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. These risk factors
should be read carefully in connection with evaluating our business and in connection with the forward-looking statements and
other information contained in this Quarterly Report on Form 10-Q. Any of the risks described in this Quarterly Report on Form
10-Q could materially affect our business, financial condition or future results and the actual outcome of matters as to which
forward-looking statements are made. The risk factors below amend and supersede the risk factors previously disclosed in our Annual
Report on Form 10-K for the year ended December 31, 2019.
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, including the effects of the ongoing COVID-19 pandemic, or an outbreak of another
highly infectious or contagious disease.
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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,
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, including the ongoing COVID-19 pandemic, 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 ongoing COVID-19 pandemic), 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.
Adverse
economic developments, like the ongoing COVID-19 pandemic, can have an unpredictable impact on our business. 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; however, temporary limits on businesses due to mandated “social distancing”
measures and “stay at home” work restrictions have limited our ability to conduct auctions and liquidations.
In
addition, weakness or disruption in equity markets, such as the recent market volatility due to the ongoing COVID-19 pandemic,
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, which we are currently experiencing due to the ongoing COVID-19 pandemic. Reductions in the trading
prices for equity securities, such as those that have occurred due to the ongoing COVID-19 pandemic, 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,
such as those that have occurred due to the ongoing COVID-19 pandemic, 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 the current financial market and economic conditions related to the ongoing COVID-19 pandemic
will continue, whether they will further deteriorate and if they do, which of our business lines will be adversely affected. We
are currently being impacted by the ongoing COVID-19 pandemic, including with respect to the above-described risks. While we are
continuing to monitor the spread of COVID-19 and related risks, the rapid development and fluidity of situation precludes any
prediction as to its ultimate impact on us. However, if the spread continues, such impact could grow and our business, financial
condition, results of operations and cash flows could be materially adversely affected.
Global
economic and political uncertainty, in particular due to the ongoing COVID-19 pandemic, 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.
The
ongoing COVID-19 pandemic has caused severe disruptions in the U.S. and global economy, which has impacted the business, activities,
and operations of our customers, as well as our business and operations. In March 2020, the Federal Reserve lowered the target
range for the federal funds rate to a range from 0 to 0.25 percent, citing concerns about the impact of COVID-19 on markets and
stress in the energy sector. Many states and localities have imposed limitations on commercial activity and public gatherings
and events, as well as moratoria on evictions. Concern about the spread of COVID-19 has caused and is likely to continue to cause
quarantines, business shutdowns, reduction in business activity and financial transactions, labor shortages, supply chain interruptions,
increased unemployment and overall economic and financial market instability, all of which may result a decrease in our business.
Such conditions are likely to exacerbate many of the risks described elsewhere in these Risk Factors. Unfavorable economic conditions
may also make it more difficult for us to access the capital markets, use the capital markets for our clients or otherwise obtain
additional financing.
The
continued spread of COVID-19, or a significant outbreak of another contagious disease, could negatively impact the availability
of key personnel necessary to conduct our business, and the business and operations of our third-party service providers who perform
critical services for our business. If COVID-19, or a future highly infectious or contagious disease, is not successfully contained,
we could experience a material adverse effect on our business, financial condition, results of operations and cash flow. Among
the factors outside our control that are likely to affect the impact the COVID-19 pandemic will ultimately have on our business
are:
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the
pandemic’s course and severity;
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the
direct and indirect results of the pandemic, such as recessionary economic trends, including with respect to employment, wages
and benefits and commercial activity;
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political,
legal and regulatory actions and policies in response to the pandemic, including the effects of restrictions on commerce or other
public activities, moratoria and other suspensions of evictions or rent and related obligations;
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the
timing, magnitude and effect of public spending, directly or through subsidies, its direct and indirect effects on commercial
activity and incentives of employers and individuals to resume or increase employment, wages and benefits and commercial activity;
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the
timing and availability of direct and indirect governmental support for various financial assets, and possible related distortions
in market values and liquidity for such assets whose markets have or are assumed to have government support versus possibly similar
assets that do not;
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potential
longer-term effects of increased government spending on the interest rate environment and borrowing costs for non-governmental
parties;
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the
ability of our employees and our third-party vendors to work effectively during the course of the pandemic;
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potential
longer-term shifts toward telecommuting and telecommerce; and
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geographic
variation in the severity and duration of the COVID-19 pandemic, including in states such as New York and California where high
percentages of our clients, customers and personnel are located.
