Heritage Global Inc.

Good afternoon and welcome to the Heritage Global Second Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to John Nesbitt, Investor Relations for Heritage Global. 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, we should not place under reliance on these forward-looking statements, which speak only at 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. Now I'd like to turn the call over to Heritage Global's Chief Executive Officer, Mr. Ross Dove. Ross?

Thank you, John. Good afternoon, everyone. Welcome to our second quarter 2022 earnings conference call. Let's start today's call with Brian Cobb, our Chief Financial Officer. Brian will discuss the financial performance to date. Go ahead, Brian. You're up.

Thanks, Ross. As expected, we reported strong operating results in the second quarter with operating income of $3.6 million, improved profitability, and EBITDA of $3.8 million. From my perspective, our financial performance during the quarter and the first half of 2022 can be summarized by the following. First, we have seen a significant increase in the number of principal transactions executed in our industrial assets division, evidenced by a 279% increase in asset sales for the six months ended June 30, 2022, as compared to the same period in 2021. This is primarily the result of a record number of industrial auctions held during the second quarter, as well as operations at American Laboratory Trading, which was not active as a heritage business in the first six months of 2021. Second, we have realized increased services revenue during the second quarter due to an increase in financial asset volume industry-wide. We saw an increase in spending, charge-off and delinquency rates beginning in the fourth quarter of 2021, which has started to materialize with increased revenues from our financial asset brokerage. Following suit, I would expect that our specialty lending group will see increased opportunity to deploy cash in the second half of the year and into 2023. And last but not least, We closed on the two remaining Huntsville transactions, which favorably impacted our operating income during the quarter by approximately $2.6 million. As we stated previously, strategic real estate partnerships have generated high margins for us, and we plan to continue periodically purchasing real estate as part of the assets we acquire for resale, most recent of which was the acquisition of two pharmaceutical plants in Missouri formerly of Nesher Pharmaceuticals. On a consolidated basis, operating income for the quarter was 3.6 million compared to 73,000 in the second quarter of 2021. Operating income in the industrial assets division was 3.3 million in the second quarter of 2022, a significant increase as compared to 433,000 in the second quarter of 2021. In our financial assets division, we saw growth of 156% to $1.2 million in operating income compared to $462,000 in the second quarter of 2021. Net income was $2.6 million or $0.07 per basic and diluted share compared to net income of $587,000 or $0.02 per basic and diluted share in the second quarter of 2021. We reported strong adjusted EBITDA of $3.9 million for the second quarter of 2022, up from $239,000 in the second quarter of 2021. At June 30, 2022, we had aggregate tax net operating loss carry-fors of approximately $78 million, a considerable amount that will prove to be a valuable asset to the company as we continue to grow our profits. Finally, our balance sheet remains strong with stockholders' equity of $36 million as of June 30, 2022, compared to $32.6 million as of December 31, 2021, and a net working capital of $10.5 million. With that, I'll now turn the call back over to Ross.

