Quarterly Report (10-q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended December 31, 2019

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-37689

ALJ REGIONAL HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

Delaware		13-4082185
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

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)

Title of class of registered securities

Common Stock, par value $0.01 per share

Ticker Symbol

ALJJ

Name of exchange on which registered

NASDAQ

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.

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐	Smaller Reporting Company	☒
Emerging growth company	☒

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 January 31, 2020 was 42,172,791.

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:

•

any statements regarding our expectations for future performance;

•

our ability to integrate business acquisitions;

•

our ability to compete effectively;

•

statements regarding future revenue and the potential concentration of such revenue coming from a limited number of customers;

•

our ability to meet customer needs;

•

our expectations that interest expense will increase;

•

our expectations that we will continue to have non-cash compensation expenses;

•

our expectation that we will be in compliance with the required covenants pursuant to our loan agreements;

•

regulatory compliance costs;

•

our ability to manage cost cutting activities;

•

our ability to improve margins and profitability on contracts we enter into; and

•

the other matters described in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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.

ALJ REGIONAL HOLDINGS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED DECEMBER 31, 2019

INDEX

		Page

	PART I – FINANCIAL INFORMATION	4

Item 1	Financial Statements	4
	Condensed Consolidated Balance Sheets	4
	Condensed Consolidated Statements of Operations (unaudited)	5
	Condensed Consolidated Statements of Cash Flows (unaudited)	6
	Condensed Consolidated Statements of Equity (unaudited)	7
	Notes to Condensed Consolidated Financial Statements	8

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34

Item 3	Quantitative and Qualitative Disclosures About Market Risk	43

Item 4	Controls and Procedures	43

	PART II – OTHER INFORMATION	44

Item 1	Legal Proceedings	44

Item 1A	Risk Factors	45

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	58

Item 3	Defaults Upon Senior Securities	58

Item 4	Mine Safety Disclosures	58

Item 5	Other Information	58

Item 6	Exhibits	59

	Signatures	60

PART I. FINANCIAL INFORMATION

Item 1 - Financial Statements

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

	December 31,			September 30,
	2019			2019
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	2,554		$	4,529
Accounts receivable, net of allowance for doubtful accounts of $126 at December 31, 2019 and September 30, 2019		50,106			41,707
Inventories, net		6,864			6,777
Prepaid expenses and other current assets		10,356			5,515
Income tax receivable		—			897
Total current assets		69,880			59,425
Property and equipment, net		66,176			69,870
Goodwill		59,047			59,047
Intangible assets, net		39,803			41,148
Collateral deposits		695			695
Other assets		1,281			992
Total assets	$	236,882		$	231,177
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	15,578		$	15,070
Accrued expenses		15,563			16,092
Income taxes payable		619			367
Deferred revenue and customer deposits		5,505			1,965
Current portion of term loans, net of deferred loan costs		9,106			9,119
Current portion of capital lease obligations		2,173			2,535
Current portion of workers’ compensation reserve		1,026			1,043
Other current liabilities		78			72
Total current liabilities		49,648			46,263
Line of credit, net of deferred loan costs		19,662			9,372
Term loans, less current portion, net of deferred loan costs		70,527			73,614
Deferred revenue, less current portion		281			349
Workers’ compensation reserve, less current portion		1,312			1,312
Capital lease obligations, less current portion		2,184			2,623
Deferred tax liabilities, net		1,748			2,795
Other non-current liabilities		11,482			11,733
Total liabilities		156,844			148,061
Commitments and contingencies (Note 9)
Stockholders’ equity:
Common stock, $0.01 par value; authorized – 100,000 shares; 42,173 shares issued and outstanding at December 31, 2019 and September 30, 2019		422			422
Additional paid-in capital		287,779			287,101
Accumulated deficit		(208,163	)		(204,407	)
Total stockholders’ equity		80,038			83,116
Total liabilities and stockholders’ equity	$	236,882		$	231,177

See accompanying notes

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(in thousands, except per share amounts)

	Three Months Ended December 31,
	2019			2018
Net revenue	$	90,465		$	93,784
Costs and expenses:
Cost of revenue		75,726			74,646
Selling, general, and administrative expense		16,610			15,647
Loss (gain) on disposal of assets and other gain, net		2			(223	)
Total operating expenses		92,338			90,070
Operating (loss) income		(1,873	)		3,714
Other (expense) income:
Interest expense, net		(2,564	)		(2,715	)
Interest from legal settlement		200			—
Total other expense, net		(2,364	)		(2,715	)
(Loss) income before income taxes		(4,237	)		999
Provision for income taxes		(40	)		(288	)
Net (loss) income	$	(4,277	)	$	711
Basic (loss) earnings per share of common stock	$	(0.10	)	$	0.02
Diluted (loss) earnings per share of common stock	$	(0.10	)	$	0.02
Weighted average shares of common stock outstanding:
Basic		42,173			38,047
Diluted		42,173			38,097

See accompanying notes

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

	December 31,
	2019			2018
Operating activities
Net (loss) income	$	(4,277	)	$	711
Adjustments to reconcile net (loss) income to cash used for operating activities:
Depreciation and amortization		5,242			4,446
Stock-based compensation expense		112			185
Fair value of warrants issued in connection with debt modification		594			—
Provision for bad debts and obsolete inventory		104			68
Deferred income taxes		(1,047	)		49
Loss (gain) on disposal of assets and other gain, net		2			(223	)
Interest expense accreted to term loan		6			—
Amortization of deferred loan costs		173			238
Changes in operating assets and liabilities:
Accounts receivable, net		(8,096	)		(7,918	)
Inventories, net		(389	)		21
Prepaid expenses, collateral deposits, and other current assets		(4,217	)		(1,221	)
Income tax receivable		897			—
Other assets		(289	)		283
Accounts payable		508			1,230
Accrued expenses		(365	)		1,493
Income tax payable		252			(28	)
Deferred revenue and customer deposits		3,300			(1,054	)
Other current liabilities		(11	)		(109	)
Other liabilities		(251	)		(340	)
Cash used for operating activities		(7,752	)		(2,169	)
Investing activities
Acquisitions, net of cash acquired		—			(1,000	)
Proceeds from sales of assets		1			308
Capital expenditures		(675	)		(4,883	)
Cash used for investing activities		(674	)		(5,575	)
Financing activities
Net proceeds from line of credit		10,490			6,868
Payments on term loans		(3,215	)		(2,743	)
Proceeds from term loan		—			5,000
Deferred loan costs		(264	)		(402	)
Payments on capital leases		(560	)		(811	)
Cash provided by financing activities		6,451			7,912
Change in cash and cash equivalents		(1,975	)		168
Cash and cash equivalents at beginning of period		4,529			2,000
Cash and cash equivalents at end of period	$	2,554		$	2,168
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Taxes	$	517		$	372
Interest	$	2,344		$	2,359
Non-cash investing and financing activities:
Capital equipment purchases financed with capital leases	$	110		$	—
Capital equipment purchases financed with term loan	$	—		$	4,060
Construction in process funded by landlord tenant improvement allowance	$	—		$	3,500
Construction in process not yet paid for	$	—		$	2,700

See accompanying notes

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)

(in thousands)

	Three Months Ended December 31,
	2019			2018
Common stock
Balance, beginning of period	$	422		$	381
Common stock retired		—			(1	)
Balance, end of period	$	422		$	380
Additional paid in capital
Balance, beginning of period	$	287,101		$	279,575
Stock-based compensation expense - options		84			84
Fair value of warrants issued in connection with term loan modification		594			—
Common stock retired		—			(147	)
Balance, end of period	$	287,779		$	279,512
Accumulated deficit
Balance, beginning of period	$	(204,407	)	$	(188,428	)
Net (loss) income		(4,277	)		711
Cumulative impact of adopting ASC 606 on October 1, 2019		521			—
Balance, end of period	$	(208,163	)	$	(187,717	)
Total stockholders' equity	$	80,038		$	92,175

See accompanying notes

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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. As of December 31, 2019, ALJ consisted of the following wholly owned subsidiaries:

•

Faneuil, Inc. (including its subsidiaries, “Faneuil”). Faneuil is a leading provider of call center services, back-office operations, staffing services, and toll collection services to government and regulated commercial clients across the United States, focusing on the healthcare, utility, consumer goods, toll and transportation industries. Faneuil is headquartered in Hampton, Virginia. ALJ acquired Faneuil in October 2013.

•

Floors-N-More, LLC, d/b/a, Carpets N’ More (“Carpets”). Carpets is one of the largest floor covering retailers in Las Vegas, Nevada, and a provider of multiple products for the commercial, retail and home builder markets including all types of flooring, countertops, cabinets, window coverings and garage/closet organizers, with two retail locations, as well as a stone and solid surface fabrication facility. ALJ acquired Carpets in April 2014.

•

Phoenix Color Corp. (including its subsidiaries, “Phoenix”). Phoenix is a leading manufacturer of book components, educational materials and related products producing value-added components, heavily illustrated books and specialty commercial products using a broad spectrum of materials and decorative technologies. Phoenix is headquartered in Hagerstown, Maryland. ALJ acquired Phoenix in August 2015.

ALJ has organized its business and corporate structure along the following business segments: Faneuil, Carpets, and Phoenix.

Basis of Presentation

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, 2019, filed with the SEC on December 23, 2019.

Revision of Previously Reported Financial Information

The Company has historically classified expenses incurred by the Faneuil reportable segment as either cost of revenue or selling, general, and administrative expense based on whether such expenses represented salaries and wages or an expense other than salary and wages. Faneuil is a labor intensive business with labor representing the majority of the cost of revenue. Management determined that certain costs classified as cost of revenue should be classified as selling, general, and administrative expense, while other costs classified as selling, general, and administrative expense should be classified as cost of revenue. Accordingly, the accompanying Condensed Consolidated Statement of Operations for the three months ended December 31, 2018 has been revised to correct the amounts previously reported as cost of revenue and selling, general, and administrative expense as applicable.

In accordance with Accounting Standards Codification ASC 250 (Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin 99, Assessing Materiality), the Company concluded that the reclassifications between cost of revenue and selling, general, and administrative expense were not material to any of its previously issued annual or interim financial statements.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following tables presents the impact of Faneuil’s reclassification on the Condensed Consolidated Statement of Operations for the three months ended December 31, 2018 and the year ended September 30, 2019:

	Three Months Ended December 31, 2018
(in thousands, except per share amounts)	As Previously Reported			Revisions			As Revised
Net revenue	$	93,784		$	—		$	93,784
Costs and expenses:
Cost of revenue		72,827			1,819			74,646
Selling, general, and administrative expense		17,466			(1,819	)		15,647
(Gain) loss on disposal of assets and other gain, net		(223	)		—			(223	)
Total operating expenses		90,070			—			90,070
Operating income		3,714			—			3,714
Other (expense) income:
Interest expense, net		(2,715	)		—			(2,715	)
Total other expense		(2,715	)		—			(2,715	)
Income before income taxes		999						999
Provision for income taxes		(288	)		—			(288	)
Net income	$	711		$	—		$	711
Basic earnings per share of common stock	$	0.02		$	—		$	0.02
Diluted earnings per share of common stock	$	0.02		$	—		$	0.02
Basic		38,047			—			38,047
Diluted		38,097			—			38,097

	Year Ended September 30, 2019
(in thousands, except per share amounts)	As Previously Reported			Revisions			As Revised
Net revenue	$	354,997		$	—		$	354,997
Costs and expenses:
Cost of revenue		277,454			6,422			283,876
Selling, general, and administrative expense		72,375			(6,422	)		65,953
Impairment of intangible assets		746			—			746
(Gain) loss on disposal of assets and other gain, net		(216	)		—			(216	)
Total operating expenses		350,359			—			350,359
Operating income		4,638			—			4,638
Other (expense) income:
Interest expense, net		(10,611	)		—			(10,611	)
Total other expense, net		(10,611	)		—			(10,611	)
Loss before income taxes		(5,973	)		—			(5,973	)
Provision for income taxes		(10,006	)		—			(10,006	)
Net loss	$	(15,979	)	$	—		$	(15,979	)
Loss per share of common stock–basic and diluted	$	(0.41	)	$	—		$	(0.41	)
Weighted-average shares of common stock outstanding– basic and diluted		38,710			—			38,710

The correction of these previously reported amounts had no impact on the Company’s consolidated income (loss) before income taxes, net income (loss), financial position, or cash flows. In addition, corresponding revisions had no impact to Reportable Segments or Geographic disclosures.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

2. RECENT ACCOUNTING STANDARDS

Accounting Standards Adopted

Stock Compensation

In June 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-07, Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This amendment expands the scope of the FASB’s ASC Topic 718, Compensation—Stock Compensation (which currently includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 was effective for ALJ on October 1, 2019. The adoption of ASU 2018-07 did not significantly impact ALJ’s consolidated financial statements.

Revenue from Contracts with Customers

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, with several clarifying updates issued during 2016 and 2017, referred to collectively hereafter as “ASC 606.” This new standard supersedes all current revenue recognition standards and guidance. Revenue recognition will occur when promised goods or services are transferred to customers in amounts that reflect the consideration to which the Company expects to be entitled to in exchange for those goods or services.

On October 1, 2019 ALJ adopted ASC 606 using the modified retrospective transition method. The Company applied the new revenue standard to contracts not completed as of the date of initial application. As part of the adoption of ASC 606, the Company assessed all aspects of ASC 606 and the potential impact on each entity. The adoption impacted each entity as follows:

Faneuil. The performance obligations in contracts vary depending on the nature of the contract. Contracts generally include the provision of call center services and in certain contracts the provision of various implementation services.

