Aterian, Inc. (ATER) Earnings Call Transcript & Summary

Welcome to Aterian, Inc. Q1 Earnings Report Conference Call. My name is James, and I'll be your operator for today's call. [Operator Instructions] And I'd like to turn the call over to Ilya Grozovsky, Director of Investor Relations and Corporate Development. Ilya, please go ahead.

Thank you. Thank you for joining us on today's call to discuss Aterian's first quarter 2021 earnings results. On today's call are Yaniv Sarig, Co-Founder and CEO; and Arturo Rodriguez, our Chief Financial Officer. A copy of today's press release is available on the Investor Relations section of Aterian's website at aterian.io. I would like to remind you that certain statements we make in this presentation are forward-looking statements, and these forward-looking statements reflect Aterian's judgment and analysis only as of today. And actual results may differ materially from current expectations based on a number of factors affecting Aterian's business. Accordingly, you should not place undue reliance on these forward-looking statements. For a more thorough discussion of the risks and uncertainties associated with the forward-looking statements to be made in this conference call and webcast, we refer you to the disclaimer regarding forward-looking statements that is included on our first quarter earnings release as well as our filings with the SEC. We do not undertake any obligation to update or alter any forward-looking statements whether as a result of new information, future events or otherwise. In addition, the company may refer to certain non-GAAP metrics on this call. Explanation of these metrics can be found in the earnings release filed earlier today. With that, I will turn the call over to Yaniv.

