The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1 –Basis of Presentation
These unaudited condensed consolidated interim financial statements include the accounts of Heritage Global Inc. together with its subsidiaries, including Heritage Global Partners, Inc. (“HGP”), Heritage Global LLC (“HG LLC”), Equity Partners HG LLC (“Equity Partners”) and National Loan Exchange, Inc. (“NLEX”). These entities, collectively, are referred to as “HGI,” the “Company,” “we” or “our” in these financial statements. Our unaudited condensed consolidated interim financial statements were prepared in conformity with generally accepted accounting principles in the United States of America (“GAAP”), as outlined in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), and include the assets, liabilities, revenues, and expenses of all subsidiaries over which HGI exercises control. All significant intercompany accounts and transactions have been eliminated upon consolidation. The Company’s sole operating segment is its asset liquidation business.
HGI provides an array of value-added capital and financial asset solutions: auction and appraisal services, traditional asset disposition sales, and financial solutions for distressed businesses and properties
.
We have prepared the condensed consolidated interim financial statements included herein pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). In management’s opinion, these financial statements reflect all adjustments that are necessary to present fairly the results for the interim periods included herein. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations; however, we believe that the disclosures are appropriate. These unaudited condensed consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2015, filed with the SEC on March 17, 2016.
The results of operations for the three and nine month periods ended September 30, 2016 are not necessarily indicative of those operating results to be expected for any subsequent interim period or for the entire year ending December 31, 2016. The accompanying condensed consolidated balance sheet at December 31, 2015 has been derived from the audited consolidated balance sheet at December 31, 2015, contained in the above referenced Form 10-K.
Note 2 – Summary of Significant Accounting Policies
Use of Estimates
The preparation of the Company’s consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results could differ from those estimates.
Significant estimates include the assessment of collectability of revenue recognized, and the valuation of accounts receivable, inventory, investments, goodwill and intangible assets, liabilities, contingent consideration, deferred income tax assets and liabilities, and stock-based compensation. These estimates have the potential to significantly affect our consolidated financial statements, either because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events that are continuous in nature.
Foreign Currency
The functional currency of foreign operations is deemed to be the local country’s currency. Assets and liabilities of operations outside of the United States are generally translated into U.S. dollars, and the effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income (loss).
Reclassifications
Certain prior year balances within the condensed consolidated financial statements have been reclassified to conform to the current year presentation.
7
The critical accounting policies used in the preparation of our audited consolidated financial statements are discussed in our Annual Report on Form 10-K for the year ended December 31, 2015. There have been no changes to these policies in the first ni
ne months of 2016.
Recently Adopted Accounting Pronouncements
In January 2015, the FASB issued Accounting Standards update 2015-01,
Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items
(“ASU 2015-01”). ASU 2015-01 eliminates the requirement for entities to consider whether an underlying event or transaction is extraordinary, and, if so, to separately present the item in the income statement net of tax, after income from continuing operations. Instead, items that are both unusual and infrequent should be separately presented as a component of income from continuing operations, or be disclosed in the notes to the financial statements. ASU 2015-01 became effective January 1, 2016, and did not have a material impact on the Company’s consolidated financial statements.
In March 2015, the FASB issued Accounting Standards update 2015-02,
Amendments to the Consolidation Analysis
(“ASU 2015-02”). ASU 2015-02 eliminates entity-specific consolidation guidance for limited partnerships, and revises other aspects of the consolidation analysis, but does not change the existing consolidation guidance for corporations that are not variable interest entities (“VIEs”). ASU 2015-02 became effective January 1, 2016, and did not have a material impact on the Company’s consolidated financial statements.
In April 2015, the FASB issued Accounting Standards update 2015-03,
Simplifying the Presentation of Debt Issuance Costs
(“ASU 2015-03”). ASU 2015-03 changes the presentation of debt issuance costs in financial statements, by requiring them to be presented in the balance sheet as a direct deduction from the related debt liability, rather than as an asset. Amortization of the costs is reported as interest expense. There is no change to the current guidance on the recognition and measurement of debt issuance costs. ASU 2015-03 became effective January 1, 2016, and did not have a material impact on the Company’s consolidated financial statements.
