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  • H&R Block – The Stars Are Aligning
    After the seven month market melt up, it is quite difficult to find a long idea that has: a cheap valuation, a real dividend, a brand/franchise, analyst sentiment that will likely improve, and multiple catalysts in the form of positive surprises. H&R Block (NYSE: HRB) possesses all of these characteristics and could be a double from current levels regardless of what the overall market does. H&R Block is a world-class franchise that is on the precipice of a fundamental improvement in its competitive landscape that will provide HRB with its largest competitive advantage in decades. The changing operating landscape discussed below should drive earnings estimates materially higher, which will lead the cadre of neutral rated analysts to upgrade their ratings. Shockingly, not one analyst has written about the disruptions in the financial service products segment, including refund anticipation loans (RALs), which could cripple H&R Block’s competition. To top it off, HRB trades at a 37% discount to the S&P 500 with a healthy dividend yield to boot.
    As Wall Street will come to realize (to the benefit of HRB), RALs represent roughly 6% of earnings at H&R Block. However, without RALs, most of H&R Block’s competitors would lose 100%+ of their earnings. As I articulate below, the disruptions occurring today could impact more than 11 million returns in 2010, compared to 15 million tax returns performed at HRB’s retail locations. Under the best case scenario for HRB’s competitors, they will have to significantly increase their pricing. Under the worst case, many will be out of business. If HRB can capture a small portion of the market that is impacted by this disruption, it will have its best tax season in years, resulting in substantially higher earnings. With the potential to add more than $0.25 of incremental earnings in the tax business, more than $0.10 from the resumption of their share repurchase program, and a reduced drag from subprime, HRB’s earnings power will exceed $2.00 per share next year. At a meager market multiple of 15x (although this franchise should trade at a premium), HRB will trade north of $30 per share by early tax season (mid January / early February). 
    Refund Anticipation Loans
    Financial service products have historically been an important part of the economics of the retail tax preparation business. A RAL is a short term loan, usually around eleven days, and is secured by a taxpayer’s expected refund. RALs have proven to be attractive products because they provide a filer with immediate access to his/her tax refund. Another popular product, refund anticipation checks (“RACs”, also known as “assisted returns”, “refund transfers” or “electronic refund checks”), is a lower fee product that provides quick access to a refund, typically in 10 to 15 days (compared to six weeks for the IRS to send a check). Based on their egregious APR’s (as high as 350% in some cases), these financial service products have been in the cross hairs of consumer advocates for years. 
    The IRS does not allow tax preparation firms to provide RAL loans. As a result, tax preparers rely on banks for the funding of RALs and RACs. For example, HSBC provides RALs for HRB customers. Under their multiyear contract that runs through 2011, HRB retains 49.9% interest in all RALs offered through HSBC. In 2007, HRB and HSBC proactively responded to concerns of consumer advocates and cut the APRs on their RAL offering to 36%. In fiscal 2006, HRB earned $107 million of pretax profits from RALs, or 22% of total earnings. In fiscal 2009, as a result of the lower APR, RALs contributed only 6.5% of HRB’s earnings (10k, page 9 http://www.sec.gov/Archives/edgar/data/12659/000095012309018620/c51997e10vk.htm). HRB has responded to regulatory concerns and reduced its reliance on the RAL business. However, H&R Block’s competition maintains operating and financial models that are entirely dependent on RALs. As a result, it is my belief that any disruption to the RAL market, or legislative change banning RALs, would create a huge competitive advantage for HRB. 
    Tax Prep Competition – Take away the RAL, take away the earnings
    HRB’s competitors may not exist without RALs.   For example, in fiscal 2009 Jackson Hewitt (NYSE: JTX) derived $59.9 million of revenue from “financial product fees.” According to analysts and company representatives, greater than 85% of this line item was RAL and RAC fees that have minimal associated costs (according to management it is roughly 80% margin). At 80% margin this represents 104% of pretax earnings of $45.9 million. Simply put, Jackson Hewitt loses money without RAL and RAC fees. http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9OTEyN3xDaGlsZElEPS0xfFR5cGU9Mw==&t=1.
    Jackson Hewitt’s business is geared towards the early tax season and driving large fees from financial services. In fiscal 2009, the company completed 2.96 million returns and sold 2.75 million financial products—a massive attach rate relative to HRB’s - 15 million returns with only 3 million RALs. JTX offers their financial products (RALs and RACs) through two bank relationships: Republic Bank and Santa Barbara Bank & Trust. Customers typically pay around $130 for a RAL (average size loan of around $3,000), with the economics split between the banks and JTX. The APR’s on JTX’s RALs usually represent a 100% to 180% APR (versus 36% at HRB). 
