NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016
NOTE 1—ORGANIZATION AND DESCRIPTION OF BUSINESS ACTIVITIES
Founded in December 2006 as a Florida limited liability company, Imperial Holdings, LLC, converted into Imperial Holdings, Inc. on February 3, 2011, in connection with the Company’s initial public offering. Effective September 1, 2015, the Company changed its name to Emergent Capital, Inc. (with its subsidiary companies, the "Company" or "Emergent Capital").
Incorporated in Florida, Emergent Capital, through its subsidiary companies, 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.
619
of these policies, with an aggregate death benefit of approximately
$2.9 billion
and a fair value of
$497.7 million
at
December 31, 2016
are pledged under a
$370.0 million
, revolving credit agreement (the "White Eagle Revolving Credit Facility") entered into by the Company’s indirect subsidiary, White Eagle Asset Portfolio, LP ("White Eagle"). At
December 31, 2016
,
2
policies owned by the Company, with an aggregate death benefit of approximately
$12.0 million
and a fair value of
$680,000
were not pledged as collateral under the White Eagle Revolving Credit Facility.
NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company, all of its wholly-owned subsidiary companies and its special purpose entities, with the exception of Imperial Settlements Financing 2010, LLC ("ISF 2010"), an unconsolidated special purpose entity which is accounted for using the cost method of accounting. The special purpose entity has been created to fulfill specific objectives. All significant intercompany balances and transactions have been eliminated in consolidation, including income from services performed by subsidiary companies in connection with the Revolving Credit Facilities. Notwithstanding consolidation, as referenced above, White Eagle is the owner of
619
policies, with an aggregate death benefit of approximately
$2.9 billion
and an estimated fair value of approximately
$497.7 million
.
Going Concern and Management's Plan
The Company has incurred substantial losses and reported negative cash flows from operating activities of
$45.6 million
,
$54.3 million
and
$32.9 million
for the years ended
December 31, 2016
,
2015
and
2014
, respectively. As of
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. These factors raise substantial doubt about the ability of the Company to continue as a going concern.
The Company’s ability to continue as a going concern is dependent on its ability to meet its liquidity needs 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 certain asset sale restrictions) and cash on hand. Based on management’s forecast, the Company currently has sufficient cash to continue in operations approximately three months from the date of this report. The Company has entered into an agreement as described below subsequent to year end. No assurance can be given that the Company will be successful in these efforts.
On March 15, 2017, the Company entered into a series of separate Master Transaction Agreements (together, the "Agreements") by and between the Company, PJC Investments, LLC, a Texas limited liability company ("
PJC
"), and each such Consenting Convertible Note Holder that is a party to such Agreement ("Consenting
Holders") regarding a series of integrated transactions with the intent to effect a recapitalization of the Company (the "Transaction"), which includes an Amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of the Company's common stock,
$0.01
par value (the "Common Stock"), a Common Stock Purchase Agreement, a Convertible Note Exchange Offer, a New Convertible Note Indenture providing for the issuance of New Convertible Notes, a Senior Note Exchange Offer, a New Senior Note Indenture providing for the issuance of New Senior Notes, a Senior Note Purchase Agreement, a Warrant and certain other agreements and documents to be delivered in connection with the Transaction (each as defined in the Agreements, and together
with the Agreements, the "Transaction
Documents"). The Agreements and the transactions contemplated under the Agreements were unanimously approved by the Board of Directors of the Company on March 13, 2017.
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 herein, 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.
See Note 20 "Subsequent Events," to the accompanying consolidated financial statements for additional information.
Event of Default
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.
The accompanying consolidated financial statements are prepared on a going concern basis and do not include any adjustments that might result from uncertainty about the Company’s ability to continue as a going concern.
Discontinued Operations
On October 25, 2013, the Company sold substantially all of the assets comprising its structured settlement business for
$12.0 million
. As a result, the Company has discontinued segment reporting and classified its operating results of the structured settlement business, net of income taxes, as discontinued operations. The accompanying consolidated statements of operations for each of the three years in the period ended
December 31, 2016
,
2015
and
2014
and the related notes to the consolidated financial statements reflect the classification of its structured settlement business operating results, net of tax, as discontinued operations. See Note 6, "Discontinued Operations," of the accompanying consolidated financial statements for further information. Unless otherwise noted, the following notes refer to the Company’s continuing operations.
Ownership of Life Insurance Policies
In the ordinary course of our legacy premium finance business, a large portion of our borrowers defaulted by not paying off their loans and relinquished ownership of their life insurance policies to us in exchange for our release of the obligation to pay amounts due. We also buy life insurance policies in the secondary and tertiary markets. We account for life insurance policies that we own as life settlements (life insurance policies) in accordance with ASC 325-30,
Investments in Insurance Contracts
, which requires us to either elect the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. We have elected to account for these life insurance policies as investments using the fair value method.
We initially record life settlements at the transaction price. For policies acquired upon relinquishment by our borrowers, we determined the transaction price based on fair value of the acquired policies at the date of relinquishment. The difference between the net carrying value of the loan and the transaction price is recorded as a gain (loss) on loan payoffs and settlement. For policies acquired for cash, the transaction price is the amount paid.
Valuation of Insurance Policies
Our valuation of insurance policies is a critical component of our estimate of the fair value of our life settlements (life insurance policies). We currently use a probabilistic method of valuing life insurance policies, which we believe to be the preferred valuation method in the industry. The most significant assumptions are the Company’s estimate of the life expectancy of the insured and the discount rate. See Note 13, "Fair Value Measurements" of the accompanying consolidated financial statements.
Fair Value Measurement Guidance
We follow ASC 820,
Fair Value Measurements and Disclosures
, which defines fair value as an exit price representing the amount that would be received if an asset were sold or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our investments in life insurance policies, and debt under the Revolving Credit Facilities are considered Level 3 as there is currently no active market where we are able to observe quoted prices for identical assets/liabilities and our valuation model incorporates significant inputs that are not observable. See Note 13, "Fair Value Measurements" of the accompanying consolidated financial statements.
Fair Value Option
We have elected to account for life settlements using the fair value method. The fair value of the asset is the estimated amount that would be received to sell an asset in an orderly transaction between market participants at the measurement date. We calculate the fair value of the asset using a present value technique to estimate the fair value of the life settlements. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. See Note 7, "Life Settlements (Life Insurance Policies)" and Note 13, "Fair Value Measurements" of the accompanying consolidated financial statements.
We have elected to account for the debt under the Revolving Credit Facilities, which includes the interests in policy proceeds to the lender, using the fair value method. The fair value of the debt is the estimated amount that would have to be paid to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the applicable credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of assumptions and/or estimation methodologies could have a material effect on estimated fair values.
In February 2014, the Company issued and sold
$70.7 million
in aggregate principal amount of
8.50%
senior unsecured convertible notes due 2019 (the "Convertible Notes"). Prior to shareholder approval on June 5, 2014 to issue shares of common stock upon conversion of the Convertible Notes in excess of New York Stock Exchange limits for share issuances without shareholder approval, the Convertible Notes contained an embedded derivative feature. In accordance with Accounting Standards Codification ("ASC" 815,
Derivatives and Hedging),
derivative instruments are recognized as either assets or liabilities on the Company’s balance sheet and are measured at fair value with gains or losses recognized in earnings. Embedded derivatives that are not clearly and closely related to the host contract, such as the Convertible Notes, are bifurcated and recognized at fair value with changes in fair value recognized as either a gain or loss in earnings if they can be reliably measured. The Company determined the fair value of its embedded derivative based upon available market data and unobservable inputs using a Black Scholes pricing model. In accordance with ASC 815, upon receipt of shareholder approval on June 5, 2014, the Company reclassified the embedded derivative to equity along with unamortized transaction costs proportionate to the allocation of the initial debt discount and the principal amount of the Convertible Notes. The Convertible Notes are recorded at accreted value and will continue to be accreted up to the par value of the Convertible Notes at maturity. See Note 10, "8.50% Senior Unsecured Convertible Notes" of the accompanying consolidated financial statements.
Income Recognition from Continuing Operations
Our primary sources of income from continuing operations are in the form of changes in fair value 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 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 a death notice or verified obituary of the insured. This income is the difference between the death benefit and fair value of the policy at the time of maturity.
|
|
|
•
|
Loss on Life Settlements, Net
—The Company recognizes gains or losses from the sale of life settlement contracts that the Company owns upon the signed sale agreement and/or filing of ownership forms and funds transferred to escrow.
|
Income Taxes
In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists ("ASU 2013-11"). ASU 2013-11 requires, unless certain conditions exists, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, similar tax loss, or a tax credit carryforward. The Company adopted ASU 2013-11 effective on
January 1, 2014
, which required the Company to reclassify a
$6.3 million
current liability for unrecognized tax benefits to deferred taxes.
In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, which requires that all deferred tax assets and liabilities, along with any related valuation allowances be classified as a net noncurrent asset or liability in the balance sheet based on a jurisdictional basis. The new guidance will be effective for public business entities in fiscal years beginning after December 15, 2016, including interim periods within those years. The adoption of this guidance only affects the presentation of deferred taxes in the Company’s consolidated balance sheets.
On March 30, 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. Under current GAAP a difference exists between the amount and timing of compensation cost recognized for financial reporting purposes and compensation cost that is ultimately deductible for income tax purposes, thus creating deferred taxes. Upon exercise or vesting of an award, the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting creates an excess tax benefit or tax deficiency, which is recorded against the APIC pool. ASU 2016-09 eliminates the APIC pool as all tax benefits and tax deficiencies would be recognized as an income tax benefit or expense in the income statement period in which they become deductible on the tax return. The new guidance will become effective for fiscal years beginning after December 15, 2016, including interim periods within those years. We are currently evaluating whether the adoption of this new guidance will have a significant impact on the consolidated financial statements and related disclosures.
In October 2016, the FASB issued ASU No. 2016-16 Income Taxes (Topic 740): Intra-entity transfers of assets other than inventory (“ASU 2016-16”). Current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party. This prohibition on recognition is an exception to the principle of comprehensive recognition of current and deferred income taxes in GAAP. The Board decided that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Consequently, the amendments in this Update eliminate the exception for an intra-entity transfer of an asset other than inventory. For public business entities, the amendments in this Update are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. We are currently evaluating whether the adoption of this new guidance will have a significant impact on our consolidated financial statements and related disclosures.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and all highly liquid instruments with an original maturity of three months or less, when purchased. The Company maintains the majority of its cash in several operating accounts with two
commercial banks. Balances on deposit are insured by the Federal Deposit Insurance Corporation ("FDIC"). However, from time to time, the Company’s balances may exceed the FDIC insurable amount at its banks.
Certificate of Deposit
The Company maintains a portion of its operating funds in certificate of deposits. At
December 31, 2016
, the carrying amount of the certificates of deposit is
$6.0 million
, consisting of certificates amounting to
$1.0 million
and
$5.0 million
, which approximates fair value. The certificates of deposit mature on September 22, 2017 and June 7, 2017, respectively and bears interest at a rate of
0.2%
and
1%
, respectively.
Deferred Debt Costs
Deferred debt costs include costs incurred in connection with acquiring and maintaining debt arrangements. These costs are amortized over the life of the related debt instrument using the effective interest method and are classified as interest expense in the accompanying consolidated statement of operations. These deferred debt costs are related to the Company’s Convertible Notes and
15%
Senior Secured Notes that were issued by the Company. The Company did
not
recognize any deferred costs on its Revolving Credit Facilities given all costs were expensed due to electing the fair value option in valuing the Revolving Credit Facilities.
Treasury Stock
The Company accounts for its treasury stock using the treasury stock method as set forth in ASC 505-30,
Treasury Stock
. Under the treasury stock method, the total amount paid to acquire the stock is recorded and no gain or loss is recognized at the time of purchase. Gains and losses are recognized at the time the treasury stock is reinstated or retired and are recorded in additional paid in capital or retained earnings. At
December 31, 2016
, the Company owned
608,000
shares of treasury stock.
Stock-Based Compensation
We have adopted ASC 718,
Compensation—Stock Compensation.
ASC 718 addresses accounting for share-based awards, including stock options, restricted stock, performance shares and warrants, with compensation expense measured using fair value and recorded over the requisite service or performance period of the award. The fair value of equity instruments awarded will be determined based on a valuation using an option pricing model that takes into account various assumptions that are subjective. Key assumptions used in the valuation will include the expected term of the equity award taking into account both the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award. Compensation expense associated with performance shares is only recognized to the extent that it is probable the performance measurement will be met.
Earnings Per Share
The Company computes net income per share in accordance with ASC 260,
Earnings Per Share
. Under the provisions of ASC 260, basic net income per share is computed by dividing the net income available to common shareholders by the weighted average common shares outstanding during the period. Diluted net income per share adjusts basic net income per share for the effects of stock options, warrants and restricted stock awards only in periods in which such effect is dilutive. ASC 260 also requires the Company to present basic and diluted earnings per share information separately for each class of equity instruments that participate in any income distribution with primary equity instruments.
Held-for-sale and discontinued operations
We report a business as held-for-sale when management has approved or received approval to sell the business and is committed to a formal plan, the business is available for immediate sale, the business is being actively marketed, the sale is anticipated to occur during the ensuing year and certain other specified criteria are met. A business classified as held-for-sale is recorded at the lower of its carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Depreciation is not recorded on assets of a business classified as held-for-sale. Assets and liabilities related to a business classified as held-for-sale are segregated in the Consolidated Balance Sheet and major classes are separately disclosed in the notes to the Consolidated Financial Statements commencing in the period in which the business is classified as held-for-sale. We report the results of operations of a business as discontinued operations if the business is classified as held-for-sale, the operations and cash flows of the business have been or will be eliminated from the ongoing operations of the Company as a result of a disposal transaction and we will not have any significant continuing involvement in the operations of the business after the disposal transaction. The results of discontinued operations are reported in Discontinued Operations in the Consolidated Statement of Operations for current and prior periods commencing in the period in which the business meets the criteria of a discontinued operation, and include any gain or loss recognized on closing or adjustment of the carrying amount to fair value less cost to sell. During the fourth quarter of 2013, we sold substantially all of our structured settlements business. As a result, we have classified our structured settlement operating results as discontinued operations.
Foreign Currency
We own certain foreign subsidiary companies formed under the laws of Ireland, Bahamas and Bermuda. These foreign subsidiary companies utilize the U.S. dollar as their functional currency. The foreign subsidiary companies financial statements are denominated in U.S. dollars and therefore, there are no translation gains and losses resulting from converting the financial statements at exchange rates other than the functional currency. Any gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the subsidiary companies functional currency) are included in income. These gains and losses are immaterial to our financial statements.
Use of Estimates
The preparation of these consolidated financial statements, in conformity with generally accepted accounting principles in the United States of America ("GAAP"), requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from these estimates and such differences could be material. Significant estimates made by management include income taxes, the valuation of life settlements, the valuation of the debt owing under the White Eagle Revolving Credit Facility, the valuation of equity awards and the valuation of the conversion derivative liability formerly embedded within the Company’s Convertible Notes.
Risks and Uncertainties
In the normal course of business, the Company encounters economic, legal and longevity risk. There are two main components of economic risk that could potentially impact the Company: market risk and concentration of credit risk. Market risk for the Company includes interest rate risk. Market risk also reflects the risk of declines in valuation of the Company’s life settlements, including declines caused by the selection of increased discount rates associated with the Company’s fair value model for life settlements. It is reasonably possible that future changes to estimates involved in valuing life settlements could change and result in material effects to the future financial statements. Concentration of credit risk includes the risk that an insurance carrier who has issued life insurance policies held by the Company in its portfolio, does not remit the amount due under those policies due to the deteriorating financial condition of the carrier or otherwise. Legal risk includes the risk that statutes define or courts interpret insurable interest in a manner adverse to the Company’s ownership rights in its portfolio of life insurance policies and the risk that courts allow insurance carriers to retain premiums paid by the Company in respect of insurance policies that have been successfully rescinded or contested. Longevity risk refers to the risk that the Company does not experience the mortalities of insureds in its portfolio of life insurance policies that are anticipated to occur on an actuarial basis in a timely manner, which would result in the Company expending additional amounts for the payment of premiums.
