Algorhythm Holdings, Inc 10-Q, filed Feb 14, 2020
Algorhythm Holdings, Inc. (RIME)
About this 10-Q
Algorhythm Holdings, Inc filed this 10-Q on February 14, 2020, covering the quarter ended December 31, 2019.
Headline figures
Quarter ended December 31, 2019, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $15.52M
- down 20.2% from $19.45M a year earlier
- Net loss
- $757.95K
- compared with net income of $1.29M a year earlier
- Diluted EPS
- -$0.02
- compared with $0.03 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
| [X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For quarter ended December 31, 2019 | ||
| [ ] | 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 0 - 24968
THE SINGING MACHINE COMPANY, INC.
(Exact Name of Registrant as Specified in its Charter)
| DELAWARE | 95-3795478 | |
| (State of Incorporation) | (IRS Employer I.D. 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)
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 requirement for the past 90 days. Yes [X] No [ ]
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 definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X] Smaller Reporting Company [X] Emerging growth company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
APPLICABLE ONLY TO ISSUES INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicated by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities and Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
| CLASS | NUMBER OF SHARES OUTSTANDING | |
| Common Stock, $0.01 par value | 38,557,643 as of February 14, 2020 |
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARIES
INDEX
| 2 |
The Singing Machine Company, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
| December 31, 2019 | March 31, 2019 | |||||||
| (Unaudited) | ||||||||
| Assets | ||||||||
| Current Assets | ||||||||
| Cash | $ | 518,608 | $ | 211,408 | ||||
| Accounts receivable, net of allowances of $184,120 and $51,096, respectively | 7,761,832 | 1,769,404 | ||||||
| Due from PNC Bank | 2,447,868 | 2,236,779 | ||||||
| Accounts receivable related party - Cosmo Communications Canada, Inc | 38,962 | - | ||||||
| Accounts receivable related party - Winglight Pacific, Ltd | 1,145,196 | 288,941 | ||||||
| Insurance claim receivable | 1,286,158 | - | ||||||
| Inventories, net | 8,102,914 | 6,024,311 | ||||||
| Prepaid expenses and other current assets | 139,680 | 274,278 | ||||||
| Deferred financing costs | 6,667 | 13,333 | ||||||
| Total Current Assets | 21,447,885 | 10,818,454 | ||||||
| Property and equipment, net | 844,246 | 522,910 | ||||||
| Deferred financing costs, net of current portion | - | 3,333 | ||||||
| Deferred tax assets | 1,052,999 | 758,366 | ||||||
| Operating Leases - right of use assets | 710,961 | - | ||||||
| Other non-current assets | 23,059 | 90,082 | ||||||
| Total Assets | $ | 24,079,150 | $ | 12,193,145 | ||||
| Liabilities and Shareholders’ Equity | ||||||||
| Current Liabilities | ||||||||
| Accounts payable | $ | 6,584,894 | $ | 842,708 | ||||
| Accrued expenses | 2,605,128 | 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 | 281,700 | - | ||||||
| Due to related party - Starlight R&D, Ltd. | 103,572 | - | ||||||
| Refunds due to customers | 510,833 | 31,075 | ||||||
| Reserve for sales returns | 4,546,317 | 896,154 | ||||||
| Current portion of finance leases | 14,816 | 14,414 | ||||||
| Current portion of installment notes | 49,016 | - | ||||||
| Current portion of operating lease liabilities | 445,322 | - | ||||||
| Current portion of subordinated related party debt - Starlight Marketing Development, Ltd. | 802,659 | 815,367 | ||||||
| Total Current Liabilities | 15,958,657 | 3,675,491 | ||||||
| Finance leases, net of current portion | 6,340 | 17,499 | ||||||
| Installment notes, net of current portion | 227,520 | - | ||||||
| Operating lease liabilities, net of current portion | 349,880 | - | ||||||
| Total Liabilities | 16,542,397 | 3,692,990 | ||||||
| Commitments and Contingencies | ||||||||
| Shareholders’ Equity | ||||||||
| 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 | 385,577 | 384,647 | ||||||
| Additional paid-in capital | 19,724,040 | 19,687,264 | ||||||
| Subscriptions receivable | - | (2,200 | ) | |||||
| Accumulated deficit | (12,572,864 | ) | (11,569,556 | ) | ||||
| Total Shareholders’ Equity | 7,536,753 | 8,500,155 | ||||||
| Total Liabilities and Shareholders’ Equity | $ | 24,079,150 | $ | 12,193,145 | ||||
See notes to the condensed consolidated financial statements
| 3 |
The Singing Machine Company, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
| For the Three Months Ended | For the Nine Months Ended | |||||||||||||||
| December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | |||||||||||||
| Net Sales | $ | 15,519,516 | $ | 19,452,450 | $ | 40,410,398 | $ | 45,593,906 | ||||||||
| Cost of Goods Sold | 11,486,520 | 13,826,176 | 29,747,376 | 34,369,467 | ||||||||||||
| Gross Profit | 4,032,996 | 5,626,274 | 10,663,022 | 11,224,439 | ||||||||||||
| Operating Expenses | ||||||||||||||||
| Selling expenses | 3,402,717 | 2,236,777 | 6,550,139 | 4,698,141 | ||||||||||||
| General and administrative expenses | 1,442,192 | 1,524,810 | 5,048,517 | 4,185,579 | ||||||||||||
| Depreciation | 77,161 | 64,357 | 196,210 | 200,138 | ||||||||||||
| Total Operating Expenses | 4,922,070 | 3,825,944 | 11,794,866 | 9,083,858 | ||||||||||||
| (Loss) Income from Operations | (889,074 | ) | 1,800,330 | (1,131,844 | ) | 2,140,581 | ||||||||||
| Other Expenses | ||||||||||||||||
| Interest expense | (105,583 | ) | (139,729 | ) | (156,097 | ) | (235,290 | ) | ||||||||
| Finance costs | (3,334 | ) | (3,333 | ) | (10,000 | ) | (10,000 | ) | ||||||||
| Total Other Expenses | (108,917 | ) | (143,062 | ) | (166,097 | ) | (245,290 | ) | ||||||||
| (Loss) Income Before Income Tax Benefit (Provision) | (997,991 | ) | 1,657,268 | (1,297,941 | ) | 1,895,291 | ||||||||||
| Income Tax Benefit (Provision) | 240,042 | (367,255 | ) | 294,633 | (422,000 | ) | ||||||||||
| Net (Loss) Income | $ | (757,949 | ) | $ | 1,290,013 | $ | (1,003,308 | ) | $ | 1,473,291 | ||||||
| Net (Loss) Income per Common Share | ||||||||||||||||
| Basic | $ | (0.02 | ) | $ | 0.03 | $ | (0.03 | ) | $ | 0.04 | ||||||
| Diluted | $ | (0.02 | ) | $ | 0.03 | $ | (0.03 | ) | $ | 0.04 | ||||||
| Weighted Average Common and Common | ||||||||||||||||
| Equivalent Shares: | ||||||||||||||||
| Basic | 38,557,643 | 38,384,753 | 38,524,698 | 38,315,395 | ||||||||||||
| Diluted | 38,557,643 | 39,459,369 | 38,524,698 | 39,397,875 | ||||||||||||
See notes to the condensed consolidated financial statements
| 4 |
The Singing Machine Company, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| For the Nine Months Ended | ||||||||
| December 31, 2019 | December 31, 2018 | |||||||
| Cash flows from operating activities | ||||||||
| Net (loss) income | $ | (1,003,308 | ) | $ | 1,473,291 | |||
| Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: | ||||||||
| Depreciation | 196,210 | 200,138 | ||||||
| Amortization of deferred financing costs | 9,999 | 10,000 | ||||||
| Change in inventory reserve | 150,000 | (56,780 | ) | |||||
| Change in allowance for bad debts | 133,024 | 162,198 | ||||||
| Stock based compensation | 27,506 | 42,879 | ||||||
| Change in net deferred tax assets | (294,633 | ) | 422,001 | |||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (6,125,452 | ) | (9,697,203 | ) | ||||
| Due from PNC Bank | (211,089 | ) | 6,212 | |||||
| Accounts receivable - related parties | (895,217 | ) | (515,580 | ) | ||||
| Insurance receivable | (1,286,158 | ) | - | |||||
| Inventories | (2,228,603 | ) | 2,475,145 | |||||
| Prepaid expenses and other current assets | 134,598 | 25,587 | ||||||
| Other non-current assets | 67,023 | (516 | ) | |||||
| Accounts payable | 5,742,186 | 1,744,862 | ||||||
| Accrued expenses | 1,780,393 | 1,036,699 | ||||||