In August 2015, the FASB issued Accounting Standards update 2015-15,
Interest – Imputation of Interest
, (“ASU 2015-15”). ASU 2015-15 amends subtopic 835-30 of the ASC (which was previously amended by ASU 2015-03) to allow for the capitalization of debt issuance costs related to line of credit agreements. Capitalized costs would be presented as an asset and subsequently amortized ratably over the term of the line of credit. ASU 2015-15 became effective January 1, 2016, and did not have a material impact on the Company’s consolidated financial statements.
In September 2015, the FASB issued Accounting Standards update 2015-16,
Simplifying the Accounting for Measurement-Period Adjustments
(“ASU 2015-16”). ASU 2015-16 changes the recognition of business combination adjustments by requiring acquirers to recognize adjustments to provisional amounts identified during the measurement period in the reporting period in which the adjustment amounts are determined. The acquirer is required to record the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts. These amounts are calculated as if the accounting was completed at acquisition date. The acquirer is also required to present separately on the face of the income statement, or disclose in the notes, the amount recorded in current-period earnings (by line item) that would have been recorded in previous reporting periods had the adjustments been recognized as of the acquisition date. ASU 2015-16 became effective January 1, 2016, and did not have a material impact on the Company’s consolidated financial statements.
Future Accounting Pronouncements
In February 2016, the FASB issued Accounting Standards update 2016-02,
Leases
, (“ASU 2016-02”). ASU 2016-02 changes the accounting for leases previously classified as operating leases under GAAP, by, among other things, requiring a company to recognize the lease on the balance sheet with a right-of-use asset and a lease liability. ASU 2016-02 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company has not yet adopted ASU 2016-02 nor assessed its potential impact on its consolidated financial statements.
In March 2016, the FASB issued Accounting Standards update 2016-07,
Investments – Equity Method and Joint Ventures
(“ASU 2016-07”), which simplifies the transition to the equity method of accounting by, among other things, eliminating retroactive adjustments to the investments as a result of an increase in the level of ownership interest or degree of influence. ASU 2016-07 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The Company has not yet adopted ASU 2016-07 nor assessed its potential impact on its consolidated financial statements.
In March 2016, the FASB issued Accounting Standards update 2016-08,
Revenue from Contracts with Customers
(“ASU 2016-08”), which provides clarity on the implementation of guidance on principal versus agent considerations (reporting of revenue on a
8
gross basis versus net basis). ASU 2016-08 will be effective for fiscal years, and interim periods within those
fiscal years, beginning after December 15, 2017. The Company does not believe that the clarification of the implementation of the guidance will change the conclusions reached in its current analysis of principal versus agent considerations for reporting o
f revenue.
In March 2016, the FASB issued Accounting Standards update 2016-09,
Compensation – Stock Compensation
(“ASU 2016-09”), which provides improvements to employee share-based payment accounting. ASU 2016-09 simplifies the accounting and presentation of various elements of share-based compensation including, but not limited to, income taxes, excess tax benefits, statutory tax withholding requirements, payment of employee taxes, and award assumptions. ASU 2016-09 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The Company is still assessing the impact ASU 2016-09 will have on its consolidated financial statements.
In April 2016, the FASB issued Accounting Standards update 2016-10,
Revenue from Contracts with Customers
(“ASU 2016-10”), which provides clarity on identifying performance obligations and licensing. ASU 2016-10 clarifies how an entity identifies performance obligations and whether that entity’s promise to grant a license provides a customer with either a right to use the entity’s intellectual property or a right to access the entity’s intellectual property. ASU 2016-10 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company has not yet adopted ASU 2016-10 nor assessed its potential impact on its consolidated financial statements.
In May 2016, the FASB issued Accounting Standards update 2016-12,
Revenue from Contracts with Customers
(“ASU 2016-12”), which provides clarity and simplification to the transition guidance from the previously issued ASU 2014-09. ASU 2016-12 provides narrow scope improvements to assessing the collectability criterion, the presentation of sales and other similar taxes, non-cash consideration, contract modifications, completed contracts, and technical corrections. ASU 2016-12 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company has not yet adopted ASU 2016-12 nor assessed its potential impact on its consolidated financial statements.
