ALJ REGIONAL HOLDINGS INC - Annual Report: 2018 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended September 30, 2018

OR

FOR THE TRANSITION PERIOD FROM                       TO

Commission File Number 001-37689

ALJ REGIONAL HOLDINGS, INC.

(Exact name of Registrant as specified in its Charter)

244 Madison Avenue, PMB #358

New York, NY 10016

(Address of principal executive offices, Zip code)

Registrant’s telephone number, including area code: (212) 883-0083

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

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

None

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

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

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☐

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

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

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

The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates was approximately $35,866,293, based on the closing price of $2.10 for such common equity on March 31, 2018.

The number of shares of common stock, $0.01 par value per share, outstanding as of November 30, 2018, was 38,026,435.

DOCUMENTS INCORPORATED BY REFERENCE

None

Table of Contents

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FORWARD-LOOKING STATEMENTS

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

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

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PART I

ITEM 1. BUSINESS.

Overview and Business Organization

ALJ Regional Holdings, Inc. (including subsidiaries, referred to collectively in this report as “ALJ,” the “Company” or “we”) is a holding company.  ALJ’s primary assets as of September 30, 2018 were all of the outstanding capital stock of the following companies:

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

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

Faneuil

Background

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

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

Acquisition of Customer Management Outsourcing Business

In May 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.  

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

Services

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

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Faneuil’s core competencies include:

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

Employees

Faneuil had 5,042 employees as of September 30, 2018 (up from 4,393 employees as of September 30, 2017), all of whom are located in the U.S. No employees are subject to any collective bargaining agreements. Faneuil considers its employee relations good.

Customers

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

The percentages of Faneuil net revenue derived from its significant customers for the years ended September 30, 2018 and 2017 were as follows:

** Less than 10% of Faneuil net revenue.

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

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Competition

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

Properties

Faneuil leases all its properties with various locations throughout the United States for customer contact centers, walk-in retail, and administration. Corporate headquarters are located in Hampton, VA.  Faneuil’s leased facilities comprise an aggregate of approximately 400,000 square feet with leases that expire at various dates through April 2029.  Faneuil believes that its leased facilities will be adequate for at least the next 12 months.

Backlog

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

The following table reflects the amount of Faneuil backlog by the year we expect to recognize revenue (in millions):

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

Seasonality

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

Governmental Regulation

Faneuil’s business is subject to many legal and regulatory requirements in the United States, covering such matters as data privacy, consumer protection, 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,” including the collection of patient data through Faneuil’s contact center services and medical device tracking services, which is subject to the Health Insurance Portability and Accountability Act of 1996, commonly known as HIPAA, which protects the privacy of patient data. These laws, regulations, and agreements require Faneuil to develop and implement policies to protect non-public personal information and to disclose these policies to consumers before a customer relationship is established and periodically after that. These laws, regulations, and agreements limit the ability to use or disclose non-public personal information for purposes other than the purposes originally intended. Many of these regulations, including those related to data privacy, frequently change and sometimes conflict with existing regulations amongst the various

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jurisdictions in which Faneuil provides services. Violations of these laws and regulations could result in liability for damages, fines, criminal prosecution, unfavorable publicity and restrictions on Faneuil’s operations.  Failure to adhere to or successfully implement processes in response to changing regulatory requirements in this area could result in legal liability or impairment to Faneuil’s reputation in the marketplace, which could have a material adverse effect on Faneuil’s business, results of operations and financial condition. Also, because a substantial portion of Faneuil operating costs consists of labor costs, changes in governmental regulations relating to wages, healthcare and healthcare reform and other benefits or employment taxes could have a material adverse effect on Faneuil’s business, results of operations or financial condition.

Management

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

Carpets N’ More

Background

Carpets was originally organized in Nevada in 2002. We acquired Carpets from Levine Leichtman for aggregate consideration of $5.3 million.

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

Products and Services

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

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

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

Customers

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

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

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A small number of customers have historically accounted for a substantial portion of Carpets net revenue.  The percentages of Carpets net revenue derived from its significant customers for the years ended September 30, 2018 and 2017 were as follows:

Suppliers

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

The percentages of Carpets inventory purchases from its significant suppliers for the years ended September 30, 2018 and 2017 were as follows:

** Less than 10% of Carpets inventory purchases.

Backlog

Carpets backlog represents open purchase orders.  Carpets total backlog, which is expected to be fully realized within the next 12 months, as of September 30, 2018 was $12.5 million compared to $20.4 million as of September 30, 2017.  The decrease in Carpets backlog at September 30, 2018, compared to September 30, 2017, was the result of a strategic decision to only accept jobs that yield a targeted profit margin.

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

Competition

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

Seasonality

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

Employees

Carpets had 361 employees, including part-time installers, as of September 30, 2018 (down from 436 employees at September 30, 2017), all of whom are located in the U.S.  No employees are subject to any collective bargaining agreements. Carpets considers its employee relations good.

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Properties

Carpets leases its corporate office, two retail locations, solid surface fabrication facility, and flooring and cabinet warehouses, which are all located in or around Las Vegas, NV.  Leased facilities total approximately 99,000 square feet with leases that expire at various dates through June 2021. Carpets believes its leased facilities will be adequate for at least the next 12 months.

Management

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

Phoenix Color Corp.

Background

Phoenix was originally incorporated in New York in 1979 and reincorporated in Delaware in 1996. We acquired Phoenix from Visant Corporation for aggregate consideration of $88.3 million.

Phoenix is a premier full-service, full-color printer with over 35 years of superior printing experience. Drawing on a broad spectrum of materials and decorative technologies, Phoenix produces memorable, value-added components, heavily illustrated books, and specialty commercial products. Book publishers generally design book components to enhance the sales appeal of their books. The production of book components requires specialized equipment, materials, and finishes and often demands high-quality, intricate work. As a result, many leading publishers rely on specialty printers such as Phoenix to supply high-quality book components. This same philosophy applies to labels, packaging, and specialty commercial products, where Phoenix customers require the knowledge and expertise of a printer that can enhance their products for sale into the commercial marketplace. Phoenix has been servicing the publishing industry within the United States since 1979 and has formed lasting relationships with many of the biggest names in book publishing.

