Incorporated in Florida, Emergent Capital owns a portfolio of 621 life insurance policies, also referred to as life settlements, with a fair value of $498.4 million and an aggregate death benefit of approximately $2.9 billion at December 31, 2016. The Company primarily earns income on these policies from changes in their fair value and through death benefits.
At December 31, 2016, we had approximately $11.3 million of cash and cash equivalents and certificates of deposit of $6.0 million; of this amount, approximately $8.3 million is available to pay premiums on the two unencumbered policies and other overhead expenses, with approximately $9.1 million being restricted by the White Eagle Revolving Credit Facility. Approximately $108.6 million was undrawn and $674,800 was available to borrow under the White Eagle Revolving Credit Facility. The amount available to borrow is calculated based on and limited to the premium payments and expenses if any, that are due as of the calculation date. In essence, what is available, is what is required to pay expenses and keep the policies in force as of the calculation date. We believe these funds should be sufficient to fund our operations through three months after the date of this report.
The Company did not make an interest payment of $1.1 million, due March 15, 2017, on the 15.0% Senior Secured Notes, of which $30.0 million principal amount was outstanding on that date. If the interest payment is not made within five business days of its due date, such failure would result in an event of default under the Senior Secured Indenture
governing the 15.0% Senior Secured Notes, and the trustee or holders of at least 25% in principal amount of the outstanding 15.0% Senior Secured Notes may declare the principal, premium, if any, and accrued but unpaid interest immediately due and payable. The Company released the cash interest payment of $1.1 million to the holders of the 15% Senior Secured Notes on March 20, 2017.
As part of the Transaction, the Company will offer to exchange, in each case with existing holders, its outstanding 8.5% Senior Unsecured Convertible Notes due 2019 (the "Existing Convertible Notes") for 5.0% Senior Unsecured Convertible Notes due 2023 (the "New Convertible Notes"), and its outstanding 15.0% Senior Secured Notes due 2018 (the "Existing Senior Notes") for 8.5% Senior Notes due 2021 (the "New Senior Notes"). As a result of such exchanges. At least 98% of the holders of each class of notes must tender in the relevant exchange offer as a condition to closing the Transaction.
At or contemporaneously with the closing of the Transaction, PJC or the Investor and certain holders of New Senior Notes (the "Holders") will enter into a Note Purchase Agreement (the "Note Purchase Agreement"). The Note Purchase Agreement will generally provide for PJC or the Investor to purchase up to 100% of the New Senior Notes held by the Holders for an aggregate purchase price equal to the face amount of such purchased New Senior Notes.
As of our filing date, we anticipate that we will not comply with our financial covenant under the White Eagle Revolving Credit Facility to maintain a cash interest coverage ratio of at least 2.0:1. Absent waivers or cures, non-compliance with such covenant would result in the cash flow sweep percentage being equal to one-hundred percent (100%), and even if the required LTV ratio was satisfied, the Company would not participate in the cash flow sweep. As of December 31, 2016, the cash interest coverage ratio was 1.65:1 and the loan to value ("LTV") ratio was 55%, which was calculated using the lenders' valuation. It is possible we could obtain waivers from our debt holder; however, the aforementioned projections and certain liquidity risks raise substantial doubt about whether we will meet our obligations as they become due within one year after the date of issuance of this report.
The waterfall for distribution of proceeds from the policies pledged as collateral under the White Eagle Revolving Credit Facility was changed to the structure set forth in the table below. Absent an event of default, after distributions for
premium payments, fees to service providers and payments of interest, a percentage of the collections from policy proceeds are to be paid to the Company, which will vary depending on the then LTV ratio as illustrated below where the valuation is determined by the lenders:
Commencing in the third quarter of 2015, 24 of our policies became subject to a cost of insurance increase. During the year ended December 31, 2016, the cost of insurance increase for these additional policies caused the fair value of our life settlements to decrease by approximately $3.2 million and by approximately $7.6 million since the third quarter of 2015. Further cost of insurance increases may cause our projected premium payments to significantly increase, adversely affect the loan to value ratios under the White Eagle Revolving Credit Facility and otherwise have a material adverse, effect on our business, results of operations and the value of any affected policies.
