Special Note: Certain statements set forth below under this caption constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. See Special Note Regarding Forward-Looking
Statements for additional factors relating to such statements.
We provide the following discussion to assist in understanding our financial position as of
February 28, 2014("fiscal 2014"), and results of operations for the year then ended, and as of and for the years ended February 28, 2013("fiscal 2013"), and February 29, 2012("fiscal 2012"). As you read this discussion, refer to our Consolidated Financial Statements and Notes thereto. We analyze and explain the differences between periods in the material line items of these statements. 17
Critical Accounting Estimates, Assumptions and Policies
Our discussion and analysis of financial condition and results of operations are based on our Consolidated Financial Statements that were prepared in accordance with accounting principles generally accepted in
the United States of America. To guide our preparation, we follow accounting policies, some of which represent critical accounting policies as defined by the SEC. The SECdefines critical accounting policies as those that are both most important to the portrayal of a company's financial condition and results and require management's most difficult, subjective, or complex judgment, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Certain accounting estimates involve significant judgments, assumptions and estimates by management that may have a material impact on the carrying value of certain assets and liabilities, disclosures of contingent liabilities, and the reported amounts of income and expenses during the reporting period that management considers to be critical accounting estimates. The judgments, assumptions and estimates used by management are based on historical experience, management's experience, knowledge of the accounts and other factors that are believed to be reasonable. Because of the nature of the judgments and assumptions made by management, actual results may differ materially from these judgments and estimates, which could have a material impact on the carrying values of our assets and liabilities and the results of our operations. Areas affected by our estimates and assumptions are identified below.
We recognize revenue at the time a settlement closes and defer a portion of the revenue in anticipation of policy monitoring services. We amortize the costs of these services over the anticipated life expectancy of the insureds. We sometimes make short-term advances to facilitate life settlement transactions. These amounts are included in "Accounts receivable - trade" and are collected as the life settlement transactions close. All amounts are considered collectible as we are repaid the advance before any other parties involved in the transaction receive funds. We follow the guidance contained in
Financial Accounting Standards BoardAccounting Standards Codification "FASB ASC" 325-30, Investments in Insurance Contracts, to account for our investments in life settlement contracts. ASC 325-30 states that a purchaser may elect to account for its investments in life settlement contracts using either the investment method or the fair value method. The election is made on an instrument by instrument basis and is irrevocable. Under the investment method, a purchaser recognizes the initial investment at the purchase price plus all initial direct costs. Continuing costs (e.g., policy premiums and direct external costs, if any) to keep the policy in force are capitalized. Under the fair value method, a purchaser recognizes the initial investment at the purchase price. In subsequent periods, the purchaser re-measures the investment at fair value in its entirety at each reporting period and recognizes changes in fair value earnings (or other performance indicators for entities that do not report earnings) in the period in which the changes occur. We elected to value our investments in life settlement contracts using the investment method. The current portion of our investments in policies was carried at $1,075,205and $2,329,005at February 28, 2014and 2013, respectively. The long-term portion of our investments in policies was carried at $1,165,941and $0at February 28, 2014and 2013, respectively. We review the carrying value of our investments in policies for impairment whenever events and circumstances indicate that we might not recover the carrying value of the policies from future maturities. In cases where undiscounted expected proceeds from future maturities are less than the carrying value, we recognize an impairment loss equal to an amount by which the carrying value (including expected future costs to maintain the policies) exceeds the expected proceeds. Based on this assessment, we recorded impairment costs for our investments in policies of $297,610, $745,402, and $906,451during fiscal 2014, 2013 and 2012, respectively. 18
