Heritage Global Inc. (HGBL) Earnings Call Transcript & Summary

Thank you for standing by. This is the conference operator. Welcome to the Heritage Global Inc. Fourth Quarter 2020 Earnings Call. [Operator Instructions] The conference is being recorded. [Operator Instructions] I would now like to turn the conference over to John Nesbett, IMS Investor Relations. Please go ahead.

Thank you, and good afternoon, everyone. Before we begin, I'd like to remind everyone that this conference call contains forward-looking statements based on our current expectations and projections about future events and are subject to change based on various important factors. In light of these risks, uncertainties and assumptions, you should not place undue reliance on these forward-looking statements, which speak only as of the date of this release. For more details on factors that could affect these expectations, please see our filings with the Securities and Exchange Commission. Now I'd like to turn the call over to Heritage Global's Chief Executive Officer, Mr. Ross Dove. Go ahead, Ross.

Thanks, John, and good afternoon, everyone. Welcome to our fourth quarter and full year 2020 earnings conference call. As you all know, 2020 was quite the ride. Yet despite the public health and economic challenges presented by the COVID-19 pandemic, Heritage closed the year with record fourth quarter results as reflected in net income of $6.3 million and substantially improved EBITDA of $3.5 million. We believe these results demonstrate the strength and the resilience of our diverse business model, which has enabled us to continue to drive momentum in our business despite the challenging economic landscape. We saw particular strength during the quarter from our industrial assets division, where the close of several large transactions contributed significantly to the growth in the fourth quarter. We expect to experience continued robust supply on the auction side of the business. And as the pandemic continues to drive the liquidation of industrial equipment and assets, the reality is there are many companies out there that need to reduce and monetize surplus equipment as they reposition themselves to emerge viably from the pandemic economy, and we are seeing strong growth in our online auction volumes. With our visibility of the marketplace today, we expect to see continued and increasing demand for our industrial recommercing capabilities. We are similarly optimistic about our prospects in our financial assets division. Over the course of the calendar year, we expect to see an increase in the release of nonperforming loans into the marketplace. The National Loan Exchange, or NLEX as we refer to it, is poised to benefit from the increased activity. Specifically, the current stay-at-home economy as a result from COVID-19 restrictions has produced increased online shopping activity, which has driven rapid growth of the Buy Now, Pay Later, or as they say BNPL sales. And this is resulting in an increase in charge-off inventories of these assets in the U.S. NLEX is competitively positioned to provide an effective and efficient debt sale process between our BNPL issuers. In fact, we recently announced the closure of a sale of $25 million portfolio of BNPL charge-off accounts, and we believe to see similar opportunities in the coming year and beyond. Likewise, Heritage Global Capital continues to ramp up its business, providing specialty financing solutions for small and medium-sized investors of charge-off and nonperforming loan portfolios. Looking ahead, we expect the challenging economic landscape to endure for some time, presenting increased opportunities for both sides of our business. Our industrial assets business is well-established and respected partner in the liquidation of surplus and distressed assets, and we believe the current economy will drive rising demand for our expertise and proven success with brokered asset sales and online auctions. Additionally, even as vaccinations take hold and the economy begins to emerge from the pandemic, we believe NLEX is well positioned to address the market opportunity around continued increases in charge-off and nonperforming consumer loans related to the growth of digital and other nonbank lending platforms that proliferated at the stay-at-home economy. And finally, Heritage Global Capital remains well positioned to benefit from this demand. We are pleased with the progress we made in 2020 and focused on continuing to capitalize on the interest and demand we're seeing across both our industrial and financial segments in our business. With that, I'd like to pass it over to our Chief Financial Officer, Scott West, who will do a deeper dive into our financials, and I thank you all.