This reduction in cash flows may reduce funds available to us from policy proceeds, including from the White Eagle Revolving Credit Facility, and may adversely affect our ability to service our indebtedness. Future changes in life expectancies or actuarial tables could have a material adverse effect on the fair value of our life settlements, which could have a material adverse effect on our business, financial condition and results of operations.
On March 11, 2016 (the "Initial Closing Date"), the Company, as issuer, entered into an indenture with Wilmington Trust Company, as indenture trustee. The indenture provides for the issuance of up to $30.0 million in senior secured notes of which approximately $21.2 million were issued on the Initial Closing Date with an additional $8.8 million issued on March 24, 2016. The 15% Senior Secured Notes were purchased in private transactions exempt from the registration requirements of the Securities Act of 1933, as amended, under the note purchase agreements with certain accredited investors and/or non U.S. persons, including certain members of the Company's board of directors, management and their affiliates, who purchased approximately $3.3 million of the 15% Senior Secured Notes issued on the Initial Closing Date. See Note 11, "15% Senior Secured Notes," of the notes to the accompanying consolidated financial statements.
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 these sources of income are as follows:
Changes in Fair Value of Life Settlements-When the Company acquires certain life insurance policies we initially record these investments at the transaction price, which is the fair value of the policy for those acquired upon relinquishment or the amount paid for policies acquired for cash. The fair value of the investment in insurance policies is evaluated at the end of each reporting period. Changes in the fair value of the investment based on evaluations are recorded as changes in fair value of life settlements in our consolidated statement of operations. The fair value is determined on a discounted cash flow basis that incorporates current life expectancy assumptions. The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The Company recognizes income from life settlement maturities upon receipt of death notice or verified obituary of the insured. This income is the difference between the death benefits and fair values of the policy at the time of maturity.
Our provision for income taxes results in an annual effective tax rate of 0.00% in 2016 compared to 22.30% in 2015.
The accounting for uncertain tax positions guidance under ASC 740 requires that we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. We recognize interest and penalties (if any) on uncertain tax positions as a component of income tax expense.
Net loss from continuing operations for the year ended December 31, 2016 was $49.4 million as compared to a loss of $30.4 million for the year ended December 31, 2015. Our net loss for the year ended December 31, 2015 included approximately $8.7 million in income tax benefit. There was no tax benefit for the year ended December 31, 2016. The following is our analysis of net loss for the year (in thousands).
See Notes 12, "12.875% Senior Secured Notes," and 18, "Income Taxes," to the accompanying consolidated financial statements.
Of these 621 policies owned as of December 31, 2016, 539 were previously premium financed and are valued using discount rates that range from 16.00% - 21.00%. The remaining 82 policies are valued using discount rates that range from 15.00% - 18.00%. See Note 13, "Fair Value Measurements," to the accompanying consolidated financial statements.
There were no policy sales during the year ended December 31, 2016. The loss in 2015 related to one policy sale on net proceeds of $2.2 million.
fair value option for valuing these debt facilities, and $11.0 million and $4.0 million related to interest payments paid during the year ended December 31, 2016, respectively.
See Notes 9 "Red Falcon Revolving Credit Facility," and 12 "12.875% Senior Secured Notes" of the accompanying consolidated financial statements.
At December 31, 2016, the White Eagle Revolving Credit Facility shows a gain of approximately $1.4 million compared to a loss of $11.9 million for the year ended December 31, 2015. This gain in 2016 is attributable to a combination of offsetting factors as discussed below:
See Note 13, "Fair Value Measurements," to the accompanying consolidated financial statements.
During the year ended December 31, 2016, as part of a reduction in force, the Company reduced its headcount from 31 employees to 24 employees inclusive of two executives. The expense associated with this reduction was approximately
$1.0 million for the year ended December 31, 2016 which related to separation costs.
Our expense from continuing operations for the year ended December 31, 2015 was significantly higher than 2014 due to interest expense of $27.3 million compared to $16.2 million, legal expense of $20.7 million compared to $13.6 million, change in fair value of the Revolving Credit Facilities of $12.2 million compared to a gain of $5.5 million, loss on extinguishment of Secured Notes of $8.8 million and professional fees of $7.1 million compared to $5.3 million, for the years ended December 31, 2015 and December 31, 2014 respectively. 2014 was significantly impacted by a onetime charge of change in fair value of conversion derivative liability of $6.8 million which is associated with our Convertible Notes. Legal expenses for the year ended December 31, 2015 included approximately $6.5 million in payments relating to the Company's indemnification obligations for the conclusion of the USAO Investigation.