| Due to related parties | 399,672 | 293,717 | ||||||
| Refunds due to customers | 479,758 | (445,484 | ) | |||||
| Reserve for sales returns | 3,650,163 | 1,324,486 | ||||||
| Operating lease liabilities, net of operating leases - right of use assets | (41,797 | ) | - | |||||
| Net cash provided by (used in) operating activities | 684,275 | (1,498,348 | ) | |||||
| Cash flows from investing activities | ||||||||
| Purchase of property and equipment | (517,546 | ) | (288,740 | ) | ||||
| Net cash used in investing activities | (517,546 | ) | (288,740 | ) | ||||
| Cash flows from financing activities | ||||||||
| Net proceeds from revolving line of credit | - | 2,931,118 | ||||||
| Proceeds from installment notes | 283,840 | - | ||||||
| Payments on installment notes | (7,304 | ) | - | |||||
| Proceeds from subscription receivable | 2,200 | - | ||||||
| Proceeds from exercise of stock options | 10,200 | 6,400 | ||||||
| Payment of bank term note | (125,000 | ) | (375,000 | ) | ||||
| Payment on subordinated debt - related party | (12,708 | ) | - | |||||
| Payments on finance leases | (10,757 | ) | (8,093 | ) | ||||
| Net cash provided by financing activities | 140,471 | 2,554,425 | ||||||
| Net change in cash | 307,200 | 767,337 | ||||||
| Cash at beginning of period | 211,408 | 813,908 | ||||||
| Cash at end of period | $ | 518,608 | $ | 1,581,245 | ||||
| Supplemental disclosures of cash flow information: | ||||||||
| Cash paid for interest | $ | 167,954 | $ | 215,501 | ||||
| Equipment purchased under capital lease | $ | - | $ | 43,527 | ||||
| Operating leases - right of use assets initial adoption | $ | 1,108,330 | $ | - | ||||
| Operating lease liabilities - initial adoption | $ | 1,234,368 | $ | - | ||||
See notes to the condensed consolidated financial statements
| 5 |
The Singing Machine Company, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the three months ended December 31, 2019 and 2018
(Unaudited)
| Preferred Stock | Common Stock | Additional Paid in | Subscriptions | Accumulated | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Receivable | Deficit | Total | |||||||||||||||||||||||||
| Balance at September 30, 2019 | - | $ | - | 38,557,643 | $ | 385,577 | $ | 19,719,038 | $ | - | $ | (11,814,915 | ) | $ | 8,289,700 | |||||||||||||||||
| Net Loss | (757,949 | ) | (757,949 | ) | ||||||||||||||||||||||||||||
| Employee compensation-stock option | 5,002 | 5,002 | ||||||||||||||||||||||||||||||
| Balance at December 31, 2019 | - | $ | - | 38,557,643 | $ | 385,577 | $ | 19,724,040 | $ | - | $ | (12,572,864 | ) | $ | 7,536,753 | |||||||||||||||||
| Balance at September 30, 2018 | - | $ | - | 38,384,753 | $ | 383,847 | $ | 19,662,766 | $ | - | $ | (12,017,825 | ) | $ | 8,028,788 | |||||||||||||||||
| Net lncome | 1,290,013 | 1,290,013 | ||||||||||||||||||||||||||||||
| Employee compensation-stock option | 9,549 | 9,549 | ||||||||||||||||||||||||||||||
| Balance at December 31, 2018 | - | $ | - | 38,384,753 | $ | 383,847 | $ | 19,672,315 | $ | - | $ | (10,727,812 | ) | $ | 9,328,350 | |||||||||||||||||
The Singing Machine Company, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the nine months ended December 31, 2019 and 2018
(Unaudited)
| Preferred Stock | Common Stock | Additional Paid in | Subscriptions | Accumulated | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Receivable | Deficit | Total | |||||||||||||||||||||||||
| Balance at March 31, 2019 | - | $ | - | 38,464,753 | $ | 384,648 | $ | 19,687,263 | $ | (2,200 | ) | $ | (11,569,556 | ) | $ | 8,500,155 | ||||||||||||||||
| Net Loss | (1,003,308 | ) | (1,003,308 | ) | ||||||||||||||||||||||||||||
| Employee compensation-stock option | 15,006 | 15,006 | ||||||||||||||||||||||||||||||
| 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 | 329 | 12,171 | 12,500 | ||||||||||||||||||||||||||||
| Balance at December 31, 2019 | - | $ | - | 38,557,643 | $ | 385,577 | $ | 19,724,040 | $ | - | $ | (12,572,864 | ) | $ | 7,536,753 | |||||||||||||||||
| Balance at March 31, 2018 | - | $ | - | 38,282,028 | $ | 382,820 | $ | 19,624,063 | $ | - | $ | (12,201,103 | ) | $ | 7,805,780 | |||||||||||||||||
| Net Income | 1,473,291 | 1,473,291 | ||||||||||||||||||||||||||||||
| Employee compensation-stock option | 30,379 | 30,379 | ||||||||||||||||||||||||||||||
| Exercise of stock options | 80,000 | 800 | 5,600 | 6,400 | ||||||||||||||||||||||||||||
| Director fees | 22,725 | 227 | 12,273 | 12,500 | ||||||||||||||||||||||||||||
| Balance at December 31, 2018 | - | $ | - | 38,384,753 | $ | 383,847 | $ | 19,672,315 | $ | - | $ | (10,727,812 | ) | $ | 9,328,350 | |||||||||||||||||
See notes to the condensed consolidated financial statements.
| 6 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
NOTE 1 – BASIS OF PRESENTATION
OVERVIEW
The Singing Machine Company, Inc., a Delaware corporation (the “Company”, “SMC”, “The Singing Machine”) and its three 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 systems, accessories, musical instruments and musical recordings. The products are sold by SMC to retailers and distributors for resale to consumers.
NOTE 2 – LIQUIDITY
In August 2019, we received notification from a major customer that several containers of goods from multiple vessels purchased direct import by the customer had arrived severely water damaged. Upon inspection of the damaged goods by insurance surveyors it was their opinion that the source of the damage was due to moisture in the pallets provided by the factory which caused significant condensation and consequently water damage to the merchandise. Actual damage to the goods occurred while the goods were in transit. We have filed insurance claims on our cargo insurance policy which does provide for recovery of the sales value plus additional expenses associated with the damaged goods. For the three months ended December 31, 2019, the customer charged us back a total of approximately $48,000 for damaged goods consisting of sales value of approximately $46,000 which was recorded as a reduction in net sales and approximately $2,000 in survey fees which were expensed as a component of general and administrative expenses on the accompanying condensed consolidated statements of operations. For the nine months ended December 31, 2019, the customer charged us back a total of approximately $1,691,000 for damaged goods consisting of sales value of approximately $1,580,000 which was recorded as a reduction in net sales, approximately $109,000 in freight charges which were expensed as a component of sales and marketing expenses and approximately $2,000 in survey fees which were expensed as a component of general and administrative expenses on the accompanying condensed consolidated statements of operations. For the three and nine months ended December 31, 2019 we have incurred additional related expenses of approximately $127,000 and $346,000, respectively that were included as a component of general and administrative expenses on the accompanying condensed consolidated statements of operations. We continue to gather the relevant information required to complete the insurance claims, however due to the significant extent of the damage more time will be required by the underwriter to determine the final claim settlement. As such, we have recorded a refund due to the customer of approximately $510,000 which reflects approximately $1,691,000 of chargebacks by the customer less approximately $1,181,000 the customer has deducted on payment remittances to the Company as of December 31, 2019. We recognized an insurance claim receivable of approximately $1,286,000 (the approximate cost of the damaged goods returned that will be destroyed) on the accompanying condensed consolidated balance sheet at December 31, 2019. The timing of the collection of this insurance claim receivable remains uncertain at this time.
