UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

For the fiscal year ended September 30, 2020

OR

FOR THE TRANSITION PERIOD FROM                       TO

Commission File Number 001-37689

 

ALJ REGIONAL HOLDINGS, INC.

(Exact name of Registrant as specified in its Charter)

 

 

 

244 Madison Avenue, PMB #358

New York, NY 10016

(Address of principal executive offices, Zip code)

Registrant’s telephone number, including area code: (888) 486-7775

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

   Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☒

   Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes    ☐  No    ☒

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

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

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

 

 

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

   Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes Oxley Act (15 U.S.C. 7262 (b)) by the registered public accounting firm that prepared or issued its audit report. ☐

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

   The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates was approximately $11,523,803, based on the closing price of $0.60 for such common equity on March 31, 2020.

   The number of shares of common stock, $0.01 par value per share, outstanding as of November 30, 2020, was 42,321,048.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

None

 

 

 

 

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Table of Contents

 

 

 

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FORWARD-LOOKING STATEMENTS

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

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

 

 

 

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PART I

ITEM 1. BUSINESS.

Overview and Business Organization

ALJ Regional Holdings, Inc. (including subsidiaries, referred to collectively in this report as “ALJ,” the “Company” or “we”) is a holding company.  As of September 30, 2020, ALJ consisted of the following wholly-owned subsidiaries:

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

ALJ has organized its business and corporate structure along the following business segments: Faneuil, Carpets, and Phoenix. ALJ is reported as corporate overhead. For results of operations by business segment, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Faneuil

Background

Faneuil is a Delaware corporation with headquarters in Hampton, VA. We acquired Faneuil from Harland Clarke Holdings Corp., a wholly-owned subsidiary of MacAndrews & Forbes Holdings Inc., for aggregate consideration of $53.0 million.

Faneuil is a nationally recognized leader in technology-enabled in-person and automated service delivery, particularly in regulated, highly complex environments.

Acquisition of Realtime Digital Innovations, LLC

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

Acquisition of Customer Management Outsourcing Business

In May 2017, Faneuil acquired certain assets and assumed certain liabilities associated with the customer management outsourcing business (“CMO Business”) of Vertex Business Services LLC.  

Faneuil purchased the CMO Business to expand into the utilities market by providing direct customer care call center operations, back-office processes, including billing, collections and business analytics, and installation and cloud-based customer care support for the utilities industry.

 

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Services

Faneuil provides business processing solutions for an extensive client portfolio that includes both commercial and government entities across several verticals, including transportation, utilities, healthcare, consumer goods, and government/municipal services.  Utilizing advanced applications and a dedicated team of service professionals, Faneuil delivers broad outsourcing support, ranging from customer contact centers, fulfillment operations, and information technology services, to manual and electronic toll collection and violation processing, with the goal of building its clients’ brands by providing exemplary customer service.

Faneuil’s core competencies include:

Faneuil employees who have contact with customers undergo intensive training and development, followed by structured monitoring and assessments before they are certified to process customer contacts. Faneuil’s customer contact employees provide service delivery through multiple communication channels, including telephone, fax, email, web chat and face-to-face interaction. Additionally, Faneuil provides multi-lingual representatives to accommodate the communication needs of non-English-speaking customers, as well as the hearing-impaired.

Employees

Faneuil had 7,743 employees as of September 30, 2020 (up from 5,499 employees as of September 30, 2019), all of whom are located in the U.S. No employees are subject to any collective bargaining agreements. Faneuil considers its employee relations good.

Customers

Faneuil’s client portfolio includes both government and commercial entities nationwide, including several toll authorities, state agencies, municipalities, publicly-owned utilities, health benefit exchanges, one government agency that operates the major airports serving the Washington, D.C. area, and several other public and private entities.

The percentages of Faneuil net revenue derived from its significant customers for the years ended September 30, 2020 and 2019 were as follows:

 

 

** Less than 10% of Faneuil net revenue. 

Many Faneuil customers are government agencies subject to contractual budgetary ceilings. State and local funding for these agencies is approved by the respective state legislature(s) each year. Depending on budgetary constraints, the contract values may be subject to change based upon ongoing legislative approval.

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Competition

Primary competitors to Faneuil are other large providers of toll services, such as Conduent, AEComm, and TransCore, Inc., as well as contact center operators such as Maximus and Automated Health Services. In many cases, Faneuil is smaller and has less financial and personnel resources than its competitors. If Faneuil cannot compete effectively to win new business and retain existing clients, its operating results will be negatively affected. To remain competitive, Faneuil must continuously implement new technologies and expand its portfolio of outsourced services and may have to make occasional strategic adjustments to its pricing for its services.

Properties

Faneuil leases all its properties in various locations throughout the United States for customer contact centers, walk-in retail, and administration. Corporate headquarters are located in Hampton, VA.  Faneuil’s leased facilities comprise an aggregate of approximately 558,000 square feet with leases that expire at various dates through April 2030.  Faneuil believes that its existing leased facilities are adequate for current requirements.  

Backlog

Faneuil backlog represents executed contracts for future services.  Most contracts are long-term and obligate Faneuil to provide services over multiple years.  Faneuil backlog may not represent firm commitments as some contracts, especially with government entities, allow for cancellation under certain instances.  Faneuil adjusts backlog to reflect contract cancellations, deferrals, and revisions known at the reporting date.  However, Faneuil could experience additional contract modifications or cancellations, which may increase or decrease backlog.  

 

The following table reflects the amount of Faneuil backlog by the fiscal year we expect to recognize revenue:  

 

 

The increase in Faneuil backlog at September 30, 2020 compared to September 30, 2019 was primarily driven by one large multi-year transportation contract award and one large healthcare customer contract extension.

 

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

Seasonality

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

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Governmental Regulation

Faneuil’s business is subject to many legal and regulatory requirements in the United States, covering such matters as data privacy, consumer protection, healthcare requirements, labor relations, taxation, internal and disclosure control obligations, governmental affairs and immigration. For example, Faneuil is subject to state and federal laws and regulations regarding the protection of consumer information commonly referred to as “non-public personal information,” including the collection of patient data through Faneuil’s contact center services and medical device tracking services, which is subject to the Health Insurance Portability and Accountability Act of 1996, commonly known as HIPAA, which protects the privacy of patient data. These laws, regulations, and agreements require Faneuil to develop and implement policies to protect non-public personal information and to disclose these policies to consumers before a customer relationship is established and periodically thereafter. These laws, regulations, and agreements limit the ability to use or disclose non-public personal information for purposes other than the purposes originally intended. Many of these regulations, including those related to data privacy, frequently change and sometimes conflict with existing regulations amongst the various jurisdictions in which Faneuil provides services. Violations of these laws and regulations could result in liability for damages, fines, criminal prosecution, unfavorable publicity and restrictions on Faneuil’s operations.  Failure to adhere to or successfully implement processes in response to changing regulatory requirements in this area could result in legal liability or impairment to Faneuil’s reputation in the marketplace, which could have a material adverse effect on Faneuil’s business, results of operations and financial condition. Also, because a substantial portion of Faneuil operating costs consists of labor costs, changes in governmental regulations relating to wages, healthcare and healthcare reform and other benefits or employment taxes could have a material adverse effect on Faneuil’s business, results of operations or financial condition.

Management

Faneuil is led by ALJ board member Anna Van Buren, who has served as President and Chief Executive Officer since 2009 and previously served in executive roles at Faneuil since 2004. For additional information regarding Ms. Van Buren, see “Part III, Item 10. Directors, Executive Officers and Corporate Governance.”

Carpets N’ More

Background

Carpets is a Nevada limited liability company headquartered in Las Vegas, Nevada. We acquired Carpets from Levine Leichtman for aggregate consideration of $5.3 million.

Carpets is one of the largest floor covering retailers in Las Vegas, Nevada, and a provider of multiple products for the commercial, retail and home builder markets, including flooring, countertops, cabinets, window coverings, and garage/closet organizers. In addition to a stone and solid surface fabrication facility, Carpets has one retail location in the Las Vegas area.  

Products and Services

Floor Coverings. Carpets provides various floor coverings to home builders, commercial and retail customers including carpet, hardwood, laminate, tile, ceramic, porcelain, natural stone, vinyl plank, vinyl tile, area rugs, and specialty flooring including bamboo, leather, cork and large format tile.

Countertops and Surrounds. Carpets provides countertop and surrounds, primarily for bathrooms and kitchens, including natural stone, granite, ceramic, porcelain, solid surface, quartz, and piedrafina.

Cabinets and Other Products. Carpets provides kitchen, bathroom, and garage cabinets, closet and closet organizers, and window coverings including blinds, shutters, and shades.

Customers

Carpets sells to a variety of customers, including home builders, commercial, and retail customers.  Home building customers of Carpets include some of the largest home builders in the United States, along with local builders in and around Las Vegas, Nevada. Commercial customers of Carpets include general contractors, real estate investment firms/funds, and other commercial entities such as casinos and other companies looking to improve their office space. Retail customers of Carpets include the general public interested in making home improvements.

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Carpets bids directly with home builders on residential developments and is awarded flooring, countertops and surrounds, and/or cabinet contracts. These contracts involve installing the base level products in each of the residential homes within the awarded development and, when requested, providing upgraded materials and services to the base level products. Carpets also bids on commercial work and is awarded contracts generally on a fixed price basis. These projects generally involve high-rise condos, office buildings, tenant improvements, and off-strip casinos. Carpets also engages in marketing activities, including Internet search engine optimization, banner advertising, car wraps, affiliate websites, radio and television advertising, and referrals targeted toward retail customers.

A small number of customers have historically accounted for a substantial portion of Carpets net revenue.  The percentages of Carpets net revenue derived from its significant customers for the years ended September 30, 2020 and 2019 were as follows:

 

 

Suppliers

Carpets has historically purchased materials from a small number of suppliers primarily to control the quality of the product and to capitalize on volume discounts.  If these suppliers were unable to provide materials on a timely basis, Carpets management believes alternative suppliers could provide the required materials with minimal disruption to the business.  Historically, Carpets has never experienced any significant delay or shortage in the supply of materials.

The percentages of Carpets inventory purchases from its significant suppliers for the years ended September 30, 2020 and 2019 were as follows:

 

 

** Less than 10% of Carpets inventory purchases.

Backlog

 

Carpets backlog represents open purchase orders.  As of September 30, 2020, Carpets total backlog, which is expected to be fully realized within the next 12 months, was $7.5 million compared to $11.0 million as of September 30, 2019.  The decrease in Carpets backlog at September 30, 2020, compared to September 30, 2019, was the result of a lower sales pipeline.

 

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

Competition

Primary competitors to Carpets include other flooring, countertop and surround, and cabinet providers both nationally and in the Las Vegas area, such as Interior Specialist Inc. and Classic Flooring, as well as large box stores such as Lowe’s, Home Depot, and RC Willey. Carpets believes that its competitive advantages include a comprehensive and high-end quality solution for home builders for flooring, surrounds, and cabinets, which provides them with a single point of accountability. Carpets also competes with discounted flooring companies such as Cloud Carpet and Carpets Galore.

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Seasonality

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

Employees

Carpets had 247 employees, including part-time installers, as of September 30, 2020 (down from 386 employees at September 30, 2019), all of whom are located in the U.S.  No employees are subject to any collective bargaining agreements. Carpets considers its employee relations good.

Properties

Carpets leases its corporate office, one retail location, solid surface fabrication facility, and flooring and cabinet warehouses, which are all located in or around Las Vegas, NV.  Leased facilities total approximately 90,000 square feet with leases that expire at various dates through March 2022. Carpets believes its leased facilities will be adequate for at least the next 12 months.

Management

Carpets is led by Steve Chesin, who has served as its Chief Executive Officer since 2007. For additional information about Mr. Chesin, see “Part III, Item 10. Directors, Executive Officers and Corporate Governance.”

Phoenix Color Corp.

Background

Phoenix is a Delaware corporation headquartered in Hagerstown, Maryland.  We acquired Phoenix from Visant Corporation for aggregate consideration of $88.3 million.

Phoenix is a premier full-service, full-color printer with over 40 years of superior printing experience. Drawing on a broad spectrum of materials and decorative technologies, Phoenix produces memorable, value-added components, heavily illustrated books, and specialty commercial products. Book publishers generally design book components to enhance the sales appeal of their books. The production of book components requires specialized equipment, materials, and finishes and often demands high-quality, intricate work. As a result, many leading publishers rely on specialty printers such as Phoenix to supply high-quality book components. This same philosophy applies to labels, packaging, and specialty commercial products, where Phoenix customers require the knowledge and expertise of a printer that can enhance their products for sale into the commercial marketplace. Phoenix has been servicing the publishing industry within the United States since 1979 and has formed lasting relationships with many of the biggest names in book publishing.

As a domestic manufacturer, Phoenix offers extensive, in-house digital pre-press capabilities and its technologically advanced UV printing platform supports an array of printing and finishing options. Phoenix innovative special effects include foil stamping, UV embellishments, and laminations, as well as its trademarked products LithoFoil^®, MetalTone™, Look of Leather™, and VibraColor™.

Acquisition of Printing Components Business

On October 2, 2017, Phoenix acquired certain assets and assumed certain liabilities from LSC Communications, Inc. (“LSC”) and Moore-Langen Printing Company, Inc. related to LSC’s printing and manufacturing services division in Terre Haute, Indiana (“Printing Components Business”) for aggregate consideration of $10.0 million.    

The Printing Components Business leverages existing capabilities and core competencies of Phoenix, strengthens its position in the education markets, and expands its revenue into new markets.

Acquisition of Color Optics

In July 2016, Phoenix acquired certain assets and assumed certain liabilities from AKI, Inc. (“AKI”) in respect of AKI’s Color Optics division (“Color Optics”) for an adjusted purchase price of $6.6 million.  

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Color Optics is a leading printing and packaging solutions business servicing the beauty, fragrance, cosmetic, and consumer-packaged goods markets.  The purchase of Color Optics complements Phoenix product offerings and has allowed Phoenix to expand and diversify its product offerings by leveraging its existing core competencies.

 

Products and Services

Books and Components

Phoenix offers several products for books and components, which represents approximately 90% of Phoenix net revenue.

Phoenix is a leader in providing distinctive cover components and high-quality, heavily illustrated and multi-colored books for all markets. With its technologically advanced pre-press and press operations as well as an array of finishing applications and innovative special effects, Phoenix is committed to producing memorable, value-added products.

Labels and Packaging

In recent years, Phoenix has expanded into the label and packaging markets to leverage its unique printing and finishing capabilities as well as its trademarked special effects and extensive offerings of finishes and coatings. In 2014, Phoenix acquired the Brady Palmer Company, establishing its presence in the cut and stack label market.  With the subsequent purchase of Color Optics, Phoenix strengthened its presence in the label and packaging markets.

Employees

Phoenix had 413 employees as of September 30, 2020 (down from 433 employees as of September 30, 2019), all of whom are located in the U.S.  Phoenix considers its employee relations good.

Customers

Phoenix sells to many of the leading publishing companies.  A small number of customers have historically accounted for a substantial portion of Phoenix net revenue.  The percentages of Phoenix net revenue derived from its significant customers for the years ended September 30, 2020 and 2019 were as follows:

 

 

** Less than 10% of Phoenix net revenue.

 

Suppliers

Phoenix has historically purchased raw materials from a small number of suppliers primarily to control the quality of the product and to capitalize on volume discounts.  If these suppliers were unable to provide materials on a timely basis, Phoenix management believes alternative suppliers could provide the required materials with minimal disruption to the business.  Historically, Phoenix has not experienced any significant delay or shortage in the supply of materials.

The percentages of Phoenix inventory purchases from its significant suppliers for the years ended September 30, 2020 and 2019 were as follows:

 

 

** Less than 10% of Phoenix inventory purchases.

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Backlog

 

Phoenix backlog represents executed master service agreements (“MSA”) that contain minimum volume commitments over multiple years for future product deliveries. Phoenix includes only the estimated minimum commitments in the MSA as backlog. As Phoenix executed MSAs mostly provide for minimum volume commitments rather than minimum aggregate dollar spend, the actual revenue from such agreements may differ from our backlog estimates as to the total order volume and the timing of such volume. Phoenix adjusts backlog to reflect estimated order volumes delivered by its customers based on historical experience known at the reporting date; however, future variations in order volumes by Phoenix customers may increase or decrease backlog and future revenue.

The following table reflects the amount of Phoenix backlog by the fiscal year we expect to recognize revenue:

 

 

The increase in Phoenix backlog at September 30, 2020 compared to September 30, 2019 was primarily driven by the execution of a multi-year extension of a strategic customer supply agreement with increased volume commitments through 2027.  

 

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

Seasonality

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

Competition

The printing industry in general and the printing and manufacturing of books, in particular, is extremely competitive. Over the past several years, there has been significant consolidation in the publishing industry, such that fewer publishers control a greater share of the market. Although there are still many small, independent publishers, they do not wield the leverage held by major publishing houses. Additionally, the printing industry has experienced a reduction in demand for trade books due to the impact of the e-book market and a reduction in textbooks due to lower state government funding, alternative product formats and digital distribution of content.

