UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934
For the transition period from _________ to ________
Commission File Number: None
GWG HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
| Delaware | 26-2222607 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
220 South Sixth Street, Suite 1200
Minneapolis, MN 55402
(Address of principal executive offices, including zip code)
(612) 746-1944
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
| Large accelerated filer ☐ | Accelerated filer ☐ | |
| Non-accelerated filer ☐ | Smaller reporting company ☒ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
As of November 10, 2016, GWG Holdings, Inc. had 5,980,190 shares of common stock outstanding.
GWG HOLDINGS, INC.
Index to Form 10-Q
for the Quarter Ended September 30, 2016
| Page No. | ||
| PART I. | FINANCIAL INFORMATION | |
| Item 1. | Financial Statements | 1 |
| Condensed Consolidated Balance Sheets as of September 30, 2016, and December 31, 2015 | 1 | |
| Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and 2015 | 2 | |
| Condensed Consolidated Statements of Cash Flows for the three and nine months ended September 30, 2016 and 2015 | 3 | |
| Consolidated Statement of Changes in Stockholders’ Equity | 5 | |
| Notes to Condensed Consolidated Financial Statements | 6 | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 27 |
| Item 4. | Controls and Procedures | 54 |
| PART II. | OTHER INFORMATION | |
| Item 1A. | Risk Factors | 55 |
| Item 5. | Other Information | 56 |
| Item 6. | Exhibits | 56 |
| SIGNATURES | 57 | |
PART I—FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
GWG HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, (unaudited) | December 31, 2015 | |||||||
| A S S E T S | ||||||||
| Cash and cash equivalents | $ | 18,773,828 | $ | 34,425,105 | ||||
| Restricted cash | 15,688,025 | 2,341,900 | ||||||
| Investment in life insurance contracts, at fair value | 477,585,100 | 356,649,715 | ||||||
| Secured MCA advances | 6,113,831 | - | ||||||
| Life insurance contract benefits receivable | 6,129,022 | - | ||||||
| Other assets | 3,131,107 | 2,461,045 | ||||||
| TOTAL ASSETS | $ | 527,420,913 | $ | 395,877,765 | ||||
| L I A B I L I T I E S & S T O C K H O L D E R S’ E Q U I T Y | ||||||||
| LIABILITIES | ||||||||
| Senior Credit Facilities | $ | 63,699,385 | $ | 63,279,596 | ||||
| Series I Secured Notes | 17,553,307 | 23,287,704 | ||||||
| L Bonds | 379,858,737 | 276,482,796 | ||||||
| Accounts payable | 2,442,449 | 1,517,440 | ||||||
| Interest payable | 13,633,640 | 12,340,061 | ||||||
| Other accrued expenses | 645,343 | 1,060,786 | ||||||
| Deferred taxes, net | 3,242,586 | 1,763,968 | ||||||
| TOTAL LIABILITIES | $ | 481,075,447 | $ | 379,732,351 | ||||
| STOCKHOLDERS’ EQUITY | ||||||||
| CONVERTIBLE PREFERRED STOCK | ||||||||
| (par value $0.001; shares authorized 40,000,000; shares outstanding 2,649,665 and 2,781,735; liquidation preference of $19,872,000 and $20,863,000 on September 30, 2016 and December 31, 2015, respectively) | 19,772,931 | 20,784,841 | ||||||
| REDEEMABLE PREFERRED STOCK | ||||||||
| (par value $0.001; shares authorized 100,000; shares outstanding 33,201; liquidation preference of $33,176,600 on September 30, 2016) | 33,176,600 | - | ||||||
| COMMON STOCK | ||||||||
| (par value $0.001: shares authorized 210,000,000; shares issued and outstanding 5,980,190 and 5,941,790 on September 30, 2016 and December 31, 2015) | 5,980 | 5,942 | ||||||
| Additional paid-in capital | 15,226,449 | 17,149,391 | ||||||
| Accumulated deficit | (21,836,494 | ) | (21,794,760 | ) | ||||
| TOTAL STOCKHOLDERS’ EQUITY | 46,345,466 | 16,145,414 | ||||||
| TOTAL LIABILITIES & EQUITY | $ | 527,420,913 | $ | 395,877,765 | ||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
| 1 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, 2016 | September 30, 2015 | September 30, 2016 | September 30, 2015 | |||||||||||||
| REVENUE | ||||||||||||||||
| Gain on life insurance contracts, net | $ | 13,509,755 | $ | 8,189,261 | $ | 51,606,815 | $ | 33,446,556 | ||||||||
| MCA income | 286,225 | - | 654,441 | - | ||||||||||||
| Interest and other income | 124,998 | 93,841 | 341,098 | 233,516 | ||||||||||||
| TOTAL REVENUE | 13,920,978 | 8,283,102 | 52,602,354 | 33,680,072 | ||||||||||||
| EXPENSES | ||||||||||||||||
| Interest expense | 11,983,968 | 8,650,149 | 32,009,934 | 23,149,030 | ||||||||||||
| Employee compensation and benefits | 2,912,463 | 2,308,246 | 8,450,168 | 6,180,886 | ||||||||||||
| Legal and professional fees | 586,830 | 822,077 | 3,097,312 | 1,988,261 | ||||||||||||
| Other expenses | 2,863,212 | 2,231,341 | 7,608,057 | 5,646,402 | ||||||||||||
| TOTAL EXPENSES | 18,346,473 | 14,011,813 | 51,165,471 | 36,964,579 | ||||||||||||
| INCOME (LOSS) BEFORE INCOME TAXES | (4,425,495 | ) | (5,728,711 | ) | 1,436,883 | (3,284,507 | ) | |||||||||
| INCOME TAX EXPENSE (BENEFIT) | (1,428,130 | ) | (2,097,633 | ) | 1,478,617 | (664,905 | ) | |||||||||
| NET LOSS | $ | (2,997,365 | ) | (3,631,078 | ) | $ | (41,734 | ) | $ | (2,619,602 | ) | |||||
| Loss attributable to preferred shareholders | 421,026 | 343,644 | 1,103,896 | 1,041,648 | ||||||||||||
| INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS | $ | (2,576,339 | ) | (3,287,434 | ) | $ | 1,062,162 | $ | (1,577,954 | ) | ||||||
| NET INCOME (LOSS) PER SHARE | ||||||||||||||||
| Basic | $ | (0.50 | ) | (0.61 | ) | $ | (0.01 | ) | $ | (0.44 | ) | |||||
| Diluted | $ | (0.50 | ) | (0.61 | ) | $ | 0.13 | $ | (0.44 | ) | ||||||
| WEIGHTED AVERAGE SHARES OUTSTANDING | ||||||||||||||||
| Basic | 5,978,322 | 5,937,320 | 5,962,938 | 5,894,956 | ||||||||||||
| Diluted | 5,978,322 | 5,937,320 | 8,092,196 | 5,894,956 | ||||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
| 2 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, 2016 | September 30, 2015 | September 30, 2016 | September 30, 2015 | |||||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||||||||
| Net loss | $ | (2,997,365 | ) | $ | (3,631,078 | ) | $ | (41,734 | ) | $ | (2,619,602 | ) | ||||
| Adjustments to reconcile net loss to net cash flows from operating activities: | ||||||||||||||||
| Gain on life insurance contracts | (21,073,226 | ) | (14,516,881 | ) | (53,846,155 | ) | (26,651,363 | ) | ||||||||
| Amortization of deferred financing and issuance costs | 2,765,743 | 1,933,776 | 6,077,905 | 1,891,772 | ||||||||||||
| Deferred income taxes | (1,428,130 | ) | (1,916,686 | ) | 1,478,617 | (664,905 | ) | |||||||||
| Preferred stock dividends payable | 333,565 | 173,993 | 663,614 | 509,225 | ||||||||||||
| (Increase) decrease in operating assets: | ||||||||||||||||
| Life insurance contract benefits receivable | 700,000 | 2,142,986 | (6,129,022 | ) | 1,392,986 | |||||||||||
| Other assets | 419,836 | (417,990 | ) | (617,630 | ) | (774,539 | ) | |||||||||
| Increase (decrease) in operating liabilities: | ||||||||||||||||
| Due to related party | (80,949 | ) | - | (182,730 | ) | - | ||||||||||
| Accounts payable and other accrued expenses | (3,216,990 | ) | 2,534,269 | (2,024,234 | ) | 3,836,715 | ||||||||||
| NET CASH FLOWS USED IN OPERATING ACTIVITIES | (24,577,516 | ) | (13,697,611 | ) | (54,621,369 | ) | (23,079,711 | ) | ||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||||||||
| Investment in life insurance contracts | (25,770,326 | ) | (13,626,842 | ) | (74,470,362 | ) | (23,850,860 | ) | ||||||||
| Carrying value of matured life insurance contracts | 1,078,889 | 80,000 | 7,381,132 | 3,822,983 | ||||||||||||
| Investment in Secured MCA advances | (1,965,896 | ) | - | (7,613,310 | ) | - | ||||||||||
| Proceeds from Secured MCA advances | 220,911 | - | 1,246,703 | - | ||||||||||||
| NET CASH FLOWS USED IN INVESTING ACTIVITIES | (26,436,422 | ) | (13,546,842 | ) | (73,455,837 | ) | (20,027,877 | ) | ||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||||||
| Net borrowings on (repayments of) Senior Credit Facilities | (10,761,048 | ) | - | 6,238,952 | (7,150,000 | ) | ||||||||||
| Payments for redemption of Series I Secured Notes | (541,275 | ) | (890,586 | ) | (6,264,018 | ) | (4,508,130 | ) | ||||||||
| Proceeds from issuance of L Bonds | 64,350,430 | 37,122,127 | 135,477,090 | 87,620,483 | ||||||||||||
| Payments for issuance and redemption of L Bonds | (14,373,447 | ) | (19,363,047 | ) | (37,036,922 | ) | (32,376,104 | ) | ||||||||
| Proceeds from (increase in) restricted cash | (4,527,232 | ) | 651,630 | (13,346,126 | ) | (2,975,507 | ) | |||||||||
| Issuance of common stock | 31,515 | - | 244,185 | 582,000 | ||||||||||||
| Proceeds from issuance of preferred stock | 20,786,332 | - | 31,287,541 | - | ||||||||||||
| Payments for issuance and redemption of preferred stock | (2,556,859 | ) | (21,187 | ) | (4,174,773 | ) | (295,185 | ) | ||||||||
| NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES | 52,408,416 | 17,498,937 | 112,425,929 | 40,897,557 | ||||||||||||
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 1,394,478 | (9,745,516 | ) | (15,651,277 | ) | (2,210,031 | ) | |||||||||
| CASH AND CASH EQUIVALENTS | ||||||||||||||||
| BEGINNING OF PERIOD | 17,379,350 | 38,198,189 | 34,425,105 | 30,662,704 | ||||||||||||
| END OF PERIOD | $ | 18,773,828 | $ | 28,452,673 | $ | 18,773,828 | $ | 28,452,673 | ||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
| 3 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS – CONTINUED
(unaudited)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, 2016 | September 30, 2015 | September 30, 2016 | September 30, 2015 | |||||||||||||
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | ||||||||||||||||
| Interest and preferred dividends paid | $ | 11,516,000 | $ | 5,385,000 | $ | 28,683,000 | $ | 18,529,000 | ||||||||
| Premiums paid | $ | 11,785,000 | $ | 6,603,000 | $ | 29,225,000 | $ | 19,069,000 | ||||||||
| Stock-based compensation | $ | 162,000 | $ | 176,000 | $ | 213,000 | $ | 208,000 | ||||||||
| NON-CASH INVESTING AND FINANCING ACTIVITIES | ||||||||||||||||
| Series I Secured Notes: | ||||||||||||||||
| Conversion of accrued interest and commissions payable to principal | $ | 47,000 | $ | 61,000 | $ | 234,000 | $ | 188,000 | ||||||||
| L Bonds: | ||||||||||||||||
| Conversion of accrued interest and commissions payable to principal | $ | 854,000 | $ | 491,000 | $ | 1,515,000 | $ | 929,000 | ||||||||
| Issuance of Series A Preferred Stock in lieu of cash dividends | $ | 170,000 | $ | 172,000 | $ | 509,000 | $ | 507,000 | ||||||||
| Investment in life insurance contracts included in accounts payable | $ | 1,603,000 | $ | 559,000 | $ | 1,603,000 | $ | 559,000 | ||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
| 4 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(unaudited)
| Preferred Stock | Preferred | Common | Common Stock | Additional Paid-in | Accumulated | Total | ||||||||||||||||||||||
| Shares | Stock | Shares | (par) | Capital | Deficit | Equity | ||||||||||||||||||||||
| Balance, December 31, 2014 | 2,738,966 | $ | 20,527,866 | 5,870,193 | $ | 5,870 | $ | 16,257,686 | $ | (14,401,486 | ) | $ | 22,389,936 | |||||||||||||||
| Net loss | - | - | - | - | - | (7,393,274 | ) | (7,393,274 | ) | |||||||||||||||||||
| Issuance of common stock | - | - | 60,000 | 60 | 581,940 | - | 582,000 | |||||||||||||||||||||
| Series A Preferred Stock conversion to common stock | (15,463 | ) | (115,973 | ) | 11,597 | 12 | 115,961 | - | - | |||||||||||||||||||
| Issuance of preferred stock | 58,232 | 372,948 | - | - | - | - | 372,948 | |||||||||||||||||||||
| Issuance of stock options | - | - | - | - | 193,804 | - | 193,804 | |||||||||||||||||||||
| Balance, December 31, 2015 | 2,781,735 | $ | 20,784,841 | 5,941,790 | $ | 5,942 | $ | 17,149,391 | $ | (21,794,760 | ) | $ | 16,145,414 | |||||||||||||||
| Net income | - | - | - | - | - | (41,734 | ) | (41,734 | ) | |||||||||||||||||||
| Issuance of common stock | - | - | 36,450 | 36 | 244,149 | - | 244,185 | |||||||||||||||||||||
| Redemption of Series A Preferred Stock | (204,848 | ) | (1,521,358 | ) | 1,950 | 2 | 19,498 | - | (1,501,858 | ) | ||||||||||||||||||
| Issuance of Series A Preferred Stock | 72,778 | 509,448 | - | - | - | - | 509,448 | |||||||||||||||||||||
| Issuance of redeemable preferred stock | 33,201 | 33,176,600 | - | - | (2,399,219 | ) | - | 30,777,381 | ||||||||||||||||||||
| Issuance of stock options | - | - | - | - | 212,630 | - | 212,630 | |||||||||||||||||||||
| Balance, September 30, 2016 | 2,682,866 | $ | 52,949,531 | 5,980,190 | $ | 5,980 | $ | 15,226,449 | $ | (21,836,494 | ) | $ | 46,345,466 | |||||||||||||||
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
| 5 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) Nature of Business and Summary of Significant Accounting Policies
Nature of Business – Through its wholly owned subsidiaries, GWG Holdings, Inc. owns a portfolio of life insurance contracts. As of the date of this report, our portfolio had an aggregate fair value of $477.6 million. We earn income from changes in the fair value of our portfolio and through the benefits we receive from the life insurance contracts we own. We are also involved in other lines of business, including a business that collects commissions for facilitating the conversion of term life insurance contracts into universal, or permanent, life insurance, and a business that participates in the merchant cash advance industry by advancing sums to merchants and lending money to businesses that advance sums to merchants. Operating results for the three- and nine-month periods included in this report are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.
