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10-Q
LIQUIDITY SERVICES INC filed this Form 10-Q on 02/05/2016
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ended December 31, 2015

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the transition period from                    to                   

 

Commission file number 0-51813

 

LIQUIDITY SERVICES, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

52-2209244

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

 

 

1920 L Street, N.W., 6th Floor, Washington, D.C.

 

20036

(Address of Principal Executive Offices)

 

(Zip Code)

 

(202) 467-6868

(Registrant’s Telephone Number, Including Area Code)

 

 

(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)

 

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

 

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

 

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

 

Large accelerated filer x

 

Accelerated filer o

Non-accelerated filer o

 

Smaller reporting companyo

 

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

 

The number of shares outstanding of the issuer’s common stock, par value $.001 per share, as of February 2, 2016 was 30,606,566.

 

 

 



Table of Contents

 

INDEX

 

 

 

Page

Part I. FINANCIAL INFORMATION (UNAUDITED)

 

 

 

 

Item 1.

Consolidated Financial Statements

3

 

 

 

 

Consolidated Balance Sheets

3

 

 

 

 

Consolidated Statements of Operations

4

 

 

 

 

Consolidated Statements of Comprehensive Income

5

 

 

 

 

Consolidated Statement of Changes in Stockholders’ Equity

6

 

 

 

 

Consolidated Statements of Cash Flows

7

 

 

 

 

Notes to the Unaudited Consolidated Financial Statements

8

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

33

 

 

 

Item 4.

Controls and Procedures

33

 

 

 

Part II. OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

34

 

 

 

Item 1A.

Risk Factors

35

 

 

 

Item 6.

Exhibits

36

 

 

 

SIGNATURES

37

 

2



Table of Contents

 

PART I—FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements.

 

Liquidity Services, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in Thousands)

 

 

 

December 31,

 

September 30,

 

 

 

2015

 

2015

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

85,452

 

$

95,465

 

Accounts receivable, net of allowance for doubtful accounts of $549 and $471 at December 31, 2015 and September 30, 2015, respectively

 

6,039

 

6,194

 

Inventory

 

27,454

 

25,510

 

Tax refund receivable

 

33,491

 

33,491

 

Prepaid and deferred taxes

 

20,124

 

19,903

 

Prepaid expenses and other current assets

 

7,044

 

7,826

 

Total current assets

 

179,604

 

188,389

 

Property and equipment, net

 

13,485

 

13,356

 

Intangible assets, net

 

3,704

 

4,051

 

Goodwill

 

63,529

 

64,073

 

Deferred long-term tax assets

 

8,025

 

5,871

 

Other assets

 

14,499

 

12,748

 

Total assets

 

$

282,846

 

$

288,488

 

Liabilities and stockholders’ equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

10,094

 

$

9,500

 

Accrued expenses and other current liabilities

 

25,267

 

27,350

 

Profit-sharing distributions payable

 

1,343

 

2,512

 

Customer payables

 

30,385

 

29,802

 

Total current liabilities

 

67,089

 

69,164

 

Other long-term liabilities

 

3,334

 

3,322

 

Total liabilities

 

70,423

 

72,486

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.001 par value; 120,000,000 shares authorized; 30,552,286 shares issued and outstanding at December 31, 2015; 30,026,223 shares issued and outstanding at September 30, 2015

 

29

 

29

 

Additional paid-in capital

 

213,087

 

210,712

 

Accumulated other comprehensive loss

 

(6,383

)

(5,626

)

Retained earnings

 

5,690

 

10,887

 

Total stockholders’ equity

 

212,423

 

216,002

 

Total liabilities and stockholders’ equity

 

$

282,846

 

$

288,488

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

3



Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Unaudited Consolidated Statements of Operations
(Dollars in Thousands, Except Per Share Data)

 

 

 

Three Months Ended December 31,

 

 

 

2015

 

2014

 

 

 

 

 

 

 

Revenue

 

$

50,138

 

$

98,163

 

Fee revenue

 

15,737

 

26,980

 

Total revenue

 

65,875

 

125,143

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

Cost of goods sold (excluding amortization)

 

26,883

 

54,315

 

Profit-sharing distributions

 

2,357

 

9,592

 

Technology and operations

 

22,807

 

26,878

 

Sales and marketing

 

9,460

 

10,385

 

General and administrative

 

10,068

 

9,528

 

Amortization of contract intangibles

 

 

1,211

 

Depreciation and amortization

 

1,672

 

1,992

 

Acquisition costs and related fair value adjustments and impairment of goodwill and long-lived assets

 

39

 

96,238

 

 

 

 

 

 

 

Total costs and expenses

 

73,286

 

210,139

 

 

 

 

 

 

 

Loss from operations

 

(7,411

)

(84,996

)

Interest (income) expense and other expense, net

 

(60

)

38

 

 

 

 

 

 

 

Loss before benefit from income taxes

 

(7,351

)

(85,034

)

Benefit from income taxes

 

(2,154

)

(20,918

)

 

 

 

 

 

 

Net loss

 

$

(5,197

)

$

(64,116

)

Basic loss per common share

 

$

(0.17

)

$

(2.14

)

Diluted loss per common share

 

$

(0.17

)

$

(2.14

)

 

 

 

 

 

 

Basic weighted average shares outstanding

 

30,490,670

 

29,926,273

 

Diluted weighted average shares outstanding

 

30,490,670

 

29,926,273

 

 

See accompanying notes to the unaudited consolidated financial statements

 

4



Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Unaudited Consolidated Statements of Comprehensive Income
(Dollars in Thousands)

 

 

 

Three Months Ended December 31,

 

 

 

2015

 

2014

 

 

 

 

 

 

 

Net loss

 

$

(5,197

)

$

(64,116

)

Other comprehensive loss:

 

 

 

 

 

Foreign currency translation

 

(757

)

(1,956

)

Other comprehensive loss, net of taxes

 

(757

)

(1,956

)

Comprehensive loss

 

$

(5,954

)

$

(66,072

)

 

See accompanying notes to the unaudited consolidated financial statements.

 

5



Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Unaudited Consolidated Statement of Changes in Stockholders’ Equity
(In Thousands Except Share Data)

 

 

 

 

 

Additional

 

Accumulated
Other

 

 

 

 

 

 

 

Common Stock

 

Paid-in

 

Comprehensive

 

Retained

 

 

 

 

 

Shares

 

Amount

 

Capital

 

Loss

 

Earnings

 

Total

 

Balance at September 30, 2015

 

30,026,223

 

$

29

 

$

210,712

 

$

(5,626

)

$

10,887

 

$

216,002

 

Exercise of common stock options and vesting of restricted stock

 

526,063

 

 

 

 

 

 

Compensation expense and incremental tax benefit from grants of common stock options and restricted stock

 

 

 

2,375

 

 

 

2,375

 

Net loss

 

 

 

 

 

(5,197

)

(5,197

)

Foreign currency translation

 

 

 

 

(757

)

 

(757

)

Balance at December 31, 2015

 

30,552,286

 

$

29

 

$

213,087

 

$

(6,383

)

$

5,690

 

$

212,423

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

6



Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Unaudited Consolidated Statements of Cash Flows
(In Thousands)

 

 

 

Three Months Ended
December 31,

 

 

 

2015

 

2014

 

Operating activities

 

 

 

 

 

Net loss

 

$

(5,197

)

$

(64,116

)

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

1,672

 

3,203

 

Stock compensation expense

 

2,420

 

2,602

 

Provision (benefit) for inventory allowance

 

1,208

 

(48

)

Provision for doubtful accounts

 

78

 

121

 

Deferred tax benefit

 

 

(22,145

)

Impairment of goodwill and long-lived assets

 

 

96,238

 

Incremental tax benefit from exercise of common stock options

 

48

 

(163

)

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

77

 

1,347

 

Inventory

 

(3,152

)

8,138

 

Prepaid and deferred taxes

 

(2,424

)

290

 

Prepaid expenses and other assets

 

(969

)

658

 

Accounts payable

 

594

 

(859

)

Accrued expenses and other

 

(2,070

)

(7,534

)

Profit-sharing distributions payable

 

(1,169

)

(392

)

Customer payables

 

583

 

(3,815

)

Other liabilities

 

3

 

(461

)

Net cash (used in) provided by operating activities

 

(8,298

)

13,064

 

Investing activities

 

 

 

 

 

Increase in intangibles

 

(29

)

(3

)

Purchases of property and equipment

 

(1,428

)

(1,612

)

Net cash used in investing activities

 

(1,457

)

(1,615

)

Financing activities

 

 

 

 

 

Proceeds from exercise of common stock options (net of tax)

 

 

71

 

Incremental tax benefit from exercise of common stock options

 

(48

)

163

 

Net cash (used in) provided by financing activities

 

(48

)

234

 

Effect of exchange rate differences on cash and cash equivalents

 

(210

)

(59

)

Net (decrease) increase in cash and cash equivalents

 

(10,013

)

11,624

 

Cash and cash equivalents at beginning of period

 

95,465

 

62,598

 

Cash and cash equivalents at end of period

 

$

85,452

 

$

74,222

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information

 

 

 

 

 

Cash paid for income taxes

 

$

237

 

$

589

 

 

See accompanying notes to the unaudited consolidated financial statements.

 

7



Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements

 

1.             Organization

 

Liquidity Services, Inc. and subsidiaries (LS or the Company) operates leading auction marketplaces for surplus and salvage assets.  LS enables buyers and sellers to transact in an efficient, automated online auction environment offering over 500 product categories. The Company’s marketplaces provide professional buyers access to a global, organized supply of surplus and salvage assets presented with digital images and other relevant product information. Additionally, LS enables its corporate and government sellers to enhance their financial return on excess assets by providing a liquid marketplace and value-added services that integrate sales and marketing, logistics and transaction settlement into a single offering. LS organizes its products into categories across major industry verticals such as consumer electronics, general merchandise, apparel, scientific equipment, aerospace parts and equipment, technology hardware, energy equipment, industrial capital assets, fleet and transportation equipment and specialty equipment. The Company’s marketplaces are www.liquidation.com, www.govliquidation.com, www.govdeals.com, www.networkintl.com, www.truckcenter.com, www.secondipity.com, and www.go-dove.com. LS has one reportable segment consisting of operating auction marketplaces for sellers and buyers of surplus, salvage and scrap assets.

 

2.             Summary of Significant Accounting Policies

 

Unaudited Interim Financial Information

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal, recurring adjustments, considered necessary for a fair presentation have been included. The information disclosed in the notes to the consolidated financial statements for these periods is unaudited. Operating results for the three months ended December 31, 2015 are not necessarily indicative of the results that may be expected for the year ending September 30, 2016 or any future period.  Fee revenue is revenue earned under the consignment model, as well as other fee revenue, and is presented separately as it accounts for more than 10% of total revenue.

