Good afternoon, ladies and gentlemen. And welcome to the Heritage Global Inc Third Quarter 2020 Earnings Conference Call. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this call may be recorded. I would now like to turn the conference over to Michael Kim, Investor Relations. Please go ahead, Michael.

Thank you, and good afternoon, everyone. Before we begin, I'd like to remind to 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 last -- as of the date of this release. For more details on 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?

Thanks, Michael. And good afternoon, everyone. Welcome to Heritage Global's first earnings conference call. As you may know, we recently uplisted our shares to the NASDAQ stock market and successfully completed a public offering of our common stock, which I'll discuss in more detail a bit later. So as part of our effort to enhance Investor Relations, we wanted to provide the investment community with a forum to discuss quarterly results, as well as review why we believe the company is positioned to increasingly leverage our differentiated diversified business model. Heritage Global is an acid liquidation services company specializing in financial and industrial asset transactions. We provide options, brokered asset sales, principle market making, secured lending and asset advisory services to a diversified clientele base from across sectors and geographies. Turning to our performance for third quarter, we reported strong results highlighted by net income of $1.3 million consistent with the third quarter of 2019 and adjusted EBITDA of $1.8 million equating to 28% growth over the third quarter of 2019. Focusing on industrial assets, Heritage Global advises enterprise and financial customers on the sale via auctions of industrial assets, mostly from surplus and sometimes distressed circumstances, while acting in a range of roles, including as an agent, a guarantor or principal. During the quarter, we continue to capitalize on rising demand for the recommerce of used surplus equipment, as companies increasingly look to source more affordable machinery. As a result, we benefited from strong growth in online auction volumes and related revenue. In addition, auctions represent a key source of market intelligence for our valuation business, which provides industrial and wholesale inventory and equipment valuations, to assist financial decisions in making lending decisions. Turning to financial assets. We have two powerful reasons for our optimism. Firstly, we believe Heritage…

Thanks, Ross. For the third quarter of 2020, total revenue increased 14% year-over-year to $7.6 million reflecting strong growth in services revenue, which were up 16% as well as higher asset sales. Importantly, we maintain multiple revenue streams across businesses, including brokered asset sales, principle auctions, sales commissions, and advisory and secured lending fees on top of recurring foreign flow contracts, with industry leading customers, reinforcing the sustainability of our top line growth. Gross profit or total revenue, less cost of services revenue and asset sales totaled $5 million for the third quarter of 2020, compared to $5.3 million in the prior year quarter, with a modest decline mostly a function of timing and activity of asset liquidation transactions, as well as a mix shift between financial assets and industrial assets. Operating income grew 27% to $1.6 million, compared to $1.3 million for the third quarter of 2019. We lower selling general and administrative expenses, mostly due to the discontinuation of Equity Partners at the end of last year was partially offset by slightly lower gross profit and higher compensation expense related to improve financial performance by the industrial assets division and additional headcount to underpin growth, primarily at Heritage Global Capital. From a margin perspective, we believe that tailwinds going forward will include a favorable mix-shift toward higher contribution businesses and fee structures, as well as rising operating 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. And as mentioned earlier, net income totaled $1.3 million or $0.4 per share for the third quarter of 2020, and adjusted EBITDA was up 28% year-over-year to $1.8 million from $1.4…

Thank you. [Operator Instructions]. The first question comes from Mark Argento from Lake Street Capital Markets. Please go ahead.

Just wanted to dig in a little bit, kind of in the environment we have right now, it's going to be unique environment you got, partially the economy doing really well, starting to see maybe a little distress on the consumer credit side, can you just maybe do some talking us through some of the things that you guys are focused on in terms of identifying opportunities, and then to take on the financial asset side. Is there a backlog they're building in terms of assets that some of these institutions maybe get off their books?

