LM Funding America Inc (LMFA) 2016 Q3 法說會逐字稿

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LM Funding America's third-quarter 2016 earnings call. My name is Chelsea and I will be your conference call operator. At this time, all participants will be in a listen-only mode. Joining us for today's presentation is LM Funding America's Chairman, CEO, and Founder, Bruce Rogers; and its Chief Financial Officer, Steve Weclew. Following their 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 a link in the investor relations section of the company's website, available at www.lmfunding.com.

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

Thank you, Chelsea, and good morning, everyone. Thank you for joining us today for our third-quarter 2016 earnings conference call. As we do at the beginning of each quarter 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 of 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 upon 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 away your home. This auction process allows the municipality to monetize their delinquent receivables, which results in the municipality being able to fund their budgets, continue to provide government services.

Now, if you live in a community association, your elected association's 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. When 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 forgoing property maintenance.

If the homeowner or condo owner doesn't pay their dues, associations have similar lien and foreclosure rights as municipalities. However, unlike municipalities, there was 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 have 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 have experienced over 13,000 collection events resulting in more than $57 million returned to the approximately 500 associations we have contracted with. We have 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 simply purchases 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 association.

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 association 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 delinquency 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 delinquency 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, therefore, the creditworthiness of a given association.

As for our current target markets, we began our operation in Florida in 2008 and have since expanded into Washington state, Colorado, and, most recently, Illinois. Given our history of 13,000 collection events, we have 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 association debt, we realize a $5 payout at some point in the future.

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 enhance, essentially automates the entire collection process. It ensures that all the necessary legal documentation is submitted and complete, that all figures are accurate, and 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 accounting and legal filings like we can.

Our Company PowerPoint presentation, which we provide to investors who request it from the investors 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 would now like to discuss our results for the third quarter of 2016. Following our IPO during October of last year, the third quarter of 2016 was highlighted by the continued implementation of our strategic growth plan, as well as the cost-cutting initiatives we began during the quarter.

It is important to note that the $2.6 million to $3 million of annual expenses we expect to remove from our operations, beginning in the fourth quarter this year, will have minimal impact on our recently expanded sales team.

Our results for the third quarter of 2016 reflected another slow quarter of real estate transactions in our target markets, which resulted in lighter numbers. In response, we are focusing our legal team's collection efforts on high revenue accounts, such as the approximately 100 accounts that do not have a mortgage on them. Historically, these accounts have returned, on average, $25,000 per payoff. So if we are successful in accelerating the timing of collection of these fee simple accounts, our revenue should improve.

One of the areas which we continue to see growth is our REO portfolio, which at quarter's end consisted of 72 properties, which are either currently being rented out or in the process of being rented out. This is up from 63 at June 30, 2016, and 33 at September 30, 2015.

This increase represents a tremendous value to the Company, both in terms of potential revenue as well as an increase in our Company's assets, which Steve will get to in a moment.

Additionally, subsequent to quarter's end, we initiated a number of strategies to monetize $165 million of unsecured assets that are not reflected on our balance sheet. Although it is too early to predict exactly what this means for the Company, we are confident that this will generate a significant amount of capital in the future, which will benefit LM Funding and its client community associations.

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

Thank you, Bruce, and thanks, everyone, for joining us today. For the third quarter of 2016, total revenues were just over $1 million, compared to $1.43 million in the second quarter 2016, and $1.61 million in the third quarter of 2015. For the first nine months of 2016, total revenues were a little over $4 million compared to $5.21 million in the first nine months of 2015.

These results reflect a decrease in total payoff events as we collected revenue from 217 payoff occurrences for the third quarter 2016, compared with 401 payoff occurrences for the third quarter of 2015, and 796 payoff occurrences for the first nine months of 2016, compared with 1,123 for the first nine months of 2015.

The decrease in payoff events was offset by an increase in the average total income statement revenue collected per unit to $4,640 in the third quarter of 2016, from $4,010 for the third quarter of 2015, and to $5,050 during the first nine months of 2016 from $4,640 for the first nine months of 2015.

Further, the decrease in revenues was partially offset by an increase in rental revenue from our REO properties. Operating expenses in the third quarter of 2016 were $2,340,000 compared to $2,070,000 in the second quarter of 2016, and $1,030,000 in the third quarter of 2015.

