UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

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

 

For the quarterly period ended March 31, 2017

Or

 

o	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 000-54010

 

 

B. RILEY FINANCIAL, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware	27-0223495
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
21255 Burbank Boulevard, Suite 400 Woodland Hills, CA	91367
(Address of Principal Executive Offices)	(Zip Code)

 

(818) 884-3737
(Registrant’s telephone number, including area code)

 

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes x No o

 

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

 

Large accelerated filer ¨	Accelerated filer x
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 x

 

As of May 8, 2017, there were 19,465,492 shares of the registrant’s common stock, par value $0.0001 per share, outstanding.

  

 

 

B. Riley Financial, Inc.

Quarterly Report on Form 10-Q

For The Quarter Ended March 31, 2017

Table of Contents

 

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Unaudited Financial Statements	3
	Condensed Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016	3
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2017 and 2016	4
	Condensed Consolidated Statements of Comprehensive Income for the three months ended March 31, 2017 and 2016	5
	Condensed Consolidated Statements of Equity for the three months ended March 31, 2017 and 2016	6
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016	7
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.	Controls and Procedures	35
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	36
Item 1A.	Risk Factors	36
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3.	Defaults Upon Senior Securities	36
Item 4.	Mine Safety Disclosures	36
Item 5.	Other Information	37
Item 6.	Exhibits	37
	Signatures	38

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Dollars in thousands, except par value)

 

		March 31,				December 31,
		2017				2016
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	71,541			$	112,105
Restricted cash			518				3,294
Securities and other investments owned, at fair value			41,093				16,579
Accounts receivable, net			18,022				18,989
Due from related parties			4,267				3,009
Advances against customer contracts			1,474				427
Prepaid expenses and other current assets			3,592				3,578
Total current assets			140,507				157,981
Property and equipment, net			5,409				5,785
Goodwill			48,903				48,903
Other intangible assets, net			39,239				41,166
Deferred income taxes			18,894				8,619
Other assets			1,981				2,164
Total assets		$	254,933			$	264,618
Liabilities and Equity
Current liabilities:
Accounts payable		$	2,498			$	2,703
Accrued payroll and related expenses			6,159				15,738
Accrued value added tax payable			169				6,371
Income taxes payable			15,260				9,691
Accrued expenses and other liabilities			18,389				18,505
Deferred revenue			3,815				4,130
Due to related parties and partners			416				10,037
Securities sold not yet purchased			1,659				846
Acquisition consideration payable			10,381				10,381
Mandatorily redeemable noncontrolling interests			3,850				4,019
Contingent consideration- current portion			—				1,242
Total current liabilities			62,596				83,663
Other liabilities			2,578				2,863
Senior notes payable			27,754				27,700
Total liabilities			92,928				114,226
Commitments and contingencies
B. Riley Financial, Inc. stockholders' equity:
Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued							—
Common stock, $0.0001 par value; 40,000,000 shares authorized; 19,307,008 and 19,140,342 issued and outstanding as of March 31, 2017 and December 31, 2016, respectively			2				2
Additional paid-in capital			143,228				141,170
Retained earnings			18,888				9,887
Accumulated other comprehensive loss			(1,067	)			(1,712	)
Total B. Riley Financial, Inc. stockholders' equity			161,051				149,347
Noncontrolling interests			954				1,045
Total equity			162,005				150,392
Total liabilities and equity		$	254,933			$	264,618

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(Unaudited)

(Dollars in thousands, except share data)

 

		Three Months Ended March 31,
		2017				2016
Revenues:
Services and fees		$	52,818			$	19,944
Sale of goods			79				2
Total revenues			52,897				19,946
Operating expenses:
Direct cost of services			17,601				6,683
Cost of goods sold			59				2
Selling, general and administrative expenses			24,152				11,596
Restructuring charge			374				—
Total operating expenses			42,186				18,281
Operating income			10,711				1,665
Other income (expense):
Interest income			132				3
Interest expense			(791	)			(132	)
Income before income taxes			10,052				1,536
Benefit (provision) for income taxes			3,849				(166	)
Net income			13,901				1,370
Net (loss) income attributable to noncontrolling interests			(120	)			1,122
Net income attributable to B. Riley Financial, Inc.		$	14,021			$	248
Basic income per share		$	0.73			$	0.02
Diluted income per share		$	0.71			$	0.01
Cash dividends per share		$	0.26			$	0.00
Weighted average basic shares outstanding			19,181,749				16,490,178
Weighted average diluted shares outstanding			19,626,574				16,553,953

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

(Dollars in thousands)

 

		Three Months Ended March 31,
		2017				2016
Net income		$	13,901			$	1,370
Other comprehensive income:
Change in cumulative translation adjustment			645				65
Other comprehensive income, net of tax			645				65
Total comprehensive income			14,546				1,435
Comprehensive (loss) income attributable to noncontrolling interests			(120	)			1,122
Comprehensive income attributable to B. Riley Financial, Inc.		$	14,666			$	313

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Equity

(Unaudited)

(Dollars in thousands)

 

																										Accumulated
																		Additional				Retained				Other
		Preferred Stock								Common Stock								Paid-in				Earnings				Comprehensive				Noncontrolling				Total
		Shares				Amount				Shares				Amount				Capital				(Deficit)				Loss				Interests				Equity
Balance, January 1, 2016			—			$	—				16,448,119			$	2			$	116,799			$	(6,305	)		$	(1,058	)		$	(118	)		$	109,320
Issuance of common stock for acquisition of MK Capital, LLC - contigent equity consideration on February 2, 2016			—				—				166,667				—				—				—				—				—				—
Share based compensation			—				—				—				—				437				—				—				—				437
Net income for the three months ended March 31, 2016			—				—				—				—				—				248				—				1,122				1,370
Foreign currency translation adjustment			—				—				—				—				—				—				65				—				65
Balance, March 31, 2016			—			$	—				16,614,786			$	2			$	117,236			$	(6,057	)		$	(993	)		$	1,004			$	111,192
Balance, January 1, 2017			—			$	—				19,140,342			$	2			$	141,170			$	9,887			$	(1,712	)		$	1,045			$	150,392
Issuance of common stock for acquisition of MK Capital, LLC - contingent equity consideration on February 2, 2017			—				—				166,666				—				1,151				—				—				—				1,151
Share based compensation			—				—				—				—				907				—				—				—				907
Dividends paid			—				—				—				—				—				(5,020	)			—				—				(5,020	)
Net income (loss) for the three months ended March 31, 2017			—				—				—				—				—				14,021				—				(91	)			13,930
Foreign currency translation adjustment			—				—				—				—				—				—				645				—				645
Balance, March 31, 2017			—			$	—				19,307,008			$	2			$	143,228			$	18,888			$	(1,067	)		$	954			$	162,005

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

 

		Three Months Ended March 31,
		2017				2016
Cash flows from operating activities:
Net income		$	13,901			$	1,370
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization			2,042				203
Provision (recoveries) for doubtful accounts			325				(20	)
Share based compensation			907				437
Non-cash interest and other			15				31
Effect of foreign currency on operations			(1,167	)			–
Deferred income taxes			(9,124	)			152
Income allocated and fair value adjustment for mandatorily redeemable noncontrolling interests			402				425
Change in operating assets and liabilities:
Accounts receivable and advances against customer contracts			(347	)			6,442
Securities and other investments owned			(24,514	)			(67	)
Goods held for sale or auction			–				2
Prepaid expenses and other assets			242				(2,060	)
Accounts payable, accrued payroll and related expenses, accrued value added tax payable and other accrued expenses			(11,127	)			(6,643	)
Amounts due to (from) related parties and partners			(10,908	)			(1,556	)
Securities sold, not yet purchased			813				239
Deferred revenue			(315	)
Net cash used in operating activities			(38,855	)			(1,045	)
Cash flows from investing activities:
Purchases of property and equipment			(191	)			(18	)
Proceeds from sales of property and equipment			6				–
Proceeds from sale of intangible assets			453				–
Decrease (increase) in restricted cash			2,852				(1	)
Net cash provided by (used in) investing activities			3,120				(19	)
Cash flows from financing activities:
Repayment of revolving line of credit			–				(272	)
Payment of contingent consideration			(1,250	)			(1,250	)
Dividends paid			(5,020	)			–
Distribution to noncontrolling interests			(571	)			(665	)
Net cash used in financing activities			(6,841	)			(2,187	)
Decrease in cash and cash equivalents			(42,576	)			(3,251	)
Effect of foreign currency on cash			2,012				25
Net decrease in cash and cash equivalents			(40,564	)			(3,226	)
Cash and cash equivalents, beginning of period			112,105				30,012
Cash and cash equivalents, end of period		$	71,541			$	26,786
Supplemental disclosures:
Interest paid		$	1,386			$	7
Taxes paid		$	71			$	369

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except share data)

 

NOTE 1—ORGANIZATION, BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

 

Organization and Nature of Operations

 

B. Riley Financial, Inc. and its subsidiaries (collectively the “Company”) provide investment banking and financial services to corporate, institutional and high net worth clients, and asset disposition, valuation and appraisal and capital advisory services to a wide range of retail, wholesale and industrial clients, as well as lenders, capital providers, private equity investors and professional services firms throughout the United States, Australia, Canada, and Europe and with the acquisition of United Online, Inc. (“UOL”) on July 1, 2016, provide consumer Internet access and related subscription services.

 

With the acquisition of UOL, the Company now operates in four operating segments: (i) Capital Markets, through which the Company provides investment banking, corporate finance, restructuring, research, sales and trading and wealth management services to corporate, institutional and high net worth clients; (ii) Auction and Liquidation, through which the Company provides auction and liquidation services to help clients dispose of assets that include multi-location retail inventory, wholesale inventory, trade fixtures, machinery and equipment, intellectual property and real property; (iii) Valuation and Appraisal, through which the Company provides valuation and appraisal services to clients with independent appraisals in connection with asset based loans, acquisitions, divestitures and other business needs and (iv) Principal Investments - United Online, through which the Company provides consumer Internet access and related subscription services.

 

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

(a)

Principles of Consolidation and Basis of Presentation

 

The condensed consolidated financial statements include the accounts of B. Riley Financial, Inc. and its wholly-owned and majority-owned subsidiaries. The condensed consolidated financial statements also include the accounts of (a) Great American Global Partners, LLC which is controlled by the Company as a result of its ownership of a 50% member interest, appointment of two of the three executive officers and significant influence over the funding of operations, and (b) GA Retail Investments, L.P. which is controlled by the Company as a result of its ownership of a 50% partnership interest, appointment of executive officers and significant influence over the operations. All intercompany accounts and transactions have been eliminated upon consolidation. The condensed consolidated financial statements have been prepared by the Company, without audit, pursuant to interim financial reporting guidelines and the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company’s management, all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the periods presented have been included. These condensed consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission on March 10, 2017. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the operating results to be expected for the full fiscal year or any future periods.

 

(b)

Use of Estimates

 

The preparation of the condensed consolidated financial statements in accordance with Generally Accepted Accounting Principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and reported amounts of revenue and expense during the reporting period. Estimates are used when accounting for certain items such as valuation of securities, reserves for accounts receivable and slow moving goods held for sale or auction, the carrying value of intangible assets and goodwill, the fair value of mandatorily redeemable noncontrolling interests, fair value of share based arrangements, fair value of contingent consideration in business combination’s and accounting for income tax valuation allowances. Estimates are based on historical experience, where applicable, and assumptions that management believes are reasonable under the circumstances. Due to the inherent uncertainty involved with estimates, actual results may differ.

 

(c)

Revenue Recognition

 

Revenues are recognized in accordance with the accounting guidance when persuasive evidence of an arrangement exists, the related services have been provided, the fee is fixed or determinable, and collection is reasonably assured.

 

 

Revenues in the Capital Markets segment are primarily comprised of (i) fees earned from corporate finance, investment banking, restructuring and wealth management services; and (ii) revenues from sales and trading activities.

 

Fees earned from corporate finance and investment banking services are derived from debt, equity and convertible securities offerings in which the Company acted as an underwriter or placement agent and from financial advisory services rendered in connection with client mergers, acquisitions, restructurings, recapitalizations and other strategic transactions. Fees from underwriting activities are recognized in earnings when the services related to the underwriting transaction are completed under the terms of the engagement and when the income was determined and is not subject to any other contingencies.

 

Fees earned from wealth management services consist primarily of investment management fees that are recognized over the period the services are provided. Investment management fees are primarily comprised of fees for investment management services and are generally based on the dollar amount of the assets being managed.

 

Revenues from sales and trading includes (i) commissions resulting from equity securities transactions executed as agent or principal and are recorded on a trade date basis, (ii) related net trading gains and losses from market making activities and from the commitment of capital to facilitate customer orders, (iii) fees paid for equity research and (iv) principal transactions which include realized and unrealized net gains and losses resulting from our principal investments in equity and other securities for the Company’s account.

 

Revenues in the Auction and Liquidation segment are comprised of (i) commissions and fees earned on the sale of goods at auctions and liquidations; (ii) revenues from auction and liquidation services contracts where the Company guarantees a minimum recovery value for goods being sold at auction or liquidation; (iii) revenue from the sale of goods that are purchased by the Company for sale at auction or liquidation sales events; (iv) fees earned from real estate services and the origination of loans; (v) revenues from financing activities is recorded over the lives of related loans receivable using the interest method; and (vi) revenues from contractual reimbursable expenses incurred in connection with auction and liquidation contracts.

