Heritage Global Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparative period is Q1 2018. Figures below are in U.S. dollars. Financial statements are unaudited.
Business context
Heritage Global operates one segment, an asset liquidation business offering auction, appraisal, advisory, asset-sale and charged-off receivables brokerage services. Revenue is reported as services revenue and asset sales.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Services revenue | $4.408 million | $5.039 million | Down 13% |
| Asset sales | $2.143 million | $0.775 million | Up 177% |
| Total revenue | $6.551 million | $5.814 million | Up 13% |
| Gross profit on services and asset sales | $4.7 million | $5.0 million | Down about 6% |
| Operating income | $0.659 million | $1.405 million | Down 53% |
| Net income | $0.612 million | $1.289 million | Down 53% |
| Basic and diluted EPS | $0.02 | $0.05 | Lower |
| Adjusted EBITDA | $0.806 million | $1.550 million | Down about 48% |
Operating margin was approximately 10% versus 24% in Q1 2018; net margin was approximately 9% versus 22%. Cost of services and asset sales rose to $1.891 million from $0.828 million. SG&A increased 12% to $3.925 million, which management attributed largely to higher salaries and commissions associated with improved performance in the HGP and NLEX divisions. Interest and other expense declined to $23,000 from $116,000; income tax expense was $24,000 versus none.
Cash flow, balance sheet and debt
- Cash and cash equivalents were $1.836 million at March 31, 2019, down from $4.268 million at year-end. Operating cash flow was negative $2.335 million, compared with negative $0.274 million in Q1 2018. Management cited large auction settlement payments and lower net income; working-capital movements also reflected the timing of discrete transactions.
- Investing cash outflow was $5,000 and financing cash outflow was $92,000, mainly debt repayment. The quarter’s net cash decrease was $2.432 million.
- Current assets were $5.358 million and current liabilities $7.844 million, a working-capital deficit of approximately $2.5 million, similar to year-end. Total assets were $19.341 million; stockholders’ equity was $8.283 million.
- Reported debt totaled $1.524 million ($1.184 million current and $0.340 million noncurrent). This included a First Choice Bank revolving facility balance reported as $0.8 million and a settlement note with a $0.724 million outstanding balance. The filing says the facility was amended to a $3.0 million limit, maturing April 5, 2020, with a variable prime rate subject to a 5.50% floor.
- The filing states both that the company had not drawn on the line during the quarter and that the balance was $0.8 million at March 31. The wording does not clearly distinguish existing borrowings from new draws.
- Adoption of the lease standard on January 1, 2019 added $1.103 million of right-of-use assets and $1.162 million of lease liabilities to the balance sheet. These are separate from reported debt.
Material changes, outlook and risks
Revenue grew mainly because asset-sale revenue increased, while services revenue declined. Higher direct costs and SG&A caused operating income, net income and adjusted EBITDA to fall despite the revenue increase. Management said the lower gross profit reflected the timing and magnitude of asset liquidation transactions.
No quantified earnings or revenue guidance was provided. Management said it expects to fund operations, its working-capital deficit and debt service through ongoing asset-liquidation cash flows and access to the revolving facility, and believes current capital resources are sufficient for projected needs. Results from this quarter are not necessarily indicative of full-year results.
- Liquidity is sensitive to the timing and scale of individual liquidation deals and related auction settlement receipts and payments. Management identified reliance on operating cash flows and the credit line as funding sources.
- The business faces competition from liquidators, auction companies, dealers and brokers, including competitors with greater resources and name recognition. The filing also cites regulatory and compliance requirements and related costs.
- The company reported approximately $71.8 million of tax net operating loss carryforwards, including $15.2 million subject to ownership-change limitations. It maintains a full valuation allowance against net deferred tax assets because of cumulative losses and uncertainty about future taxable income.
- A March 2019 warrant agreement with Napier Park may provide warrants tied to qualifying cumulative gross profit above $2.5 million from the joint venture before December 19, 2022. No warrants were issued in Q1.
- The company leases office space from NLEX President David Ludwig; related-party rent expense was approximately $27,000 in Q1 2019. No material subsequent events were reported, and the company said there were no material changes to previously reported legal proceedings.
Management concluded disclosure controls and procedures were effective at quarter-end and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Clarify the credit-facility disclosure: the reported $0.8 million balance, statement that there were no draws during the quarter, facility availability, covenants and borrowing capacity.
- Monitor cash conversion, auction settlement timing and the working-capital deficit, given negative operating cash flow and the cash decline.
- Assess whether the increase in asset sales and the decline in services revenue and profitability persist; quarterly results can vary with deal timing and size.
- Review repayment requirements for the settlement note, including scheduled installments and its January 30, 2021 maturity, alongside facility maturity and interest-rate terms.
- Evaluate the realization prospects and ownership-change limits on tax attributes, and the potential dilution conditions under the Napier Park warrant agreement.