Item 1A. Risk Factors
The following risk factors and other information included in this Form 10-Q should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, financial condition and operating results could be significantly harmed.
Risks Related to Faneuil
Economic downturns and reductions in government funding could have a negative effect on Faneuil’s business.
Demand for the services offered by Faneuil has been, and is expected to continue to be, subject to significant fluctuations due to a variety of factors beyond its control, including economic conditions. During economic downturns, the ability of both private and governmental entities to make expenditures may decline significantly. We cannot be certain that economic or political conditions will be generally favorable or that there will not be significant fluctuations adversely affecting Faneuil
’
s industry as a whole, or key industry segments targeted by Faneuil. In addition, Faneuil
’
s operations are, in part, dependent upon state government funding. Significant changes in the level of state government funding could have an unfavorable effect on Faneuil
’
s business, financial position, results of operations and cash flows.
Faneuil’s business involves many program-related and contract-related risks.
Faneuil
’
s business is subject to a variety of program-related risks, including changes in political and other circumstances, particularly since contracts for major programs are performed over extended periods of time. These risks include changes in personnel at government authorities, the failure of applicable government authorities to take necessary actions, opposition by third parties to particular programs and the failure by customers to obtain adequate financing for particular programs. Due to these factors, losses on a particular contract or contracts could occur, and Faneuil could experience significant changes in operating results on a quarterly or annual basis.
Delays in the government budget process or a government shutdown may adversely affect Faneuil’s cash flows and operating results.
Faneuil derives a significant portion of its revenue from state government contracts and programs. Any delay in the state government budget process or a state government shutdown may result in Faneuil
’
s incurrence of substantial labor or other costs without reimbursement under customer contracts, or the delay or cancellation of key programs in which Faneuil is involved, which could materially adversely affect Faneuil
’
s cash flows and operating results.
Faneuil faces intense competition. If Faneuil does not compete effectively, its business may suffer.
Faneuil faces intense competition from numerous competitors. Faneuil primarily competes on the basis of quality, performance, innovation, technology, price, applications expertise, system and service flexibility and established customer service capabilities, as its services relate to toll collection, customer contact centers and employee staffing. Faneuil may not be able to compete effectively on all of these fronts or with all of its competitors. In addition, new competitors may emerge, and service offerings may be threatened by new technologies or market trends that reduce the value of the services Faneuil provides. To remain competitive, Faneuil must respond to new technologies and enhance its existing services, and we anticipate that it may have to adjust the pricing for its services to stay competitive on future responses to proposals. If Faneuil does not compete effectively, its business, financial position, results of operations and cash flows could be materially adversely affected.
Faneuil’s dependence on a small number of customers could adversely affect its business or results of operations.
Faneuil derives a substantial portion of its revenue from a relatively small number of customers. For additional information regarding Faneuil
’
s customer concentrations, see
“Part I – Financial Information,
Item 1. Financial Statements – Note 3. Concentration Risks.”
- 30 -
We expect that Faneuil
’
s largest customers will continue to account for a substantial portion of its total net revenue for the fo
reseeable future. Faneuil has long-standing relationships with many of its significant customers. However, because Faneuil
’
s customers generally contract for specific projects or programs with a finite duration, Faneuil may lose these customers if funding
for their respective programs is discontinued, or if their projects end and the contracts are not renewed or replaced. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could materially reduce F
aneuil
’
s revenue and cash flows. Additionally, many of Faneuil
’
s customers are government entities, which can unilaterally terminate or modify the existing contracts with Faneuil without cause and penalty to such government entities in many situations. If
Faneuil does not replace them with other customers or other programs, the loss of business from any one of such customers could have a material adverse effect on its business or results of operations.
Faneuil’s ability to recover capital investments in connection with its contracts is subject to risk.
In order to attract and retain large outsourcing contracts, Faneuil sometimes makes significant capital investments to perform its services under the contract, such as purchases of information technology equipment and costs incurred to develop and implement software. The net book value of such assets, including a portion of Faneuil
’
s intangible assets, could be impaired, and Faneuil
’
s earnings and cash flow could be materially adversely affected in the event of the early termination of all or a part of such a contract, reduction in volumes and services thereunder for reasons including, but not limited to, a client
’
s merger or acquisition, divestiture of assets or businesses, business failure or deterioration, or a client
’
s exercise of contract termination rights.
Faneuil’s business could be adversely affected if Faneuil’s clients are not satisfied with its services.
Faneuil
’
s business model depends in large part on its ability to attract new work from its base of existing clients. Faneuil
’
s business model also depends on relationships it develops with its clients with respect to understanding its clients
’
needs and delivering solutions that are tailored to those needs. If a client is not satisfied with the quality of work performed by Faneuil or a subcontractor or with the type of services or solutions delivered, Faneuil could incur additional costs to address the situation, the profitability of that work might be impaired and the client
’
s dissatisfaction with Faneuil
’
s services could lead to the termination of that work or damage Faneuil
’
s ability to obtain additional work from that client. Also, negative publicity related to Faneuil
’
s client relationships, regardless of its accuracy, may further damage Faneuil
’
s business by affecting its ability to compete for new contracts with current and prospective clients.
Faneuil’s dependence on subcontractors and equipment manufacturers could adversely affect it.
