Heritage Global Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis should be read in conjunction with our consolidated financial statements and the notes thereto, included in “Item 15. Exhibits and Financial Statement Schedules” of this Report. Our accounting policies have the potential to significantly impact our 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. Business Overview, Recent Developments and Outlook Please see “Item 1. Business” of this Report for an overview of our business and recent developments. Please see “Item 1A. Risk Factors” of this Report for a discussion of the risk factors that may impact our current and future operations, and financial condition. Equity Partners Separation In September 2019, we entered into an Amendment (the “Mann Amendment”) to the Employment Agreement (the “Mann Employment Agreement”) for Kenneth Mann, a named executive officer of the Company and the Senior Managing Director of Equity Partners. Pursuant to the terms of the Mann Amendment, Mr. Mann continued his current employment with Equity Partners until December 31, 2019, after which time the Mann Employment Agreement and Mann Amendment terminated and Mr. Mann’s employment with Equity Partners ceased (the “Resignation Time”). Equity Partners agreed to provide Mr. Mann with his current annual salary of $375,000, potential bonus in an amount equal to $50,000 paid in regular payroll, and continued benefits. In addition, Equity Partners agreed to pay to the personnel of Equity Partners (including Mr. Mann) an aggregate bonus equal to the sum of 50% of Equity Partners’ 2019 net operating income (if any), plus $25,000. Mr. Mann agreed to surrender, and to cause an entity controlled by him to surrender, at the Resignation Time certain options to purchase our common stock possessed by either Mr. Mann or the entity controlled by Mr. Mann. On January 1, 2020 Equity Partners transferred to Mr. Mann certain assets of Equity Partners (the “Transferred Assets”), free and clear of all liens. The Mann Amendment provided Mr. Mann the right to choose, in his sole discretion, to accept assignment from Equity Partners of any of the liabilities and obligations of Equity Partners listed in the Mann Amendment by providing written notice to Equity Partners by November 29, 2019. Other than the Transferred Assets, Equity Partners retained all of the assets and rights held by Equity Partners. In accordance with the agreement, Mr. Mann agreed to pay, or to cause a buyer to pay, to Equity Partners a percentage of all revenue received with respect to each engagement for which we were engaged or retained as of December 31, 2019 but that was closed or completed following December 31, 2019, subject to certain exclusions. The percentage to be paid is determined by multiplying the revenue by the percentage of the engagement completed prior to December 31, 2019, as determined in good faith by Mr. Mann and a representative of Equity Partners on or before December 31, 2019. Equity Partners maintains a right to audit Mr. Mann’s and a buyer’s records for up to one year following the final payment for all such engagements. We recorded a non-cash goodwill impairment charge on December 31, 2019 of $0.6 million as a result of this separation transaction. 17 Liquidity and Capital Resources Liquidity At December 31, 2020, we had working capital of $13.0 million, as compared to a working capital deficit of $2.4 million at December 31, 2019, an increase of $15.4 million. On October 6, 2020, we completed a public offering (the “2020 Public Offering”) of 5,462,500 shares of our common stock, at a public offering price of $1.75 per share, which included a full exercise of the underwriters’ option to purchase 712,500 additional shares of common stock from us. We received approximately $8.7 million of net proceeds, after deducting underwriting discounts and commissions, but before offering expenses. We intend to use the net proceeds to provide additional funds for general corporate purposes, which may include, without limitation, the expansion of the businesses of HGC and HGP, working capital and growth capital. Our current assets increased to $27.0 million at December 31, 2020 compared to $6.8 million at December 31, 2019. Within current assets, the most significant change was an approximate $20.7 million increase in cash, primarily as a result of proceeds from the sale of shares of common stock completed in October of 2020, cash distributions from equity method investments, and the result of timing of certain auctions held in the fourth quarter of 2020 that will be settled in the first quarter of 2021. Our current liabilities increased to $14.0 million at December 31, 2020 as compared to $9.1 million at December 31, 2019. The most significant change was an increase of $5.5 million in accounts payable and accrued liabilities, primarily the result of timing of certain auction settlement liabilities, offset by a decrease of $0.4 million in third party debt. We believe we can fund our operations and our debt service obligations during 2021 and beyond through a combination of cash flows from our on-going asset liquidation operations, proceeds from the sale of shares of common stock completed in October 2020, and accessing financing from our existing