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

Acquisition of Printing Components Business

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

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

Acquisition of Color Optics

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

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

Products and Services

Books and Components

Phoenix offers several products for books and components, which represents approximately 85% of Phoenix net revenue.

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

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Labels and Packaging

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

Employees

Phoenix had 444 employees as of September 30, 2018 (up from 398 employees as of September 30, 2017), of which one was subject to a collective bargaining agreement. All employees work in the U.S.  Phoenix considers its employee relations good.

Customers

Phoenix sells to many of the leading publishing companies.  A small number of customers have historically accounted for a substantial portion of Phoenix net revenue.  The percentages of Phoenix net revenue derived from its significant customers for the years ended September 30, 2018 and 2017 were as follows:

** Less than 10% of Phoenix net revenue.

Suppliers

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

The percentages of Phoenix inventory purchases from its significant suppliers for the years ended September 30, 2018 and 2017 were as follows:

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Backlog

Phoenix backlog represents executed contracts that contain minimum volume commitments over multiple years for future product deliveries. Phoenix includes only the minimum commitments as backlog. As Phoenix executed contracts mostly provide for minimum volume commitments rather than minimum revenue commitments, the actual revenue from such contracts may differ from our backlog estimates as total order volume from Phoenix customers may vary. Phoenix adjusts backlog to reflect estimated order volumes delivered by its customers based on historical experience known at the reporting date; however, future variations in order volumes by Phoenix customers may increase or decrease backlog and future revenue.

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

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

Seasonality

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

Competition

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

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

Properties

Phoenix owns its principal properties for corporate offices and production located in Hagerstown, MD, which totals approximately 276,000 square feet.   Additionally, Phoenix owns two buildings totaling approximately 45,000 square feet in Terre Haute, IN, which were acquired as part of the Printing Components Business.  Color Optics leases approximately 84,000 square feet in Rockaway, NJ, which expires in May 2020.  During the year ended September 30, 2018, Phoenix relocated equipment and printing from its Rockaway facility to its Hagerstown facility.  Relocation efforts were completed in November 2018.  Phoenix believes its facilities will be adequate for at least the next 12 months.

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Management

Phoenix is led by our board member Marc Reisch, who serves as its Chairman and previously served as its Chief Executive Officer from 2008 to 2015. For additional information regarding Mr. Reisch, see “Part III, Item 10. Directors, Executive Officers and Corporate Governance.”

Additional Information About ALJ and its Subsidiaries

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

As of September 30, 2018, ALJ had two employees, its Executive Chairman and its Chief Financial Officer, performing services dedicated primarily to general corporate and administrative matters. Neither employee is represented by a labor union.

Intellectual Property

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

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

Available Information

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

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

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ITEM 1A. RISK FACTORS.

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

Risks Related to Faneuil

The anticipated benefits of the CMO Business acquisition may not be realized.

Faneuil acquired the CMO Business in May 2017 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 several 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 the ability to achieve anticipated benefits.

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

On March 23, 2010, President Obama signed the Affordable Care Act (the “Affordable Care Act”) into law, which has affected comprehensive health insurance reform, including the creation of health insurance exchanges, among other reforms. A portion of Faneuil’s healthcare business relates to providing services to health insurance exchanges in various states, and Faneuil believes that there may be significant opportunities for growth in this area.  President Trump has disclosed that a key initiative for his Presidency is to repeal or substantially change the Affordable Care Act. While Congress has not passed repeal legislation, the Tax Reform Law includes a provision repealing, effective January 1, 2019, the tax-based shared responsibility payment imposed by the Affordable Care Act on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate,” which could lead to fewer enrollments in health care exchanges. It is unclear whether further changes that President Trump has planned to the Affordable Care Act will be enacted, or if enacted changes will affect Faneuil’s business.  Further significant changes to, or repeal of, the Affordable Care Act could materially and adversely affect that aspect of Faneuil’s business.

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

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

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

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

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

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

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

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

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

Faneuil derives a substantial portion of its revenue from a relatively small number of customers. For additional information regarding Faneuil customer concentrations, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 4. Concentration Risks.” We expect the largest customers of Faneuil to continue to account for a substantial portion of its total net revenue for the foreseeable future. Faneuil has long-standing relationships with many of its significant customers. However, because Faneuil customers generally contract for specific projects or programs with a finite duration, Faneuil may lose these customers if funding for their respective programs is discontinued, or if their projects end and the contracts are not renewed or replaced. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could materially reduce Faneuil revenue and cash flows. Additionally, many Faneuil customers are government entities, which can unilaterally terminate or modify the existing contracts with Faneuil without cause and penalty to such government entities in many situations. If Faneuil does not replace them with other customers or other programs, the loss of business from any one of such customers could have a material adverse effect on its business or results of operations.

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

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

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

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

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

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

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

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

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

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

Adequate bonding is necessary for Faneuil to win new contracts.

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

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

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

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

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

Faneuil’s business is subject to many laws and regulatory requirements in the United States, covering such matters as data privacy, consumer protection, 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 the ability to use or disclose non-public personal information for purposes other than the ones originally intended. Many of these regulations, including those related to data privacy, are frequently changing and sometimes conflict with existing ones among the various jurisdictions in which Faneuil provides services. Violations of these laws and regulations could result in liability for damages, fines, criminal prosecution, unfavorable publicity and restrictions placed on Faneuil operations.  Faneuil’s failure to adhere to or successfully implement processes in response to changing regulatory requirements in this area could result in legal liability or impairment to Faneuil’s reputation in the marketplace, which could have a material adverse effect on Faneuil’s business, results of operations and financial condition. In addition, because a substantial portion of Faneuil operating costs consists of labor costs, changes in governmental regulations relating to wages, healthcare and healthcare reform and other benefits or employment taxes could have a material adverse effect on Faneuil’s business, results of operations or financial condition.

