LM Funding America Inc (LMFA) 2016 Q2 法說會逐字稿

Good afternoon, and welcome to LM Funding America's second-quarter 2016 earnings call. My name is Karen, and I will be your conference operator.

(Operator Instructions)

Joining us for today's presentation is LM Funding America's Chairman, CEO, and Founder, Bruce Rodgers; and it's Chief Financial Officer, Steve Weclew. Following the remarks, we will open up the call for your questions.

Then, before we conclude today's call, I will provide the necessary cautions regarding the forward-looking statements made by management during this call. I would like to remind everyone that this call will be recorded and made available for replay via link in the investor relations section of our Company's website, available at www.lmfunding.com.

Now, I would like to turn the call over to Mr. Bruce Rodgers. Sir, please proceed.

Thank you, Karen. And good afternoon, everyone.

Thank you for joining us today for our second-quarter 2016 earnings conference call. As we do at the beginning of each quarterly conference call, I would like to take a moment to provide a brief overview of our Company for those new to our story before I get into the results for the quarter.

LM Funding was founded in 2008 when we recognized the need for nonprofit community associations like homeowners associations and condominium owners associations to better manage unpaid association dues and to secure the funds needed for successful operations. As all homeowners know, if you don't pay your property taxes, the local municipality has the right to issue a tax lien on your property. If your taxes continue to go unpaid, they can auction off a certificate representing the tax lien against your property and ultimately take your home. This auction process allows the municipality to monetize their delinquent receivables, which results in the municipality being able fund their budgets and continue to provide government services.

Now if you live in a community association, your association's elected board of directors sets a budget and imposes assessments on the community residents, which is effectively a tax, in order to provide all the promised association amenities. If too many association fees go unpaid, associations become unable to meet their budgets and ultimately they either must levy a special assessment on all the paying residents or cut association services, like closing down the hot tub or pool, or foregoing property maintenance.

If a homeowner or condo owner doesn't pay their dues, associations have similar lien and foreclosure rights as municipalities; however, unlike municipalities, there is no easy way for associations to monetize these delinquent receivables. They cannot convert them into lien certificates and sell them at auction. The market for this simply does not exist. Their only option is to hire a law firm to pursue collections, and traditionally this has been a very slow, expensive, complicated, and inefficient process.

In fact, associations are sometimes left with legal bills that are equal to the amounts collected by the law firm, that is if they are successful in collecting anything at all. So there has been no easy solution; that is, until LM Funding came along.

We've established a long and successful track record of returning capital to associations in a highly efficient and successful manner. In fact, since we began in 2008, we've experienced over 12,000 collection events resulting in more than $57 million returned to the approximately 500 associations we have contracted with, which is up from $55 million at the end of 2015.

We've accomplished this with two product offerings that are designed to help associations solve this burdensome problem of delinquent accounts. Our first product, which we call our original product, provides associations an easy straightforward way to recover overdue assessments. LM Funding is simply purchasing delinquent accounts from the association giving the association immediate financial relief. We then apply our proprietary procedures and software system to manage and ultimately collect the delinquent assessments, and in most cases, return additional capital to the associations.

Our second product, which we introduced in 2013, we call the New Neighbor Guaranty. Our New Neighbor Guaranty provides associations guaranteed funding going forward as we agree to pay the monthly or quarterly assessments for a given delinquent account in exchange for the right to collect all past-due assessments. This in effect guarantees that associations' budgets are met.

Both of our solutions become particularly attractive when the delinquency rate of an association reaches two specific thresholds. First, when an association's overall delinquent rate reaches 8%, banks will typically no longer lend to the association. So if a community needs to borrow money for a new roof, elevator repairs, new asphalt, the bank will not provide financing to cover these basic needs. Their only option is to levy a special assessment on the current paying owners, which in turn usually leads to even more delinquencies.

Second, when an association's overall delinquent rate reaches 15%, government-backed mortgage lenders will no longer lend to potential home or condo buyers, therefore requiring potential buyers to pay in cash. As you would expect, this has a very negative effect on real estate prices. We have found our New Neighbor Guaranty product is particularly helpful in both scenarios as we can virtually guarantee the future budget and creditworthiness of a given association. As for our current target markets, we began our operations in Florida in 2008 and have since expanded into Washington State, Colorado, and most recently, Illinois.