In some cases, Faneuil relies on and partners with third party subcontractors as well as third-party equipment manufacturers to provide services under its contracts. To the extent that Faneuil cannot engage subcontractors or acquire equipment or materials, Faneuil
’
s ability to perform according to the terms of its contracts with its customers may be impaired. If the amount Faneuil is required to pay for subcontracted services or equipment exceeds the amount Faneuil has estimated in bidding for fixed prices or fixed unit price contracts, it could experience reduced profit or losses in the performance of these contracts with its customers. Also, if a subcontractor or a manufacturer is unable to deliver its services, equipment or materials according to the negotiated terms for any reason, including the deterioration of its financial condition, Faneuil may be required to purchase the services, equipment or materials from another source at a higher price. This may reduce the expected profit or result in a loss on a customer contract for which the services, equipment or materials were needed.
Faneuil’s dependence on primary contractors could adversely affect its ability to secure new projects and derive a profit from its existing projects.
In some cases, Faneuil partners as a subcontractor with third parties who are the primary contractors. In these cases, Faneuil is largely dependent on the judgments of the primary contractors in bidding for new projects and negotiating the primary contracts, including establishing the scope of services and service levels to be provided. Furthermore, even if projects are secured, if a primary contractor is unable to deliver its services according to the negotiated terms of the primary contract for any reason, including the deterioration of its financial condition, the customer may terminate or modify the primary contract, which may reduce Faneuil
’
s profit or cause losses in the performance of the contract.
If Faneuil or a primary contractor guarantees to a customer the timely implementation or performance standards of a program, Faneuil could incur additional costs to meet its guaranteed obligations or liquidated damages if it fails to perform as agreed.
In certain instances, Faneuil or its primary contractor guarantees a customer that it will implement a program by a scheduled date. At times, they also provide that the program will achieve or adhere to certain performance standards or key performance indicators. Although Faneuil generally provides input to its primary contractors regarding the scope of services and service levels to be provided,
- 31 -
it is possible that a primary contractor may make commitments without Faneuil
’
s input or approval. If Faneuil or t
he primary contractor subsequently fails to implement the program as scheduled, or if the program subsequently fails to meet the guaranteed performance standards, Faneuil may be held responsible for costs to the client resulting from any delay in implement
ation, or the costs incurred by the program to achieve the performance standards. In most cases where Faneuil or the primary contractor fails to meet contractually defined performance standards, Faneuil may be subject to agreed-upon liquidated damages. To
the extent that these events occur, the total costs for the program would exceed Faneuil
’
s original estimates, and it could experience reduced profits or in some cases a loss for that program.
Adequate bonding is necessary for Faneuil to win new contracts.
In line with industry practice, Faneuil is often required, primarily in its toll and transportation programs, to provide performance and surety bonds to customers in conjunction with its contracts. These bonds indemnify the customer should Faneuil fail to perform its obligations under the contracts. If a bond is required for a particular program and Faneuil is unable to obtain an appropriate bond, Faneuil cannot pursue that program. The issuance of a bond is at the surety
’
s sole discretion. Moreover, due to events that affect the insurance and bonding markets generally, bonding may be more difficult to obtain in the future or may only be available at significant additional costs. There can be no assurance that bonds will continue to be available on reasonable terms, or at all. Any inability to obtain adequate bonding and, as a result, to bid on new work could harm Faneuil
’
s business.
Interruption of Faneuil’s data centers and customer contact centers could negatively impact Faneuil’s business.
If Faneuil were to experience a temporary or permanent interruption at one or more of Faneuil
’
s data or customer contact centers due to natural disaster, casualty, operating malfunction, cyber-attack, sabotage or any other cause, Faneuil may be unable to provide the services it is contractually obligated to deliver. This could result in Faneuil being required to pay contractual damages to some clients or to allow some clients to terminate or renegotiate their contracts. Notwithstanding disaster recovery and business continuity plans and precautions instituted to protect Faneuil
’
s clients and Faneuil from events that could interrupt delivery of services, there is no guarantee that such interruptions would not result in a prolonged interruption in Faneuil
’
s ability to provide services to its clients or that such precautions would adequately compensate Faneuil for any losses it may incur as a result of such interruptions.
Any business disruptions due to political instability, armed hostilities, and acts of terrorism or natural disasters could adversely affect Faneuil’s financial performance.
If terrorist activities, armed conflicts, political instability or natural disasters occur in the United States or other locations, such events may negatively affect Faneuil
’
s operations, cause general economic conditions to deteriorate or cause demand for Faneuil
’
s services, many of which depend on travel, to decline. A prolonged economic slowdown or recession could reduce the demand for Faneuil
’
s services, and consequently, negatively affect Faneuil
’
s future sales and profits. Any of these events could have a significant effect on Faneuil
’
s business, financial condition or results of operations.
Faneuil is subject to uncertainties regarding healthcare reform that could materially and adversely affect that aspect of our business.
On March 23, 2010, President Obama signed the Affordable Care Act (the
“
Affordable Care Act
”
) into law, which has affected comprehensive health insurance reform, including the creation of health insurance exchanges, among other reforms. A portion of Faneuil
’
s healthcare business relates to providing services to health insurance exchanges in various states and Faneuil believes that there may be significant opportunities for growth in this area. However, as has been widely publicized, the Affordable Care Act has been fraught with challenges. Given these challenges, there is uncertainty about continued developments with respect to healthcare reform. Significant changes to, or repeal of, the Affordable Care Act could materially and adversely affect that aspect of our business.
Faneuil’s business is subject to many regulatory requirements, and current or future regulation could significantly increase Faneuil’s cost of doing business.
Faneuil
’
s business is subject to many laws and regulatory requirements in the United States, covering such matters as data privacy, consumer protection, health care requirements, labor relations, taxation, internal and disclosure control obligations, governmental affairs and immigration. For example, Faneuil is subject to state and federal laws and regulations regarding the protection of consumer information commonly referred to as
“
non-public personal information.
