Earnings Transcript for ATER - Q2 Fiscal Year 2023

Operator: Good afternoon, and welcome to the Aterian, Incorporated Second Quarter 2023 Earnings Report Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Ilya Grozovsky, Vice President of Investor Relations and Corporate Development. Please go ahead.

Ilya Grozovsky: Thank you for joining us today to discuss Aterian's second quarter 2023 earnings results. On today's call are Joe Risico and Arturo Rodriguez, our Co-CEOs. A copy of today's press release is available on the Investor Relations section of Aterian's website at iterian.io. Before we get started, I want to remind everyone that the remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 that are based on current management expectations. It may include without limitation, predictions, expectations, targets or estimates, including regarding our anticipated financial performance, business plans and objectives, future events and developments and actual results could differ materially from those mentioned. These forward-looking statements also involve substantial risks and uncertainties, some of which maybe outside of our control and that could cause actual results to differ materially from those expressed or implied by such statements. These risks and uncertainties among others are discussed in our filings with the SEC. We encourage you to review these filings for a discussion of these risks, including our Annual report on Form 10-K filed on March 16, 2023 and our quarterly report on Form 10-Q which is when it is available on the Investors portion of our website at aterian.io. You should not place undue reliance on these forward-looking statements. These statements are made only as of today, and we undertake no obligation to update or revise them for any new information as required by law. This call will also contain certain non-GAAP financial measures, including adjusted EBITDA and adjusted EBITDA margin, which we believe are useful supplemental measures that assist in evaluating our ability to generate earnings, provide consistency and comparability with our past performance and facilitate period to period comparisons of our core operating results. Reconciliation of these non-GAAP measures to the most comparable GAAP measures and definitions of these indicators are included in our earnings release, which is available on the investors portion of our website at aterian.io. Please note that our definition of these measures may differ from similarly titled metrics presented by other companies. We are unable to provide a reconciliation of non-GAAP adjusted EBITDA margin to net income margin, the most directly comparable GAAP financial measure on a forward-looking basis without unreasonable efforts because items that impact this GAAP financial measure are not within the company's control and or cannot be reasonably predicted. With that, I will turn the call over to Joe.

Joseph A. Risico: Thank you, Ilya, and thank you everyone for joining us today. Today I'm going to discuss our recent management change, the challenges we experienced in the second quarter, and then share with you our near-term strategy with a focus on our path to adjusted EBITDA profitability. Arty will then cover our financial results for the second quarter, and our outlook for Q3. As previously announced, as of July 27, Arty and I've taken on the role of Co-CEOs of Aterian. I want to thank Yaniv Sarig, Co-Founder and former CEO of Aterian on behalf of myself, Arty, our Board and our people for his relentless and tireless efforts to steward Aterian. It's been a long journey for Arty and I as we both joined Aterian over 5 years ago prior to its IPO. I'm very proud to say that practically from day one, Arty and I have been strong business partners, taking Aterian through its IPO as well as helping Aterian navigate a number of headwinds over the years, including the tariffs on Chinese imports, the COVID-19 pandemic, the supply chain crisis, rapidly escalating costs, and now Aterian's current challenges given the high consumer inflationary environment and the reductions and shifts in consumer discretionary spending, in particular, for the categories of products that we sell. Arty will continue to serve as CFO and will lead the company operationally, which includes oversight of our supply chain and technology. I will lead primarily on revenue, strategy and growth related initiatives. While there will likely be bumps in the road ahead, Arty and I are excited and grateful for the opportunity to lead Aterian into the future. Moving on to second quarter results. Our results reflect reduced consumer discretionary spending across our portfolio, and to some extent unfavorable weather patterns in parts of the United States, where we expected stronger sales of our environmental appliances, in particular, for our dehumidifier and air conditioning product lines. We also experienced significant pricing pressure in light of the above. And we're also impacted by competitive dynamics that come with selling on unlimited shelves on marketplaces such as Amazon, which is where we earn almost all of our revenues today. We expect reduced consumer discretionary spending and competitive pricing and other competitive pressures to continue to release the rest of 2023. Having said that, we do believe that we have a strong set of core products and we will be taking actions in the coming months to better position Aterian's organic business, or sustainable adjusted EBITDA profitability and growth. Aterian's primary goal is to continue to deliver high performing products that provide consumers with great value for the price, and that results in good margins for Aterian. As for our strategy in the near-term, Arty and I will be leading with three recurring themes around revenues and operations