line of credit. Our indebtedness consists of any amounts borrowed under our Credit Facility. On February 10, 2020, we entered into a secured promissory note, business loan agreement, commercial security agreement and agreement to provide insurance (the “Credit Facility”) with C3bank, National Association for a $5.0 million revolving line of credit, which was subsequently amended on March 3, 2021. The Credit Facility matures on April 5, 2021 and replaces a secured promissory note, as amended, totaling $3.0 million. We are permitted to use the proceeds of the loan solely for our business operations. As of December 31, 2020, we had an outstanding balance of zero on the Credit Facility. During 2020, our primary sources of cash were the operations of our asset liquidation business and proceeds from the sale of shares of common stock completed in October 2020 . Cash disbursements during 2020 consisted primarily of settlement of auction proceeds, lending activity under our new specialty finance unit of HGC, debt repayment, purchases of inventory and payment of operating expenses. We expect that our asset liquidation business will continue to be the primary source of cash required for ongoing operations for the foreseeable future. Ownership Structure and Capital Resources At December 31, 2020 and 2019, we had stockholders’ equity of $29.9 million and $11.8 million, respectively. We determine our future capital and operating requirements based upon our current and projected operating performance and contractual commitments. We expect to be able to finance our future operations through a combination of our asset liquidation business, our Credit Facility and securing additional debt financing if needed. Our contractual requirements are limited to the outstanding debt and lease commitments with related and unrelated parties. Capital requirements are generally limited to our purchases of surplus and distressed assets and our lending activity under our specialty finance unit of HGC. We believe that our current capital resources, including available borrowing capacity from our Credit Facility, are sufficient for these requirements. In the event additional capital is needed, we believe we can obtain additional debt financing through either capital partners or a new credit facility. 18 Cash Position and Cash Flows Cash and cash equivalents at December 31, 2020 were $23.4 million compared to $2.7 million at December 31, 2019. Cash provided by operating activities. Cash provided by operating activities was $9.1 million during 2020 as compared to cash provided by operating activities of $0.8 million during 2019. The approximate $8.3 million increase was primarily attributable to a net favorable change of $7.7 million in the operating assets and liabilities in 2020 compared to 2019, largely due to an increase in auction activity towards the end of 2020, plus a $0.6 million favorable change in the net income adjusted for noncash items. The significant changes in operating assets and liabilities during 2020 as compared to 2019 are primarily due to the nature of our operations. We earn revenue from discrete asset liquidation deals that vary considerably with respect to their magnitude and timing, and that can consist of fees, commissions, asset sale proceeds, or a combination of all. The operating assets and liabilities associated with such transactions are therefore subject to the same variability and can be different at the end of any given period. Cash provided by (used in) investing activities. Cash provided by investing activities during 2020 was $4.5 million, as compared to cash used in investing activities of $1.2 million during 2019. The approximate $5.7 million change was primarily attributable to an increase in cash distributions from our equity method investments of $3.0 million, as compared to distributions in 2019, and cash received on transfer of notes receivable to partners of $5.0 million related to our specialty financing division. The increase was offset by an increase of lending activity in our specialty financing division in 2020 of approximately $2.5 million. Cash provided by (used in) financing activities. Cash provided by financing activities was $7.0 million during 2020, as compared to cash used in financing activities of $1.2 million during 2019. The 2020 activity consisted primarily of a $5.6 million draw and repayment on our Credit Facility, $0.4 million of repayments on third party debt, and $7.5 million in net proceeds from the sale of shares of common stock completed in October 2020. The 2019 activity consisted primarily of a $1.3 million draw offset by $2.1 million of repayments on our 2018 Credit Facility, and $0.3 million of repayments on third party debt. Management’s Discussion of Results of Operations The following table summarizes our consolidated results of operations for 2020 and 2019 (in thousands). Year ended December 31, 2020 2019 Revenues: Services revenue $ 21,806 $ 20,100 Asset sales 4,377 6,068 Total revenues 26,183 26,168 Operating costs and expenses: Cost of services revenue 6,320 3,374 Cost of asset sales 2,789 4,365 Selling, general and administrative 14,449 15,874 Depreciation and amortization 362 305 Impairment of goodwill — 573 Total operating costs and expenses 23,920 