Heritage Global (NASDAQ:HGBL) Q4 2020 Earnings Call

0:00 Thank you for standing by. This is the conference operator. Welcome to the Heritage Global Inc. fourth quarter 2020 earnings call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star then one on your telephone keypad. Should you need assistance during a conference call, You may signal operator by pressing star and zero. I would now like to turn the conference over to John Nesbitt, 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 and factors that could affect these expectations, please see our filings with the Securities and Exchange Commission.

1:11 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.

1:59 We saw a 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 re-commercing capabilities.

2:50 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 non-performing 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 has resulted 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 of charged off inventories of these assets in the U.S. NLAC 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 charged-off accounts, and we believe to see similar opportunities in the coming year and beyond.

3:54 Likewise, Harris Global Capital continues to ramp up its business, providing specialty financing solutions for small and medium-sized investors of charged-off and non-performing 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 a 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. Thank you very much.

5:04 Thank you for joining us. 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.

5:50 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 NICs 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.

6:46 Net income increased to 6.3 million or 17 cents diluted earnings per share for the fourth quarter of 2020 as compared to $600,000 or 2 cents 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 into 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 into December 31, 2019.

7:57 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 Thank you for joining us. and many more.

9:21 The company had aggregate tax net operating loss carry forwards of approximately $78 million, including $62 million of unrestricted net operating tax losses and approximately $60 million of restricted net operating tax losses. Substantially, all of the net operating loss carry forwards expire between 2024 and 2037. Finally, turning to our financial position. Thank you for joining us. Operator?

10:21 We will now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. The first question comes from Mike Schiske from Collier Security. Please go ahead. Good afternoon, guys. Hi, Mike. So, hello there. So you did raise some capital during the quarter, but your cash balance of $23 million, that was very large.

11:10 Can you take us through some of the finer points of the cash flow in the quarter? And maybe, you know, besides the equity, were there any other large, chunky types of, you know, one-time 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 belonged to Odwalla that we made a significant profit on, realized the return of that cash in the quarter. We had the sale of a building that we'd been holding for multiple months, in fact, for over a year, that was part of a larger acquisition of a pharmaceutical plant.

12:03 That sale closed in that quarter. and returned a lot of capital to the company. 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 two of the significant wins. Hey, Mike. Good to hear from you. So, yeah, 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.

12:50 So 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. So that was part of it, but Ross is right. We had a fantastic year with a free cash flow, great EBITDA, and with the equity raise, that's how we ended up with so much cash at December 31. Got it. Does that make sense, Mike? I want to move on to the Yes, that makes perfect sense. I'll have to go through the individual numbers, but sure, certainly. Thank you very much for that. I also wanted to kind of move on to the buy now, pay later portfolio and that whole sector.

13:38 I guess, was that one large $20 million transaction for you? Was that one that would be called unusually large for the BNPL sector? And then more broadly... 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.

14:23 BNPL has 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 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 out of, I believe, Sweden. And they, I believe, raised another billion dollars last week.

15:12 So, Yeah, 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're seeing 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. So, you know, the curve takes a while. In fintech, a lot of these companies are basically three and four and five years into their ALT, 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 BNPL, 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, you know, we're extrapolating from how much money is going out that at some point in time we're going to see a much bigger non-performing loan segment come to market, Mike.

16:29 Got it. Got it. And then one last one for me. There's a lot of headlines about a rising interest rate environment. Does that help your auction business at all? Maybe some companies who have Some variable rate debt might want to sell off some old assets to kind of raise some cash to pay things down. Has that been in the past a challenge 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 unperforming assets in order to meet their obligations.

17:21 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 the 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.

18:07 Gotcha. That makes sense. Well, Scott, thank you. I'll pass it on. I'll talk to you later. Thanks, Mike. Once again, if you have a question, please press star, then one. The next question comes from Mark Argento from Lake Street Capital. Please go ahead. Hi, Ross. Hi, Scott. Hi, Mark. Congrats on a strong... All right, congrats on a strong quarter. Big year for you guys. Looking at the mix of the industrial business as you look out into 2021, is it still quite a bit of pharma and that M&A cycle in pharma? Are you still looking at being a big beneficiary of that?

18:52 Are there any other key sectors that you're focusing on right now? 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 Aerothrust 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.

19:48 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 two or three 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.

20:33 So, you know, the auction side, super busy. The financial side, trying to get super busy. Ross, when it comes to the financial side, I know politically it's been a little bit of a hot button in terms of, you know, potentially writing off or for giving some student loans. Does any of that really play into what you guys are doing? I assume that's more the federally backed loans versus any kind of private market loans, but any kind of thoughts there? Yeah, 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.

21:20 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 those are two 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. Thank you for joining us. 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're all got a vaccine and we're all healthy, we think will stimulate that business back to normal levels, Mark.

22:44 But we're just the auctioneer, not the analyst. Sure, sure. You did a good job, but yeah, I know 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 wrapping up the book? Yeah, good question, Mark. 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 it to happen in 2021. But we did recently fund a very large deal, which we're very happy about.

23:33 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? Yeah, and then do you anticipate, is that like three-year money, five-year money? Remind us again kind of how long you're, how quickly you turn that book. Yeah, it's in the two to four-year range, Mark. Some of them will be on the shorter end and others will be on the longer end, but on average around three years is a safe rule of thumb to use. Great. Appreciate it. Thanks, guys. Good luck.

24:18 Have a great day, Mark. Bye now. The next question comes from Michael Banner from the Maxon Group. Please go ahead. Thank you. Hi, Michael. Hi. How are you? Just on the staging of your probable revenue growth, it sounds like from what you've been saying, you expect – The problem is it's very hard. Thank you very much.

25:36 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 know 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 you know 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.

26:38 Yeah, okay, that's great. Thank you. Thank you, Mike. This concludes the question and answer session. I'd 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 that there's 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 in 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.

27:33 Bye-bye. This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.