 

Commission and fees earned on the sale of goods at auction and liquidation sales are recognized when evidence of an arrangement exists, the sales price has been determined, title has passed to the buyer and the buyer has assumed the risks of ownership, and collection is reasonably assured. The commission and fees earned for these services are included in revenues in the accompanying condensed consolidated statements of operations. Under these types of arrangements, revenues also include contractual reimbursable costs which totaled $10,610 and $3,018 for the three months ended March 31, 2017 and 2016, respectively.

 

Revenues earned from auction and liquidation services contracts where the Company guarantees a minimum recovery value for goods being sold at auction or liquidation are recognized based on proceeds received. The Company records proceeds received from these types of engagements first as a reduction of contractual reimbursable expenses, second as a recovery of its guarantee and thereafter as revenue, subject to such revenue meeting the criteria of having been fixed or determinable. Contractual reimbursable expenses and amounts advanced to customers for minimum guarantees are initially recorded as advances against customer contracts in the accompanying condensed consolidated balance sheets. If, during the auction or liquidation sale, the Company determines that the proceeds from the sale will not meet the minimum guaranteed recovery value as defined in the auction or liquidation services contract, the Company accrues a loss on the contract in the period that the loss becomes known.

 

The Company also evaluates revenue from auction and liquidation contracts in accordance with the accounting guidance to determine whether to report Auction and Liquidation segment revenue on a gross or net basis. The Company has determined that it acts as an agent in a substantial majority of its auction and liquidation services contracts and therefore reports the auction and liquidation revenues on a net basis.

 

Revenues from the sale of goods are recorded gross and are recognized in the period in which the sale of goods held for sale or auction are completed, title to the property passes to the purchaser and the Company has fulfilled its obligations with respect to the transaction. These revenues are primarily the result of the Company acquiring title to merchandise with the intent of selling the items at auction or for augmenting liquidation sales. For liquidation contracts where we take title to retail goods, our net sales represent gross sales invoiced to customers, less certain related charges for discounts, returns, and other promotional allowances and are recorded net of sales or value added tax.

 

Revenues in the Valuation and Appraisal segment are primarily comprised of fees for valuation and appraisal services. Revenues are recognized upon the delivery of the completed services to the related customers and collection of the fee is reasonably assured. Revenues in the Valuation and Appraisal segment also include contractual reimbursable costs which totaled $665 and $679 for the three months ended March 31, 2017 and 2016, respectively.

 

 

Revenues in the Principal Investments - United Online segment are primarily comprised of services revenues, which are derived primarily from fees charged to pay accounts; advertising and other revenues; and products revenues, which are derived primarily from the sale mobile broadband service devices, including the related shipping and handling fees.

 

Service revenues are derived primarily from fees charged to pay accounts and are recognized in the period in which fees are fixed or determinable and the related services are provided to the customer. The Company’s pay accounts generally pay in advance for their services by credit card, PayPal, automated clearinghouse or check, and revenues are then recognized ratably over the service period. Advance payments from pay accounts are recorded in the condensed consolidated balance sheet as deferred revenue. In circumstances where payment is not received in advance, revenues are only recognized if collectability is reasonably assured.

 

Advertising revenues consist primarily of amounts from the Company’s Internet search partner that are generated as a result of users utilizing the partner’s Internet search services and amounts generated from display advertisements. The Company recognizes such advertising revenues in the period in which the advertisement is displayed or, for performance-based arrangements, when the related performance criteria are met. In determining whether an arrangement exists, the Company ensures that a written contract is in place, such as a standard insertion order or a customer-specific agreement. The Company assesses whether performance criteria have been met and whether the fees are fixed or determinable based on a reconciliation of the performance criteria and the payment terms associated with the transaction. The reconciliation of the performance criteria generally includes a comparison of customer-provided performance data to the contractual performance obligation and to internal or third-party performance data in circumstances where that data is available.

 

(d)

Direct Cost of Services

 

Direct cost of services relate to service and fee revenues. The costs consist of employee compensation and related payroll benefits, travel expenses, the cost of consultants assigned to revenue-generating activities and direct expenses billable to clients in the Valuation and Appraisal segment. Direct costs of services include participation in profits under collaborative arrangements in which the Company is a majority participant. Direct costs of services also include the cost of consultants and other direct expenses related to auction and liquidation contracts pursuant to commission and fee based arrangements in the Auction and Liquidation segment. Direct cost of services in the Principal Investments - United Online segment include cost of telecommunications and data center costs, personnel and overhead-related costs associated with operating the Company’s networks and data centers, depreciation of network computers and equipment, third party advertising sales commissions, license fees, costs related to providing customer support, costs related to customer billing and processing of customer credit cards and associated bank fees. Direct cost of services does not include an allocation of the Company’s overhead costs.

 

(e)

Concentration of Risk

 

Revenues from one liquidation service contract to a retailer represented 12.2% of total revenues during the three months ended March 31, 2017. Revenues in the Capital Markets, Auction and Liquidation, Valuation and Appraisal and Principal Investments - United Online segment are primarily generated in the United States, Australia, Canada and Europe.

 

The Company’s activities in the Auction and Liquidation segment are executed frequently with, and on behalf of, distressed customers and secured creditors. Concentrations of credit risk can be affected by changes in economic, industry, or geographical factors. The Company seeks to control its credit risk and potential risk concentration through risk management activities that limit the Company’s exposure to losses on any one specific liquidation services contract or concentration within any one specific industry. To mitigate the exposure to losses on any one specific liquidation services contract, the Company sometimes conducts operations with third parties through collaborative arrangements.

 

The Company maintains cash in various federally insured banking institutions. The account balances at each institution periodically exceed the Federal Deposit Insurance Corporation’s (“FDIC”) insurance coverage, and as a result, there is a concentration of credit risk related to amounts in excess of FDIC insurance coverage. The Company has not experienced any losses in such accounts. The Company also has substantial cash balances from proceeds received from auctions and liquidation engagements that are distributed to parties in accordance with the collaborative arrangements.

 

(f)

Advertising Expenses

 

The Company expenses advertising costs, which consist primarily of costs for printed materials, as incurred. Advertising costs totaled $176 and $193 for the three months ended March 31, 2017 and 2016, respectively. Advertising expense is included as a component of selling, general and administrative expenses in the accompanying condensed consolidated statement of operations.

 

 

(g)

Share-Based Compensation

 

The Company’s share based payment awards principally consist of grants of restricted stock and restricted stock units. In accordance with the applicable accounting guidance, share based payment awards are classified as either equity or liabilities. For equity-classified awards, the Company measures compensation cost for the grant of membership interests at fair value on the date of grant and recognizes compensation expense in the condensed consolidated statement of operations over the requisite service or performance period the award is expected to vest. The fair value of the liability-classified award will be subsequently remeasured at each reporting date through the settlement date. Change in fair value during the requisite service period will be recognized as compensation cost over that period.

 

(h)

Income Taxes

 

The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the condensed consolidated financial statements or tax returns. Deferred tax liabilities and assets are determined based on the difference between the financial statement basis and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company estimates the degree to which tax assets and credit carryforwards will result in a benefit based on expected profitability by tax jurisdiction. A valuation allowance for such tax assets and loss carryforwards is provided when it is determined to be more likely than not that the benefit of such deferred tax asset will not be realized in future periods. Tax benefits of operating loss carryforwards are evaluated on an ongoing basis, including a review of historical and projected future operating results, the eligible carryforward period, and other circumstances. If it becomes more likely than not that a tax asset will be used, the related valuation allowance on such assets would be reduced.

 

The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. Once this threshold has been met, the Company's measurement of its expected tax benefits is recognized in its financial statements. The Company accrues interest on unrecognized tax benefits as a component of income tax expense. Penalties, if incurred, would be recognized as a component of income tax expense.

 

(i)

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

 

(j)

Restricted Cash

 

As of March 31, 2017, restricted cash included $518 of cash segregated in a special bank accounts for the benefit of customers related to our broker dealer subsidiary and collateral for one of our telecommunication suppliers. As of December 31, 2016, restricted cash included $1,440 of cash collateral related to a retail liquidation engagement in Australia, $1,320 of cash collateral for foreign exchange contracts and $534 cash segregated in a special bank accounts for the benefit of customers related to our broker dealer subsidiary and collateral for one of our telecommunication suppliers.

 

(k)

Accounts Receivable

 

Accounts receivable represents amounts due from the Company’s auction and liquidation, valuation and appraisal, capital markets and principal investments - United Online customers. The Company maintains an allowance for doubtful accounts for estimated losses inherent in its accounts receivable portfolio. In establishing the required allowance, management utilizes a specific customer identification methodology. Management also considers historical losses adjusted for current market conditions and the customers’ financial condition and the current receivables aging and current payment patterns. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance sheet credit exposure related to its customers. Bad debt expense and changes in the allowance for doubtful accounts for the three months ended March 31, 2017 and 2016 are included in Note 4.

 

(l)

Advances Against Customer Contracts

 

Advances against customer contracts represent advances of contractually reimbursable expenses incurred prior to, and during the term of the auction and liquidation services contract. These advances are charged to expense in the period that revenue is recognized under the contract.

 

 

(m)

Property and Equipment

 

Property and equipment are stated at cost. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Property and equipment held under capital leases are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset. Depreciation and amortization expense was $520 and $91 for the three months ended March 31, 2017 and 2016, respectively.

 

(n)

Securities and Other Investments Owned and Securities Sold Not Yet Purchased

 

Securities and other investments owned consist of marketable securities and investments in partnership interests, loans receivable and other securities recorded at fair value.  Securities sold, but not yet purchased represents obligations of the Company to deliver the specified security at the contracted price and thereby create a liability to purchase the security in the market at prevailing prices.  Changes in the value of these securities are reflected currently in the results of operations.

 

As of March 31, 2017 and December 31, 2016, the Company’s securities and other investments owned owned and securities sold not yet purchased at fair value consisted of the following securities:

 

		March 31,				December 31,
		2017				2016
Securities and other investments owned
Common stocks		$	7,273			$	2,084
Corporate bonds			1,771				1,025
Loans receivable			11,831				-
Partnership interests			20,218				13,470
		$	41,093			$	16,579
Securities sold not yet purchased
Common stocks		$	105			$	-
Corporate bonds			1,554				846
		$	1,659			$	846

 

(o)

Fair Value Measurements

 

The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market. In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) for identical instruments that are highly liquid, observable and actively traded in over-the-counter markets. Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations whose inputs are observable and can be corroborated by market data. Level 3 inputs are unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 

 

The Company’s securities owned and securities sold and not yet purchased are comprised of common stocks, corporate bonds and investments in partnerships and loans receivable. Investments in common stocks are based on quoted prices in active markets which are included in Level 1 of the fair value hierarchy. The Company also holds nonpublic common stocks and warrants for which there is little or no public market and fair value is determined by management on a consistent basis. For investments where little or no public market exists, management’s determination of fair value is based on the best available information which may incorporate management’s own assumptions and involves a significant degree of judgment, taking into consideration various factors including earnings history, financial condition, recent sales prices of the issuer’s securities and liquidity risks. These investments are included in Level 3 of the fair value hierarchy. Investments in partnership interests include investments in private equity partnerships that primarily invest in equity securities, bonds, and direct lending funds. The Company’s partnership interests are valued based on the Company’s proportionate share of the net assets of the partnership which is derived from the most recent statements received from the general partner which are included in Level 2 of the fair value hierarchy. Loans receivable are valued at fair value based on the market yield of similar second lien loans collateralized by inventory and other assets of the borrower and included in Level 3 of the fair value hierarchy.

  

The fair value of mandatorily redeemable noncontrolling interests is determined based on the issuance of similar interests for cash, references to industry comparables, and relied, in part, on information obtained from appraisal reports and internal valuation models.

 

The following tables present information on the financial assets and liabilities measured and recorded at fair value on a recurring basis as of March 31, 2017 and December 31, 2016.

 

		Financial Assets and Liabilities Measured at Fair Value
		on a Recurring Basis at March 31, 2017, Using
						Quoted prices in				Other				Significant
		Fair Value at				active markets for				observable				unobservable
		March 31,				identical assets				inputs				inputs
		2017				(Level 1)				(Level 2)				(Level 3)
Assets:
Securities owned
Common stocks		$	7,273			$	7,272			$	-			$	1
Corporate bonds			1,771				-				1,611				160
Loan receivable			11,831				-				-				11,831
Partnership interests			20,218				4,403				44				15,771
Total assets measured at fair value		$	41,093			$	11,675			$	1,655			$	27,763
Liabilities:
Securities sold not yet purchased
Common stocks		$	105			$	-			$	105			$	-
Corporate bonds			1,554				-				1,554				-
Total securities sold not yet purchased			1,659				-				1,659				-
Mandatorily redeemable noncontrolling interests issued after November 5, 2003			3,190				-				-				3,190
Total liabilities measured at fair value		$	4,849			$	-			$	1,659			$	3,190

 

		Financial Assets and Liabilities Measured at Fair Value
		on a Recurring Basis at December 31, 2016, Using
						Quoted prices in				Other				Significant
		Fair Value at				active markets for				observable				unobservable
		December 31,				identical assets				inputs				inputs
		2016				(Level 1)				(Level 2)				(Level 3)
Assets:
Securities owned
Common stocks		$	2,084			$	1,785			$	-			$	299
Corporate bonds			1,025				-				865				160
Partnership interests			13,470				-				44				13,426
Total assets measured at fair value		$	16,579			$	1,785			$	909			$	13,885
Liabilities:
Securities sold not yet purchased
Corporate bonds		$	846			$	-			$	846			$	-
Mandatorily redeemable noncontrolling interests issued after November 5, 2003		$	3,214			$	-			$	-			$	3,214
Contingent consideration		$	1,242			$	-			$	-			$	1,242
Total liabilities measured at fair value		$	5,302			$	-			$	846			$	4,456

 

 

The changes in Level 3 fair value hierarchy during the three months ended March 31, 2017 and 2016 is as follows:

 

		Level 3				Level 3 Changes During the Year																Level 3
		Balance at				Fair				Relating to				Purchases,				Transfer in				Balance at
		Beginning of				Value				Undistributed				Sales and				and/or out				End of
		Period				Adjustments				Earnings				Settlements				of Level 3				Period
Three Months Ended March 31, 2017
Common stocks		$	299			$	87			$	-			$	(385	)		$	-			$	1
Corporate bonds			160				-				-				-				-				160
Loan receivable			-				-				-				11,831				-				11,831
Partnership interests			13,426				2,061				-				284				-				15,771
Mandatorily redeemable noncontrolling interests issued after November 5, 2003			3,214				-				(24	)			-				-				3,190
Contingent consideration			1,242				8				-				(1,250	)			-				-
Three Months Ended March 31, 2016
Common stocks		$	290			$	(80	)		$	-			$	-			$	-			$	210
Partnership interests			1,766				65				(15	)			-				-				1,816
Mandatorily redeemable noncontrolling interests issued after November 5, 2003			2,330				-				(99	)			-				-				2,231
Contingent consideration			2,391				31				-				(1,250	)			-				1,172

  

The fair value adjustment for contingent consideration of $8 and $31 represents imputed interest for the three months ended March 31, 2017 and 2016, respectively. The amount reported in the table above for the three months ended March 31, 2017 and 2016 includes the amount of undistributed earnings attributable to the noncontrolling interests that is distributed on a quarterly basis.

