Emergent Capital's (EMG) CEO Tony Mitchell on Q2 2016 Results - Earnings Call Transcript

| About: Emergent Capital, (EMG)

Emergent Capital, Inc. (NYSE:EMG)

Q2 2016 Earnings Conference Call

August 3, 2016, 5:00 pm ET

Executives

David Sasso - SVP, Corporate Development & IR

Tony Mitchell - CEO

Miriam Martinez - Acting CFO

Analysts

Bob Ramsey - FBR

Quinton Mathews - QKM

Operator

Good afternoon, and welcome to the Emergent Capital Second Quarter 2016 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.

I would now like to turn the conference over to David Sasso, Senior Vice President, Corporate Development and Investor Relations. Please go ahead sir.

David Sasso

Denise, thank you. Good afternoon everyone and thank you for joining the Emergent Capital 2016 second quarter earnings conference call. With me today is Tony Mitchell, our CEO and Miriam Martinez, our Acting Chief Financial Officer.

Our financial results press release was issued after the market closed today and is posted in the Investor Relations section of our website at EmergentCapital.com.

Before we begin, I would like to remind everyone that some of the comments made on today's call may contain forward-looking statements. These forward-looking statements are subject to the risks and uncertainties described in the company's earnings release and other filings with the SEC, including the company's most recent 10-K filing. We encourage you to read the company's latest filings in their entirety.

With that, I would like to turn the call over to Tony. Tony?

Tony Mitchell

Thanks, David, and good afternoon, everyone. In Q2, we continued with the theme of de-risking the company whilst reducing cash expenses as much as possible, whilst also retaining a core origination capability.

With the AGM and related company presentation just a few weeks ago, I apologize, if some of my initial Q2 comments are repetitive.

Looking through the quarter, in April, we learned the IRS ended its investigation into our legacy structure settlement business. We were very proactive on this front and are pleased it has concluded.

In May, we completed a reduction in force and reduced our personnel expenses by some 20%.

Legal fees are significantly lower and now largely consist of our suit against Sun Life. You will recall that this matter is set for trial in October and we very much look forward to our day in court.

At the AGM, we gave a comprehensive annual update on all the metrics surrounding our life settlements portfolio. We thank our shareholders who attended in person or through the web and received a lot of positive comments on the information provided.

During Q2, we adopted the 2015 Valuation Basic Table or 2015 VBT for short. This is reflected in our Q2 financials. I would like to note that all the metrics we gave at the AGM assumes the adoption of the 2015 VBT and they remain current. Miriam will expand on that development shortly.

Most recently, we financed all remaining balance sheet policies except for the Sun Life policies which are related to our case to recover damages. And with this the company drew an additional $3 million from the Red Falcon credit facility and all future premiums will now be covered from this facility.

Our efforts to de-risk the company have not gone unnoticed. In Q2, we started receiving unsolicited inbound inquiries about the company and its assets. This led to the announcement on Monday that our Board has engaged FBR Capital Markets to evaluate any inquiries and spearhead a formal strategic process. This highlights our continued commitment to delivering value to our shareholders.

I would like to close by saying, I'm extremely confident in our Board's ability to evaluate the recent interest in the company. They have been steadfast in resolute during the past few years for which we're very thankful. And we as a management team will continue to work diligently to preserve the value of the organization and look forward to updating when appropriate.

And with that, I would like to turn the call over to Miriam, who will review our financial results for Q2. Miriam?

Miriam Martinez

Thank you, Tony, and good afternoon, everyone. For the quarter ended June 30, our total income from continuing operations was a loss of $15.8 million compared to total income of $28.0 million during the same period in 2015, a decrease of $43.8 million. Our income for the quarter was impacted due to zero maturities. The company had two maturities with gains totaling $2.5 million compared to seven maturities with gains totaling $26.1 million for the same period in 2015. The average pace on these policies were approximately 2.1 million compared to 5.2 million for 2016 and 2015 respectively.

Income for the quarter was also affected by the updating of life expectancy. The net impact on the change in fair value was approximately $8.2 million. The weighted average discount rate decreased from 17.02 at December 31 to 16.49 at June 30. This resulted in a gain of $7.1 million from the change in the discount rate assumption.

Our income for the quarter was also impacted by the adoption of the 2015 VBT which results in an reduction in the fair value of life settlement of approximately $17.6 million or 3.6% reduction from the fair value at December 31.

During the 2015, the U.S. Society of Actuaries released new versions of the 2015 VBT. This is becoming the industry standard mortality table used for determining the fair value of life settlements. The adoption of the table results in an overall delay in the timing of our expected cash flows based on the probabilistic methodology. While most policies had a decrease in value due to the adoption, some gained value.

