Algorhythm Holdings, Inc 10-K, filed Aug 13, 2020
Algorhythm Holdings, Inc. (RIME)
About this 10-K
Algorhythm Holdings, Inc filed this 10-K on August 13, 2020, covering the fiscal year ended March 31, 2020.
Headline figures
Fiscal year ended March 31, 2020, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $41.42M
- down 10.9% from $46.48M a year earlier
- Net loss
- $2.86M
- compared with net income of $631.55K a year earlier
- Diluted EPS
- -$0.07
- compared with $0.02 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark one)
| [X] | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the fiscal year ended March 31, 2020 | |
| OR | |
| [ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the transition period from _________ to ___________ |
Commission file number 000-24968
THE SINGING MACHINE COMPANY, INC.
(Exact name of registrant as specified in its charter)
| Delaware | 95-3795478 | |
| (State or other jurisdiction of | (I.R.S. Employer | |
| incorporation or organization) | Identification No.) |
6301 NW 5th Way, Suite 2900, Fort Lauderdale, FL 33309
(Address of principal executive offices)
(954) 596-1000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 Par Value Per Share
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company,” in Rule 12b-2 of the Exchange Act).:
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [X] Emerging growth company [ ]
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act) Yes [ ] No [X]
As of September 30, 2019, the aggregate market value of the issued and outstanding common stock held by non-affiliates of the registrant, based upon the closing price of the common stock as quoted on the OTCQX of $0.24 was approximately $3,746,000 (based on 14,579,024) shares outstanding to non-affiliates). For purposes of the above statement only, all directors, executive officers and 10% shareholders are assumed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.
Number of shares of common stock outstanding as of August 12, 2020 was 38,557,643
DOCUMENTS INCORPORATED BY REFERENCE – None
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARIES
INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED MARCH 31, 2020
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RELIANCE ON SECURITIES AND EXCHANGE COMMISSION ORDER
On June 26, 2020, the Company filed a Current Report on form 8-K expressing reliance on the Securities and Exchange Commission’s (“SEC”) order (the “Order”) under the Exchange Act of 1934 (the “Exchange Act”) extending the deadlines for filing certain reports made under the Exchange Act, including annual reports on Form 10-K, for registrants subject to the reporting obligations under the Exchange Act that have been particularly impacted by the coronavirus disease 2019 (“COVID-19”) and which reports have filing deadlines between March 1 and July 1, 2020. The Company is relying on the Order due to the suspension of access to in-person operations and other financial and operational concerns associated with or caused by COVID-19.
See “Part I. Item 1A. Risk Factors - Risks Associated With Our Business”:
| ● | “The COVID-19 Pandemic has Affected Our Business In Many Different Ways, and May Amplify the Risks and Uncertainties Facing Our Business and their Potential Impact on Our Financial Position, Results of Operations, and Cash Flows” | |
| ● | “Our Supply Chain May be Materially Adversely Impacted Due to the COVID-19 Pandemic” |
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (the “Annual Report”) contains ’‘forward-looking statements’’ that represent our beliefs, projections and predictions about future events within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact are ’‘forward-looking statements’’, including any projections of earnings, revenue or other financial items, any statements of the plans, strategies and objectives of management for future operations, any statements concerning proposed new projects or other developments, any statements regarding future economic conditions or performance, any statements of management’s beliefs, goals, strategies, intentions and objectives, and any statements of assumptions underlying any of the foregoing. Words such as ’‘may’’, ’‘will’’, ’’should’’, ’‘could’’, ’‘would’’, ’‘predicts’’, ’‘potential’’, ’‘continue’’, ’‘expects’’, ’‘anticipates’’, ’‘future’’, ’‘intends’’, ’‘plans’’, ’‘believes’’, ’‘estimates’’ and similar expressions, as well as statements in the future tense, identify forward-looking statements.
These statements are necessarily subjective and involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any future results, performance or achievements described in or implied by such statements. Actual results may differ materially from expected results described in our forward-looking statements, including with respect to correct measurement and identification of factors affecting our business or the extent of their likely impact, the accuracy and completeness of the publicly available information with respect to the factors upon which our business strategy is based or the success of our business. Furthermore, industry forecasts are likely to be inaccurate, especially over long periods of time and in relatively new and rapidly developing industries such as oil and gas. Factors that may cause actual results, our performance or achievements, or industry results, to differ materially from those contemplated by such forward-looking statements include without limitation:
| ● | our ability to attract and retain management; | |
| ● | our growth strategies; | |
| ● | anticipated trends in our business; | |
| ● | our future results of operations; | |
| ● | our ability to incorporate new and changing technologies; | |
| ● | our willingness to develop technological innovation; | |
| ● | our liquidity and ability to finance our acquisition and development activities; | |
| ● | the impact of government regulation; | |
| ● | planned capital expenditures (including the amount and nature thereof); | |
| ● | our financial position, business strategy and other plans and objectives for future operations; | |
| ● | competition; | |
| ● | the ability of our management team to execute its plans to meet our goals; | |
| ● | general economic conditions, whether internationally, nationally or in the regional and local market areas in which we are doing business, that may be less favorable than expected; and | |
| ● | other economic, competitive, governmental (including new tariffs), legislative, regulatory, geopolitical and technological factors that may negatively impact our businesses, operations and pricing. |
Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of whether, or the times by which, our performance or results may be achieved. Forward-looking statements are based on information available at the time those statements are made and management’s belief as of that time with respect to future events and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to, those factors discussed under the headings ’‘Risk Factors’’, ’‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’, ’‘Business’’ and elsewhere in this Annual Report.
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OVERVIEW
The Singing Machine Company, Inc., (“Company,” “Singing Machine,” “we,” “us,” or, “our”) is engaged in the development, production, marketing and distribution of consumer karaoke audio equipment, toy products, licensed products, accessories, music, and audio consumer electronic products. We contract for the manufacturing of all our electronic equipment products with factories located in China. We have also collaborated with a music content service provider that allows the Company to offer karaoke downloads, and streaming subscription services. This collaboration provides the Company with a distribution platform for digital music sales and subscriptions and furthermore it opens up the Company’s music sales to customers who purchase our competitors’ karaoke machines as well. The capabilities of the Company’s music distribution system include the ability to download or stream selections from this content library, creating the opportunity to open new revenue sources through the sale of subscriptions.
We were incorporated in California in 1982. We originally sold our products exclusively to professional and semi-professional singers. In 1988, we began marketing karaoke equipment for home use. We believe we are the first company to introduce the home karaoke products to the United States (“U.S.”). In May 1994, we merged into a wholly-owned subsidiary incorporated in Delaware with the same name. As a result of that merger the Delaware corporation became the successor to the business and operations of the California corporation and retained the name The Singing Machine Company, Inc. (“SMC”). In December 2005, we formed a wholly-owned subsidiary SMC (Comercial Offshore De Macau) Limitada in Macau, China (“SMC Macau” or “Macau subsidiary”), to provide sales, financing, shipping, engineering and sourcing support for Singing Machine and Subsidiaries. Our Macau subsidiary has been approved to operate its business in Macau as Macau Offshore Company (MOC) and is exempt for the Macau corporate income tax. In February 2008, we formed a wholly-owned subsidiary SMC Logistics, Inc. (“SMC-L”), a California corporation, to manage the U.S. domestic logistics and fulfillment warehouse servicing for the Company and in April 2008 a wholly-owned subsidiary, SMC Music, Inc. (“SMC-M”) to contract with third party music providers. The Company trades on the Over the Counter Bulletin Board (“OTCQX”) under the symbol “SMDM”. Our principal executive offices are located in Fort Lauderdale, Florida.
The Company is partially held by koncepts International Limited (“koncepts”) who is major shareholder of the Company, owning approximately 49% of our shares of common stock outstanding on a fully diluted basis as of March 31, 2020. The Company is also partly held by Treasure Green Holdings Ltd. (“Treasure Green) who owns approximately 2% of our common stock. In total approximately 51% of the Company’s shares of common stock on a fully diluted basis as of August 12, 2020 are owned by koncepts and Treasure Green.
For most of the Fiscal Year, China Sinostar Group Company Limited (Sinostar and its subsidiaries collectively referred to herein as the “Sinostar Group” or “Sinostar”) held 100% of the common stock of koncepts and Treasure Green. Sinostar is a company whose principal activities include property development, property management, property investment, management of hydroelectric power stations, and design and sale of electronic products through its various subsidiaries. We do business with a number of entities that are indirectly wholly-owned or majority owned subsidiaries of Sinostar, including Starlight R&D Ltd (“Starlight R&D”), Starlight Consumer Electronics USA, Inc., (“SCE”), Cosmo Communications Corporation of Canada, Inc. (“Cosmo”) and Star Light Electronics Company Ltd (Starlite), among others. On December 12, 2019, Sinostar transferred the assets of its consumer electronics division (including all of its shares of koncepts and Treasure Green) to Fairy King Prawn Holdings Limited (“Fairy King”), an investment holding company incorporated in the British Virgin Islands, principally owned by the Company’s Chairman, Philip Lau.
GROWTH STRATEGY
The overall objective of the Singing Machine is to create an efficient platform for the development, manufacture, and world-wide marketing and distribution of home entertainment based consumer electronics. The Company will also seek new revenue opportunities through hardware-based music content delivery and the creation of a community based entertainment platform. The Company intends to leverage our valuable customer base and strong relationships with our factories to achieve our organic growth initiatives.
Organic Growth Strategy
We intend to pursue various initiatives to execute our organic growth strategy which is designed to enhance our market presence, expand our customer base and be an industry leader in new product development. Key elements of our organic growth strategy include:
Toy Products. Historically karaoke has been our core business. The Singing Machine brand is widely recognized as a leader in karaoke and consequently we hold a dominant market share in the business. While consistently a market leader, the Company has determined that it needs to diversify and expand its core focus in order to grow its business. The Company has therefore refocused its self-perception and is determined to build on its success by defining ourselves as a provider of quality home entertainment – not just home karaoke hardware. Critical to this strategy, the Company continued to market a line of toy products branded SMC Kids. We intend to grow our line of sing-along music themed toy products at lower opening price points. We believe this toy line, if successful, can leverage existing relationships with our current retail partners and help the Company organically grow.
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Licensed Products. Last year we acquired a license from CBS for the series “Carpool Karaoke” featured on the Late Late Show with James Corden. Inspired by the segment that has become a global, viral hit with over 2.3 billion views online, Carpool Karaoke The Mic allows friends and family to sing along to their favorite songs in their cars and recreate their favorite moments from the show. This product got off to a slower than expected start in Fiscal 2020 but has recently generated great deal of interest recently on social media and we intend to leverage this attention and market this product in different sales channels.
Expand Access to Digital Karaoke Music Offerings. Karaoke content has been exceedingly harder to find in physical format (CD+G discs) at retail stores. It remains the Company’s strategy to better promote our streaming App available on iOS and Android platforms to provide better music choices for our customers. It is also the Company’s strategy to work with its music partner, Stingray, to improve features to enhance the value proposition of the App to our customers.
Focus On International Growth. We believe that we have the most recognized and trusted brand in the world for consumer karaoke. We also have the most karaoke product offerings and features of any of our competitors in the karaoke market. We have been and will continue aggressively pursuing international business outside of North America to capture a vastly untapped market for home karaoke. The Company’s early efforts to open up new international markets has been successful. Through economies of scale and financed on a direct import basis, we believe this is one of the major areas in which we can substantially increase our revenues. Internationally, our products are currently distributed in Australia, Canada, United Kingdom, Ireland, Sweden, Norway, Finland, Spain, Italy, and Mexico.
PRODUCT LINES
We currently have four different product lines which consist in total of over 35 different models. The product lines consist of the following:
| ● | Classic Karaoke Machines represent the majority of our karaoke machines currently sold. These machines incorporate traditional karaoke features such as CD+G playback, echo, and voice control features, sound enhancement, built-in monitors, A/V out connections to TV for scrolling lyrics, and microphone inputs. Built-in cameras, Bluetooth and recording functions are available in some select models. The retail price range is from $49 to $199. This product line accounted for approximately 70% of total revenue for fiscal 2020. | |
| ● | Download Karaoke Machines represent a line of digital karaoke machines capable of playing back digital karaoke content. These machines include custom proprietary software to play high-definition digital downloaded content from our Singing Machine download store. These machines offer a full range of features including searching, playlist creation, Bluetooth, full motion videos, lead vocal, and HDMI output. The retail price range is from $79 to $199. This product line accounted for approximately 14% of total revenue in fiscal 2020. | |
| ● | SMC Kids Toy Products represents a new category of products for the Company, launched in the Fall of fiscal 2018. These toy products range from youth Bluetooth microphones to sing-along music players. The retail price range is from $19.99 to $39.99. This product line accounted for approximately 2% of total revenue in fiscal 2020. | |
| ● | Licensed Products represents a category of products done in collaboration between Singing Machine and third-party licensors. This includes product lines like “Carpool Karaoke” plus any future licenses that we take on. This product line accounted for approximately 5% of total revenue in fiscal 2020. |
The remaining 9% of total revenue was from the sales of karaoke related accessories consisting primarily of microphones, music subscriptions and downloads, and other miscellaneous electronic accessories.
MARKETING, SALES
Our karaoke machines and music are sold nationally and internationally to a broad spectrum of customers, primarily through mass merchandisers, department stores, direct mail catalogs and showrooms, music and record stores, national chains, specialty stores and warehouse clubs. Our product lines are currently sold by the following retailers, among others: Amazon.com, Best Buy, Costco, Sam’s Club, Target, and Wal-Mart Our sales strategy includes offering domestic sales as well as direct import sales made direct to the customer.
Domestic Sales. Our strategy of selling products from a domestic warehouse enables us to provide timely delivery and serve as a domestic supplier of imported goods. We purchase karaoke machines overseas from factories in China for our own account and warehouse the products in leased facilities in California. We are responsible for costs of shipping, insurance, customs clearance, duties, storage and distribution related to such products and, therefore, domestic sales command higher sales prices than direct import sales. We generally sell from our own inventory in less than container-sized lots. Domestic sales also include our new rapidly growing business of e-commerce in which we ship product directly to the end-consumer.
Direct Import Sales. We ship some hardware products sold by us directly to customers from China through SMC Macau. Sales made through our subsidiary are completed by either delivering products to the customers’ common carriers at the shipping point or by shipping the products to the customers’ distribution centers, warehouses, or stores. Direct import sales are made in larger quantities (generally container sized lots) to customers worldwide, which pay SMC Macau pursuant to their own international, irrevocable, transferable letters of credit or on open account.
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In fiscal 2020, approximately 43% of sales revenues were from direct import sales and 57% of revenues were domestic sales. Our sales within the U.S. are primarily made by our in-house sales team and our independent sales representatives. Our independent sales representatives are paid a commission based upon sales made in their respective territories. We utilize some of our outside independent sales representatives to help us provide service to our mass merchandisers and other retailers. The sales representative agreements are generally one (1) year agreements, which automatically renew on an annual basis, unless terminated by either party on 30 days’ notice. Our international sales are primarily made by our in-house sales representatives and our independent distributors.
As a percentage of net sales, our sales in the aggregate to our five largest customers during the fiscal years ended March 31, 2020 and 2019, approximately 81% and 86%, respectively. In fiscal 2020, the top three major customers accounted for approximately 39%, 13% and 11% of our net revenues. Although we have long-established relationships with all of our customers, we do not have contractual arrangements to purchase fixed quantities with any of them. A decrease in business or a loss of any of our major customers could have a material adverse effect on our results of operations and financial condition.
We also market our products at various national and international trade shows each year. We regularly attend the following trade shows and conventions: The Consumer Electronics Show which takes place each January in Las Vegas; the New York Toy Fair which occurs each February in New York; Distoy which occurs every year in May in London; and the Hong Kong Electronics Show stages each October in Hong Kong.
We believe the Singing Machine brand is one of the most widely recognized karaoke brands in the United States, Canada, Australia and Europe. While we continue to heavily focus on our core karaoke business, we wish to expand our business into other product categories. Our strong product procurement team in Hong Kong and China combined with our experienced sales and service team in North America enables us to compete not only in the karaoke market but also in other markets, such as musical instruments, licensed toy products and other consumer electronics products.
RETURNS
Returns of electronic hardware and music products by our customers generally occur after approval involving damaged goods, goods shipped in error and overstock. Our policy is to give credit to our customers for the returns in conjunction with the receipt of new replacement purchase orders. Our total returns represented 13.1% and 8.2% of our net sales in fiscal 2020 and 2019, respectively. The increase of 4.9 percentage points in return rate compared to prior fiscal year was due primarily to returns of approximately $1.1 million in overstock licensed product from one major customer due to the slower than expected results of our launch of the Carpool Karaoke The Mic product. This accounted for approximately 2.7 percentage points of the increase with the remaining increase primarily due to overstock returns from three other major customers.
DISTRIBUTION
We distribute hardware products to retailers and wholesale distributors through two methods: shipment of products from inventory held at our warehouse facilities in California (domestic sales), shipments directly through our Macau subsidiary, and manufacturers in China of products (direct import sales). Domestic sales are made to customers located throughout North America from inventories maintained at our warehouse facilities in California. In the fiscal year ended March 31, 2020, approximately 57% of our sales were shipped from our domestic warehouses (“Domestic Sales”) and 43% were sales shipped directly from China (“Direct Import Sales”).
MANUFACTURING AND PRODUCTION
Our karaoke machines are manufactured and assembled by third parties pursuant to design specifications provided by us. Currently, we have ongoing relationships with five factories, located in Guangdong Province of the People’s Republic of China, which assemble our karaoke machines. During fiscal 2021, we anticipate that 100% of our karaoke products will be produced by these factories, who have verbally agreed to extend financing to us. We believe that the manufacturing capacity of our factories is adequate to meet the demands for our products in fiscal year 2021. However, if our primary factory in China was prevented from manufacturing and delivering our karaoke products, our operation would be severely disrupted until alternative sources of supply are located. In manufacturing our karaoke related products, these factories use molds and certain other tooling, most of which are owned by us. Our products contain electronic components manufactured by other companies such as Panasonic, Sanyo, Toshiba, and Sony. Our manufacturers purchase and install these electronic components in our karaoke machines and related products. The finished products are packaged and labeled under our trademark, The Singing Machine(R) and private labels.
Our main office in China is located in Hong Kong which has recently experienced some political unrest and anti-government protests from citizens of Hong Kong. Should tensions continue to escalate it could potentially affect our employees and disrupt our ability to perform necessary administrative tasks required to manage the supply chain with our suppliers.
While our equipment manufacturers purchase our supplies from a small number of large suppliers, all of the electronic components and raw materials used by us are available from several sources of supply. We depend on limited suppliers for some key components and the loss of any single supplier may have a material long-term adverse effect on our business, operations, or financial condition. To ensure that our high standards of product quality are met and that factories consistently meet our shipping schedules, we utilize Hong Kong and China based employees as our representatives. These employees include product inspectors who are knowledgeable about product specifications and work closely with the factories to verify that such specifications are met. Additionally, key personnel frequently visit our factories for quality assurance and to support good working relationships.
All of the electronic equipment sold by us is warrantied to the end user against manufacturing defects for a period of ninety (90) days for labor and parts. All music sold is similarly warrantied for a period of 30 days. During the fiscal years ended March 31, 2020 and 2019, warranty claims have not been material to our results of operations.
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COMPETITION
Our business is highly competitive. Our major competitors for karaoke machines and related products are Singsation, Ion Audio, Singtrix, Karaoke USA, licensed property karaoke products and other consumer electronics companies. We believe that competition for karaoke machines is based primarily on price, product features, reputation, delivery times, and customer support. We believe that our brand name is well recognized in the industry and helps us compete in the karaoke machine category. Our primary competitors for download or streaming karaoke music are Youtube, Sybersound, Smule, and Karaoke Anywhere. We believe that competition for karaoke music is based primarily on popularity of song titles, price, reputation, and delivery times.
In addition, we compete with all other existing forms of entertainment including, but not limited to, motion pictures, video arcade games, home video games, theme parks, nightclubs, television and prerecorded tapes, CD’s, and DVD’s. Our financial position depends, among other things, on our ability to keep pace with changes and developments in the entertainment industry and to respond to the requirements of our customers. Many of our competitors have significantly greater financial, marketing, and operating resources and broader product lines than we do.
TRADEMARKS AND PATENTS
We have obtained registered trademarks for The Singing Machine name and the logo in the U.S., Canada, Australia, Hong Kong, China, European Union, Japan, Mexico and the Republic of Korea. We have also obtained registered trademarks for SMC Kids and the logo in the U.S., Canada, Australia, European Union, and the Republic of Korea. In 2003 we also obtained two U.S. design patents for karaoke machines, patent numbers US D505,960 S and US D524,325 S.
Our trademarks are a significant asset because they provide product recognition. We believe that our intellectual property is significantly protected, but there are no assurances that these rights can be successfully asserted in the future or will not be invalidated, circumvented or challenged.
COPYRIGHTS AND LICENSES
We offer karaoke music through our Singing Machine Karaoke Download Store, Community, and iPhone/iPad App through a partnership with Stingray Digital Group (“Stingray”). Stingray holds all licensing agreements directly with the music publishers and is responsible for all royalty payments. We share a revenue split with Stingray on all karaoke videos streamed or downloaded by our customers. Stingray is the leading multi-platform music service provider in the world, with an estimated 110 million Pay-TV subscribers in 111 countries around the world. Geared towards individuals and businesses alike, the company’s commercial entities include leading digital music and video services Stingray Music, Concert TV and The KARAOKE Channel. Stingray also offers various business solutions, including music and digital display-based solutions through its Stingray Business division.
