LM Funding America Inc (LMFA) 2016 Q4 法說會逐字稿

Good afternoon and welcome to LM Funding America's fourth-quarter and full-year 2016 earnings call. My name is Latif and I will be your conference call operator. (Operator Instructions).

Joining us for today's presentation is LM Funding America's Chairman, CEO and Founder, Bruce Rodgers, 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 Rodgers. Sir, please proceed.

Thank you, Latif, and good afternoon, everyone. Thank you for joining us today to discuss our fourth-quarter and full-year 2016 results. As we do at the beginning of each quarterly conference call, for those new to our story I would like to provide a brief overview of our Company before getting into financial results.

LM Funding was founded in 2008 when we recognized the need for nonprofit community associations like homeowner associations and condominium owner 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 to fund their budgets and 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 of the promised association amenities. When too many association fees go unpaid associations become unable to meet their budgets and ultimately they must either 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 a 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 an 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 successful manner. In fact, since we began in 2008 we have had over 12,000 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 the 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 association 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 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 or new asphalt the bank will not provide financing to cover these basic needs. Their only option is then to level a special assessment on the current paying owners, which in turn usually leads to more delinquencies in the association.

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 budgets and therefore the credit worthiness of a given association.

As for our current target markets, we began our operations in Florida in 2008 and since expanded into Washington state, Colorado and most recently Illinois. Given our history of approximately 12,000 collection events, we discovered a certain general formula that has remained fairly consistent, which demonstrates the strong leverage in our business model. That is for about every $1.00 we deploy to purchase association debt we realize a $5.00 payout some point in the future and this number is trending upward.

Certainly handling thousands 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 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 that 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 take a look.

So now that you have a better understanding of our business model and how it works, I would like to discuss our results for the quarter. The fourth quarter of 2016 was highlighted by the realization of our cost-cutting initiative implemented during the third quarter. This initiative led to a 34% reduction of operating expenses compared to the third quarter and we continue to expect this initiative to drive $2.6 million to $3 million of annual savings.

Revenues for the fourth quarter of 2016 reflected another slow period of real estate transactions in our target markets which resulted in lighter numbers. In response we are continuing to focus our legal team's collection efforts on higher revenue accounts such as the approximately 100 accounts that do not have a mortgage on them. Historically these accounts have returned an average $25,000 per payoff. We believe our increased foreclosure capacity should improve the monetization of these accounts in 2017.

We have successfully maintained strong rental revenue across our REO portfolio during this period. In fact, at the end of fourth quarter 95% of our properties were generating recurring rental income. At December 31, 2016 we had 67 properties in our REO portfolio compared to 43 units in 2015, a 56% increase.

These properties continue to represent a tremendous increase in value to the Company, both in terms of potential rental revenue as well as an increase in our Company's assets that is reflected on our balance sheet as our cost basis rather than fair market value, which we believe to be a significantly large amount. Steve will elaborate on this a little further.

Additionally, during the quarter 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.

Subsequent to the quarter, in February we received a favorable ruling from a federal district court judge regarding a proposed class action lawsuit filed by Wilmington Savings Fund Society FSB. This was a major win for not only LM Funding but for homeowner associations and every home and condominium owner throughout Florida. Ultimately this ruling enables associations to continue to collect what they are owed without placing additional burden on every person who pays their fees and mortgages on time every month.

Before I get into more details I would like to turn the call over to our CFO, Steve Weclew, to walk you through our financial results. Steve.

Thank you, Bruce. And thank you, everyone, for joining us today. For the fourth quarter of 2016 revenues were $900,000 compared to $1 million in the third quarter of 2016 and $1.8 million in the fourth quarter of 2015. For the full year 2016 total revenues were $4.9 million compared to $7 million in 2015.

These results reflect a decrease in total payoff events as we collected revenue from 163 payoff occurrences in the fourth quarter of 2016 compared to 353 payoff occurrences in the fourth quarter of 2015, and 959 payoff occurrences for the full year 2016 compared to 1,476 payoffs for 2015. The decrease in revenues was offset by an increase in rental revenue from our REO properties.

Operating expenses in the fourth quarter of 2016 decreased to $1.5 million compared to $2.3 million in the third quarter of 2016 and $1.5 million in the fourth quarter of 2015. And operating expenses for the year totaled $8 million compared to $4.3 million in 2015.

As Bruce mentioned earlier, the 34% quarterly reduction in operating expenses from Q3 2016 to Q4 2016 is a result of our cost-cutting initiative implemented in the third quarter of 2016, while the full year comparable increase was driven by increases in professional fees, legal fees and payroll due to increased headcount. Beginning with the next quarterly update we will finally have clean year-over-year comparisons as a public company.

Interest expense in the fourth quarter of 2016 was $130,000 compared to $188,000 in the year ago quarter. For the year interest expense was $600,000 compared to $920,000 in 2015. The annual 30% reduction was attributable to our financing of $1.8 million of debt in July 2015 at 6% interest.