So, I'll take it from here and Scott can add on. This is Ross, and great to hear from you Mark. So, really what you're looking at right now is, what I'd call a pent-up demand by the buyers of non-performing loans. They've all raised a lot of capital and they all looked to borrow a lot of capital in this marketplace, where it's available from people like us. But at the same time, there has not been enough product released yet. So, we’re looking at the loan loss reserves from the nation's lenders, they're looking at increased FinTech assets that they think are going to become available very soon. There is obviously the new category of the buy now pay later assets that are about to come on market too. So there's a general enthusiasm, that there's going to be a lot of products. But I would say, honestly, that product we're probably looking at not getting till next year, we think with the elections just finishing. And everybody's still kind of being careful that you're really looking at it next year and the year after increase.

Yes, I agree with that Ross and hi Mark. Just kind of like the floods, the rains are pouring. The water is building up behind the dam, we know the volume is increasing. But we just haven't seen as much as we expect to see in the coming, quarters and years.

On the flip side Mark in our industrial assets group, we've seen record attendance at our auctions, and record pricing. Right now the supply chain on new equipment is slowed down the ingress and egress globally hasn't been what it was before COVID. And even at this current point in time, used assets are bringing a premium in most of the sectors we're in. And demand is very high, because you're able to get those assets and purchase them real time. So we expect that to continue over the next year. And it will continue getting record crowds in a very high prices on used equipment.

Yes, that's super helpful. And I know in a pharma is an area that you guys have built kind of an expertise in. From the continued M&A activity in that space you guys are seeing continued activity there. Is that going to be a focus again going forward?

Yes, I mean, if you look right now we have three assets currently on the book for Pfizer, everybody will read the world class, great announcement today that we're moving towards a vaccine. We think that not only bodes well for the world, but we think it's going to free up a lot of redundant assets, as pharma companies across the world retool and as the government's put leverage on all of them to cooperate in rolling out these vaccines, you're going to see a strong purchase of new equipment. And you're going to see a lot of secondary equipment get to the marketplace, which is much needed by the smaller companies now. So we think it bodes well, not just for the country, but we think it bodes well for the people that can take advantage of use equipment, increasing in volume.

That's great. And it just Scott just turned into the P&L here. Looks like you got some a pretty nice leverage in the model here as incremental revenues kind of build, maybe talk to you a little bit about how you think about how this model scales and in particular kind of thinking about it in terms of incremental margin.

Sure, yes. Happy to this Mark. So as a services-based business our primary operating costs are people costs. And so in terms of the fixed costs, in addition to that people got to know we have some rents and things like that. But our overall fixed operating costs are about $10 million a year. So that's about $2 million to $2.5 million per quarter. And as we were broken into the two divisions of industrial assets and financial assets. On the financial asset side, for every $1 of incremental revenue once we've covered our fixed operating costs, then that drops about $0.70 $0.75 to the bottom line. And then on the industrial asset side for every incremental dollar of revenue, it drops about $0.40 to $0.45 to the bottom line. So the model is very scalable.

I was going to sort of put that in a while to use some good earnings here. Like you got some nice margin or a nice incremental margins there. And there's just one last one for me, maybe for Ross, in terms of M&A opportunities, what's the high level criteria that you guys are really focused on there?

So when we look hard at M&A right now and what I would call a very transitionary marketplace where there's really two different segments in both segments, M&A would be what I would call, probably more of a niche play of built on of a specialty entity. On the industrial asset side, it could be somebody with expertise in global arbitrage of medical equipment, it could be somebody that has a special understanding of hospitality equipment as the world changes. So they would be both on. And on the financial asset side, we think that there's just a ton of room for de novo organic growth and that the current plan is to go greenfield. So the capital we raised primarily wasn't raised as M&A capital, the capital we raised was really primarily organic growth capital. We always have our eyes open Mark, but it's not, on our current plan it's not at the forefront.

The next question comes from Michael Diana for Maxim Group. Please go ahead.

First of all, thanks for having the call. I think the calls are a really good idea for you to tell your story in your own voice. In Scott's remarks, he mentioned a favorable mix shift. And I think when he was just talking about the scalability of the financial side versus the industrial side, maybe partly answered that question, but could one or both you to talk about the favorable mix shift, possible favorable mix shift?