    Jackson Hewitt is not alone in their reliance on RALs and RACs. Another large competitor, Liberty Tax, generated $23.8mm of revenue in “bank product and tax discount income” versus $20.8 million in pretax earnings. (http://www.libertytax.com/uploadedFiles/Media/Liberty%20Financial%20Statements%20-%20FY09.pdf). Assuming Liberty Tax’s financial services revenue has similar margin characteristics to those of JTX’s, Liberty would also generate almost all of its earnings from RAL / RACs. I believe thousands of independent firms--affectionately known as “RAL shops” in the industry—operate with a similar reliance on financial service fees as JTX and Liberty Tax. 
    Trouble at Two Largest RAL / RAC Providers
    I believe a massive disruption in the U.S. tax business is currently underway that could be devastating to firms that are reliant on financial service fees and create a fantastic competitive backdrop for HRB. Republic Bank (NASDAQ: RBCAA) is the second largest provider of RAL and RACs in the U.S. Republic has key relationships with Jackson Hewitt, Liberty Tax, and many other independent operators. I estimate that RBCAA provided approximately 1 million RALs and 2 million RACs in 2009 (based on information from their public filings). Last tax season, the average sized RAL generated an APR between 100% and 180%. Earlier in the year, the FDIC issued a cease and desist order to Republic Bank due to its tax business and its “unsafe or unsound banking practices” that “violated federal consumer protection laws.” http://www.examiner.com/x-3747-Louisville-City-Hall-Examiner~y2009m3d31-FDIC-smacks-Republic-bank-again.  Last month, in an attempt to appease bank regulators, Republic announced dramatic new pricing for its RAL product. These changes were geared towards improving the “long-term health and viability of the tax refund industry.” http://www.sec.gov/Archives/edgar/data/921557/000114420409047275/v159872_8k.htm. For the 2010 tax season, RBCAA has reduced its RAL fee on its average sized loans from $126 to $60. RBCAA’s management expects the new pricing structure to be revenue “neutral” assuming the same volume of returns. This strategy would be a massive blow to the tax prep companies that rely on Republic. Republic’s goal will be to make up the fee reduction because it “does not expect to share revenue with third parties in connection with the delivery of tax refund products associated with in-person tax preparation services.” This has created a dreadful dilemma for competitors of H&R Block as the source of their profitability may vanish. In previous years, Republic’s RAL fees and RAC fees were split with the tax preparer, resulting in high margin revenue for the tax preparers. In 2010, it is my understanding that Republic Bank will retain THE ENTIRE RAL and RAC fee, thus this profit center disappears for tax preparers. 
    The situation is even more critical for the largest provider of RALs and RACs, Pacific Capital’s (ticker PCBC) main bank subsidiary, Santa Barbara Bank & Trust. The company disclosed that they processed 5.6 million RACs last tax season (10q, page 19 http://www.sec.gov/Archives/edgar/data/357264/000119312509106907/d10q.htm) and I estimate around 3 million RALs. In past years, SBB&T offered RALs at yields similar to Republic Bank (100-180%). This year, a best case scenario for SBB&T’s tax prep clients is that SBB&T reduces its pricing to levels consistent with the rest by the industry—thus cutting a high margin revenue source for tax prep firms. That is the best scenario. 
    The more likely outcome is that SBB&T will not be able to service any of its 8.4 million returns. PCBC is a California bank with toxic construction and commercial real estate exposure. PCBC currently trades at 27% of book value and its stock is down 92% year-to-date. It is currently operating under a memorandum of understanding from the OCC and the Fed. Under the MOU, PCBC agreed to maintain a minimum Tier 1 leverage ratio of 9.0% by 9/30/09. The Tier 1 leverage ratio was 5.6% at 6/30/09 and additional future losses will continue to drive its capital ratios lower. To get to a 9% Tier 1 leverage ratio, PCBC needs to raise $275 million to $300 million of equity capital ($8.4 billion tangible assets and $496 million of Tier 1 capital equaled at $288 million capital deficiency at June 30). That compares to a current market cap of $56 million. The capital and equity markets remain somewhat open to bank recapitulations, but there has yet to be one bank that was able to raise 100% of it market cap in a recapitalization. PCBC needs to raise 5 times its market cap!  
    During the 2008 tax season, SBB&T funded its tax business with $1.3 billion of brokered deposits and a $524 million syndicated bank line. Typically, under a formal MOU, a bank cannot raise brokered deposits. In addition, with a Caa1 debt rating and E+ financial strength rating from Moody’s (http://www.alacrastore.com/storecontent/moodys/COP_600062874), it will be nearly impossible for PCBC to get another syndicated line. With the securitization market currently closed, PCBC has no alternative source of funding its tax business. The sad fact is that unless PCBC is able to pull off the largest bank recapitulation in years, it will likely become a failed bank. Under that scenario, who will be there to fill the void for 8.4 million returns?