While this affected the change in the fair value of the life settlements on the asset side, we benefit from a gain on the liability side. The change in the expected cash flow stream resulted in an increasing borrowings resulting in a gain of approximately $15.7 million for the change in fair value of the revolving credit facility. Thus, the net impact of the 2000 VBT adoption was a loss of $1.9 million.

Total expenses from continuing operations resulted in income of $6.0 million for the quarter or a decrease of $33.4 million compared to total expenses from continuing operations of $27.4 million incurred during the same period in 2015. The decrease was primarily due to the positive change in the fair value of the revolving credit facility of $19.7 million, again due to the adoption of the 2015 VBT table.

Other items impacting the gain was the lengthening of life expectancies of certain insured's offset by slight reduction in the discount rates for both facilities.

Total SG&A expenses were $6.3 million for the quarter compared to $7.2 million a year ago or 13% decline. Our SG&A includes a one-time severance cost of approximately $922,000. As mentioned above, as part of the reduction in force, the company reduced its headcount from 31 employees to 25 employees inclusive of two executives. The improvement in SG&A is largely driven by legal expense which shows a reduction of approximately $1.5 million when compared to a year ago. As the company continues its ongoing efforts to reduce SG&A cost and conserve cash, our SG&A expenses for the six months period were $12 million compared to $15.9 million for the same period in 2015, a decrease of $3.9 million or 24%.

Our net loss from continuing operations for the second quarter of $9.8 million or $0.36 per diluted share as compared to net income of $1.0 million or $0.04 per diluted share for the same period last year.

Now turning to the balance sheet, as of June 30 we owned 625 policies with an estimated fair value of $473.0 million compared to 632 policies with an estimated fair value of $461.9 million at December 31. As of June 30, the aggregate debt benefit of our life settlement was approximately $3.0 billion.

During the three months ended June 30, two of our policies became subject to a cost of insurance entry resulting in a total of 24 policies impacted since the third quarter of 2015. The cost of insurance additional policies caused the fair value of our life settlement to decrease by approximately $1.3 million.

Turning to the revolving credit facilities, the fair value of the debt for the White Eagle facility was $172 million with the outstanding principal balance of approximately $189.7 million. The discount rate applied to the debt during the second quarter was 19.9% compared to 20.55% at December 31. The Red Falcon facility, the fair value of the debt was $55.1 million with the outstanding principal balance of approximately $56 million. The discount rate applied to the debt was 11.06% at June 30 compared to 11.65% at December 31, 2015.

Frequently, we contributed an additional six policies to the Red Falcon portfolio. In doing so, we eliminated $1.1 million in annual premium load and were able to take an advance or a draw of $3 million from the facility.

Finally we ended the quarter with cash and cash equivalents inclusive of certificates of deposits of $31.6 million. Our book value per share as of June 30, 2016, was $7.31.

This concludes my remarks and the financial results for the second quarter and I would like to turn the call over to the operator for questions.

Question-and-Answer Session

Operator

Thank you. At this time, we will begin the question-and-answer session. [Operator Instructions].

And your first question will come from Bob Ramsey of FBR. Please go ahead.

Bob Ramsey

Hey good afternoon. First question was the transfer of the remaining policies in Red Falcon and [indiscernible] was recent, was that done in the second quarter or after the end of the second quarter?

Miriam Martinez

Yes it was done after the second quarter.

Bob Ramsey

Got it. With change in the fair value of those credit facilities end of second quarter, I guess one of you could kind of walk me through what reduced the value of the debt, I mean our cents tied to the VBT adjustment on the policy side but just hoping if you could explain the delta there, the change?

Tony Mitchell

Yes good afternoon, Bob. Bob from a macro standpoint, what those 2015 VBT does is it; it just pushes out the probabilistic cash flows which means the debt will be outstanding a little bit longer. Deals participation in the net debt benefits will be pushed out longer therefore were a little bit less and therefore it makes the -- with fair value of the debt, so willing buy, willing seller, and therefore using that metric, it makes it a less desirable piece of debt which drops the value.

Bob Ramsey

Okay. I guess maybe I'll ask a little bit differently if the drop in the fair value of the debt is about 90% of the drop in the fair value of the policies, it just seems like a big adjustment in that, I don't think it would be 90% of the economics on the policies. So I'm just curious if you could help me understand what the magnitude is a bigger proportion of the drop in the value of the assets?