Operating expenses in the first nine months of 2016 totaled $6.53 million compared to $2.9 million during the first nine months of 2015. The increases were a result of increased staff costs and payroll, as well as an increase in professional fees which included the services 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 the 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 third quarter of 2016 was $119,000 compared with $131,000 during the second quarter of 2016, and $163,000 in the third quarter of 2015. Interest expense in the first nine months of 2016 was $390,000 compared to $566,000 in the first nine months of 2015.

The decrease in interest expense is attributable to the refinancing of $1.8 million of debt in July of 2015 at 6% interest; and the refinancing of $7.4 million, in December 2014, at 8% interest.

Prior to this refinancing, the interest rates were approximately 14% and 10%.

Net loss in the third quarter of 2016 totaled $914,000 or negative $0.28 per basic and diluted share compared with a net loss of $496,000 or $0.15 per basic or diluted share during the second quarter of 2016, and net income before taxes of $409,000 in the third quarter of 2015. Net loss in the first nine months of 2016 totaled $1.85 million, or negative $0.56 per basic and diluted share, compared with net income before taxes of $1.74 million in the first nine 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 corporate income tax is not applicable for the aforementioned periods. Decrease in net income was driven by the aforementioned increase in operating expenses and a decrease in revenues.

Now turning to the balance sheet, at September 30, 2016, we had a total of $3.6 million in cash, which compares to $5.8 million at June 30, 2016, and $9 million at December 31, 2015.

I would now like to point out a few items in our balance sheet that a fairly unique to our business. Our receivables are calculated using cash recovery 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 September 30, 2016, our balance sheet shows that our original product receivables totaled $1.17 million. This amount only represents the capital we have deployed to purchase the delinquent accounts.

However, a third-party actuarial estimate, completed as part of our 2015 year-end audit, estimated the actual fair value of these receivables in terms of what we could possibly collect to be around $9 million.

Also at the end of the third-quarter 2016, our balance sheet shows our New Neighbor Guaranty products receivables totaled $524,000, net of a credit allowance of $125,000. And, similar to the original product, the actual 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 had delinquent assessments, 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 about 72 properties as compared to 63 at the end of the second quarter of 2016, and 33 properties at the end of the third quarter of 2015.

Our rental revenues for the quarter totaled $107,000, which compared with $68,000 for the second quarter of 2016 and $38,000 in the third quarter of 2015. On a go-forward basis, the gross rental revenue of our current REO portfolio is approximately $180,000 per quarter, which is a 38% increase when compared to $130,000 at the end of last quarter, and an increase of 221% from $56,000 at September 30, 2015.

During the quarter, we continued progress monetizing our book of rental business as we are now generating monthly rental income from 78% of our REO properties, which is up slightly from 76% the end of last quarter.

At quarter end, our balance sheet showed our real estate owned assets were valued at $793,000. Again, this amount is what we paid to acquire and rehab properties. This represents an average investment of roughly $11,000 per property. And, according to Zillow, the sales value of those properties totals around $7.6 million at quarter end, compared with $3.6 million at December 31, 2015. This $4 million increase in value is not fully reflected in 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 have acquired.

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

Thank you, Steve. Since coming public in October of 2015, we have focused on building the infrastructure of our Company to prepare it for the significant opportunities that we see in the market. Our results continue to reflect the implementation of this growth plan and investment in the future of our business, with the continued efforts of our recently expanded sales team.

Additionally during the quarter, we took a hard look at our business and saw many places in which we could improve operational efficiencies, and took the necessary steps to remove between $2.6 million and $3 million of annual expenses off our books. While the results for the third quarter do not reflect these expense reductions, we expect these initiatives to start having a meaningful impact on our operations during the fourth quarter of 2016 and beyond.

One of the things we are very excited about is the strategic initiative we recently began. For each delinquent account we acquire, part is secured by real property; and, therefore, guaranteed to pay out sometime in the future, while the remaining amount is unsecured. Our focus and core competency has been, and will remain, monetizing the property secured portion of each account.

