Earnings Call Transcript - AENT Q2 2024

Operator, Operator

Greetings, and welcome to the Alliance Entertainment Second Quarter Fiscal Year 2024 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. Before we begin the formal presentation, I would like to remind everyone that statements made on the call and webcast may include predictions, estimates, or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this presentation. Please keep in mind that we are not obligating ourselves to revise our publicly released results of any revisions to these forward-looking statements in light of new information or future events. Throughout today's discussion, we will attempt to present some important factors relating to our business that may affect our predictions. You should also review our most recent Form 10-K for a more complete discussion of these factors and other risks, particularly under the heading risk factors. During this conference call, we will discuss non-GAAP financial measures, including a discussion of adjusted EBITDA. We believe non-GAAP disclosures enable investors to better understand Alliance Entertainment's core operating performance. Please refer to the investor presentation for a reconciliation of each non-GAAP measure to their most directly comparable GAAP financial measure. A press release detailing these results crossed the wires this afternoon at 4:05 PM Eastern Time, and it is available in the Investor Relations section of our company's website, aent.com. Your host today, Bruce Ogilvie, Executive Chairman; and Jeff Walker, Chief Executive Officer and Chief Financial Officer, will present results of operations for the fiscal second quarter ended December 31, 2023. At this time, I'll turn the call over to Alliance's Entertainment Executive Chairman, Bruce Ogilvie.

Bruce Ogilvie, Executive Chairman

Thank you, operator, and good afternoon, everyone. I'm pleased to welcome you to today's fiscal second quarter ended December 31, 2023 financial results conference call. For those of you that are new to our story, we bring entertainment to you. Alliance talks to the world's largest selection of music, movies, video games, gaming hardware, arcades, collectibles, toys, and consumer electronics. We are a trusted omnichannel supplier to the largest retailers and wholesalers across the globe and a trusted distributor for the world's most recognized entertainment and gaming brand. As of our most recent June 30, 2023 fiscal year-end, we produced over $1.1 billion in annual revenue and employed over 700 team members. Alliance is a gateway between brands and retailers. We are a trusted omnichannel supplier to Walmart, Amazon, Best Buy, Costco, Target, Kohl's, BJ's, Meyer, Barnes and Noble, and 2,000 additional retailers and wholesalers worldwide, and a trusted distributor for Disney, Paramount, Sony, Warner, Universal, Microsoft, Nintendo, Activision, Electronic Arts, Mattel, Hasbro, Sunco, Arcade1Up, and 600 others. We have over 200 customers that sell online worldwide and ship to more than 35,000 storefronts in 72 countries and distribute over 325,000 in-stock SKUs to the largest retailers and wholesalers in the world. Our AMPED and Distribution Solutions division distributes physical exclusive music and exclusive video respectively, and our Mill Creek division engages in exclusive video licensing and content from Disney, Sony, Universal, Lionsgate, CBS, and others. Distribution Solutions has over 62 significant exclusive video studios that rely on Distribution Solutions to manufacture, supply, and market video products and have direct sales through accounts with Amazon, Walmart, Target, and thousands of retailers and websites through Alliance Entertainment's vast distribution channels. AMPED has more than 90 exclusive labels that rely on AMPED to supply and market music, vinyl, and CDs, and sells and markets music through Amazon, Walmart, Target, Barnes and Noble, Best Buy, and over 2,000 independent music stores in the US through Alliance Entertainment's worldwide distribution channels. Mill Creek licenses video content from studios to create, manufacture, market, and sell video DVDs with content licensed from Disney, Sony, Universal, Lionsgate, CBS, and significant independent studios. Alliance provides traditional retailers with world-class distribution and e-commerce capabilities by focusing on service, selection, and technology by providing our retailers superior service, stocking the world's largest physical media and entertainment selection, and state-of-the-art technology systems and facilities. Alliance provides efficient omnichannel expansion solutions for retailers, offering a full enterprise-level infrastructure and dropship orders directly to consumers on behalf of its customers. The entire ordering, confirmation, and invoicing process is automated, allowing customers to focus on sales while we perform all stocking, warehousing, and shipping functions through the consumer whose shipment they received, which looks like it was sent by the large retailers we service. Alliance is also a leader in vendor-managed inventory solutions, providing solutions tailored to our customers to support their inventory needs. These value-add services provide a highly technical critical business function for our partners. Alliance consolidates and distributes a vast portfolio of entertainment products, while a proprietary database powers retailers' online music and gaming offerings, including vinyl, CDs, DVDs, Blu-ray, gaming products, and retro arcades. Currently, we have over 325,000 unique SKUs in stock to support our customers vast selection of needs. Alliance has invested in enhancements to our automated handling equipment, which reduced shipping time, streamlined order processing, reduced labor costs, and improved overall warehouse management. Just over a year ago, we installed an automated storage retrieval system at our Shepherdsville warehouse. This improved warehouse operations allowing us to achieve increased levels of speed, reliability, capacity, and precision, that resulted in significant cost savings. This slide highlights our strategically located operations that include seven offices and four distribution centers, including our 873,000 square foot facility in Shepherdsville, Kentucky. In 2023, warehouse shipments totaled over 70 million units through our highly skilled workforce with tech-enabled facilities and infrastructure that allow Alliance to achieve industry-leading speed and accuracy metrics. I will now hand the call over to Alliance’s CEO and CFO, my partner, Jeff Walker.

