Heritage Global Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 –Basis of Presentation

These unaudited condensed consolidated interim financial statements include the accounts of Heritage Global Inc. ("HG") together with its subsidiaries, including Heritage Global Partners, Inc. (“HGP”), National Loan Exchange Inc. (“NLEX”), Heritage Global LLC (“HG LLC”), Heritage Global Capital LLC (“HGC”), and Heritage ALT LLC (“ALT”). These entities, collectively, are referred to as "the Company,” "us" “we” or “our” in these consolidated financial statements. These consolidated 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 HG exercises control. All significant intercompany accounts and transactions have been eliminated upon consolidation.

The Company began its operations in 2009 with the establishment of HG LLC. The business was subsequently expanded by the acquisitions of HGP, NLEX, and ALT in 2012, 2014, and 2021 respectively, and the creation of HGC in 2019. As a result, HG is positioned to provide an array of value-added capital and financial asset solutions: auction and appraisal services, traditional asset disposition sales, and specialty financing solutions. The Company’s reportable segments consist of Auction and Liquidation, through HGP, Refurbishment & Resale, through ALT, Brokerage, through NLEX and Specialty Lending, through HGC.

The Company prepared the unaudited 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 condensed 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 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, 2023, filed with the SEC on March 14, 2024 (the “Form 10-K”).

The results of operations for the nine-month period ended September 30, 2024 are not necessarily indicative of those operating results to be expected for any subsequent interim period or for the entire year ending December 31, 2024. The accompanying condensed consolidated balance sheet as of December 31, 2023 has been derived from the audited consolidated balance sheet as of December 31, 2023, contained in the Company’s Form 10-K.

Repurchase Program

The Company’s Board of Directors authorized a share repurchase program on May 5, 2022 (“Repurchase Program”), which permits the Company to purchase up to an aggregate of $4.0 million in common shares over a three year period ending in June 2025. On September 13, 2024 the Company's Board of Directors approved an amendment to the Repurchase Program which increased the authorized aggregate amount of common shares the Company may repurchase to an aggregate of $6.0 million in common shares. The Company repurchased 601,449 shares in the open market for a purchase price of approximately $1.1 million during the three and nine months ended September 30, 2024. As of September 30, 2024, the Company had approximately $4.1 million in remaining aggregate dollar value of shares that may be purchased under the Repurchase Program.

Note 2 – Summary of Significant Accounting Policies

Use of estimates

The preparation of the Company’s unaudited condensed consolidated interim 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 and notes receivable, inventory, investments, goodwill and intangible assets, liabilities, deferred income tax assets and liabilities, including projecting future years’ taxable income, and stock-based compensation. These estimates have the potential to significantly impact our condensed consolidated interim 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.

Revenue recognition

The Company recognizes revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers(“ASC 606”) and ASC Topic 310, Receivables(“ASC 310”).

Services revenue generally consists of commissions and fees from providing auction services, appraisals, brokering of sales transactions, and secured lending. Asset sales revenue generally consists of proceeds obtained through sales of purchased assets. With the exception of revenue generated within our Specialty Lending segment, 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 consists ofthree reportable segments: Auction and Liquidation, Refurbishment & Resale, and Brokerage. Generally, revenue is recognized 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 (less than 1% of total revenues for the nine months ended September 30, 2024 and 2023), 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”. The deferred revenue balance was approximately $0.5 million as of both September 30, 2024 and December 31, 2023 and is reflected in accounts payable and accrued liabilities on the condensed consolidated balance sheets. The deferred revenue balance is primarily related to customer deposits on asset sales within the Refurbishment & Resale segment. The Company records receivables in certain situations based on timing of payments for Auction and 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.

For auction services and brokerage sale transactions, funds are typically collected from buyers and are held by the Company on the seller's behalf. The funds are included in cash and cash equivalents in the condensed consolidated balance sheets. The Company releases the funds to the seller, less the Company's commission and other fees due, after the buyer has accepted the goods. The amount of cash held on behalf of the sellers is recorded as payables to sellers in the accompanying condensed consolidated balance sheets.

The Company evaluates revenue from Auction and Liquidation and Brokerage segment transactions in accordance with the accounting guidance to determine whether to report such revenue on a gross or net basis. The Company has determined that it acts as an agent for its fee based transactions and therefore reports the revenue from transactions in which the Company acts as an agent on a net basis.