Miriam Martinez

So getting back to what Tony said, I mean the drop in the asset was 17.6 and the drop in the value of the debt is 15.7 because basically again you are going to have to borrow more which is -- it's certainly impactful and plus the adoption of the VBT once again is you are moving that curve so the cash flows that we expected earlier are now being pushed out and that does have a material impact on both facilities.

Much more so on the White Eagle facility because it's a longer facility than that of Red Falcon. So just for an example on the White Eagle facility, the impact on the fair value of the debt was $14.7 million and yet the impact on the Red Falcon facility was only $1.0 million. So that kind of shows you the magnitude because White Eagle is a much bigger facility and a much longer facility, the impact of the adoption of the VBT was greater than that of Red Falcon.

Bob Ramsey

Okay. All right. May be we can follow-up offline because I'm in more trouble but I won't leave at a point. Shifting gears I appreciate the understanding and predictability of the timing of realized gains is really hard to predict. But I think you guys have talked in the Annual Shareholder slides about $145 million of maturity is likely over the next three years. Can you give any sort of estimate or expectation over the next 12 months just sort of trying and get a sense of what the -- how frontend or backend loaded that might be?

Tony Mitchell

So the -- while the passage of time is everything is trending, you get more maturities with the passage of time. So everything is a little backend loaded. You expect more in 2017 and more again in 2018, but just the inherent volatility of the maturities, we don't pinpoint year-by-year.

David Sasso

And I would just point out Bob, one maturity that we did have so far this quarter was the maturity that would fall in that bucket.

Bob Ramsey

Okay, okay. I guess last question and I will hop out to give someone else a chance. So just hoping you could talk a little bit about cash flow needs and balances as we sort of enter the next quarter. Could you update us on what the quarterly cash expenses are on a go forward basis as we go into the third quarter? Sort of thinking about OpEx and then the cash interest component.

Tony Mitchell

Yes, certainly Bob let's get you that number.

Miriam Martinez

So basically I guess you are asking more about our cash burns.

Bob Ramsey

Yes.

Miriam Martinez

Okay. So we expect at least for the remainder of the year that in total our total cash burn is going to be with the total year around $40 million and again that also is going to depend on the maturity because, as you know, the ready -- the Red Falcon facility for example if we have maturities then we are able to participate in the waterfall but again right now we are looking at that our burn rate is around $40 million.

David Sasso

Okay. And so a portion of that is coming out of the facility.

Miriam Martinez

Yes, yes, yes, and so Dave is correct.

David Sasso

So you want the cash burn at Holdco right?

Bob Ramsey

Yes I'm not talking about building or accruing additional interest, I'm talking about Holdco, what is your cash spend on the interest, you have to pay in cash and then for your SG&A?

Tony Mitchell

I will get that for you but I think the number is in the neighborhood of couple of million a month, like $2 million, $2.5 million a month.

Bob Ramsey

Okay. And does that include any revenue assumption or is that purely on the expense side?

Tony Mitchell

Say that again?

Bob Ramsey

Is that $2 million to $2.5 million a month, does that include any assumed revenues or is that purely just like now what the expenses are in a cash basis?

David Sasso

Yes, purely cash burn, Bob.

Bob Ramsey

Okay. So assuming no maturities I mean just -- that's just the cash out expenses?

David Sasso

Yes and that is right, yes.

Bob Ramsey

Okay. All right, thank you. I will hop out.

David Sasso

Thank you.

Tony Mitchell

Thanks Bob.

Miriam Martinez

Thank you.

Operator

The next question will come from Quinton Mathews of QKM. Please go ahead.

Quinton Mathews

Good afternoon. Correct me if I'm wrong but I think at the end of last year, maybe it was the first quarter you guys were anticipating to be cash flow positive this year is that am I correct on that and is that still the expectation?

Tony Mitchell

So the -- we always expected the second half of 2016 to have more maturities and on a run rate basis to be cash flow positive which we obviously still have quite a few months left to go in this year and that's our expectation.

Quinton Mathews

Okay. And also jog my memory, were you trying to refinance out of one of the Beal facilities or were you trying to refinance out of the convertibles and that's already happened. Just update me on where you guys stand, I think last quarter you guys were trying to there is a question about why it was so hard to get debt financing, if you guys were working on that?

Tony Mitchell

Yes, so just to be clear, the only thing we were seeking to do and we've been successful in doing this is to raise $30 million of the senior secured notes at the parent level. The other thing that we talked about on the prior quarter was closing some balance sheet policies into Beal, into the Red Falcon facility and drawing some cash which we also did in July.

Quinton Mathews

Okay. And remind me what's the cost of the senior secured debt?

Tony Mitchell

The cost of the senior secured debt is 15% coupons.

Quinton Mathews

Okay.