 

New Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (FASB) issued a new standard that will change the way the Company recognizes revenue and significantly expand the disclosure requirements for revenue arrangements.  In July 2015, the FASB delayed the effective date of the new standard such that the new standard will be effective for the Company beginning on October 1, 2018, and may be adopted either retrospectively or on a modified retrospective basis whereby the new standard would be applied to new and existing arrangements with remaining performance obligations as of the effective date, with a cumulative catch-up adjustment recorded to retained earnings at the effective date for existing arrangements with remaining performance obligations.  The Company is currently evaluating the methods of adoption allowed by the new standard and the effect that adoption of the standard is expected to have on the consolidated financial statements and related disclosures.  As a result, the Company’s evaluation of the effect of the new standard will likely extend over several future periods.

 

Business Combinations

 

The Company recognizes all of the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. Acquisition-related costs are recognized separately from the acquisition and expensed as incurred. Restructuring costs incurred in periods subsequent to the acquisition date are expensed when incurred. Subsequent changes to the purchase price (i.e., working capital adjustments) or other fair value adjustments determined during the measurement period are recorded as an adjustment to goodwill, with the exception of contingent consideration, which is recognized in the statement of operations in the period it is modified. All subsequent changes to a valuation allowance or uncertain tax position that relate to the acquired company and existed at the acquisition date that occur both within the measurement period and as a result of facts and circumstances that existed at the acquisition date are recognized as an adjustment to goodwill. All other changes in valuation allowances are recognized as a reduction or increase to income tax expense.

 

8



Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements — (Continued)

 

2.             Summary of Significant Accounting Policies (continued)

 

Accounts Receivable

 

Accounts receivable are recorded at the invoiced amount and are non-interest bearing. The Company maintains an allowance for doubtful accounts to reserve for potentially uncollectible receivables. Allowances are based on management’s judgment, which considers historical experience and specific knowledge of accounts where collectability may not be probable. The Company makes provisions based on historical bad debt experience, a specific review of all significant outstanding invoices and an assessment of general economic conditions.

 

Inventory

 

Inventory consists of property obtained for resale, generally through the online auction process, and is stated at the lower of cost or market. Cost is determined using the specific identification method. Charges for unsellable inventory are included in cost of goods sold in the period in which they have been determined to occur.  As of the three months ended September 30, 2015 and December 31, 2015, the Company’s inventory reserve was approximately $0.8 million and $2.0 million, respectively.

 

Earnings per Share

 

Basic net income attributable to common stockholders per share is computed by dividing net income attributable to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net income attributable to common stockholders per share includes the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. The Company had 2,286,685 unvested restricted shares outstanding at December 31, 2015, which were issued at prices ranging from $6.63 to $52.55, of which 2,286,685 and 1,672,394 shares have been excluded from the calculation of income per share for the three months ended December 31, 2015 and 2014, respectively, due to the net losses incurred for the three months ended December 31, 2015 and December 31, 2014. The Company has also excluded the following stock options from its calculation of diluted income per share because the option exercise prices were greater than the average market prices for the applicable period:

 

(a)     for the three months ended December 31, 2015, 1,427,944 options; and

 

(b)     for the three months ended December 31, 2014, 1,424,035 options.

 

The following summarizes the potential outstanding common stock of the Company as of the dates set forth below:

 

 

 

Three Months Ended December 31,

 

 

 

2015

 

2014

 

 

 

(unaudited)
(dollars in thousands except per

share amounts)

 

 

 

 

 

 

 

Weighted average shares calculation:

 

 

 

 

 

Basic weighted average shares outstanding

 

30,490,670

 

29,926,273

 

Treasury stock effect of options and restricted stock

 

 

 

 

 

 

 

 

 

Diluted weighted average common shares outstanding

 

30,490,670

 

29,926,273

 

Net loss

 

$

(5,197

)

$

(64,116

)

Basic loss per common share

 

$

(0.17

)

$

(2.14

)

Diluted loss per common share

 

$

(0.17

)

$

(2.14

)

 

9



Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements — (Continued)

 

2.             Summary of Significant Accounting Policies (continued)

 

Stock-Based Compensation

 

The Company estimates the fair value of share-based awards on the date of grant. The fair value of stock options and stock appreciation rights is determined using the Black-Scholes option-pricing model. The fair value of restricted stock awards is based on the closing price of the Company’s common stock on the date of grant. The determination of the fair value of the Company’s stock option awards and stock appreciation rights is based on a variety of factors including, but not limited to, the Company’s common stock price, expected stock price volatility over the expected life of awards, and actual and projected exercise behavior. Additionally, the Company has estimated forfeitures for share-based awards at the dates of grant based on historical experience, adjusted for future expectation. The forfeiture estimate is revised as necessary if actual forfeitures differ from these estimates.

 

The Company issues restricted stock awards where restrictions lapse upon either the passage of time (service vesting), achieving performance targets, or some combination of these restrictions. For those restricted stock awards with only service conditions, the Company recognizes compensation cost on a straight-line basis over the explicit service period. For awards with both performance and service conditions, the Company starts recognizing compensation cost over the remaining service period, when it is probable the performance condition will be met. For stock awards that contain performance vesting conditions, the Company excludes these awards from diluted earnings per share computations until the contingency is met as of the end of that reporting period.  For awards to non-employees (who are not directors), the Company records compensation cost when the performance condition is met.

 

The Company presents the cash flows resulting from the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) as a financing activity with a corresponding operating cash outflow in the Consolidated Statements of Cash Flows.

 

3.             Defense Logistics Agency (DLA) Disposition Services Contracts

 

The Company has a Surplus Contract with the DLA Disposition Services.  The base term of the initial contract has been extended through November 2015. On November 13, 2015, the DLA Disposition Services notified the Company that they were amending the current (second) Surplus Contract to extend the wind-down period by an additional ten months to allow for the continued processing of usable non-rolling stock surplus property.  All other terms, including pricing, remain consistent with the second Surplus Contract.  Under the second Surplus Contract, the Company is required to purchase all usable surplus property offered to the Company by the Department of Defense at a fixed percentage equal to 1.8% of the DoD’s original acquisition value (OAV). The Company retains 100% of the profits from the resale of the property and bears all of the costs for the merchandising and sale of the property.  Included in Accrued expenses and other current liabilities in the Consolidated Balance Sheet is a liability to the DoD of approximately $5,529,000 and $2,026,000 for inventory as of December 31, 2015 and September 30, 2015, respectively. The Surplus Contract contains a provision providing for a mutual termination of the contract for convenience.

 

The DoD, in accordance with the award of the current (third) Surplus Contract, split the contract into a rolling stock and a non-rolling stock contract.  On April 1, 2014, the Company was the high bidder for the non-rolling stock surplus contract with a bid equal to 4.35% of the DoD’s OAV. The non-rolling stock surplus contract has a base term of two years with four one-year renewal options.  The price the Company pays for inventory under the current (third) Surplus Contract increased from 1.8% to 4.35% of OAV, resulting in significantly higher Cost of Goods Sold (COGS) in fiscal year 2016 and beyond. This Surplus Contract became effective November 14, 2015.

 

As a result of the Surplus Contract, the Company is the sole remarketer of all DoD non-rolling stock surplus turned into the DLA Disposition Services available for sale within the United States, Puerto Rico, and Guam.

 

10



Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements — (Continued)

 

3.             Defense Logistics Agency (DLA) Disposition Services Contracts (Continued)

 

The Company has a Scrap Contract with the DLA Disposition Services which was amended effective June 9, 2015.  Modifications were made to the principal terms of the Scrap Contract including that (i) contract pricing was adjusted to reflect a 65% profit sharing distribution to the DLA Disposition Services; (ii) DLA Disposition Services may elect to terminate portions of the Scrap Contract by location with a 90-day notification required; and (iii) DLA Disposition Services may elect to terminate portions of the Scrap Contract by certain commodity categories with a 60-day notification required.

 

DLA Disposition Services has initiated an Invitation to Bid for the next Scrap Contract, which will be a three year contract with two one-year options.  The Company anticipates that DLA Disposition Services may solicit bids as early as March 2016.

 

As a result of the Scrap Contract, the Company is the sole remarketer of all U.S. Department of Defense scrap turned into the DLA Disposition Services available for sale within the United States, Puerto Rico, and Guam.

 

4.             Goodwill

 

The goodwill of acquired companies is primarily related to the acquisition of an experienced and knowledgeable workforce.  The following summarizes goodwill activity for the periods indicated:

 

 

 

Goodwill
(in thousands)

 

Balance at September 30, 2015

 

$

64,073

 

Translation adjustments

 

(544

)

Balance at December 31, 2015

 

$

63,529

 

 

Impairment of Goodwill

 

The Company performs its annual goodwill impairment assessment as of the end of the fiscal year.  The last impairment assessment was performed as of September 30, 2015 and the Company identified indicators of impairment, including a decline in the Company’s market capitalization. Goodwill impairment losses as of September 30, 2015, were $136.2 million, including $85.1 million recognized in the quarter ended December 31, 2014.  During the three months ended December 31, 2015, no indicators of impairment were identified.

 

11



Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements — (Continued)

 

5.             Intangible Assets

 

As a result of the acquisition of Jacobs Trading Company on October 1, 2011, the Company assumed the rights and obligations of Jacobs Trading Company under Seller’s Master Merchandise Salvage Contract (the “Wal-Mart Agreement”) dated May 13, 2011.  On December 1, 2014, Wal-Mart provided the Company with written notice terminating the Wal-Mart Agreement effective December 8, 2014.  As a result of the termination of the Wal-Mart Agreement, the Company concluded that the intangible asset related to the Wal-Mart Agreement was impaired and reduced the remaining unamortized contract intangible asset of $10.3 million to zero during the three months ended December 31, 2014.  This impairment charge is recorded in Acquisition costs and related fair value adjustments and impairment of goodwill and long-lived assets in the statements of operations.  Intangible assets at December 31, 2015 and September 30, 2015 consisted of the following:

 

 

 

 

 

December 31, 2015

 

September  30, 2015

 

 

 

Useful
Life
(in years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net
Carrying
Amount

 

 

 

(dollars in thousands)

 

Contract intangibles

 

10

 

$

1,500

 

$

(37

)

$

1,463

 

$

1,500

 

$

 

$

1,500

 

Brand and technology

 

3 - 5

 

5,749

 

(4,214

)

1,535

 

5,749

 

(3,926

)

1,823

 

Covenants not to compete

 

3 - 5

 

700

 

(458

)

242

 

700

 

(433

)

267

 

Patent and trademarks

 

3 - 10

 

819

 

(355

)

464

 

792

 

(331

)

461

 

Total intangible assets, net

 

 

 

$

8,768

 

$

(5,064

)

$

3,704

 

$

8,741

 

$

(4,690

)

$

4,051

 

 

Future expected amortization of intangible assets at December 31, 2015 was as follows:

 

 

 

Future
Amortization

 

 Years ending September 30,

 

(in thousands)

 

 

 

 

 

2016 (remaining nine months)

 

$

1,067

 

2017

 

1,073

 

2018

 

281

 

2019

 

207

 

2020 and after

 

1,076

 

Total

 

$

3,704

 

 

Intangible assets amortization expense was approximately $0.4 million and $1.1 million for the three months ended December 31, 2015 and 2014, respectively.

