Heritage Global - Q2 2024

Transcript

Operator (participant)

Good day, everyone, and welcome to the Heritage Global Inc. second quarter 2024 earnings call. At this time, all participants are in a listen-only mode. Later, you'll have the opportunity to ask questions during the question-and-answer session. You may register to ask a question at any time by pressing the Star and One on your telephone keypad. Please note, today's call will be recorded, and we will be standing by if you should need any assistance. It is now my pleasure to turn today's conference over to John Nesbett, President, IMS Investor Relations. Please go ahead.

John Nesbett (Founder and President)

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 call. For more details and 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. Ross, please go ahead.

Ross Dove (CEO and Director)

Well, thank you, John. Good afternoon, everyone, and welcome to our call. Before I give the call over to Brian to go into all of the details of the call, I thought I'd just give you a couple of quick observations. Q2 was a really solid performance for us, primarily because it was across both financial and industrial. $3.5 million in consolidated operating income and $4 million in EBITDA was a big improvement over Q1 and bodes well for looking into where we're seeing ourselves going in Q3 and Q4, where we've had some accelerated client retention and the market is really strong. What I leave you with before Brian, is really just one thought. Sometimes you have a really solid quarter, and at the end of that quarter, you're left without a lot of prospects for the second quarter.

That did not happen at all this time. We ended the quarter very strong with a robust pipeline. We've actually added new forward flow clients on both sides of the business, and we're rolling into Q3 with really a very, very solid, very bullish view on Q3 and Q4. So with that, I'll give it over to Brian to go through this quarter, to walk you through all of the businesses, to walk you through what we're doing to create some improvements in Heritage Global Capital, which has been the one part of our business that we need to get on a better track. Everything else is on the exact right track, and Brian will walk through what we're doing there, along with everything else. So Brian, go ahead and take it away.

Brian Cobb (CFO)

Thank you, Ross. I'll begin by going over our divisional highlights before moving into our financial results. Our industrial assets division continued to execute in the second quarter of 2024, reporting total divisional operating income of $2.1 million, an increase from $1.5 million in the prior year period. Our auction business, in particular, had a strong quarter. Increased economic pressures continue to cause downsizing and office closures in a variety of businesses across the country, resulting in the sale of surplus industrial machinery and equipment. As previously disclosed, in conjunction with our partners, the division completed a transaction that involved the sale of equipment and a 10-year building lease on the recently acquired pharmaceutical plant in Fenton, Missouri.

The lease was determined to be a sales-type lease, and together with the sale of equipment, the company recorded a total of $1.3 million in earnings for its respective share in the second quarter. As we look to the back half of 2024, we have a strong auction pipeline in place and expect to see continued activity in the second half of the year. Our financial assets division performed consistently in the second quarter of 2024 compared to the prior year quarter, with operating income of $2.7 million. Our brokerage business continues to perform well. We continue to see steady volumes of charged-off credit cards and non-performing loans and are optimistic about the growth of this business moving forward.

As of June 30, 2024, our total amortized cost basis of loans to buyers of charged-off and non-performing receivable portfolios was $35.2 million, classified on our balance sheet as both notes receivable and equity method investments. As previously noted, we are in an economic environment where consumers have less capacity to pay their debts, which results in lower collection rates industry-wide. As a result, the company's largest borrower has had continued difficulties meeting their obligations. This borrower continues to collect on the underlying portfolios and remit these collections to the company net of servicing fees. However, these net collections are currently not sufficient to satisfy all minimum required payments. Beginning in June 2024, after this borrower's June remittance fell short of the minimum amount due, the company placed the loans on non-accrual status.

The company's share of payments received on loans in non-accrual status, including interest, will be applied against the outstanding balance. As of June 30, 2024, the amortized cost basis of loans in non-accrual status was $24.6 million, compared to no loans in non-accrual status as of December 31, 2023, primarily due to the loss of interest income from the cost recovery accounting treatment. The default is currently expected to reduce the company's total 2024 operating income by approximately $1.6 million. It is important to reiterate that Heritage Global is a profitable, diversified business with multiple growth avenues going forward.

Reflecting the strength of our cash flow and balance sheet, the company completely paid off the remaining principal balance outstanding under its 2023 credit facility with C3 Bank, which was executed subsequent to the quarter and in advance of the loan's maturity date in 2028. Now turning to the financial results. Consolidated operating income was $3.5 million in the second quarter of 2024, compared to $3.1 million in the second quarter of 2023. For the quarter, we reported Adjusted EBITDA of $4 million, compared to $3.5 million in the prior year period. Net income was $2.5 million, or $0.07 per diluted share, compared to net income of $2.8 million, or $0.07 per diluted share in the second quarter of 2023.

