Heritage Global Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017; comparisons are to the same 2016 periods. Amounts are in U.S. dollars, in thousands, except per-share data. Heritage Global provides asset liquidation services, including auctions, appraisals, advisory services and brokerage of charged-off receivables.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Services revenue | $4,231 | $3,824 | $12,637 | $11,718 |
| Asset sales | $506 | $4,758 | $1,915 | $6,245 |
| Total revenue | $4,737 | $8,582 | $14,552 | $17,963 |
| Operating income (loss) | $316 | $(402) | $736 | $(444) |
| Net income (loss) | $83 | $(371) | $138 | $313 |
| Adjusted EBITDA | $448 | $(312) | $1,155 | $(133) |
| Operating cash flow | Not presented quarterly | $1,839 | $3,982 |
Q3 basic and diluted EPS were reported as $0.00, versus $(0.01) in Q3 2016. Nine-month EPS was $0.00 versus $0.01 in 2016. Gross profit on services and asset sales combined was approximately $3.9 million in Q3 (about 82% of revenue), versus $2.5 million (about 29%); for nine months it was $10.7 million (about 74%) versus $8.7 million (about 49%). These gross profit and margin figures are derived from the filing’s revenue and direct-cost amounts.
Balance sheet and liquidity
- At September 30, cash was $2.959 million; total assets were $14.620 million; stockholders’ equity was $3.815 million.
- Current assets were $4.125 million and current liabilities $9.110 million, a $4.985 million working-capital deficit. The deficit widened from $4.1 million at December 31, 2016.
- Debt was $541,000, all current and owed to a related party, down from $1.012 million at year-end. A separate related-party revolving credit facility of up to $1.5 million was undrawn.
- Contingent consideration totaled $2.372 million, including $1.637 million current. The company paid $897,000 during the nine-month period; the balance is measured using Level 3 inputs and management estimates.
- Operating cash flow was positive but declined from $3.982 million to $1.839 million. Financing used $1.394 million, primarily for $498,000 of related-party debt repayment and $897,000 of contingent consideration. Cash increased $429,000 from year-end.
Material changes and management commentary
- Q3 revenue fell 45%; nine-month revenue fell 19%. The principal reason was lower asset-sale revenue following the 2016 sale of real estate inventory. Services revenue rose 11% in Q3 and 8% for nine months, with management citing higher deal volume at Equity Partners and NLEX.
- Despite lower revenue, combined gross profit rose about 56% in Q3 and 23% for nine months, reflecting lower direct costs and a shift in the mix of transactions. Management cautioned that deal timing, size and mix vary and results should be considered as a whole.
- SG&A increased 27% in Q3 and 9% for nine months. Management attributed the increase to compensation, bonuses and commissions, consulting and higher stock-based compensation, among other costs.
- The contingent-consideration fair-value adjustment was a $246,000 expense in Q3 and a $536,000 expense for nine months, compared with a $43,000 gain and a $900,000 gain, respectively, in 2016. This noncash item materially affects period-to-period earnings comparisons.
Outlook, risks and other disclosures
- No specific revenue or earnings guidance was provided. Management expects the asset liquidation business to remain the primary source of cash for operations and believes current capital resources are sufficient; it may draw on the undrawn related-party facility if additional capital is needed.
- The company expected to pay approximately $2.1 million over the remaining NLEX earn-out period. Payments are tied to NLEX net profits, and management reported an in-principle agreement to extend the earn-out, subject to board ratification.
- Management highlighted variability in transaction timing and magnitude, competition from larger firms, and regulatory and compliance costs. Significant accounting estimates include collectability and valuations of receivables, inventory, goodwill, intangibles and contingent consideration.
- The company reported $74.5 million of tax net operating loss carryforwards, some restricted under ownership-change rules, and a full valuation allowance against net deferred tax assets. No material subsequent events or material changes to previously reported legal proceedings were disclosed. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether the improvement in gross profit and adjusted EBITDA is repeatable given transaction mix and the unusually large real-estate asset sale in 2016.
- How the working-capital deficit and upcoming earn-out payments will be funded, and whether the related-party credit facility remains available on its stated terms.
- The assumptions underlying the Level 3 contingent-consideration valuation and the amount and timing of remaining earn-out obligations.
- The effect of the NLEX earn-out extension, if ratified, on future liabilities and cash flows; and the realization prospects for tax carryforwards subject to restrictions and a full valuation allowance.