Welcome to the Heritage Global Inc. First Quarter 2023 Earnings Call. I will now turn the call over to your host, John Nesbett, IMS Investor Relations. You may begin.

Thank you, and good afternoon, everyone. Before we begin, I'd like to remind everyone that this conference call contains forward-looking statements based on our current expectations and projections about future events and are subject to change based on various important factors. In light of these risks, uncertainties, and assumptions, you should not place undue reliance on these forward-looking statements, which speak only as of the date of this call. 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, go ahead.

Thanks, John, and good afternoon, everyone. Welcome to our first quarter 2023 earnings conference call. Let's start today's call with Brian Cobb, our Chief Financial Officer, who will discuss our financial performance. Brian, your turn.

Thanks, Ross. Our 2023 first quarter performance reflected strong operating results, including record net operating income of $3.9 million, improved profitability of $0.08 per diluted share and EBITDA of $4 million. We saw growth from both our financial assets and our industrial assets divisions, with all four operating segments contributing to our profitability. This quarter's performance is even more significant than a record result for two main reasons. Not only did we achieve a record quarter, but we did so without real estate sales in our joint ventures as seen in the last three quarters of 2022. Although we continue to search for lucrative asset purchases that include a real estate component, this is evidence, even without real estate transactions, that we can continue to perform at a high level and grow profits in each of our segments. The second being the recent growth we have seen and the ability to deploy capital through our specialty lending segment. Our total balance related to investments in loans to buyers of charged off and nonperforming receivable portfolios was $28.4 million as of March 31, 2023. We have seen an increase of more than $20 million in the total balance from one year ago and an increase of $6.7 million since December 31, 2022. Beyond Q1, our 2023 outlook is very promising. As more businesses face challenges in a difficult economy, our Industrial Assets division sees increased activity as downsizing and facility closures occur, and companies look for ways to responsibly dispose of assets. The slowing economy has also contributed to increased volumes in our Financial Assets division as consumers are more reliant on credit cards and installment loans to make purchases. As consumer debt grows, so does the volume of charged-off consumer loans being sold by financial institutions, and we anticipate that we'll continue to capitalize on the increasing asset flow as we move through 2023. We remain optimistic that the current economic landscape will continue to produce tailwinds on both sides of our business and drive continued financial success. Turning to the financial details of the first quarter. Consolidated net operating income was a record $3.9 million as compared to $875,000 in the first quarter of 2022. Net income was $2.8 million or $0.08 per basic and diluted share compared to net income of $645,000 or $0.02 per basic and diluted share in the first quarter of 2022. EBITDA of $4 million increased substantially as compared to EBITDA of $1 million in the first quarter of 2022, and adjusted EBITDA grew to $4.2 million for the first quarter of 2023, up from $1.1 million in the first quarter of 2022. Our balance sheet remains strong with stockholders' equity of $51.2 million as of March 31, 2023, compared to $48.3 million as of December 31, 2022, and a net working capital of $8.6 million. With that, I will now turn the call back over to Ross.