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

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

Risks Related to Carpets

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

The floor covering industry is highly dependent on construction activity, including new construction, which is cyclical in nature 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.  Diminished consumer confidence in general, or specifically with respect to purchasing homes, or lack of consumer interest in purchasing a home compared to other housing alternatives due to location

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preferences, perceived affordability constraints or otherwise, may contribute to such a downturn. Further, changes to monetary policy or other actions by the Federal Reserve resulting in an adverse effect on interest rates (including mortgage interest rates), a downward trend in employment levels and job and wage growth, and increasing prices for available new or existing homes could lead to a decline in housing activity and negatively impact Carpets business.  A significant or prolonged decline in residential/commercial remodeling or new construction activity could have a material adverse effect on the business and results of operations of Carpets.

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

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

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

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

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

Carpets operates in a market sector where demand is strongly influenced by rapidly changing customer preferences as to product design and features. The success of Carpets depends on its ability to anticipate and react to changing consumer demands promptly. All of its products are subject to changing consumer preferences that cannot be predicted with certainty. Also, long lead times for certain of its products may make it hard for it to respond quickly to changes in consumer demands. Consumer preferences could shift rapidly to different types of products or away from the types of products Carpets carries altogether, and 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. The ability to access products can also be adversely affected by political instability, the financial instability of suppliers, suppliers’ noncompliance with applicable laws, trade restrictions, tariffs, currency exchange rates, supply disruptions, weather conditions, natural disasters, 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.

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

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

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

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

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

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

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

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

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

A small number of customers have historically accounted for a substantial portion of Carpets net revenue. We expect that key customers will continue to account for a substantial portion of Carpets net revenue for the foreseeable future. However, Carpets may lose these customers due to pricing, quality or other various issues. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could have a material adverse effect on its business or results of operations. For additional information regarding customer concentrations, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – 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 a short period of time. For additional information regarding vendor concentrations, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 4. Concentration Risks.”  

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Risks Related to Phoenix

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

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

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

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

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

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

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

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

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

Additionally, Phoenix purchases certain limited grades of paper to produce book and component products. If Phoenix’s suppliers reduce their supplies or discontinue these grades of paper, Phoenix may be unable to fulfill its contract obligations, which could have a material adverse effect on its business.  See “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 4. Concentration Risks.”   

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

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

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

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

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

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

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

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

The integrations of the Printing Components Business and Color Optics may place a significant burden on Phoenix 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.

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

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

Risks Related to our Businesses Generally and our Common Stock

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

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

The ability of ALJ, Faneuil, Carpets, and Phoenix to borrow under our loan arrangements depends upon their respective abilities to comply with certain covenants and borrowing base requirements.  The ability 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, if we do not have sufficient funds to repay the debt at maturity of these loans, we will need to refinance this debt. If the credit environment is constrained at the time the balloon payment is due or our indebtedness otherwise matures, we may not be able to refinance our existing indebtedness on acceptable terms and may be forced to choose from a number of unfavorable options. These options include agreeing to otherwise unfavorable financing terms, selling assets on disadvantageous terms or defaulting on the loan and permitting the lender to foreclose. Accordingly, our ability to meet our obligations depends on our future performance and capital raising activities, which will be affected by financial, business, economic and other factors, many of which are beyond our control. If our cash flow and capital resources prove inadequate to allow us to pay the principal and interest on our debt and meet our other obligations, our ability to execute our business plan and effectively compete in the marketplace may be materially adversely affected.

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

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

Changes in interest rates may increase our interest expense.

As of September 30, 2018, $93.7 million of our current borrowings under the Cerberus Term Loan, Cerberus/PNC Revolver, and potential future borrowings are, and may continue to be, at variable rates of interest, tied to LIBOR or the Prime Rate of interest, thus exposing us to interest rate risk. Such rates tend to fluctuate based on general economic conditions, general interest rates, Federal Reserve rates and the supply of and demand for credit in the relevant interbanking market. In recent years, the Fed has incrementally raised the target range for the federal funds rate, with additional increases expected to come over the next year. Increases in the interest rate generally, and particularly when coupled with any significant variable rate indebtedness, could materially adversely impact our interest expenses. If interest rates continue increasing, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income and cash flows, including cash available for servicing our indebtedness, will correspondingly decrease. For example, if interest rates increased in the future by 100 basis points, based on our current borrowings as of September 30, 2018, we would incur approximately an additional $0.9 million per year 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 September 30, 2018, each of our subsidiaries had a significant backlog.  Our backlog is typically subject to large variations from quarter to quarter and comparisons of backlog from period to period are not necessarily indicative of future revenue. The contracts comprising our backlog may not result in actual revenue in any particular period or at all, and the actual revenue from such contracts may differ from our backlog estimates. The timing of receipt of revenue, if any, for projects included in backlog could change because many factors affect the scheduling of projects. In certain instances, customers may have the right to cancel, reduce or defer amounts that we have in our backlog, which could negatively affect our future revenue.  The failure to realize all amounts in our backlog could adversely affect our revenue and gross margins. As a result, our subsidiaries’ backlog as of any particular date may not be an accurate indicator of our future revenue or earnings.

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

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

Some of our officers 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.

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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:

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

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

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

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

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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, 2018, we had net operating loss carryforwards for federal income tax purposes of approximately $144.3 million that start expiring in 2022. Approximately $121.3 million of the carryforward expires in 2022. Our inability to utilize our NOLs would have a negative impact on our financial position and results of operations.

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

In 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.

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

The Tax Reform Law contains many significant changes to the U.S. federal income tax laws, the full consequences of which have not yet been determined. As a result of the enacted reduction in the federal corporate income tax rate, we recorded a one-time, non-cash increase to deferred income tax expense of $4.1 million to revalue ALJ’s net deferred tax asset during the year ended September 30, 2018.  The one-time revaluation was based on our current knowledge, interpretation and understanding of the Tax Reform Law and its impact to our business. Other aspects of the Tax Reform Law, including, but not limited to the state tax effect of adjustments made to federal taxes and the interest expense deduction limitation may have additional material impacts on the value of our deferred tax assets, could result in significant one-time charges in the current or future taxable years, and could increase our future tax expense. The foregoing items could have a material adverse effect on our business, cash flow, results of operations or financial conditions.  

