Heritage Global Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited results are consolidated and cover the company’s asset liquidation business, including auction, appraisal, advisory, asset disposition and charged-off receivables brokerage services. Amounts below are in U.S. dollars; financial statement figures are shown in millions unless stated otherwise.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $6.816 | $4.782 | $12.630 | $9.815 |
| Operating income | $1.630 | $0.027 | $3.035 | $0.420 |
| Net income (loss) | $1.685 | $(0.199) | $2.974 | $0.055 |
| Diluted EPS | $0.06 | $(0.01) | $0.10 | $0.00 |
| Adjusted EBITDA | $1.791 | $0.166 | $3.341 | $0.707 |
- Q2 revenue increased 43% year over year; first-half revenue increased 29%. Services revenue rose 64% in Q2 and 37% for the half, while asset sales declined 59% and 21%, respectively.
- Gross profit, as presented by management, was approximately $5.8 million in Q2, up 87%, and $10.8 million for the first half, up 59%. Approximate gross margins were 85% and 85%, respectively, versus 65% and 69% in the comparable periods.
- Operating margins were approximately 24% in Q2 and 24% for the first half, compared with approximately 1% and 4% a year earlier. SG&A rose 36% in Q2 and 22% for the half, largely due to higher salaries and commissions, particularly at HGP and NLEX.
- Q2 and first-half results included a $157,000 gain from the fair-value reduction in contingent consideration; the comparable 2017 periods included gains of $179,000 and $290,000.
Cash, liquidity and debt
- Cash was $4.752 million at June 30, up from $2.109 million at December 31, 2017. First-half operating cash flow was $4.040 million, versus $0.884 million in 2017. Investing used $0.077 million and financing used $1.320 million.
- Management reported a $2.5 million working capital deficit at June 30, improved from $5.6 million at year-end. Current assets were $6.230 million and current liabilities $8.746 million.
- Total reported debt was $1.137 million, comprising $141,000 of related-party debt and $996,000 of third-party debt. The company also had $1.618 million of contingent consideration outstanding, down from $2.774 million at year-end after a $1.0 million payment and fair-value adjustment.
- In July 2018, the company entered into a replacement revolving credit facility with a bank for up to $1.5 million, guaranteed by Ross Dove and Kirk Dove. Management said it expects to fund operations primarily through operating cash flows, with occasional credit-facility draws, and believes current resources are sufficient.
Changes, outlook and notable matters
- Management attributed improved revenue and gross profit primarily to higher deal volume at NLEX and the variable timing and size of asset liquidation transactions. It cautioned that first-half results are not necessarily indicative of full-year results.
- The final NLEX earn-out payment was a significant cash use: $1.0 million was paid in the first half and approximately $1.6 million in July 2018 for the remaining amount owed.
- Effective June 1, employment agreements for NLEX executives David and Tom Ludwig were extended through May 2023. The revised arrangements provide for incentive pools tied to NLEX results. The company also issued 600,000 restricted shares and options for 300,000 shares to NLEX employees; the latter options expired July 31, 2018.
- Management provided no specific revenue or earnings guidance. The company reported a full valuation allowance against net deferred tax assets and approximately $76.3 million of tax net operating loss carryforwards, some subject to ownership-change restrictions.
- Risks include variability in the timing and magnitude of transactions, competition from larger and better-resourced firms, regulatory and compliance costs, and significant judgment in valuation estimates. The company reported no off-balance-sheet arrangements, no material subsequent events, and no material change in legal proceedings. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether the sharp improvement in operating results and cash generation is sustainable given transaction timing and the decline in asset-sales revenue.
- The July payment of the remaining NLEX earn-out and the resulting contingent-consideration balance after payment.
- Terms, availability, guarantees and actual borrowing under the replacement $1.5 million bank facility.
- The cash-flow and earnings effects of the new NLEX incentive pools, restricted stock and future option awards.
- Collection of receivables, valuation assumptions for contingent consideration and goodwill, and the utilization limits on tax loss carryforwards.