Heritage Global Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; filed March 9, 2020. This is an annual report, not a standalone fourth-quarter report. Heritage Global provides asset liquidation services, including auctions, appraisals, asset sales, charged-off receivables brokerage and, beginning in 2019, specialty financing. Its sole reported operating segment is asset liquidation.
Financial performance
| Metric | FY2019 | FY2018 |
|---|---|---|
| Services revenue | $20.1 million | $21.7 million |
| Asset sales revenue | $6.1 million | $2.0 million |
| Total revenue | $26.2 million | $23.7 million |
| Gross profit | $18.4 million | $19.6 million |
| Operating income | $3.1 million | $4.1 million |
| Net income | $3.9 million | $3.8 million |
| Diluted earnings per share | $0.13 | $0.13 |
| Adjusted EBITDA (non-GAAP) | $4.2 million | $4.7 million |
Margins: Gross margin was approximately 70% (versus 83%); operating margin approximately 12% (versus 17%); net margin approximately 15% (versus 16%). The company reported $1.4 million of equity-method investment earnings in 2019, compared with none in 2018. Net income also benefited from a $0.9 million income tax benefit; the prior year had $0.3 million of tax expense.
Cash flow and liquidity: Operating cash flow was $0.8 million, down from $7.5 million. Investing activities used $1.2 million, including $2.8 million invested in notes receivable for the new financing business; financing activities used $1.2 million. Cash declined to $2.7 million from $4.3 million. Working capital deficit was $2.3 million, versus $2.5 million.
Debt and balance sheet: Third-party debt was $0.4 million at year-end, down from $1.6 million; the $3.0 million revolving facility had no outstanding balance at December 31, 2019. Total liabilities were $10.1 million and stockholders’ equity was $11.8 million. Adoption of lease accounting brought $1.5 million of lease liabilities onto the balance sheet.
Changes versus prior year
- Revenue rose 11%, as asset sales increased by $4.1 million, partly offset by a $1.6 million decline in services revenue.
- Gross profit fell approximately $1.2 million, or 6%, and operating income fell approximately $1.0 million. Management attributed cost and revenue mix changes to higher HGP deal volume, which carries higher direct costs than NLEX business.
- SG&A increased 5% to $15.9 million, including higher NLEX incentive compensation, HGC staffing costs, and professional fees.
- Cash from operations fell substantially, reflecting the timing and working-capital effects of discrete transactions, including the prior-year pharmaceutical campus purchase and related partner payments.
- The company formed Heritage Global Capital to finance investors in charged-off and nonperforming asset portfolios; notes receivable reached approximately $2.7 million gross principal, with no credit-loss allowance recorded.
Outlook, material events and risks
- Outlook: The filing gives no numerical revenue or earnings guidance. Management expects ongoing asset liquidation operations to remain the primary cash source and believes operating cash flow and available borrowing capacity should meet requirements. The company acknowledged that results can fluctuate materially with deal size and timing.
- Credit facility: In February 2020, the company entered a secured $5.0 million revolving facility with C3bank, maturing February 5, 2021, replacing the prior $3.0 million facility. Proceeds are restricted to business operations.
- Equity Partners separation: Kenneth Mann’s employment ended December 31, 2019, and certain assets transferred to him January 1, 2020. The company recorded a non-cash $0.6 million goodwill impairment. Certain post-year-end engagement revenue remains subject to a sharing arrangement.
- Partner obligation: Remaining guaranteed distributions connected with the Huntsville pharmaceutical campus were reported as approximately $0.8 million in the financial-statement note; MD&A describes approximately $0.9 million, due by May 26, 2020.
- Taxes: The company recognized a $0.4 million net deferred tax asset after reducing its valuation allowance. It reported approximately $83.2 million in tax net operating loss carryforwards, some restricted by ownership-change rules and subject to expiration and other limitations.
- Principal risks: Deal timing and concentration, competition, inventory resale and credit risk, reliance on joint-venture partners and key personnel, financing availability, goodwill impairment, tax-attribute limitations, regulatory and cyber risks, and limited trading liquidity. The common stock trades on OTCQB and the Canadian Securities Exchange.
- Contingencies and controls: The company reported ordinary-course legal matters not expected to have a material adverse effect and no off-balance-sheet arrangements. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor did not express an opinion on internal control.
Investor verification priorities
- Assess the sustainability and cash conversion of earnings, particularly the contribution from equity-method investments and the 2019 tax benefit.
- Review the performance, repayment terms, borrower concentration and credit-loss assumptions for HGC’s new notes receivable; no allowance was recorded at year-end.
- Confirm actual use and availability of the C3bank facility, its covenants and repayment or refinancing needs before its February 2021 maturity.
- Reconcile the reported Huntsville partner-payment obligation ($0.8 million in the note versus about $0.9 million in MD&A) and confirm its settlement.
- Evaluate the continuing effects of the Equity Partners separation, including revenue-sharing collections and any further impairment exposure.
- Consider dilution and governance factors: 3.6 million options were outstanding at year-end, executives and directors beneficially owned approximately 34.8% of common stock, and the stock has a limited public market.