stream			-				5,254,500
Investment in life settlements trust			-				(47,695	)
Proceeds from sales of investments in policies			1,945,025				68,626
Maturities of investments in policies			33,788				8,419
Purchase of investment in policies and capitalized premiums			(301,847	)			(214,823	)
Net cash provided by investing activities			1,660,515				5,545,100
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on notes payable			(101,445	)			-
Dividends paid			(2,797,236	)			(3,729,569	)
Net cash used in financing activities			(2,898,681	)			(3,729,569	)
NET DECREASE IN CASH AND CASH EQUIVALENTS			(1,913,982	)			(3,617,909	)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD			6,134,731				7,575,579
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	4,220,749			$	3,957,670
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid		$	2,583			$	75
Income taxes paid		$	75,777			$	54,319
Insurance premiums financed		$	338,963			$	-

 

See accompanying notes to Consolidated Condensed Financial Statements.

 

 

Life Partners Holdings, Inc.

 

Notes to Consolidated Condensed Financial Statements

 

November 30, 2014

 

(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 company in the United States engaged in the secondary market for life insurance known generally as “life settlements”. LPI facilitates the sale of life settlements between sellers and purchasers, but does not take possession or control of the policies. The purchasers acquire the life insurance policies at a discount to their face value for investment purposes.

 

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation. The accompanying Consolidated Condensed Financial Statements include the accounts of Life Partners and its wholly owned subsidiaries, LPI and LPI Financial Services, Inc. (“LPIFS”.) 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 Consolidated Condensed Financial Statements should be read in conjunction with the financial statements and the summary of significant accounting policies and notes thereto included in our most recent Annual Report on Form 10-K.

 

Reclassifications. We have made certain reclassifications to prior period amounts to conform to current year presentations.

 

Property and Equipment. Our property and equipment are depreciated over their estimated useful lives using the straight-line method. Depreciation expense for the nine months ended November 30, 2014 and 2013 (the “First Nine Months of this year” and “First Nine Months of last year”, respectively) was $143,241 and $150,582, respectively. The useful lives of property and equipment for purposes of computing depreciation are:

 

Building and components		7 to 39 years
Machinery and equipment		5 to 7 years
Software		3 to 7 years
Transportation equipment		5 years

 

Artifacts and Other. The artifacts and other assets are stated at cost. We have evaluated these assets and believe there is no impairment in their value as of November 30, 2014, and February 28, 2014.

 

 

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 and Investment in Life Settlements Trust are the two balance sheet items that have been impaired. During the First Nine Months of this year and last year, we recorded impairment expense of $38,150 and $282,830, respectively.

 

Revenue Recognition. We recognize income from life settlements at the time a settlement closes and we defer revenue to cover minor 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. Beginning in the Third Quarter of this year, LPIFS, a new subsidiary of LPI, billed the life settlement investors for ministerial services in order to recover the expenses of tracking, coordinating, and reconciling policy premium payments and maturity payouts through the life settlement process. The billing was for services performed for the prior twelve months and revenue was recognized on the cash method of accounting.

 

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. In the Third Quarter of this year, there were four  licensees whose compensation represented more than 10% of brokerage fees and in the Third Quarter of last year, there were two licensees whose compensation represented more than 10% of brokerage fees. In the First Nine Months of this year and in the First Nine Months of last year, there was one licensee whose compensation represented more than 10% of brokerage fees. For the Third Quarter of this year, one  broker, who accounted for more than 10% of the face value of all completed initial transactions, constituted 16.7% of the total face value of completed initial transactions. For the Third Quarter of last year, two brokers, who each accounted for more than 10% of the face value of all completed initial transactions, constituted 78% of the total face value of completed initial transactions. For the First Nine Months of this year, two brokers, who each accounted for more than 10% of the face value of all completed initial transactions, constituted 88.9 % of the total face value of completed initial transactions. For the First Nine Months of last year, four brokers accounted for more than 10% of the face value of all completed initial transactions, and constituted 87 % of the total face value of completed initial transactions.

 

(3) NEW ACCOUNTING PRONOUNCEMENTS

 

In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The amendments in ASU 2013-11 provide guidance on the financial statement presentation of unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU 2013-11 is effective for fiscal years beginning after December 15, 2013. These amendments became effective for the Company in the first quarter of fiscal 2015. These amendments did not have a material impact on our Consolidated Financial Statements.

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (ASU 2014-09), which supersedes nearly all existing revenue recognition guidance under U.S GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services.  The standard is effective for annual periods beginning after December 15, 2016, and interim periods therein.  We are currently evaluating the impact of our pending adoption of ASU 2014-09.

 

 

(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 Federal Deposit Insurance Corporation (“FDIC”) currently insures all bank accounts up to $250,000. 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. The average balance of our operating checking account balance is generally in excess of $250,000. We believe we have mitigated our exposure to loss with deposits in a combination of five smaller, community banks and one of the largest national financial institutions.

 

(5) CERTIFICATES OF DEPOSIT

 

Two certificates of deposit with an original maturity of greater than three months, but less than a year, were held in separate banking institutions at February 28, 2014. One of these certificates of deposit matured in August 2014. It was replaced by a new certificate of deposit at this same banking institution and it has an original maturity of greater than three months, but less than a year. A second certificate of deposit with an original maturity of greater than three months, but less than a year was held in a separate banking institution at November 30, 2014.

 

(6) ACCOUNTS RECEIVABLE – TRADE

 

The amounts shown on the consolidated balance sheets 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, 2014, and February 28, 2014, were $57,049 and $17,480, respectively.

 

(7) ACCOUNTS RECEIVABLE – OTHER

 

The amounts shown on the consolidated balance sheets termed Accounts Receivable – Other, are amounts owed to us from employees as well as amounts due us from maturities of policies. The receivable amounts at November 30, 2014, and February 28, 2014, were $31,429 and $20,750, respectively. The amount shown on the consolidated balance sheet at August 31, 2014, termed Accounts Receivable – Other, included an amount owed from a closed foreign trading account when the account was liquidated and the funds were allegedly diverted by the trading manager. The amount was $257,395 as of August 31, 2014, which we reported on our balance sheet for the First Quarter of fiscal 2015 as part of Cash and Cash Equivalents. The amount reported as part of Cash and Cash Equivalents as of February 28, 2014, was $258,243. The situation was discovered during the Second Quarter of the current fiscal year. We have subsequently determined that the amount is non-recoverable and have recorded a loss of $257,395 in the Third Quarter of this year.

 

(8) NOTE RECEIVABLE

 

The amount of $8,912 shown on the consolidated balance sheets at each of November 30, 2014 and February 28, 2014, termed Note Receivable, represents a note from a non-related person dated January 28, 2013, due April 28, 2013, at 5% annual interest. The note is currently past due and unpaid, with the exception of one partial payment through collection efforts. We have filed suit with the McLennan County Justice Court to recover amounts owed on this note.

 

(9) PREMIUM ADVANCES

 

We occasionally make advances on policy premiums to maintain certain policies. In the life settlements we broker, estimated future premium amounts are escrowed with a trust company. When the future premium amounts in escrow are exhausted, purchasers are contractually obligated to pay the additional policy premiums. Most purchasers pay the 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 and to preserve business relationships. In these instances, we pay the premiums to the trust company. By making the advance, we have a contractual right to reimbursement from policy proceeds before the proceeds are distributed to the purchaser, and we make estimates of the collectability of these premium advances and make allowances for nonpayment of the advances.

 

 

The table below shows the changes in the premium advances account.

 

Total premium advance balance at February 28, 2014		$	11,705,633
Advances			2,414,078
Reimbursements and adjustments			(1,739,572	)
Total premium advance balance at November 30, 2014			12,380,139
Allowance for doubtful accounts			(5,080,077	)
Net premium advance balance at November 30, 2014		$	7,300,062

 

(10) INVESTMENTS IN POLICIES

 

From time to time, we purchase interests in policies to hold for investment purposes. ASC 325-30, Investments in Insurance Contracts, provides that a purchaser may elect to account for its investments in life settlement contracts based on the initial investment at the purchase price plus all initial direct costs. Continuing costs (e.g., policy premiums, statutory interest, and direct external costs, if any) to keep the policy in force are capitalized. We have historically elected to use the investment method, and refer to the recorded amount as the carrying value of the policies.

 

The table below describes the Investments in Policies account at November 30, 2014.

 

Policies With Remaining  Life Expectancy (in years)		Number of Life Settlement Contracts				Carrying Value				Face Value
0-1			10			$	35,091			$	405,970
1-2			1				16,497				103,345
2-3			4				70,566				110,962
3-4			5				53,583				152,889
4-5			11				9,890				163,356
Thereafter			287				309,179				3,491,217
Total			318			$	494,806			$	4,427,739

 

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 $38,150 and $282,830 of impairment for the First Nine Months of this year and last year, respectively. The fair value of the impaired policies at November 30, 2014 and February 28, 2014, was $201,620 and $752,713, 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, 2014, are as follows.

 

Year 1		$	16,150
Year 2			109,427
Year 3			105,326
Year 4			100,304
Year 5			107,177
Thereafter			1,657,946
Total estimated premiums		$	2,096,330

 

 

The majority of our Investments in Policies was purchased as part of settlement agreements and purchases from existing clients, which we refer to as tertiary purchases. We do not currently have a strategy of buying large amounts of policies for investment purposes, but we expect to continue to make purchases as they may be presented to us and if the purchases can be made with benefit to both parties. Since the purchases for our own account are motivated by settlements and tertiary purchases, the supply of available policies in the secondary market does not affect our purchases. The risks that we might experience as a result of investing in policies are unknown remaining life expectancy, a change in credit worthiness of the policy issuer, funds needed to maintain the asset until maturity and changes in discount rates.

 

At November 30, 2014, we held Investments in Policies of $494,806, net of impairment, of which $363,995 is classified as a current asset, as we anticipate selling the policy interests within the next twelve months. The balance of $130,811 is classified as long-term as there is no ready market for these policy interests.

  

(11) 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 February 28, 2014, we owned 19.9% of the trust, carried at $6.6 million, and accounted for on the equity method of accounting. At February 28, 2014, the Trust owned a portfolio of 228 life insurance settlements with a face value of $610.5 million, of which LPI supplied settlements with a face value of approximately $278 million. At August 31, 2014, the Trust no longer owned the portfolio due to a foreclosure sale on August 6, 2014 and as such we impaired the investment because of uncertainty of foreclosure and seizure of the portfolio of assets by the German bank (see discussion below.)