As of December 31, 2019 the Company was in default 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 as well as a loss from operations. In November 2019, the Company entered into a Forbearance Agreement with PNC Bank, National Association (“PNC”) whereby PNC “forbears” taking action it would be entitled to under a default through March 31, 2020 at which time we would renegotiate renewal of the Revolving Credit Facility or obtain alternative financing.
| ● | PNC implemented a $1,000,000 loan availability block. | |
| ● | PNC required an EBITDA hurdle greater than or equal to $400,000 for the third quarter ending December 31, 2019 and requires EBITDA of $0 for the six months ending March 31, 2020 and $(83,000) for the twelve months ending March 31, 2020. | |
| ● | PNC implemented loan pricing increase of .5% until March 31, 2020 which will continue until the Company achieves compliance with the original fixed charge coverage ratio test of 1.1:1. |
As of December 31, 2019 the Company did not meet the required EBITDA hurdle of greater than or equal to $400,000 for the third quarter ended December 31, 2019 and is unlikely to meet the remaining hurdles of the Forbearance Agreement for the fiscal year ending March 31, 2020. As of December 31, 2019 the Revolving Credit Facility has no outstanding balance and there have been no further actions by PNC to exercise any of their options afforded to them as per the terms of the Revolving Credit Facility.
For the nine months ended December 31, 2019, the Company incurred a net loss of approximately $1,003,000 compared to net income of approximately $1,473,000 for the nine months ended December 31, 2018. The Company expects cash flows from operations as well as other financing resources to be adequate to satisfy working capital requirements for at least the next twelve months from the date the accompanying condensed consolidated financial statements are issued. The Company plans to supplement cash flows from operations from several activities and resources including the following:
| ● | Reduce operating expenses. | |
| ● | Continue to negotiate renewal of the existing Revolving Credit Facility with PNC Bank prior to its expiration on July 15, 2020. | |
| ● | Continuing discussions for alternative financing arrangements with several financial institutions. | |
| ● | Utilize “dynamic discount” programs offered by several of the Company’s major customers which allow for accelerated payment of invoices in exchange for an early pay discount. |
| 7 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
There can be no assurances that any of the above actions can be accomplished or that financing will be available on acceptable terms. If the Company is unable to obtain financing or continues to experience sustained losses from operations this would have a material adverse effect on its ability to meet its financial obligations when due.
NOTE 3 - SUMMARY OF ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in the condensed consolidated financial statements. The accompanying unaudited financial statements for the three and nine months ended December 31, 2019 and 2018 have been prepared in accordance with generally accepted accounting principles applicable to interim financial information and the requirements of Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete consolidated financial statements. In the opinion of management, such condensed consolidated financial statements include all adjustments (consisting of normal recurring accruals) necessary for the fair presentation of the condensed consolidated financial position and the condensed consolidated results of operations. The condensed consolidated results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. The condensed consolidated balance sheet information as of March 31, 2019 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2019. The interim condensed consolidated financial statements should be read in conjunction with that report.
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 condition. 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 reserves 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.
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 condensed consolidated statement of operations and translations are 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 more than the Federal Deposit Insurance Corporation insured amounts. The Company also maintains cash balances in foreign financial institutions. The amounts at foreign financial institutions at December 31, 2019 and March 31, 2019 are approximately $426,000 and $211,000, respectively.
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 December 31, 2019 and March 31, 2019 the estimated amounts for these future inventory returns were approximately $2,444,000 and $599,000, 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 December 31, 2019 and March 31, 2019 the Company had inventory reserves of approximately $404,000 and $254,000 respectively for estimated excess and obsolete inventory.
| 8 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
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 subordinated debt to Starlight Marketing Development, Ltd. (related party) and finance leases approximate fair value due to the relatively short period to maturity and related interest accrued at a rate similar to market rates. The carrying amount on the revolving line of credit approximates fair value due to 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”. The Company’s contracts with customers consist of one performance obligation (the sale of the Company’s products). Revenue is recognized when the goods are delivered and control of the goods sold is transferred to the customer. 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 condensed consolidated statements of operations.
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).
The Company generally does not allow products to be returned other than return allowance programs for goods returned to the customer for various reasons and accordingly records a sales return reserve based on historic return amounts, events as identified and management estimates.
The Company’s reserve for sales returns were approximately $4,546,000 and $896,000 as of December 31, 2019 and March 31, 2019, respectively.
| 9 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
Revenue is derived from four different major product lines. Disaggregated revenue from these product lines for the three and nine months ended December 31, 2019 and 2018 consisted of the following:
| Revenue by Product Line | ||||||||||||||||
| Three Months Ended | Nine Months Ended | |||||||||||||||
| Product Line | 12/31/2019 | 12/31/2018 | 12/31/2019 | 12/31/2018 | ||||||||||||
| Classic Karaoke Machines | $ | 10,336,078 | $ | 10,740,373 | $ | 29,067,908 | $ | 28,014,115 | ||||||||
| Download Karaoke Machines | 3,636,057 | 7,343,426 | 5,534,065 | 12,750,096 | ||||||||||||
| SMC Kids Toys | 339,577 | 334,150 | 967,939 | 2,036,623 | ||||||||||||
| Music and Accessories | 1,207,804 | 1,034,501 | 4,840,486 | 2,793,072 | ||||||||||||
| Total Net Sales | $ | 15,519,516 | $ | 19,452,450 | $ | 40,410,398 | $ | 45,593,906 | ||||||||
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 condensed consolidated statements 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 for the three and nine months ended December 31, 2019 and 2018 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 three months ended December 31, 2019 and 2018, the stock option expense was approximately $5,000 and $10,000, respectively. For the nine months ended December 31, 2019 and 2018, the stock option expense was $15,000 and $30,000, respectively.
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 indicate 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, which is included as a component of selling expenses on the accompanying condensed consolidated statements of operations, for the three months ended December 31, 2019 and 2018 was approximately $2,040,000 and $1,328,000, respectively. Advertising expense for the nine months ended December 31, 2019 and 2018 was approximately $3,820,000 and $2,877,000, respectively. As of December 31, 2019 and March 31, 2019 there was an accrual for cooperative advertising allowances of $1,689,000 and $185,000, respectively. These amounts were a component of accrued expenses in the condensed consolidated balance sheets.
RESEARCH AND DEVELOPMENT COSTS
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 condensed consolidated statements of operations. For the three months ended December 31, 2019 and 2018, these amounts totaled approximately $13,000 and $27,000, respectively. For the nine months ended December 31, 2019 and 2018, these amounts totaled approximately $36,000 and $64,000 respectively.
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 analyzes its deferred tax assets and liabilities at the end of each interim period and, based on management’s best estimate of its full year effective tax rate, recognizes cumulative adjustments to its deferred tax assets and liabilities. For the nine months ended December 31, 2019 and 2018 we estimated our effective tax rate to be approximately 22%. As of December 31, 2019 and March 31, 2019, the Company had gross deferred tax assets of approximately $1,053,000 and $758,000, respectively. The Company recorded an income tax benefit of approximately $240,000 and an income tax provision of approximately $367,000 for the three months ended December 31, 2019 and 2018, respectively. The Company recorded an income tax benefit of approximately $295,000 and an income tax provision of $422,000 for the nine months ended December 31, 2019 and 2018, respectively.
| 10 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
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 December 31, 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.
COMPUTATION OF EARNINGS (LOSS) PER SHARE
Income (loss) per common share is computed by dividing net income (loss) by the weighted average of common shares outstanding during the period. As of December 31, 2019 and 2018 total potential dilutive shares from common stock options amounted to approximately 2,250,000 and 2,350,000 shares, respectively. These shares were not included in the computation of diluted earnings per share for the three and nine months ended December 31, 2019 because their effect was anti-dilutive. These shares were included in the computation of diluted earnings per share for the three and nine months ended December 31, 2018.
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).
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.