Primary competitors in the printing and manufacturing of books and book components include, but are not limited to Coral Graphics, Quad Graphics, and Worzalla. There is no reliable industry data available to determine Phoenix’s market share and position versus that of its competitors. With respect to book components, a portion of the products is produced by the book manufacturers and a portion by component printers. The dollar value of book components manufactured by the book manufacturers or by other component printers is unknown. Phoenix and Coral Graphics are the two primary trade book component manufacturers used by major publishers in the U.S. market. Most high-quality, heavily-illustrated and multi-colored books sold in the U.S. are produced outside of the U.S. Phoenix competes with Worzalla and several domestic book manufacturers for that portion that is produced domestically.

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Properties

Phoenix owns its principal properties for corporate offices and production located in Hagerstown, MD, which totals approximately 276,000 square feet. Phoenix owns two buildings totaling approximately 45,000 square feet in Terre Haute, IN, which were acquired as part of the Printing Components Business.  Additionally, Phoenix rents approximately 10,000 square feet in Rockaway, NJ (reduced to 5,000 square feet on October 1, 2020) and 3,000 square feet in New York, NY.  Both leases are month-to-month. Phoenix believes its facilities will be adequate for at least the next 12 months.

Management

Phoenix is led by Marc Reisch, who currently serves as its Chairman and previously served as its Chief Executive Officer from 2008 to 2015. Mr. Reisch served as a director on ALJ’s Board of Directors from August 2015 until October 2019.  For additional information regarding Mr. Reisch, see “Part III, Item 10. Directors, Executive Officers and Corporate Governance.”

Additional Information About ALJ and its Subsidiaries

ALJ was originally incorporated in the State of Delaware under the name Nuparent, Inc. on June 22, 1999. The Company’s name was changed to YouthStream Media Networks, Inc. on June 24, 1999, and that name was used through October 23, 2006. The Company’s name was changed to ALJ Regional Holdings, Inc. on October 23, 2006.

As of September 30, 2020, ALJ had four employees, its Chief Executive Officer, Chief Financial Officer, and two support staff, performing services dedicated primarily to general corporate and administrative matters. No employee is represented by a labor union.

Intellectual Property

We rely on copyright, trademark, and trade secret laws as well as contractual restrictions to protect our proprietary information and intellectual property rights. We control access to our proprietary information and intellectual property, in part, by entering into confidentiality and invention assignment agreements with our employees, contractors, and business partners. We also control the use of our proprietary information and intellectual property through provisions in our client agreements and distribution partner agreements.

We have a limited number of registered trademarks and registered copyrights in the United States as well as a number of common law trademarks and trade names. We rely substantially on unpatented proprietary technology. We do not consider the success of our business, as a whole to be dependent on our intellectual property.

Available Information

We make available free of charge our annual, quarterly and current reports, proxy statements and other information, in electronic format, upon request. To request such materials, please contact our Chief Financial Officer at 244 Madison Avenue, PMB #358, New York, NY 10016 or call 212-883-0083.

Additionally, many reports and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our website at www.aljregionalholdings.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (“SEC”).  Information on our website and other information that can be accessed through our website are not part of this report.

 

 

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ITEM 1A. RISK FACTORS.

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

Risks Related to Faneuil

 

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

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

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

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

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

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

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

Faneuil derives a substantial portion of its revenue from a relatively small number of customers. For additional information regarding Faneuil customer concentrations, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 5. Concentration Risks.”  We expect the largest customers of Faneuil to continue to account for a substantial portion of its total net revenue for the foreseeable future. Faneuil has long-standing relationships with many of its significant customers. However, because Faneuil customers generally contract for specific projects or programs with a finite duration, Faneuil may lose these customers if funding for their respective programs is discontinued, or if their projects end and the contracts are not renewed or replaced. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could materially reduce Faneuil revenue and cash flows. Additionally, many Faneuil customers are government entities, which can unilaterally terminate or modify the existing contracts with Faneuil without cause and penalty to such government entities in many situations. If Faneuil does not replace them with other customers or other programs, the loss of business from any one of such customers could have a material adverse effect on its business or results of operations.

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

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

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

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

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

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

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

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

Adequate bonding is necessary for Faneuil to win new contracts.

Faneuil is often required, primarily in its toll and transportation programs, to provide performance and surety bonds to customers in conjunction with its contracts. These bonds indemnify the customer should Faneuil fail to perform its obligations under the contracts. If a bond is required for a particular program and Faneuil is unable to obtain an appropriate bond, Faneuil cannot pursue that program. The issuance of a bond is at the surety’s sole discretion. Moreover, due to events that affect the insurance and bonding markets generally, bonding may be more difficult to obtain in the future or may only be available at significant additional costs. There can be no assurance that bonds will continue to be available on reasonable terms, or at all. Any inability to obtain adequate bonding and, as a result, to bid on new work could harm Faneuil’s business.

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

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

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

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

Changes in employment laws and prevailing wage standards may adversely affect our business.

The industries in which Faneuil competes is labor intensive. Faneuil’s ability to meet its labor needs on a cost-effective basis is subject to numerous external factors, including the availability of qualified personnel in the workforce in the local markets in which it operates, unemployment levels within those markets, prevailing wage rates, health and other insurance costs and changes in employment and labor laws. Such laws related to employee hours, wages, job classification and benefits could significantly increase Faneuil’s operating costs. Additionally, in the event prevailing wage rates increase in the local markets in which Faneuil operates, Faneuil may be required to concurrently increase the wages paid to its employees to maintain the quality of its workforce and customer service. To the extent such increases are not covered by our customers, Faneuil’s profit margins may decrease as a result. If Faneuil is unable to hire and retain employees capable of meeting its business needs and expectations, its business and brand image may be impaired. Any failure to meet Faneuil’s staffing needs or any material increase in turnover rates of its employees may adversely affect its business, results of operations and financial condition.

Risks Related to Carpets

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

 

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

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

 

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

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

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

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

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

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

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

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

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

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

A small number of customers have historically accounted for a substantial portion of Carpets net revenue. We expect that key customers will continue to account for a substantial portion of Carpets net revenue for the foreseeable future. However, Carpets may lose these customers due to pricing, quality or other various issues. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could have a material adverse effect on its business or results of operations. For additional information regarding customer concentrations, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 5. Concentration Risks.”  

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Historically, Carpets has purchased inventory from a small number of vendors. If these vendors became unable to provide materials promptly, or if such vendors became unable to satisfy Carpets’ standards for quality and its need to access products in a timely, efficient and cost-effective manner, Carpets would be required to find alternative vendors. The ability to access products can also be adversely affected by political instability, the financial instability of suppliers, suppliers’ noncompliance with applicable laws, trade restrictions, tariffs, currency exchange rates, supply disruptions, weather conditions, natural disasters, including climate change related events, shipping or logistical interruptions or costs and other factors beyond its control. If these vendors fail or are unable to perform as expected and Carpets is unable to replace them quickly, its business could suffer material adverse short- and long-term effects. For additional information regarding vendor concentrations, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 5. Concentration Risks.”  

Risks Related to Phoenix

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

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

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

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

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

Phoenix has significant customer and supplier concentration. For additional information regarding customer and supplier concentrations, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 5. Concentration Risks.” Any significant cancellation, deferral or reduction in the quantity or type of products sold to these principal customers or a significant number of smaller customers, including as a result of Phoenix’s failure to perform, the impact of economic weakness and challenges to customer businesses, a change in buying habits, further industry consolidation or the impact of the shift to alternative methods of content delivery, including digital distribution and printing, to customers, could have a material adverse effect on Phoenix business. Further, if Phoenix’s significant customers, in turn, are not able to secure large orders, they will not be able to place orders with Phoenix. A substantial decrease or interruption in business from Phoenix’s significant customers could result in write-offs or the loss of future business and could have a material adverse effect on Phoenix’s business.

Additionally, Phoenix purchases certain limited grades of paper to produce book and component products. If Phoenix’s suppliers reduce their supplies or discontinue these grades of paper, Phoenix may be unable to fulfill its contract obligations, which could have a material adverse effect on its business. See “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 5. Concentration Risks.”  

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

The industry in which Phoenix operates is experiencing rapid change due to the impact of digital media and content on printed products. Electronic delivery of information offer alternatives to traditional delivery in the form of print materials provided by Phoenix. Further improvements in the accessibility and quality of digital media, mobile technologies, e-reader technologies, digital retailing and the digital distribution of documents and data has resulted and may continue to result in increased consumer substitution away from Phoenix’s printed products. Continued consumer acceptance of such digital media, as an alternative to print materials, is

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uncertain and difficult to predict and may decrease the demand for the Phoenix’s printed products, result in reduced pricing for its printing services and additional excess capacity in the printing industry, and could materially adversely affect Phoenix’s business.

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

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

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

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

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

Risks Related to our Businesses Generally

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

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

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

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

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

 

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

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

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

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

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

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

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

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

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

Carpets competes with several home improvement stores, building materials supply houses and lumber yards, specialty design stores, showrooms, discount stores, local, regional and national hardware stores, mail order firms, warehouse clubs, independent building supply stores, and other retailers, as well as with installers. Also, it faces growing competition from online and multichannel retailers as its customers increasingly use computers, tablets, smartphones, and other mobile devices to shop online and compare prices and products in real time.

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

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

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

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Changes in interest rates may increase our interest expense.

 

As of September 30, 2020, $95.2 million of our current borrowings under the Cerberus Term Loan, Cerberus/PNC Revolver, and potential future borrowings are, and may continue to be, at variable rates of interest, tied to LIBOR or the Prime Rate of interest, thus exposing us to interest rate risk. Such rates tend to fluctuate based on general economic conditions, general interest rates, Federal Reserve rates and the supply of and demand for credit in the relevant interbanking market. In recent years, the Fed has incrementally changed the target range for the federal funds rate. Changes in the interest rate generally, and particularly when coupled with any significant variable rate indebtedness, could materially adversely impact our interest expense. If interest rates changed in the future by 100 basis points, based on our current borrowings as of September 30, 2020, our interest expense would increase or decrease by $1.0 million per year.

 

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

 

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

 

As of September 30, 2020, each of our subsidiaries had a significant backlog. Our backlog is typically subject to large variations from quarter to quarter and comparisons of backlog from period to period are not necessarily indicative of future revenue. The contracts comprising our backlog may not result in actual revenue in any particular period or at all, and the actual revenue from such contracts may differ from our backlog estimates. The timing of receipt of revenue, if any, for projects included in backlog could change because many factors affect the scheduling of projects. In certain instances, customers may have the right to cancel, reduce or defer amounts that we have in our backlog, which could negatively affect our future revenue. The failure to realize all amounts in our backlog could adversely affect our revenue and gross margins. As a result, our subsidiaries’ backlog as of any particular date may not be an accurate indicator of our future revenue or earnings.

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

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

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

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

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

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

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

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

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

Our executive officers and directors and their affiliated entities together beneficially owned approximately 58.5% of our outstanding common stock at November 30, 2020. Jess Ravich, our current Chief Executive Officer, beneficially owned approximately 49.8% of our common stock as of November 30, 2020. As a result, these stockholders, if they act together or in a block, could have significant influence over most matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions, even if other stockholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.

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

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

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

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

General Risk Factors

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

On December 22, 2017, President Trump signed into law the final version of the Tax Reform Law. The Tax Reform Law significantly reforms the Internal Revenue Code of 1986, as amended, with many of its provisions effective for tax years beginning on or after January 1, 2018. The Tax Reform Law, among other things, contains significant changes to corporate taxation, including a permanent reduction of the corporate income tax rate, a partial limitation on the deductibility of business interest expense, a limitation of the deduction for net operating loss carryforwards, an indefinite net operating loss carryforward and the elimination of the two-year net operating loss carryback, temporary, immediate expensing for certain new investments and the modification or repeal of many business deductions and credits. We continue to examine the impact this tax reform legislation may have on our business. Notwithstanding the reduction in the corporate income tax rate, the overall impact of the Tax Reform Law is uncertain and our business and financial condition could be adversely affected. The impact of this reform on our stockholders is uncertain. Stockholders should consult with their tax advisors regarding the effect of the Tax Reform Law and other potential changes to the U.S. Federal tax laws on them.

The market price of our common stock is volatile.

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

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

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

We, our officers, and our subsidiaries, are currently involved in, and from time to time may become involved in, legal proceedings or be subject to claims arising in the ordinary course of our business. Litigation is inherently unpredictable, time-consuming and distracting to our management team, and the expenses of conducting litigation are not inconsequential. Such distraction and expense may adversely affect the execution of our business plan and our ability to compete effectively in the marketplace. Further, if we do not prevail in litigation in which we may be involved, our results could be adversely affected, in some cases, materially. For additional information, see “Part I. Item 3, Legal Proceedings.”

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

If terrorist activities, armed conflicts, political instability or natural disasters, including climate change related events, occur in the United States, such events may negatively affect the operations of our subsidiaries, cause general economic conditions to deteriorate or cause demand for our subsidiaries’ services to decline. A prolonged economic slowdown or recession could reduce the demand for

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our subsidiaries’ services, and consequently, negatively affect our subsidiaries’ future sales and profits. Additionally, certain of our subsidiaries are dependent on key production facilities and certain specialized machines. Any disruption of production capabilities due to unforeseen events at any of our subsidiaries’ principal facilities could adversely affect our business, results of operations, cash flows, and financial condition.

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

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

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

Your share ownership may be diluted by the issuance of additional shares of our common or preferred stock or securities convertible into common or preferred stock in the future. As of September 30, 2020, a total of 1,849,000 shares of our common stock are issuable pursuant to outstanding options issued by us at a weighted-average exercise price of $3.09, and 2,907,529 shares of our common stock are issuable pursuant to outstanding warrants at a weighted-average exercise price of $1.11. As of September 30, 2020, ALJ had debt that was convertible into 10,707,000 shares of common stock at the discretion of the debt holder.  It is probable that options or warrants to purchase our common stock, or debt that is convertible into common stock, will be exercised during their respective terms if the fair market value of our common stock exceeds the exercise price of the particular option or warrant. If the stock options or warrants are exercised, your share ownership will be diluted. Additionally, options to purchase up to 1,085,000 shares of ALJ common stock are available for grant under our existing equity compensation plans as of September 30, 2020.

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

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

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

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

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

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

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

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For so long as we remain an emerging growth company, we are subject to reduced public company reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404(b) of Sarbanes Oxley and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements. We are also exempt from Section 14A (a) and (b) of the Securities Exchange Act of 1934 which require shareholder approval of executive compensation and golden parachutes for so long as we remain an emerging growth company.

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

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

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

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

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES.

ALJ’s corporate mailing address is 244 Madison Avenue, PMB #358, New York, NY 10016. ALJ does not maintain any physical corporate offices. For additional information about the properties of each of ALJ’s operating subsidiaries, see “Item 1. Business.”

ITEM 3. LEGAL PROCEEDINGS.  

The Company has been named in, and from time to time may become named in, various other lawsuits or threatened actions that are incidental to our ordinary business. For additional information regarding such matters, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 9. Commitments and Contingencies - Litigation, Claims, and Assessments.”  

ITEM 4. MINE SAFETY DISCLOSURE.

Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.  

Market Information

On May 11, 2016, our stock began trading on NASDAQ under the ticker symbol “ALJJ.”  Prior to May 11, 2016, our stock traded on the OTC Bulletin Board.  Although a market for our common stock exists, it is relatively illiquid.

 

Record Holders

As of November 30, 2020, there were 125 registered holders of ALJ’s common stock.  In addition, there are a significant number of holders of ALJ common stock that are “street name” or beneficial holders, whose shares are held of record by banks, brokers, and other financial institutions.  

Dividends

We have not declared or paid dividends on our common stock to date.  We intend to retain any earnings for use in the business for the foreseeable future.

Equity Compensation Plan Information

On July 11, 2016, ALJ shareholders approved ALJ’s Omnibus Equity Incentive Plan (the “2016 Plan”), which allows ALJ and its subsidiaries to grant securities of ALJ to officers, employees, directors or consultants.  ALJ believes that equity-based compensation is fundamental to attracting, motivating and retaining highly-qualified dedicated employees who have the skills and experience required to achieve business goals.  Further, ALJ believes the 2016 Plan aligns the compensation of directors, officers, and employees with shareholder interest.  

The 2016 Plan is administered by ALJ’s Compensation, Nominating and Corporate Governance Committee (the “Compensation, Nominating, and Corporate Governance Committee”) of the Board.  The maximum aggregate number of common stock shares that may be granted under the 2016 Plan is 2,000,000.  The 2016 Plan generally provides for the grant of qualified or nonqualified stock options, restricted stock and restricted stock units, unrestricted stock, stock appreciation rights, performance awards and other awards.  The Compensation, Nominating, and Corporate Governance Committee has full discretion to set the vesting criteria.  The exercise price of a stock option may not be less than 100% of the fair market value of ALJ’s common stock on the date of grant. The 2016 Plan prohibits the repricing of outstanding stock options without prior shareholder approval. The term of stock options granted under the 2016 Plan may not exceed ten years.  Awards are subject to accelerated vesting upon a change in control in the event the acquiring company does not assume the awards.

The Board may amend, alter, or discontinue the 2016 Plan, but shall obtain shareholder approval of any amendment as required by applicable law or stock exchange listing requirements.  