Reclassification
Certain reclassification of the prior period amounts and presentation have been made to conform to the presentation of the current period. This reclassification relates primarily to the adoption of ASU No. 2015-03, "Interest—Imputation of Interest (Subtopic 835-30): which provides guidance on the balance sheet presentation for debt issuance costs and impacts the Convertible Notes.
Change in Accounting Principle and Accounting for Debt Issuance Costs
The Company adopted ASU No. 2015-03, "Interest—Imputation of Interest (Subtopic 835-30)" on January 1, 2016. Upon adoption of ASU No. 2015-03, deferred debt issuance costs related to the Convertible Notes previously presented in the Company's consolidated balance sheet as an asset have been reclassified as a direct deduction to the carrying amount of the liability. The adoption of this ASU did not result in changes to the consolidated statements of operations, stockholders' equity, or statement of cash flows. In transitioning the application of this guidance, retrospective application to all periods presented in the consolidated financial statements has been performed as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As reported under previous accounting guidance
|
|
As reported under ASU 2015-03
|
|
Effect of change
|
Balance Sheet
|
|
|
|
|
|
December 31, 2015
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
Deferred debt costs
|
$
|
1,797
|
|
|
$
|
—
|
|
|
$
|
(1,797
|
)
|
Total assets
|
$
|
509,857
|
|
|
$
|
508,060
|
|
|
$
|
(1,797
|
)
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
Convertible Notes, net of discount
|
58,609
|
|
|
56,812
|
|
|
(1,797
|
)
|
Total liabilities
|
289,500
|
|
|
287,703
|
|
|
(1,797
|
)
|
|
|
|
|
|
|
Total stockholders' equity
|
220,357
|
|
|
220,357
|
|
|
—
|
|
|
|
|
|
|
|
Total liabilities and stockholders' equity
|
$
|
509,857
|
|
|
$
|
508,060
|
|
|
$
|
(1,797
|
)
|
|
|
|
|
|
|
Net effect
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers," which converges the FASB and the International Accounting Standards Board ("IASB") standard on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. In April 2015, the FASB voted to defer the effective date of the new revenue recognition standard by one year. As a result, the provisions of this ASU are now effective for interim and annual periods beginning after December 15, 2017. The Company does not expect that this guidance will have a material impact on its financial position, results of operations or cash flows.
In August 2014, the FASB issued ASU No. 2014-15, "Disclosures of Uncertainties About an Entity’s Ability to Continue as a Going Concern." The standard provides guidance around management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The Company did not early adopt, but will adopt in the first quarter of 2017 and management will be required to perform a going concern analysis given our current liquidity needs.
In February 2015, the FASB issued ASU No. 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis." This guidance focuses on a reporting company’s consolidation evaluation to determine whether they should consolidate certain legal entities. This guidance is effective for annual periods beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Company has determined that this guidance does not have
an impact on its consolidated financial statements.
In November 2015, the FASB issued ASU No. 2015-17, "Income Taxes (Topic 740): Balance Sheet Classifications of Deferred Taxes," which aligns the FASB and the IASB standard for financial statement presentation of deferred income taxes. To simplify the presentation of deferred income taxes, this standard requires that deferred tax assets and liabilities be presented as noncurrent on the balance sheet. This ASU is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted, including adoption in an interim period. This guidance did not have any material impact on our financial position, results of operations or cash flows.
In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments." This ASU provides specific guidance on eight cash flow classification issues that are either unclear or not included in current GAAP. These cash flow classification issues include debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. We are currently evaluating the impact that the adoption of ASU 2016-15 will have on our consolidated financial statements.
NOTE 3—CONSOLIDATION OF VARIABLE INTEREST ENTITIES
The Company evaluates its interests in variable interest entities ("VIEs") on an ongoing basis and consolidates those VIEs in which it has a controlling financial interest and is thus deemed to be the primary beneficiary. A controlling financial interest has both of the following characteristics: (i) the power to direct the activities of the VIE that most significantly impact its economic performance; and (ii) the obligation to absorb losses of the VIE that could potentially be significant to it or the right to receive benefits from the VIE that could be potentially significant to the VIE.
The following table presents the consolidated assets and consolidated liabilities of VIEs for which the Company has concluded that it is the primary beneficiary and which are consolidated in the Company’s financial statements as of
December 31, 2016
and
2015
, as well as non-consolidated VIEs for which the Company has determined it is not the primary beneficiary (in thousands):
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|
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|
|
|
|
|
|
|
|
|
|
|
|
Primary Beneficiary
|
|
Not Primary Beneficiary
|
|
Consolidated VIEs
|
|
Non-consolidated VIEs
|
|
Assets
|
|
Liabilities
|
|
Total Assets
|
|
Maximum Exposure To Loss
|
December 31, 2016
|
$
|
511,792
|
|
|
$
|
257,678
|
|
|
$
|
2,384
|
|
|
$
|
2,384
|
|
December 31, 2015
|
$
|
475,597
|
|
|
$
|
225,208
|
|
|
$
|
2,384
|
|
|
$
|
2,384
|
|
As of
December 31, 2016
,
619
life insurance policies owned by White Eagle with an aggregate death benefit of approximately
$2.9 billion
and an estimated fair value of approximately
$497.7 million
were pledged as collateral under the White Eagle Revolving Credit Facility. In accordance with ASC 810,
Consolidation
, the Company consolidated White Eagle in its financial statements for the years ended
December 31, 2016
and
2015
.
As of
December 31, 2015
,
156
life insurance policies owned by Red Falcon were pledged as collateral under the Red Falcon Revolving Credit Facility. In accordance with ASC 810,
Consolidation
, the Company consolidated Red Falcon in its financial statements for the years ended
December 31, 2015
and 2016 (until termination). The Red Falcon Facility was terminated on December 29, 2016. See Note 9, "Red Falcon Revolving Credit Facility" to the accompanying consolidated financial statements.
NOTE 4—EARNINGS PER SHARE
As of
December 31, 2016
,
2015
and
2014
, there were
29,021,844
,
28,130,508
and
21,402,990
shares of common stock issued, respectively, and
28,413,844
,
27,522,508
, and
21,402,990
of shares of common stock outstanding, respectively. Outstanding shares as of
December 31, 2016
and
2015
have been adjusted to reflect
608,000
treasury shares.
Basic net income per share is computed by dividing the net earnings attributable to common shareholders by the weighted average number of common shares outstanding during the period.
Diluted earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding, increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Conversion or exercise of the potential common shares is not reflected in diluted earnings per share unless the effect is dilutive. The dilutive effect, if any, of outstanding common share equivalents is reflected in diluted earnings per share by application of the treasury stock method, as applicable.
The following tables reconcile actual basic and diluted earnings per share for the years ended
December 31, 2016
,
2015
and
2014
(in thousands except per share data).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
|
(1)
|
|
(2)
|
|
(3)
|
Loss per share:
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
Net (loss) income from continuing operations
|
$
|
(49,429
|
)
|
|
$
|
(30,380
|
)
|
|
$
|
(5,151
|
)
|
Net (loss) income from discontinued operations
|
(260
|
)
|
|
(644
|
)
|
|
(369
|
)
|
Net (loss) income
|
$
|
(49,689
|
)
|
|
$
|
(31,024
|
)
|
|
$
|
(5,520
|
)
|
Basic and diluted (loss) income per common share:
|
|
|
|
|
|
Basic and diluted (loss) income per share from continuing operations
|
$
|
(1.79
|
)
|
|
$
|
(1.22
|
)
|
|
$
|
(0.24
|
)
|
Basic and diluted (loss) income per share from discontinued operations
|
$
|
(0.01
|
)
|
|
$
|
(0.03
|
)
|
|
(0.02
|
)
|
Basic and diluted (loss) income per share available to common shareholders
|
$
|
(1.80
|
)
|
|
$
|
(1.25
|
)
|
|
$
|
(0.26
|
)
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
Basic and diluted
|
27,660,711
|
|
|
24,851,178
|
|
|
21,354,567
|
|
|
|
(1)
|
The computation of diluted EPS does not include
763,594
options,
6,240,521
warrants,
265,212
shares of restricted stock, and up to
10,738,165
shares of underlying common stock issuable upon conversion of the Convertible Notes for the year ended
December 31, 2016
, as the effect of their inclusion would have been anti-dilutive.
|
|
|
(2)
|
The computation of diluted EPS did not include
774,394
options,
6,240,521
warrants,
41,259
shares of restricted stock, up to
10,738,165
shares of underlying common stock issuable upon conversion of the Convertible Notes and
319,500
performance shares for the year ended
December 31, 2015
, as the effect of their inclusion would have been anti-dilutive.
|
|
|
(3)
|
The computation of diluted EPS did not include
807,949
options and
6,240,521
warrants,
41,060
shares of restricted stock, up to
10,464,941
shares of underlying common stock issuable upon conversion of the Convertible Notes, and
323,500
performance shares for the year ended
December 31, 2014
, as the effect of their inclusion would have been anti-dilutive.
|
NOTE 5—STOCK-BASED COMPENSATION
On May 28, 2015, the Company amended and restated its 2010 Omnibus Incentive Plan (the "Omnibus Plan"). Awards under the Omnibus Plan may consist of incentive awards, stock options, stock appreciation rights, performance shares, performance units, and shares of common stock, restricted stock, restricted stock units or other stock-based awards as determined by the compensation committee of the Company's board of directors. The Omnibus Plan provides for an aggregate of
2,700,000
shares of common stock to be reserved for issuance under the Omnibus Plan, subject to adjustment as provided in the Omnibus Plan.
Options
As of
December 31, 2016
, all options to purchase shares of common stock issued by the Company were fully vested. The Company recognized approximately
$0
,
$238,000
, and
$765,000
in stock-based compensation expense relating to stock options it granted under the Omnibus Plan during the years ended
December 31, 2016
,
2015
, and
2014
, respectively.
As of
December 31, 2016
, options to purchase
763,594
shares of common stock were outstanding under the Omnibus Plan at a weighted average exercise price of
$8.52
per share.
The following table presents the activity of the Company’s outstanding stock options of common stock for the year ended
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock Options
|
Number of Shares
|
|
Weighted Average Price per Share
|
|
Weighted Average Remaining Contractual Term
|
|
Aggregate Intrinsic Value
|
Options outstanding, January 1, 2016
|
774,394
|
|
|
$
|
8.50
|
|
|
3.47
|
|
|
$
|
—
|
|
Options granted
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
Options exercised
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
Options forfeited
|
(10,800
|
)
|
|
7.22
|
|
|
—
|
|
|
|
|
Options expired
|
—
|
|
|
—
|
|
|
—
|
|
|
|
|
Options outstanding, December 31, 2016
|
763,594
|
|
|
$
|
8.52
|
|
|
2.47
|
|
|
$
|
—
|
|
Exercisable at December 31, 2016
|
763,594
|
|
|
8.52
|
|
|
2.47
|
|
|
|
|
Unvested at December 31, 2016
|
—
|
|
|
$
|
—
|
|
|
—
|
|
|
$
|
—
|
|
As of
December 31, 2016
, all outstanding stock options had an exercise price above the fair market value of the common stock on that date. There are
no
remaining unamortized amounts to be recognized on these options.
Restricted Stock
The Company incurred additional stock-based compensation expense of approximately
$411,000
,
$252,000
, and
$191,000
relating to restricted stock granted to its board of directors and certain employees during the years ended
December 31, 2016
,
2015
, and
2014
, respectively.
Under the Omnibus Plan,
41,060
shares of restricted stock granted to the Company's directors during 2014 vested during the year ended
December 31, 2015
. The fair value of the restricted stock was approximately
$255,000
based on the closing price of the Company's shares on the day prior to the grant date. The Company incurred additional stock-based compensation expense of approximately
$0
and
$108,000
, respectively, related to these
41,060
shares of restricted stock during the years ended
December 31, 2016
and
2015
.
Under the Omnibus Plan,
41,259
shares of restricted stock granted to the Company's directors during 2015 vested during the year ended
December 31, 2016
. The fair value of the restricted stock was valued at
$255,000
based on the closing price of the Company’s shares on the day prior to the grant date. The Company incurred stock-based compensation expense of approximately
$103,000
and
$144,000
related to these
41,259
shares of restricted stock during the years ended
December 31, 2016
and
2015
, respectively.
During the year ended
December 31, 2016
, the Company granted
65,212
shares of restricted stock to its directors under the Omnibus Plan, which are subject to a
one
year vesting period that commenced on the date of the grant. The fair value of the unvested restricted stock was valued at approximately
$255,000
based on the closing price of the Company's shares on the date prior to the grant date. The Company incurred stock-based compensation expense of approximately
$141,000
related to these
65,212
shares of restricted stock during the year ended
December 31, 2016
.
During the year ended
December 31, 2016
, the Company granted
200,000
shares of restricted stock units to certain employees under the Omnibus Plan, which are subject to a
two
year vesting period that commenced on the date of grant. The fair value of the unvested restricted stock was valued at approximately
$674,000
based on the closing price of the Company's shares on the day prior to the grant date. The Company incurred stock-based compensation expense of approximately
$168,000
related to these
200,000
shares of restricted stock during the year ended
December 31, 2016
.
The following table presents the activity of the Company’s unvested restricted stock for the year ended
December 31, 2016
:
|
|
|
|
Common Unvested Shares
|
Number of Shares
|
Outstanding January 1, 2016
|
41,259
|
|
Granted
|
265,212
|
|
Vested
|
(41,259
|
)
|
Forfeited
|
—
|
|
Outstanding December 31, 2016
|
265,212
|
|
The aggregate intrinsic value of the awards of
65,212
and
200,000
is
$78,000
and
$242,000
, respectively, and the remaining weighted average life of these awards is
0.42
years and
1.48
years, respectively, as of
December 31, 2016
.
Performance Shares
During 2014, the Company awarded
323,500
target performance shares for restricted common stock to its directors and certain employees, of which
150,000
shares were subject to shareholder approval of the Omnibus Plan, which was obtained at the Company’s 2015 annual meeting on May 28, 2015. The issuance of the performance shares was contingent on the Company’s financial performance, as well as the performance of the Company’s common stock through June 30, 2016, with the actual shares to be issued ranging between
0
–
150%
of the target performance shares. During the year ended
December 31, 2015
,
4,000
of the performance shares were forfeited. Given that the Company's financial performance goal was not achieved during the year ended
December 31, 2016
, the remaining performance shares have been forfeited. At
December 31, 2015
, the Company determined that it was not probable that the performance conditions would be achieved and
no
related expense was recognized for the year then ended.
The following table presents the activity of the Company’s performance share awards for the year ended
December 31, 2016
:
|
|
|
|
Performance Shares
|
Number of Shares
|
Outstanding January 1, 2016
|
319,500
|
|
Awarded
|
—
|
|
Vested
|
—
|
|
Forfeited
|
(319,500
|
)
|
Outstanding December 31, 2016
|
—
|
|
Warrants
On February 11, 2011,
three
shareholders received warrants that may be exercised for up to a total of
4,240,521
shares of the Company’s common stock at a weighted average exercise price of
$14.51
per share. The warrants will expire
seven years
after the date of issuance and are exercisable as they are fully vested. At
December 31, 2016
, all
4,240,521
warrants remained outstanding.
In connection with a settlement of class action litigation arising in connection with the investigation by the U.S. Attorney's Office for District of New Hampshire ("USAO") into the Company's now legacy premium finance business (the "USAO Investigation"), the Company issued warrants to purchase
2,000,000
shares of the Company’s stock into an escrow account in April of 2014. The estimated fair value as of the measurement date of such warrants was
$5.4 million
, which is included in stockholders’ equity. The warrants were distributed in October 2014 and have a
five
-year term from the date they were distributed to the class participants with an exercise price of
$10.75
. The Company is obligated to file a registration statement to register the shares underlying the warrants with the SEC if shares of the Company’s common stock have an average daily trading closing price of at least
$8.50
per share for a
45
day period. The warrants will be exercisable upon effectiveness of the registration statement.