Thanks, Ilya, and good afternoon, everyone. I'm really excited for this first conference call as Aterian, following our rebranding announcement last week. Changing our company name to Aterian was an important decision we thoughtfully considered over a significant period of time. First of all, it was about telling our story more concisely. As a company at the intersection of e-commerce, technology and consumer products, we often found that those new to our story had a difficult time grasping the full breadth of our vision. Thanks to the strong work of our team, our new website does a great job of explaining our business and the differentiation our team is driving in the consumer product industry. As many of you are aware, this week, an anonymous short seller made various unfounded claims against our business practices and integrity in an effort to reap profits from a decline in our stock. We welcome questions from all our shareholders and have always been proud to showcase what our incredible team had built through the years on the technology, marketing and supply chain side. Yesterday, we issued a release where we addressed the factual inaccuracies and mischaracterizations. If you wish to spend time with us to learn more about our efforts to build a scalable consumer product platform for e-commerce, please reach out to Ilya Grozovsky, our Director of IR, whose e-mail can be found at the bottom of our earnings release. We welcome investors to see live demonstration of our AIMEE platform, to answer questions about our business, our go-to-market strategy, all subject to Reg FD, of course. We hope that the content we share help those who are interested in our company understand what our tech platform actually does, the nuances of online marketing and the efforts we have made to be competitive while remaining compliant with rules and regulations. Q1 was an incredible learning opportunity for our company. While we faced the most difficult supply chain challenges in the history of our firm, despite all our efforts, we were not able to maximize the full potential of our portfolio revenue. Regardless, I know that we learned a lot and improved on many fronts. In my 7 years leading this company, I've learned that every time our team is tested, we come out stronger and more capable. To our sourcing, supply chain and operations teams, I've watched you fight through the incredible complexity of daily supply chain disruption, both domestically and internationally, while continuing to work on the supply chain optimization of our recent acquisitions. On behalf of all shareholders, I thank you for your efforts and dedication as well as your ability to creatively solve difficult problems on the fly. To give more context to the audience today regarding the scale of the crisis, according to Drewry, a maritime research and consulting service, the historical shortage of containers in Q4 and Q1 2021 has led to 3 to 4x increase in cost of shipping, while the reliability of maritime schedules has plummeted to 55% by September 2020, as reported by Sea-Intelligence. Compounded by the increased demand for e-commerce items and continued growth of certain top products, we struggled to keep inventory on hand and missed approximately $6 million in sales for the quarter. Over the past 3 quarters, we believe that we missed a cumulative of approximately $20 million in revenue as a result of inventory shortages. We continue to monitor the challenging international shipping environment and have chosen to remain conservative with our adjusted EBITDA guidance in case shipping rates, container congestion, pricing of last-mile shipping and other supply chain factors continue to increase and affect our bottom line. We expect to have more clarity on the normalization of the supply chain irregularities in the coming months. As most of you already read in our earnings press release today, we're proud to announce that we're officially adding 2 new brands to our portfolio. As previously mentioned, we closed the acquisition of Photo Paper Direct, a leading online brand in the office and printing business based in the United Kingdom. Photo Paper Direct has established itself as a category leader in various inkjet media product categories and created a strong moat on Amazon. The strong addition to our portfolio further diversifies our product categories as well as our footprint on various marketplaces in Europe. We intend to leverage the company's local team expertise in the European market to accelerate our international expansion. Additionally, we're super excited to announce that Squatty Potty is joining the Aterian family, adding a nationally loved brand to our portfolio. Squatty Potty has brought to market health and personal care products with a touch of humor and an abundance of caring for others while creating an entire category in the space. According to our estimate, an average of 1 million searches of Squatty Potty products occur on Amazon.com every month. With the product appearing early on Shark Tank and video ads watched over 30 million times on YouTube, we believe Squatty Potty is poised to continue to dominate the market it's created. We see significant opportunity expanding the brand's success in the United States, into international channels as well as developing additional products to delight the brand's followers. On a broader note, we continue to pursue our M&A strategy and review new opportunities on a weekly basis. We intend to continue to invest in our team, infrastructure and deal flow capabilities to drive growth through the acquisitions. When it comes to launching new products, this quarter marks a record for our company with 21 new products introduced. While initially we projected launching a higher amount of product, we recalibrated in favor of quality and timing and are very happy with our achievements on that front given the complex challenges of supply chain that affected our manufacturing partners as well. Certain products that suffered a delay have been put on hold as their launch could have missed seasonality-related windows. Additionally, COVID travel restrictions have prevented our team from being able to completely and fully run quality control procedures, which resulted in some cancellation and delays. Overall, our team have worked tirelessly to overcome these challenges, and I think we made the best possible judgment calls given our expectations versus the reality that's been imposed on us. We're looking forward to the challenges and exciting opportunities ahead in Q2 and beyond. Lastly, I thought it was important on this call to address questions around some of the management teams selling of stock during the last open trading window. As we mentioned in previous earnings call, most of management's stocks holding, including mine, are in the form of restricted stocks. And as you may know, taxes for these shares are due at the time of vesting. No individual on the team is able to cover those taxes without selling. Also, we would like to preserve the company's cash for growth versus covering management's significant tax liabilities. Most of the shares that were sold were done to cover taxes, with some individuals choosing to sell additional shares after many years of hard work. It's important to mention too that we've required the management team several times to delay the vesting of their shares and even on one occasion to forfeit their shares in order to protect the potential downward pressure on the company's share price that could have resulted from tax-related selling. Our management team includes some of the hardest working and most dedicated people I've ever had the privilege of partnering with, and they remain extremely invested in the company's long-term success. On a personal note, as part of my long-term wealth planning and as reported in 2019, I decided to gift a significant portion of my holding in the company to an irrevocable trust on the benefit of my children. This company is my life's work, and I'll continue to do everything in my power to lead in a way that drives maximum long term shareholder value. With that, I'll pass it on to Arty for our finance update.

