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, 2020 | ||
| [ ] | 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)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
| Common Stock, Class B | SMDM | OTCQX |
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 [ ] 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 | 39,040,748 as of February 19, 2021 |
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARIES
| 2 |
The Singing Machine Company, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
| December 31, 2020 | March 31, 2020 | |||||||
| (Unaudited) | ||||||||
| Assets | ||||||||
| Current Assets | ||||||||
| Cash | $ | 823,373 | $ | 345,200 | ||||
| Accounts receivable, net of allowances of $281,501 and $337,461 respectively | 8,972,049 | 1,860,500 | ||||||
| Due from banks | 3,560,812 | 2,388,438 | ||||||
| Accounts receivable related party - Winglight Pacific, Ltd | - | 100,000 | ||||||
| Insurance claim receivable | - | 1,268,463 | ||||||
| Inventories, net | 5,336,912 | 7,601,277 | ||||||
| Prepaid expenses and other current assets | 141,168 | 252,473 | ||||||
| Deferred financing costs | 33,791 | 3,333 | ||||||
| Total Current Assets | 18,868,105 | 13,819,684 | ||||||
| Property and equipment, net | 655,839 | 771,349 | ||||||
| Deferred tax assets | 413,335 | 1,285,721 | ||||||
| Operating Leases - right of use assets | 2,269,108 | 573,874 | ||||||
| Other non-current assets | 97,797 | 150,509 | ||||||
| Total Assets | $ | 22,304,184 | $ | 16,601,137 | ||||
| Liabilities and Shareholders’ Equity | ||||||||
| Current Liabilities | ||||||||
| Accounts payable | $ | 3,961,840 | $ | 5,041,610 | ||||
| Accrued expenses | 2,108,900 | 1,529,168 | ||||||
| Due to related party - Starlight Consumer Electronics Co., Ltd. | 14,400 | 14,400 | ||||||
| Due to related party - Starlight Electronics Co., Ltd | - | 372,300 | ||||||
| Due to related party - Starlight R&D, Ltd. | 115,016 | 115,016 | ||||||
| Revolving line of credit - Iron Horse Credit | 64,915 | - | ||||||
| Refunds due to customers | 101,731 | 806,475 | ||||||
| Reserve for sales returns | 2,966,434 | 1,224,000 | ||||||
| Current portion of finance leases | 6,336 | 14,953 | ||||||
| Current portion of installment notes | 66,917 | 63,098 | ||||||
| Current portion of note payable - Paycheck Protection Program | 296,649 | - | ||||||
| Current portion of operating lease liabilities | 779,905 | 321,389 | ||||||
| Current portion of subordinated related party debt - Starlight Marketing Development, Ltd. | 750,000 | - | ||||||
| Total Current Liabilities | 11,233,043 | 9,502,409 | ||||||
| Finance leases, net of current portion | - | 2,550 | ||||||
| Installment notes, net of current portion | 230,572 | 283,193 | ||||||
| Note payable - Payroll Protection Program, net of current portion | 147,251 | - | ||||||
| Operating lease liabilities, net of current portion | 1,540,226 | 322,263 | ||||||
| Subordinated related party debt - Starlight Marketing Development, Ltd., | 52,659 | 802,659 | ||||||
| Total Liabilities | 13,203,751 | 10,913,074 | ||||||
| Commitments and Contingencies | ||||||||
| Shareholders’ Equity | ||||||||
| Preferred stock, $1.00 par value; 1,000,000 shares authorized; no shares issued and outstanding | - | - | ||||||
| Common stock, Class A, $0.01 par value; 100,000 shares authorized; no shares issued and outstanding | - | - | ||||||
| Common stock, Class B, $0.01 par value; 100,000,000 shares authorized; 39,040,748 and 38,557,643 shares issued and outstanding, respectively | 390,407 | 385,576 | ||||||
| Additional paid-in capital | 19,768,217 | 19,729,043 | ||||||
| Accumulated deficit | (11,058,191 | ) | (14,426,556 | ) | ||||
| Total Shareholders’ Equity | 9,100,433 | 5,688,063 | ||||||
| Total Liabilities and Shareholders’ Equity | $ | 22,304,184 | $ | 16,601,137 | ||||
See notes to the condensed consolidated financial statements
| 3 |
The Singing Machine Company, Inc. and Subsidiaries
CONDENSED CONSOLIDATED INCOME STATEMENTS
(Unaudited)
| For the Three Months Ended | For the Nine Months Ended | |||||||||||||||
| December 31, 2020 | December 31, 2019 | December 31, 2020 | December 31, 2019 | |||||||||||||
| (restated) | (restated) | |||||||||||||||
| Net Sales | $ | 16,972,603 | $ | 13,857,576 | $ | 42,309,825 | $ | 37,552,329 | ||||||||
| Cost of Goods Sold | 11,998,640 | 11,486,520 | 30,550,406 | 29,747,376 | ||||||||||||
| Gross Profit | 4,973,963 | 2,371,056 | 11,759,419 | 7,804,953 | ||||||||||||
| Operating Expenses | ||||||||||||||||
| Selling expenses | 1,490,560 | 1,740,777 | 3,264,364 | 3,692,070 | ||||||||||||
| General and administrative expenses | 1,925,233 | 1,442,192 | 5,130,396 | 5,048,517 | ||||||||||||
| Depreciation | 65,465 | 77,161 | 204,353 | 196,210 | ||||||||||||
| Total Operating Expenses | 3,481,258 | 3,260,130 | 8,599,113 | 8,936,797 | ||||||||||||
| Income (Loss) from Operations | 1,492,705 | (889,074 | ) | 3,160,306 | (1,131,844 | ) | ||||||||||
| Other Income (Expenses) | ||||||||||||||||
| Gain from damaged goods insurance claim | - | - | 1,067,829 | - | ||||||||||||
| Gain from extinguishment of accounts payable | - | - | 390,000 | - | ||||||||||||
| Gain - related party | 187,988 | - | 187,988 | - | ||||||||||||
| Interest expense | (231,034 | ) | (105,583 | ) | (388,355 | ) | (156,097 | ) | ||||||||
| Finance costs | (18,432 | ) | (3,334 | ) | (43,268 | ) | (10,000 | ) | ||||||||
| Total Other Income (Expenses), net | (61,478 | ) | (108,917 | ) | 1,214,194 | (166,097 | ) | |||||||||
| Income (Loss) Before Income Tax (Provision) Benefit | 1,431,227 | (997,991 | ) | 4,374,500 | (1,297,941 | ) | ||||||||||
| Income Tax (Provision) Benefit | (263,932 | ) | 240,042 | (1,006,135 | ) | 294,633 | ||||||||||
| Net Income (Loss) | $ | 1,167,295 | $ | (757,949 | ) | $ | 3,368,365 | $ | (1,003,308 | ) | ||||||
| Net Income (Loss) per Common Share | ||||||||||||||||
| Basic and Diluted | $ | 0.03 | $ | (0.02 | ) | $ | 0.09 | $ | (0.03 | ) | ||||||
| Diluted | $ | 0.03 | $ | (0.02 | ) | $ | 0.09 | $ | (0.03 | ) | ||||||
| Weighted Average Common and Common | ||||||||||||||||
| Equivalent Shares: | ||||||||||||||||
| Basic | 38,885,185 | 38,557,643 | 38,667,221 | 38,524,698 | ||||||||||||
| Diluted | 39,156,481 | 38,557,643 | 39,041,074 | 38,524,698 | ||||||||||||
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, 2020 | December 31, 2019 | |||||||
| Cash flows from operating activities | ||||||||
| Net Income (loss) | $ | 3,368,365 | $ | (1,003,308 | ) | |||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | ||||||||
| Depreciation | 204,353 | 196,210 | ||||||
| Amortization of deferred financing costs | 43,268 | 9,999 | ||||||
| Change in inventory reserve | 482,926 | 150,000 | ||||||
| Change in allowance for bad debts | (55,960 | ) | 133,024 | |||||
| Stock based compensation | 17,605 | 27,506 | ||||||
| Gain - related party | (187,988 | ) | - | |||||
| Change in net deferred tax assets | 872,386 | (294,633 | ) | |||||
| Gain from extinguishment of accounts payable | 390,000 | - | ||||||
| Changes in operating assets and liabilities: | ||||||||
| Accounts receivable | (7,055,589 | ) | (6,125,452 | ) | ||||
| Due from banks | (1,172,374 | ) | (211,089 | ) | ||||
| Accounts receivable - related parties | 100,000 | (895,217 | ) | |||||
| Insurance receivable | 1,268,463 | (1,286,158 | ) | |||||
| Inventories | 1,781,439 | (2,228,603 | ) | |||||
| Prepaid expenses and other current assets | 111,305 | 134,598 | ||||||
| Other non-current assets | 52,712 | 67,023 | ||||||
| Accounts payable | (1,469,770 | ) | 5,742,186 | |||||
| Accrued expenses | 579,732 | 1,780,393 | ||||||
| Due to related parties | (184,312 | ) | 399,672 | |||||
| Refunds due to customers | (704,744 | ) | 479,758 | |||||
| Reserve for sales returns | 1,742,434 | 3,650,163 | ||||||
