ALJ REGIONAL HOLDINGS INC - Quarter Report: 2017 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended June 30, 2017

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

For the transition period from to

Commission File Number: 001-37689

ALJ REGIONAL HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

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

244 Madison Avenue, PMB #358

New York, NY 10016

(Address of principal executive offices, Zip code)

(212) 883-0083

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

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

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

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

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

The number of shares of common stock, $0.01 par value per share, outstanding as of August 4, 2017 was 36,041,308.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes statements regarding our assumptions, projections, expectations, targets, intentions or beliefs about future events or other statements that are not historical facts. Forward-looking statements in this Quarterly Report on Form 10-Q include, without limitation, statements regarding management’s plans, our ability to continue to fund operations and our future sources of liquidity and capital resources, the execution of our strategy of buying attractively-valued assets, the expected synergies resulting from integrating acquisitions into our operations, the implementation of cost-savings measures at certain of our subsidiaries, our ability to improve operating margins, and the resolution of our current or potential litigation. Words or phrases such as “anticipates,” “may,” “will,” “should,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “targets,” “will likely result,” “will continue” or similar expressions are intended to identify forward-looking statements. These forward-looking statements are based on current assumptions and predictions and are subject to numerous risks and uncertainties. Actual results or events could differ materially from those set forth or implied by such forward-looking statements and related assumptions due to certain factors, including, without limitation, the risks set forth under the caption “Risk Factors” below.

Any forward-looking statements included in this Quarterly Report on Form 10-Q are made as of the date hereof, based on information available to us as of the date hereof, and, we assume no obligation to update any forward-looking statements.

ALJ REGIONAL HOLDINGS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED JUNE 30, 2017

INDEX

		Page
	PART I – FINANCIAL INFORMATION

Item 1	Financial Statements
	Condensed Consolidated Balance Sheets – June 30, 2017 and September 30, 2016	4
	Condensed Consolidated Statements of Income – Three and Nine Months Ended June 30, 2017 and 2016	5
	Condensed Consolidated Statements of Cash Flows – Nine Months Ended June 30, 2017 and 2016	6
	Notes to Condensed Consolidated Financial Statements	7

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3	Quantitative and Qualitative Disclosures About Market Risk	34

Item 4	Controls and Procedures	34

	PART II – OTHER INFORMATION

Item 1	Legal Proceedings	35

Item 1A	Risk Factors	36

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	49

Item 3	Defaults Upon Senior Securities	49

Item 4	Mine Safety Disclosures	49

Item 5	Other Information	49

Item 6	Exhibits	50

	Signatures	51

PART I. FINANCIAL INFORMATION

Item 1 - Financial Statements

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

	June 30,			September 30,
	2017			2016
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,876		$	5,279
Accounts receivable (net of allowances of $838 in 2017 and $830 in 2016)		50,607			44,288
Inventories, net		10,019			8,873
Prepaid expenses and other current assets		5,891			5,404
Assets held for sale		—			140
Total current assets		68,393			63,984
Property and equipment, net		52,590			51,811
Goodwill		54,964			53,417
Intangible assets, net		44,509			38,196
Collateral deposits, less current portion		879			2,179
Other assets		6,039			5,723
Total assets	$	227,374		$	215,310
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	13,059		$	13,258
Accrued expenses		12,401			10,614
Income taxes payable		894			633
Deferred revenue and customer deposits		6,941			2,981
Current portion of term loan, net of deferred loan costs		7,686			9,887
Current portion of capital lease obligations		1,978			2,046
Current portion of workers’ compensation reserve		1,031			1,053
Other current liabilities		420			1,679
Total current liabilities		44,410			42,151
Line of credit, less current portion, net of deferred loan costs		6,280			—
Term loan payable, less current portion, net of deferred loan costs		82,828			88,666
Deferred revenue, less current portion		3,404			3,783
Workers’ compensation reserve, less current portion		1,789			1,822
Capital lease obligations, less current portion		3,562			2,705
Deferred tax liability		2,037			1,430
Other non-current liabilities		2,198			806
Total liabilities		146,508			141,363
Commitments and contingencies (Note 8)
Stockholders’ equity:
Preferred stock, $0.01 par value; total authorized – 5,000,000 shares; 1,000,000 shares authorized for Series A; 550,000 shares authorized for Series B; none issued and outstanding as of June 30, 2017 and September 30, 2016		—			—
Common stock, $0.01 par value; authorized – 100,000,000 shares; 36,041,308 and 34,574,641 shares issued and outstanding at June 30, 2017 and September 30, 2016, respectively		360			346
Additional paid-in capital		275,372			270,370
Accumulated deficit		(194,866	)		(196,769	)
Total stockholders’ equity		80,866			73,947
Total liabilities and stockholders’ equity	$	227,374		$	215,310

See accompanying notes

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(in thousands, except per share amounts)

	Three Months Ended June 30,						Nine Months Ended June 30,
	2017			2016			2017			2016
Net revenue	$	83,473		$	64,857		$	240,386		$	195,933
Costs and expenses:
Cost of revenue		63,505			48,903			184,693			149,797
Selling, general, and administrative expense		16,431			11,962			45,728			36,798
(Gain) loss on disposal of assets, net		(4	)		2			8			(117	)
Total operating expenses		79,932			60,867			230,429			186,478
Operating income		3,541			3,990			9,957			9,455
Other (expense) income:
Interest expense, net		(2,302	)		(2,175	)		(7,020	)		(6,701	)
Other income		298			—			298			—
Total other, net		(2,004	)		(2,175	)		(6,722	)		(6,701	)
Income before income taxes		1,537			1,815			3,235			2,754
Provision for income taxes		(577	)		(407	)		(1,332	)		(579	)
Net income	$	960		$	1,408		$	1,903		$	2,175
Basic earnings per share of common stock	$	0.03		$	0.04		$	0.05		$	0.06
Diluted earnings per share of common stock	$	0.03		$	0.04		$	0.05		$	0.06
Weighted average shares of common stock outstanding:
Basic		35,139			34,698			34,763			34,902
Diluted		36,164			35,838			35,880			36,068

See accompanying notes

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)

	Nine Months Ended June 30,
	2017			2016
Operating activities
Net income	$	1,903		$	2,175
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization - cost of revenue		3,993			2,792
Depreciation and amortization - selling, general, and administrative expense		8,185			6,798
Stock-based compensation expense		563			689
Provision for bad debts		155			300
Deferred income taxes		607			18
Noncash (gain) loss, net		(290	)		(117	)
Amortization of deferred loan costs		772			741
Changes in operating assets and liabilities:
Accounts receivable, net		(3,034	)		(1,967	)
Inventories, net		(1,146	)		(743	)
Collateral deposits		1,300			1,821
Prepaid expenses and other current assets		886			1,028
Other assets		(156	)		(1,713	)
Accounts payable		(701	)		1,308
Accrued expenses		1,293			(961	)
Income tax payable		261			407
Deferred revenue and customer deposits		1,560			1,900
Workers’ compensation reserve		(55	)		(96	)
Other current liabilities		(760	)		(97	)
Other liabilities		1,392			(316	)
Cash provided by operating activities		16,728			13,967
Investing activities
Acquisitions, net of cash acquired		(8,037	)		—
Proceeds from sale of assets		152			945
Capital expenditures		(6,905	)		(3,183	)
Cash used by investing activities		(14,790	)		(2,238	)
Financing activities
Net proceeds (payments) on line of credit		6,458			(21	)
Payments on term loan		(8,795	)		(8,906	)
Repurchase of common stock		—			(2,063	)
Debt issuance costs		(194	)		(339	)
Payments on financed insurance premiums		(1,067	)		(806	)
Payments on capital leases		(1,743	)		(829	)
Cash used by financing activities		(5,341	)		(12,964	)
Change in cash and cash equivalents		(3,403	)		(1,235	)
Cash and cash equivalents at beginning of period		5,279			5,103
Cash and cash equivalents at end of period	$	1,876		$	3,868
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Taxes	$	588		$	155
Interest	$	6,283		$	5,991
Non-cash investing and financing activities:
Capital equipment purchases financed with capital leases	$	2,532		$	1,427
Financed insurance premiums	$	866		$	1,131
Issuance of common stock for acquisition	$	4,708		$	—

See accompanying notes

ALJ REGIONAL HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Basis of Presentation

Organization

ALJ Regional Holdings, Inc. (including subsidiaries, referred to collectively in this Report as “ALJ,” the “Company” or “we”) is a holding company. ALJ’s primary assets as of June 30, 2017, were all of the outstanding capital stock of the following companies:

•

Faneuil, Inc. (including its subsidiaries, “Faneuil”). Faneuil is a leading provider of call center services, back office operations, staffing services, and toll collection services to government and regulated commercial clients across the United States, focusing on the healthcare, utility, toll and transportation industries. Faneuil is headquartered in Hampton, Virginia. ALJ acquired Faneuil effective October 19, 2013.

•

Floors-N-More, LLC, d/b/a Carpets N’ More (“Carpets”). Carpets is one of the largest floor covering retailers in Las Vegas, Nevada, and a provider of multiple products, including all types of flooring, countertops, cabinets, window coverings and garage/closet organizers, for the commercial, retail and home builder markets. Carpets operates four retail locations, as well as a stone and solid surface fabrication facility. ALJ acquired Carpets effective April 1, 2014.

•

Phoenix Color Corp. (including its subsidiaries, “Phoenix”). Phoenix is a leading manufacturer of book components, educational materials and related products producing value-added components, heavily illustrated books and specialty commercial products using a broad spectrum of materials and decorative technologies. Phoenix is headquartered in Hagerstown, Maryland. ALJ acquired Phoenix effective August 9, 2015.

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

Basis of Presentation

The interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP, for interim financial information, with applicable rules and regulations of the Securities and Exchange Commission, or SEC, and with Article 10 of SEC Regulation S-X. They do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. Therefore, these financial statements should be read in conjunction with ALJ’s audited financial statements and notes thereto for the years ended September 30, 2016 and 2015, filed with the SEC on December 23, 2016.

The Company has made estimates and judgments affecting the amounts reported in its condensed consolidated financial statements and the accompanying notes. Significant estimates and assumptions by management are used for, but are not limited to, determining the fair value of assets and liabilities, including intangible assets acquired and allocation of acquisition purchase prices, estimated useful lives, recoverability of long-lived and intangible assets, the recoverability of goodwill, the realizability of deferred tax assets, stock-based compensation, the likelihood of material loss as a result of loss contingencies, customer lives, the allowance for doubtful accounts and inventory reserves, and calculation of insurance reserves. Actual results may differ materially from estimates. The interim financial information is unaudited but reflects all normal recurring accruals and adjustments that, in the opinion of management, are necessary to present fairly ALJ’s results of operations and financial position for the interim period. The results of operations for the three and nine months ended June 30, 2017, are not necessarily indicative of the results expected for future quarters or the full year. ALJ reclassified certain prior period amounts on the balance sheet to conform to current period presentation. See Note 2 – Accounting Standard Adopted for further discussion.

For a complete summary of ALJ’s significant accounting policies, please refer to Note 2, “Summary of Significant Accounting Policies,” included with ALJ’s audited financial statements and notes thereto for the years ended September 30, 2016 and 2015, filed with the SEC on December 23, 2016 as part of ALJ’s Annual Report on Form 10-K. There were no material changes to significant accounting policies during the nine months ended June 30, 2017.

2. Recent Accounting Standards

Accounting Standards Adopted

In February 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-02, “Amendments to the Consolidation Analysis.” ASU 2015-02 changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. ALJ adopted ASU 2015-02 on October 1, 2016. The standard did not have a significant impact on our condensed consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03 “Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs,” which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. ALJ adopted ASU 2015-03 on October 1, 2016. As a result of the adoption, ALJ made the following adjustments to the condensed consolidated balance sheet as of September 30, 2016: a $3.4 million decrease to total assets, a $1.0 million decrease to total current liabilities, and a $2.4 million decrease to non-current liabilities.

In September 2015, the FASB issued ASU 2015-16, “Business Combinations.” ASU 2015-16 simplifies the accounting for measurement-period adjustments by eliminating the requirement to restate prior period financial statements for measurement period adjustments. The new guidance requires the cumulative impact of measurement period adjustments, including the impact on prior periods, to be recognized in the reporting period in which the adjustment is identified. ALJ adopted ASU 2015-16 on October 1, 2016. The standard did not have a significant impact on our condensed consolidated financial statements.