In August 2016, the FASB issued Accounting Standards update 2016-15,
Statement of Cash Flows
(“ASU 2016-15”), which clarifies the classification of certain cash receipts and payments. The specific cash flow issues addressed by ASU 2016-15, with the objective of reducing the existing diversity in practice, are as follows: (1) Debt prepayment or debt extinguishment costs; (2) Settlement of zero-coupon debt instruments or other debt instruments with insignificant coupon interest rates; (3) Contingent consideration payments made after a business combination; (4) Proceeds from the settlement of insurance claims; (5) Proceeds from the settlement of corporate-owned life insurance policies; (6) Distributions received from equity method investees; (7) Beneficial interest in securitization transactions; and (8) Separately identifiable cash flows and application of the predominance in principle. ASU 2016-15 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company is still assessing the impact of ASU 2016-15 on its consolidated financial statements.
Note 3 – Real Estate Inventory
In the first quarter of 2016, the Company entered into a purchase and sale agreement with International Auto Processing Inc. (“IAP”) to sell the Company’s real estate inventory for $4.1 million. IAP subsequently assigned the purchase and sale agreement to an affiliate, International Investments and Infrastructure, LLC (“III”).
Concurrently, the Company entered into a five-year lease agreement with an affiliate of III to lease the building during the escrow period, which terminates at the close of escrow. The purchase agreement gave IAP the right to terminate its obligation to consummate the sale for any reason before June 9, 2016, but in the event the sale is not consummated, the lease agreement would continue through the end of the lease term.
Annual rental payments under the lease were $0.7 million, and the lessee was responsible for all operating costs associated with the property. During the three and nine months ended September 30, 2016, the Company earned rental income of $10,000 and $0.3 million, respectively, which is included within services revenue in the condensed consolidated statement of operations. No rental income was earned during the three or nine months ended September 30, 2015.
In the third quarter of 2016, the Company completed the sale of its real estate inventory and, in accordance with the purchase and sale agreement, terminated the previously existing lease agreement between the Company and an affiliate of III. The Company sold the real estate inventory for $4.1 million and, after recognizing carrying costs of $3.7 million and closing costs of $0.3 million, realized a gross profit of $0.1 million.
In the third quarter of 2015, the Company determined that the net realizable value of its real estate inventory, based on the most probable selling price net of costs to complete the sale, was $3.8 million. As such, the Company recorded an inventory write-down
9
charge during the three months ended September 30, 2015, of $2.7 million, reducing the carrying cost of the inventory to $3.8 million. The
re were no such similar charges during the three or nine months ended September 30, 2016, as the Company executed the aforementioned purchase and sale agreement for a sales price in excess of the carrying cost of the real estate inventory.
Note 4 – Stock-based Compensation
Options
At September 30, 2016 the Company had four stock-based compensation plans. Three of these plans are described more fully in Note 16 to the audited consolidated financial statements for the year ended December 31, 2015, contained in the Company’s most recently filed Annual Report on Form 10-K. The fourth plan was adopted on May 5, 2016 and received approval from the Company’s shareholders at the special meeting of stockholders held on September 14, 2016. The maximum aggregate number of shares of common stock that may be issued pursuant to the stock option plan is 3,150,000. Refer to the Form 8-K filed on September 15, 2016 and the Definitive Proxy Statement filed on August 5, 2016 with the SEC for more information on the 2016 stock option plan.
During the first nine months of 2016, the Company issued options to purchase a total of 70,000 shares of common stock to the Company’s independent directors as part of their annual compensation. During the same period, the Company cancelled options to purchase 187,500 shares of common stock as a result of the expiration of the allowable exercise period for options held by the former directors of the Company, who resigned in the second quarter of 2016.
The following summarizes the changes in common stock options for the nine months ended September 30, 2016:
|
|
Options
|
|
|
Weighted
Average
Exercise
Price
|
|
Outstanding at December 31, 2015
|
|
|
2,175,000
|
|
|
$
|
1.70
|
|
Granted
|
|
|
70,000
|
|
|
$
|
0.24
|
|
Exercised
|
|
|
(40,000
|
)
|
|
$
|
0.12
|
|
Cancelled
|
|
|
(187,500
|
)
|
|
$
|
0.83
|
|
Expired
|
|
|
(20,000
|
)
|
|
$
|
0.15
|
|
Outstanding at September 30, 2016
|
|
|
1,997,500
|
|
|
$
|
1.77
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at September 30, 2016
|
|
|
1,862,500
|
|
|
$
|
1.86
|
|
The Company recognized stock-based compensation expense related to stock options of $7,000 and $50,000 for the three and nine months ended September 30, 2016, respectively. As of September 30, 2016, there is approximately $33,000 of unrecognized stock-based compensation expense related to unvested option awards outstanding, which is expected to be recognized over a weighted average period of 2.2 years.
