Algorhythm Holdings, Inc. annual report, FY2019

Business context and reporting period

This is The Singing Machine Company, Inc.’s Form 10-K for the fiscal year ended March 31, 2019, comparing fiscal 2019 with fiscal 2018. Although the request identifies the period as “2018 Q4,” the filing is an annual report; it also includes unaudited fourth-quarter results. The cover names The Singing Machine Company, Inc. as registrant.

The company develops, markets and distributes karaoke equipment, toys, licensed products and related music and accessories. Products are manufactured by third parties in China. The business is highly seasonal, with 94% of fiscal 2019 sales in the second and third fiscal quarters combined.

Financial performance and position

At March 31, 2019, working capital was approximately $7.1 million, based on current assets of $10.82 million and current liabilities of $3.68 million. Inventory was $6.02 million, down from $8.54 million. Total liabilities were $3.69 million and shareholders’ equity was $8.50 million. The balance sheet included $0.13 million of current bank term debt, $0.82 million of current subordinated related-party debt and $0.03 million of capital lease liabilities. No balance was outstanding under the PNC revolving facility at year-end. The facility expires July 15, 2020, with stated seasonal limits of $15 million (potentially $20 million with bank approval) and $7.5 million outside peak season.

Changes versus the prior comparable period

• Sales fell $14.3 million, or about 25%, largely following the Toys “R” Us bankruptcy, which reduced fiscal 2019 sales by approximately $10.1 million. The loss of a holiday promotional product for another major customer also contributed.
• Gross profit declined about $3.9 million, primarily with lower sales; gross margin narrowed 0.5 percentage point to 25.3%, reflecting the loss of higher-margin Toys “R” Us products.
• Operating expenses declined approximately $4.0 million. Much of the comparison reflects the prior-year Toys “R” Us bad-debt charge of about $3.1 million and approximately $0.5 million of fiscal 2019 recovery/write-off adjustments. Operating income increased modestly despite lower sales.
• Net income increased by about $0.48 million. The tax provision fell from approximately $0.54 million to $0.16 million; fiscal 2018 included a substantial tax charge associated with the Tax Cuts and Jobs Act and deferred-tax revaluation.
• Operating cash flow improved from a $0.71 million use to $0.19 million provided, helped by inventory reduction. Cash nevertheless declined by about $0.60 million after capital spending and debt repayments.

Outlook, risks and unusual items

• Management said it expected available cash, the revolving facility and vendor payment terms to meet liquidity needs over the next 12 months. This is management’s assessment, not quantified earnings guidance. Fiscal 2020 priorities include expanding product lines and international sales, promoting digital karaoke services, and marketing licensed products including Carpool Karaoke and The Voice.
• Management anticipated higher finished-goods costs in fiscal 2020 from oil, trans-oceanic freight and China labor costs. It warned that inability to absorb or pass through those increases could reduce margins. Its products were not then subject to the cited U.S. tariffs on some China imports, but expansion of tariffs to its products could raise costs.
• Customer concentration is substantial: the five largest customers generated 86% of fiscal 2019 sales, versus 80% in fiscal 2018; the three largest represented 39%, 14% and 13%. There are no fixed-quantity purchase commitments. Returns were $3.83 million, or 8.2% of net sales, versus $3.65 million, or 6.0%, in fiscal 2018.
• All product purchases came from China manufacturers; the company described reliance on a limited set of factories and suppliers, long production lead times, seasonal inventory risk and intense price competition. Related-party ownership and transactions are also notable: the Sinostar Group held approximately 51% of the company.
• Six scheduled installments on the approximately $0.82 million subordinated related-party debt were not made because liquidity conditions for payment were not met; the balance was classified as current. The filing says the company was compliant with PNC covenants at March 31, 2019, after a prior waiver of a fixed-charge coverage violation and an amendment to the capital-expenditure limit.
• A three-year Carpool Karaoke license carries a $650,000 minimum royalty guarantee over its term. The filing also anticipated approximately $1.2 million of right-of-use assets and lease liabilities upon adoption of the lease standard in April 2019. A subsequent ERP project was estimated at $0.4 million and financed over 60 months at approximately 6.22%.
• The company reported effective disclosure controls and internal control over financial reporting; its auditor did not provide an internal-control attestation. The financial statement audit opinion was unqualified. Management reported no material legal proceedings beyond ordinary-course matters.

Most important facts for investors to verify

1. Confirm the issuer identity and period: the supplied filing is for The Singing Machine Company, Inc. and fiscal 2019, not a fiscal 2018 fourth-quarter-only filing.
2. Review the complete audited financial statements and notes, especially the liquidity assessment, PNC borrowing-base availability and covenants, and the missed related-party debt installments.
3. Assess whether fiscal 2020 sales and cash generation could replace Toys “R” Us business, given customer concentration, seasonality, returns and the inventory still on hand.
4. Verify the economics and payment schedule of the Carpool Karaoke license, as well as the expected cost impact from freight, labor and potential tariffs.
5. Examine related-party ownership, sales, service payments and debt terms, and consider the potential effect of outstanding options and other share issuance on dilution.