| Operating lease liabilities, net of operating leases - right of use assets | (18,755 | ) | (41,797 | ) | ||||
| Net cash provided by operating activities | 165,496 | 684,275 | ||||||
| Cash flows from investing activities | ||||||||
| Purchase of property and equipment | (88,843 | ) | (517,546 | ) | ||||
| Net cash used in investing activities | (88,843 | ) | (517,546 | ) | ||||
| Cash flows from financing activities | ||||||||
| Net proceeds from revolving lines of credit | 64,915 | - | ||||||
| Proceeds from note payable - Payroll Protection Program | 443,900 | - | ||||||
| Payment of bank term note | - | (125,000 | ) | |||||
| Payment of deferred financing charges | (73,726 | ) | - | |||||
| Proceeds from installment notes | - | 283,840 | ||||||
| Payments on installment notes | (48,802 | ) | (7,304 | ) | ||||
| Proceeds from subscription receivable | - | 2,200 | ||||||
| Proceeds from exercise of stock options | 26,400 | 10,200 | ||||||
| Payment on subordinated debt - related party | - | �� | (12,708 | ) | ||||
| Payments on finance leases | (11,167 | ) | (10,757 | ) | ||||
| Net cash provided by financing activities | 401,520 | 140,471 | ||||||
| Net change in cash | 478,173 | 307,200 | ||||||
| Cash at beginning of period | 345,200 | 211,408 | ||||||
| Cash at end of period | $ | 823,373 | $ | 518,608 | ||||
| Supplemental disclosures of cash flow information: | ||||||||
| Cash paid for interest | $ | 429,264 | $ | 167,954 | ||||
| Operating leases - right of use assets initial adoption | $ | - | $ | 1,108,330 | ||||
| Operating lease liabilities - initial adoption | $ | - | $ | 1,234,368 | ||||
| Operating leases - right of use assets and lease liabilities at inception of lease | $ | 2,184,105 | $ | - | ||||
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, 2020 and 2019
(Unaudited)
| Preferred Stock | Common Stock | Additional Paid in | Subscriptions | Accumulated | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Receivable | Deficit | Total | |||||||||||||||||||||||||
| Balance at September 30, 2020 | - | $ | - | 38,557,643 | $ | 385,576 | $ | 19,729,043 | $ | - | $ | (12,225,486 | ) | $ | 7,889,133 | |||||||||||||||||
| Net income | 1,167,295 | 1,167,295 | ||||||||||||||||||||||||||||||
| Employee compensation-stock option | 5,105 | 5,105 | ||||||||||||||||||||||||||||||
| Issuance of common stock - directors | 43,105 | 431 | 12,069 | 12,500 | ||||||||||||||||||||||||||||
| Exercise of stock options | 440,000 | 4,400 | 22,000 | 26,400 | ||||||||||||||||||||||||||||
| Balance at December 31, 2020 | - | $ | - | 39,040,748 | $ | 390,407 | $ | 19,768,217 | $ | - | $ | (11,058,191 | ) | $ | 9,100,433 | |||||||||||||||||
| 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 | |||||||||||||||||
The Singing Machine Company, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
For the nine months ended December 31, 2020 and 2019
(Unaudited)
| Preferred Stock | Common Stock | Additional Paid in | Subscriptions | Accumulated | ||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Receivable | Deficit | Total | |||||||||||||||||||||||||
| Balance at March 31, 2020 | - | $ | - | 38,557,643 | $ | 385,576 | $ | 19,729,043 | $ | - | $ | (14,426,556 | ) | $ | 5,688,063 | |||||||||||||||||
| Net income | 3,368,365 | 3,368,365 | ||||||||||||||||||||||||||||||
| Employee compensation-stock option | 5,105 | 5,105 | ||||||||||||||||||||||||||||||
| Issuance of common stock - directors | 43,105 | 431 | 12,069 | - | 12,500 | |||||||||||||||||||||||||||
| Exercise of stock options | 440,000 | 4,400 | 22,000 | 26,400 | ||||||||||||||||||||||||||||
| Balance at December 31, 2020 | - | $ | - | 39,040,748 | $ | 390,407 | $ | 19,768,217 | $ | - | $ | (11,058,191 | ) | $ | 9,100,433 | |||||||||||||||||
| 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 | |||||||||||||||||
See notes to the condensed consolidated financial statements.
| 6 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 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 – RESTATEMENT OF PREVIOUSLY ISSUED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The Company has determined that in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, “Revenue from Contract with Customers,” the Company incorrectly accounted for the cost of its cooperative (“co-op”) promotion allowances (previously referred to as “cooperative advertising”) with its customers as selling expenses instead of a reduction in net sales for the three and nine months ended December 31, 2019, as these co-op promotion allowances are not a distinct good or service and the Company cannot reasonably estimate the fair value of the benefit it receives from these arrangements.
The effects of this accounting error do not impact the condensed consolidated balance sheets, statements of cash flows and statements of shareholders’ equity. The effects are confined to the condensed consolidated statements of operations, and these notes to condensed consolidated financial statements. The tables below set forth the condensed consolidated statements of operations, including the balances as originally reported, adjustments and the as restated balances for each of the periods affected:
| For the Three Months Ended | ||||||||||||
| As Reported | As Restated | |||||||||||
| December 31, 2019 | Adjustment | December 31, 2019 | ||||||||||
| Net Sales | $ | 15,519,516 | $ | (1,661,940 | ) | $ | 13,857,576 | |||||
| Cost of Goods Sold | 11,486,520 | - | 11,486,520 | |||||||||
| Gross Profit | 4,032,996 | (1,661,940 | ) | 2,371,056 | ||||||||
| Operating Expenses | ||||||||||||
| Selling expenses | 3,402,717 | (1,661,940 | ) | 1,740,777 | ||||||||
| General and administrative expenses | 1,442,192 | - | 1,442,192 | |||||||||
| Depreciation | 77,161 | - | 77,161 | |||||||||
| Total Operating Expenses | 4,922,070 | (1,661,940 | ) | 3,260,130 | ||||||||
| Loss from Operations | (889,074 | ) | - | (889,074 | ) | |||||||
| Other Expenses | ||||||||||||
| Interest Expense | (105,583 | ) | - | (105,583 | ) | |||||||
| Finance Costs | (3,334 | ) | - | (3,334 | ) | |||||||
| Total Other Expenses | (108,917 | ) | - | (108,917 | ) | |||||||
| Loss Before Income Tax Benefit | (997,991 | ) | - | (997,991 | ) | |||||||
| Income Tax Benefit | 240,042 | - | 240,042 | |||||||||
| Net Loss | $ | (757,949 | ) | $ | - | $ | (757,949 | ) | ||||
| For the Nine Months Ended | ||||||||||||
| As Reported | As Restated | |||||||||||
| December 31, 2019 | Adjustment | December 31, 2019 | ||||||||||
| Net Sales | $ | 40,410,398 | $ | (2,858,069 | ) | $ | 37,552,329 | |||||
| Cost of Goods Sold | 29,747,376 | - | 29,747,376 | |||||||||
| Gross Profit | 10,663,022 | (2,858,069 | ) | 7,804,953 | ||||||||
| Operating Expenses | ||||||||||||
| Selling expenses | 6,550,139 | (2,858,069 | ) | 3,692,070 | ||||||||
| General and administrative expenses | 5,048,517 | - | 5,048,517 | |||||||||
| Depreciation | 196,210 | - | 196,210 | |||||||||
| Total Operating Expenses | 11,794,866 | (2,858,069 | ) | 8,936,797 | ||||||||
| Loss from Operations | (1,131,844 | ) | - | (1,131,844 | ) | |||||||
| Other Expenses | ||||||||||||
| Interest Expense | (156,097 | ) | - | (156,097 | ) | |||||||
| Finance Costs | (10,000 | ) | - | (10,000 | ) | |||||||
| Total Other Expenses | (166,097 | ) | - | (166,097 | ) | |||||||
| Loss Before Income Tax Benefit | (1,297,941 | ) | - | (1,297,941 | ) | |||||||
| Income Tax Benefit | 294,633 | - | 294,633 | |||||||||
| Net Loss | $ | (1,003,308 | ) | $ | - | $ | (1,003,308 | ) | ||||
| 7 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
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, 2020 and 2019 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, 2020 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K/A for the year ended March 31, 2020. 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.
