Heritage Global Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Financial statements are unaudited; dollar amounts below are in millions unless noted. Heritage Global provides auction, liquidation, refurbishment and resale, brokerage, and specialty lending services through its Industrial Assets and Financial Assets divisions.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Revenue | $15.6 | $12.7 | $45.3 | $33.1 |
| Operating income | $2.8 | $3.5 | $9.8 | $8.0 |
| Net income | $2.0 | $2.3 | $7.6 | $5.5 |
| Diluted EPS | $0.05 | $0.06 | $0.20 | $0.15 |
| Adjusted EBITDA (non-GAAP) | $3.1 | $3.8 | $10.7 | $8.8 |
- Revenue mix: Q3 services revenue was $10.0 million and asset sales were $5.6 million. For nine months, services revenue rose 86% to $30.0 million, while asset sales declined 10% to $15.2 million.
- Margins: Management reported gross profit of $9.7 million for Q3, up approximately 28%, and $29.0 million for nine months, up approximately 68%. These imply approximate gross margins of 62% and 64%, respectively. Net margins were approximately 13% for Q3 and 17% for nine months.
- Cash flow: Nine-month operating cash flow was $12.6 million, versus $2.6 million a year earlier. Investing activities used $14.5 million, primarily for lending investments; financing provided $4.9 million. Cash increased by $2.9 million to $15.6 million.
- Liquidity: Working capital was $13.8 million, compared with $7.7 million at year-end 2022. Current assets were $33.9 million and current liabilities $20.1 million. The company said it expects to fund operations and debt service for at least 12 months from filing through working capital, operating cash flow, and its existing credit line.
- Debt: Third-party debt totaled $9.2 million: $1.6 million outstanding on the 2021 revolving facility, $6.6 million on the 2023 term loan, and $1.0 million on the ALT note. Lease liabilities were a further $2.8 million. The company reported compliance with debt covenants at quarter-end.
- Balance sheet: Total assets were $84.4 million, stockholders’ equity $56.4 million, and notes receivable net of reserves $20.6 million, versus $8.6 million at December 2022.
Material changes versus comparable periods
- Nine-month revenue grew 37% and net income grew 37%. Higher Financial Assets Division performance drove much of the revenue and gross-profit growth; SG&A rose 31% to $19.5 million, including higher compensation and credit-loss provisions.
- Q3 revenue increased 23%, but net income declined 14% and operating income declined 20%. Equity-method investment earnings shifted from $1.7 million of earnings in Q3 2022 to an $8,000 loss in Q3 2023, contributing to the lower operating income.
- For nine months, Brokerage operating income increased to $6.2 million from $2.6 million; Auction and Liquidation declined to $3.3 million from $6.2 million; Refurbishment & Resale rose to $2.8 million from $1.0 million. Specialty Lending reported a Q3 operating loss of $0.2 million, versus income of $0.3 million a year earlier.
- Cash used in investing swung to $14.5 million from cash provided of $3.9 million, reflecting a sharp increase in notes-receivable and equity-method investment activity. Financing included $13.0 million of new borrowing proceeds.
Outlook, risks, and notable items
- Specialty lending credit risk: One borrower represented $21.8 million, or 58%, of the company’s $37.6 million gross lending investments recorded across notes receivable and equity-method investments. The borrower requested extended repayment terms amid declining collections. Amended loan terms were still being finalized at quarter-end; proposed terms would extend repayment and increase the interest rate.
- The company increased its credit-loss reserve by $0.9 million to $1.4 million (3.8%). Nine-month provision expense on notes receivable was approximately $0.6 million; the company also reported its share of joint-venture credit-loss reserves. It had recorded no actual credit losses through September 30, 2023.
- Management said industry-wide collections were declining and expected to remain under pressure in the short term. It expects an approximately 20% or greater annual return on its share of notes receivable, based on loan terms and collection performance; this is an expectation, not a guarantee.
- The 2021 credit facility matures October 27, 2024 and bears interest at prime plus 1.00%, subject to a 6.75% floor. The $7.0 million term loan matures in 2028, bears variable interest at prime plus 0.25%, and is secured in part by ALT’s East Lyme, Connecticut building.
- The company adopted the expected-credit-loss accounting standard (ASC 326) on January 1, 2023, recording a $0.2 million after-tax cumulative adjustment to opening equity. Prior periods were not restated.
- No material changes to previously reported legal proceedings were disclosed. Management stated there were no off-balance-sheet arrangements and no expected dividends. Disclosure controls were assessed as effective.
Most important facts for investors to verify
- Whether the largest borrower agrees to amended repayment terms, and how collections and collateral recoveries develop.
- Credit-loss reserve adequacy and the concentration of lending exposure, including joint-venture exposures and any additional provisions.
- Cash generation after considering timing-related seller payables, continued lending investments, and debt-service needs.
- Performance sustainability by segment, particularly the Q3 weakness in Auction and Liquidation and Specialty Lending compared with Brokerage growth.
- Borrowing costs, available revolving-credit capacity, and compliance with covenants as the 2021 facility approaches its October 2024 maturity.