Thank you, Brian. So this is a really fun call for me. I'm really proud of our team and our performance. There is a time when you just got to really say, Everything is working as planned. It doesn't mean it's always going to work as planned. It doesn't mean that the hard work is over with or that all of our goals are accomplished, but it does mean right now that Heritage Global is firing on all cylinders. Everything is working in all five revenue streams, and it's a team that has worked to very hard, very diligently for a long time to put all the pieces together at the right time in the right place, and that's us today. Let me walk you through why I believe that, why I believe that we've hit the stride where this kind of performance is sustainable, both near-term and long-term. I'll do it division by division. As you know, we have two different income streams, a financial asset income stream and an industrial asset income stream. I'll start with our financial assets, where, as you know, we have two different entities, NLEX, which is a brokerage that sells basically all kinds of non-performing loan portfolios, and Heritage Capital, which is a specialty lender to the companies that buy those kinds of asset portfolios. What's happened with NLEX is it was slowed during the pandemic, but we're now hitting post-pandemic strides, and we're back in a growth mode. Our income is very much tied to the macro economy, and the increase that's basically been month after month and now quarter after quarter and the amount of borrowings that are being done is basically converting into more defaults and more charge-offs as volumes have risen. And as volumes on consumer debt continue to rise, our product launch is continuing to grow. We've added new clients, and our existing clients have added more products and more services to us so that, in the end, NLEX, is actually at a point in time where I think it can actually beat its post-pandemic highs. That tied into the fact that about a year and a half or two years ago, we opened up Heritage Global Capital to lend. That business wasn't growing as fast as we'd hoped during a pandemic when most of the assets were being sold to the large public companies and the people borrowing from us were basically not that strong in the market as they are today. Today, we have a record number of onboarded companies, and those companies are actively using us. So we're seeing growth on both ends of the financial spectrum, and we think that growth is sustainable as we think the consumer spending is continuing to rise. Let's shoot on over to industrial. In industrial, we've had a record back-to-back several quarters of principal deals where we've made high margins. On top of that, our fully integrated acquisition of American Lab Trading is really launching us into higher heights than we'd initially even predicted. What's happened there is there's an enormous synergy between American Lab Trading and our auction division, where American Lab Trading before only acquired assets it could put into inventory. So it was pretty restricted on what it could buy because basically it had to find assets that would fit into inventory and trade out of their ongoing operations. Today, because they have the diversification of the auction division and the ability to look at a far wider array of assets, where we can put some assets in inventory and then simultaneously liquidate other assets real time, expediting the ROI. We're now looking at many more portfolios. We're bidding on many more portfolios. Our recovery is much quicker on a lot of the portfolios because we're bifurcating the assets into inventory assets and auction assets, and the auction assets oftentimes produce enough revenue that the inventory assets are on the books at a very low dollar value, and we're able to monetize those more rapidly and give even more attractive opportunities to our buyers. So because we have a growing refreshed inventory, we're gaining more traction with our buyers, and because AOT is finding assets for our auctions, our auction platform is simultaneously growing. So we're hitting it on all fronts on industrial there. Our third industrial group and final group is our valuation practice. As there is some fears that we're moving into a recession, that most of the money center banks and a lot of the asset-based lenders are getting more and more concerned about asset-based values and not just enterprise values, and we've seen an uptick in our usage as more people want to know what the actual market value is of their assets. Overall, both financial and industrial are in full swing and full stride. We had a record Q2. We believe that that is sustainable and that we're going to see a fantastic Q3 and a record-breaking year this year. We've basically given guidance that we believe this will be the best year in the history of the company, and I'm here today to tell you that I'm more and more positive that that is true and more and more bullish on our future than I have been in any other time. So thank you very much for hearing me out, and everyone have a great day.

We will now begin the question and answer session.

To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2.

At this time, we will pause momentarily to assemble our roster. And our first question comes from Mark Argento of Lake Street.

Please go ahead.

Hey, Ross and Brian. Congrats on a really strong quarter. Obviously, this is your kind of market, so it's fun to see you guys perform well. Just a couple of things. I was wondering, Brian, could you help us better understand when you have some of the Huntsville you know, revenue, the real estate revenue, kind of how does that work through the P&L? I'm just trying to better understand the impact there and understand how that kind of makes its way through the numbers.

Yeah, so the first thing to really understand, I think, for you is the Huntsville deal as a whole was kind of unique in the sense that we bought a large campus, three buildings with machinery and equipment, However, the real estate portion of that deal was housed in the joint venture, and the machinery and equipment was not. So there's a little bit of complexity there. We also have some costs that have been incurred outside of that joint venture. So accounting-wise, a large part of our earnings in Q2 were due to the closure of those two buildings. But there's also P&L impact above in asset sales, cost of asset sales. So net impact for that deal specifically to operating income was $2.6 million.

