Algorhythm Holdings, Inc.: Form 10-Q for the period ended Jun 30, 2024

This Quarterly Report on Form 10-Q contains forward-looking statements that involve a number of risks and uncertainties. Words such as “anticipates,” “expects,” “intends,” “goals,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” “will,” “would,” “should,” “could,” and variations of such words and similar expressions are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, uncertain events or assumptions, and other characterizations of future events or circumstances are forward-looking statements. Such statements are based on management’s expectations as of the date of this filing and involve many risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include those described throughout this report and our Transition Report on Form 10-KT for the nine months period ended December 31, 2023, particularly the “Risk Factors” sections of such reports. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Readers are urged to carefully review and consider the various disclosures made in this Form 10-Q and in other documents we file from time to time with the Securities and Exchange Commission (the “SEC”) that disclose risks and uncertainties that may affect our business. The forward-looking statements in this Form 10-Q are made as of the date of this filing, and we do not undertake, and expressly disclaim any duty to update such statements, whether as a result of new information, new developments or otherwise, except to the extent that disclosure may be required by law.

You should read the following management’s discussion and analysis of financial condition and results of operations in conjunction with our unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our audited financial statements and related notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Transition Report on Form 10-KT, filed with the SEC on April 15, 2024.

In this Quarterly Report, unless the context requires otherwise, references to the “Company,” “Singing Machine,” “we,” “our company” and “us” refer to The Singing Machine Company, Inc., a Delaware corporation, as well as our wholly owned subsidiaries; “SMCL” refers to SMC Logistics, Inc., a California corporation, “SMCM” refers to SMC-Music, Inc., a Florida corporation, “SMH” refers to SMC (HK) Limited, a Hong Kong company, and “MICS NY” refers to MICS Nomad, LLC, a Delaware limited liability company.

The objective of this Management’s Discussion and Analysis of Financial Condition and Results of Operation is to allow investors to view our company from management’s perspective, considering items that would have a material impact on future operations.

Overview

The Singing Machine Company, Inc., a Delaware corporation (the “Company” or “The Singing Machine”) is a consumer electronics manufacturer of retail karaoke products. Based in Fort Lauderdale, Florida, and founded over forty years ago, the Company is primarily engaged in the development, marketing, and sale of a wide assortment of at-home and in-car consumer karaoke audio equipment, accessories, musical recordings and products. The Company’s portfolio is marketed under both proprietary brands and licenses including Carpool Karaoke and Sesame Street. The Company’s products are sold in locations worldwide, primarily through 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.

The Singing Machine’s operations include its wholly owned subsidiaries, SMC Logistics, Inc., a California corporation (“SMCL”),SMC-Music, Inc., a Florida corporation (“SMCM”), SMC (HK) Limited, a Hong Kong company (“SMH”), MICS Hospitality Holdings, Inc., a Delaware corporation (“MICS Hospitality”), MICS Hospitality Management, LLC, a Delaware limited liability company (“MICS Hospitality Management”) and MICS Nomad, LLC, a Delaware limited liability company (“MICS NY”).

Recent Developments

Change in Fiscal Year

During 2023, our Board of Directors approved a change in our fiscal year end from March 31 to December 31. Our results of operations, cash flows, and all transactions impacting shareholders’ equity presented in this Quarterly Report on Form 10-Q as of June 30, 2024 are for the three and six month periods ended June 30, 2024 and 2023.

ATM Offering June 2024

On June 26, 2024, the Company entered into an At-The-Market Issuance Sales Agreement (the “Sales Agreement”) with Ascendiant Capital markets, LLC, as sales agent (the “Agent”), pursuant to which the Company could offer and sell, from time to time, through the Agent (the “ATM Offering”), up to approximately $1,100,000 in shares of the Company’s common stock. On July 8, 2024, the Company entered into the First Amendment to the Sales Agreement (the “Amendment”) to increase the number of shares to be sold in the ATM Offering to $2,020,000. On August 9, 2024, the Company entered into the Second Amendment to the Sales Agreement (the “Amendment”) to increase the number of shares to be sold in the ATM Offering to $3,100,000. For the three and six months ended June 30, 2024, the Company had not yet sold any shares of its common stock from this ATM Offering. Pursuant to the agreement, the Agent is to be paid $30,000 in fees to cover legal and administrative expenses and will receive an amount equal to 3% of the gross proceeds from each sale of the Company’s share of common stock.

Subsequent to June 30, 2024 and through August 16, 2024(the last trading day prior to filing), the Company sold 1,657,172 shares of common stock under the ATM offering, and received net proceeds from the ATM of approximately $1,676,000 after payment of brokerage commissions and administrative fees to the agent of approximately $51,000.

