UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)  
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to

 

Commission File Number 001-37503

 

 

 

B. RILEY FINANCIAL, INC.
(Exact Name of Registrant as Specified in Its Charter)

 

Delaware 27-0223495

(State or Other Jurisdiction of

Incorporation or Organization)

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

21255 Burbank Boulevard, Suite 400

Woodland Hills, CA

91367

(Address of Principal Executive Offices) (Zip Code)

 

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

 

 

  

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

 

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

 

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

 

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

 

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

 

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

 

As of July 30, 2018, there were 26,127,031 shares of the registrant’s common stock, par value $0.0001 per share, outstanding.

 

 

 

 

 

B. Riley Financial, Inc. 

Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2018

Table of Contents

     
    Page
     
PART I. FINANCIAL INFORMATION  
Item 1. Unaudited Financial Statements 3
  Condensed Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017 3
  Condensed Consolidated Statements of Income for the three and six months ended June 30, 2018 and 2017 4
 

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2018 and 2017

5
  Condensed Consolidated Statements of Equity for the six months ended June 30, 2018 and 2017 6
  Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2018 and 2017 7
  Notes to Condensed Consolidated Financial Statements 8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 39
Item 3. Quantitative and Qualitative Disclosures About Market Risk 57
Item 4. Controls and Procedures 57
PART II. OTHER INFORMATION  
Item 1. Legal Proceedings 59
Item 1A. Risk Factors 60
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 60
Item 3. Defaults Upon Senior Securities 60
Item 4. Mine Safety Disclosures 60
Item 5. Other Information 60
Item 6. Exhibits 61
  Signatures 62


 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(Dollars in thousands, except par value)

 

   June 30,   December 31, 
   2018   2017 
   (Unaudited)     
Assets        
Assets        
Cash and cash equivalents  $191,274   $132,823 
Restricted cash   467    19,711 
Due from clearing brokers   35,242    31,479 
Securities and other investments owned, at fair value   160,540    145,360 
Securities borrowed   1,013,988    807,089 
Accounts receivable, net   33,111    20,015 
Due from related parties   8,042    5,689 
Advances against customer contracts   200,036    5,208 
Prepaid expenses and other assets   42,203    22,605 
Property and equipment, net   11,195    11,977 
Goodwill   99,246    98,771 
Other intangible assets, net   52,603    56,948 
Deferred income taxes   29,222    29,229 
Total assets  $1,877,169   $1,386,904 
Liabilities and Equity          
Liabilities          
Accounts payable  $3,790   $2,650 
Accrued expenses and other liabilities   72,986    71,685 
Deferred revenue   3,600    3,141 
Due to partners   7,398    1,578 
Securities sold not yet purchased   17,583    28,291 
Securities loaned   1,012,240    803,371 
Mandatorily redeemable noncontrolling interests   4,238    4,478 
Asset based credit facility   105,004     
Notes payable   52,286    2,243 
Senior notes payable   333,768    203,621 
Total liabilities   1,612,893    1,121,058 
           
Commitments and contingencies          
B. Riley Financial, Inc. stockholders’ equity:          
Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued        
Common stock, $0.0001 par value; 100,000,000 shares authorized; 26,070,165 and 26,569,462 issued and outstanding as of June 30, 2018 and December 31, 2017, respectively   2    2 
Additional paid-in capital   244,631    259,980 
Retained earnings   20,408    6,582 
Accumulated other comprehensive loss   (1,619)   (534)
Total B. Riley Financial, Inc. stockholders’ equity   263,422    266,030 
Noncontrolling interests   854    (184)
Total equity   264,276    265,846 
Total liabilities and equity  $1,877,169   $1,386,904 

 

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

 

3 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Income

(Unaudited)

(Dollars in thousands, except share data)

                 
   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2018   2017   2018   2017 
Revenues:                
Services and fees  $118,882   $64,395   $207,331   $117,213 
Interest income - Securities lending   6,591    2,218    13,882    2,218 
Sale of goods   28    63    66    142 
Total revenues   125,501    66,676    221,279    119,573 
Operating expenses:                    
Direct cost of services   13,925    18,485    25,577    36,086 
Cost of goods sold   49    130    90    189 
Selling, general and administrative expenses   76,723    37,722    144,821    61,874 
Restructuring charge   1,602    6,214    1,819    6,588 
Interest expense - Securities lending   4,724    1,565    9,892    1,565 
Total operating expenses   97,023    64,116    182,199    106,302 
Operating income   28,478    2,560    39,080    13,271 
Other income (expense):                    
Interest income   166    150    294    282 
Income from equity investment   4,893        4,221     
Interest expense   (10,359)   (1,894)   (14,586)   (2,685)
Income before income taxes   23,178    816    29,009    10,868 
(Provision for) benefit from income taxes   (5,377)   2,547    (6,366)   6,396 
Net income   17,801    3,363    22,643    17,264 
Net income (loss) attributable to noncontrolling interests   804    83    1,143    (37)
Net income attributable to B. Riley Financial, Inc.  $16,997   $3,280   $21,500   $17,301 
                     
Basic income per share  $0.67   $0.15   $0.83   $0.85 
Diluted income per share  $0.64   $0.15   $0.80   $0.82 
                     
Cash dividends per share  $0.12   $0.16   $0.28   $0.42 
                     
Weighted average basic shares outstanding   25,424,178    21,216,829    25,799,077    20,311,231 
Weighted average diluted shares outstanding   26,397,513    22,119,055    26,785,169    20,984,757 

 

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

 

4 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(Unaudited)

(Dollars in thousands)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2018   2017   2018   2017 
Net income  $17,801   $3,363   $22,643   $17,264 
Other comprehensive (loss) income:                    
Change in cumulative translation adjustment   (865)   401    (1,085)   1,046 
Other comprehensive (loss) income, net of tax   (865)   401    (1,085)   1,046 
Total comprehensive income   16,936    3,764    21,558    18,310 
Comprehensive income (loss) attributable to noncontrolling interests   804    83    1,143    (37)
Comprehensive income attributable to B. Riley Financial, Inc.  $16,132   $3,681   $20,415   $18,347 

 

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

 

5 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Equity

(Unaudited)

(Dollars in thousands)

 

                   Accumulated         
                   Additional       Other         
   Preferred Stock   Common Stock   Paid-in   Retained   Comprehensive   Noncontrolling   Total 
   Shares   Amount   Shares   Amount   Capital   Earnings   Loss   Interests   Equity 
Balance, January 1, 2017      $    19,140,342   $2   $141,170   $9,887   $(1,712)  $1,045   $150,392 
Issuance of common stock for acquisition of MK Capital, LLC - contingent equity consideration on February 2, 2017           166,666        1,151                1,151 
Issuance of common stock for acquisition of Dialectic general partner interests on April 13, 2017           158,484        1,952                1,952 
Issuance of common stock for acquisition of FBR & Co. on June 1, 2017           4,779,354        73,472                73,472 
Vesting of restricted stock, net of shares withheld for employer taxes           132,960        (1,057)               (1,057)
Share based payments                   3,940                3,940 
Dividends on common stock                       (8,134)           (8,134)
Net income for the six months ended June 30, 2017                       17,301        16    17,317 
Foreign currency translation adjustment                           1,046        1,046 
Balance, June 30, 2017      $    24,377,806   $2   $220,628   $19,054   $(666)  $1,061   $240,079 
                                              
Balance, January 1, 2018      $    26,569,462   $2   $259,980   $6,582   $(534)  $(184)  $265,846 
Vesting of restricted stock, net of shares withheld for employer taxes           450,703        (3,570)               (3,570)
Stock repurchased and retired           (950,000)       (17,338)               (17,338)
Share based payments                   5,559                5,559 
Dividends on common stock                       (7,674)           (7,674)
Net income for the six months ended June 30, 2018                       21,500        1,038    22,538 
Foreign currency translation adjustment                           (1,085)       (1,085)
Balance, June 30, 2018      $    26,070,165   $2   $244,631   $20,408   $(1,619)  $854   $264,276 

 

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

 

6 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)

 

   Six Months Ended 
   June 30, 
   2018   2017 
Cash flows from operating activities:          
Net income  $22,643   $17,264 
Adjustments to reconcile net income to net cash used in operating activities:          
Depreciation and amortization   6,670    4,290 
Provision for doubtful accounts   648    704 
Share-based compensation   5,559    3,940 
Recovery of key man life insurance       (6,000)
Non-cash interest and other   1,870    166 
Effect of foreign currency on operations   (582)   (855)
Income from equity investment   (4,221)    
Deferred income taxes   7    (23,636)
Impairment of leaseholds, lease loss accrual and loss on disposal of fixed assets   1,403    1,371 
Income allocated and fair value adjustment for mandatorily redeemable noncontrolling interests   543    7,268 
Change in operating assets and liabilities:          
Due from clearing brokers   (3,763)   13,408 
Securities and other investments owned   (15,180)   (40,975)
Securities borrowed   (206,899)   (48,134)
Accounts receivable and advances against customer contracts   (208,658)   (37,153)
Prepaid expenses and other assets   (16,108)   14,988 
Accounts payable, accrued payroll and related expenses, accrued value added tax payable and other accrued expenses   5,320    (22,748)
Amounts due to/from related parties and partners   3,362    (13,333)
Securities sold, not yet purchased   (10,708)   2,675 
Deferred revenue   459    (425)
Securities loaned   208,869    44,365 
Net cash used in operating activities   (208,766)   (82,820)
Cash flows from investing activities:          
Cash acquired from acquisition of FBR & Co.       15,738 
Acquisition of other businesses       (2,052)
Acquisition consideration payable       (10,381)
Purchases of property and equipment and intangible assets   (1,836)   (306)
Proceeds from key man life insurance       6,000 
Proceeds from sale of property and equipment and intangible assets   37    619 
Equity investments   (3,575)    
Dividends from equity investment   1,695     
Net cash (used in) provided by investing activities   (3,679)   9,618 
Cash flows from financing activities:          
Proceeds from asset based credit facility   300,000    65,987 
Repayment of asset based credit facility   (194,460)   (45,750)
Payment of contingent consideration       (1,250)
Proceeds from notes payable   51,020     
Repayment of notes payable   (357)    
Proceeds from issuance of senior notes   132,123    60,375 
Payment of debt issuance costs   (4,936)   (2,528)
Payment of employment taxes on vesting of restricted stock   (3,570)   (1,057)
Dividends paid   (9,549)   (8,380)
Repurchase of common stock   (17,338)    
Distribution to noncontrolling interests   (782)   (1,646)
Net cash provided by financing activities   252,151    65,751 
Increase (decrease) in cash, cash equivalents and restricted cash   39,706    (7,451)
Effect of foreign currency on cash, cash equivalents and restricted cash   (499)   2,354 
Net increase (decrease) in cash, cash equivalents and restricted cash   39,207    (5,097)
Cash, cash equivalents and restricted cash, beginning of  year   152,534    115,399 
Cash, cash equivalents and restricted cash, end of period  $191,741   $110,302 
           
Supplemental disclosures:          
Interest paid  $21,868   $2,890 
Taxes paid  $2,306   $9,689 

 

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

 

7 

 

 

B. RILEY FINANCIAL, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except share data)

 

NOTE 1—ORGANIZATION, BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

 

Organization and Nature of Operations

 

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

 

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

 

On November 9, 2017, the Company entered into an Agreement and Plan of Merger with B. R. Acquisition Ltd., an Israeli corporation and wholly-owned subsidiary of the Company (“Merger Sub”), and magicJack VocalTec Ltd., an Israeli corporation (“magicJack”), pursuant to which Merger Sub will merge with and into magicJack, with magicJack continuing as the surviving corporation and as an indirect subsidiary of the Company. Subject to the terms and conditions of the Agreement and Plan of Merger, each outstanding share of magicJack will be converted into the right to receive $8.71 in cash without interest, representing approximately $143,500 in aggregate merger consideration. The closing of the transaction is subject to the receipt of certain regulatory approvals and the satisfaction of other closing conditions. It is anticipated that the acquisition of magicJack will close in the second half of 2018.