Thank you, Brian. You did that so well that you didn't leave me that much to add to it, but I'll do my best anyway. So coming off a record year, it was really exciting that we are able, right after a record year, to post our best quarter since our inception. So that was our best quarter in the 12 years we've been running Heritage by a mile. And as Brian said, that quarter was all organic de novo growth, hitting our stride against all five revenue streams. There was no extraordinary win in that quarter. It was just pure blocking and tackling and an entire team of 100 people performing at a very high level. So now you say to yourself, 'Okay, they had a great year and then it's followed by a great quarter. What does that mean going forward? How can I look at the future? And what can I access from that performance? Do these guys still have more hat tricks in the bag? Can these guys still grow at record levels?' So the question you want to say to yourself is very simple: after a decade in business, working hard, is Heritage in a position now where it's truly not just a market leader but a built-to-last company? So the answer for me is, I believe everyone coming together and staying together with very little turnover, gaining clients across the board in industrial and financial, that this company has the right strategy and it operated with the right tactics. And I'm proud to say as the CEO that as the oldest guy here, I look at everybody younger than me and I say to them all, 'Stick around because Heritage is built to last. It has years and years of growth if we all perform.' So why do I say that? Because I think, at this point in time, every one of our revenue streams, from industrial to financial, is positioned with true growth drivers already existing and already in place. Let me do a real quick update on the growth drivers across both sides of the business. In Financial Assets, you've got a quarter-century-old business called NLEX that sells every kind of nonperforming loan from credit card loans to auto loans, and it's a growth company because alternative lending in fintech continues to grow and we continue to garner more share there while maintaining our legacy clients. As we maintain our legacy clients and grow new clients, there is the potential for exponential growth year-over-year for quite a while. On top of that, the pandemic is now over with, and we're seeing increased consumer spending in all of the segments we operate in. As consumer spending continues to increase, defaults naturally follow, to some extent. And as defaults follow, then charge-offs follow. So right now, we're looking at a great last year and a very pleasing multiyear future. Simultaneous to that, the people that we've onboarded has grown. We have more onboarded clients in our lending division than ever. And they're winning more portfolios; they're relying upon us more, and that business has literally the best predictability of any of our revenue streams and the most clear path to exponential growth. Every time we fund that business, we wind up growing the business automatically. So that's a business that, in the end, will constantly, year after year, improve as long as funding stays static even. If funding grows, then that business truly has legs. So that's on that side of the business. Now switching over to the industrial platform. The industrial platform is really positioned in the right place now strategically and tactically. The acquisition of American Lab Trading has proved highly synergistic with our auction division. In fact, on a monthly basis, they're finding assets that we can auction as long as it's assets that they can resell. So packaging that together, that's a business with true growth. Our valuation business is more and more needed as we potentially move into recessionary times, and there's a greater concern with asset values. So that business has true legs right now. And so basically, if you look at all of our businesses, every business has a growth driver. The obvious growth driver is Heritage Global Partners, the auction company. The growth driver there is the entire industrial marketplace is moving to rightsizing. As it moves to rightsizing, as it moves to lean manufacturing, it moves the business process outsourcing. So these companies more and more are using industrial auctioneers. They're also looking more and more to prevent assets from going into landfill. The best way to prevent assets from going into landfill is to consign them to an auctioneer with a worldwide purchasing base. So over and over, I can say, not just this year, not just next year, but I'd like to look at this company for years to come. And I'm a long-term holder, and I believe we have a group of employees dedicated to staying here a long time and really building something of value. Thank you all for hearing me out.

Our first question comes from Mark Argento from Lake Street. Please go ahead, Mark.

Hi Ross, hi Brian, congrats on a great quarter, really impressive. Just wanted to maybe drill down a little bit on the various segments. And historically, I know you guys have commented on unit-level profitability or, I should say, division-level profitability. Any data or anything you guys can provide? I know you said, at a high level, all four units, four businesses contributed. But could you give us a little granularity into Financial Assets versus Industrial Assets in terms of revenue contribution, operating income contribution? Anything there would be helpful.

So I'll let Brian add on afterwards. But just at a higher level, over the last literal year and over the last six to nine months, the biggest comeback has been in Financial, not in Industrial. The pandemic really had not a negative impact on Industrial because the supply chain was called on new equipment, so use of equipment sold at a premium, and people needed it. However, on the Financial Asset side, as you know, the pandemic dramatically impacted the volume of assets we were receiving to sell. That over with, we had, I don't want to say a resurgence in Financial as much as a comeback. So we had to come back, and now we're starting to see a resurgence. So Financial Assets, I don't want to say it was a surprise, but it was the biggest higher performer going forward. Brian, if you can add to that.

Yes. So I'll add on to that. As we look at each of the operating segments, it's very evenly split when you look to operating income. Now Ross is correct with the comeback. From Q1 of 2022 to Q1 of 2023, you see a larger increase in the Financial Assets division driven by the higher volumes. And I'll also point out that we had a fantastic quarter from our refurbishment and resale segment, and that's the ALT acquisition. They had a larger purchase in Q4, which we resold in Q1, which contributed to the increase in the overall Industrial Asset division. So $2.5 million, $2.6 million approximately contribution from each division this quarter.

That's super helpful. And on the Financial Asset side of the house, given just moving paper digits versus physical goods, the scalability and the margin profile on that business, I would assume incremental margins are high. Any kind of thoughts on the margin profile there as that business scales?

So the margin on both sides of the business has just dramatically changed, with everything being on an e-commerce platform and a lower physical touch on the Industrial side of the platform. We used to physically go call bids, Mark, at an auction, fly people out and the buyers had to fly out to go bid on the assets. So that dramatically changed over there, and it gives us huge scalability that everything can sell worldwide over the Internet without the buyer having to travel to the site. On the Financial Asset side, the leverage was always there that people didn't have to physically look at the assets. So on that side, it's not so much a switch to an e-commerce platform as the scalability is that the more volume we have, we don't need an increased OpEx to do the volume. Our staff is there and ready. So literally, we're in a position in this company that if we can garner more supply across the board, we don't have to raise substantially any of our internal costs to sell more supply. So we view ourselves as a highly leveraged company that we can really leverage more supply without adding more cost, if that makes sense.