 

In May 2013, we entered into Assignments of Right to Receive Future Payments (the “ Assignments ”) with four unaffiliated, accredited investors (the “Assignees”), in which we assigned our right to receive distributions from the Trust, subject to a retained reversionary interest, in exchange for $5,650,000. Under the terms of the Assignment, our reversionary interest was to have been triggered when the Assignees received cumulative payments of $9,411,667, if the payments had provided an annually compounded rate of return of 12% or more on amounts invested. If the Assignees had not received the required return, they were to continue to receive payments until they received the 12% return on their invested amount. Since the Trust no longer owns the portfolio, it is not expected that any further payments will be made to us or the Assignees since the Trust no longer owns the portfolio, which was the source of the payments, nor do we expect to receive the reversionary interest, unless there is a positive result in the disposition of the amended claims discussed in the following paragraph. The Assignees are each private investors who have purchased life settlements from us previously. Apart from these purchases, they have no affiliation with us or our directors or officers.  A referral fee of $395,500 was paid to an unaffiliated individual in connection with the assignment.

 

Subsequent to the Assignments in May 2013, we learned that a German bank, which had loaned the Trust funds for policy acquisitions, would not renew its loan and was seeking payment. The Trust was unsuccessful in its attempts to refinance the loan and to negotiate a settlement with the bank. The bank declared a default on the loan, and on May 8, 2014, the bank issued a notice of foreclosure and instructed the credit facility’s master collateral agent to conduct a public auction of the collateral, which consisted primarily of the policies. The Trust retained legal counsel in the matter. Initially the Trust obtained a temporary restraining order to enjoin the foreclosure. At the subsequent hearing on June 17, 2014, however, the court lifted the restraining order and allowed the bank to proceed with the sale. The foreclosure sale was held on August 6, 2014, and the bank was the successful bidder for the portfolio. The portfolio of 225 life insurance settlements with a face value of approximately $604.1 million was sold for $202.7 million. The Trust’s counsel filed an amended complaint on August 12, 2014, alleging that the sale was not conducted in a commercially reasonable manner to yield a higher purchase price of the collateral so as to satisfy the obligations under the loan and potentially yield a surplus for itself and its investors. The opposing counsel filed a motion to dismiss our amended complaint on September 15, 2014. The hearing on the motion to dismiss is still pending. After the Court rules on the motion to dismiss, we will know whether or not our amended claims will survive. We cannot predict how long after the hearing the Court will rule on the motion to dismiss and there can be no assurance of the outcome of this matter. Due to the uncertainty of the timeline or of the ultimate outcome of the potential litigation proceedings we impaired the investment value as of August 31, 2014.

 

The Trust distributed $227,508 in the First Nine Months of last year, which was before the Assignments discussed above. The Trust has made no distributions since then.

 

(12) CURRENT PORTION OF NOTES PAYABLE

 

The amount shown on the consolidated balance sheets termed Current Portion of Notes Payable at November 30, 2014, represents the amount due on a note payable related to the financing of insurance premiums. The note is due July 1, 2015, with principal and interest payments due monthly and bears interest of 3.15% annually. The note is unsecured. There was no note payable as of February 28, 2014.

 

 

(13) INCOME TAXES

 

Income tax benefit was made up of the following components:

 

		Nine Months Ended November 30,
		2014				2013
Current income tax expense		$	52,028			$	46,942
Deferred tax (benefit)			(604,628	)			(551,210	)
Total income tax (benefit)		$	(552,600	)		$	(504,268	)

 

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 November 30,
		2014				2013
United States statutory rate			35.0	%			35.0	%
State income taxes			(0.4	)%			(0.4	)%
Change in valuation allowance			(27.6	)%			(0.0	)%
Permanent differences			(0.4	)%			(2.3	)%
Combined effective tax rate			6.6	%			32.3	%

 

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, 2014				Feb. 28, 2014
Deferred tax assets:
Impairment of investment in policies		$	231,886			$	388,676
Premium advances allowance			1,778,027				1,631,684
Deferred policy monitoring costs			1,759,630				1,585,675
Capital loss carryover			672,115				672,115
Net operating loss			626,551				335,930
Charitable contributions			389,722				353,380
Contingency costs			15,924				15,924
Compensated absences			48,869				35,842
Loss on investment in life settlements trust			2,313,627				-
State taxes			17,037				672
			7,853,388				5,019,898
Valuation allowance			(2,999,082	)			(672,115	)
Net deferred tax assets			4,854,306				4,347,783
Deferred tax liabilities:
Settlement costs			(36,129	)			(46,169	)
Depreciation			(36,198	)			(61,879	)
Prepaid expenses			(110,850	)			(43,750	)
Unrealized revenues and brokerage fees			(38,710	)			(154,854	)
Loss on investment in trust			-				(13,340	)
Net deferred tax liabilities			(221,887	)			(319,992	)
Total deferred tax asset, net		$	4,632,419			$	4,027,791
Summary of deferred tax assets:
Current		$	608,644			$	585,498
Non-current			4,023,775				3,442,293
Total deferred tax asset, net		$	4,632,419			$	4,027,791

 

 

Valuation Allowance. At February 28 and November 30, 2014, we had a valuation allowance of $672,115 and $2,999,082, respectively, for capital losses resulting from other-than-temporary impairments. This amount represents capital losses that we are not able to deduct until we have corresponding capital gains to apply the losses against.

 

Tax Examination. The Internal Revenue Service is currently examining our Federal income tax returns for fiscal years 2010, 2011, and 2012 and our Form 1042 for calendar years 2008, 2009, and 2010. (See Section (16) Contingencies regarding the Internal Revenue Service’s examination of Form 1042.) With few exceptions, we are no longer subject to Federal, state or local examinations by tax authorities for fiscal years 2007 and earlier.

 

Accounting for Uncertainty in Income Taxes. In determining our tax position, we follow FASB’s ASC 740. Under the FASB’s 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. 

 

(14) NET INCOME (LOSS) PER SHARE, SHAREHOLDERS’ EQUITY, STOCK TRANSACTIONS AND SHARE BASED AWARDS

 

Net income (loss) for the Third Quarter of this year and last year was $1,077,945 and ($938,766), respectively. Loss for the First Nine Months of this year and last year was ($7,869,206) and ($1,052,891), respectively. Basic and diluted earnings per share for net income (loss) for the Third Quarter of this year and last year, net of tax, were $0.06 and ($0.05), respectively. Basic and diluted earnings per share for net loss for the First Nine Months of this year and last year, net of tax, were ($0.42) and ($0.06), respectively.

 

Dividends. We declared and paid dividends in the amounts as set forth in the following table for the First Nine Months of this year and last year. No dividends were declared for the Third Quarter of this year.

 

Date Declared		Date Paid		Dividend Amount
06/04/13		06/17/13		$	0.05
09/06/13		09/20/13		$	0.05
12/17/13		01/03/14		$	0.05
05/28/14		06/16/14		$	0.05
09/02/14		09/17/14		$	0.05

 

Share Based Awards. 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.

 

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.

 

Our financial assets and liabilities are certificates of deposit, accounts receivable, note receivable, investments in policies, investment in life settlements trust, accounts payable and accrued liabilities. The recorded values of certificates of deposit, accounts receivable, accounts payable, and accrued liabilities approximate their fair values based on their short-term nature and are discussed in Notes 5, 6, or 7. The recorded value of the note receivable is the current balance amount of the note. The note’s fair value is not readily determinable; it is discussed in Note 8. As discussed in Note 11, the investment in life settlement’s trust was fully impaired at August 31, 2014.

 

The carrying value of our investments in policies totaled $494,806, which includes $218,827 of capitalized premiums, and has an estimated fair value, net of the present value of estimated premiums, of $460,007. Fair value of the investments 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 investments in policies are discussed more fully in Note 10. A progression of the Level 3 inputs is shown in the table below:

 

Balance at February 28, 2014		$	1,737,197
Purchases of policies			741,648
Sales and maturities of policies			(2,031,202	)
Change in valuation			12,364
Estimated Fair Value at November 30, 2014		$	460,007

 

(16) RELATED PARTY TRANSACTION

 

We currently operate under an agreement with ESP Communications, Inc. (“ESP”), which is owned by the spouse of our Chief Executive Officer. Under the agreement, ESP performs certain post-settlement services for us, which include periodic contact with insureds and their health care providers, monthly record checks to determine an insured’s status, and working with the outside escrow agent in the filing of death claims. Either party may cancel the agreement with a 30-day written notice. We currently pay ESP $7,500 on a semi-monthly basis for its services. We recorded management services expense concerning this agreement with ESP of $135,000 in each of the First Nine Months of this year and last year.

 

We periodically use an aircraft owned by our Chairman and CEO, and reimburse him for the incremental costs of our use, as described in applicable Federal Aviation Administration Regulations (FAA Part 91, Subpart F). We believe the reimbursed cost is well below the fair rental value for such use. For the First Nine Months of this year and last year, we reimbursed costs of $334,230 and $711,055 , respectively, for such use. As of November 30, 2014, we had an account payable due to Mr. Pardo of $21,754 which arose from the aircraft use. Nothing was owed to Mr. Pardo as of February 28, 2014.

 

During the Second Half of last year, we began acquiring and reselling defaulted positions, as provided in our purchase documentation. A portion of these policies was resold to Paget Holdings Limited, which is affiliated with the Pardo Family Trust, of which Deborah Carr, our Vice President of Administration, is the beneficiary. Deborah Carr is the daughter of Brian Pardo, our Chairman and CEO. In the First Nine Months of this year and last year, we received $1,606,230  and $467,833, respectively, of fee income from the resales of abandoned positions to Paget. Paget paid the same fixed percentage paid by other third parties. Additionally, Paget resold a portion of the purchased abandoned positions to third parties of which we earned resale fee income of $1,315,565 in the First Nine Months of this year. Paget had no resales of purchased abandoned positions to third parties in the First Nine Months of last year.

 

(17) CONTINGENCIES

 

We are aware of certain instances wherein the insurance companies denied payment on policies in which we arranged the settlement with purchasers. Most of these denials are related to unforeseeable reduction in face value. Face value of the policies in question total $76,973 and are recorded in accrued settlement expense at November 30, 2014. During the Third Quarter of this year, we accrued no additional amounts for future claims that might arise in relation to these policies and had no payments of settlements.

 

On January 3, 2012, we and certain current directors and current and former officers were sued by the SEC in an action styled Securities and Exchange Commission v. Life Partners Holdings, Inc., Brian D. Pardo, R. Scott Peden and David M. Martin, Civil Action No.: 6:12-CV-00002. (the “SEC action”). The suit was filed in the Federal District Court for the Western District of Texas (Austin Division) and alleged that we, our Chairman and CEO, Brian Pardo, General Counsel, Scott Peden, and former Chief Financial Officer, David Martin, had knowledge of, but failed to disclose to our shareholders, the alleged underestimation of the life expectancies of settlors of viatical and life settlement policies. The suit further claimed that we prematurely recognized revenues from the sale of the settlements and that we understated the impairment of our investments in policies. The suit also claimed that Mr. Pardo and Mr. Peden sold shares while possessing inside information (i.e., the alleged knowledge of the underestimation of life expectancies and the purported impact on revenues from such practice). In addition, the suit alleged that the defendants misled the auditors about our revenue recognition policy.