Accounting Standards Not Yet Adopted

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” to supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than required under existing U.S. GAAP including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. Subsequently, the FASB has issued the following standards to provide additional clarification and implementation guidance for ASU 2014-09: (i) ASU 2016-08, “Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” (ii) ASU 2016-10, “Identifying Performance Obligations and Licensing,” and (iii) ASU 2016-12, “Narrow-Scope Improvements and Practical Expedients.” Management is currently assessing the effect that ASU 2014-09, including all subsequently issued standards, will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date and transition method for adoption. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In July 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory (Topic 330): Simplifying the Measurement of Inventory.” The amendments in ASU 2015-11 require an entity to measure inventory at the lower of cost or market. Market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. The amendments do not apply to inventory that is measured using last-in, first out (LIFO) or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost. The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. Management is currently assessing the effect that ASU 2015-11 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date and transition method for adoption. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In November 2015, the FASB issued ASU 2015-17, “Income Taxes,” to simplify the presentation of deferred taxes. This amendment requires that all deferred tax assets and liabilities, along with any related valuation allowances, be classified as noncurrent on the balance sheet. Management is currently assessing the effect that ASU 2015-17 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date and transition method for adoption. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In February 2016, the FASB issued ASU 2016-02, “Leases.” ASU 2016-02 requires companies to generally recognize on the balance sheet operating and financing lease liabilities and corresponding right-of-use assets. Management is currently assessing the effect that ASU 2016-02 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date and transition method for adoption. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation.” ASU 2016-09 simplifies the accounting for share-based payment transactions. Included in the update are modifications to the accounting for income taxes upon vesting or settlement of awards, employer tax withholding on shared-based compensation, forfeitures, and financial statement presentation of

excess tax benefits. Management is currently assessing the effect that ASU 2016-09 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date and transition method for adoption. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 provides new guidance that changes the accounting for recognizing impairments of financial assets. Under the new guidance, credit losses for certain types of financial instruments will be estimated based on expected losses. The new guidance also modifies the impairment models for available-for-sale debt securities and for purchased financial assets with credit deterioration since their origination. Management is currently assessing the effect that ASU 2016-13 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date and transition method for adoption. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In August 2016, the FASB issued ASU 2016-15, “Classification of Certain Cash Receipts and Cash Payments.” ASU 2016-15 provides new guidance related to the classification of certain cash receipts and cash payments on the statement of cash flows. Management is currently assessing the effect that ASU 2016-15 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date and transition method for adoption. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In October 2016, the FASB issued ASU 2016-16, “Intra-Entity Transfers of Assets Other Than Inventory.” ASU 2016-16 provides new guidance that changes the accounting for income tax effects of intra-entity transfers of assets other than inventory. Under the new guidance, the selling (transferring) entity is required to recognize a current tax expense or benefit upon transfer of the asset. Similarly, the purchasing (receiving) entity is required to recognize a deferred tax asset or deferred tax liability, as well as the related deferred tax benefit or expense, upon receipt of the asset. Management is currently assessing the effect that ASU 2016-16 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date and transition method for adoption. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In January 2017, the FASB issued ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. Management is currently assessing the effect that ASU 2017-04 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date and transition method for adoption. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In May 2017, the FASB issued ASU 2017-9, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which provides guidance about what changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. Per ASU 2017-9, an entity should account for the effects of a modification unless all the following are met: (1) the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification, (2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified, and (3) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to apply modification accounting under the amendments in ASU 2017-9. Management is currently assessing the effect that ASU 2017-9 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

In May 2017, the FASB issued ASU 2017-10, Service Concession Arrangements (Topic 853): Determining the Customer of the Operation Services, which eliminates uncertainty regarding how an operating entity determines the customer of the operation services for transactions within the scope of Topic 853. ASU 2017-10 clarifies that the grantor is the customer of the operation services in all cases for service concession arrangements within the scope of Topic 853. Management is currently assessing the effect that ASU 2017-10 will have on the Company’s consolidated financial statements and related disclosures. Included in management’s assessment is the determination of an effective adoption date. We expect to complete our initial assessment process, including the selection of an effective adoption date and transition method for adoption, by September 30, 2017.

3. Acquisition

Customer Management Outsourcing Business

On May 26, 2017 (the “CMO Business Purchase Date”), Faneuil acquired certain assets and assumed certain liabilities associated with the customer management outsourcing business (“CMO Business”) of Vertex Business Services LLC (“Vertex”) for an adjusted purchase price of $12.7 million. ALJ financed the acquisition with cash on hand, increased borrowings of $5.5 million on its line of credit, and the issuance of 1,466,667 shares of ALJ common stock. The common stock was valued at $3.21 per share, which was the closing price of the common stock as listed on the NASDAQ Global Market on the CMO Business Purchase Date.

The CMO Business, which was purchased to expand Faneuil’s presence into the utilities market, provides direct customer care call center operations, back-office processes, including billing, collections and business analytics, and installation and cloud-based customer care support exclusively for the utilities industry.

The following schedule reflects the estimated fair value of assets acquired and liabilities assumed on the CMO Business Purchase Date and the purchase price details (in thousands):

	Purchase Price
Balance Sheet Caption	Allocation
Total current assets	$	3,947
Fixed assets		553
Identified intangible assets:
Customer relationships		3,790
Supply agreements/contract backlog		5,418
Non-compete agreements		250
Goodwill		1,547
Total assets		15,505
Total current liabilities		(2,760	)
Purchase price	$	12,745

Break Out of Components of Purchase Price Consideration
Cash	$	2,537
Line of credit (note 7)		5,500
Common stock issued (note 9)		4,708
Purchase price	$	12,745

Impact of the CMO Business Acquisition to the Consolidated Results of Operations

The following is a summary of CMO Business revenue and earnings included in the Company’s consolidated statements of income for both the three and nine months ended June 30, 2017 (in thousands):

Income Statement Caption	Amount
Revenue	$	3,648
Operating income		1,067

The Company accounted for the CMO Business acquisition using the acquisition method of accounting. Accordingly, the assets and liabilities were recorded at their fair values at the date of acquisition. The excess of the purchase price over the fair value of the tangible and intangible assets acquired and the liabilities assumed was recorded as goodwill. During the measurement period, if new information is obtained about facts and circumstances that existed as of the acquisition date, cumulative changes in the estimated fair

values of the net assets recorded may change the amount of the purchase price allocable to goodwill. During the measurement period, which expires one year from the acquisition date, changes to any purchase price allocations that are material to the Company's consolidated financial results will be adjusted in the reporting period in which the adjustment amount is determined.

During the three months ended June 30, 2017, the Company incurred approximately $0.2 million of acquisition-related costs in connection with the CMO Business, which were expensed to selling, general, and administrative expense as incurred.

4. Concentration Risks

Cash

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

Major Customers and Accounts Receivable

ALJ did not have any customer with net revenue in excess of 10% of consolidated net revenue during the three or nine months ended June 30, 2017. ALJ had one customer with net revenue of 19.3% and 19.0% of consolidated net revenue for the three and nine months ended June 30, 2016. Each of ALJ’s segments had customers that represented more than 10% of their respective net revenue, as described below.

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

	Three Months Ended June 30,						Nine Months Ended June 30,
	2017			2016			2017			2016
Customer A		17.9	%		38.9	%		18.5	%		37.2	%
Customer B	**			**				13.8			12.8
Customer C	**			**				10.9		**

** Less than 10% of Faneuil net revenue.

Trade receivables from these customers totaled $5.3 million on June 30, 2017. As of June 30, 2017, all Faneuil accounts receivable were unsecured. Risk with respect to Faneuil accounts receivable is mitigated by credit evaluations performed on customers and the short duration of payment terms extended to customers.

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

	Three Months Ended June 30,					Nine Months Ended June 30,
	2017			2016		2017			2016
Customer A		38.4	%	**			33.6	%	**
Customer B		20.3			27.9		24.9			29.3
Customer C		18.2			27.1		17.7			24.8

** Less than 10% of Carpets net revenue.

Trade receivables from these customers totaled $5.9 million on June 30, 2017. As of June 30, 2017, all Carpets accounts receivable were unsecured. Risk with respect to Carpets accounts receivable is mitigated by credit evaluations performed on customers and the short duration of payment terms extended to customers.

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

	Three Months Ended June 30,						Nine Months Ended June 30,
	2017			2016			2017			2016
Customer A		13.5	%		15.2	%		18.1	%		19.7	%
Customer B		12.2			11.1			11.5		**
Customer C		11.4			16.6			10.0			12.9
Customer D	**				12.5		**			**

** Less than 10% of Phoenix net revenue.

Trade receivables from these customers totaled $1.5 million on June 30, 2017. As of June 30, 2017, all Phoenix accounts receivable were unsecured. Risk with respect to Phoenix accounts receivable is mitigated by credit evaluations performed on customers and the short duration of payment terms extended to customers.

Supplier Risk

ALJ did not have any suppliers that represented more than 10% of consolidated inventory purchases during the three or nine months ended June 30, 2017 or 2016. However, two of ALJ’s segments had suppliers that represented more than 10% of their respective inventory purchases, as described below.

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

	Three Months Ended June 30,						Nine Months Ended June 30,
	2017			2016			2017			2016
Supplier A		26.2	%		14.2	%		27.0	%		18.9	%
Supplier B	24.1			18.0			22.1				18.1
Supplier C	11.6			11.5			11.2			12.4

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

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

	Three Months Ended June 30,						Nine Months Ended June 30,
	2017			2016			2017			2016
Supplier A		25.0	%		32.3	%		28.3	%		31.1	%
Supplier B	**			15.3			**				12.8
Supplier C	**			**				10.2			11.4

** Less than 10% of Phoenix inventory purchases.

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

5. Composition of Certain Financial Statement Captions

Accounts Receivable

The following table summarizes accounts receivable at the end of each reporting period (in thousands):

	June 30,			September 30,
	2017			2016
Accounts receivable	$	46,122		$	40,597
Unbilled receivables		5,323			4,521
Total accounts receivable		51,445			45,118
Less: Allowance for doubtful accounts		(838	)		(830	)
Total accounts receivable, net	$	50,607		$	44,288

Inventories

The following table summarizes inventories at the end of each reporting period (in thousands):

	June 30,			September 30,
	2017			2016
Raw materials	$	3,406		$	3,248
Semi-finished goods/work in process		4,071			3,361
Finished goods		2,683			2,447
Total inventory		10,160			9,056
Less: Allowance for obsolete inventory		(141	)		(183	)
Total inventory, net	$	10,019		$	8,873

Property and Equipment

The following table summarizes property and equipment at the end of each reporting period (in thousands):

	June 30,			September 30,
	2017			2016
Computer and office equipment	$	9,017		$	7,983
Software		9,982			8,999
Furniture and fixtures		3,599			2,963
Leasehold improvements		8,810			5,983
Construction in process		257			240
Vehicles		228			216
Land		9,167			9,167
Building and improvements		15,614			15,591
Machinery and equipment		21,793			17,599
Total property and equipment		78,467			68,741
Less: Accumulated depreciation and amortization		(25,877	)		(16,930	)
Total property and equipment, net	$	52,590		$	51,811

Property and equipment depreciation and amortization expense, including amounts related to capitalized leased assets, was $3,035,000 and $2,291,000 for the three months ended June 30, 2017 and 2016, respectively, and $9,032,000 and $6,674,000 for the nine months ended June 30, 2017 and 2016, respectively.

Goodwill

The following table summarizes goodwill by reportable segment at the end of each reporting period (in thousands):

	June 30,		September 30,
	2017		2016
Faneuil	$	21,276	$	19,729
Carpets		2,555		2,555
Phoenix		31,133		31,133
Total goodwill	$	54,964	$	53,417

Intangible Assets

The following table summarizes identified intangible assets at the end of each reporting period (in thousands):

	June 30, 2017							September 30, 2016
	Gross		Accumulated Amortization			Net		Gross		Accumulated Amortization			Net
Customer relationships	$	34,400	$	(6,726	)	$	27,674	$	30,610	$	(4,816	)	$	25,794
Trade names		10,760		(1,035	)		9,725		10,760		(713	)		10,047
Internal software		580		(358	)		222		580		(285	)		295
Supply agreements/contract backlog		5,658		(144	)		5,514		240		(13	)		227
Non-compete agreements		3,590		(2,216	)		1,374		3,340		(1,507	)		1,833
Total intangible assets	$	54,988	$	(10,479	)	$	44,509	$	45,530	$	(7,334	)	$	38,196

Intangible asset amortization expense was $1,129,000 and $972,000 for the three months ended June 30, 2017 and 2016, respectively, and $3,146,000 and $2,916,000 for the nine months ended June 30, 2017 and 2016, respectively.

The following table presents expected future amortization expense for the remainder of 2017 and yearly thereafter (in thousands):

	Estimated Future Amortization
2017	$	1,330
2018		5,166
2019		4,786
2020		4,487
2021		4,172
Thereafter		24,568
Total estimated future amortization expense	$	44,509

Term Loan

The following table summarizes ALJ’s current and noncurrent term loan payables at the end of each reporting period (in thousands):

	June 30,			September 30,
	2017			2016
Line of credit:
Line of credit	$	6,458		$	—
Less: deferred loan costs		(178	)		—
Line of credit, net of deferred loan costs		6,280			—
Current portion of term loan:
Current portion of term loan	$	8,625		$	10,893
Less: deferred loan costs		(939	)		(1,006	)
Current portion of term loan, net of deferred loan costs		7,686			9,887
Term loan payable, less current portion:
Term loan payable, less current portion		84,549			91,076
Less: deferred loan costs		(1,721	)		(2,410	)
Term loan payable, less current portion, net of deferred loan costs	$	82,828		$	88,666

Accrued Expenses

The following table summarizes accrued expenses at the end of each reporting period (in thousands):

	June 30,		September 30,
	2017		2016
Accrued compensation and related taxes	$	7,179	$	6,103
Accrued board of director fees		520		130
Rebates payable		1,173		1,834
Interest payable		678		722
Medical and benefit-related expense payables		604		386
Sales tax payable		193		191
Deferred rent		267		155
Other		1,787		1,093
Total accrued expenses	$	12,401	$	10,614

Workers’ Compensation Reserve

Faneuil. Faneuil is self-insured for workers’ compensation claims up to $350,000 per incident, and maintains insurance coverage for costs above the specified limit. Faneuil is self-insured for health insurance claims up to $150,000 per incident, and maintains insurance coverage for costs above the specified limit. Reserves have been provided for workers’ compensation and health claims based upon insurance coverages, third-party actuarial analysis, and management’s judgment.