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.
| 11 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
NOTE 4 - INVENTORIES, NET
Inventories are comprised of the following components:
| December 31, 2019 | March 31, 2019 | |||||||
| Finished Goods | $ | 6,062,661 | $ | 5,679,245 | ||||
| Estimated Amount of Future Returns | 2,444,253 | 599,066 | ||||||
| Subtotal | 8,506,914 | 6,278,311 | ||||||
| Less:Inventory Reserve | 404,000 | 254,000 | ||||||
| Inventories, net | $ | 8,102,914 | $ | 6,024,311 | ||||
NOTE 5 – PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
| USEFUL | December 31, | March 31, | |||||||||
| LIFE | 2019 | 2019 | |||||||||
| Computer and office equipment | 5 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 | 1,680,022 | 1,466,837 | ||||||||
| 2,418,768 | 1,915,241 | ||||||||||
| Less: Accumulated depreciation | 1,574,522 | 1,392,331 | |||||||||
| $ | 844,246 | $ | 522,910 | ||||||||
Depreciation expense for the three months ended December 31, 2019 and 2018 was approximately $77,000 and $64,000, respectively. Depreciation expense for the nine months ended December 31, 2019 and 2018 was approximately $196,000 and $200,000, respectively.
NOTE 6 – BANK FINANCING
Revolving Credit Facility
On June 22, 2017, the Company renewed the existing revolving credit facility (the “Revolving Credit Facility”) with PNC for an additional three years expiring on July 15, 2020. The outstanding loan balance cannot exceed $15,000,000 during peak selling season between August 1 and December 31 (with the ability of the Company to request an additional $5,000,000 of availability during peak selling season if required) and is reduced to a maximum of $7,500,000 between January 1 and July 31. At December 31, 2019 and March 31, 2019, the outstanding balance was approximately $0 and $0, respectively, on the Revolving Credit Facility. As of December 31, 2019, there was approximately $15,000,000 available to borrow on the Revolving Credit Facility, assuming compliance with the limits and covenants as discussed below. Usage under the Revolving Credit Facility shall not exceed the sum of the following (the “Borrowing Base”):
| ● | Up to 85% of the company’s eligible domestic and Canadian accounts receivable and up to 90% of eligible foreign credit insured accounts aged less than 60 days past due (not to exceed 90 days from invoice date, cross aged on the basis of 50% or more past due with certain specific accounts qualifying for up to 120 days from invoice date not to exceed 30 days from the due date; 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 includes the following sub-limits:
| ● | Letters of Credit to be issued limited to $3,000,000. | |
| ● | Inventory availability limited to $5,000,000. | |
| ● | $500,000 eligible in-transit inventory sublimit within the $5,000,000 total inventory. | |
| ● | Mandatory pay-down to $1,000,000 (excluding letters of credit) for any 30 consecutive days between February 1 and April 30. |
The Revolving Credit Facility must comply with the following quarterly financial covenants to avoid default:
| ● | Fixed charge coverage ratio test of 1.1:1 times measured on a rolling four quarter 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. | |
| ● | Capital expenditures limited to $375,000 per year. |
| 12 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
As of December 31, 2019 the Company remained in default on the Revolving Credit Facility due to non-compliance with the fixed charge coverage ratio in part due to the loss of margin and related expenses associated with the damaged goods received by one major customer in August, 2019. In November 2019, the Company entered into a Forbearance Agreement with PNC whereby PNC “forbears” taking action it would be entitled to under a default through March 31, 2020 and would continue forbearance actions provided the Company continued to meet compliance with certain conditions (See Note 2 – LIQUIDITY).
As of December 31, 2019 the Company did not meet the required conditions of the Forbearance Agreement and is unlikely to meet the remaining hurdles of the Forbearance Agreement for the fiscal year ending March 31, 2020. As of December 31, 2019 the Revolving Credit Facility has no outstanding balance and there have been no further actions by PNC to exercise any of their options afforded to them as per the terms of the Revolving Credit Facility.
Prior 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% (See Note 2 – LIQUIDITY). There is an unused facility fee equal to ..375% per annum on the unused portion of the Revolving Credit Facility which will be 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 three months ended December 31, 2019 and 2018 the Company incurred interest expense of approximately $86,000 and $100,000, respectively, on amounts borrowed against the Revolving Credit Facility. During the nine months ended December 31, 2019 and 2018, the Company incurred interest expense of approximately $119,000 and $155,000, respectively on amounts borrowed against the Revolving Credit Facility. During the three months ended December 31, 2019 and 2018, the Company incurred an unused facility fee of approximately $10,000 and $8,000, respectively on the unused portion of the Revolving Credit Facility. During the nine months ended December 31, 2019 and 2018, the Company incurred an unused facility fee of approximately $30,000 and $23,000, respectively on the unused portion of the Revolving Credit Facility.
The Revolving Line of Credit is 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 is 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 are being amortized over the term of the agreement. During the three months ended December 31, 2019 and 2018, the Company incurred amortization expense of approximately $3,000 associated with the amortization of deferred financing costs from the original Revolving Credit Facility. During the nine months ended December 31, 2019 and 2018 the Company incurred amortization expense of approximately $10,000 associated with the amortization of deferred financing costs from the original Revolving Credit Facility.
Subordinated Related Party Debt
The subordination agreement was amended reducing the amount of related party subordinated debt to the remaining amount due of approximately $815,000. Provision has also been 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. There are no provisions to continue accruing interest on the outstanding principal amount due as of June 30, 2019. Payments of $123,000 are 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 cannot be made as a result of the foregoing prohibition, including payments after the scheduled maturity date, shall not be deemed an Event of Default and can be made as soon as the Company is able to demonstrate that it meets 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 $123,000 which includes principal and interest, was not made during the three months ended December 31, 2019. 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. During the three months ended December 31, 2019 and 2018, the Company incurred interest expense of approximately $0 and $7,000 respectively on the related party subordinated debt. During the nine months ended December 31, 2019 and 2018, the Company incurred interest expense of approximately $0 and $20,000, respectively on the related party subordinated debt. As of December 31, 2019 and March 31, 2019, the remaining amount due on the subordinated related party debt was approximately $803,000 and $815,000, respectively.
Bank Term Note
The Company repaid the final $125,000 installment of a term loan with PNC which originated in fiscal year 2018.
| 13 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
NOTE 7 - COMMITMENTS AND CONTINGENCIES
LEASES
Operating Leases
We have operating lease agreements for offices and a warehouse facility in Florida, California and Hong Kong 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. The lease provides for a renewal option to extend the lease term for 5 years at the fair market value at the time of renewal.
We entered into an operating lease agreement, effective May 1, 2018, for 424 square feet of office space in Macau, Hong Kong. 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.
Supplemental balance sheet information related to leases as of December 31, 2019 is as follows:
| Assets: | ||||||||
| Operating lease - right-of-use assets | $ | 710,961 | ||||||
| Finance leases as a component of property and equipment, net of accumulated depreciation of $10,363 | 33,163 | |||||||
| Liabilities | ||||||||
| Current | ||||||||
| Current portion of operating leases | $ | 445,322 | ||||||
| Current portion of finance leases | 14,816 | |||||||
| Noncurrent | ||||||||
| Operating lease liabilities, net of current portion | $ | 349,880 | ||||||
| Finance leases, net of current portion | 6,340 | |||||||
Supplemental statement of operations information related to leases for the three and nine months ended December 31, 2019 is as follows:
| Three Months Ended | Nine
Months Ended | |||||||
| December 31 2019 | December 31 2019 | |||||||
| Operating lease expense as a component of general and administrative expenses | $ | 148,725 | $ | 446,173 | ||||
| Finance lease cost | ||||||||
| Depreciation of leased assets as a component of depreciation | $ | 1,554 | $ | 4,664 | ||||
| Interest on lease liabilities as a component of interest expense | $ | 217 | $ | 750 | ||||
| Supplemental cash flow information related to leases for the nine months ended December 31, 2019 is as follows: | ||||||||
| Cash paid for amounts included in the measurement of lease liabilities: | ||||||||
| Operating cash flow paid for operating leases | $ | 487,971 | ||||||
| Financing cash flow paid for finance leases | $ | 10,757 | ||||||
| Lease term and Discount Rate | ||||||||
| Weighted average remaining lease term (months) | 32.6 | |||||||
| Operating leases | 17.0 | |||||||
| Finance leases | ||||||||
| Weighted average discount rate | ||||||||
| Operating leases | 6.25 | % | ||||||
| Finance leases | 3.68 | % |
| 14 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
Scheduled maturities of operating and finance lease liabilities outstanding as of December 31, 2019 are as follows:
| Year | Operating Leases | Finance Leases | ||||||
| 2020, for the remaining 3 months | $ | 163,179 | $ | 3,837 | ||||
| 2021 | 348,531 | 15,347 | ||||||
| 2022 | 115,812 | 2,558 | ||||||
| 2023 | 117,638 | - | ||||||
| 2024 | 121,167 | - | ||||||
| Total Minimum Future Payments | 866,327 | 21,741 | ||||||
| Less: Imputed Interest | 71,125 | 585 | ||||||
| Present Value of Lease Liabilities | $ | 795,202 | $ | 21,156 | ||||
Installment Notes
On June 18, 2019, the Company entered into a financing arrangement with Dimension Funding, LLC (“Dimension”) to finance a new Enterprise Resource Planning (“ERP”) System project over a term of 60 months at a cost of approximately $375,000. Dimension has a 100% security interest in the licensed software being financed. We estimate the system to be placed in service on April 1, 2020. Upon approval by Company management, Dimension released progress payments directly to the project consultants as specific project milestones were met.
