UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the Quarterly Period Ended March 31, 2021

For the transition period from           to           

Commission File Number: 001-37689

 

ALJ REGIONAL HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

244 Madison Avenue, PMB #358

New York, NY 10016

(Address of principal executive offices, Zip code)

(888) 486-7775

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes    ☐    No  ☒ 

The number of shares of common stock, $0.01 par value per share, outstanding as of May 1, 2021 was 42,321,048.

 

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

The statements included in this Form 10-Q regarding future financial performance, results and conditions and other statements that are not historical facts, including, among others, the statements regarding competition, the Company’s intention to retain earnings for use in the Company’s business operations, the Company’s ability to continue to fund its operations and service its indebtedness, the adequacy of the Company’s accrual for tax liabilities, management’s projection of continued taxable income, and the Company’s ability to offset future income against net operating loss carryovers, constitute forward-looking statements. The words “can,” “could,” “may,” “will,” “would,” “plan,” “future,” “believes,” “intends,” “expects,” “anticipates,” “projects,” “estimates,” and similar expressions are also intended to identify forward-looking statements. These forward-looking statements are based on current expectations and are subject to risks and uncertainties. Actual results or events could differ materially from those set forth or implied by such forward-looking statements and related assumptions due to certain important factors, including, without limitation, the risks set forth under the caption “Risk Factors” below, which are incorporated herein by reference. Some, but not all, of the forward-looking statements contained in this Form 10-Q include, among other things, statements about the following:

The Company is also subject to general business risks, including results of tax audits, adverse state, federal or foreign legislation and regulation, changes in general economic conditions, the Company’s ability to retain and attract key employees, acts of war or global terrorism and unexpected natural disasters. Any forward-looking statements included in this Form 10-Q are made as of the date hereof, based on information available to the Company as of the date hereof, and the Company assumes no obligation to update any forward-looking statements.

 

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ALJ REGIONAL HOLDINGS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED MARCH 31, 2021

INDEX

 

 

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PART I. FINANCIAL INFORMATION

Item 1 - Financial Statements

 

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

 

See accompanying notes

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share amounts)

 

^{__________________________________________________}

⁽¹⁾ Amounts may not add due to rounding.

 

See accompanying notes

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands) 

 

See accompanying notes

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands) 

 

 

See accompanying notes

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)

(in thousands) 

 

See accompanying notes

 

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. ORGANIZATION AND BASIS OF PRESENTATION

Organization

ALJ Regional Holdings, Inc. (including subsidiaries, referred to collectively herein as “ALJ” or “Company”) is a holding company. During the three and six months ended March 31, 2021 and 2020, ALJ consisted of the following wholly owned subsidiaries:  

As a result of selling one of its segments during the three months ended March 31, 2021, discussed below, ALJ has organized its business and corporate structure into two business segments: Faneuil and Phoenix.

Basis of Presentation

 

In January 2021, ALJ entered into a Purchase and Sale Agreement (“PSA”), by and among the Company, Superior Interior Finishes, LLC, a Nevada limited liability company (“Purchaser” or “Superior”) and Carpets, pursuant to which the Company agreed to sell 100% of the membership interests of Carpets to the Purchaser for an aggregate purchase price of $0.5 million (the “Purchase Price”) in cash (the “Transaction”). At the time of the PSA, Superior was 100% owned by Steve Chesin, the Chief Executive Officer of Carpets. The Company entered into the PSA because its Carpets business segment had been deemed a non-core holding and had underperformed over the past several years.  The Transaction, which was approved by a committee of the Board comprised solely of certain independent directors of the Company, closed in February 2021.  As such, the results of operations, assets, liabilities, and cash flows of Carpets were classified as discontinued operations in ALJ’s financial statements for all periods presented. See Note 4 for additional information about the divestiture of Carpets.  

The interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”). The Condensed Consolidated Financial Statements and footnotes thereto are unaudited. In the opinion of the Company’s management, the Condensed Consolidated Financial Statements reflect all adjustments, which are of a normal recurring nature, that are necessary for a fair presentation of the Company’s interim financial results. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the assets, liabilities, revenue and expenses that are reported in the Condensed Consolidated Financial Statements and footnotes thereto. Actual results may differ from those estimates. Interim financial results are not necessarily indicative of financial results for a full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2020, filed with the SEC on December 18, 2020.

 

Impact of Coronavirus Pandemic

In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic, which continues to spread throughout the U.S. COVID-19 is having an unprecedented impact on the U.S. economy as federal, state, and local governments react to this public health crisis.

 

Currently, all of ALJ’s subsidiaries have been deemed “Essential Services” and have continued to operate with limited disruption. To date, COVID-19 has not materially impacted ALJ’s financial position, results of operations or cash flows. The Company took immediate actions in March 2020 to enable working-from-home where possible and put in place increased safety precautions,

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

including social distancing, at other locations where essential services on site are required. The duration of these measures is unknown, may be extended and additional measures may be imposed.

Management expects that ALJ could continue to be impacted in the near term by lower sales volumes in several parts of ALJ’s business, resulting in lower revenue and profit. While the impact of COVID-19 on the Company’s future financial position, results of operations and cash flows cannot be estimated with certainty, such impact could be significant if the global pandemic continues to adversely impact the U.S. economy for an extended period of time. The extent to which COVID-19 impacts ALJ’s operations will depend on future developments, which are highly uncertain. These include among others, the duration of the outbreak, vaccination rate, emergence of new variants, if portions of the Company’s business segments are recharacterized as non-essential for which closure of some or all of the Company’s operations could be required, information that may emerge concerning the severity of COVID-19 and the actions, especially those taken by governmental authorities, to contain the pandemic or treat its impact. As events are rapidly developing, additional impacts may arise that are not known at this time.

As of March 31, 2021, ALJ’s total available liquidity was $21.7 million, which included $4.6 million of cash and cash equivalents and $17.1 million of unused borrowing capacity under the Company’s revolving credit facility. While the impact that COVID-19 may have on the Company’s financial position, results of operations, and cash flows in the future cannot be estimated with certainty, based on current estimates regarding the magnitude and duration of the global pandemic, ALJ does not anticipate an impact on the Company’s ability to meet its obligations when due for at least the next 12 months.  However, the ultimate magnitude and duration of the global pandemic is highly uncertain and, as such, will require ALJ to continually assess the situation for the foreseeable future.  Accordingly, the Company’s estimates regarding the magnitude and duration of the global pandemic may change in the future and such changes could be material.

As a result of the decline in ALJ’s actual and forecasted results of operations, including the potential effects of COVID-19, ALJ (i) sought an easement of certain financial covenants, under the Financing Agreement (as defined below), in order to maintain compliance therewith, and (ii) the elimination of certain quarterly principal payment obligations. Accordingly, the Company executed the Ninth Amendment to the Financing Agreement on May 12, 2020.  See Note 8 “Ninth Amendment to the Financing Agreement” for additional information regarding the terms and conditions required by the Ninth Amendment to the Financing Agreement.  

While the Company currently anticipates it will be able to maintain compliance with the terms and conditions of the Financing Agreement (as amended to date) for at least the next 12 months, the ultimate magnitude and duration of the global pandemic is highly uncertain and, as such, will require ALJ to continually assess its current estimates of compliance for the foreseeable future. Accordingly, the Company’s anticipated compliance with its financial covenants may adversely change if the magnitude and duration of the global pandemic has a materially adverse effect on the Company in the future.

 

 

 

 

2. RECENT ACCOUNTING STANDARDS   

 

Accounting Standards Adopted

 

Leases

 

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (ASU 2016-02, Leases and subsequent amendments to the initial guidance: ASU 2017-13, ASU 2018-10, ASU 2018-11, ASU 2018-20 and ASU 2019-01 (referred to collectively as “ASC 842”)). ASC 842 requires lessees to recognize a right-of-use (“ROU”) asset and corresponding lease liability for all leases with terms of more than 12 months and provides enhanced disclosure of lease activity. Recognition, measurement, and presentation of expenses depend on classification as either a finance or operating lease.   

 

ALJ adopted ASC 842 as of October 1, 2020, the effective and initial application date, using the modified retrospective approach. Comparative periods presented in the consolidated financial statements prior to October 1, 2020 continue to be presented under Accounting Standards Codification (“ASC”) 840. ALJ elected the package of practical expedients, which allowed the Company to not reassess, as of the adoption date, whether arrangements contain leases, the classification of existing leases, and the capitalization of initial direct costs of the existing leases. The Company also made a policy election to exclude leases with an initial term of 12 months or less from the Consolidated Balance Sheet.  The Company recognizes lease expense for these leases on a straight-line basis over the lease term.

 

The Company’s October 1, 2020 adoption of ASC 842 resulted in the recognition of operating lease obligations totaling $42.6 million, based upon the present value of the remaining minimum rental payments using discount rates as of the adoption date, of which

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

$5.2 million was in operating lease obligations - current installments, and $37.4 million was in operating lease liabilities, less current installments. In addition, ALJ recorded corresponding operating lease right-of-use assets totaling $33.4 million. The new standard did not have a material impact on the Consolidated Statements of Operations or the Consolidated Statements of Cash Flows. See Note 10 for further discussion of the Company’s leasing arrangements and required ASC 842 disclosures. 

 

Income Taxes

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which simplifies certain aspects of the accounting for income taxes as well as clarifies and amends existing guidance to improve consistent application. ALJ early adopted ASU 2019-12 as of January 1, 2021. The impact of ASU 2019-12 on ALJ’s consolidated financial statements and related disclosures was not material.

Accounting Standards Not Yet Adopted

 

Internal-Use Software

 

In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, to provide guidance on implementation costs incurred in a cloud computing arrangement (“CCA”) that is a service contract. ASU 2018-15 aligns the accounting for such costs with the guidance on capitalizing costs associated with developing or obtaining internal-use software. Specifically, ASU 2018-15 amends ASC 350, Intangibles–Goodwill and Other, to include in its scope implementation costs of a CCA that is a service contract and clarifies that a customer should apply ASC 350-40 to determine which implementation costs should be capitalized in such a CCA. ASU 2018-15 will be effective for ALJ on October 1, 2021. ALJ does not anticipate the adoption of ASU 2018-15 to significantly impact its consolidated financial statements and related disclosures.

 

 

3. REVENUE RECOGNITION

 

Disaggregation of Revenue

Revenue by contract type was as follows for the three and six months ended March 31, 2021 and 2020:

 

 

Substantially all of Faneuil revenue is recognized over time and substantially all of Phoenix revenue is recognized at a point in time.

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Contract Assets and Liabilities

 

The following table provides information about consolidated contract assets and contract liabilities at March 31, 2021 and September 30, 2020:

 

 

 

 

The following table provides changes in consolidated contract assets and contract liabilities during the six months ended March 31, 2021:  

 

 

 

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

Deferred Revenue and Remaining Performance Obligations

 

Deferred revenue primarily consists of billings or payments received in advance of revenue recognition from call center services, including non-refundable payments made prior to operations. Deferred revenue is recognized as revenue when transfer of control to customers has occurred. Customers are typically invoiced for these agreements in regular installments and revenue is recognized ratably over the contractual service period. The deferred revenue balance is influenced by several factors, including seasonality, the compounding effects of renewals, invoice duration, invoice timing, size and new business linearity within the quarter. Deferred revenue does not represent the total contract value of annual or multi-year non-cancellable agreements.

 

Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 60 days. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined that contracts generally do not include a significant financing component. The primary purpose of invoicing terms is to provide customers with simplified and predictable ways of purchasing products and services, not to receive financing from customers. Any potential financing fees are considered de minimis.

Transaction price allocated to remaining performance obligations represents contracted revenue that has not yet been recognized, which includes deferred revenue. Transaction price allocated to the remaining performance obligation is influenced by several factors, including the timing of renewals and average contract terms. The Company applied practical expedients to exclude amounts related to performance obligations that are billed and recognized as they are delivered, optional purchases that do not represent material rights, and any estimated amounts of variable consideration that are subject to constraint in accordance with the new revenue standard.

The Company has elected to apply the optional exemption for the disclosure of remaining performance obligations for contracts that have an original expected duration of one year or less, are billed and recognized as services are delivered and/or variable consideration allocated entirely to a wholly unsatisfied promise to transfer a distinct good or service that forms part of a single performance obligation.  This primarily consists of call center services that are billed monthly based on the services performed each month.

Costs to Obtain a Contract

 

The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the benefit of those costs to be longer than one year. The costs to obtain a contract capitalized under the new revenue standard are primarily sales commissions paid to our sales force personnel. Capitalized costs may also include portions of fringe benefits and payroll taxes associated with compensation for incremental costs to acquire customer contracts and incentive payments to partners. These costs are amortized over the term of the contract or the estimated life of the customer relationship, if renewals are expected and the renewal commission is not commensurate with the initial commission. The Company expenses sales commissions when incurred if the amortization period of the sales commission is one year or less. The accounting for incremental costs of obtaining a contract with a customer is consistent with the accounting under previous guidance.

 

During the six months ended March 31, 2021, the Company capitalized $0.1 million of costs to obtain a contract.  During the six months ended March 31, 2021, the Company amortized $0.3 million of these costs, which is included in selling, general, and administrative expense.  The net book value of costs to obtain a contract was $0.4 million as of March 31, 2021, of which $0.3 million was in prepaid expenses and other current assets, and $0.1 million was in other assets.

Costs to Fulfill a Contract

 

The Company also capitalizes costs incurred to fulfill its contracts that (i) relate directly to the contract, (ii) are expected to generate resources that will be used to satisfy the Company’s performance obligation under the contract, and (iii) are expected to be recovered through revenue generated under the contract. Contract fulfillment costs are expensed to cost of revenue as the Company satisfies its performance obligations by transferring the service to the customer. These costs are amortized on a systematic basis over the expected period of benefit.