24,491 Earnings of equity method investments 3,796 1,373 Operating income 6,059 3,050 Interest and other expense, net (45 ) (64 ) Income before income tax benefit 6,014 2,986 Income tax benefit (3,644 ) (913 ) Net income $ 9,658 $ 3,899 19 Our asset liquidation revenue has several components: (1) traditional fee based asset disposition services, such as commissions from on-line and webcast auctions, liquidations and negotiated sales, and commissions from the NLEX charged-off receivables business, (2) the acquisition and subsequent disposition of distressed and surplus assets, including industrial machinery and equipment and real estate, and (3) fees earned for appraisal, management advisory services and specialty financing services. The Company reports segment information based on the “management” approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of the Company’s reportable segments. The Company manages its business primarily on differentiated revenue streams for services offered. The Company’s reportable segments consist of the Industrial Asset Division and Financial Assets Division. Our Industrial Assets division advises enterprise and financial customers on the sale of industrial assets mostly from surplus and sometimes distressed circumstances while acting as an agent, guarantor or principal in the sale. Our Financial Assets division provides liquidity to issuers of consumer credit that are looking to monetize nonperforming and charged-off loans — loans that creditors have written off as uncollectable. Nonperforming and charged-off loans typically originate from banks that issue unsecured consumer credit. The Company evaluates the performance of its reportable segments based primarily on net operating income. Further, the Company does not utilize segmented asset information to evaluate the performance of its reportable segments and does not include intercompany transfers between segments for management reporting purposes. The following table sets forth certain financial information for the Company's reportable segments (in thousands): Year Ended December 31, 2020 2019 Industrial Assets Division: Net operating income $ 5,764 $ 2,834 Financial Assets Division: Net operating income $ 2,637 $ 3,337 Corporate and Other: Net operating income $ (2,342 ) $ (3,121 ) Consolidated: Net operating income $ 6,059 $ 3,050 2020 Compared to 2019 Revenues and cost of revenues – Revenues were $26.2 million in both 2020 and 2019 and costs of services revenue and asset sales were $9.1 million in 2020 compared to $7.7 million in 2019. The gross profits were therefore $17.1 million in 2020 compared to $18.4 million in 2019, a decrease of approximately $1.3 million or approximately 7%. The decreased gross profit in the current year reflects the vagaries of the timing and magnitude of asset liquidation transactions. Selling, general and administrative expense – Selling, general and administrative expense was $14.4 million in 2020 as compared to $15.9 million in 2019, a decrease of $1.4 million or 9%. Expenses decreased overall primarily due to the elimination of Equity Partners compensation costs as the Equity Partners team separated from the Company at December 31, 2019. 20 Significant components of selling, general and administrative expense were as shown below (dollars in thousands): Year ended December 31, 2020 2019 % change Compensation: HGP $ 4,987 $ 4,652 7 % NLEX 3,571 4,151 -14 % Equity Partners — 1,621 -100 % HGI 1,119 677 65 % HGC 442 147 201 % Stock-based compensation 353 283 25 % Consulting 286 228 25 % Board of Directors fees 258 258 0 % Accounting, tax and legal professional fees 802 749 7 % Insurance 453 361 25 % Occupancy 886 860 3 % Travel and entertainment 277 772 -64 % Advertising and promotion 444 609 -27 % Information technology support 288 290 -1 % Other 283 216 31 % Total selling, general and administrative expense $ 14,449 $ 15,874 -9 % Depreciation and amortization expense – Depreciation and amortization expense was $0.4 million in 2020 and $0.3 million in 2019, and consisted almost entirely of amortization expense related to intangible assets. In both years the depreciation of property and equipment was not material. Impairment of goodwill – We recorded an impairment charge of $0.6 million to reduce the carrying value of goodwill in connection with the Equity Partners separation transaction at the end of 2019. Refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Equity Partners Separation” for more information. Off-Balance Sheet Arrangements – We had no off-balance sheet arrangements during the years ended December 31, 2020 and 2019. 