NOTE 6—DISCONTINUED OPERATIONS
On October 25, 2013, the Company sold substantially all of the operating assets comprising its structured settlement business to Majestic Opco LLC pursuant to an Asset Purchase Agreement. No structured settlement receivables were sold and
no on-balance sheet liabilities were transferred in connection with the sale. On August 18, 2015, the Company sold its remaining structured settlement receivables asset for
$920,000
to the buyer of its operating assets.
As a result of the sale of its structured settlements business, the Company reclassified its structured settlement business operating results as discontinued operations in the accompanying Consolidated Statements of Operations for all periods presented.
Operating results related to the Company’s discontinued structured settlement business are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2016
|
|
2015
|
|
2014
|
|
(in thousands)
|
Total income
|
$
|
12
|
|
|
$
|
81
|
|
|
$
|
192
|
|
Total expenses
|
272
|
|
|
725
|
|
|
793
|
|
Income (loss) before income taxes
|
(260
|
)
|
|
(644
|
)
|
|
(601
|
)
|
Income tax benefit
|
—
|
|
|
—
|
|
|
232
|
|
Income (loss) from discontinued operations, net of income taxes
|
$
|
(260
|
)
|
|
$
|
(644
|
)
|
|
$
|
(369
|
)
|
NOTE 7—LIFE SETTLEMENTS (LIFE INSURANCE POLICIES)
The Company accounts for policies it acquires using the fair value method in accordance with ASC 325-30-50
Investments—Other—Investment in Insurance Contracts
. Under the fair value method, the Company recognizes the initial investment at the purchase price. For policies that were relinquished in satisfaction of premium finance loans at maturity, the initial investment is the loan carrying value. For policies purchased in the secondary or tertiary markets, the initial investment is the amount of cash outlay at the time of purchase. At each reporting period, the Company re-measures the investment at fair value in its entirety and recognizes changes in the Statements of Operations in the periods in which the changes occur.
As of
December 31, 2016
and
2015
, the Company owned
621
and
632
policies, respectively, with an aggregate estimated fair value of life settlements of
$498.4 million
and
$461.9 million
, respectively.
The weighted average life expectancy calculated based on death benefit of insureds in the policies owned by the Company at
December 31, 2016
was
9.0 years
. The following table describes the Company’s life settlements as of
December 31, 2016
(dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Remaining Life Expectancy (In Years)*
|
Number of Life Settlement Contracts
|
|
Fair Value
|
|
Face Value
|
0-1
|
4
|
|
|
$
|
16,280
|
|
|
$
|
19,497
|
|
1-2
|
14
|
|
|
35,019
|
|
|
52,093
|
|
2-3
|
14
|
|
|
31,300
|
|
|
57,274
|
|
3-4
|
31
|
|
|
44,096
|
|
|
114,449
|
|
4-5
|
40
|
|
|
57,792
|
|
|
172,157
|
|
Thereafter
|
518
|
|
|
313,913
|
|
|
2,531,041
|
|
Total
|
621
|
|
|
$
|
498,400
|
|
|
$
|
2,946,511
|
|
*Based on remaining life expectancy at
December 31, 2016
, as derived from reports of third party life expectancy providers, and does not indicate the timing of expected death benefits. See "Life Settlements," in Note 13, "Fair Value Measurements," of the accompanying consolidated financial statements.
The weighted average life expectancy calculated based on death benefit of insureds in the policies owned by the Company at
December 31, 2015
was
9.9 years
. The following table describes the Company’s life settlements as of
December 31, 2015
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Remaining Life Expectancy (In Years)*
|
Number of Life Settlement Contracts
|
|
Fair Value
|
|
Face Value
|
0-1
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
1-2
|
12
|
|
|
28,873
|
|
|
42,988
|
|
2-3
|
17
|
|
|
47,272
|
|
|
84,497
|
|
3-4
|
18
|
|
|
24,450
|
|
|
58,154
|
|
4-5
|
31
|
|
|
42,304
|
|
|
124,720
|
|
Thereafter
|
554
|
|
|
319,026
|
|
|
2,668,993
|
|
Total
|
632
|
|
|
$
|
461,925
|
|
|
$
|
2,979,352
|
|
*Based on remaining life expectancy at
December 31, 2015
, as derived from reports of third party life expectancy providers, and does not indicate the timing of expected death benefits. See "Life Settlements," in Note 13, "Fair Value Measurements," of the accompanying consolidated financial statements.
Estimated premiums to be paid for each of the five succeeding fiscal years and thereafter to keep the life insurance policies in force as of
December 31, 2016
, are as follows (in thousands):
|
|
|
|
|
2017
|
$
|
82,267
|
|
2018
|
85,023
|
|
2019
|
92,442
|
|
2020
|
96,650
|
|
2021
|
97,135
|
|
Thereafter
|
877,808
|
|
|
$
|
1,331,325
|
|
The amount of
$1.33 billion
noted above represents the estimated total future premium payments required to keep the life insurance policies in force during the life expectancies of all the underlying insured lives and does not give effect to projected receipt of death benefits. The estimated total future premium payments could increase or decrease significantly to the extent that insurance carriers increase the cost of insurance on their issued policies or that actual mortalities of insureds differs from the estimated life expectancies.
NOTE 8—WHITE EAGLE REVOLVING CREDIT FACILITY
Effective
April 29, 2013
, White Eagle entered into a
15
-year revolving credit agreement with LNV Corporation, as initial lender, Imperial Finance & Trading, LLC, as servicer and portfolio manager and CLMG Corp., as administrative agent. Proceeds from the initial advance under the facility were used, in part, to retire a bridge facility and to fund a payment to the lender protection insurance provider to release subrogation rights in certain of the policies pledged as collateral for the White Eagle Revolving Credit Facility. On May 16, 2014, White Eagle Asset Portfolio, LLC converted from a Delaware limited liability company to White Eagle Asset Portfolio, LP, a Delaware limited partnership (the “Conversion”) and all of its ownership interests were transferred to an indirect, wholly-owned Irish subsidiary of the Company. In connection with the Conversion, the White Eagle Revolving Credit Facility was amended and restated among White Eagle, as borrower, 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. The White Eagle Revolving Credit Facility was amended on November 9, 2015. As amended, the White Eagle Revolving Credit Facility may provide earlier participation in the portfolio cash flows if certain loan to value ("LTV") ratios are achieved. Additionally, the maximum facility limit was reduced from
$300.0 million
to
$250.0 million
, and the interest rate under the facility was increased by
50 basis points
.
On December 29, 2016, White Eagle entered into a Second Amendment to the Amended and Restated Loan and Security Agreement ("White Eagle Second Amendment") and on
January 31, 2017, as required by the terms of the White Eagle Amendment, White Eagle executed the Second Amended and Restated Loan and Security Agreement, dated January 31, 2017, which consolidated into a single document the amendments evidenced by the White Eagle Amendment and all previous amendments. See Note 20 "Subsequent Events," of the accompanying consolidated financial statements.
As amended, the White Eagle Revolving Credit Facility adjusted the ("LTV") ratios which directed cash flow participation and became subjected to achieving certain financial metrics, as more fully described below under "Amortization & Distributions." Pursuant to the White Eagle Second Amendment,
190
life settlement policies purchased from wholly owned subsidiaries of the Company were pledged as additional collateral under the facility for an additional policy advance of approximately
$71.1 million
. The maximum facility limit was increased to
$370.0 million
and the term of the facility was extended to December 31, 2031. Additional loan terms and amendment changes are more fully described in the sections that follow.
General & Security
. The White Eagle Revolving Credit Facility provides for an asset-based revolving credit facility backed by White Eagle’s portfolio of life insurance policies with an aggregate lender commitment of up to
$370.0 million
, subject to borrowing base availability.
619
life insurance policies with an aggregate death benefit of approximately
$2.9 billion
and an estimated fair value of approximately
$497.7 million
are pledged as collateral under the White Eagle Revolving Credit Facility at
December 31, 2016
. In addition, the equity interests in White Eagle have been pledged under the White Eagle Revolving Credit Facility.
Borrowing Base.
Borrowing availability under the White Eagle Revolving Credit Facility is subject to a borrowing base, which at any time is equal to the lesser of (A) the sum of all of the following amounts that have been funded or are to be funded through the next distribution date (i) the initial advance and all additional advances to acquire additional pledged policies that are not for ongoing maintenance advances, plus (ii)
100%
of the sum of the ongoing maintenance costs, plus (iii)
100%
of accrued and unpaid interest on borrowings (excluding the rate floor portion described below), plus (iv)
100%
of any other fees and expenses funded and to be funded as approved by the required lenders, less (v) any required payments of principal and interest previously distributed and to be distributed through the next distribution date; (B)
75%
of the valuation of the policies pledged as collateral as determined by the lenders; (C)
50%
of the aggregate face amount of the policies pledged as collateral (excluding certain specified life insurance policies); and (D) the then applicable facility limit. At
December 31, 2016
,
$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.
Amortization & Distributions.
Proceeds from the maturity of the policies pledged as collateral under the White Eagle Revolving Credit Facility are distributed pursuant to a waterfall. 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:
|
|
|
|
|
|
|
|
|
|
LTV
|
|
Premiums, Interest & Other Fees
|
|
Principal
|
|
Distribution to White Eagle - 55%
|
|
Lender Participation - 45%
|
N/A
|
|
100%
|
|
—%
|
|
—%
|
|
—%
|
>65%
|
|
N/A
|
|
100%
|
|
—%
|
|
—%
|
50-65%
|
|
N/A
|
|
70%
|
|
16.5%
|
|
13.5%
|
35-50%
|
|
N/A
|
|
55%
|
|
24.8%
|
|
20.3%
|
0-35%
|
|
N/A
|
|
45%
|
|
30.3%
|
|
24.8%
|
Provided that (i) if (a) the Company failed to maintain a cash interest coverage ratio of at least
2.0
:1 at any time during the immediately preceding calendar quarter or (b) the Company fails to take steps to improve its solvency in a manner acceptable to the required lenders (as determined in their sole and absolute discretion), then the cash flow sweep percentage to the lenders shall equal one-hundred percent (
100%
) and (ii) if such distribution date occurs on or after December 29, 2025, then the cash flow sweep percentage shall equal one-hundred percent (
100%
). As of
December 31, 2016
, the cash interest coverage ratio was
1.65
:1 and the loan to value ratio was
55%
, as calculated using the lenders' valuation.
The cash interest coverage ratio is the ratio of (i) consolidated cash and cash equivalents maintained by the Company to (ii) the aggregate interest amounts that will be due and payable in cash on (x) the
$30.0 million
Senior Secured Notes due September 14, 2018 (and any notes issued by the Company or any of its Affiliates in connection with refinancing, replacing, substituting or any similar action with respect to any such notes) and the
$70.7 million
Convertible Notes due February 15, 2019 (and any notes issued by the Company or any of its Affiliates in connection with refinancing, replacing, substituting or any similar action with respect to any such notes) and (y) any additional indebtedness issued by the Company after December 29, 2016, in each case, during the twelve month period following such date of determination. See Note 10, "
8.50%
Senior
Unsecured Convertible Notes" and Note 11 "
15%
Senior Secured Notes" to the accompanying consolidated financial statements.
With respect to approximately
25%
of the face amount of policies pledged as collateral under the White Eagle Revolving Credit Facility, White Eagle has agreed that if policy proceeds that are otherwise due are not paid by an insurance carrier, the foregoing distributions will be altered such that the lenders will receive any "catch-up" payments with respect to amounts that they would have received in the waterfall prior to distributions being made to White Eagle. During the continuance of events of default or unmatured events of default, the amounts from collections of policy proceeds that might otherwise be paid to White Eagle will instead be held in a designated account controlled by the lenders and may be applied to fund operating and third party expenses, interest and principal, "catch-up" payments or percentage payments that would go to the lenders as described above.
Assuming no event of default, funds on account from policy proceeds shall be distributed in specified stages of priority. For the year ended
December 31, 2016
, approximately
$46.0 million
of proceeds received from the maturity of policies pledged under the White Eagle Revolving Credit Facility, were distributed through the waterfall in the following stages of priority (in thousands):
|
|
|
|
|
|
|
|
Clause
|
|
Amount
|
|
Use of Proceeds
|
First:
|
|
$
|
239
|
|
|
Custodian and Securities Intermediary
|
Second:
|
|
—
|
|
|
White Eagle - Ongoing Maintenance Cost Reimbursable
|
Third:
|
|
—
|
|
|
Administrative Agent - Protective Advances
|
Fourth:
|
|
53
|
|
|
Administrative Agent - Administrative Agent Fee and Legal Expense Reimbursement
|
Fifth:
|
|
10,932
|
|
|
Administrative Agent - Accrued and Unpaid Interest
|
Sixth:
|
|
34,799
|
|
|
Administrative Agent - Required Amortization
|
Seventh:
|
|
—
|
|
|
Administrative Agent - Amortization Shortfall
|
Eighth:
|
|
—
|
|
|
Administrative Agent - Participation Interest
|
Ninth:
|
|
—
|
|
|
Reserved - $0
|
Tenth:
|
|
—
|
|
|
Administrative Agent Aggregate Unpaid Participation Interest
|
Eleventh:
|
|
—
|
|
|
Administrative Agent - Remaining Available Amount After Clause First to Tenth
|
Twelfth:
|
|
—
|
|
|
Wilmington Trust - Custodian and Securities Intermediary - Unpaid Fees
|
Thirteenth:
|
|
—
|
|
|
Borrower - Any Remaining Available Amount After Clause First to Twelfth
|
Total Distributions
|
|
$
|
46,023
|
|
|
|
The below is a reconciliation of proceeds collected by the White Eagle Revolving Credit Facility and distributed through the waterfall as shown above:
|
|
|
|
|
Face value collected in 2015 and distributed in 2016
|
$
|
5,000
|
|
Face value collected in 2016 and distributed in 2016
|
40,500
|
|
Face value collected in 2016 and distributed in 2017
|
2,480
|
|
Other collections*
|
523
|
|
Total collection in 2016
|
48,503
|
|
Less: Total waterfall distribution in 2016
|
(46,023
|
)
|
Total to be distributed in 2017
|
$
|
2,480
|
|
*Includes refund of premiums and interest earned on maturity proceeds
Use of Proceeds.
Generally, ongoing advances may be made for paying premiums on the life insurance policies pledged as collateral and to pay the fees of service providers. Effective with the White Eagle Amendment on November 9, 2015, ongoing advances may no longer be used to pay interest, which will now be paid by White Eagle if there is not otherwise sufficient amounts available from policy proceeds to be distributed to pay interest expense pursuant to the waterfall described above in "Amortization and Distributions." Subsequent advances and the use of proceeds from those advances are at the
discretion of the lenders. During the years ended
December 31, 2016
and 2015, approximately
$51.3 million
and
$45.7 million
was drawn on the facility for premium payments,
$1.7 million
and
$2.2 million
in fees to service providers, respectively. Approximately
$6.7 million
was drawn on the facility for interest during 2015. Effective with the November 9, 2015 Amendment, interest is no longer withheld from borrowings and, therefore,
no
interest was drawn on the facility during 2016.
Interest.
Borrowings under the White Eagle Revolving Credit Facility bear interest at a rate equal to LIBOR or, if LIBOR is unavailable, the base rate, in each case plus an applicable margin of
4.50%
, which was increased from
4.00%
pursuant to the November 9, 2015 amendment, and subject to a rate floor component equal to the greater of LIBOR (or the applicable rate) and
1.5%
. The base rate under the White Eagle Revolving Credit Facility equals the sum of (i) the weighted average of the interest rates on overnight federal funds transactions or, if unavailable, the average of three federal funds quotations received by the Agent plus
0.75%
and (ii)
0.5%
. 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. On December 30, 2016, the LIBOR floor increased from
1.50%
to
1.69%
. The effective rate at
December 31, 2016
was
6.19%
compared to
6.00%
at
December 31, 2015
.
Interest paid during the period is recorded in the Company’s consolidated financial statements. Accrued interest is reflected as a component of the estimated fair value of the White Eagle Revolving Credit Facility debt. Effective with the White Eagle Amendment on November 9, 2015, interest for the applicable margin of
4.50%
is no longer withheld from borrowings by the lender. Total interest expense on the facility for the year ended
December 31, 2016
was
$11.4 million
and comprised
$10.9 million
paid through the waterfall distribution from maturity proceeds and
$103,000
paid directly by the Company. Interest expense included
$388,000
in debt issuance costs associated with the additional policy advance which was not capitalized as a result of electing the fair value option for valuing this debt.