COLLECTABILITY 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. 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.
The Company is subject to chargebacks from customers for cooperative promotional programs, defective returns, return freight and handling charges that are deducted from open invoices and reduce collectability of open invoices.
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 statements 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, 2020 and March 31, 2020 are approximately $801,000 and $217,000, 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 promotional programs. As of December 31, 2020 and March 31, 2020 the estimated amounts for these future inventory returns were approximately $1,846,000 and $1,367,000, 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, 2020 and March 31, 2020 the Company had inventory reserves of approximately $917,000 and $434,000 respectively for estimated excess and obsolete inventory
| 8 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
DEFERRED FINANCING COSTS
The Company classifies deferred financing costs incurred when obtaining or renewing revolving credit facilities as assets in the accompanying condensed consolidated balance sheets as it is likely that during certain periods during non-peak season there will be no balance due on these credit facilities to offset the deferred financing costs. In June 2020, the Company incurred approximately $74,000 in deferred financing costs associated with the closing of the Crestmark Facility and the IHC Facility which are being amortized over twelve months and were classified as current assets on the accompanying condensed consolidated balance sheets.
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 FASB ASC 360-10-05, “Accounting for the Impairment or Disposal of Long-Lived Assets.”
LEASES
The Company follows FASB ASC 842, “Leases”. The ASC requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. The 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 are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. (See Note 6– 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.
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), finance leases and installment notes 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 lines of credit approximate fair value due the relatively short period to maturity and related interest accrued at market rates. The carrying amount on the Payroll Protection Program note payable approximates fair value due the relatively short period to maturity as management intends to apply for total forgiveness of the loan in the current fiscal year.
REVENUE RECOGNITION AND RESERVE FOR SALES RETURNS
The Company recognizes revenue in accordance with FASB ASC 606, “Revenue from Contracts with Customers”. All revenue is generated from contracts with customers. The Company recognizes revenue when the goods are delivered and control of the goods sold is transferred to the customer, in an amount, referred to as the transaction price, that reflects the consideration to which the Company is expected to be entitled in exchange for those goods at a point in time. The Company determines revenue recognition utilizing the following five steps: (1) identification of the contract with a customer, (2) identification of the performance obligations in the contract (promised goods or services that are distinct), (3) determination of the transaction price, (4) allocation of the transaction price to the performance obligations, and (5) recognition of revenue when, or as, the Company transfers control of the product or service for each performance obligation.
| 9 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
The Company’s contracts with customers consist of one performance obligation (the sale of the Company’s products). The Company’s contracts have no financing elements, payment terms are less than 120 days and have no further contract asset or liability obligations once control of goods is transferred to the customer. Revenue is recorded in the amount of consideration the Company expects to receive for the sale of these goods.
The Company selectively participates in a retailer’s co-op promotion initiatives to maximize sales of the Company’s products on the retail floor or to assist in developing consumer awareness of new product launches, by providing marketing fund allowances to our customers. As these co-op promotion initiatives are not a distinct good or service and the Company cannot reasonably estimate the fair value of the benefit it receives from these arrangements, the cost of these allowances at the time they are offered to the customers are recorded as a reduction to net sales. For the three months ended December 31, 2020 and 2019, co-op promotion allowances were approximately $858,000 and $1,662,000, respectively. For the nine months ended December 31, 2020 and 2019, co-op promotion allowances were approximately $2,032,000 and $2,858,000, respectively.
Costs incurred in fulfilling contracts with customers include administrative costs associated with the procurement of goods are included in general and administrative expenses, in-bound freight costs are included in the cost of goods sold and accrued sales representative commissions are included in selling expenses in the accompanying consolidated statements of operations as our underlying customer agreements are less than one year.
The Company disaggregates revenues by product line and major geographic region as most of its revenue is generated by the sales of karaoke hardware and the Company has no other material business segments (See Note 9 – GEOGRAPHICAL INFORMATION).
While the Company generally does not allow products to be returned, the Company does provide for variable consideration contingent upon the occurrence of uncertain future events. Variable consideration is estimated at the expected value or at the most likely amount depending on the type of consideration. Estimated amounts are included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. The Company estimates variable consideration under our return allowance programs for goods returned to the customer for various reasons, whereby a sales return reserve is recorded based on historic return amounts, specific events as identified and management estimates.
The Company’s reserve for sales returns was approximately $2,966,000 and $1,224,000 as of December 31, 2020 and March 31, 2020, respectively.
Revenue is derived from four different major product lines. Disaggregated revenue from these product lines for the three and nine months ended December 31, 2020 and 2019 consisted of the following:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| Product Line | December 31, 2020 | December 31, 2019 | December 31, 2020 | December 31, 2019 | ||||||||||||
| (as restated) | (as restated) | |||||||||||||||
| Classic Karaoke Machines | $ | 8,296,000 | $ | 9,223,000 | $ | 25,320,000 | $ | 26,980,000 | ||||||||
| Download Karaoke Machines | 3,898,000 | 3,254,000 | 7,314,000 | 5,163,000 | ||||||||||||
| SMC Kids Toys | 609,000 | 306,000 | 1,003,000 | 911,000 | ||||||||||||
| Music and Accessories | 4,170,000 | 1,075,000 | 8,673,000 | 4,498,000 | ||||||||||||
| Total Net Sales | $ | 16,973,000 | $ | 13,858,000 | $ | 42,310,000 | $ | 37,552,000 | ||||||||
SHIPPING AND HANDLING COSTS
Shipping and handling costs are performed by both the Company and third-party logistics companies. Shipping and handling activities are performed before the customer obtains control of the goods sold to them and are considered activities to fulfill the Company’s promise to transfer the goods. For the three months ended December 31, 2020 and 2019 shipping and handling expenses were approximately $512,000 and $675,000, respectively. For the nine months ended December 31, 2020 and 2019 shipping and handling expenses were approximately $900,000 and $989,000, respectively. These expenses are classified as a component of selling expenses in the accompanying condensed consolidated statements of operations.
STOCK BASED COMPENSATION
The Company follows the provisions of the FASB ASC 718-20, “Compensation – Stock Compensation Awards Classified as Equity”. ASC 718-20 requires all share-based payments to employees including grants of employee stock options, be measured at fair value and expensed in the 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, 2020 and 2019 includes the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period for the entire portion of the award. For the three months ended December 31, 2020 and 2019, the stock option expense was approximately $5,000. For the nine months ended December 31, 2020 and 2019, the stock option expense was $5,000 and $15,000, respectively.
| 10 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
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, 2020 and 2019, these amounts totaled approximately $33,000 and $13,000, respectively. For the nine months ended December 31, 2020 and 2019, these amounts totaled $48,000 and $36,000, 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. As of December 31, 2020 and March 31, 2020 the Company recognized a valuation allowance reserve of approximately $88,000 for deferred tax assets relating to net operating loss carryforwards that the Company will more than likely not be able to realize prior to their expiration.
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, 2020 and 2019 we estimated our effective tax rate to be approximately 23% and 22%, respectively. As of December 31, 2020 and March 31, 2020 the Singing Machine had net deferred tax assets of approximately $413,000 and $1,286,000, respectively. The Company recorded an income tax provision of approximately $264,000 for the three months ended December 31, 2020 and an income tax benefit of approximately $240,000 for the three months ended December 31, 2019. The Company recorded an income tax provision of approximately $1,006,000 for the nine months ended December 31, 2020 and an income tax benefit of approximately $295,000 for the nine months ended December 31, 2019.