Thanks, Ross. The company achieved operating income of $3.3 million for the fourth quarter of 2020, demonstrating significant improvement as compared to an operating loss of $446,000 in the fourth quarter of 2019. The improved performance was primarily due to the completion of multiple large transactions in the company's industrial auction business. As Ross mentioned, this growth reflects the underlying strength of our multiple revenue streams from brokered asset sales, principal auctions, sales commissions and advisory and secured lending fees. The fourth quarter of 2019 included a $600,000 impairment charge related to Equity Partners, which was discontinued as of December 31, 2019. From a margin perspective, we believe that tailwinds going forward will include a favorable shift in mix toward higher contribution businesses and fee structures as well as rising operational leverage as economies of scale increasingly build within businesses and across platforms. We remain focused on managing expenses both at the corporate level and across business units and increasingly, leveraging synergies across processes and systems to drive further operational efficiencies. Net income increased to $6.3 million or $0.17 diluted earnings per share for the fourth quarter of 2020 as compared to $600,000 or $0.02 diluted earnings per share in the fourth quarter of 2019. The financial results for 2020 include an income tax benefit of $3 million for the fourth quarter of 2020 and an income tax benefit of $3.6 million for the year ended December 31, 2020, which included the reversal of the income tax valuation allowance as required according to the income tax accounting standards. Excluding the income tax benefit resulting from the income tax valuation allowance, the net income for the fourth quarter of 2020 would have been $2.5 million or $0.07 diluted earnings per share and $4.5 million or $0.14 diluted earnings per share for the year ended December 31, 2020, compared to net loss for the fourth quarter of 2019 of $1.2 million or $0.04 diluted earnings per share and net income of $2.1 million or $0.07 diluted earnings per share for the year ended December 31, 2019. The company recorded EBITDA of $3.4 million in the fourth quarter of 2020 versus an EBITDA loss of $400,000 in the fourth quarter of 2019. Adjusted EBITDA was $3.5 million compared to $300,000 in the fourth quarter of 2019, reflecting the earnings power of our model. Now let's take a look at full year 2020 results. Full year 2020 operating income almost doubled to a record $6.1 million compared to $3.1 million in the prior year. SG&A expense decreased to $14.4 million in full year 2020 compared to $15.9 million in 2019 primarily due to the elimination of costs related to Equity Partners, which as previously mentioned was discontinued as of December 31, 2019. Net income grew significantly to $9.7 million or $0.30 per diluted share for full year 2020 compared to net income of $3.9 million or $0.13 per diluted share in 2019. The company achieved EBITDA of $6.4 million for 2020 compared to $3.4 million in 2019. Adjusted EBITDA for the full year 2020 was $6.8 million compared to $4.2 million for full year 2019. At December 31, 2020, the company had aggregate tax net operating loss carryforwards of approximately $78 million, including $62 million of unrestricted net operating tax losses and approximately [ $16 million ] of restricted net operating tax losses. Substantially, all of the net operating loss carryforwards expire between 2024 and 2037. Finally, turning to our financial position. The company maintained a strong and growing balance sheet with net cash of $23.4 million at December 31, 2020, and stockholders' equity of $29.9 million. Importantly, our $5 million credit facility remained untapped, and we raised approximately $8 million of net proceeds from the company's common stock offering that closed on October 6, 2020. With that, we'll open up the call for questions. Operator?

[Operator Instructions] The first question comes from Mike Shlisky from Colliers Securities.

So you did raise some capital during the quarter, but your cash balance of $23 million, that was very large. Can you take us through some of the finer points of the cash flow in the quarter? And maybe besides the equity, were there any other large, chunky type of onetime cash inflows at all?

So obviously, there was the capital raise, which is reflected. On top of the capital raise, there was lots of free cash flow in the quarter. We had some very significant transaction wins. We did a transportation auction of some assets from Coca-Cola that belong to Odwalla that we made a significant profit on realized return of that cash in the quarter. We had the sale of a building that we've been holding for multiple months, in fact, for over a year, that was part of a larger acquisition of a pharmaceutical plant. That sale closed in that quarter and returned a lot of capital to the company that -- so both of those capital returns had been outstanding capital. And so I'll turn it over to Scott to add color, but those were 2 of the significant wins.

Mike, good to hear from you. So yes, just to add on to what Ross said, the way our industrial assets business works, our auction business, we're very fortunate. On the day that an auction closes, we invoice all the buyers. And the buyers have, essentially, 24 to 48 hours to wire us the funds, the winning bid price, right? And then we actually sit on that cash for anywhere from 30 to 45 days before we settle with the seller. So there -- because of the large transactions that Ross had mentioned, we do get -- when we get to the quarter end, there are times if we have a lot of large auctions at the end of a quarter, that we will have an inflated cash balance. But -- so that was part of it, but Ross is right. We had a fantastic year with a free cash flow, a great EBITDA and with the equity raise. That's how we ended up with so much cash at December 31. Does that make sense, Mike?