The Company also earns income through transactions that involve the Company acting jointly with one or more additional purchasers or lenders, pursuant to a partnership, joint venture or limited liability company (“LLC”) agreement (collectively, “Joint Ventures”). For these transactions, in which the Company’s ownership share meets the criteria for the equity method investments under ASC Topic 323, Equity Method and Joint Ventures, the Company does not record 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.

Through our Specialty Lending segment, the Company provides specialty financing solutions to investors in charged-off and nonperforming asset portfolios. The Company recognizes revenue generated by lending activity in accordance with ASC 310. Fees collected in relation to the issuance of loans include loan origination fees, interest income, portfolio monitoring fees, and a backend profit share percentage related to the underlying asset portfolio.

The loan origination fees are offset with any direct origination costs and are deferred upon issuance of the loan and amortized over the lives of the related loans, as an adjustment to interest income. The interest method is used to arrive at a periodic interest cost (including amortization) that will represent a level effective rate on the sum of the face amount of the debt and (plus or minus) the unamortized premium or discount and expense at the beginning of each period.

The monitoring fees and the backend profit share are considered a separate earnings process as compared to the origination fees and interest income. Monitoring fees are recorded at the agreed upon rate, and at the moment in which payments are made by the borrower. The backend profit share is recognized in accordance with the agreed upon rate at the time in which the amount is realizable and earned. The recognition policy was established due to the uncertainty of timing of the amount of backend profit share which will be realized.

Through our Refurbishment and Resale segment, the Company offers financing on its standard laboratory equipment sales. The Company recognizes revenue upon shipment of its financed products in accordance with ASC 606. The Company records a loan receivable for the unpaid balance of the order. A loan amortization table is created upon shipment outlining the principal and interest income portion of each future payment. These loans are classified as held-for-investment and accounted for under the guidelines of ASC 310. Direct loan origination fees are offset by the expenses incurred and the net amount is amortized over the life of the related loan using the interest method described in ASC 835.

Nonaccrual Loans

The Company determines a loan to be in a default status when the minimum payment amount has not been received within the grace period of the payment due date. The status of default does not solely trigger nonaccrual loan status. The Company considers quantitative and qualitative factors when evaluating a loan in default status to determine the likelihood of recovering the outstanding principal balance and contractual interest payments. The Company also monitors its borrowers’ financial standing and performance on an ongoing basis and regularly updates the collection forecasts for the underlying charged off or nonperforming receivable portfolios related to each outstanding loan. If management determines (1) it is not probable that the projected cash flows expected from the borrower’s collection efforts on the underlying charged off or nonperforming receivable portfolio will be sufficient to satisfy all of the outstanding principal balance and contractual interest payments, and (2) it is not probable that the borrower will be able to meet the minimum required principal and interest payments through other operational cash flows, the Company will place the loans on nonaccrual status. If, based on its analysis, the Company elects to maintain accrual status after initial payment default, the loan will generally be placed on nonaccrual status if principal or interest payments become 90 days past due.

The accrual of interest is generally discontinued when a loan is placed on nonaccrual status. Interest received on such loans is accounted for using the cost-recovery or the cash-basis method, until qualifying for return to accrual. Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Under the cash-basis method, interest payments received by the creditor are recorded as interest income provided the amount does not exceed the amount that would have been earned at the loan’s original effective interest rate. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current, there is a sustained period of repayment performance, and all remaining principal and interest payments are deemed probable.

In November 2023, the Company and its affiliated joint ventures restructured loans with its largest borrower by restructuring certain outstanding loans (the "Restructured Loans") with an amortized cost basis of $51.6 million or 59% of the amortized cost basis of the total charged-off asset portfolio loans of HGC and its affiliated joint ventures. The Company’s share of the Restructured Loans amortized cost basis was $22.2 million, or 57% of HGC’s share of the loan book. All Restructured Loans were restructured by term extension, adding a weighted average of 1.5 years to the life of the Restructured Loans, which reduced the monthly payments for the borrower. As of September 30, 2023, the Company increased its allowance for credit losses related to its largest borrower experiencing financial difficulties. This resulted in an allowance for credit losses on the loans later restructured of $1.0 million as of September 30, 2023. As of September 30, 2024, the Company’s allowance for credit losses related to the Restructured Loans was $1.1 million, of which $0.3 million was classified as notes receivable and $0.8 million was recorded within equity method investments.