GOVERNMENT REGULATION
Our karaoke machines must meet the safety standards imposed in various national, state, local, and provincial jurisdictions. Our karaoke machines sold in the U.S. are designed, manufactured and tested to meet the safety standards of Underwriters Laboratories, Inc. (“ULE”) or Electronic Testing Laboratories (“ETL”). In Europe and other foreign countries, our products are manufactured to meet the Consumer Electronics (“CE”) marking requirements. CE marking is a mandatory European product marking and certification system for certain designated products. When affixed to a product and product packaging, CE marking indicates that a particular product complies with all applicable European product safety, health and environmental requirements within the CE marking system. Products complying with CE marking are now accepted to be safe in 28 European countries. However, ULE or ETL certification does not mean that a product complies with the product safety, health and environmental regulations contained in all fifty states in the United States. Therefore, we maintain a quality control program designed to ensure compliance with all applicable U.S. and federal laws pertaining to the sale of our products. Our production and sale of music products is subject to federal copyright laws.
The manufacturing operations of our foreign suppliers in China are subject to foreign regulation. China has permanent “normal trade relations” (“NTR”) status under U.S. tariff laws, which provides a favorable category of U.S. import duties. China’s NTR status became permanent on January 1, 2002. In July, 2018, the U.S. government imposed tariffs on many products imported from China. All of our products are manufactured and imported from China however, only our microphones are currently subject to a 7.5% tariff. Should the government decide to expand its list of products to include our karaoke products that would subject our products to tariffs in the future, there could be a significant increase in the landed cost of our products. If we are unable to mitigate these increased costs through price increases we could experience reductions in revenues, gross profit margin and results from operations.
SEASONALITY AND SEASONAL FINANCING
Our business is highly seasonal, with consumers making a large percentage of karaoke purchases around the traditional holiday season in our second and third quarter ending September 30 and December 31. These seasonal purchasing patterns and requisite production lead times cause risk to our business associated with the underproduction or overproduction of products that do not match consumer demand. Retailers also attempt to manage their inventories more tightly, requiring that we ship products closer to the time that retailers expect to sell the products to consumers. These factors increase the risk that we may not be able to meet demand for certain products at peak demand times, or that our own inventory levels may be adversely affected by the need to pre-build products before orders are placed. As of March 31, 2020, we had inventory of approximately $7.6 million (net of reserves totaling approximately $0.4 million) compared to inventory of approximately $6.0 million as of March 31, 2019 (net of reserves totaling approximately $0.3 million).
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Our financing of seasonal working capital during Fiscal 2020 was from a Revolving Credit Facility from PNC Bank (“Revolving Credit Facility”) and vendor extended accounts payable terms from certain China manufacturers. The Revolving Credit Facility was terminated on June 16, 2020. On June 16, 2020, the Company executed a tri-party Intercreditor Agreement for a Revolving Line of Credit (Intercreditor Revolving Credit Facility”) on eligible accounts receivable and inventory. The Company signed a two-year Loan and Security Agreement for a $10,000,000 financing facility with Crestmark, a division of Meta Bank, NA (“Crestmark”) on eligible accounts receivable. Further, the Company also executed a two-year Loan and Security Agreement with Iron Horse Credit (“Iron Horse”) for up to $2,500,000 in inventory financing. Both agreements automatically renew each year until expiration unless advance written notification is given and both agreements expire on June 15, 2022. The combined facility provides the Company with up to $12,500,000 in financing during the Company’s peak season.
During Fiscal 2021, we plan on financing our inventory purchases by borrowing on our Intercreditor Revolving Credit Facility and using payment terms that have been granted to us by the factories in China.
EMPLOYEES
As of July 28, 2020 we employed 32 full-time employees. We have 1 administrative employee located at SMC Macau’s office with the remaining 31 employees based in the U.S. Our U.S. employees include 3 executive officers, 13 engaged in warehousing and administrative logistics/technical support and 15 in accounting, marketing, sales and administrative functions.
Set forth below and elsewhere in this Annual Report on Form 10-K and in the other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward looking statements contained in this Annual Report.
RISKS ASSOCIATED WITH OUR BUSINESS
THE COVID-19 PANDEMIC HAS AFFECTED OUR BUSINESS IN MANY DIFFERENT WAYS, AND MAY AMPLIFY THE RISKS AND UNCERTAINTIES FACING OUR BUSINESS AND THEIR POTENTIAL IMPACT ON OUR FINANCIAL POSITION, RESULTS OF OPERATIONS, AND CASH FLOWS.
The COVID-19 pandemic has significantly affected U.S. consumer shopping patterns and caused the health of the U.S. economy to deteriorate. We cannot foresee whether the outbreak of COVID-19 will be effectively contained, nor can we predict the severity and duration of its impact on our business and our financial results. If the outbreak of COVID-19 is not effectively and timely controlled, our business operations, financial condition, and liquidity may be materially and adversely affected as a result of prolonged disruptions in consumer spending, a lack of demand for our products, forced retail store closures and other factors that we cannot foresee. The extent to which COVID-19 will impact our business and our financial results will depend on future developments which are highly uncertain and cannot be predicted.
OUR SUPPLY CHAIN MAY BE MATERIALLY ADVERSELY IMPACTED DUE TO THE COVID-19 PANDEMIC.
We rely upon the facilities of our third-party manufacturers in China to manufacture our products and export our products throughout the world. The pandemic has resulted in significant governmental measures being implemented to control the spread of COVID-19, including, among others, restrictions on manufacturing and the movement of employees in many regions of China. If the outbreak of COVID-19 is not effectively controlled, our third-party manufacturers may not have the materials, capacity, or capability to manufacture our products according to our schedule and specifications. If our third-party manufacturers’ operations are curtailed, we may need to seek alternate manufacturing sources, which may be more expensive and cause significant delays in procurement. At the current moment, restrictions have been eased and our third-party manufacturers in China are able to operate normally, however we are unable to predict future supply chain disruptions should the pandemic continue. If the pandemic continues uncontrolled, the impact on our supply chain in China may have a material adverse effect on our results of operations and cash flows. Furthermore, we currently distribute all of our products from our warehouse facility in Ontario California. An outbreak of COVID-19 infections among our warehouse staff could close the warehouse, resulting in loss of sales. The COVID-19 outbreak could also delay our release or delivery of new or product offerings or require us to make unexpected changes to such offerings, which may materially adversely affect our business and operating results.
CHANGES IN GOVERNMENT REGULATIONS RELATING TO INTERNATIONAL TARIFFS COULD SIGNIFICANTLY REDUCE OUR REVENUES, PRODUCT COST AND PROFITABILITY.
The Trump administration and members of the U.S. Congress have made public statements indicating possible significant changes in U.S. trade policy and have taken certain actions that may impact U.S. trade, including imposing tariffs on certain goods imported into the United States. Any changes in U.S. trade policy could trigger retaliatory actions by affected countries, resulting in “trade wars,” in increased costs for goods imported into the United States. All of our products are manufactured and imported from China however, only our microphone products are currently subject to 7.5% tariffs currently in place. Should the government decide to expand its list of products to include our karaoke products that would subject our products to tariffs in the future, there could be a significant increase in the landed cost of our products. If we are unable to mitigate these increased costs through price increases we could experience reductions in revenues, gross profit margin and results from operations.
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A SMALL NUMBER OF OUR CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR REVENUES, AND THE LOSS OF ONE OR MORE OF THESE KEY CUSTOMERS COULD SIGNIFICANTLY REDUCE OUR REVENUES AND CASH FLOW.
We rely on a few large customers to provide a substantial portion of our revenues. As a percentage of net sales, our sales to our three largest customers during the years ended March 31, 2020 and 2019 were approximately 63% and 66%, respectively . We do not have long-term contractual arrangements with any of our customers and they can cancel their orders at any time prior to delivery. A substantial reduction in or termination of orders from any of our largest customers would decrease our revenues and cash flow.
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.
In fiscal 2020 and 2019, a number of our customers and distributors returned karaoke products that they had purchased from us. Our customers returned goods valued at approximately $5.4 million or 13.1% of our net sales in fiscal 2020 and approximately $3.8 million or 8.2% of our net sales in fiscal 2019. The return of products is due to a variety of reasons including defective units, customers’ overstock and buyer’s remorse. The primary reason for the 4.9 percentage point increase in returns was primarily due to overstock returns of licensed goods from one major customer and overstock returns of non-licensed products from three other major customers. Our factories charge customary repair and freight costs which increase our expenses and reduce profitability. If any of our customers were to increase the volume of their returned karaoke products to us, it would reduce our revenues and profitability.
WE ARE SUBJECT TO PRESSURE FROM OUR CUSTOMERS RELATING TO PRICE REDUCTION AND FINANCIAL INCENTIVES AND IF WE ARE PRESSURED TO MAKE THESE CONCESSIONS TO OUR CUSTOMERS, IT WILL REDUCE OUR REVENUES AND PROFITABILITY.
Because there is intense competition in the karaoke industry, we are subject to pricing pressure from our customers. Many of our customers have demanded that we lower our prices or they will buy our competitor’s products. If we do not meet our customer’s demands for lower prices, we will not sell as many karaoke products. We are also subject to pressure from our customers regarding certain financial incentives, such as return credits or large advertising or cooperative advertising allowances, which effectively reduce our profit. We gave advertising allowances of approximately $2.9 million during fiscal 2020 and $2.3 million during fiscal 2019. We have historically offered advertising allowances to our customers because it is standard practice in the retail industry.
WE EXPERIENCE DIFFICULTY FORECASTING THE DEMAND FOR OUR KARAOKE PRODUCTS AND IF WE DO NOT ACCURATELY FORECAST DEMAND, OUR REVENUES, NET INCOME AND CASH FLOW MAY BE AFFECTED.
Because of our reliance on manufacturers in China for our machine production, our production lead times range from one to four months. Therefore, we must commit to production in advance of customers’ orders. It is difficult to forecast customer demand because we do not have any scientific or quantitative method to predict this demand. Our forecasting is based on management’s general expectations about customer demand, the general strength of the retail market and management’s historical experiences. In past years we have overestimated demand for our products which led to excess inventory in some of our products and caused liquidity problems that adversely affected our revenues, net income and cash flow.
WE ARE SUBJECT TO THE COSTS AND RISKS OF CARRYING INVENTORY FOR OUR CUSTOMERS AND IF WE HAVE TOO MUCH INVENTORY, IT WILL AFFECT OUR REVENUES AND NET INCOME.
Many of our customers place orders with us several months prior to the holiday season, but they schedule delivery two or three weeks before the holiday season begins. As such, we are subject to the risks and costs of carrying inventory during the time period between the placement of the order and the delivery date, which reduces our cash flow. As of March 31, 2020 we had approximately $7.6 million in inventory. It is important that we sell this inventory during fiscal 2021, so we have sufficient cash flow for operations.
WE ARE SUBJECT TO INSURANCE RISK OF LOSS FOR GOODS DAMAGED WHILE IN TRANSIT FROM THE MANUFACTURER TO THE CUSTOMER AND OUR WAREHOUSE.
All of our goods are manufactured in China and are transported to customers and our warehouse in California via ocean vessel. As such, we are subject to damages that may occur to these goods when they are in transit to customers or our warehouse. Should substantial damage incur while goods are in transit we could experience a significant loss of revenue, inventory and incur significant out of pocket expenses associated with destruction of the damaged goods which could cause a significant loss from operations and reduction in cash flow. In August 2019, a major customer received goods that were significantly water damaged due to excess moisture absorbed in pallets shipped by the factory. As a result we incurred a loss of approximately $2.4 million. As of July 10, 2020 we have recovered approximately $2.3 million from our cargo insurance coverage and secured vendor invoice credits of $0.4 million from the factory that caused the damage. While we have taken measures to prevent a similar incident in the future there can be no guarantee that this type of damage or other types of damage could occur in the future. Unfortunately, due the size of the claim, we can no longer afford the same insurance coverage for goods damaged in transit and are now at risk for costs associated with damage to goods in transit.
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OUR BUSINESS IS SEASONAL AND THEREFORE OUR ANNUAL OPERATING RESULTS WILL DEPEND, IN LARGE PART, ON OUR SALES DURING THE RELATIVELY BRIEF HOLIDAY SEASON.
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 98% and 94% of net sales in fiscal 2020 and 2019, respectively.
IF WE ARE UNABLE TO COMPETE IN THE KARAOKE PRODUCTS CATEGORY, OUR REVENUES AND NET PROFITABILITY WILL BE REDUCED.
Our major competitors for karaoke machines and related products are Singsation, Singtrix, Ion Audio, Karaoke USA and licensed property karaoke products and other consumer electronics companies. We believe that competition for karaoke machines is based primarily on price, product features, reputation, delivery times, and customer support. To the extent that we lower prices to attempt to enhance or retain market share, we may adversely impact our operating margins. Conversely, if we opt not to match competitor’s price reductions we may lose market share, resulting in decreased volume and revenue. To the extent our leading competitors reduce prices on their karaoke machines, we must remain flexible to reduce our prices. If we are forced to reduce our prices, it will result in lower margins and reduced profitability. Because of intense competition in the karaoke industry in the United States during fiscal 2020, we expect that the intense pricing pressure in the low end of the market will continue in the karaoke market in the United States in fiscal 2021. In addition, we must compete with all the other existing forms of entertainment including, but not limited to: motion pictures, video arcade games, home video games, theme parks, nightclubs, television, prerecorded tapes, CD’s, and DVD’s and streaming video.
IF WE ARE UNABLE TO DEVELOP NEW KARAOKE PRODUCTS, OUR REVENUES MAY NOT CONTINUE TO GROW.
The karaoke industry is characterized by rapid technological change, frequent new product introductions and enhancements and ongoing customer demands for greater performance. In addition, the average selling price of any karaoke machine has historically decreased over its life, and we expect that trend to continue. As a result, our products may not be competitive if we fail to introduce new products or product enhancements that meet evolving customer demands. The development of new products is complex, and we may not be able to complete development in a timely manner. To introduce products on a timely basis, we must:
| ● | accurately define and design new products to meet market demand; | |
| ● | design features that continue to differentiate our products from those of our competitors; | |
| ● | transition our products to new manufacturing process technologies; | |
| ● | identify emerging technological trends in our target markets; | |
| ● | anticipate changes in end-user preferences with respect to our customers’ products; | |
| ● | bring products to market on a timely basis at competitive prices; and | |
| ● | respond effectively to technological changes or product announcements by others. |
We believe that we will need to continue to enhance our karaoke machines and develop new machines to keep pace with competitive and technological developments and to achieve market acceptance for our products. At the same time, we need to identify and develop other products which may be different from karaoke machines.
OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD PREVENT OR DELAY OUR CUSTOMERS’ RECEIPT OF INVENTORY.
We rely principally on four contract ocean carriers to ship virtually all of the products that we import to our warehouse facility in Ontario, California. Retailers that take delivery of our products in China rely on a variety of carriers to import those products. Any disruptions in shipping, whether in California or China, caused by labor strikes, other labor disputes, terrorism, and international incidents may prevent or delay our customers’ receipt of inventory. If our customers do not receive their inventory on a timely basis, they may cancel their orders or return products to us. Consequently, our revenues and net income would be reduced and our results of operations adversely affected.
OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE’S REPUBLIC OF CHINA, SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS. IF THERE IS ANY PROBLEM WITH THE MANUFACTURING PROCESS, OUR REVENUES AND NET PROFITABILITY MAY BE REDUCED.
We are using five factories in the People’s Republic of China to manufacture the majority of our karaoke machines. These factories will be producing all of our karaoke products in fiscal 2021. Our arrangements with these factories are subject to the risks of doing business abroad, such as import duties, trade restrictions, work stoppages, and foreign currency fluctuations, limitations on the repatriation of earnings and political instability, which could have an adverse impact on our business. Furthermore, we have limited control over the manufacturing processes. As a result, any difficulties encountered by our third-party manufacturers that result in product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis could adversely affect our revenues, profitability and cash flow. Also, since we do not have written agreements with any of these factories, we are subject to additional uncertainty if the factories do not deliver products to us on a timely basis.
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WE DEPEND ON THIRD PARTY SUPPLIERS FOR PARTS FOR OUR KARAOKE MACHINES AND RELATED PRODUCTS, AND IF WE CANNOT OBTAIN SUPPLIES AS NEEDED, OUR OPERATIONS WILL BE SEVERELY DAMAGED.
Our growth and ability to meet customer demand depends in part on our capability to obtain timely deliveries of karaoke machines and our electronic products. We rely on third party suppliers to produce the parts and materials we use to manufacture and produce these products. If our suppliers are unable to provide our factories with the parts and supplies, we will be unable to produce our products. We cannot guarantee that we will be able to purchase the parts we need at reasonable prices or in a timely fashion. If we are unable to anticipate any shortages of parts and materials in the future, we may experience severe production problems, which would impact our sales.
CONSUMER DISCRETIONARY SPENDING MAY AFFECT KARAOKE PURCHASES AND IS AFFECTED BY VARIOUS ECONOMIC CONDITIONS AND CHANGES.
Our business and financial performance may be damaged more than most companies by adverse financial conditions affecting our business or by a general weakening of the economy. Purchases of karaoke machines and music are considered discretionary for consumers. Our success will therefore be influenced by a number of economic factors affecting discretionary and consumer spending, such as employment levels, business, interest rates, and taxation rates, all of which are not under our control. Additionally, other extraordinary events such as terrorist attacks or military engagements, which adversely affect the retail environment may restrict consumer spending and thereby adversely affect our sales growth and profitability.
WE ARE EXPOSED TO THE CREDIT RISK OF OUR CUSTOMERS, WHO ARE EXPERIENCING FINANCIAL DIFFICULTIES, AND IF THESE CUSTOMERS ARE UNABLE TO PAY US, OUR REVENUES AND PROFITABILITY WILL BE REDUCED.
We sell products to retailers, including national chains, warehouse clubs, department stores, lifestyle merchants, specialty stores, and direct mail catalogs and showrooms. Deterioration in the financial condition of our customers could result in bad debt expense to us and have a material adverse effect on our revenues and future profitability. As of August 12, 2020 we are not aware of any customers that are operating under the protection of bankruptcy laws other than J. C. Penney who does not have any unpaid invoices. This customer accounted for less than 3% of net sales for the Fiscal 2020.
A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTER IN CALIFORNIA COULD IMPACT OUR ABILITY TO DELIVER MERCHANDISE TO OUR CUSTOMERS, WHICH COULD ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY.
A significant amount of our merchandise is shipped to our customers from our warehouse located in Ontario, California. Events such as fire or other catastrophic events, any malfunction or disruption of our centralized information systems or shipping problems may result in delays or disruptions in the timely distribution of merchandise to our customers, which could substantially decrease our revenues and profitability.
CURRENT LEVELS OF SECURITIES AND FINANCIAL MARKET RISK.
During the past twelve months, our financial condition and results of operations have affected our ability to continue traditional financing with PNC Bank and PNC chose not to renew financing with the Company. The PNC Revolving Credit Facility was terminated on June 16, 2020. On June 16, 2020, the Company executed a tri-party Intercreditor Agreement for a Revolving Line of Credit (Intercreditor Revolving Credit Facility”) on eligible accounts receivable and inventory. The Company signed a two-year Loan and Security Agreement for a $10,000,000 financing facility with Crestmark, a division of Meta Bank, NA (“Crestmark”) on eligible accounts receivable. Further, the Company also executed a two-year Loan and Security Agreement with Iron Horse Credit (“Iron Horse”) for up to $2,500,000 in inventory financing. Should there be a disruption in the current levels of these markets or a deterioration of our business, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
CURRENCY EXCHANGE RATE RISK
The majority of our products are currently manufactured in the People’s Republic of China. During the fiscal year ended March 31, 2020, the Chinese local currency had no material effect on the Company as all of our purchases are denominated in U.S. currency. However, in the event our purchases are required to be made in Chinese local currency, the Yuan, we will be subject to the risks involved in foreign exchange rates. In the future the value of the Yuan may depend to a large extent on the Chinese government’s policies and China’s domestic and international economic and political developments. As a result, our production costs may increase if we are required to make purchases using the Yuan instead of the U.S. dollar and the value of the Yuan increases over time. Any significant increase in the cost of manufacturing our products would have a material adverse effect on our business and results of operations.
INCREASED RAW MATERIAL/PRODUCTION PRICING
Fluctuation in the price of oil has and will continue to affect the Company in connection with the sourcing and utilizing of petroleum based raw materials and services. We do not expect to see increased cost in our finished goods during fiscal year 2021 due to the significant decrease in the price of oil offset by increased cost of trans-oceanic shipping and increases in the cost of labor related to regulations instituted in China which impact wages related to the cost of production. These issues are common to all companies in the same type of business and if the Company is not able to negotiate lower costs, reduce other expenses, or pass on some or all of these price increases to our customers, our profit margin may be decreased.
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RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
IF OUR OUTSTANDING STOCK OPTIONS ARE EXERCISED, OUR EXISTING SHAREHOLDERS WILL SUFFER DILUTION.
As of March 31, 2020, there were outstanding stock options to purchase an aggregate of 2,230,000 shares of common stock at exercise prices ranging from $0.04 to $0.55 per share, not all of which are immediately exercisable. The weighted average exercise price of the outstanding stock options is approximately $0.26 per share.
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT SHAREHOLDERS AND INVESTORS MAY DEPRESS OUR STOCK PRICE.
