Business context and reporting period
This Form 10-Q covers the quarter and six months ended September 30, 2013, for The Singing Machine Company, Inc. and subsidiaries, which design, market and sell karaoke equipment, accessories and recordings. The filing identifies the issuer as The Singing Machine Company, Inc.; it does not identify Algorhythm Holdings, Inc. as the registrant.
Financial highlights
| Metric | Three months ended September 30, 2013 | Six months ended September 30, 2013 |
|---|---|---|
| Net sales | $10.83 million, down 24.6% year over year | $12.25 million, down 24.1% |
| Gross profit / margin | $2.40 million / 22.2%, versus $3.47 million / 24.1% | $2.70 million / 22.1%, versus $3.91 million / 24.3% |
| Operating income (loss) | $519,839, versus $1.44 million | $(346,600), versus $962,890 |
| Net income (loss) | $323,951, versus $1.43 million | $(217,115), versus $954,448 |
| Operating cash flow | Not presented separately | $(1.91) million, versus $2.67 million provided |
At September 30, cash was $1.01 million, plus $137,967 of restricted cash; working capital was $3.10 million. Current assets were $20.86 million and current liabilities $17.76 million. Inventory was $9.47 million, including $3.13 million in transit, and accounts receivable was $7.91 million.
Liabilities included a $1.57 million balance on the Crestmark line of credit, $9.40 million due to related parties, and $31,620 under a capital lease. Total liabilities were $20.28 million and shareholders’ equity was $2.40 million. The credit line permits advances against eligible receivables, subject to seasonal borrowing caps of $5 million and $500,000; it is secured by company assets.
Material changes versus the prior comparable period
- Management attributed lower sales to vendor production, quality, weather, inspection and subcontract delays. Customer orders scheduled for August and September were shifted to October and November.
- Lower sales and a greater share of lower-margin products reduced gross margin. Products yielding less than 14% gross margin were about 15% of quarterly gross sales, versus 8% a year earlier; for the six-month period, about 19.5%, versus 9.2%.
- Six-month operating expenses increased $98,792: lower selling costs were more than offset by higher general and administrative expenses, including financing fees, stock compensation and reduced related-party warehouse reimbursements.
- Operating cash use reflected seasonal increases in receivables and inventory, partly offset by increases in accounts payable and related-party payables. The company borrowed $1.57 million on its line of credit during the six months.
- Related-party balances increased: amounts due to affiliates were $9.40 million, compared with $4.62 million at March 31, 2013; amounts due from affiliates were $1.58 million, compared with $403,154.
Outlook, risks and unusual items
- Management said vendor delays on higher-margin goods were resolved in October and November and expected gross margins to improve; this is a forward-looking statement, not a quantified earnings forecast. The filing provides no formal revenue or earnings guidance.
- The business is seasonal, with sales concentrated in the second and third fiscal quarters. Management estimated about $900,000 of working-capital needs for the next three months and was seeking additional financing and capital investment. It warned that failure to obtain needed financing could materially affect its ability to meet obligations and continue as a going concern.
- Management said it expected extended trade-payment terms from the Starlight Group to remain available for at least 12 months and did not expect to need group bridge financing during fiscal 2014. These are important financing assumptions.
- Key risks include seasonal cash needs, customer collection or returns, inventory valuation, supplier delays, competitive pricing and margin pressure, and dependence on related-party suppliers and credit support. Management reported a $1.6 million valuation allowance against gross deferred tax assets of about $3.4 million.
- The company disclosed an IRS claim of about $241,639 relating to a former subsidiary’s 2003 tax return; management, relying on outside counsel, did not believe the company would be liable. Management reported no known current legal proceedings.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the issuer and filing period: the supplied filing is for The Singing Machine Company, Inc., for the quarter ended September 30, 2013.
- Check whether the deferred October–November customer shipments occurred, were collected, and improved sales and gross margins.
- Monitor receivables, in-transit inventory, returns and reserves, and the conversion of seasonal working capital into cash.
- Verify availability and terms of the bank line, related-party payment extensions, and any additional financing; assess concentration in related-party balances and purchases.
- Review the former-subsidiary tax matter and the recoverability of deferred tax assets as new information becomes available.