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Item 7. Management’s Discussion and Analysis

2023-10-19 compared with 2023-03-30 · 319 added, 111 removed, 3 unchanged (99% of the section changed)

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

The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with our audited financial statements and the notes related thereto which are included in “Item 8.

Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.

Certain information contained in the discussion and analysis set forth below includes forward-looking statements.

Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under “Special Note Regarding Forward-Looking Statements,” “Item 1A.

Risk Factors” and elsewhere in this Annual Report on Form 10-K.

We are a blank check company formed under the laws of the State of Delaware on August 5, 2020 for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination with one or more businesses.

We intend to effectuate our Business Combination using cash from the proceeds of the IPO and the sale of the Private Placement Warrants, our capital stock, debt or a combination of cash, stock and debt.

While our efforts to identify a target business may span many industries and regions worldwide, we intend to focus our search for businesses in the consumer products industry and related sectors, including those consumer industry businesses in the health and wellness, e-commerce, discretionary spending, and information technology sectors and related channels of distribution.

We expect to continue to incur significant costs in the pursuit of our acquisition plans.

We cannot assure you that our plans to complete a Business Combination will be successful.

Recent Developments

On February 10, 2023 (the “Closing Date”), Alliance Entertainment Holding Corporation, a Delaware corporation (“Alliance”), Adara Acquisition Corp., a Delaware corporation (“Adara”), and Adara Merger Sub, Inc., a Delaware corporation (“Merger Sub”), consummated the closing of the transactions (the “Closing“) contemplated by the Business Combination Agreement, dated June 22, 2022, by and among Alliance, Adara and Merger Sub (the “Business Combination Agreement”), following their approval at a special meeting of the stockholders of Adara held on January 18, 2023 (the “Special Meeting”),

On June 22, 2022, the Company, Alliance Merger Sub, Inc.

(“Merger Sub”) and Alliance Entertainment Holding Corporation (“Alliance”) entered into the Business Combination Agreement (the “BCA”), pursuant to which the Company and Alliance consummated the Business Combination.

Pursuant to the BCA, Merger Sub merged with and into Alliance, with Alliance being the surviving entity (the “Merger”).

The Merger became effective by the filing of a certificate of merger with the Secretary of State of the State of Delaware, in accordance with the relevant provisions of the Delaware General Corporation Law (such time, “Effective Time”).

The parties held the closing immediately prior to such filing of a certificate of merger, on the closing date.

At the Effective Time, by virtue of the Merger and without any action on the part of Adara, Merger Sub, Alliance or the holders of any of Alliance’s securities:

● Each share of Alliance common stock issued and outstanding immediately prior to the Effective Time will be cancelled and automatically converted into the right to receive the number of shares of the Company surviving the Business Combination (the “Combined Company Common Stock”) equal to the Exchange Ratio;

● No certificates or scrip or shares representing fractional shares of Combined Company Common Stock shall be issued upon the exchange of Alliance common stock and such fractional share interests will not entitle the owner thereof to vote or to have any rights of a stockholder of Adara or a holder of shares of Combined Company Common Stock.

In lieu of any fractional share of Combined Company Common Stock to which each holder of Alliance common stock would otherwise be entitled, the fractional share shall be rounded up or down to the nearest whole share of Combined Company Common Stock, with a fraction of 0.5 rounded up.

No cash settlements shall be made with respect to fractional shares eliminated by rounding.

At the closing, the Company also issued to the Alliance stockholders shares of a to be formed Class E Common Stock (the ”Contingent Consideration Shares”) which were placed into an escrow account pursuant to the Contingent Consideration Shares Agreement and shall not be released from escrow over a ten-year period unless and until they are earned as a result of the occurrence of the applicable triggering event as follows:

20,000,000 Contingent Consideration Shares will be earned upon the occurrence of triggering event I prior to the five-year anniversary of the closing;

20,000,000 Contingent Consideration Shares will be earned upon the occurrence of triggering event II prior to the seven-year anniversary of the closing;

and 20,000,000 Contingent Consideration Shares will be earned upon the occurrence of triggering event III prior to the ten-year anniversary of the closing.

Upon the occurrence of a triggering event, the Contingent Consideration Shares released from the escrow shall automatically convert into an equal number of shares of Combined Company Common Stock.

On August 16, 2022, the Inflation Reduction Act of 2022 (the “IR Act”) was signed into federal law.

The IR Act provides for, among other things, a new U.S.

federal 1% excise tax on certain repurchases of stock by publicly traded U.S.

domestic corporations and certain U.S.

domestic subsidiaries of publicly traded foreign corporations occurring on or after January 1, 2023.

The excise tax is imposed on the repurchasing corporation itself, not its shareholders from which shares are repurchased.

The amount of the excise tax is generally 1% of the fair market value of the shares repurchased at the time of the repurchase.

However, for purposes of calculating the excise tax, repurchasing corporations are permitted to net the fair market value of certain new stock issuances against the fair market value of stock repurchases during the same taxable year.

In addition, certain exceptions apply to the excise tax.

