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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 0-21874
LONDON PACIFIC GROUP LIMITED
(Exact name of registrant as specified in its charter)
----------------------
JERSEY, CHANNEL ISLANDS NOT APPLICABLE
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
MINDEN HOUSE, 6 MINDEN PLACE
ST. HELIER, JERSEY JE2 4WQ
CHANNEL ISLANDS
(Address of principal executive offices)
(Zip Code)
011 44 (1534) 607700
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has 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 such
filing requirements for the past 90 days. Yes [X] No [ ]
As of November 14, 2002, the registrant had outstanding 64,439,073 Ordinary
Shares, par value $0.05 per share.
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TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
PAGE
ITEM 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of September 30, 2002 and
December 31, 2001 ..................................................................... 3
Condensed Consolidated Statements of Income for the three and nine months
ended September 30, 2002 and 2001...................................................... 4
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2002 and 2001...................................................... 5
Consolidated Statements of Changes in Shareholders' Equity for the nine months
ended September 30, 2002............................................................... 6
Consolidated Statements of Comprehensive Income for the three and nine months
ended September 30, 2002 and 2001...................................................... 7
Notes to Interim Consolidated Financial Statements......................................... 8
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................................. 20
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk ................................ 36
ITEM 4. Controls and Procedures.................................................................... 37
PART II
OTHER INFORMATION
ITEM 1. Legal Proceedings.......................................................................... 38
ITEM 2. Changes in Securities and Use of Proceeds.................................................. 38
ITEM 3. Defaults Upon Senior Securities............................................................ 38
ITEM 5. Other Information.......................................................................... 39
ITEM 6. Exhibits and Reports on Form 8-K .......................................................... 39
SIGNATURE ........................................................................................... 41
CERTIFICATIONS.......................................................................................... 42
2
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share amounts)
SEPTEMBER 30, DECEMBER 31,
2002 2001(1)
---------------- ----------------
ASSETS
Investments (principally of life insurance subsidiary):
Fixed maturities:
Available-for-sale, at fair value (amortized cost: $33,812 and $116,853
as of September 30, 2002 and December 31, 2001, respectively)..................... $ 33,736 $ 117,701
Held-to-maturity, at amortized cost (fair value: $180 and $871
as of September 30, 2002 and December 31, 2001, respectively)..................... 180 871
Equity securities:
Trading, at fair value (cost: $32,261 and $64,175 as of September 30, 2002
and December 31, 2001, respectively) ............................................. 13,190 67,617
Available-for-sale, at fair value (cost: $18,405 and $17,297 as of
September 30, 2002 and December 31, 2001, respectively) .......................... 12,030 15,303
---------------- ----------------
Total investments ......................................................................... 59,136 201,492
Cash and cash equivalents.................................................................. 18,110 61,317
Accrued investment income ................................................................. 1,392 3,214
Deferred policy acquisition costs ......................................................... - 3,113
Other assets............................................................................... 11,319 12,684
Total assets of discontinued operations.................................................... - 2,254,508
---------------- ----------------
TOTAL ASSETS .............................................................................. $ 89,957 $2,536,328
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Life insurance policy liabilities ......................................................... $ 40,580 $ 131,831
Notes payable.............................................................................. 12,314 36,874
Accounts payable, accruals and other liabilities .......................................... 4,037 9,988
Total liabilities of discontinued operations............................................... - 2,135,982
---------------- ----------------
TOTAL LIABILITIES ......................................................................... 56,931 2,314,675
---------------- ----------------
COMMITMENTS AND CONTINGENCIES (Notes 7. and 9.)
SHAREHOLDERS' EQUITY:
Ordinary shares, $0.05 par value per share: 86,400,000 shares authorized;
64,439,073 shares issued and outstanding as of September 30, 2002 and
December 31, 2001 ...................................................................... 3,222 3,222
Additional paid-in capital ................................................................ 68,364 68,346
Retained earnings ......................................................................... 32,007 223,590
Employee benefit trusts, at cost (13,684,881 and 13,698,181 shares as of
September 30, 2002 and December 31, 2001, respectively)................................. (63,571) (63,599)
Accumulated other comprehensive income (loss) ............................................. (6,996) (9,906)
---------------- ----------------
TOTAL SHAREHOLDERS' EQUITY ................................................................ 33,026 221,653
---------------- ----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ................................................ $ 89,957 $2,536,328
================ ================
(1) Reclassifications have been made related to discontinued operations - see
Note 3.
See accompanying Notes to Interim Consolidated Financial Statements.
3
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In thousands, except per share and ADS amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
CONTINUING OPERATIONS: 2002 2001(1) 2002 2001(1)
------------- ------------- ------------- -------------
REVENUES:
Investment income...................................................... $ 1,343 $ 2,453 $ 5,982 $ 6,401
Insurance policy charges............................................... 1,207 21 1,152 21
Financial advisory services, asset management and other
fee income (2) .................................................... 4,886 8,526 19,715 26,823
Net realized investment gains (losses)................................. (2,065) 457 (1,740) 36,537
Change in net unrealized investment gains and losses
on trading securities .............................................. (5,403) (106,022) (31,276) (258,976)
------------- ------------- ------------- -------------
(32) (94,565) (6,167) (189,194)
EXPENSES:
Interest credited on insurance policyholder accounts................... 1,423 1,804 5,495 4,392
Amortization of deferred policy acquisition costs...................... 1,689 311 2,952 604
Operating expenses..................................................... 8,418 11,176 28,286 33,926
Goodwill amortization and write-offs................................... 7 57 7 172
Interest expense....................................................... 231 481 839 1,846
------------- ------------- ------------- -------------
11,768 13,829 37,579 40,940
------------- ------------- ------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES................................................. (11,800) (108,394) (43,746) (230,134)
Income tax expense (benefit)........................................... (181) (1,024) 2,511 (385)
------------- ------------- ------------- -------------
INCOME (LOSS) FROM CONTINUING OPERATIONS............................... (11,619) (107,370) (46,257) (229,749)
DISCONTINUED OPERATIONS:
Income (loss) from discontinued operations, net of income
tax expense (benefit) of $0, $(20,032), $(7,730) and
$(35,338), respectively............................................. - (37,075) (104,762) (65,539)
Loss on disposal of discontinued operations, net of income
tax benefit of $0................................................... (38,532) - (38,532) -
------------- ------------- ------------- -------------
INCOME (LOSS) ON DISCONTINUED OPERATIONS............................... (38,532) (37,075) (143,294) (65,539)
------------- ------------- ------------- -------------
NET INCOME (LOSS)...................................................... $(50,151) $(144,445) $(189,551) $(295,288)
============= ============= ============= =============
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE:
Continuing operations.................................................. $ (0.23) $ (2.12) $ (0.91) $ (4.50)
Discontinued operations................................................ (0.76) (0.73) (2.82) (1.28)
------------- ------------- ------------- -------------
$ (0.99) $ (2.85) $ (3.73) $ (5.78)
============= ============= ============= =============
BASIC AND DILUTED EARNINGS (LOSS) PER ADS(3):
Continuing operations.................................................. $ (2.29) $ (21.16) $ (9.12) $ (44.99)
Discontinued operations................................................ (7.59) (7.31) (28.23) (12.84)
------------- ------------- ------------- -------------
$ (9.88) $ (28.47) $ (37.35) $ (57.83)
============= ============= ============= =============
(1) Reclassifications have been made related to discontinued operations - see
Note 3.
(2) Includes amounts of $0, $2,930, $3,632 and $8,676 for revenues earned from
discontinued operations for the three months ended September 30, 2002 and 2001
and the nine months ended September 30, 2002 and 2001, respectively.
(3) ADS amounts have been restated to reflect the one-for-ten reverse split in
June 2002.
See accompanying Notes to Interim Consolidated Financial Statements.
4
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------------
2002 2001
------------ ------------
NET CASH FLOWS PROVIDED BY CONTINUING OPERATIONS....................................... $22,280 $31,514
NET CASH FLOWS PROVIDED BY (USED IN) DISCONTINUED OPERATIONS........................... (18,412) (26,468)
------------ ------------
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES ....................................... 3,868 5,046
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of held-to-maturity fixed maturity securities ............................... (2,828) (1,950)
Purchases of available-for-sale fixed maturity securities ............................. (7,209) (64,636)
Purchases of available-for-sale equity securities ..................................... - (16,000)
Proceeds from redemption of held-to-maturity fixed maturity securities ................ 568 1,733
Proceeds from sale of available-for-sale fixed maturity securities .................... 93,256 411
Proceeds from sale of available-for-sale equity securities ............................ - 13,670
Capital expenditures .................................................................. (728) (849)
------------ ------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES ................................... 83,059 (67,621)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Insurance policyholder contract deposits .............................................. 6,827 65,317
Insurance policyholder benefits paid .................................................. (110,620) (2,066)
Issuance of Ordinary Shares ........................................................... - 3
Purchases of Ordinary Shares by the employee benefit trusts............................ - (6,005)
Proceeds from disposal of shares by the employee benefit trusts........................ 43 440
Dividends paid......................................................................... (2,032) (11,802)
Proceeds from issuance of notes payable................................................ 2,440 1,318
Repayment of notes payable............................................................. (27,000) -
------------ ------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES ................................... (130,342) 47,205
------------ ------------
Net increase (decrease) in cash and cash equivalents .................................. (43,415) (15,370)
Cash and cash equivalents at beginning of period(1) .................................. 61,317 80,395
Foreign currency translation adjustment ............................................... 208 (22)
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD(1) ......................................... $18,110 $65,003
============ ============
(1) Amounts are for continuing operations only.
See accompanying Notes to Interim Consolidated Financial Statements.
5
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
(In thousands)
ACCUMULATED
OTHER
ORDINARY ADDITIONAL EMPLOYEE COMPRE- TOTAL
SHARES AT PAID-IN RETAINED BENEFIT HENSIVE SHAREHOLDERS'
PAR VALUE CAPITAL EARNINGS TRUSTS INCOME (LOSS) EQUITY
------------ ------------- ------------- ------------- ------------- -------------
Balance as of January 1, 2002 ........ $ 3,222 $ 68,346 $ 223,590 $ (63,599) $ (9,906) $ 221,653
Net income (loss)..................... - - (189,551) - - (189,551)
Change in net unrealized gains
and losses on available-for-sale
securities......................... - - - - 3,298 3,298
Foreign currency translation
adjustment......................... - - - - (388) (388)
Exercise of employee share
options, including income
tax effect......................... - 3 - 28 - 31
Net realized gains on disposal
of shares held by the
employee benefit trusts............ - 15 - - - 15
Cash dividends declared ($0.04
net per share and $0.40 per
ADS) (1) .......................... - - (2,032) - - (2,032)
----------- ------------ ------------- ------------ ------------ ------------
BALANCE AS OF SEPTEMBER 30, 2002...... $ 3,222 $ 68,364 $ 32,007 $ (63,571) $ (6,996) $ 33,026
=========== ============ ============= ============ ============ ============
(1) ADS amounts have been restated to reflect the one-for-ten reverse split in
June 2002.
See accompanying Notes to Interim Consolidated Financial Statements.
6
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
Net income (loss)........................................................ $ (50,151) $(144,445) $(189,551) $(295,288)
OTHER COMPREHENSIVE INCOME (LOSS), NET OF DEFERRED
INCOME TAXES:
Foreign currency translation adjustments, net of income
taxes of $0........................................................... 115 17 (388) 2
Change in net unrealized gains and losses related to
continuing operations:
Change in net unrealized gains and losses
on available-for-sale securities................................... (4,059) (354) (5,305) 113
Deferred policy acquisition cost amortization adjustments............. - 741 (551) (145)
Deferred income taxes................................................. - - - -
Change in net unrealized gains and losses related to
discontinued operations:
Change in net unrealized gains and losses on
available-for-sale securities...................................... - 8,353 5,744 36,286
Deferred policy acquisition cost amortization adjustments............. - (7,412) (8,044) (19,479)
Deferred income taxes................................................. - (485) 805 (6,038)
Reclassification adjustment for losses of discontinued
operations include in net income (loss)............................ 10,649 - 10,649 -
------------- ------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS) ....................................... 6,705 860 2,910 10,739
------------- ------------- ------------- -------------
COMPREHENSIVE INCOME (LOSS) ............................................. $ (43,446) $(143,585) $(186,641) $(284,549)
============= ============= ============= =============
See accompanying Notes to Interim Consolidated Financial Statements.
7
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. MATERIAL EVENTS
During the third quarter of 2002, London Pacific Life & Annuity Company
("LPLA"), the primary insurance company of London Pacific Group Limited (the
"Company"), was placed under regulatory control and rehabilitation based on
LPLA's statutory capital and surplus as of June 30, 2002. On August 6, 2002, on
petition of the Commissioner of Insurance of the State of North Carolina (the
"Commissioner") with the consent of LPLA and unanimous approval of its board of
directors, the Superior Court of Wake County in the State of North Carolina
ordered the Commissioner to take possession and control of all of the property,
books and accounts, documents and other records of LPLA. Based on this court
order, the Company no longer exercises control over LPLA. As a result of this
event, the Company has deconsolidated LPLA and recorded a charge to earnings in
the third quarter of 2002 of $38.5 million for losses resulting from the
disposition of LPLA.