 

The carrying amounts reported in the condensed consolidated financial statements for cash, restricted cash, accounts receivable, accounts payable, accrued payroll and related, accrued value added tax, income taxes payable and accrued expenses and other current liabilities approximate fair value based on the short-term maturity of these instruments.

 

The carrying amount of the senior notes payable approximates fair value because the contractual interest rates or effective yields of such instruments are consistent with current market rates of interest for instruments of comparable credit risk.

 

(p)

Contingent Consideration

 

In connection with the acquisition of MK Capital Advisors, LLC (“MK Capital”) on February 2, 2015, the purchase agreement required the payment of contingent consideration to the former members of MK Capital in the form of future cash payments of $1,250 and issuance of 166,667 shares of common stock on the first anniversary date of the closing (February 2, 2016) and a final cash payment of $1,250 and issuance of 166,666 shares of common stock on the second anniversary date of the closing (February 2, 2017). The contingent cash consideration was classified as a liability in the condensed balance sheets in accordance with ASC 805, “Business Combination” (“ASC 805”). The fair value of the contingent cash consideration was discounted at 8.0%. The balance of the contingent consideration liability in the condensed consolidated balance sheet was $1,242 (discount of $8) at December 31, 2016. Imputed interest expense totaled $8 and $31 for the three months ended March 31, 2017 and 2016, respectively. The fair value of the contingent stock consideration was classified as equity in accordance with ASC 805.

 

The contingent cash and stock consideration was payable on the first and second anniversary dates of the closing provided that MK Capital generated a minimum amount of gross revenues as defined in the purchase agreement for the twelve months following the first and second anniversary dates of the closing. MK Capital achieved the minimum amount of revenues for the first and second anniversary periods and the contingent cash consideration and contingent stock consideration for the first anniversary period was paid and issued on February 2, 2016 and for the second anniversary period was paid and issued on February 2, 2017. Upon the payment of the contingent stock consideration on February 2, 2017, the Company recorded a deferred tax benefit and an increase to additional paid-in capital in the amount of $1,151 in accordance with ASC 805.

 

(q)

Derivative and Foreign Currency Translation

 

The Company periodically uses derivative instruments, which primarily consist of the purchase of forward exchange contracts, for certain auction and liquidation engagements with operations outside the United States. During the three months ended March 31, 2017, the Company’s use of derivatives consisted of the purchase of forward exchange contracts in the amount of $25,000 Australian dollars that was settled on January 31, 2017.  The Company did not use any derivative contracts during the three months ended March 31, 2016.  The forward exchange contract was entered into to improve the predictability of cash flows related to a retail store liquidation engagement that was completed in December 2016.  The net loss from forward exchange contracts was $70 during the three months ended March 31, 2017. This amount is reported as a component of selling, general and administrative expenses in the condensed consolidated financial statements of operations.

 

 

The Company transacts business in various foreign currencies. In countries where the functional currency of the underlying operations has been determined to be the local country's currency, revenues and expenses of operations outside the United States are translated into United States dollars using average exchange rates while assets and liabilities of operations outside the United States are translated into United States dollars using year-end exchange rates. The effects of foreign currency translation adjustments are included in stockholders' equity as a component of accumulated other comprehensive income in the accompanying condensed consolidated balance sheets. Transaction losses were $324 and $145 during the three months ended March 31, 2017 and 2016, respectively. These amounts are included in selling, general and administrative expenses in our condensed consolidated statements of operations.

 

(r)

Recent Accounting Pronouncements

 

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02: Leases (Topic 842) (“ASU 2016-02”). The amendments in this update require lessees, among other things, to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous authoritative guidance. This update also introduces new disclosure requirements for leasing arrangements. ASU 2016-02 will be effective for the Company in fiscal year 2019, but early application is permitted. The Company is currently evaluating the impact of this update on the consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606).   Under this ASU and subsequently issued amendments, revenue are recognized at the time when goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to receive in exchange for those goods or services. This standard sets forth a five-step revenue recognition model which replaces the current revenue recognition guidance in its entirety and is intended to eliminate numerous industry-specific pieces of revenue recognition guidance.  This standard is effective in the first quarter of 2018 for public companies and requires either a retrospective or a modified retrospective approach to adoption.  The Company believes the adoption of this standard may impact engagements that contain performance-based arrangements in which a success or completion fee is earned when and if certain predefined outcomes occur and engagements and contracts where services are provided under fixed-fees arrangements that have multiple performance obligations. The Company has not completed an assessment and has not yet determined whether the impact of the adoption of this standard on the consolidated financial statements will be material. The Company will adopt this standard on January 1, 2018 but have not concluded on a transition approach. The Company expects to complete the assessment process, including selecting a transition method for adoption during third quarter of 2017.

 

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments in this update do not change the core principle of the guidance as noted above at ASU No. 2014-09. The amendments clarify the implementation guidance on principal versus agent considerations. The effective date and transition requirements for the amendments in this update are the same as the effective date and transition requirements of ASU No. 2014-09. The Company has not yet adopted this update and is currently evaluating the impact it may have on its financial condition and results of operations.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15), which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. ASU 2016-15 is effective for us in our first quarter of fiscal year 2019 , but early application is permitted. The Company has not yet adopted this update and is currently evaluating the impact it may have on its financial condition and results of operations.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350) Simplifying the Test for Goodwill Impairment.   This standard simplifies the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.  The revised guidance will be applied prospectively, and is effective for calendar year-end SEC filers for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019.  Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  The Company has not yet adopted this update and currently evaluating the effect this new standard will have on its financial condition and results of operations.

 

 

NOTE 3— ACQUISITIONS

 

On May 4, 2016, the Company entered into a definitive agreement and plan of merger to acquire all of the outstanding common stock of UOL, a provider of consumer Internet access and related subscription services, for $11.00 per share, or approximately $169,354 in aggregate merger consideration. The consideration includes $10,381 that remains payable at March 31, 2017, which is included in acquisition consideration payable in the condensed consolidated balance sheet, pending the outcome of the legal matter more fully described in Note 10.  The shareholders of UOL approved the acquisition on June 29, 2016 and customary closing conditions were satisfied and the acquisition was completed on July 1, 2016. The acquisition of UOL allows the Company to benefit from the expected cash flows of UOL due in part to planned synergies from the elimination of duplicate overhead functions with the Company. The acquisition of UOL is accounted for using the purchase method of accounting.

 

The assets and liabilities of UOL, both tangible and intangible, were recorded at their estimated fair values as of the July 1, 2016 acquisition date for UOL. The application of the purchase method of accounting resulted in goodwill of $14,375 which represents expected overhead synergies and acquired workforce. The revenue and earnings of UOL included in our condensed consolidated financial statements for the three months ended March 31, 2017 was $13,382 and $4,202, respectively.

 

Pro Forma Financial Information

 

The unaudited financial information in the table below summarizes the combined results of operations of the Company and UOL, as though it had occurred as of January 1, 2016. The pro forma financial information presented includes the effects of adjustments related to the amortization charges from the acquired intangible assets and the elimination of certain activities excluded from the transaction. The pro forma financial information as presented below is for informational purposes only and is not necessarily indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of the earliest period presented, nor does it intend to be a projection of future results.

 

		Pro Forma Unaudited
		Three Months Ended
		March 31,
		2016
Revenues		$	38,382
Net loss attributable to B. Riley Financial, Inc.		$	(2,132	)
Basic loss per share		$	(0.13	)
Diluted loss per share		$	(0.13	)
Weighted average basic shares outstanding			16,490,178
Weighted average diluted shares outstanding			16,490,178

 

NOTE 4— ACCOUNTS RECEIVABLE

 

The components of accounts receivable, net, include the following:

 

		March 31,				December 31,
		2017				2016
Accounts receivable		$	14,662			$	16,610
Investment banking fees, commissions and other receivables			807				576
Unbilled receivables			3,109				2,058
Total accounts receivable			18,578				19,244
Allowance for doubtful accounts			(556	)			(255	)
Accounts receivable, net		$	18,022			$	18,989

 

 

Additions and changes to the allowance for doubtful accounts consist of the following:

 

		Three Months Ended
		March 31,
		2017				2016
Balance, beginning of period		$	255			$	89
Add: Additions to reserve			325				5
Less: Write-offs			(24	)			-
Less: Recoveries			-				(25	)
Balance, end of period		$	556			$	69

 

Unbilled receivables represent the amount of contractual reimbursable costs and fees for services performed in connection with fee and service based auction and liquidation contracts.

 

NOTE 5— GOODWILL AND OTHER INTANGIBLE ASSETS

 

Goodwill of $48,903 at March 31, 2017 and December 31, 2016 is comprised of $28,840 in the Capital Markets segment, $1,975 in the Auction and Liquidation segment, $3,713 in the Valuation and Appraisal segment, and $14,375 in the Principal Investments - United Online segment. There were no changes in goodwill during the three months ended March 31, 2017.

 

Intangible assets consisted of the following:

 

				March 31, 2017												December 31, 2016
				Gross												Gross
				Carrying				Accumulated				Intangibles				Carrying				Accumulated				Intangibles
		Useful Life		Value				Amortization				Net				Value				Amortization				Net
Amortizable assets:
Customer relationships		4 to 13 Years		$	37,300			$	4,290			$	33,010			$	37,300			$	3,100			$	34,200
Domain names		7 Years			967				104				863				1,419				101				1,318
Advertising relationships		8 Years			100				9				91				100				6				94
Internally developed software		0.5 to 4 Years			3,333				795				2,538				3,333				550				2,783
Trademarks		8 Years			1,100				103				997				1,100				69				1,031
Non-amortizable assets:
Tradenames					1,740				-				1,740				1,740				-				1,740
Total intangible assets				$	44,540			$	5,301			$	39,239			$	44,992			$	3,826			$	41,166

 

Amortization expense was $1,522 and $112 for the three months ended March 31, 2017 and 2016, respectively. At March 31, 2017, estimated future amortization expense is $4,386, $5,592, $5,487, $5,105 and $4,723 for the years ended December 31, 2017 (remaining nine months), 2018, 2019, 2020 and 2021, respectively. The estimated future amortization expense after December 31, 2021 is $12,206.

 

NOTE 6— CREDIT FACILITIES

 

Credit facilities consist of the following arrangements:

 

(a)

$200,000 Asset Based Credit Facility

 

On April 21, 2017, the Company amended its credit agreement (as amended, the “Credit Agreement”) governing its asset based credit facility with Wells Fargo Bank, National Association (“Wells Fargo Bank”) to increase the maximum borrowing limit from $100,000 to $200,000. Such amendment, among other things, also extended the expiration date of the credit facility from July 15, 2018 to April 21, 2022. The Credit Agreement continues to allow for borrowings under the separate credit agreement (a “UK Credit Agreement”) which was dated March 19, 2015 with an affiliate of Wells Fargo Bank which provides for the financing of transactions in the United Kingdom. The facility allows the Company to borrow up to 50 million British Pounds. Any borrowings on the UK Credit Agreement reduce the availability on the asset based $200,000 credit facility. The UK Credit Agreement is cross collateralized and integrated in certain respects with the Credit Agreement. Cash advances and the issuance of letters of credit under the credit facility are made at the lender’s discretion. The letters of credit issued under this facility are furnished by the lender to third parties for the principal purpose of securing minimum guarantees under liquidation services contracts more fully described in Note 2(c). All outstanding loans, letters of credit, and interest are due on the expiration date which is generally within 180 days of funding. The credit facility is secured by the proceeds received for services rendered in connection with liquidation service contracts pursuant to which any outstanding loan or letters of credit are issued and the assets that are sold at liquidation related to such contract. The Company paid Wells Fargo Bank a closing fee in the amount of $500 in connection with the recent amendment to the Credit Agreement. The interest rate for each revolving credit advance under the Credit Agreement is, subject to certain terms and conditions, equal to the LIBOR plus a margin of 2.25% to 3.25% depending on the type of advance and the percentage such advance represents of the related transaction for which such advance is provided. The credit facility also provides for success fees in the amount of 2.5% to 17.5% of the net profits, if any, earned on the liquidation engagements funded under the Credit Agreement as set forth therein. Interest expense totaled $27 and $23 for the three months ended March 31, 2017 and 2016, respectively. There was no outstanding balance under this credit facility at March 31, 2017 and December 31, 2016.