Department of the Treasury (the “Treasury”) has been given authority to provide regulations and other guidance to carry out and prevent the abuse or avoidance of the excise tax.

Any redemption or other repurchase that occurs after December 31, 2022, in connection with a Business Combination, extension vote or otherwise, may be subject to the excise tax.

Whether and to what extent the Company would be subject to the excise tax in connection with a Business Combination, extension vote or otherwise would depend on a number of factors, including (i) the fair market value of the redemptions and repurchases in connection with the Business Combination, extension or otherwise, (ii) the structure of a Business Combination, (iii) the nature and amount of any “PIPE” or other equity issuances in connection with a Business Combination (or otherwise issued not in connection with a Business Combination but issued within the same taxable year of a Business Combination) and (iv) the content of regulations and other guidance from the Treasury.

In addition, because the excise tax would be payable by the Company and not by the redeeming holder, the mechanics of any required payment of the excise tax have not been determined.

The foregoing could cause a reduction in the cash available on hand to complete a Business Combination and in the Company’s ability to complete a Business Combination.

The Company is permitted to use interest earned on the proceeds placed in the trust account to pay taxes, which could include any excise tax due under the IR Act on any redemptions or stock buybacks by Adara.

Results of Operations

We have neither engaged in any operations nor generated any revenues to date.

Our only activities from August 5, 2020 (inception) through December 31, 2021 were organizational activities, those necessary to prepare for the IPO, described below, and identifying a target company for a Business Combination.

We do not expect to generate any operating revenues until after the completion of our Business Combination.

We generate non-operating income in the form of interest income on marketable securities held in the Trust Account.

We incur expenses as a result of being a public company (for legal, financial reporting, accounting and auditing compliance), as well as for due diligence expenses.

For the year ended December 31, 2022, we had net income of $2,943,538, which consists of changes in fair value of the warrant liabilities of $4,166,900 and interest earned on marketable securities held in Trust Account of $1,649,169, offset by operating and formation costs of $2,608,046 and provision for income taxes of $264,485.

For the year ended December 31, 2021, we had a net income of $3,244,206, which consists of interest income on marketable securities held in the Trust Accounts of $10,281 and change in fair value of warrant liabilities of $4,297,300, offset by operating costs of $976,831 and transaction cost incurred in connection with IPO of $86,544.

The objective for the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is to provide information the Company’s management team believes is necessary to achieve an understanding of its financial condition and the results of business operations with particular emphasis on the Company’s future and should be read in conjunction with the Company’s audited consolidated financial statements, and footnotes.

This analysis contains forward-looking statements concerning the Company’s performance expectations and estimates.

Other than statements with historical context, commentary should be considered forward- looking and carries with it risks and uncertainties.

“Statement Regarding Forward-Looking Statements” and Part I, Item 1A.

Risk Factors, of this Form 10-K for a discussion of other uncertainties, risks and assumptions associated with these statements.

Alliance is a leading global wholesaler, direct-to-consumer (“DTC”) distributor and e-commerce provider for the entertainment industry.

Alliance serves as the gateway between well-known international branded manufacturers of entertainment content, such as Universal Pictures, Warner Brothers Home Video, Walt Disney Studios, Sony Pictures, Lionsgate, Paramount, Universal Music Group, Sony Music, Warner Music Group, Microsoft, Nintendo, Take Two, Electronic Arts, Ubisoft, Square Enix, and others, and leading retailer customers in the United States and internationally, including Walmart, Amazon, Best Buy, Barnes & Noble, Wayfair, Costco, Dell, Verizon, Kohl’s, Target and Shopify, among others.

The Company distributes its physical media, entertainment products, hardware, and accessories through an established multi-channel strategy.

The Company currently sells its products that it is allowed to export to more than 100 countries around the world.

Alliance provides state-of-the art warehousing and distribution technologies, operating systems and services that seamlessly enable entertainment product transactions to better serve customers directly or through our distribution affiliates.

These technology-led platforms with access to the Company’s in stock inventory of over 375,000 SKU products, consisting of vinyl records, video games, compact discs, DVD, Blu-Rays, toys, and collectibles, combined with Alliance’s sales and distribution network, create a modern entertainment physical product marketplace that provides the discerning customer with enhanced options on efficient consumer-friendly platforms inventory.

Alliance is the retailers’ back office for in-store and e-commerce solutions.

All electronic data interchange (“EDI”) and logistics are operational and ready for existing retail channels to add new products.

Merger and Business Acquisition

Alliance has a proven history of successfully acquiring and integrating competitors and complementary businesses.

The Company will continue to evaluate opportunities to identify targets that meet strategic and economic criteria.

On July 1, 2022, Alliance purchased the assets and liabilities of Think3Fold, Inc, a collectibles distribution company.

This acquisition resulted in increased shelf space at our largest customer and expanded our product offerings.

On February 10, 2023, Alliance, Adara and Merger Sub consummated the closing of the transactions contemplated by the Business Combination Agreement.

Pursuant to the terms of the Business Combination Agreement, a business combination of Legacy Alliance and Adara was effected by the merger of Merger Sub with and into Alliance (the “Merger”), with Alliance surviving the Merger as a wholly-owned subsidiary of Adara.