Total interest expense on the facility for the year ended
December 31, 2015
was
$9.2 million
, which includes
$6.7 million
withheld from borrowings by the lender and
$2.5 million
paid by White Eagle.
Maturity.
Effective with the White Eagle Second Amendment, the term of the White Eagle Revolving Credit Facility expires
December 31, 2031
, which is also the scheduled commitment termination date (though the lenders’ commitments to fund borrowings may terminate earlier in an event of default). The lenders’ interests in and rights to a portion of the proceeds of the policies does not terminate with the repayment of the principal borrowed and interest accrued thereon, the termination of the White Eagle Revolving Credit Facility or expiration of the lenders’ commitments.
Covenants/Events of Defaults
. The White Eagle Revolving Credit Facility contains covenants and events of default that are customary for asset-based credit agreements of this type, but also include cross defaults under the servicing, account control, contribution and pledge agreements entered into in connection with the White Eagle Revolving Credit Facility (including in relation to breaches by third parties thereunder), certain changes in law, changes in control of or insolvency or bankruptcy of the Company and relevant subsidiary companies and performance of certain obligations by certain relevant subsidiary companies, White Eagle and third parties. Effective with the White Eagle Second Amendment, and as described above in "Amortization and Distributions", the White Eagle Revolving Credit Facility contains a financial covenant requiring White Eagle to maintain a cash interest coverage ratio of at least
1.75
:1 commencing after June 30, 2019. Failure to maintain this ratio for
60
consecutive days after June 30, 2019 constitutes an event of default. There is no interest coverage ratio requirement that would result in an event of default prior to this date; however, any failure to maintain a cash interest coverage ratio of at least
2.0
:1 does impact the cash flow sweep percentage for proceeds distributed through the waterfall. As of
December 31, 2016
, the cash interest coverage ratio was
1.65
:1. The White Eagle Revolving Credit Facility also contains certain tests relating to asset maintenance, performance and valuation, the satisfaction of which will be determined by the lenders with a high degree of discretion.
Remedies.
The White Eagle Revolving Credit Facility and ancillary transaction documents afford the lenders a high degree of discretion in their selection and implementation of remedies, including strict foreclosure, in relation to any event of default, including a high degree of discretion in determining whether to foreclose upon and liquidate all or any pledged policies, the interests in White Eagle, and the manner of any such liquidation. White Eagle has limited ability to cure events of default through the sale of policies or the procurement of replacement financing.
The Company elected to account for the debt under the White Eagle Revolving Credit Facility in accordance with ASC 820, which includes the
45%
interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. The Company calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the Company’s estimates are not necessarily indicative of the amounts that the
Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.
At
December 31, 2016
, the fair value of the outstanding debt was
$257.1 million
and the borrowing base was approximately
$262.1 million
, which includes
$261.4 million
of outstanding principal. Approximately
$674,800
was available to borrow under the White Eagle Revolving Credit Facility.
There are no scheduled repayments of principal prior to maturity although payments are due upon the next distribution date following the receipt of death benefits and distributed pursuant to the waterfall as described above. At
December 31, 2016
, approximately
$2.5 million
included in restricted cash was on account with White Eagle awaiting distribution through the waterfall.
NOTE 9—RED FALCON REVOLVING CREDIT FACILITY
Effective
July 16, 2015
, Red Falcon Trust ("Red Falcon"), a Delaware statutory trust formed by Blue Heron Designated Activity Company ("Blue Heron"), a wholly-owned Irish subsidiary of the Company, entered into a revolving loan and security agreement (together with its ancillary documents, the "Red Falcon Revolving Credit Facility," and together with the White Eagle Revolving Credit Facility, the "Revolving Credit Facilities.") 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 (the "Agent"). On July 15, 2016, the Company amended its Red Falcon Revolving Credit Facility (the "Red Falcon Amendment"). Pursuant to the amendment,
six
additional policies and additional portions of
20
policies that were previously pledged in part as collateral under the initial credit agreement were pledged for an additional policy advance. Amounts advanced to Red Falcon following effectiveness of the amendment to the credit agreement were approximately
$3.0 million
.
On December 29, 2016, the Red Falcon Revolving Credit Facility was terminated (the "Facility Termination"). The policies pledged under the Red Falcon Revolving Credit Facility were sold to White Eagle, a subsidiary of the Company, in exchange for a distribution of cash totaling
$65.1 million
, which was used to repay all outstanding principal and interest due under the Red Falcon Revolving Credit Facility. The significant terms in effect through the termination date are included below.
General & Security
. The Red Falcon Revolving Credit Facility provided for a revolving credit facility backed by Red Falcon’s portfolio of life insurance policies with an initial aggregate lender commitment of up to
$110.0 million
, subject to borrowing base availability. As of December 29, 2016, all life insurance policies previously owned by Red Falcon and pledged as collateral under the Red Falcon Revolving Credit Facility were sold to White Eagle an affiliate of the Company. See Note 8 "White Eagle Revolving Credit Facility," to the accompanying consolidated financial statements for further information regarding the Company's portfolio subsequent to the Red Falcon Revolving Credit Facility termination.
Borrowing Base & Availability
. Revolving credit borrowings were permitted for a
five
-year period with the loans under the Red Falcon Revolving Credit Facility maturing on July 15, 2022. Borrowing availability under the Red Falcon Revolving Credit Facility was subject to a borrowing base, which at any time was equal to the lesser of (A) the sum of all of the following amounts that were funded or were to be funded through the next distribution date (i) the initial advance and all additional advances in respect of newly pledged policies that were not for ongoing maintenance advances, plus (ii)
100%
of the sum of the ongoing maintenance costs, less (iii) any required amortization payments previously distributed and which were to be distributed through the next distribution date; (B)
60%
of the valuation of the policies pledged as collateral as determined by the lenders; (C)
45%
of the aggregate face amount of the policies pledged as collateral; and (D)
$110.0 million
. All outstanding principal and interest was repaid in connection with the Facility Termination at
December 31, 2016
.
Amortization & Distributions.
Proceeds from the policies pledged as collateral under the Red Falcon Revolving Credit Facility were distributed pursuant to a waterfall with, subject to yield maintenance provisions,
5%
of policy proceeds directed to the lenders. Thereafter proceeds were directed to pay fees to service providers and premiums with any remaining proceeds directed to pay outstanding interest and required amortization of
8%
per annum on the greater of the then outstanding balance of the loan or the initial advance. Generally, after payment of interest and required amortization, a percentage of the collections from policy proceeds were to be paid to the lenders, which varied depending on the then loan to value ratio ("LTV") as follows: (1) if the LTV was equal to or greater than
50%
, all remaining proceeds were to be directed to the lenders to repay the then
outstanding principal balance; (2) if the LTV was less than
50%
but greater than or equal to
25%
,
65%
of the remaining proceeds were to be directed to the lenders to repay the then outstanding principal balance; or (3) if the LTV is less than
25%
,
35%
of the remaining proceeds were to be directed to the lenders to repay the then outstanding principal balance, in each case, with remaining proceeds directed to Red Falcon. To the extent there were not sufficient remaining proceeds in the waterfall to satisfy the amount of required interest and amortization then due, Red Falcon would have had to pay any such shortfall amount.
Assuming no event of default, funds on account from policy proceeds shall be distributed in specified stages of priority. For the year ended
December 31, 2016
, approximately
$7.6 million
of proceeds received from the maturity of policies which were pledged under the Red Falcon Revolving Credit Facility were distributed through the waterfall in the following stages of priority (in thousands):
|
|
|
|
|
|
|
|
Clause
|
|
Amount
|
|
Distribution of Proceeds
|
First:
|
|
$
|
378
|
|
|
Administrative Agent - 5% Contingent Interest
|
Second:
|
|
37
|
|
|
Servicer, Custodian and Securities Intermediary Fees
|
Third:
|
|
15
|
|
|
Portfolio Manager Fees
|
Fourth:
|
|
—
|
|
|
Administrative Agent - Protective Advances
|
Fifth:
|
|
47
|
|
|
Administrative Agent Fees
|
Sixth:
|
|
537
|
|
|
Accrued and Unpaid Interest
|
Seventh:
|
|
756
|
|
|
Lender - Repayment of Principal - 0.5% of Proceeds
|
Eighth:
|
|
5,787
|
|
|
Lender - Repayment of Principal - LTV over 50%
|
Ninth:
|
|
—
|
|
|
Unpaid Servicer, Custodian and Securities Fees
|
Tenth:
|
|
—
|
|
|
Red Falcon
|
Total Distributions
|
|
$
|
7,557
|
|
|
|
Initial Advance and Use of Proceeds.
Amounts advanced to Red Falcon following effectiveness of the Red Falcon Revolving Credit Facility were approximately
$54.0 million
with certain of the proceeds used to pay transaction expenses and to purchase the policies pledged as collateral under the Red Falcon Revolving Credit Facility from certain affiliates of the Company, who then made a distribution to the Company which was used to redeem the Company's
12.875%
Secured Notes. Generally, ongoing advances may have been made for paying premiums on the life insurance policies pledged as collateral, and to pay the fees of service providers.
Interest.
Borrowings under the Red Falcon Revolving Credit Facility bore interest at a rate equal to LIBOR or, if LIBOR was unavailable, the base rate, in each case plus an applicable margin of
4.50%
and subject to a rate floor of
1.0%
. The base rate under the Red Falcon Revolving Credit Facility equaled the sum of (i) the weighted average of the interest rates on overnight federal funds transactions or, if unavailable, the average of three federal funds quotations received by the Agent plus
0.75%
and (ii)
0.5%
. Based on the loan agreement, the LIBOR portion of the interest rate readjusted monthly, once the floor had exceeded
1.0%
. The applicable rate was dependent on the rate at the last business day of the immediately preceding calendar month. During the year ended
December 31, 2016
, the LIBOR floor increased from
1.0%
to
1.64%
prior to the Facility Termination.
Interest expense paid during the period is recorded in the Company’s consolidated financial statements. Interest expense on the facility was
$4.3 million
and
$4.9 million
and included
$297,000
and
$3.3 million
in debt issuance costs which were not capitalized as a result of electing the fair value option for valuing this debt and
$4.0 million
and
$1.5 million
relating to interest payments paid by Red Falcon for the year ended
December 31, 2016
and
2015
, respectively.
Maturity and Early Extinguishment.
The original term of the Red Falcon Revolving Credit Facility expired
July 15, 2022
. On December 29, 2016, Red Falcon terminated the facility and repaid all outstanding principal and interest in the amount of
$65.1 million
. Approximately
$554,000
was recorded as a loss on extinguishment of debt related to the early repayment of the facility. This includes the debt valuation allowance of
$239,000
and costs incurred related to the facility termination of
$315,000
at
December 31, 2016
.
Covenants/Events of Defaults
. The Red Falcon Revolving Credit Facility contained covenants and events of default, including those that are customary for asset-based credit facilities of this type and including cross defaults under the servicing, portfolio management and sales agreements entered into in connection with the Red Falcon Revolving Credit Facility, changes
in control of or insolvency or bankruptcy of the Company and relevant subsidiary companies and performance of certain obligations by certain relevant subsidiary companies, Red Falcon and third parties. The Red Falcon Revolving Credit Facility did not contain any financial covenants, but did contain certain tests relating to asset maintenance, performance and valuation with determinations as to the satisfaction of such tests involving determinations made by the lenders with a high degree of discretion.
The Company elected to account for the debt under the Red Falcon Revolving Credit Facility using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. The Company calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the Company’s estimates are not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have had a material effect on the estimated fair values.
At
December 31, 2016
, all outstanding principal and interest under the Red Falcon Facility had been repaid.
NOTE 10—
8.50%
SENIOR UNSECURED CONVERTIBLE NOTES
In February 2014, the Company issued
$70.7 million
in an aggregate principal amount of
8.50%
senior unsecured convertible notes due
2019
(the "Convertible Notes"). The Convertible Notes were issued pursuant to an indenture dated
February 21, 2014
, between the Company and U.S. Bank National Association, as trustee (the "Convertible Note Indenture").
Two
members of the Company's Board of Directors, Messrs. Dakos and Goldstein, are affiliated with Bulldog Investors, LLC, who purchased
$9.2 million
of the Convertible Notes.
The Convertible Notes are general senior unsecured obligations and rank equally in right of payment with all of the Company's other existing and future senior unsecured indebtedness. The Convertible Notes are effectively subordinate to all of the Company's secured indebtedness to the extent of the value of the assets collateralizing such indebtedness. The Convertible Notes are not guaranteed by the Company's subsidiaries.
The maturity date of the Convertible Notes is
February 15, 2019
. The Convertible Notes accrue interest at the rate of
8.50%
per annum on the principal amount of the Convertible Notes, payable
semi-annually in arrears on August 15 and February 15 of each year
.
The Convertible Notes are convertible into shares of common stock at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date. Initially, the Convertible Notes were convertible into shares of common stock at a conversion rate of
147.9290
shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of
$6.76
per share of common stock). In the second quarter of 2015, the conversion rate was adjusted to
151.7912
shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of
$6.59
per share of common stock) in connection with an anti-dilution adjustment triggered by a rights offering that resulted in the issuance of
6,688,433
shares of the Company’s common stock.
The Company may not redeem the Convertible Notes prior to
February 15, 2017
. On and after such date, and prior to the maturity date, the Company may redeem for cash all, but not less than all, of the Convertible Notes if the last reported sale price of the Company’s common stock equals or exceeds
130%
of the applicable conversion price for at least
20
trading days during the
30
consecutive trading day period ending on the trading day immediately prior to the date the Company delivers notice of the redemption. The redemption price will be equal to
100%
of the principal amount of the Convertible Notes, plus any accrued and unpaid interest to, but excluding, the redemption date. In addition, if the Company calls the Convertible Notes for redemption, a make-whole fundamental charge will be deemed to occur. As a result, the Company will, in certain circumstances, increase the conversion rate by a number of additional shares of common stock for holders who convert their notes prior to the redemption date.
The Company determined that an embedded conversion option existed in the Convertible Notes that was required to be separately accounted for as a derivative under ASC 815 which required the Company to bifurcate the embedded conversion option, record it as a liability at fair value and record a debt discount by an equal amount. Upon receipt of shareholder approval to issue shares of common stock upon conversion of the Convertible Notes in an amount that exceeded applicable New York
Stock Exchange limits for issuances without shareholder approval, the Company reclassified the embedded conversion derivative liability to equity. The Convertible Notes are recorded at accreted value and will continue to be accreted up to the par value of the Convertible Notes at maturity.
As of
December 31, 2016
, the carrying value of the Convertible Notes was
$60.5 million
, net of unamortized debt discounts and deferred debt costs of
$8.9 million
and
$1.3 million
, respectively. These are being amortized over the remaining life of the Convertible Notes using the effective interest method.
The Company recorded
$9.7 million
of interest expense on the Convertible Notes, including
$6.0 million
,
$3.2 million
and
$480,000
from interest, amortizing debt discounts and originations costs, respectively, during the year ended
December 31, 2016
.
For the year ended
December 31, 2015
, the Company recorded
$9.1 million
of interest expense on the Convertible Notes, including
$6.0 million
,
$2.7 million
and
$404,000
from interest, amortizing debt discounts and origination costs, respectively.
During the year ended
December 31, 2016
the Company adopted ASU No. 2015-03, "Interest-Imputation of
Interest (Subtopic 835-30)." This standard provides guidance on the balance sheet presentation of debt issuance cost, discount and premiums. See Note 2 "Summary of Significant Accounting Policies," of the accompanying financial statements.
Subsequent Events
Issuance of Additional Convertible Notes
On February 14, 2017, the Company entered into a solicitation to consent (the "Consent Solicitation") to issue additional
8.50%
Senior Unsecured Convertible Notes (the "Additional Convertible Notes") in lieu of a cash payment of interest on February 15, 2017 (the "2017 Interest Payment Date") to holders of the Convertible Notes.
