Heritage Global Inc. — Q3 2019 Form 10-Q
Business context and period. This unaudited report covers the three and nine months ended September 30, 2019. Heritage Global operates a single asset liquidation business, providing auction, appraisal, advisory, brokerage and asset-sale services. Amounts below are in U.S. dollars; financial statement amounts are in thousands unless otherwise stated.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $6.622 million | $5.128 million | $20.597 million | $17.758 million |
| Operating income | $1.267 million | $0.416 million | $3.496 million | $3.451 million |
| Net income | $1.216 million | $0.369 million | $3.322 million | $3.343 million |
| Diluted EPS | $0.04 | $0.01 | $0.11 | $0.12 |
| Adjusted EBITDA | $1.404 million | $0.568 million | $3.932 million | $3.909 million |
- Q3 services revenue was $5.207 million, up 6%; asset sales were $1.415 million, up $1.184 million. Management reported gross profit of approximately $5.3 million, up 26% year over year.
- Nine-month services revenue declined 9% to $14.950 million, while asset sales rose 318% to $5.647 million. Management reported gross profit of approximately $14.0 million, down about 7%. The filing attributes period-to-period variability to the timing and size of individual liquidation transactions.
- Nine-month operating cash flow was $1.047 million, versus $4.372 million in 2018. Investing activities used $0.368 million and financing activities used $1.046 million. Cash declined $0.367 million to $3.901 million from December 31, 2018.
- At September 30, current assets were $7.316 million and current liabilities were $10.261 million, a $2.9 million working capital deficit. Total assets were $22.548 million; stockholders’ equity was $11.132 million, compared with $7.600 million at year-end 2018.
- Total debt was $0.570 million, all reported as the remaining third-party promissory note; the revolving credit facility had a zero balance at quarter-end. The facility’s capacity was amended to $3.0 million, with a 5.50% minimum variable rate and an April 5, 2020 maturity. Lease liabilities of $0.910 million were recognized following adoption of the new lease standard.
- Income tax expense was $0.117 million for the nine months. The company reported approximately $71.8 million of tax loss carryforwards and a full valuation allowance against net deferred tax assets.
Material changes, outlook and risks
- Q3 net income increased to $1.216 million from $0.369 million, supported by higher revenue and gross profit. Nine-month net income was slightly lower year over year despite higher revenue; direct costs rose substantially, while reported operating income was nearly flat.
- Equity-method investment earnings contributed $1.277 million in the first nine months, versus none in 2018. The company owns 25% of CPFH LLC, which reported nine-month revenue of $11.106 million and net income of $5.068 million. The company reported no formal earnings or revenue guidance.
- In June, the company and partners entered into a sales-type lease arrangement for a Huntsville, Alabama manufacturing facility and equipment, with a purchase option for $20.0 million exercisable from December 1, 2019 through May 31, 2021. The company recognized approximately $1.2 million of equipment-sale revenue and expects approximately $0.5 million of interest income before the purchase option is exercised.
- Kenneth Mann’s employment with Equity Partners is scheduled to end December 31, 2019. Certain assets are to transfer to him in January 2020, subject to stated conditions. The company expects a non-cash goodwill impairment charge of approximately $573,000 at December 31, 2019.
- Management stated it expects to fund operations, its working capital deficit and debt service through operating cash flows and access to the credit facility, and believes current capital resources are sufficient. Cash generation can fluctuate with deal timing; operating cash flow was materially lower year over year.
- Other considerations include competition from larger, better-resourced firms; regulatory and compliance costs; uncertainty in estimates and asset valuations; and restrictions on use of some tax losses under ownership-change rules. Management reported disclosure controls as effective and no material changes in internal control over financial reporting. No material changes to previously disclosed legal proceedings were reported.
Important facts for investors to verify
- Whether operating cash flow improves and the company can manage its working capital deficit without increasing borrowings.
- The timing, profitability and cash conversion of asset liquidation deals, particularly the contribution from asset sales and equity-method investments.
- Progress and economics of the Huntsville lease, including whether the purchase option is exercised and the expected interest income is realized.
- The final terms and financial effects of the Equity Partners separation, including the expected $573,000 goodwill impairment and any transferred assets or liabilities.
- Availability and renewal or refinancing of the $3.0 million credit facility before its April 5, 2020 maturity, and scheduled payments on the remaining promissory note through its January 2021 balloon date.