    A vacuum is being created:
    Over ten banks used to provide RAL loans to the tax prep industry. Bank regulators have made it very difficult on these banks--even forcing some banks to exit the tax business altogether. Today, the number of banks providing tax loans is down to four: RBCAA, PCBC, HSBC and JP Morgan. Three years ago, HSBC was the largest provider of RALs. More recently, HSBC has dramatically reduced their tax exposure, and now is the exclusive provider to H&R Block. JP Morgan also used to be significantly larger in RAL lending but has significantly reduced the size of their business after lowering its rates to 36% APR. It is my understanding from discussions with industry participants that JPM will continue to reduce exposure to RALs. As a result, I believe there is a vacuum that will be created for the 2010 tax season by Pacific Capital’s potential failure and the changes at Republic Bank. This belief is supported by RBCAA’s drastic pricing change. As “one of a limited number of financial institutions which facilitates the payment of federal and state tax refunds through third party tax-preparers,” the bank can dramatically alter the economic split because the tax prep firms literally have no other alternative. (http://www.sec.gov/Archives/edgar/data/921557/000114420409047275/v159872_8k.htm
    With No One to Fill the Void on Funding, How bad is it for the “other” prep companies?
    Many tax preparation firms “live by the RAL”, but unfortunately this year, many will “die by the RAL.” In response to Republic’s price cuts, I believe tax preparation firms will attempt to charge their own RAL fees or will be forced to increase their tax preparation fees. However, firms will be limited in their ability to charge additional RAL fees. It is my understanding that Republic must operate under Kentucky usury law (under 30% APR) as a result of its cease and desist from the FDIC (the bank cannot access its federal saving charter to bypass state usury). If this is the case, it will limit tax prep firm’s ability to charge additional fees (that would drive the APR higher, violating state usury laws). As a result, tax preparation firms will be forced to increase their standard tax preparation fees as a way to recoup the RAL losses. To fill the high margin revenue hole, tax firms may have to raise prices by 25% to 35%. These price hikes at other tax preparers should be a significant benefit to HRB because of its minor RAL exposure, stable relationship with HSBC, and its massive scale. 
    Firms with large franchise operations, like Jackson Hewitt and Liberty Tax, are in a difficult situation. For example, Jackson Hewitt retains 100% of the RAL / RAC fees but only collects 20% of tax preparation fees from its franchisees in the form of royalty payments. To replace the earnings of a RAL for the parent company, JTX’s franchisee would have to raise prices by $150—which would price them out of nearly every market.   At a bare minimum, it is going to be almost impossible for JTX to fill this profit hole. Given its debt load and restrictive covenants, the company does not have much wiggle room even with a solid tax season. JTX had $232 million of debt at 6/30/09 and requires additional debt during the early tax season that could peak around $350 million by January 2010 (debt was $356 million at 1/31/09). Analysts are currently forecasting $70.9 million of EBITDA in 2010, suggesting only $300 million dollars of debt capacity relative to its 4.25 debt to EBITDA covenant (calculated with average LTM debt and LTM EBITDA) and $296 mm of current average debt. (10k, page http://www.sec.gov/Archives/edgar/data/1283552/000119312509143755/d10k.htm). Incredibly, analyst estimates do not include ANY impact related to Republic Bank or Santa Barbara Bank & Trust. Yet the impact is massive. For example, if JTX lost 25% of its financial services revenue, the impact to EBITDA would be $11 million, which would cause its leverage to shoot up to 5.0 times. If it loses 100%, its leverage will increase to greater than 11 times. Under these scenarios, JTX will be in violation of their debt covenants and potentially have significant cash flow problems. As a result, I believe the company will be unable to pay off their $25 million debt payment due April 2010. Unless JTX can figure out how to rapidly rewrite its franchise agreements or totally alter its economic profile, it will be difficult for JTX to avoid bankruptcy. 
    I cannot overstate the devastation the industry will likely face from PCBC’s likely inability to fund RALs/RACs in 2010. Jackson Hewitt and Liberty Tax may not be able to offer one of the most important products to tax filers as they make their decisions on who to hire for tax prep. A common oversight by Wall Street has been focusing on HRB vs. JTX, yet missing the fact there are thousands of other tax preparers that will likely cede ground to H&R Block. HRB may be the only firm with capacity to provide these products. Liberty Tax appears to be trying to address the issue. Last month Liberty Tax’s parent company, JTH Tax, offered to buy a tiny $90 million asset bank from a bankrupt company.   (http://kansascity.bizjournals.com/kansascity/stories/2009/10/05/story1.html). Regulatory approval will be difficult and the bank will not be able to help Liberty this tax season, but at least Liberty is trying to address their long-term future. Even the volume of digital tax returns could be impacted. Intuit’s (NASDAQ: INTU) TurboTax is a large client of Santa Barbara Bank & Trust.