”
For instance, the collection of patient data through Faneuil
’
s contact center services is subject to the Health Insurance Portability and Accountability Act of 1996, commonly known as HIPAA, which protects the privacy of patients
’
data. These laws, regulations and agreements require Faneuil to develop and implement policies to protect non-public personal information and to disclose these policies to consumers before a customer relationship is established and periodically after that. These laws, regulations, and agreements limit Faneuil
’
s ability to use or disclose non-public personal information for purposes other than the ones originally intended. Many of these regulations, including those related to data
- 32 -
privacy, are frequently ch
anging and sometimes conflict with existing ones among the various jurisdictions in which Faneuil provides services. Violations of these laws and regulations could result in Faneuil
’
s liability for damages, fines, criminal prosecution, unfavorable publicit
y and restrictions on Faneuil
’
s ability to operate. Faneuil
’
s failure to adhere to or successfully implement processes in response to changing regulatory requirements in this area could result in legal liability or impairment to Faneuil
’
s reputation in the
marketplace, which could have a material adverse effect on Faneuil
’
s business, results of operations and financial condition. In addition, because a substantial portion of Faneuil
’
s operating costs consist of labor costs, changes in governmental regulatio
ns relating to wages, healthcare and healthcare reform and other benefits or employment taxes could have a material adverse effect on Faneuil
’
s business, results of operations or financial condition.
A failure to attract and retain necessary personnel, skilled management, and qualified subcontractors may have an adverse impact on Faneuil’s business.
Because Faneuil operates in intensely competitive markets, its success depends to a significant extent upon its ability to attract, retain and motivate highly skilled and qualified personnel and to subcontract with qualified, competent subcontractors. If Faneuil fails to attract, develop, motivate, retain, and effectively utilize personnel with the desired levels of training or experience, or is unable to contract with qualified, competent subcontractors, Faneuil
’
s business will be harmed. Experienced and capable personnel remain in high demand, and there is continual competition for their talents. Additionally, regarding the labor-intensive business of Faneuil, quality service depends on Faneuil
’
s ability to retain employees and control personnel turnover. Any increase in the employee turnover rate could increase recruiting and training costs and could decrease operating effectiveness and productivity. Faneuil may not be able to continue to hire, train and retain a sufficient number of qualified personnel to adequately staff new client projects. Faneuil
’
s business is driven in part by the personal relationships of Faneuil
’
s senior management team, and its success depends on the skills, experience and performance of members of Faneuil
’
s senior management team. Despite executing an employment agreement with Faneuil
’
s CEO, she or other members of the management team may discontinue service with Faneuil and Faneuil may not be able to find individuals to replace them at the same cost, or at all. Faneuil has not obtained
“
key person
”
insurance for any member of its senior management team. The loss or interruption of the services of any key employee or the loss of a key subcontractor relationship could hurt Faneuil
’
s business, financial condition, cash flow, results of operations and prospects.
Risks Related to Carpets
The floor covering industry is highly dependent on national and regional economic conditions, such as consumer confidence and income, corporate and individual spending, interest rate levels, availability of credit and demand for housing. A decline in residential or commercial construction activity or remodeling and refurbishment in Las Vegas could have a material adverse effect on our business.
The floor covering industry is highly dependent on construction activity, including new construction, which is cyclical in nature and recently experienced a downturn. The downturn in the U.S. and global economies, along with the residential and commercial markets in such economies, particularly in Las Vegas, negatively impacted the floor covering industry and Carpets
’
business. Although the impact of a decline in new construction activity is typically accompanied by an increase in remodeling and replacement activity, these activities lagged during the downturn. Although these difficult economic conditions have improved, there may be additional downturns that could cause the industry to deteriorate in the future. A significant or prolonged decline in residential/commercial remodeling or new construction activity could have a material adverse effect on the Company
’
s business and results of operations.
Carpets faces intense competition in the floor covering industry that could decrease demand for its products or force it to lower prices, which could have a material adverse effect on our business.
The floor covering industry is highly competitive. Carpets competes with a number of home improvement stores, building materials supply houses and lumber yards, specialty design stores, showrooms, discount stores, local, regional and national hardware stores, mail order firms, warehouse clubs, independent building supply stores and other retailers, as well as with installers. Also, it faces growing competition from online and multichannel retailers as its customers increasingly use computers, tablets, smart phones and other mobile devices to shop online and compare prices and products in real time. Intense competitive pressures from one or more of Carpets
’
competitors or its inability to adapt effectively and quickly to a changing competitive landscape could affect its prices, its margins or demand for its products and services. If it is unable to respond timely and appropriately to these competitive pressures, including through maintaining competitive locations of stores, customer service, quality and price of merchandise and services, in-stock levels, and merchandise assortment and presentation, its market share and its financial performance could be adversely affected.
- 33 -
Carpets may not timely identify or effectively respond to consumer needs, expectations or trends, which could adversely affect its relationship with customers, its reputation, demand for its products and services an
d its market share.
Carpets operates in a market sector where demand is strongly influenced by rapidly changing customer preferences as to product design and features. Carpets
’
success depends on its ability to anticipate and react to changing consumer demands promptly. All of its products are subject to changing consumer preferences that cannot be predicted with certainty. Also, long lead times for certain of its products may make it hard for it to respond quickly to changes in consumer demands. Consumer preferences could shift rapidly to different types of products or away from the types of products Carpets carries altogether, and its future success depends, in part, on its ability to anticipate and respond to these changes. Failure to anticipate and respond promptly to changing consumer preferences could lead to, among other things, lower sales and excess inventory levels, which could have a material adverse effect on its financial condition.
