Algorhythm Holdings, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS The following discussion should be read in conjunction with the condensed consolidated financial statements and notes included elsewhere in this quarterly report. This document contains certain forward-looking statements including, among others, anticipated trends in our financial condition and results of operations and our business strategy. (See Part II, Item 1A, “Risk Factors “). These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially from these forward-looking statements. Statements included in this quarterly report that do not relate to present or historical conditions are called “forward-looking statements.” Such forward-looking statements involve known and unknown risks and uncertainties and other factors that could cause actual results or outcomes to differ materially from those expressed in, or implied by, the forward-looking statements. Forward-looking statements may include, without limitation, statements relating to our plans, strategies, objectives, expectations and intentions. Words such as “believes,” “forecasts,” “intends,” “possible,” “estimates,” “anticipates,” “expects,” “plans,” “should,” “could,” “will,” and similar expressions are intended to identify forward-looking statements. Our ability to predict or project future results or the effect of events on our operating results is inherently uncertain. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved. Important factors to consider in evaluating such forward-looking statements include, but are not limited to: (i) changes in external factors or in our internal budgeting process which might impact trends in our results of operations; (ii) unanticipated working capital or other cash requirements; (iii) changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the industries in which we operate; and (iv) the effects of adverse general economic conditions, both within the United States and globally, (v) vendor price increases and decreased margins due to competitive pricing during the economic downturn (vi)various competitive market factors that may prevent us from competing successfully in the marketplace and (vii) other factors described in the risk factors section of our Annual Report on Form 10-K, this Quarterly Report on 10-Q, or in our other filings made with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. 18 OVERVIEW The Singing Machine Company, Inc., a Delaware corporation (the “Company”, “SMC”, “The Singing Machine”) and its three wholly-owned subsidiaries SMC (Comercial Offshore De Macau) Limitada (“Macau Subsidiary”), SMC Logistics, Inc. (“SMC-L”) and SMC-Music, Inc.(“SMC-M”) are primarily engaged in the development, marketing, and sale of consumer karaoke audio systems, accessories, musical instruments and musical recordings. The products are sold by SMC to retailers and distributors for resale to consumers. Our products are sold throughout North America, Europe and Australia primarily through major mass merchandisers and warehouse clubs, on-line retailers and to a lesser extent department stores, lifestyle merchants, direct mail catalogs and showrooms, music and record stores, and specialty stores. Representative customers include Amazon, Best Buy, BJ’s Wholesale, Costco, Sam’s Club, Target, and Wal-Mart. Our business has historically been subject to seasonal fluctuations causing our revenues to vary from quarter to quarter and between the same periods in different fiscal years. Our products are manufactured for the most part based on the purchase indications of our customers. We are uncertain of how significantly our business would be harmed by a prolonged economic recession, but we anticipate that continued contraction of consumer spending would negatively affect our revenues and profit margins. Sales of consumer electronics and toy products in the retail channel are highly seasonal, with a majority of retail sales occurring during the period from September through December in anticipation of the holiday season, which includes Christmas. A substantial majority of our sales occur during the second quarter ending September 30 and the third quarter ending December 31. Sales in our second and third quarter, combined, accounted for approximately 86% and 85% of net sales in fiscal 2021 and 2020, respectively. COVID-19 UPDATE In January 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of coronavirus originating in Wuhan, China (“COVID-19”) and the risks to the international community. The WHO declared COVID-19 a global pandemic on March 11, 2020 and since that time many of the previously imposed restrictions and other measures which were instituted in response have been subsequently reduced or lifted. However, the COVID-19 pandemic remains highly unpredictable and dynamic and its duration and extent continue to be dependent on various developments, such as the emergence of variants to the virus that may cause additional strains of