 

During the six months ended March 31, 2021, the Company capitalized $6.0 million of costs to fulfill a contract.  The amortization of costs to fulfill contracts, which comprise set-up/transition activities, for the six months ended March 31, 2021 was approximately $6.7 million. The net book value of the costs to fulfill a contract as of March 31, 2021, was $4.4 million of which $1.6 million was in prepaid expenses and other current assets, and $2.8 million was in other assets.

 

Capitalized costs to obtain and fulfill a contract are periodically reviewed for impairment. We did not incur any impairment losses during the six months ended March 31, 2021 or March 31, 2020.

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

4. ACQUISITIONS AND DIVESTITURES  

RDI Acquisition

On July 31, 2019 (“RDI Purchase Date”), Faneuil acquired Realtime Digital Innovations, LLC (“RDI” and such acquisition, the “RDI Acquisition”), a provider of workflow automation and business intelligence services. The RDI Acquisition is expected to provide Faneuil with a sustainable competitive advantage in the business process outsourcing space by allowing it to, among others, (i) automate process workflows and business intelligence, (ii) generate labor efficiencies for existing programs, (iii) expand potential new client target entry points, (iv) improve overall customer experience, and (v) increase margin profiles through shorter sales cycles and software license sales.

The aggregate cash consideration for the RDI Acquisition paid at closing was $2.5 million, with earn-outs up to $7.5 million to be paid upon the achievement of certain financial metrics over a three-year period, subject to a guaranteed payout of $2.5 million.  In March 2021, Faneuil made the first earn-out payment of $2.5 million. The RDI Acquisition was not material to the Company's results of operations, financial position, or cash flows and, therefore, the pro forma impact is not presented.

The following schedule reflects the final fair value of assets acquired and liabilities assumed on the RDI Purchase Date (in thousands):

 

 

 

Fair Value Adjustment of Deferred and Contingent Consideration Liabilities

 

The fair value of the deferred and contingent consideration liabilities is remeasured to fair value at each reporting period using Level 3 inputs such as cash flow forecast, discount rate, and equity risk premium.  The change in fair value, including accretion for the passage of time, is recognized in earnings until the deferred and contingent considerations are resolved. ALJ did not recognize any change in fair value during the three and six months ended March 31, 2021 and 2020.  

Acquisition-Related Expenses

During the six months ended March 31, 2020, the Company incurred less than $0.1 million of acquisition-related expenses in connection with the RDI acquisition, which were expensed to selling, general, and administrative expense.  There were no acquisition-related expenses incurred during any other periods presented.  

Carpets Divestiture

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

As previously disclosed in Note 1, ALJ sold Carpets in February 2021.  As a result, ALJ recognized a loss on sale of $0.8 million during the three months ended March 31, 2021 calculated as follows:

 

The carrying value of the net assets sold, at the time of closing, were as follows:

 

 

The following table presents the aggregate carrying amounts of the classes of assets and liabilities of discontinued operations at September 30, 2020:

 

 

The following table presents information regarding certain components of loss from discontinued operations for the three and six months ended March 31, 2021 and 2020:

 

 

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

The following table presents significant components of cash flows of discontinued operations for the six months ended March 31, 2021 and 2020:

 

 

 

5. CONCENTRATION RISKS

Cash

The Company maintains its cash balances in accounts, which, at times, may exceed federally insured limits. The Company has not experienced any loss in such accounts and believes there is little exposure to any significant credit risk.

Major Customers and Accounts Receivable

 

ALJ did not generate net revenue from any one customer in excess of 10% of consolidated net revenue. Each of ALJ’s segments had customers that represent more than 10% of their respective net revenue, as described below.

  

Faneuil. The percentage of Faneuil net revenue derived from its significant customers was as follows:

 

 

 

 

Accounts receivable from significant customers during the three or six months ended March 31, 2021 totaled $5.0 million on March 31, 2021. As of March 31, 2021, all Faneuil accounts receivable were unsecured. The risk with respect to accounts receivable is mitigated by credit evaluations performed on customers and the short duration of payment terms extended to customers.

 

Phoenix. The percentage of Phoenix net revenue derived from its significant customers was as follows:

 

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

Accounts receivable from significant customers during the three or six months ended March 31, 2021 totaled $4.0 million on March 31, 2021. As of March 31, 2021, all Phoenix accounts receivable were unsecured. The risk with respect to accounts receivable is mitigated by credit evaluations performed on customers and the short duration of payment terms extended to most customers.

Supplier Risk

ALJ has only one segment, Phoenix, that purchases inventory.  Phoenix had suppliers that represented more than 10% of both Phoenix inventory purchases and consolidated ALJ inventory purchases as follows:

 

 

If these suppliers were unable to provide materials on a timely basis, Phoenix management believes alternative suppliers could provide the required supplies with minimal disruption to the business.

 

6. COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

Accounts Receivable, Net

The following table summarizes accounts receivable at the end of each reporting period:

 

 

Inventories, Net

The following table summarizes inventories at the end of each reporting period:

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

Property and Equipment

The following table summarizes property and equipment at the end of each reporting period:

 

 

Property and equipment depreciation and amortization expense, including amounts related to finance leased assets, was $3.7 million and $3.5 million for the three months ended March 31, 2021 and 2020, respectively, and $7.4 million and $7.2 million for the six months ended March 31, 2021 and 2020, respectively.

Intangible Assets

The following tables summarize identified intangible assets at the end of each reporting period:

 

 

 

Intangible asset amortization expense was $1.3 million for both the three months ended March 31, 2021 and 2020, and $2.6 million for both the six months ended March 31, 2021 and 2020.  

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

The following table presents expected future amortization expense for the remainder of Fiscal 2021 and yearly thereafter:

 

Accrued Expenses

The following table summarizes accrued expenses at the end of each reporting period:

 

 

Workers’ Compensation Reserve

 

The Company is self-insured for certain workers’ compensation claims as discussed below.  The current portion of workers’ compensation reserve is disclosed with accrued expenses.  The non-current portion of workers’ compensation reserve is disclosed with other non-current liabilities.

Faneuil. Faneuil is self-insured for workers’ compensation claims up to $500,000 per incident. Reserves have been provided for workers’ compensation based upon insurance coverages, third-party actuarial analysis, and management’s judgment.

Phoenix. Phoenix maintains a fully insured plan for workers’ compensation claims.

 

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

7. INCOME (LOSS) PER SHARE

The following table summarizes basic and diluted income (loss) per share of common stock for each period presented:

 

^{__________________________________________________}

⁽¹⁾ Amounts may not add due to rounding.

 

 

ALJ computed basic loss per share of common stock using net loss divided by the weighted-average number of shares of common stock outstanding during the period.  ALJ computed diluted loss earnings per share of common stock using net loss divided by the weighted-average number of shares of common stock outstanding plus potentially dilutive shares of common stock outstanding during the period. Potentially dilutive shares issuable upon exercise of options to purchase common stock were determined by applying the treasury stock method to the assumed exercise of outstanding stock options.  

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

8. DEBT

Debt

The following table summarizes ALJ’s line of credit, term loan, and equipment financing at the end of each reporting period:

 

 

Term Loan and Line of Credit

 

In August 2015, ALJ entered into a financing agreement (“Financing Agreement”) with Cerberus Business Finance, LLC (“Cerberus”), to borrow $105.0 million in a term loan (“Cerberus Term Loan”) and have available up to $32.5 million in a revolving loan (“Cerberus/PNC Revolver,” and together with the Cerberus Term Loan, “Cerberus Debt”). ALJ has subsequently entered into nine amendments to the Financing Agreement, of which four were entered into since October 1, 2019 and are described below. The Cerberus Debt matures on November 28, 2023 (“Maturity Date”).

Sixth Amendment to the Financing Agreement

 

In December 2019, ALJ entered into the Sixth Amendment (“Sixth Amendment”) to the Financing Agreement. The Sixth Amendment amended certain terms and covenants in order to support the continued growth of the Company, as summarized below:

 

 

 

 

 

Additionally, the Sixth Amendment added a deleveraging fee (“Deleveraging Fee”), of which the first payment was made on March 31, 2020, and the second payment was due on June 30, 2020 unless one or more persons purchased a $2.5 million participating interest in the Cerberus Term Loan prior to June 30, 2020.  The first payment made on March 31, 2020 was expensed to selling, general, and administrative expense.  As a result of the Ninth Amendment (see Ninth Amendment to the Financing Agreement below), the second payment was not required by Cerberus.  

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

Seventh Amendment to the Financing Agreement

 

In February 2020, ALJ entered into the Seventh Amendment (“Seventh Amendment”) to the Financing Agreement to temporarily increase the Cerberus/PNC Revolver borrowing capacity as follows:  

  

 

 

Eighth Amendment to the Financing Agreement

In March 2020, ALJ entered into the Eighth Amendment (“Eighth Amendment”) to the Financing Agreement to amend certain terms and covenants, which included:

 

 

 

 

 

Ninth Amendment to the Financing Agreement

 

As a result of the decline in ALJ’s actual and forecasted results of operations, including the potential effects of COVID-19, ALJ sought an easement of certain debt covenants and the elimination of certain quarterly principal payment obligations under the Financing Agreement.

 

In May 2020, ALJ entered into the Ninth Amendment (“Ninth Amendment”) to the Financing Agreement. The Ninth Amendment amended certain terms and covenants as summarized below:

 

 

 

 

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

 

 

 

Junior Participation Agreement – Term B Loan and Warrants Issued

 

In December 2019, in connection with the Sixth Amendment, certain trusts and other entities formed for the benefit of, or otherwise affiliated with, Jess Ravich, the Company’s Chief Executive Officer and Chairman of the Board (“Ravich Entities”), entered into a Junior Participation Agreement with Cerberus (“Junior Participation Agreement”), pursuant to which the Ravich Entities agreed to purchase $4.1 million in junior participation interests in the Term B loan under the Financing Agreement (“Junior Participation” and such interests, “Junior Participation Interests”). The Junior Participation Interests are junior and subordinate to the Cerberus Term Loan in all respects and have no quarterly payments. Through March 26, 2020, interest accrued under the Junior Participation (i) in cash, accrued at the same rate per annum as the Cerberus Term Loan and paid monthly, and (ii) in kind, accrued at 4.00% per annum, payable on the Maturity Date.  See “Amendment to Junior Participation Agreement -Term B Loan and Warrants Issued” below for interest earned subsequent to March 26, 2020.

 

In connection with the Junior Participation, the Company issued fully vested warrants to purchase 1.23 million shares of the Company’s common stock (“Junior Participation Agreement Warrants”) to the Ravich Entities, with a five-year term and an exercise price equal to the lesser of the 30-day trailing average closing price of the Company’s common stock as traded on the Nasdaq Stock Market on (i) December 17, 2019 or (ii) six months from December 17, 2019. The 30-day trailing average closing price of the Company’s common stock on December 17, 2019 was $1.20. The 30-day trailing average closing price of the Company’s common stock on June 17, 2020 was $0.54.

 

The fair value of the Junior Participation Agreement Warrants was calculated using the Black Scholes Model with the following assumptions:  contractual life of five years, volatility of 42.3%, dividend yield of 0.00%, and annual risk-free interest rate of 1.7%. The fair value of the Junior Participation Agreement Warrants of $0.6 million was expensed to selling, general, and administrative expense in June 2020.  

 

Amendment to Junior Participation Agreement – Term B Loan and Warrants Issued

In March 2020, in connection with the Eighth Amendment to the Financing Agreement, the Ravich Entities entered into the First Amendment to the Junior Participation Agreement (“First Amendment to Junior Participation Agreement”). The amended terms under the First Amendment to Junior Participation Agreement include:

 

In connection with the First Amendment to Junior Participation Agreement, the Company issued fully vested warrants to purchase 0.4 million shares of the Company’s common stock (“First Amendment to Junior Participation Agreement Warrants”) to the Ravich Entities, with a five year term and an exercise price equal to the lesser of the 10-day trailing average closing price of the Company’s common stock as traded on the Nasdaq Stock Market on (i) March 26, 2020 or (ii) six months from March 26, 2020. The 10-day trailing average closing price of the Company’s common stock on the issuance date was $0.72.

 

The fair value of the First Amendment to Junior Participation Agreement Warrants was calculated using the Black Scholes Model with the following assumptions:  contractual life of five years, volatility of 43.8%, dividend yield of 0.00%, and annual risk-free interest rate of 0.5%. The fair value of the First Amendment to Junior Participation Agreement Warrants of $0.1 million was expensed to selling, general, and administrative expense in March 2020.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Amendment to the Junior Participation Agreements – Term C Loan

 

In May 2020, in connection with, and as a condition to, the Ninth Amendment, certain stockholders of the Company (“Term C Loan Junior Participants”), including Mr. Ravich, entered into or amended certain Junior Participation Agreements (collectively, “Term C Loan Junior Participation Agreements”) with Cerberus.  Pursuant to the Term C Loan Junior Participation Agreements (as may be amended and/or restated from time to time), the Term C Loan Junior Participants acquired junior participation interests in the Term C Loan in an aggregate amount of $5.6 million on May 12, 2020 (“Term C Loan”) and Mr. Ravich agreed to acquire additional junior participation interests in the Term B Loan in an aggregate amount of (i) $2.5 million on June 30, 2021 and (ii) $2.5 million on September 30, 2021.

 

The $5.6 million Term C Loan is convertible, at the option of the Term C Loan Junior Participants, into shares of the Company’s common stock, at a conversion price of $0.54 per share.

 

The $5.6 million Term C Loan and the $5.0 million additional Term B Loan are junior and subordinate to the Cerberus Debt in all respects and have no quarterly payments. Beginning May 12, 2020, the $5.6 million Term C Loan accrues interest in kind at the same rate per annum as the Cerberus Term Loan, payable on the Maturity Date.  Beginning March 31, 2021, the $5.0 million additional Term B Loan will accrue interest in kind at the same rate per annum as the Cerberus Term Loan plus 4.00% per annum, payable on the Maturity Date.  

 

Summary of the Financing Agreement and Amendments

 

The Financing Agreement and amendments thereto are summarized below (in thousands):

 

 

*Range of annual interest rates accrued during the six months ended March 31, 2021.

