ALLIANCE ENTERTAINMENT HOLDING CORP

Current report

Consumer products revenue decreased from $10.6 million to $7.3 million (-$3.4 million, or -31.6%) versus the prior year. The average selling price per unit declined this quarter primarily due to mix and was partially offset by increased sales volume. The collectables industry appears to have stabilized in the post- pandemic era and major trade shows have resumed their promotion of these unique products. The collectables market is an integral part of the entertainment market segment due to its mix of nostalgic, investment, and intrinsic value. As such, we believe there is continued profitable growth in this category as the industry solidifies how best to leverage and satisfy the consumer demand for collectibles related to movie & TV franchise and classic toy trends.

Current report

Gaming product revenue increased from $52.6 million to $57.1 million ($4.5 million, 8.6%). The revenue derived from a higher price point was the direct result of our success selling more hardware and retro arcades than in prior periods. Gaming suppliers continue to transition to subscription-based models, and we expect to benefit from new hardware releases during the next year. We continue to proactively monitor gaming industry trends to ensure we have the right product mix to meet market demand and maximize profitability.

Current report

**Operating Expenses:**Total operating expenses for the quarter decreased from $28 million to $23 million and decreased as a percentage of net revenue from 12.2% to 10.3% during the same period the prior year. Total Distribution and fulfillment expense declined from $11.7 million to $9.0 million (-$2.7 million, -23%) and decreased from 5.2% to 3.9% as a percentage of net revenue for the three months ended September 30, 2024, versus the same period prior year. We continue to invest in warehouse automation to reduce the need for total warehouse labor and utilize temporary labor forces to manage changes in demand. As a result, fulfillment payroll declined from $7.3 million to $6.3 million (-$1.0 million, -14%) for the three months ending September 30, 2024, versus the same period of the prior year. In addition, despite low unemployment rates, the average cost per labor hour declined approximately 5%. In May of 2024, we consolidated operations by closing our Shakopee, MN warehouse which also helped reduce operating costs and improve efficiency by centralizing operations and reducing redundancy. And, as we continue to identify and implement business process changes to improve overall efficiency, total selling, general and administrative costs remained flat year over year.

Current report

For the three months ended September 30, 2024, on net income of $0.4 million, the Company’s cash used in operating activities was $11.6 million versus $2.7 million used in operations for the three months ended September 30, 2023. Compared to the same three-month period last year, there was a $4 million improvement in net income combined with a $41 million increase in inventory versus a decrease of $13 million increase in inventory for the same three-month period prior year. The key driver was approximately $21 million less inventory on-hand to support sales for the three months ended September 30, 2024, due to the relatively high inventory position on September 30, 2023, because of the supply chain disruptions that occurred in the prior year. The $41 million decrease in inventory for the three months ending September 30, 2024, was offset of $43 million increase to accounts payable and a $10 million increase in trade receivables.

Current report

Net cash provided by financing activities was $14.7 million for the three months ending September 30, 2024, versus cash provided of $3.1 million for the same period prior year. The primary reason was an increase in borrowing necessary to obtain desired inventory levels which increased from $97 million on June 30, 2024, to $138 million ($41 million or 42%) at September 30, 2024. However, year over year, financing requirements were reduced because the value of inventory declined from $159 million on September 30, 2023, to $138 million on September 30, 2024 (-$20 million or -13%). In addition, our debt service exposure declined year over year as the revolver balance declined from $126 million to $85 million (-$41 million or -33%) from September 30, 2023, to 2024, respectively.

Current report

Our consolidated financial statements have been prepared in accordance with U.S. GAAP. Our discussion and analysis of the financial condition and results of operations are based on these financial statements. The preparation of these financial statements requires the application of accounting policies in addition to certain estimates and judgments by our management. Our estimates and judgments are based on currently available information, historical results, and other assumptions we believe are reasonable. The actual results could differ materially from these estimates.

Current report

No changes were made to the critical accounting estimates discussed in the 2024 Annual Report during the three months ending September 30, 2024.

Previous report

Year-over-year, gaming sales decreased from $55 million to $43 million (-$12 million, -22%) for the three months ended March 31, 2024. The average selling price of gaming products increased 40% which was offset by a decrease in volume as we focus on profitable growth. As gaming suppliers attempt to transition to subscription-based models, we are experiencing increased sales of gaming hardware and accessories including retro arcade games. We continue to monitor gaming market trends to ensure we have the right product mix to meet market demand and maximize profitability.