Not $2.6 million in total profit for the deal. $2.6 million recognized in profit for the quarter. The deal brought in substantially more, but a lot of the revenue was recognized in prior quarters. So it is now a complete, finite, finished deal, and that's pretty much the end of the revenue. There might be a small amount trickling in going forward, but we're pretty much done with that deal now, Mark.

Got it. That's helpful. And then I think you had mentioned, Ross, in your prepared remarks, maybe it was Brian, that you guys just took down some additional real estate. Is that a similar type of deal? transaction in terms of the setup and how that might flow through as well?

Yeah, I mean, it's very similar in the reason we bought it, the theory behind the acquisition. The financial structure is a little different. But ultimately, we believe it'll produce the same kind of profits. And we're very excited about it. We've already sold a substantial amount of the capital assets to tangible machinery and equipment. And we're now working through the process of selling the buildings. It was also done in a partnership with some industry peers. And we think a lot of the revenue will be recognized over the next three to nine months.

And just also to add, this is a deal that's more straightforward than the Huntsville deal that we just talked about. And so a lot of the earnings, 100% of the earnings should flow through the equity method line.

It's helpful. And then just touching a little bit on the NLEX business, the financial assets business. That's a business that we had been talking about and looking for a tailwind. Looks like we have that tailwind. Can you talk a little bit or at least try to help quantify maybe the pipeline or the activity you're seeing in terms of either a number of portfolios or

and new customers you're on board just give us something to better understand kind of how that's shaping up i sure will when i was talking for the last five or six months about being bullish on the future of that business it's because we really do see the early warning signs here because we basically are the back end we're the bottom half of the last of the mile of the supply chain so first you start seeing a rise in consumer spending that follows by a rise in defaults eventually because more spending just by prima facie evidence produces more defaults ultimately more defaults convert to more charge-offs and then after there's more charge-offs finally there's the disposition of those charge-offs which falls into our brokerage activity Ultimately, then when there's an acquisition of those charge-offs and the people that we've onboarded are the purchasers, it then flows into our lending business. So it took about six or nine months of growth in the volumes for us to hit stride. We've now hit stride where we're looking at a very strong Q3 and very strong Q4, not just because we've added some new clients, which we have, but because our incumbent clients now have more supply. And as they have more supply, more supply flows through our channels. There's also been a growing pressure for ESG in the environment of the financial world where they want to show more transparency. So a lot of the sellers that were selling direct in the past now want to work in an open market where there's competitive bidding and they're assuring everyone that they're getting mark-to-market values. So we think there'll be an increase in the amount of people that use third-party brokers in competitive processes.

Got it. That's helpful.

And just one last one for me, and I'll jump back in the queue.

We'll give you two more questions, Mark, if you want.

Two more? All right. Yeah. I appreciate that.

Special offer today. Special offer today. We're feeling generous.

All right. Just quickly. So deploying capital, obviously with the financial assets, more portfolios out there, more opportunity. to fund buyers of these portfolios. Where are you in terms of lending? How much capital or how much capacity do you have or how much capital do you have at this point?

To date, we've funded, along with our partners, to date we've funded $40 million since inception. We're hopeful that we can double that within the next year to get to $80 to $100 million. We have the capital in place right now to do that with our partners, with our hedge fund partners. We'll be announcing very soon our new deal, but I can tell you in advance that we have the capital ready to go. We're able to deploy pretty much what we need. We're very fortunate that we have really strong cash flow right now. So our own balance sheet is growing and we're able to deploy our own capital along with partner capital. We've renewed our line with C3 Bank. Our line is at zero right now and we have $10 million of capacity on that line on top of the hedge fund funding. So we see clear sailing for the next 12 months. Sometime down the road, if we like the value of our enterprise, we would be potentially looking at raising capital, but right now that's not a consideration today. We think we're fine as is.

Doug tails. We'll take the last one. Then since you're giving it to me, um, you know, let's think you bought a little stock back in the corner, a quarter, you know, any reason you might not be a little more aggressive here, uh, with the buyback. That's it for me. Thanks.