For further discussion, see Note 3. "Discontinued Operations" below and
the "Liquidity and Capital Resources" section in Part I, Item 2 "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
On July 2, 2002, the Group announced that further declines in the value
of LPLA's investment portfolio due to persistent negative events in the equity
and bond markets continued to erode significantly the statutory capital of LPLA
and that, to date, the Group had been unsuccessful in concluding a transaction
to enhance the capital of LPLA. As a consequence, LPLA discontinued the issuance
of new policies as of July 2, 2002. Although the statutory capital of the
Company's Jersey insurance subsidiary, London Pacific Assurance Limited
("LPAL"), had not been affected by the adverse equity and bond markets to the
same extent as the statutory capital of LPLA, the Company also announced on July
2, 2002 that LPAL would discontinue writing new policies effective immediately.
The decision to discontinue the issuance of new policies through LPAL was made
to avoid the increased capital requirement created by additional policyholder
liabilities. Subsequent to this announcement and other announcements relating to
the Company and LPLA, LPAL policy surrenders increased substantially.
Approximately 71% of LPAL's policyholder liabilities as of June 30, 2002 have
been redeemed as of September 30, 2002.
NOTE 2. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The accompanying interim consolidated financial statements are unaudited
and have been prepared by the Company in conformity with United States generally
accepted accounting principles ("U.S. GAAP"). These consolidated financial
statements include the accounts of the Company, its subsidiaries (with the
exception of LPLA as discussed above in Note 1. "Material Events"), the Employee
Share Option Trust and the Agent Loyalty Opportunity Trust (collectively, the
"Group"). Significant subsidiaries included in the continuing operations of the
Group and discussed in this document include: London Pacific Assurance Limited,
London Pacific Advisors, Berkeley Capital Management and Berkeley International
Capital Corporation. All intercompany transactions and balances have been
eliminated in consolidation except for intercompany transactions between
continuing and discontinued operations principally related to investment
management fees from LPLA (the discontinued operations) to the continuing
operations.
Certain information and note disclosures normally included in the
Group's annual consolidated financial statements have been condensed or omitted.
The interim consolidated financial statements, in the opinion of management,
reflect all adjustments (consisting of normal recurring accruals) which are
necessary for a fair statement of the results for the interim periods presented.
8
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
While the Group's management believes that the disclosures presented are
adequate to make the information not misleading, these interim consolidated
financial statements should be read in conjunction with the audited financial
statements and related notes for the year ended December 31, 2001, which are
contained in the Company's Annual Report on Form 10-K, filed with the U.S.
Securities and Exchange Commission ("SEC") on April 1, 2002. The year-end
condensed balance sheet data was derived from audited financial statements but
does not include all disclosures required by U.S. GAAP.
The preparation of financial statements in conformity with U.S. 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 condensed interim consolidated financial
statements as well as the reported amount of revenues and expenses during the
reporting period. Actual results could differ from these estimates. Certain
estimates such as fair value and actuarial assumptions have a significant impact
on the gains and losses recorded on investments and balance of life insurance
policy liabilities.
Because of the events described above in Note 1. "Material Events," as
well as other unknown events that may occur during the next three months, the
results for the three and nine month periods ended September 30, 2002, are not
indicative of the results to be expected for the full fiscal year.
The Company's Ordinary Shares are traded on the London Stock Exchange
and on the Over-the-Counter ("OTC") Bulletin Board in the U.S. in the form of
American Depositary Shares ("ADSs"), which are evidenced by American Depositary
Receipts ("ADRs"). During the second quarter of 2002, the Company completed a
one-for-ten reverse split of its ADSs. On June 24, 2002, every ten of the
Company's ADSs issued and outstanding were converted and reclassified into one
post-split ADS. Consequently, effective from the opening of business on June 24,
2002, each ADS is equal to ten Ordinary Shares. All dividend and earnings per
ADS amounts disclosed in these financial statements have been restated to
reflect this split.
NOTE 3. DISCONTINUED OPERATIONS
As described in Note 1. "Material Events" and in the "Liquidity and
Capital Resources" section in Part I, Item 2 "Management's Discussion and
Analysis of Financial Condition and Results of Operations," the Group
consensually ceded control of its primary insurance company, LPLA, to the North
Carolina insurance regulators on August 6, 2002. In connection therewith, the
Group deconsolidated LPLA and recorded a charge to earnings of $38.5 million for
losses in accordance with Statement of Financial Accounting Standard No. 144
("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets."
Under SFAS 144, the results of operations of a discontinued business, and any
impairment losses related to a discontinued business, are reported separately in
the income statement under discontinued operations for the current and prior
periods, and in the prior period balance sheet as total assets of discontinued
operations and total liabilities of discontinued operations.
A summary of LPLA's pre-tax operating results for the three and nine
month periods ended September 30, 2002 and 2001, respectively, and LPLA's total
assets and total liabilities as of December 31, 2001, are shown below.
9
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2002(1) 2001 2002(1) 2001
------------- ------------- ------------- -------------
(In thousands)
REVENUES:
Investment income before intercompany management fees.................. $ - $ 33,973 $ 62,453 $ 100,644
Intercompany management fees (2)....................................... - (2,930) (3,632) (8,676)
Other income........................................................... - 1,727 4,176 5,204
Net realized and change in net unrealized investment gains
and losses.......................................................... - (53,092) (97,618) (91,449)
------------- ------------- ------------- -------------
Total revenues and net investment gains (losses)....................... - (20,322) (34,621) 5,723
EXPENSES:
Interest credited on insurance policyholder accounts................... - 29,083 56,133 83,546
Amortization of deferred policy acquisition costs...................... - 5,894 17,145 17,152
Other expenses......................................................... - 1,808 4,593 5,902
------------- ------------- ------------- -------------
TOTAL EXPENSES......................................................... - 36,785 77,871 106,600
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES...................................... $ - $ (57,107) $(112,492) $(100,877)
============= ============= ============= =============
(1) Though the Group did not lose control of LPLA until August 6, 2002, the
Group was not able to obtain LPLA's financial results on a U.S. GAAP basis for
the period July 1, 2002 up to August 6, 2002. Therefore, the Group's
consolidated income statement includes LPLA's results only through June 30,
2002. These results are reflected as discontinued operations in the consolidated
income statement.
(2) These fees were paid to and included in the revenues of the venture capital
management and asset management business segments of continuing operations.
DECEMBER 31,
2001
----------------
(In thousands)
ASSETS OF DISCONTINUED OPERATIONS:
Cash and investments.................................... $1,755,260
Deferred policy acquisition costs....................... 165,713
Assets held in separate accounts........................ 227,675
Reinsurance assets...................................... 42,025
Other assets............................................ 63,835
----------------
TOTAL ASSETS OF DISCONTINUED OPERATIONS................. $2,254,508
================
LIABILITIES OF DISCONTINUED OPERATIONS:
Life insurance policy liabilities....................... $1,900,022
Liabilities related to separate accounts................ 226,015
Accounts payable, accruals and other liabilities........ 9,945
----------------
TOTAL LIABILITIES OF DISCONTINUED OPERATIONS............ $2,135,982
================
LPLA had been included in the Group's life insurance and annuities
business segment.
10
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
The loss on disposal of discontinued operations, net of tax, which was
recorded in the third quarter of 2002, consisted of the following for the three
and nine months ended September 30, 2002:
(In thousands)
Net unrealized losses on available-for-sale securities, net of
deferred policy acquisition cost amortization adjustments and deferred income taxes....... $10,649
Impairment on long-lived assets (LPLA's net assets).......................................... 12,269
Write-off of doubtful receivables from LPLA.................................................. 15,614
----------------
38,532
Income tax benefit........................................................................... -
----------------
NET LOSS ON DISPOSAL OF DISCONTINUED OPERATIONS.............................................. $38,532
================
NOTE 4. EARNINGS PER SHARE AND ADS
The Group calculates earnings per share in accordance with Statement of
Financial Accounting Standards No. 128 ("SFAS 128"), "Earnings per Share." This
statement requires the presentation of basic and diluted earnings per share.
Basic earnings per share is calculated by dividing net income or loss by the
weighted average number of Ordinary Shares outstanding during the applicable
period, excluding shares held by the Employee Share Option Trust and the Agent
Loyalty Opportunity Trust which are regarded as treasury stock for the purposes
of this calculation. The Group has issued employee share options, which are
considered potential common stock equivalents under SFAS 128. Diluted earnings
per share is calculated by dividing net income by the weighted average number of
Ordinary Shares outstanding during the applicable period as adjusted for these
potentially dilutive options which are determined based on the "Treasury Stock
Method." As the Group recorded a net loss for both of the three month periods
ended September 30, 2002 and 2001, and for both of the nine month periods ended
September 30, 2002 and 2001, the calculations of diluted earnings per share for
these periods do not include these potentially dilutive options because they are
anti-dilutive and, if included, would result in a reduction of net loss per
share. If the Group had reported net income for both of the three month periods
ended September 30, 2002 and 2001, and for both of the nine month periods ended
September 30, 2002 and 2001, there would have been an additional 0, 2,057,944,
431,334 and 3,914,920 shares, respectively, included in the calculations of
diluted earnings per share for these periods.
11
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
A reconciliation of the numerators and denominators for the basic and
diluted earnings per share calculations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(In thousands, except share,
per share and per ADS amounts)
Income (loss) from continuing operations............................... $ (11,619) $(107,370) $ (46,257) $(229,749)
Income (loss) on discontinued operations............................... (38,532) (37,075) (143,294) (65,539)
------------- ------------- ------------- -------------
NET INCOME (LOSS)...................................................... $ (50,151) $(144,445) $(189,551) $(295,288)
============= ============= ============= =============
BASIC AND DILUTED EARNINGS (LOSS) PER SHARE AND ADS: (1)
Weighted average number of Ordinary Shares outstanding,
excluding shares held by the employee benefit trusts.............. 50,754,192 50,740,892 50,754,192 51,065,230
------------- ------------- ------------- -------------
Basic and diluted earnings (loss) per share:
Continuing operations................................................ $ (0.23) $ (2.12) $ (0.91) $ (4.50)
Discontinued operations.............................................. (0.76) (0.73) (2.82) (1.28)
------------- ------------- ------------- -------------
$ (0.99) $ (2.85) $ (3.73) $ (5.78)
============= ============= ============= =============
Basic and diluted earnings (loss) per ADS: (1)
Continuing operations................................................ $ (2.29) $(21.16) $ (9.12) $(44.99)
Discontinued operations.............................................. (7.59) (7.31) (28.23) (12.84)
------------- ------------- ------------- -------------
$ (9.88) $(28.47) $(37.35) $(57.83)
============= ============= ============= =============
(1) ADS amounts have been restated to reflect the one-for-ten reverse split in
June 2002.
NOTE 5. INVESTMENTS
The Group's investments consist of fixed maturity and equity securities.
Fixed maturity securities are classified as either available-for-sale or
held-to-maturity, and equity securities are classified as either trading or
available-for-sale. The investments are accounted for as follows:
i) available-for-sale securities are recorded at fair value, with
changes in unrealized gains and losses excluded from net income,
but reported net of applicable income taxes and adjustments to
deferred policy acquisition cost amortization as a separate
component of accumulated other comprehensive income;
ii) held-to-maturity securities are recorded at amortized cost unless
these securities become other-than-temporarily impaired; and
iii) trading securities are recorded at fair value with changes in
unrealized gains and losses included in net income.
12
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
When a quoted market price is available for a security, the Group uses
this price in the determination of fair value. If a quoted market price is not
available for a security, management estimates the security's fair value based
on appropriate valuation methodologies.
For a discussion of the Group's accounting policies with respect to the
determination of fair values of investments and other-than-temporary
impairments, see the section entitled "Critical Accounting Policies" in Part I,
Item 2 "Management's Discussion and Analysis of Financial Condition and Results
of Operations" below. The Group's private securities are primarily convertible
preferred stock holdings in technology companies. Financial information with
respect to the issuers of these equity securities is received and reviewed
periodically by the Group's management. In addition, the Group's management
maintains contact with the management of these issuers through ongoing dialogue
to examine the issuers' future plans and prospects.
The Group's fixed maturity securities are principally comprised of U.S.
and non-U.S. corporate debt. Generally, quoted market prices are available for
these securities.
FIXED MATURITY SECURITIES
An analysis of fixed maturity securities is as follows:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
--------------------------------------------------- ------------------------------------------------
GROSS GROSS ESTIMATED GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
----------- ---------- ---------- ----------- ----------- ---------- ---------- -----------
(In thousands)
AVAILABLE-FOR-SALE:
Non-U.S. government
debt securities.............. $ - $ - $ - $ - $ 7,629 $ 97 $ - $ 7,726
Non-U.S. corporate
debt securities.............. 16,461 282 (334) 16,409 64,323 981 (359) 64,945
Corporate debt securities ..... 17,351 131 (155) 17,327 44,901 477 (348) 45,030
----------- ---------- ---------- ----------- ----------- ---------- ---------- -----------
$ 33,812 $ 413 $ (489)$ 33,736 $ 116,853 $ 1,555 $ (707) $ 117,701
----------- ---------- ---------- ----------- ----------- ---------- ---------- -----------
HELD-TO-MATURITY:
Private corporate debt
securities................... $ 180 $ - $ - $ 180 $ 871 $ - $ - $ 871
----------- ---------- ---------- ----------- ----------- ---------- ---------- -----------
Total fixed maturity securities $ 33,992 $ 413 $ (489)$ 33,916 $ 117,724 $ 1,555 $ (707) $ 118,572
=========== ========== ========== =========== =========== ========== ========== ===========
During the first nine months of 2002 and 2001, fixed maturity securities
classified as held-to-maturity with an aggregate carrying value of $2,440,000
and $10,448,000, respectively, were exchanged into preferred stock and
classified as available-for-sale. The exchanges resulted from refinancings by
the investee companies and a realized loss of $1,190,000 was recognized in the
first nine months of 2002 only.