21 Key Performance Indicators We monitor a number of financial and non-financial measures on a regular basis in order to track our underlying operational performance and trends. Other than the operating income of our liquidation business ( a GAAP financial measure as shown in our consolidated income statements ), which we believe is the most important measure of our operational performance and trends, w e believe that EBITDA and Adjusted EBITDA (non-GAAP financial measures) are key performance indicators (“KPIs”) for our business. These KPIs may not be defined or calculated in the same way as similar KPIs used by other companies. We prepared our audited consolidated financial statements in accordance with GAAP. We define EBITDA as net income plus depreciation and amortization, interest and other expense, and provision for income taxes. Adjusted EBITDA reflects EBITDA adjusted further to eliminate the effects of stock-based compensation and impairment of goodwill. Management uses EBITDA and Adjusted EBITDA in assessing the Company’s results, evaluating the Company’s performance and in reaching operating and strategic decisions. Management believes that the presentation of EBITDA and Adjusted EBITDA, when considered together with our GAAP financial statements and the reconciliation to the most directly comparable GAAP financial measure, is useful in providing investors a more complete understanding of the factors and trends affecting the underlying performance of the Company on a historical and ongoing basis. Our use of EBITDA and Adjusted EBITDA is not meant to be, and should not be, considered in isolation or as a substitute for, or superior to, any GAAP financial measure. You should carefully evaluate the financial information below, which reconciles our GAAP reported net income to EBITDA and Adjusted EBITDA for the periods presented (in thousands). Year ended December 31, 2020 2019 Net income $ 9,658 $ 3,899 Add back: Depreciation and amortization 362 305 Interest and other expense, net 45 64 Income tax benefit (3,644 ) (913 ) EBITDA 6,421 3,355 Management add back: Stock based compensation 353 283 Impairment of goodwill — 573 Adjusted EBITDA $ 6,774 $ 4,211 Recently adopted accounting pronouncements 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 applies to fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. ASU 2017-04 became effective January 1, 2020 and did not have a material impact on our 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. ASU 2018-07 became effective January 1, 2019 and did not have a material impact on our consolidated financial statements. Future accounting pronouncements In 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which simplifies the accounting for income taxes. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We anticipate that the impact will not be material to our consolidated financial statements. 22 In 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (“ASU 2016-13”), which applies a current expected credit loss model which is a new impairment model based on expected losses rather than incurred losses. The expected credit losses, and subsequent adjustments to such losses, will be recorded through an allowance account that is deducted from, or added to, the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the consolidated balance sheet at the amount expected to be collected. ASU 2016-13 eliminates the current accounting model for loans and debt securities acquired with deteriorated credit quality under ASC 310-30, which provides authoritative guidance for the accounting of our notes receivable . With respect to smaller reporting companies, the amendments in this update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We are currently evaluating the impact of the new guidance on our consolidated financial statements. Critical Accounting Policies Use of estimates The preparation of our 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 and notes receivable, inventory, investments, goodwill and intangible assets, liabilities, contingent consideration, 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 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. Revenue recognition In 2018, we adopted the accounting standard FASB ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”) to all contracts using the modified retrospective method. Services revenue generally consists of commissions and fees from providing auction services, appraisals, brokering of sales transactions, secured lending 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 within the asset liquidation business, which consists of two reportable segments, the Industrial Assets Division and the Financial Assets Division. 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 this 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 year ended December 31, 2020), 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 our “contract liability”. As of December 31, 2020, the deferred revenue balance was $17,000. We record 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 we satisfy the performance obligation and cash is collected. We do 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. 