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 for our fiscal year ended March 31, 2023, 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. 23 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 62% and 81% of net sales in fiscal 2023 and 2022, respectively. Recent Developments 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 sold 1,067,000 shares of common stock through the ATM Offering at an average price of approximately $1.64 per share for gross proceeds of approximately $1,745,000. We received net cash proceeds of approximately $1,690,000 after payment of brokerage commissions and administrative fees to the agent. The ATM Offering closed May 12, 2023. Acquisition On June 13, 2022, Ault Alliance, Inc., Ault Lending, LLC (a 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, 52.8% of the issued and outstanding shares of common stock at the date of the filing of the Schedule 13D, par value $.01 per share (the “Common Stock”) of the Company, through open market purchases. As disclosed in the Schedule 13D, as amended, and subsequent Section 16 filings, the Reporting Persons may be deemed to beneficially own an aggregate of 1,808,000 shares of our common stock, or approximately 42.8% of our outstanding shares of common stock as of the date of this report. The reduction in beneficial ownership percentage was a result of us selling share of our common stock in our ATM Offering, and not from any sales of our common stock by Ault Lending. 24 Public Offering 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 pursuant to which the Company sold to the Underwriter 1,000,000 shares of its 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. Pursuant to the terms of the Underwriting Agreement, the Company agreed to issue 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. The Company estimated the fair value of these warrants to be approximately $244,000 using the Black-Scholes Model based on the following input assumptions: common stock price of $2.90, expected life of the warrants of 3 years; stock price volatility of 176%; dividend yield of 0%; and the risk-free interest rate of 2.63%. Appointment of New Directors Effective April 5, 2023, the size of our Board of Directors was increased to ten and Messrs. Milton C. Ault, III and Henry C. W. Nisser were appointed as directors. In addition, the Board appointed Mr. Ault to the position of Executive Chairman, an executive officer position of the Company. 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. 25 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, 2023 and 2022: June 30, 2023 June 30, 2022 Net Sales 100.0 % 100.0 % Cost of Goods Sold 67.7 % 72.8 % Gross Profit 32.3 % 27.2 % Operating Expenses Selling expenses 17.0 % 5.2 % General and administrative expenses 101.0 % 20.3 % Depreciation and amortization 7.0 % 0.5 % Total Operating Expenses 125.0 % 26.0 % (Loss) Income from Operations -92.7 % 1.2 % Other Expenses Interest expense -0.3 % -1.4 % Finance costs -0.8 % -0.1 % Total Other Expenses -1.1 % -1.5 % Loss Before Income Tax Benefit -93.8 % -0.3 % Income Tax Benefit 0.0 % 0.0 % Net Loss -93.8 % -0.3 % QUARTER ENDED JUNE 30, 2023 COMPARED TO THE QUARTER ENDED JUNE 30, 2022 NET SALES Net sales for the three months ended June 30, 2023 decreased to approximately $2,625,000 from approximately $11,692,000 representing a decrease of approximately $9,067,000 (77.5%) as compared to the three months ended June 30, 2022. The significant decrease in net sales was primarily due to two factors during the quarter ended June 30, 2022, 1) the impact of a large order for initial setup in a new department from our largest single customer, and 2) accelerated direct import sales by another of our largest customers. First, the initial product set in the quarter ended June 30, 2022 was placed by the Company’s largest single customer, which expanded its commercial relationship with SMC to include its consumer electronics department. This single order contributed approximately $3,140,000 to sales in the first three months ended June 30, 2022, which represented 27% of all sales during that period, and 35% of the difference in sales in the three months ended June 30, 2022 as compared to the same period in 2023. The second significant factor for the exceptionally high sales during the three months ended June 30, 2022 was due to one sizable direct import order. This direct import order accelerated revenue recognition to the date the customer took receipt of the product in China from our contract manufacturers, instead of opting to take receipt of the product at the date of shipment from our logistics facility in Ontario, California. This accelerated revenue recognition by over two months, shifting sales from the traditional second quarter period to the first quarter. The total amount of these two orders was approximately $3,530,000, representing 30.2% of sales for the quarter and 38.9% of the difference in sales when compared to the three months ended June 30, 2023. 26 Overall, we have seen customers shifting back to the traditional just-in-time buying pattern that was common for many years prior to the COVID global pandemic. Historically, the first quarter has represented a low point in our seasonal sales cycle. To further illustrate this point, first quarter sales since 2017 have averaged approximately $3,760,000, excluding the first quarter of 2022. Outside of the 2020-2022 supply distortions due to the pandemic, first quarter sales have not generally exceeded 10% of annual sales. In general, sales for the three months June 30, 2023 were in line or slightly below management’s expectations, with the majority of the difference due to several customers electing to make final orders slightly later in the calendar year than previously forecast. GROSS PROFIT Gross profit for the three months ended June 30, 2023 decreased to approximately $848,000 from approximately $3,181,000, representing a decrease of approximately $2,332,000 as compared to the three months ended June 30, 2022. The Company improved gross margins from 27.2% to 32.3%, which generated approximately $135,000 in higher gross income than if the prior periods margins had remained unchanged. The improvement in gross margins was in part due to the significant decrease in direct import sales as a component of sales during the three months ended June 30, 2023. Historically, direct import sales carry a 3-5% lower gross margin than sales fulfilled domestically by SMC. The second significant contributing factor for the improvement in margins was lower shipping and handling costs as the Company continues to see lower costs for product delivery after an extended period of higher shipping costs