    HRB has a wide open shot on goal that investors have yet to understand
    Republic Bank and Santa Barbara Bank & Trust touched over 11 million tax returns last year. Their tax preparation clients filed a far higher number of tax returns (I estimate at least 15 million). I believe widespread price increases and the lack of availability of financial services products will have many of these retail clients looking for a new tax preparer this year. With H&R Block’s brand name, competitive pricing, and breadth of locations, they should be the main beneficiary. If H&R Block can pick up even a small part of this disrupted market, it will have its best tax season in years. For every 1 million new retail clients that HRB can add, the tax service business should grow by an incremental 600 basis points. What will be more compelling for analysts and other investors is that the same 1 million new clients will be roughly $0.25 accretive to earnings ($190 per return at a 60% incremental margin plus a small attachment rate for RALs and RACs). This impact will drive significant upside to current consensus estimates of $1.62.
    And if it couldn’t get any better for HRB….
    The market share gains from the disruption in the RAL/RAC market represent the most important near-term catalyst for HRB shares. But it gets better. One current overhang for the stock is the dispute between RSM McGladrey and its JV partner McGladrey Pullen. As a result of the dispute, HRB’s management has taken a very conservative stance towards their share repurchase plan (given the likely chance that management has material non-public information in regards to discussions with M&P). The largest potential benefit to putting the M&P dispute behind the company will be the resumption of their $2 billion share authorization. HRB currently has $1.9 billion remaining on its authorization. I expect a settlement could occur at the same time the competitive landscape is ripe for improvement.
    HRB’s subprime mortgage exposure has been another major drag on the company over the past three years. However, as the stars align, this is a drag that may actually turn into a benefit. At $707 million, mortgage portfolio is half the size it was a few years ago. The loans are mostly 2005 and 2006 vintage, which means they are seasoned loans and past the two year reset window (and peak delinquency). HRB’s 11.6% loan loss reserve is one of the highest of any bank in the U.S. and its $63 million provision in fiscal 2009 was a $0.12 drag on earnings. This drag to earnings may reverse in the next twelve months as HRB no longer is forced to take incremental provisions. This fact is another material positive that has been ignored by the sell side as it relates to HRB, despite being a major driver for higher stock prices of many pure play banks. 
    Earnings Power and Valuation
    The most interesting dynamic for the RAL / bank disruption is that Wall Street analysts and investors are totally oblivious to this dynamic and the magnitude of opportunity is has created for HRB. Shockingly, on 10/26/09 Morgan Stanley downgraded HRB because it was “vulnerable to intense competition” and the analyst stated that “competitive pressures [could] grow” in 2010” The analyst also opined that the stock was “somewhat expensive” at 5.5x EBITDA and 12x the analyst’s street low EPS estimate. I am quite confident that the exact opposite could be true this year, which would create the holy grail of positive surprises. Since RBCAA and PCBC are small cap banks with little research coverage, I believe their large impact on this year’s tax season has largely gone unnoticed.   
    HRB has all the characteristics of what investors, large and small, look for. HRB is leveraged to increased tax complexity, fueled in part by additional tax credits to spur economic growth, and a future rebound in employment. Its stable 3.3% dividend offers a bird-in-hand return. The sentiment of the 7 analysts (5 sells and neutral ratings versus only 2 buys) could swing dramatically as my catalysts materialize. Finally, expectations remain very low. Management’s 2010 guidance is $1.60 to $1.80 per share with tax revenue up low single digits. The current consensus estimates are at the low end of management’s outlook: $1.62 EPS and flat year-over-year revenue. Even small market share gains relating the RAL / RAC issues are likely to drive guidance and estimates much higher in early 2010. In addition, utilizing just one-fourth of their share reauthorization adds an incremental $0.10 per share (not included in guidance). Including the reduced drag from subprime provisions, HRB could experience powerful earnings leverage in 2010 and 2011. As investors and sell side analysts recognize HRB has $2.00 of earnings power over the next 12 months, shares of HRB will trade north of $30 per share by early tax season (mid January / early February). As I said, the stars are aligning beautifully for one of America’s most recognized brands.
    Tags: HRB, JTX, RBCAA, PCBC, INTU, Tax, RALs
    Nov 02 06:34 pm | Link | Comment!
  • Challenge to LPHI's Auditor - Address Company's Red Flags