Sales of fixed maturity securities classified as available-for-sale
resulted from the need to fund abnormally high policy redemptions during the
quarter ended September 30, 2002. See the discussion in Note 1. "Material
Events."
13
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
EQUITY SECURITIES
Equity securities are comprised of available-for-sale and trading
securities. An analysis of equity securities is as follows:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
--------------------------------------------------- -------------------------------------------------
GROSS GROSS ESTIMATED GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED FAIR UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
----------- ---------- ---------- ----------- ----------- ---------- ---------- -----------
(In thousands)
Private corporate equity
securities............... $ 18,405$ - $ (6,375) $ 12,030 $ 17,155 $ - $ (1,875) $ 15,280
Other equity securities ... - - - - 142 - (119) 23
----------- ---------- ---------- ----------- ----------- ---------- ---------- -----------
Total available-for-sale
equity securities........ 18,405 - (6,375) 12,030 17,297 - (1,994) 15,303
Trading securities......... 32,261 97 (19,168) 13,190 64,175 16,317 (12,875) 67,617
----------- ---------- ---------- ----------- ----------- ---------- ---------- -----------
Total equity securities.... $ 50,666 $ 97 $(25,543) $ 25,220 $ 81,472 $ 16,317 $(14,869) $ 82,920
=========== ========== ========== =========== =========== ========== ========== ===========
Trading securities are carried at fair value with changes in net
unrealized gains and losses of $(5,403,000) and $(106,022,000) included in the
losses for the three month periods ended September 30, 2002 and 2001,
respectively, and of $(31,276,000) and $(258,976,000) included in the losses for
the nine month periods ended September 30, 2002 and 2001, respectively.
INVESTMENT CONCENTRATION AND RISK
As of September 30, 2002, fixed maturity securities held by the Group
included investments in General Motors of $7,932,000, and equity securities held
by the Group included investments in Ceon Corporation of $5,093,000, Agility
Communications, Inc. of $3,375,000, New Focus, Inc. of $4,429,000 and Packeteer,
Inc. of $6,304,000. These five corporate issuers each represented more than ten
percent of shareholders' equity as of September 30, 2002.
14
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
REALIZED GAINS AND LOSSES
Information about gross realized gains and losses on securities
transactions included in continuing operations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(In thousands)
GROSS REALIZED GAINS (LOSSES) ON SECURITIES TRANSACTIONS:
Fixed maturities, available-for-sale:
Gross gains...................................................... $ 1,767 $ 25 $ 1,770 $ 26
Gross losses..................................................... (1,858) (13) (4,679) (15)
Fixed maturities, held-to-maturity:
Gross losses..................................................... (1,190) - (1,701) -
Equity securities, trading:
Gross gains...................................................... - - 3,841 36,070
Gross losses..................................................... (784) - (851) -
Equity securities, available-for-sale:
Gross gains...................................................... - 445 - 456
Gross losses..................................................... - - (120) -
------------- ------------- ------------- -------------
Net realized investment gains (losses) on securities
transactions..................................................... $ (2,065) $ 457 $ (1,740) $36,537
============= ============= ============= =============
During the three month period ended September 30, 2002, management
determined that no securities held by the Group were other-than-temporarily
impaired.
During the nine month period ended September 30, 2002, two private
investments held by continuing operations and classified as held-to-maturity
were considered by management to be other-than-temporarily impaired and realized
losses totaling $0.4 million related to these investments were recorded in the
consolidated income statement.
NOTE 6. DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs are the costs of producing life insurance and
annuity business: principally commissions, underwriting costs and certain
marketing expenses which vary with, and are primarily related to, the
acquisition of new business. Policy acquisition costs are deferred and amortized
over the estimated lives of the policies in relation to their estimated future
gross profits. Due to the events described in Note 1. "Material Events," LPAL
discontinued the issuance of new policies on July 2, 2002 and since that date
has experienced a substantial increase in policy redemptions. Based on revised
estimates of the gross profits on the remaining block of business, management
determined that the balance of deferred policy acquisition costs should be
written-off in full as of September 30, 2002.
15
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 7. NOTES PAYABLE
Under the Group's $23.0 million bank facility with the Bank of Scotland,
$12.3 million was outstanding as of September 30, 2002. In addition, the
remaining $10.7 million under the facility was utilized in the form of letters
of credit and guarantees provided on behalf of certain former investee
companies. The facility bears interest at 2% over the applicable LIBOR rate (the
current annual interest rate is 3.875%). The Company is the primary obligor
under the facility. In addition, the facility is guaranteed by the Company and
substantially all of its subsidiaries, excluding LPLA and LPAL. The Group has
committed to provide the bank with a security interest over certain of the
Group's listed equity securities (which securities had an aggregate market value
of $5.8 million as of September 30, 2002, and $10.6 million as of November 13,
2002).
The Group's consolidated results for the quarters ended June 30, 2002
and September 30, 2002 have resulted in breaches of the net worth, operating
profit/interest charge and intangible asset ratio financial covenants under its
bank facility. Subsequent to September 30, 2002, the Company and the Bank of
Scotland have agreed to the terms and conditions of a new credit facility which
replaces the current credit facility, subject to the bank's final due diligence,
documentation and the satisfaction of certain conditions. The new facility
provides up to $23.0 million, with an interest rate of 3.5% above the LIBOR rate
on borrowings up to $10.0 million and 4.5% above the LIBOR rate on borrowings
between $10.0 million and $23.0 million. The facility limit decreases at the end
of each quarter, such that the facility is repaid in full no later than December
31, 2003; however, the bank has agreed to consider an extension of the final
facility expiration date in light of the overall circumstances prevailing at the
time of any such request by the Company. In addition to providing the bank with
security interest over certain of the Group's listed equity securities as
mentioned above, the Company will be required to give the bank other guarantees,
pledges and security interests over certain other Group assets. The Company has
agreed to pay the bank a one-time restructuring fee of (pound)180,000, monthly
management fees of (pound)10,000 and quarterly facility fees which begin at 0.5%
per annum and increase each quarter until they reach 2.5% per annum in the third
quarter of 2003 based on the average loan amount outstanding during the quarter.
The Company has also agreed to grant to the bank warrants to subscribe for 3% of
the Ordinary Shares of the Company. New financial covenants will be set under
this reducing credit facility with testing to take place as of the end of each
quarter. There is no assurance that a definitive agreement will be signed.
Consequently, the existing facility remains in default and is repayable upon
demand.
If the bank demanded immediate full repayment of the existing facility,
the Group's management believes that it is unlikely that the former investee
companies would currently have the ability to repay their borrowings totaling
$10.7 million, and thus the Group would be obligated to pay this amount on their
behalf. As of September 30, 2002, the Group excluding LPAL had $20.9 million of
cash and liquid securities. (The market value of the Group's listed securities
discussed above increased from $5.8 million as of September 30, 2002 to $10.6
million as of November 13, 2002.) Immediate repayment of the full $23.0 million
by the Group would create serious liquidity issues for the Group. As a result,
the Group has restructured its operations and reduced expenses in order to
retire its outstanding bank debt over time. The Group intends to use a
combination of cash and the proceeds from listed equity security sales or other
asset disposals in order to meet the pay down schedule under the new bank
facility described above.
For further discussion, see the "Liquidity and Capital Resources"
section in Part I, Item 2 "Management's Discussion of Financial Condition and
Results of Operations."
NOTE 8. SHAREHOLDERS' EQUITY
Total dividends declared and paid were $0.05 gross per Ordinary Share
($0.04 net of 20% Jersey tax) and $0.40 per ADS (net of 20% Jersey tax) during
the nine months ended September 30, 2002. Total dividends declared and paid
16
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
were $0.29 gross per Ordinary Share ($0.232 net of 20% Jersey tax) and $2.32 per
ADS (net of 20% Jersey tax) during the year ended December 31, 2001.
Dividends per ADS have been restated to reflect the one-for-ten reverse
split in June 2002.
NOTE 9. COMMITMENTS AND CONTINGENCIES
As of September 30, 2002, total operating and capital lease commitments
of the Group were approximately $1.7 million and $0.3 million, respectively.
Commitments eliminated as a result of the actions of the North Carolina
Department of Insurance ("NCDOI") with respect to LPLA (as described in Note 1.
"Material Events") for operating and capital lease commitments were
approximately $10.8 million and $0, respectively.
As previously reported in the Group's quarterly report on Form 10-Q for
the quarter ended June 30, 2002, which was filed with the SEC on August 14,
2002, under an agreement between a Group subsidiary and LPLA, the Group
subsidiary may have been obligated to pay LPLA a maximum of $2.0 million per
year, with an overall cap of $6.0 million. The Group subsidiary's obligation to
pay LPLA was in exchange for the right to exercise serial call options to
purchase certain private equity securities held by LPLA at LPLA's original cost.
On October 9, 2002, the Group was informed of the rejection and termination of
this agreement by the NCDOI. Consequently, the Group subsidiary's obligation to
LPLA under the agreement has been cancelled.
In the course of the administration of LPLA in rehabilitation, the NCDOI
has recently requested information concerning the history of a limited number of
investments in securities of portfolio companies. These portfolio investments
have been associated with LPLA for more than seven years, and involve
intercompany transfers. The history of their investment performance and
ownership is complex. The Company is complying with these requests. The Company
is not able at this time to predict what conclusions the NCDOI will reach after
evaluation of this information.
NOTE 10. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
On January 1, 2002, the Group adopted Statement of Financial Accounting
Standard No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which
superseded APB Opinion No. 17, "Intangible Assets." SFAS 142 eliminates the
requirement to amortize goodwill and indefinite-lived intangible assets,
addresses the amortization of intangible assets with a defined life, and
addresses the impairment testing and recognition for goodwill and intangible
assets. The adoption of SFAS 142 did not have a material effect on the Group's
consolidated results of operations or financial position. For the nine month
period ended September 30, 2002, the Group realized a goodwill write-off in the
amount of $7,000 compared to goodwill amortization of $172,000 for the same
period in 2001.
On January 1, 2002, the Group adopted Statement of Financial Accounting
Standard No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets." SFAS 144 addresses financial accounting and reporting for
the impairment or disposal of long-lived assets and supersedes, with exceptions,
Statement of Financial Accounting Standard No. 121, "Accounting for the
Impairment of Long-Lived Assets to Be Disposed Of." The Group followed SFAS 144
in determining the accounting treatment for the impairment of its subsidiary,
LPLA, during the quarter ended September 30, 2002. See Note 1. "Material
Events," and Note 3. "Discontinued Operations" for further information.
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 145 ("SFAS 145"), "Rescission of
FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and
Technical Corrections." SFAS 145 updates, clarifies and simplifies existing
17
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
accounting pronouncements. Management does not expect the standard to have any
material impact on the Group's consolidated results of operations or financial
position.
In June 2002, the FASB issued Statement of Financial Accounting Standard
No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires the Group to recognize costs associated with exit
or disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS 146 replaces Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." The provisions of SFAS 146 will be applied prospectively
to exit or disposal activities initiated after December 31, 2002.
NOTE 11. BUSINESS SEGMENT AND GEOGRAPHICAL INFORMATION
The Group's reportable operating segments are classified according to
its principal businesses, which are the following: life insurance and annuities,
financial advisory services, asset management and venture capital management.
During the three month periods ended September 30, 2002 and 2001, the
asset management and venture capital management segments generated portfolio
management fees from LPLA (discontinued operations) of $0 and $2,930,000,
respectively. During the nine month periods ended September 30, 2002 and 2001,
the asset management and venture capital management segments generated portfolio
management fees from LPLA of $3,632,000 and $8,676,000, respectively. These
portfolio management fees are included in the revenues of continuing operations
and have not been eliminated in the consolidated financial statements.
Realized investment losses in the amount of $31,368,000 were recorded
during the first nine months of 2002 by the venture capital management segment,
related to intersegmental investment sales to the life insurance and annuities
segment. These realized investment losses were offset by a corresponding
increase in unrealized investment gains on trading securities for the same
amount. These gains and losses have been eliminated in the Group's consolidated
financial statements.
