BRC Group Holdings, Inc. Q1 FY2024 Earnings Call

Good afternoon and welcome to B. Riley Financial's First Quarter 2024 Earnings Call. My name is Ariel, and I will be your call coordinator. Earlier today, B. Riley issued a press release and financial supplement detailing its results for the first quarter of 2024, which can be found on its Investor Relations website at ir.brileyfin.com. Today's call includes prepared remarks from the company followed by a question-and-answer session. Joining us today from B. Riley are Bryant Riley, Chairman, Co-Founder and Co-CEO; Tom Kelleher, Co-Founder and Co-CEO; and Phillip Ahn, CFO and COO. After management's remarks, we will open the line for questions. As a reminder, this call is being recorded. An audio replay will be available on the company's Investor Relations website later today. Today's call will also include non-GAAP measures. The reconciliation for these as well as an explanation for the use of these metrics and a definition of these terms is available in the earnings press release and financial supplement, both of which are available on the company's Investor Relations website. And before we conclude today's call, I will provide the necessary cautions regarding forward-looking statements. Now I will turn the call over to Mr. Bryant Riley. Mr. Riley, please proceed.

Thank you for joining our call this afternoon. Before we get into these results for the quarter, I want to thank our employees, investors and partners for your continued patience throughout what has been a highly unusual period for our firm. Against that backdrop, I'd like to start by putting our operating performance for the quarter into perspective and then providing some context on our investments. We had a solid quarter from an operating perspective. We generated $66 million of operating adjusted EBITDA compared to $88 million in the same period last year. Our Advisory Services business had a record Q1. BRAS saw increased fee income year-over-year despite a decrease in overall Capital Markets segment revenues, and Wealth Management operating margins have continued to improve. At the same time, we monetized investments consistent with our business model and used capital to both repay outstanding debt while investing in attractive new opportunities such as Nogin. For context, our first quarter results reflected $59 million of investment-related losses, which are primarily unrealized, in addition to incremental costs due to the late filing of our 10-K, internal review and subsequent independent investigation undertaken by our Board's Audit Committee, which we are happy to have behind us. In contrast, last year, our first quarter results benefited from approximately $23 million of investment-related gains and an increase in interest income from a pool of performing consumer receivables that we acquired from Babcock in the prior year, which has generated returns north of 20%. That portfolio is maturing as reflected in the year-over-year change in our total loan receivables balance. On a more normalized basis and excluding the incremental costs and our noncash gains and losses, operating income was flat at approximately $33 million when compared to the same period last year. From a revenue perspective, the increase in fee income in our Capital Markets segment was offset by lower interest income in line with the reduction of consumer receivables and our overall loan portfolio from the same period in 2023. As I mentioned, Advisory Services had a record first quarter. This was both in terms of revenue and operating income. This is a business that was generating approximately $76 million in revenue a little over 3 years ago and is now generating revenues at an annual rate of over $100 million. Operating margins in our Wealth Management business have continued to improve over the last few years, and while Targus is continuing to work through the macro headwinds that impacted the global PC market, we believe the business is well positioned for when this market normalizes. I appreciate some of this call may be new to our story. It's important for investors to understand that we have a long history of making investments and acquisitions, and we utilize the services and expertise on our platform to not only maximize the potential value of our investments but also to manage any potential downside. This is core to our business and what we do. Our portfolio is going to fluctuate in marks from quarter-to-quarter due to the nature of our investments. We acknowledge the volatility this creates in our periodic results. However, it is important to view our investments over a longer time horizon. As I mentioned, net loss for the quarter included an investment loss of $59 million, which was driven by changes in fair market valuations for our investments, including Freedom VCM, which consists of the underlying business of FRG, and also investment in BW. As we discussed on our last call, since the closing of FRG's take-private in August of last year, FRG management has executed 2 transactions that are aligned with our stated investment thesis. Those 2 transactions are the sale of Badcock Furniture in December '23 and Sylvan Learning in February '24, which sold for a higher multiple than what FRG management expected and that was originally underwritten for this business. The adjustment in the fair market value for Freedom reflected the overall softness in the consumer market during the first quarter. Despite the change, we remain confident in the operators and the management team of each of these businesses and in their ability to execute on strategy. For those familiar with B. Riley, you know we often describe our firm as a collection of operating businesses on the one hand and our investment book on the other. What perhaps is less appreciated is the challenges that the uniqueness of our firm presents from an evaluation perspective for investors in looking at our P&L and balance sheet relative to the inherent value we've created with our wholly owned subsidiaries and the businesses we have built. For perspective, over the last year, we have taken noncash impairment charges related to Targus, which has underperformed since we purchased it 1.5 years ago. On the other hand, our Great American businesses, which consist of appraisal and asset disposition, are on our books for approximately $35 million. And our GlassRatner advisory business, which we acquired in 2018 and has approximately $35 million invested, including tuck-ins, combined in 2023 to generate approximately $52 million of operating income, which includes a roughly $1 million of income from our real estate advisory. This $52 million is represented in our auction and liquidation and financial segment income. Taken together, our core operations continue to generate strong free cash flow. And combined with the actions we are taking, we expect to exit 2024 with ample liquidity to aggressively capitalize on the opportunities ahead of us. We remain focused on running our business in the best interest of our stakeholders by addressing the needs of our clients, partners and employees. The market opportunity in the small- and mid-cap space remains as attractive as ever, and we believe B. Riley is uniquely positioned to meet the needs of companies in this space. To that end, we are pleased to deliver our investors a dividend of $0.50 per share related to our operating performance for the first quarter. We're thankful to our many supporters for their outreach and continued confidence in B. Riley. With that, I will turn the call over to Phil Ahn, our CFO and COO, to discuss key metrics for the quarter. Phil?