Given our history of approximately 12,000 collection events, we've discovered a certain general formula that has remained fairly consistent which demonstrates the strong leverage in our business model. That is, for about every $1 we deploy to purchase associate debt, we realize a $5 payout at some point in the future. That said, in quarters where we have made strategic investments into our business, like the past two quarters, we expect our free cash flow per unit to be below average. Once we begin to see newly acquired accounts begin to collect in significant numbers, we are confident we will again see the typical operating leverage we are used to.

Certainly, handling hundreds of collection events per year is not an easy task, so a critical part of what has made our business so successful and the reason we have been able to scale over the years is our proprietary software. This software, which we have developed internally and continually enhanced over the years, essentially automates the entire collection process.

It ensures that all the necessary paperwork is submitted and complete, that all figures are accurate, and that all state and specific local ordinances are followed, as well as it ensures that critical deadlines are met. Altogether, it has put tremendous efficiency, speed, capacity, and quality control into a collection process that previously was tedious, time consuming, and subject to human error.

In a way, this supporting system represents our secret sauce. And we have seen many copycat competitors go out of business over the years because they simply cannot handle the volume of paperwork like we can. Our Company PowerPoint presentation, which we provide to investors who request it from the investor section of our website, provides some great examples about how this all works in terms of real numbers. So if you haven't seen it, we encourage you to have a look.

So now that you have a better understanding about our business model and how it works, I'd like to discuss our results from the second quarter of 2016. On the heels of our IPO during October of last year, the second quarter of 2016 was highlighted by the continued implementation of our strategic growth plan, despite the slowing real estate transactions in our target markets which resulted in lower collection events and lower revenues. We continued to invest in the future of our business with the continued efforts in our recently expanded sales and marketing team.

Further at quarter's end, our REO portfolio consisted of 63 properties, which are either currently being rented out or in the process of being rented out, which is up from 56 at March 31, 2016. This increase represents a tremendous value to the Company both in terms of potential rental revenue, as well as an increase in our Company's assets, which Steve will get into in a moment.

Before I get into more details, I'd like to now turn the call over to our CFO, Steve Weclew, who will go through the financial results. Steve?

Thank you, Bruce. And thanks, everyone, for joining us today.

For the second quarter of 2016, revenues were $1.46 million compared with $1.58 million in the first quarter of 2016, and $2.02 million in the second quarter of 2015. For the first six months of 2016, revenues were $3.04 million compared with $3.6 million in the first six months of 2015.

These results reflect the decrease in the average revenue collected per unit to $4,300 in the second quarter of 2016 from $5,300 for the second quarter of 2015, and to $4,300 during the first six months of 2016 from $4,900 for the first six months of 2015. These figures were partially due to an increased number of payoffs related to single-family homes compared to condominiums, which typically have higher payouts.

Additionally, a decrease in total payoff events contributed to our results as we collected revenue from 237 payoff occurrences for the second quarter of 2016, compared with 411 payoff occurrences for the second quarter of 2015 and 579 payout occurrences for the first six months of 2016 compared with 722 for the first six months of 2015. The slight decrease in revenues is partially offset by an increase in revenue generated by our New Neighbor Guaranty product and an increase in rental revenue from our REO properties.

Operating expenses in the second quarter of 2016 were $2.07 million compared with $2.12 million in the first quarter of 2016 and $880,000 in the second quarter of 2015. Operating expenses in the first six months of 2016 totaled $4.19 million compared with $1.87 million during the six months of 2015.

The quarterly and six months increases were a result of increased staff costs and payroll, as well as an increase in professional fees, which include the service agreement with Business Law Group established in the fourth quarter of 2015. Also adding to the increases were expenses incurred as a result of being a public company and expenses related to increased legal activity. We view the increase in legal fees as compared to previous quarters as a necessary investment in developing precedent for future cases that will enhance the value of our portfolio of delinquent accounts.

