Thank you for standing by. This is the conference operator. Welcome to the Heritage Global Inc. Fourth Quarter 2020 Earnings Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to John Nesbett, IMS Investor Relations. Please go ahead.

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 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. Go ahead, Ross.

Thanks, John, and good afternoon, everyone. Welcome to our fourth quarter and full year 2020 earnings conference call. As you all know, 2020 was quite the ride. Yet despite the public health and economic challenges presented by the COVID 19 pandemic, Heritage closed the year with record fourth quarter results as reflected in net income of $6.3 million and substantially improved EBITDA of $3.5 million. We believe these results demonstrate the strength and the resilience of our diverse business model, which has enabled us to continue to drive momentum in our business despite the challenging economic landscape. We saw a particular strength during the quarter from our industrial assets division, where the close of several large transactions contributed significantly to the growth in the fourth quarter. We expect to experience continued robust supply on the auction side of the business and as the pandemic continues to drive the liquidation of industrial equipment and assets. The reality is, there are many companies out there that need to reduce and monetize surplus equipment as they reposition themselves to emerge viably from the pandemic economy. And we are seeing strong growth in our online auction volumes. With our visibility in the marketplace today, we expect to see continued and increasing demand for our industrial re-commercing capabilities. We are similarly optimistic about our prospects in our financial assets division. Over the course of the calendar year, we expect to see an increase in the release of non-performing loans into the marketplace. The National Loan Exchange, or NLEX as we've referred to it, is poised to benefit from the increased activity. Specifically, the current stay-at-home economy as resulted from COVID-19 restrictions has produced increased online shopping activity, which has driven rapid growth of the buy now pay later, or as they say BNPL sales, and…

Thanks, Ross. The company achieved operating income of $3.3 million for the fourth quarter of 2020, demonstrating significant improvement as compared to an operating loss of $446,000 in the fourth quarter of 2019. The improved performance was primarily due to the completion of multiple large transactions in the company's industrial auction business. As Ross mentioned, this growth reflects the underlying strength of our multiple revenue streams from brokered asset sales, principal auctions, sales commissions, and advisory and secured lending fees. The fourth quarter of 2019 included a $600,000 impairment charge related to Equity Partners, which was discontinued as of December 31, 2019. From a margin perspective, we believe that tailwinds going forward will include a favorable shift in mix toward a higher contribution businesses and fee structures, as well as rising operational leverage as economies of scale increasingly build within businesses and across platforms. We remain focused on managing expenses both at the corporate level and across business units, and increasingly leveraging synergies across processes and systems to drive further operational efficiencies. Net income increased to $6.3 million or $0.17 diluted earnings per share for the fourth quarter of 2020, as compared to $600,000, or $0.02 diluted earnings per share in the fourth quarter of 2019. The financial results for 2020 include an income tax benefit of $3 million for the fourth quarter of 2020, and an income tax benefit of $3.6 million for the year ended December 31, 2020, which included the reversal of the Income Tax Valuation allowance, as required according to the income tax accounting standards. Excluding the income tax benefit, resulting from the Income Tax Valuation allowance, the net income for the fourth quarter of 2020 would have been $2.5 million or $0.07 diluted earnings per share, and $4.5 million or $0.14 diluted earnings per share…

[Operator Instructions] The first question comes from Mike Shlisky from Colliers Securities, please go ahead.

Good afternoon. So you did raise some capital during the quarter, but your cash balance of $23 million, that was very large. Can you take us through some of the finer points of the cash flow in the quarter? And maybe, besides the equity, were there any other large, chunky types of one-time cash inflows at all?

So, obviously, there was the capital raise which is reflected, on top of the capital raise, there was lots of free cash flow in the quarter. We had some very significant transaction wins. We did a transportation auction of some assets from Coca Cola that belonged to Odwalla, that we made a significant profit on realized return of that cash in the quarter. We had the sale of a building that we've been holding for multiple months, in fact, for over a year, that was part of a larger acquisition of a pharmaceutical plant, that sale closed in that quarter, and returned a lot of capital to the company, so both of those capital returns had been outstanding capital. And so I'll turn it over to Scott to add color, but those were two of the significant wins.