Summary revenue and investment gain (loss) information by geographic
segment, based on the domicile of the Group company generating those revenues,
is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(In thousands)
Jersey............................................................ $ (711) $ (26,389) $ (7,824) $(143,371)
Guernsey.......................................................... (4,329) (76,929) (17,832) (73,509)
United States..................................................... 5,008 8,753 19,489 27,686
------------- ------------- ------------- -------------
CONSOLIDATED REVENUES AND NET INVESTMENT GAINS (LOSSES)
FOR CONTINUING OPERATIONS...................................... $ (32) $ (94,565) $ (6,167) $(189,194)
============= ============= ============= =============
18
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Revenues and income before taxes for the Group's reportable operating
segments included in continuing operations, based on management's internal
reporting structure, were as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(In thousands)
REVENUES:
Life insurance and annuities (1),(2),(3).............................. $ 334 $ (24,859) $ (5,851) $(139,718)
Financial advisory services........................................... 3,766 4,361 12,583 14,487
Asset management (2) ................................................. 1,125 1,716 4,259 5,130
Venture capital management (3) ....................................... (5,352) (76,342) (17,669) (70,824)
------------- ------------- ------------- -------------
(127) (95,124) (6,678) (190,925)
Reconciliation of segment amounts to consolidated amounts:
Interest income ...................................................... 95 559 511 1,731
------------- ------------- ------------- -------------
CONSOLIDATED REVENUES AND NET INVESTMENT GAINS (LOSSES)
FOR CONTINUING OPERATIONS.......................................... $ (32) $ (94,565) $ (6,167) $(189,194)
============= ============= ============= =============
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES:
Life insurance and annuities (1),(2),(3).............................. $ (3,125) $ (27,391) $(15,212) $(145,414)
Financial advisory services .......................................... (1,083) (1,071) (2,818) (2,878)
Asset management (2).................................................. 46 588 573 1,102
Venture capital management (3) ....................................... (6,035) (79,225) (20,964) (78,211)
------------- ------------- ------------- -------------
(10,197) (107,099) (38,421) (225,401)
Reconciliation of segment amounts to consolidated amounts:
Interest income ...................................................... 95 559 511 1,731
Corporate expenses ................................................... (1,460) (1,316) (4,990) (4,446)
Goodwill amortization and write-offs ................................. (7) (57) (7) (172)
Interest expense (4).................................................. (231) (481) (839) (1,846)
------------- ------------- ------------- -------------
CONSOLIDATED INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES ............................................... $ (11,800) $(108,394) $ (43,746) $(230,134)
============= ============= ============= =============
(1) Netted against the revenues (investment income) of the life insurance and
annuities segment are management fees paid to the asset management segment of
$5,000 and $13,000 in the third quarters of 2002 and 2001, respectively, and
$35,000 and $33,000 in the first nine months of 2002 and 2001, respectively.
(2) Included in the revenues of the asset management segment are management fees
from the life insurance and annuities segment of $5,000 and $13,000 in the third
quarters of 2002 and 2001, respectively, and $35,000 and $33,000 in the first
nine months of 2002 and 2001, respectively. In addition, revenues of the asset
management segment also include management fees from LPLA (discontinued
operations) of $0 and $468,000 in the third quarters of 2002 and 2001,
respectively, and $724,000 and $1,437,000 in the first nine months of 2002 and
2001, respectively.
(3) Included in the revenues of the venture capital management segment are
management fees from LPLA (discontinued operations) of $0 and $2,462,000 in the
third quarters of 2002 and 2001, respectively, and $2,908,000 and $7,239,000 in
the first nine months of 2002 and 2001, respectively.
(4) Included in interest expense is interest paid to LPLA (discontinued
operations) of $0 and $14,000 in the third quarters of 2002 and 2001,
respectively, and $30,000 and $43,000 in the first nine months of 2002 and 2001,
respectively.
19
LONDON PACIFIC GROUP LIMITED AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Material changes in segmental assets of continuing operations during the
third quarter of 2002 occurred in: a) the life insurance and annuities segment,
where assets decreased by $106,783,000 from $163,523,000 to $56,740,000,
primarily due to the sale of investments to fund policy redemptions; b) the
venture capital management segment, where assets decreased by $5,353,000 from
$12,659,000 to $7,306,000, primarily caused by the change in net unrealized
gains and losses on listed equity securities in the trading account; and c) the
corporate and other segment, where assets decreased by $41,377,000 from
$50,374,000 to $8,997,000, primarily due to the use of $27 million of cash to
repay part of the bank loan and due to the impairment write-off of $15 million
in loans to LPLA (discontinued operations).
Material changes in segmental assets of continuing operations during the
first nine months of 2002 occurred in: a) the life insurance and annuities
segment, where assets decreased by $107,915,000 from $164,655,000 to
$56,740,000, primarily due to the sale of investments to fund policy
redemptions; b) the venture capital management segment, where assets decreased
by $38,947,000 from $46,253,000 to $7,306,000, primarily caused by the transfer
of certain trading securities from the venture capital management segment to the
life insurance and annuities segment, and the change in net unrealized gains and
losses on listed equity securities in the trading account; and c) the corporate
and other segment, where assets decreased by $45,645,000 from $54,642,000 to
$8,997,000, primarily due to the use of $27 million of cash to repay part of the
bank loan and due to the impairment write-off of $15 million in loans to LPLA
(discontinued operations).
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the unaudited interim
consolidated financial statements, and the notes thereto, presented elsewhere in
this report. The interim consolidated financial statements are prepared in
accordance with U.S. GAAP. This item should also be read in conjunction with the
"Forward-Looking Statements and Factors That May Affect Future Results" which
are set forth below and in the Company's other filings with the SEC.
FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other sections of this report contain forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended. Such forward-looking statements are based on current
expectations, estimates, forecasts and projections about the industries in which
the Group operates, management's current beliefs and assumptions made by
management. Words such as "expects," "anticipates," "intends," "projects,"
"targets," "plans," "believes," "seeks," "estimates," "goals," variations of
such words and similar expressions are intended to identify such forward-looking
statements. These statements are not guarantees of future performance and
involve certain risks, uncertainties and assumptions that are difficult to
predict. Future outcomes and results may differ materially from what is
expressed or forecast in such forward-looking statements. The Group undertakes
no obligation to update any forward-looking statements, whether as a result of
new information, future developments or otherwise.
Factors that could cause or contribute to deviations from the
forward-looking statements include those discussed in this section, elsewhere in
this report and in the Company's other filings with the SEC. The factors
include, but are not limited to, (i) the risks described in Item 3 "Quantitative
and Qualitative Disclosures About Market Risk," (ii) variations in demand for
the Group's products and services, (iii) the success of new products and
services provided by the Group, (iv) significant changes in net cash flows in or
out of the Group's businesses, (v) fluctuations in the performance of debt and
equity markets worldwide, (vi) the enactment of adverse state, federal or
20
foreign regulation or changes in government policy or regulation (including
accounting standards) affecting the Group's operations, (vii) the effect of
economic conditions and interest rates in the U.S., the U.K. or internationally,
(viii) the ability of the Group's subsidiaries to compete in their respective
businesses, (ix) the ability of the Group to attract and retain key personnel,
and (x) actions by governmental authorities that regulate the Group's
businesses, including insurance commissions.
CRITICAL ACCOUNTING POLICIES
Management has identified those accounting policies that management
believes are most important to the portrayal of the Group's financial condition
and results of operations and that require management's most complex or
subjective judgments, often as a result of the need to make estimates about the
effect of matters that are inherently uncertain. These most critical accounting
policies pertain to the Group's investments, and to the accounting for life
insurance policy liabilities and deferred policy acquisition costs. These
critical accounting policies are described below.
DETERMINATION OF FAIR VALUES OF INVESTMENTS
When a quoted market price is available for a security, the Group uses
this price in the determination of fair value. If a quoted market price is not
available for a security, management estimates the security's fair value based
on valuation methodologies as described below.
The Group holds investments in privately held equity securities,
primarily convertible preferred stock in venture capital companies doing
business in various segments of technology industries. Venture capital investing
entails making investments in companies that are developing products or services
for large emerging markets with the belief that these investments will yield
superior returns if these companies are successful. These investments are
normally held for a number of years. When the Group makes these investments,
most of the companies are still developing the products they intend to bring to
market or are in the early stages of product sales. Venture capital companies
are net consumers of cash and often dependent upon additional financing to
execute their business plans. These investments involve substantial risk and the
companies generally lack meaningful historical financial results used in
traditional valuation models. The process of pricing these securities ranges
from fierce competitive bidding between financial institutions to existing
investors negotiating prices with the company without outside investor
validation. Investments in convertible preferred stock come with rights that
vary dramatically both from company to company and between rounds of financing
within the same company. These rights, such as anti-dilution, redemption,
liquidation preferences and participation, bear directly on the price an
investor is willing to pay for a security. The returns on these investments are
generally realized through an initial public offering of the company's shares
or, more commonly, through the company's acquisition by a public company.
One of the factors affecting fair value is the amount of time before a
company requires additional financing to support its operations. Management
believes that companies that are financed to the estimated point of operational
profitability or for a period greater than one year will most likely return
value to the investor through an acquisition between a willing buyer and seller,
as the company does not need to seek financing from an opportunistic investor or
insider in an adverse investment environment. If a particular company needs
capital in the near term, management considers a range of factors in its fair
value analysis, including the Group's ability to recover its investment through
surviving liquidation preferences. Management's valuation methodologies also
include fundamental analysis that evaluates the investee company's progress in
developing products, building intellectual property portfolios and securing
customer relationships, as well as overall industry conditions, conditions in
and prospects for the investee's geographic region, and overall equity market
conditions. This is combined with analysis of comparable acquisition
transactions and values to determine if the security's liquidation preferences
will ensure full recovery of the Group's investment in a likely acquisition
outcome. In its valuation analysis, management also considers the most recent
transaction in a company's shares.
The determination of fair values of investments requires the application
of significant judgment. It is possible that the factors evaluated by management
and fair values will change in subsequent periods, especially with respect to
21
the Group's privately held equity securities in technology companies, resulting
in material impairment charges in future periods.
OTHER-THAN-TEMPORARY IMPAIRMENTS
Management performs an ongoing review of all investments in its
portfolio to determine if there are any declines in fair value that are
other-than-temporary.
As the Group's listed equity securities are classified as trading
securities, impairment adjustments are not required as any change in the market
value of these securities between reporting periods is included in earnings.
In relation to the Group's equity securities that do not have a readily
determinable fair value and are classified as available-for-sale, factors
considered in impairment reviews include: (i) the length of time and extent to
which estimated fair values have been below cost and the reasons for the
decline, (ii) the investee's recent financial performance and condition,
earnings trends and future prospects, (iii) the market condition of either the
investee's geographic area or industry as a whole, and (iv) concerns regarding
the investee's ability to continue as a going concern (such as the inability to
obtain additional financing). If the evidence supports that a decline in fair
value is other-than-temporary, then the investment is reduced to its estimated
fair value, which becomes its new cost basis, and a realized loss is reflected
in earnings.
A fixed maturity security is deemed to be impaired when it is determined
that it is probable that amounts due (principal and interest) will not be fully
collected according to the security's contractual terms. This determination is
made by considering all available facts and circumstances, including the Group's
intent and ability to continue to hold the investment to maturity. Factors
considered include: (i) the length of time and extent to which the market values
have been below amortized cost and the reasons for the decline, (ii) the
issuer's recent financial performance and condition, earnings trends and future
prospects in the near to mid-term, (iii) changes in the issuer's debt rating
and/or regulatory actions or other events that may effect the issuer's
operations, (iv) the market condition of either the issuer's geographic area or
industry as a whole, and (v) factors that raise doubt about the issuer's ability
to continue as a going concern. If the evidence supports that a decline in fair
value is other-than-temporary, then the fixed maturity security is written down
to it's quoted market value, if such a value is available. If a readily
determinable fair value does not exist, then the fixed maturity security is
written down to management's estimate of its fair value, which is based on the
valuation methodologies as described above. Write-downs are recorded as realized
losses and included in earnings.
The evaluations for other-than-temporary impairments require the
application of significant judgment. It is possible that the impairment factors
evaluated by management and fair values will change in subsequent periods,
especially with respect to the Group's privately held equity securities in
technology companies, resulting in material impairment charges in future
periods.
LIFE INSURANCE POLICY LIABILITIES
Life insurance policy liabilities are accounted for in accordance with
Statement of Financial Accounting Standards No. 97, "Accounting and Reporting by
Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains
and Losses from the Sale of Investments." Life insurance policy liabilities for
deferred annuities are accounted for as investment-type insurance products and
are recorded at accumulated value (premiums received, plus accrued interest to
the balance sheet date, less withdrawals and assessed fees).
DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs are the costs of producing life insurance and
annuity business: principally commissions, underwriting costs and certain
marketing expenses which vary with, and are primarily related to, the
acquisition of new business. Policy acquisition costs are deferred and amortized
over the estimated lives of the policies in relation to their estimated future
gross profits. Amortization is adjusted in the current year when estimates of
total profits to be realized from a group of products are revised.
22
Deferred policy acquisition costs are adjusted for the change in
amortization that would have been recorded if fixed maturity securities
classified as available-for-sale had been sold at their stated aggregate fair
value and the proceeds reinvested at current yields. The impact of this
adjustment is included in accumulated other comprehensive income within
shareholders' equity.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
LIFE INSURANCE AND ANNUITIES
During the third quarter of 2002, the life insurance and annuities
segment continued to suffer from the adverse conditions in the equity markets.
During this reporting period, the Group's primary insurance company,
LPLA, was placed under regulatory control and rehabilitation based on LPLA's
statutory capital and surplus as of June 30, 2002. On August 6, 2002, on
petition of the Commissioner of Insurance of the State of North Carolina (the
"Commissioner") with the consent of LPLA and unanimous approval of its board of
directors, the Superior Court of Wake County in the State of North Carolina
ordered the Commissioner to take possession and control of all of the property,
books and accounts, documents and other records of LPLA. Based on this court
order, the Company no longer exercises control over LPLA. As a result of this
event, the Company has deconsolidated LPLA and recorded a charge to earnings in
the third quarter of 2002 of $38.5 million for losses resulting from the
disposition of LPLA.
For further discussion, see the "Liquidity and Capital Resources"
section in Part I, Item 2 "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Note 3. "Discontinued Operations" to
the Consolidated Financial Statements in Part I, Item 1.