As of July 28, 2020 there were 38,557,643 shares of our common stock outstanding. We have filed two registration statements registering an aggregate 3,794,250 of shares of our common stock (a registration statement on Form S-8 to register the sale of 1,844,250 shares underlying options granted under our 1994 Stock Option Plan and a registration statement on Form S-8 to register 1,950,000 shares of our common stock underlying options granted under our Year 2001 Stock Option Plan). The market price of our common stock could drop due to the sale of large number of shares of our common stock, such as the shares sold pursuant to the registration statements or under Rule 144, or the perception that these sales could occur.
OUR STOCK PRICE MAY DECREASE IF WE ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK.
Our certificate of incorporation, as amended in January 2006, authorizes the issuance of 100,000,000 shares of common stock. As of August 12, 2020, we had 38,557,643 shares of common stock issued and outstanding and an aggregate of 2,230,000 shares issuable under our outstanding stock options. As such, our Board of Directors has the power, without stockholder approval, to issue up to 59,212,357 shares of common stock. Any issuance of additional shares of common stock, whether by us to new shareholders or the exercise of outstanding options, may result in a reduction of the book value or market price per share of our outstanding common stock. Issuance of additional shares will reduce the proportionate ownership and voting power of our then existing shareholders.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAKE IT DIFFICULT FOR A THIRD PARTY TO ACQUIRE OUR COMPANY AND COULD DEPRESS THE PRICE OF OUR COMMON STOCK.
Delaware law and our certificate of incorporation and bylaws contain provisions that could delay, defer or prevent a change in control of our Company or a change in our management. These provisions could also discourage proxy contests and make it more difficult for you and other shareholders to elect directors and take other corporate actions. These provisions of our certificate of incorporation include: authorizing our board of directors to issue additional preferred stock, limiting the persons who may call special meetings of shareholders, and establishing advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by shareholders at shareholder meetings.
IF WE FAIL TO MAINTAIN EFFECTIVE INTERNAL CONTROLS OVER FINANCIAL REPORTING, THE PRICE OF OUR COMMON STOCK MAY BE ADVERSELY AFFECTED.
We are required to establish and maintain appropriate internal controls over financial reporting. Failure to establish those controls, or any failure of those controls once established, could adversely impact our public disclosures regarding our business, financial condition or results of operations. Any actual or perceived weaknesses and conditions that need to be addressed in our internal controls over financial reporting or disclosure of our management’s assessment of our internal controls over financial reporting may have an adverse impact on the price of our common stock.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE ADVERSELY AFFECTED BY SEVERAL FACTORS.
The market price of our common stock could fluctuate significantly in response to various factors and events, including:
| ● | our ability to execute our business plan; |
| ● | operating results below expectations; |
| ● | loss of any strategic relationship; |
| ● | industry developments; |
| ● | economic and other external factors; |
| ● | changes in government regulations Including tariffs; and |
| ● | period-to-period fluctuations in its financial results. |
In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock.
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WE HAVE NOT PAID CASH DIVIDENDS IN THE PAST AND DO NOT EXPECT TO PAY CASH DIVIDENDS IN THE FUTURE. ANY RETURN ON INVESTMENT MAY BE LIMITED TO THE VALUE OF OUR STOCK.
We have never paid cash dividends on our stock and do not anticipate paying cash dividends on our stock in the foreseeable future. The payment of cash dividends on our stock will depend on our earnings, financial condition and other business and economic factors affecting us at such time as the board of directors may consider relevant. If we do not pay cash dividends, our stock may be less valuable because a return on your investment will only occur if our stock price appreciates.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
Our corporate headquarters are located in Fort Lauderdale, Florida where we lease approximately 6,500 square feet of office space. The lease expires on March 31, 2024. The annual rental expense for office facilities was approximately $0.2 million for the fiscal year ended March 31, 2020.
We lease approximately 86,000 square feet of warehouse space in Ontario, California for our logistics operations. The lease expires on August 31, 2020 (original term of 87 months). The annual rental expense for warehouse facilities was approximately $0.5 million for the fiscal year ended March 31, 2020. On June 15, 2020 we executed a three-year lease extension which will expire on August 31, 2023.
We lease a 424 square foot office in Macau. The annual rent expense for this facility was approximately $19,000 for the fiscal year ended March 31, 2020. The rent is fixed at approximately $1,600 per month for the duration of the lease which expires on April 30, 2021.
We believe that the facilities are well maintained, in substantial compliance with environmental laws and regulations, and adequately covered by insurance. We also believe that these leased facilities are not unique and could be replaced, if necessary, at the end of the term of the existing leases.
On or about February 4, 2020 Singing Machine was named in a product liability complaint alongside Target and Energizer Brands in the state of Missouri. It is alleged by the Plaintiff, an individual, that one of Singing Machine’s karaoke products injured the plaintiff while she was operating the product from battery power. Plaintiff alleges her injury occurred when battery acid leaked from the karaoke product. The plaintiff purchased the karaoke machine at Target and operated the karaoke machine with Energizer batteries. Plaintiff is suing both Singing Machine and Energizer because she is unsure whether the karaoke product or the batteries caused the battery acid leak.
The plaintiff alleges four counts of action against Singing Machine including strict product liability, negligence, breach of warranty, and failure to warn. Singing Machine has product liability insurance and the matter has been turned over the matter to insurance company’s counsel in defending the matter. The Company does not believe that the resolution of this matter is likely to have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
As of August 12, 2020 management is not aware of any other legal proceedings other than matters that arise in the ordinary course of business.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable
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ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company has traded on the Over the Counter Bulletin Board (“OTCBX”) under the symbol “SMDM”. Set forth below is the range of high and low sales prices for our common stock during Fiscal 2020 and Fiscal 2019.
| FISCAL PERIOD | HIGH | LOW | ||||||
| Fiscal 2020: | ||||||||
| First quarter (April 1 - June 30, 2019) | $ | 0.44 | $ | 0.26 | ||||
| Second quarter (July 1 - September 30, 2019) | 0.34 | 0.22 | ||||||
| Third quarter (October 1 - December 31, 2019) | 0.31 | 0.24 | ||||||
| Fourth quarter (January 1 - March 31, 2020) | 0.26 | 0.10 | ||||||
| Fiscal 2019: | ||||||||
| First quarter (April 1 - June 30, 2018) | $ | 0.47 | $ | 0.33 | ||||
| Second quarter (July 1 - September 30, 2018) | 0.44 | 0.31 | ||||||
| Third quarter (October 1 - December 31, 2018) | 0.40 | 0.28 | ||||||
| Fourth quarter (January 1 - March 31, 2019) | 0.44 | 0.29 | ||||||
As of July 28, 2020, based upon information received from our transfer agent, there were approximately 188 record holders of our outstanding common stock. This number does not include:
| ● | any beneficial owners of common stock whose shares are held in the names of various dealers, clearing agencies, banks, brokers and other fiduciaries, or | |
| ● | broker-dealers or other participants who hold or clear shares directly or indirectly through the Depository Trust Company, or its nominee, Cede & Co. |
DIVIDENDS
We have never declared or paid cash dividends on our common stock and our Board of Directors intends to continue its policy for the foreseeable future. Future dividend policy will depend upon our earnings, financial condition, contractual restrictions and other factors considered relevant by our Board of Directors and will be subject to limitations imposed under Delaware law.
EQUITY COMPENSATION PLAN INFORMATION
The following table summarizes our equity compensation plan information as of March 31, 2020:
| ISSUANCE UNDER EQUITY PLAN CATEGORY |
NUMBER OF SECURITIES TO BE ISSUED UPON EXERCISE OF OUTSTANDING OPTIONS, WARRANTS AND RIGHTS |
WEIGHTED-AVERAGE EXERCISE PRICE OF OUTSTANDING OPTIONS, WARRANTS AND RIGHTS |
NUMBER OF SECURITIES REMAINING AVAILABLE FOR FUTURE COMPENSATION PLANS (EXCLUDING SECURITIES IN COLUMN (A)) |
|||||||||
| Equity Compensation Plans approved by Security Holders | 580,000 | $ | .06 | 0 | ||||||||
| Equity Compensation Plans Not approved by Security Holders | 1,650,000 | $ | .33 | 0 | ||||||||
RECENT SALES OF UNREGISTERED SECURITIES
COMMON STOCK ISSUANCES
On August 30, 2019 the Company issued 60,000 shares of its common stock to a former director who exercised stock options at an average exercise price of $.17 per share.
On June 12, 2019, the Company issued 32,890 shares of its common stock to our Board of Directors at $0.38 per share, pursuant to our annual director compensation plan for the fiscal year ending March 31, 2020.
All of the above issuances and sales were deemed to be exempt under Rule 506 of Regulation D and/or Section 4(2) of the Securities Act. No advertising or general solicitation was employed in offering the securities. The offerings and sales were made to a limited number of persons, all of whom were accredited investors, business associates of the Singing Machine or executive officers of the Singing Machine, and transfer was restricted by the Singing Machine in accordance with the requirement of the Securities Act. In addition to representations by the above-reference persons, we have made independent determinations that all of the above-referenced persons were accredited or sophisticated investors, and that they were capable of analyzing the merits and risks of their investment, and that they understood the speculative nature of their investment. Furthermore, all of the above-referenced persons were provided with access to our Securities and Exchange Commission filings.
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PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
None.
ITEM 6. SELECTED FINANCIAL DATA
We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Financial Statements and Notes thereto. Our fiscal year ends March 31. This document contains certain forward-looking statements regarding anticipated trends in our financial condition and results of operations and our business strategy. (See Part I, 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. Important factors to consider in evaluating such forward-looking statements include (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) various competitive market factors that may prevent us from competing successfully in the marketplace.
Statements included in this Annual Report that do not relate to present or historical conditions are called “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. 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.
OVERVIEW
Our primary objectives for the fiscal year ended March 31, 2020 (“Fiscal 2020”) were to:
| ● | maintain our revenues by expanding our product lines and customer base; | |
| ● | decrease the general and administrative costs to accommodate loss of revenue; | |
| ● | decrease ending inventory on hand; | |
| ● | improve profitability; |
Revenues decreased by approximately $5.1 million or approximately 11% primarily due to reduced holiday foot traffic at large wholesale customers and lower than expected sales of the newly introduced Carpool Karaoke product. Gross profit margins increased by approximately 1.5 margin points to 26.8% primarily due to the high margin yield of the Carpool Karaoke product. Operating expenses (excluding bad debt expense and recovery) increased approximately $0.8 million primarily due to unreimbursed out-of-pocket expenses of approximately $0.7 million associated with warehousing and destruction of damaged goods received by one major customer and additional insurance cost of approximately $0.1 million for credit protection on another major customer. Inventory on hand increased by approximately $1.6 million primarily due to significant overstock returns of the Carpool Karaoke product as well as traditional product associated with reduced holiday foot traffic major wholesale customers. Net loss increased by approximately $3.5 million primarily due to increased operating expenses associated with one-time losses incurred relating to water damaged goods, an increase in discretionary marketing spending associated with the rollout of the new Carpool Karaoke product and increases in co-op marketing programs.
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RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain income and expense items expressed as a percentage of the Company’s total revenues:
| 2020 | 2019 | |||||||
| Total Revenues | 100.0 | % | 100.0 | % | ||||
| Cost of Sales | 73.2 | % | 74.7 | % | ||||
| Operating Expenses | 34.5 | % | 23.1 | % | ||||
| Operating (Loss) Income | -7.7 | % | 2.2 | % | ||||
| Other (Expenses), net | -0.6 | % | -0.6 | % | ||||
| (Loss)Income before Tax provision | -8.3 | % | 1.6 | % | ||||
| Benefit from (provision for) Income Taxes | 1.5 | % | -0.2 | % | ||||
| Net (Loss) Income | -6.8 | % | 1.4 | % | ||||
FISCAL YEAR ENDED MARCH 31, 2020 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2019
NET SALES
Net sales for the year ended March 31, 2020 (“Fiscal 2020”) were approximately $41.4 million. This represents a decrease of approximately $5.1 million as compared to approximately $46.5 million in the fiscal year ended March 31, 2019 (“Fiscal 2019”). There was a significant decrease in sales to our UK and Canada distributors of $2.1 million and $1.4 million, respectively as both distributors ended the prior year with significant overstock inventory and purchased less inventory for Fiscal 2020. In August 2019, a major customer charged the Company back for goods that suffered severe water damage due to excess moisture absorbed in pallets shipped by the factory and as a result we incurred a loss of approximately $1.6 million in net sales. There was one major domestic customer who ended the prior year with significant inventory from the prior season and purchased approximately $1.1 million less for Fiscal 2020. There was another major domestic customer who returned approximately $0.7 million in overstock due to less than expected holiday season sales. These decreases to net sales of approximately $6.9 million were offset by an increase in sales to one major customer of approximately $1.5 million where our products were offered in brick and mortar stores in Fiscal 2020 compared to Fiscal 2019 when our products were offered for internet fulfillment only.
GROSS PROFIT
Gross profit for Fiscal 2020 was approximately $11.0 million or 26.8% of total revenues compared to approximately $11.8 million or 25.3% of sales for Fiscal 2019, a decrease of approximately $0.8 million as compared to the same period in the prior year. The decrease in net sales as explained above accounted for approximately $1.3 million of the decrease in gross profit and was offset by an increase of approximately $0.5 million due to an increase in profit margin.
Gross profit margin for Fiscal 2020 was 26.8% compared to 25.3% for Fiscal 2019, an increase of 1.5 margin points. There was an increase in gross profit margin of approximately $1.7 million or 2.6 margin points due to sales of our new licensed Carpool Karaoke which yielded average gross profit margins of 61.7%. This increase was offset by a 1.1 margin point decrease primarily due the margin yield on the mix of excess core product returned by customers.
OPERATING EXPENSES
In fiscal year 2020, our operating expenses increased from approximately $10.7 million to approximately $14.3 million, an increase of approximately $3.6 million or 33.7% compared to the same period last year. Selling expenses increased by approximately $2.1 million due to increases in advertising allowance of approximately $0.7 million due to increased holiday sales co-op programs, an increase in freight expense of approximately $0.7 million due to increases in freight costs and a significant increase in freight expenses associated with returned and water damaged goods, an increase in discretionary marketing expenses of approximately $0.3 million associated with one-time expenses associated with the rollout of the new Carpool Karaoke product, an increase in royalty expense of approximately $0.3 million for royalties associated with the Carpool Karaoke product with the remaining approximately $0.1 million increase due to an increase in commission expense.
General and administrative expenses increased approximately $0.8 million from approximately $5.8 million in Fiscal 2019 to approximately $6.6 million in Fiscal 2020. The $0.8 million increase was primarily due to out of pocket expenses of approximately $0.7 million associated with the warehousing, inspection, and ultimate destruction of the water damaged goods returned by a major customer and increased credit insurance expense of approximately $0.1 million for J.C. Penney whose deteriorating financial condition required extra protection. This customer accounted for less than 3% of net sales for Fiscal 2020.
There was an increase in bad debt expense of approximately $0.8 million primarily due to the bankruptcy filing of two customers of approximately $0.4 million compared to a partial recovery of approximately $0.4 million from Toys R Us bankruptcy administrative claims in Fiscal 2019.
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(LOSS) INCOME BEFORE INCOME TAX BENEFIT (PROVISION)
We had a loss before income tax benefit of approximately $3.5 million in Fiscal 2020 compared to income before tax provision of approximately $0.8 million in Fiscal 2019 for a total decrease in net income of approximately $4.3 million. There was a one-time charge of approximately $1.1 million in Fiscal 2020 associated with the loss on water damaged goods returned to us by a major customer due to uncertainty of the recovery amount to be received from insurance coverage and other sources. As of July 28, 2020 we have recovered all of the losses including out of pocket expenses from insurance proceeds and a credit to the Company by the factory causing the damage. The remaining $3.2 million decrease is due to the decrease in sales and increased operating expenses as discussed in Net Sales, Gross Profit and Operating Expenses above.
INCOME TAX BENEFIT (PROVISION)
Significant management judgment is required in developing our provisions for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against deferred tax assets. Management evaluates its ability to realize its deferred tax assets on a quarterly basis and adjusts its valuation allowance when it believes that it is not likely to be realized. On March 31, 2020 and 2019, we had net deferred tax assets of approximately $1.3 million and approximately $0.8 million, respectively. The deferred tax assets on March 31, 2020 were net of a valuation allowance of approximately $0.1 million due to management’s belief that certain tax assets will more than likely expire prior to the Company’s ability to realize these assets.
In Fiscal 2020 we recognized an income tax benefit of approximately $0.6 million compared to an income tax provision of approximately $0.2 million in Fiscal 2019. The Company’s effective tax rate for the fiscal year ended March 31, 2020 was approximately 18.1% as compared to 20.1% for Fiscal 2019.
We operate within multiple taxing jurisdictions and are subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve. In management’s opinion, adequate provisions for income taxes have been made.
NET INCOME
As a result of the foregoing, we had a net loss of approximately $2.9 million and net income of $0.6 million for Fiscal 2020 and Fiscal 2019, respectively.
LIQUIDITY AND CAPITAL RESOURCES
On March 31, 2020, we had cash on hand of approximately $0.3 million as compared to cash on hand of approximately $0.2 million on March 31, 2019. The increase of cash on hand of approximately $0.1 million was primarily due to approximately $0.4 million provided by operating activities and approximately $0.2 million in net cash provided by financing activities offset by approximately $0.5 million used for the purchase of fixed assets.
Cash provided by operating activities in Fiscal 2020 was approximately $0.4 million. There was a net loss of approximately $2.9 million. There was an increase in insurance receivable of approximately $1.3 million associated with the water damaged goods pending insurance claim and an increase in inventory of approximately $1.8 million primarily due to significant overstock returns and excess Carpool Karaoke inventory as sales of this product did not meet estimates. These decreases in net cash provided by operating activities were offset by an increase in accounts payable of approximately $4.2 million due to significant hold back of payments from the factory that caused the damaged goods issue pending collection of insurance proceeds, an increase in accrued expenses of approximately $0.7 million associated with estimated remaining co-op advertising credits not yet deducted by customers, an increase in refunds due to customers of approximately $0.8 million primarily due to the unpaid portion of chargebacks for damaged goods due to one customer, and approximately $0.7 million due to related parties for services provided by the parent company and licensing fees for use of pedestal model molds and tooling belonging to the parent company.
Cash provided by operating activities in Fiscal 2019 was approximately $0.2 million. There was a decrease in inventory of approximately $2.5 million primarily due to the sale of prior year’s excess inventory purchased for two major customers one of whom (Toys R Us) filed for bankruptcy. There was a decrease in amounts due from related parties decreased by approximately $0.9 million due collections made on related party shipments. There was an increase in accrued expenses of approximately $0.2 million and an increase in reserve for estimated sales returns of approximately $0.2 million. These increases in cash provided by operating activities of approximately $3.9 million were offset by increases in amounts due from PNC Bank for collections in excess of amounts due on the revolving credit facility of approximately $2.2 million, a decrease in accounts payable of approximately $0.8 million related to the decrease in sales requiring less product purchases and an increase in accounts receivable of approximately $0.7 million.
Cash used by investing activities for Fiscal 2020 of approximately $0.5 million were primarily due to the purchase of a new business reporting system for approximately $0.3 million and the purchase of molds and tooling for new karaoke models of approximately $0.2 million. Cash used by investing activities for Fiscal 2019 of approximately $0.3 million were primarily due to the purchase of molds and tooling for new karaoke models.
Cash provided by financing activities for Fiscal 2020 was approximately $0.2 million. Proceeds of approximately $0.4 million from installment notes for financing the new business reporting system were offset by approximately $0.2 million in scheduled payments on the remaining portion of the bank term note and payments on financed leases and installment notes. In Fiscal 2019, $0.5 million was used for scheduled payments on the bank term note.
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As of March 31, 2020 our working capital was approximately $4.3 million. Our current liabilities of approximately $9.5 million include:
| ● | Accounts payable of approximately $5.0 million of which approximately $4.6 million were amounts due to product vendors which will be settled with insurance proceeds and borrowings on Intercreditor Revolving Credit Facility. | |
| ● | Accrued expenses of approximately $1.5 million of which approximately $0.2 million was accrued payroll, approximately $0.7 million was due to customers for advertising and co-op allowances, approximately $0.2 million for other accrued expenses, approximately $0.1 million for accrued interest on subordinated related party debt, approximately $0.1 million for accrued royalties related to Carpool Karaoke and approximately $0.2 million for accrued product repairs. | |
| ● | Due to related parties of approximately $0.5 million for Hong Kong office administrative expenses and mold and tooling licensing fees. | |
| ● | Refunds due to customers of approximately $0.8 million - the amount will be satisfied by future purchases or refunds. | |
| ● | Reserve for sales returns of approximately $1.2 million – the amount will be satisfied by future purchases or refunds. | |
| ● | Current portion of operating lease liabilities of approximately $0.3 million. | |
| ● | Current portion of installment notes and capital lease payments of approximately $0.1 million. |
WORKING CAPITAL REQUIREMENTS DURING THE SHORT AND LONG TERM
During the next twelve-month period, we plan on financing our working capital needs primarily from:
1) Vendor financing – Some of our key vendors in China have agreed to manufacture on behalf of the Company without advanced payments and have extended payment terms to the Company. The terms with the factories are sufficient to cover the factory direct import sales which are expected to account for approximately 50% of the total revenues in Fiscal 2021.
2) Line of Credit - The Company now has an Intercreditor Revolving Credit Facility expiring on June 15, 2022 with Crestmark Bank for a $10.0 million facility on eligible accounts receivable and a $2.5 million facility on eligible inventory with Iron Horse Credit. Approximately $1.5 million of borrowings are available under all our credit facilities as of the date of this filing.