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 distract 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 of September 30, 2018. As a result, these stockholders, if they act together or in a block, could have significant influence over most matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions, even if other stockholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.

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

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

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

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

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(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 are 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 of 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, which allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates.

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

The market price of our common stock is volatile.

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

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 September 30, 2018, a total of 1,674,000 shares of our common stock are issuable pursuant to outstanding options issued by us at a weighted-average exercise price of $3.38.  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, options to purchase up to 1,260,000 shares of ALJ common stock are available for grant under our existing equity compensation plans as of September 30, 2018.  

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

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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 (the “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, 2018, we had approximately $144.3 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 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES.

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

ITEM 3. LEGAL PROCEEDINGS.

Litigation, Claims, and Assessments

Faneuil, Inc. v. 3M Company

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

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

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The matter was tried in a bench trial from April 30, 2018 through May 2, 2018.  On May 15, 2018, the Circuit Court for the City of Richmond, Virginia (the “Richmond Circuit Court”) issued its opinion, which dismissed both Faneuil’s complaint and 3M’s counterclaim with prejudice.  No monetary damages were awarded to either Faneuil or 3M.  As a result of the Richmond Circuit Court’s opinion, ALJ recorded a non-cash litigation loss of $2.9 million (the outstanding unreserved receivable from 3M), which was included with selling, general and administrative expense during the year ended September 30, 2018.  Faneuil has filed an appeal of the Richmond Circuit Court’s judgment.

Marshall v. Faneuil, Inc.

On July 31, 2017, plaintiff Donna Marshall (“Marshall”), filed a proposed class action lawsuit in the Superior Court of the State of California for the County of Sacramento against Faneuil and ALJ. Marshall, a previously terminated Faneuil employee, alleges various California state law employment-related claims against Faneuil.  Faneuil has answered the complaint and removed the matter to the United States District Court for the Eastern District of California; however, Marshall filed a motion to remand the case back to state court. The motion to remand has been fully briefed and argued and remains pending before the court.  The case is in early discovery at this time. Faneuil believes this action is without merit and intends to defend it vigorously.

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 September 30, 2018 that the ultimate resolution of these matters (including the matters described above) will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.

ITEM 4. MINE SAFETY DISCLOSURE.

Not applicable.

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PART II

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

Market Information

On May 11, 2016, our stock began trading on NASDAQ under the ticker symbol “ALJJ.”  Prior to May 11, 2016, our stock traded on the OTC Bulletin Board (“OTCBB”).  The following table sets forth the range of high and low sales prices for the Company’s common stock for the periods indicated:

Record Holders

As of November 30, 2018, there were 127 registered holders of ALJ’s common stock.  In addition, there are a significant number of holders of ALJ common stock that are “street name” or beneficial holders, whose shares are held of record by banks, brokers, and other financial institutions.  

Dividends

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

Equity Compensation Plan Information

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

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

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

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The following table sets forth certain information concerning shares of common stock authorized for issuance under the Company’s existing equity compensation plans as of September 30, 2018:

Recent Sales of Unregistered Securities

None.

Issuer Purchases of Equity Securities

None.

ITEM 6. SELECTED FINANCIAL DATA.

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

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

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

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

Overview

ALJ Regional Holdings, Inc. (“ALJ” or “we”) is a holding company that operates Faneuil, Inc., 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 the acquisition of the Printing Components Business by Phoenix on October 2, 2017, the acquisition of the CMO Business by Faneuil on May 26, 2017, and the acquisition of Color Optics by Phoenix on July 18, 2016.  In analyzing the financial impact of any potential acquisition, we focus on earnings, operating margin, cash flow and return on invested capital targets. We hire successful and experienced management teams to run each of our operating companies and incentivize them to drive higher profits. We are focused on increasing our net revenue at each of our operating subsidiaries by investing in sales and marketing, expanding into new products and markets, and evaluating and executing on tuck-in acquisitions, while continually examining our cost structures to drive higher profits.

Results of Operations

Our results of operations are impacted by the timing of acquisitions, including the CMO Business acquired by Faneuil on May 26, 2017, and the Printing Components Business acquired by Phoenix on October 2, 2017.  

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

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Net Revenue

Faneuil Net Revenue

Faneuil net revenue for Fiscal 2018 was $188.2 million, an increase of $30.0 million, or 18.9%, compared to net revenue of $158.3 million for Fiscal 2017.  The increase was mainly attributable to a $22.0 million increase from the CMO Business acquisition, a $12.5 million increase from new customers, and a $0.7 million increase in revenue from existing customers, partly offset by a $5.2 million decrease driven by the completion of customer contracts.  The remaining change was a result of normal fluctuations in existing customer contracts.

Carpets Net Revenue

Carpets net revenue for Fiscal 2018 was $68.4 million, a decrease of $1.3 million, or 1.9%, compared to net revenue of $69.7 million for Fiscal 2017.  The slight decrease was primarily attributable to lower volumes from granite and cabinet sales, somewhat offset by an increase in volume from flooring sales.    

Phoenix Net Revenue

Phoenix net revenue for Fiscal 2018 was $113.1 million, an increase of $14.4 million, or 14.6%, compared to $98.7 million during Fiscal 2017.  The increase was a result of the acquisition of the Printing Component Business, which contributed net revenue of $15.7 million during Fiscal 2018.  This increase was offset by a decrease in revenue from the remaining business of $1.3 million during Fiscal 2018 compared to Fiscal 2017, due to lower volumes primarily for packaging.

Cost of Revenue

Faneuil Cost of Revenue

Faneuil cost of revenue for Fiscal 2018 was $146.0 million, an increase of $25.2 million, or 20.9%, compared to $120.8 million for Fiscal 2017.  The absolute dollar increase in cost of revenue was a direct result of the increased net revenue.  During Fiscal 2018 as compared to Fiscal 2017, Faneuil cost of revenue as a percentage of segment net revenue increased to 77.6% from 76.3% as a result of the integration of the CMO Business.  

