This Annual Report
on Form 10-K (this “Annual Report”) contains forward-looking statements regarding our business, financial condition,
results of operations and prospects. Words such as “expect,” “anticipate,” “intend,” “plan,”
“believe,” “seek,” “may,” “will,” “should,” “could,” “future,”
“likely,” “predict,” “project,” “potential,” “continue,” “estimate”
and similar expressions are generally intended to identify forward-looking statements, but are not exclusive means of identifying
forward-looking statements in this Annual Report. You should not place undue reliance on such forward-looking statements, which
are based on the information currently available to us and speak only as of the date on which this Annual Report was filed with
the Securities and Exchange Commission (the “SEC”). Because these forward-looking statements involve known and unknown
risks and uncertainties, there are important factors that could cause actual results, events or developments to differ materially
from those expressed or implied by these forward-looking statements, including our plans, objectives, expectations and intentions
and other factors discussed in “Part I — Item 1A. Risk Factors” contained in this Annual Report. We undertake
no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events
or otherwise.
Item 1. BUSINESS
General
B. Riley Financial,
Inc. (NASDAQ: RILY) and its subsidiaries provide collaborative financial services and solutions through several operating subsidiaries
including:
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B.
Riley FBR, Inc. (“B. Riley FBR”) is a leading, full service investment bank
providing financial advisory, corporate finance, research, securities lending and sales
and trading services to corporate, institutional and high net worth individual clients.
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B.
Riley Wealth Management, Inc. (“B. Riley Wealth Management”) provides comprehensive
wealth management and brokerage services to individuals and families, corporations and
non-profit organizations, including qualified retirement plans, trusts, foundations and
endowments.
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B.
Riley Capital Management, LLC, a Securities and Exchange Commission (“SEC”)
registered investment advisor, which includes:
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B. Riley Asset Management, an advisor to certain private funds and to institutional and high net
worth investors;
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Great American Capital Partners, LLC (“GACP”), the general partner of two private funds,
GACP I, L.P. and GACP II, L.P., both direct lending funds that provide senior secured loans and second lien secured loan facilities
to middle market public and private U.S. companies.
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GlassRatner
Advisory & Capital Group LLC (“GlassRatner”), a specialty financial advisory
services firm that provides consulting services to shareholders, creditors and companies,
including due diligence, fraud investigations, corporate litigation support, crisis management
and bankruptcy services.
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Great
American Group, LLC, (“Great American Group”) a leading provider of asset
disposition and auction solutions to a wide range of retail and industrial clients.
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Great
American Group Advisory and Valuation Services, LLC, a leading provider of appraisal
and valuation services for asset based lenders, private equity firms and corporate clients.
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We
also pursue a strategy of investing in or acquiring companies which we believe have attractive investment return characteristics.
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United
Online, Inc. (“UOL” or “United Online”), which we acquired on
July 1, 2016, is a communications company that offers consumer subscription services
and products, consisting of Internet access services and devices under the NetZero and
Juno brands primarily sold in the United States.
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magicJack
VocalTec Ltd. (“magicJack”), which we acquired on November 14, 2018, is a
Voice over IP (“VoIP”) cloud-based technology and services communications
provider.
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BR Brand Holdings
LLC (“BR Brand”), in which we acquired a majority investment interest on October 28, 2019, provides licensing of a
brand investment portfolio. BR Brand owns the assets and intellectual property related to licenses of six brands: Catherine
Malandrino, English Laundry, Joan Vass, Kensie Girl, Limited Too and Nanette Lepore.
We are headquartered
in Los Angeles with offices in major cities throughout the United States including New York, Chicago, Boston, Dallas, Memphis,
Metro Washington D.C and West Palm Beach.
For financial reporting
purposes we classify our businesses into five operating segments: (i) Capital Markets, (ii) Auction and Liquidation, (iii) Valuation
and Appraisal, (iv) Principal Investments – United Online and magicJack, and (v) Brands.
Capital Markets
Segment. Our Capital Markets segment provides a full array of investment banking, corporate finance, consulting, financial
advisory, research, securities lending, wealth management and sales and trading services to corporate, institutional and high net
worth clients. Our corporate finance and investment banking services include merger and acquisitions as well as restructuring advisory
services to public and private companies, initial and secondary public offerings, and institutional private placements. In addition,
we trade equity securities as a principal for our account, including investments in funds managed by our subsidiaries. Our Capital
Markets segment also includes our asset management businesses that manage various private and public funds for institutional and
individual investors.
Auction and Liquidation
Segment. Our Auction and Liquidation segment utilizes our significant industry experience, a scalable network of independent
contractors and industry-specific advisors to tailor our services to the specific needs of a multitude of clients, logistical challenges
and distressed circumstances. Furthermore, our scale and pool of resources allow us to offer our services across North American
as well as parts of Europe, Asia and Australia. Our Auction and Liquidation segment operates through two main divisions, retail
store liquidations and wholesale and industrial assets dispositions. Our wholesale and industrial assets dispositions division
operates through limited liability companies that are controlled by us.
Valuation and Appraisal
Segment. Our Valuation and Appraisal segment provides Valuation and Appraisal services to financial institutions, lenders,
private equity firms and other providers of capital. These services primarily include the valuation of assets (i) for purposes
of determining and monitoring the value of collateral securing financial transactions and loan arrangements and (ii) in connection
with potential business combinations. Our Valuation and Appraisal segment operates through limited liability companies that are
majority owned by us.
Principal Investments
- United Online and magicJack Segment. Our Principal Investments - United Online and magicJack segment consists of businesses
which have been acquired primarily for attractive investment return characteristics. Currently, this segment includes UOL, through
which we provide consumer Internet access, and magicJack, through which we provide VoIP communication and related product and subscription
services.
Brands Segment.
Our Brands segment consists of our brand investment portfolio that is focused on generating revenue through the licensing of trademarks
and is held by BR Brand.
Recent Developments
Securities Offerings
Preferred
Stock Offering
On October 7, 2019,
we closed our underwritten public offering of depositary shares (the “Depositary Shares”), each representing 1/1000th of
a share of 6.875% Series A Cumulative Perpetual Preferred Stock, par value $0.0001 per share (the “Series A Preferred Stock”).
The liquidation preference of each share of Series A Preferred Stock is $25,000 ($25.00 per Depositary Share). At the closing,
we issued 2,000 shares of Series A Preferred Stock represented by 2,000,000 Depositary Shares issued. The offering was conducted
pursuant to an underwriting agreement, dated October 2, 2019, by and among us and B. Riley FBR, as representative of the several
underwriters named therein. On October 11, 2019, we closed on the issuance of an additional 300,000 additional Depositary Shares
pursuant to the full exercise of the underwriters’ over-allotment option. The Depositary Shares were offered pursuant to
our shelf registration statement on Form S-3 (Registration No. 333-233907)
initially filed with the SEC on September 23, 2019 and declared effective by the SEC on September 30, 2019 (the “September
2019 Shelf Registration”).
December 2019 At
Market Issuance Sales Agreement
On December 5, 2019,
we entered into an At Market Issuance Sales Agreement (the “December 2019 Sales Agreement”) with B. Riley FBR, pursuant
to which the Company may offer and sell, from time to time, up to $100,000,000 of the Company’s 7.25% Senior Notes due 2027
(the “7.25% 2027 Notes”), 7.50% Senior Notes due 2027 (the “7.50% 2027 Notes”), 7.375% Senior Notes due
2023 (the “7.375% 2023 Notes”), 6.875% Senior Notes due 2023 (the “6.875% 2023 Notes”), 6.75% Senior Notes
due 2024 (the “2024 Notes”) and 6.50% Senior Notes due 2026 (the “2026 Notes”), Common Stock and Depositary
Shares (collectively, the “December 2019 Offered Securities”). Sales of the December 2019 Offered Securities pursuant
to the Sales Agreement, if any, may be made in transactions that are deemed to be “at the market offerings” as defined
in Rule 415 under the Securities Act. B. Riley FBR is not required to sell any specific number of the December 2019 Offered Securities,
but B. Riley FBR will make all sales using commercially reasonable efforts consistent with its normal trading and sales practices
on mutually agreed terms between B. Riley FBR and the Company. Under the December 2019 Sales Agreement, B. Riley FBR will be entitled
to compensation of up to 2.0% of the gross proceeds of all December 2019 Offered Securities sold through it as the Company’s
agent.
6.375 Senior Notes
due 2025
On February 12, 2020,
we closed our underwritten public offering of $132,250,000 aggregate principal amount of 6.375% Senior Notes due 2025 (the “2025
Notes”), which included $17.25 million of notes issued pursuant to the full exercise by the underwriters of their overallotment
option. The offering was conducted pursuant to an underwriting agreement, dated February 10, 2020, by and among us and B. Riley
FBR, as representative of the several underwriters named therein. The 2025 Notes were offered pursuant to the September 2019 Shelf
Registration and the Company’s registration statement on Form S-3 (Registration No. 333-236347) filed with the SEC and effective
on February 10, 2020.
February 2020 Shelf
Registration Statement and At Market Issuance Sales Agreement
On February 14, 2020,
we filed a registration statement on Form S-3 (Registration No. 333-236463) with the SEC for up to $350,000,000 of the Company’s
common stock, preferred stock, warrants, debt securities, depositary shares and/or units (the “February 2020 Registration
Statement”), which was declared effective by the SEC on February 24, 2020. Contemporaneously, we entered into an At Market
Issuance Sales Agreement (the “February 2020 Sales Agreement”) with B. Riley FBR, pursuant to which the Company may
offer and sell, from time to time, up to $150,000,000 of 7.25% 2027 Notes, 7.375% 2023 Notes, 6.875% 2023 Notes, 2024 Notes, 2026
Notes, 2025 Notes, and Depositary Shares (collectively, the “February 2020 Offered Securities”). Sales of the February
2020 Offered Securities pursuant to the Sales Agreement, if any, may be made in transactions that are deemed to be “at the
market offerings” as defined in Rule 415 under the Securities Act. B. Riley FBR is not required to sell any specific number
of the February 2020 Offered Securities, but B. Riley FBR will make all sales using commercially reasonable efforts consistent
with its normal trading and sales practices on mutually agreed terms between B. Riley FBR and the Company. Under the February
2020 Sales Agreement, B. Riley FBR will be entitled to compensation of up to 2.0% of the gross proceeds of all February 2020 Offered
Securities sold through it as the Company’s agent.
Acquisition of Majority Interest in
BR Brand
On October 28, 2019,
the Company and B. Riley Brand Management LLC, an indirect wholly-owned subsidiary of the Company (the “B. Riley Member”),
completed the acquisition of a majority equity interest in BR Brand in exchange for (i) aggregate consideration of $116.5 million
in cash and (ii) the issuance by the Company to Bluestar, an affiliate of the manager of BR Brand, of a warrant to purchase up
to 200,000 shares of the Company’s Common Stock, par value $0.0001 per share, at an exercise price per share equal to $26.24.
One-third of the shares of common stock issuable under the Warrant vested and became exercisable immediately upon its issuance
at the Closing, and the remaining two-thirds of such shares of common stock will vest and become exercisable following the first
and/or second anniversaries of the closing, subject to BR Brand’s (or another related joint venture with Bluestar) satisfaction
of specified financial performance targets. In connection with the closing, the manager of BR Brand caused the transfer to BR Brand
of certain trademarks, domain names, license agreements and related assets from existing brand owners. Each of the B. Riley Member
and the manager of BR Brand is, as applicable, subject to certain post-closing obligations to indemnify BR Brand for breaches of
representations or warranties, covenants certain tax liabilities certain pre-closing liabilities.
Our Business
B. Riley FBR
Investment Banking and Corporate
Finance
B. Riley FBR’s
investment banking professionals provide equity and debt capital raising, merger and acquisition, financial advisory and restructuring
advisory services to both private and publicly traded companies. Those services include: follow-on public offerings, debt and equity
private placements, debt refinancing, corporate debt and equity security repurchases, and buy-side and sell-side representation,
divestitures/carveouts, leveraged buyouts, management buyouts, strategic alternatives reviews, fairness opinions, valuations, return-of-capital
advisory, hostile/activist advisory, and options trading programs.
Sales, Trading and Corporate
Services
Our sales and trading
professionals distribute B. Riley proprietary research products to our institutional investor clients and high net worth individuals.
B. Riley FBR sales and trading also sells the securities of companies in which B. Riley FBR acts as an underwriter and executes
equity trades on behalf of clients. We maintain active trading relationships with substantially all major institutional money managers.
Our equity and fixed income traders make markets in approximately 1,036 securities. B. Riley FBR also conducts securities lending
activities which involves the borrowing and lending of equity and fixed income securities. Our corporate services include retail
orders, block trades, Rule 144 transactions, cashless exercise of options, and corporate equity repurchase programs.
Equity Research
Our equity research
is focused on fundamentals-based research. Our research focuses on an in-depth analysis of earnings, cash flow trends, balance
sheet strength, industry outlook, and strength of management that involves extensive meetings with key management, competitors,
channel partners and customers. We provide research on all sizes of firms; however, our research primarily focuses on small and
mid-cap stocks that are under-followed by Wall Street. Our analysts regularly communicate their findings through Research Updates
and daily Morning Notes.
Our research department
includes research analysts maintaining coverage on a variety of companies in a variety of industry sectors. Our research department
annually organizes non-deal road shows for issuers in our targeted industries. To provide our institutional clients access to management
teams of companies in our coverage universe and others, our research department has held 21 consecutive annual institutional investor
conferences.
Capital Management
We provide investment
management services under our subsidiary, B. Riley Capital Management, LLC. The registered investment advisor manages private
investment funds, including a fund of funds. All of the funds managed typically invest in both public and private equity and debt.
Investors in the various funds include institutional, high net worth, and individual investors. GACP is the general partner of
GACP I, L.P. and GACP II, L.P., direct lending funds that provide senior secured loans and second lien secured loan facilities
to middle market public and private U.S. companies.
Proprietary Trading
We engage in trading
activities for strategic investment purposes (i.e. proprietary trading) utilizing the firm’s capital. Proprietary trading
activities include investments in public and private stock and debt securities. In 2010, the federal government passed the Dodd-Frank
Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). Dodd-Frank significantly restructured and intensified
regulation in the financial services industry, and the “Volcker Rule” was promulgated under Dodd-Frank. The Volcker
Rule provides for a limitation on proprietary trading and investments by bank holding companies and banks. We are not a bank holding
company or bank and, as a result, the Volcker Rule and its proprietary trading and investment limitations do not apply to us.
The business described
above for B. Riley FBR is reported in our Capital Markets segment for financial reporting purposes.
B. Riley Wealth Management
Wealth Management
B. Riley Wealth Management
provides comprehensive wealth management and brokerage services to individuals and families, corporations and non-profit organizations,
including qualified retirement plans, trusts, foundations and endowments. Our financial advisors provide a broad range of investments
and services to our clients, including financial planning services. Wunderlich Securities, Inc. (“Wunderlich”) was
established in 1996 and headquartered in Memphis, Tennessee. Wunderlich became a wholly-owned subsidiary of B. Riley Financial,
Inc., in July 2017 and its operations are included in our Capital Markets segment. In June 2018, Wunderlich changed its name to
B. Riley Wealth Management, Inc.
GlassRatner
Financial Advisory
Services
GlassRatner, a specialty
financial advisory services firm we acquired on August 1, 2018, provides consulting services to shareholders, creditors and companies,
including due diligence, fraud investigations, corporate litigation support, crisis management and bankruptcy services. The addition
of GlassRatner strengthens B. Riley’s diverse platform and compliments the restructuring services provided by B. Riley FBR.
Great American Group
Retail Store Liquidations
and Wholesale and Industrial Liquidations
We enable our clients
to quickly and efficiently dispose of under-performing assets and generate cash from excess inventory by conducting or assisting
in retail store closings, going out of business sales, bankruptcy sales and fixture sales. Financial institution and other capital
providers rely on us to maximize recovery rates in distressed asset sales and in retail bankruptcy situations. Additionally, healthy,
mature retailers utilize our proven inventory management and strategic disposition solutions, relying on our extensive network
of retail professionals, to close unproductive stores and dispose of surplus inventory and fixtures as existing stores are updated.
We
often conduct large retail liquidations that entail significant capital requirements through collaborative arrangements with other
liquidators. By entering into an agreement with one or more collaborators, we are able to bid on larger engagements that we could
not conduct on our own due to the significant capital outlay involved, number of independent contractors required or financial
risk associated with the particular engagement. We act as the lead partner in many of the collaborative arrangements that we enter
into, meaning that we have primary responsibility for the due diligence, contract negotiation and execution of the engagement.
We design and implement
customized disposition programs for our clients seeking to convert excess wholesale and industrial inventory and operational assets
into capital. We dispose of a wide array of assets including, among others, equipment related to transportation, heavy mobile construction,
energy exploration and services, metal fabrication, food processing, semiconductor fabrication, and distribution services. We manage
projects of all sizes and scopes across a variety of asset categories. We believe that our databases of information regarding potential
buyers that we have collected from past transactions and engagements, our nationwide name recognition and experience with alternative
distribution channels allow us to provide superior wholesale and industrial disposition services.
Great American Group
provides the foregoing services to clients on a guarantee, fee or outright purchase basis.
Guarantee.
When providing services on a guarantee basis, we guarantee the client a specific recovery often expressed as a percentage of retail
inventory value or wholesale inventory cost or, in the case of machinery or equipment, a set dollar amount. This guarantee is often
required to be supported by a letter of credit, a cash deposit or a combination thereof. Cash deposits are typically funded in
part with available cash together with short term borrowings under our credit facilities. Often when we provide auction or liquidation
services on a guarantee basis, we do so through a collaborative arrangement with other service providers. In this situation, each
collaborator agrees to provide a certain percentage of the guaranteed amount to the client through a combination of letters of
credit, cash and financing. If we are engaged individually, we receive 100% of the net profit, less debt financing fees, sale related
expenses (if any) and any share of the profits due to the client as a result of any profit sharing arrangement entered into based
on a pre-negotiated formula. If the engagement was conducted through a collaborative arrangement, the profits or losses are divided
among us and our partner or partners as set forth in the agreement governing the collaborative arrangement. If the net sales proceeds
after expenses are less than the guarantee, we, together with our partners if the engagement was conducted through a collaborative
arrangement, are responsible for the shortfall and will recognize a loss on the engagement.
Fee. When we
provide services on a fee basis, clients pay a pre-negotiated flat fee for the services provided, a percentage of asset sales generated
or a combination of both.
Outright Purchase.
When providing services on an outright purchase basis, we purchase the assets from the client and typically sell them at auction,
orderly liquidation, through a third-party broker or, less frequently, as augmented inventory in conjunction with another liquidation
that we are conducting. In an outright purchase, we take, together with any collaboration partners, title to the assets and absorb
the profit or loss associated with the asset disposition.
The
retail store liquidations and wholesale and industrial asset dispositions business of Great American Group described above is reported
in our Auction and Liquidation segment for financial reporting purposes.
Valuation and Appraisal
Our Valuation and
Appraisal teams provide independent appraisals to financial institutions, lenders, private equity firms and other providers of
capital for estimated liquidation values of assets. These teams include experts specializing in particular industry niches and
asset classes. We provide Valuation and Appraisal services across five general categories:
Consumer and Retail
Inventory. Representative types of appraisals and valuations include inventory of specialty apparel retailers, department stores,
jewelry retailers, sporting goods retailers, mass and discount merchants, home furnishing retailers and footwear retailers.
Wholesale and Industrial
Inventory. Representative types of appraisals and valuations include inventory held by manufacturers or distributors of automotive
parts, chemicals, food and beverage products, wine and spirits, building and construction products, industrial products, metals,
paper and packaging.
Machinery and Equipment.
Representative types of asset appraisals and valuations include a broad range of equipment utilized in manufacturing, construction,
transportation and healthcare.
Intangible Assets.
Representative types of asset appraisals and valuations include intellectual property, goodwill, brands, logos, trademarks and
customer lists.
We provide Valuation
and Appraisal services on a pre-negotiated flat fee basis.
The Valuation and
Appraisal services business of Great American Group described above is reported in our Valuation and Appraisal segment for financial
reporting purposes.
Principal Investments - United Online
and magicJack
We acquired UOL on
July 1, 2016 and magicJack on November 14, 2018 as part of our principal investment strategy. UOL’s primary pay service is
Internet access, offered under the NetZero and Juno brands. Internet access includes dial-up service, mobile broadband and DSL.
magicJack is a VoIP cloud-based technology and services communications provider and the inventor of the magicJack devices.
Internet Access
Our Internet access
services consist of dial-up, mobile broadband and, to a much lesser extent, DSL services. Our dial-up Internet access services
are provided on both a free and pay basis, with the free services subject to hourly and other limitations. Basic pay dial-up Internet
access services include accelerated dial-up Internet access and an email account. Our Internet access services are also bundled
with additional benefits, including antivirus software and enhanced email storage, although we also offer each of these features
and certain other value-added features as stand-alone pay services. We offer mobile broadband devices for sale in connection with
our mobile broadband services. We also generate revenues from the resale of telecommunications to third parties. Over the past
several years revenues from paid subscription services have declined year over year as a result of a decline in the number of paid
subscribers for our services. Management believes the decline in paid subscriber accounts is primarily attributable to the
industry trends of consumers switching from dial-up Internet access to high speed Internet access such as cable and DSL.
Management expects revenues in the Principal Investments - United Online and magicJack segment to continue to decline year over
year.
magicJack Devices
The magicJack is a
VoIP device weighing about one ounce which includes an initial access right period. Customers receive free VoIP phone service for
their home, enterprise or while traveling. The initial access right period for the different versions ranges from three to twelve
months. The current device available for purchase is the magicJack GO, which includes a twelve month access right period. magicJack
devices are sold either directly to customers through our website or through retailers.
Mobile apps
The Company also offers
magicJack mobile apps, which are applications that allow users to make and receive telephone calls through their smart phones or
devices. The mobile apps allow customers to place and receive telephone calls in the U.S. or Canada on their mobile devices through
either an existing or new magicJack account. The mobile apps also give users the ability to add a second phone number to their
smart phone for a monthly or annual fee. Customers may purchase international minutes to place telephone calls through the magicJack
device or mobile apps to locations outside of the U.S. and Canada.
Access Right Renewals
Customers who own
a magicJack device or mobile app may renew access rights for periods ranging from one month to five years.
Other magicJack-Related
Products
The Company offers
customers other optional products related to their magicJack devices and services, such as custom or vanity phone numbers, Canadian
phone numbers and the ability to either change their existing phone numbers or port them to a magicJack device.
Prepaid Minutes
The Company’s
customers can purchase international minutes on a prepaid basis.
Access and Wholesale
Charges
The Company generates
revenues from access fees charged to other carriers, as well as wholesaling telephone service to VoIP providers and telecommunication
carriers.
UCaaS Services
and Equipment
The Company provided
hosted communication services and sold hardware and network equipment that are compatible with the service, through its subsidiary,
Broadsmart, which was sold during 2019.
Advertising and other revenue
Advertising and other
revenues are primarily derived from various advertising, marketing and media-related initiatives. The majority of our advertising
and other revenues include advertising revenues from search placements, display advertisements and online market research associated
with our Internet access and email services.
Brands
Our
brand investment portfolio focuses on generating revenue through the licensing of trademarks. The
Company holds a majority ownership interest in BR Brand, which owns the assets and intellectual property related to licenses of
six brands: Catherine Malandrino, English Laundry, Joan Vass, Kensie Girl, Limited Too and Nanette Lepore as well as an investment
in the Hurley Brand with Bluestar Alliance LLC (“Bluestar”). The Company intends to grow licensing revenue from the
brand holdings in partnership with Bluestar by leveraging its extensive relationships and strategic partnerships in the retail
sector. The Company intends to pursue future acquisitions of consumer brands, intellectual property, trademarks and licenses, and
participate in select transactions as an equity owner.
Customers
We serve retail, corporate,
capital provider and individual customers across our services lines. The services provided to these customers were under short-term
liquidation contracts that generally do not exceed a period of six months. There were no recurring revenues from year-to-year in
connection with the services we performed under these contracts.
B. Riley FBR
We are engaged by
corporate customers, including publicly held and privately owned companies, to provide investment banking, corporate finance, restructuring
advisory, research and sales and trading services. We also provide corporate finance, research, wealth management, and sales and
trading services to high net worth individuals. We maintain client relationships with companies in the consumer goods, consumer
services, defense, industrials and technology industries.
