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. These entities, collectively, are referred to as the “Company” in these financial statements. The Company’s 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.
The Company provides an array of value-added capital and financial asset solutions: auction and appraisal services, traditional asset disposition sales, and financial solutions for businesses and properties in transition.
The Company has 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 the opinion of management, 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, the Company believes 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, 2016, filed with the SEC on March 7, 2017.
The results of operations for the three and six month periods ended June 30, 2017 are not necessarily indicative of those operating results to be expected for any subsequent interim period or for the entire year ending December 31, 2017. The accompanying condensed consolidated balance sheet at December 31, 2016 has been derived from the audited consolidated balance sheet at December 31, 2016, 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, other assets, goodwill and intangible assets, liabilities, contingent consideration, deferred income tax assets and liabilities, and stock-based compensation. These estimates have the potential to significantly impact the Company’s 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.
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 the Company’s audited consolidated fi
nancial statements are discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. There have been no changes to these policies in the six months ended June 30, 2017.
Recent Accounting Pronouncements
In 2016, the FASB issued Accounting Standards update (“ASU”) 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 became effective January 1, 2017 and did not have a material impact on the Company’s consolidated financial statements.
In 2016, the FASB issued ASU 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 became effective January 1, 2017 and did not have a material impact on the Company’s consolidated financial statements.
In 2016, the FASB issued ASU 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 2014, the Financial Accounting Standards Board, or FASB, issued new guidance related to revenue recognition (ASU No. 2014-09 Revenue from Contracts with Customers (Topic 606)). Subsequently the FASB has issued additional guidance (ASU Nos. 2015-14; 2016-08; 2016-10; 2016-12; 2016-20 Revenue from Contracts with Customers (Topic 606)). The guidance establishes principles for reporting information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Although the Company is still evaluating the impact of the new standard, the Company anticipates that the impact will not be material to the consolidated financial statements.
In 2016, the FASB issued ASU 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.
In 2017, the FASB issued ASU 2017-01,
Business Combinations
(“ASU 2017-01”), which clarifies the definition of a business under topic 805 of the Accounting Standards Codification. The main provisions of ASU 2017-01 provide a screen to determine when an integrated set of assets and activities is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. ASU 2017-01 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 2017-01 on its consolidated financial statements.
In 2017, the FASB issued ASU 2017-04,
Intangibles – Goodwill and Other
(“ASU 2017-04”), which simplifies the test for goodwill impairment. The main provisions of ASU 2017-04 eliminate the second step of the goodwill impairment test which previously was performed to determine the goodwill impairment loss for an entity by calculating the difference between the implied fair value of the entity’s goodwill and its carrying value. Under ASU 2017-04, if a reporting unit’s carrying value exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill which is allocated to that reporting unit. ASU 2017-04 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The Company is still assessing the impact of ASU 2017-04 on its consolidated financial statements.
8
Note 3 – Stock-
based Compensation
Options
At June 30, 2017 the Company had four stock-based compensation plans, which are described more fully in Note 15 to the audited consolidated financial statements for the year ended December 31, 2016, contained in the Company’s most recently filed Annual Report on Form 10-K.
During the six months ended June 30, 2017, the Company issued options to purchase a total of 50,000 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 10,350 shares of common stock as a result of employee resignations. Pursuant to the exercise of common stock options 10,000 shares of common stock were issued during the six months ended June 30, 2017.
The following summarizes the changes in common stock options for the six months ended June 30, 2017:
|
|
Options
|
|
|
Weighted
Average
Exercise
Price
|
|
Outstanding at December 31, 2016
|
|
|
5,169,200
|
|
|
$
|
0.96
|
|
Granted
|
|
|
50,000
|
|
|
$
|
0.48
|
|
Exercised
|
|
|
(10,000
|
)
|
|
$
|
0.08
|
|
Forfeited
|
|
|
(10,350
|
)
|
|
$
|
0.45
|
|
Outstanding at June 30, 2017
|
|
|
5,198,850
|
|
|
$
|
0.95
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at June 30, 2017
|
|
|
1,912,500
|
|
|
$
|
1.82
|
|
The Company recognized stock-based compensation expense related to stock options of $0.1 million and $0.1 million, respectively, for the three and six months ended June 30, 2017. As of June 30, 2017, there is approximately $0.9 million of unrecognized stock-based compensation expense related to unvested option awards outstanding, which is expected to be recognized over a weighted average period of 3.4 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.
The following summarizes the changes in restricted stock awards for the six months ended June 30, 2017:
|
|
Restricted
Stock
Awards
|
|
|
Weighted
Average
Grant
Date Fair Value
Per Share
|
|
Unvested awards at December 31, 2016
|
|
|
37,500
|
|
|
$
|
0.38
|
|
Vested
|
|
|
(37,500
|
)
|
|
$
|
0.38
|
|
Unvested awards at June 30, 2017
|
|
|
—
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Vested awards at June 30, 2017
|
|
|
262,500
|
|
|
$
|
0.38
|
|
Stock-based compensation expense related to restricted stock awards was not material for the three and six months ended June 30, 2017 and 2016.