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, 2020, 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
Computation of dilutive shares for the three and nine months ended December 31, 2020 are as follows:
| For the three months ended December 31, 2020 | For the nine months ended December 31, 2020 | |||||||
| Basic weighted average common shares outstanding | 38,885,000 | 38,667,000 | ||||||
| Effect of dilutive stock options | 271,000 | 374,000 | ||||||
| Diluted weighted average of common shares outstanding | 39,156,000 | 39,041,000 | ||||||
Basic net income per share is based on the weighted average number of shares of common stock outstanding during the period. Diluted net income per share reflects the potential dilution assuming shares of common stock were issued upon the exercise of outstanding in-the-money options and the proceeds thereof were used to purchase shares of the Company’s common stock at the average market price during the period using the treasury stock method. For the three and nine months ended December 31, 2020, options to purchase approximately 271,000 and 374,000 shares of common stock, respectively, have been included in the calculation of diluted net income per share as compared to approximately 371,000 shares that were excluded for both the three and nine months ended December 31, 2019, as the result would have been anti-dilutive.
| 11 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
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.
NOTE 3 - INVENTORIES, NET
Inventories are comprised of the following components:
| December 31, | March 31, | |||||||
| 2020 | 2020 | |||||||
| Finished Goods | $ | 4,189,000 | $ | 6,595,000 | ||||
| Inventory in Transit | 219,000 | 73,000 | ||||||
| Estimated Amount of Future Returns | 1,846,000 | 1,367,000 | ||||||
| Subtotal | 6,254,000 | 8,035,000 | ||||||
| Less:Inventory Reserve | 917,000 | 434,000 | ||||||
| Inventories, net | $ | 5,337,000 | $ | 7,601,000 | ||||
NOTE 4 – PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
| USEFUL | December 31, | March 31, | ||||||||
| LIFE | 2020 | 2020 | ||||||||
| Computer and office equipment | 5-7 years | $ | 445,000 | $ | 445,000 | |||||
| Furniture and fixtures | 7 years | 98,000 | 98,000 | |||||||
| Warehouse equipment | 7 years | 199,000 | 195,000 | |||||||
| Molds and tooling | 3-5 years | 1,765,000 | 1,680,000 | |||||||
| 2,507,000 | 2,418,000 | |||||||||
| Less: Accumulated depreciation | 1,851,000 | 1,647,000 | ||||||||
| $ | 656,000 | $ | 771,000 | |||||||
Depreciation expense for the three months ended December 31, 2020 and 2019 was approximately $65,000 and $77,000, respectively. Depreciation expense for the nine months ended December 31, 2020 and 2019 was approximately $204,000 and $196,000, respectively.
NOTE 5 – BANK FINANCING
Intercreditor Revolving Credit Facility Crestmark Bank and Iron Horse Credit
On June 16, 2020, the Company executed an Intercreditor Revolving Credit Facility on eligible accounts receivable and inventory which replaced the Company’s previous revolving credit facility with PNC Bank which was terminated on June 16, 2020. The Company signed a two-year Loan and Security Agreement for a $10.0 million financing facility with Crestmark Bank (“Crestmark Facility”) on eligible accounts receivable. The outstanding loan balance cannot exceed $10.0 million during peak selling season between July 1 and December 31and is reduced to a maximum of $5.0 million between January 1 and July 31. Costs associated with closing of the Intercreditor Revolving Credit Facility of approximately $74,000 are deferred and will be amortized over one year. During the three and nine months ended December 31, 2020 the Company incurred amortization expense of approximately $19,000 and $40,000, respectively associated with the amortization of deferred financing costs from the Intercreditor Revolving Credit Facility.
| 12 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
Under the Crestmark Facility:
| ● | Advance rate shall not exceed 70% of Eligible Accounts Receivable aged less than 90 days from invoice date. | |
| ● | Crestmark shall maintain a base dilution reserve of 1% for each 1% of dilution over 15%. | |
| ● | Crestmark will implement an availability block of 20% of amounts due on Iron Horse Credit (“IHC”) Intercreditor Revolving Credit Facility. | |
| ● | Mandatory pay-down of the loan to zero in January and February each year. |
The Crestmark Facility is secured by a perfected security interest in all assets including a first security interest in Accounts Receivable and Inventory. Notwithstanding the foregoing, Crestmark shall subordinate its first security interest in inventory to IHC as agreed between all parties. The Crestmark Facility bears interest at the Wall Street Journal Prime Rate plus 5.50% with a floor of 8.75%. Interest and Maintenance Fees shall be calculated on the higher of the actual average monthly loan balance from the prior month or a minimum average loan balance of $2,000,000. For the three and nine months ended December 31, 2020 the Company recorded interest expense of approximately $100,000 and $151,000, respectively. The Crestmark Facility expires on June 15, 2022. As of December 31, 2020, the Company had no outstanding balance on the Crestmark Facility. In addition, the Company executed a two-year Loan and Security Agreement with Iron Horse Credit (“IHC Facility”) for up to $2,500,000 in inventory financing.
Under the IHC Facility:
| ● | Advance rate shall not exceed the lower of (a) 70% of the inventory cost or (b) 85% of Net Orderly Liquidation Value (NOLV) as determined by an independent third-party appraiser engaged by IHC. | |
| ● | The Company must maintain a fixed charge coverage ratio test of 1:1 times measured on a rolling 12-month basis, defined as earnings before interest, taxes, depreciation and amortization (“EBITDA”) less non-financed capital expenditures, cash dividends and distributions paid and cash taxes paid divided by the sum of interest and principal on all indebtedness. This financial covenant has been waived for the first six months of the IHC Facility. As of December 31, 2020, the Company is in compliance with this covenant. |
The IHC Facility is secured by a perfected security interest in the Company’s inventory. The IHC Facility bears interest at 1.292% per month or 15.51% annually. Interest shall be calculated on the higher of the actual average monthly loan balance from the prior month or a minimum average loan balance of $1,000,000. Interest expense for the three and nine months ended December 31, 2020 was approximately $41,000 and $103,000, respectively. The IHC Facility expires on June 15, 2022. As of December 31, 2020, there was an outstanding balance of approximately $65,000.
Revolving Credit Facility PNC Bank
On June 22, 2017, the Company renewed the existing revolving credit facility (the “PNC Revolving Credit Facility”) with PNC Bank, National Association (“PNC”) for an additional three years which was terminated on June 16, 2020 and replaced by the Intercreditor Revolving Credit Facility with Crestmark and IHC. In September 2019, the Company defaulted on the PNC Revolving Credit Facility due to non-compliance with the fixed charge coverage ratio requirement. In November 2019, the Company entered into a Forbearance Agreement with PNC whereby PNC delayed taking action they would have been be entitled to under a default through March 31, 2020. The Company remained in default of the Forbearance Agreement up until termination of the Revolving Credit Facility on June 16, 2020 at which time the Company executed the Intercreditor Revolving Credit Facility with Crestmark and IHC. As of December 31, 2020, and March 31, 2020 there were no amounts due on the PNC Revolving Credit Facility. During the three months ended December 31, 2020 and 2019 the Company incurred interest expense of approximately $0 and $86,000, respectively, on amounts borrowed against the PNC Revolving Credit Facility. During the nine months ended December 31, 2020 and 2019 the Company incurred interest expense of approximately $0 and $119,000, respectively on amounts borrowed against the PNC Revolving Credit Facility.
Note Payable Payroll Protection Plan
On May 5, 2020, the Company received loan proceeds from Crestmark in the amount of approximately $444,000 under the Paycheck Protection Program (“PPP”). The PPP was established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest may be forgivable to the extent the Company uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness may be reduced if the borrower terminates employees or reduces salaries during the eligible period. The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments until a forgiveness application has been accepted and reviewed by the SBA, and the SBA has provided Crestmark with the loan forgiveness amount. For the three months ended December 31, 2020 and 2019 the Company incurred interest expense of approximately $1,000 and $0, respectively. For the nine months ended December 31, 2020 and 2019 the Company incurred interest expense of approximately $3,000 and $0, respectively. As of December 31, 2020 there was an outstanding balance on the PPP note payable of approximately $444,000. The Company currently expects to apply for forgiveness of the entire loan balance.
| 13 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
Installment Notes Payable
On June 18, 2019, the Company entered into a financing arrangement with Dimension Funding, LLC (“Dimension”) to finance an entire ERP System project over a term of 60 months at a cost of approximately $365,000. As of December 31, 2020, the Company executed three installment notes totaling approximately $365,000 for payments issued to the project vendor. The installment notes have 60-month terms with interest rates of 7.58%, 8.55% and 9.25%, respectively. The installment notes are payable in monthly installments of $7,459 which include principal and interest. As of December 31, 2020, and March 31, 2020 there was an outstanding balance on the installment notes of approximately $297,000 and $346,000, respectively. For the three months ended December 31, 2020 and 2019 the Company incurred interest expense of approximately $6,000. For the nine months ended December 31, 2020 and 2019 the Company incurred interest expense of approximately $20,000 and $14,000, respectively.