B. Riley
Wealth Management
We act as financial
wealth management advisors to individuals, families, small businesses, non-profit organizations, and qualified retirement plans.
Our investment services are primarily comprised of asset management services to meet the financial plans, financial goals and needs
of our customers. We service our customers through a network of 21 branch offices located in 14 states primarily located in the
Mid-west and Southern section of the United States.
GlassRatner
We provide specialty
financial advisory services to companies, shareholders, creditors and investors on complex business problems and critical board
level agenda items including transaction advisory and due diligence, fraud investigations, corporate litigation, business valuations,
crisis management and bankruptcy. We provide bankruptcy and restructuring services, forensic accounting and litigation support,
valuation services, and real estate consulting.
Great
American Group
Our retail Auction
and Liquidation clients include financially healthy retailers as well as distressed retailers, bankruptcy professionals, financial
institution workout groups and a wide range of professional service providers. Some retail segments in which we specialize include
apparel, arts and crafts, department stores, discount stores, drug / health and beauty, electronics, footwear, grocery stores,
hardware / home improvement, home goods and linens, jewelry, office / party supplies, specialty stores, and sporting goods. We
also provide wholesale and industrial auction services and customized disposition programs to a wide range of clients.
We are engaged by
financial institutions, lenders, private equity firms and other capital providers, as well as professional service providers, to
provide valuation and advisory services. We have extensive experience in the appraisal and valuation of retail and consumer inventories,
wholesale and industrial inventories, machinery and equipment, intellectual property and real estate. We maintain ongoing client
relationships with major asset based lenders including Bank of America, JPMorgan Chase, and Wells Fargo.
United
Online
Our Internet access
services are available to customers, which are primarily comprised of individuals, in more than 12,000 cities across the U.S. and
Canada. Generally, our Internet access customers also subscribe to value-added features that include antivirus software and enhanced
email storage. Our advertising customers primarily include business customers that market products and services over the Internet.
magicJack
magicJack provides
complete phone service for home, enterprise and while traveling for retailers, wholesalers or directly to customer over the period
associated with the access right period. The Company provides customers with an ability to make and receive telephone calls through
their smart phones, add a second phone number to their smart phone and purchase prepaid minutes to place telephone calls through
the magicJack device or mobile apps to locations outside of the U.S. and Canada.
Competition
B. Riley
FBR, B. Riley Wealth Management and GlassRatner
We face intense competition
for our Capital Markets services. Since the mid-1990s, there has been substantial consolidation among U.S. and global financial
institutions. In particular, a number of large commercial banks, insurance companies and other diversified financial services firms
have merged with other financial institutions or have established or acquired broker-dealers. During 2008, the failure or near-collapse
of a number of very large financial institutions led to the acquisition of several of the most sizeable U.S. investment banking
firms, consolidating the financial industry to an even greater extent. Currently, our competitors are other investment banks, bank
holding companies, brokerage firms, merchant banks and financial advisory firms. Our focus on our target industries also subjects
us to direct competition from a number of specialty securities firms and smaller investment banking boutiques that specialize in
providing services to these industries.
The industry trend
toward consolidation has significantly increased the capital base and geographic reach of many of our competitors. Our larger and
better-capitalized competitors may be better able than we are to respond to changes in the investment banking industry, to recruit
and retain skilled professionals, to finance acquisitions, to fund internal growth and to compete for market share generally. Many
of these firms have the ability to offer a wider range of products than we do, including loans, deposit-taking and insurance, in
addition to brokerage, asset management and investment banking services, all of which may enhance their competitive position relative
to us. These firms also have the ability to support investment banking and securities products with commercial banking, insurance
and other financial services revenues in an effort to gain market share, which could result in downward pricing pressure in our
businesses. In particular, the trend in the equity underwriting business toward multiple book runners and co-managers has increased
the competitive pressure in the investment banking industry and has placed downward pressure on average transaction fees.
As we seek to expand
our asset management business, we face competition in the pursuit of investors for our investment funds, in the identification
and completion of investments in attractive portfolio companies or securities, and in the recruitment and retention of skilled
asset management professionals.
Great American
Group
We also face intense
competition in our other service areas. While some competitors are unique to specific service offerings, some competitors cross
multiple service offerings. A number of companies provide services or products to the Auction and Liquidation and Valuation and
Appraisal markets, and existing and potential clients can, or will be able to, choose from a variety of qualified service providers.
Some of our competitors may even be able to offer discounts or other preferred pricing arrangements. In a cost-sensitive environment,
such arrangements may prevent us from acquiring new clients or new engagements with existing clients. Some of our competitors may
be able to negotiate secure alliances with clients and affiliates on more favorable terms, devote greater resources to marketing
and promotional campaigns or to the development of technology systems than us. In addition, new technologies and the expansion
of existing technologies with respect to the online auction business may increase the competitive pressures on us. We must also
compete for the services of skilled professionals. There can be no assurance that we will be able to compete successfully against
current or future competitors, and competitive pressures we face could harm our business, operating results and financial condition.
We face competition
for our retail services from traditional liquidators as well as Internet-based liquidators such as overstock.com and eBay. Our
wholesale and industrial services competitors include traditional auctioneers and fixed site auction houses that may specialize
in particular industries or geographic regions as well as other large, prestigious or well-recognized auctioneers. We also face
competition and pricing pressure from the internal remarketing groups of our clients and potential clients and from companies that
may choose to liquidate or auction assets and/or excess inventory without assistance from service providers like us. We face competition
for our Valuation and Appraisal services from large accounting, consulting and other professional service firms as well as other
valuation, appraisal and advisory firms.
United
Online
The U.S. market for
Internet and broadband services is highly competitive. We compete with numerous providers of broadband services, as well as other
dial-up Internet access providers. Our principal competitors for broadband services include, among others, local exchange carriers,
wireless and satellite service providers, cable service providers, and broadband resellers. These competitors include established
providers such as AT&T, Verizon, Sprint and T-Mobile. Our principal dial-up Internet access competitors include established
online service and content providers, such as AOL and MSN, and independent national Internet service providers, such as EarthLink.
We believe the primary competitive factors in the Internet access industry are speed, price, coverage area, ease of use, scope
of services, quality of service, and features. Our dial-up Internet access services do not compete favorably with broadband services
with respect to certain of these factors, including, but not limited to, speed.
magicJack
The principal competitors
for our products and services include the traditional telephone service providers, such as AT&T, Inc., CenturyLink, Inc. and
Verizon Communications Inc., which provide telephone service using the public switched telephone network. Certain of these traditional
providers have also added, or are planning to add, broadband telephone services to their existing telephone and broadband offerings.
We also face, or expect to face, competition from cable companies, such as Cablevision Systems Corp., Charter Communications, Inc.,
Comcast Corporation, Cox Communications, Inc. and Time Warner Cable (a division of Time Warner Inc.), which offer broadband telephone
services to their existing cable television and broadband offerings. Further, wireless providers, including AT&T Mobility,
Inc., Sprint Corporation, T-Mobile USA Inc., and Verizon Wireless, Inc. offer services that some customers may prefer over wireline-based
service. In the future, as wireless companies offer more minutes at lower prices, their services may become more attractive to
customers as a replacement for broadband or wireline-based phone service.
We face competition on magicJack device sales from Apple, Samsung,
Motorola and other manufacturers of smart phones, tablets and other handheld wireless devices. Also, we compete against established
alternative voice communication providers, such as Vonage, Google Voice, Ooma, and Skype, which is another non-interconnected voice
provider, and may face competition from other large, well-capitalized Internet companies. In addition, we compete with independent
broadband telephone service providers.
Brands
Our brand investment
portfolio competes with companies that own other brands and trademarks, as these companies could enter into similar licensing arrangements
with retailers and wholesalers in the United States and internationally. These arrangements could be with our existing retail and
wholesale partners, thereby competing with us for consumer attention and limited floor or rack space in the same stores in which
our branded products are sold, and vying with us for the time and resources of the retailers and wholesale licensees that manufacture
and distribute our products. These companies may be able to respond more quickly to changes in retailer, wholesaler and consumer
preferences and devote greater resources to brand acquisition, development and marketing. We may not be able to compete effectively
against these companies.
Regulation
We are subject to
federal and state consumer protection laws, including regulations prohibiting unfair and deceptive trade practices. In addition,
numerous states and municipalities regulate the conduct of auctions and the liability of auctioneers. We and/or our auctioneers
are licensed or bonded in the following states where we conduct, or have conducted, retail, wholesale or industrial asset auctions:
California, Florida, Georgia, Illinois, Massachusetts, Ohio, South Carolina, Texas, Virginia and Washington. In addition, we are
licensed or obtain permits in cities and/or counties where we conduct auctions, as required. If we conduct an auction in a state
where we are not licensed or where reciprocity laws do not exist, we will work with an auctioneer of record in such state.
As a participant in
the financial services industry, we are subject to complex and extensive regulation of most aspects of our business by U.S. federal
and state regulatory agencies, self-regulatory organizations and securities exchanges. The laws, rules and regulations comprising
the regulatory framework are constantly changing, as are the interpretation and enforcement of existing laws, rules and regulations.
The effect of any such changes cannot be predicted and may direct the manner of our operations and affect our profitability.
B. Riley FBR and B.
Riley Wealth Management, our broker-dealer subsidiaries, are subject to regulations governing every aspect of the securities business,
including the execution of securities transactions; capital requirements; record-keeping and reporting procedures; relationships
with customers, including the handling of cash and margin accounts; the experience of and training requirements for certain employees;
and business interactions with firms that are not members of regulatory bodies.
B. Riley FBR and B.
Riley Wealth Management are registered as securities broker-dealers with the SEC and are members of FINRA. FINRA is a self-regulatory
body composed of members such as our broker-dealer subsidiary that have agreed to abide by the rules and regulations of FINRA.
FINRA may expel, fine and otherwise discipline member firms and their employees. B. Riley FBR and B. Riley Wealth Management are
licensed as broker-dealers in all 50 states in the U.S., requiring us to comply with the laws, rules and regulations of each such
state. Each state may revoke the license to conduct securities business, fine and otherwise discipline broker-dealers and their
employees. We are also registered with NASDAQ and must comply with its applicable rules.
B. Riley FBR and B.
Riley Wealth Management are also subject to the SEC’s Uniform Net Capital Rule, Rule 15c3-1, which may limit our ability
to make withdrawals of capital from our broker-dealer subsidiaries. The Uniform Net Capital Rule sets the minimum level of net
capital a broker-dealer must maintain and also requires that a portion of its assets be relatively liquid. In addition, B. Riley
FBR and B. Riley Wealth Management are subject to certain notification requirements related to withdrawals of excess net capital.
We are also subject
to the USA PATRIOT Act of 2001 (the Patriot Act), which imposes obligations regarding the prevention and detection of money-laundering
activities, including the establishment of customer due diligence and customer verification, and other compliance policies and
procedures. The conduct of research analysts is also the subject of rule-making by the SEC, FINRA and the federal government through
the Sarbanes-Oxley Act. These regulations require certain disclosures by, and restrict the activities of, research analysts and
broker-dealers, among others. Failure to comply with these requirements may result in monetary, regulatory and, in the case of
the USA Patriot Act, criminal penalties.
Our asset management
subsidiaries, B. Riley Capital Management, LLC and B. Riley Wealth Management, are SEC-registered investment advisers, and accordingly
subject to regulation by the SEC. Requirements under the Investment Advisors Act of 1940 include record-keeping, advertising and
operating requirements, and prohibitions on fraudulent activities.
Various regulators,
including the SEC, FINRA and state securities regulators and attorneys general, are conducting both targeted and industry-wide
investigations of certain practices relating to the financial services industry, including marketing, sales practices, valuation
practices, asset managers, and market and compensation arrangements. These investigations, which have been highly publicized, have
involved mutual fund companies, broker-dealers, hedge funds, investors and others.
In addition, the SEC
staff has conducted studies with respect to soft dollar practices in the brokerage and asset management industries and proposed
interpretive guidance regarding the scope of permitted brokerage and research services in connection with soft dollar practices
In July 2010, Congress
enacted Dodd-Frank. Dodd-Frank institutes a wide range of reforms that impact financial services firms and resulted in significant
rule-making. In addition, the legislation mandates multiple studies, which could result in additional legislative or regulatory
action. Certain provisions of Dodd-Frank remain subject to further rulemaking procedures and studies. As a result, we cannot assess
the impact of these new legislative and regulatory changes on our business at the present time.
UOL is subject to
a number of international, federal, state, and local laws and regulations, including, without limitation, those relating to taxation,
bulk email or “spam,” advertising, user privacy and data protection, consumer protection, antitrust, export, and unclaimed
property. In addition, proposed laws and regulations relating to some or all of the foregoing, as well as to other areas affecting
our businesses, are continuously debated and considered for adoption in the U.S. and other countries, and such laws and regulations
could be adopted in the future. For additional information, see “Risk Factors,” which appears in Item 1A of this
Annual Report on Form 10-K.
In the United States,
magicJack is subject to federal regulation under the rules and regulations of the Federal Communications Commission (“FCC”
or the “Commission”) and various state and local regulations. magicJack provides broadband telephone services using
VoIP technology and/or services treated as information services by the FCC. magicJack is also licensed as a Competitive Local Exchange
Carrier (“CLEC”) and is subject to extensive federal and state regulation applicable to CLECs. The FCC has to date
asserted limited statutory jurisdiction and regulatory authority over the operations and offerings of certain providers of broadband
telephone services, including non-interconnected VoIP. FCC regulations may now, or may in the future, be applied to magicJack’s
broadband telephone operations. Other FCC regulations apply to magicJack because it provides international calling capability.
Some of the magicJack’s operations are also subject to regulation by state public utility commissions.
Employees
As of December 31, 2019,
we had 982 full time employees. We are not a party to any collective bargaining agreements. We have never experienced a work stoppage
or strike and believe that relations with our employees are good.
Acquisition of magicJack
On November 9, 2017,
we entered into the magicJack Merger Agreement with B. R. Acquisition Ltd., an Israeli corporation and wholly-owned subsidiary
of ours (“Merger Sub”), pursuant to which Merger Sub would merge with and into magicJack, with magicJack continuing
as the surviving corporation and as an indirect subsidiary of the Company. Pursuant to the terms of the magicJack Merger Agreement,
customary closing conditions were satisfied, and the acquisition was completed on November 14, 2018. Subject to the terms
and conditions of the magicJack Merger Agreement, each outstanding share of magicJack converted into the right to receive $8.71
in cash without interest, representing approximately $143.1 million in aggregate merger consideration.
Acquisition of Wunderlich
On May 17, 2017, we
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 $65.1 million paid to Wunderlich shareholders in connection with the Wunderlich acquisition was comprised of (a) cash in the
amount of $29.7 million; (b) 1,974,812 newly issued shares of our common stock at closing which were valued at $31.5 million for
accounting purposes determined based on the closing market price of our 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 $3.9 million.
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 us for certain representations and warranties in connection with the acquisition.
We believe that the acquisition of Wunderlich will allow us 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. We 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 our common stock in certain future registered offerings of shares of our common stock. In June 2018, Wunderlich
changed its name to B. Riley Wealth Management, Inc.
Acquisition of FBR
On June 1, 2017, we
completed the purchase of all of the outstanding common stock of FBR Capital Markets & Co. (“FBR”), a mid-sized
investment bank with operations primarily in Washington D.C and New York, pursuant to a purchase agreement we entered into with
FBR on February 17, 2017. The aggregate purchase price for the acquisition was $73.5 million in a stock transaction through the
issuance of 4,831,633 shares of our common stock. Upon completion of the acquisition, we integrated and merged the investment banking
operations of B. Riley & Co, LLC. with and into FBR and changed the name of FBR to B. Riley FBR.
Acquisition of Majority Interest in
BR Brand
On October 28,
2019, the Company and the “B. Riley Member”, completed the acquisition of a majority equity interest in BR Brand
as described above under the heading “Recent Developments”.
Available Information
We were incorporated
in Delaware in May 2009. We maintain a website at www.brileyfin.com. The information on our website is not a part of, or
incorporated in, this Annual Report. We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, proxy and information statements, among other reports and filings, with the SEC, and make available, free of charge, on or
through our website, such reports and filings and amendments thereto filed or furnished pursuant to Section 13(a) or 15(d) of
the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the SEC. The public may obtain copies of these reports and filings and any amendments
thereto at the SEC’s Internet site, www.sec.gov.
Item 1A. Risk Factors
Given the nature of
our operations and services we provide, a wide range of factors could materially affect our operations and profitability. Changes
in competitive, market and economic conditions also affect our operations. The risks and uncertainties described below are not
the only risks and uncertainties facing us. Additional risks and uncertainties not presently known or that are currently considered
to be immaterial may also materially and adversely affect our business operations or stock price. If any of the following risks
or uncertainties occurs, our business, financial condition or operating results could materially suffer.
Our revenues and results
of operations are volatile and difficult to predict.
Our revenues and results
of operations fluctuate significantly from quarter to quarter, due to a number of factors. These factors include, but are not
limited to, the following:
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Our
ability to attract new clients and obtain additional business from our existing client
base;
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The
number, size and timing of mergers and acquisition transactions, capital raising transactions
and other strategic advisory services where we act as an adviser on our Auction and Liquidation
and investment banking engagements;
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The
extent to which we acquire assets for resale, or guarantee a minimum return thereon,
and our ability to resell those assets at favorable prices;
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Variability
in the mix of revenues from the Auction and Liquidation and Valuation and Appraisal businesses;
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The
rate of decline we experience from our dial-up and DSL Internet access pay accounts in
our UOL business as customers continue to migrate to broadband access which provides
faster Internet connection and download speeds offered by our competitors;
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The
rate of growth of new service areas;
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The
types of fees we charge clients, or other financial arrangements we enter into with clients;
and
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Changes
in general economic and market conditions.
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We
have limited or no control over some of the factors set forth above and, as a result, may be unable to forecast our revenues accurately.
For example, our investment banking revenues are typically earned upon the successful completion of a transaction, the timing
of which is uncertain and beyond our control. A client’s acquisition transaction may be delayed or terminated because
of a failure to agree upon final terms with the counterparty, failure to obtain necessary regulatory consents or board or stockholder
approvals, failure to secure necessary financing, adverse market conditions or unexpected financial or other problems in the business
of a client or a counterparty. If the parties fail to complete a transaction on which we are advising or an offering in which
we are participating, we will earn little or no revenue from the contemplated transaction.
We rely on projections
of revenues in developing our operating plans for the future and will base our expectations regarding expenses on these projections
and plans. If we inaccurately forecast revenues and/or earnings, or fail to accurately project expenses, “FBR” we may
be unable to adjust our spending in a timely manner to compensate for these inaccuracies and, as a result, may suffer operating
losses and such losses could have a negative impact on our financial condition and results of operations. If, for any reason, we
fail to meet company, investor or analyst projections of revenue, growth or earnings, the market price of the common stock could
decline and you may lose all or part of your investment.
Conditions in
the financial markets and general economic conditions have impacted and may continue to impact our ability to generate business
and revenues, which may cause significant fluctuations in our stock price.
Our business has been
in the past, and we expect it in the future to be, be materially affected by conditions in the financial market and general economic
conditions, such as the level and volatility of interest rates, investor sentiment, the availability and the cost of credit, the
U.S. mortgage market, the U.S. real estate market, volatile energy prices, consumer confidence, unemployment, the adverse effects of events such as outbreaks of contagious
disease (such as the novel coronavirus), and geopolitical
issues. Further, certain aspects of our business are cyclical in nature and changes in the current economic environment may require
us to adjust our sales and marketing practices and react to different business opportunities and modes of competition. If we are
not successful in reacting to changing economic conditions, we may lose business opportunities which could harm our financial condition.
For example, we are more likely to conduct auctions and liquidations in connection with insolvencies and store closures during
periods of economic downturn relative to periods of economic expansion. Conversely, during an economic downturn, financial institutions
that provide asset-based loans typically reduce the number of loans made, which reduces their need for our Valuation and Appraisal
services.
In addition, weakness
or disruption in equity markets and diminished trading volume of securities could adversely impact our sales and trading business
in the future. Any industry-wide declines in the size and number of underwritings and mergers and acquisitions transactions could
also have an adverse effect on our investment banking revenues. Reductions in the trading prices for equity securities tend to
reduce the transaction value of investment banking transactions, such as underwriting and mergers and acquisitions transactions,
which in turn may reduce the fees we earn from these transactions. Market conditions may also affect the level and volatility
of securities prices and the liquidity and value of investments in our funds and proprietary inventory, and we may not be able
to manage our business’s exposure to these market conditions. In addition to these factors, deterioration in the financial
markets or economic conditions could materially affect our investment banking business
in other ways, including the following:
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Our opportunity to act as underwriter or placement agent could be adversely affected by a reduction in the number and size of capital raising transactions or by competing sources of equity.
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The
number and size of mergers and acquisitions transactions or other strategic advisory
services where we act as adviser could be adversely affected by continued uncertainties
in valuations related to asset quality and creditworthiness, volatility in the equity
markets, and diminished access to financing.
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Market
volatility could lead to a decline in the volume of transactions that we execute for
our customers and, therefore, to a decline in the revenue we receive from commissions
and spreads.
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We
may experience losses in securities trading activities, or as a result of write-downs
in the value of securities that we own, as a result of deteriorations in the businesses
or creditworthiness of the issuers of such securities.
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We
may experience losses or write downs in the realizable value of our proprietary investments
due to the inability of companies we invest in to repay their borrowings.
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Our
access to liquidity and the capital markets could be limited, preventing us from making
proprietary investments and restricting our sales and trading businesses.
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We
may incur unexpected costs or losses as a result of the bankruptcy or other failure of
companies for which we have performed investment banking services to honor ongoing obligations
such as indemnification or expense reimbursement agreements.
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Sudden
sharp declines in market values of securities can result in illiquid markets and the
failure of counterparties to perform their obligations, which could make it difficult
for us to sell securities, hedge securities positions, and invest funds under management.
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As
an introducing broker to clearing firms, we are responsible to the clearing firm and
could be held liable for the defaults of our customers, including losses incurred as
the result of a customer’s failure to meet a margin call. When we allow customers
to purchase securities on margin, we are subject to risks inherent in extending credit.
This risk increases when a market is rapidly declining and the value of the collateral
held falls below the amount of a customer’s indebtedness. If a customer’s
account is liquidated as the result of a margin call, we are liable to our clearing firm
for any deficiency.
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Competition
in our investment banking, sales, and trading businesses could intensify as a result
of the increasing pressures on financial services companies and larger firms competing
for transactions and business that historically would have been too small for them to
consider.
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Market
volatility could result in lower prices for securities, which may result in reduced management
fees calculated as a percentage of assets under management.
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Market
declines could increase claims and litigation, including arbitration claims from customers.
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Our
industry could face increased regulation as a result of legislative or regulatory initiatives.
Compliance with such regulation may increase our costs and limit our ability to pursue
business opportunities.
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Government
intervention may not succeed in improving the financial and credit markets and may have
negative consequences for our business.
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It is difficult to
predict how long current financial market and economic conditions will continue, whether they will deteriorate and if they do,
which of our business lines will be adversely affected. If one or more of the foregoing risks occurs, our revenues are likely to
decline and, if we were unable to reduce expenses at the same pace, our profit margins could erode.
Global economic
and political uncertainty, including Brexit, could adversely affect our revenue and results of operations.
As a result of the
international nature of our business, we are subject to the risks arising from adverse changes in global economic and political
conditions. Uncertainty about the effects of current and future economic and political conditions on us, our customers, suppliers
and partners makes it difficult for us to forecast operating results and to make decisions about future investments. Deterioration
in economic conditions in any of the countries in which we do business could result in reductions in sales of our products and
services and could cause slower or impaired collections on accounts receivable, which may adversely impact our liquidity and financial
condition.
On June 23, 2016,
the United Kingdom left the European Union, commonly referred to as “Brexit”. Events related to Brexit are causing
significant political uncertainty in both the United Kingdom and the European Union. The impact of Brexit and the resulting effect
on the political and economic future of the United Kingdom and the European Union is uncertain, and our business may be adversely
affected in ways we do not currently anticipate. Brexit may result in a significant change in the British regulatory environment,
which may likely increase our compliance costs. We may find it more difficult to conduct business in the United Kingdom and the
European Union, as Brexit may result in increased restrictions on the movement of capital, goods and personnel. Depending on developments
with respect to Brexit, we may decide to relocate or otherwise alter our European operations to respond to the new business, legal,
regulatory, tax and trade environments that may result.