Carpets relies on third-party suppliers for its products. If it fails to identify and develop relationships with a sufficient number of qualified suppliers, or if its suppliers experience financial or operational difficulties, its ability to timely and efficiently access products that meet its standards could be adversely affected.
Carpets sources, stocks and sells products from vendors, and its ability to fulfill their orders reliably and efficiently is critical to its business success. Its ability to continue to identify and develop relationships with qualified suppliers who can satisfy its standards for quality and the need to access products in a timely, efficient and cost-effective manner is a significant challenge. Carpets
’
ability to access products can also be adversely affected by political instability, the financial instability of suppliers, suppliers
’
noncompliance with applicable laws, trade restrictions, tariffs, currency exchange rates, supply disruptions, weather conditions, natural disasters, shipping or logistical interruptions or costs and other factors beyond its control. If these vendors fail or are unable to perform as expected and Carpets is unable to replace them quickly, its business could be adversely affected, at least temporarily, until it can do so, and potentially, in some cases, permanently.
Failure to achieve and maintain a high level of product and service quality could damage Carpets’ image with customers and negatively impact its sales, profitability, cash flows and financial condition.
Product and service quality issues could result in a negative impact on customer confidence in Carpets and the Carpets brand image. As a result, Carpets
’
reputation as a retailer of high-quality products and services could suffer and impact customer loyalty. Additionally, a decline in product and service quality could result in product recalls, product liability and warranty claims. Carpets generally provides a one-year warranty on the installation of any of its products. Warranty work related directly to installation is repaired at the cost to Carpets, and product defects are generally charged back to the manufacturer.
If Carpets is unable to manage its installation service business effectively, it could suffer lost sales and be subject to fines, lawsuits and a damaged reputation.
Carpets acts as a general contractor to provide installation services to its customers. As such, it is subject to regulatory requirements and risks applicable to general contractors, which include management of licensing, permitting and the quality of its installers. If Carpets fails to effectively manage these processes or provide proper oversight of these services, it could suffer lost sales, fines and lawsuits, as well as damage to its reputation, which could adversely affect its business.
A portion of Carpets’ business is dependent on estimating fixed price projects correctly and completing the installations within budget. Carpets could suffer losses associated with installations on fixed price projects.
A portion of Carpets
’
business consists of fixed price projects that are bid for and contracted based on estimated costs. The estimating process includes budgeting for the appropriate amount of materials, labor and overhead. At times, this work can be substantial and as a result Carpets
’
ability to estimate costs correctly and its ability to complete the project within budget or satisfaction without material defect is essential. If Carpets is unable to estimate a project properly or unable to complete the project within budget or without material defect, it may suffer losses, which could adversely affect its reputation, business, and financial condition.
Carpets’ success depends upon its ability to attract, train and retain highly qualified associates while also controlling its labor costs.
Carpets
’
customers expect a high level of customer service and product knowledge from its associates. To meet the needs and expectations of its customers, it must attract, train and retain a large number of highly qualified associates while at the same time controlling labor costs. Its ability to control labor costs is subject to numerous external factors, including prevailing wage rates and health and other insurance costs, as well as the impact of legislation or regulations governing labor relations or healthcare benefits. Also, Carpets competes with other retail businesses for many of its associates in hourly positions, and it invests significant resources
- 34 -
in training and motivating them to maintain a high level of job satisfaction. These positions have historica
lly had high turnover rates, which can lead to increased training and retention costs. There is no assurance that Carpets will be able to attract or retain highly qualified associates in the future.
A substantial decrease or interruption in business from Carpets’ significant customers or suppliers could adversely affect its business.
A small number of customers have historically accounted for a substantial portion of Carpets net revenue. We expect that key customers will continue to account for a substantial portion of Carpets net revenue for the foreseeable future. However, Carpets may lose these customers due to pricing, quality or other various issues. The loss or reduction of, or failure to renew or replace, any significant contracts with any of these customers could have a material adverse effect on its business or results of operations. For additional information regarding customer concentrations, see
“Part I – Financial Information,
Item 1. Financial Statements – Note 3. Concentration Risks.”
Historically, Carpets has purchased inventory from a small number of vendors. If these vendors became unable to provide materials promptly, Carpets would be required to find alternative vendors. Management estimates they could locate and qualify new vendors in approximately two weeks. For additional information regarding vendor concentrations, see
“Part I – Financial Information,
Item 1. Financial Statements – Note 3. Concentration Risks.”
Risks Related to Phoenix
Phoenix faces intense competition in the printing industry that could decrease demand for its products or force it to lower prices.
The printing industry is highly competitive. Phoenix competes directly or indirectly with a number of established book and book component manufacturers. New distribution channels such as digital formats, the internet and online retailers and growing delivery platforms (
e.g
., tablets and e-readers), combined with the concentration of retailer power, pose threats and provide opportunities to traditional consumer publishing models, potentially impacting both sales volumes and pricing.
C
ompetitive pressures or the inability to adapt effectively and quickly to a changing competitive landscape could affect Phoenix
’
s prices, its margins or demand for its products and services. If Phoenix is unable to respond timely and appropriately to these competitive pressures, from existing or new competitors, its business could be adversely affected.
Economic weakness and uncertainty, as well as the effects of these conditions on Phoenix’s customers and suppliers, could reduce demand for or Phoenix’s ability to provide its products and services.
