Business context and reporting period
Alliance Entertainment Holding Corporation distributes physical music, movies, video games, accessories and collectibles, and provides logistics and e-commerce services. This unaudited Form 10-Q covers the quarter and nine months ended March 31, 2023 (the company’s fiscal third quarter); the request metadata’s “2022 Q3” does not match the filing period. The company completed its merger with Adara on February 10, 2023, and acquired collectibles distributor Think3Fold on July 1, 2022.
Financial results and liquidity
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Revenue | $227.7 million, down 29% year over year | $911.6 million, down 21% |
| Gross profit / margin | $27.3 million / 12.0%, versus 12.5% | $73.7 million / 8.1%, versus about 13% |
| Operating income (loss) | $(7.4) million, versus $5.9 million | $(33.0) million, versus $46.5 million |
| Net income (loss) | $(7.8) million; $(0.16) per share | $(30.8) million; $(0.64) per share |
| Adjusted EBITDA (non-GAAP) | $(2.4) million, versus $9.6 million | $(21.0) million, versus $60.6 million |
For the nine months, operating cash flow was positive $8.3 million, compared with cash used of $83.6 million a year earlier. Investing cash flow was approximately breakeven; financing used $8.8 million. Cash was $1.0 million at March 31. Net working capital was negative approximately $42.2 million, based on current assets of $251.4 million and current liabilities of $293.5 million.
Revolver borrowings were approximately $127.4 million, with reported availability of about $24 million at March 31; the facility is borrowing-base-limited and secured by substantially all company assets. The revolver’s effective rate was 5.48% for the nine-month period, and interest expense rose to $9.1 million from $2.7 million. The balance sheet also reported finance lease obligations totaling approximately $8.3 million.
Material changes and unusual items
- Management attributed lower revenue to retailers’ cautious inventory management, competition and macroeconomic uncertainty. Nine-month B2B revenue declined 22%; DTC omni-channel sales declined 11%, while Direct2You sales increased 8%. Gaming and vinyl together represented 63% of nine-month revenue; gaming sales fell 30% and vinyl 3%. Consumer-products sales rose 44%, partly reflecting Think3Fold.
- Gross margin weakened amid inventory valuation adjustments, high freight and transportation costs, arcade markdowns, reduced supplier marketing support and additional consumer-product reserves. The filing reports a $10.8 million inventory write-down in the notes; MD&A also describes $7.1 million of arcade inventory write-downs and $3.7 million of consumer-products reserves. It separately cites $15.2 million of excessive transportation costs and $12.2 million of arcade markdowns. These disclosures describe different expense categories and should be reconciled against the detailed statements.
- Merger-related transaction costs were $3.3 million in the quarter. Nine-month transaction costs were $4.4 million, including acquisition and merger costs. The IC-DISC arrangement was discontinued effective December 31, 2022; its owners forgave $6.6 million of commissions, recorded as a deemed capital contribution.
- Think3Fold contributed $13.2 million of revenue and $1.5 million of net income for the nine months. Its purchase-price allocation remains provisional; the company recorded $7.2 million of goodwill.
- At March 31, 2023, 49.2 million Class A shares were outstanding. Up to 60 million additional shares may be issued if specified stock-price targets are met, and approximately 9.9 million warrants are outstanding with an $11.50 exercise price.
Outlook, risks and contingencies
- Going concern and refinancing: Management states that operating losses, a working-capital deficit and the revolver’s September 29, 2023 maturity raise substantial doubt about the company’s ability to continue as a going concern for one year after issuance. As of the filing, management was discussing renewal with lenders and evaluating cost reductions, efficiencies and growth strategies; it warns that failure to extend the facility and implement mitigation could require limiting operations.
- Covenants and subsequent amendment: The company failed to meet its fixed-charge coverage covenant and had other covenant breaches. On April 21, 2023, lenders waived specified defaults, suspended the fixed-charge coverage requirement until a compliance date, and imposed minimum EBITDA requirements in the interim. The amendment reduced the facility commitment from $225 million to $175 million and required a waiver fee of about $180,000. The filing states that minimum EBITDA measurements apply through December 31, 2023.
- Operating risks: Management cites inflation, interest rates, supply-chain and freight costs, labor availability, product obsolescence, the shift from physical to digital entertainment, concentrated retail customers and changing consumer demand. It expects continued upward pressure on labor costs and availability. A 100-basis-point increase in daily borrowing rates would add approximately $0.4 million of quarterly interest expense, based on the period’s average balance.
- Legal and controls: A March 31 class action alleges fiduciary-duty and disclosure failures relating to the business combination. The company intends to defend the suit but cannot estimate potential losses. Disclosure controls were ineffective at March 31 due to an unremediated material weakness involving accounting and reporting controls, including revolving-credit classification and certain transactions. Remediation work is underway but has not been validated as effective.
- The filing provides no quantitative revenue or earnings guidance. Management describes its commentary as forward-looking and subject to risks and uncertainties.
Important facts for investors to verify
- Whether the revolver was renewed or refinanced before maturity, and the company’s subsequent covenant compliance, borrowing availability and minimum-EBITDA performance.
- Cash generation and working-capital trends, including the sustainability of operating cash flow as inventory and accounts payable change.
- The composition and full financial impact of inventory write-downs, freight costs, markdowns, storage fees and other unusual charges.
- Progress toward remediating the material weakness and any subsequent financial-reporting corrections.
- Developments in the class action and the potential dilution from contingent shares, warrants and equity-plan awards.