As with any political
instability or adverse political developments in or around any of the major countries in which we do business, developments related
to Brexit may materially and adversely affect with customers, suppliers and employees and could harm our business, results of operations
and financial condition.
We focus principally
on specific sectors of the economy in our investment banking operations, and deterioration in the business environment in these
sectors or a decline in the market for securities of companies within these sectors could harm our business.
We focus principally
on five target industries in our investment banking operations: consumer goods, consumer services, defense, industrials and technology.
Volatility in the business environment in these industries or in the market for securities of companies within these industries
could adversely affect our financial results and the market value of our common stock. The business environment for companies in
some of these industries has been subject to high levels of volatility in recent years, and our financial results have consequently
been subject to significant variations from year to year. The market for securities in each of our target industries may also be
subject to industry-specific risks. For example, we have research, investment banking and Principal Investments focused in the
areas of defense. This sector has been subject to U.S. Department of Defense budget cuts as well as by disruptions in the financial
markets and downturns in the general economy. The consumer goods and services sectors are subject to consumer spending trends,
which have been volatile, to mall traffic trends, which have been down, to the availability of credit, and to broader trends such
as the rise of Internet retailers. Emerging markets have driven the growth of certain consumer companies but emerging market economies
are fragile, subject to wide swings in GDP, and subject to changes in foreign currencies. The technology industry has been volatile,
driven by evolving technology trends, by technological obsolescence, by enterprise spending, and by changes in the capital spending
trends of major corporations and government agencies around the world.
Our investment banking
operations focus on various sectors of the economy, and we also depend significantly on private company transactions for sources
of revenues and potential business opportunities. Most of these private company clients are initially funded and controlled by
private equity firms. To the extent that the pace of these private company transactions slows or the average transaction size declines
due to a decrease in private equity financings, difficult market conditions in our target industries or other factors, our business
and results of operations may be harmed.
Underwriting and other
corporate finance transactions, strategic advisory engagements and related sales and trading activities in our target industries
represent a significant portion of our investment banking business. This concentration of activity in our target industries exposes
us to the risk of declines in revenues in the event of downturns in these industries.
Our corporate
finance and strategic advisory engagements are singular in nature and do not generally provide for subsequent engagements.
Our investment banking
clients generally retain us on a short-term, engagement-by-engagement basis in connection with specific corporate finance, merger
and acquisition transactions (often as an advisor in company sale transactions) and other strategic advisory services, rather than
on a recurring basis under long-term contracts. As these transactions are typically singular in nature and our engagements with
these clients may not recur, we must seek new engagements when our current engagements are successfully completed or are terminated.
As a result, high activity levels in any period are not necessarily indicative of continued high levels of activity in any subsequent
period. If we are unable to generate a substantial number of new engagements that generate fees from new or existing clients, our
business, results of operations and financial condition could be adversely affected.
The asset management business
is intensely competitive.
Over the past several
years, the size and number of asset management funds, including hedge funds and mutual funds, has continued to increase. If this
trend continues, it is possible that it will become increasingly difficult for our funds to raise capital. More significantly,
the allocation of increasing amounts of capital to alternative investment strategies by institutional and individual investors
leads to a reduction in the size and duration of pricing inefficiencies. Many alternative investment strategies seek to exploit
these inefficiencies and, in certain industries, this drives prices for investments higher, in either case increasing the difficulty
of achieving targeted returns. In addition, if interest rates were to rise or there were to be a prolonged bull market in equities,
the attractiveness of our funds relative to investments in other investment products could decrease. Competition is based on a
variety of factors, including:
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investment
performance;
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investor
perception of the drive, focus and alignment of interest of an investment manager;
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quality
of service provided to and duration of relationship with investors;
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business
reputation; and
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level
of fees and expenses charged for services.
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We compete in the
asset management business with a large number of investment management firms, private equity fund sponsors, hedge fund sponsors
and other financial institutions. A number of factors serve to increase our competitive risks, as follows:
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investors
may develop concerns that we will allow a fund to grow to the detriment of its performance;
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some
of our competitors have greater capital, lower targeted returns or greater sector or
investment strategy specific expertise than we do, which creates competitive disadvantages
with respect to investment opportunities;
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some
of our competitors may perceive risk differently than we do which could allow them either
to outbid us for investments in particular sectors or, generally, to consider a wider
variety of investments;
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there
are relatively few barriers to entry impeding new asset management firms, and the successful
efforts of new entrants into our various lines of business, including former “star”
portfolio managers at large diversified financial institutions as well as such institutions
themselves, will continue to result in increased competition; and
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other
industry participants in the asset management business continuously seek to recruit our
best and brightest investment professionals away from us.
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These and other factors
could reduce our earnings and revenues and adversely affect our business. In addition, if we are forced to compete with other alternative
asset managers on the basis of price, we may not be able to maintain our current base management and incentive fee structures.
We have historically competed primarily on the performance of our funds, and not on the level of our fees relative to those of
our competitors. However, there is a risk that fees in the alternative investment management industry will decline, without regard
to the historical performance of a manager, including our managers. Fee reductions on our existing or future funds, without corresponding
decreases in our cost structure, would adversely affect our revenues and distributable earnings.
Poor investment
performance may decrease assets under management and reduce revenues from and the profitability of our asset management business.
Revenues from our
asset management business are primarily derived from asset management fees. Asset management fees are generally comprised of management
and incentive fees. Management fees are typically based on assets under management, and incentive fees are earned on a quarterly
or annual basis only if the return on our managed accounts exceeds a certain threshold return, or “highwater mark,”
for each investor. We will not earn incentive fee income during a particular period, even when a fund had positive returns in that
period, if we do not generate cumulative performance that surpasses a highwater mark. If a fund experiences losses, we will not
earn incentive fees with regard to investors in that fund until its returns exceed the relevant highwater mark.
In addition, investment
performance is one of the most important factors in retaining existing investors and competing for new asset management business.
Investment performance may be poor as a result of the current or future difficult market or economic conditions, including changes
in interest rates or inflation, terrorism or political uncertainty, our investment style, the particular investments that we make,
and other factors. Poor investment performance may result in a decline in our revenues and income by causing (i) the net asset
value of the assets under our management to decrease, which would result in lower management fees to us, (ii) lower investment
returns, resulting in a reduction of incentive fee income to us, and (iii) investor redemptions, which would result in lower fees
to us because we would have fewer assets under management.
To the extent our
future investment performance is perceived to be poor in either relative or absolute terms, the revenues and profitability of our
asset management business will likely be reduced and our ability to grow existing funds and raise new funds in the future will
likely be impaired.
The historical returns
of our funds may not be indicative of the future results of our funds.
The historical returns
of our funds should not be considered indicative of the future results that should be expected from such funds or from any future
funds we may raise. Our rates of returns reflect unrealized gains, as of the applicable measurement date, which may never be realized
due to changes in market and other conditions not in our control that may adversely affect the ultimate value realized from the
investments in a fund. The returns of our funds may have also benefited from investment opportunities and general market conditions
that may not repeat themselves, and there can be no assurance that our current or future funds will be able to avail themselves
of profitable investment opportunities. Furthermore, the historical and potential future returns of the funds we manage also may
not necessarily bear any relationship to potential returns on our common stock.
We are subject to risks
in using custodians.
Our asset management
subsidiary and its managed funds depend on the services of custodians to settle and report securities transactions. In the event
of the insolvency of a custodian, our funds might not be able to recover equivalent assets in whole or in part as they will rank
among the custodian’s unsecured creditors in relation to assets which the custodian borrows, lends or otherwise uses. In
addition, cash held by our funds with the custodian will not be segregated from the custodian’s own cash, and the funds will
therefore rank as unsecured creditors in relation thereto.
We may suffer losses if
our reputation is harmed.
Our ability to attract
and retain customers and employees may be diminished to the extent our reputation is damaged. If we fail, or are perceived to fail,
to address various issues that may give rise to reputational risk, we could harm our business prospects. These issues include,
but are not limited to, appropriately dealing with market dynamics, potential conflicts of interest, legal and regulatory requirements,
ethical issues, customer privacy, record-keeping, sales and trading practices, and the proper identification of the legal, reputational,
credit, liquidity and market risks inherent in our products and services. Failure to appropriately address these issues could give
rise to loss of existing or future business, financial loss, and legal or regulatory liability, including complaints, claims and
enforcement proceedings against us, which could, in turn, subject us to fines, judgments and other penalties. In addition, our
Capital Markets operations depend to a large extent on our relationships with our clients and reputation for integrity and high-caliber
professional services to attract and retain clients. As a result, if a client is not satisfied with our services, it may be more
damaging in our business than in other businesses.
Our Capital
Markets operations are highly dependent on communications, information and other systems and third parties, and any systems failures
could significantly disrupt our Capital Markets business.
Our data and transaction
processing, custody, financial, accounting and other technology and operating systems are essential to our Capital Markets operations.
A system malfunction (due to hardware failure, capacity overload, security incident, data corruption, etc.) or mistake made relating
to the processing of transactions could result in financial loss, liability to clients, regulatory intervention, reputational damage
and constraints on our ability to grow. We outsource a substantial portion of our critical data processing activities, including
trade processing and back office data processing. We also contract with third parties for market data and other services. In the
event that any of these service providers fails to adequately perform such services or the relationship between that service provider
and us is terminated, we may experience a significant disruption in our operations, including our ability to timely and accurately
process transactions or maintain complete and accurate records of those transactions.
Adapting or developing
our technology systems to meet new regulatory requirements, client needs, expansion and industry demands also is critical for our
business. Introduction of new technologies present new challenges on a regular basis. We have an ongoing need to upgrade and improve
our various technology systems, including our data and transaction processing, financial, accounting, risk management and trading
systems. This need could present operational issues or require significant capital spending. It also may require us to make additional
investments in technology systems and may require us to reevaluate the current value and/or expected useful lives of our technology
systems, which could negatively impact our results of operations.
Secure processing, storage and transmission of confidential
and other information in our internal and outsourced computer systems and networks also is critically important to our business.
We take protective measures and endeavor to modify them as circumstances warrant. However, our computer systems and software are
subject to unauthorized access, computer viruses or other malicious code, inadvertent, erroneous or intercepted transmission of
information (including by e-mail), and other events that have had an information security impact. If one or more of such events
occur, this potentially could jeopardize our or our clients’ or counterparties’ confidential and other information
processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions
in our, our clients’, our counterparties’ or third parties’ operations. We may be required to expend significant
additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and
we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance
maintained by us.
A disruption in the
infrastructure that supports our business due to fire, natural disaster, health emergency (for example, a disease pandemic), power
or communication failure, act of terrorism or war may affect our ability to service and interact with our clients. If we are not
able to implement contingency plans effectively, any such disruption could harm our results of operations.
The growth of
electronic trading and the introduction of new technology in the markets in which our market-making business operates may adversely
affect this business and may increase competition.
The continued growth
of electronic trading and the introduction of new technologies is changing our market-making business and presenting new challenges.
Securities, futures and options transactions are increasingly occurring electronically, through alternative trading systems. We
expect that the trend toward alternative trading systems will continue to accelerate. This acceleration could further increase
program trading, increase the speed of transactions and decrease our ability to participate in transactions as principal, which
would reduce the profitability of our market-making business. Some of these alternative trading systems compete with our market-making
business and with our algorithmic trading platform, and we may experience continued competitive pressures in these and other areas.
Significant resources have been invested in the development of our electronic trading systems, which includes our at-the-market
business, but there is no assurance that the revenues generated by these systems will yield an adequate return on the investment,
particularly given the increased program trading and increased percentage of stocks trading off of the historically manual trading
markets.
Pricing and other competitive
pressures may impair the revenues of our sales and trading business.
We derive a significant
portion of our revenues for our investment banking operations from our sales and trading business. There has been intense price
competition and trading volume reduction in this business in recent years. In particular, the ability to execute trades electronically
and through alternative trading systems has increased the downward pressure on per share trading commissions and spreads. We expect
these trends toward alternative trading systems and downward pricing pressure in the business to continue. We experience competitive
pressures in these and other areas in the future as some of our competitors seek to obtain market share by competing on the basis
of price or by using their own capital to facilitate client trading activities. In addition, we face pressure from our larger
competitors, many of whom are better able to offer a broader range of complementary products and services to clients in order
to win their trading business. These larger competitors may also be better able to respond to changes in the research, brokerage
and investment banking industries, to compete for skilled professionals, to finance acquisitions, to fund internal growth and
to compete for market share generally. As we are committed to maintaining and improving our comprehensive research coverage in
our target sectors to support our sales and trading business, we may be required to make substantial investments in our research
capabilities to remain competitive. If we are unable to compete effectively in these areas, the revenues of our sales and trading
business may decline, and our business, results of operations and financial condition may be harmed.
Some of our large
institutional sales and trading clients in terms of brokerage revenues have entered into arrangements with us and other investment
banking firms under which they separate payments for research products or services from trading commissions for sales and trading
services, and pay for research directly in cash, instead of compensating the research providers through trading commissions (referred
to as “soft dollar” practices). In addition, we have entered into certain commission sharing arrangements in which
institutional clients execute trades with a limited number of brokers and instruct those brokers to allocate a portion of the commission
directly to us or other broker-dealers for research or to an independent research provider. If more of such arrangements are reached
between our clients and us, or if similar practices are adopted by more firms in the investment banking industry, we expect that
would increase the competitive pressures on trading commissions and spreads and reduce the value our clients place on high quality
research. Conversely, if we are unable to make similar arrangements with other investment managers that insist on separating trading
commissions from research products, volumes and trading commissions in our sales and trading business also would likely decrease.
Larger and more
frequent capital commitments in our trading and underwriting businesses increase the potential for significant losses.
Certain financial
services firms make larger and more frequent commitments of capital in many of their activities. For example, in order to win business,
some investment banks increasingly commit to purchase large blocks of stock from publicly traded issuers or significant stockholders,
instead of the more traditional marketed underwriting process in which marketing is typically completed before an investment bank
commits to purchase securities for resale. We have participated in this activity and expect to continue to do so and, as a result,
we are subject to increased risk. Conversely, if we do not have sufficient regulatory capital to so participate, our business may
suffer. Furthermore, we may suffer losses as a result of the positions taken in these transactions even when economic and market
conditions are generally favorable for others in the industry.
We may increasingly
commit our own capital as part of our trading business to facilitate client sales and trading activities. The number and size of
these transactions may adversely affect our results of operations in a given period. We may also incur significant losses from
our sales and trading activities due to market fluctuations and volatility in our results of operations. To the extent that we
own assets, i.e., have long positions, in any of those markets, a downturn in the value of those assets or in those markets could
result in losses. Conversely, to the extent that we have sold assets we do not own, i.e., have short positions, in any of those
markets, an upturn in those markets could expose us to potentially large losses as we attempt to cover our short positions by acquiring
assets in a rising market.
We have made
and may make Principal Investments in relatively high-risk, illiquid assets that often have significantly leveraged capital structures,
and we may fail to realize any profits from these activities for a considerable period of time or lose some or all of the principal
amount we invest in these activities.
From time to time,
we use our capital, including on a leveraged basis, in proprietary investments in both private company and public company securities
that may be illiquid and volatile. The equity securities of a privately-held entity in which we make a proprietary investment are
likely to be restricted as to resale and are otherwise typically highly illiquid. In the case of fund or similar investments, our
investments may be illiquid until such investment vehicles are liquidated. We expect that there will be restrictions on our ability
to resell the securities that we acquire for a period of up to one year after we acquire those securities. Thereafter, a public
market sale may be subject to volume limitations or dependent upon securing a registration statement for an initial and potentially
secondary public offering of the securities. We may make Principal Investments that are significant relative to the overall capitalization
of the investee company and resales of significant amounts of these securities might be subject to significant limitations and
adversely affect the market and the sales price for the securities in which we invest. In addition, our Principal Investments may
involve entities or businesses with capital structures that have significant leverage. The large amount of borrowing in the leveraged
capital structure increases the risk of losses due to factors such as rising interest rates, downturns in the economy or deteriorations
in the condition of the investment or its industry. In the event of defaults under borrowings, the assets being financed would
be at risk of foreclosure, and we could lose our entire investment.
Even if we make an
appropriate investment decision based on the intrinsic value of an enterprise, we cannot assure you that general market conditions
will not cause the market value of our investments to decline. For example, an increase in interest rates, a general decline in
the stock markets, or other market and industry conditions adverse to companies of the type in which we invest and intend to invest
could result in a decline in the value of our investments or a total loss of our investment.
In addition, some
of these investments are, or may in the future be, in industries or sectors which are unstable, in distress or undergoing some
uncertainty. Further, the companies in which we invest may rely on new or developing technologies or novel business models, or
concentrate on markets which are or may be disproportionately impacted by pressures in the financial services and/or mortgage and
real estate sectors, have not yet developed and which may never develop sufficiently to support successful operations, or their
existing business operations may deteriorate or may not expand or perform as projected. Such investments may be subject to rapid
changes in value caused by sudden company-specific or industry-wide developments. Contributing capital to these investments is
risky, and we may lose some or all of the principal amount of our investments. There are no regularly quoted market prices for
a number of the investments that we make. The value of our investments is determined using fair value methodologies described in
valuation policies, which may consider, among other things, the nature of the investment, the expected cash flows from the investment,
bid or ask prices provided by third parties for the investment and the trading price of recent sales of securities (in the case
of publicly-traded securities), restrictions on transfer and other recognized valuation methodologies. The methodologies we use
in valuing individual investments are based on estimates and assumptions specific to the particular investments. Therefore, the
value of our investments does not necessarily reflect the prices that would actually be obtained by us when such investments are
sold. Realizations, if any, at values significantly lower than the values at which investments have been reflected on our balance
sheet would result in loses of potential incentive income and Principal Investments.
We
are exposed to credit risk from a variety of our activities and we may not be able to fully realize the value of the collateral
securing certain of our loans.
We are generally exposed
to the risk that third parties that owe us money, securities or other assets will fail to meet their obligations to us due to numerous
causes, including bankruptcy, lack of liquidity, or operational failure, among others. Additionally, when we guarantee or backstop
the obligations of third parties, we are exposed to the risk that our guarantee or backstop may be called by the holder following
a default by the primary obligor, which could cause us to incur significant losses, and, when our obligations are secured, expose
us to the risk that the holder may seek to foreclose on collateral pledged by us.
We incur credit risk
through loans, lines of credit, guarantees and backstop commitments issued to or on behalf of businesses and individuals, and other
loans collateralized by a variety of assets, including securities. Our credit risk and credit losses can increase if our loans
or investments are concentrated among borrowers or issuers engaged in the same or similar activities, industries, or geographies,
or to borrowers or issuers who as a group may be uniquely or disproportionately affected by economic or market conditions. The
deterioration of an individually large exposure, for example due to natural disasters, health emergencies or pandemics, acts of
terrorism, severe weather events or other adverse economic events, could lead to additional loan loss provisions and/or charges-offs,
or credit impairment of our investments, and subsequently have a material impact on our net income and regulatory capital.
The
amount and duration of our credit exposures have been increasing over the past year, as have the breadth and size of the entities
to which we have credit exposures.
We
permit our clients to purchase securities on margin. During periods of steep declines in securities prices, the value of the collateral
securing client margin loans may fall below the amount of the purchaser’s indebtedness. If clients are unable to provide
additional collateral for these margin loans, we may incur losses on those margin transactions. This may cause us to incur additional
expenses defending or pursuing claims or litigation related to counterparty or client defaults.
Although a substantial
amount of our loans to counterparties are protected by holding security interests in the assets or equity interests of the borrower,
we may not be able to fully realize the value of the collateral securing our loans due to one or more of the
following factors:
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Our
loans may be unsecured, therefore our liens on the collateral, if any, are subordinated
to those of the senior secured debt of the borrower, if any. As a result, we may not
be able to control remedies with respect to the collateral.
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The
collateral may not be valuable enough to satisfy all of the obligations under our secured
loan, particularly after giving effect to the repayment of secured debt of the borrower
that ranks senior to our loan.
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Bankruptcy
laws may limit our ability to realize value from the collateral and may delay the realization
process.
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Our
rights in the collateral may be adversely affected by the failure to perfect security
interests in the collateral.
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The
need to obtain regulatory and contractual consents could impair or impede how effectively
the collateral would be liquidated and could affect the value received.
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Some
or all of the collateral may be illiquid and may have no readily ascertainable market
value. The liquidity and value of the collateral could be impaired as a result of changing
economic conditions, competition, and other factors, including the availability of suitable
buyers.
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We
may experience write downs of our investments and other losses related to the valuation of our investments
and volatile and illiquid market conditions.
In our proprietary
investment activities, our concentrated holdings, illiquidity and market volatility may make it difficult to value certain of our
investment securities. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values
of these securities in future periods. In addition, at the time of any sales and settlements of these securities, the price we
ultimately realize will depend on the demand and liquidity in the market at that time and may be materially lower than their current
fair value. Any of these factors could require us to take write downs in the value of our investment and securities portfolio,
which may have an adverse effect on our results of operations in future periods.
Our underwriting and market
making activities may place our capital at risk.
We may incur losses
and be subject to reputational harm to the extent that, for any reason, we are unable to sell securities we purchased as an underwriter
at the anticipated price levels. As an underwriter, we also are subject to heightened standards regarding liability for material
misstatements or omissions in prospectuses and other offering documents relating to offerings we underwrite. Further, even though
underwriting agreements with issuing companies typically include a right to indemnification in favor of the underwriter for these
offerings to cover potential liability from any material misstatements or omissions, indemnification may be unavailable or insufficient
in certain circumstances, for example if the issuing company has become insolvent. As a market maker, we may own large positions
in specific securities, and these undiversified holdings concentrate the risk of market fluctuations and may result in greater
losses than would be the case if our holdings were more diversified.
Our businesses
may be adversely affected by the disruptions in the credit markets, including reduced access to credit and liquidity and higher
costs of obtaining credit.
In the event existing
internal and external financial resources do not satisfy our needs, we would have to seek additional outside financing. The availability
of outside financing will depend on a variety of factors, such as our financial condition and results of operations, the availability
of acceptable collateral, market conditions, the general availability of credit, the volume of trading activities, and the overall
availability of credit to the financial services industry.
Widening credit spreads,
as well as significant declines in the availability of credit, could adversely affect our ability to borrow on an unsecured basis.
Disruptions in the credit markets could make it more difficult and more expensive to obtain funding for our businesses. If our
available funding is limited or we are forced to fund our operations at a higher cost, these conditions may require us to curtail
our business activities and increase our cost of funding, both of which could reduce our profitability, particularly in our businesses
that involve investing and taking principal positions.
Liquidity, or ready
access to funds, is essential to financial services firms, including ours. Failures of financial institutions have often been attributable
in large part to insufficient liquidity. Liquidity is of particular importance to our sales and trading business, and perceived
liquidity issues may affect the willingness of our clients and counterparties to engage in sales and trading transactions with
us. Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption
or an operational problem that affects our sales and trading clients, third parties or us. Further, our ability to sell assets
may be impaired if other market participants are seeking to sell similar assets at the same time.
Our clients engaging
us with respect to mergers and acquisitions often rely on access to the secured and unsecured credit markets to finance their transactions.
The lack of available credit and the increased cost of credit could adversely affect the size, volume and timing of our clients’
merger and acquisition transactions-particularly large transactions-and adversely affect our investment banking business and revenues.
We have experienced losses
and may not achieve or maintain profitability.
Our profitability in
each reporting period is impacted by the number and size of retail liquidation and Capital Markets engagements we perform on a
quarterly or annual basis. It is possible that we will experience losses with respect to our current operations as we continue
to expand our operations. In addition, we expect that our operating expenses will increase to the extent that we grow our business.
We may not be able to generate sufficient revenues to maintain profitability.
Because of their
significant stock ownership, some of our existing stockholders will be able to exert control over us and our significant corporate
decisions.
Our
executive officers, directors and their affiliates own or control, in the aggregate, approximately 24.3% of our outstanding common
stock as of December 31, 2019. In particular, our Chairman and Co-Chief Executive Officer, Bryant R. Riley, owns or controls,
in the aggregate, 4,717,755 shares of our common stock or 17.5% of our outstanding common stock as of December 31, 2019.