9
Note 4 – 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 June 30,
|
|
|
Six Months Ended June 30,
|
|
Weighted Average Shares Calculation:
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Basic weighted average shares outstanding
|
|
|
28,480,148
|
|
|
|
28,418,582
|
|
|
|
28,456,750
|
|
|
|
28,368,774
|
|
Treasury stock effect of common stock options and restricted
stock awards
|
|
|
—
|
|
|
|
12,824
|
|
|
|
16,160
|
|
|
|
12,504
|
|
Diluted weighted average common shares outstanding
|
|
|
28,480,148
|
|
|
|
28,431,406
|
|
|
|
28,472,910
|
|
|
|
28,381,278
|
|
Potential common shares that were not included in the computation of diluted EPS because they would have been anti-dilutive for the three and six months ended June 30, 2017 were 5.1 million and 2.0 million, respectively. Potential common shares not included for both the three and six months ended June 30, 2016 were 2.2 million.
Note 5 – 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 tradename 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, 2016
|
|
|
Amortization
|
|
|
June 30, 2017
|
|
Customer Network (HGP)
|
|
$
|
158
|
|
|
$
|
(11
|
)
|
|
$
|
147
|
|
Trade Name (HGP)
|
|
|
953
|
|
|
|
(52
|
)
|
|
|
901
|
|
Customer Relationships (NLEX)
|
|
|
550
|
|
|
|
(54
|
)
|
|
|
496
|
|
Website (NLEX)
|
|
|
24
|
|
|
|
(6
|
)
|
|
|
18
|
|
Total
|
|
|
1,685
|
|
|
|
(123
|
)
|
|
|
1,562
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade Name (NLEX)
|
|
|
2,437
|
|
|
|
—
|
|
|
|
2,437
|
|
Total
|
|
$
|
4,122
|
|
|
$
|
(123
|
)
|
|
$
|
3,999
|
|
Amortization expense during each of the six months ended June 30, 2017 and 2016 was $0.1 million.
10
The estimated amortization expense as of June 30, 2017 during the next five fiscal years and thereafter is shown below (in
thousands):
Year
|
|
Amount
|
|
2017 (remainder of year from July 1, 2017 to December 31, 2017)
|
|
$
|
122
|
|
2018
|
|
|
245
|
|
2019
|
|
|
240
|
|
2020
|
|
|
236
|
|
2021
|
|
|
236
|
|
Thereafter
|
|
|
483
|
|
Total
|
|
$
|
1,562
|
|
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 to the carrying amount of goodwill during the three or six months ended June 30, 2017 and 2016.
Acquisition
|
|
June 30, 2017
|
|
|
December 31, 2016
|
|
Equity Partners
|
|
$
|
573
|
|
|
$
|
573
|
|
HGP
|
|
|
2,040
|
|
|
|
2,040
|
|
NLEX
|
|
|
3,545
|
|
|
|
3,545
|
|
Total goodwill
|
|
$
|
6,158
|
|
|
$
|
6,158
|
|
Note 6 – Debt
Outstanding debt at June 30, 2017 and December 31, 2016 is summarized as follows (in thousands):
|
|
June 30, 2017
|
|
|
December 31, 2016
|
|
Current:
|
|
|
|
|
|
|
|
|
Related party debt
|
|
$
|
496
|
|
|
$
|
664
|
|
Non-current:
|
|
|
|
|
|
|
|
|
Related party debt
|
|
|
120
|
|
|
|
348
|
|
|
|
|
|
|
|
|
|
|
Total debt
|
|
$
|
616
|
|
|
$
|
1,012
|
|
In 2016, following an amendment, the Company’s related party debt with Street Capital (the “Street Capital Loan”) began accruing interest at a rate per annum equal to the Wall Street Journal prime rate + 1.0%. The Company also agreed to a monthly payment schedule which began in the first quarter of 2017. As of June 30, 2017 and December 31, 2016, the interest rate on the loan was 5.25% and 4.75%, respectively. Please see Note 9 for further discussion of transactions with Street Capital.
In 2016, the Company entered into a related party secured promissory note with an entity owned by certain executive officers of the Company (the “Entity”) for a revolving line of credit (the “Line of Credit”). Under the terms of the Line of Credit, the Company received a revolving line of credit with an aggregate borrowing capacity of $1.5 million. Interest under the Line of Credit is charged at a variable rate. Aggregate loans under the Line of Credit up to $1.0 million incur interest at a variable rate per annum based on the rate charged to the Entity by its bank, plus 2.0%. Amounts outstanding at any time in excess of $1.0 million incur interest at a rate of 8.0% per annum. The Company is required to pay the Entity an annual commitment fee of $15,000, payable on a monthly basis, and due regardless of amounts drawn against the line. Further, the Entity is eligible to participate in the net profits and net losses of certain industrial auction principal and guarantee transactions entered into by the Company on or after January 1, 2017, and consummated on or prior to the maturity date. Principal transactions are those in which the Company purchases assets for resale. Guarantee transactions are those in which the Company guarantees its client a minimum amount of proceeds from the auction.