We establish litigation and policy analysis loss accruals based on our best estimates as to the ultimate outcome of contingent liabilities. This loss analysis is necessary to properly match current expenses to currently recognized revenues and to recognize that there is a certain amount of liability associated with litigation and policy losses. Through these accruals, we recognize the estimated cost to settle pending litigation as an expense. These estimates are reviewed on a quarterly basis and adjusted to management's best estimate of the anticipated liability on a case-by-case basis. A high degree of judgment is required in determining these estimated accrual amounts since the outcomes are affected by numerous factors, many of which are beyond our control. As a result, there is a risk that the estimates of future litigation and policy analysis loss costs could differ from our currently estimated amounts. Any difference between estimates and actual final outcomes could have a material impact on our financial statements. We must make estimates of the collectability of accounts and notes receivable and premium advances. The accounts associated with these areas are critical to recognizing the correct amount of revenue and expenses in the proper period. Our historical success of collecting premium advances has enabled us to build a body of evidence by which we can demonstrate full collectability of the remaining balance of advanced premiums. We review the carrying value of our property and equipment for impairment whenever events and circumstances indicate that the carrying value of an asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of assets. The factors considered by management in performing this assessment includes current operating results, trends and prospects, the manner in which the property is used, and the effects of obsolescence, demand, competition and other economic factors. Based on this assessment, there was no impairment for property and equipment during fiscal 2014, 2013 and 2012. We must evaluate the carrying value of our investment in life settlements trust 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. We have an investment in a financial instrument held by a third party. We do not have direct ownership of the individual policies but have a derivative right to share in income generated from the policies. Impairment testing entails evaluating our indirect investment in the policies, based on insurance carriers, legal environment, political environment and a basis using the entity's financial statements. Based on this assessment, we believe that there was no impairment for our investment during fiscal 2014, 2013 and 2012. We must evaluate the useful lives of our property and equipment to assure that an adequate amount of depreciation is being charged to operations. Useful lives are based generally on specific knowledge of life for specific types of assets. We are required to estimate our income taxes. This process involves estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include a tax provision or reduce our tax benefit in the statements of operations. We use our judgment to determine our provision or benefit for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We cannot predict what future laws and regulations might be passed that could have a material effect on our results of operations. We assess the impact of significant changes in laws and regulations on a regular basis and update the assumptions and estimates used to prepare our financial statements when we
deem it necessary. 19
New Accounting Pronouncements
For a discussion of recent accounting pronouncements, refer to Note 3 of our Consolidated Financial Statements. New pronouncements issued but not effective for us until after
February 28, 2014, are not expected to have a material impact on our financial position, results of operations or liquidity. Life PartnersWe are the world's oldest and only publicly traded company operating exclusively in the life settlement industry. Our revenues are primarily derived from fees associated with facilitating life settlement transactions.
Comparison of Fiscal 2014, 2013 and 2012
We had a net loss of
$2,454,105for fiscal 2014, compared to net losses of $2,877,025for fiscal 2013 and $3,123,478for fiscal 2012. The net loss in fiscal 2014, with a 17.0% decrease in gross revenues and a 30.2% decline in revenues, net of brokerage fees, was due to primarily the damage to our licensee network and purchaser base resulting from the SECinvestigation and subsequent lawsuit, the filing of multiple private suits, and the publication of news articles criticizing our operations. We have made significant reductions in legal and professional fees, premium advances and impairment expenses which were positive influences in fiscal 2014 when compared to fiscal 2013. The 42.6% decrease in gross revenue and 51.1% decrease in revenues, net of brokerage fees, in fiscal 2013 was primarily the result of the aforementioned news articles and disclosure of the SECinvestigation, which occurred in the fourth quarter of fiscal 2011. In fiscal 2012, the aforementioned news articles and disclosure of the SECinvestigation resulted in a 67.6% decrease in gross revenues and a 78.8% decrease in revenues, net of brokerage and licensee fees. The decrease in revenues, net of brokerage and licensee fees, together with a large increase in legal and professional fees and impairment expense, offset by significant reduction in settlement costs, resulted in a loss from operations of $5,736,639. Legal and professional costs were $3,211,799, $3,713,536, and $6,522,221in fiscal 2014, 2013 and 2012, respectively, and were the largest single general and administrative expense. The legal and professional costs were attributable primarily to legal costs associated with the SECinvestigation and lawsuit, related private