Good day, everyone, and welcome to the Heritage Global Inc. Second Quarter 2024 Earnings Call. At this time all participants are in a listen-only mode. Later, you'll have the opportunity to ask questions during the question-and-answer session. Please note, today's call will be recorded and we will be standing by if you should need any assistance. It is now my pleasure to turn today's conference over to John Nesbett, President, IMS Investor Relations. Please go ahead.

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, please go ahead.

Well, thank you, John. Good afternoon, everyone, and welcome to our call. Before I give the call over to Brian to go into all of the details of the call, I thought I'd just give you a couple of quick observations. Q2 was a really solid performance for us, primarily because it was across both Financial and Industrial assets, with $3.5 million in consolidated operating income and $4 million in EBITDA, which was a big improvement over Q1 and bodes well for our outlook into Q3 and Q4, where we've had some accelerated client retention and the market is really strong. One thought I want to leave you with before Brian takes over is that sometimes you have a really solid quarter and at the end, you're left without many prospects for the next quarter. That did not happen at all this time. We ended the quarter very strong with a robust pipeline. We've actually added new forward flow clients on both sides of the business, and we're rolling into Q3 with a very solid and bullish view. So with that, I'll turn it over to Brian to walk you through all of the businesses and what we're doing to create improvements in Heritage Global Capital, which has been the one part of our business that we need to get on a better track. Everything else is on the exact right track. Brian, take it away.

Thank you, Ross. I'll begin by going over our divisional highlights before moving into our financial results. Our Industrial Assets division continued to execute in the second quarter of 2024, reporting total divisional operating income of $2.1 million, an increase from $1.5 million in the prior year period. Our auction business, in particular, had a strong quarter. Increased economic pressures continued to cause downsizing and office closures in various businesses across the country, resulting in the sale of surplus industrial machinery and equipment. As previously disclosed, in conjunction with our partners, the division completed a transaction that involved the sale of equipment and a 10-year building lease on the recently acquired pharmaceutical plant in Fenton, Missouri. The lease was determined to be a sales-type lease. Together with the sale of equipment, the company recorded a total of $1.3 million in earnings for its respective share in the second quarter. As we look to the back half of 2024, we have a strong auction pipeline in place and expect to see continued activity in the second half of the year. Our Financial Assets division performed consistently in the second quarter of 2024 compared to the prior year quarter with operating income of $2.7 million. Our brokerage business continues to perform well. We continue to see steady volumes of charge-off credit cards and nonperforming loans and are optimistic about the growth of this business moving forward. As of June 30, 2024, our total amortized cost basis of loans to buyers of charged-off and nonperforming receivable portfolios was $35.2 million, classified on our balance sheet as both notes receivable and equity method investments. As previously noted, we are in an economic environment where consumers have less capacity to pay their debts, resulting in lower collection rates industry-wide. As a result, the company's largest borrower has had continued difficulties meeting their obligations. This borrower continues to collect on the underlying portfolios and remit these collections to the company net of servicing fees. However, these net collections are currently not sufficient to satisfy all minimum required payments. Beginning in June 2024, after this borrower's June remittance fell short of the minimum amount due, the company placed the loans on nonaccrual status. The company's share of payments received on loans on nonaccrual status, including interest, will be applied against the outstanding balance. As of June 30, 2024, the amortized cost basis of loans on nonaccrual status was $24.6 million compared to no loans in nonaccrual status as of December 31, 2023, primarily due to the loss of interest income from the cost recovery accounting treatment. The default is currently expected to reduce the company's total 2024 operating income by approximately $1.6 million. It is important to reiterate that Heritage Global is a profitable, diversified business with multiple growth avenues going forward. Reflecting the strength of our cash flow and balance sheet, the company completely paid off the remaining principal balance outstanding under its 2023 credit facility with C3Bank, executed subsequent to the quarter and in advance of the loan's maturity date in 2028. Now turning to the financial results, consolidated operating income was $3.5 million in the second quarter of 2024 compared to $3.1 million in the second quarter of 2023. For the quarter, we reported adjusted EBITDA of $4 million compared to $3.5 million in the prior year period. Net income was $2.5 million or $0.07 per diluted share compared to net income of $2.8 million or $0.07 per diluted share in the second quarter of 2023. Our balance sheet remains strong with stockholders' equity of $65.8 million as of June 30, 2024, up from $61.1 million at December 31, 2023, and net working capital of $17.9 million. As we move through the second half of 2024, our core auction and brokerage segments are expected to produce continued strong operating results with an attractive pipeline of opportunities in the marketplace. We are steadfast in our mission to continue driving organic growth and profitability while positioning the company to take advantage of M&A opportunities when they arise. And with that, I will turn the call back over to Ross.

