Heritage Global Inc. — Q2 2021 Form 10-Q
Reporting period: Three and six months ended June 30, 2021; filed August 12, 2021. Heritage Global provides industrial asset liquidation, auction and appraisal services, charged-off debt brokerage, and specialty financing. Figures below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Revenue | $5.18 | $6.12 | $12.28 | $10.36 |
| Gross profit on services and asset sales | $3.84 | $4.60 | $8.95 | $8.25 |
| Operating income | $0.07 | $1.02 | $1.12 | $1.12 |
| Net income | $0.59 | $2.04 | $1.62 | $2.08 |
| Diluted EPS | $0.02 | $0.07 | $0.04 | $0.07 |
| Adjusted EBITDA | $0.24 | $1.20 | $1.72 | $1.46 |
Gross margin was approximately 74% in Q2 versus 75% a year earlier, and 73% for the first half versus 80%. Operating margin was approximately 1% in Q2 versus 17%, and 9% for the first half versus 11%. Net income was aided by income tax benefits of $0.51 million in Q2 and $0.49 million for the first half; the filing reports substantial tax net operating loss carryforwards and a partial valuation allowance.
Liquidity, cash flow and balance sheet
- Cash was $17.5 million at June 30, down $5.9 million from year-end 2020. Current assets were $22.0 million and current liabilities $9.3 million; working capital was approximately $12.6 million in the balance sheet (MD&A reports $12.5 million).
- Operating cash use was $4.3 million in the first half, compared with $0.8 million in the prior-year period. Investing cash use was $0.8 million, versus $0.5 million provided; financing cash use was $0.8 million.
- The first-half operating cash outflow included a $4.8 million reduction in accounts payable and accrued liabilities and a $1.0 million increase in receivables. Investing included $4.8 million of new notes receivable, partly offset by $2.5 million in collections and $2.0 million in notes transferred to partners.
- No debt was outstanding at June 30. A new secured $10 million revolving credit facility was entered into in May 2021, matures May 11, 2023, and was undrawn at quarter-end. The rate is variable, based on prime plus 1.70%, subject to a 4.95% floor, with financial and other covenants.
- Total assets were $42.8 million, total liabilities $11.8 million, and stockholders’ equity $31.0 million. Lease liabilities totaled $3.0 million. Common shares outstanding were 36.3 million at quarter-end.
Changes and segment results
- Q2 revenue fell 15% year over year as services revenue declined 25%; asset sales increased 83%. Management attributed lower quarterly gross profit to the timing and size of asset liquidation transactions.
- First-half revenue rose 18%, led by asset sales of $3.1 million versus $0.7 million. Services revenue declined 5%. First-half gross profit increased about 8%, while operating income was essentially flat.
- Q2 segment operating income was $0.43 million for Industrial Assets and $0.46 million for Financial Assets; corporate and other posted a $0.82 million loss. For the first half, Industrial Assets generated $1.77 million, Financial Assets $0.92 million, and corporate and other recorded a $1.58 million loss. Industrial Assets improved from the prior-year first half, while Financial Assets declined.
- Q2 net income fell 71%. For the first half, net income fell 22% despite higher revenue, reflecting higher operating costs and substantially lower equity-method investment earnings.
Outlook, risks and unusual items
- No specific revenue or earnings guidance was provided. Management said it believed cash, ongoing operating cash flows and the undrawn credit facility would fund operations and debt service for at least 12 months from filing.
- Management said COVID-19 negatively affected both 2021 quarters through travel and work restrictions, stimulus payments and credit policies affecting debt sales, and delays in asset sales. It anticipated potential longer-term opportunities from increased distressed-asset supply, supply-chain disruption and greater availability of charged-off loans, but warned that Delta-variant surges or continued stimulus and credit policies could delay Financial Assets revenue.
- On May 31, the lessee exercised a purchase option on a leased pharmaceutical manufacturing campus. For the machinery and equipment portion, the Company derecognized approximately $0.9 million of assets and recognized approximately $1.2 million of revenue and a receivable; it expects about $0.5 million of interest income before exercise of the option.
- The Company reported $2.3 million of notes receivable outstanding and no allowance for credit losses. It also disclosed a $200,000 separation payment, payable over six months, plus health-coverage payments to a former executive. The first-half adjusted EBITDA reconciliation adds back the $200,000 separation expense.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. No material subsequent events or material changes in previously disclosed legal proceedings were reported.
Important facts for investors to verify
- Whether operating cash flow recovers, particularly as accounts payable and accrued liabilities settle and receivables are collected.
- Performance and credit quality of HGC’s loan portfolio, including the rationale for recording no credit-loss allowance on notes receivable.
- Whether expected distressed-asset and debt-sale opportunities materialize, and how stimulus policy, Delta-related disruption and transaction timing affect segment results.
- Compliance with the secured credit facility’s financial covenants and the effect of its variable interest rate if the Company draws funds.
- The sustainability of earnings given quarterly transaction variability, lower Q2 operating income, tax benefits, and dilution from stock options and share issuance.