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

Phoenix. Before the acquisition of Phoenix by ALJ, Phoenix was self-insured for workers’ compensation under their parent company for claims up to $500,000 per incident, and maintains coverage for costs above the specified limit. After the acquisition, Phoenix changed to a fully insured plan.

6. Earnings Per Share

ALJ computed basic and diluted earnings per common share for each period as follows (in thousands, except per share amounts):

	Three Months Ended June 30,				Nine Months Ended June 30,
	2017		2016		2017		2016
Net income	$	960	$	1,408	$	1,903	$	2,175
Weighted average shares of common stock outstanding - basic		35,139		34,698		34,763		34,902
Potentially dilutive effect of options to purchase common stock		1,025		1,140		1,117		1,166
Weighted average shares of common stock outstanding – diluted		36,164		35,838		35,880		36,068
Basic earnings per share of common stock	$	0.03	$	0.04	$	0.05	$	0.06
Diluted earnings per share of common stock	$	0.03	$	0.04	$	0.05	$	0.06

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

7. Debt

Term Loan and Line of Credit

In August 2015, ALJ entered into a financing agreement (“Financing Agreement”) with Cerberus Business Finance, LLC (“Cerberus”), to borrow $105.0 million in a term loan (“Cerberus Term Loan”) and have available up to $30.0 million in a revolving loan (“Cerberus/PNC Revolver”), collectively (“Cerberus Debt”). The proceeds were used to fund the acquisition of Phoenix, to refinance the outstanding debt of ALJ, Faneuil and Carpets, and to provide working capital facilities to all three of ALJ’s subsidiaries

and ALJ. In July 2016, ALJ entered into the First Amendment to the Financing Agreement, which increased borrowings under the Cerberus Term Loan by $10.0 million and modified certain covenants. In May 2017, ALJ entered into the Second Amendment to the Financing Agreement, which updated certain definitions, representations and warranties, and covenants to reflect the CMO Business acquisition (note 3).

During the nine months ended June 30, 2017, interest accrued at an annual rates ranging from 9.5% to 9.65% on the $10.0 million incremental borrowings, and 7.5% to 7.65% on the remaining Cerberus Term Loan borrowings. When certain loan covenants are met, the annual interest rate on the incremental borrowings will decrease from 9.5% to 7.5%. Interest payments are due in arrears on the first day of each month. Quarterly principal payments of approximately $2.2 million are due on the last day of each fiscal quarter and annual principal payments equal to 75% of ALJ’s excess cash flow, as defined in the Financing Agreement, are due upon delivery of the audited financial statements. A final balloon payment is due at maturity, August 14, 2020. There is a prepayment penalty equal to 2% if the Cerberus Term Loan is repaid prior to August 2017, and 1% if it is paid between August 2017 and August 2018. ALJ may make payments of up to $7.0 million against the loan with no penalty. As of June 30, 2017, ALJ’s balance on the Cerberus Term Loan was approximately $93.2 million.

ALJ has the option to prepay (and re-borrow) the outstanding balance of the Cerberus/PNC Revolver, without penalty. Each subsidiary has the ability to borrow under the Cerberus/PNC Revolver (up to $30.0 million in the aggregate for all subsidiaries combined) but availability is limited to 85% of eligible receivables. The Cerberus/PNC Revolver carries an unused fee of 0.5%. Additionally, the Cerberus/PNC Revolver provides for a sublimit for letters of credit up to $15.0 million. Faneuil had a $2.7 million letter of credit under the Financing Agreement as of June 30, 2017. The Cerberus/PNC Revolver has a final maturity date of August 14, 2020. As discussed in note 3, ALJ funded a portion of the CMO Business acquisition by borrowing $5.5 million under the Cerberus/PNC Revolver, which accrued interest at annual rates ranging from 7.54% to 7.8% from the CMO Business Purchase Date through June 30, 2017. The remaining balance under the Cerberus/PNC Revolver accrued interest at annual rates ranging from 9.25% to 9.5%. As of June 30, 2017, ALJ’s balance on the Cerberus/PNC Revolver was approximately $6.5 million.

The Cerberus Debt is secured by substantially all the Company’s assets and imposes certain limitations on the Company, including its ability to incur debt, grant liens, initiate certain investments, declare dividends and dispose of assets. The Cerberus Debt also requires ALJ to comply with certain debt covenants. As of June 30, 2017, ALJ was in compliance with all debt covenants and had unused borrowing capacity of $14.5 million.

As of June 30, 2017, estimated future minimum payments under the Cerberus Term Loan are as follows (in thousands):

For the Year Ending June 30,	Estimated Future Minimum Payments
2018	$	8,625
2019		8,625
2020		8,625
2021*		73,757
Total estimated future minimum payments	$	99,632

* The majority of this amount is the final balloon payment due at maturity, August 14, 2020.

Capital Lease Obligations

Faneuil and Phoenix lease equipment under non-cancelable capital leases. As of June 30, 2017, estimated future minimum payments under non-cancelable capital leases with initial or remaining terms of one year or more are as follows (in thousands):

For the Year Ending June 30,	Estimated Future Minimum Payments
2018	$	2,159
2019		1,450
2020		583
2021		535
2022		535
Thereafter		837
Total estimated future minimum payments		6,099
Less: current portion of capital lease obligations		(1,978	)
Less: imputed interest		(559	)
Capital lease obligations, less current portion	$	3,562

8. Commitments and Contingencies

Operating Leases

The Company leases real estate, equipment, and vehicles under noncancellable operating leases. As of June 30, 2017, estimated future minimum rental commitments under noncancellable leases were as follows (in thousands):

For the Year Ending June 30,	Estimated Future Minimum Payments
2017	$	5,038
2018		3,481
2019		2,146
2020		1,216
2021		166
Total estimated future minimum payments	$	12,047

Employment Agreements

ALJ maintains employment agreements with certain key executive officers that provide for a base salary and annual bonus to be determined by the Board of Directors through its Compensation, Nominating, and Corporate Governance Committee. The agreements also provide for termination payments (including payments of base salary and performance bonus), stock options, non-competition provisions, and other terms and conditions of employment. As of June 30, 2017, termination payments related to base salary totaled $888,000.

Surety Bonds

As part of Faneuil’s normal course of operations, certain customers require surety bonds guaranteeing the performance of a contract. As of June 30, 2017, the face value of such surety bonds, which represents the maximum cash payments that Faneuil would have to make under certain circumstances of non-performance, was $33.1 million. To date, Faneuil has not made any non-performance payments.

Litigation, Claims, and Assessments

Faneuil, Inc. v. 3M Company

against 3M to collect on its outstanding receivables. In its complaint, Faneuil seeks recovery of $5.1 million based on three causes of action: breach of contract, breach of the implied covenant of good faith and fair dealing and unjust enrichment.

Subsequent to filing suit against 3M, Faneuil entered into an agreement with ERC whereby ERC would become responsible for paying Faneuil directly for all services rendered from April 1, 2016 through December 31, 2016. That agreement resulted in a payment from ERC to Faneuil on December 8, 2016, which resolved a portion of the $5.1 million claim against 3M.

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

A five-day bench trial is set for January 22-26, 2018. A pretrial scheduling order has been entered. The parties are engaged in substantive discovery at this time. During the three months ended June 30, 2017, ERC transitioned the services that were provided by Faneuil to an internal customer service operation. As a result of this transition, Faneuil no longer provides services to 3M or ERC. ERC continues to reimburse Faneuil for immaterial transition costs incurred by Faneuil.

Faneuil believes the facts support its claims that the disputed services should be paid and that 3M’s counterclaims are without merit. Faneuil intends to vigorously prosecute its claims against 3M and to defend against 3M’s counterclaims. Although litigation is inherently unpredictable, Faneuil remains confident in its ability to collect its outstanding receivables from 3M.

McNeil, et al. v. Faneuil, Inc.

Tammy McNeil, a former Faneuil call center employee, filed a Fair Labor Standards Act collective action case against Faneuil in federal court in Newport News, Virginia in 2015. The class asserted various timekeeping and overtime violations that Faneuil denied. During the three months ended June 30, 2017, a tentative settlement was reached for approximately $0.3 million. The settlement has to be approved by the district court. Pursuant to the terms of the settlement agreement, the parties agreed to let the district court determine the appropriate amount of an award of attorney’s fees to the plaintiffs. A hearing was held on July 24, 2017 but the court has not yet issued an opinion on fees or the fairness of the settlement agreement.

Thornton vs. ALJ Regional Holdings, Inc., et al.

On September 21, 2016, Plaintiffs Clifford Thornton and Tracey Thornton filed a complaint in the Nevada District Court for Clark County against ALJ, Carpets, Steve Chesin, and Jess Ravich. The complaint includes claims for (1) fraud, (2) bad faith, (3) civil conspiracy, (4) unjust enrichment, (5) wrongful termination, (6) intentional infliction of emotional distress, (7) negligent infliction of emotional distress, and (8) loss of marital consortium. On November 1, 2016, the defendants filed an answer to the complaint generally denying all claims. ALJ and Carpets believe this action is without merit and intend to defend it vigorously.

In connection with its pending litigation matters (including the matters described above), management has estimated the range of possible loss, including expenses, to be between $1.5 million and $1.7 million; however, as management has determined that no one estimate within the range is better than another, it has accrued $1.5 million as of June 30, 2017.

Other Litigation

We and our subsidiaries have been named in, and from time to time may become named in, various other lawsuits or threatened actions that are incidental to our ordinary business. Litigation is inherently unpredictable. Any claims against us, whether meritorious or not, could be time-consuming, cause us to incur costs and expenses, require significant amounts of management time and result in the diversion of significant operational resources. The results of these lawsuits and actions cannot be predicted with certainty. We concluded as of June 30, 2017 that the ultimate resolution of these matters will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.

9. Equity

Common Stock

As part of the CMO Business acquisition (note 3), ALJ issued 1,466,667 shares of common stock valued at $3.21 per share, which was the closing price of ALJ common stock as listed on the NASDAQ Global Market on the CMO Business Purchase Date.

ALJ repurchased 16,520 shares of ALJ common stock at an average price of $3.90 per share and retired 85,454 shares of common stock during the nine months ended June 30, 2016.

Equity Incentive Plans

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

Stock-Based Compensation.

The following table sets forth the total stock-based compensation expense included in selling, general, and administrative expense on ALJ’s Statements of Income (in thousands):

	Three Months Ended June 30,				Nine Months Ended June 30,
	2017		2016		2017		2016
Stock options	$	121	$	149	$	308	$	349
Restricted stock		85		115		255		340
Total stock-based compensation expense	$	206	$	264	$	563	$	689

At June 30, 2017, ALJ had approximately $0.8 million of total unrecognized compensation cost related to unvested stock options. This cost is expected to be recognized over a weighted-average period of approximately 2.0 years.

Stock Option Awards. ALJ granted 320,000 stock option awards with a total estimated fair value of approximately $442,000 during the three and nine months ended June 30, 2017. ALJ estimated the fair value of the options on the respective grant date using the Black-Scholes valuation model under the following assumptions: weighted average expected option life in years of 5.2 years, weighted average expected volatility of 46.7%, expected dividend yield of 0%, and weighted average risk free interest rate of 1.7%.

The “intrinsic value” of options is the excess of the value of ALJ stock over the exercise price of such options. The total intrinsic value of options outstanding (of which all are vested or expected to vest) was approximately $3.2 million at June 30, 2017.

Restricted Stock Awards. In December 2015, ALJ’s Board of Directors approved a director compensation package that included an annual restricted stock award (“RSA”) with a value of $40,000 for each outside director. Additionally the Board of Directors approved an annual RSA for ALJ’s Executive Chairman with a value of $100,000.

10. Related-Party Transactions

Harland Clarke Holdings Corp. (“Harland Clarke”), a stockholder who owns in excess of five percent of ALJ outstanding common stock, is a counterparty to Faneuil in two contracts. Under one contract, Faneuil provides call center services to support Harland Clarke’s banking-related products. This contract renews annually every April. Under the other contract, Faneuil provides managed print services to Harland Clarke. The term of this contract concludes on September 30, 2018. Faneuil recognized revenue from Harland Clarke totaling $200,000 and $799,000 for the three and nine months ended June 30, 2017, respectively, and $262,000 and $1,033,000 for the three and nine months ended June 30, 2016, respectively. The associated cost of revenue was $198,000 and $762,000 for the three and nine months ended June 30, 2017, respectively, and $245,000 and $991,000 for the three and nine months ended June 30, 2016, respectively. All revenue from Harland Clarke contained similar terms and conditions as revenue earned from other transactions of this nature entered into by Faneuil. Total accounts receivable from Harland Clarke was $124,000 and $176,000 at June 30, 2017 and September 30, 2016, respectively.