Total progress payments will be made to the vendor over a period of approximately nine months and the Company will be charged financing costs on the amounts preapproved for the project. Payments advanced by Dimension to the project consultant during the three months ended December 31, 2019 totaled approximately $108,000. Payments advanced by Dimension to the project consultant during the nine months ended December 31, 2019 totaled approximately $284,000. As of December 31, 2019 these advances were converted to installment notes which call for estimated monthly installment payments of approximately $5,785 (including principal and interest) over a 60 month period and bear interest of approximately 8.2%. As of December 31, 2019 the total principal amount outstanding on the installment notes was approximately $276,000 of which approximately $49,000 is classified as a current liability and approximately $227,000 is classified as a long-term liability on the accompanying condensed consolidated balance sheet. Total interest expense on the installment notes was approximately $3,000, and $10,000 for the three and nine months ended December 31, 2019.
LEGAL MATTERS
Management is not aware of any legal proceedings other than matters that arise in the ordinary course of business.
NOTE 8 - STOCK OPTIONS
During the nine months ended December 31, 2019 the Company issued 100,000 stock options at an exercise price of $.38 to directors as compensation for their service.
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. The following inputs were used to value each option grant:
| ● | For nine months ended December 31, 2019: expected dividend yield of 0%, risk-free interest rate of 2.08%, volatility of 112.3% and an expected term of three years. |
| 15 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
A summary of stock option activity for the nine months ended December 31, 2019 is summarized below:
| December 31, 2019 | ||||||||
| Number of Options | Weighted Average Exercise Price | |||||||
| Stock Options: | ||||||||
| Balance at beginning of period | 2,210,000 | $ | 0.25 | |||||
| Granted | 100,000 | $ | 0.38 | |||||
| Exercised | (60,000 | ) | $ | 0.17 | ||||
| Balance at end of period | 2,250,000 | $ | 0.26 | |||||
| Options exercisable at end of period | 2,150,000 | $ | 0.25 | |||||
The following table summarizes information about employee stock options outstanding at December 31, 2019:
| Range of Exercise Price | Number Outstanding at December 31, 2019 | Weighted Average Remaining Contractural Life | Weighted Average Exercise Price | Number Exercisable at December 31, 2019 | Weighted Average Exercise Price | |||||||||||||||||
| $.03 - $.32 | 1,570,000 | 3.5 | $ | 0.16 | 1,570,000 | $ | 0.16 | |||||||||||||||
| $.38 - $.55 | 680,000 | 8.1 | $ | 0.42 | 580,000 | $ | 0.50 | |||||||||||||||
| * | 2,250,000 | 2,150,000 | ||||||||||||||||||||
* Total number of options outstanding as of December 31, 2019 includes 500,000 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.
As of December 31, 2019 there was unrecognized expense of approximately $5,000 remaining on options currently vesting over time with approximately three months remaining until these options are fully vested.
The intrinsic value of vested options as of December 31, 2019 was approximately $134,000.
NOTE 9 – COMMON STOCK ISSUANCES
On June 12, 2019, the Company issued 32,890 shares of its common stock to its Board of Directors valued at $0.38 per share, pursuant to our annual director compensation plan for the fiscal year ending March 31, 2019. The Company recorded director compensation of $0 and $12,500 during the three and nine months ended December 31, 2019, respectively.
NOTE 10 - GEOGRAPHICAL INFORMATION
Sales to customers outside of the United States for the three and nine months ended December 31, 2019 and 2018 were primarily made by the Macau Subsidiary in US dollars. Sales by geographic region for the periods presented are as follows:
| FOR THE THREE MONTHS ENDED | FOR THE NINE MONTHS ENDED | |||||||||||||||
| December 31, | December 31, | |||||||||||||||
| 2019 | 2018 | 2019 | 2018 | |||||||||||||
| North America | $ | 14,087,271 | $ | 18,627,982 | $ | 34,964,607 | $ | 41,704,128 | ||||||||
| Europe | 1,396,148 | 679,499 | 4,935,548 | 3,657,429 | ||||||||||||
| Australia | 36,097 | 100,768 | 510,243 | 179,923 | ||||||||||||
| Others | - | 44,201 | - | 52,426 | ||||||||||||
| $ | 15,519,516 | $ | 19,452,450 | $ | 40,410,398 | $ | 45,593,906 | |||||||||
The geographic area of sales was based on the location where the product is delivered.
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THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
NOTE 11 –RELATED PARTY TRANSACTIONS
All transactions listed below are related to the Company as they are all with affiliates of our Chairman of the Board, Mr. Phillip Lau.
DUE TO/FROM RELATED PARTIES
On December 31, 2019 and March 31, 2019, in the aggregate the Company had approximately $1,184,000 and $289,000, respectively, due from related parties for goods and services sold to these companies.
On December 31, 2019 and March 31, 2019, the Company had amounts due to related parties in the amounts of approximately $400,000 and $0 for facility fees, storage and administrative services provided to the Company by these related parties.
Subordinated Related Party Debt
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 bears interest at 6% and is 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. There are no provisions to continue accruing interest on the outstanding amount due as of June 30, 2019. The remaining amount due on the subordinated debt of approximately $803,000 and $815,000 were classified as a current liability as of December 31, 2019 and March 31, 2019, respectively on the condensed consolidated balance sheets. Quarterly installment payments of $123,000 due on the last day of each fiscal quarter have not been made since September 2017; however a payment of $25,000 which includes principal and interest, was made during the nine months ended December 31, 2019. During the three months ended December 31, 2019 and 2018 the Company incurred interest expense of approximately $0 and $4,000 respectively on the related party subordinated debt. During the nine months ended December 31, 2019 and 2018 the Company incurred interest expense of approximately $0 and $20,000, respectively on the related party subordinated debt.
TRADE
During the three months ended December 31, 2019 and 2018 the Company sold approximately $0 and $33,000, respectively to Winglight Pacific, Ltd. (“Winglight”), a related party, 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 Winglight for the three months ended December 31, 2019 and 2018 was NA and 23.9%, respectively. The product was shipped to Cosmo Communications of Canada (“Cosmo”), another related company and the Company’s primary distributor of its products to Canada. These amounts were included as a component of net sales in the accompanying condensed consolidated statements of operations.
During the three months ended December 31, 2019 and 2018 the Company sold approximately $45,000 and $16,000 respectively of product directly to Cosmo from its California warehouse facility. These amounts were included as a component of net sales in the accompanying condensed consolidated statements of operations.
During the nine months ended December 31, 2019 and 2018 the Company sold approximately $852,000 and $1,183,000, respectively to Winglight 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 Winglight for the nine months ended December 31, 2019 and 2018 was 23.7% and 30.0%, respectively. The product was shipped to Cosmo. These amounts were included as a component of net sales in the accompanying condensed consolidated statements of operations.