Asset Purchase

On June 11, 2024, the Company and its wholly owned subsidiary SemiCab Holdings, LLC, a Nevada limited liability company (“SemiCab LLC” and collectively with the Company, the “Buyer”), SemiCab, Inc., a Delaware corporation (“SemiCab” or the “Seller”), Ajesh Kapoor and Vivek Sehgal entered into an asset purchase agreement (the “Asset Purchase Agreement”) pursuant to which the Seller agreed to sell and assign to the Company, and the Company agreed to purchase and assume from the Seller, substantially all the assets, and certain specified liabilities relating to the business of the Seller. Subject to certain exceptions set forth in the Asset Purchase Agreement, the parties agreed that the Buyer will not assume the liabilities of the Seller. SemiCab is an artificial intelligence, cloud-based collaborative transportation platform built to achieve the scalability required to predict and optimize semi-tractor trailer load efficiency.

On July 3, 2024, the parties closed on the asset purchase whereby the Company issued to the Seller (i) 641,806 shares of the Company’s common stock (ii) a twenty percent (20%) membership interest in SemiCab LLC.

Pursuant to the asset acquisition agreement, the Company and Seller entered into an option agreement (the “Option Agreement”), granting the Buyer the right to acquire all of the issued and outstanding capital securities of SMCB Solutions Private Limited, a wholly owned subsidiary of the Seller, in consideration for 320,903 shares of common stock of the Company. The Option Agreement has not been exercised through the date of this filing.

Private Placement

On November 20, 2023, the Company entered into an agreement to sell $2,000,000 in common stock through a private placement of common stock (the “Private Placement”). The Private Placement was completed with two Affiliates, (Stingray Group, Inc. and Jay Foreman), both of which were existing shareholders with Board representation. The Private Placement was completed at $0.91 per share of common stock, with a total of approximately 2,198,000 shares issued. Net proceeds from the transaction were approximately $1,900,000, net of transaction fees of approximately $100,000. During the six-month period after the closing date, the purchasers may make a written request for registration under the Securities Act of all or any portion of the shares purchased. During the six months ended June 30, 2024, Jay Foreman has made a written request to register his 1,099,000 shares.

Hospitality Lease

On August 23, 2023, MICS NY entered into an Agreement of Lease (the “Lease Agreement”) with OAC 111 Flatiron, LLC and OAC Adelphi, LLC (the “Landlord”), pursuant to which MICS NY agreed to lease approximately 10,000 square feet of ground floor retail space and a portion of the basement underneath the ground floor retail space in the property located at 111 West 24th Street, New York, New York (the “Premises”).

The term of the Lease Agreement is for fifteen (15) years, or on such an earlier date upon which the term shall expire, be canceled or terminated pursuant to any of the conditions or covenants of the Lease Agreement. Pursuant to the Lease Agreement, MICS NY is obligated to pay an initial base rent in the amount of $30,000 beginning August 1, 2024, with scheduled increases over the term, as set forth in the Lease Agreement.

During the three months ended June 30, 2024, the Company abandoned its plans to continue use of the leased space due to failure to receive a liquor license. Consequently, the Company exercised its early termination provision of the Lease Agreement which was not accepted by the Landlord. While attempting to settle, the Company failed to make the first recurring cash lease payment due on July 31, 2024, and as a result defaulted on the lease. Due to the abandonment of the lease, all assets related to the lease were impaired. Assets including security deposits, rent deposits and right of use assets of approximately $3,878,000 have been written off during the three months ended June 30, 2024 and are included as a component of operating expenses in the accompanying condensed consolidated statements of operations.

On July 26, 2024, OAC 111 Flatiron, LLC and OAC Adelphi, LLC, filed a civil action in the Supreme Court of the State of New York against MICS NY and the Company (“the Defendants”) for alleged breach of lease, seeking monetary damages including unpaid rent, future unpaid rent, and other expenses related to the lease. The complaint alleges the Defendants breached the lease in various material respects.

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 as follows:

Three Months Ended June 30, 2024 Compared to the Three Months Ended June 30, 2023

Net Sales

Net sales for the three months ended June 30, 2024, decreased to approximately $2,440,000 from approximately $2,625,000 representing a decrease of approximately $185,000 (7.0 %) as compared to the three months ended June 30, 2023. The decrease was primarily due to lower overall sell-through results during the past holiday season, mostly with our largest customer, Walmart, which in turn diminished inventory restocking requirements during the first six months of the calendar year which is historically off-peak shipping season.

Gross Profit

Gross profit for the three months ended June 30, 2024 decreased to approximately $324,000 from approximately $529,000 representing a decrease of approximately $205,000 (38.8%) as compared to the three months ended June 30, 2023. Gross margins for the three months ended June 30, 2024 were 13.3% as compared to 20.2% for the three months ended June 30, 2023. Approximately $260,000 of the decrease in gross profit was primarily due to increased sales in excess inventory which yielded significantly lower margin than current models sold and was offset by a decrease in expenses of approximately $57,000 associated with the miscellaneous logistics costs related to the timing of receipt of new goods.