11. Reportable Segments and Geographic Information

Reportable Segments

As discussed in Note 1, ALJ has organized its business along three reportable segments (Faneuil, Carpets, and Phoenix), together with a corporate group for certain support services. ALJ’s operations are aligned on the basis of products, services and industry. ALJ’s Chief Operating Decision Maker (“CODM”) is its Executive Chairman. The CODM allocates resources to and assesses the performance of each operating segment using information about its net revenue and operating income. The CODM does not evaluate operating segments using discrete asset information. The accounting policies for segment reporting are the same as for ALJ as a whole.

Net revenue and operating income by reportable segment for each period were as follows (in thousands):

	Three Months Ended June 30,						Nine Months Ended June 30,
	2017			2016			2017			2016
Net revenue:
Faneuil	$	39,469		$	32,070		$	114,242		$	99,814
Carpets		18,458			12,562			51,907			35,651
Phoenix		25,546			20,225			74,237			60,468
Consolidated net revenue	$	83,473		$	64,857		$	240,386		$	195,933
Operating income (loss):
Faneuil	$	1,408		$	1,337		$	4,347		$	3,486
Carpets		254			418			114			60
Phoenix		2,444			3,243			7,642			9,320
ALJ		(565	)		(1,008	)		(2,146	)		(3,411	)
Consolidated operating income	$	3,541		$	3,990		$	9,957		$	9,455

Geographic Information

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

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

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

•

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

•

Results of Operations. An analysis comparing our financial results for the three months ended June 30, 2017 to the three months ended June 30, 2016, and the nine months ended June 30, 2017 to the nine months ended June 30, 2017.

•

Liquidity and Capital Resources. An analysis of changes in our cash flows and discussion of our financial condition and liquidity.

•

Contractual Obligations. Discussion of our contractual obligations as of June 30, 2017.

•

Off-Balance Sheet Arrangements. Discussion of our off-balance sheet arrangements as of June 30, 2017.

•

Critical Accounting Policies and Estimates. This section provides a discussion of the significant estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses of the Company, and related disclosure of contingent assets and liabilities.

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

Overview

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

We continue to see our business evolve as we execute our strategy of buying attractively valued assets, such as Faneuil’s May 26, 2017 acquisition of certain assets and assumption of certain liabilities of the customer management outsourcing business (“CMO Business”) of Vertex Business Services LLC (“Vertex”), and Phoenix’s July 18, 2016 acquisition of Color Optics, a leading printing and packaging solutions enterprise servicing the beauty, fragrance, cosmetic and consumer-packaged goods markets. In analyzing the financial impact of any potential acquisition, we focus on earnings, operating margin, cash flow and return on invested capital targets. We hire successful and experienced management teams to run each of our operating companies and incentivize them to drive higher profits. We are focused on increasing our revenue at each of our operating subsidiaries by investing in sales and marketing, expanding into new products and markets, and evaluating and executing on tuck-in acquisitions, while continually examining our cost structures to drive higher profits.

Results of Operations

Three Months Ended June 30, 2017 Compared to Three Months Ended June 30, 2016

The following table sets forth certain condensed consolidated statements of income data as a percentage of net revenue for each period as follows (in thousands, except per share amounts):

	Three Months Ended June 30, 2017						Three Months Ended June 30, 2016
				% of						% of
	Dollars			Net Revenue			Dollars			Net Revenue
Net revenue⁽¹⁾
Faneuil	$	39,469			47.3	%	$	32,070			49.4	%
Carpets		18,458			22.1			12,562			19.3
Phoenix		25,546			30.6			20,225			31.2
Consolidated net revenue		83,473			100.0			64,857			100.0
Cost of revenue ⁽²⁾
Faneuil		29,459			74.6			25,273			78.8
Carpets		14,640			79.3			10,020			79.8
Phoenix ⁽³⁾		19,406			76.0			13,610			67.3
Consolidated cost of revenue		63,505			76.1			48,903			75.4
Selling, general and administrative expense ⁽²⁾
Faneuil		6,635			16.8			3,925			12.2
Carpets		3,381			18.3			1,959			15.6
Phoenix		3,057			12.0			2,757			13.6
ALJ		565			—			1,008			—
Consolidated selling, general and administrative expense		13,638			16.3			9,649			14.9
Depreciation and amortization ⁽²⁾
Faneuil		1,967			5.0			1,535			4.8
Carpets		183			1.0			165			1.3
Phoenix⁽⁴⁾		643			2.5			613			3.0
Consolidated depreciation and amortization		2,793			3.3			2,313			3.6
(Gain) loss on disposal of assets, net ⁽²⁾
Phoenix		4			0.0			(2	)		(0.0	)
Segment operating income (loss) ⁽²⁾
Faneuil		1,408			3.6			1,337			4.2
Carpets		254			1.4			418			3.3
Phoenix		2,444			9.6			3,243			16.0
ALJ		(565	)		—			(1,008	)		—
Consolidated operating income		3,541			4.2			3,990			6.2
Interest expense ⁽⁵⁾		(2,302	)		(2.8	)		(2,175	)		(3.4	)
Other income		298			0.4			—			—
Provision for income taxes⁽⁵⁾		(577	)		(0.7	)		(407	)		(0.6	)
Net income ⁽⁵⁾	$	960			1.2		$	1,408			2.2
Basic earnings per share of common stock	$	0.03					$	0.04
Diluted earnings per share of common stock	$	0.03					$	0.04

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

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

⁽³⁾	Includes depreciation expense of $1,370,000 and $950,000 for the three months ended June 30, 2017 and 2016, respectively.

⁽⁴⁾	Primarily amortization of intangible assets. Total depreciation and amortization for Phoenix including depreciation expense captured in cost of revenue was $2,013,000 and $1,563,000 for the three months ended June 30, 2017 and 2016, respectively.

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

Net Revenue

	Three Months Ended June 30,
(in thousands)	2017		2016		$ Change		% Change
Faneuil	$	39,469	$	32,070	$	7,399		23.1	%
Carpets		18,458		12,562		5,896		46.9
Phoenix		25,546		20,225		5,321		26.3
Consolidated net revenue	$	83,473	$	64,857	$	18,616		28.7	%

Faneuil Net Revenue

Faneuil net revenue for the three months ended June 30, 2017, was $39.5 million, an increase of $7.4 million, or 23.1%, compared to net revenue of $32.1 million for the three months ended June 30, 2016. Of the $7.4 million increase, $3.6 million was attributable to the acquisition of the CMO Business. The remaining increase was due to new customer awards.

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

	As of June 30,
	2017		2016
Within one year	$	100.0	$	66.2
Between one year and two years		62.4		49.6
Between two years and three years		61.4		45.2
Between three years and four years		30.7		44.7
Thereafter		4.4		20.6
Total Faneuil backlog	$	258.9	$	226.3

The increase in backlog as of June 30, 2017 compared to June 30, 2016 was due to the acquisition of the CMO Business. Excluding the impact of the CMO Business acquisition, backlog decreased by $10.7 million due to fulfillment of legacy contracts.

Carpets Net Revenue

Carpets net revenue for the three months ended June 30, 2017 was $18.5 million, an increase of $5.9 million, or 46.9%, compared to net revenue of $12.6 million for the three months ended June 30, 2016. The increase was primarily attributable to one national builder awarding Carpets the majority of its flooring and granite work, and one national builder that significantly increased its volume during the three months ended June 30, 2017.

The following table reflects the amount of Carpets backlog, which represents multi-year contracts with contractors to build-out communities with typical terms of two to three years, by the fiscal year Carpets expects to recognize such revenue (in millions):

	As of June 30,
	2017		2016
Within one year	$	25.8	$	22.4
Between one year and two years		24.7		16.3
Between two years and three years		9.8		6.6
Between three years and four years		2.6		0.7
Total Carpets backlog	$	62.9	$	46.0

The majority of the backlog increase as of June 30, 2017 compared to June 30, 2016 was a result of new contracts executed during the past twelve months.

Phoenix Net Revenue

Phoenix net revenue for the three months ended June 30, 2017 was $25.5 million, an increase of $5.3 million, or 26.3%, compared to net revenue of $20.2 million for the three months ended June 30, 2016. Excluding the impact of the Color Optics acquisition, net revenue decreased $0.9 million, or 4.2%, due to lower volumes for educational components.

Phoenix has recently executed several contract renewals and extensions with its largest customers. These extensions provide for combined expected revenue during the additional terms, which range from two to four years, of over $100 million. In connection with these extensions, Phoenix agreed to lower pricing in exchange for higher sales volume guarantees over the life of the contracts.

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

	As of June 30,
	2017		2016
Within one year	$	58.1	$	41.7
Between one year and two years		50.3		37.2
Between two years and three years		43.8		22.2
Between three years and four years		9.3		11.2
Thereafter		—		5.6
Total Phoenix backlog	$	161.5	$	117.9

The majority of the backlog increase as of June 30, 2017 compared to June 30, 2016 was a result of new contracts with volume commitments executed during the last twelve months.

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

Cost of Revenue

	Three Months Ended June 30,
(in thousands)	2017			2016			$ Change		% Change
Faneuil	$	29,459		$	25,273		$	4,186		16.6	%
As a percentage of Faneuil net revenue		74.6	%		78.8	%
Carpets		14,640			10,020			4,620		46.1
As a percentage of Carpets net revenue		79.3	%		79.8	%
Phoenix		19,406			13,610			5,796		42.6
As a percentage of Phoenix net revenue		76.0	%		67.3	%
Consolidated cost of revenue	$	63,505		$	48,903		$	14,602		29.9	%

Faneuil Cost of Revenue

Faneuil cost of revenue for the three months ended June 30, 2017 was $29.5 million, an increase of $4.2 million, or 16.6%, compared to cost of revenue of $25.3 million for the three months ended June 30, 2016. The absolute dollar increase in cost of revenue was a direct result of the increased net revenue. During the three months ended June 30, 2017, as compared to the three months ended June 30, 2016, cost of revenue as a percentage of net revenue decreased to 74.6% from 78.8% as a result of favorable contract rates during the three months ended June 30, 2017.

Carpets Cost of Revenue

Carpets cost of revenue for the three months ended June 30, 2017 was $14.6 million, an increase of $4.6 million, or 46.1%, compared to cost of revenue of $10.0 million for the three months ended June 30, 2016. The absolute dollar increase in cost of revenue was a direct result of increased net revenue. Cost of revenue as a percentage of net revenue remained relatively consistent at 79.3% during the three months ended

June 30, 2017 and 79.8% during the three months ended June 30, 2016. Carpets management anticipates that future improvements and operating efficiencies within the cabinet and granite businesses will reduce cost of revenue as a percentage of net revenue.

Phoenix Cost of Revenue

Phoenix cost of revenue for the three months ended June 30, 2017 was $19.4 million, an increase of $5.8 million, or 42.6% compared to cost of revenue of $13.6 million for the three months ended June 30, 2016. The absolute dollar increase in cost of revenue was mainly attributable to increased packaging revenue as a result of the Color Optics acquisition on July 18, 2016. During the three months ended June 30, 2017, as compared to the three months ended June 30, 2016, cost of revenue as a percentage of net revenue increased to 76.0% from 67.3% as a result of changes in product mix sold and higher fixed costs, primarily depreciation expense, associated with the Color Optics business relative to Phoenix. Phoenix anticipates reducing these fixed costs over the next 12 months as Color Optics is fully integrated into Phoenix operations. Phoenix experiences normal fluctuations to cost of revenue as a percentage of net revenue as a result of changes to the mix of products sold.

Selling, General and Administrative Expense

	Three Months Ended June 30,
(in thousands)	2017		2016		$ Change			% Change
Faneuil	$	6,635	$	3,925	$	2,710			69.0	%
Carpets		3,381		1,959		1,422			72.6
Phoenix		3,057		2,757		300			10.9
ALJ		565		1,008		(443	)		(43.9	)
Consolidated selling, general and administrative expense	$	13,638	$	9,649	$	3,989			41.3	%

Faneuil Selling, General and Administrative Expense

Faneuil selling, general and administrative expense for the three months ended June 30, 2017 was $6.6 million, an increase of $2.7 million, or 69.0%, compared to selling, general and administrative expense of $3.9 million for the three months ended June 30, 2016. The increase was primarily attributable to $0.7 million of facility expenses and $0.8 million of technology and communication expenses to support new customers, $0.4 million related to the CMO Business operations, $0.2 million of non-recurring acquisition-related legal expenses, and $0.3 million increased legal fees to support Faneuil’s various legal actions. These increases were slightly offset by decreased support related to customer contracts that concluded, and $0.3 million reduction to the provision for bad debts. Certain expenses, which do not fluctuate directly with net revenue, including legal, communications, software maintenance, general business insurance and business taxes, increased during the three months ended June 30, 2017 compared to the three months ended June 30, 2016. As a result, selling, general and administrative expense as a percentage of net revenue increased to 16.8% for the three months ended June 30, 2017 from 12.2% for the three months ended June 30, 2016.

Carpets Selling, General and Administrative Expense

Carpets selling, general and administrative expense was $3.4 million for the three months ended June 30, 2017, an increase of $1.4 million, or 72.6%, compared to selling, general and administrative expense of $2.0 million for the three months June 30, 2016. The increase was primarily attributable to higher sales commissions as a result of increased net revenue, increased headcount to support growth in the cabinet and granite divisions, and to a lesser extent increased legal fees to defend against legal claims. Carpets has invested heavily in its cabinet and granite infrastructure to ensure a high level of quality in an expected rapid sales growth phase. Selling, general and administrative expense as a percentage of net revenue increased to 18.3% for the three months ended June 30, 2017 from 15.6% for the three months ended June 30, 2016 as a result of fixed expenses, mainly facilities and headcount, which do not fluctuate with net revenue. During the three months ended June 30, 2017, Carpets began to reorganize and streamline operations, and implement cost savings measures. We expect selling, general and administrative expense to decline as it continues its reorganization efforts.

