Algorhythm Holdings, Inc. 10-K

ITEM 1. BUSINESS Overview We are primarily engaged in the development, marketing, and sale of consumer karaoke audio equipment, accessories and musical recordings. We believe we are a leading global karaoke and music entertainment company that specializes in the design and production of quality karaoke and music enabled consumer products for adults and children. Our products are among the most widely available karaoke products in the world. Our mission is to “create joy through music.” In order to deliver on this mission, we are focused on the following multi-prong approach: ● In the short-term, improve profitability by optimizing operations and continue to expand gross margins; and ● In the mid-to-long-term, continue to grow our global distribution and expand into new product categories that take advantage of our vast distribution relationships and sourcing abilities. Recent Events and Developments Stock Redemption Agreement Prior to August 10, 2021, we were partially held by koncepts International Limited (“koncepts”) which was a major stockholder of our company, that beneficially owned approximately 49% of our shares of common stock outstanding as of March 31, 2021. We were also partly held by Treasure Green Holdings Ltd. (“Treasure Green”), which owned approximately 2% of our common stock. In total, approximately 51% of our shares of common stock on a fully diluted basis as of March 31, 2021 were previously owned by koncepts and Treasure Green. koncepts and Treasure Green are owned by Fairy King Prawn Holdings Limited (“Fairy King”), an investment holding company incorporated in the British Virgin Islands, principally owned by our then Chairman, Philip Lau. On August 5, 2021, we entered into a stock redemption agreement (the “Redemption Agreement”) with koncepts and Treasure Green, pursuant to which we redeemed 654,105 shares of our common stock (the “Redeemed Shares”). The closing of the transaction set forth in the Redemption Agreement took place on August 10, 2021, at which time the Redeemed Shares were assigned and transferred back to us in consideration of a payment by us of approximately $7.2 million to koncepts and Treasure Green. The Redeemed Shares were retired and returned as unissued authorized capital. Prior to August 10, 2021, we did business with a number of entities that are principally owned by our former Chairman, Philip Lau, including Starlight R&D Ltd (“SLRD”), Starlight Consumer Electronics USA, Inc., (“SCE”), Cosmo Communications Corporation of Canada, Inc. (“Cosmo”), Winglight Pacific, Ltd (“Winglight”) and Starlight Electronics Company Ltd (“SLE”), among others. Pursuant to the Redemption Agreement, neither koncepts nor Treasure Green remained stockholders of our company and SLRD, SCE, Cosmo, Winglight and SLE are no longer related parties. Reverse Stock Split and Nasdaq Listing On May 23, 2022, we effected a reverse stock split of our shares of common stock in a ratio of 1:30. The reverse stock split was affected to meet The Nasdaq Capital Market’s minimum bid price requirement. All information in this Annual Report on Form 10-K has been retroactively adjusted to give effect to this 1-for-30 reverse stock split. Our common stock was approved for listing on the Nasdaq Capital Market under the symbol “MICS” and began trading on the Nasdaq Capital Market on May 24, 2022. Underwritten Public Offering On May 23, 2022, we 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 pursuant to which we sold to the Underwriter 1,000,000 shares of our common stock for gross proceeds of $4.0 million, prior to deducting underwriting discounts and commissions and other estimated offering expenses of approximately $0.6 million. 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. We received net proceeds of approximately $3.4 million. Pursuant to the terms of the Underwriting Agreement, we issued to the Underwriter warrants to purchase up to 100,000 shares of common stock, representing 10% of the shares sold in the offering, excluding any shares sold through the over-allotment option. The warrants are exercisable six months from the commencement of sales under the offering, have an exercise price of $5.00 per share and expire five years from the date of issuance. 4 Acquisition of Control On June 13, 2022, Ault Alliance, Inc. (“Ault Alliance”), formerly BitNile Holdings, Inc., a Delaware corporation, Ault Lending, LLC (“Ault Lending”), a California limited liability company and subsidiary of Ault Alliance, and Milton C. Ault, III (“Ault”), Founder and Executive Chairman of Ault Alliance (collectively the “Reporting Persons”) filed a joint Schedule 13D filing (the “Schedule 13D”) reporting that the Reporting Persons acquired, in the aggregate, 1,405,000 shares, or 52.8% of the issued and outstanding shares of our common stock, through open market purchases. As disclosed in the Schedule 13D, as amended and subsequent Section 16 filings, Ault Lending currently owns, and Ault Alliance and Ault may be deemed to beneficially own, an aggregate of 1,808,000 shares of common stock, or approximately 42.8% of the outstanding shares of common stock as of the date of this Annual Report. The reduction in beneficial ownership percentage was a result of us selling stock in our ATM Offering (as defined and discussed below), and not from any sales of our common stock by Ault Lending. Credit Facility On October 14, 2022, we and our wholly-owned subsidiary, SMC Logistics, Inc. (“SMC”), entered into a Credit and Security Agreement (the “Credit Agreement”) with Fifth Third Bank, National Association, as Lender (“Fifth Third”). The Credit Agreement provides for a three-year secured revolving credit facility in an aggregate principal amount of up to $15,000,000 decreased