 

 

The Credit Agreement governing the credit facility contains certain covenants, including covenants that limit or restrict the Company’s ability to incur liens, incur indebtedness, make investments, dispose of assets, make certain restricted payments, merge or consolidate and enter into certain transactions with affiliates. Upon the occurrence of an event of default under the Credit Agreement, the lender may cease making loans, terminate the Credit Agreement and declare all amounts outstanding under the Credit Agreement to be immediately due and payable. The Credit Agreement specifies a number of events of default (some of which are subject to applicable grace or cure periods), including, among other things, nonpayment defaults, covenant defaults, cross-defaults to other material indebtedness, bankruptcy and insolvency defaults, and material judgment defaults.

 

(b)

$20,000 UOL Line of Credit

 

On April 13, 2017, UOL, in the capacity as borrower, entered into a credit agreement (the “UOL Credit Agreement”) with the Banc of California, N.A. in the capacity as agent and lender. The UOL Credit Agreement provides for a revolving credit facility under which UOL may borrow (or request the issuance of letters of credit) up to $20,000 which amount is reduced by $1,500 commencing on June 30, 2017 and on the last day of each calendar quarter thereafter. The final maturity date is April 13, 2020.  The proceeds of the UOL Credit Agreement can be used (a) for working capital and general corporate purposes and/or (b) to pay dividends or permitted tax distributions to its parent company, subject to the terms of the UOL Credit Agreement. Borrowings under the UOL Credit Agreement will bear interest at a rate equal to (a) (i) the base rate (the greater of the federal funds rate plus one half of one percent (0.5%), or the prime rate) for U.S. dollar loans or (ii) at UOL’s option, the LIBOR Rate for Eurodollar loans, plus (b) the applicable margin rate, which ranges from two percent (2%) to three and one-half percent (3.5%) per annum, based upon UOL’s ratio of funded indebtedness to adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) for the preceding four (4) fiscal quarters. Interest payments are to be made each one, three or six months for Eurodollar loans, and quarterly for U.S. dollar loans.

 

UOL paid a commitment fee equal to 1.00% of the aggregate commitments upon the closing of the UOL Credit Agreement. The UOL Credit Agreement also provides for an unused line fee payable quarterly, in arrears, in an amount equal to: (a) 0.50% per annum times the amount of the unused revolving commitment that is less than or equal to the amount of the cash maintained in accounts with the agent (as depositary bank); plus (b) 1.00% per annum times the amount of the unused revolving commitment that is greater than the amount of the cash maintained in accounts with the agent (as depositary bank). Any amounts outstanding under the UOL Credit Facility are due at maturity.

 

Each of UOL’s U.S. subsidiaries is a guarantor of all obligations under the UOL Credit Agreement and are parties to the UOL Credit Agreement in such capacity (collectively, the “Secured Guarantors”). In addition, the Company and B. Riley Principal Investments, LLC, the parent corporation of UOL and a subsidiary of the Company, are guarantors of the obligations under the UOL Credit Agreement pursuant to standalone guaranty agreements pursuant to which the shares of outstanding capital stock of UOL are pledged as collateral. The obligations under the UOL Credit Agreement are secured by first-priority liens on, and a first-priority security interest in, substantially all of the assets of UOL and the Secured Guarantors, including a pledge of (a) 100% of the equity interests of the Secured Guarantors and (b) 65% of the equity interests in United Online Software Development (India) Private Limited, a private limited company organized under the laws of India. Such security interests are evidenced by pledge, security and other related agreements.

 

The UOL Credit Agreement contains certain negative covenants, including those limiting UOL’s and its subsidiaries’ ability to incur indebtedness, incur liens, sell or acquire assets or businesses, change the nature of their businesses, engage in transactions with related parties, make certain investments or pay dividends. In addition, the UOL Credit Agreement requires UOL and its subsidiaries to maintain certain financial ratios.

  

 

NOTE 7—NOTES PAYABLE

 

(a)

$28,750 Senior Note Payable

 

On November 2, 2016, the Company issued $28,750 of Senior Notes Payable (“Senior Notes”) due in 2021, interest payable quarterly at 7.5% commencing January 31, 2017. The Senior Notes are unsecured and due and payable in full on October 31, 2021. In connection with the issuance of the Senior Notes the Company received net proceeds of $27,664 (after underwriting commissions, fees and other issuance costs of $1,086). The outstanding balance of the Senior Notes was $27,754 (net of unamortized debt issue costs of $996) and $27,700 (net of unamortized debt issue costs of $1,050) at March 31, 2017 and December 31, 2016, respectively. In connection with the offering of $28,750 of Senior Notes, certain members of management and the Board of Directors of the Company purchased $2,731 or 9.5% of the Senior Notes offered by the Company. Interest expense on the Senior Notes totaled $593 for the three months ended March 31, 2017.

 

(b)

Australian Dollar $80,000 Note Payable

 

In August 2016, the Company formed GA Retail Investments, L.P., a Delaware limited partnership, (the “Partnership”) which required the Company to contribute $15,350. The Partnership borrowed $80,000 Australian dollars from a third party investor in connection with its formation and the $80,000 Australian dollars was exchanged for a 50% special limited partnership interest in the Partnership. The Partnership was formed to provide funding for the retail liquidation engagement the Company entered into to liquidate the Masters Home Improvement stores. The $80,000 Australian dollar participating note payable was non-interest bearing, shares in 50% of the all of the profits and losses of the Partnership and was subject to repayment upon the completion of the going-out-of-business sale of Masters Home Improvement stores as defined in the partnership agreement. Although the terms of the participating note payable included the issuance of a 50% equity interest in the Partnership, sharing in all profits and losses of the Partnership, and no repayment until certain events occur, in accordance with ASC 480 Distinguishing Liabilities From Equity, this financial instrument was classified as a participating note payable. The $80,000 Australian dollar participating note payable was repaid in December 2016 upon the completion of the going-out-of-business sale of Masters Home Improvement stores as defined in the partnership agreement. At March 31, 2017 and December 31, 2016, $416 and $10,037, respectively, was payable in accordance with the participating note payable share of profits and is included in amounts due to related parties and partners in the condensed consolidated financial statements.

 

NOTE 8— INCOME TAXES

 

The Company’s effective income tax rate was a benefit of 38.3% for the three months ended March 31, 2017. The Company’s income tax rate was 10.8% for the three months ended March 31, 2016. During the three months ended March 31, 2017, the Company elected to treat the acquisition of UOL as a taxable business combination for income tax purposes in accordance with Internal Revenue Code Section 338(g) (“IRS Code Section 338(g)”). This resulted in the Company foregoing the income tax attributes of UOL that existed at the acquisition date which included net operating loss carryforwards, capital loss carryforwards and foreign tax credits. The income tax election in accordance with IRS Code Section 338(g) provides the Company with a tax step-up in the basis of the intangible assets and goodwill acquired for tax purposes. In accordance with ASC 740, the impact of the election in accordance with IRS Code Section 338(g) on deferred income taxes resulted in the recording of a tax benefit in the amount of $8,389 during the three months ended March 31, 2017. The effective income tax rate for the three months ended March 31, 2016 was lower than the statutory federal and state income tax rate due to the tax differential on net income attributable to noncontrolling interests.

 

As of March 31, 2017, the Company had federal net operating loss carry forwards of $7,600 and state net operating loss carry forwards of $11,800. The Company’s federal net operating loss carry forwards will expire in the tax year ending December 31, 2034, the state net operating loss carry forwards will expire in 2032, and the foreign tax credit carry forwards will expire in 2023.

 

The Company establishes a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Tax benefits of operating loss and tax credit carry forwards are evaluated on an ongoing basis, including a review of historical and projected future operating results, the eligible carry forward period, and other circumstances. As a result of the common stock offering by the Company that was completed on June 5, 2014, the Company had a more than 50% ownership shift in accordance with Internal Revenue Code Section 382. Accordingly, the Company is limited to the amount of net operating loss that may be utilized in future taxable years depending on the Company’s actual taxable income. As of March 31, 2017, the Company believes that the net operating loss that existed as of the more than 50% ownership shift will be utilized in future tax periods before the loss carry forwards expire and it is more-likely-than-not that future taxable earnings will be sufficient to realize its deferred tax assets and has not provided an allowance.

 

 

The Company files income tax returns in the U.S., various state and local jurisdictions, and certain other foreign jurisdictions. The Company is currently under audit by certain state and local, and foreign tax authorities. The audits are in varying stages of completion. The Company evaluates its tax positions and establishes liabilities for uncertain tax positions that may be challenged by tax authorities. Uncertain tax positions are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, case law developments and closing of statutes of limitations. Such adjustments are reflected in the provision for income taxes, as appropriate. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the calendar years ended December 31, 2013 to 2016.

 

NOTE 9— EARNINGS PER SHARE

 

Basic earnings per share is calculated by dividing net income by the weighted-average number of shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding, after giving effect to all dilutive potential common shares outstanding during the period. Basic common shares outstanding exclude 66,000 common shares that are held in escrow and subject to forfeiture as a result of the failure to achieve certain performance targets specified in connection with the transaction with Alternative Asset Management Acquisition Corp. in 2009 (the “Acquisition”). The 66,000 common shares issued to the former members of Great American Group, LLC are subject to forfeiture upon the final settlement of claims for goods held for sale in connection with the Acquisition. Dilutive common shares outstanding includes contingently issuable shares that are currently in escrow and subject to release if the conditions for the final settlement of claims for goods held for sale in connection with the Acquisition was satisfied at the end of the respective periods.

 

Basic and diluted earnings per share was calculated as follows:

 

		Three Months Ended
		March 31,
		2017				2016
Net income attributable to B. Riley Financial, Inc.		$	14,021			$	248
Weighted average shares outstanding:
Basic			19,181,749				16,490,178
Effect of dilutive potential common shares:
Restricted stock units and non-vested shares			400,058				19,113
Contingently issuable shares			44,767				44,662
Diluted			19,626,574				16,553,953
Basic income per share		$	0.73			$	0.02
Diluted income per share		$	0.71			$	0.01

 

NOTE 10— COMMITMENTS AND CONTINGENCIES

 

Legal Matters

 

The Company is subject to certain legal and other claims that arise in the ordinary course of its business. The Company does not believe that the results of these claims are likely to have a material effect on its condensed consolidated financial position or results of operations.

 

In January 2015, the Company was served with a lawsuit that seeks to assert claims of breach of contract and other matters in connection with auction services provided to a debtor.  The proceeding in the United States Bankruptcy Court for the District of Delaware (“Bankruptcy Court”) is pending in the bankruptcy case of the debtor and its affiliates (the “Debtor”).  In the lawsuit, a former landlord of the Debtor generally alleges that the Company and a joint venture partner were responsible for contamination while performing services in connection with the auction of certain assets of the Debtor and is seeking approximately $10,000 in damages.  The Company filed a motion to dismiss the lawsuit and in March 2016 the Bankruptcy Court issued its opinion dismissing some claims while denying the motion with respect to other claims.  In April 2016, the Company filed an answer with the Bankruptcy Court denying the allegations in the complaint. In December 2016, the parties exchanged initial disclosures.  In January 2017, the parties filed a proposed scheduling order with the Bankruptcy Court. Discovery in the action is currently proceeding. The Company is vigorously defending this lawsuit. This lawsuit is in the initial stages, and the financial impact to the Company, if any, cannot be estimated.

 

 

On July 5, 2016, Quadre Investments LP (“Quadre”) filed a petition with the Delaware Court of Chancery (the “Court”) seeking a determination of fair value for 943,769 shares of common stock of UOL in connection with the acquisition of UOL by the Company. Such transaction gave rise to appraisal rights pursuant to Section 262 of the General Corporation Law of the State of Delaware. As a result, Quadre is entitled to petition the Court to receive fair value as determined by the Court. The Company does not believe that the fair value of each share exceeds $11.00 per share, the acquisition consideration paid to UOL stockholders pursuant to the agreement to acquire UOL, and the Company intends to contest the petition. Discovery in the case has commenced. As of March 31, 2017 and December 31, 2016, the Company has recorded $10,381 of acquisition consideration payable in connection with the Quadre petition. Interest expense accrued on the acquisition consideration payable amounted to $457 and $306 at March 31, 2017 and December 31, 2016, respectively.

 

On March 10, 2017, UOL received a letter from PeopleConnect, Inc., the successor entity to Classmates, Inc., a former subsidiary of UOL (“PeopleConnect”), regarding a notice of investigation received from the Consumer Protection Divisions of the District Attorneys’ offices of four California counties (“California DAs”).  The California DAs suggest that PeopleConnect may be in violation of California codes relating to unfair competition, false or deceptive advertising, and auto-renewal practices (the “Claims”).  PeopleConnect asserts that the Claims are indemnifiable claims under the purchase agreement between UOL and the buyer of Classmates, Inc.   At the present time, any potential liability and damages cannot be estimated.

 

NOTE 11— SHARE BASED PAYMENTS

 

During the three months ended March 31, 2017, the Company granted restricted stock units representing 47,438 shares of common stock with a total fair value of $916 to certain employees of the Company. During the year ended December 31, 2016, the Company granted restricted stock units representing 544,605 shares of common stock with a total fair value of $5,301 to certain employees and directors of the Company. Share based compensation expense for the restricted stock units was $907 and $437 for the three months ended March 31, 2017 and 2016, respectively.