Arturo Rodriguez: Good evening, everyone. Thanks, Joe and welcome to your first earnings call as Co- CEO. I'm very honored and humbled to have the opportunity to co-lead Aterian into its futures. Both days in as Co-CEO I'm even more excited to partner with you Joe and the rest of the team. Aterian has some great products and brands supported by an impressive supply chain and tech, and most importantly our fantastic people. Together with every single person that is hearing, we are going to continue to successfully navigate some of the remaining obstacles that have challenged us over the past few years as highlighted earlier by Joe. Joe and I strongly believe that our path to profitability is achievable, so it will take longer than originally anticipated. Regardless of that delay, we have continued to improve our balance sheet which we believe will give us the runway to get to our goal of adjusted EBITDA profitability. Joe and I have a lot of work to do as we embark on our respective mission. However, our shared initial vision of focusing simplifying and stabilizing and tearing towards profitability, and ultimately back to growth is resolute. Now here are the financial performance details of our second quarter. For the second quarter of 2023, net revenues declined 39.5% to $35.3 million from $58.3 million in the year ago quarter, primarily due to reduced consumer discretionary spending and significant competitive pricing pressures across our portfolio. Looking at our second quarter net revenue by phase as defined in our press release, the $35.3 million broke down as follows

Operator: [Operator Instructions] Our first question comes from Marvin Fong with BTIG. Please go ahead.

Marvin Fong: Hey, good evening, Arty and Joe. Joe welcome to the CEO role. So kind of question just on the initiative to, I guess, rationalized of the portfolio and focused on your most profitable offering. So I guess two questions on this and maybe the first one, could you maybe give us an idea of what -- how much of your revenue base will kind of be included in this kind of more profitable viewpoint? So like, how much can we expect the revenue base to kind of be rationalized?

Joseph A. Risico: Arty -- do you want to take that one, Arty?

Arturo Rodriguez: Got it, Joe. Thanks. Hi, Marvin. Good to hear you. Hope you're doing well. Yes, to the question, Marvin, as Joe said, [indiscernible] that is our primary focus, we're working through that. We do think that any rationalization we do, will have some impact, but we don't think right now. It's hard to say, but we don't think it's going to be over material from a revenue perspective based off where our current guidance is. That said, I do think, we're very excited to do this. We think the impact on the profitability is a lot stronger than it is on the revenue, but we still need time to work through it. And as Joe mentioned, we'll be able to hopefully provide more color on that in our next earnings call. But we don't think it's going to be as material, cut than what we're currently seeing in our current consumers -- current guided numbers.

Marvin Fong: Okay, great. And I guess another question on this topic. But I know you said you're just 12 days in, but is it possible that whole brand might be eliminated? Or is this going to be more like surgical and what you do with the cross [indiscernible]?

Joseph A. Risico: I'll take that one, Arty. I think we're for sure going to be -- so we're going to do a line review, Marvin, right SKU by SKU across all the brands. So it will definitely be surgical. Now in the course of that work, we might decide to Jettison [ph] one or more brands that really don't -- that don't drive any P&L meaningfully today. But it's -- right now, we're thinking of it more surgically, right, and then we'll see if that expands to brands.

Marvin Fong: Okay, perfect. And maybe already just one P&L question. So the fixed distribution costing the kind of increase quarter-over-quarter, was that just a one-time thing? Can we expect that to come back down? I know you mentioned restructuring savings should start kicking in. But just why did that jump in this quarter, and what can we expect going forward?

Joseph A. Risico: Yes. So I think from memory, I think Marvin there's some restructuring costs in there. So I think when you back that out, I think you'll probably be more normal. But certainly we do expect that fixed costs to actually start coming down a bit more in Q3 anyway, as we kind of action the restructuring.

Marvin Fong: Perfect. Okay. Thanks, guys.

Operator: The next question is from Brian Kinstlinger with Alliance Global Partners. Please go ahead.