 

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

(a)Principles of Consolidation and Basis of Presentation

 

The condensed consolidated financial statements include the accounts of B. Riley Financial, Inc. and its wholly-owned and majority-owned subsidiaries. The condensed consolidated financial statements also include the accounts of (a) Great American Global Partners, LLC which is controlled by the Company as a result of its ownership of a 50% member interest, appointment of two of the three executive officers and significant influence over the funding of operations, and (b) GA Retail Investments, L.P. which is controlled by the Company as a result of its ownership of a 50% partnership interest, appointment of executive officers and significant influence over the operations. The condensed consolidated financial statements have been prepared by the Company, without audit, pursuant to interim financial reporting guidelines and the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. In the opinion of the Company’s management, all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the financial position and the results of operations for the periods presented have been included. These condensed consolidated financial statements and the accompanying notes should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on March 14, 2018. The results of operations for the six months ended June 30, 2018 are not necessarily indicative of the operating results to be expected for the full fiscal year or any future periods.

 

(b)Use of Estimates

 

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

 

8 

 

(c)Revenue Recognition

 

On January 1, 2018, we adopted Accounting Standards Codification (“ASC”) 606 – Revenue from Contracts with Customers using the modified retrospective method and the impact was determined to be immaterial on our consolidated financial statements. The new revenue standard was applied prospectively in our condensed consolidated financial statements from January 1, 2018 forward and reported financial information for historical comparable periods will not be revised and will continue to be reported under the accounting standards in effect during those historical periods.

 

Revenues are recognized when control of the promised goods or performance obligations for services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for the goods or services.

 

Revenues from contracts with customers in the Capital Markets segment, Auction and Liquidation segment, Valuation and Appraisal segment, and Principal Investments – United Online segment are primarily comprised of the following:

 

Capital Markets segment - Fees earned from corporate finance and investment banking services are derived from debt, equity and convertible securities offerings in which the Company acted as an underwriter or placement agent. Fees from underwriting activities are recognized as revenues when the performance obligation for the services related to the underwriting transaction is satisfied under the terms of the engagement and is not subject to any other contingencies. Fees are also earned from financial advisory services rendered in connection with client mergers, acquisitions, restructurings, recapitalizations and other strategic transactions. The performance obligation for financial advisory services is satisfied over time as work progresses on the engagement and services are delivered to the client. The performance obligation for financial advisory services may also include success and performance based fees which are recognized as revenue when the performance obligation is no longer constrained and it is not probable that the revenue recognized would be subject to significant reversal in a future period. Generally, it is probable that the revenue recognized is no longer subject to significant reversal upon the closing of the investment banking transaction.

 

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

 

Revenues from sales and trading are recognized when the performance obligation is satisfied and include commissions resulting from equity securities transactions executed as agent or principal and are recorded on a trade date basis and fees paid for equity research.

 

Auction and Liquidation segment - Commission and fees earned on the sale of goods at auction and liquidation sales are recognized when evidence of a contract or arrangement exists, the transaction price has been determined, and the performance obligation has been satisfied when control of the product and risks of ownership has been transferred to the buyer. The commission and fees earned for these services are included in revenues in the accompanying condensed consolidated statements of income. Under these types of arrangements, revenues also include contractual reimbursable costs.

 

Revenues earned from auction and liquidation services contracts where the Company guarantees a minimum recovery value for goods being sold at auction or liquidation are recognized over time when the performance obligation is satisfied. We generally use the cost-to-cost measure of progress for our contracts because it best depicts the transfer of services to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenues, including estimated fees or profits, are recorded proportionally as costs are incurred. Costs to fulfill the contract include labor and other direct costs related to the contract. Due to the nature of the guarantees and performance obligations under these contracts, the estimation of revenue that is ultimately earned is complex and subject to many variables and requires significant judgment. It is common for these contracts to contain provisions that can either increase or decrease the transaction price upon completion of our performance obligations under the contract. Estimated amounts are included in the transaction price at the most likely amount it is probable that a significant reversal of revenue will not occur. Our estimates of variable consideration and determination of whether or not to include estimated amounts in the transaction price are based on an assessment of our anticipated performance under the contract taking into consideration all historical, current and forecasted information that is reasonably available to us. Costs that directly relate to the contract and expected to be recoverable are capitalized as an asset and included in advances against customer contracts the accompanying condensed consolidated balance sheets. These costs are amortized as the services are transferred to the customer over the contract period, which generally does not exceed six months, and the expense is recognized a component of direct cost of services. If, during the auction or liquidation sale, the Company determines that the total costs to be incurred on a performance obligation under a contract exceeds the total estimated revenues to be earned, a provision for the entire loss on the performance obligation is recognized in the period the loss is determined.

 

9 

 

Valuation and Appraisal segment - Revenues in the Valuation and Appraisal segment are primarily comprised of fees for valuation and appraisal services. Revenues are recognized when the performance obligation is completed and is generally at the point in time upon delivery of the completed services to the customer. Revenues in the Valuation and Appraisal segment also include contractual reimbursable costs.

 

Principal Investments – United Online segment - Revenues in the Principal Investments - United Online segment include subscription service revenues that are derived primarily from fees charged to pay accounts and are recognized in the period in which the transaction price has been determinable and the related performance obligations for services are provided to the customer. The Company’s pay accounts generally pay in advance for their services by credit card, PayPal, automated clearinghouse or check, and revenues are then recognized ratably over the service period. Payments from pay accounts received in advance of our performance obligations are recorded in the condensed consolidated balance sheets as deferred revenue. 

 

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

 

Sale of product revenues are derived primarily from the sale of mobile broadband service devices to customers and includes the related shipping and handling fees.

 

Revenues from other sources in the capital markets segment is primarily comprised of (i) interest income from securities lending activities, (ii) related net trading gains and losses from market making activities, the commitment of capital to facilitate customer orders, (iii) trading activities from our principal investments in equity and other securities for the Company’s account, and (iv) other income.

 

Interest income from securities lending activities consists of interest income from equity and fixed income securities that are borrowed from one party and loaned to another. The Company maintains relationships with a broad group of banks and broker-dealers to facilitate the sourcing, borrowing and lending of equity and fixed income securities in a “matched book” to limit the Company’s exposure to fluctuations in the market value or securities borrowed and securities loaned.

 

Other revenues includes (i) net trading gains and losses from market making activities in our fixed income group, (ii) carried interest from our asset management recognized as earnings from financial assets within the scope of ASC 323 - Investments - Equity Method and Joint Ventures, and therefore will not be in the scope of ASC 606 - Revenue from Contracts with Customers. In accordance with ASC 323 - Investments - Equity Method and Joint Ventures, the Company will record equity method income (losses) as a component of investment income based on the change in our proportionate claim on net assets of the investment fund, including performance-based capital allocations, assuming the investment fund was liquidated as of each reporting date pursuant to each fund’s governing agreements, and (iii) other miscellaneous income.

 

(d)Direct Cost of Services

 

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

 

10 

 

(e)Interest Expense - Securities Lending Activities

 

Interest expense from securities lending activities is included in operating expenses related to operations in the capital markets segment. Interest expense from securities lending activities is incurred from equity and fixed income securities that are loaned to the Company.

 

(f)Concentration of Risk

 

Revenues from one liquidation service contract to a retailer represented 13.6% of total revenues during the three months ended June 30, 2018. Revenues in the capital markets, valuation and appraisal and principal investments – United Online segments are currently primarily generated in the United States. Revenues in the auction and liquidation segment are primarily generated in the United States, Australia, Canada and Europe.

 

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

 

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

 

(g)Advertising Expenses

 

The Company expenses advertising costs, which consist primarily of costs for printed materials, as incurred. Advertising costs totaled $1,192 and $862 for the three months ended June 30, 2018 and 2017, respectively, and $1,285 and $1,043 for the six months ended June 30, 2018 and 2017, respectively. Advertising expense is included as a component of selling, general and administrative expenses in the accompanying condensed consolidated statements of income.

 

(h)Share-Based Compensation

 

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

 

(i)Restructuring Charge

 

The Company recorded a restructuring charge in the amount of $1,602 and $6,214 for the three months ended June 30, 2018 and 2017, respectively, and $1,819 and $6,588, for the six months ended June 30, 2018 and 2017, respectively.

 

The restructuring charge of $1,602 and $1,819 during the three and six months ended June 30, 2018, respectively, was primarily related to severance costs and lease loss accruals for the planned consolidation of office space related to operations in the capital markets segment.

 

The restructuring charge of $6,214 and $6,588 during the three and six months ended June 30, 2017, respectively, was primarily related to costs savings measures taking into account the planned synergies as a result of the acquisition of FBR & Co. (“FBR”), which included a reduction in force for some of the corporate executives of FBR and a restructuring to integrate FBR’s operations with the Company’s operations in the capital markets segment.

 

11 

 

The following table summarizes the changes in accrued restructuring charge during the three and six months ended June 30, 2018 and 2017:

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2018   2017   2018   2017 
Balance, beginning of period  $1,576    817    2,600   $694 
Restructuring charge   1,602    6,214    1,819    6,588 
Cash paid   (1,229)   (1,537)   (2,450)   (1,788)
Non-cash items   (122)   (2,207)   (142)   (2,207)
Balance, end of period  $1,827   $3,287   $1,827   $3,287 

 

The following table summarizes the restructuring activities during the three months ended June 30, 2018 and 2017:

 

   Three Months Ended June 30, 
   2018   2017 
       Principal               Principal         
       Investments -               Investments -         
   Capital   United           Capital   United         
   Markets   Online   Corporate   Total   Markets   Online   Corporate   Total 
Restructuring charge:                                        
Employee termination costs  $682            682   $2,534   $109   $2,182   $4,825 
Facility closure and consolidation charge (recovery)   1,092        (172)   920    1,389            1,389 
Total restructuring charge  $1,774   $   $(172)  $1,602   $3,923   $109   $2,182   $6,214 

 

The following table summarizes the restructuring activities during the six months ended June 30, 2018 and 2017:

 

   Six Months Ended June 30, 
   2018   2017 
       Principal               Principal         
       Investments -               Investments -         
   Capital   United           Capital   United         
   Markets   Online   Corporate   Total   Markets   Online   Corporate   Total 
Restructuring charge:                                        
Employee termination costs  $653            653   $2,534   $483   $2,182   $5,199 
Facility closure and consolidation charge (recovery)   1,376        (210)   1,166    1,389            1,389 
Total restructuring charge  $2,029   $   $(210)  $1,819   $3,923   $483   $2,182   $6,588 

 

(j)Income Taxes

 

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

 

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

 

The Tax Cuts and Jobs Act (the “Tax Act”) was enacted on December 22, 2017. The Tax Act reduces the U.S. federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, provides an exemption from U.S. federal tax for dividends received from foreign subsidiaries, and creates new taxes on certain foreign sourced earnings. As of the completion of these financial statements and related disclosures, we have not completed our accounting for the tax effects of the Tax Act; however, as described below, we have made a reasonable estimate of such effects and recorded a provisional tax expense of $13,052, which is included as a component of income tax expense in the fourth quarter of 2017. This provisional tax expense incorporates assumptions made based upon the Company’s current interpretation of the Tax Act, and may change as we receive additional clarification and implementation guidance and as the interpretation of the Tax Act evolves. In accordance with SEC Staff Accounting Bulletin No. 118, the Company will finalize the accounting for the effects of the Tax Act no later than the fourth quarter of 2018. Future adjustments made to the provisional effects will be reported as a component of income tax expense from continuing operations in the reporting period in which any such adjustments are determined.