Economic conditions and, in particular, conditions in Phoenix
’
s customers
’
and suppliers
’
businesses, could affect its business and results of operations. Phoenix has experienced and may continue to experience reduced demand for certain of its products and services. As a result of uncertainty about global economic conditions, including factors such as unemployment, bankruptcies, financial market volatility, sovereign debt issues, government budget deficits and other factors which continue to affect the global economy, Phoenix
’
s customers and suppliers may experience further deterioration of their businesses, suffer cash flow shortages or file for bankruptcy. In turn, existing or potential customers may delay or decline to purchase Phoenix
’
s products and related services, and Phoenix
’
s suppliers and customers may not be able to fulfill their obligations to it in a timely fashion.
Phoenix
’
s educational textbook cover and component sales depend on continued government funding for educational spending, which impacts demand by its customers, and may be affected by changes in or continued restrictions on local, state and/or federal funding and school budgets. As a result, a reduction in consumer discretionary spending or disposable income and/or adverse trends in the general economy (and consumer perceptions of those trends) may affect Phoenix more significantly than other businesses in other industries.
In addition, customer difficulties could result in increases in bad debt write-offs and increases to Phoenix
’
s allowance for doubtful accounts receivable. Further, Phoenix
’
s suppliers may experience similar conditions as its customers, which may impact their viability and their ability to fulfill their obligations to it. Negative changes in these or related economic factors could materially adversely affect Phoenix
’
s business.
- 35 -
A substantial decrease or interruption in business from Phoenix’s significant custo
mers or suppliers could adversely affect its business.
Phoenix has significant customer and supplier concentration. For additional information regarding customer and supplier concentrations, see
“Part I – Financial Information,
Item 1. Financial Statements – Note 3. Concentration Risks.” Any significant cancellation, deferral or reduction in the quantity or type of products sold to these principal customers or a significant number of smaller customers, including as a result of our failure to perform, the impact of economic weakness and challenges to their businesses, a change in buying habits, further industry consolidation or the impact of the shift to alternative methods of content delivery, including digital distribution and printing, to customers, could have a material adverse effect on Phoenix
’
s business. Further, if Phoenix
’
s major customers, in turn, are not able to secure large orders, they will not be able to place orders with Phoenix. A substantial decrease or interruption in business from Phoenix
’
s significant customers could result in write-offs or the loss of future business and could have a material adverse effect on Phoenix
’
s business.
Additionally, Phoenix purchases certain limited grades of paper for the production of their book and component products. If our suppliers reduce their supplies or discontinue these grades of paper, we may be unable to fulfill our contract obligations, which could have a material adverse effect on Phoenix
’
s business.
Fluctuations in the cost and availability of raw materials could increase Phoenix’s cost of sales.
Phoenix is dependent upon the availability of raw materials to produce its products. Phoenix primarily uses paper, ink and adhesives, and the price and availability of these raw materials are affected by numerous factors beyond Phoenix
’
s control. These factors include:
|
·
|
the level of consumer demand for these materials and downstream products containing or using these materials;
|
|
·
|
the supply of these materials and the impact of industry consolidation;
|
|
·
|
government regulation and taxes;
|
|
·
|
volatility in the capital and credit markets;
|
|
·
|
environmental conditions and regulations; and
|
|
·
|
political and global economic conditions.
|
Any material increase in the price of key raw materials could adversely impact Phoenix
’
s cost of sales or result in the loss of availability of such materials at reasonable prices. When these fluctuations result in significantly higher raw material costs, Phoenix
’
s operating results are adversely affected to the extent it is unable to pass on these increased costs to its customers or to the extent they materially affect customer buying habits. Significant fluctuations in prices for paper, ink and adhesives could, therefore, have a material adverse effect on Phoenix
’
s business.
Any disruption at Phoenix’s production facility could adversely affect its results of operations.
Phoenix is dependent on certain key production facilities and certain specialized machines. Any disruption of production capabilities due to unforeseen events, including mechanical failures, labor disturbances, weather or other force majeure events, at any of its principal facilities could adversely affect its business, results of operations, cash flows, and financial condition. Further, if any of the specialized equipment that Phoenix relies upon to make its products becomes inoperable, Phoenix may experience delays in its ability to fulfill customer orders, which could harm its relationships with its customers.
Phoenix is subject to environmental obligations and liabilities that could impose substantial costs upon Phoenix.
Phoenix
’
s operations are subject to a variety of federal, state, local and foreign laws and regulations governing emissions to air, discharge to water, the generation, handling, storage, transportation, treatment and disposal of hazardous substances and other materials, and employee health and safety matters. As an owner and operator of real property and a generator of hazardous substances, Phoenix may be subject to environmental cleanup liability, regardless of fault, pursuant to the Comprehensive Environmental Response, Compensation and Liability Act or analogous state laws, as well as to claims for harm to health or property or for natural resource damages arising out of contamination or exposure to hazardous substances. Some of Phoenix
’
s current or past operations have involved metalworking and plating, printing and other activities that have resulted in or could result in environmental conditions giving rise to liabilities. If Phoenix incurs significant expenses related to environmental cleanup or damages stemming from harm or alleged harm to health, property or natural resources arising from contamination or exposure to hazardous substances, Phoenix
’
s business may be materially and adversely affected.
- 36 -
Risks Related to our Businesses Generally and our Common Stock
Our ability to engage in some business transactions may be limited by the terms of our debt.