23 We also earn asset liquidation income through asset liquidation transactions that involve us acting jointly with one or more additional purchasers, pursuant to a partnership, joint venture or limited liability company agreement (collectively, “Joint Ventures”). For these transactions, in which our ownership share meets the criteria for the equity method investments under ASC 323, we do not record asset liquidation revenue or expense. Instead, our 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. In 2019, we began providing specialty financing solutions to investors in charged-off and nonperforming asset portfolios. Fees collected in relation to the issuance of loans includes 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, and the lack of historical precedence as we started in this business in 2019. During 2020 and 2019, the Company generated revenues specific to one customer representing 10% and 14% of total revenues for the respective periods. Cost of services revenue and asset sales Cost of services revenue generally includes the direct costs associated with generating commissions and fees from our auction and appraisal services, merger and acquisition advisory services, and brokering of charged-off receivable portfolios. We generally recognize these expenses in the period in which the revenue they relate to is recorded. Cost of asset sales generally includes the cost of purchased inventory and the related direct costs of selling inventory. We recognize these expenses in the period in which title to the inventory passes to the buyer and the buyer assumes the risk and reward of the inventory. Accounts receivable Our accounts receivable primarily relate to the operations of our asset liquidation business. They generally consist of three major categories: fees, commissions and retainers relating to appraisals and auctions, receivables from asset sales, and receivables from Joint Venture partners. The initial value of an account receivable corresponds to the fair value of the underlying goods or services. To date, a majority of the receivables have been classified as current and, due to their short-term nature, any decline in fair value would be due to issues involving collectability. At each financial statement date the collectability of each outstanding account receivable is evaluated, and an allowance is recorded if the book value exceeds the amount that is deemed collectable. See Note 10 to our consolidated financial statements for more detail regarding our accounts receivable. Notes receivable, net Our notes receivable balance consists of loans to buyers of charged-off receivable portfolios, which is considered the only loan category or segment to be reported under the applicable accounting guidance. These loans are measured at historical costs and reported at their outstanding principal balances net of any unamortized deferred fees and costs on originated loans. Loan origination fees and certain direct origination costs are deferred and recognized as adjustments to interest income over the lives of the related loans. As of December 31, 2020, we have not recorded an allowance for credit losses related to notes receivable outstanding. In order to evaluate the need for an adjustment to the receivable balance related to credit losses, or impairment, we perform 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. 24 Inventory Our inventory consists of assets acquired for resale. Machinery and equipment inventory is classified as current, and historically is sold within a one-year operating cycle. Real estate inventory is generally classified as non-current due to uncertainties relating to the timing of resale. All inventory is recorded at the lower of cost or net realizable value. There is a risk that assets acquired for resale may be subsequently sold for less than their cost, or may remain unsold. Historically, the assets’ selling prices have generally been in excess of their cost. Equity Method Investments As noted above, we conduct a portion of our asset liquidation business through Joint Ventures. Transactions in which our ownership share meets the criteria for the equity method investments under ASC 323 are accounted for using the equity method of accounting whereby our proportionate share of the Joint Venture’s net income (loss) is reported in the consolidated income statement as earnings of equity method investments. At the balance sheet date, our investments in these Joint Ventures are reported in the consolidated balance sheet as equity method investments. We monitor the value of each Joint Ventures’ underlying assets and liabilities, and record a write down of our investments should we conclude that there has been a decline in the value of the net assets. Given that the underlying transactions are identical, in all material aspects, to asset liquidation transactions that we undertake independently, the net assets are similarly expected to be sold within a one-year operating cycle. However, these investments have historically been classified as non-current in our consolidated financial statements due to the uncertainties relating to the timing of resale of the underlying assets as a result of the Joint Venture relationship. See Note 2 and Note 5 to our consolidated financial statements for further detail. Intangible assets and goodwill Intangible assets are recorded at fair value upon acquisition. Those with an estimated useful life are amortized, and those with an indefinite useful life are unamortized. Subsequent to acquisition, we monitor events and changes in circumstances that require an assessment of intangible asset recoverability. Indefinite-lived intangible assets are assessed at least annually to determine both if they remain indefinite-lived and if they are impaired. We assess whether or not there have been any events or changes in circumstances that suggest the value of the asset may not be recoverable. Amortized intangible assets are not tested annually, but are assessed when events