Net loss in the fourth quarter of 2016 was $524,000 or negative $0.16 per share compared to a net loss of $914,000 or negative $0.28 per share in the third quarter of 2016 and net income of $230,000 in the year ago quarter.

Net loss for the full year 2016 was $2.4 million or negative $0.72 per share compared to net income before tax of $1.9 million in 2015. The improvement in quarterly net loss compared to Q3 was driven by the aforementioned cost-cutting initiatives, while the full-year decline was driven by the annual decrease in revenues and higher operating expenses associated with being a public company.

As I mentioned earlier, LM Funding was not a publicly traded company for the majority of 2015 and organized as a Florida limited liability company. So per share figures and corporate income tax is not applicable for the aforementioned periods.

Now turning to the balance sheet, at December 31, 2016 we had a total of $2.3 million of cash which compares to $3.6 million at September 30, 2016 and $9 million at December 31, 2015.

For newcomers to our story I would like to point out a few items in 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 this delinquent debt, not the actual underlying value of the debt.

For example, at December 31, 2016 our balance sheet shows that our original product receivables totaled $1 million. This amount only represents the capital we have deployed to purchase the delinquent accounts. However, our third-party actuarial estimate completed as part of our 2016 yearend audit estimated the actual fair value of these receivables in terms of what we could potentially collect to be around $7.9 million based on the income approach using a discount rate of 8.45%.

Also at the end of the fourth quarter of 2016 our balance sheet shows our New Neighbor Guaranty product receivables totaled $492,000 net of a credit allowance of $125,000. And similar to the original product, the actuarial estimate for the fair values of these receivables at year end were about $1 million, also based on the net income approach using the same discount rate of 8.45%.

Further, given the nature of our business we often receive title on property that has 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 year end we controlled about 67 properties compared to 72 at the end of the third quarter of 2016 and 43 properties at the end of the fourth quarter 2015.

Our rental revenues for the quarter were up 9% to $117,000 compared to the third quarter of 2016 and up 117% from $56,000 in the fourth quarter of 2015. This increase in revenue, despite having less potential units, reflects our higher occupancy rates in our control properties. During the quarter we continued to make progress in monetizing our book of rental business as we are now generating monthly rental income from 95% of our REO properties, which is up from 78% at the end of last quarter.

At December 31, 2016 our balance sheet shows our real estate owned assets were valued at $735,000. Again, this is the amount we paid to acquire and rehab the properties. This represents an average investment of roughly $11,000 per property. And according to Zillow, the gross sales value of those properties totaled $7.2 million at year end compared with $3.6 million at December 31, 2015.

This $3.6 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 in 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. So now with that, I would like to turn the call back over to Bruce. Bruce.

Thanks, Steve. Since going public in October 2015 we have focused on building the infrastructure of our Company to prepare it for the significant opportunity that we see in our market. Our results continue to reflect the implementation of this growth plan and investment in the future of our business.

During the third 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. We successfully implemented this initiative in October and reduced Q4 expenses by more than 34%. And we believe expenses will trend down further as we incur fewer one-time costs.

One of the things we are very excited about is the strategic initiative we began late last year to monetize delinquent accounts. 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 part is unsecured.

Our focus and core competency has been and will remain monetizing the property secured proportion 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 quite meaningful.

We also continue to believe our proprietary software will 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 go up when our previously acquired accounts come in. On the contrary, when the market cools prices stay flat, transaction volume falls and delinquencies rise setting the table for our future growth.

During the fourth quarter the Florida real estate market was once again soft in transaction volume compared to the same period in 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 future profits when we buy accounts.

I remind listeners that in Florida counties where we have full-time sales staff we believe there are approximately 100,000 delinquent accounts owing about $500 million annually. 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 have spent significant funds 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 have and continue to 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 67 REO properties on December 31, 2016. We also bought and sold an additional 35 properties during 2016.

Finally, given the tremendous opportunity in the market, we have built a highly 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 will pay off as we have little control over the speed of the court system and other variables. We also continue to believe that due to the 2016 decline in volume of real estate transactions, the accounts that have not paid off at historical rates will pay off in the future at a higher amount per account since they all are secured by liens against real property and accruing interest at 18% annually.

Now turning to our legal expenses. As expected fourth-quarter legal fees were up both sequentially and year over year. Although we cannot comment on ongoing legal issues, we strongly believe we are making the necessary investments in setting future precedent around purchasing and collecting delinquent association dues. In fact, subsequent to the quarter we received a favorable ruling related to the proposed class-action lawsuit filed by Wilmington Savings Fund Society.