    In February 2009 Citron Research (http://www.citronresea...) and Jim Cramer (http://seekingalpha.co...) provided a critical assessment of Life Partners’ (ticker LPHI) business and management. The Citron report focused on LPHI's "egregious fees", the unlikely sustainability of those fees, the CEO’s past accounting indiscretions, and LPHI's tiny auditor and equally-small audit fees. A few days after the critical report from Citron, LPHI's management posted a response on its website. Oddly, management has since removed the response, but a copy can be found under the comments sections at this link. (http://www.fool.com/in...)

     
    The reports peaked my interest and as a result, I conducted additional research on LPHI’s business practices and management. I believe many of Citron’s red flags have merit, and found additional red flags that suggest a business model that revolves around exorbitant fees charged to retail investors and possible forensic accounting issues.
     
    Challenge to Eide Bailly
    There is one entity in the position to address many of LPHI's red flags, their new auditor Eide Bailly. Eide Bailly acquired LPHI’s tiny auditor Murrell, Hall, McIntosh in August 2008. Eide Bailly is expected to provide its first audited financial statements on LPHI in mid-May 2009. I believe investors should demand more oversight than what was provided in Murrell's 2008 audit (fees of only $85,881). Eide Bailly has a significant opportunity to standout among the smaller audit firms. IF LPHI is taking advantage of its retail customers in a potentially illegal manner (something I suspect but CANNOT verify), then Eide Bailly is in the best position to expose these issues and protect public investors and clients. They are also in the best position to address potential forensic accounting issues highlighted below.
     