On March 14, 2017, the Company issued an additional
$3.5 million
in Additional Convertible Notes following the Company’s receipt of requisite consents of the holders of the Convertible Notes of approximately
98%
of the aggregate principal amount of Convertible Notes (the "Consenting Holders"), pursuant to the Consent Solicitation, whereby each Consenting Holder agreed to accept Additional Convertible Notes in lieu of a cash payment of interest on the Convertible Notes due on the 2017 Interest Payment Date. All Additional Convertible Notes issued by the Company to Consenting Holders were issued under the Convertible Note Indenture and such Additional Convertible Notes have identical terms to existing Convertible Notes. Interest on the Additional Convertible Notes will accrue from February 15, 2017.
Master Transaction Agreement
On March 15, 2017, the Company entered into a series of separate Master Transaction Agreements (the "Agreements") by and between the Company, PJC Investments, LLC, a Texas limited liability company ("PJC") and each such Consenting Convertible Note Holder that is a party to such Agreement ("Consenting Holders") regarding a series of integrated transactions with the intent to effect a recapitalization of the Company (the "Transaction") which includes, among other transactions, a Convertible Note Exchange Offer and a New Convertible Note Indenture providing for the issuance of New Convertible Notes to be delivered in connection with the Transaction (each as defined in the Agreements).
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")
5%
Senior Unsecured Convertible Notes due 2023 (the "New Convertible Notes"). 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 between the Company and the trustee to be later identified (the "New Convertible Indenture").
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 financial statements for additional information.
NOTE 11—
15%
SENIOR SECURED NOTES
On March 11, 2016, the Company, as issuer, entered into an indenture with Wilmington Trust Company, as indenture trustee (the "Senior Secured Indenture"). The Senior Secured Indenture provides for the issuance of up to
$30.0 million
in senior secured notes (the "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.
Interest on the
15%
Senior Secured Notes accrues at
15.0%
per annum payable quarterly and all
15%
Senior Secured Notes will mature on
September 14, 2018
(the "Maturity Date"). The
15%
Senior Secured Notes may be optionally redeemed in full at any time and must be redeemed in full upon additional issuances of debt by Emergent Capital, Inc., in each case, at a price equal to
100%
of the principal amount redeemed plus (i) accrued and unpaid interest on the
15%
Senior Secured Notes redeemed up to the date of redemption, and (ii) the present value, as of the date of redemption of all remaining interest payments to the Maturity Date using a discount rate equal to the yield to maturity at the time of computation on the US treasury security with a constant maturity most nearly equal to the period from the redemption date to the Maturity Date plus
50
basis points. Upon a change of control, the Company will be required to make an offer to holders of the Senior Secured Notes to repurchase the Senior Secured Notes at a price equal to
107.5%
of their principal amount.
The
15%
Senior Secured Notes contain negative covenants restricting additional debt incurred by Emergent Capital, Inc., creation of liens on the collateral securing the
15%
Senior Secured Notes, and restrictions on dividends and stock repurchases. The
15%
Senior Secured Notes are secured by settlement proceeds, if any, received from certain litigation involving the Company, certain notes issued to the Company and a pledge of
65%
of the equity interests in Blue Heron Designated Activity Company, OLIPP IV, LLC and Red Reef Alternative Investments, LLC.
During the year ended December 31, 2016, the Company adopted ASU No. 2015-03, "Interest - Imputation of Interest (Subtopic 835-30)." This standard provides guidance on the balance sheet presentation of debt issuance cost, discount and premiums.
As of
December 31, 2016
, the carrying value of the
15%
Senior Secured Notes was
$29.3 million
, net of unamortized debt origination costs of
$703,000
, which is being amortized over the remaining life of the Senior Secured Notes using the effective interest method.
The Company recorded approximately
$4.0 million
of interest expense on the
15%
Senior Secured Notes, which includes
$3.7 million
of interest and
$348,000
of amortizing debt issuance costs, during the year ended
December 31, 2016
.
Subsequent Events
Master Transaction Agreement
On March 15, 2017, the Company entered into a series of separate Master Transaction Agreements (together, the "Agreements") by and between the Company, PJC Investments, LLC, a Texas limited liability company ("PJC") and each such Consenting Convertible Note Holder that is a party to such Agreement ("Consenting Holders") regarding a series of integrated transactions with the intent to effect a recapitalization of the Company (the "Transaction") which includes, among other transactions, a Senior Note Exchange Offer, a New Senior Note Indenture providing for the issuance of New Senior Notes, and a Senior Note Purchase Agreement to be delivered in connection with the Transaction (each as defined herein).
As part of the Transaction, the Company will offer to exchange, in each case with existing holders, its outstanding
15.0%
Senior Notes due 2018 (the "Existing Senior Notes") for New Senior Notes. 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
8.5%
Senior Notes due 2021 (the "New Senior Notes") in an aggregate amount not to exceed approximately
$40.0 million
pursuant to a Senior Note Indenture (the "New Senior Note Indenture") between the Company, as issuer, and the trustee to be later identified. Up to approximately
$30.0 million
aggregate principal amount of New Senior Notes may be issued to holders of the Existing Senior Notes in the relevant exchange offer, and PJC or the Investor may acquire up to an additional
$10.0 million
principal amount of New Senior Notes.
The New Senior Notes will be secured senior obligations of the Company and will mature
four
years from the date of Closing. The New Senior Notes will bear interest at a rate of
8.5%
per annum, payable quarterly.
Event of Default
The Company did not make an interest payment of
$1.1 million
, due March 15, 2017, on the
15%
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%
Senior Secured Notes, and the trustee or holders of at least
25%
in principal amount of the outstanding
15%
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.
See Note 20 "Subsequent Events," of the accompanying consolidated financial statements for additional information.
NOTE 12—
12.875%
Senior Secured Notes
On November 10, 2014 and January 21, 2015, the Company issued an aggregate of
$50.0 million
in
12.875%
Senior Secured Notes (the "Secured Notes") in
two
$25.0 million
tranches. The Secured Notes were issued at
96%
of their face amount. Fees and expenses paid by the Company in connection with the initial and subsequent issuances were approximately
$1.8 million
and
$305,000
, respectively.
Secured Notes issued under the indenture were scheduled to mature on
November 10, 2017
. On July 16, 2015, the Company redeemed all of the outstanding Secured Notes at
106%
of their principal amount plus interest up to November 10, 2015. Approximately
$8.8 million
was expensed as extinguishment related to the early repayment of the facility in July 2015, including
$5.2 million
,
$171,000
,
$1.7 million
and
$1.7 million
related to interest and prepayment penalties, unused fees, a write off of debt discounts and write off of issuance costs, respectively.
The Company 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, during the year ended
December 31, 2015
, respectively.
NOTE 13—FAIR VALUE MEASUREMENTS
The Company carries life settlements and debt under the Revolving Credit Facilities at fair value as shown in the consolidated balance sheets. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. Fair value measurements are classified based on the following fair value hierarchy:
Level 1
—Valuation is based on unadjusted quoted prices in active markets for identical assets and liabilities that are accessible at the reporting date. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
Level 2
—Valuation is determined from pricing inputs that are other than quoted prices in active markets that are either directly or indirectly observable as of the reporting date. Observable inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and interest rates and yield curves that are observable at commonly quoted intervals.
Level 3—Valuation is based on inputs that are both significant to the fair value measurement and unobservable. Level 3 inputs include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value generally require significant management judgment or estimation.
Assets and liabilities measured at fair value on a recurring basis
The balances of the Company’s assets measured at fair value on a recurring basis as of
December 31, 2016
, are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total Fair Value
|
Assets:
|
|
|
|
|
|
|
|
Investment in life settlements
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
498,400
|
|
|
$
|
498,400
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
498,400
|
|
|
$
|
498,400
|
|
The balances of the Company’s liabilities measured at fair value on a recurring basis as of
December 31, 2016
, are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total Fair Value
|
Liabilities:
|
|
|
|
|
|
|
|
White Eagle Revolving Credit Facility
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
257,085
|
|
|
$
|
257,085
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
257,085
|
|
|
$
|
257,085
|
|
The balances of the Company’s assets measured at fair value on a recurring basis as of
December 31, 2015
, are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total Fair Value
|
Assets:
|
|
|
|
|
|
|
|
Investment in life settlements
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
461,925
|
|
|
$
|
461,925
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
461,925
|
|
|
$
|
461,925
|
|
The balances of the Company’s liabilities measured at fair value on a recurring basis as of
December 31, 2015
, are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total Fair Value
|
Liabilities:
|
|
|
|
|
|
|
|
White Eagle Revolving Credit Facility
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
169,131
|
|
|
$
|
169,131
|
|
Red Falcon Revolving Credit Facility
|
|
|
|
|
$
|
55,658
|
|
|
$
|
55,658
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
224,789
|
|
|
$
|
224,789
|
|
The Company categorizes its investment in life settlement portfolio in two classes, non-premium financed and premium financed. In considering the categories, historically, it has generally believed that market participants would require a lower risk premium for policies that were non-premium financed, while a higher risk premium would be required for policies that were premium financed; the Company believes that this risk premium has been declining.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ in thousands)
|
Quantitative Information about Level 3 Fair Value Measurements
|
|
Fair Value at 12/31/16
|
|
Aggregate death benefit 12/31/2016
|
|
Valuation Technique (s)
|
|
Unobservable Input
|
|
Range (Weighted Average)
|
Non-premium financed
|
$
|
100,523
|
|
|
$
|
325,291
|
|
|
Discounted cash flow
|
|
Discount rate
|
|
15.00% - 18.00%
|
|
|
|
|
|
|
|
Life expectancy evaluation
|
|
5.8 years
|
Premium financed
|
$
|
397,877
|
|
|
$
|
2,621,220
|
|
|
Discounted cash flow
|
|
Discount rate
|
|
16.00% - 21.00%
|
|
|
|
|
|
|
|
Life expectancy evaluation
|
|
9.4 years
|
Life settlements
|
$
|
498,400
|
|
|
$
|
2,946,511
|
|
|
Discounted cash flow
|
|
Discount rate
|
|
16.37%
|
|
|
|
|
|
|
|
Life expectancy evaluation
|
|
9.0 years
|
White Eagle Revolving Credit Facility
|
$
|
257,085
|
|
|
$
|
2,934,511
|
|
|
Discounted cash flow
|
|
Discount rate
|
|
18.50%
|
|
|
|
|
|
|
|
Life expectancy evaluation
|
|
9.0 years
|
Following is a description of the methodologies used to estimate the fair values of assets and liabilities measured at fair value on a recurring basis and within the fair value hierarchy.
Life settlements
—The Company has elected to account for the life settlement policies it acquires using the fair value method. The Company uses a present value technique to estimate the fair value of its life settlements, which is a Level 3 fair value measurement as the significant inputs are unobservable and require significant management judgment or estimation. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate.
The Company provides medical records for each insured to LE providers. Each LE provider reviews and analyzes the medical records and identifies all medical conditions it feels are relevant to the life expectancy determination of the insured. Debits and credits are assigned by each LE provider to the individual’s health based on identified medical conditions which are derived from the experience of mortality attributed to relevant conditions in the portfolio of lives that the LE provider monitors. The health of the insured is summarized by the LE provider into a life assessment of the individual’s life expectancy expressed both in terms of months and in mortality factor. The mortality factor represents the degree to which the given life can be considered more or less impaired than a life having similar characteristics (e.g. gender, age, smoking, etc.). For example, a standard insured (the average life for the given mortality table) would carry a mortality rating of
100%
. A similar but impaired life bearing a mortality rating of
200%
would be considered to have twice the chance of dying earlier than the standard life relative to the LE provider’s population. Since each provider’s mortality factor is based on its own mortality table, the Company calculates its own factors to apply to the table selected by the Company.
The Company calculates mortality factors so that when applied to the mortality table selected by the Company, the resulting LE equals the LE provided by each LE provider. The resulting mortality factors are then blended to determine a factor for each insured.
A mortality curve is then generated based on the calculated mortality factors and the rates from the Company selected mortality table to generate the best estimated probabilistic cash flow stream. The net present value of the cash flows is then calculated to determine the policy value.
If the insured dies earlier than expected, the return will be higher than if the insured dies when expected or later than expected. The calculation allows for the possibility that if the insured dies earlier than expected, the premiums needed to keep the policy in force will not have to be paid. Conversely, the calculation also considers the possibility that if the insured lives longer than expected, more premium payments will be necessary.
Since the quarter ended September 30, 2012, and prior to June 30, 2016, the Company used the 2008 Valuation Basic tables, smoker distinct ("2008 VBT"), mortality tables developed by the U.S. Society of Actuaries (the "SOA"). The mortality tables are created based on the expected rates of death among different groups categorized by factors such as age and gender. During 2015, the SOA released new versions of the Valuation Basic Tables (the "2015 VBT"). The 2015 VBT has a significant increase in exposure and number of claims compared to the 2008 VBT and is believed to be a better fit for the life settlement
industry and is becoming more widely accepted. During the year ended
December 31, 2016
, the Company changed its valuation technique and decided to adopt the 2015 VBT, smoker and gender distinct tables, to determine the value of the policies. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams. The resulting impact is approximately
$17.6 million
reduction in the fair value of our life settlements.
Future changes in the life expectancies could have a material adverse effect on the fair value of the Company’s life settlements, which could have a material adverse effect on its business, financial condition and results of operations.
Life expectancy sensitivity analysis
If all of the insured lives in the Company’s life settlement portfolio lived six months shorter or longer than the life expectancies provided by these third parties, the change in estimated fair value would be as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
Life Expectancy Months Adjustment
|
Value
|
|
Change in Value
|
+6
|
$
|
416,520
|
|
|
$
|
(81,880
|
)
|
-
|
$
|
498,400
|
|
|
—
|
|
-6
|
$
|
585,852
|
|
|
$
|
87,452
|
|
Discount rate
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 re-evaluates its discount rates at the end of every reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company’s portfolio of life insurance policies. In doing so, the Company relies on management insight, engages third party consultants to corroborate its assessment, engages in discussions with other market participants and extrapolates the discount rate underlying actual sales of policies.
At one time, due to the Company’s association with the USAO Investigation and certain civil litigation involving the Company, the Company believed that, when given the choice to invest in a policy that was associated with the Company’s premium finance business and a similar policy without such an association, all else being equal, an investor would have generally opted to invest in the policy that was not associated with the Company’s premium finance business. However, since the Company entered into a Non-prosecution Agreement, investors have required less of a risk premium to transact in policies associated with the Company’s legacy premium finance business. With passage of time, and resolution of litigations, the Company now believes investors no longer require a greater risk premium for policies associated with the Company's premium finance business than the risk premium otherwise required for policies that were premium financed. In general, the Company believes that the risk premium an investor would require to transact in a policy that has been premium financed versus a policy without premium financing is lessening in the current market environment and further expects that, with the passage of time, investors will continue to require less of a risk premium to transact in policies that had been premium financed.
Credit exposure of insurance company
The Company considers the financial standing of the issuer of each life insurance policy. Typically, we seek to hold policies issued by insurance companies that are rated investment grade by the top three credit rating agencies. At
December 2016
, the Company had
18
life insurance policies issued by
two
carriers that were rated non-investment grade as of that date. In order to compensate a market participant for the perceived credit and challenge risks associated with these policies, the Company applied an additional 300 basis point risk premium.
The following table provides information about the life insurance issuer concentrations that exceed 10% of total death benefit and 10% of total fair value of the Company's life settlements as of
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
Carrier
|
Percentage of Total Fair Value
|
|
Percentage of Total Death Benefit
|
|
Moody’s Rating
|
|
S&P Rating
|
Lincoln National Life Insurance Company
|
21.7
|
%
|
|
19.3
|
%
|
|
A1
|
|
AA-
|
Transamerica Life Insurance Company
|
18.4
|
%
|
|
20.6
|
%
|
|
A1
|
|
AA-
|
Estimated risk premium
As of
December 31, 2016
, the Company owned
621
policies with an estimated fair value of
$498.4 million
. Of these
621
policies,
539
were previously premium financed and are valued using discount rates that range from
16.00%
to
21.00%
. The remaining
82
policies, which are non-premium financed, are valued using discount rates that range from
15.00%
to
18.00%
. As of
December 31, 2016
, the weighted average discount rate calculated based on death benefit used in valuing the policies in the Company's life settlement portfolio was
16.37%
.