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The following table sets forth certain information concerning shares of common stock authorized for issuance under the Company’s existing equity compensation plans as of September 30, 2020:

 

 

 

Recent Sales of Unregistered Securities

None, other than as previously disclosed by the Company.

Issuer Purchases of Equity Securities

None.

ITEM 6. SELECTED FINANCIAL DATA.

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

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

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes included in “Part IV, Item 15. Exhibits, Financial Statement Schedules.”  The following discussion contains a number of forward-looking statements that involve a number of risks and uncertainties. Words such as "anticipates," "expects," "intends," "goals," "plans," "believes," "seeks," "estimates," "continues," "may," "will," "should," and variations of such words and similar expressions are intended to identify such forward-looking statements. Such statements are based on our current expectations and could be affected by the risk and uncertainties described in “Part I, Item 1A. Risk Factors.” Our actual results may differ materially.

Overview

ALJ Regional Holdings, Inc. (“ALJ” or “we”) is a holding company that operates Faneuil, Inc. (“Faneuil”), Floors-N-More, LLC, d/b/a Carpets N’ More (“Carpets”), and Phoenix Color Corp. (“Phoenix”). With several members of our senior management and Board of Directors coming from long careers in the professional services industry, ALJ is focused on acquiring and operating exceptional businesses.

We continue to see our business evolve as we execute our strategy of buying attractively valued assets, such as the acquisition of a printing and manufacturing services division in Terre Haute, Indiana by Phoenix in October 2017 (the “Printing Components Business”), the acquisition of the customer management outsourcing business (“CMO Business”) by Faneuil in May 2017, and the acquisition of Color Optics by Phoenix in July 2016. In analyzing the financial impact of any potential acquisition, we focus on earnings, operating margin, cash flow and return on invested capital targets. We hire successful and experienced management teams to run each of our operating companies and incentivize them to drive higher profits. We are focused on increasing our net revenue at each of our operating subsidiaries by investing in sales and marketing, expanding into new products and markets, and evaluating and executing on tuck-in acquisitions, while continually examining our cost structures to drive higher profits.

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

Impact of Coronavirus Pandemic

 

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

 

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Currently, all ALJ’s subsidiaries have been deemed “Essential Services” and have continued to operate. As such, COVID-19 did not directly impact ALJ’s results of operations for the year ended September 30, 2020. However, the Company took immediate actions to enable working-from-home where possible and put in place increased safety precautions, including social distancing, at other locations where essential services on site are required. The duration of these measures is unknown, may be extended, and additional measures may be imposed.

 

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

Revision of Previously Reported Financial Information

 

During the first quarter of our current fiscal year, we identified and reclassified certain expenses between cost of revenue and selling, general, and administrative expenses. For additional details, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 1. Organization and Basis of Presentation.”  Accordingly, we have revised previously issued financial statements contained in this Annual Report on Form 10-K to reflect the revisions in the corresponding periods. Management’s discussion and analysis included herein is based on the revised financial results for the year ended September 30, 2019.

 

 

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Results of Operations

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

 

 

 

 

Net Revenue

 

 

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Faneuil Net Revenue

 

Faneuil net revenue for Fiscal 2020 was $247.0 million, an increase of $50.2 million, or 25.5%, compared to net revenue of $196.8 million for Fiscal 2019.  The increase was attributable to a $72.3 million increase in revenues from new customers, partly offset by a $13.1 million decrease in revenues from existing customers and a $9.0 million decrease driven by the completion of customer contracts.  

 

Carpets Net Revenue

Carpets net revenue for Fiscal 2020 was $39.1 million, a decrease of $9.9 million, or 20.2%, compared to net revenue of $49.0 million for Fiscal 2019.  The decrease was primarily attributable to lower sales volumes in cabinets, flooring, and granite.  

Phoenix Net Revenue

Phoenix net revenue for Fiscal 2020 was $103.0 million, a decrease of $6.2 million, or 5.7%, compared to net revenue of $109.2 million during Fiscal 2019.  The decrease was a result of lower volumes in component sales primarily related to education.  

Cost of Revenue

 

 

Faneuil Cost of Revenue

Faneuil cost of revenue for Fiscal 2020 was $203.4 million, an increase of $39.5 million, or 24.1%, compared to cost of revenue of $163.9 million for Fiscal 2019.  The absolute dollar increase in cost of revenue was a direct result of the increased net revenue.  During Fiscal 2020, as compared to Fiscal 2019, Faneuil cost of revenue as a percentage of segment net revenue decreased to 82.3% from 83.3% as a result of the mix of customer contracts and timing of ramp-up costs related to new contracts.

Carpets Cost of Revenue

 

Carpets cost of revenue for Fiscal 2020 was $31.5 million, a decrease of $6.7 million, or 17.5%, compared to cost of revenue of $38.2 million for Fiscal 2019.  The absolute dollar decrease in cost of revenue was a direct result of decreased net revenue.  During Fiscal 2020 as compared to Fiscal 2019, cost of revenue as a percentage of segment net revenue increased to 80.6% from 78.0% in the normal course of business.  

Phoenix Cost of Revenue

Phoenix cost of revenue for Fiscal 2020 was $79.1 million, a decrease of $2.7 million, or 3.3% compared to cost of revenue of $81.8 million for Fiscal 2019.  The absolute dollar decrease in cost of revenue was a direct result of decreased net revenue.  During Fiscal 2020, as compared to Fiscal 2019, Phoenix cost of revenue as a percentage of segment net revenue increased to 76.8% from 74.9%, respectively.  Phoenix experiences normal fluctuations to cost of revenue as a percentage of segment net revenue as a result of changes to the mix of products sold. Additionally, certain costs do not fluctuate directly with net revenue.

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Selling, General, and Administrative Expense

 

 

Faneuil Selling, General, and Administrative Expense

Faneuil selling, general, and administrative expense for Fiscal 2020 was $34.6 million, an increase of $10.0 million, or 40.8%, compared to selling, general, and administrative expense of $24.6 million for Fiscal 2019. The increase was primarily attributable to an increase of $8.0 million to support new customers, $1.2 million loan amendment fees, $1.1 million non-cash change in fair value expense, and $1.0 million to shut down call centers and pay severance as part of Faneuil’s cost reduction initiative, partly offset by $1.3 million recovery from litigation loss. During Fiscal 2020, as compared to Fiscal 2019, Faneuil selling, general, and administrative expense as a percentage of segment net revenue increased to 14.0% from 12.5%. Certain selling, general, and administrative expenses do not fluctuate directly with net revenue.  As such, we expect selling, general, and administrative expense as a percentage of segment net revenue to fluctuate.  

Carpets Selling, General, and Administrative Expense

Carpets selling, general, and administrative expense was $8.0 million for Fiscal 2020, a decrease of $1.4 million, or 14.6%, compared to selling, general, and administrative expense of $9.3 million for Fiscal 2019. The decrease was primarily attributable to process improvements and cost reductions throughout the organization. Selling, general, and administrative expense as a percentage of segment net revenue increased to 12.3% for Fiscal 2020 from 11.3% for Fiscal 2019, which was mainly attributable to the reduction in net revenue. Certain selling, general, and administrative expenses do not fluctuate directly with net revenue. As such, we expect selling, general, and administrative expense as a percentage of segment net revenue to fluctuate.

Phoenix Selling, General, and Administrative Expense

 

Phoenix selling, general, and administrative expense for Fiscal 2020 was $12.7 million, an increase of $0.3 million, or approximately 2.1%, compared to $12.4 million for Fiscal 2019. The increase was mainly attributable to the $0.3 million bad debt allowance recorded during Fiscal 2020 as a result of a Phoenix customer’s bankruptcy reorganization, somewhat offset by the completion of the process to consolidate manufacturing facilities and sublease redundant facilities and lower travel expenses as a result of COVID-19. Phoenix selling, general, and administrative expense as a percentage of segment net revenue increased to 12.3% for Fiscal 2020 from 11.3% for Fiscal 2019, which was mainly attributable to the reduction in Phoenix net revenue and the previously mentioned bad debt allowance. Certain Phoenix selling, general, and administrative expenses do not fluctuate directly with net revenue.  As such, we expect Phoenix selling, general, and administrative expense as a percentage of segment net revenue to fluctuate.  

 

ALJ Selling, General, and Administrative Expense

 

ALJ selling, general, and administrative expense for Fiscal 2020 was $4.9 million, an increase of $0.9 million, or 24.0%, compared to selling, general, and administrative expense of $3.9 million for Fiscal 2019. ALJ selling, general, and administrative expenses were impacted by non-cash banking fees as part of amending our financing agreement, which added $0.6 million, and the hiring of additional personnel, which added $0.4 million.  We expect selling, general, and administrative expense to fluctuate in the future as we comply with SEC reporting requirements and regulations and allocate certain expenses to our subsidiaries.

 

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Depreciation and Amortization

 

 

Faneuil Depreciation and Amortization

Faneuil depreciation and amortization expense for Fiscal 2020 was $13.0 million, an increase of $0.2 million, or 1.9%, compared to $12.7 million for Fiscal 2019.  The increase was attributable to leasehold improvements for new call center buildouts and capital equipment purchased to support new and expanded contracts, somewhat offset by fully depreciated and amortized assets.  Faneuil expects future depreciation and amortization expense to increase as Faneuil continues to invest in its customers, which includes opening new call centers.  Because certain Faneuil contracts require capital investments such as lease buildouts, Faneuil depreciation and amortization expense is impacted by the timing of new contracts and the completion of existing contracts.  

Carpets Depreciation and Amortization

Carpets depreciation and amortization expense for Fiscal 2020 was $0.6 million, a decrease of $0.2 million, or 27.4%, compared to $0.8 million for Fiscal 2019.  The decrease was a result of certain intangible assets being fully amortized during Fiscal 2019.  

Phoenix Depreciation and Amortization

 

Phoenix depreciation and amortization expense consists primarily of amortization of acquisition-related intangible assets. Depreciation and amortization expense was consistent at $2.2 million and $2.3 million for both Fiscal 2020 and Fiscal 2019, respectively.  

 

Impairment of Goodwill

 

As a result of the decline in ALJ’s market capitalization, downward economic pressure, declines in actual and forecasted results of operations, including the estimated effects of COVID-19, management determined that it was more likely than not that the fair value of goodwill for all three reporting units was below each reporting unit’s respective carrying amount. As such, management performed an impairment test as of March 31, 2020, based on discounted cash flows, which were derived from internal forecasts and more cautious economic expectations for all three reporting units.

 

As a result of the test, ALJ recognized a non-cash impairment of goodwill totaling $59.0 million during Fiscal 2020.

 

Impairment of Intangible Assets

During Fiscal 2019, Faneuil recorded an impairment of intangible assets of $0.7 million to write off the remaining carrying value of certain intangible assets related to the CMO Business acquisition in May 2017.  During the fourth quarter of Fiscal 2019, certain conditions came to light, largely regarding the lack of profitability related to one customer contract, which indicated that the carrying value of the asset may not be fully recoverable. As such, management performed an impairment test based on a comparison of the undiscounted cash flows expected to be generated by the asset, to the recorded value of the asset and concluded that the associated cash flows did not support any of the carrying value of the intangible asset and Faneuil recorded a full impairment charge.

 

Interest Expense

 

Interest expense was consistent at $10.5 million and $10.6 million for Fiscal 2020 and Fiscal 2019, respectively.  Interest expense was impacted by the additional amortization of loan amendment fees and increased weighted-average outstanding balance on our line of credit, offset by a lower weighted-average interest rate and a lower average outstanding balance on our term loans.

 

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Interest from Legal Settlement

 

During Fiscal 2020, Faneuil received a onetime $1.5 million settlement, of which $0.2 million was attributable to interest. See “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 9. Commitments and Contingencies.”

Income Taxes

Our benefit from income taxes was $2.0 million for Fiscal 2020 compared to a provision for income taxes of $10.0 million for Fiscal 2019. Fiscal 2020 reflected a $1.9 million alternative minimum tax refund partly offset by state income taxes. Fiscal 2019 reflected a non-cash deferred income tax expense of $9.7 million, the majority of which was to reduce the net value of our NOL carryforward deferred tax assets.  The remaining provision for income taxes during Fiscal 2019 was a result of generating state taxable income.

Segment Adjusted EBITDA

 

Faneuil Segment Adjusted EBITDA

Faneuil segment adjusted EBITDA for Fiscal 2020 was $11.2 million compared to segment adjusted EBITDA of $8.8 million for Fiscal 2019.  Faneuil segment adjusted EBITDA increase for Fiscal 2020 was driven by the ramp-up of new state unemployment contracts, and the completion of certain deliverables related to the implementation of new contracts.  Such increase was somewhat offset by operational inefficiencies from the start of production of new contracts, increased medical claims, increased reserves for workers’ compensation claims, and higher rent expense for new call centers.  

Carpets Segment Adjusted EBITDA

Carpets segment adjusted EBITDA loss for Fiscal 2020 was ($0.1) million compared to segment adjusted EBITDA of $1.6 million for Fiscal 2019.  Carpets segment adjusted EBITDA for Fiscal 2020 was impacted by lower volumes and fewer upgrades to higher margin products by builder customers.

Phoenix Segment Adjusted EBITDA

Phoenix segment adjusted EBITDA for Fiscal 2020 was $16.7 million compared to segment adjusted EBITDA of $20.5 million for Fiscal 2019.  Phoenix segment adjusted EBITDA for Fiscal 2020 was impacted by lower component sales primarily related to education and a $0.3 million bad debt allowance for a customer bankruptcy. Although production labor decreased in response to the decreased volumes, such decrease in production labor did not keep pace with the decreased volumes.

ALJ Segment Adjusted EBITDA

ALJ segment adjusted EBITDA loss for Fiscal 2020 was ($3.9) million compared to segment adjusted EBITDA loss of ($3.2) million for Fiscal 2019. ALJ segment adjusted EBITDA loss for the year ended September 30, 2020 was impacted by increased legal fees for general corporate matters, including increased corporate governance to manage the impact of COVID-19, and the change from stock compensation, which does not impact adjusted EBITDA, to cash compensation, which does impact adjusted EBITDA, for our Chief Executive Officer.

Segment adjusted EBITDA is not considered a non-GAAP measure because we include segment adjusted EBITDA in our segment disclosures in accordance with the Accounting Standards Codification Topic 280 – Segment Reporting.  See “Part IV, Item 15. Exhibits, Financial Statements Schedules – Note 13. Reportable Segments and Geographic Information.”  

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Seasonality

Faneuil

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

Carpets

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

Phoenix

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

Liquidity and Capital Resources

Our principal sources of liquidity have been cash provided by operations and borrowings under various debt arrangements.  At September 30, 2020, our principal sources of liquidity included cash and cash equivalents of $6.1 million and an available borrowing capacity of $14.6 million on our line of credit.  Our principal uses of cash have been for acquisitions and to pay down debt.  We anticipate that our principal uses of cash will continue to be to acquire businesses and pay down our debt.    

Global financial and credit markets have been volatile in recent years, and future adverse conditions of these markets could negatively affect our ability to secure funds or raise capital at a reasonable cost or at all.  For additional discussion of our various debt arrangements see Contractual Obligations below.    

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

 

 

We recognized a net loss of $67.7 million for Fiscal 2020, and generated cash from operating activities of $12.9 million, offset by cash used for investing and financing activities of $9.5 million and $1.8 million, respectively.

 

We recognized a net loss of $16.0 million for Fiscal 2019, and generated cash from operating activities of $24.6 million, offset by cash used for investing and financing activities of $21.4 million and $0.6 million, respectively.

 

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Operating Activities

Cash provided by operating activities of $12.9 million during Fiscal 2020 was the result of our $67.7 million net loss, $83.8 million addback of net non-cash expenses, and $3.2 million of net cash used for changes in operating assets and liabilities. The most significant components of net non-cash expenses include the impairment of goodwill of $59.0 million, depreciation and amortization expense of $20.3 million, $1.4 million provision for bad debts and obsolete inventory, $1.1 million change in fair value of contingent consideration, and $1.1 million interest expense accreted to term loans, partly offset by $1.8 million deferred income taxes. The most significant components of changes in operating assets and liabilities were mostly attributable to the timing of Faneuil’s significant new customer implementations and included accounts receivable of $19.0 million, prepaid expenses, collateral deposits, and other current assets of $3.3 million, and other assets of $1.7 million, which used cash, offset by deferred revenue and customer deposits of $8.6 million, accounts payable of $3.1 million, and accrued expenses of $4.1 million, which provided cash.  Additionally, the CARES Act allowed us to defer payment for $5.3 million of payroll-related taxes, which positively impacted our cash flow from operations.  The CARES Act payroll liability is recorded in other non-current liabilities at September 30, 2020.