 

12 

 

(k)Cash and Cash Equivalents

 

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

 

(l)Restricted Cash

 

As of June 30, 2018, restricted cash balance of $467 is cash collateral for one of our telecommunication suppliers. As of December 31, 2017, restricted cash balance of $19,711 included $19,197 of cash collateral related to a retail liquidation engagement and $514 cash segregated in a special bank account for the benefit of customers related to our broker dealer subsidiary and collateral for one of our telecommunication suppliers.

 

(m)Securities Borrowed and Securities Loaned

 

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

 

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

 

(n)Due from/to Brokers, Dealers, and Clearing Organizations

 

The Company clears all of its proprietary and customer transactions through other broker-dealers on a fully disclosed basis. The amount receivable from or payable to the clearing brokers represents the net of proceeds from unsettled securities sold, the Company’s clearing deposit and amounts receivable for commissions less amounts payable for unsettled securities purchased by the Company and amounts payable for clearing costs and other settlement charges. This amount also includes the cash collateral received for securities loaned less cash collateral for securities borrowed. Any amounts payable would be fully collateralized by all of the securities owned by the Company and held on deposit at the clearing broker.

 

(o)Accounts Receivable

 

Accounts receivable represents amounts due from the Company’s auction and liquidation, valuation and appraisal, capital markets and principal investments - United Online customers. The Company maintains an allowance for doubtful accounts for estimated losses inherent in its accounts receivable portfolio. In establishing the required allowance, management utilizes a specific customer identification methodology. Management also considers historical losses adjusted for current market conditions and the customers’ financial condition and the current receivables aging and current payment patterns. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The Company does not have any off-balance sheet credit exposure related to its customers. Bad debt expense and changes in the allowance for doubtful accounts for the three and six months ended June 30, 2018 and 2017 are included in Note 5.

 

13 

 

(p)Advances Against Customer Contracts

 

Advances against customer contracts represent advances of contractually reimbursable funds incurred prior to, and during the term of the auction and liquidation services contract. On April 18, 2018, the Company entered into an agency agreement to participate in the right to liquidate certain assets of The Bon-Ton Stores, Inc. (the “Agency Agreement”).  There are three parties to the Agency Agreement which were granted the right to act as the exclusive agent to conduct the sale of substantially all of the assets of The Bon-Ton Stores, Inc. (the “Bon-Ton Transaction”).  The Company initially advanced $407,426 in connection with Agency Agreement.  As of June 30, 2018, $199,243 remained outstanding and is included in the advances against customer contracts balance of $200,036.  Management expects the outstanding advance continue to be repaid from proceeds generated from the liquidation of the assets related to the Bon-Ton Transaction. 

 

(q)Property and Equipment

 

Property and equipment are stated at cost. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the assets. Property and equipment held under capital leases are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset. Depreciation and amortization expense was $1,187 and $694 for the three months ended June 30, 2018 and 2017, respectively, and $2,364 and $1,214 for the six months ended June 30, 2018 and 2017, respectively.

 

(r)Securities Owned and Securities Sold Not Yet Purchased

 

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

 

As of June 30, 2018 and December 31, 2017, the Company’s securities owned and securities sold not yet purchased at fair value consisted of the following securities:

 

   June 30,   December 31, 
   2018   2017 
Securities and other investments owned:          
Common stocks and warrants  $83,755   $67,306 
Corporate bonds   6,508    6,539 
Fixed income securities   5,760    2,329 
Loans receivable   16,829    33,713 
Partnership interests and other   47,688    35,473 
   $160,540   $145,360 
           
Securities sold not yet purchased:          
Common stocks  $6,466   $19,145 
Corporate bonds   2,740    1,175 
Fixed income securities   2,613    699 
Partnership interests and other   5,764    7,272 
   $17,583   $28,291 

 

(s)Fair Value Measurements

 

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

 

14 

 

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

 

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

 

15 

 

The following tables present information on the financial assets and liabilities measured and recorded at fair value on a recurring basis as of June 30, 2018 and December 31, 2017:

 

  

Financial Assets and Liabilities Measured at Fair Value
on a Recurring Basis at June 30, 2018 Using

 
       Quoted prices in   Other   Significant 
   Fair value at   active markets   observable   unobservable 
   June 30,   identical assets   inputs   inputs 
   2018   (Level 1)   (Level 2)   (Level 3) 
Assets:                    
Securities and other investments owned:                    
Common stocks and warrants  $83,755   $57,533   $   $26,222 
Corporate bonds   6,508        6,508     
Fixed income securities   5,760        5,760     
Loans receivable   16,829            16,829 
Partnership interests and other   45,150    473    11    44,666 
Total assets measured at fair value  $158,002   $58,006   $12,279   $87,717 
                     
Liabilities:                    
Securities sold not yet purchased:                    
Common stocks  $6,466   $6,466   $   $ 
Corporate bonds   2,740        2,740      
Fixed income securities   2,613        2,613     
Partnership interests and other   5,764    5,764         
Total securities sold not yet purchased   17,583    12,230    5,353     
                     
Mandatorily redeemable noncontrolling interests issued after November 5, 2003   4,238            4,238 
Total liabilities measured at fair value  $21,821   $12,230   $5,353   $4,238 

 

16 

 

   Financial Assets and Liabilities Measured at Fair Value 
   on a Recurring Basis at December 31, 2017 Using 
       Quoted prices in   Other   Significant 
   Fair value at   active markets   observable   unobservable 
   December 31,   identical assets   inputs   inputs 
   2017   (Level 1)   (Level 2)   (Level 3) 
Assets:                
Securities and other investments owned:                    
Common stocks and warrants  $67,306   $38,960   $   $28,346 
Corporate bonds   6,539        6,539     
Fixed income securities   2,329        2,329     
Loans receivable   33,713            33,713 
Partnership interests and other   31,883    686    5,093    26,104 
Total assets measured at fair value  $141,770   $39,646   $13,961   $88,163 
                     
Liabilities:                    
Securities sold not yet purchased:                    
Common stocks  $19,145   $19,145   $   $ 
Corporate bonds   1,175        1,175     
Fixed income securities   699        699     
Partnership interests and other   7,272    7,272         
Total securities sold not yet purchased   28,291    26,417    1,874     
                     
Mandatorily redeemable noncontrolling interests issued after November 5, 2003   4,478            4,478 
Total liabilities measured at fair value  $32,769   $26,417   $1,874   $4,478 

 

As of June 30, 2018, securities and other investments owned included $2,538 of investment funds valued at NAV per share as a practical expedient. As such, total securities and other investments owned of $160,540 in the condensed consolidated balance sheets at June 30, 2018 included investments in investment funds of $2,538 and securities and other investments owned in the amount of $158,002 as outlined in the fair value table above.

 

As of December 31, 2017, securities and other investments owned included $3,590 of investment funds valued at NAV per share as a practical expedient. As such, total securities and other investments owned of $145,360 in the condensed consolidated balance sheets at December 31, 2017 included investments in investment funds of $3,590 and securities and other investments owned in the amount of $141,770 as outlined in the fair value table above.

 

As of June 30, 2018 and December 31, 2017, financial assets measured and reported at fair value on a recurring basis and classified within Level 3 were $87,717 and $88,163, respectively, or 4.7% and 6.4%, respectively, of the Company’s total assets. In determining the fair value for these Level 3 financial assets, the Company analyzes various financial, performance and market factors to estimate the value, including where applicable, over-the-counter market trading activity.

 

17 

 

The changes in Level 3 fair value hierarchy during the six months ended June 30, 2018 and 2017 are as follows:

 

   Level 3   Level 3 Changes During the Period   Level 3 
   Balance at   Fair   Relating to   Purchases,   Transfer in   Balance at 
   Beginning of   Value   Undistributed   Sales and   and/or out   End of 
   Year   Adjustments   Earnings   Settlements   of Level 3   Period 
Six Months Ended June 30, 2018                        
Common stocks and warrants  $28,346   $(3,246)  $578   $544   $   $26,222 
Loans receivable   33,713    (2)       (16,882)       16,829 
Partnership interests and other   26,104    968    (685)   18,279        44,666 
Mandatorily redeemable noncontrolling interests issued after November 5, 2003   4,478        (240)           4,238 
                               
Six Months Ended June 30, 2017                              
Common stocks and warrants  $299   $(667)  $   $10,131   $   $9,763 
Corporate bonds   160                (160)    
Loans receivables       (100)       29,208        29,108 
Partnership interests   13,426    2,697        899        17,022 
Mandatorily redeemable noncontrolling interests issued after November 5, 2003   3,214    6,250    (272)       449    9,641 
Contingent consideration   1,242    8        (1,250)        

 

The fair value adjustment for contingent consideration of $8 represents imputed interest for the six months ended June 30, 2017. During the second quarter of 2017, the Company had a triggering event for the mandatorily redeemable noncontrolling interests that resulted in a fair value adjustment of $6,250. In connection with this event, the Company received proceeds of $6,000 from key man life insurance. These amounts have been recorded in the condensed consolidated statements of income in selling, general and administrative expenses in the corporate segment. The amount reported in the table above also for the six months ended June 30, 2018 and 2017 includes the amount of undistributed earnings attributable to the noncontrolling interests that is distributed on a quarterly basis.

 

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

 

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

 

During the six months ended June 30, 2018 and 2017, there were no assets or liabilities measured at fair value on a non-recurring basis.

 

(t)Derivative and Foreign Currency Translation

 

The Company periodically uses derivative instruments, which primarily consist of the purchase of forward exchange contracts, for certain auction and liquidation engagements with operations outside the United States. During the six months ended June 30, 2018, the Company’s use of derivative consisted of the purchase of forward exchange contracts (a) in the amount of $54,406 Canadian dollars that were settled during the six months ended June 30, 2018 and (b) $1,500 Euro’s that settled in March 2018. During the six months ended June 30, 2017, the Company’s use of derivatives consisted of the purchase of forward exchange contracts in the amount of $25,000 Australian dollars that was settled on January 31, 2017. The forward exchange contract was entered into to improve the predictability of cash flows related to a retail store liquidation engagement that was completed in December 2016. The net loss from forward exchange contracts was $121 and $0 during the three months ended June 30, 2018 and 2017, respectively, and $91 and $70 during the six months ended June 30, 2018 and 2017, respectively. This amount is reported as a component of selling, general and administrative expenses in the condensed consolidated statements of income.

