10-Q 1 f10q0320_brileyfinancial.htm QUARTERLY REPORT

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-Q

 

(Mark One)

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

 

For the quarterly period ended March 31, 2020

 

Or

 

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

 

For the transition period from           to           

 

Commission File Number 001-37503

 

 

 

B. RILEY FINANCIAL, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   27-0223495

(State or Other Jurisdiction of

Incorporation or Organization)

  (I.R.S. Employer
Identification No.)
     

21255 Burbank Boulevard, Suite 400

Woodland Hills, CA

 

 

91367

(Address of Principal Executive Offices)   (Zip Code)

 

(818) 884-3737

(Registrant’s telephone number, including area code)

 

 

 

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

 

Title of each class   Trading
Symbol(s)
  Name of each exchange on which registered
Common Stock, par value $0.0001 per share   RILY   Nasdaq Global Market
Depositary Shares, each representing a 1/1000th fractional interest in a share of Series A Cumulative Perpetual Preferred Stock   RILYP   Nasdaq Global Market
7.25% Senior Notes due 2027   RILYG   Nasdaq Global Market
7.50% Senior Notes due 2027   RILYZ   Nasdaq Global Market
6.50% Senior Notes due 2026   RILYN   Nasdaq Global Market
6.375% Senior Notes due 2025   RILYM   Nasdaq Global Market
6.75% Senior Notes due 2024   RILYO   Nasdaq Global Market
7.375% Senior Notes due 2023   RILYH   Nasdaq Global Market
6.875% Senior Notes due 2023   RILYI   Nasdaq Global Market

 

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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one)

 

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

 

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

 

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

 

As of May 8, 2020, there were 25,827,322 shares of the registrant’s common stock, par value $0.0001 per share, outstanding.

 

 

 

 

 

 

B. Riley Financial, Inc.

Quarterly Report on Form 10-Q

For the Quarterly Period Ended March 31, 2020 

Table of Contents

 

    Page
     
PART I. FINANCIAL INFORMATION 1
Item 1. Financial Statements 1
  Condensed Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019 1
  Condensed Consolidated Statements of Operations for the three months ended March 31, 2020 and 2019 2
 

Condensed Consolidated Statements of Comprehensive (Loss) Income for the three months ended March 31, 2020 and 2019

3
  Condensed Consolidated Statements of Equity for the three months ended March 31, 2020 and 2019 4
  Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019 5
  Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 30
Item 3. Quantitative and Qualitative Disclosures About Market Risk 41
Item 4. Controls and Procedures 42
PART II. OTHER INFORMATION 43
Item 1. Legal Proceedings 43
Item 1A. Risk Factors 43
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 83
Item 3. Defaults Upon Senior Securities 83
Item 4. Mine Safety Disclosures 83
Item 5. Other Information 83
Item 6. Exhibits 83
SIGNATURES 85

 

i

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

B. RILEY FINANCIAL, INC.

Condensed Consolidated Balance Sheets

(Dollars in thousands, except par value)

 

   March 31,   December 31, 
   2020   2019 
   (Unaudited)     
Assets        
Assets:        
Cash and cash equivalents  $124,231   $104,268 
Restricted cash   471    471 
Due from clearing brokers   10,879    23,818 
Securities and other investments owned, at fair value   287,786    408,213 
Securities borrowed   674,163    814,331 
Accounts receivable, net   46,450    46,624 
Due from related parties   4,391    5,832 
Advances against customer contracts   11,121    27,347 
Loans receivable, at fair value (includes $216,302 from related parties at March 31, 2020)   326,299    43,338 
Loans receivable, at cost (includes $157,080 from related parties at December 31, 2019)       225,848 
Prepaid expenses and other assets   114,686    81,808 
Operating lease right-of-use assets   46,213    47,809 
Property and equipment, net   12,223    12,727 
Goodwill   223,697    223,697 
Other intangible assets, net   212,500    220,525 
Deferred income taxes   35,786    31,522 
Total assets  $2,130,896   $2,318,178 
Liabilities and Equity          
Liabilities:          
Accounts payable  $6,858   $4,477 
Accrued expenses and other liabilities   103,452    130,714 
Deferred revenue   73,709    67,121 
Due to related parties and partners   1,061    1,750 
Due to clearing brokers   5,126     
Securities sold not yet purchased   14,298    41,820 
Securities loaned   670,859    810,495 
Mandatorily redeemable noncontrolling interests   4,508    4,616 
Operating lease liabilities   59,430    61,511 
Notes payable   714    38,167 
Loan participations sold   12,405    12,478 
Term loan   61,932    66,666 
Senior notes payable   853,523    688,112 
Total liabilities   1,867,875    1,927,927 
           
Commitments and contingencies (Note 14)          
B. Riley Financial, Inc. stockholders’ equity:          
Preferred stock, $0.0001 par value; 1,000,000 shares authorized; 2,531 and 2,349 issued and outstanding as of March 31, 2020 and December 31, 2019, respectively; liquidation preference of $63,273 and $58,723 as of March 31, 2020 and December 31, 2019, respectively.        
Common stock, $0.0001 par value; 100,000,000 shares authorized; 25,988,565 and 26,972,332 issued and outstanding as of March 31, 2020 and December 31, 2019, respectively.   3    3 
Additional paid-in capital   308,472    323,109 
(Accumulated deficit) retained earnings   (70,232)   39,536 
Accumulated other comprehensive loss   (3,208)   (1,988)
Total B. Riley Financial, Inc. stockholders’ equity   235,035    360,660 
Noncontrolling interests   27,986    29,591 
Total equity   263,021    390,251 
Total liabilities and equity  $2,130,896   $2,318,178 

 

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

 

1

 

 

B. RILEY FINANCIAL, INC.

Condensed Consolidated Statements of Operations

(Unaudited)

(Dollars in thousands, except share data)

 

   Three Months Ended 
   March 31, 
   2020   2019 
Revenues:        
Services and fees  $159,381   $103,896 
Trading (losses) income and fair value adjustments on loans   (182,442)   25,867 
Interest income - Loans and securities lending   21,851    11,420 
Sale of goods   1,004    945 
Total revenues   (206)   142,128 
Operating expenses:          
Direct cost of services   19,952    14,116 
Cost of goods sold   769    1,119 
Selling, general and administrative expenses   

87,744

    94,964 
Restructuring charge       147 
Impairment of tradenames   4,000     
Interest expense - Securities lending and loan participations sold   8,473    6,804 
Total operating expenses   120,938    117,150 
Operating (loss) income   (121,144)   24,978 
Other income (expense):          
Interest income   246    637 
Loss from equity investments   (236)   (3,762)
Interest expense   (15,654)   (10,770)
(Loss) income before income taxes   (136,788)   11,083 
Benefit (provision) for income taxes   37,539    (3,104)
Net (loss) income   (99,249)   7,979 
Net loss attributable to noncontrolling interests   (584)   (44)
Net (loss) income attributable to B. Riley Financial, Inc.  $(98,665)  $8,023 
Preferred stock dividends   1,055     
Net (loss) income available to common shareholders  $(99,720)  $8,023 
           
Basic (loss) income per common share  $(3.83)  $0.31 
Diluted (loss) income per common share  $(3.83)  $0.30 
           
Weighted average basic common shares outstanding   26,028,613    26,217,215 
Weighted average diluted common shares outstanding   26,028,613    26,687,531 

 

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

 

2

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive (Loss) Income

(Unaudited)

(Dollars in thousands)

 

   Three Months Ended 
   March 31, 
   2020   2019 
Net (loss) income  $(99,249)  $7,979 
Other comprehensive (loss) income:          
Change in cumulative translation adjustment   (1,220)   170 
Other comprehensive (loss) income, net of tax   (1,220)   170 
Total comprehensive (loss) income   (100,469)   8,149 
Comprehensive (loss) income attributable to noncontrolling interests   (584)   (44)
Comprehensive (loss) income attributable to B. Riley Financial, Inc.  $(99,885)  $8,193 

 

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

 

3

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Equity

(Unaudited)

(Dollars in thousands, except share data)

 

                   Accumulated         
                   Additional       Other         
   Preferred Stock   Common Stock   Paid-in   Retained   Comprehensive   Noncontrolling   Total 
   Shares   Amount   Shares   Amount   Capital   Earnings  

Loss

   Interests   Equity 
Balance, January 1, 2020   2,349   $    26,972,332   $3   $323,109   $39,536   $(1,988)  $29,591   $390,251 
Preferred stock issued   182                4,630                4,630 
Vesting of restricted stock, net of shares withheld for employer taxes           38,298        (520)               (520)
Common stock repurchased and retired           (1,022,065)       (24,068)               (24,068)
Share based payments                   5,321                5,321 
Dividends on common stock ($0.35 per share)                       (10,048)           (10,048)
Dividends on preferred stock ($429.69 per share)                       (1,055)           (1,055)
Net loss                       (98,665)       (584)   (99,249)
Distributions to noncontrolling interests                               (1,021)   (1,021)
Other comprehensive loss                           (1,220)       (1,220)
Balance, March 31, 2020   2,531   $    25,988,565   $3   $308,472   $(70,232)  $(3,208)  $27,986   $263,021 
                                              
Balance, January 1, 2019      $    26,603,355   $2   $258,638   $1,579   $(2,161)  $602   $258,660 
Vesting of restricted stock, net of shares withheld for employer taxes           78,911        (714)               (714)
Common stock repurchased and retired           (157,050)       (2,650)               (2,650)
Share based payments                   2,614                2,614 
Dividends on common stock ($0.08 per share)                       (2,134)           (2,134)
Net income                       8,023        (44)   7,979 
Other comprehensive income                           170        170 
Balance, March 31, 2019      $    26,525,216   $2   $257,888   $7,468   $(1,991)  $558   $263,925 

 

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

 

4

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

 

   Three Months Ended
March 31,
 
   2020   2019 
Cash flows from operating activities:        
Net (loss) income  $(99,249)  $7,979 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   4,956    4,913 
Provision for doubtful accounts   724    233 
Share-based compensation   5,322    2,614 
Fair value adjustments, non-cash   17,926    49 
Non-cash interest and other   (2,827)   736 
Effect of foreign currency on operations   179    130 
Loss from equity investments   236    3,762 
Deferred income taxes   (4,254)   (390)
Impairment of intangibles and loss on disposal of fixed assets   4,046    88 
Gain on extinguishment of debt   (1,556)    
Income allocated for mandatorily redeemable noncontrolling interests   175    169 
Change in operating assets and liabilities:          
Due from clearing brokers   12,939    15,320 
Securities and other investments owned   125,061    (15,274)
Securities borrowed   140,168    104,104 
Accounts receivable and advances against customer contracts   15,674    (2,845)
Prepaid expenses and other assets   (37,151)   (3,706)
Accounts payable, accrued expenses and other liabilities   (22,097)   (1,251)
Amounts due to/from related parties and partners   752    (1,236)
Securities sold, not yet purchased   (27,522)   (1,675)
Deferred revenue   6,589    893 
Securities loaned   (139,636)   (105,689)
Net cash provided by operating activities   455    8,924 
Cash flows from investing activities:          
Purchases of loans receivable   (115,328)   (20,154)
Repayments of loans receivable   42,128    5,500 
Sale of loan receivable to related party   1,800     
Repayment of loan participations sold   (244)    
Purchases of property, equipment and other   (438)   (1,746)
Proceeds from sale of property, equipment and intangible assets   1    12 
Purchase of equity investments       (10,558)
Dividends and distributions from equity investments   589    433 
Net cash used in investing activities   (71,492)   (26,513)
Cash flows from financing activities:          
Repayment of asset based credit facility   (37,096)    
Repayment of notes payable   (357)   (357)
Proceeds from term loan       10,000 
Repayment of term loan   (4,810)    
Proceeds from issuance of senior notes   171,078    4,987 
Redemption of senior notes   (1,829)    
Payment of debt issuance costs   (2,724)   (145)
Payment of employment taxes on vesting of restricted stock   (505)   (714)
Common dividends paid   (9,609)   (2,606)
Preferred dividends paid   (1,055)    
Repurchase of common stock   (24,068)   (2,650)
Distribution to noncontrolling interests   (1,323)   (274)
Proceeds from issuance of preferred stock   4,630     
Net cash provided by financing activities   92,332    8,241 
Increase (decrease) in cash, cash equivalents and restricted cash   21,295    (9,348)
Effect of foreign currency on cash, cash equivalents and restricted cash   (1,332)   23 
Net increase (decrease) in cash, cash equivalents and restricted cash   19,963    (9,325)
Cash, cash equivalents and restricted cash, beginning of period   104,739    180,278 
Cash, cash equivalents and restricted cash, end of period  $124,702   $170,953 
           
Supplemental disclosures:          
Interest paid  $21,785   $17,435 
Taxes paid  $574   $192 

 

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

 

5

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except share data)

 

NOTE 1—ORGANIZATION AND NATURE OF BUSINESS OPERATIONS

 

B. Riley Financial, Inc. and its subsidiaries (collectively, the “Company”) provide investment banking and financial services to corporate, institutional and high net worth clients, and asset disposition, valuation and appraisal and capital advisory services to a wide range of retail, wholesale and industrial clients, as well as lenders, capital providers, private equity investors and professional services firms throughout the United States, Australia, Canada, and Europe and with the acquisitions of United Online, Inc. (“UOL” or “United Online”) on July 1, 2016 and magicJack VocalTec Ltd. (“magicJack”) on November 14, 2018, provide consumer Internet access and cloud communication services. The Company acquired a majority ownership interest in BR Brand Holding, LLC on October 28, 2019, which provides licensing of trademarks. 

 

The Company operates in five operating segments: (i) Capital Markets, through which the Company provides investment banking, corporate finance, securities lending, restructuring, consulting, research, sales and trading and wealth management services to corporate, institutional and high net worth clients; (ii) Auction and Liquidation, through which the Company provides auction and liquidation services to help clients dispose of assets that include multi-location retail inventory, wholesale inventory, trade fixtures, machinery and equipment, intellectual property and real property; (iii) Valuation and Appraisal, through which the Company provides valuation and appraisal services to clients with independent appraisals in connection with asset based loans, acquisitions, divestitures and other business needs; (iv) Principal Investments - United Online and magicJack, through which the Company provides consumer Internet access and related subscription services from United Online and cloud communication services primarily through the magicJack devices; and (v) Brands, which is focused on generating revenue through the licensing of trademarks.

 

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

(a) Principles of Consolidation and Basis of Presentation

 

The condensed consolidated financial statements include the accounts of B. Riley Financial, Inc. and its wholly-owned and majority-owned subsidiaries. The condensed consolidated financial statements also include the accounts of (a) Great American Global Partners, LLC which is controlled by the Company as a result of its ownership of a 50% member interest, appointment of two of the three executive officers and significant influence over the funding of operations, and (b) GA Retail Investments, L.P. which is controlled by the Company as a result of its ownership of a 50% partnership interest, appointment of executive officers and significant influence over the operations. The condensed consolidated financial statements have been prepared by the Company, without audit, pursuant to interim financial reporting guidelines and the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company’s management, all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the periods presented have been included. These condensed consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 10, 2020. The results of operations for the three months ended March 31, 2020 are not necessarily indicative of the operating results to be expected for the full fiscal year or any future periods.

 

(b) Use of Estimates

 

The preparation of the condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and reported amounts of revenue and expense during the reporting period. Estimates are used when accounting for certain items such as valuation of securities and loan receivables, allowance for doubtful accounts, the fair value of intangible assets and goodwill, the fair value of mandatorily redeemable noncontrolling interests, fair value of share based arrangements, accounting for income tax valuation allowances, recovery of contract assets and sales returns and allowances. Estimates are based on historical experience, where applicable, and assumptions that management believes are reasonable under the circumstances. Due to the inherent uncertainty involved with estimates, actual results may differ.

 

On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus (the “COVID-19 outbreak”). In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. The full impact of the COVID-19 outbreak continues to evolve. The impact of the COVID-19 outbreak on the Company’s results of operations, financial position and cash flows will depend on future developments, including the duration and spread of the outbreak and related advisories and restrictions. These developments and the impact of the COVID-19 outbreak on the financial markets and the overall economy are highly uncertain and cannot be predicted. If the financial markets and/or the overall economy are impacted for an extended period, the Company’s results of operations, financial position and cash flows may be materially adversely affected.

 

6

 

 

(c) Interest Expense — Securities Lending Activities and Loan Participations Sold

 

Interest expense from securities lending activities is included in operating expenses related to operations in the Capital Markets segment. Interest expense from securities lending activities is incurred from equity and fixed income securities that are loaned to the Company and totaled $7,921 and $6,804 for the three months ended March 31, 2020 and 2019, respectively. Loan participations sold as of March 31, 3020 totaled $12,405. Interest expense from loan participations sold totaled $552 for the three months ended March 31, 2020.

 

(d) Concentration of Risk

 

Revenues in the Capital Markets, Valuation and Appraisal and Principal Investments — United Online and magicJack segments are currently primarily generated in the United States. Revenues in the Auction and Liquidation segment are primarily generated in the United States, Australia, Canada and Europe. Revenues in the Brands segment are primarily generated in the United States and Canada.

 

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

 

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

 

(e) Advertising Expenses

 

The Company expenses advertising costs, which consist primarily of costs for printed materials, as incurred. Advertising costs totaled $841 and $362 for the three months ended March 31, 2020 and 2019, respectively. Advertising expense is included as a component of selling, general and administrative expenses in the accompanying condensed consolidated statements of operations.

 

(f) Share-Based Compensation

 

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

 

In June 2018, the Company adopted the 2018 Employee Stock Purchase Plan (“Purchase Plan”) which allows eligible employees to purchase common stock through payroll deductions at a price that is 85% of the market value of the common stock on the last day of the offering period. In accordance with the provisions of ASC 718, Compensation — Stock Compensation (“ASC 718”), the Company is required to recognize compensation expense relating to shares offered under the Purchase Plan.

 

(g) Income Taxes

 

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

 

7

 

 

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

 

(h) Cash and Cash Equivalents

 

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

 

(i) Restricted Cash

 

As of March 31, 2020 and December 31, 2019, restricted cash balance of $471 related to one of the Company’s telecommunication suppliers.

 

(j) Securities Borrowed and Securities Loaned

 

Securities borrowed and securities loaned are recorded based upon the amount of cash advanced or received. Securities borrowed transactions facilitate the settlement process and require the Company to deposit cash or other collateral with the lender. With respect to securities loaned, the Company receives collateral in the form of cash. The amount of collateral required to be deposited for securities borrowed, or received for securities loaned, is an amount generally in excess of the market value of the applicable securities borrowed or loaned. The Company monitors the market value of the securities borrowed and loaned on a daily basis, with additional collateral obtained, or excess collateral recalled, when deemed appropriate.

 

The Company accounts for securities lending transactions in accordance with ASC “Topic 210: Balance Sheet,” which requires companies to report disclosures of offsetting assets and liabilities. The Company does not net securities borrowed and securities loaned and these items are presented on a gross basis in the condensed consolidated balance sheets.

 

(k) Property and Equipment

 

Property and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. Property and equipment held under finance leases are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset. Depreciation and amortization expense on property and equipment was $932 and $1,536 for the three months ended March 31, 2020 and 2019, respectively.

 

(l) Loans Receivable

 

Loans receivable, at fair value are loans held for investment that are accounted for at fair value under the fair value option. The Company adopted ASU 2016-13 and its amendment ASU 2019-05 effective January 1, 2020. Pursuant to ASU 2016-13 and its amendment ASU 2019-05, the Company elected the irrevocable fair value option for all outstanding loans receivable that were measured at amortized cost as of December 31, 2019. As of March 31, 2020 and December 31, 2019, loans receivable, at fair value totaled $326,299 and $43,338, respectively, with various maturities through December 2024. As of March 31, 2020 and December 31, 2019, loans receivable, at fair value had principal balances totaling $339,630 and $32,691, respectively, with cost basis, net of unamortized costs, origination fees, premiums and discounts, totaling $333,466 and $32,578, respectively. During the three months ended March 31, 2020, the Company recorded unrealized losses of $17,926 on the loans receivable, at fair value, which is included in trading (losses) income and fair value adjustments on loans on the condensed consolidated statement of operations.

 

Loans receivable, at cost are measured at historical cost and reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans, and for purchased loans, net of any unamortized premiums or discounts. As of December 31, 2019, loans receivable at cost had a carrying value of $225,848.

 

Interest income on loans receivable is recognized based on the stated rate of the loan and the unpaid principal balance plus the amortization of any costs, origination fees, premiums and discounts and is included in interest income - loans and securities lending on the condensed consolidated statement of operations. Loan origination fees and certain direct origination costs are deferred and recognized as adjustments to interest income over the lives of the related loans. Unearned income, discounts and premiums are amortized to interest income using a level yield methodology.

 

8

 

 

(m) Securities and Other Investments Owned and Securities Sold Not Yet Purchased

 

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

 

As of March 31, 2020 and December 31, 2019, the Company’s securities and other investments owned and securities sold not yet purchased at fair value consisted of the following securities:

 

   March 31,   December 31, 
   2020   2019 
Securities and other investments owned:        
Equity securities  $234,867   $353,162 
Corporate bonds   18,429    19,020 
Other fixed income securities   5,243    8,414 
Partnership interests and other   29,247    27,617 
   $287,786   $408,213 
           
Securities sold not yet purchased:          
Equity securities  $124   $5,360 
Corporate bonds   13,361    33,436 
Other fixed income securities   813    3,024 
   $14,298   $41,820 

 

(n) Fair Value Measurements

 

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

 

The Company’s securities and other investments owned and securities sold and not yet purchased are comprised of common and preferred stocks and warrants, corporate bonds, and investments in partnerships. Investments in common stocks that are based on quoted prices in active markets are included in Level 1 of the fair value hierarchy. The Company also holds loans receivable valued at fair value, nonpublic common and preferred stocks and warrants for which there is little or no public market and fair value is determined by management on a consistent basis. For investments where little or no public market exists, management’s determination of fair value is based on the best available information which may incorporate management’s own assumptions and involves a significant degree of judgment, taking into consideration various factors including earnings history, financial condition, recent sales prices of the issuer’s securities and liquidity risks. These investments are included in Level 3 of the fair value hierarchy. Investments in partnership interests include investments in private equity partnerships that primarily invest in equity securities, bonds, and direct lending funds. The Company also invests in priority investment funds and the underlying securities held by these funds are primarily corporate and asset-backed fixed income securities and restrictions exist on the redemption of amounts invested by the Company. The Company’s partnership and investment fund interests are valued based on the Company’s proportionate share of the net assets of the partnerships and funds; the value for these investments are derived from the most recent statements received from the general partner or fund administrator. These partnership and investment fund interests are valued at net asset value (“NAV”) in accordance with ASC “Topic 820: Fair Value Measurements.”

