Emergent Capital, Inc. (EMG) Q4 2015 Earnings Conference Call March 14, 2016 5:00 PM ET
David Sasso - Investor Relations
Tony Mitchell - Chief Executive Officer
Rory O'Connell - Chief Financial Officer
Bob Ramsey - FBR Capital Markets
Quinton Mathews - QKM
Rich Jacinto - Atlas Capital
Ted Wachtell - Millennium Partners
Good afternoon, and welcome to the Emergent Capital year-end 2015 conference call. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to David Sasso. Please go ahead.
Thank you, Amy. Good afternoon, everyone, and thank you for joining the Emergent Capital 2015 fourth-quarter and year-end earnings conference call. With me today is Tony Mitchell, our CEO and Rory O'Connell, our CFO. Our financial results press release was issued after the market close 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 filing in its entirety.
With that, I would like to turn the call over to Tony Mitchell. Tony?
Thanks, David, and good afternoon, everyone. I am pleased to say that the end of 2015 marks a true inflection point for our Company. We have achieved material expense reduction, whilst at the same time significantly increasing near-term expected cash flows.
On December 31 of 2015, the U.S. Attorney in New Hampshire formally concluded its investigation into former Company employees. Together with the end of the NPA and related continuing obligations, the result is a total elimination of costs associated with this matter. For perspective, the direct and indirect costs of this investigation totaled a staggering $75 million, of which $17 million was incurred in 2015 alone.
The Board and management have been focused on managing indemnification and legal costs associated with the investigation for the past 4.5 years. Historically, this matter had an average cost of $18.75 million per year, which represents an equally staggering 41% of our SG&A. Along with the end of the government investigation and the amendments made to the White Eagle credit facility, together with the cash flow participation in the Red Falcon facility, we expect to receive significant net cash flows for the foreseeable future.
Equally important, the Emergent Board, management and employees can now focus solely on our life settlements business. Our first task in this regard will be to further enhance our liquidity. We are working with our lender under the Red Falcon credit facility to finance all remaining policies on our balance sheet by the end of the second quarter this year. If successful, this will remove an additional $4.5 million corporate cash burden, which is a further 18% savings on corporate overhead.
Furthermore, we anticipate drawing an additional $8 million under the Red Falcon credit facility taken together, this represents a $12.5 million positive change in cash for 2016 alone. We look forward to announcing both these and other cash-saving initiatives on our Q1 call. I'd like to spend a few moments on our current cash position and recent capital-raising initiatives. After we closed the Red Falcon credit facility and amended the White Eagle facility, we took a very detailed review of our liquidity needs going forward in an effort to eliminate ongoing dependency on the capital markets for operating expenses.
At the conclusion of the DOJ investigation and the resulting expense reductions, we were able to determine that, as modeled, we should not need much, if any, additional capital. However, we don't run the Business solely on models therefore, we elected to borrow up to $30 million as defensive capital. This should ensure that there will be no adverse impact from timing mismatches with our expected cash flows. I'm delighted to announce that we have raised just over $21 million to date, and expect to raise the full $30 million over the coming few weeks. Rory will discuss our capital-raising efforts in greater detail shortly. We will continue to evaluate a return to the markets for accretive opportunities.
Using existing capacity under our Red Falcon credit facility, the Company can add policies to the balance sheet with very minimal net cash outlays. The result will be adding to our already significant projected cash flows going forward.
In an effort to position the Company to capture these future opportunities, we have filed a prospectus supplement for an ATM, or at-the-market, offering for our equities. The advantage to an ATM is it that it can generate proceeds cost effectively with the timing and price determined at the discretion of the Company. The ATM is intended to complement our financing needs, and increase the financial flexibility of our Company. As we said earlier, we do not intend to tap the equity markets unless an accretive opportunity presents itself. To that extent, in the event our model shows we are able to execute accretive transactions using equity, we will explain to investors in detail the economics behind any trade.