Operating Expenses

During the three months ended June 30, 2024, total operating expenses increased to approximately $6,478,000, compared to approximately $2,960,000 during the three months ended June 30, 2023. This represents an increase in total operating expenses of approximately $3,518,000 from the three months ended June 30, 2023. The increase in operating expenses was primarily due to the write-off of impaired operating lease assets of approximately $3,878,000 related to the hospitality lease (See Hospitality Lease in Recent Developments). This increase in operating expenses was offset by a decrease in seasonal bad debt reserves of approximately $156,000, a decrease in logistics costs of approximately $124,000 associated with the closing of the warehouse operation and outsourcing of logistics to a third-party logistics company, acceleration of depreciation expense of approximately $130,000 recognized in the prior year on impaired fixed assets associated with the closing of the warehouse.

Other Expenses, net

Other expense consisted of interest expense of approximately $17,000 for the three months ended June 30, 2024, as compared to interest expense of approximately $29,000 for the three months ended June 30, 2023.

Income Taxes

For the three months ended June 30, 2024 and 2023 the Company recognized a tax benefit of approximately $52,000 and $0, respectively. The Company is not recognizing any tax provision for the six months ended June 30, 2024 as the Company is not forecasting any taxable income for the current year and had a loss before income tax benefit in the previous year. The Company’s income tax expense differs for the expected tax benefit based on statutory rates primarily due history of losses and forecasts that suggest the Company will not be able to utilize any deferred tax assets in the future.

Six Months Ended June 30, 2024 Compared to the Six Months Ended June 30, 2023

Net Sales

Net sales for the six months ended June 30, 2024, decreased to approximately $4,866,000 from approximately $6,008,000 representing a decrease of approximately $1,142,000 (19.0 %) as compared to the six months ended June 30, 2023. The decrease was primarily due to lower overall sell-through results during the past holiday season, mostly with our largest customer, Walmart, which in turn diminished inventory restocking requirements during the first six months of the calendar year which is historically off-peak shipping season.

Gross Profit

Gross profit for the six months ended June 30, 2024 decreased to approximately $826,000 from approximately $1,349,000 representing a decrease of approximately $523,000 (38.8%) as compared to the six months ended June 30, 2023. Gross margins for the six months ended June 30, 2024 were 17.0%, as compared to 22.5% for the six months ended June 30, 2023. There was a decrease of approximately $276,000 primarily due to lower gross margins caused by increased sales mix of excess inventory yielding margins that were less than current models sold. The remaining decrease in net sales as explained above accounted most of the remaining $267,000 of the decrease in gross profit.

Operating Expenses

During the six months ended June 30, 2024, total operating expenses increased to approximately $9,267,000 compared to approximately $5,927,000 during the six months ended June 30, 2023. This represents an increase in total operating expenses of approximately $3,340,000 from the six months ended June 30, 2023. The increase in operating expenses was primarily due to the write-off of impaired operating lease assets of approximately $3,878,000 related to the hospitality lease (See Hospitality Lease in Recent Developments). The increase in operating expenses was primarily attributable to a seasonal decrease in bad debt reserves of approximately $81,000, acceleration of depreciation expense of approximately $133,000 recognized in the prior year on impaired fixed assets associated with the closing of the logistics warehouse, a decrease in stock based compensation expense of approximately $101,000, reduced costs in selling expense of approximately $81,000 due to significantly lower inbound freight costs related to the reduced volume of product returns and a decrease in travel and entertainment of approximately $81,000.

Other (Expenses) Income, net

Other expense consisted of interest expense of approximately $45,000 for the six months ended June 30, 2024 as compared to other income, net of approximately $635,000. During the six months ended June 30, 2023, there was a one-time refund of approximately $704,000 from the Employee Retention Credit program offset by interest expense of approximately $69,000 which accounted for the increase in other income, net.

Income Taxes

For the six months ended June 30, 2024, the Company did not recognize any income tax provision as the Company is not forecasting any taxable income for the current year. The Company’s income tax provision for the six months ended June 30, 2023, was approximately $1,502,000 as the Company recognized a full valuation allowance on all of its deferred tax assets based on the recent history of losses and forecasts that suggested the Company would not be able to utilize the deferred tax assets in the future. The Company’s income tax expense differs for the expected tax benefit/expense based on statutory rates primarily due to full valuation allowance for all of its subsidiaries for the six months ended June 30, 2023.

Liquidity and Capital Resources

The Company incurred a net loss of approximately $8,486,000 for the six-month period ended June 30, 2024, and has a history of recurring losses.