 

6.             Debt

 

Senior Credit Facility

 

In 2010, the Company entered into a senior credit facility (the Agreement) with a bank, which provides for borrowings up to $75.0 million, as amended.  On May 1, 2015, the Company amended this credit facility extending the term to May 31, 2018. Borrowings under the Agreement bear interest at an annual rate equal to the 30 day LIBOR rate plus 1.25% (1.608% at December 31, 2015) due monthly.  As of September 30, 2015 and December 31, 2015, the Company had no outstanding borrowings under the Agreement, and the Company’s borrowing availability was $37.5 million, of which the Company has used $8.4 and $5.9 million, respectively, for issued letters of credit.

 

Borrowings under the Agreement are secured by substantially all of the assets of the Company. The Agreement contains certain financial and non-financial restrictive covenants including, among others, the requirements to maintain a minimum level of earnings before interest, income taxes, depreciation and amortization (EBITDA) and a minimum debt coverage ratio. As of December 31, 2015, the Company was in compliance with these covenants.

 

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Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements — (Continued)

 

7.             Income Taxes

 

The Company’s interim effective income tax rate is based on management’s best current estimate of the expected annual effective income tax rate. The Company reflected a pre-tax loss in its first quarter of fiscal year 2016 and its corresponding effective tax rate is approximately 29.3%.

 

The Company applies the guidance related to uncertainty in income taxes. The Company has concluded that there were no uncertain tax positions identified during its analysis. The Company’s policy is to recognize interest and penalties in the period in which they occur in the income tax provision. The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, various state and local jurisdictions and in foreign jurisdictions, primarily Canada and the U.K. Currently, the Company is subject to income tax examinations for fiscal 2012 through 2014. The Company anticipates no material tax liability to arise from these examinations. The statute of limitations for U.S. federal income tax returns for years prior to fiscal 2012 is now closed. However, certain tax attribute carryforwards that were generated prior to fiscal 2012 may be adjusted upon examination by tax authorities if they are utilized.

 

8.             Stockholders’ Equity

 

Share Repurchase Program

 

Since 2008, the Company’s Board of Directors has approved the repurchase of up to $101.9 million in shares under a share repurchase program. Under the program, the Company is authorized to repurchase the issued and outstanding shares of common stock.  Share repurchases may be made through open market purchases, privately negotiated transactions or otherwise, at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements and other market conditions.  The repurchase program may be discontinued or suspended at any time, and will be funded using the Company’s available cash. The Company’s Board of Directors reviews the share repurchase program periodically, the last such review having occurred in February 2014. The Company did not repurchase any shares during the three months ended December 31, 2015 or 2014.  As of December 31, 2015, there was approximately $5.1 million that may yet be expended to repurchase shares under the program.

 

2006 Omnibus Long-Term Incentive Plan (the 2006 Plan)

 

Under the 2006 Plan, as amended, 10,000,000 shares of common stock were available for issuance. At September 30, 2014, there were 772,227 shares remaining reserved for issuance in connection with awards under the 2006 Plan.  In February 2015, at the Company’s annual meeting of stockholders, the stockholders approved an amendment to the Plan which provided for an increase of 3,000,000 shares of the Company’s common stock to the shares available for issuance under the 2006 Plan and established a fungible share pool so that grants of awards other than options or stock appreciation rights after January 9, 2016, would be counted as 1.5 shares from the reserve. During fiscal year 2015, the Company granted options to purchase 310,177 shares to employees and directors with exercise prices between $9.35 and $10.41, and options to purchase 288,572 shares were forfeited. During fiscal year 2015, the Company granted 1,298,604 restricted shares to employees and directors at prices ranging from $9.35 to $12.57, and 486,040 restricted shares were forfeited. At September 30, 2015, there were 2,364,472 shares remaining reserved for issuance in connection with awards under the 2006 Plan. During the three months ended December 31, 2015, the Company granted options to purchase 236,952 shares to employees and directors with exercise prices between $6.63 and $8.17, and options to purchase 3,419 shares were forfeited. During the three months ended December 31, 2015, the Company issued 480,503 restricted shares to employees and directors at prices ranging from $6.63 to $8.17, and 34,942 restricted shares were forfeited. At December 31, 2015, there were 1,450,410 shares remaining reserved for issuance in connection with awards under the 2006 Plan. During fiscal year 2015, the Company issued 737,972 cash-settled stock appreciation rights at the price of $9.35, and 59,156 cash-settled stock appreciation rights were forfeited.  During the three months ended December 31, 2015, no stock appreciation rights were issued and 21,270 cash-settled stock appreciation rights were forfeited.  Stock appreciation rights are recorded as liability awards. The maximum number of shares subject to options or stock appreciation rights that can be awarded under the 2006 Plan to any person is 1,000,000 per year. The maximum number of shares that can be awarded under the 2006 Plan to any person, other than pursuant to an option or stock appreciation right, is 700,000 per year. These shares and options generally vest over a period of one to four years conditioned on continued employment for the incentive period.

 

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Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements — (Continued)

 

8.             Stockholders’ Equity (Continued)

 

Stock Option Activity

 

A summary of the Company’s stock option activity for the year ended September 30, 2015 and the three months ended December 31, 2015 is as follows:

 

 

 

Options

 

Weighted-
Average
Exercise Price

 

Options outstanding at September 30, 2014

 

1,465,907

 

$

19.50

 

Options granted

 

310,177

 

9.92

 

Options exercised

 

(14,869

)

7.09

 

Options canceled

 

(288,572

)

20.26

 

Options outstanding at September 30, 2015

 

1,472,643

 

17.46

 

Options granted

 

236,952

 

7.02

 

Options exercised

 

 

 

Options canceled

 

(3,419

)

24.26

 

Options outstanding at December 31, 2015

 

1,706,176

 

16.00

 

Options exercisable at December 31, 2015

 

1,008,292

 

17.91

 

 

The intrinsic value and weighted average remaining contractual life in years of outstanding and exercisable options at December 31, 2015 is approximately $1,000 and 6.26 and $1,000 and 4.31, respectively, based on a stock price of $6.50 on December 31, 2015.  Over the last three years, volatility rates have ranged from 50.90% - 77.92%, the dividend rate has been 0%, risk free interest rates have ranged from 0.12% - 1.51% and expected forfeiture rates have ranged from 19.70% - 23.54%.

 

Restricted Share Activity

 

A summary of the Company’s restricted share activity for the year ended September 30, 2015 and the three months ended December 31, 2015 is as follows:

 

 

 

Restricted
Shares

 

Weighted-
Average
Fair Value

 

Unvested restricted shares at September 30, 2014

 

1,897,827

 

$

24.96

 

Restricted shares granted

 

1,298,604

 

10.04

 

Restricted shares vested

 

(343,204

)

27.50

 

Restricted shares canceled

 

(486,040

)

26.54

 

Unvested restricted shares at September 30, 2015

 

2,367,187

 

16.08

 

Restricted shares granted

 

480,503

 

6.86

 

Restricted shares vested

 

(526,063

)

16.20

 

Restricted shares canceled

 

(34,942

)

17.22

 

Unvested restricted shares at December 31, 2015

 

2,286,685

 

14.10

 

 

The intrinsic value and weighted average remaining contractual life in years of unvested restricted shares at December 31, 2015 is approximately $14.9 million and 8.82, respectively, based on a stock price of $6.50 on December 31, 2015.

 

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Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements — (Continued)

 

9.             Fair Value Measurement

 

The Company measures and records in the accompanying consolidated financial statements certain liabilities at fair value on a recurring basis. Authoritative guidance issued by the FASB establishes a fair value hierarchy for those instruments measured at fair value that distinguishes between assumptions based on market data (observable inputs) and the Company’s assumptions (unobservable inputs).  The hierarchy consists of three levels:

 

 

Level 1        Quoted market prices in active markets for identical assets or liabilities;

Level 2        Inputs other than Level 1 inputs that are either directly or indirectly observable; and

Level 3        Unobservable inputs developed using estimates and assumptions developed by the Company, which reflect those that a market participant would use.

 

As of December 31, 2015 and September 30, 2015, the Company had no Level 1, Level 2, or Level 3 assets or liabilities that were recorded at fair value on a recurring basis.

 

The Company’s financial assets not measured at fair value are cash and cash equivalents (which includes cash and commercial paper with original maturities of less than 90 days).  The Company believes the carrying value approximates fair value due to the short term maturity of these instruments.

 

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Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements — (Continued)

 

10.          Defined Benefit Pension Plan

 

Certain employees of GoIndustry, which the Company acquired in July 2012, are covered by the Henry Butcher Pension Fund and Life Assurance Scheme, a qualified defined benefit pension plan.

 

The net periodic benefit cost recognized for the three months ended December 31, 2015 and 2014 included the following components:

 

Qualified Defined Benefit Pension Plan

 

Three months ended December 31,

 

(in thousands)

 

2015

 

2014

 

Service cost

 

 

 

Interest cost

 

$

222

 

$

248

 

Expected return on plan assets

 

(283

)

(299

)

Amortization of prior service cost

 

 

 

Amortization of actuarial (gain)/loss

 

 

 

Amortization of transitional obligation/(asset)

 

 

 

 

 

 

 

 

 

Total net periodic benefit cost

 

$

(61

)

$

(51

)

 

11.          Guarantees

 

During the second quarter of 2015, the Company issued a guarantee to GoIndustry (UK) Limited (the “Subsidiary”) and the Trustees (the “Trustees”) of the Henry Butcher Pension Fund and Life Assurance Scheme (the “Scheme”). Under the arrangement, the Company irrevocably and unconditionally (a) guarantees to the Trustees punctual performance by the Subsidiary of all its Guaranteed Obligations, defined as all present and future obligations and liabilities (whether actual or contingent and whether owed jointly or severally in any capacity whatsoever) of the Company to make payments to the Scheme up to a maximum of 10 million British pounds, (b) undertakes with the Trustees that, whenever the Subsidiary does not pay any amount when due in respect of its Guaranteed Obligations, it must immediately on demand by the Trustees pay that amount as if it were the principal obligor; and (c) indemnifies the Trustees as an independent and primary obligation immediately on demand against any cost, charge, expense, loss or liability suffered or incurred by the Trustees if any payment obligation guaranteed by it is or becomes unenforceable, invalid or illegal; the amount of the cost, charge, expense, loss or liability under this indemnity will be equal to the amount the Trustees would otherwise have been entitled to recover on the basis of a guarantee.   The guarantee is a continuing guarantee that will extend to the ultimate balance of all sums payable by the Company in respect of its Guaranteed Obligations.  The funded status of the Scheme as of September 30, 2015, was disclosed in our Annual Report on Form 10-K in Note 14, Defined Benefit Pension Plan.