    1) Are LPHI’s Fees the Highest in the World for Any Asset Class?
    In management’s response to the Citron report, management stated that their fees are “only” 7% of face and that there is no company with which these fees can be compared. I believe the way management characterizes its fees is highly misleading. In LPHI’s 3Q (the last quarter with a 10q or 10k), LPHI had $28.1 million of “gross” revenue and $14.2 million of “net” revenue. The difference in gross and net is the fees LPHI pays to its licensees, agents and brokers. While management discloses their fees as a percentage of face value (14.4% gross and 7.3% net of policy face value transacted), they do not disclose the purchase price of the policies. Policies are acquired at a large discount to face value. According to R. Scott Peden, LPI’s President, on LPHI’s second quarter earnings conference call, “it’s not so much the precision of the life expectancy as it is the discount at which we purchase.” The fees as a  percentage of the amount invested are much more relevant to LPHI’s investors than as a percentage of face value. 
     

    Based on assumptions laid out in the table below (price paid to policyholder between 15% to 45% of face value), LPHI’s fees would equate to 16% to 49% to the gross price paid to the policyholder. In addition, LPHI’s clients must bear the cost of LPHI’s net fees AND the fees paid to LPHI’s licensees, agents and brokers. This is why “gross” revenue / fees is much more relevant to LPHI’s clients than net fees. As the table illustrates, if LPHI acquired a $1 million face policy for 30% or $300,000, LPHI would collect close to $73,000 of fees and LPHI’s brokers and agents would collect close to $71,000. So for a policy that someone was willing to sell for $300,000 (I assume this would be a “market price”), LPHI’s investor would have to pay almost $444,000 for it after accounting for all those fees.

    Table 1
    $1 milion face value % 
      Face 
    Revenue 14.4% 
    Brokerage and referral fees 7.1% 
      Net revenues to LPHI 7.3% 
        
    Gross price as a % face15%30%45%
    Price in $150,000300,000450,000
      Fees to broker70,89770,89770,897
      Net fees to LPHI72,88672,88672,886
        Total fees143,784143,784143,784
       &nbs... as % gross sale value95.9%47.9%32.0%
        LPHI's fee % gross price48.6%24.3%16.2%

    Disclosure: Short LPHI with a borrow

    Image buying Apple’s (ticker AAPL) stock for $125 because your financial advisor told you it was going to $250, and having to write a check upfront for $185 ($125 for the stock plus 48% fee or $60). Not only would investors avoid that proposition if they had the appropriate disclosures, but regulators would be outraged. This appears to be the reality for LPHI clients. Based on the table above, 32% to 96% of the amount invested will be paid in fees assuming a 15% to 45% discount. Said another way, for every $100 invested, $24 to $49 would go to LPHI and LPHI's licensees. At that fee level, I cannot find another example of an asset class or asset management firm that charges fees anywhere close to the levels LPHI charges its clients.
     