Following the consummation of the Merger on the closing of the Business Combination, Adara changed its name from Adara Acquisition Corp.

to Alliance Entertainment Holding Corporation.

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 consolidated financial statements of Legacy Alliance in many respects.

Accordingly, the consolidated assets, liabilities, and results of operations of Legacy Alliance became the historical consolidated financial statements of the combined company, and Adara’s assets, liabilities and results of operations were consolidated with Legacy Alliance beginning on the acquisition date.

Operations prior to the Merger are presented as those of Legacy Alliance in future reports.

The net assets of Adara were recognized at historical cost (which was consistent with carrying value), with no goodwill or other intangible assets recorded.

Upon consummation of the Merger, the most significant change in Legacy Alliance’s future reported financial position and results of operations was a decrease in net Equity of $787,000 as compared to Legacy Alliance’s consolidated balance sheet.

As a result of the Merger, Alliance Entertainment became the successor to an SEC-registered company, which requires us to hire additional personnel and implement procedures and processes to address public company regulatory requirements and customary practices.

We expect to incur additional annual expenses as a public company for, among other things, directors’ and officers’ liability insurance, director fees and additional internal and external accounting, legal and administrative resources, including increased audit and legal fees.

Covid-19 and Macroeconomic Uncertainties

The residual effects of the Covid-19 pandemic will continue to directly or indirectly impact our business and the results of operations and financial impact, including expenses and employee-related costs, but are highly dependent on future developments that are uncertain at this time.

While we maintained uninterrupted operations during the pandemic, macroeconomic conditions and supply chain disruptions resulted in downstream shocks.

The most pronounced consequences were the exorbitant international shipping costs for arcades, and the incremental Marketing Development Funds in the form of customer rebates recorded during year ended June 30, 2023.

The disruptions in the transportation industry resulted in higher landed costs and a $8.2 million write down was recorded for units sold and a $7.1 million write down for gaming arcade units on-hand.

In addition, customer rebates of approximately $12.2 million were incurred to spur demand for arcades.

Finally, approximately $4.6 million of incremental storage costs was recognized to warehouse excess arcade inventory.

Any new information that emerges concerning Covid-19, including the actions taken to contain or manage, as well as the economic impact on local, regional, national customers, suppliers and markets, are uncertain and cannot be predicted at this time.

However, the management team is actively monitoring internal and external factors and assessing the potential impact on its financial performance, liquidity, operations, and workforce;

however, the full extent of the risk is uncertain.

Inflation typically affects us by increasing our cost of finished products purchased from studios and manufacturers, freight & shipping costs, and payroll.

The short-term impact of inflation on the results of the company’s operations is largely dependent on whether we can pass through incremental cost to our customers, which is subject to market conditions.

During fiscal year 2021, we began to experience inflationary pressure on freight and labor.

Disruptions in the transportation industry resulted in higher landed costs of $15.3 million, which was recorded as an inventory write down for the year ended June 30, 2023.

Subsequently, cargo container shipping costs have returned to pre-Covid levels.

More recently, consistent with other retailers and distributors, higher interest rates and energy costs began to affect economic conditions in the United States.

Inflation risk may deter consumer spending if economic conditions worsen, and our results of operations could be adversely affected if the high inflation continues for an extended period.

We continue to monitor interest rates and believe they will have some impact on operations until they stabilize.

Combined, general business conditions and inflationary factors may impact sales, gross profits, and gross margins.

Key Performance Indicators

Management monitors and analyzes key performance indicators to evaluate financial performance, including:

To derive Net Revenue, the Company reduces total gross sales by customer returns, returns reserve, and allowances including discounts.

Cost of Revenues (excluding depreciation and amortization):

Our cost of revenues reflects the total costs incurred to market and distribute products to customers.

Changes in cost are impacted primarily by sales volume, product mix, product obsolescence, freight costs, and market development funds (“MDF”).

To analyze profitability, the Company reviews gross and net margins in dollars and as a percent of revenue by line of business and product line.

Operating Expenses:

Our Operating Expenses are the direct and indirect costs associated with the distribution and fulfillment of products and services.

They include both Distribution and Fulfillment and Selling, General and Administrative (SG&A) Expenses.

The Distribution and Fulfillment Expenses are the payroll and operating expenses associated with the receipt, warehousing, and distribution of product.

Selling, General and Administrative Expenses:

The Selling, General and Administrative Expenses are payroll and operating costs for Information Technology, Sales & Marketing, and General & Administrative functions.

In addition, we include Depreciation and Amortization expenses and Transaction Costs, if applicable.

Balance Sheet Indicators:

The Company views cash, product inventory, accounts payable, and working capital as key indicators of its financial position.

