Algorhythm Holdings, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS The objective of this Management’s Discussion and Analysis of Financial Condition and Results of Operation is to allow investors to view the Company from management’s perspective, considering items that would have a material impact on future operations. 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. OVERVIEW The Singing Machine Company, Inc., a Delaware corporation (the “Company,” “SMC”, “The Singing Machine”), and wholly-owned subsidiaries SMC (Comercial Offshore De Macau) Limitada (“Macau Subsidiary”), SMC Logistics, Inc. (“SMCL”), SMC-Music, Inc. (“SMCM”) and SMC (HK) Limited (“SMH”), are primarily engaged in the development, marketing, and sale of consumer karaoke audio equipment, accessories and musical recordings. The products are sold directly to distributors and retail customers. 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 81% and 86% of net sales in fiscal 2022 and 2021, respectively. Recent Developments Controlled Company As of the date of this report, Digital Power Lending, LLC (“Digital Power Lending ”) beneficially owns and BitNile Holdings, Inc. (“BitNile Holdings”) and Milton C. Ault, III (“Ault,” and collectively with Digital Power Lending and BitNile Holdings, “BitNile”) may be deemed to beneficially own an aggregate of 1,683,000 shares of our common stock or approximately 54.4% of our outstanding shares. Digital Power Lending is a wholly owned subsidiary of BitNile Holdings. Mr. Ault is the Executive Chairman of BitNile Holdings. 20 As longs as BitNile continues to hold more than 50% of the voting power of our Company, we will be a “controlled company” as defined under Nasdaq Marketplace Rules. For so long as we are a controlled company under Nasdaq Marketplace Rules, we are permitted to elect to rely on certain exemptions from corporate governance rules, including: ● an exemption from the rule that a majority of our board of directors must be independent directors; ● an exemption from the rule that the compensation of our CEO must be determined or recommended solely by independent directors; and ● an exemption from the rule that our director nominees must be selected or recommended solely by independent directors. Appointment of New Directors Effective July 27, 2022, the Board of Directors (the “Board”) of the Company increased the number of directors to eight and appointed Messrs. Bernardo Melo, James Turner and Kenneth Cragun as directors. Messrs. Melo, Turner and Cragun will serve as members of the Board until the next annual meeting of the Company’s stockholders, and until their successors are elected and qualified or until their earlier death, resignation or removal. Messrs. Turner and Cragun were recommended for nomination by BitNile, the Company’s majority stockholder, and evaluated and nominated by the Company’s Nominating and Corporate Governance Committee. 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. We may also experience logistical issues with when we receive inventory and the timing of customer demand which could result in potential reductions in profit margins and/or the need for additional inventory reserves. 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 2022 Annual Report on Form 10-K. HIGH INFLATION AND UNFAVORABLE ECONOMIC CONDITIONS COULD NEGATIVELY AFFECT OUR OPERATIONS AND RESULTS. Unfavorable global or regional economic conditions may be triggered by numerous developments beyond our control, including inflation, geopolitical events, health crises such as the COVID-19 pandemic, and other events that trigger economic volatility on a global or regional basis. Those types of unfavorable economic conditions could adversely affect our business and financial results. In particular, a significant deterioration in economic conditions, including economic slowdowns or recessions, increased unemployment levels, inflationary pressures or disruptions to credit and capital markets, could lead to decreased consumer confidence and consumer spending more generally, thus reducing consumer demand for our products. For example, in 2021 and continuing into 2022, the United States has experienced a rapid increase in inflation levels of over 9%, which is now at a 40-year historic high. While we have experienced a significant decrease in container costs for inbound containers due to decreased demand in general, we are continuing to see increases in drayage costs due to cost of fuel increases as well as significant charges from the Port of Los Angeles such as “port congestion fees” and other surcharges due to inflation. The cost of labor, employee benefits, pallets and warehouse supplies and other logistics related costs continue to increase at record rates. Such heightened inflationary levels may negatively impact consumer disposable income and discretionary spending and, in turn, reduce consumer demand for our products and increase our costs. 