GWG Holdings, Inc. and all of its subsidiaries are incorporated and organized in Delaware. Unless the context otherwise requires or we specifically so indicate, all references in these footnotes to “we,” “us,” “our,” “our Company,” “GWG,” or the “Company” refer to GWG Holdings, Inc. and its subsidiaries collectively and on a consolidated basis. References to the full names of particular entities, such as “GWG Holdings, Inc.” or “GWG Holdings,” are meant to refer only to the particular entity referenced.
Use of Estimates – The preparation of our consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities at the date of the consolidated financial statements, as well as the reported amounts of revenue during the reporting period. The Company regularly evaluates estimates and assumptions, which are based on current facts, historical experience, and various other factors that it believes to be reasonable under the circumstances. The actual results experienced by the Company may differ materially and adversely from the Company’s estimates. The most significant estimates with regard to these consolidated financial statements relate to (1) the determination of the assumptions used in estimating the fair value of our investments in life insurance contracts, and (2) the value of our deferred tax assets and liabilities.
Cash and Cash Equivalents – We consider cash in demand deposit accounts and temporary investments purchased with an original maturity of three months or less to be cash equivalents. We maintain our cash and cash equivalents with highly rated financial institutions. The balances in our bank accounts may exceed Federal Deposit Insurance Corporation limits. We periodically evaluate the risk of exceeding insured levels and may transfer funds as we deem appropriate.
Life Insurance Contracts – ASC 325-30, Investments in Insurance Contracts (“ASC 325-30”), permits a reporting entity to account for its investments in life insurance contracts using either the investment method or the fair value method. We elected to use the fair value method to account for our life insurance contracts. Under the fair value method, we recognize our initial investment at the purchase price. At each subsequent reporting period, we re-measure the investment at fair value in its entirety and recognize the change in fair value as revenue in the current period net of premiums paid. We use the term “life insurance contracts” to have the same meaning as “life insurance policies.”
We also recognize realized gain (revenue) from a life insurance contract upon one of the two following events: (1) our receipt of notice or verified mortality of the insured; or (2) our sale of the contract, filing of change-of-ownership forms and receipt of payment. In the case of mortality, the gain (or loss) we recognize is the difference between the contract benefits and the carrying values of the contract once we receive notice or verify the mortality of the insured. In the case of a contract sale, the gain (or loss) we recognize is the difference between the sale price and the carrying value of the contract on the date of our receipt of sale proceeds.
In a case where our acquisition of a contract is not complete as of a reporting date, but we have nonetheless advanced direct costs and deposits for the acquisition, those costs and deposits are recorded as “other assets” on our balance sheet until the acquisition is complete and we secured title to the contract. On September 30, 2016 and December 31, 2015, a total of $34,000 and $31,000, respectively, of our “other assets” comprised direct costs and deposits that we advanced for contract acquisitions.
Other Assets – GWG acquired the exclusive option to license “DNA Methylation Based Predictor of Mortality” technology from the University of California, Los Angeles (UCLA). The technology was discovered by Dr. Steven Horvath and is featured in the September 2016 edition of Aging. In 2013, Dr. Horvath reported that human cells have a mechanism that records biological aging progression based on DNA methylation that is independent from chronological aging progression. In 2016, Dr. Horvath discovered a specific set of DNA methylation-based bio-markers that are highly predictive of all-cause mortality. The discovery was made through a statistical analysis of bio-markers found in DNA samples from over 13,000 individuals whose health had been studied for decades. The implications of Dr. Horvath’s discovery are simple and profound: A biostatistician can review a specific set of identified bio-markers and develop a highly predictive analytical model of an individual’s lifespan. The cost of entering into this exclusive option agreement is listed as “other assets”.
| 6 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Deferred Financing and Issuance Costs – Loans advanced to us under our senior credit facilities, as described in Notes 5 and 6, are reported net of financing costs, which are amortized using the straight-line method over the term of the facility. The Series I Secured Notes and L Bonds, as respectively described in Notes 7 and 8, are reported net of issuance costs, sales commissions and other direct expenses, which are amortized using the interest method over the term of those borrowings. The Series A Preferred Stock, as described in Note 9, is reported net of issuance costs, sales commissions (including the fair value of warrants issued) and other direct expenses, all of which were fully amortized using the interest method as of December 31, 2015. Selling and issuance costs of Redeemable Preferred Stock and MCA Preferred Stock, described in Notes 10 and 11, are netted against additional paid-in-capital.
Earnings (loss) per Share – Basic earnings (loss) per share attributable to non-redeemable interests are calculated using the weighted-average number of shares outstanding during the reported period. Diluted earnings (loss) per share are calculated based on the potential dilutive impact of our outstanding Series A Preferred Stock, Redeemable Preferred Stock, warrants and stock options.
Recently Adopted Pronouncements – On April 7, 2015, the FASB issued Accounting Standards Update No. 2015-03, Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), as part of its simplification initiative. ASU 2015-03 changes the presentation of debt issuance costs by presenting those costs in the balance sheet as a direct deduction from the related debt liability. Amortization of the costs is reported as interest expense. We adopted ASU 2015-03 effective January 1, 2016, as required for public reporting entities.
Reclassification – Certain 2015 amounts have been reclassified to conform to ASU 2015-03, and that adoption reduced our assets, together with a corresponding reduction to our liabilities, by approximately $2,288,000 as of December 31, 2015. There was no impact on our statements of operations in 2015, and these reclassifications had no effect on our reported consolidated net income or loss for prior periods.
(2) Restrictions on Cash
Under the terms of our senior credit facilities (discussed in Notes 5 and 6), we are required to maintain collection and escrow accounts that are used to fund the acquisition of contracts, pay annual contract premiums, pay interest and other charges under the facility, and collect contract benefits. The agent for the lender authorizes the disbursements from these accounts. At September 30, 2016 and December 31, 2015, there was a balance of $15,688,000, and $2,342,000, respectively, in these restricted cash accounts.
(3) Investment in Life Insurance Contracts
Life insurance contracts are valued based on unobservable inputs that are significant to their overall fair value. Changes in the fair value of these contracts are recorded as gain or loss on life insurance contracts, net of cash premiums paid on those contracts, in our consolidated statements of operations. Fair value is determined on a discounted cash flow basis that incorporates life expectancy assumptions derived from reports obtained from widely accepted life expectancy providers, assumptions relating to cost-of-insurance (premium) rates and other assumptions. The discount rate we apply incorporates current information about discount rate applied by other reporting companies owning portfolios of life insurance contracts, the discount rates observed in the life insurance secondary market, market interest rates, our credit exposure to the insurance companies that issued the life insurance contracts and management’s estimate of the risk premium a purchaser would require to receive the future cash flows derived from our portfolio as a whole. As a result of management’s analysis, discount rates of 11.07% and 11.09% were applied to our portfolio as of September 30, 2016 and December 31, 2015, respectively.
| 7 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
We recognized life insurance benefits of $5,300,000 and $357,000 during the three months ended September 30, 2016 and 2015, respectively, related to contracts with a carrying value of $1,078,000 and $80,000, respectively, and as a result recorded realized gains of $4,221,000 and $277,000. We recognized life insurance benefits of $34,367,000 and $29,732,000 during the nine months ended September 30, 2016 and 2015, respectively, related to contracts with a carrying value of $7,381,000 and $3,823,000, respectively, and as a result recorded realized gains of $26,986,000 and $25,909,000.
Reconciliation of gain on life insurance contracts:
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2016 | 2015 | 2016 | 2015 | |||||||||||||
| Change in fair value | $ | 21,073,000 | $ | 14,517,000 | $ | 53,846,000 | $ | 26,651,000 | ||||||||
| Premiums and other fees | (11,784,000 | ) | (6,605,000 | ) | (29,225,000 | ) | (19,114,000 | ) | ||||||||
| Contract maturities | 4,221,000 | 277,000 | 26,986,000 | 25,909,000 | ||||||||||||
| Gain on life insurance contracts, net | $ | 13,510,000 | $ | 8,189,000 | $ | 51,607,000 | $ | 33,446,000 | ||||||||
We currently estimate that premium payments and servicing fees required to maintain our current portfolio of life insurance contracts in force for the next five years, assuming no mortalities, are as follows:
| Years Ending December 31, | Premiums | Servicing | Premiums and Servicing Fees | |||||||||
| Three months ending December 31, 2016 | $ | 10,449,000 | $ | 188,000 | $ | 10,637,000 | ||||||
| 2017 | 43,155,000 | 750,000 | 43,905,000 | |||||||||
| 2018 | 46,847,000 | 750,000 | 47,597,000 | |||||||||
| 2019 | 50,813,000 | 750,000 | 51,563,000 | |||||||||
| 2020 | 56,633,000 | 750,000 | 57,383,000 | |||||||||
| 2021 | 63,222,000 | 750,000 | 63,972,000 | |||||||||
| $ | 271,119,000 | $ | 3,938,000 | $ | 275,057,000 | |||||||
Management anticipates funding the premium payments estimated above with proceeds from our senior credit facilities, proceeds from additional debt and equity financing, and proceeds from maturities of life insurance contracts. The proceeds of these capital sources may also be used for the purchase, financing, and maintenance of additional life insurance contracts.
| 8 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(4) Fair Value Definition and Hierarchy
ASC 820, Fair Value Measurement (“ASC 820”), establishes a hierarchical disclosure framework that prioritizes and ranks the level of market price observability used in measuring assets and liabilities at fair value. Market price observability is affected by a number of factors, including the type of investment, the characteristics specific to the investment and the state of the marketplace, including the existence and transparency of transactions between market participants. Assets and liabilities with readily available and actively quoted prices, or for which fair value can be measured from actively quoted prices in an orderly market, generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. ASC 820 maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring the use of observable inputs whenever available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect assumptions about how market participants price an asset or liability developed based on the best available information. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.
The hierarchy is broken down into three levels based on the observability of inputs as follows:
| ● | Level 1 - Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. 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 - Valuations based on one or more quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly. |
| ● | Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement. |
The availability of observable inputs can vary by types of assets and liabilities and is affected by a wide variety of factors, including, for example, whether an instrument is established in the marketplace, the liquidity of markets and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for assets and liabilities categorized in Level 3.
Level 3 Valuation Process
The estimated fair value of our portfolio of life insurance contracts is determined on a quarterly basis by our portfolio management committee, taking into consideration changes in discount rate assumptions, estimated premium payments and life expectancy estimate assumptions, as well as any changes in economic and other relevant conditions. The discount rate incorporates (i) current information about discount rate applied by other reporting companies owning portfolios of life insurance contracts, (ii) the discount rates observed in the life insurance secondary market, (iii) market interest rates, (iv) our credit exposure to the insurance company that issued the life insurance contract and (v) management’s estimate of the risk premium a purchaser would require to receive the future cash flows derived from our portfolio as a whole.
