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/A, this Quarterly Report on 10-Q/A, 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. 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. 21 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. 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 improved and economic activity increased, 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. 22 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain items related to our consolidated statements of income as a percentage of net sales for the three and six months ended September 30, 2021 and 2020 as restated: The Singing Machine Company, Inc. and Subsidiaries CONDENDSED CONSOLIDATED STATEMENTS OF OPERATIONS For Three Months Ended For the Six Months Ended September 30, 2021 September 30, 2020 September 30, 2021 September 30, 2020 Net Sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of Goods Sold 80.8 % 73.9 % 79.1 % 73.2 % Gross Profit 19.2 % 26.1 % 20.9 % 26.8 % Operating Expenses Selling expenses 4.2 % 6.6 % 5.6 % 7.0 % General and administrative expenses 10.2 % 8.3 % 13.6 % 12.7 % Depreciation and amortization 0.4 % 0.3 % 0.6 % 0.5 % Total Operating Expenses 14.8 % 15.2 % 19.8 % 20.2 % Income from Operations 4.4 % 10.9 % 1.1 % 6.6 % Other Income (Expenses) Gain from damaged goods insurance claim 0.0 % 4.2 % 0.0 % 4.2 % Gain from extinguishment of accounts payable 1.4 % 0.0 % 1.0 % 1.5 % Interest expense -0.6 % -0.6 % -0.9 % -0.6 % Financing costs -0.1 % -0.1 % -0.1 % -0.1 % Total Other Income (expenses), net 0.7 % 3.5 % 0.0 % 5.0 % Income Before Income Tax Provision 5.1 % 14.4 % 1.1 % 11.6 % Income Tax Provision -1.0 % -3.7 % -0.6 % -2.9 % Net Income 4.1 % 10.7 % 0.5 % 8.7 % QUARTER ENDED SEPTEMBER 30, 2021 COMPARED TO THE QUARTER ENDED SEPTEMBER 30, 2020 NET SALES Net sales for the quarter ended September 30, 2021 decreased to approximately $17,369,000 from approximately $22,285,000 a decrease of approximately $4,916,000 as compared to the same period ended September 30, 2020. Sales of our Carpool Karaoke The Mic (“CPK”) product decreased by approximately $2,306,000 during the three months ended September 30, 2021 compared to the same period ended September 30, 2020 as the company winds down it’s promotion of the original version of the product and recently launched a new version of the product with several enhanced features for sale during the upcoming holiday season. The remaining decrease in sales was primarily due to delays in receiving goods from the Port of Los Angeles due to the disruption in the global supply chain. GROSS PROFIT Gross profit for the quarter ended September 30, 2021 decreased to approximately $3,327,000 from approximately $5,823,000 a decrease of approximately $2,496,000 as compared to the same period in the prior year. The decrease in net sales contributed approximately $1,284,000 to the decrease in gross profit. The remaining decrease was primarily due to the decrease in gross profit margin of approximately 6.9 points on products sold. Gross profit margin for the three months ended September 30, 2021 was 19.2% compared to 26.1% for the three months ended September 30, 2020. The decrease in CPK product sales which yield substantially more gross profit margin than our traditional product accounted for approximately 4.0 margin points of the 6.9 gross profit margin point decrease with the remaining 2.9 point decrease primarily due to product cost increases in raw materials and a significant increase in freight costs . OPERATING EXPENSES For the quarter ended September 30, 2021, total operating expenses decreased to approximately $2,577,000 compared to approximately $3,384,000 from the same period in the prior year. This represents a decrease in total operating expenses of approximately $807,000 from the quarter ended September 30, 2020. The decrease in operating expenses is primarily due to a decrease in selling expenses of $742,000. There was a decrease in royalty expenses of approximately $321,000 associated with the decrease in CPK sales as explained in net sales. Freight expense decreased by approximately $286,000 due to the decrease in net sales and returns. There was a decrease in in commissions of approximately $83,000 commensurate with the decrease in net sales and discretionary marketing expenditures were down by approximately $52,000. The remaining decrease in operating expenses was due to variable general and administrative expenses. 23 INCOME FROM OPERATIONS There was income from operations of approximately $750,000 for the three months ended September 30, 2021 compared to income from operations of approximately $2,439,000 for the three months ended September 30, 2020. The decrease in income from operations of approximately $1,689,000 was primarily due to the decrease in gross profit offset by the reduction in operating expenses as explained above. OTHER INCOME (EXPENSES) Other income and (expenses) decreased by approximately $674,000 to approximately $116,000 in other income, net for the three months ended September 30, 2021 compared to approximately $790,000 in other income, net for the same period ended September 30, 2020. During the three months ended September 30, 2021 there was accounts payable forgiveness of approximately $236,000 from one vendor on goods that were damaged in the prior year compared to a recovery of approximately $937,000 in out-of-pocket expenses relating to a prior year damaged goods insurance claim during the three months ended September 30, 2020. The remaining variance in other income, net was primarily due to a decrease in interest expense and amortization of deferred financing costs associated with the