Heritage Global Inc. — FY2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; comparisons are with FY2016. The company provides asset liquidation services, including auctions, appraisals, M&A advisory and charged-off receivables brokerage, and also buys and resells distressed or surplus assets.
Financial performance and liquidity
| Metric | FY2017 | FY2016 |
|---|---|---|
| Revenue | $20.1 million | $23.8 million |
| Gross profit | $15.4 million; 76.6% margin | $12.5 million; 52.5% margin |
| Operating income | $0.4 million; 1.8% margin | $0.2 million; 0.8% margin |
| Net income (loss) | $(0.25) million; $(0.01) per share | $0.01 million; approximately $0.00 per share |
| Adjusted EBITDA | $2.1 million | $0.6 million |
| Cash from operations | $1.2 million | $3.9 million |
| Cash and cash equivalents | $2.1 million | $2.5 million |
| Working capital | $(5.6) million | $(4.1) million |
| Total debt reported at year-end | $1.5 million | $1.0 million |
| Stockholders’ equity | $3.5 million | $3.5 million |
Revenue declined 16% as 2016 included the sale of real estate inventory; service revenue rose 17% to $17.9 million, while asset-sale revenue fell to $2.2 million from $8.5 million. Direct costs fell faster than revenue, lifting gross profit about 23%. SG&A increased 13% to $13.6 million. The company reported a $0.25 million GAAP net loss despite $2.1 million Adjusted EBITDA; the latter adds back, among other items, a $1.1 million settlement accrual and a $0.9 million contingent-consideration fair-value adjustment.
Operating cash flow decreased by $2.7 million, primarily reflecting working-capital movements and the absence of the prior-year real-estate inventory sale. Financing cash outflows included $0.6 million of repayments to Street Capital and $0.9 million paid on the NLEX earn-out. Year-end current assets of $3.0 million were well below current liabilities of $8.7 million. Management said it expected to fund operations and debt service from operating cash flows and existing borrowing capacity, but noted that continued debt financing may be needed until consistent profitability is achieved.
Material changes, outlook and risks
- The NLEX earn-out liability was valued at $2.8 million at year-end. Management estimated the $5.0 million maximum earn-out would be reached in 2018 based on NLEX performance; the associated 2017 fair-value adjustment materially reduced pretax results.
- A long-standing litigation matter was settled on January 30, 2018. A co-defendant affiliate funded the company’s $1.26 million settlement obligation in exchange for a promissory note, guaranteed by HGI. Repayment is in 36 monthly installments of $35,000, with any remaining balance due January 30, 2021. The company accrued the present value, $1.142 million, in 2017.
- In January 2018, HGI also entered into a $1.26 million third-party note related to that settlement. The reported year-end debt summary lists $1.524 million of debt and does not include the settlement note in that total; see investor verification items below.
- The company provided no numerical earnings or revenue guidance. It expects asset liquidation operations to remain its primary cash source. Management’s outlook depends on the timing and size of discrete transactions, which can cause substantial period-to-period fluctuations.
- Key risks include a $5.6 million working-capital deficit, reliance on financing, competition from larger and better-capitalized firms, inventory resale and credit risks, dependence on key personnel and joint-venture partners, foreign-exchange exposure, and potential limitations on tax-loss carryforwards. The company had a full valuation allowance against deferred tax assets and approximately $76.2 million of tax net operating loss carryforwards, some restricted or subject to expiration.
- The 2017 Tax Cuts and Jobs Act reduced the U.S. corporate tax rate to 21%; the company remeasured deferred tax liabilities, reducing them by approximately $1.5 million. Revenue-recognition adoption was expected to affect disclosures but not materially change reported revenue amounts or timing. The company said it had not yet assessed the potential effect of the new lease standard.
- Management reported effective disclosure controls and internal control over financial reporting as of December 31, 2017. The independent auditor issued an unqualified opinion on the financial statements but was not engaged to audit internal control.
Important facts for investors to verify
- Reconcile the $1.142 million settlement accrual and $1.26 million January 2018 note to the balance sheet, debt disclosures and cash-flow classification; confirm payment terms and the parent guarantee.
- Track the NLEX earn-out settlement, including whether the $5.0 million maximum is reached in 2018 and the resulting cash requirements.
- Assess whether operating cash generation and available credit are sufficient to address the working-capital deficit, lease obligations and debt service.
- Evaluate the sustainability of improved gross profit and Adjusted EBITDA against the GAAP loss, higher SG&A and volatile transaction timing; review the non-GAAP adjustments.
- Verify the assumptions underlying NLEX contingent consideration and the carrying values of $6.2 million goodwill and $3.9 million intangible assets; no impairment was recorded in 2017.