 

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

 

9

 

 

The following tables present information on the financial assets and liabilities measured and recorded at fair value on a recurring basis as of March 31, 2020 and December 31, 2019.

 

   Financial Assets and Liabilities Measured at Fair Value 
   on a Recurring Basis at March 31, 2020 Using 
       Quoted prices        
   Fair value at   in active markets for identical   Other observable   Significant unobservable 
   March 31,   assets   inputs   inputs 
   2020   (Level 1)   (Level 2)   (Level 3) 
Assets:                
Securities and other investments owned:                
Equity securities  $234,867   $139,751   $   $95,116 
Corporate bonds   18,429        18,429     
Other fixed income securities   5,243        5,243     
Investment funds valued at net asset value(1)   29,247                
Total securities and other investments owned   287,786    139,751    23,672    95,116 
Loans receivable, at fair value   326,299            326,299 
Total assets measured at fair value  $614,085   $139,751   $23,672   $421,415 
                     
Liabilities:                    
Securities sold not yet purchased:                    
Equity securities  $124   $124   $   $ 
Corporate bonds   13,361        13,361     
Other fixed income securities   813        813     
Total securities sold not yet purchased   14,298    124    14,174     
Mandatorily redeemable noncontrolling interests issued after November 5, 2003   4,508            4,508 
Total liabilities measured at fair value  $18,806   $124   $14,174   $4,508 

 

   Financial Assets and Liabilities Measured at Fair Value 
   on a Recurring Basis at December 31, 2019 Using 
       Quoted prices        
      in active markets for   Other   Significant 
   Fair value at December 31   identical
assets
   observable inputs   unobservable inputs 
   2019   (Level 1)   (Level 2)   (Level 3) 
Assets:                
Securities and other investments owned:                
Equity securities  $353,162   $243,911   $   $109,251 
Corporate bonds   19,020        19,020     
Other fixed income securities   8,414        8,414     
Investment funds valued at net asset value(1)   27,617                
Total securities and other investments owned   408,213    243,911    27,434    109,251 
Loans receivable, at fair value   43,338            43,338 
Total assets measured at fair value  $451,551   $243,911   $27,434   $152,589 
                     
Liabilities:                    
Securities sold not yet purchased:                    
Equity securities  $5,360   $5,360   $   $ 
Corporate bonds   33,436        33,436     
Other fixed income securities   3,024        3,024     
Total securities sold not yet purchased   41,820    5,360    36,460     
                     
Mandatorily redeemable noncontrolling interests issued after November 5, 2003   4,616            4,616 
Total liabilities measured at fair value  $46,436   $5,360   $36,460   $4,616 

 

(1)Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy in accordance with ASC “Topic 820 Fair Value Measurements.” The fair value amounts presented in the tables above for investment funds valued at net asset value are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the condensed consolidated balance sheets.

 

10

 

 

As of March 31, 2020 and December 31, 2019, financial assets measured and reported at fair value on a recurring basis and classified within Level 3 were $421,415 and $152,589, respectively, or 19.8% and 6.6%, respectively, of the Company’s total assets. In determining the fair value for these Level 3 financial assets, the Company analyzes various financial, performance and market factors to estimate the value, including where applicable, over-the-counter market trading activity.

 

The following table summarizes the significant unobservable inputs in the fair value measurement of level 3 financial assets and liabilities by category of investment and valuation technique as of March 31, 2020:

 

    Fair value at                  
    March 31,                 Weighted
    2020     Valuation Technique   Unobservable Input   Range   Average
Assets:                      
Equity securities   $ 95,116     Market approach   Multiple of revenue   2.2x - 4.9x   3.7x
                Multiple of EBITDA   6.0x - 10.0x   6.6x
                Multiple of PV-10   0.28x   0.28x
                Market price of related security   $0.63 - $1.02/share   $0.68
            Discounted cash flow   Market interest rate   33.1%   33.1%
            Option pricing model   Annualized volatility   100.0%   100%
Loans receivable at fair value     326,299     Discounted cash flow   Market interest rate   9.9% -30.4%   17.0%
            Market approach   Market price of related security   $0.63 - $0.77/share   $0.65
Total level 3 assets measured at fair value   $ 421,415                  
                         
Liabilities:                        
Mandatorily redeemable noncontrolling interests issued after November 5, 2003   $ 4,508     Market approach   Operating income multiple   6.0x   6.0x

  

The changes in Level 3 fair value hierarchy during the three months ended March 31, 2020 and 2019 are as follows:

 

   Level 3   Level 3 Changes During the Period   Level 3 
   Balance at   Fair   Relating to   Purchases,   Transfer in   Balance at 
   Beginning of   Value   Undistributed   Sales and   and/or out   End of 
   Year   Adjustments   Earnings   Settlements   of Level 3   Period 
Three Months Ended March 31, 2020                        
Equity securities  $109,251   $(15,135)  $   $1,000   $   $95,116 
Loans receivable at fair value   43,338    (17,926)   1,289    73,750    225,848    326,299 
Mandatorily redeemable noncontrolling interests issued after November 5, 2003   4,616        (108)           4,508 
Three Months Ended March 31, 2019                              
Equity securities  $24,577   $(18)  $   $(45)  $   $24,514 
Corporate bonds                   1,330    1,330 
Loans receivable at fair value   33,731    35    475    (200)       34,041 
Mandatorily redeemable noncontrolling interests issued after November 5, 2003   4,633        (104)           4,529 

 

The Company adopted ASU 2016-13 and its amendment ASU 2019-05 effective January 1, 2020. Pursuant to ASU 2016-13 and its amendment ASU 2019-05, the Company elected the irrevocable fair value option for all outstanding loans receivable that were measured at amortized cost as of December 31, 2019. The loans receivable, at fair value are included in transfers into level 3 fair value assets in the above table. During the three months ended March 31, 2019, there was a transfer of one financial asset from level 1 to level 3 in the fair value hierarchy as a result of the asset’s principal market becoming inactive during the quarter.

 

The amount reported in the table above for the three months ended March 31, 2020 and 2019 includes the amount of undistributed earnings attributable to the noncontrolling interests that is distributed on a quarterly basis. The carrying amounts reported in the condensed consolidated financial statements for cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued expenses and other liabilities approximate fair value based on the short-term maturity of these instruments.

 

As of March 31, 2020, the senior notes payable had a carrying amount of $853,523 and fair value of $666,428. The carrying amount of the term loan approximates fair value because the effective yield of such instrument is consistent with current market rates of interest for instruments of comparable credit risk.

 

During the three months ended March 31, 2020 and 2019, except for the impact of the intangible impairment charge as described in Note 7- Goodwill and Intangible Assets, there were no assets or liabilities measured at fair value on a non-recurring basis. The fair value of the indefinite-lived intangible assets was determined based on a discounted cash flow model using a rate of 14.0%.  The indefinite-lived intangible assets are level 3 assets in the fair value hierarchy.

 

11

 

 

(o) Foreign Currency Translation

 

The Company transacts business in various foreign currencies. In countries where the functional currency of the underlying operations has been determined to be the local country’s currency, revenues and expenses of operations outside the United States are translated into United States dollars using average exchange rates while assets and liabilities of operations outside the United States are translated into United States dollars using period-end exchange rates. The effects of foreign currency translation adjustments are included in stockholders’ equity as a component of accumulated other comprehensive loss in the accompanying condensed consolidated balance sheets. Transaction gains (loss) were $949 and ($186) during the three months ended March 31, 2020 and 2019, respectively. These amounts are included in selling, general and administrative expenses in the Company’s condensed consolidated statements of operations.

 

(p) Common Stock Warrants

 

The Company issued 821,816 warrants to purchase common stock of the Company (the “Wunderlich Warrants”) in connection with the acquisition of Wunderlich Securities, Inc. (“Wunderlich”) on July 3, 2017. The Wunderlich Warrants entitle the holders of the warrants to acquire shares of the Company’s common stock from the Company at an exercise price of $17.50 per share, subject to, among other matters, the proper completion of an exercise notice and payment. The exercise price and the number of shares of Company common stock issuable upon exercise are subject to customary anti-dilution and adjustment provisions, which include stock splits, subdivisions or reclassifications of the Company’s common stock. The Wunderlich Warrants expire on July 3, 2022. On May 16, 2019, the Company repurchased 638,311 warrants for $2,777 ($4.35 per warrant). As of March 31, 2020, Wunderlich Warrants to purchase 183,505 shares of common stock were outstanding.

 

On October 28, 2019, the Company issued 200,000 warrants to purchase common stock of the Company (the “BR Brands Warrants”) in connection with the acquisition of a majority ownership interest in BR Brand Holdings LLC (“BR Brand”). The BR Brand Warrants entitle the holders of the warrants to acquire shares of the Company’s common stock from the Company at an exercise price of $26.24 per share. One-third of the BR Brand Warrants immediately vested and became exercisable upon issuance, and the remaining two-thirds of warrants will vest and become exercisable following the first and/or second anniversaries of the closing, subject to BR Brand’s (or another related joint venture with Bluestar Alliance LLC) satisfaction of specified financial performance targets. The BR Brand warrants expire three years after the last vesting event occurs.

 

   Exercise   Expiration  Issued and Outstanding Warrants as of Beginning   Warrants   Warrants   Issued and Outstanding Warrants as of End of 
   Price   Date  of Period   Issued   Repurchased   Period 
                        
For the year ended December 31, 2019                       
Wunderlich Warrants  $17.50   July 3, 2022   821,816        (638,311)   183,505 
BR Brand Warrants  $26.24   October 28, 2024       200,000        200,000 
Total           821,816    200,000    (638,311)   383,505 
                             
For the three months ended March 31, 2020                            
Wunderlich Warrants  $17.50   July 3, 2022   183,505            183,505 
BR Brand Warrants  $26.24   October 28, 2024   200,000            200,000 
Total           383,505            383,505 

 

(q) Equity Investment

 

bebe stores, inc.

 

At March 31, 2020, the Company had a 30.5% ownership interest in bebe stores, inc. (“bebe”). The equity ownership in bebe is accounted for under the equity method of accounting and is included in prepaid expenses and other assets in the condensed consolidated balance sheets.

 

National Holdings Corporation

 

On November 14, 2018, the Company entered into an agreement to acquire shares of National Holdings Corporation (“National Holdings”), a Nasdaq-listed issuer, from Fortress Biotech, Inc. for an aggregate purchase price totaling approximately $22.9 million. The transaction was completed in two tranches. In the first tranche, which was completed in the fourth quarter of 2018, the Company acquired shares representing 24% of the total outstanding shares of National Holdings. The second tranche was completed in the first quarter of 2019. As of March 31, 2020, the Company had purchased 6,159,550 shares of National Holdings’ common stock, representing 46.8% of National Holdings’ outstanding shares, at $3.25 per share. The carrying value for the National Holdings investment is included in prepaid expenses and other assets in the condensed consolidated balance sheets. The equity ownership in National Holdings is accounted for under the equity method of accounting.

 

12

 

 

As of March 31, 2020, the carrying values of the Company’s investments in bebe and National Holdings exceeded their fair values based on their quoted market prices. In light of these facts, the Company evaluated its investments in bebe and National Holdings for impairment. The Company utilized no bright- line tests in such evaluations. Based on the available facts and information regarding the operating results of both entities, the Company’s ability and intent to hold the investments until recovery, the relative amount of the declines, and the length of time that the fair values were less than the carrying values, the Company concluded that recognition of impairment losses in earnings was not required. However, the Company will continue to monitor these investments and it is possible that impairment losses will be recorded in earnings in future periods based on changes in facts and circumstances or intentions.

 

(r) Loan Participations Sold

 

As of March 31, 2020, the Company has sold investments (“Loan Participations Sold”) to third parties (“Participants”) that are accounted for as secured borrowings under ASC Topic 860, Transfers and Servicing. Under ASC Topic 860, a partial loan transfer does not qualify for sale accounting in order for sale treatment to be allowed. A participation or other partial loan transfer that meets the definition of a participating interest is classified as loan receivable and the portion transferred is recorded as a secured borrowing under loan participations sold in the condensed consolidated balance sheet. The Participants are entitled to payments made by the borrower of the related loan equal to the current Loan Participations Sold outstanding at the interest rates for the respective investment. In the event that the borrower defaults, the Participants have rights to payments from such borrower, but do not have recourse to the Company. The terms of the Loan Participations Sold are commensurate with the terms of the related loan.

 

As of March 31, 2020, the Company had entered into participation agreements for a total of $12,405. In addition, the interest income and interest expense related to the Loan Participations Sold resulted in interest income and interest expense which is presented gross on the condensed consolidated statement of operations.

 

(s) Supplemental Non-cash Disclosures

 

During the three months ended March 31, 2020, non-cash investing activities included $4,633 non-cash conversion of an equity method investment.

 

(t) Reclassifications

 

As of December 31, 2019, loans receivable recorded at fair value of $43,338 were previously included in securities and other investments owned, at fair value. These loans receivable amounts have been reclassified and reported in loans receivable, at fair value to conform to the 2020 presentation. During the three months ended March 31, 2019, trading income and fair value adjustments on loans of $25,867 was previously included in services and fees income in the capital markets segment. These trading income and fair value adjustments on loans amounts have been reclassified and reported in trading (loss) income and fair value adjustments on loans to conform to the 2020 presentation. During the three months ended March 31, 2019, interest income earned on loans of $2,090 was previously included in services and fees income in the capital markets segment. These interest income amounts have been reclassified and reported in interest income – loans and securities lending to conform to the 2020 presentation. During the three months ended March 31, 2019, expenses of $4,421, were previously included in direct cost of services in the valuation and appraisal segment. These expenses have been reclassified and reported in selling, general and administrative expenses to conform to the 2020 presentation.

 

(u) Variable Interest Entity

 

In 2018, the operations of GACP II, LP, a private debt investment limited partnership (the “Partnership”) commenced operations. The Company’s investment in the Partnership is a variable interest entity (“VIE”) since the unaffiliated limited partners do not have substantive kick- out or participating rights to remove the Company’s subsidiary that is the general partner managing the Partnership. The Company has determined that it is not the primary beneficiary due to the fact that its fee arrangements are considered at-market and thus not deemed to be variable interests, and it does not hold any other interests in the Partnership that are considered to be more than insignificant. The Company determines whether it is the primary beneficiary of a VIE at the time it becomes involved with a VIE and reconsiders that conclusion at each reporting date. In evaluating whether the Company is the primary beneficiary, the Company evaluates its economic interests in the entity held either directly by the Company or indirectly through related parties. The consolidation analysis can generally be performed qualitatively; however, if it is not readily apparent that the Company is not the primary beneficiary, a quantitative analysis may also be performed.

 

The carrying value of the Company’s investments in the VIE that was not consolidated is shown below.

 

   March 31, 2020 
Partnership investments  $14,751 
Due from related party   14 
Maximum exposure to loss  $14,765 

 

13

 

 

(v) Recent Accounting Standards

 

Recently adopted

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments − Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASC 326”). This standard requires an allowance to be recorded for all expected credit losses for certain financial assets. The new standard introduces an approach, based on expected losses, to estimate credit losses on certain types of financial instruments. In May 2019, the FASB issued ASU No. 2019-05, Financial Instruments − Credit Losses (Topic 326); Targeted Transition Relief,” which allows entities to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. ASU 2016-13 and ASU 2019-05 are effective for public companies for interim and annual period beginning December 15, 2019.

 

The Company adopted the new credit losses standard effective January 1, 2020. Pursuant to ASU 2016-13 and its amendment ASU 2019-05, the Company elected the irrevocable fair value option for all outstanding loans receivable that were previously measured at amortized cost. Under the fair value option, loans receivable are now measured at each reporting period based upon their exit value in an orderly transaction and unrealized gains or losses from changes in fair value are recorded in the consolidated statements of operations. These loans are no longer subject to evaluation for impairment through an allowance for loan loss as such losses will be captured through fair value changes. The impact of adopting ASC 326 was immaterial to the consolidated financial statements. 

 

NOTE 3—ACQUISITIONS

 

Membership Interest Purchase Agreement with BR Brand Acquisition LLC

 

On October 11, 2019, the Company and B. Riley Brand Management LLC, an indirect wholly-owned subsidiary of the Company (the “B. Riley Member”), entered into a Membership Interest Purchase Agreement (the “MIPA”) with BR Brand Acquisition LLC (the “BR Brand Member”) and BR Brand, pursuant to which the B. Riley Member acquired a majority of the equity interest in BR Brand. The closing of the transactions in accordance with the MIPA (the “Closing”) occurred on October 28, 2019.

 

The B. Riley Member completed the Closing of a majority of the equity interest in BR Brand pursuant to the terms of the MIPA in exchange for (i) aggregate consideration of $116,500 in cash and (ii) warrant consideration of $990 from the issuance by the Company to Bluestar Alliance LLC (“Bluestar”), an affiliate of the BR Brand Member, of a warrant to purchase up to 200,000 shares of the Company’s common stock at an exercise price per share equal to $26.24. One-third of the shares of common stock issuable under the warrant immediately vested and became exercisable upon issuance at the Closing, and the remaining two-thirds of such shares of common stock will vest and become exercisable following the first and/or second anniversaries of the Closing, subject to BR Brand’s (or another related joint venture with Bluestar) satisfaction of specified financial performance targets. The fair value of the non-controlling interest in the amount of $29,373 was determined based on the relative fair value of the net assets acquired. The Company incurred $570 of transaction costs in connection with the acquisition.

 

In connection with the Closing, (i) the BR Brand Member has caused the transfer of certain trademarks, domain names, license agreements and related assets from existing brand owners to BR Brand and (ii) the Company, Bluestar and certain of their affiliates (including the B. Riley Member and the BR Brand Member) entered into an amended and restated operating agreement for BR Brand and certain other commercial agreements.

 

The Company evaluated the transaction under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations, and Accounting Standards Update (“ASU”) 2017-01, Business Combinations: Clarifying the Definition of a Business. Based on this evaluation, the Company has determined that the acquisition did not meet the definition of a business and, therefore, has accounted for the transaction as an acquisition of assets. The fair value of the assets acquired, including transaction costs, have been reflected in the accompanying financial statements as follows:

 

Consideration paid by B. Riley:    
Cash acquisition consideration  $116,500 
Transaction costs   570 
Total cash consideration   117,070 
Warrant consideration   990 
Total consideration  $118,060 
      
Tangible assets acquired and assumed:     
Cash and cash equivalents  $2,160 
Accounts receivable   1,751 
Deferred revenue   (1,332)
Tradename   136,176 
Customer list   8,678 
Non-controlling interest   (29,373)
Total  $118,060 

 

14

 

 

NOTE 4— RESTRUCTURING CHARGE

 

The Company did not record any restructuring charges for the three months ended March 31, 2020. The Company recorded restructuring charges in the amount of $147 for the three months ended March 31, 2019.

 

The restructuring charge of $147 during the three months ended March 31, 2019 was primarily related to severance costs for magicJack employees from a reduction in workforce in the Principal Investments – United Online and magicJack segment.

 

The following tables summarize the changes in accrued restructuring charge during the three months ended March 31, 2020 and 2019:

 

   Three Months Ended 
   March 31, 
   2020   2019 
Balance, beginning of period  $1,600    3,855 
Restructuring charge       147 
Cash paid   (316)   (636)
Non-cash items       18 
Balance, end of period  $1,284   $3,384 

 

The following tables summarize the restructuring activities by reportable segment during the three months ended March 31, 2019:

 

   Three Months Ended March 31, 2019 
       Principal         
       Investments -         
      United Online         
   Capital Markets   and
magicJack
   Corporate   Total 
Restructuring charge:                
Employee termination costs  $   $176   $   $176 
Facility closure and consolidation charge (recovery)   (29)           (29)
Total restructuring charge  $(29)  $176   $   $147 

 

15

 

 

NOTE 5—SECURITIES LENDING

 

The following table presents the contractual gross and net securities borrowing and lending balances and the related offsetting amount as of March 31, 2020 and December 31, 2019:

 

               Amounts not     
               offset in the     
               consolidated balance     
       Gross amounts   Net amounts   sheets but eligible for     
       offset in the   included    offsetting     
   Gross amounts  

consolidated

balance
   in the consolidated   upon counterparty     
   recognized   sheets(1)   balance sheets   default(2)   Net amounts 
As of March 31, 2020                    
Securities borrowed  $674,163   $   $674,163   $674,163   $ 
Securities loaned  $670,859   $   $670,859   $670,859   $ 
As of December 31, 2019                         
Securities borrowed  $814,331   $   $814,331   $814,331   $ 
Securities loaned  $810,495   $   $810,495   $810,495   $ 

 

 

(1) Includes financial instruments subject to enforceable master netting provisions that are permitted to be offset to the extent an event of default has occurred.
(2) Includes the amount of cash collateral held/posted.