 

The restricted stock units generally vest over a period of one to three years based on continued service. In determining the fair value of restricted stock units on the grant date, the fair value is adjusted for (a) estimated forfeitures, (b) expected dividends based on historical patterns and the Company’s anticipated dividend payments over the expected holding period and (c) the risk-free interest rate based on U.S. Treasuries for a maturity matching the expected holding period. As of March 31, 2017, the expected remaining unrecognized share based compensation expense of $5,483 will be expensed over a weighted average period of 2.0 years.

 

A summary of equity incentive award activity for the periods indicated was as follows:

 

						Weighted
						Average
		Shares				Fair Value
Nonvested at December 31, 2016			680,135			$	9.74
Granted			47,438				19.30
Vested			-				-
Forfeited			-				-
Nonvested at March 31, 2017			727,573			$	10.36

 

The per-share weighted average grant-date fair value of restricted stock units was $19.30 during the three months ended March 31, 2017. There were no restricted stock units that vested during the three months ended March 31, 2017.

 

NOTE 12— NET CAPITAL REQUIREMENTS

 

B. Riley & Co., LLC (“BRC”), a subsidiary of the Company, is a registered broker-dealer and, accordingly, is subject to the SEC Uniform Net Capital Rule (Rule 15c3-1) which requires BRC to maintain minimum net capital and requires that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to 1.  As of March 31, 2017, BRC had net capital of $8,045 (an excess of $7,482).  BRC’s net capital ratio for March 31, 2017 was 1.05 to 1.

 

NOTE 13— RELATED PARTY TRANSACTIONS

 

At March 31, 2017, amounts due from related parties include $3,170 from GACP I, L.P. for management fees, incentive fees and other operating expenses and $1,097 from CA Global Partners, LLC (“CA Global”). At December 31, 2016, amounts due from related parties include $2,050 from GACP I, L.P. for management fees, incentive fees and other operating expenses and $959 from CA Global Partners, LLC (“CA Global”). Great American Capital Partners, LLC, a subsidiary of the Company, is the general partner of GACP I, L.P. CA Global is one of the members of Great American Global Partners, LLC (“GA Global Ptrs”). The amounts receivable and payable from CA Global are comprised of amounts due to and due from CA Global in connection with certain auctions of wholesale and industrial machinery and equipment that they were managed by CA Global on behalf of GA Global Ptrs.

 

 

In connection with the offering of $28,750 of Senior Notes as more fully described in Note 7, certain members of management and the Board of Directors of the Company purchased $2,731 or 9.5% of the Senior Notes offered by the Company.

 

NOTE 14— BUSINESS SEGMENTS

 

The Company’s operating segments reflect the manner in which the business is managed and how the Company allocates resources and assesses performance internally. The Company has several operating subsidiaries through which it delivers specific services. The Company provides investment banking, corporate finance, restructuring, research, wealth management, sales and trading services to corporate, institutional and high net worth clients. The Company also provides auction and liquidation services to help clients dispose of assets that include multi-location retail inventory, wholesale inventory, trade fixtures, machinery and equipment, intellectual property and real property and valuation and appraisal services to clients with independent appraisals in connection with asset based loans, acquisitions, divestitures and other business needs. As a result of the acquisition of UOL on July 1, 2016, the Company provides consumer services and products over the Internet.

 

The Company’s business is classified into the Capital Markets segment, Auction and Liquidation segment, Valuation and Appraisal segment and Principal Investments - United Online segment. These reportable segments are all distinct businesses, each with a different marketing strategy and management structure.

 

The following is a summary of certain financial data for each of the Company’s reportable segments:

 

		Three Months Ended
		March 31,
		2017				2016
Capital markets reportable segment:
Revenues - Services and fees		$	17,723			$	5,564
Selling, general, and administrative expenses			(10,969	)			(6,174	)
Depreciation and amortization			(127	)			(21	)
Segment (loss) income			6,627				(631	)
Auction and Liquidation reportable segment:
Revenues - Services and fees			13,996				6,907
Revenues - Sale of goods			-				2
Total revenues			13,996				6,909
Direct cost of services			(10,334	)			(3,418	)
Cost of goods sold			-				(2	)
Selling, general, and administrative expenses			(1,850	)			(1,225	)
Depreciation and amortization			(5	)			(41	)
Segment income			1,807				2,223
Valuation and Appraisal reportable segment:
Revenues - Services and fees			7,796				7,473
Direct cost of services			(3,672	)			(3,265	)
Selling, general, and administrative expenses			(2,080	)			(2,119	)
Depreciation and amortization			(44	)			(29	)
Segment income			2,000				2,060
Principal Investments - United Online segment:
Revenues - Services and fees			13,303				-
Revenues - Sale of goods			79				-
Total revenues			13,382				-
Direct cost of services			(3,595	)			-
Cost of goods sold			(59	)			-
Selling, general, and administrative expenses			(3,312	)			-
Depreciation and amortization			(1,840	)			-
Restructuring costs			(374	)			-
Segment income			4,202				-
Consolidated operating income from reportable
segments			14,636				3,652
Corporate and other expenses			(3,925	)			(1,987	)
Interest income			132				3
Interest expense			(791	)			(132	)
Income before income taxes			10,052				1,536
Benefit (provision) for income taxes			3,849				(166	)
Net income			13,901				1,370
Net (loss) income attributable to noncontrolling interests			(120	)			1,122
Net income attributable to B. Riley Financial, Inc.		$	14,021			$	248

 

  

The following table presents revenues by geographical area:

 

		Three Months Ended March 31,
		2017				2016
Revenues:
Revenues - Services and fees:
North America		$	51,062			$	19,938
Australia			940				-
Europe			816				6
Total Revenues - Services and fees		$	52,818			$	19,944
Revenues - Sale of goods
North America		$	79			$	2
Australia			-				-
Europe			-				-
Total Revenues - Sale of goods		$	79			$	2
Total Revenues:
North America		$	51,141			$	19,940
Australia			940				-
Europe			816				6
Total Revenues - Services and fees		$	52,897			$	19,946

 

The following table presents long-lived assets, which consists of property and equipment and other assets, by geographical area:

 

		As of				As of
		March 31,				December 31,
		2017				2016
Long-lived Assets - Property and Equipment,net:
North America		$	5,409			$	5,785
Australia			-				-
Europe			-				-
Total		$	5,409			$	5,785

 

Segment assets are not reported to, or used by, the Company's CODM to allocate resources to, or assess performance of, the segments and therefore, total segment assets have not been disclosed.

 

NOTE 15— SUBSEQUENT EVENTS

 

Acquisition of Rights to Manage Dialectic Hedge Funds

 

On April 13, 2017, the Company entered into an Asset Purchase and Assignment Agreement with Dialectic Capital Management, L.P., Dialectic Capital, LLC and John Fichthorn (collectively “Dialectic”), pursuant to which Dialectic assigned and transferred the rights to manage certain hedge funds to the Company (the “Dialectic Acquisition”). In addition to obtaining the rights to manage certain hedge funds previously managed by Dialectic, the Company hired all of the employees that were previously employed by the management company that managed the Dialectic hedge funds and assumed Dialectic’s office lease. In connection with Dialectic Acquisition the Company paid the Dialectic parties $700 in cash consideration and 158,484 shares of common stock which has a fair value of approximately $2,125 for total purchase consideration of $2,825. The purchase and assignment of the rights to manage certain hedge funds of Dialectic is expected to result in the recognition of intangible assets and goodwill in the amount of $2,825.

 

Acquisition of FBR & Co.

 

On February 17, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with FBR & Co. (“FBR”), pursuant to which FBR will merge with and into the Company (or a subsidiary of the Company), with the Company (or its subsidiary) as the surviving corporation (the “Merger”). Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each outstanding share of FBR common stock, par value $0.001 per share (“FBR Common Stock”), excluding certain specified shares, will be converted into the right to receive 0.671 of a share of the Company’s common stock, par value $0.0001 per share. In addition, prior to the closing of the Merger, the board of directors of FBR may declare and pay a cash dividend (the “Pre-Closing Dividend”) to holders of FBR Common Stock and FBR equity awards. The Pre-Closing Dividend on a per share basis will be equal to the value of cash and certain specified investments on FBR’s balance sheet in excess of $33,500 and certain transaction expenses divided by the total number of fully diluted shares of FBR Common Stock outstanding (subject to certain adjustments if the Pre-Closing Dividend would be equal to or more than $8.50 per fully diluted share of FBR Common Stock).

 

On May 1, 2017, the Company and FBR filed a registration statement for the planned Merger. Consummation of the Merger is subject to certain closing conditions, as set forth in the Merger Agreement, including the approval of the Merger by our shareholders and the shareholders of FBR. The shareholders of the Company and FBR are scheduled to vote on the on Merger on June 1, 2017. It is anticipated that the Merger will close during the second quarter of 2017.

 

Dividends

 

On May 10, 2017, the Company’s Board of Directors approved a regular quarterly dividend of $0.08 per share and a special dividend of $0.08 per share, which will be paid on or about May 31, 2017 to stockholders of record on May 23, 2017.

 

 

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

 

This report contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially.

 

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we, nor any other person, assume responsibility for the accuracy and completeness of the forward-looking statements. We are under no obligation to update any of the forward-looking statements after the filing of this Annual Report to conform such statements to actual results or to changes in our expectations.

 

The following discussion of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes and other financial information appearing elsewhere in this Quarterly Report. Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made in Item 1A of Part II of this Quarterly Report under the caption “Risk Factors”.

 

Risk factors that could cause actual results to differ from those contained in the forward-looking statements include but are not limited to risks related to: volatility in our revenues and results of operations; changing conditions in the financial markets; our ability to generate sufficient revenues to achieve and maintain profitability; the short term nature of our engagements; the accuracy of our estimates and valuations of inventory or assets in “guarantee” based engagements; competition in the asset management business; potential losses related to our auction or liquidation engagements; our dependence on communications, information and other systems and third parties; potential losses related to purchase transactions in our auction and liquidations business; the potential loss of financial institution clients; potential losses from or illiquidity of our proprietary investments; changing economic and market conditions; potential liability and harm to our reputation if we were to provide an inaccurate appraisal or valuation; potential mark-downs in inventory in connection with purchase transactions; failure to successfully compete in any of our segments; loss of key personnel; our ability to borrow under our credit facilities as necessary; failure to comply with the terms of our credit agreements; our ability to meet future capital requirements; our ability to realize the benefits of our completed and proposed acquisitions, including our ability to achieve anticipated opportunities and operating cost savings, and accretion to reported earnings estimated to result from completed and proposed acquisitions in the time frame expected by management or at all ; the possibility that our proposed acquisition of FBR & Co, Inc. (“FBR”) does not close when expected or at all; our ability to promptly and effectively integrate our business with that of FBR if such transaction closes; the reaction to the FBR acquisition of our and FBR’s customers, employees and counterparties; and the diversion of management time on acquisition-related issues. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Except as otherwise required by the context, references in this Annual Report to “the “Company,” “B. Riley,” “we,” “us” or “our” refer to the combined business of B. Riley Financial, Inc. and all of its subsidiaries.

 

Overview

 

B. Riley Financial, Inc. and its subsidiaries (NASDAQ: RILY) provide collaborative financial services and solutions through several subsidiaries, including:

 

·

B. Riley & Co., LLC (“BRC”), a mid-sized, full service investment bank providing financial advisory, corporate finance, research, and sales & trading services to corporate, institutional and high net worth individual clients;

 

·

B. Riley Capital Management, LLC, a Securities and Exchange Commission (“SEC”) registered investment advisor, which includes:

 

o

B. Riley Asset Management, an advisor to certain private funds and to institutional and high net worth investors;

o

B. Riley Wealth Management (formerly MK Capital Advisors), a multi-family office practice and wealth management firm focused on the needs of ultra-high net worth individuals and families; and

o

Great American Capital Partners, LLC (“GACP”), the general partner of a private fund, GACP I, L.P. a direct lending fund that provides senior secured loans and second lien secured loan facilities to middle market public and private U.S. companies.

 

 

·

Great American Group, LLC, a leading provider of asset disposition and auction solutions to a wide range of retail and industrial clients;

 

·

Great American Group Advisory and Valuation Services, LLC, a leading provider of appraisal and valuation services for asset based lenders, private equity firms and corporate clients; and

 

We also pursue a strategy of investing in or acquiring companies which we believe have attractive investment return characteristics. On July 1, 2016, we acquired United Online, Inc.(“UOL”) as part of our principal investment strategy.

 

·

UOL is a communications company that offers subscription services and products, consisting of Internet access services and devices under the NetZero and Juno brands primarily sold in the United States.

 

We are headquartered in Los Angeles with offices in major financial markets throughout the United States and Europe.

 

For financial reporting purposes we classify our businesses into four segments: (i) capital markets, (ii) auction and liquidation, (iii) valuation and appraisal and (vi) principal investments – United Online.

 

Capital Markets Segment. Our capital markets segment provides a full array of investment banking, corporate finance, research, wealth management, sales and trading services to corporate, institutional and high net worth clients. Our corporate finance and investment banking services include merger and acquisitions as well as restructuring advisory services to public and private companies, initial and secondary public offerings, and institutional private placements.  In addition, we trade equity securities as a principal for our account, including investments in funds managed by our subsidiaries. Our capital markets segment also includes our asset management businesses that manage various private and public funds for institutional and individual investors.

 

Auction and Liquidation Segment. Our auction and liquidation segment utilizes our significant industry experience, a scalable network of independent contractors and industry-specific advisors to tailor our services to the specific needs of a multitude of clients, logistical challenges and distressed circumstances. Furthermore, our scale and pool of resources allow us to offer our services across North American as well as parts of Europe, Asia and Australia. Our auction and liquidation segment operates through two main divisions, retail store liquidations and wholesale and industrial assets dispositions. Our wholesale and industrial assets disposition division operates through limited liability companies that are controlled by us.

