Heritage Global Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited. The company operates one segment, asset liquidation, providing auction, appraisal, advisory, asset-sale and charged-off receivables brokerage services.
Financial performance and position
- Revenue: $5.814 million, up 16% from $5.033 million. Services revenue was $5.039 million, up 13%; asset sales were $775,000, up 36%.
- Profit and margins: Gross profit was $5.0 million versus $3.7 million, with gross margin of approximately 86% versus 73%. Operating income was $1.405 million versus $394,000; operating margin was approximately 24% versus 8%. Net income was $1.289 million, or $0.05 per diluted share, versus $255,000, or $0.01.
- Adjusted EBITDA: $1.550 million versus $541,000. This is a non-GAAP measure; the company excludes stock-based compensation and contingent consideration fair-value changes.
- Cash flow and liquidity: Operating cash flow was negative $274,000 versus positive $1.564 million a year earlier, primarily reflecting working-capital movements, including a $1.373 million increase in receivables. Cash declined to $1.596 million from $2.109 million. Working capital remained negative at $4.3 million, improved from a $5.6 million deficit at year-end; current assets were $3.967 million and current liabilities $8.261 million.
- Debt and obligations: Total debt was $1.346 million, down from $1.524 million at December 31, 2017. This includes $262,000 of related-party debt and $1.084 million of third-party debt. Contingent consideration was $2.774 million, all current. The company expected to pay approximately $2.8 million for the remaining NLEX earn-out during 2018.
- Balance sheet: Total assets were $14.366 million; stockholders’ equity was $4.838 million. Goodwill was $6.158 million, with no impairment reported in the quarter.
Material changes versus Q1 2017
- Revenue increased $781,000, while operating costs and expenses decreased $230,000. Management attributed higher gross profit in part to greater NLEX deal volume, which carries lower direct costs than HGP transactions; results are also affected by the timing and size of individual liquidation deals.
- SG&A increased 9% to $3.497 million, primarily due to salaries and commissions associated with improved HGP and NLEX performance. Advertising and promotion and travel costs also increased.
- Interest and other expense rose to $116,000 from $15,000, including accrued profit-share costs under a related-party loan arrangement. Operating cash flow shifted from positive to negative, largely because of working-capital timing.
Outlook, risks and unusual items
- No specific revenue, earnings or cash-flow guidance was provided. Management expects the asset liquidation business to remain the primary source of operating cash and says current capital resources are sufficient for expected requirements; it may draw on a related-party credit line with up to $1.5 million capacity if additional capital is needed. No draw was outstanding during Q1.
- Management cautions that results are not necessarily indicative of full-year performance. Deal size and timing can vary substantially, affecting earnings and working capital. The market is fragmented and includes competitors with greater financial and marketing resources.
- The company reported a $76.3 million tax NOL carryforward, including $15.2 million subject to ownership-change restrictions, and a full valuation allowance against net deferred tax assets.
- In January, a long-standing litigation matter involving a subsidiary’s predecessor was settled. The subsidiary’s $1.26 million share was paid by a co-defendant and funded through a promissory note guaranteed by HGI, payable in 36 monthly installments of $35,000 with any remaining balance due January 2021. The company made the first two payments in Q1.
- After quarter-end, employment agreements for two NLEX executives were extended through May 2023. The addendum provides incentive pools tied to NLEX operating income and contemplates restricted stock and future option awards; the detailed agreements and awards should be reviewed.
- ASC 606 was adopted January 1, 2018, with no opening retained-earnings adjustment and no expected material ongoing impact. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Key facts for investors to verify
- Timing and collection of the $1.757 million quarter-end receivables balance, given the negative Q1 operating cash flow.
- Funding and payment timing for the approximately $2.8 million remaining NLEX earn-out, relative to $1.596 million of cash and the $4.3 million working-capital deficit.
- Terms, repayments and related-party implications of the debt and credit line, including the Street Capital loan and executive-linked profit-share provisions.
- Final costs and terms of the litigation settlement note and the economic impact of the post-quarter NLEX compensation and equity arrangements.
- Performance sustainability: Q1 earnings rose sharply, but management attributes results partly to deal mix and timing; verify subsequent-period revenue, margins and cash conversion.