 

NOTE 6—ACCOUNTS RECEIVABLE

 

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

 

   March 31,   December 31, 
   2020   2019 
Accounts receivable  $34,500   $36,385 
Investment banking fees, commissions and other receivables   9,607    8,043 
Unbilled receivables   4,581    3,710 
Total accounts receivable   48,688    48,138 
Allowance for doubtful accounts   (2,238)   (1,514)
Accounts receivable, net  $46,450   $46,624 

 

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

 

   Three Months Ended 
   March 31, 
   2020   2019 
Balance, beginning of period  $1,514    696 
Add: Additions to reserve   1,141    233 
Less: Write-offs   (417)   (163)
Less: Recovery        
Balance, end of period  $2,238   $766 

 

16

 

 

NOTE 7—GOODWILL AND OTHER INTANGIBLE ASSETS

 

Goodwill was $223,697 at both March 31, 2020 and December 31, 2019.

 

Intangible assets consisted of the following:

 

      As of March 31, 2020   As of December 31, 2019 
      Gross           Gross         
      Carrying   Accumulated   Intangibles   Carrying   Accumulated   Intangibles 
   Useful Life  Value   Amortization   Net   Value   Amortization   Net 
Amortizable assets:                           
Customer relationships  2 to 16 Years  $99,008   $30,528   $68,480   $99,008   $27,269   $71,739 
Domain names  7 Years   230    123    107    233    117    116 
Advertising relationships  8 Years   100    47    53    100    44    56 
Internally developed software and other intangibles  0.5 to 5 Years   11,765    5,456    6,309    11,765    4,843    6,922 
Trademarks  7 to 10 Years   4,600    1,465    3,135    4,600    1,324    3,276 
Total      115,703    37,619    78,084    115,706    33,597    82,109 
                                  
Non-amortizable assets:                              
Tradenames      134,416        134,416    138,416        138,416 
Total intangible assets     $250,119   $37,619   $212,500   $254,122   $33,597   $220,525 

 

Amortization expense was $4,024 and $3,377 for the three months ended March 31, 2020 and 2019, respectively. At March 31, 2020, estimated future amortization expense was $11,689, $15,218, $14,564, $12,573 and $8,486 for the years ended December 31, 2020 (remaining nine months), 2021, 2022, 2023 and 2024, respectively. The estimated future amortization expense after December 31, 2024 was $15,553. 

 

In the first quarter of 2020, in accordance with ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, the Company made a qualitative assessment of the impact of the COVID-19 outbreak on goodwill and other intangible assets. The Company determined that the COVID-19 outbreak was a triggering event for testing the indefinite-lived tradenames in the Brands segment and made a determination that the indefinite-lived tradenames in the Brands segment were impaired. In the three months ended March 31, 2020, the Company recognized an impairment charge of $4,000 for the indefinite-lived tradenames in the Brands segment. We will continue to monitor the impacts of the COVID-19 outbreak in future quarters. Changes in our forecasts could cause the book values of indefinite-lived tradenames to exceed fair values which may result in additional impairment charges in future periods.

 

NOTE 8—NOTES PAYABLE

 

Asset Based Credit Facility

 

On April 21, 2017, the Company amended its credit agreement (as amended, the “Credit Agreement”) governing its asset based credit facility with Wells Fargo Bank, National Association (“Wells Fargo Bank”) to increase the maximum borrowing limit from $100,000 to $200,000. Such amendment, among other things, also extended the expiration date of the credit facility from July 15, 2018 to April 21, 2022. The Credit Agreement continues to allow for borrowings under the separate credit agreement (a “UK Credit Agreement”) which was dated March 19, 2015 with an affiliate of Wells Fargo Bank which provides for the financing of transactions in the United Kingdom. Such facility allows the Company to borrow up to 50 million British Pounds. Any borrowings on the UK Credit Agreement reduce the availability on the asset based $200,000 credit facility. The UK Credit Agreement is cross collateralized and integrated in certain respects with the Credit Agreement. Cash advances and the issuance of letters of credit under the credit facility are made at the lender’s discretion. The letters of credit issued under this facility are furnished by the lender to third parties for the principal purpose of securing minimum guarantees under liquidation services contracts more fully described in Note 2(c). All outstanding loans, letters of credit, and interest are due on the expiration date which is generally within 180 days of funding. The credit facility is secured by the proceeds received for services rendered in connection with liquidation service contracts pursuant to which any outstanding loan or letters of credit are issued and the assets that are sold at liquidation related to such contract. The Company paid Wells Fargo Bank a closing fee in the amount of $500 in connection with the April 2017 amendment to the Credit Agreement. The interest rate for each revolving credit advance under the Credit Agreement is, subject to certain terms and conditions, equal to the LIBOR plus a margin of 2.25% to 3.25% depending on the type of advance and the percentage such advance represents of the related transaction for which such advance is provided. The credit facility also provides for success fees in the amount of 2.5% to 17.5% of the net profits, if any, earned on the liquidation engagements funded under the Credit Agreement as set forth therein. Interest expense totaled $277 and $481 for the three months ended March 31, 2020 and 2019, respectively. There was no outstanding balance on this credit facility at March 31, 2020. The outstanding balance on this credit facility was $37,096 at December 31, 2019. At March 31, 2020, there were no open letters of credit outstanding.

 

17

 

 

We are in compliance with all financial covenants in the asset based credit facility at March 31, 2020.

 

Other Notes Payable

 

Notes payable include notes payable to a clearing organization for one of the Company’s broker dealers. The notes payable accrue interest at the prime rate plus 2.0% (6.75% at March 31, 2020) payable annually, maturing January 31, 2022. At March 31, 2020 and December 31, 2019, the outstanding balance for the notes payable was $714 and $1,071, respectively. Interest expense was $15 and $23 for the three months ended March 31, 2020 and 2019, respectively.

 

NOTE 9—TERM LOAN

 

On December 19, 2018, BRPI Acquisition Co LLC (“BRPAC”), a Delaware limited liability company, UOL, and YMAX Corporation, Delaware corporations (collectively, the “Borrowers”), indirect wholly owned subsidiaries of the Company, in the capacity as borrowers, entered into a credit agreement (the “BRPAC Credit Agreement”) with the Banc of California, N.A. in the capacity as agent (the “Agent”) and lender and with the other lenders party thereto (the “Closing Date Lenders”). Certain of the Borrowers’ U.S. subsidiaries are guarantors of all obligations under the BRPAC Credit Agreement and are parties to the BRPAC Credit Agreement in such capacity (collectively, the “Secured Guarantors”; and together with the Borrowers, the “Credit Parties”). In addition, the Company and B. Riley Principal Investments, LLC, the parent corporation of BRPAC and a subsidiary of the Company, are guarantors of the obligations under the BRPAC Credit Agreement pursuant to standalone guaranty agreements pursuant to which the shares outstanding membership interests of BRPAC are pledged as collateral.

 

The obligations under the BRPAC Credit Agreement are secured by first-priority liens on, and first priority security interest in, substantially all of the assets of the Credit Parties, including a pledge of (a) 100% of the equity interests of the Credit Parties, (b) 65% of the equity interests in United Online Software Development (India) Private Limited, a private limited company organized under the laws of India; and (c) 65% of the equity interests in magicJack VocalTec LTD., a limited company organized under the laws of Israel. Such security interests are evidenced by pledge, security and other related agreements.

 

The BRPAC Credit Agreement contains certain covenants, including those limiting the Credit Parties’, and their subsidiaries’ ability to incur indebtedness, incur liens, sell or acquire assets or businesses, change the nature of their businesses, engage in transactions with related parties, make certain investments or pay dividends. In addition, the BRPAC Credit Agreement requires the Credit Parties to maintain certain financial ratios. The BRPAC Credit Agreement also contains customary representations and warranties, affirmative covenants and events of default, including payment defaults, breach of representations and warranties, covenant defaults and cross defaults. If an event of default occurs, the agent would be entitled to take various actions, including the acceleration of amounts due under the outstanding BRPAC Credit Agreement.

 

Under the BRPAC Credit Agreement, the Company borrowed $80,000 due December 19, 2023. Pursuant to the terms of the BRPAC Credit Agreement, the Company may request additional optional term loans in an aggregate principal amount of up to $10,000 at any time prior to the first anniversary of the agreement date (the “Option Loan”) with a final maturity date of December 19, 2023. On February 1, 2019, the Credit Parties, the Closing Date Lenders, the Agent and City National Bank, as a new lender (the “New Lender”), entered into the First Amendment to the Credit Agreement and Joinder (the “First Amendment”) pursuant to which, among other things, (i) New Lender became a party to the BRPAC Credit Agreement, (ii) the New Lender extended to Borrowers the Option Loan in the amount of $10,000, (iii) the aggregate outstanding principal amount of the term loans was increased from $80,000 to $90,000; and (iv) the amortization schedule under the BRPAC was amended as set forth in the First Amendment. Additionally, in connection with the Option Loan, the Borrowers executed a term note in favor of New Lender dated February 1, 2019 in the amount of $10,000. Borrowings under the BRPAC Credit Agreement bear interest at a rate equal to (a) the LIBOR rate for Eurodollar loans, plus (b) the applicable margin rate, which ranges from two and one-half percent (2.5%) to three percent (3.0%) per annum, based upon the Borrowers’ ratio of consolidated funded indebtedness to adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) for the preceding four fiscal quarters or other applicable period. At March 31, 2020, the interest rate on the BRPAC Credit Agreement was at 3.74%. Interest payments are to be made each one, three or six months. Amounts outstanding under the BRPAC Credit Agreement are due in quarterly installments commencing on March 31, 2019 with any remaining amounts outstanding due at maturity. For the $80,000 loan, quarterly installments from March 31, 2020 to December 31, 2022 are in the amount of $4,244 per quarter and from March 31, 2023 to December 31, 2023 are $2,122 per quarter. For the $10,000 loan, quarterly installments from March 31, 2020 to December 31, 2022 are $566 per quarter and from March 31, 2023 to December 31, 2023 are $265 per quarter. As of March 31, 2020 and December 31, 2019, the outstanding balance on the term loan was $61,932 (net of unamortized debt issuance costs of $524) and $66,666 (net of unamortized debt issuance costs of $600), respectively. Interest expense on the term loan during the three months ended March 31, 2020 and 2019 was $829 (including amortization of deferred debt issuance costs of $76) and $1,278 (including amortization of deferred debt issuance costs of $88), respectively.

 

We are in compliance with all financial covenants in the BRPAC Credit Agreement at March 31, 2020.

 

18

 

 

NOTE 10—SENIOR NOTES PAYABLE

 

Senior notes payable, net, are comprised of the following:

 

   March 31,   December 31, 
   2020   2019 
7.50% Senior notes due May 31, 2027  $125,536   $117,954 
7.25% Senior notes due December 31, 2027   122,545    120,126 
7.375% Senior notes due May 31, 2023   127,358    122,140 
6.875% Senior notes due September 30, 2023   113,109    105,952 
6.75% Senior notes due May 31, 2024   110,476    106,589 
6.50% Senior notes due September 30, 2026   134,657    124,226 
6.375% Senior notes due February 28, 2025   130,942     
    864,623    696,987 
Less: Unamortized debt issuance costs   (11,100)   (8,875)
   $853,523   $688,112 

 

During the three months ended March 31, 2020, the Company issued $38,828 of senior notes due with maturities dates ranging from May 2023 to December 2027 pursuant to At the Market Issuance Sales Agreements with B. Riley FBR, Inc. which governs the program of at-the-market sales of the Company’s senior notes. A series of prospectus supplements were filed by the Company with the SEC which allowed the Company to sell these senior notes.

 

On February 12, 2020, the Company issued $132,250 of senior notes due in February 2025 (“6.375% 2025 Notes”) pursuant to the prospectus supplement dated February 10, 2020. Interest on the 6.375% 2025 Notes is payable quarterly at 6.375%. The 6.375% 2025 Notes are unsecured and due and payable in full on February 28, 2025. In connection with the issuance of the 6.375% 2025 Notes, the Company received net proceeds of $129,233 (after underwriting commissions, fees and other issuance costs of $3,017).

 

During March 2020, the Company repurchased bonds with an aggregate face value of $3,443 for $1,829 resulting in a gain net of expenses and original issue discount of $1,556 during the three months ended March 31, 2020. As part of the repurchase, the Company paid $30 in interest accrued through the date of each respective repurchase.

 

At March 31, 2020 and December 31, 2019, the total senior notes outstanding was $853,523 (net of unamortized debt issue costs of $11,100) and $688,112 (net of unamortized debt issue costs of $8,875) with a weighted average interest rate of 6.94% and 7.05%, respectively. Interest on senior notes is payable on a quarterly basis. Interest expense on senior notes totaled $14,392 and $8,855 for the three months ended March 31, 2020 and 2019, respectively.

 

Sales Agreement Prospectus to Issue Up to $150,000 of Senior Notes

 

On February 14, 2020, the Company entered into a new At Market Issuance Sales Agreement (the “February 2020 Sales Agreement”) with B. Riley FBR, Inc. governing a program of at-the-market sales of certain of the Company’s senior notes. The most recent sales agreement prospectus was filed by the Company with the SEC on February 14, 2020 (the “February 2020 Sales Agreement Prospectus”). The Sales Agreement Prospectus allows the Company to sell up to $150,000 of certain of the Company’s senior notes pursuant to an effective Registration Statement on Form S-3. As of March 31, 2020, the Company had $148,415 remaining availability under the February 2020 Sales Agreement.

 

19

 

 

NOTE 11—REVENUE FROM CONTRACTS WITH CUSTOMERS

 

Revenue from contracts with customers by reportable segment for the three months ended March 31, 2020 and 2019 is as follows:

 

   Three Months Ended March 31, 2020 
   Reportable Segment 
               Principal         
               Investments -         
   Capital   Auction and   Valuation and   United
Online and
         
   Markets   Liquidation   Appraisal   magicJack   Brands   Total 
                         
Corporate finance, consulting and investment banking fees  $67,382   $   $   $   $   $67,382 
Wealth and asset management fees   20,320                    20,320 
Commissions, fees and reimbursed expenses   14,470    16,178    8,788            39,436 
Subscription services               18,833        18,833 
Service contract revenues       4,483                4,483 
Advertising, licensing and other               3,889    3,801    7,690 
Total revenues from contracts with customers   102,172    20,661    8,788    22,722    3,801    158,144 
                               
Interest income - Loans and securities lending   21,851                    21,851 
Trading losses on investments   (164,516)                   (164,516)
Fair value adjustment on loans   (17,926)                   (17,926)
Other   2,241                    2,241 
Total revenues  $(56,178)  $20,661   $8,788   $22,722   $3,801   $(206)

 

   Three Months Ended March 31, 2019 
   Reportable Segment 
               Principal         
               Investments -         
   Capital   Auction and   Valuation and   United
Online and
         
   Markets   Liquidation   Appraisal   magicJack   Brands   Total 
                         
Corporate finance, consulting and investment banking fees  $17,836   $   $   $   $   $17,836 
Wealth and asset management fees   17,535                    17,535 
Commissions, fees and reimbursed expenses   10,897    7,633    8,583            27,113 
Subscription services               22,398        22,398 
Service contract revenues       13,076                13,076 
Advertising, licensing and other               5,137        5,137 
Total revenues from contracts with customers   46,268    20,709    8,583    27,535        103,095 
                               
Interest income - Loans and securities lending   11,420                    11,420 
Trading gains on investments   25,916                    25,916 
Fair value adjustment on loans   (49)                   (49)
Other   1,746                    1,746 
Total revenues  $85,301   $20,709   $8,583   $27,535   $   $142,128 

 

20

 

 

Contract Balances

 

The timing of the Company’s revenue recognition may differ from the timing of payment by its customers. The Company records a receivable when revenue is recognized prior to payment and the Company has an unconditional right to payment. Alternatively, when payment precedes the provision of the related services, the Company records deferred revenue until the performance obligations are satisfied. Receivables related to revenues from contracts with customers totaled $46,450 and $46,624 at March 31, 2020 and December 31, 2019, respectively. The Company had no significant impairments related to these receivables during the three months ended March 31, 2020. The Company’s deferred revenue primarily relates to retainer and milestone fees received from corporate finance and investment banking advisory engagements, asset management agreements, Valuation and Appraisal engagements and subscription services where the performance obligation has not yet been satisfied. Deferred revenue at March 31, 2020 and December 31, 2019 was $73,709 and $67,121, respectively. During the three months ended March 31, 2020 and 2019, the Company recognized revenue of $13,987 and $13,234 that was recorded as deferred revenue at the beginning of the respective year.

 

Contract Costs

 

Contract costs include: (1) costs to fulfill contracts associated with corporate finance and investment banking engagements are capitalized where the revenue is recognized at a point in time and the costs are determined to be recoverable; (2) costs to fulfill Auction and Liquidation services contracts where the Company guarantees a minimum recovery value for goods being sold at auction or liquidation where the revenue is recognized over time when the performance obligation is satisfied; and (3) commissions paid to obtain magicJack contracts which are recognized ratably over the contract term and third party support costs for magicJack and related equipment purchased by customers which are recognized ratably over the service period.

 

The capitalized costs to fulfill a contract were $460 and $450 at March 31, 2020 and December 31, 2019, respectively, and are recorded in prepaid expenses and other assets in the condensed consolidated balance sheets. For the three months ended March 31, 2020 and 2019, the Company recognized expenses of $72 and $601 related to capitalized costs to fulfill a contract, respectively. There were no significant impairment charges recognized in relation to these capitalized costs during the three months ended March 31, 2020 and 2019.

 

Remaining Performance Obligations and Revenue Recognized from Past Performance

 

The Company does not disclose information about remaining performance obligations pertaining to contracts that have an original expected duration of one year or less. The transaction price allocated to remaining unsatisfied or partially unsatisfied performance obligations with an original expected duration exceeding one year was not material at March 31, 2020. Corporate finance and investment banking fees and retail liquidation engagement fees that are contingent upon completion of a specific milestone and fees associated with certain distribution services are also excluded as the fees are considered variable and not included in the transaction price at March 31, 2020.

 

NOTE 12—INCOME TAXES

 

The Company’s effective income tax rate was a benefit of 27.4% and provision of 28.0% for the three months ended March 31, 2020 and 2019, respectively.

 

As of March 2020, the Company had federal net operating loss carryforwards of $53,932 and state net operating loss carryforwards of $64,088. The Company’s federal net operating loss carryforwards will expire in the tax years commencing in December 31, 2032 through December 31, 2037. The state net operating loss carryforwards will expire in the tax years commencing in December 31, 2029.

 

The Company establishes a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Tax benefits of operating loss, capital loss and tax credit carryforwards are evaluated on an ongoing basis, including a review of historical and projected future operating results, the eligible carryforward period, and other circumstances. The Company’s net operating losses are subject to annual limitations in accordance with Internal Revenue Code Section 382. Accordingly, the Company is limited to the amount of net operating loss that may be utilized in future taxable years depending on the Company’s actual taxable income. As of March 31, 2020, the Company believes that the existing net operating loss carryforwards will be utilized in future tax periods before the loss carryforwards expire and it is more-likely-than-not that future taxable earnings will be sufficient to realize its deferred tax assets and has not provided a valuation allowance. The Company does not believe that it is more likely than not that the Company will be able to utilize the benefits related to capital loss carryforwards and has provided a valuation allowance in the amount of $61,945 against these deferred tax assets.

 

The Company files income tax returns in the U.S., various state and local jurisdictions, and certain other foreign jurisdictions. The Company is currently under audit by certain federal, state and local, and foreign tax authorities. The audits are in varying stages of completion. The Company evaluates its tax positions and establishes liabilities for uncertain tax positions that may be challenged by tax authorities. Uncertain tax positions are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, case law developments and closing of statutes of limitations. Such adjustments are reflected in the provision for income taxes, as appropriate. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the calendar years ended December 31, 2016 to 2019.

 

21

 

 

NOTE 13— EARNINGS PER SHARE

 

Basic earnings per share is calculated by dividing net income by the weighted-average number of shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding, after giving effect to all dilutive potential common shares outstanding during the period. Basic common shares outstanding exclude 387,365 common shares in 2020 and 387,365 common shares in 2019 that are held in escrow and subject to forfeiture. The common shares held in escrow includes 387,365 common shares that are subject to forfeiture to indemnify the Company for certain representations and warranties in connection with the acquisition of Wunderlich. The shares that remain in escrow are subject to forfeiture upon the final settlement of claims as more fully described in the related escrow instructions. Dilutive common shares outstanding includes contingently issuable shares that are currently in escrow and subject to release if the conditions for the final settlement of claims in accordance with the escrow instructions were satisfied at the end of the respective years. Securities that could potentially dilute basic net income per share in the future that were not included in the computation of diluted net income per share were 1,820,178 and 1,952,868 for the three months ended March 31, 2020 and 2019, respectively, because to do so would have been anti-dilutive.

 

Basic and diluted earnings per share were calculated as follows:

 

   Three Months Ended 
   March 31, 
   2020   2019 
Net (loss) income attributable to B. Riley Financial, Inc.  $(98,665)  $8,023 
Preferred stock dividends   (1,055)    
Net (loss) income applicable to common shareholders  $(99,720)  $8,023 
           
Weighted average common shares outstanding:          
Basic   26,028,613    26,217,215 
Effect of dilutive potential common shares:          
Restricted stock units and warrants       352,938 
Contingently issuable shares       117,378 
Diluted   26,028,613    26,687,531 
           
Basic income per common share  $(3.83)  $0.31 
Diluted income per common share  $(3.83)  $0.30 

 

NOTE 14—COMMITMENTS AND CONTINGENCIES

 

(a) Legal Matters

 

The Company is subject to certain legal and other claims that arise in the ordinary course of its business. In particular, the Company and its subsidiaries are named in and subject to various proceedings and claims arising primarily from the Company’s securities business activities, including lawsuits, arbitration claims, class actions, and regulatory matters. Some of these claims seek substantial compensatory, punitive, or indeterminate damages. The Company and its subsidiaries are also involved in other reviews, investigations, and proceedings by governmental and self-regulatory organizations regarding the Company’s business, which may result in adverse judgments, settlements, fines, penalties, injunctions, and other relief. In view of the number and diversity of claims against the Company, the number of jurisdictions in which litigation is pending, and the inherent difficulty of predicting the outcome of litigation and other claims, the Company cannot state with certainty what the eventual outcome of pending litigation or other claims will be. Notwithstanding this uncertainty, the Company does not believe that the results of these claims are likely to have a material effect on its financial position or results of operations.