 

Valuation and Appraisal Segment. Our valuation and appraisal segment provides valuation and appraisal services to financial institutions, lenders, private equity firms and other providers of capital. These services primarily include the valuation of assets (i) for purposes of determining and monitoring the value of collateral securing financial transactions and loan arrangements and (ii) in connection with potential business combinations. Our valuation and appraisal segment operates through limited liability companies that are majority owned by us.

 

Principal Investments – United Online Segment. Our principal investments - United Online segment consists of businesses which have been acquired primarily for attractive investment return characteristics. Currently, this segment includes UOL, a company that offers consumer subscription services consisting of Internet access under the NetZero and Juno brands. Internet access includes paid dial-up, mobile broadband and DSL subscription services. We also offer email, Internet security, web hosting services, and other services.

 

Recent Developments

 

On February 17, 2017, we entered into an agreement and plan of merger (the “Merger Agreement”) to acquire FBR, an investment banking and brokerage firm that provides investment banking, M&A advisory, institutional brokerage, and research services, pursuant to which FBR will merge with and into us (or a subsidiary of us), with us (or our subsidiary) as the surviving corporation (the “Merger”). Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each outstanding share of FBR common stock, excluding certain specified shares, will be converted into the right to receive 0.671 of a share of our common stock. We currently estimate that approximately 5.3 million shares of our common stock will be issued in connection with this transaction, with an assumed value of approximately $93.0 million based on the closing price of our common stock on February 17, 2017. In addition, prior to the closing of the Merger, the board of directors of FBR may declare and pay a cash dividend to holders of FBR Common Stock and FBR equity awards. Such dividend on a per share basis will be equal to the value of cash and certain specified investments on FBR’s balance sheet in excess of $33.5 million divided by the total number of fully diluted shares of FBR Common Stock outstanding (subject to certain adjustments if such dividend would be equal to or more than $8.50 per fully diluted share of FBR Common Stock).

 

 

The Merger Agreement further provides that, at or prior to the effective time of the Merger, the number of directors comprising our full Board of Directors will be increased by one, with Richard J. Hendrix, Chairman, President and Chief Executive Officer of FBR, being appointed to fill the new seat in accordance with the terms of the employment agreement described below. In connection with the execution of the Merger Agreement, on February 17, 2017, BRC and we entered into an employment agreement with Mr. Hendrix, which provides that, following the closing of the Merger, Mr. Hendrix will become President and Chief Executive Officer of the combined business of FBR and BRC and will be appointed to our Board of Directors, contingent on Mr. Hendrix remaining employed by FBR through the closing of the Merger. In addition, on February 17, 2017, certain officers and directors of FBR entered into voting agreements with us with respect to shares of FBR common stock held by such officers or directors, and certain of our officers and directors entered into voting agreements with FBR with respect to shares of our common stock held by such officers or directors, which generally require each stockholder party thereto in his or her capacity as a stockholder, to vote all of the shares of common stock over which such party has voting control in favor of adoption of the Merger Agreement and certain related matters and against alternative transactions and generally prohibit them from transferring their shares of common stock, subject to certain exceptions.

 

On May 1, 2017, the Company and FBR filed a registration statement for the Merger. Consummation of the Merger is subject to certain closing conditions, as set forth in the Merger Agreement, including the approval of the Merger by our shareholders and the shareholders of FBR. The shareholders of the Company and FBR are scheduled to vote on the on Merger on June 1, 2017. It is anticipated that the Merger will close during the second quarter of 2017. If the Merger is consummated, we anticipate that FBR’s operations will be included in our capital markets segment.

 

Critical Accounting Policies

 

Our condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”), which require management to make estimates and assumptions that affect reported amounts. The estimates and assumptions are based on historical experience and on other factors that management believes to be reasonable. Actual results may differ from those estimates. Critical accounting policies represent the areas where more significant judgments and estimates are used in the preparation of our condensed consolidated financial statements. A discussion of such critical accounting policies, which include revenue recognition, reserves for accounts receivable and slow moving goods held for sale or auction, the carrying value of goodwill and other intangible assets, fair value measurements, share based compensation and accounting for income tax valuation allowances can be found in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016. There have been no material changes to the policies noted above as of this quarterly report on Form 10-Q for the period ended March 31, 2017.

 

Results of Operations

 

The following period to period comparisons of our financial results and our interim results are not necessarily indicative of future results.

 

 

Three Months Ended March 31, 2017 Compared to Three Months Ended March 31, 2016

 

Condensed Consolidated Statements of Operations

(Dollars in thousands)

 

		Three Months March 31, 2017								Three Months March 31, 2016
		Amount				%				Amount				%
Revenues:
Services and fees		$	52,818				99.9	%		$	19,944				100.0	%
Sale of goods			79				0.1	%			2				0.0	%
Total revenues			52,897				100.0	%			19,946				100.0	%
Operating expenses:
Direct cost of services			17,601				33.3	%			6,683				33.5	%
Cost of goods sold			59				0.1	%			2				0.0	%
Selling, general and administrative expenses			24,152				45.7	%			11,596				58.1	%
Restructuring costs			374				0.7	%			-				0.0	%
Total operating expenses			42,186				79.8	%			18,281				91.7	%
Operating income			10,711				20.2	%			1,665				8.3	%
Other income (expense):
Interest income			132				0.2	%			3				0.0	%
Interest expense			(791	)			-1.4	%			(132	)			-0.7	%
Income before income taxes			10,052				19.0	%			1,536				7.7	%
Benefit (provision) for income taxes			3,849				7.3	%			(166	)			-0.8	%
Net income			13,901				26.3	%			1,370				6.9	%
Net (loss) income attributable to noncontrolling interests			(120	)			-0.2	%			1,122				5.6	%
Net income attributable to B. Riley Financial, Inc.		$	14,021				26.5	%		$	248				1.2	%

 

Revenues.

 

The table below and the discussion that follows are based on how we analyze our business.

 

		Three Months Ended March 31, 2017								Three Months Ended March 31, 2016								Change
		Amount				%				Amount				%				Amount				%
Revenues - Serivces and Fees:
Capital Markets segment		$	17,723				33.5	%		$	5,564				27.9	%		$	12,159				218.5	%
Auction and Liquidation segment			13,996				26.5	%			6,907				34.6	%			7,089				102.6	%
Valuation and Appraisal segment			7,796				14.7	%			7,473				37.5	%			323				4.3	%
Principal Investments - United Online segment			13,303				25.1	%			-				n/m				13,303				n/m
Subtotal			52,818				99.9	%			19,944				100.0	%			32,874				164.8	%
Revenues - Sale of goods
Auction and Liquidation			-				n/m				2				0.0	%			(2	)			n/m
Principal Investments - United Online segment			79				0.1	%			-				n/m				79				n/m
Subtotal			79				0.1	%			2				0.0	%			77				n/m
Total revenues		$	52,897				100.0	%		$	19,946				100.0	%		$	32,951				165.2	%

 

n/m - Not applicable or not meaningful.

 

Total revenues increased $33.0 million to $52.9 million during the three months ended March 31, 2017 from $19.9 million during the three months ended March 31, 2016. The increase in revenues during the three months ended March 31, 2017 was primarily due to an increase in revenues from services and fees of $32.9 million and an increase in revenues from the sale of goods of $0.1 million. The increase in revenues from services and fees of $32.9 million in 2017 was primarily due to an increase in revenues of (a) $12.2 million in the capital markets segment, (b) $7.1 million in the auction and liquidation segment, (c) $0.3 million in the valuation and appraisal segment, and (d) $13.3 million in the principal investments - United Online segment from the acquisition of UOL on July 1, 2016. The increase in revenues from sale of goods of $0.1 million was primarily due to sale of certain products in the principal investments - United Online segment.

 

 

Revenues from services and fees in the capital markets segment increased $12.2 million, to $17.7 million during the three months ended March 31, 2017 from $5.6 million during the three months ended March 31, 2016. The increase in revenues was primarily due to an increase in revenues of $7.4 million from investment banking fees, $2.6 million from commissions, fees and other income primarily earned from research, sales and trading, and wealth management services and $2.1 million from trading income. The increase in revenues from investment banking fees was primarily due to an increase in the number of investment banking transactions where we acted as an advisor in 2017 as compared to the same period in 2016. The increase in revenues from commissions, fees and other income primarily earned from research, sales and trading, and wealth management services was primarily due to an increase in fees and commissions earned from research, sales and trading and incentive management fees earned from our various funds we manage. The increase in revenues from trading income in 2017 was primarily due to an increase in income we earned from trading activities in our propriety trading account.

 

Revenues from services and fees in the auction and liquidation solutions increased $7.1 million, to $14.0 million during the three months ended March 31, 2017 from $6.9 million during the three months ended March 31, 2016. The increase in revenues of $7.1 million was primarily due to an increase in revenues of $9.6 million from services and fees from retail liquidation engagements, offset by a decrease in revenues of $2.5 million from services and fees in our wholesale and industrial auction division. The increase in revenues from services and fees from retail liquidation engagements was primarily due to an increase in the number of fee and commission based retail liquidation engagements for store closings and going-out-of-business sales in 2017 as compared to the same period in 2016. The decrease in revenues from services and fees in our wholesale and industrial division was primarily due to a decrease in the number of wholesale and industrial auction engagements in 2017 as compared to the same period in 2016.

 

Revenues from services and fees in the valuation and appraisal segment increased $0.3 million, or 4.3%, to $7.8 million during the three months ended March 31, 2017 from $7.5 million during the three months ended March 31, 2016. The increase in revenues was primarily due to increases of (a) $0.2 million related to appraisal engagements where we perform valuations of machinery and equipment and (b) $0.1 million related to appraisal engagements where we perform valuations of intellectual property and business valuations.

 

Revenues from services and fees in the principal investments - United Online segment of $13.3 million during the three months ended March 31, 2017 were the result of the acquisition of UOL on July 1, 2016.  These revenues include $10.7 million in services and fees primarily from customer paid accounts related to our Internet access and related subscription services and $2.6 million in advertising revenues from Internet display advertising and search related to our email and Internet access services. Over the past several years revenues from paid subscription services have declined year over year as a result of a decline in the number of paid subscribers for our services.  Management believes the decline in paid subscriber accounts is primarily attributable to the industry trends of consumers switching from dial-up Internet access to high speed Internet access such as cable and DSL.  Management expects revenues in the principal investments - United Online segment to continue to decline year over year.

 

Operating Expenses

 

Direct Cost of Services. Direct cost of services and direct cost of services measured as a percentage of revenues – services and fees by segment during the three months ended March 31, 2017 and 2016 are as follows:

 

		Three Months Ended March 31, 2017																Three Months Ended March 31, 2016
										Principal																Principal
		Auction and				Valuation and				Investments -								Auction and				Valuation and				Investments -
		Liquidation				Appraisal				United Online								Liquidation				Appraisal				United Online
		Segment				Segment				Segment				Total				Segment				Segment				Segment				Total
Revenues - Services and fees		$	13,996			$	7,796			$	13,303							$	6,907			$	7,473			$	-
Direct cost of services			10,334				3,672				3,595			$	17,601				3,418				3,265				-			$	6,683
Gross margin on services and fees		$	3,662			$	4,124			$	9,708							$	3,489			$	4,208			$	-
Gross margin percentage			26.2	%			52.9	%			73.0	%							50.5	%			56.3	%			n/m

 

n/m - Not applicable or not meaningful.

 

 

Total direct costs increased $10.9 million, to $17.6 million during the three months ended March 31, 2017 from $6.7 million during the three months ended March 31, 2016. Direct costs of services increased by (a) $6.9 million in the auction and liquidation segment, (b) $0.4 million in the valuation and appraisal segment, and (c) $3.6 million in the principal investments - United Online segment as a result of the acquisition of UOL on July 1, 2016. The increase in direct costs in the auction and liquidation segment was primarily due to an increase in the number of fee and commission type engagements in 2017 and compared to the same period in 2016. The increase in direct costs of services in the valuation and appraisal segment was primarily due to an increase in payroll and related expenses due to an increase headcount 2017 as compared to the same period in 2016.

 

Gross margin in the auction and liquidation segment for services and fees decreased to 26.2% of revenues during the three months ended March 31, 2017, as compared to 50.5% of revenues during the three months ended March 31, 2016. The decrease in the gross margin during the three months ended March 31, 2017 was primarily due to a change in the mix of fee and commission type engagements. The decrease in fee and commission income was primarily due to some of the fee and commission type engagements included certain hurdles that were not achieved until the second quarter of 2017.

 

 

Gross margin in the valuation and appraisal segment for services and fees decreased to 52.9% of revenues during the three months ended March 31, 2017, as compared to 56.3% of revenues during the three months ended March 31, 2016. The decrease in gross margin is primarily due to an increase in payroll and related expenses during the three months ended March 31, 2017 as compared to same period in 2016.