The costs incurred as part of implementation relate to either a partially satisfied performance obligation, fulfillment costs, or administrative costs. Under current guidance, Faneuil capitalizes these costs and amortizes them over the stated contractual term on a straight-line basis. Under ASC 606, the only costs that are capitalizable are fulfillment costs.

Certain contracts require that a customer make nonrefundable payments to Faneuil prior to the commencement of call center services. The timing of fixed payments may be based on the achievement of specified implementation milestones. Additionally, customers may be required to make certain nonrefundable variable payments (e.g., training of personnel) prior to the commencement of operations.

Under ASC 606, when upfront fees do not relate directly to the satisfaction or partial satisfaction of a performance obligation, the payments are deemed to be advance payments for future services. In such, instances, the fees are allocated to performance obligations and recognized when or as the performance obligations are satisfied over the contract term. As a result of termination provisions, the contract term under ASC 606 may be shorter than the contractually stated contract term, resulting in the upfront nonrefundable fees being fully recognized prior to the expiration of the stated term of the contract.

Under previous guidance, depending on the nature of the upfront fees, the fees may be recognized as implementation services are provided or, in cases where implementation services are not provided, deferred and amortized over the stated contractual term on a straight-line basis.

Faneuil concluded that, in most cases, pass through and reimbursed costs are accounted for on a gross basis as Faneuil incurs these costs as part of performing the call center services. Additionally, in certain arrangements, Faneuil utilizes third-party service providers in performing the obligations in the contract. Faneuil has concluded that it acts as the principal for all arrangements in which a third-party is utilized as part of the implementation or operation of a call center. This accounting is consistent with the accounting under previous guidance.

Upon adoption of ASC 606, Faneuil eliminated deferred costs incurred during the implementation phase relating to partially satisfied performance obligations and reduced deferred revenue as a result of contracts with termination provisions that accelerated the period over which deferred revenue was recognized.

Carpets. Under ASC 606 revenue is recognized over time using the input method for the majority of its contracts. This pattern of revenue recognition under ASC 606 does not differ materially from the method of recognizing revenue under previous guidance.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Although Carpets determined that the timing and amount of total revenue recognized over the life of a construction project is not materially impacted, the revenue recognized on a quarterly basis during the construction period may change. Carpets determined that ASC 606 is more impactful to certain of its lump sum projects as a result of the following required changes from its current practices:

•

Performance obligations. ASC 606 requires a review of contracts to determine whether there are multiple performance obligations. Each separate performance obligation must be accounted separately, which can impact the timing of revenue recognition. In connection with its evaluation, Carpets identified certain contracts that had more than one performance obligation, which can impact the revenue recognition pattern and methodology for that contract.

•

Variable consideration. In accordance with ASC 606, variable consideration, including potential liquidated damages, adjusts the transaction price of a contract. Under previous revenue recognition guidance, Carpets generally assessed the impact of liquidated damages as an estimated cost of the project. In connection with its evaluation, Carpets did not identify any uncompleted contract in which consideration of liquidated damages under ASC 606 affected the amount of revenue to be recorded relating to liquidated damages.

Upon adoption of ASC 606, Carpets adjusted the following:

•

Revenue associated with open contracts to the amount determined by applying the input method of recognizing revenue to the transaction price for each separate performance obligation within a contract; and

•

Estimated losses when estimated contract costs exceeded the transaction price.

Phoenix. Based on analysis of specific terms associated with customer contracts uncompleted at the date of adoption, Phoenix concluded that revenue is recognized at a point in time for substantially all products. This treatment is consistent with how revenue was recognized under the previous guidance, which was when the products were completed and shipped to the customer (dependent upon specific shipping terms). Contracts requiring revenue to be recognized over time, as opposed to a point in time, are expected to be immaterial due to the de minimis nature of any particular order under such contracts in production at any given point in time.

Phoenix determined that ASC 606 impacts the timing of revenue recognition under the following circumstances:

•

Completed production held in inventory. With certain customer contracts, Phoenix is required to complete a pre-defined quantity of customized products and hold these products in inventory until the customer requests shipment (which generally is required to be delivered in the same year as production). For these items, Phoenix has the contractual right to receive payment once production of the products is complete, regardless of the ultimate delivery date. Under previous guidance, Phoenix held the customized products in inventory and recognized revenue upon shipment to the customer. Following the guidance of ASC 606, in these circumstances, Phoenix recognizes revenue when production of the customized products is complete.

•

Safety stock. In limited situations, Phoenix is required to produce and hold in inventory a pre-defined quantity of customized products for a customer as safety stock. Similar to completed production held in inventory, Phoenix has the contractual right to receive payment from the customer for the pre-defined quantity of safety stock once production is complete, regardless of the ultimate delivery date. Under previous guidance, Phoenix held the safety stock in inventory and recognized revenue upon shipment to the customer. Following the guidance of ASC 606, in these circumstances, Phoenix recognizes revenue when production of the safety stock is complete.

Lastly, the contracts that Phoenix has with its customers often include prospective and retrospective volume rebates, credits, discounts, and other similar items that generally decrease the amount a customer pays Phoenix. These variable amounts generally are credited to the customer, based on achieving certain levels of sales activity, when contracts are signed, or making payments within payment specific terms. Under ASC 606, with the exception of prospective volume rebates, these adjustments are classified as variable consideration, which is estimated at contract inception, and included as part of the transaction price, subject to constraints. Under ASC 606, prospective volume rebates are not part of the transaction price, but are instead accounted for as a material right and separate performance obligation.

Upon adoption of ASC 606, Phoenix recognized revenue associated with certain completed inventory and safety stock held in inventory as discussed above, adjusted revenue for prospective volume rebates treated as material rights and adjusted the timing of revenue recognition relating to variable consideration.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Based upon the balances that existed as of September 30, 2019, the Company recorded adjustments to the following accounts as of October 1, 2019:

				Adjustments for the Adoption of ASC 606
(in thousands)	As Reported September 30, 2019			Faneuil		Carpets			Phoenix			Total Adjustment			Adjusted October 1, 2019
Assets
Prepaid expenses and other current assets	$	5,515		$	777	$	(61	)	$	161		$	877		$	6,392
Inventories, net		6,777			—		19			(217	)		(198	)		6,579
Liabilities
Accrued expenses		16,092			—		(12	)		(2	)		(14	)		16,078
Deferred revenue and customer deposits		1,965			172		—			—			172			2,137
Stockholders’ equity
Accumulated deficit		(204,407	)		605		(30	)		(54	)		521			(203,886	)

As a result of the above adjustments, total assets increased by $0.7 million, total liabilities increased by $0.2 million, and total stockholders’ equity increased by $0.5 million.

The following table summarize the impacts of adopting the new revenue accounting guidance on ALJ’s Consolidated Balance Sheet as of December 31, 2019:

	As of December 31, 2019
				Adjustments for the Adoption of ASC 606
(in thousands)	As Reported			Faneuil			Carpets			Phoenix			Total Adjustment			As if Previous Standard was in Effect
Assets
Prepaid expenses and other current assets	$	10,356		$	(1,207	)	$	(8	)	$	(669	)	$	(1,884	)	$	8,472
Inventories, net		6,864			—			6			528			534			7,398
Liabilities
Accrued expenses		15,563			(10	)		7			2			(1	)		15,562
Deferred revenue and customer deposits		5,505			(541	)		—			—			(541	)		4,964
Stockholders’ equity
Accumulated deficit		(208,163	)		(656	)		(9	)		(143	)		(808	)		(208,971	)

The difference between the reported balances and the amounts that would have been recorded had the previous guidance been in effect is primarily due to the following:

•

Inventory in the amounts that would have been recorded had the previous guidance been in effect associated with completed production held in inventory and safety stock.

•

Receivables and other assets in the amounts that would have been recorded had the previous guidance been in effect include receivables for a contract based on milestone billings and therefore do not include unbilled receivables relating over time recognition in accordance with ASC 606.

•

Deferred revenue in the amounts that would have been recorded had the previous guidance been in effect do not include certain upfront variable payments relating to training.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following table summarize the impacts of adopting the new revenue accounting guidance on ALJ’s Statement of Operation for the three months ended December 31, 2019:

	Three Months Ended December 31, 2019
				Adjustments for the Adoption of ASC 606
(in thousands, except per share amounts)	As Reported			Faneuil			Carpets		Phoenix			Total Adjustment			As if Previous Standard was in Effect
Net revenue	$	90,465		$	(354	)	$	53	$	(834	)	$	(1,135	)	$	89,330
Cost of revenue		75,726			907			32		(745	)		194			75,920
Net loss		(4,277	)		(1,261	)		21		(89	)		(1,329	)		(5,606	)
Loss per share of common stock–basic and diluted		(0.10	)		(0.03	)		0.00		(0.00	)		(0.03	)		(0.13	)

The differences between the reported balances and the amounts that would have been recorded had the previous guidance been in effect are due to the following impacts:

•

Reduction in the revenue and cost of revenue in the amounts that would have been recorded had the previous guidance been in effect associated with completed production held in inventory.

•

Reduction in revenue and cost of revenue in the amounts that would have been recorded had the previous guidance been in effect to recognize revenue for a contract under the milestone billings in accordance with ASC 605.

•

Increase in revenue and cost of revenue in the amounts that would have been recorded had the previous guidance been in effect to recognize revenue and related expenses relating to certain upfront variable payments as incurred.

The consolidated statement of cash flows for the three months ended December 31, 2019 takes into consideration the effect of adopting ASC 606. Adoption of the new accounting guidance had no impact to net cash provided by (used for) operating, financing or investing activities on our condensed consolidated statement of cash flows for the three months ended December 31, 2019.

Accounting Standards Not Yet Adopted

Leases

In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 requires lessees to recognize a right-of-use asset and corresponding lease liability for all leases with terms of more than 12 months. Recognition, measurement, and presentation of expenses will depend on classification as either a finance or operating lease. ASU 2016-02 also requires certain quantitative and qualitative disclosures. The provisions of ASU 2016-02 should be applied on a modified retrospective basis. ASU 2016-02 will be effective for ALJ on October 1, 2020. The adoption of ASU 2016-02 will result in a material increase to the Company’s consolidated balance sheets for lease liabilities and right-of-use assets. The Company is currently evaluating the other effects the adoption of ASU 2016-02 will have on its consolidated financial statements and related disclosures.

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.

3. REVENUE RECOGNITION

Accounting Policy Update

As a result of adopting ASC 606, ALJ updated its revenue recognition accounting policy effective October 1, 2019. The Company recognized revenue when control of the promised goods or services is transferred to its customers in an amount that reflects the consideration that the Company expects to receive in exchange for those goods or services.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Faneuil. Faneuil contracts with its customers are typically in the form of a written contract executed between the Faneuil its customers that may include a Statement of Work, Request for Proposal, Responses to the Request for Proposal, and other correspondence. The contracts often provide the customer with renewal and/or termination options that impact the contract term under ASC 606.

Faneuil contracts often include promises to transfer multiple products and services to its customers. Determining whether products and services are considered distinct performance obligations that should be accounted for separately, versus together, requires significant judgment. Typically, Faneuil contracts include performance obligation(s) to stand-ready on a daily or monthly basis to provide services to its customers. Under a stand-ready obligation, the evaluation of the nature of the performance obligation is focused on each time increment rather than the underlying activities. Accordingly, the promise to stand-ready is accounted for as a single-series performance obligation.

Faneuil provides implementation activities prior to commencing services under the stand-ready obligation. The determination of whether the implementation activities are classified as fulfillment activities or promised goods and services and the determination of whether the implementation promised goods and services are distinct performance requirements requires significant judgment.

Once Faneuil determines the performance obligations, Faneuil estimates the amount of variable consideration to be included in determining the transaction price. Typical forms of variable consideration include variable pricing based on the number of transactions processed or usage-based pricing arrangements. Variable consideration is also present in the form of tiered and declining pricing, penalties for service level agreements, performance bonuses, and credits. In circumstances where Faneuil meets certain requirements to allocate variable consideration to a distinct service within a series of related services, Faneuil allocates variable consideration to each distinct period of service within the series. If Faneuil does not meet those requirements, Faneuil includes an estimate of variable consideration in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty is resolved. For contracts with multiple performance obligations, the transaction price is allocated to the separate performance obligations on a relative stand-alone selling price basis. Faneuil generally determines stand-alone selling prices based on the prices charged to customers or by using expected cost plus a margin.

Faneuil typically satisfies its performance obligations over time as the services are provided. A time-elapsed output method is used to measure progress because the nature of Faneuil’s promise is a stand-ready service and efforts are expended evenly throughout the period. Faneuil uses a cost-to-cost based input method to measure progress on its implementation services. Faneuil has determined that the above methods provide a faithful depiction of the transfer of services to the customer.

Revenue expected to be recognized in future periods exclude unexercised customer options to purchase additional services that do not represent material rights to the customer. Customer options that do not represent a material right are only accounted for when the customer exercises its option to purchase additional goods or services.

When more than one party is involved in providing services to a customer, Faneuil evaluates whether it is the principal, and reports revenue on a gross basis, or as an agent, and reports revenue on a net basis. In this assessment, Faneuil considers the following: if it obtains control of the specified services before they are transferred to the customer; if it is primarily responsible for fulfillment; and whether it has discretion in establishing price. Based on its evaluation, in most circumstances, Faneuil determined that it acts as the principal.

Faneuil's payment terms vary by type of services offered. Generally, the time between provision of services during the operational phase, invoicing, and when payment is due is not significant. However, Faneuil sometimes receives advances or deposits from its customers before revenue is recognized, resulting in deferred revenue, which is recorded as a contract liability. The timing of when Faneuil bills its customers during the implementation phase is generally dependent upon agreed-upon contractual terms, milestone billings based on the completion of certain phases of the work, or when services are provided. Sometimes, billing occurs subsequent to revenue recognition, resulting in unbilled revenue, which is recorded as a contract asset.