Interest payments are due in arrears on the first day of each month. Quarterly principal payments are due on the last day of each fiscal quarter. Annual principal payments equal to 75% of ALJ’s excess cash flow (“ECF”), as defined in the Financing Agreement, are due annually each December, upon delivery of the annual audited financial statements. The annual ECF calculation, based on results of operations for the years ended September 30, 2020 and 2019, did not require ALJ to make an annual ECF payment in December 2020 or 2019.

In certain instances, ALJ is required to make mandatory term loan payments if ALJ receives cash outside the normal course of business. No mandatory payments were required during the six months ended March 31, 2021.  ALJ made a mandatory payment of $0.9 million during the six months ended March 31, 2020.  

As of March 31, 2021, ALJ will be assessed a prepayment penalty equal to 1% of the outstanding Cerberus Debt plus any unused available credit on the PNC Revolver if the Cerberus Term Loan is repaid before November 28, 2021. A final balloon payment is due on the Maturity Date.

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

The Cerberus Debt is secured by substantially all the Company’s assets and imposes certain limitations on the Company, including its ability to incur debt, grant liens, initiate certain investments, declare dividends and dispose of assets. The Cerberus Debt also requires ALJ to comply with certain debt covenants. As of March 31, 2021, ALJ was in compliance with all debt covenants and had unused borrowing capacity of $17.1 million.

 

Loan Amendment Fees

 

ALJ has accounted for all amendments as debt modifications pursuant to ASC 470, Debt.  ALJ did not pay any loan amendment fees during the three or six months ended March 31, 2021.  

 

During the three and six months ended March 31, 2020, ALJ paid $0.3 million and $0.7 million, respectively, of legal and other fees of which $0.2 million and $0.5 million, respectively, were added to deferred loan costs and are being amortized to interest expense through the Maturity Date. The remaining fees of $0.1 million and $0.2 million were expensed to selling, general, and administrative expense during the three and six months ended March 31, 2020, respectively.

 

Equipment Financing

In June 2020, Phoenix purchased a Heidelberg Press for $2.6 million by securing $1.8 million equipment financing (“June 2020 Equipment Financing”), paying $0.5 million in cash, and receiving a $0.3 million trade-in allowance. The June 2020 Equipment Financing term is 36 months, requires monthly principal and interest payments, accrues interest at 2.66% per year, and is secured by the Heidelberg Press.

In October 2020, the board of directors approved the purchase of a second Heidelberg Press for $4.5 million. During the three months ended March 31, 2021, Phoenix paid the vendor $0.9 million, received a trade-in allowance of $0.1 million, and secured equipment financing of $3.5 million (“March 2021 Equipment Financing” and together with the June 2020 Equipment Financing, the “Equipment Financings”).  Of the $3.5 million, $1.4 million was paid to the vendor in March 2021.  The balance is expected to be paid to the vendor by June 2021. The second Heidelberg Press is projected to be operational in June 2021.  The March 2021 Equipment Financing term is 60 months, requires monthly principal and interest payments, accrues interest at 4.5% per year, and is secured by the Heidelberg Press.

Estimated Future Minimum Principal Payments

Estimated future minimum principal payments for the Cerberus Debt and Equipment Financings are as follows (in thousands):

 

 

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

9. COMMITMENTS AND CONTINGENCIES

Employment Agreements

ALJ maintains employment agreements with certain key executive officers that provide for a base salary and an annual bonus, with annual bonus amounts to be determined by the Board of Directors or the Chief Executive Officer. The agreements also provide for involuntary termination payments, which includes base salary, performance bonus, medical premiums, stock options, non-competition provisions, and other terms and conditions of employment. On March 31, 2021, contingent termination payments related to base salary and medical premiums totaled $1.1 million.

Surety Bonds

As part of Faneuil’s normal course of operations, certain customers require surety bonds guaranteeing the performance of a contract. On March 31, 2021, the face value of such surety bonds, which represents the maximum cash payments that Faneuil’s surety would be obligated to pay under certain circumstances of non-performance, was $41.5 million. To date, Faneuil has not made any non-performance payments to any of its sureties.

Letters of Credit

The Company had letters of credit totaling $3.3 million outstanding on March 31, 2021.

Litigation, Claims, and Assessments

Faneuil, Inc. v. 3M Company

On September 22, 2016, Faneuil filed a complaint against 3M Company (“3M”) in the Circuit Court for the City of Richmond, Virginia (the “Richmond Circuit Court”). The dispute arose out of a subcontract entered into between 3M and Faneuil in relation to a toll road project in Portsmouth, Virginia. In its complaint, Faneuil sought recovery of $5.1 million based on three causes of action: breach of contract, breach of the implied covenant of good faith and fair dealing, and unjust enrichment. 

On October 14, 2016, 3M filed its answer and counterclaim against Faneuil. In its counterclaim, 3M sought recovery in excess of $10.0 million based on three claims:  breach of contract/indemnification, breach of the implied covenant of good faith and fair dealing, and unjust enrichment.  3M’s counterclaim alleged it incurred approximately $3.2 million in damages as a result of Faneuil’s conduct and sought indemnification of an additional $10.0 million in damages incurred as a result of continued performance.

 

The matter was tried in a bench trial from April 30, 2018 through May 2, 2018. On May 15, 2018, the Richmond Circuit Court issued its opinion, which dismissed both Faneuil’s complaint and 3M’s counterclaim with prejudice. No monetary damages were awarded to either Faneuil or 3M. As a result of the Richmond Circuit Court’s opinion, ALJ recorded a non-cash litigation loss of $2.9 million (the outstanding unreserved receivable from 3M), which was included in selling, general, and administrative expense during the year ended September 30, 2018. The matter was appealed to the Supreme Court of Virginia where Faneuil was awarded approximately $1.2 million, plus pre- and post-judgment interest. The matter was remanded to the trial court for calculation of interest and entry of final judgment. Faneuil and 3M settled on the amount of interest to be paid. The final judgment plus interest, which totaled $1.5 million, was received and recorded by Faneuil in December 2019. Of the total $1.5 million, $1.3 million was booked as a reduction to selling, general, and administrative expense, and $0.2 million was booked to interest from legal settlement on the Statement of Operations during the six months ended March 31, 2020.    

Marshall v. Faneuil, Inc.

 

On July 31, 2017, plaintiff Donna Marshall (“Marshall”) filed a proposed class action lawsuit in the Superior Court of the State of California for the County of Sacramento against Faneuil and ALJ. Marshall, a previously terminated Faneuil employee, alleges various California state law employment-related claims against Faneuil. Faneuil has answered the complaint and removed the matter to the United States District Court for the Eastern District of California; however, Marshall filed a motion to remand the case back to state court, which has been granted. In connection with the above, an amended complaint was filed by certain plaintiffs to add a claim for penalties under the California Private Attorneys General Act (the “PAGA Claim”). Faneuil demurred to the PAGA Claim and it was eventually dismissed by the trial court.

The parties are currently engaged in limited discovery. A mediation was held on March 11, 2021 and discussions are ongoing. Faneuil believes this action is without merit and intends to defend this case vigorously.

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Harris v. Faneuil

Lois Harris, an employee of Faneuil in Georgia, filed a collective action complaint on April 18, 2021 in the United States District Court for the Northern District of Georgia.  Harris alleges, on behalf of herself and other current and former non-exempt Call Center Agent employees who received nondiscretionary bonuses for periods in which they worked overtime hours, that Faneuil violated the Fair Labor Standards Act by failing to include nondiscretionary bonuses in the regular rate of pay when calculating the overtime rate for Harris and other similarly-situated persons.  Faneuil has engaged counsel to defend it in this action.  The financial impact of this case is not reasonably estimable.  

Other Litigation

The Company has been named in, and from time to time may become named in, various other lawsuits or threatened actions that are incidental to our ordinary business. Litigation is inherently unpredictable. Any claims against the Company, whether meritorious or not, could be time-consuming, cause the Company to incur costs and expenses, require significant amounts of management time and result in the diversion of significant operational resources. The results of these lawsuits and actions cannot be predicted with certainty. The Company concluded as of March 31, 2021 that the ultimate resolution of these matters (including the matters described above) will not have a material adverse effect on the Company’s business, consolidated financial position, results of operations or cash flows.

Environmental Matters

The operations of Phoenix are subject to various laws and related regulations governing environmental matters. Under such laws, an owner or lessee of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances located on or in, or emanating from, such property, as well as investigation of property damage. Phoenix incurs ongoing expenses associated with the performance of appropriate monitoring and remediation at certain of its locations.

 

 

10. LEASES

 

ALJ has operating leases for facilities, equipment, and vehicles, and finance leases for equipment.  Over 95% of operating leases are for facilities. Many of the Company’s facilities leases contain renewal options and rent escalation clauses.

 

The Company determines if an arrangement is a lease at inception and recognizes a finance or operating lease liability and right-of-use asset in the Company’s Consolidated Balance Sheet. Right-of-use assets and lease liabilities for both operating and finance leases are recognized based on present value of lease payments over the lease term at commencement date.  

 

In instances where the lease does not provide an implicit rate, the Company estimates an incremental borrowing rate (“IBR”) based on the information available at commencement date to determine the present value of lease payments. ALJ does not have a published credit rating because it has no publicly traded debt. However, the Company does have several privately held debt instruments that were taken into consideration.  The Company generates its IBR, using a synthetic credit rating model that estimates the likelihood (probability) of a borrower receiving a given credit rating based on relevant credit factors or predictor variables. It is based on a regression analysis using selected financial ratios of publicly traded industry comparable companies and the companies’ credit ratings. The estimated IBR is then adjusted for (i) the length of the lease term, and (ii) the effect of designating specific collateral with a value equal to the unpaid lease payments. Finally, ALJ applies the estimated IBR on a lease-by-lease basis as each lease has different start and end dates and has different assumptions regarding purchase or renewal options.  

 

For facilities leases, ALJ accounts for non-lease components such as maintenance, taxes, and insurance, separately.  For equipment leases, ALJ accounts for lease and non-lease components as a single lease component. The difference between the operating lease right-of-use assets and operating lease liabilities primarily relates to adjustments for deferred rent and tenant improvement allowances.

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

The following table presents the location of the ROU assets and liabilities in the Consolidated Balance Sheet and ALJ’s weighted-average lease term and discount rate:

 

 

 

The following table presents the components of lease cost and the location of such cost in ALJ’s Consolidated Statement of Operations:

 

 

 

The following table presents supplemental cash flow information related to leases:

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

Maturities of lease liabilities as of March 31, 2021 are as follows (in thousands):

 

 

 

11. EQUITY

Common Stock Activity during the Six Months Ended March 31, 2021

ALJ issued 23,256 shares of common stock upon the cashless exercise of stock options.  

Common Stock Activity during the Six Months Ended March 31, 2020

ALJ did not have any common stock activity during the six months ended March 31, 2020.

Equity Incentive Plans

ALJ’s equity incentive plans are broad-based, long-term programs intended to attract and retain talented employees and align stockholder and employee interests.

Stock-Based Compensation.

The following table sets forth the total stock-based compensation expense included in selling, general, and administrative expense on the Statement of Operations:

 

 

On March 31, 2021, ALJ had less than $0.1 million of total unrecognized compensation cost related to unvested stock options. This cost is expected to be recognized over a weighted-average period of approximately 1.2 years.

 

Stock Option Awards.

 

ALJ had no option grants during the six months ended March 31, 2021 or March 31, 2020. ALJ had forfeitures of 250,000 options during the six months ended March 31, 2021 and no option forfeitures during the six months ended March 31, 2020.

The “intrinsic value” of options is the excess of the value of ALJ stock over the exercise price of such options. The total intrinsic value of options outstanding (of which all are vested or expected to vest) was less than $0.1 million on March 31, 2021.

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Common Stock Awards. Members of ALJ’s Board of Directors receive a director compensation package that includes an annual common stock award. In connection with such awards, ALJ recorded stock-based compensation expense of less than $0.1 million for both the three months ended March 31, 2021 and 2020, and $0.1 million for both the six months ended March 31, 2021 and 2020.

Common Stock Options and Warrants Outstanding on March 31, 2021

 

On March 31, 2021, ALJ had 1.5 million stock options with a weighted average exercise price of $3.54 outstanding and warrants exercisable to purchase 2.9 million shares of common stock with a weighted average exercise price of $1.11 outstanding.

12. INCOME TAX

 

 

ALJ recorded a provision for income taxes from continuing operations of $0.3 million and a benefit for income taxes from continuing operations of $1.3 million for the six months ended March 31, 2021 and 2020, respectively. ALJ’s effective tax rate for the six months ended March 31, 2021 was (42.0%), as a result of generating state taxable income, offset by changes to the valuation allowance recorded against net deferred tax assets. ALJ’s effective tax rate for the six months ended March 31, 2020 was 2.0%, which was also due to generating state taxable income, offset by changes to the valuation allowance recorded against net deferred tax assets.  The decrease in ALJ’s effective tax rate was attributable to a decrease in forecasted pre-tax losses, as well as changes to the valuation allowance recorded against net deferred tax assets.

ALJ did not record a provision for or benefit from income taxes for discontinued operations during any period presented.

 

 

13. REPORTABLE SEGMENTS AND GEOGRAPHIC INFORMATION

Reportable Segments

 

As discussed in Note 1, ALJ has organized its business along two reportable segments (Faneuil and Phoenix), together with a corporate group for certain support services. ALJ’s operating segments are aligned on the basis of products, services, and industry. The Chief Operating Decision Maker (“CODM”) is ALJ’s Chief Executive Officer. The CODM manages the business, allocates resources to, and assesses the performance of each operating segment using information about its net revenue and segment adjusted EBITDA. ALJ defines segment adjusted EBITDA as segment net income (loss) before depreciation and amortization expense, interest expense, litigation loss, recovery of litigation loss, restructuring and cost reduction initiatives, loan amendment expenses, fair value of warrants issued in connection with loan amendments, stock-based compensation, acquisition-related expenses, (loss) gain on disposal of assets and other gain, net, provision for income taxes, and other non-recurring items. Such amounts are detailed in our segment reconciliation below. The accounting policies for segment reporting are the same as for ALJ as a whole.