 

 

Trial before a jury was held in February 2014. The jury found that neither we, Mr. Pardo nor Mr. Peden committed securities fraud under Section 10(b) of the Exchange Act and Rule 10b-5 and that Mr. Pardo and Mr. Peden did not engage in insider trading. In March 2014, the Federal court ruled that the SEC failed to prove any of its fraud claims against us, Mr. Pardo and Mr. Peden under Section 17 of the Securities Act of 1933 (the “Securities Act”), finding that there was no evidence to support the allegations related to revenue recognition for the period of time in question and ordered that judgment be entered in favor of us, Mr. Pardo and Mr. Peden on that issue. As a result of this ruling, the Company, Mr. Pardo and Mr. Peden were completely exonerated from any allegations of fraud alleged by the SEC. The Court let stand the jury's findings against us, Mr. Pardo and Mr. Peden for violations of various revenue recognition matters. On July 16, 2014, Defendants filed a motion to enter judgment in this case. On July 30, 2014, Plaintiff filed its own motion to enter judgment and its response to Defendants’ motion to enter judgment. On December 2, 2014, the Court entered a final judgment in this case which enjoined us and our agents, servants, employees, attorneys, and all persons in active concert or participation with them from violating, directly or indirectly, from filing forms with the Commission containing false statements of material fact or failing to include material information that is necessary to make the statements not misleading, unless Defendants act in good faith and do not directly or indirectly induce the act or acts constituting the violation. The Court also ordered that Messrs. Pardo and Peden, and their agents, servants, employees, attorneys, and all persons in active concert or participation with them are permanently restrained and enjoined from aiding and abetting any violation of federal securities laws and regulations by knowingly providing substantial assistance to an issuer that fails to file timely with the Commission all accurate and complete information, documents, and reports required by the rules and regulations prescribed by the Commission. The Court further ordered that Mr. Pardo and his agents, servants, employees, attorneys, and all persons in active concert or participation with them are permanently restrained and enjoined from using any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange to include a false and misleading certification with any annual or quarterly report required to be filed with the SEC. The Court further ordered Life Partners to disgorge $15,000,000 and to pay a civil penalty of $23,700,000. The Court further ordered Mr. Pardo to pay a civil penalty of $6,161,843 and Mr. Peden to pay a civil penalty of $2,000,000. On December 30, 2014, we and Mr. Pardo and Mr. Peden filed a motion to alter or amend the judgment through which we challenged the amounts and basis for the judgment as well as a notice of appeal to the Fifth Circuit Court of Appeals. The Court has not yet ruled on the motion to alter or amend. We and Mr. Pardo and Mr. Peden also filed motions to permit us to post security in an amount lower than the amount of the judgment in order to prevent execution of the judgment while we appeal. The District Court has not yet ruled on these motions. On January 5, 2015, the SEC filed a motion to appoint a receiver for us and our affiliates. A hearing on this motion is set for January 21, 2015 before Magistrate Judge Andrew Austin, to whom the Court referred all dispositive and non-dispositive motions in this case.

 

In February and March of 2011, six putative securities class action complaints were filed in the U.S. District Court for the Western District of Texas, Waco Division. On July 5, 2011, these actions were consolidated into the case styled Selma Stone, et al. v. Life Partners Holdings, Inc., Brian D. Pardo, R. Scott Peden, and David M. Martin, Civil Action No. DR-11-CV-16-AM in the U.S. District Court for the Western District of Texas, Del Rio Division. Plaintiffs assert substantially similar, and at times identical, facts and allegations to those asserted by the SEC in its complaint in the SEC action and seek damages and an award of costs on behalf of a class of shareholders who purchased or otherwise acquired our common stock between May 26, 2006, and June 17, 2011. On March 26, 2012, Defendants filed their motion to dismiss the amended complaint which the court denied on March 15, 2014. On September 15, 2014, Plaintiffs filed a motion to stay all proceedings in this case until the Court issues a ruling on the SEC's motion for judgment in Securities and Exchange Commission v. Life Partners Holdings, Inc., et al. The Court granted the motion on September 17, 2014 and ordered all proceedings in this case stayed until a ruling is issued in the SEC case. The Court further ordered that, within the 45-day period following the entry of a judgment in the SEC Action, the Plaintiffs shall either 1) file a motion to dismiss this action, or 2) file a motion for class certification.

 

On March 11, 2011, a purported class action suit was filed in the 191st Judicial District Court of Dallas County, Texas, styled Helen Z. McDermott, Individually and on Behalf of all Others Similarly Situated v. Life Partners, Inc., Cause No. 11-02966. The original petition asserted claims for breach of contract, breach of fiduciary duty, and unjust enrichment on behalf of a putative class of all persons residing in the United States who purchased any portion of a life settlement that matured earlier than the estimated maximum life expectancy. Pursuant to three amendments to the Petition, the plaintiff revised the putative class of persons on whose behalf the plaintiff seeks to represent to be limited to all persons residing in the United States who purchased any portion of one particular life settlement. The plaintiff seeks as purported damages the amount of funds placed in escrow for policy maintenance that was allegedly not needed or used for policy maintenance and was not returned or paid to the plaintiff or the putative class members as well as attorneys’ fees and costs. The plaintiff also seeks certain equitable relief, including injunctive relief, restitution, and disgorgement. Following briefing by the parties and a hearing before the court, the court certified a class consisting of 38 persons residing in the United States that purchased any portion of a life settlement interest in the designated policy which we appealed. On June 23, 2014, the Court upheld the district court’s order certifying the class.

 

 

On April 8, 2011, a putative class action complaint was filed in the 40^th Judicial District Court of Ellis County, Texas, styled John Willingham, individually and on behalf of all other Texas citizens similarly situated, v. Life Partners, Inc., Cause No. 82640 (MR). On July 27, 2011, by agreement of the parties, the Willingham case was transferred to the 101st Judicial District Court of Dallas County under Cause No. DC-11-10639. All of the plaintiff’s claims are based upon the alleged overpayment of premiums to the insurance company, that is, the alleged failure to engage in “premium optimization” on behalf of all Texas residents that purchased an interest in a life settlement facilitated by LPI. On March 15, 2013, the plaintiff filed his fourth amended petition in which eight new named-plaintiffs were added to the suit, and we, Brian D. Pardo, and R. Scott Peden were added as defendants. In addition to the putative class claims concerning the alleged overpayment of premiums, the amended petition asserts individual claims of breach of fiduciary duty against LPI arising from the alleged overpayment of premiums and the alleged use of underestimated life expectancies provided by Dr. Donald Cassidy, as well as aiding and abetting claims against us, Pardo and Peden. On January 22, 2013, a petition was filed in the 162 ^nd Judicial District Court, Dallas County, Texas, styled Stephen Eccles, et al vs. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo and R. Scott Peden on behalf of 23 individuals, all of whom were represented by the same counsel for the plaintiff in the Willingham case. On March 20, 2013, the parties filed a joint motion to consolidate the Eccles case with the Willingham case, which was granted on March 25, 2013. On April 15, 2013, the plaintiffs filed their fifth amended petition dropping all putative class claims and asserting individual claims of breach of fiduciary duty, common law fraud, civil conspiracy, aiding and abetting breach of fiduciary duty and common law fraud, and negligence against us, LPI, Pardo and Peden. The plaintiff seeks economic and exemplary damages, disgorgement and/or fee forfeiture, attorneys’ fees and costs, and post and pre-judgment interest. On April 9, 2013, an original petition was filed in the 352^nd Judicial District Court, Tarrant County, Texas, styled Todd McClain, et al v. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo, and R. Scott Peden. This suit is virtually identical to the Willingham case. On May 15, 2013, the defendants filed a motion to transfer the McClain and Willingham cases to a Multi-District Litigation Panel for the purposes of transferring and consolidating the Willingham case and the McClain case to a single forum for pretrial purposes. On August 16, 2013, the Multidistrict Litigation Panel issued an opinion granting the motion to transfer, and on September 9, 2013, the Panel issued an Order transferring the McClain case to Judge Slaughter of the 191^st District Court of Dallas County and consolidating the McClain case (and any tag along cases subsequently filed) with the Willingham case. The consolidated MDL case is styled In re Life Partners, Inc. Litigation (the “MDL Proceedings”). In the MDL Proceedings, all of plaintiffs’ claims are based upon the alleged failure to engage in “premium optimization,” as well as the alleged provision of underestimated life expectancies by Dr. Donald Cassidy to LPI and LPI’s use in the facilitation of life settlement transactions in which plaintiffs acquired interests in life insurance policies. Plaintiffs seek economic and exemplary damages, disgorgement and/or fee forfeiture, attorneys’ fees and costs, and post and pre-judgment interest. On August 9, 2013, the Court entered a scheduling order setting a bellwether trial consisting of ten plaintiffs, five selected by plaintiffs and five selected by defendants, with the remaining plaintiffs trying their claims in groups of 16 approximately 90 days after the conclusion of each trial. On September 10, 2014, Defendants filed a Writ of Mandamus with the Fifth Court of Appeals concerning the issue of whether the Court abused its discretion by not excluding certain expert witnesses. On September 12, 2014, the Fifth Court of Appeals issued an order staying the bellwether trial which had been set for September 29, 2014 until further order of the Court.

 

On November 8, 2011, a putative class action suit was filed, styled Marilyn Steuben, on behalf of herself and all other California citizens similarly situated v. Life Partners, Inc., Superior Court of the State of California for the County of Los Angeles Court, Case No. BC472953. This suit asserts claims of fiduciary duty, breach of contract, and violations of California’s Unfair Competition law based upon the alleged overpayment of premiums to the insurance company, that is, the alleged failure to engage in “premium optimization.” On December 3, 2012, the plaintiffs filed their motion to intervene in the Turnbow case whereby the plaintiffs sought to join the putative Turnbow class and subclass and to create a new subclass asserting claims for damages related to the defendants’ alleged overpayment of premiums. The Federal District Judge in the Turnbow case denied the plaintiffs’ motion to intervene on February 5, 2013 and the Turnbow case was voluntarily dismissed in December 2013. On June 5, 2014, the parties filed a joint status report with the court, and the court continued to stay the case pending resolution of the Willingham suit. No trial date has been set. Please see the Annual Report on Form 10-K for the year ended February 28, 2014 (the “2014 Annual Report) for a discussion of the case styled Turnbow et al. v. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo, and R. Scott Peden , Civil Action No. 3:11-CV-1030-M and the case styled John Willingham, individually and on behalf of all other Texas citizens similarly situated, v. Life Partners, Inc., Cause No. 82640 (MR ).