to $7,500,000 during the period of January 1 through July 31 of each year (the “Credit Facility”). The Credit Agreement matures on October 14, 2025. The revolving Credit Facility bears interest of (a) the Prime Rate plus 0.50% or (b) the 30 day Term SOFR rate plus 3.00% (subject in each case to a floor of 0.50%), depending on the type of loan we request. “Term SOFR” means the forward-looking SOFR rate administered by CME Group, Inc. (or other administrator selected by Fifth Third) and published on the applicable Bloomberg LP screen page (or such other commercially available source providing such quotations as may be selected by Fifth Third), fixed by the administrator thereof two business days prior to the commencement of the applicable interest period (provided, however, that if Term SOFR is not published for such business day, then Term SOFR shall be determined by reference to the immediately preceding business day on which such rate is published), rounded upwards, if necessary, to the next 1/8th of 1% and adjusted for reserves if Fifth Third is required to maintain reserves with respect to the relevant loans. We are required to pay an unused line fee of 0.35% per annum equal to the difference between (i) the maximum revolving loan limit then in effect and (ii) the average daily balance of the revolving loans for each month, which fee shall be fully earned by Fifth Third and payable monthly in arrears on the first business day of each month. Said fee shall be calculated on the basis of a 360 day year. The Credit Agreement provides for an early termination fee of 2% if we prepay or terminate Fifth Third’s commitment to make loans under the Credit Agreement two or more years prior to the maturity or 0.5% if such prepayment occurs less than two year prior to the maturity or during any renewal period. The obligations under the Credit Agreement are secured by all of our assets and the assets of SMC, presently owned or later acquired, and all cash and non-cash proceeds thereof (including, without limitation, insurance proceeds). As of March 31, 2023, we were in default under the Credit Agreement due to non-compliance with the fixed charge coverage ratio covenant of 1:05 : 1.0. On May 19, 2023, we executed a Waiver and First Amendment agreement which provides for a waiver of previous defaults and new covenants that are required. We must comply monthly with minimum liquidity (defined as excess loan availability plus cash on hand) of $2.5 million between February and July and $4.0 million between September and June. We must also maintain pre-defined minimum operating cash flows between February and August 2023, until we achieve a fixed charge ratio of 1.15 : 1.0 beginning in September 2023 and throughout the remaining term of the Credit Agreement. ATM Offering On February 15, 2023, we entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Aegis Capital Corp, as sales agent (the “Agent”), pursuant to which we could offer and sell, from time to time, through the Agent (the “ATM Offering”), up to approximately $1.8 million in shares of its common stock. Shares offered and sold in the ATM Offering were issued pursuant to the registration statement on Form S-3 (File No. 333-269183) filed with the Securities and Exchange Commission (the “SEC”) on January 11, 2023 and declared effective by the SEC on January 20, 2023, and the prospectus supplement relating to the ATM Offering filed with the SEC on February 15, 2023. During the fiscal year ended March 31, 2023, we received total net proceeds from the ATM Offering of approximately $36,000 on sales of 14,230 shares of common stock at an average price of $2.56 per share. Through May 12, 2023, we received total net proceeds from the ATM Offering of approximately $1.7 million on sales of 1,052,770 shares of common stock at an average price of $1.64 per share. The Sales Agreement has been terminated. Our Product Portfolio Our products are sold directly to distributors and retail customers. Our portfolio of owned and licensed brands and products are organized into the following categories: 5 Karaoke — including our flagship brand Singing Machine, our karaoke line is driven by quality products at affordable price points that we believe deliver great value to our customers. All of our karaoke products are Bluetooth® enabled to allow access to digital music content via our mobile apps available on iOS and Android platforms. We believe our core karaoke line offers best-in-class advanced features, including but not limited to, enabling customers to output video to a TV screen, correcting singer’s pitch in real-time with our proprietary PitchLab™ technology, streaming karaoke content directly to the machine via WiFi, casting karaoke songs from a mobile device to our karaoke machines through our SingCast™ casting technology, singing duets, and displaying scrolling lyrics in-time with the song. Our products are sold directly to consumers via our retail channels, ecommerce, our own website, and distributors worldwide. This product category accounted for approximately 73% of our net sales in our fiscal year ended March 31, 2023. Licensed Products — including brands such as Carpool Karaoke. In 2019, we entered into a 3-year license agreement with CBS ® for its Carpool Karaoke brand, made popular by James Corden on The Late Show with James Corden. We launched an innovative Carpool Karaoke Microphone that works specifically in the car. This license agreement with CBS expired on September 30, 2022. On February 28, 2023, we renewed this license agreement for an additional three years. On March 16, 2023, we entered into a three-year license agreement with Sesame Street Workshop for its Sesame Street brand for karaoke and singalong toy products, effective January 1, 