Heritage Global Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016. Amounts are in U.S. dollars, generally in millions unless noted. Heritage Global operates a single asset-liquidation business, providing auction, appraisal, advisory, asset-sale, and charged-off receivables brokerage services.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 / prior period |
|---|---|---|
| Services revenue | $4.462 million | $4.192 million |
| Asset-sale revenue | $0.571 million | $1.228 million |
| Total revenue | $5.033 million | $5.420 million |
| Operating income | $0.394 million | $0.192 million |
| Net income | $0.255 million | $0.060 million |
| Diluted EPS | $0.01 | $0.00 |
| Operating cash flow | $1.564 million provided | $1.442 million used |
| Cash and equivalents | $3.846 million | $2.530 million at Dec. 31, 2016 |
| Total debt | $0.773 million | $1.012 million at Dec. 31, 2016 |
| Working capital | $(3.7) million deficit | $(4.1) million deficit at Dec. 31, 2016 |
Gross profit on services and asset sales was approximately $3.7 million, up about 9% from $3.4 million; the corresponding gross margin was approximately 73% versus 62%. Operating margin was approximately 7.8% versus 3.5%, and net margin approximately 5.1% versus 1.1%. Adjusted EBITDA, a non-GAAP measure, was $0.541 million versus $0.336 million.
Cash increased by approximately $1.3 million during the quarter. Operating cash generation reflected working-capital changes, including collections and higher accounts payable and accrued liabilities; management cautions that deal timing and size can make these balances and cash flows variable. Financing used $0.249 million, including $0.250 million of related-party debt repayments. No investing cash flow was reported.
At March 31, 2017, current assets were $5.223 million and current liabilities $8.876 million. Stockholders’ equity was $3.819 million. Related-party debt was $0.773 million in total, and contingent consideration was $2.844 million, including $0.868 million current and $1.976 million non-current. The company also had a $1.5 million related-party revolving credit facility, undrawn at quarter-end.
Changes from the comparable period
- Total revenue declined 7%, as a 54% reduction in asset-sale revenue more than offset 6% growth in services revenue.
- Operating expenses fell 11%, principally because cost of asset sales decreased; SG&A rose 4% to $3.210 million, partly due to stock-based compensation, occupancy, and finder’s fees.
- Operating income more than doubled and net income increased to $0.255 million. Interest expense fell to $0.015 million from $0.073 million.
- Operating cash flow improved by approximately $3.0 million year over year, from cash used to cash provided; management attributes most of the change to operating asset and liability movements.
Outlook, risks, and notable items
- 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 the related-party credit line if needed. No numerical earnings or revenue guidance is provided.
- The company expected to pay approximately $2.8 million under the NLEX earn-out from 2017 through 2019. An extension was agreed in principle in Q4 2016 but remained subject to board ratification. Payments depend on NLEX net profits.
- The Street Capital related-party loan carries interest at prime plus 1%; its rate was 5.0% at quarter-end. The company disclosed $0.5 million of accrued interest on this debt that remained unpaid. The separate revolving line is also related-party financing and includes a $15,000 annual commitment fee.
- Contingent consideration is a Level 3 fair-value estimate based primarily on management’s estimate of NLEX net profits; its carrying value increased by $0.111 million during the quarter.
- Management identified deal timing and transaction variability, competition in a fragmented market, regulatory and compliance costs, and significant estimates—including receivable collectability, goodwill, intangibles, and contingent consideration—as relevant uncertainties. The filing reported no material change in previously disclosed risk factors or legal proceedings.
- Management concluded there was no substantial doubt about the company’s ability to continue as a going concern for one year after issuance. Disclosure controls were deemed effective, and no material change in internal control over financial reporting was reported. No material subsequent events were disclosed.
Investor verification points
- Review the composition and timing of client-related payables and other working-capital movements that supported Q1 operating cash flow.
- Verify the NLEX earn-out amount, payment schedule, and status of the proposed extension, alongside the Level 3 contingent-consideration assumptions.
- Assess liquidity against the $3.7 million working-capital deficit, related-party debt and unpaid accrued interest, and the terms and availability of the undrawn credit facility.
- Evaluate whether services growth can offset lower, transaction-dependent asset-sale revenue and whether SG&A and other costs remain controlled.
- Consider the limits of the quarter’s results: management states that interim performance is not necessarily indicative of full-year results, and Adjusted EBITDA is non-GAAP.