during the supply chain constraints resulting from the global pandemic in 2020 through early 2022. OPERATING EXPENSES During the three months ended June 30, 2023, total operating expenses increased to approximately $3,280,000 compared to approximately $3,034,000 during the three months ended June 30, 2022. This represents an increase in total operating expenses of approximately $246,000 (8.1%) from the three months ended June 30, 2022. The increase in operating expenses is primarily due to the impact of the Company’s decision to transition to an outsourced logistics model. First, there was approximately $60,000 in severance expenses for head count reduction. Second, there was approximately $118,000 in various costs incurred with the closure of the Ontario facility, the transportation of the inventory to the outsourced logistics provider, and the increase in depreciation of approximately $122,000. Beyond the closure of the Ontario facility, the Company also incurred higher accounting and legal expenses due to increased audit and legal services required to support certain aspects of being a company under common control. Lastly, the Company spent approximately $100,000 on consulting and legal services for marketing research. Virtually all other selling, general and administrative expenses were flat or decreased during the first three months of fiscal year 2024. INCOME FROM OPERATIONS There was a loss from operations of approximately $2,431,000 for the three months ended June 30, 2023 compared to income from operations of approximately $147,000 for the three months ended June 30, 2022. The decrease in income from operations of approximately $2,578,000 was primarily due to the decrease in gross profit generated by lower net sales as explained above. OTHER EXPENSES Other expenses were approximately $29,000 for the three months ended June 30, 2023, as compared to approximately $168,000 in other expenses for the three months ended June 30, 2022. All of the reduction in expenses were due to lower interest and financing costs. 27 INCOME TAXES For the three months ended June 30, 2023, the Company did not recognize any income tax benefit due to a net loss as management determined it is more likely than not that the Company will not recognize any deferred tax asset generated from the net loss. For the three months ended June 30, 2022, the Company recognized an income tax benefit of approximately $0 and $5,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 24.1%. NET LOSS For the three months ended June 30, 2023, we reported a net loss of approximately $2,460,000 compared to a net loss of approximately $16,000 for the three months ended June 30, 2022. The increase in the net loss was primarily due to the same reasons discussed in Net Sales and Operating Expenses. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2023, the Company had cash on hand of approximately $1,890,000 as compared to cash on hand of approximately $2,278,000 as of June 30, 2022. We had working capital of approximately $8,644,000 as of June 30, 2023. Net cash used in operating activities was approximately $2,548,000 for the three months ended June 30, 2023. During the three months ended June 30, 2023 there was a decrease in accounts receivable of approximately $1,382,000 due to a decrease in sales to one of our major customers as discussed in net sales above. This decrease in accounts receivable was offset by an increase in inventory of approximately $1,100,000 due to products arriving for the upcoming season. There was a decrease in accrued expenses of approximately $970,000 and reserves for sales returns of approximately $568,000 primarily related to the settlement of co-op incentives and credits for sales returns accrued at March 31, 2023 and the significant decrease in net sales requiring less accruals for co-op incentives and sales returns as of June 30, 2023. There was an increase in prepaid expenses of approximately $207,000 primarily due to a prepayment of a promotion and marketing campaign for our Carpool Karaoke product. 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 used in investing activities for the three months ended June 30, 2023 and 2022 was approximately $43,000 and $22,000, respectively. These investments consisted primarily of purchases of molds and tooling for new products. Net cash provided by financing activities for the three months ended June 30, 2023 and 2022 was approximately $1,586,000 and $4,159,000, respectively. In both instances, the primary source of cash from financings was the result of an equity capital markets transaction. In May 2023, we received net proceeds of approximately $1,604,000 through an ATM Offering as discussed below. All proceeds were used for working capital and general corporate purposes. 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 $1,800,000 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 $1,604,000 on sales of 1,052,770 shares of common stock at an average price of $1.64 per share. The ATM Offering closed May 12, 2023. 28 In May 2022, we received net proceeds of approximately $3,363,000 from a public offering we executed in conjunction with our up-listing to Nasdaq as discussed below. 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 and general corporate purposes. 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 of common stock, par value $0.01 per share 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 and general corporate purposes. Credit Facility - We currently have a three-year revolving Credit Facility with Fifth Third Bank for a $15.0 million facility (decreasing to $7.5 million in off-peak season) on eligible accounts receivable and inventory which terminates on October 14, 2025. As of the date of the filing of this Quarterly Report, there was approximately $1.5 million available to borrow on the revolving Credit Facility. 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 financial covenants. 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. As of the date of filing this Quarterly Report, we are in compliance with the amended covenants and there is no outstanding balance on the Credit Facility. 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. While the Company is optimistic that it will be successful in these efforts to achieve our plan, there can be no assurance that we will be successful in doing so. As such, the Company has a continued support letter from its largest stockholder, Ault Alliance, through August 31, 2024. 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 Annual Report for the fiscal year ended March 31, 2023. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not required for small reporting companies.