Phoenix Selling, General and Administrative Expense

Phoenix selling, general and administrative expense for the three months ended June 30, 2017 was $3.1 million, an increase of $0.3 million, or 10.9%, compared to selling, general and administrative expense of $2.8 million for the three months ended June 30, 2016. The increase was mainly to support the expansion of revenue from packaging services as a result of the Color Optics acquisition. Selling, general and

administrative expense as a percentage of net revenue decreased to 12.0% for the three months ended June 30, 2017 from 13.6% for the three months ended June 30, 2016 as a result of fixed expenses, mainly headcount, which do not fluctuate with net revenue.

ALJ Selling, General and Administrative Expense

ALJ selling, general and administrative expense for the three months ended June 30, 2017 was $0.6 million, a decrease of $0.4 million, or 43.9%, compared to selling, general and administrative expense of $1.0 million for the three months ended June 30, 2016. The decrease was primarily attributable to a decrease in legal and accounting fees as a result of completing the uplisting process from the Pink Sheets to NASDAQ during May 2016, partially offset by an increase in the ongoing cost of maintaining our public reporting status. We expect higher selling, general and administrative expense in the future as we comply with SEC reporting requirements and regulations.

Depreciation and Amortization

	Three Months Ended June 30,
(in thousands)	2017		2016		$ Change		% Change
Faneuil	$	1,967	$	1,535	$	432		28.1	%
Carpets		183		165		18		10.9
Phoenix		643		613		30		4.9
Consolidated depreciation and amortization	$	2,793	$	2,313	$	480		20.8	%

Faneuil Depreciation and Amortization

Faneuil depreciation and amortization expense for the three months ended June 30, 2017 was $2.0 million, an increase of $0.4 million, or 28.1% compared to depreciation and amortization expense of $1.5 million for the three months ended June 30, 2016. The increase was attributable to capital equipment purchased to support new and expanded contracts. Because each Faneuil contract requires unique capital investment and infrastructure such as lease buildouts, Faneuil depreciation and amortization expense is impacted by the timing of new contracts and the completion of existing contracts.

Carpets Depreciation and Amortization

Carpets depreciation and amortization expense remained constant at $0.2 million for both the three months ended June 30, 2017 and 2016.

Phoenix Depreciation and Amortization

Phoenix depreciation and amortization expense consists primarily of amortization of acquisition-related intangible assets. Depreciation and amortization expense remained constant at $0.6 million for both the three months ended June 30, 2017 and 2016.

Interest Expense

Interest expense remained fairly constant at $2.3 million for the three months ended June 30, 2017, compared to $2.2 million for the three months ended June 30, 2016. The slight increase was a result of increased borrowing on our line of credit, which was used to acquire the CMO Business on May 26, 2017 and the $10.0 million increased borrowing on our term loan, which was used to acquire Color Optics in July 2016, partially offset by our term loan quarterly principal payments.

Other Income

Other income for the three months ended June 30, 2017 related to a one-time derecognition of a liability for discontinued business operations, which management determined was no longer required.

Income Taxes

Income tax provision for the three months ended June 30, 2017 was $0.6 million, an increase of $0.2 million, compared to income tax provision of $0.4 million for the three months ended June 30, 2016. The effective income tax rates for the three months ended June 30, 2017 and June 30, 2016 were 37.5% and 22.4%, respectively. The increase to both the income tax provision and the effective income tax rate was attributable to the treatment of net operating loss carry forward (“NOL”) valuation allowance. As of September 30, 2016, our NOL valuation allowance was reduced. The provision for income taxes for the three months ended June 30, 2017 includes deferred income tax expense, whereas the three months ended June 30, 2016 did not include deferred income tax expense.

Nine Months Ended June 30, 2017 Compared to Nine Months Ended June 30, 2016

The following table sets forth certain condensed consolidated statements of income data as a percentage of net revenue for each period as follows (in thousands, except per share amounts):

	Nine Months Ended June 30, 2017						Nine Months Ended June 30, 2016
				% of						% of
	Dollars			Net Revenue			Dollars			Net Revenue
Net revenue⁽¹⁾
Faneuil	$	114,242			47.5	%	$	99,814			50.9	%
Carpets		51,907			21.6			35,651			18.2
Phoenix		74,237			30.9			60,468			30.9
Consolidated net revenue		240,386			100.0			195,933			100.0
Cost of revenue ⁽²⁾
Faneuil		86,523			75.7			79,187			79.3
Carpets		42,679			82.2			29,230			82.0
Phoenix ⁽³⁾		55,491			74.7			41,380			68.4
Consolidated cost of revenue		184,693			76.8			149,797			76.5
Selling, general and administrative expense⁽²⁾
Faneuil		17,653			15.5			12,646			12.7
Carpets		8,577			16.5			5,890			16.5
Phoenix		9,168			12.3			8,053			13.3
ALJ		2,146			—			3,411			—
Consolidated selling, general and administrative expense		37,544			15.6			30,000			15.3
Depreciation and amortization⁽²⁾
Faneuil		5,719			5.0			4,495			4.5
Carpets		537			1.0			471			1.3
Phoenix⁽⁴⁾		1,928			2.6			1,832			3.0
Consolidated depreciation and amortization		8,184			3.4			6,798			3.5
(Loss) gain on disposal of assets, net⁽²⁾
Phoenix		(8	)		(0.0	)		117			0.2
Segment operating income (loss) ⁽²⁾
Faneuil		4,347			3.8			3,486			3.5
Carpets		114			0.2			60			0.2
Phoenix		7,642			10.3			9,320			15.4
ALJ		(2,146	)		—			(3,411	)		—
Consolidated operating income		9,957			4.1			9,455			4.8
Interest expense ⁽⁵⁾		(7,020	)		(2.9	)		(6,701	)		(3.4	)
Other income		298			0.1			—			—
Provision for income tax⁽⁵⁾		(1,332	)		(0.6	)		(579	)		(0.3	)
Net income⁽⁵⁾	$	1,903			0.8		$	2,175			1.1
Basic earnings per share of common stock	$	0.05					$	0.06
Diluted earnings per share of common stock	$	0.05					$	0.06

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

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

⁽³⁾	Includes depreciation expense of $3,993,000 and $2,792,000 for the nine months ended June 30, 2017 and 2016, respectively.

⁽⁴⁾	Primarily amortization of intangible assets. Total depreciation and amortization for Phoenix including depreciation expense captured in cost of revenue was $5,921,000 and $4,624,000 for the nine months ended June 30, 2017 and 2016, respectively.

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

Net Revenue

	Nine Months Ended June 30,
(in thousands)	2017		2016		$ Change		% Change
Faneuil	$	114,242	$	99,814	$	14,428		14.5	%
Carpets		51,907		35,651		16,256		45.6
Phoenix		74,237		60,468		13,769		22.8
Consolidated net revenue	$	240,386	$	195,933	$	44,453		22.7	%

Faneuil Net Revenue

Faneuil net revenue for the nine months ended June 30, 2017, was $114.2 million, an increase of $14.4 million, or 14.5%, compared to net revenue of $99.8 million for the nine months ended June 30, 2016. Of the $14.4 million increase, $3.6 million was attributable to the CMO Business acquisition. The remaining increase was due to improved contract renewals and new contract awards.

Carpets Net Revenue

Carpets net revenue for the nine months ended June 30, 2017 was $51.9 million, an increase of $16.3 million, or 45.6%, compared to net revenue of $35.7 million for the nine months ended June 30, 2016. The increase was primarily attributable to one national builder awarding Carpets the majority of its flooring and granite work, and one national builder that significantly increased its volume during the nine months ended June 30, 2017.

Phoenix Net Revenue

Phoenix net revenue for the nine months ended June 30, 2017 was $74.2 million, an increase of $13.8 million, or 22.8%, compared to net revenue of $60.5 million for the nine months ended June 30, 2016. Excluding the impact of the Color Optics acquisition, revenue decreased by $0.5 million, less than 1.0%, due to lower volumes for educational components.

Cost of Revenue

	Nine Months Ended June 30,
(in thousands)	2017			2016			$ Change		% Change
Faneuil	$	86,523		$	79,187		$	7,336		9.3	%
As a percentage of Faneuil net revenue		75.7	%		79.3	%
Carpets		42,679			29,230			13,449		46.0
As a percentage of Carpets net revenue		82.2	%		82.0	%
Phoenix		55,491			41,380			14,111		34.1
As a percentage of Phoenix net revenue		74.7	%		68.4	%
Consolidated cost of revenue	$	184,693		$	149,797		$	34,896		23.3	%

Faneuil Cost of Revenue

Faneuil cost of revenue for the nine months ended June 30, 2017 was $86.5 million, an increase of $7.3 million, or 9.3%, compared to cost of revenue of $79.2 million for the nine months ended June 30, 2016. The absolute dollar increase in cost of revenue was a direct result of the increased net revenue. During the nine months ended June 30, 2017, as compared to the nine months ended June 30, 2016, cost of revenue as a percentage of net revenue decreased to 75.7% from 79.3% as a result of favorable contract rates during the nine months ended June 30, 2017.

Carpets Cost of Revenue

Carpets cost of revenue for the nine months ended June 30, 2017 was $42.7 million, an increase of $13.4 million, or 46.0%, compared to cost of revenue of $29.2 million for the nine months ended June 30, 2016. The absolute dollar increase in cost of revenue was a direct result of increased net revenue. Cost of revenue as a percentage of net revenue was relatively constant at 82.2% during the nine months ended June 30, 2017 and 82.0% during the nine months ended June 30, 2016.

Phoenix Cost of Revenue

Phoenix cost of revenue for the nine months ended June 30, 2017 was $55.5 million, an increase of $14.1 million, or 34.1%, compared to cost of revenue of $41.4 million for the nine months ended June 30, 2016. The absolute dollar increase in cost of revenue was mainly attributable to increased packaging revenue as a result of the Color Optics acquisition. During the nine months ended June 30, 2017, as compared to the nine months ended June 30, 2017, cost of revenue as a percentage of net revenue increased to 74.7% from 68.4% as a result of changes in product mix sold and higher fixed costs, primarily depreciation expense, associated with the Color Optics business relative to Phoenix. Phoenix anticipates reducing these fixed costs over the next 12 months as Color Optics is fully integrated into Phoenix operations. Phoenix experiences normal fluctuations to cost of revenue as a percentage of net revenue as a result of changes to the mix of products sold.

Selling, General and Administrative Expense

	Nine Months Ended June 30,
(in thousands)	2017		2016		$ Change			% Change
Faneuil	$	17,653	$	12,646	$	5,007			39.6	%
Carpets		8,577		5,890		2,687			45.6
Phoenix		9,168		8,053		1,115			13.8
ALJ		2,146		3,411		(1,265	)		(37.1	)
Consolidated selling, general and administrative expense	$	37,544	$	30,000	$	7,544			25.1	%

Faneuil Selling, General and Administrative Expense

Faneuil selling, general and administrative expense for the nine months ended June 30, 2017 was $17.7 million, an increase of $5.0 million, or 39.6%, compared to selling, general and administrative expense of $12.7 million for the nine months ended June 30, 2016. The increase was primarily attributable to $0.9 million of facility expenses and $2.0 million of technology and communication expenses to support new customers, $0.4 million related to the CMO Business operations, $0.2 million of non-recurring acquisition-related legal expenses, and $0.5 million of legal fees to support Faneuil’s various legal actions. These increases were slightly offset by decreased support related to customer contracts that concluded, and a $0.4 million reduction to the provision for bad debts. Certain expenses, which do not fluctuate directly with net revenue, including legal, communications, software maintenance, general business insurance, and business taxes, increased during the nine months ended June 30, 2017 compared to the nine months ended June 30, 2016. As a result, selling, general and administrative expense as a percentage of net revenue increased to 15.5% for the nine months ended June 30, 2017 from 12.7% for the nine months ended June 30, 2016.

Carpets Selling, General and Administrative Expense

Carpets selling, general and administrative expense was $8.6 million for the nine months ended June 30, 2017, an increase of $2.7 million, or 45.6%, compared to selling, general and administrative expense of $5.9 million for the nine months ended June 30, 2016. The increase was primarily attributable to higher sales commissions as a result of increased net revenue, increased headcount, including a chief operating officer to support Carpets reorganization efforts and growth in the cabinet and granite divisions, and to a lesser extent increased legal fees to defend against legal claims. Carpets has invested heavily in its cabinet and granite infrastructure to ensure a high level of quality in an expected rapid sales growth phase. Selling, general and administrative expense as a percentage of net revenue remained constant at 16.5% for both the nine months ended June 30, 2017 and 2016. We expect Carpets selling, general and administrative expenses to decline as it continues to implement further cost savings measures over the next three to six months.