These inputs are then used to estimate the discounted cash flows from the portfolio using the Model Actuarial Pricing System probabilistic portfolio price model, which estimates the cash flows using various mortality probabilities and scenarios. The valuation process includes a review by senior management as of each valuation date. We also engage a third-party expert to independently test the accuracy of the valuations using the inputs we provide on a quarterly basis. See Exhibit 99.1 filed herewith.
The following table reconciles the beginning and ending fair value of our Level 3 investments in our portfolio of life insurance contracts for the periods ended September 30, as follows:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
| 2016 | 2015 | 2016 | 2015 | |||||||||||||
| Beginning balance | $ | 431,820,000 | $ | 301,499,000 | $ | 356,650,000 | $ | 282,883,000 | ||||||||
| Purchases | 25,770,000 | 13,626,000 | 74,470,000 | 23,851,000 | ||||||||||||
| Maturities (carrying value) | (1,078,000 | ) | (80,000 | ) | (7,381,000 | ) | (3,823,000 | ) | ||||||||
| Net change in fair value | 21,073,000 | 14,517,000 | 53,846,000 | 26,651,000 | ||||||||||||
| Ending balance (September 30) | $ | 477,585,000 | $ | 329,562,000 | $ | 477,585,000 | $ | 329,562,000 | ||||||||
| 9 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
We periodically update the independent life expectancy estimates on the insured lives in our portfolio, other than insured lives covered under small face amount contracts (i.e., $1 million in face value benefits or less), on a continuous rotating three-year cycle. Accordingly, we update life expectancies for approximately one-twelfth of our portfolio each quarter.
The following table summarizes the inputs utilized in estimating the fair value of our portfolio of life insurance contracts:
As
of | As
of | |||||||
| Weighted-average age of insured, years | 81.8 | 82.6 | ||||||
| Weighted-average life expectancy, months | 81.8 | 79.3 | ||||||
| Average face amount per contract | $ | 2,035,000 | $ | 2,386,000 | ||||
| Discount rate | 11.07 | % | 11.09 | % | ||||
These assumptions are, by their nature, inherently uncertain and the effect of changes in estimates may be significant. For example, if the life expectancy estimates were increased or decreased by four and eight months on each outstanding contract, and the discount rates were increased or decreased by 1% and 2%, while all other variables were held constant, the fair value of our investment in life insurance contracts would increase or (decrease) as summarized below:
Change in Fair Value of the Investment in Life Insurance Contracts
| Change in life expectancy estimates | ||||||||||||||||
| minus 8 months | minus 4 months | plus 4 months | plus 8 months | |||||||||||||
| September 30, 2016 | $ | 64,713,000 | $ | 32,215,000 | $ | (31,450,000 | ) | $ | (62,258,000 | ) | ||||||
| December 31, 2015 | $ | 48,339,000 | $ | 24,076,000 | $ | (23,501,000 | ) | $ | (46,482,000 | ) | ||||||
| Change in discount rate | ||||||||||||||||
| minus 2% | minus 1% | plus 1% | plus 2% | |||||||||||||
| September 30, 2016 | $ | 50,097,000 | $ | 23,990,000 | $ | (22,096,000 | ) | $ | (42,492,000 | ) | ||||||
| December 31, 2015 | $ | 35,024,000 | $ | 16,786,000 | $ | (15,485,000 | ) | $ | (29,803,000 | ) | ||||||
Other Fair Value Considerations
The carrying value of receivables, prepaid expenses, accounts payable and accrued expenses approximate fair value due to their short-term maturities and low credit risk. Using the income-based valuation approach, the estimated fair value of our Series I Secured Notes and L Bonds, having a combined aggregate face value of $402,416,000 as of September 30, 2016, is approximately $414,023,000 based on a weighted-average market interest rate of 6.36%. The carrying value of the senior credit facilities reflects interest charged at the commercial paper rate or 12-month LIBOR, as applicable, plus an applicable margin. The margin represents our credit risk, and the strength of the portfolio of life insurance contracts collateralizing the debt. The overall rate reflects market, and the carrying value of the facility approximates fair value.
Our wholly owned subsidiary GWG MCA Capital, Inc. (“GWG MCA”) participates in the merchant cash advance by directly advancing sums to merchants and lending money, on a secured basis, to companies that advance sums to merchants. Each quarter, we review the carrying value of these advances and loans, and determine if an impairment reserve is necessary. At September 30, 2016, one of our secured loans to Nulook Capital LLC was potentially impaired. The secured loan to Nulook Capital LLC had an outstanding balance of $3,215,000 and a loan loss reserve of $400,000 at September 30, 2016. We deem fair value to be the estimated collectible value on each loan or advance made from GWG MCA. Where we estimate the collectible amount to be less than the outstanding balance, we record a reserve for the difference.
| 10 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The following table summarizes outstanding warrants as of September 30, 2016:
| Month issued | Warrants issued | Fair value per share | Risk free rate | Volatility | Term | |||||||||||||||
| December 2011 | 68,937 | $ | 0.22 | 0.42 | % | 25.25 | % | 5 years | ||||||||||||
| March 2012 | 38,130 | $ | 0.52 | 0.38 | % | 36.20 | % | 5 years | ||||||||||||
| June 2012 | 161,840 | $ | 1.16 | 0.41 | % | 47.36 | % | 5 years | ||||||||||||
| July 2012 | 144,547 | $ | 1.16 | 0.41 | % | 47.36 | % | 5 years | ||||||||||||
| September 2012 | 2,500 | $ | 0.72 | 0.31 | % | 40.49 | % | 5 years | ||||||||||||
| September 2014 | 16,000 | $ | 1.26 | 1.85 | % | 17.03 | % | 5 years | ||||||||||||
| 431,954 | ||||||||||||||||||||
(5) Credit Facility – Autobahn Funding Company LLC
Through our subsidiaries GWG DLP Funding II, LLC (“DLP II”) and GWG DLP Funding III, LLC (“DLP III”), we are party to a $105 million revolving senior credit facility with Autobahn Funding Company LLC (“Autobahn”), with a maturity date of June 30, 2018. The facility is governed by a Credit and Security Agreement (the “Agreement”), and DZ Bank AG Deutsche Zentral-Genossenschaftsbank (“DZ Bank”) acts as the agent for Autobahn under the Agreement. On September 14, 2016, we paid off the revolving senior credit facility in full with funds received from a new senior secured term loan with LNV Corporation as described in Note 6.
Advances under the facility bear interest at a commercial paper rate of the lender at the time of the advance, or at the lender’s cost of borrowing plus 4.25%. We make interest payments on a monthly basis. The effective rate of interest was 5.42% at September 14, 2016 and 5.58% at December 31, 2015. The weighted-average effective interest rate, after excluding an unused line fee, was 5.46% and 5.42% for the three months ended September 30, 2016 and 2015, respectively, and 5.54% and 5.81% for the nine months ended September 30, 2016 and 2015, respectively.
The amount outstanding under this facility was $0 and $65,011,000 at September 30, 2016 and December 31, 2015, respectively. GWG Holdings is a performance guarantor of the various obligations of GWG Life, LLC (“GWG Life”), as servicer, under the Agreement. Obligations under the facility are secured by our pledge of ownership in our life insurance contracts to DZ Bank through an arrangement under which Wells Fargo serves as a securities intermediary.
The Agreement has certain financial (as described below) and non-financial covenants, and we were in compliance with these covenants at September 30, 2016 and December 31, 2015.
We have agreed to maintain (i) a positive consolidated net income on a non-GAAP basis (as defined and calculated under the Agreement) for each complete fiscal year, (ii) a tangible net worth on a non-GAAP basis (again, as defined and calculated under the Agreement) of not less than $45 million, and (iii) maintain cash and eligible investments of $15 million or above. Consolidated non-GAAP net income and non-GAAP tangible net worth as of and for the four quarters ended September 30, 2016, as calculated under the Agreement, was $33,877,000 and $149,361,000, respectively.
Total funds available for additional borrowings under the facility at December 31, 2015, was $39,989,000. At September 30, 2016, the amount outstanding was $0 and there were no policies pledged to the facility.
(6) Credit Facility – LNV Corporation
On September 14, 2016, we entered into a senior secured term loan with LNV Corporation (“LNV”) as lender through our subsidiary GWG DLP Funding IV, LLC (“DLP IV”) as borrower. The facility is governed by a Loan and Security Agreement (the “Loan Agreement”), with CLMG Corp. (“CLMG”) acting as administrative agent on behalf of the lender under the Loan Agreement. The Loan Agreement makes available a total of up to $172,300,000 in credit with a maturity date of September 14, 2026. Additional quarterly advances are available under the Loan Agreement. Interest will accrue on amounts borrowed under the agreement at an annual interest rate, determined as of each date of borrowing, equal to (A) the greater of 12-month LIBOR or the federal funds rate (as defined in the agreement) plus one-half of one percent per annum, plus (B) 5.75% per annum. Interest payments are made on a quarterly basis.
At September 30, 2016, the amount outstanding under this facility was $71,250,000 and total funds available for additional borrowing, net of required reserve, was $76,629,000.
| 11 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Obligations under the facility are secured by a security interest in DLP IV’s assets, for the benefit of the lenders under the Loan Agreement, through an arrangement under which Wells Fargo serves as security intermediary.
The Loan Agreement requires DLP IV to maintain a reserve account in an amount sufficient to pay 12 months of servicing, administrative and third party expenses identified under the Loan Agreement, and 12 months of debt service as calculated under the Loan Agreement. As of November 10, 2016, the amount set aside in the reserve account is $27,500,000.
The Agreement has no financial covenants and certain non-financial reporting covenants, and we were in compliance with these covenants at September 30, 2016.
(7) Series I Secured Notes
Series I Secured Notes (“Notes”) are legal obligations of GWG Life and were privately offered and sold from August 2009 through June 2011. The Notes are secured by the assets of GWG Life and are subordinate to obligations under our senior credit facilities (see Notes 5 and 6). We are party to a Third Amended and Restated Note Issuance and Security Agreement dated November 1, 2011, as amended, under which GWG Life is obligor, GWG Holdings is guarantor, and Lord Securities Corporation serves as trustee of the GWG Life Trust (“Trust”). This agreement contains certain financial and non-financial covenants, and we were in compliance with these covenants at September 30, 2016 and December 31, 2015.
The Notes were sold with original maturity dates ranging from six months to seven years, and with fixed interest rates varying from 5.65% to 9.55% depending on the term of the Note. The Notes have renewal features under which we may elect to permit their renewal, subject to the right of bondholders to elect to receive payment at maturity. Effective September 1, 2016, we no longer anticipate renewing the Notes.
Interest on the Notes is payable monthly, quarterly, annually or at maturity depending on the election of the investor. At September 30, 2016 and December 31, 2015, the weighted-average interest rate of our Notes was 8.63% and 8.47%, respectively. The principal amount of Notes outstanding was $17,830,000 and $23,578,000 at September 30, 2016 and December 31, 2015, respectively. The difference between the amount outstanding on the Notes and the carrying amount on our balance sheet is due to netting of unamortized deferred issuance costs. Overall, interest expense includes amortization of deferred financing and issuance costs of $82,000 and $275,000 for the three and nine months ended September 30, 2016 and $49,000 and $260,000 for the three and nine months ended September 30, 2015. Future expected amortization of deferred financing costs is $277,000 in total over the next six years.
Future contractual maturities of Notes payable and future amortization of their deferred financing costs at September 30, 2016 are as follows:
| Years Ending December 31, | Contractual Maturities | Amortization of Deferred Financing Costs | ||||||
| Three months ending December 31 ,2016 | $ | 1,177,000 | $ | 5,000 | ||||
| 2017 | 10,522,000 | 88,000 | ||||||
| 2018 | 2,401,000 | 49,000 | ||||||
| 2019 | 1,023,000 | 22,000 | ||||||
| 2020 | 1,766,000 | 55,000 | ||||||
| Thereafter | 941,000 | 58,000 | ||||||
| $ | 17,830,000 | $ | 277,000 | |||||
| 12 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(8) L Bonds
Our L Bonds are legal obligations of GWG Holdings. Obligations under the L Bonds are secured by the assets of GWG Holdings and by GWG Life, as a guarantor, and are subordinate to the obligations under our senior credit facilities (see Notes 5 and 6). We began publicly offering and selling L Bonds in January 2012 under the name “Renewable Secured Debentures.” These debt securities were re-named “L Bonds” in January 2015. L Bonds are publicly offered and sold on a continuous basis under a registration statement permitting us to sell up to $1.0 billion in principal amount of L Bonds. We are party to an indenture governing the L Bonds dated October 19, 2011, as amended (“Indenture”), under which GWG Holdings is obligor, GWG Life is guarantor, and Bank of Utah serves as indenture trustee. The Indenture contains certain financial and non-financial covenants, and we were in compliance with these covenants at September 30, 2016 and December 31, 2015.
