Heritage Global Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020; financial statements are unaudited. Heritage Global operates a single asset liquidation business, providing auction, appraisal, brokerage, asset disposition and specialty financing services.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Services revenue | $6.06m | $5.21m | $15.71m | $14.95m |
| Asset sales revenue | $1.51m | $1.42m | $2.21m | $5.65m |
| Total revenue | $7.57m | $6.62m | $17.93m | $20.60m |
| Operating income | $1.61m | $1.27m | $2.73m | $3.50m |
| Net income | $1.26m | $1.22m | $3.34m | $3.32m |
| Diluted EPS | $0.04 | $0.04 | $0.11 | $0.11 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $2.81m | $1.05m |
- For Q3, gross profit on services and asset sales was approximately $5.0m, down 6% from $5.3m. The corresponding gross margin was approximately 65.7%, versus 79.4%.
- For the first nine months, gross profit was approximately $13.2m, down 6% from $14.0m; the corresponding margin was approximately 73.8%, versus 67.9%. These margins are calculated from reported revenue and costs of services and asset sales.
- Q3 selling, general and administrative expense fell 14% to $3.38m. Nine-month expense fell 9% to $10.52m. Management attributed the reductions mainly to the departure of the Equity Partners team and lower travel expense, partly offset by higher HGP and HGC compensation.
Balance sheet, liquidity and debt
- At September 30, 2020, cash was $5.80m, total current assets $10.95m, current liabilities $10.06m, and working capital approximately $0.9m. The company reported a $2.3m working-capital deficit at December 31, 2019.
- Total assets were $26.77m and stockholders’ equity was $15.96m, compared with $21.92m and $11.85m, respectively, at year-end 2019.
- Total debt was $138,000, all current, compared with $438,000 at December 31, 2019. The $5.0m C3bank revolving facility had no balance outstanding at quarter-end and matures February 5, 2021; it is secured and subject to financial and other covenants. The separate settlement-related note had a $138,000 balance due by January 30, 2021.
- Cash increased $3.07m during the nine months. Investing activities provided $0.62m, including cash received upon transferring notes receivable to partners; financing activities used $0.36m.
Material changes and notable items
- Q3 revenue increased 14%, while nine-month revenue decreased 13%. The nine-month decline principally reflected asset sales falling 61% and equity-method investment earnings dropping to $0.29m from $1.28m. Services revenue increased 5% for the nine months.
- Despite lower nine-month operating income, net income was nearly unchanged, supported in part by a $649,000 income tax benefit versus $117,000 of tax expense in 2019. The filing cites deferred tax asset valuation allowance changes and other tax items; the company retained a partial valuation allowance.
- HGC, the specialty finance subsidiary, originated approximately $4.5m of notes during the nine months. Notes were also transferred to partners and a joint venture; the company reported approximately $1.1m of notes receivable outstanding and no allowance for credit losses.
- On October 6, 2020, after quarter-end, the company completed an offering of 5,462,500 shares, generating approximately $9.1m in net proceeds. On October 27, HGP signed a 90-month lease for 30,321 square feet of industrial space; initial monthly base rent is $27,289, rising to $33,562 in the final year, plus common-area costs. The company guarantees the lease.
- Common shares outstanding were 29.72m at quarter-end; 35.19m were reported outstanding as of November 1, 2020. The difference includes the subsequent offering.
Outlook, risks and management commentary
- Management said COVID-19 had a minor negative impact through September 30, including travel and work restrictions and delayed asset sales. It expected possible benefits from increased distressed and surplus assets, online auctions, charged-off loan sales, financing opportunities and valuation work. It cautioned that continuing restrictions could reduce revenue, particularly in business units reliant on travel and field work.
- Management stated it expected to fund operations and debt service through operating cash flows, the October offering proceeds and access to the revolving facility, and believed current capital resources were sufficient. No specific financial guidance was provided.
- Results can vary with the timing and size of individual asset liquidation transactions. The business faces competition from larger liquidators and brokers and is subject to consumer-protection, privacy and auction regulations. A single customer represented 12% of revenue in each nine-month period.
- The filing reported no material subsequent events other than the offering and lease described above, no material changes to previously reported legal proceedings, and effective disclosure controls and procedures.
Important facts for investors to verify
- Whether the October offering proceeds and subsequent lease costs materially change liquidity and capital needs.
- The February 2021 maturity and covenant compliance of the credit facility, and repayment of the settlement-related note due January 2021.
- Collections and credit quality of HGC notes receivable, partner transfers, and the absence of a recorded credit-loss allowance.
- How sustainable service revenue growth and the improved nine-month gross margin are, given deal timing and lower asset-sale revenue.
- The basis and durability of the nine-month income tax benefit, including the partial valuation allowance and tax-loss restrictions.
- Whether customer concentration and the business effects of COVID-19 travel restrictions or economic conditions change.