Cash provided by operations of $24.6 million during Fiscal 2019 was the result of our $16.0 million net loss, $32.4 million addback of net non-cash expenses, and $8.2 million of net cash provided by changes in operating assets and liabilities.  The most significant components of net non-cash expenses were depreciation and amortization of $20.6 million, deferred income taxes of $9.5 million, as a result of increasing our NOL carryforwards valuation allowance, impairment of intangible assets of $0.7 million, amortization of deferred loan costs of $0.7 million, and stock-based compensation of $0.7 million.  The most significant components of changes in operating assets and liabilities that provided cash include accounts receivable of $4.6 million as a result of lower fourth quarter sales at Phoenix and Carpets, accounts payable of $2.4 million due to timing of payments in the normal course of business, accrued expenses of $1.3 million, and other assets of $1.4 million.  The most significant component of changes in operating assets and liabilities that provided cash was deferred revenue and customer deposits of $2.2 million as a result of Faneuil recognizing revenue for amounts deferred at September 30, 2018.  

Cash provided by operations for Fiscal 2020 compared to cash provided by operations for Fiscal 2019, was impacted by lower cash earnings, increased accounts receivable due to the timing of Faneuil’s new customer implementations, managing vendor payments to preserve cashflow, and deferring payment of certain payroll-related taxes pursuant to the CARES Act.

Investing Activities

During Fiscal 2020, our investing activities used $9.5 million of cash, of which $5.8 million was used to purchase equipment, software and leasehold improvements for Faneuil’s new and existing customers, and $3.7 million was used to purchase capital equipment in the normal course of operations.  

During Fiscal 2019, our investing activities used $21.4 million of cash, of which $14.5 million was for the buildout of Faneuil’s three new call centers, $2.5 million was for Faneuil’s RDI Acquisition, $1.0 million was for payment of the holdback related to Phoenix’s Printing Components Business acquisition, $2.9 million was used to purchase capital equipment in the normal course of operations, and $0.9 million was used to purchase equipment, software and leasehold improvements for Faneuil’s new and existing customers, partially offset by $0.3 million proceeds received from the sale of equipment.

 

Cash used for investing activities for Fiscal 2020 compared to Fiscal 2019 decreased due to the completion of Faneuil’s three new customer call center buildouts, which were completed in April 2019.

 

Financing Activities

 

For Fiscal, 2020, our financing activities used $1.8 million of cash. Net proceeds from our line of credit provided $4.6 million to fund working capital requirements at Faneuil, Phoenix, and Corporate.  Our Ninth Amendment provided $1.5 million of cash, which was used to pay down our line of credit.  Financing activities which used cash included $4.3 million to pay down our term loans, $2.8 million for capital lease payments, and $0.8 million for deferred loan costs related to the Sixth, Seventh, Eighth, and Ninth Amendments to our Financing Agreement. See “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 8. Debt.”

 

 

During Fiscal 2019, our financing activities used $0.6 million of cash.  Financing activities which used cash included $9.9 million to pay down our term loan, $3.0 million of capital lease payments, and $0.9 million for debt and stock issuance costs.  Proceeds from our line of credit and our amended term loan provided $1.1 million and $5.0 million, respectively (see further discussion at Contractual Obligations below).  Proceeds from the issuance of common stock provided $7.0 million, which was used to fund Faneuil’s RDI Acquisition.

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Cash provided by financing activities for Fiscal 2020 compared to cash used for financing activities for Fiscal 2019 was impacted by increased borrowings on our line of credit and the deferral of three quarterly term loan principal payments due on March 31, 2020, June 30, 2020, and September 30, 2020, which were negotiated as part of the Eighth and Ninth Amendments to the Financing Agreement.

Contractual Obligations

The following table summarizes our significant contractual obligations at September 30, 2020, and the effect such obligations are expected to have on our liquidity and cash flows in future periods:

 

 

Off-Balance Sheet Arrangements

As of September 30, 2020, we had two types of off-balance sheet arrangements.

Surety Bonds.  In the normal course of operations, certain Faneuil customers require surety bonds guaranteeing the performance of a contract.  As of September 30, 2020, the face value of such surety bonds, which represents the maximum cash payments that Faneuil would have to make under certain circumstances of non-performance, was approximately $25.5 million.

Letters of Credit.  ALJ had letters of credit totaling $3.6 million outstanding as of September 30, 2020, in connection with workers’ compensation insurance requirements.

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Critical Accounting Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses during the reporting period. We regularly evaluate our estimates and assumptions related to the fair value of assets and liabilities, including intangible assets acquired and allocation of purchase price, useful lives, carrying value and recoverability of long-lived and intangible assets, the recoverability of goodwill, and revenue recognition.  Certain accounting policies, as described below, are considered "critical accounting policies" because they are particularly dependent on estimates made by us about matters that are inherently uncertain and could have a material impact on our consolidated financial statements. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.  A summary of all of our significant accounting policies is included in “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 2. Summary of Significant Accounting Policies.”

We believe the following are critical accounting policies that require us to make significant estimates, assumptions or judgments:

Business Acquisitions

Accounting for acquisitions requires our management to estimate the fair value of the assets acquired and liabilities assumed, which involves a number of judgments, assumptions, and estimates that could materially affect the timing or amounts recognized in our financial statements. The items involving the most significant assumptions, estimates, and judgments include determining the fair value of the following:

The goodwill and intangible assets acquired in business acquisitions are pushed down to the reporting unit that benefits from the business combination.

We use an independent valuation firm to assist with our valuation, and our assumptions and estimates are based upon comparable market data and information obtained from our management and the management of the acquired companies. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year following the acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill.

Long-Lived Asset Impairments

Identified Intangibles

We make judgments about the recoverability of purchased finite-lived intangible assets whenever events or changes in circumstances indicate that an impairment may exist. Recoverability of finite-lived intangible assets is measured by comparing the carrying amount of the asset to the future undiscounted cash flows that the asset is expected to generate.

The assumptions and estimates used to determine future values, such as expected future net cash flows, and remaining useful lives of our intangible and other long-lived assets are complex and subjective. They can be affected by internal factors such as changes in our business strategy or external factors such as industry and economic trends.  

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Goodwill

The application of the goodwill impairment test is considered a critical accounting estimate.  We perform an annual impairment assessment of goodwill as of September 30 each year, or more frequently if indicators of potential impairment exist, which includes evaluating qualitative and quantitative factors to assess the likelihood of an impairment of goodwill.  Each of our reporting units has goodwill assigned, which is assessed independently.    

 

Qualitative factors considered in this assessment include industry and market considerations, overall financial performance, and other relevant events and factors affecting the reporting units.   Additionally, as part of this assessment, we may perform a quantitative analysis to supplement and support the qualitative factors.  

 

Our goodwill impairment test considers both the income method and the market method to estimate fair value.  For both Faneuil and Phoenix, the goodwill impairment test is weighted 50% on the income method and 50% on the market method.  For Carpets, the goodwill impairment test is weighted 100% on the income method.  The income method is based on a discounted future cash flow approach that uses the following major assumptions and inputs: revenue, based on assumed market segment growth rates and assumed market segment share, estimated costs, and weighted average cost of capital (“WACC”).  WACC was estimated using guideline companies adjusted for a company-specific risk premium.  Estimates of market segment growth, market segment share, and costs are based on historical data, various internal estimates, and a variety of external sources. The same estimates are also used in the Company’s business planning and forecasting process. The data is tested for reasonableness of the inputs and outcomes of our discounted cash flow analysis against available comparable market data. The market method used at Faneuil and Phoenix in estimating fair value is based on financial multiples and transaction prices of comparable companies.  Significant judgment is required to estimate the fair value of reporting units which includes estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment.

 

During the year ended September 30, 2020, we wrote off 100% of our goodwill and recognized a non-cash impairment of goodwill totaling $59.0 million.

Revenue Recognition

We must make subjective estimates as to when our revenue is earned, the impact of pricing adjustments, and the collectability of our accounts receivable.

 

When upfront fees do not relate directly to the satisfaction or partial satisfaction of a performance obligation, the payments are deemed to be advance payments for future services. In such, instances, the fees are allocated to performance obligations and recognized when or as the performance obligations, typically call center services, are satisfied over the contract term, as defined under Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”).  If a contract contains termination provisions, and such termination provisions are not substantive, the upfront nonrefundable fees may be fully recognized prior to the expiration of the stated term of the contract.

We record reductions to revenue for pricing adjustments, such as rebates, in the same period that the related revenue is recorded. Phoenix often has contract with its customers that include prospective and retrospective volume rebates, credits, discounts, and other similar items that generally decrease the amount a customer pays Phoenix. These variable amounts generally are credited to the customer, based on achieving certain levels of sales activity during the contract term, or making payments within a specified number of days. Under ASC 606, with the exception of prospective volume rebates, these adjustments are classified as variable consideration, which is estimated at contract inception and included as part of the transaction price. Under ASC 606, prospective volume rebates are not part of the transaction price but are instead accounted for as a material right and separate performance obligation.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.  

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.  

The financial statements and supplementary data required by this item are included in “Part IV, Item 15. Exhibits, Financial Statement Schedules.”  

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.  

None.

 

ITEM 9A. CONTROLS AND PROCEDURES.  

Evaluation of Disclosure Controls and Procedures

Based on management’s evaluation (with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”)), as of the end of the period covered by this report, our CEO and CFO have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)), are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in U.S. Securities and Exchange Commission (“SEC”) rules and forms, and is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth fiscal quarter for the year ended September 30, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of consolidated financial statements for external purposes in accordance with U.S. generally accepted accounting principles (“GAAP”).

Management assessed our internal control over financial reporting as of September 30, 2020, the end of our fiscal year. Management based its assessment on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Management’s assessment included evaluation of elements such as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment.

Based on this assessment, management has concluded that our internal controls over financial reporting were effective as of September 30, 2020, and provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external reporting purposes in accordance with GAAP. We reviewed the results of management’s assessment with the Audit Committee of our Board of Directors.

This Annual Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Our report was not subject to attestation by our independent registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit us to provide only management’s report in this report.

Inherent Limitations on Effectiveness of Controls

Our management, including our CEO and CFO, 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.

ITEM 9B. OTHER INFORMATION.

None.

 

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PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE.

Directors and Executive Officers

The following table sets forth the names, ages, and principal offices and positions of our current directors and executive officers as of November 30, 2020.

 

 

The following is a brief summary of the backgrounds of the Company’s directors and executive officers.

Jess M. Ravich. Mr. Ravich has served as a director since June 2006 and Chairman of the Board of Directors since August 2006.  He served as the Executive Chairman and senior executive officer of the Company from December 2012 through July 2019, at which time he became the Company’s fulltime Chief Executive Officer.  Mr. Ravich was a Group Managing Director at The TCW Group from December 2012 until July 2019. From 2009 to 2012, Mr. Ravich was Managing Director at Houlihan Lokey.  In 1991 Mr. Ravich founded Libra Securities, LLC (“Libra Securities”), a Los Angeles-based investment banking firm that focused on capital raising and financial advisory services for middle-market corporate clients and the sales and trading of debt and equity securities for institutional investors, and served as its Chairman and Chief Executive Officer from 1991 until 2009.  Prior to founding Libra Securities, Mr. Ravich was an Executive Vice President at Jefferies & Co., Inc. and a Senior Vice President at Drexel Burnham Lambert.

Mr. Ravich has been a member of the board of directors of Apex Global Brands (Nasdaq: APEX), formerly known as Cherokee Inc. (Nasdaq CHKE) since May 1995 and served as its Chairman of the Board from 2011 until 2017.  Mr. Ravich has also served on the Board of Directors of A-Mark International since 2014.  In addition to his professional responsibilities, Mr. Ravich has also served on the Undergraduate Executive Board of the Wharton School and the Board of Trustees of the Archer School for Girls. Mr. Ravich earned both a B.S and M.S. from the Wharton School and a J.D. from Harvard University.  Mr. Ravich is the father of Rae Ravich, a director of the Company.

Brian Hartman.  Mr. Hartman has served as Chief Financial Officer since August 2017.  Previously, Mr. Hartman was the Senior Vice President, Chief Financial Officer of Arcade Beauty, a manufacturer of sampling solutions for the beauty, fragrance and skincare segments, having served in such role since March 2012.  From April 2005 to March 2012, Mr. Hartman was the Vice President, Corporate Controller of Visant Corporation, a specialty printing and marketing services enterprise.  From January 1996 to April 2005, Mr. Hartman was the Controller for Metallurg Inc, a producer and distributor of specialty metals.  Prior to this, Mr. Hartman held various accounting and auditing positions at Witco Chemical Corp., a manufacturer of specialty chemicals, and Deloitte & Touche LLP.  Mr. Hartman is a certified public accountant and received a Bachelor of Business Administration degree in public accounting and a Master of Business Administration in financial management from Pace University.

Anna Van Buren. Ms. Van Buren has served as a director since November 2013. Ms. Van Buren was appointed President and Chief Executive Officer of Faneuil in April 2009, after previously serving as President and Chief Operating Officer from 2007 to 2009, as Vice President and Managing Director of Faneuil’s Government Services Division from 2005 to 2007, and as Vice President of Business Development from 2004 to 2005. Prior to her association with Faneuil, Ms. Van Buren founded Capital Initiatives, a consulting service for clients seeking visibility among federal lawmakers with the objective of encouraging legislative action, and operated numerous government services and marketing companies. Ms. Van Buren has served in leadership roles for many civic and business organizations including chairmanship of the United Way of the Virginia Peninsula, the Peninsula Chamber of Commerce and the NASA Aeronautics Support Team. She is the recipient of numerous awards including the Women in Business Achievement Award by Inside Business Magazine, the Presidential Citizenship Award from Hampton University and the NCCJ Humanitarian Award. Ms. Van Buren holds a degree in biology from Hollins University and the University of Virginia Executive School.

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John Scheel. Mr. Scheel has served as a director since September 2006 and our Vice Chairman since December 2016. From August 2006 to February 2013, Mr. Scheel was the President and Chief Executive Officer of the Company. Mr. Scheel is a principal of, and also currently serves as the Chief Operating Officer, of Pinnacle Steel.  He served as the plant manager for the Company’s former subsidiary Kentucky Electric Steel’s (“KES”) steel mini-mill in Ashland, Kentucky (the “Mill”) and managed the operations of KES on our behalf from January 2004 until its sale in February 2013 to Optima Specialty Steel (“Optima”).  Following such sale, Mr. Scheel not only continued to manage the Mill for Optima as its general manager, but also managed the melt shop and caster for Warren Steel Holdings EAF in Warren, Ohio, which was also managed by Optima. Prior to joining Pinnacle Steel, Mr. Scheel held various positions of increased responsibility at AK Steel, Nucor Corporation, and Birmingham Steel Management. Mr. Scheel holds both B.S. and M.S. degrees in Metallurgical Engineering from Purdue University and a Master of Business Administration in Finance and International Business from Xavier University.

Michael Borofsky. Mr. Borofsky has served as a director since September 2013.  Mr. Borofsky is currently general counsel for Gryphon Investors.  From 2019 to mid-2020, Mr. Borofsky was the Chief Operating and Strategy Officer for The Pohland Company.  Prior to that, Mr. Borofsky was a Senior Vice President of MacAndrews & Forbes. Mr. Borofsky earned a B.A. from Yale University and a J.D. from Columbia University School of Law.

Hal G. Byer. Mr. Byer has served as a director since January 2003. Mr. Byer joined Houlihan Lokey as a Senior Vice President in its Financial Sponsors Coverage Group in December 2009.   He was a director for Houlihan Lokey from 2011 to 2017 and a senior advisor during 2017 until his retirement in November 2017.  From May 2001 to November 2009, Mr. Byer was a Senior Vice President of Libra Securities, a broker-dealer registered with the SEC and an NASD member. From 1995 to 2003, Mr. Byer was Chief Executive Officer of Byer Distributing Co., a snack food distribution company. From 2000 to 2003, Mr. Byer was also the Chief Operating Officer of eGreatcause.com, an internet start-up involved in fundraising for charitable and non-profit organizations that is no longer active.

 

Julie Cavanna-Jerbic. Ms. Cavanna-Jerbic has served as a director since July 2020. Ms. Cavanna-Jerbic is currently the principal and founder of Iron Butterfly LLC, a consulting firm providing business advisory and executive education services which she founded in 2012. Since November 2012, Ms. Cavanna-Jerbic has served on the Supervisory (Audit) Committee of First Tech Federal Credit Union, and since August 2012, Ms. Cavanna-Jerbic has served as a member of the Board of Trustees, Morrissey Compton Educational Center. Prior to this, Ms. Cavanna-Jerbic held various positions at Hewlett Packard, including as the Chief Financial Officer & Vice President of Global Information Technology and the Chief Information Officer & Vice President of Information Technology and Integrations.

Robert Scott Fritz. Mr. Fritz has served as a director since January 2003. Since May 1982, Mr. Fritz has served as the President of Robert Fritz and Sons Sales Company, a New Jersey-based food broker and paper distributor that he owns.  Mr. Fritz earned a B.S. in Business from Fairleigh Dickinson University.

Rae Ravich. Ms. Ravich has served as a director since June 2014. Ms. Ravich is currently the founder of a startup engaged in the health and wellness space, which she founded in July 2016.  From July 2013 until June 2016, Ms. Ravich was an Associate in the direct lending group at TCW Financial Planning LLC. Previously, Ms. Ravich was a Financial Analyst at Houlihan Lokey, which she joined in July 2013. Ms. Ravich has dual B.S. degrees from the Wharton School and the Nursing School at the University of Pennsylvania. Ms. Ravich is the daughter of Jess Ravich, ALJ’s CEO and Executive Chairman.