Our balance sheet remains strong, with stockholders' equity of $65.8 million as of June 30, 2024, up from $61.1 million at December 31, 2023, and net working capital of $17.9 million. As we move through the second half of 2024, our core auction and brokerage segments are expected to produce continued strong operating results with an attractive pipeline of opportunities in the marketplace. We are steadfast in our mission to continue driving organic growth and profitability while positioning the company to take advantage of M&A opportunities when they arise. With that, I will turn the call back over to Ross.

Ross Dove (CEO and Director)

Thank you, Brian. So let me take a few minutes to tell you why we're actually very excited about both our organic growth and the increased opportunities we're seeing in M&A across both sides of our business, the financial assets and the industrial assets. Let me kind of start with the financial assets. It's pretty clear right now that everyone can see that our pipeline is solid because of the macroeconomy and also all the efforts we're doing to garner new clients and win business and execute. But on the macro side, we're looking at consumer debt has been rising since 2021. Our revenue is rising along with it. We've now got household debt at $17.5 trillion, if you can imagine that, and up $200 billion in just one quarter.

We're looking at credit card balances now of over $1 trillion, adding $50 billion this quarter. All of that just shows you that the volume is continuing to grow and grow. With that volume, the amount of charge-offs has to grow with it, and we think our business has solid growth for years organically. We're now looking on the credit cards at 49% of all credit cards, basically going month to month on payments rather than paying them off at the end of the month, which is the first telltale sign into more growth in charge-offs. We're now looking at 6% of credit card accounts being past due. You know, just two, three years ago, it was 4%. So is our business growing? Yes. Will our business continue to grow?

If you say our business grows because supply grows, then there is clearly no argument our business won't grow. What that does is it gives us more and more cash flow and more and more strength in a position where we're stronger in the market to do M&A. There are now companies available in M&A that basically were doing okay during the pandemic and have struggled afterwards, which is the opposite of NLEX, which is growing afterwards. So we see opportunities there for bolt-ons that we're aggressively looking at, and hopefully, we can get something done, and within the next year, year and a half, that will be highly accretive. So we're solid there. We believe in M&A opportunities, and we're solid there, and we believe continued organic growth. Now move on over to industrial.

If you're looking at industrial right now, you are seeing that a lot of companies are doing well, but simultaneously, many companies are experiencing sluggish manufacturing right now, and you don't have to basically look too far to basically see every day. If you look at a Google or a Yahoo announcement, you see another headcount reduction. As I said over and over again, these headcount reductions produce surplus assets and produce industrial auctions. They don't happen the day you notice that the headcount reduction has been announced. There is a period of three, four, or five months where they have to basically execute on the headcount reduction, do the layoffs, and discover the surplus. That's happening now from the layoffs four, five, and six months ago.

But what bodes well for the future is there are still sectors of the economy where the manufacturing is sluggish, and there's also sectors of the economy where the manufacturing has a heightened growth. But its heightened growth is adding AI in a lot of instances, which frees up surplus machinery. It's focusing on lean manufacturing, which also frees up surplus machinery. So the Institute for Supply Management is saying that there'll be an increase in secondhand equipment on the market over the next one to two to three years. So we see organically our industrial business being very bullish and prices holding up. The fact that we've had several years of inflation now has actually increased the value of used assets. So at our auctions, we're actually getting very high prices for the equipment, and we think that will continue even if the economy and inflation softens.

So we think organically, we're very, very solid there. There is the beginning of talks about roll-ups in the industry, where we think will be a significant player in the fact that basically, more and more of these sectors are coming together to where the guys that do pharma also have a great database for medical, et cetera, kind of across all the sectors. So we see that there will be a consolidation of industrial auctioneers that we believe will be one of the significant leaders in. That M&A should happen over the next two - three years. So we stand ready to grow both organically and through M&A. We're working through multiple issues with Heritage Global Capital. We've hired a special advisor to work with us, and I'm very excited because we see prospects there to really get that thing humming once again.

There's been some difficulty in collections, but we think overall, Heritage Global is in a very solid position. Thank you all for sticking with us. Thank you all for hearing us out. We're open to any questions at any time and appreciate your interest very much. Thanks again.

Operator (participant)

At this time, if you would like to ask a question, please press the star and one key on your telephone keypad. Keep in mind that you may remove yourself from the question queue at any time by pressing the pound key. Again, it is star and one to ask a question. I'll take our first question from Mark Argento with Lake Street. Please go ahead. Your line is open.