Briefly turning back to legal matters, as I stated earlier, we're thrilled that the DOJ investigation is concluded. Also, our continued litigation with Sun Life is moving forward. On February 3, 2016, the District Court set a trial date for our case against Sun Life. Trial is now set for October 31.
Now that I've covered highlights of 2015 and the start of 2016, let me turn the call over to Rory who will review our financial results and expectations.
Thanks, Tony. Good afternoon, everyone. For the full-year 2015, we reported a $30.4 million net loss, or a loss of $1.22 per share. Book value stands at $8.01 per share. Impacting this full-year loss amount were legal fees of $20.7 million, and another $8.8 million of loss due to the acceleration of deferred financing costs associated with the prepayment of secured notes that would not have been issued on such terms if not for the outsized legal expenses incurred.
A huge drain on our liquidity resources resulting from the DOJ investigation forced us to raise capital several times that was more expensive than it otherwise would have been. This domino effect of raising expensive capital to pay outsized non-operating legal expenses further depressed cash flows and financial performance. However, now that the DOJ investigation has fully and finally ended, our past financial performance does not inform our future. We are a different Company now.
Indeed, over the course of this difficult four-year period, the asset portfolio has grown four-fold and has seasoned -- seasoned through what is often called the cash hog period of the lifecycle of a life settlement portfolio, which is the early period when total premiums paid are in excess of total death benefits received. In 2015, we appeared to have exited this part of the life cycle, as the Company's portfolio realized $67.5 million in death benefits and paid $64.9 million in total premiums. With a large portfolio of aging and impaired losses, we soon expect to begin a prolonged period of cash flow generation.
As of December 31, 2015, the Company owned 632 policies with a weighted average life expectancy of 9.9 years, and an estimated fair value of $461.9 million using a weighted average discount rate of 17.02% to value the policies. As of December 31, the aggregate death benefit of the Company's investment in life settlements was approximately $3 billion. The ratio of total fair value to aggregate death benefit is 15.4%.
Now, this is an important figure. I think of a life settlement portfolio as akin to a portfolio of zero-coupon bonds with a negative carry. Our portfolio of zeros are marked at $0.154 on the dollar, and they will accrete up to par over time, some faster and some slower, but all will ultimately accrete to par. This suggests that there is a lot of asset value growth to come over the next several years.
In fact, we estimate that the current portfolio, without adding any new policies, will continue to appreciate in total value for the next 5 to 6 years, even as mortalities occur and policies are removed from the portfolio. During this same time period, the revolving loan balances used to pay premiums will decline according to our models by approximately 80% as death benefits are run through their respective waterfalls. Thus, we believe that we are now entering a period of significant asset growth, coupled with balance sheet deleveraging. This period should be characterized by rising asset values and significant debt reduction resulting in fast rising shareholder value.
Now let's turn to our revolving subsidiary debt. At year end, the fair value of our debt was $224.8 million. The outstanding principal balance was approximately $229.5 million. The discount rate applied to the debt during the fourth quarter was 20.55% on the White Eagle facility and 11.65% on the Red Falcon facility. As many of you know, the White Eagle facility, which was established in 2013, pays all quarterly premiums due and is secured by 437 policies. The Red Falcon facility was established in July 2015, pays all quarterly premiums due on, and is secured by 156 policies.
For the next couple of years, the Red Falcon facility is our leverage growth vehicle. This is a terrific and as yet untapped asset of the Company. It provides for smart, modest leverage of 1 to 2 times, thereby providing significantly more asset purchasing power than the Company can generate via net cash flows alone. Simply put, we expect the Red Falcon facility advance rate on new acquisitions to allow the Company to purchase roughly twice as much face amount with the same amount of balance sheet cash deployed, and it should boost our average unlevered [ph] internal rates of return by 1,000 basis points or more. So, now, for the first time, we have access to a vehicle that can deliver enhanced returns through smart leverage.
