We provide the following discussion to assist in understanding our financial position as of February 29, 2012 (“fiscal 2012”), and results of operations for the years ended February 29, 2012, and February 28, 2011 (“fiscal 2011”) and 2010 (“fiscal 2010”). 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.
We sometimes make short-term advances to facilitate a life settlement transaction. These amounts are included in “Accounts receivable - trade” and are collected as the life settlement transactions close. All amounts are considered collectible as we are repaid the advance before any of the other parties involved in the transaction receive funds.
We follow the guidance contained in Financial Accounting Standards Board Accounting 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. Investment in life settlements held for our own account were carried at $8,858,534 and $9,506,495 at February 29, 2012 and February 28, 2011, respectively.
We establish litigation and policy analysis loss accruals based on our best estimates as to the ultimate outcome of contingent liabilities. This loss analysis is necessary to properly match current expenses to currently recognized revenues and to recognize that there is a certain amount of liability associated with litigation and policy losses. Through these accruals, we recognize the estimated cost to settle pending litigation as an expense. These estimates are reviewed on a quarterly basis and adjusted to management’s best estimate of the anticipated liability on a case-by-case basis. A high degree of judgment is required in determining these estimated accrual amounts since the outcomes are affected by numerous factors, many of which are beyond our control. As a result, there is a risk that the estimates of future litigation and policy analysis loss costs could differ from our currently estimated amounts. Any difference between estimates and actual final outcomes could have a material impact on our financial statements.
Recent accounting pronouncements have been issued including ASU 2011-04, 2011-05, 2011-06 and 2011-12. For a discussion of these pronouncements, refer to Note 3 of our Consolidated Financial Statements.
We had a net loss of $3,123,478 for fiscal 2012, compared to net income of $23,425,749 for fiscal 2011 and $26,077,214 for fiscal 2010. The net loss in fiscal 2012, with a 67.6% decrease in gross revenues and a 78.8% decline in revenues, net of brokerage fees, was due to three factors. First, our licensee network and purchaser base were damaged by the SEC investigation and subsequent lawsuit, the filing of multiple private suits, and publication of news articles criticizing our operations. A second contributing factor was the substantial decline in the life settlement market, which dropped from an estimated $8 billion in face value transactions in calendar 2009 to approximately $4 billion in each of calendar 2010 and 2011. The third factor was our large increase in legal and professional expense. Large reductions in impairment expense and bonuses were positive influences on fiscal 2012. The 6.6% decrease in revenue in fiscal 2011 was primarily the result of the aforementioned general market decline, the news articles and disclosure of the SEC investigation, which occurred in the fourth quarter of fiscal 2011. In fiscal 2010, our ability to increase our operating margins by remaining highly selective in our purchasing strategies resulted in a 10.6% increase in revenues net of brokerage and licensee fees. The increase in revenues, net of brokerage fees, together with the large decrease in the allowance account for premium advances, resulted in an increase in income from operations of 15.7%. Legal and professional costs were $6,522,221, $1,986,648 and $1,311,637 in fiscal 2012, 2011 and 2010, respectively, and were the largest single general and administrative expense. The legal and professional costs were attributable primarily to legal costs associated with the SEC investigation and lawsuit, litigation, and our audit fees. See Item 3, Legal Proceedings.
Revenues - Revenues decreased by $68,657,024, or 67.6%, from $101,579,213 in fiscal 2011 to $32,922,189 in fiscal 2012. This decrease was due primarily to the decreased number of settlements, from 166 in fiscal 2011 to 62 in fiscal 2012, along with lower revenues, net of brokerage fees, as a percentage of gross revenue. Revenues, net of brokerage fees, was 35.6% of gross revenue in fiscal 2012, vs. 54.3% in fiscal 2011 and 54.7% in fiscal 2010, as we increased promotional bonuses and lowered our fees to obtain business. Average revenue per settlement also declined 13.2%, from $611,923 in fiscal 2011 to $531,003 in fiscal 2012. Revenues decreased $7,213,346 in fiscal 2011, from $108,792,559 in fiscal 2010 to $101,579,213 in fiscal 2011. This decrease was due primarily to the decreased number of settlements from 186 in fiscal 2010 to 166 in fiscal 2011 and a decrease in the total face value of policies from $541,755,547 in fiscal 2010 to $515,109,503 in fiscal 2011. Average revenue per settlement increased in both fiscal 2010 and 2011. The average revenue per settlement increased 4.6% from $584,906 in fiscal 2010 to $611,923 in fiscal 2011.
Many states now license life settlement brokerage activity, which may result in the capping of fees or the increased disclosure of fees. Industry analysts have suggested that these regulations could tend to lower the fees, although we have yet to see such a result directly from regulation.