The build that really we're most excited about, is that we built this business so that we didn't need both businesses to do great at the same time, there were different times in different financial marketplaces, where there's a lot of nonperforming loans, but there's a tightness in the amount of surplus industrial asset available and vice versa. So the good news is right now, we see tailwinds for very logical reasons in both businesses at once. And when both businesses once synergistically are growing, it puts us in the best spot we can be in. Why is that happening? It's happening because there's a pent up demand of nonperforming loans. And it's very unlikely that nonperforming loans magically become performing loans. So generally speaking, once they're nonperforming, whether they're getting sold now or getting sold in the future, the supply is growing. And simultaneous to that there's a growth in the supply of industrial assets coming on the market that has nothing really to do with COVID. COVID created a huge buyer demand but the seller demand is because there's now going to be lots of technological advances, as we move forward that are creating excess surplus assets. So, there is, the favorable mix-shift is really the fact that what Scott is looking at is, we believe we can get a higher contribution with the capital we've raised. Meaning, we can add some more as a principle where generally speaking, when a principal and the guarantor on the industrial asset side, there's greater margins than just fee based. And we have more free capital there, and simultaneously with us growing our capital and growing our credit lines on the financial asset side, we're going to be able to put our capital to work, not just as an advisor, but as the principle lender and taking that mix so where we can actually have a lot more capital out, producing a lot more revenue simultaneous to the growth in our fee-based. It goes well, we believe for the next 18 to 36 months. Scott?

Yes. Thank you, Ross. Hi, Mike. With the generation of good profits, good cash flows, good EBITDA, what that does is, it creates more opportunities for us as you know we have on the industrial options side, there's the various options of a fee-based option a commission-based option or a guarantee or a principal transaction. And on the principal transaction and on the guarantees, our margins tend to be a lot higher and having all this excess cash does give us, a lot more opportunities to take advantage of these guarantee principal options.

All right. Thanks very much.

Fair enough, Michael? And when Scott says excess cash, it's my job as the CEO to make sure it doesn't say excess to ensure we deploy it.

Okay. All right. I like the 36 months part, you mentioned, the longer.

Especially for a young guy like me. Are there any other questions Mike?

Thank you, sir. The next question comes from John Fichthorn from Dialectic Capital. Please go ahead.

Hi. Thanks for taking my question and nice job on the quarter. Just looking out at next year at any point in time in the future that you're comfortable talking about with this kind of demand. Could you talk about the capital intensity or cap structure? And how you guys think about the two different lines of business? And like how much more capital you're going to need to grow one of them out relative to the other one? And what you think you might need to do? Kind of, how you balance capital needs versus revenue growth really.

So there's a very different dynamic between the industrial assets division and the financial assets division. The reason is, in the industrial assets division, there's a fairly rapid return on capital. So even if we bought transactions for $5 million, $10 million, $15 million, generally speaking, within 45 to 60 days, we can do an auction sale because most of what we're doing on the industrial assets side is really dates certain sales. So, it's not like a brokerage where you're buying, putting on the market and waiting. We're pretty much marking the market. We're trying to be a principal and get it at the right undervalued price and then mark-the-market rapidly. So, there's a constant return of capital, and because of the recycled capital, we have enough in the short run that we don't feel intense pressure. Now the flip side is on the lending side, when our clients come up to us and they want to buy a non performing loan portfolio, they're generally speaking when you collect the money over two to four years. So our capital is tied up for two to four years, yes, we're getting high returns on it, but we're getting it monthly, not that all at once. So the only way to grow that business is with a combination of strong credit lines and strong financial partners. So there it is more capital intensive, as you want to grow within the industrial side. However, if we can stay continually profitable, and continually build lots of free cash flow in the enterprise and reinvest that cash flow, then we don't have to go out to the marketplace for any kind of an equity raise, we think that we can do a lot of organic growth by producing revenue and putting that revenue to work for us, as both the principal on the industrial side, and as a lender on the financial side. And we create growth. Sort of fair answer, John?