Other Key Employees

Marc Reisch. Mr. Reisch was appointed Chairman of Phoenix in August 2015 and served as a director of the Company from that time until his resignation as director effective October 24, 2019. Mr. Reisch served as Chairman of the Board, Chief Executive Officer and President of Visant and Visant Holding Corp. from October 2004 to November 2015. Prior to joining Visant, he served as Senior Advisor to Kohlberg Kravis Roberts & Co. and has over 35 years of experience in the printing and publishing industries. Mr. Reisch holds a Bachelor of Science degree and a Master of Business Administration degree from Cornell University.

Steve Chesin. Mr. Chesin has served as the Chief Executive Officer of Carpets since August 2007. From 2002 to 2007, Mr. Chesin served as the Executive Vice President of Carpets. From 1995 to 2001, Mr. Chesin served as the Senior Vice President and the Chief Operating Officer of Carpet Barn Inc., a subsidiary of Nations Flooring Inc. Mr. Chesin attended University of Nevada, Las Vegas.

Involvement in Certain Legal Proceedings

To the best of our knowledge, none of our directors or officers has had a determination during the past ten years in any legal proceedings listed in Item 401(f) of Regulation S-K that may bear on his or her ability or integrity to serve as a director or officer of the Company.

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Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires our directors and executive officers, as well as persons who own more than 10% of a registered class of our equity securities, to file with the SEC initial reports of ownership and reports of changes in beneficial ownership. Directors, executive officers, and greater than 10% shareholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based solely on a review of copies of Section 16(a) reports and representations received by us from reporting persons, and without conducting any independent investigation of our own, we believe all Forms 3, 4 and 5 were timely filed with the SEC by such reporting persons during the year ended September 30, 2020.

Code of Business Conduct and Ethics

Our Board of Directors adopted a Code of Business Conduct and Ethics (“Ethics Code”), which is applicable to all employees of ALJ, ALJ subsidiaries, and members of our Board of Directors.  

The Ethics Code addresses, among other things, honesty and ethical conduct, conflicts of interest, compliance with laws and regulations, policies related to disclosure requirements under federal securities laws, confidentiality, trading on insider information, and reporting violations of the Ethics Code.  Any amendment to our Ethics Code, or waiver thereof, applicable to our principal executive officer, principal financial officer, directors, or persons performing similar functions will be disclosed on our website within five days of the date of such amendment or waiver. In the case of a waiver, the nature of the waiver, the name of the person to whom the waiver was granted and the date of the waiver will also be disclosed.

Our Ethics Code can be found in the Investor Relations section of the Company’s website, www.aljregionalholdings.com, and is filed as Exhibit 14.1 to this Form 10-K.  In addition, a printed copy of our Ethics Code can be requested by writing our Chief Financial Officer at 244 Madison Avenue, PMB #358, New York, NY 10016.  

Committees of the Board of Directors

The Board of Directors has a standing audit committee (“Audit Committee”) and compensation, nominating, and corporate governance committee (“Compensation, Nominating, and Corporate Governance Committee”). The composition and responsibilities of each committee are described below. Members serve on these committees until their resignation or until otherwise determined by the Board of Directors.

The Board of Directors has determined that all members of both committees are independent under the applicable rules and regulations of NASDAQ and the SEC as currently in effect.  The Audit Committee and the Compensation, Nominating, and Corporate Governance Committee each operate under a written charter approved by the Board of Directors. Each committee will review and reassess the adequacy of its charter periodically. The charters of both committees are available in the Investor Relations section of the Company’s website, www.aljregionalholdings.com.

The following chart details the current membership of each committee:

 

 

Audit Committee

Our Audit Committee consists of Ms. Cavanna-Jerbic, and Messrs. Scheel, Borofsky and Fritz, with Mr. Scheel chairing this committee. All members of our Audit Committee are independent directors and meet the requirements for financial literacy as defined by SEC guidelines. Our Board of Directors has determined that Mr. Scheel is an “audit committee financial expert” as defined by SEC guidelines.  

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The Audit Committee’s responsibilities include, among other responsibilities:

Compensation, Nominating, and Corporate Governance Committee

Our Compensation, Nominating, and Corporate Governance Committee consists of Ms. Cavanna-Jerbic, and Messrs. Borofsky and Byer, with Mr. Borofsky chairing this committee. All members of this committee meet the requirements for independence under the applicable rules and regulations of the SEC, NASDAQ, and the Code, as amended, including the application of such rules and regulations to members of a listed company’s compensation committee.

The Compensation, Nominating, and Corporate Governance Committee’s responsibilities include:

There have been no material changes to the procedures by which shareholders may nominate nominees to our Board of Directors during the year ended September 30, 2020.  

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ITEM 11. EXECUTIVE COMPENSATION.

Summary Compensation

Our executive compensation program, consisting of a three-part compensation strategy that includes base salary, annual discretionary cash bonuses, and equity incentive compensation, is designed to (i) pay for performance to encourage both Company and individual achievement; (ii) encourage efficient use of shareholder resources; and (iii) provide market competitive compensation to attract and retain highly qualified individuals who are capable of making significant contributions to the long-term success of the Company.

We do not adopt express formulae for weighting different elements of compensation or for allocating between long-term and short-term compensation but strive to develop comprehensive packages that are competitive with those offered by other companies with which we compete to attract and retain talented executives. Under our compensation practices, cash compensation consists of an annual base salary and discretionary bonuses.  Equity-based compensation is primarily stock options.

The following table sets forth, for the years indicated, all compensation awarded to, paid to or earned by each of our named executive officers and certain other key employees.

SUMMARY COMPENSATION TABLE

 

 

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Employment Arrangements with Named Executive Officers and Other Key Employees

Named Executive Officers

Jess Ravich. On July 29, 2019, the Company entered into an employment agreement (the “Ravich Employment Agreement”) with Jess Ravich. Prior to entering into the Employment Agreement, Mr. Ravich served as the Company’s Executive Chairman.  Pursuant to the Ravich Employment Agreement, Mr. Ravich assumed full-time responsibilities as the Company’s Chief Executive Officer until September 30, 2020 (the “Initial Term”), subject to subsequent automatic two-year renewals.  

 

Additional material terms of the Ravich Employment Agreement include:

 

 

On June 21, 2020, the Company entered into an amended and restated employment agreement with Jess Ravich (the “A&R Ravich Employment Agreement”). The A&R Ravich Employment Agreement amended and restated Ravich Employment Agreement, which term was to expire on September 30, 2020. Pursuant to the A&R Ravich Employment Agreement, effective July 1, 2020 (the “Effective Date”), Mr. Ravich will continue to serve as the Company’s Chief Executive Officer until September 30, 2022 (the “A&R Initial Term”), subject to subsequent automatic two-year renewals.  

 

Additional material terms amended by the A&R Ravich Employment Agreement include:

 

 

 

As of September 30, 2020, if Mr. Ravich’s employment is terminated by ALJ without cause, or by Mr. Ravich for good reason, Mr. Ravich is entitled to receive as severance: (i) the lesser of one-year base salary or pro-rated base salary for the remaining term; (ii) continuation of group health plan benefits, with the cost of the regular premium for such benefits paid in full by Faneuil; and (iii) annual bonus prorated for the period of Mr. Ravich’s service during the year of termination and calculated based on actual EBITDA (as defined in the Ravich Employment Agreement) for the year of termination equal to full annual bonus for the year of termination if otherwise entitled to receive the bonus.

Anna Van Buren. In October 2013, concurrent with ALJ’s acquisition of Faneuil, Faneuil entered into an employment agreement with Ms. Van Buren through December 2018. In August 2017, Faneuil and Ms. Van Buren entered into an amended employment agreement (the “Van Buren Amended Employment Agreement”), which extended the term to December 2021.  Pursuant to the Van

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Buren Amended Employment Agreement, Ms. Van Buren receives an annual base salary of $520,000 and is eligible to earn an incentive bonus equal to 10% of Faneuil EBITDA, as defined in the Van Buren Amended Employment Agreement, before any bonus amount owed to Ms. Van Buren, in excess of $6,250,000 for calendar year 2017 and $7,500,000 thereafter, subject to further adjustment by ALJ Compensation, Nominating and Corporate Governance Committee from time to time in its discretion, with a step down to 5% of pre-bonus Faneuil EBITDA at $2,000,000 total compensation.

As of September 30, 2020, if Ms. Van Buren’s employment is terminated by Faneuil without cause, or by Ms. Van Buren for good reason, Ms. Van Buren is entitled to receive: (i) the lesser of one-year base salary or pro-rated base salary for the remaining term; (ii) continuation of group health plan benefits, with the cost of the regular premium for such benefits paid in full by Faneuil; (iii) full annual bonus for the year of termination if otherwise entitled to receive the bonus; and (iv) the annual bonus for the previous year if such bonus has been earned but not yet paid at time of termination.

Brian Hartman.   In connection with ALJ’s appointment of Brian Hartman to serve as its Chief Financial Officer in August 2017, ALJ entered into an employment agreement with Mr. Hartman through August 2018, subject to one-year renewals.  Pursuant to the employment agreement, Mr. Hartman received an annual base salary of $300,000, a one-time sign-on bonus of $75,000, a cash bonus of $100,000 for the calendar year 2017, and an individual bonus target of 50% of annual base salary effective January 2018.  In August 2019, the Company entered into the Second Amended and Restated Employment Agreement (the “A&R Employment Agreement”) with Mr. Hartman, its Chief Financial Officer.  The A&R Employment Agreement amended and restated the Employment Agreement, dated August 8, 2017, as amended by the First Amended and Restated Employment Agreement dated August 2, 2018, between Mr. Hartman and the Company, which term expired in August 2019.  Pursuant to the A&R Employment Agreement Mr. Hartman will serve as the Company’s Chief Financial Officer until September 30, 2021, subject to further one-year or two-year renewals, as determined by the Chief Executive Officer of the Company. Additional material terms changed by the A&R Employment Agreement include: (i) an increase in base salary from $350,000 to $375,000 effective October 2019, and (ii) Mr. Hartman’s incentive bonus structure, which was amended to include an annual bonus target of (a) up to 50% of his annual base salary based on the general quality and success of his efforts during the immediately preceding fiscal year and (b) up to 25% of his annual base salary based on certain goals agreed between the Chief Executive Officer and Mr. Hartman for the applicable fiscal year.

As of September 30, 2020, if Mr. Hartman’s employment is terminated by ALJ without cause, or by Mr. Hartman for good reason, Mr. Hartman is entitled to receive: (i) nine months of base salary; (ii) continuation of group health plan benefits with the cost of the regular premium for such benefits shared in the same relative proportion by ALJ and Mr. Hartman as in effect on the date of termination; (iii) full annual bonus for the year of termination if otherwise entitled to receive the bonus; and (iv) the annual bonus for the previous year if such bonus has been earned but not yet paid at time of termination.

Other Key Employees

Marc Reisch. In August 2015, concurrent with ALJ’s acquisition of Phoenix, Phoenix entered into an employment agreement with Mr. Reisch through December 2018. In August 2018, Phoenix entered into a new employment agreement with Mr. Reisch, which superseded and terminated the August 2015 employment agreement, and extended the term to December 2021. In November 2020, Phoenix entered into a new employment agreement (the “New Reisch Agreement”) with Mr. Reisch. In connection with the entry into the New Reisch Agreement, the previous employment agreement, entered into in August 2018 (the “Old Reisch Agreement”) was superseded and terminated. Pursuant to the New Reisch Agreement, Mr. Reisch’s term was extended to September 2023. Additional material terms changed by the New Reisch Agreement as compared to the Old Reisch Agreement include:

 

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Steve Chesin.  During April 2014, concurrent with ALJ’s acquisition of Carpets, Carpets entered into an employment agreement with Mr. Chesin through December 2017.  In December 2017, Carpets and Mr. Chesin entered into the first amended employment agreement.  Effective January 2019, Carpets and Mr. Chesin entered into the second amended employment agreement (the “New Chesin Employment Agreement”), which extended the term to December 2020.  Under the New Chesin Employment Agreement, Mr. Chesin receives an annual base salary of $300,000 and is eligible to earn an annual bonus equal to 5% of any pre-bonus EBITDA of Carpets in excess of $1,000,000.

As of September 30, 2020, if Mr. Chesin’s employment is terminated by Carpets without cause, or by Mr. Chesin for good reason, Mr. Chesin is entitled to receive: (i) one year of base salary; (ii) continuation of group health plan benefits, with the cost of the regular premium for such benefits paid in full by Carpets; (iii) full annual bonus for the year of termination if otherwise entitled to receive the bonus; and (iv) the annual bonus for the previous year if such bonus has been earned but not yet paid at time of termination.

Outstanding Equity Awards at Fiscal Year End

The following table sets forth certain information regarding outstanding equity awards at September 30, 2020, by the named executive officers and other key employees. 

OUTSTANDING EQUITY AWARDS TABLE

 

 

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Director Compensation

The following table sets forth the total compensation paid or accrued by ALJ to the named directors for services rendered during the year ended September 30, 2020:

DIRECTOR COMPENSATION TABLE

 

 

In December 2015, the Board of Directors approved an outside directors compensation package comprised of (i) an annual retainer of $40,000 in cash, (ii) an annual grant of common stock with a value of $40,000, (iii) an additional $12,500 for the chair and $5,000 for each other member of the Audit Committee, and (iv) an additional $10,000 for the chair and $4,000 for each other member of the Compensation, Nominating, and Corporate Governance Committee.  Effective July 1, 2017, each outside director was given the option of how to allocate the payment between cash and common stock. Director who are employees do not receive any additional compensation for their service on the Board of Directors.

Report on Repricing of Stock Options

We did not re-price any stock options during the year ended September 30, 2020.  

 

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

The following table sets forth, as of November 30, 2020, information regarding the beneficial ownership of our common stock based upon the most recent information available to us for: (i) each person known by us to own beneficially more than five (5%) percent of our outstanding common stock; (ii) each of our named executive officers, directors, and other key employees; and (iii) all of our named executive officers, directors, and other key employees as a group.  Unless otherwise indicated, each stockholder listed below has sole voting and investment power with respect to the shares beneficially owned by them and has the following address: c/o ALJ Regional Holdings, Inc., 244 Madison Avenue, PMB #358, New York, NY 10016.  As of November 30, 2020, there were 42,321,048 shares of our common stock outstanding, which was the only class of voting securities outstanding.

 

 

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Securities Authorized for Issuance under Equity Compensation Plans

For information regarding securities authorized for issuance under Equity Compensation Plans and the equity compensation plan information table see “Part II, Item 5. Market for Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

Changes in Control

We are not aware of any arrangements that may result in a change in control of the Company.

ITEM 13. CERTAIN RELATIONSHIPS RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

Certain Relationships and Related Transactions

During the years ended September 30, 2020 and 2019, we entered into the following transactions required to be reported under Item 404 of Regulation S-K (“Item 404”):

Revenue

Harland Clarke Holdings Corp. (“Harland Clarke”), a stockholder who owns ALJ shares in excess of five percent, had a contract with Faneuil to provide call center services for Harland Clarke’s banking-related products. The contract completed in March 2019. Faneuil did not provide services to Harland Clarke subsequent to such completion date. Faneuil did not recognize any revenue or cost of revenue attributable to Harland Clarke during the year ended September 30, 2020.  Faneuil recognized $0.1 million of revenue for the year ended September 30, 2019. The associated cost of revenue was $0.1 million for the year ended September 30, 2019.  All revenue from Harland Clarke contained similar terms and conditions as those found in other transactions of this nature entered into by Faneuil. Harland Clarke did not owe Faneuil any amounts at September 30, 2020 or 2019.

Common Stock Activity

In July 2019, ALJ sold 3.9 million shares of common stock at $1.80 per share for total cash proceeds of $7.0 million.  Of the common shares sold, 2.2 million shares were to unaffiliated investors, 1.6 million shares were to ALJ’s Chief Executive Officer, and 0.1 million were to Faneuil’s President and Chief Executive Officer.  In connection with such purchase and sale, each investor thereto, including ALJ’s CEO and Faneuil’s President and CEO, received 33% warrant coverage with a two-year term to purchase ALJ common stock at $1.80 per share.

Debt

 

Junior Participation Agreement – Term B Loan and Warrants Issued

 

On December 17, 2019, in connection with the Sixth Amendment to the Financing Agreement, certain trusts and other entities formed for the benefit of, or otherwise affiliated with, Jess Ravich, the Company’s Chief Executive Officer and Chairman of the Board (“Ravich Entities”), entered into a Junior Participation Agreement with Cerberus (“Junior Participation Agreement”), pursuant to which the Ravich Entities agreed to purchase $4.1 million in junior participation interests in the Term B loan under the Financing Agreement (“Junior Participation” and such interests, “Junior Participation Interests”). The Junior Participation Interests are junior and subordinate to the Cerberus Term Loan in all respects and have no quarterly principal payments. Through March 26, 2020, interest accrued under the Junior Participation (i) in cash, accrued at the same rate per annum as the Cerberus Term Loan and paid monthly, and (ii) in kind, accrued at 4.00% per annum, payable on the Maturity Date.  See “Amendment to Junior Participation Agreement -Term B Loan and Warrants Issued” below for interest earned subsequent to March 26, 2020.

