Heritage Global Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; balance-sheet comparisons are to December 31, 2018. Unaudited results are presented in U.S. dollars. Heritage Global provides asset liquidation services, including auctions, appraisals, advisory services, asset sales, and charged-off receivables brokerage.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Services revenue | $5.335m | $6.471m | $9.743m | $11.510m |
| Asset sales | $2.089m | $0.345m | $4.232m | $1.120m |
| Total revenue | $7.424m | $6.816m | $13.975m | $12.630m |
| Operating income | $1.570m | $1.630m | $2.229m | $3.035m |
| Net income | $1.494m | $1.685m | $2.106m | $2.974m |
| Diluted EPS | $0.05 | $0.06 | $0.07 | $0.10 |
| Adjusted EBITDA | $1.722m | $1.791m | $2.528m | $3.341m |
For Q2, revenue increased 9%, but reported gross profit on services and asset sales fell approximately 31% to $4.0m; the corresponding margin was about 54%, versus 85% in Q2 2018. For the six-month period, revenue increased 11%, while gross profit fell approximately 19% to $8.7m, a margin of about 62% versus 86%. Management attributed the gross-profit declines to the timing and magnitude of asset liquidation transactions. Equity-method investment earnings contributed $1.269m in 2019, with no comparable earnings in 2018.
Cash, liquidity, and debt
- Cash was $3.751m at June 30, down $0.517m from year-end. Operating cash flow was $0.686m for the first half, versus $4.040m a year earlier; investing cash use was $0.217m and financing cash use was $0.986m.
- Working-capital deficit widened to $4.1m from $2.5m. Current assets were $7.714m and current liabilities $11.776m. Accounts payable and accrued liabilities increased approximately $2.8m, primarily due to timing of auction settlement liabilities.
- Total debt was $0.631m, consisting of the scheduled-payment promissory note associated with a 2018 litigation settlement. The amended bank revolver has a $3.0m limit, a 5.50% minimum variable rate, and an April 5, 2020 maturity; the company reported a zero revolver balance at June 30. The note’s remaining balance is due by January 30, 2021.
- Total assets were $22.984m and stockholders’ equity was $9.853m. The company adopted lease accounting in 2019, recording $0.985m of right-of-use assets and $1.037m of lease liabilities.
Material changes and notable items
- Services revenue declined 18% in Q2 and 15% in the first half, while asset-sale revenue rose sharply from a comparatively low prior-year base. Higher costs of services and asset sales more than offset the revenue increase and reduced gross profit.
- Net income declined 11% in Q2 and 29% in the first half. First-half operating cash flow also decreased materially, including from a $2.369m increase in accounts receivable and lower net income adjusted for noncash items.
- A June 27 sales-type lease arrangement covers a Huntsville, Alabama manufacturing building and equipment. Stated lease payments total approximately $13.2m for real estate over ten years and $9.7m for equipment over six years; a purchase option may be exercised for $20.0m between December 1, 2019 and May 31, 2021. The company recognized approximately $1.2m of equipment-related revenue and a lease receivable; it expects approximately $0.5m of interest income before any option exercise.
- The company’s 25% CPFH LLC joint-venture interest generated $1.269m of first-half equity-method earnings. CPFH reported first-half revenue of $11.092m and net income of $5.057m.
- The company reported approximately $71.8m of tax net operating loss carryforwards, subject to restrictions and expirations, and a full valuation allowance against net deferred tax assets.
Outlook, risks, and controls
Management said it expects cash flows from ongoing operations and access to the revolver to fund operations, working capital, and debt service, and believes current capital resources are sufficient. No specific revenue or earnings guidance was provided. Management cautioned that results vary with the timing and size of individual liquidation deals. Other disclosed considerations include competition, regulatory and compliance costs, and estimates concerning receivables, inventory, and asset valuations. The filing reported no material change in legal proceedings, no material subsequent events, and effective disclosure controls; it also stated there were no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether the higher asset-sale revenue and new lease-related income are repeatable, and how the lease purchase option affects future cash flows and earnings.
- Collection and timing of receivables, auction settlement liabilities, and the causes of the sharp decline in operating cash flow.
- Liquidity and covenant capacity given the working-capital deficit, the revolver’s terms and maturity, and the remaining settlement-note payments.
- The sustainability of CPFH joint-venture earnings and the company’s ability to use its tax-loss carryforwards.