As I mentioned earlier, this was not only a major win for LM Funding but for homeowners associations and every individual home and condo owner throughout Florida. After the federal district court judge rejected Wilmington's request for class action status, the court went on to say that Florida law already has an efficient way to handle these types of disputes and those laws are a much better way to resolve matters than a class-action.

We will now pursue legal fees in the Wilmington case and will continue to fight another class action lawsuit in Miami-Dade County involving the Solaris Condominium Association. Ultimately we believe our growth and profitability will be unhindered by these types of predatory lawsuits.

I'd also like to note some recent developments regarding accounting rules of going concern assessments. In August 2014 FASB issued ASU 2014-15 titled Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern, which requires management to assess a company's ability to continue as a going concern within one year from financial statement issuance without regard to planned refinancing and other capital [events] and to provide related footnote disclosures in certain circumstances, which we have disclosed in Note 13 of our 10-K.

The Company has debt obligations rising within a little over a year that if not refinanced will, under the accounting rules, raise substantial doubt about the Company's ability to continue as a going concern. Management has performed the accounting rules required assessment and has concluded that it is probable that its plans will mitigate the conditions that raise going concern issues.

Specifically the Company has a history of refinancing debt and we are confident that we will be able to successfully refinance the current debt obligations. We base this on our perceived attractiveness to a lender of the value ascribed to our available collateral by independent actuaries as set forth in footnote 11, the hidden value in our REO portfolio and the unsecured debt portfolio.

We believe all of these assets can over-collateralize the refinancing of our current debt and much of our future capital liens. Although the Company experienced significant operating losses in 2016, we believe that there have been positive financial trends for the six-month period ended February 2017. Our significant expense reduction starting in September of 2016 will greatly benefit 2017 operations.

We believe our new sales team will achieve significant increases in unit acquisitions that will increase 2017 revenues and beyond. We have also acquired a large real estate base that, if needed, could be sold to help the Company's liquidity. We expect to generate additional liquidity through the monetization of our real estate and additional debt financing obligations.

We expect that these actions will be executed in alignment with the anticipated timing of our liquidity needs. We also continue to explore ways to unlock value across a range of assets, including ways to maximize the value of our unsecured debt.

We believe that the actions discussed above and further in Note 13 of our 10-K mitigate the substantial doubt raised by our recent operating losses and refinancing needs and satisfy our estimated liquidity needs over 12 months from the issuance of the financial statements.

In 2017 we will continue to execute on our various growth and profitability initiatives to unlock the value of our Company. This includes our strategies to collect from higher revenue generating accounts, continuing to build and monetize both our balance sheet and off-balance-sheet assets, and maintaining a keen focus on cost reduction initiatives while building an efficient scalable operation.

We continue to believe LM Funding is in the right place at the right time as the Florida real estate market begins to turn. And have every expectation that we will be able to refinance our capital needs for long-term growth.

Now with that we are ready to open the call for your questions. Operator, please provide the appropriate instructions.

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

You talked about the 25-month rough lag between acquiring an asset and then monetization. Is there a way to look at your portfolio and come up with some weighted average or the age of what you have and your best guess as the estimated timing of when we start seeing acceleration of realizations?

Yes, Bill. Obviously 10-K you are governed by your auditors and in this case the actuaries. And so, they are using the nine-year trailing average of what time it takes. That 25-month number is decreasing and it decreases by a number of factors. One is we get better at managing the law firms and managing the transaction cycle to a collection.

And so, it has come down quite a bit. But we went with the conservative approach and agreed with how the actuaries are doing it and they are looking at the nine-year history. It will creep down, but not as fast as it is actually creeping down probably in our financial reports.

So does that lead us to a late 2017-2018 acceleration in you realizing returns?

Yes, I believe so. And it is also the velocity of turning over accounts is greatly determined on the amount of new accounts you buy because our crazy sales cycle, which takes three to six months to buy an account -- well, what happens during that three to six months is the Board of Directors of this not-for-profit that meets once a month. They stop doing everything for a period of time before they decide to engage us, which means that there is lots of accounts where somebody feels like they have gotten away with something for a period of time.

And then suddenly once the account is in our hands and it is being diligently prosecuted they sort of look at it and go, wow, I don't really want to be liened and foreclosed on and these fees are outrageous and I need to pay off. So, we will see a decrease in the average hold time with an increase in the amount of accounts purchased and that is ongoing as we speak. And I look forward to talking to everybody in about 45 days or less about how well that is going.

Good, thank you.

(Operator Instructions). At this time I would like to turn the call back over to Mr. Rodgers for his closing remarks.

Well, 2016 was a challenging year for us and we plan to improve upon that, it is not an immediate thing, but we have got the team in place, we have got our costs reduced and we will be turning the corner to profitability again and refinancing our debt and doing some things that are going to make this what it has been for the last nine years. Unfortunately the last year was the only one of the nine, other than the first year, that was painful. So bear with us and I look forward to talking to you all in another 45 days.

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. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful day.