Restricted Stock
Restricted stock awards represent a right to receive shares of common stock at a future date determined in accordance with the participant’s award agreement. There is no exercise price and no monetary payment required for receipt of restricted stock awards or the shares issued in settlement of the award. Instead, consideration is furnished in the form of the participant’s services to the Company. Compensation cost for these awards is based on the fair value on the date of grant and recognized as compensation expense on a straight-line basis over the requisite service period.
10
The following summarizes the chang
es in restricted stock awards for the nine months ended September 30, 2016:
|
|
Restricted
Stock
Awards
|
|
|
Weighted
Average
Grant
Date Fair Value
Per Share
|
|
Unvested Awards at December 31, 2015
|
|
|
150,000
|
|
|
$
|
0.38
|
|
Granted
|
|
|
—
|
|
|
|
—
|
|
Vested
|
|
|
(75,000
|
)
|
|
$
|
0.38
|
|
Unvested awards at September 30, 2016
|
|
|
75,000
|
|
|
$
|
0.38
|
|
|
|
|
|
|
|
|
|
|
Vested awards at September 30, 2016
|
|
|
225,000
|
|
|
$
|
0.38
|
|
Stock-based compensation expense related to restricted stock awards was $7,000 and $21,000 for the three and nine months ended September 30, 2016, respectively.
Note 5 – Earnings Per Share
The Company is required, in periods in which it has net income, to calculate basic earnings per share (“basic EPS”) using the two-class method. The two-class method is required because the Company’s Class N preferred shares, each of which is convertible to 40 common shares, have the right to receive dividends or dividend equivalents should the Company declare dividends on its common stock. Under the two-class method, earnings for the period are allocated on a pro-rata basis to the common and preferred stockholders. The weighted-average number of common and preferred shares outstanding during the period is then used to calculate basic EPS for each class of shares.
In periods in which the Company has a net loss, basic loss per share is calculated by dividing the loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period. The two-class method is not used in periods in which the Company has a net loss because the preferred stock does not participate in losses.
Stock options and other potential common shares are included in the calculation of diluted earnings per share (“diluted EPS”), since they are assumed to be exercised or converted, except when their effect would be anti-dilutive.
The table below shows the calculation of the shares used in computing diluted EPS.
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
Weighted Average Shares Calculation:
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Basic weighted average shares outstanding
|
|
|
28,432,648
|
|
|
|
28,317,648
|
|
|
|
28,390,221
|
|
|
|
28,230,169
|
|
Treasury stock effect of common stock options and restricted
stock awards
|
|
|
—
|
|
|
|
—
|
|
|
|
9,538
|
|
|
|
—
|
|
Diluted weighted average common shares outstanding
|
|
|
28,432,648
|
|
|
|
28,317,648
|
|
|
|
28,399,759
|
|
|
|
28,230,169
|
|
There were 1.9 million potential common shares not included in the computation of diluted EPS because they would have been anti-dilutive for the nine months ended September 30, 2016. No potential common shares were included for the three months ended September 30, 2016, nor the three and nine months ended September 30, 2015, as the Company generated a net loss. Therefore basic EPS was the same as diluted EPS during those respective periods.
11
Note 6 – Intangible Assets and Goodwill
Identifiable intangible assets
The Company’s identifiable intangible assets are associated with its acquisitions of HGP in 2012 and NLEX in 2014, as shown in the table below (in thousands), and are amortized using the straight-line method over their estimated useful lives of two to twelve years. The Company’s trade name, acquired as part of the acquisition of NLEX in 2014, has an indefinite life and therefore is not amortized.