Interest expense in the second quarter of 2016 was $131,000 compared with $140,000 during the first quarter of 2016 and $209,000 in the second quarter of 2015. Interest expense in the first six months of 2016 was $270,000 compared with $403,000 in the first six months of 2015. The decrease in interest expense was attributable to the refinancing of $1.8 million in debt in July of 2015 at 6% interest and the refinancing of $7.4 million in December of 2014 at 8% interest.

Prior to this refinancing, the interest rates were approximately 14% and 10%. Net loss in the second quarter of 2016 totaled $478,000 or negative $0.14 per basic and diluted share, compared with net loss of $436,000 or negative $0.13 per basic and diluted share during the first quarter of 2016, and net income before taxes of $929,000 in the second quarter of 2015. Net loss in the first six months of 2016 totaled $914,000 or negative $0.28 per basic and diluted share compared with net income before taxes of $1.33 million in the first six months of 2015.

In 2015, LM Funding was not a publicly traded company and organized as a Florida limited liability company, so per share figures and any corporate income tax was not applicable for the aforementioned period. The decrease in net income was driven by the aforementioned increase in operating expenses and decrease in revenues.

Now turning to the balance sheet, at June 30, 2016, we had a total of $5.8 million in cash, which compares to $7.3 million at March 31, 2016, and $9 million at December 31, 2015. I would now like to point out a few items on our balance sheet that are fairly unique to our business. Our receivables are calculated using the cash recovery method of accounting.

This means we only account for the dollar amount paid to acquire the delinquent debt, not the actual underlying value of the debt. For example, at June 30, 2016, our balance sheet shows that our original product receivables totaled $1.24 million. This amount only represents the capital we have deployed to purchase the delinquent accounts. However, our third-party actuarial estimates, completed as part of our 2015 year-end audit, estimated the actual fair value of these receivables in terms of what we could potentially collect to be around $9 million.

Also, at the of the second quarter of 2016, our balance sheet shows our New Neighbor Guaranty product receivables totaled $652,000 net of a credit allowance of $125,000. Similar to the original product, the actuarial estimate of the fair value of these receivables at year end were about $1.5 million.

Further, given the nature of our business, we often receive title on a property that has a delinquent assessment, with this title also having considerable inherent value to consider. Bruce will expand on this in a moment, but when we take title we typically refurbish the property and rent it out. So at quarter end, we controlled 63 properties as compared to 56 at the end of the first quarter of 2016 and 31 properties at the end of the second quarter of 2015.

Our rental revenues for the quarter totaled $96,000, which compared to $55,000 for the first quarter of 2016 and $38,000 in the second quarter of 2015. On a go-forward basis, our current REO portfolio is expected to produce cash flows of approximately $141,000 per quarter, which is an 88% increase when compared with $75,000 at the end of Q1 2016 and an increase of 120% from $64,000 at the end of 2015.

During the quarter, we made significant progress monetizing our book of rental business, as we are now generating monthly rental income from 76% of our REO properties, which is up significantly from 52% at the end of last quarter. At quarter end, our balance sheet showed our real estate owned assets were valued at $800,000. Again, this amount is what we paid to acquire and rehab the properties.

This represents an average investment of roughly $12,700 per property, and according to Zillow, the value of these properties totals around $6.9 million at quarter end compared with $3.6 million at December 31, 2015, an $3.3 million increase in value. It is not fully reflected on our financial statements and should be considered when looking at the Company's overall performance. So we believe these fairly unique aspects of our business as reflected on our balance sheet are important things to consider when evaluating our performance, and particularly our prospects for realizing the inherent value of the assets we acquired.

Now with that, I'd like to turn the call back over to Bruce. Bruce?

Thank you, Steve.

Second quarter of 2016 was a reflection of the implementation of our strategic growth plan, an investment in the future of our business and the continued efforts of our recently expanded sales and marketing team. As I described earlier, our business model is unique. When the real estate market is hot, prices typically could go up, transaction volume increases, and delinquencies, go down.