 

On March 31, 2014, a complaint was filed in the United States District Court for the Southern District of Florida, styled John Woelfel, individually and F/B/O and In His Capacity as Owner and Beneficiary of the John Woelfel Self-Directed IRA v. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo, R. Scott Peden, and Pardo Family Holdings, Ltd. On May 9, 2014, following Defendants filing of a Motion to Dismiss the Complaint, Plaintiffs filed their First Amended Complaint in which Plaintiffs Henry and Diana Funke were added as parties. On May 23, 2014, Defendants filed a Motion to Dismiss Plaintiffs’ First Amended Complaint. On June 17, 2014, plaintiffs voluntarily dismissed their claims for alleged violations of the Federal Securities Act. Defendants’ Motion to Dismiss the Amended Complaint is pending as of the date of this disclosure. This suit asserts claims of breach of fiduciary duty, negligence, common law fraud, aiding and abetting breach of fiduciary duty and common law fraud and civil conspiracy, constructive trust, fraudulent transfer, and unjust enrichment. This suit is virtually identical to the MDL Proceedings. All of plaintiffs’ claims are based upon the alleged failure to utilize “premium optimization” and the alleged provision of underestimated life expectancies by Dr. Donald Cassidy to LPI and LPI’s use of those life expectancies in the facilitation of life settlement transactions in which plaintiffs acquired interests in life insurance policies. Plaintiffs seek economic and exemplary damages, disgorgement and/or fee forfeiture, rescission, attorneys’ fees and costs, and post and pre-judgment interest. A trial is set to begin on April 20, 2015.

  

 

On July 8, 2014, a complaint was filed in the United States District Court for the Western District of Pennsylvania, styled Arthur W. Morrow, individually and F/B/O and In His Capacity as Owner and Beneficiary of the Arthur W. Morrow Self-Directed IRA et al. v. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo, R. Scott Peden, and Pardo Family Holdings, Ltd., Civil Action No. 3:14-cv-141. This suit is virtually identical to the Woelfel lawsuit and Plaintiffs are represented by the same law firm as in that case. The case asserts claims of breach of fiduciary duty, negligence, common law fraud, aiding and abetting breach of fiduciary duty and common law fraud and civil conspiracy, constructive trust, fraudulent transfer, and unjust enrichment. All of plaintiffs’ claims are based upon the alleged failure to utilize “premium optimization” and the alleged provision of underestimated life expectancies by Dr. Donald Cassidy to LPI and LPI’s use of those life expectancies in the facilitation of life settlement transactions in which plaintiffs acquired interests in life insurance policies. Plaintiffs seek economic and exemplary damages, disgorgement and/or fee forfeiture, rescission, attorneys’ fees and costs, and post and pre-judgment interest. The trial is in its initial stages and no discovery has been conducted yet.

 

The Company is currently under audit by the Internal Revenue Service for years 2008, 2009 and 2010 for failure to withhold taxes on certain dividends paid to foreign shareholders and has issued a proposed adjustment of $3,991,351 in taxes including penalties. The Company has obtained legal counsel to defend its position that the withholding liability rests with the last U.S. person who makes payment to a foreign person if the U.S. person is a financial institution and the withholding agent has no reason to believe that the financial institution will not comply with its obligation to withhold. The Company is filing an administrative appeal to contest the IRS’ findings with the IRS appeals division. The deadline for filing the appeal is January 23, 2015.

 

During the current quarter, there have been no material developments for legal proceedings except as described above and in our 2014 Annual Report. For a full disclosure of legal proceedings, please reference our 2014 Annual Report.

 

Management believes, and we have been so advised by counsel handling the respective proceedings, that we have meritorious defenses in all pending litigation to which we or our directors or officers are a party, as well as valid bases for appeal of potential adverse rulings that may be rendered against us. We intend to defend all such proceedings vigorously and, to the extent available, will pursue all valid counterclaims. Notwithstanding this fact, as with all litigation, the defense of such proceedings is subject to inherent uncertainties, and the actual costs will depend upon numerous factors, many of which are as yet unknown and unascertainable. Likewise, the outcome of any litigation is necessarily uncertain. We may be forced to continue to expend considerable funds in connection with attorneys’ fees, costs, and litigation-related expenses associated with the defense of these proceedings, and management’s time and attention will also be taxed during the pendency of these proceedings. We may enter into settlement discussions in particular proceedings if we believe it is in the best interests of our shareholders to do so.

 

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 Financial Statements for unfavorable outcomes, if any.

 

(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 expense for our matching contributions to the 401(k) plan for the First Nine Months of this year and last year was $60,025 and $56,971, respectively.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Special Note: Certain statements in this quarterly report on Form 10-Q concerning our business prospects or future financial performance, anticipated revenues, expenses, profitability or other financial items, estimates as to size, growth in or projected revenues from the life settlement market, developments in industry regulations and the application of such regulations, expected outcomes of pending or potential litigation and regulatory actions, and our strategies, plans and objectives, together with other statements that are not historical facts, are “forward-looking statements” as that term is defined under the federal securities laws. All of these forward-looking statements are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. You should carefully review the risks described herein and in other documents we file from time to time with the Securities and Exchange Commission, (“ SEC ”), including our Annual Report on Form 10-K for the year ended February 28, 2014 (“ Fiscal 2014 ”), 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.

 

 

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 company 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 provide 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 approximately 162,000 purchaser transactions involving over 6,500 policies totaling over $3.2 billion in face value. We believe our experience, infrastructure, and intellectual capital provide us a unique market position and will enable us to maintain sustainable growth within the life settlement market.

 

 The following table shows the number of settlement contracts we have transacted, the aggregate face values of those contracts, and the revenues we derived, for the Third Quarters and First Nine Months of this year and last year:

 

		Three Months Ended November 30								Nine Months Ended November 30,
		2014				2013				2014				2013
Number of settlements			2				6				7				21
Face value of policies		$	600,000			$	17,392,581			$	9,426,088			$	64,776,621
Net revenues derived*		$	850,109			$	1,577,366			$	4,341,686			$	2,548,568

 

 

*       Net revenues derived from all settlement transactions include tertiary market transactions and are exclusive of brokerage and referral fees. 

 

Ministerial Services Fees: Beginning in the Third Quarter of this year, LPIFS, a new subsidiary of LPI, billed the life settlement investors for ministerial services fees in order to recover the expenses of tracking, coordinating, and reconciling policy premium payments and maturity payouts through the life settlement process. The billing was for services performed for the prior twelve months. Because the billing was in arrears, the next annual billing is scheduled for the Third Quarter of Fiscal Year 2016. LPIFS recorded payments of $4,399,591 during the Third Quarter and is recognizing revenue on the cash method of accounting in this same amount.

 

Comparison of the Three Months Ended November 30, 2014 and 2013

 

We reported net income of $1,077,945 for the three months ended November 30, 2014 (the “Third Quarter of this year”), compared to net loss of ($938,766) for the three months ended November 30, 2013 (the “Third Quarter of last year”). The net income for the Third Quarter of this year was primarily due to the billing for ministerial services fees to recover the expenses of tracking, coordinating, and reconciling policy premium payments and maturity payouts through the life settlement process. The billing was for services performed for the prior twelve months. Without this billing, we would have realized a net loss, before taxes, of ($2,687,719) for the Third Quarter of this year. Revenues net of brokerage fees were up by 232.8%, the result of an increase in revenues of 37.8% and a decrease in brokerage fees of (68.0%). We brokered two settlement transactions for the Third Quarter of this year compared to six in the Third Quarter of last year. Operating and administrative expenses increased by 6.1%, which was largely attributable to an 11.7% increase in legal and professional fees and payment of consulting fees related to the implementation of the platform billing service charges, offset by a 13.8% decrease in premium advances, net, a 21.3% decrease in aircraft expenses and an 88.5% decrease in impairment expense from $59,266 in the Third Quarter of last year to $6,814 in the Third Quarter of this year.

 

Revenues: Revenues increased by $1,696,288, or 37.8%, from $4,485,284 in the Third Quarter of last year to $6,181,572 in the Third Quarter of this year. Net revenues increased from $1,577,367 in the Third Quarter of last year to $5,249,661 in the Third Quarter of this year, resulting in a 232.8% increase in the net revenues derived. The increase in net revenues was due to ministerial services fees billed in the Third Quarter of this year offset by decreases in net revenues from initial settlement transactions and decreases in commissions and fees from resales or tertiary transactions compared to amounts reported in the Third Quarter of last year.

 

 

Revenues from initial settlement transactions were $1,691,872 in the Third Quarter of last year compared to $81,863 in the Third Quarter of this year. The drop in revenues from initial settlement transactions was largely offset by revenue of $4,399,591 from billing for ministerial services. Commissions and fees from resales or tertiary sales decreased $1,093,294 from $2,793,412 in the Third Quarter of last year to $1,700,118 in the Third Quarter of this year. Tertiary sales revenue in the Third Quarter of this year included fee income from resales of abandoned interests of $308,400, a decrease of $814,882 from $1,123,282 in the Third Quarter of last year.

 

Since the filing of a civil action by the SEC in January 2012 and related private litigation, demand for our services has been negatively impacted. Since that time, 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. During the 2014 calendar year, over 2,500 of our clients were paid more than $71 million in maturity proceeds from their life settlement transactions. We believe these payouts will result in an increased demand for our services and will enable us to gradually rebuild our markets and expand our client base. We intend to continue devoting resources to rebuild our client base and increase demand for our services in fiscal 2015 as well as pursue new opportunities and transaction structures for us in the life settlements industry. However, restoration of demand approaching levels we recorded in fiscal 2012 may not occur until and unless we are able to repair the damage caused by the SEC suit, restore confidence within our licensee network and purchaser base, and rebuild our reputation within the industry.

 

Brokerage and Referral Fees: Brokerage and referral fees decreased 68% or $1,976,006 from $2,907,918 in the Third Quarter of last year to $931,911 in the Third Quarter of this year. Brokerage and referral fees as a percentage of gross revenue decreased from 65% in the Third Quarter of last year to 15% in the Third Quarter of this year. Without the revenue from ministerial services fees, brokerage and referral fees as a percentage of gross revenue would be 52% for the Third Quarter of this year. Brokerage and referral fees in primary and secondary transactions were $60,277 and $871,634, respectively, in the Third Quarter of this year compared to $1,208,767 and $1,699,151, respectively, in the Third Quarter of last year. Brokerage and referral fees as a percentage of gross revenue from primary transactions increased slightly from 71.4% in the Third Quarter of last year to 73.6% in the Third Quarter of this year. Brokerage and referral fees as a percentage of gross revenue from secondary transaction decreased from 60.8% in the Third Quarter of last year to 51.3% in the Third Quarter of this year. This decrease is due primarily to timing differences in the Third Quarter of last year related to payment of referral fees and payment of a special incentive promotional bonus that ended in August 2013. In the Third Quarter of this year broker referrals accounted for 16.7% of the total face value of policies transacted compared to last year when broker referrals accounted for 93.0% of the total face value of policies transacted. For the Third Quarter of this year, one broker accounted for more than 10% of the face value of all completed transactions and constituted 16.7% of the total face value of completed transactions. For the Third Quarter of last year, two brokers accounted for more than 10% of the face value of all completed transactions and constituted 78% of the total face value of completed transactions

 

Brokerage and referral fees generally increase or decrease with revenues, face values of policies transacted, and the volume of transactions, although the exact ratio of fees may vary according to a number of factors. 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. To counter declining revenues and to stimulate transaction interest, we have implemented licensee-directed promotional programs, which have increased referral fees as a percentage of revenues. We also have reduced our fees on select brokerage transactions to remain competitive in the marketplace.