Got it. Yes, that makes perfect sense. I'll have to go through some of the individual numbers, but sure, certainly. I also wanted to kind of move on to the Buy Now, Pay Later portfolio and that whole sector. I guess, was that one large [ $20 million ] transaction before you, was that one that would be called unusually large for the BNPL sector? And then more broadly...

No.

It's not? Okay. [indiscernible]

It was actually not large. It was actually a trial where potentially, since we did great, it could actually expand and the other ones be bigger. $25 million of BNPL doesn't scratch the surface on what's starting to come to market. The fact is we're very early, and it was an entry deal. Fintech and peer-to-peer has been around a long time. BNPL is really just started to grow and really grow kind of in leaps due to the pandemic and everybody staying home and buying all of their retail items and using BNPL. So no, it was actually a small transaction compared to what could come if the -- if we become basically the dominant or preeminent firm that they're using, Mike.

And just to follow on to that, what Ross said, there's just a tremendous amount of capital being raised in that space, in the Buy Now, Pay Later space. As a matter of fact, the largest BNPL lender was Klarna, I believe, Sweden. And they, I believe, raised another $1 billion last week. So we see tremendous growth opportunities in this space.

And just to clarify, that space is not seeing the same kind of pent-up charge-offs that you see in other types of loans, like a student loan or a credit card portfolio? Is that a more open market right now?

The curve takes a while. In fintech, a lot of these companies are basically 3 and 4 and 5 years into their ALP, their alternative lending platforms, and they're starting to build up NPL portfolios. We're not trying to be the soothsayer and say what's going to happen with the NPL. But we do know that as we track the amount of loans that increase on a monthly basis, the increase in loans almost always produces down the road an increase in NPLs. So we're extrapolating from how much money is going out that at some point in time, we're going to see a much bigger nonperforming loan segment come to market, Mike.

Got it. Got it. And then maybe one last one for me. There's been a lot of headlines about a rising interest rate environment. Does that help your auction business at all as maybe some companies who have some very low rate debt might want to sell off some old assets to kind of raise some cash to pay things down? Is that in the past a tailwind for you?

It's kind of a little bit different than that, but you're kind of on to something. Rising interest rates often are tied to companies struggling that are manufacturing companies and corporate companies with loan covenants. And the rising interest rates sometimes are telling that the company is going to not necessarily meet all its obligations and have to monetize idle or nonperforming assets in order to meet their obligations. And sometimes with the rising interest rates, they actually rise faster on the more troubled side of the bank on the asset-based side. And so sometimes, even if the interest rates look good to really, really healthy companies who are really driving down the best interest rates, the interest rates can go up quicker on the ABL side. And then it does have an impact, obviously, because as companies need to service debt, they start looking harder at what assets are truly performing in their manufacturing process and what assets they can free up. So we think it will have more of a positive impact than a negative impact on the asset flow.

[Operator Instructions] The next question comes from Mark Argento from Lake Street Capital.

Congrats on a strong quarter, big year for you guys. Again, kind of looking at the mix of the industrial business as you kind of look out in 2021, is it still quite a bit of pharma and that M&A cycle with pharma? Are you going to -- still looking at being a big beneficiary of that? And are there any other kind of key sectors that you're focusing on right now?

Yes, I'll start on the industrial side. We've got a ton of pharma stuff signed right now. If you look at our website, you can see auctions for Pfizer. You can see auctions for Amgen. But we're also starting to see an increase in the amount of auctions we're looking at in the aerospace side. We've got an auction coming up now for iAero Thrust that's very large with older airplanes that basically are going to sell for parts, et cetera, and engines that basically are going to sell to resellers. But we're seeing that a lot of the people that are basically in the aerospace business that were servicing the big companies are looking to monetize assets. And obviously, when you look at the big manufacturers of airplanes, they're sitting on a lot of inventory. So a lot of the people that basically were manufacturing for them to put inventory into new planes, we think post COVID, they're not going to be building as many planes for a while. So I would say our second sector other than pharma is aerospace that I think could be hot over the next 2 or 3 years. And obviously, we're looking at a whole bunch of deals in the food processing space where there's constant change. But it looks to us like it's going to be fairly robust across the manufacturing sectors we're in Mark. On the financial asset side, our problem is the same. There's a massive still pent-up demand among buyers, and we still haven't seen the release of all the loans everybody says are coming forward. So the auction side, super busy. The financial side, trying to get super busy.