The decrease in fiscal 2012 was due primarily to executive bonuses. Bonuses decreased $2,044,135 in fiscal 2012 as there were no executive bonuses. Executive and employee bonuses decreased $615,716 in fiscal 2011 as earnings decreased. Increased payments in 2010 and decreased payments in 2011 and 2012 are a direct result of our increasing and decreasing profitability, which is linked to executive compensation plans and bonuses given to all employees.
The increase in legal and professional fees in fiscal 2012 was partially offset by lower impairment expense. Impairment expense for fiscal 2012 declined $5,305,699 to $906,451, as many of the older viatical policies that we own were fully impaired in previous periods. We increased impairment expense for our investment in policies from $2,139,183 in fiscal 2010 to $6,212,150 in fiscal 2011 due primarily to longer projected life expectancies within the investment portfolio.
For various legal actions or claims in which we believe we might incur liability, we paid non-recurring settlement expenses of $613,374 in fiscal 2012 and $789,622 in fiscal 2011, compared to $3,615,726 in fiscal 2010. The settlement expense in fiscal 2010 included settlements with Maxim for $1,250,000 of treasury stock, the State of Florida for $770,000, and a $500,000 reimbursement to purchasers for prepaid premiums.
We must make estimates of the collectability of these premium advances. We recorded an allowance against the premium advances at the time of the advance and treated reimbursements as a reduction of the allowance. Until fiscal 2010, due to the uncertainty of the outcome of a court case with the State of Texas, we were unable to estimate the amount of any future advances we may elect to make or the timing of the amount of reimbursements we were likely to receive. Within fiscal 2010, issues were resolved that enabled us to better estimate the collectability of premium advances. The agreement with the State of Texas allowed us to specifically identify a class of investors for whom we made premium advances and which, under the terms of the agreement, will be uncollectible. Our historical success of collecting premium advances has enabled us to build a body of evidence by which we can demonstrate full collectability of the remaining balance of advanced premiums. To date, we have ultimately been fully reimbursed when we have made an advance and the policy has matured. As a result, we eliminated $6.4 million of the allowance on the advanced premiums account in the fourth quarter of fiscal 2010.
Income Taxes - The income tax benefit was $1,429,921 in fiscal 2012 as we had negative pretax earnings. Income tax expense decreased by $4,410,635, or 25.6%, from $17,197,268 in fiscal 2010 to $12,786,633 in fiscal 2011. Income tax expense is in direct correlation to pretax earnings, taxed at 35% at the Federal level. In fiscal 2010, we had an additional accrual of $831,233 of Texas Margin Tax; $402,104 for an estimated assessment due to non-deductibility of certain payments in past and current periods included in our calculation of the Texas Margin, and $429,129 for the current year taxes due in May 2011. Income tax expense was also affected by the impact of establishing a $611,298 valuation allowance within the deferred income tax asset account. This allowance was established to recognize the uncertainty of netting future capital gains against a current capital loss.
Investing and Financing Activities - Our investing activities provided cash of $4,403,837 in fiscal 2012, primarily from $4,663,547 of proceeds from sales of securities and $1,027,018 of proceeds from sales of investments in policies, less $769,835 used for purchases of investments in policies and $712,333 of net premium advances. In contrast, we used cash of $3,615,737 in investing activities in fiscal 2011 versus $12,590,680 in fiscal 2010. We used available cash to purchase policy interests for our own account. We purchased policies of $3,654,183 in fiscal 2011 and $7,863,520 in fiscal 2010. Of the policies purchased in fiscal 2010, $6,441,625 represented policies that we acquired in connection with a settlement with the state of Colorado. We have continued to acquire policy interests on a discretionary basis as those opportunities are presented to us by existing clients and on terms that are agreeable to both parties. We believe that we will profit from the investment in these policies when they mature. We also used cash to make net premium advances, which were $712,333, $2,954,289 and $3,549,912 in fiscal 2012, 2011 and 2010, respectively. In fiscal 2010, we invested $1,227,484 in a life settlements trust, which acquired life settlement interests. In addition to investing, we acted as a non-exclusive purchasing agent for the trust and its predecessor partnership. The trust is no longer acquiring life settlements and we do not anticipate further investments. The trust owns a portfolio of life insurance settlements with an initial face value of $706 million, which we anticipate will mature over the next few years. The trust experienced some maturities during fiscal 2012, 2011 and 2010, which paid us $84,443, $464,796 and $420,743, respectively.
Our audited Consolidated Financial Statements, together with the report of auditors and the notes to the Consolidated Financial Statements, are included in this Annual Report beginning on page 37.
The following tables set forth our unaudited consolidated financial data regarding operations for each quarter of fiscal 2012, 2011 and 2010. This information, in the opinion of management, includes all adjustments necessary, consisting only of normal and recurring adjustments, to state fairly the information set forth therein.