 

The Company transacts business in various foreign currencies. In countries where the functional currency of the underlying operations has been determined to be the local country’s currency, revenues and expenses of operations outside the United States are translated into United States dollars using average exchange rates while assets and liabilities of operations outside the United States are translated into United States dollars using period-end exchange rates. The effects of foreign currency translation adjustments are included in stockholders’ equity as a component of accumulated other comprehensive income in the accompanying condensed consolidated balance sheets. Transaction gains were $756 and transaction losses were $131 during the three months ended June 30, 2018 and 2017, respectively, and transactions gains were $894 and transaction losses of $530 during the six months ended June 2018 and 2017, respectively. These amounts are included in selling, general and administrative expenses in our condensed consolidated statements of income.

 

18 

 

(u)Common Stock Warrants

 

The Company issued 821,816 warrants to purchase common stock of the Company in connection with the acquisition of Wunderlich Investment Company, Inc., a Delaware corporation (“Wunderlich”) on July 3, 2017. The common stock warrants entitle the holders of the warrants to acquire shares of the Company’s common stock from the Company at a price of $17.50 per share (the “Exercise Price”), subject to, among other matters, the proper completion of an exercise notice and payment. The Exercise Price and the number of shares of Company common stock issuable upon exercise are subject to customary anti-dilution and adjustment provisions, which include stock splits, subdivisions or reclassifications of the Company’s common stock. The common stock warrants expire on July 3, 2022.

 

(v)Equity Investment

 

At December 31, 2017, the Company had a loan receivable from bebe stores, inc. (“bebe”) with a fair value of $16,867 included in securities and other investments owned. On January 12, 2018, the loan receivable in the amount of $16,867 plus accrued interest of $51 was converted into 2,819,528 shares of common stock of bebe, representing a conversion price at $6.00 per share. On January 12, 2018, the Company also purchased 500,000 shares of bebe common stock at $6.00 per share of which 250,000 shares were newly issued common stock by bebe and 250,000 shares were purchased from the majority shareholder of bebe. At June 30, 2018, the Company had an ownership of approximately 30.1% of bebe’s outstanding common shares.

 

The equity ownership in bebe is accounted for under the equity method of accounting. The carrying value for the bebe investment at June 30, 2018 was $24,951 and is included in prepaid expenses and other assets in the condensed consolidated balance sheets. For the three and six months ended June 30, 2018, the equity income from the 30.1% ownership in bebe was $6,470 and $6,082, respectively, and is included in income from equity investments on the condensed consolidated statements of income.

 

(w)Statements of Cash Flows – Supplemental Non-cash Disclosures

 

During the six months ended June 30, 2018, non-cash investing activities included the conversion of a loan receivable in the amount of $16,867 and accrued interest receivable of $51 into an equity investment that totaled $16,918 as more fully discussed in Note 2(v) above.

 

(x)Variable Interest Entity

 

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

 

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

 

   June 30, 2018 
Partnership investments  $6,562 
Due from related party   528 
Maximum exposure to loss  $7,090 

 

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(y)Reclassification

 

The Company reclassified $262 of revenues that was reported as interest income – securities lending during the three months ended March 31, 2018 to revenues – services and fees. The previously reported amount of $7,553 as interest income – securities lending was reduced by $262 to $7,291 for the three months ended March 31, 2018 and the previously reported amount of $52,776 as revenues – services and fees was increased by $262 to $53,038 for the three months ended March 31, 2018. The impact of this reclassification is reflected in the revenues as reported in the condensed consolidated statements of income for the six months June 30, 2018. The impact of this reclassification on the amount reported during the three months ended March 31, 2018 was deemed to be immaterial.

 

(z)Recent Accounting Pronouncements

 

In March 2018, the Financial Accounting Standards Board (the “FASB”) issued ASU 2018-05: Income Taxes (Topic 740) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. The amendments in this update provide guidance on when to record and disclose provisional amounts for certain income tax effects of the Tax Cuts and Jobs Act (“Tax Reform Act”). The amendments also require any provisional amounts or subsequent adjustments to be included in net income from continuing operations. This ASU also discusses required disclosures that an entity must make with regard to the Tax Reform Act. This ASU is effective immediately as new information is available to adjust provisional amounts that were previously recorded. The Company has adopted this standard and will continue to evaluate indicators that may give rise to a change in our tax provision as a result of the Tax Reform Act. See Note 10 for additional information on the Tax Reform Act.

 

In February 2016, the FASB issued ASU No. 2016-02: Leases (Topic 842) (“ASU 2016-02”). The amendments in this update require lessees, among other things, to recognize lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous authoritative guidance. This update also introduces new disclosure requirements for leasing arrangements. In July 2018, the FASB issued ASU 2018-10: Codification Improvements to Topic 842, Leases, which provides narrow-scope improvements to the lease standard. ASU 2016-02 and ASU 2018-10 will be effective for the Company in fiscal year 2019, but early application is permitted. The Company is currently evaluating the impact of these updates on the consolidated financial statements.

 

In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income that provides for the reclassification from accumulated other comprehensive income to retained earnings for stranded effects resulting from the Tax Cuts and Jobs Act of 2017. The accounting update is effective for the fiscal year beginning after December 15, 2018 and early adoption is permitted. The accounting update should be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act of 2017 is recognized. We are currently evaluating the impact of the accounting update, but the adoption is not expected to have a material impact on our consolidated financial statements.

 

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

 

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

 

On January 1, 2018, we adopted ASU 2016-18 – Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”) using the retrospective method which requires adjustment to prior periods in the statement of cash flows. ASU 2016-18 clarifies how restricted cash should be presented on the statement of cash flows and requires companies to include restricted cash with cash and cash equivalents when reconciling the beginning of period and end of period totals on the statement of cash flows. Restricted cash previously classified under investing activities is now included in the reconciliation of beginning and ending cash on the statement of cash flows. The adoption of ASU 2016-18 did not have a material impact on the Company’s financial condition and results of operations.

 

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On January 1, 2018, we adopted ASC 606 – Revenue from Contracts with Customers using the modified retrospective method and the impact was determined to be immaterial on our consolidated financial statements. The new revenue standard was applied prospectively in our consolidated financial statements from January 1, 2018 forward and reported financial information for historical comparable periods will not be revised and will continue to be reported under the accounting standards in effect during those historical periods. See Note 9 for additional information on the adoption of this standard.

 

NOTE 3— ACQUISITIONS

 

Acquisition of Wunderlich Investment Company, Inc.

 

On May 17, 2017, the Company entered into a Merger Agreement (the “Wunderlich Merger Agreement”) with Wunderlich. Pursuant to the Wunderlich Merger Agreement, customary closing conditions were satisfied and the acquisition was completed on July 3, 2017. The total consideration of $65,118 paid to Wunderlich shareholders in connection with the Wunderlich acquisition was comprised of (a) cash in the amount of $29,737; (b) 1,974,812 newly issued shares of the Company’s common stock at closing which were valued at $31,495 for accounting purposes determined based on the closing market price of the Company’s shares of common stock on the acquisition date on July 3, 2017, less a 13.0% discount for lack of marketability as the shares issued are subject to certain escrow provisions and restrictions that limit their trade or transfer; and (c) 821,816 newly issued common stock warrants with an estimated fair value of $3,886. The common stock and common stock warrants issued includes 387,365 common shares and 167,352 common stock warrants that are held in escrow and subject to forfeiture to indemnify the Company for certain representations and warranties in connection with the acquisition. The Company believes that the acquisition of Wunderlich will allow the Company to benefit from wealth management, investment banking, corporate finance, and sales and trading services provided by Wunderlich. The acquisition of Wunderlich is accounted for using the purchase method of accounting. The Company also entered into a registration rights agreement with certain shareholders of Wunderlich (the “Registration Rights Agreement”) on July 3, 2017 for the shares issued in connection with the Wunderlich Merger Agreement. The Registration Rights Agreement provides the Wunderlich shareholders with the right to notice of and, subject to certain conditions, the right to register shares of the Company’s common stock in certain future registered offerings of shares of the Company’s common stock.

 

The assets and liabilities of Wunderlich, both tangible and intangible, were recorded at their estimated fair values as of the July 3, 2017 acquisition date for Wunderlich. The application of the purchase method of accounting resulted in goodwill of $35,113 which represents the benefits from synergies with our existing business and acquired workforce. For the six months ended June 30, 2018, acquisition related costs, such as legal, accounting, valuation and other professional fees related to the acquisition of Wunderlich, were charged against earnings in the amount of $12 are included in selling, general and administrative expenses in the condensed consolidated statements of income. The preliminary purchase accounting for the acquisition has been accounted for as a stock purchase with all of the recognized goodwill is expected to be non-deductible for tax purposes.

 

The preliminary purchase price allocation was as follows:

 

Consideration paid by B. Riley:     
Cash paid  $29,737 
Fair value of 1,974,812 B. Riley common shares issued   31,495 
Fair value of 821,816 B. Riley common stock warrants issued   3,886 
Total consideration  $65,118 

 

21 

 

The preliminary assets acquired and assumed was as follows:

 

Tangible assets acquired and assumed:     
Cash and cash equivalents  $4,259 
Securities owned   1,413 
Accounts receivable   3,193 
Due from clearing broker   15,133 
Prepaid expenses and other assets   10,103 
Property and equipment   2,315 
Deferred taxes   7,568 
Accounts payable   (1,718)
Accrued payroll and related expenses   (6,387)
Accrued expenses and other liabilities   (10,248)
Securities sold, not yet purchased   (1,707)
Notes payable   (10,579)
Customer relationships   15,320 
Trademarks   1,340 
Goodwill   35,113 
Total  $65,118 

 

The revenue and loss of Wunderlich included in our condensed consolidated financial statements for the three and six months ended June 30, 2018 were $21,026 and $1,203, and $43,339 and $1,120, respectively. The loss from Wunderlich of $1,203 and $1,120 for the three and six months ended June 30, 2018, respectively, includes restructuring charges in the amount of $718 and $766, respectively, related primarily to severance costs and lease loss accruals for the planned consolidation of office space related to operations in the capital markets segment.

 

Acquisition of FBR & Co.

 

On February 17, 2017, the Company entered into an Agreement and Plan of Merger (the “FBR Merger Agreement”) with FBR & Co. (“FBR”), pursuant to which FBR was to merge with and into the Company (or a subsidiary of the Company), with the Company (or its subsidiary) as the surviving corporation (the “Merger”). On May 1, 2017, the Company and FBR filed a registration statement for the planned Merger. The stockholders of the Company and FBR approved the acquisition on June 1, 2017, customary closing conditions were satisfied and the acquisition was completed on June 1, 2017. Subject to the terms and conditions of the FBR Merger Agreement, each outstanding share of FBR common stock (“FBR Common Stock”) was converted into the right to receive 0.671 of a share of the Company’s common stock as summarized below. The Company believes that the acquisition of FBR will allow the Company to benefit from investment banking, corporate finance, securities lending, research, and sales and trading services provided by FBR and planned synergies from the elimination of duplicate corporate overhead and management functions with the Company. The acquisition of FBR is accounted for using the purchase method of accounting.