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 extent to which the fair value could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount rate on the death benefit used to estimate the fair value. If the weighted average discount rate was increased or decreased by 1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in estimated fair value would be as follows (dollars in thousands):
Market interest rate sensitivity analysis
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average Rate Calculated Based on Death Benefit
|
Rate Adjustment
|
|
Value
|
|
Change in Value
|
15.87%
|
-0.50
|
%
|
|
$
|
511,823
|
|
|
$
|
13,423
|
|
16.37%
|
—
|
|
|
$
|
498,400
|
|
|
$
|
—
|
|
16.87%
|
0.50
|
%
|
|
$
|
485,545
|
|
|
$
|
(12,855
|
)
|
Future changes in the discount rates we use to value life insurance policies could have a material effect on the Company's yield on life settlement transactions, which could have a material adverse effect on our business, financial condition and results of our operations.
At the end of each reporting period we re-value the life insurance policies using our valuation model in order to update our estimate of fair value for investments in policies held on our balance sheet. This includes reviewing our assumptions for discount rates and life expectancies as well as incorporating current information for premium payments and the passage of time.
White Eagle Revolving Credit Facility
—As of
December 31, 2016
,
619
policies are pledged by White Eagle to serve as collateral for its obligations under the White Eagle Revolving Credit Facility. Absent an event of default under the White Eagle Revolving Credit Facility, ongoing borrowings will be used to pay the premiums on these policies and certain approved third party expenses. As more fully described in Note 8, "White Eagle Revolving Credit Facility," proceeds from the maturity of the policies pledged as collateral under the White Eagle Revolving Credit Facility are distributed pursuant to a waterfall. After 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.
The Company elected to account for the debt under the White Eagle Revolving Credit Facility in accordance with ASC 820, which includes the
45%
interest in policy proceeds payable to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the White Eagle Revolving Credit Facility and probabilistic cash flows from the pledged policies. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.
During the year ended
December 31, 2016
, the Company changed its valuation technique by adopting the 2015 VBT, smoker and gender distinct tables, to determine the value of the life insurance policies pledged as collateral in the facility. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company's expected cash flow streams, which resulted in an increase in projected borrowings. The resulting impact is a positive change in fair value of the White Eagle Revolving Credit Facility of approximately
$14.7 million
.
Life expectancy sensitivity analysis of the White Eagle Revolving Credit Facility
A considerable portion of the fair value of the White Eagle Revolving Credit Facility is determined by the timing of receipt of future policy proceeds. Should life expectancies lengthen such that policy proceeds are collected further into the future, the fair value of this debt will decline. Conversely, should life expectancies shorten, the fair value of this debt will increase. Considerable judgment is required in interpreting market data to develop the estimates of fair value.
If all of the insured lives in the life settlement portfolio pledged under the White Eagle Revolving Credit Facility live six months shorter or longer than the life expectancies used to calculate the estimated fair value of the White Eagle Revolving Credit Facility debt, the change in estimated fair value would be as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
Life Expectancy Months Adjustment
|
Fair Value of White Eagle Revolving Credit Facility
|
|
Change in Value
|
+6
|
$
|
201,868
|
|
|
$
|
(55,217
|
)
|
-
|
$
|
257,085
|
|
|
—
|
|
-6
|
$
|
296,665
|
|
|
$
|
39,580
|
|
Future changes in the life expectancies could have a material effect on the fair value of the White Eagle Revolving Credit Facility, which could have a material adverse effect on its business, financial condition and results of operations.
Discount rate of the White Eagle
Revolving Credit Facility
The discount rate incorporates current information about market interest rates, credit exposure to insurance companies and the Company’s estimate of the return a lender lending against the policies would require.
Market interest rate sensitivity analysis of the White Eagle Revolving Credit Facility
The extent to which the fair value of the White Eagle Revolving Credit Facility could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount. If the weighted average discount rate were increased or decreased by
1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in estimated fair value of the White Eagle Revolving Credit Facility as of
December 31, 2016
would be as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
Discount Rate
|
Rate Adjustment
|
|
Fair Value of White Eagle Revolving Credit Facility
|
|
Change in Value
|
18.00%
|
-0.50
|
%
|
|
$
|
264,213
|
|
|
$
|
7,128
|
|
18.50%
|
—
|
|
|
$
|
257,085
|
|
|
$
|
—
|
|
19.00%
|
0.50
|
%
|
|
$
|
250,241
|
|
|
$
|
(6,844
|
)
|
Future changes in the discount rates could have a material effect on the fair value of the White Eagle Revolving Credit Facility, which could have a material adverse effect on its business, financial condition and results of its operations.
At
December 31, 2016
, the fair value of the debt was
$257.1 million
and the outstanding principal was approximately
$261.4 million
.
Red Falcon Revolving Credit Facility
—During the year ended December 2016, the Company terminated the Red Falcon Revolving Credit Facility and repaid all outstanding principal and interest. At
December 31, 2016
, all policies that were pledged by Red Falcon to serve as collateral for its obligations under the Red Falcon Revolving Credit Facility were sold to White Eagle.
Prior to the Facility Termination, proceeds from the policies pledged as collateral under the Red Falcon Credit Facility were distributed pursuant to a waterfall with, subject to yield maintenance provisions,
5%
of policy proceeds directed to the lenders. Thereafter proceeds were directed to pay fees to service providers and premiums with any remaining proceeds directed to pay outstanding interest and required amortization of
8%
per annum on the loan. Generally, after payment of interest and required amortization, a percentage of the collections from policy proceeds were to be paid to the lenders to repay the then outstanding principal balance, which varied depending on the then loan to value ratio as more fully described in Note 9,"Red Falcon Revolving Credit Facility."
The Company had elected to account for this long-term debt using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. The Company calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the Red Falcon Revolving Credit Facility and probabilistic cash flows from the pledged policies. Accordingly, the Company’s estimates were not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions were the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.
During the year ended
December 31, 2016
, the Company changed its valuation technique by adopting the 2015 VBT, smoker and gender distinct tables, to determine the value of the life insurance policies pledged as collateral in the facility. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams, which resulted in an increase in projected borrowings. The resulting impact is a positive change in fair value of the Red Falcon Revolving Credit Facility of approximately
$1.0 million
.
Convertible Notes
—The Company determined that an embedded conversion option in the Convertible Notes was required to be separately accounted for as a derivative under Accounting Standards Codification 815,
Derivatives and Hedging
("ASC 815")
.
ASC 815 required the Company to bifurcate the embedded conversion option and record it as a liability at fair value and reduce the debt liability by a corresponding discount of an equivalent amount. The Company used a Black Scholes pricing model that incorporates present valuation techniques and reflect both the time value and the intrinsic value of the embedded conversion option to approximate the fair value of the conversion derivative liability at the end of each reporting period. This model required assumptions as to expected volatility, dividends, terms, and risk free rates.
In accordance with ASC 815, upon receipt of shareholder approval, the Company reclassified the embedded derivative 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. The Convertible Notes continue to be recorded at accreted value up to the par value of the Convertible Notes at maturity. See Note 10, "
8.50%
Senior Unsecured Convertible Notes," of the accompanying consolidated financial statements. Although the Company believes its valuation method is appropriate, the use of different methodologies or assumptions to determine the fair value could result in different fair values.
Changes in Fair Value
The following table provides a roll-forward in the changes in fair value for the year ended
December 31, 2016
, for all assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs, which consists solely of life settlements (in thousands):
|
|
|
|
|
Life Settlements:
|
|
Balance, January 1, 2016
|
$
|
461,925
|
|
Purchase of policies
|
16
|
|
Retained death benefits acquisitions
|
1,374
|
|
Change in fair value*
|
864
|
|
Matured/lapsed/sold polices
|
(37,460
|
)
|
Premiums paid
|
71,681
|
|
Transfers into level 3
|
—
|
|
Transfers out of level 3
|
—
|
|
Balance, December 31, 2016
|
$
|
498,400
|
|
Changes in fair value included in earnings for the period relating to assets held at December 31, 2016
|
$
|
(17,442
|
)
|
*Change in the mortality curve after adoption of 2015 VBT resulted in approximately
$17.6 million
reduction in the fair value of our life settlements.
The following table provides a roll-forward in the changes in fair value for the year ended
December 31, 2016
, for the White Eagle Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
|
|
|
|
|
White Eagle Revolving Credit Facility:
|
|
Balance, January 1, 2016
|
$
|
169,131
|
|
Draws under the White Eagle Revolving Credit Facility
|
124,142
|
|
Payments on White Eagle Revolving Credit Facility
|
(34,799
|
)
|
Unrealized change in fair value
|
(1,389
|
)
|
Transfers into level 3
|
—
|
|
Transfer out of level 3
|
—
|
|
Balance, December 31, 2016
|
$
|
257,085
|
|
Changes in fair value included in earnings for the period relating to liabilities at December 31, 2016
|
$
|
(1,389
|
)
|
The following table provides a roll-forward in the changes in fair value for the year ended
December 31, 2016
, for the Red Falcon Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
|
|
|
|
|
Red Falcon Revolving Credit Facility:
|
|
Balance, January 1, 2016
|
$
|
55,658
|
|
Initial advance under the Red Falcon Revolving Credit Facility
|
—
|
|
Subsequent draws under the Red Falcon Revolving Credit Facility
|
20,029
|
|
Payments on Red Falcon Revolving Credit Facility
|
(75,417
|
)
|
Unrealized change in fair value
|
(509
|
)
|
Extinguishment
|
239
|
|
Transfers into level 3
|
—
|
|
Transfer out of level 3
|
—
|
|
Balance, December 31, 2016
|
$
|
—
|
|
Changes in fair value included in earnings for the period relating to liabilities held at December 31, 2016
|
$
|
—
|
|
The following table provides a roll-forward in the changes in fair value for the year ended
December 31, 2015
, for all assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs, which consists solely of life settlements (in thousands):
|
|
|
|
|
Life Settlements:
|
|
Balance, January 1, 2015
|
$
|
388,886
|
|
Purchase of policies
|
30,695
|
|
Change in fair value
|
46,717
|
|
Matured/lapsed/sold polices
|
(69,296
|
)
|
Premiums paid
|
64,923
|
|
Transfers into level 3
|
—
|
|
Transfers out of level 3
|
—
|
|
Balance, December 31, 2015
|
$
|
461,925
|
|
Changes in fair value included in earnings for the period relating to assets held at December 31, 2015
|
$
|
(1,442
|
)
|
The following table provides a roll-forward in the changes in fair value for the year ended
December 31, 2015
, for the White Eagle Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
|
|
|
|
|
White Eagle Revolving Credit Facility:
|
|
Balance, January 1, 2015
|
$
|
145,831
|
|
Draws under the White Eagle Revolving Credit Facility
|
54,614
|
|
Payments on White Eagle Revolving Credit Facility
|
(43,241
|
)
|
Unrealized change in fair value
|
11,927
|
|
Transfers into level 3
|
—
|
|
Transfer out of level 3
|
—
|
|
Balance, December 31, 2015
|
$
|
169,131
|
|
Changes in fair value included in earnings for the period relating to liabilities at December 31, 2015
|
$
|
11,927
|
|
The following table provides a roll-forward in the changes in fair value for the year ended
December 31, 2015
, for the Red Falcon Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
|
|
|
|
|
Red Falcon Revolving Credit Facility
|
|
Balance, January 1, 2015
|
$
|
—
|
|
Initial advance under the Red Falcon Revolving Credit Facility
|
54,000
|
|
Subsequent draws under the Red Falcon Revolving Credit Facility
|
5,766
|
|
Payments on Red Falcon Revolving Credit Facility
|
(4,378
|
)
|
Unrealized change in fair value
|
270
|
|
Transfers into level 3
|
—
|
|
Transfer out of level 3
|
—
|
|
Balance, December 31, 2015
|
$
|
55,658
|
|
Changes in fair value included in earnings for the period relating to liabilities at December 31, 2015
|
$
|
270
|
|
There were no transfers of financial assets or liabilities between levels of the fair value hierarchy during the years ended
December 31, 2016
and
2015
.
Other Fair Value Considerations
—
Carrying value of certificate of deposits, prepaid expenses and other assets, receivable for maturity of life settlements, investment in affiliates, Senior Secured Notes, accounts payable and accrued expenses approximate fair value due to their short-term maturities and/or low credit risk.
NOTE 14—SEGMENT INFORMATION
On October 25, 2013, the Company sold its structured settlement business, which was previously reported as an operating segment. The operating results related to the Company’s structured settlement business have been included in discontinued operations in the Company’s Consolidated Statements of Operations for all periods presented and the Company has discontinued segment reporting. See, Note 6 "Discontinued Operations" to the accompanying consolidated financial statements.
NOTE 15—COMMITMENTS AND CONTINGENCIES
Lease Agreements
The Company leases office space under a lease that commenced on October 1, 2014. The lease expires on
September 30, 2020
. The annual base rent is
$239,000
, with a provision for a
3%
increase on each anniversary of the rent commencement date. Rent expense was approximately
$412,000
,
$423,000
and
$513,000
for the years ended
December 31, 2016
,
2015
and
2014
, respectively.
Future minimum payments under operating leases for each of the four succeeding years subsequent to
December 31, 2016
are as follows (in thousands):
|
|
|
|
|
December 31,
|
|
2017
|
$
|
241
|
|
2018
|
248
|
|
2019
|
255
|
|
2020
|
196
|
|
|
$
|
940
|
|
Employment Agreements
The Company has entered into employment agreements with certain of its officers, including with its chief executive officer, whose agreement provides for substantial payments in the event that the executive terminates his employment with the Company due to a material change in the geographic location where the chief executive officer performs his duties or upon a material diminution of his base salary or responsibilities, with or without cause. These payments are equal to
three
times the sum of the chief executive officer’s base salary and the average of the preceding
three
years’ annual cash bonus.
The Company does not have any general policies regarding the use of employment agreements, but has and may, from time to time, enter into such a written agreement to reflect the terms and conditions of employment of a particular named executive officer, whether at the time of hire or thereafter.
Separation Agreement
On April 26, 2012, the Company entered into a Separation Agreement and General Release of Claims (the "Separation Agreement") with its former chief operating officer, Jonathan Neuman. The Separation Agreement obligates the Company to
indemnify Mr. Neuman for his legal expenses, including expenses incurred as part of the USAO Investigation and SEC investigation. The Company recognized indemnification expenses of
$493,000
,
$8.5 million
and
$2.1 million
during the years ended
December 31, 2016
,
2015
and
2014
, respectively. On December 31, 2015, the Company received a letter from the USAO indicating that the USAO had concluded the USAO Investigation. On December 27, 2016, the Company received notification from the SEC that it had concluded its investigation as to the Company and did not intend to recommend an enforcement action against the Company. Accordingly, the Company does not expect to incur advancement or indemnification expenses related to the USAO Investigation or SEC investigation going forward.
Litigation
In accordance with applicable accounting guidance, the Company establishes an accrued liability for litigation and regulatory matters when those matters present loss contingencies that are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. When a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. As a litigation or regulatory matter develops, the Company, in conjunction with any outside counsel handling the matter, evaluates on an ongoing basis whether such matter presents a loss contingency that is probable and estimable. If, at the time of evaluation, the loss contingency related to a litigation or regulatory matter is
not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable. When a loss contingency related to a litigation or regulatory matter is deemed to be both probable and estimable, the Company will establish an accrued liability with respect to such loss contingency and record a corresponding amount of litigation-related expense. The Company will then continue to monitor the matter for further developments that could affect the amount of any such accrued liability.
Non-Prosecution Agreement & Indemnification Obligations
On September 27, 2011, the Company was informed that it was being investigated by the U.S. Attorney’s Office for the District of New Hampshire in connection with the Company’s now legacy premium finance loan business. On April 30, 2012, the Company entered into a Non-Prosecution Agreement (the "Non-Prosecution Agreement") with the USAO.
