Algorhythm Holdings, Inc. annual report, FY2018

Business context and reporting period

The supplied filing is The Singing Machine Company, Inc.’s Form 10-K for the fiscal year ended March 31, 2018—not a filing identified as Algorhythm Holdings, Inc. or a calendar 2017 fourth-quarter report. The company develops and sells karaoke equipment, accessories, music and, beginning in fiscal 2018, children’s toys. Its products are manufactured by third parties in China. China Sinostar Group and related entities held approximately 51% of the company’s shares.

Financial performance and liquidity

Revenue rose approximately 14.9%, while net income fell about 91%. The company attributed the earnings decline principally to approximately $3.1 million of bad-debt expense related to Toys “R” Us. Operating expenses increased to $14.7 million from $10.8 million; the reported operating margin was 1.6%, versus 5.6%.

At March 31, 2018, cash was $0.81 million, working capital was $6.64 million and the current ratio was 244%. Inventory was $8.06 million, up from $5.43 million. Total liabilities were $4.86 million. Debt included a $625,000 bank term note and approximately $815,000 of subordinated related-party debt. No balance was outstanding on the PNC revolving credit facility at year-end; its borrowing limits were subject to the borrowing base and other conditions. Shareholders’ equity was $7.81 million.

Material changes versus the prior year

• Sales increased by $7.9 million, driven by customer promotions and expanded retail distribution, online sales, and stronger UK sales.
• Gross margin declined 0.3 percentage points, which management attributed primarily to product mix.
• Bad-debt expense increased to $3.20 million from $84,000, principally due to the Toys “R” Us bankruptcy and liquidation process. The customer represented approximately 17.3% of FY2018 sales.
• Operating cash flow shifted from a $1.02 million inflow to a $0.71 million outflow; year-end cash declined by $1.49 million.
• Inventory rose approximately $2.6 million, including goods purchased for customers that were not shipped. The inventory reserve decreased to $280,000 from $700,000.
• The company renewed its PNC facility through July 2020 and used a $1.0 million term note to reduce related-party debt. Scheduled payments on subordinated debt were missed when liquidity conditions were not met.

Outlook, risks and notable items

Management said it expected to fund fiscal 2019 working capital with vendor payment terms and PNC borrowings, and expressed confidence that deferred related-party payments, credit availability and inventory reduction would cover obligations over the next twelve months. This assessment depends on the facility’s availability and the company’s ability to sell down seasonal inventory. Management planned a fiscal 2019 launch of streaming karaoke hardware; SMC Kids toys launched in fiscal 2018. No quantified revenue or earnings guidance was provided.

• Sales are highly seasonal: the second and third fiscal quarters generated 89.2% of FY2018 sales. The five largest customers accounted for approximately 80% of sales, with no fixed-quantity purchase contracts.
• Management cited continuing US price competition and anticipated higher fiscal 2019 product costs from oil, ocean freight and Chinese labor. The filing said the company’s products were not then subject to newly announced US tariffs on certain Chinese imports, but expansion of tariffs could raise costs.
• All electronic products were sourced from China; manufacturing, shipping, supplier and component disruptions could delay deliveries or increase costs. Some factory financing terms were described as verbal.
• The company recorded an approximately $0.3 million additional tax provision associated primarily with remeasurement of deferred tax assets under the Tax Act; the reported effective tax rate was approximately 78.1%.
• The company disclosed related-party sales, purchases, services and debt, and significant majority ownership by Sinostar Group entities. It reported no material legal proceedings known to management.
• Management concluded disclosure controls and internal control over financial reporting were effective. The independent auditor issued an unqualified opinion on the financial statements; the auditor did not attest to internal control effectiveness.
• New revenue-recognition guidance was to be adopted beginning April 1, 2018; management expected changes in balance-sheet presentation for estimated returns. Lease guidance was expected to require recognition of right-of-use assets and lease liabilities, with a significant financial-statement impact.

Most important facts for investors to verify

• Confirm the issuer and period: the filing names The Singing Machine Company, Inc. and covers the year ended March 31, 2018, despite the request metadata naming Algorhythm Holdings, Inc. and 2017 Q4.
• Review Toys “R” Us recovery, the $3.1 million receivable write-off, and any resulting fiscal 2019 sales or cash-flow loss.
• Assess inventory quality, aging and sell-through, particularly the $8.06 million year-end balance and the adequacy of the $280,000 reserve.
• Confirm PNC borrowing availability, covenant compliance, and the status of bank and related-party debt payments after year-end.
• Examine customer concentration, related-party transactions and governance given Sinostar Group’s approximately 51% ownership.
• Verify the financial effects of return accounting, lease accounting, tariff exposure and the stated fiscal 2019 cost pressures.