Thanks, Yaniv, and good afternoon, everyone. Here are the operational performance details of our first quarter. For the first quarter of 2021, net revenue increased 88% to $48.1 million from $25.6 million in the year ago quarter. This strong gain was primarily from growth in our sustain products of $25.1 million to $42 million from $16.9 million, including our recently acquired products, and wholesale revenue of $1.9 million, including $0.6 million of PPE versus $0 in the prior year period. The quarter also saw a decrease in launch product revenue of $2.6 million versus prior year period $6.2 million, as the majority of the 21 products launched in the period happened in the late period of March. We suffered from inventory shortage in the quarter, which we estimate to be an impact of approximately $6 million, meaning we estimated that we could have sold an additional $6 million with normal inventory levels. Gross margin for the first quarter increased to 54.1% from 40.2% the year ago quarter and increased from 45.6% in Q4 2020. This year-over-year and sequential improvements in gross margin was due to both favorable product mix, including new products acquired pursuant to M&A and pricing from vendors, offset by wholesale revenue, which carries a much lower gross margin. Our overall Q1 2021 contribution margin was 12.7% as a result of previously mentioned factors which improved compared to prior year's CM loss of 2.9%. Within CM, our sales and distribution costs were negatively impacted by the supply chain crisis, which drove higher costs in last-mile fulfillment given the carriers' tightness in the quarter. E-commerce platform commissions, online advertising and logistic expenses, including within sales and distribution expenses, i.e. our variable sales and distribution expenses as a percentage of net revenue, increased to 45.2% for the 3 months ended March 31, 2021, as compared to 43.1% for the 3 months ended March 31, 2020. We continue to see some of these increased costs impacting our Q2. Q1 2021, which is historically our softest quarter, saw our sustain products contribution margin grow to 18.2% when excluding the $1.8 million noncash inventory step-up related to M&A versus 6.4% in Q1 2020. We continue to see year-over-year improvement in our product unit economics from mix and pricing. Adjusted EBITDA, which excludes stock-based compensation, change in fair market value of earn-out liabilities, net charges from changes in fair value of warrants and the loss on the issuance of the warrants, amortization of inventory step-up from acquisitions and other M&A-related costs for the first quarter of 2021, improved to a loss of $1.3 million from a loss of $6.4 million in the first quarter of 2020. I would like to highlight, if not for the inventory shortages described earlier, we believe that adjusted EBITDA would have been approximately breakeven. Excluding M&A-related costs from professional fees and transition of the Healing Solutions, our fixed cost increased approximately $1.5 million as compared to the prior year period. Our headcount rose, as previously mentioned, to 220 people as of March 31, 2020, as we added headcount primarily in customer service and other customer-related roles, predominantly in the Philippines. We expect to see our revenue per full-time employee equivalent to be near $1.4 million for 2021 versus 2020's of approximately $1.2 million. This is a continued example of our operating leverage in our technology-led business model. Our net loss, which has been impacted from charges of changes in fair value on warrants and losses on the issuance of warrants on a net basis, was $50.3 million. As part of our refinancing completed in April, we have amended the warrants to be treated as equity as opposed to debt and expect to avoid these impacts in the future. Turning to the balance sheet. At March 31, 2021, we had cash of $35 million compared to $26.7 million at the end of December 31, 2020. The increase in cash was primarily driven by financing cash proceeds from the exercise of warrants of $25 million, the High Trail Note 2 for $14 million, offset by cash portion of the purchase of Healing Solutions of $15.3 million, repayments on seller notes from Smash of $4.7 million, working capital usage of $13.6 million as we build up for inventory in the summer season and our cash net loss. The company does have approximately $9.7 million in escrow accounts as of March 31, 2020, related to deposits for certain inventory purchases which have been treated as restricted cash. As previously announced, the company closed its $110 million debt refinancing on April 8. The company views its debt financing as a stepped approach. As we continue to execute on our M&A strategy and other strategic initiatives, we do expect the opportunities to improve our debt profile over time. The historical Smash audit, which is for the period of 2018 and 2019, has been completed. And we expect to file our delayed 8-K/A, including pro formas, no later than May 14. As previously mentioned, the delay was related to the earlier periods, including the opening balance sheet period of December 31, 2017. The audit results, including the reviewed 9-month period of 9/30/2020, which will be included in the 8-K/A pro formas, are in line with previously disclosed financial results for the Smash acquisition. For guidance, the full year guidance for 2021 on revenue, the company now expects net revenue to be in the range of $360 million to $390 million, up from $350 million to $380 million, reflecting the addition of Squatty Potty. For the full year 2021 adjusted EBITDA guidance, the company expects adjusted EBITDA to remain in the range of $30 million to $34 million. The adjusted EBITDA increase of Squatty Potty of approximately $2.5 million based on the timing of closing of that acquisition is offset by some cautious planning and costs related to the current global crisis in the supply chain. We do expect to raise prices to offset the impact of this global crisis. The timing and speed of raising prices is always managed not to impact the long-term listing position of our products on marketplaces. With that, I'll turn back the call to the operator to open the call for questions.