 

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Table of Contents

 

Liquidity Services, Inc. and Subsidiaries
Notes to the Unaudited Consolidated Financial Statements — (Continued)

 

12.          Business Realignment Expenses

 

On October 1, 2014, the Company announced that it had realigned its workforce in response to the new terms and scope of the current (third) Surplus Contract with the DoD for non-rolling stock and to adjust for the efficiencies realized in its commercial business through ongoing integration efforts to support the future vision and growth of the Company. The business realignment included employee reductions across the organization. Business realignment expenses during the fiscal year ended September 30, 2014, included costs of $1.8 million in employee severance and benefit costs. In September 2015, the Company evaluated its business realignment effort which resulted in a net increase of $0.3 million in accrued expense primarily due to timing changes in commencement of the current (third) DoD Surplus Contract and the delay in the wind-down of the NESA business.

 

The table below sets forth the significant components and activity in the business realignment initiatives during the three months ended December 31, 2015.

 

 

 

Liability Balance
at September 30,
2015

 

Business
Realignment
Expenses

 

Cash Payments

 

Liability Balance
at December 31,
2015

 

Employee severance and benefit costs for fiscal 2014 accrual

 

$

356

 

$

26

 

$

(239

)

$

143

 

Employee severance and benefit costs for fiscal 2015 accrual

 

489

 

(75

)

(369

)

45

 

Total

 

$

845

 

$

(49

)

$

(608

)

$

188

 

 

The business realignment expenses are recorded in costs and expenses from operations in the statement of operations, and in accrued expenses and other current liabilities on the balance sheet as of September 30, 2015 and December 31, 2015.

 

13.          Legal Proceedings

 

On July 14, 2014, Leonard Howard filed a putative class action complaint in the United States District Court for the District of Columbia against the Company and its chief executive officer, chief financial officer, and chief accounting officer, on behalf of stockholders who purchased the Company’s common stock between February 1, 2012, and May 7, 2014.  The complaint alleges that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by, among other things, misrepresenting the Company’s growth initiative, growth potential, and financial and operating conditions, thereby artificially inflating its share price, and seeks unspecified compensatory damages and costs and expenses, including attorneys’ and experts’ fees.  On October 14, 2014, the Court appointed Caisse de Dépôt et Placement du Québec and the Newport News Employees’ Retirement Fund as co-lead plaintiffs.  The Plaintiffs filed an amended complaint on December 15, 2014, which alleges substantially similar claims but which does not name the chief accounting officer as a defendant.   The Company believes the allegations are without merit and on March 2, 2015, moved to dismiss the amended complaint for failure to state a claim or plead fraud with the requisite particularity.  That motion was fully submitted as of June 1, 2015, and the Company is awaiting a decision by the Court. The Company cannot estimate a range of potential liability, if any, at this time.

 

14.          Termination of the Wal-Mart Agreement

 

As a result of the acquisition of Jacobs Trading Company on October 1, 2011, the Company assumed the rights and obligations of Jacobs Trading Company under Seller’s Master Merchandise Salvage Contract (the “Wal-Mart Agreement”) dated May 13, 2011.  On December 1, 2014, Wal-Mart provided the Company written notice (the “Termination Notice”) terminating the Wal-Mart Agreement effective December 8, 2014.  The Termination Notice alleged that the Company failed to comply with certain provisions under the Wal-Mart Agreement with respect to service level requirements and restrictions on the disposition of merchandise. The Company disputed these allegations and contested the termination of the Wal-Mart Agreement with Wal-Mart.  As a result of negotiations with Wal-Mart, on January 22, 2015, a settlement was finalized whereby, in exchange for both parties waiving all respective claims against the other, Wal-Mart agreed to pay $7.5 million in damages. The payment was received from Wal-Mart in February 2015.

 

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Table of Contents

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

FORWARD-LOOKING STATEMENTS

 

This document contains forward-looking statements. These statements are only predictions. The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to differ materially from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These risks and other factors include but are not limited to the factors set forth in our Annual Report on Form 10-K for the year ended September 30, 2015 and subsequent filings with the Securities and Exchange Commission. You can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “would,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continues” or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. There may be other factors of which we are currently unaware or deem immaterial that may cause our actual results to differ materially from the forward-looking statements.

 

All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this document and are expressly qualified in their entirety by the cautionary statements included in this document. Except as may be required by law, we undertake no obligation to publicly update or revise any forward-looking statement to reflect events or circumstances occurring after the date of this document or to reflect the occurrence of unanticipated events.

 

The following discussion should be read in conjunction with our consolidated financial statements and related notes and the information contained elsewhere in this document.

 

Overview

 

About us.  We operate leading auction marketplaces for surplus and salvage assets. We enable buyers and sellers to transact in an efficient, online auction environment offering over 500 product categories. Our marketplaces provide professional buyers access to a global, organized supply of surplus and salvage assets presented with customer focused information including digital images and other relevant product information along with services to efficiently complete the transaction. Additionally, we enable our corporate and government sellers to enhance their financial return on excess assets by providing liquid marketplaces and value-added services that integrate sales and marketing, logistics and transaction settlement into a single offering. We organize our products into categories across major industry verticals such as consumer electronics, general merchandise, apparel, scientific equipment, aerospace parts and equipment, technology hardware, energy equipment, industrial capital assets, fleet and transportation equipment and specialty equipment. Our online marketplaces are www.liquidation.com, www.govliquidation.com, www.govdeals.com, www.networkintl.com, www.truckcenter.com, www.secondipity.com, and www.go-dove.com.

 

We believe our ability to create liquid marketplaces for surplus and salvage assets generates a continuous flow of goods from our corporate and government sellers. This flow of goods in turn attracts an increasing number of professional buyers to our marketplaces. During the 12 months ended December 31, 2015, the number of registered buyers grew from approximately 2,646,000 to approximately 2,875,000, or 8.6%.

 

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Table of Contents

 

Our revenue.  We generate substantially all of our revenue by retaining a percentage of the proceeds from the sales we manage for our sellers. We offer our sellers various transaction models.

 

·                  Consignment model — fee revenue.  Under our consignment model, we recognize commission revenue from sales of merchandise in our marketplaces that is owned by others. These commissions, which we refer to as seller commissions, represent a percentage of the sale price the buyer pays upon completion of a transaction. We vary the percentage amount of the seller commission depending on the various value-added services we provide to the seller to facilitate the transaction. For example, we generally increase the percentage amount of the commission if we take possession, handle, ship, or provide enhanced product information for the merchandise. We collect the seller commission by deducting the appropriate amount from the sales proceeds prior to their distribution to the seller after completion of the transaction. Revenue from our consignment model  accounted for approximately 23.8% of our total revenue for the three months ended December 31, 2015. The merchandise sold under our consignment model accounted for approximately 66.9% of our GMV for the three months ended December 31, 2015.

 

·                  Purchase model.  Under our purchase model, we offer our sellers a fixed amount or the option to share a portion of the proceeds received from our completed sales in the form of a distribution. Distributions are calculated based on the value we receive from the sale after deducting a required return to us that we have negotiated with the seller. Because we are the primary obligor, and take general and physical inventory risks and credit risk under this transaction model, we recognize as revenue the sale price paid by the buyer upon completion of a transaction. Revenue from our purchase model accounted for approximately 63.2% of our total revenue for the three months ended December 31, 2015. The merchandise sold under our purchase model accounted for approximately 27.5% of our GMV for the three months ended December 31, 2015.

 

·                  Other.  This revenue category is intended to include revenue from profit-sharing and non-consignment fee revenue. Under our profit-sharing model, we purchase inventory from our suppliers and share with them a portion of the profits received from a completed sale in the form of a distribution. Other revenue accounted for approximately 13.0% of our total revenue for the three months ended December 31, 2015 and approximately 5.6% of our gross merchandise volume, or GMV, for the three months ended December 31, 2015.

 

We collect a buyer premium on substantially all of our transactions under all of our transaction models. Buyer premiums are calculated as a percentage of the sale price of the merchandise sold and are paid to us by the buyer. Buyer premiums are in addition to the price of the merchandise. Under our profit-sharing model, we typically share the proceeds of any buyer premiums with our sellers.

 

Industry trends.  We believe there are several industry trends impacting the growth of our business including: (1) the increase in the adoption of the Internet by businesses to conduct e-commerce both in the United States and abroad; (2) in the near term the decrease in the volume, innovation, and price of consumer electronic products, resulting in lower supply from our retail clients and lower per unit prices and margins in our retail goods marketplace, although in the long term we expect innovation in the retail supply chain will increase the pace of product obsolescence and, therefore, the supply of surplus assets; (3) the increase in the volume of returned merchandise handled by both online and offline retailers; (4) the increase in government regulations and the need for corporations to have sustainability solutions necessitating verifiable recycling and remarketing of surplus assets; (5) the increase in outsourcing by corporate and government organizations of disposition activities for surplus and end-of-life assets as they focus on reducing costs, improving transparency, compliance and working capital flows, and increasingly prefer service providers with a proven track record, innovative scalable solutions and the ability to make a strategic impact in the reverse supply chain, which we expect to increase our seller base; and (6) an increase in buyer demand for surplus merchandise as consumers trade down by purchasing less expensive goods and seek greater value from their purchases, which results in lower per unit prices and margins in our retail goods vertical.

 

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Table of Contents

 

Our Seller Agreements

 

Our DoD agreements.  We have two contracts with the DoD pursuant to which we acquire, manage and sell excess property:

 

·              Surplus Contract.  In June 2001, we were awarded the first Surplus Contract, a competitive-bid exclusive contract under which we acquire, manage and sell all usable DoD surplus personal property turned into the DLA Disposition Services. Surplus property generally consists of items determined by the DoD to be no longer needed, and not claimed for reuse by, any federal agency, such as computers, electronics, office supplies, scientific and medical equipment, aircraft parts, clothing and textiles. We responded to a RFP from the DLA Disposition Services regarding a renewal of the Surplus Contract, and we were awarded the contract. We executed the second Contract on December 18, 2008. The second Surplus Contract was to expire in February 2014. In January 2014, the DoD awarded the Company with a follow-on contract to extend the terms of the second Surplus Contract for a base term of ten months with two one-month renewal option periods. On December 3, 2014, the DoD exercised the two one-month renewal option periods.  In February 2015, the DoD awarded us a second follow-on contract to the second Surplus Contract for a base term of six months with three 30-day additional option periods.  The DoD exercised all three 30-day renewal option periods. On November 13, 2015, the DLA Disposition Services notified us that they were amending the current (second) Surplus Contract to extend the wind-down period by an additional ten months to allow for the continued processing of usable non-rolling stock surplus property.  All other terms, including pricing, remain consistent with the current (second) Surplus Contract. The DoD, in accordance with the award of the next (third) Surplus Contract, split the contract into a rolling stock and a non-rolling stock contract, with bidding on these two surplus contracts held on April 1 and 2, 2014.  On April 1, 2014, we were the high bidder for the non-rolling stock surplus contract with a bid equal to 4.35% of the DoD’s original acquisition value (OAV). The non-rolling stock surplus contract has a base term of two years with four one-year renewal options.  Following the bidding event on April 2, 2014 for the DoD rolling stock contract, we withdrew from the live auction bidding for this contract. Bidding reached a level that we determined would be economically unsustainable under the terms of the new contract, jeopardizing the high level of service we have historically provided the agency client.  The third Surplus Contract became effective November 4, 2015.