Alliance Entertainment Holding Corporation

Results of Operations Year Ended June 30, 2023, Compared to Year Ended

June 30, 2022

($ in thousands)

June 30, 2023

June 30, 2022

Cost of Revenues (excluding depreciation and amortization)

Operating Expenses

Distribution and Fulfillment Expense

Selling, General and Administrative Expense

Depreciation and Amortization

Transaction Costs

IC DISC Commissions

Restructuring Costs

Total Operating Expenses

Operating (Loss) Income

Other Expenses

Change in Fair Value of Warrants

Interest Expense, Net

Total Other Expenses

(Loss) Income Before Income Tax (Benefit) Expense

Income Tax (Benefit) Expense

Net (Loss) Income

Year-over-year, total Net Revenues decreased from $1,417 million to $1,159 million (-$259 million or -18%) for the year ended June 30, 2023.

Along with other Retailers and Distributors in the United States, we are not immune to the macroeconomic headwinds caused by increased inflation and interest rates.

Our business to business (“B2B”) customer base, which are primarily retailers, are reacting relatively conservatively with their inventory positions due to economic uncertainty and those retailers have their own inventory supply chain challenges.

Our direct to consumer (“DTC”) channels are facing constant competition and it’s important for our merchants to keep investing while keeping a tight rein on inventories.

Our B2B wholesale customer base revenue was down almost 20% over the previous year due to their relatively rigorous inventory management.

However, as economic conditions stabilized, our B2B revenues improved to -8% year over year in Q4.

For the year ended June 30, 2023, our DTC omni-channel sales decreased 11%, our Direct2You division outperformed B2B with sales up 7% year over year.

Year-over-year, for the year ended June 30, 2023, vinyl sales decreased 2% to $324 million.

Gaming products revenue decreased 30% to $391 million;

however, the decline in demand for physical gaming products presents an opportunity as we expect to benefit from industry consolidation.

Combined, for the year ended June 30, 2023, gaming and vinyl revenue totaled $715 million and 62% of our revenue mix compared to $887 million and 63% of total revenue in the prior year.

While we captured an increase in the average selling price in Gaming, it was not enough to offset the negative impact of decreased volume.

For the year ended June 30, 2023, the average selling price of Vinyl was flat and volume was down marginally;

however, for the trailing three months, both price and volume improved year over year.

Consumer Products, including revenue from our July 1, 2022, acquisition of Think3Fold, increased from $58 million to $80 million ($22 million, 37%) versus the prior year.

We benefited from an increase in both the average selling price and volume.

As the popularity of collectibles grows, an increasing number of musicians, celebrities, sport organizations, and content providers are expanding their portfolio of merchandise as a way to connect with their audiences.

The average selling price of music Compact Disc’s (CD’s) was essentially flat, and a decrease in volume resulted in a 16% year-over-year revenue decline.

We expect this trend for CDs to continue due to the popularity and growth of on-line streaming services.

Similarly, physical movie sales declined 28% year over year as the average price increase was not enough to offset the reduction of volume.

Cost of Revenues:

Total cost of revenues, excluding depreciation and amortization, decreased from $1,235 million to $1,055 million ($180 million or 15%) year over year primarily due to the direct relation of product costs to sales volume.

Gross Margin dollars declined as a result of lower sales and a lower overall product margin of 9.0% compared to 12.9% in the prior year.

The gross margin decline of approximately 4% points for the year ended June 30, 2023, over the same period prior year, was primarily due to an inventory adjustment to address the exorbitant landed cost experienced during supply chain disruptions related to Covid and reduced supplier marketing development funds (MDF).

The Company recorded an inventory write-down of $7.1 million to reduce its gaming

arcades to their estimated net realizable value.

In addition, excessive transportation costs of $15.3 million, arcade markdowns of $12.2 million, and additional reserves for consumer products inventory of $3.7 million were recorded.

The postponement of some theatrical releases delayed MDF in the form of Price Protection.

Price Protection is the mechanism used by vendors to stimulate sales when demand slows to reduce the return of product.

Also, since gaming products are largely non-returnable, the supply chain does not have an established practice and cadence for mark downs like the movie and music industries.

As such, gaming products typically require the distributor to bear the risk of slow-moving inventory which may increase the cost of goods sold as a percentage of sales.

The change in MDF in future periods is dependent on consumer demand for gaming products and the volume and success of new movie and music releases.

In addition, higher freight costs negatively impacted the cost of sales due to general rate hikes and incremental fuel surcharges.

Operating Expenses:

Total Operating Expenses as a percentage of net revenue increased year-over-year from 9.9% to 11.8%.

Total Distribution and Fulfillment Expense, as a percentage of net revenue, increased from 4.5% to 5.4% for the year ended June 30, 2023, versus the same period prior year.

Fulfillment payroll was $40.4 million for the year ended June 30, 2023, and $46.5 million for the same period of the prior year.

Despite low unemployment rates, the average cost per labor hour is down 3% versus the prior year as we increased our throughput rate and reduced our use of overtime.

To address the scarcity of labor resources, we are investing in additional warehouse automation and will continue to use temporary labor forces to manage changes in demand.

We believe that for the foreseeable future, there will continue to be upward pressure on labor costs and availability;

however, our investment in warehouse automation began to show significant improvements in fiscal Q4.

The primary factor for the increased Fulfillment expenses is storage fees, which amounted to $4.6 million for the year ended June 30, 2023.