[Operator Instructions] Our first question comes from Thomas Forte, D.A. Davidson.

Great. So I have one question and one follow-up. So Yaniv, at a high level, I wanted to know how you leverage your technology to identify opportunities to build and buy products to sell in marketplaces, to advertise those products on marketplaces and then manage logistics for those products.

Sure. Thanks, Tom. So yes, so let's touch on all these points. We use technology along the 3 ways you mentioned. First and foremost, by capturing large amounts of data from different sources, including public sources and APIs and basically build through models visibility into different categories of products, what is moving those categories, what are the trends and dislocations in those and where do we see opportunities to potentially make better products. Once those are defined, we use the software to also build a P&L and a forward-looking forecast for that product based on data that we have accumulated to help us quickly understand the opportunity, qualify it. If we qualify the opportunity, that's when we will engage our sourcing team to leverage the data and the opportunity, information that we collected to find the right suppliers to help us get the right product to market. Those suppliers, typically, it's more than one. We try to get products from many suppliers. We compare the cost and other parameters through the software and can compare different scenarios to tell us really what is the best product to launch. And once we move forward, we're launching the product. Obviously, it takes, typically, it takes 6 to 8 months from the moment we identify the idea until the product is ready to sell. When it arrives into the target market, we launch the product basically using marketing across the board to basically outperform the incumbents where we saw certain weakness in the market. And at that point in time, everything flows to the software in terms of like managing the P&L of the product, the statistics every day of how well they're doing. We automate the marketing on Amazon for those products. And then in certain cases, especially for oversized items, our software also manages the last-mile fulfillment, meaning that instead of relying on Amazon's fulfillment centers or Walmart's fulfillment centers to a large extent, if the item is large, we would typically use our own, sorry, our 3PL partners' centers that are connected to our software to manage the last-mile shipping. Does that answer your question?

Yes. It does. So then for my follow-up question, you sort of touched on this in your opening remarks. But can you walk through the impact on adjusted EBITDA in the quarter from the inventory shortfall?

Arty, you want to answer that?

Yes. Thanks, Yaniv. Tom, so yes, we estimated our short to be $6 million. And obviously, our sustain contribution margin was roughly 18%. So when you multiply those numbers, that's how you get that figure.

Our next question is from Brian Nagel, Oppenheimer.

A couple of questions. First, my first question, just on the supply chain. And I know we talk about this a lot, including last quarter, and you mentioned it here again. But could you size, I think that prior question talked about the top line impact, but maybe just to understand better the impact to EBITDA. And then philosophically, are you still basically eating these higher shipping costs or has there been some change there? And what are you seeing in terms of just within the supply chain? I mean, how much longer do you think these pressures could persist for you?

Arty, you want to take the financial part? I'll answer on the business side.

Yes. So Brian, so yes, listen, as you saw, our sales and distribution number was a little higher than prior year period, right, about 2 points. So we did eat some, right? But I think as we continue to go through this crisis, this global crisis, everyone does, right, we're expecting to raise prices, as I mentioned, right? And I do think we can offset a good portion of it with pricing increases. The question is just the timing of that, and we have to be delicate not to impact the long-term value of our listings, right? Considering how the marketplaces work, it's not something you just jam through. You got to sort of do it very thoughtfully and delicately. But that is kind of the plan to sort of really offset the majority of this stuff as we approach Q2 and Q3.