EXCHANGE RATES
We sell all of our products in U.S. dollars and pay for all of our manufacturing costs in either U.S. or Hong Kong dollars. Operating expenses of the Macau office are paid in either Hong Kong dollars or Macau Pataca (MOP). The exchange rate of the Hong Kong dollar to the U.S. dollar has been relatively stable at approximately HK $7.75 to U.S. $1.00 since 1983 and, accordingly, has not represented a currency exchange risk to the U.S. dollar. The exchange rate of the MOP to the U.S. dollar is MOP $8.00 to U.S. $1.00. While exchange rates have been stable for several years we cannot assure you that the exchange rate between the United States, Macau and Hong Kong currencies will continue to be stable and exchange rate fluctuations may have a material effect on our business, financial condition or results of operations.
SEASONAL AND QUARTERLY RESULTS
Historically, our operations have been seasonal, with the highest net sales occurring in the second and third quarters (reflecting increased orders for equipment and music merchandise during the Christmas selling months) and to a lesser extent the first and fourth quarters of the fiscal year. Sales in our fiscal second and third quarter, combined, accounted for approximately 98% and 94% of net sales in Fiscal 2020 and Fiscal 2019, respectively.
Our results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of orders placed and shipped to customers, as well as other factors. The fulfillment of orders can therefore significantly affect results of operations on a quarter-to-quarter basis.
INFLATION
Inflation has not had a significant impact on the Company’s operations. The Company has historically passed any price increases on to its customers since prices charged by the Company are generally not fixed by long-term contracts.
OFF BALANCE SHEET ARRANGEMENTS
None.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. As such, management is required to make certain estimates, judgments and assumptions that it believes are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. The significant accounting policies which management believes are the most critical to aid in fully understanding and evaluating our reported financial results included accounts receivable allowance for doubtful accounts and reserves on inventory.
ACCOUNTS RECEIVABLE AND COLLECTIBILITY
The Singing Machine’s accounts receivable consist of amounts due from customers in the ordinary course of business. Accounts receivable are carried at cost, net of allowances for uncollectible amounts. Provisions for losses are charged to operations in amounts sufficient to maintain an allowance for losses at a level considered adequate to cover probable losses inherent in the Company’s accounts receivable. The Singing Machine’s allowance for doubtful accounts is based on management’s estimates of the creditworthiness of its customers, current economic conditions and historical information, and, in the opinion of management, is believed to be an amount sufficient to respond to normal business conditions. Management sets 100% reserves for customers in bankruptcy and other reserves based upon historical collection experience. Should business conditions deteriorate or any major customer default on its obligations to the Company, this allowance may need to be significantly increased, which would have a negative impact on operations. In Fiscal 2020 the Company purchased credit insurance of approximately $0.1 million for J.C. Penney whose deteriorating financial condition required extra protection. The Company is subject to chargebacks from customers for cooperative marketing programs, defective returns, return freight and handling charges that are deducted from open invoices and reduce collectability of open invoices.
RESERVES ON INVENTORIES
The Singing Machine establishes a reserve on inventory based on the expected net realizable value of inventory on an item by item basis when it is apparent that the expected realizable value of an inventory item falls below its original cost. A charge to cost of sales results when the estimated net realizable value of specific inventory items declines below cost. Management regularly reviews the Company’s investment in inventories for such declines in value. On March 31, 2020 and 2019 the Company had inventory reserves of approximately $0.4 million and $0.3 million, respectively.
REVENUE RECOGNITION
REVENUE RECOGNITION AND RESERVE FOR SALES RETURNS
The Company recognizes revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, “Revenue from Contracts with Customers”. All revenue is generated from contracts with customers. The Company recognizes revenue when when the goods are delivered and control of the goods sold is transferred to the customer, in an amount, referred to as the transaction price, that reflects the consideration to which the Company is expected to be entitled in exchange for those goods. The Company determines revenue recognition utilizing the following five steps: (1) identification of the contract with a customer, (2) identification of the performance obligations in the contract (promised goods or services that are distinct), (3) determination of the transaction price, (4) allocation of the transaction price to the performance obligations, and (5) recognition of revenue when, or as, the Company transfers control of the product or service for each performance obligation.
The Company’s contracts with customers consist of one performance obligation (the sale of the Company’s products). The Company’s contracts have no financing elements, payment terms are less than 120 days and have no further contract asset or liability obligations once control of goods is transferred to the customer. Revenue is recorded in the amount of consideration the Company expects to receive for the sale of these goods.
Costs incurred in fulfilling contracts with customers include administrative costs associated with the procurement of goods are included in general and administrative expenses, in-bound freight costs are included in the cost of goods sold and accrued sales representative commissions are included in selling expenses in the accompanying consolidated statements of operations as our underlying customer agreements are less than one year.
The Company disaggregates revenues by product line and major geographic region as most of its revenue is generated by the sales of karaoke hardware and the Company has no other material business segments (See NOTE 10).
While the Company generally does not allow products to be returned, the Company does provide for variable consideration contingent upon the occurrence of uncertain future events. Variable consideration is estimated at the expected value or at the most likely amount depending on the type of consideration. Estimated amounts are included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. The Company estimates variable consideration under our return allowance programs for goods returned from the customer for various reasons, whereby a sales return reserve is recorded based on historic return amounts, specific events as identified and management estimates.
For the fiscal years ended March 31, 2020 and 2019 the Company received sales returns of approximately $5.4 million and $3.8 million, respectively. The return of products is due to a variety of reasons including defective units, customers’ overstock and buyer’s remorse. The primary reason for the 4.9 percentage point increase in returns was primarily due to overstock returns of licensed goods from one major customer and overstock returns of non-licensed products from three other major customers.
The Company’s reserve for sales returns were approximately $1.2 million and $0.9 million as of March 31, 2020 and 2019, respectively. (See Note 14 – RESERVE FOR SALES RETURNS).
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INCOME TAXES
We operate within multiple taxing jurisdictions and are subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve. In management’s opinion, adequate provisions for potential income taxes in the jurisdictions have been made. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. If it is more likely than not that some portion of a deferred tax asset will not be realized, a valuation allowance is recognized.
OTHER ESTIMATES
We make other estimates in the ordinary course of business relating to sales returns and allowances, warranty reserves, and reserves for promotional incentives. Historically, past changes to these estimates have not had a material impact on our financial condition. However, circumstances could change which may alter future expectations.
ADOPTION OF NEW ACCOUNTING STANDARDS
In February 2016, the FASB issued ASU 2016-02, Topic 842, as amended, “Leases”. The ASU requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than twelve months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. On April 1, 2019, the Company adopted the new lease standard using the optional transition method under which comparative financial information will not be restated and continue to apply the provisions of the previous lease standard in its disclosures for the comparative periods. (See Note 7– LEASES).
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740). Among several issues addressed in this ASU, there was one area that may potentially affect the Company’s calculations of interim income tax provision or benefit. The guidance specifies that an entity should apply the annual effective tax rate to the year-to date income or loss as long as the tax benefits for any losses are expected to be realized during the year or would be recognizable as a deferred tax asset at the end of the year eliminating the requirement of a valuation allowance for that interim period. There is specific guidance for circumstances in which an entity incurs a loss on a year-to-date basis that exceeds the anticipated ordinary loss for the year, which is an exception to the general guidance in Subtopic 740-270. This new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We are currently evaluating the potential effects of this updated guidance on our consolidated financial statements and related disclosures.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments—Credit Losses” (Topic 326). This ASU represents a significant change in the current accounting model by requiring immediate recognition of management’s estimates of current expected credit losses. Under the prior model, losses were recognized only as they were incurred, which delayed recognition of expected losses that might not yet have met the threshold of being probable. The amendments in ASU 2016-03 for smaller reporting companies are effective for fiscal years beginning after April 1, 2023 including interim periods within that fiscal year. Early adoption is permitted. We are currently evaluating the potential effects of this updated guidance on our consolidated financial statements and related disclosures.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplemental data required pursuant to this Item 8 are included in this Annual Report, as a separate section, commencing on page F-1 and are incorporated herein by reference.
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
N/A
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Annual Report, we conducted an evaluation as required by Rule 13a-15(b) and Rule 15d-15(b) of the Exchange Act, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the relationship between the benefit of desired controls and procedures and the cost of implementing new controls and procedures.
(b) Management’s Annual Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. This rule defines internal control over financial reporting as a process designed by, or under the supervision of Company management to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Management has assessed the effectiveness of our internal control over financial reporting using the components established in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A material weakness is any deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our internal control over financial reporting was effective as of the year covered by this Annual Report.
(c) Changes in Internal Controls
There were no changes in the Company’s internal controls over financial reporting during the quarter ended March 31, 2020, that materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting.
This Annual Report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management’s report in this Annual Report.
None.
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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth certain information with respect to our executive officers, directors and significant employees as of March 31, 2020.
Directors and Executive Officers
For Fiscal Year Ended March 31, 2020
| Name | Age | Position | ||||
| Gary Atkinson | 38 | CEO | ||||
| Bernardo Melo | 43 | VP Global Sales and Marketing | ||||
| Lionel Marquis | 67 | CFO | ||||
| Phillip Lau | 72 | Chairman | ||||
| Harvey Judkowitz | 75 | Director | ||||
| Joseph Kling | 90 | Director | ||||
| Peter Hon | 79 | Director | ||||
| Yat Tung Lau | 41 | Director | ||||
Directors are elected or appointed to serve until the next annual meeting and until their successors are elected and qualified. Officers are appointed to serve for one year until the meeting of the Board of Directors following the annual meeting of stockholders and until their successors have been elected and qualified. Any officer elected or appointed by the Board or appointed by an executive officer or by a committee may be removed by the Board either with or without cause, and in the case of an officer appointed by an executive officer or by a committee, by the officer or committee that appointed him or by the president.
The following information sets forth the backgrounds and business experience of our directors and executive officers and has been provided to us by each respective individual:
Gary Atkinson joined the Company in January 2008 and served as General Counsel and Corporate Secretary. In November 2009, Mr. Atkinson was appointed as Interim Chief Executive Officer and was promoted as the Company’s permanent Chief Executive Officer in May, 2012. Since taking over as Chief Executive Officer, Gary has led the Company to seven consecutive years of profitability and growth in sales. Mr. Atkinson is a licensed attorney in the State of Florida and Georgia. He graduated from the University of Rochester with a Bachelors Degree in Economics and has been awarded a dual-degree J.D./M.B.A. from Case Western Reserve University School of Law and Weatherhead School of Management.
Bernardo Melo has been with the Company since February 2003 and has served as the Vice President of Global Sales and Marketing (“VP of Sales”) since 2008. During his tenure at the Singing Machine, Mr. Melo has overseen the sales and operations of the music division as well as managed the customer service department. Before taking over the responsibility of VP of Sales, Mr. Melo held dual roles with the Company managing the operations, licensing and sales of the music division while concentrating on hardware sales for the Latin America and Canada market as well as key U.S. accounts such as Walmart. Prior to joining the Company, Mr. Melo held a consulting role for Rewards Network formerly Idine. Mr. Melo’s assignment during his tenure was improving their operational procedures while increasing efficiencies and lowering operating cost. Mr. Melo also worked at Coverall North America as Director of Sales managing a startup initiative for the company covering 15 regional office and 40 sales reps across North America focusing on franchise sales. Overall Mr. Melo has over 15 years of sales, marketing and management experience.
Lionel Marquis joined the Company in June 2008 as Controller and Principal Accounting Officer and was appointed as the Company’s Chief Financial Officer in May, 2012. For the past 25 years Mr. Marquis has served as Controller and or Chief Financial Officer for several manufacturing and distribution companies in the South Florida area. Some of these companies include Computer Products, Inc (Artesyn Technologies Inc), US Plastic Lumber Corp., Casi-Rusco, (division of Interlogix Inc.), DHF Industries, Inc and Ingear Fashions, Inc. Mr. Marquis graduated from Bryant University with a Bachelors Degree in Business Administration with a major in accounting. Mr. Marquis is a Certified Public Accountant in the state of Florida.
Philip Lau joined the Company’s board of directors on February 15, 2015 and was appointed as Chairman of the Company’s Board of Directors. Mr. Lau served as Chairman and Managing Director of the Starlight Group of companies since September of 1989. Mr. Lau has over 48 years of management experience in the consumer electronics industry and is a director in a number of Starlight group companies.
Harvey Judkowitz has served as a director of the Company since March 29, 2004 and is the chairman of the Audit Committee. He is licensed as a CPA in New York and Florida. From 1988 to the present date, Mr. Judkowitz has conducted his own CPA practices. He has served as the Chairman and CEO of UniPro Financial Services, a diversified financial services company up until the company was sold in September of 2005. He was formerly the President and Chief Operating Officer of Photovoltaic Solar Cells, Inc.
Peter Hon has served as a director of the Company since January 12, 2007. Mr. Hon has been a non-executive of the Starlight Group since 1998. Mr. Hon passed the College of Law qualifying examination in 1969 in the United Kingdom and began practicing law in Hong Kong in that year after being admitted to the High Court of Hong Kong. He has been the principal of Hon and Co, a law firm in Hong Kong for the past 40 plus years.
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Yat Tung Lau has served as a director of the Company since January 12, 2007. Mr. Lau joined the Starlight Group in 2003 as assistant to the Chairman of the Board of Starlight International and is now head of corporate relations. He is also responsible for local sales in China and heads the computer information system department for the Starlight Group. From 2002 to 2003, he held a marketing executive position in Storage Technology Corporation. Mr. Lau received an MBA from the University of Minnesota and also holds a Bachelor of Arts degree in business marketing from Indiana University.
Joseph Kling was appointed as a director of the Company on May 9, 2017. Mr. Kling has spent his entire career in the toy industry, most notably serving as CEO of View-Master, the iconic stereoscopic toy company, which later purchased Ideal Toy from CBS and later became View-Master Ideal, publicly traded on the Nasdaq. View-Master Ideal later acquired California Plush Toys and the entire group was later acquired by Tyco Toys in 1989. Kling later went into private M&A consulting and sat on the board of Russ Berrie & Co (currently known as Kids Brands, Inc.) for 21 years advising on the acquisition of several toy companies. Mr. Kling has also served on the Board of Crown Crafts, a large distributor of infant, toddler, and juvenile consumer products and on the board of Lancit Media Entertainment, a children’s and family media production company (formerly listed on the Nasdaq). Notably, Mr. Kling has been involved in many major toy company acquisitions of brands such as Melissa & Doug and Brio.
BOARD COMMITTEES
We have an audit committee, a compensation committee and a nominating committee.
The audit committee consisted of Messrs. Judkowitz (Chairman) and Kling. The Board has determined that Mr. Judkowitz qualifies as an “audit committee financial expert,” as defined under Item 407 of Regulation S-K of the Exchange Act. The Board has determined that each of Messrs. Judkowitz and Kling were “independent directors” within the meaning of the listing standards of the major stock exchanges. The audit committee recommends the engagement of independent auditors to the board, initiates and oversees investigations into matters relating to audit functions, reviews the plans and results of audits with our independent auditors, reviews our internal accounting controls, and approves services to be performed by our independent auditors.
The compensation committee consisted of Messrs. Judkowitz, Kling and Philip Lau. The compensation committee considers and authorizes remuneration arrangements for senior management and grants options under, and administers our employee stock option plan.
The nominating committee consisted of Messrs. Philip Lau and Yat Tung Lau. The nominating committee is responsible for reviewing the qualifications of potential nominees for election to the Board of Directors and recommending the nominees to the Board of Directors for such election.
NOMINATION OF DIRECTORS
As provided in our nominating committee charter and our Company’s corporate governance principles, the Nominating Committee is responsible for identifying individuals qualified to become directors. The Nominating Committee seeks to identify director candidates based on input provided by a number of sources, including (1) the Nominating Committee members, (2) our other directors, (3) our shareholders, (4) our Chief Executive Officer or Chairman, and (5) third parties such as professional search firms. In evaluating potential candidates for director, the Nominating Committee considers the entirety of each candidate’s credentials.
Qualifications for consideration as a director nominee may vary according to the particular areas of expertise being sought as a complement to the existing composition of the Board of Directors. However, at a minimum, candidates for director must possess:
| ● | high personal and professional ethics and integrity; | |
| ● | the ability to exercise sound judgment; | |
| ● | the ability to make independent analytical inquiries; | |
| ● | a willingness and ability to devote adequate time and resources to diligently perform Board and committee duties; and | |
| ● | the appropriate and relevant business experience and acumen. |
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In addition to these minimum qualifications, the Nominating Committee also takes into account when considering whether to nominate a potential director candidate the following factors:
| ● | whether the person possesses specific industry expertise and familiarity with general issues affecting our business; | |
| ● | whether the person’s nomination and election would enable the Board to have a member that qualifies as an “audit committee financial expert” as such term is defined by the Securities and Exchange Commission (the “SEC”) in Item 401 of Regulation S-K; | |
| ● | whether the person would qualify as an “independent” director under the listing standards of the OTC; | |
| ● | the importance of continuity of the existing composition of the Board of Directors to provide long term stability and experienced oversight; and | |
| ● | the importance of diversified Board membership, in terms of both the individuals involved and their various experiences and areas of expertise. |
There have been no material changes to the procedures by which stockholders may recommend nominees to the Company’s board of directors as set forth in the Company’s Proxy Statement on Schedule 14A filed with the SEC on February 5, 2019.
FAMILY RELATIONSHIPS
There are no family relationships among any of our officers or other directors, except for Chairman Philip Lau who is the father of Director Yat Tung Lau and the uncle of Gary Atkinson, the Company’s CEO.
CODE OF ETHICS
We have adopted a Code of Business Conduct and Ethics, which is applicable to all directors, officers and employees of the Singing Machine, including our principal executive officer, our principal financial officer, and our principal accounting officer or controller or other persons performing similar functions. A copy of the Code of Ethics is posted on the Company’s website at www.singingmachine.com. We intend to post amendments to or waivers from our Code of Ethics (to the extent applicable to our chief executive officer, principal financial officer, principal accounting officer or controller or other persons performing similar functions) on our website.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Section 16(a) of the Exchange Act requires our officers, directors, and persons who own more than ten percent of a registered class of our equity securities to file reports of securities ownership and changes in such ownership with the SEC. Officers, directors, and greater-than-ten-percent stockholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms that they file.
Based solely upon a review of Forms 3, Forms 4, and Forms 5 furnished to us pursuant to Rule 16a-3 under the Exchange Act, we believe that all such forms required to be filed pursuant to Section 16(a) of the Exchange Act during the year ended March 31, 2020 were timely filed, as necessary, by the officers, directors, and security holders required to file such forms except for the following:
Mr. Harvey Judkowitz filed a Form 5 in lieu of filing a timely Form 4 with respect to one transaction;
Mr. Peter Hon filed a Form 5 in lieu of filing a timely Form 4 with respect to one transaction;
Mr. Yat-Tung Lau filed a Form 5 in lieu of filing a timely Form 4 with respect to one transactions;
Mr. Philip Lau filed a Form 5 in lieu of filing a timely Form 4 with respect to one transactions;
Mr. Joseph Kling filed a Form 5 in lieu of filing a timely Form 4 with respect to one transactions.
ITEM 11. EXECUTIVE COMPENSATION
The following table provides certain summary information concerning compensation awarded to, earned by or paid to our Chief Executive Officer and other named executive officers of our Company (collectively, the “named executive officers”) for Fiscal 2019.
SUMMARY COMPENSATION TABLE
| Name and Principal Position | Year | Salary | Bonus | Stock Awards | Option Awards | Non-Equity Incentive Plan Comp | Non-Qualified Deferred Compensation Earnings | Other Comp | TOTAL COMP | |||||||||||||||||||||||||||
| Gary Atkinson | 2020 | $ | 150,000 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 150,000 | |||||||||||||||||||
| Chief Executive Officer | 2019 | $ | 150,000 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 150,000 | |||||||||||||||||||
| Lionel Marquis | 2020 | $ | 149,153 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 149,153 | |||||||||||||||||||||
| Chief Financial Officer | 2019 | $ | 142,952 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 142,952 | |||||||||||||||||||
| Bernardo Melo | 2020 | $ | 157,200 | $ | 70,771 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 227,971 | |||||||||||||||||||
| VP Global Sales & Marketing | 2019 | $ | 157,200 | $ | 110,747 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 267,947 | |||||||||||||||||||
Narrative Disclosure to Summary Compensation Table
Mr. Atkinson does not have an employment contract with the Company and had an annual salary of $150,000 for the fiscal year ended March 31, 2020 and 2019.
Mr. Marquis does not have an employment contract with the Company and had an annual salary of $150,000 for the fiscal year ended March 31, 2020 and 2019.
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Mr. Melo does not have an employment contract with the Company and had an annual salary of $157,200 for the fiscal years ended March 31, 2020 and 2019.