2023. Through this license agreement, we will be able to develop and offer for sale all the iconic and beloved Sesame Street characters like Elmo, Big Bird, Cookie Monster, Abby Cadabby, and many more. This product category accounted for less than 1% of our net sales in our fiscal year ended March 31, 2023. Microphones and Accessories — we currently offer a line of traditional microphone accessories that are compatible with our karaoke machines. These microphones feature an assortment of colors, come wired or wireless, and may include new features like party lighting and voice changing effects. We are also seeing growth in portable Bluetooth microphones which are marketed under our Party Machine brand. This product category accounted for approximately 20% of our net sales in our fiscal year ended March 31, 2023. Singing Machine Kids Youth Electronics — including the brand Singing Machine Kids. Our kids’ line of products offers fun music entertainment features designed specifically for children. Our kids’ products provide a high-quality introduction to singing and music entertainment for young singers and offer advanced features, such as voice changing effects, recording, Bluetooth compatibility, and portability. This product category accounted for approximately 5% of our net sales in our fiscal year ended March 31, 2023. Automotive — In January 2023, we announced at the Consumer Electronics Show that we will be entering the connected vehicle karaoke device market in partnership with Stingray Group, Inc. (“Stingray”). We have developed microphone hardware utilizing our PitchLab™ technology to offer integrated wireless microphones for connection with major automotive brand’s vehicles. We are currently in discussion with many automotive brands to offer our products. This product category is new and did not contribute to net sales in our fiscal year ended March 31, 2023. Music Subscriptions — in conjunction with our premium partner, Stingray, we offer karaoke music subscription services for the iOS and Android platforms as well as a web-based download store and integrated streaming services for our hardware. We currently offer almost 20,000 licensed karaoke songs in the catalog. This product category accounted for approximately 2% of our net sales in our fiscal year ended March 31, 2023. Product Development and Design Product development is a key element of our strategic growth plan. We strive to deliver many new, exciting consumer products to market every single year to retain our presence as the market-leader in consumer karaoke products. Strategic product development is done in-house from our corporate headquarters in Fort Lauderdale, FL where we identify new potential categories, features, and price points. Products are created in conjunction with contract product designers and inventors in collaboration with our contract manufacturers in China to deliver products that represent tremendous value to our customers. In addition to new products, we always look for ways to improve existing products to hit more affordable price points or improve features based upon market feedback. Business Segments We operate in one principal industry segment across geographically diverse marketplaces, selling our products globally to large, national retailers as well as independent retailers, on our retailer’s websites, and our own direct to consumer website. In North America, our customers include Amazon, Costco, Sam’s Club, Target and Wal-Mart. Our largest international territories are the U.K. and Australia, where we sell through international distributors. We also sell to select international retail customers in geographic locations where we do not have a direct sales presence. Suppliers and Manufacturing We source our products from a variety of contract manufacturers in southern China. We are not dependent on any one supplier as we use many manufacturers (currently five) to make our products. We maintain a Hong Kong office that provides us with factory management, sourcing, quality control, engineering, and product development. We buy finished goods from our suppliers and generally do not source raw materials for manufacturing, however in limited circumstances where we develop proprietary hardware and software, we will secure the proprietary circuits and provide them to our contract manufacturers for assembly into the final product. While we are not responsible for sourcing raw materials, we rely on our contract manufacturers’ ability to secure injected plastic, wood cabinets, integrated circuits, display panels, speaker drivers, and other components that are necessary for assembly into our final products. Our goods are produced by our contract manufacturers and are either shipped via ocean vessels to our distribution center in Ontario, California or we utilize a direct import program where our retail customers coordinate to pick up the goods FOB China. The direct import program allows our customers to take advantage of better ocean container rates through bigger volume and allows us to bypass our California warehouse. We maintain a third-party logistics warehouse in Canada where we sell directly to retail customers and independent channels in Canada. Historically, most of our customers pick up goods from our warehouse (freight collect). On August 31, 2023, the lease at our Ontario, California warehouse facility will terminate. We do not intend to renew the lease agreement and have signed a service agreement with a third-party logistics company to provide domestic and Canadian warehousing services, effective September 1, 2023. 