Thank you, Brian. So let me take a few minutes to tell you why we're actually very excited about both our organic growth and increased opportunities we're seeing in M&A across both sides of our business, the Financial Assets and the Industrial Assets. Starting with the Financial Assets, it's pretty clear right now that everyone can see that our pipeline is solid because of the macroeconomy and all the efforts we're making to garner new clients and win business and execute. On the macro side, consumer debt has been rising since 2021. Our revenue is rising along with it. We've now got household debt at $17.5 trillion, which has increased by $200 billion in just one quarter. We're looking at credit card balances now exceeding $1 trillion, adding $50 billion this quarter. This indicates that the volume is continuing to grow. With that volume, the amount of charge-offs has to grow as well, leading us to believe that our business has solid growth prospects for years to come. We're seeing around 49% of all credit cards going month-to-month on payments rather than being paid off, which is a clear sign of increasing growth in charge-offs. Additionally, around 6% of credit card accounts are past due, up from 4% just two to three years ago. So is our business growing? Yes. Will our business continue to grow? Clearly, there is no argument that our business won’t grow, as supply continues to increase. This gives us greater cash flow and strength in a position where we're stronger in the market to pursue M&A. There are now companies available in M&A that did relatively well during the pandemic and have struggled afterward, which is the opposite of us, as we are now growing. We see opportunities for bolt-ons that we're aggressively looking at and hopefully can accomplish something that will be highly accretive within the next year to 1.5 years. We are confident in both M&A opportunities and continued organic growth. Moving on to Industrial, many companies are doing well, but simultaneously, some are experiencing sluggish manufacturing right now. Numerous headcount reductions have been announced across different sectors, which leads to surplus assets and subsequently industrial auctions. It's important to note that these reductions don’t reflect immediate auction activity but rather take a few months to process. This disruption, while challenging, is creating opportunities for us as we expect to see increased second-hand equipment in the market over the next few years. We believe our industrial business is poised for growth, and we have been able to achieve strong prices for the equipment due to years of inflation. We foresee continued strength in organic growth in both sectors, and we are ready to capitalize on M&A opportunities as they arise. There are multiple challenges in Heritage Global Capital, and we have hired a special adviser to assist with this. Despite this, we believe Heritage Global is in a very solid position. Thank you all for your attention.

We'll take our first question from Mark Argento with Lake Street. Please go ahead. Your line is open.

Hey, Brian. Hey, Ross. Just a few quick ones here. The impairment or the change in status in terms of the part of the loan book, what happens going forward? What should we be looking for in terms of seeing any improvement in the situation? It sounds like you've got something you're working with. Do you guys look to sell the book off? Maybe just walk us through at a high level what next steps are there?

So I'll take it first, Brian. We've hired an adviser to work with. There is, at this time, no announcement of selling a book or any kind of change at this point other than our rigorous efforts to enhance collection efforts and to recover as much of the money as we can. We don’t anticipate any further actions beyond what we've announced. We aim to recover 100% of the amount. We took a $1.5 million charge previously, and we're not changing that now. While collections have been somewhat short of minimum payment, they are coming in steadily, and we will continue monitoring them closely. There will be announcements in the future if we make any changes, but for now, nothing has been decided. Brian?