 

On August 11, 2017, a putative class action lawsuit titled Freedman v. magicJack VocalTec Ltd. et al., Case 9-17-cv-80940, was filed against magicJack and its Board of Directors in the United States District Court for the Southern District of Florida (Case No: 9:17-cv-80940-RLR). Oral arguments were held on for January 17, 2020 and the Company is awaiting the court’s decision. The Company cannot estimate the amount of potential liability, if any, that could arise from this matter.

 

On January 5, 2017, complaints filed in November 2015 and May 2016 naming MLV & Co. (“MLV”), a broker-dealer subsidiary of FBR, as a defendant in putative class action lawsuits alleging claims under the Securities Act, in connection with the offerings of Miller Energy Resources, Inc. (“Miller”) have been consolidated. The Master Consolidated Complaint, styled Gaynor v. Miller et al., is pending in the United States District Court for the Eastern District of Tennessee, and, like its predecessor complaints, continues to allege claims under Sections 11 and 12 of the Securities Act against nine underwriters for alleged material misrepresentations and omissions in the registration statement and prospectuses issued in connection with six offerings (February 13, 2013; May 8, 2013; June 28, 2013; September 26, 2013; October 17, 2013 (as to MLV only) and August 21, 2014) with an alleged aggregate offering price of approximately $151,000. The Court ordered mediation before a federal magistrate took place on August 6, 2019, with no resolution. In December 2019, the Court remanded the case to state court.

 

22

 

 

 

In July 2017, an arbitration claim was filed with FINRA by Dominick & Dickerman LLC and Michael Campbell against WSI and Gary Wunderlich with respect to the acquisition by Wunderlich Investment Company, Inc. (“WIC”) (the parent corporation of WSI) of certain assets of Dominick & Dominick LLC in 2015. The Claimants allege that respondents overvalued WIC so that the purchase price paid to the Claimants in shares of WIC stock was artificially inflated. On April 7, 2020, the arbitration panel issued an award against B. Riley Wealth Management, LLC (formerly, Wunderlich Securities, Inc.) and Gary Wunderlich holding each party jointly and severally liable for damages, costs and expenses in an aggregate amount of $11,400. The Company recorded a loss accrual in the consolidated financial statements during the three months ended March 31, 2020. The Company filed a petition to vacate the arbitration award in the U.S. District Court for the Southern District of New York on May 5, 2020.

 

In December 2015, magicJack received a Letter of Inquiry (the “2015 LOI”) from the Enforcement Bureau (the “Bureau”) of the Federal Communications Commission (“FCC”) in which the Bureau indicated that it was investigating whether magicJack was subject to the FCC’s rules applicable to interconnected VoIP providers. magicJack believes that it is not an interconnected VoIP provider under current regulations and is not subject to the FCC rules. Previously, magicJack received similar letters of inquiry in 2010 and 2013, neither of which resulted in any enforcement action. magicJack responded to the 2015 LOI in February 2016. magicJack is currently participating in discussions with the FCC regarding a potential settlement.

 

(b) Tax Contingencies

 

magicJack believes that it files all required tax returns and pays all required federal, state and municipal taxes (such as sales, excise, utility, and ad valorem taxes), fees and surcharges. magicJack is the subject of inquiries and examinations by various states and municipalities in the normal course of business. In accordance with generally accepted accounting principles, magicJack makes a provision for a liability for taxes when it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. These provisions are reviewed at least quarterly and adjusted to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and other information and events pertaining to a particular case. magicJack believes any possible claims are without merit and vigorously defends its rights. However, if a government entity were to prevail in any matter, it could have a material adverse effect on magicJack’s financial condition, results of operation and cash flows. In addition, it is at least reasonably possible that a potential loss may exist for tax contingencies in addition to the provisions taken by magicJack.

 

Historically, magicJack considered the requirements to collect sales taxes under the auspices of a 1991 Supreme Court case, Quill Corp. v. North Dakota, which established the precedent that a physical presence in the respective state is required for an entity to be subject to a state’s sales and use tax requirements. Accordingly, magicJack had concluded that it did not have nexus for sales tax in those states in which it had no physical presence (i.e., it had no employees regularly and systematically there and it had no property there). On June 21, 2018, via South Dakota v. Wayfair, Inc. (No. 17-494) (“Wayfair”) the U.S. Supreme Court reversed its prior ruling and eliminated the “physical presence” requirement. In consideration of the ruling, magicJack made the decision to start collecting sales tax on direct sales of its magicJack device and access right renewals in states that have adopted similar “Economic Nexus” laws. magicJack began registering for, collecting and remitting sales tax to identified jurisdictions during the third quarter of 2018. The Company will continue to monitor the situation and add additional states if deemed necessary. Though the South Dakota law is to be applied prospectively, it is not certain if other states may try to enact laws on a retrospective basis based on the Wayfair ruling, and the Company cannot estimate the likelihood of liability or the potential amount of assessments that could arise from prior periods if other states tried to apply the ruling on a retrospective basis.

 

In a letter dated September 12, 2019, the Company received notice that the State of California has selected the Company’s 2016 and 2017 California corporate income tax returns for examination. The Company has received the initial information document request and the first meeting with the auditor scheduled in March 2020 was rescheduled to a date to be determined due to COVID -19. The Company believes that the positions taken in its 2016 and 2017 California corporate income tax returns are reasonable and appropriate, however, the Company cannot be sure of the ultimate outcome of the examination and cannot estimate the likelihood of liability or the amount of potential assessments, if any, that could arise from the examination.

 

(c) Franchise Group Commitment Letter, Loan Participant Guaranty and CIBC Guarantee

 

Franchise Group Commitment Letter and Loan Participant Guaranty

 

Commitment Letter

 

On February 14, 2020, affiliates of Franchise Group, Inc. (collectively with all of its affiliates, “FRG”) entered into an ABL Credit Agreement (the “Franchise Credit Agreement”), with GACP Finance Co., LLC (“GACP Finance”) as administrative agent and collateral agent, and the lenders from time to time party thereto, pursuant to which the lenders provided an asset based credit facility to FRG in an aggregate principal amount of $100,000 In connection with the Franchise Credit Agreement, the Company entered into a commitment letter, dated as of February 14, 2020 (the “Commitment Letter”), pursuant to which the Company committed to provide a $100,000 asset based lending facility to FRG, on April 14, 2020 if, on or before such date, the obligations under the Franchise Credit Agreement are not refinanced in full. On May 1, 2020, the Company extended its commitment under the Commitment Letter until 30 days prior to the maturity date which is currently set forth in the Franchise Credit Agreement as September 30, 2020.

 

The Loan Participant Guaranty

 

On February 14, 2020, FRG, the lenders from time to time party thereto and GACP Finance as administrative agent, entered into a Credit Agreement (the “Term Loan Credit Agreement”), pursuant to which the lenders provided a term loan facility to FRG in an aggregate principal amount of $575,000.

 

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On February 19, 2020, the Company entered into a limited guaranty (the “Loan Participant Guaranty”) to one of the lenders under the Term Loan Credit Agreement (the “Loan Participant”) pursuant to which the Company guaranteed the payment when due of certain obligations, including principal, interest, and other amounts payable to the Loan Participant under the Term Loan Credit Agreement in an amount not to exceed $50,000 plus certain expenses of the Loan Participant and certain protective advances related to such guaranteed obligations (the “Loan Participant Guaranteed Obligations”). The Loan Participant may require payment of the Loan Participant Guaranteed Obligations by the Company upon the occurrence of certain guarantor events of default, including payment or bankruptcy events of default, in each case pursuant to the Term Loan Credit Agreement. The Loan Participant Guaranty remains in effect until the date that the Loan Participant Guaranteed Obligations have been paid in full.

 

The Loan Participant Guaranteed Obligations are unsecured obligations of the Company and rank equally in right of payment with all of the Company’s other existing and future unsecured and unsubordinated indebtedness. The Loan Participant Guaranteed Obligations are effectively subordinated in right of payment to all of the Company’s existing and future secured indebtedness and structurally subordinated to all existing and future indebtedness of the Company’s subsidiaries, including trade payables.

 

CIBC Guaranty

 

On February 14, 2020, the Company entered into a limited guaranty (the “CIBC Guaranty”) in favor of CIBC Bank USA (“CIBC”), pursuant to which the Company guaranteed the payment when due of certain obligations, including all principal, interest, and other amounts that shall be at any time payable by FRG under FRG’s credit agreement with CIBC and the lenders party thereto, dated as of May 16, 2019, as amended (the “CIBC Credit Agreement”) in an amount not to exceed $125,000 plus certain expenses of CIBC related to such guaranteed obligations (the “CIBC Guaranteed Obligations”). CIBC may require payment of the CIBC Guaranteed Obligations by the Company upon the occurrence of either (a) the failure of FRG to pay any principal of any loan or any reimbursement obligation in respect of any letter of credit disbursement or (b) the failure of FRG to pay any interest on any loan or on any reimbursement obligation in respect of any letter of credit disbursement within five business days of the date due, in each case pursuant to the CIBC Credit Agreement. The CIBC Guaranty remains in effect until the earlier of (a) the date that the CIBC Guaranteed Obligations have been paid in full or (b) June 30, 2020.

 

The CIBC Guaranteed Obligations are unsecured obligations of the Company and rank equally in right of payment with all of the Company’s other existing and future unsecured and unsubordinated indebtedness. The CIBC Guaranteed Obligations are effectively subordinated in right of payment to all of the Company’s existing and future secured indebtedness and structurally subordinated to all existing and future indebtedness of the Company’s subsidiaries, including trade payables.

 

NOTE 15—SHARE-BASED PAYMENTS

 

(a) Amended and Restated 2009 Stock Incentive Plan

 

Share- based compensation expense for restricted stock units under the Company’s Amended and Restated 2009 Stock Incentive Plan (the “Plan”) was $4,109 and $1,726 for the three months ended March 31, 2020 and 2019, respectively.

 

The restricted stock units generally vest over a period of one to three years based on continued service. Performance based restricted stock units generally vest based on both the employee’s continued service and the Company’s common stock price, as defined in the grant, achieving a set threshold during the three-year period following the grant. In determining the fair value of restricted stock units on the grant date, the fair value is adjusted for (a) estimated forfeitures, (b) expected dividends based on historical patterns and the Company’s anticipated dividend payments over the expected holding period and (c) the risk-free interest rate based on U.S. Treasuries for a maturity matching the expected holding period.

 

As of March 31, 2020, the expected remaining unrecognized share-based compensation expense of $15,238 will be expensed over a weighted average period of 1.3 years.

 

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A summary of equity incentive award activity for the three months ended March 31, 2020 was as follows:

 

       Weighted 
       Average 
   Shares   Fair Value 
Nonvested at January 1, 2020   2,263,988   $12.35 
Granted   5,575    24.54 
Vested   (16,157)   19.30 
Nonvested at March 31, 2020   2,253,406   $12.33 

 

The total fair value of shares vested during the three months ended March 31, 2020 was $312.

 

(b) Amended and Restated FBR & Co. 2006 Long-Term Stock Incentive Plan

 

In connection with the acquisition of FBR & Co. on June 1, 2017, the equity awards previously granted or available for issuance under the FBR & Co. 2006 Long-Term Stock Incentive Plan (the “FBR Stock Plan”) may be issued under the Plan. The share-based compensation expense in connection with the FBR Stock Plan restricted stock awards was $791 and $767 during the three months ended March 31, 2020 and 2019, respectively. As of March 31, 2020, the expected remaining unrecognized share-based compensation expense of $3,833 will be expensed over a weighted average period of 1.6 years.

 

A summary of equity incentive award activity for the three months ended March 31, 2020 was as follows:

 

       Weighted 
       Average 
   Shares   Fair Value 
Nonvested at January 1, 2020   485,033   $18.33 
Vested   (41,963)   15.66 
Forfeited   (5,306)   19.18 
Nonvested at March 31, 2020   437,764   $18.57 

 

The total fair value of shares vested under the FBR Stock Plan during the three months ended March 31, 2020 was $657.

 

(c) 2018 Employee Stock Purchase Plan

 

In connection with the Company’s Purchase Plan, share based compensation was $165 and $121 for the three months ended March 31, 2020 and 2019, respectively. At March 31, 2020, there were 592 shares reserved for issuance under the Purchase Plan.

 

NOTE 16—NET CAPITAL REQUIREMENTS

 

B. Riley FBR, MLV and B. Riley Wealth Management (“BRWM”), the Company’s broker-dealer subsidiaries, are registered with the SEC as broker-dealers and are members of the Financial Industry Regulatory Authority, Inc. (“FINRA”). The Company’s broker-dealer subsidiaries are subject to SEC Uniform Net Capital Rule (Rule 15c3-1) which requires the subsidiaries to maintain minimum net capital and that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to 1. As such, they are subject to the minimum net capital requirements promulgated by the SEC. As of March 31, 2020, B. Riley FBR had net capital of $103,271, which was $100,994 in excess of its required net capital of $2,277; MLV had net capital of $91, which was $50 in excess of its required net capital of $41; and BRWM had net capital of $5,569, which was $4,975 in excess of its required net capital of $594.

 

NOTE 17—RELATED PARTY TRANSACTIONS

 

At March 31, 2020, amounts due from related parties of $4,391 includes $32 from GACP I, L.P. (“GACP I”) and $14 from GACP II, L.P. (“GACP II”) for management fees and other operating expenses, $5 due from B. Riley Principal Merger Corp, a company that consummated its initial public offering on April 11, 2019, and our wholly owned subsidiary, B. Riley Principal Sponsor Co. LLC, is the Sponsor, and $4,340 due from John Ahn, President of Great American Partners, LLC, our indirect wholly owned subsidiary (“GACP”), pursuant to a Secured Line of Promissory Note connected with a Transfer Agreement as further discussed below. At March 31, 2020, amounts due to related parties includes $353 due to CA Global Partners (“CA Global”) for operating expenses related to wholesale and industrial liquidation engagements managed by CA Global on behalf of GA Global Ptrs, and is included in due to related parties and partners on the accompanying condensed balance sheets. During the three months ended March 31, 2020, the Company sold a portion of a loan receivable to GACP for $1,800. At March 31, 2020, the Company had sold loan participations to B. Riley Partners Opportunity Fund, a private equity fund managed by one of our subsidiaries, in the amount of $12,405, and recorded interest expense of $552 during the three months ended March 31, 2020 related to B. Riley Partners Opportunity Fund’s loan participations. Our executive officer’s and board of directors have a 69.8% financial interest, which includes a financial interest of Bryant Riley, our Co-Chief Executive Officer, of 48.8% in the B. Riley Partners Opportunity Fund at March 31, 2020. At December 31, 2019, amounts due from related parties of $5,832 included $145 from GACP I and $12 from GACP II for management fees and other operating expenses, $13 due from B. Riley Principal Merger Corp, and $3,846 due from John Ahn, pursuant to a Secured Line of Promissory Note connected with a Transfer Agreement as further discussed below. At December 31, 2019, the Company had outstanding loan to participations to B. Riley Partners Opportunity Fund in the amount of $12,478

 

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On April 1, 2019, the Company entered into a Transfer Agreement (the “Transfer Agreement”) with GACP II, a fund managed by GACP, and John Ahn, the President of GACP. The Transfer Agreement provides for among other things, the transfer to Mr. J. Ahn 55.56% of the Company’s limited partnership interest in GACP II (the “Transferred Interest”), which represents a capital commitment in the aggregate amount of $5,000. In connection with the Transfer Agreement, the Company provided Mr. J. Ahn with a non-recourse, secured line of credit in an aggregate amount of up to $5,003 pursuant to the terms of a Secured Line of Credit Promissory Note (the “Note”) dated April 1, 2019, to fund the purchase price of the Transferred Interest. We also entered into a Security Agreement with Mr. J. Ahn on April 1, 2019, which granted to the Company a security interest in the Transferred Interest to secure Mr. J. Ahn’s obligations under the Note. The Note is subject to an interest rate per annum of 7.00%. As of March 31, 2020, the principal and accrued interest on the Note were $4,291 (amount transferred as of March 31, 2020) and $49, respectively. For the three months ended March 31, 2020 interest earned on the Note was $74

 

The Company periodically participates in loans and financing arrangements in respect of companies in which the Company has an equity ownership and representation on the board of directors or equivalent body. The Company may also provide consulting services or investment banking services to raise capital for these companies. These transactions can be summarized as follows:

 

Sonim

 

The Company has a loan receivable due from Sonim Technologies, Inc. (“Sonim”) that is included in loans receivable at fair value with a fair value of $9,155 and $9,603 at March 31, 2020 and December 31, 2019, respectively. The principal amount due on the loan at March 31, 2020 was $10,170, interest is payable at 10.0% per annum with a maturity date of September 1, 2022. During the three months ended March 31, 2020, the Company received principal payments in the amount of $88. A portion of the loan receivable is convertible into common stock of Sonim at $8.87 per share depending on when the Company elects to exercise its’ option to convert the principal balance of the loan into common stock of Sonim.

 

The original loan was made in October 2017 in connection with the Company’s initial investment in common stock and preferred stock that was purchased from Sonim’s existing shareholders. In October 2017, the Company also entered into a management services agreement with Sonim to provide advisory and consulting services for management fees of up to $200 per year. The management services agreement was terminated in September 2019.

 

Babcock and Wilcox

 

The Company has a last-out term loan receivable due from Babcock & Wilcox Enterprises, Inc. (“B&W”) that is included in loans receivable, at fair value with a fair value of $104,998 at March 31, 2020. As of December 31, 2019, the last-out term loan was included in loans receivable, at cost with a carrying value of $109,147. The carrying value of the loan was comprised of the principal amount of $113,330 less original issue discount of $4,183 at December 31, 2019. Interest is payable monthly at the fixed rate of 12.0% per annum. The loan was made to B&W as part of various amendments to B&W’s existing credit agreement with other lenders not related to the Company. In connection with making the loan to B&W, in April 2019 the Company received warrants to purchase 1,666,667 shares of common stock of B&W with an exercise price of $0.01 per share. The option to exercise the warrants expires on April 5, 2022.

 

One of the Company’s wholly owned subsidiaries entered into a services agreement with B&W that provided for the President of the Company to serve as the Chief Executive Officer of B&W until November 30, 2020 (the “Executive Consulting Agreement”), unless terminated by either party with thirty days written notice. Under this agreement, fees for services provided are $750 per annum, paid monthly. In addition, subject to the achievement of certain performance objectives as determined by B&W’s compensation committee of the board, a bonus or bonuses may also be earned and payable to the Company.

 

On January 31, 2020, the Company provided B&W with $30,000 of additional last-out term loans pursuant to new amendments to B&W’s existing credit agreement discussed above. The additional last-out term loan receivable due from B&W is included in loans receivable, at fair value with a fair value of $27,603 at March 31, 2020. Pursuant to the new amendment, the Company also agreed upon a term sheet pursuant to which B&W would undertake a refinancing transaction on or prior to May 11, 2020 (the “Refinancing”) and B&W and the existing lenders would amend and restate the credit agreement. As part of the Refinancing, the size of the B&W’s board of directors may also be reduced to five members, with the Company retaining the ability to appoint two members. On January 31, 2020, the Company also entered into a letter agreement with B&W (the “Backstop Commitment Letter”) pursuant to which the Company agreed to fund any shortfall in the $200,000 of new debt or equity financing required as part of the terms of the Refinancing to the extent such amounts have not been raised from third parties on the same terms contemplated by the Refinancing. The Company, B&W and the lenders that are a party to B&W’s existing credit agreement are in negotiations to amend and restate B&W’s existing credit agreement, which would include, among other things, an extension of the maturity of amounts outstanding under the credit facility, the termination of the Backstop Commitment Letter, the commitment by an affiliate of the Company to provide up to $70,000 in additional term loan financing incrementally over the duration of the amended credit facility, and a limited guaranty by the Company of B&W’s obligations under the amended credit facility. 

 

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Maven

 

The Company has loans receivable due from theMaven, Inc. (“Maven”) that are included in loans receivable, at fair value with a fair value of $25,572 and $21,150 at March 31, 2020 and December 31, 2019, respectively. The Company also has a loan receivable due from Maven that is included loans receivable, at fair value with a fair value of $44,323 March 31, 2020. As of December 31, 2019, the loan was included in loans receivable, at cost with a carrying value of $47,933. The loan receivable was comprised of the principal balance due in the amount of $49,921, less original issue discount of $1,988 at December 31, 2019. Interest on these loans is payable at rates of 12.0% to 15.0% per annum with maturity dates through June 2022.

 

Franchise Group

 

The Company has a loan receivable due from Vitamin Shoppe, a subsidiary of Franchise Group, Inc., (“Vitamin Shoppe”) that is included in loans receivable, at fair value with a fair value of $4,651 and $4,951 at March 31, 2020 and December 31, 2019, respectively. Interest is payable at 13.7% per annum with a maturity date of December 16, 2022. During the three months ended March 31, 2020, the Company recognized $7,160 of advisory fees from FRG in connection with FRG’s capital rasing and acquisition transactions.

 

The Company also entered into a Commitment Letter, Loan Participant Guaranty and CIBC Guarantee with FRG as disclosed above in Note 14 – Commitments and Contingencies.