On July 2, 2002, the Company announced that further declines in the
value of LPLA's investment portfolio due to persistent negative events in the
equity and bond markets continued to erode significantly the statutory capital
of LPLA and that, to date, the Company had been unsuccessful in concluding a
transaction to enhance the capital of LPLA. As a consequence, LPLA discontinued
the issuance of new policies as of July 2, 2002. Although the statutory capital
of the Group's Jersey insurance subsidiary, LPAL, had not been affected by the
adverse equity and bond markets to the same extent as the statutory capital of
LPLA, the Group also announced on July 2, 2002 that LPAL would discontinue
writing new policies effective immediately. The decision to discontinue the
issuance of new policies through LPAL was made to avoid the increased capital
requirement created by additional policyholder liabilities. Subsequent to this
announcement and other announcements relating to the Company and LPLA, LPAL
policy surrenders increased substantially. Approximately 71% of LPAL's
policyholder liabilities as of June 30, 2002 have been redeemed as of September
30, 2002.
Due to the events referred to above, the Group no longer plans to write
insurance policies, will let its Jersey, Channel Islands insurance business
wind-down over time and will discontinue its insurance business segment. The
Group is continuing its focus on increasing assets under management, consulting
and administration in its financial advisory services and asset management
businesses. Berkeley International Capital Corporation ("BICC") plans to
continue to develop its venture capital business.
23
Certain information regarding the life insurance and annuities segment's
results of operations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(In thousands)
REVENUES:
Investment income.................................................... $ 1,243 $ 1,881 $ 5,436 $ 4,637
Insurance policy charges ............................................ 1,207 21 1,152 21
Net realized investment gains (losses)............................... (65,586) 13 (73,512) 36,082
Change in net unrealized investment gains and losses on
trading securities................................................. 63,470 (26,774) 61,073 (180,458)
------------- ------------- ------------- -------------
TOTAL REVENUES AND INVESTMENT GAINS (LOSSES)......................... 334 (24,859) (5,851) (139,718)
EXPENSES:
Interest credited on insurance policyholder accounts ................ 1,423 1,804 5,495 4,392
Amortization of deferred policy acquisition costs ................... 1,689 311 2,952 604
General and administrative expenses ................................. 347 417 914 700
------------- ------------- ------------- -------------
TOTAL EXPENSES RELATED TO OPERATIONS ................................ 3,459 2,532 9,361 5,696
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES ................................... $ (3,125) $ (27,391) $ (15,212) $(145,414)
============= ============= ============= =============
THIRD QUARTER OF 2002 COMPARED TO THIRD QUARTER OF 2001
In the third quarter of 2002, the life insurance and annuities segment,
which now only consists of LPAL, contributed a loss before income taxes of $3.1
million to the Group's overall loss before income taxes, compared to a loss
before income taxes of $27.4 million in the third quarter of 2001. Net realized
investment losses in the third quarter of 2002, were $65.6 million, compared to
net realized investment gains of $13,000 in the third quarter of 2001. The gain
from the change in net unrealized investment gains and losses was $63.5 million
in the third quarter of 2002, compared to a loss of $26.8 million in the third
quarter of 2001. In the third quarter of 2002, the spread between investment
income and interest credited to policyholder accounts decreased by $0.3 million;
amortization of deferred policy acquisition costs ("DPAC") increased by $1.4
million; and general and administrative expenses decreased by $0.1 million, each
as compared to the third quarter of 2001. Policy charges for the third quarter
of 2002 increased by $1.2 million, compared to the third quarter of 2001.
In accordance with U.S. GAAP, premiums collected on annuity contracts
are not reported as revenues, but rather as deposits to insurance liabilities.
Revenues for these products are recognized over time in the form of investment
income and surrender or other charges. LPAL offers guaranteed bond contracts
which typically have an interest rate guaranteed from three to seven years. LPAL
began selling guaranteed bond contracts, in the Jersey, Channel Islands and U.K.
markets in early 2000.
LPAL did not generate any premiums during the third quarter of 2002.
During the third quarter of 2001, $16.1 million in premiums were received. As
discussed above, LPAL discontinued the issuance of new policies on July 2, 2002
and therefore will not generate any premiums in the remainder of 2002.
Interest and dividend income on investments decreased by $0.6 million in
the third quarter of 2002, compared with the third quarter of 2001. Yielding
investments decreased in the third quarter of 2002 as corporate bonds were sold
to cover the increase in policy surrenders.
Net investment losses were $2.1 million in the third quarter of 2002,
compared to net investment losses of $26.8 million in the third quarter of 2001.
Net investment losses in the third quarter of 2002 were comprised of net
24
realized investment losses of $65.6 million and a $63.5 million gain from the
change in net unrealized gains and losses on the listed equity securities held
in the trading portfolio. The trading portfolio decreased from $15.1 million as
of June 30, 2002 to $7.4 million as of September 30, 2002. LPAL sold certain
trading positions during the third quarter of 2002, which resulted in net
realized losses of $65.5 million based on an aggregate original cost of $71.2
million. These disposals represented shares previously held in a company that
had completed an initial public offering of their securities. In the third
quarter of 2002, LPAL had additional net realized losses of $0.1 million on
sales of $88.3 million of publicly traded corporate debt securities.
Total invested assets (defined as total assets excluding DPAC and other
assets) decreased from $162.0 million as of June 30, 2002 to $56.7 million as of
September 30, 2002. On total average invested assets for the third quarter of
2002, the average annualized net return, including both realized and unrealized
investment gains and losses, was -1.82%, compared with -58.81% for the third
quarter of 2001.
Policy surrender charge income increased by $1.2 million in the third
quarter of 2002 to $1.2 million, compared with $21,000 in the third quarter of
2001. The increase in policy surrenders followed the events as described above.
Interest credited on policyholder accounts decreased by $0.4 million in
the third quarter of 2002 to $1.4 million, compared with $1.8 million in the
third quarter of 2001. The decrease was primarily due to policy surrenders in
the third quarter of 2002. The average rate credited to policyholders was 5.63%
during the third quarter of 2002, compared with 6.29% during the third quarter
of 2001.
Amortization of DPAC was $1.7 million in the third quarter of 2002, an
increase of $1.4 million over the third quarter of 2001. This increase was due
to the acceleration of DPAC amortization as a result of the discontinuance of
new business and the lack of interest spread on the remaining block of business.
General and administrative expenses were $0.3 million in the third
quarter of 2002, compared with $0.4 million in the third quarter of 2001. This
$0.1 million decrease was primarily due to lower marketing costs and outside
policy administration fees as a result of the declining block of business.
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001
In the first nine months of 2002, LPAL contributed a loss before income
taxes of $15.2 million to the Group's overall loss before income taxes, compared
to a loss before income taxes of $145.4 million in the first nine months of
2001. Net realized investment losses in the first nine months of 2002 were $73.5
million, compared to net realized investment gains of $36.1 million in the first
nine months of 2001. The gain from the change in net unrealized investment gains
and losses was $61.1 million in the first nine months of 2002, compared to a
loss of $180.5 million in the first nine months of 2001. In the first nine
months of 2002, the spread between investment income and interest credited to
policyholder accounts decreased by $0.3 million; amortization of DPAC increased
by $2.3 million; and general and administrative expenses increased by $0.2
million, each as compared to the first nine months of 2001. Policy charges for
the first nine months of 2002 increased by $1.1 million, compared to the first
nine months of 2001.
LPAL generated $6.5 million of premiums during the first nine months of
2002, a decrease of $60.0 million from the premiums received by LPAL during the
first nine months of 2001. LPAL's premium volume continued to decline as a
result of lowering interest crediting rates during the last quarter of 2001 and
the events as described above.
Interest and dividend income on investments was $5.4 million in the
first nine months of 2002, compared with $4.6 million in the first nine months
of 2001. This $0.8 million increase was primarily due to the increase in
invested assets during the first nine months of 2002 compared to the first nine
months of 2001.
Net investment losses were $12.4 million in the first nine months of
2002, compared to net investment losses of $144.4 million in the first nine
months of 2001. Net investment losses in the first nine months of 2002 were
comprised of net realized investment losses of $73.5 million and a $61.1 million
25
gain from the change in net unrealized gains and losses on the listed equity
securities held in the trading portfolio. The trading portfolio decreased from
$22.3 million as of December 31, 2001 to $7.4 million as of September 30, 2002.
Additions to the trading portfolio during the first nine months of 2002 of $5.0
million resulted from the transfer of certain listed equity securities from the
venture capital management segment. LPAL sold certain trading positions during
the first nine months of 2002, which resulted in net realized losses of $70.6
million based on an aggregate original cost of $81.0 million. These disposals
represented shares held in companies that had completed initial public offerings
of their securities. These realized losses were increased by net realized losses
of $2.9 million on sales of $93.3 million of publicly traded corporate debt
securities.
Total invested assets (defined as total assets excluding DPAC and other
assets) decreased to $56.7 million as of September 30, 2002, compared to $161.5
million as of December 31, 2001. On total average invested assets for the first
nine months of 2002, the average annualized net return, including both realized
and unrealized investment gains and losses, was -6.64%, compared with -90.65%
for the first nine months of 2001.
Policy surrender and mortality charge income increased by $1.1 million
in the first nine months of 2002 to $1.2 million, compared with $21,000 in the
first nine months of 2001. The increase in policy surrenders followed the events
as described above.
Interest credited on policyholder accounts increased by $1.1 million in
the first nine months of 2002 to $5.5 million, compared with $4.4 million in the
first nine months of 2001. The increase was primarily due to new business growth
up to the end of the second quarter of 2002. The average rate credited to
policyholders was 6.16% during the first nine months of 2002, compared with
6.64% during the first nine months of 2001.
Amortization of DPAC was $2.9 million in the first nine months of 2002,
an increase of $2.3 million over the first nine months of 2001. This increase
was due to the acceleration of DPAC amortization as a result of the
discontinuance of new business at the start of the third quarter of 2002 and the
lack of interest spread on the remaining block of business.
General and administrative expenses were $0.9 million in the first nine
months of 2002, compared with $0.7 million in the first nine months of 2001.
This $0.2 million increase was primarily due to the reduction in expenses
deferred as policy acquisition costs.
FINANCIAL ADVISORY SERVICES
Certain information regarding the financial advisory services segment's
results of operations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(In thousands)
Gross financial advisory services fees................... $ 3,766 $ 4,361 $12,583 $14,487
Payouts due to independent advisors...................... (2,300) (2,822) (7,853) (9,511)
------------- ------------- ------------- -------------
1,466 1,539 4,730 4,976
Operating expenses....................................... 2,549 2,610 7,548 7,854
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES ....................... $(1,083) $(1,071) $(2,818) $(2,878)
============= ============= ============= =============
26
THIRD QUARTER OF 2002 COMPARED TO THIRD QUARTER OF 2001
The pre-tax loss from the financial advisory services segment remained
constant at $1.1 million for the third quarter of 2002 compared to the third
quarter of 2001. A decrease in net revenues resulting from overall market
declines affecting asset management and brokerage product lines was largely
offset by increased revenues from institutional client asset growth and reduced
operating expenses.
Net revenues also remained constant at $1.5 million for the third
quarter of 2002 compared to the third quarter of 2001. Net asset management and
consulting fees, and brokerage and commission product sales, decreased from the
prior period due to sustained declining market conditions prevalent throughout
the year that resulted in overall diminished portfolio values and trading
volume. Decreases in net revenues from fee based management and consulting
services, and commission based brokerage services, were partially offset by an
increase in institutional revenues.
Assets under management, consulting or administration were $2.1 billion
as of both September 30, 2002 and September 30, 2001. Assets from institutional
sources increased due to the addition of new clients, despite decreasing market
values. In contrast, managed and consulting assets decreased, primarily due to
the general decline in market values. The net revenue to asset ratio is higher
for managed assets as compared to institutional assets.
Operating expenses decreased slightly by $0.1 million to $2.5 million in
the third quarter of 2002 compared to the third quarter of 2001, due to lower
salary and other staff costs, offset by a reduction in the amount of web
development costs capitalized.
In late 1999, the Group decided to make the London Pacific Advisors
("LPA") business the foundation for an Internet based initiative that would
deliver a full complement of consulting and back office services to institutions
and financial advisors through the Internet. The total investment in this
project through September 30, 2002 was $3.6 million, including $0.1 million in
the third quarter of 2002. Of this total, $2.9 million has been capitalized as
software development costs and is being amortized (as a component of operating
expenses) over five years; amortization of these costs began in May 2001, and
the amount amortized during the third quarter of 2002 was $0.1 million.
Successful completion of the LPA initiative opened the door for
marketing of its services to institutions and large groups of advisors. To date,
service contracts have been signed with eleven major institutions, and
additional contracts are currently under negotiation. Revenues related to these
contracts have steadily increased since the launch of the institutional
business.
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001
The pre-tax loss from the financial advisory services segment decreased
by $0.1 million to $2.8 million in the first nine months of 2002 compared to the
first nine months of 2001. Increased revenues from institutional client asset
growth and lower operating expenses, were largely offset by overall market
declines that adversely impacted net revenues from the asset management,
portfolio servicing, commission and brokerage product lines.
Net revenues decreased from $5.0 million in the first nine months of
2001 to $4.7 million in the first nine months of 2002. Net asset management and
consulting fees, as well as net revenues from brokerage and commission product
sales decreased from the prior period as a result of the erosion in portfolio
values and the continued decline in general market conditions throughout the
year. These decreases in net revenues were partially offset by an increase in
institutional revenues.