COVID-19, the administration and ultimate effectiveness of vaccines, and the eventual timeline to achieve a sufficient level of herd immunity among the general population. Accordingly, the COVID-19 pandemic may continue to have negative effects on the health of the U.S. economy for the foreseeable future. While our facilities have remained operational during the first half of 2021, we continue to experience various degrees of manufacturing cost pressures due to raw material and electronic component shortages as well as inflationary price increases. Although we regularly monitor the financial health and operations of companies in our supply chain, and use alternative suppliers when necessary and available, financial hardship or government restrictions on our suppliers or sub-suppliers caused by the COVID-19 pandemic could cause a disruption in our ability to obtain raw materials or components required to manufacture our products and adversely affect our operations. Further, as consumer demand improves and economic activity increases, we have experienced supply chain challenges, including increased lead times, port closures in China and delays in Los Angeles, global container shortages, as well as inflation of logistics and labor costs due to availability constraints and high demand. We expect these inflationary trends to continue throughout the remainder of the fiscal year. During Fiscal 2021, we experienced growth in our karaoke, microphone, and toy categories as the pandemic increased demand for home entertainment. For the current fiscal year, demand from consumers and retailers continue to remain strong led by shortages of toys and home entertainment product availability in the market. We maintain our commitment to protect the health and safety of our employees, customers, and suppliers by continuing our enhanced safety protocols for those on-site at our warehouse facilities. In addition, employees who do not need to be physically present at our corporate office to perform their job responsibilities generally continue to work from home and essential business travel remains the main travel activity. The extent of the COVID-19 pandemic’s effect on our operational and financial performance in the future will depend on future developments, including the duration, geographic location and intensity of the pandemic, the impact of virus variants, the rate of vaccinations, our continued ability to manufacture and distribute our products, as well as any future actions that may be taken by governmental authorities or by us relating to the pandemic. For more information regarding factors and events that may impact our business, results of operations and financial condition as a result of the COVID-19 pandemic, see “Risk Factors” included in Item 1A. “Risk Factors” in our 2021 Annual Report on Form 10-K. 19 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain items related to our condensed consolidated statements of operations as a percentage of net sales for the three months ended June 30, 2021 and 2020 as restated: For Three Months Ended June 30, 2021 June 30, 2020 Net Sales 100.0 % 100.0 % Cost of Goods Sold 74.0 % 68.5 % Gross Profit 26.0 % 31.5 % Operating Expenses Selling expenses 9.5 % 9.8 % General and administrative expenses 23.4 % 44.7 % Depreciation and amortization 1.1 % 2.3 % Total Operating Expenses 34.0 % 56.8 % Loss from Operations -8.0 % -25.3 % Other Income (Expenses) Gain from Payroll Protection Plan loan forgiveness 7.4 % 0.0 % Gain - related party 0.2 % 0.0 % Gain from damaged goods insurance claim 0.0 % 4.3 % Gain from extinguishment of accounts payable 0.0 % 12.8 % Interest expense -1.6 % -1.0 % Finance costs -0.3 % -0.2 % Total Other Income (expenses), net 5.7 % 15.9 % Loss Before Income Tax Benefit -2.3 % -9.4 % Income Tax Benefit 0.5 % 2.6 % Net Loss -1.8 % -6.8 % QUARTER ENDED JUNE 30, 2021 COMPARED TO THE QUARTER ENDED JUNE 30, 2020 NET SALES Net sales for the quarter ended June 30, 2021 increased to approximately $6,066,000 from approximately $3,052,000 an increase of approximately $3,014,000 as compared to the same period ended June 30, 2020. We shipped approximately $2,444,000 in holiday promotion goods to one major customer who committed to earlier delivery for the three months ended June 30, 2021 as compared to the prior three months ended June 30, 2020 when no holiday promotion goods were shipped to this customer. The remaining increase in sales was primarily due to another major customer that ordinarily does not order spring goods and decided to offer our product year-round. GROSS PROFIT Gross profit for the quarter ended June 30, 2021 increased to approximately $1,578,000 from approximately $962,000 an increase of approximately $616,000 as compared to the same period in the prior year. The increase in net sales contributed approximately $949,000 to the increase in gross profit but was offset by a decrease in gross profit margin percentage of approximately 5.5% or approximately $333,000. Gross profit margin for the three months ended June 30, 2021 was 26.0% compared to 31.5% for the three months ended June 30, 2020 due primarily to the increase in holiday promotion goods as explained in net sales that yield a significantly lower gross profit margin and accounted for approximately 4.4 margin points of the 5.5 margin point decrease. The remaining decrease was primarily due to the gross margin on the mix of products returned during the three months ended June 30, 2021. OPERATING EXPENSES For the quarter ended June 30, 2021, total operating expenses increased to approximately $2,068,000 compared to approximately $1,733,000 from the same period in the prior year. This represents an increase in total operating expenses of approximately $335,000 from the quarter ended June 30, 2020. There was an increase in selling expenses of approximately $279,000 of which $182,000 was primarily due to variable expenses including commissions, freight and royalties which were all commensurate with the increase in net sales. There was an increase in discretionary expenses of approximately $97,000 due to increased on-line media marketing for the spring and summer seasons. General and administrative expenses increased by approximately $58,000 due to increased costs associated with the logistics operations. 20 For the three months ended June 30, 2021 and 2020, total operating expenses as a percentage of net sales were 34.0% and 56.8%, respectively. This decrease of approximately 22.8 percentage points was primarily due to the significant increase in holiday promotion goods shipped direct import to one major customer that incurred significantly less selling and administrative expenses as compared to goods shipped from our California warehouse facility. LOSS FROM OPERATIONS There was a loss from operations of approximately $490,000 for the three months ended June 30, 2021 compared to a loss from operations of approximately $771,000 for the three months ended June 30, 2020. The decrease in the loss from operations of approximately $281,000 was primarily due to the increase in gross profit from increased net sales offset by an increase in operating expenses as explained above. OTHER INCOME (EXPENSES) Other income, net decreased by approximately $142,000 to approximately $343,000 in other income, net for the three months ended June 30, 2021 compared to approximately $485,000 in other income, net for the same period ended June 30, 2020. For the three months ended June 30, 2021, there were one-time gains of approximately $459,000 primarily due to forgiveness of the loan under the Paycheck Protection Program of approximately $448,000 which included principal and interest and offset by $116,000 in other expenses primarily due to interest paid on the Intercreditor Revolving Credit Facility. For the three months ended June 30, 2020, there were one-time gains of approximately $521,000 due to a gain from insurance proceeds received for a damaged goods claim of approximately $131,000 and settlement of accounts payable of approximately $390,000 by the vendor responsible for the damaged goods. These one-time gains were offset by approximately $36,000 in other expenses primarily due to interest paid on existing debt. INCOME TAXES For the three months ended June 30, 2021 and 2020 the Company recognized an income tax benefit of approximately $28,000 and $79,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 19.1% and 27.6%, respectively. NET INCOME For the three months ended June 30, 2021 there was a net loss of approximately $119,000 compared to a net loss of approximately $207,000 for the same period a year ago. The increase in net income was primarily due to the same reasons discussed in Loss from Operations and Other Income (Expenses). LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2021, Singing Machine had cash on hand of approximately $1,383,000 as compared to cash on hand of approximately $1,805,000 on June 30, 2020. We had working capital of approximately $5,556,000 as of June 30, 2021. Net cash provided by operating activities was approximately $794,000 for the three months ended June 30, 2021, as compared to approximately $244,000 used in operating activities for the same period a year ago. During the three months ended June 30, 2021 there was a decrease in amounts due from Crestmark Bank of approximately $4,214,000 as cash collected in excess of amounts due on accounts receivable financing was transferred to operating cash. There was an increase in accounts payable of approximately $3,790,000 primarily related to the purchase of inventory for the upcoming peak season. These increases to cash provided by operating expenses were offset by an increase in accounts receivable of approximately $3,251,000 due to the increase in sales to two major customers and an increase in inventories of approximately $2,880,000 due to an earlier build-up of inventory for the upcoming peak season due to global