Yes. If I can add to that, Brian, just to touch more on what Arty said, right? As you know, the marketplaces are very competitive, right? And the dilemma is always, as you kind of see increasing prices of shipping, if you start increasing your price to obviously absorb that and produce better contribution margin, it's going to potentially come at the expense of a more aggressive competitor who is going to try to keep its price low, take more market share from you, and potentially, in the long term, affect the performance of your product, right? So on a case-per-case basis, the decision has to be made given many factors. And we try to find that sweet spot between optimizing for contribution margin and also, long term, conserving the market share that we have.

Yes. Got it. So just a follow-up on that. So Arty, is there a way you could say the actual impact on adjusted EBITDA from these supply chain issues?

Brian, I can't disclose that at this point. I think we measure the guidance and the EBITDA overall, right? And I think we pointed to, and I think you'll see it in the Q. We did mention in the script, there's about a 2-point impact, right, in the sense of what you saw in the sales and distribution side, which I think is predominantly where we saw the impact for Q1. It's last-mile. But to quantify what we think the future is, I can't do that right now.

Got it.

No. I think the question was on the Q1, right? Sorry, Brian, did you ask Q1?

Q1. I was asking the Q1.

Oh, Q1. I thought you meant on the guidance. Got it. Q1, yes, I would say 2 points.

Okay. Two points. Okay. Then we'll do the math. And then I guess my final question, probably more for Yaniv, but just any update on the Truweo product within your portfolio?

Yes. Sure. So the Truweo product was basically attacked in one of the most aggressive ways by another black hat seller, which has caused it to decline in sales. And there actually is still evidence of that on Amazon that some of these black hat sellers are still appearing on the page. We're working with Amazon on that problem. Obviously, there was a decline in its sales. One thing I'd caution is to try to estimate those numbers using some external tools that are very inaccurate from what we've seen. But again, this is an ongoing issue. We're working with Amazon on this. It's not clear exactly when it'll get resolved, but it's one of the most egregious black hat attacks that we've seen. And we think it's very, very limited to this category and the nature of these products and cannot necessarily affect other of our products. And again, we're working on resolving that.

Our next question is from Marvin Fong of BTIG.

A couple for me. Actually, just building on the last question. Maybe it'd be helpful for investors to also hear how some of the other deals that you've executed have performed. Maybe Smash being the next oldest, you can provide some insight into how that's progressed against your expectations. And then I have a couple of follow-ups.

Yes. Look, I mean, in general, we don't want to break the acquisitions on a regular basis. I can tell you that Smash for the first 4 months of the year grew a little over 20% versus same time last year. But here, let me explain our approach, right, and help understand how we think about this, right? So look, we manage all our products, whether they're acquired or launched, as one large portfolio who uses the same pool of resources, right? So we think of it as, what does the data tell us? We have all these different assets. We have a certain amount of resources that we can invest in growth. And our goal is obviously to drive growth across the entire portfolio at the best possible positive CM with the lowest possible fixed cost. I mean, remember, like the investments we're making in tech is really to be able to manage thousands and thousands of products over time across many different channels at the optimal fixed cost and with the best decisions on a per product basis around contribution margin or growth or both, right? So I mean, to give you an example, right? I mean, if we, at a certain point in time, the data shows us more opportunities in appliances, for example. And we think we need to launch more product in that category, and we invest more in the growth there at the expense, for example, of some product that we have in the beauty category, that doesn't mean that those products are not good or we're going to stop selling them. Because again, as long as they're managed profitably and efficiently, that's really the beauty of the model, right? So as you have certain limited resources to invest in growth, whether through building more product or doubling down on the market in a certain category, that decision is done across the entire portfolio, not per brand, but really based on what the data tells us, right? I can tell you also that, for example, 88% of the revenue generated by all the products launched by us or acquired grew on an LTM basis, right? So again, we take a portfolio view. And 88% of all the revenue generated by all our products has been in a growth pattern, right? So does that make sense? Again, the approach that we take is not as traditional as a certain brand that is in one particular category. We look at this entire portfolio and where the data tells us that there's more opportunity, that's where we'll double down on growth. That's why it's difficult to necessarily start breaking it down and trying to figure out what does it mean, right, if this product is not growing as much as the other one.