and changes in circumstances suggest the assets may be impaired. If an assessment determines that the carrying amount of any intangible asset is not recoverable, an impairment loss is recognized in the income statement, determined by comparing the carrying amount of the asset to its fair value. All of our identifiable intangible assets at December 31, 2020 have been acquired as part of the acquisitions of HGP in 2012 and NLEX in 2014, and are discussed in more detail in Note 9 to our consolidated financial statements. No impairment charges were necessary during 2020. Goodwill, which results from the difference between the purchase price and the fair value of net identifiable tangible and intangible assets acquired in a business combination, is not amortized, but is tested at least annually for impairment. We perform our annual impairment test on October 1. In testing goodwill, we initially use a qualitative approach and analyze relevant factors to determine if events and circumstances have affected the value of the goodwill. If the result of this qualitative analysis indicates that the value has been impaired, we then apply a quantitative approach to calculate the difference between the goodwill’s recorded value and its fair value. An impairment loss is recognized to the extent that the recorded value exceeds its fair value. Goodwill, in addition to being tested for impairment annually, is tested for impairment at interim periods if an event occurs or circumstances change such that it is more likely than not that the carrying amount of goodwill may be impaired. All of our goodwill relates to our acquisitions of HGP in 2012 and NLEX in 2014, and is discussed in more detail in Note 9 to our consolidated financial statements. As a result of the Equity Partners separation transaction at the end of 2019, we recorded an impairment charge of $0.6 million to reduce the carrying value of goodwill related to the acquisition of Equity Partners in 2011. Refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Equity Partners Separation” for more information. Future impairment of our intangible assets and goodwill could result from changes in assumptions, estimates or circumstances, some of which are beyond our control. The most significant items that could impact our business and result in an impairment charge are outlined in “Item 1A. Risk Factors” of this Report. 25 Deferred income taxes We recognize deferred tax assets and liabilities for temporary differences between the tax basis of assets and liabilities and the amounts at which they are carried in the financial statements, based upon the enacted tax rates in effect for the year in which the differences are expected to reverse. We periodically assess the value of our deferred tax assets, which have been generated by a history of net operating and net capital losses, and determine the necessity for a valuation allowance that will reduce deferred tax assets to the amount expected to be realized. We evaluate which portion of the deferred tax assets, if any, will more likely than not be realized by offsetting future taxable income, taking into consideration any limitations that may exist on our use of our net operating and net capital loss carryforwards. In 2019 and 2020 we recorded a reduction to the valuation allowance resulting in a net deferred tax asset balance of approximately $0.4 million and $4.4 million, respectively, as we believe that it is more likely than not that some of our net operating loss carryforwards will be utilized. For further discussion of our income taxes, see Note 13 to our consolidated financial statements. Liabilities and contingencies We are involved from time to time in various legal matters arising out of our operations in the normal course of business. On a case by case basis, we evaluate the likelihood of possible outcomes for these contingent matters. Based on this evaluation, we determine whether a loss accrual is appropriate. If the likelihood of a negative outcome is probable, and the amount can be estimated, we accrue the estimated loss in the current period. Refer to Note 15 to our consolidated financial statements for further detail. Stock-based compensation Our stock-based compensation is primarily in the form of options to purchase common shares. The fair value of stock options is calculated using the Black-Scholes option pricing model. The determination of the fair value of our stock options is based on a variety of factors including, but not limited to, the price of our common stock, the expected volatility of the stock price over the expected life of the award, and expected exercise behavior. The fair value of the awards is subsequently expensed over the vesting period, net of estimated forfeitures. The provisions of our stock-based compensation plans do not require that we settle any options by transferring cash or other assets, and therefore we classify the option awards as equity. See Note 16 to our consolidated financial statements for further discussion of our stock-based compensation. Item 7A. Quantitative and Qualitative Disclosures about Market Risk. As a Smaller Reporting Company, we are electing scaled reporting obligations and therefore are not required to provide the information requested by this Item.