Assets under management, consulting or administration declined from $2.3
billion as of December 31, 2001 to $2.1 billion as of September 30, 2002. The
decline in assets resulting from negative market conditions during 2002 was
partially offset by the addition of assets from existing and new institutional
clients.
27
Operating expenses decreased by $0.3 million to $7.5 million in the
first nine months of 2002 compared to the first nine months of 2001, primarily
due to lower salary and other staff costs, and data information and computer
services costs.
ASSET MANAGEMENT
Certain information regarding the asset management segment's results of
operations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(In thousands)
Revenues ........................................ $1,125 $1,716 $4,259 $5,130
Operating expenses .............................. 1,079 1,128 3,686 4,028
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES ...................... $ 46 $ 588 $ 573 $1,102
============= ============= ============= =============
THIRD QUARTER OF 2002 COMPARED TO THIRD QUARTER OF 2001
Berkeley Capital Management ("BCM"), the Group's U.S. asset manager,
generates most of this segment's revenues and expenses. BCM's revenues declined
in the third quarter of 2002 compared to the third quarter of 2001 by $0.3
million to $1.1 million, and expenses remained level at $1.1 million. This
decreased BCM's contribution to segment income by $0.3 million in the third
quarter of 2002 compared to the third quarter of 2001.
The decrease in BCM's revenues was primarily due to the loss of
management fees from the Group's U.S. life insurance subsidiary (LPLA) and a
lower fee structure paid by one of BCM's largest wrap clients, which became
effective January 1, 2002. The wrap account revenues generated during the third
quarter of 2002 were primarily based upon asset values at the beginning of the
quarter due to the billing pattern of wrap program sponsors. Therefore, the
decrease in market values during the second quarter of 2002 decreased BCM's
revenues during the third quarter of 2002.
Total wrap fee account assets under management were $818 million as of
September 30, 2002, compared to $991 million as of June 30, 2002 and $934
million as of September 30, 2001. The lower wrap assets under management as of
September 30, 2002 compared to June 30, 2002 resulted from the sharp stock
market decline during the period in addition to a 1% net decrease in the number
of wrap accounts during the quarter. The $116 million decline in total wrap fee
assets under management as of September 30, 2002 compared to September 30, 2001
was due to the market decline over the period which more than offset the 5%
increase in the number of wrap accounts under management compared to one year
earlier.
BCM seeks to add an additional wrap account product during the fourth
quarter of 2002 with the objective of boosting BCM's assets under management and
profitability in future years.
The asset management segment did not generate portfolio management fees
from LPLA during the third quarter of 2002. During the third quarter of 2001,
$0.5 million in management fees were received from LPLA. The Group, including
BCM, no longer manages LPLA's investment portfolio.
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001
BCM's revenues were $4.0 million in the first nine months of 2002, a
decline of $0.3 million compared to the first nine months of 2001. Expenses
decreased in the first nine months of 2002 by $0.3 million to $3.7 million,
primarily due to lower wholesaler commissions as a result of lower wrap sales.
The lower revenues were offset by the lower expenses which maintained BCM's
contribution to segment income at $0.3 million in the first nine months of 2002,
compared to the first nine months of 2001.
28
The decline in revenues was due to lower management fees from LPLA and
to a lower fee structure paid by one of BCM's largest wrap clients which became
effective January 1, 2002. This more than offset the increased revenues from new
client accounts and new assets over the period. BCM was able to attract net new
wrap assets in its Income Equity investment product during the first nine months
of 2002. However, total wrap assets declined from $997 million as of December
31, 2001 to $818 million as of September 30, 2002 due to the market's decline
and the loss of assets in its Growth Equity style. BCM's core product, Income
Equity, continued to outperform the S&P 500 during the first nine months of
2002. Sales of this product could not offset the decline in the market value of
the accounts during the period, although the total number of wrap fee accounts
increased 2% during the first nine months of 2002.
The asset management segment generated portfolio management fees from
LPLA of $0.7 million for the first nine months of 2002, compared with $1.4
million for the first nine months of 2001 ($0.4 million and $0.6 million of
these fees were recognized by BCM for the first nine months of 2002 and 2001,
respectively). This decrease resulted from the reduced level of fees from LPLA
for the second quarter of 2002, and for the third quarter of 2002, no fees were
recognized. The Group, including BCM, no longer manages LPLA's investment
portfolio.
VENTURE CAPITAL MANAGEMENT
Certain information regarding the venture capital management segment's
results of operations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(In thousands)
REVENUES:
Management fees..................................................... $ - $ 2,462 $ 2,908 $ 7,239
Net realized investment gains (losses) (1).......................... (1,190) 444 (33,188) 37,724
Change in net unrealized investment gains and losses
on trading securities (1)......................................... (4,162) (79,248) 12,611 (115,787)
------------- ------------- ------------- -------------
Total revenues and net investment gains (losses).................... (5,352) (76,342) (17,669) (70,824)
Operating expenses.................................................. 683 2,883 3,295 7,387
------------- ------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES................................... $ (6,035) $(79,225) $(20,964) $(78,211)
============= ============= ============= =============
(1) Realized investment gains (losses) in the amount of $(31,368,000) and
$37,269,000 were recorded during the first nine months of 2002 and 2001,
respectively, by the venture capital management segment, related to
intersegmental investment sales to the life insurance and annuities segment.
These realized investment gains and losses were offset by corresponding
increases and decreases in unrealized investment gains and losses on trading
securities for the same amounts. These gains and losses have been eliminated in
the Group's consolidated financial statements.
THIRD QUARTER OF 2002 COMPARED TO THIRD QUARTER OF 2001
The pre-tax loss from the venture capital management segment decreased
from $79.2 million in the third quarter of 2001 to $6.0 million in the third
quarter of 2002. This loss was primarily attributable to the change in net
unrealized gains and losses on the listed equity securities held in the trading
portfolio. These positions in listed equity securities resulted from privately
held technology companies in which the venture capital management segment had an
equity interest completing initial public offerings or being acquired by
publicly traded companies in stock-for-stock acquisitions.
The change in net unrealized gains and losses in the listed equity
trading portfolio during the third quarter of 2002 was a loss of $4.2 million.
The trading portfolio decreased from $10.0 million as of June 30, 2002 to $5.8
29
million as of September 30, 2002. There were no additions to the trading
portfolio during the third quarter of 2002.
The Group's management expects significant fluctuations in net
unrealized gains and losses in the listed equity trading portfolio in future
periods, reflecting continued equity market volatility, especially in the
technology sector.
The venture capital management segment did not earn portfolio management
fees from LPLA for the third quarter of 2002, compared to $2.5 million of fees
for the third quarter of 2001. Due to the subsequent events described in the
"Liquidity and Capital Resources" section below, BICC no longer manages LPLA's
investment portfolio.
Operating expenses in the third quarter of 2002 were $0.7 million,
compared to $2.9 million in the third quarter of 2001. This $2.2 million
decrease was primarily attributable to lower staff costs.
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001
The pre-tax loss from the venture capital management segment decreased
from $78.2 million in the first nine months of 2001 to $21.0 million in the
first nine months of 2002. This loss was primarily attributable to the change in
net unrealized gains and losses on the listed equity securities held in the
trading portfolio, excluding the intersegmental gains and losses as noted above.
These positions in listed equity securities resulted from privately held
technology companies in which the venture capital management segment had an
equity interest completing initial public offerings or being acquired by
publicly traded companies in stock-for-stock acquisitions.
The change in net unrealized gains and losses in the listed equity
trading portfolio during the first nine months of 2002 was a gain of $12.6
million, which was more than offset by realized losses of $33.2 million, of
which $31.4 million resulted from disposals of certain listed equity securities
to the life insurance and annuities segment, based on their aggregate cost of
$53.4 million. The trading portfolio decreased from $45.3 million as of December
31, 2001 to $5.8 million as of September 30, 2002. Additions to the trading
portfolio during the first nine months of 2002 of $1.3 million resulted from the
purchase of listed equity securities.
The Group's management expects significant fluctuations in net
unrealized gains and losses in the listed equity trading portfolio in future
periods, reflecting continued equity market volatility, especially in the
technology sector.
The venture capital management segment earned portfolio management fees
from LPLA of $2.9 million for the first nine months of 2002, compared to $7.2
million for the first nine months of 2001. The $4.3 million decrease in fees
resulted from the lower value of the assets managed, the lower percentage fees
recorded for the second quarter of 2002, and for the third quarter of 2002 no
fees were recognized. Due to the subsequent events described in the "Liquidity
and Capital Resources" section below, BICC no longer manages LPLA's investment
portfolio.
Total financings completed by BICC during the first nine months of 2002
were $27.2 million, compared to $51.1 million during the first nine months of
2001. There were no financings made in new companies during the first nine
months of 2002, but follow-on investments were added in selected portfolio
companies where, in some cases, larger ownership stakes could be taken in
promising companies at attractive prices. This decreased level of activity in
venture capital placements reflected a general trend in the industry as a whole
during the first nine months of 2002, as many venture capitalists curtailed
their investments in view of the difficulties experienced by the market and the
technology sector in particular.
Operating expenses in the first nine months of 2002 were $3.3 million,
compared to $7.4 million in the first nine months of 2001. This $4.1 million
decrease was primarily attributable to lower staff costs.
30
CORPORATE AND OTHER
THIRD QUARTER OF 2002 COMPARED TO THIRD QUARTER OF 2001
Corporate expenses increased by $0.2 million to $1.5 million in the
third quarter of 2002, as compared to $1.3 million in the third quarter of 2001,
primarily due to an increase in professional fees and bank line fees which were
partially offset by lower staff costs and directors costs.
Interest income earned by the Group (excluding the life insurance and
annuities segment) decreased by $0.5 million to $0.1 million in the third
quarter of 2002 as compared with the third quarter of 2001, primarily due to the
decrease in average cash and cash equivalents held by the Group. Interest
expense incurred by the Group (excluding the life insurance and annuities
segment) decreased by $0.2 million to $0.2 million in the third quarter of 2002
as compared with the third quarter of 2001, primarily due to the partial
repayment of the bank loan and the lower interest rate environment. A discussion
of the Group's sources and uses of cash is discussed in the "Liquidity and
Capital Resources" section below.
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001
Corporate expenses increased by $0.5 million to $5.0 million in the
first nine months of 2002, as compared to $4.5 million in the first nine months
of 2001, primarily due to an increase in professional fees, corporate insurance
premiums, bank line fees, bank charges and pension costs which were partially
offset by lower staff costs and directors costs. Compensation expense of $0.5
million in the first nine months of 2001, relating to the grant of employee
share options at an exercise price below fair market value on the date of the
grant, was not repeated in 2002.
Interest income earned by the Group (excluding the life insurance and
annuities segment) decreased by $1.2 million to $0.5 million in the first nine
months of 2002 as compared with the first nine months of 2001, primarily due to
the decrease in average cash and cash equivalents held by the Group. Interest
expense incurred by the Group (excluding the life insurance and annuities
segment) decreased by $1.0 million to $0.8 million in the first nine months of
2002 as compared with the first nine months of 2001, primarily due to the
partial repayment of the bank loan and the lower interest rate environment. A
discussion of the Group's sources and uses of cash is discussed in the
"Liquidity and Capital Resources" section below.
CONSOLIDATED INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
THIRD QUARTER OF 2002 COMPARED TO THIRD QUARTER OF 2001
The consolidated loss from continuing operations before income taxes
decreased from $108.4 million in the third quarter of 2001 to a loss of $11.8
million in the third quarter of 2002, primarily due to lower net unrealized
investment losses.
Consolidated income (losses) before income taxes for the remainder of
2002 and future years may be volatile due to the Group's holdings of listed
equity securities primarily in the technology sector, which are marked to market
with changes in their market value recognized in the income statement for each
period. Other-than-temporary impairments of the Group's private equity
securities, primarily in the technology sector, could also affect consolidated
income before income taxes in future periods. For more information on the
possible effects of volatility in the prices of equity securities, see Item 3
"Quantitative and Qualitative Disclosures About Market Risk" below.
SEE DISCUSSION OF EVENTS RELATING TO LPLA AND LPAL IN THE "LIQUIDITY AND
CAPITAL RESOURCES" SECTION BELOW.
31
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001
The consolidated loss from continuing operations before income taxes
decreased from $230.1 million in the first nine months of 2001 to $43.7 million
in the first nine months of 2002, primarily due to lower net unrealized
investment losses.
Consolidated income (losses) before income taxes for the remainder of
2002 and future years may be volatile due to the Group's holdings of listed
equity securities primarily in the technology sector, which are marked to market
with changes in their market value recognized in the income statement for each
period. Other-than-temporary impairments of the Group's private equity
securities, primarily in the technology sector, could also affect consolidated
income before income taxes in future periods. For more information on the
possible effects of volatility in the prices of equity securities, see Item 3
"Quantitative and Qualitative Disclosures About Market Risk" below.
SEE DISCUSSION OF EVENTS RELATING TO LPLA AND LPAL IN THE "LIQUIDITY AND
CAPITAL RESOURCES" SECTION BELOW.
INCOME TAXES
The Group is subject to taxation on its income in all countries in which
it operates based upon the taxable income arising in each country. However,
realized gains on certain investments are exempt from Jersey and Guernsey
taxation. The Group is subject to income tax in Jersey at a rate of 20%. In the
United States, the Group is subject to both federal and California taxes at
34-35% and 8.84%, respectively.