6 Sales and Marketing Our products are marketed and sold through our direct sales team, working in conjunction with independent sales representatives that provide sales and customer support for our retail customers in North America. Sales are recognized upon transfer of title to our customers and are made utilizing standard credit terms of approximately 60-90 days. Our sales terms indicate that we only accept returns for defective merchandise, however we have accepted overstock returns from our retail partners in the past. Please see risk factor titled “ We are subject to the risk that some of our large customers may return karaoke products that they have purchased from us and if this happens, it would reduce our revenues and profitability” under “Risk Factors”. We seek to expand our direct-to-consumer sales, which we believe will increase overall gross margins and also increase brand awareness. Marketing, promotion and consumer engagement are key elements in the youth electronics, toy, and music categories. Historically, a significant percentage of our promotional spending has been structured as co-op promotion incentives with our large retail partners. We continue to focus our marketing efforts on growing brand awareness among our target consumer demographic, optimizing marketing investments, and executing an integrated marketing strategy. We believe an important component of our future growth is based on speaking to the right customer, with the right content, in the right channel, at the right time. We have implemented online marketing, social media, and digital analytics tools, which allow us to better measure the performance of our marketing activities, learn from our consumers, and receive valuable insights into industry and competitor activities. Customer service is a critical component of our marketing strategy. We maintain a U.S.-based internal customer service department within our corporate headquarters that responds to customer inquiries, investigates and resolves issues, and is available to assist customers and consumers during business hours. Competition The youth electronics, toy, and music industries have many participants, none of which have a dominant market share, though certain companies may have disproportionate strength in specific product categories. We compete with a number of different companies in a variety of categories, although there is no single company that competes with us across all of our product categories. Our largest direct competitors are Singsation ® , Singtrix ® , eKids ® , Bonaok, Karaoke USA ™ , and Ion ® Audio. The primary methods of competition in the industry consist of brand positioning, product innovation, quality, price, and timely distribution. Our competitive strengths include our ability to develop innovative new products and features, speed to market, our relationships with major retailers, and the quality and pricing of our products. Intellectual Property We rely on a combination of word and design mark trademarks and trade secrets to protect our intellectual property. In certain circumstances, we will partner with third parties to develop proprietary products, and, where appropriate, we have license agreements related to the use of third-party innovation in our products. The duration of our trademark registrations varies from country to country. However, trademarks are generally valid and may be renewed indefinitely as long as they are in use and/or their registrations are properly maintained. Customers Sales to our top five customers together comprised approximately 89% and 90% of our net sales for fiscal years ended March 31, 2023 and 2022, respectively. In our fiscal year ended March 31, 2023, revenues from two of these customers represented greater than 10% of net sales, at 48% and 21% of total net sales. In our fiscal year ended March 31, 2022, revenues from three of these customers represented greater than 10% of net sales, at 37%, 18%, and 17% of total net sales. We have no long-term contracts with these customers, and as a result, our success depends heavily on our customers’ willingness to purchase and provide floor or shelf space for our products. Seasonality We do experience heightened seasonal demand for our products in our second and third quarters of our fiscal year. In our fiscal years ended March 31, 2023 and 2022, approximately 62% and 81%, respectively, of our net sales shipped in our second and third quarters. However, we continually look for products and new categories to reduce our exposure to seasonality variances. Regulatory Matters Each of our products is designed to comply with all applicable mandatory and voluntary safety standards. In the United States, these safety standards are promulgated by federal, state and independent agencies such as the US Consumer Product Safety Commission, ASTM International, the Federal Communications Commission, and various states Attorney Generals and state regulatory agencies. All of our products are independently tested by third party laboratories accepted by the Consumer Product Safety Commission to verify compliance to applicable safety standards. A similar approach is used to design and test products sold internationally. 