Heritage Global Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; comparisons are to fiscal 2015. The filing was signed March 7, 2017. The company operates a single asset-liquidation business through auction, appraisal and advisory services, distressed-asset sales, M&A advisory, and charged-off receivables brokerage.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Services revenue | $15.371 million | $13.485 million |
| Asset sales | $8.410 million | $3.946 million |
| Total revenue | $23.781 million | $17.431 million |
| Operating income (loss) | $190,000 | $(10.354) million |
| Net income (loss) | $14,000 | $(10.421) million |
| Operating cash flow | $3.914 million | $(836,000) |
| Cash and cash equivalents at year-end | $2.530 million | $2.777 million |
- Revenue grew approximately 36%; management attributed the increase primarily to the real-estate inventory sale. Services revenue rose about 14% and asset-sales revenue more than doubled.
- Cost of services and asset sales totaled $11.318 million in 2016 versus $6.537 million in 2015. Management reported gross profit, including equity-method investment earnings, of approximately $12.5 million versus $11.2 million, up about 12%. The implied margin on revenue plus equity-method earnings was approximately 53% versus 64%; the shift reflects transaction mix, including the larger volume of asset sales.
- Adjusted EBITDA, a company-defined non-GAAP measure, was $724,000 versus a loss of $1.167 million. It adds back depreciation and amortization, interest, taxes, selected write-downs and impairments, stock compensation, and contingent-consideration fair-value changes; it is not a substitute for GAAP results.
- Working capital deficit improved to $4.1 million from $5.1 million. Current assets were $4.433 million and current liabilities $8.570 million. Stockholders’ equity was $3.494 million, compared with $3.394 million.
- Year-end debt was $1.012 million, all related-party debt owed to Street Capital: $664,000 current and $348,000 non-current. The $2.5 million third-party loan was repaid in 2016. Street Capital debt was scheduled for repayment through the third quarter of 2018; the year-end rate was 4.75%.
- Cash flows included $3.847 million of cash released from real-estate and equipment inventory. Investing activities used $79,000 and financing activities used $4.086 million. Cash declined by $251,000 during the year.
Material changes and unusual items
- The company sold its real-estate inventory in the third quarter for $4.1 million. Against $3.7 million carrying value and $0.3 million closing costs, it recorded gross profit of approximately $0.1 million. Related rental income of $0.3 million was recorded in 2016 before the sale closed.
- Fiscal 2015 included a $2.748 million real-estate inventory write-down and $5.437 million goodwill and intangible-asset impairment charge; neither recurred in 2016. No 2016 impairment was recorded.
- Net income was nearly break-even despite positive operating income: the 2016 income statement included $182,000 interest expense, $92,000 expense from the contingent-consideration fair-value adjustment, and $21,000 income-tax expense.
- The company paid $816,000 on the NLEX earn-out in 2016. Its remaining contingent-consideration liability was $2.733 million, measured using Level 3 inputs. Management assumed an earn-out extension of at least one year and recorded an approximately $1.0 million liability adjustment based on expected payments; the extension was subject to Board ratification.
- The company sold its VoIP patent portfolio for $100,000 in the third quarter of 2016 and fulfilled remaining obligations to the vendor.
- Stock options outstanding increased to 5.169 million from 2.175 million, including 3.259 million options granted in 2016, generally at a $0.45 exercise price. This creates potential dilution; 3.322 million options were unvested at year-end.
Outlook, risks and contingencies
- Management expects asset-liquidation operations to remain the primary source of cash and believes operations, the working-capital deficit, and debt service can be funded through operations and additional related-party financing. It stated that it expected sufficient resources for requirements, while acknowledging reliance on debt financing until profitability is achieved. No revenue or earnings guidance was provided.
- Management concluded that substantial doubt about the company’s ability to continue as a going concern did not exist for the year following issuance of the statements. This assessment coexists with a $4.1 million working-capital deficit, an accumulated deficit of $280.9 million, and the stated financing dependence.
- A related-party revolving credit facility with borrowing capacity of up to $1.5 million was established in the fourth quarter; no amount was drawn at year-end. It carries a $15,000 annual commitment fee and allows the lender-related entity to share in profits and losses from certain industrial auction transactions beginning in 2017. The filing also describes a related-party profit-sharing arrangement involving CEO Ross Dove for certain transactions.
- Key risks include deal timing and revenue volatility; competition from larger, better-capitalized firms; inventory valuation and resale risk; dependence on joint-venture partners and key personnel; foreign-currency exposure; potential need for additional financing; and regulatory, export-control, FCPA, and environmental compliance risks.
- The company had $1.941 million of future lease commitments. It reported ordinary-course legal matters not expected to have a material adverse effect. It carried a full valuation allowance against deferred tax assets and disclosed approximately $74.5 million of tax net operating loss carryforwards, some subject to ownership-change restrictions and potential expiration.
- Management reported effective disclosure controls and internal control over financial reporting at year-end; the auditor did not provide an internal-control attestation. The independent auditor gave an unqualified opinion on the consolidated financial statements.
Most important facts for investors to verify
- Whether the company can sustain positive operating cash flow after the one-time release of cash from selling real-estate inventory, and whether its working-capital deficit narrows.
- Street Capital loan repayment progress and the availability, terms, and related-party conditions of the $1.5 million credit facility; verify any subsequent borrowing or refinancing.
- The Board’s ratification and final terms of the NLEX earn-out extension, the assumptions behind the $2.733 million liability, and actual future payments to the NLEX seller.
- The repeatability and margins of the 2016 revenue mix, particularly asset sales, and the conversion of reported operating income into GAAP net income and cash.
- The dilution and compensation cost from the enlarged option pool, and the economics of related-party profit-sharing arrangements.
- The usability and expiration profile of tax-loss carryforwards, including potential Section 382 ownership-change limitations.