Mark Argento (President and Head of Institutional Equities)

Hey, Brian. Hey, Ross. Just a few quick ones here. You know, the impairment or the, you know, the change in status in terms of the, a part of the loan book, what, you know, what happens going forward? What should we be looking for in terms of, you know, seeing any improvement in the situation? You know, it sounds like you got, you know, somebody you're working with. Do you guys look to, you know, sell the book off? You know, maybe just walk us through at a high level, what next steps are there?

Ross Dove (CEO and Director)

So I'll take it first, Brian. So we've hired an advisor to work with. There is, at this time, no announcement of selling a book, no announcement of any kind of change right now, other than working very, very hard to enhance the collection efforts and to recover, you know, trying to recover 100% of the money. We don't anticipate at this time taking any further efforts than what we've announced. So we hope to get back as much, if not all, of the money as we can. We took a $1.5 million charge a while ago. We're not changing that at this point in time. We're getting collections on a monthly basis.

We continue to get collections, albeit they've been a little bit short of the minimum payment, but they're coming in very steady, and we're going to continue monitoring them and working with the, and working with them to try to do the best we can. There will be announcements in the future if we make any change, but at this time, we don't have one. I'll let Brian add to that. Brian, if you'd like.

Brian Cobb (CFO)

Yeah. So, the main thing that we've been working on, the finance group is really trying to figure out with the borrower, with our senior lenders, how the structure of these specific loans can be changed in a way that can improve the collections. And really one way is to help the servicer of those collections or the manager or borrower collect in legal methods. And so we think that there might be some improvement there. But on the accounting side, the way I look at this is we're taking a conservative position right now to allocate all of the collections or net collections to the principal balance until we see a lot of positive data or changes that could allow us to collect all principal and interest.

I think that a non-accrual status will remain in the short term.

Mark Argento (President and Head of Institutional Equities)

Got it. Then, are you guys, you know, have you stopped any additional lending, you know, or putting any additional capital out with other customers at this point? Or what's the general-

Ross Dove (CEO and Director)

No, we're not. We're obviously, we're obviously not funding that customer at this point in time, and we have no plans to fund that customer until this is 100% accretive and straightened out and paying, and then we would make a decision there. There are some customers that we have funded that are highly performing customers. We're being very prudent, and we're being very careful only to fund the best of the best, but we are still looking at deals, albeit less aggressively, Mark.

Mark Argento (President and Head of Institutional Equities)

Got it.

Ross Dove (CEO and Director)

Or I should say, more aggressively, we're looking... We're, we're very, very particular about what we would fund. But we have a lot of free cash flow right now.... and a lot of that free cash flow, maybe we're holding back because we're looking at M&A, et cetera, but we're in a very strong financial position. So if somebody came to us with a great loan, we're well capitalized to do it.

Mark Argento (President and Head of Institutional Equities)

Great. Just pivoting over to, you know, just you had mentioned forward flows on both the financial asset, industrial asset businesses, you know, are robust. Maybe, you know, I know historically, we've talked a little bit about the, you know, the financial asset forward flows, but on the industrial asset side, it, you know, it's a little bit of a newer concept. What, maybe just walk us through, you know, what is the forward flow?

Ross Dove (CEO and Director)

So our largest-

Mark Argento (President and Head of Institutional Equities)

Is that just the pipe you're talking about?

Ross Dove (CEO and Director)

Our largest forward flow is an existing client, which is Pfizer. So they do auctions with us every month. We're having our best year with them now because they've been doing a lot of worldwide planning, recalibrating, and restructuring, which has freed up more assets than last year. So the auctions are very good right now. The assets are very good, and we're getting very large crowds. We've added some other more regional clients on that end, and some of the clients that we've done past auctions for are now becoming repeat clients. So we're getting more repeat business, so it's not all brand new one-offs, which is the most expensive business, as you know, to get, where you're making the presentations versus receiving the call in.

So we're getting more repeat business on the industrial side, and we're looking at a very strong Q3, Q4 with ongoing business there. On the financial asset side, there have been some new companies, both fintech companies and and banks, and also we've added more, companies that have non-performing real estate right now, which is a growing non-performing sector, as you know. So we've added some forward flow clients on that side, too, and we're looking at, a really solid Q3 and Q4, we think will beat the first half of the year on the financial side, at the brokerage segment.

Mark Argento (President and Head of Institutional Equities)

Great. I'll hop back in the queue. Thanks, guys.

Ross Dove (CEO and Director)

Thank you, Mark.

Operator (participant)

We'll take our next question from George Sutton with Craig-Hallum. Please go ahead. Your line is open.