The Company's largest borrower continues to collect on the underlying charged off and nonperforming consumer loan portfolios and remit net collections to the Company and senior lenders, however this borrower's June remittance did not meet the minimum required payment amount. The Company has determined (1) it is not probable that the projected cash flows expected from the borrower’s collection efforts on the underlying charged off or nonperforming receivable portfolio will be sufficient to satisfy all of the outstanding principal balance and contractual interest payments, and (2) it is not probable that the borrower will be able to meet the minimum required principal and interest payments through other operational cash flows. While the Company continues to work closely with the borrower and its senior lenders in an effort to mitigate the default in an efficient and effective manner, the impacted loans were placed in nonaccrual status in June 2024. In addition, there was a balance of $1.5 million from the Company’s share of other loans within its affiliated joint ventures that are impacted by the default with the largest borrower and were placed in nonaccrual status in June 2024. The Company's share of payments received from the nonaccrual loans, including interest, will be applied against the outstanding loan balance. As of September 30, 2024, the amortized cost basis of loans in nonaccrual status was $24.0 million, of which $5.4 million is recorded within notes receivable and $18.6 million is recorded within equity method investments. There wereno loans in nonaccrual status as of December 31, 2023.

Specialty Lending - Concentration and credit risk

As of September 30, 2024, the Company held a gross balance of investments in notes receivable of $32.0 million, recorded in both notes receivable and equity method investments, and consisting of one borrower’s note balance of approximately $22.5 million, or 70% as of September 30, 2024, as compared to 62% as of December 31, 2023. The Company does not intend to hold highly concentrated balances due from one borrower as part of its long-term strategy but may, in the short term, have concentration risk on its path to an established and diversified portfolio.

The Company does not evaluate concentration risk solely based on balance due from specific borrowers, but also considers the number of portfolio purchases, type of charged off accounts within the portfolio, and the seller of the portfolio when determining the overall risk. Of the balance due from one borrower of $22.5 million, there are 11 distinct loan agreements. The underlying portfolio of accounts are diversified throughout FinTech loans, installment loans and credit card accounts, and further diversified amongst six separate sellers of these charged off portfolios.

The Company mitigates this concentration risk by requiring, and monitoring, security from each borrower consisting of their charged off and nonperforming receivable portfolios. The Company engages in a due diligence process that leverages its valuation expertise and knowledge in the underlying nonperforming receivable portfolios marketplace. In the event of default, the Company is entitled to call the unpaid interest and principal balances and receive all net collections directly. The Company may also recover its investment by engaging a third party to collect on the underlying charged off or nonperforming receivable portfolio or the underlying portfolio can be sold through the Company's Brokerage segment. In certain cases, the Company’s recovery options may be subject to concurrence of the originator or other prior holder of the assets.

Accounts receivable

The Company carries accounts receivable at the face amounts less an allowance for estimated credit losses. The Company estimates its reserve for credit losses using relevant available information from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts.

The Company only extends credit to entities and institutions of significance, such as well-known academic and financial institutions and U.S. government agencies. Consequently, historical accounts receivable credit losses are nearly zero, which provides the starting point for management’s assessment of the reserve for credit losses for its accounts receivable. The Company estimates its expected credit losses for accounts receivable based on historical credit loss experience, its assessment of current conditions, and other relevant available information from internal and external sources on a quarterly basis.

As of both September 30, 2024 and December 31, 2023, the reserve for credit losses related to accounts receivable was approximately $0.1 million.

Notes receivable

Under ASC 326, the Company evaluates notes receivable as a single pool, for individual notes receivable and borrowers with similar risk characteristics. Notes receivable and borrowers that do not share risk characteristics are evaluated on an individual basis. Management evaluates the Company's notes receivables related to financing laboratory equipment sales within the notes receivable pool. Management estimates the reserve balance using relevant available information from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts. Historical credit loss experience typically provides the basis for an estimation of expected credit losses; however, the Company lacks sufficient data upon which to base a historical estimation. Additionally, since the Company began recording notes receivable on the condensed consolidated balance sheets, the Company has recorded no actual credit losses to notes receivable.

Lacking historical internal data upon which to base a reserve for credit losses to notes receivable, the Company, under ASC 326, estimates its reserve using external credit loss experience data. Management observes that the Company's notes receivable are similar in character to transactions undertaken by smaller banking institutions. The Company estimates its expected credit losses based on the Scaled Current Expected Credit Loss (CECL) Allowance Loss Estimator ("SCALE rate") available from the Federal Reserve. The SCALE rate methodology is endorsed by the FASB and the Conference of State Bank Supervisors. Management determined under ASC 326 that the SCALE rate, a generally applicable rate, may be appropriately adjusted by its assessment of observable facts and relevant circumstances indicating that the factors analyzed in the determination of the SCALE rate may not conform to the Company's operations and borrower assessments.

