Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview
Alliance Entertainment Corp. ("Alliance" or the "Company") is the
largest full service distributor of pre-recorded music and music
related products in the United States and is also actively engaged in
the acquisition and exploitation of proprietary content rights with
respect to recorded music, video and video CDs. In August 1996 as part
of its strategy to expand its proprietary content business, Alliance
acquired Red Ant L.L.C. ("Red Ant"), a new music label formed by Alvin
N. Teller, to build a roster of alternative rock, urban contemporary
and country artists. In conjunction with the acquisition of Red Ant,
Mr. Teller (the former Chairman and Chief Executive Officer of MCA
Music) became Co-Chairman, Chief Executive Officer and President of
Alliance.
Prior to the acquisition of Red Ant, Alliance's proprietary content
business conducted through the Proprietary Product Group consisted
primarily of the operations of Castle Communications plc ("Castle") and
Concord Jazz, Inc. ("Concord"). Castle's catalog includes proprietary
rights with respect to The Kinks, The Searchers, Status Quo and
Donovan, and rock music from the 1970's by bands such as Motorhead and
Uriah Heep. Since 1994, Castle has also actively acquired domestic
and/or worldwide rights to a broader range of proprietary rights,
including catalogs of artists such Black Sabbath and Iron Maiden as
well as world-wide rights to projects of newly recorded music by
established artists formerly with the six major record companies: Sony
Music, Time Warner, Polygram, MCA, EMI and BMG (the "Major Labels")
such as Cheap Trick, REO Speedwagon and Ugly Kid Joe. Concord, a label
established in 1974 and acquired by the Company in late 1994, has a
catalog of over 600 jazz recordings by artists such as Rosemary
Clooney, Mel Torme, Tito Puente, and Art Blakey as well as exclusive
recording agreements for new recordings with a number of other
established jazz artists such as Chick Corea and Maynard Ferguson. The
acquisition of Red Ant will add additional artist development
capabilities to Alliance's proprietary content business.
The Company's distribution segment is conducted through the One Stop
Group and Independent Distribution Group. The One Stop Group
specializes in the wholesale distribution of all available pre-recorded
music product (i.e., pre-recorded music manufactured by the Major
Labels as well as music manufactured by independent labels). The
Independent Distribution Group specializes in the domestic wholesale
distribution of pre-recorded music manufactured by third party
independent labels on an exclusive and regional basis. The Independent
Distribution Group has historically generated higher gross margins than
has the One Stop Group but carries a higher degree of risk related to
industry conditions due to a greater dependence on new release product
and a higher degree of exposure to product returns.
The International Distribution Group specializes in wholesale
distribution of pre-recorded music product outside the United States,
primarily in Brazil and Canada. The International Distribution Group
consists of (i) the Company's Brazilian operations conducted through
DisqueMusic Comercial Importadora Ltda., Brasison Distribuidora de
Discos Ltda. and Distribuidora de Discos E Fitas Canta Brasil Ltda.
(Canta Brasil was acquired by the Company in October 1995) and (ii) the
Company's Canadian operation conducted through The St. Clair
Entertainment Group Inc. ("St. Clair"). The Company is currently
evaluating a plan to divest itself of its Brazilian operations and such
evaluation is expected to be completed in the fourth quarter of 1996.
See, "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Recent Events - Consolidation Plan."
Recent Events
Acquisition of Red Ant L.L.C.
On August 27, 1996, the Company acquired Red Ant L.L.C., a Delaware
limited liability corporation ("Red Ant"), pursuant to the terms of the
Stock Acquisition and Merger Agreement, dated August 15, 1996, among
Alliance, Alvin N. Teller, Wasserstein & Co., Inc. ("WCI"), and other
parties thereto. The Company acquired all of the outstanding units of
Red Ant from Mr. Teller and WCI in exchange for (i) 760,823 shares of
the Company's common stock, $.0001 par value per share (the "Common
Stock"), issued to Mr. Teller and 5,957,928 shares of Common Stock
issued to WCI and its affiliates and (ii) the right for Mr. Teller and
WCI and affiliates to receive additional shares of Common Stock
contingent upon the market price of the Common Stock achieving defined
target prices or upon certain events. In conjunction with the
acquisition of Red Ant, Mr. Teller (the former Chairman and Chief
Executive Officer of MCA Music) became Co-Chairman, Chief Executive
Officer and
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President of Alliance. The acquisition of Red Ant for shares of the
Company's Common Stock with an aggregate value of $26,875,004 resulted
in the recognition of costs in excess of net assets acquired in the
amount of $8,100,000. Pro-forma financial information has not been
presented with respect to the acquisition of Red Ant because such
information would not be materially different from the historical
information presented herein.