Previous report

Consumer products revenue decreased from $19 million to $9 million (-$10 million, or -53%) versus the prior year. The average selling price has increased by more than 60% versus the prior year period as the toys & collectibles industry normalizes in the post-

Previous report

pandemic era. And while volume declined for the three months ended March 31, 2024, margins improved significantly as we rationalized our inventory and procure market driven collectables and accessories.

Previous report

Cost of Revenues: Total cost of revenues, excluding depreciation and amortization, decreased from $200 million to $183 million (-$17 million or -9%) the prior year period primarily due to the direct relation of product costs to sales volume. However, gross margin dollars increased the prior year period as product margins improved from 12.0% to 13.3% primarily due to less overstock inventory resulting in significantly less consumer incentives to stimulate demand.

Previous report

Operating Expenses: Total operating expenses decreased from $34.7 million to $28.8 million (-5.9 million, -17%) and decreased as a percentage of net revenue over the same period prior year from 15.3% to 13.6% (-1.7% points). Total Distribution and Fulfillment Expense declined 25% and decreased from 6.6% to 5.3% (-1.3% points) as a percentage of net revenue for the three months ended March 31, 2024, versus the same period prior year. Fulfillment payroll was $7.4 million for the three months ended March 31, 2024, and $9.5 million (-$2.1 million, -22%) for the same period of the prior year. Low unemployment rates, combined with competition for temporary labor, increased the average cost per labor hour approximately 4% versus the prior year. To address the scarcity of labor resources, we have invested in warehouse automation and will continue to use temporary labor forces to manage changes in demand. Since we believe that for the foreseeable future, there will be upward pressure on labor availability and costs, we continue to innovate our warehouse processes to reduce fulfilment costs. Total selling, administrative, and general costs decreased by $0.8 million or 6% compared to the same period last year due primarily due to the reduction in workforce last Spring to right size the back-office support for the business.

Previous report

Interest Expense: For the three months ended March 31, 2024, interest expense decreased from $3.2 million to $3.1 million (-$0.1 million, -3%) versus the same period of the prior year. While our effective interest rate increased from 6.9% to 10.0% (3.1 points), the financial impact was tempered by a significant decline of the average revolver balance from $150 million to $94 million (-$56 million, -37%) year over year.

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Results of Operations Nine Months Ended March 31, 2024, Compared to Nine Months Ended

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Net Revenue: Net revenue decreased from $912 million to $864 million (-$47 million, -5%) for the nine months ended March 31, 2024 over the prior year period. Along with other retailers and distributors in the United States, we are not immune to the macroeconomic headwinds caused by high interest rates and consumer discretion prompted by reduced buying power. Alliance Entertainment stands out as a value-added retail distributor thanks to our exclusive distribution rights for approximately 160 studios and labels in the film and music industry. This extensive portfolio of unique content enables us to cater to bulk B2B and DTC businesses with a vast selection of products unavailable through other distributors. Our unique DTC suite of distribution and inventory solutions for the e-commerce retail industry, including our consumer direct subsidiary DirectToU LLC, enabled approximately 40% of our gross sales revenue for the nine months ended March 31, 2024, versus 34% for the same period prior year.

Previous report

Gaming sales decreased from $333 million to $287 million (-$46 million, -14%) for the nine months ended March 31, 2024 over the prior year period. The average selling price of gaming products nearly doubled and offset by a decrease in volume as we transitioned to higher dollar margin products including hardware and retro arcade games. Gaming hardware sales were up significantly as suppliers capitalized on gaming social trends and subscription-based models.

Previous report

Consumer products revenue decreased from $65 million to $35 million (-$30 million, or -46%) for the nine months ended March 31, 2024, versus the same period prior year. The average selling price has increased by 27% versus the same period prior year as the toys & collectibles industry normalizes in the post-pandemic era. And while volume declined for the period, margins more than doubled as we rationalized our inventory and procure market driven collectables and accessories.