As of September 30, 2024, the SCALE rate was 1.3834% and the Company's credit loss allowance rate specific to notes receivable was 3.6%. The increase over the SCALE rate was due to both the above mentioned risks presented by a concentrated balance with a single borrower and declining collections industry-wide. As of September 30, 2024 and December 31, 2023, the Company's allowance for credit losses related to notes receivable outstanding was $0.4 million and $0.7 million, respectively. In order to evaluate the need for an adjustment to the receivable balance related to credit losses, or impairment, the Company performs a review of all outstanding loan receivables on a quarterly basis to determine if any indicators exist that suggest the loan will not be fully recoverable and assess the credit quality of the loan receivables. This review includes monthly and cumulative key performance indicators for each loan and borrower, as well as evaluation of borrower's financial condition.

Equity method investments

Similar to notes receivable, the loans held by the joint ventures are evaluated on a quarterly basis to determine if an adjustment to the allowance for credit losses is needed.

As of September 30, 2024, the SCALE rate was 1.3834% and the credit loss allowance rate specific to equity method investments was 4.8%. The increase over the SCALE rate was due to both the above mentioned risks presented by a concentrated balance with a single borrower and declining collections industry-wide. As of September 30, 2024 and December 31, 2023, the Company's allowance for credit losses related to its equity method investments was $1.0 million and $0.9 million, respectively.

Future accounting pronouncements

In November 2023, the Financial Accounting Standards Board ("FASB") issued ASU 2023-07, "Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures" ("ASU 2023-07"), which, among other updates, requires enhanced disclosures about significant segment expenses regularly provided to the chief operating decision maker, as well as the aggregate amount of other segment items included in the reported measure of segment profit or loss. ASU 2023-07 is effective for fiscal years beginning after December 15, 2023, and for interim periods within fiscal years beginning after December 15, 2024, and requires retrospective adoption. Early adoption is permitted. The Company anticipates that ASU 2023-07 will have no accounting impact, but will require additional disclosure for each of its reportable segments.

In December 2023, the FASB issued ASU 2023-09, "Income Taxes (Topic 740): Improvements to Income Tax Disclosures" ("ASU 2023-09"), which requires enhanced annual disclosures with respect to the rate reconciliation and income taxes paid information. ASU 2023-09 is effective for fiscal years beginning after December 15, 2024, and may be adopted on a prospective or retrospective basis. Early adoption is permitted. The Company anticipates that ASU 2023-09 will have no accounting impact but will require additional disclosure related to certain income tax calculations.

Note 3 – Accounts Receivable, net

The Company’s accounts receivable, net consists of accounts receivables recorded in the ordinary course of business associated with the recognition of revenue from contracts with customers.

In accordance with ASC 326, the Company performs a review of accounts receivables on a quarterly basis. During the nine months ended September 30, 2024, the Company recorded no material adjustments for credit losses in selling, general and administrative expense on the consolidated statement of income related to accounts receivable. As of both September 30, 2024 and December 31, 2023, the reserve for credit losses was approximately $0.1 million.

Note 4 – Notes Receivable, net

The Company’s notes receivable, net consists of investments in loans to buyers of charged-off and nonperforming receivable portfolios through HGC and financing of laboratory equipment sales through ALT.

As of September 30, 2024 and December 31, 2023, the Company’s outstanding notes receivables related to loans to buyers of charged-off and nonperforming receivable portfolios, net of unamortized deferred fees and costs on originated loans, and adjusted for the reserve for credit losses was $10.9 million and $17.5 million, respectively. The activity during the nine months ended September 30, 2024 includes the additional investment in notes receivable of approximately $4.5 million, which was offset by principal payments made by borrowers of approximately $8.8 million and noncash transfer of notes receivable to equity method investments of approximately $2.5 million.

As of September 30, 2024, the Company’s outstanding notes receivables related to financing of laboratory equipment sales, net of unamortized deferred fees and costs on originated loans and adjusted for the reserve for credit losses was $0.4 million. There wasno notes receivable balance related to financing of laboratory equipment sales as of December 31, 2023. The activity during the nine months ended September 30, 2024 includes the investment in notes receivable of approximately $0.6 million, which was offset by principal payments made by purchasers of $0.2 million andimmaterial deferred financing fees, and allowance for credit losses.