Sure. And so -- I mean, that's a very quite frankly, it's a surprising statement, given the idea of pent up demand for next year which I fully buy into. And I keep hearing stories of this kind of wall of NPL is going to hit the universe next year. It would seem to me like there's no way you're going to generate enough cash flow to recycle it into satisfying that demand. But maybe I don't know, maybe the cap structure is such that the equity you have to put up is relatively low, or there's a first loss feature or whatever else it just seems.

There is a first loss feature, and we have over $100 million in relationships in current commitments from large hedge funds that have already underwritten us and back us. The reason for that is that we are a market maker in these kinds of assets, and that they're very comfortable that we know the right borrowers. And we can underwrite what an auto portfolio or a FinTech portfolio or credit card portfolio, this tertiary is worth. So we're comfortable that we're going to be able to leverage those relationships, grow new relationships and it combined between those relationships that we currently have, and others we're working with, that we can leverage their capital along with our capital and keep growing. At least that's our next two year plan. And as we need more capital, capital is being raised every day for distressed debt. And we think that capital is going to rely upon knowledgeable domain expertise operators like us.

It's great. Thank you in the last -- my last quick kind of random question is, what's the most surprising thing you think we'll see from your markets? What's the thing that surprised you over the last three months as you look out, either in terms of sector that's doing better or worse, or just whatever kind of surprising change you've seen in the market over the last few months that you think would be valuable to us to understand where your business is?

I think, to me, I think that unfortunately, and I don't want to be the Grim Reaper anyway. But I think unfortunately, a lot of plants that were closed in the short term because they thought that COVID was the reason they're closing. I think we're going to find out and maybe it's not so much of a surprise to me is I think it's going to be the dam, that the world has changed. And when this pandemic is long over again, there were certain things that we experienced, that are really going to change commerce for many, many years to come. I think it's going to have an impact on the hospitality industry, an impact on the travel industry, and an impact on the aircraft industry. And I think that the surface contractor to the supporting those industries have many plants that may not reopen, they're going to have to be monetized, and the assets transferred to other plants. If there's any surprises, I would say it is the resilience of the secondary market, that when a little second industry may be struggling, there are entrepreneurs and other industries that have figured out how to really utilize ecommerce and buy those assets. So when we first worry about the impact of the pandemic on surplus assets, my surprise was the resilience of the secondary market, and how those assets continue to sell at high prices, and continue to get reutilizing and continue to get absorbed, which really, I think, says a tremendous amount about the entrepreneurial ship in America, and the fact that these idle assets are all going to have a second life and that we're going to come out of this stronger than ever.

Hey, John, this is Scott, I agree with what Ross has said and to me the most surprising thing was just the speed in which the industrial assets, division with the options at which the buyers came in record numbers and the prices that were achieved. We had a slowdown in March when most of the country in the world closed down. But by the second quarter, we were seeing record attendance at our auctions, and we were seeing a record prices on the assets that we were selling just in a very short window. So that's what I was most surprised by.

The final question comes from Mike Shlisky from Colliers Securities. Please go ahead.

I wanted to start off maybe by asking a little bit about the pent up supply in the financial assets business, and that the cadence of how this might play out whenever the dam will be open. And do you think you're going to have one gigantic quarter where everything kind of comes out in advance? So is there going to be kind of a more measured approach measured because the banks let the assets come out that way, but also because there's only so much that the customers can actually handle? Just some sense so how does my rough and everything you see on your assets grow?

So it's a little bit not about the liquidity. We believe that the liquidity is there in the buying community into the capital is there. It's really about the lenders, basically different appetites. So some of them are going to test the market, see the pricing and watch for others. And some of them are going to want to get out early and sell the assets that they've had pent up demand. So we think that there may be a faster growth in the amount of assets that come out of nonbanks lenders. They come out of FinTech lenders that come out of buy now pay later lenders, they come out of different various lenders that are not FDIC chartered institutions. And even though they had the loan losses in the FDIC chartered institutions, we think that could be a process of the next year or two of those loans coming out. And I don't want to say dripping out. But I think that in the end, you're not going to see much change this year. You'll see volumes beginning to increase in Q1 and increasing and we estimate for the next two, three years. Every time we've seen the country go into increased nonperforming loans in the past going back all the way to the yes or no price in the FDIC days through the 2008 financial stresses. We saw that there was a two or three year period to rationalize the non-performing loans and get the levels under control. So we're bullish on there being activity, but we're not looking for some massive one quarter or two quarter, get rich quick windfall. We're looking at a steady two to three year supply increase.