However, we have accumulated the rights to collect over $165 million of unsecured debt, which we believe we can monetize by partnering with unsecured collections specialists. In fact, we have already placed $5 million of these assets with an experienced collections specialist. Although it is hard to put an exact value on what this will mean, we believe these initiatives will generate a significant amount of capital, which will benefit our association clients as well as our Company.

A 2013 study performed by the Federal Trade Commission estimates that the average portfolio of debt face value goes for about $0.04 on the dollar. So the impact could be meaningful.

We also believe our proprietary software will ultimately enable us to acquire and service this type of unsecured debt on a national basis, as most all community associations possess some unsecured debt, and we know of no one else in the business of acquiring and servicing it.

As I described earlier, our business model is unique. When the real estate market is hot, prices typically go up, transaction volume increases, and delinquencies go down, but revenues on our previously acquired accounts come in. On the contrary, when the market cools, prices stay flat, volume falls, and delinquencies rise, setting the table for our future growth.

During the quarter, we saw another 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, and we lock in our profits when we buy accounts.

Our 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 to make inroads with new and existing homeowner and condo owner associations.

In fact, we are beginning to see new sales closed from our staff, and are excited to see how they grow in the future. Just in the Florida counties where we have a full-time sales staff, we believe there are approximately 100,000 delinquent accounts owing about $500 million. Our stated goal of acquiring 2,000 delinquent accounts by the end of the third quarter of 2017 will produce $9.4 million in future cash flows for the Company. These numbers are based upon historically low delinquencies. And any downturn in the real estate markets in which we operate will make them increase.

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 our awareness with our unique funding solutions. Given this funding, we are better equipped to take advantage of this opportunity in three 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 required.

Second, we can now increase the number of REO properties in our portfolio, which can provide a steady, reliable stream of recurring income. We have increased our REO holdings from 41 properties on December 31, 2015, to 73 properties on September 30, 2016.

Finally, given the tremendous opportunities in the market, we have built a qualified, entrepreneurial-minded sales team, and begun to roll them out on a wide scale.

It is also important to note that we deploy approximately $1,000 to acquire a delinquent unit; and, on average, it takes 25 months to collect. And, throughout our history, we have averaged approximately $5,500 in collections per condominium association account.

One of the challenges in this business is predicting when accounts pay off, as we have little control over the speed of the court system and other variables. Due to the decline in the volume of real estate transactions, we have revised our projection for 2016 payoffs from $1,500 down to $1,100.

While this trend has decreased year-to-date revenue, we believe the accounts that are not paying off today at historical rates will pay off in the future and at a higher amount per account, since they are all secured by liens against real property and accruing interest at 18% annually.

Now turning to our legal expenses. As we did last quarter, we saw a year-over-year increase in our legal and settlement expenses. Although we cannot comment on ongoing legal issues, we strongly believe we are making the necessary investments and setting future precedent around purchasing and collecting delinquent association dues. We do, however, expect to announce some favorable litigation outcomes in the fourth quarter.

Since our IPO, we have made significant progress executing our growth strategies, which include building and training our Florida sales team. Despite the income statement results for the quarter, we were able to grow the value of our real estate by $4 million, which we believe will be a significant long-term asset for the Company.

We are confident we are making the necessary investments in our business. And the result will be an extremely efficient, scalable operation that will see future growth in 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 to your questions. Operator, please provide the appropriate instructions.

(Operator Instructions). William Gibson, ROTH Capital Partners.

Let's start with the big one: the strategy to monetize the unsecured assets. You talked about the historical number of 4%. In the case where you have got a split with someone, do I roughly cut that in half? Or what is the math there?

So we went and shopped this, and got kind of fuzzy offers all over the board on just selling it outright. So what we have done is basically partnered on a 70/30 split with anybody -- we get 70%; they get 30% of whatever we collect. And we figured after we shake this out, $10 million worth of it, we will then actually know what it is worth. And then if you sell it outright, you're going to sell it at a discount to what it's worth, but it turns into cash right away. You hang in there and do it on a contingency basis; maybe make more. So that is kind of our attitude towards that right now.

Okay. Now, that makes sense. One of the things -- when you talked about trying to monetize 100 properties with no mortgages, why would they even be in arrears if there is no mortgage?