Effective September 1, 2016, we discontinued the sales of 6-month and 1-year L Bonds. In addition, effective September 1, 2016, the L Bond interest rates changed to 5.50%, 6.25%, 7.50% and 8.50% for the 2-, 3-, 5- and 7-year L Bonds, respectively. The bonds have renewal features under which we may elect to permit their renewal, subject to the right of bondholders to elect to receive payment at maturity. Interest is payable monthly or annually depending on the election of the investor.
At September 30, 2016 and December 31, 2015, the weighted-average interest rate of our L Bonds was 7.16% and 7.18%, respectively. The principal amount of L Bonds outstanding was $384,586,000 and $282,171,000 at September 30, 2016 and December 31, 2015, respectively. The difference between the amount of outstanding L Bonds and the carrying amount on our balance sheets is due to netting of unamortized deferred issuance costs and cash receipts for new issuances in process. Amortization of deferred issuance costs was $2,073,000 and $5,362,000 for the three and nine months ended September 30, 2016 and $1,892,000 and $4,232,000 for the three and nine months ended September 30, 2015. Future expected amortization of deferred financing costs as of September 30, 2016 is $11,622,000 in total over the next eight years.
Future contractual maturities of L Bonds, and future amortization of their deferred financing costs, at September 30, 2016 are as follows:
| Years Ending December 31, | Contractual Maturities | Amortization of Deferred Financing Costs | ||||||
| Three months ending December 31, 2016 | $ | 23,548,000 | $ | 115,000 | ||||
| 2017 | 112,987,000 | 1,708,000 | ||||||
| 2018 | 101,130,000 | 3,106,000 | ||||||
| 2019 | 78,098,000 | 3,222,000 | ||||||
| 2020 | 19,291,000 | 784,000 | ||||||
| Thereafter | 49,532,000 | 2,687,000 | ||||||
| $ | 384,586,000 | $ | 11,622,000 | |||||
(9) Convertible Preferred Stock
From July 2011 until September 2012, we privately offered shares of Series A Preferred Stock (“Series A”) of GWG Holdings at $7.50 per share. In the offering, we sold an aggregate of 3,278,000 shares for gross consideration of $24,582,000. Holders of Series A are entitled to cumulative dividends at the rate of 10% per annum, paid quarterly. Dividends on the Series A are included as interest expense in the statements of operations. Under certain circumstances described in the Certificate of Designation for the Series A, additional Series A shares may be issued in lieu of cash dividends at the rate of $7.00 per share.
Holders of Series A are entitled to a liquidation preference equal to the stated value of their preferred shares (i.e., $7.50 per share) plus accrued but unpaid dividends. Holders of Series A may presently convert each share of their Series A into 0.75 shares of our common stock at the rate of $10.00 per share.
As of September 30, 2016, we issued an aggregate of 447,000 shares of Series A in satisfaction of $3,129,000 in dividends on the Series A, and an aggregate of 696,000 shares of Series A were converted into 522,000 shares of our common stock. As of September 30, 2016, we had 2,650,000 Series A shares outstanding with respect to which we incurred aggregate issuance costs of $2,838,000, all of which is included as a component of additional paid-in capital.
| 13 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Purchasers of Series A in our offering received warrants to purchase an aggregate of 431,954 shares of our common stock at an exercise price of $12.50 per share. The grant date fair value of these warrants was $428,000. As of September 30, 2016 and December 31, 2015, none of these warrants were exercised, and the weighted-average remaining life of these warrants was 0.68 and 1.43 years, respectively.
In September 2012, we completed a public offering of our common stock and, as a result, the Series A was reclassified from temporary equity to permanent equity. We may redeem Series A shares under the Certificate of Designation at a price equal to 110% of their liquidation preference ($7.50 per share) at any time. As of September 30, 2016, we have redeemed an aggregate of 277,000 shares of Series A.
(10) Redeemable Preferred Stock
Beginning November 30, 2015, we began publicly offering up to 100,000 shares of Redeemable Preferred Stock (“RPS”) at $1,000 per share. Holders of RPS are entitled to cumulative dividends at the rate of 7% per annum, paid monthly. Dividends on the RPS are included as interest expense in the statements of operations. Under certain circumstances described in the Certificate of Designation for the RPS, additional shares of RPS may be issued in lieu of cash dividends.
The RPS ranks senior to our common stock and pari passu with our Series A, and entitles its holders to a liquidation preference equal to the stated value per share (i.e., $1,000) plus accrued but unpaid dividends. Holders of RPS may presently convert their RPS into our common stock at a conversion price equal to the volume-weighted average price of our common stock for the 20 trading days immediately prior to the date of conversion, subject to a minimum conversion price of $15.00 and in an aggregate amount limited to 15% of the stated value of RPS originally purchased by such holder from us and still held by such holder.
Holders of RPS may request that we redeem their RPS at a price equal to their liquidation preference at a price equal to their stated value plus accrued but unpaid dividends, less an applicable redemption fee, if any. Nevertheless, the Certificate of Designation for RPS permits us to decline requests for redemption in certain circumstances. Subject to certain restrictions and conditions, we may also redeem shares of RPS without a redemption fee upon a holder’s death, total disability or bankruptcy. In addition, after one year from the date of original issuance, we may, at our option, call and redeem shares of RPS at a price equal to their liquidation preference.
As of September 30, 2016, we had sold 33,201 shares of RPS for aggregate gross consideration of $33,177,000, and incurred approximately $2,399,000 of selling costs related to the sale of those shares.
(11) GWG MCA Capital, Inc - 9% Preferred Stock
Beginning March 31, 2016, GWG MCA began privately offering up to 2,000,000 shares of GWG MCA 9% Preferred Stock (“MCA Preferred”) at $10.00 per share. Holders of MCA Preferred are entitled to cumulative dividends at a rate of 9% per annum, paid monthly. Dividends on the MCA Preferred are included as interest expense in the statements of operations. As of September 30, 2016, a total of 7,155 shares of MCA Preferred had been sold for aggregate gross consideration of $72,000 and approximately $7,000 of selling costs related to the sale of these shares were incurred.
Holders of MCA Preferred were redeemed as of September 30, 2016 at the stated value of their shares plus accrued but unpaid dividends.
| 14 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(12) Income Taxes
We had a current income tax liability of $0 as of both September 30, 2016 and December 31, 2015. The components of current and deferred income tax expense for the three and nine months ended September 30, 2016 and 2015, respectfully, consisted of the following:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | September 30, | September 30, | |||||||||||||
| 2016 | 2015 | 2016 | 2015 | |||||||||||||
| Income tax provision (benefit): | ||||||||||||||||
| Current: | ||||||||||||||||
| Federal | $ | - | $ | (141,000 | ) | $ | - | $ | - | |||||||
| State | $ | - | $ | (40,000 | ) | $ | - | $ | - | |||||||
| Total current tax expense (benefit) | - | (181,000 | ) | - | - | |||||||||||
| Deferred: | ||||||||||||||||
| Federal | $ | (1,082,000 | ) | $ | (1,488,000 | ) | $ | 1,121,000 | $ | (504,000 | ) | |||||
| State | $ | (346,000 | ) | $ | (429,000 | ) | $ | 358,000 | $ | (161,000 | ) | |||||
| Total deferred tax expense (benefit) | (1,428,000 | ) | (1,917,000 | ) | 1,479,000 | (665,000 | ) | |||||||||
| Total income tax expense (benefit) | (1,428,000 | ) | (2,098,000 | ) | 1,479,000 | (665,000 | ) | |||||||||
We provided a valuation allowance against the deferred tax asset related to a note receivable, which was charged-off for financial reporting purposes, because we believe that, when realized for tax purposes, it will result in a capital loss that will not be utilized because we have no expectation of generating a capital gain within the applicable carryforward period. Therefore, we do not believe that it is “more likely than not” that the deferred tax asset will be realized.
We also provided a valuation allowance against the deferred tax asset related to a tax basis capital loss generated with respect to our settlement and subsequent disposal of an earlier investment in Athena Structured Funds PLC. As we have no expectation of generating capital gains with the applicable carryforward period, we do not believe that it is “more likely than not” that the deferred asset will be realized.
The primary differences between the September 30, 2016 effective tax rate and the statutory federal rate are the accrual of non-deductible preferred stock dividend expense of $2,153,000, state taxes, and other non-deductible expenses. The most significant temporary differences between GAAP net income and taxable net income are the treatment of interest costs with respect to the acquisition of the life insurance contracts and revenue recognition with respect to the mark-to-market of our life insurance portfolio.
(13) Common Stock
In September 2014, we consummated an initial public offering of our common stock resulting in the sale of 800,000 shares of common stock at $12.50 per share, and net proceeds of approximately $8.6 million after the payment of underwriting commissions, discounts and expense reimbursements. In connection with this offering, we listed our common stock on the Nasdaq Capital Market under the ticker symbol “GWGH.”
On June 24, 2015 we issued 60,000 restricted common shares at $9.70 per share, determined by the closing market price on the date of grant, to a vendor as payment for services to be rendered over three years. The cost of these shares is amortized over a 12-month period. On March 17, 2016, we issued an additional 6,500 restricted common shares at an average price of $7.16 per share, determined by the closing market price on the date of grant, to this same vendor for additional services provided to us. On April 25, 2016, we issued 25,000 restricted shares of common stock at $6.25 per share, determined by the closing market price on the date of grant, to a vendor as a form of payment for services the vendor is providing to us, which is expensed in the current period.
| 15 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(14) Stock Incentive Plan
We adopted our GWG Holdings 2013 Stock Incentive Plan in March 2013. The Compensation Committee of our Board of Directors administers the plan. Incentives under the plan may be granted incentive stock options and non-statutory stock options; stock appreciation rights; stock awards; restricted stock; restricted stock units; and performance shares. Eligible participants include officers and employees of GWG Holdings and its subsidiaries, members of our Board of Directors, and consultants. 2,000,000 common shares are presently issuable under the plan.
Stock Options – Through September 30, 2016, we issued stock options for 1,237,000 shares of common stock to employees, officers, and directors under the plan. Options for 687,000 shares have vested, and the remaining options are scheduled to vest over three years. The options were issued with an exercise price between $6.35 and $10.18 for those beneficially owning more than 10% of our common stock, and between $6.00 and $10.25 for all others, which is equal to the estimated market price of the shares on the date of grant using Black-Scholes binomial option pricing model. The expected annualized volatility used in the Black-Scholes model valuation of options issued during the period was 25.5%. The annual volatility rate is based on the standard deviation of the average continuously compounded rate of return of five selected comparable companies over the previous 52 weeks. A forfeiture rate of 15% is based on historical information and expected future trend. As of September 30, 2016, stock options for 415,000 shares were forfeited and stock options for 28,000 shares were exercised.
Outstanding stock options:
| Vested | Un-vested | Total | ||||||||||
| Balance as of December 31, 2014 | 314,288 | 685,813 | 1,000,101 | |||||||||
| Granted during the year | 79,500 | 273,700 | 353,200 | |||||||||
| Vested during the year | 238,999 | (238,999 | ) | - | ||||||||
| Exercised during the year | (27,667 | ) | - | (27,667 | ) | |||||||
| Forfeited during the year | (121,417 | ) | (150,602 | ) | (272,019 | ) | ||||||
| Balance as of December 31, 2015 | 483,703 | 569,912 | 1,053,615 | |||||||||
| Granted during the year | 22,500 | 239,948 | 262,448 | |||||||||
| Vested during the year | 187,473 | (187,473 | ) | - | ||||||||
| Forfeited during the year | (6,676 | ) | (72,824 | ) | (79,500 | ) | ||||||
| Balance as of September 30, 2016 | 687,000 | 549,563 | 1,236,563 | |||||||||
Compensation expense related to un-vested options not yet recognized is $420,000. We expect to recognize this compensation expense over the next three years ($14,000 in 2016, $240,000 in 2017, $109,000 in 2018, and $57,000 in 2019).
Stock Appreciation Rights (SARs) - On September 19, 2016 we issued SARs for 145,388 shares of the common stock to employees. The strike price of the SARs was $8.76, which was equal to the market price of the common stock at the close of business on September 19, 2016. 56,358 of the SARs were vested as of September 30, 2016, on which date the market price of the common stock was $8.82. A forfeiture rate of 15% was used in calculating our liability for the SARs.
Outstanding Stock Appreciation Rights:
| Vested | Un-vested | Total | ||||||||||
| Balance as of December 31, 2015 | - | - | - | |||||||||
| Granted during the year | 56,358 | 89,030 | 145,388 | |||||||||
| Vested during the year | 56,358 | 89,030 | 145,388 | |||||||||
| Forfeited during the year | - | - | - | |||||||||
| Balance as of September 30, 2016 | 56,358 | 89,030 | 145,388 | |||||||||
A liability for Stock Appreciation Rights - Compensation Expense was recorded on September 30, 2016 in the amount of $3,381 and Compensation Expense was charged for the same amount.