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

The following tables present ALJ’s segment information for the three and six months ended March 31, 2021 and 2020:

 

 

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

 

 

 

 

 

 

Geographic Information

 

Substantially all of the Company’s assets were located in the United States. Substantially all of the Company’s revenue was earned in the United States.

 

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Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is provided in addition to the accompanying condensed consolidated financial statements and notes to assist readers in understanding our results of operations, financial condition and cash flows. MD&A is organized as follows:

The following discussion should be read in conjunction with our condensed consolidated financial statements and accompanying notes included in “Part I, Item 1 – Financial Statements.”  The following discussion contains a number of forward-looking statements that involve risks and uncertainties. Words such as "anticipates," "expects," "intends," "goals," "plans," "believes," "seeks," "estimates," "continues," "may," "will," "should," and variations of such words and similar expressions are intended to identify such forward-looking statements. Such statements are based on our current expectations and could be affected by the risk and uncertainties described in “Part II, Item 1A - Risk Factors.”  Our actual results may differ materially.   

Overview

ALJ Regional Holdings, Inc. (“ALJ” or “we”) is a holding company that operates Faneuil, Inc. (“Faneuil”) and Phoenix Color Corp. (“Phoenix”). Additionally, ALJ operated Floors-N-More, LLC, d/b/a Carpets N’ More (“Carpets”) through February 2021.  

In January 2021, ALJ entered into a Purchase and Sale Agreement (“PSA”), by and among ALJ, Superior Interior Finishes, LLC, a Nevada limited liability company (“Purchaser” or “Superior”) and Carpets, pursuant to which ALJ agreed to sell 100% of the membership interests of Carpets to the Purchaser for an aggregate purchase price of $0.5 million (the “Purchase Price”) in cash (the “Transaction”). At the time of the PSA, Superior was 100% owned by Steve Chesin, the Chief Executive Officer of Carpets. ALJ entered into the PSA because its Carpets business segment had been deemed a non-core holding and had underperformed over the past several years.  The Transaction, which was approved by a committee of the Board comprised solely of certain independent directors of the Company, closed in February 2021. As such, the results of operations, assets, liabilities, and cashflows of Carpets were classified as discontinued operations in ALJ’s financial statements for all periods presented. See “Part I, Item 1 - Financial Statements – Note 4. Acquisitions and Divestitures – Carpets Divestiture” for additional information about the divestiture of Carpets.  

With several members of our senior management and Board of Directors coming from long careers in the professional services industry, ALJ is focused on acquiring and operating exceptional businesses.

We continue to see our business evolve as we execute our strategy of buying attractively valued assets. In analyzing the financial impact of any potential acquisition, we focus on earnings, operating margin, cash flow and return on invested capital targets. We hire successful and experienced management teams to run each of our operating companies and incentivize them to drive higher profits. We are focused on increasing our net revenue at each of our operating subsidiaries by investing in sales and marketing, expanding into new products and markets, and evaluating and executing on tuck-in acquisitions, while continually examining our cost structures to drive higher profits.

Impact of Coronavirus Pandemic - Update

 

In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic, which continues to spread throughout the world. COVID-19 is having an unprecedented impact on the U.S. economy as federal, state, and local governments react to this public health crisis.

 

Currently, all ALJ’s subsidiaries have been deemed “Essential Services” and have continued to operate. To date, the impact of COVID-19 has been minimal.  The Company took immediate actions to enable work-from-home where possible and put in place

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increased safety precautions, including social distancing, at other locations where essential services on site are required. The duration of these measures is unknown, may be extended, and additional measures may be imposed.

 

Management expects that ALJ could be impacted in the near term by lower volumes in several parts of its business, resulting in lower revenue and profit. While the impact of COVID-19 on ALJ’s future financial position, results of operations and cash flows cannot be estimated with certainty, such impact could be significantly negative. The extent to which COVID-19 impacts ALJ’s operations will depend on future developments, which are highly uncertain, including, among others, the duration of the outbreak, vaccination rate, new variants, new information that may emerge concerning the severity of COVID-19 and the actions, especially those taken by governmental authorities, to contain the pandemic or treat its impact. As events are rapidly changing, additional impacts may arise that are not known at this time. See “Part II, Item 1A, Risk Factors - Risks Related to our Businesses Generally - A widespread health crisis, such as the COVID-19 pandemic, may adversely affect our business, results of operations and financial condition,” for an additional discussion of risk related to COVID-19.

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Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020

The following table sets forth certain Condensed Consolidated Statements of Operations data as a percentage of net revenue for each period as follows:

 

 

 

 

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Net Revenue

 

Faneuil Net Revenue

Faneuil net revenue for the three months ended March 31, 2021 was $84.4 million, an increase of $25.6 million, or 43.5%, compared to net revenue of $58.8 million for the three months ended March 31, 2020. The increase was mainly attributable to a $23.4 million increase in new customer contracts and $6.6 million net increase in existing customers mostly due to increased call center volumes for expanded call center services provided, partially offset by a $4.4 million reduction driven by the completion of customer contracts.  

The following table reflects the amount of Faneuil’s backlog, which represents multi-year contract deliverables, by the year Faneuil expects to recognize such net revenue:

 

Phoenix Net Revenue

Phoenix net revenue for the three months ended March 31, 2021 was $30.2 million, an increase of $3.5 million, or 13.2%, compared to net revenue of $26.7 million for the three months ended March 31, 2020. The increase was primarily attributable to higher component sales primarily related to trade, somewhat offset by lower packaging sales.

The following table reflects the amount of Phoenix’s backlog, which represents executed contracts that contain minimum volume commitments over multiple years for future product deliveries, by the year Phoenix expects to recognize such net revenue:

 

 

For further discussion of our subsidiaries’ backlog, see “Part II, Item 1A. Risk Factors - Risks Related to our Business Generally and our Common Stock - We may not receive the full amounts estimated under the contracts in our backlog, which could reduce our net revenue in future periods below the levels anticipated. This makes backlog an uncertain indicator of future operating results.”

Cost of Revenue

 

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Faneuil Cost of Revenue

Faneuil cost of revenue for the three months ended March 31, 2021 was $70.2 million, an increase of $19.8 million, or 39.4%, compared to cost of revenue of $50.3 million for the three months ended March 31, 2020. The increase in cost of revenue was a direct result of the increased net revenue. During the three months ended March 31, 2021, as compared to the three months ended March 31, 2020, cost of revenue as a percentage of segment net revenue decreased to 83.1% from 85.6%, respectively, as a result of several short-term contracts, which yielded a higher profit margin.    

Phoenix Cost of Revenue

Phoenix cost of revenue for the three months ended March 31, 2021 was $23.3 million, an increase of $3.4 million, or 16.8%, compared to cost of revenue of $20.0 million for the three months ended March 31, 2020. During the three months ended March 31, 2021, as compared to the three months ended March 31, 2020, cost of revenue as a percentage of segment net revenue increased to 77.3% from 74.9%. Phoenix experiences normal fluctuations to cost of revenue as a percentage of net revenue as a result of changes to the mix of products sold.  Additionally, certain costs do not fluctuate directly with net revenue.

Selling, General, and Administrative Expense

 

 

Faneuil Selling, General, and Administrative Expense

 

Faneuil selling, general, and administrative expense for the three months ended March 31, 2021 was $9.4 million, an increase of $1.5 million, or 18.3%, compared to selling, general, and administrative expense of $8.0 million for the three months ended March 31, 2020. The increase was primarily attributable to higher salaries and the expansion of software solutions to improve Faneuil’s customer experience and support call center efficiencies. During the three months ended March 31, 2021 compared to the three months ended March 31, 2020, selling, general, and administrative expense as a percentage of segment net revenue decreased to 11.2% from 13.5%. Certain selling, general, and administrative expenses do not fluctuate directly with net revenue. As such, we expect selling, general, and administrative expense as a percentage of segment net revenue to fluctuate.

 

Phoenix Selling, General, and Administrative Expense

Phoenix selling, general, and administrative expense for the three months ended March 31, 2021 was $2.9 million, a decrease of $0.7 million, or 20.1%, compared to selling, general, and administrative expense of $3.6 million for the three months ended March 31, 2020. The decrease was mainly attributable to the onetime bad debt allowance of $0.3 million recorded during the three months ended March 31, 2020 as a result of a Phoenix customer’s bankruptcy reorganization, and lower travel expenses.  Selling, general, and administrative expense as a percentage of segment net revenue decreased to 9.7% for the three months ended March 31, 2021 from 13.7% for the three months ended March 31, 2020, which was mainly attributable to the increase in net revenue and the previously mentioned bad debt allowance. Certain selling, general, and administrative expenses do not fluctuate directly with net revenue. As such, we expect selling, general, and administrative expense as a percentage of segment net revenue to fluctuate.

ALJ Selling, General, and Administrative Expense

ALJ selling, general, and administrative expense for the three months ended March 31, 2021 was $1.7 million, an increase of $0.8 million, or 79.4%, compared to selling, general, and administrative expense of $1.0 million for the three months ended March 31, 2020. The increase was mainly attributable to a $0.4 million increased bonus accrual and a $0.3 million non-cash banking fee as part of the Eighth Amendment to our Financing Agreement.  We expect selling, general, and administrative expense to fluctuate in the future as we comply with SEC reporting requirements and regulations and allocate certain expenses to our subsidiaries.

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Depreciation and Amortization Expense

 

Faneuil Depreciation and Amortization Expense

Faneuil depreciation and amortization expense was $3.1 million for both the three months ended March 31, 2021 and 2020.  Because certain Faneuil contracts require capital investments, Faneuil depreciation and amortization expense is impacted by the timing of new contracts and the completion of existing contracts.

Phoenix Depreciation and Amortization Expense

Phoenix depreciation and amortization expense consists primarily of amortization of acquisition-related intangible assets. Depreciation and amortization expense was consistent at $0.5 million and $0.6 million for the three months ended March 31, 2021 and March 31, 2020, respectively.   

Interest Expense

Interest expense for the three months ended March 31, 2021 was $2.5 million, a decrease of $0.4 million, or 13.8%, compared to $2.8 million for the three months ended March 31, 2020.  The decrease was mainly attributable to decreased weighted-average outstanding balance on our line of credit as we were able to fund working capital requirements from operations rather than borrowing on our line of credit, and to a lesser extent, reduced amortization of deferred loan costs.

Provision for (Benefit from) Income Taxes

 

We recorded a provision for income taxes of less than $0.1 million for the three months ended March 31, 2021 compared to a benefit from income taxes of $1.3 million for the three months ended March 31, 2020.  The provision for income taxes for the three months ended March 31, 2021 was a result of generating state taxable income.  Our benefit from income taxes for the three months ended March 31, 2020 was the result of generating state taxable income, offset by changes to the valuation allowance recorded against net deferred tax assets.  

 

ALJ did not record a provision for or benefit from income taxes for discontinued operations during either the three months ended March 31, 2021 or the three months ended March 31, 2020.

Net Loss from Discontinued Operations

 

As a result of the sale of Carpets in February 2021, we recognized a net loss from discontinued operations of $0.9 million during the three months ended March 31, 2021, of which $0.8 million was attributable to the onetime loss on the sale of Carpets, and $2.6 million during the three months ended March 31, 2020, which was fully attributable to the operations of Carpets.  

Segment Adjusted EBITDA

Segment adjusted EBITDA is a financial measure used by our management and chief operating decision maker (“CODM”) to manage the business, allocate resources, and assess the performance of each operating segment. ALJ defines segment adjusted EBITDA as segment net income (loss) before depreciation and amortization expense, interest expense, litigation loss, recovery of litigation loss, restructuring and cost reduction initiatives, loan amendment expenses, fair value of warrants issued in connection with loan amendments, change in fair value of contingent consideration, stock-based compensation, acquisition-related expenses, (loss) gain on disposal of assets and other gain, net, provision for income taxes, and other non-recurring items. The following table summarizes segment adjusted EBITDA.

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Faneuil Segment Adjusted EBITDA

Faneuil segment adjusted EBITDA was $5.0 million for the three months ended March 31, 2021 compared to $1.4 million for the three months ended March 31, 2020.  Segment adjusted EBITDA increased $3.6 million, or 264.7%, driven by the startup of new contracts, operational improvements at existing contracts, reduced costs for medical and workers compensation claims, offset somewhat by continuing losses for one healthcare contract.

Phoenix Segment Adjusted EBITDA

Phoenix recognized segment adjusted EBITDA of $5.3 million for the three months ended March 31, 2021 compared to $4.2 million for the three months ended March 31, 2020. Segment adjusted EBITDA increased by $1.1 million, or 25.7%, as a result of higher volumes from components and books as well as lower overall expenses.  

ALJ Segment Adjusted EBITDA

ALJ segment adjusted EBITDA loss for the three months ended March 31, 2021 was ($1.4) million compared to segment adjusted EBITDA loss of ($0.9) million for the three months ended March 31, 2020. ALJ segment adjusted EBITDA loss for three months ended March 31, 2021 was impacted by an increased bonus accrual.

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Six Months Ended March 31, 2021 Compared to Six Months Ended March 31, 2020

The following table sets forth certain Condensed Consolidated Statements of Operations data as a percentage of net revenue for each period as follows:

 

 

 

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Net Revenue

 

Faneuil Net Revenue

Faneuil net revenue for the six months ended March 31, 2021 was $170.4 million, an increase of $53.0 million, or 45.1%, compared to net revenue of $117.4 million for the six months ended March 31, 2020. The increase was mainly attributable to a $50.2 million increase in new customer contracts and a $12.5 million net increase in existing customers mostly due to open enrollment volumes for healthcare contracts and expanded call center services provided, partially offset by a $9.7 million reduction driven by the completion of customer contracts.  