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We
focus principally on certain 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.
Volatility
in the business environment in the industries in which our clients operate 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. For example, 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. Most recently, the consumer goods and services sector
has been severely impacted by the ongoing COVID-19 pandemic, which has resulted in mandatory store closures of uncertain duration
due to “social distancing” measures, “stay at home” work restrictions and the closing of non-essential
businesses imposed to control the pandemic. 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, such as those due to the ongoing COVID-19
pandemic, 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, such as those due to the ongoing
COVID-19 pandemic.
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, widespread outbreaks of disease, such as the ongoing COVID-19 pandemic,
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, the
ongoing COVID-19 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. Due to the ongoing COVID-19 pandemic, many businesses, including ours, have shifted largely to telecommuting. While
we continue to evaluate the situation and invest in our technological infrastructure, the duration and effects of this shift are
uncertain, but could make our operations more vulnerable.
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, such as the recent declines in the stock markets due to the ongoing COVID-19 pandemic, 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
(like the ongoing COVID-19 pandemic), 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, such as those due to the ongoing COVID-19 pandemic,
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, all of which may be negatively
impacted due to the ongoing COVID-19 pandemic.
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,
including disruptions due to the ongoing COVID-19 pandemic, 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. We have experienced losses with respect to our current operations and it is possible
that we may continue to experience losses as we continue to expand our operations and manage disruptions due to the ongoing COVID-19
pandemic. 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 25.4% of our outstanding common
stock as of March 31, 2020. In particular, our Chairman and Co-Chief Executive Officer, Bryant R. Riley, owns or controls, in
the aggregate,4,722,409 shares of our common stock or 18.2% of our outstanding common stock as of March 31, 2020. 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.
The
ongoing COVID-19 pandemic has temporarily limited our Auction and Liquidation businesses.
While
we expect that our Auction and Liquidation services business will experience increased demand in the medium to long term as a
result of business disruptions due to the ongoing COVID-19 pandemic, restrictions limiting travel, public gatherings and requiring
store closures due to “social distancing” measures imposed to control the pandemic has temporarily limited our ability
to conduct auctions and liquidations. We cannot predict when these restrictions will be relaxed or lifted or the extent to which
such restrictions will materially and negatively affect our auction and liquidation businesses.
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. Additionally, the ongoing COVID-19 pandemic could affect the availability of our key personnel.
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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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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trading volume of our common stock;
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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.
The
trading price of our common shares is subject to volatility.
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 and 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.
Due
to the ongoing COVID-19 pandemic, most of our personnel have shifted to working remotely and we cannot predict the duration of
this shift. While we have made substantial investments on our information security infrastructure, this shift has could put stress
on our information security infrastructure and increase the risk of a data breach.
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 ongoing COVID-19 pandemic has put
increased strain on the internet due to, among other things, an increase in remote work and the effects on our business are difficult
to estimate.
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.
The independent retailers we rely on may be impacted by the ongoing COVID-19 pandemic, which has resulted in mandatory store closures
of uncertain duration due to “social distancing” measures imposed to control the pandemic and they may be limited
in their ability to sell magicJack devices to customers.
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.
The
consumer goods and services sector has been severely impacted by the ongoing COVID-19 pandemic, which has resulted in mandatory
store closures of uncertain duration due to “social distancing” measures imposed to control the pandemic and our licensees
may have difficulty selling their merchandise and meeting their financial obligations to us.
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 $113.1 million; (b) the 7.375% 2023 Notes with an
aggregate principal amount of approximately $127.4 million, (c) the 7.25% 2027 Notes with an aggregate principal amount of $122.5
million; (d) the 7.50% 2027 Notes with an aggregate principal amount of $125.5 million; (e) the 2024 Notes with an aggregate principal
amount of approximately $110.5 million; (f) the 2026 Notes with an aggregate principal amount of approximately $134.7 million and
(g) the 2025 Notes with an aggregate principal amount of approximately $130.9 million. The Company periodically enters into At
Market Issuance Sales Agreements with B. Riley FBR. Most recently, the Company entered into the February 2020 Sales Agreement on
February 14, 2020. 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. At March 31, 2020, the Company had $148.4 million available for offer and
sale pursuant to the February 2020 Sales Agreement.
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 9 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,”
the 2026 Notes are quoted on Nasdaq under the symbol “RILYN,” and the 2025 Notes are quoted on Nasdaq under the symbol
“RILYM.” 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.