Jeff Walker, CEO & CFO

Thank you, Bruce. And thank you all for joining us today. We'll now turn to an overview of our financial results in the second fiscal quarter ended December 31, 2023. Net revenues for the fiscal second quarter ended December 31, 2023 were $426 million compared to $445 million in the same period of 2022. Of note, our consumer direct shipments grew to 45% of gross sales revenue for the fiscal second quarter compared to 37% in the year-ago period, totaling 2.3 million shipments of 5.3 million units. Gross profit for the fiscal second quarter ended December 31, 2023 was $47.7 million compared to $20.9 million in the same period of 2022, an increase of 128%. Gross profit margin for the fiscal second quarter ended December 31, 2023 was 11.2%, up from 4.7% in the same period of 2022. Net income for the fiscal second quarter ended December 31, 2023 was $8.9 million compared to a net loss of $15.5 million for the same period of 2022. Adjusted EBITDA for the fiscal second quarter ended December 31, 2023 was $17.9 million compared to adjusted EBITDA loss of $14.5 million for the same period of 2022. Over the last 12 months, we have significantly reduced inventory and debt with fiscal second quarter December 31, 2023 year-over-year inventory decreasing from $175 million down to $114 million and debt down from $177 million to $107 million. We also closed on a new three-year $120 million senior secured asset-based credit facility with White Oak Commercial Finance LLC, replacing the company's revolver with Bank of America. On this slide, you can see fiscal year 2022, we were experiencing the benefits of COVID with peak sales of $1.42 billion in revenue. Fiscal 2023, our sales normalized after COVID with sales of $1.16 billion. For fiscal 2023, adjusted EBITDA was negatively affected by one-time supply chain costs of $35.8 million. We've gone past those one-time supply issues. For the second quarter ending December 31, 2023, our adjusted EBITDA was 4.2% of revenue. We are continuing to reduce operating costs and improve margins in 2024 to get back to 5% adjusted EBITDA of sales. For this slide, you will see six months of sales compared to the previous four fiscal years. We wanted to show you how diversified Alliance is and how consistent sales by configuration are. The diversified products offered is a big part of the Alliance winning formula. In addition to the huge growth in our year-over-year quarterly gross profit, we reduced operating costs by $5.2 million through warehouse efficiencies and new technology implemented, going from $35.4 million down to $30.2 million. These efficiencies will have an ongoing positive impact going forward. On this slide, gross profit improvement and expense reductions also led to a third consecutive quarter of positive adjusted EBITDA, increasing to $17.9 million in the fiscal second quarter compared to an adjusted EBITDA loss of $14.5 million in the prior year. EBITDA as a percentage of sales was a strong 4.2%. The first half of our fiscal year saw net revenues for the six months ending December 31, 2023 total $652 million compared with $684 million in the same period of 2022, a decrease of 4.6%. Gross profit was $74 million compared to $46.4 million in the same period of 2022, an increase of 59.5%. Gross profit margin was 11.3%, up from 6.8% in the same period of 2022. Net income was $5.5 million compared to a net loss of $23 million for the same period of 2022. Adjusted EBITDA for the six months ending December 31, 2023 was $19.2 million compared to adjusted EBITDA loss of $18.6 million for the same period of 2022. For this slide, it shows the quarterly results in Q1 2020 for gross profit net income for GAAP and adjusted EBITDA. Comparing Q2 fiscal year ’20 to Q2 fiscal year '24, adjusted EBITDA has increased from $11.2 million to $17.9 million, which is a 60% increase over the past four years. We have taken significant steps over the past year to strengthen our balance sheet with additional cost savings initiatives planned. Throughout 2023, we were highly focused on reducing inventory and debt with fiscal second quarter year-over-year inventory decreasing from $175 million to $114 million and debt down from $177 million to $107 million. We also expect significant cost savings in fiscal year ending 2025 with the planned closing of our Minnesota facility in May of 2024. Additionally, to support growth we recently secured a new three-year $120 million senior secured asset-based credit facility with White Oak Commercial Finance. The proceeds of which we've used to refinance the existing credit facility, fund the working capital needs, and provide for general corporate purposes. These steps have also positioned us to focus and execute on implementing our acquisition strategy going forward. I will now turn the call back over to Bruce.