 

Expenses: Operating and administrative expenses increased by 6.1% or $183,813 from $3,032,185 in the Third Quarter of last year to $3,215,998 in the Third Quarter of this year. Increases in general and administrative expenses and legal and professional fees were offset by a decrease in premium advances, net and impairment of investments in policies. Legal and professional fees increased by 11.7%, or $69,592, from $594,098 in the Third Quarter of last year to $663,690 in the Third Quarter of this year, primarily due to the legal fees associated with the SEC litigation and related shareholder lawsuits. General and administrative expenses increased by 10.6%, or $215,932, primarily due to increases in salaries and wages and related payroll costs, consulting services related to platform billing, and insurance, offset by decreases in aircraft expense, advertising and promotion, and other outside services for temporary help who later were hired as employees.

 

During the Third Quarter of this year and last year, we made premium advances of $818,774 and $869,170, respectively, and were reimbursed $613,466 and $1,976,044, 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, for business goodwill, 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 $229,822 and $266,578, respectively, primarily as a result of a reduction in the amount of discretionary premium advances.

 

 

Impairment of investments in policies in the Third Quarter of this year decreased to $6,814 from $59,266 in the Third Quarter of last year primarily due to impairment on a policy in the prior year which previously had not qualified for impairment testing.

 

Settlement costs decreased 37.5%, or $7,809, to $13,000 from $20,809 in the Third Quarter of this year and last year respectively.

 

Total Other Income and Expense: Total other income (expense) decreased $353,685 to ($321,791) expense in the Third Quarter of this year from $31,894 income in the Third Quarter of last year. The primary component of other expense in the Third Quarter of this year is the recording of a loss on a closed foreign trading account in the amount of $257,395 when the account was liquidated and the funds were allegedly diverted by the trading manager.

 

Income Taxes: Income tax expense was $633,927 in the Third Quarter of this year compared to income tax benefit of ($484,159) in the Third Quarter of last year due to net income in the Third Quarter of this year compared to net loss in the Third Quarter of last year.

 

Comparison of the Nine Months Ended November 30, 2014 and 2013

 

We reported a net loss of $7,869,206 for the Nine Months Ended November 30, 2014 (the “First Nine Months of this year”), compared to a net loss of $1,052,891 for the Nine Months Ended November 30, 2013 (the “First Nine Months of last year”). The primary contributors to the increase in net loss are the recording of an impairment reserve against the value of the investment in life settlements trust along with an increase in legal and professional fees in the First Nine Months of this year compared to the one time receipt of proceeds from assignments of income stream in a life settlements trust investment in the First Nine Months of last year.

 

Revenues: Revenues increased by $2,719,781, or 23.5%, to $14,306,149 in the First Nine Months of this year from $11,586,368 in the First Nine Months of last year. Net revenues increased from $2,548,568 in the First Nine Months of last year to $8,741,238 in the First Nine Months of this year, resulting in a 243.0% increase in the net revenues derived. The increases in net revenues were due to increases in net revenues from tertiary transactions as well as ministerial services fees billed in the Third Quarter of this year offset by decreases in net revenues from initial settlement transactions compared to amounts reported in the First Nine Months of last year.

 

Revenues from initial settlement transactions were $7,473,582 in the First Nine Months of last year compared to $649,723 in the First Nine Months of this year. The drop in revenues from initial settlement transactions (from 21 to 7) was offset by commissions and fees from resales or tertiary sales, which increased $3,188,960 from $4,112,786 in the First Nine Months of last year to $7,301,746 in the First Nine Months of this year. This year’s increase in tertiary sales revenue included gross proceeds from the sale of a policy in the First Nine Months of this year, ministerial service fees of $4,399,591 and fee income from resales of abandoned interests of $1,835,110. Fees from resales of abandoned interests were $1,166,118 in the First Nine Months of last year.

 

Since the filing of a civil action by the SEC in January 2012 and related private litigation, demand for our services has been negatively impacted. Since that time, we have devoted substantial resources and the personal time of our senior management to improve licensee relations, develop new clients and business opportunities and work to rebuild confidence in our company. During the 2014 calendar year, over 2,500 of our clients were paid more than $71 million in maturity proceeds from their life settlement transactions. We believe these payouts will result in an increased demand for our services and will enable us to gradually rebuild our markets and expand our client base. We intend to continue devoting resources to rebuild our client base and increase demand for our services in fiscal 2015 as well as pursue new opportunities and transaction structures for us in the life settlements industry. However, restoration of demand approaching levels we recorded in fiscal 2012 may not occur until and unless we are able to repair the damage caused by the SEC suit, restore trust and confidence within our licensee network and purchaser base, and rebuild our reputation within the industry.

 

Brokerage and Referral Fees: Brokerage and referral fees decreased 38.4% or $3,472,889 from $9,037,800 in the First Nine Months of last year to $5,564,911 in the First Nine Months of this year. Brokerage and referral fees as a percentage of gross revenue decreased from 78.0% in the First Nine Months of last year to 38.9% in the First Nine Months of this year, or 56.2% of gross revenues from life settlement transactions (excluding fee income from platform billing.) This decrease is due to adjustments made in the Third Quarter of last year to discontinue payment of a special incentive promotional bonus along with changes made to the calculation of referral fees. In addition, there are minimal costs of sales associated with tertiary fee revenue from abandoned policies, which further improved our gross margin in the First Nine Months of this year compared to the First Nine Months of last year. In the First Nine Months of this year, broker referrals accounted for 91.5% of the total face value of policies transacted. Broker referrals accounted for 98% of the total face value of policies in the First Nine Months of last year. For the First Nine Months of this year, two brokers, who each accounted for more than 10% of the face value of all completed transactions, constituted 88.9% of the total face value of completed transactions. For the First Nine Months of last year, four brokers, who each accounted for more than 10% of the face value of all completed transactions, constituted 87% of the total face value of completed transactions. No one licensee or licensee organization 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.

 

Expenses: Total operating and administrative expenses increased by 7.2% or $686,454 from $9,580,627 in the First Nine Months of last year to $10,267,081 in the First Nine Months of this year. The increase is primarily due to a 41.6% increase in legal and professional fees offset by an 86.5% decrease in impairment expense. Legal and professional fees were $3,164,727 and $2,235,110 in the First Nine Months of this year and last year, respectively, primarily due to the legal fees associated with the SEC litigation and related shareholder lawsuits.

 

Impairment of owned policies in the First Nine Months of this year and last was $38,150 and $282,830, respectively. 

 

During the First Nine Months of this year and last year, we made premium advances of $2,414,077 and $2,997,883, respectively, and were reimbursed $1,739,572 and $4,495,647, 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 $618,457 and $627,522, respectively. See the discussion of Policy Advances within Critical Accounting Estimates, Assumptions and Policies on page 23.

 

Settlement costs decreased 62.6% or $22,722 from $36,322 in the First Nine Months of last year to $13,600 in the First Nine Months of this year.

 

Other Income (Expenses): Total other income decreased from $5,474,900 income in the First Nine Months of last year to ($6,895,963) expense in the First Nine Months of this year. The primary components in the First Nine Months of last year were the assignments of a future income stream from a life settlements trust investment, which generated net proceeds of $5,254,500, and distributions from the life settlements trust (before the assignment) of $114,886. The primary component of other expense in the First Nine Months of this year is the recording of an impairment reserve of $6,648,478 against the value of the investment in the life settlements trust due to foreclosure and seizure of the portfolio assets by the German bank that had loaned the trust funds for policy acquisitions and the recording of a loss in the amount of $257,395 on a closed foreign trading account when the account was liquidated and the funds were allegedly diverted by the trading manager.

 

Income Taxes: Income tax benefit increased slightly from $504,268 in the First Nine Months of last year to $552,600 in the First Nine Months of this year. The benefit for the First Nine Months of this year excludes consideration for the impairment reserve for investment in life settlements trust.

 

Contractual Obligations and Commitments

 

Our outstanding contractual obligations and commitments as of November 30, 2014, 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		$	217,803			$	73,235			$	95,758			$	43,387			$	5,423
Total obligations		$	217,803			$	73,235			$	95,758			$	43,387			$	5,423

 

Liquidity and Capital Resources

 

Operating Activities: Net cash flows used by operating activities for the First Nine Months of this year were $675,816. Uses of cash flow were primarily from a net loss of $7,869,206, an increase in accounts receivable of $50,248, an increase in prepaid expenses of $33,720, an increase in premiums advanced on behalf of purchasers and bad debt expense of $674,506, and an increase in deferred income taxes of $604,628. Cash flows provided by operating activities were from an increase of $497,012 in deferred policy monitoring costs, an increase in accounts payable of $662,097, an increase in accrued liabilities of $119,714, and a reserve for impairment in investment in life settlements trust of $6,648,478. Net cash flows used by operating activities for the First Nine Months of last year were $5,433,440. Uses of cash flow were primarily from a net loss of $1,052,891, income from assignments of an income stream from life settlement trust investment of $5,254,500, and a decrease in accounts payable of $982,251. Cash flows provided by operating activities were from a decrease in premium advances of $1,497,813 and an increase in deferred policy monitoring costs of $701,244.

 

 

Investing Activities: Net cash flows provided by investing activities in the First Nine Months of this year were $1,660,515. This amount was primarily due to proceeds from the sale of investments in policies of $1,945,025, proceeds from the maturities on investments in policies of $33,788 less $301,847 for the purchase of investment in policies for investment purposes. In comparison, during the First Nine Months of last year, we generated $5,545,100 from investing activities. This was primarily from the proceeds of $5,254,500 from the assignments of future income from our life settlement trust investment, proceeds from investments in certificates of deposits of $500,931, proceeds from the life settlements trust of $227,508, and proceeds from sales of investments in policies of $68,626, less $47,695 return of investment in life settlements trust, $250,000 investment in a certificate of deposit and $214,823 purchase of investment in policies for investment purposes. 

 

Financing Activities: Net cash used for financing activities for the First Nine Months of this year included $2,797,236 for the payment of dividends and $101,445 for payments on a note payable to finance an insurance policy. Net cash used for financing activities for the First Nine Months of last year was $3,729,569 for the payment of dividends.

 

Working Capital and Capital Availability: As of November 30, 2014, we had working capital of $3,199,605, which reflects a working capital decrease of $6,503,683 during the last twelve month period, primarily due to operating losses and payment of dividends. Cash and cash equivalents increased $263,079 to $4,220,749 as of November 30, 2014 from $3,957,670 as of November 30, 2013.