Thanks, Bryant. For the first quarter ended March 31, 2024, we reported total revenues of $343 million and a net loss attributable to common shareholders of $51 million driven by approximately $59 million of investment-related losses and incremental expenses related to the filing of our 10-K and the internal review and subsequent investigation undertaken by our Audit Committee. As Bryant noted, investment gains and losses have and will continue to create volatility in our periodic earnings. For this reason, we generally discuss our performance in the context of our operating revenues and operating adjusted EBITDA, which are considered non-GAAP financial measures. Excluding investment gains and losses, operating revenues were $379 million for the first quarter of 2024 compared to $389 million in the prior year quarter. Revenues from services and fees increased 9% to $257 million in the first quarter, up from $236 million in the same prior year period. Interest income from loans and securities lending was $60 million for the first quarter of 2024 compared to $77 million in the prior year quarter. This decrease was driven primarily by the reduction of our loans receivable at fair value balance from $772 million as of March 31, 2023, to $452 million as of March 31, 2024. And as Bryant noted, we generated operating adjusted EBITDA of $66 million in the first quarter of 2024, which compared to $88 million in the first quarter of 2023. Turning to highlights from our balance sheet. As of March 31, we had $191 million in unrestricted cash and cash equivalents, $943 million in net securities and other investments owned and $452 million in loans receivable at fair value. At quarter end, we had a total cash and investments balance of approximately $1.6 billion, which includes approximately $21 million of other investments reported in our prepaid and other assets. Total debt as of March 31 was approximately $2.2 billion. And total debt, net of cash and investments, was approximately $581 million at quarter end. During the quarter, we redeemed approximately $115 million of our Riley old senior notes on February 29, 2024. And earlier this month, we announced the remaining $25 million of our Riley old senior notes will be redeemed on May 31, 2024. Finally, as Bryant noted, we've declared a dividend of $0.50 per common share. Our quarterly dividend will be paid on or about June 11 to common shareholders of record as of May 27. That completes my summary. I'll now turn the call over to Tom to discuss our business segments. Tom?