The table below shows the Company’s lending activity as of September 30, 2024 (in thousands):

In accordance with ASC 326, the Company performs a review of notes receivable on a quarterly basis. During the nine months ended September 30, 2024, the Company recorded a credit of $0.3 million to the provision for credit losses in selling, general and administrative expense on the consolidated statement of income, which was primarily due to the decrease in balance of notes receivables. As of September 30, 2024 and December 31, 2023, the allowance for credit losses was approximately $0.4 million and $0.7 million, respectively. As of September 30, 2024, the amortized cost basis of notes receivable in nonaccrual status was $5.4 million.

Note 5 – Stock-based Compensation

As of September 30, 2024, the Company had four stock-based compensation plans, which are described more fully in Note 16 – Stockholders' Equity - Stock-Based Compensation Plansof the Company's audited consolidated financial statements for the year ended December 31, 2023 contained in the Company’s Form 10-K.

Stock Options

During the nine months ended September 30, 2024, the Company issued options to purchase 35,000 shares of common stock to certain of the Company’s employees. During the same period, the Company canceled 12,750 options to purchase common stock as a result of employee resignations.

The following summarizes the changes in common stock options for the nine months ended September 30, 2024:

The Company recognized stock-based compensation expense related to common stock options of $0.4 million for the nine months ended September 30, 2024 and $0.6 million for the nine months ended September 30, 2023. As of September 30, 2024, there was appr oximately $1.0 million of unrecognized stock-based compensation expense related to unvested common stock options outstanding, which is expected to be recognized over aweighted average period of 1.6 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 of the shares of common stock on the date of grant and recognized as compensation expense on a straight-line basis over the requisite service period.

On March 7, 2024, the Company granted 128,044 shares of Company restricted common stock to employees under the 2022 Heritage Global Inc. Equity Incentive Plan. The restricted stock shares vest on March 7, 2025.

On March 7, 2024, the Company granted 75,000 shares of Company restricted common stock to non-executive directors under the 2022 Heritage Global Inc. Equity Incentive Plan. The restricted stock shares vest on March 7, 2025.

The Company determined the fair value of the shares awarded by using the closing price of our common stock as of the grant date. Stock-based compensation expense related to the restricted stock awards was approximately $0.4 million for the nine months ended September 30, 2024 and $0.1 million for the nine months ended September 30, 2023. The unrecognized stock-based compensation expense as of September 30, 2024 was approximately $0.3 million, which is expected to be recognized over aweighted average period of 0.4 years.

Note 6 – Equity Method Investments

In November 2018, CPFH LLC, of which the Company holds a 25% share, was formed to purchase certain real estate assets among partners in a joint venture. In March 2020, HGC Origination I LLC and HGC Funding I LLC were formed as joint ventures with a partner for purposes of conducting business relating to the sourcing, origination and funding of loans to debt purchasing clients. In April 2022, KNFH LLC, of which the Company holds a 25% share, was formed to purchase certain real estate assets and machinery and equipment among partners in a joint venture. In December 2022, DHC8 LLC, of which the Company holds a 13.33% share was formed to provide funding and receive principal and interest payments as a result of the initial investment. In May 2023, HGC MPG Funding LLC, of which the Company holds a 25% share, was formed as a joint venture with a partner for purposes of conducting business relating to the sourcing, origination and funding of loans to debt purchasing clients. In December 2023, KNFH II LLC, of which the Company holds a 25% share, was formed to purchase certain real estate assets and machinery and equipment among partners in a joint venture. CPFH LLC, KNFH LLC, DHC8 LLC and KNFH II LLC are joint ventures formed in connection with the Company’s Industrial Assets division, whereas HGC Origination I LLC, HGC Funding I LLC, and HGC MPG Funding LLC were formed in connection with the Financial Assets division. The Company has significant influence over the operations and financial policies of each of its equity method investments.

In accordance with ASC 326, the Company performs a review of notes receivable on a quarterly basis for each of its specialty lending investments. During the nine months ended September 30, 2024, the Company recorded a $0.1 million adjustment for its share of the joint venture’s increase to the provision for credit losses. As of September 30, 2024, the Company's share of the allowance for credit losses was approximately $1.0 million, which was primarily related to HGC Origination I LLC and HGC MPG Funding LLC. As of September 30, 2024, the Company has incurred no actual credit losses through its equity method investments. As of September 30, 2024, the amortized cost basis of the Company's share of loans in nonaccrual status recorded in equity method investments was $18.5 million.

