Our offices are located at 5355 Town Center Road, Suite 701, Boca Raton, Florida 33486 and consist of approximately 11,000 square feet of leased office space. We consider our facilities to be adequate for our current operations.
As of February 3, 2011, the Company had 3,600,000 shares of common stock outstanding. As of December 31, 2015, there were 28,130,508 issued and outstanding shares and 608,000 shares of treasury stock.
You should read the following discussion in conjunction with the consolidated financial statements and accompanying notes and the information contained in other sections of this Annual Report on Form 10-K, particularly under the headings “Risk Factors,” “Selected Financial Data” and “Business.” This discussion and analysis is based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. The statements in this discussion and analysis concerning expectations regarding our future performance, liquidity and capital resources, as well as other non-historical statements in this discussion and analysis, are forward-looking statements. See “Cautionary Statement Regarding Forward-Looking Statements.” These forward-looking statements are subject to numerous risks and uncertainties, including those described under “Risk Factors.” Our actual results could differ materially from those suggested or implied by any forward-looking statements.
On December 31, 2015, the Company received a letter from the USAO indicating that the USAO Investigation formally concluded, that the Company fully complied with all of its obligations under the Non-Prosecution Agreement and that the Company was released from any further obligations under the Non-Prosecution Agreement. Since learning of the USAO Investigation in 2011, the Company has spent an aggregate of $56.6 million on legal and related fees, including contractually obligated advancement and indemnification expenses. With the conclusion of the USAO Investigation, the Company expects that it will no longer incur indemnification and advancement expenses or any material expenses in connection with the matter.
The Company determined that an embedded conversion option existed in the Convertible Notes, prior to June 5, 2014, that was required to be separately accounted for as a derivative under Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging. On June 5, 2014, the Company obtained shareholder approval to issue shares of common stock upon conversion of the Convertible Notes in an amount that exceeded the New York Stock Exchange limits for issuances without shareholder approval. In accordance with ASC 815, the Company reclassified the conversion derivative liability to
stockholders’ equity along with unamortized transaction costs proportionate to the allocation of the initial debt discount and the principal amount of the Convertible Notes. In subsequent reporting periods, the Convertible Notes will continue to be recorded at accreted value up to the par value of the Convertible Notes at maturity. The debt discount will be amortized into interest expense using the interest method, in an aggregate amount equal to the amount of the conversion derivative liability reclassified into equity along with any unamortized transaction costs. See Note 10, “8.50% Senior Unsecured Convertible Notes.”
Our primary sources of income are in the form of changes in fair value of life settlements and gains on life settlements, net. Our income recognition policies for this source of income is as follows:
Our provision for income taxes results in an annual effective tax rate of 22.30% in 2015 compared to (2.50)% in 2014.
Change in fair value of life settlements. Change in fair value of life settlements was a gain of approximately $46.7 million for the year ended December 31, 2015 compared to a gain of $44.1 million for the year ended December 31, 2014, an increase of $2.6 million. The gain for both years was primarily a result of maturities and increased life settlement values.
Of the interest expense of $27.3 million for the year ended December 31, 2015, approximately $9.2 million represents interest paid on the White Eagle Revolving Credit Facility and approximately $4.9 million was attributable to the Red Falcon Revolving Credit Facility, which includes $3.3 million relating to the debt issuance cost which was not capitalized as a result of electing the fair value option for valuing this debt and an additional $1.6 million related to interest payments paid during the year ended December 31, 2015.
Interest expense on the Convertible Notes totaled $9.1 million, including $6.0 million, $2.7 million and $404,000 representing interest, amortization of debt discount and issuance costs, respectively. We recorded $4.0 million of interest expense on the Secured Notes, including $3.2 million, $265,000, $264,000 and $277,000 from interest, unused fees, amortizing debt discounts and issuance costs, respectively, during the year ended December 31, 2015.
Of the interest expense of $16.2 million for year ended December 31, 2014, approximately $8.0 million represents interest paid on the White Eagle Revolving Credit Facility. Interest expense on the Convertible Notes totaled $7.5 million including $5.2 million, $2.0 million and $332,000 representing interest, amortization of debt discount and issuance costs, respectively. The Company recorded $694,000 of interest expense on the Secured Notes, including $592,000, $36,000, and $66,000 from interest, amortizing debt discounts and issuance costs, respectively, during the year ended December 31, 2014.
