Heritage Global Inc. — Q2 2023 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2023, compared with the corresponding 2022 periods. Heritage Global provides auction, liquidation, appraisal, refurbishment and resale services, brokerage of charged-off receivables, and specialty lending.
Financial performance and condition
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue, 2023 (2022) | $13.1M ($11.1M), up 18% | $29.7M ($20.4M), up 45% |
| Net income, 2023 (2022) | $2.8M ($2.6M), up 8% | $5.6M ($3.2M), up 74% |
| Diluted EPS, 2023 (2022) | $0.07 ($0.07) | $0.15 ($0.09) |
| Operating income, 2023 (2022) | $3.1M ($3.6M) | $7.0M ($4.5M) |
| Operating cash flow, 2023 (2022) | Not separately presented | $6.7M ($1.1M) |
- Q2 service revenue rose 113% to $9.8M, while asset sales declined 49% to $3.3M. First-half service revenue rose 129% to $20.1M; asset sales fell 17% to $9.7M.
- Gross profit on services and asset sales was $9.4M in Q2 versus $4.5M, and $19.3M for the first half versus $9.7M. The corresponding gross margins were approximately 71% versus 41% and 65% versus 48%, respectively.
- Q2 operating income declined 14% despite higher gross profit, reflecting lower equity-method earnings ($0.3M versus $4.2M) and higher SG&A ($6.4M, up 30%). First-half operating income increased 55%; equity-method earnings fell 84% to $0.7M.
- First-half EBITDA was $7.2M versus $4.8M; Adjusted EBITDA, which adds back stock compensation, was $7.6M versus $5.0M. These are non-GAAP measures.
- Cash and cash equivalents were $15.0M at June 30, up from $12.7M at year-end. Working capital was $15.5M versus $7.7M; total assets were $79.9M and stockholders’ equity was $54.2M.
- Third-party debt totaled $8.1M, up from $4.3M at December 31, 2022; lease liabilities were $3.0M. The debt includes a $6.9M term loan and $1.2M ALT note. The $10M revolving credit facility had no outstanding balance at quarter-end.
- Investing cash outflow was $8.0M, mainly from $18.7M of new notes-receivable investments and $4.2M of equity-method investments, partly offset by collections and transfers to partners. Financing cash inflow was $3.7M.
Material changes versus prior comparable periods
- Growth was concentrated in services, particularly the Financial Assets Division. For the first half, Brokerage operating income increased to $4.2M from $1.3M and Specialty Lending to $1.3M from $0.6M. Industrial Assets Division operating income was $4.0M versus $4.2M.
- Q2 Auction and Liquidation operating income fell to $0.7M from $3.2M, while Refurbishment & Resale rose to $0.7M from $0.1M. Management attributes period-to-period results in part to the timing and size of discrete asset liquidation transactions.
- SG&A rose 38% to $12.7M for the first half, primarily from increased compensation and headcount, alongside higher professional fees and occupancy costs.
- In May 2023, the company obtained a $7.0M term loan due April 2028 and modified its revolving facility. The revolver maturity was extended to October 2024; its rate became prime plus 1.00%, subject to a 6.75% floor.
Outlook, commentary, risks and unusual items
- No specific revenue or earnings guidance was provided. Management said it believes working capital, operating cash flows and access to its existing credit line can fund operations and debt service for at least 12 months from the filing date. Management also cited an expected annual return of approximately 20% or more on its share of specialty-lending notes, dependent on loan terms and collection performance.
- Management described the business as event-driven, with revenue and associated working capital subject to variability in deal timing and magnitude. It cited opportunities from surplus and distressed assets and growth in nonperforming consumer loans, but these are forward-looking expectations, not assured outcomes.
- Specialty lending carries borrower concentration risk: one borrower represented approximately $22.2M, or 73%, of gross notes-receivable investments at June 30. The company reported no actual credit losses to date, but recognized a $0.1M first-half credit-loss provision and held approximately $0.2M in notes-receivable reserves.
- The company adopted the expected-credit-loss standard (ASC 326) on January 1, 2023, recording a cumulative $0.2M reduction to opening equity after tax. Management did not expect the change to materially affect ongoing results.
- The term loan and revolving facility have variable rates, security interests and financial covenants. The company reported compliance with covenants at June 30. Management identified competition, regulatory compliance costs, credit conditions and estimation uncertainty as business risks. No material change to previously reported legal proceedings was disclosed.
- Disclosure controls were reported effective at June 30, 2023; no material changes to internal control over financial reporting were reported during the first half.
Important facts for investors to verify
- Whether the sharp increase in service revenue and Financial Assets Division earnings is sustainable, and how much depends on transaction timing or one-off deals.
- Performance, collateral quality and collection outcomes for the concentrated specialty-lending exposure, including the large single-borrower balance.
- Debt service capacity under the new variable-rate term loan and modified revolving facility, including future borrowing availability and covenant compliance.
- Whether higher SG&A and compensation costs remain proportionate to revenue growth, and how equity-method investment earnings evolve.
- Whether the reported cash and working-capital position remains available after settlement of seller payables and continued lending and investment activity.