 

In connection with the Junior Participation, the Company issued fully vested warrants to purchase 1.23 million shares of the Company’s common stock (“Junior Participation Agreement Warrants”) to the Ravich Entities, with a five-year term and an exercise price of $0.54.

 

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

On March 26, 2020, in connection with the Eighth Amendment to the Financing Agreement, the Ravich Entities entered into the First Amendment to the Junior Participation Agreement (“First Amendment to Junior Participation Agreement”). The amended terms under the First Amendment to Junior Participation Agreement include:

 

In connection with the First Amendment to Junior Participation Agreement, the Company issued fully vested warrants to purchase 0.4 million shares of the Company’s common stock (“First Amendment to Junior Participation Agreement Warrants”) to the Ravich Entities, with a five year term and an exercise price of $0.62.

 

Amendment to the Junior Participation Agreements – Term C Loan

 

On May 12, 2020, in connection with, and as a condition to, the Ninth Amendment to the Financing Agreement, certain stockholders of the Company (“Term C Loan Junior Participants”), including Mr. Ravich, entered into or amended certain Junior Participation Agreements (collectively, “Term C Loan Junior Participation Agreements”) with Cerberus.  Pursuant to the Term C Loan Junior Participation Agreements, the Term C Loan Junior Participants acquired junior participation interests in Term C Loan in an aggregate amount of $5.6 million, of which $4.1 million was entered into by Mr. Ravich, on May 12, 2020 (“Term C Loan”).  Additionally, Mr. Ravich agreed to acquire additional junior participation interests in the Term B Loan in an aggregate amount of (i) $2.5 million on March 31, 2021 and (ii) $2.5 million on June 30, 2021.

 

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

 

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

Backstop Letter Agreement

 

In November 2018, in connection with the Fourth Amendment, the Company entered into a Backstop Letter Agreement with Jess Ravich, the Company’s Chairman and Chief Executive Officer. Pursuant to the Backstop Letter Agreement, Mr. Ravich will provide a “backstop” that would enable the Company to satisfy the Alternative Financing Requirement by agreeing, if the Company is unable to locate alternative financing on terms, conditions and timing reasonably acceptable to it, and if required by Cerberus.  In consideration of Mr. Ravich entering into such backstop arrangement, the Company’s Audit Committee and independent directors reviewed, approved and agreed to a backstop fee package, pursuant to which the Company would (i) pay to Mr. Ravich’s trust a one-time backstop fee of $0.1 million, and (ii) if the purchase of such subordinated debt is required by Cerberus and the Company has failed to secure a financing alternative more advantageous to the Company, to issue to Mr. Ravich’s trust a five-year warrant (the “Warrant”) to purchase 1,500,000 shares of ALJ common stock at an exercise price equal to the average closing price of the Company’s common stock as reported on The Nasdaq Stock Market for the 30 trading days preceding the warrant issuance date.  

Director Independence

The following directors qualify as “independent” in accordance with the rules and regulations of the SEC and NASDAQ, as applicable:

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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

 

The Audit Committee of ALJ’s Board of Directors has engaged Deloitte & Touche LLP (“Deloitte”) as the independent registered public accounting firm for the Company and its subsidiaries for the fiscal year ended September 30, 2020.  The Audit Committee regularly reviews and determines whether any non-audit services provided by Deloitte potentially affects its independence with respect to the Company. The Audit Committee’s policy is to pre-approve all audit and permissible non-audit services provided by Deloitte. Pre-approval is generally provided by the Audit Committee for up to one year, is detailed as to the particular service or category of services to be rendered and is generally subject to a specific budget. The Audit Committee may also pre-approve additional services or specific engagements on a case-by-case basis. Management provides annual updates to the Audit Committee regarding the extent of any services provided in accordance with this pre-approval.  To date, all services performed by Deloitte have been pre-approved by the Audit Committee in accordance with this policy.

 

Prior to August 21, 2019, the Audit Committee had engaged Mayer Hoffman McCann P.C. (“MHM”) as the independent registered public accounting firm for the Company.  As previously disclosed, on July 23, 2019, the Audit Committee of ALJ’s Board of Directors determined, pending execution of an engagement letter in form and substance satisfactory to the Company (the “Engagement Letter”), to appoint Deloitte and dismiss MHM.  On August 21, 2019, the Company executed the Engagement Letter, and Deloitte was formally appointed by the Audit Committee, and MHM was formally dismissed, as the Company’s independent registered public accounting firm.

 

The reports of MHM on the consolidated financial statements of the Company and subsidiaries as of and for the fiscal year ended September 30, 2018 and the subsequent interim period through August 21, 2019 did not contain any adverse opinion or a disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles.

 

During the fiscal year ended September 30, 2018 and the subsequent interim period through August 21, 2019, there were (i) no disagreements within the meaning of Item 304(a)(1)(iv) of Regulation S-K between the Company and MHM on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, any of which, if not resolved to MHM’s satisfaction, would have caused MHM to make reference thereto in their reports, and (ii) no “reportable events” within the meaning of Item 304(a)(1)(v) of Regulation S-K.

 

The following table sets forth the aggregate fees billed, or expected to be billed, by Deloitte with respect to audit and non-audit services for the Company during the fiscal years ended September 30, 2020 and 2019, and the aggregate fees billed by MHM with respect to audit and non-audit services for the Company during the fiscal year ended September 30, 2019 before the change in auditors became effective:

 

 

 

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

Financial Statements

 

The financial statements required by this Item are included beginning at page F-1.

 

Financial Statement Schedules

 

The financial statement schedules required by this Item are included on page S-1.

 

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Exhibits

The following documents are filed as exhibits hereto:

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

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POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Jess Ravich and Brian Hartman, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for her or him and in her or his name, place, and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as she or he might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.

 

 

 

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

F-1

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Report of Independent Registered Public Accounting Firm

 

 

To the Stockholders and the Board of Directors of ALJ Regional Holdings, Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of ALJ Regional Holdings, Inc. and subsidiaries (the "Company") as of September 30, 2020 and 2019, the related consolidated statements of operations, stockholders’ equity and cash flows for each of the two years in period ended September 30, 2020, and the related notes and the consolidated financial statement schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2020 and 2019, and the results of its operations and its cash flows for each of the two years in the period ended September 30, 2020, in conformity with accounting principles generally accepted in the United States of America.

  

Basis for Opinion

 

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provides a reasonable basis for our opinion.

 

/s/ Deloitte & Touche LLP

 

Jericho, New York

December 18, 2020

 

We have served as the Company’s auditor since 2019.

 

 

 

 

 

F-2

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

 

 

See accompanying notes to consolidated financial statements.

F-3

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

 

 

See accompanying notes to consolidated financial statements.

F-4

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

 

 

See accompanying notes to consolidated financial statements.

F-5

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

See accompanying notes to consolidated financial statements.

F-6

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

See accompanying notes to consolidated financial statements.

 

F-7

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ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED SEPTEMBER 30, 2020 AND 2019

 

1. ORGANIZATION AND BASIS OF PRESENTATION

Organization

ALJ Regional Holdings, Inc. (including subsidiaries, referred to collectively herein as “ALJ” or “Company”) is a holding company.  As of September 30, 2020, ALJ consisted of the following wholly-owned subsidiaries:  

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

Basis of Presentation

Overall

The accompanying consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of ALJ and its subsidiaries.  All intercompany items and transactions have been eliminated in consolidation.

 

Revision of Previously Reported Financial Information  

The Company has historically classified expenses incurred by the Faneuil reportable segment as either cost of revenue or selling, general, and administrative expense based on whether such expenses represented salaries and wages or an expense other than salary and wages. Faneuil is a labor-intensive business with labor representing the majority of the cost of revenue. Management determined that certain costs classified as cost of revenue should be classified as selling, general, and administrative expense, while other costs classified as selling, general, and administrative expense should be classified as cost of revenue. Accordingly, the accompanying Consolidated Statement of Operations for the year ended September 30, 2019 has been revised to correct the amounts previously reported as cost of revenue and selling, general, and administrative expense as applicable.

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

F-8

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The following table presents the impact of Faneuil’s reclassification on the Consolidated Statements of Operations for the year ended September 30, 2019:

 

 

 

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

 

Impact of Coronavirus Pandemic

 

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

 

Currently, all of ALJ’s subsidiaries have been deemed “Essential Services” and have continued to operate with limited disruption, albeit with lower sales volume at Carpets and Phoenix. As such, COVID-19 did not materially impact ALJ’s financial position, or results of operations and cash flows as of and for the year ended September 30, 2020. However, the Company took immediate actions in March 2020 to enable working-from-home where possible and put in place increased safety precautions, including social distancing, at other locations where essential services on site are required. The duration of these measures is unknown, may be extended and additional measures may be imposed.

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

As of September 30, 2020, ALJ’s total available liquidity was $20.7 million, which included $6.1 million of cash and cash equivalents and $14.6 million of unused borrowing capacity under the Company’s revolving credit facility. While the impact that COVID-19 may have on the Company’s financial position, results of operations, and cash flows in the future cannot be estimated with certainty, based on current estimates regarding the magnitude and duration of the global pandemic, ALJ does not anticipate an impact on the Company’s ability to meet its obligations when due for at least the next 12 months.  However, the ultimate magnitude and duration of the global pandemic is highly uncertain and, as such, will require ALJ to continually assess the situation for the foreseeable future.  Accordingly, the Company’s estimates regarding the magnitude and duration of the global pandemic may change in the future and such changes could be material.

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

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

 

 

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Although actual results could differ materially from those estimates, such estimates are based on the best information available to management and management’s best judgments at the time. Significant estimates and assumptions by management are used for, but are not limited to, determining the fair value of assets and liabilities, including intangible assets acquired and allocation of acquisition purchase prices, estimated useful lives of certain assets, recoverability of long-lived and intangible assets, the recoverability of goodwill, the realizability of deferred tax assets, stock-based compensation, the likelihood of material loss as a result of loss contingencies, customer lives used for revenue recognition, the allowance for doubtful accounts and inventory reserves, and calculation of insurance reserves.  Actual results may differ materially from estimates.

 

Business Combinations

The Company accounts for business combinations under the acquisition method of accounting in accordance with the Financial Accounting Standards Board (“FASB”) ASC 805, Business Combinations (“ASC 805”). The Company recognizes the fair value of the assets acquired and liabilities assumed, immediately expenses transaction costs and accounts for restructuring plans separately from the business combination. The excess of the cost of the acquisition over the fair value of the net tangible and identifiable intangible assets acquired is recorded as goodwill. Results of operations of the acquired business are included in the Consolidated Statements of Operations from the effective date of acquisition.

ALJ uses its best estimates and assumptions to accurately value assets acquired, and liabilities assumed at the acquisition date. The measurement period for the valuation of assets acquired and liabilities assumed ends as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but does not exceed 12 months. Adjustments to purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined.

 

Cash and Cash Equivalents

Cash and equivalents include all cash, demand deposits, and money market accounts with original maturities of three months or less.

Accounts Receivable

ALJ presents accounts receivable, net of allowances for doubtful accounts and returns.  Allowances, when required, are calculated based on a detailed review of certain individual customer accounts and an estimation of the overall economic conditions affecting ALJ’s customer base. ALJ reviews a customer’s credit history before extending credit. If the financial condition of its customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances might be required.

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Inventory

Carpets. Inventory, which consists of carpet, wood, vinyl, granite and other related hard surfaces, cabinets and window treatments, is stated at the lower of cost or net realizable value.  Cost is computed on a first-in, first-out basis (“FIFO”).  Carpets reserves for slow-moving and obsolete inventory based on historical and/or projected usage of the product.

Phoenix.  Inventory, which consists primarily of paper, laminating film and inks, is stated at lower of cost or net realizable value.  Cost is determined using FIFO and includes direct materials, direct labor, and applicable overhead.  Phoenix reserves for slow-moving and obsolete inventory based on historical and/or projected usage of the product.  

Property and Equipment

 

Property and equipment are initially recorded at cost and are depreciated over the estimated useful lives of the assets using the straight-line method.  Estimated useful lives are as follows:

 

 

Property and equipment acquired in a business acquisition are recorded at fair value on the date of acquisition. Subsequent purchases are recorded at historical cost. Significant improvements and betterments are capitalized. Routine repairs and maintenance are expensed when incurred. Gains and losses on disposal of fixed assets are recognized in the Consolidated Statements of Operations based on the net disposal proceeds less the carrying amount of the assets.

Goodwill

ALJ records goodwill when the purchase price of an acquisition exceeds the fair value of the net tangible and identified intangible assets acquired.  ALJ assigns the goodwill to its reporting units consistent with the future economic benefits and synergies expected to be achieved.  ALJ performs an annual impairment assessment annually as of September 30, or more frequently if indicators of potential impairment exist, which includes evaluating qualitative and quantitative factors to assess the likelihood of an impairment of a segment’s goodwill.

Intangible Assets

As of September 30, 2020 and 2019, all intangible assets were acquisition-related, recorded at fair value on the dates acquired, and subject to amortization.  ALJ amortizes intangible assets over their estimated useful life based on expected economic benefit using the straight-line method.  In the quarter following the period in which the intangible asset becomes fully amortized, ALJ removes the fully amortized balances from the gross asset and accumulated amortization amounts.

The estimated useful life ranges for all identified intangible assets were as follows:

 

 

 

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Deferred Loan Costs

 

Deferred loan costs related to ALJ’s term loans are amortized to interest expense using the effective yield method over the contractual life of the debt.  Additional amortization is recorded in periods where optional prepayments on debt are made.  Deferred loan costs related to ALJ’s line of credit are amortized to interest expense using the straight-line method over the life of the debt.

  

Workers’ Compensation Reserve

The Company is self-insured for certain insurance coverages as discussed below.    

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

Carpets.  Effective October 1, 2018, Carpets changed from a fully insured plan for workers’ compensation to a self-insured plan, to reduce expenses, for claims up to $200,000 per incident and maintains insurance coverage for costs above the specified limit.  Effective October 1, 2020, Carpets changed back to a fully insured plan.

Phoenix. Phoenix maintains outside insurance to cover workers’ compensation claims.  

 

Fair Value of Financial Instruments

 

ALJ accounts for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

 

Level 1. Inputs are based upon unadjusted quoted prices for identical instruments in active markets. ALJ had no Level 1 assets or liabilities.

 

Level 2. Inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques (e.g., the Black-Scholes model) for which all significant inputs are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. ALJ had no Level 2 assets or liabilities.

 

Level 3. Inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques, including option pricing models and discounted cash flow models.  Unobservable inputs used in the models are significant to the fair values of the assets and liabilities.  ALJ had no Level 3 assets.  ALJ’s only Level 3 liabilities are acquisition-related contingent consideration.  The fair values were determined using a variation of the income approach, known as the real options method, where certain revenue was simulated in a risk-neutral framework using Geometric Brownian Motion, a well-accepted model of stock price behavior that is used in option pricing models such as the Black-Scholes option pricing model.  See Note 4.  

 

ALJ’s other fair value instruments consist of accounts receivable, accounts payable, accrued expenses, line of credit, and term-loans.  As of September 30, 2020 and 2019, carrying values of accounts receivable, accounts payable and accrued expenses approximate fair values due to the short-term nature of the instrument.   Additionally, ALJ’s line of credit and term loans both carry a variable interest rate set at current market rates, and as such, the carrying value approximates fair value. 

Revenue from Contracts with Customers – Impact of Adoption

 

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

 

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

 

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

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Costs incurred as part of contract implementation either represent costs incurred towards the partial satisfaction of a performance obligation, fulfillment costs, or administrative costs. Under ASC 606, fulfillment costs are capitalizable and are amortized over the contract term, consistent with the definition of a contract term under ASC 606.  As a result of termination provisions, the contract term under ASC 606 may be shorter than the contractually stated contract term. Under the previous guidance, all costs incurred as part of contract implementation were capitalized and amortized over the stated contractual term, disregarding any termination provisions, on a straight-line basis.

 

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

 

Under ASC 606, when upfront fees do not relate directly to the satisfaction or partial satisfaction of a performance obligation, the payments are deemed to be advance payments for future services. In such, instances, the fees are allocated to performance obligations and recognized when or as the performance obligations, typically call center services, are satisfied over the contract term, as defined under ASC 606.  If a contract contains termination provisions, and such termination provisions are not substantive, the upfront nonrefundable fees will be fully recognized prior to the expiration of the stated term of the contract.

 

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

 

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

 

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

 

Upon adoption of ASC 606, Carpets adjusted the following:

Phoenix. Based on analysis of specific terms associated with customer contracts uncompleted at the date of adoption, Phoenix concluded that revenue is recognized at a point in time for substantially all products. This treatment is consistent with how revenue was recognized under the previous guidance, which was when the products were completed and shipped to the customer (dependent upon specific shipping terms).