 

Revenue from our second and third Surplus Contracts (including buyer premiums) accounted for approximately 31.0% of our total revenue for the three months ended December 31, 2015.  The property sold under our second Surplus Contract accounted for approximately 13.0% of our GMV for the three months ended December 31, 2015.

 

Under the second Surplus Contract we are obligated to purchase all DoD surplus property at 1.8% of Disposition Services’ OAV. Under the third Surplus Contract, we are obligated to purchase all DoD surplus property at 4.35% of Disposition Services’ OAV. The DoD has broad discretion to determine what property will be made available for sale to us under the second Surplus Contract and may retrieve or restrict property previously sold to us for national security reasons or if the property is otherwise needed to support the mission of the DoD.

 

·              Scrap Contract.   In June 2005, we were awarded a competitive-bid exclusive contract under which we acquire, manage and sell substantially all scrap property of the DoD turned into the DLA Disposition Services. Scrap property generally consists of items determined by the DoD to have no use beyond their base material content, such as metals, alloys, and building materials. Following the DoD’s exercise of all three renewal options, the Scrap Contact expired, and on June 8, 2015 we were notified by the DoD that it was extending the performance period relating to the Scrap Contract by nine months with three three-month additional option periods commencing on June 9, 2015.

 

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Table of Contents

 

Under the Scrap Contract, we acquire scrap property at a per pound price and disburse to the DLA Disposition Services a percentage of the profits realized from the sale of the inventory, after deduction for allowable expenses.  We refer to these disbursement payments to the DoD as profit-sharing distributions. As a result of these arrangements, we recognize as revenue the gross proceeds from these sales. The DoD also reimburses us for actual costs incurred for packing, loading and shipping property under the Scrap and original Surplus Contracts that we are obligated to pick up from non-DoD locations.  We also had a small business performance incentive based on the number of scrap buyers that are small businesses that allowed us to receive up to an additional 2% of the profit sharing distribution. On May 21, 2007, we entered into a bilateral contract modification under which the DoD agreed to increase our profit-sharing distribution for the Scrap Contract from 20% to 23% effective June 1, 2007, in exchange for our agreement to implement additional inventory assurance processes and procedures with respect to the mutilation of demilitarized scrap property sold.  Effective June 9, 2015, modifications were made to the principal terms of the Scrap Contract including that:  (i) contract pricing was adjusted to reflect a 65% profit sharing distribution to the DLA Disposition Services; (ii) DLA Disposition Services may elect to terminate portions of the Scrap Contract by location with a 90-day notification required; provided that no such termination shall be effective sooner than February 8, 2016; and (iii) DLA Disposition Services may elect to terminate portions of the Scrap Contact by certain commodity categories with a 60-day notification required. DLA Disposition Services has initiated an Invitation to Bid for the next Scrap Contract, which will be a three year contract with two one-year options.  We anticipate that DLA Disposition Services may solicit bids as early as March 2016.

 

Our Wal-Mart Contracts.  We have various contracts with Wal-Mart Stores, Inc., under which we purchase certain consumer products from Wal-Mart that have been removed from the sales stream of its retail operations. All of these agreements have customary commercial terms, which generally expire within a year and allow both parties to terminate for convenience with reasonable notice.  As a result of the Jacobs Trading acquisition, we also had a long-term contract with Wal-Mart that did not provide for termination for convenience (the “Wal-Mart Agreement”).  The term of this agreement was scheduled to expire on May 16, 2016. On December 1, 2014, Wal-Mart provided us written notice (the “Termination Notice”) terminating the Wal-Mart Agreement effective December 8, 2014.  The Termination Notice alleged that we failed to comply with certain provisions under the Wal-Mart Agreement with respect to service level requirements and restrictions on the disposition of merchandise. We disputed these allegations and contested the termination of the Wal-Mart Agreement with Wal-Mart. As a result of negotiations with Wal-Mart, on January 22, 2015, we finalized a settlement whereby, in exchange for both parties waiving all respective claims against the other, Wal-Mart agreed to pay $7.5 million in damages.  The amount of the settlement was recorded within accounts receivable and a reduction of inventory on the consolidated balance sheet as of December 31, 2014, as the settlement compensated us for the overpayment of inventory from Wal-Mart.  We received the payment in February 2015.  On September 30, 2015, we sold certain assets related to the Jacobs Trading business to a buyer, Tanager Acquisitions, LLC.  In connection with the disposition, the buyer assumed certain liabilities related to the Jacobs Trading business. The buyer issued to us a promissory note in the amount of $12.3 million.  The divestiture of the Jacobs Trading business resulted in an $8.0 million loss.  The sale generated a tax loss that is expected to result in a $31.5 million cash benefit from prior year income taxes and $2.0 million of additional tax credits available to offset future taxes.

 

Our commercial agreements.  We have over 600 corporate clients each of which has sold in excess of $10,000 of surplus and salvage assets in our marketplaces during the last twelve months. Our agreements with these clients are generally terminable at will by either party.

 

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Key Business Metrics

 

Our management periodically reviews certain key business metrics for operational planning purposes and to evaluate the effectiveness of our operational strategies, allocation of resources and our capacity to fund capital expenditures and expand our business. These key business metrics include:

 

Gross merchandise volume.  Gross merchandise volume, or GMV, is the total sales value of all merchandise sold through our marketplaces during a given period. We review GMV because it provides a measure of the volume of goods being sold in our marketplaces and thus the activity of those marketplaces. GMV also provides a means to evaluate the effectiveness of investments that we have made and continue to make, including in the areas of customer support, value-added services, product development, sales and marketing, and operations. The GMV of goods sold in our marketplaces during the three months ended December 31, 2015 and December 31, 2014 totaled $151.4 million and $245.3 million, respectively.

 

Total registered buyers.  We grow our buyer base through a combination of marketing and promotional efforts.  A person becomes a registered buyer by completing an online registration process on one of our marketplaces. As part of this process, we collect business and personal information, including name, title, company name, business address and contact information, and information on how the person intends to use our marketplaces. Each prospective buyer must also accept our terms and conditions of use. Following the completion of the online registration process, we verify each prospective buyer’s e-mail address and confirm that the person is not listed on any banned persons list maintained internally or by the U.S. federal government. After the verification process, which is completed generally within 24 hours, the registration is approved and activated and the prospective buyer is added to our registered buyer list.

 

Total registered buyers, as of a given date, represent the aggregate number of persons or entities who have registered on one of our marketplaces. We use this metric to evaluate how well our marketing and promotional efforts are performing. Total registered buyers excludes duplicate registrations, buyers who are suspended from utilizing our marketplaces and those buyers who have voluntarily removed themselves from our registration database. In addition, if we become aware of registered buyers that are no longer in business, we remove them from our database. As of December 31, 2015 and September 30, 2015, we had approximately 2,875,000 and 2,845,000 registered buyers, respectively.

 

Total auction participants.  For each auction we manage, the number of auction participants represents the total number of registered buyers who have bid one or more times in that auction. As a result, a registered buyer who bids, or participates, in more than one auction is counted as an auction participant in each auction in which he or she participates. Thus, total auction participants for a given period is the sum of the auction participants in each auction conducted during that period. We use this metric to allow us to compare our online auction marketplaces to our competitors, including other online auction sites and traditional on-site auctioneers. In addition, we measure total auction participants on a periodic basis to evaluate the activity level of our base of registered buyers and to measure the performance of our marketing and promotional efforts. For the three months ended December 31, 2015 and December 31, 2014, approximately 561,000 and 631,000 total auction participants participated in auctions on our marketplaces, respectively.

 

Completed transactions.  Completed transactions represents the number of auctions in a given period from which we have recorded revenue. Similar to GMV, we believe that completed transactions is a key business metric because it provides an additional measurement of the volume of activity flowing through our marketplaces. During the three months ended December 31, 2015 and December 31, 2014, we completed approximately 133,000 and 146,000 transactions, respectively.

 

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Non-GAAP Financial Measures

 

EBITDA and adjusted EBITDA. EBITDA is a supplemental non-GAAP financial measure and is equal to net income plus interest expense and other (income) expense, net; provision for income taxes; amortization of contract intangibles; and depreciation and amortization. Our definition of adjusted EBITDA differs from EBITDA because we further adjust EBITDA for stock-based compensation expense, acquisition costs such as transaction expenses and changes in earn out estimates, business realignment expense, disposition expenses, and goodwill and long-lived asset impairment.

 

We believe EBITDA and adjusted EBITDA are useful to an investor in evaluating our performance for the following reasons:

 

·                                          The amortization of contract intangibles relates to amortization of the contract related intangible assets associated with the Jacobs Trading acquisition on October 1, 2011 and the NESA acquisition on November 1, 2012. Depreciation and amortization expense primarily relates to property and equipment. Both of these expenses are non-cash charges that have fluctuated significantly over the past five years. As a result, we believe that adding back these non-cash charges to net income is useful in evaluating the operating performance of our business on a consistent basis from year-to-year.

 

·                                          As a result of varying federal and state income tax rates, we believe that presenting a financial measure that adjusts net income for provision for income taxes is useful to investors when evaluating the operating performance of our business.

 

·                                          The authoritative guidance for stock-based compensation requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their estimated fair values. Accordingly, we believe adjusting net income for this non-cash stock based compensation expense is useful to investors when evaluating the operating performance of our business.

 

·                                          The authoritative guidance related to business combinations requires the recognition of contingent consideration so that it is recognized at the time of acquisition rather than when it is probable and disallows the capitalization of transaction costs. Accordingly, we believe adjusting net income for these acquisition related expenses is useful to investors when evaluating the operating performance of our business on a consistent basis from year-to-year.

 

·                                          We believe these measures are important indicators of our operational strength and the performance of our business because they provide a link between profitability and operating cash flow.

 

·                                          We believe isolating non-cash charges, such as amortization and depreciation, and other items, such as business realignment expenses, disposition expenses, impairment costs incurred outside our ordinary course of business, provides additional information about our cost structure, and, over time, helps track our performance.

 

·                                          We also believe that analysts and investors use EBITDA and adjusted EBITDA as supplemental measures to evaluate the overall operating performance of companies in our industry.