Subordinated Debt/Note Payable to Related Party
In conjunction with the Crestmark Facility and IHC Facility there is a subordination agreement on related party debt due to Starlight Marketing Development, Ltd. of approximately $803,000. On June 1, 2020 the remaining amount due on the subordinated debt of approximately $803,000 was converted to a note payable (“subordinated note payable”) which bears interest at 6%. As part of the agreement to convert the subordinated debt to a note payable it was agreed that interest expense would be accrued at the same 6% interest rate on the unpaid principal retroactively from the date that previously scheduled payments had been missed. During the three months ended December 31, 2020 and 2019 interest expense was approximately $12,000 and $0, respectively on the subordinated note payable and the related party subordinated debt. During the nine months ended December 31, 2020 and 2019 interest expense was approximately $36,000 and $0, respectively on the subordinated note payable and the related party subordinated debt.
In connection with the Intercreditor Revolving Credit Facility the Company was required to subordinate the subordinated note payable. Both the Crestmark Facility and IHC Facility agreements allow for the repayment of the subordinated note payable provided any amounts borrowed against these credit facilities are paid in full, the Company maintains a 1 : 1 debt coverage ratio and exhibits sufficient cash liquidity to support on-going operations. As of December 31, 2020, the Company missed the first scheduled payment due on December 31, 2020 and obtained a waiver from the subordinated note holder allowing the first payment to be deferred until February 2021. The Company intends to make additional payments per the note repayment schedule providing the Company meets all repayment requirements of the Crestmark Facility and IHC Facility agreements.
Scheduled maturities of outstanding debt as of December 31, 2020 are as follows:
| Year Ended December 31, | Revolving Line of Credit Iron Horse Credit | Installment Notes | Note Payable Payroll Protection Program | Subordinated Related Party Debt | ||||||||||||
| 2021 | $ | 65,000 | 67,000 | 297,000 | 750,000 | |||||||||||
| 2022 | - | 73,000 | 149,000 | 53,000 | ||||||||||||
| 2023 | - | 79,000 | - | - | ||||||||||||
| 2024 | - | 75,000 | - | - | ||||||||||||
| 2025 and beyond | - | 3,000 | - | - | ||||||||||||
| Scheduled Payments | $ | 65,000 | $ | 297,000 | $ | 446,000 | $ | 803,000 | ||||||||
NOTE 6 - COMMITMENTS AND CONTINGENCIES
INSURANCE CLAIM SETTLEMENT – DAMAGED GOODS INCIDENT
During the nine-months ended December 31, 2020, we have recovered approximately $2,336,000 from our cargo insurance coverage which settled approximately $1,268,000 in an insurance claim receivable with the remaining proceeds reflected in other income and (expenses) as a gain from damaged goods insurance claim in the condensed consolidated statements of operations. For the three and nine months ended December 31, 2020 the gain from damaged goods insurance claim was approximately $0 and $1,068,000, respectively. The insurance claim is now closed.
LEGAL MATTERS
Management is not aware of any legal proceedings other than matters that arise in the ordinary course of business.
| 14 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
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. On June 15, 2020 we executed a three-year lease extension which will expire on August 31, 2023. The renewal base rent payment is $65,300 with a 3% increase every 12 months for the remaining term of the extension.
We entered into an operating lease agreement, effective May 1, 2018, for 424 square feet of office space in Macau. The rent is fixed at approximately $1,600 per month for the duration of the lease which expires on April 30, 2021. The lease provides for a renewal option to extend the lease.
Lease expense for our operating leases is recognized on a straight-line basis over the lease terms.
Finance Leases
On May 25, 2018 and June 4, 2018, we entered into two long-term capital leasing arrangements with Wells Fargo Equipment Finance (“Wells Fargo”) to finance the leasing of two used forklift vehicles in the amount of approximately $44,000. The leases require monthly payments in the amount of $1,279 per month over a total lease term of 36 months which commenced on June 1, 2018. The agreement has an effective interest rate of 4.5% and the Company has the option to purchase the equipment at the end of the lease term for one dollar. As of December 31, 2020 and March 31, 2020, the remaining amounts due on these capital leasing arrangements was approximately $6,000 and $18,000, respectively.
Supplemental balance sheet information related to leases as of December 31, 2020 is as follows:
| Assets: | ||||
| Operating lease - right-of-use assets | $ | 2,269,108 | ||
| Finance leases as a component of property and equipment, net of accumulated depreciation of $16,582 | 26,945 | |||
| Liabilities | ||||
| Current | ||||
| Current portion of operating leases | $ | 779,905 | ||
| Current portion of finance leases | 6,336 | |||
| Noncurrent | ||||
| Operating lease liabilities, net of current portion | $ | 1,540,226 | ||
| Finance leases, net of current portion | - | |||
Supplemental statement of operations information related to leases for the three and nine months ended December 31, 2020 is as follows:
| Three Months Ended | Nine Months Ended | |||||||
| December 31, 2020 | December 31, 2020 | |||||||
| Operating lease expense as a component of general and administrative expenses | $ | 232,646 | $ | 558,069 | ||||
| Finance lease cost | ||||||||
| Depreciation of leased assets as a component of depreciation | $ | 1,555 | $ | 4,664 | ||||
| Interest on lease liabilities as a component of interest expense | $ | 52 | $ | 315 | ||||
| Supplemental cash flow information related to leases for the nine months ended December 31, 2020 is as follows: | ||||||||
| Cash paid for amounts included in the measurement of lease liabilities: | ||||||||
| Operating cash flow paid for operating leases | $ | 576,824 | ||||||
| Financing cash flow paid for finance leases | $ | 11,167 | ||||||
| Lease term and Discount Rate | ||||||||
| Weighted average remaining lease term (months) | ||||||||
| Operating leases | 33.0 | |||||||
| Finance leases | 5.0 | |||||||
| Weighted average discount rate | ||||||||
| Operating leases | 6.25 | % | ||||||
| Finance leases | 3.68 | % | ||||||
| 15 |
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
Scheduled maturities of operating and finance lease liabilities outstanding as of December 31, 2020 are as follows:
| Year ended December 31, | Operating Leases | Finance Leases | ||||||
| 2021 | $ | 911,000 | $ | 6,000 | ||||
| 2022 | 932,000 | - | ||||||
| 2023 | 674,000 | - | ||||||
| 2024 | 31,000 | - | ||||||
| Total Minimum Future Payments | 2,548,000 | 6,000 | ||||||
| Less: Imputed Interest | 228,000 | - | ||||||
| Present Value of Lease Liabilities | $ | 2,320,000 | $ | 6,000 | ||||
NOTE 7 - STOCK OPTIONS
During the nine months ended December 31, 2020 and 2019 the Company issued 100,000 stock options at an exercise price of $.29 and $.38, respectively 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, 2020: expected dividend yield of 0%, risk-free interest rate of 0.18%, volatility of 146.7% and an expected term of three years. |
A summary of stock option activity for the nine months ended December 31, 2020 is summarized below:
| December 31, 2020 | ||||||||
| Number of Options | Weighted Average Exercise Price | |||||||
| Stock Options: | ||||||||
| Balance at beginning of period | 2,230,000 | $ | 0.26 | |||||
| Granted | 100,000 | $ | 0.29 | |||||
| Exercised | (440,000 | ) | $ | 0.06 | ||||
| Forfeited | (190,000 | ) | $ | 0.19 | ||||
| Balance at end of period | 1,700,000 | $ | 0.32 | |||||
| Options exercisable at end of period | 1,600,000 | $ | 0.32 | |||||
The following table summarizes information about employee stock options outstanding at December 31, 2020:
| Range of Exercise Price | Number Outstanding at December 31, 20 | Weighted Average Remaining Contractural Life | Weighted Average Exercise Price | Number Exercisable at December 31, 2020 | Weighted Average Exercise Price | |||||||||||||||||
| $ | .03 - $.38 | 1,150,000 | 4.3 | 0.23 | 1,050,000 | 0.23 | ||||||||||||||||
| $ | .47 - $.55 | 550,000 | 6.7 | 0.50 | 550,000 | 0.50 | ||||||||||||||||
| * | 1,700,000 | 1,600,000 | ||||||||||||||||||||
* Total number of options outstanding as of December 31, 2020 includes 600,000 options issued to five current and two former directors as compensation and 1,040,000 options issued to key employees that were not issued from the Plan.