Brian Kinstlinger: Hi. Thanks for taking my questions, guys. First one, maybe you answered sorry, I missed it. Can you talk about how much inventory you still have remaining as part of the planned liquidation process in the SKU that were high priced or overbought?

Joseph A. Risico: Arty?

Arturo Rodriguez: Yes, Joe, so I'll grab that. Thanks. Hey, Brian, how are you doing? Hope you're doing well. Listen, we're still working through that, right? I think in some aspects, we went from sometime last year at $76 million -- really cut that down to $36 million. So we're very pleased in what we've been doing and how we've been fixing that. But as we said earlier, we've got a little bit more work to do. We didn't really state a number out there, Brian. But I think in general, what we said in the past is, listen, there's always going to be some component of injury that we're not pleased with as long on and right inventory is never perfect. We want that number to be below 10% of our average balances. I think right now we're probably looking at that number being 15% to 17.5% versus 10%. So from an average basis, so that's roughly like $5 million bucks or something like that. So that's kind of the amount that they want to sort of work down. But obviously, that that's still very fluid as we kind of work with both SKU rationalization in the current consumer environment, but that's kind of what we're thinking right now.

Brian Kinstlinger: Got it. Thanks. And then, you obviously highlighted the pricing pressure in the cooling and air quality products. That's been a meaningful piece of your business, at least historically. I'm curious simply under the quarter, have you begun to see pricing pressure on other SKUs?

Joseph A. Risico: I can take that, Arty. You can jump in. I would say that, generally speaking, it's in pockets. But there's pricing pressures across the portfolio, right. And in some cases, though, we have some very strong products that that do well have very strong margins, they’re best sellers. And then in other areas that I think are a little more discretionary, you're seeing pressure there as well, right. People, sellers want to obviously get their daily run rates and also get out of their inventory.

Brian Kinstlinger: Yes, okay. Last question for me. You highlighted returning to profitability in the adjusted EBITDA basis more likely in the summer of 2024 [indiscernible], which sounds like $6 million in annual OpEx. In order to get back to positive adjusted EBITDA, you have to cut more or will -- or do you expect it all to come from returning to revenue growth.

Joseph A. Risico: Go ahead, Arty [multiple speakers] that one.

Arturo Rodriguez: Yes. Thanks. So, Brian, good question. Listen, we believe as we focus our product portfolio and brands as Joe mentioned, [indiscernible] natural recover, right? As I think I highlighted earlier one of the question, the rationalization probably a bigger drag on profitability than its top line revenue. And so when you kind of factor that in, I think, again, early targets, you think the CM probably gets pretty quickly above that 13% number that we haven't seen in a while, and maybe even closer to our target of 15%. I think when you factor that in even on a reduced revenue, you're kind of right there, especially after the fixed cost cutting that we just did, right, we think our total fixed costs, I think, will be run rating kind of below $23 million. And that's before any type of rationalization on an efficiency that comes out of supply chain for doing less SKUs, there's going to be efficiencies that naturally come through that, right. So I think when you factor that all in, I think that's how we kind of see it. And that's where we have line of sight. But we still have a lot of work to get there, as we mentioned, and we're going to roll up our sleeves and really focus on doing that. But that's kind of how you kind of -- that's how we see it and how we can get there.

Brian Kinstlinger: Great. Good luck, guys. Thank you so much.

Joseph A. Risico: Thank you, Brian.

Arturo Rodriguez: Thanks, Brian.

Operator: The next question is from Alex Fuhrman with Craig-Hallum Capital Group. Please go ahead.

Alex Fuhrman: Hi, guys. Thanks for taking my question. Arty, I think you mentioned about $6 million of annualized cost cuts that you're going to see starting in the current quarter. Can you give us a little bit more granular sense of what that $6 million is? How much of that is headcount versus other fixed expenses? And then how much should we expect to see in the third quarter and the fourth quarter this year? And when would you expect to see the full run rate of that in the P&L?

Arturo Rodriguez: Hey, Alex, how are you doing and thanks for the question. I would say that the predominant amount of savings there was people. I would say probably 90% to 95% of that number is coming from people cost at this point in time. I do think that we'll start seeing some of the -- most of the impacts in Q3. But I would say the full run rate, you probably expect some time and pretty close in Q4, if not totally by Q1. There's a little bit of tiny elements there that we have to work through. But you start seeing the impacts of the savings in Q3. You see a lot bigger portion of that in Q4. And then I would say by Q1 of next year, you'll definitely see 100% of that coming through.