 

The large drop in revenues and revenues net of brokerage fees, the significant legal and professional fees, and large operating losses have eroded the strength of our financial condition. We are managing our cash to fund our current operations through fiscal 2015. We suspended our stock dividends and may make further cuts. Working capital is tight and we may have to explore other financing options if business does not increase and such financing options may not be available on favorable terms to us if at all.

 

Outlook 

 

We are confronting a general decline in the life settlement markets and the fallout of the SEC action and the resulting private litigation. Regarding the life settlement markets, we believe that life settlements have desirable investment features that will eventually restore their attractiveness in the marketplace. We expect the supply of qualified life settlements to remain sufficient for our clients’ demand and believe the low correlation of life settlements returns to fixed-income and equity securities and their competitive rates offer an attractive alternative investment.

 

Even though we, Mr. Pardo and Mr. Peden were completely exonerated from any allegations of fraud alleged by the SEC, the Court let stand the jury’s findings against us, Mr. Pardo and Mr. Peden for violations of various revenue recognition matters. It is clear that the suit did damage to our reputation and our relationships within our licensee network and client base. Furthermore, the uncertainty of our appeal of the final judgment in this case entered by the Court on December 2, 2014, will most likely hinder our ability to rebuild confidence among our licensees and clients and to expand our client base. (See Part II, Item 1 Legal Proceedings.) We continue to invest significantly in programs to develop and strengthen our relationships with new and inactive licensees. We have increased our communication with our client base, emphasizing the inherent benefits of life settlements as an asset class and the particular advantages of our settlements, which do not cap investor returns as do many of the settlements offered in the industry. We are exploring alternatives for expanding our client base, including new structures for investing in life settlements, such as the marketing of life settlements as securities. Over the last three calendar years, there have been over $184 million in payouts from our life settlement transactions.

 

While we are working diligently on plans to increase business for both individual and institutional investors, our operating results for the First Nine Months of this year from life settlement transactions are disappointing and we must do more to improve our operating results. Despite the increase in revenues, the significant legal and professional fees and the operating losses we experienced in fiscal 2014 have eroded the strength of our financial condition. Our recurring operations are not currently generating sufficient cash to support operations. In the Third Quarter of this year we billed our life settlement investors for ministerial services fees in order to recover the expenses of tracking policy premium payments and maturity payouts through the life settlement process. We are continuing to collect these policy monitoring fees in the Fourth Quarter of this year. We believe we have sufficient currently available working capital to fund our current operations through fiscal 2015 and well into fiscal 2016. While we believe we could further support our working capital through other possible asset dispositions, borrowings or equity sales, our opportunities for generating significant cash apart from continuing operations are narrowing. We are conserving our cash. We eliminated the dividends for the remainder of fiscal 2015 and may do so for 2016 to conserve working capital until we can realize improved operating results. However, our current cash position is not sufficient to settle the judgment at its current amount. We have filed motions to post security in an amount lower than the judgment in order to prevent execution on the judgment while we appeal. A hearing on this motion is set for January 21, 2015, before Magistrate Judge Andrew Austin, to whom the Court referred all dispositive and non-dispositive motions on this case. In a Board of Directors meeting held on January 12, 2015, the Board discussed the motion by the Securities and Exchange Commission for the appointment of a receiver for us and our affiliates as part of its effort to enforce the judgment it secured against us (See Part II, Item 1. Legal Proceedings) and the various consequences that could arise from such an appointment by the Federal Court. The Board was of the unanimous belief that if we cannot get this resolved in a manner favorable to us, we may have to seek protection under Chapter 11 of the Bankruptcy Code.

 

 

Critical Accounting Estimates, Assumptions and Policies

 

See “Critical Accounting Estimates, Assumptions and Policies” under Item 7 of our Annual Report on Form 10-K for the fiscal year ended February 28, 2014, filed with the SEC and incorporated by reference herein.  There were no changes to our critical accounting policies during the Second Quarter of this year.

 

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 

 

Not applicable 

 

ITEM 4. CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures. With the participation of our Chief Executive Officer and Chief Financial 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 Financial 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 SEC’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 Financial 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, 2014).

 

PART II – OTHER INFORMATION 

ITEM 1. LEGAL PROCEEDINGS

 

On January 3, 2012, we and certain current directors and current and former officers were sued by the SEC in an action styled Securities and Exchange Commission v. Life Partners Holdings, Inc., Brian D. Pardo, R. Scott Peden and David M. Martin, Civil Action No.: 6:12-CV-00002. (the “SEC action”). The suit was filed in the Federal District Court for the Western District of Texas (Austin Division) and alleged that we, our Chairman and CEO, Brian Pardo, General Counsel, Scott Peden, and former Chief Financial Officer, David Martin, had knowledge of, but failed to disclose to our shareholders, the alleged underestimation of the life expectancies of settlors of viatical and life settlement policies. The suit further claimed that we prematurely recognized revenues from the sale of the settlements and that we understated the impairment of our investments in policies. The suit also claimed that Mr. Pardo and Mr. Peden sold shares while possessing inside information ( i.e. , the alleged knowledge of the underestimation of life expectancies and the purported impact on revenues from such practice). In addition, the suit alleged that the defendants misled the auditors about our revenue recognition policy.

 

Trial before a jury was held in February 2014. The jury found that neither we, Mr. Pardo nor Mr. Peden committed securities fraud under Section 10(b) of the Exchange Act and Rule 10b-5 and that Mr. Pardo and Mr. Peden did not engage in insider trading. In March 2014, the Federal court ruled that the SEC failed to prove any of its fraud claims against us, Mr. Pardo and Mr. Peden under Section 17 of the Securities Act of 1933 (the “Securities Act”), finding that there was no evidence to support the allegations related to revenue recognition for the period of time in question and ordered that judgment be entered in favor of us, Mr. Pardo and Mr. Peden on that issue. As a result of this ruling, the Company, Mr. Pardo and Mr. Peden were completely exonerated from any allegations of fraud alleged by the SEC. The Court let stand the jury's findings against us, Mr. Pardo and Mr. Peden for violations of various revenue recognition matters. On July 16, 2014, Defendants filed a motion to enter judgment in this case. On July 30, 2014, Plaintiff filed its own motion to enter judgment and its response to Defendants’ motion to enter judgment. On December 2, 2014, the Court entered a final judgment in this case which enjoined us and our agents, servants, employees, attorneys, and all persons in active concert or participation with them from violating, directly or indirectly, from filing forms with the Commission containing false statements of material fact or failing to include material information that is necessary to make the statements not misleading, unless Defendants act in good faith and do not directly or indirectly induce the act or acts constituting the violation. The Court also ordered that Messrs. Pardo and Peden, and their agents, servants, employees, attorneys, and all persons in active concert or participation with them are permanently restrained and enjoined from aiding and abetting any violation of federal securities laws and regulations by knowingly providing substantial assistance to an issuer that fails to file timely with the Commission all accurate and complete information, documents, and reports required by the rules and regulations prescribed by the Commission. The Court further ordered that Mr. Pardo and his agents, servants, employees, attorneys, and all persons in active concert or participation with them are permanently restrained and enjoined from using any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange to include a false and misleading certification with any annual or quarterly report required to be filed with the SEC. The Court further ordered Life Partners to disgorge $15,000,000 and to pay a civil penalty of $23,700,000. The Court further ordered Mr. Pardo to pay a civil penalty of $6,161,843 and Mr. Peden to pay a civil penalty of $2,000,000. On December 30, 2014, we and Mr. Pardo and Mr. Peden filed a motion to alter or amend the judgment through which we challenged the amounts and basis for the judgment as well as a notice of appeal to the Fifth Circuit Court of Appeals. The Court has not yet ruled on the motion to alter or amend. We and Mr. Pardo and Mr. Peden also filed motions to permit us to post security in an amount lower than the amount of the judgment in order to prevent execution on the judgment while we appeal. The District Court has not yet ruled on these motions. On January 5, 2015, the SEC filed a motion to appoint a receiver for us and our affiliates. A hearing on this motion is set for January 21, 2015, before Magistrate Judge Andrew Austin, to whom the Court referred all dispositive and non-dispositive motions in this case.

 

 

In February and March of 2011, six putative securities class action complaints were filed in the U.S. District Court for the Western District of Texas, Waco Division. On July 5, 2011, these actions were consolidated into the case styled Selma Stone, et al. v. Life Partners Holdings, Inc., Brian D. Pardo, R. Scott Peden, and David M. Martin, Civil Action No. DR-11-CV-16-AM in the U.S. District Court for the Western District of Texas, Del Rio Division. Plaintiffs assert substantially similar, and at times identical, facts and allegations to those asserted by the SEC in its complaint in the SEC action and seek damages and an award of costs on behalf of a class of shareholders who purchased or otherwise acquired our common stock between May 26, 2006, and June 17, 2011. On March 26, 2012, Defendants filed their motion to dismiss the amended complaint which the court denied on March 15, 2014. On September 15, 2014, Plaintiffs filed a motion to stay all proceedings in this case until the Court issues a ruling on the SEC's motion for judgment in Securities and Exchange Commission v. Life Partners Holdings, Inc., et al. The Court granted the motion on September 17, 2014 and ordered all proceedings in this case stayed until a ruling is issued in the SEC case. The Court further ordered that, within the 45-day period following the entry of a judgment in the SEC Action, the Plaintiffs shall either 1) file a motion to dismiss this action, or 2) file a motion for class certification.

 

On March 11, 2011, a purported class action suit was filed in the 191^st Judicial District Court of Dallas County, Texas, styled Helen Z. McDermott, Individually and on Behalf of all Others Similarly Situated v. Life Partners, Inc., Cause No. 11-02966. The original petition asserted claims for breach of contract, breach of fiduciary duty, and unjust enrichment on behalf of a putative class of all persons residing in the United States who purchased any portion of a life settlement that matured earlier than the estimated maximum life expectancy. Pursuant to three amendments to the Petition, the plaintiff revised the putative class of persons on whose behalf the plaintiff seeks to represent to be limited to all persons residing in the United States who purchased any portion of one particular life settlement. The plaintiff seeks as purported damages the amount of funds placed in escrow for policy maintenance that was allegedly not needed or used for policy maintenance and was not returned or paid to the plaintiff or the putative class members as well as attorneys’ fees and costs. The plaintiff also seeks certain equitable relief, including injunctive relief, restitution, and disgorgement. Following briefing by the parties and a hearing before the court, the court certified a class consisting of 38 persons residing in the United States that purchased any portion of a life settlement interest in the designated policy. LPI appealed the designation of the class, but the appeal was recently rejected by the Fifth District Court of Appeals, Dallas, Texas. The case will eventually be returned to the 191^st District Court for further proceedings.