 

NOTE 18—BUSINESS SEGMENTS

 

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

 

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

 

   Three Months Ended 
   March 31, 
   2020   2019 
Capital Markets segment:        
Revenues - Services and fees  $104,413    48,014 
Trading (losses) income and fair value adjustments on loans   (182,442)   25,867 
Interest income - Loans and securities lending   21,851    11,420 
Total revenues   (56,178)   85,301 
Selling, general and administrative expenses   (54,711)   (63,389)
Restructuring recovery       29 
Interest expense - Securities lending and loan participations sold   (8,473)   (6,804)
Depreciation and amortization   (1,105)   (1,276)
Segment (loss) income   (120,467)   13,861 
Auction and Liquidation segment:          
Revenues - Services and fees   20,661    20,709 
Direct cost of services   (14,816)   (6,274)
Cost of goods sold   (29)   (14)
Selling, general and administrative expenses   (1,526)   (2,915)
Depreciation and amortization   (1)   (2)
Segment income   4,289    11,504 
Valuation and Appraisal segment:          
Revenues - Services and fees   8,788    8,583 
Selling, general and administrative expenses   (6,867)   (7,187)
Depreciation and amortization   (41)   (33)
Segment income   1,880    1,363 
Principal Investments - United Online and magicJack segment:          
Revenues - Services and fees   21,718    26,590 
Revenues - Sale of goods   1,004    945 
Total revenues   22,722    27,535 
Direct cost of services   (5,136)   (7,842)
Cost of goods sold   (740)   (1,105)
Selling, general and administrative expenses   (5,463)   (7,020)
Depreciation and amortization   (2,879)   (3,463)
Restructuring charge       (176)
Segment income   8,504    7,929 
Brands segment:          
Revenues - Services and fees   3,801     
Selling, general and administrative expenses   (904)    
Depreciation and amortization   (714)    
Impairment of tradenames   (4,000)    
Segment loss   (1,817)    
Consolidated operating (loss) income from reportable segments   (107,611)   34,657 
           
Corporate and other expenses   (13,533)   (9,679)
Interest income   246    637 
Loss on equity investments   (236)   (3,762)
Interest expense   (15,654)   (10,770)
(Loss) income before income taxes   (136,788)   11,083 
Benefit (provision) for income taxes   37,539    (3,104)
Net (loss) income   (99,249)   7,979 
Net loss attributable to noncontrolling interests   (584)   (44)
Net (loss) income attributable to B. Riley Financial, Inc.   (98,665)   8,023 
Preferred stock dividends   1,055     
Net (loss) income available to common shareholders  $(99,720)  $8,023 

 

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The following table presents revenues by geographical area:

 

   Three Months Ended 
   March 31, 
   2020   2019 
Revenues:        
Revenues - Services and fees:        
North America  $158,466   $103,820 
Australia   664    15 
Europe   251    61 
Total Revenues - Services and fees  $159,381   $103,896 
           
Trading (losses) income and fair value adjustments on loans  $(182,442)  $25,867 
North America          
           
Revenues - Sale of goods          
North America  $1,004   $945 
           
Revenues - Interest income - Loans and securities lending:          
North America  $21,851   $11,420 
           
Total Revenues:          
North America  $(1,121)  $142,052 
Australia   664    15 
Europe   251    61 
Total Revenues  $(206)  $142,128 

  

During the three months ended March 31, 2020 and 2019, long-lived assets, which consist of property and equipment and other assets, of $12,223 and $12,727, respectively, were located in North America.

 

Segment assets are not reported to, or used by, the Company’s Chief Operating Decision Maker to allocate resources to, or assess performance of, the segments and therefore, total segment assets have not been disclosed.

 

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

 

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

 

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

 

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

 

Risk factors that could cause actual results to differ materially from those contained in the forward-looking statements include but are not limited to risks related to: volatility in our revenues and results of operations; the unpredictable and ongoing impact of the COVID-19 pandemic; changing conditions in the financial markets; our ability to generate sufficient revenues to achieve and maintain profitability; our exposure to credit risk; the short term nature of our engagements; the accuracy of our estimates and valuations of inventory or assets in “guarantee” based engagements; competition in the asset management business; potential losses related to our auction or liquidation engagements; our dependence on communications, information and other systems and third parties; potential losses related to purchase transactions in our auction and liquidations business; the potential loss of financial institution clients; potential losses from or illiquidity of our proprietary investments; changing economic and market conditions; potential liability and harm to our reputation if we were to provide an inaccurate appraisal or valuation; potential mark-downs in inventory in connection with purchase transactions; failure to successfully compete in any of our segments; loss of key personnel; our ability to borrow under our credit facilities or at-the-market offering as necessary; failure to comply with the terms of our credit agreements or senior notes; our ability to meet future capital requirements; our ability to realize the benefits of our completed acquisitions, including our ability to achieve anticipated opportunities and operating cost savings, and accretion to reported earnings estimated to result from completed and proposed acquisitions in the time frame expected by management or at all; the diversion of management time on acquisition- related issues; the failure of our brand investment portfolio licensees to pay us royalties; and the intense competition to which our brand investment portfolio is subject. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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

 

Overview

 

General

 

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

 

B. Riley FBR, Inc. (“B. Riley FBR”) is a leading, full service investment bank providing financial advisory, corporate finance, research, securities lending and sales and trading services to corporate, institutional and high net worth individual clients. B. Riley FBR was formed in November 2017 through the merger of B. Riley & Co, LLC and FBR Capital Markets & Co., which the Company acquired in June 2017; the name of the combined broker dealer was subsequently changed to B. Riley FBR, Inc.

 

B. Riley Wealth Management, Inc. (“B. Riley Wealth Management”) provides comprehensive wealth management and brokerage services to individuals and families, corporations and non-profit organizations, including qualified retirement plans, trusts, foundations and endowments. B. Riley Wealth Management was formerly Wunderlich Securities, Inc., which the Company acquired on July 3, 2017 and changed the name in June 2018.

 

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

 

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

 

oGreat American Capital Partners, LLC (“GACP”), the general partner of two private funds, GACP I, L.P. and GACP II, L.P., both direct lending funds that provide senior secured loans and second lien secured loan facilities to middle market public and private U.S. companies.

 

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GlassRatner Advisory & Capital Group LLC (“GlassRatner”), a specialty financial advisory services firm that provides consulting services to shareholders, creditors and companies, including due diligence, fraud investigations, corporate litigation support, crisis management and bankruptcy services. We acquired GlassRatner on August 1, 2018. GlassRatner strengthens B. Riley’s diverse platform and compliments the restructuring services provided by B. Riley FBR.

 

Great American Group, LLC(“Great American Group”), a leading provider of asset disposition and auction solutions to a wide range of retail and industrial clients.

 

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

 

We also pursue a strategy of investing in or acquiring companies which we believe have attractive investment return characteristics. We acquired United Online, Inc. (“UOL” or “United Online”) on July 1, 2016 and magicJack VocalTec Ltd. (“magicJack”) on November 14, 2018 as part of our principal investment strategy.

 

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

 

magicJack is a Voice over IP (“VoIP”) cloud-based technology and services communications provider.

 

BR Brand, in which the company owns a majority interest, provides licensing of a brand investment portfolio. BR Brand owns the assets and intellectual property related to licenses of six brands: Catherine Malandrino, English Laundry, Joan Vass, Kensie Girl, Limited Too and Nanette Lepore.

 

We are headquartered in Los Angeles with offices in major cities throughout the United States including New York, Chicago, Boston, Dallas, Memphis, Metro Washington D.C and West Palm Beach.

 

For financial reporting purposes we classify our businesses into five operating segments: (i) Capital Markets, (ii) Auction and Liquidation, (iii) Valuation and Appraisal, (iv) Principal Investments – United Online and magicJack and (v) Brands.

 

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

 

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

 

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

 

Principal Investments - United Online and magicJack Segment. Our Principal Investments - United Online and magicJack segment consists of businesses which have been acquired primarily for attractive investment return characteristics. Currently, this segment includes UOL, through which we provide consumer Internet access, and magicJack, through which we provide VoIP communication and related product and subscription services.

 

Brands Segment. Our Brands segment consists of our brand investment portfolio that is focused on generating revenue through the licensing of trademarks and is held by BR Brand.

 

Recent Developments

 

On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus (the “COVID-19 outbreak”). In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. The full impact of the COVID-19 outbreak continues to evolve. The impact of the COVID-19 outbreak on our results of operations, financial position and cash flows will depend on future developments, including the duration and spread of the outbreak and related advisories and restrictions. These developments and the impact of the COVID-19 outbreak on the financial markets and the overall economy are highly uncertain and cannot be predicted. If the financial markets and/or the overall economy are impacted for an extended period, our results of operations, financial position and cash flows may be materially adversely affected.

 

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Results of Operations

 

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

 

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019

 

Condensed Consolidated Statements of Operations

(Dollars in thousands)

 

   Three Months Ended     
   March 31, 2020   March 31, 2019   Change 
Revenues:            
Services and fees  $159,381   $103,896   $55,485 
Trading (losses) income and fair value adjustments on loans   (182,442)   25,867    (208,309)
Interest income - Loans and securities lending   21,851    11,420    10,431 
Sale of goods   1,004    945    59 
Total revenues   (206)   142,128    (142,334)
                
Operating expenses:               
Direct cost of services   19,952    14,116    5,836 
Cost of goods sold   769    1,119    (350)
Selling, general and administrative expenses   

87,744

    94,964    (7,220)
Restructuring charge       147    (147)
Impairment of tradenames   4,000        4,000 
Interest expense - Securities lending and loan participations sold   8,473    6,804    1,669 
Total operating expenses   120,938    117,150    3,788 
Operating (loss) income   (121,144)   24,978    (146,122)
Other income (expense):               
Interest income   246    637    (391)
Loss from equity investments   (236)   (3,762)   3,526 
Interest expense   (15,654)   (10,770)   (4,884)
(Loss) income before income taxes   (136,788)   11,083    (147,871)
Benefit (provision) for income taxes   37,539    (3,104)   40,643 
Net (loss) income   (99,249)   7,979    (107,228)
Net loss attributable to noncontrolling interests   (584)   (44)   (540)
Net (loss) income attributable to B. Riley Financial, Inc.   (98,665)   8,023    (106,688)
Preferred stock dividends   1,055        1,055 
Net (loss) income available to common shareholders  $(99,720)  $8,023   $(107,743)

 

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Revenues

 

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

 

   Three Months Ended         
   March 31, 2020   March 31, 2019   Change 
   Amount   Amount   Amount   % 
Revenues - Services and fees:                
Capital Markets segment  $104,413   $48,014   $56,399    117.5%
Auction and Liquidation segment   20,661    20,709    (48)   -0.2%
Valuation and Appraisal segment   8,788    8,583    205    2.4%
Principal Investments - United Online and magicJack segment   21,718    26,590    (4,872)   -18.3%
Brands   3,801        3,801    100.0%
Subtotal   159,381    103,896    55,485    53.4%
                     
Revenues - Sale of goods:                    
Principal Investments - United Online and magicJack segment   1,004    945    59    6.2%
Subtotal   1,004    945    59    6.2%
                     
Trading (losses) income and fair value adjustments on loans                    
Capital Markets segment   (182,442)   25,867    (208,309)   -805.3%
Subtotal   (182,442)   25,867    (208,309)   -805.3%
                     
Interest income - Loans and securities lending:                    
Capital Markets segment   21,851    11,420    10,431    91.3%
Total revenues  $(206)  $142,128   $(142,334)   -100.1%

 

Total revenues decreased approximately $142.3 million to ($0.2 million) during the three months ended March 31, 2020 from $142.1 million during the three months ended March 31, 2019. The decrease in revenues during the three months ended March 31, 2020 was primarily due to a decrease in revenue from trading losses and fair value adjustments on loans of $208.3 million, partially offset by increases in revenue from services and fees of $55.5 million and interest income - loans and securities lending of $10.4 million. The increase in revenue from services and fees of $55.5 million in the three months ended March 31, 2020 was primarily due to increases in revenue of $56.4 million in the Capital Markets segment, $0.2 million in the Valuation and Appraisal segment and $3.8 million in the Brands segment partially offset by a decrease of revenue of $4.9 million in the Principal Investments — United Online and magicJack segment.

 

Revenues from services and fees in the Capital Markets segment increased $56.4 million, to $104.4 million during the three months ended March 31, 2020 from $48.0 million during the three months ended March 31, 2019. The increase in revenues was primarily due to an increase in revenue of $49.5 million from corporate finance, consulting and investment banking fees, an increase in commissions of $3.6 million and an increase in asset management fees of $2.8 million.

 

Revenues from services and fees in the Auction and Liquidation segment remained at $20.7 million during the three months ended March 31, 2020 and 2019.

 

Revenues from services and fees in the Valuation and Appraisal segment increased $0.2 million to $8.8 million during the three months ended March 31, 2020 from $8.6 million during the three months ended March 31, 2019. The increase in revenues in the Valuation and Appraisal segment is primarily due to an increase in revenues for appraisal engagements where we perform valuations for the monitoring of collateral for financial institutions, lenders, and private equity investors.

 

Revenues from services and fees in the Principal Investments - United Online and magicJack segment decreased $4.9 million to $21.7 million during the three months ended March 31, 2020 from $26.6 million during the three months ended March 31, 2019. The decrease in revenues from services and fees is a result of a decrease in subscription services of $3.6 million and a decrease in advertising licensing and other of $1.3 million. Management expects revenues from the Principal Investments - United Online and magicJack segment to continue to decline year over year.

 

Revenues from services and fees in the Brands segment were $3.8 million for the three months ended March 31, 2020. We established the Brands segment in 2019 following the acquisition of a majority interest in BR Brands on October 28, 2019. The primary source of revenue included in this segment is the licensing of trademarks.

 

Trading income and fair value adjustments on loans decreased to a loss of $182.4 million for the three months ended March 31, 2020 from a gain of $25.9 million for the three months ended March 31, 2019. The $182.4 million loss for the three months ended March 31, 2020 includes realized and unrealized amounts earned on investments made in our proprietary trading account of $164.5 million and unrealized amounts on our loans receivable at fair value of $17.9 million.

 

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Interest income – loans and securities lending increased $10.4 million, to $21.9 million during the three months ended March 31, 2020 from $11.4 million during the three months ended March 31, 2019. Interest income from securities lending was $10.1 million and $9.3 million during the three months ended March 31, 2020 and 2019, respectively. Interest income from loans was $11.7 million and $2.1 million during the three months ended March 31, 2020 and 2019, respectively. The increase in interest income on loans was primarily due to the increase in lending activities in our Capital Markets segment which included an increase in loans receivable to $326.3 million at March 31, 2020 from $87.5 million at March 31, 2019.

 

Sale of Goods, Cost of Goods Sold and Gross Margin

 

   Three Months Ended March 31, 2020   Three Months Ended March 31, 2019 
       Principal           Principal     
       Investments -           Investments -     
   Auction    United        Auction    United      
   and
Liquidation
   Online and
magicJack
       and
Liquidation
   Online and
magicJack
     
   Segment   Segment   Total   Segment   Segment   Total 
Revenues - Sale of Goods  $   $1,004   $1,004   $   $945   $945 
Cost of goods sold   29    740    769    14    1,105    1,119 
Gross margin on sale of goods  $(29)  $264   $235   $(14)  $(160)  $(174)
                               
Gross margin percentage   (100.0%)   26.3%   23.4%   (100.0%)   (16.9%)   (18.4%)

 

 Revenues from the sale of goods increased $0.1 million, to $1.0 million during the three months ended March 31, 2020 from $0.9 million during the three months ended March 31, 2019. The increase in revenues from sale of goods were attributable to $0.1 million of sales of magicJack devices that are sold in connection with VoIP services. Cost of goods sold for the three months ended March 31, 2020 was $0.8 million, resulting in a gross margin of 23.4%. 

 

Operating Expenses

 

Direct Cost of Services. Direct cost of services and direct cost of services measured as a percentage of revenues – services and fees by segment during the three months ended March 31, 2020 and 2019 are as follows:

 

   Three Months Ended March 31, 2020   Three Months Ended March 31, 2019 
       Principal           Principal     
       Investments -           Investments -     
   Auction    United        Auction    United      
   and
Liquidation
   Online and
magicJack
       and
Liquidation
   Online and
magicJack
     
   Segment   Segment   Total   Segment   Segment   Total 
Revenues - Services and fees  $20,661    21,718        $20,709   $26,590      
Direct cost of services   14,816    5,136   $19,952    6,274    7,842   $14,116 
Gross margin on services and fees  $5,845   $16,582        $14,435   $18,748      
                               
Gross margin percentage   28.3%   76.4%        69.7%   70.5%     

 

Total direct costs increased $5.8 million, to $20.0 million during the three months ended March 31, 2020 from $14.1 million during the three months ended March 31, 2019. Direct costs of services increased by $8.5 million in the Auction and Liquidation segment partially offset by a decrease of $2.7 million in the Principal Investments — United Online and magicJack segment. The increase in direct costs in the Auction and Liquidation segment was primarily due to mix of engagement types performed during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019. The decrease in direct costs in the Principal Investments — United Online and magicJack segment was primarily as a result of the sale of a division of magicJack in the second quarter of 2019.

 

Auction and Liquidation

 

Gross margin in the Auction and Liquidation segment for services and fees decreased to 28.3% of revenues during the three months ended March 31, 2020, as compared to 69.7% of revenues during the three months ended March 31, 2020. The decrease in margin in the Auction and Liquidation segment is due to the mix of engagement types between guarantee and commission and fees engagements performed during the three months ended March 31, 2020 as compared to the prior year period.

 

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Principal Investments—United Online and magicJack

 

Gross margins in the Principal Investments — United Online and magicJack segment increased to 76.4% of revenues during the three months ended March 31, 2020, as compared to 70.5% of revenues during the three months ended March 31, 2020. The increase in margin in the Principal Investments — United Online and magicJack segment is primarily due to the sale of a division of magicJack in the second quarter of 2019.

 

Selling, General and Administrative Expenses. Selling, general and administrative expenses during the three months ended March 31, 2020 and 2019 were comprised of the following:

 

Selling, General and Administrative Expenses

 

   Three Months Ended   Three Months Ended         
   March 31, 2020   March 31, 2019   Change 
   Amount   %   Amount   %   Amount   % 
Capital Markets segment  $55,816    63.7%  $64,665    68.1%  $(8,849)   (13.7%)
Auction and Liquidation segment   1,527    1.7%   2,917    3.1%   (1,390)   (47.7%)
Valuation and Appraisal segment   6,908    7.9%   7,220    7.6%   (312)   (4.3%)
Principal Investments - United Online and magicJack segment   8,342    9.5%   10,483    11.0%   (2,141)   (20.4%)
Brands segment   1,618    1.8%       0.0%   1,618    100.0%
Corporate and Other segment   13,533    15.4%   9,679    10.2%   3,854    39.8%
Total selling, general & administrative expenses  $87,744    100.0%  $94,964    100.0%  $(7,220)   (7.6%)

 

Total selling, general and administrative expenses decreased approximately $7.2 million to $87.7 million during the three months ended March 31, 2020 from $95.0 million for the three months ended March 31, 2019. The decrease of approximately $7.2 million in selling, general and administrative expenses was due to a decrease of $8.8 million in the Capital Markets segment, a decrease of $1.4 million in the Auction and Liquidation segment, a decrease of $0.3 million in the Valuation and Appraisal segment, a decrease of $2.1 million in the Principal Investments — United Online and magicJack segment, partially offset by an increase of $1.6 million in the Brands segment and an increase of $3.9 million in the Corporate and Other segment. 

 

Capital Markets

 

Selling, general and administrative expenses in the Capital Markets segment decreased by $8.8 million to $55.8 million during the three months ended March 31, 2020 from $64.7 million during the three months ended March 31, 2019. The decrease was primarily due to a decrease of $25.8 million in consulting expenses partially offset by increases of $15.1 million in payroll and related expenses.

 

Auction and Liquidation

 

Selling, general and administrative expenses in the Auction and Liquidation segment decreased by $1.4 million to $1.5 million during the three months ended March 31, 2020 from $2.9 million during the three months ended March 31, 2019. The decrease in selling, general and administrative expenses in the Auction and Liquidation segment was primarily due to a decrease of $1.2 million in payroll and related expenses.

 

Valuation and Appraisal

 

Selling, general and administrative expenses in the Valuation and Appraisal segment decreased by $0.3 million to $6.9 million during the three months ended March 31, 2020 from $7.2 million during the three months ended March 31, 2019. The decrease in selling, general and administrative expenses in the Valuation and Appraisal segment was primarily due to a decrease of $0.4 million in payroll and related expenses.

 

Principal Investments — United Online and magicJack

 

Selling, general and administrative expenses in the Principal Investments — United Online and magicJack segment decreased $2.1 million to $8.3 million for the three months ended March 31, 2020 from $10.5 million for the three months ended March 31, 2019. The decrease in selling, general and administrative expenses in the Principal Investments — United Online and magicJack segment is primarily due to a decrease of $0.8 million in payroll and related expenses and $0.5 million in legal expenses.

 

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Brands

 

Selling, general and administrative expenses in the Brands segment was $1.6 million for the three months ended March 31, 2020. We established the Brands segment in 2019 following the acquisition of a majority equity interest in BR Brands on October 28, 2019.

 

Corporate and Other

 

Selling, general and administrative expenses for the Corporate and Other segment increased approximately $3.8 million to $13.5 million during the three months ended March 31, 2020 from $9.7 million for the three months ended March 31, 2019. The increase of expenses in the Corporate and Other segment for the three months ended March 31, 2020 was primarily due to recording a pre-acquisition litigation claim related to one of our acquired subsidiaries of $10.2 million in other expenses partially offset by a gain of $1.6 million on extinguishment of debt from the repurchase of senior notes and a decrease of $5.5 million in professional fees.