Alex Fuhrman: Okay. That that's really helpful. And then can you just kind of from a high-level, just give us a sense here of, as you think about rationalizing some SKU, what right now are your top performing most profitable brands that you're really going to be willing to put investment and marketing dollars behind?

Joseph A. Risico: Sure. I can take that one, Arty. So, look, Squatty Potty is a great brand, right? It's the product, right, its Squatty Potty, right. So that's a great brand. We have a few other brands, [indiscernible], we have an oils brand, our paper brand. We've got some home and kitchen appliance brands, these are all brands that, again, have some SKUs in them that needs to be rationalized, but that have some really, really great products in them. And so, we'll provide more color on where we think we're going to make bigger [indiscernible] in the coming months, Alex. But those are the areas where we think we'll be spending most of our time for now.

Alex Fuhrman: Okay. That's very helpful. Thank you very much.

Joseph A. Risico: You're welcome.

Operator: The next question is from Matt Koranda with ROTH MKM. Please go ahead.

Matt Koranda: Hey, guys. Good evening. Just wanted to get a little bit more color on explicitly what's driving sort of the erosion in year-over-year declines in the third quarter? The third quarter outlook, I think imply things have gotten a little worse in the last month, I guess. So what categories in particular have you seen erosion and then maybe, could you clarify for us like are you losing top of search in any of those categories? Or because it seems a little too stark to chalk it all up to macro weakness. So just wanted to see if you can maybe put a finer point on sort of, are there some categories where maybe we've lost top of search. And then just lastly, maybe address the pricing dynamic versus unit volume pressure that you're seeing? It sounds like you're saying that there's some pricing pressure and some competition in some key categories, so maybe just put a finer point on that as well for us.

Joseph A. Risico: Arty, I can try to address this and then maybe you can just jump in over me.

Arturo Rodriguez: Perfect, Joe. Thank you.

Joseph A. Risico: Okay. So, Matt, in second quarter, right, the environmental appliances are the products that we expect to sort of drive most of the P&L, so those are our air conditioners and dehumidifiers. When it comes to dehumidifiers, it's interesting. So, I spoke about this in my remarks a little bit. There was a loss of rank there. We had a product that -- and this is part of the challenges of being on a marketplace, right. We had a product that came into the category that's not actually a dehumidifier. But it took the bestseller tag away from us. So that that's the bestseller tag is very differentiating, and when you lose that tag, you take an immediate hit on velocity, right, sales velocity. On top of that, and again this is the challenges of being on the marketplace, there are other competitors, right, that are getting a bestseller tag that they don't deserve to have. So if you're in front of your computer, and you type in dehumidifier, you'll see a brand called NineSky. And that product has the bestseller tag on it. But when you click on the bestseller tag, right, and do the work, you'll see that it's the number one ranked product for Christmas stockings, okay. So it's -- there's -- there are players out there that are sort of gaming the algorithms, it's confusing consumers, we had another product coming to the category that also shouldn't have the tag, all of which creates -- makes it harder for the consumer to find our product, even though we know we have a great product, and it's well priced, and it does the job. And so, that's the kind of dynamic that we're seeing sort of in the dehumidifier category, right. And that -- and those kinds of things can sort of make or break you, right, in the quarter. And then because the weather, it hasn't been incredible humidity in the second quarter, right, it started out rather -- a rather mild season, folks are loaded up on inventory, right, and they need to exit for the season. So prices come down. And so, you start to see a little bit of pressure that way as well. That's what I've got for you. I don't know if there's a follow-up or Arty, if you want to add anything there.

Arturo Rodriguez: No, I think, Joe, it answered well. I think, Matt, to your point, we did see some improvement in our run rates, especially when we got into July, because I think in some aspects, it started heating up. So we did see the numbers increase a bit, but we're still being very cautious as we guided because the consumer spend and some of these other very particular good points that you brought up are just -- we're just trying to be cautious there, right? We don't -- we have seen some improvements, but we're still being cautious. So that's why I think when you look at the guide, we're kind of almost flat to Q2. And keep in mind, really similar to Q2, Q3 has like two strong months and September starts to wane. And even August, second half August tends to wane. Weather has been very unpredictable. So maybe we'll have some good news at the end. But certainly we're being cautious there and that's why the numbers look relatively flat in Q3 versus Q2.