Hey Mike, good to hear from you. So yes, just to add on to what Ross said, the way our industrial assets business work, our works our auction business, we're very fortunate with -- on the day that an auction closes, we invoice all the buyers and the buyers have essentially 24 to 48 hours to wire us the funds, the winning bid price. And then, we actually sit on that cash for anywhere from 30 to 45 days before we settle with the seller. So there, because of the large transactions that Ross had mentioned, we do get -- when we get to the quarter end, there are times if we have a lot of large auctions at the end of the quarter that we will have an inflated cash balance. But that was part of it. But Ross is right, we had a fantastic year with the free cash flow and great EBITDA. And with the equity raise, that's how we ended up with so much cash at December 31. Does that make sense?

Yes, that makes perfect sense. I want to go through some of the individual numbers but sure, certainly, thank you very much for that. I also wanted to move on to the buy now pay later portfolio and that whole sector. I guess was that one large [$25 million] [ph] transaction for you -- was that one that would be called unusually large for the BNPL sector?

No.

It's not, okay.

It was actually not large, it was actually a trial where potentially, since we did great, it could actually expand and the other ones be bigger. $25 million of BNPL doesn't scratch the surface on what's starting to come to market. The fact is, we're very early and it was an entry deal. FinTech and peer-to-peer has been around a long time. BNPL is really just started to grow and really grow in leaps due to the pandemic and everybody staying home and buying all of their retail items and using BNPL. So, no, it was actually a small transaction compared to what could come if we become the basically the dominant or preeminent firm that they're using, Mike.

Yes, just to follow on to what Ross said, there's just a tremendous amount of capital being raised in that space, in the buy now pay later space. As a matter of fact, the largest BNPL lender was Klarna, I believe Sweden, and they, I believe, raised another $1 billion last week. So, we see tremendous growth opportunities in this space.

And just to clarify, that space is not seeing the same pent up charge offs that you're seeing in other types of loans, like a student loan, or a credit card portfolio, is that a more open market right now?

The curve takes a while. In FinTech, a lot of these companies are basically three and four and five years into their [ALT] [ph], their alternative lending platforms, and they're starting to build up NPL portfolios. We're not trying to be the soothsayer and say what's going to happen with BNPL, but we do know that as we track the amount of loans that increased on a monthly basis, the increase in loans almost always produces down the road an increase in NPLs. So we're extrapolating from how much money is going out that at some point in time, we're going to see a much bigger non-performing loan segment come to the market, Mike.

Got it. And then, one last one for me, there's a lot of headlines about a rising interest rate environment, does that help your auction business at all, as companies who have some variable rate debt might want to sell off some old assets to raise some cash to pay things down, is that been in the past a tailwind for you?

It's a little bit different than that, but you're onto something. Rising interest rates often are tied to companies struggling, that are manufacturing companies, and corporate companies with loan covenants, and the rising interest rates sometimes are telling that the company is going to not necessarily meet all its obligations, and have to monetize idle or underperforming assets in order to meet their obligations. And sometimes with the rising interest rates, they actually rise faster on the more troubled side of the bank on the asset base side. And so, sometimes, even if the interest rates look good to the really, really healthy companies, who are really driving down the best interest rates, the interest rates can go up quicker on the ABL side, and then it does have an impact, obviously. Because, as companies need to service debt, they start looking harder at what assets are truly performing in their manufacturing process, and what assets they can free up. So we think it will have more of a positive impact than a negative impact on the assets flow.

Got it. That makes sense. Ross, Scott, thank you. I'll pass it over.

[Operator Instructions] The next question comes from Mark Argento from Lake Street Capital. Please go ahead.

Ross, Scott, congrats on a strong quarter, big year for you. Looking at the mix of industrial businesses, as you look out into 2021, is it's still quite a bit of pharma -- in that M&A cycle in pharma, are you still looking to be a big beneficiary of that? And are there any other key sectors that you're focusing on right now?

Well, I'll start on the industrial side. We've got a ton of pharma stuff signed right now, if you look at our website, you can see auctions for Pfizer, you can see auctions for AMGEN. But we're also starting to see an increase in the amount of auctions we're looking at in the aerospace side. We've got an option coming up now for iAero Thrust, this very large with -- older airplanes that basically are going to sell for parts etcetera. And engines that basically are going to sell to resellers. But we're seeing that a lot of the people that are basically in the aerospace business that we're servicing the big companies, are looking to monetize assets. And obviously, when you look at the big manufacturers of airplanes, they're sitting on a lot of inventory. So a lot of the people that basically we're manufacturing for them to put inventory into new planes. We think post-COVID, they're not going to be building these many planes for a while. So I would say our second sector other than pharma is aerospace, that I think could be hot over the next two or three years. And obviously, we're looking at a whole bunch of deals from the food processing space, where this constant change is, but it looks to us like it's going to be fairly robust across the manufacturing sectors we're in, Mark. On the financial assets side, our problem is the same, there's a massive, still pent up demand among buyers. And we still haven't seen the release of all the loans, everybody says are coming forward. So, the auction side, super busy, the financial side, trying to get super busy.