Yes. No, that makes sense. Just pivoting briefly to the balance sheet, in particular the loan book for the nonperforming loan buyers. Obviously grown fairly substantially over the last year and even sequentially from Q4, I think you said it was $28 million or somewhere around there. What is your current capacity and then, more importantly, ability to deploy additional capital? It sounds like fairly high at this point. Maybe you could help us just think through the...

That's a great question for Heritage's CFO to shine. So Brian, it's on you.

Yes. Thanks, Mark. So the growth in our lending balance currently is $28.4 million. That consists of notes receivable and the investments in equity method. That balance is really correlated with asset supply and kind of the performance on the brokerage side. So as we see the volumes and transaction levels on the brokerage side go up, we see our onboarded clients, our borrowers winning more deals, and the ability to deploy capital to our onboarded list of clients is greater. So we see a great potential for that business to continue to grow that balance over this year, with the assumption that our assets and our transaction volume overall stays high or grows, for that matter.

And the current capacity to be able to put additional capital out right now, where does that sit?

Let me answer first. What you have to look at is we have free cash flow every quarter. We reported $4 million in EBITDA this quarter. We're very confident we're going to have ongoing free cash flow. So our free cash flow is not needed for operations. It's not needed for headcount growth. So our free cash flow can contribute on a regular basis to exponential growth in our lending business. So that's number one. So we're not in a position where we can't continue to fund based upon us contributing free cash flow to fund. And as you know, free cash flow does not have a debt component to it, so our ROI is always going to be higher on free cash flow. Simultaneously, we have good debt instruments and good partners. So if you want to add to that, Brian, go ahead.

I think you covered it. So our NOI or our operating income roughly mirrors our EBITDA because the tax expense that we record on a quarterly basis is noncash due to our NOLs. So I think that's another big piece to consider. Our total cash flows from operations is pretax. And then our principal remittances that we're getting from all the loans outstanding come back at 4% or 5% a month that we also can recycle back out into loans.

That's helpful. And just last one for me. Ross, you talked about building the company for the long duration. When you think about investing back into the business, in areas where you could invest back in the business, either in technology, additional M&A, maybe you could just talk through what the priorities are right now to really take advantage of the strength of the business and get a little more aggressive either with some M&A. Obviously, the ALT acquisition is performing well, but what can you do while the sun's shining, so to speak, here to really fortify and really build this business for the long term?

So we're not an Apple or a Google, and I'm not talking about size. With this massive war chest of free capital that the best deployment is to buy back your own stock. We're a growth company that's micro-cap, and our best deployment of capital is not in a buyback; our best deployment of capital is growth capital to enhance our profits. So what we're looking at is using our capital on a contributing basis every quarter and literally annually to put that money back into our lending segment, which we think is our most predictable revenue and our most logical place to put back our free cash flow and our profits. On top of that, we're always going to hold back enough opportunistic capital that on the industrial side, if we find a highly accretive deal, it will be financeable internally by us without us looking for future capital. So there's a balance there that we're constantly looking at quarter-over-quarter on making sure that we're financially capitalized for the future, Mark, if that makes sense.

No, that's helpful. I appreciate the time. And again, congrats on a really, really strong quarter.

Well, thank you very much for congratulating us because we're quite happy with the quarter, and we anticipate that we're in a good place right now, Mark.

And at this time, there appears to be no further questions. I would like to turn the call back to management for closing remarks.

All right. So this is Ross, the CEO of management. I want to thank you all for listening. I want to thank you all, our existing shareholders, for sticking with us. It really matters to us, and we're always available to talk to you. And if there's anybody considering being a new shareholder, we're very, very available to talk to you, walk you through our business plan and understand what you're looking for against what we think we can accomplish. And we look forward to encouraging people to take a hard look at Heritage because underneath the radar screen, looking at ourselves, we're pretty proud of what we're doing. And we think we can do more, and we're looking for more people to pay attention to us. So we're extremely appreciative for anybody who paid enough attention to listen in. And I thank you all graciously. Everyone, have a great day.

This concludes today's conference call. Thank you for attending.