See Notes 8, "White Eagle Revolving Credit Facility," 9, "Red Falcon Revolving Credit Facility," 10, "8.50% Senior Unsecured Convertible Notes," and 12, "12.857% Senior Secured Notes," to the accompanying consolidated financial statements.
During the year ended December 31, 2015, the Company redeemed all of the outstanding 12.875% Senior Secured Notes and discharged the related indenture. The Secured Notes were redeemed at 106% of their principal amount plus interest up to but excluding November 10, 2015. Approximately $8.8 million was expensed as extinguishment related to the early repayment of the Secured Notes for the year ended December 31, 2016. This included $5.2 million, $171,000, $1.7 million and $1.7 million related to interest and prepayment penalties, unused fees, write off of debt discount and write off of issuance cost.
The $11.9 million loss attributable to the White Eagle Revolving Credit Facility was due to a reduction in the discount rate after amending the facility along with projected earlier repayments due to maturities. These were offset by increased borrowings, lengthening of life expectancies of certain insureds underlying policies pledged as collateral in the facilities and projected costs of insurance increases. The $5.5 million gain for 2014 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. The White Eagle Revolving Credit Facility is valued at December 31, 2015 using a discount rate of 20.55% compared to 23.89% at December 31, 2014.
Total expenses from our discontinued structured settlement operations were $272,000 for the year ended December 31, 2016 compared to $725,000 incurred during the same period in 2015. This decrease was attributable to a $497,000 decrease in legal fees.
Unrealized change in fair value of structured settlements receivable was $20,000 and $32,000 for the years ended December 31, 2015 and 2014, respectively.
Total expenses from our discontinued structured settlement operations were $725,000 for the year ended December 31, 2015 compared to $793,000 during the same period in 2014. This decrease was attributable to a $42,000 decrease in legal fees, a $15,000 decrease in professional fees, and an $11,000 decrease in other SG&A expenses.
liabilities in the normal course of business, as well as continued compliance with the covenants contained in the indentures governing our Convertible Notes and 15% Senior Secured Notes and other financing arrangements.
As of our filing date, we anticipate that we will not comply with our financial covenant under the White Eagle Revolving Credit Facility to maintain a cash interest coverage ratio of at least 2.0:1. Absent waivers or cures, non-compliance with such covenant would result in the cash flow sweep percentage being equal to one-hundred percent (100%), and even if the required LTV ratio was satisfied, the Company would not participate in any cash flow sweep. As of December 31, 2016, the cash interest coverage ratio was 1.65:1 and the LTV ratio was 55%, which was calculated using the lender's valuation. It is possible we could obtain waivers from our debt holder.
At December 31, 2016, we had approximately $11.3 million of cash and cash equivalents and certificate of deposits of $6.0 million; of this amount, approximately $8.3 million is available to pay premiums on the two unencumbered policies and other overhead expenses, with approximately $9.1 million being restricted by the White Eagle Revolving Credit Facility. We expect to meet our liquidity needs for the foreseeable future primarily through a combination of the receipt of death benefits from life insurance policy maturities, borrowings under the White Eagle Revolving Credit Facility, strategic capital market raises, policy sales (subject to the asset sale restrictions in our debt arrangements) and cash on hand.
For the year ended December 31, 2016, we paid $71.7 million in premiums to maintain our policies in force. Of this amount, $53.6 million was paid by White Eagle through its borrowings and $14.7 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 White Eagle Revolving Credit Facility has been mitigated, any distributions from available proceeds under the White Eagle Revolving Credit Facility will vary based on the respective then current loan to value ratio as well as the cash interest coverage ratio. Accordingly, there can be no assurance as to when the proceeds from maturities of the policies pledged as collateral under the White Eagle Revolving Credit Facility will be distributed to the Company. Additionally, White Eagle may not borrow under the White Eagle Revolving Credit Facility to pay interest. To the extent there are insufficient collections from policy proceeds to cover interest, the required payment will put further stress on our available cash. Assuming no policy maturities, as of December 31, 2016, we expect to pay $118,000 in premiums during 2017 on the two policies that have not been pledged under the White Eagle Revolving Credit Facility; 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 White Eagle Revolving Credit Facility. Additionally, at December 31, 2016, we had $70.7 million and $30.0 million in aggregate principal amount of outstanding
During the year ended December 31, 2016, actual maturities have fallen below the Company's expectations. As a result, the Company anticipates a liquidity shortfall within three months after the date of this report, unless additional liquidity is obtained. Accordingly, the Company will continue to proactively manage its cash in order to effectively run its businesses and service its debt. The Company may, subject to the covenants and restrictions in its debt arrangements, sell or, under very limited circumstances, lapse certain of its policies as its portfolio management strategy and liquidity needs dictate. The lapsing of policies, if any, could result in events of default under the White Eagle Revolving Credit Facility and would create losses as such assets would be written down to zero.