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Carpets Cost of Revenue

Carpets cost of revenue for Fiscal 2018 was $56.2 million, a decrease of $0.6 million, or 1.1%, compared to cost of revenue of $56.8 million for Fiscal 2017.  The absolute dollar decrease in cost of revenue was a direct result of decreased net revenue.  Although Carpets cost of revenue as a percentage of net revenue was relatively constant at 82.1% during Fiscal 2018 and 81.4% during Fiscal 2017, it was impacted by the change in the relative percentage of net revenue generated from new home, retail, and commercial sales.

Phoenix Cost of Revenue

Phoenix cost of revenue for Fiscal 2018 was $83.7 million, an increase of $10.6 million, or 14.5% compared to cost of revenue of $73.1 million for Fiscal 2017.  The absolute dollar increase in cost of revenue was mainly attributable to increased net revenue associated with the aforementioned Printing Components Business acquisition.  During Fiscal 2018, as compared to Fiscal 2017, Phoenix cost of revenue as a percentage of segment net revenue was flat at 74.0% and 74.1%, respectively.  Phoenix experiences normal fluctuations to cost of revenue as a percentage of segment net revenue as a result of changes to the mix of products sold.

Selling, General and Administrative Expense

Faneuil Selling, General and Administrative Expense

Faneuil selling, general and administrative expense for Fiscal 2018 was $32.0 million, an increase of $7.4 million, or 30.3%, compared to selling, general and administrative expense of $24.6 million for Fiscal 2017.  The increase was primarily attributable to a $3.4 million increase from the CMO Business acquisition, a $2.9 million non-cash litigation loss, and a $1.5 million increase to support new customers, offset by $0.1 million decrease to support existing customers, and concluded contracts of $0.3 million.  During Fiscal 2018 compared to Fiscal 2017, Faneuil selling, general and administrative expense as a percentage of segment net revenue increased to 17.0% from 15.5% principally as a result of the aforementioned non-cash litigation loss.

Carpets Selling, General and Administrative Expense

Carpets selling, general and administrative expense was $11.8 million for Fiscal 2018, an increase of $0.1 million, or 1.2%, compared to selling, general and administrative expense of $11.7 million for Fiscal 2017.  Although selling, general and administrative expenses were flat, they were impacted by higher labor costs and increased insurance premiums, slightly offset by reduced legal fees.  Carpets selling, general and administrative expense as a percentage of segment net revenue increased to 17.3% for Fiscal 2018 from 16.7% for Fiscal 2017 as a result of incurring additional expenses in Fiscal 2018, including insurance and equipment maintenance, which do not fluctuate with net revenue.

Phoenix Selling, General and Administrative Expense

Phoenix selling, general and administrative expense for Fiscal 2018 was $15.4 million, an increase of $2.9 million, or approximately 22.9%, compared to $12.5 million for Fiscal 2017.  The increase was mainly attributable to the Printing Component Business acquisition, and non-recurring relocation and restructuring expense totaling $2.5 million to consolidate manufacturing facilities.  Phoenix selling, general and administrative expense as a percentage of segment net revenue increased to 13.6% for Fiscal 2018 from 12.7% for Fiscal 2017, which was mainly attributable to the non-recurring relocation and restructuring expense incurred during Fiscal 2018.  

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ALJ Selling, General and Administrative Expense

ALJ selling, general and administrative expense for Fiscal 2018 was $3.8 million, an increase of $0.6 million, or 20.0%, compared to selling, general and administrative expense of $3.1 million for Fiscal 2017. The increase was primarily attributable to the hiring of a full-time chief financial officer in August 2017 and additional personnel to support ALJ’s business, acquisition-related legal expenses to support our strategy of acquisitions, and an increase in non-cash stock-based compensation costs for key employees and board of directors.  Such increase was somewhat offset by allocating certain expenses, including accounting and tax preparation, to subsidiaries to better align expenses with ALJ’s consolidated reporting structure.  

Depreciation and Amortization

Faneuil Depreciation and Amortization

Faneuil depreciation and amortization expense for Fiscal 2018 was $10.3 million, an increase of $2.2 million, or 26.8%, compared to $8.1 million for Fiscal 2017.  The increase was mainly attributable to the CMO Business acquisition, and to a lesser extent capital equipment purchased to support new and expanded contracts.  Because each Faneuil contract requires 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 Fiscal 2018 was $0.9 million, an increase of $0.1 million, or 16.8%, compared to $0.7 million for Fiscal 2017.  Carpets expects to experience an increase in depreciation and amortization expense as new automation machinery for its granite and stone facility is acquired.

Phoenix Depreciation and Amortization

Phoenix depreciation and amortization expense was $2.5 million for both Fiscal 2018 and Fiscal 2017.  The majority of Phoenix depreciation and amortization expense was included in the cost of revenue.

Interest Expense

Interest expense for Fiscal 2018 was $10.6 million, an increase of $0.8 million, or 8.4%, compared to interest expense of $9.7 million for Fiscal 2017.  The increase was attributable to the increased weighted-average outstanding balance on our line of credit to fund capital expenditures and working capital requirements, increased interest rates, $0.2 million increased amortization of deferred loan costs, and the $7.5 million increased borrowing on our term loan to acquire the Printing Components Business, partially offset by reduced interest resulting from principal payments.

Other Income

Other income for Fiscal 2017 related to a one-time derecognition of a liability for discontinued business operations, which management determined was no longer required.  

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Income Taxes

We recognized a provision for income tax of $4.3 million for Fiscal 2018 compared to a benefit from income tax of $12.4 million for Fiscal 2017.  The effective tax rate during Fiscal 2018 compared to Fiscal 2017 was impacted by the reduced corporate income tax rates as part of the tax reform legislation enacted on December 22, 2017 (the “Tax Reform Law”).  As a result of the enacted reduction in the federal corporate income tax rate, we recorded a one-time, non-cash increase to deferred income tax expense of $4.1 million to revalue ALJ’s net deferred tax asset.  We recorded the provisional impacts of the Tax Reform Law, based on our current knowledge, interpretation, and understanding of the Tax Reform Law and its impact to our business.  While we were able to make reasonable estimates of the impact of certain aspects of the Tax Reform Law, we may be affected by other aspects, including, but not limited to, the state tax effect of adjustments made to federal temporary differences, and the interest expense deduction limitation.