 

On April 8, 2011, a putative class action complaint was filed in the 40^th Judicial District Court of Ellis County, Texas, styled John Willingham, individually and on behalf of all other Texas citizens similarly situated, v. Life Partners, Inc., Cause No. 82640 (MR). On July 27, 2011, by agreement of the parties, the Willingham case was transferred to the 101st Judicial District Court of Dallas County under Cause No. DC-11-10639. All of the plaintiff’s claims are based upon the alleged overpayment of premiums to the insurance company, that is, the alleged failure to engage in “premium optimization” on behalf of all Texas residents that purchased an interest in a life settlement facilitated by LPI. On March 15, 2013, the plaintiff filed his fourth amended petition in which eight new named-plaintiffs were added to the suit, and we, Brian D. Pardo, and R. Scott Peden were added as defendants. In addition to the putative class claims concerning the alleged overpayment of premiums, the amended petition asserts individual claims of breach of fiduciary duty against LPI arising from the alleged overpayment of premiums and the alleged use of underestimated life expectancies provided by Dr. Donald Cassidy, as well as aiding and abetting claims against us, Pardo and Peden. On January 22, 2013, a petition was filed in the 162 ^nd Judicial District Court, Dallas County, Texas, styled Stephen Eccles, et al vs. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo and R. Scott Peden on behalf of 23 individuals, all of whom were represented by the same counsel for the plaintiff in the Willingham case. On March 20, 2013, the parties filed a joint motion to consolidate the Eccles case with the Willingham case, which was granted on March 25, 2013. On April 15, 2013, the plaintiffs filed their fifth amended petition dropping all putative class claims and asserting individual claims of breach of fiduciary duty, common law fraud, civil conspiracy, aiding and abetting breach of fiduciary duty and common law fraud, and negligence against us, LPI, Pardo and Peden. The plaintiff seeks economic and exemplary damages, disgorgement and/or fee forfeiture, attorneys’ fees and costs, and post and pre-judgment interest. On April 9, 2013, an original petition was filed in the 352 ^nd Judicial District Court, Tarrant County, Texas, styled Todd McClain, et al v. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo, and R. Scott Peden. This suit is virtually identical to the Willingham case. On May 15, 2013, the defendants filed a motion to transfer the McClain and Willingham cases to a Multi-District Litigation Panel for the purposes of transferring and consolidating the Willingham case and the McClain case to a single forum for pretrial purposes. On August 16, 2013, the Multidistrict Litigation Panel issued an opinion granting the motion to transfer, and on September 9, 2013, the Panel issued an Order transferring the McClain case to Judge Slaughter of the 191^st District Court of Dallas County and consolidating the McClain case (and any tag along cases subsequently filed) with the Willingham case. The consolidated MDL case is styled In re Life Partners, Inc. Litigation (the “MDL Proceedings ”). In the MDL Proceedings, all of plaintiffs’ claims are based upon the alleged failure to engage in “premium optimization,” as well as the alleged provision of underestimated life expectancies by Dr. Donald Cassidy to LPI and LPI’s use in the facilitation of life settlement transactions in which plaintiffs acquired interests in life insurance policies. Plaintiffs seek economic and exemplary damages, disgorgement and/or fee forfeiture, attorneys’ fees and costs, and post and pre-judgment interest. On August 9, 2013, the Court entered a scheduling order setting a bellwether trial consisting of ten plaintiffs, five selected by plaintiffs and five selected by defendants, with the remaining plaintiffs trying their claims in groups of 16 approximately 90 days after the conclusion of each trial. On September 10, 2014, Defendants filed a Writ of Mandamus with the Fifth Court of Appeals concerning the issue of whether the Court abused its discretion by not excluding certain expert witnesses. On September 12, 2014, the Fifth Court of Appeals issued an order staying the bellwether trial which had been set for September 29, 2014 until further order of the Court.

 

 

On November 8, 2011, a putative class action suit was filed, styled Marilyn Steuben, on behalf of herself and all other California citizens similarly situated v. Life Partners, Inc., Superior Court of the State of California for the County of Los Angeles Court, Case No. BC472953. This suit asserts claims of fiduciary duty, breach of contract, and violations of California’s Unfair Competition law based upon the alleged overpayment of premiums to the insurance company, that is, the alleged failure to engage in “premium optimization.” On December 3, 2012, the plaintiffs filed their motion to intervene in the Turnbow case whereby the plaintiffs sought to join the putative Turnbow class and subclass and to create a new subclass asserting claims for damages related to the defendants’ alleged overpayment of premiums. The Federal District Judge in the Turnbow case denied the plaintiffs’ motion to intervene on February 5, 2013 and the Turnbow case was voluntarily dismissed in December 2013. On June 5, 2014, the parties filed a joint status report with the court, and the court continued to stay the case pending resolution of the Willingham suit. No trial date has been set. Please see the Annual Report on Form 10-K for the year ended February 28, 2014 (the “2014 Annual Report) for a discussion of the case styled Turnbow et al. v. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo, and R. Scott Peden , Civil Action No. 3:11-CV-1030-M and the case styled John Willingham, individually and on behalf of all other Texas citizens similarly situated, v. Life Partners, Inc., Cause No. 82640 (MR ).

 

On March 31, 2014, a complaint was filed in the United States District Court for the Southern District of Florida, styled John Woelfel, individually and F/B/O and In His Capacity as Owner and Beneficiary of the John Woelfel Self-Directed IRA v. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo, R. Scott Peden, and Pardo Family Holdings, Ltd. Case No. 14-80433-CIV-COHN/SELTZER. On May 9, 2014, following Defendants filing of a Motion to Dismiss the Complaint, Plaintiffs filed their First Amended Complaint in which Plaintiffs Henry and Diana Funke were added as parties. On May 23, 2014, Defendants filed a Motion to Dismiss Plaintiffs’ First Amended Complaint. On June 17, 2014, plaintiffs voluntarily dismissed their claims for alleged violations of the Federal Securities Act. Defendants’ Motion to Dismiss the Amended Complaint is pending as of the date of this disclosure. This suit asserts claims of breach of fiduciary duty, negligence, common law fraud, aiding and abetting breach of fiduciary duty and common law fraud and civil conspiracy, constructive trust, fraudulent transfer, and unjust enrichment. This suit is virtually identical to the MDL Proceedings and Plaintiffs are represented by the same law firm as in the MDL Proceedings. All of plaintiffs’ claims are based upon the alleged failure to utilize “premium optimization” and the alleged provision of underestimated life expectancies by Dr. Donald Cassidy to LPI and LPI’s use of those life expectancies in the facilitation of life settlement transactions in which plaintiffs acquired interests in life insurance policies. Plaintiffs seek economic and exemplary damages, disgorgement and/or fee forfeiture, rescission, attorneys’ fees and costs, and post and pre-judgment interest. Initial discovery has begun and trial is set to begin on April 20, 2015.

 

On July 8, 2014, a complaint was filed in the United States District Court for the Western District of Pennsylvania, styled Arthur W. Morrow, individually and F/B/O and In His Capacity as Owner and Beneficiary of the Arthur W. Morrow Self-Directed IRA et al. v. Life Partners, Inc., Life Partners Holdings, Inc., Brian D. Pardo, R. Scott Peden, and Pardo Family Holdings, Ltd., Civil Action No. 3:14-cv-141. This suit is virtually identical to the Woelfel lawsuit and Plaintiffs are represented by the same law firm as in that case. The case asserts claims of breach of fiduciary duty, negligence, common law fraud, aiding and abetting breach of fiduciary duty and common law fraud and civil conspiracy, constructive trust, fraudulent transfer, and unjust enrichment. All of plaintiffs’ claims are based upon the alleged failure to utilize “premium optimization” and the alleged provision of underestimated life expectancies by Dr. Donald Cassidy to LPI and LPI’s use of those life expectancies in the facilitation of life settlement transactions in which plaintiffs acquired interests in life insurance policies. Plaintiffs seek economic and exemplary damages, disgorgement and/or fee forfeiture, rescission, attorneys’ fees and costs, and post and pre-judgment interest. The trial is in its initial stages and no discovery has been conducted yet.

 

The Company is currently under audit by the Internal Revenue Service for years 2008, 2009 and 2010 for failure to withhold taxes on certain dividends paid to foreign shareholders and has issued a proposed adjustment of $3,991,351 in taxes including penalties. The Company has obtained legal counsel to defend its position that the withholding liability rests with the last U.S. person who makes payment to a foreign person if the U.S. person is a financial institution and the withholding agent has no reason to believe that the financial institution will not comply with its obligation to withhold.  The Company is filing an administrative appeal to contest the IRS’ findings with the IRS appeals division. The deadline for filing the appeal is January 23, 2015.

 

During the current quarter, there have been no material developments for legal proceedings except as described above and in our Annual Report on Form 10-K for the year ended February 28, 2014 (the “2014 Annual Report”). For a full disclosure of legal proceedings, please reference our 2014 Annual Report.

 

 

Management believes, and we have been so advised by counsel handling the respective proceedings, that we have meritorious defenses in all pending litigation to which we or our directors or officers are a party, as well as valid bases for appeal of potential adverse rulings that may be rendered against us. We intend to defend all such proceedings vigorously and, to the extent available, will pursue all valid counterclaims. Notwithstanding this fact, as with all litigation, the defense of such proceedings is subject to inherent uncertainties, and the actual costs will depend upon numerous factors, many of which are as yet unknown and unascertainable. Likewise, the outcome of any litigation is necessarily uncertain. We may be forced to continue to expend considerable funds in connection with attorneys’ fees, costs, and litigation-related expenses associated with the defense of these proceedings, and management’s time and attention will also be taxed during the pendency of these proceedings. We may enter into settlement discussions in particular proceedings if we believe it is in the best interests of our shareholders to do so.

 

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 Financial Statements for unfavorable outcomes, if any.

 

ITEM 1A.

RISK FACTORS

 

The risks described in our Annual Report on Form 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently believe to be immaterial also may adversely affect our business, financial condition and/or operating results. This section updates our risk factors as stated in our Annual Report in Form 10-K to reflect material developments since our Form 10-K was filed.

 

Our life settlement transaction volumes and revenues and earnings have declined following adverse news articles about our business, the filing of an SEC enforcement action and negative publicity. Whether and when we might recover from these events is uncertain.

 

In the fourth quarter of fiscal 2011, we were hurt by news articles critical of our business and by the announcement of a pending SEC investigation. Several putative securities class actions and shareholder derivative claims were subsequently filed against us and certain officers and, in the fourth quarter of fiscal 2012, the SEC filed a civil enforcement action against us and certain officers, and since these filings, demand for our services has been negatively impacted and our business has not recovered from the damage done by these events. Our volume of life settlement transactions dropped, as did our profitability. The events particularly affected our business in that we are the only publicly held company dedicated to life settlements and the only prominent company with a broad, retail base within the life settlement industry. We are working to repair the damage caused by the SEC suit, restore trust and confidence within our licensee network and purchaser base, and rebuild our reputation within the industry. Furthermore, the uncertainty of our appeal of the final judgment in the SEC case entered by the court on December 2, 2014 will most likely hinder our ability to rebuild confidence among our licensees and clients and to expand our client base. We cannot say, however, when or if we can accomplish these tasks and return to the levels of activity we previously enjoyed.

