Heritage Global Inc. — FY2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020; comparisons are with FY2019. Heritage Global provides industrial asset auction, appraisal and advisory services, charged-off receivables brokerage, and specialty lending through its Industrial Assets and Financial Assets divisions.
Financial results and liquidity
| Metric | 2020 | 2019 |
|---|---|---|
| Total revenue | $26.183 million | $26.168 million |
| Gross profit | $17.074 million | $18.429 million |
| Gross margin | 65.2% | 70.4% |
| Operating income | $6.059 million | $3.050 million |
| Net income | $9.658 million | $3.899 million |
| Diluted EPS | $0.30 | $0.13 |
| Cash provided by operating activities | $9.148 million | $0.794 million |
Revenue was nearly flat: services revenue rose 8.5% to $21.806 million, while asset-sale revenue fell 27.9% to $4.377 million. Gross profit declined about 7%, reflecting deal timing and mix, but lower SG&A ($14.449 million, down 9%) and higher equity-method investment earnings ($3.796 million versus $1.373 million) supported higher operating income. Segment operating income increased to $5.764 million in Industrial Assets from $2.834 million; Financial Assets decreased to $2.637 million from $3.337 million.
Net income included a $3.644 million income tax benefit, driven in significant part by a valuation-allowance reduction as management concluded additional deferred tax assets were more likely than not realizable. The benefit materially boosted reported earnings; it should not be treated as recurring operating performance without further analysis. Adjusted EBITDA, a non-GAAP measure, was $6.774 million versus $4.211 million.
Cash and cash equivalents were $23.385 million at year-end versus $2.728 million; working capital was $13.0 million versus a $2.4 million deficit. Investing activities provided $4.508 million, including equity-method investment distributions and proceeds from transferring notes to partners. Financing activities provided $7.001 million, including $7.541 million net cash proceeds from the common-stock offering. The October offering sold 5,462,500 shares at $1.75 each; the company reported approximately $8.7 million proceeds after underwriting discounts and commissions but before offering expenses.
There was no outstanding balance on the $5.0 million secured revolving credit facility at December 31, 2020; the company drew and repaid $5.6 million during the year. The facility carried a minimum 5.50% prime-based rate and was secured by specified company and subsidiary assets. Its maturity was extended to April 5, 2021 in a March 3, 2021 amendment. Year-end lease liabilities totaled approximately $1.003 million. Total liabilities were $14.612 million, including $13.609 million of accounts payable and accrued liabilities, much of which related to auction clients and transaction timing.
Material changes and notable items
- Cash and stockholders’ equity rose substantially, principally following the October equity offering; common shares outstanding increased from 29.34 million to 35.28 million by year-end.
- SG&A declined mainly because Equity Partners compensation ended after that business’s separation at year-end 2019. The separation was associated with a $0.573 million goodwill impairment in 2019; no goodwill impairment was recorded in 2020.
- HGC expanded specialty lending. Year-end notes receivable were $2.086 million, down from $2.661 million; the company recorded no allowance for credit losses on these notes.
- Deferred tax assets, net of valuation allowance, rose to $4.402 million from $0.372 million. The tax valuation allowance remained significant, at $13.097 million.
- One customer accounted for 10% of revenue in 2020, compared with 14% in 2019.
Outlook, risks and controls
Management said COVID-19 had a minor negative effect in 2020 through travel and work restrictions and delayed asset sales. It expected potential benefits from increased distressed-asset supply, online auction demand, nonperforming loan activity, HGC funding opportunities and collateral valuation work, while warning that travel and field-work restrictions could offset those benefits. The filing provides no quantified revenue or earnings guidance.
Management believed cash flows, cash raised in the offering and access to the credit facility would fund operations and debt service in 2021 and beyond. Key risks include deal timing and quarterly earnings volatility; competition and customer concentration; inventory resale and credit risk; dependence on key personnel and joint-venture partners; funding needs; cybersecurity and regulatory compliance; and possible limits on tax-loss carryforwards. Legal proceedings in the ordinary course were not expected to have a material adverse effect. The company reported effective disclosure controls and effective internal control over financial reporting as of year-end; the independent auditor did not provide an opinion on internal-control effectiveness.
Investor verification priorities
- Assess how much of 2020 net income and EPS depended on the tax benefit and whether deferred tax assets can be realized; review tax-loss restrictions, expirations and audit exposure.
- Examine the quality and timing of operating cash flow, including the $5.5 million increase in accounts payable and accrued liabilities and auction settlement balances.
- Review the credit facility’s March 2021 amendment, subsequent repayment or refinancing, covenants and borrowing availability after its April 5, 2021 maturity.
- Evaluate concentration and returns in equity-method investments: their reported earnings increased materially and contributed substantially to operating income.
- Review HGC loan performance, partner funding arrangements and the rationale for recording no credit-loss allowance on notes receivable.
- Consider dilution from the public offering and outstanding options; the filing reports 3.516 million options outstanding at year-end.