 

Selling, General and Administrative Expenses. Selling, general and administrative expenses during the three months ended March 31, 2017 and 2016 were comprised of the following:

 

Selling, General and Administrative Expenses

 

		Three Months Ended March 31, 2017								Three Months Ended March 31, 2016								Change
		Amount				%				Amount				%				Amount				%
Capital Markets segment		$	11,096				45.9	%		$	6,195				53.5	%		$	4,901				79.1	%
Auction and Liquidation segment			1,855				7.7	%			1,266				10.9	%			589				46.5	%
Valuation and Appraisal segment			2,124				8.8	%			2,148				18.5	%			(24	)			-1.1	%
Principal Investments - United Online segment			5,152				21.3	%			-				n/m				5,152				n/m
Corporate and Other segment			3,925				16.3	%			1,987				17.1	%			1,938				97.5	%
Total selling, general & administrative expenses		$	24,152				100.0	%		$	11,596				100.0	%		$	12,556				108.3	%

 

Total selling, general and administrative expenses increased $12.6 million, to $24.2 million during the three months ended March 31, 2017 from $11.6 million for the three months ended March 31, 2016. The increase was primarily due to an increase in selling, general and administrative expenses of (a) $4.9 million in the capital markets segment, (b) $0.6 million in the auction and liquidation segment, (c) $5.2 million in the principal investments - United Online segment as a result of the acquisition of UOL on July 1, 2016, and (d) $1.9 million in corporate and other.

 

Capital Markets

 

Selling, general and administrative expenses in the capital markets segment increased by $4.9 million, or 79.1% to $11.1 million during the three months ended March 31, 2017 from $6.2 million during the three months ended March 31, 2016. The increase in expenses was primarily due to an increase in (a) payroll and related expenses of $4.6 million that included an additional increase in incentive compensation as a result of the increase in revenues from investment banking fees in 2017 as compared to the same period in 2016 discussed above, and (b) other general and administrative expenses of $0.3 million.

 

Auction and Liquidation

 

Selling, general and administrative expenses in the auction and liquidation segment increased $0.6 million, or 46.5%, to $1.9 million during the three months ended March 31, 2017 from $1.3 million for the three months ended March 31, 2016. The increase in expenses was primarily due to an increase in (a) bad debt expense in the amount of $0.2 million, (b) losses on foreign currency translation amounts in the amount of $0.3 million related to our Australian and European operations, and (c) other general and administrative expenses of $0.1 million.

 

Valuation and Appraisal

 

Selling, general and administrative expenses in the valuation and appraisal segment were $2.1 million during each of the three month periods ended March 31, 2017 and 2016.

 

Principal Investments - United Online

 

Selling, general and administrative expenses in the principal investments - United Online segment of $5.2 million during the three months ended March 31, 2017 were the result of the acquisition of UOL on July 1, 2016. These expenses include $1.3 million of technology and development expenses, $0.3 million of sales and marketing expenses, $2.2 million of general and administrative expenses and $1.4 million of amortization of intangibles. Technology and development expenses include expenses for product development, maintenance of existing software, technology and websites. Sales and marketing expenses include expenses associated personnel and overhead-related expenses for marketing, customer service, and advertising sales personnel to acquire and retain paid subscribers. Expenses associated with generating advertising revenues include sales commissions and personnel-related expenses. General and administrative expenses consist of personnel-related expenses for management in the principal investments - United Online segment, facilities, internal customer support personnel and personnel associated with operating our corporate systems. Amortization of intangibles includes amortization expense related to customer lists, advertising relationships, domain names and internally developed software.

 

 

Corporate and Other

 

Selling, general and administrative expenses for corporate and other increased $1.9 million, to $3.9 million during the three months ended March 31, 2017 from $2.0 million for the three months ended March 31, 2016. The increase was primarily due to an increase in (a) payroll and related expenses of $0.8 million in 2017 as compared to the same period in 2016, (b) an increase in professional fees and other general corporate expenses of $0.3 million, and (c) transactions costs of $0.9 million incurred for professional fees that primarily related to the pending acquisition of FBR during the three months ended March 31, 2017 as discussed in note 15 to our condensed consolidated financial statements.

 

Restructuring Charge. During the three months ended March 31, 2017, we incurred a restructuring charge of $0.4 million. There was no restructuring charge during the three months ended March 31, 2016. The restructuring charge in 2017 was primarily comprised of employee termination costs related to a reduction in personnel in the principal investments – United Online segment of our operations.

 

Other Income (Expense). Other income included interest income of $0.1 million during the three months ended March 31, 2017 and less than $0.1 million during the three months ended March 31, 2016. Interest expense was $0.8 million during the three months ended March 31, 2017 as compared to $0.1 million during the three months ended March 31, 2016. The increase in interest expense during the three months ended March 31, 2017 was primarily due to (a) interest expense of $0.2 million incurred on the acquisition consideration payable related to our acquisition of UOL on July 1, 2016 as a result of the Quadre Litigation and (b) interest expense of $0.6 million incurred in 2016 from the issuance of senior notes in November 2016.

 

Income Before Income Taxes. Income before income taxes increased $8.5 million, to $10.0 million during the three months ended March 31, 2017 from $1.5 million during the three months ended March 31, 2016. The increase in income before income taxes was primarily due to an increase in operating income of (a) $6.0 million in our capital markets segment and (b) $4.2 million of income generated from our principal investments - United Online segment as a result of the acquisition of UOL on July 1, 2016, offset by (a) a decrease in operating income of $0.4 million in our auction and liquidation segment and $0.1 million in our valuation and appraisal segment, (b) an increase in corporate overhead of $2.0 million, and (c) an increase in net interest expense of $0.5 million.

 

Benefit (Provision) For Income Taxes. Benefit for taxes was $3.8 million during the three months ended March 31, 2017 compared to a provision for income taxes $0.2 million during the three months ended March 31, 2016. The benefit for income taxes during the three months ended March 31, 2017 included a tax benefit of $8.4 million related to the Company’s election to treat the acquisition of UOL as a taxable business combination for income tax purposes in accordance with Internal Revenue Code Section 338(g) as more fully discussed in note 8 in the condensed consolidated financial statements. The effective income tax rate was a benefit of 38.3% for the three months ended March 31, 2017 as compared to a provision for income taxes at a income tax rate of 10.8% for the three months ended March 31, 2016.

 

Net (Loss) Income Attributable to Noncontrolling Interest. Net (loss) income attributable to noncontrolling interests represents the proportionate share of net (loss) income generated by Great American Global Partners, LLC, in which the Company has a 50% membership interest, that we do not own. The net loss attributable to noncontrolling interests was $0.1 million during the three months ended March 31, 2017 compared to net income attributable to noncontrolling interests of $1.1 million during the three months ended March 31, 2016.

 

Net Income Attributable to the Company. Net income attributable to the Company for the three months ended March 31, 2017 was $14.0 million, an increase of $13.8 million, from net income attributable to the Company of $0.2 million for the three months ended March 31, 2016. The increase in net income during the three months ended March 31, 2017 as compared to the same period in 2016 was primarily due to (a) an increase in operating income in the capital markets segment, (b) operating income from the principal investments - United Online segment as a result of the acquisition of UOL on July 1, 2016 as discussed above, and (c) the impact of the benefit from income taxes as discussed above.

 

Liquidity and Capital Resources

 

Our operations are funded through a combination of existing cash on hand, cash generated from operations, proceeds from the issuance of common stock, and borrowings under our senior notes payable, credit facility and special purposes financing arrangements.  On May 10, 2016, we completed a secondary offering of 2,420,980 shares of common stock at a price to the public of $9.50 per share.  The net proceeds from the offering were $22.8 million after deducting underwriting commissions and other offering expenses.  On November 2, 2016, the Company issued $28.75 million of Senior Notes, interest payable quarterly at 7.5% commencing January 31, 2017. The Senior Notes are unsecured and due and payable in full on October 31, 2021. In connection with the issuance of the Senior Notes, the Company received net proceeds of $27.7 million (after underwriting commissions and fees of $1.1 million). During the three months ended March 31, 2017 and year ended December 31, 2016 we generated net income of $14.0 million and $21.5 million, respectively. Our cash flows and profitability are impacted by the number and size of retail liquidation and capital markets engagements performed on a quarterly and annual basis.

 

 

As of March 31, 2017, we had $71.5 million of unrestricted cash, $0.5 million of restricted cash, net investments in securities of $39.4 million, and $27.8 million of borrowings outstanding from the issuance of our Senior Notes Payable in November 2016. We believe that our current cash and cash equivalents, funds available under our asset based credit facility and cash expected to be generated from operating activities will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months from issuance date of the accompanying financial statements. We continue to monitor our financial performance to ensure sufficient liquidity to fund operations and execute on our business plan.

 

From time to time, we may decide to pay dividends which will be dependent upon our financial condition and results of operations. During the three months ended March 31, 2017 and year ended December 31, 2016, we paid cash dividends of $5.0 million and $5.3 million, respectively, on our common stock. While it is the Board’s current intention to make regular dividend payments of $0.08 per share each quarter and special dividend payments dependent upon exceptional circumstances from time to time, our Board of Directors may reduce or discontinue the payment of dividends at any time for any reason it deems relevant. The declaration and payment of any future dividends or repurchases of our common stock will be made at the discretion of our Board of Directors and will be dependent upon our financial condition, results of operations, cash flows, capital expenditures, and other factors that may be deemed relevant by our Board of Directors.

 

Our principal sources of liquidity to finance our business is our existing cash on hand, cash flows generated from operating activities, funds available under revolving credit facilities and special purpose financing arrangements.

 

Cash Flow Summary

 

		Three Months Ended
		March 31,
		2017				2016
		(Dollars in thousands)
Net cash provided by (used in):
Operating activities		$	(38,855	)		$	(1,045	)
Investing activities			3,120				(19	)
Financing activities			(6,841	)			(2,187	)
Effect of foreign currecy on cash			2,012				25
Net decrease in cash and cash equivalents		$	(40,564	)		$	(3,226	)

 

Cash used in operating activities was $38.9 million for the three months ended March 31, 2017, an increase of $37.9 million, from cash used in operating activities of $1.0 million for the three months ended March 31, 2016. Cash used in operating activities for the three months ended March 31, 2017 includes net income of $13.9 million adjusted for noncash items and changes in operating assets and liabilities. The increase in cash used in operating activities of $37.9 million was primarily due to (a) non-cash charges and other items of $6.6 million which included depreciation and amortization of $2.0 million, share based compensation $0.9 million and deferred income taxes of $(9.1) million, and (b) changes in operating assets and liabilities that resulted in a decrease of $46.2 million in cash flows from operations during the three months ended March 31, 2017 as compared to the same period in 2016, offset by an increase in net income of $12.5 million to $13.9 million during the three months ended March 31, 2017, from $1.4 million during the comparable period in 2016.

 

Cash provided by investing activities was $3.1 million during the three months ended March 31, 2017 compared to cash used in investing activities of less than $0.1 million for the three months ended March 31, 2016. During the three months ended March 31, 2017, cash provided by investing activities consisted of (a) a decrease in restricted cash of $2.8 million that primarily related to a retail liquidation engagement we completed in December 2016 in Australia and (b) proceeds of $0.5 million from the sale of intangible assets, offset by the use of $0.2 million of cash to purchase of property and equipment. During the three months ended March 31, 2016, cash used in investing activities was primarily comprised of the purchase of property and equipment.

 

Cash used in financing activities was $6.8 million during the three months ended March 31, 2017 compared to $2.2 million during the three months ended March 31, 2016. During the three months ended March 31, 2017, cash used in financing activities primarily consisted of (a) $1.3 million payment for the second anniversary of contingent consideration in connection with the acquisition of MK Capital, (b) $5.0 of dividends paid on our common stock, and (c) $0.6 million of distributions to noncontrolling interests. During the three months ended March 31, 2016, cash used in financing activities consisted of (a) $1.3 million payment for the first anniversary of contingent consideration in connection with the acquisition of MK Capital, (b) $0.3 million used to repay a revolving line of credit, and (c) $0.7 million of distributions to noncontrolling interests.

 

 

Contingent Consideration

 

In connection with the acquisition of MK Capital on February 2, 2015 for a total purchase price of $9.4 million, at closing $2.5 million of the purchase price was paid in cash and 333,333 newly issued shares of our common stock with a fair value of $2.7 million were issued to the former members of MK Capital. The purchase agreement also required the payment of contingent consideration in the form of future cash payments with a fair value of $2.2 million and the issuance of shares of common stock with a fair value of $2.0 million. The contingent cash consideration of $2.2 million payable to the former members of MK Capital represents the fair value of the contingent cash consideration of $1.25 million due on the first anniversary date of the closing (February 2, 2016) and a final cash payment of $1.25 million due on the second anniversary date of the closing (February 2, 2017), with imputed interest expense calculated at 8% per annum. The contingent stock consideration of $2.0 million was comprised of the issuance of 166,667 shares of common stock on the first anniversary date of the closing (February 2, 2016) and 166,666 shares of common stock on the second anniversary date of the closing (February 2, 2017). The contingent cash and stock consideration was payable on the first and second anniversary dates of the closing provided that MK Capital generated a minimum amount of gross revenues as defined in the purchase agreement for the twelve months following the first and second anniversary dates of the closing. MK Capital achieved the minimum amount of revenues for the first and second anniversary periods. The contingent cash consideration for such first anniversary period of $1.25 million was paid and contingent stock consideration for such first anniversary period of 166,667 common shares was issued to the former members of MK Capital on February 2, 2016. The contingent cash consideration for such second anniversary period of $1.25 million was paid and contingent stock consideration for such second anniversary period of 166,666 common shares was issued to the former members of MK Capital on February 2, 2017.