(15) Net Income per Common Share
We have outstanding Series A, as described in Note 9. The Series A are dilutive to our net income per common share calculation for the nine-month period ended September 30, 2016. They are anti-dilutive for the three-month period ended September 30, 2016 and for both three and nine-month periods ended September 30, 2015. We also issued warrants to purchase common stock in conjunction with the sale of Series A (see Note 9). Both those warrants and our vested stock options are anti-dilutive for both three and nine-month periods ended September 30, 2016 and 2015 and have not been included in the fully diluted net loss per common share calculation. We issued RPS (see Note 10). The RPS is dilutive for the nine-month period ended September 30, 2016 and anti-dilutive for the three-month period ended September 30, 2016.
| 16 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(16) Commitments
We are party to an office lease with U.S. Bank National Association as the landlord. On September 1, 2015, we entered into an amendment to our original lease that expanded the leased space to 17,687 square feet and extended the term through August 31, 2025. Under the amended lease, we are obligated to pay base rent plus common area maintenance and a share of building operating costs. Rent expenses under these lease arrangements were $102,000 and $71,000 for the three months ended September 30, 2016 and 2015, respectively, and $306,000 and $193,000 for the nine months ended September 30, 2016 and 2015, respectively.
Minimum lease payments under the amended lease are as follows:
| Three months ending December 31, 2016 | $ | 44,000 | ||
| 2017 | 178,000 | |||
| 2018 | 185,000 | |||
| 2019 | 191,000 | |||
| 2020 | 198,000 | |||
| 2021 | 204,000 | |||
| 2022 | 210,000 | |||
| 2023 | 217,000 | |||
| 2024 | 223,000 | |||
| 2025 | 230,000 | |||
| 2026 | 38,000 | |||
| $ | 1,918,000 |
(17) Contingencies
Litigation – In the normal course of business, we are involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on our financial position, results of operations or cash flows.
(18) Guarantee of L Bonds
We are publicly offering and selling L Bond under a registration statement declared effective by the SEC, as described in Note 8. Our obligations under the L Bonds are secured by substantially all the assets of GWG Holdings, a pledge of all the common stock held individually by our largest stockholders, and by a guarantee and corresponding grant of a security interest in substantially all the assets of GWG Life. As a guarantor, GWG Life has fully and unconditionally guaranteed the payment of principal and interest on the L Bonds. Substantially all of GWG’s life insurance contracts are held by wholly owned subsidiaries of GWG Life: DLP III, DLP IV and the Trust. GWG Life’s equity ownership in these subsidiaries serves as collateral for the L Bond obligation. The life insurance contracts held by DLP III and DLP IV are not direct collateral for the L Bond obligations but do serve as direct collateral for the senior credit facilities.
The consolidating financial statements are presented in lieu of separate financial statements and other related disclosures of the subsidiary guarantor and issuer because management does not believe that separate financial statements and related disclosures would be material to investors. There are currently no significant restrictions on the ability of GWG Holdings or GWG Life, the guarantor subsidiary, to obtain funds from its subsidiaries by dividend or loan, except as provided herein. A majority of insurance contracts we own are subject to a collateral arrangement with LNV described in Note 6. Under this arrangement, collection and escrow accounts are used to fund premiums for the insurance contracts and to pay interest and other charges under the senior credit facility.
The following represents consolidating financial
information as of September 30, 2016 and December 31, 2015, with respect to the financial position, and for the three and nine
months ended September 30, 2016 and 2015, with respect to results of operations and cash flows of GWG Holdings and its subsidiaries.
The parent column presents the financial information of GWG Holdings, the primary obligor for the L Bonds. The guarantor subsidiary
column presents the financial information of GWG Life, the guarantor subsidiary of the L Bonds, presenting its investment in DLP
III, DLP IV and the Trust under the equity method. The non-guarantor subsidiaries column presents the financial information of
all non-guarantor subsidiaries, including DLP III, DLP IV and the Trust.
| 17 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Condensed Consolidating Balance Sheets
| September 30, 2016 | Parent | Guarantor Subsidiary | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| A S S E T S | ||||||||||||||||||||
| Cash and cash equivalents | $ | 13,312,751 | $ | 4,372,845 | $ | 1,088,232 | $ | - | $ | 18,773,828 | ||||||||||
| Restricted cash | - | 4,438,025 | 11,250,000 | - | 15,688,025 | |||||||||||||||
| Investment in life insurance contracts, at fair value | - | - | 477,585,100 | - | 477,585,100 | |||||||||||||||
| Secured MCA advances | - | - | 6,113,831 | - | 6,113,831 | |||||||||||||||
| Life insurance contract benefits receivable | - | - | 6,129,022 | - | 6,129,022 | |||||||||||||||
| Other assets | 4,706,121 | 1,224,386 | 54,726 | (2,854,126 | ) | 3,131,107 | ||||||||||||||
| Investment in subsidiaries | 422,185,881 | 429,441,035 | - | (851,626,916 | ) | - | ||||||||||||||
| TOTAL ASSETS | $ | 440,204,753 | $ | 439,476,291 | $ | 502,220,911 | $ | (854,481,042 | ) | $ | 527,420,913 | |||||||||
| L I A B I L I T I E S & S T O C K H O L D E R S' E Q U I T Y (D E F I C I T) | ||||||||||||||||||||
| LIABILITIES | ||||||||||||||||||||
| Senior credit facilities | $ | - | $ | - | $ | 63,699,385 | $ | - | $ | 63,699,385 | ||||||||||
| Series I Secured Notes | - | 17,553,307 | - | - | 17,553,307 | |||||||||||||||
| L Bonds | 379,858,737 | - | - | - | 379,858,737 | |||||||||||||||
| Notes payable to related parties | - | - | 2,700,000 | (2,700,000 | ) | - | ||||||||||||||
| Accounts payable | 699,507 | 99,705 | 1,643,237 | - | 2,442,449 | |||||||||||||||
| Interest payable | 9,798,735 | 3,588,954 | 400,077 | (154,126 | ) | 13,633,640 | ||||||||||||||
| Other accrued expenses | 259,722 | 351,896 | 33,725 | - | 645,343 | |||||||||||||||
| Deferred taxes, net | 3,242,586 | - | - | - | 3,242,586 | |||||||||||||||
| TOTAL LIABILITIES | 393,859,287 | 21,593,862 | 68,476,424 | (2,854,126 | ) | 481,075,447 | ||||||||||||||
| STOCKHOLDERS’ EQUITY (DEFICIT) | ||||||||||||||||||||
| Member capital | - | 417,882,429 | 433,744,487 | (851,626,916 | ) | - | ||||||||||||||
| Convertible preferred stock | 19,772,931 | - | - | - | 19,772,931 | |||||||||||||||
| Redeemable preferred stock | 33,176,600 | - | - | - | 33,176,600 | |||||||||||||||
| Common stock | 5,980 | - | - | - | 5,980 | |||||||||||||||
| Additional paid-in capital | 15,226,449 | - | - | - | 15,226,449 | |||||||||||||||
| Accumulated deficit | (21,836,494 | ) | - | - | - | (21,836,494 | ) | |||||||||||||
| TOTAL STOCKHOLDERS’ EQUITY (DEFICIT) | 46,345,466 | 417,882,429 | 433,744,487 | (851,626,916 | ) | 46,345,466 | ||||||||||||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT) | $ | 440,204,753 | $ | 439,476,291 | $ | 502,220,911 | $ | (854,481,042 | ) | $ | 527,420,913 | |||||||||
| 18 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Condensed Consolidating Balance Sheets (continued)
| December 31, 2015 | Parent | Guarantor Subsidiary | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| A S S E T S | ||||||||||||||||||||
| Cash and cash equivalents | $ | 32,292,162 | $ | 1,982,722 | $ | 150,221 | $ | - | $ | 34,425,105 | ||||||||||
| Restricted cash | - | 2,102,257 | 239,643 | - | 2,341,900 | |||||||||||||||
| Investment in life insurance contracts, at fair value | - | - | 356,649,715 | - | 356,649,715 | |||||||||||||||
| Other assets | 1,742,074 | 688,071 | 30,900 | - | 2,461,045 | |||||||||||||||
| Investment in subsidiaries | 269,886,254 | 291,295,951 | - | (561,182,205 | ) | - | ||||||||||||||
| TOTAL ASSETS | $ | 303,920,490 | $ | 296,069,001 | $ | 357,070,479 | $ | (561,182,205 | ) | $ | 395,877,765 | |||||||||
| L I A B I L I T I E S & S T O C K H O L D E R S' E Q U I T Y (D E F I C I T) | ||||||||||||||||||||
| LIABILITIES | ||||||||||||||||||||
| Senior credit facilities | $ | - | $ | (1,000,000 | ) | $ | 64,279,596 | $ | - | $ | 63,279,596 | |||||||||
| Series I Secured Notes | - | 23,287,704 | - | - | 23,287,704 | |||||||||||||||
| L Bonds | 276,482,796 | - | - | - | 276,482,796 | |||||||||||||||
| Accounts payable | 280,988 | 157,217 | 1,079,235 | - | 1,517,440 | |||||||||||||||
| Interest payable | 8,529,959 | 3,544,626 | 265,476 | - | 12,340,061 | |||||||||||||||
| Other accrued expenses | 717,365 | 343,421 | - | - | 1,060,786 | |||||||||||||||
| Deferred taxes, net | 1,763,968 | - | - | - | 1,763,968 | |||||||||||||||
| TOTAL LIABILITIES | 287,775,076 | 26,332,968 | 65,624,307 | - | 379,732,351 | |||||||||||||||
| STOCKHOLDERS’ EQUITY (DEFICIT) | ||||||||||||||||||||
| Member capital | - | 269,736,033 | 291,446,172 | (561,182,205 | ) | - | ||||||||||||||
| Convertible preferred stock | 20,784,841 | - | - | - | 20,784,841 | |||||||||||||||
| Common stock | 5,942 | - | - | - | 5,942 | |||||||||||||||
| Additional paid-in capital | 17,149,391 | - | - | - | 17,149,391 | |||||||||||||||
| Accumulated deficit | (21,794,760 | ) | - | - | - | (21,794,760 | ) | |||||||||||||
| TOTAL STOCKHOLDERS’ EQUITY (DEFICIT) | 16,145,414 | 269,736,033 | 291,446,172 | (561,182,205 | ) | 16,145,414 | ||||||||||||||
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT) | $ | 303,920,490 | $ | 296,069,001 | $ | 357,070,479 | $ | (561,182,205 | ) | $ | 395,877,765 | |||||||||
| 19 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Condensed Consolidating Statements of Operations
| For the nine months ended September 30, 2016 | Parent | Guarantor Subsidiary | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| REVENUE | ||||||||||||||||||||
| Origination and servicing income | $ | - | $ | 13,417 | $ | - | $ | (13,417 | ) | $ | - | |||||||||
| Gain on life insurance contracts, net | - | - | 51,606,815 | - | 51,606,815 | |||||||||||||||
| MCA income | - | - | 654,441 | - | 654,441 | |||||||||||||||
| Interest and other income | 181,828 | 31,137 | 282,259 | (154,126 | ) | 341,098 | ||||||||||||||
| TOTAL REVENUE | 181,828 | 44,554 | 52,543,515 | (167,543 | ) | 52,602,354 | ||||||||||||||
| EXPENSES | ||||||||||||||||||||
| Origination and servicing fees | - | - | 13,417 | (13,417 | ) | - | ||||||||||||||
| Interest expense | 25,477,320 | 1,856,909 | 4,829,831 | (154,126 | ) | 32,009,934 | ||||||||||||||
| Employee compensation and benefits | 4,894,006 | 3,151,107 | 405,055 | - | 8,450,168 | |||||||||||||||
| Legal and professional fees | 1,642,252 | 1,308,959 | 146,101 | - | 3,097,312 | |||||||||||||||
| Other expenses | 4,241,825 | 2,197,133 | 1,169,099 | - | 7,608,057 | |||||||||||||||
| TOTAL EXPENSES | 36,255,403 | 8,514,108 | 6,563,503 | (167,543 | ) | 51,165,471 | ||||||||||||||
| INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES | (36,073,575 | ) | (8,469,554 | ) | 45,980,012 | - | 1,436,883 | |||||||||||||
| EQUITY IN INCOME OF SUBSIDIARY | 37,510,458 | 46,497,731 | - | (84,008,189 | ) | - | ||||||||||||||
| INCOME BEFORE INCOME TAXES | 1,436,883 | 38,028,177 | 45,980,012 | (84,008,189 | ) | 1,436,883 | ||||||||||||||
| INCOME TAX EXPENSE | 1,478,617 | - | - | - | 1,478,617 | |||||||||||||||
| NET INCOME (LOSS) | $ | (41,734 | ) | $ | 38,028,177 | $ | 45,980,012 | $ | (84,008,189 | ) | $ | (41,734 | ) | |||||||
For