Phoenix Net Revenue

Phoenix net revenue for the six months ended March 31, 2021 was $55.3 million, an increase of $6.6 million, or 13.4%, compared to net revenue of $48.8 million for the six months ended March 31, 2020. The increase was primarily attributable to higher component sales primarily related to trade and book sales.

Cost of Revenue

 

Faneuil Cost of Revenue

Faneuil cost of revenue for the six months ended March 31, 2021 was $144.0 million, an increase of $43.5 million, or 43.3%, compared to cost of revenue of $100.5 million for the six months ended March 31, 2020. The increase in cost of revenue was a direct result of the increased net revenue. During the six months ended March 31, 2021, as compared to the six months ended March 31, 2020, cost of revenue as a percentage of segment net revenue decreased slightly from 84.5% and 85.6%, respectively, as a result of several short-term contracts, which yield a higher profit margin.      

Phoenix Cost of Revenue

Phoenix cost of revenue for the six months ended March 31, 2021 was $42.6 million, an increase of $4.9 million, or 12.9%, compared to cost of revenue of $37.7 million for the six months ended March 31, 2020. During the six months ended March 31, 2021, as compared to the six months ended March 31, 2020, cost of revenue as a percentage of segment net revenue remained consistent at 77.0% and 77.3%, respectively. Phoenix experiences normal fluctuations to cost of revenue as a percentage of net revenue as a result of changes to the mix of products sold.  Additionally, certain costs do not fluctuate directly with net revenue.

Selling, General, and Administrative Expense

 

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Faneuil Selling, General, and Administrative Expense

 

Faneuil selling, general, and administrative expense for the six months ended March 31, 2021 was $17.9 million, an increase of $3.5 million, or 24.2%, compared to selling, general, and administrative expense of $14.4 million for the six months ended March 31, 2020. The increase was primarily attributable to certain nonrecurring transactions during the six months ended March 31, 2020, including $1.3 million recovery of litigation loss slightly offset by $0.8 million loan amendment fees.  The remaining increase was attributable to higher salaries and the expansion of software solutions to improve Faneuil’s customer experience and support call center efficiencies. During the six months ended March 31, 2021 compared to the six months ended March 31, 2020, selling, general, and administrative expense as a percentage of segment net revenue decreased to 10.5% from 12.3%. Certain selling, general, and administrative expenses do not fluctuate directly with net revenue. As such, we expect selling, general, and administrative expense as a percentage of segment net revenue to fluctuate.

Phoenix Selling, General, and Administrative Expense

Phoenix selling, general, and administrative expense for the six months ended March 31, 2021 was $6.1 million, a decrease of $0.4 million, or 6.3%, compared to selling, general, and administrative expense of $6.5 million for the six months ended March 31, 2020. The decrease was mainly attributable to the $0.3 million bad debt allowance recorded during the six months ended March 31, 2020 as a result of a Phoenix customer’s bankruptcy reorganization. Selling, general, and administrative expense as a percentage of segment net revenue decreased to 11.0% for the six months ended March 31, 2021 from 13.3% for the six months ended March 31, 2020, which was mainly attributable to the increase in net revenue. Certain selling, general, and administrative expenses do not fluctuate directly with net revenue. As such, we expect selling, general, and administrative expense as a percentage of segment net revenue to fluctuate.

ALJ Selling, General, and Administrative Expense

ALJ selling, general, and administrative expense for the six months ended March 31, 2021 was $3.5 million, an increase of $1.3 million, or 60.4%, compared to selling, general, and administrative expense of $2.2 million for the six months ended March 31, 2020. The increase was mainly attributable to a $0.8 million increased bonus accrual and a $0.6 million non-cash banking fee as part of the Eighth Amendment to our Financing Agreement. We expect selling, general, and administrative expense to fluctuate in the future as we comply with SEC reporting requirements and regulations and allocate certain expenses to our subsidiaries.

Depreciation and Amortization Expense

 

Faneuil Depreciation and Amortization Expense

Faneuil depreciation and amortization expense for the six months ended March 31, 2021 was $6.3 million, a decrease of $0.2 million, or 2.7%, compared to depreciation and amortization expense of $6.5 million for the six months ended March 31, 2020.  The decrease was attributable to leasehold improvements for one large call center that were fully amortized. Because certain Faneuil contracts require capital investments, Faneuil depreciation and amortization expense is impacted by the timing of new contracts and the completion of existing contracts.

Phoenix Depreciation and Amortization Expense

Phoenix depreciation and amortization expense consists primarily of amortization of acquisition-related intangible assets. Depreciation and amortization expense was consistent at $1.1 for both the six months ended March 31, 2021 and March 31, 2020.

Impairment of Goodwill

 

As a result of the decline in ALJ’s market capitalization, downward economic pressure, declines in actual and forecasted results of operations including the estimated effects of COVID-19, management determined that it was more likely than not that the fair value of goodwill for all reporting units was below each reporting unit’s respective carrying amount. As such, management performed an

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interim impairment test as of March 31, 2020, based on discounted cash flows, which were derived from internal forecasts and more cautious economic expectations for all reporting units.

 

As a result of the interim test, ALJ recognized a non-cash impairment of goodwill totaling $56.5 million during the six months ended March 31, 2020.

Interest Expense

 

Interest expense for the six months ended March 31, 2021 was $5.0 million, a decrease of $0.4 million, or 6.9%, compared to $5.4 million for the six months ended March 31, 2020.  The decrease was mainly attributable to decreased weighted-average outstanding balance on our line of credit as we were able to fund working capital requirements from operations rather than borrowing on our line of credit, and to a lesser extent, reduced amortization of deferred loan costs.

Interest from Legal Settlement

During the six months ended March 31, 2020, Faneuil received a onetime $1.5 million settlement, of which $0.2 million was attributable to interest. See “Part I, Item 1. Financial Statements – Note 9. Commitments and Contingencies.”

Provision for Income Taxes

 

ALJ recorded a provision for income taxes from continuing operations of $0.3 million and a benefit for income taxes from continuing operations of $1.3 million for the six months ended March 31, 2021 and 2020, respectively. ALJ’s effective tax rate for the six months ended March 31, 2021 was (42.0%), as a result of generating state taxable income, offset by changes to the valuation allowance recorded against net deferred tax assets. ALJ’s effective tax rate for the six months ended March 31, 2020 was 2.0%, which was also due to generating state taxable income, offset by changes to the valuation allowance recorded against net deferred tax assets.  The decrease in ALJ’s effective tax rate was attributable to a decrease in forecasted pre-tax losses, as well as changes to the valuation allowance recorded against net deferred tax assets.

ALJ did not record a provision for or benefit from income taxes for discontinued operations during the six months ended March 31, 2021 or the six months ended March 31, 2020.

Net Income (Loss) from Discontinued Operations

 

As a result of the sale of Carpets in February 2021, we recognized a net loss from discontinued operations of $1.1 million during the six months ended March 31, 2021, of which $0.8 million was attributable to the onetime loss on the sale of Carpets, and $2.9 million during the three months ended March 31, 2020, which was fully attributable to the operations of Carpets.  

Segment Adjusted EBITDA

 

 

Faneuil Segment Adjusted EBITDA

Faneuil segment adjusted EBITDA for the six months ended March 31, 2021 was $8.6 million compared to segment adjusted EBITDA of $3.0 million for the six months ended March 31, 2020. Faneuil segment adjusted EBITDA for the six months ended March 31, 2021 was driven by the startup of new contracts, operational improvements at existing contracts, reduced costs for medical and workers compensation claims, offset somewhat by continuing losses for one healthcare contract.

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Phoenix Segment Adjusted EBITDA

Phoenix segment adjusted EBITDA for the six months ended March 31, 2021 was $9.3 million compared to segment adjusted EBITDA of $7.0 million for the six months ended March 31, 2020. Phoenix segment adjusted EBITDA for the six months ended March 31, 2021 benefitted from higher volumes from trade components and books.    

ALJ Segment Adjusted EBITDA

ALJ segment adjusted EBITDA loss for the six months ended March 31, 2021 was ($2.6) million compared to segment adjusted EBITDA loss of ($1.9) million for the six months ended March 31, 2020. ALJ segment adjusted EBITDA loss for six months ended March 31, 2021 was impacted by an increased bonus accrual.  

Seasonality

Faneuil

Faneuil experiences seasonality within its various lines of business. For example, during the end of the calendar year through the end of the first calendar quarter, Faneuil generally experiences higher revenue with its healthcare customers as the customer contact centers increase operations during the enrollment periods of the healthcare exchanges. Faneuil’s revenue from its healthcare customers generally decreases during the remaining portion of the year after the enrollment period. Seasonality is less prevalent in the transportation industry, though there is typically an increase in volume during the summer months.

Phoenix

There is seasonality to Phoenix’s business. Education book component sales (school and college) traditionally peak in the first and second quarters of the calendar year. Other book sales traditionally peak in the third quarter of the calendar year. Book sales also traditionally peak in the third quarter of the calendar year. The fourth quarter of the calendar year traditionally has been Phoenix’s weakest quarter. These seasonal factors are not significant.

Liquidity and Capital Resources

Historically, our principal sources of liquidity have been cash provided by operations and borrowings under various debt arrangements. At March 31, 2021, our principal sources of liquidity included cash and cash equivalents of $4.6 million and an unused borrowing capacity of $17.1 million on our line of credit. Our principal uses of cash have been for acquisitions, capital expenditures to support Faneuil’s customers, and to pay down debt. We anticipate these uses will continue to be our principal uses of liquidity in the future.

Global financial and credit markets have been volatile in recent years and has been further exacerbated by COVID-19 since March 2020. Future adverse conditions of these markets could negatively affect our ability to secure funds or raise capital at a reasonable cost or at all. For additional discussion of our various debt arrangements see Contractual Obligations below.

In summary, our cash flows for each period were as follows:

 

 

 

For the six months ended March 31, 2021, we recognized a net loss of $2.2 million, generated cash from operating activities of $11.1 million, used cash for investing activities of $3.7 million, and used cash for financing activities of $8.9 million.

 

For the six months ended March 31, 2020, we recognized net loss of $66.1 million, which included a non-recurring impairment of goodwill of $56.5 million, used cash for operating activities of $3.0 million and investing activities of $2.9 million, which was offset by cash provided by financing activities of $4.5 million.

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Operating Activities

Cash provided by operating activities of $11.1 million during the six months ended March 31, 2021 was the result of our $2.2 million net loss, $12.1 million addback of net non-cash expenses, and $1.2 million of net cash provided by changes in operating assets and liabilities. The most significant component of net non-cash expenses was depreciation and amortization expense of $10.0 million. The most significant components of changes in operating assets and liabilities were mostly attributable to the timing of Faneuil’s significant new customer implementations and included accounts receivable of $1.9 million, prepaid expenses, collateral deposits, and other current assets of $1.6 million, and other current liabilities and other non-current liabilities of $3.7 million, which provided cash, partially offset by accounts payable of $2.9 million, and deferred revenue and customer deposits of $2.8 million, which used cash.  The CARES Act allowed us to defer payment for $8.4 million of payroll-related taxes, of which $4.2 million is recorded in accrued expenses and $4.2 million is recorded in other non-current liabilities at March 31, 2021.

 

Cash used for operating activities of $3.0 million during the six months ended March 31, 2020 was the result of our $66.1 million net loss, $67.0 million addback of net non-cash expenses, and $3.9 million of net cash used for changes in operating assets and liabilities. The most significant components of net non-cash expenses were the impairment of goodwill of $56.5 million, depreciation and amortization expense of $9.9 million, $0.7 million fair value of warrants issued in connection with loan amendments, and amortization of deferred loan costs of $0.6 million, offset by a $1.4 million deferred tax benefit. The most significant components of changes in operating assets and liabilities were mostly attributable to the timing of Faneuil’s significant new customer implementations and included accounts receivable of $9.1 million, prepaid expenses, collateral deposits, and other current assets of $6.7 million, which used cash, offset by deferred revenue and customer deposits of $4.5 million, accounts payable of $3.8 million, and accrued expenses of $1.9 million, which provided cash.

Cash provided by operations for the six months ended March 31, 2021 compared to cash used for operations for the six months ended March 31, 2020, was impacted by the deferral of payroll-related taxes under the CARES Act.

Investing Activities

For the six months ended March 31, 2021, our investing activities used $3.7 million of cash, of which $2.6 million was used to purchase equipment, software, and leasehold improvements for Faneuil’s new and existing customers, and $1.6 million was used to purchase capital equipment in the normal course of operations, offset by $0.4 million cash proceeds from the sale of Carpets.

 

For the six months ended March 31, 2020, our investing activities used $2.9 million of cash, of which $1.5 million was used to purchase equipment, software and leasehold improvements for Faneuil’s new and existing customers, and $1.4 million was used to purchase capital equipment in the normal course of operations.

 

Cash used for investing activities for the six months ended March 31, 2021 compared to the six months ended March 31, 2020 increased due to the timing of capital requirement to support Faneuil’s customers.

Financing Activities

 

For the six months ended March 31, 2021, our financing activities used $8.9 million of cash.  We used $2.3 million to pay down our line of credit, $1.4 million for capital lease payments, and $5.2 million to pay down our term loans.

 

For the six months ended March 31, 2020, our financing activities provided $4.5 million of cash. Net proceeds from our line of credit provided $9.7 million to fund working capital requirements at Faneuil, Phoenix, and Corporate. Financing activities which used cash included $3.5 million to pay down our term loan, $1.2 million for capital lease payments, and $0.5 million for deferred loan costs related to the Sixth, Seventh, and Eighth Amendments to our Financing Agreement.  See “Part I, Item 1. Financial Statements – Note 8. Debt.”  

 

Cash used for financing activities for the six months ended March 31, 2021 compared to cash provided by financing activities for the six months ended March 31, 2020 was impacted by quarterly payments on our term loans and managing our line of credit and day-to-day working capital needs.