Tony Mitchell

30 months paper it matures in August of 2018.

Quinton Mathews

Okay. And I know you win over last quarter why -- just recall why you were paying such high cost of debt, is part of that and I'm going to tie this then to some of the interested buyers and their cost of capital. Do you think that it's been difficult to get debt at a lower cost because of the historical issues the company has faced or is it an industry-wide kind of reticent to land. And then I guess I would the third piece to that is of the individuals that are institutions whoever is looking to buy and you guys, what is their cost of debt and is it significantly lower?

Tony Mitchell

Yes. So it's a great question, thank you. I think the -- since the capital crisis, the life settlement asset has been difficult to finance. As we've reported on interest in this space has been picking up now for the past two to three years but whether you are lending directly against the policies or you are putting money into the parent in a senior secured note, you are essentially -- all things have triggered off the life settlements and the debt in the space tends to be in the 12% to 15% range.

I don't think our history has helped us in our capital raising efforts particularly getting lower cost of capital; it wasn't until late December of last year that the government concluded its investigation and that was a big variable for perspective debt lenders. It actually meant that we were out seeking debt in probably the worst time January and February of Q1, I think were which is historically difficult to get debt, it's an improved environment. And that was just unfortunate, it was unfortunate timing.

We started seeking debt in July of 2015. So we knew what we needed to do and we started early and it was proved to be incredibly difficult and I can assure you it was not through lack of effort.

Quinton Mathews

Yes, I understand. The new down in the discount rates, what drove that this quarter and is that closer to what you would consider an industry average discount rate for life portfolio?

Tony Mitchell

So there is quite a lot of metrics going to the discount rates. We are seeing industry participants with discount rates as low as 12%. We have what we call a base rate of 15% and then we risk adjust policies for different reasons and when you get a blend that's where we get to a 16%, 16.5% blended discount rate.

Quinton Mathews

And was there something, I mean is it a -- is it a lot of different moving parts that move it down from above 17% and the 16% range or was there something more material that move it down in this quarter?

Tony Mitchell

No I think the passage of time we get there are people that report on life settlement transactions, there are companies that produce reports which we read. There is some risk premiums attached to Emergent's policies because of our legacy issues that simply burn off over time, as you continue to make quarterly premium payments, you clean up the issues that we've had, it's no longer appropriate to assign a risk premium to that. So you see those burning off over time.

Quinton Mathews

Okay. Just couple more. I know the majority of the legal bill is if you're suing Sun Life but is there additional legal expense that's going to other matters?

Tony Mitchell

Not significant, there's a little bit on SEC related things and then you just got your general, your general corporate expenses.

Quinton Mathews

Okay. And any that you care to comment or is there anything noteworthy on the SEC just kind of saying that there is after things that haven't done anything?

Tony Mitchell

Yes no, nothing, nothing noteworthy at all in that regard.

Quinton Mathews

But you do -- they do continue to offer things or it's just been nothing for you as such?

Tony Mitchell

We had some document productions in the early part of the year which triggered some expense but we -- haven't currently had any expense for a month or two in that regard.

Quinton Mathews

Okay. And then kind of last one for me, if you could just broadly talk about the inbound increase, the nature of the buyers are they institutional buyers who are their sole business is life settlements or they just bought some private equities kind of give us an idea who is that expensed?

Tony Mitchell

Yes so I'm going to direct you to the press release because I think the -- it's a thoughtful press release. The -- I can tell you that the inbound inquiries are from sophisticated substantial counterparties and we're pleased to have them inquiring about the company. As it relates to these specific names and so on and so forth, FBR now formalizing that process, they are reporting up to special committee of the Board and it's not appropriate for me to comment any further.

Quinton Mathews

Okay. And I don't know if you disclosed it, is Phil still seen on that special committee?

Tony Mitchell

He is not.

Quinton Mathews

Okay. Last one for me, these deals generally trade at book value or discount to book value or premium to book value, if you look at the recent comps?

Tony Mitchell

Again I don't think it would be appropriate to comment it's a unique business unique asset class and there are many, many different ways of viewing it, many different ways of structurally putting a transaction together. And I know it's frustrating but I think this will play out over time and we will be happy to update as we get information.

Quinton Mathews

Right. Appreciate all your input. Thank you very much.

Tony Mitchell

No thank you for your questions. Thanks.

Operator

And ladies and gentlemen, this will conclude our question-and-answer session. I would like to hand the conference back over to Tony Mitchell for his closing comments.

Tony Mitchell

Thank you. That wraps up the Q2 call. We look forward to updating the shareholders in November and thanks for the participation.

Operator

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!