Our financing documents contain affirmative and negative financial covenants restricting ALJ, Faneuil, Carpets and Phoenix. Specifically, our loan facilities include covenants restricting ALJ
’
s, Faneuil
’
s, Carpets
’
and Phoenix
’
s ability to:
|
·
|
make certain capital expenditures;
|
|
·
|
incur or permit liens to exist;
|
|
·
|
enter into transactions with affiliates;
|
|
·
|
guarantee the debt of other entities, including joint ventures;
|
|
·
|
merge or consolidate or otherwise combine with another company; or
|
|
·
|
transfer or sale of our assets.
|
ALJ
’
s, Faneuil
’
s, Carpets
’
and Phoenix
’
s respective abilities to borrow under our loan arrangements depend upon their respective abilities to comply with certain covenants and borrowing base requirements. Our and our subsidiaries
’
abilities to meet these covenants and requirements may be affected by events beyond our control, and we or they may not meet these obligations. The failure of any of us or our subsidiaries to comply with these covenants and requirements could result in an event of default under our loan arrangements that, if not cured or waived, could terminate such party
’
s ability to borrow further, permit acceleration of the relevant debt (and other indebtedness based on cross-default provisions) and permit foreclosure on any collateral granted as security under the loan arrangements, which includes substantially all of our assets. Accordingly, any default under our loan facilities could also result in a material adverse effect on us that may result in our lenders seeking to recover from us or against our assets. There can also be no assurance that the lenders will grant waivers on covenant violations if they occur. Any such event of default would have a material adverse effect on us.
We have substantial indebtedness and our ability to generate cash to service our indebtedness depends on factors that are beyond our control.
We currently have, and will likely continue to have, a substantial amount of indebtedness. Our indebtedness could, among other things, make it more difficult for us to satisfy our debt obligations, require us to use a large portion of our cash flow from operations to repay and service our debt or otherwise create liquidity problems, limit our flexibility to adjust to market conditions and place us at a competitive disadvantage. We expect to obtain the money to pay our expenses and pay the principal and interest on our indebtedness from cash flow from our operations and potentially from debt or equity offerings. Accordingly, our ability to meet our obligations depends on our future performance and capital raising activities, which will be affected by financial, business, economic and other factors, many of which are beyond our control. If our cash flow and capital resources prove inadequate to allow us to pay the principal and interest on our debt and meet our other obligations, we could face substantial liquidity problems and might be required to dispose of material assets or operations, restructure or refinance our debt, which we may be unable to do on acceptable terms, or forgo attractive business opportunities.
We have been and may in the future become subject to claims arising in the ordinary course of our business.
We and our subsidiaries are currently involved in, and from time to time may become involved in, legal proceedings or be subject to claims arising in the ordinary course of our business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of any currently pending legal proceedings to which we or our subsidiaries are a party will not have a material adverse effect on our business, operating results, financial condition or cash flows. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.
Such diversion of resources may adversely affect the execution of our business plan and our ability to effectively compete in the marketplace.
Changes in interest rates may increase our interest expense.
As of June 30, 2016, $94.1 million of our current borrowings under the Cerberus Term Loan and potential future borrowings are and may continue to be at variable rates of interest, tied to LIBOR or the Prime Rate of interest, thus exposing us to interest rate risk. As recently announced by the Federal Reserve Board, the federal funds rate is expected to increase in the near term, which may also have an impact on long-term rates. If interest rates do increase, our debt service obligations on our variable rate indebtedness could increase
- 37 -
even if the amount bo
rrowed remained the same, resulting in a decrease in our net income. For example, if interest rates increased in the future by 100 basis points, based on our current borrowings as of June 30, 2016, we would incur approximately an a
dditional $0.9
million pe
r annum in interest expense.
Account data breaches involving stored data or the misuse of such data could adversely affect our reputation, performance, and financial condition.
We provide services that involve the storage of non-public information. Cyber attacks designed to gain access to sensitive information are constantly evolving, and high profile electronic security breaches leading to unauthorized releases of sensitive information have occurred recently at a number of major U.S. companies, including several large retailers, despite widespread recognition of the cyber-attack threat and improved data protection methods. Any breach of the systems on which sensitive data and account information are stored or archived and any misuse by our employees, by employees of data archiving services or by other unauthorized users of such data could lead to damage to our reputation, claims against us and other potential increases in costs. If we are unsuccessful in defending any lawsuit involving such data security breaches or misuse, we may be forced to pay damages, which could materially and adversely affect our profitability and financial condition. Also, damage to our reputation stemming from such breaches could adversely affect our prospects. As the regulatory environment relating to companies
’
obligations to protect such sensitive data becomes stricter, a material failure on our part to comply with applicable regulations could subject us to fines or other regulatory sanctions.
Some of our officers do not devote all of their time to us because of outside business interests, which could impair our ability to implement our business strategies and lead to potential conflicts of interest.
Jess Ravich, our Executive Chairman, is also the Group Managing Director of The TCW Group, an asset management firm. T. Robert Christ, our Chief Financial Officer, is also the Executive Vice President of Aristotle Inc., a political software company and age and identity verification company. While we believe that Messrs. Ravich and Christ are able to devote sufficient amounts of time to our business, the fact that Messrs. Ravich and Christ have outside business interests could lessen their focus on our business, and jeopardize our ability to implement our business strategies.
Additionally, some of our officers, in the course of their other business activities, may become aware of investments, business or other information which may be appropriate for presentation to us as well as to other entities to which they owe a fiduciary duty. They may also in the future become affiliated with entities that are engaged in business or other activities similar to those we intend to conduct. As a result, they may have conflicts of interest in determining to which entity particular opportunities or information should be presented. If, as a result of such conflict, we are deprived of investments, business or information, the execution of our business plan and our ability to effectively compete in the marketplace may be adversely affected.
We may not be able to consummate additional acquisitions and dispositions on acceptable terms or at all. Furthermore, we may not be able to integrate acquisitions successfully and achieve anticipated synergies, or the acquisitions and dispositions we pursue could disrupt our business and harm our financial condition and operating results.