 

 Impairment of tradenames. Due to the impact of the COVID-19 outbreak on economic activity and market volatility, we tested our intangible assets as of March 31, 2020 and made the determination that the indefinite-lived tradenames in the Brands segment were impaired. In the three months ended March 31, 2020, the Company recognized impairment of $4.0 million on the indefinite-lived tradenames.

 

Other Income (Expense). Other income included interest income of $0.2 million during the three months ended March 31, 2020 and $0.6 million during the three months ended March 31, 2019. Interest expense was $15.7 million during the three months ended March 31, 2020 compared to $10.8 million during the three months ended March 31, 2019. The increase in interest expense during the three months ended March 31, 2020 was primarily due to an increase in interest expense of $5.5 million from the issuance of senior notes due in 2021, 2023, 2024, 2025, 2026 and 2027, partially offset by a decrease in interest expense of $0.4 million from the term loan dated December 2018 and a decrease in interest expense on our asset based credit facility and other of $0.2 million. Other income in the three months ended March 31, 2020 included a loss on equity investments of $0.2 million income on equity investments compared to $3.8 million in the prior year period.

 

(Loss) Income Before Income Taxes. Loss before income taxes was $136.8 million during the three months ended March 31, 2020 compared to income before income taxes of $11.1 million during the three months ended March 31, 2019. The decrease in income before income taxes was primarily due to a decrease in revenues of approximately $142.3 million, an increase in interest expense of $4.9 million, an increase in operating expenses of $3.8 million and a decrease in interest income of $0.4 million, partially offset by a decrease in loss from equity investments of $3.5 million, as discussed above.

 

Benefit (Provision) for Income Taxes. Benefit from income taxes was $37.5 million during the three months ended March 31, 2020 compared to provision for income taxes of $3.1 million during the three months ended March 31, 2019. The effective income tax rate was a benefit of 27.4% for the three months ended March 31, 2020 as compared to a provision of 28.0% for the three months ended March 31, 2019.

 

Net Loss Attributable to Noncontrolling Interest. Net income attributable to noncontrolling interests represents the proportionate share of net income generated by BR Brand, 20% of the membership interest of which we do not own and Great American Global Partners, LLC, 50% of the membership interest of which we do not own. The net loss attributable to noncontrolling interests was $0.6 million during the three months ended March 31, 2020 compared to $44 thousand during the three months ended March 31, 2019.

 

Net (Loss) Income Attributable to the Company. Net loss attributable to the Company for the three months ended March 31, 2020 was $98.7 million, from net income attributable to the Company of $8.0 million for the three months ended March 31, 2019. The decrease in net income attributable to the Company during the three months ended March 31, 2020 as compared to the same period in 2019 was primarily due to a decrease in operating income of $146.1 million, an increase in interest expense of $4.9 million and a decrease in interest income of $0.4 million and an increase in loss attributable to noncontrolling interest of $0.5 million, partially offset by an increase in benefit from income taxes of $40.6 million and a decrease in loss from equity investments of $3.5 million.

 

Preferred Stock Dividends. On October 7, 2019, the Company closed its public offering of Depositary Shares, each representing 1/1000th of a share of 6.875% Series A Cumulative Perpetual Preferred Stock, par value $0.0001 per share. Holders of Series A Preferred Stock, when and as authorized by the board of directors of the Company, are entitled to cumulative cash dividends at the rate of 6.875% per annum of the $25,000 liquidation preference ($25.00 per Depositary Share) per year (equivalent to $1,718.75 or $1.71875 per Depositary Share). Dividends will be payable quarterly in arrears, on or about the last day of January, April, July and October. On January 9, 2020, the Company declared a cash dividend representing $0.4296875 per Depositary Share, which was paid on January 31, 2020 to holders of record as of the close of business on January 21, 2020.

 

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Net (Loss) Income Available to Common Shareholders. Net loss available to common shareholders for the three months ended March 31, 2020 was $99.7 million, from net income available to common shareholders of $8.0 million for the three months ended March 31, 2019. The increase in net loss available to common shareholders during the three months ended March 31, 2020 as compared to the same period in 2019 was primarily due to a decrease in operating income of $146.1 million, an increase in interest expense of $4.9 million, a decrease in interest income of $0.4 million and an increase in loss attributable to noncontrolling interest of $0.5 million and an increase in preferred stock dividends of $1.1 million, partially offset by an increase in benefit from income taxes of $40.6 million and a decrease in loss from equity investments of $3.5 million.

 

Liquidity and Capital Resources

 

Our operations are funded through a combination of existing cash on hand, cash generated from operations, borrowings under our senior notes payable, term loan and credit facility, and special purposes financing arrangements.

 

On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus (the “COVID-19 outbreak”). In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally. The full impact of the COVID-19 outbreak continues to evolve. The impact of the COVID-19 outbreak on the Company’s results of operations, financial position and cash flows will depend on future developments, including the duration and spread of the outbreak and related advisories and restrictions. These developments and the impact of the COVID-19 outbreak on the financial markets and the overall economy are highly uncertain and cannot be predicted. If the financial markets and/or the overall economy are impacted for an extended period, the Company’s results of operations, financial position and cash flows may be materially adversely affected.

 

During the three months ended March 31, 2020 and 2019, we generated net loss of $99.2 million and net income of $8.0 million, respectively. Our cash flows and profitability are impacted by the number and size of retail liquidation and capital markets engagements performed on a quarterly and annual basis.

 

As of March 31, 2020, we had $124.2 million of unrestricted cash and cash equivalents, $0.5 million of restricted cash, $287.8 million of securities and other investments held at fair value, $326.3 million of loans receivable, and $939.7 million of borrowings outstanding. The borrowings outstanding of $939.7 million at March 31, 2020 included (a) $125.5 million of borrowings from the issuance of the 7.50% 2027 Notes, (b) $122.5 million of borrowings from the issuance of the 7.25% 2027 Notes, (c) $127.4 million of borrowings from the issuance of the 7.375% 2023 Notes, (d) $113.1 million of borrowings from the issuance of the 6.875% 2023 Notes, (e) $110.5 million of borrowings from the issuance of the 6.75% 2024 Notes, (f) $134.7 million of borrowings from the issuance of the 6.50% 2026 Notes, (g) $130.9 million of borrowings from the issuance of the 6.375% 2025 Notes, (h) $61.9 million term loan borrowed pursuant to the BRPAC Credit Agreement discussed below, (i) $0.7 million of notes payable, and (j) $12.4 million of loan participations sold. We believe that our current cash and cash equivalents, securities and other investments owned, funds available under our asset based credit facility, and cash expected to be generated from operating activities will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months from issuance date of the accompanying financial statements. We continue to monitor our financial performance to ensure sufficient liquidity to fund operations and execute on our business plan.

 

From time to time, we may decide to pay dividends which will be dependent upon our financial condition and results of operations. On May 8, 2020, we declared a quarterly dividend of $0.25 per share which will be paid on or about June 10, 2020 to stockholders of record as of June 1, 2020. During the year ended December 31, 2019, we paid cash dividends on our common stock of $41.1 million. On March 3, 2020, the Board of Directors announced an increase to the regular quarterly dividend from $0.175 per share to $0.25 per share. While it is the Board’s current intention to make regular dividend payments of $0.25 per share each quarter and special dividend payments dependent upon exceptional circumstances from time to time, our Board of Directors may reduce or discontinue the payment of dividends at any time for any reason it deems relevant. The declaration and payment of any future dividends or repurchases of our common stock will be made at the discretion of our Board of Directors and will be dependent upon our financial condition, results of operations, cash flows, capital expenditures, and other factors that may be deemed relevant by our Board of Directors.

 

A summary of our common stock dividend activity for the three months ended March 31, 2020 and the year ended December 31, 2019 was as follows:

 

            Regular     Special     Total  
        Stockholder   Dividend     Dividend     Dividend  
Date Declared   Date Paid   Record Date   Amount     Amount     Amount  
March 3, 2020   March 31, 2020   March 17, 2020   $ 0.25      $ 0.10      $ 0.35  
October 30, 2019   November 26, 2019   November 14, 2019     0.175       0.475       0.650  
August 1, 2019   August 29, 2019   August 15, 2019     0.175       0.325       0.500  
May 1, 2019   May 29, 2019   May 15, 2019     0.08       0.18       0.26  
March 5, 2019   March 26, 2019   March 19, 2019     0.08       0.00       0.08  

 

Holders of Series A Preferred Stock, when and as authorized by the board of directors of the Company, are entitled to cumulative cash dividends at the rate of 6.875% per annum of the $25,000 liquidation preference ($25.00 per Depositary Share) per year (equivalent to $1,718.75 or $1.71875 per Depositary Share). Dividends will be payable quarterly in arrears, on or about the last day of January, April, July and October. As of March 31, 2020, dividends in arrears in respect of the Depositary Shares were $725. On January 9, 2020, the Company declared a cash dividend $0.4296875 per Depositary Share, which was paid on January 31, 2020 to holders of record as of the close of business on January 21, 2020. On April 13, 2020, the Company declared a cash dividend $0.4296875 per Depositary Share, which was paid on April 30, 2020 to holders of record as of the close of business on April 23, 2020. 

 

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Our principal sources of liquidity to finance our business are our existing cash on hand, cash generated from operations, borrowings under our senior notes payable, term loan and credit facility, issuances of common and preferred stock and special purpose financing arrangements.

 

Cash Flow Summary

 

   Three Months Ended 
   March 31, 
   2020   2019 
   (Dollars in thousands) 

Net cash provided by (used in):

        
Operating activities  $455   $8,924 
Investing activities   (71,492)   (26,513)
Financing activities   92,332    8,241 
Effect of foreign currency on cash   (1,332)   23 
Net increase (decrease) in cash, cash equivalents and restricted cash  $19,963   $(9,325)

 

Cash provided by in operating activities was $0.5 million during the three months ended March 31, 2020 compared to $8.9 million during the three months ended March 31, 2019. Cash provided by operating activities for the three months ended March 31, 2020 included net loss of $99.2 million adjusted for noncash items of $24.9 million and changes in operating assets and liabilities of $74.8 million. Noncash items of $24.9 million include (a) depreciation and amortization of $5.0 million, (b) share-based compensation of $5.3 million, (c) loss on equity investments of $0.2 million, (d) fair value adjustments of $17.9 million, (e) provision for doubtful accounts of $0.7 million, (f) income allocated for mandatorily redeemable noncontrolling interests of $0.2 million, (g) other noncash interest and other of $2.8 million, (h) deferred income taxes of $4.3 million, (i) impairment of intangibles and loss on disposal of fixed assets of $4.0 million and (j) gain on extinguishment of debt of $1.6 million. 

 

Cash used in investing activities was $71.5 million during the three months ended March 31, 2020 compared to cash used in investing activities of $26.5 million for the three months ended March 31, 2019. During the three months ended March 31, 2020, cash used in investing activities consisted of cash used for loans receivable of $115.3 million, repayments of loan participations sold of $0.2 million and cash used for purchases of property and equipment of $0.4 million, offset by cash received from loans receivable repayment of $42.1 million, sale of a loan receivable to a related party of $1.8 million, and dividends from equity investments of $0.6 million. During the three months ended March 31, 2019, cash used in investing activities consisted of cash used for loans receivable of $20.2 million, cash used for equity investments of $10.6 million and cash used for purchases of property and equipment of $1.7 million, cash received from loans receivable repayment of $5.5 million and dividends from equity investments of $0.4 million.

 

Cash provided by financing activities was $92.3 million during the three months ended March 31, 2020 compared to cash provided by financing activities of $8.2 million during the three months ended March 31, 2019. During the three months ended March 31, 2020, cash provided by financing activities primarily consisted of $171.1 million proceeds from issuance of senior notes and $4.6 million proceeds from issuance of preferred stock, offset by (a) $37.1 million used to repay our asset based credit facility, (b) $24.1 million used to repurchase our common stock, (c) $9.6 million used to pay dividends on our common shares, (d) $4.8 million use for repayment on our term loan, (e) $1.8 million used to repurchase our senior notes, (f) $2.7 million used to pay debt issuance costs, (g) $1.3 million distribution to noncontrolling interests, (h) $1.1 million used to pay dividends on our preferred shares (i) $0.5 million used for payment of employment taxes on vesting of restricted stock and (j) $0.4 million used to repay our other notes payable. During the three months ended March 31, 2019, cash provided by financing activities primarily consisted of $10.0 million proceeds from our term loan, $5.0 million proceeds from issuance of senior notes, offset by (a) $2.6 million used to buyback our common stocks, (b) $2.6 million used to pay cash dividends on our common stocks, (c) $0.7 million used for payment of employment taxes on vesting of restricted stock (d) $0.4 million used for repayment of notes payable, approximately $0.2 million used for debt issuance costs and (e) $0.3 million distribution to noncontrolling interests. 

 

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Credit Agreements

 

On April 21, 2017, we amended the asset based credit facility agreement (as amended, the “Credit Agreement”) with Wells Fargo Bank to increase the maximum borrowing limit from $100.0 million to $200.0 million. Such amendment, among other things, also extended the expiration date of the credit facility from July 15, 2018 to April 21, 2022. The Credit Agreement continues to allow for borrowings under the separate credit agreement (a “UK Credit Agreement”) which was dated March 19, 2015 with an affiliate of Wells Fargo Bank which provides for the financing of transactions in the United Kingdom with borrowings up to 50.0 million British Pounds. Any borrowing on the UK Credit Agreement reduce the availability of the asset based $200.0 million credit facility. The UK Credit Agreement is cross collateralized and integrated in certain respects with the Credit Agreement. The Credit Agreement continues to include the addition of our Canadian subsidiary, from the October 5, 2016 amendment to the Credit Agreement, to facilitate borrowings to fund retail liquidation transactions in Canada. From time to time, we utilize this credit facility to fund costs and expenses incurred in connection with liquidation engagements. We also utilize this credit facility in order to issue letters of credit in connection with liquidation engagements conducted on a guaranteed basis. Subject to certain limitations and offsets, we are permitted to borrow up to $200.0 million under the credit facility, less the aggregate principal amount borrowed under the UK Credit Agreement (if in effect). Borrowings under the credit facility are only made at the discretion of the lender and are generally required to be repaid within 180 days. The interest rate for each revolving credit advance under the related credit agreement is, subject to certain terms and conditions, equal to the LIBOR plus a margin of 2.25% to 3.25% depending on the type of advance and the percentage such advance represents of the related transaction for which such advance is provided. The credit facility is secured by the proceeds received for services rendered in connection with the liquidation service contracts pursuant to which any outstanding loan or letters of credit are issued and the assets that are sold at liquidation related to such contract, if any. The credit facility also provides for success fees in the amount of 2.5% to 17.5% of the net profits, if any, earned on liquidation engagements that are financed under the credit facility as set forth in the related credit agreement. We typically seek borrowings on an engagement-by- engagement basis. The credit agreement governing the credit facility contains certain covenants, including covenants that limit or restrict our ability to incur liens, incur indebtedness, make investments, dispose of assets, make certain restricted payments, merge or consolidate and enter into certain transactions with affiliates. There was no outstanding balance on this credit facility at March 31, 2020. The outstanding balance on this credit facility was $37.1 million at December 31, 2019. At March 31, 2020, there were no open letters of credit outstanding.

 

On December 19, 2018, BRPI Acquisition Co LLC (“BRPAC”), a Delaware limited liability company, UOL, and YMAX Corporation, Delaware corporations (collectively, the “Borrowers”), indirect wholly owned subsidiaries of the Company, in the capacity of borrowers, entered into a credit agreement with the Banc of California, N.A. in the capacity as agent and lender and with the other lenders party thereto (the “BRPAC Credit Agreement”). Under the BRPAC Credit Agreement, we borrowed $80.0 million due December 19, 2023. Pursuant to the terms of the BRPAC Credit Agreement, we may request additional optional term loans in an aggregate principal amount of up to $10.0 million at any time prior to the first anniversary of the agreement date. On February 1, 2019, the Borrowers entered into the First Amendment to Credit Agreement and Joinder with City National Bank as a new lender in which the new lender extended to Borrowers the additional $10.0 million as further discussed in Note 9 to the accompanying financial statements. The borrowings under the BRPAC Credit Agreement bear interest equal to the LIBOR plus a margin of 2.50% to 3.00% depending on the Borrowers’ consolidated total funded debt ratio as defined in the BRPAC Credit Agreement.

 

Borrowings under the BRPAC Credit Agreement are due in quarterly installments commencing on March 31, 2019 with any remaining amounts outstanding due at maturity. For the $80.0 million loan, quarterly installments from March 31, 2020 to December 31, 2022 are $4.2 million per quarter and from March 31, 2023 to December 31, 2023, the quarterly installments are $2.1 million per quarter. For the $10.0 million loan, quarterly installments from March 31, 2020 to December 31, 2022 are $0.6 million per quarter and from March 31, 2023 to December 31, 2023, the quarterly installments are $0.3 million per quarter. At March 31, 2020 and December 31, 2019, the outstanding balance of the term loan was $61.9 million (net of unamortized debt issuance costs of $0.5 million) and $66.7 million (net of unamortized debt issuance costs of $0.6 million), respectively.

 

Senior Note Offerings

 

During the three months ended March 31, 2020, we issued $38.8 million of senior notes due with maturities dates ranging from May 2023 to December 2027 pursuant to At the Market Issuance Sales Agreements with B. Riley FBR, Inc. which governs the program of at-the-market sales of our senior notes. We filed a series of prospectus supplements with the SEC which allowed us to sell these senior notes. 

 

On February 12, 2020, we issued $132.3 million of senior notes due in February 2025 (“6.375% 2025 Notes”) pursuant to the prospectus supplement dated February 10, 2020. Interest on the 6.375% 2025 Notes is payable quarterly at 6.375%. The 6.375% 2025 Notes are unsecured and due and payable in full on February 28, 2025. In connection with the issuance of the 6.375% 2025 Notes, we received net proceeds of $129.2 million (after underwriting commissions, fees and other issuance costs of $3.0 million).

 

During March 2020, we repurchased bonds with an aggregate face value of $3.4 million for $1.8 million resulting in a gain net of expenses of $1.6 million as of March 31, 2020. As part of the repurchase, we paid $30 thousand in interest accrued through the date of each respective repurchase. 

 

At March 31, 2020 and December 31, 2019, the total senior notes outstanding was $853.5 million (net of unamortized debt issue costs of $11.1 million) and $688.1 million (net of unamortized debt issue costs of $8.9 million) with a weighted average interest rate of 6.94% and 7.05%, respectively. Interest on senior notes is payable on a quarterly basis. Interest expense on senior notes totaled $14.3 million and $8.9 million for the three months ended March 31, 2020 and 2019, respectively.

 

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On February 14, 2020, we entered into a new At Market Issuance Sales Agreement (the “February 2020 Sales Agreement”) with B. Riley FBR, Inc. governing a program of at-the-market sales of certain of our senior notes. The most recent sales agreement prospectus was filed by us with the SEC on February 14, 2020 (the “February 2020 Sales Agreement Prospectus”). The Sales Agreement Prospectus allows us to sell up to $150.0 million of certain of our senior notes pursuant to an effective Registration Statement on Form S-3. As of March 31, 2020, we had $148.4 million remaining availability under the February 2020 Sales Agreement.

 

Off Balance Sheet Arrangements

 

As part of our investment banking and financial services activities, from time to time we enter into guaranties of debt, commitments of other entities, and similar transactions that may be considered off-balance sheet arrangements.

 

B&W Credit Agreement and Backstop

 

On January 31, 2020, the Company provided Babcock & Wilcox Enterprises, Inc. (“B&W”) $30 million of additional Tranche A-4 last out term loans pursuant to Amendment No. 20 (“Amendment No. 20”) to the Credit Agreement, dated May 11, 2015 (as amended to date, the “B&W Credit Agreement”) with Bank of America, N.A., as administrative agent and lender, and the other lenders party thereto. The Company is a lender with respect to B&W’s existing last out term loans under the Credit Agreement. Kenneth Young, our President, is the Chief Executive Officer of B&W. Pursuant to Amendment No. 20, B&W and the lenders, including the Company, also agreed upon a term sheet pursuant to which B&W would undertake a refinancing transaction on or prior to May 11, 2020 (the “Refinancing”) and B&W and the lenders, including the Company, would amend and restate the Credit Agreement on the terms specified therein. As part of the Refinancing, the size of B&W’s board of directors may also be reduced to 5 members, with the Company retaining the ability to appoint 2 members. On January 31, 2020, B&W also entered into a letter agreement with the Company (the “Backstop Commitment Letter”) pursuant to which the Company agreed to fund any shortfall in the $200 million of new debt or equity financing required as part of the terms of the Refinancing to the extent such amounts have not been raised from third parties on the same terms contemplated by the Refinancing. The Company, B&W and the lenders that are a party to B&W’s existing credit agreement are in negotiations to amend and restate B&W’s existing credit agreement, which would include, among other things, an extension of the maturity of amounts outstanding under the credit facility, the termination of the Backstop Commitment Letter, the commitment by an affiliate of the Company to provide up to $70.0 million in additional term loan financing incrementally over the duration of the amended credit facility, and a limited guaranty by the Company of B&W’s obligations under the amended credit facility. 

 

Franchise Group Commitment Letter and Loan Participant Guaranty

 

Commitment Letter

 

On February 14, 2020, affiliates of Franchise Group, Inc. (collectively with all of its affiliates, “FRG”) entered into an ABL Credit Agreement (the “Franchise Credit Agreement”), with GACP Finance Co., LLC (“GACP Finance”) as administrative agent and collateral agent, and the lenders from time to time party thereto, pursuant to which the lenders provided an asset based credit facility to FRG in an aggregate principal amount of $100.0 million. In connection with the Franchise Credit Agreement, the Company entered into a commitment letter, dated as of February 14, 2020 (the “Commitment Letter”), pursuant to which the Company committed to provide a $100.0 million asset based lending facility to FRG, on April 14, 2020 if, on or before such date, the obligations under the Franchise Credit Agreement are not refinanced in full. On May 1, 2020, we extended our commitment under the Commitment Letter until 30 days prior to the maturity date which is currently set forth in the Franchise Credit Agreement as September 30, 2020.