THIRD QUARTER OF 2002 COMPARED TO THIRD QUARTER OF 2001 - CONTINUING OPERATIONS
The effective tax credit rate, as a percentage of the loss from
continuing operations before income taxes of $11.8 million, for the third
quarter of 2002 was 2%. This very low effective tax credit rate was primarily
attributable to losses of $10.0 million contributed by the Jersey and Guernsey
operations during the quarter, which consisted primarily of realized and
unrealized investment losses for which no tax benefits will be realized. In
addition, the deferred tax asset valuation allowance was increased during the
quarter by $2.1 million, primarily in LPA. The increased allowance was
considered necessary by LPA due to its high level of operating loss carryovers
as of September 30, 2002, raising doubt about the company's ability to utilize
these loss carryovers. During the third quarter of 2002, over-accruals of Jersey
taxes for 2001 and the first half of 2002 of $0.7 million and $1.0 million,
respectively, were reversed.
The effective tax credit rate, as a percentage of the loss from
continuing operations before income taxes of $108.4 million, for the third
quarter of 2001 was 1%. This very low effective tax credit rate was primarily
attributable to losses of $108.5 million contributed by the Jersey and Guernsey
operations during the quarter, which primarily consisted of unrealized
investment losses for which no tax benefits will be realized.
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001 - CONTINUING
OPERATIONS
Although the loss from continuing operations before income taxes was
$43.7 million for the first nine months of 2002, an income tax expense of $2.5
million resulted for the quarter. This was largely attributable to losses of
$40.3 million contributed by the Jersey and Guernsey operations during the
period, which primarily consisted of realized and unrealized investment losses
for which no tax benefits will be realized. In addition, deferred tax asset
valuation allowances of $4.0 million were established in the U.S. subsidiaries
during the period. These allowances were considered necessary due to the high
level of operating loss carryovers in the two U.S. tax groups, raising doubt
about their ability to utilize these carryovers.
The effective tax credit rate, as a percentage of the loss from
continuing operations before income taxes of $230.1 million, for the first nine
months of 2001 was 0.2%. This very low effective tax credit rate was primarily
attributable to losses of $231.1 million contributed by the Jersey and Guernsey
operations during the period, which primarily consisted of unrealized investment
losses for which no tax benefits will be realized.
32
DISCONTINUED OPERATIONS
THIRD QUARTER OF 2002 COMPARED TO THIRD QUARTER OF 2001
LPLA, the Group's U.S. insurance company, was placed under regulatory
control and rehabilitation on August 6, 2002, resulting in the Group losing
control of LPLA. Following this event, during the third quarter of 2002, the
Group deconsolidated LPLA, wrote-off $15.6 million of doubtful receivables from
LPLA and $12.3 million of net assets of LPLA, and recognized $10.6 million in
its income statement for LPLA's net unrealized losses on available-for-sale
securities, net of deferred policy acquisition cost amortization adjustments and
deferred income taxes. In the third quarter of 2001, LPLA had an after-tax loss
from operations of $37.1 million.
FIRST NINE MONTHS OF 2002 COMPARED TO FIRST NINE MONTHS OF 2001
In the first nine months of 2002, the Group recorded an after-tax loss
from operations of LPLA of $104.8 million, compared to an after-tax loss from
operations of LPLA of $65.5 million in the first nine months of 2001. As
discussed above, the Group recorded impairment losses totaling $27.9 million
related to LPLA in the third quarter of 2002, and recognized $10.6 million in
its income statement for LPLA's net unrealized losses on available-for-sale
securities, net of deferred policy acquisition cost amortization adjustments and
deferred income taxes. For further information see Note 3. "Discontinued
Operations" to the consolidated financial statements in Part I, Item 1.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents of the Group decreased during the first nine
months of 2002 by $43.2 million to $18.1 million. This decrease resulted from
$130.3 million of cash used in financing activities during the period, offset by
$3.9 million and $83.1 million provided by operating and investing activities
during the period, respectively. The majority of cash from investing activities,
and used in financing activities, related to investment and insurance
policyholder transactions within the life insurance and annuities segment. In
addition, the Group used $27.0 million of cash to pay down bank borrowings
during the period. As of September 30, 2002, cash and cash equivalents of the
Group, excluding the life insurance and annuities segment, amounted to $15.0
million, a decrease of $43.3 million from December 31, 2001. The Group,
excluding the life insurance and annuities segment, also held $5.8 million of
marketable equity securities as of September 30, 2002, compared to $45.3 million
as of December 31, 2001.
As of September 30, 2002, the Group held $0.2 million in private
corporate debt securities and $12.0 million in private corporate equity
securities, compared to $0.8 million and $15.3 million, respectively, as of
December 31, 2001. Except for the $0.2 million of debt securities, these private
securities were held as of September 30, 2002, in the investment portfolio of
the Group's insurance subsidiary, LPAL. No public price information is available
for these securities. Debt securities that are classified as held-to-maturity
are valued at amortized cost, unless these securities become
other-than-temporarily impaired, and all other debt and equity securities are
classified as available-for-sale and valued at estimated fair value based on
appropriate valuation methodologies. For a discussion of the Group's accounting
policies with respect to the determination of fair values of investments and
other-than-temporary impairments, see the section entitled "Critical Accounting
Policies" above in this Item 2. Debt securities represent loans to companies
that are diversified by industry, geography and financial structure. The private
equity securities are primarily convertible preferred stock holdings in
technology companies. Financial information on the issuers of these debt and
equity securities is received and reviewed periodically by the Group's
management. In addition, the Group's management maintains contact with the
management of these issuers through ongoing dialogue to examine the issuers'
future plans and prospects.
The Group's investment portfolio includes three private equity
investments in technology companies with an aggregate fair value of $10.7
million as of September 30, 2002. The $4.5 million decrease in the private
equity technology portfolio from December 31, 2001 resulted from a decline in
value of $4.5 million on one security which the Group's management believes will
be temporary.
33
Shareholders' equity decreased during the first nine months of 2002 by
$188.7 million from $221.7 million to $33.0 million, primarily due to a net loss
for the period of $189.6 million, dividends paid to shareholders of $2.0
million, and a decrease in net unrealized losses on available-for-sale
securities of $3.3 million. As of September 30, 2002, $63.6 million of the
Company's Ordinary Shares, at cost, held by the employee benefit trusts were
netted against shareholders' equity.
As of September 30, 2002, the Group had $23.0 million outstanding under
its bank facility with Bank of Scotland, including $10.7 million in the form of
letters of credit and guarantees in connection with certain former investee
companies. The $12.3 million of direct bank borrowings were used for general
corporate purposes.
During the first nine months of 2002, the outstanding letters of credit
and guarantees relating to the former investee companies were reduced by $2.0
million, and the amounts actually drawn on the bank facility were decreased by a
net $24.6 million. The aggregate facility cap was also reduced, by agreement
with Bank of Scotland in May 2002, from $50.0 million to $45.0 million, and in
August 2002, from $45.0 million to $23.0 million.
The Group's consolidated results for the quarter ended March 31, 2002
resulted in a breach of the net worth and operating profit/interest charge
financial covenants under its bank facility. In response, Bank of Scotland
retained outside advisors to evaluate the bank's collateral position and the
Group's future prospects. Following completion of the first phase of that
evaluation, the bank agreed to waive the covenant breaches on the condition that
the Group make a cash payment of $22.0 million in permanent reduction of the
bank facility, that the Group provide the bank with a security interest over
certain of its marketable equity securities (which securities had an aggregate
market value of $5.8 million as of September 30, 2002 and $10.6 million as of
November 13, 2002), and that no shareholder dividends are declared without the
prior consent of the bank. These conditions were met. As of August 12, 2002, the
Group had $23.0 million outstanding under the bank facility, including $10.7
million in the form of letters of credit and guarantees provided on behalf of
certain former investee companies.
The Group's consolidated results for the quarters ended June 30, 2002
and September 30, 2002 have resulted in breaches of the net worth, operating
profit/interest charge and intangible asset ratio financial covenants under its
bank facility. Subsequent to September 30, 2002, the Company and the Bank of
Scotland have agreed to the terms and conditions of a new credit facility which
replaces the current credit facility, subject to the bank's final due diligence,
documentation and the satisfaction of certain conditions. The new facility
provides up to $23.0 million, with an interest rate of 3.5% above the LIBOR rate
on borrowings up to $10.0 million and 4.5% above the LIBOR rate on borrowings
between $10.0 million and $23.0 million. The facility limit decreases at the end
of each quarter, such that the facility is repaid in full no later than December
31, 2003; however, the bank has agreed to consider an extension of the final
facility expiration date in light of the overall circumstances prevailing at the
time of any such request by the Company. In addition to providing the bank with
security interest over certain of the Group's listed equity securities as
mentioned above, the Company will be required to give the bank other guarantees,
pledges and security interests over certain other Group assets. The Company has
agreed to pay the bank a one-time restructuring fee of (pound)180,000, monthly
management fees of (pound)10,000 and quarterly facility fees which begin at 0.5%
per annum and increase each quarter until they reach 2.5% per annum in the third
quarter of 2003 based on the average loan amount outstanding during the quarter.
The Company has also agreed to grant to the bank warrants to subscribe for 3% of
the Ordinary Shares of the Company. New financial covenants will be set under
this reducing credit facility with testing to take place as of the end of each
quarter. There is no assurance that a definitive agreement will be signed.
Consequently, the existing facility remains in default and is repayable upon
demand.
If the bank demanded immediate full repayment of the existing facility,
the Group's management believes that it is unlikely that the former investee
companies would currently have the ability to repay their borrowings totaling
$10.7 million, and thus the Group would be obligated to pay this amount on their
behalf. As of September 30, 2002, the Group excluding LPAL had $20.9 million of
cash and liquid securities. (The market value of the Group's listed securities
discussed above increased from $5.8 million as of September 30, 2002 to $10.6
million as of November 13, 2002.) Immediate repayment of the full $23.0 million
by the Group would create serious liquidity issues for the Group. As a result,
34
the Group has restructured its operations and reduced expenses in order to
retire its outstanding bank debt over time. The Group intends to use a
combination of cash and the proceeds from listed equity security sales or other
asset disposals in order to meet the pay down schedule under the new bank
facility described above. The Group's management believes that the balances of
cash, marketable securities, proceeds from certain asset disposals or available
borrowings under the new bank facility will be sufficient to satisfy the Group's
obligations during the next twelve months.
As disclosed in the Company's quarterly report on Form 10-Q for the
quarter ended March 31, 2002, which was filed with the SEC on May 17, 2002, the
statutory capital and surplus of the Group's primary insurance company, LPLA,
decreased to a level which resulted in LPLA's risk based capital ("RBC") ratio
falling to the "company action level." The Group pursued various corrective
measures designed to raise LPLA's RBC position above the "company action level,"
including a sale of LPLA, reinsurance of all or a portion of LPLA's existing
block of business, and an exchange by LPLA of its private equity and debt
portfolio for an equity-linked note. On July 2, 2002, the Group announced that
further declines in the value of LPLA's investment portfolio due to persistent
negative events in the bond and equity markets continued to erode significantly
the statutory capital of LPLA and that, to date, the Group had been unsuccessful
in concluding a transaction to enhance the capital of LPLA. As a consequence,
LPLA discontinued the issuance of new policies. Though the statutory capital of
the Group's Jersey, Channel Islands insurance subsidiary, LPAL, had not been
affected to the same extent as the statutory capital of LPLA, LPAL also
discontinued writing new policies effective as of July 2, 2002. The decision to
discontinue writing new policies through LPAL was made to avoid the increased
capital requirement created by additional policyholder liabilities.
As a result of LPLA informing the North Carolina Department of Insurance
("NCDOI") that further deterioration in LPLA's capital and surplus caused by
declines in the fair values of its investments would reduce LPLA's RBC ratio to
the "authorized control level," the NCDOI placed LPLA under administrative
supervision on July 3, 2002.
As the Group's further efforts to conclude a transaction to sell LPLA or
to enhance its capital were unsuccessful, and as the RBC ratio of LPLA as of
June 30, 2002, as subsequently determined, fell below the "authorized control
level," on August 6, 2002, on petition of the Commissioner with the consent of
LPLA and unanimous approval of its board of directors, the Superior Court of
Wake County in the State of North Carolina ordered the Commissioner to take
possession and control of all of the property, books and accounts, documents and
other records of LPLA. LPLA and its officers, directors, agents, employees and
all other persons were enjoined from disposing of LPLA's property and from
transacting LPLA's business except with the consent of the Commissioner. The
Court appointed the Commissioner as Rehabilitator of LPLA. Based on this court
order, the Company no longer exercises control over LPLA.
Due to the loss of control of LPLA, a loss for the impairment of the
Group's investment in LPLA in the amount of $27.9 million has been recorded in
the Group's consolidated financial statements during the third quarter of 2002.
This amount consists of the $12.3 million in LPLA's net equity as of June 30,
2002 as determined under U.S. GAAP and $15.6 million of the Group's receivables
from LPLA which may be uncollectible. In addition, LPLA's net unrealized losses
of $10.6 million as of June 30, 2002 on available-for-sale securities, net of
deferred policy acquisition cost amortization adjustments and deferred income
taxes, were recognized in the Group's consolidated income statement in the third
quarter of 2002.