See Notes 8, “White Eagle Revolving Credit Facility,” 9,“Red Falcon Revolving Credit Facility,” 10,“8.5% Senior Unsecured Convertible Notes,” and 11,“12.875% Secured Notes,'' to the accompanying consolidated financial statements.
See Note 12, “Fair Value Measurements,” to the accompanying consolidated financial statements.
Selling, general and administrative expenses. SG&A expenses were $37.7 million for the year ended December 31, 2015 compared to $31.3 million for the same period in 2014. This was primarily a result of an increase in legal expense of $7.1
million, an increase in professional fees of $1.9 million, and a $188,000 increase in other SG&A expenses. These increases were offset by a reduction in personnel costs of $2.4 million and a $392,000 decrease in insurance costs.
See Note 14, “Commitments and Contingencies,” to the accompanying consolidated financial statements.
During the year ended December 31, 2014, seven life insurance policies with face amounts totaling $25.5 million matured compared to four policies with face amount of $14.1 million for the same period in 2013. The net gain on these maturities was $16.4 million and $9.2 million for 2014 and 2013, respectively, and is recorded as a change in fair value of life settlements in the consolidated statements of operations for the years ended December 31, 2014 and 2013. Proceeds from maturities totaling $23.6 million were received during the year ended December 31, 2014, which includes $21.5 million associated with maturities occurring in 2014 and $2.1 million that was accounted for as a receivable as of December 31, 2013. All seven maturities for 2014 occurred on policies that served as collateral under the White Eagle Revolving Credit Facility and amounts totaling $23.6 million were utilized to repay borrowings under the facility. The Company also recorded a $4.0 million receivable for maturity of life settlements at December 31, 2014.
As of December 31, 2014, the Company owned 607 policies with an estimated fair value of $388.9 million compared to 612 policies with a fair value of $303.0 million at December 31, 2013, an increase of $85.9 million or 28%. Of the 607 policies, 450 policies were pledged to the White Eagle Revolving Credit Facility. During the year ended December 31, 2013, the Company acquired 432 life insurance policies, 16 of which were a result of certain of the Company’s borrowers defaulting on premium finance loans and relinquishing the underlying policies to the Company. Of the remaining 416 policies, 323 policies were previously considered contingent assets held off balance sheet and known as life settlements with subrogation rights, net with the remaining 93 acquired through the Company’s acquisition of CTL Holdings, LLC. As of December 31, 2014, the aggregate death benefit of the Company’s investment in life settlements was $2.9 billion.
Loss on life settlements, net. Loss on life settlements, net was approximately $426,000 for the year ended December 31, 2014 compared to a loss of $2.0 million as of December 31, 2013 a reduction of $1.6 million. During the year ended December 31, 2014, 14 policies were sold resulting in a loss of approximately $426,000 on net proceeds of $4.0 million. During the year ended December 31, 2013, the Company sold eight policies that resulted in a loss of approximately $922,000 on net proceeds of $5.8 million.
Interest expense. Interest expense increased to $16.2 million during the year ended December 31, 2014, compared to $13.7 during the same period in 2013, an increase of $2.6 million, as the principal on the Company’s outstanding debt increased by $123.2 to $256.4 million as of December 31, 2014. Outstanding debt includes $160.7 million of outstanding principal on the White Eagle Revolving Credit Facility, $70.7 million of Convertible Notes and $25.0 million of Secured Notes.
Change in fair value of the White Eagle Revolving Credit Facility. Change in fair value of the debt under the White Eagle Revolving Credit Facility was a gain of approximately $5.5 million for the year ended December 31, 2014 compared to a gain of approximately $9.4 million for the year ended December 31, 2013. This change is associated with the lengthening of life expectancy estimates for the policies pledged under the White Eagle Revolving Credit Facility offset by a reduction in the discount rate. The White Eagle Revolving Credit Facility is valued at December 31, 2014 using a discount rate of 23.89%. See Note 12, “Fair Value Measurements,” to the accompanying consolidated financial statements.
Net loss from our discontinued structured settlement operations for the year ended December 31, 2015 was $644,400 as compared to a net loss of $369,000 for the year ended December 31, 2014. Total income from our discontinued structured settlement operations was $81,300 for the year ended December 31, 2015 compared to $192,000 for 2014.