The annual storage expenses will decline as the incremental inventory occupying this space is sold.

Total Selling, Administrative, and General costs increased by $0.6 million or 1% versus the same period last year;

however, non-customer impact staffing reductions were made in Q4 to reduce costs and position the company for the future.

For the year ended June 30, 2023, vs same period prior year, Consolidated Depreciation and Amortization expense decreased from $8.3 million to $6.6 million ($1.6 million or -20%) due to fully depreciated assets and the declining balance method of intangible asset amortization.

Transaction Costs for the year ended June 30, 2023, were $5.0 million for expenses related to the Think3Fold acquisition and the merger with Adara.

These expenses were required for legal, financial advisory and other professional fees associated with the acquisition and execution of the business combination agreement.

Year over year, the IC DISC Commissions decreased from $9.9 million to $2.8 million due to reduced eligible sales and elimination of the IC DISC.

The owners of the IC-DISC forgave the commission expense for the calendar year ended December 31, 2022, which was recorded as a capital contribution by our shareholders.

Interest Expense:

For the year ended June 30, 2023, Interest Expense increased from $4.1 million to $11.7 million ($7.6 million or 189%) versus the prior year.

The primary driver for the increase was a higher average revolver balance of $156 million and an increase of 3.7% points of effective interest rate to 6.0%.

For the year ended June 30, 2023, an income tax benefit of $9.1 million was recorded compared to an expense of $9.4 million for the same period in the prior year.

Alliance reported a pretax loss of $(44.5) million and pretax net income of $38.0 million for the years ended June 30, 2023, and 2022, respectively.

The annual effective tax rate (“ETR”) for the year ended June 30, 2023, was -21%.

Provision for income taxes, effective tax rate and statutory federal income tax rate for the years ended June 30, 2023 and 2022 were as follows:

($ in thousands)

June 30, 2023

June 30, 2022

Income tax (benefit) expense

Effective tax rate

Statutory federal income tax rate

Non-GAAP Financial Measures:

For the year ended June 30, 2023, we had non-GAAP Adjusted EBITDA of approximately $(17.6) million compared with Adjusted EBITDA of approximately $60.0 million prior year.

Adjusted EBITDA for the year ended June 30, 2023, includes excessive transportation costs of $15.3 million, arcade markdowns of $12.2 million, incremental arcade storage fees of $4.6 million and additional reserves for consumer products inventory of $3.7 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) other infrequent, 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.

($ in thousands)

June 30, 2023

June 30, 2022

Net (Loss) Income

Interest Expense

Income Tax (Benefit) Expense

Depreciation and Amortization

SPAC Merger Transaction Cost

Restructuring Cost

Stock-based Compensation Expense

Change in Fair Value of Warrants

Contingent Loss

Gain on Disposal of PPE

Adjusted EBITDA

Adjusted EBITDA for the year ended June 30, 2023, includes the following expenses:

Excessive International Transportation Costs (Units Sold)

Excessive International Transportation Costs (On Hand)

Markdown for Arcades Sold

Incremental Storage Fees Arcades

Consumer Products Inventory Reserve

LIQUIDITY AND CAPITAL RESOURCES

On February 11, 2021, the Company consummated the IPO of 11,500,000 Units, which includes the full exercise by the underwriters of their over-allotment option in the amount of 1,500,000 Units, at $10.00 per Unit, generating gross proceeds of $115,000,000.

Simultaneously with the closing of the IPO, the Company consummated the sale of 4,120,000 Private Placement Warrants, at a price of $1.00 per Private Placement Warrant in a private placement to the Sponsor, generating gross proceeds of $4,120,000.

For the year ended December 31, 2022, cash used in operating activities was $1,208,635.

Net income of $2,943,538 was affected by the changes in fair value of the warrant liabilities of $4,166,900 and interest earned on marketable securities held in Trust Account of $1,649,169.

Changes in operating assets and liabilities provided $1,663,896 of cash for operating activities.

For the year ended December 31, 2021, cash used in operating activities was $340,634.

Net income of $3,244,206 was impacted by interest earned on marketable securities held in the Trust Accounts of $10,281, change in fair value of warrant liabilities of $4,297,300 and transaction cost incurred in connection with IPO of $86,544.

Changes in operating assets and liabilities, which provided $636,197 of cash from operating activities.

As of December 31, 2022, we had marketable securities held in the Trust Account of $117,809,450 (including $1,659,450 of interest income) consisting of U.S.

Treasury Bills with a maturity of 185 days or less.

Interest income on the balance in the Trust Account may be used by us to pay taxes.

Through December 31, 2022, we have not withdrawn any interest earned from the Trust Account.

We intend to use substantially all of the funds held in the Trust Account, including any amounts representing interest earned on the Trust Account (less income taxes payable), to complete our Business Combination.

To the extent that our capital stock or debt is used, in whole or in part, as consideration to complete our Business Combination, the remaining proceeds held in the Trust Account will be used as working capital to finance the operations of the target business or businesses, make other acquisitions and pursue our growth strategies.