As part of our business strategy, we intend to continue to pursue acquisitions and dispositions. Acquisitions and dispositions could involve a number of risks and present financial, managerial and operational challenges, including:
|
·
|
adverse developments with respect to our results of operations as a result of an acquisition which may require us to incur charges and/or substantial debt or liabilities;
|
|
·
|
disruption of our ongoing business and diversion of resources and management attention from existing businesses and strategic matters;
|
|
·
|
difficulty with assimilation and integration of operations, technologies, products, personnel or financial or other systems;
|
|
·
|
increased expenses, including compensation expenses resulting from newly hired employees and/or workforce integration and restructuring;
|
|
·
|
disruption of relationships with current and new personnel, customers and suppliers;
|
|
·
|
integration challenges related to implementing or improving internal controls, procedures and/or policies at a business that prior to the acquisition lacked the same level of controls, procedures and/or policies;
|
|
·
|
the assumption of certain known and unknown liabilities of the acquired business;
|
- 38 -
|
·
|
regulatory challenges or r
esulting delays; and
|
|
·
|
potential disputes (including with respect to indemnification claims) with the buyers of disposed businesses or with the sellers of acquired businesses, technologies, services or products.
|
We may not be able to consummate acquisitions or dispositions on favorable terms or at all. Our ability to consummate acquisitions will be limited by our ability to identify appropriate acquisition candidates, to negotiate acceptable terms for purchase and our access to financial resources, including available cash and borrowing capacity. In addition, we could experience financial or other setbacks if we are unable to realize, or are delayed in realizing, the anticipated benefits resulting from an acquisition, if we incur greater than expected costs in achieving the anticipated benefits or if any business that we acquire or invest in encounters problems or liabilities which we were not aware of or were more extensive than believed.
Our net operating loss carry-forwards could be substantially limited if we experience an “ownership change,” as defined in Section 382 of the Internal Revenue Code.
Our ability to utilize net operating losses (
“
NOLs
”
) and built in losses under Section 382 of the Code and tax credit carry-forwards to offset our future taxable income and/or to recover previously paid taxes would be limited if we were to undergo an
“
ownership change
”
within the meaning of Section 382 of the Code.
Section 382 of the Code contains rules that limit the ability of a company that undergoes an
“
ownership change,
”
which is generally any change in ownership of more than 50% of its stock over a three-year period, to utilize its NOLs and certain built-in losses recognized in years after the ownership change. These rules generally operate by focusing on ownership changes among stockholders owning directly or indirectly 5% or more of the stock of a company and any change in ownership arising from a new issuance of stock by the company.
If we undergo an ownership change for purposes of Section 382 as a result of future transactions involving our common stock, including purchases or sales of stock between 5% stockholders, our ability to use our NOLs and to recognize certain built-in losses would be subject to the limitations of Section 382. Depending on the resulting limitation, a significant portion of our NOLs could expire before we would be able to use them. At the end of our last fiscal year, September 30, 2015, we had an NOL carryforward for federal income tax purposes of approximately $162 million that expires from 2020 through 2028. Approximately $140 million of the carryforward expires in 2022. Our inability to utilize our NOLs would have a negative impact on our financial position and results of operations.
We do not believe we have experienced an
“
ownership change
”
as defined by Section 382 in the last three years. However, whether a change in ownership occurs in the future is largely outside of our control, and there can be no assurance that such a change will not occur.
In May 2009, we announced that our Board of Directors adopted a shareholder rights plan (the
“
Rights Plan
”
) designed to preserve stockholder value and the value of certain tax assets primarily associated with NOLs and built-in losses under Section 382 of the Code. We also amended our certificate of incorporation to add certain restrictions on transfers of our stock that may result in an ownership change under Section 382.
Our internal controls and procedures may be deficient.
Our internal controls and procedures, including the internal controls and procedures of our subsidiaries, may be subject to deficiencies or weaknesses. Remedying and monitoring internal controls and procedures distracts our management from its operations, planning, oversight and performance functions, which could harm our operating results. Additionally, any failure of our internal controls or procedures could harm our operating results or cause us to fail to meet our obligations to maintain adequate public information or to file periodic reports with the SEC, as applicable.
The concentration of our capital stock ownership with insiders will likely limit your ability to influence corporate matters.
Our executive officers and directors and their affiliated entities together beneficially own a majority of our outstanding common stock and our Executive Chairman owns approximately 40% of our outstanding common stock. As a result, these stockholders, if they act together or in a block, could have significant influence over most matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions, even if other stockholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.
- 39 -
We are an “emerging growth company” and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are n
ot “emerging growth companies.”
We qualify as an
“
emerging growth company,
”
as defined in Section 2(a) of the Securities Act of 1933, as amended, as modified by the Jumpstart Our Business Startups Act of 2012 (the
“
JOBS Act
”
). We shall continue to be deemed an emerging growth company until the earliest of:
(a) the last day of the fiscal year in which we have total annual gross revenues of $1 billion or more;
(b) the last day of the fiscal year of the issuer following the fifth anniversary of the date of the first sale of common equity securities of the issuer pursuant to an effective registration statement;
(c) the date on which we have issued more than $1 billion in non-convertible debt, during the previous 3-year period, issued; or
(d) the date on which we are deemed to be a large accelerated filer.
As an emerging growth company we will be subject to reduced public company reporting requirements. As an emerging growth company we are exempt from Section 404(b) of Sarbanes Oxley. Section 404(a) requires issuers to publish information in their annual reports concerning the scope and adequacy of the internal control structure and procedures for financial reporting. This statement shall also assess the effectiveness of such internal controls and procedures. Section 404(b) requires that the registered accounting firm shall, in the same report, attest to and report on the assessment on the effectiveness of the internal control structure and procedures for financial reporting.