As Tony mentioned, we have just closed on $21.2 million of new debt in a private placement. This debt offering is fully expected to complete the stated raise of $30 million, the debt carries a coupon of 15%, and a term of 30 months. Now, anyone who follows the corporate debt markets can tell you that the past few months have been an especially difficult period for debt issuance, particularly for small-cap companies. Indeed, we had gone to market with an investment bank-led offering, but pulled it because we felt that the indicative pricing terms were not reflective of a company with our upside. In the end, we have been successful with a transaction that appropriately mitigates the risk of a possible short-term liquidity gap without saddling the Company with expensive long-term debt.
And further to this point, we expect to close on an additional advance from the Red Falcon facility, which will finance the remaining 37 policies on our balance sheet, thereby removing the last $4.5 million of annual premium expense being paid directly by the Company. We also expect to take a draw of approximately $8 million. The result of this financing will thus improve net cash balances by approximately $12.5 million. Together, these actions provide the Company with sufficient cash balances. Today, our cash balance is in excess of $30 million. With an additional $8.8 million expected from the private notes offering, and the expected draw from Red Falcon, our cash balances will rise to over $45 million. The Company expects no further issuance of Holding Company debt for the foreseeable future.
In summary, while 2015 financial performance was disappointing, we took significant steps to de-risk the Company, strengthen our balance sheet, drastically reduce expenses, improve near-term cash flows, and add leveraged financing for future growth. I want to conclude my remarks by stating that the Company is off to a good start in 2016, generally tracking expectations with five policies maturing to date totaling $11 million in death benefit. And it is worthwhile noting that four of these five policies were purchased by the Company in the past 18 months, anecdotal evidence that the recent shaping of the Red Falcon portfolio has reduced portfolio duration.
Thank you. And with that, I would like to turn the call back to the operator for questions.
Just before we go to questions, we are so anxious to get to the Q&A. I know we've just discussed a number of topics and we've thrown a lot of numbers your way, so I just wanted to recap the material changes that have occurred.
First, we can now project significant cash flows from the two facilities going forward. Second, we have incurred approximately $18.5 million a year in DOJ-related legal matters, an amount that has gone away completely. Our three-year expected premium spend of nearly $13.5 million is expected to be $0 in the near future, and we will bring in $8 million in cash from the advance from our Red Falcon credit facility.
Overall, I'm thrilled to report these major developments, and we look forward to updating you on our Q1 call in May.
Now, we're ready for questions. Thanks, operator.
[Operator Instructions] And our first question comes from Bob Ramsey at FBR.
First of all, congratulations on the legal settlement. I know that's been a long time coming and also on the debt deal. I know that's taken a lot of work. I guess you guys did a really nice job of sort of outlining the cash balances that you guys have today given some of the recent moving pieces here at about $45 million. I was wondering if you could talk about the cash expenses over the next 12 months?
Thank you, Bob. The runway right now, Bob, for cash expenses are about $25 million a year. We expect $4.5 million of premium expense to go in Q2, which will be sort of partially offset by the -- if we raise the full $30 million at 15%, then we'll add back in the $4.5 million of interest expense on the senior secured notes. We will have more to talk about in Q1. One of the big themes of 2016 is aggressively looking at our cash expenditures and working with all our vendors and third parties to see if there's anything we can do to continue to drive down our overhead. So I hope that answers the question Bob and we'll have further updates in Q1 and beyond.
Okay. So about $25 million of operating expense on a cash basis plus the interest expense that --.
Yes, and then, Bob, we'll be reducing -- we expect to reduce $4.5 million in premium. We should end up at about $25 million before other cost-cutting initiatives.
And then talk about you mentioned the capacity under Red Eagle to do more policy acquisitions. Just curious as how much appetite you guys have, how you balance the opportunity to either add more [indiscernible] there versus letting that sort of deleverage and pay down and take some of the cash flow out.