|
|
Carrying Value
|
|
|
|
|
|
|
Carrying Value
|
|
Amortized Intangible Assets
|
|
December 31, 2015
|
|
|
Amortization
|
|
|
September 30, 2016
|
|
Customer Network (HGP)
|
|
$
|
178
|
|
|
$
|
(17
|
)
|
|
$
|
161
|
|
Trade Name (HGP)
|
|
|
1,059
|
|
|
|
(78
|
)
|
|
|
981
|
|
Customer Relationships (NLEX)
|
|
|
660
|
|
|
|
(82
|
)
|
|
|
578
|
|
Non-Compete Agreement (NLEX)
|
|
|
15
|
|
|
|
(15
|
)
|
|
|
—
|
|
Website (NLEX)
|
|
|
33
|
|
|
|
(7
|
)
|
|
|
26
|
|
Total
|
|
|
1,945
|
|
|
|
(199
|
)
|
|
|
1,746
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade Name (NLEX)
|
|
|
2,437
|
|
|
|
—
|
|
|
|
2,437
|
|
Total
|
|
$
|
4,382
|
|
|
$
|
(199
|
)
|
|
$
|
4,183
|
|
Amortization expense during the first nine months of 2016 and 2015 was $0.2 million and $0.5 million, respectively.
The estimated amortization expense as of September 30, 2016 during the remainder of the current fiscal year, the next four fiscal years, and thereafter is shown below (in thousands):
Year
|
|
Amount
|
|
2016 (remainder of year from October 1, 2016 to December 31, 2016)
|
|
$
|
61
|
|
2017
|
|
|
245
|
|
2018
|
|
|
245
|
|
2019
|
|
|
240
|
|
2020
|
|
|
236
|
|
Thereafter
|
|
|
719
|
|
Total
|
|
$
|
1,746
|
|
Goodwill
The Company’s goodwill is related to its asset liquidation business, and is comprised of goodwill from three acquisitions, as shown in the table below (in thousands). There were no impairment losses or other charges to the carrying amount of goodwill during the nine months ended September 30, 2016 and 2015.
Acquisition
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
Equity Partners
|
|
$
|
573
|
|
|
$
|
573
|
|
HGP
|
|
|
2,040
|
|
|
|
2,040
|
|
NLEX
|
|
|
3,545
|
|
|
|
3,545
|
|
Total goodwill
|
|
$
|
6,158
|
|
|
$
|
6,158
|
|
12
Note 7 – Debt
Outstanding debt at September 30, 2016 and December 31, 2015 is summarized as follows (in thousands):
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
Current:
|
|
|
|
|
|
|
|
|
Related party debt
|
|
|
1,090
|
|
|
|
1,721
|
|
|
|
|
1,090
|
|
|
|
1,721
|
|
Non-current:
|
|
|
|
|
|
|
|
|
Related party debt
|
|
460
|
|
|
|
—
|
|
Third party debt
|
|
|
—
|
|
|
|
2,500
|
|
|
|
|
|
|
|
|
|
|
Total debt
|
|
$
|
1,550
|
|
|
$
|
4,221
|
|
The Company entered into a loan with an unrelated party (the “Third Party Debt”) during 2014 for a principal amount of $2.5 million. The loan bore interest at 6% and had an original maturity date of January 15, 2015. In December 2014, the maturity date was extended to January 15, 2016 at the same interest rate, and in the first quarter of 2016, the maturity date was further extended to January 15, 2017 at the same interest rate. The Third Party Debt was not subject to any covenants or conditions.
In July 2016, the Company repaid $2.5 million of outstanding principal, plus accrued interest, on the Third Party Debt, and terminated the loan agreement with the third party.
The Company entered into a related party loan (the “Street Capital Loan”) with Street Capital Group Inc. (“Street Capital”) in 2003. The Street Capital Loan accrued interest at 10% per annum compounded quarterly from the date funds were advanced. In 2014, following Street Capital’s distribution of its ownership interest in HGI to Street Capital shareholders as a dividend in kind, the unpaid balance of the Street Capital Loan began accruing interest at a rate per annum equal to the lesser of the Wall St. Journal (“WSJ”) prime rate + 2.0%, or the maximum rate allowable by law.
In the third quarter of 2016, following an amendment to the Street Capital Loan began accruing interest at a rate per annum equal to the WSJ prime rate + 1.0%. The Company also agreed to a monthly payment schedule to begin in the first quarter of 2017. Additionally, the Company repaid $0.8 million of outstanding principal in connection with the amendment. As of September 30, 2016 and December 31, 2015, the interest rate on the loan was 4.50% and 5.50%, respectively. As of September 30, 2016 and December 31, 2015, amounts owed to Street Capital under the Street Capital Loan were $1.0 million and $1.7 million, respectively. Please see Note 10 for further discussion of transactions with Street Capital.