As of December 31, 2022, we had cash of $17,956 held outside of the Trust Account.

We intend to use the funds held outside the Trust Account primarily to identify and evaluate target businesses, perform business due diligence on prospective target businesses, travel to and from the offices, plants or similar locations of prospective target businesses or their representatives or owners, review corporate documents and material agreements of prospective target businesses, and structure, negotiate and complete a Business Combination.

In order to fund working capital deficiencies or finance transaction costs in connection with a Business Combination, the Sponsor, or certain of our officers and directors or their affiliates may, but are not obligated to, loan us funds as may be required.

If we complete a Business Combination, we would repay such loaned amounts.

In the event that a Business Combination does not close, we may use a portion of the working capital held outside the Trust Account to repay such loaned amounts but no proceeds from our Trust Account would be used for such repayment.

Up to $1,500,000 of such Working Capital Loans may be convertible into warrants of the post-Business Combination entity at a price of $1.00 per warrant.

Liquidity Capital Resources and Going Concern

Until the consummation of a Business Combination, the Company will be using the funds not held in the Trust Account for identifying and evaluating prospective acquisition candidates, performing due diligence on prospective target businesses, paying for travel expenditures, selecting the target business to acquire, and structuring, negotiating and consummating the Business Combination.

Until the consummation of the Business Combination, the Company used the funds not held in the Trust Account for identifying and evaluating target businesses, performing due diligence on prospective target businesses, traveling to and from the offices, plants or similar location of prospective target businesses or their representatives or owners, reviewing corporate documents and material agreements of prospective target businesses and structuring, negotiating and completing a Business Combination, which was the Business Combination with Alliance.

The Company completed its Business Combination on February 10, 2023, which was the Business Combination with Alliance, and has raised sufficient capital for its operations.

Off-Balance Sheet Financing Arrangements

We have no obligations, assets or liabilities, which would be considered off-balance sheet arrangements as of December 31, 2022.

We do not participate in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.

We have not entered into any off-balance sheet financing arrangements, established any special purpose entities, guaranteed any debt or commitments of other entities, or purchased any non-financial assets.

Contractual Obligations

We do not have any long-term debt, capital lease obligations, operating lease obligations or long-term liabilities, other than an agreement to pay our Sponsor a monthly fee of $10,000 for office space, utilities and secretarial and administrative support.

We began incurring these fees on February 8, 2021 and will continue to incur these fees monthly until the earlier of the completion of the Business Combination and our liquidation.

Critical Accounting Policies

The preparation of consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and income and expenses during the periods reported.

Actual results could materially differ from those estimates.

We have identified the following critical accounting policies:

Warrant Liabilities

We account for the Warrants in accordance with the guidance contained in ASC 815-40-15-7D and 7F under which the Warrants do not meet the criteria for equity treatment and must be recorded as liabilities.

Accordingly, we classify the Warrants as liabilities at their fair value and adjust the Warrants to fair value at each reporting period.

This liability is subject to re-measurement at each consolidated balance sheet date until exercised, and any change in fair value is recognized in our statement of operations.

The Private Warrants and the Public Warrants for periods where no observable traded price was available are valued using a binomial lattice model, specifically a binomial lattice model.

For periods subsequent to the detachment of the Public Warrants from the Units, the Public Warrant quoted market price was used as the fair value as of each relevant date.

Class A Common Stock Subject to Possible Redemption

We account for our Class A common stock subject to possible redemption in accordance with the guidance in Accounting Standards Codification (“ASC”) Topic 480 “Distinguishing Liabilities from Equity.” Shares of Class A common stock subject to mandatory redemption is classified as a liability instrument and is measured at fair value.

Conditionally redeemable common stock (including common stock that feature redemption rights that is either within the control of the holder or subject to redemption upon the occurrence of uncertain events not solely within our control) is classified as temporary equity.

At all other times, common stock is classified as stockholders’ equity.

Our Class A common stock features certain redemption rights that are considered to be outside of our control and subject to occurrence of uncertain future events.

Accordingly, shares of Class A common stock subject to possible redemption are presented as temporary equity, outside of the stockholders’ deficit section of our consolidated balance sheets.

Net Loss per Common Share

Net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period.

We apply the two-class method in calculating income (loss) per common share, evenly allocating the net income (loss) to each class of stock.

The deemed dividend associated with the redeemable shares of Class A common stock is included in income (loss) per common share in the IPO quarter and year to date calculation in which the IPO occurred.

Recent Accounting Standards

In August 2020, the FASB issued Accounting Standards Update (“ASU”) 2020-06, Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40) (“ASU 2020-06”) to simplify accounting for certain financial instruments.

ASU 2020-06 eliminates the current models that require separation of beneficial conversion and cash conversion features from convertible instruments and simplifies the derivative scope exception guidance pertaining to equity classification of contracts in an entity’s own equity.

The new standard also introduces additional disclosures for convertible debt and freestanding instruments that are indexed to and settled in an entity’s own equity.

ASU 2020-06 amends the diluted earnings per share guidance, including the requirement to use the if-converted method for all convertible instruments.