Yes, Bob. We have a voracious appetite for business. We love this business. We love these assets. They are high yield and uncorrelated and through off tremendous cash flows. You've hit the nail on the head. We have no intention of having to go back to the capital markets because of capital shortfall, and where we're looking out for accretive ways to grow the book to increase the future cash flows, and we've got to marry that with a cost-effective and also an accretive way of having the equity to buy the policies so that we can put them into Red Falcon. And that plan is going to develop throughout 2016, but now we've really shed a huge, huge expense load. Our focus and the Board's focus is growing cash flows, delivering shareholder value in any way that we can.
Okay. Is it fair to think that some of that investment would be more sort of back-end loaded into 2016, that you'll sort of wait for some of these pieces to all settle out and then would be investing more, 3Q, 4Q than 1Q, 2Q? Or do you see it being sooner than that?
You know, look, we have a pipeline to build, Bob, if we see great opportunities we'll move on it. But yes, I think the passage of time, now we're in both cash waterfalls in White Eagle and Red Falcon, things improve throughout the course of 2016.
I would just add to that, Bob, I think that's right. I think Tony has that right. We are close to participating in both of those waterfalls, which is to say that the LTVs of both are really just above 50%, and so without guessing at exactly when we certainly expect, we do expect to receive cash from death benefits from both waterfalls in 2016. So we do expect net cash to come out of both of those facilities. And that provides we don't expect -- we do not intend to use this new cash raised as growth capital, right. This is sort of defensive capital that supports the balance sheet. But as we get cash flows out of the two facilities, that provides the equity to then further leverage the Red Falcon facility.
Got it. Perfect. All right. That's helpful. I guess the other question, I know you guys mentioned the ATM offering. I'm just curious how you are thinking about that. Is that something that you are fairly price sensitive about? Is that something that will be -- how much you use will be dictated by what you see on the investment front or how you're thinking about use of the ATM?
Yes, Bob. Great question. I want to be very clear for both you, Bob, and all our investors. We only ever intend to use the ATM facility to make accretive trades, in life settlements, period, full stop. We have got no desire raising equity at these levels unless it's accretive. We have -- as Rory's worked through -- sometime in mid-April, we expect to have $46 million in cash on the balance sheet, and we expect to be receiving distributions from the credit facilities, so the -- again, want to be crystal clear. We do not want to raise dilutive equity at these levels, period, full stop.
[Operator Instructions] And our next question comes from Quinton Mathews with QKM.
As a long-time shareholder, I speak for us all that we've all been through the ride. You guys have done a tremendous job. Thank you. First off just on the cost setting. I know you guys are going to get to it coming up in the first quarter, so if you don't have any details for us, that's fine. If you guys are in your planning on a percent basis of that $25 million operating expense, what are you guys shooting for or what you think the low-hanging fruit is and if could you give us any kind of target on that?
So Quinton, thank you for your question and thank you for being a long-term shareholder, and thank you for speaking with us. We really do appreciate it. Quinton, as you are aware, our capital raise took quite a lot longer than we expected. We went out in Q4 and January and early February into very, very difficult markets. As I said earlier, we do not want to raise equity at these levels, so we became very, very focused on the capital raise. The low-hanging fruit on expenses are the $4.5 million of premiums that we hold on balance sheet and that's what we are addressing first.
And that's what we'd like to talk about. I don't want to shoot from the hip. We certainly have other ideas, but we're in the fortunate position of the Q1 call being in just in six or seven weeks, and I'd like to address the cost-cutting at that point. If you can indulge us just a little bit on that.
Fair enough. Fair enough. As you guys kind of think about as we get cash flow, these deals getting a waterfall, you kind think of growth, and you -- is it fair to say that or let me put it -- is it wrong to assume that returning shareholder value may include the dividend at some point?
I think we have a Board that is extremely frustrated with the stock price, extremely frustrated with book value erosion. The management team feel the same way, and I think when we have free cash available, the Board will use every tool it's got in its bag to return value to shareholders.