During the nine months ended December 31, 2019 and 2018 the Company sold approximately $284,000 and $655,000, respectively of product directly to Cosmo from its California warehouse facility. These amounts were included as a component of net sales in the accompanying condensed consolidated statements of operations.
The Company incurred service expenses from Starlight Electronics Co, Ltd, (“SLE”) a related party. The services from SLE for the three months ended December 31, 2019 and 2018 were approximately $91,000, and $87,000 respectively. The services from SLE for the nine months ended December 31, 2019 and 2018 were approximately $282,000 and $268,000 respectively. These amounts were included as a component of general and administrative expenses in the accompanying condensed consolidated statements of operations.
NOTE 12 – 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 allowed to return defective goods within a specified period of time after shipment (between 6 and 9 months). 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.
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THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2019
(Unaudited)
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 condensed consolidated balance sheets.
Changes in the Company’s reserve for sales returns are presented in the following table:
| December 31, 2019 | December 31, 2018 | |||||||
| Reserve for sales returns at beginning of the period | $ | 896,154 | $ | 726,000 | ||||
| Provision for estimated sales returns | 6,757,115 | 3,235,305 | ||||||
| Sales returns received | (3,106,951 | ) | (1,910,819 | ) | ||||
| Reserve for sales returns at end of the period | $ | 4,546,317 | $ | 2,050,486 | ||||
NOTE 13 – REFUNDS DUE TO CUSTOMERS
As of December 31, 2019 and March 31, 2019 the amount of refunds due to customers was approximately $510,000 and $31,000, respectively Refunds due to customers at December 31, 2019 are due to one major customer which reflects approximately $1,691,000 of chargebacks less approximately $1,181,000 that the customer has deducted on payment remittances to the Company as of December 31, 2019. (See Note 2 – LIQUIDITY).
NOTE 14 - 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 three months ended December 31, 2019 and 2018 totaled approximately $15,000 and $18,000, respectively. The amounts charged to operations for contributions to this plan and administrative costs during the nine months ended December 31, 2019 and 2018 totaled approximately $47,000 and $51,000, respectively. The amounts are included as a component of general and administrative expense in the accompanying condensed consolidated statements of operations. The Company does not provide any post-employment benefits to retirees.
NOTE 15 - CONCENTRATIONS OF CREDIT AND SALES RISK
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 December 31, 2019, 74% of accounts receivable were due from five customers in North America that individually owed over 10% of total accounts receivable. At March 31, 2019, 62% of accounts receivable were due from three customers in North America that individually owed over 10% of total accounts receivable.
The Company generates most of its revenue from retailers of products in the United States with a significant amount of sales concentrated with several large customers the loss of which could have an adverse impact on the financial position of the Company. For the three months ended December 31, 2019, there were four customers who individually accounted for 10% or more of the Company’s net sales. Revenue derived from these customers as a percentage of net sales were 27%, 17%, 13%, and 12% respectively. For the three months ended December 31, 2018, there were five customers who individually accounted for 10% or more of the Company’s net sales. Revenue derived from these customers as a percentage of net sales were 34%, 17%, 16%, 13% and 13%, respectively.
For the nine months ended December 31, 2019, there were three customers who individually accounted for 10% or more of the Company’s net sales. Revenue derived from these customers as a percentage of net sales were 39%, 13% and 10% respectively. For the nine months ended December 31, 2018, there were five customers who individually accounted for 10% or more of the Company’s net sales. Revenue derived from these customers as a percentage of net sales were 37%, 14%, 13%, 12% and 10%, respectively.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes included elsewhere in this quarterly report. This document contains certain forward-looking statements including, among others, anticipated trends in our financial condition and results of operations and our business strategy. (See Part II, Item 1A, “Risk Factors”). These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially from these forward-looking statements.
Statements included in this quarterly report that do not relate to present or historical conditions are called “forward-looking statements.” Such forward-looking statements involve known and unknown risks and uncertainties and other factors that could cause actual results or outcomes to differ materially from those expressed in, or implied by, the forward-looking statements. Forward-looking statements may include, without limitation, statements relating to our plans, strategies, objectives, expectations and intentions. Words such as “believes,” “forecasts,” “intends,” “possible,” “estimates,” “anticipates,” “expects,” “plans,” “should,” “could,” “will,” and similar expressions are intended to identify forward-looking statements. Our ability to predict or project future results or the effect of events on our operating results is inherently uncertain. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved.
Important factors to consider in evaluating such forward-looking statements include, but are not limited to: (i) changes in external factors or in our internal budgeting process which might impact trends in our results of operations; (ii) unanticipated working capital or other cash requirements; (iii) changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the industries in which we operate; and (iv) the effects of adverse general economic conditions, both within the United States and globally, (v) vendor price increases and decreased margins due to competitive pricing during the economic downturn (vi)various competitive market factors that may prevent us from competing successfully in the marketplace and (vii) other factors described in the risk factors section of our Annual Report on Form 10-K, this Quarterly Report on 10-Q, or in our other filings made with the SEC.
Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements.
OVERVIEW
The Singing Machine Company, Inc., a Delaware corporation (the “Company”, “SMC”, “The Singing Machine”) and its three 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 systems, accessories, musical instruments and musical recordings. The products are sold by SMC to retailers and distributors for resale to consumers.
Our products are sold throughout North America, Europe, Australia and South Africa primarily through major mass merchandisers and warehouse clubs, on-line retailers and to a lesser extent department stores, lifestyle merchants, direct mail catalogs and showrooms, music and record stores, and specialty stores.
Representative customers include Amazon, Best Buy, BJ’s Wholesale, Costco, Sam’s Club, Target, JC Penney and Wal-Mart. Our business has historically been subject to seasonal fluctuations causing our revenues to vary from quarter to quarter and between the same periods in different fiscal years. Our products are manufactured for the most part based on the purchase indications of our customers. We are uncertain of how significantly our business would be harmed by a prolonged economic recession, but we anticipate that continued contraction of consumer spending would negatively affect our revenues and profit margins.
Sales of consumer electronics and toy products in the retail channel are highly seasonal, with a majority of retail sales occurring during the period from September through December in anticipation of the holiday season, which includes Christmas. A substantial majority of our sales occur during the second quarter ending September 30 and the third quarter ending December 31. Sales in our second and third quarter, combined, accounted for approximately 94% and 89% of net sales in fiscal 2019 and 2018, respectively.
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RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain items related to our consolidated statements of operations as a percentage of net sales for the three and nine months ended December 31, 2019 and 2018:
The Singing Machine Company, Inc. and Subsidiaries
CONDENDSED CONSOLIDATED STATEMENTS OF OPERATIONS
| For Three Months Ended | For Nine Months Ended | |||||||||||||||
| December 31, 2019 | December 31, 2018 | December 31, 2019 | December 31, 2018 | |||||||||||||
| Net Sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
| Cost of Goods Sold | 74.0 | % | 71.1 | % | 73.6 | % | 75.4 | % | ||||||||
| Gross Profit | 26.0 | % | 28.9 | % | 26.4 | % | 24.6 | % | ||||||||
| Operating Expenses | ||||||||||||||||
| Selling expenses | 21.9 | % | 11.5 | % | 16.2 | % | 10.3 | % | ||||||||
| General and administrative expenses | 9.3 | % | 7.9 | % | 12.5 | % | 9.2 | % | ||||||||
| Depreciation and amortization | 0.5 | % | 0.3 | % | 0.5 | % | 0.4 | % | ||||||||
| Total Operating Expenses | 31.7 | % | 19.7 | % | 29.2 | % | 19.9 | % | ||||||||
| Income from Operations | -5.7 | % | 9.2 | % | -2.8 | % | 4.7 | % | ||||||||
| Other Expenses | ||||||||||||||||
| Interest expense | -0.7 | % | -0.7 | % | -0.4 | % | -0.5 | % | ||||||||
| Financing costs | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % | ||||||||
| Total Other Expenses | -0.7 | % | -0.7 | % | -0.4 | % | -0.5 | % | ||||||||
| Income Before Income Tax Provision | -6.4 | % | 8.5 | % | -3.2 | % | 4.2 | % | ||||||||
| Income Tax Provision | 1.5 | % | -1.9 | % | 0.7 | % | -1.0 | % | ||||||||
| Net Income | -4.9 | % | 6.6 | % | -2.5 | % | 3.2 | % | ||||||||
See notes to the condensed consolidated financial statements
QUARTER ENDED DECEMBER 31, 2019 COMPARED TO THE QUARTER ENDED DECEMBER 31, 2018
NET SALES
Net sales for the quarter ended December 31, 2019 decreased to approximately $15,520,000 from $19,452,000 a decrease of approximately $3,932,000 as compared to the same period ended December 31, 2018. There was a decrease in sales of approximately $512,000 to our UK distributor and a decrease of sales to one major customer of approximately $1,596,000 both of whom ended the prior year with excess inventory and reduced purchases during the quarter ended December 31, 2019. The remaining decrease of approximately $1,824,000 was primarily due to additional sales adjustments required for the estimated returns of the new Carpool Karaoke The Mic (“CPK”) product of approximately $532,000 that did not sell as well as projected and estimated additional returns of core product due to a disappointing holiday season for the consumer electronics and toy industries in general.