The tables below details the Company’s joint venture revenues and earnings during the nine months ended September 30, 2024 and 2023 (in thousands):

The table below details the summarized components of assets and liabilities of the Company’s joint ventures, as of September 30, 2024 and December 31, 2023 (in thousands):

Note 7 – 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 becausethe Company’s shares of Series N preferred stock, 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. For both the three and nine months ended September 30, 2024 and 2023, the earnings allocated to the outstanding preferred shares were not material.

In periods in which the Company records 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. As the preferred stock does not participate in losses, the two-class method is not used in periods in which the Company records a net loss.

Stock options and other potential common shares are included in the calculation of diluted earnings per share (“diluted EPS”). In calculating diluted EPS, such shares are assumed to be exercised or converted, except when their effect would be anti-dilutive.

The table below shows the calculation of the number of shares used in computing diluted EPS:

For the three months ended September 30, 2024 and 2023, there were potential common shares of 0.6 million and 0.9 million, respectively, that were excluded from the computation of diluted EPS, as the inclusion of such common shares would have been anti-dilutive. For the nine months ended September 30, 2024 and 2023, there were potential common shares of 0.7 million and 0.9 million, respectively, that were excluded from the computation of diluted EPS, as the inclusion of such common shares would have been anti-dilutive.

Note 8 – Leases

The Company leases office and warehouse space infour locations: Del Mar, California, Hayward, California, San Diego, California and Edwardsville, Illinois. The Company determined that all of its lease arrangements are classified as operating leases.

On August 12, 2022, the Company entered into an agreement with Liberty Industrial Park, LLC pursuant to which the Company leases 6,627 square feet of industrial space in San Diego, California. The commencement date of the lease was September 1, 2022 and the lease term expires on August 30, 2027. It provides for an initial monthly base rent of $11,266, which increases on an annual basis to $13,180 per month in the final year. In addition, the Company is obligated to pay its share of maintenance costs of common areas.

On June 1, 2023, the Company amended its Edwardsville office building lease with David Ludwig, extending the term of the agreement to May 31, 2027 and setting rent amounts for the new term. It provides for an initial monthly base rent of $9,412, which increases on an annual basis to $9,914 per month in the final year.

On September 23, 2024, the Company amended its Del Mar office lease with OF 09 Hacienda, LLC, extending the term of the agreement by 24 months to February 28, 2027 and setting rent amounts for the new term. The amended Del Mar office lease provides for an initial monthly base rent of $14,660 beginning March 1, 2025 and increases on an annual basis to $15,099 per month in the final year.

The right-of-use assets and lease liabilities for each lease location are as follows (in thousands):

The Company’s leases generally do not provide an implicit rate, and, therefore, the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur at lease commencement to borrow an amount equal to the lease payments on a collateralized basis over the term of a lease within the same particular economic environment. The Company used its incremental borrowing rate as of January 1, 2019 for operating leases that commenced prior to that date. As of January 1, 2019, the Company’s incremental borrowing rate was 5.25%. For leases commencing after January 1, 2019 the Company uses its incremental borrowing rate at time of commencement. On September 1, 2022, June 1, 2023, and September 23, 2024, the Company’s incremental borrowing rate was 5.50%,7.25%, and 6.25%, respectively. The weighted average remaining lease term for operating leases is 3.4 years and the weighted average discount rate is 5.51% as of September 30, 2024.

Lease expense is recognized on a straight-line basis over the lease term. For both the nine months ended September 30, 2024 and September 30, 2023, lease expense was approximately $0.6 million. As of September 30, 2024, undiscounted future minimum lease payments related to leases that have initial or remaining lease terms in excess of one year are as follows (in thousands):

Note 9 – Lessor Arrangement

In December 2023, the Company, with certain partners making up the KNFH II LLC joint venture, entered into a purchase and sale agreement for a pharmaceutical plant in Fenton, Missouri, including land, a building, and all machinery and equipment held within with a purchase price of $8.0 million.

In April 2024, KNFH II LLC entered into a purchase and sale agreement for the machinery and equipment within the pharmaceutical plant with a purchase price of $5.0 million. Additionally, KNFH II LLC entered into a lease agreement for the lease of the real estate assets; the building and land. This lease agreement includes a purchase option with a purchase price of $8.0 million that is expected to be exercised by the lessee. The lessor arrangement is classified as a sales-type lease, and, therefore, the present value of future lease payments, including the purchase option, has been recognized as revenue and a lease receivable as of the effective date. As of September 30, 2024, the Company recognized approximately $1.3 million in earnings from equity method investments, related to the Company’s share of net income attributable to KNFH II LLC.