Um, As far as more aggressive, I guess the answer is yes. Our intention is to continue the buyback. When our board approved the buyback program, they approved it for some longevity, not just for a very brief period of time. So it's an ongoing buyback program where we still have available capital allotted to the buyback. We'll follow the stock and we'll – We'll make real-time decisions, but at this time, we still believe that there's real value in our stock, and we're still very bullish on our personal ownership of it as an entity.

Thanks, guys. Thank you, Mark. Appreciate the call.

Once again, if you would like to ask a question, please press star, then 1. And our next question will come from Michael Diana of Maxim Group. Please go ahead.

Hi, Michael.

Hey, Rob.

So on the financial assets for the last – since you've been talking about FinTechs and Buy Now, Pay Later, and in the release I noticed you talked about credit cards. So I assume all these are sources now – of your charged off assets?

Yeah, credit cards and auto loans have been basically a staple for a decade before the FinTech and obviously before the new BNPL. And it looked like in the pandemic that the growth we're seeing was in the FinTech, where every month they announced a new $100 or $200 million from a new entity that was lending along with the insurgence of the BNPL. But now it looks like there's growth across the board. We've seen a dramatic increase in the rise of credit cards and the rise of credit card products flowing to us, along with auto product. And most recently, over the last, I'd say, four or five months, we've seen a real steady increase in what we're doing now with real estate. to where there's a growth in the non-performing real estate loans we've been selling, too. So we're not just tied to kind of the new age fintech and BNPL. Kind of all of our old school products are growing simultaneously. So we're really bullish on the next year kind of across the board with all of our products.

Okay, great. That's what I thought. Okay, thank you.

Thank you, Michael. Have a great day.

The next question comes from Chad Stauffer of A Private Investor. Please go ahead.

Hi, Chad. Hello, hello. Congratulations on a great quarter. I just had a question on some of the loan charge-offs from banks with CESA requirements coming in right before COVID. I know it didn't really change anything, but now that we're seeing them have to set aside more funds, is that increasing? I think I was surprised how quickly you guys are seeing a pickup in your charge-off loan auctions today. Is the CISO requirements on banks pushing them to get them to you faster? And if so, is that improving the quality and the rate you're going to get for those charges off loans?

Yeah, some of it is coming from banks, but I don't think it's so much FDIC or credit regulatory pressure. I think a lot of it is basically kind of a social decision that during the pandemic, there was a hold back. on lenders not wanting to appear to be the grim reaper and put a lot of sell-side orders in when they really didn't want collection agents and putting a lot of stress on people that were out of work. And now that pretty much people are going back to work, pretty much the pandemic isn't as really solid an issue. I think a lot of these lenders have just held back putting product on the streets. have now kind of growing amounts of non-performing loans. And as their loans grow, there is pressure to monetize them that's a little greater than it was, say, a year ago. So we're just seeing kind of more activity across the board, Chad.

That sounds great. I appreciate your filling in on everything. Congratulations again.

Well, thank you very much, and thanks for following us.

This concludes our question and answer session.

I would like to turn the conference back over to Ross Dove for any closing remarks.

I'd like to thank everybody for listening in.

I'd like to thank all of our shareholders for sticking with us through a pandemic and for having faith that we were going to come out of it stronger and better and more solid and on a real growth trajectory. As I said in the earnings call today, I'm really proud of our people and I'm really proud of our performance. And our goal is to keep on going, to keep on working hard and to keep fulfilling our commitment to all of our employees, to all of our clients and to all of you that we're in the right place at the right time, doing the right things to continue servicing this marketplace and growing. And we're very optimistic about the future. And we welcome all of you as shareholders. We welcome all of you as followers. And we're very thankful for anybody who's paying attention to us.

So thanks a lot, and everyone have a great day.

The conference is now concluded. Thank you for attending today's presentation, and you may now disconnect.