GROSS PROFIT
Gross profit for the quarter ended December 31, 2019 decreased to approximately $4,033,000 from $5,626,000 a decrease of approximately $1,593,000 as compared to the same period in the prior year. Approximately $1,136,000 of the decrease was commensurate with the drop in net sales. The remaining decrease was primarily due to the increased sales adjustments required for estimated returns of both the CPK products and core products.
Gross profit margin for the three months ended December 31, 2019 was 26.0% compared to 28.9% for the three months ended December 31, 2018. The additional reserve accrual for estimated returns of CPK product contributed approximately 1.6 margin points of the decrease due to the significantly higher margin yield of this product. The remaining 1.3 margin point decrease was primarily due the margin yield on the estimated mix of excess core product to be returned by customers.
OPERATING EXPENSES
For the quarter ended December 31, 2019, total operating expenses increased to approximately $4,922,000 compared to approximately $3,826,000 from the same period in the prior year. This represents an increase in total operating expenses of approximately $1,096,000 from the quarter ended December 31, 2018. Selling expenses increased by approximately $1,166,000, of which approximately $559,000 was due to an increase in advertising allowances granted to major customers to assist in sales of inventories during peak season, approximately $314,000 was due to marketing and royalty expenses associated with the CPK product with the remaining variance primarily due to additional expenses in freight related to the increase in returned goods.
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General and administrative expenses decreased by approximately $83,000 to approximately $1,442,000 for the three months ended December 31, 2019 compared to approximately $1,525,000 for the same period ended December 31, 2018 primarily due to the reversal of an accrual for unexercised and expired stock warrants issued to an investment banking firm previously expensed at a fair market value of approximately $101,000 in a prior year.
(LOSS) INCOME FROM OPERATIONS
There was a loss from operations of approximately $889,000 for the three months ended December 31, 2019 compared to income from operations of approximately $1,800,000 for the three months ended December 31, 2018. The decrease in income from operations of approximately $2,689,000 was primarily due to the decrease in gross profit and increase in selling expenses as explained above.
INCOME TAXES
For the three months ended December 31, 2019 and 2018 the Company recognized an income tax benefit of approximately $240,000 and an income tax provision of approximately $367,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 22.7% and 22.0%, respectively.
NET (LOSS) INCOME
For the three months ended December 31, 2019 there was a net loss of approximately $758,000 compared to net income of approximately $1,290,000 for the same period a year ago. The decrease in net income was primarily due to the same reasons discussed in (Loss) Income from Operations and Income Taxes.
NINE MONTHS ENDED DECEMBER 31, 2019 COMPARED TO THE NINE MONTHS ENDED DECEMBER 31, 2018
NET SALES
Net sales for the nine months ended December 31, 2019 decreased to approximately $40,410,000 from $45,594,000 a decrease of approximately $5,184,000 as compared to the same period ended December 31, 2018. There were decreases in sales of approximately $1,990,000 to our UK distributor and approximately $1,237,000 to one major customer both of whom ended the prior year with excess inventory and reduced purchases during the nine months ended December 31, 2019. There was a reduction in net sales of approximately $1,596,000 to one major customer who charged the Company back for goods shipped direct import that were damaged in transit (See Note 2 – LIQUIDITY). The remaining decrease of was primarily due to additional sales adjustments required for the estimated returns of the new CPK and core product.
GROSS PROFIT
Gross profit for the nine months ended December 31, 2019 decreased to approximately $10,663,000 from approximately $11,224,000 a decrease of approximately $561,000 as compared to the same period in the prior year. The decrease in sales accounted for a decrease in gross profit of approximately $1,275,000. There was an increase in the cost of our microphone products of approximately $104,000 due to the late season 15% tariff assessment that we were unable to pass on to the customer. These decreases in gross profit were offset by approximately $893,000 the high margin yield of CPK product that was sold with the remaining variance due to margin yield on mix of other products sold.
Gross profit margin for the nine months ended December 31, 2019 was 26.4% compared to 24.6% for the nine months ended December 31, 2018. The sale of the new CPK product introduced in fiscal 2020 accounted for approximately 2.2 points of the gross profit margin increase with the remaining .4 points of margin decrease primarily due to the mix of other products sold.
OPERATING EXPENSES
For the nine months ended December 31, 2019, total operating expenses increased to approximately $11,795,000 compared to approximately $9,084,000 from the same period in the prior year. This represents an increase in total operating expenses of approximately $2,711,000 from the nine months ended December 31, 2018. Selling expenses increased by approximately $1,852,000, primarily due to discretionary marketing expenses, commission and royalty expenses of approximately $806,000 primarily associated with the launch and sale of the CPK product. There was an increase in advertising allowance expense of approximately $580,000 as incremental co-op advertising was required to help customers sell through stock of CPK and core product due to lagging performance in holiday sales for the consumer electronics and toy industries in general. There was an increase in freight costs of approximately $109,000 due to in-bound freight and handling charged by one major customer for the return of damaged goods as explained in net sales.
General and administrative expenses increased by approximately $863,000 to approximately $5,049,000 for the nine months ended December 31, 2019 compared to approximately $4,186,000 for the same period ended December 31, 2018. There was an increase of approximately $295,000 in bad debt expense primarily due to recovery of bad debt from the Toys R Us bankruptcy during the nine months ended December 31, 2018 of approximately $325,000 compared to no significant recovery of bad debt expenses during the nine months ended December 31, 2019. Insurance expense increased approximately $135,000 over the same period ending December 31, 2018 due to accounts receivable insurance purchased for a major customer. There was approximately $346,000 in administrative expenses relating to the processing of damaged goods received by one major customer as explained in net sales with the remaining variance due to other variable administrative expenses.
(LOSS) INCOME FROM OPERATIONS
There was a loss from operations of approximately $1,132,000 for the nine months ended December 31, 2019 compared to income from operations of approximately $2,141,000 for the nine months ended December 31, 2018. The decrease in income from operations of approximately $3,273,000 was primarily due the decrease in gross profit and increase in selling and general administrative expenses as explained above.
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INCOME TAXES
For the nine months ended December 31, 2019 and 2018 the Company recognized an income tax benefit of approximately $295,000 and an income tax provision of approximately $422,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 22.7% and 22.0%, respectively.