These stockholders are able to exercise influence over matters requiring stockholder approval, such as the election of directors
and the approval of significant corporate transactions, including transactions involving an actual or potential change of control
of the company or other transactions that non-controlling stockholders may not deem to be in their best interests. This concentration
of ownership may harm the market price of our common stock by, among other things:
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delaying,
deferring, or preventing a change in control of our company;
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impeding
a merger, consolidation, takeover, or other business combination involving our company;
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causing
us to enter into transactions or agreements that are not in the best interests of all
stockholders; or
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discouraging
a potential acquirer from making a tender offer or otherwise attempting to obtain control
of our company.
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We
may incur losses as a result of “guarantee” based engagements that we enter into in connection with our Auction and
Liquidation solutions business.
In many instances, in
order to secure an engagement, we are required to bid for that engagement by guaranteeing to the client a minimum amount that such
client will receive from the sale of inventory or assets. Our bid is based on a variety of factors, including: our experience,
expertise, perceived value added by engagement, valuation of the inventory or assets and the prices we believe potential buyers
would be willing to pay for such inventory or assets. An inaccurate estimate of any of the above or inaccurate valuation of the
assets or inventory could result in us submitting a bid that exceeds the realizable proceeds from any engagement. If the liquidation
proceeds, net of direct operating expenses, are less than the amount we guaranteed in our bid, we will incur a loss. Therefore,
in the event that the proceeds, net of direct operating expenses, from an engagement are less than the bid, the value of the assets
or inventory decline in value prior to the disposition or liquidation, or the assets are overvalued for any reason, we may suffer
a loss and our financial condition and results of operations could be adversely affected.
Losses due to
any auction or liquidation engagement may cause us to become unable to make payments due to our creditors and may cause us to default
on our debt obligations.
We have three engagement
structures for our Auction and Liquidation services: (i) a “fee” based structure under which we are compensated for
our role in an engagement on a commission basis, (ii) purchase on an outright basis (and take title to) the assets or inventory
of the client, and (iii) “guarantee” to the client that a certain amount will be realized by the client upon the sale
of the assets or inventory based on contractually defined terms in the auction or liquidation contract. We bear the risk of loss
under the purchase and guarantee structures of Auction and Liquidation contracts. If the amount realized from the sale or disposition
of assets, net of direct operating expenses, does not equal or exceed the purchase price (in purchase transaction), we will recognize
a loss on the engagement, or should the amount realized, net of direct operating expenses, not equal or exceed the “guarantee,”
we are still required to pay the guaranteed amount to the client.
We could incur
losses in connection with outright purchase transactions in which we engage as part of our Auction and Liquidation solutions business.
When we conduct an
asset disposition or liquidation on an outright purchase basis, we purchase from the client the assets or inventory to be sold
or liquidated and therefore, we hold title to any assets or inventory that we are not able to sell. In other situations, we may
acquire assets from our clients if we believe that we can identify a potential buyer and sell the assets at a premium to the price
paid. We store these unsold or acquired assets and inventory until they can be sold or, alternatively, transported to the site
of a liquidation of comparable assets or inventory that we are conducting. If we are forced to sell these assets for less than
we paid, or are required to transport and store assets multiple times, the related expenses could have a material adverse effect
on our results of operations.
We depend on
financial institutions as primary clients for our Valuation and Appraisal business. Consequently, the loss of any financial institutions
as clients may have an adverse impact on our business.
A majority of the
revenue from our Valuation and Appraisal business is derived from engagements by financial institutions. As a result, any loss
of financial institutions as clients of our valuation and advisory services, whether due to changing preferences in service providers,
failures of financial institutions or mergers and consolidations within the finance industry, could significantly reduce the number
of existing, repeat and potential clients, thereby adversely affecting our revenues. In addition, any larger financial institutions
that result from mergers or consolidations in the financial services industry could have greater leverage in negotiating terms
of engagements with us, or could decide to internally perform some or all of the Valuation and Appraisal services which we currently
provide to one of the constituent institutions involved in the merger or consolidation or which we could provide in the future.
Any of these developments could have a material adverse effect on our Valuation and Appraisal business.
We may face
liability or harm to our reputation as a result of a claim that we provided an inaccurate appraisal or valuation and our insurance
coverage may not be sufficient to cover the liability.
We could face liability
in connection with a claim by a client that we provided an inaccurate appraisal or valuation on which the client relied. Any claim
of this type, whether with or without merit, could result in costly litigation, which could divert management’s attention
and company resources and harm our reputation. Furthermore, if we are found to be liable, we may be required to pay damages. While
our appraisals and valuations are typically provided only for the benefit of our clients, if a third party relies on an appraisal
or valuation and suffers harm as a result, we may become subject to a legal claim, even if the claim is without merit. We carry
insurance for liability resulting from errors or omissions in connection with our appraisals and valuations; however, the coverage
may not be sufficient if we are found to be liable in connection with a claim by a client or third party.
We could be forced to
mark down the value of certain assets acquired in connection with outright purchase transactions.
In most instances,
inventory is reported on the balance sheet at its historical cost; however, according to U.S. Generally Accepted Accounting Principles,
inventory whose historical cost exceeds its market value should be valued conservatively, which dictates a lower value should apply.
Accordingly, should the replacement cost (due to technological obsolescence or otherwise), or the net realizable value of any inventory
we hold be less than the cost paid to acquire such inventory (purchase price), we will be required to “mark down” the
value of such inventory held. If the value of any inventory held on our balance sheet is required to be written down, such write
down could have a material adverse effect on our financial position and results of operations.
We operate in
highly competitive industries. Some of our competitors may have certain competitive advantages, which may cause us to be unable
to effectively compete with or gain market share from our competitors.
We face competition
with respect to all of our service areas. The level of competition depends on the particular service area and, in the case of our
asset and liquidation services, the category of assets being liquidated or appraised. We compete with other companies and investment
banks to help clients with their corporate finance and capital needs. In addition, we compete with companies and online services
in the bidding for assets and inventory to be liquidated. The demand for online solutions continues to grow and our online competitors
include other e-commerce providers, auction websites such as eBay, as well as government agencies and traditional liquidators and
auctioneers that have created websites to further enhance their product offerings and more efficiently liquidate assets. We expect
the market to become even more competitive as the demand for such services continues to increase and traditional and online liquidators
and auctioneers continue to develop online and offline services for disposition, redeployment and remarketing of wholesale surplus
and salvage assets. In addition, manufacturers, retailers and government agencies may decide to create their own websites to sell
their own surplus assets and inventory and those of third parties.
We also compete with
other providers of valuation and advisory services. Competitive pressures within the Valuation and Appraisal services market, including
a decrease in the number of engagements and/or a decrease in the fees which can be charged for these services, could affect revenues
from our Valuation and Appraisal services as well as our ability to engage new or repeat clients. We believe that given the relatively
low barriers to entry in the Valuation and Appraisal services market, this market may become more competitive as the demand for
such services increases.
Some of our competitors
may be able to devote greater financial resources to marketing and promotional campaigns, secure merchandise from sellers on more
favorable terms, adopt more aggressive pricing or inventory availability policies and devote more resources to website and systems
development than we are able to do. Any inability on our part to effectively compete could have a material adverse effect on our
financial condition, growth potential and results of operations.
We compete with specialized
investment banks to provide financial and investment banking services to small and middle-market companies. Middle-market investment
banks provide access to capital and strategic advice to small and middle-market companies in our target industries. We compete
with those investment banks on the basis of a number of factors, including client relationships, reputation, the abilities of our
professionals, transaction execution, innovation, price, market focus and the relative quality of our products and services. We
have experienced intense competition over obtaining advisory mandates in recent years, and we may experience pricing pressures
in our investment banking business in the future as some of our competitors seek to obtain increased market share by reducing fees.
Competition in the middle-market may further intensify if larger Wall Street investment banks expand their focus to this sector
of the market. Increased competition could reduce our market share from investment banking services and our ability to generate
fees at historical levels.
We also face increased
competition due to a trend toward consolidation. In recent years, there has been substantial consolidation and convergence among
companies in the financial services industry. This trend was amplified in connection with the unprecedented disruption and volatility
in the financial markets during the past several years, and, as a result, a number of financial services companies have merged,
been acquired or have fundamentally changed their respective business models. Many of these firms may have the ability to support
investment banking, including financial advisory services, with commercial banking, insurance and other financial services in an
effort to gain market share, which could result in pricing pressure in our businesses.
UOL competes with
numerous providers of broadband, mobile broadband and DSL services, as well as other dial-up Internet access providers, many of
whom are large and have significantly more financial and marketing resources. The principal competitors for UOL’s mobile
broadband and DSL services include, among others, local exchange carriers, wireless and satellite service providers, and cable
service providers.
magicJack
competes with the traditional telephone service providers, which provide telephone service using the public switched telephone
network. Certain of these traditional providers have also added, or are planning to add, broadband telephone services to their
existing telephone and broadband offerings. We also face, or expect to face, competition from cable companies, which offer broadband
telephone services to their existing cable television and broadband offerings. Further, wireless providers offer services that
some customers may prefer over wireline-based service. In the future, as wireless companies offer more minutes at lower prices,
their services may become more attractive to customers as a replacement for broadband or wireline-based phone service. We face
competition on magicJack device sales from manufacturers of smart phones, tablets and other handheld wireless devices. Also, we
compete against established alternative voice communication providers, and may face competition from other large, well-capitalized
Internet companies. In addition, we compete with independent broadband telephone service providers.
Our
brand investment portfolio competes with companies that own other brands and trademarks, as these companies could enter into similar
licensing arrangements with retailers and wholesalers in the United States and internationally. These arrangements could be with
our existing retail and wholesale partners, thereby competing with us for consumer attention and limited floor or rack space in
the same stores in which our branded products are sold, and vying with us for the time and resources of the retailers and wholesale
licensees that manufacture and distribute our products. These companies may be able to respond more quickly to changes in retailer,
wholesaler and consumer preferences and devote greater resources to brand acquisition, development and marketing.
If we are unable to attract
and retain qualified personnel, we may not be able to compete successfully in our industry.
Our future success
depends to a significant degree upon the continued contributions of senior management and the ability to attract and retain other
highly qualified management personnel. We face competition for management from other companies and organizations; therefore, we
may not be able to retain our existing personnel or fill new positions or vacancies created by expansion or turnover at existing
compensation levels. Although we have entered into employment agreements with key members of the senior management team, there
can be no assurances such key individuals will remain with us. The loss of any of our executive officers or other key management
personnel would disrupt our operations and divert the time and attention of our remaining officers and management personnel which
could have an adverse effect on our results of operations and potential for growth.
We also face competition
for highly skilled employees with experience in our industry, which requires a unique knowledge base. We may be unable to recruit
or retain other existing technical, sales and client support personnel that are critical to our ability to execute our business
plan.
We frequently
use borrowings under credit facilities in connection with our guaranty engagements, in which we guarantee a minimum recovery to
the client, and outright purchase transactions.
In engagements where
we operate on a guaranty or purchase basis, we are typically required to make an upfront payment to the client. If the upfront
payment is less than 100% of the guarantee or the purchase price in a “purchase” transaction, we may be required to
make successive cash payments until the guarantee is met or we may issue a letter of credit in favor of the client. Depending on
the size and structure of the engagement, we may borrow under our credit facilities and may be required to issue a letter of credit
in favor of the client for these additional amounts. If we lose any availability under our credit facilities, are unable to borrow
under credit facilities and/or issue letters of credit in favor of clients, or borrow under credit facilities and/or issue letters
of credit on commercially reasonable terms, we may be unable to pursue large liquidation and disposition engagements, engage in
multiple concurrent engagements, pursue new engagements or expand our operations. We are required to obtain approval from the lenders
under our existing credit facilities prior to making any borrowings thereunder in connection with a particular engagement. Any
inability to borrow under our credit facilities, or enter into one or more other credit facilities on commercially reasonable terms
may have a material adverse effect on our financial condition, results of operations and growth.
Defaults under our credit
agreements could have an adverse impact on our ability to finance potential engagements.
The terms of our credit
agreements contain a number of events of default. Should we default under any of our credit agreements in the future, lenders may
take any or all remedial actions set forth in such credit agreement, including, but not limited to, accelerating payment and/or
charging us a default rate of interest on all outstanding amounts, refusing to make any further advances or issue letters of credit,
or terminating the line of credit. As a result of our reliance on lines of credit and letters of credit, any default under a credit
agreement, or remedial actions pursued by lenders following any default under a credit agreement, may require us to immediately
repay all outstanding amounts, which may preclude us from pursuing new liquidation and disposition engagements and may increase
our cost of capital, each of which may have a material adverse effect on our financial condition and results of operations.
If we cannot
meet our future capital requirements, we may be unable to develop and enhance our services, take advantage of business opportunities
and respond to competitive pressures.
We may need to raise
additional funds in the future to grow our business internally, invest in new businesses, expand through acquisitions, enhance
our current services or respond to changes in our target markets. If we raise additional capital through the sale of equity or
equity derivative securities, the issuance of these securities could result in dilution to our existing stockholders. If additional
funds are raised through the issuance of debt securities, the terms of that debt could impose additional restrictions on our operations
or harm our financial condition. Additional financing may be unavailable on acceptable terms.
We are subject
to net capital and other regulatory capital requirements; failure to comply with these rules would significantly harm our business.
B. Riley FBR, our
broker-dealer subsidiary, is subject to the net capital requirements of the SEC, FINRA, and various self-regulatory organizations
of which it is a member. These requirements typically specify the minimum level of net capital a broker-dealer must maintain and
also mandate that a significant part of its assets be kept in relatively liquid form. Failure to maintain the required net capital
may subject a firm to limitation of its activities, including suspension or revocation of its registration by the SEC and suspension
or expulsion by FINRA and other regulatory bodies, and ultimately may require its liquidation. Failure to comply
with the net capital rules could have material and adverse consequences, such as:
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limiting
our operations that require intensive use of capital, such as underwriting or trading
activities; or
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restricting
us from withdrawing capital from our subsidiaries, when our broker-dealer subsidiary
has more than the minimum amount of required capital. This, in turn, could limit our
ability to implement our business and growth strategies, pay interest on and repay the
principal of our debt and/or repurchase our shares.
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addition, a change in the net capital rules or the imposition of new rules affecting the scope, coverage, calculation, or amount
of net capital requirements, or a significant operating loss or any large charge against net capital, could have similar
adverse effects.
Furthermore, B. Riley
FBR is subject to laws that authorize regulatory bodies to block or reduce the flow of funds from it to B. Riley Financial, Inc.
As a holding company, B. Riley Financial, Inc. depends on dividends, distributions and other payments from its subsidiaries to
fund dividend payments, if any, and to fund all payments on its obligations, including debt obligations. As a result, regulatory
actions could impede access to funds that B. Riley Financial, Inc. needs to make payments on obligations, including debt obligations,
or dividend payments. In addition, because B. Riley Financial, Inc. holds equity interests in the firm’s subsidiaries, its
rights as an equity holder to the assets of these subsidiaries may not materialize, if at all, until the claims of the creditors
of these subsidiaries are first satisfied.
We may incur losses as
a result of ineffective risk management processes and strategies.
We seek to monitor and
control our risk exposure through operational and compliance reporting systems, internal controls, management review processes
and other mechanisms. Our investing and trading processes seek to balance our ability to profit from investment and trading positions
with our exposure to potential losses. While we employ limits and other risk mitigation techniques, those techniques and the judgments
that accompany their application cannot anticipate economic and financial outcomes or the specifics and timing of such outcomes.
Thus, we may, in the course of our investment and trading activities, incur losses, which may be significant.
In addition, we are
investing our own capital in our funds and funds of funds as well as principal investing activities, and limitations on our ability
to withdraw some or all of our investments in these funds or liquidate our investment positions, whether for legal, reputational,
illiquidity or other reasons, may make it more difficult for us to control the risk exposures relating to these investments.
Our risk management policies
and procedures may leave us exposed to unidentified or unanticipated risks.
Our risk management
strategies and techniques may not be fully effective in mitigating our risk exposure in all market environments or against all
types of risk. We seek to manage, monitor and control our operational, legal and regulatory risk through operational and compliance
reporting systems, internal controls, management review processes and other mechanisms; however, there can be no assurance that
our procedures will be fully effective. Further, our risk management methods may not effectively predict future risk exposures,
which could be significantly greater than the historical measures indicate. In addition, some of our risk management methods are
based on an evaluation of information regarding markets, clients and other matters that are based on assumptions that may no longer
be accurate. A failure to adequately manage our growth, or to effectively manage our risk, could materially and adversely affect
our business and financial condition.
We are exposed to the
risk that third parties that owe us money, securities or other assets will not perform their obligations. These parties may default
on their obligations to us due to bankruptcy, lack of liquidity, operational failure, and breach of contract or other reasons.
We are also subject to the risk that our rights against third parties may not be enforceable in all circumstances. As an introducing
broker, we could be held responsible for the defaults or misconduct of our customers. These may present credit concerns, and default
risks may arise from events or circumstances that are difficult to detect, foresee or reasonably guard against. In addition, concerns
about, or a default by, one institution could lead to significant liquidity problems, losses or defaults by other institutions,
which in turn could adversely affect us. If any of the variety of instruments, processes and strategies we utilize to manage our
exposure to various types of risk are not effective, we may incur losses.
Our common stock price
may fluctuate substantially, and your investment could suffer a decline in value.
The market price of
our common stock may be volatile and could fluctuate substantially due to many factors, including, among other things:
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actual
or anticipated fluctuations in our results of operations;
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announcements
of significant contracts and transactions by us or our competitors;
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sale
of common stock or other securities in the future;
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the
trading volume of our common stock;
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changes
in our pricing policies or the pricing policies of our competitors; and
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general
economic conditions
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In addition, the stock
market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the
operating performance of those companies. These broad market factors may materially harm the market price of our common stock,
regardless of our operating performance.
There is a limited market
for our common shares and the trading price of our common shares is subject to volatility.
Our common shares
began trading on the over-the-counter bulletin board in August 2009, and we obtained approval to list and trade our shares on the
NASDAQ Capital Market on July 16, 2015. On November 16, 2016, we began trading our shares on the NASDAQ Global Market. Trading
of our common stock has in the past been highly volatile with low trading volume and an active trading market for shares of our
common stock may not develop. In such case, selling shares of our common stock may be difficult because the limited trading market
for our shares could result in lower prices and larger spreads in the bid and ask prices of our shares, as well as lower trading
volume. Further, the market price of shares of our common stock could continue to fluctuate substantially. Additionally, if we
are not able to maintain our listing on NASDAQ, then our common stock will again be quoted for trading on an over-the-counter quotation
system and may be subject to more significant fluctuations in stock price and trading volume and large bid and ask price spreads.
Our amended
and restated certificate of incorporation authorizes our board of directors to issue new series of preferred stock that may have
the effect of delaying or preventing a change of control, which could adversely affect the value of your shares.
Our amended and restated
certificate of incorporation provides that our board of directors will be authorized to issue from time to time, without further
stockholder approval, up to 1,000,000 shares of preferred stock in one or more series and to fix or alter the designations, preferences,
rights and any qualifications, limitations or restrictions of the shares of each series, including the dividend rights, dividend
rates, conversion rights, voting rights, rights of redemption, including sinking fund provisions, redemption price or prices, liquidation
preferences and the number of shares constituting any series or designations of any series. Such shares of preferred stock could
have preferences over our common stock with respect to dividends and liquidation rights. We may issue additional preferred stock
in ways which may delay, defer or prevent a change of control of our company without further action by our stockholders. Such shares
of preferred stock may be issued with voting rights that may adversely affect the voting power of the holders of our common stock
by increasing the number of outstanding shares having voting rights, and by the creation of class or series voting rights.
Anti-takeover
provisions under our charter documents and Delaware law could delay or prevent a change of control and could also limit the market
price of our stock.
Our amended and restated
certificate of incorporation and our bylaws, as amended, contain provisions that could delay or prevent a change of control of
our company or changes in our board of directors that our stockholders might consider favorable. We are also governed by the provisions
of Section 203 of the Delaware General Corporate Law, which may prohibit certain business combinations with stockholders owning
15% or more of our outstanding voting stock. The foregoing and other provisions in our amended and restated certificate of incorporation,
our bylaws, as amended, and Delaware law could make it more difficult for stockholders or potential acquirers to obtain control
of our board of directors or initiate actions that are opposed by the then-current board of directors, including delaying or impeding
a merger, tender offer, or proxy contest or other change of control transaction involving our company. Any delay or prevention
of a change of control transaction or changes in our board of directors could prevent the consummation of a transaction in which
our stockholders could receive a substantial premium over the then current market price for their shares.
Our ability to use net
loss carryovers to reduce our taxable income may be limited.
As a result of the
common stock offering that was completed on June 5, 2014, the Company had a more than 50% ownership shift in accordance with Section
382 of the Internal Revenue Code of 1986, as amended (the “Code”). Accordingly, the Company may be 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 a
result of the acquisition of UOL on July 1, 2016, the historical net operating losses of UOL are limited to offset income we generate
post acquisition. As of December 31, 2019, the Company believes that the net operating loss that existed as of the more than 50%
ownership shift 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 an allowance. However, to the
extent that the Company is unable to utilize such net operating loss, it may have a material adverse effect on our financial condition
and results of operations.
The tax benefits,
grants and other incentives available to us require us to continue to meet various conditions and may be terminated, repaid or
reduced in the future, which could increase our costs and taxes.
The Israeli government
currently provides major tax and capital investment incentives to domestic companies, as well as grant and loan programs relating
to research and development and marketing and export activities. In recent years, the Israeli Government has reduced the benefits
available under these programs and the Israeli Governmental authorities have indicated that the government may in the future further
reduce, seek repayment or eliminate the benefits of those programs. magicJack currently takes advantage of these programs. There
is no assurance that we will continue to meet the conditions of such benefits and programs or that such benefits and programs would
continue to be available to us in the future. If we fail to meet the conditions of such benefits and programs or if they are terminated
or further reduced, it could have an adverse effect on our business, operating results and financial condition.
Changes in tax
laws or regulations, or to interpretations of existing tax laws or regulations, to which we are subject could adversely affect
our financial condition and cash flows.
We are subject to
taxation in the United States and in some foreign jurisdictions. Our financial condition and cash flows are impacted by tax policy
implemented at each of the federal, state, local and international levels. We cannot predict whether any changes to tax laws
or regulations, or to interpretations of existing tax laws or regulations, will be implemented in the future or whether any such
changes would have a material adverse effect on our financial condition and cash flows. However, future changes to tax laws
or regulations, or to interpretations of existing tax laws or regulations, could increase our tax burden or otherwise adversely
affect our financial condition and cash flows.
Financial services
firms have been subject to increased scrutiny over the last several years, increasing the risk of financial liability and reputational
harm resulting from adverse regulatory actions.
Firms in the financial
services industry have been operating in a difficult regulatory environment which we expect will become even more stringent in
light of recent well-publicized failures of regulators to detect and prevent fraud. The industry has experienced increased scrutiny
from a variety of regulators, including the SEC, the NYSE, FINRA and state attorneys general. Penalties and fines sought by regulatory
authorities have increased substantially over the last several years. This regulatory and enforcement environment has created uncertainty
with respect to a number of transactions that had historically been entered into by financial services firms and that were generally
believed to be permissible and appropriate. We may be adversely affected by changes in the interpretation or enforcement of existing
laws and rules by these governmental authorities and self-regulatory organizations. Each of the regulatory bodies with jurisdiction
over us has regulatory powers dealing with many aspects of financial services, including, but not limited to, the authority to
fine us and to grant, cancel, restrict or otherwise impose conditions on the right to carry on particular businesses. For example,
a failure to comply with the obligations imposed by the Exchange Act on broker-dealers and the Investment Advisers Act of 1940
on investment advisers, including record-keeping, advertising and operating requirements, disclosure obligations and prohibitions
on fraudulent activities, or by the Investment Company Act of 1940, could result in investigations, sanctions and reputational
damage. We also may be adversely affected as a result of new or revised legislation or regulations imposed by the SEC, other U.S.
or foreign governmental regulatory authorities or FINRA or other self-regulatory organizations that supervise the financial markets.
Substantial legal liability or significant regulatory action against us could have adverse financial effects on us or cause reputational
harm to us, which could harm our business prospects.