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Contractual Obligations  

The following table summarizes our significant contractual obligations at March 31, 2021, and the effect such obligations are expected to have on our liquidity and cash flows in future periods:

 

 

 

Off-Balance Sheet Arrangements

At March 31, 2021, we had two types of off-balance sheet arrangements.

Surety Bonds. As part of Faneuil’s normal course of operations, certain customers require surety bonds guaranteeing the performance of a contract. At March 31, 2021, the face value of such surety bonds, which represents the maximum cash payments that Faneuil would have to make under certain circumstances of non-performance, was approximately $41.5 million.

Letters of Credit. ALJ had letters of credit totaling $3.3 million outstanding at March 31, 2021.

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Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during the reporting period. We regularly evaluate our estimates and assumptions related to the fair value of assets and liabilities, including intangible assets acquired and allocation of purchase price, useful lives, carrying value and recoverability of long-lived and intangible assets, the recoverability of goodwill, and revenue recognition. Certain accounting policies are considered "critical accounting policies" because they are particularly dependent on estimates made by us about matters that are inherently uncertain and could have a material impact on our consolidated financial statements. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

For a complete summary of our critical accounting policies, please refer to “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Form 10-K for the fiscal year ended September 30, 2020, filed with the SEC on December 18, 2020 (“Fiscal 2020 Form 10-K”).

For a complete summary of our significant accounting policies, please refer to “Part IV. Exhibits, Financial Statement Schedules –Note 2. Summary of Significant Accounting Policies,” included in our Fiscal 2020 Form 10-K. As a result of adopting ASC 842, we revised our accounting policy for leases. See further discussion at “Part I, Item 1. Financial Statements – Note 2. Recent Accounting Standards.”  There were no other changes to our accounting policies during the six months ended March 31, 2021.

Item 3. Qualitative and Quantitative Disclosures about Market Risk

Not applicable.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(b) and Rule 15d-15(b) of the Exchange Act, our management evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report at the reasonable assurance level in ensuring that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. There has been no change in the company’s internal control over financial reporting that occurred during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting decisions regarding required disclosure.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The Company has been named in, and from time to time may become named in, various lawsuits or threatened actions that are incidental to our ordinary business. For additional information regarding such matters, see “Part I, Item 1. Financial Statements – Note 9. Commitments and Contingencies - Litigation, Claims, and Assessments.”  

 

Item 1A. Risk Factors

The following risk factors and other information included in this Form 10-Q should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, financial condition and operating results could be significantly harmed.

 

Risks Related to Faneuil

 

Faneuil is subject to uncertainties regarding healthcare reform that could materially and adversely affect that aspect of our business.

Since its adoption into law in 2010, the Affordable Care Act has been challenged before the U.S. Supreme Court, and several bills have been and continue to be introduced in Congress to delay, defund, or repeal implementation of or amend significant provisions of the Affordable Care Act. In addition, there continues to be ongoing litigation over the interpretation and implementation of certain provisions of the law. New tax reform legislation enacted on December 22, 2017 (“Tax Reform Law”) includes a provision repealing, effective January 1, 2019, the tax-based shared responsibility payment imposed by the Affordable Care Act on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate,” which could lead to fewer enrollments in healthcare exchanges. Further significant changes to, or repeal of, the Affordable Care Act could materially and adversely affect that aspect of Faneuil’s business.

Economic downturns, reductions in government funding and other program-related and contract-related risks could have a negative effect on Faneuil’s business.

Demand for the services offered by Faneuil has been, and is expected to continue to be, subject to significant fluctuations due to a variety of factors beyond its control, including economic conditions, particularly since contracts for major programs are performed over extended periods of time. During economic downturns, the ability of both private and governmental entities to make expenditures may decline significantly. We cannot be certain that economic or political conditions will be generally favorable or that there will not be significant fluctuations adversely affecting Faneuil as a whole, or key industry segments targeted by Faneuil. In addition, Faneuil’s operations are, in part, dependent upon state government funding. Significant changes in the level of state government funding, changes in personnel at government authorities, the failure of applicable government authorities to take necessary actions, opposition by third parties to particular programs, any delay in the state government budget process or a state government shutdown could have an unfavorable effect on Faneuil’s business, financial position, results of operations and cash flows.

Faneuil’s profitability is dependent in part on Faneuil’s ability to estimate correctly, obtain adequate pricing, and control its cost structure related to fixed “price per call” contracts.

A significant portion of Faneuil’s revenues are derived from commercial and government contracts awarded through competitive bidding processes. Many of these contracts are extremely complex and require the investment of significant resources in order to prepare accurate bids and pricing based on both current and future conditions, such as the cost of labor, that could impact profitability of such contracts. Our success depends on Faneuil’s ability to accurately estimate the resources and costs that will be required to implement and service any contracts we are awarded, sometimes in advance of the final determination of such contracts’ full scope and design, and negotiate adequate pricing for call center services that provide a reasonable return to our shareholders based on such estimates. Additionally, in order to attract and retain certain contracts, we are sometimes required to make significant capital and other investments to enable us to perform our services under those contracts, such as facility leases, information technology equipment purchases, labor resources, and costs incurred to develop and implement software. If Faneuil is unable to accurately estimate its costs to provide call center services, obtain adequate pricing, or control costs for fixed “price per call” contracts, it could materially adversely affect our results of operations and financial condition.

Faneuil’s dependence on a small number of customers could adversely affect its business or results of operations.

Faneuil derives a substantial portion of its revenue from a relatively small number of customers. For additional information regarding Faneuil customer concentrations, see “Part I, Item 1. Financial Statements – Note 5. Concentration Risks.” We expect the largest customers of Faneuil to continue to account for a substantial portion of its total net revenue for the foreseeable future. Faneuil has

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long-standing relationships with many of its significant customers. However, because Faneuil customers generally contract for specific projects or programs with a finite duration, Faneuil may lose these customers if funding for their respective programs is discontinued, or if their projects end and the contracts are not renewed or replaced. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could materially reduce Faneuil revenue and cash flows. Additionally, many Faneuil customers are government entities, which can unilaterally terminate or modify the existing contracts with Faneuil without cause and penalty to such government entities in many situations. If Faneuil does not replace them with other customers or other programs, the loss of business from any one of such customers could have a material adverse effect on its business or results of operations.

The recovery of capital investments in Faneuil contracts is subject to risk.

In order to attract and retain large outsourcing contracts, Faneuil may be required to make significant capital investments to perform its services under the contract, such as purchases of information technology equipment and costs incurred to develop and implement software. The net book value of such assets, including intangible assets, could be impaired, and Faneuil earnings and cash flow could be materially adversely affected in the event of the early termination of all or a part of such a contract, reduction in volumes and services thereunder for reasons including, but not limited to, a client’s merger or acquisition, divestiture of assets or businesses, business failure or deterioration, or a client’s exercise of contract termination rights.

Faneuil’s dependence on subcontractors and equipment manufacturers could adversely affect it.

In some cases, Faneuil relies on and partners with third-party subcontractors as well as third-party equipment manufacturers to provide services under its contracts. To the extent that Faneuil cannot engage subcontractors or acquire equipment or materials, its performance, according to the terms of the customer contract, may be impaired. If the amount Faneuil is required to pay for subcontracted services or equipment exceeds the amount Faneuil has estimated in bidding for fixed prices or fixed unit price contracts, it could experience reduced profit or losses in the performance of these contracts with its customers. Also, if a subcontractor or a manufacturer is unable to deliver its services, equipment or materials according to the negotiated terms for any reason, including the deterioration of its financial condition, Faneuil may be required to purchase the services, equipment or materials from another source at a higher price. This may reduce the expected profit or result in a loss of a customer contract for which the services, equipment or materials were needed.

Partnerships entered into by Faneuil as a subcontractor with third parties who are primary contractors could adversely affect its ability to secure new projects and derive a profit from its existing projects.

In some cases, Faneuil partners as a subcontractor with third parties who are the primary contractors. In these cases, Faneuil is largely dependent on the judgments of the primary contractors in bidding for new projects and negotiating the primary contracts, including establishing the scope of services and service levels to be provided. Furthermore, even if projects are secured, if a primary contractor is unable to deliver its services according to the negotiated terms of the primary contract for any reason, including the deterioration of its financial condition, the customer may terminate or modify the primary contract, which may reduce Faneuil profit or cause losses in the performance of the contract.  In certain instances, the subcontract agreement includes a “Pay When Paid” provision, which allows the primary contractor to hold back payments to a subcontractor until they are paid by the customer, which has negatively impacted Faneuil cashflow.

If Faneuil or a primary contractor guarantees to a customer the timely implementation or performance standards of a program, Faneuil could incur additional costs to meet its guaranteed obligations or liquidated damages if it fails to perform as agreed.

In certain instances, Faneuil or its primary contractor guarantees a customer that it will implement a program by a scheduled date. At times, they also provide that the program will achieve or adhere to certain performance standards or key performance indicators. Although Faneuil generally provides input to its primary contractors regarding the scope of services and service levels to be provided, it is possible that a primary contractor may make commitments without Faneuil’s input or approval. If Faneuil or the primary contractor subsequently fails to implement the program as scheduled, or if the program subsequently fails to meet the guaranteed performance standards, Faneuil may be held responsible for costs to the client resulting from any delay in implementation, or the costs incurred by the program to achieve the performance standards. In most cases where Faneuil or the primary contractor fails to meet contractually defined performance standards, Faneuil may be subject to agreed-upon liquidated damages. To the extent that these events occur, the total costs for such program may exceed original estimates, and cause reduced profits, or in some cases a loss for that program.

Adequate bonding is necessary for Faneuil to win new contracts.

Faneuil is often required, primarily in its toll and transportation programs, to provide performance and surety bonds to customers in conjunction with its contracts. These bonds indemnify the customer should Faneuil fail to perform its obligations under the contracts.

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If a bond is required for a particular program and Faneuil is unable to obtain an appropriate bond, Faneuil cannot pursue that program. The issuance of a bond is at the surety’s sole discretion. Moreover, due to events that affect the insurance and bonding markets generally, bonding may be more difficult to obtain in the future or may only be available at significant additional costs. There can be no assurance that bonds will continue to be available on reasonable terms, or at all. Any inability to obtain adequate bonding and, as a result, to bid on new work could harm Faneuil’s business.

Interruption of Faneuil data centers and customer contact centers could negatively impact Faneuil’s business.

If Faneuil was to experience a temporary or permanent interruption at a customer contact center due to natural disaster, casualty, operating malfunction, cyber-attack, sabotage or any other cause, Faneuil might be unable to provide the services it is contractually obligated to deliver. This could result in Faneuil being required to pay contractual damages to some clients or to allow some clients to terminate or renegotiate their contracts. Notwithstanding disaster recovery and business continuity plans and precautions instituted to protect Faneuil and Faneuil clients from events that could interrupt delivery of services, there is no guarantee that such interruptions would not result in a prolonged interruption in service, or that such precautions would adequately compensate Faneuil for any losses it may incur as a result of such interruptions.

Faneuil’s business is subject to many regulatory requirements, and current or future regulation could significantly increase Faneuil’s cost of doing business.

Faneuil’s business is subject to many laws and regulatory requirements in the United States, covering such matters as data privacy, consumer protection, healthcare requirements, labor relations, taxation, internal and disclosure control obligations, governmental affairs and immigration. For example, Faneuil is subject to state and federal laws and regulations regarding the protection of consumer information commonly referred to as “non-public personal information.” For instance, the collection of patient data through Faneuil’s contact center services is subject to HIPAA, which protects the privacy of patients’ data. These laws, regulations, and agreements require Faneuil to develop and implement policies to protect non-public personal information and to disclose these policies to consumers before a customer relationship is established and periodically after that. These laws, regulations, and agreements limit the ability to use or disclose non-public personal information for purposes other than the ones originally intended. Many of these regulations, including those related to data privacy, are frequently changing and sometimes conflict with existing ones among the various jurisdictions in which Faneuil provides services. Violations of these laws and regulations could result in liability for damages, fines, criminal prosecution, unfavorable publicity and restrictions placed on Faneuil operations. Faneuil’s failure to adhere to or successfully implement processes in response to changing regulatory requirements in this area could result in legal liability or impairment to Faneuil’s reputation in the marketplace, which could have a material adverse effect on Faneuil’s business, results of operations and financial condition. In addition, because a substantial portion of Faneuil operating costs consists of labor costs, changes in governmental regulations relating to wages, healthcare and healthcare reform and other benefits or employment taxes could have a material adverse effect on Faneuil’s business, results of operations or financial condition.

Matters relating to employment and labor laws and prevailing wage standards may adversely affect our business.

The industries in which Faneuil competes is labor intensive and governed by various federal and state labor laws with respect to its relationship with its employees. Faneuil’s ability to meet its labor needs on a cost-effective basis is subject to numerous external factors, including the availability of qualified personnel in the workforce in the local markets in which it operates, unemployment levels within those markets, prevailing wage rates, health and other insurance costs and changes in employment and labor laws. Such laws related to employee hours, wages, job classification and benefits could significantly increase Faneuil’s operating costs. Faneuil is also subject to employee claims against it based on such laws and other actions or inactions of its employees. Some or all of these claims may give rise to litigation, including class action litigation under the Fair Labor Standards Act and state wage and hour lawsuits. Such class action lawsuits are typically brought by specialized plaintiff law firms who often seek large settlements based entirely on the number of potential plaintiffs in a class, whether or not there is any basis for the claims that they make on behalf of their clients, most of whom do not believe themselves to be aggrieved nor seek recourse until solicited. Due to the inherent uncertainties of litigation, Faneuil may not be able to accurately determine the impact on it of any future adverse outcome of such proceedings. The ultimate resolution of these matters could have a material adverse impact on Faneuil’s financial condition, results of operations, and liquidity. In addition, regardless of the outcome, these proceedings could result in substantial cost to Faneuil and may require Faneuil to devote substantial resources to defend itself.