NET (LOSS) INCOME
For the nine months ended December 31, 2019 there was a net loss of approximately $1,003,000 compared to net income of approximately $1,473,000 for the same period a year ago. The decrease in net income was primarily due to the same reasons discussed in (Loss) Income from Operations and Income Taxes.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2019, the Company had cash on hand of approximately $519,000 as compared to cash on hand of approximately $211,000 on March 31, 2019. We had working capital of approximately $5,489,000 as of December 31, 2019. Net cash provided by operating activities was approximately $684,000 for the nine months ended December 31, 2019, as compared to approximately $1,498,000 used in operating activities for the same period a year ago. During the nine months ended December 31, 2019 there was an increase in accounts payable of approximately $5,742,000 partially due to pending resolution and payment of the related insurance claim filed (See Note 2 – LIQUIDITY). There was an increase in reserves for sales returns of approximately $3,650,000 based on anticipated returns of CPK product as well as in increase in overstock returns of core product due to decreased performance in the consumer electronic and toy industry segments in general. There was an increase in accrued expenses of approximately $1,780,000 primarily due to the significant increase in advertising allowance granted to customers to assist in customer product sell-through related to the CPK product as well as to help mitigate overstock returns of core product after peak season. These increases in cash provided by operations were offset by an increase in accounts receivable of approximately $6,125,000 due to peak season sales, an increase in insurance receivable of approximately $1,286,000 relating to damaged goods claims from one customer (See Note 2 – LIQUIDITY), an increase of approximately $2,229,000 in inventories due to increased estimated future returns primarily related to the CPK product. There were increases in related party accounts receivable of approximately $895,000 due to peak seasonal amounts due for goods shipped to our Canadian distributor. These activities accounted for approximately 93% of cash provided operations with the remaining 7% due to seasonal changes in other operating assets and liabilities.
Net cash used in operating activities was approximately $1,498,000 for the nine months ended December 31, 2018. During the nine months ended December 31, 2018 the Company had net income of approximately $1,473,000 inclusive of bad debt recovery of Toys R Us bankruptcy administrative claims of approximately $253,000. During this period accounts receivable increased by approximately $9,697,000 due primarily to the seasonal increase in net sales during the quarter ended December 31, 2018. This use of operating cash was offset by operating activities that provided cash including a decrease in inventories of approximately $2,475,000 due to the sale of prior year excess inventory related to the Toys R Us bankruptcy, a seasonal increase in accounts payable (primarily inventory vendors) of approximately $1,745,000, a seasonal increase in accrued expenses of approximately $1,037,000, a seasonal increase in reserves for estimated sales returns of approximately $1,324,000, an increase in amounts due to related parties of approximately $294,000. These activities accounted for approximately 90% of the cash used in operations with the remaining 10% due to seasonal changes in other operating assets and liabilities.
Net cash used in investing activities for the nine months ended December 31, 2019 was approximately $517,000 as compared to approximately $289,000 used in investing activities for the same period ended a year ago and consisted primarily of purchases of molds and tooling for new products and a current fiscal year investment in a new Enterprise Resourcing Planning (ERP) system of approximately $304,000.
Net cash provided by financing activities for the nine months ended December 31, 2019 was approximately $140,000 compared to cash provided by financing activities of approximately $2,554,000 for the same period ended of the prior year. We received approximately $284,000 from a financing arrangement with Dimension Funding to finance implementation of a new Enterprise Resource Planning system. This increase in cash provided by financing activities were offset by payments of finance leases and the bank term note of approximately $136,000.
As of December 31, 2019 the Company was in default on the Revolving Credit Facility due to non-compliance with the fixed charge coverage ratio in part due to the loss of margin and related expenses associated with the damaged goods received by one major customer in August, 2019. In November 2019, the Company entered into a Forbearance Agreement with PNC Bank National Association (“PNC”) whereby PNC “forbears” taking action it would be entitled to under a default through March 31, 2020 at which time we would renegotiate renewal of the Revolving Credit Facility or obtain alternative financing.
| ● | PNC implemented a $1,000,000 loan availability block. | |
| ● | PNC required an EBITDA hurdle greater than or equal to $400,000 for the third quarter ending December 31, 2019, and requires EBITDA of $0 for the six months ending March 31, 2020 and $(83,000) for the twelve months ending March 31, 2020. | |
| ● | PNC implemented loan pricing increase of .5% until March 31, 2020 which will continue until the Company achieves compliance with the original fixed charge coverage ratio test of 1.1:1. |
As of December 31,2019 the Company did not meet the required EBITDA hurdle of greater than or equal to $400,000 for the third quarter ended December 31, 2019 and is unlikely to meet the remaining hurdles of the Forbearance Agreement for the fiscal year ending March 31, 2020. As of December 31, 2019 the Revolving Credit Facility was settled in full and there have been no further actions by PNC to exercise any of their options afforded to them as per the terms of the Revolving Credit Facility.
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For the nine months ended December 31, 2019, the Company incurred a net loss of approximately $1,003,000 compared to net income of approximately $1,473,000 for the nine months ended December 31, 2018. The Company expects cash flows from operations as well as other financing resources to be adequate to satisfy working capital requirements for at least the next twelve months from the date the accompanying condensed consolidated financial statements are issued. The Company plans to supplement cash flows from operations from several activities and resources including the following:
| ● | Reduce operating expenses. | |
| ● | Continue to negotiate renewal of the existing Revolving Credit Facility with PNC Bank prior to its expiration on July 15, 2020. | |
| ● | Continuing discussions for alternative financing arrangements with several financial institutions. | |
| ● | Utilize “dynamic discount” programs offered by several of the Company’s major customers which allow for accelerated payment of invoices in exchange for an early pay discount. |
There can be no assurances that any of the above actions can be accomplished or that financing will be available on acceptable terms. If the Company is unable to obtain financing or continues to experience sustained losses from operations this would have a material adverse effect on its consolidated financial condition and the ability to meet its financial obligations when due.
INVENTORY SELL THROUGH
We monitor the inventory levels and sell through activity of our major customers to properly anticipate defective returns and maintain the appropriate level of inventory. We believe that our warranty provision reflects the proper amount of reserves to cover potential defective sales returns based on historical return ratios and information available from the customers.
SEASONAL AND QUARTERLY RESULTS
Historically, our operations have been seasonal, with the highest net sales occurring in our second and third fiscal quarters (reflecting increased orders for systems and music merchandise during the Christmas holiday season) and to a lesser extent the first and fourth quarters of the fiscal year. Sales in our second and third fiscal quarters, combined, accounted for approximately 94% and 89% of net sales in fiscal 2019 and 2018, 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 our operations. We generally have adjusted our prices to track changes in the Consumer Price Index since prices we charge are generally not fixed by long-term contracts.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.
CRITICAL ACCOUNTING POLICIES
The Company’s interim financial statements were prepared in accordance with United States generally accepted accounting principles, which require management to make subjective decisions, assessments and estimates about the effect of matters that are inherently uncertain. As the number of variables and assumptions affecting the judgement increases such judgements become even more subjective. While management believes that its assumptions are reasonable and appropriate, actual results may be materially different than estimated. The critical accounting estimates and assumptions have not materially changed from those identified in the Company’s 2019 Annual Report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required for small reporting companies.
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ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. As of the end of the period covered by this report, we conducted an evaluation, 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 are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms and is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
(b) Changes in Internal Controls. There was no change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 under the Exchange Act that occurred during the period covered by this report that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
Management is not aware of any legal proceedings other than matters that arise in the ordinary course of business.
Not applicable for smaller reporting companies
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
See Note 6 – BANK FINANCING in the notes to the condensed consolidated financial statements.
ITEM 4. MINE SAFETY DISCLOSURES
None.
None.
* Filed herewith
| 24 |
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| THE SINGING MACHINE COMPANY, INC. | ||
| Date: February 14, 2020 | By: | /s/ Gary Atkinson |
| Gary Atkinson | ||
| Chief Executive Officer | ||
| /s/ Lionel Marquis | ||
| Lionel Marquis | ||
| Chief Financial Officer |
| 25 |
EXHIBIT 31.1
CERTIFICATIONS
I, Gary Atkinson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Singing Machine Company, Inc. for the period ended December 31, 2019;
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 controls 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: February 14, 2020 |
EXHIBIT 31.2
CERTIFICATIONS
I, Lionel Marquis, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Singing Machine Company, Inc. for the period ended December 31, 2019;
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 controls 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 Accounting and Financial Officer)
Date: February 14, 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 Quarterly Report of The Singing Machine Company, Inc. (the “Company”) on Form 10-Q for the period ended December 31, 2019 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: February 14, 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 Quarterly Report of The Singing Machine Company, Inc. (the “Company”) on Form 10-Q for the period ended December 31, 2019 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 Accounting and Financial Officer)
Date: February 14, 2020 |