From time to time, Faneuil contracts are modified to account for additions or changes to existing performance obligations. Each modification is evaluated under the guidance of ASC 606 and accounted for based on the specific modifications. When a contract modification relates to a stand-ready performance obligation, the impact of the modification is generally accounted for prospectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Carpets. The majority of Carpets revenue is from the installation of flooring, cabinets, and countertops for new homes. The contracts for these products are with homebuilders in the form of a purchase order issued in connection with a Master Service Agreement (“MSA”) and Work Agreement. Carpets also enters into contracts with retail customers to install these same products in the form of a purchase order. The majority of the work performed under each purchase order is completed in less than two-weeks. Carpets also enters into construction contracts with its commercial customers. The work performed under a construction contract ranges from a couple of weeks up to a year. Carpets contracts are fixed-price contracts.

Carpets evaluates whether two or more contracts should be combined and accounted for as one single performance obligation and whether a single contract should be accounted for as more than one performance obligation. The majority of Carpets contracts have a single performance obligation, as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contract and, therefore, is not distinct. However, occasionally Carpets may have contracts with multiple performance obligations.

For contracts with multiple performance obligations, Carpets allocates the contracts transaction price to each performance obligation using the observable stand-alone selling price, if available, or alternatively Carpets best estimate of the stand-alone selling price of each distinct performance obligation in the contract. The primary method used to estimate stand-alone selling price is the expected cost plus a margin approach for each performance obligation.

The nature of Carpets contracts give rise to several types of variable consideration, including contract modifications (change orders and claims), liquidated damages, and other terms that can either increase or decrease the transaction price. Carpets estimates variable consideration as the most likely amount to which Carpets expects to be entitled. Carpets includes estimated amounts in the transaction price to the extent Carpets believes it has an enforceable right and it is probable that a significant reversal of cumulative revenue recognized will not occur. Carpets estimates variable consideration and the determination of whether to include estimated amounts in the transaction price are based largely on an assessment of its anticipated performance and all information (historical, current and forecasted) that is reasonably available at this time.

The contract transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. This evaluation may require significant judgment and the decision to combine a group of contracts or separate a contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period.

Revenue is recognized over time as work is completed because of the continuous transfer of control to the customer (typically using an input measure such as costs incurred to date relative to total estimated costs at completion to measure progress). Carpets uses a cost-to-cost based input method using labor costs to measure progress on its services. Carpets has determined that using labor costs to measure its progress is the method that most faithfully depicts its performance in transferring control of the performance obligation (installed products) to the builder.

As a significant change in one or more of these estimates could affect the profitability of Carpets contracts, Carpets reviews and updates its contract-related estimates regularly. Carpets recognizes adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the cumulative impact of the profit adjustment is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance are recognized using the adjusted estimate. Such adjustments have not been material due to the shorter term of the majority of Carpets contracts. If at any time the estimate of contract profitability indicates an anticipated loss on a contract, the projected loss is recognized in full, including any previously recognized profit, in the period it is identified and recognized as an accrued contract losses (contract liability). For contract revenue recognized over time, the accrued contract losses is adjusted so that the gross profit for the contract remains zero in future periods.

Contract modifications result from changes in contract specifications or requirements. Carpets considers unapproved change orders to be contract modifications for which customers have not agreed to both scope and price. Carpets considers claims to be contract modifications for which Carpets seeks, or will seek, to collect from customers, or others, for customer-caused changes in contract specifications or design, or other customer-related causes of unanticipated additional contract costs on which there is no agreement with customers. Claims can also be caused by non-customer-caused changes, such as rain or other weather delays. Costs associated with contract modifications are included in the estimated costs to complete the contracts and are treated as project costs when incurred. In most instances, contract modifications are for goods or services that are not distinct, and, therefore, are accounted for as part of the existing contract. The effect of a contract modification on the transaction price, and Carpets’ measure of progress for the performance obligation to which it relates, is recognized as an adjustment to revenue on a cumulative catch-up basis. In some cases, settlement of contract modifications may not occur until after completion of work under the contract.

The timing of when Carpets bills its customers is generally dependent upon agreed-upon contractual terms, milestone billings based on the completion of certain phases of the work, or when services are provided. Sometimes, billing occurs subsequent to revenue

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

recognition, resulting in unbilled revenue, which is a contract asset. However, Carpets sometimes receive advances or deposits from its customers before revenue is recognized, resulting in deferred revenue, which is a contract liability.

Carpets estimates the collectability of contract amounts at the same time that Carpets estimates project costs. If Carpets anticipates that there may be issues associated with the collectability of the full amount calculated as the transaction price, Carpets may reduce the amount recognized as revenue to reflect the uncertainty associated with realization of the eventual cash collection.

Carpets provides a warranty relating to the products installed and the installation of the products. Since the warranty covers instances when products installed are defective and/or are not installed properly, the warranty is classified as an assurance warranty. Carpets accrues for expected warranty work as revenue is recognized.

Phoenix. Phoenix contracts with its customers are typically in the form of a purchase order issued to the Company by its customers and, in the form of a purchase order issued in connection with a formal MSA executed with a customer.

The majority of Phoenix revenue is derived from purchases under which Phoenix provides a specific product or service and, as a result, each product or service is one performance obligation. Additionally, Phoenix concluded that prospective volume rebates provided to certain customers are material rights, which is a separate performance obligation.

Revenue is measured as the amount of consideration Phoenix expects to receive in exchange for transferring goods or providing services, which is based on transaction prices set forth in contracts with customers and an estimate of variable consideration, as applicable.

Variable consideration resulting from volume rebates, fixed rebates, and sales discounts that are offered within contracts between Phoenix and its customers is recognized in the period the related revenue is recognized. Estimates of variable consideration are based on stated contract terms and an analysis of historical experience. The amount of variable consideration is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period.

The contract transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. For contracts with multiple performance obligations, such as when a contract contains a material right, the transaction price allocated to each performance obligation is based on the price stated in the customer contract, which represents Phoenix’s best estimate of the stand-alone selling price of each distinct good or service in the contract and the expected value of a prospective volume rebate.

Phoenix recognizes revenue at a point in time for substantially all products. The point in time when revenue is recognized is when the performance obligation has been completed and the customer obtains control of the products, which is generally upon shipment to the customer (dependent upon specific shipping terms).

Under agreements with certain customers, custom products may be stored by the Company for future delivery. Based upon contractual terms, Phoenix is typically able to recognize revenue once the performance obligation is satisfied and the customer obtains control of the completed product, usually when it completes production (depending on the specific facts and circumstances). In these situations, Phoenix may also receive a logistics or warehouse management fee for the services it provides, which Phoenix recognizes over time as the services are provided.

•

With certain customer contracts, Phoenix is permitted to complete a pre-defined quantity of custom products and holds such inventory until the customer requests shipment (which generally is required to be delivered in the same year as production). For these items, Phoenix has the contractual right to receive payment once the production is completed, regardless of the ultimate delivery date. Based upon contractual terms, Phoenix recognizes revenue once the performance obligation has been satisfied and the customer obtains control of the completed products, usually when production is completed.

•

In limited situations, Phoenix is permitted to produce and hold in inventory a pre-defined quantity of custom products as safety stock. Similar to completed production held in inventory, for these items, Phoenix has the contractual right to receive payment for the pre-defined quantity once the production is completed, regardless of the ultimate delivery date. Based upon Phoenix’s evaluation of the contractual terms, Phoenix recognizes revenue once the performance obligation has been satisfied and the customer obtains control of the completed product, usually when production is completed.

Billings for shipping and handling costs are recorded in revenue on a gross basis. Phoenix made an accounting policy election under ASC 606 to account for shipping and handling after the customer obtains control of the good as fulfillment activities rather than as a

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

separate service to the customer. As a result, when Phoenix is responsible for shipment, Phoenix accrues the costs of the shipping and handling if revenue is recognized for the related good before the fulfillment activities occur.

Many of Phoenix’s operations process materials, primarily paper, that may be supplied directly by customers or may be purchased by Phoenix and sold to customers as part of the end product. No revenue is recognized for customer-supplied paper, but revenue for Phoenix-supplied paper is recognized on a gross basis.

In limited circumstances, Phoenix collects taxes from its customers. When taxes are collected, Phoenix records the taxes collected from customers and remitted to governmental authorities on a net basis.

Contracts do not contain a significant financing component as payment terms on invoiced amounts are typically between 30 to 120 days, based on a credit assessment of individual customers, as well as industry expectations.

The timing of revenue recognition, billings, and cash collections results in accounts receivable and unbilled receivables (contract assets), and customer advances and deposits (contract liabilities) on the Consolidated Balance Sheet. Revenue recognition generally coincides with Phoenix’s contractual right to consideration and the issuance of invoices to customers. Depending on the nature of the performance obligation and arrangements with customers, the timing of the issuance of invoices may result in contract assets or contract liabilities. Contract assets related to unbilled receivables are recognized for satisfied performance obligations for which Phoenix cannot yet issue an invoice. Contract liabilities result from advances or deposits from customers on performance obligations not yet satisfied.

Phoenix provides a warranty that the products conform to the customer specifications and are free of defects. The warranty is classified as an assurance warranty. Phoenix generally obtains customer approval prior to commencing production to minimize warranty issues. As a result, warranty claims are generally not significant. However, Phoenix accrues for the estimated warranty work when revenue is recognized, if material.

Because the majority of Phoenix products are customized, product returns are not significant. However, Phoenix accrues for the estimated amount of customer returns at the time of sale, if deemed material.

Contract Assets and Liabilities

The following table provides information about consolidated contract assets and contract liabilities at December 31, 2019 and October 1, 2019:

(in thousands)	December 31, 2019		October 1, 2019
Contract assets:
Unbilled revenue ⁽¹⁾	$	2,255	$	825
Total contract assets	$	2,255	$	825
Contract liabilities
Deferred revenue	$	5,238	$	1,838
Accrued rebates and material rights ⁽²⁾		3,281		2,612
Accrued contract losses ⁽³⁾		12		15
Total contract liabilities	$	8,531	$	4,465

⁽¹⁾

Included in prepaid expenses and other current assets on the Consolidated Balance Sheet. Unbilled revenue represent rights to consideration for services provided when the right is conditioned on something other than passage of time (for example, meeting a milestone for the right to bill under the cost-to-cost measure of progress). Unbilled revenue is transferred to accounts receivable when the rights become unconditional.

⁽²⁾	Of the total balance, $0.4 million is included in other non-current liabilities and $2.9 million is included in accrued expenses on the Consolidated Balance Sheet.

⁽³⁾	Included in accrued expenses on the Consolidated Balance Sheet.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following table provides changes in consolidated contract assets and contract liabilities during the three months ended December 31, 2019:

(in thousands)	Contract Assets		Contract Liabilities
Balance, beginning of period (October 1, 2019)	$	825	$	4,465
Additions to unbilled revenue, net		1,430		—
Revenue recognized		—		(1,956	)
Change in loss accrual		—		(3	)
Accrued rebates		—		669
Cash received from customer		—		5,356
Balance, end of period	$	2,255	$	8,531

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.

Estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially satisfied at December 31, 2019, was de minimis. This balance does not include revenue related to performance obligations that are part of a contract whose original expected duration is one year or less, including contracts with a penalty-free termination for convenience clause. In addition, this disclosure does not include (i) expected consideration related to performance obligations for which the Company elects to recognize revenue in the amount it has a right to invoice (e.g., usage-based pricing terms), and (ii) any variable consideration which is allocated entirely to future performance obligations including variable transaction fees or fees tied directly to costs incurred.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Disaggregation of Revenue

Revenue by contract type was as follows for the three months ended December 31, 2019:

(in thousands)	Three Months Ended December 31, 2019
Faneuil:
Transportation	$	17,128
Utility		13,927
Healthcare		25,367
Government		1,049
Other		1,096
Total Faneuil	$	58,567
Carpets
Builder	$	6,959
Commercial		1,628
Retail		1,187
Total Carpets	$	9,774
Phoenix:
Publisher
MSA	$	12,430
Non-MSA		6,560
Commercial
MSA		805
Non-MSA		2,329
Total Phoenix	$	22,124
Total consolidated revenue, net	$	90,465

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

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 three months ended December 31, 2019, the Company recognized $0.1 million of amortization of these costs, which is included in selling, general, and administrative expense in our Consolidated Statement of Operations. The net book value of these costs was $0.6 million as of December 31, 2019, of which $0.3 million was in prepaid expenses and other current assets, and $0.3 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The amortization of costs incurred to fulfill contracts, which comprise set-up/transition activities, for the three months ended December 31, 2019 was approximately $1.5 million. The net book value of the costs as of December 31, 2019, was $2.1 million as of December 31, 2019, of which $1.7 million was in prepaid expenses and other current assets, and $0.4 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 three months ended December 31, 2019.

4. ACQUISITIONS

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 other things, (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.

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

	Purchase Price
Balance Sheet Caption	Allocation
Total current assets	$	53
Fixed assets		11
Identified intangible assets:
Technology		3,400
Non-compete agreements		1,300
Goodwill		2,675
Total assets		7,439
Accrued expenses		(39	)
Fair value of deferred and contingent consideration – current ⁽¹⁾		(2,100	)
Fair value of deferred and contingent consideration – non-current ⁽²⁾		(2,800	)
Cash paid at closing	$	2,500

⁽¹⁾	Included in accrued expenses on the Consolidated Balance Sheet at December 31, 2019. There was no change in the fair value from the RDI Purchase Date to December 31, 2019.