Additionally, in the event prevailing wage rates increase in the local markets in which Faneuil operates, Faneuil may be required to concurrently increase the wages paid to its employees to maintain the quality of its workforce and customer service. To the extent such increases are not covered by our customers, Faneuil’s profit margins may decrease as a result.  If Faneuil is unable to hire and retain employees capable of meeting its business needs and expectations, its business and brand image may be impaired. Any failure to meet Faneuil’s staffing needs or any material increase in turnover rates of its employees may adversely affect its business, results of operations and financial condition.

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Risks Related to Phoenix

Economic weakness and uncertainty, as well as the effects of these conditions on Phoenix’s customers and suppliers, could reduce demand for or the ability of Phoenix to provide its products and services.

Economic conditions related to Phoenix, Phoenix’s customers, and Phoenix’s suppliers, could negatively impact Phoenix’s business and results of operations. Phoenix has experienced, and may continue to experience, reduced demand for certain of its products and services. As a result of uncertainty about global economic conditions, including factors such as unemployment, bankruptcies, financial market volatility, sovereign debt issues, government budget deficits, tariffs, and other factors which continue to affect the global economy, Phoenix’s customers and suppliers may experience further deterioration of their businesses, suffer cash flow shortages or file for bankruptcy. In turn, existing or potential customers may delay or decline to purchase Phoenix products and related services, and Phoenix’s suppliers and customers may not be able to fulfill their obligations to it in a timely fashion.

Educational textbook cover and component sales depend on continued government funding for educational spending, which impacts demand by its customers, and may be affected by changes in or continued restrictions on local, state and/or federal funding and school budgets. As a result, a reduction in consumer discretionary spending or disposable income and/or adverse trends in the general economy (and consumer perceptions of those trends) may affect Phoenix more significantly than other businesses in other industries.

In addition, customer difficulties could result in increases in bad debt write-offs and increases to Phoenix’s allowance for doubtful accounts receivable. Further, Phoenix’s suppliers may experience similar conditions as its customers, which may impact their viability and their ability to fulfill their obligations to Phoenix. Negative changes in these or related economic factors could materially adversely affect Phoenix’s business.

A substantial decrease or interruption in business from Phoenix’s significant customers or suppliers could adversely affect its business.

Phoenix has significant customer and supplier concentration. For additional information regarding customer and supplier concentrations, see “Part I, Item 1. Financial Statements – Note 5. Concentration Risks.” Any significant cancellation, deferral or reduction in the quantity or type of products sold to these principal customers or a significant number of smaller customers, including as a result of Phoenix’s failure to perform, the impact of economic weakness and challenges to customer businesses, a change in buying habits, further industry consolidation or the impact of the shift to alternative methods of content delivery, including digital distribution and printing, to customers, could have a material adverse effect on Phoenix business. Further, if Phoenix’s significant customers, in turn, are not able to secure large orders, they will not be able to place orders with Phoenix. A substantial decrease or interruption in business from Phoenix’s significant customers could result in write-offs or the loss of future business and could have a material adverse effect on Phoenix’s business.

Additionally, Phoenix purchases certain limited grades of paper to produce book and component products. If Phoenix’s suppliers reduce their supplies or discontinue these grades of paper, Phoenix may be unable to fulfill its contract obligations, which could have a material adverse effect on its business. See “Part I, Item 1. Financial Statements – Note 5. Concentration Risks.”  

The impact of digital media and similar technological changes, including the substitution of printed products with digital content, may continue to adversely affect the results of Phoenix’s operations.

The industry in which Phoenix operates is experiencing rapid change due to the impact of digital media and content on printed products. Electronic delivery of information offer alternatives to traditional delivery in the form of print materials provided by Phoenix. Further improvements in the accessibility and quality of digital media, mobile technologies, e-reader technologies, digital retailing and the digital distribution of documents and data has resulted and may continue to result in increased consumer substitution away from Phoenix’s printed products. Continued consumer acceptance of such digital media, as an alternative to print materials, is uncertain and difficult to predict and may decrease the demand for the Phoenix’s printed products, result in reduced pricing for its printing services and additional excess capacity in the printing industry, and could materially adversely affect Phoenix’s business.

Fluctuations in the cost and availability of raw materials could increase Phoenix cost of sales.

To produce its products, Phoenix is dependent upon the availability of raw materials, including paper, ink, and adhesives, the price and availability of which are affected by numerous factors beyond its control. These factors include:

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Any material increase in the price of key raw materials could adversely impact Phoenix cost of sales or result in the loss of availability of such materials at reasonable prices. When these fluctuations result in significantly higher raw material costs, Phoenix’s operating results are adversely affected to the extent it is unable to pass on these increased costs to its customers or to the extent they materially affect customer buying habits. Significant fluctuations in prices for paper, ink, and adhesives could, therefore, have a material adverse effect on Phoenix’s business.

Phoenix is subject to environmental obligations and liabilities that could impose substantial costs upon Phoenix.

Phoenix’s operations are subject to a variety of federal, state, local and foreign laws and regulations governing emissions to air, discharge to water, the generation, handling, storage, transportation, treatment and disposal of hazardous substances and other materials, and employee health and safety matters. As an owner and operator of real property and a generator of hazardous substances, Phoenix may be subject to environmental cleanup liability, regardless of fault, pursuant to the Comprehensive Environmental Response, Compensation and Liability Act or analogous state laws, as well as to claims for harm to health or property or for natural resource damages arising out of contamination or exposure to hazardous substances. Some current or past operations have involved metalworking and plating, printing and other activities that have resulted in or could result in environmental conditions giving rise to liabilities. If Phoenix incurs significant expenses related to environmental cleanup or damages stemming from harm or alleged harm to health, property or natural resources arising from contamination or exposure to hazardous substances, Phoenix’s business may be materially and adversely affected.

Risks Related to our Businesses Generally

A widespread health crisis, such as the COVID-19 pandemic, may adversely affect our business, results of operations and financial condition.

A widespread health crisis, including the COVID-19 pandemic, and related governmental responses may adversely affect our business, results of operations and financial condition. These effects could include disruptions to our workforce due to illness or “shelter-in-place” restrictions, temporary closures of our facilities, the interruption of our supply chains and distribution channels, and similar effects on our customers or suppliers that may impact their ability to perform under their contracts with us or cause them to curtail their business with us. In addition, we have taken and will continue to take temporary precautionary measures intended to help minimize the risk of COVID-19 to our employees, including requiring certain employees to work remotely and suspending non-essential travel and in-person meetings, which could negatively affect our business. Further, COVID-19 has and is expected to continue to adversely affect the economies and financial markets of many countries and most areas of the United States, which may affect demand for our products and services and our ability to obtain additional financing for our business. Further impacts specific to our subsidiaries’ businesses may include:

Any of these events could materially and adversely affect our business and our financial results. To the extent that the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in this “Risk Factors” section, such as those relating to our high level of indebtedness, our need to generate sufficient cash flows to service our indebtedness and our ability to comply with the covenants contained in our credit agreement.

The extent to which COVID-19 will impact our business and our financial results will depend on future developments, which are highly uncertain and cannot be predicted with certainty. Such developments may include the ongoing spread of the virus, the vaccination rates, the emergence of new variants, the severity of the disease, the duration of the outbreak and the type and duration of actions that may be taken by various governmental authorities in response to the outbreak and the impact on the economy. As a result, at the time of this filing, it is not possible to predict the overall impact of COVID-19 on our business, liquidity, and financial results.

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We previously received a notice of failure to satisfy a continued listing rule from the Nasdaq.

 

On April 9, 2020, we received a letter from the Listing Qualifications Department of the Nasdaq Stock Market (“Nasdaq”) indicating that, based upon the closing bid price of our common stock for the last 30 consecutive business days, we did not meet the minimum bid price of $1.00 per share required for continued listing on The Nasdaq Global Market pursuant to Nasdaq Listing Rule 5450(a)(1). Pursuant to the initial Nasdaq notice and Rule 5810(c)(3)(A) of the Nasdaq Listing Rules, we originally had 180 calendar days from the date of the notice, or until October 6, 2020, to regain compliance with the minimum bid price requirement in Rule 5550(a)(2) by achieving a closing bid price for our common stock of at least $1.00 per share over a minimum of 10 consecutive business days. However, on April 17, 2020, we received a second letter from the Nasdaq indicating that, given the extraordinary market conditions, effective as of April 16, 2020, the Nasdaq has determined to toll the compliance periods for the minimum bid price requirement through June 30, 2020, such that we had until December 21, 2020, to regain compliance. On November 5, 2020, we received a notice from NASDAQ that we had regained compliance with Listing Rule 5450(a)(1). Despite Nasdaq now considering this matter closed, there can be no assurance that we will be able to remain in compliance with the minimum bid price requirement or with other Nasdaq listing requirements in the future. If we are unable to remain in compliance with the minimum bid price requirement or with any of the other continued listing requirements, the Nasdaq may take steps to delist our common stock, which could have adverse results, including, but not limited to, a decrease in the liquidity and market price of our common stock, loss of confidence by our employees and investors, loss of business opportunities, and limitations in potential financing options.

Our ability to engage in some business transactions may be limited by the terms of our debt.

Our financing documents contain affirmative and negative financial covenants restricting ALJ, Faneuil, and Phoenix. Specifically, our loan facilities covenants restrict ALJ, Faneuil, and Phoenix from:

Our ability to borrow under our loan arrangements depends on our compliance with certain covenants and borrowing base requirements. A significant deterioration in our profitability and/or cash flow, whether caused by our inability to grow our businesses in a profitable manner, or by events beyond our control, may cause us to fall out of compliance with such covenants and borrowing base requirements. The failure to comply with these covenants and requirements could result in an event of default under our loan arrangements that, if not cured or waived, could terminate such party’s ability to borrow further, permit acceleration of the relevant debt (and other indebtedness based on cross-default provisions) and permit foreclosure on any collateral granted as security under the loan arrangements, which includes substantially all of our assets. Accordingly, any default under our loan facilities could also result in a material adverse effect on us that may result in our lenders seeking to recover from us or against our assets. There can also be no assurance that the lenders will grant waivers on covenant violations if they occur. Any such event of default would have a material adverse effect on us.

We have substantial indebtedness and our ability to generate cash to service our indebtedness depends on factors that are beyond our control.

We currently have, and will likely continue to have, a substantial amount of indebtedness, some of which require us to make a lump-sum or “balloon” payment at maturity. Our indebtedness could, among other things, make it more difficult for us to satisfy our debt obligations, require us to use a large portion of our cash flow from operations to repay and service our debt or otherwise create liquidity problems, limit our flexibility to adjust to market conditions and place us at a competitive disadvantage. We expect to obtain the money to pay our expenses and pay the principal and interest on our indebtedness from cash flow from our operations and potentially from debt or equity offerings. However, if we do not have sufficient funds to repay the debt at maturity of these loans, we will need to refinance this debt. If the credit environment is constrained at the time the balloon payment is due or our indebtedness otherwise matures, we may not be able to refinance our existing indebtedness on acceptable terms and may be forced to choose from a number of unfavorable options. These options include agreeing to otherwise unfavorable financing terms, selling assets on disadvantageous terms or defaulting on the loan and permitting the lender to foreclose. Accordingly, our ability to meet our obligations depends on our future performance and capital raising activities, which will be affected by financial, business, economic

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and other factors, many of which are beyond our control. If our cash flow and capital resources prove inadequate to allow us to pay the principal and interest on our debt and meet our other obligations, our ability to execute our business plan and effectively compete in the marketplace may be materially adversely affected.

The industries in which our subsidiaries operate are highly competitive, which could decrease demand for our subsidiaries’ products or force them to lower their prices, which could have a material adverse effect on their business and our financial results.

Faneuil primarily competes based on quality, performance, innovation, technology, price, applications expertise, system and service flexibility, and established customer service capabilities, as its services relate to toll collection, customer contact centers, and employee staffing. Faneuil may not be able to compete effectively on all these fronts or with all of its competitors.

Phoenix competes directly or indirectly with several established book and book component manufacturers. New distribution channels such as digital formats, the internet and online retailers and growing delivery platforms (e.g., tablets and e-readers), combined with the concentration of retailer power, pose threats and provide opportunities to traditional consumer publishing models, potentially impacting both sales volumes and pricing.

Competitive pressures or the inability by our subsidiaries to adapt effectively and quickly to a changing competitive landscape could affect prices, margins or demand for products and services. If our subsidiaries are unable to respond timely and appropriately to these competitive pressures, from existing or new competitors, their business, market share and financial performance could be adversely affected.

A failure to attract and retain necessary personnel, skilled management, and qualified subcontractors may have an adverse impact on the business of our subsidiaries.

Because each of our subsidiaries operates in intensely competitive markets, its success depends to a significant extent upon each subsidiary’s ability to attract, retain and motivate highly skilled and qualified personnel and to subcontract with qualified, competent subcontractors. If our subsidiaries fail to attract, develop, motivate, retain, and effectively utilize personnel with the desired levels of training or experience, or, as applicable, are unable to contract with qualified, competent subcontractors, their business will be harmed. Experienced and capable personnel remain in high demand, and there is continual competition for their talents. Quality service depends on the ability to retain employees and control personnel turnover, as any increase in the employee turnover rate could increase recruiting and training costs and could decrease operating effectiveness and productivity. Additionally, our subsidiaries’ businesses are driven in part by the personal relationships, skills, experience and performance of each subsidiary’s senior management team. Despite executing employment agreements with members of each subsidiary’s senior management team, such members may discontinue service with our subsidiaries and we may not be able to find individuals to replace them at the same cost, or at all. We have not obtained “key person” insurance for any member of our senior management team. The loss or interruption of the services of any key employee or the loss of a key subcontractor relationship could hurt our business, financial condition, cash flow, results of operations and prospects.

Changes in interest rates may increase our interest expense.