In addition, financial
services firms are subject to numerous conflicts of interests or perceived conflicts. The SEC and other federal and state regulators
have increased their scrutiny of potential conflicts of interest. We have adopted various policies, controls and procedures to
address or limit actual or perceived conflicts and regularly review and update our policies, controls and procedures. However,
appropriately addressing conflicts of interest is complex and difficult and our reputation could be damaged if we fail, or appear
to fail, to appropriately address conflicts of interest. Our policies and procedures to address or limit actual or perceived conflicts
may also result in increased costs and additional operational personnel. Failure to adhere to these policies and procedures may
result in regulatory sanctions or litigation against us. For example, the research operations of investment banks have been and
remain the subject of heightened regulatory scrutiny which has led to increased restrictions on the interaction between equity
research analysts and investment banking professionals at securities firms. Several securities firms in the U.S. reached a global
settlement in 2003 and 2004 with certain federal and state securities regulators and self-regulatory organizations to resolve investigations
into the alleged conflicts of interest of research analysts, which resulted in rules that have imposed additional costs and limitations
on the conduct of our business.
Asset management businesses
have experienced a number of highly publicized regulatory inquiries which have resulted in increased scrutiny within the industry
and new rules and regulations for mutual funds, investment advisors and broker-dealers. Our subsidiary, B. Riley Capital Management,
LLC, is registered as an investment advisor with the SEC and regulatory scrutiny and rulemaking initiatives may result in an increase
in operational and compliance costs or the assessment of significant fines or penalties against our asset management business,
and may otherwise limit our ability to engage in certain activities. In addition, the SEC staff has conducted studies with respect
to soft dollar practices in the brokerage and asset management industries and proposed interpretive guidance regarding the scope
of permitted brokerage and research services in connection with soft dollar practices. The SEC staff has indicated that it is considering
additional rulemaking in this and other areas, and we cannot predict the effect that additional rulemaking may have on our asset
management or brokerage business or whether it will be adverse to us. In addition, Congress is currently considering imposing new
requirements on entities that securitize assets, which could affect our credit activities. It is impossible to determine the extent
of the impact of any new laws, regulations or initiatives that may be proposed, or whether any of the proposals will become law.
Compliance with any new laws or regulations could make compliance more difficult and expensive and affect the manner in which we
conduct business.
Financial reforms and
related regulations may negatively affect our business activities, financial position and profitability.
The Dodd-Frank Wall
Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) instituted a wide range of reforms that have impacted
and will continue to impact financial services firms and continues to require significant rule-making. In addition, the legislation
mandates multiple studies, which could result in additional legislative or regulatory action. The legislation and regulation of
financial institutions, both domestically and internationally, include calls to increase capital and liquidity requirements; limit
the size and types of the activities permitted; and increase taxes on some institutions. FINRA’s oversight over broker-dealers
and investment advisors may be expanded, and new regulations on having investment banking and securities analyst functions in the
same firm may be created. Certain of the provisions of the Dodd-Frank Act remain subject to further rule making procedures and
studies. As a result, we cannot assess the full impact of all of these legislative and regulatory changes on our business at the
present time. However, these legislative and regulatory changes could affect our revenue, limit our ability to pursue business
opportunities, impact the value of assets that we hold, require us to change certain of our business practices, impose additional
costs on us, or otherwise adversely affect our businesses. If we do not comply with current or future legislation and regulations
that apply to our operations, we may be subject to fines, penalties or material restrictions on our businesses in the jurisdiction
where the violation occurred. Accordingly, such legislation or regulation could have an adverse effect on our business, results
of operations, cash flows or financial condition.
Our failure to deal appropriately
with conflicts of interest could damage our reputation and adversely affect our business.
As we have expanded
the number and scope of our businesses, we increasingly confront potential conflicts of interest relating to our and our funds’
and clients’ investment and other activities. Certain of our funds have overlapping investment objectives, including funds
which have different fee structures, and potential conflicts may arise with respect to our decisions regarding how to allocate
investment opportunities among ourselves and those funds. For example, a decision to acquire material non-public information about
a company while pursuing an investment opportunity for a particular fund gives rise to a potential conflict of interest when it
results in our having to restrict the ability of the Company or other funds to take any action.
In addition, there
may be conflicts of interest regarding investment decisions for funds in which our officers, directors and employees, who have
made and may continue to make significant personal investments in a variety of funds, are personally invested. Similarly, conflicts
of interest may exist or develop regarding decisions about the allocation of specific investment opportunities between the Company
and the funds.
We also have potential
conflicts of interest with our investment banking and institutional clients including situations where our services to a particular
client or our own proprietary or fund investments or interests conflict or are perceived to conflict with a client. It is possible
that potential or perceived conflicts could give rise to investor or client dissatisfaction or litigation or regulatory enforcement
actions. Appropriately dealing with conflicts of interest is complex and difficult and our reputation could be damaged if we fail,
or appear to fail, to deal appropriately with one or more potential or actual conflicts of interest. Regulatory scrutiny of, or
litigation in connection with, conflicts of interest would have a material adverse effect on our reputation, which would materially
adversely affect our business in a number of ways, including as a result of redemptions by our investors from our hedge funds,
an inability to raise additional funds and a reluctance of counterparties to do business with us.
Our exposure to legal liability
is significant, and could lead to substantial damages.
We face significant
legal risks in our businesses. These risks include potential liability under securities laws and regulations in connection with
our Capital Markets, asset management and other businesses. The volume and amount of damages claimed in litigation, arbitrations,
regulatory enforcement actions and other adversarial proceedings against financial services firms have increased in recent years.
We also are subject to claims from disputes with our employees and our former employees under various circumstances. Risks associated
with legal liability often are difficult to assess or quantify and their existence and magnitude can remain unknown for significant
periods of time, making the amount of legal reserves related to these legal liabilities difficult to determine and subject to future
revision. Legal or regulatory matters involving our directors, officers or employees in their individual capacities also may create
exposure for us because we may be obligated or may choose to indemnify the affected individuals against liabilities and expenses
they incur in connection with such matters to the extent permitted under applicable law. In addition, like other financial services
companies, we may face the possibility of employee fraud or misconduct. The precautions we take to prevent and detect this activity
may not be effective in all cases and there can be no assurance that we will be able to deter or prevent fraud or misconduct. Exposures
from and expenses incurred related to any of the foregoing actions or proceedings could have a negative impact on our results of
operations and financial condition. In addition, future results of operations could be adversely affected if reserves relating
to these legal liabilities are required to be increased or legal proceedings are resolved in excess of established reserves.
Misconduct by our employees
or by the employees of our business partners could harm us and is difficult to detect and prevent.
There have been a
number of highly publicized cases involving fraud or other misconduct by employees in the financial services industry in recent
years, and we run the risk that employee misconduct could occur at our firm. For example, misconduct could involve the improper
use or disclosure of confidential information, which could result in regulatory sanctions and serious reputational or financial
harm. It is not always possible to deter misconduct and the precautions we take to detect and prevent this activity may not be
effective in all cases. Our ability to detect and prevent misconduct by entities with which we do business may be even more limited.
We may suffer reputational harm for any misconduct by our employees or those entities with which we do business.
Our failure
to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could
have a material adverse effect on our financial condition, results of operations and business and the price of our common stock
and other securities.
The Sarbanes-Oxley
Act and the related rules require our management to conduct an annual assessment of the effectiveness of our internal control over
financial reporting and require a report by our independent registered public accounting firm addressing our internal control over
financial reporting. To comply with Section 404 of the Sarbanes-Oxley Act, we are required to document formal policies, processes
and practices related to financial reporting that are necessary to comply with Section 404. Such policies, processes and practices
are important to ensure the identification of key financial reporting risks, assessment of their potential impact and linkage of
those risks to specific areas and activities within our organization.
If we fail for any
reason to comply with the requirements of Section 404 in a timely manner, our independent registered public accounting firm
may, at that time, issue an adverse report regarding the effectiveness of our internal control over financial reporting. Matters
impacting our internal controls may cause us to be unable to report our financial information on a timely basis and thereby subject
us to adverse regulatory consequences, including sanctions by the SEC or violations of applicable stock exchange listing rules.
There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability
of our financial statements. Any such event could adversely affect our financial condition, results of operations and business,
and result in a decline in the price of our common stock and other securities.
We may not pay dividends
regularly or at all in the future.
From time to time,
we may decide to pay dividends which will be dependent upon our financial condition and results of operations. Our Board of Directors
may reduce or discontinue dividends at any time for any reason it deems relevant and there can be no assurances that we will continue
to generate sufficient cash to pay dividends, or that we will continue to pay dividends with the cash that we do generate. The
determination regarding the payment of dividends is subject to the discretion of our Board of Directors, and there can be no assurances
that we will continue to generate sufficient cash to pay dividends, or that we will pay dividends in future periods.
Security breaches
and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation
to suffer.
In the ordinary course
of our business, we collect and store sensitive data, including intellectual property, our proprietary business information and
that of our customers, clients and business partners, and personally identifiable information of our employees, in our servers
and on our networks. The secure processing, maintenance and transmission of this information is critical to our operations and
business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by
hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and
the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of
information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information,
and regulatory penalties. In addition, such a breach could disrupt our operations and the services we provide to our clients, damage
our reputation, and cause a loss of confidence in our services, which could adversely affect our business and our financial condition.
Significant
disruptions of information technology systems, breaches of data security, or unauthorized disclosures of sensitive data or personally
identifiable information could adversely affect our business, and could subject us to liability or reputational damage.
Our business is increasingly
dependent on critical, complex, and interdependent information technology (“IT”) systems, including Internet-based
systems, some of which are managed or hosted by third parties, to support business processes as well as internal and external
communications. The size and complexity of our IT systems make us vulnerable to, and we have experienced, IT system breakdowns,
malicious intrusion, and computer viruses, which may result in the impairment of our ability to operate our business effectively.
In addition, our systems
and the systems of our third-party providers and collaborators are potentially vulnerable to data security breaches which may expose
sensitive data to unauthorized persons or to the public. Such data security breaches could lead to the loss of confidential information,
trade secrets or other intellectual property, or could lead to the public exposure of personal information (including personally
identifiable information) of our employees, customers, business partners, and others. In addition, the increased use of social
media by our employees and contractors could result in inadvertent disclosure of sensitive data or personal information, including
but not limited to, confidential information, trade secrets and other intellectual property.
Any such disruption
or security breach, as well as any action by us or our employees or contractors that might be inconsistent with the rapidly evolving
data privacy and security laws and regulations applicable within the United States and elsewhere where we conduct business, could
result in enforcement actions by U.S. states, the U.S. Federal government or foreign governments, liability or sanctions under
data privacy laws that protect personally identifiable information, regulatory penalties, other legal proceedings such as but not
limited to private litigation, the incurrence of significant remediation costs, disruptions to our development programs, business
operations and collaborations, diversion of management efforts and damage to our reputation, which could harm our business and
operations. Because of the rapidly moving nature of technology and the increasing sophistication of cybersecurity threats, our
measures to prevent, respond to and minimize such risks may be unsuccessful.
In
addition, the European Parliament and the Council of the European Union adopted a comprehensive general data privacy regulation
(“GDPR”) in 2016 that took effect in May 2018 and governs the collection and use of personal data in the European Union.
The GDPR, which is wide-ranging in scope, will impose several requirements relating to the consent of the individuals to whom the
personal data relates, the information provided to the individuals, the security and confidentiality of the personal data, data
breach notification and the use of third party processors in connection with the processing of the personal data. The GDPR also
imposes strict rules on the transfer of personal data out of the European Union to the United States, enhances enforcement authority
and imposes large penalties for noncompliance, including the potential for fines of up to €20 million or 4% of the annual
global revenues of the infringer, whichever is greater. In addition, the
California Consumer Privacy Act effective on January 1, 2020 and applies to for-profit businesses that conduct business in California
and meet certain revenue or data collection thresholds. The CCPA will give consumers the right to request disclosure of information
collected about them, and whether that information has been sold or shared with others, the right to request deletion of personal
information (subject to certain exceptions), the right to opt out of the sale of the consumer’s personal information, and
the right not to be discriminated against for exercising these rights. In October 2019, the California Attorney General adopted
regulations to implement the CCPA. In addition, similar laws have and may be adopted by other states where the Company does business.
The impact of the CCPA and other state privacy laws on the Company’s business is yet to be determined.
We may enter
into new lines of business, make strategic investments or acquisitions or enter into joint ventures, each of which may result in
additional risks and uncertainties for our business.
We may enter into new
lines of business, make future strategic investments or acquisitions and enter into joint ventures. As we have in the past, and
subject to market conditions, we may grow our business by increasing assets under management in existing investment strategies,
pursue new investment strategies, which may be similar or complementary to our existing strategies or be wholly new initiatives,
or enter into strategic relationships, or joint ventures. In addition, opportunities may arise to acquire or invest in other businesses
that are related or unrelated to our current businesses.
To the extent we make
strategic investments or acquisitions, enter into strategic relationships or joint ventures or enter into new lines of business,
we will face numerous risks and uncertainties, including risks associated with the required investment of capital and other resources
and with combining or integrating operational and management systems and controls and managing potential conflicts. Entry into
certain lines of business may subject us to new laws and regulations with which we are not familiar, or from which we are currently
exempt, and may lead to increased litigation and regulatory risk. If a new business generates insufficient revenues, or produces
investment losses, or if we are unable to efficiently manage our expanded operations, our results of operations will be adversely
affected, and our reputation and business may be harmed. In the case of joint ventures, we are subject to additional risks and
uncertainties in that we may be dependent upon, and subject to liability, losses or reputational damage relating to, systems, controls
and personnel that are not under our control.
UOL competes
against large companies, many of whom have significantly more financial and marketing resources, and our business will suffer if
we are unable to compete successfully.
UOL competes with numerous
providers of broadband, mobile broadband and DSL services, as well as other dial-up Internet access providers, many of whom are
large and have significantly more financial and marketing resources. The principal competitors for UOL’s mobile broadband
and DSL services include, among others, local exchange carriers, wireless and satellite service providers, and cable service providers.
These competitors include established providers such as AT&T, Verizon, Sprint, and T-Mobile. UOL’s principal dial-up
Internet access competitors include established online service and content providers, such as AOL and MSN, and independent national
Internet service providers, such as EarthLink and its PeoplePC subsidiary. Dial-up Internet access services do not compete favorably
with broadband services with respect to connection speed and do not have a significant, if any, price advantage over certain broadband
services. In addition, there are a number of mobile virtual network operators, some of which focus on pricing as their main selling
point. Certain portions of the U.S., primarily rural areas, currently have limited or no access to broadband services. However,
the U.S. government has indicated its intention to facilitate the provision of broadband services to such areas. Such expansion
of the availability of broadband services will increase the competition for Internet access subscribers in such areas and will
likely adversely affect the UOL business. In addition to competition from broadband, mobile broadband, and DSL providers, competition
among dial-up Internet access service providers is intense and neither UOL’s pricing nor the features of UOL’s services
provides us with a significant competitive advantage, if any, over certain of UOL’s dial-up Internet access competitors.
We expect that competition, particularly with respect to price, for broadband, mobile broadband, and DSL services, as well as dial-up
Internet access services, will continue and may materially and adversely impact our business, financial condition, results of operations,
and cash flows.
Dial-up and
DSL pay accounts may decline faster than expected and adversely impact our business.
A significant portion
of UOL’s revenues and profits come from dial-up Internet and DSL access services and related services and advertising revenues.
UOL’s dial-up and DSL Internet access pay accounts and revenues have been declining and are expected to continue to decline
due to the continued maturation of the market for dial-up and DSL Internet access, competitive pressures in the industry and limited
sales efforts. Consumers continue to migrate to broadband access, primarily due to the faster connection and download speeds provided
by broadband access. Advanced applications such as online gaming, music downloads and videos require greater bandwidth for optimal
performance, which adds to the demand for broadband access. The pricing for basic broadband services has been declining as well,
making it a more viable option for consumers. In addition, the popularity of accessing the Internet through tablets and mobile
devices has been growing and may accelerate the migration of consumers away from dial-up Internet access. The number of dial-up
Internet access pay accounts has been adversely impacted by both a decrease in the number of new pay accounts signing up for UOL’s
services, as well as the impact of subscribers canceling their accounts, which we refer to as “churn.” Churn has increased
from time to time and may increase in the future. If we experience a higher than expected level of churn, it will make it more
difficult for us to increase or maintain the number of pay accounts, which could adversely affect our business, financial condition,
results of operations, and cash flows.
We expect UOL’s
dial-up and DSL Internet access pay accounts to continue to decline. As a result, related services revenues and the profitability
of this segment may decline. The rate of decline in these revenues may continue to accelerate.
We may not be able to
consistently make a high level of expense reductions in the future. Continued declines in revenues relating to the UOL business,
particularly if such declines accelerate, will materially and adversely impact the profitability of this business.
Failure to maintain
or grow advertising revenues from UOL, including as a result of failing to increase or maintain the number of subscribers for UOL’s
services, could have a negative impact on advertising profitability.
Advertising revenues
are a key component of revenues and profitability from UOL. UOL’s services currently generate advertising revenues from search
placements, display advertisements and online market research associated with Internet access and email services. Factors that
have caused, or may cause in the future, UOL’s advertising revenues to fluctuate include, without limitation, changes in
the number of visitors to UOL’s websites, active accounts or consumers purchasing our services and products, the effect of,
changes to, or terminations of key advertising relationships, changes to UOL’s websites and advertising inventory, changes
in applicable laws, regulations or business practices, including those related to behavioral or targeted advertising, user privacy,
and taxation, changes in business models, changes in the online advertising market, changes in the economy, advertisers’
budgeting and buying patterns, competition, and changes in usage of UOL’s services. Decreases in UOL’s advertising
revenues are likely to adversely impact our profitability. Further, our successful operation and management of UOL, including the
ability to generate advertising revenues for UOL’s services, will depend in part upon our ability to increase or maintain
the number of subscribers for UOL’s services. A decline in the number of subscribers using UOL’s services could result
in decreased advertising revenues, and decreases in advertising revenues would adversely impact our profitability. The failure
to increase or maintain the number of subscribers for UOL’s services could have a material adverse effect on advertising
revenues and our profitability.
Interruption
or failure of the network, information systems or other technologies essential to the UOL business could impair our ability to
provide services relating to the UOL business, which could damage our reputation and harm our operating results.
Our successful operation
of the UOL business depends on our ability to provide reliable service. Many of UOL’s products are supported by data centers.
UOL’s network, data centers, central offices and those of UOL’s third-party service providers are vulnerable to damage
or interruption from fires, earthquakes, hurricanes, tornados, floods and other natural disasters, terrorist attacks, power loss,
capacity limitations, telecommunications failures, software and hardware defects or malfunctions, break ins, sabotage and vandalism,
human error and other disruptions that are beyond our control. Some of the systems serving the UOL business are not fully redundant,
and our disaster recovery or business continuity planning may not be adequate. The UOL business could also experience interruptions
due to cable damage, theft of equipment, power outages, inclement weather and service failures of third-party service providers.
The occurrence of any disruption or system failure or other significant disruption to business continuity may result in a loss
of business, increase expenses, damage to reputation for providing reliable service, subject us to additional regulatory scrutiny
or expose us to litigation and possible financial losses, any of which could adversely affect our business, results of operations
and cash flows.
We may be accused
of infringing upon the intellectual property rights of third parties, which is costly to defend and could limit our ability to
use certain technologies in the future.
From time to time third
parties have alleged that UOL infringes on their intellectual property rights, including patent rights. We may be unaware of filed
patent applications and of issued patents that could be related to the products and services we acquired in the UOL acquisition.
These claims are often made by patent holding companies that are not operating companies. The alleging parties generally seek royalty
payments for prior use as well as future royalty streams. Defending against disputes, litigation or other legal proceedings, whether
or not meritorious, may involve significant expense and diversion of management’s attention and resources from other matters.
Due to the inherent uncertainties of litigation, we may not prevail in these actions. Both the costs of defending lawsuits and
any settlements or judgments against us could adversely affect our results of operations and cash flows.
If there are
events or circumstances affecting the reliability or security of the Internet, access to the websites related to the UOL business
and/or the ability to safeguard confidential information could be impaired causing a negative effect on the financial results of
our business operations.
Our website infrastructure
and the website infrastructure of UOL may be vulnerable to computer viruses, hacking or similar disruptive problems caused by customers,
other Internet users, other connected Internet sites, and the interconnecting telecommunications networks. Such problems caused
by third-parties could lead to interruptions, delays or cessation of service to the customers of the UOL products and services.
Inappropriate use of the Internet by third-parties could also potentially jeopardize the security of confidential information stored
in our computer system, which may deter individuals from becoming customers. There can be no assurance that any such measures would
not be circumvented in future. Dealing with problems caused by computer viruses or other inappropriate uses or security breaches
may require interruptions, delays or cessation of service to customers, which could have a material adverse effect on our business,
financial condition and results of operations.
The UOL business
processes, stores and uses personal information and other data, which subjects us to governmental regulation and other legal obligations
related to privacy, and our actual or perceived failure to comply with such obligations could harm our business.
The UOL business receives,
stores and processes personal information and other customer data, and UOL enables customers to share their personal information
with each other and with third parties. There are numerous federal, state and local laws around the world regarding privacy and
the storing, sharing, use, processing, disclosure and protection of personal information and other customer data, the scope of
which are changing, subject to differing interpretations, and may be inconsistent between countries or conflict with other rules.
We will generally comply with industry standards and are and will be subject to the terms of privacy policies and privacy-related
obligations to third parties. We will strive to comply with all applicable laws, policies, legal obligations and industry codes
of conduct relating to privacy and data protection, to the extent possible. However, it is possible that these obligations may
be interpreted and applied in a manner that is inconsistent from one jurisdiction to another and may conflict with other rules
or UOL’s practices. Any failure or perceived failure to comply with UOL’s privacy policies, privacy-related obligations
to customers or other third parties, or privacy-related legal obligations, or any compromise of security that results in the unauthorized
release or transfer of personally identifiable information or other customer data, may result in governmental enforcement actions,
litigation or public statements against us by consumer advocacy groups or others and could cause customers to lose trust in us,
which could have an adverse effect on our business. Additionally, if third parties we work with, such as customers, vendors or
developers, violate applicable laws or policies, such violations may also put our customers’ information at risk and could
in turn have an adverse effect on our business.
Our marketing
efforts for UOL’s business may not be successful or may become more expensive, either of which could increase our costs and
adversely impact our business, financial condition, results of operations, and cash flows.
We rely on relationships
for our UOL business with a wide variety of third parties, including Internet search providers such as Google, social networking
platforms such as Facebook, Internet advertising networks, co-registration partners, retailers, distributors, television advertising
agencies, and direct marketers, to source new members and to promote or distribute our services and products. In addition, in connection
with the launch of new services or products for our UOL business, we may spend a significant amount of resources on marketing.
With any of our brands, services, and products, if our marketing activities are inefficient or unsuccessful, if important third-party
relationships or marketing strategies, such as Internet search engine marketing and search engine optimization, become more expensive
or unavailable, or are suspended, modified, or terminated, for any reason, if there is an increase in the proportion of consumers
visiting our websites or purchasing our services and products by way of marketing channels with higher marketing costs as compared
to channels that have lower or no associated marketing costs, or if our marketing efforts do not result in our services and products
being prominently ranked in Internet search listings, our business, financial condition, results of operations, and cash flows
could be materially and adversely impacted.
Our UOL business
is dependent on the availability of telecommunications services and compatibility with third-party systems and products.
Our UOL business substantially
depends on the availability, capacity, affordability, reliability, and security of our telecommunications networks. Only a limited
number of telecommunications providers offer the network and data services we currently require for our UOL business, and we purchase
most of our telecommunications services from a few providers. Some of our telecommunications services are provided pursuant to
short-term agreements that the providers can terminate or elect not to renew. In addition, some telecommunications providers may
cease to offer network services for certain less populated areas, which would reduce the number of providers from which we may
purchase services and may entirely eliminate our ability to purchase services for certain areas. Currently, our mobile broadband
service of our UOL business is entirely dependent upon services acquired from one service provider, and the devices required by
the provider can be used for only such provider’s service. If we are unable to maintain, renew or obtain a new agreement
with the telecommunications provider on acceptable terms, or the provider discontinues its services, our business, financial condition,
results of operations, and cash flows could be materially and adversely affected. Sprint, which owns Clearwire, ceased using WiMAX
technology on the Clearwire network. This affected our mobile broadband subscribers for our UOL business that utilized the Clearwire
network.