As of June 28, 2020, the Company did not have any employment contracts with any of its employees. However, on January 3, 2014, the Company entered into agreements with the three executive officers named above that if an executive’s employment is terminated by the executive or the Company following a change in control, the executive will be entitled to the following within 10 days of termination:
| ● | All accrued and unpaid compensation due to the executive as of the date of termination. | |
| ● | A lump sum payment equal to one year’s executive base salary if the executive terminates employment. | |
| ● | A lump sum of one and a half year’s executive base salary and targeted annual bonus if the Company terminates employment. | |
| ● | All outstanding stock options shall be fully vested and exercisable for the remainder of their full term. | |
| ● | All outstanding equity-based compensation awards (other than stock options) shall become fully vested with any restrictions removed. |
OPTION GRANTS IN FISCAL 2020
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table sets forth information with respect to outstanding grants of options to purchase our common stock under our Year 2001 Stock Option Plan as well as other stock option awards issued with Board of Directors approval to the named executive officers as of the fiscal year ended March 31, 2020:
| Name and Principal Position | Number of Securities Underlying Unexercised Options (#) Exercisable | Number of Securities Underlying Unexercised Options (#) Unexercisable | Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) | Option Exercise Price ($) | Option Expiration Date | Number of Shares or Units of Stock That Have Not Vested (#) | Market Value of Shares or Units of Stock That Have Not Vested ($) | Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested (#) | Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested ($) | |||||||||||||||
| Gary Atkinson, CEO - Year 2001 Stock Option Plan | 120,000 | - | N/A | 0.06 | 10/29/2020 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 150,000 | - | N/A | 0.21 | 7/1/2023 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 50,000 | - | N/A | 0.24 | 3/31/2026 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 100,000 | - | N/A | 0.47 | 5/3/2027 | N/A | N/A | N/A | N/A | |||||||||||||||
| Lionel Marquis, CFO - Year 2001 Stock Option Plan | 120,000 | - | N/A | 0.06 | 10/29/2020 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 100,000 | - | N/A | 0.21 | 7/1/2023 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 15,000 | - | N/A | 0.24 | 3/31/2026 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 50,000 | - | N/A | 0.47 | 5/3/2027 | N/A | N/A | N/A | N/A | |||||||||||||||
| Bernardo Melo, VP Sales - Year 2001 Stock Option Plan | 200,000 | - | N/A | 0.06 | 10/29/2020 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 250,000 | - | N/A | 0.21 | 7/1/2023 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 25,000 | - | N/A | 0.17 | 6/30/2025 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 100,000 | - | N/A | 0.32 | 8/10/2026 | N/A | N/A | N/A | N/A | |||||||||||||||
| - Other stock option awards | 200,000 | - | N/A | 0.47 | 5/3/2027 | N/A | N/A | N/A | N/A | |||||||||||||||
CHIEF EXECUTIVE PAY RATIO DISCLOSURE
The Securities and Exchange Commission adopted a rule requiring annual disclosure of the ratio of the total annual compensation of the chief executive officer to the median employee’s total annual compensation. Mr. Atkinson’s total compensation as reported in the Executive Summary Compensation Table is compared to the median employee’s total compensation as reflected in the ratio table below. The median employee was determined using the quarterly average number of active full-time employees and a subcontractor for the fiscal year ended March 31, 2020 excluding Mr. Atkinson. All wages, cash bonuses, contractor payments, and fair market value of stock option awards granted to each employee (excluding Mr. Atkinson) were included in determining the median employee’s total compensation. The table below presents the ratio of Mr. Atkinson’s total annual compensation to the median employee’s total annual compensation.
| Mr. Atkinson’s total annual compensation | $ | 150,000 | ||
| Median employee’s total annual compensation | $ | 53,159 | ||
| Ratio of Chief Executive Officer to median emloyee | 2.4 : 1 |
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The following table sets forth with respect to the named director, compensation information inclusive of equity awards and payments made in Fiscal 2020.
DIRECTOR COMPENSATION
| Name | Fees Earned or Paid in Cash | Stock Awards (1) | Option Awards (2) | Non-Equity Incentive Plan Compensation ($) | Nonqualified Deferred Comepnsation Earnings | All Other Compensation | Total | |||||||||||||||||||||
| Peter Hon | $ | 500 | $ | 2,500 | $ | 4,002 | $ | - | $ | - | $ | - | $ | 7,002 | ||||||||||||||
| Harvey Judkowitz | $ | 9,750 | $ | 2,500 | $ | 4,001 | $ | - | $ | - | $ | - | $ | 16,251 | ||||||||||||||
| Phillip Lau | $ | 250 | $ | 2,500 | $ | 4,002 | $ | - | $ | - | $ | - | $ | 6,752 | ||||||||||||||
| Yat Tung Lau | $ | - | $ | 2,500 | $ | 4,002 | $ | - | $ | - | $ | - | $ | 6,502 | ||||||||||||||
| Joseph Kling | $ | 9,500 | $ | 2,500 | $ | 4,001 | $ | - | $ | - | $ | - | $ | 16,001 | ||||||||||||||
Refer to Note 1 “Stock Based Compensation” in the Notes to the Consolidated Financial Statements included elsewhere in this Annual Report for the relevant assumptions used to determine the valuation of our option awards.
1) As of March 31, 2020 the aggregate number of stock awards held by Messrs. Judkowitz and Kling is 350,337 and 15,668, respectively. The aggregate stock awards held by Messrs. Hon, Yat Tung Lau and Philip Lau is 54,942, 44,525 and 15,668, respectively.
(2) As of March 31, 2020 the aggregate number of Company stock options held by Messrs. Judkowitz and Kling is 160,000 and 60,000, respectively and Messrs. Hon, Yat Tung Lau and Philip Lau is 80,000, 60,000 and 60,000 respectively.
During Fiscal 2020, our compensation package for our non-employee directors consisted of grants of stock options, cash payments, stock issuances and reimbursement of costs and expenses associated with attending our board meetings. Our five non-employee directors during Fiscal 2020 were Messrs. Judkowitz, Hon, Kling, Yat Tung Lau and Philip Lau.
During Fiscal 2020, we have utilized the following compensation policy for our directors:
| ● | An initial grant of 20,000 Singing Machine stock options with an exercise price determined as the closing price on the day of joining the board. The options will vest in one year and expire in ten years while they are board members or the lesser of five years or remaining life of the stock option once they are no longer board members. | |
| ● | An annual cash payment of $7,500 will be made for each completed full year of service or prorated for a partial year. The payment will be made on or before March 31. | |
| ● | An annual stock grant of stock equivalent in value to $2,500 for each completed full year of service or prorated for a partial year. The stock price at grant will be determined at the closing price on the day of the Annual Stockholder Meeting. The actual grant will be made on or before March 31. | |
| ● | An annual grant of 20,000 Singing Machine stock options with an exercise price determined as the closing price on the day of the Annual Stockholder Meeting. If the Annual Meeting is held less than 6 months after the board member first joined the board he or she will not receive another option grant. | |
| ● | Independent board members will receive a $500 fee for each board meeting and annual meeting they attend. Committee meetings and telephone board meetings will be compensated with a $250 fee. | |
| ● | All expenses will be reimbursed for attending board, committee and annual meetings or when their presence at a location away from home is requested. |
YEAR 2001 PLAN
On June 1, 2001, our Board of Directors approved the Year 2001 Plan and it was approved by our shareholders at our special meeting held September 6, 2001. The Year 2001 Plan was developed to provide a means whereby directors and selected employees, officers, consultants, and advisors of the Company may be granted incentive or non-qualified stock options to purchase common stock of the Company. The Year 2001 Plan authorized an aggregate of 1,950,000 shares of the Company’s common stock with a maximum of 450,000 shares to any one individual in any one fiscal year. The shares of common stock available under the Year 2001 Plan were subject to adjustment for any stock split, declaration of a stock dividend or similar event. At March 31, 2020, we had granted 940,000 options under the Year 2001 Plan 200,000 of which had expired, 160,000 which had been exercised and 580,000 of which remained outstanding and fully vested. As of this date the Year 2001 Plan has expired and no further options can be issued thereunder.
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Options granted under the Year 2001 Plan are not transferable except by will or applicable laws of descent and distribution. Except as expressly determined by the Compensation Committee, no option under the Year 2001 Plan is exercisable after thirty (30) days following an individual’s termination of employment with the Company or a subsidiary, unless such termination of employment occurs by reason of such individual’s disability, retirement or death. The obligations of the Company under the Year 2001 Plan are binding on (1) any successor corporation or organization resulting from the merger, consolidation or other reorganization of the Company or (2) any successor corporation or organization succeeding to all or substantially all of the assets and business of the Company. In the event of any of the foregoing, the Compensation Committee may, at its discretion, prior to the consummation of the transaction, offer to purchase, cancel, exchange, adjust or modify any outstanding options, as such time and in such manner as the Compensation Committee deems appropriate.
401(K) PLAN
Effective January 1, 2001, we adopted a voluntary 401(k) plan. All employees with at least one year of service are eligible to participate in our 401(k) plan. 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 for each payroll period. The amounts charged to earnings for contributions to this plan and administrative costs during the years ended March 31, 2020 and 2019 totaled approximately $63,000 and $70,000, respectively.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth as of August 12, 2020 (the “record date”), certain information concerning beneficial ownership of our common stock by:
| ● | all directors and former directors of the Singing Machine, | |
| ● | all named executive officers of the Singing Machine; and | |
| ● | persons known to own more than 5% of our common stock. |
Security ownership is based on 38,557,643 shares of our common stock issued and outstanding. In computing the number and percentage of shares beneficially owned by a person, shares of common stock subject to convertible securities and options currently convertible or exercisable, or convertible or exercisable within 60 days of August 12, 2020 are counted as outstanding, but these shares are not counted as outstanding for computing the percentage ownership of any other person.
As used herein, the term beneficial ownership with respect to a security is defined by Rule 13d-3 under the Securities Exchange Act of 1934 as consisting of sole or shared voting power (including the power to vote or direct the vote) and/or sole or shared investment power (including the power to dispose or direct the disposition of) with respect to the security through any contract, arrangement, understanding, relationship or otherwise, including a right to acquire such power(s) during the next 60 days. Unless otherwise noted below, and subject to applicable property laws, to our knowledge each person has sole investment and sole voting power over the shares shown as beneficially owned by them. Unless otherwise noted, the principal address of each of the directors and officers listed below is c/o The Singing Machine Company, Inc., 6301 NW 5th Way, Suite 2900, Fort Lauderdale, FL 33309.
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Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
As of August 12, 2020
| Name and Address of Beneficial Owner | Amount and Nature of Certain Beneficial Ownership of Common Stock | Percentage of outstanding shares of common stock | ||||||
| Security Ownership of Management: | ||||||||
| Gary Atkinson (1) | 459,481 | 1.2 | % | |||||
| Lionel Marquis (1) | 285,000 | * | ||||||
| Bernardo Melo (1) | 863,916 | 2.2 | % | |||||
| Philip Lau (1) | 75,668 | * | ||||||
| Harvey Judkowitz (1) | 510,337 | 1.3 | % | |||||
| Joseph Kling (1) | 75,668 | * | ||||||
| Yat Tung Lau (1) | 104,525 | * | ||||||
| Peter Hon (1) | 134,942 | * | ||||||
| Officers & Directors as a Group (8 persons) | 2,509,537 | 6.5 | % | |||||
| Security Ownership of Certain Beneficial Owners: | ||||||||
| Fairy King (2) | 19,623,155 | 51.0 | % | |||||
| Arts Electronics Ltd. (3) | 3,745,917 | 9.7 | % | |||||
| Gentle Boss Investments Ltd (4) | 2,100,000 | 5.5 | % | |||||
* Less than 1%
| Total Shares of Common Stock as of August 12, 2020 | 38,464,753 | |||
| Stock Options Exercisable within 60 days of August, 2020 | 2,210,000 | |||
| Total | 40,674,753 |
(1) Includes as to the person indicated, the following outstanding stock options to purchase shares of the Company’s Common Stock issued under 2001 Stock Option Plan, which will be vested and exercisable within 60 days of the record date: 420,000 options held by Gary Atkinson, 775,000 options held by Bernardo Melo, 285,000 options held by Lionel Marquis, 160,000 options held by Harvey Judkowitz, 60,000 options held by Joseph Kling, 80,000 options held by Peter Hon, 60,000 held by Yat Tung Lau and 60,000 held by Philip Lau.
(2) “Fairy King” is defined in Part I, Item 1 under “Business Overview.” Koncepts International Ltd. and Treasure Green Holdings, Ltd. own 18,682,679 and 940,476, respectively of the Company’s Common Stock and are wholly owned subsidiaries of Fairy King. The address for Fairy King is: 5/F Shing Dao Industrial Bldg., 232 Aberdeen Rd., Hong Kong. Fairy King is owned by Philip Lau, our Chairman of the Board.
(3) The address for Arts Electronics Ltd. is Room 101, Fo Tan Ind CTR 1/F, 26-28 Au Pui Wan, Fo Tan, Shatin N.T. Hong Kong.
(4) The address for Gentle Boss Investments Ltd. is Unit 6, 9/F, Tower B, 55 Hoi Yuen Road, Kwun Tong, Kowloon Hong Kong.
ITEM 13. CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
DUE TO/FROM RELATED PARTIES
On March 31, 2020 the Company had approximately $0.5 million due to related parties for services provided by these companies and licensing fees for use of pedestal model molds and tools owned by the parent company. On March 31, 2019, the Company had approximately $0.3 million due from related parties for goods and services sold to these companies.
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Subordinated Related Party Debt and Note Payable
In connection with the Revolving Credit Facility the Company was required to subordinate related party debt to Starlight Marketing Development, Ltd. (“subordinated debt”). The subordinated debt of approximately $924,000 bore interest at 6% and was scheduled to be paid in quarterly installments of $123,000 which include interest and commenced September 30, 2017 and ending on the debt maturity date of June 30, 2019. Quarterly installment payments of $123,000 due on the last day of each fiscal quarter were not been made since September 2017; however a payment of $25,000 which includes principal and interest, was made during the Fiscal 2020. On June 1, 2020 the remaining amount due on the subordinated debt of approximately $803,000 was converted to a note payable which bears interest at 6%. As part of the agreement to convert the subordinated debt to a note payable it was agreed that interest expense would be accrued on the unpaid principal retroactively from the date that scheduled payments had been missed resulting in an incremental charge to interest expense of approximately $72,000 for the Fiscal 2020.
During the years ended March 31, 2020 and 2019 interest expense was approximately $74,000 and $21,000, respectively on the related party subordinated debt.
In connection with the Intercreditor Revolving Credit Facility the Company was required to subordinate the note payable (“subordinated note payable”) to Starlight Marketing Development, Ltd. Both agreements allow for the repayment of the subordinated note payable provided any amounts borrowed against these credit facilities are paid in full, the Company maintains a 1 : 1 debt coverage ratio and exhibits sufficient cash liquidity to support on-going operations. There is no set schedule with regards to payment of the note and as such note has been classified as a non-current liability for the year ended March 31, 2020 on the consolidated balance sheets. As of March 31, 2019 the remaining amount due on the subordinated debt was approximately $815,000 and was classified as a current liability on the consolidated balance sheets.
TRADE
During both Fiscal 2020 and 2019 the Company paid approximately $0.4 million to Starlight Electronics Company, Ltd (“SLE”) as reimbursement for engineering, quality control and other administrative services performed on our behalf in China. These expense reimbursements were included in general and administrative expenses on our consolidated statements of operations.
During Fiscal 2020 and 2019 the Company sold approximately $0.9 million and $1.2 million, respectively of product to Winglight Pacific, Ltd. (“Winglight”) a related company, for direct shipment to Cosmo Communications of Canada, Ltd (“Cosmo”), another related company, at discounted pricing granted to major direct import customers shipped internationally with freight prepaid. The average gross profit margin on sales to Winglight for Fiscal 2020 and 2019 was 23.7% and 30.1%, respectively. These amounts were included as a component of net sales in the accompanying consolidated statements of operations.
During Fiscal 2020 and 2019 the Company sold approximately $0.3 million and $0.4 million, respectively of product to Cosmo from our California warehouse facility. These goods were sold at a discounted price, similar to prices granted to major direct import customers shipped internationally with freight prepaid. The average gross profit margin on sales to Cosmo yielded 26.6% and 22.5%, respectively. These amounts were included as a component of net sales in the accompanying consolidated statements of operations.
On July 30, 2020 The Company and Cosmo reached agreement that Cosmo would no longer be the Company’s Canadian distributor and the Company became the sole and exclusive distributor of the Company’s products in Canada. As part of the agreement, the companies executed a Purchase and Sales agreement whereby the Company acquired all of Cosmo’s karaoke inventory for approximately $685,000.
Review, Approval or Ratification of Transactions with Related Persons
We believe that the terms of all of the above transactions are commercially reasonable and no less favorable to us than we could have obtained from an unaffiliated third party. Our policy requires that all related parties recuse themselves from negotiating and voting on behalf of our company in connection with related party transactions. While we do not maintain a written policy with respect to related party transactions, our board of directors routinely reviews potential transactions with those parties we have identified as related parties prior to the consummation of the transaction. Each transaction is reviewed to determine that a related party transaction is entered into by us with the related party pursuant to normal competitive negotiation. We also generally require that all related parties recuse themselves from negotiating and voting on behalf of the Company in connection with related party transactions.
CORPORATE GOVERNANCE
Board Determination of Independence
The Board has determined that Messrs. Judkowitz and Kling are “independent directors” within the meaning of the listing standards of major stock exchanges. The audit committee recommends the engagement of independent auditors to the board, initiates and oversees investigations into matters relating to audit functions, reviews the plans and results of audits with our independent auditors, reviews our internal accounting controls, and approves services to be performed by our independent auditors.
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ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following is a summary of the fees billed to the Singing Machine by our independent registered public accounting firms for professional services rendered for Fiscal 2020 and Fiscal 2019:
| Fee Category | Fiscal 2020 | Fiscal 2019 | ||||||
| Audit Fees | $ | 122,199 | $ | 104,276 | ||||
| All Other Fees | - | 20,821 | ||||||
| Total Fees | $ | 122,199 | $ | 125,097 | ||||
Audit Fees - Consists of fees billed for professional services rendered for the audit of the Singing Machine’s consolidated financial statements and review of the interim consolidated financial statements included in quarterly reports and services that were provided by EisnerAmper, LLP, respectively.
All Other Fees - Consists of fees for products and services other than the services reported above including review of proxy statements and services provided in connection with the audit of China Sinostar, our parent company.
POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT SERVICES OF INDEPENDENT AUDITORS
The Audit Committee’s policy is to pre-approve all audit and permissible non-audit services provided by the independent registered public accounting firm. These services may include audit services, audit-related services, tax services and other services. Pre-approval is generally provided for up to one year and any pre-approval is detailed as to the particular service or category of services and is generally subject to a specific budget. The auditors and management are required to periodically report to the Audit Committee regarding the extent of services provided by the auditors in accordance with this pre-approval, and the fees for the services performed to date. The Audit Committee may also pre-approve particular services on a case-by-case basis.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) 1. The following financial statements for The Singing Machine Company, Inc. and Subsidiaries are filed as a part of this report:
Consolidated Balance Sheets— March 31, 2020 and 2019.
Consolidated Statements of Operations—Years ended March 31, 2020 and 2019.
Consolidated Statements of Cash Flows—Years ended March 31, 2020 and 2019.
Consolidated Statements of Shareholders’ Equity—Years ended March 31, 2020 and 2019.
2. Notes to Consolidated Financial Statements
Schedules are omitted because of the absence of conditions under which they are required or because the information is included in the financial statements or notes thereto.
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(b) Exhibits.
* Filed herewith
+ Compensatory plan or arrangement.
None.
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In accordance with the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, The Singing Machine Company, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| THE SINGING MACHINE COMPANY, INC. | ||
| Date: August 13, 2020 | By: | /s/ Gary Atkinson |
| Gary Atkinson | ||
| Chief Executive Officer |
In accordance with the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of The Singing Machine Company, Inc. and in the capacities and on the dates indicated.
| SIGNATURE | CAPACITY | DATE | ||
| /s/ GARY ATKINSON | Chief Executive Officer | August 13, 2020 | ||
| Gary Atkinson | (Principal Executive Officer) | |||
| /s/ LIONEL MARQUIS | Chief Financial Officer | August 13, 2020 | ||
| Lionel Marquis | (Principal Financial Officer) | |||
| /s/ PHILIP LAU | Chairman | August 13, 2020 | ||
| Philip Lau | ||||
| /s/ HARVEY JUDKOWITZ | Director | August 13, 2020 | ||
| Harvey Judkowitz | ||||
| /s/ Joseph KLING | Director | August 13, 2020 | ||
| Joseph Kling | ||||
| /s/ YAT TUNG LAU | Director | August 13, 2020 | ||
Yat Tung Lau |
||||
| /s/ peter hon | Director | August 13, 2020 | ||
| Peter Hon |
| 32 |
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARIES
FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
| F-1 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
The Singing Machine Company, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of The Singing Machine Company, Inc. and Subsidiaries (the “Company”) as of March 31, 2020 and 2019, and the related consolidated statements of operations, cash flows, and shareholders’ equity for each of the years then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the consolidated financial position of the Company as of March 31, 2020 and 2019, and the consolidated results of their operations and their cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Change in Accounting Principle
As discussed in Note 3 to the financial statements, the Company has changed its method of accounting for leases in fiscal year 2020 due to the adoption of Accounting Standards Codification Topic 842, Leases.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ EisnerAmper LLP
We have served as the Company’s auditor since 2016.