 

The assets and liabilities of FBR, both tangible and intangible, were recorded at their estimated fair values as of the June 1, 2017 acquisition date for FBR. The application of the purchase method of accounting resulted in goodwill of $11,336 which represents expected overhead synergies and acquired workforce. The purchase accounting for the acquisition has been accounted for as a stock purchase with all of the recognized goodwill is expected to be non-deductible for tax purposes.

 

22 

 

The purchase price allocation was as follows:

 

Consideration paid by B. Riley:    
Number of FBR Common Shares outstanding at June 1, 2017   7,099,511 
Stock merger exchange ratio   0.671 
Number of B. Riley common shares   4,763,772 
Number of B. Riley common shares to be issued from acceleration of vesting for outstanding FBR stock options, restricted stock and RSU awards   67,861 
Total number of B. Riley common shares to be issued   4,831,633 
Closing market price of B. Riley common shares on December 31, 2016  $14.70 
Total value of B. Riley common shares   71,025 
Fair value of RSU’s attributable to service period prior to June 1, 2017 (a)   2,446 
Total consideration  $73,471 

 

(a)Outstanding FBR restricted stock awards at June 1, 2017, the date of the acquisition, were adjusted in accordance with the FBR Merger Agreement with the right to receive 0.671 shares of the Company’s common stock for each outstanding FBR stock award unit. The fair value of the FBR restricted stock awards at June 1, 2017 was determined based on the closing price of the Company’s common stock of $14.70 on June 1, 2017. The fair value of the FBR restricted stock awards were apportioned as purchase consideration based on service provided to FBR as of June 1, 2017 with the remaining fair value of the FBR restricted stock awards to be recognized prospectively over the restricted stock and FBR restricted stock awards remaining vesting period.

 

The assets acquired and assumed was as follows:

 

Tangible assets acquired and assumed:     
Cash and cash equivalents  $15,738 
Securities owned   11,188 
Securities borrowed   861,197 
Accounts receivable   4,341 
Due from clearing broker   29,169 
Prepaid expenses and other assets   5,486 
Property and equipment   8,663 
Deferred taxes   17,706 
Accounts payable   (1,524)
Accrued payroll and related expenses   (7,182)
Accrued expenses and other liabilities   (22,411)
Securities loaned   (867,626)
Customer relationships   5,600 
Tradename and other intangibles   1,790 
Goodwill   11,336 
Total  $73,471 

 

The revenue and earnings of FBR included in our condensed consolidated financial statements for the three and six months ended June 30, 2018 were $57,346 and $16,556, and $94,274 and $17,610, respectively. The revenue and loss of FBR included in our condensed consolidated financial statements for the period from June 1, 2017 (acquisition date) through June 30, 2017 were $11,287 and $8,956, respectively. The earnings from FBR of $16,556 and $17,610 for the three and six months ended June 30, 2018, respectively, include restructuring charge in the amount of $1,056 and $1,263, respectively, related primarily to lease loss accruals for the planned consolidation of office space related to operations in the capital markets segment. The loss from FBR of $8,956 for the 2017 period includes transaction costs of $3,551 related to an employment agreement with the former Chief Executive Officer of FBR and a restructuring charge in the amount of $6,105 related primarily to severance costs and lease loss accruals for the planned consolidation of office space related to the operations in the capital markets segment.

 

23 

 

Acquisition of Rights to Manage Dialectic Hedge Funds

 

On April 13, 2017, the Company entered into an Asset Purchase and Assignment Agreement with Dialectic Capital Management, L.P., Dialectic Capital, LLC and John Fichthorn (collectively “Dialectic”), pursuant to which Dialectic assigned and transferred the rights to manage certain hedge funds to the Company (the “Dialectic Acquisition”). In addition to obtaining the rights to manage certain hedge funds previously managed by Dialectic, the Company hired the employees that were previously employed by the management company that managed the Dialectic hedge funds and assumed Dialectic’s office lease. In connection with the Dialectic Acquisition, the Company paid the Dialectic parties $700 in cash consideration and 158,484 shares of common stock which has a fair value of approximately $1,952 for total purchase consideration of $2,652. The Dialectic Acquisition expands the Company’s assets under management in the capital markets segment and the Company believes such acquisition will allow the Company to benefit from planned synergies from the elimination of duplicate administrative functions of the Company. The acquisition of Dialectic is accounted for using the purchase method of accounting.

 

The assets acquired from Dialectic were recorded at fair value as of April 13, 2017, the acquisition date of Dialectic. The application of the purchase method of accounting resulted in purchase allocation of $2,542 to goodwill, which represents expected overhead synergies and acquired workforce, and $110 to other intangible assets - customer relationship for total acquisition consideration of $2,652. There were no tangible assets or liabilities acquired in connection with Dialectic. The purchase accounting for the acquisition has been accounted for as an asset purchase with all of the recognized goodwill and other intangible assets expected to be deductible for tax purposes.

 

The revenue and loss of Dialectic included in our condensed consolidated financial statements for the three and six months ended June 30, 2018 were $185 and $965, and $388 and $1,427, respectively. The revenue and loss of Dialectic included in our condensed consolidated financial statements for the period from April 13, 2017 (acquisition date) through June 30, 2017 were $401 and $154, respectively.

 

Pro Forma Financial Information

 

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

 

   Pro Forma (Unaudited) 
   Three Months
Ended June 30,
2017
   Six Months
Ended June 30, 
 2017
 
Revenues  $111,543   $228,085 
Net (loss) income attributable to B. Riley Financial, Inc.  $(3,029)  $11,827 
           
Basic (loss) earnings per share  $(0.12)  $0.46 
Diluted (loss) earnings per share  $(0.11)  $0.44 
           
Weighted average basic shares outstanding   26,008,019    25,885,873 
Weighted average diluted shares outstanding   27,297,610    26,946,764 

 

NOTE 4— SECURITIES LENDING

 

As a result of the acquisition of FBR, the Company has an active securities borrowed and loaned business in which it borrows securities from one party and lends them to another. Securities borrowed and securities loaned are recorded based upon the amount of cash advanced or received. Securities borrowed transactions facilitate the settlement process and require the Company to deposit cash or other collateral with the lender. With respect to securities loaned, the Company receives collateral in the form of cash. The amount of collateral required to be deposited for securities borrowed, or received for securities loaned, is an amount generally in excess of the market value of the applicable securities borrowed or loaned. The Company monitors the market value of the securities borrowed and loaned on a daily basis, with additional collateral obtained, or excess collateral recalled, when deemed appropriate.

 

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The following table presents the contractual gross and net securities borrowing and lending balances and the related offsetting amount as of June 30, 2018 and December 31, 2017

 

               Amounts not    
               offset in the    
               consolidated balance    
       Gross amounts   Net amounts   sheets but eligible    
       offset in the   included in the   for offsetting    
   Gross amounts   consolidated   consolidated   upon counterparty    
   recognized   balance sheets (1)   balance sheets   default(2)  Net amounts 
As of June 30, 2018                       
Securities borrowed  $1,013,988   $   $1,013,988   $ 1,013,988  $ 
Securities loaned  $1,012,240   $   $1,012,240   $ 1,012,240  $ 
As of December 31, 2017                       
Securities borrowed  $807,089   $   $807,089   $ 807,089  $ 
Securities loaned  $803,371   $   $803,371   $ 803,371  $ 

 

 

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

 

NOTE 5— ACCOUNTS RECEIVABLE

 

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

 

   June 30,   December 31, 
   2018   2017 
Accounts receivable  $18,817   $15,593 
Investment banking fees, commissions and other receivables   4,226    4,199 
Unbilled receivables   10,864    1,023 
Total accounts receivable   33,907    20,815 
Allowance for doubtful accounts   (796)   (800)
Accounts receivable, net  $33,111   $20,015 

 

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

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2018   2017   2018   2017 
Balance, beginning of period  $661   $556   $800   $255 
Add:  Additions to reserve   343    379    648    704 
Less:  Write-offs   (208)   (144)   (652)   (168)
Less:  Recoveries       (192)       (192)
Balance, end of period  $796   $599   $796   $599 

 

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

 

25 

 

NOTE 6— GOODWILL AND OTHER INTANGIBLE ASSETS

 

Goodwill was $99,246 and $98,771 at June 30, 2018 and December 31, 2017, respectively. At June 30, 2018, goodwill is comprised of $77,831 in the capital markets segment, $1,975 in the auction and liquidation segment, $3,713 in the valuation and appraisal segment and $15,727 in the principal investments - United Online segment. At December 31, 2017, goodwill is comprised of $77,356 in the capital markets segment, $1,975 in the auction and liquidation segment, $3,713 in the valuation and appraisal segment and $15,727 in the principal investments - United Online segment.

 

Intangible assets consisted of the following:

 

      As of June 30, 2018   As of December 31, 2017 
      Gross           Gross         
      Carrying   Accumulated   Intangibles   Carrying   Accumulated   Intangibles 
   Useful Life  Value   Amortization   Net   Value   Amortization   Net 
Amortizable assets:                                 
Customer relationships   4 to 16 Years  $58,330   $12,694   $45,636   $58,330   $9,100   $49,230 
Domain names  7 Years   237    68    169    287    61    226 
Advertising relationships   8 Years   100    25    75    100    19    81 
Internally developed software and other intangibles  0.5 to 4 Years   3,373    1,844    1,529    3,373    1,445    1,928 
Trademarks   7 to 8 Years   4,190    736    3,454    4,190    447    3,743 
Total      66,230    15,367    50,863    66,280    11,072    55,208 
                                  
Non-amortizable assets:                                 
Tradenames      1,740        1,740    1,740        1,740 
Total intangible assets     $67,970   $15,367   $52,603   $68,020   $11,072   $56,948 

 

Amortization expense was $2,146 and $1,555 for the three months ended June 30, 2018 and 2017, respectively, and $4,306 and $3,077 for the six months ended June 30, 2018 and 2017, respectively. At June 30, 2018, estimated future amortization expense is $4,185, $8,369, $7,987, $7,610 and $7,585 for the years ended December 31, 2018 (remaining six months), 2019, 2020, 2021 and 2022, respectively. The estimated future amortization expense after December 31, 2022 is $15,127.