litigation, and our audit fees. See Item 3, Legal Proceedings. Revenues - Revenues decreased by $3,218,598, or 17.0%, from $18,904,837in fiscal 2013 to $15,686,239in fiscal 2014. This decrease was due primarily to the decreased number of settlements, from 35 in fiscal 2013 to 26 in fiscal 2014, along with lower revenues, net of brokerage fees, as a percentage of gross revenue. Revenues decreased by $14,017,352, or 42.6%, from $32,922,189in fiscal 2012 to $18,904,837in fiscal 2013. This decrease was due primarily to the decreased number of settlements, from 62 in fiscal 2012 to 35 in fiscal 2013, along with lower revenues, net of brokerage fees, as a percentage of gross revenue. Revenues, net of brokerage fees, were $3,997,820in fiscal 2014 or 25.5% of gross revenue in fiscal 2014, versus $5,729,582or 30.3% of gross revenue in fiscal 2013 and $11,714,430or 35.6% of gross revenue in fiscal 2012, as we increased promotional bonuses and lowered our fees to obtain business. Average revenue per settlement, net of brokerage fees, increased 11.7%, or $63,179to $603,317in fiscal 2014 compared to $540,138in fiscal 2013 and $531,003in fiscal 2012. Revenues from initial settlement transactions were $8,572,203for fiscal 2014 compared to $16,573,473for fiscal 2013. The drop in revenues from initial sales was largely offset by commissions and fees from resales or tertiary sales, which increased $4,782,672from $2,331,364in fiscal 2013 to $7,114,036in fiscal 2014. This year's increase in tertiary sale revenue included fee income from resales of abandoned interests of $2,314,888, which was not in place in fiscal 2013. 20 Since the filing of a civil action by the SECin January 2012and 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 2013 calendar year, over 2,800 of our clients were paid more than $74 millionin 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 have observed an increase in new clients and deposits into escrow and greater interest in our services. We intend to continue devoting resources to rebuild our client base and increase demand for our services in fiscal 2015. 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 SECsuit, 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 11.3%, or $1,486,836from $13,175,255in fiscal 2013 to $11,688,419in fiscal 2014. Brokerage and referral fees decreased 37.9%, or $8,032,504from $21,207,759in fiscal 2012 to $13,175,255in fiscal 2013. Brokerage and referral fees constituted 74.5%, 69.7%, and 64.4% of revenues in fiscal 2014, 2013 and 2012, respectively. In fiscal 2014, broker referrals accounted for 98% of the total face value of policies transacted. In fiscal 2013, broker referral accounted for 91% of the total face value of policies transacted, and in fiscal 2012, 99%. Policies presented from five brokers each represented more than 10% of all completed transactions in fiscal 2014 and represented 94.7% in total. Policies presented from three brokers each represented more than 10% of all completed transactions in fiscal 2013 and represented 54.7% in total. Policies presented from two brokers each represented more than 10% of all completed transaction in fiscal 2012 and represented 24.3% in total. Brokerage and referral fees generally increase or decrease with revenues, face value of policies transacted and the volume of transactions, although the exact ratio 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 will 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. The effect of the growing concentration is also reflected in the increase of broker fees as a percentage of revenues.
Operating Expense- General and administrative expenses increased by 8.5% to
Legal and professional expenses decreased by 13.5% to
$3,211,799in fiscal 2014 versus $3,713,536in fiscal 2013. These expenses are primarily associated with the SEClawsuit, the private litigation that followed disclosure of the SECinvestigation, and auditing fees. Legal and professional expenses in fiscal
$6,522,221. Impairment expense for fiscal 2014 declined $447,792to $297,610. Many of the remaining older viatical policies that were fully impaired in previous periods were sold in fiscal 2013. We decreased impairment expense for our investments in policies from $906,451in fiscal 2012 to $745,402in fiscal 2013 again because many of the older viatical policies that we owned were fully impaired in previous periods and were sold. General and administrative expenses increased 8.5% or $663,474from $7,813,970in fiscal 2013 to $8,477,444in fiscal 2014. Increases of $763,672in personnel expenses and $83,006in postage expenses were mitigated by decreases of $134,330in charitable contributions, and $233,726in other outside services. 21
Employee bonuses increased