On August 1, 2016, the Company initiated a formal process to explore strategic alternatives in response to receiving a number of unsolicited inquiries from several interested parties. The Company’s Board of Directors formed a special committee whose mandate is to review and consider strategic alternatives and to make recommendations to the full Board of Directors. Some of the possible strategic alternatives the special committee may consider are a sale of the Company, a merger or other business combination, a sale of all or a material portion of the Company’s assets, a joint venture, and a recapitalization. At December 31, 2016, the special committee was continuing its efforts to explore these initiatives. As a result, the Company does not currently intend to expend resources acquiring policies and will continue to sell shares of common stock under the Company's at-the-market offering program to assist with funding business operations.
While we expect to meet our liquidity needs for the next several months primarily through a combination of the receipt of death benefits from life insurance policy maturities, borrowings under the White Eagle Revolving Credit Facility, strategic capital market raises, delaying interest and other payments, policy sales (subject to the asset sale restrictions in our debt arrangements) and cash on hand, the Company has incurred substantial losses and negative cash flows from operating activities. The Company's current operating plan indicates that we will continue to incur losses from operations. These projections and other liquidity risks raise substantial doubt about whether we will meet our obligations as they become due within three months after the date of this report. As a result of these factors, as well as the continued uncertainty surrounding the timing of death benefits and our ability to raise capital, there exists substantial doubt whether we will be able to continue as a going concern.
The accompanying consolidated financial statements are prepared on a going concern basis and do not include any adjustments that might result from uncertainty about our ability to continue as a going concern. The report from our independent registered public accounting firm on our consolidated financial statements for the year ended December 31, 2016 includes an emphasis of matter paragraph that summarizes the salient facts or conditions that raise substantial doubt about our ability to continue as a going concern.
Under the Agreements, PJC and other parties agreed to certain undertakings, including: (i) PJC or its designee (the "Investor") purchasing up to 100% of the Company’s New Senior Notes from the Holders (as defined herein) pursuant to the Senior Note Purchase Agreement, (ii) PJC or the Investor purchasing $15.0 million in shares of Common Stock, pursuant to the Common Stock Purchase Agreement, and (iii) issuance to PJC or the Investor of a warrant to purchase up to 34,000,000 shares of Common Stock at an exercise price of $0.25 per share for an aggregate purchase price of up to $8.5 million. Upon the closing of the proposed transactions, the Company’s Board of Directors will include four members representing PJC and one member representing the convertible note holders. The Transaction is subject to certain conditions described in this Annual Report on Form 10-K, including that the Company shall have obtained the requisite approval by the Company's shareholders to the Articles Amendment and that the requisite number of holders of the Company's senior secured notes and unsecured convertible notes shall have tendered their notes in connection with the applicable exchange offer as described below, and certain customary closing conditions, including that each of the Transaction Documents shall have been executed and delivered to the other parties thereto. The Transaction is expected to close in the second quarter of 2017, although the consummation of the Transaction is subject to multiple conditions and there can be no assurance that the Transaction will close on a timely basis or at all.
At or contemporaneously with the closing of the Transaction, the Company will enter into a Common Stock Purchase Agreement (the "Purchase Agreement") with the purchasers' party to the Purchase Agreement (the "Purchasers"). The Purchase Agreement will generally provide for the Purchasers to purchase up to 92,000,000 shares of Common Stock at a price of $0.25 per share for an aggregate price of up to $23.0 million, of which PJC or the Investor will purchase 60,000,000 shares of Common Stock for an aggregate price of $15.0 million. The remaining Purchasers may purchase up to 32,000,000 shares of Common Stock for an aggregate price of up to $8.0 million. The Purchase Agreement shall contain customary representations, warranties, and covenants.
