Heritage Global Inc. — Q2 2017 Form 10-Q
Business and period: The company’s sole operating segment is asset liquidation, including auction, appraisal and advisory services, asset sales, and brokerage of charged-off receivables. This unaudited report covers the three and six months ended June 30, 2017; comparisons are to the same 2016 periods. Amounts below are in U.S. dollars.
Financial results
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $4.782 million | $3.961 million | $9.815 million | $9.381 million |
| Operating income (loss) | $27,000 | ($234,000) | $420,000 | ($42,000) |
| Net income (loss) | ($199,000) | $624,000 | $55,000 | $684,000 |
| Adjusted EBITDA | $166,000 | ($132,000) | $707,000 | $179,000 |
| Operating cash flow | Not separately stated | Not separately stated | $884,000 | ($262,000) |
- Q2 revenue increased 21%; service revenue rose 7% and asset sales rose 223%. Six-month revenue increased 5%, as service revenue rose 6% while asset sales declined 5%.
- Gross profit on services and asset sales was $3.1 million in Q2 versus $2.9 million, and $6.8 million for the first half versus $6.3 million. Approximate gross margins, calculated from reported revenue and cost figures, were 65% and 74% for Q2 2017 and 2016, respectively, and 69% and 67% for the first halves.
- Q2 net loss included a $179,000 unfavorable fair-value adjustment to contingent consideration, compared with a $925,000 favorable adjustment in Q2 2016. For the first half, the adjustment was a $290,000 expense versus an $857,000 gain in 2016. These noncash valuation changes significantly affected year-over-year net income.
- At June 30, cash was $2.6 million; current assets were $4.4 million and current liabilities $8.0 million, producing a $3.7 million working-capital deficit. Stockholders’ equity was $3.7 million.
- Total related-party debt was $616,000, down from $1.012 million at year-end 2016. The company also reported $2.623 million of contingent consideration, a Level 3 fair-value liability. It paid $400,000 toward contingent consideration and repaid $415,000 of related-party debt during the first half.
Changes, outlook and risks
- Operating cash flow improved by $1.146 million year over year, to $884,000 provided, primarily reflecting changes in operating assets and liabilities and improved net income adjusted for noncash items. Cash increased $70,000 during the first half to $2.6 million.
- Management said the asset liquidation business is expected to remain the primary source of operating cash and considers current capital resources sufficient. A related-party revolving credit facility has $1.5 million of capacity and was undrawn at June 30; management said it could be used if additional capital is needed.
- The company expects to pay approximately $3.0 million on the NLEX earn-out from 2017 to 2019. Earn-out amounts depend on NLEX net profits; the reported liability valuation relies on significant unobservable inputs and management estimates. An earn-out extension was agreed in principle but remained subject to board ratification.
- Management disclosed the potential for up to $5.6 million in additional service-fee revenue over the next 12 months from third-party asset-sale transactions. The fees, if received, are expected to have little offsetting expense, but depend on contracts and performance by parties outside the company’s control; management cautioned that realization is uncertain.
- No formal earnings or revenue guidance was provided. Management emphasized that deal timing and size cause variability in results. Other risks include competition, regulatory compliance, estimates affecting receivable collectability and asset/liability valuations, and liquidity needs. The filing reported no material changes to previously disclosed risk factors or legal proceedings and no material subsequent events requiring disclosure.
- On August 7, 2017, the board elected Emmett DeMoss as a Class III director. The board then had seven members, five independent.
Investor verification points
- Track whether the potential $5.6 million of service fees becomes contractually secured and is recognized.
- Verify the timing, amount and funding of NLEX earn-out payments, including any board-approved extension.
- Monitor working-capital needs, operating cash generation and availability and terms of the related-party credit facility.
- Review the assumptions and sensitivity underlying the Level 3 contingent-consideration valuation and resulting fair-value gains or charges.
- Distinguish GAAP results from Adjusted EBITDA, a non-GAAP measure that excludes contingent-consideration fair-value changes and stock-based compensation.