Phoenix Selling, General and Administrative Expense

Phoenix selling, general and administrative expense for the nine months ended June 30, 2017 was $9.2 million, an increase of $1.1 million, or 13.8%, compared to selling, general and administrative expense of $8.1 million for the nine months ended June 30, 2016. The increase was mainly to support the expansion of revenue from packaging services as a result of the Color Optics acquisition. Selling, general and administrative expense as a percentage of net revenue decreased to 12.3% for the nine months ended June 30, 2017 from 13.3% for the nine months ended June 30, 2016 as a result of fixed expenses, mainly headcount, which do not fluctuate with net revenue.

ALJ Selling, General and Administrative Expense

ALJ selling, general and administrative expense for the nine months ended June 30, 2017 was $2.1 million, a decrease of $1.3 million, or 37.1%, compared to selling, general and administrative expense of $3.4 million for the nine months ended June 30, 2016. The decrease was primarily attributable to a decrease in legal and accounting fees as a result of completing the uplisting process from the Pink Sheets to NASDAQ during May 2016. We expect higher selling, general and administrative expense in the future as we comply with SEC reporting requirements and regulations.

Depreciation and Amortization

	Nine Months Ended June 30,
(in thousands)	2017		2016		$ Change		% Change
Faneuil	$	5,719	$	4,495	$	1,224		27.2	%
Carpets		537		471		66		14.0
Phoenix		1,928		1,832		96		5.2
Consolidated depreciation and amortization	$	8,184	$	6,798	$	1,386		20.4	%

Faneuil Depreciation and Amortization

Faneuil depreciation and amortization expense for the nine months ended June 30, 2017 was $5.7 million, an increase of $1.2 million, or 27.2%, compared to depreciation and amortization expense of $4.5 million for the nine months ended June 30, 2016. The increase was attributable to capital equipment purchased to support new and expanded contracts. Because each Faneuil contract requires specific capital investment and infrastructure such as lease buildouts, Faneuil depreciation and amortization expense is impacted by the timing of new contracts and the completion of existing contracts.

Carpets Depreciation and Amortization

Carpets depreciation and amortization expense for both the nine months ended June 30, 2017 and 2016 was $0.5 million.

Phoenix Depreciation and Amortization

Phoenix depreciation and amortization expense for the nine months ended June 30, 2017 was $1.9 million, an increase of $0.1 million, or 5.2% compared to depreciation and amortization expense of $1.8 million for the nine months ended June 30, 2016. The slight increase was attributable to amortization of intangible assets associated with the Color Optics acquisition.

Interest Expense

Interest expense for the nine months ended June 30, 2017 was $7.0 million, an increase of $0.3 million, or 4.8% compared to interest expense of $6.7 million for the nine months ended June 30, 2016. The increase was a result of a $10.0 million increased borrowing on our term loan, which was used to acquire Color Optics, slightly offset by reduced interest expense as a result of quarterly principal payments.

Other Income

Other income for the nine months ended June 30, 2017 related to a one-time derecognition of liabilities for discontinued business operations, which management determined was no longer required.

Income Taxes

Income tax provision for the nine months ended June 30, 2017 was $1.3 million, an increase of $0.7 million, compared to income tax provision of $0.6 million for the nine months ended June 30, 2016. The effective income tax rates for the nine months ended June 30, 2017 and the nine months ended June 30, 2016 were 41.2% and 21.0%, respectively. The increase to both the income tax provision and the effective income tax rate was attributable to the treatment of the NOL valuation allowance. As of September 30, 2016, our NOL valuation allowance was reduced. The provision for income taxes for the nine months ended June 30, 2017 includes deferred income tax expense, whereas the nine months ended June 30, 2016 did not include deferred income tax expense.

Seasonality

Faneuil Seasonality

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

Carpets Seasonality

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

Phoenix Seasonality

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

Liquidity and Capital Resources

Historically, our principal sources of liquidity have been cash provided by operations and borrowings under various debt arrangements. At June 30, 2017, our principal sources of liquidity included cash and cash equivalents of $1.9 million and an available borrowing capacity of $14.5 million on our line of credit. Our principal uses of cash have been for acquisitions and to pay down debt. We anticipate these uses will continue to be our principal uses of liquidity in the future.

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

In summary, our cash flows for each period were as follows (in thousands):

	Nine Months Ended June 30,
	2017			2016
Cash provided by operating activities	$	16,728		$	13,967
Cash used by investing activities		(14,790	)		(2,238	)
Cash used by financing activities		(5,341	)		(12,964	)
Change in cash and cash equivalents	$	(3,403	)	$	(1,235	)

We recognized net income of $1.9 million for the nine months ended June 30, 2017 and generated cash from operating activities of $16.7 million, offset by cash used by investing activities of $14.8 million and financing activities of $5.3 million.

We recognized net income of $2.2 million for the nine months ended June 30, 2016 and generated cash from operating activities of $14.0 million, offset by cash used in investing activities of $2.2 million and financing activities of $13.0 million.

Operating Activities

Cash provided by operations of $16.7 million during the nine months ended June 30, 2017 was the result of our $1.9 million net income and $14.3 million addback of net non-cash expenses, and $0.5 million of net cash provided by changes in operating assets and liabilities. The most significant components of net non-cash expenses were depreciation and amortization of $12.2 million, amortization of non-cash interest expense of $0.8 million, stock-based compensation of $0.6 million, and deferred income taxes of $0.6 million. The most significant components of changes in operating assets and liabilities included collateral deposits of $1.3 million, deferred revenue and customer deposits of $1.6 million, and other liabilities of $1.4 million, which provided cash, and accounts receivable of $3.0 million, which used cash.

Cash provided by operations of $14.0 million during the nine months ended June 30, 2016 was the result of our $2.2 million net income and $11.2 million addback of net non-cash expenses, and $0.6 million of net cash provided by changes in operating assets and liabilities. The most significant components of net non-cash expenses were depreciation and amortization of $9.6 million, stock-based compensation of $0.7 million, and amortization of non-cash interest expense of $0.7 million. The most significant components of changes in operating assets and liabilities included collateral deposits of $1.8 million, accounts payable of $1.3 million, and deferred revenue and customer deposits of $1.9 million, which provided cash, and accounts receivable of $2.0 million and other assets of $1.7 million, which used cash.

Investing Activities

For the nine months ended June 30, 2017, our investing activities used $14.8 million of cash, of which $8.0 million was used to purchase the CMO Business, $4.9 million was used to purchase equipment, software and leasehold improvements for Faneuil’s new and existing customers, and $2.0 million was used to purchase capital equipment in the normal course of operations, partially offset by $0.2 million proceeds received from the sale of equipment.

For the nine months ended June 30, 2016, our investing activities used $2.2 million of cash, of which $1.3 million was used to purchase equipment, software and leasehold improvements for Faneuil’s new and existing customers, and $1.9 million was used to purchase capital equipment in the normal course of operations, partially offset by $0.9 million received from the sale of equipment.

Financing Activities

For the nine months ended June 30, 2017, our financing activities used $5.3 million of cash, of which $8.8 million was used to pay down our term loan, $1.8 million was used for payments on capital leases, $1.1 million was used for payments on financed insurance premiums, and $0.2 million of debt issuance costs, offset by net advances on our line of credit of $6.5 million.

For the nine months ended June 30, 2016, our financing activities used $13.0 million of cash, of which $9.0 million was used to pay down our term loan, $0.8 million was used for payments on capital leases, $0.8 million was used for payments on financed insurance premiums, $2.1 million was used to repurchase our common stock, and $0.3 million of debt issuance costs.

Contractual Obligations

The following table summarizes our significant contractual obligations at June 30, 2017, and the effect such obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

	Payments due by Period
			Less Than		One – Three		Four – Five		More than Five
	Total		One Year		Years		Years		Years
Line of credit⁽¹⁾	$	6,458	$	—	$	—	$	6,458	$	—
Term loan payable⁽¹⁾		93,174		8,625		25,875		58,674		—
Operating lease obligations		12,047		5,038		6,843		166		—
Capital lease obligations		5,540		1,978		2,322		1,240		—
Other long-term liabilities⁽²⁾		5,018		1,031		3,987		—		—
Total contractual cash obligations	$	122,237	$	16,672	$	39,027	$	66,538	$	—

⁽¹⁾

In August 2015, we entered into a financing agreement (“Financing Agreement”) with Cerberus Business Finance, LLC (“Cerberus”) to borrow $105.0 million in a term loan (“Cerberus Term Loan”) and have available up to $30.0 million in a revolving loan (“Cerberus/PNC Revolver”), collectively (“Cerberus Debt”). The proceeds were used to fund the acquisition of Phoenix, to refinance the outstanding debt of ALJ, Faneuil and Carpets, and to provide working capital facilities to all three of our subsidiaries and ALJ. In July 2016, we entered into the First Amendment to the Financing Agreement, which increased borrowings under the Cerberus Term Loan by $10.0 million and modified certain covenants. In May 2017, we entered into the Second Amendment to the Financing Agreement, which updated certain definitions, representations and warranties, and covenants to reflect the CMO Business acquisition.

During the nine months ended June 30, 2017, interest accrued at annual rates ranging from 9.5% to 9.65% on the $10.0 million incremental borrowings, and 7.5% on the remaining Cerberus Term Loan borrowings. When certain loan covenants are met, the annual interest rate on the incremental borrowings will decrease from 9.5% to 7.5%. Interest payments are due in arrears on the first day of each month. Quarterly principal payments of approximately $2.2 million are due on the last day of each fiscal

quarter and annual principal payments equal to 75% of our excess cash flow, as defined in the Financing Agreement, are due upon delivery of the audited financial statements. A final balloon payment is due at maturity, August 14, 2020. There is a prepayment penalty equal to 2% if the Cerberus Term Loan is repaid prior to August 2017, and 1% if it is paid between August 2017 and August 2018. We may make payments against the loan with no penalty up to $7.0 million. As of June 30, 2017, the balance on the Cerberus Term Loan was approximately $93.2 million.

We have the option to prepay (and re-borrow) the outstanding balance of the Cerberus/PNC Revolver, without penalty. Each subsidiary has the ability to borrow under the Cerberus/PNC Revolver (up to $30.0 million in the aggregate for all subsidiaries combined) but availability is limited to 85% of eligible receivables. The Cerberus/PNC Revolver carries an unused fee of 0.5%. Additionally, the Cerberus/PNC Revolver provides for a sublimit for letters of credit up to $15.0 million. Faneuil had a $2.7 million letter of credit under the Financing Agreement as of June 30, 2017. The Cerberus/PNC Revolver has a final maturity date of August 14, 2020. ALJ funded a portion of the CMO Business acquisition by borrowing $5.5 million under the Cerberus/PNC Revolver, which accrued interest at annual rates ranging from 7.54% to 7.8% from the CMO Business Purchase Date through June 30, 2017. The remaining balance under the Cerberus/PNC Revolver accrued interest at annual rates ranging from 9.25% to 9.5% during the nine months ended June 30, 2017. As of June 30, 2017, the balance on the Cerberus/PNC Revolver was approximately $6.5 million.

The Cerberus Debt is secured by substantially all our assets and imposes certain limitations on us, including our ability to incur debt, grant liens, initiate certain investments, declare dividends and dispose of assets. The Cerberus Debt also requires us to comply with certain debt covenants. As of June 30, 2017, we were in compliance with all debt covenants and had unused borrowing capacity of $14.5 million.

⁽²⁾	Amounts represent future cash payments to satisfy our short- and long-term workers’ compensation reserve and other long-term liabilities recorded on our consolidated balance sheets

Off-Balance Sheet Arrangements

As of June 30, 2017, we had two types of off-balance sheet arrangements.

Surety Bonds. As part of Faneuil’s normal course of operations, certain customers require surety bonds guaranteeing the performance of a contract. As of June 30, 2017, the face value of such surety bonds, which represents the maximum cash payments that Faneuil would have to make under certain circumstances of non-performance, was approximately $33.1 million.

Letter of Credit. Faneuil had a letter of credit for $2.7 million as of June 30, 2017.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. Significant estimates and assumptions by management are used for, but are not limited to, determining the fair value of assets and liabilities, including intangible assets acquired and allocation of acquisition purchase prices, estimated useful lives, recoverability of long-lived and intangible assets, the recoverability of goodwill, the realizability of deferred tax assets, stock-based compensation, the likelihood of material loss as a result of loss contingencies, customer lives, the allowance for doubtful accounts and inventory reserves, and calculation of insurance reserves. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

For a complete summary of our significant accounting policies, please refer to Note 2, “Summary of Significant Accounting Policies,” included with our audited financial statements and notes thereto for the years ended September 30, 2016 and 2015, filed with the SEC on December 23, 2016. There were no material changes to significant accounting policies during the nine months ended June 30, 2017.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Faneuil, Inc. v. 3M Company

Faneuil filed a complaint against 3M Company on September 22, 2016 in the Circuit Court for the City of Richmond, Virginia. The dispute arises out of a subcontract entered into between 3M and Faneuil in relation to a toll road project in Portsmouth, Virginia. Under the terms of the subcontract, Faneuil provides certain services to 3M as part of 3M’s agreement to provide services to Elizabeth River Crossing (“ERC”). After multiple attempts to resolve a dispute over unpaid invoices failed, Faneuil determined to file suit against 3M to collect on its outstanding receivables. In its complaint, Faneuil seeks recovery of $5.1 million based on three causes of action: breach of contract, breach of the implied covenant of good faith and fair dealing and unjust enrichment.