financing terms of the Crestmark Facility and IHC Facility and decreased borrowings from the Crestmark Facility. INCOME TAXES For the three months ended September 30, 2021 and 2020 the Company recognized an income tax provision of approximately $174,000 and $821,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 20.1% and 25.2%, respectively. NET INCOME For the three months ended September 30, 2021 there was net income of approximately $692,000 compared to net income of approximately $2,408,000 for the same period a year ago. The decrease in net income was primarily due to the same reasons discussed in Income from Operations, Other Income (Expenses) and Income Taxes. SIX MONTHS ENDED SEPTEMBER 30, 2021 COMPARED TO THE SIX MONTHS ENDED SEPTEMBER 30, 2020 NET SALES Net sales for the six months ended September 30, 2021 decreased to approximately $23,435,000 from $25,337,000 a decrease of approximately $1,902,000 as compared to the same period ended September 30, 2020. Sales of our CPK product decreased by approximately $1,488,000 during the six months ended September 30, 2021 compared to the same period ended September 30, 2020 as the Company winds down it’s promotion of the original version of the product and recently launched a new version of the product with several enhanced features for sale during the upcoming holiday season. The remaining decrease in sales was primarily due to delays in receiving goods from the Port of Los Angeles due to the disruption in the global supply chain. GROSS PROFIT Gross profit for the six months ended September 30, 2021 decreased to approximately $4,905,000 from approximately $6,785,000 a decrease of approximately $1,880,000 as compared to the same period in the prior year. The decrease in net sales as indicated in Net Sales contributed approximately $509,000 to the decrease in gross profit margin. The remaining decrease was primarily due to the decrease in gross profit margin of approximately 5.9 points on products sold. Gross profit margin for the six months ended September 30, 2021 was 20.9% compared to 26.8% for the six months ended September 30, 2020. The decrease in CPK product sales which yield substantially more gross profit margin than our traditional product accounted for approximately 2.3 margin points of the 5.9 gross profit margin point decrease. There was a decrease of approximately 2.5 points of gross margin primarily due to product cost increases in raw materials, a significant increase in freight costs with the remaining variance due to the mix of products sold. 24 OPERATING EXPENSES For the six months ended September 30, 2021, total operating expenses decreased to approximately $4,645,000 compared to approximately $5,118,000 from the same period in the prior year. This represents a decrease in total operating expenses of approximately $473,000 from the six months ended September 30, 2020. The decrease in operating expenses is primarily due to a decrease in selling expenses of $463,000. There was a decrease in royalty expenses of approximately $210,000 associated with the decrease in CPK sales as explained in net sales. Freight expense decreased by approximately $251,000 due to the decrease in net sales and returns. There was a decrease in in commissions of approximately $46,000 commensurate with the decrease in net sales. These decreases in selling expenses were offset by an increase in discretionary marketing expenditures of approximately $45,000 with the remaining variance primarily due to variable general and administrative expenses. INCOME FROM OPERATIONS There was income from operations of approximately $261,000 for the six months ended September 30, 2021 compared to income from operations of approximately $1,668,000 for the six months ended September 30, 2020. The decrease in income from operations of approximately $1,407,000 was primarily due to the decrease in gross profit offset by a reduction in operating expenses as explained above. OTHER INCOME (EXPENSES) Other income and (expenses) decreased by approximately $817,000 to approximately $459,000 in other income, net for the six months ended September 30, 2021 compared to approximately $1,276,000 in other income, net for the same period ended September 30, 2020. During the six months ended September 30, 2021 there were one-time gains of approximately $684,000 primarily due to forgiveness of the loan under the Paycheck Protection Program of approximately $448,000 which included principal and interest and there was an accounts payable forgiveness of approximately $236,000 from one vendor on goods that were damaged in the prior year compared to a recovery of approximately $1,067,000 in out-of-pocket expenses relating to a prior year damaged goods insurance claim during the six months ended September 30, 2020 and accounts payable forgiveness of $390,000 from the vendor who caused the damaged goods problem. The remaining variance in other income, net was primarily due to an increase in interest expense and amortization of deferred financing costs associated with the financing terms of the Crestmark Facility and IHC Facility. INCOME TAXES For the six months ended September 30, 2021 and 2020 the Company recorded an income tax provision of approximately $146,000 and an income tax provision of approximately $742,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 20.1% and 25.2%, respectively. NET INCOME For the six months ended September 30, 2021 there was net income of approximately $574,000 compared to net income of approximately $2,201,000 for the same period a year ago. The decrease in net income was primarily due to the same reasons discussed in Income from Operations, Other Income (Expenses) and Income Taxes. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 2021, Singing Machine had cash on hand of approximately $3,338,000 as compared to cash on hand of approximately $1,071,000 on September 30, 2020. We had working capital of approximately $8,295,000 as of September 30, 2021. Net cash used in operating activities was approximately $576,000 for the six months ended September 30, 2021, as compared to approximately $674,000 used in operating activities for the same period a year ago. During the six months ended September 30, 2021 there was an increase in accounts receivable of approximately $9,410,000 due to a seasonal increase in sales and a seasonal increase in inventories of approximately $13,722,000 due to in-transit and receipt of inventory for peak season. These increases in net cashed used in operating activities were offset by an increase in in accounts payable of approximately $16,409,000 due to seasonal purchases of product for the peak season. There was a decrease in amounts due from Crestmark Bank of approximately $4,557,000 as cash collected in excess of amounts due on the revolving credit during the first quarter was used to pay for the seasonal increase in inventory. There was a seasonal increase in reserve for sales returns of approximately $904,000. Net cash used in operating activities was approximately $674,000 for the six months ended September 30, 2020. During the six months ended September 30, 2020 there was an increase in accounts receivable of approximately $16,576,000 due to a seasonal increase in sales and a seasonal increase in inventories of approximately $1,072,000 due to receipt of inventory for peak season, and a decrease in refunds due to customers of approximately $686,000 as most of the refunds due to the damaged goods incident from the prior year were refunded to the customer. These increases in cash used in operating activities were offset by an increase in accounts payable of approximately $9,498,000 due to seasonal purchases of product for the peak season and a decrease in insurance receivable of approximately $1,268,000 as we received proceeds for the one-time damaged goods incident that occurred in the prior fiscal year. There was a decrease in amounts due from banks of approximately $2,388,000 due to excess cash collected in excess of amounts due on the revolving credit facilities with PNC Bank and Crestmark Bank and a seasonal increase in reserve for sales returns of approximately $499,000. Net cash used in investing activities for the six months ended September 30, 2021 was approximately $78,000 as compared to approximately $85,000 used in investing activities for the same period ended a year ago and consisted primarily of purchases of molds and tooling for new products. 25 Net cash provided by financing activities for the six months ended September 30, 2021 was approximately $3,595,000 compared to cash provided by financing activities of approximately $1,485,000 for the same period ended of the prior year. We borrowed approximately $1,977,000 from our Crestmark Facility and IHC Facility for working capital. In August 2021, the Company received net proceeds of approximately $1,838,000 from the execution of private placement and stock redemption agreements as summarized in the next two paragraphs. These financing activities were offset by a payment of $150,000 on the subordinated related party debt, payment of deferred finance charges associated with the closing of the Crestmark and IHC Facilities of approximately $38,000 with the remaining difference used to pay scheduled installments on installment notes and finance leases. In August 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) 16,500,001 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 received by the Company. Approximately $7,200,000 of the funds received were used to execute the Redemption Agreement as explained in the next paragraph. The Company received 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, 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 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 paid approximately $7,200,000 to Koncepts and Treasure Green. The Redeemed Shares were retired and are available for reissuance in the future. Net cash provided by financing activities for the six months ended September 30, 2020 was approximately $1,485,000 compared to cash provided by financing activities of approximately $4,472,000 for the same period ended of the prior year. We borrowed approximately $1,156,000 from our Crestmark Facility and IHC Facility for working capital and received loan proceeds from Crestmark in the amount of approximately $444,000 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 6 – 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 $5,600,000 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 $5,900,000 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 and six months ended September 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 income. 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 the prior fiscal year. As of this filing we have 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 condensed consolidated statement of income. For the three and six months ended September 30, 2020 the gain from damaged goods insurance claim was approximately $937,000 and $1,068,000, respectively. We also secured vendor invoice credits of $390,000 from the factory that caused the damage which is reflected as gain from extinguishment of accounts payable in the condensed consolidated statement of income for the six months ended September 30, 2020. 26 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.