The Company accounts for the transaction under the equity method where the Company’s share in earnings from equity method investments is shown in one line item on the income statement. Refer to Note 6 for further information.

Note 10 – Intangible Assets and Goodwill

Intangible assets

The Company’s identifiable intangible assets are associated with its acquisitions of HGP in 2012, NLEX in 2014 and ALT in 2021, as shown in the table below (in thousands except for lives), and are amortized using the straight-line method over their remaining estimated useful lives. The Company’s tradename that was acquired as part of the acquisition of NLEX in 2014 has an indefinite life and therefore is not amortized.

Amortization expense during both the nine months ended September 30, 2024 and 2023 was $0.3 million. The Company estimates that the residual value for intangible assets isnot significant.

As of September 30, 2024, the estimated amortization expense for the remainder of the current fiscal year and the next five fiscal years and thereafter is shown below (in thousands):

Goodwill

The Company’s goodwill relates to its acquisition of various entities. Goodwill consists of the following at September 30, 2024 and December 31, 2023 (in thousands):

There wereno additions to goodwill andno impairments recorded to the carrying value of goodwill during the nine months ended September 30, 2024.

Note 11 – Debt

Outstanding debt as of September 30, 2024 and December 31, 2023 is summarized as follows (in thousands):

2021 Credit Facility

On May 5, 2021, the Company entered into a promissory note, business loan agreement, commercial security agreement and pledge agreement (the “2021 Credit Facility”) with C3bank, National Association ("Lender") for a $10.0 million revolving line of credit. The Company is permitted to use the proceeds of the loan solely for its business operations. The Company is the borrower under the 2021 Credit Facility. The 2021 Credit Facility is secured by a security interest in certain of the Company’s subsidiaries’ current and future tangible and intangible assets, inventory, chattel paper, accounts, equipment and general intangibles, and a pledge of the equity of the direct and indirect subsidiaries of the Company.

On August 23, 2022, the Company entered into a Loan Modification Agreement and Reaffirmation of Loan (the “2022 Modification Agreement”), effective as of April 1, 2022, by and between the Company and Lender. The 2022 Modification Agreement modified and reaffirmed the 2021 Credit Facility to provide for, among other things, the arrangement of financial covenants, which remained unchanged, into two categories: (i) financial covenants used to resize the maximum principal amount available to the Company as of the date of determination (as determined by Lender in its sole discretion), and (ii) financial covenants to be maintained by the Company.

On May 26, 2023, the Company entered into a Loan Modification Agreement and Reaffirmation of Loan (the “Modification Agreement”), effective as of May 26, 2023, by and between the Company and Lender. The Modification Agreement modifies and reaffirms the 2021 Credit Facility to, among other things, extend the maturity date, modify the applicable interest rate, and further modify the loan covenants. The maturity date was modified to October 27, 2024. The applicable interest rate spread and floor was modified to be the Wall Street Journal Prime rate plus 1.00% (such rate not to be less than 6.75% per annum). Additionally, the Modification Agreement modifies the loan covenants to provide that the Company shall pay the Lender an annual unused line fee, payable on the earlier of (a) bi-annually every six (6) months in arrears, within ten (10) days thereof, commencing on October 27, 2023, or (b) the payment in full of the 2021 Credit Facility, but only if the average balance of the 2021 Credit Facility for the respective six months is below $5.0 million. The availability of additional draws under the 2021 Credit Facility is conditioned, among other things, on the compliance with certain customary representations and warranties, including default, insolvency or bankruptcy, material adverse change in financial condition and any guarantor’s attempt to revise its guarantee. The agreement governing the 2021 Credit Facility also contains customary affirmative covenants regarding, among other things, the maintenance of records, maintenance of certain insurance coverage, compliance with governmental requirements and maintenance of several financial covenants. The 2021 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, 2024, there wasno outstanding balance on the 2021 Credit Facility.

On July 24, 2024 the Company entered into a Loan Modification Agreement and Reaffirmation of Loan (the “Second Modification Agreement”), effective as of July 24, 2024, to modify certain loan covenants. As of September 30, 2024 the Company was in compliance with all financial and negative covenants.