In the first quarter of 2016, the Company entered into a related party loan with a trust controlled by certain executive officers of the Company. The Company received proceeds of $0.4 million. The loan accrued interest at 10% per annum and was payable within 90 days of the loan date. The Company repaid the loan plus accrued interest in March 2016.
In the third quarter of 2016, the Company entered into a related party loan with an entity owned by certain executive officers of the Company, and the Company’s Chief Executive Officer. The Company received proceeds of $0.7 million. The loan accrues interest at 10% per annum and is payable within 180 days of the loan date. The Company repaid $0.1 million of principal in September 2016. As of September 30, 2016 and December 31, 2015, amounts owed under the loan were $0.6 million and $0, respectively.
Note 8 – Fair Value Measurements
In accordance with the authoritative guidance for financial assets and liabilities measured at fair value on a recurring basis, the Company prioritizes the inputs used to measure fair value from market-based assumptions to entity-specific assumptions:
|
•
|
Level 1 – Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.
|
|
•
|
Level 2 – Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
|
|
•
|
Level 3 – Inputs which reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instruments valuation.
|
13
As of September 30, 2016 and December 31, 2015, t
he Company had no Level 1 or Level 2 assets or liabilities measured at fair value. As of September 30, 2016 and December 31, 2015, the Company’s contingent consideration from the acquisition of NLEX in 2014 of $1.9 and $3.5 million, respectively, was the
only liability measured at fair value on a recurring basis, and was classified as Level 3 within the fair value hierarchy. The fair value of the Company’s contingent consideration was determined using a discounted cash flow analysis, which is based on sig
nificant inputs that are not observable in the market. As of September 30, 2016 and December 31, 2015, the Company had no Level 3 assets measured at fair value.
The following tables present the Company’s hierarchy for its liabilities measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 (in thousands):
|
|
Fair Value as of September 30, 2016
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,930
|
|
|
$
|
1,930
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value as of December 31, 2015
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
3,457
|
|
|
$
|
3,457
|
|
When valuing its Level 3 liabilities, the Company gives consideration to operating results, financial condition, economic and/or market events, and other pertinent information that would impact its estimate of the expected contingent consideration payment. The valuation of the liability is primarily based on management’s estimate of the Net Profits of NLEX (as defined in the NLEX stock purchase agreement). Given the short term nature of the contingent consideration periods, changes in the discount rate are not expected to have a material impact on the fair value of the liability.
During the nine months ended September 30, 2016, the Company paid the former owner of NLEX $0.6 million of the total $0.8 million second earn-out payment as required under the earn-out provision of the NLEX stock purchase agreement. The following table summarizes the changes in the fair value of the liability during the nine months ended September 30, 2016 (in thousands):
Balance at December 31, 2015
|
|
$
|
3,457
|
|
Payment of contingent consideration
|
|
|
(627
|
)
|
Fair value adjustment of contingent consideration
|
|
|
(900
|
)
|
Balance at September 30, 2016
|
|
$
|
1,930
|
|
The Company had no assets or liabilities measured at fair value on a non-recurring basis as of September 30, 2016.
Note 9 – Income Taxes
At September 30, 2016, the Company had aggregate tax net operating loss carry forwards of approximately $74.0 million ($58.9 million of unrestricted net operating tax losses and approximately $15.1 million of restricted net operating tax losses) and unused minimum tax credit carry forwards of $0.5 million. Substantially all of the net operating loss carry forwards and unused minimum tax credit carry forwards expire between 2025 and 2035. The Company’s utilization of restricted net operating tax loss carry forwards against future income for tax purposes is restricted pursuant to the “change in ownership” rules in Section 382 of the Internal Revenue Code.
The reported tax expense varies from the amount that would be provided by applying the statutory U.S. Federal income tax rate to the loss from operations before taxes primarily as a result of the change in the deferred tax asset valuation allowance.
The Company records net deferred tax assets to the extent that it believes such assets will more likely than not be realized. As a result of our cumulative losses and uncertainty with respect to future taxable income, we have provided a full valuation allowance against our net deferred tax assets as of December 31, 2015 and September 30, 2016.