Net loss from our discontinued structured settlement operations for the year ended December 31, 2014 was $369,000 as compared to income of $13.5 million for the year ended December 31, 2013. Total income from our discontinued structured settlement operations was $192,000 for the year ended December 31, 2014 compared to $22.6 million in 2013. This reduction is mainly associated with the sale of the structured settlement operations in October 2013.
During the year ended December 31, 2014, our discontinued structured settlement operations sold 8 structured settlements for a gain of $18,000, compared to the sale of 529 structured settlements for a gain of $9.6 million.
Unrealized change in fair value of structured settlements receivable was $32,000 for the year ended December 31, 2014 compared to $1.2 million for the year ended December 31, 2013.
Total expenses from our discontinued structured settlement operations were $793,000 for the year ended December 31, 2014 compared to $9.1 million incurred during the same period in 2013. This reduction is mainly associated with the sale of the structured settlement operations in October 2013; including a $4.2 million decrease in personnel cost, $2.0 million decrease in marketing cost, $1.1 million decrease in professional fees, $946,000 decrease in other SG&A expenses and $218,000 decrease in legal fees.
Our consolidated financial statements have been prepared assuming the realization of assets and the satisfaction of liabilities in the normal course, as well as continued compliance with the covenants contained in the Revolving Credit Facilities, the indenture governing our Convertible Notes and other financing arrangements.
For the year ended December 31, 2015, we paid $64.9 million in premiums to maintain our policies in force. Of this amount, $47.0 million was paid by White Eagle through its borrowings and $6.5 million was paid by Red Falcon through its borrowings. While the liquidity risk associated with the policies that have been pledged as collateral under the Revolving Credit Facilities has been mitigated, any distributions from available proceeds under the Revolving Credit Facilities will vary based on the respective then current loan to value ratio. Accordingly, there can be no assurance as to when the proceeds from maturities of the policies pledged as collateral under the Revolving Credit Facilities will be distributed to the Company. Additionally, White Eagle and Red Falcon may not borrow under their respective facilities to pay interest and the Red Falcon Credit Facility requires mandatory amortization of the debt under the facility of 8% per annum. To the extent there are insufficient collections from policy proceeds to cover these amounts, these required payments will put further stress on our available cash. As we continue to acquire additional life settlement assets, we expect our premium obligations to increase. Assuming no policy maturities, as of December 31, 2015, we expect to pay 4.2 million in premiums during 2016 on the 39 policies that have not been pledged under the Revolving Credit Facilities; however, any future cost of insurance increases may cause our projected premium payments to significantly increase and adversely affect the loan to value ratios under the Revolving Credit Facilities. Additionally, at December 31, 2015, $70.7 million in aggregate principal amount of Convertible Notes was outstanding, which accrued interest at 8.50%. Interest on the Convertible Notes is due semi-annually.
Effective July 16, 2015, Red Falcon, as borrower, entered into a $110.0 million 7-year credit facility that provides for five years of revolving credit borrowing with LNV Corporation, as initial lender, the other lenders party thereto from time to time, Imperial Finance & Trading, LLC, as guarantor, Blue Heron as portfolio administrator and CLMG Corp., as administrative agent.
Borrowing availability under the Red Falcon Revolving Credit Facility is subject to a borrowing base, which among other items is capped at 60% of the valuation of the policies pledged as collateral. This loan to value calculation is determined by the lenders with a high degree of discretion. At December 31, 2015, $54.6 million was undrawn and $1.7 million was available to borrow under the Red Falcon Revolving Credit Facility. For a description of the facility see Note 9, “Red Falcon Revolving Credit Facility,” of the notes to Consolidated Financial Statements.
At December 31, 2015, the fair value of the debt under the Red Falcon Revolving Credit Facility $55.7 million. As of December 31, 2015, the borrowing base was approximately $57.1 million, including $55.4 million in outstanding principal. Outstanding interest at 5.5% per annum and required amortization at 8% per annum on the greater of the then outstanding balance of the loan or the initial advance are due monthly. During the year ended December 31, 2015, required amortization paid was $4.4 million, which included $916,600 paid directly by Red Falcon and $3.5 million from policy proceeds. Interest totaling $1.6 million was paid during 2015 which included $502,700 paid directly by Red Falcon and $1.1 million from policy proceeds.