During 2001, LPLA paid investment management fees to the Group's asset
management and venture capital management segments totaling $11.9 million. The
investment management agreement between LPLA and the Group and related fees had
been approved by the NCDOI. Due to the loss of control of LPLA, the Group no
longer manages LPLA's portfolio of public corporate bonds and private equity and
debt investments and no longer receives investment management fees for these
services.
In the course of the administration of LPLA in rehabilitation, the NCDOI
has recently requested information concerning the history of a limited number of
investments in securities of portfolio companies. These portfolio investments
have been associated with LPLA for more than seven years, and involve
intercompany transfers. The history of their investment performance and
ownership is complex. The Company is complying with these requests. The Company
is not able at this time to predict what conclusions the NCDOI will reach after
evaluation of this information.
35
As discussed above, on July 2, 2002, the Group announced that LPAL
discontinued issuing new policies. Subsequent to this announcement and other
announcements relating to the Group and LPLA, LPAL policy surrenders
substantially increased. Approximately 71% of LPAL's policyholder liabilities as
of June 30, 2002 have been redeemed as of September 30, 2002.
Private equity investments in three technology companies held by LPAL as
of September 30, 2002 totaled $10.7 million. The determination of fair values
for private equity securities and the evaluations for other than-temporary
impairments require the application of significant judgment. It is possible that
the impairment factors evaluated by management and fair values could change in
subsequent periods. Declines in the value of LPAL's private equity portfolio
could have a significant impact on LPAL's statutory capital level. Prior to
September 30, 2002, LPAL identified three private securities, having an
aggregate unrealized loss of $6.4 million, that could become
other-than-temporary impairments in future reporting periods. Declines in the
market value of LPAL's listed equity securities, which totaled $7.4 million as
of September 30, 2002, could also have a significant impact on LPAL's statutory
capital level. In the future, if LPAL's statutory capital falls below the
minimum solvency level required by the Jersey insurance regulators, the Group
may be required to inject additional capital into LPAL. A capital injection
would be limited to the extent any shortfall arises from a decline in the value
of LPAL's private equity securities that are required to support minimum
solvency. As of September 30, 2002, approximately $3.6 million of the private
equity holdings were required to support the minimum solvency requirement. The
required level of private equity holdings has fallen significantly since
September 30, 2002 due to the decline in the level of assets and liabilities on
LPAL's balance sheet. As of November 11, 2002, none of the private equity
holdings were required to support the minimum solvency requirement.
Given the liquidity issues facing the Group as discussed above and in
view of the agreement with Bank of Scotland regarding their approval of
dividends, the Company's Board of Directors suspended the 2002 interim dividend
to shareholders and ADR holders.
As of September 30, 2002, the Group had no material commitments
outstanding for capital expenditures or additional funding for private equity
portfolio companies.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The nature of the Group's businesses exposes the Group to market risk.
Market risk is the risk of loss that may occur when changes in interest rates
and public equity prices adversely affect the value of invested assets.
INTEREST RATE RISK
LPAL is subject to risk from interest rate fluctuations when payments
due to policyholders are not matched in respect of amount and duration with
income from investments. LPAL attempts to minimize this risk by ensuring that
payments and income are matched as closely as possible while also maximizing
investment returns. LPAL has not used derivative financial instruments as part
of its investment strategy. Exposure to interest rate risk is estimated by
performing sensitivity tests to changes in interest rates.
For LPAL's business, the amount of policyholder liabilities is
unaffected by changes in interest rates. To determine the sensitivity of asset
values to changes in interest rates, calculations were carried out to estimate
the effect of a change in market interest rates of 100 basis points. These
calculations showed that an increase in market interest rates of 100 basis
points would decrease the value of assets at risk by $0.5 million, and a
decrease in market interest rates of 100 basis points would increase the value
of assets by a similar amount.
EQUITY PRICE RISK
The Group is exposed to equity price risk on the listed equity
securities held entirely in its trading portfolio. Changes in the level or
volatility of equity prices affect the value of the listed equity securities.
36
These changes in turn directly affect the Group's net income because the Group's
holdings of listed equity securities are marked to market, with changes in their
market value recognized in the income statement for the period in which the
changes occur. These listed equity securities are primarily in companies in the
high technology industry sector, many of which are small capitalization stocks.
If the fair value of the Group's listed equity portfolio, as of
September 30, 2002 and December 31, 2001, which totaled $13.2 million and $67.6
million, respectively, had abruptly increased or decreased by 50%, the fair
value of the listed equity portfolio would have increased or decreased by $6.6
million and $33.8 million, respectively.
The Group's listed equity securities largely represent investments that
were originally made as private equity investments in companies that
subsequently completed an initial public offering or were acquired by a larger
publicly traded company. The performance of these listed equity securities can
be highly volatile, but the Group attempts to manage its risk in various ways.
The performance of the listed equity securities are monitored daily. In
addition, the Group seeks to sell investments after a period of time,
particularly in the case of large public company securities.
As of September 30, 2002, the Group held $12.0 million in private
corporate equity securities primarily in technology companies for which liquid
markets do not exist. Private equity prices do not fluctuate directly with
public equity markets, but significant market movements may trigger a review for
other-than-temporary adjustment of the carrying values of the Group's private
equity securities. For example, see the discussion under "Liquidity and Capital
Resources" for a description of such reductions in the carrying value of certain
of the Group's private equity securities during the first nine months of 2002,
and of such reductions that may need to be considered for future reporting
periods. The risks inherent in these private equity investments relate primarily
to the viability of the investee companies. These risks are managed in various
ways. Extensive due diligence procedures are performed prior to making an
investment, and regular reviews of the progress of the investee companies are
carried out.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the periods specified in the rules and forms of
the Securities and Exchange Commission. Such information is accumulated and
communicated to the Company's management, including its principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. The Company's management, including the
principal executive officer and the principal financial officer, recognizes that
any set of controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control
objectives.
Within 90 days prior to the filing date of this quarterly report on Form
10-Q, the Company has carried out an evaluation, under the supervision and with
the participation of the Company's management, including the Company's principal
executive officer and the Company's principal financial officer, of the
effectiveness of the design and operation of the Company's disclosure and
procedures. Based on such evaluation, the Company's principal executive officer
and principal financial officer concluded that the Company's disclosure controls
and procedures are effective.
There have been no significant changes in the Company's internal
controls or in other factors that could significantly affect the internal
controls subsequent to the date of their evaluation in connection with the
preparation of this quarterly report on Form 10-Q.
37
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On August 6, 2002, on petition of the Commissioner with the consent of
LPLA and unanimous approval of its board of directors, the Superior Court of
Wake County in the State of North Carolina ordered the Commissioner to take
possession and control of all of the property, books and accounts, documents and
other records of LPLA. LPLA and its officers, directors, agents, employees and
all other persons were enjoined from disposing of LPLA's property and from
transacting LPLA's business except with the consent of the Commissioner. The
Court appointed the Commissioner as rehabilitator of LPLA. Based on the court
order, the Company no longer exercises control over LPLA.
For further discussion, see the "Liquidity and Capital Resources"
section in Item 2 of Part I.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
As a condition for the receipt of the waiver of the covenant breaches
relating to the Group's bank facility, received from Bank of Scotland for both
the periods ended December 31, 2001 and March 31, 2002, the Company agreed that
no dividends shall be declared without the prior consent of the Bank of
Scotland.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Under the Group's $23.0 million bank facility with the Bank of Scotland,
$12.3 million was outstanding as of September 30, 2002. In addition, the
remaining $10.7 million under the facility was utilized in the form of letters
of credit and guarantees provided on behalf of certain former investee
companies. The Group has committed to provide the bank with a security interest
over certain of the Group's listed equity securities (which securities had an
aggregate market value of $5.8 million as of September 30, 2002, and $10.6
million as of November 13, 2002).
The Group's consolidated results for the quarters ended June 30, 2002
and September 30, 2002 have resulted in breaches of the net worth, operating
profit/interest charge and intangible asset ratio financial covenants under its
bank facility. Subsequent to September 30, 2002, the Company and the Bank of
Scotland have agreed to the terms and conditions of a new credit facility which
replaces the current credit facility, subject to the bank's final due diligence,
documentation and the satisfaction of certain conditions. The new facility
provides up to $23.0 million, with an interest rate of 3.5% above the LIBOR rate
on borrowings up to $10.0 million and 4.5% above the LIBOR rate on borrowings
between $10.0 million and $23.0 million. The facility limit decreases at the end
of each quarter, such that the facility is repaid in full no later than December
31, 2003; however, the bank has agreed to consider an extension of the final
facility expiration date in light of the overall circumstances prevailing at the
time of any such request by the Company. In addition to providing the bank with
security interest over certain of the Group's listed equity securities as
mentioned above, the Company will be required to give the bank other guarantees,
pledges and security interests over certain other Group assets. The Company has
agreed to pay the bank a one-time restructuring fee of (pound)180,000, monthly
management fees of (pound)10,000 and quarterly facility fees which begin at 0.5%
per annum and increase each quarter until they reach 2.5% per annum in the third
quarter of 2003 based on the average loan amount outstanding during the quarter.
The Company has also agreed to grant to the bank warrants to subscribe for 3% of
the Ordinary Shares of the Company. New financial covenants will be set under
this reducing credit facility with testing to take place as of the end of each
quarter. There is no assurance that a definitive agreement will be signed.
Consequently, the existing facility remains in default and is repayable upon
demand.
If the bank demanded immediate full repayment of the existing facility,
the Group's management believes that it is unlikely that the former investee
companies would currently have the ability to repay their borrowings totaling
$10.7 million, and thus the Group would be obligated to pay this amount on their
behalf. As of September 30, 2002, the Group excluding LPAL had $20.9 million of
38
cash and liquid securities. (The market value of the Group's listed securities
discussed above increased from $5.8 million as of September 30, 2002 to $10.6
million as of November 13, 2002.) Immediate repayment of the full $23.0 million
by the Group would create serious liquidity issues for the Group. As a result,
the Group has restructured its operations and reduced expenses in order to
retire its outstanding bank debt over time. The Group intends to use a
combination of cash and the proceeds from listed equity security sales or other
asset disposals in order to meet the pay down schedule under the new bank
facility described above.
ITEM 5. OTHER INFORMATION
On July 3, 2002, the New York Stock Exchange ("NYSE") halted trading of the
Company's American Depositary Receipts ("ADRs") in response to the
administrative actions taken by the North Carolina Department of Insurance
relating to LPLA. On July 9, 2002, trading of the ADRs was suspended and the
securities were delisted from the NYSE. As a result of the delisting, the
liquidity of the Company's common stock and its price have been adversely
affected. This may limit the Company's ability to raise additional capital in
the future, and there is no assurance that a significant trading market for the
ADRs will develop. If an active trading market does not develop, ADR holders may
be unable to sell their ADRs.
Subsequent to the delisting, the ability of ADR holders to buy and sell is
limited to trading on the Over-the-Counter ("OTC") Bulletin Board under the
ticker symbol LDPGY.PK. Shares traded on the OTC market generally experience
lower trading volume than those traded on the organized exchanges. The trading
volume of the ADRs has decreased substantially since the NYSE delisting and the
transfer of the ADRs to the OTC Bulletin Board.
Effective November 14, 2002, Harold E. Hughes, Jr., an existing member of the
Company's Audit Committee (the "Committee"), was appointed chairman of the
Committee, The Viscount Trenchard was appointed to the Committee, and Gary L.
Wilcox retired as a member and the chairman of the Committee.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
The following exhibits are filed herewith:
EXHIBIT
NUMBER TITLE
- ------- ------
99.1 Certification by the Company's Executive Chairman pursuant to
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
99.2 Certification by the Company's Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(B) REPORTS ON FORM 8-K
The Company filed three Current Reports on Form 8-K during the third
quarter of 2002 as follows:
The report filed on July 3, 2002 contained information announcing that
LPLA had received notice on July 3, 2002 that it had been placed under
administrative supervision by the North Carolina Department of Insurance.
39
The report filed on July 31, 2002 contained information announcing the
appointment of BDO International and BDO Seidman, LLP as auditors for the
Registrant and its subsidiaries with effect from July 31, 2002.
The report filed on August 6, 2002 contained information announcing that
LPLA had been placed in rehabilitation by the Superior Court of Wake County,
North Carolina on August 6, 2002, with the consent of LPLA and unanimous
approval of its board of directors.
40
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LONDON PACIFIC GROUP LIMITED
(Registrant)
Date: November 14, 2002 By: /s/ Ian K. Whitehead
----------------------------------------------
IAN K. WHITEHEAD
CHIEF FINANCIAL OFFICER
(Principal Financial and Accounting Officer
and Duly Authorized Officer of the Registrant)
41
CERTIFICATION
I, Arthur I. Trueger, certify that:
(1) I have reviewed this quarterly report on Form 10-Q of London Pacific
Group Limited;
(2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in
this quarterly report;
(4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which the
periodic report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report ("Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
(5) The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of the registrant's board of directors (or
persons performing the equivalent function):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
(6) The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002 By: /s/ Arthur I. Trueger
---------------------------------
ARTHUR I. TRUEGER
EXECUTIVE CHAIRMAN
(PRINCIPAL EXECUTIVE OFFICER)
42
CERTIFICATION
I, Ian K. Whitehead, certify that:
(1) I have reviewed this quarterly report on Form 10-Q of London Pacific
Group Limited;
(2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
(4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which the
periodic report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report ("Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
(5) The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent function):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
(6) The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002 By: /s/ Ian K. Whitehead
-----------------------------
IAN K. WHITEHEAD
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
43