Business context and reporting period
This is Counsel RB Capital Inc.’s Form 10-K for the fiscal year ended December 31, 2011, filed March 22, 2012. The filing describes the company now identified in the request as Heritage Global Inc. The business had two segments: asset liquidation, its principal operating business, and patent licensing. Asset liquidation includes purchasing and reselling distressed or surplus assets, auctions and advisory services. The company reported no patent licensing revenue in 2011 or 2010.
In June 2011, the company acquired Equity Partners, a distressed-business financial advisory firm, for $819, including cash, shares and options. After year-end, on February 29, 2012, it acquired Heritage Global Partners (HGP), a global auction and asset advisory firm, for $3.0 million cash, $1.0 million in notes, 1.0 million shares and options to purchase 625,000 shares.
Financial results and position
Amounts below are in thousands of U.S. dollars, except per-share data. Fiscal-year comparisons are 2011 versus 2010.
| Metric | 2011 | 2010 |
|---|---|---|
| Asset liquidation revenue | $17,238 | $3,266 |
| Operating income | $4,583 | $5,430 |
| Income before tax recovery and other equity-investment earnings | $4,368 | $4,866 |
| Income tax recovery | $26,317 | $1,318 |
| Net income attributable to controlling interest | $30,713 | $4,829 |
| Basic / diluted common EPS | $1.14 / $1.13 | $0.21 / $0.21 |
| Cash from operating activities | $4,051 | $4,555 |
| Cash and cash equivalents at year-end | $6,672 | $2,608 |
| Working capital | $7,626 | $1,621 |
| Third-party debt at year-end | $3,091 | $4,485 |
| Total assets / stockholders’ equity | $47,147 / $42,940 | $16,686 / $9,448 |
Revenue rose substantially with the expansion of asset-liquidation operations and the Equity Partners acquisition. Asset sale proceeds increased to $14,733 from $2,733; commissions and other revenue rose to $2,505 from $533. However, operating income declined, and net income’s large increase principally reflects the $26,317 tax recovery—not comparable growth in operating earnings. The recovery followed reversal of the valuation allowance on deferred tax assets; it was noncash, as reflected in the cash-flow reconciliation.
Asset liquidation costs were $9,766 versus $2,062, while earnings from equity-accounted asset-liquidation investments fell to $2,183 from $7,586. Management said the combined contribution of revenue, direct asset-liquidation costs and these investment earnings was $9,655, compared with $8,790 in 2010. SG&A, including related-party expenses, was $4,986 versus $3,232. Interest expense was $245 versus $336. There were no 2011 inventory write-downs or goodwill impairment charges; 2010 included a $123 inventory write-down and $173 goodwill impairment.
Operating cash flow was $4,051 despite reported net income of $30,713, primarily because the tax recovery was noncash. Investing activities used $213, including the $175 cash portion of the Equity Partners purchase; financing activities provided $226. The company’s $10 million revolving credit facility finances eligible assets for resale; $3,091 was outstanding at year-end, secured by $4,303 of assets. The company reported compliance with its covenants. GAAP working capital excludes real-estate inventory and asset-liquidation investments classified as noncurrent, although management expects them to convert to cash within a year; reclassifying those assets would produce working capital of $13,212.
Material changes, outlook and risks
- Tax assets and earnings quality: Management concluded that use of tax-loss carryforwards was more likely than not and reversed the full valuation allowance. The resulting deferred tax asset was $28,783. Approximately $28,700 of net operating loss carryforwards are subject to ownership-change limitations; further restrictions could reduce tax benefits or require a valuation allowance.
- Liquidity outlook: Management said it expected Counsel RB’s operations to provide sufficient cash for ongoing requirements for at least the next 12 months, even if no new patent licensing agreements were secured. The filing provides no quantified earnings or revenue guidance.
- Acquisition and dilution: The HGP acquisition occurred after year-end and added cash and note obligations plus shares and options. The company also granted 2.52 million options during 2011; year-end options outstanding totaled 3.14 million.
- Concentration and governance: Parent Counsel owned approximately 76.1% at year-end and controlled the company. Related-party arrangements included a $360 annual management-services charge, a $70 additional Counsel-services charge in 2011, and office leases with entities controlled by a Co-CEO.
- Operating risks: Management highlighted deal-to-deal revenue variability, competition, inventory valuation and resale risk, reliance on joint ventures, credit and environmental exposure, dependence on key personnel, possible financing needs, and illiquidity of private investments. The Polaroid investment represented about 6% of total assets and is not publicly traded.
- Legal contingencies: A patent infringement case against PAETEC remained pending in the Eastern District of Texas, with no trial date stated; three other defendants’ claims had been dismissed without prejudice. Separately, a limited-partnership investment disclosed a claim seeking $16.49 million plus interest and costs; management considered it without merit and recorded no provision. The filing elsewhere says the company had no material litigation, so the status and relationship of this partnership claim merit clarification.
- Other disclosures: The core VoIP patents have finite lives, with the listed U.S. patents generally expiring between 2015 and 2018. The common stock traded over the counter, had a limited public market, and the company did not expect to pay dividends. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not provide an internal-control attestation.
Most important facts for investors to verify
- How much of 2011’s reported net income is attributable to the one-time, noncash deferred-tax valuation-allowance reversal, and how tax-loss restrictions affect future tax expense and cash taxes.
- Whether operating cash generation can be sustained as asset-liquidation deal mix changes, and how much working capital depends on assets classified as noncurrent.
- The status, potential exposure and applicable entity for the $16.49 million partnership claim and the pending patent litigation.
- The HGP acquisition’s final accounting, integration results, cash and note obligations, and dilution from issued shares and options.
- The company’s related-party arrangements, parent control, revolving-credit covenants and remaining borrowing capacity.