Yeah. So the main effort from our finance group is to engage with our senior lenders to explore how the structure of these specific loans could be altered to improve collections. One method may involve assisting the servicer of those collections to operate within legal frameworks. We believe some improvement is possible. In accounting terms, we're adopting a conservative stance by allocating collections to the principal balance. Until we observe significant positive data or changes that would allow for complete recovery of principal and interest, we expect nonaccrual status to remain in the short term.

Got it. Have you guys stopped any additional lending or putting out any additional capital with other customers at this point? Or what's the general status there?

We're obviously not funding that customer right now. We don't plan to fund that customer until the situation is 100% back on track. We are, however, providing funding to other performing customers. We're being very prudent and selective in our funding decisions. We continue to evaluate opportunities, but we are more cautious than before. Fortunately, we have a lot of free cash flow and remain in a strong financial position. If a solid lending opportunity arises, we have the capital to pursue it.

Great. Just pivoting over to the robust forward flows on both the Financial Asset and Industrial Asset businesses. Maybe just walk us through the forward flow?

Our largest forward flow comes from an existing client, Pfizer. They conduct monthly auctions with us. We are having our best year with them so far, partly due to their extensive worldwide planning and restructuring, which has released more assets than last year. The auctions are performing strongly, and we are seeing large crowds. Additionally, we have added regional clients and some past auction clients are becoming repeat clients, which boosts our business. Thus, we expect Q3 and Q4 to be robust for the Industrial side as well. In terms of the Financial Assets side, we've added many new companies, including fintech firms and banks, and have seen growth in nonperforming real estate, which contributes to a promising outlook for Q3 and Q4.

Great. I'll hop back in the queue. Thanks, guys.

Thank you, Mark.

We'll take our next question from George Sutton with Craig-Hallum. Please go ahead. Your line is open.

Hey, good afternoon, guys. This is actually Logan on for George today.

Hi, Logan.

I’m wondering if I could just ask one on the borrower. Can you walk us through the underlying assumptions that led to the determination that there was no need to increase the credit loss reserve? Additionally, do you have any insight into where the weakness is arising from the underlying portfolios?

Our decision was based on a thorough analysis which involved consulting with an independent adviser, discussions with senior lenders, and a review of past collection rates. All these factors convinced us that we were in a solid position. Although collections are somewhat short of minimum payments, they remain consistent. We are confident in our current status as we have thousands of accounts to work through. Brian, do you want to add anything?

To add to that, while the perceived risk increases when a borrower defaults, we have strong reliance on collections from those portfolio assets. Additionally, cash flows are being applied against the principal balance. This conservative method mitigates the perceived risk adequately.

Okay. Got it. And maybe just one other on the brokerage side. It seems like commentary from the significant purchasers indicates that charge-offs may rise towards the end of this year and into next. Could you elaborate on that? Also, Ross, you had mentioned buy-now pay-later in the past. Are you observing any competitive dynamics in that space?

The volume is indeed increasing, and we were early entrants into selling buy-now pay-later assets. Our team saw the potential before many others and established relationships with both sellers and buyers of these assets. As this sector expands, we are well-positioned as an industry leader. Overall, we believe there is substantial growth in the nonperforming loans business across multiple sectors, including credit cards, fintech, and real estate loans. Hence, our outlook remains bullish for the upcoming years.

Thanks for taking my questions.

Thank you.

This does conclude the Q&A session. I will turn the program to Ross Dove for any closing or additional remarks.

Thank you all very much for sticking with us, for listening, and for your interest. We are happy to engage in further discussions or answer follow-up questions at any time. The company is in a very strong position across the board. We have some work to do to enhance Heritage Global Capital, but please keep in mind that we didn’t default on anybody; someone defaulted on us. We are prepared for this, and we will make the best of the situation, aiming to recover as much as we can. As we look to the future, we anticipate record years coming up and see this as a very dynamic and growth-oriented company. Thank you, everyone, and have a great day. Bye-bye.

This does conclude today's program. Thank you for your participation, and you may now disconnect.