 

NOTE 7— CREDIT FACILITIES

 

Credit facilities consist of the following arrangements:

 

(a)     $200,000 Asset Based Credit Facility

 

On April 21, 2017, the Company amended its credit agreement (as amended, the “Credit Agreement”) governing its asset based credit facility with Wells Fargo Bank, National Association (“Wells Fargo Bank”) to increase the maximum borrowing limit from $100,000 to $200,000. Such amendment, among other things, also extended the expiration date of the credit facility from July 15, 2018 to April 21, 2022. On April 19, 2018, the Company entered into an amended and restated consent to the Credit Agreement, pursuant to which Wells Fargo Bank increased the maximum borrowing limit solely for the purposes of the Bon-Ton Transaction from $200,000 to $300,000, and reverts back to $200,000 upon repayment of the amounts borrowed in connection with the Bon-Ton Transaction. The Credit Agreement continues to allow for borrowings under the separate credit agreement (a “UK Credit Agreement”) which was dated March 19, 2015 with an affiliate of Wells Fargo Bank which provides for the financing of transactions in the United Kingdom. Such facility allows the Company to borrow up to 50 million British Pounds. Any borrowings on the UK Credit Agreement reduce the availability on the asset based $200,000 credit facility. The UK Credit Agreement is cross collateralized and integrated in certain respects with the Credit Agreement. Cash advances and the issuance of letters of credit under the credit facility are made at the lender’s discretion. The letters of credit issued under this facility are furnished by the lender to third parties for the principal purpose of securing minimum guarantees under liquidation services contracts more fully described in Note 2(c). All outstanding loans, letters of credit, and interest are due on the expiration date which is generally within 180 days of funding. The credit facility is secured by the proceeds received for services rendered in connection with liquidation service contracts pursuant to which any outstanding loan or letters of credit are issued and the assets that are sold at liquidation related to such contract. The Company paid Wells Fargo Bank a closing fee in the amount of $500 in connection with the April 2017 amendment to the Credit Agreement. The interest rate for each revolving credit advance under the Credit Agreement is, subject to certain terms and conditions, equal to the LIBOR plus a margin of 2.25% to 3.25% depending on the type of advance and the percentage such advance represents of the related transaction for which such advance is provided. The credit facility also provides for success fees in the amount of 2.5% to 17.5% of the net profits, if any, earned on the liquidation engagements funded under the Credit Agreement as set forth therein. Interest expense totaled $3,242 and $668 for the three months ended June 30, 2018 and 2017, respectively, and for the six months ended June 30, 2018 and 2017, $3,329 and $695, respectively. At June 30, 2018, the balance on the asset based credit facility was $105,004 (net of unamortized deferred loan costs of $536). At December 31, 2017, there was $18,505 of letters of credit outstanding under the credit facility.

 

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

 

(b)     $20,000 UOL Line of Credit

 

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

 

UOL paid a commitment fee equal to 1.00% of the aggregate commitments upon the closing of the UOL Credit Agreement. The UOL Credit Agreement also provides for an unused line fee payable quarterly, in arrears, in an amount equal to: (a) 0.50% per annum times the amount of the unused revolving commitment that is less than or equal to the amount of the cash maintained in accounts with the agent (as depositary bank); plus (b) 1.00% per annum times the amount of the unused revolving commitment that is greater than the amount of the cash maintained in accounts with the agent (as depositary bank). Any amounts outstanding under the UOL Credit Facility are due at maturity. Interest expense for the three and six months ended June 30, 2018, totaled $114 (including amortization of deferred loan fees of $34) and $166 (including amortization of deferred loan fees of $68) respectively. At June 30, 2018 and December 31, 2017, there was no outstanding balances under the UOL Credit Agreement.

 

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

 

The UOL Credit Agreement contains certain negative covenants, including those limiting UOL’s and its subsidiaries’ ability to incur indebtedness, incur liens, sell or acquire assets or businesses, change the nature of their businesses, engage in transactions with related parties, make certain investments or pay dividends. In addition, the UOL Credit Agreement requires UOL and its subsidiaries to maintain certain financial ratios. We are in compliance with all covenants in the UOL Credit Agreement at June 30, 2018.

 

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NOTE 8—NOTES PAYABLE

 

Senior Notes Payable

 

Senior notes payable, net, is comprised of the following as of June 30, 2018 and December 31, 2017:

 

   June 30,   December 31, 
   2018   2017 
7.50% Senior notes due October 31, 2021  $41,194   $35,231 
7.50% Senior notes due May 31, 2027   100,628    92,490 
7.25% Senior notes due December 31, 2027   96,910    80,500 
7.375% Senior notes due May 31, 2023   101,611     
    340,343    208,221 
Less: Unamortized debt issuance costs   (6,575)   (4,600)
   $333,768   $203,621 

 

(a)     $41,194 Senior Notes Payable due October 31, 2021

 

At June 30, 2018, the Company had $41,194 of Senior Notes Payable (“2021 Notes”) due in 2021, interest payable quarterly at 7.50%. On November 2, 2016, the Company issued $28,750 of the 2021 Notes and during the second half of 2017, the Company issued an additional $6,481 of the 2021 Notes pursuant to the At the Market Issuance Sales Agreement (the “Sales Agreement”) as further discussed below. During the six months ended June 30, 2018, the Company issued an additional $5,963 of the 2021 Notes. The 2021 Notes are unsecured and due and payable in full on October 31, 2021. In connection with the issuance of the 2021 Notes, the Company received net proceeds of $40,248 (after underwriting commissions, fees and other issuance costs of $946). The outstanding balance of the 2021 Notes was $40,589 (net of unamortized debt issue costs and premiums of $605) and $34,483 (net of unamortized debt issue costs and premiums of $748) at June 30, 2018 and December 31, 2017, respectively. Interest expense on the 2021 Notes totaled $771 and $593 for the three months ended June 30, 2018 and 2017, respectively, and $1,482 and $1,186 for the six months ended June 30, 2018 and 2017, respectively.

 

(b)     $100,628 Senior Notes Payable due May 31, 2027

 

At June 30, 2018, the Company had $100,628 of Senior Notes Payable (“2027 Notes”) due in 2027, interest payable quarterly at 7.50%. On May 31, 2017, the Company issued $60,375 of the 7.5% 2027 Notes and during the second half of 2017, the Company issued an additional $32,115 of the 7.50% 2027 Notes pursuant to the Sales Agreement. During the six months ended June 30, 2018, the Company issued an additional $8,138 of the 7.50% 2027 Notes. The 2027 Notes are unsecured and due and payable in full on May 31, 2027. In connection with the issuance of the 7.50% 2027 Notes, the Company received net proceeds of $98,877 (after underwriting commissions, fees and other issuance costs of $1,751). The outstanding balance of the 7.50% 2027 Notes at June 30, 2018 and December 31, 2017 was $99,071 (net of unamortized debt issue costs and premium of $1,557) and $90,904 (net of unamortized debt issuance costs and premium of $1,586), respectively. Interest expense on the 2027 Notes for the three and six months ended June 30, 2018 was $1,860 and $3,638, respectively. Interest expense was $403 for the three and six months ended June 30, 2017.

 

(c)       $96,910 Senior Notes Payable due December 31, 2027

 

At June 30, 2018, the Company had $96,910 of Senior Notes Payable (“7.25% 2027 Notes”) due in December 2027, interest payable quarterly at 7.25%. In December 2017, the Company issued $80,500 of the 7.25% 2027 Notes and during the six months ended June 30, 2018, the Company issued an additional $16,410 of the 7.25% 2027 Notes pursuant to the Sales Agreement. The 7.25% 2027 Notes are unsecured and due and payable in full on December 31, 2027. In connection with the issuance of the 7.25% 2027 Notes, the Company received net proceeds of $94,337 (after underwriting commissions, fees and other issuance costs of $2,573). The outstanding balance of the 7.25% 2027 Notes was $94,468 (net of unamortized debt issue costs and premium of $2,442) and $78,234 (net of unamortized debt issue costs of $2,266) at June 30, 2018 and December 31, 2017, respectively. Interest expense on the 7.25% 2027 Notes totaled $1,751 and $3,285 for the three and six months ended June 30, 2018, respectively.

 

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(d)       $101,611 Senior Notes Payable due May 31, 2023

 

At June 30, 2018, the Company had $101,611 of Senior Notes Payable (“2023 Notes”) due in May 2023, interest payable quarterly at 7.375%. In May 2018, the Company issued $100,050 of the 2023 Notes and during the three months ended June 30 2018, the Company issued an additional $1,561 of the 2023 Notes pursuant to the Sales Agreement. The 2023 Notes are unsecured and due and payable in full on May 31, 2023. In connection with the issuance of the 2023 Notes, the Company received net proceeds of $99,590 (after underwriting commissions, fees and other issuance costs of $2,021). The outstanding balance of the 2023 Notes was $99,640 (net of unamortized debt issue costs and premium of $1,971) at June 30, 2018. Interest expense on the 2023 Notes totaled $976 for the three months ended June 30, 2018.

 

(e)       At Market Issuance Sales Agreement to Issue Up to Aggregate of $50,000 of 2021 Notes, 7.50% 2027 Notes, 7.25% 2027 Notes or 2023 Notes

 

On June 5, 2018, the Company filed a prospectus supplement pursuant to which the Company may sell from time to time, at the Company’s option up to an aggregate of $50,000, including notes offered pursuant to the prior prospectus supplement, of the 2021 Notes, the 7.50% 2027 Notes, the 7.25% 2027 Notes and the 2023 Notes. On December 19, 2017, the Company previously entered into an At Market Issuance Sales Agreement (the “Sales Agreement”) with B. Riley FBR, Inc., pursuant to which the Company may offer to sell, from time to time, the 2021 Notes, the 7.50% 2027 Notes and the 7.25% 2027 Notes. As of June 5, 2018, the Company sold Notes having an aggregate offering price of $6,343 under the prior prospectus supplement dated April 25, 2018, leaving up to $43,657 available for offer and sale pursuant to the June 5, 2018 prospectus. The Notes sold pursuant to the Sales Agreement on or following June 5, 2018 will be issued pursuant to a prospectus dated April 6, 2018, as supplemented by a prospectus supplement dated June 5, 2018, in each case filed with the SEC pursuant to the Company’s effective Registration Statement on Form S-3 (File No. 333-223789), which was declared effective by the SEC on April 6, 2018. The Notes will be issued pursuant to the Indenture, dated as of November 2, 2016, as supplemented by a First Supplemental Indenture, dated as of November 2, 2016, the Second Supplemental Indenture, dated as of May 31, 2017, and the Third Supplemental Indenture, dated as of December 13, 2017 and the Fourth Supplemental Indenture, dated as of May 17, 2018, each between the Company and U.S. Bank, National Association, as trustee. Future sales of the 2021 Notes, 7.50% 2027 Notes, 7.25% 2027 Notes and 2023 Notes pursuant to the Sales Agreement will depend on a variety of factors including, but not limited to, market conditions, the trading price of the notes and the Company’s capital needs. At June 30, 2018, the Company had an additional $36,214 of 2021 Notes, 7.50% 2027 Notes, 7.25% 2027 Notes or 2023 Notes that may be sold pursuant to the Sales Agreement. There can be no assurance that the Company will be successful in consummating future sales based on prevailing market conditions or in the quantities or at the prices that the Company may deem appropriate.

 

Notes Payable

 

Notes payable include notes payable to a clearing organization for one of the Company’s broker dealers. The notes payable accrue interest at rates ranging from the prime rate plus 0.25% to 2.0% (5.25% to 7.00% at June 30, 2018) payable annually. The principal payments on the notes payable are due annually in the amount of $357 on January 31, $214 on September 30, and $121 on October 31. The notes payable mature at various dates from September 30, 2018 through January 31, 2022. At June 30, 2018 and December 31, 2017, the outstanding balance for the notes payable was $1,886 and $2,243, respectively. Interest expense was $29 and $57 for the three and six months ended June 30, 2018.