As of December 31, 2020 there was unrecognized expense of approximately $15,000 remaining on options currently vesting over time with approximately ten months remaining until these options are fully vested.
The intrinsic value of vested options as of December 31, 2020 was approximately $121,000.
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THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
NOTE 8 – COMMON STOCK ISSUANCES
On November 6, 2020, the Company issued 43,105 shares of its common stock to its Board of Directors valued at $0.29 per share, pursuant to our annual director compensation plan for the fiscal year ending March 31, 2020. The Company recorded director compensation of $12,500 during the three and nine months ended December 31, 2020, respectively.
NOTE 9 - GEOGRAPHICAL INFORMATION
Sales to customers outside of the United States for the three and nine months ended December 31, 2020 and 2019 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, | |||||||||||||||
| 2020 | 2019 | 2020 | 2019 | |||||||||||||
| (as restated) | (as restated) | |||||||||||||||
| North America | $ | 16,623,000 | $ | 12,426,000 | $ | 41,014,000 | $ | 32,106,000 | ||||||||
| Europe | 31,000 | 1,396,000 | 924,000 | 4,936,000 | ||||||||||||
| Australia | 319,000 | 36,000 | 372,000 | 510,000 | ||||||||||||
| $ | 16,973,000 | $ | 13,858,000 | $ | 42,310,000 | $ | 37,552,000 | |||||||||
The geographic area of sales was based on the location where the product is delivered.
NOTE 10 –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, 2020 and March 31, 2020, in the aggregate the Company had approximately $0 and $100,000, respectively, due from related parties for goods and services sold to these companies.
On December 31, 2020 and March 31, 2020, the Company had amounts due to related parties in the amounts of approximately $129,000 and $502,000 for facility fees, storage and administrative services provided to the Company by these related parties.
TRADE
During the three months ended December 31, 2020 and 2019 the Company did not sell any products to Winglight Pacific, Ltd. (“Winglight”), a related party. During the nine months ended December 31, 2020 and 2019 the Company sold approximately $0 and $852,000, 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, 2020 and 2019 was NA and 23.7%, 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 at that time.
During the three months ended December 31, 2020 and 2019 the Company sold approximately $0 and $45,000 respectively, of product directly to Cosmo from its California warehouse facility. During the nine months ended December 31, 2020 and 2019 the Company sold approximately $0 and $284,000, 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.
On July 30, 2020, the Company and Cosmo reached agreement that Cosmo would no longer be the Company’s Canadian distributor and the Company became the sole and exclusive distributor of the Company’s products in Canada. As part of the agreement, the companies executed a Purchase and Sales agreement whereby the Company acquired all of Cosmo’s karaoke inventory for approximately $685,000. During the three and nine months ended December 31, 2020, there was a gain of approximately $188,000 from Cosmo related to the payment in fiscal 2021 on prior year sales and the related receivable previously reversed and written off as initially deemed uncollectible.
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, 2020 and 2019 were approximately $91,000. The services from SLE for the nine months ended December 31, 2020 and 2019 were approximately $272,000 and $282,000, respectively. These amounts were included as a component of general and administrative expenses in the accompanying condensed consolidated statements of operations.
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THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2020 and 2019
(Unaudited)
NOTE 11 – 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.
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, | December 31, | |||||||
| 2020 | 2019 | |||||||
| Reserve for sales returns at beginning of the year | $ | 1,224,000 | $ | 896,000 | ||||
| Provision for estimated sales returns | 4,187,000 | 6,757,000 | ||||||
| Sales returns received | (2,445,000 | ) | (3,107,000 | ) | ||||
| Reserve for sales returns at end of the period | $ | 2,966,000 | $ | 4,546,000 | ||||
NOTE 12 – REFUNDS DUE TO CUSTOMERS
As of December 31, 2020 and March 31, 2020 the amount of refunds due to customers was approximately $102,000 and $807,000, respectively. Refunds due to customers at December 31, 2020 were primarily due to one customer for overstock returns. Refunds due to customers at March 31, 2020 were primarily due to one major customer which reflects approximately $1,691,000 of chargebacks less approximately $1,181,000 that the customer had deducted on payment remittances to the Company as of March 31, 2020. The remaining $297,000 was primarily due to amounts due to two major customers for overstock returns.
NOTE 13 - 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, 2020 and 2019 totaled approximately $20,000 and $15,000, respectively. The amounts charged to operations for contributions to this plan and administrative costs during the nine months ended December 31, 2020 and 2019 totaled approximately $54,000 and $47,000, 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 14 - CONCENTRATIONS OF CREDIT AND SALES RISK
The Company derives a majority of its revenues from retailers of products in the United States. At December 31, 2020, 41% of accounts receivable were due from two customers in North America that individually owed over 10% of total accounts receivable. At March 31, 2020, 82% 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, 2020, 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 22%, 22%, 19%, 12%, and 12% respectively. 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 25%, 21%, 13% and 10%, respectively.
For the nine months ended December 31, 2020, 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 34%, 19%, 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 38%, 14% 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 and Australia primarily through major mass merchandisers and warehouse clubs, on-line retailers and to a lesser extent department stores, lifestyle merchants, direct mail catalogs and showrooms, music and record stores, and specialty stores.
Representative customers include Amazon, Best Buy, BJ’s Wholesale, Costco, Sam’s Club, Target, and Wal-Mart. Our business has historically been subject to seasonal fluctuations causing our revenues to vary from quarter to quarter and between the same periods in different fiscal years. Our products are manufactured for the most part based on the purchase indications of our customers. We are uncertain of how significantly our business would be harmed by a prolonged economic recession, but we anticipate that continued contraction of consumer spending would negatively affect our revenues and profit margins.
Sales of consumer electronics and toy products in the retail channel are highly seasonal, with a majority of retail sales occurring during the period from September through December in anticipation of the holiday season, which includes Christmas. A substantial majority of our sales occur during the second quarter ending September 30 and the third quarter ending December 31. Sales in our second and third quarter, combined, accounted for approximately 85% and 94% of net sales in fiscal 2020 and 2019, respectively.
The COVID-19 pandemic has significantly affected U.S. consumer shopping patterns and caused the health of the U.S. economy to deteriorate. We cannot foresee whether the outbreak of COVID-19 will be effectively contained, nor can we predict the severity and duration of its impact on our business and our financial results. If the outbreak of COVID-19 is not effectively and timely controlled, our business operations, financial condition, and liquidity may be materially and adversely affected as a result of prolonged disruptions in consumer spending, a lack of demand for our products, forced retail store closures and other factors that we cannot foresee. The extent to which COVID-19 will impact our business and our financial results will depend on future developments which are highly uncertain and cannot be predicted.