Got it. On the Sun Life, you mentioned your countersuit to them. And I know their suit against you was dismissed. Is that still appeal -- weren't they trying to appeal that? Can you just give me an update on where they are with that?
Yes, so Quinton, there's a concept called litigation privilege. Sun Life appealed to the 11th Circuit under the litigation privilege doctrine. The 11th Circuit pushed that back to the District Court and set our case against Sun Life for trial which as we've mentioned is going to be up at the end of October later this year.
Okay. So does that -- how does that work in the sense that you're potentially going to be trying both suits under that one trial?
No. Quinton, just to be clear, Sun Life's case against ours has been dismissed. Five of the seven counts at motion to dismiss and two for summary judgment. Their case against us is over at this stage. Our case against them is really just set for trial. At the conclusion of that, we have to see where we are at.
Okay. Assuming that you guys keep up on this kind of sort of STOLI related litigation across the country more so than I do, are there any other cases of precedent that would, like the Sun Life being dismissed that kind of rule in favor that give you guys the comfort when you look out that this is the business is not going to look materially different in five years, meaning to say that you guys are going use the cash flow to continue to invest in life settlements and you think it's a safe place to be or there are lawsuits that you can point us to that say it's still kind of murky?
So Quinton, I don't think the life settlements space is at all murky. I think that people have a sense that there is a ton of litigation in this space, but I think in reality most of the litigation was several years ago, and I'm told it never reached 5% of all policies outstanding in the life settlements space. It was never as big as it seems. Obviously, you read about the lawsuits but you don't read about things that go normally. There's one case going through Florida. It's called the Brasner, which is up at the Florida Supreme Court. Whatever happens there, we don't think is precedential for us, and we're very comfortable with the litigation landscape.
Okay. The last one I have, and I know -- I don't want to hit it too much because you guys already said you're not going to do un-accretive deals. But I want to make sure with the aftermarket offering, it's one thing to kind of pencil it out and look at the deal and see whether it's an interest rate arbitrage, or I don't know what kind of deals are floating around there right now.
And [indiscernible] being accretive, but I would imagine that it would have -- given what the stock is and given what the book value is and given the nature of the business that book value gross over time that it would have to be extremely accretive, or it would have to be an extremely kind of -- the seller would have to be under extreme pressure which may be not be the kind of market we are in to make it accretive given where the stock price is.
So am I right in thinking that that's the characterization of the type of deal it would have to be or am I thinking about it incorrectly?
So Quinton, I will reiterate really what I said to Bob. Come mid-April, we have $46 million of cash sitting on the balance sheet. We're participating in both credit facilities. We do not have any liquidity issues in the company, period, full stop. The aftermarket offering, it's a useful tool. It sits there. We can be opportunistic, but I want to be very clear. We have no intention of issuing equity this discount to book unless the opportunities are accretive and will significantly add to the Company's cash flow, again, so that we can deliver value back to the shareholders in the form of dividends or buybacks, et cetera.
And on the Q1 call or the annual general meeting, we will -- which is where we get into a lot of the weeds of our business. However we describe it on this call, we cannot adequately describe how valuable Red Falcon is to the Company and our shareholders, and we're going to take the time to articulate that in graphs and presentations and at that point, you'll be very clear about our intentions.
The next question is from Rich Jacinto at Atlas Capital.
I heard you say loud and clear that the ATM facility would only be for accretive opportunities. Did I hear you say that it would only be for opportunities in the life settlement industry? Did I hear you correctly with that?
So we didn't actually say that, Rich, but I will say it right now. It's a great question. We have no intentions, no plans, we are not looking at anything to issue equity through the ATM for anything other than life settlements.
With the stock currently where it is, is it possible that you would find an accretive opportunity and use the ATM with the stock at current levels? Do you think there's opportunities that are that good out there?