There is a number of reasons. The primary reason we end up with accounts like that is when a bank forecloses and takes title. The servicer doesn't have any money to pay assessments. And so, while they are rehabbing, selling, trying to monetize the property, they go to delinquent. And have about 61 days after they take title, we can foreclose on them. And so we have got to get sharper at pursuing those properties because they turn into being full payoffs and/or you end up owning something fee simple that's got equity in it. So the failure of managing the lawyers on my part that we have 100 of these, but we won't have 100 of these, years from now.

Okay. And, then, in the release you talked about the income statement revenue per unit. I guess it is a little funny; you said income statement. Do you measure it a different way, or what is behind that number?

I will let Steve handle that one.

All right. So what it is is, if we look at just a standard payout from our traditional line of business, that doesn't include any revenues generated from rental revenue. So when we talk about income statement revenue, we are talking about the actual revenue you see on the income statement, divided by the number of payouts that happened, which gives you a better picture of how we are truly monetizing the payout.

Thanks, Steve. That's it for me.

(Operator Instructions). Jeff Silver, Berson and Corrado.

Thank you. Bruce, can you talk about the number of new accounts that you have accumulated, year to date? And you mentioned that the payoffs were 1,100 -- or that you've had 1,100 payoffs, which is short of where you were hoping. Can you maybe sort of walk us through, with some kind of a bridge as to what impact those things have had on cash flow? And that, if the payoff -- if the rate of payoffs doesn't change, maybe give us some idea of what happens to cash flow in the next three or six months.

And I understand you're trying to monetize some of these unsecured assets. And I am assuming that is sort of by way of attempting to provide some of the necessary funding. But maybe you can just sort of -- there's a number of variables -- maybe you can sort of put a little narrative around that.

Sure. I will try. We get -- payoffs come from basically four or five different ways. There will be a mortgage foreclosure, in which case, we might just end up with a super lien, plus a few months' assessments afterwards. That is our kind of worst case. Sales, short sales, or full payoffs, owner payoffs occur when owners protect the equity in their property. And then, the outlier or association foreclosure, is when we take title and have to monetize the property through rent.

So at this point in the real estate market, we are seeing less real estate transactions; less sales, short sales, refinances, because it has been done and finished. And we could say that with some level of accuracy because we have to be contacted by the realtors and the title agent every time there is a real estate transaction.

So from January through September, we are down in 50% in these payoff requests that indicate whether or not transaction has happened. They don't always happen when they contact us. But it is a good indicator of what is going on out there. It doesn't affect the value of the portfolio, because the portfolio -- the actuaries still say it is worth $5,500 per account, and it is in there. It is just the sizzle in the market is not there like it was a year ago, in terms of people who are buying and selling.

And the other nice feature of that is if people are not buying and selling today, that means we are going to head on the downward cycle, at some point next year in the real estate cycle. We make our money on the buy. And as the real estate market softens, there will be more delinquencies. You will be getting 20 when you go to a condo association rather than 4. It works out.

It is just -- we are sort of at that flat plateau at the top of the market, as if we had started the business in 2007 rather than 2008, is how it feels to me.

Okay. How many new accounts have you obtained this year?

I am looking it up real quickly, to be precise. It is somewhere between 350 and 400. And I don't know if that is counting this month's to date, or not.

And so how confident are you that looking out over the next 12 months, you can obtain 2,000 accounts?

The cycle here is that we could -- the salesforce together in the first quarter; they spent the second quarter learning this complicated little business we have got. And in the last quarter, all of the people we have put on the ground were able to get in front of boards and close and buy units. The scary part is over. Now it is a matter of how many boards are they getting in front of? And how many units are they buying? And they can actually compete with one another in terms of how well they are doing.

Initially, you're kind of worried that -- do we have the right person? Have we given them the right tools, are they in the right place? And once they start closing units, your confidence level goes up.

Good. Thanks.

(Operator Instructions). At this time, this concludes our question-and-answer session.

I would like to turn the call back over to Mr. Rogers for his closing remarks.

Thank you all for tuning in. And I look forward to bringing better news at the end of the fourth quarter, or sometime in January.

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.