Heritage Global Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Unaudited results; dollar amounts below are in millions unless stated otherwise. Heritage Global operates a single asset-liquidation business, including auction, appraisal, brokerage, asset sales and specialty financing services.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $6.12 | $7.42 | $10.36 | $13.98 |
| Operating income | $1.02 | $1.57 | $1.12 | $2.23 |
| Net income | $2.04 | $1.49 | $2.08 | $2.11 |
| Diluted EPS | $0.07 | $0.05 | $0.07 | $0.07 |
| Adjusted EBITDA | $1.20 | $1.72 | $1.46 | $2.53 |
Q2 revenue declined 18%, primarily reflecting asset sales revenue falling 74% to $0.55 million; services revenue rose 4% to $5.57 million. Six-month revenue fell 26%, including an 83% decline in asset sales. Management reported gross profit on services and asset sales of $4.6 million in Q2, up about 12%, and $8.3 million for the first half, down about 5%. Operating income declined 35% in Q2 and 50% for the first half. Net income comparisons were affected by a substantial income-tax benefit in 2020.
At June 30, cash was $2.23 million, total assets $23.43 million, total liabilities $9.31 million and stockholders’ equity $14.11 million. Working capital remained negative at $1.2 million, improved from a $2.3 million deficit at year-end 2019. Six-month operating cash flow was negative $0.83 million, versus positive $0.69 million a year earlier; investing activities provided $0.50 million and financing activities used $0.17 million. Cash declined $0.50 million to $2.23 million. Debt was $0.24 million, all current; there was no outstanding balance on the $5 million revolving facility at quarter-end. Lease liabilities totaled $1.28 million.
Material changes and unusual items
- The company recorded income-tax benefits of $1.02 million in Q2 and $0.99 million for the first half, versus tax expenses in the comparable 2019 periods. Management attributed the benefit primarily to reducing its deferred-tax-asset valuation allowance after concluding that an additional $1.3 million of deferred taxes was more likely than not realizable. This drove Q2 net income higher despite lower operating income.
- Equity-method investment earnings fell to $0.18 million for the first half from $1.27 million. The company reported that its joint ventures’ combined revenue was $2.04 million for the first half, compared with $11.09 million in 2019; joint-venture activity and transaction timing contributed to the comparison.
- The company originated approximately $4.5 million of notes receivable and transferred notes to partners and a newly formed joint venture. Notes receivable were approximately $1.4 million at June 30, versus $2.7 million at year-end. No allowance for credit losses was recorded.
- SG&A declined 6% for the first half, partly because the Equity Partners team departed at year-end 2019; lower travel costs also contributed. Q2 SG&A was broadly unchanged.
- The company recognized a $1.3 million refundable deposit for a potential inventory purchase and advance auction guarantee payments of approximately $0.5 million as significant operating-asset cash uses; the deposit was refunded in July 2020.
Outlook, risks and contingencies
Management said COVID-19 had a minor negative impact through travel and work restrictions and delayed asset sales. It did not expect a material ongoing negative impact, anticipating that economic weakness and supply-chain disruption could increase the supply of distressed and surplus assets. However, continued restrictions could reduce revenue in business units reliant on travel and field work. The filing provides no quantified earnings or revenue guidance.
Management believed operations, the working-capital deficit and debt service could be funded through operating cash flows and the existing credit line. The $5 million C3bank facility matures February 5, 2021, bears a variable rate with a 5.5% floor, and includes financial and other covenants. A separate note had a $0.24 million outstanding balance, with the remaining amount due January 30, 2021. Other risks include transaction timing variability, customer concentration (one customer represented 15% of first-half revenue), competition, and collectability and valuation judgments. No material subsequent events or material changes to previously reported legal proceedings were disclosed. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the deferred-tax valuation allowance release and expected realization of deferred tax assets are supportable; the tax benefit materially affected reported net income.
- Liquidity and refinancing capacity ahead of the February 2021 revolving-facility maturity and January 2021 note payment, including compliance with credit covenants.
- Collections and credit quality of the specialty-finance notes receivable, particularly given the absence of a recorded credit-loss allowance.
- Timing and profitability of asset-liquidation transactions and joint ventures, which drove significant year-over-year revenue and earnings variability.
- Exposure to COVID-related travel and field-work restrictions, and the extent of customer concentration.