Bruce Ogilvie, Executive Chairman

Thank you, Jeff. Going back to what Jeff mentioned regarding our acquisition strategy. Alliance has a proven track record of successfully acquiring and integrating competitors and complementary businesses. We have acquired over a dozen companies in the last 20 years, including Alliance Entertainment, AN Connect, Mecca Electronics, Distribution Solutions, COKeM, and Think 3Fold. We also continue to focus on acquiring more licenses and exclusive distribution agreements in music, video, gaming, collectibles, and electronics. Expanding our existing product and service offering and executing our acquisition strategy will drive Alliance's efforts toward increasing market share. Alliance will further invest in automating facilities and upgrading proprietary software. Alliance's direct-to-consumer or DTC services are in greater demand as consumer preferences shift and stress retailers’ e-commerce and DTC capabilities. Enhancing DTC relationships will grow existing revenue lines, and improving capabilities will generate a more attractive overall service offering. Leveraging existing relationships, Alliance can expand into new consumer product segments, growing its product offering and providing more selection and diversity to our existing customer base while attracting new customers in the process. In closing, Alliance is a leading global entertainment wholesaler, direct-to-consumer distributor, and e-commerce provider for the entertainment industry with over 30 years of operations experience within the entire Alliance management team, which beneficially owns more than 81% of the common shares outstanding and has extensive knowledge and expertise to lead the company toward future growth. We are a leader in fulfillment and e-commerce distribution with over 325,000 SKUs physically in stock protected by a focused commitment of service, selection of technology, suppliers, and brick-and-mortar retailers, omni retailers, online retailers, and consumers rely on the company's platforms to fuel transactional volume for trusted, dependable relationships. Through the expansion of partnerships with our vendors and our customers as well as investment in existing facilities, Alliance expects to continue to grow revenue and expand margins. Again, we have a proven track record of M&A, having successfully acquired and integrated 12 significant businesses in 2003. There are significant future acquisition and consolidation opportunities to drive future growth through the acquisition of complementary businesses and competitors. Finally, the company's technology platform increases the efficiency of transactions, reduces labor costs, provides great mobile accessibility, and incorporates modern marketing and fintech tools. We look forward to providing our shareholders with further updates in the near term as we strengthen our leadership position as the premier distributor of music, movies, video games, arcade, toys, collectibles, and consumer electronics. I thank you all for attending, and I'd like to hand the call back over to the operator to begin our question-and-answer session.

Operator, Operator

Our first question comes from Ashok Kumar with ThinkEquity.

Ashok Kumar, Analyst

The first question is about your operational key performance indicators, specifically regarding distribution and fulfillment expense. Year-over-year, comparing December 31, 2023, to the previous year, there was a $5.6 million decrease, which translates to a full point improvement as a percentage of sales. What caused this change? The second question pertains to adjusted EBITDA, where you mentioned a $35.8 million adjustment, with the footnote referencing excessive transportation cost markdowns and other arcade-related expenses. Could you explain this further? Lastly, regarding your balance sheet, your inventory showed a $61 million improvement, and the revolving credit decreased by $69.7 million. Can you provide more details on what drove these improvements?