A five-day bench trial is set for January 22-26, 2018. The parties are engaged in substantive discovery at this time. During the three months ended June 30, 2017, ERC transitioned the services that were provided by Faneuil to an internal customer service operation. As a result of this transition, Faneuil no longer provides services to 3M or ERC. ERC continues to reimburse Faneuil for immaterial transition costs incurred by Faneuil.

McNeil, et al. v. Faneuil, Inc.

Thornton vs. ALJ Regional Holdings, Inc., et al.

Other Litigation

Item 1A. Risk Factors

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

Risks Related to Faneuil

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

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

Faneuil may not be able to integrate the CMO Business successfully and the anticipated benefits of the CMO Business acquisition may not be realized.

Faneuil acquired the CMO Business with the expectation that the acquisition would result in various benefits, including, among other things, expansion and diversification of Faneuil’s revenue base into the utilities market while leveraging its existing core competencies. Achieving those anticipated benefits is subject to a number of uncertainties, including whether Faneuil can integrate the operations of the CMO Business in an efficient and effective manner. The integration process could also take longer than Faneuil anticipates and could result in the loss of valuable employees, the disruption of each company’s ongoing businesses, processes and systems or inconsistencies in standards, controls, procedures, practices, policies and compensation arrangements, any of which could adversely affect Faneuil’s ability to achieve the benefits it anticipates.

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

On March 23, 2010, President Obama signed the Affordable Care Act (the “Affordable Care Act”) into law, which has affected comprehensive health insurance reform, including the creation of health insurance exchanges, among other reforms. A portion of Faneuil’s healthcare business relates to providing services to health insurance exchanges in various states and Faneuil believes that there may be significant opportunities for growth in this area. President Trump has disclosed that a key initiative for his Presidency is to repeal or substantially change the Affordable Care Act. It is unclear whether changes that President Trump has planned to the Affordable Care Act may affect Faneuil’s business. Significant changes to, or repeal of, the Affordable Care Act could materially and adversely affect that aspect of our business.

Economic downturns and reductions in government funding could have a negative effect on Faneuil’s business.

Demand for the services offered by Faneuil has been, and is expected to continue to be, subject to significant fluctuations due to a variety of factors beyond its control, including economic conditions. During economic downturns, the ability of both private and governmental entities to make expenditures may decline significantly. We cannot be certain that economic or political conditions will be generally favorable or that there will not be significant fluctuations adversely affecting Faneuil’s industry as a whole, or key industry segments targeted by Faneuil. In addition, Faneuil’s operations are, in part, dependent upon state government funding. Significant changes in the level of state government funding could have an unfavorable effect on Faneuil’s business, financial position, results of operations and cash flows.

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

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

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

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

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

Faneuil faces intense competition from numerous competitors. Faneuil primarily competes on the basis of quality, performance, innovation, technology, price, applications expertise, system and service flexibility and established customer service capabilities, as its services relate to toll collection, customer contact centers and employee staffing. Faneuil may not be able to compete effectively on all of these fronts or with all of its competitors. In addition, new competitors may emerge, and service offerings may be threatened by new technologies or market trends that reduce the value of the services Faneuil provides. To remain competitive, Faneuil must respond to new technologies and enhance its existing services, and we anticipate that it may have to adjust the pricing for its services to stay competitive on future responses to proposals. If Faneuil does not compete effectively, its business, financial position, results of operations and cash flows could be materially adversely affected.

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

Faneuil derives a substantial portion of its revenue from a relatively small number of customers. For additional information regarding Faneuil’s customer concentrations, see “Part I, Item 1. Financial Statements – Note 4. Concentration Risks.” We expect that Faneuil’s largest customers will continue to account for a substantial portion of its total net revenue for the foreseeable future. Faneuil has long-standing relationships with many of its significant customers. However, because Faneuil’s customers generally contract for specific projects or programs with a finite duration, Faneuil may lose these customers if funding for their respective programs is discontinued, or if their projects end and the contracts are not renewed or replaced. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could materially reduce Faneuil’s revenue and cash flows. Additionally, many of Faneuil’s customers are government entities, which can unilaterally terminate or modify the existing contracts with Faneuil without cause and penalty to such government entities in many situations. If Faneuil does not replace them with other customers or other programs, the loss of business from any one of such customers could have a material adverse effect on its business or results of operations.

Faneuil’s ability to recover capital investments in connection with its contracts is subject to risk.

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

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

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

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

In some cases, Faneuil relies on and partners with third party subcontractors as well as third-party equipment manufacturers to provide services under its contracts. To the extent that Faneuil cannot engage subcontractors or acquire equipment or materials, Faneuil’s ability to perform according to the terms of its contracts with its customers may be impaired. If the amount Faneuil is required to pay for subcontracted services or equipment exceeds the amount Faneuil has estimated in bidding for fixed prices or fixed unit price

contracts, it could experience reduced profit or losses in the performance of these contracts with its customers. Also, if a subcontractor or a manufacturer is unable to deliver its services, equipment or materials according to the negotiated terms for any reason, including the deterioration of its financial condition, Faneuil may be required to purchase the services, equipment or materials from another source at a higher price. This may reduce the expected profit or result in a loss on a customer contract for which the services, equipment or materials were needed.

Faneuil’s dependence on primary contractors could adversely affect its ability to secure new projects and derive a profit from its existing projects.

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

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

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

Adequate bonding is necessary for Faneuil to win new contracts.

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

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

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

Any business disruptions due to political instability, armed hostilities, and acts of terrorism or natural disasters could adversely affect Faneuil’s financial performance.

If terrorist activities, armed conflicts, political instability or natural disasters occur in the United States or other locations, such events may negatively affect Faneuil’s operations, cause general economic conditions to deteriorate or cause demand for Faneuil’s services, many of which depend on travel, to decline. A prolonged economic slowdown or recession could reduce the demand for Faneuil’s

services, and consequently, negatively affect Faneuil’s future sales and profits. Any of these events could have a significant effect on Faneuil’s business, financial condition or results of operations.

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

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

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

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

Risks Related to Carpets

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

The floor covering industry is highly dependent on construction activity, including new construction, which is cyclical in nature and recently experienced a downturn. The downturn in the U.S. and global economies, along with the residential and commercial markets in such economies, particularly in Las Vegas, negatively impacted the floor covering industry and Carpets’ business. Although the impact of a decline in new construction activity is typically accompanied by an increase in remodeling and replacement activity, these activities lagged during the downturn. Although these difficult economic conditions have improved, there may be additional downturns that could cause the industry to deteriorate in the future. A significant or prolonged decline in residential/commercial remodeling or new construction activity could have a material adverse effect on the Company’s business and results of operations.

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

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

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

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

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

Carpets sources, stocks and sells products from vendors, and its ability to fulfill their orders reliably and efficiently is critical to its business success. Its ability to continue to identify and develop relationships with qualified suppliers who can satisfy its standards for quality and the need to access products in a timely, efficient and cost-effective manner is a significant challenge. Carpets’ ability to access products can also be adversely affected by political instability, the financial instability of suppliers, suppliers’ noncompliance with applicable laws, trade restrictions, tariffs, currency exchange rates, supply disruptions, weather conditions, natural disasters, shipping or logistical interruptions or costs and other factors beyond its control. If these vendors fail or are unable to perform as expected and Carpets is unable to replace them quickly, its business could be adversely affected, at least temporarily, until it can do so, and potentially, in some cases, permanently.

Failure to achieve and maintain a high level of product and service quality could damage Carpets’ image with customers and negatively impact its sales, profitability, cash flows and financial condition.

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

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

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

A portion of Carpets’ business is dependent on estimating fixed price projects correctly and completing the installations within budget. Carpets could suffer losses associated with installations on fixed price projects.

A portion of Carpets’ business consists of fixed price projects that are bid for and contracted based on estimated costs. The estimating process includes budgeting for the appropriate amount of materials, labor and overhead. At times, this work can be substantial and as a

result Carpets’ ability to estimate costs correctly and its ability to complete the project within budget or satisfaction without material defect is essential. If Carpets is unable to estimate a project properly or unable to complete the project within budget or without material defect, it may suffer losses, which could adversely affect its reputation, business, and financial condition.

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

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

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

A small number of customers have historically accounted for a substantial portion of Carpets net revenue. We expect that key customers will continue to account for a substantial portion of Carpets net revenue for the foreseeable future. However, Carpets may lose these customers due to pricing, quality or other various issues. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could have a material adverse effect on its business or results of operations. For additional information regarding customer concentrations, see “Part I, Item 1. Financial Statements – Note 4. Concentration Risks.”

Historically, Carpets has purchased inventory from a small number of vendors. If these vendors became unable to provide materials promptly, Carpets would be required to find alternative vendors. Management estimates they could locate and qualify new vendors in approximately two weeks. For additional information regarding vendor concentrations, see “Part I, Item 1. Financial Statements – Note 4. Concentration Risks.”

Risks Related to Phoenix

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

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

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

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

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

Phoenix’s educational textbook cover and component sales depend on continued government funding for educational spending, which impacts demand by its customers, and may be affected by changes in or continued restrictions on local, state and/or federal funding and school budgets. As a result, a reduction in consumer discretionary spending or disposable income and/or adverse trends in the

general economy (and consumer perceptions of those trends) may affect Phoenix more significantly than other businesses in other industries.

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

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

Phoenix has significant customer and supplier concentration. For additional information regarding customer and supplier concentrations, see “Part I, Item 1. Financial Statements – Note 4. Concentration Risks.” Any significant cancellation, deferral or reduction in the quantity or type of products sold to these principal customers or a significant number of smaller customers, including as a result of our failure to perform, the impact of economic weakness and challenges to their businesses, a change in buying habits, further industry consolidation or the impact of the shift to alternative methods of content delivery, including digital distribution and printing, to customers, could have a material adverse effect on Phoenix’s business. Further, if Phoenix’s major customers, in turn, are not able to secure large orders, they will not be able to place orders with Phoenix. A substantial decrease or interruption in business from Phoenix’s significant customers could result in write-offs or the loss of future business and could have a material adverse effect on Phoenix’s business.

Additionally, Phoenix purchases certain limited grades of paper for the production of their book and component products. If our suppliers reduce their supplies or discontinue these grades of paper, we may be unable to fulfill our contract obligations, which could have a material adverse effect on Phoenix’s business. “Part I, Item 1. Financial Statements – Note 4. Concentration Risks.”

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

Phoenix is dependent upon the availability of raw materials to produce its products. Phoenix primarily uses paper, ink and adhesives, and the price and availability of these raw materials are affected by numerous factors beyond Phoenix’s control. These factors include:

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

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

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government regulation and taxes;

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market uncertainty;

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volatility in the capital and credit markets;

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environmental conditions and regulations; and

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political and global economic conditions.

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

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

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

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

Phoenix’s operations are subject to a variety of federal, state, local and foreign laws and regulations governing emissions to air, discharge to water, the generation, handling, storage, transportation, treatment and disposal of hazardous substances and other

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

The diversion of resources and management’s attention to the integration of Color Optics could adversely affect Phoenix’s day-to-day business.

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

Phoenix may not be able to integrate Color Optics successfully and the anticipated benefits of the Color Optics acquisition may not be realized.

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

Risks Related to our Businesses Generally and our Common Stock

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

Our financing documents contain affirmative and negative financial covenants restricting ALJ, Faneuil, Carpets and Phoenix. Specifically, our loan facilities include covenants restricting ALJ’s, Faneuil’s, Carpets’ and Phoenix’s ability to:

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incur additional debt;

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make certain capital expenditures;

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incur or permit liens to exist;

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enter into transactions with affiliates;

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guarantee the debt of other entities, including joint ventures;

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merge or consolidate or otherwise combine with another company; or

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transfer or sale of our assets.

ALJ’s, Faneuil’s, Carpets’ and Phoenix’s respective abilities to borrow under our loan arrangements depend upon their respective abilities to comply with certain covenants and borrowing base requirements. Our and our subsidiaries’ abilities to meet these covenants and requirements may be affected by events beyond our control, and we or they may not meet these obligations. The failure of any of us or our subsidiaries to comply with these covenants and requirements could result in an event of default under our loan arrangements that, if not cured or waived, could terminate such party’s ability to borrow further, permit acceleration of the relevant debt (and other indebtedness based on cross-default provisions) and permit foreclosure on any collateral granted as security under the loan arrangements, which includes substantially all of our assets. Accordingly, any default under our loan facilities could also result in a material adverse effect on us that may result in our lenders seeking to recover from us or against our assets. There can also be no assurance that the lenders will grant waivers on covenant violations if they occur. Any such event of default would have a material adverse effect on us.

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

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

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

We and our subsidiaries are currently involved in, and from time to time may become involved in, legal proceedings or be subject to claims arising in the ordinary course of our business. Our subsidiaries Carpets and Faneuil have each been named in lawsuits incidental to its ordinary business, and have filed actions against third parties in connection with such lawsuits. We have carefully analyzed our cases with our counsel, and we believe that we are not subject to any material risk of liability. Nevertheless, litigation is inherently unpredictable, time consuming and distracting to our management team, and the expenses of conducting litigation are not inconsequential. Such distraction and expense may adversely affect the execution of our business plan and our ability to effectively compete in the marketplace. For additional information, see “Part II. Item 1, Legal Proceedings.”

Changes in interest rates may increase our interest expense.