We will continue to assess the impact of the Tax Reform Law on our future taxes and our consolidated financial statements. Actual impacts could be materially different from current estimates.  See “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 10. Income Taxes.”

Segment Adjusted EBITDA

Faneuil Segment Adjusted EBITDA

Faneuil segment adjusted EBITDA was $13.1 million for both Fiscal 2018 and Fiscal 2017.  Higher expenses related to new technology, training and call handling for the new CMO Business offset the increased net revenue recognized from the new CMO Business contracts.

Carpets Segment Adjusted EBITDA

Carpets segment adjusted EBITDA for Fiscal 2018 was $0.5 million compared to segment adjusted EBITDA of $1.3 million for Fiscal 2017.  Fiscal 2018 was impacted by lower revenue, and higher material, labor, and customer service expenses.

Phoenix Segment Adjusted EBITDA

Phoenix segment adjusted EBITDA for Fiscal 2018 was $22.1 million compared to segment adjusted EBITDA of $18.9 million for Fiscal 2017.  The increase was a result of the Printing Component Business acquisition somewhat offset by reduced net revenues in packaging.

ALJ Segment Adjusted EBITDA

ALJ segment adjusted EBITDA for Fiscal 2018 was $(2.6) million compared to segment adjusted EBITDA of $(2.3) million for Fiscal 2017.  Fiscal 2018 was impacted by the hiring of a full-time chief financial officer and other headcount to support ALJ’s business.  

Segment adjusted EBITDA is not considered a non-GAAP measure because we include segment adjusted EBITDA in our segment disclosures in accordance with the Accounting Standards Codification Topic 280 – Segment Reporting.  See “Part IV, Item 15. Exhibits, Financial Statements Schedules – Note 12. Reportable Segments and Geographic Information.”  

Seasonality

Faneuil

Faneuil experiences seasonality within its various lines of business. For example, during the end of the calendar year through the end of the first calendar quarter, Faneuil generally experiences higher revenue attributable to its healthcare customers as the customer contact centers increase operations during the open enrollment periods of the healthcare exchanges. Faneuil revenue from its healthcare customers generally decreases during the remaining portion of the year after the open enrollment period. Seasonality is less

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pronounced with Faneuil customers in the transportation industry, though there is typically some volume increase during the summer months.

Carpets

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

Phoenix

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

Liquidity and Capital Resources

Our principal sources of liquidity have been cash provided by operations and borrowings under various debt arrangements.  At September 30, 2018, our principal sources of liquidity included cash and cash equivalents of $2.0 million and an available borrowing capacity of $14.4 million on our line of credit.  Our principal uses of cash have been for acquisitions and to pay down debt.  We anticipate that our principal uses of cash will continue to be to acquire businesses and pay down our debt.    

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

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

We recognized a net loss of $7.3 million for Fiscal 2018, and generated cash from operating activities of $17.8 million, offset by cash used for investing and financing activities of $17.1 million and $4.3 million, respectively.

We recognized net income of $15.7 million for Fiscal 2017, and generated cash from operating activities of $25.2 million, offset by cash used for investing and financing activities of $17.2 million and $7.7 million, respectively.

Operating Activities

Cash provided by operations of $17.8 million during Fiscal 2018 was the result of our $7.3 million net loss, $27.8 million addback of net non-cash expenses, and $2.7 million of net cash used by changes in operating assets and liabilities.  The most significant components of net non-cash expenses were depreciation and amortization of $19.0 million, deferred income taxes of $3.4 million, litigation loss of $2.9 million, amortization of deferred loan costs of $1.3 million, and stock-based compensation of $1.1 million.  The most significant components of changes in operating assets and liabilities included inventories of $3.1 million and other assets of $2.0 million, which provided cash, and deferred revenue and customer deposits of $4.3 million, and accounts payable of $2.9 million, which used cash.  

Cash provided by operations of $25.2 million during Fiscal 2017 was the result of our $15.7 million net income, $5.9 million addback of net non-cash expenses, and $3.6 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 $16.6 million, stock-based compensation of $0.8 million and amortization of deferred loan costs of $1.1 million, offset by deferred income tax benefit of $12.5 million.  The most significant components of changes in operating assets and liabilities included prepaid expenses and other current assets of $1.4 million, accounts

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payable of $1.8 million, and accrued expenses of $1.5 million, which provided cash, and accounts receivable of $1.9 million, which used cash.  

Investing Activities

During Fiscal 2018, our investing activities used $17.1 million of cash, of which $9.0 million was for our Printing Components Business acquisition, $5.9 million was used to purchase equipment, software and leasehold improvements for Faneuil’s new and existing customers, and $2.7 million was used to purchase capital equipment in the normal course of operations, partially offset by $0.5 million proceeds received from the sale of equipment.

During Fiscal 2017, our investing activities used $17.2 million of cash, mainly for the CMO Business acquisition and purchases of equipment, software and leasehold improvements, which used $8.0 million and $9.3 million, respectively, slightly offset by $0.2 million of proceeds from the sale of assets.  The majority of the capital expenditures were to support Faneuil new and existing customers, and purchase of production equipment by Phoenix.

Financing Activities

During Fiscal 2018, our financing activities used $4.3 million of cash.  Financing activities which used cash included $13.5 million to pay down our term loan, $2.8 million of capital lease payments, and $0.5 million for debt and stock issuance costs.  Proceeds from our line of credit and our amended term loan provided $3.2 million and $7.5 million, respectively (see further discussion at Contractual Obligations below).  Proceeds from the issuance of common stock and exercise of stock options provided $1.5 million and $0.3 million, respectively. Proceeds from the amended term loan and issuance of common stock were used to fund our Printing Components Business acquisition discussed above.