Bruce Ogilvie, Executive Chairman

Jeff, I think you should begin there.

Jeff Walker, CEO & CFO

Well, I'll start off with the last question, a big reduction in our inventory and our debt at 12/31. Those two kind of really go hand in hand. As we came out of 12/31/22, we still had a high level of inventory, higher than optimal levels, and we've been diligently working on reducing down that inventory during calendar 2023. And as we reduced down that inventory, the cash conversion from the inventory reduced our line of credit along the way there. The other component, one last piece that factors into there is with interest rates really increasing over the last couple of years prior when we had very low interest costs, it was optimal for us to carry a much higher level of inventory. As interest costs have increased over the last two years, that definitely makes us readjust our inventory buying processes. In some cases, we might have bought a month's worth of stock at a time. Now we might buy two weeks at a time and then two weeks later replenish some more to help continue to improve our inventory turns and so forth.

Bruce Ogilvie, Executive Chairman

On the question of reducing our operating expenses, we definitely had a significant improvement in our fourth quarter operating expenses; that's primarily all warehouse and facility expenses. A big component was with our AutoStore system, that system is highly efficient and reduces the significant amount of people needed to put away product in the warehouse and pick orders as well. So that was a big component. We did also see a little bit easing up on labor over this last Q4 versus the prior Q4. In Q4 of 2022, we definitely had to do a lot more incentives for labor in the warehouse to have the warehouse fully staffed, and that eased up a little bit in 2023. I'll take that last question there, that three-part question there on the one-time supply chain issues. I believe that's what you asked. So it really started a couple of years before; it really started in ‘21 where we were doing really well in arcades and we placed very large orders in 2021 because we had large orders from all the major retailers, Target, Walmart, Costco, anybody, and everybody at Walmart carrying arcades during COVID, selling anything that would make man caves better for people at home to have a good time. So we placed all the orders; we had to put in deposits and secure supply chain financing, like letters of credit. Unfortunately, we got caught up in all those supply chain issues that all retailers had to deal with, whether it be Walmart, Target, Kohl's, or Bed Bath & Beyond, where the ships just could not get unloaded. With all that product that we needed for Q4 of ‘21, just did not arrive, and we could not deliver to retail when they wanted it for those big high selling seasons when the arcades were at their peak time. We came out of that holiday with over $130 million in arcade inventory when we were forecasting we should have no more than $50 million, and we missed all the sales opportunities in ‘21 that we were planning on. So ‘22, now we were way overstocked in arcades, and we had to deal with the fact that interest rates were going up, gas prices were rising, and inflation was hitting; there was no more stimulus money coming from the government. We spent all of ‘22 selling off that inventory and trying to reduce our balance sheet. We did bring that $130 million for ‘22 down by $80 million, which was great from a balance sheet perspective but wreaked havoc with our financial statement. If we had been smarter, and hindsight's always 20/20, we should have put some big reserves on our June 30, 2023 financials so that we didn't have this significant hit in Q2 of our financials. We had a $21 million loss instead of a profit, and that hurt everything about our financials, causing a bank violation, the start of the bane of all our problems. The good news is we cut through all that and were able to turn that around.

Jeff Walker, CEO & CFO

The reserve that we really should have put on would have been on June 30, 2022 financing.

Bruce Ogilvie, Executive Chairman

So ‘23 arcades, we had $50 million worth of arcades, we bought another $20 million, and by December 31, 2023, we were down to $17 million in arcades. So we are very happy with our current position. We do not have that supply chain risk that we had, and we are not placing big orders and big bets like we did in the past; it's now just a normal-sized business that we can handle and operate. Our Q4 results illustrate the progress we made compared to the same Q4 the year before.

Operator, Operator

Our next question comes from the line of Matt Koranda with ROTH MKM.

Mike Zebran, Analyst

This is Mike Zebran on for Matt. I guess I noticed that customer direct fulfillment revenues were about 800 basis points higher year-over-year. So now we're at 45% of sales. Maybe just discuss the outlook for customer direct fulfillment revenue mix in the second half of the year, and how should we think about how that mix will affect the P&L?

