BRC Group Holdings, Inc. quarterly report, Q3 FY2017

Filing overview

Registrant discrepancy: The supplied filing identifies the registrant as B. Riley Financial, Inc. (Nasdaq: RILY), not BRC Group Holdings, Inc. This is an unaudited Form 10-Q for the quarter ended September 30, 2017, with comparisons to the three and nine months ended September 30, 2016. Dollar amounts below are in millions unless stated otherwise.

Financial performance and position

• Q3 revenue rose 62.2%, but operating income fell to $1.4 million and attributable net income declined to $0.4 million. Operating margin was 1.5%, versus 27.1% a year earlier.
• Nine-month revenue increased 118.2%, while operating income decreased; operating margin was 6.9%, versus 17.8%. Attributable net income rose, helped in part by a $7.8 million income-tax benefit, including an $8.4 million benefit from the UOL tax election.
• At September 30, cash and cash equivalents were $102.4 million, restricted cash $9.3 million, securities and other investments owned $96.0 million, total assets $1.226 billion, and total equity $274.6 million. Cash declined $9.7 million from year-end 2016.
• Reported borrowings were approximately $117.9 million: $33.2 million carrying value of 7.5% senior notes due 2021, $82.4 million of 7.5% senior notes due 2027, and $2.4 million of other notes. No balance was outstanding under the $200 million asset-based facility or UOL’s revolving line at quarter-end.
• Operating cash outflow of $48.8 million reflected substantial working-capital movements, including changes in securities-borrowing and securities-lending balances. Investing cash outflow was $22.9 million; financing cash inflow was $58.7 million.

Material changes and business drivers

• 2017 results include acquisitions not present for the full comparable 2016 periods: FBR (June 1), Wunderlich (July 3), and Dialectic (April 13). FBR and Wunderlich expanded Capital Markets, including securities lending, investment banking, trading, and wealth management. These transactions materially affect year-over-year comparability.
• Capital Markets drove much of the revenue growth, including $7.2 million of Q3 securities-lending interest income. However, Q3 segment results included elevated expenses and restructuring; the segment reported a $0.2 million loss.
• Auction and Liquidation revenue fell sharply in Q3 versus 2016, primarily because the prior-year period included a large Hancock Fabrics liquidation. Nine-month segment revenue increased, but its services-and-fees gross margin declined to 41.0% from 66.4%.
• United Online revenue declined 20.9% in Q3, attributed to fewer paid subscribers and lower advertising impressions. Management expects this segment’s revenue to continue declining as consumers move from dial-up to higher-speed internet.
• Restructuring charges were $4.9 million in Q3 and $11.5 million for nine months, principally related to integrating FBR and Wunderlich, severance, accelerated stock-award vesting, and office consolidation.

Outlook, risks and unusual items

• Management stated that cash, investments, available credit facilities, and expected operating cash generation should be sufficient for working capital and capital expenditure needs for at least 12 months. No numerical earnings or revenue guidance was provided.
• The company reported a $6.0 million key-person life-insurance recovery and an $8.4 million tax benefit from electing taxable treatment for the UOL acquisition. These items affect period comparisons.
• After quarter-end, the board approved a regular dividend of $0.08 per share and a special dividend of $0.04 per share. On November 9, 2017, the company agreed to acquire magicJack for approximately $143.5 million, subject to approvals and other closing conditions; completion was anticipated in the first half of 2018.
• Risks cited include volatile engagement-driven revenue, market conditions, guarantee-based liquidation exposures, proprietary-investment valuation and liquidity, acquisition integration and synergies, personnel retention, financing availability and covenant compliance, and litigation or regulatory matters. Several claims have damages sought in the millions; the company said certain potential impacts could not be estimated and did not believe pending claims were likely to materially affect its financial position or results.
• Approximately $48.7 million of recurring fair-value assets were Level 3, including a $26.9 million loan receivable, requiring significant unobservable valuation inputs. The company also disclosed multiple securities-related and other legal matters, including claims with substantial asserted damages.
• Management reported effective disclosure controls as of September 30, 2017 and no material change in internal control over financial reporting during the quarter.

Key facts for investors to verify

1. Confirm the intended issuer: the filing is for B. Riley Financial, Inc., which conflicts with the request metadata naming BRC Group Holdings, Inc.
2. Separate organic performance from acquisition contributions and assess whether cost savings and integration benefits from FBR and Wunderlich materialize.
3. Assess the sustainability of earnings excluding the UOL tax benefit, insurance recovery, and restructuring and acquisition-related items.
4. Review the drivers of negative operating cash flow, liquidity needs of the securities-lending business, and the terms and availability of credit facilities and senior notes.
5. Evaluate United Online’s continuing subscriber and revenue declines, Auction and Liquidation’s engagement volatility and margins, and the valuation assumptions for Level 3 assets.
6. Monitor the outcome and potential exposure of disclosed legal claims, the proposed magicJack acquisition, and future dividend decisions.