⁽²⁾	Included in other non-current liabilities on the Consolidated Balance Sheet at December 31, 2019. There was no change in the fair value from the RDI Purchase Date to December 31, 2019.

The Company accounted for the RDI Acquisition using the purchase method of accounting. Accordingly, the assets and liabilities were recorded at their fair values at the RDI Purchase Date. The excess of the purchase price over the fair value of the tangible and intangible assets acquired, liabilities assumed, and deferred and contingent consideration, was recorded as goodwill.

During the three months ended December 31, 2019, 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.

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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Major Customers and Accounts Receivable

During the three months ended December 31, 2019, ALJ generated 10.2% of consolidated net revenue from one customer. During the three months ended December 31, 2018, ALJ did not have any customers with net revenue 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:

	Three Months Ended December 31,
	2019			2018
Customer A		15.7	%		16.2	%
Customer B		11.6			13.0

Accounts receivables from these customers totaled $8.2 million on December 31, 2019. As of December 31, 2019, 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.

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

	Three Months Ended December 31,
	2019			2018
Customer A		26.8	%		29.3	%
Customer B		23.6			27.4
Customer C		16.0			19.4

Accounts receivables from these customers totaled $1.5 million on December 31, 2019. As of December 31, 2019, all Carpets 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:

	Three Months Ended December 31,
	2019			2018
Customer A		24.9	%		19.0	%
Customer B		16.6			17.8
Customer C		12.1			12.3
Customer D	**				12.2

**	Less than 10% of Phoenix net revenue.

Accounts receivables from these customers totaled $6.1 million on December 31, 2019. As of December 31, 2019, 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

Two of ALJ’s segments had suppliers that represented more than 10% of their respective inventory purchases, as described below.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Carpets. The percentage of Carpets inventory purchases from its significant suppliers was as follows:

	Three Months Ended December 31,
	2019			2018
Supplier A		19.7	%		13.8	%
Supplier B		17.0		24.3
Supplier C	**			11.4
Supplier D	**			10.7

**	Less than 10% of Carpets inventory purchases.

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

Phoenix. The percentage of Phoenix inventory purchases from its significant suppliers was as follows:

	Three Months Ended December 31,
	2019			2018
Supplier A ⁽¹⁾		17.5	%	**
Supplier B ⁽²⁾	16.5				26.2	%
Supplier C	10.9			10.9

** Less than 10% of Phoenix inventory purchases.

⁽¹⁾Represents 11.6% of consolidated inventory purchases for the three months ended December 31, 2019.

⁽²⁾ Represents 11.0% and 17.5% of consolidated inventory purchases for the three months ended December 31, 2019 and 2018, respectively.

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:

	December 31,			September 30,
(in thousands)	2019			2019
Accounts receivable	$	49,711		$	41,251
Unbilled receivables		521			582
Accounts receivable		50,232			41,833
Less: allowance for doubtful accounts		(126	)		(126	)
Accounts receivable, net	$	50,106		$	41,707

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Inventories, Net

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

	December 31,			September 30,
(in thousands)	2019			2019
Raw materials	$	3,956		$	3,837
Semi-finished goods/work in process		1,641			2,111
Finished goods		1,771			1,230
Inventories		7,368			7,178
Less: allowance for obsolete inventory		(504	)		(401	)
Inventories, net	$	6,864		$	6,777

Property and Equipment

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

	December 31,			September 30,
(in thousands)	2019			2019
Leasehold improvements	$	31,478		$	31,370
Machinery and equipment		30,915			30,805
Building and improvements		17,403			17,403
Software		15,094			16,139
Computer and office equipment		13,629			13,273
Land		9,267			9,267
Furniture and fixtures		7,822			7,796
Vehicles		386			386
Construction and equipment in process		128			206
Property and equipment		126,122			126,645
Less: accumulated depreciation and amortization		(59,946	)		(56,775	)
Property and equipment, net	$	66,176		$	69,870

Property and equipment depreciation and amortization expense, including amounts related to capitalized leased assets, was $3.9 million and $3.1 million for the three months ended December 31, 2019 and 2018, respectively.

Intangible Assets

The following table summarizes identified intangible assets at the end of each reporting period:

	December 31, 2019							September 30, 2019
(in thousands)	Gross		Accumulated Amortization			Net		Gross		Accumulated Amortization			Net
Customer relationships	$	33,660	$	(13,761	)	$	19,899	$	33,660	$	(13,039	)	$	20,621
Trade names		10,760		(2,111	)		8,649		10,760		(2,004	)		8,756
Supply agreements		9,930		(3,330	)		6,600		9,930		(3,002	)		6,928
Technology		3,400		(177	)		3,223		3,400		(71	)		3,329
Non-compete agreements		1,820		(388	)		1,432		1,820		(311	)		1,509
Internal-use software		580		(580	)		—		580		(575	)		5
Totals	$	60,150	$	(20,347	)	$	39,803	$	60,150	$	(19,002	)	$	41,148

Intangible asset amortization expense was $1.3 million for both the three months ended December 31, 2019 and 2018.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following table presents expected future amortization expense for the remainder of fiscal 2020 and yearly thereafter:

(in thousands)	Estimated Future Amortization
Remainder of Fiscal 2020	$	3,916
Fiscal 2021		4,982
Fiscal 2022		4,635
Fiscal 2023		4,635
Fiscal 2024		4,496
Thereafter		17,139
Total	$	39,803

Accrued Expenses

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

	December 31,		September 30,
(in thousands)	2019		2019
Accrued compensation and related taxes	$	6,479	$	8,041
Rebates payable		2,840		2,157
Acquisition contingent consideration		2,100		2,100
Deferred lease incentives		1,159		1,159
Medical and benefit-related payables		959		964
Interest payable		764		723
Other		760		342
Accrued board of director fees		218		109
Deferred rent		100		112
Call center buildouts		96		274
Sales tax payable		88		111
Total accrued expenses	$	15,563	$	16,092

Workers’ Compensation Reserve

The Company is self-insured for certain workers’ compensation claims as discussed below.

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.

Carpets. Carpets maintains a self-insured plan for workers’ compensation claims up to $200,000 per incident and maintains insurance coverage for costs above the specified limit. 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.

7. (LOSS) EARNINGS PER SHARE

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

	Three Months Ended December 31,
(in thousands, except per share amounts)	2019			2018
Net (loss) income	$	(4,277	)	$	711
Weighted average shares of common stock outstanding – basic		42,173			38,047
Potentially dilutive effect of options to purchase common stock		—			50
Weighted average shares of common stock outstanding – diluted		42,173			38,097
Basic (loss) earnings per share of common stock	$	(0.10	)	$	0.02
Diluted (loss) earnings per share of common stock	$	(0.10	)	$	0.02

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

ALJ computed basic (loss) earnings per share of common stock using net (loss) income 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) income 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.

Stock options and warrants to purchase 4.2 million and 1.5 million shares of common stock were not considered in calculating ALJ’s diluted loss per common share for the three months ended December 31, 2019 and 2018, respectively, as their effect would be anti-dilutive.

8. DEBT

Debt

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

	December 31,			September 30,
(in thousands)	2019			2019
Line of credit:
Line of credit	$	20,313		$	9,823
Less: deferred loan costs		(651	)		(451	)
Line of credit, net of deferred loan costs	$	19,662		$	9,372
Current portion of term loans:
Current portion of term loan	$	8,200		$	8,200
Current portion of equipment financing		1,311			1,336
Less: deferred loan costs		(405	)		(417	)
Current portion of term loans, net of deferred loan costs	$	9,106		$	9,119
Term loans, less current portion:
Term loan, less current portion	$	65,836		$	72,882
Term B loan and related payment in kind interest		4,106		$	—
Equipment financing, less current portion		1,521			1,765
Less: deferred loan costs		(936	)		(1,033	)
Term loans, less current portion, net of deferred loan costs	$	70,527		$	73,614

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, the “Cerberus Debt”). ALJ has subsequently entered into six amendments to the Financing Agreement. The most recent amendment is described below. The Cerberus Debt matures on November 28, 2023 (“Maturity Date”).

Sixth Amendment to Financing Agreement

On December 17, 2019, ALJ entered into the Sixth Amendment (“Sixth Amendment”) to the Financing Agreement. The Sixth Amendment amends certain terms and covenants in order to support the continued growth of the Company, as summarized below:

•

a conversion of $4.1 million in aggregate principal amount from the Cerberus Term Loan to a new term loan (referred to hereafter as “Term B” loan) as discussed in more detail below;

•

an adjustment to the leverage ratio threshold to (i) 5.25:1.00 for the fiscal quarter ending December 31, 2019, (ii) 4.50:1.00 for the fiscal quarter ending March 31, 2020, (iii) 3.75:1.00 for the fiscal quarter ending June 30, 2020, (iv) 3.50:1:00 for each fiscal quarter beginning with the fiscal quarter ending September 30, 2020 through the fiscal quarter ending December 31, 2020, and (v) 3.25:1:00 for each fiscal quarter beginning with the fiscal quarter ending March 31, 2021 through the fiscal quarter ending June 30, 2021, (vi) 3.00:1.00 for the fiscal quarter ending September 30, 2021, (vii) 3.25:1.00 for the fiscal quarter ending December 31, 2021, and (viii) 3.00:1.00 for each fiscal quarter beginning with the fiscal quarter ending March 31, 2022 and for each fiscal quarter thereafter;

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

•

a decrease in fixed charge coverage ratio threshold from (a) 1.05:1.00 to (i) 0.85:1.00 for the fiscal quarters ending December 31, 2019 and March 31, 2020, (ii) 0.95:1.00 for the fiscal quarter ending June 30, 2020 and (iii) 1.00:1.00 for the fiscal quarter ending in September 30, 2020 and (b) from 1.10:1.00 to 1.05:1.00 for each fiscal quarter beginning with the fiscal quarter ending December 31, 2020 and for each fiscal quarter thereafter; and

•

an increase of the interest rate floor for LIBOR rate loans from 1.0% to 1.50% per annum and an increase of the interest rate floor for Prime rate loans from 3.25% to 4.75% per annum.

Junior Participation Agreement – Term B Loan

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 (the “Ravich Entities”), entered into a Junior Participation Agreement with Cerberus (the “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 (the “Junior Participation” and such interests, the “Junior Participation Interests”). The Junior Participation Interests are junior and subordinate to the Cerberus Term Loan in all respects, have no quarterly payments, and accrue interest under the financing agreement (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. In addition, on December 17, 2019 (the “Issuance Date”), in consideration of the Ravich Entities agreeing to enter into the Junior Participation, the Company agreed to issue the Ravich Entities fully vested warrants to purchase 1.23 million shares of the Company’s common stock (the “Warrants”), 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) the Issuance Date, or (ii) the six month anniversary of the Issuance Date. The 30 day trailing average closing price of the Company’s common stock on the Issuance Date was $1.20.

The fair value of the 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 total fair value of the warrants, $0.6 million, was expensed to selling, general, and administrative expense during the three months ended December 31, 2019.

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

Description

Use of Proceeds

Origination Date

Interest Rate *

Quarterly

Payments

Balance at

December 31, 2019

Term Loan:

Financing Agreement

Phoenix acquisition

August 2015

8.46% to 8.80%

1,610

58,139

First Amendment

Color Optics acquisition

July 2016

8.46% to 8.80%

175

6,333

Third Amendment

Printing Components Business acquisition

October 2017

8.46% to 8.80%

151

5,434

Fourth Amendment

Working capital

November 2018

8.46% to 8.80%

114

4,130

Sixth Amendment (Term B loan)

N/A

December 2019

12.46% to 12.80%

—

4,106

Totals

2,050

78,142

Line of Credit:

Cerberus/PNC Revolver (includes

Second and Fifth Amendments)

Working capital

August 2015

10.50% to 10.75%

—

20,313

*	Range of annual interest rates accrued during the three months ended December 31, 2019.

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 year ended September 30, 2019, did not require ALJ to make an annual ECF payment in December 2019. During December 2018, ALJ made an ECF payment of $0.3 million.

In certain instances, ALJ is required to make mandatory term loan payments if ALJ receives cash outside the normal course of business. As a result, during the three months ended December 31, 2019 and 2018, ALJ made mandatory payments of $0.9 million and $0.4 million, respectively.

As of December 31, 2019, ALJ will be assessed a prepayment penalty equal to 2% and 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, 2020 and November 28, 2021, respectively. ALJ may make payments of up to $7.0 million against the loan with no penalty. A final balloon payment is due on the Maturity Date.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 December 31, 2019, ALJ was in compliance with all debt covenants and had unused borrowing capacity of $8.9 million.

Backstop Letter Agreement

In November 2018, in connection with the Fourth Amendment to the Financing Agreement (“Fourth Amendment”), the Company entered into a Backstop Letter Agreement with Jess Ravich. Pursuant to the Backstop Letter Agreement, Mr. Ravich agreed to provide a “backstop” that enabled the Company to satisfy an alternative financing requirement as required by the Fourth Amendment. Mr. Ravich agreed that, if the Company is unable to locate alternative financing on terms, conditions and timing reasonably acceptable to it, and if required by Cerberus, he would satisfy the alternative financing requirement. In consideration of Mr. Ravich entering into such backstop arrangement, the Company’s Audit Committee and independent directors reviewed, approved and agreed to a backstop fee package, pursuant to which the Company would (i) pay to Mr. Ravich’s trust a one-time backstop fee of $0.1 million, and (ii) if the purchase of such subordinated debt is required by Cerberus and the Company has failed to secure a financing alternative more advantageous to the Company, issue to Mr. Ravich’s trust a five-year warrant (the “Warrant”) to purchase 1.5 million shares of ALJ common stock at an exercise price equal to the average closing price of the Company’s common stock as reported on The Nasdaq Stock Market for the 30 trading days preceding the warrant issuance date.