As an emerging growth company we are also exempt from Section 14A (a) and (b) of the Securities Exchange Act of 1934 which require the shareholder approval of executive compensation and golden parachutes.
We have elected to use the extended transition period for complying with new or revised accounting standards under Section 102(b)(2) of the JOBS Act, that allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates.
An active trading market for our common stock may never develop or be sustained.
On May 11, 2016, our stock began trading on the NASDAQ market under the ticker symbol “ALJJ.” We cannot assure you that an active trading market for our common stock will develop on NASDAQ or elsewhere or, if developed, that any market will be sustained. Accordingly, we cannot assure you that a liquid trading market will exist, that you will be able to sell your shares of our common stock when you wish, or that you will obtain your desired price for your shares of our common stock.
We cannot assure you that our common stock will continue to trade on NASDAQ.
Although our stock began trading on the NASDAQ, we cannot assure you that we will be able to maintain NASDAQ’s continued listing requirements.
Such a listing helps our stockholders by providing a readily available trading market with current quotations. Without that, stockholders may have a difficult time getting a quote for the sale or purchase of our stock, the sale or purchase of our stock would likely be made more difficult and the trading volume and liquidity of our stock would likely decline. In that regard, listing on a recognized national trading market such as NASDAQ will also affect our ability to benefit from the use of our operations and expansion plans, including the development of strategic relationships and acquisitions, which are critical to our business and strategy. Any failure to maintain NASDAQ’s continued listing requirements would result in negative publicity and would negatively impact our ability to raise capital in the future.
The market price of our common stock is volatile.
The market price of our common stock could fluctuate substantially in the future in response to a number of factors, including the following:
|
·
|
our quarterly operating results or the operating results of other companies in our industry;
|
|
·
|
changes in general conditions in the economy, the financial markets or our industry;
|
|
·
|
announcements by our competitors of significant acquisitions; and
|
|
·
|
the occurrence of various risks described in these Risk Factors.
|
- 40 -
Also, the stock market has experienced extreme price and volume fluctuations recently. This volatility has had a significant impact on the market prices of securities issued by many companies for reas
ons unrelated to their operating performance. These broad market fluctuations may materially adversely affect our stock price, regardless of our operating results.
Your share ownership may be diluted by the issuance of additional shares of our common or preferred stock in the future.
Your share ownership may be diluted by the issuance of additional shares of our common or preferred stock or securities convertible into common or preferred stock in the future. As of June 30, 2016, a total of 2,284,000 shares of our common stock are issuable pursuant to vested and outstanding options issued by us at a weighted-average exercise price of $2.15. It is probable that options to purchase our common stock will be exercised during their respective terms if the fair market value of our common stock exceeds the exercise price of the particular option. If the stock options are exercised, your share ownership will be diluted.
In addition, our board of directors may determine from time to time that we need to raise additional capital by issuing additional shares of our common stock or other securities. We are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common or preferred stock. The issuance of any additional shares of common stock or preferred stock or securities convertible into, exchangeable for or that represent the right to receive common or preferred stock or the exercise of such securities could be substantially dilutive to shareholders of our common stock. New investors also may have rights, preferences and privileges that are senior to, and that adversely affect, our then current shareholders. Holders of our shares of common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series. The market price of our common stock could decline as a result of sales of shares of our common stock made after this offering or the perception that such sales could occur. We cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our shareholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings.
We do not currently plan to pay dividends to holders of our common stock.
We do not currently anticipate paying cash dividends to the holders of our common stock. Accordingly, holders of our common stock must rely on price appreciation as the sole method to realize a gain on their investment. There can be no assurances that the price of our common stock will ever appreciate in value.
The anti-takeover provisions of our stockholders rights plan may have the effect of delaying or preventing beneficial takeover bids by third parties.
We have a stockholder rights plan designed to preserve the value of certain tax assets primarily associated with our NOLs and built-in losses under Section 382. As of the end of our last fiscal year, September 30, 2015, we had approximately $162 million of NOLs. The use of such losses to offset federal income tax would be limited if we experience an
“
ownership change
”
under Section 382. This would occur if stockholders owning (or deemed under Section 382 to own) 5% or more of our stock by value increase their collective ownership of the aggregate amount of our stock by more than 50 percentage points over a defined period. The Rights Plan was adopted to reduce the likelihood of an
“
ownership change
”
occurring as defined by Section 382.
In connection with the Rights Plan, we declared a dividend of one preferred share purchase right for each share of its common stock outstanding as of the close of business on May 21, 2009. Pursuant to the Rights Plan, any stockholder or group that acquires beneficial ownership of 4.9 percent or more of our outstanding stock (an
“
Acquiring Person
”
) without the approval of our Board of Directors would be subjected to significant dilution of its holdings. Any existing stockholder holding 4.9% or more of our stock will not be considered an Acquiring Person unless such stockholder acquires additional stock; provided that existing stockholders actually known to us to hold 4.9% or more of its stock as of April 30, 2009 are permitted to purchase up to an additional 5% of our stock without triggering the Rights Plan. In addition, in its discretion, the Board of Directors may exempt certain persons whose acquisition of securities is determined by the Board of Directors not to jeopardize our deferred tax assets and may also exempt certain transactions. The Rights Plan will continue in effect until May 13, 2019, unless it is terminated or the preferred share purchase rights are redeemed earlier by the Board of Directors.
While the Rights Plan is intended to protect our NOLs and built-in losses under Section 382, it may also have the effect of delaying or preventing beneficial takeover bids by third parties.