Our dial-up Internet
access services of our UOL business also rely on their compatibility with other third-party systems, products and features, including
operating systems. Incompatibility with third-party systems and products could adversely affect our ability to deliver our services
or a user’s ability to access our services and could also adversely impact the distribution channels for our services. Our
dial-up Internet access services are dependent on dial-up modems and an increasing number of computer manufacturers, including
certain manufacturers with whom we have distribution relationships, do not pre-load their new computers with dial-up modems, requiring
the user to separately acquire a modem to access our services. We cannot assure you that, as the dial-up Internet access market
declines and new technologies emerge, we will be able to continue to effectively distribute and deliver our services.
Government regulations
could adversely affect our business or force us to change our business practices.
The services that are
provided by UOL are subject to varying degrees of international, federal, state and local laws and regulation, including, without
limitation, those relating to taxation, bulk email or “spam,” advertising (including, without limitation, targeted
or behavioral advertising), user privacy and data protection, consumer protection, antitrust, export, and unclaimed property. Compliance
with such laws and regulations, which in many instances are unclear or unsettled, is complex. New laws and regulations, such as
those being considered or recently enacted by certain states, the federal government, or international authorities related to automatic-renewal
practices, spam, user privacy, targeted or behavioral advertising, and taxation, could impact our revenues or certain of our business
practices or those of our advertisers.
UOL resells broadband
Internet access services offered by other parties pursuant to wholesale agreements with those providers. In an order released in
March 2015, the Federal Communications Commission (the “FCC”) classified retail broadband Internet access services
as telecommunications services subject to regulation under Title II of the Communications Act. That ruling is subject to a pending
appeal. The classification of retail broadband Internet access services as telecommunications services means that providers of
these services are subject to the general requirement that their charges, practices and classifications for telecommunications
services be “just and reasonable,” and that they refrain from engaging in any “unjust or unreasonable discrimination”
with respect to their charges, practices or classifications. However, the FCC has not determined what, if any, regulations will
apply to wholesale broadband Internet access services, and it is uncertain whether it will adopt requirements that will be favorable
or unfavorable to us. It is also possible that the classification of retail broadband Internet access services will be overturned
on appeal, that Congress will adopt legislation reversing that decision, or that a future FCC will reverse that decision.
Broadband Internet access
is also currently classified as an “information service.” While current policy exempts broadband Internet access services
(but not all broadband services) from contributing to the Universal Service Fund (“USF”), Congress and the FCC may
consider expanding the USF contribution base to include broadband Internet access services. If broadband Internet access providers
become subject to USF contribution obligations, they would likely impose a USF surcharge on end users. Such a surcharge will raise
the effective cost of our broadband services to UOL’s customers, which could adversely affect customer satisfaction and have
an adverse impact on our revenues and profitability.
Failure to make proper
payments for federal USF contributions, FCC regulatory fees or other amounts mandated by federal and state regulations; failure
to maintain proper state tariffs and certifications; failure to comply with federal, state or local laws and regulations; failure
to obtain and maintain required licenses, franchises and permits; imposition of burdensome license, franchise or permit requirements
for us to operate in public rights-of-way; and imposition of new burdensome or adverse regulatory requirements could limit the
types of services we provide or the terms on which we provide these services.
We cannot predict
the outcome of any ongoing legislative initiatives or administrative or judicial proceedings or their potential impact upon the
communications and information technology industries generally or upon the UOL business specifically. Any changes in the laws and
regulations applicable to UOL, the enactment of any additional laws or regulations, or the failure to comply with, or increased
enforcement activity by regulators of, such laws and regulations, could significantly impact our services and products, our costs,
or the manner in which we or our advertisers conduct business, all of which could adversely impact our business, financial condition,
results of operations, and cash flows and cause our business to suffer.
The FCC and some states
require us to obtain prior approval of certain major merger and acquisition transactions, such as the acquisition of control of
another telecommunications carrier. Delays in obtaining such approvals could affect our ability to close proposed transactions
in a timely manner and could increase our costs and increase the risk of non-consummation of some transactions.
We manage debt
investments that involve significant risks and potential additional liabilities.
GACP I., L.P. and
GACP II, L.P., both direct lending funds of which our wholly owned subsidiary GACP is the general partner, may invest in secured
debt issued by companies that have or may incur additional debt that is senior to the secured debt owned by the fund. In the event
of insolvency, liquidation, dissolution, reorganization or bankruptcy of any such company, the owners of senior secured debt (i.e.,
the owners of first priority liens) generally will be entitled to receive proceeds from any realization of the secured collateral
until they have been reimbursed. At such time, the owners of junior secured debt (including, in certain circumstances, the fund)
will be entitled to receive proceeds from the realization of the collateral securing such debt. There can be no assurances that
the proceeds, if any, from the sale of such collateral would be sufficient to satisfy the loan obligations secured by subordinate
debt instruments. To the extent that the fund owns secured debt that is junior to other secured debt, the fund may lose the value
of its entire investment in such secured debt.
In addition, the fund
may invest in loans that are secured by a second lien on assets. Second lien loans have been a developed market for a relatively
short period of time, and there is limited historical data on the performance of second lien loans in adverse economic circumstances.
In addition, second lien loan products are subject to intercreditor arrangements with the holders of first lien indebtedness, pursuant
to which the second lien holders have waived many of the rights of a secured creditor, and some rights of unsecured creditors,
including rights in bankruptcy, which can materially affect recoveries. While there is broad market acceptance of some second lien
intercreditor terms, no clear market standard has developed for certain other material intercreditor terms for second lien loan
products. This variation in key intercreditor terms may result in dissimilar recoveries across otherwise similarly situated second
lien loans in insolvency or distressed situations. While uncertainty of recovery in an insolvency or distressed situation is inherent
in all debt instruments, second lien loan products carry more risks than certain other debt products.
The market in
which magicJack participates is highly competitive and if we do not compete effectively, our operating results may be harmed by
loss of market share and revenues.
The telecommunications
industry is highly competitive. We face intense competition from traditional telephone companies, wireless companies, cable companies
and alternative voice communication providers and manufacturers of communication devices.
The principal competitors
for our products and services include the traditional telephone service providers, such as AT&T, Inc., CenturyLink, Inc.
and Verizon Communications Inc., which provide telephone service using the public switched telephone network. Certain of these
traditional providers have also added, or are planning to add, broadband telephone services to their existing telephone and broadband
offerings. We also face, or expect to face, competition from cable companies, such as Cablevision Systems Corp., Charter Communications, Inc.,
Comcast Corporation, Cox Communications, Inc. and Time Warner Cable (a division of Time Warner Inc.), which offer broadband
telephone services to their existing cable television and broadband offerings. Further, wireless providers, including AT&T
Mobility, Inc., Sprint Corporation, T-Mobile USA Inc., and Verizon Wireless, Inc. offer services that some customers may prefer
over wireline-based service. In the future, as wireless companies offer more minutes at lower prices, their services may become
more attractive to customers as a replacement for broadband or wireline-based phone service.
We face competition on magicJack device sales from Apple, Samsung,
Motorola and other manufacturers of smart phones, tablets and other handheld wireless devices. Also, we compete against established
alternative voice communication providers, such as Vonage, Google Voice, Ooma, and Skype, which is another non-interconnected voice
provider, and may face competition from other large, well-capitalized Internet companies. In addition, we compete with independent
broadband telephone service providers.
Increased competition
may result in our competitors using aggressive business tactics, including providing financial incentives to customers, selling
their products or services at a discount or loss, offering products or services similar to our products and services on a bundled
basis at a discounted rate or no charge, announcing competing products or services combined with aggressive marketing efforts,
and asserting intellectual property rights or claims, irrespective of their validity.
We believe that some
of our existing competitors may choose to consolidate or may be acquired in the future. Additionally, some of our competitors
may enter into alliances or joint ventures with each other or establish or strengthen relationships with other third parties.
Any such consolidation, acquisition, alliance, joint venture or other relationship could adversely affect our ability to compete
effectively, lead to pricing pressure, our loss of market share and could harm our business, results of operations and financial
condition.
magicJack may
face difficulty in attracting new customers, and if we fail to attract new customers, our business and results of operations may
suffer.
Most traditional wireline
and wireless telephone service providers and cable companies are substantially larger and better capitalized than us and have the
advantage of a large existing customer base. Because most of our customers are purchasing communications services from one or more
of these providers, our success is dependent upon our ability to attract customers away from their existing providers. In addition,
these competitors could focus their substantial financial resources to develop competing technology that may be more attractive
to potential customers than what we offer. Our competitors’ financial resources may allow them to offer services at prices
below cost or even for free in order to maintain and gain market share or otherwise improve their competitive positions.
magicJack’s
competitors also could use their greater financial resources to offer broadband telephone service with more attractive service
packages that include on-site installation and more robust customer service. In addition, because of the other services that our
competitors provide, they may choose to offer broadband telephone service as part of a bundle that includes other products, such
as video, high speed Internet access and wireless telephone service, which we do not offer at the present time. This bundle may
enable our competitors to offer broadband telephone service at prices with which we may not be able to compete or to offer functionality
that integrates broadband telephone service with their other offerings, both of which may be more desirable to consumers. Any of
these competitive factors could make it more difficult for us to attract and retain customers to our products, and cause us to
lower our prices in order to compete and reduce our market share and revenues.
magicJack may
be unable to obtain enough phone numbers in desirable area codes to meet demand, which may adversely affect our ability to attract
new customers and our results of operations.
magicJack’s
operations are subject to varying degrees of federal and state regulation. It currently allows customers to select the area code
for their desired phone number from a list of available area codes in cities throughout much of the United States. This selection
may become limited if we are unable to obtain phone numbers, or a sufficient quantity of phone numbers, including certain area
codes, due to exhaustion and consequent shortages of numbers in those area codes, restrictions imposed by federal or state regulatory
agencies, or a lack of telephone numbers made available to us by third parties. If we are unable to provide our customers with
a nationwide selection of phone numbers, or any phone numbers at all, in all geographical areas and is unable to obtain telephone
numbers from another alternative source, or is required to incur significant new costs in connection with obtaining such phone
numbers, our relationships with current and future customers may be damaged, causing a shortfall in expected revenue, increased
customer attrition, and an inability to attract new customers. As a result, our business, results of operations and financial condition
could be materially and adversely affected.
If magicJack’s
services are not commercially accepted by customers, our prospects for growth will suffer.
Our success in deriving
a substantial amount of revenues from magicJack’s broadband telephone service offering sold to consumers and businesses relies
on the commercial acceptance of our offering from consumers and business. Although we currently sell our services to a number of
customers, it cannot be certain that future customers will find our services attractive. If customer demand for our services does
not develop or develops more slowly than anticipated, it would have a material adverse effect on our business, results of operations
and financial condition. Our success relies on the commercial acceptance of our offering from these advertisers and retailers.
magicJack is not currently selling its advertising and retailing services and it cannot be certain future online advertisers and
retailers will find its services attractive. If demand for these services does not develop or develops more slowly than anticipated,
it would have a material adverse effect on our business, results of operations and financial condition.
If magicJack
is unable to retain its existing customers, our revenue and results of operations would be adversely affected.
We offer magicJack
services pursuant to a subscriber agreement that ranges generally from one month to five years in duration and allows our customers
to gain access to our servers for telephone calls. Our customers do not have an obligation to renew their subscriber agreement
after their initial term period expires, and these agreements may not be renewed on the same or on more profitable terms. As a
result, our ability to grow depends in part on retaining customers for renewals. We may not be able to accurately predict future
trends in customer renewals, and our customers’ renewal rates may decline or fluctuate because of several factors, including
their satisfaction or dissatisfaction with our services, the prices of our services, the fees imposed by government entities, the
prices of comparable services offered by our competitors or reductions in our customers’ spending levels. If our customers
do not renew their services, renew on less favorable terms, or do not purchase additional functionality, our revenue may grow more
slowly than expected or decline, and our profitability and gross margins may be harmed.
The market for
magicJack’s services and products is characterized by rapidly changing technology and our success will depend on our ability
to enhance our existing service and product offerings and to introduce new services and products on a timely and cost effective
basis.
The market for magicJack’s
services and products is characterized by rapidly changing enabling technology, frequent enhancements and evolving industry standards.
Our continued success depends on our ability to accurately anticipate the evolution of new products and technologies and to enhance
our existing products and services. Historically, several factors have deterred consumers and businesses from using voice over
broadband service, including security concerns, inconsistent quality of service, increasing broadband traffic and incompatible
software products. If we are unable to continue to address those concerns and foster greater consumer demand for our products and
services, our business and results of operations will be adversely affected.
Our success also depends
on our ability to develop and introduce innovative new magicJack services and products that gain market acceptance. We may not
be successful in selecting, developing, manufacturing and marketing new products and services or enhancing existing products and
services on a timely basis. We may experience difficulties with software development, industry standards, design or marketing that
could delay or prevent our development, introduction or implementation of new products, services and enhancements. The introduction
of new products or services by competitors, the emergence of new industry standards or the development of entirely new technologies
to replace existing service offerings could render our existing or future services obsolete. If our services become obsolete due
to wide-spread adoption of alternative connectivity technologies, our ability to generate revenue may be impaired. In addition,
any new markets into which we attempt to sell our services, including new countries or regions, may not be receptive. If we are
unable to successfully develop or acquire new products or services, enhance our existing products or services to anticipate and
meet customer preferences or sell magicJack products and services into new markets, our revenue and results of operations would
be adversely affected.
We may be unsuccessful
in protecting our proprietary rights or may have to defend ourselves against claims of infringement, which could impair or significantly
affect our business.
Our means of protecting
our proprietary rights may not be adequate and our competitors may independently develop technology that is similar ours. Legal
protections afford only limited protection for our technology. The laws of many countries do not protect our proprietary rights
to as great an extent as do the laws of the United States. Despite our efforts to protect our proprietary rights, unauthorized
parties have in the past attempted, and may in the future attempt, to copy aspects of our products or to obtain and use information
that it regards as proprietary. Third parties may also design around our proprietary rights, which may render our protected products
less valuable, if the design around is favorably received in the marketplace. In addition, if any our products or the technology
underlying our products is covered by third-party patents or other intellectual property rights, we could be subject to various
legal actions.
We cannot assure you
that our products do not infringe intellectual property rights held by others or that they will not in the future. Third parties
may assert infringement, misappropriation, or breach of license claims against us from time to time. Such claims could cause
us to incur substantial liabilities and to suspend or permanently cease the use of critical technologies or processes or the production
or sale of major products. Litigation may be necessary to enforce our intellectual property rights, to protect our trade secrets,
to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity,
misappropriation, or other claims. Any such litigation could result in substantial costs and diversion of our resources, which
in turn could materially adversely affect our business and financial condition. Moreover, any settlement of or adverse judgment
resulting from such litigation could require us to obtain a license to continue to use the technology that is the subject of the
claim, or otherwise restrict or prohibit our use of the technology. Any required licenses may not be available to us on acceptable
terms, if at all. If we attempt to design around the technology at issue or to find another provider of suitable alternative technology
to permit it to continue offering applicable software or product solutions, our continued supply of software or product solutions
could be disrupted or our introduction of new or enhanced software or products could be significantly delayed.
magicJack’s
products must comply with various domestic and international regulations and standards and failure to do so could have an adverse
effect on our business, operating results and financial condition.
magicJack’s
products must comply with various domestic and international regulations and standards defined by regulatory agencies. If it does
not comply with existing or evolving industry standards and other regulatory requirements or if we fail to obtain in
a timely manner any required domestic or foreign regulatory approvals or certificates, we will not be able to sell our products
where these standards or regulations apply, which may harm our business. Moreover, distribution partners or customers may require
us, or we may otherwise deem it necessary or advisable, to alter our products to address actual or anticipated changes in the regulatory
environment. Our inability to alter our products to address these requirements and any regulatory changes could have a material
adverse effect on our business, financial condition, and operating results.
magicJack’s
emergency and E911 calling services are different from those offered by traditional wireline telephone companies and may expose
us to significant liability.
While we do not believe
that we are currently subject to regulatory requirements to provide such capability, we provide our customers with emergency calling
services/E911 calling services (“E911”) that significantly differ from the emergency calling services offered by traditional
wireline telephone companies. Those differences may cause significant delays, or even failures, in callers’ receipt of the
emergency assistance they need. Traditional wireline telephone companies route emergency calls from a fixed location over a dedicated
infrastructure directly to an emergency services dispatcher at the public safety answering point (“PSAP”) in
the caller’s area. Generally, the dispatcher automatically receives the caller’s phone number and actual location information.
Because the magicJack devices are portable or nomadic, the only way we can determine to which PSAP to route an emergency call,
and the only location information that our E911 service can transmit to a dispatcher at a PSAP is the information that our customers
have registered with us. A customer’s registered location may be different from the customer’s actual location at the
time of the call because customers can use their magicJack devices to make calls almost anywhere a broadband connection is available.
Significant delays may occur in a customer updating its registered location information, and in applicable databases being updated
and new routing implemented once a customer has provided new information. If our customers encounter delays when making emergency
services calls and any inability to route emergency calls properly, or of the answering point to automatically recognize the caller’s
location or telephone number, such delays can have devastating consequences. Customers may, in the future, attempt to hold us responsible
for any loss, damage, personal injury or death suffered as a result.
Traditional phone
companies also may be unable to provide the precise location or the caller’s telephone number when their customers place
emergency calls. However, traditional phone companies are covered by federal legislation exempting them from liability for failures
of emergency calling services, and magicJack is not afforded such protection. In addition, magicJack has lost, and may in the
future lose, existing and prospective customers because of the limitations inherent in our emergency calling services. Additionally,
service interruptions from our third-party providers could cause failures in our customers’ access to E911 services. Any
of these factors could cause us to lose revenues, incur greater expenses or cause our reputation or financial results to suffer.
State and local
governments may seek to impose E911 fees.
Many state and local
governments have sought to impose fees on customers of VoIP providers, or to collect fees from VoIP providers, to support implementation
of E911 services in their area. The application of such fees with respect to magicJack users and use is not clear because various
statutes and regulations may not cover our services, we do not bill our customers monthly, nor do we bill customers at all for
telecommunication services. We may also not know the end user’s location because the magicJack devices and services are
nomadic. Should a regulatory authority require payment of money from us for such support, we may be required to develop a mechanism
to collect fees from our customers, which may or may not be satisfactory to the entity requesting us to be a billing agent. We
cannot predict whether the collection of such additional fees or limitations on where our services are available would impact
customers’ interest in purchasing our products.
In settlement of litigation,
magicJack agreed that it would, at least once a year, issue bills for 911 emergency calling services to each user who has access
to 911 services through their magicJack services, and who has provided a valid address in a U.S. jurisdiction that provides access
to 911 services and which is legally empowered to impose 911 charges on such users in accordance with applicable state and/or local
law.
Certain
E911 regulatory authorities have asserted or may assert in the future that we are liable for damages, including end user
assessed E911 taxes, surcharges and/or fees, for not having billed and collected E911 fees from our customers in the past or in
the future. If a jurisdiction were to prevail in such claims, the decision could have a material adverse effect on our financial
condition and results of operations.
Increases in
credit card processing fees and high chargeback costs would increase our operating expenses and adversely affect our results of
operations, and an adverse change in, or the termination of, magicJack’s relationship with any major credit card company
would have a severe, negative impact on our business.
A significant number
of magicJack’s customers purchase its products through magicJack’s website and pay for its products and services using
credit or debit cards. The major credit card companies or the issuing banks may increase the fees that they charge for transactions
using their cards. An increase in those fees would require us to either increase the prices we charge for our products, or suffer
a negative impact on our profitability, either of which could adversely affect our business, financial condition and results of
operations.
We have potential
liability for chargebacks associated with the transactions we process, or that are processed on our behalf by merchants selling
our products. If a customer returns his or her magicJack products at any time, or claims that magicJack’s product was purchased
fraudulently, the returned product is “charged back” to magicJack or its bank, as applicable. If magicJack or its sponsoring
banks are unable to collect the chargeback from the merchant’s account, or, if the merchant refuses or is financially unable,
due to bankruptcy or other reasons, to reimburse the merchant’s bank for the chargeback, we bear the loss for the amount
of the refund paid.
We are vulnerable
to credit card fraud, as we sell magicJack products directly to customers through our website. Card fraud occurs when a customer
uses a stolen card (or a stolen card number in a card-not-present-transaction) to purchase merchandise or services. In a traditional
card-present transaction, if the merchant swipes the card, receives authorization for the transaction from the card issuing bank
and verifies the signature on the back of the card against the paper receipt signed by the customer, the card issuing bank remains
liable for any loss. In a fraudulent card-not-present transaction, even if the merchant or magicJack receive authorization for
the transaction, magicJack or the merchant are liable for any loss arising from the transaction. Because sales made directly from
magicJack’s website are card-not-present transactions, we are more vulnerable to customer fraud. We are also subject to acts
of consumer fraud by customers that purchase magicJack products and services and subsequently claim that such purchases were not
made.
In addition, as a
result of high chargeback rates or other reasons beyond our control, the credit card companies or issuing bank may terminate their
relationship with magicJack, and there are no assurances that it will be able to enter into a new credit card processing agreement
on similar terms, if at all. Upon a termination, if magicJack’s credit card processor does not assist it in transitioning
its business to another credit card processor, or if magicJack were not able to obtain a new credit card processor, the negative
impact on our liquidity likely would be significant. The credit card processor may also prohibit magicJack from billing discounts
annually or for any other reason. Any increases in the magicJack’s credit card fees could adversely affect our results of
operations, particularly if we elect not to raise our service rates to offset the increase. The termination of magicJack’s
ability to process payments on any major credit or debit card, due to high chargebacks or otherwise, would significantly impair
our ability to operate our business.
Flaws in magicJack’s
technology and systems could cause delays or interruptions of service, damage our reputation, cause us to lose customers and limit
our growth.
Our service could
be disrupted by problems with magicJack technology and systems, such as malfunctions in our software or other facilities and overloading
of our servers. Our customers could experience interruptions in the future as a result of these types of problems. Interruptions
could in the future cause us to lose customers, which could adversely affect our revenue and profitability. In addition, because
magicJack’s systems and our customers’ ability to use our services are Internet-dependent, our services may be subject
to “hacker attacks” from the Internet, which could have a significant impact on our systems and services. If service
interruptions adversely affect the perceived reliability of our service, it may have difficulty attracting and retaining customers
and our brand reputation and growth may suffer.
We depend on
overseas manufacturers, and for certain magicJack products, third-party suppliers, and our reputation and results of operations
would be harmed if these manufacturers or suppliers fail to meet magicJack’s requirements.
The manufacture of
the magicJack devices is conducted by a manufacturing company in China, and certain parts are produced in Taiwan
and Hong Kong. These manufacturers supply substantially all of the raw materials and provide all facilities and labor required
to manufacture our products. If these companies were to terminate their arrangements with us or fail to provide the required capacity
and quality on a timely basis, either due to actions of the manufacturers; earthquakes, typhoons, tsunamis, fires, floods, or other
natural disasters; or the actions of their respective governments, we would be unable to manufacture our products until replacement
contract manufacturing services could be obtained. To qualify a new contract manufacturer, familiarize it with the magicJack products,
quality standards and other requirements, and commence volume production is a costly and time-consuming process. We cannot assure
you that we would be able to establish alternative manufacturing relationships on acceptable terms or in a timely manner that would
not cause disruptions in our supply. Any interruption in the manufacture of our products would be likely to result in delays in
shipment, lost sales and revenue and damage to our reputation in the market, all of which would harm our business and results of
operations. In addition, while the magicJack contract obligations with its contract manufacturer in China is denominated in U.S. dollars,
changes in currency exchange rates could impact our suppliers and increase our prices.
We rely on independent
retailers to sell the magicJack devices, and disruption to these channels would harm our business.
Because we sell a
significant amount of the magicJack devices, other devices and certain services to independent retailers, we are subject to many
risks, including risks related to their inventory levels and support for magicJack’s products. In particular, magicJack’s
retailers maintain significant levels of our products in their inventories. If retailers attempt to reduce their levels of inventory
or if they do not maintain sufficient levels to meet customer demand, our sales could be negatively impacted.