As part of the Transaction, the Company will offer to exchange, in each case with existing holders, its outstanding 8.5%Convertible Notes (the "Existing Convertible Notes") for 5.0% Senior Unsecured Convertible Notes due 2023 (the "New Convertible Notes") , and its outstanding 15.0% Senior Secured Notes (the "Existing Senior Notes") for 8.5% Senior Notes due 2021 (the "New Senior Notes". As a result of such exchanges. At least 98% of the holders of each class of notes must tender in the relevant exchange offer as a condition to closing the Transaction.
At or contemporaneously with the closing of the Transaction, the Company will cause to be issued the New Convertible Notes in an aggregate amount not to exceed approximately $75.0 million pursuant to a Convertible Note Indenture (the "New Convertible Note Indenture") between the Company and a trustee to be later identified.
The New Convertible Notes will be unsecured senior obligations of the Company and will mature six years from the Closing. The New Convertible Notes will bear interest at a rate of 5.00% per annum from the issue date, payable semi-annually.
See Note 20 "Subsequent Events," of the accompanying consolidated financial statements for additional information.
At December 31, 2016, the fair value of the debt under the White Eagle Revolving Credit Facility was $257.1 million. As of December 31, 2016, the borrowing base was approximately $262.1 million including $261.4 million in outstanding principal. Interest is calculated at LIBOR (subject to a floor of 1.5%) plus an applicable margin of 4.5% and is due quarterly. Interest totaling $11.0 million was paid during the year ended December 31, 2016, all of which was paid from policy proceeds. There are no scheduled repayments of principal prior to maturity although payments are due upon receipt of death benefits and distributed pursuant to the waterfall. At December 31, 2016, approximately $2.5 million included in cash and cash equivalents -VIE was on account with White Eagle for distribution through the waterfall.
Based on the loan agreement, the LIBOR portion of the interest rate will re-adjust annually once the floor has exceeded 1.5%. The applicable rate will be dependent on the rate at the last business day of the preceding calendar year. Future increase in LIBOR could have a material adverse effect on the Company’s financial position and results of operations. At December 31, 2016, LIBOR was increased to 1.69%.
At December 31, 2016, there was $70.7 million in aggregate principal amount of the Company’s 8.50% senior unsecured convertible notes due 2019 outstanding. For a description of the Convertible Notes see Note 10, "8.50% Senior Unsecured Convertible Notes," of the accompanying consolidated financial statement.
At December 31, 2016, there was $30.0 million in aggregate principal amount of the Company’s 15% Senior Secured
Effective July 16, 2015, Red Falcon, as borrower, entered into a $110.0 million 7-year credit facility that provided 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.
On December 29, 2016, Red Falcon Trust, entered into a Master Termination Agreement with its lender. The policies which served as collateral under the Red Falcon Revolving Credit Facility were sold to While Eagle. Proceeds totaling $65.1 million from this sale were utilized to repay the lender. See Note 9, "Red Falcon Revolving Credit Facility" to the accompanying consolidated financial statements.
On March 14, 2016, we filed a prospectus supplement with the SEC related to the offer and sale from time to time of our common stock at an aggregate offering price of up to $50.0 million through FBR Capital Markets & Co. and MLV & Co. LLC, as distribution agents. Sales of shares of our common stock under the prospectus supplement and the equity distribution agreement entered into with the distribution agents, if any, may be made in negotiated transactions or transactions that are
Net cash used in investing activities for the year ended December 31, 2015 was $41.0 million and included 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 certificate of deposit.
Net cash provided by financing activities for the year ended December 31, 2016 was $62.7 million and included $30.0 million of proceeds from the 15% Senior Secured Notes; $58.0 million of borrowings from the White Eagle Revolving Credit Facility; $19.7 million of borrowings from the Red Falcon Revolving Credit Facility and $1.8 million from issuance of common stock through the Company's "at the market" offerings. These were offset by $34.8 million in repayment of borrowings under the White Eagle Revolving Credit Facility and $10.5 million in repayment of borrowings under the Red Falcon Revolving Credit Facility.
Includes $2.4 million related to outstanding interest due for the White Eagle Revolving Credit Facility.