 

Our success depends on restoring trust within our referral networks.

 

We rely primarily upon brokers to refer potential sellers of policies to us and upon financial professionals, known as licensees, to refer retail purchasers to us. These relationships are essential to our operations and we must maintain these relationships to be successful. We do not have fixed contractual arrangements with life settlement brokers, and they are free to do business with our competitors. Our network of licensees is much broader, but no less important. The announcements of the SEC investigation and subsequent enforcement action and court judgment, other private litigation, illegal short selling and critical news articles have damaged our reputation within the industry and have hurt our business. Our licensee network was particularly hurt, which has reduced the supply of capital for the purchase of life settlements and our transaction volumes. The restoration of the relationships with our licensees and brokers will depend upon our ability to rebut the adverse publicity and to restore trust in these relationships. If we are unable to restore our relationships with our licensees and brokers, it will have a material adverse effect on our business, financial condition and results of operations.

 

If we fail to price policies to yield competitive returns, we may lose purchasers.

 

We price settlements based on a number of factors including the policy face amount, policy maintenance costs, achieving a competitive return and maintaining a profitable transaction, even if the insured lives into their early to mid-nineties. If our pricing method indicates values that are not competitive in the marketplace, we could lose purchasers and/or policy sellers, and those losses could have a material adverse effect on our business, financial condition, and results of operations.

 

We rely on outside advisors for life expectancy estimates.

 

We have historically relied on an outside practicing oncologist, Dr. Donald T. Cassidy, of Reno, Nevada. In fiscal 2012, we implemented a practice of obtaining a second life expectancy estimate from a leading industry provider, 21^st Services, LLC, in addition to Dr. Cassidy’s estimate. We believe a life expectancy estimate that accounts for individual circumstances is preferable to a probabilistic methodology that relies solely on actuarial and statistical data. While their methodologies and data sourcing vary somewhat, each of the analyses done by Dr. Cassidy or 21^st Services adjusts the estimate from life expectancy tables to account for the insured’s medical conditions, family health history, and social/lifestyle factors. If those estimates consistently tended to underestimate life expectancies, our business could be adversely affected.

 

The expanding market for life settlement resales may divert purchasers from initial life settlement transactions.

 

As the life settlement industry matures, the secondary market for life insurance policies is expanding to include resales of life settlements. Our business model accommodates the resales of life settlements. Our revenues from resales, also referred to as tertiary sales, grew from 12% of our total revenues in fiscal 2013 to 45% of our total revenues in fiscal 2014. The growth in tertiary sales has to some extent offset a decline in our sales of life settlements from insureds to an initial purchaser. Our initial sales declined from $16.6 million in fiscal 2013 to $8.6 million in fiscal 2014. Rather than expanding the secondary life settlements market, it appears that tertiary sales are diverting purchasers from initial sales. While continuing to accommodate tertiary sales, we are taking additional steps to interest more purchasers in secondary sales. Without a solid volume of initial sales, the supply of policies for tertiary sales will eventually decline, which would result in further declines in our revenues.

 

 

We had an investment in a life settlement trust that may not be recovered.

 

As of February 28, 2014, our balance sheet showed $6,648,478 as an “Investment in Life Settlements Trust”. The investment is in Life Assets Trust, S.A., an unaffiliated Luxembourg joint stock company (the “Trust”), which was created for the acquisition of life settlements. As of February 28, 2014, we owned approximately 19.9% of the Trust, which we believe then owned a portfolio of 228 life insurance settlements with a face value of $610.5 million, of which we supplied settlements with a face value of approximately $278 million. In May 2013, we assigned certain rights to receive future distributions from the Trust for $5,650,000. We subsequently learned that a German bank, which had loaned the Trust funds for policy acquisitions, would not renew its loan and was seeking repayment. The Trust was unsuccessful in its attempts to refinance the loan and to negotiate a settlement with the bank. The bank has declared the loan in default and has instituted proceedings to foreclose its security interest in the Trust’s assets and take the assets in satisfaction of the loan. We, along with the other limited partners and general partner of the Trust, have retained legal counsel to represent our interests. The bank declared a default on the loan, and on May 8, 2014, the bank issued a notice of foreclosure and instructed the credit facility’s master collateral agent to conduct a public auction of the collateral, which consisted primarily of the policies. The Trust retained legal counsel in the matter. Initially the Trust obtained a temporary restraining order to enjoin the foreclosure. At the subsequent hearing on June 17, 2014, however, the court lifted the restraining order and allowed the bank to proceed with the sale. The foreclosure sale was held on August 6, 2014, and the bank was the successful bidder for the portfolio. The portfolio of 225 life insurance settlements with a face value of approximately $604.1 million was sold for $202.7 million. The Trust’s counsel filed an amended complaint on August 12, 2014, alleging that the sale was not conducted in a commercially reasonable manner to yield a higher purchase price of the collateral so as to satisfy the obligations under the loan and potentially yield a surplus for itself and its investors. The opposing counsel filed a motion to dismiss our amended complaint on September 15, 2014. The hearing on the motion to dismiss is still pending. After the court rules on the motion to dismiss, we will know whether or not our amended claims will survive. We cannot predict how long after the hearing the court will rule on the motion to dismiss and there can be no assurance of the outcome of this matter. Due to the uncertainty of the timeline or of the ultimate outcome of the potential litigation proceedings we impaired the investment value as of August 31, 2014. If this matter is decided adversely to us, we may not recover any portion of the investment.

 

While we prevailed on the fraud and insider trading charges in the SEC enforcement action, we were found to have violated lesser charges. The final judgment included significant penalties that could have a material adverse impact on our business and financial condition.

 

In its enforcement action against us, the SEC asserted multiple claims against us and certain of our executive officers, including fraud and insider trading claims. The jury found in our favor on the majority of the claims, including all fraud and insider trading claims. However, the jury found against us and our CEO, Brian Pardo, and General Counsel, Scott Peden, regarding violations relating to our revenue recognition policies and a restatement of revenues. It also found against Mr. Pardo for having improperly certified our SEC reports. The SEC did not introduce any evidence regarding these revenue recognition issues and in a subsequent ruling the court found there was no evidence of any fraud.

 

On December 2, 2014, the court entered a final judgment in this case which enjoined us and our agents, servants, employees, attorneys, and all persons in active concert or participation with them from violating, directly or indirectly, from filing forms with the SEC containing false statements of material fact or failing to include material information that is necessary to make the statements not misleading, unless Defendants act in good faith and do not directly or indirectly induce the act or acts constituting the violation. The court also ordered that Messrs. Pardo and Peden, and their agents, servants, employees, attorneys, and all persons in active concert or participation with them are permanently restrained and enjoined from aiding and abetting any violation of federal securities laws and regulations by knowingly providing substantial assistance to an issuer that fails to file timely with the Commission all accurate and complete information, documents, and reports required by the rules and regulations prescribed by the Commission. The court further ordered that Mr. Pardo and his agents, servants, employees, attorneys, and all persons in active concert or participation with them are permanently restrained and enjoined from using any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange to include a false and misleading certification with any annual or quarterly report required to be filed with the SEC. The court further ordered Life Partners to disgorge $15,000,000 and to pay a civil penalty of $23,700,000. The court further ordered Mr. Pardo to pay a civil penalty of $6,161,843 and Mr. Peden to pay a civil penalty of $2,000,000. On December 30, 2014, we and Mr. Pardo and Mr. Peden filed a motion to alter or amend the judgment through which we challenged the amounts and basis for the judgment as well as a notice of appeal to the Fifth Circuit Court of Appeals. The court has not yet ruled on the motion to alter or amend. We and Mr. Pardo and Mr. Peden also filed motions to permit us to post security in an amount lower than the amount of the judgment in order to prevent execution on the judgment while we appeal. The District Court has not yet ruled on these motions. On January 5, 2015, the SEC filed a motion to appoint a receiver for us and our affiliates. A hearing on this motion is set for January 21, 2015 before Magistrate Judge Andrew Austin, to whom the court referred all dispositive and non-dispositive motions in this case. In addition, the SEC has moved for the appointment of a receiver for us and our affiliates which we believe is unsupported by the evidence in their case and which we will vigorously oppose. We cannot predict the impact on our business strategy, operations or financial results if the SEC is successful in its motion for the appointment of a receiver.

 

 

While we are working diligently on plans to increase business for both individual and institutional investors, our operating results for the First Nine Months of this year are disappointing and we must do more to improve our operating results. Despite the increase in revenues, the significant legal and professional fees and the operating losses we experienced in fiscal 2014 have eroded the strength of our financial condition. Our recurring operations are not currently generating sufficient cash to support operations. We may require additional capital from equity or debt financings in the future to fund our operations or respond to competitive pressures or strategic opportunities. We may not be able to secure timely additional financing on favorable terms, or at all. The terms of any additional financing may limit our financial and operating flexibility. If we raise additional funds through further issuances of equity, convertible debt securities or other securities convertible into equity, our existing shareholders could suffer significant dilution in their percentage ownership of our company, and any new securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. If we are unable to obtain adequate financing or financing on terms satisfactory to us if and when we require it, our ability to conduct our business and to respond to business challenges could be significantly limited. As a result of the judgment, our ability to use certain exemptions from securities registration has been impaired, which may limit our ability to raise funds through the sale of securities. Our current cash position is not sufficient to settle the judgment at its current amount. If we are not successful in our motion to post security in an amount lower than the amount of the judgment in order to prevent execution on the judgment while we appeal, we may seek protection by Chapter 11 of the bankruptcy code.

 

Government regulation could negatively impact our business.

 

We are licensed and regulated by the Texas Department of Insurance as a viatical and life settlement company and hold licenses as a life settlement provider in other states as well. State laws requiring the licensing of life settlement providers govern many aspects of our conduct, operations, advertising and disclosures and are designed to afford consumer-protection benefits. The laws vary from state to state, however, and our activities and those of brokers with whom we do business can be affected by changes in these laws. Compliance with current laws regulating life settlement companies and life settlement providers is costly and complex. Any changes in these laws or governmental regulation could have a material adverse effect on our business.

 

Our Chairman and Chief Executive Officer beneficially owns 50% of our common stock and, as a result, can exercise significant influence over us.

 

Under SEC regulations, Mr. Brian D. Pardo, our Chairman and Chief Executive Officer, is considered the beneficial owner of approximately 50% of our common stock, largely as the result of exercising voting power by proxy over shares held by The Pardo Family Trust. He could control most matters requiring approval by our shareholders, including the election of directors and approval of significant corporate transactions.

  

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

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

 

 

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 14, 2015

 

	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

 

 

EXHIBIT INDEX

 

DESCRIPTION OF EXHIBITS

 

Number		Description		Page
31.1		Rule 13a-14(a) Certification of CEO		31
31.2		Rule 13a-14(a) Certification of CFO		32
32.1		Section 1350 Certification		33