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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, 2020 and 2019:
The Singing Machine Company, Inc. and Subsidiaries
CONDENDSED CONSOLIDATED STATEMENTS OF OPERATIONS
| For Three Months Ended | For Nine Months Ended | |||||||||||||||
| December 31, 2020 | December 31, 2019 | December 31, 2020 | December 31, 2019 | |||||||||||||
| Net Sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
| Cost of Goods Sold | 70.7 | % | 82.9 | % | 72.2 | % | 79.2 | % | ||||||||
| Gross Profit | 29.3 | % | 17.1 | % | 27.8 | % | 20.8 | % | ||||||||
| Operating Expenses | ||||||||||||||||
| Selling expenses | 8.8 | % | 12.6 | % | 7.7 | % | 9.8 | % | ||||||||
| General and administrative expenses | 11.3 | % | 10.4 | % | 12.1 | % | 13.4 | % | ||||||||
| Depreciation and amortization | 0.4 | % | 0.6 | % | 0.5 | % | 0.5 | % | ||||||||
| Total Operating Expenses | 20.5 | % | 23.6 | % | 20.3 | % | 23.7 | % | ||||||||
| Income (Loss) from Operations | 8.8 | % | -6.5 | % | 7.5 | % | -2.9 | % | ||||||||
| Other Income and (Expenses) | ||||||||||||||||
| Gain from damaged goods insurance claim | 0.0 | % | 0.0 | % | 2.5 | % | 0.0 | % | ||||||||
| Gain from vendor credit for damaged goods | 0.0 | % | 0.0 | % | 0.9 | % | 0.0 | % | ||||||||
| Contigency gain - related party | 1.1 | % | 0.0 | % | 0.4 | % | 0.0 | % | ||||||||
| Interest expense | -1.4 | % | -0.8 | % | -0.9 | % | -0.4 | % | ||||||||
| Financing costs | -0.1 | % | 0.0 | % | -0.1 | % | 0.0 | % | ||||||||
| Total Other Income and (Expenses) | -0.4 | % | -0.8 | % | 2.8 | % | -0.4 | % | ||||||||
| Income (Loss) Before Income Tax (Provision) Benefit | 8.4 | % | -7.3 | % | 10.3 | % | -3.3 | % | ||||||||
| Income Tax (Provision) Benefit | -1.6 | % | 1.7 | % | -2.4 | % | 0.8 | % | ||||||||
| Net Income (Loss) | 6.8 | % | -5.6 | % | 7.9 | % | -2.5 | % | ||||||||
QUARTER ENDED DECEMBER 31, 2020 COMPARED TO THE QUARTER ENDED DECEMBER 31, 2019
NET SALES
Net sales for the quarter ended December 31, 2020 increased to approximately $16,973,000 from $13,858,000 an increase of approximately $3,115,000 as compared to the same period ended December 31, 2019. This increase was primarily due to an increase in sales to two major customers of approximately $2,798,000 due in part to the continued success of the Carpool Karaoke Microphone (“CPK”) product and increased demand in consumer electronics products due to COVID-19 and a reduction in co-op promotion allowances of approximately $803,000.
GROSS PROFIT
Gross profit for the quarter ended December 31, 2020 increased to approximately $4,974,000 from $2,371,000 an increase of approximately $2,603,000 as compared to the same period in the prior year. Approximately $601,000 of the increase was commensurate with the increase in net sales, approximately $803,000 was due to a decrease in co-op promotion allowances with the remaining variance primarily due to an increase in profit margin on the mix of products sold.
Gross profit margin for the three months ended December 31, 2020 was 29.3% compared to 17.1% for the three months ended December 31, 2019. The increase in CPK product sales which yielded significantly higher profit margin accounted for approximately 5.1 margin points of the increase. The decrease in co-op promotion allowances accounted for approximately 4.9 points of the 12.2 margin point increase with the remaining 2.2 points in margin increase due to the higher margin yield in the remaining mix of products sold.
OPERATING EXPENSES
For the quarter ended December 31, 2020, total operating expenses increased to approximately $3,481,000 compared to approximately $3,260,000 from the same period in the prior year. This represents an increase in total operating expenses of approximately $221,000 from the quarter ended December 31, 2019. Selling expenses decreased by approximately $250,000, There was a reduction in discretionary marketing spending of approximately $181,000 associated with one-time roll-out expenses of the CPK product in the prior fiscal year with the remaining decrease primarily due to a decrease in freight expense associated with a one-time freight charge in the prior fiscal year for damaged goods received by one major customer.
General and administrative expenses increased by approximately $483,000 to approximately $1,925,000 for the three months ended December 31, 2020 compared to approximately $1,442,000 for the same period ended December 31, 2019. There was an increase in payroll expense of approximately $346,000 primarily due to payment of officer and key employee bonuses as well as additional COVID related bonus payments made to our California warehouse personnel. There was an increase in rent expense of approximately $78,000 from the new lease renewal for the California warehouse which commenced in September 2020. The remaining variance was primarily due to other variable expenses associated with the increase in net sales.
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INCOME (LOSS) INCOME FROM OPERATIONS
There was income from operations of approximately $1,493,000 for the three months ended December 31, 2020 compared to a loss from operations of approximately $889,000 for the three months ended December 31, 2019. The increase in income from operations of approximately $2,382,000 was primarily due to the increase in gross profit of approximately $2,603,000 offset by a decrease in selling expenses of approximately $250,000 as explained above.
OTHER INCOME (EXPENSES)
Other income and (expenses), net increased by approximately $48,000 to approximately $61,000 in other expenses, net for the three months ended December 31, 2020 compared to approximately $109,000 in other expenses, net for the same period ended December 31, 2019. There was an increase in interest expense and amortization of deferred financing costs of approximately $140,000 associated with the financing terms of the Crestmark Facility and IHC Facility which was offset by a gain of approximately $188,000 from Cosmo related to the payment in fiscal 2021 on prior year sales and the related receivable previously reversed and written off as initially deemed uncollectible.
INCOME TAXES
For the three months ended December 31, 2020 and 2019 the Company recognized an income tax provision of approximately $264,000 and an income tax benefit of approximately $240,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 23.0% and 22.7%, respectively.
NET INCOME(LOSS)
For the three months ended December 31, 2020 there was net income of approximately $1,167,000 compared to a net loss of approximately $758,000 for the same period a year ago. The increase in net income was primarily due to the same reasons discussed in Income (Loss) from Operations and Income Taxes.
NINE MONTHS ENDED DECEMBER 31, 2020 COMPARED TO THE NINE MONTHS ENDED DECEMBER 31, 2019
NET SALES
Net sales for the nine months ended December 31, 2020 increased to approximately $42,310,000 from $37,552,000 an increase of approximately $4,758,000 as compared to the same period ended December 31, 2019. There was an increase in sales of approximately $4,380,000 to one major customer whose internet business flourished during the COVID pandemic and also had significant success selling our CPK product. The remaining increase of approximately $378,000 is primarily due to increased sales of our CPK product by some of our other major customers.
GROSS PROFIT
Gross profit for the nine months ended December 31, 2020 increased to approximately $11,759,000 from approximately $7,805,000 an increase of approximately $3,954,000 as compared to the same period in the prior year. Approximately $1,037,000 of the increase was commensurate with the increase in net sales, approximately $826,000 was due to a decrease in co-op promotion allowances with the remaining variance primarily due to an increase in profit margin on the mix of products sold.
Gross profit margin for the nine months ended December 31, 2020 was 27.8% compared to 20.8% for the nine months ended December 31, 2019. The increase in CPK product sales which yielded significantly higher profit margin accounted for approximately 3.6 margin points of the increase. The decrease in co-op promotion allowances accounted for approximately 2.0 points of the 7.0 margin point increase with the remaining 1.4 points in margin increase due to the higher margin yield in the remaining mix of products sold.
OPERATING EXPENSES
For the nine months ended December 31, 2020, total operating expenses decreased to approximately $8,599,000 compared to approximately $8,937,000 from the same period in the prior year. This represents a decrease in total operating expenses of approximately $338,000 from the nine months ended December 31, 2019. Selling expenses decreased by approximately $428,000 primarily due to a reduction in discretionary marketing spending of approximately $525,000 associated with one-time roll-out expenses of the CPK product in the prior fiscal year offset by an increase of approximately $108,000 in royalty expense associated with the increase in CPK licensed product sales.
General and administrative expenses increased by approximately $81,000 to approximately $5,130,000 for the nine months ended December 31, 2020 compared to approximately $5,049,000 for the same period ended December 31, 2019. There was an increase in payroll expense of approximately $386,000 primarily due to payment of officer and key employee bonuses as well as additional COVID related bonus payments made to our California warehouse personnel. This increase was offset by a decrease of approximately $346,000 one-time administrative expenses incurred in the prior year relating to the processing of damaged goods received by one major customer with the remaining variance due to other variable administrative expenses.
INCOME (LOSS) FROM OPERATIONS
There was income from operations of approximately $3,160,000 for the nine months ended December 31, 2020 compared to a loss from operations of approximately $1,132,000 for the nine months ended December 31, 2019. The increase in income from operations of approximately $4,292,000 was primarily due the increase in gross profit and decrease in selling and general administrative expenses as explained above.