Okay. Ross, when it comes to the financial side, I know politically, that's been a little bit of a hot spot in terms of potentially writing off or forgiving some student loans. Does any of that really play into what you guys are doing? I assume that's more of the federally backed loans versus any kind of private market loans. But any kind of thoughts there?

Yes. When basically the buyers are not sure about the future economic situation, they either want to buy at a greater discount or they want to hold back. Because in the end of the day, if they don't know what kind of new forbearances could be put in place, they don't know how long until they can collect and they can kind of get around it and still buy assets if they're looking at a forbearance, they can't buy assets if they're looking at a potential forgiveness. So there's a big -- those are 2 big words to start with that. But forbearance, they can kind of figure out because it's a timing issue and you can do the math on how long before you can do something. Forgiveness, no. So it's been slow, but that's not the sociopolitical part that's really impacted us. It's really more been sellers not wanting to sell assets during a pandemic and be the grim reaper and put assets on the marketplace and create collections prematurely. And so that's why everyone is telling us that everyone's going to have to start dealing with this in the second half of the year. What they're really saying, I believe, is that they think we're going to have a vaccine by the second half of the year, and we're no longer probably going to have a bunch of brand new stimulus packages after this one. So kind of the ending of the stimulus packages and the beginning of the greatest news of all time, which is that we've all got vaccines and we're all healthy, we think, will stimulate that business back to normal levels, Mark. But we're not -- we're just the auctioneer, not the analysts.

You did a good job. But yes, no, it's good insight there. And then just lastly, Scott, in terms of the amount of capital that you guys have out right now in terms of lending on some of these portfolios, have you been able to deploy more capital? How's the initiative there in terms of ramping up the book?

Yes, good question, Mark. And we have deployed some of the capital that we raised. Not as much as we'd like, but there's just not the volume yet. We know that there will be, and we expect that to happen in 2021. But we did recently fund a very large deal, which we're very happy about. That bodes really well because it's one of our identified super mid-tier debt buyers that we have a 20-plus year long relationship with. Does that answer your question, Mark?

Yes. And then do you anticipate -- is that like 3-year money, 5-year money? What -- remind us again kind of how long -- how quickly you turn that book?

Yes, it's in the 2- to 4-year range, Mark. Some of them will be on the shorter end, and others will be on the longer end. But on average, around 3 years is a safe rule of thumb to use.

The next question comes from Michael Diana from The Maxim Group.

Just on the staging of your probable revenue growth. It sounds like from what you've been saying you expect the surplus equipment business to be very strong, and then sort of the next wave would be the financial assets and then after that, the capital business, the lending. I know those 2 sort of go together. But I mean, it sounds like you're -- it's setting up here for somewhat of a lengthy stage thing.

Yes, the problem is it's very hard to take our company and say this is what we think we're going to make annually and then cut it up by the quarter and make it equivalent quarter-after-quarter. A lot of times, there are big spikes. But on top of big spikes, there's also a building. Just as an example, in our lending business, the reporting is tied to GAAP. So even if you're collecting large fees upfront, a lot of times, those fees are amortized and they reflect over years and you see them more towards the back end of the year. In our financial assets business, everyone says the second half is going to be twice as big as the first half. I'm not going to be the analyst. But I can tell you that we're talking to so many people who are telling us get ready that there's going to be asset flow. It just hasn't happened yet. Same thing, our valuation business is starting to pick up now. And so you don't want to tell everybody it's going to be a second half of the year and not have a great second half of the year because you don't have enough visibility. But without a crystal ball, everyone on the outside looking in is telling us it's going to get busier as the year progresses. And we have not been incredibly busy in Q1 in financial assets. We've been pretty darn busy in industrial assets. So that's kind of all I can tell you from what I see today, Michael.

This concludes the question-and-answer session. I would like to turn the conference back over to Ross Dove for any closing remarks.

For any closing remarks, well, I just wanted to take a real quick moment to thank everybody for their participation, for their interest. And we're very encouraged that people are following us, that are paying attention to us and it is a growing cadre of investors who are learning to believe in us. And we're here to work as hard as we can, work and perform as well as we can. And we see that there's a bright future out there and our belief -- and we hope you keep an eye on us. And if you keep an eye on us, we'll try to make it an eye worth keeping. So thank you very much. Bye-bye.

Thank you. Take care. Bye, everyone.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.