logistics issues and risks. Net cash used in operating activities was approximately $244,000 for the three months ended June 30, 2020. During the three months ended June 30, 2020 there was a decrease in accounts payable of approximately $2,913,000 as the Company paid past due invoices to the vendor that caused the damaged goods incident as explained below. There was a seasonal decrease in reserves for sales returns of approximately $844,000, a decrease in accrued expenses of approximately $521,000 and a decrease in refunds due to customers of approximately $415,000 primarily due to repayment of chargebacks to one customer for damaged goods received as explained below. These decreases in cash used in operating activities were offset by a decrease in amounts due from PNC Bank and Crestmark for collections on accounts receivable that exceeded amounts due on the PNC and Crestmark Revolving Credit Facilities of approximately $2,121,000, a decrease in insurance receivable of approximately $1,269,000 primarily due to proceeds received from the damaged goods insurance claim as explained below. Inventories decreased by approximately $698,000 primarily due to one major customer buying goods for a summer program due to the increased demand for karaoke products. Net cash used in investing activities for the three months ended June 30, 2021 was approximately $56,000 as compared to approximately $45,000 used in investing activities for the same period ended a year ago and consisted primarily of purchases of molds and tooling for new products. Net cash provided by financing activities for the three months ended June 30, 2021 was approximately $248,000 compared to cash provided by financing activities of approximately $1,749,000 for the same period ended of the prior year. During the three months ended June 30, 2021, we borrowed approximately $300,000 from our Intercreditor Revolving Credit Facility for working capital. These financing activities were offset by payments made on deferred finance charges associated with the renewal of the IHC Facility of approximately $38,000 with the remaining difference primarily used to pay scheduled installments on installment notes and finance leases. 21 Net cash provided by financing activities for the three months ended June 30, 2020 was approximately $1,749,000. We borrowed $1,400,000 from our IHC Facility and received loan proceeds from Crestmark in the amount of approximately $444,000 million under the Paycheck Protection Program. These financing activities were offset by payments made on deferred finance charges associated with the closing of the Crestmark and IHC Facilities of approximately $74,000 with the remaining difference used to pay scheduled installments on installment notes and finance leases. On June 16, 2020, the Company executed an Intercreditor Revolving Credit Facility with Crestmark and IHC on eligible accounts receivable and inventory which replaced the Company’s previous revolving credit facility with PNC Bank which was terminated on June 16, 2020 (See Note 4 – Bank Financing). As of this filing, we have borrowed approximately $990,000 on the IHC Facility, which provides for a maximum loan amount of $2,500,000 on eligible inventory and borrowed approximately $500,000 on our Crestmark Facility which will make available up to $10,000,000 of eligible accounts receivable as the fiscal year progresses. As of this filing the Company has approximately $2,200,000 currently available from these two credit facilities. On May 5, 2020, the Company received loan proceeds from Crestmark in the amount of approximately $444,000 under the Paycheck Protection Program (“PPP”). The PPP was established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest may be forgivable to the extent the Company uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness may be reduced if the borrower terminates employees or reduces salaries during the eligible period. The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments until a forgiveness application has been accepted and reviewed by the Small Business Administration (“SBA”), and the SBA provided Crestmark with the loan forgiveness amount. In June 2021 the Company received notification from the SBA that the loan had been forgiven in its entirety. For the three months ended June 30, 2021, a gain of approximately $448,000 (including principal and interest) from the forgiveness of the loan was included in other income and expenses in the accompanying condensed consolidated statements of operations. On August 5, 2021, the Company entered into a stock redemption agreement (the “Redemption Agreement”) with Koncepts International Limited (“Koncepts”) and Treasure Green Holdings, Ltd. (“Treasure Green”), pursuant to which the Company agreed to redeem approximately 19,623,155 shares of common stock of the Company (the “Redeemed Shares”). The closing of the transactions set forth in the Redemption Agreement took place on August 10, 2021, at