The retailers who
sell magicJack products also sell products offered by its competitors. If these competitors offer the retailers more favorable
terms, those retailers may de-emphasize or decline to carry magicJack’s products. In the future, we may not be able to retain
or attract a sufficient number of qualified retailers. If we are unable to maintain successful relationships with retailers or
to expand our distribution channels, our business will suffer.
To continue this method
of sales, we will have to allocate resources to train vendors, systems integrators and business partners as to the use of our products,
resulting in additional costs and additional time until sales by such vendors, systems integrators and business partners are made
feasible. Our business depends to a certain extent upon the success of such channels and the broad market acceptance of our products.
To the extent that our channels are unsuccessful in selling our products, our revenues and operating results will be adversely
affected.
Many factors out of
our control could interfere with our ability to market, license, implement or support magicJack products with any of our channels,
which in turn could harm our business. These factors include, but are not limited to, a change in the business strategy of magicJack’s
channels, the introduction of competitive product offerings by other companies that are sold through one or more of its channels,
potential contract defaults by one or more of its channels, bankruptcy of one or more distribution channel, or changes in ownership
or management of one or more of its channels. For example, in February 2015, RadioShack Corporation, one of magicJack’s
retail customers, filed a voluntary petition in bankruptcy court. magicJack was owed $1.3 million by RadioShack which it did not
collect and sales to RadioShack were ceased to limit exposure. magicJack made limited sales to the RadioShack entity that emerged
from the bankruptcy proceedings and terminated its relationship with that entity effective as of October 27, 2016. Some of magicJack’s
competitors may have stronger relationships with its channels than magicJack does or offer more favorable terms with respect to
their products, and magicJack has limited control, if any, as to whether those channels implement its products rather than its
competitors’ products or whether they devote resources to market and support its competitors’ products rather than
its offerings. If magicJack fails to maintain relationships with these channels, fails to develop new channels, fails to effectively
manage, train, or provide incentives to existing channels or if these channels are not successful in their sales efforts, sales
of magicJack’s products may decrease and our operating results would suffer.
We may not be
able to maintain adequate customer care during periods of growth or in connection with our addition of new and complex devices
or features, which could adversely affect our ability to grow and cause our financial results to be negatively impacted.
We consider our offshore
customer care to be critically important to acquiring and retaining customers. A portion of our customer care for magicJack products
is provided by third parties located in Costa Rica and the Philippines. This approach exposes us to the risk that we may not maintain
service quality, control or effective management within these business operations. The increased elements of risk that arise from
conducting certain operating processes in some jurisdictions could lead to an increase in reputational risk. Interruptions in our
customer care caused by disruptions at our third-party facilities may cause us to lose customers, which could adversely affect
our revenue and profitability. If our customer base expands rapidly in the U.S. or abroad, we may not be able to expand our outsourced
customer care operations quickly enough to meet the needs of our customer base, and the quality of our customer care will suffer
and our access right renewal rate may decrease. As we broaden our magicJack offerings and its customers build increasingly complex
home networking environments, we will face additional challenges in training our customer care staff. We could face a high turnover
rate among our customer service providers. We intend to have our customer care provider hire and train customer care representatives
in order to meet the needs of our customer base. If they are unable to hire, train and retain sufficient personnel to provide adequate
customer care, we may experience slower growth, increased costs and higher levels of customer attrition, which would adversely
affect our business and results of operations.
If we are unable
to maintain an effective process for local number portability provisioning, our growth may be negatively impacted.
We comply with requests
for local number portability from our customers. Local number portability means that our customers can retain their existing telephone
numbers when subscribing to magicJack’s services, and would in turn allow former customers to retain their telephone numbers
should they subscribe to another carrier. If we are unable to maintain the technology to expedite porting our customers’
numbers, demand for our services may be reduced, and this will adversely affect our revenue and profitability.
If we cannot
continue to obtain key switching elements from magicJack’s primary competitors on acceptable terms, we may not be able to
offer our local voice and data services on a profitable basis, if at all.
We will not be able
to provide our local voice and data services on a profitable basis, if at all, unless we are able to obtain key switching elements
from some of magicJack’s primary competitors on acceptable terms. To offer local voice and data services in a market, we
must connect our servers with other carriers in a specific market. This relationship is governed by an interconnection agreement
or carrier service agreement between us and that carrier. magicJack has such agreements with Verizon, AT&T, XO Communications
Services and CenturyLink in a majority of its markets. If we are unable to continue these relationships, enter into new interconnection
agreements or carrier service agreements with additional carriers in other markets or if these providers liquidate or file for
bankruptcy, our business and profitability may suffer.
Regulatory initiatives
may continue to reduce the maximum rates we are permitted to charge long distance service providers for completing calls by our
customers to customers served by our servers.
The rates that we
charge and is charged by service providers for terminating calls by their customers to customers served by its servers, and for
transferring calls by its customers onto other carriers, cannot exceed rates determined by regulatory authorities. In 2011, the
FCC adopted an order fundamentally overhauling its existing intercarrier compensation (“ICC”) rules, which govern
payments between carriers for exchange traffic. This order established a new ICC regime that will result in the elimination
of virtually all terminating switched access charges and reciprocal compensation payments over a transition period that will end
in 2020. The reductions resulting from these new ICC rules have affected and will continue to affect our revenues and results of
operations.
Regulation of
broadband telephone services are developing and therefore uncertain; and future legislative, regulatory or judicial actions could
adversely impact our business and expose us to liability.
The current regulatory
environment for broadband telephone services is developing and therefore uncertain. The United States and other countries have
begun to assert regulatory authority over broadband telephone service and are continuing to evaluate how broadband telephone service
will be regulated in the future. Both the application of existing rules to us and our competitors and the effects of future regulatory
developments are uncertain. Future legislative, judicial or other regulatory actions could have a negative effect on our business.
If its VoIP telephony service or our other magicJack products and services become subject to the rules and regulations applicable
to telecommunications providers, if current broadband telephone service rules are expanded and applied to us, or if additional
rules and regulations applicable specifically to broadband telephone services are adopted, we may incur significant compliance
costs, and we may have to restructure our service offerings, exit certain markets or start charging for our services at least to
the extent of regulatory costs or requirements, any of which could cause our services to be less attractive to customers. We are
faced, and may continue to face, difficulty collecting such charges from our customers and/or carriers, and collecting such charges
may cause us to incur legal fees. We may be unsuccessful in collecting all of the regulatory fees owed to us. The imposition of
any such additional regulatory fees, charges, taxes and regulations on VoIP communications services could materially increase our
costs and may limit or eliminate our competitive pricing advantages.
Regulatory and governmental
agencies may determine that we should be subject to rules applicable to certain broadband telephone service providers or seek to
impose new or increased fees, taxes, and administrative burdens on broadband telephone service providers. We also may change our
product and service offerings in a manner that subjects us to greater regulation and taxation. Such obligations could include requirements
that we contribute directly to federal or state Universal Service Funds. We may also be required to meet various disability access
requirements, number portability obligations, and interception or wiretapping requirements, such as the Communications Assistance
for Law Enforcement Act. The imposition of such regulatory obligations or the imposition of additional federal, state or local
taxes on our services could increase our cost of doing business and limit our growth.
We offer our magicJack
products and services in other countries, and therefore could also be subject to regulatory risks in each such foreign jurisdiction,
including the risk that regulations in some jurisdictions will prohibit us from providing our services cost-effectively or at all,
which could limit our growth. Currently, there are several countries where regulations prohibit us from offering service. In addition,
because customers can use our services almost anywhere that a broadband Internet connection is available, including countries where
providing broadband telephone service is illegal, the governments of those countries may attempt to assert jurisdiction over us.
Violations of these laws and regulations could result in fines, criminal sanctions against us, our officers or our employees, and
prohibitions on the conduct of our business. Any such violations could include prohibitions on our ability to offer our products
and services in one or more countries, could delay or prevent potential acquisitions, expose us to significant liability and regulation
and could also materially damage our reputation, our brand, our international expansion efforts, our ability to attract and retain
employees, our business and our operating results. Our success depends, in part, on our ability to anticipate these risks and manage
these difficulties.
The success
of our business relies on customers’ continued and unimpeded access to broadband service. Providers of broadband services
may be able to block our services or charge their customers more for also using our services, which could adversely affect our
revenue and growth.
Our customers
must have broadband access to the Internet in order to use our service. Providers of broadband access, some of whom are also competing
providers of voice services, may take measures that affect their customers’ ability to use our service, such as degrading
the quality of the data packets they transmit over their lines, giving those packets low priority, giving other packets higher
priority than ours, blocking our packets entirely or attempting to charge their customers more for also using our services.
In 2015, the FCC adopted
net neutrality rules that prohibited broadband providers from: 1) blocking legal content, applications, services, or non-harmful
devices; 2) impairing or degrading lawful Internet traffic on the basis of content, applications, services, or non-harmful devices;
3) engaging in paid prioritization by favoring some lawful Internet traffic over other lawful traffic in exchange for consideration
of any kind or by prioritizing content and services of their affiliates; and 4) unreasonably interfering with or unreasonably disadvantaging
the ability of consumers to select, access, and use the lawful content, applications, services, or devices of their choosing; or
of edge providers to make lawful content, applications, services, or devices available to consumers. In doing so, the FCC reclassified
broadband Internet access - the retail broadband service mass-market customers buy from cable, phone, and wireless providers -
as a telecommunications service regulated under Title II of the Communications Act of 1934, although the FCC agreed to forbear
from many requirements of Title II. Significantly, these rules applied equally to fixed and mobile broadband networks.
After the FCC’s
new net neutrality rules went into effect in June 2015, various broadband providers and their trade associations challenged the
FCC’s decision before the U.S. Court of Appeals for the D.C. Circuit. In June 2016, the D.C. Circuit issued its decision
upholding the FCC’s rules. The D.C. Circuit also denied various petitions seeking rehearing en banc of the court’s
decision. Various parties have sought review by the United States Supreme Court of the D.C. Circuit’s decision, which
remains pending. We cannot predict the outcome of these proceedings.
In December 2017,
the FCC adopted its “Restoring Internet Freedom Order,” which: 1) restored the classification of broadband Internet
access services as unregulated information services, ending Title II regulation of these services; 2) eliminated the FCC’s
three “bright-line” net neutrality rules; 3) eliminated the FCC’s “general conduct” rule; and 4)
adopted a new transparency rule.
Multiple parties filed
petitions seeking judicial review of the “Restoring Internet Freedom Order,” which were consolidated and heard by
the United States Court of Appeals for the D.C. Circuit. In October 2019, the D.C. Circuit largely upheld the FCC decision
to eliminate legal prohibitions against broadband providers blocking, throttling, or otherwise degrading the quality of our data
packets or attempting to extract additional fees from us or our customers, which could adversely impact our business.
We may be bound
by certain FCC regulations relating to the provision of E911 service, and if we fail to comply with FCC regulations requiring us
to provide E911 emergency calling services, we may be subject to fines or penalties.
In 2005, the FCC issued
regulations requiring interconnected voice-over broadband providers to provide E911 services and to notify customers of any differences
between the broadband telephone service emergency calling services and those available through traditional telephone providers
and obtain affirmative acknowledgments from customers of those notifications. In 2019, the FCC adopted rules broadening the scope
of its E911 requirements, including imposing 911 obligations on outbound VoIP providers – obligations that will take effect
in two years.
Limitations on our
ability to provide E911 service or comply with the FCC’s new mandates could materially limit our growth and have a material
adverse effect on our profitability. We could be subjected to various fines and forfeitures. FCC rulings could also subject us
to greater regulation in some states.
Regulatory rulings
and/or carrier disputes could affect the manner in which we interconnect and exchange traffic with other providers and the costs
and revenues associated with doing so.
We exchange calls
with other providers pursuant to applicable law and interconnection agreements and other carrier contracts that define the rates,
terms, and conditions applicable to such traffic exchange. The calls we exchange originate from and terminate to a customer that
uses a broadband Internet connection to access our services and are routed using telephone numbers of the customer’s choosing.
There is uncertainty, however, with respect to intercarrier compensation for such traffic while rules continue to be challenged
in various courts. The FCC Report and Order issued in November 2011 has asserted its jurisdiction over such traffic. Various state
commissions have also issued rulings with respect to the exchange of different categories of traffic under interconnection agreements.
To the extent that another provider were to assert that the traffic we exchanges with them is subject to higher levels of compensation
than we, or the third parties terminating our traffic to the PSTN, pay today (if any), or if other providers from whom we currently
collect compensation for the exchange of such traffic refuse to pay it going forward, we may need to seek regulatory relief to
resolve such a dispute. Given the recent changes to the intercarrier compensation regime, we cannot guarantee that the outcome
of any proceeding would be favorable, and an unfavorable ruling could adversely affect the amounts we collect and/or pay to other
providers in connection with the exchange of our traffic. The FCC clarified in January 2015 that its VoIP symmetry rule does not
require a CLEC or its VoIP provider partner to provide the physical last-mile facility to the VoIP provider’s end user customers
in order to provide the functional equivalent of end office switching, and thus for the CLEC to be eligible to assess access charges
for this service. The ruling confirms that the VoIP symmetry rule is technology and facilities neutral and applies regardless
of whether a CLEC’s VoIP partner is a facilities-based or over-the-top VoIP provider. However, in November 2016, the U.S.
Court of Appeals for the D.C. Circuit vacated the FCC’s ruling. In December 2019, the Federal
Communications Commission (FCC) issued an order on remand revisiting its interpretation of the VoIP symmetry rule, concluding
that LECs may assesses end office switched access charges only if the LEC or its VoIP partner provides a physical connection to
the last-mile facilities used to serve an end user. If neither the LEC nor its VoIP partner provides such physical connection,
it is not providing the functional equivalent of end office switched access and the LEC may not assess end office switched access
charges. The FCC also decided to give its order retroactive effect to “prevent an undue hardship being worked upon
those parties who properly interpreted the VoIP Symmetry Rule and have been in disputes ever since.” We are
still assessing the impact of this recent FCC order that will affect the amounts we collect and/or pay to other providers in connection
with the exchange of our traffic.
Server failures
or system breaches could cause delays or adversely affect our service quality, which may cause us to lose customers and revenue.
In operating our servers,
we may be unable to connect and manage a large number of customers or a large quantity of traffic at high speeds. Any failure or
perceived failure to achieve or maintain high-speed data transmission could significantly reduce demand for our magicJack services
and adversely affect our operating results. In addition, computer viruses, break-ins, human error, natural disasters and other
problems may disrupt our servers. The system security and stability measures we implement may be circumvented in the future or
otherwise fail to prevent the disruption of our services. The costs and resources required to eliminate computer viruses and other
security problems may result in interruptions, delays or cessation of services to our customers, which could decrease demand, decrease
our revenue and slow our planned expansion.
Hardware and
software failures, delays in the operation of magicJack’s computer and communications systems or the failure to implement
system enhancements may harm our business.
Our success depends
on the efficient and uninterrupted operation of magicJack’s software and communications systems. A failure of our servers
could impede the delivery of services, customer orders and day-to-day management of our business and could result in the corruption
or loss of data. Despite any precautions we may take, damage from fire, floods, hurricanes, power loss, telecommunications failures,
computer viruses, break-ins and similar events at our various facilities could result in interruptions in the flow of data to our
servers and from our servers to our customers. In addition, any failure by our computer environment to provide our required telephone
communications capacity could result in interruptions in our service. Additionally, significant delays in the planned delivery
of system enhancements and improvements, or inadequate performance of the systems once they are completed, could damage our reputation
and harm our business. Finally, long-term disruptions in infrastructure caused by events such as natural disasters, the outbreak
of war, the escalation of hostilities, and acts of terrorism (particularly involving cities in which it has offices) could adversely
affect our business. Although we maintain general liability insurance, including coverage for errors and omissions, this coverage
may be inadequate, or may not be available in the future on reasonable terms, or at all. We cannot assure you that this policy
will cover any claim against us for loss of data or other indirect or consequential damages and defending a lawsuit, regardless
of its merit, could be costly and divert management’s attention. In addition to potential liability, if we experience interruptions
in our ability to supply our services, our reputation could be harmed and we could lose customers.
Our magicJack
service requires an operative broadband connection, and if the adoption of broadband does not progress as expected, the market
for our services will not grow and we may not be able to grow our business and increase our revenue.
Use of magicJack’s
service requires that the user be a subscriber to an existing broadband Internet service, most typically provided through a cable
or digital subscriber line, or DSL, connection. Although the number of broadband subscribers in the U.S. and worldwide has grown
significantly over the last five years, this service has not yet been adopted by all consumers and is not available in every part
of the United States and Canada, particularly rural locations. If the adoption of broadband services does not continue to grow,
the market for our services may not grow.
Our magicJack
business is subject to privacy and online security risks, including security breaches, and we could be liable for such breaches
of security. If we are unable to protect the privacy of our customers making calls using our service, or information obtained from
our customers in connection with their use or payment of our services, in violation of privacy or security laws or expectations,
we could be subject to significant liability and damage to our reputation.
Although we have developed
systems and processes that are designed to protect customer information and prevent fraudulent transactions, data loss and other
security breaches, such systems and processes may not be sufficient to prevent fraudulent transactions, data loss and other security
breaches. Failure to prevent or mitigate such breaches may adversely affect our operating results.
Customers may believe
that using our services to make and receive telephone calls using their broadband connection could result in a reduction of their
privacy, as compared to traditional wireline carriers. Additionally, our website, www.magicJack.com, serves as an online sales
portal. We currently obtain and retain personal information about our website users in connection with such purchases.
In addition, we obtain personal information about our customers as part of their registration to use our products and services.
Federal, state and foreign governments have enacted or may enact laws or regulations regarding the collection and use of personal
information.
Our business involves
the storage and transmission of users’ proprietary information, and security breaches could expose us to a risk of loss or
misuse of this information, litigation, and potential liability. An increasing number of websites, including several other Internet
companies, have recently disclosed breaches of their security, some of which have involved sophisticated and highly targeted attacks
on portions of their sites. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage
systems, change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques
or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception
of the effectiveness of our security measures could be harmed and we could lose users. A party that is able to circumvent our security
measures could misappropriate magicJack’s or its users’ proprietary information, cause interruption in our operations,
damage our computers or those of our users, or otherwise damage our reputation and business. Any compromise of our security could
result in a violation of applicable privacy and other laws, significant legal and financial exposure, damage to our reputation,
and a loss of confidence in our security measures, which could harm our business.
Currently, a significant
number of our users authorize it to bill their credit card accounts directly for all transaction fees charged by us. We rely on
encryption and authentication technology licensed from third parties to provide the security and authentication to effectively
secure transmission of confidential information, including customer credit card numbers. Advances in computer capabilities, new
discoveries in the field of cryptography or other developments may result in the technology used by us to protect transaction data
being breached or compromised. Non-technical means, for example, actions by a suborned employee, can also result in a data breach.
Possession and use
of personal information in conducting our business subjects it to legislative and regulatory burdens that could require notification
of data breach, restrict our use of personal information and hinder our ability to acquire new customers or market to existing
customers. We may incur expenses to comply with privacy and security standards and protocols imposed by law, regulation, industry
standards or contractual obligations.
Under payment card
rules and magicJack’s contracts with its card processors, if there is a breach of payment card information that we store,
we could be liable to the payment card issuing banks for their cost of issuing new cards and related expenses. In addition, if
we fail to follow payment card industry security standards, even if there is no compromise of customer information, we could incur
significant fines or lose our ability to give customers the option of using payment cards to fund their payments or pay their fees.
If we were unable to accept payment cards, our business would be seriously damaged.
Our servers are also
vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions. We may need to expend significant resources
to protect against security breaches or to address problems caused by breaches. These issues are likely to become more difficult
as we expand the number of places where we operate. Security breaches, including any breach by us or by parties with which we have
commercial relationships that result in the unauthorized release of magicJack’s users’ personal information, could
damage our reputation and expose us to a risk of loss or litigation and liability. Our insurance policies carry coverage limits
that may not be adequate to reimburse it for losses caused by security breaches.
magicJack’s
users, as well as those of other prominent Internet companies, have been and will continue to be targeted by parties using fraudulent
“spoof” and “phishing” emails to misappropriate passwords, credit card numbers, or other personal information
or to introduce viruses or other malware through “trojan horse” programs to magicJack’s users’ computers.
These emails appear to be legitimate emails sent by magicJack, but direct recipients to fake websites operated by the sender of
the email or request that the recipient send a password or other confidential information via email or download a program. Despite
our efforts to mitigate “spoof” and “phishing” emails through product improvements and user education,
“spoof” and “phishing” remain a serious problem that may damage our brands, discourage use of our websites,
and increase our costs.
We have a stringent
privacy policy covering the information we collect from our customers and have established security features to protect this information.
However, our security measures may not prevent security breaches. We may need to expend resources to protect against security breaches
or to address problems caused by breaches. If unauthorized third parties were able to penetrate our security and gain access to,
or otherwise misappropriate, our customers’ personal information or be able to access their telephone calls, it could harm
our reputation and, therefore, our business and magicJack could be subject to liability. Such liability could include claims for
misuse of personal information or unauthorized use of credit cards. These claims could result in litigation, our involvement in
which, regardless of the outcome, could require us to expend significant financial resources. Internet privacy is a rapidly changing
area and we may be subject to future requirements and legislation that are costly to implement and negatively impact our results.
magicJack has
operations located in Israel, and therefore our results may be adversely affected by political, economic and military conditions
in Israel.
magicJack’s
business and operations may be directly influenced by the political, economic and military conditions affecting Israel at any given
time. A change in the security and political situation in Israel could have a material adverse effect on our business, operating
results and financial condition. Since the establishment of the State of Israel in 1948, a number of armed conflicts have
taken place between Israel and its Arab neighbors, including Hezbollah in Lebanon and Hamas in the Gaza Strip. In the
last few years, these conflicts involved missile strikes against civilian targets in various parts of Israel and negatively affected
business conditions in Israel. In addition, political uprisings and conflicts in various countries in the Middle East, including
Syria and Iraq, and including terrorist organizations gaining control and political power in the region such as the Islamic State
of Iraq and Syria, or ISIS, are affecting the political stability of those countries. It is not clear how this instability will
develop and how it will affect the political and security situation in the Middle East.
Our commercial insurance
does not cover losses that may occur as a result of events associated with the security situation in the Middle East. Although
the Israeli government currently covers the reinstatement value of direct damages that are caused by terrorist attacks or acts
of war, we cannot assure you that this government coverage will be maintained. Any losses or damages incurred by us could
have a material adverse effect on our business, operating results and financial condition.
Furthermore, several
countries, principally in the Middle East, restrict doing business with Israel and Israeli companies, and additional countries
may impose restrictions on doing business with Israel and Israeli companies if hostilities in the region continue or intensify. Any
hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could
have a material adverse effect on our business, operating results and financial condition.
Our operations
could be disrupted as a result of the obligation of magicJack’s personnel to perform military service.
Several of magicJack’s
employees reside in Israel and may be required to perform annual military reserve duty and may be called for active duty under
emergency circumstances at any time. Our operations could be disrupted by the absence for a significant period of time of one or
more of these employees due to military service. Any such disruption could adversely affect our business, results of operations
and financial condition.
The failure
of our licensees to sell products that generate royalties to us, to pay us royalties pursuant to their license agreements
with us, or to renew these agreements could negatively affect our results of operations and financial condition.
Our revenues are dependent
on royalty payments made to us under our license agreements. Although some of our license agreements guarantee a minimum
royalty payment to us each year, the failure of our licensees to satisfy these or the other obligations under their agreements
with us, their decision to not renew their agreements with us or their inability to grow or maintain their sales of products bearing
our brands or their businesses generally could cause our revenues to decline. These events or circumstances could occur
for a variety of reasons, many of which are outside our control, including business and operational risks that impact our licensees’
ability to make payments and sell products generally, such as obtaining and maintaining desirable store locations and consumer
acceptance and presence; retaining key personnel, including the specific individuals who work on sales and marketing for products
bearing our brands; and liquidity and capital resources risks. Further, the failure by any of our key licensees or the
concurrent failure by several licensees to meet their financial obligations to us or to renew their respective license agreements
with us could materially and adversely impact our results of operations and our financial condition.
Our brand investment
portfolio is subject to intense competition.
We
hold a majority interest in a brand investment portfolio that is focused on generating revenue through the licensing of trademarks.