Thanks, Phil. As Bryant previously mentioned, while there was a decrease in overall Capital Markets segment revenue due to unrealized investment losses, B. Riley's securities benefited from the steady deal-making environment and generated more in fee income this quarter compared to the same period last year. BRAS generated over $100 million in operating revenues and over $18 million of operating EBITDA during the quarter. In Wealth Management, we're beginning to see consistent normalized production as a result of our strategic realignment of this business following our 2021 purchase of National Holdings. Revenues increased to $52 million in the first quarter of 2024, surpassing prior revenues on both a year-over-year and sequential basis. Wealth Management brokerage revenues, advisory revenues and syndicate revenues all showed improvement from the fourth quarter of 2023. Operating income also benefited from higher seasonal tax revenues from our accounting and tax prep division. Assets under management totaled $25.8 billion at March 31, 2024. Auction and Liquidation contributed revenues of $5.8 million and operating income of $2 million during the first quarter. Our team was engaged in several ongoing projects during the quarter, both domestic and international. Returning clients drove most of our revenue opportunities, coupled with new business activity, which we expect to realize later this year. Our prospects in Europe continue to be steady with several opportunities in early stages. Our Financial Consulting segment includes our legacy Great American appraisal group, our GlassRatner consulting division and our B. Riley Real Estate brokerage division, which we established in 2020. Each of our appraisal and consulting divisions, known as B. Riley Advisory Services, experienced a record first quarter, which contributed to a 40% increase in segment revenues to $35 million and a 62% increase in segment operating income to $6.1 million compared to the same period last year. Our acquisitions of Farber and Crawford & Winiarski in 2023 also contributed to the increase in advisory, bankruptcy and forensic litigation consulting assignments. In addition to the more robust demand for our legacy appraisal and consulting services during the quarter, we have continued to develop other lines of service, including our field exam group, and expanded others like executive search. Our portfolio of Communications businesses has continued to contribute steady cash flow to our platform, generating revenues of $82 million and operating income of $8 million during the quarter. And in our Consumer Products segment, the continued softness in global PC and laptop sales resulted in a segment loss of $3 million during the quarter. As Bryant noted, Targus is continuing to work through some headwinds. However, we believe the business is well positioned to turn as the market for PC accessory sales recovers. Finally, our continued success is due in no small part to the dedication of our employees across B. Riley, and we could not be more grateful. A world-class team of professionals continues to demonstrate complete focus and commitment in serving our clients and customers. With that, we will now open the call up for questions before turning the call back to Bryant for closing remarks.

Our first question comes from Sean of Charles Lane Capital.

I'm actually from Charles Lane Capital, not B. Riley. But so first question here is on the Consumer Products. In your release, you said you had $56 million of revenue from goods sold, and there's about $52 million in Consumer Products revenue. What accounts for that delta? And where would that show up?

Sean, Phil, you're talking about the $4 million delta?

Yes.

I'm imagining that is something from retail, but I'm not sure. Phil, do you know the delta?

No. We're going to have to get back to you. I mean we've got a mixture of different things in there. When we do retail liquidation, some of the retail sales gets mixed in there.

Okay. I figured it was some liquidation. I just want to confirm that. And then on Communications, how should we think about that margin? It looks like the incremental margin came down a touch. How do we think about that? How much of that is fixed expense versus variable?

I believe that the group has performed exceptionally well, with three assets standing out. We've had strong returns from our $45 million investment in United Online, and magicJack has proven to be an incredible investment, while Marconi has been our top performer. However, the other two assets, Lingo and BullsEye, have been more challenging and have contributed to some margin contraction. We think we have a solution that involves divesting a portion of that business, which isn't for a large amount but is necessary to address the margin issues. Most of the margin impact is coming from that side of the business. Phil, do you have anything to add?

No. I think you captured it.

Okay. And then just a couple more for me. So on the dividend savings going from $1 to $0.50, about $30 million a year, should we expect that to be funneled towards deleveraging? Or how should we think about the capital being allocated?

I think we're aware that any actions we take, including selling stocks or assets, impact our capital structure. We're selling for a slightly higher price, whether the yield to maturity is 20 or 22 or something else. We need to consider this. We've made significant investments over the past year, and as those investments yield returns, our perspective will change. We have discussed the process regarding GA, which you would see contributing a substantial amount of additional capital based on comparisons. We believe we will have numerous options, but it's crucial to ensure our dividend is supported by our operating EBITDA and free cash flow. Additionally, we see potential opportunities. We often evaluate GAAP, and one challenging aspect is that we issued many bonds at rates that likely require you to pay twice as much in interest rates if in a similar situation. There’s considerable embedded value, though we also face some negative factors surrounding us that we plan to leverage. Overall, there is significant embedded value in those bonds that we can utilize, and we are considering all these factors.

Yes. Makes sense. And then just 2 more for me. On Capital Markets, any color there on kind of how Q1 booked and how Q2 is beginning to shape up? And any commentary on FocalPoint would be helpful.

Yes. I would say we had our biggest fee in FocalPoint since we acquired them, and they're definitely gaining traction. The M&A market has been relatively slow, and Capital Markets started off slow in Q1 and continued into Q2 but have shown significant improvement recently, particularly in the last few weeks compared to the previous months. I believe that when we didn't have our K out, we lost a bit of market share, but that is changing. Our clients and investors recognize our unique situation and our 27 years in the industry, which I believe will work in our favor. I'm excited about our upcoming conference where we can share our story, and I expect to see real momentum in the capital markets, which is crucial for our overall strategy. We anticipate amazing opportunities in the next 3 to 4 years, and we're in a strong position to capitalize on them. The market has been largely closed or very slow for three years, but if conditions improve with either growing companies or those reassessing their debt, we believe we are positioned well. I'm looking forward to the momentum we'll see in Capital Markets as this year progresses.

Great. My last question is a good segue. You reported an extraordinary $7 million loss from the internal investigation. Are there any additional expenses you anticipate carrying over into Q2? Also, how should we consider expenses related to your upcoming conference?

Phil, I believe the leakage is not going to be significant. You can elaborate on that. Regarding the conference, we've been conducting it since our first year, managing it efficiently with numerous sponsors while ensuring fiscal responsibility. Therefore, the impact is relatively small compared to the additional costs we incurred for the internal review and completing the audit. Phil, as you assess the second quarter, how would you respond?

Yes, there is likely some spillover from the K release in mid to late April. However, I don't expect it to be anything like what we experienced in Q1.

Got it. Okay. Congrats.

Our next question comes from Paul of Punch & Associates.

Can you provide any more details on the Great American transaction and its timeline, as well as any other noncore divestiture opportunities?

We are currently evaluating our position and have been pleased with the interest we've received. We see the asset as valuable and believe it offers significant opportunities for someone who can leverage it, whether that involves acquiring brands through auctions, consignment, or developing a direct lending business. I'm excited about the potential for this asset, although I personally don't favor selling it. However, we are considering the benefits that might come from the potential sale, especially in the small-cap sector where we originated. We anticipate a positive trajectory moving forward. Our firm believes that this will unfold naturally. We've discussed some of our other noncore assets, like Brands, which have proven to be a great investment, providing substantial returns. There could be a chance to reassess those opportunities within the next year. We are mindful of creating value by repurchasing our debt at discounts, which is a part of our strategy. As of now, we have $190 million in cash, and we have sold some noncore assets recently, continuing this trend as needed. We also want to ensure we’re prepared to support potential deals. While these decisions generally take longer than expected, I think if I were to estimate, a decision might come in the early part of Q3. People recognize the uniqueness of the asset, and that is a significant factor.

Yes, yes. Okay. And then Franchise Group, there were a couple of news headlines. You've commented on human performance but very little detail out there. Any update you can give on the remaining operating segments?

Yes. I would say that this investment started off differently than we anticipated. The management team has done an excellent job of taking control. The Conn's transaction that we facilitated was a really good first step. Sylvan was crucial because the cash really extends their ability to navigate a challenging consumer environment. There’s been no change to the model, and all parties appreciate that. You also saw the potential for a securitization on Pet Supplies Plus, which is an exciting market that could create significant liquidity and debt repayment opportunities. We have other assets we're working on, so I won't get into too many specifics. I believe all parties are aligned and the management team is performing well. We're fortunate to have sold Sylvan and brought in substantial cash, allowing us to invest in businesses like American Freight, which have historically been strong but are currently facing challenges. I believe cycles will turn, and as long as we can withstand this period, we will be well positioned. We did not anticipate that American Freight would take as long to recover as it has, but we are fortunate to have the runway to wait.