On the contrary, when the market cools, prices stay flat, volume falls, and delinquencies rise. During the quarter, we saw a slowdown of transactions across the Florida market when compared with 2015. While this had a negative impact on our results for the quarter, we believe that this macro indicator bodes well for the long-term future of our business as we expect the number of delinquent accounts in the market to start to increase.

Our recently formed sales team, which consists of 10 full-time sales and marketing professionals compared to only three at the end of 2015, began working together in the first quarter and continues with the new and existing homeowner and condo associations. As the amount of delinquent accounts increased throughout our target markets, we expect our sales team will capitalize on this opportunity. In fact, we estimate that within our targeted markets in Florida, annual delinquent units will total 125,000, representing a $590 million opportunity.

Our stated goal of acquiring 2,000 new delinquent units by the end of the first quarter of 2017 represents acquiring just 1.6% market share in Florida, but projects to add over $9 million to future cash flows. So the investment we have made in our more robust salesforce promises long-term financial reward for our Company.

Now turning to our legal expenses, as we did last quarter, we saw a year-over-year increase in our legal and settlement expenses. We believe these are necessary investments in setting future precedents around purchasing and collecting delinquent association dues. We expect that our operating expenses to remain fully consistent over the next few quarters as we invest into the infrastructure of our Company for future growth.

Recent market data shows that there are 65 million Americans living in over 333,000 community associations, and in the four states in which we are currently operating, there are 85,000 associations governing 2.7 million homes and condos. Assuming the delinquency rate of 6%, which usually is approximate to the unemployment rate, in our current market we see a total of $1.8 billion in annual delinquent assessments. To put this in perspective, we've collected a total of $114 million since 2008, which averages out to about $16 million a year.

In order to take better advantage of this opportunity, we raised money in our IPO last October in order to expand our reach and spread awareness of our unique funding solutions. Given this funding, we were better equipped to take advantage of this opportunity in three key ways. First, we now have more funds available to purchase delinquent accounts for both our original product and New Neighbor Guaranty product. And we have already seen and continue to see the increase in the number of delinquent accounts acquired.

Second, we can now increase the number of REO properties in our portfolio, which can provide a steady, reliable stream of recurring income. We've increased our REO holdings from 41 properties on December 31, 2015, to 63 properties on June 30, 2016.

Finally, given the tremendous opportunity we our unique products, we've built a highly qualified, entrepreneurial-minded sales team and begun to roll them out on a wide scale. Supported by the influx of capital and expansion of our sales team, we continue to work to increase the number of delinquent accounts we own.

We currently own 1,860 accounts, which on a net basis is down slightly from 2,000 at the end of the first quarter. During the second quarter, we added 113 accounts and remain confident that we will achieve our ambitious goal of acquiring a total of 2,000 new accounts during the 12 months ended March 31, 2017. It's also important to note that we deploy approximately $1,000 to acquire a delinquent unit and on average it takes 25 months to collect.

Throughout our history, we've averaged approximately $5,500 in collections per condominium association account. One of the challenges in this business is predicting when accounts will pay off as we have little control over the speed of the court systems and other variables. However, based upon our history, we maintain our projections that we set last quarter, between 1,500 and 1,700 accounts will pay off in 2016.

Since our IPO, we've made significant progress executing our growth strategies, which include building and training our Florida sales team and opening operations in Chicago. Despite the income statement results of the quarter, we were able to grow the value of our real estate by $1.8 million, which we believe will be a significant long-term asset to the Company.

We are confident we are making the necessary investments into our business that will grow both our top line, bottom line, and balance sheet, which will ultimately build significant long-term shareholder value. Now with that, we are ready to open the call for your questions. Operator, please provide the appropriate instructions.

Thank you.

(Operator Instructions)

Casey Alexander, Compass Point.

Remind me again a little bit how this works, particularly on the real estate owned portfolio. Basically, you've moved the previous owner out and taken possession of the property; and until you can sell it, you are renting the property? Is that what you're doing?

Yes. There are several different scenarios.