The Non-Prosecution Agreement had a term of
three
years and expired in accordance with its terms on April 30, 2015. While the Non-Prosecution Agreement effectively resolved the USAO Investigation as it pertained to the Company, the Company had continuing cooperation obligations to the USAO and, since entering the Non-Prosecution Agreement, the USAO had been investigating certain individuals and entities formerly associated with the Company’s legacy premium finance business. Settlements of certain civil litigation with the Company’s director and officer liability insurance carriers related to the USAO Investigation and other contractual obligations required the Company to advance legal fees to and indemnify these individuals and entities. On December 31, 2015, the Company received a letter from the USAO indicating that the USAO Investigation had 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. Accordingly, the Company does not expect to incur advancement or indemnification expenses related to the USAO Investigation going forward.
SEC Investigation
On February 17, 2012, the Company received an initial subpoena issued by the staff of the SEC seeking documents from 2007 through the date of the subpoena, generally related to the Company’s premium finance business and corresponding financial reporting. The SEC was investigating whether any violations of federal securities laws had occurred and the Company fully cooperated with the SEC regarding the matter. On December 27, 2016, the Company received notification from the SEC that it had concluded its investigation as to the Company and did not intend to recommend an enforcement action against the Company.
Sun Life
On April 18, 2013, Sun Life Assurance Company of Canada ("Sun Life") filed a complaint against the Company and several of its affiliates in the United States District Court for the Southern District of Florida, entitled
Sun Life Assurance Company of Canada v. Imperial Holdings, Inc., et al
. ("
Sun Life Case
"), asserting, among other things, that at least
28
life insurance policies issued by Sun Life and owned by the Company through certain of its subsidiary companies were invalid. The Sun Life complaint, as amended, asserted the following claims: (1) violations of the federal Racketeer Influenced and Corrupt Organizations ("RICO") Act, (2) conspiracy to violate the RICO Act, (3) common law fraud, (4) aiding and abetting fraud, (5) civil conspiracy to commit fraud, (6) tortious interference with contractual obligations, and (7) a declaration that the policies issued were void. Following the filing of a motion by the Company to dismiss the Sun Life Case, on December 9, 2014, counts (2), (4), (5), (6) and (7) of the Sun Life Case were dismissed with prejudice. The Company then filed a motion for summary judgment on the remaining counts. On February 4, 2015, the Court issued an order (the "Order") granting the Company’s motion for summary judgment on counts (1) and (3), resulting in the Company prevailing on all counts in the Sun Life Case.
On July 29, 2013, the Company filed a separate complaint against Sun Life in United States District Court for the Southern District of Florida, entitled
Imperial Premium Finance, LLC v. Sun Life Assurance Company of Canada
("
Imperial Case"
), which was subsequently consolidated with the Sun Life Case. The Imperial complaint asserts claims against Sun Life for breach of contract, breach of the covenant of good faith and fair dealing, and fraud, and seeks a judgment declaring that Sun Life is obligated to comply with the promises made by it in certain insurance policies. The complaint also seeks compensatory damages of no less than
$30.0 million
in addition to an award of punitive damages. On August 23, 2013, Sun Life moved to dismiss the complaint, which was denied by the Court as part of the Order. On February 26, 2015, Sun Life filed a Notice of Appeal from the Order to the United States Court of Appeals for the Eleventh Circuit, which had denied Sun Life’s motion to dismiss. On December 17, 2015, after the matter was fully briefed, the Circuit Court issued an order granting the Company’s motion to dismiss and sent the case back to the District Court. The District Court lifted the stay and ordered Sun Life to file its
Answer to the Imperial Case by January 22, 2016. On February 3, 2016, the District Court set a trial date of the Imperial Case for October 31, 2016.
On September 22, 2016, the Court granted summary judgment in favor of Sun Life on the entirety of the Imperial complaint and subsequently entered final judgment to end the case. After denial of its motion to alter or amend the judgment, the Company filed a notice of appeal on January 12, 2017. Sun Life filed its notice of appeal on January 24, 2017.
IRS Investigation
The Internal Revenue Service ("IRS) Criminal Investigation Division notified the Company in February 2014 that it was conducting an investigation related to the Company and its legacy structured settlements business (the "IRS Investigation"). On May 3, 2016, the Company was informed that the IRS Investigation has been closed. The IRS may still refer any civil aspects of this matter to its Collection and Examination functions. If any such referral is made and results in a determination by the IRS that the Company has failed to comply with any of its obligations under the Internal Revenue Code or regulations hereunder, the Company could incur additional tax liability, restitution payment obligations, penalties, fines or other liabilities and a reduction in the Company’s net operating losses, that could have a material adverse effect on the Company, its personnel, its financial condition, cash flows and its results of operations. The Company did not establish any provision for losses related to this matter.
Other Litigation
A complaint was filed against the Company’s subsidiary, styled
Kenneth Jennings v. Washington Square Financial, LLC d/b/a Imperial Structured Settlements
("Washington Square"), and was pending in the United States District Court for the Northern District of Illinois. The plaintiff sought, in a purported class action, to represent all individuals who sold all or a part of a structured settlement annuity to Washington Square under the Illinois Structured Settlement Protections Act (the “Illinois Act”), where the underlying annuity contract contained an anti-assignment clause, and where a court issued an order under the Illinois Act approving the transaction. The complaint sought, among other things, a declaration that all such transactions are void and compensatory and punitive damages. On September 28, 2016, the District Court terminated the case pursuant to a notice of voluntary dismissal, without prejudice, which had been filed by the plaintiff.
The Company is party to various other legal proceedings that arise in the ordinary course of business. Due to the inherent difficulty of predicting the outcome of litigation and other legal proceedings, the Company cannot predict the eventual outcome of these matters, and it is reasonably possible that some of them could be resolved unfavorably to the Company. As a result, it is possible that the Company’s results of operations or cash flows in a particular fiscal period could be materially affected by an unfavorable resolution of pending litigation or contingencies. However, the Company believes that the resolution of these other proceedings will not, based on information currently available, have a material adverse effect on the Company’s financial position or results of operations.
NOTE 16—STOCKHOLDERS’ EQUITY
During the second quarter of 2015, the Company issued
6,688,433
shares of common stock pursuant to a rights offering at a price of
$5.75
per share.
In connection with the settlement of class litigation, the Company issued warrants to purchase
two million
shares of the Company’s stock into an escrow account in April 2014 and were distributed in October 2014. The estimated fair value at the measurement date of such warrants was
$5.4 million
, which is included in stockholder’s equity. The warrants have a
five
-year term from the date of their distribution with an exercise price of
$10.75
. The Company is obligated to file a registration statement to register the shares underlying the warrants with the SEC if shares of the Company’s common stock have an average daily trading closing price of at least
$8.50
per share for a
45
day period. The warrants will be exercisable upon effectiveness of the registration statement.
The Company has reserved an aggregate of
2,700,000
shares of common stock under its Omnibus Plan, of which
763,594
options to purchase shares of common stock granted to existing employees were outstanding as of
December 31, 2016
, and
116,871
shares of restricted stock had been granted to directors under the plan with
265,212
subject to vesting. There were
1,554,323
securities remaining for future issuance under the Omnibus Plan as of
December 31, 2016
.
On September 1, 2015, the Company announced that its Board of Directors authorized a
$10.0 million
share and note repurchase program. The program has a
two
-year expiration date, and authorizes the Company to repurchase up to
$10.0 million
of its common stock and/or its Convertible Notes due 2019. During 2015, the Company purchased
608,000
shares for a total cost of approximately
$2.5 million
, which is an average cost of
$4.17
per share, including transaction fees. There were
no
purchases during the year ended
December 31, 2016
. As of
December 31, 2016
, the Company may purchase up to approximately
$7.5 million
of additional common stock or Convertible Notes under its board authorized plan. However, the Company's
15%
Senior Secured Notes restrict the Company from repurchasing its common stock if the Company has less than
$20 million
in cash and cash equivalents.
On March 14, 2016, the Company filed a prospectus supplement with the SEC related to the offer and sale from time to time of the Company's 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 the Company's 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 deemed to be "at the market" offerings as defined in Rule 415 under the Securities Act of 1933. The Company has agreed to pay the distribution agents a commission rate of up to
3%
of the gross proceeds from the sale of any shares of common stock sold through the equity distribution agreement. During the year ended
December 31, 2016
, the Company sold
628,309
shares of common stock under this prospectus supplement at a weighted average price per share of
$3.00
, receiving proceeds net of commissions totaling approximately
$1.8 million
. Approximately
$56,600
in commissions were paid in connection with the sales of shares.
On March 15, 2017, the Company entered into a series of separate Master Transaction Agreements (together, the "Agreements") by and between the Company, PJC Investments, LLC, a Texas limited liability company ("
PJC
"), and each such Consenting Convertible Note Holder that is a party to such Agreement ("Consenting
Holders") regarding a series of integrated transactions with the intent to effect a recapitalization of the Company (the "Transaction"), which includes an Amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of the Company's common stock,
$0.01
par value (the "Common Stock"), a Common Stock Purchase Agreement, a Convertible Note Exchange Offer, a New Convertible Note Indenture providing for the issuance of New Convertible Notes, a Senior Note Exchange Offer, a New Senior Note Indenture providing for the issuance of New Senior Notes, a Senior Note Purchase Agreement, a Warrant and certain other agreements and documents to be delivered in connection with the Transaction (each as defined in the Agreements, and together with the Agreements, the "Transaction Documents"). The Agreements and the transactions contemplated under the Agreements were unanimously approved by the Board of Directors of the Company on March 13, 2017.
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 herein, 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.
At or contemporaneously with the closing of the Transaction, the Company will cause to be issued a warrant (the "Warrant") to the Investor to purchase up to an aggregate of
34,000,000
shares of the Common Stock at an exercise price of
$0.25
per share (the "Warrant Shares") for an aggregate price of up to
$8.5 million
.
See Note 20 "Subsequent Events," of the accompanying financial statements for additional information.
NOTE 17—EMPLOYEE BENEFIT PLAN
The Company has adopted a 401(k) plan that covers employees that have reached
18
years of age and completed
three months
of service. The plan provides for voluntary employee contributions through salary deductions, as well as discretionary employer contributions. For the years ended
December 31, 2016
,
2015
and
2014
, there were
no
employer contributions made.
NOTE 18—SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
The following tables set forth our unaudited consolidated financial data regarding continuing operations for each quarter of fiscal
2016
and
2015
(in thousands). This information, in the opinion of management, includes all adjustments necessary, consisting only of normal and recurring adjustments, to state fairly the information set forth therein. Certain amounts previously reported have been reclassified to conform to the current presentation. These reclassifications had no net impact on the results of operations (in thousands).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal 2016
|
|
|
1st Quarter
|
|
2nd Quarter
|
|
3rd Quarter
|
|
4th Quarter
|
|
Total income
|
8,454
|
|
|
(15,786
|
)
|
|
4,767
|
|
|
3,680
|
|
|
(Loss)/income from continuing operations before taxes
|
(7,445
|
)
|
|
(9,775
|
)
|
|
(8,543
|
)
|
|
(23,666
|
)
|
|
Net (loss)/income from continuing operations
|
(7,445
|
)
|
|
(9,775
|
)
|
|
(8,543
|
)
|
|
(23,666
|
)
|
|
(Loss)/income per share from continuing operations:
|
|
|
|
|
|
|
|
|
Basic and diluted
|
$
|
(0.27
|
)
|
|
$
|
(0.36
|
)
|
|
$
|
(0.31
|
)
|
|
$
|
(0.84
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal 2015
|
|
|
1st Quarter
|
|
2nd Quarter
|
|
3rd Quarter
|
|
4th Quarter
|
|
Total income
|
12,980
|
|
|
28,034
|
|
|
2,769
|
|
|
3,108
|
|
|
(Loss)/income from continuing operations before income taxes
|
(6,102
|
)
|
|
644
|
|
|
(18,212
|
)
|
|
(15,429
|
)
|
|
Net (loss)/income from continuing operations
|
(4,165
|
)
|
|
966
|
|
|
(13,491
|
)
|
|
(13,690
|
)
|
|
(Loss)/income per share from continuing operations:
|
|
|
|
|
|
|
|
|
Basic and diluted
|
$
|
(0.19
|
)
|
|
$
|
0.04
|
|
|
$
|
(0.48
|
)
|
|
$
|
(0.49
|
)
|
(1)
|
|
|
(1)
|
The sum of the basic and diluted earnings per share amounts for each quarter in fiscal year
2016
and the diluted for
2015
do not equal the amount presented in the statements of operations for the years ended
December 31, 2016
and
December 31, 2015
due to the Company having a net loss for the years ended
December 31, 2016
and
December 31, 2015
and therefore all common stock equivalents were antidilutive.
|
NOTE 19—INCOME TAXES
The provision (benefit) for income taxes from continuing operations consisted of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
|
December 31, 2014
|
Continuing operations
|
$
|
—
|
|
|
$
|
(8,719
|
)
|
|
$
|
125
|
|
Discontinued operations
|
—
|
|
|
—
|
|
|
(232
|
)
|
Provision (benefit) for income taxes
|
$
|
—
|
|
|
$
|
(8,719
|
)
|
|
$
|
(107
|
)
|
Current
|
|
|
|
|
|
Federal
|
$
|
—
|
|
|
$
|
10
|
|
|
$
|
—
|
|
State
|
—
|
|
|
—
|
|
|
—
|
|
|
$
|
—
|
|
|
$
|
10
|
|
|
$
|
—
|
|
Deferred
|
|
|
|
|
|
Federal
|
(16,550
|
)
|
|
(9,149
|
)
|
|
5,214
|
|
State
|
(1,292
|
)
|
|
(3,846
|
)
|
|
(2,522
|
)
|
|
(17,842
|
)
|
|
(12,995
|
)
|
|
2,692
|
|
Valuation allowance increase (decrease)
|
17,842
|
|
|
4,266
|
|
|
(2,567
|
)
|
|
$
|
—
|
|
|
$
|
(8,729
|
)
|
|
$
|
125
|
|
|
|
|
|
|
|
Provision (benefit) for income taxes from continuing operations
|
$
|
—
|
|
|
$
|
(8,729
|
)
|
|
$
|
125
|
|
U.S. and foreign components of income (loss) from continuing operations before income taxes were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
|
December 31, 2014
|
U.S.
|
$
|
(23,405
|
)
|
|
$
|
(51,749
|
)
|
|
$
|
(10,824
|
)
|
Foreign
|
(26,024
|
)
|
|
12,650
|
|
|
5,798
|
|
|
$
|
(49,429
|
)
|
|
$
|
(39,099
|
)
|
|
$
|
(5,026
|
)
|
The Company’s actual provision (benefit) for income taxes from continuing operations differ from the federal expected income tax provision as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2016
|
|
2015
|
|
2014
|
|
Amount
|
|
Rate
|
|
Amount
|
|
Rate
|
|
Amount
|
|
Rate
|
Tax provision (benefit) at statutory rate
|
$
|
(17,300
|
)
|
|
35.00
|
%
|
|
$
|
(13,685
|
)
|
|
35.00
|
%
|
|
$
|
(1,759
|
)
|
|
35.00
|
%
|
Increase (decrease) in taxes resulting from:
|
|
|
|
|
|
|
|
|
|
|
|
State tax (net of federal benefit)
|
(836
|
)
|
|
1.72
|
|
|
(1,617
|
)
|
|
4.14
|
|
|
(364
|
)
|
|
7.24
|
|
Impact of rate changes
|
253
|
|
|
(0.50
|
)
|
|
23
|
|
|
(0.06
|
)
|
|
(1,851
|
)
|
|
36.84
|
|
Litigation settlement
|
—
|
|
|
—
|
|
|
2,275
|
|
|
(5.82
|
)
|
|
—
|
|
|
—
|
|
Other permanent items
|
4
|
|
|
(0.01
|
)
|
|
18
|
|
|
(0.05
|
)
|
|
371
|
|
|
(7.40
|
)
|
Adoption of ASU 2013-11
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
6,295
|
|
|
(125.26
|
)
|
Other
|
37
|
|
|
(0.07
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Valuation allowance (decrease) increase
|
17,842
|
|
|
(36.14
|
)
|
|
4,267
|
|
|
(10.91
|
)
|
|
(2,567
|
)
|
|
51.08
|
|
Provision (benefit) for income taxes
|
$
|
—
|
|
|
—
|
%
|
|
$
|
(8,719
|
)
|
|
22.30
|
%
|
|
$
|
125
|
|
|
(2.50
|
)%
|
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and tax liabilities were (in thousands):
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
Deferred tax assets:
|
|
|
|
Federal and state net operating loss carryforward
|
$
|
37,511
|
|
|
$
|
31,588
|
|
Revolving Credit Facilities
|
7,024
|
|
|
8,973
|
|
Deferred gain
|
14,112
|
|
|
13,423
|
|
Other
|
1,930
|
|
|
1,960
|
|
Total gross deferred tax assets
|
60,577
|
|
|
55,944
|
|
Less valuation allowance
|
(22,457
|
)
|
|
(4,515
|
)
|
Total deferred tax assets
|
38,120
|
|
|
51,429
|
|
Deferred tax liabilities:
|
|
|
|
Unrealized gains on life and structured settlements
|
20,321
|
|
|
29,473
|
|
Gain on structured settlements deferred for tax purposes
|
3,655
|
|
|
4,607
|
|
Convertible debt discount
|
3,430
|
|
|
4,681
|
|
Deferred income
|
10,714
|
|
|
12,668
|
|
Total deferred tax liabilities
|
38,120
|
|
|
51,429
|
|
Total net deferred tax asset (liability)
|
$
|
—
|
|
|
$
|
—
|
|
The Company evaluates its deferred tax assets to determine if valuation allowances are required. In its evaluation, management considers taxable loss carryback availability, expectations of sufficient future taxable income, trends in earnings, existence of taxable income in recent years, the future reversal of temporary differences, and available tax planning strategies that could be implemented, if required. Valuation allowances are established based on the consideration of all available evidence using a more likely than not standard. Based on the Company’s evaluation, a deferred tax valuation allowance was established against its net deferred tax assets as of
December 31, 2016
. This valuation allowance was determined to be necessary as an offset to the full amount of the federal and state deferred tax asset.