 

Credit Agreements

 

On April 21, 2017, we amended the credit agreement governing our asset based credit facility with Wells Fargo Bank, National Association to increase the maximum borrowing limit from $100.0 million to $200.0 million. Such amendment, among other things, also extended the expiration date of the credit facility from July 15, 2018 to April 21, 2022. From time to time, we utilize this credit facility  to fund costs and expenses incurred in connection with liquidation engagements. We also utilize this credit facility in order to issue letters of credit in connection with liquidation engagements conducted on a guaranteed basis. Subject to certain limitations and offsets, we are permitted to borrow up to $200.0 million under the credit facility, less the aggregate principal amount borrowed under the UK Credit Agreement (if in effect). Borrowings under the credit facility are only made at the discretion of the lender and are generally required to be repaid within 180 days. The interest rate for each revolving credit advance under the related credit agreement is, subject to certain terms and conditions, equal to the LIBOR plus a margin of 2.25% to 3.25% depending on the type of advance and the percentage such advance represents of the related transaction for which such advance is provided. On March 19, 2014, we entered into a separate credit agreement (a “UK Credit Agreement”) with an affiliate of Wells Fargo Bank, National Association which provides for the financing of transactions in the United Kingdom. The facility allows us to borrow up to 50.0 million British Pounds. Any borrowings on the UK Credit Agreement reduce the availability on the asset based $200.0 million credit facility. The UK Credit Agreement is cross collateralized and integrated in certain respects with the credit agreement governing the credit facility. On October 5, 2016 we amended the Credit Agreement to add our Canadian subsidiary in order to facilitate borrowings to fund retail liquidation transactions in Canada. The credit facility is secured by the proceeds received for services rendered in connection with the liquidation service contracts pursuant to which any outstanding loan or letters of credit are issued and the assets that are sold at liquidation related to such contract, if any. The credit facility also provides for success fees in the amount of 2.5% to 17.5% of the net profits, if any, earned on liquidation engagements that are financed under the credit facility as set forth in the related credit agreement. We typically seek borrowings on an engagement-by- engagement basis. The credit agreement governing the credit facility contains certain covenants, including covenants that limit or restrict our ability to incur liens, incur indebtedness, make investments, dispose of assets, make certain restricted payments, merge or consolidate and enter into certain transactions with affiliates. At March 31, 2017 and December 31, 2016, there were no borrowings or letters of credits outstanding under the credit facility.

 

On April 13, 2017, UOL, in the capacity as borrower entered into a credit agreement (the “UOL Credit Agreement”) with the Banc of California, N.A. in the capacity as agent and lender. The UOL Credit Agreement provides for a revolving credit facility under which UOL may borrow (or request the issuance of letters of credit) up to $20.0 million which amount is reduced by $1.5 million commencing on June 30, 2017 and on the last day of each calendar quarter thereafter. The final maturity date is April 13, 2020.  The proceeds of the UOL Credit Agreement can be used (a) for working capital and general corporate purposes and/or (b) to pay dividends or permitted tax distributions to its parent company, subject to the terms of the UOL Credit Agreement. Borrowings under the UOL Credit Agreement will bear interest at a rate equal to (a) (i) the base rate (the greater of the federal funds rate plus one half of one percent (0.5%), or the prime rate) for U.S. dollar loans or (ii) at UOL’s option, the LIBOR Rate for Eurodollar loans, plus (b) the applicable margin rate, which ranges from two percent (2%) to three and one-half percent (3.5%) per annum, based upon UOL’s ratio of funded indebtedness to adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) for the preceding four (4) fiscal quarters. Interest payments are to be made each one, three or six months for Eurodollar loans, and quarterly for U.S. dollar loans.

 

 

UOL paid a commitment fee equal to 1.00% of the aggregate commitments upon the closing of the UOL Credit Agreement. The UOL Credit Agreement also provides for an unused line fee payable quarterly, in arrears, in an amount equal to: (a) 0.50% per annum times the amount of the unused revolving commitment that is less than or equal to the amount of the cash maintained in accounts with the agent (as depositary bank); plus (b) 1.00% per annum times the amount of the unused revolving commitment that is greater than the amount of the cash maintained in accounts with the agent (as depositary bank). Any amounts outstanding under the UOL Credit Facility are due at maturity.

 

Senior Note Offering

 

On November 2, 2016, we issued $28.75 million of Senior Notes, interest payable quarterly at 7.5% commencing January 31, 2017. The Senior Notes are unsecured and due and payable in full on October 31, 2021. In connection with the issuance of the Senior Notes, we received net proceeds of $27.7 million (after underwriting commissions and fees of $1.1 million). In connection with the offering of the Senior Notes, members of our management and Board of Directors purchased $2.7 million or 9.5% of the Senior Notes we offered.

 

Other Borrowings

 

In August 2016, we formed GA Retail Investments, L.P., a Delaware limited partnership, (the “Partnership”) which required us to contribute $15.4 million. The Partnership borrowed $80.0 million Australian dollars from a third party investor in connection with its formation and the $80.0 million Australian dollars was exchanged for a 50% special limited partnership interest in the Partnership. The Partnership was formed to provide funding for the retail liquidation engagement we entered into to liquidate the Masters Home Improvement stores. The $80.0 million Australian participating note payable was non-interest bearing, shares in 50% of the all of the profits and losses of the Partnership and the principal amount was repaid in December 2016 upon the completion of the going-out-of-business sale of Masters Home Improvement stores as defined in the partnership agreement. At March 31, 2017 and December 31, 2016, $0.4 million and $10.0 million, respectively, was payable in accordance with the participating note payable share of profits and is included net income attributable to noncontrolling interests and amounts due to related parties and partners in the condensed consolidated financial statements.

 

Off Balance Sheet Arrangements

 

We have no obligations, assets or liabilities which would be considered off-balance sheet arrangements and do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, established for the purpose of facilitating off-balance sheet arrangements. We have not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.

 

Contractual Obligations

 

On February 17, 2017, we entered into the Merger Agreement to acquire FBR pursuant to the Merger. Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each outstanding share of FBR common stock, excluding certain specified shares, will be converted into the right to receive 0.671 of a share of our common stock. We currently estimate that approximately 5.3 million shares of our common stock will be issued in connection with this transaction, with an assumed value of approximately $93.0 million based on the closing price of our common stock on February 17, 2017. It is anticipated that the Merger will close during the second quarter of 2017.

 

New Accounting Standards

 

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02: Leases (Topic 842) (“ASU 2016-02”). The amendments in this update require lessees, among other things, to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous authoritative guidance. This update also introduces new disclosure requirements for leasing arrangements. ASU 2016-02 will be effective for the Company in fiscal year 2019, but early application is permitted. The Company is currently evaluating the impact of this update on the consolidated financial statements.

 

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606).   Under this ASU and subsequently issued amendments, revenue are recognized at the time when goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to receive in exchange for those goods or services. This standard sets forth a five-step revenue recognition model which replaces the current revenue recognition guidance in its entirety and is intended to eliminate numerous industry-specific pieces of revenue recognition guidance.  This standard is effective in the first quarter of 2018 for public companies and requires either a retrospective or a modified retrospective approach to adoption.  The Company believes the adoption of this standard may impact engagements that contain performance-based arrangements in which a success or completion fee is earned when and if certain predefined outcomes occur and engagements and contracts where services are provided under fixed-fees arrangements that have multiple performance obligations. The Company has not completed an assessment and has not yet determined whether the impact of the adoption of this standard on the consolidated financial statements will be material. The Company will adopt this standard on January 1, 2018 but have not concluded on a transition approach. The Company expects to complete the assessment process, including selecting a transition method for adoption during third quarter of 2017.

 

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments in this update do not change the core principle of the guidance as noted above at ASU No. 2014-09. The amendments clarify the implementation guidance on principal versus agent considerations. The effective date and transition requirements for the amendments in this update are the same as the effective date and transition requirements of ASU No. 2014-09. The Company has not yet adopted this update and is currently evaluating the impact it may have on its financial condition and results of operations.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15), which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. ASU 2016-15 is effective for us in our first quarter of fiscal year 2019 , but early application is permitted. The Company has not yet adopted this update and is currently evaluating the impact it may have on its financial condition and results of operations.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350) Simplifying the Test for Goodwill Impairment.   This standard simplifies the accounting for goodwill impairment. The guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.  The revised guidance will be applied prospectively, and is effective for calendar year-end SEC filers for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019.  Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  The Company has not yet adopted this update and currently evaluating the effect this new standard will have on its financial condition and results of operations.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Not applicable.

 

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

We maintain a system of disclosure controls and procedures (as defined in the Rules 13a-15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that is designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

 

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act. Based upon the foregoing evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that as of March 31, 2017 our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes to our internal control over financial reporting during the fiscal quarter covered by this Quarterly Report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Inherent Limitation on Effectiveness of Controls

 

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well-designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

 

 

PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

From time to time, we are involved in litigation which arises in the normal course of our business operations. Except as set forth below, we believe that we are not currently a party to any proceedings the adverse outcome of which, individually or in the aggregate, would have a material adverse effect on our financial position or results of operations:

 

On January 19, 2015, a complaint (the “Complaint”) was filed against Great American Group, LLC, in the United States Bankruptcy Court for the District of Delaware (“Court”), adversary proceeding 15-50057 (MFW), by 9586 LLC asserting claims arising out of the Great American Group, LLC’s activities with respect to an auction of equipment in Colorado in October 2012.  This proceeding is pending in the bankruptcy cases of Abound Solar Manufacturing, LLC and certain of its affiliates (the “Debtors”), case no. 12-11974.  The Complaint asserts claims for breach of contract, negligence, fraud, unjust enrichment, negligent misrepresentation, nuisance, and violations of the Colorado Consumer Protection Act (“CCPA”).  In the Complaint, the plaintiff, a former landlord of the Debtors, generally alleges that Great American Group, LLC and a joint venture partner were responsible for contamination while performing services in connection with an auction of solar machinery, and is seeking approximately $9.7 million in damages.  Great American Group, LLC filed a Motion to Dismiss the Complaint and on March 1, 2016, the Court issued its Opinion on Great American Group, LLC’s Motion to Dismiss dismissing the unjust enrichment claim and the CCPA claim, but denied the motion with respect to the other claims. In April 2016, Great American Group, LLC filed an answer with the Court denying the allegations in the complaint. In December 2016, the parties exchanged initial disclosures.  In January 2017, the parties filed a proposed scheduling order with the Court. Discovery in the action is currently proceeding. We intend to continue to vigorously defend this action which we consider to be meritless. An adverse judgment in this matter could materially and adversely affect the Company and its financial condition.

 

On July 5, 2016, Quadre Investments LP (“Quadre”) filed a petition with the Delaware Court of Chancery (the “Chancery Court”) seeking a determination of fair value for 943,769 shares of common stock of UOL in connection with the acquisition of UOL by the Company (the “Quadre Litigation”). Such transaction gave rise to appraisal rights pursuant to Section 262 of the General Corporation Law of the State of Delaware. As a result, Quadre is entitled to petition the Chancery Court to receive fair value as determined by the Chancery Court. We do not believe that the fair value of each share exceeds $11.00 per share, the merger consideration paid to UOL stockholders pursuant to the merger agreement in such acquisition, and we intend to contest the petition. Discovery in the case has commenced. As of March 31, 2017, we have recorded approximately $10.4 million of acquisition consideration payable and approximately $0.5 million of accrued interest payable in connection with the Quadre Litigation.

 

On March 10, 2017, UOL received a letter from PeopleConnect, Inc., the successor entity to Classmates, Inc., a former subsidiary of UOL (“PeopleConnect”), regarding a notice of investigation received from the Consumer Protection Divisions of the District Attorneys’ offices of four California counties (“California DAs”).  The California DAs suggest that PeopleConnect may be in violation of California codes relating to unfair competition, false or deceptive advertising, and auto-renewal practices (the “Claims”).  PeopleConnect asserts that the Claims are indemnifiable claims under the purchase agreement between UOL and the buyer of Classmates, Inc.   At the present time, any potential liability and damages cannot be estimated.

 

Item 1A. Risk Factors.

 

There are certain risks and uncertainties in our business that could cause our actual results to differ materially from those anticipated. A detailed discussion of our risk factors was included in Part I, Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission on March 10, 2017. These risk factors should be read carefully in connection with evaluating our business and in connection with the forward-looking statements and other information contained in this Quarterly Report on Form 10-Q. Any of the risks described in the Annual Report on Form 10-K for the year ended December 31, 2016 could materially affect our business, financial condition or future results and the actual outcome of matters as to which forward-looking statements are made. There were no material changes to the risk factors during the three months ended March 31, 2017, compared to the risk factors set forth in the Annual Report on Form 10-K for the year ended December 31, 2016.

 

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

 

None.

 

Item 3. Defaults Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures.

 

Not applicable.

 

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

 

The exhibits filed as part of this Quarterly Report are listed in the index to exhibits immediately preceding such exhibits, which index to exhibits is incorporated herein by reference.

 

 

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.

 

		B. Riley Financial, Inc.
Date: May 10, 2017	By:	/s/ PHILLIP J. AHN
		Name: Phillip J. Ahn
		Title: Chief Financial Officer and Chief Operating Officer
		(Principal Financial Officer)

 

 

Exhibit Index

 

Exhibit No.		Description
2.1(1)+		Agreement and Plan of Merger, dated February 17, 2017, by and between the registrant and FBR & Co.
31.1*		Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
31.2*		Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
32.1*†		Certification required by 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*†		Certification required by 18 United States Code Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
10.1*		Credit Agreement, dated as of April 13, 2017, by and among United Online, Inc., the subsidiaries of United Online, Inc. from time to time party thereto and Banc of California, N.A.
101.INS*		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document

 

*

Filed herewith.

†

These exhibits are being “furnished” and shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, nor shall they be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, except as shall be expressly set forth by specific reference in such filing.

+

Schedules to this exhibit have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The registrant hereby agrees to furnish a copy of any omitted schedules to the Securities and Exchange Commission upon request.

(1)

Incorporated by reference to the registrant’s Current Report on Form 8-K filed with the SEC on February 21, 2017.