    LPHI often mentions that there are no public competitors to measure their fees against. However, Peachtree, a direct competitor to LPHI, was a publicly traded company on London’s AIM market prior to their acquisition by DLJ Merchant Banking. (http://www.peachholdin...) Peachtree’s last earnings release is somewhat dated (6/30/06), but does provide some color on their fees. “In the first half of 2006, Peachtree purchased policies with a face value of US$400 million generating gross revenue of US$24 million.” (http://www.peachholdin...). Peachtree’s “gross revenue” of 6.0% was less than half of LPHI’s gross revenue to face (14.4%). Surely, this cannot go unnoticed forever. 
     
    I believe LPHI’s exorbitant fees are susceptible to regulation and competition, along with greater awareness including more disclosure to LPHI’s clients. According to Colorado’s complaint, Life Partners “failed to disclose to investors the method by which life expectancy was determined; the high frequency rate in which viators outlived the life expectancies predicted by Life Partners; and that if the viator outlived the life expectancies, the investor was liable to make the premium payments. It is further alleged that Life Partners failed to disclose the original purchase price of the policy and commissions paid to the sales agents, making it impossible for an investor to determine the true market value of the policy.” http://www.dora.state....
     
    State and federal regulators are expected to continue to drive transparency of the life settlements market, which should standardize and collapse fees. For example, New York recently proposed legislation that aims to increase disclosures of the ”value of offers and counter-offers, the fees paid to life settlement brokers and the contractual arrangements among the parties involved in a transaction” as a means to regulated an industry that “can be ripe for abuse”. http://www.ins.state.n...
     
    2) Audit and Accounting Issues – How is LPHI Accounting For Repuchases?
    The challenge to Edie Bailly LLC as they conduct their first annual audit is, can they answer and address the following questions:
    1) Are 100% of LPHI's policy acquisitions legitimate? 
    2) How does LPHI generate fees at more than two times the industry averages?
    3) Has LPHI's historical return figures included in their marketing materials been audited and verified?
    4) Does LPHI apply consistent treatment to accounts receivable and revenue recognition with "closed transactions," especially at quarter end?
    5) Does LPHI's GAAP income statement include all expenses associated with its operations, including the costs associated with its ongoing legal battles?
    6) Does LPHI’s revenue recognition (gross revenue) conform to GAAP?
    7) Does LPHI properly account for policy repurchases?
     
    There seems to a major GAAP violation as it related to question #7. As part of its agreement with the State of Colorado, LPHI “offered to repurchase the viatical settlement policy interest from all Colorado residents who purchased viatical settlement since January 1, 2006…The rescission offer will be made by letter by or before January 31, 2009, and will require the purchasers’ acceptance of the offer by or before March 3, 2009…Payment to all Colorado purchasers accepting the rescission offer will occur by or before April 30, 2009. With regard to those individuals who have previously accepted Life Partners, Inc.’s prior repurchase offer, they will receive an additional sum consistent with statutory requirements, in addition to the amounts already received by them.”
     
    According to LPHI’s 3Q08 10Q, “during the First Nine Months of this year, we recorded $4,951,832 for purchases of policies for investment purposes.”
    http://www.sec.gov/Arc... According to LPHI’s conference call on 1/13/09, the $5 million of purchases relate to Colorado repurchases: 
    <Q - John Nobile>: Yes, I know that at least on November 30, you had about $7.5 million in investments in policies. When I looked at the Q, I noticed that I think it's about $5 million in the first nine months of the year was used to purchase policies to settle claims, I was hoping you could shed some light on that $5 million?
    <A - Brian Pardo>: That was Colorado, I believe and what Colorado want to do is they claimed that this a security which we just agree with, but to settle the issue we just had to look if anybody wants to sell their policies back to us, at their statutory rate of interest, we'll just – we'll buy it.
    <Q - John Nobile>: All right. So that's more or less a one-time item or there still could be a few more policies that might trickle in?
    <A - Brian Pardo>: Yes, there could be, but we are buying in anyway.
     