the nine months ended | Parent | Guarantor Subsidiary | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| REVENUE | ||||||||||||||||||||
| Origination and servicing income | $ | - | $ | 2,022,774 | $ | - | $ | (2,022,774 | ) | $ | - | |||||||||
| Gain on life settlements, net | - | - | 33,446,556 | - | 33,446,556 | |||||||||||||||
| Interest and other income | 38,944 | 61,694 | 132,878 | - | 233,516 | |||||||||||||||
| TOTAL REVENUE | 38,944 | 2,084,468 | 33,579,434 | (2,022,774 | ) | 33,680,072 | ||||||||||||||
| EXPENSES | ||||||||||||||||||||
| Origination and servicing fees | - | - | 2,022,774 | (2,022,774 | ) | - | ||||||||||||||
| Interest expense | 18,011,890 | 1,984,356 | 3,152,784 | - | 23,149,030 | |||||||||||||||
| Employee compensation and benefits | 4,671,183 | 1,509,703 | - | - | 6,180,886 | |||||||||||||||
| Legal and professional fees | 1,427,388 | 560,873 | - | - | 1,988,261 | |||||||||||||||
| Other expenses | 3,251,606 | 2,297,063 | 97,733 | - | 5,646,402 | |||||||||||||||
| TOTAL EXPENSES | 27,362,067 | 6,351,995 | 5,273,291 | (2,022,774 | ) | 36,964,579 | ||||||||||||||
| INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES | (27,323,123 | ) | (4,267,527 | ) | 28,306,143 | - | (3,284,507 | ) | ||||||||||||
| EQUITY IN INCOME OF SUBSIDIARY | 24,038,616 | 28,305,979 | - | (52,344,595 | ) | - | ||||||||||||||
| NET INCOME (LOSS) BEFORE INCOME TAXES | (3,284,507 | ) | 24,038,452 | 28,306,143 | (52,344,595 | ) | (3,284,507 | ) | ||||||||||||
| INCOME TAX BENEFIT | (664,905 | ) | - | - | - | (664,905 | ) | |||||||||||||
| NET INCOME (LOSS) | $ | (2,619,602 | ) | $ | 24,038,452 | $ | 28,306,143 | $ | (52,344,595 | ) | $ | (2,619,602 | ) | |||||||
| 20 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Condensed Consolidating Statements of Operations (continued)
For the three months ended September 30, 2016 | Parent | Guarantor Subsidiary | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| REVENUE | ||||||||||||||||||||
| Gain on life insurance contracts, net | - | - | 13,509,755 | - | 13,509,755 | |||||||||||||||
| MCA income | - | - | 286,225 | - | 286,225 | |||||||||||||||
| Interest and other income | 75,808 | 30,126 | 83,313 | (64,249 | ) | 124,998 | ||||||||||||||
| TOTAL REVENUE | 75,808 | 30,126 | 13,879,293 | (64,249 | ) | 13,920,978 | ||||||||||||||
| EXPENSES | ||||||||||||||||||||
| Interest expense | 9,747,128 | 554,938 | 1,746,151 | (64,249 | ) | 11,983,968 | ||||||||||||||
| Employee compensation and benefits | 1,718,683 | 1,038,058 | 155,722 | - | 2,912,463 | |||||||||||||||
| Legal and professional fees | 263,917 | 297,804 | 25,109 | - | 586,830 | |||||||||||||||
| Other expenses | 1,464,498 | 803,106 | 595,608 | - | 2,863,212 | |||||||||||||||
| TOTAL EXPENSES | 13,194,226 | 2,693,906 | 2,522,590 | (64,249 | ) | 18,346,473 | ||||||||||||||
| INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES | (13,118,418 | ) | (2,663,780 | ) | 11,356,703 | - | (4,425,495 | ) | ||||||||||||
| EQUITY IN INCOME OF SUBSIDIARY | 8,692,923 | 11,361,329 | - | (20,054,252 | ) | - | ||||||||||||||
| INCOME (LOSS) BEFORE INCOME TAXES | (4,425,495 | ) | 8,697,549 | 11,356,703 | (20,054,252 | ) | (4,425,495 | ) | ||||||||||||
| INCOME TAX BENEFIT | (1,418,130 | ) | - | - | - | (1,428,130 | ) | |||||||||||||
| NET INCOME (LOSS) | $ | (2,997,365 | ) | $ | 8,697,549 | $ | 11,356,703 | $ | (20,054,252 | ) | $ | (2,997,365 | ) | |||||||
For the three months ended September 30, 2015 | Parent | Guarantor Subsidiary | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| REVENUE | ||||||||||||||||||||
| Origination and servicing income | $ | - | $ | 1,004,024 | $ | - | $ | (1,004,024 | ) | $ | - | |||||||||
| Gain on life settlements, net | - | - | 8,189,261 | - | 8,189,261 | |||||||||||||||
| Interest and other income | 13,922 | 54,813 | 25,106 | - | 93,841 | |||||||||||||||
| TOTAL REVENUE | 13,922 | 1,058,837 | 8,214,367 | (1,004,024 | ) | 8,283,102 | ||||||||||||||
| EXPENSES | ||||||||||||||||||||
| Origination and servicing fees | - | - | 1,004,024 | (1,004,024 | ) | - | ||||||||||||||
| Interest expense | 6,980,132 | 525,391 | 1,144,626 | - | 8,650,149 | |||||||||||||||
| Employee compensation and benefits | 1,759,589 | 548,657 | - | - | 2,308,246 | |||||||||||||||
| Legal and professional fees | 598,530 | 223,547 | - | - | 822,077 | |||||||||||||||
| Other expenses | 1,195,417 | 995,026 | 40,898 | - | 2,231,341 | |||||||||||||||
| TOTAL EXPENSES | 10,533,668 | 2,292,621 | 2,189,548 | (1,004,024 | ) | 14,011,813 | ||||||||||||||
| INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES | (10,519,746 | ) | (1,233,784 | ) | 6,024,819 | - | (5,728,711 | ) | ||||||||||||
| EQUITY IN INCOME OF SUBSIDIARY | 4,791,035 | 6,024,762 | - | (10,815,797 | ) | - | ||||||||||||||
| NET INCOME (LOSS) BEFORE INCOME TAXES | (5,728,711 | ) | 4,790,978 | 6,024,819 | (10,815,797 | ) | (5,728,711 | ) | ||||||||||||
| INCOME TAX BENEFIT | (2,097,633 | ) | - | - | - | (2,097,633 | ) | |||||||||||||
| NET INCOME (LOSS) | $ | (3,631,078 | ) | $ | 4,790,978 | $ | 6,024,819 | $ | (10,815,797 | ) | $ | (3,631,078 | ) | |||||||
| 21 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Condensed Consolidating Statements of Cash Flows
| For the nine months ended September 30, 2016 | Parent | Guarantor Subsidiary | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||||||||||||
| Net income | $ | (41,734 | ) | $ | 38,028,177 | $ | 45,980,012 | $ | (84,008,189 | ) | $ | (41,734 | ) | |||||||
| Adjustments to reconcile net income to net cash flows from operating activities: | ||||||||||||||||||||
| (Equity) of subsidiaries | (37,510,459 | ) | (46,497,730 | ) | - | 84,008,189 | - | |||||||||||||
| Gain on life insurance contracts | - | - | (53,846,155 | ) | - | (53,846,155 | ) | |||||||||||||
| Amortization of deferred financing and issuance costs | 5,982,802 | (1,364,614 | ) | 1,459,717 | - | 6,077,905 | ||||||||||||||
| Deferred income taxes | 1,478,617 | - | - | - | 1,478,617 | |||||||||||||||
| Preferred stock dividends payable | 663,614 | - | - | - | 663,614 | |||||||||||||||
| (Increase) in operating assets: | ||||||||||||||||||||
| Life insurance contract benefits receivable | - | - | (6,129,022 | ) | (6,129,022 | ) | ||||||||||||||
| Other assets | (114,885,990 | ) | (92,168,163 | ) | - | 206,436,523 | (617,630 | ) | ||||||||||||
| Increase (decrease) in operating liabilities: | ||||||||||||||||||||
| Due to related party | (2,867,225 | ) | (15,505 | ) | 2,700,000 | - | (182,730 | ) | ||||||||||||
| Accounts payable and accrued expenses | 2,396,503 | 2,889,525 | (7,310,262 | ) | - | (2,024,234 | ) | |||||||||||||
| NET CASH FLOWS USED IN OPERATING ACTIVITIES | (144,783,872 | ) | (99,128,310 | ) | (17,145,710 | ) | 206,436,523 | (54,621,369 | ) | |||||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||||||||||||
| Investment in life insurance contracts | - | - | (74,470,362 | ) | - | (74,470,362 | ) | |||||||||||||
| Carrying value of matured life insurance contracts | - | - | 7,381,132 | - | 7,381,132 | |||||||||||||||
| Investment in Secured MCA advances | - | - | (7,613,310 | ) | - | (7,613,310 | ) | |||||||||||||
| Proceeds from Secured MCA advances | - | - | 1,246,703 | - | 1,246,703 | |||||||||||||||
| NET CASH FLOWS USED IN INVESTING ACTIVITIES | - | - | (73,455,837 | ) | - | (73,455,837 | ) | |||||||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||||||||||
| Net borrowings on Senior Credit Facilities | - | - | 6,238,952 | - | 6,238,952 | |||||||||||||||
| Payments for redemption of Series I Secured Notes | - | (6,264,018 | ) | - | - | (6,264,018 | ) | |||||||||||||
| Proceeds from issuance of L Bonds | 135,477,090 | - | - | - | 135,477,090 | |||||||||||||||
| Payments for redemption and issuance of L Bonds | (37,036,922 | ) | - | - | - | (37,036,922 | ) | |||||||||||||
| Proceeds from (increase in) restricted cash | - | (2,335,768 | ) | (11,010,358 | ) | - | (13,346,126 | ) | ||||||||||||
| Issuance of common stock | 244,185 | - | - | - | 244,185 | |||||||||||||||
| Proceeds from issuance of preferred stock | 31,215,986 | - | 71,555 | - | 31,287,541 | |||||||||||||||
| Payments for issuance and redemption of preferred stock | (4,095,878 | ) | - | (78,895 | ) | - | (4,174,773 | ) | ||||||||||||
| Issuance of member capital | - | 110,118,219 | 96,318,304 | (206,436,523 | ) | - | ||||||||||||||
| NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES | 125,804,461 | 101,518,433 | 91,539,558 | (206,436,523 | ) | 112,425,929 | ||||||||||||||
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | (18,979,411 | ) | 2,390,123 | 938,011 | - | (15,651,277 | ) | |||||||||||||
| CASH AND CASH EQUIVALENTS | ||||||||||||||||||||
| BEGINNING OF THE PERIOD | 32,292,162 | 1,982,722 | 150,221 | - | 34,425,105 | |||||||||||||||
| END OF THE PERIOD | $ | 13,312,751 | $ | 4,372,845 | $ | 1,088,232 | $ | - | $ | 18,773,828 | ||||||||||
| 22 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Consolidating Statements of Cash Flows (continued)
| For
the nine months ended September 30, 2015 | Parent | Guarantor Subsidiary | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||||||||||||
| Net income (loss) | $ | (2,619,602 | ) | $ | 24,038,452 | $ | 28,306,143 | $ | (52,344,595 | ) | $ | (2,619,602 | ) | |||||||
| Adjustments to reconcile net income to net cash flows from operating activities: | ||||||||||||||||||||
| (Equity) of subsidiaries | (24,038,617 | ) | (28,305,978 | ) | - | 52,344,595 | - | |||||||||||||
| Gain on life settlements | - | - | (26,651,363 | ) | - | (26,651,363 | ) | |||||||||||||
| Amortization of deferred financing and issuance costs | 2,832,487 | 260,455 | (1,201,170 | ) | - | 1,891,772 | ||||||||||||||
| Deferred income taxes | (664,905 | ) | - | - | - | (664,905 | ) | |||||||||||||
| Convertible, redeemable preferred dividends payable | 509,225 | - | - | - | 509,225 | |||||||||||||||
| (Increase) decrease in operating assets: | ||||||||||||||||||||
| Policy benefits receivable | - | - | 1,392,986 | 1,392,986 | ||||||||||||||||
| Other assets | (40,145,769 | ) | (26,745,888 | ) | - | 66,117,118 | (774,539 | ) | ||||||||||||
| Increase (decrease) in operating liabilities: | ||||||||||||||||||||
| Accounts payable and accrued expenses | 4,503,624 | 123,222 | (790,131 | ) | - | 3,836,715 | ||||||||||||||
| NET CASH FLOWS USED IN OPERATING ACTIVITIES | (30,425,246 | ) | (30,629,737 | ) | 1,056,465 | 66,117,118 | (23,079,711 | ) | ||||||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||||||||||||
| Investment in life settlements | - | - | (23,850,860 | ) | - | (23,850,860 | ) | |||||||||||||
| Carrying value of matured life insurance contracts | - | - | 3,822,983 | - | 3,822,983 | |||||||||||||||
| NET CASH FLOWS USED IN INVESTING ACTIVITIES | - | - | (20,027,877 | ) | - | (20,027,877 | ) | |||||||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||||||||||
| Repayment of senior credit facilities | - | - | (7,150,000 | ) | - | (7,150,000 | ) | |||||||||||||
| Payments for redemption of Series I Secured Notes | - | (4,508,130 | ) | - | - | (4,508,130 | ) | |||||||||||||
| Proceeds from issuance of L Bonds | 87,620,483 | - | - | - | 87,620,483 | |||||||||||||||
| Payments for redemption and issuance of L Bonds | (32,376,104 | ) | - | - | - | (32,376,104 | ) | |||||||||||||
| Payments from restricted cash | - | (2,306,300 | ) | (669,207 | ) | - | (2,975,507 | ) | ||||||||||||
| Issuance of common stock | 582,000 | - | - | - | 582,000 | |||||||||||||||
| Payments for redemption preferred stock | (295,185 | ) | - | - | - | (295,185 | ) | |||||||||||||
| Issuance of member capital | - | 39,176,335 | 26,940,783 | (66,117,118 | ) | - | ||||||||||||||
| NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES | 55,531,194 | 32,361,905 | 19,121,576 | (66,117,118 | ) | 40,897,557 | ||||||||||||||
