Heritage Global Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Unless otherwise noted, financial amounts are in thousands of U.S. dollars. The company’s sole operating segment is asset liquidation, including auctions, asset advisory, asset sales and, since its May 2014 acquisition, charged-off receivables brokerage.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $6,103 | $2,889 | $10,899 | $6,413 |
| Operating income (loss) | $(140) | $234 | $(1,386) | $(1,778) |
| Income (loss) before tax | $(262) | $104 | $(1,785) | $(2,177) |
| Income tax expense (recovery) | $55 | $387 | $24,722 | $(466) |
| Net loss | $(188) | $(260) | $(26,343) | $(1,650) |
| Net loss per share | $(0.01) | $(0.01) | $(0.94) | $(0.06) |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $281 | $2,368 |
Q3 revenue growth primarily reflected asset liquidation activity and NLEX, which contributed $771 of the quarter’s net asset-liquidation earnings. Nine-month asset-liquidation revenue rose to $10,899 from $5,589, while intellectual-property licensing revenue fell to zero from $824. Nine-month asset-liquidation investment results shifted to a $53 loss from $1,265 in earnings. Management attributes results in part to the timing of transactions. The filing does not provide a clear consolidated gross-margin measure.
The nine-month net loss was dominated by a $24,667 noncash write-down of deferred tax assets after the company recorded a full valuation allowance. The filing reports a nine-month non-GAAP EBITDA loss of $865, compared with a loss of $1,359 in 2013; EBITDA is supplemental and not a substitute for GAAP results.
Balance sheet, debt and liquidity
| Metric | September 30, 2014 | December 31, 2013 |
|---|---|---|
| Cash and cash equivalents | $4,400 | $3,213 |
| Total assets | $32,972 | $49,995 |
| Current assets | $7,649 | $7,324 |
| Current liabilities | $15,898 | $10,498 |
| Working capital | $(8,249) | $(3,174) |
| Total debt, all current | $6,030 | $3,988 |
| Stockholders’ equity | $13,526 | $39,497 |
Cash increased by $1,187 over the nine-month period. Operating activities provided $281; investing activities used $941, including $1,361 net cash paid for NLEX; financing activities provided $1,847. Cash generation was supported by financing and working-capital movements, while operating cash flow fell from the prior-year period.
Debt comprises $2,974 owed to third parties and a $3,056 related-party Counsel loan; all debt is classified as current. The $2,542 third-party loan bears 6% interest and matures January 15, 2015. The Counsel facility requires payment within 30 days after each quarter-end, with unpaid amounts accruing interest. The $15,000 asset-backed revolving facility had $432 outstanding; the company reported covenant compliance at September 30, 2014. The working-capital deficit widened by $5,075.
Material changes, outlook and risks
- NLEX acquisition: Acquired effective May 31, 2014 for $2,000 cash plus contingent consideration estimated at $4,198 present value, capped at $5,000. The earnout is based on NLEX revenues less specified expenses over four years. The purchase-price allocation remained subject to finalization; $6,185 was recorded as goodwill.
- Taxes: A full valuation allowance reduced net deferred tax assets from $24,667 at year-end 2013 to zero. The company reported approximately $74,128 of tax loss carryforwards, some restricted and subject to potential further ownership-change limitations.
- Ownership and management: Counsel distributed its HGI shares to its shareholders in April 2014 but remains a related party and external manager under a services agreement. Management stated an intention to internalize management in the future, without a stated timetable.
- Outlook: No numerical earnings or revenue guidance was provided. Management expects the asset liquidation business to remain the primary source of operating cash for the foreseeable future and cautioned that interim results are not necessarily indicative of full-year results.
- Key risks and unusual items: Transaction timing contributes to volatile results; the company faces competition from larger, better-resourced participants. Its portfolio investments are illiquid. The company also noted possible foreign-exchange exposure as European operations expand and limits on use of tax loss carryforwards. No material changes to previously disclosed legal proceedings or risk factors were reported.
- Other developments: The company changed its independent accounting firm effective September 27, 2014. Management concluded disclosure controls were effective and reported no material changes in internal control over financial reporting during Q3.
Important facts for investors to verify
- Whether NLEX meets the earnout assumptions and how the final purchase-price allocation affects goodwill and contingent consideration.
- How the company will manage its current liabilities, including the January 2015 third-party loan and quarterly Counsel-loan payment terms.
- Whether operating cash flow improves, given the widened working-capital deficit and lower year-to-date operating cash generation.
- Whether future taxable income can support use of tax loss carryforwards, considering the valuation allowance and potential ownership-change restrictions.
- Whether asset-liquidation transaction timing, the illiquid investments, and the company’s shift toward service-based revenues affect sustainable margins and cash generation.