As of December 31, 2019, Cerberus had not required ALJ to satisfy the alternative financing requirement.

Loan Amendment Fees

ALJ has accounted for all amendments as debt modifications pursuant to ASC 470, Debt. During the three months ended December 31, 2019, ALJ paid $0.4 million of legal and other fees, of which $0.3 million were added to deferred loan costs and are being amortized to interest expense through the maturity date. The remaining $0.1 million were expensed to selling, general, and administrative expense.

During the three months ended December 31, 2018, ALJ paid legal and other fees totaling $0.6 million, of which $0.4 million were added to deferred loan costs and are being amortized to interest expense through the maturity date. The remaining $0.2 million were expensed to selling, general, and administrative expense.

Contingent Loan Costs

Pursuant to the Financing Agreement, ALJ is required to pay a fee (a “Contingent Payment”) in each of three consecutive annual periods which began on May 27, 2018, if at any time during each annual period there are any amounts outstanding on the Cerberus/PNC Revolver. Such Contingent Payments become due and payable on the first day within each annual period there is an outstanding balance on the Cerberus/PNC Revolver. ALJ made the first Contingent Payment during May 2018. ALJ made the second Contingent Payment during May 2019. Both Contingent Payments were added to deferred loan costs and amortized to interest expense for one year following the respective Contingent Payment. As of December 31, 2019, one Contingent Payment remained outstanding.

In February 2020, ALJ entered into the seventh amendment to the Financing Agreement. See Note 14.

Equipment Financing

In December 2018, Phoenix purchased a Heidelberg Press for $4.1 million pursuant to an equipment financing agreement (the “Equipment Financing”). The Equipment Financing term is 36 months, requires monthly principal and interest payments, accrues interest at 4.94% per year, and is secured by the Heidelberg Press.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Estimated Future Minimum Principal Payments

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

Year Ending December 31,	Equipment Financing		Cerberus Debt		Total
2020	$	1,311	$	8,200	$	9,511
2021		1,400		8,200		9,600
2022		121		8,200		8,321
2023		—		8,200		8,200
2024*		—		65,649		65,649
Total	$	2,832	$	98,449	$	101,281

*	The majority of this amount is the final balloon payment due on the maturity date, December 1, 2023.

Capital Lease Obligations

Faneuil and Phoenix lease equipment under non-cancelable capital leases. As of December 31, 2019, future minimum payments under non-cancelable capital leases with initial or remaining terms of one year or more are as follows (in thousands):

Year Ending December 31,	Estimated Future Payments
2020	$	2,337
2021		1,058
2022		703
2023		498
2024		71
Total minimum required payments		4,667
Less: current portion of capital lease obligations		(2,173	)
Less: imputed interest		(310	)
Capital lease obligations, less current portion	$	2,184

9. COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company leases real estate, equipment, and vehicles under non-cancellable operating leases. As of December 31, 2019, future minimum rental commitments, net of sublease income, under non-cancellable leases were as follows (in thousands):

Year Ending December 31,	Future Minimum Lease Payments
2020	$	8,245
2021		7,230
2022		6,426
2023		6,399
2024		6,699
Thereafter		27,582
Total	$	62,581

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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. As of December 31, 2019, contingent termination payments related to base salary and medical premiums totaled $1.3 million.

Surety Bonds

As part of Faneuil’s normal course of operations, certain customers require surety bonds guaranteeing the performance of a contract. As of December 31, 2019, 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 $30.0 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 $2.7 million outstanding as of December 31, 2019.

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 three months ended December 31, 2019.

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.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The parties are currently engaged in limited discovery. A court-ordered mediation is scheduled between the parties for May 2020. Faneuil believes this action is without merit and intends to defend this case vigorously. The Company has not accrued any amounts related to the Marshall claim as of December 31, 2019.

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 December 31, 2019 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. EQUITY

Common Stock Activity during the Three Months ended December 31, 2019

ALJ did not have any common stock activity during the three months ended December 31, 2019.

Common Stock Activity during the Three Months ended December 31, 2018

During the three months ended December 31, 2018, ALJ retired 84,000 shares of common stock, which were received by ALJ as part of a settlement agreement related to Faneuil’s acquisition of certain customer management outsourcing business assets and liabilities (the “CMO Business”) in May 2017. In connection with the settlement, ALJ recognized a $0.1 million gain during the three months ended December 31, 2018, which was included with loss (gain) on disposal of assets and other gain, net on the statement of operations.

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:

	Three Months Ended December 31,
(in thousands)	2019		2018
Stock options	$	84	$	84
Common stock awards		28		101
Total stock-based compensation expense	$	112	$	185

At December 31, 2019, ALJ had approximately $0.2 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 one year.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Stock Option Awards. ALJ had no option grants or exercises during the three months ended December 31, 2019 or 2018. ALJ had no option forfeitures during the three months ended December 31, 2019 and had forfeitures of 20,000 options during the three months ended December 31, 2018.

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) was less than $0.1 million at December 31, 2019.

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 and $0.1 million for the three months ended December 31, 2019 and 2018, respectively.

Common Stock Options and Warrants Outstanding at December 31, 2019

As of December 31, 2019, ALJ had 1.7 million stock options with a weighted average exercise price of $3.39 outstanding, and warrants exercisable to purchase 2.5 million shares of common stock with a weighted average exercise price of $1.51 outstanding.

11. INCOME TAX

ALJ’s effective tax rate for the three months ended December 31, 2019 is (1.0%), which is due to current state income tax, offset by changes to the valuation allowance recorded against net deferred tax assets. ALJ’s effective tax rate for the three months ended December 31, 2018 was 29.0%, which was due to current state income tax. The decrease in the effective tax rate was attributable to a decrease in forecasted taxable income, as well as a decrease to the valuation allowance recorded against net deferred tax assets.

12. RELATED-PARTY TRANSACTIONS

Harland Clarke Holdings Corp. (“Harland Clarke”), a stockholder who owns ALJ shares in excess of five percent, had a contract with Faneuil to provide call center services for Harland Clarke’s banking-related products. The contract completed in March 2019. Faneuil did not recognize revenue or cost of revenue subsequent to such completion date. Faneuil recognized revenue from Harland Clarke totaling $0.1 million for the three months ended December 31, 2018. The associated cost of revenue was $0.1 million for the three months ended December 31, 2018. All revenue from Harland Clarke contained similar terms and conditions as those found in other transactions of this nature entered into by Faneuil. Harland Clarke did not owe Faneuil any amounts at December 31, 2019 and owed Faneuil less than $0.1 million at December 31, 2018.

13. REPORTABLE SEGMENTS AND GEOGRAPHIC INFORMATION

Reportable Segments

As discussed in Note 1, ALJ has organized its business along three reportable segments (Faneuil, Carpets, 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, interest expense, litigation loss, recovery of litigation loss, restructuring and cost reduction initiatives, lease payments in anticipation of facility shutdown, loan amendment expenses, 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.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The following tables present ALJ’s segment information for the three months ended December 31, 2019 and 2018:

	Three Months Ended December 31, 2019
(in thousands)	Faneuil		Carpets			Phoenix		ALJ			Total
Net revenue	$	58,567	$	9,774		$	22,124	$	—		$	90,465

Segment adjusted EBITDA	$	1,653	$	(78	)	$	2,840	$	(1,055	)	$	3,360
Depreciation and amortization												(5,242	)
Interest expense												(2,564	)
Loan amendment expenses												(769	)
Restructuring and cost reduction initiatives												(277	)
Stock-based compensation												(112	)
Acquisition-related expenses												(49	)
Provision for income taxes												(40	)
Lease payments in anticipation of facility shutdown												(38	)
(Loss) gain on disposal of assets and other gain, net												(2	)
Interest from legal settlement												200
Recovery of litigation loss												1,256
Net loss											$	(4,277	)

	Three Months Ended December 31, 2018
(in thousands)	Faneuil		Carpets		Phoenix		ALJ			Total
Net revenue	$	55,202	$	12,362	$	26,220	$	—		$	93,784

Segment adjusted EBITDA	$	4,946	$	160	$	4,221	$	(721	)	$	8,606
Depreciation and amortization											(4,446	)
Interest expense											(2,715	)
Provision for income taxes											(288	)
Loan amendment expenses											(201	)
Lease payments in anticipation of facility shutdown											(186	)
Stock-based compensation											(185	)
Restructuring and cost reduction initiatives											(85	)
Acquisition-related expenses											(12	)
Gain (loss) on disposal of assets and other gain, net											223
Net income										$	711

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.

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

14. SUBSEQUENT EVENTS

Seventh Amendment to Financing Agreement

On February 13, 2020, ALJ entered into the Seventh Amendment (“Seventh Amendment”) to the Financing Agreement. See Note 8. The Seventh Amendment amends certain terms and covenants in order to support the continued growth of the Company, as summarized below:

•

An extension of the seasonal increase period in 2020 during which the available amount under the Cerberus/PNC Revolver is $32.5 million from February 14, 2020 to March 15, 2020; and

•

An increase in the available amount under the Cerberus/PNC Revolver from March 16, 2020 to March 31, 2020 from $25.0 million to $30.0 million.

Amendment 7 does not impact Maturity Date, quarterly payments, or interest rates. Additionally, Amendment 7 does not impact the presentation and related disclosure of the Cerberus Term Loan at December 31, 2019.

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 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:

•

Overview. Discussion of our business and overall analysis of financial and other highlights affecting us to provide context for the remainder of MD&A.

•

Results of Operations. An analysis comparing our financial results for the three months ended December 31, 2019 to the three months ended December 31, 2018.

•

Liquidity and Capital Resources. An analysis comparing our cash flows for the three months ended December 31, 2019 to the three months ended December 30, 2018, and discussion of our financial condition and liquidity.

•

Contractual Obligations. Discussion of contractual obligations as of December 31, 2019.

•

Off-Balance Sheet Arrangements. Discussion of off-balance sheet arrangements as of December 31, 2019.

•

Critical Accounting Policies and Estimates. Discussion of the significant estimates and judgments that affect the reported amounts of assets, liabilities, net revenue and expenses, and related disclosure of contingent assets and liabilities.

The following discussion should be read in conjunction with our 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”), Floors-N-More, LLC, d/b/a Carpets N’ More (“Carpets”), and Phoenix Color Corp. (“Phoenix”). 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, such as the acquisition of a printing and manufacturing services division in Terre Haute, Indiana by Phoenix in October 2017 (the “Printing Components Business”), the acquisition of the CMO Business by Faneuil in May 2017, and the acquisition of Color Optics by Phoenix in July 2016. 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.

On July 31, 2019, ALJ acquired Realtime Digital Innovations, LLC (the “RDI Acquisition”), an exclusive partner of Faneuil for the past 21 months providing 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 other things, (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.

Revision of Previously Reported Financial Information

During the three months ended December 31, 2019, we identified and reclassified certain expenses between cost of revenue and selling, general, and administrative expenses. For additional details, see “Part I, Item 1. Financial Statements – Note 1. Organization and Basis of Presentation.” Accordingly, we have revised previously issued financial statements contained in this Quarterly Report on Form 10-Q to reflect the revisions in the corresponding periods. Management’s discussion and analysis included herein is based on the revised financial results for the three months ended December 31, 2018.

Three Months Ended December 31, 2019 Compared to Three Months Ended December 31, 2018

The following table sets forth certain condensed consolidated statements of operations data as a percentage of net revenue for each period as follows:

	Three Months Ended December 31, 2019						Three Months Ended December 31, 2018
				% of						% of
(in thousands, except per share amounts)	Dollars			Net Revenue			Dollars			Net Revenue
Net revenue⁽¹⁾
Faneuil	$	58,567			64.7	%	$	55,202			58.9	%
Carpets		9,774			10.8			12,362			13.2
Phoenix		22,124			24.5			26,220			27.9
Consolidated net revenue		90,465			100.0			93,784			100.0
Cost of revenue ⁽²⁾
Faneuil		50,172			85.7			44,467			80.6
Carpets		7,791			79.7			9,816			79.4
Phoenix ⁽³⁾		17,763			80.3			20,363			77.7
Consolidated cost of revenue		75,726			83.7			74,646			79.6
Selling, general, and administrative expense ⁽²⁾
Faneuil		6,450			11.0			5,989			10.8
Carpets		2,061			21.1			2,386			19.3
Phoenix		2,826			12.8			3,067			11.7
ALJ		1,164			—			918			—
Consolidated selling, general, and administrative expense		12,501			13.8			12,360			13.2
Depreciation and amortization ⁽²⁾
Faneuil		3,398			5.8			2,494			4.5
Carpets		143			1.5			229			1.9
Phoenix⁽⁴⁾		568			2.6			564			2.2
Consolidated depreciation and amortization expense		4,109			4.5			3,287			3.5
Loss (gain) on disposal of assets and other gain, net ⁽⁵⁾		2			—			(223	)		—
Total consolidated operating expenses ⁽⁵⁾		92,338			102.1			90,070			96.0
Consolidated operating (loss) income		(1,873	)		(2.1	)		3,714			4.0
Interest expense ⁽⁵⁾		(2,564	)		(2.8	)		(2,715	)		(2.9	)
Interest from legal settlement ⁽⁵⁾		200			0.2			—			—
Provision for income taxes⁽⁵⁾		(40	)		(0.0	)		(288	)		(0.3	)
Net (loss) income ⁽⁵⁾	$	(4,277	)		(4.7	)	$	711			0.8
(Loss) earnings per share of common stock–basic and diluted	$	(0.10	)				$	0.02

⁽¹⁾	Percentage is calculated as segment net revenue divided by consolidated net revenue.