The stockholders of the Company ratified the terms of the Company's
acquisition of Red Ant at a Special Meeting of the Company's
stockholders on October 29, 1996.
Restructuring Charges
During the first six months of 1996, the Company recognized certain
non-recurring expenses of $20.4 million (the "Restructuring Charges")
relating to the termination of the proposed merger of the Company and
Metromedia International Group, Inc., the consolidation and relocation
of two of the Company's warehouse facilities, as well as charges
relating to the current industry climate. Approximately $11.0 million
of these charges resulted in an increase to cost of goods sold, while
the remaining $9.4 million was a charge against selling, general and
administrative expenses. The Restructuring Charges (which relate
primarily to the Company's One Stop Group distribution operations)
include termination costs, severance and other incremental costs
relating to the closure of two facilities and relocation of operations
in Miami, Florida to the Company's Coral Springs, Florida facility, as
well as expenses relating to the further reduction of inventory levels
once the relocation is completed. The relocation to the Coral Springs
facility is expected to be completed by the first quarter of 1997. The
Restructuring Charges pertaining to the current industry environment
relate to the further strengthening the Company's reserve position with
regard to customer returns, return penalties to vendors, and allowance
for doubtful accounts.
BT Capital and BCI Preferred Stock Issuance.
On July 16, 1996, the Company entered into a Preferred Stock Purchase
Agreement (the "Preferred Stock Purchase Agreement"), with BT Capital
Partners, Inc. ("BT"), an affiliate of Bankers Trust, and BCI Growth
IV, LP ("BCI"), pursuant to which the Company issued a total of $42.25
million of new preferred stock, the proceeds of which were used to fund
the purchase of catalog and other proprietary rights and for general
corporate purposes. BT purchased $35 million and BCI purchased $7.25
million of the preferred stock. The preferred stock has a cumulative
dividend rate of 7 7/8% per annum, payable in additional shares of
preferred stock, and is convertible into shares of the Company's Common
Stock at a conversion rate equal to $7.25 per share of Common Stock
subject to anti-dilution adjustments.
The Company's stockholders approved the issuance of shares of Common
Stock upon conversion of the preferred stock at a Special Meeting of
the Company's stockholders on October 29, 1996.
Matrix Software Acquisition
On October 11, 1996, the Company acquired Matrix Software, Inc.
("Matrix"), a leading provider of music product databases to
cyber-retailers selling prerecorded music over the internet. Matrix is
the creator of the All-Music and All-Movie Guides, print and software
encyclopedic databases widely used by music retailers and the key
element of search engines for most on-line/web sites that sell
prerecorded music and video. Matrix also maintains two proprietary web
sites ("www.allmusic.com" and "www.allmovie.com") on the world wide web
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promoting the All-Music Guide and the All-Movie Guide. The acquisition
of Matrix is part of the Company's strategy to create a full service
music distribution company serving existing as well as future
internet-based retailers by combining its music distribution expertise
with an extensive music software database.
Consolidation Plan
On November 14, 1996, the Company announced a significant Consolidation
Plan (the "Consolidation Plan") involving its North American
Distribution operations. The Consolidation Plan calls for the closure
of five of the Company's eight domestic distribution facilities and the
centralization of all administrative functions for the Company's One
Stop Group and Independent
Distribution Group. Additionally, under the Consolidation Plan, the
administrative functions of the Company's three domestic proprietary
labels (Red Ant, Castle (US) and Concord) will be consolidated under
Red Ant. The Company expects that the Consolidation Plan will require
a fourth quarter charge of approximately $28 to $32 million
encompassing lease termination costs, severance costs and other
expenses relating to the Consolidation Plan of which approximately $18
to $21 million will be cash expenditures. The largest portion
of these expenditures will occur during 1997. It is the Company's
expectation that once fully implemented, the Consolidation Plan will
result in annualized cost savings in excess of $20 million. It is
currently anticipated that the Consolidation Plan will be completed by
March 1998. See, "Management's Discussion and Analysis of Financial
Condition and Results of Operations Liquidity and Capital Resources."
Concurrent with the Consolidation Plan, the Company is also evaluating
the divestiture of its Brazilian distribution operations and its
Premier Artists Services subsidiary. Depending on the results of this
evaluation, which is anticipated to be completed in the fourth quarter
of 1996, such divestitures could result in an impairment charge with
respect to certain of the Company's long-lived assets and intangibles
under The Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long Lived
Assets to be Disposed Of." At September 30, 1996, the aggregate total
investment in and advances to the operations subject to evaluation was
$32.2 million.