On October 4, 2024 the Company entered into a Loan Modification Agreement and Reaffirmation of Loan (the “Third Modification Agreement”), effective as of October 4, 2024, to extend the maturity date of the 2021 Credit Facility to December 27, 2024.

The Company's weighted average interest rate on short-term borrowings as of September 30, 2024 and December 31, 2023 was 8.75% and 9.51%, respectively.

ALT Note

On August 23, 2021, the Company entered into a $2.0 million subordinated promissory note with an interest rate of 3% per annum and a maturity date of August 23, 2025 (the “ALT Note”) as part of the aggregate purchase price paid to acquire certain assets and liabilities of American Laboratory Trading. The ALT Note requires 48 equal installments of approximately $44,000 on the first day of each month beginning September 23, 2021 with the final payment due on August 23, 2025. The outstanding balance of the ALT Note as of September 30, 2024 was $0.5 million.

2023 Credit Facility

On May 26, 2023, the Company entered into a promissory note, a business loan agreement and commercial security agreement (collectively, the “2023 Credit Facility”) with C3 Bank. The 2023 Credit Facility provides for a new $7.0 million term loan (the "Term Loan"), which is repayable in monthly installments of principal and interest until the maturity date of April 27, 2028. The Company determines the current portion of the Term Loan to be the amount of principal owed in the next 12 months. The Term Loan sets the interest rate spread and interest rate floor to accrue at a variable interest rate, which is based on the rate of interest last quoted by The Wall Street Journal as the “prime rate,” plus a margin of 0.250%. Additionally, the Term Loan provides that in the event of prepayment the Company shall pay the Lender a prepayment fee during the first year equal to twelve months of interest (less interest actually paid). The Company is the borrower under the Term Loan and is permitted to use the proceeds of the Term Loan solely for its business operations. The Term Loan is secured by a security interest in certain of the Company’s and its certain subsidiaries’ current and future tangible and intangible assets, inventory, chattel paper, accounts, equipment and general intangibles and a pledge of the equity of the direct and indirect subsidiaries of the Company. Specifically, the Term Loan is secured by the building currently used by ALT in East Lyme, CT.

On July 24, 2024, the Company paid $5.8 million for the full remaining principal balance outstanding of $5.7 million on its Term Loan agreement with C3 Bank, in advance of the loan’s April 27, 2028 maturity date, and $0.1 million in interest accrued to July 24, 2024.

Note 12 – Income Taxes

At September 30, 2024, the Company had aggregate federal net operating loss carry forwards of $50.3 million. These net operating loss carry forwards begin to expire in 2024. 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. These rules, in general, provide that an ownership change occurs when the percentage shareholdings of 5% direct or indirect stockholders of a loss corporation have, in aggregate, increased by more than 50 percentage points during the immediately preceding three years. Restrictions in net operating loss carry forwards occurred in 2001 as a result of the acquisition of the Company by Street Capital. Pursuant to Section 382 of the Internal Revenue Code, the annual usage of the Company’s net operating loss carry forwards was limited to approximately $2.5 million per annum until 2008 and $1.7 million per annum through December 31, 2023. As of December 31, 2023, all of the Company's restricted net operating loss carry forwards have been fully utilized. The Company has no net operating loss carry forwards limited under Section 382 of the Internal Revenue Code as of September 30, 2024.

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 impact of state income taxes.

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 partial valuation allowance against its net deferred tax assets. As of both September 30, 2024 and December 31, 2023, the Company's valuation allowance against its deferred tax assets was approximately $2.2 million.

Note 13 – Related Party Transactions

As part of the operations of NLEX, the Company leases office space in Edwardsville, IL that is owned by the President of NLEX and a member of the board of directors of the Company, David Ludwig. The total amount paid to the related party for both the nine months ended September 30, 2024 and 2023 was approximately $85,000 and is included in selling, general and administrative expenses in the unaudited condensed consolidated statements of income.

Note 14 – Segment Information

The following table sets forth certain financial information for the Company's reportable segments (in thousands):

Note 15 – Subsequent Events

The Company has evaluated events subsequent to September 30, 2024 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, other than noted below.

On October 4, 2024 the Company entered into a Loan Modification Agreement and Reaffirmation of Loan (the “Third Modification Agreement”), effective as of October 4, 2024, to extend the maturity date of the 2021 Credit Facility to December 27, 2024. There is no outstanding balance on the 2021 Credit Facility as of September 30, 2024.