 

Our management uses EBITDA and adjusted EBITDA:

 

·                                          as measurements of operating performance because they assist us in comparing our operating performance on a consistent basis as they remove the impact of items not directly resulting from our core operations;

 

·                                          for planning purposes, including the preparation of our internal annual operating budget;

 

·                                          to allocate resources to enhance the financial performance of our business;

 

·                                          to evaluate the effectiveness of our operational strategies; and

 

·                                          to evaluate our capacity to fund capital expenditures and expand our business.

 

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EBITDA and adjusted EBITDA as calculated by us are not necessarily comparable to similarly titled measures used by other companies. In addition, EBITDA and adjusted EBITDA: (a) do not represent net income or cash flows from operating activities as defined by GAAP; (b) are not necessarily indicative of cash available to fund our cash flow needs; and (c) should not be considered as alternatives to net income, income from operations, cash provided by operating activities or our other financial information as determined under GAAP.

 

We prepare adjusted EBITDA by adjusting EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. As an analytical tool, adjusted EBITDA is subject to all of the limitations applicable to EBITDA. Our presentation of adjusted EBITDA should not be construed as an implication that our future results will be unaffected by unusual or non-recurring items.

 

The table below reconciles net income to EBITDA and adjusted EBITDA for the periods presented.

 

 

 

Three Months
Ended December 31,

 

 

 

2015

 

2014

 

 

 

(In thousands)

 

 

 

(Unaudited)

 

Net loss

 

$

(5,197

)

$

(64,116

)

Interest (income) expense and other expense, net

 

(60

)

38

 

Benefit from income taxes

 

(2,154

)

(20,918

)

Amortization of contract intangibles

 

 

1,211

 

Depreciation and amortization

 

1,672

 

1,992

 

EBITDA

 

(5,739

)

(81,793

)

Stock compensation expense

 

2,420

 

2,602

 

Acquisition costs and related fair value adjustments and impairment of goodwill and long-lived assets

 

39

 

96,238

 

 

 

 

 

 

 

Adjusted EBITDA

 

$

(3,280

)

$

17,047

 

 

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Critical Accounting Estimates

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. A “critical accounting estimate” is one which is both important to the portrayal of our financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We continuously evaluate our critical accounting estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

Revenue recognition.  For transactions in our online marketplaces, which generate substantially all of our revenue, we recognize revenue when all of the following criteria are met:

 

·                  a buyer submits the winning bid in an auction and, as a result, evidence of an arrangement exists and the sale price has been determined;

 

·                  the buyer has assumed risks and rewards of ownership; and

 

·                  collection is reasonably assured.

 

Most of our sales are recorded subsequent to payment authorization being received, utilizing credit cards, wire transfers and PayPal, an Internet based payment system, as methods of payments. As a result, we are not subject to significant collection risk, as goods are generally not shipped before payment is received.

 

Revenue is also evaluated for reporting revenue of gross proceeds when we act as the principal in the arrangement or net of commissions when we act as an agent. In arrangements in which we are deemed to be the primary obligor, bear physical and general inventory risk, and credit risk, we recognize as revenue the gross proceeds from the sale, including buyer’s premiums. In arrangements in which we act as an agent or broker on a consignment basis, without taking general or physical inventory risk, revenue is recognized based on the sales commissions that are paid to us by the sellers for utilizing our services; in this situation, sales commissions represent a percentage of the gross proceeds from the sale that the seller pays to us upon completion of the transaction.

 

We have evaluated our revenue recognition policy related to sales under our profit-sharing model and determined it is appropriate to account for these sales on a gross basis. The following factors were most heavily relied upon in our determination:

 

·                  We are the primary obligor in the arrangement.

 

·                  We are the seller in substance and in appearance to the buyer; the buyer contacts us if there is a problem with the purchase. Only we and the buyer are parties to the sales contract and the buyer has no recourse to the supplier. If the buyer has a problem, he or she looks to us, not the supplier.

 

·                  The buyer does not and cannot look to the supplier for fulfillment or for product acceptability concerns.

 

·                  We have general inventory risk.

 

·                  We take title to the inventory upon paying the amount set forth in the contract with the supplier. Such amount is generally a percentage of the supplier’s original acquisition cost and varies depending on the type of the inventory purchased or a fixed price per pound under our Scrap Contract.

 

·                  We are at risk of loss for all amounts paid to the supplier in the event the property is damaged or otherwise becomes unsaleable. In addition, as payments made for inventory are excluded from the calculation for the profit-sharing distribution under our DoD contracts, we effectively bear inventory risk for the full amount paid to acquire the property (i.e., there is no sharing of inventory risk).

 

The amount of our revenue that was generated outside of the U.S. for the three months ended December 31, 2015 and 2014 was 11.6% and 15.5%, respectively.

 

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Inventory.  Inventory consists of products available for sale and is valued at the lower of cost or market.  This valuation requires us to make judgments based on currently available information about expected recoverable value.

 

Business Combinations.  We recognize all of the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. Acquisition-related costs are recognized separately from the acquisition and expensed as incurred. Generally, restructuring costs incurred in periods subsequent to the acquisition date are expensed when incurred. Subsequent changes to the purchase price (i.e., working capital adjustments) or other fair value adjustments determined during the measurement period are recorded as an adjustment to goodwill. All subsequent changes to a valuation allowance or uncertain tax position that relate to the acquired company and existed at the acquisition date that occur both within the measurement period and as a result of facts and circumstances that existed at the acquisition date are recognized as an adjustment to goodwill. All other changes in valuation allowances are recognized as a reduction or increase to income tax expense.

 

Valuation of goodwill and other intangible assets.  We identify and value intangible assets that we acquire in business combinations, such as customer arrangements, customer relationships and non-compete agreements, that arise from contractual or other legal rights or that are capable of being separated or divided from the acquired entity and sold, transferred, licensed, rented or exchanged. The fair value of identified intangible assets is based upon an estimate of the future economic benefits expected to result from ownership, which represents the amount at which the assets could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidation sale.

 

We test our goodwill and other intangible assets for impairment annually or more frequently if events or circumstances indicate impairment may exist. Examples of such events or circumstances could include a significant change in business climate, a loss of significant customers, or a significant decline in stock price. We make a qualitative evaluation about the likelihood of goodwill impairment to determine whether we should calculate the fair value of a reporting unit.  If our evaluation indicates a likelihood of goodwill impairment, we apply a two-step fair value-based test to assess goodwill for impairment of our two reporting units. The first step compares the fair value of a reporting unit to its carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds its fair value, the second step is then performed. The second step compares the carrying amount of the reporting unit’s goodwill to the implied fair value of the goodwill. If the fair value of the goodwill is less than the carrying amount, an impairment loss would be recorded in our statements of operations. Intangible assets with definite lives are amortized over their estimated useful lives and are also reviewed for impairment if events or changes in circumstances indicate that their carrying amount may not be realizable.

 

Our management makes certain estimates and assumptions in order to determine the fair value of net assets and liabilities, including, among other things, an assessment of market conditions, projected cash flows, cost of capital and growth rates, which could significantly impact the reported value of goodwill and other intangible assets. Estimating future cash flows requires significant judgment, and our projections may vary from cash flows eventually realized. The valuations employ a combination of present value techniques to measure fair value, corroborated by comparisons to estimated market multiples. These valuations are based on a discount rate determined by our management to be consistent with industry discount rates and the risks inherent in our current business model.

 

We perform the annual goodwill impairment assessment as of the end of the fiscal year. During the three months ended December 31, 2014, we identified indicators of impairment, including the termination of the Wal-Mart Agreement on December 1, 2014, the significant decline in market capitalization during the quarter, and continued uncertainty in projections for fiscal year 2015 and beyond.  As a result, we tested the goodwill for impairment as of December 31, 2014.  Based on the goodwill impairment analysis as of the interim testing date, the carrying values of our two reporting units exceeded their fair values.  Accordingly, step two of the goodwill impairment test was performed, where we determined the estimated fair values of the assets and liabilities of the reporting units.  As a result of the step two test, we recorded a goodwill impairment charge of $85.1 million during the first quarter of fiscal 2015.  As part of our annual impairment assessment as of September 30, 2015, we identified indicators of impairment, including a decline in our market capitalization. As a result, we tested the goodwill for impairment as of September 30, 2015.  Based on the results of step one of our goodwill impairment analysis as of the fiscal year ended September 30, 2015, the carrying values of both of our two reporting units exceeded their fair value.  Accordingly, step two of the goodwill impairment test was performed, where we determined the estimated fair value of the assets and liabilities of the impaired reporting units.  As a result of the step two test, we recorded a goodwill impairment charge of $51.2 million during the fourth quarter of fiscal 2015.  During the three months ended December 31, 2015, no indicators of impairment were identified.

 

In accordance with Accounting Standards Codification Topic 280, which provides that the characteristics of a component require that it (a) constitutes a business, (b) has discrete financial information, and (c) its performance is reviewed by management, the Company has identified its reporting units as LSI-Retail Supply Chain Group (RSCG) and LSI-Capital Assets Group (CAG).  As the RSCG operations and the CAG operations represent two distinct components under the guidance of ASC 280, goodwill should be measured for impairment separately for each of these components.

 

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Determining the fair value of a reporting unit requires the exercise of significant judgment, including judgments about the appropriate discount rates, terminal growth rates, weighted average costs of capital, exit multiples, and the amount and timing of expected future cash flows.  The judgments used in determining the fair value of our reporting units are based on significant unobservable inputs which causes the determination of the implied fair value of goodwill to fall within level three of the GAAP fair value hierarchy.  The cash flows employed in the discounted cash flow analysis are based on the most recent budgets, forecasts, and business plans as well as various growth rate assumptions for years beyond the current business plan period.  Discount rate assumptions are based on an assessment of the risk inherent in the future revenue streams and cash flows of the reporting unit. Various factors, including the failure to successfully implement our business plan for any of our reporting units, as well as other factors beyond our control, could have a negative effect on the fair value of such reporting unit, and increase the risk of further impairments of goodwill in the future.

 

We cannot predict the occurrence of certain future events that might adversely affect the reported value of goodwill and other intangible assets, which totaled $67.2 million at December 31, 2015. Such events may include strategic decisions made in response to economic and competitive conditions, the impact of the economic environment on our base of buyers and sellers or material negative changes in our relationships with material customers.

 

Income taxes.  We account for income taxes using the asset and liability approach for measuring deferred taxes based on temporary differences between the financial statement and income tax bases of assets and liabilities existing at each balance sheet date using enacted tax rates for the years in which the taxes are expected to be paid or recovered. A valuation allowance is provided to reduce the deferred tax assets to a level that we believe will more likely than not be realized. The resulting net deferred tax asset reflects management’s estimate of the amount that will be realized.

 

We apply the guidance related to accounting for uncertainty in income taxes. We concluded that there were no uncertain tax positions identified during our analysis.