Industry Conditions
During the nine months ended September 30, 1996, the Company's
distribution segment experienced lower than anticipated net sales to
its customers as a result of the continued weak music retail
environment. This weakness has particularly impacted the Independent
Distribution Group, as continued retail closings have resulted in
higher than expected product returns from its customers. During the
third quarter, the Company's net sales were negatively impacted by: (i)
higher than anticipated customer returns; (ii) limited customer budgets
allocated to the purchase of new release and catalog product and (iii)
the reduction in successful new product released by the industry during
1996.
Results of Operations
The following discussion and analysis should be read in conjunction
with the unaudited financial statements of the Company and the notes
thereto included elsewhere in this report.
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The following table sets forth, for the three months and nine months
ended September 30, 1995 and 1996, certain operating data as a
percentage of net sales.
Three Months Ended
September 30
------------
1995 1996
---- ----
Net Sales 100.0% 100.0%
Gross Profit 20.2 17.5
Selling, General &
Administrative
Expenses 13.6 19.9
Amortization of
Intangible Assets 1.7 1.8
Other income (expense)
primarily interest (3.7) (5.7)
expense
Provision (benefit) for
income tax .6 (4.0)
Net Income (loss) .5 (5.9)
(TABLE CONTINUED)
Nine Months Ended
September 30(1)
---------------
1996 Pre-
Restructuring
1995 1996 Charges
---- ---- ------
Net Sales 100.0% 100.0% 100.0%
Gross Profit 19.6 16.4 18.6
Selling, General &
Administrative
Expenses 13.0 19.9 18.0
Amortization of
Intangible Assets 1.6 1.7 1.7
Other income (expense)
primarily interest (3.0) (5.5) (5.5)
expense
Provision (benefit) for
income tax .9 (3.5) (2.2)
Net Income (loss) 1.1 (7.2) (4.4)
(1) Cost of sales and selling, general & administrative expenses for
the nine months ended September 30, 1996 include restructuring charges
of $11.0 million and $9.4 million ($2.5 million of which reflects
non-recurring expenses related to the termination of the proposed
merger of the Company and Metromedia International Group, Inc.),
respectively. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Recent Events Restructuring
Charges" and "Results of Operations-Nine Months Ended September 30,
1996 vs. Nine Months Ended September 30, 1995."
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The following table sets forth, for the three months and nine months
ended September 30, 1996, certain operating data by business segment,
excluding corporate related expenses and assets.
Three Months Ended
September 30, 1996
------------------
Distribution Proprietary
Products
Net Sales $144,007 $16,562
Depreciation &
Amortization 953 1,967
Operating Income
(Loss) -
Pre-Restructuring (661) (594)
Charges (1)
Operating Income
(loss) -
Post-Restructuring (661) (594)
Charges (1)
Capital Expenditures 1,874 624
Identifiable Assets
(TABLE CONTINUED)
Nine Months Ended
September 30, 1996
------------------
Proprietary
Distribution Products
Net Sales $448,213 $51,443
Depreciation &
Amortization 3,137 5,783
Operating Income
(Loss) -
Pre-Restructuring 7,762 619
Charges (1)
Operating Income
(loss) -
Post-Restructuring (9,575) 453
Charges (1)
Capital Expenditures 3,261 1,677
Identifiable Assets 351,949 156,247
(1) See "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Recent Events - Restructuring Charges."
Three Months Ended September 30, 1996 vs. Three Months
Ended September 30, 1995
Net sales decreased 12%, from $182.5 million for the three months ended
September 30, 1995 to $160.6 million for the three months ended
September 30, 1996. Net sales attributable to the Company's
distribution segment for the three months ended September 30, 1996 were
approximately $144.0 million compared to $166.6 million for the three
months ended September 30, 1995 despite the inclusion of net sales for
three months of Independent National Distributors, Inc. ("INDI") and
One Way Records Inc. ("One Way") in the period ended September 30,
1996 as compared to two months net sales for INDI and one month net
sales for One Way for the three months ended September 30, 1995.
During the three months ended September 30, 1996, the Company's
distribution segment, in particular the Independent Distribution Group,
continued to experience lower than anticipated net sales to its
customers in part due to: (i) higher than expected product returns from
customers as a result of weak retail sales and store closings,
especially with respect to traditional retailers; (ii) limited budgets
allocated to the purchase of new product by certain of the Company's
customers; and (iii) the reduction in successful new product released
by the industry during the second and third quarters of 1996. Net
sales attributable to the Company's proprietary product segment for the
three months ended September 30, 1996 were approximately $16.6 million,
compared to $15.9
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Transmitted: 12/24/96 17:41 (ACDSC) |