During Fiscal 2017, our financing activities used $7.7 million of cash, mainly for term-loan payments totaling $11.0 million and $2.3 million of capital lease payments, partially offset by an increase in our line of credit of $5.5 million, which was used to fund the CMO Business acquisition discussed above.

Contractual Obligations

The following table summarizes our significant contractual obligations at September 30, 2018, and the effect such obligations are expected to have on our liquidity and cash flows in future periods:

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Interest payments are due in arrears on the first day of each month.  Quarterly principal payments are due on the last day of each fiscal quarter.  Annual principal payments equal to 75% of ALJ’s excess cash flow (“ECF”), as defined in the Financing Agreement, are due upon delivery of the audited financial statements.  During Fiscal 2018, ALJ made an ECF payment of $4.1 million, and mandatory payments totaling $0.2 million as a result of receiving proceeds from sales of assets.  A final balloon payment is due at maturity, August 14, 2020.  

The Cerberus Debt is secured by substantially all the Company’s assets and imposes certain limitations on the Company, including its ability to incur debt, grant liens, initiate certain investments, declare dividends and dispose of assets.  The Cerberus Debt also requires ALJ to comply with certain debt covenants.  As of September 30, 2018, ALJ was in compliance with all debt covenants and had unused borrowing capacity of $14.4 million.  

In November 2018, we entered into the Fourth Amendment to the Financing Agreement, which is not reflected in the above table.  For further discussion of the Fourth Amendment to the Financing Agreement, see “Part IV, Item 15. Exhibits, Financial Statement Schedules – Note 13.  Subsequent Events.”

Off-Balance Sheet Arrangements

As of September 30, 2018, we had two types of off-balance sheet arrangements.

Surety Bonds.  In the normal course of operations, certain Faneuil customers require surety bonds guaranteeing the performance of a contract.  As of September 30, 2018, 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 $29.6 million.

Letter of Credit.  Faneuil had a letter of credit for $2.6 million as of September 30, 2018.

Critical Accounting Estimates

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

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

Business Acquisitions

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

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

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

Long-Lived Asset Impairments

Property and Equipment

We assess property and equipment for impairment when events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Factors that we consider in deciding when to perform an impairment review include significant under-performance of a business or product line in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in our use of the assets. We measure the impairment by comparing the difference between the carrying value and its fair value. Property and equipment is considered a non-financial asset and is recorded at fair value only if an impairment charge is recognized.  When we determine that the useful lives of assets are shorter than we had originally estimated, we accelerate the rate of depreciation over the assets’ new, shorter useful lives.

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Identified Intangibles

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

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

Goodwill

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

Qualitative factors considered in this assessment include industry and market considerations, overall financial performance, and other relevant events and factors affecting the subsidiary.   Additionally, as part of this assessment, we may perform a quantitative analysis to supplement and support the qualitative factors.  Although there were no specific qualitative indicators of impairment for our subsidiaries, we elected to perform a step 1 impairment test in the fourth quarter of Fiscal 2018.

Our goodwill impairment test considers both the income method and the market method to estimate fair value.  Determining the fair value of a reporting segment involves the use of significant estimates and assumptions.  The income method is based on a discounted future cash flow approach that uses the following major assumptions and inputs: revenue, based on assumed market segment growth rates and our assumed market segment share, and estimated costs.  Our estimates of market segment growth, our market segment share, and costs are based on historical data, various internal estimates, and a variety of external sources. The same estimates are also used in our business planning and forecasting process. We test the reasonableness of the inputs and outcomes of our discounted cash flow analysis against available comparable market data. The market method is based on financial multiples and transaction prices of comparable companies.  

Each of our subsidiaries were deemed to have fair values that exceeded their carrying value.

Income Taxes

We make estimates and judgments in determining the provision for taxes for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities that arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties related to uncertain tax positions. Significant changes in these estimates may result in an increase or decrease in our tax provision in a subsequent period.

We must assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not more likely than not, we must increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. We believe that we will ultimately recover the deferred tax assets recorded on our consolidated balance sheets. However, should a change occur in our ability to recover our deferred tax assets, our tax provision would increase in the period in which we determined that the recovery is not more likely than not. Recovery of a portion of our deferred tax assets is impacted by management’s plans with respect to holding or disposing of certain investments; therefore, changes in management’s plans with respect to holding or disposing of investments could affect our future provision for taxes.

At September 30, 2018, we had a $30.3 million deferred tax asset related to net operating loss (“NOL”) carryforwards, with a related valuation allowance of $17.7 million.  The valuation allowance was based on the weight of positive and negative evidence considered, including history of income or loss, projected future taxable income, availability of tax planning strategies and the expiration dates of these carryforwards.

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We use a two-step process to recognize liabilities for uncertain tax positions. The first step is to evaluate the tax position for recognition by determining whether the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. If we determine that a tax position will more likely than not be sustained on audit, the second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and may not accurately forecast actual outcomes. Determining whether an uncertain tax position is effectively settled requires judgment. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.

Revenue Recognition

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

We recognize revenue from non-refundable up-front payments attributable to contract implementation over the longer of the initial term of the contract or the expected customer life, which is estimated at the time the initial contract is executed.

We record reductions to revenue for pricing adjustments, such as rebates, in the same period that the related revenue is recorded. We accrue 100% of potential rebates at the time of sale.   We reverse the accrual of unclaimed rebate amounts as specific rebate programs contractually end and when we believe unclaimed rebates are no longer subject to payment and will not be paid. Thus the reversal of unclaimed rebates may have a positive impact on our net revenue and net income in subsequent periods. Additional reductions to revenue will result if actual pricing adjustments exceed our estimates.

We establish an allowance for doubtful accounts to cover probable and estimable losses on our customer accounts receivable resulting from the failure of customers to make contractual payments.  A portion of our customer portfolio consists of a small number of relatively large accounts, which are individually evaluated for realizability.  These estimates have a direct impact on our net income because a higher bad debt allowance for a particular period would result in lower net income in that period.  