As a smaller reporting company, ASU 2020-06 is effective January 1, 2024 for fiscal years beginning after December 15, 2023 and should be applied on a full or modified retrospective basis, with early adoption permitted beginning on January 1, 2021.

We are currently assessing the impact, if any, that ASU 2020-06 would have on our financial position, results of operations or cash flows.

We have not adopted this guidance as of December 31, 2022.

Management does not believe that any other recently issued, but not yet effective, accounting standards, if currently adopted, would have a material effect on our consolidated financial statements.

As of June 30, 2023 we had cash and cash equivalents and borrowing capacity under the revolving credit facility of $0.9 million and of $1.7 million, respectively.

Our primary sources of liquidity are existing cash and cash equivalents, cash provided by operating activities, and borrowings under our credit facilities.

On September 29, 2020, the credit line with Bank of America was extended for three years and increased from $125 million to $175 million.

On June 30, 2022, the credit line with Bank of America was amended for the current period which ends September 29, 2023, and increased from $175 million to $225 million.

On April 21, 2023, in connection with the Amendment No.

12 as defined below, the Credit Facility with Bank of America was reduced from $225 million to $175 million.

($in millions)

Revolver Balance

Our principal source of liquidity is our borrowing capacity under the revolving credit facility with Bank of America and cash generated from operations.

The revolving credit facility, which was scheduled to expire on September 29, 2023, was extended for 93-days in connection with Amendment No.

13 as defined below.

Management is in active discussions with lenders to renew the revolver and expect to have it in place prior to the expiration of the revised term which expires on December 31, 2023.

Since we do not have a revised long-term revolver in place, along with the Company’s losses from operations, there is a substantial doubt as to the Company’s ability to continue as a going concern for one year from the issuance of the June 30, 2023 financial statements.

The consolidated financial statements included herein have been prepared assuming that we will continue as a going concern and do not include mitigation efforts that might result from the outcome of this uncertainty.

Management is currently evaluating cost reduction

opportunities, process efficiencies, and its overall growth and diversification strategy.

If we are unable to get an extension of our revolver and implement our mitigation efforts, we may need to alter our operations including ceasing some functions.

As disclosed in Note 8 to the Company’s consolidated financial statements, during the year ended June 30, 2023, the Company failed to meet the Fixed Charge Coverage Ratio covenant requirement.

On April 21, 2023, certain subsidiaries of the Company, as Borrowers thereunder (the “Borrowers”), entered into an Amendment Number Twelve and Waiver (“Amendment No.

12”) to the Credit Facility.

Amendment No.

12 provides for the waiver by Bank of America and the Required Lenders (as defined in the Credit Facility) of certain specified events of default under the Credit Facility, including the failure by the Borrowers to meet the Fixed Charge Coverage Ratio covenant requirement for the twelve trailing months ended November 30, 2022, December 31, 2023, January 31, 2023 and February 28, 2023 and certain other non-financial covenant breaches, and modifies the Credit Facility to, among other things, (i) suspend the Fixed Charge Coverage Ratio covenant requirement until the first calendar month end for which the Borrowers are in compliance with such requirement (the “Fixed Charge Coverage Compliance Date”), and (ii) add an additional covenant requiring the Borrowers to maintain specified minimum levels of EBITDA, which requirement will remain in effect until the Fixed Charge Coverage Compliance Date.

On April 21, 2023, certain subsidiaries of the Company, as Borrowers thereunder (the “Borrowers”), entered into an Amendment Number Twelve and Waiver (“Amendment No.

12”) to the Credit Facility.

Amendment No.

12 provides for the waiver by Bank of America and the Required Lenders (as defined in the Credit Facility) of certain specified events of default under the Credit Facility, including the failure by the Borrowers to meet the Fixed Charge Coverage Ratio covenant requirement for the twelve trailing months ended November 30, 2022, December 31, 2023, January 31, 2023 and February 28, 2023 and certain other non- financial covenant breaches, and modifies the Credit Facility to, among other things, (i) suspend the Fixed Charge Coverage Ratio covenant requirement until the first calendar month end for which the Borrowers are in compliance with such requirement (the “Fixed Charge Coverage Compliance Date”), and (ii) add an additional covenant requiring the Borrowers to maintain specified minimum levels of EBITDA, which requirement will remain in effect until the Fixed Charge Coverage Compliance Date.

Pursuant to Amendment No.

12, the Borrowers agreed to pay to Agent a waiver fee in the amount of $179,883.

On September 13, 2023, certain subsidiaries of Alliance Entertainment Holding Corporation, a Delaware corporation (the “Company” or “Alliance”), as Borrowers thereunder (the “Borrowers”), entered into an Amendment Number Thirteen and Waiver (“Amendment No.

13”) to the Loan and Security Agreement (the “Credit Facility”) with Bank of America, N.A.

(the “Agent”), as agent for the Lenders thereunder.

Pursuant to Amendment No.