Jeff Walker, CEO & CFO

We're very pleased with the progress. Achieving 45% indicates we expect this trend to continue. A key element of our success is the design of our business, which encompasses a comprehensive array of entertainment products. We ensure that our products are available for purchase across all major retail websites, including Walmart, Target, Best Buy, Barnes and Noble, Wayfair, Home Depot, and of course, Amazon. As we introduce new products, they are listed on these platforms. A significant part of our success comes from our vinyl offerings at Walmart stores, where we feature a curated selection of about 700 titles. Additionally, Walmart.com hosts over 30,000 unique vinyl titles available for online order. Customers can easily order these titles directly from our warehouse, and we ship them out the same day under Walmart's branding. This model serves as a fulfillment center for entertainment products across major retailers, benefiting them by eliminating inventory risk since they simply facilitate the sale while we handle the shipping. This approach leads to incremental sales and profits for these retailers. We remain committed to enhancing our e-commerce capabilities and attracting more customers in this area.

Bruce Ogilvie, Executive Chairman

I think your question is how it will affect us over the next four quarters. We definitely believe that percentage will hold steady, and it isn’t negatively impacting us. Whether we deliver one or two units to each consumer or send a box to retail, we adjust the pricing accordingly. This allows us to maintain the same margins we have always had. We operate a business, not a charity.

Jeff Walker, CEO & CFO

Correct, it's a profitable direct-to-consumer business.

Mike Zebran, Analyst

And we expect that mix to continue to climb going forward. Is that the right way to think about it?

Bruce Ogilvie, Executive Chairman

I don't think you could say it was going to...

Jeff Walker, CEO & CFO

I don't know if it will grow as fast as it did this year-over-year, but it's definitely growing and will continue to expand.

Bruce Ogilvie, Executive Chairman

On arcades, our business has shifted more to shipping direct-to-consumer than shipping to brick and mortar. Those are high dollar ranks, so that has a weighting effect to some degree. It's better for everybody involved to not try to ship it into brick-and-mortar retail. There's freight cost to get it into retail and then you got to turn around and if they're going to ship it to the consumer, it's better to ship it from one central point. The way we have it set up now, it all comes in, and we don't have to re-distribute it again. I think we've got it all dialed in to be the most efficient for the retailer and for us.

Jeff Walker, CEO & CFO

One last thing. One thing that didn't really get into the Q4 numbers is we took over all the music and video direct-to-consumer business for target.com, and that really went live like mid-December. So it really didn't click into those numbers for this last quarter, and that's a big increase for us. They're doing a lot of vinyl, K-pop on the music side, as well as new releases in all the movies and TV shows.

Mike Zebran, Analyst

One more from me. The gross margin improvement in Q2 is pretty large. I think we're at 11% versus around 4.7% last year. Let me just specify the drivers of the improvement. So how much was mix improvement and shedding lower margin revenues versus cost cutting?

Jeff Walker, CEO & CFO

Well, I think on the gross margin, the bulk of the gross margin improvement is that we didn't have the big write-offs and adjustments that really reduced it in 2022. We have seen margin improvements in some of our vinyl sales and we've also seen it in our arcade sales. We were I would say abnormally low in 2022 with the 4% range of gross margin; that was not in our historical history. The change is kind of an anomaly. We're more in the consistent range that we're in now in this last quarter going forward. We won't see it go back to the 4% is another way to say it.

Operator, Operator

Our next question comes from the line of Douglas Hobbs with Hobbs Family Office.

Douglas Hobbs, Analyst

It seems Alliance is utilizing software and technology much better these days. Can you expound on any cost savings, compliance, and controls improvements?