Previous report

Operating Expenses: Total operating expenses decreased from $107 million to $88 million (-$19 million, 18%) and decreased as a percentage of net revenue over the same period prior year from 11.7% to 10.2%. There was a $2.1 million transaction expense for a non-cash out of period transaction, without which total operating costs as a percentage of net revenue would have decreased to 10.0%. This adjustment is directly related to the purchase accounting of a recent acquisition by the company. Had this adjustment been recognized within the designated measurement period, it would have led to an increase in the Goodwill of the Company. Total distribution and fulfillment expense declined 24% and decreased from 5.5% to 4.4% as a percentage of net revenue for the nine months ended March 31, 2024, versus the same period prior year. Fulfillment payroll was $24 million for the nine months ended March 31, 2024, and $32 million (-$8 million, 25%) for the same period of the prior year. Low unemployment rates and competition for temporary labor increased the average cost per labor hour by approximately 3% versus the same period prior year. To address the scarcity of labor resources, we have invested in warehouse automation and will continue to use temporary labor forces to manage changes in demand. Since we believe that there will be upward pressure on labor availability and costs for the foreseeable future, we will continue to innovate our warehouse processes to reduce fulfillment costs. Total selling, administrative, and general costs decreased by $1.0 million or 2% compared to the same period last year primarily due to the reduction in the workforce. Selling, administrative, and general costs also include a one-time expense of $1.4 million for restricted stock awards. IC DISC Commissions were $0 for the nine months ended March 31, 2024, versus $2.8 million for the same period of the prior year. The IC DISC was discontinued as of December 31, 2022, and no additional expenses were incurred.

Previous report

**Income Tax:**For the nine months ended March 31, 2024, an income tax expense of $2.0 million was recorded compared to a benefit of $11.4 million for the same period in the prior year. Alliance reported a pretax income of $4.1 million and a pretax loss of $42.2 million for the nine months ended March 31, 2024, and 2023, respectively. The expected annual effective tax rate (“ETR”) for twelve months ending June 30, 2024, is 50%, including two discrete one-time tax adjustments for out of period Goodwill adjustment and the distribution of Restricted Stock Units.

Previous report

In addition, we may lower the exercise price of the Warrants in accordance with the Warrant Agreement to induce the holders to exercise such Warrants. We may effect such reduction in exercise price without the consent of such warrant holders and such reduction would decrease the maximum amount of cash proceeds we would receive upon the exercise in full of the Warrants for cash. Further, the holders of the Private Warrants and the Underwriter Warrants may exercise such Warrants on a cashless basis at any time and the holders of the Public Warrants may exercise such Warrants on a cashless basis at any time an effective registration statement is not available for the issuance of shares of Class A common stock upon such exercise. Accordingly, we would not receive any proceeds from a cashless exercise of Warrants.

Previous report

For the nine months ended March 31, 2024, on a net income of $2.0 million, the Company’s cash provided by operating activities was $46.2 million versus $8.3 million for the nine months ended March 31, 2023. The $37.9 million improvement to cash provided by operating activities was driven by several variables. Net income, year over year, improved $32.9 million or from a net loss of ($30.8) million to $2.7 million for the trailing nine months. Accounts payable increased $19.1 million for the trailing nine months versus an increase of $73.3 million to accounts payable for the same period prior year. The relatively large change in payables was directly attributed to the Company’s objective to reduce inventory on-hand. Inventory decreased $38.9 million for the nine months ended March 31, 2024, versus a decrease of $80.8 million for same nine-month period prior year; however, the central element was an ending inventory of $108 million at March 31, 2024 versus $163 million (-$55 million, -34%) at March 31, 2023.

Previous report

Net cash used in financing activities was $45.2 million for the nine months ended March 31, 2024, versus cash used in financing of $8.8 million for the same period prior year. The primary reason for the favorable change in borrowing was our ability to sell through excess inventory levels. In addition, our debt service exposure declined as the revolver balance declined from $127 million on March 31, 2023, to $81 million (-$46 million or -36%) on March 31, 2024.

Previous report

The consolidated financial statements and disclosures have been prepared in accordance with generally accepted accounting principles (GAAP) which requires that management apply accounting policies, estimates, and assumptions that impact the results of operations and the reported amounts of assets and liabilities in the financial statements. Management uses estimates and judgments based on historical experience and other variables believed to be reasonable at the time. Actual results may differ from these estimates under a separate set of assumptions or conditions. Note 1 of the Notes to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used by the Company in the preparation of its consolidated financial statements. Management believes that of the Company’s significant accounting policies and estimates, the following involve a higher degree of judgment or complexity:

Previous report

Inventory and Returns Reserve: Product inventory is recorded at the lower of cost or net realizable value. The valuation of inventory requires significant judgment and estimates, including evaluating the need for any adjustments to net realizable value related to excess or obsolete inventory to ensure that the inventory is reported at the lower of cost or net realizable value. For all product categories, the Company records any adjustments to net realizable value, if appropriate, based on historical sales, current inventory levels, anticipated customer demand, and general market conditions.