$232,110in fiscal 2014, due in part to $150,000in executive bonuses paid in the fourth quarter as recognition for efforts in anticipation of the SECtrial scheduled for January 2014and $137,307in executive bonuses paid in the second quarter after positive first quarter results. Officer salaries also increased $304,975in fiscal 2014 to partially offset the compensation declines from earlier years with the absence of profit-based bonuses. Employee bonuses increased $126,064in fiscal 2013, due in part to $81,708in executive bonuses paid in the second quarter after positive first quarter results. We paid $12,511of settlement expenses for various legal action or claims in fiscal 2014. In fiscal 2013 we recovered non-recurring settlement expenses of $104,453. Settlement expenses in fiscal 2012 were $613,374. Premium advances, net of reimbursements, in fiscal 2014, 2013 and 2012 were $931,304, $1,526,547, and $1,363,915respectively. For business goodwill, we may make advances on policy premiums to maintain certain policies. In the typical life settlement, policy premiums for the insured's projected life expectancy or a fixed period 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. We have several ways to proceed if a purchaser fails to pay premiums. In the past, we have negotiated a repurchase of the policy. In other instances, we have advanced the premiums to maintain the policies. With some advances, we historically allowed the purchaser to retain the policy as an accommodation and based our assumptions that we will ultimately recoup the advances upon the insured's death. More recently, we have acquired and resold defaulted positions, as provided in the policy funding agreements with clients. We resell the abandoned policies at a fixed percentage of the policy face plus the amount of the premiums advanced. The resale of these policies has improved our cash flow and lowered premium advances. We must make estimates of the collectability of these premium advances. We record an allowance against the premium advances at the time of the advance as needed and treat reimbursements as a reduction of the allowance if previously reserved. Our historical success of collecting premium advances has enabled us to build a body of evidence by which we can demonstrate full collectability of the remaining balance of advanced premiums. Interest and Other Income - Interest and other income decreased $103,075to $83,961in fiscal 2014 from $187,036in fiscal 2013. Interest and other income decreased $349,329from $536,365in fiscal 2012 to $187,036in fiscal 2013. The decreases in interest and other income in fiscal 2014 and fiscal 2013 were due to a lower amount of cash available for investment. Investment and Assignment of Interest in Life Settlement Trust- We have an investment in a life settlement trust, which we believe owns a portfolio of 228 life insurance settlements with a face value of $610.5 million. Our investment was recorded at $6,648,478as of February 28, 2014. Our earnings from the trust were $114,886, $458,377and $28,807in fiscal 2014, 2013 and 2012, respectively. In fiscal 2014, we assigned our distribution rights, subject to a reversionary interest, to unaffiliated third parties, in exchange for net proceeds of $5,254,500. Until and unless the reversionary interest arises, we will not receive further distributions from the trust. The trust has defaulted on certain secured borrowings and the lender 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. We believe the carrying value we have recorded will be fully realized in the future. See Footnote 10 to the Consolidated Financial Statements. 22 Income from Investments in Policies - Income from investments in policies decreased $3,621,490from $3,716,225in fiscal 2013 to $94,735in fiscal 2014. Income in fiscal 2012 was $809,218. This income in all three years was from sales and maturities in which we owned an interest. The decline in fiscal 2014 income reflects the lower quality of policies that we had in inventory following the sales in fiscal 2013. The current carrying value of all policies we own, net of impairment, was $2,241,146as of February 28, 2014. We have classified one policy interest valued at $1,075,205, net of impairment, as a current asset, as we anticipate selling this policy interest within the next twelve months. We believe the remainder are not currently marketable and have classified those interests as held for long term. See Footnote 9 to the Consolidated Financial Statements. Loss on Settlement of Note Receivable - Loss on settlement of note receivable of $231,096in fiscal 2013 is the net amount from the proceeds received of $350,000versus amount of note receivable on the consolidated balance sheet at February 29, 2012, which was $581,096. See Footnote 7 to the Consolidated Financial Statements. Realized Gain/Loss on Investment Securities- We realized a gain on sales of investment securities of $22in fiscal 2013 and a loss of $185,456in fiscal 2012. We had no gain or loss in fiscal 2014. Income Taxes- The income tax benefits were $1,142,312in fiscal 2014, $1,212,363in fiscal 2013, and $1,429,921in fiscal 2012, which arose from negative pretax earnings in each fiscal year. Income tax expense is in direct correlation to pretax earnings, taxed at 35% at the Federal level. Fiscal 2014's income tax benefit of $1,142,312is comprised of current Federal expense benefit of $(79), current state tax expense of $63,659, and deferred tax benefit of $1,205,892. Fiscal 2014 tax expense includes an accrual of Texasmargin tax in the amount of $72,428that was paid with the filing of the 2014 annual return on May 15, 2014. Income tax expense was also affected by the establishment of a $611,298valuation allowance within the deferred income tax asset account in 2011. This allowance was established to recognize the uncertainty of netting future capital gains against a current capital loss. We have net capital losses from prior years of $91,729. This increased the valuation allowance to $643,403at February 29, 2012and February 28, 2013and other adjustments increased the valuation allowance to $672,115at February 28, 2014.