⁽²⁾	Percentage is calculated as a percentage of the respective segment net revenue.

⁽³⁾	Includes depreciation expense of $1.1 million and $1.2 million for the three months ended December 31, 2019 and 2018, respectively.

⁽⁴⁾	Primarily amortization of intangible assets. Total depreciation and amortization expense for Phoenix, including depreciation expense captured in cost of revenue, was $1.7 for both the three months ended December 31, 2019 and 2018, respectively.

⁽⁵⁾	Percentage is calculated as a percentage of consolidated net revenue.

Net Revenue

	Three Months Ended December 31,
(in thousands)	2019		2018		$ Change			% Change
Faneuil	$	58,567	$	55,202	$	3,365			6.1	%
Carpets		9,774		12,362		(2,588	)		(20.9	)
Phoenix		22,124		26,220		(4,096	)		(15.6	)
Consolidated net revenue	$	90,465	$	93,784	$	(3,319	)		(3.5	)%

Faneuil Net Revenue

Faneuil net revenue for the three months ended December 31, 2019 was $58.6 million, an increase of $3.4 million, or 6.1%, compared to net revenue of $55.2 million for the three months ended December 31, 2018. The increase was mainly attributable to a $7.6 million increase in new customer contracts, offset by a $2.4 million net decrease in existing customers mostly due to lower call volumes, and a $1.8 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:

	As of December 31,
(in millions)	2019		2018
Within one year	$	223.1	$	158.1
Between one year and two years		145.3		101.3
Between two years and three years		99.4		25.7
Between three years and four years		63.9		15.0
Thereafter		82.6		1.3
Total Faneuil backlog	$	614.3	$	301.4

The increase in Faneuil backlog at December 31, 2019 compared to December 31, 2018 was primarily driven by new healthcare customer contract awards, and several transportation contract awards including the Metro ExpressLanes Customer Service Center Operations contract by the Los Angeles County Metropolitan Transportation Authority (“LA Metro”).

Carpets Net Revenue

Carpets net revenue for the three months ended December 31, 2019 was $9.8 million, a decrease of $2.6 million, or 20.9%, compared to net revenue of $12.4 million for the three months ended December 31, 2018. The decrease was primarily attributable to lower sales volumes in flooring, cabinets, and granite.

Carpets backlog represents open purchase orders. Carpets total contract backlog, which is expected to be fully realized within the next 12 months, as of December 31, 2019 was $9.4 million compared to $11.6 million as of December 31, 2018. The decrease in Carpets backlog at December 31, 2019 compared to December 31, 2018, was the result of a lower sales pipeline.

Phoenix Net Revenue

Phoenix net revenue for the three months ended December 31, 2019 was $22.1 million, a decrease of $4.1 million, or 15.6%, compared to net revenue of $26.2 million for the three months ended December 31, 2018. The decrease was a result of several large orders during the three months ended December 31, 2018, that did not reoccur during the three months ended December 31, 2019, and lower component sales related to education.

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:

	As of December 31,
(in millions)	2019		2018
Within one year	$	67.7	$	70.8
Between one year and two years		48.4		55.7
Between two years and three years		35.3		24.5
Between three years and four years		9.4		14.6
Total Phoenix backlog	$	160.8	$	165.6

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

	Three Months Ended December 31,
(in thousands)	2019			2018			$ Change			% Change
Faneuil	$	50,172		$	44,467		$	5,705			12.8	%
As a percentage of segment net revenue		85.7	%		80.6	%
Carpets		7,791			9,816			(2,025	)		(20.6	)
As a percentage of segment net revenue		79.7	%		79.4	%
Phoenix		17,763			20,363			(2,600	)		(12.8	)
As a percentage of segment net revenue		80.3	%		77.7	%
Consolidated cost of revenue	$	75,726		$	74,646		$	1,080			1.4	%

Faneuil Cost of Revenue

Faneuil cost of revenue for the three months ended December 31, 2019 was $50.2 million, an increase of $5.7 million, or 12.8%, compared to cost of revenue of $44.5 million for the three months ended December 31, 2018. The increase in cost of revenue was a direct result of the increased net revenue, inefficiencies related to the startup of new contracts, operational challenges related to the expansion of certain ongoing contracts, higher rent expense, and costs to implement the new revenue recognition standard. During the three months ended December 31, 2019, as compared to the three months ended December 31, 2018, cost of revenue as a percentage of segment net revenue increased to 85.7% from 80.6% as a result of the above mentioned items other than the increased net revenue.

Carpets Cost of Revenue

Carpets cost of revenue for the three months ended December 31, 2019 was $7.8 million, a decrease of $2.0 million, or 20.6%, compared to cost of revenue of $9.8 million for the three months ended December 31, 2018. The absolute dollar decrease in cost of revenue was mainly attributable to decreased net revenue. During the three months ended December 31, 2019, as compared to the three months ended December 31, 2018, cost of revenue as a percentage of segment net revenue increased slightly to 79.7% from 79.4% in the normal course of business.

Phoenix Cost of Revenue

Phoenix cost of revenue for the three months ended December 31, 2019 was $17.8 million, a decrease of $2.6 million, or 12.8%, compared to cost of revenue of $20.4 million for the three months ended December 31, 2018. During the three months ended December 31, 2019, as compared to the three months ended December 31, 2018, cost of revenue as a percentage of segment net revenue increased to 80.3% from 77.7%. 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.

Selling, General, and Administrative Expense

	Three Months Ended December 31,
(in thousands)	2019		2018		$ Change			% Change
Faneuil	$	6,450	$	5,989	$	461			7.7	%
Carpets		2,061		2,386		(325	)		(13.6	)
Phoenix		2,826		3,067		(241	)		(7.9	)
ALJ		1,164		918		246			26.8
Consolidated selling, general, and administrative expense	$	12,501	$	12,360	$	141			1.1	%

Faneuil Selling, General, and Administrative Expense

Faneuil selling, general, and administrative expense for the three months ended December 31, 2019 was $6.5 million, an increase of $0.5 million, or 7.7%, compared to selling, general, and administrative expense of $6.0 million for the three months ended December 31, 2018. The increase was primarily attributable to an increase of $1.1 million to support new customers, a non-cash expense of $0.6 million for the fair value of warrants issued in connection with debt modification, increased expenses to comply with new revenue recognition standards, and severance payments as part of Faneuil’s cost reduction initiative, offset by a $1.2 million recovery of litigation loss. See “Part II. Other Information, Item 1. Legal Proceedings.” During the three months ended December 31, 2019 compared to the three months ended December 31, 2018, selling, general, and administrative expense as a percentage of segment net revenue increased slightly to 11.0% from 10.8%. 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.

Carpets Selling, General, and Administrative Expense

Carpets selling, general, and administrative expense was $2.1 million for the three months ended December 31, 2019, a decrease of $0.3 million, or 13.6%, compared to selling, general, and administrative expense of $2.4 million for the three months ended December 31, 2018. The decrease was primarily attributable to process improvements and cost reductions throughout the organization. Selling, general, and administrative expense as a percentage of segment net revenue increased to 21.1% for the three months ended December 31, 2019 from 19.3% for the three months ended December 31, 2018, which was mainly attributable to the reduction 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.

Phoenix Selling, General, and Administrative Expense

Phoenix selling, general, and administrative expense for the three months ended December 31, 2019 was $2.8 million, a decrease of $0.2 million, or 7.9%, compared to selling, general, and administrative expense of $3.1 million for the three months ended December 31, 2018. The decrease was mainly attributable to the completion of the process to consolidate manufacturing facilities and cost reduction initiatives. Selling, general, and administrative expense as a percentage of segment net revenue increased to 12.8% for the three months ended December 31, 2019 from 11.7% for the three months ended December 31, 2018, which was mainly attributable to the reduction 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 three months ended December 31, 2019 was $1.2 million, an increase of $0.2 million, or 26.8%, compared to selling, general, and administrative expense of $0.9 million for the three months ended December 31, 2018. The increase was mainly personnel related, including the hiring of headcount to support our business and our strategy of acquisitions. 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

	Three Months Ended December 31,
(in thousands)	2019		2018		$ Change			% Change
Faneuil	$	3,398	$	2,494	$	904			36.2	%
Carpets		143		229		(86	)		(37.6	)
Phoenix		568		564		4			0.7
Consolidated depreciation and amortization expense	$	4,109	$	3,287	$	822			25.0	%

Faneuil Depreciation and Amortization Expense

Faneuil depreciation and amortization expense for the three months ended December 31, 2019 was $3.4 million, an increase of $0.9 million, or 36.2%, compared to depreciation and amortization expense of $2.5 million for the three months ended December 31, 2018. The increase was attributable to leasehold improvements for new call center buildouts, and capital equipment purchased to support new and expanded contracts. Faneuil expects future depreciation and amortization expense to increase as Faneuil continues to invest in its business, which includes opening new call centers. Because certain Faneuil contracts require capital investments such as lease buildouts, Faneuil depreciation and amortization expense is impacted by the timing of new contracts and the completion of existing contracts.

Carpets Depreciation and Amortization Expense

Carpets depreciation and amortization expense for the three months ended December 31, 2019 was $0.1 million, a decrease of $0.1 million, or 37.6%, compared to depreciation and amortization expense of $0.2 million for the three months ended December 31, 2018. The decrease was attributable to fully amortized intangible assets.

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 $0.6 million for both the three months ended December 31, 2019 and 2018.

Interest Expense

Interest expense for the three months ended December 31, 2019 was $2.6 million, a decrease of $0.2 million, or 5.6%, compared to $2.7 million for the three months ended December 31, 2018. Interest expense was impacted by reduced interest expense resulting from quarterly principal payments on our term loan offset by increased weighted-average outstanding balance on our line of credit used to fund Faneuil’s call center buildouts and other working capital requirements.

Interest from Legal Settlement

During the three months ended December 31, 2019, Faneuil received a onetime $1.5 million settlement, of which $0.2 million was attributable to interest. See “Part II. Other Information, Item 1. Legal Proceedings.”

Provision for Income Taxes

Our provision for income taxes was less than $0.1 million for the three months ended December 31, 2019 compared to $0.3 million for the three months ended December 31, 2018. Our provision for income taxes for the three months ended December 31, 2019 was the result of generating state taxable income, offset by changes to the valuation allowance recorded against net deferred tax assets. Our provision for income taxes for the three months ended December 31, 2018 was the result of generating state taxable income.

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, interest expense, litigation loss, recovery of litigation loss, restructuring and cost reduction initiatives, lease payments in anticipation of facility shutdown, loan amendment expenses, 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.

	Three Months Ended December 31,
(in thousands)	2019			2018			$ Change			% Change
Faneuil	$	1,653		$	4,946		$	(3,293	)		(66.6	)%
Carpets		(78	)		160			(238	)		(148.8	)
Phoenix		2,840			4,221			(1,381	)		(32.7	)
ALJ		(1,055	)		(721	)		(334	)		(46.3	)
Segment adjusted EBITDA	$	3,360		$	8,606		$	(5,246	)		(61.0	)%

Faneuil Segment Adjusted EBITDA

Faneuil segment adjusted EBITDA for the three months ended December 31, 2019 was $1.7 million compared to segment adjusted EBITDA of $4.9 million for the three months ended December 31, 2018. Faneuil segment adjusted EBITDA for the three months ended December 31, 2019 was impacted by operational inefficiencies from the start up of new contracts, increased medical claims, higher rent expense, and the cost to implement new revenue recognitions standards.

Carpets Segment Adjusted EBITDA

Carpets segment adjusted EBITDA loss for the three months ended December 31, 2019 was ($0.1) million compared to segment adjusted EBITDA of $0.2 million for the three months ended December 31, 2018. Carpets segment adjusted EBITDA was impacted by lower volumes from builders and fewer upgrading to higher margin products by retail customers.

Phoenix Segment Adjusted EBITDA

Phoenix segment adjusted EBITDA for the three months ended December 31, 2019 was $2.8 million compared to segment adjusted EBITDA of $4.2 million for the three months ended December 31, 2018. Phoenix segment adjusted EBITDA for the three months ended December 31, 2019 was impacted by the decrease in volumes from components and books, somewhat offset by the decrease to selling, general, and administrative expenses resulting from consolidating printing facilities.

ALJ Segment Adjusted EBITDA

ALJ segment adjusted EBITDA loss for the three months ended December 31, 2019 was ($1.1) million compared to segment adjusted EBITDA of ($0.7) million for the three months ended December 31, 2018. ALJ segment adjusted EBITDA for three months ended December 31, 2019 was impacted by increased headcount.

Segment adjusted EBITDA is not considered a non-GAAP measure because we include segment adjusted EBITDA in our segment disclosures in accordance with the ASC Topic 280 – Segment Reporting. See “Part I, Item 1. Financial Statement – Note 13. Reportable Segments and Geographic Information.” As such, we do not provide a reconciliation from net income (loss) to segment adjusted EBITDA.

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.

Carpets

Carpets generally experiences seasonality within the home building business as the number of houses sold during the winter months is generally lower than the number of homes sold during other times during the year. Conversely, the number of houses sold and delivered during the remaining portion of the year increases by comparison.