As of June 30, 2017, $99.6 million of our current borrowings under the Cerberus Term Loan, Cerberus/PNC Revolver, and potential future borrowings are, and may continue to be, at variable rates of interest, tied to LIBOR or the Prime Rate of interest, thus exposing us to interest rate risk. If interest rates do increase, our debt service obligations on our variable rate indebtedness could increase even if the amount borrowed remained the same, resulting in a decrease in our net income. For example, if interest rates increased in the future by 100 basis points, based on our current borrowings as of June 30, 2017, we would incur approximately an additional $1.0 million per annum in interest expense.

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

As of June 30, 2017, each of our subsidiaries had a significant backlog. Our backlog is typically subject to large variations from quarter to quarter and comparisons of backlog from period to period are not necessarily indicative of future revenue. The contracts comprising our backlog may not result in actual revenue in any particular period or at all, and the actual revenue from such contracts may differ from our backlog estimates. The timing of receipt of revenue, if any, on projects included in backlog could change because many factors affect the scheduling of projects. In certain instances, customers may have the right to cancel, reduce or defer amounts that we have in our backlog, which could negatively affect our future revenue. The failure to realize all amounts in our backlog could adversely affect our revenue and gross margins. As a result, our subsidiaries’ backlog as of any particular date may not be an accurate indicator of our future revenue or earnings.

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

We provide services that involve the storage of non-public information. Cyber attacks designed to gain access to sensitive information are constantly evolving, and high profile electronic security breaches leading to unauthorized releases of sensitive information have occurred recently at a number of major U.S. companies, including several large retailers, despite widespread recognition of the cyber-attack threat and improved data protection methods. Any breach of the systems on which sensitive data and account information are stored or archived and any misuse by our employees, by employees of data archiving services or by other unauthorized users of such

data could lead to damage to our reputation, claims against us and other potential increases in costs. If we are unsuccessful in defending any lawsuit involving such data security breaches or misuse, we may be forced to pay damages, which could materially and adversely affect our profitability and financial condition. Also, damage to our reputation stemming from such breaches could adversely affect our prospects. As the regulatory environment relating to companies’ obligations to protect such sensitive data becomes stricter, a material failure on our part to comply with applicable regulations could subject us to fines or other regulatory sanctions.

Some of our officers do not devote all of their time to us because of outside business interests, which could impair our ability to implement our business strategies and lead to potential conflicts of interest.

Jess Ravich, our Executive Chairman, is also the Group Managing Director of The TCW Group, an asset management firm. While we believe that Mr. Ravich is able to devote sufficient amounts of time to our business, the fact that Mr. Ravich has outside business interests could lessen his focus on our business, and jeopardize our ability to implement our business strategies.

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

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

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

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adverse developments with respect to our results of operations as a result of an acquisition which may require us to incur charges and/or substantial debt or liabilities;

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

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

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

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

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

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

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regulatory challenges or resulting delays; and

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

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

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

Our ability to utilize net operating losses (“NOLs”) and built in losses under Section 382 of the Code and tax credit carry-forwards to offset our future taxable income and/or to recover previously paid taxes would be limited if we were to undergo an “ownership change” within the meaning of Section 382 of the Code.

Section 382 of the Code contains rules that limit the ability of a company that undergoes an “ownership change,” which is generally any change in ownership of more than 50% of its stock over a three-year period, to utilize its NOLs and certain built-in losses recognized in years after the ownership change. These rules generally operate by focusing on ownership changes among stockholders owning directly or indirectly 5% or more of the stock of a company and any change in ownership arising from a new issuance of stock by the company.

If we undergo an ownership change for purposes of Section 382 as a result of future transactions involving our common stock, including purchases or sales of stock between 5% stockholders, our ability to use our NOLs and to recognize certain built-in losses would be subject to the limitations of Section 382. Depending on the resulting limitation, a significant portion of our NOLs could expire before we would be able to use them. At the end of our last fiscal year, September 30, 2016, we had net operating loss carryforwards for federal income tax purposes of approximately $159 million that start expiring in 2022. Approximately $140 million of the carryforward expires in 2022. Our inability to utilize our NOLs would have a negative impact on our financial position and results of operations.

We do not believe we have experienced an “ownership change” as defined by Section 382 in the last three years. However, whether a change in ownership occurs in the future is largely outside of our control, and there can be no assurance that such a change will not occur.

In May 2009, we announced that our Board of Directors adopted a shareholder rights plan (the “Rights Plan”) designed to preserve stockholder value and the value of certain tax assets primarily associated with NOLs and built-in losses under Section 382 of the Code. We also amended our certificate of incorporation to add certain restrictions on transfers of our stock that may result in an ownership change under Section 382.

U.S. tax law changes have been proposed that could reduce the corporate tax rate and otherwise change the corporate tax regime, which could impose new taxes on our operations, limit certain business deductions or negatively affect the value of our deferred tax assets.

In April 2017, the Trump administration announced a broad plan for proposed tax reform, including a reduction of the corporate tax rate from 35% to 15%, a one-time tax imposed at a reduced rate on un-repatriated offshore earnings, and the elimination of U.S. tax on foreign earnings. A set of tax reforms proposed in 2016 by certain Republican members of the House of Representatives included some of these as well as a reduction of the corporate tax rate to 20%, possible limitations on the deduction for interest expense, imposition of income tax on imported goods and elimination of income tax on exported goods, immediate tax deductions for new investments instead of deductions for depreciation expense over time, and possible indefinite carryforwards of tax NOLs. It is uncertain at the present time if, when and in what form, any proposed corporate tax reforms might be implemented and the likely impact of such legislation on our business and financial results. While a reduction in the corporate income tax rate could result in lower future tax expense and tax payments, such changes could result in a potentially significant reduction in the value and utility of our U.S. federal NOLs and other tax assets.

Our internal controls and procedures may be deficient.

Our internal controls and procedures, including the internal controls and procedures of our subsidiaries, may be subject to deficiencies or weaknesses. Remedying and monitoring internal controls and procedures distracts our management from its operations, planning, oversight and performance functions, which could harm our operating results. Additionally, any failure of our internal controls or procedures could harm our operating results or cause us to fail to meet our obligations to maintain adequate public information or to file periodic reports with the SEC, as applicable.

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

Our executive officers and directors and their affiliated entities together beneficially own a majority of our outstanding common stock and our Executive Chairman owns approximately 37.1% of our outstanding common stock. As a result, these stockholders, if they act together or in a block, could have significant influence over most matters that require approval by our stockholders, including the election

of directors and approval of significant corporate transactions, even if other stockholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.

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

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

(a) the last day of the fiscal year in which we have total annual gross revenue of $1 billion or more;

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

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

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

As an emerging growth company we will be subject to reduced public company reporting requirements. As an emerging growth company we are exempt from Section 404(b) of Sarbanes Oxley. Section 404(a) requires issuers to publish information in their annual reports concerning the scope and adequacy of the internal control structure and procedures for financial reporting. This statement shall also assess the effectiveness of such internal controls and procedures. Section 404(b) requires that the registered accounting firm shall, in the same report, attest to and report on the assessment on the effectiveness of the internal control structure and procedures for financial reporting.

As an emerging growth company we are also exempt from Section 14A (a) and (b) of the Securities Exchange Act of 1934 which require the shareholder approval of executive compensation and golden parachutes.

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

An active trading market for our common stock may never develop or be sustained.

On May 11, 2016, our stock began trading on The NASDAQ Global Market (“NASDAQ”) under the ticker symbol “ALJJ.” We cannot assure you that an active trading market for our common stock will develop on NASDAQ or elsewhere or, if developed, that any market will be sustained. Accordingly, we cannot assure you that a liquid trading market will exist, that you will be able to sell your shares of our common stock when you wish, or that you will obtain your desired price for your shares of our common stock.

We cannot assure you that our common stock will continue to trade on NASDAQ.

Although our stock began trading on NASDAQ, we cannot assure you that we will be able to maintain NASDAQ’s continued listing requirements. Such a listing helps our stockholders by providing a readily available trading market with current quotations. Without that, stockholders may have a difficult time getting a quote for the sale or purchase of our stock, the sale or purchase of our stock would likely be made more difficult and the trading volume and liquidity of our stock would likely decline. In that regard, listing on a recognized national trading market such as NASDAQ will also affect our ability to benefit from the use of our operations and expansion plans, including the development of strategic relationships and acquisitions, which are critical to our business and strategy. Any failure to maintain NASDAQ’s continued listing requirements would result in negative publicity and would negatively impact our ability to raise capital in the future.

The market price of our common stock is volatile.

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

•

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

•

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

•

announcements by our competitors of significant acquisitions; and

•

the occurrence of various risks described in these Risk Factors.

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

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

Your share ownership may be diluted by the issuance of additional shares of our common or preferred stock or securities convertible into common or preferred stock in the future. As of June 30, 2017, a total of 2,604,000 shares of our common stock are issuable pursuant to outstanding options issued by us at a weighted-average exercise price of $2.28. It is probable that options to purchase our common stock will be exercised during their respective terms if the fair market value of our common stock exceeds the exercise price of the particular option. If the stock options are exercised, your share ownership will be diluted. Additionally, we have options to purchase up to 1,680,000 shares of ALJ common stock available for grant under our existing equity compensation plans as of June 30, 2017.

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

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

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

The anti-takeover provisions of our stockholders rights plan may have the effect of delaying or preventing beneficial takeover bids by third parties.

We have a stockholder rights plan designed to preserve the value of certain tax assets primarily associated with our NOLs and built-in losses under Section 382. At the end of our last fiscal year, September 30, 2016, we had approximately $159 million of NOLs. The use of such losses to offset federal income tax would be limited if we experience an “ownership change” under Section 382. This would occur if stockholders owning (or deemed under Section 382 to own) 5% or more of our stock by value increase their collective ownership of the aggregate amount of our stock by more than 50 percentage points over a defined period. The Rights Plan was adopted to reduce the likelihood of an “ownership change” occurring as defined by Section 382.

In connection with the Rights Plan, we declared a dividend of one preferred share purchase right for each share of its common stock outstanding as of the close of business on May 21, 2009. Pursuant to the Rights Plan, any stockholder or group that acquires beneficial ownership of 4.9 percent or more of our outstanding stock (an “Acquiring Person”) without the approval of our Board of Directors would be subjected to significant dilution of its holdings. Any existing stockholder holding 4.9% or more of our stock will not be considered an Acquiring Person unless such stockholder acquires additional stock; provided that existing stockholders actually known to us to hold 4.9% or more of its stock as of April 30, 2009 are permitted to purchase up to an additional 5% of our stock without triggering the Rights

Plan. In addition, in its discretion, the Board of Directors may exempt certain persons whose acquisition of securities is determined by the Board of Directors not to jeopardize our deferred tax assets and may also exempt certain transactions. The Rights Plan will continue in effect until May 13, 2019, unless it is terminated or the preferred share purchase rights are redeemed earlier by the Board of Directors.

While the Rights Plan is intended to protect our NOLs and built-in losses under Section 382, it may also have the effect of delaying or preventing beneficial takeover bids by third parties.

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

On May 26, 2017, Faneuil acquired certain assets and assumed certain liabilities associated with the customer management outsourcing business of Vertex Business Services LLC for an adjusted purchase price of $12.7 million. ALJ financed the acquisition with cash on hand, increased borrowings of $5.5 million on its line of credit, and the issuance of 1,466,667 shares of ALJ common stock. The common stock was issued in a private placement pursuant to the exemption from registration contained in Section 4(a)(2) of the Securities Act.

On July 17, 2017, ALJ filed a Form S-3 with the Securities and Exchange Commission (“SEC”) to register the 1,466,667 shares. On July 31, 2017, the Company received a Notice of Effectiveness from the SEC with respect to the 1,466,667 shares.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosure

Not applicable.

Item 5. Other Information

None

Item 6 - Exhibits

Exhibit Number	Description of Exhibit	Method of Filing

3.1	First Amendment to the Restated Certificate of Incorporation of ALJ Regional Holdings, Inc. as filed with the Secretary of State of the State of Delaware on June 1, 2010	Incorporated by reference to Exhibit 3.1 to Form 10-12B as filed February 2, 2016.

3.2	Restated Certificate of Incorporation of ALJ Regional Holdings, Inc. as filed with the Secretary of State of the State of Delaware on June 16, 2009	Incorporated by reference to Exhibit 3.2 to Form 10-12B as filed February 2, 2016.

3.3	Certificate of Ownership and Merger of YouthStream Media Networks, Inc. as filed with the Secretary of State of the State of Delaware on October 23, 2006	Incorporated by reference to Exhibit 3.3 to Form 10-12B as filed February 2, 2016.

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

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

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

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

101.INS	XBRL Instance Document	Filed herewith

101.SCH	XBRL Taxonomy Extension Schema Document	Filed herewith

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document	Filed herewith

101.DEF	XBRL Taxonomy Extension Definition Linkbase Document	Filed herewith

101.LAB	XBRL Taxonomy Extension Label Linkbase Document	Filed herewith

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document	Filed herewith

SIGNATURES

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

ALJ Regional Holdings, Inc.

Date: August 14, 2017

/s/ Jess Ravich

Jess Ravich

Executive Chairman

(Principal Executive Officer)

Date: August 14, 2017

/s/ Brian Hartman

Brian Hartman

Chief Financial Officer

(Principal Accounting Officer)