 

On April 19, 2018, the Company borrowed $51,020 from GACP II, L.P., a direct lending fund managed by Great American Capital Partners, LLC, a wholly owned subsidiary of the Company.  In accordance with the note payable, the Company was advanced $50,000 and the note payable included an origination fee of $1,020 that increased the face value of the note payable to $51,020.  Interest is payable monthly and accrues at the three-month LIBOR rate plus 9% (11.34% at June 30, 2018).  The note payable is due in full on September 28, 2018 and is collateralized by the proceeds generated from the joint venture liquidation of inventory and real estate related to a retail liquidation agreement. At June 30, 2018, the outstanding balance was $50,400 (net of unamortized debt issuance cost of $620). Interest expense was $1,618 (including amortization of deferred loan fees of $490) for three and six months ended June 30, 2018.

 

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NOTE 9— REVENUE FROM CONTRACTS WITH CUSTOMERS

 

Revenue from contracts with customers by reportable segment for the three months ended June 30, 2018 is as follows:

 

   Reportable Segment 
               Principal     
       Auction and   Valuation and   Investments -     
   Capital Markets   Liquidation   Appraisal   United Online   Total 
Revenues from contracts with customers:                         
Corporate finance and investment banking fees  $28,059   $   $   $   $28,059 
Wealth and asset management fees   18,587                18,587 
Commissions, fees and reimbursed expenses   10,324    24,479    9,459        44,262 
Subscription services               9,044    9,044 
Service contract revenues       2,357            2,357 
Advertising and other               2,377    2,377 
  Total revenues from contracts with customers   56,970    26,836    9,459    11,421    104,686 
                          
Other sources of revenue:                         
Interest income - Securities lending   6,591                6,591 
Trading gain on investments   8,410                8,410 
Other   5,814                5,814 
  Total revenues  $77,785   $26,836   $9,459   $11,421   $125,501 

 

Revenue from contracts with customers by reportable segment for the six months ended June 30, 2018 is as follows:

 

   Reportable Segment 
               Principal     
       Auction and   Valuation and   Investments -     
   Capital Markets   Liquidation   Appraisal   United Online   Total 
Revenues from contracts with customers:                         
Corporate finance and investment banking fees  $49,025   $   $   $   $49,025 
Wealth and asset management fees   37,757                37,757 
Commissions, fees and reimbursed expenses   21,013    30,813    17,979        69,805 
Subscription services               18,185    18,185 
Service contract revenues       11,540            11,540 
Advertising and other               4,648    4,648 
  Total revenues from contracts with customers   107,795    42,353    17,979    22,833    190,960 
                          
Other sources of revenue:                         
Interest income - Securities lending   13,882                13,882 
Trading gain on investments   4,911                4,911 
Other   11,526                11,526 
  Total revenues  $138,114   $42,353   $17,979   $22,833   $221,279 

 

Revenues are recognized when control of the promised goods or performance obligations for services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for the goods or services. A performance obligation may be satisfied over time or at a point in time. Revenue from a performance obligation satisfied over time is recognized by measuring our progress in satisfying the performance obligation in a manner that depicts the transfer of the goods or services to the customer. Revenue from a performance obligation satisfied at a point in time is recognized at the point in time that we determine the customer obtains control over the promised good or service. The amount of revenue recognized reflects the consideration we expect to be entitled to in exchange for those promised goods or services (i.e., the “transaction price”). In determining the transaction price, we consider multiple factors, including the effects of variable consideration. Variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainties with respect to the amount are resolved. In determining when to include variable consideration in the transaction price, we consider the range of possible outcomes, the predictive value of our past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of our influence, such as market volatility or the judgment and actions of third parties. Revenues by geographic region by segment is included in Note 16 – Business Segments.

 

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The following provides detailed information on the recognition of our revenues from contracts with customers:

 

Corporate finance and investment banking fees. Fees earned from corporate finance and investment banking services are derived from debt, equity and convertible securities offerings in which the Company acted as an underwriter or placement agent. Fees from underwriting activities are recognized as revenues when the performance obligation for the services related to the underwriting transaction is satisfied under the terms of the engagement and is not subject to any other contingencies. Fees are also earned from financial advisory services rendered in connection with client mergers, acquisitions, restructurings, recapitalizations and other strategic transactions. The performance obligation for financial advisory services is satisfied over time as work progresses on the engagement and services are delivered to the client. The performance obligation for financial advisory services may also include success and performance based fees which are recognized as revenue when the performance obligation is no longer constrained and it is not probable that the revenue recognized would be subject to significant reversal in a future period. Generally, it is probable that the revenue recognized is no longer subject to significant reversal upon the closing of the investment banking transaction.

 

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

 

Commissions, fees and reimbursed expenses. Commissions and other fees from clients for trading activities are earned from equity securities transactions executed as agent or principal are recorded at a point in time on a trade date basis. Commission, fees and reimbursed expenses earned on the sale of goods at auction and liquidation sales are recognized when evidence of a contract or arrangement exists, the transaction price has been determined, and the performance obligation has been satisfied when control of the product and risks of ownership has been transferred to the buyer. Revenues from fees and reimbursed expenses for valuation services to clients are recognized when the performance obligation is completed and is generally at the point in time upon delivery of the completed services to the customer.

 

Subscription services. Subscription service revenues are derived primarily from fees charged to pay accounts and are recognized in the period in which the transaction price has been determinable and the related performance obligations for services are provided to the customer. The Company’s pay accounts generally pay in advance for their services by credit card, PayPal, automated clearinghouse or check, and revenues are then recognized ratably over the service period.

 

Service contract revenues. Service contract revenues are primarily earned from auction and liquidation services contracts where the Company guarantees a minimum recovery value for goods being sold at auction or liquidation are recognized over time when the performance obligation is satisfied. We generally use the cost-to-cost measure of progress for our contracts because it best depicts the transfer of services to the customer which occurs as we incur costs on our contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. Revenues, including estimated fees or profits, are recorded proportionally as costs are incurred. Costs to fulfill the contract include labor and other direct costs related to the contract. Due to the nature of the guarantees and performance obligations under these contracts, the estimation of revenue that is ultimately earned is complex and subject to many variables and requires significant judgment. It is common for these contracts to contain provisions that can either increase or decrease the transaction price upon completion of our performance obligations under the contract. Estimated amounts are included in the transaction price at the most likely amount it is probable that a significant reversal of revenue will not occur. Our estimates of variable consideration and determination of whether or not to include estimated amounts in the transaction price are based on an assessment of our anticipated performance under the contract taking into consideration all historical, current and forecasted information that is reasonably available to us.

 

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

 

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Information on Remaining Performance Obligations and Revenue Recognized from Past Performance

 

We do not disclose information about remaining performance obligations pertaining to contracts that have an original expected duration of one year or less. The transaction price allocated to remaining unsatisfied or partially unsatisfied performance obligations with an original expected duration exceeding one year was not material at June 30, 2018. Corporate finance and investment banking fees and retail liquidation engagement fees that are contingent upon completion of a specific milestone and fees associated with certain distribution services are also excluded as the fees are considered variable and not included in the transaction price at June 30, 2018.

 

Contract Balances

 

The timing of our revenue recognition may differ from the timing of payment by our customers. We record a receivable when revenue is recognized prior to payment and we have an unconditional right to payment. Alternatively, when payment precedes the provision of the related services, we record deferred revenue until the performance obligations are satisfied. Receivables related to revenues from contracts with customers totaled $33,111 and $20,015 at June 30, 2018 and December 31, 2017, respectively. We had no significant impairments related to these receivables during the three and six months ended June 30, 2018. Our deferred revenue primarily relates to retainer and milestone fees received from corporate finance and investment banking advisory engagements, asset management agreements, valuation and appraisal engagements and subscription services where the performance obligation has not yet been satisfied. Deferred revenue at June 30, 2018 and December 31, 2017 was $3,600 and $3,141, respectively. During the three and six months ended June 30, 2018, we recognized revenue of $2,491 and $4,466, respectively, that was recorded as deferred revenue at the beginning of the period.

 

Contract Costs

 

Contract costs include: (1) costs to fulfill contracts associated with corporate finance and investment banking engagements are capitalized where the revenue is recognized at a point in time and the costs are determined to be recoverable and (2) costs to fulfill auction and liquidation services contracts where the Company guarantees a minimum recovery value for goods being sold at auction or liquidation where the revenue is recognized over time when the performance obligation is satisfied.

 

At June 30, 2018, capitalized costs to fulfill a contract were $605, which is recorded in prepaid expenses and other assets in the condensed consolidated balance sheet. For the three and six months ended June 30, 2018, we recognized expenses and related capitalized costs to fulfill a contract of $147 and $602, respectively. There were no significant impairment charges recognized in relation to these capitalized costs during the three and six months ended June 30, 2018.

 

NOTE 10— INCOME TAXES

 

The Tax Act was enacted on December 22, 2017. The Tax Act reduces the U.S. federal corporate tax rate from 35% to 21%, requires companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, provides an exemption from U.S. federal tax for dividends received from foreign subsidiaries, and creates new taxes on certain foreign sourced earnings. As of the completion of these financial statements and related disclosures, we have not completed our accounting for the tax effects of the Tax Act; however, we have made a reasonable estimate of such effects and recorded a provisional tax expense of $13,052, which is included as a component of income tax expense in the fourth quarter of 2017 and is comprised of (a) $12,954 related to the remeasurement of deferred tax assets and liabilities in the United States and (b) $98 related to the transition tax on foreign earnings. This provisional tax expense incorporates assumptions made based upon the Company’s current interpretation of the Tax Act, and may change as we receive additional clarification and implementation guidance and as the interpretation of the Tax Act evolves. In accordance with SEC Staff Accounting Bulletin No. 118, the Company will finalize the accounting for the effects of the Tax Act no later than the fourth quarter of 2018. Future adjustments made to the provisional effects will be reported as a component of income tax expense in the reporting period in which any such adjustments are determined.

 

The Company’s effective income tax rate was a provision of 21.9% and a benefit of 58.9% for the six months ended June 30, 2018 and 2017, respectively. During the six months ended June 30, 2017, the Company elected to treat the acquisition of UOL as a taxable business combination for income tax purposes in accordance with Internal Revenue Code Section 338(g) (“IRS Code Section 338(g)”). This resulted in the Company foregoing the income tax attributes of UOL that existed at the acquisition date which included net operating loss carryforwards, capital loss carryforwards and foreign tax credits. The income tax election in accordance with IRS Code Section 338(g) provides the Company with a tax step-up in the basis of the intangible assets and goodwill acquired for tax purposes. In accordance with ASC 740, the impact of the election in accordance with IRS Code Section 338(g) on deferred income taxes resulted in the recording of a tax benefit in the amount of $8,389 during the six months ended June 30, 2017.

 

32 

 

As of June 30, 2018, the Company had federal net operating loss carryforwards of approximately $63,445 and state net operating loss carryforwards of $76,978. The Company’s federal net operating loss carryforwards will expire in the tax years commencing in December 31, 2029 through December 31, 2034. The state net operating loss carryforwards will expire in the tax years commencing in December 31, 2029.