13, (i) the termination date of the Credit Facility was extended to December 31, 2023, (ii) the definitions of Subordinated Debt and Permitted Contingent Obligations were amended, (iii) the Borrowers are not permitted to create, incur, guarantee or offer to exit any new debt or liens, other than certain specified liens, or to make or declare any distribution, other than certain permitted distributions, (iv) loans and advances that were previously permitted, as well as previously permitted acquisitions, will be considered restricted investments and may not be made, (v) the Borrowers may not make any loans or advances of money to any persons, and (vi) the lenders waived certain events of default, including certain breaches of negative covenants.

Our liquidity position has not changed significantly since the Merger, and we intend to principally rely on our borrowing capacity under the Credit Facility as well as any renewal of such facility.

Since the exercise price of the Warrants of $11.50 per share is significantly greater than the current market price of the Class A common stock, we do not expect the Warrants to be exercised until such time, if ever, that the market price of the Class A common stock exceeds the exercise price of the Warrants.

Although the Company does not currently intend to do so, following this offering, the Company may seek to raise additional capital through the sale of equity securities.

The receipt of cash proceeds from the exercise of our Warrants is dependent upon the market price exceeding the $11.50 exercise price and the Warrants being exercised for cash.

The $11.50 exercise price per share of the Warrants is considerably higher than the $1.32 closing sale price of the Class A common stock on October 17, 2023.

If the price of our Class A Common Stock remains below the respective Warrant exercise prices per share, we believe warrant holders will be unlikely to cash exercise their Warrants, resulting in little or no cash proceeds to us.

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 a registration statement is not effective and a 10-K is not currently 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.

The following table summarizes our net cash provided by or used on operating activities, investing activities and financing activities for the periods indicated and should be read in conjunction with our consolidated financial statements for the year ended June 30, 2023 and 2022.

($ in thousands)

June 30, 2023

June 30, 2022

Net Income (Loss)

Net Cash (Used In) Provided By:

Operating Activities

Investing Activities

Financing Activities

For the year ended June 30, 2023, on a net loss of $(35.4) million, the Company’s cash provided by operating activities was $3.4 million versus $(83.6) million used in operations for the year ended June 30, 2022.

The primary drivers, year over year, was a $64.0 million decline in Net Income combined with a $99.7 million reduction in Inventory vs.

an increase of $108 million prior year.

Less inventory was required to support sales for the year ended June 30, 2023, due to the relatively high inventory position on June 30, 2022, because of the supply chain disruptions that occurred in the prior year.

As a result, Accounts Payable increased approximately $69 million vs.

an increase of $16 million prior year because of liabilities related to the Think3Fold acquisition and less pre-paid purchases which were required to support the gaming inventory prior year.

In addition, Deferred Income Taxes increased by $8.2 million due to fiscal year 2023 losses.

Other Assets decreased by $5.0 million primarily due to the merger-related transactions costs that were classified as prepaids and subsequently expensed.

The cashflow from investing activities was marginal due to the combined net working capital structure of the acquisition transaction attributed to Cash Paid for Business Acquisition of Think3Fold that was acquired for no consideration.

Net cash used in financing activities was $3.2 million for the year ended June 30, 2023, versus cash provided of $81.0 million for the same period prior year.

The primary reason for the decline was reduced borrowing, necessary to maintain lower, desired inventory levels.

Critical Accounting Policies and Estimates

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:

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.

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.

Management completed an analysis of the net realizable value of inventory and recognized a $7.1 million write-down for gaming arcades and $3.7 million for consumer products to their estimated net realizable value, which was recorded in

cost of revenue during the year ended June 30, 2023.

Prolonged macroeconomic instability in the United States including interest rates, inflation, or supply chain disruption could materially impact our assumptions for net realizable value.

Goodwill and Definite-Lived Intangible Assets, Net:

The Company tests its goodwill for impairment on an annual basis, or 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 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.

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 it’s 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.

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.

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 year ended June 30, 2023, or 2022.

As of the date of the annual goodwill impairment test, the fair value of the Company’s reporting unit exceeded its carrying value by less than 10%.

Either a reduction in the long-term growth rate by more than 25 basis points or an increase in the discount rate by 65 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, which amounts to $89,116 as of June 30, 2023.

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.

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.

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 June 30, 2023 and February 10, 2023 (the initial recognition) are as follows:

Exercise price per share

Risk-free interest rate

Expected term (years)

Expected volatility

Expected dividend yield

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

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

● Risk-free interest rate:

the risk-free interest rate is based on the U.S.

Treasury rate with a term matching the time to expiration.

● Expected term:

the expected term is estimated to be equivalent to the remaining contractual term.

● Expected volatility:

expected stock volatility is based on daily observations of the Company’s historical stock value and implied by market price of the Public Warrants, adjusted by guideline public company volatility.

● Expected dividend yield:

expected dividend yield is based on the Company’s anticipated dividend payments.

As the Company has never issued dividends, the expected dividend yield is 0% and this assumption will be continued in future calculations unless the Company changes its dividend policy.

Quantitative and Qualitative Disclosures about Market Risk.

Not required for smaller reporting companies.

Not applicable.

Financial Statements and Supplementary Data.

This information appears following Item 15 of this annual report and is included herein by reference.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis