The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1 –Basis of Presentation
These unaudited condensed consolidated interim financial statements include the accounts of Heritage Global Inc. (“HGI”) together with its subsidiaries, including Heritage Global Partners, Inc. (“HGP”), Heritage Global LLC (“HG LLC”), Equity Partners HG LLC (“Equity Partners”) and National Loan Exchange, Inc. (“NLEX”). These entities, collectively, are referred to as the “Company” in these financial statements. The Company’s unaudited condensed consolidated interim financial statements were prepared in conformity with generally accepted accounting principles in the United States of America (“GAAP”), as outlined in the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), and include the assets, liabilities, revenues, and expenses of all subsidiaries over which HGI exercises control. All significant intercompany accounts and transactions have been eliminated upon consolidation. The Company’s sole operating segment is its asset liquidation business.
The Company provides an array of value-added capital and financial asset solutions: auction and appraisal services, traditional asset disposition sales, and financial solutions for businesses and properties in transition.
The Company has prepared the condensed consolidated interim financial statements included herein pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). In the opinion of management, these financial statements reflect all adjustments that are necessary to present fairly the results for the interim periods included herein. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations; however, the Company believes that the disclosures are appropriate. These unaudited condensed consolidated interim financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 13, 2018.
The results of operations for the nine month period ended September 30, 2018 are not necessarily indicative of those operating results to be expected for any subsequent interim period or for the entire year ending December 31, 2018. The accompanying condensed consolidated balance sheet at December 31, 2017 has been derived from the audited consolidated balance sheet at December 31, 2017, contained in the above referenced Form 10-K.
Note 2 – Summary of Significant Accounting Policies
Use of Estimates
The preparation of the Company’s consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances. Actual results could differ from those estimates.
Significant estimates include the assessment of collectability of revenue recognized, and the valuation of accounts receivable, inventory, other assets, goodwill and intangible assets, liabilities, contingent consideration, deferred income tax assets and liabilities, and stock-based compensation. These estimates have the potential to significantly impact the Company’s consolidated financial statements, either because of the significance of the financial statement item to which they relate, or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events that are continuous in nature.
Foreign Currency
The functional currency of foreign operations is deemed to be the local country’s currency. Assets and liabilities of operations outside of the United States are generally translated into U.S. dollars, and the effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income.
Reclassifications
Certain prior year balances within the condensed consolidated financial statements have been reclassified to conform to the current year presentation.
7
Revenue Recognition
On January 1, 2018, the Company adopted the new accounting standard FASB ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”) to all contracts using the modified retrospective method. Based on the Company’s analysis of contracts with customers in prior periods, there was no cumulative effect adjustment to the opening balance of the Company’s accumulated deficit as a result of the adoption of this new standard. We expect the impact of the adoption of the new standard to be immaterial to the consolidated financial statements on an ongoing basis.
Services revenue generally consists of commissions and fees from providing auction services, appraisals, brokering of sales transactions and providing merger and acquisition advisory services. Asset sales revenue generally consists of proceeds obtained through sales of purchased assets. Revenue is recognized for both services revenue and asset sales revenue based on the ASC 606 standard recognition model, which consists of the following: (1) an agreement exists between two or more parties that creates enforceable rights and obligations, (2) the performance obligations are clearly identified, (3) the transaction price has been determined, (4) the transaction price has been properly allocated to each performance obligation, and (5) the entity satisfies a performance obligation by transferring a promised good or service to a customer for each of the entities.
All services and asset sales revenue from contracts with customers is considered to be one reporting segment – the asset liquidation business. Although the Company provides various services within the asset liquidation business, it does not disaggregate revenue streams further than that in its statement of operations, services revenue and asset sales. Generally, revenue is recognized in the asset liquidation business at the point in time in which the performance obligation has been satisfied and full consideration is received. The exception to recognition at a point in time occurs when certain contracts provide for advance payments recognized over a period of time. Services revenue recognized over a period of time is not material in comparison to total revenues (4% of total revenues for the nine month period ended September 30, 2018), and therefore not reported on a disaggregated basis. Further, as certain contracts stipulate that the customer make advance payments, amounts not recognized within the reporting period are considered deferred revenue and the Company’s “contract liability”. As of September 30, 2018, the deferred revenue balance was approximately $10,000. The Company records receivables related to asset liquidation in certain situations based on timing of payments for asset liquidation transactions held at the end of the reporting period; however, revenue is generally recognized in the period that the Company satisfies the performance obligation and cash is collected. The Company does not record a “contract asset” for partially satisfied performance obligations.
We evaluate revenue from asset liquidation transactions in accordance with the accounting guidance to determine whether to report such revenue on a gross or net basis. We have determined that we act as an agent for our fee based asset liquidation transactions and therefore we report the revenue from transactions in which we act as an agent on a net basis.
The Company also earns asset liquidation income through asset liquidation transactions that involve the Company acting jointly with one or more additional purchasers, pursuant to a partnership, joint venture or limited liability company (“LLC”) agreement (collectively, “Joint Ventures”). For these transactions, the Company does not record asset liquidation revenue or expense. Instead, the Company’s proportionate share of the net income (loss) is reported as earnings of equity method investments. In general, the Joint Ventures apply the same revenue recognition and other accounting policies as the Company.
The critical accounting policies used in the preparation of the Company’s audited consolidated financial statements are discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. There have been no changes to these policies in the nine months ended September 30, 2018, except for the adoption of ASC 606 as described above.
Recent Accounting Pronouncements
In 2016, the FASB issued ASU 2016-02,
Leases
, (“ASU 2016-02”). ASU 2016-02 changes the accounting for leases previously classified as operating leases under GAAP by, among other things, requiring a Company to recognize the lease on the balance sheet with a right-of-use asset and a lease liability. ASU 2016-02 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company has not yet adopted ASU 2016-02 nor completed its assessment of the potential impact of this new guidance on its consolidated financial statements.
In 2014, the FASB issued new guidance related to revenue recognition (ASU 2014-09 Revenue from Contracts with Customers (Topic 606)). Subsequently the FASB has issued additional guidance (ASUs 2015-14; 2016-08; 2016-10; 2016-12; 2016-13; 2016-20). The guidance establishes principles for reporting information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The above stated updates became effective January 1, 2018 and did not have a material impact on the Company’s consolidated financial statements, except for more comprehensive disclosure requirements (see Note 2 – Revenue Recognition for further detail).
8
In 2016, the FASB issued ASU 2016-15,
Statement of Cash Flows
(“ASU 2016-15”), which clarifies
the classification of certain cash receipts and payments. The specific cash flow issues addressed by ASU 2016-15, with the objective of reducing the existing diversity in practice, are as follows: (1) Debt prepayment or debt extinguishment costs; (2) Set
tlement of zero-coupon debt instruments or other debt instruments with insignificant coupon interest rates; (3) Contingent consideration payments made after a business combination; (4) Proceeds from the settlement of insurance claims; (5) Proceeds from the
settlement of corporate-owned life insurance policies; (6) Distributions received from equity method investees; (7) Beneficial interest in securitization transactions; and (8) Separately identifiable cash flows and application of the predominance in princ
iple.
ASU 2016-15 became effective January 1, 2018 and did not have a material impact on the Company’s consolidated financial statements.
In 2017, the FASB issued ASU 2017-01,
Business Combinations
(“ASU 2017-01”), which clarifies the definition of a business under ASC 805. The main provisions of ASU 2017-01 provide a screen to determine when an integrated set of assets and activities is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets, the set is not a business. ASU 2017-01 became effective January 1, 2018 and did not have a material impact on the Company’s consolidated financial statements.
In 2017, the FASB issued ASU 2017-04,
Intangibles – Goodwill and Other
(“ASU 2017-04”), which simplifies the test for goodwill impairment. The main provisions of ASU 2017-04 eliminate the second step of the goodwill impairment test which previously was performed to determine the goodwill impairment loss for an entity by calculating the difference between the implied fair value of the entity’s goodwill and its carrying value. Under ASU 2017-04, if a reporting unit’s carrying value exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill which is allocated to that reporting unit. ASU 2017-04 will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The Company is still assessing the impact of ASU 2017-04 on its consolidated financial statements.
In 2018, the FASB issued ASU 2018-07,
Compensation
– Stock Compensation
(“ASU 2018-07”), which expands the scope of Topic 718 to include share based payment transactions for acquiring goods and services from nonemployees. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The Company is still evaluating the impact of ASU 2018-07 on the consolidated financial statements.
Note 3 – Stock-based Compensation
Options
At September 30, 2018 the Company had four stock-based compensation plans, which are described more fully in Note 15 to the audited consolidated financial statements for the year ended December 31, 2017, contained in the Company’s most recently filed Annual Report on Form 10-K.
During the nine months ended September 30, 2018, the Company issued options to purchase 441,500 shares of common stock to the Company’s employees and options to purchase 85,000 shares of common stock to the Company’s non-employee directors as part of their annual compensation. During the same period, the Company cancelled options to purchase 1,058,420 shares of common stock as a result of employee resignations and natural expiration.
On June 1, 2018, the Company issued options to purchase 300,000 shares of common stock to the employees of NLEX, in connection with the Addendum to the Employment Agreements of David Ludwig and Tom Ludwig. As of September 30, 2018, 173,130 shares of common stock were issued pursuant to the exercise of these common stock options. The remaining 126,870 shares expired as of July 31, 2018.
The following summarizes the changes in common stock options for the nine months ended September 30, 2018:
9
|
|
Options
|
|
|
Weighted
Average
Exercise
Price
|
|
Outstanding at December 31, 2017
|
|
|
5,040,450
|
|
|
$
|
0.97
|
|
Granted
|
|
|
526,500
|
|
|
$
|
0.43
|
|
Exercised
|
|
|
(173,130
|
)
|
|
$
|
0.43
|
|
Forfeited
|
|
|
(1,058,420
|
)
|
|
$
|
1.71
|
|
Outstanding at September 30, 2018
|
|
|
4,335,400
|
|
|
$
|
0.59
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at September 30, 2018
|
|
|
1,800,975
|
|
|
$
|
1.17
|
|
The Company recognized stock-based compensation expense related to stock options of $0.1 million and $0.2 million, respectively, for the three and nine months ended September 30, 2018. As of September 30, 2018, there is approximately $0.8 million of unrecognized stock-based compensation expense related to unvested option awards outstanding, which is expected to be recognized over a weighted average period of 3.0 years.
Restricted Stock
Restricted stock awards represent a right to receive shares of common stock at a future date determined in accordance with the participant’s award agreement. There is no exercise price and no monetary payment required for receipt of restricted stock awards or the shares issued in settlement of the award. Instead, consideration is furnished in the form of the participant’s services to the Company. Compensation cost for these awards is based on the fair value on the date of grant and recognized as compensation expense on a straight-line basis over the requisite service period.
On June 1, 2018, the Company granted 600,000 shares of Company restricted common stock in connection with the Addendum to the Employment Agreements of David Ludwig and Tom Ludwig. The shares are subject to certain restrictions on transfer and a right of repurchase over five years, ending May 31, 2023, and require a continued term of service to the Company. Stock-based compensation expense related to the restricted stock awards, calculated by using the grant date fair value of $0.43 per share, was $12,900 and $17,200 for the three and nine months ended September 30, 2018, respectively. The unrecognized stock-based compensation expense as of September 30, 2018 was approximately $0.2 million.
Note 4 – Earnings Per Share
The Company is required in periods in which it has net income to calculate basic earnings per share (“basic EPS”) using the two-class method. The two-class method is required because the Company’s Class N preferred shares, each of which is convertible to 40 common shares, have the right to receive dividends or dividend equivalents should the Company declare dividends on its common stock. Under the two-class method, earnings for the period are allocated on a pro-rata basis to the common and preferred stockholders. The weighted-average number of common and preferred shares outstanding during the period is then used to calculate basic EPS for each class of shares.
In periods in which the Company has a net loss, basic loss per share is calculated by dividing the loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period. The two-class method is not used in periods in which the Company has a net loss because the preferred stock does not participate in losses.
Stock options and other potential common shares are included in the calculation of diluted earnings per share (“diluted EPS”), since they are assumed to be exercised or converted, except when their effect would be anti-dilutive. The table below shows the calculation of the shares used in computing diluted EPS.
10
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
Weighted Average Shares Calculation:
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Basic weighted average shares outstanding
|
|
|
28,653,278
|
|
|
|
28,480,148
|
|
|
|
28,557,517
|
|
|
|
28,464,635
|
|
Treasury stock effect of common stock options and restricted stock awards
|
|
|
170,640
|
|
|
|
1,148
|
|
|
|
344,982
|
|
|
|
10,362
|
|
Diluted weighted average common shares outstanding
|
|
|
28,823,918
|
|
|
|
28,481,296
|
|
|
|
28,902,499
|
|
|
|
28,474,997
|
|
For the nine months ended September 30, 2018 and 2017 there were potential common shares totaling approximately 1.0 million and 5.0 million, respectively, that were excluded from the computation of diluted EPS as the inclusion of such shares would have been anti-dilutive. For the three months ended September 30, 2018 and 2017 there were potential common shares totaling approximately 1.0 million and 5.0 million, respectively, that were excluded.
Note 5 – Intangible Assets and Goodwill
Identifiable intangible assets
The Company’s identifiable intangible assets are associated with its acquisitions of HGP in 2012 and NLEX in 2014, as shown in the table below (in thousands), and are amortized using the straight-line method over their remaining estimated useful lives of one to eight years. The Company’s tradename acquired as part of the acquisition of NLEX in 2014 has an indefinite life and therefore is not amortized.
|
|
Carrying Value
|
|
|
|
|
|
|
Carrying Value
|
|
|
|
December 31,
|
|
|
|
|
|
|
September 30,
|
|
Amortized Intangible Assets
|
|
2017
|
|
|
Amortization
|
|
|
2018
|
|
Customer Network (HGP)
|
|
$
|
136
|
|
|
$
|
(17
|
)
|
|
$
|
119
|
|
Trade Name (HGP)
|
|
|
850
|
|
|
|
(78
|
)
|
|
|
772
|
|
Customer Relationships (NLEX)
|
|
|
440
|
|
|
|
(82
|
)
|
|
|
358
|
|
Website (NLEX)
|
|
|
14
|
|
|
|
(9
|
)
|
|
|
5
|
|
Total
|
|
|
1,440
|
|
|
|
(186
|
)
|
|
|
1,254
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade Name (NLEX)
|
|
|
2,437
|
|
|
|
—
|
|
|
|
2,437
|
|
Total
|
|
$
|
3,877
|
|
|
$
|
(186
|
)
|
|
$
|
3,691
|
|
Amortization expense during the nine months ended September 30, 2018 and 2017 was $0.2 million.
The estimated amortization expense as of September 30, 2018 during the next five fiscal years and thereafter is shown below (in thousands):
Year
|
|
Amount
|
|
2018 (remainder of year from October 1, 2018 to December 31, 2018)
|
|
$
|
63
|
|
2019
|
|
|
236
|
|
2020
|
|
|
236
|
|
2021
|
|
|
236
|
|
2022
|
|
|
128
|
|
Thereafter
|
|
|
355
|
|
Total
|
|
$
|
1,254
|
|
11
Goodwill
The Company’s goodwill is related
to its asset liquidation business, and is comprised of goodwill from three acquisitions, as shown in the table below (in thousands). There were no additions to goodwill and no impairment losses to the carrying amount of goodwill during the three or nine months ended September 30, 2018 and 2017.
Acquisition
|
|
September 30, 2018
|
|
|
December 31, 2017
|
|
Equity Partners
|
|
$
|
573
|
|
|
$
|
573
|
|
HGP
|
|
|
2,040
|
|
|
|
2,040
|
|
NLEX
|
|
|
3,545
|
|
|
|
3,545
|
|
Total goodwill
|
|
$
|
6,158
|
|
|
$
|
6,158
|
|
Note 6 – Debt
Outstanding debt at September 30, 2018 and December 31, 2017 is summarized as follows (in thousands):
|
|
September 30, 2018
|
|
|
December 31, 2017
|
|
Current:
|
|
|
|
|
|
|
|
|
Related party debt
|
|
$
|
-
|
|
|
$
|
382
|
|
Third party debt
|
|
|
372
|
|
|
|
356
|
|
Non-current:
|
|
|
|
|
|
|
|
|
Third party debt
|
|
|
535
|
|
|
|
786
|
|
Total debt
|
|
$
|
907
|
|
|
$
|
1,524
|
|
In 2016, following an amendment, the Company’s related party debt with Street Capital (the “Street Capital Loan”) began accruing interest at a rate per annum equal to the Wall Street Journal prime rate + 1.0%. During the period ending September 30, 2018, the Company terminated the existing Street Capital Loan with repayment of all principal and interest outstanding. Please see Note 9 for further discussion of transactions with Street Capital.
In 2016, the Company entered into a related party secured promissory note with an entity owned by certain executive officers of the Company (the “Entity”) for a revolving line of credit (the “Line of Credit”). Under the terms of the Line of Credit, the Company received a revolving line of credit with an aggregate borrowing capacity of $1.5 million. Interest under the Line of Credit was charged at a variable rate, and the Entity was eligible to participate in the net profits and net losses of certain industrial auction principal and guarantee transactions entered into by the Company on or after January 1, 2017, and consummated on or prior to the maturity date. In connection with the Company entering into a new credit facility with a third party bank o
n September 27, 2018, the Company terminated the related party secured promissory note with the Entity.
On September 27, 2018, Heritage Global, Inc. entered into a secured promissory note and business loan agreement (the “Credit Facility”) with First Choice Bank, for a $1.5 million revolving line of credit. The Credit Facility matures on October 5, 2019 and replaced the Line of Credit. The Company is permitted to use the proceeds of the loan solely for its business operations. The Credit Facility accrues at a variable interest rate, which is equal to the rate of interest last quoted by The Wall Street Journal as the “prime rate,” not to be less than 5.25% per annum, with a minimum interest charge of $100.00 per month. The Company will pay interest on the Credit Facility in regular monthly payments, beginning on November 5, 2018. The Company may prepay the Credit Facility without penalty, subject to the minimum monthly interest charge. The Company is the borrower, with certain of the subsidiaries of the Company as guarantors under the Credit Facility. The Credit Facility is secured by a first priority security interest in all of the Company’s and its certain subsidiaries’ current and future tangible and intangible assets, inventory, chattel paper, accounts, equipment and general intangibles. The availability of draws under the Credit Facility is conditioned, among other things, on the compliance with certain customary representations and warranties, including the preparation of timely financial statements, payment of taxes and disclosure of all material legal or administrative proceedings. The agreement governing the Credit Facility also contains customary affirmative covenants regarding, among other things, the maintenance of records, compliance with governmental requirements, timely submission of all filings with the Securities and Exchange Commission and payment of taxes. The Credit Facility contains certain customary financial covenants and negative covenants that, among other things, include restrictions on the Company’s ability to create, incur or assume indebtedness for borrowed money, including capital leases or to sell, transfer, mortgage, assign, pledge, lease, grant a security interest in, or encumber any of the Company’s assets. As of September 30, 2018, the Company had not drawn on the line of credit.
12
On January
30, 2018, HG LLC
, a wholly owned subsidiary of HGI, settled a long-standing litigation matter that was commenced against the predecessor in interest of HG
LLC. The settlement, which also involved several other co
-defendant parties, included a complete release of HG
LLC’s predecessor in interest and its successors and affiliates by the plaintiffs from all claims arising from or relating to the facts and circumstan
ces underlying the litigation.
The portion of the se
ttlement attributable to HG
LLC’s predecessor in interest was paid on behalf of HG
LLC by 54 Finance, LLC (“54 Finance”) (an affiliate of a co-defendant in the litigation) in consideration of a Promissory Note dated January 30, 2018 (the “Note”) from HG
LL
C in the amount of $1,260,000. Pursuant to a Guaranty dated January 30, 2018, HGI has guaranteed the obli
gations of HG
LLC under the Note, which are required to be paid
in 36 equal installments of $35,000,
with
any remaining outstanding balance due and pay
able in full on January 30, 2021. As of December 31, 2017,
the Company
accrued the present value of the Note based on the payment terms noted above and at an interest rate of 6.5%. The Note was recorded as this was determined to be a recognized subsequent
event pursuant to ASC 855, Subsequent Events. Upon the occurrence of any Event of Default (as defined below), in the sole discretion of 54 Finance, the outstanding principal balance of the Note will bear interest at a rate per annum (computed on the basis
of a 360-day year, actual days elapsed) equal to 12%. An “Event of Default” means: (a) any failure of HG
LLC to pay when due any amount thereunder, when and as due, (b) any failure on the part of HG
LLC to pay upon 54 Finance’s demand any fees, costs, expe
nses or other charges hereunder or otherwise due to HG
LLC under the Note or the Guaranty, (c) any breach, failure or default under the Guaranty, (d) HG
LLC or HGI repudiates or revokes, or purports to repudiate or revoke, any obligation under the Note or
the Guaranty, or the obligation of HGI under the Guaranty is limited or terminated by operation of law or by HGI, or (e) HG
LLC or HGI
are
insolvent or admit in writing its inability to pay debts as they mature, or make a general assignment for the benefit
of its creditors, or institute any bankruptcy, insolvency or similar proceeding under the laws of any jurisdiction, or take any action to authorize such proceeding.
D
uring the
nine
months ended
September
30
, 2018
, th
e Company
made the
scheduled
payments on the Note totaling
$
280
,000.
The outstanding balance on the Note as of September 30, 2018 was $
907,000
.
