Algorhythm Holdings, Inc. (named The Singing Machine Company, Inc. in this filing) — Form 10-K summary
Reporting period: Fiscal year ended March 31, 2015, with fiscal 2014 as the primary comparison. This is an annual report, not a filing for calendar 2014 Q4; the company’s fiscal fourth quarter was January–March 2015. The filing reports consolidated results for The Singing Machine Company, Inc. and subsidiaries.
Business context
The company develops, markets and distributes karaoke equipment, accessories and music content, and provides logistics services. It contracts with factories in China to manufacture its hardware. Its strategy included expanding digital downloads and streaming, launching new digital karaoke products in fiscal 2016, growing international sales and third-party logistics revenue. The Shihua Group owned approximately 52% of the company.
Financial performance
| Metric | FY ended Mar. 31, 2015 | FY ended Mar. 31, 2014 |
|---|---|---|
| Net sales | $39.31 million | $31.38 million |
| Gross profit / margin | $8.31 million / 21.1% | $7.11 million / 22.6% |
| Operating income | $568,612 | $278,965 |
| Income before tax | $262,859 | $225,519 |
| Net income | $170,158 | $1.00 million |
| Operating cash flow | $(1.11) million | $64,428 |
| Cash at year-end | $116,286 | $1.35 million |
| Working capital | $4.07 million | $1.35 million |
| Total assets / shareholders’ equity | $12.21 million / $3.93 million | $11.73 million / $3.71 million |
Revenue rose 25.3%, driven chiefly by approximately $7.0 million of incremental sales from expansion into one major retailer’s stores; increased distributor sales in Europe and Australia contributed the remainder. Gross margin fell 1.5 percentage points amid volume and promotional pricing. Operating expenses increased 13.2% to $7.74 million, while other expenses rose to $305,753, principally due to higher interest and financing costs. The tax comparison was also significant: FY2014 net income included a $778,797 tax benefit, whereas FY2015 recorded a $92,701 tax provision.
In fiscal Q4 2015, sales were $2.73 million and the company recorded a net loss of $685,000, compared with sales of $2.32 million and net income of $400,000 in fiscal Q4 2014. The filing attributes much of its business to the holiday season: fiscal Q2 and Q3 together represented approximately 86.6% of FY2015 sales.
Liquidity, debt and cash flow
Operating activities used $1.11 million of cash, mainly reflecting a $1.40 million inventory increase and higher receivables, partly offset by an $849,104 increase in accounts payable. Inventory was $7.45 million, net of a $421,000 reserve, up from $5.83 million a year earlier. Management estimated monthly operating expenses of about $330,000 and said approximately $1.0 million was needed to cover the following three months.
The company replaced its Crestmark facility with a PNC revolving credit facility in July 2014. The facility runs to July 2017, with stated maximum borrowing limits of $15 million during the peak season and $7.5 million during the rest of the year, subject to a borrowing base, reserves and financial covenants. The filing does not provide a clear year-end outstanding balance for the PNC facility. It reports $4.41 million due to related parties, including a $1.92 million subordinated balance, and a $1.10 million related-party note bearing 6% interest. Two scheduled note payments were not made because the facility’s availability condition was not met; the filing says these deferrals were permitted under the note terms. Total liabilities were $8.29 million.
Material changes, outlook and risks
- Management estimated that port slowdowns delayed deliveries and caused more than $1.5 million of lost sales, contributing to the year-end inventory buildup. It reported that a new dockworkers’ agreement was ratified in May 2015 and did not anticipate significant port disruptions in FY2016.
- Management expected to finance FY2016 working capital through the PNC facility, vendor credit and extended related-party payment terms. It anticipated no additional short-term bridge financing from Shihua, while continuing to depend on related parties for extended trade terms.
- Management planned new download and streaming karaoke products, cost controls, direct shipments to reduce warehouse inventory, and third-party logistics services. It estimated approximately $200,000 of FY2016 service revenue from seven non-related logistics customers; a renewed affiliate logistics agreement was expected to provide about $100,000 in expense reimbursements.
- Important risks include dependence on a few customers (the top five contributed 77% of FY2015 revenue), no long-term customer purchase commitments, product returns of $3.4 million (8.8% of net product sales), seasonal demand, price pressure, and reliance on Chinese manufacturers and suppliers. Management said nearly all FY2016 karaoke products were expected from five factories; certain manufacturing and financing arrangements were verbal.
- Related-party dealings are significant, and several supplier entities had become controlled by or affiliated with the company’s chairman after restructuring. The filing states that management considered the transactions commercially reasonable.
- The independent auditor gave an unqualified opinion on the financial statements. Management concluded disclosure controls and internal control over financial reporting were effective at March 31, 2015, reporting that a prior-year material weakness in accounts-payable controls had been remediated. The auditor did not attest to internal-control effectiveness. Management reported no known legal proceedings.
Important facts for investors to verify
- Current PNC revolver usage, borrowing-base availability, covenant compliance and the terms governing mandatory paydowns.
- Whether the $7.45 million inventory balance was sold without additional discounting, returns or reserve increases, and whether operating cash flow improved after year-end.
- Customer concentration, order visibility and the durability and margins of the major retailer’s contribution to FY2015 growth.
- Execution, launch timing, demand and economics of the planned digital products and third-party logistics services.
- Continuity of related-party manufacturing, supplier credit and extended payment terms, including the status of the deferred Ram Light note payments.
- The accuracy of the filing’s reported FY2015 fourth-quarter loss and its reconciliation with the audited annual results.