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 components 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 December 31, 2019, our principal sources of liquidity included cash and cash equivalents of $2.6 million and an available borrowing capacity of $8.9 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 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:

	December 31,
(in thousands)	2019			2018
Cash used for operating activities	$	(7,752	)	$	(2,169	)
Cash used for investing activities		(674	)		(5,575	)
Cash provided by financing activities		6,451			7,912
Change in cash and cash equivalents	$	(1,975	)	$	168

We recognized net loss of $4.3 million for the three months ended December 31, 2019, used cash for operating activities of $7.8 million and investing activities of $0.7 million, offset by cash used provided by financing activities of $6.4 million.

We recognized net income of $0.7 million for the three months ended December 31, 2018 and used cash of $2.2 million for operating activities and $5.6 million for investing activities, offset by $7.9 million cash provided by financing activities.

Operating Activities

Cash used by operating activities of $7.8 million during the three months ended December 31, 2019 was the result of $4.3 million net loss, $5.2 million addback of net non-cash expenses, and $8.7 million of net cash used for changes in operating assets and liabilities. The most significant components of net non-cash expenses were depreciation and amortization expense of $5.2 million, $0.6 million fair value of warrants issued in connection with debt modification, offset by $1.0 million deferred tax benefit. The most significant components of changes in operating assets and liabilities included accounts receivable of $8.1 million, prepaid expenses, collateral deposits, and other current assets of $4.2 million, which used cash, offset by deferred revenue and customer deposits of $3.3 million, which provided cash.

Cash used by operating activities of $2.2 million during the three months ended December 31, 2018 was the result of $0.7 million net income, $4.7 million addback of net non-cash expenses, and $7.6 million of net cash used for changes in operating assets and liabilities. The most significant components of net non-cash expenses were depreciation and amortization expense of $4.4 million, stock-based compensation of $0.2 million, and amortization of deferred loan costs of $0.2 million, offset by $0.2 million of (loss) gain on disposal of assets and other gain, net. The most significant components of changes in operating assets and liabilities included accounts receivable of $7.9 million, prepaid expenses, collateral deposits, and other current assets of $1.2 million, and deferred revenue and customer deposits of $1.1 million, which used cash, offset by accounts payable of $1.2 million and accrued expenses of $1.5 million, which provided cash.

Cash used by operations for the three months ended December 31, 2019 compared to the three months ended December 31, 2018, was impacted by lower cash earnings from operations, offset by higher depreciation and amortization attributable to Faneuil’s customer call center buildouts and RDI Acquisition-related assets, and several new Faneuil contracts with deferred implementation revenue.

Investing Activities

For the three months ended December 31, 2019, our investing activities used $0.7 million of cash, of which $0.6 million was used to purchase equipment, software and leasehold improvements for Faneuil’s new and existing customers, and $0.1 million was used to purchase capital equipment in the normal course of operations. During the three months ended December 31, 2019 as compared to the three months ended December 31, 2018, Faneuil’s capital equipment purchases dropped sharply due to the completion of Faneuil’s three new customer call center buildouts.

For the three months ended December 31, 2018, our investing activities used $5.6 million of cash, of which $1.0 million was the final payment for our Printing Components Business acquisition, $3.9 million was used to purchase equipment, software and leasehold improvements for Faneuil’s new and existing customers, and $1.0 million was used to purchase capital equipment in the normal course of operations, partially offset by $0.3 million proceeds received from the sale of equipment.

Financing Activities

For the three months ended December 31, 2019, our financing activities provided $6.5 million of cash. Proceeds from our line of credit provided $10.5 million to fund working capital requirements at Faneuil and Phoenix. Financing activities which used cash included $3.2 million to pay down our term loan, $0.6 million for capital lease payments, and $0.3 million for deferred loan costs related to the Sixth Amendment.

For the three months ended December 31, 2018, our financing activities provided $7.9 million of cash. Proceeds from our line of credit and term loan provided $6.9 million and $5.0 million, respectively. Financing activities which used cash included $2.7 million to pay down our term loan, $0.8 million for capital lease payments, and $0.4 million for deferred loan costs related to the Fourth Amendment.

Contractual Obligations

The following table summarizes our significant contractual obligations at December 31, 2019, and the effect such obligations are expected to have on our liquidity and cash flows in future periods:

	Payments due by Period
			Less Than		One – Three		Four – Five		More than Five
(in thousands)	Total		One Year		Years		Years		Years
Term loan ⁽¹⁾	$	74,036	$	8,200	$	24,600	$	41,236	$	—
Operating lease obligations ⁽²⁾		62,581		8,245		13,656		13,098		27,582
Line of credit ⁽¹⁾		20,313		—		—		20,313		—
Other liabilities ⁽³⁾		13,820		1,026		12,794		—		—
Capital lease obligations ⁽¹⁾		4,357		2,173		1,651		533		—
Term B loan ⁽¹⁾		4,106		—		—		4,106		—
Equipment financing agreement ⁽¹⁾		2,832		1,311		1,521		—		—
Total contractual cash obligations⁽⁴⁾	$	182,045	$	20,955	$	54,222	$	79,286	$	27,582

⁽¹⁾	Refer to “Part I, Item 1. Financial Statements – Note 8. Debt.”

⁽²⁾	Refer to “Part I, Item 1. Financial Statements – Note 9. Commitments and Contingencies.”

⁽³⁾

Amounts represent future cash payments to satisfy our short- and long-term workers’ compensation reserve, short- and long-term acquisition-related deferred and contingent liabilities, and other long-term liabilities recorded on our consolidated balance sheets. It excludes deferred revenue and non-cash items. Short- and long-term acquisition-related deferred and contingent payments are included in the table at total fair value, as defined by generally accepted accounting principles, of $4.9 million. The total maximum amount of acquisition-related deferred and contingent cash payments is $7.5 million.

⁽⁴⁾

Total excludes contractual obligations already recorded on our consolidated balance sheets as current liabilities, except for the short-term portions of our term loan, short-term portion of acquisition-related deferred and contingent payments, equipment financing agreement, and workers’ compensation reserve.

Off-Balance Sheet Arrangements

As of December 31, 2019, 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. As of December 31, 2019, 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 $30.0 million.

Letters of Credit. ALJ had letters of credit totaling $2.7 million outstanding as of December 31, 2019.

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, 2019, filed with the Securities and Exchange Commission (“SEC”) on December 23, 2019 (“Fiscal 2019 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 2019 Form 10-K. As a result of adopting ASC 606, we revised our revenue recognition accounting policy. 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 three months ended December 31, 2019.

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.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Litigation, Claims, and Assessments

Faneuil, Inc. v. 3M Company

Marshall v. Faneuil, Inc.

Other Litigation

Environmental Matters

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.

On March 23, 2010, President Obama signed the Affordable Care Act (the “Affordable Care Act”) into law, which has affected comprehensive health insurance reform, including the creation of health insurance exchanges, among other reforms. A portion of Faneuil’s healthcare business relates to providing services to health insurance exchanges in various states, and Faneuil believes that there may be significant opportunities for growth in this area. President Trump has disclosed that a key initiative for his Presidency is to repeal or substantially change the Affordable Care Act. While Congress has not passed repeal legislation, 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. It is unclear whether further changes that President Trump has planned to the Affordable Care Act will be enacted, or if enacted changes will affect Faneuil’s business. Further significant changes to, or repeal of, the Affordable Care Act could materially and adversely affect that aspect of Faneuil’s business.

Economic downturns and reductions in government funding 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. 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 could have an unfavorable effect on Faneuil’s business, financial position, results of operations and cash flows.

Faneuil’s business involves many program-related and contract-related risks.

Faneuil’s business is subject to a variety of program-related risks, including changes in political and other circumstances, particularly since contracts for major programs are performed over extended periods of time. These risks include changes in personnel at government authorities, the failure of applicable government authorities to take necessary actions, opposition by third parties to particular programs and the failure by customers to obtain adequate financing for particular programs. Due to these factors, losses on a particular contract or contracts could occur, and Faneuil could experience significant changes in operating results on a quarterly or annual basis.

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.

The diversion of resources and management’s attention to the integration of the RDI Acquisition could adversely affect Faneuil’s day-to-day business.

The integration of the RDI Acquisition may place a significant burden on Faneuil management and internal resources. The diversion of Faneuil management’s attention away from day-to-day business concerns and any difficulties encountered in the transition and integration process could adversely affect Faneuil’s financial results.

Delays in the government budget process or a government shutdown may adversely affect Faneuil’s cash flows and operating results.

Faneuil derives a significant portion of its revenue from state government contracts and programs. Any delay in the state government budget process or a state government shutdown may result in Faneuil incurring substantial labor or other costs without reimbursement under customer contracts, or the delay or cancellation of key programs in which Faneuil is involved, which could materially adversely affect Faneuil’s cash flows and operating results.

Faneuil faces intense competition. If Faneuil does not compete effectively, its business may suffer.

Faneuil faces intense competition from numerous competitors. 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. In addition, new competitors may emerge, and service offerings may be threatened by new technologies or market trends that reduce the value of the services Faneuil provides. To remain competitive, Faneuil must respond to new technologies and enhance its existing services, and we anticipate that it may have to adjust the pricing for its services to stay competitive on future responses to proposals. If Faneuil does not compete effectively, its business, financial position, results of operations and cash flows could be materially adversely affected.

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 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 business could be adversely affected if Faneuil’s clients are not satisfied with its services.

Faneuil’s business model largely depends on the ability to attract new work from existing clients. Faneuil’s business model also depends on client relationships, understanding client needs, and delivering specific solutions to meet such needs. If a client is not satisfied with the quality of work performed by Faneuil or a subcontractor or with the type of services or solutions delivered, Faneuil could incur additional costs to address the situation, the profitability of that work might be impaired and the client’s dissatisfaction with Faneuil’s services could lead to the termination of that work or damage Faneuil’s ability to obtain additional work from that client. Also, negative publicity related to Faneuil’s client relationships, regardless of its accuracy, may further damage Faneuil’s business by affecting its ability to compete for new contracts with current and prospective clients.

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. 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.

Any business disruptions due to political instability, armed hostilities, and acts of terrorism or natural disasters could adversely affect Faneuil’s 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 Faneuil operations, cause general economic conditions to deteriorate or cause demand for Faneuil services, many of which depend on travel, to decline. A prolonged economic slowdown or recession could reduce the demand for Faneuil services, and consequently, negatively affect Faneuil’s future sales and profits. Any of these events could have a significant effect on Faneuil’s business, financial condition or results of operations.

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.

A failure to attract and retain necessary personnel, skilled management, and qualified subcontractors may have an adverse impact on Faneuil’s business.

Because Faneuil operates in intensely competitive markets, its success depends to a significant extent upon its ability to attract, retain and motivate highly skilled and qualified personnel and to subcontract with qualified, competent subcontractors. If Faneuil fails to attract, develop, motivate, retain, and effectively utilize personnel with the desired levels of training or experience, or is unable to contract with qualified, competent subcontractors, Faneuil’s business will be harmed. Experienced and capable personnel remain in high demand, and there is continual competition for their talents. Additionally, regarding the labor-intensive business of Faneuil, quality service depends on the ability to retain employees and control personnel turnover. Any increase in the employee turnover rate could increase recruiting and training costs and could decrease operating effectiveness and productivity. Faneuil may not be able to continue to hire, train and retain a sufficient number of qualified personnel to adequately staff new client projects. Faneuil’s business is driven in part by the personal relationships of Faneuil’s senior management team, and its success depends on the skills, experience, and performance of members of Faneuil’s senior management team. Despite executing an employment agreement with Faneuil’s CEO, she or other members of the management team may discontinue service with Faneuil and Faneuil may not be able to find individuals to replace them at the same cost, or at all. Faneuil has not obtained “key person” insurance for any member of its senior management team. The loss or interruption of the services of any key employee or the loss of a key subcontractor relationship could hurt Faneuil’s business, financial condition, cash flow, results of operations and prospects.

Risks Related to Carpets

The floor covering industry is highly dependent on national and regional economic conditions, such as consumer confidence and income, corporate and individual spending, interest rate levels, availability of credit and demand for housing. A decline in residential or commercial construction activity or remodeling and refurbishment in Las Vegas could have a material adverse effect on Carpets business.

The floor covering industry is highly dependent on construction activity, including new construction, which is cyclical in nature. Historically, downturns in the U.S. and global economies, along with the residential and commercial markets in such economies, particularly in Las Vegas, have negatively impacted the floor covering industry and Carpets business. Although the impact of a decline in new construction activity is typically accompanied by an increase in remodeling and replacement activity, these activities lagged during the recent downturns. Diminished consumer confidence in general, or specifically with respect to purchasing homes, or lack of consumer interest in purchasing a home compared to other housing alternatives due to location preferences, perceived affordability constraints or otherwise, may contribute to such a downturn. Further, changes to monetary policy or other actions by the Federal Reserve resulting in an adverse effect on interest rates (including mortgage interest rates), a downward trend in employment levels and job and wage growth, and increasing prices for available new or existing homes could lead to a decline in housing activity and negatively impact Carpets business. A significant or prolonged decline in residential/commercial remodeling or new construction activity could have a material adverse effect on the business and results of operations of Carpets.

Because all of Carpets operations are concentrated in the Las Vegas area, it is especially subject to certain risks, including economic and competitive risks, associated with the conditions in that area and in the areas from which it draws customers.

Carpets currently operates solely in the Las Vegas area. Due to this geographic concentration, its results of operations and financial conditions are subject to greater risks from changes in local and regional conditions, such as changes in local or regional economic conditions and unemployment rates; changes in local and state laws and regulations; a decline in the number of residents in the Las Vegas area; and changes in the local or regional competitive environment. As a result of the geographic concentration of is business, Carpets faces a greater risk of a negative impact on its business, financial condition, results of operations and prospects if any of the geographic areas in which it operates is more severely impacted by any such adverse condition, as compared to other areas in the United States.