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OTHER INCOME (EXPENSES)
Other income and (expenses), net increased by approximately $1,380,000 to approximately $1,214,000 in other income, net for the nine months ended December 31, 2020 compared to approximately $166,000 in other expenses, net for the same period ended December 31, 2019 primarily due to the recovery of approximately $1,068,000 in out-of-pocket expenses relating to a prior year damaged goods insurance claim and a vendor extinguishing accounts payable of $390,000 from the factory that caused the damage. There was a gain of approximately $188,000 from Cosmo related to the payment in fiscal 2021 on prior year sales and the related receivable previously reversed and written off as initially deemed uncollectible. These increases in other income were offset by an increase in interest expense and amortization of deferred financing costs of approximately $266,000 associated with the financing terms of the Crestmark Facility and IHC Facility.
INCOME TAXES
For the nine months ended December 31, 2020 and 2019 the Company recognized an income tax provision of approximately $1,006,000 and an income tax benefit of approximately $295,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 23.0% and 22.7%, respectively.
NET INCOME (LOSS)
For the nine months ended December 31, 2020 there was net income of approximately $3,368,000 compared to a net loss of approximately $1,003,000 for the same period a year ago. The increase in net income was primarily due to the same reasons discussed in Income (Loss) from Operations and Income Taxes.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2020, the Company had cash on hand of approximately $823,000 as compared to cash on hand of approximately $684,000 December 31, 2019. We had working capital of approximately $7,635,000 as of December 31, 2020. Net cash provided by operating activities was approximately $165,000 for the nine months ended December 31, 2020, as compared to approximately $684,000 provided by operating activities for the same period a year ago. See below for discussion of borrowing availability under our existing lending arrangements.
During the nine months ended December 31, 2020 there was a decrease in insurance receivable of approximately $1,268,000 as we received proceeds for the one-time damaged goods incident that occurred in the prior fiscal year as well as a gain from the extinguishment of accounts payable of $390,000 from one vendor related to the damaged goods issue. There was a decrease in inventory of approximately $1,781,000 as the Company sold excess inventory left over from the prior fiscal year. There was a seasonal increase in reserves for sales returns of approximately $1,742,000. There was an increase in accrued expenses of approximately $580,000 primarily due to seasonal co-op promotion allowances, commissions and royalties. These increases in cash provided by operations were offset by an increase in accounts receivable of approximately $7,056,000 due to peak season sales. There was an increase in amounts due from banks of approximately $1,172,000 due to cash collected in excess of amounts due on the revolving credit facilities with Crestmark Bank. There was a reduction in refunds due to customers of approximately $705,000 primarily due to settlement of prior year damaged goods claims with one major customer. There was a decrease in accounts payable of approximately $1,470,000 as the Company sold off excess inventory from the prior year and did not need to purchase as much new inventory to fulfill orders.
Net cash provided by operating activities was approximately $684,000 for the nine months ended December 31, 2019. During the nine months ended December 31, 2019 there was an increase in accounts payable of approximately $5,742,000 as we held back payments to one vendor who caused the damaged goods issue with one major customer pending resolution of the related insurance claim filed. 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, 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.
Net cash used in investing activities for the nine months ended December 31, 2020 was approximately $89,000 as compared to approximately $517,000 used in investing activities for the same period ended a year ago. Investing activities consisted primarily of purchases of molds and tooling for new products for the nine months ended December 31, 2020. In the prior fiscal year, the Company invested in a new Enterprise Resourcing Planning (ERP) system of approximately $304,000 with the remaining cash used in investment activities consisting primarily of purchases of new product molds and tooling.
Net cash provided by financing activities for the nine months ended December 31, 2020 was approximately $402,000 compared to cash provided by financing activities of approximately $140,000 for the same period ended of the prior year. We received loan proceeds from Crestmark in the amount of approximately $444,000 under the Paycheck Protection Program with the remaining variance primarily due to repayments of installment and capital lease payments. In the prior fiscal 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.
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On June 16, 2020, the Company executed an Intercreditor Revolving Credit Facility with Crestmark and IHC on eligible accounts receivable and inventory which replaced the Company’s previous revolving credit facility with PNC Bank which was terminated on June 16, 2020 (See Note 5 – Bank Financing). As of this filing, we have borrowed approximately $65,000 on the IHC Facility, which provides for a maximum loan amount of $2,500,000 on eligible inventory and had no borrowings on our Crestmark Facility which will make available up to $10,000,000 of eligible accounts receivable as the next twelve months progress. As of this filing the Company has approximately $171,000 currently available from these two credit facilities based on eligible inventory with IHC and a mandatory pay-down of the Crestmark Facility loan to $0 for the months of January and February.
In August 2019, a major customer received goods that were significantly water damaged due to excess moisture absorbed in pallets shipped by the factory. As a result we incurred a loss in cash flow of approximately $1,559,000 in revenue and approximately $849,000 in additional out of pocket expenses to retrieve, inspect, warehouse and properly destroy the goods in the prior fiscal year. As of this filing we have we recovered approximately $2,336,000 from our cargo insurance coverage which settled approximately $1,268,000 in insurance claim receivable with the remaining proceeds reflected in other income and (expenses) as a gain from damaged goods insurance claim in the condensed consolidated statement of operations. For the three and nine months ended December 31, 2020 the gain from damaged goods insurance claim was approximately $0 and $1,068,000, respectively. We also secured vendor invoice credits of $390,000 from the factory that caused the damage which is reflected as gain from extinguishment of accounts payable in the condensed consolidated statement of operations for the nine months ended December 31, 2020.
On May 5, 2020, the Company received loan proceeds from Crestmark Bank in the amount of approximately $444,000 under the Paycheck Protection Program (“PPP”). The PPP was established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest may be forgivable to the extent the Company uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness may be reduced if the borrower terminates employees or reduces salaries during the eligible period. The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments until a forgiveness application has been accepted and reviewed by the SBA, and the SBA has provided Crestmark with the loan forgiveness amount. For the three and nine months ended December 31, 2020 the Company incurred interest expense of approximately $1,000 and $3,000, respectively. The Company currently expects to apply for forgiveness of the entire loan balance.
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 85% and 94% of net sales in fiscal 2020 and 2019, respectively.
Our results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of orders placed and shipped to customers, as well as other factors. The fulfillment of orders can therefore significantly affect results of operations on a quarter-to-quarter basis.
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 2020 Form 10K/A.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required for small reporting companies.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
As of the end of the period covered by this Quarterly Report, we conducted an evaluation as required by Rule 13a-15(b) and Rule 15d-15(b) of the Exchange Act, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that due to the material weakness described below, our disclosure controls and procedures were not effective at a reasonable assurance level as of the end of the period covered by this Report.
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A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A material weakness is any deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our internal control over financial reporting was not effective as of the period covered by this Quarterly Report.
Following the initial filing of our Form 10-K for the year ended March 31, 2020, our Forms 10-Q for the three months ended June 30, 2020 the six months ended September 30, 2020, management identified a material weakness in our internal controls over financial reporting that existed as of the dates of those filings related to the design and implementation of control activities intended to mitigate the risk that transactions be incorrectly accounted for in accordance with generally accepted accounting principles. Specifically, we did not maintain effective internal controls over the accounting for costs related to our co-op promotion allowances, pursuant to ASC 606, Revenue from Contract with Customers, as we incorrectly recorded these allowances as selling expenses when they should be recorded as a reduction in net sales. This material weakness resulted in material misstatements to the consolidated statements of operations for the aforementioned periods. The consolidated balance sheets, statement of cash flows, statement of shareholders’ equity, net income or loss for the affected periods remained unaffected.
Plan for Material Weakness in Internal Control over Financial Reporting
The Company’s management has begun to design and implement certain remediation measures to address the above-described material weakness and enhance the Company’s internal control in order to remediate this material weakness. As part of our remediation measures, the Company has identified and will implement plans to enhance the Company’s process and controls including ensuring adequate resources and use of accounting experts for guidance in the application of new accounting standards.
(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
We are not currently in default upon any of our senior securities.
ITEM 4. MINE SAFETY DISCLOSURES
None.
None.
* Filed herewith
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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 22, 2021 | By: | /s/ Gary Atkinson |
| Gary Atkinson | ||
| Chief Executive Officer | ||
| /s/ Lionel Marquis | ||
| Lionel Marquis | ||
| Chief Financial Officer | ||
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