7 Insurance We carry product liability insurance that provides us with $10,000,000 coverage with a minimal deductible. We consult with our insurers to ascertain appropriate liability coverage for our product mix. We believe our current coverage is adequate for our existing business and will continue to evaluate our coverage in the future in line with our expanding sales and product breadth. Human Capital Resources We are committed to attracting and retaining the brightest and best talent, so investing in human capital is critical to our success. The employee traits we value include industriousness, intellectual curiosity, growth mindset and deeply caring about the quality of work. The human capital measures and objectives that we focus on in managing our business include employee safety, talent acquisition and retention, employee engagement, development and training, diversity and inclusion, and compensation and pay equity. Employee Profile As of March 31, 2023, we had 37 employees, with 18 located at our corporate office, 12 at our logistics center in Ontario, California and 7 in our office in Hong Kong. Of our employees, 1 was engaged in engineering and product development, 7 in sales and marketing, 20 in customer support or general operations and 9 in general administration and finance. All of these employees are employed on a full-time basis. As of March 31, 2023, approximately 51.4% of our current workforce is female, 48.6% male, and our average tenure is 5.48 years. None of our employees is represented by a collective bargaining unit or is a party to a collective bargaining agreement. We believe that our relationship with our employees is good. Talent A core tenet of our talent system is to both develop talent from within and supplement with external hires. This approach has yielded loyalty and commitment in our employee base which in turn grows our business, our products, and our customers, while adding new employees and external ideas supports a continuous improvement mindset and our goals of a diverse and inclusive workforce. We believe that our average tenure of 5.48 years as of the end of the fiscal year 2023 reflects the engagement of our employees in this core talent system tenet. We believes that we materially comply with all applicable state, local and international laws governing nondiscrimination in employment in every location in which we operate. All applicants and employees are treated with the same high level of respect regardless of their gender, ethnicity, religion, national origin, age, marital status, political affiliation, sexual orientation, gender identity, disability or protected veteran status. Employee Engagement and Development Our employee engagement efforts include our frequent and transparent “all-hands” meetings and executive communications, through which we aim to keep our employees well-informed and to increase transparency. We believe in continual improvement and use employee feedback to drive and improve processes that support our customers and ensure a deep understanding of our employees’ needs. We plan to conduct annual confidential employee surveys as we believe that ongoing performance feedback encourages greater engagement in our business and improves individual performance. Our employees will participate in a 360-degree evaluation process to identify critical capabilities for development and establish new stretch goals. Pay Equity Our employee compensation strategy supports three primary objectives: attract and retain the best team members; reflect and reinforce our most important values; and align team member interests with stockholder interests in building enduring value. We believe people should be paid for what they do and how they do it, regardless of their gender, race or other personal characteristics. To deliver on that commitment, we benchmark and set pay ranges based on market data and consider factors such as an employee’s role and experience, the location of their job, and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, to ensure our pay is fair and equitable. Total Rewards As part of our compensation philosophy, we believe that we must offer and maintain market competitive total rewards programs for our employees in order to attract and retain superior talent. In addition to healthy base wages, additional programs include annual bonus opportunities, 12 paid company holidays a year, healthcare and insurance benefits, including 100% paid health benefits for the employee, generous paid time off and family leave, family care resources and flexible work hours to work-from-home. We also have a company matched 401(k) plan, where we make a matching contribution of 100% of salary deferral contributions up to 3% of pay, plus 50% of salary deferral contributions from 3% to 5% of pay. To support the advancement of our employees, we offer training and development programs encouraging advancement from within. 8 Health and Safety The success of our business is fundamentally connected to the well-being of our people. Accordingly, we are committed to the health, safety and wellness of our employees. We provide our employees and their families with access to a variety of flexible and convenient health and welfare programs, including benefits that support their physical and mental health by providing tools and resources to help them improve or maintain their health status; and that offer choice where possible so they can customize their benefits to meet their needs and the needs of their families. In response to the COVID-19 pandemic, we implemented significant operating environment changes that we determined were in the best interest of our employees, as well as the communities in which we operate, and which comply with government regulations. This includes having a significant portion of our employees work from home, while implementing additional safety measures for employees continuing critical on-site work. Available Information We are a Delaware corporation that was formed in 1994. Our common stock is traded on the NASDAQ Capital Market under the symbol “MICS”. Our principal executive offices are located at 6301 NW 5 th Way, Suite 2900, Fort Lauderdale, FL, and our telephone number is (954) 596-1000. We maintain our corporate website at www.singingmachine.com . Our website also includes corporate governance information, including our Code of Ethics and our Board committee charters. The information contained on our website does not constitute a part of this Annual Report.