Matt Koranda: Okay. Okay. Fair enough, guys. And then maybe just as a follow-up to Joe's comments, it's interesting. I guess, how do you raise that sort of, for lack of a better term, like the seller gamesmanship issue with Amazon, what's your avenue for redress? Is Amazon receptive to you guys sort of highlighting some of the challenges with the product listing that you mentioned? How do you get through that?

Joseph A. Risico: Yes, we -- look, we don't have Jeff Bezos on speed dial, but we have our people constantly filing complaints. We do have Amazon representatives that will take our phone call, right, but it's a very large org. We know they care about these things, right. Integrity on the marketplace is super important. But it's not just something that gets fixed overnight on that.

Matt Koranda: Okay, all right. Fair enough. And then just on the inventory write-down, can you guys cover maybe I missed it too. I've been bouncing between calls here, but what -- was that focused in any particular category where maybe you're winding down product or maybe just put explicitly spell out what was written down for us, if you could.

Arturo Rodriguez: Yes. Yes, sure. Sure. Sure, Matt. That the -- I think we said in prepared marks, it was predominantly expiring essential oils, especially with the consumer downturns that we saw, we had some big plans for moving out of those oils, and unfortunately, which we couldn't get them done in time when some of it expires. In reality, when they expire within a certain day range, right, we got 60 days to sell it. You still have to take the charge to them. So I'm going to let you put it on the platform.

Matt Koranda: Okay, got it. I'll take care [indiscernible] guys. Thank you.

Operator: At this time, I'd like to turn the conference over to Ilya Grozovsky. Please go ahead.

Ilya Grozovsky: Thanks. As part of our shareholder perks program, which as a reminder, investors can sign up for at aterian.io/perks. Participants have the ability to ask management questions on our earnings calls. I wanted to thank all of the shareholder perks participants for their loyalty, their participation in the program, and their questions. I have picked a few of the most popular questions that they have submitted. Question number one, what is the progress with your European expansion?

Joseph A. Risico: I think I addressed this in the remarks. We -- right now we've got a lot of wood to chop right with SKU rationalization. And we think there's a lot of opportunity in the U.S markets, and that's where we want to focus. Having said that, we appreciate that international expansion is important, and it's something we will continue to think about it when the time is right for the company.

Ilya Grozovsky: Great, thanks. Update on the reverse split efforts given the annual meeting [indiscernible].

Joseph A. Risico: [Indiscernible] already. So, the quick update there is we expect to get the approval to effect the reverse split. We -- right now, again, the theme of the day is focus. So, for us, closing in on the path to adjusted EBITDA profitability is the name of the game. We continue to think about whether we will need to reverse stock. And that's really all we can comment on at this time. But we're doing the work, we're evaluating it, we're thinking a lot about it.

Ilya Grozovsky: Great. And the last question was, what is the plan to increase transparency and regain shareholder confidence?

Joseph A. Risico: Thank you, Ilya. So I -- look, I just want to say, Arty and I are extremely grateful that we get these questions and we appreciate the engagement, and we appreciate the support. We realize that we're largely a retail stock today. I think before Arty and I took this role, we were both fiduciaries at Aterian and we endeavor always to be transparent, right. That's extremely important for us. So we expect to continue to be transparent and for us, we know we have a lot of work to do. And hopefully if we can get on that path to profitability, that will go a long way to reestablishing confidence.

Ilya Grozovsky: Great, thank you.

Operator: This concludes the question-and-answer portion of the call. In terms of the upcoming calendar, Aterian management will be participating in the H.C. Wainwright 25th Annual Global Investment Conference on September 11 through 15 in New York, the 2023 LD Micro Main Event 16 October 3 through 5 in Los Angeles, Craig-Hallum 14th Annual Alpha Select Conference in New York on November 16. We look forward to speaking with you on future calls. This ends our call. You may now disconnect.