Note 7 – Fair Value Measurements
In accordance with the authoritative guidance for financial assets and liabilities measured at fair value on a recurring basis, the Company prioritizes the inputs used to measure fair value from market-based assumptions to entity specific assumptions:
|
•
|
Level 1 – Inputs based on quoted market prices for identical assets or liabilities in active markets at the measurement date.
|
|
•
|
Level 2 – Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
|
|
•
|
Level 3 – Inputs which reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instruments valuation.
|
As of September 30, 2018 and December 31, 2017, the Company had no Level 1 or Level 2 assets or liabilities measured at fair value. As of December 31, 2017, the Company’s contingent consideration from the 2014 acquisition of NLEX was the only Level 3 liability measured at fair value on a recurring basis which had a fair value of $2,774,000. The fair value of the Company’s contingent consideration was determined using a discounted cash flow analysis, which is based on significant inputs that are not observable in the market. As of September 30, 2018, the contingent consideration had been fully satisfied in accordance with terms stated within the NLEX stock purchase agreement.
When valuing its Level 3 liabilities, the Company gives consideration to operating results, financial condition, economic and/or market events, and other pertinent information that would impact its estimate of the expected contingent consideration payments. The valuation of the liability is primarily based on management’s estimate of the Net Profits of NLEX (as defined in the NLEX stock purchase agreement). Given the short term nature of the contingent consideration periods, changes in the discount rate did not have a material impact on the fair value of the liability.
The following table summarizes the changes in the fair value of the liability during the nine months ended September 30, 2018 (in thousands):
Balance at December 31, 2017
|
|
$
|
2,774
|
|
Payment of contingent consideration
|
|
|
(2,618
|
)
|
Fair value adjustment of contingent consideration
|
|
|
(157
|
)
|
Balance at September 30, 2018
|
|
$
|
-
|
|
13
Note
8 – Income Taxes
At September 30, 2018 the Company has aggregate tax net operating loss carry forwards of approximately $73.0 million ($57.8 million of unrestricted net operating tax losses and approximately $15.2 million of restricted net operating tax losses) and unused minimum tax credit carry forwards of $0.5 million. Substantially all of the net operating loss carry forwards and unused minimum tax credit carry forwards expire between 2024 and 2036. The Company’s utilization of restricted net operating tax loss carry forwards against future income for tax purposes is restricted pursuant to the “change in ownership” rules in Section 382 of the Internal Revenue Code.
The reported tax expense varies from the amount that would be provided by applying the statutory U.S. Federal income tax rate to the income from operations before taxes primarily as a result of the change in the deferred tax asset valuation allowance.
The Company records net deferred tax assets to the extent that it believes such assets will more likely than not be realized. As a result of cumulative losses and uncertainty with respect to future taxable income, the Company has provided a full valuation allowance against its net deferred tax assets as of September 30, 2018 and December 31, 2017.
Note 9 – Related Party Transactions
Debt with Street Capital
During the period ending September 30, 2018, the Company terminated the existing Street Capital Loan with repayment of all principal and interest outstanding. The Company’s loan from Street Capital was previously classified as related party debt because Allan Silber, an affiliate of Street Capital, is the Company’s chairman of the board and a significant shareholder of the Company.
Transactions with Other Related Parties
As part of the operations of NLEX, the Company leases office space in Edwardsville, IL that is owned by the President of NLEX, David Ludwig. The total amount paid to the related party was approximately $78,000 and $75,000 for the nine months ended September 30, 2018 and 2017, respectively, and is included in selling, general and administrative expenses in the consolidated financial statements. All of the payments in both 2018 and 2017 were made to David Ludwig. On June 1, 2018, the Company amended its lease agreement with David Ludwig, whereby the term of the agreement extends to May 31, 2023 and the rent amounts were agreed upon for the new term.
In 2016 the Company entered into a secured related party loan agreement with certain executive officers of the Company which is more fully described in Note 6. Both Ross Dove and Kirk Dove, who were parties to the related party loan, share equally in all payments made by the Company to satisfy obligations under the loan agreement. During the nine months ended September 30, 2018, the Company made payment of approximately $34,000 to the respective parties based on the profit share provision for principal and guarantee transactions that occurred in 2017. Additionally, the Company has accrued as interest expense approximately $150,000 profit share for principal and guarantee transactions that occurred in the nine months ended September 30, 2018. In connection with the Company entering into a new credit facility with a third party bank
on
September 27, 2018, the Company terminated the related party loan agreement.
Note 10 – Subsequent Events
The Company has evaluated events subsequent to September 30, 2018 for potential recognition or disclosure in its condensed consolidated financial statements. There have been no material subsequent events requiring recognition or disclosure in this Quarterly Report on Form 10-Q.
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