Liquidity and Capital Resources
Operating Activities - Net cash flows used in operating activities in fiscal 2014 were
$2,343,287. Uses of cash flow resulted primarily from a net loss of $2,454,105, income from assignment of income stream of $5,254,500and a decrease in accounts payable of $682,432. Cash flows provided by operating activities were from an increase in income taxes receivable of $3,445,564, a decrease in net premium advances of $1,907,054and an increase in deferred policy monitoring costs of $1,245,032. Net cash flows used in operating activities decreased by 59.0%, decreasing $3,367,556from $5,710,843in fiscal 2013 to $2,343,287in fiscal 2014. Net cash flows used in operating activities in fiscal 2013 decreased by 10.6%, decreasing by $676,851from $6,387,694in fiscal 2012 to $5,710,843in fiscal 2013. Fiscal 2013's uses of cash flow were primarily from a net loss of $2,877,025, an increase of income taxes receivable of $1,659,388, net premium advances of $2,591,934, gain on sales of investments in policies of $3,716,225, and the gain on investment in life settlements trust of $458,377, offset by an increase in accounts payable of $881,247and an increase in deferred policy monitoring costs of $363,289. Fiscal 2012's uses of cash flow were primarily from a net loss of $3,123,478and a decrease in income taxes payable, a decrease in accounts payable and a gain on sales of investments in policies, while impairment of policies and deferred income taxes had a positive impact. 23
Investing and Financing Activities - Our investing activities provided cash of
$5,564,339in fiscal 2014, primarily from the proceeds of $5,254,500from the assignment of future income from our life settlement trust investment, proceeds from investments in certificates of deposits of $500,728, proceeds from the life settlements trust of $227,508, and proceeds from sales of investments in policies of $146,530, less $47,695return of investment in life settlements trust, $250,000investment in certificate of deposit and $298,844purchase of investment in policies for investment purposes. Net cash flow provided by investing activities in fiscal 2013 of $9,387,419consisted of $9,817,929proceeds from sales of investments in policies, $400,000proceeds from sales of investments in securities, $691,682proceeds from our investment in the life settlement trust, offset by $369,611purchases of policies for investment purposes and $609,371investment in life settlement trust. We used $4,661,900in financing activities in fiscal 2014 versus $7,463,685in fiscal 2013 and $14,920,716in fiscal 2012. Financing activities in all three years were solely for dividends. Working Capital and Capital Availability - As of February 28, 2014, we had cash and cash equivalents of $6,134,731and working capital of $6,897,415, compared to working capital of $11,381,163as of February 28, 2013. Our cash during fiscal 2014 decreased by $1,440,848, compared to a decrease of $3,787,109in fiscal 2013 and a decrease of $16,247,876in fiscal 2012. We believe our existing working capital and future cash flows from operating activities will allow us to fund our current operations through fiscal 2015. Our recurring operations are not currently generating sufficient cash to support operations. To fund our short and long-term operations and to pay dividends, we have liquidated much of our investment portfolio, including most of our investments in policies and our investments in securities. We have monetized our investment in the life settlement trust by assigning our current rights to future income. During the fourth quarter of fiscal 2014 we received a Federal income tax refund of $3,507,242, which aided our cash available. Except for our cash and cash equivalents, we have few sources of additional liquidity. As a result, we may not be able to continue to pay dividends at the historical rate and may reduce or eliminate dividends to conserve working capital until we can realize improved operating results. Outlook
We have confronted a decline in our life settlement markets and the fallout of the
SECaction and the resulting private litigation. We believe the market has begun recover. We expect the supply of qualified life settlements to remain strong and believe the low correlation of life settlements returns to fixed-income and equity securities and their competitive rates offer an attractive alternative investment. While we were exonerated by the outcome of the SECsuit, it is clear that the suit did damage to our reputation and our relationships within our licensee network and client base. We are working to rebuild confidence among our licensees and clients and to expand our client base. 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 have no annual management fees and do not cap investor returns as do many of the settlements offered in the industry. We believe we have made substantial progress in restoring the confidence and interest of our clients. We are exploring alternatives for expanding our client base, including the marketing of life settlements as securities. Quarterly revenues have increased in the third and fourth quarters of fiscal 2014, reversing a downward trend that began with announcement of the SECinvestigation in the fourth quarter of fiscal 2011. Over the past two calendar years, there have been over $112 millionin payouts from our life settlement transactions. 24 While these positive developments are encouraging, we must do more. The large drops in revenues, the significant legal and professional fees, and operating losses we have experienced during fiscal 2014 have eroded the strength of our financial condition. We believe we have sufficient currently available working capital to fund our current operations through fiscal 2015. Our recurring operations are not currently generating sufficient cash to support operations. To supplement recurring operations, we have sold most of the settlements we held for investment and have monetized our investment in the life settlement trust. 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 believe we must generate approximately $30 millionin annual revenues to cash flow our operations and pay dividends, and we are working toward that end. In the meanwhile, we are conserving our cash. We have decreased our cash dividends and may reduce or eliminate the dividends for fiscal 2015 and 2016 to conserve working capital until we can realize improved operating results.
Off-Balance Sheet Arrangements
We do not engage in any off-balance sheet arrangements or transactions.
Contractual Obligations and Commitments
Our outstanding contractual obligations and commitments as of
February 28, 2014were: Due in less Due in Due in Due after Total than 1 year 1 to 3 years 4 to 5 years 5 years Operating leases $ 47,314 $ 32,688 $ 14,626$ - $ - Total obligations $ 47,314 $ 32,688 $ 14,626$ - $ -