Rich, there definitely are. Look, we've just come through obviously 4 1/2 years of extreme difficulty. We happen to need the last piece of capital to complete the capital structure in very difficult markets, which we have done, and we've got no intention, Rich, of diluting shareholders and having liquidity issues going forward. There are, again, under the Red Falcon credit facilities, which we are going to take the time to walk investors like yourself through in great detail, you can get some really accretive opportunities through that facility.
But we are very pleased where we are. We are very pleased with the progress, and whatever we do from here on in is going to be very strategic and it's going to be planned meticulously.
So it is possible that you could find an attractive enough opportunity where you might use the ATM with the stock at current levels?
Rich, it is possible to do that. Yes.
[Operator Instructions] The next question comes from Ted Wachtell at Millennium.
I wonder if you can give us a little more detail on the $21 million, 15% fundraising, and under what terms will that potentially go to $30 million. Is it at the -- your option or you're still marketing? What are the specific terms of that debt, and how many? Is it with a single counterparty? Can you give us a little more detail on the 15% that you just raised?
Yes, certainly Ted. It's a senior secured note, or notes. Its 30 months in duration. Its 15% interest paid on a quarterly basis. It funded at par, and there is roughly $3 million of the $21 million funded by insiders, and then the rest of the offering to date is from institutional investors.
Okay. And you are still potentially open on that deal?
So it is still open, Ted, though we've got purchase agreements, commitments, et cetera. In my mind, the offering is largely done but as we sit today, it's currently open, yes.
I don't know if I said but it's a private deal, not a public deal.
Right. And so you just from a timing perspective, I mean obviously the markets were not hospitable, that's kind of turned around a little bit. I'm not sure that you would've fared much better in the last week and a half as the markets have improved and how you'll debt and loan facilities. But suffice to say, this was in the range of what you were originally looking at, and you want me to comment and this goes back a little bit too would you -- this goes to the topic of when would you use the ATM.
When you were doing this debt deal, obviously you viewed a reopening the convert or doing another convertible as far more expensive. I just wondered you could walk through a little bit, your thinking on that, and at what level of equity would a convert potentially have made more sense relative to this 15% senior secured.
So Ted, we absolutely analyzed all available instruments. We did an equity rights offering that was very strongly supported by our shareholders at $5.75 and we find ourselves at $4. So when we looked, the opening up the converts, we spent a lot of time with FBR. It's not easy, and obviously whilst we were thinking about that, the markets were particularly volatile like for anything, of course, and once you open up that up, you're opening up everything like the whole $70 million. Everything gets reset and it becomes more and more diluted. I'll remind you, Ted, and the people on the call that last March, the stock traded at just a little north of $7 a share.
Fundamentally, the Company is in much, much better health now. We view the $4 equity price to be an anomaly. We're a small cap financial that have been really beaten up in Q4, and obviously Q1 so far hasn't been kind to small cap financials. So this debt at 30 months, Ted, is sized to -- we may not actually have a liquidity gap at all, but it's imprudent and we'd never do it. You can't run a life settlement company like that because there's always going to be volatility around your cash flows. So, this -- we sized this to be -- it's not cheap, but it's prudent debt and it's sized to make sure that any stressed modeled scenario is covered, period, full stop.
Ted, its David Sasso. I think I would just add that I recommended to the Management team and the Board as I hear from Rich, I hear from yourself, the sensitivity to further dilution. So the convert or even with the baby bond offering, there was price talk, I can tell you in this range but it also it talked about having some warrants or some other upside equity. We were very, very sensitive to that. The reason we are discussing the ATM today because documents are being filed publicly and we want investors to know that even though that is talk of equity, it would only be done in an accretive manner. The way we look at that is at every level, it happens to be accretive, but we're super sensitive to the price level today of the stock and wants to walk everybody through that first before we would do anything.
Okay. Thank you.
Operator, I think that's it.
Okay, would you like to make any closing remarks?
Yes, operator. Thank you. I just want to thank everyone for their time today. We are busily at work here and we look forward to updating everybody on the Q1 earnings call in May. Thanks very much, everyone.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.