Yes. Okay. And Tom, you talked about Targus being poised to turn. Just wanted to see if there's any more color you can provide on kind of what you're seeing in terms of that industry and thoughts there in terms of timeline to normalization.

Yes. I believe this business and industry are closely linked to the broader hardware market. It became evident during COVID, when many people began working from home and purchased a significant number of laptops. However, this trend is likely to shift over time, which will positively impact Targus's sales. The consumer recovery is taking longer than we expected, but we are confident that it will eventually occur. Overall, we feel good about our investment.

I appreciate your question, TK. An important aspect of what we do is finding opportunities, and with Franchise Group, we had a bit of a shift. Michael Williams, who leads that business, has a successful track record with two public companies and one private company, and he approached us because he wanted to acquire it. I believe he is one of the top CEOs in the industry. We have the capacity to invest when others might struggle. Some of our competitors are having difficulties, and as we navigate this, we see the potential in investments like American Freight while others are closing stores or in Targus. We believe in the strength of our partnerships and management teams. This is not new; we have experienced similar situations before. Paul, you might recall our discussions on Wealth Management, and it’s clear that Chuck, Mike, and Ron have made significant improvements in that area with our support. The wealth managers have been incredibly supportive throughout these challenging times. This is how business operates — sometimes acquisitions thrive immediately, like GlassRatner and the brands, while others require effort and persistence, like we did with Select Interior and Core, which faced a 75% markdown on one of their assets. We just need to push through and collaborate with management to turn these situations around. That has been our approach throughout our careers, and I’m confident we will see success again in these segments.

Yes. We get it. We get it. And then, Bryant, maybe just to wrap up here. You talked about crazy dynamics and unusual last few months. Any learnings or insights from the period that you think will impact either operations or capital allocation going forward?

It's a reflective question for me and for our firm. We clearly operate as a challenging public company. There's a part of our business that functions like private equity, and another part that focuses strictly on investments. When you combine those aspects, it creates a unique situation. If an operating business we develop declines, we mark it down. Conversely, if we acquire a business and it appreciates, we do not mark it up. So, we find ourselves in a complicated position due to this dynamic. This isn't a reaction to any specific event; rather, it's where we see future opportunities. We believe we are on the brink of significant growth in financial services. I am really impressed with what Andy, Jimmy, and their team have achieved in brokerage despite the challenging capital markets. Our team has worked tirelessly, and I am confident we will emerge stronger. I'm optimistic about what's happening in financial services. While we might consider opportunistic investments, like the dial-up Internet company we bought for $45 million that returned $135 million, I would approach future opportunities with more caution due to the complexities of our business. This complexity affects everything, including how we are understood and our auditing processes. A simpler approach could be beneficial, but there are many ways we can identify opportunities within our platform, and that won't rule out any possibilities.

Our next question comes from Robert of Concise Capital Management.

On the Investor Day, you gave a nice EBITDA like kind of peak in the last 12 months of the various businesses. Just hoping we could maybe get a guide for the various businesses. Just you spoke about the ability to cover the dividend really more in line with just interest coverage and how you see that going forward, that would be great.

Our operating EBITDA for the trailing month is approximately $340 million. We need around $60 million in operating EBITDA to cover our dividends, interest, and other expenses. This is primarily supported by our recurring businesses. The key considerations will be the actions of the broker-dealer and the retail segment, which are still integral to our operations. Ideally, over the next year or two, our interest expense will be manageable as we have mostly baby bonds with an average yield of about 5.8%, which benefits us as we pay down debt. To maintain the dividend, which is around $2, we need approximately $60 million each quarter. This quarter, we didn’t see any contribution from Targus, and our receivables book provided less than expected. The retail environment was somewhat subdued; we made profits, but it was not very active. However, some of our other businesses are performing consistently well, particularly in advisory services. I’m confident about our setup where a significant portion of our expenses, including interest and dividends, are covered by our recurring operating EBITDA, while the broker-dealer activity adds variability. This isn't a new scenario for us; back in 2021, we earned $15 per share, but we weren’t overly enthusiastic because many gains were unrealized and arose during a particularly inflated market. Currently, we find ourselves in a challenging small-cap market. If we can continue generating this level of operating EBITDA without Targus contributing, while seeing improvements in our Wealth Management and appraisal businesses, we’re quite optimistic. I hope this addresses your question.