    Back to LPHI’s 10Q: “LPI has made repurchase offers to certain Colorado purchasers, some of whom have accepted the offer. Under the terms of the settlement, the purchasers that accepted the repurchase offer will receive statutory interest on the repurchase amount. We estimate the interest will be approximately $1,549,000, which will increase our basis in Investments in Policies.”
     
    Serious questions remain surrounding the method LPHI uses to account for repurchased policies. If LPHI recognized revenue and earnings when they sold the policies to their clients, they should have taken a charge for these earnings related to the $5 million repurchased (in addition to future repurchases and interest payments).   Assuming LPHI charged their investors 40% gross sale amount (or around 15% of face), LPHI would have recognized $2 million of revenue on these transactions. Ass... an operating margin consistent with the 3Q08 of 39%, LPHI recognized $750,000 of pretax or $0.03 per share related to these transactions. If LPHI had to buy the policies back, how are these profits not reversed? According the Colorado lawsuit, LPHI “collectively have obtained more than $11,500,000 from approximately 114 Colorado investors to purchase viatical settlements”.&nb... the same assumptions as above, if LPHI repurchased all $11.5 million, this would equate to $4.6 million of revenue, $1.8 mm of pretax profits or $0.08 per share (16% of 3Q08 earnings).   Using a 39% operating margin assumes LPHI would be able to recollect fees paid out to licensees and recollect sunk costs. Assuming that they could not recapture these costs, a 100% of gross revenue charge equals $0.20 per share or 41% of 3Q earnings.
     
    While the charges above are not massive sums, the treatment of LPHI’s repurchases does create another startling red flag regarding LPHI’s accounting and creates additional questions. For example, are there other occasions where management sold policies to clients, recognized revenue and profits, and later repurchased the policies?
     
    3) More questions regarding CEO
     
    In LPHI’s “Citron Response”, management stated that Brian Pardo entered into a consent decree relating to the sanctioning by the SEC for revenue recognition reporting issues “in order to resolve the issue amicably.” ... the South Florida Business Journal suggests he agreed because the company was already in bankruptcy: “the SEC filed a complaint against Pardo and his company Ask Corp. of Waco, charging him with falsifying financial reports to shareholders. Prado consented to the SEC's charges. By then, Ask Corp., a heating and air-conditioning company, already had filed for bankruptcy.” http://www.bizjournals...
     
    Another oddity about LPHI's CEO Brian Pardo is the address and location of Pardo's trust. 
    According to SEC filings (http://www.sec.gov/Arc...), the Pardo Family Trust is located in Gibraltar. A simple google address search shows that the Pardo Family trust shares an address with online gambling websites (allpro.com, eBets.com, allhorseracing.com, etc.). The implications of having his trust in a protected offshore location is unclear. However, it does provide another potential red flag for investors. 
     
    In another strange turn of events for Brian Pardo and Life Partners. On April 8th 2009, Pardo and Life Partners filed a $50 million lawsuit against a Yahoo! Message Board poster. While I do not agree with the statements Mr. Kane made on the message board, I do hope he has the resources to find out (in his words) if “lphi=scam rips off INVESTORS!!!” dockets.justia.com/doc.../
     
    Public Notice to Eide Bailly
    In recent accounting scandals and frauds, the accounting firms have shared significant blame in perpetrating and extending dubious actions by corporate managers. I want this to serve as a Public Notice to Eide Bally. There are significant red flags associated with LPHI’s management and business practices. The auditors at Eide Bally are in a position to verify or refute these concerns. Let this also serve as a Public Record, Eide Bailly is in a position to protect current and future LPHI customers and investors. If some of these concerns and red flags turn out to be verified at a later date, and Eide Bailly missed them, let this provide a record so that customers and investors can hold Eide Bailly accountable. Thou... of people were exposed to Madoff after Harry Markopolos first raised his concerns to people in position to protect investors; I hope the same does not occur now that the red flags have been raised for Eide Bailly to observe.
    Tags: LPHI
    Apr 27 12:18 pm | Link | Comment!
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