 

We provide for income taxes based on our estimate of federal and state tax liabilities. These estimates include, among other items, effective rates for state and local income taxes, estimates related to depreciation and amortization expense allowable for tax purposes, and the tax deductibility of certain other items. Our estimates are based on the information available to us at the time we prepare the income tax provision. We generally file our annual income tax returns several months after our fiscal year-end. Income tax returns are subject to audit by federal, state and local governments, generally years after the returns are filed. These returns could be subject to material adjustments or differing interpretations of the tax laws.

 

Stock-based compensation.  We recognize in the statements of operations all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their estimated fair values. We use the Black-Scholes option pricing model to estimate the fair values of share-based payments.

 

The above list is not intended to be a comprehensive list of all of our accounting estimates. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP, with little need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. See our audited financial statements and related notes, which contain accounting policies and other disclosures required by GAAP.

 

Components of Revenue and Expenses

 

Revenue.  We generate substantially all of our revenue from sales of merchandise held in inventory and by retaining a percentage of the proceeds from the sales. Our revenue recognition practices are discussed in more detail in the section above entitled “Critical Accounting Estimates.”

 

Cost of goods sold (excluding amortization).  Cost of goods sold includes the costs of purchasing and transporting property for auction, as well as credit card transaction fees.

 

Profit-sharing distributions.  Our Scrap Contract with the DoD has been structured as a profit-sharing arrangement in which we purchase and take possession of all goods we receive from the DoD at a contractual price per pound.  After deducting allowable operating expenses, we disburse to the DoD on a monthly basis a percentage of the profits of the aggregate monthly sales. We retain the remaining percentage of these profits after the DoD’s disbursement. We refer to these disbursement payments to the DoD as profit-sharing distributions.

 

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Technology and operations.  Technology expenses consist primarily of personnel costs related to our programming staff who develop and deploy new marketplaces and continuously enhance existing marketplaces. These personnel also develop and upgrade the software systems that support our operations, such as sales processing. Because our marketplaces and support systems require frequent upgrades and enhancements to maintain viability, we have determined that the useful life for substantially all of our internally developed software is less than one year. As a result, we expense these costs as incurred.

 

Operations expenses consist primarily of operating costs, including buyer relations, shipping logistics and distribution center operating costs.

 

Sales and marketing.  Sales and marketing expenses include the cost of our sales and marketing personnel as well as the cost of marketing and promotional activities. These activities include online marketing campaigns such as paid search advertising.

 

General and administrative.  General and administrative expenses include all corporate and administrative functions that support our operations and provide an infrastructure to facilitate our future growth. Components of these expenses include executive management and staff salaries, bonuses and related taxes and employee benefits; travel; headquarters rent and related occupancy costs; and legal and accounting fees. The salaries, bonus and employee benefits costs included as general and administrative expenses are generally more fixed in nature than our operating expenses and do not vary directly with the volume of merchandise sold through our marketplaces.

 

Amortization of contract intangibles.  Amortization of contract intangibles expense consists of the amortization of our contract intangibles associated with the Jacobs Trading acquisition on October 1, 2011, and the NESA transaction on November 1, 2012. The intangible asset created in conjunction with the acquisition of Jacobs Trading was valued at $33.3 million and was being amortized over 55 months on a straight-line basis. The amortization period was correlated to the base term of the Wal-Mart contract from the acquisition date, exclusive of renewal periods.  Upon the early termination of the Wal-Mart contract in December 2014, we expensed the remaining amount of unamortized expense of approximately $10.3 million during the three months ended December 2014. The vendor contract intangible asset created in conjunction with the NESA acquisition was valued at $3.9 million and was being amortized over 20 months, on a straight-line basis.  The amortization period was correlated to the base term of the contract, from the acquisition date, exclusive of renewal periods.

 

Depreciation and amortization.  Depreciation and amortization expenses consist primarily of the depreciation and amortization of amounts recorded in connection with the purchase of furniture, fixtures and equipment and amortization of intangible assets from our acquisitions.

 

Acquisition costs and related fair value adjustments and impairment of goodwill and long-lived assets.  Acquisition costs and related fair value adjustments and impairment of goodwill and long-lived assets consist of expenses incurred to complete a business combination, adjustments to the fair value of earn-outs, and impairment of goodwill and long-lived assets.

 

Interest (income) expense and other expense, net.  Interest (income) expense and other expense, net consists primarily of interest income on the note receivable related to the sale of the Jacobs Trading Company business and other expenses related to our credit facility.

 

Income taxes.  For interim income tax reporting the Company estimates its annual effective tax rate and applies this effective tax rate to its year to date pre-tax (loss) income.  The Company’s effective income tax rate before discrete items was 29.3% and 24.6% for the three months ended December 31, 2015 and December 31, 2014, respectively. The 2015 effective tax rate differed from the statutory federal rate of 35.0% primarily as a result of the impact of foreign, state, and local income taxes and permanent tax adjustments. We expect our future years’ tax rates to be between 30% and 40%.

 

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Results of Operations

 

The following table sets forth, for the periods indicated, selected statement of operations data expressed as a percentage of revenue.

 

 

 

Three Months
Ended December 31,

 

 

 

2015

 

2014

 

Revenue

 

100.0

%

100.0

%

Costs and expenses:

 

 

 

 

 

Cost of goods sold (excluding amortization)

 

40.8

 

43.4

 

Profit-sharing distributions

 

3.6

 

7.6

 

Technology and operations

 

34.6

 

21.5

 

Sales and marketing

 

14.4

 

8.3

 

General and administrative

 

15.3

 

7.6

 

Amortization of contract intangibles

 

0.0

 

1.0

 

Depreciation and amortization

 

2.5

 

1.6

 

Acquisition costs and related fair value adjustments and impairment of goodwill and long-lived assets

 

0.1

 

76.9

 

 

 

 

 

 

 

Total costs and expenses

 

111.3

 

167.9

 

 

 

 

 

 

 

Loss from operations

 

(11.3

)

(67.9

)

Interest (income) expense and other expense, net

 

(0.1

)

0.0

 

 

 

 

 

 

 

Loss from operations before benefit from income taxes

 

(11.2

)

(67.9

)

Benefit from income taxes

 

(3.3

)

(16.7

)

 

 

 

 

 

 

Net loss

 

(7.9

)%

(51.2

)%

 

Three Months Ended December 31, 2015 Compared to Three Months Ended December 31, 2014

 

Revenue.  Revenue decreased $59.3 million, or 47.4%, to $65.9 million for the three months ended December 31, 2015 from $125.1 million for the three months ended December 31, 2014, primarily due to (1) a 54.9% decrease, or $38.4 million, in our commercial marketplaces mostly due to the sale of the Jacobs Trading Company business, the wind down of the NESA refurbishment business in Canada, fewer principal deals, and continued weakness in the energy vertical; and (2) a 42.6% decrease, or $21.5 million, in our DoD businesses as a result of reduced property flows of lesser value product and lower commodity prices. These decreases were partially offset by a 12.9% increase, or $0.6 million, in our state and local government (GovDeals) marketplace due to an increase in the number of sellers. The amount of gross merchandise volume decreased 38.3%, or $93.9 million to $151.4 million, for the three months ended December 31, 2015 from $245.3 million for the three months ended December 31, 2014, primarily due to (1) a 52.9% decrease, or $79.1 million, in our commercial marketplaces mostly due to the sale of the Jacobs Trading, the wind down of the NESA business, fewer principal deals, and continued weakness in the energy sector; and (2) a 42.6% decrease, or $21.5 million, in our DoD businesses as a result of reduced property flows of lower value product and lower commodity prices. These GMV decreases were partially offset by a 14.6% increase, or $6.7 million, in our state and local government (GovDeals) marketplace due to an increase in the number of sellers.

 

Cost of goods sold (excluding amortization).  Cost of goods sold (excluding amortization) decreased $27.4 million, or 50.5%, to $26.9 million for the three months ended December 31, 2015 from $54.3 million for the three months ended December 31, 2014.  As a percentage of revenue, cost of goods sold (excluding amortization) decreased to 40.8% from 43.4%.  These decreases were primarily due to decreases in product flows for transactions using the purchase model in the commercial retail marketplaces and fewer principal deals  in the capital assets marketplaces.

 

Profit-sharing distributions.  Profit-sharing distributions decreased $7.2 million, or 75.4%, to $2.4 million for the three months ended December 31, 2015 from $9.6 million for the three months ended December 31, 2014. As a percentage of revenue, profit-sharing distributions decreased to 3.6% from 7.6%. These decreases are due to decreases in property flow from the DoD in our scrap business and lower commodity prices.

 

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Technology and operations expenses.  Technology and operations expenses decreased $4.1 million, or 15.1%, to $22.8 million for the three months ended December 31, 2015 from $26.9 million for the three months ended December 31, 2014, primarily due to a $3.2 million decrease in staff and temporary wages, including performance-based compensation, and $0.8 million in expenses due to our business realignment initiative, including the sale of the Jacobs Trading Company business, wind-down of the NESA business, and closure of our Cranbury, New Jersey warehouse.  As a percentage of revenue, technology and operations expenses increased to 34.6% from 21.5% primarily as a result of the decrease in revenue described above.

 

Sales and marketing expenses.  Sales and marketing expenses decreased $0.9 million, or 8.9%, to $9.5 million for the three months ended December 31, 2015 from $10.4 million for the three months ended December 31, 2014, primarily due to our business realignment initiative.  As a percentage of revenue, sales and marketing expenses increased to 14.4% from 8.3% primarily as a result of the decrease in revenue described above.

 

General and administrative expenses.  General and administrative expenses increased $0.6 million, or 5.7%, to $10.1 million for the three months ended December 31, 2015 from $9.5 million for the three months ended December 31, 2014, which is not significant. As a percentage of revenue, general and administrative expenses increased to 15.3% from 7.6% primarily as a result of the decrease in revenue described above.

 

Amortization of contract intangibles.  Amortization of contract intangibles was related to the contract intangible asset created in conjunction with the Jacobs Trading acquisition which was valued at $33.3 million and was being amortized over 55 months on a straight-line basis. Amortization of contract intangibles for the three months ended December 31, 2015 and December 31, 2014 was zero and $1.2 million, respectively. This decrease was due to the write-off of the remaining unamortized expense related to the Jacobs Trading acquisition contract intangible asset due to the early termination of the Wal-Mart contract in December 2014.

 

Depreciation and amortization expenses.  Depreciation and amortization expenses decreased $0.3 million, or 16.0%, to $1.7 million for the three months ended December 31, 2015 from $2.0 million for the three months ended December 31, 2014, primarily as a result of the sale of the Jacobs Trading Company business in September 2015 and downsizing of staff and facilities as part of the business realignment initiative.

 

Acquisition costs and related fair value adjustments and impairment of goodwill and long-lived assets.  Acquisition costs and related fair value adjustments and impairment of goodwill and long-lived assets decreased $96.2 million, or 100.0% to zero for the three months ended December 31, 2015 from $96.2 million for the three months ended December 31, 2014, due to the write-downs of impaired goodwill and the remaining unamortized expense related to the Jacobs Trading acquisition contract intangible asset due to the early termination of the Wal-Mart contract in December 2014.