Iselin, New Jersey
August 13, 2020
| F-2 |
The Singing Machine Company, Inc. and Subsidiaries
| March 31, 2020 | March 31, 2019 | |||||||
| Assets | ||||||||
| Current Assets | ||||||||
| Cash | $ | 345,200 | $ | 211,408 | ||||
| Accounts receivable, net of allowances of $337,461 and $51,906, respectively | 1,860,500 | 1,769,404 | ||||||
| Due from PNC Bank | 2,388,438 | 2,236,779 | ||||||
| Accounts receivable related party - Winglight Pacific, Ltd | 100,000 | 288,941 | ||||||
| Insurance claim receivable | 1,268,463 | - | ||||||
| Inventories, net | 7,601,277 | 6,024,311 | ||||||
| Prepaid expenses and other current assets | 252,473 | 274,278 | ||||||
| Deferred financing costs | 3,333 | 13,333 | ||||||
| Total Current Assets | 13,819,684 | 10,818,454 | ||||||
| Property and equipment, net | 771,349 | 522,910 | ||||||
| Deferred financing costs, net of current portion | - | 3,333 | ||||||
| Deferred tax assets | 1,285,721 | 758,366 | ||||||
| Operating Leases - right of use assets | 573,874 | - | ||||||
| Other non-current assets | 150,509 | 90,082 | ||||||
| Total Assets | $ | 16,601,137 | $ | 12,193,145 | ||||
| Liabilities and Shareholders’ Equity | ||||||||
| Current Liabilities | ||||||||
| Accounts payable | $ | 5,041,610 | $ | 842,708 | ||||
| Accrued expenses | 1,529,168 | 950,773 | ||||||
| Current portion of bank term note payable | - | 125,000 | ||||||
| Due to related party - Starlight Consumer Electronics Co., Ltd. | 14,400 | - | ||||||
| Due to related party - Starlight Electronics Co., Ltd | 372,300 | - | ||||||
| Due to related party - Starlight R&D, Ltd. | 115,016 | - | ||||||
| Refunds due to customers | 806,475 | 31,075 | ||||||
| Reserve for sales returns | 1,224,000 | 896,154 | ||||||
| Current portion of finance leases | 14,953 | 14,414 | ||||||
| Current portion of installment notes | 63,098 | - | ||||||
| Current portion of operating lease liabilities | 321,389 | - | ||||||
| Current portion of subordinated related party debt - Starlight Marketing Development, Ltd. | - | 815,367 | ||||||
| Total Current Liabilities | 9,502,409 | 3,675,491 | ||||||
| Finance leases, net of current portion | 2,550 | 17,499 | ||||||
| Installment notes, net of current portion | 283,193 | - | ||||||
| Operating lease liabilities, net of current portion | 322,263 | - | ||||||
| Subordinated related party debt - Starlight Marketing Development, Ltd., | ||||||||
| net of current portion | 802,659 | - | ||||||
| Total Liabilities | 10,913,074 | 3,692,990 | ||||||
| Commitments and Contingencies | ||||||||
| Shareholders’ Equity | ||||||||
| Preferred stock, $1.00 par value; 1,000,000 shares authorized; no shares issued and outstanding | - | - | ||||||
| Common stock, Class A, $0.01 par value; 100,000 shares authorized; no shares issued and outstanding | - | - | ||||||
| Common stock, Class B, $0.01 par value; 100,000,000 shares authorized; 38,557,643 and 38,464,753 shares issued and outstanding, respectively | 385,576 | 384,648 | ||||||
| Additional paid-in capital | 19,729,043 | 19,687,263 | ||||||
| Subscriptions receivable | - | (2,200 | ) | |||||
| Accumulated deficit | (14,426,556 | ) | (11,569,556 | ) | ||||
| Total Shareholders’ Equity | 5,688,063 | 8,500,155 | ||||||
| Total Liabilities and Shareholders’ Equity | $ | 16,601,137 | $ | 12,193,145 | ||||
See notes to the consolidated financial statements
| F-3 |
The Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
| For the Years Ended | ||||||||
| March 31, 2020 | March 31, 2019 | |||||||
| Net Sales | $ | 41,418,304 | $ | 46,482,998 | ||||
| Cost of Goods Sold | 30,323,223 | 34,709,799 | ||||||
| Gross Profit | 11,095,081 | 11,773,199 | ||||||
| Operating Expenses | ||||||||
| Selling expenses | 7,203,991 | 5,117,235 | ||||||
| General and administrative expenses | 6,564,422 | 5,790,019 | ||||||
| Bad debt expense (recovery) | 302,333 | (442,671 | ) | |||||
| Depreciation | 269,107 | 259,662 | ||||||
| Total Operating Expenses | 14,339,853 | 10,724,245 | ||||||
| (Loss) Income from Operations | (3,244,772 | ) | 1,048,954 | |||||
| Other Expenses | ||||||||
| Interest expense | (240,709 | ) | (244,593 | ) | ||||
| Finance costs | (13,333 | ) | (13,334 | ) | ||||
| Total Other Expenses | (254,042 | ) | (257,927 | ) | ||||
| (Loss) Income Before Income Tax Benefit (Provision) | (3,498,814 | ) | 791,027 | |||||
| Income Tax Benefit (Provision) | 641,814 | (159,480 | ) | |||||
| Net (Loss) Income | $ | (2,857,000 | ) | $ | 631,547 | |||
| Net (Loss) Income per Common Share | ||||||||
| Basic | $ | (0.07 | ) | $ | 0.02 | |||
| Diluted | $ | (0.07 | ) | $ | 0.02 | |||
| Weighted Average Common and Common Equivalent Shares: | ||||||||
| Basic | 38,532,889 | 38,360,883 | ||||||
| Diluted | 38,532,889 | 39,244,250 | ||||||
See notes to the consolidated financial statements
| F-4 |
The Singing Machine Company, Inc. and Subsidiaries
CONDENSED STATEMENTS OF CASH FLOWS
| For the Years Ended | ||||||||
| March 31, 2020 | March 31, 2019 | |||||||
| Cash flows from operating activities | ||||||||
| Net (loss) Income | $ | (2,857,000 | ) | $ | 631,547 | |||
| Adjustments to reconcile net (loss) income to net cash provided by operating activities: | ||||||||
| Depreciation | 269,107 | 259,662 | ||||||
| Amortization of deferred financing costs | 13,333 | 13,334 | ||||||
| Change in inventory reserve | 180,000 | (26,000 | ) | |||||
| Change in allowance for bad debts | 286,365 | (31,006 | ) | |||||
| Stock based compensation | 32,508 | 52,428 | ||||||
| Change in net deferred tax assets | (527,355 | ) | 178,771 | |||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (377,461 | ) | (671,559 | ) | ||||
| Due from PNC Bank | (151,659 | ) | (2,230,567 | ) | ||||
| Accounts receivable - related parties | 188,941 | 868,217 | ||||||
| Insurance receivable | (1,268,463 | ) | - | |||||
| Inventories | (1,756,966 | ) | 2,538,623 | |||||
| Prepaid expenses and other current assets | 21,805 | (136,308 | ) | |||||
| Other non-current assets | (60,427 | ) | (78,559 | ) | ||||
| Accounts payable | 4,198,902 | (772,040 | ) | |||||
| Accrued expenses | 704,433 | 248,841 | ||||||
| Due to related parties | 501,716 | (413,675 | ) | |||||
| Refunds due to customers | 775,400 | (414,409 | ) | |||||
| Reserve for sales returns | 327,846 | 170,154 | ||||||
| Operating lease liabilities, net of operating leases - right of use assets | (56,260 | ) | - | |||||
| Net cash provided by operating activities | 444,765 | 187,454 | ||||||
| Cash flows from investing activities | ||||||||
| Purchase of property and equipment | (517,546 | ) | (288,741 | ) | ||||
| Net cash used in investing activities | (517,546 | ) | (288,741 | ) | ||||
| Cash flows from financing activities | ||||||||
| Payment of bank term note | (125,000 | ) | (500,000 | ) | ||||
| Proceeds from installment notes | 365,340 | - | ||||||
| Payments on installment notes | (19,049 | ) | - | |||||
| Proceeds from subscription receivable | 2,200 | - | ||||||
| Proceeds from exercise of stock options | 10,200 | 10,400 | ||||||
| Payment on subordinated debt - related party | (12,708 | ) | - | |||||
| Payments on finance leases | (14,410 | ) | (11,613 | ) | ||||
| Net cash provided by (used by) financing activities | 206,573 | (501,213 | ) | |||||
| Net change in cash | 133,792 | (602,500 | ) | |||||
| Cash at beginning of year | 211,408 | 813,908 | ||||||
| Cash at end of year | $ | 345,200 | $ | 211,408 | ||||
| Supplemental disclosures of cash flow information: | ||||||||
| Cash paid for interest | $ | 179,811 | $ | 230,242 | ||||
| Equipment purchased under capital lease | $ | - | $ | 43,526 | ||||
| Operating leases - right of use assets initial adoption | $ | 1,108,330 | $ | - | ||||
| Operating lease liabilities - initial adoption | $ | 1,234,368 | $ | - | ||||
See notes to the consolidated financial statements
| F-5 |
The Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the years ended March 31, 2020 and March 31, 2019
| Preferred Stock | Common Stock | Additional Paid | Subscriptions | Accumulated | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | in Capital | Receivable | Deficit | Total | |||||||||||||||||||||||||
| Balance at March 31, 2018 | - | $ | - | 38,282,028 | $ | 382,820 | $ | 19,624,063 | $ | - | $ | (12,201,103 | ) | $ | 7,805,780 | |||||||||||||||||
| Net Income | 631,547 | 631,547 | ||||||||||||||||||||||||||||||
| Employee compensation-stock option | 39,928 | 39,928 | ||||||||||||||||||||||||||||||
| Exercise of stock options | 160,000 | 1,600 | 11,000 | (2,200 | ) | 10,400 | ||||||||||||||||||||||||||
| Director fees | 22,725 | 228 | 12,272 | 12,500 | ||||||||||||||||||||||||||||
| Balance at March 31, 2019 | - | - | 38,464,753 | 384,648 | 19,687,263 | (2,200 | ) | (11,569,556 | ) | 8,500,155 | ||||||||||||||||||||||
| Net Loss | (2,857,000 | ) | (2,857,000 | ) | ||||||||||||||||||||||||||||
| Employee compensation-stock option | 20,008 | 20,008 | ||||||||||||||||||||||||||||||
| Collection of subscription receivable | 2,200 | 2,200 | ||||||||||||||||||||||||||||||
| Exercise of stock options | 60,000 | 600 | 9,600 | 10,200 | ||||||||||||||||||||||||||||
| Issuance of common stock - directors | 32,890 | 328 | 12,172 | 12,500 | ||||||||||||||||||||||||||||
| Balance at March 31, 2020 | - | $ | - | 38,557,643 | $ | 385,576 | $ | 19,729,043 | $ | - | $ | (14,426,556 | ) | $ | 5,688,063 | |||||||||||||||||
See notes to the consolidated financial statements.
| F-6 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
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. (“SMC-L”) and SMC-Music, Inc. (“SMC-M”), 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.
The Company is partially held by koncepts International Limited (“koncepts”) who is major shareholder of the Company, owning approximately 49% of our shares of common stock outstanding on a fully diluted basis as of March 31, 2020. The Company is also partly held by Treasure Green Holdings Ltd. (“Treasure Green) who owns approximately 2% of our common stock. In total approximately 51% of the Company’s shares of common stock on a fully diluted basis as of March 31, 2020 are owned by koncepts and Treasure Green.
For most of the Fiscal Year, China Sinostar Group Company Limited (Sinostar and its subsidiaries collectively referred to herein as the “Sinostar Group” or “Sinostar”) held 100% of the common stock of koncepts and Treasure Green. Sinostar is a company whose principal activities include property development, property management, property investment, management of hydroelectric power stations, and design and sale of electronic products through its various subsidiaries. We do business with a number of entities that are indirectly wholly-owned or majority owned subsidiaries of Sinostar, including Starlight R&D Ltd (“Starlight R&D”), Starlight Consumer Electronics USA, Inc., (“SCE”), Cosmo Communications Corporation of Canada, Inc. (“Cosmo”) and Star Light Electronics Company Ltd (Starlite), among others. On December 12, 2019, Sinostar transferred the assets of its consumer electronics division (including all of it’s shares of koncepts and Treasure Green to Fairy King Prawn Holdings Limited (“Fairy King”), an investment holding company incorporated in the British Virgin Islands, principally owned by the Company’s Chairman, Philip Lau.
NOTE 2 - LIQUIDITY
The Company reported net loss of approximately $2.9 million for the fiscal year ended March 31, 2020 as compared to net income of approximately $0.6 million for the fiscal year ended March 31, 2019. In August 2019, a major customer received goods that were significantly water damaged due to excess moisture absorbed in pallets shipped by the factory. As a result we incurred a loss in cash flow of approximately $1.6 million in revenue and approximately $0.8 million in additional out of pocket expenses to retrieve, inspect, warehouse and properly destroy the goods. As of July 10, 2020 we have recovered approximately $2.3 million from our cargo insurance coverage and secured vendor invoice credits of $0.4 million from the factory that caused the damage. The Company’s inventory also increased by approximately $1.5 million due to overstock returns as well as excess inventory of the new Carpool Karaoke product. On June 16, 2020, the Company executed the Intercreditor Revolving Credit Facility on eligible accounts receivable and inventory. The Company signed a two-year Loan and Security Agreement for a $10,000,000 financing facility with Crestmark on eligible accounts receivable. Further, the Company also executed a two-year Loan and Security Agreement with Iron Horse for up to $2,500,000 in inventory financing. The Intercreditor Revolving Loan Facility expire on June 15, 2022. The Company has adequate cash on hand and cash available on its Intecreditor Revolving Credit Facility, approximately $1.4 million as of the date of this filing, to meet all obligations during this off-peak season. Management is confident that the availability of cash from our Intercreditor Revolving Credit Facility and our projections to reduce excess inventory during the next year will be adequate to meet the Company’s liquidity requirements for at least the next twelve months.
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company, its Macau Subsidiary, SMC-L, and SMC-M. All inter-company accounts and transactions have been eliminated in consolidation for all periods presented.
USE OF ESTIMATES
The Singing Machine makes estimates and assumptions in the ordinary course of business relating to sales returns and allowances, warranty reserves, inventory reserves and reserves for promotional incentives that affect the reported amounts of assets and liabilities and of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Future events and their effects cannot be determined with absolute certainty; therefore, the determination of estimates requires the exercise of judgment. Historically, past changes to these estimates have not had a material impact on the Company’s financial statements. However, circumstances could change which may alter future expectations.
COLLECTIBILITY OF ACCOUNTS RECEIVABLE
The Singing Machine’s allowance for doubtful accounts is based on management’s estimates of the creditworthiness of its customers, current economic conditions and historical information, and, in the opinion of management, is believed to be in an amount sufficient to respond to normal business conditions. Management sets 100% reserves for customers in bankruptcy and other allowances based upon historical collection experience. The Company is subject to chargebacks from customers for cooperative marketing programs, defective returns, return freight and handling charges that are deducted from open invoices and reduce collectability of open invoices. Should business conditions deteriorate or any major customer default on its obligations to the Company, this allowance may need to be significantly increased, which would have a negative impact on operations.
| F-7 |
FOREIGN CURRENCY TRANSLATION
The functional currency of the Macau Subsidiary is the Hong Kong dollar. The financial statements of the subsidiary are translated to U.S. dollars using period-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are recorded in the consolidated statement of operations and translations would be recorded in a separate component of shareholders’ equity. Any such amounts were not material during the periods presented.
Concentration of Credit Risk
At times, the Company maintains cash in United States bank accounts that are in excess of the Federal Deposit Insurance Corporation insured amounts. The Company maintains cash balances in foreign financial institutions. The amounts at foreign financial institutions at March 31, 2020 and 2019 were approximately $0.2 million.
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist of accounts receivable.
INVENTORY
Inventories are comprised primarily of electronic karaoke equipment, microphones and accessories, and are stated at the lower of cost or net realizable value, as determined using the first in, first out method. Inventories also include an estimate for the net realizable value of expected future inventory returns due to warranty and allowance programs. As of March 31, 2020 and March 31, 2019 the estimated amounts for these future inventory returns were approximately $1.4 million and $0.6 million, respectively. The Company reduces inventory on hand to its net realizable value on an item-by-item basis when it is apparent that the expected realizable value of an inventory item falls below its original cost. A charge to cost of sales results when the estimated net realizable value of specific inventory items declines below cost. Management regularly reviews the Company’s investment in inventories for such declines in value. As of March 31, 2020 and 2019 the Company had inventory reserves of approximately and $0.4 million and $0.3 million, respectively for estimated excess and obsolete inventory.
LONG-LIVED ASSETS
The Company reviews long-lived assets for impairment whenever circumstances and situations change such that there is an indication that the carrying amounts may not be recoverable. If the undiscounted future cash flows attributable to the related assets are less than the carrying amount, the carrying amounts are reduced to fair value and an impairment loss is recognized in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360-10-05, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation. Expenditures for repairs and maintenance are charged to expense as incurred. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to their estimated useful lives using accelerated and straight-line methods.
FAIR VALUE OF FINANCIAL INSTRUMENTS
We follow FASB ASC 825, Financial Instruments, which requires disclosures of information about the fair value of certain financial instruments for which it is practicable to estimate that value. For purposes of this disclosure, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation.
The carrying amounts of the Company’s short-term financial instruments, including accounts receivable, accounts payable, accrued expenses, refunds due to customers, and due to/from related parties approximates fair value due to the relatively short period to maturity for these instruments. The carrying amounts on the bank term note payable, the subordinated debt to Starlight Marketing Development, Ltd. (related party) and finance leases approximate fair value either due to the relatively short period to maturity or the related interest is accrued at a rate similar to market rates. The carrying amounts on the revolving line of credit approximates fair value due the relatively short period to maturity and related interest accrued at market rates.
REVENUE RECOGNITION AND RESERVE FOR SALES RETURNS
The Company recognizes revenue in accordance with FASB ASC 606, “Revenue from Contracts with Customers”. All revenue is generated from contracts with customers. The Company recognizes revenue when the goods are delivered and control of the goods sold is transferred to the customer, in an amount, referred to as the transaction price, that reflects the consideration to which the Company is expected to be entitled in exchange for those goods. The Company determines revenue recognition utilizing the following five steps: (1) identification of the contract with a customer, (2) identification of the performance obligations in the contract (promised goods or services that are distinct), (3) determination of the transaction price, (4) allocation of the transaction price to the performance obligations, and (5) recognition of revenue when, or as, the Company transfers control of the product or service for each performance obligation.
The Company’s contracts with customers consist of one performance obligation (the sale of the Company’s products). The Company’s contracts have no financing elements, payment terms are less than 120 days and have no further contract asset or liability obligations once control of goods is transferred to the customer. Revenue is recorded in the amount of consideration the Company expects to receive for the sale of these goods.
| F-8 |
Costs incurred in fulfilling contracts with customers include administrative costs associated with the procurement of goods are included in general and administrative expenses, in-bound freight costs are included in the cost of goods sold and accrued sales representative commissions are included in selling expenses in the accompanying consolidated statements of operations as our underlying customer agreements are less than one year.
The Company disaggregates revenues by product line and major geographic region as most of its revenue is generated by the sales of karaoke hardware and the Company has no other material business segments (See NOTE 10).
While the Company generally does not allow products to be returned, the Company does provide for variable consideration contingent upon the occurrence of uncertain future events. Variable consideration is estimated at the expected value or at the most likely amount depending on the type of consideration. Estimated amounts are included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. The Company estimates variable consideration under our return allowance programs for goods returned to the customer for various reasons, whereby a sales return reserve is recorded based on historic return amounts, specific events as identified and management estimates.
The Company’s reserve for sales returns were approximately $1.2 million and $0.9 million as of March 31, 2020 and March 31, 2019, respectively.
During fiscal 2020 and 2019 revenue was derived from five different major product lines. Disaggregated approximate revenue from these product lines consisted of the following:
| Revenue by Product Line | ||||||||
| Fiscal Years Ended | ||||||||
| Product Line | March 31, 2020 | March 31, 2019 | ||||||
| Classic Karaoke Machines | $ | 29,200,000 | $ | 25,100,000 | ||||
| Download Karaoke Machines | 5,800,000 | 13,000,000 | ||||||
| SMC Kids Toys | 1,000,000 | 4,200,000 | ||||||
| Licensed Product | 2,100,000 | - | ||||||
| Music and Accessories | 3,300,000 | 4,200,000 | ||||||
| Total Net Sales | $ | 41,400,000 | $ | 46,500,000 | ||||
SHIPPING AND HANDLING COSTS
Shipping and handling costs are performed by both the Company and third party logistics companies. Shipping and handling activities are performed before the customer obtains control of the goods sold to them and are considered activities to fulfill the Company’s promise to transfer the goods. For Fiscal 2020 and 2019 shipping and handling expenses were approximately $1.2 million and $0.9 million. These expenses are classified as a component of selling expenses in the accompanying consolidated statements of operations.
STOCK-BASED COMPENSATION
The Company follows the provisions of the FASB ASC 718-20, “Compensation – Stock Compensation Awards Classified as Equity”. ASC 718-20 requires all share-based payments to employees including grants of employee stock options, be measured at fair value and expensed in the consolidated statement of operations over the service period (generally the vesting period). The Company uses the Black-Scholes option valuation model to value stock options. Employee stock option compensation expense in fiscal years 2020 and 2019 includes the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period for the entire portion of the award. For the years ended March 31, 2020 and 2019, the stock option expense was approximately $20,000 and $52,000, respectively.