Potential Loss from Litigation

We are involved in disputes, litigation, and other legal proceedings. We prosecute and defend these matters aggressively. However, there are many uncertainties associated with any litigation, and we cannot provide assurance that these actions or other third-party claims against us will be resolved without costly litigation and/or substantial settlement costs.  We establish an accrual based on our estimate of the potential loss from litigation.  Our estimate has a direct impact on our net income because a higher accrual for a particular period would result in lower net income in that period.  

Workers’ Compensation Reserves

Our accrued self-insurance reserves represent the estimated costs of known and anticipated or unasserted claims under our workers’ compensation insurance policies. Accrued insurance provisions for unasserted claims arising from unreported incidents are based on an analysis of historical claims data using an independent actuarial analysis. For each unasserted claim, we record a self-insurance provision up to the estimated amount of the probable claim utilizing loss-development factors calculated by an actuary, applied to actual claims data. Our self-insurance provisions are susceptible to change to the extent that actual claims development differs from historical claims development. Historically, we have not experienced significant variability in our actuarial estimates for claims incurred but not reported.  Accrued insurance provisions for reported claims are evaluated by management each quarter.  Our assessment of whether a loss is probable and/or reasonably estimable is updated as necessary. Due to the inherently uncertain nature of workers’ compensation claims, the ultimate loss may differ materially from our estimates, which could directly impact our operating expense and net income.  

Share-Based Awards

The calculation of the fair value of share-based awards is subjective and requires several assumptions over such items as expected life and expected stock volatility. These assumptions have a direct impact on our net income because a higher share-based awards fair value would result in higher compensation expense and lower net income for a particular period.

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

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

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.  

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

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

None.

ITEM 9A. CONTROLS AND PROCEDURES.  

Evaluation of Disclosure Controls and Procedures

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

Changes in Internal Control Over Financial Reporting

There were no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the fourth fiscal quarter for the year ended September 30, 2018, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Management Report on Internal Control Over Financial Reporting

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

Management assessed our internal control over financial reporting as of September 30, 2018, the end of our fiscal year. Management based its assessment on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Management’s assessment included evaluation of elements such as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment.

Based on this assessment, management has concluded that our internal controls over financial reporting were effective as of September 30, 2018, and provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external reporting purposes in accordance with GAAP. We reviewed the results of management’s assessment with the Audit Committee of our Board of Directors.

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

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Inherent Limitations on Effectiveness of Controls

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

ITEM 9B. OTHER INFORMATION.

None.

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PART III

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

Directors and Executive Officers

The following table sets forth the names, ages, and principal offices and positions of our current directors and executive officers as of November 30, 2018.

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

Jess M. Ravich. Mr. Ravich has served as a director since June 2006 and Chairman of the Board of Directors since August 2006.  He has served as the Executive Chairman and senior executive officer of the Company since February 2013. Mr. Ravich joined The TCW Group as Group Managing Director in December 2012. From 2009 to 2012, Mr. Ravich was Managing Director at Houlihan Lokey.  In 1991 Mr. Ravich founded Libra Securities, LLC (“Libra Securities”), a Los Angeles-based investment banking firm that focused on capital raising and financial advisory services for middle-market corporate clients and the sales and trading of debt and equity securities for institutional investors, and served as its Chairman and Chief Executive Officer from 1991 until 2009.  Prior to founding Libra Securities, Mr. Ravich was an Executive Vice President at Jefferies & Co., Inc. and a Senior Vice President at Drexel Burnham Lambert.

Mr. Ravich has been a member of the board of directors of Cherokee Inc. (Nasdaq GS: CHKE) since May 1995 and served as its Chairman of the Board until June 2017.  Mr. Ravich has also served on the Board of Directors of A-Mark International since 2014 and Unwired Planet since November 2015. In addition to his professional responsibilities, Mr. Ravich has also served on the Undergraduate Executive Board of the Wharton School and the Board of Trustees of the Archer School for Girls. Mr. Ravich earned both a B.S and M.S. from the Wharton School and a J.D. from Harvard University.  Mr. Ravich is the father of Rae Ravich, a director of the Company.

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

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

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

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

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

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

Michael Borofsky. Mr. Borofsky has served as a director since September 2013.  Mr. Borofsky was formerly Senior Vice President of MacAndrews & Forbes. Prior to that, Mr. Borofsky worked for Skadden, Arps, Slate, Meagher & Flom LLP, where he specialized in mergers & acquisitions, and was an analyst at Goldman Sachs. Mr. Borofsky earned a B.A. from Yale University and a J.D. from Columbia University School of Law.

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

Margarita Paláu Hernández. Ms. Paláu Hernández has served as a director since November 2015. Ms. Paláu Hernández is a Principal and Founding Partner of Hernández Ventures, a privately held entity engaged in the acquisition and management of a variety of business interests. She has served in this capacity since 1988. Prior to founding Hernández Ventures, Ms. Paláu Hernández was an attorney with the law firm of McCutcheon, Black, Verleger & Shea, where she focused on domestic and international business and real estate transactions. Ms. Paláu Hernández has a B.A. from the University of San Diego and a J.D. from UCLA School of Law.

Other Key Employees

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

Involvement in Certain Legal Proceedings

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

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Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires our directors and executive officers, as well as persons who own more than 10% of a registered class of our equity securities, to file with the SEC initial reports of ownership and reports of changes in beneficial ownership. Directors, executive officers, and greater than 10% shareholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based solely on a review of copies of Section 16(a) reports and representations received by us from reporting persons, and without conducting any independent investigation of our own, we believe all Forms 3, 4 and 5 were timely filed with the SEC by such reporting persons during the year ended September 30, 2018.

Code of Business Conduct and Ethics

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

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

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

Committees of the Board of Directors

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

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

The following chart details the current membership of each committee:

Audit Committee

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

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

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Compensation, Nominating, and Corporate Governance Committee

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

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

There have been no material changes to the procedures by which shareholders may nominate nominees to our Board of Directors during the year ended September 30, 2018.  

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ITEM 11. EXECUTIVE COMPENSATION.

Summary Compensation

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

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

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

SUMMARY COMPENSATION TABLE