Yes, it's useful to consider this for future reference, possibly in the prepared comments. As you mentioned, understanding the business can be challenging, but viewing it as a collection of parts and their individual contributions may provide clarity. To follow up, you have 25 baby bonds that are current. Do you see this as a limitation on the dividend, and how do you plan to tackle it? Perhaps that's the reason the Great American group is available for sale, which would be unfortunate since it offers great investment opportunities. However, you need to address the debt. Is that the reason it's for sale? And is that how you plan to manage it?

I think part of our role is to identify assets that are undervalued or out of favor for various reasons and work to enhance their value. We previously discussed our investment in GA, and the potential for growth is significant. However, it's important to acknowledge that this growth may require substantial capital, such as billions for a direct lending fund, or greater involvement in areas like consignment. For example, we acquired many brands at low prices, which turned out to be highly profitable. As we evaluate our assets now, sometimes it makes financial sense to divest, even if it's not our preference. We're in a strong financial position with $190 million in cash and numerous assets, so selling GA isn't a necessity for us. If we don't receive an acceptable offer, we're okay with that. Our company was not established to endlessly buy without consideration for selling; we made a conscious decision to diversify our investments. Overall, we view GA as a valuable asset that has benefitted us and could benefit someone else in the future.

This concludes the Q&A. Handing it back to Mr. Riley for any final remarks.

Great. Well, I wanted to remind everybody that tomorrow is our Commission For Charity day. So 100% of tomorrow's trading commissions goes to the Sugar Ray Leonard Foundation. It's an important cause that funds research and programs for childhood type 1 and 2 diabetes. Next week is our 24th Annual Institutional Investor Conference. We're very excited about that. We feel like that's going to be a great forum for us to really kind of continue to build the momentum we've seen here this month and over the last few years. So there will be 200 public and private companies, 1,000 attendees and a great way to highlight our firm. And then I just think it's really amazing and a testimony to the people who manage this business, not the people on the executive side but the people that manage the operating businesses that we have been through a lot. And we have maintained the culture, we maintained the people. I think the overall employee base, I think, is really excited and fired up. And I'm excited about what the next year brings. So we're looking forward to talking to you next quarter, and appreciate it. Thank you, operator.

Thank you. Before we conclude today's call, I will provide B. Riley Financial's safe harbor statement, which includes important cautions regarding forward-looking statements made during this call. Statements made during this call that are not descriptions of historical facts are forward-looking statements that are based on management's current expectations and assumptions and are subject to risks and uncertainties. If such risks or uncertainties materialize or such assumptions prove incorrect, our business, operating results, financial condition and stock price could be materially negatively affected. You should not place undue reliance on such forward-looking statements, which are based on the information currently available to us and speak only as of today's date. Such forward-looking statements include, but are not limited to, statements regarding our excitement and the expected growth of our business segments and statements regarding the company's strategic review process for the Great American business and any potential resulting ramifications. Factors that could cause such actual results to differ materially from those contemplated or implied by such forward-looking statements include without limitation the risks described from time to time in B. Riley Financial, Inc.'s period filings with the SEC, including without limitation the risks described in B. Riley Financial, Inc.'s annual report on Form 10-K for the year ended December 31, 2023, under the captions Risk Factors and Management's Discussion and Analysis of Financial Condition and Results of Operations, as applicable. Additional information will be set forth in B. Riley Financial's quarterly report on Form 10-Q for the 3-month period ended March 31, 2024. These factors should be considered carefully, and participants are cautioned not to place undue reliance on such forward-looking statements. All information is current as of today's call, and B. Riley Financial undertakes no duty to update this information. Thank you for joining us today for B. Riley Financial's First Quarter 2024 Earnings Conference Call. You may now disconnect.