On June 30, 2024, we had cash on hand of approximately $1,245,000 as compared to approximately $6,703,000 on December 31, 2023. The decrease in cash on hand of approximately $5,458,000 from December 31, 2023, was primarily due to approximately $5,410,000 used in operations of which approximately $4,711,000 was used to seasonally pay down accounts payable and accrued expenses. There were seasonal reductions in customer deposits and refunds to customers of approximately $1,221,000 and a reduction of approximately $1,217,000 in reserves for sales returns as customers seasonally returned defective and overstock goods from the past holiday season during the six months ended June 30, 2024. These uses of cash for operating activities were offset by a seasonal reduction of approximately $5,000,000 in accounts receivable of which a significant amount of the reduction was offset by customers netting credit amounts due to them from returns and co-op incentive programs against open invoices. As of June 30, 2024, our working capital was approximately $2,688,000.

On June 30, 2023, we had cash on hand of approximately $1,890,000 as compared to $2,795,000 as of December 31, 2022. The decrease in cash on hand of approximately $905,000 was primarily due to approximately $614,000 used in operating activities primarily due to off-peak seasonal settlement of accounts receivable offset by seasonal increases in accounts payable, accrued expenses related to seasonal accruals for estimated returned goods, co-op incentive program expenses and customer refunds, approximately $137,000 used investing activities for the purchase of molds and tooling and approximately $154,000 used in financing activities. While the Company received proceeds from the exercise of common stock warrants and issuance of common stock (net of offering costs) of approximately $1,640,000, this increase in financing activities was offset by repayment of revolving credit lines of credit and other debt of approximately $1,794,000 during the six months ended June 30, 2024.

Based on cash flow projections from operating and financing activities and the existing balance of cash, management is of the opinion that the Company has insufficient funds to sustain operations for at least one year after the date of this report, and it may not be able to meet its payment obligations from operations and related commitments, if the Company is not able to obtain outside financing to allow the Company to continue as a going concern. Based on these factors, the Company has substantial doubt that it will continue as a going concern for the twelve months following the issuance date of the financial statements included elsewhere in this report.

The Company’s plan to alleviate the going concern issue is to increase revenue while controlling operating costs and expenses and obtaining funds from outside sources of financing to generate positive financing cash flows. While management is optimistic about its ability to raise funds to fund operations for at least one year after the date of this report, there can be no assurance that any such measures will be successful.

The Company’s ability to raise additional funds will depend, in part, on the success of our product development activities, and other events or conditions that may affect the share value or prospects, as well as factors related to financial, economic and market conditions, many of which are beyond our control. There can be no assurances that sufficient funds will be available to us when required or on acceptable terms, if at all. Accordingly, management has concluded that these plans do not alleviate substantial doubt about the Company’s ability to continue as a going concern. Our failure to achieve or maintain profitability could negatively impact the value of our common stock.

Critical Accounting Estimates

Our 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 our Transition Report for the period ended December 31, 2023.

Evaluation of Disclosure Controls and Procedures

We have established disclosure controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to management, including the principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.

Our principal executive officer and principal financial officer, with the assistance of other members of our management, have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report. Based upon this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are not effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms and is accumulated and communicated to our management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Controls over Financial Reporting

During our transition period ended December 31, 2023, our Chief Executive Officer and Chief Financial Officer concluded that our internal control over financial reporting was not effective due to the material weaknesses described below.

1. We lack sufficient resources in our accounting department restricting our ability to review and approve certain material journal entries which increases the likelihood that a material misstatement of interim or annual financial statements might not be prevented. Management evaluated our current process of review and approval of certain material journal entries and concluded this deficiency represented a material weakness.

2. We lack sufficient resources in our accounting department, which restricts our ability to review certain material reconciliations related to financial reporting in a timely manner. Due to our size and nature, segregation of all conflicting duties may not always be possible and may not be economically feasible. Management evaluated the impact of our failure to have proper segregation between the preparation, review and approval of account reconciliations and concluded that this control deficiency represented a material weakness.

3. Due to resource restrictions, we have not established a three-way match of documents or other controls precise enough to detect a material misstatement in revenue. Management evaluated our current process of determining the occurrence of revenue and concluded this deficiency represented a material weakness.

Planned Remediation

We continue to work on improving and simplifying our internal processes and implement enhanced controls to address the material weaknesses in our internal control over financial reporting discussed above and to remedy the ineffectiveness of our disclosure controls and procedures. We are addressing our accounting resource requirements to help remediate the segregation of duties and plan to implement a concise “three-way” document matching procedure. These material weaknesses will not be considered as remediated until the applicable remediated controls are operating for a sufficient period and management has concluded, through testing, that these controls are operating effectively.

Despite the material weaknesses identified above, we believe that the consolidated financial statements included in the period covered by this report on Form 10-Q fairly present, in all material aspects, our financial conditions, results of operations and cash flows for the periods presented in conformity with U.S. generally accepted accounting principles.

During the fiscal quarter ended June 30, 2024, there were no additional changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.