Yes. I agree with that as well. I think the analogy back to the dam is, I think the dam will start to open it up, but I don't think it will come crashing down all at once. So, I don't think there will be a huge influx in any one quarter, but we have seen that these lenders do kind of operate in tandem. So, I do expect that, when it does turn and opens up, I think there's going to be an increased flow that we'll see for multiple quarters and years, actually in light of what's been happening across the macro economy.

And just to follow up on your Heritage capital business, do you feel that what you just raised and you have pretty solid cash balance at the end of quarter, by the way? So the cash you've got available to you, does that allow you to follow that kind of multi-year tailwind? Or you have to get to more capital after the first span of year or two?

We have a very strong belief that, with our performance and our ongoing continued performance that, the $5 million credit line that we have with our incumbent lender will be expanded. We haven't really pursued big expansion yet because it's been untapped. But as we tap it and show that we're using it in accretive fashion, and as we're growing the business, we believe that we'll be able to increase our debt position based upon our profits. So, we're not anticipating going out to the marketplace for more capital right away. Will I make a promise that we never will? No. I can't make that promise, but it's nothing we're currently working on. It's not on our plate, it's not on their agenda. We are actively negotiating with our capital partners to also expand our alliance there. And anytime we can obviously drive down our costs with all of our capital partners, but we feel pretty good that over the next 18 months, we've got visibility that we can put out enough money to make a big, big difference in our earnings.

And as we all know, the best time to ask for increased capacity on a line of credit is when you don't need it. So, we're real pleased obviously with the profits we're generating, the cash flow from operations EBITDA et cetera, in our cash position. So hope that helps.

Sure. Yes. I mean, obviously when you guys have all this tasks done and you did it with much greater term profile in mind, that's probably ready on the cost of capital. So kudos to you for that. You wouldn't ask for the money if you didn't have [indiscernible] of course.

Correct.

Can you maybe also just, I may have two more here. Can we have just give a sense that the growth rate that you've got in your business that deals with some of the FinTech lenders out there. Is it above the company run rate or is target below the current time?

So about half of the non-performing loans we sell, I mean, FinTech is a pretty, pretty broad category. But about half loans, I would say digital commerce loans and the other app for basically old school, auto loans and credit card loans and bank loans. So, it's about half digital commerce. Going forward, we think it's going to be maybe 60% to 65% digital commerce over the next 24 months. It's hard for us to know how many of the larger banks and money center banks are going to use a third party broker to sell their assets versus sell them direct on their own. We think there's a much more growing cadre of digital commerce clients who are new to the business, who are going to want the open sea and the transparency of using somebody like us, who's got a large built in base of buyers. So that's a fair answer. A best guess would be maybe getting up to eventually two-thirds of non-banks FinTech and one-third traditional banks.

And then maybe one last one from the here, the results of last three collections to this change the environment for you anyway from a regulatory standpoint, do you think it will be for the positive or the negative?

We're not going to -- we're not going to pretend it were CNN versus Fox News here to where it is. This is one question. I'm happy to say. I'm clueless and don't know. And I got scrutiny of anti-asset.

Fair enough. Okay. I'll pass it along.

You're the analyst not me. I'm just an operator.

It's not going to change the fact that the volume of the assets that we sell, are increasing. So

Yes, you got it. I have a great day. And I'd like to thank everybody and end the call by saying that this is our first live earnings call. And we're extremely appreciative to have the opportunity to get to -- tell our story to get to speak with you all and we're grateful and thankful for those of you who dialed in and wanted to pay attention and those of you listening later. And we're going to do everything we can here at Heritage to bust -- whatever you bust in order to really make sure that we perform and make you all proud. So thank you very much.

Thank you. This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.