 

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

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

 

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

 

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

 

 

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

 

The following table summarizes the pre-tax impacts of adopting the new revenue accounting guidance on ALJ’s Consolidated Balance Sheet as of September 30, 2020:

 

 

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The following tables summarize the pre-tax impacts of adopting the new revenue accounting guidance on ALJ’s Statement of Operations for the year ended September 30, 2020:

 

 

The Consolidated Statement of Cash Flows for the year ended September 30, 2020 takes into consideration the effect of adopting ASC 606.  The adoption of ASC 606 had no impact to net cash provided by (used for) operating, financing or investing activities on the Company’s Consolidated Statement of Cash Flows for the year ended September 30, 2020.

 

Revenue from Contracts with Customers - Accounting Policy Update

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The timing of when Carpets bills its customers is generally dependent upon agreed-upon contractual terms, milestone billings based on the completion of certain phases of the work, or when services are provided. Sometimes, billing occurs subsequent to transfer of control of goods or services, resulting in unbilled revenue, which is recorded as a contract asset. However, Carpets sometimes receives advances or deposits from its customers before revenue is recognized, resulting in deferred revenue, which is recorded as a contract liability.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

Billings for shipping and handling costs are recorded in revenue on a gross basis. Phoenix made an accounting policy election under ASC 606 to account for shipping and handling after the customer obtains control of the good as fulfillment activities rather than as a separate service to the customer. As a result, when Phoenix is responsible for shipment, Phoenix accrues the costs of the shipping and handling if revenue is recognized for the related good before the fulfillment activities occur.

 

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

 

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

 

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

 

The timing of revenue recognition, billings, and cash collections results in accounts receivable and unbilled receivables (contract assets), and customer advances and deposits (contract liabilities) on the Consolidated Balance Sheet. Revenue recognition generally coincides with Phoenix’s contractual right to consideration and the issuance of invoices to customers. Depending on the nature of the performance obligation and arrangements with customers, the timing of the issuance of invoices may result in contract assets or contract liabilities. Sometimes, billing occurs subsequent to transfer of control of goods or services, resulting in unbilled revenue, which is recorded as a contract asset. Contract liabilities result from advances or deposits from customers on performance obligations not yet satisfied.

 

Phoenix provides a warranty that the products conform to the customer specifications and are free of defects. The warranty is classified as an assurance warranty. Phoenix generally obtains customer approval prior to commencing production to minimize warranty issues. As a result, warranty claims are generally not significant.

 

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

Impairment of Goodwill and Long-Lived Assets

 

Goodwill. The Company assesses the recoverability of goodwill on an annual basis in accordance with ASC 350 Intangibles - Goodwill and Other. The measurement date is September 30, or more frequently, if events or circumstances indicate that it is more likely than not that the fair value of a reporting unit is less than the carrying value. The impairment test includes evaluating qualitative and quantitative factors to assess the likelihood of an impairment of goodwill. Each of the Company’s three reporting units has goodwill assigned, which is assessed independently.

 

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As a result of the decline in ALJ’s market capitalization, downward economic pressure, declines in actual and forecasted results of operations including the estimated effects of COVID-19, management determined that it was more likely than not that the fair value of goodwill for all three reporting units was below each reporting unit’s respective carrying amount. As such, management performed an interim impairment test as of March 31, 2020, based on discounted cash flows, which were derived from internal forecasts and more cautious economic expectations for all three reporting units.

 

As a result of the interim test, ALJ recognized a non-cash impairment of goodwill totaling $59.0 million, which was reflected on the Company’s Consolidated Statement of Operations for the year ended September 30, 2020. The Company did not have any impairment of goodwill during the year ended September 30, 2019.

 

Long-Lived Assets. Long-lived assets, such as property and equipment and intangible assets subject to amortization, are reviewed for impairment when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of assets to be held and used is measured by comparing the carrying amount of an asset or asset group to estimated undiscounted future cash flows expected to be generated by the asset or asset group. If the carrying amount of an asset or asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset or asset group exceeds the estimated fair value of the asset or asset group. Long-lived assets to be disposed of by sale are reported at the lower of their carrying amounts or their estimated fair values, less costs to sell, and are not depreciated.

The Company did not have any impairment of long-lived assets during the year ended September 30, 2020. During the year ended September 30, 2019, ALJ wrote off certain intangible assets totaling $0.8 million that were deemed impaired.  

Income Taxes

The Company uses the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards, and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by the valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

The Company’s judgments relative to the current provision for income taxes take into account current tax laws, the interpretation of current tax laws and possible outcomes of current and future audits conducted by tax authorities. The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions, and is subject to U.S. federal tax and state tax examinations.  The Company’s judgments relative to the value of deferred tax assets and liabilities take into account estimates of the amount of future taxable income. Actual operating results and the underlying amount of income in future years could render current estimates of recoverable net deferred taxes inaccurate. Any of the judgments mentioned above could cause actual income tax obligations to differ from estimates, thus materially impacting the Company’s financial position and results of operations.

If the Company takes a recognized tax position or has taken a recognized tax position on a tax return that more likely than not would be sustained upon examination by tax authorities, then the Company will recognize the potential asset or liability in the financial statements. A recognized tax position is then measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Management believes that the Company has appropriate support for the income tax positions taken and to be taken on its tax returns and that its accrual for tax liabilities is adequate for all open years based on its assessment of many factors, including past experience and interpretation of tax law applied to the facts of each matter.

Stock-Based Compensation

ALJ recognizes compensation expense for its equity awards on a straight-line basis over the requisite service period of the award based on the estimated portion of the award that is expected to vest and applies estimated forfeiture rates based on analyses of historical data, including termination patterns and other factors. ALJ uses the quoted closing market price of its common stock on the grant date to measure the fair value of common stock awards and the Black-Scholes option pricing model to measure the fair value of stock option awards. The expected volatility is based on historical volatilities of ALJ’s common stock over the most recent period commensurate with the estimated expected term of the awards. The expected term of an award is equal to the midpoint between the vesting date and the end of the contractual term of the award. The risk-free interest rate is based on the rate on U.S. Treasury securities with maturities consistent with the estimated expected term of the awards. ALJ has never paid dividends and does not anticipate paying a cash dividend in the foreseeable future and, accordingly, uses an expected dividend yield of zero.

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During the year ended September 30, 2020, ALJ used the following weighted-average assumptions:  expected option life of 6.2 years, volatility of 48.6%, dividend yield of 0.00%, and annual risk-free interest rate of 0.33%.  The weighted-average fair value of the options granted during the year ended September 30, 2020 was $0.25. ALJ did not issue any options during the year ended September 30, 2019.  

Rent Expense, Deferred Rent Obligations and Deferred Lease Incentives

The Company leases most of its facilities under operating leases. Some of these lease agreements contain tenant improvement allowances funded by landlord incentives, rent holidays, and rent escalation clauses. The authoritative guidance for leases requires rent expense to be recognized on a straight-line basis over the lease term. The difference between the rent due under the stated periods of the lease compared to that of the straight-line basis is recorded as deferred rent within other accrued expenses and other non-current liabilities.   For tenant improvement allowances funded by landlord incentives and rent holidays, the Company records a deferred lease incentive liability in accrued expenses and other non-current liabilities and amortizes the deferred liability as a reduction to rent expense on the Consolidated Statements of Operations over the term of the lease.

Earnings Per Share

 

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

 

Recent Accounting Pronouncements Not Yet Adopted  

Leases

In February 2016, the FASB issued ASU 2016-02, Leases and subsequent amendments to the initial guidance: ASU 2017-13, ASU 2018-10, ASU 2018-11, ASU 2018-20 and ASU 2019-01 (referred to collectively as “ASC 842”). ASC 842 requires lessees to recognize a right-of-use (“ROU”) asset and corresponding lease liability for all leases with terms of more than 12 months and provides enhanced disclosure of lease activity. Recognition, measurement, and presentation of expenses will depend on classification as either a finance or operating lease.   ASC 842 will be effective for ALJ on October 1, 2020.

 

ASC 842 allows companies to choose to apply the provisions at the beginning of the earliest comparative period presented in the financial statements or at the beginning of the period of adoption. ALJ has elected to apply the guidance at the beginning of the period of adoption.  Consequently, financial information for the comparative periods will not be updated. ALJ will utilize the transition package of practical expedients permitted within ASC 842, which, most notably, will allow ALJ to carry forward the historical lease classification.    

 

The Company chose the systems it will use to manage the accounting for leases, determined the contracts that are considered leases under ASC 842, and implemented the systems and internal controls and procedures specific to ASC 842.

 

Upon the adoption of ASC 842, ALJ anticipates an impact to its Consolidated Balance Sheets but expects no impact to its Consolidated Statements of Operations or Consolidated Statements of Cash Flows.  The most significant impact will be the recognition of the ROU assets and lease liabilities primarily related to real estate leases classified as operating leases.  ALJ estimates the adoption of ASC 842 will result in the recognition and presentation of total operating lease ROU assets of approximately $32.2 million to $35.6 million, and total operating lease liabilities of approximately $41.3 million to $45.6 million, upon the adoption date.

Internal-Use Software

 

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

 

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Income Taxes

 

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which simplifies certain aspects of the accounting for income taxes as well as clarifies and amends existing guidance to improve consistent application. ASU 2019-12 will be effective for ALJ on October 1, 2022. The Company is currently evaluating the impact of ASU 2019-12 on its consolidated financial statements and related disclosures.

 

 

 

3. REVENUE RECOGNITION

 

Disaggregation of Revenue

Revenue by contract type was as follows for the year ended September 30, 2020:

 

 

 

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

Contract Assets and Liabilities

 

The following table provides information about consolidated contract assets and contract liabilities at September 30, 2020 and October 1, 2019:

 

 

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The following table provides changes in consolidated contract assets and contract liabilities from October 1, 2019 to September 30, 2020:  

 

 

Deferred Revenue and Remaining Performance Obligations

 

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

 

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

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

Estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied or partially satisfied at September 30, 2020, was de minimis. This balance does not include revenue related to performance obligations that are part of a contract whose original expected duration is one year or less, including contracts with a penalty-free termination for convenience clause. In addition, this disclosure does not include (i) expected consideration related to performance obligations for which the Company elects to recognize revenue in the amount it has a right to invoice (e.g., usage-based pricing terms), and (ii) any variable consideration which is allocated entirely to future performance obligations including variable transaction fees or fees tied directly to costs incurred.

Costs to Obtain a Contract

 

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

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During the year ended September 30, 2020, the Company capitalized $1.1 million of costs to obtain a contract.  During the year ended September 30, 2020, the Company recognized $0.9 million of amortization of these costs, which is included in selling, general, and administrative expense.  The net book value of costs to obtain a contract was $0.6 million as of September 30, 2020, of which $0.4 million was in prepaid expenses and other current assets, and $0.2 million was in other assets.

Costs to Fulfill a Contract

 

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

 

During the year ended September 30, 2020, the Company capitalized $7.9 million of costs to fulfill a contract.  The amortization of costs to fulfill contracts, which comprise set-up/transition activities, for the year ended September 30, 2020 was approximately $4.5 million. As of September 30, 2020, the net book value of the costs to fulfill a contract totaled $5.0 million, of which $3.5 million was in prepaid expenses and other current assets, and $1.5 million was in other assets.

 

Capitalized costs to obtain and fulfill a contract are periodically reviewed for impairment. We did not incur any impairment losses during the year ended September 30, 2020.

 

 

4. ACQUISITIONS  

RDI Acquisition

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

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

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

 

 

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The Company accounted for the RDI Acquisition using the purchase method of accounting. Accordingly, the assets and liabilities were recorded at their fair values at the RDI Purchase Date. The excess of the purchase price over the fair value of the tangible and intangible assets acquired, liabilities assumed, and deferred and contingent consideration, was recorded as goodwill. See Footnote 6.

Acquisition-Related Expenses

 

During the years ended September 30, 2020 and September 30, 2019, the Company incurred less than $0.1 million and $0.2 million of acquisition-related costs in connection with the RDI Acquisition, which were expensed to selling, general, and administrative expense as incurred.

Fair Value Adjustment of Deferred and Contingent Consideration Liabilities

 

The fair value of the deferred and contingent consideration liabilities is remeasured to fair value at each reporting period using Level 3 inputs such as cash flow forecast, discount rate, and equity risk premium.  The change in fair value, including accretion for the passage of time, is recognized in earnings until the deferred and contingent considerations are resolved. ALJ recorded a $1.1 million increase to the deferred and contingent consideration liabilities as of September 30, 2020, which was expensed to selling, general, and administrative expense during the year ended September 30, 2020.  

 

 

 

5. CONCENTRATION RISKS

Cash

The Company maintains its cash balances in accounts, which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes there is little or no exposure to any significant credit risk.

Major Customers and Accounts Receivable

ALJ did not have any customer with net revenue in excess of 10% of consolidated net revenue during the years ended September 30, 2020 and 2019.  Each of ALJ’s segments had customers that represented more than 10% of their respective net revenue, as described below.  

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

 

 

**Less than 10% of Faneuil net revenue.

 

Trade receivables from these customers totaled $6.3 million at September 30, 2020.  As of September 30, 2020, all Faneuil accounts receivable were unsecured.  The risk with respect to accounts receivable is mitigated by credit evaluations performed on customers and the short duration of payment terms extended to customers.

 

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

 

 

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Trade receivables from these customers totaled $1.8 million at September 30, 2020.  As of September 30, 2020, all Carpets accounts receivable were unsecured.  The risk with respect to accounts receivables is mitigated by credit evaluations performed on customers and the short duration of payment terms extended to customers.

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

 

 

 

Trade receivables from these customers totaled $4.4 million at September 30, 2020.  As of September 30, 2020, all Phoenix accounts receivable were unsecured.  The risk with respect to accounts receivable is mitigated by credit evaluations performed on customers and the short duration of payment terms extended to customers.

Supplier Risk

ALJ had two suppliers that represented more than 10% of consolidated inventory purchases as follows:

 

 

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

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

 

 

 

 

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

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

 

 

 

 

 

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

 

 

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6. COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS

Accounts Receivable, Net

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

 

 

 

Inventories, Net

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

 

 

 

Property and Equipment

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

 

 

 

Property and equipment depreciation and amortization expense, including amounts related to capitalized leased assets, was $15.1 million and $15.3 million for the years ended September 30, 2020 and 2019, respectively.  

Goodwill

The following table presents changes in the carrying values of goodwill by segment for the years ended September 30, 2020 and 2019:

 

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Intangible Assets

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

 

 

 

Intangible asset amortization expense was $5.3 million and $5.2 million for the years ended September 30, 2020 and 2019, respectively.

 

The following table presents expected annual amortization expense as of September 30, 2020 (in thousands):

 

 

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The following table presents changes in the carrying values of intangible assets by category for the years ended September 30, 2020 and 2019:

 

 

 

Accrued Expenses

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

 

 

7. LOSS PER SHARE

ALJ computed basic and diluted loss per common share for each period as follows:

 

 

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

 

Common stock equivalents of 4.8 million and 3.0 million were not considered in calculating ALJ’s diluted loss per common share for the years ended September 30, 2020 and 2019, respectively, as their effect would be anti-dilutive.  

 

Debt that was convertible into 10.7 million shares of ALJ common stock was not considered in calculating ALJ’s diluted loss per common share for the year ended September 30, 2020 as the effect would be anti-dilutive.  ALJ did not have any convertible debt outstanding at September 30, 2019.

 

 

8. DEBT

Debt

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

 

 

Term Loans and Line of Credit

 

In August 2015, ALJ entered into a financing agreement (“Financing Agreement”) with Cerberus Business Finance, LLC (“Cerberus”), to borrow $105.0 million in a term loan (“Cerberus Term Loan”) and have available up to $32.5 million in a revolving loan (“Cerberus/PNC Revolver,” and together with the Cerberus Term Loan, “Cerberus Debt”). ALJ has subsequently entered into nine amendments to the Financing Agreement, of which three were entered into during year ended September 30, 2020 and are described below. The Cerberus Debt matures on November 28, 2023 (“Maturity Date”).

 

Sixth Amendment to the Financing Agreement

 

 

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

 

 

 

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

 

Seventh Amendment to the Financing Agreement

 

On February 13, 2020, ALJ entered into the Seventh Amendment (“Seventh Amendment”) to the Financing Agreement to temporarily increase the Cerberus/PNC Revolver borrowing capacity as follows:  

  

 

 

Eighth Amendment to the Financing Agreement

On March 26, 2020, ALJ entered into the Eighth Amendment (“Eighth Amendment”) to the Financing Agreement to amend certain terms and covenants, which included:

 

 

 

 

 

Ninth Amendment to the Financing Agreement

 

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

 

On May 12, 2020, ALJ entered into the Ninth Amendment (“Ninth Amendment”) to the Financing Agreement. The Ninth Amendment amended certain terms and covenants as summarized below:

 

 

 

 

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Junior Participation Agreement – Term B Loan and Warrants Issued

 

On December 17, 2019, in connection with the Sixth Amendment, certain trusts and other entities formed for the benefit of, or otherwise affiliated with, Jess Ravich, the Company’s Chief Executive Officer and Chairman of the Board (“Ravich Entities”), entered into a Junior Participation Agreement with Cerberus (“Junior Participation Agreement”), pursuant to which the Ravich Entities agreed to purchase $4.1 million in junior participation interests in the Term B loan under the Financing Agreement (“Junior Participation” and such interests, “Junior Participation Interests”). The Junior Participation Interests are junior and subordinate to the Cerberus Term Loan in all respects and have no quarterly payments. Through March 26, 2020, interest accrued under the Junior Participation (i) in cash, accrued at the same rate per annum as the Cerberus Term Loan and paid monthly, and (ii) in kind, accrued at 4.00% per annum, payable on the Maturity Date.  See “Amendment to Junior Participation Agreement -Term B Loan and Warrants Issued” below for interest earned subsequent to March 26, 2020.