 

The Loan Participant Guaranty

 

On February 14, 2020 FRG, the lenders from time to time party thereto and GACP Finance as administrative agent, entered into a Credit Agreement (the “Term Loan Credit Agreement”), pursuant to which the lenders provided a term loan facility to FRG in an aggregate principal amount of $575.0 million.

 

On February 19, 2020, the Company entered into a limited guaranty (the “Loan Participant Guaranty”) to one of the lenders under the Term Loan Credit Agreement (the “Loan Participant”) pursuant to which the Company guaranteed the payment when due of certain obligations, including principal, interest, and other amounts payable to the Loan Participant under the Term Loan Credit Agreement in an amount not to exceed $50.0 million plus certain expenses of the Loan Participant and certain protective advances related to such guaranteed obligations (the “Loan Participant Guaranteed Obligations”). The Loan Participant may require payment of the Loan Participant Guaranteed Obligations by the Company upon the occurrence of certain guarantor events of default, including payment or bankruptcy events of default, in each case pursuant to the Term Loan Credit Agreement. The Loan Participant Guaranty remains in effect until the date that the Loan Participant Guaranteed Obligations have been paid in full.

 

The Loan Participant Guaranteed Obligations are unsecured obligations of the Company and rank equally in right of payment with all of the Company’s other existing and future unsecured and unsubordinated indebtedness. The Loan Participant Guaranteed Obligations are effectively subordinated in right of payment to all of the Company’s existing and future secured indebtedness and structurally subordinated to all existing and future indebtedness of the Company’s subsidiaries, including trade payables.

 

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CIBC Guaranty

 

On February 14, 2020, the Company entered into a limited guaranty (the “CIBC Guaranty”) in favor of CIBC Bank USA (“CIBC”), pursuant to which the Company guaranteed the payment when due of certain obligations, including all principal, interest, and other amounts that shall be at any time payable by FRG under FRG’s credit agreement with CIBC and the lenders party thereto, dated as of May 16, 2019, as amended (the “CIBC Credit Agreement”) in an amount not to exceed $125.0 million plus certain expenses of CIBC related to such guaranteed obligations (the “CIBC Guaranteed Obligations”). CIBC may require payment of the CIBC Guaranteed Obligations by the Company upon the occurrence of either (a) the failure of FRG to pay any principal of any loan or any reimbursement obligation in respect of any letter of credit disbursement or (b) the failure of FRG to pay any interest on any loan or on any reimbursement obligation in respect of any letter of credit disbursement within five business days of the date due, in each case pursuant to the CIBC Credit Agreement. The CIBC Guaranty remains in effect until the earlier of (a) the date that the CIBC Guaranteed Obligations have been paid in full and (b) June 30, 2020.

 

The CIBC Guaranteed Obligations are unsecured obligations of the Company and rank equally in right of payment with all of the Company’s other existing and future unsecured and unsubordinated indebtedness. The CIBC Guaranteed Obligations are effectively subordinated in right of payment to all of the Company’s existing and future secured indebtedness and structurally subordinated to all existing and future indebtedness of the Company’s subsidiaries, including trade payables.

 

Except as disclosed above, we have no material obligations, assets or liabilities which would be considered off-balance sheet arrangements and do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, established for the purpose of facilitating off-balance sheet arrangements.

 

Contractual Obligations

 

In February 2020, we issued $132.3 million of our 6.375% 2025 Notes, which are due and payable in full on February 28, 2025. As a result, our total senior notes payable increased to $1,117.0 million as of March 31, 2020 and our senior notes payable due in more than 5 years increased to $560.5 million. Additionally, our total contractual obligations increased to $1,295.8 million and our total payments due in more than 5 years increased to $585.2 million. There were no other material changes to our contractual obligations from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019.

 

Recent Accounting Standards

 

See Note 2(v) to the accompanying financial statements for recent accounting pronouncements we have not yet adopted and recently adopted.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

B. Riley’s primary exposure to market risk consists of risk related to changes in interest rates. B. Riley has not used derivative financial instruments for speculation or trading purposes.

 

Interest Rate Risk

 

Our primary exposure to market risk consists of risk related to changes in interest rates. We utilize borrowings under our senior notes payable and credit facilities to fund costs and expenses incurred in connection with our acquisitions and retail liquidation engagements. Borrowings under our senior notes payable are at fixed interest rates and borrowings under our credit facilities bear interest at a floating rate of interest. We invest in loans receivable that primarily bear interest at floating rates of interest.

 

The primary objective of our investment activities is to preserve capital for the purpose of funding operations while at the same time maximizing the income we receive from investments without significantly increasing risk. To achieve these objectives, our investments allow us to maintain a portfolio of cash equivalents, short-term investments through a variety of securities owned that primarily includes common stocks, corporate bonds and investments in partnership interests, and loans receivable. Our cash and cash equivalents through March 31, 2020 included amounts in bank checking and liquid money market accounts. We may be exposed to interest rate risk through trading activities in convertible and fixed income securities as well as U.S. Treasury securities, however, based on our daily monitoring of this risk, we believe we currently have limited exposure to interest rate risk in these activities.

 

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Foreign Currency Risk

 

The majority of our operating activities are conducted in U.S. dollars. Revenues generated from our foreign subsidiaries totaled $0.9 million for the three months ended March 31, 2020 or 0.6% of our services and fees revenues of $159.3 million during the three months ended March 31, 2020. The financial statements of our foreign subsidiaries are translated into U.S. dollars at period-end rates, with the exception of revenues, costs and expenses, which are translated at average rates during the reporting period. We include gains and losses resulting from foreign currency transactions in income, while we exclude those resulting from translation of financial statements from income and include them as a component of accumulated other comprehensive loss. Transaction gains (losses), which were included in our condensed consolidated statements of operations, amounted to a gain of $0.9 million and a gain of $0.2 million during the three months ended March 31, 2020 and 2019, respectively. We may be exposed to foreign currency risk; however, our operating results during the three months ended March 31, 2020 included less than $1.0 million of revenues from our foreign subsidiaries and a 10% appreciation of the U.S. dollar relative to the local currency exchange rates would result in less than $0.1 million increase in our operating income and a 10% depreciation of the U.S. dollar relative to the local currency exchange rates would have resulted in a net decrease in our operating income of less than $0.1 million for the three months ended March 31, 2020. 

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

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

 

Under the supervision and with the participation of our management, including our Co-Chief Executive Officers and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures pursuant to Rule 13a-15 under the Exchange Act. Based upon the foregoing evaluation, our Co-Chief Executive Officers and our Chief Financial Officer concluded that as of March 31, 2020 our disclosure controls and procedures were not effective at the reasonable assurance level.

 

Changes in Internal Control over Financial Reporting

 

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

 

Remediation

 

Management has been implementing and continues to implement measures designed to ensure that the control deficiency contributing to the material weakness as of December 31, 2019 is remediated, such that the controls are designed, implemented, and operating effectively. The remediation actions include: (i) creating a related party oversight function and (ii) enhancing the related party policies and procedures with a specific focus on related party disclosures.

 

While we believe that these actions will be sufficient to remediate the material weakness, it will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively. We expect that the remediation of this material weakness will be completed prior to the end of fiscal 2020. 

 

Inherent Limitation on Effectiveness of Controls

 

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

 

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PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

The Company is subject to certain legal and other claims that arise in the ordinary course of its business. In particular, the Company and its subsidiaries are named in and subject to various proceedings and claims arising primarily from the Company’s securities business activities, including lawsuits, arbitration claims, class actions, and regulatory matters. Some of these claims seek substantial compensatory, punitive, or indeterminate damages. The Company and its subsidiaries are also involved in other reviews, investigations, and proceedings by governmental and self-regulatory organizations regarding the Company’s business, which may result in adverse judgments, settlements, fines, penalties, injunctions, and other relief. In view of the number and diversity of claims against the Company, the number of jurisdictions in which litigation is pending, and the inherent difficulty of predicting the outcome of litigation and other claims, the Company cannot state with certainty what the eventual outcome of pending litigation or other claims will be. Notwithstanding this uncertainty, the Company does not believe that the results of these claims are likely to have a material effect on its financial position or results of operations.

 

On August 11, 2017, a putative class action lawsuit titled Freedman v. magicJack VocalTec Ltd. et al., Case 9-17-cv-80940, was filed against magicJack and its Board of Directors in the United States District Court for the Southern District of Florida (Case No: 9:17-cv-80940-RLR). Oral arguments were held on for January 17, 2020 and the Company is awaiting the court’s decision. The Company cannot estimate the amount of potential liability, if any, that could arise from this matter.

 

On January 5, 2017, complaints filed in November 2015 and May 2016 naming MLV & Co. (“MLV”), a broker-dealer subsidiary of FBR, as a defendant in putative class action lawsuits alleging claims under the Securities Act, in connection with the offerings of Miller Energy Resources, Inc. (“Miller”) have been consolidated. The Master Consolidated Complaint, styled Gaynor v. Miller et al., is pending in the United States District Court for the Eastern District of Tennessee, and, like its predecessor complaints, continues to allege claims under Sections 11 and 12 of the Securities Act against nine underwriters for alleged material misrepresentations and omissions in the registration statement and prospectuses issued in connection with six offerings (February 13, 2013; May 8, 2013; June 28, 2013; September 26, 2013; October 17, 2013 (as to MLV only) and August 21, 2014) with an alleged aggregate offering price of approximately $151.0 million. Court ordered mediation before a federal magistrate took place on August 6, 2019, with no resolution. In December 2019, the Court remanded the case to state court.

 

In July 2017, an arbitration claim was filed with FINRA by Dominick & Dickerman LLC and Michael Campbell against WSI and Gary Wunderlich with respect to the acquisition by Wunderlich Investment Company, Inc. (“WIC”) (the parent corporation of WSI) of certain assets of Dominick & Dominick LLC in 2015. The Claimants allege that respondents overvalued WIC so that the purchase price paid to the Claimants in shares of WIC stock was artificially inflated. On April 7, 2020, the arbitration panel issued an award against B. Riley Wealth Management, LLC (formerly, Wunderlich Securities, Inc.) and Gary Wunderlich holding each party jointly and severally liable for damages, costs and expenses in an aggregate amount of $11.4 million. The Company recorded a loss accrual in the consolidated financial statements during the three months ended March 31, 2020. The Company filed a petition to vacate the arbitration award in the U.S. District Court for the Southern District of New York on May 5, 2020.

 

In December 2015, magicJack received a Letter of Inquiry (the “2015 LOI”) from the Enforcement Bureau (the “Bureau”) of the Federal Communications Commission (“FCC”) in which the Bureau indicated that it was investigating whether magicJack was subject to the FCC’s rules applicable to interconnected VoIP providers. magicJack believes that it is not an interconnected VoIP provider under current regulations and is not subject to the FCC rules. Previously, magicJack received similar letters of inquiry in 2010 and 2013, neither of which resulted in any enforcement action. magicJack responded to the 2015 LOI in February 2016. magicJack is currently participating in discussions with the FCC regarding a potential settlement.

 

Item 1A. Risk Factors.

 

Given the nature of our operations and services we provide, a wide range of factors could materially affect our operations and profitability. Changes in competitive, market and economic conditions also affect our operations. The risks and uncertainties described below are not the only risks and uncertainties facing us. Additional risks and uncertainties not presently known or that are currently considered to be immaterial may also materially and adversely affect our business operations or stock price. If any of the following risks or uncertainties occurs, our business, financial condition or operating results could materially suffer. These risk factors should be read carefully in connection with evaluating our business and in connection with the forward-looking statements and other information contained in this Quarterly Report on Form 10-Q. Any of the risks described in this Quarterly Report on Form 10-Q could materially affect our business, financial condition or future results and the actual outcome of matters as to which forward-looking statements are made. The risk factors below amend and supersede the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019.

 

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Our revenues and results of operations are volatile and difficult to predict.

 

Our revenues and results of operations fluctuate significantly from quarter to quarter, due to a number of factors. These factors include, but are not limited to, the following:

 

  Our ability to attract new clients and obtain additional business from our existing client base;
     
  The number, size and timing of mergers and acquisition transactions, capital raising transactions and other strategic advisory services where we act as an adviser on our Auction and Liquidation and investment banking engagements;
     
  The extent to which we acquire assets for resale, or guarantee a minimum return thereon, and our ability to resell those assets at favorable prices;
     
  Variability in the mix of revenues from the Auction and Liquidation and Valuation and Appraisal businesses;
     
  The rate of decline we experience from our dial-up and DSL Internet access pay accounts in our UOL business as customers continue to migrate to broadband access which provides faster Internet connection and download speeds offered by our competitors;
     
  The rate of growth of new service areas;
     
  The types of fees we charge clients, or other financial arrangements we enter into with clients; and
     
  Changes in general economic and market conditions, including the effects of the ongoing COVID-19 pandemic, or an outbreak of another highly infectious or contagious disease.

 

We have limited or no control over some of the factors set forth above and, as a result, may be unable to forecast our revenues accurately. For example, our investment banking revenues are typically earned upon the successful completion of a transaction, the timing of which is uncertain and beyond our control. A client’s acquisition transaction may be delayed or terminated because of a failure to agree upon final terms with the counterparty, failure to obtain necessary regulatory consents or board or stockholder approvals, failure to secure necessary financing, adverse market conditions or unexpected financial or other problems in the business of a client or a counterparty. If the parties fail to complete a transaction on which we are advising or an offering in which we are participating, we will earn little or no revenue from the contemplated transaction.

 

We rely on projections of revenues in developing our operating plans for the future and will base our expectations regarding expenses on these projections and plans. If we inaccurately forecast revenues and/or earnings, or fail to accurately project expenses, we may be unable to adjust our spending in a timely manner to compensate for these inaccuracies and, as a result, may suffer operating losses and such losses could have a negative impact on our financial condition and results of operations. If, for any reason, we fail to meet company, investor or analyst projections of revenue, growth or earnings, the market price of the common stock could decline and you may lose all or part of your investment.

 

Conditions in the financial markets and general economic conditions, including the ongoing COVID-19 pandemic, have impacted and may continue to impact our ability to generate business and revenues, which may cause significant fluctuations in our stock price.

 

Our business has been in the past, and we expect it in the future to be, be materially affected by conditions in the financial market and general economic conditions, such as the level and volatility of interest rates, investor sentiment, the availability and the cost of credit, the U.S. mortgage market, the U.S. real estate market, volatile energy prices, consumer confidence, unemployment, the adverse effects of events such as outbreaks of contagious disease (such as the ongoing COVID-19 pandemic), and geopolitical issues. Further, certain aspects of our business are cyclical in nature and changes in the current economic environment may require us to adjust our sales and marketing practices and react to different business opportunities and modes of competition. If we are not successful in reacting to changing economic conditions, we may lose business opportunities which could harm our financial condition.

 

Adverse economic developments, like the ongoing COVID-19 pandemic, can have an unpredictable impact on our business. For example, we are more likely to conduct auctions and liquidations in connection with insolvencies and store closures during periods of economic downturn relative to periods of economic expansion; however, temporary limits on businesses due to mandated “social distancing” measures and “stay at home” work restrictions have limited our ability to conduct auctions and liquidations.

 

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In addition, weakness or disruption in equity markets, such as the recent market volatility due to the ongoing COVID-19 pandemic, and diminished trading volume of securities could adversely impact our sales and trading business in the future. Any industry-wide declines in the size and number of underwritings and mergers and acquisitions transactions could also have an adverse effect on our investment banking revenues, which we are currently experiencing due to the ongoing COVID-19 pandemic. Reductions in the trading prices for equity securities, such as those that have occurred due to the ongoing COVID-19 pandemic, tend to reduce the transaction value of investment banking transactions, such as underwriting and mergers and acquisitions transactions, which in turn may reduce the fees we earn from these transactions. Market conditions may also affect the level and volatility of securities prices and the liquidity and value of investments in our funds and proprietary inventory, and we may not be able to manage our business’s exposure to these market conditions. In addition to these factors, deterioration in the financial markets or economic conditions, such as those that have occurred due to the ongoing COVID-19 pandemic, could materially affect our investment banking business in other ways, including the following:

 

  Our opportunity to act as underwriter or placement agent could be adversely affected by a reduction in the number and size of capital raising transactions or by competing sources of equity.

 

  The number and size of mergers and acquisitions transactions or other strategic advisory services where we act as adviser could be adversely affected by continued uncertainties in valuations related to asset quality and creditworthiness, volatility in the equity markets, and diminished access to financing.

 

  Market volatility could lead to a decline in the volume of transactions that we execute for our customers and, therefore, to a decline in the revenue we receive from commissions and spreads.

 

  We may experience losses in securities trading activities, or as a result of write-downs in the value of securities that we own, as a result of deteriorations in the businesses or creditworthiness of the issuers of such securities.

 

  We may experience losses or write downs in the realizable value of our proprietary investments due to the inability of companies we invest in to repay their borrowings.

 

  Our access to liquidity and the capital markets could be limited, preventing us from making proprietary investments and restricting our sales and trading businesses.

 

  We may incur unexpected costs or losses as a result of the bankruptcy or other failure of companies for which we have performed investment banking services to honor ongoing obligations such as indemnification or expense reimbursement agreements.

 

  Sudden sharp declines in market values of securities can result in illiquid markets and the failure of counterparties to perform their obligations, which could make it difficult for us to sell securities, hedge securities positions, and invest funds under management.

 

  As an introducing broker to clearing firms, we are responsible to the clearing firm and could be held liable for the defaults of our customers, including losses incurred as the result of a customer’s failure to meet a margin call. When we allow customers to purchase securities on margin, we are subject to risks inherent in extending credit. This risk increases when a market is rapidly declining and the value of the collateral held falls below the amount of a customer’s indebtedness. If a customer’s account is liquidated as the result of a margin call, we are liable to our clearing firm for any deficiency.

 

  Competition in our investment banking, sales, and trading businesses could intensify as a result of the increasing pressures on financial services companies and larger firms competing for transactions and business that historically would have been too small for them to consider.

 

  Market volatility could result in lower prices for securities, which may result in reduced management fees calculated as a percentage of assets under management.

 

  Market declines could increase claims and litigation, including arbitration claims from customers.

 

  Our industry could face increased regulation as a result of legislative or regulatory initiatives. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.

 

  Government intervention may not succeed in improving the financial and credit markets and may have negative consequences for our business.

 

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It is difficult to predict how long the current financial market and economic conditions related to the ongoing COVID-19 pandemic will continue, whether they will further deteriorate and if they do, which of our business lines will be adversely affected. We are currently being impacted by the ongoing COVID-19 pandemic, including with respect to the above-described risks. While we are continuing to monitor the spread of COVID-19 and related risks, the rapid development and fluidity of situation precludes any prediction as to its ultimate impact on us. However, if the spread continues, such impact could grow and our business, financial condition, results of operations and cash flows could be materially adversely affected.

 

Global economic and political uncertainty, in particular due to the ongoing COVID-19 pandemic, could adversely affect our revenue and results of operations.

 

As a result of the international nature of our business, we are subject to the risks arising from adverse changes in global economic and political conditions. Uncertainty about the effects of current and future economic and political conditions on us, our customers, suppliers and partners makes it difficult for us to forecast operating results and to make decisions about future investments. Deterioration in economic conditions in any of the countries in which we do business could result in reductions in sales of our products and services and could cause slower or impaired collections on accounts receivable, which may adversely impact our liquidity and financial condition.

 

The ongoing COVID-19 pandemic has caused severe disruptions in the U.S. and global economy, which has impacted the business, activities, and operations of our customers, as well as our business and operations. In March 2020, the Federal Reserve lowered the target range for the federal funds rate to a range from 0 to 0.25 percent, citing concerns about the impact of COVID-19 on markets and stress in the energy sector. Many states and localities have imposed limitations on commercial activity and public gatherings and events, as well as moratoria on evictions. Concern about the spread of COVID-19 has caused and is likely to continue to cause quarantines, business shutdowns, reduction in business activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and overall economic and financial market instability, all of which may result a decrease in our business. Such conditions are likely to exacerbate many of the risks described elsewhere in these Risk Factors. Unfavorable economic conditions may also make it more difficult for us to access the capital markets, use the capital markets for our clients or otherwise obtain additional financing.

 

The continued spread of COVID-19, or a significant outbreak of another contagious disease, could negatively impact the availability of key personnel necessary to conduct our business, and the business and operations of our third-party service providers who perform critical services for our business. If COVID-19, or a future highly infectious or contagious disease, is not successfully contained, we could experience a material adverse effect on our business, financial condition, results of operations and cash flow. Among the factors outside our control that are likely to affect the impact the COVID-19 pandemic will ultimately have on our business are:

 

the pandemic’s course and severity;

 

the direct and indirect results of the pandemic, such as recessionary economic trends, including with respect to employment, wages and benefits and commercial activity;

 

political, legal and regulatory actions and policies in response to the pandemic, including the effects of restrictions on commerce or other public activities, moratoria and other suspensions of evictions or rent and related obligations;

 

the timing, magnitude and effect of public spending, directly or through subsidies, its direct and indirect effects on commercial activity and incentives of employers and individuals to resume or increase employment, wages and benefits and commercial activity;

 

the timing and availability of direct and indirect governmental support for various financial assets, and possible related distortions in market values and liquidity for such assets whose markets have or are assumed to have government support versus possibly similar assets that do not;

 

potential longer-term effects of increased government spending on the interest rate environment and borrowing costs for non-governmental parties;

 

the ability of our employees and our third-party vendors to work effectively during the course of the pandemic;

 

potential longer-term shifts toward telecommuting and telecommerce; and

 

geographic variation in the severity and duration of the COVID-19 pandemic, including in states such as New York and California where high percentages of our clients, customers and personnel are located.