 

As of March 31, 2021, $89.9 million of our current borrowings under the Cerberus Term Loan, Cerberus/PNC Revolver, and potential future borrowings are, and may continue to be, at variable rates of interest, tied to LIBOR or the Prime Rate of interest, thus exposing us to interest rate risk. Such rates tend to fluctuate based on general economic conditions, general interest rates, Federal Reserve rates and the supply of and demand for credit in the relevant interbanking market. In recent years, the Fed has incrementally changed the target range for the federal funds rate. Changes in the interest rate generally, and particularly when coupled with any significant variable rate indebtedness, could materially adversely impact our interest expense. If interest rates changed in the future by 100 basis points, based on our current borrowings as of March 31, 2021, our interest expense would increase or decrease by $0.9 million per year.

 

Further, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, has announced that it intends to stop encouraging or compelling banks to submit rates for the calculation of LIBOR rates after 2021 (the “FCA Announcement”). The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing U.S. dollar LIBOR with a new index, the Secured Overnight Financing Rate (“SOFR”), calculated using short-term repurchase agreements backed by Treasury securities. We are evaluating the potential impact of the eventual replacement of the LIBOR benchmark interest rate, however, we are not able to predict whether LIBOR will cease to be available after 2021 or whether SOFR will become a widely accepted benchmark in place of LIBOR. Although it is not possible to predict the effect the FCA Announcement, any discontinuation, modification or other reforms to LIBOR or the establishment of

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alternative reference rates such as SOFR may have on LIBOR, we do not expect the effect to have a material impact on our interest expense.

 

We may not receive the full amounts estimated under the contracts in our backlog, which could reduce our revenue in future periods below the levels anticipated. This makes backlog an uncertain indicator of future operating results.

 

As of March 31, 2021, both of our subsidiaries had a significant backlog. Our backlog is typically subject to large variations from quarter to quarter and comparisons of backlog from period to period are not necessarily indicative of future revenue. The contracts comprising our backlog may not result in actual revenue in any particular period or at all, and the actual revenue from such contracts may differ from our backlog estimates. The timing of receipt of revenue, if any, for projects included in backlog could change because many factors affect the scheduling of projects. In certain instances, customers may have the right to cancel, reduce or defer amounts that we have in our backlog, which could negatively affect our future revenue. The failure to realize all amounts in our backlog could adversely affect our revenue and gross margins. As a result, our subsidiaries’ backlog as of any particular date may not be an accurate indicator of our future revenue or earnings.

Some of our officers may have outside business interests, which could impair our ability to implement our business strategies and lead to potential conflicts of interest. 

Some of our officers, in the course of their other business activities, may become aware of investments, business or other information which may be appropriate for presentation to us as well as to other entities to which they owe a fiduciary duty. They may also in the future become affiliated with entities that are engaged in business or other activities similar to those we intend to conduct. As a result, they may have conflicts of interest in determining to which entity particular opportunities or information should be presented. If, as a result of such conflict, we are deprived of investments, business or information, the execution of our business plan and our ability to effectively compete in the marketplace may be adversely affected.

We may not be able to consummate additional acquisitions and dispositions on acceptable terms or at all. Furthermore, we and our subsidiaries may not be able to integrate acquisitions successfully and achieve anticipated synergies, or the acquisitions and dispositions we and our subsidiaries pursue could disrupt our business and harm our financial condition and operating results.

As part of our business strategy, we intend to continue to pursue acquisitions and dispositions. Acquisitions and dispositions could involve a number of risks and present financial, managerial and operational challenges, including:

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We may not be able to consummate acquisitions or dispositions on favorable terms or at all. Our ability to consummate acquisitions will be limited by our ability to identify appropriate acquisition candidates, to negotiate acceptable terms for purchase and our access to financial resources, including available cash and borrowing capacity. In addition, we could experience financial or other setbacks if we are unable to realize, or are delayed in realizing, the anticipated benefits resulting from an acquisition, if we incur greater than expected costs in achieving the anticipated benefits or if any business that we acquire or invest in encounters problems or liabilities which we were not aware of or were more extensive than believed.

Our net operating loss carryforwards could be substantially limited if we experience an “ownership change,” as defined in Section 382 of the Internal Revenue Code.

Our ability to utilize net operating losses (“NOLs”) and built-in losses under Section 382 of the Internal Revenue Code (the “Code”) and tax credit carryforwards to offset our future taxable income and/or to recover previously paid taxes would be limited if we were to undergo an “ownership change” within the meaning of Section 382 of the Code, which is generally any change in ownership of more than 50% of its stock over a three-year period. These rules generally operate by focusing on ownership changes among stockholders owning directly or indirectly 5% or more of the stock of a company and any change in ownership arising from a new issuance of stock by the company. Depending on the resulting limitation, a significant portion of our NOLs could expire before we would be able to use them. At the end of our last fiscal year, September 30, 2020, we had net operating loss carryforwards for federal income tax purposes of approximately $133.2 million that start expiring in 2022. Approximately $109.9 million of the carryforward expires in 2022. Our inability to utilize our NOLs would have a negative impact on our financial position and results of operations.

In August 2018, our shareholders approved the amendment of certain provisions in our Restated Certificate of Incorporation, updating certain restrictions on transfers of our stock that may result in an “ownership change” within the meaning of Section 382 in order to preserve stockholder value and the value of certain tax assets primarily associated with NOLs and built-in losses under Section 382. We do not believe we have experienced an “ownership change” as defined by Section 382 in the last three years. However, whether a change in ownership occurs in the future is largely outside of our control, and there can be no assurance that such a change will not occur.

The concentration of our capital stock ownership with insiders will likely limit your ability to influence corporate matters. 

Our executive officers and directors and their affiliated entities together beneficially owned approximately 57.9% of our outstanding common stock at May 1, 2021. Jess Ravich, our current Chief Executive Officer, beneficially owned approximately 49.6% of our common stock as of May 1, 2021. As a result, these stockholders, if they act together or in a block, could have significant influence over most matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions, even if other stockholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.

We do not currently plan to pay dividends to holders of our common stock.

We do not currently anticipate paying cash dividends to the holders of our common stock. Accordingly, holders of our common stock must rely on price appreciation as the sole method to realize a gain on their investment. There can be no assurances that the price of our common stock will ever appreciate in value.

Certain provisions in our Restated Certificate of Incorporation contain transfer restrictions that may have the effect of delaying or preventing beneficial takeover bids by third parties.

Our Restated Certificate of Incorporation imposes certain restrictions on transfer of stock designed to preserve the value of certain tax assets primarily associated with our NOLs and built-in losses under Section 382. These restrictions prohibit certain transfers that would result in a person or a group of persons acquiring 5% of more of ALJ’s outstanding stock, unless otherwise approved by our Board of Directors or a committee thereof. While such transfer restrictions are intended to protect our NOLs and built-in losses under Section 382, they may also have the effect of delaying or preventing beneficial takeover bids by third parties.

General Risk Factors

Changes in U.S. tax laws could have a material adverse effect on our business, cash flow, results of operations or financial conditions.

On December 22, 2017, President Trump signed into law the final version of the Tax Reform Law. The Tax Reform Law significantly reforms the Internal Revenue Code of 1986, as amended, with many of its provisions effective for tax years beginning on or after January 1, 2018. The Tax Reform Law, among other things, contains significant changes to corporate taxation, including a permanent

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reduction of the corporate income tax rate, a partial limitation on the deductibility of business interest expense, a limitation of the deduction for net operating loss carryforwards, an indefinite net operating loss carryforward and the elimination of the two-year net operating loss carryback, temporary, immediate expensing for certain new investments and the modification or repeal of many business deductions and credits. We continue to examine the impact this tax reform legislation may have on our business. Notwithstanding the reduction in the corporate income tax rate, the overall impact of the Tax Reform Law is uncertain and our business and financial condition could be adversely affected. The impact of this reform on our stockholders is uncertain. Stockholders should consult with their tax advisors regarding the effect of the Tax Reform Law and other potential changes to the U.S. Federal tax laws on them.

The market price of our common stock is volatile.

The market price of our common stock could fluctuate substantially in the future in response to a number of factors, including the following:

Also, the stock market has experienced extreme price and volume fluctuations recently. This volatility has had a significant impact on the market prices of securities issued by many companies for reasons unrelated to their operating performance. These broad market fluctuations may materially adversely affect our stock price, regardless of our operating results.

We are subject to claims arising in the ordinary course of our business that could be time-consuming, result in costly litigation and settlements or judgments, require significant amounts of management attention and result in the diversion of significant operational resources, which could adversely affect our business, financial condition and results of operations.

We, our officers, and our subsidiaries, are currently involved in, and from time to time may become involved in, legal proceedings or be subject to claims arising in the ordinary course of our business. Litigation is inherently unpredictable, time-consuming and distracting to our management team, and the expenses of conducting litigation are not inconsequential. Such distraction and expense may adversely affect the execution of our business plan and our ability to compete effectively in the marketplace. Further, if we do not prevail in litigation in which we may be involved, our results could be adversely affected, in some cases, materially. For additional information, see “Part II. Item 1, Legal Proceedings.”

Any business disruptions due to political instability, armed hostilities, acts of terrorism, natural disasters or other unforeseen events could adversely affect our financial performance.

If terrorist activities, armed conflicts, political instability or natural disasters, including climate change related events, occur in the United States, such events may negatively affect the operations of our subsidiaries, cause general economic conditions to deteriorate or cause demand for our subsidiaries’ services to decline. A prolonged economic slowdown or recession could reduce the demand for our subsidiaries’ services, and consequently, negatively affect our subsidiaries’ future sales and profits. Additionally, certain of our subsidiaries are dependent on key production facilities and certain specialized machines. Any disruption of production capabilities due to unforeseen events at any of our subsidiaries’ principal facilities could adversely affect our business, results of operations, cash flows, and financial condition.

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Account data breaches involving stored data, or the misuse of such data could adversely affect our reputation, performance, and financial condition.

We and each of our subsidiaries provide services that involve the storage of non-public information. Cyber-attacks designed to gain access to sensitive information are constantly evolving, and high-profile electronic security breaches leading to unauthorized releases of sensitive information have occurred recently at several major U.S. companies, including several large retailers, despite widespread recognition of the cyber-attack threat and improved data protection methods. Any breach of the systems on which sensitive data and account information are stored or archived and any misuse by our employees, by employees of data archiving services or by other unauthorized users of such data could lead to damage to our reputation, claims against us and other potential increases in costs. If we are unsuccessful in defending any lawsuit involving such data security breaches or misuse, we may be forced to pay damages, which could materially and adversely affect our profitability and financial condition. Also, damage to our reputation stemming from such breaches could adversely affect our prospects. As the regulatory environment relating to companies’ obligations to protect such sensitive data becomes stricter, a material failure on our part to comply with applicable regulations could subject us to fines or other regulatory sanctions.

Your share ownership may be diluted by the issuance of additional shares of our common or preferred stock in the future.

Your share ownership may be diluted by the issuance of additional shares of our common or preferred stock or securities convertible into common or preferred stock in the future. As of March 31, 2021, a total of 1,465,000 shares of our common stock are issuable pursuant to outstanding options issued by us at a weighted-average exercise price of $3.54, and 2,907,529 shares of our common stock are issuable pursuant to outstanding warrants at a weighted-average exercise price of $1.11. As of March 31, 2021, ALJ had debt that was convertible into approximately 11,158,000 shares of common stock at the discretion of the debt holder.  It is probable that options or warrants to purchase our common stock, or debt that is convertible into common stock, will be exercised during their respective terms if the fair market value of our common stock exceeds the exercise price of the particular option or warrant. If the stock options or warrants are exercised, your share ownership will be diluted. Additionally, options to purchase up to 1,335,000 shares of ALJ common stock are available for grant under our existing equity compensation plans as of March 31, 2021.

In addition, our Board of Directors may determine from time to time that we need to raise additional capital by issuing additional shares of our common stock or other securities. We are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common or preferred stock. The issuance of any additional shares of common stock or preferred stock or securities convertible into, exchangeable for or that represent the right to receive common or preferred stock, or the exercise of such securities could be substantially dilutive to shareholders of our common stock. New investors also may have rights, preferences, and privileges that are senior to, and that adversely affect, our then current shareholders. Holders of our shares of common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series. The market price of our common stock could decline as a result of sales of shares of our common stock made after this offering or the perception that such sales could occur. We cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our shareholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings.

We are an “emerging growth company” and a “smaller reporting company” and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” or “smaller reporting companies.”

We qualify as an “emerging growth company,” as defined in Section 2(a) of the Securities Act of 1933, as amended (the “Securities Act”), as modified by the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). We shall continue to be deemed an emerging growth company until the earliest of:

For so long as we remain an emerging growth company, we are subject to reduced public company reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404(b) of Sarbanes Oxley and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements. We are also exempt

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from Section 14A (a) and (b) of the Securities Exchange Act of 1934 which require shareholder approval of executive compensation and golden parachutes for so long as we remain an emerging growth company.

We have elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(2) of the JOBS Act, which allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates.

We are also a “smaller reporting company,” meaning that we are not an investment company, an asset-backed issuer, or a majority-owned subsidiary of a parent company that is not a “smaller reporting company,” and have either: (i) a public float of less than $250 million or (ii) annual revenues of less than $100 million during the most recently completed fiscal year and (A) no public float or (B) a public float of less than $700 million. As a “smaller reporting company,” we are subject to reduced disclosure obligations in our SEC filings compared to other issuers, including with respect to disclosure obligations regarding executive compensation in our periodic reports and proxy statements. Until such time as we cease to be a “smaller reporting company,” such reduced disclosure in our SEC filings may make it harder for investors to analyze our operating results and financial prospects.

Climate change related events may have a long-term impact on our business.

While we seek to mitigate our business risks associated with climate change, we recognize that there are inherent climate related risks regardless of where we conduct our businesses. Access to clean water and reliable energy in the communities where we conduct our business is a priority. Any of our locations may be vulnerable to the adverse effects of climate change. Climate related events have the potential to disrupt our business, including the business of our customers, and may cause us to experience higher attrition, losses and additional costs to resume operations.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosure

Not applicable.

Item 5. Other Information

None.

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Item 6 – Exhibits

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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