14
Note 10 – Related Party Transactions
Debt with Street Capital
Until the second quarter of 2014, as discussed below, Street Capital was the Company’s majority shareholder. Street Capital remained a related party following the distribution of its investment in HGI to Street Capital shareholders as Allan Silber, an affiliate of Street Capital, is the Company’s chairman of the board, and continues to be a significant shareholder of the Company. In the third quarter of 2016, the Company repaid $0.8 million of outstanding principal on the loan. At September 30, 2016 and December 31, 2015, the Company reported amounts owed to Street Capital of $1.0 million and $1.7 million as related party debt (see Note 7). Total interest of $0.5 million has been accrued on the debt through September 30, 2016.
Street Capital Services Provided to the Company
Beginning in 2004, HGI and Street Capital entered into successive annual management services agreements (collectively, the “Agreement”). Under the terms of the Agreement, HGI agreed to pay Street Capital for ongoing management services provided to HGI by Street Capital personnel. Refer to Note 14 of the Annual Report on Form 10-K filed with the SEC on March 17, 2016 for further detail on the Agreement.
In 2013, Street Capital announced its plan to dispose of its interest in HGI, and on March 20, 2014, Street Capital declared a dividend in kind, consisting of Street Capital’s distribution of its majority interest in HGI to Street Capital shareholders. The dividend was paid on April 30, 2014 to shareholders of record as of April 1, 2014.
Following this disposition, the Company and Street Capital entered into a replacement management services agreement (the “Services Agreement”). Under the terms of the Services Agreement, Street Capital remained as external manager and continued to provide the same services, at similar rates, until the Services Agreement was terminated effective August 31, 2015, as described more fully in the Current Report on Form 8-K filed with the SEC on September 1, 2015.
The amounts charged by Street Capital, which have been accrued and added to the Street Capital Loan balance, are detailed below (in thousands):
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
Management fees
|
|
$
|
—
|
|
|
$
|
240
|
|
Other charges
|
|
|
—
|
|
|
|
50
|
|
Total
|
|
$
|
—
|
|
|
$
|
290
|
|
Other Related Party Transactions
During the first nine months of 2016, the Company leased office space in Foster City, CA as part of the operations of HGP. The premises are owned by an entity that is jointly controlled by senior officers of HGI. In the second quarter of 2016, the Company terminated its lease agreement for the office space in Foster City, CA. The Company also leases office space in Edwardsville, IL, as part of the ongoing operations of NLEX. The premises are owned by senior officers of NLEX. The lease amounts paid by the Company to the related parties, which are included in selling, general and administrative expenses during the three and nine months ended September 30, 2016 and 2015, are detailed below (in thousands):
|
|
Three Months Ended September 30,
|
|
Leased premises location
|
|
2016
|
|
|
2015
|
|
Foster City, CA
|
|
$
|
—
|
|
|
$
|
57
|
|
Edwardsville, IL
|
|
|
25
|
|
|
|
24
|
|
Total
|
|
$
|
25
|
|
|
$
|
81
|
|
|
|
Nine Months Ended September 30,
|
|
Leased premises location
|
|
2016
|
|
|
2015
|
|
Foster City, CA
|
|
$
|
76
|
|
|
$
|
171
|
|
Edwardsville, IL
|
|
|
74
|
|
|
|
73
|
|
Total
|
|
$
|
150
|
|
|
$
|
244
|
|
15
In the first quarter of 2016, the Company entered into a related party loan with a trust controlled by certain executive officers of the Company. The Company received proceeds of $0.4 million. The loan accrued interest at 10% per annum and was payable within 90 days of the loan date. The Company repaid the loan plus accrued interest of $8,000 in March 2016.
In the third quarter of 2016, the Company entered into a related party loan with both an entity owned by certain executive officers of the Company and the Company’s Chief Executive Officer. The Company received proceeds of $0.7 million. The loan accrues interest at 10% per annum and is payable within 180 days of the loan date. The Company repaid $0.1 million of principal in September 2016. Interest expense on this loan for the three and nine months ended September 30, 2016 was $7,000.
Note 11 – Subsequent Events
The Company has evaluated events subsequent to September 30, 2016 for potential recognition or disclosure in its condensed consolidated financial statements.
There have been no material subsequent events requiring recognition or disclosure in this Report.
16