Heritage Global Inc. — Q3 2016 Form 10-Q
Business and period: Heritage Global provides asset liquidation services, including auctions, appraisals, advisory services, asset sales and brokerage of charged-off receivables. This unaudited report covers the three and nine months ended September 30, 2016; financial amounts below are in U.S. dollars. The company reports one operating segment.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $8.582m | $3.760m | $17.911m | $11.967m |
| Operating loss | $0.402m | $3.469m | $0.444m | $4.571m |
| Net income (loss) | $(0.371)m | $(3.637)m | $0.313m | $(4.917)m |
| Adjusted EBITDA (non-GAAP) | $(0.296)m | $(3.262)m | $(0.094)m | $(3.759)m |
| Cash from (used in) operations | — | $3.977m | $(0.848)m |
Quarterly revenue increased 128%, primarily reflecting asset sales; service revenue rose 28% and asset-sale revenue rose from $0.767m to $4.758m. Nine-month revenue increased 50%. Management reported gross profit from services, asset sales and equity-method earnings of approximately $2.5m in each Q3 period and $8.7m versus $7.8m for the nine-month periods. The corresponding approximate gross margin on total revenue was 29% versus 67% for Q3 and 49% versus 65% year to date, reflecting transaction mix and timing. SG&A was $2.783m in Q3 and $8.937m year to date, down 10% and 2%, respectively. Basic and diluted EPS were $(0.01) for Q3 and $0.01 for the nine months.
Financial position and liquidity
At September 30, 2016, cash was $3.341m, current assets $5.669m and current liabilities $10.386m, yielding a $4.7m working-capital deficit and a current ratio of approximately 0.55. The deficit improved from $5.1m at year-end 2015. Total debt was $1.550m, down from $4.221m: the company repaid its $2.5m third-party loan in July, while $1.090m of related-party debt was current and $0.460m non-current. Total liabilities were $12.683m and stockholders’ equity $3.769m.
Nine-month operating cash flow was $3.977m; investing activities used $0.071m and financing activities used $3.347m. Cash increased from $2.777m at year-end 2015 to $3.341m. Operating cash flow benefited materially from working-capital movements, including the real-estate sale and timing of auction settlement balances.
Material changes and unusual items
- The company sold its real-estate inventory for $4.1m in July 2016, recognizing approximately $0.1m gross profit after $3.7m carrying costs and $0.3m closing costs. The sale removed $3.715m of real-estate inventory from the year-end balance sheet. No comparable inventory write-down occurred in 2016; Q3 and nine-month 2015 included a $2.748m write-down.
- A $0.900m gain from the fair-value remeasurement of NLEX contingent consideration contributed to nine-month 2016 income. The liability was $1.930m at September 30, down from $3.457m at year-end, including $0.627m of payments. It is a Level 3 estimate.
- The company sold its VoIP patent portfolio during Q3 for $0.1m and reported that remaining obligations to the vendor were fulfilled.
- Related-party transactions included $1.099m of loan proceeds and $1.323m of related-party debt repayments in the first nine months. A new third-quarter loan from entities associated with executives and the CEO carried 10% interest; $0.6m remained outstanding at quarter-end.
- The company expects approximately $1.9m of remaining NLEX earn-out payments through 2018. It paid $0.627m during the first nine months of 2016 toward the second earn-out payment.
Outlook, risks and contingencies
No specific financial guidance was provided. Management expects the asset-liquidation business to remain its primary cash source and believes current capital resources are sufficient for anticipated requirements; it may seek additional debt financing, including related-party loans or a bank facility, if needed. Management cautions that deal size and timing vary considerably. Risks discussed include competition from larger, better-resourced firms, regulatory and compliance costs, and estimates involving receivables, inventory, goodwill, intangibles, contingent consideration and taxes. The company had a $74.0m tax-loss carryforward, but maintained a full valuation allowance against net deferred tax assets because of cumulative losses and uncertainty about future taxable income. Management reported effective disclosure controls; no material changes to internal control were reported. The filing states no material changes to previously disclosed legal proceedings or risk factors.
Key facts for investors to verify
- Whether operating cash generation is repeatable: reported cash flow benefited from working-capital timing and the real-estate inventory sale.
- Liquidity and refinancing capacity given the $4.7m working-capital deficit and management’s stated potential need for additional financing.
- Terms, maturity and repayment status of related-party loans, including the 10% executive-affiliated loan and Street Capital balance.
- Assumptions supporting the $1.930m Level 3 NLEX contingent-consideration liability and expected remaining earn-outs.
- How much revenue and profit depend on discrete asset-sale transactions and changing transaction mix; Q3 2016 remained loss-making despite higher revenue.