First, we buy the lien for roughly about $1,000 per lien. We have foreclosure rights, so we foreclose out the current owner. The property will either be subject to a mortgage or not subject to a mortgage. If it's not subject to a mortgage, then obviously we can sell it free and clear and get title insurance for it. If it's subject to a mortgage, we don't have to pay the mortgage and we can rent it. But it doesn't have the same marketable value as if it was not subject to a mortgage.

So those are the two strategies. And our focus right now is on renting these, although if the market times right and somebody offers us a lot of money for the free and clear ones, we'd probably consider selling them.

All right. Okay. And if it is subject to a mortgage and you're renting it out, how do you ultimately resolve that property?

One of several ways. One, is the mortgage holder can actually foreclose it out at some point in time. And then we would lose that rental income.

Two, we have the right to redeem upwards as a junior lien holder. So we could pay off the mortgage, and we do that from time to time. We will offer to buy it for a fraction of its face value to create more equity in the property.

And then three, a lot of these have bad mortgage paperwork. And the statute of limitations is tolling on them, and the mortgage foreclosure will not likely take it away from us. That's a tougher question to answer, how you get it free and clear. You have to do a quiet title action, and it's sort of a case-by-case basis of what the grounds for that would be.

Okay. Now, I would assume an association, if somebody is behind by a couple of months, they're not turning that over to you. They're going to be waiting until it's deeper in delinquency than that.

So given the number of associations that you're working with, you should sort of have a big picture view of how the funnel is developing. What's happening in the macro market, and how do you read that?

Steve, do you want to take that?

What we're seeing right now is the number of delinquencies, as we see it right now, is not where it was when we started our Company. However, what we are seeing is a turn starting to happen in the greater condominium real estate market, especially in Florida. Anybody on the call can go ahead and just Google Miami condo real estate, and you'll see many articles from Forbes and those types of things talking about what's happening right now in the real estate market.

That's also affecting us right now on the payouts. Now, just because the payouts are slowing down doesn't decrease the number of liens that we have. So because we're talking about real property, it will always change hands. It's just a matter of when.

So what we're seeing right now is the condo market is starting to turn. People have officially paid more in many, many cases for their properties in a presale than what they're worth. The number of units that are currently under construction to be delivered over the next two years is astronomical compared to what's actually changing hands. So we feel we're in this lull, if you will. We're in that time period where people are still kind of grasping at straws to try and get rid of their properties.

But we believe we're going to see a turn here in the next 6 to 12 months, where the number of delinquencies is going to grow drastically.

Okay. Great. Thank you for taking my questions.

Thank you.

This concludes our question and answer session. I would like to turn the call back over to Mr. Rodgers for his closing remarks.

Thank you.

On behalf of the entire management team, I'd like to thank our shareholders, employees, clients and partners for their ongoing support. We certainly have an exciting year ahead. We look forward to updating you on our progress next quarter.

Before we conclude today's call, I would like to take the opportunity to remind our listeners that today's presentation and responses to questions may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, that were discussed today, including without limitation, statements regarding the Company's future financial position, business strategy, budgets, projected revenues, projected costs, and plans and objectives of management for future operations are forward-looking statements.

Forward-looking statements generally can be identified by the use of forward-looking terminology such as may, will, expects, intends, plans, projects, estimates, anticipates, believes, or the negative thereof or any variation thereon or similar terminology or expressions. The Company has based these forward-looking statements on their current expectations and projections about future events. These forward-looking statements are not guarantees and are subject to known and unknown risks, uncertainties, and assumptions about us that may cause the Company's actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements.

Important factors which could materially affect the Company's results and future performance include, without limitation, the Company's ability to purchase defaulted consumer receivables at appropriate prices; changes in government regulations that affect the Company's ability to collect sufficient amounts on defaulted consumer receivables. The Company's ability to employ and retain qualified employees; changes in the credit or capital markets; changes in interest rates; deterioration in economic conditions; and negative press regarding the debt collection industry, which may have a negative impact on a debtor's willingness to pay the debt we acquire, as well as other factors set forth under Risk Factors in the Company's filing with the SEC.

Thank you for joining us today for our presentation. This concludes today's call. You may now disconnect.