 

The Company establishes a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Tax benefits of operating loss, capital loss and tax credit carryforwards are evaluated on an ongoing basis, including a review of historical and projected future operating results, the eligible carryforward period, and other circumstances. The Company’s net operating losses are subject to annual limitations in accordance with Internal Revenue Code Section 382. Accordingly, the Company is limited to the amount of net operating loss that may be utilized in future taxable years depending on the Company’s actual taxable income. As of June 30, 2018, the Company believes that the existing net operating loss carryforwards will be utilized in future tax periods before the loss carryforwards expire and it is more-likely-than-not that future taxable earnings will be sufficient to realize its deferred tax assets and has not provided a valuation allowance. The Company does not believe that it is more likely than not that the Company will be able to utilize the benefits related to capital loss carryforwards and has provided a full valuation allowance in the amount of $2,582 against these deferred tax assets.

 

The Company files income tax returns in the U.S., various state and local jurisdictions, and certain other foreign jurisdictions. The Company is currently under audit by certain federal, state and local, and foreign tax authorities. The audits are in varying stages of completion. The Company evaluates its tax positions and establishes liabilities for uncertain tax positions that may be challenged by tax authorities. Uncertain tax positions are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, case law developments and closing of statutes of limitations. Such adjustments are reflected in the provision for income taxes, as appropriate. The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the calendar years ended December 31, 2014 to 2017.

 

NOTE 11— EARNINGS PER SHARE

 

Basic earnings per share is calculated by dividing net income by the weighted-average number of shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding, after giving effect to all dilutive potential common shares outstanding during the period. Basic common shares outstanding exclude 453,365 common shares that are held in escrow and subject to forfeiture, the common shares held in escrow includes 66,000 common shares issued to the former members of Great American Group, LLC that are subject to forfeiture upon the final settlement of claims for goods held for sale in connection with the transaction with Alternative Asset Management Acquisition Corp. in 2009 and 387,365 common shares that are subject to forfeiture to indemnify the Company for certain representations and warranties in connection with the acquisition of Wunderlich. These shares are subject to forfeiture upon the final settlement of claims as more fully described in the related escrow instructions. Dilutive common shares outstanding includes contingently issuable shares that are currently in escrow and subject to release if the conditions for the final settlement of claims in accordance with the escrow instructions were satisfied at the end of the respective periods.

 

Basic and diluted earnings per share was calculated as follows:

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2018   2017   2018   2017 
Net income attributable to B. Riley Financial, Inc.  $16,997   $3,280   $21,500   $17,301 
                     
Weighted average shares outstanding:                    
Basic   25,424,178    21,216,829    25,799,077    20,311,231 
Effect of dilutive potential common shares:                    
   Restricted stock units and warrants   734,149    857,459    746,906    628,759 
   Contingently issuable shares   239,186    44,767    239,186    44,767 
Diluted   26,397,513    22,119,055    26,785,169    20,984,757 
                     
Basic income per share  $0.67   $0.15   $0.83   $0.85 
Diluted income per share  $0.64   $0.15   $0.80   $0.82 

 

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NOTE 12— COMMITMENTS AND CONTINGENCIES

 

Legal Matters

 

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

 

In 2012, Gladden v. Cumberland Trust, WSI, et al. filed a complaint in Circuit Court, Hamblen County, TN at Morristown, Case No. 12-CV-119. This complaint alleges the improper distribution and misappropriation of trust funds. The plaintiff seeks damages of no less than $3,925, an accounting, and among other things, punitive damages. In October 2017, the Tennessee Supreme Court remanded the case to the Tennessee State Trial Court for determination of which claims are subject to arbitration and which are not. This case was settled during the second quarter of 2018.

 

In May 2014, Waterford Township Police & Fire Retirement System et al. v. Regional Management Corp et al., filed a complaint in the Southern District of New York (the “Court”), against underwriters alleging violations under sections 11 and 12 of the Securities Act of 1933, as amended (the “Securities Act”). B. Riley FBR, Inc. (“B. Riley FBR”) (formerly, FBR Capital Markets & Co. (“FBRCM”)), a broker-dealer subsidiary of ours, was a co-manager of 2 offerings. On January 30, 2017, the Court denied the plaintiffs’ motion to file a first amended complaint, which would have revived claims previously dismissed by the Court on March 30, 2016. On March 1, 2017, the plaintiffs filed a notice of appeal and an opening brief on June 21, 2017. Defendant’s opposition motion was filed on September 12, 2017. Appellants filed their reply brief on October 17, 2017 and oral argument was held on November 17, 2017. On January 26, 2018, the Appellate court issued its order affirming the court’s order dismissing the plaintiff’s case and denying leave to amend.

 

On January 5, 2017, complaints filed in November 2015 and May 2016 naming MLV & Co. (“MLV”), a broker-dealer subsidiary of FBR, as a defendant in putative class action lawsuits alleging claims under the Securities Act, in connection with the offerings of Miller Energy Resources, Inc. (“Miller”) have been consolidated. The Master Consolidated Complaint, styled Gaynor v. Miller et al., is pending in the United States District Court for the Eastern District of Tennessee, and, like its predecessor complaints, continues to allege claims under Sections 11 and 12 of the Securities Act against nine underwriters for alleged material misrepresentations and omissions in the registration statement and prospectuses issued in connection with six offerings (February 13, 2013; May 8, 2013; June 28, 2013; September 26, 2013; October 17, 2013 (as to MLV only) and August 21, 2014) with an alleged aggregate offering price of approximately $151,000. The plaintiffs seek unspecified compensatory damages and reimbursement of certain costs and expenses. In August 2017, the Court granted Defendant’s Motion to Dismiss on Section 12 claims and found that the plaintiffs had not sufficiently alleged a corrective disclosure prior to August 6, 2015, when an SEC civil action was announced. Defendants’ answer was filed on September 25, 2017. Plaintiffs have filed motions for class certification and to remand the case to state court following a positive ruling in an unrelated case by the U.S. Supreme Court. Although MLV is contractually entitled to be indemnified by Miller in connection with this lawsuit, Miller filed for bankruptcy in October 2015 and this likely will decrease or eliminate the value of the indemnity that MLV receives from Miller.

 

In February 2017, certain former employees filed an arbitration claim with FINRA against Wunderlich Securities, Inc. (“WSI”) alleging misrepresentations in the recruitment of claimants to join WSI. Claimants also allege that WSI failed to support their mortgage trading business resulting in the loss of opportunities during their employment with WSI. Claimants are seeking $10,000 in damages. WSI has counterclaimed alleging that claimants misrepresented their process for doing business, particularly their capital needs, resulting in substantial losses to WSI. WSI believes the claims are meritless and intends to vigorously defend the action.

 

In March 2017, United Online, Inc. received a letter from PeopleConnect, Inc. (formerly, Classmates, Inc.) (“Classmates”) regarding a notice of investigation received from the Consumer Protection Divisions of the District Attorneys’ offices of four California counties (“California DAs”). These entities suggest that Classmates may be in violation of California codes relating to unfair competition, false or deceptive advertising, and auto-renewal practices. Classmates asserts that these claims are indemnifiable claims under the purchase agreement between United Online, Inc. and the buyer of Classmates. A tolling agreement with certain California District Attorneys has been signed and informal discovery and production is in process. At the present time, the financial impact to the Company, if any, cannot be estimated.

 

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In July 2017, an arbitration claim was filed with FINRA by Dominick & Dickerman LLC and Michael Campbell against WSI and Gary Wunderlich with respect to the acquisition by Wunderlich Investment Company, Inc. (“WIC”) (the parent corporation of WSI) of certain assets of Dominick & Dominick LLC in 2015. The Claimants allege that respondents overvalued WIC so that the purchase price paid to the Claimants in shares of WIC stock was artificially inflated. The Statement of Claim includes claims for common law fraud, negligent misrepresentation, and breach of contract. Claimants are seeking damages of approximately $8,000 plus unspecified punitive damages. Respondents believe the claims are meritless and intend to vigorously defend the action.

 

In September 2017, Frontier State Bank (“Frontier”) filed a lawsuit against Wunderlich Loan Capital Corp., a subsidiary of WIC (“WLCC”), seeking rescission of the purchase a residential mortgage in the amount of $1,300. Vanguard Funding, LLC (“Vanguard”) sold the mortgage to WLCC who then assigned its rights to Frontier. Shortly after closing, Frontier was advised that the mortgage had been previously pledged to another lender. In the lawsuit against WLCC, it is alleged that WLCC did not deliver the mortgage to Frontier with clear title. Discovery is ongoing.

 

NOTE 13— SHARE-BASED PAYMENTS

 

(a) Amended and Restated 2009 Stock Incentive Plan

 

During the six months ended June 30, 2018, the Company granted restricted stock units representing 412,925 shares of common stock with a total fair value of $8,609 to certain employees of the Company under the Company’s Amended and Restated 2009 Stock Incentive Plan (the “Plan”). During the year ended December 31, 2017, the Company granted restricted stock units representing 486,049 shares of common stock with a total fair value of $7,732 to certain employees and directors of the Company under the Plan. Share-based compensation expense for such restricted stock units was $1,261 and $1,305 for the three months ended June 30, 2018 and 2017, respectively, and $2,371 and $2,212 for six months ended June 30, 2018 and 2017, respectively.

  

The restricted stock units generally vest over a period of one to three years based on continued service. In determining the fair value of restricted stock units on the grant date, the fair value is adjusted for (a) estimated forfeitures, (b) expected dividends based on historical patterns and the Company’s anticipated dividend payments over the expected holding period and (c) the risk-free interest rate based on U.S. Treasuries for a maturity matching the expected holding period. As of June 30, 2018, the expected remaining unrecognized share-based compensation expense of $14,141 will be expensed over a weighted average period of 2.4 years.

 

A summary of equity incentive award activity under the Plan for the six months ended June 30, 2018 was as follows:

 

        Weighted 
        Average 
    Shares   Fair Value 
Nonvested at January 1, 2018    792,264   $13.30 
Granted    412,925    20.85 
Vested    (292,799)   13.08 
Forfeited    (6,638)   11.74 
Nonvested at June 30, 2018    905,752   $16.83 

 

The per-share weighted average grant-date fair value of restricted stock units was $20.85 during the six months ended June 30, 2018. There were 292,799 restricted stock units with a fair value of $3,828 that vested during the six months ended June 30, 2018 under the Plan.

 

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

 

In connection with the acquisition of FBR on June 1, 2017, the equity awards previously granted or available for issuance under the FBR & Co. 2006 Long-Term Stock Incentive Plan (the “FBR Stock Plan”) may be issued under the Plan. During the six months ended June 30, 2018, the Company granted restricted stock units representing 156,391 shares of common stock with a total grant date fair value of $3,208 under the FBR Stock Plan. During the year ended December 31, 2017, the Company granted restricted stock units representing 871,317 shares of common stock with a total fair value of $14,577 to certain employees under the FBR Stock Plan. Share-based compensation expense was $1,740 and $3,188 for the three and six months ended June 30, 2018, respectively. In connection with the June 13, 2017 award, share-based compensation was $120 for the period from June 1, 2017 (acquisition date) through June 30, 2017. As of June 30, 2018, the expected remaining unrecognized share-based compensation expense of $10,076 will be expensed over a weighted average period of 2.5 years.

 

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A summary of equity incentive award activity under the Plan for the six months ended June 30, 2018 was as follows:

 

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        Weighted