 

Interest(income) expense and other expense, net.  Interest (income) expense and other expense, net, increased $0.1 million, or 258.0%, to $0.1 million of income for the three months ended December 31, 2015 from zero for the three months ended December 31, 2014, primarily due to the interest on the note receivable related to the Jacobs Trading Company sale.

 

Benefit for income tax expense.  Income tax benefit decreased $18.7 million, or 89.7%, to $2.2 million for three months ended December 31, 2015 from $20.9 million for the three months ended December 31, 2014, primarily due to the write-down of impaired goodwill and long-lived assets in the three months ended December 2014.

 

Net loss.  Net loss decreased $58.9 million, or 91.9%, to $5.2 million for the three months ended December 31, 2015 from $64.1 million for the three months ended December 31, 2014, primarily as a result of the write-down of impaired goodwill and long-lived assets in the three months ended December 2014.

 

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Liquidity and Capital Resources

 

Historically, our primary cash needs have been working capital (including capital used for inventory purchases), which we have funded primarily through cash generated from operations. As of December 31, 2015, we had approximately $85.5 million in cash and cash equivalents and $37.5 million available under our $75.0 million senior credit facility, as amended, of which we have used $5.9 million for issued letters of credit.

 

The Company has not recorded a provision for deferred U.S. tax expense on the undistributed earnings of foreign subsidiaries since the Company intends to indefinitely reinvest the earnings of these foreign subsidiaries outside the U.S. The amount of such undistributed foreign earnings was approximately $12.0 million as of December 31, 2015.  As of December 31, 2015 and September 30, 2015, approximately $23.1 million and $23.6 million, respectively, of cash and cash equivalents was held overseas and not available to fund domestic operations without incurring taxes upon repatriation.

 

The Company did not repurchase shares during the three months ended December 31, 2015 or 2014 with the approximately $5.1 million remaining under a share repurchase program approved by our Board of Directors.  Under the program, we are authorized to repurchase the issued and outstanding shares of common stock.  Share repurchases may be made through open market purchases, privately negotiated transactions or otherwise, at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements and other market conditions.  The repurchase program may be discontinued or suspended at any time, and will be funded using our available cash. Our Board of Directors reviews the share repurchase program periodically, the last such review having occurred in February 2014.

 

Most of our sales are recorded subsequent to receipt of payment authorization, utilizing credit cards, wire transfers and PayPal, an Internet based payment system, as methods of payments. As a result, we are not subject to significant collection risk, as goods are generally not shipped before payment is received.

 

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Changes in Cash Flows: Three Months Ended December 31, 2015 Compared to Three Months Ended December 31, 2014

 

Net cash used in by operating activities was $8.3 million for the three months ended December 31, 2015 and net cash provided by operating activities was $13.1 million for the three months ended December 31, 2014. For the three months ended December 31, 2015, net cash used in operating activities primarily consisted of a net loss of $5.2 million, net increase of $6.5 million in accounts receivable, prepaid assets, tax assets, and inventory, including investing in growth initiatives and new business opportunities, and net decrease in accounts payable and accrued liabilities of $2.0 million, offset by depreciation and amortization expense of $1.7 million, stock compensation expense of $2.4 million, and provision for inventory allowance, doubtful accounts, and incremental tax from exercises of common stock options of $1.3 million, net. For the three months ended December 31, 2014, net cash provided by operating activities primarily consisted of a net loss of $64.1 million, depreciation and amortization expense of $3.2 million, stock compensation expense of $2.6 million, impairment of goodwill and long-lived assets of $96.2 million, inventory decrease of $8.1 million, a net decrease in accounts receivable and prepaid assets of $2.3 million, a net decrease in accounts payable, accrued expenses and other liabilities of $13.0 million, provisions for inventory allowance, doubtful accounts, and incremental tax from exercises of common stock options of $0.1 million, net, and deferred tax benefit of $22.1 million as a result of the impairment of goodwill and long-lived assets.

 

Net cash used in investing activities was $1.5 million for the three months ended December 31, 2015 and $1.6 million for the three months ended December 31, 2014.  Net cash used in investing activities for the three months ended December 31, 2015 consisted primarily of expenditures of $1.5 million for purchases of equipment and leasehold improvements and increases in intangible assets.  Net cash used in investing activities for the three months ended December 31, 2014 consisted primarily of capital expenditures of $1.6 million for purchases of equipment and leasehold improvements.

 

Net cash used by financing activities was zero for the three months ended December 31, 2015 and net cash provided by financing activities was $0.2 million for the three months ended December 31, 2014.  Net cash provided by financing activities for the three months ended December 31, 2014 consisted primarily of proceeds from the exercise of common stock options including the tax benefit of $0.2 million.

 

Capital Expenditures.  Our capital expenditures consist primarily of computers and purchased software, office equipment, furniture and fixtures, and leasehold improvements. The timing and volume of such capital expenditures in the future will be affected by the addition of new customers or expansion of existing customer relationships. We expect capital expenditures to range from $8.0 million to $9.5 million in the fiscal year ending September 30, 2016. We intend to fund those expenditures primarily from operating cash flows. Our capital expenditures for the three months ended December 31, 2015 were $1.4 million. As of December 31, 2015, we had no outstanding commitments for capital expenditures.

 

Senior credit facility.  We maintain a $75.0 million senior credit facility due May 31, 2018. The senior credit facility bears an annual interest rate of 30 day LIBOR plus 1.25%. As of December 31, 2015, we had no outstanding indebtedness under our senior credit facility and our borrowing availability was $37.5 million, of which we have used $5.9 million for issued letters of credit. The obligations under our senior credit facility are unconditionally guaranteed by us and each of our existing and subsequently acquired or organized subsidiaries (other than our subsidiary organized to service our DoD Scrap Contract) and secured on a first priority basis by security interests (subject to permitted liens) in substantially all assets owned by us, and each of our other domestic subsidiaries, subject to limited exceptions. The Agreement contains certain financial and non-financial restrictive covenants including, among others, the requirements to maintain a minimum level of earnings before interest, income taxes, depreciation and amortization (EBITDA) and a minimum debt coverage ratio. Our credit agreement contains a number of affirmative and restrictive covenants including limitations on mergers, consolidations and dissolutions, sales of assets, investments and acquisitions, indebtedness and liens, and dividends and other restricted payments. As of December 31, 2015, we were in full compliance with the terms and conditions of our credit agreement.

 

We believe that our existing cash and cash equivalents, will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our future capital requirements will depend on many factors including our rate of revenue growth, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the development and deployment of new marketplaces, the introduction of new value added services and the costs to establish additional distribution centers. Although we are currently not a party to any definitive agreement with respect to potential investments in, or acquisitions of, complementary businesses, products or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. The sale of additional equity securities or convertible debt securities would result in additional dilution to our stockholders. Additional debt would result in increased interest expense and could result in covenants that would restrict our operations. There is no assurance that such financing, if required, will be available in amounts or on terms acceptable to us, if at all.

 

Off-Balance Sheet Arrangements

 

We do not have any transactions, obligations or relationships that could be considered material off-balance sheet arrangements.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

 

Interest rate sensitivity. We had no debt as of December 31, 2015, and thus do not have any related interest rate exposure. Our investment policy requires us to invest funds in excess of current operating requirements. The principal objectives of our investment activities are to preserve principal, provide liquidity and maximize income consistent with minimizing risk of material loss.

 

Exchange rate sensitivity. We consider our exposure to foreign currency exchange rate fluctuations to be minimal, as approximately 11.6% percent of our sales are denominated in foreign currencies. We have not engaged in any hedging or other derivative transactions to date.

 

Item 4. Controls and Procedures.

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

During the most recent fiscal quarter, there has not occurred any change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

As of December 31, 2015, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer, our Chief Financial Officer, and our Chief Accounting Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer concluded that our disclosure controls and procedures were effective and were operating to provide reasonable assurance that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and to provide reasonable assurance that such information is accumulated and communicated to our management, including our principal executive officer, principal financial officer, and principal accounting officer, as appropriate to allow timely decisions regarding required disclosure.

 

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PART II—OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

From time to time, we may become involved in litigation relating to claims arising in the ordinary course of our business.  On July 14, 2014, Leonard Howard filed a putative class action complaint in the United States District Court for the District of Columbia against the Company and its chief executive officer, chief financial officer, and chief accounting officer, on behalf of stockholders who purchased the Company’s common stock between February 1, 2012, and May 7, 2014.  The complaint alleges that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by, among other things, misrepresenting the Company’s growth initiative, growth potential, and financial and operating conditions, thereby artificially inflating its share price, and seeks unspecified compensatory damages and costs and expenses, including attorneys’ and experts’ fees.  On October 14, 2014, the Court appointed Caisse de Dépôt et Placement du Québec and the Newport News Employees’ Retirement Fund as co-lead plaintiffs.  The Plaintiffs filed an amended complaint on December 15, 2014, which alleges substantially similar claims but which does not name the chief accounting officer as a defendant.   The Company believes the allegations are without merit and on March 2, 2015, moved to dismiss the amended complaint for failure to state a claim or plead fraud with the requisite particularity.  That motion was fully submitted as of June 1, 2015, and the Company is awaiting a decision by the Court. The Company cannot estimate a range of potential liability, if any, at this time.

 

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Item 1A. Risk Factors.

 

In addition to the other information set forth in this report, you should carefully consider the factors set forth in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended September 30, 2015, which could materially affect our business, financial condition or future results. The risks described in our Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

 

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Item 6. Exhibits.

 

Exhibit No.

 

Description

3.1

 

Fourth Amended and Restated Certificate of Incorporation, incorporated herein by reference to Exhibit 3.1 to Amendment No. 2 to the Company’s Registration Statement on Form S-1 (Registration No. 333-129656), filed with the SEC on January 17, 2006.

3.2

 

Amended and Restated Bylaws, incorporated herein by reference to Exhibit 3.2 to Amendment No. 2 to the Company’s Registration Statement on Form S-1 (Registration No. 333-129656), filed with the SEC on January 17, 2006.

31.1

 

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

31.2

 

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

31.3

 

Certification of Chief Accounting Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.

32.1

 

Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.3

 

Certification of Chief Accounting Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101

 

The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2015, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Changes in Stockholders’ Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Consolidated Financial Statements.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on February 5, 2016.

 

 

LIQUIDITY SERVICES, INC.

 

 

(Registrant)

 

 

 

 

 

 

 

By:

/s/ William P. Angrick, III

 

 

William P. Angrick, III

 

 

Chairman of the Board of Directors and Chief Executive Officer

 

 

 

 

 

 

 

By:

/s/ Jorge A. Celaya

 

 

Jorge A. Celaya

 

 

Executive Vice President and Chief Financial Officer

 

 

 

 

 

 

 

By:

/s/ Kathryn A. Domino

 

 

Kathryn A. Domino

 

 

Chief Accounting Officer

 

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