 

In connection with the Junior Participation, the Company issued fully vested warrants to purchase 1.23 million shares of the Company’s common stock (“Junior Participation Agreement Warrants”) to the Ravich Entities, with a five-year term and an exercise price of $0.54.

 

The fair value of the Junior Participation Agreement Warrants was calculated using the Black Scholes Model with the following assumptions:  contractual life of five years, volatility of 42.3%, dividend yield of 0.00%, and annual risk-free interest rate of 1.7%. The fair value of the Junior Participation Agreement Warrants of $0.6 million was expensed to selling, general, and administrative expense during the year ended September 30, 2020.  

 

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

On March 26, 2020, in connection with the Eighth Amendment to the Financing Agreement, the Ravich Entities entered into the First Amendment to the Junior Participation Agreement (“First Amendment to Junior Participation Agreement”). The amended terms under the First Amendment to Junior Participation Agreement include:

 

In connection with the First Amendment to Junior Participation Agreement, the Company issued fully vested warrants to purchase 0.4 million shares of the Company’s common stock (“First Amendment to Junior Participation Agreement Warrants”) to the Ravich Entities, with a five year term and an exercise price of $0.62.

 

The fair value of the First Amendment to Junior Participation Agreement Warrants was calculated using the Black Scholes Model with the following assumptions:  contractual life of five years, volatility of 43.8%, dividend yield of 0.00%, and annual risk-free interest rate of 0.5%. The fair value of the First Amendment to Junior Participation Agreement Warrants of $0.1 million was expensed to selling, general, and administrative expense during the year ended September 30, 2020.

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Amendment to the Junior Participation Agreements – Term C Loan

 

On May 12, 2020, in connection with, and as a condition to, the Ninth Amendment, certain stockholders of the Company (“Term C Loan Junior Participants”), including Mr. Ravich, entered into or amended certain Junior Participation Agreements (collectively, “Term C Loan Junior Participation Agreements”) with Cerberus.  Pursuant to the Term C Loan Junior Participation Agreements, the Term C Loan Junior Participants acquired junior participation interests in Term C Loan in an aggregate amount of $5.6 million on May 12, 2020 (“Term C Loan”).  Additionally, Mr. Ravich agreed to acquire additional junior participation interests in the Term B Loan in an aggregate amount of (i) $2.5 million on March 31, 2021 and (ii) $2.5 million on June 30, 2021.

 

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

 

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

 

Summary of the Financing Agreement and Amendments

 

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

 

 

Interest payments are due in arrears on the first day of each month. Quarterly principal payments are due on the last day of each fiscal quarter. Annual principal payments equal to 75% of ALJ’s excess cash flow (“ECF”), as defined in the Financing Agreement, are due annually each December, upon delivery of the annual audited financial statements. The annual ECF calculation, based on results of operations for the year ended September 30, 2019, did not require ALJ to make an annual ECF payment in December 2019. During December 2018, ALJ made an ECF payment of $0.3 million.

In certain instances, ALJ is required to make mandatory term loan payments if ALJ receives cash outside the normal course of business. As a result, during the years ended September 30, 2020 and 2019, ALJ made mandatory payments of $0.9 million and $0.4 million, respectively.

As of September 30, 2020, ALJ will be assessed a prepayment penalty equal to 2% and 1% of the outstanding Cerberus Debt plus any unused available credit on the PNC Revolver if the Cerberus Term Loan is repaid before November 28, 2020 and November 28, 2021, respectively. A final balloon payment is due on the Maturity Date.

The Cerberus Debt is secured by substantially all the Company’s assets and imposes certain limitations on the Company, including its ability to incur debt, grant liens, initiate certain investments, declare dividends and dispose of assets. The Cerberus Debt also requires ALJ to comply with certain debt covenants. As of September 30, 2020, ALJ was in compliance with all debt covenants and had unused borrowing capacity of $14.6 million.

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Backstop Letter Agreement

 

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

 

The Term C Loan Junior Participation Agreements discussed above satisfied the alternative financing requirement.

 

Loan Amendment Fees

 

ALJ has accounted for all loan amendments as debt modifications pursuant to ASC 470, Debt.

 

During the year ended September 30, 2020, ALJ paid $0.9 million of legal and other fees of which $0.6 million was added to deferred loan costs and is being amortized to interest expense through the Maturity Date. The remaining fees of $0.3 million were expensed to selling, general, and administrative expense during the year ended September 30, 2020.

 

During the year ended September 30, 2019, ALJ paid $1.2 million of legal and other fees of which $0.9 million was added to deferred loan costs and is being amortized to interest expense through the Maturity Date. The remaining fees of $0.3 million were expensed to selling, general, and administrative expense during the year ended September 30, 2019.

Contingent Loan Costs

 

Pursuant to the Financing Agreement, ALJ was required to pay a fee (a “Contingent Payment”) in each of three consecutive annual

periods which began on May 27, 2018, if at any time during each annual period there are any amounts outstanding on the Cerberus/PNC Revolver.  Such Contingent Payments become due and payable on the first day within each annual period there is an outstanding balance on the Cerberus/PNC Revolver. ALJ made the first Contingent Payment during May 2018, the second Contingent Payment during May 2019, and the final Contingent Payment during May 2020. Contingent Payments were added to deferred loan costs and amortized to interest expense for one year following the respective Contingent Payment.

Equipment Financing

 

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

In June 2020, Phoenix purchased a Heidelberg Press for $2.6 million by securing $1.8 million equipment financing (“Second Equipment Financing”), paying $0.5 million in cash, and receiving a $0.3 million trade-in allowance. The Second Equipment Financing term is 36 months, requires monthly principal and interest payments, accrues interest at 2.66% per year, and is secured by the second Heidelberg Press.  In connection with the trade-in allowance, Phoenix recorded a $0.3 million gain on disposal of assets during the year ended September 30, 2020.

In October 2020, the board of directors approved the purchase of a Heidelberg Press for $4.5 million by securing equipment financing.  The Heidelberg Press is projected to be operational in May 2021.

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Estimated Future Minimum Principal Payments

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

 

 

Capital Lease Obligations

Faneuil and Phoenix lease equipment under non-cancelable capital leases. As of September 30, 2020, future minimum payments under non-cancelable capital leases with initial or remaining terms of one year or more are as follows (in thousands):

 

 

 

9. COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company leases real estate, equipment, and vehicles under noncancellable operating leases. As of September 30, 2020, future minimum rental commitments under noncancellable leases were as follows (in thousands):

 

 

During the years ended September 30, 2020 and 2019 rental expense under operating leases was $9.1 million and $7.1 million, respectively, and was included with selling, general, and administrative expense.

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Employment Agreements

ALJ maintains employment agreements with certain key executive officers that provide for a base salary and annual bonus to be determined by the Board of Directors.  The agreements also provide for termination payments, which includes base salary and performance bonus, stock options, non-competition provisions, and other terms and conditions of employment.  As of September 30, 2020, contingent termination payments related to base salary totaled $1.4 million.

Surety Bonds

In the normal course of operations, certain Faneuil customers require surety bonds guaranteeing the performance of a contract.  As of September 30, 2020, the face value of such surety bonds, which represents the maximum cash payments that Faneuil would have to make under certain circumstances of non-performance, was $25.5 million.  To date, Faneuil has not made any non-performance payments.

Letters of Credit

ALJ had letters of credit totaling for $3.6 million as of September 30, 2020, in connection with workers’ compensation insurance requirements.

 

Litigation, Claims, and Assessments

 

Faneuil, Inc. v. 3M Company

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

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

 

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

Marshall v. Faneuil, Inc.

 

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

The parties are currently engaged in limited discovery. A court-ordered mediation is scheduled between the parties for November 2020. Faneuil believes this action is without merit and intends to defend this case vigorously. The Company has not accrued any amounts related to the Marshall claim as of September 30, 2020.

 

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The Company has been named in, and from time to time may become named in, various other lawsuits or threatened actions that are incidental to our ordinary business. Litigation is inherently unpredictable. Any claims against the Company, whether meritorious or not, could be time-consuming, cause the Company to incur costs and expenses, require significant amounts of management time and result in the diversion of significant operational resources. The results of these lawsuits and actions cannot be predicted with certainty.  The Company concluded as of September 30, 2020 that the ultimate resolution of these matters (including the matters described above) will not have a material adverse effect on the Company’s business, consolidated financial position, results of operations or cash flows.

Environmental Matters

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

 

10. EQUITY

Common Stock Activity during the Year Ended September 30, 2020

ALJ issued 0.1 million shares of common stock to members of ALJ’s Board of Directors as compensation.  See “Common Stock Awards” below for further discussion.

Common Stock Activity during the Year Ended September 30, 2019

ALJ’s common stock activity for the year ended September 30, 2019 consisted of the following:

Preferred Stock

 

In August 2018, ALJ shareholders approved the amendment and restatement of ALJ’s Restated Certificate of Incorporation to eliminate the preferred stock and authorize the issuance of 5.0 million shares of blank check preferred stock.  ALJ had no preferred stock outstanding at September 30, 2020 or 2019.

Equity Incentive Plans

On July 11, 2016, ALJ shareholders approved ALJ’s Omnibus Equity Incentive Plan (“2016 Plan”), which allows ALJ and its subsidiaries to grant securities of ALJ to officers, employees, directors or consultants.  ALJ believes that equity-based compensation is fundamental to attracting, motivating and retaining highly-qualified dedicated employees who have the skills and experience required to achieve business goals.  Further, ALJ believes the 2016 Plan aligns the compensation of directors, officers, and employees with shareholder interest.  

 

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The 2016 Plan is administered by ALJ’s Compensation, Nominating and Corporate Governance Committee (“Committee”) of the Board.  The maximum aggregate number of common stock shares that may be granted under the 2016 Plan is 2.0 million.  The 2016 Plan generally provides for the grant of qualified or nonqualified stock options, restricted stock and restricted stock units, unrestricted stock, stock appreciation rights, performance awards and other awards.  The Committee has full discretion to set the vesting criteria.  The exercise price of a stock option may not be less than 100% of the fair market value of ALJ’s common stock on the date of grant. The 2016 Plan prohibits the repricing of outstanding stock options without prior shareholder approval. The term of stock options granted under the 2016 Plan may not exceed ten years.  Awards are subject to accelerated vesting upon a change in control in the event the acquiring company does not assume the awards.  The Board may amend, alter, or discontinue the 2016 Plan, but shall obtain shareholder approval of any amendment as required by applicable law or stock exchange listing requirements.  As of September 30, 2019, there were 1.1 million options available for future grant under the 2016 Plan.

Prior to the approval of the 2016 Plan, ALJ issued stock options that were approved by ALJ’s board of directors on a case-by-case basis.  

Stock-Based Compensation Expense  

The following table sets forth the total stock-based compensation expense included in ALJ’s Consolidated Statements of Operations:

 

 

At September 30, 2020, ALJ had approximately $0.1 million of total unrecognized compensation cost related to unvested stock options. This cost is expected to be recognized over a weighted-average period of approximately 1.8 years.

 

Stock Option Activity and Outstanding

The following table summarizes stock option activity during the years ended September 30, 2020 and 2019:

 

 

The following table summarizes all options outstanding and exercisable by price range as of September 30, 2020:

 

 

 

The “intrinsic value” of options is the excess of the value of ALJ stock over the exercise price of such options.  The total intrinsic value of options outstanding (of which all are vested or expected to vest) and the total intrinsic value of options exercisable were less than $0.1 million at September 30, 2020 and 2019. There were no options exercised during the year ended September 30, 2020 or 2019.

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Common Stock Awards

ALJ’s board of directors receive a director compensation package that includes an annual common stock award.  In connection with such awards, ALJ recorded stock-based compensation expense of $0.1 million and $0.3 million during the years ended September 30, 2020 and 2019, respectively.  

Common Stock Options and Warrants Outstanding at September 30, 2020

 

As of September 30, 2020, ALJ had 1.8 million stock options with a weighted average exercise price of $3.09 outstanding, and warrants exercisable to purchase 2.9 million shares of common stock with a weighted average exercise price of $1.11 outstanding.

 

 

11. INCOME TAXES

Loss before income taxes and the provision for income taxes for the years ended September 30, 2020 and 2019 consisted of the following:

 

 

The difference between the statutory federal income tax rate and the effective tax rate for the years ended September 30, 2020 and 2019 was as follows:

 

 

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Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled.  Significant components of the Company’s deferred tax assets and liabilities as of September 30, 2019 and 2018 were as follows:

 

 

The net deferred tax (liabilities) assets are recorded as non-current liabilities at September 30, 2020 and 2019.

Open Tax Returns, Deferred Tax Assets, and Net Operating Loss Carryforward

The Company files income tax returns in the U.S. federal jurisdiction and various states. The years still open to audit under the applicable statutes of limitations are June 30, 2018 through June 30, 2020 for federal tax purposes and June 30, 2017 through June 30, 2020 for state tax purposes.  Tax years ending June 30, 2002 through June 30, 2009 generated a federal net operating loss carryforward and remain subject to examination.  The amount of any tax assessments and penalties may be material and may negatively impact the Company’s operations. Given the uncertainty in the amount and the difficulty in estimating the probability of the assessments arising from future tax examinations, the Company has not made any accruals for such tax contingencies.  The Company recently completed an IRS audit with respect to its June 30, 2017 federal tax return.  The impact was less than a $0.1 million increase to the Company’s federal NOL carryforwards.  No tax returns are currently under examination by any tax authorities.

 

As of September 30, 2020, the Company’s deferred tax assets were primarily the result of U.S. net operating losses (“NOL”) carryforwards.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.  As of each reporting date, the Company’s management considers new evidence, both positive and negative, that could impact management’s assessment with regard to future realization of deferred tax assets.  Based on the assessment, management believes it is more likely than not that certain deferred tax assets will not be fully realized.  As a result, management established a valuation allowance against such deferred tax assets for the amount that will likely not be realized.  

 

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. At September 30, 2020 and 2019, the Company does not have a liability for uncertain tax positions. Additionally, the Company does not anticipate that there will be a material change of unrecognized tax benefits within the next 12 months.

 

At September 30, 2020, the Company has NOL carryforwards for federal income tax purposes of approximately $133.2 million that begin expiring in 2022. In addition, the use of this NOL in future years may be restricted under Section 382 of the IRC if there is a change of ownership.

 

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ALJ’s NOL carryforwards by year of expiration are as follows (in thousands):

 

 

The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted on March 27, 2020.  The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side payroll tax, net operating loss carryback periods, alternative minimum tax credit refunds, and modifications to the net interest deduction limitations.  At September 30, 2020, the Company had deferred payroll taxes of $5.3 million, which was included with other non-current liabilities on the Consolidated Balance Sheet.  

 

H.R. 1 (the “Tax Reform Law”) was enacted on December 22, 2017.  As a result of the Tax Reform Law, ALJ qualified for a $1.8 million alternative minimum tax (“AMT”) refund, of which $0.9 million was recorded as an income tax receivable and $0.9 million was recorded as a deferred tax asset at September 30, 2019.  ALJ received $0.9 million in November 2019.  As of September 30, 2019, ALJ anticipated receiving the remaining $0.9 million AMT refund ratably over the next several years. The CARES Act allowed ALJ to apply for quicker receipt of the remaining $0.9 million AMT refund. As a result, ALJ recorded a $0.9 million income tax receivable at June 30, 2020.  The remaining $0.9 million AMT refund was received in August 2020.

 

 

 

12. RELATED PARTY TRANSACTIONS  

Revenue

Harland Clarke Holdings Corp. (“Harland Clarke”), a stockholder who owns ALJ shares in excess of five percent, had a contract with Faneuil to provide call center services for Harland Clarke’s banking-related products. The contract completed in March 2019. Faneuil did not provide services to Harland Clarke subsequent to such completion date. Faneuil did not recognize any revenue or cost of revenue attributable to Harland Clarke during the year ended September 30, 2020.  Faneuil recognized $0.1 million of revenue for the year ended September 30, 2019. The associated cost of revenue was $0.1 million for the year ended September 30, 2019.  All revenue from Harland Clarke contained similar terms and conditions as those found in other transactions of this nature entered into by Faneuil. Harland Clarke did not owe Faneuil any amounts at September 30, 2020 or 2019.

 

 

13. REPORTABLE SEGMENTS AND GEOGRAPHIC INFORMATION

Reportable Segments

 

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

 

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The following tables present ALJ’s segment information as of or for the years ended September 30, 2020 and 2019:

 

 

 

 

Geographic Information

All assets were located in the United States.  All revenue was earned in the United States.

 

 

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ALJ REGIONAL HOLDINGS, INC.

SCHEDULE II — CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS

(in thousands)

 

 

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