21 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 months ended June 30, 2022 and 2021: CONDENDSED CONSOLIDATED STATEMENTS OF OPERATIONS For Three Months Ended June 30, 2022 June 30, 2021 Net Sales 100.0 % 100.0 % Cost of Goods Sold 72.8 % 74.0 % Gross Profit 27.2 % 26.0 % Operating Expenses Selling expenses 5.2 % 9.5 % General and administrative expenses 20.3 % 23.4 % Depreciation and amortization 0.5 % 1.1 % Total Operating Expenses 26.0 % 34.0 % Income (Loss) from Operations 1.2 % -8.0 % Other (Expenses) Income Gain from Paycheck Protection Plan loan forgiveness 0.0 % 7.4 % Gain - related party 0.0 % 0.2 % Interest expense -1.4 % -1.6 % Finance costs -0.1 % -0.3 % Total Other (Expenses) Income, net -1.5 % 5.7 % Loss Before Income Tax Benefit -0.3 % -2.3 % Income Tax Benefit 0.0 % 0.5 % Net Loss -0.3 % -1.8 % QUARTER ENDED JUNE 30, 2022 COMPARED TO THE QUARTER ENDED JUNE 30, 2021 NET SALES Net sales for the three months ended June 30, 2022 increased to approximately $11,692,000 from approximately $6,066,000 an increase of approximately $5,626,000 as compared to the three months ended June 30, 2021. The increase in net sales was primarily due to an initial spring product set in one major customer’s consumer electronics department which contributed approximately $3,140,000 of the increase with the remaining increase primarily due to another major customer that opted to receive product via direct import and accelerated their delivery schedule. GROSS PROFIT Gross profit for the three months ended June 30, 2022 increased to approximately $3,181,000 from approximately $1,578,000 an increase of approximately $1,603,000 as compared to the three months ended June 30, 2021. The increase in net sales contributed approximately $1,463,000 with the remaining increase due to improvement of gross profit margin of approximately $140,000. Gross profit margin for the three months ended June 30, 2022 was 27.2% compared to 26.0% for the three months ended June 30, 2021. The primary reason for the increase in gross profit margin was due to the favorable product mix for one major customer’s initial product set as indicated in net sales above which included several new products in their product assortment that yield higher margins. OPERATING EXPENSES During the three months ended June 30, 2022, total operating expenses increased to approximately $3,034,000 compared to approximately $2,068,000 during the three months ended June 30, 2021. This represents an increase in total operating expenses of approximately $966,000 from the three months ended June 30, 2021. The increase in operating expenses is primarily due to an increase in general and administrative expenses of approximately $949,000. There was an increase in pallet expenses, warehouse supplies and expense and temporary labor at our California facility of approximately $262,000 due to an increase in third party logistics business, a one-time project associated with the initial product set in a major customer’s consumer electronics department (see NET SALES), as well as price increases due to inflation and supply chain shortages. There was an increase in legal, professional, investor relations and stock exchange listing fees of approximately $222,000 primarily related to the public offering and Nasdaq up-listing in May 2022 (see NOTE 12 -PUBLIC OFFERING AND NASDAQ UPLISTING). There was an increase in compensation of approximately $172,000 primarily due to compensation for new members of the board of directors and officers’ incentive bonuses. There was an increase in bad debt reserve expense of approximately $151,000 related to required reserves commensurate with the increase in net sales and accounts receivable. The remaining increase was primarily due to one-time ERP system projects, increases in costs due to inflation and increases selling and administrative variable expenses commensurate with the increase in net sales. 22 INCOME FROM OPERATIONS There was income from operations of approximately $147,000 for the three months ended June 30, 2022 compared to a loss from operations of approximately $490,000 for the three months ended June 30, 2021. The increase in income from operations of approximately $637,000 was primarily due to the increase in gross profit offset by the increase in operating expenses as explained above. OTHER (EXPENSES) INCOME Other expenses increased by approximately $511,000 to approximately $168,000 in other expenses for the three months ended June 30, 2022 compared to approximately $343,000 in other income, net for the three months ended June 30, 2021. During the three months ended June 30, 2022, there was an increase in interest expense of approximately $60,000 as the Company had outstanding borrowings of $2,500,000 on the IHC inventory financing facility during the three months ended June 30, 2022 compared to borrowings of approximately $365,000 outstanding borrowings during the three months ended June 30, 2021. During the three months ended June 30, 2021 there was a one-time gain from the forgiveness of the Payroll Protection Plan loan of approximately $448,000. INCOME TAXES For the three months ended June 30, 2022 and 2021, the Company recognized an income tax benefit of approximately $5,000 and $28,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 24.1% and 19.1%, respectively. NET LOSS For the three months ended June 30, 2022 there was a net loss of approximately $16,000 compared to a net loss of approximately $119,000 for the three months ended June 30, 2021. The decrease in the net loss was primarily due to the same reasons discussed in Income from Operations, Other (Expenses) and Income Taxes. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2022, the Company had cash on hand of approximately $2,278,000 as compared to cash on hand of approximately $1,383,000 on June 30, 2021. We had working capital of approximately $12,006,000 as of June 30, 2022. Net cash used in operating activities was approximately $4,149,000 for the three months ended June 30, 2022. During the three months ended June 30, 2022 there was an increase in accounts receivable of approximately $7,002,000 due to an increase in sales to two major customers as explained in net sales above. This increase in net cash used in operating activities was offset by an increase in in accounts payable and accrued expenses of approximately $1,839,000 primarily due to payment of prior season’s inventory that arrived late due to global logistics issues. There was a decrease in inventory of approximately $1,205,000 primarily due to a decrease in-transit inventory from March 31, 2022 as new product for the initial spring product set at one major customer was shipped during the three months ended June 30, 2022. Net cash provided by operating activities was approximately $794,000 for the three months ended June 30, 2021. 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 $3,813,000 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 investing activities for the three months ended June 30, 2022 was approximately $22,000 as compared to approximately $56,000 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, 2022 was approximately $4,159,000 compared to cash provided by financing activities of approximately $248,000 for the same period ended of the prior year. In May 2022, we received net proceeds of approximately $3,363,000 from the public offering we executed in conjunction with our up-listing to Nasdaq as summarized in the next two paragraphs. In addition, during the three-months ended June 30, 2022, we received proceeds of approximately $816,000 from the exercise of pre-funded and common stock warrants. All proceeds were used for working capital. 23 On May 23, 2022, the “Company entered into an underwriting agreement (the “Underwriting Agreement”) with Aegis Capital Corp., who acted as the sole underwriter (the “Underwriter”), in a firm commitment underwritten public offering (the “Offering”) pursuant to which the Company sold to the Underwriter 1,000,000 shares (the “Shares”) of common stock, par value $0.01 per share (the “Common Stock”) for gross proceeds of $4,000,000 prior to deducting underwriting discounts and commissions and other estimated offering expenses of approximately $637,000. The price to the public in the Offering was $4.00 per Share, before underwriting discounts and commissions. The offering closed on May 26, 2022. The Company received net proceeds of approximately $3,363,000 which was used for working capital. On May 24, 2022, the Company’s Common Stock was approved to list on the Nasdaq Capital Market under the symbol “MICS” and began trading on the Nasdaq Capital Market on May 24, 2022. We currently have an Intercreditor Revolving Credit Facility with Crestmark Bank for a $10.0 million facility (decreasing to $5.0 million in off-peak season) on eligible accounts receivable under an evergreen arrangement that terminates upon written notice by the Company and is subject to a termination fee if terminated by the Company anytime other than the annual renewal date of June 11. We also have a $2.5 million facility on eligible inventory with Iron Horse Credit that was to expire on June 11, 2022. However, absent any termination notice given by the Company to IHC, the current financing arrangement automatically renewed for another twelve-month term and is subject to a termination fee if terminated by the Company prior to the twelve-month renewal date. As of this filing, we have borrowed approximately $2,500,000 on the IHC Facility, which is the maximum loan amount allowed on eligible inventory and no borrowings on our Crestmark Facility which will make available up to $10.0 million of eligible accounts receivable as the next twelve months progress as long as the loan is in place. As of this filing the Company has approximately $3,000,000 currently available from these two credit facilities based on eligible inventory with IHC and eligible accounts receivable with Crestmark. We believe that our cash on hand, working capital (net of cash), cash expected to be generated from our operating forecast, along with the availability of cash from our credit facilities (See Note 7 –FINANCING) will be adequate to meet the Company’s liquidity requirements for at least twelve months from the filing of this report. 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 2022 Annual Report. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not required for small reporting companies.