Heritage Global Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Dollar amounts are in thousands of U.S. dollars unless noted. Heritage Global’s sole operating segment is asset liquidation, including auctions, asset advisory, distressed-asset transactions, and, following its acquisition, charged-off receivables brokerage.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $2,811 | $1,932 | $4,796 | $3,524 |
| Operating loss | $(469) | $(1,107) | $(1,246) | $(2,012) |
| Loss before income taxes | $(608) | $(1,281) | $(1,523) | $(2,281) |
| Income tax expense (recovery) | — | $(500) | $24,667 | $(853) |
| Net loss | $(584) | $(743) | $(26,155) | $(1,390) |
| Net loss per share | $(0.02) | $(0.03) | $(0.93) | $(0.05) |
- Q2 revenue increased about 45%; six-month revenue increased about 36%. Six-month asset liquidation revenue was $4,796, versus $3,324. Intellectual-property licensing revenue was nil, compared with $200 in the first half of 2013.
- Q2 operating loss narrowed to $469 from $1,107. For the first half, asset liquidation revenue, expense, and equity-accounted asset liquidation investment results together generated $3,750 of net earnings, versus $3,362 a year earlier; operating expenses also declined.
- The first-half net loss was driven principally by the $24,667 tax expense recorded after the Company established a valuation allowance against all net deferred tax assets. The filing reports a $1,523 pretax loss; the tax charge was largely a noncash accounting adjustment.
- Cash used in operating activities was $1,189, compared with $2,966 provided in the first half of 2013. Investing activities used $966, including $1,361 net cash paid for NLEX; financing activities provided $1,299. Cash fell to $2,357 from $3,213 at year-end.
Financial position and liquidity
- At June 30, 2014, total assets were $29,131, liabilities $15,528, and equity $13,603. Total assets and equity declined from $49,995 and $39,497, respectively, at December 31, 2013, largely reflecting the removal of deferred tax assets and the first-half loss.
- Working capital was negative $7,007, compared with negative $3,174 at year-end. Management notes that real estate inventory and asset liquidation investments are classified as noncurrent under GAAP although generally expected to convert to cash within a year; including them as current would produce working capital of $288.
- All debt was current: $2,751 payable to third parties and $2,655 to related party Counsel, totaling $5,406, versus $3,988 at year-end. Third-party debt included a $2,500 loan bearing 6% and maturing January 15, 2015, and $247 outstanding under a revolving facility. The Counsel Loan balance bore 5.25% for Q2 and was payable within 30 days after each quarter.
- The $15,000 revolving facility is subject to eligible-asset collateral and financial terms; the Company reported compliance with its covenants at June 30, 2014. Cash resources, working-capital deficit, current maturities, and reliance on asset-liquidation cash flows remain important liquidity considerations.
Material changes, outlook, and risks
- On June 2, 2014, effective May 31, the Company acquired all of National Loan Exchange, Inc. for $2,000 cash plus contingent consideration tied to four years of performance, capped at $5,000. The estimated present value of the contingent consideration was $4,198; purchase accounting was not final. NLEX contributed $303 revenue and $65 earnings in the reported period, including only about one month of operations.
- The acquisition added $6,185 of goodwill, bringing total goodwill to $11,486. The purchase-price allocation remained subject to change. The earnout, goodwill valuation, and NLEX integration are notable items to monitor.
- Former majority shareholder Counsel distributed its HGI shares to its shareholders in April 2014 but remains a related party, providing management services under a replacement agreement. The Company says it intends to internalize management in the future, without a stated timetable.
- Deferred tax assets were reduced to zero, including recognition of a valuation allowance. The Company reported approximately $74,775 of tax net operating loss carryforwards, some restricted under ownership-change rules; their future use is uncertain.
- No specific financial guidance was provided. Management expects the asset liquidation business to remain the primary source of operating cash for the foreseeable future. It cautioned that interim results are not necessarily indicative of full-year results and highlighted transaction timing, competition, integration costs, illiquid investments, tax-loss limitations, and potential foreign-currency exposure.
- Management reported no material changes to previously disclosed legal proceedings or risk factors, no material subsequent events, and effective disclosure controls. It reported no material off-balance-sheet transactions.
Important facts for investors to verify
- Whether NLEX meets performance expectations and the ultimate amount and timing of earnout payments; confirm the final purchase-price allocation.
- How the Company will fund operations and current debt obligations given the $7,007 working-capital deficit and $2,357 cash balance.
- Whether asset-liquidation operating performance and cash conversion improve, and how much results depend on transaction timing and investment distributions.
- The basis and ongoing adequacy of the full deferred-tax-asset valuation allowance, and the extent to which tax-loss carryforwards can be used.
- Goodwill impairment indicators, especially for the recently acquired NLEX business, and the performance and liquidity of equity-accounted investments.