As amended on November 9, 2015, White Eagle is the borrower under a $250.0 million revolving credit facility, with Imperial Finance and Trading, LLC, as the initial servicer, the initial portfolio manager and guarantor, Lamington Road Bermuda Ltd., as portfolio manager, LNV Corporation, as initial lender, the other financial institutions party thereto as lenders, and CLMG Corp., as administrative agent for the lenders.
At December 31, 2015, the fair value of the debt under the White Eagle Revolving Credit Facility was $169.1 million. As of December 31, 2015, the borrowing base was approximately $172.4 million including $172.0 million in outstanding principal. There are no scheduled repayments of principal. Payments are due upon receipt of death benefits and distributed pursuant to the waterfall described in Note 8, “White Eagle Revolving Credit Facility,” of the notes to Consolidated Financial Statements.
During the year ended December 31, 2015, operating activities used cash of $54.3 million. Our net loss of $31.0 million was adjusted for the following: Revolving Credit Facilities financing costs and fees of $7.5 million, which represent interest expense and other fees associated with the White Eagle Revolving Credit Facility withheld by the lender and added to the outstanding loan balance; change in fair value of life settlement gains of $46.7 million that is mainly attributable to the maturities of 17 policies; change in fair value of Revolving Credit Facilities loss of $12.2 million mainly attributable to a reduction in the discount rate along with projected earlier repayments due to maturities. These were offset by increased borrowings and the lengthening of life expectancies of certain insureds underlying policies pledged as collateral in the facility and cost of insurance increase. Red Falcon Revolving Credit Facility origination cost was $3.3 million relating to the debt issuance cost which was not capitalized as a result of electing the fair value option for valuing this debt. Extinguishment of Secured Notes was $8.8 million, which represents redemption at 106% of their principal amount plus interest; deferred income tax benefit of $8.7 million and a net negative change in the components of operating assets and liabilities of $3.9 million. This $3.9 million change in operating assets and liabilities is partially attributable to a $3.1 million decrease in accounts payable and accrued expenses, a $860,000 decrease in other liabilities, and a $654,000 increase in deposits. These were offset by a $1.1 million decrease in structured settlement receivables associated with the sale during the year.
During the year ended December 31, 2014, operating activities used cash of $32.9 million. Our net loss of $5.5 million was adjusted for the following: White Eagle Revolving Credit Facility financing costs and fees of $6.7 million, which represent interest expense and other fees associated with the White Eagle Revolving Credit Facility withheld by the lender and added to the outstanding loan balance; change in fair value of life settlement gains of $44.1 million that was mainly attributable to the maturities of seven policies; change in fair value of the White Eagle Revolving Credit Facility gain of $5.5 million that resulted from increased borrowings and an increase in the discount rate used to value the facility. These were offset by projected early repayment of the White Eagle Revolving Credit Facility given earlier than projected maturities; change in fair value of conversion derivative liability loss of $6.8 million resulted from an increase in the fair value of the embedded derivative included in the Convertible Notes, deferred income tax benefit of $107,000, and a net positive change in the components of operating assets and liabilities of $5.1 million. This $5.1 million change in operating assets and liabilities is partially attributable to a $14.2 million decrease in other liabilities, offset by a $13.5 million decrease in restricted cash, both associated with the settlement of the class action and derivative litigation. This reduction was offset by a $3.2 million increase in accounts payable and accrued expenses.
Net cash used in investing activities for the year ended December 31, 2015 was $41.0 million and includes proceeds of $53.5 million from maturity of 17 life settlements and $2.2 million from sale of one life settlement. These were offset by $64.9 million for premiums paid on life settlements, $29.1 million for purchases of life settlements and a $2.5 million for purchase of certificate of deposit.
Net cash provided by financing activities for the year ended December 31, 2014 was $111.1 million and includes $67.9 million in net proceeds from the Convertible Notes and $50.5 million of borrowings from the White Eagle Revolving Credit Facility. These were offset by $29.8 million in repayment of borrowings under the White Eagle Revolving Credit Facility.
The following table summarizes our contractual obligations as of December 31, 2015 (in thousands):
Required amortization is the greater of outstanding principal or amount drawn at origination due monthly, amount included is estimated based on amount drawn at origination. Please see Note 9, “Red Falcon Revolving Credit Facility,” to our consolidated financial statements.
Includes $2.1 million related to outstanding interest due for the Revolving Credit Facilities.