Previous report

For the year ended June 30, 2023, the Company performed a net realizable value analysis to determine if a reserve or write- down was necessary for excess or obsolete inventory. The two most critical assumptions in the analysis were the estimated monthly sales and the average sales price. In the analysis of the average sales price, we considered our master pricing list or alternative approximations of net realizable value including: (a) Estimates based on fluctuations of market price or cost of manufacturing similar items, (b) Invoices for new purchases made after the year-end from the original supplier of the inventory item, if sales prices are not available (replacement cost), and/or (c) Advertised prices on product brochures, also considering possible discounts, costs to complete and sell, and salability.

Previous report

Goodwill and Definite-Lived Intangible Assets, Net: The Company tests its goodwill for impairment only upon the occurrence of an event or circumstances that may indicate the fair value of the entity is less than it’s carrying amount. For the nine months ended March 31, 2024, and year ended June 30, 2023, the Company tested goodwill for impairment at the entity level, since there is one Reporting Unit. As part of the analysis, we performed a discounted cash flow based on the Company’s three-year projections and determined that the fair value of equity is higher than the carrying value of equity. As such, the Company’s analysis concluded that there was no impairment to goodwill.

Previous report

As of March 31, 2024, the fair value of the Company’s reporting unit exceeded its carrying value by approximately 11.8%. Either a reduction in the long-term growth rate by more than 80 basis points or an increase in the discount rate by 60 basis points would result in the carrying value of the Company’s reporting unit exceeding its fair value, resulting in an impairment loss of the Company’s goodwill. Given the inherent uncertainties on the macroeconomic conditions and interest rates in general, actual results may differ from management’s current estimates and could have an adverse impact on one or more of the assumptions used in our quantitative model related to impairment assessment, resulting in potential impairment charges in subsequent periods.

Previous report

When a triggering event occurs, the Company has an option to first perform a qualitative assessment to determine whether it is more likely than not (i.e., 50% likely) that the fair value of the entity is less than its carrying amount. If the Company elects to use the qualitative option, it must decide whether it is more than 50% likely that the fair value of the entity is less than its carrying amount. If so, the one-step impairment test is required. However, if management concludes that fair value exceeds the carrying amount, further testing is unnecessary. Goodwill impairment is calculated as the amount by which the carrying amount of the entity including goodwill exceeds its fair value.

Previous report

Intangible assets are stated at cost, less accumulated amortization. Amortization of customer relationships and lists is recorded using an accelerated method over the useful lives of the related assets, which range from 10 to 15 years. Covenants not to compete, trade name and favorable leases are amortized using the straight-line method over the estimated useful lives of the related assets, which range from 5 to 15 years.

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Impairment of Long-Lived Assets: Recoverability of long-lived assets, including property and equipment, goodwill and certain identifiable intangible assets are evaluated whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Factors considered important which could trigger an impairment review include but are not limited to significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of the assets or the strategy for the overall business, significant decrease in the market value of the assets and significant negative industry or economic trends. In the event the carrying amount of the long-lived assets may not be recoverable based upon the existence of one or more of the indicators, the assets are assessed for impairment based on the estimated future undiscounted cash flows expected to result from the use of the asset and its eventual deposition. If the carrying amount of an asset exceeds the sum of the estimated future undiscounted cash flow, an impairment loss is recorded for the excess of the asset’s carrying amount over its fair value. There was no impairment during the three-month period ended March 31, 2024.

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Business Combinations — Valuation of Acquired Assets and Liabilities Assumed: The Company allocates the purchase price for each business combination, or acquired business, based upon (i) the fair value of the consideration paid and (ii) the fair value of net assets acquired, and liabilities assumed. The determination of the fair value of net assets acquired and liabilities assumed requires estimates and judgements of future cash flow expectations for the acquired business and the allocation of those cash flows to identifiable tangible and intangible assets. Fair values are calculated by applying estimates related to Internal Rate of Return (IRR) and Weighted Average Cost of Capital (WACC) assumptions as well as incorporating expected cash flows into industry standard valuation techniques. Goodwill is the amount by which the purchase price consideration exceeds the fair value of tangible and intangible assets acquired, less assumed liabilities. Intangible assets, such as customer relations and trade names, when identified, are separately recognized and amortized over their estimated useful lives, if considered definite lived. Acquisition costs are expensed as incurred and are included in the consolidated statements of operations and comprehensive income.