When it comes to the financial side, I know, politically, been a little bit of a hot button in terms of potentially writing off or forgiving some student loans. Does any of that really play into what you are doing? I assume that's more of the federally-backed loans versus any private market loans, but any thoughts there?

Yes, basically, the buyers are not sure about the future economic situation, they either want to buy at a greater discount, or they want to hold back. Because in the end of the day, if they don't know what new forbearances could be put in place, they don't know how long until they can collect. And they can get around it and still buy assets if they're looking at a forbearance, they can't buy assets, if they're looking at a potential forgiveness. So there's a big -- the two big words to start with that. But forbearance, they can figure out because it's a timing issue, and you can do the math on how long before you can do something. Forgiveness, no. So it's been -- but that's not the socio-political part that really impacted us, it's really more been sellers not wanting to sell assets during a pandemic and be the Grim Reaper and put assets on the marketplace and create collections prematurely. And so that's why everyone is telling us that everyone's going to have to start dealing with this in the second half of the year. What they're really saying, I believe, is that they think we're going to have a vaccine by the second half of the year. And we're no longer probably going to have a bunch of brand new stimulus packages up to this one. So the ending of the stimulus packages and the beginning of the greatest news of all time, which is that we're all got vaccines and we're healthy, we think will stimulate that business back to normal levels. But we're not -- we're just the auctioneer, not the analyst.

You did a good job. And then just lastly, Scott, in terms of the amount of capital that you have out right now, in terms of lending on some of these portfolios, have you've been able to deploy more capital initiative there in terms of ramping up the book?

Yes, is a good question, Mark. And we have deployed some of the capital that we raised, not as much as we'd like, but there's just not the volume yet. We know that there will be and we expect it to happen in 2021. But we did recently fund a very large deal, which we're very happy about, that bodes really well because it's one of our identified super mid-tier debt buyers, that we have a 20 plus year long relationship with. Did that answer your question, Mark?

Yes, and then, you anticipate -- is that like three year money, five year money, remind us again how quickly you turn that book?

Yes, it's in the two to four year range, Mark. Some of them will be on the shorter end and others will be on the longer end. But on average, around three years is a safe rule of thumb to use.

Great, appreciate it. Thanks. Good luck.

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

Thank you. Just on the staging of your probable revenue growth, as it sounds like from what you've been saying, you expect the surplus equipment business to be very strong and then the next wave would be the financial assets and then after that the capital business, the lending. I know those two go together, but it sounds like it's setting up here for a somewhat of a lengthy stage thing.

Yes, the problem is, it's very hard to take our company and say, this is what we think we're going to make annually, and then cut it up by the quarter and make it equivalent quarter-after-quarter. A lot of times there are big spikes. But on top of big spikes, there's also a building, just as an example, in our lending business, the reporting is tied to GAAP [ph], so even if you're collecting large fees upfront, a lot of times those fees are amortized. And they reflect over years, and you see them more towards the back end of the year. In our financial assets business, everyone says the second half is going to be twice as big as the first half. I'm not going to be the analysts, but I can tell you that we're talking to so many people who are telling us, get ready, there's going to be asset flow, it's just hasn't happened yet. Same thing our valuation business is starting to pick up now. And so, you don't want to tell everybody is going to be a second half of the year and not have a great second half of the year, because you don't have enough visibility. But, without a crystal ball, everyone on the outside looking in is telling us it's going to get busier as the year progresses. And we have not been incredibly busy in Q1 in financial assets. We've been pretty darn busy in industrial assets. So, that's all I can tell you from what I see today, Michael.

Yes, okay. That's great. Thank you.

This concludes the question or the session. So I'd like to turn the conference back over to Ross Dove for any closing remarks.

For any closing remarks, I just wanted to take a real quick moment to thank everybody for their participation, for their interest. And we're very encouraged by the people are following us, that are paying attention to us. And it is a growing cadre of investors who are learning to believe in us, and we're here to work as hard as we can, work and perform as well as we can. And we see that there's a bright future out there, and our belief and we hope you keep an eye on us and if you keep an eye on us, we'll try to make it an eye worth keeping. So thank you very much. Bye.

Thank you. Take care. Bye, everyone.

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