Therefore, our degree of success is dependent on the strength of our brands, consumer acceptance of our brands and our licensees’
ability to design, manufacture and sell products bearing our brands, all of which is dependent on the ability of us and our licensees
responding to ever-changing consumer demands. We cannot control the level of consumer acceptance of our brands and changing
preferences and trends may lead customers to purchase other products. Further, we cannot control the level of resources
that our licensees commit to supporting our brands, and our licensees may choose to support products bearing other brands to the
detriment of our brands because our agreements generally do not prevent them from licensing or selling other products, including
products bearing competing brands.
In
addition, we compete with companies that own other brands and trademarks, as these companies could enter into similar licensing
arrangements with retailers and wholesalers in the United States and internationally. These arrangements could be with
our existing retail and wholesale partners, thereby competing with us for consumer attention and limited floor or rack space in
the same stores in which our branded products are sold, and vying with us for the time and resources of the retailers and wholesale
licensees that manufacture and distribute our products. These companies may be able to respond more quickly to changes
in retailer, wholesaler and consumer preferences and devote greater resources to brand acquisition, development and marketing. We
may not be able to compete effectively against these companies.
If
we or our brands are unable to compete successfully against current and future competitors, we may be unable to sustain or increase
demand for products bearing our brands, which could have a material adverse effect on our reputation, prospects, performance and
financial condition.
Our level of indebtedness, and restrictions
under such indebtedness, could adversely affect our operations and liquidity.
Our senior notes include:
(a) “the 6.875% 2023 Notes” with an aggregate principal amount of approximately $106.0 million; (b) “the 7.375%
2023 Notes” with an aggregate principal amount of approximately $122.1 million, (c) “the 7.25% 2027 Notes” with
an aggregate principal amount of $120.1 million; (d) “the 7.50% 2027 Notes” with an aggregate principal amount
of $118.0 million; (e) “2024 Notes” with an aggregate principal amount of approximately $106.6 million;
(f) “2026 Notes” with an aggregate principal amount of approximately $124.2 million and (g) 2025 Notes with
an aggregate principal amount of approximately $132.3 million. The Company periodically enters into At Market Issuance Sales Agreements
with B. Riley FBR. Most recently, the Company entered into the December 2019 Sales Agreement on December 5, 2019 and the February
2020 Sales Agreement on February 14, 2020. Pursuant to the December 2019 Sales Agreement, the Company may sell from time to time,
at the Company’s option, up to the aggregate principal amount of $100.0 million of the 6.875% 2023 Notes, 7.375% 2023
Notes, 2024 Notes, 2026 Notes, 7.25% 2027 Notes and 7.50% 2027 Notes, as well as the Company’s common stock and Depositary
Shares. At December 31, 2019, the Company had $60.8 million available for offer and sale pursuant to the December 2019
Sales Agreement. Pursuant to the February 2020 Sales Agreement, the Company may sell from time to time, at the Company’s
option, up to the aggregate principal amount of $150,000,000 of the 7.25% 2027 Notes, 7.375% 2023 Notes, 6.875% 2023 Notes, 2024
Notes, 2026 Notes, 2025 Notes and Depositary Shares.
On December 19, 2018,
BRPI Acquisition Co LLC (“BRPAC”), a Delaware limited liability company, UOL, and YMAX Corporation, a Delaware corporation
(collectively, the “Borrowers”), indirect wholly owned subsidiaries of ours, in the capacity of borrowers, entered
into a credit agreement with the Banc of California, N.A. in the capacity as agent and lender and with the other lenders party
thereto (the “BRPAC Credit Agreement”). Under the BRPAC Credit Agreement, we borrowed $80.0 million due December 19,
2023. Pursuant to the terms of the BRPAC Credit Agreement, we may request additional optional term loans in an aggregate principal
amount of up to $10.0 million at any time prior to the first anniversary of the agreement date. On February 1, 2019, the Borrowers
entered into the First Amendment to Credit Agreement and Joinder with City National Bank as a new lender in which the new lender
extended to Borrowers the additional $10.0 million as further discussed in Note 10 to the accompanying financial statements.
In April 2017, we amended our Credit Agreement with Wells Fargo Bank (the “Wells Fargo Credit Agreement”) to increase
our retail liquidation line of credit from $100 million to $200 million.
The terms of such
indebtedness contain various restrictions and covenants regarding the operation of our business, including, but not limited to,
restrictions on our ability to merge or consolidate with or into any other entity. We may also secure additional debt financing
in the future in addition to our current debt. Our level of indebtedness generally could adversely affect our operations and liquidity,
by, among other things: (i) making it more difficult for us to pay or refinance our debts as they become due during adverse economic
and industry conditions because we may not have sufficient cash flows to make our scheduled debt payments; (ii) causing us to use
a larger portion of our cash flows to fund interest and principal payments, thereby reducing the availability of cash to fund working
capital, capital expenditures and other business activities; (iii) making it more difficult for us to take advantage of significant
business opportunities, such as acquisition opportunities or other strategic transactions, and to react to changes in market or
industry conditions; and (iv) limiting our ability to borrow additional monies in the future to fund working capital, capital expenditures,
acquisitions and other general corporate purposes as and when needed, which could force us to suspend, delay or curtail business
prospects, strategies or operations.
We may not be able
to generate sufficient cash flow to pay the interest on our debt, and future working capital, borrowings or equity financing may
not be available to pay or refinance such debt. If we are unable to generate sufficient cash flow to pay the interest on our debt,
we may have to delay or curtail our operations. If we are unable to service our indebtedness, we will be forced to adopt an alternative
strategy that may include actions such as reducing capital expenditures, selling assets, restructuring or refinancing our indebtedness
or seeking additional equity capital. These alternative strategies may not be affected on satisfactory terms, if at all, and they
may not yield sufficient funds to make required payments on our indebtedness. If, for any reason, we are unable to meet our debt
service and repayment obligations, we would be in default under the terms of the agreements governing our debt, which could allow
our creditors at that time to declare certain outstanding indebtedness to be due and payable or exercise other available remedies,
which may in turn trigger cross acceleration or cross default rights in other agreements. If that should occur, we may not be able
to pay all such debt or to borrow sufficient funds to refinance it. Even if new financing were then available, it may not be on
terms that are acceptable to us.
Our senior notes
are unsecured and therefore are effectively subordinated to any secured indebtedness that we currently have or that we may incur
in the future.
Our senior notes are
not secured by any of our assets or any of the assets of our subsidiaries. As a result, our senior notes are effectively subordinated
to any secured indebtedness that we or our subsidiaries have currently outstanding or may incur in the future (or any indebtedness
that is initially unsecured to which we subsequently grant security) to the extent of the value of the assets securing such indebtedness.
The indenture governing our senior notes does not prohibit us or our subsidiaries from incurring additional secured (or unsecured)
indebtedness in the future. In any liquidation, dissolution, bankruptcy or other similar proceeding, the holders of any of our
existing or future secured indebtedness and the secured indebtedness of our subsidiaries may assert rights against the assets pledged
to secure that indebtedness and may consequently receive payment from these assets before they may be used to pay other creditors,
including the holders of our senior notes.
Our senior notes
are structurally subordinated to the indebtedness and other liabilities of our subsidiaries.
Our senior notes are
obligations exclusively of the Company and not of any of our subsidiaries. None of our subsidiaries is a guarantor of our senior
notes, and our senior notes are not required to be guaranteed by any subsidiaries we may acquire or create in the future. Therefore,
in any bankruptcy, liquidation or similar proceeding, all claims of creditors (including trade creditors) of our subsidiaries will
have priority over our equity interests in such subsidiaries (and therefore the claims of our creditors, including holders of our
senior notes) with respect to the assets of such subsidiaries. Even if we are recognized as a creditor of one or more of our subsidiaries,
our claims would still be effectively subordinated to any security interests in the assets of any such subsidiary and to any indebtedness
or other liabilities of any such subsidiary senior to our claims. Consequently, our senior notes will be structurally subordinated
to all indebtedness and other liabilities (including trade payables) of any of our subsidiaries and any subsidiaries that we may
in the future acquire or establish as financing vehicles or otherwise. The indenture governing our senior notes does not prohibit
us or our subsidiaries from incurring additional indebtedness in the future. In addition, future debt and security agreements entered
into by our subsidiaries may contain various restrictions, including restrictions on payments by our subsidiaries to us and the
transfer by our subsidiaries of assets pledged as collateral.
The indenture
under which our senior notes were issued contains limited protection for holders of our senior notes.
The
indenture under which our senior notes were issued offers limited protection to holders of our senior notes. The terms of the
indenture and our senior notes do not restrict our or any of our subsidiaries’ ability to engage in, or otherwise be a party
to, a variety of corporate transactions, circumstances or events that could have an adverse impact on the holders of our senior
notes. In particular, the terms of the indenture and
our senior notes do not place any restrictions on our or our subsidiaries’ ability to:
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issue
debt securities or otherwise incur additional indebtedness or other obligations, including
(1) any indebtedness or other obligations that would be equal in right of payment to
our senior notes, (2) any indebtedness or other obligations that would be secured and
therefore rank effectively senior in right of payment to our senior notes to the extent
of the values of the assets securing such debt, (3) indebtedness of ours that is guaranteed
by one or more of our subsidiaries and which therefore is structurally senior to our
senior notes and (4) securities, indebtedness or obligations issued or incurred by our
subsidiaries that would be senior to our equity interests in our subsidiaries and therefore
rank structurally senior to our senior notes with respect to the assets of our subsidiaries;
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pay
dividends on, or purchase or redeem or make any payments in respect of, capital stock
or other securities subordinated in right of payment to our senior notes;
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sell
assets (other than certain limited restrictions on our ability to consolidate, merge
or sell all or substantially all of our assets);
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enter
into transactions with affiliates;
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create
liens (including liens on the shares of our subsidiaries) or enter into sale and leaseback
transactions;
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create
restrictions on the payment of dividends or other amounts to us from our subsidiaries.
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In addition, the indenture
does not include any protection against certain events, such as a change of control, a leveraged recapitalization or “going
private” transaction (which may result in a significant increase of our indebtedness levels), restructuring or similar transactions.
Furthermore, the terms of the indenture and our senior notes do not protect holders of our senior notes in the event that we experience
changes (including significant adverse changes) in our financial condition, results of operations or credit ratings, as they do
not require that we or our subsidiaries adhere to any financial tests or ratios or specified levels of net worth, revenues, income,
cash flow, or liquidity. Also, an event of default or acceleration under our other indebtedness would not necessarily result in
an event of default under our senior notes.
Our ability to recapitalize,
incur additional debt and take a number of other actions that are not limited by the terms of our senior notes may have important
consequences for the holders of our senior notes, including making it more difficult for us to satisfy our obligations with respect
to our senior notes or negatively affecting the trading value of our senior notes.
Other debt we issue
or incur in the future could contain more protections for its holders than the indenture and our senior notes, including additional
covenants and events of default. The issuance or incurrence of any such debt with incremental protections could affect the market
for and trading levels and prices of our senior notes.
An increase
in market interest rates could result in a decrease in the value of our senior notes.
In general, as market
interest rates rise, notes bearing interest at a fixed rate decline in value. Consequently, if the market interest rates increase
after our senior notes were purchased, the market value of our senior notes may decline. We cannot predict the future level of
market interest rates.
An active trading
market for our senior notes may not develop, which could limit the market price of our senior notes or the ability of our senior
note holders to sell them.
The 7.25% 2027 Notes
are quoted on Nasdaq under the symbol “RILYG,” the 7.50% 2027 Notes are quoted on Nasdaq under the symbol “RILYZ,”
the 7.375% 2023 Notes are quoted on Nasdaq under the symbol “RILYH,” the 6.875% 2023 Notes are quoted on Nasdaq under
the symbol “RILYI,” the 2024 Notes are quoted on Nasdaq under the symbol “RILYO,” and the 2026 Notes are
quoted on Nasdaq under the symbol “RILYN.” We cannot provide any assurances that an active trading market will develop
for our senior notes or that our senior note holders will be able to sell their senior notes. If the senior notes are traded after
their initial issuance, they may trade at a discount from their initial offering price depending on prevailing interest rates,
the market for similar securities, our credit ratings, general economic conditions, our financial condition, performance and prospects
and other factors. Accordingly, we cannot assure our senior note holders that a liquid trading market will develop for our senior
notes, that our senior note holders will be able to sell our senior notes at a particular time or that the price our senior note
holders receive when they sell will be favorable. To the extent an active trading market does not develop, the liquidity and trading
price for our senior notes may be harmed. Accordingly, our senior note holders may be required to bear the financial risk of an
investment in our senior notes for an indefinite period of time.
We may issue
additional notes.
Under the terms of
the indenture governing our senior notes, we may from time to time without notice to, or the consent of, the holders of our senior
notes, create and issue additional notes which will be equal in rank to our senior notes. We will not issue any such additional
notes unless such issuance would constitute a “qualified reopening” for U.S. federal income tax purposes.
The rating
for the 7.25% 2027 Notes, 7.375% 2023 Notes, 6.875% 2023 Notes, 2024 Notes, 2026 Notes or 2025 Notes could at any time be revised
downward or withdrawn entirely at the discretion of the issuing rating agency.
We have obtained
a rating for the 7.25% 2027 Notes, 7.375% 2023 Notes, 6.875% 2023 Notes, 2024 Notes, 2026 Notes and 2025 Notes (collectively, the
“Rated Notes”). Ratings only reflect the views of the issuing rating agency or agencies and such ratings could at any
time be revised downward or withdrawn entirely at the discretion of the issuing rating agency. A rating is not a recommendation
to purchase, sell or hold any of the Rated Notes. Ratings do not reflect market prices or suitability of a security for a particular
investor and the rating of the Rated Notes may not reflect all risks related to us and our business, or the structure or market
value of the Rated Notes. We may elect to issue other securities for which we may seek to obtain a rating in the future. If we
issue other securities with a rating, such ratings, if they are lower than market expectations or are subsequently lowered or withdrawn,
could adversely affect the market for or the market value of the Rated Notes.
There is no
established market for the Depositary Shares and the market value of the Depositary Shares could be substantially affected by various
factors.
The Depositary Shares
are a new issue of securities with no established trading market. Although the shares recently began trading on the Nasdaq Global
Market, an active trading market on the Nasdaq Global Market for the Depositary Shares may not develop or last, in which case
the trading price of the Depositary Shares could be adversely affected. If an active trading market does develop on the Nasdaq
Global Market, the Depositary Shares may trade at prices higher or lower than their initial offering price. The
trading price of the Depositary Shares also depends on many factors, including, but not limited to:
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prevailing
interest rates;
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the
market for similar securities;
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general
economic and financial market conditions; and
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the
Company’s financial condition, results of operations and prospects.
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The
Company has been advised by some of the underwriters that they intend to make a market in the Depositary Shares, but they
are not obligated to do so and may discontinue market-making at any time without notice.
The Series
A Preferred Stock and the Depositary Shares rank junior to all of the Company’s indebtedness and other liabilities and are
effectively junior to all indebtedness and other liabilities of the Company’s subsidiaries.
In the event of a
bankruptcy, liquidation, dissolution or winding-up of the affairs of the Company, the Company’s assets will be available
to pay obligations on the 6.875% Series A Cumulative Perpetual Preferred Stock, par value $0.0001 per share (the “Series
A Preferred Stock”), only after all of the Company’s indebtedness and other liabilities have been paid. The rights
of holders of the Series A Preferred Stock to participate in the distribution of the Company’s assets will rank junior to
the prior claims of the Company’s current and future creditors and any future series or class of preferred stock the Company
may issue that ranks senior to the Series A Preferred Stock. In addition, the Series A Preferred Stock effectively ranks junior
to all existing and future indebtedness and other liabilities of (as well as any preferred equity interests held by others in)
the Company’s existing subsidiaries and any future subsidiaries. The Company’s existing subsidiaries are, and any future
subsidiaries would be, separate legal entities and have no legal obligation to pay any amounts to the Company in respect of dividends
due on the Series A Preferred Stock. If the Company is forced to liquidate its assets to pay its creditors, the Company may not
have sufficient assets to pay amounts due on any or all of the Series A Preferred Stock then outstanding. The Company and its subsidiaries
have incurred and may in the future incur substantial amounts of debt and other obligations that will rank senior to the Series
A Preferred Stock. The Company may incur additional indebtedness and become more highly leveraged in the future, which could harm
the Company’s financial position and potentially limit cash available to pay dividends. As a result, the Company may not
have sufficient funds remaining to satisfy its dividend obligations relating to the Series A Preferred Stock if the Company incurs
additional indebtedness.
Future offerings
of debt or senior equity securities may adversely affect the market price of the Depositary Shares. If the Company decides to issue
debt or senior equity securities in the future, it is possible that these securities will be governed by an indenture or other
instrument containing covenants restricting the Company’s operating flexibility. Additionally, any convertible or exchangeable
securities that the Company issues in the future may have rights, preferences and privileges more favorable than those of the Series
A Preferred Stock and may result in dilution to owners of the Depositary Shares. The Company and, indirectly, the Company’s
shareholders, will bear the cost of issuing and servicing such securities. Because the Company’s decision to issue debt or
equity securities in any future offering will depend on market conditions and other factors beyond the Company’s control,
the Company cannot predict or estimate the amount, timing or nature of the Company’s future offerings. Thus, holders of the
Depositary Shares will bear the risk of the Company’s future offerings reducing the market price of the Depositary Shares
and diluting the value of their holdings in the Company.
The Company
may issue additional shares of the Series A Preferred Stock and additional series of preferred stock that rank on a parity with
the Series A Preferred Stock as to dividend rights, rights upon liquidation or voting rights.
The Company is allowed
to issue additional shares of Series A Preferred Stock and additional series of preferred stock that would rank on a parity with
the Series A Preferred Stock as to dividend payments and rights upon the Company’s liquidation, dissolution or winding up
of the Company’s affairs pursuant to the Company’s articles of incorporation and the certificate of designation for
the Series A Preferred Stock without any vote of the holders of the Series A Preferred Stock. The Company’s articles of incorporation
authorize the Company to issue up to 1,000,000 shares of preferred stock in one or more series on terms determined by the
Company’s Board of Directors. Prior to the issuance of Series A Preferred Stock, the Company had no outstanding series of
preferred stock. However, the use of depositary shares enables the Company to issue significant amounts of preferred stock, notwithstanding
the number of shares authorized by the Company’s articles of incorporation. The issuance of additional shares of Series A
Preferred Stock and additional series of parity preferred stock could have the effect of reducing the amounts available to the
Series A Preferred Stockholders upon the Company’s liquidation or dissolution or the winding up of the Company’s affairs.
It also may reduce dividend payments on the Series A Preferred Stock issued and outstanding if the Company does not have sufficient
funds to pay dividends on all Series A Preferred Stock outstanding and other classes of stock with equal priority with respect
to dividends.
In addition, although
holders of the Depositary Shares are entitled to limited voting rights (discussed further below), the holders of the Depositary
Shares will vote separately as a class along with all other outstanding series of the Company’s preferred stock that the
Company may issue upon which like voting rights have been conferred and are exercisable. As a result, the voting rights of holders
of the Depositary Shares may be significantly diluted, and the holders of such other series of preferred stock that the Company
may issue may be able to control or significantly influence the outcome of any vote.
Future issuances
and sales of parity preferred stock, or the perception that such issuances and sales could occur, may cause prevailing market prices
for the Depositary Shares and the Company’s common stock to decline and may adversely affect the Company’s ability
to raise additional capital in the financial markets at times and prices favorable to the Company. Such issuances may also reduce
or eliminate the Company’s ability to pay dividends on the Company’s common stock.
Holders of
Depositary Shares will have extremely limited voting rights.
The voting rights
of holders of Depositary Shares will be limited. The Company’s common stock is the only class of the Company’s securities
that carries full voting rights. Voting rights for holders of Depositary Shares will exist primarily with respect to the ability
to elect (together with the holders of other outstanding series of the Company’s preferred stock, or Depositary Shares representing
interests in the Company’s preferred stock, or additional series of preferred stock the Company may issue in the future and
upon which similar voting rights have been or are in the future conferred and are exercisable) two additional directors to the
Company’s Board of Directors in the event that six quarterly dividends (whether or not declared or consecutive) payable on
the Series A Preferred Stock are in arrears, and with respect to voting on amendments to the Company’s articles of incorporation
or certificate of designation (in some cases voting together with the holders of other outstanding series of the Company’s
preferred stock as a single class) that materially and adversely affect the rights of the holders of Depositary Shares (and other
series of preferred stock, as applicable) or create additional classes or series of the Company’s stock that are senior to
the Series A Preferred Stock, provided that in any event adequate provision for redemption has not been made. Other than the limited
circumstances described in this prospectus supplement, holders of Depositary Shares will not have any voting rights.
The Depositary
Shares have not been rated.
The Series A Preferred
Stock and the Depositary Shares have not been rated and may never be rated. It is possible, however, that one or more rating agencies
might independently decide to assign a rating to the Depositary Shares or that the Company may elect to obtain a rating of the
Depositary Shares in the future. Furthermore, the Company may elect to issue other securities for which the Company may seek to
obtain a rating. If any ratings are assigned to the Depositary Shares in the future or if the Company issues other securities with
a rating, such ratings, if they are lower than market expectations or are subsequently lowered or withdrawn, could adversely affect
the market for, or the market value of, the Depositary Shares.
Ratings reflect the
views of the issuing rating agency or agencies, and such ratings could at any time be revised downward, placed on negative outlook
or withdrawn entirely at the discretion of the issuing rating agency or agencies. Furthermore, a rating is not a recommendation
to purchase, sell or hold any particular security, including the Depositary Shares. Ratings do not reflect market prices or the
suitability of a security for a particular investor, and any future rating of the Depositary Shares may not reflect all risks related
to the Company and its business, or the structure or market value of the Depositary Shares.
The conversion
feature may not adequately compensate the holders, and the conversion and redemption features of the Series A Preferred Stock and
the Depositary Shares may make it more difficult for a party to take over the Company and may discourage a party from taking over
the Company.
Upon the occurrence
of a Delisting Event or Change of Control (each as defined in the certificate of designation for the Series A Preferred Stock),
holders of the Depositary Shares will have the right (unless, prior to the Delisting Event Conversion Date or Change of Control
Conversion Date (each as defined in the certificate of designation for the Series A Preferred Stock), as applicable, the Company
has provided or provide notice of the Company’s election to redeem the Series A Preferred Stock) to direct the depositary
to convert some or all of the Series A Preferred Stock underlying their Depositary Shares into the Company’s common stock
(or equivalent value of alternative consideration), and under these circumstances the Company will also have a special optional
redemption right to redeem the Series A Preferred Stock. Upon such a conversion, the holders will be limited to a maximum number
of shares of the Company’s common stock equal to the Share Cap (as defined in the certificate of designation for the Series
A Preferred Stock) multiplied by the number of shares of Series A Preferred Stock converted. If the Common Stock Price is less
than $11.49 (which is approximately 50% of the closing sale price per share of the Company’s common stock on October 1,
2019), subject to adjustment, the holders will receive a maximum number of shares of the Company’s common stock per depositary
share, which may result in a holder receiving value that is less than the liquidation preference of the Depositary Shares. In addition,
those features of the Series A Preferred Stock and Depositary Shares may have the effect of inhibiting a third party from making
an acquisition proposal for the Company or of delaying, deferring or preventing a change of control of the Company under circumstances
that otherwise could provide the holders of the Company’s common stock and Depositary Shares with the opportunity to realize
a premium over the then-current market price or that shareholders may otherwise believe is in their best interests.
The market
price of the Depositary Shares could be substantially affected by various factors.
The market price of
the Depositary Shares will depend on many factors, which
may change from time to time, including:
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prevailing
interest rates, increases in which may have an adverse effect on the market price of
the Depositary Shares;
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the
annual yield from distributions on the Depositary Shares as compared to yields on other
financial instruments;
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general
economic and financial market conditions;
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government
action or regulation;
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the
financial condition, performance and prospects of the Company and its competitors;
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changes
in financial estimates or recommendations by securities analysts with respect to the
Company, its competitors or the industry in which the Company operates;
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the
Company’s issuance of additional preferred equity or debt securities; and
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actual
or anticipated variations in quarterly operating results of the Company and its competitors.
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As
a result of these and other factors, investors who purchase the Depositary Shares may experience a decrease, which could
be substantial and rapid, in the market price of the Depositary Shares, including decreases unrelated to the Company’s operating
performance or prospects.