The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option-pricing model with the assumptions outlined below. The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is based upon observation of actual time elapsed between date of grant and exercise of options for all employees.
| ● | For the year ended March 31, 2020: expected dividend yield 0%, risk-free interest rate of 2.08% , volatility of 194.50% and expected term of three years. | |
| ● | For the year ended March 31, 2019: expected dividend yield 0%, risk-free interest rate of 2.08% , volatility of 216.33% and expected term of three years. |
The Company’s directors were issued shares of stock as compensation for their service. For the years ended March 31, 2020 and 2019, the stock compensation expense to directors was $12,500.
| F-9 |
ADVERTISING
Costs incurred for producing and publishing advertising of the Company are charged to operations the first time the advertising takes place. The Company has entered into cooperative advertising agreements with its major customers that specifically indicated that the customer must spend the cooperative advertising fund upon the occurrence of mutually agreed events. The percentage of the cooperative advertising allowance ranges from 1% to 13% of the purchase. The customers must advertise the Company’s products in the customer’s catalog, local newspaper and other advertising media. The customer must submit the proof of the performance (such as a copy of the advertising showing the Company’s products) to the Company to request for the allowance. The customer does not have the ability to spend the allowance at their discretion. The Company believes that the identifiable benefit from the cooperative advertising program and the fair value of the advertising benefit is equal or greater than the cooperative advertising expense. Advertising expense for the fiscal years ended March 31, 2020 and 2019 was approximately $4.0 million and $3.0 million, respectively. As of March 31, 2020 and March 31, 2019, there was an accrual for cooperative advertising allowances of approximately $0.7 million and $0.6 million, respectively. These amounts were a component of accrued expenses in the consolidated balance sheets.
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to results of operations as incurred. These expenses are shown as a component of general and administrative expenses in the consolidated statements of operations. For the years ended March 31, 2020 and 2019, these amounts totaled approximately $0.1 million.
INCOME TAXES
The Company follows the provisions of FASB ASC 740 “Accounting for Income Taxes.” Under the asset and liability method of ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. If it is more likely than not that some portion of a deferred tax asset will not be realized, a valuation allowance is recognized.
The Company recognizes a liability for uncertain tax positions. An uncertain tax position is defined as a position in a previously filed tax return or a position expected to be taken in a future tax return that is not based on clear and unambiguous tax law and which is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The Company measures the tax benefits recognized based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. As of March 31, 2020 and 2019, there were no uncertain tax positions that resulted in any adjustment to the Company’s provision for income taxes. The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes. The Company currently has no liabilities recorded for accrued interest or penalties related to uncertain tax provisions.
ADOPTION OF NEW ACCOUNTING STANDARDS
In February 2016, the FASB issued ASU 2016-02, Topic 842, as amended, “Leases”. The ASU requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than twelve months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. On April 1, 2019, the Company adopted the new lease standard using the optional transition method under which comparative financial information will not be restated and continue to apply the provisions of the previous lease standard in its disclosures for the comparative periods. (See Note 7– COMMITMENTS AND CONTINGENCIES - LEASES).
The Company determines if an arrangement contains a lease at the inception of a contract. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at the commencement date. The liability is equal to the present value of the remaining minimum lease payments. The asset is based on the liability, subject to certain adjustments. Operating leases result in straight-line expense (similar to operating leases under the prior accounting standard) while finance leases result in a front-loaded expense pattern (similar to capital leases under the prior accounting standard). As the interest rate implicit in the Company’s operating leases is not readily determinable, the Company utilizes its incremental borrowing rate to discount the lease payments. The Company utilizes the implicit rate for its finance leases.
RECENT ACCOUNTING PRONOUNCEMENTS:
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740). Among several issues addressed in this ASU, there was one area that may potentially affect the Company’s calculations of interim income tax provision or benefit. The guidance specifies that an entity should apply the annual effective tax rate to the year-to date income or loss as long as the tax benefits for any losses are expected to be realized during the year or would be recognizable as a deferred tax asset at the end of the year eliminating the requirement of a valuation allowance for that interim period. There is specific guidance for circumstances in which an entity incurs a loss on a year-to-date basis that exceeds the anticipated ordinary loss for the year, which is an exception to the general guidance in Subtopic 740-270. This new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We are currently evaluating the potential effects of this updated guidance on our consolidated financial statements and related disclosures.
| F-10 |
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments—Credit Losses” (Topic 326). This ASU represents a significant change in the current accounting model by requiring immediate recognition of management’s estimates of current expected credit losses. Under the prior model, losses were recognized only as they were incurred, which delayed recognition of expected losses that might not yet have met the threshold of being probable. The amendments in ASU 2016-03 for smaller reporting companies are effective for fiscal years beginning after April 1, 2023 including interim periods within that fiscal year. Early adoption is permitted. We are currently evaluating the potential effects of this updated guidance on our consolidated financial statements and related disclosures.
NOTE 4 – INVENTORIES, NET
Inventories are comprised of the following components:
| March 31, | March 31, | |||||||
| 2020 | 2019 | |||||||
| Finished Goods | $ | 6,595,980 | $ | 5,679,245 | ||||
| Inventory in Transit | 72,607 | - | ||||||
| Estimated Amount of Future Returns | 1,366,690 | 599,066 | ||||||
| Subtotal | 8,035,277 | 6,278,311 | ||||||
| Less: Inventory Reserve | 434,000 | 254,000 | ||||||
| Total Inventories | $ | 7,601,277 | $ | 6,024,311 | ||||
NOTE 5 - PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
| USEFUL | MARCH 31, | MARCH 31, | ||||||||
| LIFE | 2020 | 2019 | ||||||||
| Computer and office equipment | 5-7 years | $ | 444,935 | $ | 140,575 | |||||
| Furniture and fixtures | 7 years | 98,410 | 98,410 | |||||||
| Warehouse equipment | 7 years | 195,401 | 209,419 | |||||||
| Molds and tooling | 3-5 years | 1,680,023 | 1,466,837 | |||||||
| 2,418,769 | 1,915,241 | |||||||||
| Less: Accumulated depreciation | 1,647,420 | 1,392,331 | ||||||||
| $ | 771,349 | $ | 522,910 | |||||||
Depreciation expense for fiscal years ended 2020 and 2019 was approximately $0.3 million.
NOTE 6 – BANK FINANCING
Revolving Credit Facility PNC Bank
On June 22, 2017, the Company renewed the existing revolving credit facility (the “Revolving Credit Facility”) with PNC Bank, National Association (“PNC”) for an additional three years which was terminated on June 16, 2020. The outstanding loan balance could not exceed $15.0 million during peak selling season between August 1 and December 31 and was reduced to a maximum of $7.5 million between January 1 and July 31. At March 31, 2020 there was no amount due on the Revolving Credit Facility. Usage under the Revolving Credit Facility could not exceed the sum of the following (the “Borrowing Base”):
| ● | Up to 70% of the Company’s eligible domestic and Canadian accounts receivable aged less than 90 days past due as defined plus | |
| ● | Up to the lesser of (a) 60% of the cost of eligible inventory or (b) 85% of net orderly liquidation value percentage of eligible inventory (annual inventory appraisals required); minus | |
| ● | Applicable reserves including a dilution reserve equal to 100% of the Company’s advertising and return accrual reserves. | |
| ● | Dilution reserve not to exceed availability generated from eligible accounts receivable. |
The Revolving Credit Facility included the following sub-limits:
| ● | Letters of Credit to be issued limited to $3.0 million. | |
| ● | Inventory availability limited to $5.0 million. | |
| ● | $0.5 million eligible in-transit inventory sublimit within the $5.0 million total inventory. | |
| ● | Mandatory pay-down to $1.0 million (excluding letters of credit) for any 30 consecutive days between February 1 and April 30. |
The Revolving Credit Facility had to comply with the following quarterly financial covenants to avoid default:
| ● | Fixed charge coverage ratio test as defined. | |
| ● | Capital expenditures limited to approximately $0.4 million per year. |
| F-11 |
As of September 30, 2019 the Company defaulted on the Revolving Credit Facility due to non-compliance with the fixed charge coverage ratio in part due to the loss of margin and expenses associated with the damaged goods discussed above. In November 2019, the Company entered into a Forbearance Agreement with PNC Bank National Association (“PNC”) whereby PNC delayed taking action it would have been be entitled to under a default through March 31, 2020. The Forbearance Agreement required, among other matters, the Company to comply with certain conditions and covenants including the following:
| ● | PNC implemented a $1,000,000 loan availability block. | |
| ● | PNC required EBITDA hurdles of greater than or equal to $400,000 for the third quarter ending December 31, 2019, of $0 for the six months ending March 31, 2020 and $(83,000) for the twelve months ending March 31, 2020. | |
| ● | PNC charged a loan pricing increase of .5% until March 31, 2020 which continued until termination of Revolving Credit Facility. |
The Company remained in default of the forbearance agreement up until termination of the Revolving Credit Facility on June 16, 2020 at which time the Company entered into the Intercreditor Revolving Credit Facility with Crestmark and Iron Horse.
Prior to the Forbearance Agreement interest on the Revolving Line of Credit was accrued at .75% per annum over PNC’s announced prime rate with an option for the Company to elect the 1, 2 or 3 month fully absorbed PNC LIBOR Rate plus 2.75% per annum with a default rate of 2% over the applicable rate. Upon execution of the Forbearance Agreement there was a pricing rate increase of ..5% on the .75% per annum rate and the PNC LIBOR Rate plus 2.75%. There was an unused facility fee equal to .375% per annum on the unused portion of the Revolving Credit Facility which was calculated on the basis of a 360 day year for the actual number of days elapsed and will be payable quarterly in arrears. During the twelve months ended March 31, 2020 and 2019 the Company incurred interest expense of approximately $0.1 million and $0.2 million, respectively, on amounts borrowed against the Revolving Credit Facility. During the twelve months ended March 31, 2020 and 2019, the Company incurred an unused facility fee of approximately $46,000 and $30,000, respectively on the unused portion of the Revolving Credit Facility.
The Revolving Line of Credit was secured by first priority security interests in all of the named borrowers’ tangible and intangible assets as well as first priority security interests of 100% of member or ownership interests of any of its domestic existing or newly formed subsidiaries and first priority lien on up to 65% of the borrowers’ foreign subsidiary’s existing or subsequently formed or acquired foreign subsidiaries. The Revolving Credit Facility was also secured by a related-party debt subordination agreement with Starlight Marketing Development, Ltd. in the amount of approximately $803,000. Costs associated with renewal of the Revolving Credit Facility of approximately $40,000 were deferred and were amortized over the term of the agreement. During the fiscal years ended March 31, 2020 and 2019 the Company incurred amortization expense of approximately $13,000 associated with the amortization of deferred financing costs from the Revolving Credit Facility.
Intercreditor Revolving Credit Facility Crestmark Bank and Iron Horse Credit
On June 16, 2020, the Company executed an Intercreditor Revolving Credit Facility on eligible accounts receivable and inventory. The Company signed a two-year Loan and Security Agreement for a $10.0 million financing facility with Crestmark on eligible accounts receivable. The outstanding loan balance cannot exceed $10.0 million during peak selling season between July 1 and December 31and is reduced to a maximum of $5.0 million between January 1 and July 31.
Under the Crestmark Bank Intercreditor Revolving Credit Line:
| ● | Advance rate shall not exceed 70% of Eligible Accounts Receivable aged less than 90 days from invoice date. | |
| ● | Crestmark shall maintain a base dilution reserve of 1% for each 1% of dilution over 15%. | |
| ● | Crestmark will implement an availability block of 20% of amounts due on Iron Horse Intercreditor Revolving Line of Credit. | |
| ● | Mandatory pay-down of the loan to zero in January and February each year. | |
| ● | All financial covenants are waived throughout the agreement. |
The Crestmark Intercreditor Revolving Credit Facility is secured by a perfected security interest in all assets including a first security interest in Accounts Receivable and Inventory. Notwithstanding the foregoing, Crestmark shall subordinate its first security interest in inventory to Iron Horse as agreed between all parties. The Crestmark Intercreditor Revolving Credit Facility bears interest at the Wall Street Journal Prime Rate plus 5.50% with a floor of 8.75%. Interest and Maintenance Fees shall be calculated on the higher of the actual average monthly loan balance from the prior month or a minimum average loan balance of $2,000,000. The Crestmark Intercreditor Revolving Credit Facility expires on June 15, 2022.
In addition, the Company also executed a two-year Loan and Security Agreement with Iron Horse for up to $2,500,000 in inventory financing.
Under the Iron Horse Intercreditor Revolving Credit Line:
| ● | Advance rate shall not exceed the lower of (a) 70% of the inventory cost or (b) 85% of Net Orderly Liquidation Value (NOLV) as determined by an independent third-party appraiser engaged by Iron Horse. | |
| ● | The Company must maintain a fixed charge coverage ratio test of 1:1 times measured on a rolling 12-month basis, defined as EBITDA less non-financed capital expenditures, cash dividends and distributions paid and cash taxes paid divided by the sum of interest and principal on all indebtedness. This financial covenant has been waived for the first six months of the Intercreditor Revolving Credit Line. |
| F-12 |
The Iron Horse Intercreditor Revolving Credit Facility is secured by a perfected security interest in the Company’s inventory. The Iron Horse Intercreditor Revolving Credit Facility bears interest at 1.292% per month or 15.51% annually. Interest shall be calculated on the higher of the actual average monthly loan balance from the prior month or a minimum average loan balance of $1,000,000. The Iron Horse Intercreditor Revolving Credit Facility expires on June 15, 2022.
Term Note Payable
In connection with the PNC Revolving Line of Credit, the agreement also included a two-year term note (“Term Note”) in the amount of $1.0 million. The Term Note bore interest at 1.75% per annum over PNC’s announced prime rate or 1, 2, or 3 month PNC LIBOR Rate plus 3.75%. The Term Note was payable in quarterly installments of $125,000 plus accrued interest with the first installment paid on August 1, 2017. At March 31, 2020 and 2019, the outstanding balance on the Term Note was approximately $0.0 million and $0.1 million, respectively. During the years ended March 31, 2020 and 2019 the Company incurred interest expense of approximately $0 and $22,000, respectively.
Installment Notes Payable
On June 18, 2019, the Company entered into a financing arrangement with Dimension Funding, LLC (“Dimension”) to finance a new ERP System project over a term of 60 months at a cost of approximately $0.4 million. Upon approval by Company management, Dimension released progress payments directly to the project vendor as specific project milestones were met. Progress payments were made to the vendor over a period of approximately nine months and the Company was charged financing costs only on the amounts released to the vendor. At the end of each quarter, progress payments made to the vendor were converted to installment notes. As of March 31, 2020 the Company executed two installment notes totaling approximately $0.3 million for payments issued to the project vendor. The installment notes have 60 month terms with interest rates of 7.58% and 9.25%, respectively. The installment notes are payable in monthly installments of $5,785 which include principal and interest. As of March 31, 2020 there was an outstanding balance on the installment notes of approximately $0.3 million. For the year ended March 31, 2020 the Company incurred interest expense of approximately $23,000.
In April 2020 the Company executed a third installment note in the amount of approximately $0.1 million for the remaining amounts payable to the project vendor. The third installment has 60 month payment terms and bears interest at 8.55%. Initial monthly payments of $1,674 commenced on April 1, 2020.
Subordinated Debt/Note Payable to Related Party
The subordination agreement was previously amended reducing the amount of related party subordinated debt to the remaining amount due of approximately $815,000. Provision was also made to allow repayment of the remaining $815,000 in quarterly installments of $123,000 including interest accrued at 6% per annum commencing September 30, 2017 and ending on the debt maturity date of June 30, 2019. Payments of $123,000 were only permitted upon receipt of the Company’s quarterly compliance certificate; the Company having met the mandatory pay-down of the Revolving Credit Facility to $1,000,000 and average excess availability for the prior 30 days (after subtraction of third party trade payables 30 days or more past due) of no less than $1,000,000 after giving effect to the payment. As part of the Conditions to Installment Payment of the subordinated debt, payments not made under this note that could be made as a result of the foregoing prohibition, including payments after the scheduled maturity date, were not be deemed an Event of Default and could made as soon as the Company was able to demonstrate that it met the liquidity requirements defined above. Quarterly installment payments of $123,000 due on the last day of each fiscal quarter have not been made since September 2017 due to the Company not meeting these requirements. A payment of $25,000 was made in August 2019 with approximately $12,500 paying down the principal and approximately $12,500 paying interest due.
On June 1, 2020 the remaining amount due on the subordinated debt of approximately $803,000 was converted to a note payable which bears interest at 6%. As part of the agreement to convert the subordinated debt to a note payable it was agreed that interest expense would be accrued on the unpaid principal retroactively from the date that scheduled payments had been missed resulting in an incremental charge to interest expense of approximately $72,000 for the Fiscal 2020. During the fiscal years ended March 31, 2020 and 2019 interest expense was approximately $74,000 and $21,000, respectively on the related party subordinated debt.
In connection with the Intercreditor Revolving Credit Facility the Company was required to subordinate the note payable (“subordinated note payable”) to Starlight Marketing Development, Ltd. Both Crestmark and Iron Horse agreements allow for the repayment of the subordinated note payable provided any amounts borrowed against these credit facilities are paid in full, the Company maintains a 1 : 1 debt coverage ratio and exhibits sufficient cash liquidity to support on-going operations. There is no set schedule with regards to repayment of the note and as such the subordinated note payable has been classified a non-current liability for the year ended March 31, 2020 on the consolidated balance sheets. As of March 31, 2019 the remaining amount due on the subordinated debt was approximately $815,000 and was classified as a current liability on the consolidated balance sheets.
NOTE 7 - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
On or about February 4, 2020 Singing Machine was named in a product liability complaint alongside Target and Energizer Brands in the state of Missouri. It is alleged by the Plaintiff, an individual, that one of Singing Machine’s karaoke products injured the plaintiff while she was operating the product from battery power. Plaintiff alleges her injury occurred when battery acid leaked from the karaoke product. The plaintiff purchased the karaoke machine at Target and operated the karaoke machine with Energizer batteries. Plaintiff is suing both Singing Machine and Energizer because she is unsure whether the karaoke product or the batteries caused the battery acid leak.
| F-13 |
The plaintiff alleges four counts of action against Singing Machine including strict product liability, negligence, breach of warranty, and failure to warn. Singing Machine has product liability insurance and the matter has been turned over the matter to insurance company’s counsel in defending the matter. The Company does not believe that the resolution of this matter is likely to have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
As of August 12, 2020 management is not aware of any other legal proceedings other than matters that arise in the ordinary course of business.
LEASES
The Company determines if an arrangement contains a lease at the inception of a contract. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at the commencement date. The liability is equal to the present value of the remaining minimum lease payments. The asset is based on the liability, subject to certain adjustments. Operating leases result in straight-line expense (similar to operating leases under the prior accounting standard) while finance leases result in a front-loaded expense pattern (similar to capital leases under the prior accounting standard). As the interest rate implicit in the Company’s operating leases is not readily determinable, the Company utilizes its incremental borrowing rate to discount the lease payments. The Company utilizes the implicit rate for its finance leases.
Operating Leases
We have operating lease agreements for offices and a warehouse facility in Florida, California and Macau expiring in various years through 2024.
We entered into an operating lease agreement, effective October 1, 2017, for the corporate headquarters located in Fort Lauderdale, Florida where we lease approximately 6,500 square feet of office space. The lease expires on March 31, 2024. The base rent payment is approximately $8,800 per month, subject to annual adjustments.
We entered into an operating lease agreement, effective June 1, 2013, for 86,000 square feet of warehouse space in Ontario, California for our logistics operations. The lease expires on August 31, 2020 (original lease term of 87 months). The base rent payment is approximately $43,700 per month for the remaining term of the lease. On June 15, 2020 we executed a three-year lease extension which will expire on August 31, 2023.
We entered into an operating lease agreement, effective May 1, 2018, for 424 square feet of office space in Macau. The rent is fixed at approximately $1,600 per month for the duration of the lease which expires on April 30, 2021. The lease provides for a renewal option to extend the lease.
Lease expense for our operating leases is recognized on a straight-line basis over the lease terms.
Finance Leases
On May 25, 2018 and June 4, 2018, we entered into two long-term capital leasing arrangements with Wells Fargo Equipment Finance (“Wells Fargo”) to finance the leasing of two used forklift vehicles in the amount of approximately $44,000. The leases require monthly payments in the amount of $1,279 per month over a total lease term of 36 months which commenced on June 1, 2018. The agreement has an effective interest rate of 4.5% and the Company has the option to purchase the equipment at the end of the lease term for one dollar. As of March 31, 2020 and 2019 the remaining amounts due on these capital leasing arrangements was $18,000 and $32,000, respectively. For the fiscal years ended March 31, 2020 and 2019 the Company incurred interest expense of $894 and $1,155, respectively.
| F-14 |
Supplemental balance sheet information related to leases as of March 31, 2020 is as follows:
| Assets: | ||||
| Operating lease - right-of-use assets | $ | 573,874 | ||
| Finance leases as a component of property and equipment, net of accumulated depreciation of $11,918 | 31,608 | |||
| Liabilities | ||||
| Current | ||||
| Current portion of operating leases | $ | 321,389 | ||
| Current portion of finance leases | 14,953 | |||
| Noncurrent | ||||
| Operating lease liabilities, net of current portion | $ | 322,263 | ||
| Finance leases, net of current portion | 2,550 |
Supplemental statement of operations information related to leases for the fiscal year ended March 31, 2020 is as follows:
| Fiscal Year Ended | ||||
| March 31, 2020 | ||||
| Operating lease expense as a component of general and administrative expenses | $ | 534,456 | ||
| Finance lease cost | ||||
| Depreciation of leased assets as a component of depreciation | $ | 6,218 | ||
| Interest on lease liabilities as a component of interest expense | $ | 894 | ||
| Supplemental cash flow information related to leases for the nine months ended March 31, 2020 is as follows: | ||||
| Cash paid for amounts included in the measurement of lease liabilities: | ||||
| Operating cash flow paid for operating leases | $ | 651,158 | ||
| Financing cash flow paid for finance leases | $ | 14,410 | ||
| Lease term and Discount Rate | ||||
| Weighted average remaining lease term (months) | 29.6 | |||
| Operating leases | 14.0 | |||
| Finance leases | ||||
| Weighted average discount rate | ||||
| Operating leases | 6.25 | % | ||
| Finance leases | 3.68 | % | ||
Scheduled maturities of operating and finance lease liabilities outstanding as of March 31, 2020 are as follows:
| Fiscal Year | Operating Leases | Finance Leases | ||||||
| 2021 | $ | 479,599 | $ | 15,347 | ||||
| 2022 | 180,300 | 2,558 | ||||||
| 2023 | 179,117 | - | ||||||
| Total Minimum Future Payments | 839,016 | 17,905 | ||||||
| Less: Imputed Interest | 195,364 | 402 | ||||||
| Present Value of Lease Liabilities | $ | 643,652 | $ | 17,503 | ||||
NOTE 8 – SHAREHOLDERS’ EQUITY
COMMON STOCK ISSUANCES
During the years ended March 31, 2020 and 2019 the Company issued the following common stock shares:
Fiscal 2020:
On August 30, 2019 the Company issued 60,000 shares of its common stock to a former director who exercised stock options at an average exercise price of $0.17 per share.