The Line of Credit matures at the earlier of (i) three years from the date of the Agreement, (ii) the termination of the Entity’s line of credit with its bank, or (iii) forty-five (45) days following the date the Company closes a new credit facility with a financial institution.
11
As of June 30, 2017 and December 31, 2016, the Company had not drawn on the Line of Credit.
Note 7 – 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.
|
As of June 30, 2017 and December 31, 2016, the Company had no Level 1 or Level 2 assets or liabilities measured at fair value. As of both June 30, 2017 and December 31, 2016, the Company’s contingent consideration from the 2014 acquisition of NLEX was the only liability measured at fair value on a recurring basis. The fair value of the Company’s contingent consideration was determined using a discounted cash flow analysis, which is based on significant inputs that are not observable in the market.
The following tables present the Company’s hierarchy for its assets and liabilities measured at fair value on a recurring basis as of June 30, 2017 and December 31, 2016 (in thousands):
|
|
Fair Value as of June 30, 2017
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,623
|
|
|
$
|
2,623
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value as of December 31, 2016
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,733
|
|
|
$
|
2,733
|
|
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 payments. 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.
The following table summarizes the changes in the fair value of the liability during the six months ended June 30, 2017 (in thousands):
Balance at December 31, 2016
|
|
$
|
2,733
|
|
Payment of contingent consideration
|
|
|
(400
|
)
|
Fair value adjustment of contingent consideration
|
|
|
290
|
|
Balance at June 30, 2017
|
|
$
|
2,623
|
|
The Company had no assets or liabilities measured at fair value on a non-recurring basis as of June 30, 2017.
Note 8 – Income Taxes
At June 30, 2017 the Company has aggregate tax net operating loss carry forwards of approximately $74.5 million ($59.3 million of unrestricted net operating tax losses and approximately $15.2 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 2024 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.
12
The reported tax expense varies from the amount that would be provided by applying the statutory U.S. Federal income tax rate to the income 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 cumulative losses and uncertainty with respect to future taxable income, the Company has provided a full valuation allowance against its net deferred tax assets as of June 30, 2017 and December 31, 2016.
Note 9 – Related Party Transactions
Debt with Street Capital
As of June 30, 2017, the Company’s loan from Street Capital continues to be classified as related party debt because Allan Silber, an affiliate of Street Capital, is the Company’s chairman of the board, and a significant shareholder of the Company. At June 30, 2017 and December 31, 2016, the Company reported amounts owed to Street Capital of $0.6 million and $1.0 million respectively, as related party debt (see Note 6). Total interest of $0.5 million has been accrued on the debt and remains unpaid through June 30, 2017.
Transactions with Other Related Parties
As part of the operations of NLEX, the Company leases office space in Edwardsville, IL that is owned by the President of NLEX, David Ludwig. The total amount paid to the related party is outlined in the table below. All of the payments in both 2017 and 2016 were made to David Ludwig.
The lease amounts paid by the Company to the related parties, which are included in selling, general and administrative expenses during the three and six months ended June 30, 2017 and 2016, are detailed below (in thousands):
|
|
Three Months Ended June 30,
|
|
Leased premises location
|
|
2017
|
|
|
2016
|
|
Foster City, CA
|
|
$
|
—
|
|
|
$
|
19
|
|
Edwardsville, IL
|
|
|
25
|
|
|
|
25
|
|
Total
|
|
$
|
25
|
|
|
$
|
44
|
|
|
|
Six Months Ended June 30,
|
|
Leased premises location
|
|
2017
|
|
|
2016
|
|
Foster City, CA
|
|
$
|
—
|
|
|
$
|
76
|
|
Edwardsville, IL
|
|
|
50
|
|
|
|
49
|
|
Total
|
|
$
|
50
|
|
|
$
|
125
|
|
In 2016 the Company entered into a secured related party loan agreement with certain executive officers of the Company which is more fully described in Note 6. Both Ross Dove and Kirk Dove, who were parties to the related party loan, shared equally in all payments made by the Company to satisfy obligations under the loan agreement. During the six months ended June 30, 2017 there were no transactions under this agreement.
During the six months ended June 30, 2017 the Company paid David Ludwig $0.4 million for a portion of his third earn-out provision payment.
Note 10 – Subsequent Events
The Company has evaluated events subsequent to June 30, 2017 for potential recognition or disclosure in its condensed consolidated financial statements. There have been no material subsequent events requiring recognition or disclosure in this Quarterly Report on Form 10-Q.
13