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | (4,092,363 | ) | 1,732,168 | 150,164 | - | (2,210,031 | ) | |||||||||||||
| CASH AND CASH EQUIVALENTS | ||||||||||||||||||||
| BEGINNING OF THE PERIOD | 30,446,473 | 216,231 | - | - | 30,662,704 | |||||||||||||||
| END OF THE PERIOD | $ | 26,354,110 | $ | 1,948,399 | $ | 150,164 | $ | - | $ | 28,452,673 | ||||||||||
| 23 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Consolidating Statements of Cash Flows (continued)
| For
the three months ended September 30, 2016 | Parent | Guarantor Subsidiary | Non-Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||||||||||||
| Net income | $ | (2,997,365 | ) | $ | 8,697,549 | $ | 11,356,703 | $ | (20,054,252 | ) | $ | (2,997,365 | ) | |||||||
| Adjustments to reconcile net loss to net cash flows from operating activities: | ||||||||||||||||||||
| (Equity) of subsidiaries | (8,692,924 | ) | (11,361,328 | ) | - | 20,054,252 | - | |||||||||||||
| Gain on life insurance contracts | - | - | (21,073,226 | ) | - | (21,073,226 | ) | |||||||||||||
| Amortization of deferred financing and issuance costs | 2,072,879 | 81,849 | 611,015 | - | 2,765,743 | |||||||||||||||
| Deferred income taxes | (1,428,130 | ) | - | - | - | (1,428,130 | ) | |||||||||||||
| Preferred stock dividends payable | 333,565 | - | - | - | 333,565 | |||||||||||||||
| (Increase) in operating assets: | ||||||||||||||||||||
| Life insurance contract benefits receivable | - | - | 700,000 | - | 700,000 | |||||||||||||||
| Other assets | (54,428,152 | ) | (54,272,589 | ) | - | 109,120,577 | 419,836 | |||||||||||||
| Increase (decrease) in operating liabilities: | ||||||||||||||||||||
| Due to related party | (64,249 | ) | (16,700 | ) | - | - | (80,949 | ) | ||||||||||||
| Accounts payable and other accrued expenses | 155,980 | 2,172,227 | (5,545,197 | ) | - | (3,216,990 | ) | |||||||||||||
| NET CASH FLOWS USED IN OPERATING ACTIVITIES | (65,048,396 | ) | (54,698,992 | ) | (13,950,705 | ) | 109,120,577 | (24,577,516 | ) | |||||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||||||||||||
| Investment in life insurance contracts | - | - | (25,770,326 | ) | - | (25,770,326 | ) | |||||||||||||
| Carrying value of matured life insurance contracts | - | - | 1,078,889 | - | 1,078,889 | |||||||||||||||
| Investment in Secured MCA advances | - | - | (1,965,896 | ) | (1,965,896 | ) | ||||||||||||||
| Proceeds from Secured MCA advances | - | - | 220,911 | - | 220,911 | |||||||||||||||
| NET CASH FLOWS USED IN INVESTING ACTIVITIES | - | - | (26,436,422 | ) | - | (26,436,422 | ) | |||||||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||||||||||
| Net repayment of Senior Credit Facilities | - | - | (10,761,048 | ) | (10,761,048 | ) | ||||||||||||||
| Payments for redemption of Series I Secured Notes | - | (541,275 | ) | - | - | (541,275 | ) | |||||||||||||
| Proceeds from issuance of L Bonds | 64,350,430 | - | - | - | 64,350,430 | |||||||||||||||
| Payments for redemption and issuance of L Bonds | (14,373,447 | ) | - | - | - | (14,373,447 | ) | |||||||||||||
| Proceeds from (increase in) restricted cash | - | 486,283 | (5,013,515 | ) | - | (4,527,232 | ) | |||||||||||||
| Issuance of member capital | - | 52,304,345 | 56,816,232 | (109,120,577 | ) | - | ||||||||||||||
| Issuance of common stock | 31,515 | - | - | - | 31,515 | |||||||||||||||
| Proceeds from issuance of preferred stock | 20,786,332 | - | - | - | 20,786,332 | |||||||||||||||
| Payments for issuance and redemption of preferred stock | (2,485,304 | ) | - | (71,555 | ) | - | (2,556,859 | ) | ||||||||||||
| NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES | 68,309,526 | 52,249,353 | 40,970,114 | (109,120,577 | ) | 52,408,416 | ||||||||||||||
| NET INCREASE IN CASH AND CASH EQUIVALENTS | 3,261,130 | (2,449,639 | ) | 582,987 | - | 1,394,478 | ||||||||||||||
| CASH AND CASH EQUIVALENTS | ||||||||||||||||||||
| BEGINNING OF THE PERIOD | 10,051,621 | 6,822,484 | 505,245 | - | 17,379,350 | |||||||||||||||
| END OF THE PERIOD | $ | 13,312,751 | $ | 4,372,845 | $ | 1,088,232 | $ | - | $ | 18,773,828 | ||||||||||
| 24 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Consolidating Statements of Cash Flows (continued)
| For
the three months ended September 30, 2015 | Parent | Guarantor Sub | Non-Guarantor Sub | Eliminations | Consolidated | |||||||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||||||||||||||
| Net income (loss) | $ | (3,631,078 | ) | $ | 4,790,978 | $ | 6,024,819 | $ | (10,815,797 | ) | $ | (3,631,078 | ) | |||||||
| Adjustments to reconcile net loss to net cash flows from operating activities: | ||||||||||||||||||||
| (Equity) of subsidiaries | (4,791,035 | ) | (6,024,762 | ) | - | 10,815,797 | - | |||||||||||||
| Gain on life settlements | - | - | (14,516,881 | ) | - | (14,516,881 | ) | |||||||||||||
| Amortization of deferred financing and issuance costs | 1,103,312 | 49,339 | 781,125 | - | 1,933,776 | |||||||||||||||
| Deferred income taxes | (1,916,686 | ) | - | - | - | (1,916,686 | ) | |||||||||||||
| Convertible, redeemable preferred stock dividends payable | 173,993 | - | - | - | 173,993 | |||||||||||||||
| (Increase) decrease in operating assets: | ||||||||||||||||||||
| Policy benefits receivable | - | - | 2,142,986 | - | 2,142,986 | |||||||||||||||
| Other assets | (22,146,946 | ) | (15,631,849 | ) | - | 37,360,805 | (417,990 | ) | ||||||||||||
| Increase (decrease) in operating liabilities: | ||||||||||||||||||||
| Accounts payable and other accrued expenses | 2,010,129 | (105,418 | ) | 629,558 | - | 2,534,269 | ||||||||||||||
| NET CASH FLOWS USED IN OPERATING ACTIVITIES | (29,198,311 | ) | (16,921,712 | ) | (4,938,393 | ) | 37,360,805 | (13,697,611 | ) | |||||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||||||||||||||
| Investment in life settlements | - | - | (13,626,842 | ) | - | (13,626,842 | ) | |||||||||||||
| Carrying value of matured life insurance contracts | - | - | 80,000 | - | 80,000 | |||||||||||||||
| NET CASH FLOWS USED IN INVESTING ACTIVITIES | - | - | (13,546,842 | ) | - | (13,546,842 | ) | |||||||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||||||||||||||
| Payments for redemption of Series I Secured Notes | - | (890,586 | ) | - | - | (890,586 | ) | |||||||||||||
| Proceeds from issuance of L Bonds | 37,122,127 | - | - | - | 37,122,127 | |||||||||||||||
| Payments for redemption and issuance of L Bonds | (19,363,047 | ) | - | - | - | (19,363,047 | ) | |||||||||||||
| Proceeds (payments) from restricted cash | - | (2,203,800 | ) | 2,855,430 | - | 651,630 | ||||||||||||||
| Issuance of member capital | - | 21,730,944 | 15,629,861 | (37,360,805 | ) | - | ||||||||||||||
| Payments for redemption preferred stock | (21,187 | ) | - | - | - | (21,187 | ) | |||||||||||||
| NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES | 17,737,893 | 18,636,558 | 18,485,291 | (37,360,805 | ) | 17,498,937 | ||||||||||||||
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | (11,460,418 | ) | 1,714,846 | 56 | - | (9,745,516 | ) | |||||||||||||
| CASH AND CASH EQUIVALENTS | ||||||||||||||||||||
| BEGINNING OF THE PERIOD | 37,814,528 | 233,553 | 150,108 | - | 38,198,189 | |||||||||||||||
| END OF THE PERIOD | $ | 26,354,110 | $ | 1,948,399 | $ | 150,164 | $ | - | $ | 28,452,673 | ||||||||||
| 25 |
GWG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(19) Concentrations
We purchase life insurance contracts written by life insurance companies having investment grade ratings by independent rating agencies. As a result, there may be concentrations of contracts with certain life insurance companies. The following summarizes the face value of insurance contracts with specific life insurance companies exceeding 10% of the total face value held by us.
| Life insurance company | September 30, | December 31, | ||||||
| 2016 | 2015 | |||||||
| AXA Equitable | 14.3 | % | 14.0 | % | ||||
| John Hancock | 13.0 | % | 12.7 | % | ||||
| Lincoln National | 11.5 | % | * | |||||
| Transamerica | 10.1 | % | * | |||||
* percentage does not exceed 10% of the total face value.
The following summarizes the number of insurance contracts insuring the lives of persons living in specific states exceeding 10% of the total face value held by us:
| State of Residence | September 30, | December 31, | ||||||
| 2016 | 2015 | |||||||
| California | 21.1 | % | 25.2 | % | ||||
| Florida | 19.0 | % | 20.0 | % | ||||
(20) Subsequent events
Subsequent to September 30, 2016, two policies covering two individual matured. The life insurance contract benefits of these policies were $3,240,000 and we recorded realized gains of $2,539,000 on these policies.
Subsequent to September 30, 2016, we have issued approximately $6,911,000 in additional principal amount of L Bonds, and 7,350 shares of RPS for gross consideration of approximately $7,350,000.
On October 28, 2016, DLP IV completed the closing of the second of two initial advances contemplated under a Loan and Security Agreement with LNV. At this closing, a total of $92,900,000 in loan proceeds were obtained by DLP IV, of which approximately $16,250,000 was used to fund a reserve account required under the Loan and Security Agreement.
| 26 |
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. |
You should read the following discussion in conjunction with the consolidated financial statements and accompanying notes and the information contained in other sections of this report. This discussion and analysis is based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management.
Risk Relating to Forward-Looking Statements
This report contains forward-looking statements that reflect our current expectations and projections about future events. Actual results could differ materially from those described in these forward-looking statements.
The words “believe,” “could,” “possibly,” “probably,” “anticipate,” “estimate,” “project,” “expect,” “may,” “will,” “should,” “seek,” “intend,” “plan” or “consider,” and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from such statements.
Such factors include, but are not limited to:
| ● | changes in the secondary market for life insurance; |
| ● | our limited operating history; |
| ● | the valuation of assets reflected on our financial statements; |
| ● | the reliability of assumptions underlying our actuarial models; |
| ● | our reliance on debt financing; |
| ● | risks relating to the validity and enforceability of the life insurance contracts we purchase; |
| ● | our reliance on information provided and obtained by third parties; |
| ● | federal, state and FINRA regulatory matters; |
| ● | competition in the secondary market of life insurance; |
| ● | the relative illiquidity of life insurance contracts; |
| ● | our ability to satisfy our debt obligations if we were to sell our entire portfolio of life insurance contracts; |
| ● | life insurance company credit exposure; |
| ● | cost-of-insurance (premium) increases on our life insurance contracts; |
| ● | general economic outlook, including prevailing interest rates; |
| ● | performance of our investments in life insurance contracts; |
| ● | financing requirements; |
| ● | risks associated with our recent entry into the merchant cash advance business; |
| ● | litigation risks; and |
| ● | restrictive covenants contained in borrowing agreements. |
We caution you that the foregoing list of factors is not exhaustive. Forward-looking statements are only estimates and predictions, or statements of current intent. Actual results, outcomes or actions that we ultimately undertake, could differ materially from those anticipated in the forward-looking statements due to risks, uncertainties or actual events differing from the assumptions underlying these statements.