The Company recorded a deferred tax asset for the increase in tax basis associated with the transfer of assets to subsidiaries located in Ireland. The net deferred asset with respect to these transactions is
$14.1 million
and
$13.4 million
for the years ended
December 31, 2016
and
December 31, 2015
, respectively, which will serve as a tax benefit upon reversal as life settlements mature or are sold.
Generally, the amount of tax expense or benefit allocated to continuing operations is determined without regard to the tax effects of other categories of income or loss, such as other comprehensive income. However, an exception to the general rule is provided when, in the presence of a valuation allowance against deferred tax assets, there is a pretax loss from continuing operations and pretax income from other categories. In such instances, income from other categories must offset the current loss from operations, the tax benefit of such offset being reflected in continuing operations. For the year ended December 31, 2013, we increased our deferred tax valuation allowance from continuing operations by
$56,000
to reflect the taxable income associated with unrealized gains in accumulated other comprehensive income.
The federal and state net operating loss carryovers (“NOLs”) generated by the Company since its conversion to a corporation are approximately
$102.0 million
that expire beginning in 2031.
Prior to the Company’s initial public offering in 2011, one of the founding members entered into a reorganization that allowed the Company to assume the corporate shareholder’s tax attributes. These tax attributes include approximately
$11.2 million
of NOLs. The utilization of the acquired NOLs is subject to an annual limitation under Section 382 based on the value of the Company at the time they were acquired. These NOLs begin to expire in 2028.
Tax years prior to 2013 are no longer subject to IRS examination. Various state jurisdiction tax years remain open to examination.
The Company recognizes interest and penalties accrued related to unrecognized tax benefits in tax expense.
A reconciliation of the total amounts of unrecognized benefits at the beginning and end of the period was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
December 31, 2015
|
|
December 31, 2014
|
Balance as of beginning of period
|
$
|
6,295
|
|
|
$
|
6,295
|
|
|
$
|
6,295
|
|
Additions based on tax positions taken in the current year
|
—
|
|
|
—
|
|
|
—
|
|
Reductions of tax positions for prior years
|
—
|
|
|
—
|
|
|
—
|
|
Balance as of end of period
|
$
|
6,295
|
|
|
$
|
6,295
|
|
|
$
|
6,295
|
|
The unrecognized benefit is reflected as a reduction of the deferred tax asset related to the Federal and State net operating loss carryforward. The recognition of the unrecognized tax benefits would result in a
$6.3
million decrease in the Company’s effective tax rate.
NOTE 20—SUBSEQUENT EVENTS
OTCQB Marketplace
On January 23, 2017, the Company announced its plans to voluntarily delist its common stock from the New York Stock Exchange and trade on the OTC Marketplace, and on February 3, 2017, the Company's common stock began trading on the OTC Market Group’s OTCQB market under the ticker symbol "EMGC".
OTCQB is designed for early-stage and developing U.S. and international companies that are current in their reporting and undergo an annual verification and management certification process. The OTCQB market is considered by the SEC as an "established public market" for the purpose of determining the public market price when registering securities for resale in equity line financings with the SEC.
Consolidation of the White Eagle Loan Agreement
On January 31, 2017, as required by the terms of the White Eagle Amendment, our indirect subsidiary, White Eagle, executed the Second Amended and Restated Loan and Security Agreement, dated January 31, 2017, which consolidated into a single document the amendments evidenced by the White Eagle Amendment and all previous amendments.
Issuance of Additional Convertible Notes
On February 14, 2017, the Company entered into a solicitation to consent (the "Consent Solicitation”) to issue additional
8.50%
Senior Unsecured Convertible Notes (the "Additional Convertible Notes") in lieu of a cash payment of interest on February 15, 2017 (the "2017 Interest Payment Date") to holders of
8.5%
Senior Unsecured Convertible Notes (the "Convertible Notes"). The Company's obligation to issue the Additional Convertible Notes was subject to the satisfaction of (1) not less than
95%
of the aggregate principal amount of Convertible Notes agreeing to accept Additional Convertible Notes in lieu of a cash payment of interest on the 2017 Interest Payment Date and (2) the amendment of the Indenture dated as of March 11, 2016 with Wilmington Trust, National Association, as indenture trustee (the "Senior Secured Indenture") for the
15%
Senior Secured Notes due 2018 (the "
15.0%
Senior Secured Notes") to permit the issuance of the Additional Convertible Notes. This consent is only effective for the cash payment of interest due on the 2017 Interest Payment Date and not for subsequent interest payments.
On March 10, 2017, the Company, as issuer, and Wilmington Trust, National Association, as trustee, entered into the First Supplemental Indenture (the "Senior Supplemental Indenture"), implementing certain amendments to the Senior Secured Indenture governing the Company’s outstanding
15.0%
Senior Secured Notes following the Company’s receipt of requisite consents of the holders of the
15.0%
Senior Secured Notes. The Senior Supplemental Indenture amends the Senior Secured Indenture to: (i) amend the definition of "Permitted Indebtedness" to include all Convertible Notes issued by the Issuer under the Indenture dated February 21, 2014 between the Company and U.S. Bank National Association (the "Convertible Indenture") after February 14, 2017, in lieu of a cash payment of interest due to the holders of the Convertible Notes, and (ii) add Section 4.07(e) to restrict the Company from increasing the interest rate payable on the Convertible Notes.
On March 13, 2017, the Company and U.S. Bank National Association, as trustee, entered into the First Supplemental Indenture (the "Convertible Supplemental Indenture"), implementing certain amendments to the Convertible Indenture governing the Convertible Notes. The Convertible Supplemental Indenture amends the Convertible Indenture to, among other things, allow for the issuance of Convertible Notes in denominations of
$1.00
principal amount and multiples of
$1.00
.
On March 14, 2017, the Company issued an additional
$3.5 million
in Additional Convertible Notes following the Company’s receipt of requisite consents of the holders of the Convertible Notes of approximately
98%
of the aggregate principal amount of Convertible Notes (the "Consenting Holders"), pursuant to the Consent Solicitation , whereby each Consenting Holder agreed to accept Additional Convertible Notes in lieu of a cash payment of interest on the Convertible Notes due on the 2017 Interest Payment Date. All Additional Convertible Notes issued by the Company to Consenting Holders were issued under the Convertible Note Indenture and such Additional Convertible Notes have identical terms to existing Convertible Notes. Interest on the Additional Convertible Notes will accrue from February 15, 2017.
Event of Default -
15.0%
Senior Secured Note
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.
The Master Transaction Agreement
On March 15, 2017, the Company entered into a series of separate Master Transaction Agreements (together, the “Agreements”) by and between the Company, PJC Investments, LLC, a Texas limited liability company ("PJC"), and each such Consenting Convertible Note Holder that is a party to such Agreement ("Consenting
Holders") regarding a series of integrated transactions with the intent to effect a recapitalization of the Company (the "Transaction"), which includes an Amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of the Company's common stock,
$0.01
par value (the "Common Stock"), a Common Stock Purchase Agreement, a Convertible Note Exchange Offer, a New Convertible Note Indenture providing for the issuance of New Convertible Notes, a Senior Note Exchange Offer, a New Senior Note Indenture providing for the issuance of New Senior Notes, a Senior Note Purchase Agreement, a Warrant and certain other agreements and documents to be delivered in connection with the Transaction (each as defined in the Agreements, and together with the Agreements, the "Transaction Documents"). The Agreements and the transactions contemplated under the Agreements were unanimously approved by the Board of Directors of the Company on March 13, 2017.
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 below) 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.
The Agreements contain standard representations and warranties related to each party, and may be terminated prior to the Closing under certain circumstances, including, without limitation, by:
|
|
i.
|
mutual written consent of PJC and the Company;
|
|
|
ii.
|
PJC or the Company, if the Closing shall not have occurred by August 31, 2017;
|
|
|
iii.
|
the Convertible Note Holders that, in the aggregate, hold a majority of the aggregate principal amount of the outstanding Convertible Notes, if the Closing shall not have occurred by September 30, 2017;
|
|
|
iv.
|
PJC or the Company, as a non-breaching party, if there has been a material breach of certain representations, warranties or covenants made by PJC or the Company, as a breaching party, which shall not have been cured or cannot be cured within 30 days of receipt of written notice of such breach;
|
|
|
v.
|
the Convertible Note Holders that, in the aggregate, hold a majority of the aggregate principal amount of the outstanding Convertible Notes, if the Company or PJC shall materially breach any representation, warranty, covenant, obligation or agreement and such breach shall not have been cured or cannot be cured within 30 days of receipt of written notice of such breach and such breach shall result in an adverse economic impact to the Consenting Convertible Note Holders;
|
|
|
vi.
|
PJC if the conditions precedent to the consummation of either Exchange Offer are not satisfied at the time such Exchange Offer expires or as of the date the other Transaction Documents are satisfied; or
|
|
|
vii.
|
PJC or the Company, if the transaction is enjoined or prohibited by governmental authorities.
|
Common Stock Purchase Agreement
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.
Common Stock Purchase Warrant
At or contemporaneously with the closing of the Transaction, the Company will cause to be issued a warrant (the "Warrant") to the Investor to purchase up to an aggregate of
34,000,000
shares of the Common Stock at an exercise price of
$0.25
per share (the "Warrant Shares") for an aggregate price of up to
$8.5 million
.
The Warrant shall vest and become exercisable as follows: (i) with respect to
14,000,000
Warrant Shares, immediately upon the issuance of the Warrant, and (ii) with respect to the remaining
20,000,000
Warrant Shares, at later times tied to the conversion of Existing Convertible Notes and New Convertible Notes outstanding upon the closing of the Transaction into shares of Common Stock. The Warrant has an
eight
year term. The number of Warrant Shares is subject to anti-dilution adjustment provisions.
Exchange Offers
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 New Convertible notes, described below, and its outstanding
15.0%
Senior Secured Notes due 2018 (the "Existing Senior Notes") for New Senior notes, described below. 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.
New Convertible Note Indenture and New Convertible Notes
At or contemporaneously with the closing of the Transaction, the Company will cause to be issued the
5.0%
Senior Unsecured Convertible Notes due 2023 (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.
The Company may redeem, in whole but not in part, the New Convertible Notes at a redemption price of
100%
of the principal amount of the New Convertible Notes to be redeemed, plus accrued and unpaid interest and additional interest, if any, if the last reported sale price of the Common Stock equals or exceeds
120%
of the conversion price for at least
15
trading days in any period of
30
consecutive trading days. The Company may, at its election, pay or deliver as the case may be, to all
Holders of the New Convertible Notes, either (a) solely cash, (b) solely shares of Common Stock, or (c) a combination of cash and shares of Common Stock.
The New Convertible Note Indenture provides for customary events of default, which include (subject in certain cases to customary grace and cure periods), among others: nonpayment of principal or interest; breach of covenants or other agreements in the New Convertible Note Indenture; defaults in failure to pay certain other indebtedness; and certain events of bankruptcy or insolvency. Generally, if an event of default occurs and is continuing under the New Convertible Note Indenture, the trustee or the holders of at least
25%
in aggregate principal amount of the New Convertible Notes then outstanding may declare all unpaid principal plus accrued interest on the New Convertible Notes immediately due and payable, subject to certain conditions set forth in the New Convertible Note Indenture. In addition, holders of the New Convertible Notes may require the Company to repurchase the New Convertible Notes upon the occurrence of certain designated events at a repurchase price of
100%
of the principal amount of the New Convertible Notes, plus accrued and unpaid interest.
New Senior Note Indenture and New Senior Notes
At or contemporaneously with the closing of the Transaction, the Company will cause to be issued the
8.5%
Senior Notes due 2021 (the "New Senior Notes") in an aggregate amount not to exceed approximately
$40.0 million
pursuant to a Senior Note Indenture (the "New Senior Note Indenture") between the Company as issuer, and the trustee to be later identified. Up to approximately
$30.0 million
aggregate principal amount of New Senior Notes may be issued to holders of the Existing Senior Notes in the relevant exchange offer, and PJC or the Investor may acquire up to an additional
$10.0 million
principal amount of New Senior Notes.
The New Senior Notes will be secured senior obligations of the Company and will mature
four
years from the date of Closing. The New Senior Notes will bear interest at a rate of
8.5%
per annum, payable quarterly.
The New Senior Notes may be optionally redeemed in full by the Company at any time and must be redeemed in full upon additional issuances of debt by the Company in each case, at a price equal to
100%
of the principal amount redeemed plus (i) accrued and unpaid interest on the New Senior Notes redeemed up to the date of redemption, and (ii) the Applicable Premium, if any, as defined in the New Senior Note Indenture. Upon a change of control, the Company will be required to make an offer to holders of the New Senior Notes to repurchase the New Senior Notes at a price equal to
107.5%
of their principal amount, plus accrued and unpaid interest up to the date of redemption.
The New Senior Notes contain negative covenants restricting additional debt incurred by the Company, creation of liens on the collateral securing the New Senior Notes, and restrictions on dividends and stock repurchases, among other things. The New Senior Notes are secured by settlement proceeds, if any, received from certain litigation involving the Company, certain notes issued to the Company, and pledges of
65%
of the equity interests in Blue Heron Designated Activity Company, OLIPP IV, LLC and Red Reef Alternative Investments, LLC.
The New Senior Note Indenture provides for customary events of default which include (subject in certain cases to customary grace and cure periods), among others: nonpayment of principal or interest; breach of covenants or other agreements in the New Senior Note Indenture; defaults in failure to pay certain other indebtedness; and certain events of bankruptcy or insolvency. Generally, if an event of default occurs and is continuing under the New Senior Note Indenture, the trustee or the holders of at least
25%
in aggregate principal amount of the New Senior Notes then outstanding may declare the principal of and accrued but unpaid interest, plus a premium, if any, on all the New Senior Notes immediately due and payable, subject to certain conditions set forth in the New Senior Note Indenture.
Note Purchase Agreement
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.
Terms not defined in this Annual Report on Form 10-K shall have the meaning as set forth in the Agreements and respective Transaction Documents. The foregoing description of the Agreements and the transactions contemplated thereby is a summary only and is qualified in its entirety by reference to the full text of the Agreements, which will be filed as exhibits to the Company’s Quarterly Report on Form 10-Q for the period ending March 31, 2017.