which time the Redeemed Shares were assigned and transferred back to the Company and the Company wired approximately $7,200,000 to Koncepts and Treasure Green. The Redeemed Shares shall be retired to treasury and shall become available for reissuance in the future. On August 5, 2021, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with large institutional investors and a strategic investor for private placement of (i) 16,500,000 shares of its common stock (the “Shares”) together with common warrants to purchase up to 16,500,000 shares of common stock for an exercise price of $0.35 per share, and (ii) 16,833,333 pre-funded warrants (“Pre-Funded Warrants”) with each Pre-Funded Warrant exercisable for one share of common stock at an exercise price of $0.01 per share, together with Common Warrants to purchase up to 16,833,333 shares of common stock at an exercise price of $0.35 per share (the “Private Placement”). Shares issuable upon the exercise of the Pre-Funded Warrants and Common Warrants are hereinafter referred to as the “Warrant Shares”. The closing of the Private Placement took place on August 10, 2021, when the Shares, Common Warrants, and Pre-Funded Warrants were delivered to the purchasers and funds, in the amount of approximately $9,800,000, were wired to the Company. Approximately $7,200,000 of the funds received were used to execute the Redemption Agreement. The Company expects an increase in working capital of approximately $1,800,000 of working capital after settlement of expenses associated with closing of these transactions. In August 2019, a major customer received goods that were significantly water damaged due to excess moisture absorbed in pallets shipped by the factory. As a result, we incurred a loss in cash flow of approximately $1,559,000 in revenue and approximately $849,000 in additional out of pocket expenses to retrieve, inspect, warehouse and properly destroy the goods in in fiscal 2020. As of the fiscal year ended March 31, 2021 we recovered approximately $2,336,000 from our cargo insurance coverage which settled approximately $1,268,000 in insurance claim receivable with the remaining proceeds reflected in other income and (expenses) as a gain from damaged goods insurance claim in the consolidated statement of income as of March 31, 2021. For the three months ended June 30, 2021 and 2020 the gain from damaged goods insurance claim was approximately $0 and $131,000, respectively. We also secured vendor invoice credits of $390,000 from the factory that caused the damage which is reflected as gain from settlement of accounts payable in the condensed consolidated statement of operations for the three months ended June 30, 2020. Effective as of August 10, 2021, and in connection with the transactions set forth in the Redemption Agreement and Purchase Agreement (as defined above ), Phillip Lau, Peter Hon, and Yat Tung Lau (each a “Director” and together, the “Directors”) resigned from the Board of Directors of the Company. The Directors’ resignations are not a result of a disagreement on any matter relating to the Company. The Company intends to fill the newly created vacancies on the Board in due course. 22 We believe that current working capital, the availability of cash from our Intercreditor Revolving Credit Facility (See Note 6 – Bank Financing), additional working capital generated by the private placement and cash generated from our operating forecast will be adequate to meet the Company’s liquidity requirements for at least the next twelve months. We believe the Intercreditor Revolving Credit Facility will be adequate to maintain and grow our business during the remaining term of the agreement. If we are unable to comply with the financial covenants defined in the financing agreement and default on the credit facility, it may have a material adverse effect on our ability to meet our financial obligations. As both the Crestmark Facility and the IHC Facility are set to expire on June 15, 2022, the Company expects to negotiate a revision or extension of these debt facilities upon their maturity however, there can be no assurance that such revision or extension will occur or at what terms. CRITICAL ACCOUNTING POLICIES The Company’s interim financial statements were prepared in accordance with United States generally accepted accounting principles, which require management to make subjective decisions, assessments and estimates about the effect of matters that are inherently uncertain. As the number of variables and assumptions affecting the judgement increases such judgements become even more subjective. While management believes that its assumptions are reasonable and appropriate, actual results may be materially different than estimated. The critical accounting estimates and assumptions have not materially changed from those identified in the Company’s 2021 Annual Report. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not required for small reporting companies.