Ross Dove (CEO and Director)

Hi, George.

Logan W. Lillehaug (Equity Research Associate)

Hey, good afternoon, guys. This is actually Logan on for George today.

Ross Dove (CEO and Director)

Hi, Logan.

Logan W. Lillehaug (Equity Research Associate)

I wonder if we could—if I could just ask one on the borrower. Can you just walk us through kind of the underlying assumptions and how you guys got to the determination that you didn't need to increase the credit loss reserve? And then maybe, do you guys have any insight into kind of the underlying portfolios, like, where the weakness is coming through? I think there's like-

Ross Dove (CEO and Director)

Yeah, so we went out. We basically, it was a multiple tiered approach to decide if we needed to do anything further, and we're pretty convinced we don't need anything further after a real thorough amount of work that included, you know, advice from an independent advisor who looked at it, including talking with both senior lenders and getting their take on it, talking with the borrower, looking at the past collection rates and what's actually being collected, and looking at the accounts going forward, and looking at, you know, third-party advice. And all of that together led us to believe that we were comfortable that we were in the right position right now.

We also have the collections going forward, and the collections going forward, although that, yes, they are short of the minimum payment, they're still substantial, and they're still coming in very regular, and there's still tens of thousands of accounts to collect on. So we feel comfortable with the position we've taken. I'll let Brian add to that if I've missed anything.

Brian Cobb (CFO)

The only thing I'll add real quick is, from a numbers perspective, I look at it as, yes, inherent risk is perceived to go up if a borrower has defaulted on the loan, so you would initially think that the reserve should go up along with that. But we're placing heavy, heavy reliance on the underlying collections on those portfolio assets, and also all of the cash flows now are being applied to principal in that analysis, and that's all being taken into consideration. So the method of accounting is really more than offsetting the inherent risk.

Logan W. Lillehaug (Equity Research Associate)

Okay, got it. And, maybe just one other on the brokerage side. I mean, certainly it seems like commentary from the big purchasers would indicate, you know, charge-offs kind of going up through the back half of this year and into next year, and I think you guys have said that, too. If I can just double click on that, maybe, and, I think, Ross, in the past, you've talked about buy now, pay now, buy it, sorry.

Ross Dove (CEO and Director)

Yeah, I got it.

Logan W. Lillehaug (Equity Research Associate)

Buy now, pay later. Anything you guys are seeing kind of from a competitive standpoint there, kind of to be positioned? I think we've seen Q Report recently, and volume seems to be up there.

Ross Dove (CEO and Director)

The volume is up there, and we were an early entry into selling the buy now, pay later assets. Dave Ludwig and Tom Ludwig, and the guys that run NLEX really kind of saw that kind of cutting edge in the very beginning. Even before some of the companies were ready to sell assets, they were there early, explaining our process, explaining how we work, who we are, and what we've been able to do with very similar assets, whether it be credit cards or auto loans, et cetera, or other kinds of consumer loans. So we got in early, and we basically have built not just a cadre of sellers, but we built a list of people that buy the buy now, pay later product. So as that grows, we should stay at the forefront as an industry leader.

You know, overall, what's happening right now is, you know, overall, all of non-performing loans seem to be a growth business right now. The credit card sales, I mean, credit cards are part of it. The fintech stuff, the buy now, pay later, is part of it. Real estate loans are part of it. Across the board, there's a growing amount of product right now and on the consumer end. So we feel good, kind of bullish on the business over the next multiple years, across all sectors.

Logan W. Lillehaug (Equity Research Associate)

Got it. Thanks for taking my questions.

Ross Dove (CEO and Director)

Thank you.

Operator (participant)

This does conclude the Q&A session. I'll return the program to Ross Dove for any closing or additional remarks.

Ross Dove (CEO and Director)

Thank you all very much for sticking with us. Thank you for listening. Thank you for paying attention. We're available for follow-ons at any time. Anybody's looking for any further information, the company is in a very strong position across the board. We have some work to do to get Heritage Global Capital to exactly where we want, but keep in mind, what we're looking at there is equity. We didn't default on anybody. Somebody defaulted on us. We're prepared for it. We're gonna make the best of it. We're gonna collect as much of the money as we can.

As we move forward, we think we're looking at record years over the next two, three, four years, and we think this is a very, very strong, dynamic growth company that we're proud to be a part of, and we're open to any question at any time and to any kind of further discussion with any of you. Thank you all for your interest. Everybody, have a great day. Bye-bye.

Operator (participant)

This does conclude today's program. Thank you for your participation, and you may now disconnect.