JOBS Act
On April 5, 2012, the Jumpstart Our Business Startups Act of 2012, or JOBS Act, was enacted. Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 for complying with new or revised accounting standards. This means that an “emerging growth company” can make an election to delay the adoption of certain accounting standards until those standards would apply to private companies. We have elected to delay such adoption of new or revised accounting standards and, as a result, we may not comply with new or revised accounting standards at the same time as other public reporting companies that are not “emerging growth companies.” This exemption will apply for a period of five years following our first sale of common equity securities under an effective registration statement or until we no longer qualify as an “emerging growth company” as defined under the JOBS Act, whichever is earlier.
| 27 |
Overview
GWG Holdings, Inc. is a financial services company participating in the life insurance secondary market. We create opportunities for consumers owning life insurance to obtain significant value for their contracts as compared to the traditional options offered by insurance companies. We also create opportunities for investors to participate in the life insurance alternative investment asset class, not correlated to traditional financial markets. In so doing, we enable investors to take advantage of financial opportunities dominated by banks prior to the 2008 credit crisis.
We seek to build a profitable and large portfolio of life insurance assets that are well diversified in terms of insurance companies and insureds. We believe that diversification is a key risk mitigation strategy to provide consistent cash flows and reliable investment returns from our portfolio. To grow our portfolio and achieve diversification, we offer investors the opportunity to participate in the yield potentially generated by our portfolio of life insurance assets through a variety of financings and securities offerings. We believe we are well positioned to continue providing investors with yield participation opportunities from the life insurance alternative asset class.
Critical Accounting Policies
Critical Accounting Estimates
The preparation of our consolidated financial statements in accordance with the Generally Accepted Accounting Principles (GAAP) requires us to make judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our judgments, estimates, and assumptions on historical experience and on various other factors believed to be reasonable under the circumstances. Actual results could differ materially from these estimates. We evaluate our judgments, estimates, and assumptions on a regular basis and make changes accordingly. We believe that the judgments, estimates, and assumptions involved in valuing our investments in life insurance contracts have the greatest potential impact on our consolidated financial statements and accordingly believe these to be our critical accounting estimates. Below we discuss the critical accounting policies associated with these estimates as well as certain other critical accounting policies.
Ownership of Life Insurance Contracts—Fair Value Option
We account for the purchase of life insurance contracts in accordance with ASC 325-30, Investments in Insurance Contracts, which requires us to use either the investment method or the fair value method. We have elected to account for all of our life insurance contracts using the fair value method.
The fair value of our life insurance contracts is determined as the net present value of the life insurance portfolio’s future expected cash flows (contract benefits received and required premium payments) that incorporates current life expectancy estimates and discount rate assumptions.
We initially record our purchase of life insurance contracts at the transaction price, which is the amount paid for the contract, inclusive of all external fees and costs associated with the acquisition. The fair value of our investment in our portfolio of insurance contracts is evaluated at the end of each subsequent reporting period. Changes in the fair value of our portfolio are based on periodic evaluations and are recorded in our consolidated and combined statement of operations as changes in fair value of life insurance contracts.
Fair Value Components – Medical Underwriting
Unobservable inputs, as discussed below, are a critical component of our estimate for the fair value of our investments in life insurance contracts. We currently use a probabilistic method of estimating and valuing the projected cash flows of our portfolio, which we believe to be the preferred and most prevalent valuation method in the industry. In this regard, the most significant assumptions we make are the life expectancy estimates of the insureds and the discount rate applied to the expected future cash flows to be derived from our portfolio.
The Society of Actuaries recently finalized the 2015 Valuation Basic Table (“2015 VBT”). The 2015 VBT is based on a much larger dataset of insured lives, face amount of contracts and more current information compared to the dataset underlying the 2008 Valuation Basic Table. The new 2015 VBT dataset includes 266 million contracts compared to the 2008 VBT dataset of 75 million. The experience data in the 2015 VBT dataset includes 2.55 million claims on contracts from 51 insurance carriers. Life expectancies implied by the 2015 VBT are generally longer for male and female nonsmokers between the ages of 65 and 80, while smokers and insureds of both genders over the age of 85 have significantly lower life expectancies. We adopted the 2015 VBT in our valuation process in June 2016.
| 28 |
In September 2015, Equitable Life Insurance Company (“AXA”) announced pending cost-of-insurance rate increases for certain universal life contracts which were effected on March 1, 2016. We identified 14 affected contracts in our portfolio. In April 2016, we received updated contract illustrations from AXA and calculated the change in the fair value of our portfolio resulting from the increased premiums to be a reduction of $2,395,000. This reduction was reflected in our balance sheet as of March 31, 2016. Our review of AXA’s cost-of-insurance rate increases is complete as of September 30, 2016.
We are aware of additional pending cost of insurance increases affecting approximately 1.1% of our portfolio by face amount of benefits. We will adjust our premium schedules and resultant valuation when we have received the required information from the related carriers.
Fair Value Components – Required Premium Payments
We must pay the premiums on the life insurance contracts within our portfolio in order to collect the contract benefit. The same probabilistic model and methodologies used to generate expected cash inflows from the life insurance contract benefits over the expected life of the insured are used to estimate cash outflows due to required premium payments. Premiums paid are offset against revenue in the applicable reporting period.
Fair Value Components – Discount Rate
A discount rate is used to calculate the net present value of the expected cash flows. The discount rate represents the internal rate of return we expect to earn on investments in a contract or in the portfolio as a whole at the stated fair value. The discount rate used to calculate fair value of our portfolio incorporates the guidance provided by ASC 820, Fair Value Measurements and Disclosures.
The table below provides the discount rate used to estimate the fair value of our portfolio of life insurance contracts for the period ending:
| September 30, 2016 | December 31, 2015 | |||
| 11.07% | 11.09% |
The change in the discount rate incorporates current information about discount rates applied by other reporting companies owning portfolios of life insurance contracts, discount rates observed by us in the life insurance secondary market, market interest rates, credit exposure to the issuing insurance companies, and our estimate of the risk premium a purchaser would require to receive the future cash flows derived from our portfolio of life insurance contracts. Because we use the discount rate to arrive at the fair value of our portfolio, the rate we choose necessarily assumes an orderly and arms-length transaction (i.e., a non-distressed transaction in which neither seller nor buyer is compelled to engage in the transaction). The carrying value of contracts acquired during each quarterly reporting period are adjusted to their current fair value using the fair value discount rate applied to the entire portfolio as of that reporting date.
We engaged Model Actuarial Pricing Systems (“MAPS”), to prepare a calculation of our life insurance portfolio. MAPS owns and maintains the portfolio pricing software we use. MAPS processed contract data, future premium data, life expectancy estimate data, and other actuarial information to calculate a net present value for our portfolio using the specified discount rate of 11.07%. MAPS independently calculated the net present value of our portfolio of 625 contracts to be $477.6 million and furnished us with a letter documenting its calculation. A copy of such letter is filed as Exhibit 99.1 to this report.
Deferred Income Taxes
Under ASC 740, Income Taxes, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is established for deferred tax assets that are not considered more likely than not to be realized. Realization of deferred tax assets depends upon having sufficient past or future taxable income in periods to which the deductible temporary differences are expected to be recovered or within any applicable carryback or carryforward periods. After assessing the realization of the net deferred tax assets, we believe that it is “more likely than not” that we will be able to realize all of our deferred tax assets other than those which are expected to result in a capital loss.
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Deferred Financing and Issuance Costs
Financing costs incurred under the senior credit facilities were capitalized and are amortized using the straight-line method over the term of the senior credit facilities. The Series I Secured Note obligations are reported net of issuance costs, sales commissions, and other direct expenses, which are amortized using the interest method over the term of each respective borrowing. The L Bonds are reported net of issuance costs, sales commissions, and other direct expenses, which are amortized using the interest method over the term of each respective borrowing. The Series A, as described in Note 9, was reported net of issuance costs, sales commissions, including the fair value of warrants issued, and other direct expenses, which were amortized using the interest method as interest expense over a three-year redemption period. As of December 31, 2015, these costs have been fully amortized. Selling and issuance costs of RPS and MCA Preferred Stock, described in Notes 10 and 11, are netted against additional paid-in-capital.
Principal Revenue and Expense Items
We earn revenues from the following three primary sources.
| ● | Life Insurance Contract Benefits Realized. We recognize the difference between the face value of the contract benefits and carrying value when an insured’s mortality event occurs. We generally collect the face value of the life insurance contract benefit from the insurance company within 45 days of recognizing the revenue. |
| ● | Change in Fair Value of Life Insurance Contracts. We value our portfolio investments for each reporting period in accordance with the fair value principles discussed herein, which includes the expected payment of premiums for future periods as shown in our consolidated financial statements net premium costs. |
| ● | Sale of a Life Insurance Contract. In the event of a sale of a contract, we recognize gain or loss as the difference between the sale price and the carrying value of the contract on the date of the receipt of payment on such sale. |
Our main components of expense are summarized below.
| ● | Selling, General and Administrative Expenses. We recognize and record expenses incurred in our business operations, including operations related to the purchasing and servicing of life insurance contracts. These expenses include salaries and benefits, sales, marketing, occupancy and other expenditures. |
| ● | Interest and Dividends. We recognize and record interest expenses associated with the costs of financing our life insurance portfolio for the current period. These expenses include interest paid to our senior lender under our senior credit facilities, interest paid on our L Bonds and other outstanding indebtedness such as our Series I Secured Notes, and dividends on our Series A and our RPS. When we issue debt, we amortize the issuance costs associated with such indebtedness over the outstanding term of the financing, and classify it as interest expense. |
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Results of Operations — Three and Nine Months Ended September 30, 2016 Compared to the Same Periods in 2015
The following is our analysis of the results of operations for the periods indicated below. This analysis should be read in conjunction with our consolidated financial statements and related notes.
Revenue.
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2016 | 2015 | 2016 | 2015 | |||||||||||||
| Revenue recognized from the receipt of contract benefits | $ | 4,221,000 | $ | 277,000 | $ | 26,986,000 | $ | 25,909,000 | ||||||||
| Revenue (expense) recognized from the change in fair value of life insurance contracts, net of premiums and carrying costs (1) | 9,289,000 | 7,912,000 | 24,621,000 | 7,538,000 | ||||||||||||
| Gain on life insurance contracts, net | $ | 13,510,000 | $ | 8,189,000 | $ | 51,607,000 | $ | 33,447,000 | ||||||||
| Number of contracts matured | 4 | 1 | 16 | 8 | ||||||||||||
| The change in fair value related to new contracts acquired | $ | 11,668,000 | $ | 7,423,000 | $ | 29,509,000 | $ | 12,546,000 | ||||||||
| (1) | The discount rate applied to estimate the fair value of the portfolio of life insurance contracts we own was 11.07% as of both September 30, 2016 and September 30, 2015. The carrying value of contracts acquired during each quarterly reporting period is adjusted to current fair value using the fair value discount rate applied to the entire portfolio as of that reporting date (see Note 4 to our condensed consolidated financial statements). |
Expenses.
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||
| 2016 | 2015 | Increase (Decrease) | 2016 | 2015 | Increase | |||||||||||||||||||
| Employee compensation and benefits (1) | $ | 2,912,000 | $ | 2,308,000 | $ | 604,000 | $ | 8,450,000 | $ | 6,181,000 | $ | 2,269,000 | ||||||||||||
| Interest expense (including amortization of deferred financing costs and preferred stock dividends) (2) | 11,984,000 | 8,650,000 | 3,334,000 | 32,010,000 | 23,149,000 | 8,861,000 | ||||||||||||||||||
| Legal and professional expenses (3) | 587,000 | 822,000 | (235,000 | ) | 3,097,000 | 1,988,000 | 1,109,000 | |||||||||||||||||
| Other expenses (4) | 2,863,000 | 2,232,000 | 631,000 | 7,608,000 | 5,646,000 | 1,962,000 | ||||||||||||||||||
| Total expenses | $ | 18,346,000 | $ | 14,012,000 | $ | 4,334,000 | $ | 51,165,000 | $ | 36,964,000 | $ | 14,201,000 | ||||||||||||
| (1) | We hired additional members to our sales, marketing, legal and information technology teams. At the end of 2015 we employed approximately 50 employees, and at September 30, 2016 we employed approximately 67 employees. |
| (2) | The increase in the current period was due to the increase in our average debt outstanding. |
| (3) | Increase is due to SEC filings and other costs related to securities offerings and on-going compliance. |
| (4) | Increase is due to increased public relations, sales and marketing costs associated with growing and servicing our network of independent financial advisors. |
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Income Tax Expense.
The following table reconciles our income tax expense at the statutory federal tax rate to our actual income tax expense:
| Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
| September 30, 2016 | September 30, 2015 | September 30, 2016 | September 30, 2015 | |||||||||||||||||||||||||||||
| Statutory federal income tax (benefit) | $ | (1,561,000 | ) | 34.0 | % | $ | (1,948,000 | ) | 34.0 | % | $ | 489,000 | 34.0 | % | $ | 1,117,000 | 34.0 | % | ||||||||||||||
| State income taxes (benefit), net of federal benefit | (227,000 | ) | 4. | 9% | (334,000 | ) | 5.8 | % | 240,000 | 16.7 | % | (105,000) | 3.2 | % | ||||||||||||||||||
| Series A preferred stock dividends | 354,000 | (7.7 | )% | 175,000 | (3.1 | )% | 732,000 | 51.0 | % | 526,000 | 16.0 | % | ||||||||||||||||||||
| Other permanent differences | 15,000 | |||||||||||||||||||||||||||||||