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Warrant Liability – The Company’s warrant liability is remeasured at fair value as of the reporting period balance sheet date. The fair value of the Private Warrant was measured using the Lattice model approach. Significant inputs into the respective models at March 31, 2024, and February 10, 2023 (the initial recognition) are as follows:

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The Warrants are scheduled to expire on February 10, 2028.

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The significant assumptions using the Lattice model approach for valuation of the Private Placement Warrants and Representative Warrants were determined in the following manner:

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Employing an established multi-channel strategy, Alliance distributes physical media, entertainment products, hardware, and accessories across various platforms. Currently, the company sells its products, permitted for export, to more than 70 countries worldwide.

Previous report — wording carried elsewhere

While the legal acquirer in the Business Combination Agreement was Adara, for financial accounting and reporting purposes under U.S. GAAP, Legacy Alliance was the accounting acquirer, and the Merger was accounted for as a “reverse recapitalization.” A reverse recapitalization (i.e., a capital transaction involving the exchange of stock by Adara for Legacy Alliance’s stock) does not result in a new basis of accounting, and the consolidated financial statements of the combined entity represent the continuation of the

Previous report — wording carried elsewhere

Vinyl record sales remained consistent at $242 million for the nine months ended March 31, 2024, compared to the prior year period. The average selling price of vinyl was up 6% and partially offset by volume versus the prior year period. Music compact discs (CDs) increased from $91 million to $97 million ($6 million, 7%). The continued popularity of K-Pop helped us realize a 12% increase in the average selling price of CDs, however, the decline in volume offset some of the gains but resulted in a year-over-year revenue improvement. Physical movie sales, which include DVDs, Blu-Ray, and Ultra HD, increased from $147 million to $159 million ($12 million, 8%) versus the same period last year. The average selling price of physical film products increased 18% year-over-year and partially offset by the decline in volume. Digital sales of our exclusive content more than doubled compared to the same period last year. The consistent flow of new theatrical releases continues to drive home video sales, combined with 4K and more recently SteelBook collectables, drove the average selling price higher. We expect the trend of higher price points to continue as brick & mortar retailers cater to the consumer preference for omnichannel shopping experiences and curated content versus inexpensive, mass market product offerings. Alliance Entertainment’s ability to offer retailers in-store and on-line channels a deep, extensive library of both music and movies helps provide them the products for a cohesive shopping experience based on personal preference and engagement with their respective brands.

Previous report — wording carried elsewhere

Non-GAAP Financial Measures: For the nine months ended March 31, 2024, we had non-GAAP Adjusted EBITDA of approximately $22.2 million compared to Adjusted EBITDA of approximately -$21.0 million for the prior year or a year-over-year improvement of $43.2 million. We define Adjusted EBITDA as net gain or loss adjusted to exclude: (i) income tax expense; (ii) other income (loss); (iii) interest expense; and (iv) depreciation and amortization expense and (v) fair value of Warrants and other non- recurring expenses. Our method of calculating Adjusted EBITDA may differ from other issuers and accordingly, this measure may not be comparable to measures used by other issuers. We use Adjusted EBITDA to evaluate our own operating performance and as an integral part of our planning process. We present Adjusted EBITDA as a supplemental measure because we believe such a measure is useful to investors as a reasonable indicator of operating performance. We believe this measure is a financial metric used by many investors to compare companies. This measure is not a recognized measure of financial performance under GAAP in the United States and should not be considered as a substitute for operating earnings (losses), net earnings (loss) from continuing operations or cash flows from operating activities, as determined in accordance with GAAP. See the table below for a reconciliation, for the periods presented, of our GAAP net income (loss) to Adjusted EBITDA.

Previous report — wording carried elsewhere

Our liquidity position has not changed significantly since the Merger, and we intend to principally rely on our borrowing capacity under the Revolving Credit Facility as well as any renewal of such facility. Although the Company does not currently intend to do so, the Company may seek to raise additional capital through the sale of equity securities.