On June 12, 2019, the Company issued 32,890 shares of its common stock to our Board of Directors at $0.38 per share, pursuant to our annual director compensation plan for the fiscal year ending March 31, 2020.
Fiscal 2019:
On March 31, 2019, the Company accrued a subscription receivable for 20,000 shares of its common stock to a former director who exercised stock options at an exercise price of $0.11 per share. The Company received payment of $2,200 in May 2019.
On January 24, 2019, the Company issued 60,000 shares of its common stock to a current director who exercised stock options at an average exercise price of $.07 per share. The Company received payment of $4,000 in January 2019.
| F-15 |
On August 3, 2018 the Company issued 80,000 shares of its common stock to a former director who exercised stock options at an average exercise price of $.08 per share. The Company received payment of $6,400 in January 2019.
On August 1, 2018, the Company issued 22,725 shares of its common stock to our Board of Directors at $0.55 per share, pursuant to our annual director compensation plan for the fiscal year ending March 31, 2019. The value of this issuance was $12,500.
EARNINGS PER SHARE
In accordance with FASB ASC 210, “Earnings per Share”, basic earnings per share are computed by dividing the net earnings for the year by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing earnings for the year by the weighted average number of common shares outstanding including the effect of common stock equivalents.
As of March 31, 2020 there were common stock equivalents to purchase 2,230,000 shares of common stock, none of which were included in the computation of diluted earnings per share because their effect on earnings per share would be anti-dilutive. For the fiscal year ended March 31, 2019 there were common stock equivalents to purchase 2,210,000 shares of common stock of which 1,630,000 were included in the computation of diluted earnings per share.
STOCK OPTIONS
On June 1, 2001, the Board of Directors approved the 2001 Stock Option Plan (“Plan”), as amended. The Plan was developed to provide a means whereby directors and selected employees, officers, consultants, and advisors of the Company may be granted incentive or non-qualified stock options to purchase common stock of the Company. As of March 31, 2020, the Plan had expired and no shares were available to be issued nor were any additional shares issued from the plan in Fiscal 2020 or 2019.
A summary of stock option activity for each of the years presented is summarized below.
| Fiscal 2020 | Fiscal 2019 | |||||||||||||||
| Number of Options | Weighted Average Exercise Price | Number of Options | Weighted Average Exercise Price | |||||||||||||
| Stock Options: | ||||||||||||||||
| Balance at beginning of year | 2,210,000 | $ | 0.25 | 2,330,000 | $ | 0.22 | ||||||||||
| Granted | 100,000 | $ | 0.38 | 100,000 | $ | 0.55 | ||||||||||
| Exercised | (60,000 | ) | $ | 0.17 | (160,000 | ) | $ | 0.08 | ||||||||
| Forfeited | (20,000 | ) | $ | 0.03 | (60,000 | ) | $ | 0.11 | ||||||||
| Balance at end of year * | 2,230,000 | $ | 0.26 | 2,210,000 | $ | 0.25 | ||||||||||
| Options exercisable at end of year | 2,130,000 | $ | 0.25 | 2,110,000 | $ | 0.15 | ||||||||||
The following table summarizes information about employee stock options outstanding at March 31, 2020:
| Range of Exercise Price | Number Outstanding at March 31, 2020 | Weighted Average Remaining Contractual Life | Weighted Average Exercise Price | Number Exercisable at March 31, 2020 | Weighted Average Exercise Price | |||||||||||||||
| $0.04 - $0.38 | 1,650,000 | 4.3 | $ | 0.13 | 1,550,000 | $ | 0.16 | |||||||||||||
| $0.47 - $0.55 | 580,000 | 7.4 | $ | 0.50 | 580,000 | $ | 0.50 | |||||||||||||
| * | 2,230,000 | 2,130,000 | ||||||||||||||||||
* Total number of options outstanding as of March 31, 2020 includes 1,080,000 options issued to five current and two former directors as compensation and 1,150,000 options issue to key employees that were not issued from the Plan.
NOTE 9 - INCOME TAXES
The Company files separate tax returns in the United States and in Macau. The Macau Subsidiary has received approval from the Macau government to operate its business as a Macau Offshore Company (MOC), and is exempt from the Macau income tax. For the fiscal years ended March 31, 2020 and 2019, the Macau Subsidiary recorded no tax provision.
The U.S. Federal net operating loss carryforward is subject to an IRS Section 382 limitation. As of March 31, 2020 and 2019, the Company had net deferred tax assets of approximately $1.3 million and $0.8 million, respectively. For the fiscal year ended March 31, 2020 we determined our effective tax rate to be approximately 18.1% and we recorded a tax benefit of approximately $0.6 million which was net of a valuation reserve of approximately $0.1 million for deferred tax assets that will most likely expire prior to the Company’s ability to realize them. For the fiscal year ended March 31, 2019 we determined our effective tax rate to be approximately 20.1% and we recorded a tax provision of approximately $0.2 million. The Company also recorded an income tax receivable of approximately $0.1 million due to the availability of net operating loss carrybacks and alternative minimum tax credits that were realized for the year ended March 31, 2020. The income tax receivable was included as a component of prepaid expenses and other current assets on the accompanying consolidated balance sheet as of March 31, 2020.
| F-16 |
The income tax(benefit) provision for federal, foreign, and state income taxes in the consolidated statements of income consisted of the following components for 2020 and 2019:
| 2020 | 2019 | |||||||
| Income tax benefit: | ||||||||
| Current: | ||||||||
| Federal | $ | (104,437 | ) | $ | (19,289 | ) | ||
| State | - | - | ||||||
| Total current Federal and State tax benefit | $ | (104,437 | ) | $ | (19,289 | ) | ||
| Deferred: | ||||||||
| Federal | $ | (521,776 | ) | $ | 159,881 | |||
| State | $ | (15,601 | ) | $ | 18,888 | |||
| Total Deferred Federal and State | $ | (537,377 | ) | $ | 178,769 | |||
| Total income tax (benefit) provision | $ | (641,814 | ) | $ | 159,480 | |||
The United States and foreign components of income (loss) before income taxes are as follows:
| 2020 | 2019 | |||||||
| United States | $ | (3,765,272 | ) | $ | 607,652 | |||
| Foreign | 266,458 | 183,375 | ||||||
| $ | (3,498,814 | ) | $ | 791,027 | ||||
The actual tax provision differs from the “expected” tax expense for the years ended March 31, 2020 and 2019 (computed by applying the U.S. Federal Corporate tax rate of 21 percent to income before taxes) as follows:
| 2020 | 2019 | |||||||
| Expected tax (benefit) expense | $ | (734,751 | ) | $ | 166,506 | |||
| State income taxes, net of Federal income tax (benefit) provision | (175,245 | ) | 13,478 | |||||
| Permanent differences | 9,977 | 8,282 | ||||||
| Deemed dividend from foreign subsidiary | - | 20,813 | ||||||
| Tax rate differential on foreign earnings | - | (20,813 | ) | |||||
| Change in valuation allowance | 87,842 | - | ||||||
| Effect of IRC §382 on NOL | 100,966 | - | ||||||
| Tax rate differential on NOL carryback | 16,263 | - | ||||||
| Correction of state rate | 83,803 | - | ||||||
| Other | (30,669 | ) | (28,786 | ) | ||||
| Actual tax (benefit) provision | $ | (641,814 | ) | $ | 159,480 | |||
| F-17 |
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows:
| 2020 | 2019 | |||||||
| NOL Federal Carryforward | $ | 312,430 | $ | 236,476 | ||||
| State NOL Carryforward | 157,967 | 272,758 | ||||||
| AMT credit carryforward | - | 19,289 | ||||||
| General business credit | 14,196 | - | ||||||
| Inventory differences | 303,529 | 176,967 | ||||||
| Stock option compensation expense | 128,220 | 109,464 | ||||||
| Stock warrants | - | 23,018 | ||||||
| Allowance for doubtful accounts | 143,748 | 11,599 | ||||||
| Insurance contingency | 220,425 | - | ||||||
| Reserve for estimated returns | 112,537 | 67,439 | ||||||
| Accrued vacation | 42,928 | 7,945 | ||||||
| Business interest deduction | 55,978 | - | ||||||
| 1,491,958 | 924,955 | |||||||
| Less: valuation allowance | (87,842 | ) | - | |||||
| $ | 1,404,116 | $ | 924,955 | |||||
| Depreciable and amortizable assets | (82,512 | ) | (108,707 | ) | ||||
| Prepaid expenses | (35,883 | ) | (57,882 | ) | ||||
| Net deferred tax liability | (118,395 | ) | (166,589 | ) | ||||
| Net deferred tax asset | $ | 1,285,721 | $ | 758,366 | ||||
The Company performed an analysis in accordance with the provisions of ASC 740, which requires an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable. The analysis performed to assess the realizability of the deferred tax assets included an evaluation of the pattern and timing of the reversals of temporary differences and the length of carryback and carryforward periods available under the applicable federal and state laws; and the amount and timing of future taxable income. At March 31, 2020, the Company evaluated the realizability of its deferred tax assets in accordance with GAAP and concluded that a $87,842 valuation allowance against deferred tax assets was necessary. The recognition of the remaining net deferred tax asset and corresponding tax benefit is based upon the Company’s conclusions regarding, among other considerations, the Company’s history of earnings and projected earnings for fiscal year 2021 and in the future.
At March 31, 2020, the Company has federal tax net operating loss carryforwards in the amount of approximately $1.7 million that begin to expire in the year 2025. $1.1 million of the net operating loss carryforward is subject to an IRS Section 382 limitation that limits the amount available to use beginning in Fiscal 2020 to approximately $0.15 million per year. In addition the Company has state tax net operating loss carryforwards of approximately $2.0 million that will begin to expire beginning in 2024.
The Company is no longer subject to income tax examinations for fiscal years before 2017.
NOTE 10 - SEGMENT INFORMATION
The Company operates in one segment. Sales by geographic region for the period presented are as follows:
| FOR THE FISCAL YEARS ENDED | ||||||||
| March 31, | March 31, | |||||||
| 2020 | 2019 | |||||||
| North America | $ | 38,918,934 | $ | 42,419,351 | ||||
| Europe | 1,653,127 | 3,723,913 | ||||||
| Asia | 336,000 | - | ||||||
| Australia | 510,243 | 286,979 | ||||||
| South Africa | - | 44,201 | ||||||
| Others | - | 8,554 | ||||||
| $ | 41,418,304 | $ | 46,482,998 | |||||
The geographic area of sales is based primarily on where the product was delivered.
NOTE 11 - EMPLOYEE BENEFIT PLANS
The Company has a 401(k) plan for its employees to which the Company makes contributions at rates dependent on the level of each employee’s contributions. Contributions made by the Company are limited to the maximum allowable for federal income tax purposes. The amounts charged to operations for contributions to this plan and administrative costs during the fiscal years ended March 31, 2020 and 2019 totaled approximately $63,000 and $70,000, respectively. The amounts are included as a component of general and administrative expense in the accompanying Consolidated Statements of Operations. The Company does not provide any post-employment benefits to retirees.
| F-18 |
NOTE 12 - CONCENTRATIONS OF CREDIT RISK, CUSTOMERS, AND SUPPLIERS
The Company derives a majority of its revenues from retailers of products in the United States. The Company’s allowance for doubtful accounts is based upon management’s estimates and historical experience and reflects the fact that accounts receivable are concentrated with several large customers. At March 31, 2020, 82% of accounts receivable were due from four customers in North America that individually owed over 10% of total accounts receivable. At March 31, 2019, 62% of accounts receivable were due from two customers in North America.
Revenues derived from three customers in 2020 and 2019 were 63% and 66%, respectively. Revenues from customers representing greater than 10% of total net sales were derived from top three customers in 2020 and 2019 as percentage of the net sales were 39%, 13% and 11% and 39%, 14% and 13%, respectively. The loss of any of these customers could have an adverse impact on the Company.
Net sales derived from the Macau Subsidiary aggregated approximately $4.5 million and $7.6 million in fiscal 2020 and 2019, respectively.
The Company is dependent upon foreign companies for the manufacture of all of its electronic products. The Company’s arrangements with manufacturers are subject to the risk of doing business abroad, such as import duties, trade restrictions, work stoppages, foreign currency fluctuations, political instability, and other factors, which could have an adverse impact on its business. The Company believes that the loss of any one or more of their suppliers would not have a long-term material adverse effect because other manufacturers with whom the Company does business would be able to increase production to fulfill their requirements. However, the loss of certain suppliers in the short-term could adversely affect business until alternative supply arrangements are secured.
During fiscal years 2020 and 2019, manufacturers in the People’s Republic of China accounted for 100% of the Company’s total product purchases, including all of the Company’s hardware purchases. In 2018 the U.S. government imposed tariffs of up to 25% on certain goods imported from China. All of our products are manufactured and imported from China however, only our microphones are currently subject to a 7.5% tariff currently in place. Should the government decide to expand its list of products to include our karaoke products that would subject our products to tariffs in the future, there could be a significant increase in the landed cost of our products. If we are unable to mitigate these increased costs through price increases we could experience reductions in revenues, gross profit margin and results from operations.
NOTE 13 – RELATED PARTY TRANSACTIONS
DUE TO/FROM RELATED PARTIES
On March 31, 2020 the Company had approximately $0.5 million due to related parties for services provided by these companies and licensing fees for use of pedestal model molds and tools owned by the parent company. On March 31, 2019, the Company had approximately $0.3 million due from related parties for goods and services sold these companies.
TRADE
During Fiscal 2020 and 2019 the Company paid approximately $0.4 million to Starlight Electronics Company, Ltd (“SLE”) as reimbursement for engineering, quality control and other administrative services performed on our behalf in China. These expense reimbursements were included in general and administrative expenses on our consolidated statements of operations.
During Fiscal 2020 and 2019 the Company sold approximately $0.9 million and $1.2 million, respectively of product to Winglight Pacific, Ltd. (“Winglight”) a related company, for direct shipment to Cosmo Communications of Canada, Ltd (“Cosmo”), another related company, at discounted pricing granted to major direct import customers shipped internationally with freight prepaid. The average gross profit margin on sales to Winglight for Fiscal 2020 and 2019 was 23.7% and 30.1%, respectively. These amounts were included as a component of net sales in the accompanying consolidated statements of operations.
During Fiscal 2020 and 2019 the Company sold approximately $0.3 million and $0.4 million, respectively of product to Cosmo from our California warehouse facility. These goods were sold at a discounted price, similar to prices granted to major direct import customers shipped internationally with freight prepaid. The average gross profit margin on sales to Cosmo yielded 26.6% and 22.5%, respectively. These amounts were included as a component of net sales in the accompanying consolidated statements of operations.
On July 30, 2020 the Company and Cosmo reached agreement that Cosmo would no longer be the Company’s Canadian distributor and the Company became the sole and exclusive distributor of the Company’s products in Canada. As part of the agreement, the companies executed a Purchase and Sale agreement whereby the Company acquired all of Cosmo’s karaoke inventory for approximately $0.7 million.
| F-19 |
NOTE 14 – RESERVE FOR SALES RETURNS
A return program for defective goods is negotiated with each of our wholesale customers on a year-to-year basis. Customers are either allowed to return defective goods within a specified period of time after shipment (between 6 and 9 months) or granted a “defective allowance” consisting of a fixed percentage (between 1% and 5%) off of invoice price in lieu of returning defective products. The Company does make occasional exceptions to this return policy and accordingly records a sales return reserve based on historic return amounts, specific exceptions as identified and management estimates.
The Company records a sales reserve for its return goods programs at the time of sale for estimated sales returns that may occur. The liability for defective goods is included in the reserve for sales returns on the consolidated balance sheets.
Changes in the Company’s reserve for sales returns are presented in the following table:
| Fiscal Year Ended | ||||||||
| March 31, | March 31, | |||||||
| 2020 | 2019 | |||||||
| Reserve for sales returns at beginning of the fiscal year | $ | 896,154 | $ | 726,000 | ||||
| Provision for estimated sales returns | 5,770,436 | 3,997,946 | ||||||
| Sales returns received | (5,442,590 | ) | (3,827,792 | ) | ||||
| Reserve for sales returns at end of the year | $ | 1,224,000 | $ | 896,154 | ||||
NOTE 15 – REFUNDS DUE TO CUSTOMERS
As of March 31, 2020 and 2019 the amount of refunds due to customers was approximately $807,000 and $31,000, respectively Refunds due to customers at March 31, 2020 were primarily due to one major customer which reflects approximately $1,691,000 of chargebacks less approximately $1,181,000 that the customer had deducted on payment remittances to the Company as of March 31, 2020. The remaining $297,000 is primarily due to amounts due to two major customers for overstock returns. (See Note 2 – LIQUIDITY).
NOTE 16 – RESERVES
Asset reserves and allowances for years ended March 31, 2020 and 2019 are presented in the following table:
| Balance at | Charged to | Reduction to | Credited to | Balance at | ||||||||||||||||
| Beginning of | Costs and | Allowance for | Costs and | End of | ||||||||||||||||
| Description | Year | Expenses | Write off | Expenses | Year | |||||||||||||||
| Year ended March 31, 2020 | ||||||||||||||||||||
| Reserves deducted from assets to which they apply: | ||||||||||||||||||||
| Allowance for doubtful accounts | $ | 51,096 | $ | 303,843 | $ | (15,303 | ) | $ | (2,175 | ) | $ | 337,461 | ||||||||
| Inventory reserve | $ | 254,000 | $ | 398,730 | $ | (218,730 | ) | $ | - | $ | 434,000 | |||||||||
| Year ended March 31, 2019 | ||||||||||||||||||||
| Reserves deducted from assets to which they apply: | ||||||||||||||||||||
| Allowance for doubtful accounts | $ | 82,102 | $ | 411,862 | $ | (31,200 | ) | $ | (411,668 | ) | $ | 51,096 | ||||||||
| Inventory reserve | $ | 280,000 | $ | 100,000 | $ | (44,220 | ) | $ | (81,780 | ) | $ | 254,000 | ||||||||
NOTE 17 – SUBSEQUENT EVENT
On May 5, 2020, the Company received loan proceeds from Crestmark Bank in the amount of approximately $0.4 million under the Paycheck Protection Program (“PPP”). The PPP was established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest may be forgivable to the extent the Company uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness may be reduced if the borrower terminates employees or reduces salaries during the eligible period.
The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments for the first six months. The Company currently expects to apply for forgiveness of the entire loan balance.
| F-20 |
Exhibit 10.8
EXHIBIT 31.1
CERTIFICATIONS
I, Gary Atkinson, certify that:
1. I have reviewed this Annual Report on Form 10-K of The Singing Machine Company, Inc. for fiscal year ended March 31, 2020;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
| /s/ Gary Atkinson | |
| Gary Atkinson | |
| Chief Executive Officer | |
| (Principal Executive Officer) | |
| Date: August 13, 2020 |
EXHIBIT 31.2
CERTIFICATIONS
I, Lionel Marquis, certify that:
1. I have reviewed this Annual Report on Form 10-K of The Singing Machine Company, Inc. for fiscal year ended March 31, 2020;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
| /s/ Lionel Marquis | |
| Lionel Marquis | |
| Chief Financial Officer | |
| (Principal Financial Officer) | |
| Date: August 13, 2020 |
EXHIBIT 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of The Singing Machine Company, Inc. (the “Company”) on Form 10-K for the year ended March 31, 2020 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gary Atkinson, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
A signed original of this written statement required by Section 906 has been provided to The Singing Machine Company, Inc. and will be retained by The Singing Machine Company, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
| /S/ Gary Atkinson | |
| Gary Atkinson | |
| Chief Executive Officer | |
| (Principal Executive Officer) | |
| Date: August 13, 2020 |
EXHIBIT 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO SECTION 906
OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of The Singing Machine Company, Inc. (the “Company”) on Form 10-K for the year ended March 31, 2020 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Lionel Marquis, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
A signed original of this written statement required by Section 906 has been provided to The Singing Machine Company, Inc. and will be retained by The Singing Machine Company, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.
| /S/ Lionel Marquis | |
| Lionel Marquis | |
| Chief Financial Officer | |
| (Principal Financial Officer) | |
| Date: August 13, 2020 |