 

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We focus principally on certain sectors of the economy in our investment banking operations, and deterioration in the business environment in these sectors or a decline in the market for securities of companies within these sectors could harm our business.

 

Volatility in the business environment in the industries in which our clients operate or in the market for securities of companies within these industries could adversely affect our financial results and the market value of our common stock. The business environment for companies in some of these industries has been subject to high levels of volatility in recent years, and our financial results have consequently been subject to significant variations from year to year. For example, the consumer goods and services sectors are subject to consumer spending trends, which have been volatile, to mall traffic trends, which have been down, to the availability of credit, and to broader trends such as the rise of Internet retailers. Most recently, the consumer goods and services sector has been severely impacted by the ongoing COVID-19 pandemic, which has resulted in mandatory store closures of uncertain duration due to “social distancing” measures, “stay at home” work restrictions and the closing of non-essential businesses imposed to control the pandemic. Emerging markets have driven the growth of certain consumer companies but emerging market economies are fragile, subject to wide swings in GDP, and subject to changes in foreign currencies. The technology industry has been volatile, driven by evolving technology trends, by technological obsolescence, by enterprise spending, and by changes in the capital spending trends of major corporations and government agencies around the world.

 

Our investment banking operations focus on various sectors of the economy, and we also depend significantly on private company transactions for sources of revenues and potential business opportunities. Most of these private company clients are initially funded and controlled by private equity firms. To the extent that the pace of these private company transactions slows or the average transaction size declines due to a decrease in private equity financings, difficult market conditions, such as those due to the ongoing COVID-19 pandemic, in our target industries or other factors, our business and results of operations may be harmed.

 

Underwriting and other corporate finance transactions, strategic advisory engagements and related sales and trading activities in our target industries represent a significant portion of our investment banking business. This concentration of activity in our target industries exposes us to the risk of declines in revenues in the event of downturns in these industries, such as those due to the ongoing COVID-19 pandemic.

 

Our corporate finance and strategic advisory engagements are singular in nature and do not generally provide for subsequent engagements.

 

Our investment banking clients generally retain us on a short-term, engagement-by-engagement basis in connection with specific corporate finance, merger and acquisition transactions (often as an advisor in company sale transactions) and other strategic advisory services, rather than on a recurring basis under long-term contracts. As these transactions are typically singular in nature and our engagements with these clients may not recur, we must seek new engagements when our current engagements are successfully completed or are terminated. As a result, high activity levels in any period are not necessarily indicative of continued high levels of activity in any subsequent period. If we are unable to generate a substantial number of new engagements that generate fees from new or existing clients, our business, results of operations and financial condition could be adversely affected.

 

The asset management business is intensely competitive.

 

Over the past several years, the size and number of asset management funds, including hedge funds and mutual funds, has continued to increase. If this trend continues, it is possible that it will become increasingly difficult for our funds to raise capital. More significantly, the allocation of increasing amounts of capital to alternative investment strategies by institutional and individual investors leads to a reduction in the size and duration of pricing inefficiencies. Many alternative investment strategies seek to exploit these inefficiencies and, in certain industries, this drives prices for investments higher, in either case increasing the difficulty of achieving targeted returns. In addition, if interest rates were to rise or there were to be a prolonged bull market in equities, the attractiveness of our funds relative to investments in other investment products could decrease. Competition is based on a variety of factors, including:

 

  investment performance;

 

  investor perception of the drive, focus and alignment of interest of an investment manager;

 

  quality of service provided to and duration of relationship with investors;

 

  business reputation; and

 

  level of fees and expenses charged for services.

 

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We compete in the asset management business with a large number of investment management firms, private equity fund sponsors, hedge fund sponsors and other financial institutions. A number of factors serve to increase our competitive risks, as follows:

 

  investors may develop concerns that we will allow a fund to grow to the detriment of its performance;

 

  some of our competitors have greater capital, lower targeted returns or greater sector or investment strategy specific expertise than we do, which creates competitive disadvantages with respect to investment opportunities;

 

  some of our competitors may perceive risk differently than we do which could allow them either to outbid us for investments in particular sectors or, generally, to consider a wider variety of investments;

 

  there are relatively few barriers to entry impeding new asset management firms, and the successful efforts of new entrants into our various lines of business, including former “star” portfolio managers at large diversified financial institutions as well as such institutions themselves, will continue to result in increased competition; and

 

  other industry participants in the asset management business continuously seek to recruit our best and brightest investment professionals away from us.

 

These and other factors could reduce our earnings and revenues and adversely affect our business. In addition, if we are forced to compete with other alternative asset managers on the basis of price, we may not be able to maintain our current base management and incentive fee structures. We have historically competed primarily on the performance of our funds, and not on the level of our fees relative to those of our competitors. However, there is a risk that fees in the alternative investment management industry will decline, without regard to the historical performance of a manager, including our managers. Fee reductions on our existing or future funds, without corresponding decreases in our cost structure, would adversely affect our revenues and distributable earnings.

 

Poor investment performance may decrease assets under management and reduce revenues from and the profitability of our asset management business.

 

Revenues from our asset management business are primarily derived from asset management fees. Asset management fees are generally comprised of management and incentive fees. Management fees are typically based on assets under management, and incentive fees are earned on a quarterly or annual basis only if the return on our managed accounts exceeds a certain threshold return, or “highwater mark,” for each investor. We will not earn incentive fee income during a particular period, even when a fund had positive returns in that period, if we do not generate cumulative performance that surpasses a highwater mark. If a fund experiences losses, we will not earn incentive fees with regard to investors in that fund until its returns exceed the relevant highwater mark.

 

In addition, investment performance is one of the most important factors in retaining existing investors and competing for new asset management business. Investment performance may be poor as a result of the current or future difficult market or economic conditions, including changes in interest rates or inflation, terrorism, widespread outbreaks of disease, such as the ongoing COVID-19 pandemic, or political uncertainty, our investment style, the particular investments that we make, and other factors. Poor investment performance may result in a decline in our revenues and income by causing (i) the net asset value of the assets under our management to decrease, which would result in lower management fees to us, (ii) lower investment returns, resulting in a reduction of incentive fee income to us, and (iii) investor redemptions, which would result in lower fees to us because we would have fewer assets under management.

 

To the extent our future investment performance is perceived to be poor in either relative or absolute terms, the revenues and profitability of our asset management business will likely be reduced and our ability to grow existing funds and raise new funds in the future will likely be impaired.

 

The historical returns of our funds may not be indicative of the future results of our funds.

 

The historical returns of our funds should not be considered indicative of the future results that should be expected from such funds or from any future funds we may raise. Our rates of returns reflect unrealized gains, as of the applicable measurement date, which may never be realized due to changes in market and other conditions not in our control that may adversely affect the ultimate value realized from the investments in a fund. The returns of our funds may have also benefited from investment opportunities and general market conditions that may not repeat themselves, and there can be no assurance that our current or future funds will be able to avail themselves of profitable investment opportunities. Furthermore, the historical and potential future returns of the funds we manage also may not necessarily bear any relationship to potential returns on our common stock.

 

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We are subject to risks in using custodians.

 

Our asset management subsidiary and its managed funds depend on the services of custodians to settle and report securities transactions. In the event of the insolvency of a custodian, our funds might not be able to recover equivalent assets in whole or in part as they will rank among the custodian’s unsecured creditors in relation to assets which the custodian borrows, lends or otherwise uses. In addition, cash held by our funds with the custodian will not be segregated from the custodian’s own cash, and the funds will therefore rank as unsecured creditors in relation thereto.

 

We may suffer losses if our reputation is harmed.

 

Our ability to attract and retain customers and employees may be diminished to the extent our reputation is damaged. If we fail, or are perceived to fail, to address various issues that may give rise to reputational risk, we could harm our business prospects. These issues include, but are not limited to, appropriately dealing with market dynamics, potential conflicts of interest, legal and regulatory requirements, ethical issues, customer privacy, record-keeping, sales and trading practices, and the proper identification of the legal, reputational, credit, liquidity and market risks inherent in our products and services. Failure to appropriately address these issues could give rise to loss of existing or future business, financial loss, and legal or regulatory liability, including complaints, claims and enforcement proceedings against us, which could, in turn, subject us to fines, judgments and other penalties. In addition, our Capital Markets operations depend to a large extent on our relationships with our clients and reputation for integrity and high-caliber professional services to attract and retain clients. As a result, if a client is not satisfied with our services, it may be more damaging in our business than in other businesses.

 

Our Capital Markets operations are highly dependent on communications, information and other systems and third parties, and any systems failures could significantly disrupt our Capital Markets business.

 

Our data and transaction processing, custody, financial, accounting and other technology and operating systems are essential to our Capital Markets operations. A system malfunction (due to hardware failure, capacity overload, security incident, data corruption, etc.) or mistake made relating to the processing of transactions could result in financial loss, liability to clients, regulatory intervention, reputational damage and constraints on our ability to grow. We outsource a substantial portion of our critical data processing activities, including trade processing and back office data processing. We also contract with third parties for market data and other services. In the event that any of these service providers fails to adequately perform such services or the relationship between that service provider and us is terminated, we may experience a significant disruption in our operations, including our ability to timely and accurately process transactions or maintain complete and accurate records of those transactions.

 

Adapting or developing our technology systems to meet new regulatory requirements, client needs, expansion and industry demands also is critical for our business. Introduction of new technologies present new challenges on a regular basis. We have an ongoing need to upgrade and improve our various technology systems, including our data and transaction processing, financial, accounting, risk management and trading systems. This need could present operational issues or require significant capital spending. It also may require us to make additional investments in technology systems and may require us to reevaluate the current value and/or expected useful lives of our technology systems, which could negatively impact our results of operations.

 

Secure processing, storage and transmission of confidential and other information in our internal and outsourced computer systems and networks also is critically important to our business. We take protective measures and endeavor to modify them as circumstances warrant. However, our computer systems and software are subject to unauthorized access, computer viruses or other malicious code, inadvertent, erroneous or intercepted transmission of information (including by e-mail), and other events that have had an information security impact. If one or more of such events occur, this potentially could jeopardize our or our clients’ or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, our clients’, our counterparties’ or third parties’ operations. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us.

 

A disruption in the infrastructure that supports our business due to fire, natural disaster, health emergency (for example, the ongoing COVID-19 pandemic), power or communication failure, act of terrorism or war may affect our ability to service and interact with our clients. If we are not able to implement contingency plans effectively, any such disruption could harm our results of operations. Due to the ongoing COVID-19 pandemic, many businesses, including ours, have shifted largely to telecommuting. While we continue to evaluate the situation and invest in our technological infrastructure, the duration and effects of this shift are uncertain, but could make our operations more vulnerable.

 

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The growth of electronic trading and the introduction of new technology in the markets in which our market-making business operates may adversely affect this business and may increase competition.

 

The continued growth of electronic trading and the introduction of new technologies is changing our market-making business and presenting new challenges. Securities, futures and options transactions are increasingly occurring electronically, through alternative trading systems. We expect that the trend toward alternative trading systems will continue to accelerate. This acceleration could further increase program trading, increase the speed of transactions and decrease our ability to participate in transactions as principal, which would reduce the profitability of our market-making business. Some of these alternative trading systems compete with our market-making business and with our algorithmic trading platform, and we may experience continued competitive pressures in these and other areas. Significant resources have been invested in the development of our electronic trading systems, which includes our at-the-market business, but there is no assurance that the revenues generated by these systems will yield an adequate return on the investment, particularly given the increased program trading and increased percentage of stocks trading off of the historically manual trading markets.

 

Pricing and other competitive pressures may impair the revenues of our sales and trading business.

 

We derive a significant portion of our revenues for our investment banking operations from our sales and trading business. There has been intense price competition and trading volume reduction in this business in recent years. In particular, the ability to execute trades electronically and through alternative trading systems has increased the downward pressure on per share trading commissions and spreads. We expect these trends toward alternative trading systems and downward pricing pressure in the business to continue. We experience competitive pressures in these and other areas in the future as some of our competitors seek to obtain market share by competing on the basis of price or by using their own capital to facilitate client trading activities. In addition, we face pressure from our larger competitors, many of whom are better able to offer a broader range of complementary products and services to clients in order to win their trading business. These larger competitors may also be better able to respond to changes in the research, brokerage and investment banking industries, to compete for skilled professionals, to finance acquisitions, to fund internal growth and to compete for market share generally. As we are committed to maintaining and improving our comprehensive research coverage in our target sectors to support our sales and trading business, we may be required to make substantial investments in our research capabilities to remain competitive. If we are unable to compete effectively in these areas, the revenues of our sales and trading business may decline, and our business, results of operations and financial condition may be harmed.

 

Some of our large institutional sales and trading clients in terms of brokerage revenues have entered into arrangements with us and other investment banking firms under which they separate payments for research products or services from trading commissions for sales and trading services, and pay for research directly in cash, instead of compensating the research providers through trading commissions (referred to as “soft dollar” practices). In addition, we have entered into certain commission sharing arrangements in which institutional clients execute trades with a limited number of brokers and instruct those brokers to allocate a portion of the commission directly to us or other broker-dealers for research or to an independent research provider. If more of such arrangements are reached between our clients and us, or if similar practices are adopted by more firms in the investment banking industry, we expect that would increase the competitive pressures on trading commissions and spreads and reduce the value our clients place on high quality research. Conversely, if we are unable to make similar arrangements with other investment managers that insist on separating trading commissions from research products, volumes and trading commissions in our sales and trading business also would likely decrease.

 

Larger and more frequent capital commitments in our trading and underwriting businesses increase the potential for significant losses.

 

Certain financial services firms make larger and more frequent commitments of capital in many of their activities. For example, in order to win business, some investment banks increasingly commit to purchase large blocks of stock from publicly traded issuers or significant stockholders, instead of the more traditional marketed underwriting process in which marketing is typically completed before an investment bank commits to purchase securities for resale. We have participated in this activity and expect to continue to do so and, as a result, we are subject to increased risk. Conversely, if we do not have sufficient regulatory capital to so participate, our business may suffer. Furthermore, we may suffer losses as a result of the positions taken in these transactions even when economic and market conditions are generally favorable for others in the industry.

 

We may increasingly commit our own capital as part of our trading business to facilitate client sales and trading activities. The number and size of these transactions may adversely affect our results of operations in a given period. We may also incur significant losses from our sales and trading activities due to market fluctuations and volatility in our results of operations. To the extent that we own assets, i.e., have long positions, in any of those markets, a downturn in the value of those assets or in those markets could result in losses. Conversely, to the extent that we have sold assets we do not own, i.e., have short positions, in any of those markets, an upturn in those markets could expose us to potentially large losses as we attempt to cover our short positions by acquiring assets in a rising market.

 

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We have made and may make Principal Investments in relatively high-risk, illiquid assets that often have significantly leveraged capital structures, and we may fail to realize any profits from these activities for a considerable period of time or lose some or all of the principal amount we invest in these activities.

 

From time to time, we use our capital, including on a leveraged basis, in proprietary investments in both private company and public company securities that may be illiquid and volatile. The equity securities of a privately-held entity in which we make a proprietary investment are likely to be restricted as to resale and are otherwise typically highly illiquid. In the case of fund or similar investments, our investments may be illiquid until such investment vehicles are liquidated. We expect that there will be restrictions on our ability to resell the securities that we acquire for a period of up to one year after we acquire those securities. Thereafter, a public market sale may be subject to volume limitations or dependent upon securing a registration statement for an initial and potentially secondary public offering of the securities. We may make Principal Investments that are significant relative to the overall capitalization of the investee company and resales of significant amounts of these securities might be subject to significant limitations and adversely affect the market and the sales price for the securities in which we invest. In addition, our Principal Investments may involve entities or businesses with capital structures that have significant leverage. The large amount of borrowing in the leveraged capital structure increases the risk of losses due to factors such as rising interest rates, downturns in the economy or deteriorations in the condition of the investment or its industry. In the event of defaults under borrowings, the assets being financed would be at risk of foreclosure, and we could lose our entire investment.

 

Even if we make an appropriate investment decision based on the intrinsic value of an enterprise, we cannot assure you that general market conditions will not cause the market value of our investments to decline. For example, an increase in interest rates, a general decline in the stock markets, such as the recent declines in the stock markets due to the ongoing COVID-19 pandemic, or other market and industry conditions adverse to companies of the type in which we invest and intend to invest could result in a decline in the value of our investments or a total loss of our investment.

 

In addition, some of these investments are, or may in the future be, in industries or sectors which are unstable, in distress or undergoing some uncertainty. Further, the companies in which we invest may rely on new or developing technologies or novel business models, or concentrate on markets which are or may be disproportionately impacted by pressures in the financial services and/or mortgage and real estate sectors, have not yet developed and which may never develop sufficiently to support successful operations, or their existing business operations may deteriorate or may not expand or perform as projected. Such investments may be subject to rapid changes in value caused by sudden company-specific or industry-wide developments. Contributing capital to these investments is risky, and we may lose some or all of the principal amount of our investments. There are no regularly quoted market prices for a number of the investments that we make. The value of our investments is determined using fair value methodologies described in valuation policies, which may consider, among other things, the nature of the investment, the expected cash flows from the investment, bid or ask prices provided by third parties for the investment and the trading price of recent sales of securities (in the case of publicly-traded securities), restrictions on transfer and other recognized valuation methodologies. The methodologies we use in valuing individual investments are based on estimates and assumptions specific to the particular investments. Therefore, the value of our investments does not necessarily reflect the prices that would actually be obtained by us when such investments are sold. Realizations, if any, at values significantly lower than the values at which investments have been reflected on our balance sheet would result in loses of potential incentive income and Principal Investments.

 

We are exposed to credit risk from a variety of our activities and we may not be able to fully realize the value of the collateral securing certain of our loans.

 

We are generally exposed to the risk that third parties that owe us money, securities or other assets will fail to meet their obligations to us due to numerous causes, including bankruptcy, lack of liquidity, or operational failure, among others. Additionally, when we guarantee or backstop the obligations of third parties, we are exposed to the risk that our guarantee or backstop may be called by the holder following a default by the primary obligor, which could cause us to incur significant losses, and, when our obligations are secured, expose us to the risk that the holder may seek to foreclose on collateral pledged by us.

 

We incur credit risk through loans, lines of credit, guarantees and backstop commitments issued to or on behalf of businesses and individuals, and other loans collateralized by a variety of assets, including securities. Our credit risk and credit losses can increase if our loans or investments are concentrated among borrowers or issuers engaged in the same or similar activities, industries, or geographies, or to borrowers or issuers who as a group may be uniquely or disproportionately affected by economic or market conditions. The deterioration of an individually large exposure, for example due to natural disasters, health emergencies or pandemics (like the ongoing COVID-19 pandemic), acts of terrorism, severe weather events or other adverse economic events, could lead to additional loan loss provisions and/or charges-offs, or credit impairment of our investments, and subsequently have a material impact on our net income and regulatory capital.

 

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The amount and duration of our credit exposures have been increasing over the past year, as have the breadth and size of the entities to which we have credit exposures.

 

We permit our clients to purchase securities on margin. During periods of steep declines in securities prices, the value of the collateral securing client margin loans may fall below the amount of the purchaser’s indebtedness. If clients are unable to provide additional collateral for these margin loans, we may incur losses on those margin transactions. This may cause us to incur additional expenses defending or pursuing claims or litigation related to counterparty or client defaults.

 

Although a substantial amount of our loans to counterparties are protected by holding security interests in the assets or equity interests of the borrower, we may not be able to fully realize the value of the collateral securing our loans due to one or more of the following factors:

 

  Our loans may be unsecured, therefore our liens on the collateral, if any, are subordinated to those of the senior secured debt of the borrower, if any. As a result, we may not be able to control remedies with respect to the collateral.

 

  The collateral may not be valuable enough to satisfy all of the obligations under our secured loan, particularly after giving effect to the repayment of secured debt of the borrower that ranks senior to our loan.

 

  Bankruptcy laws may limit our ability to realize value from the collateral and may delay the realization process.

 

  Our rights in the collateral may be adversely affected by the failure to perfect security interests in the collateral.

 

  The need to obtain regulatory and contractual consents could impair or impede how effectively the collateral would be liquidated and could affect the value received.

 

  Some or all of the collateral may be illiquid and may have no readily ascertainable market value. The liquidity and value of the collateral could be impaired as a result of changing economic conditions, competition, and other factors, including the availability of suitable buyers.

 

We may experience write downs of our investments and other losses related to the valuation of our investments and volatile and illiquid market conditions.

 

In our proprietary investment activities, our concentrated holdings, illiquidity and market volatility may make it difficult to value certain of our investment securities. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values of these securities in future periods. In addition, at the time of any sales and settlements of these securities, the price we ultimately realize will depend on the demand and liquidity in the market at that time and may be materially lower than their current fair value. Any of these factors could require us to take write downs in the value of our investment and securities portfolio, which may have an adverse effect on our results of operations in future periods.

 

Our underwriting and market making activities may place our capital at risk.

 

We may incur losses and be subject to reputational harm to the extent that, for any reason, we are unable to sell securities we purchased as an underwriter at the anticipated price levels. As an underwriter, we also are subject to heightened standards regarding liability for material misstatements or omissions in prospectuses and other offering documents relating to offerings we underwrite. Further, even though underwriting agreements with issuing companies typically include a right to indemnification in favor of the underwriter for these offerings to cover potential liability from any material misstatements or omissions, indemnification may be unavailable or insufficient in certain circumstances, for example if the issuing company has become insolvent. As a market maker, we may own large positions in specific securities, and these undiversified holdings concentrate the risk of market fluctuations and may result in greater losses than would be the case if our holdings were more diversified.

 

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Our businesses may be adversely affected by the disruptions in the credit markets, such as those due to the ongoing COVID-19 pandemic, including reduced access to credit and liquidity and higher costs of obtaining credit.