Bruce Ogilvie, Executive Chairman

Jeff mentioned that we installed AutoStore in our Kentucky facility, which I liken to a Rubik's cube for auto storage and retrieval. We have been using this equipment for 13 months now. The system involves various totes, which function as shelf locations. Instead of pickers walking to different shelf locations to fulfill an order, they remain in one spot while the system brings the shelf locations to them. This greatly reduces travel time. Previously, we could achieve about 120 shelf presentations per hour, but now we are over 300. The reason for this improvement is that every 10 seconds, a tote is delivered to the processing station where the staff can specify how many items they need from that shelf location. This change has allowed us to reduce the number of people fulfilling orders from 41 to 7 while maintaining efficiency on the put-away side as well. When we receive products, rather than searching for an empty shelf location to store them, the empty shelves come to the receiver who simply enters the number of items placed there and scans the barcode. Once received, the items are immediately available for picking. Implementing AutoStore for our vinyl, which was previously one of our most costly areas in terms of picking, has saved us approximately $3 million to $3.5 million annually. We have a four-year lease on the system, with an original purchase price of $10 million, and we anticipate a payback period of 3.5 years. We are very pleased with the outcomes from these investments.

Operator, Operator

There are no more dial-in questions. We will now take questions from the webcast.

Unidentified Company Representative, Representative

Our first webcast question asks, are you looking or working on any new acquisitions currently?

Jeff Walker, CEO & CFO

We are always working and looking at new acquisitions. We did our last big acquisition back in September of 2020 right in the middle of COVID. Looking back on it, it was kind of crazy to complete a big acquisition at that time. As we go forward, now that we have our new bank line of credit in place and we've stabilized our inventory and operations, we're definitely back looking at acquisition opportunities here in 2024. One of the things that is an opportunity for us is our diversity of products that we sell and the focus on everything entertainment gives us a pretty wide net of different businesses that can complement what we're doing at Alliance. We look at two types of acquisitions: one that might be a competitor to us in one of the categories or has similar products. Those consolidation opportunities are very accretive to value for us as we can acquire them and achieve cost savings. We are also looking at opportunities where companies have entertainment products that we don't currently sell. Those can also be very valuable for us as they may have a different set of customers that they sell to, and we can sell their products to our customers. Additionally, their product can also flow into our vast group of retailers. There are plenty of opportunities within the entertainment industry, and the valuation on some businesses has come down since two to three years ago. We definitely see some potential opportunities for good acquisitions that would be accretive to the company's value.

Unidentified Company Representative, Representative

Our next webcast question asked, on the closing of your Minnesota facility, what impact will that have on your profitability?

Jeff Walker, CEO & CFO

I just mentioned that we acquired COKeM in September of 2020. They had a large facility in the Minneapolis area. The lease on that major facility expires in May of 2024. As we progressed through the last couple of years, we've enjoyed the benefits of that facility. At the end of the day, however, that facility is not optimal for e-commerce fulfillment, which we were just speaking about earlier. We decided to close that warehouse and consolidate that product into our Kentucky facility. Bruce also mentioned that the arcades are staying on the West Coast, so we have all of our arcade business that was previously going to Minnesota that is staying on the West Coast. As far as cost savings, it’s pretty significant. Not only the simple costs like rent, taxes, and utilities, but also the operational side including the different computer system, a Nordic system. We will also save on employee training and reduce compliance costs related to being a public company. Additionally, having this product only in Kentucky will help reduce our total inventory and assist with inventory turns, which will help to reduce our debt a little bit as well. So there are many components that contribute to savings overall. We will see the bulk of all these benefits in fiscal ‘25.

Unidentified Company Representative, Representative

And our last question asks, on Slide 16, I noticed that distribution and fulfillment expenses as a percentage of sales improved from 5.42% to 4.12%. What is driving those improvements that add up to the reduction of $5.2 million?

Bruce Ogilvie, Executive Chairman

I think we covered that in the first question already. Jeff, I believe you did that.

Jeff Walker, CEO & CFO

I think Ashok had most of that question already answered. Basically, to summarize, our operation was able to get more efficient; we've mentioned how we put costs into moving our arcades to the West Coast. We also introduced AutoStore, where we talked about the savings we're getting as far as picking time and processing time. Those are all contributing to the improvements in distribution and fulfillment expenses. It shouldn't stop here as we close the Minnesota facility.

Operator, Operator

There are no further questions. I would like to turn the call back over to Mr. Ogilvie for his closing remarks.

Bruce Ogilvie, Executive Chairman

Thank you, operator. I would like to thank each of you for joining our financial results conference call today, and I look forward to continuing to update you on our ongoing progress and growth. If we were unable to answer any of your questions, please reach out to our IR firm; we'll be more than happy to assist you.

Operator, Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.