Carpets faces intense competition in the floor covering industry that could decrease demand for its products or force it to lower prices, which could have a material adverse effect on our business.

The floor covering industry is highly competitive. Carpets competes with several home improvement stores, building materials supply houses and lumber yards, specialty design stores, showrooms, discount stores, local, regional and national hardware stores, mail order firms, warehouse clubs, independent building supply stores, and other retailers, as well as with installers. Also, it faces growing competition from online and multichannel retailers as its customers increasingly use computers, tablets, smartphones, and other mobile devices to shop online and compare prices and products in real time. Intense competitive pressures from one or more competitors of Carpets or the inability by Carpets to adapt effectively and quickly to a changing competitive landscape could affect its prices, its margins or demand for its products and services. If it is unable to respond timely and appropriately to these competitive pressures, including through maintaining competitive locations of stores, customer service, quality and price of merchandise and services, in-stock levels, and merchandise assortment and presentation, its market share and its financial performance could be adversely affected.

Carpets may not timely identify or effectively respond to consumer needs, expectations or trends, which could adversely affect its relationship with customers, its reputation, demand for its products and services and its market share.

Carpets operates in a market sector where demand is strongly influenced by rapidly changing customer preferences as to product design and features. The success of Carpets depends on its ability to anticipate and react to changing consumer demands promptly. All of its products are subject to changing consumer preferences that cannot be predicted with certainty. Also, long lead times for certain of its products may make it hard for it to respond quickly to changes in consumer demands. Consumer preferences could shift rapidly to different types of products or away from the types of products Carpets carries altogether, and Carpets future success depends, in part, on its ability to anticipate and respond to these changes. Failure to anticipate and respond promptly to changing consumer preferences could lead to, among other things, lower sales and excess inventory levels, which could have a material adverse effect on its financial condition.

Carpets relies on third-party suppliers for its products. If it fails to identify and develop relationships with a sufficient number of qualified suppliers, or if its suppliers experience financial or operational difficulties, its ability to timely and efficiently access products that meet its standards could be adversely affected.

Carpets sources, stocks and sells products from vendors, and the vendors’ ability to fulfill Carpets orders reliably and efficiently is critical to its business success. Its ability to continue to identify and develop relationships with qualified suppliers who can satisfy its standards for quality and the need to access products in a timely, efficient and cost-effective manner is a significant challenge. The ability to access products can also be adversely affected by political instability, the financial instability of suppliers, suppliers’ noncompliance with applicable laws, trade restrictions, tariffs, currency exchange rates, supply disruptions, weather conditions, natural disasters, including climate change related events, shipping or logistical interruptions or costs and other factors beyond its control. If these vendors fail or are unable to perform as expected and Carpets is unable to replace them quickly, its business could suffer material adverse short- and long-term effects.

If Carpets fails to achieve and maintain a high level of product and service quality, its reputation, sales, profitability, cashflows, and financial condition could be negatively impacted.

Product and service quality issues could result in a negative impact on customer confidence in Carpets and the Carpets brand image. As a result, its reputation as a retailer of high-quality products and services could suffer and impact customer loyalty. Additionally, a decline in product and service quality could result in product recalls, product liability and warranty claims. Carpets generally provides a one-year warranty on the installation of any of its products. Warranty work related directly to installation is repaired at the cost to Carpets, and product defects are generally charged back to the manufacturer.

If Carpets is unable to manage its installation service business effectively, it could suffer lost sales and be subject to fines, lawsuits, and a damaged reputation.

Carpets acts as a general contractor to provide installation services to its customers. As such, it is subject to regulatory requirements and risks applicable to general contractors, which include management of licensing, permitting and the quality of its installers. If Carpets fails to effectively manage these processes or provide proper oversight of these services, it could suffer lost sales, fines and lawsuits, as well as damage to its reputation, which could adversely affect its business.

The business of Carpets is dependent in part on estimating fixed price projects correctly and completing the installations within budget. Carpets could suffer losses associated with installations on fixed price projects.

A portion of Carpets business consists of fixed price projects that are bid for and contracted based on estimated costs. The estimating process includes budgeting for the appropriate amount of materials, labor, and overhead. At times, this work can be substantial. The ability to estimate costs correctly and complete the project within budget or satisfaction without material defect is essential. In particular, there may be additional tariffs or taxes related to any inputs and finished goods imported by Carpets. Compliance with changes in taxes, tariffs and other regulations may require Carpets to alter its sourcing and make the process of estimating fixed price projects more difficult. If Carpets is unable to estimate a project properly or unable to complete the project within budget or without material defect, it may suffer losses, which could adversely affect its reputation, business, and financial condition.

Carpets depends upon its ability to attract, train, and retain highly qualified associates while also controlling its labor costs.

Customers expect a high level of customer service and product knowledge from associates employed by Carpets. To meet the needs and expectations of its customers, Carpets must attract, train and retain a large number of highly qualified associates while at the same time controlling labor costs. Its ability to control labor costs is subject to numerous external factors, including prevailing wage rates and health and other insurance costs, as well as the impact of legislation or regulations governing labor relations or healthcare benefits. Also, Carpets competes with other retail businesses for many of its associates in hourly positions, and it invests significant resources in training and motivating them to maintain a high level of job satisfaction. These positions have historically had high turnover rates, which can lead to increased training and retention costs. There is no assurance that Carpets will be able to attract or retain highly qualified associates in the future.

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

A small number of customers have historically accounted for a substantial portion of Carpets net revenue. We expect that key customers will continue to account for a substantial portion of Carpets net revenue for the foreseeable future. However, Carpets may lose these customers due to pricing, quality or other various issues. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could have a material adverse effect on its business or results of operations. For additional information regarding customer concentrations, see “Part I, Item 1. Financial Statements – Note 5. Concentration Risks.”

Historically, Carpets has purchased inventory from a small number of vendors. If these vendors became unable to provide materials promptly, Carpets would be required to find alternative vendors. Management estimates they could locate and qualify new vendors in a short period of time. For additional information regarding vendor concentrations, see “Part I, Item 1. Financial Statements – Note 5. Concentration Risks.”

Risks Related to Phoenix

Phoenix faces intense competition in the printing industry that could decrease demand for its products or force it to lower prices.

The printing industry is highly competitive. 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 Phoenix to adapt effectively and quickly to a changing competitive landscape could affect prices, margins or demand for products and services. If Phoenix is unable to respond timely and appropriately to these competitive pressures, from existing or new competitors, its business could be adversely affected.

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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the level of consumer demand for these materials and downstream products containing or using these materials;

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the supply of these materials and the impact of industry consolidation;

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government regulation and taxes;

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market uncertainty;

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volatility in the capital and credit markets;

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environmental conditions and regulations; and

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political and global economic conditions.

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.

Any disruption at a Phoenix production facility could adversely affect its results of operations.

Phoenix is dependent on certain key production facilities and certain specialized machines. Any disruption of production capabilities due to unforeseen events, including mechanical failures, labor disturbances, weather or other force majeure events, at any of its principal facilities could adversely affect its business, results of operations, cash flows, and financial condition. Further, if any of the specialized equipment that Phoenix relies upon to make its products becomes inoperable, Phoenix may experience delays in its ability to fulfill customer orders, which could harm its relationships with its customers.

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.

Phoenix may not be able to successfully integrate recently acquired businesses, and the anticipated benefits of the recently acquired businesses may not be realized.

Phoenix has completed multiple acquisitions with the expectation that such acquisitions would result in various benefits, including, among other things, complementing Phoenix’s current product offerings and allowing Phoenix to expand and diversify its product offerings by leveraging its existing core competencies. Achieving those anticipated benefits is subject to several uncertainties, including whether Phoenix can integrate the acquired businesses in an efficient and effective manner. The integration process could also take longer than Phoenix anticipates and could result in the loss of valuable employees, the disruption of each company’s ongoing businesses, processes and systems or inconsistencies in standards, controls, procedures, practices, policies and compensation arrangements, any of which could adversely affect the achievement of anticipated benefits.

Risks Related to our Businesses Generally and our Common Stock

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, Carpets, and Phoenix. Specifically, our loan facilities covenants restrict ALJ, Faneuil, Carpets, and Phoenix from:

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incurring additional debt;

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making certain capital expenditures;

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allowing liens to exist;

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entering transactions with affiliates;

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guaranteeing the debt of other entities, including joint ventures;

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merging, consolidating, or otherwise combining with another company; or

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transferring or selling our assets.

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 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.

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.”

Changes in interest rates may increase our interest expense.

As of December 31, 2019, $98.5 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 December 31, 2019, our interest expense would increase or decrease by $1.0 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 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 December 31, 2019, each 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.

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.

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 may not be able to integrate acquisitions successfully and achieve anticipated synergies, or the acquisitions and dispositions we 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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adverse developments with respect to our results of operations as a result of an acquisition which may require us to incur charges and/or substantial debt or liabilities;

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disruption of our ongoing business and diversion of resources and management attention from existing businesses and strategic matters;

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difficulty with assimilation and integration of operations, technologies, products, personnel or financial or other systems;

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increased expenses, including compensation expenses resulting from newly hired employees and/or workforce integration and restructuring;

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disruption of relationships with current and new personnel, customers and suppliers;

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integration challenges related to implementing or improving internal controls, procedures and/or policies at a business that prior to the acquisition lacked the same level of controls, procedures and/or policies;

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assumption of certain known and unknown liabilities of the acquired business;

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regulatory challenges or resulting delays; and

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potential disputes (including with respect to indemnification claims) with the buyers of disposed businesses or with the sellers of acquired businesses, technologies, services or products.

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.

Section 382 of the Code contains rules that limit the ability of a company that undergoes an “ownership change,” which is generally any change in ownership of more than 50% of its stock over a three-year period, to utilize its NOLs and certain built-in losses recognized in years after the ownership change. 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.

If we undergo an ownership change for purposes of Section 382 as a result of future transactions involving our common stock, including purchases or sales of stock between 5% stockholders, our ability to use our NOLs and to recognize certain built-in losses would be subject to the limitations of Section 382. 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, 2019, we had net operating loss carryforwards for federal income tax purposes of approximately $138.1 million that start expiring in 2022. Approximately $115.3 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.

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.

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.

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 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 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 50.6% of our outstanding common stock at January 31, 2020. Jess Ravich, our current Chief Executive Officer, beneficially owned approximately 40.9% of our common stock as of January 31, 2020. 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 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:

(a) the last day of the fiscal year in which we have total annual gross revenue of $1.07 billion or more;

(b) the last day of the fiscal year of the issuer following the fifth anniversary of the date of the first sale of common equity securities of the issuer pursuant to an effective registration statement;

(c) the date on which we have issued more than $1 billion in non-convertible debt, during the previous 3-year period, issued; or

(d) the date on which we are deemed to be a large accelerated filer.

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 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.

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:

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our quarterly operating results or the operating results of other companies in our industry;

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changes in general conditions in the economy, the financial markets or our industry;

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relatively low trading volumes;

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announcements by our competitors of significant acquisitions; and

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the occurrence of various risks described in these Risk Factors.

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.

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 December 31, 2019, a total of 1,654,000 shares of our common stock are issuable pursuant to outstanding options issued by us at a weighted-average exercise price of $3.39, and 2,526,991 shares of our common stock are issuable pursuant to outstanding warrants at a weighted-average exercise price of $1.51. It is probable that options or warrants to purchase our 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 1,280,000 shares of ALJ common stock are available for grant under our existing equity compensation plans as of December 31, 2019.

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 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. At the end of our last fiscal year, September 30, 2019, we had approximately $138.1 million of NOLs. The use of such losses to offset federal income tax would be limited if we experience an “ownership change” under Section 382. This would occur if stockholders owning (or deemed under Section 382 to own) 5% or more of our stock by value increase their collective ownership of the aggregate amount of our stock by more than 50 percentage points over a defined period. The transfer restrictions in our Restated Certificate of Incorporation were adopted to reduce the likelihood of an “ownership change” occurring as defined by Section 382. 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.

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 other than as previously disclosed in our current reports on Form 8-K filed with the SEC.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosure

Not applicable.

Item 5. Other Information

None.

Item 6 – Exhibits

Exhibit Number	Description of Exhibit	Method of Filing

3.1	Restated Certificate of Incorporation of ALJ Regional Holdings, Inc. as filed with the Secretary of State of the State of Delaware on August 17, 2018	Incorporated by reference to Exhibit 3.1 to Form 10-K as filed on December 17, 2018

3.2	Restated Bylaws of ALJ Regional Holdings, Inc., dated as of May 11, 2009	Incorporated by reference to Exhibit 3.4 to Form 10-12B as filed on February 2, 2016

31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")	Filed herewith

31.2	Certification of Chief Financial Officer and Principal Accounting Officer pursuant to Rule 13a-14(a) of the Exchange Act	Filed herewith

32.1	Certification of the Chief Executive Officer and the Chief Financial Officer and Principal Accounting Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed herewith

101.INS	XBRL Instance Document	Filed herewith

101.SCH	XBRL Taxonomy Extension Schema Document	Filed herewith

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document	Filed herewith

101.DEF	XBRL Taxonomy Extension Definition Linkbase Document	Filed herewith

101.LAB	XBRL Taxonomy Extension Label Linkbase Document	Filed herewith

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document	Filed herewith

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.

ALJ Regional Holdings, Inc.

Date: February 14, 2020

/s/ Jess Ravich

Jess Ravich

Chief Executive Officer

(Principal Executive Officer)

Date: February 14, 2020

/s/ Brian Hartman

Brian Hartman

Chief Financial Officer

(Principal Financial Officer)

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