The Singing Machine pany(MICS) - 2020 Q4 - Annual Report

PART I Item 1. Business The company specializes in consumer karaoke audio equipment, leveraging Chinese manufacturing and digital music services for growth OVERVIEW The company develops and distributes karaoke products, with manufacturing in China and a major shareholder owning approximately 49% of common stock - The Singing Machine Company, Inc is engaged in the development, production, marketing, and distribution of consumer karaoke audio equipment, toy products, licensed products, accessories, music, and audio consumer electronic products[16] - The company contracts manufacturing in China and offers digital music sales and subscriptions through a collaboration with a music content service provider[16] - The company was incorporated in California in 1982, introduced home karaoke products to the U S in 1988, and has subsidiaries in Macau (SMC Macau), California (SMC Logistics, Inc), and for music contracting (SMC Music, Inc)[17] - As of March 31, 2020, Koncepts International Limited is a major shareholder, owning approximately 49% of common stock[18][19] GROWTH STRATEGY The company aims to build a global entertainment platform by expanding its hardware-based music content delivery and community features - The company's overall objective is to create an efficient platform for the development, manufacture, and worldwide marketing and distribution of home entertainment-based consumer electronics, seeking new revenue opportunities through hardware-based music content delivery and a community-based entertainment platform[20] Organic Growth Strategy The company seeks to diversify its product line into lower-priced, music-themed toys to enhance its market presence and customer base - The company aims to enhance market presence, expand its customer base, and be an industry leader in new product development by diversifying beyond its core karaoke business into sing-along music-themed toy products (SMC Kids) at lower price points[21] Licensed Products The company launched a 'Carpool Karaoke' licensed product which generated significant social media interest despite a slow start - The company acquired a license from CBS for the 'Carpool Karaoke' series, launching 'Carpool Karaoke The Mic' product, which generated significant social media interest despite a slow start in Fiscal 2020[23] Expand Access to Digital Karaoke Music Offerings The company's strategy focuses on promoting its streaming app to address the decline of physical karaoke content - The company's strategy is to promote its streaming App on iOS and Android platforms and work with music partner Stingray to improve features, addressing the decreasing availability of physical karaoke content (CD+G discs)[24] Focus On International Growth The company is aggressively pursuing international business outside North America to substantially increase revenues - The company is aggressively pursuing international business outside North America, distributing products in countries like Australia, Canada, the UK, and Mexico, aiming to substantially increase revenues through economies of scale and direct import[25] PRODUCT LINES The company's revenue is primarily driven by Classic Karaoke Machines, which constitute 70% of total revenue - The company offers over 35 different models across four product lines: Classic Karaoke Machines, Download Karaoke Machines, SMC Kids Toy Products, and Licensed Products[26][30] Fiscal Year 2020 Revenue Contribution by Product Line | Product Line | % of Total Revenue (Fiscal 2020) | | :--- | :--- | | Classic Karaoke Machines | 70% | | Download Karaoke Machines | 14% | | SMC Kids Toy Products | 2% | | Licensed Products | 5% | | Karaoke related accessories | 9% | MARKETING, SALES Sales are concentrated with the five largest customers accounting for 81% of net sales in fiscal 2020 - Products are sold nationally and internationally through mass merchandisers, department stores, direct mail catalogs, music/record stores, national chains, specialty stores, and warehouse clubs, including major retailers like Amazon com, Best Buy, Costco, Sam's Club, Target, and Wal-Mart[27] - Sales are made through domestic sales (from California warehouses, including e-commerce) and direct import sales (shipped directly from China via SMC Macau)[28][29] - Sales to the five largest customers accounted for approximately 81% of net sales in fiscal 2020, with the top three major customers accounting for 39%, 13%, and 11% respectively[33] Fiscal Year 2020 Sales Revenue by Method | Sales Method | % of Sales Revenues (Fiscal 2020) | | :--- | :--- | | Direct Import | 43% | | Domestic Sales | 57% | Domestic Sales Domestic sales from California warehouses enable timely delivery and serve a growing e-commerce business - Domestic sales involve purchasing products overseas, warehousing them in California, and selling from inventory, enabling timely delivery and serving as a domestic supplier of imported goods, including a rapidly growing e-commerce business[28] Direct Import Sales Direct import sales involve shipping large-quantity hardware orders directly to customers worldwide from China - Direct import sales involve shipping hardware products directly to customers worldwide from China through SMC Macau, typically in larger quantities (container-sized lots), with customers paying via international letters of credit or open account[29] RETURNS Product returns increased significantly in fiscal 2020, primarily due to overstock of a licensed product from a major customer - Total returns represented 13.1% of net sales in fiscal 2020, an increase of 4.9 percentage points from 8 2% in fiscal 2019[36] - The increase in returns was primarily due to $1.1 million in overstock licensed product returns from one major customer (Carpool Karaoke The Mic) and overstock returns from three other major customers[36] DISTRIBUTION Hardware products are distributed through domestic sales from California and direct import sales from China - Hardware products are distributed to retailers and wholesale distributors via two methods: shipments from inventory at California warehouse facilities (Domestic Sales) and direct shipments from manufacturers in China through the Macau subsidiary (Direct Import Sales)[37] Fiscal Year 2020 Sales Distribution Method | Distribution Method | % of Sales (Fiscal 2020) | | :--- | :--- | | Domestic Sales | 57% | | Direct Import Sales | 43% | MANUFACTURING AND PRODUCTION The company relies on five third-party factories in China for manufacturing and uses its own staff for quality assurance - Karaoke machines are manufactured and assembled by five third-party factories in Guangdong Province, China, based on company design specifications[38] - The company anticipates 100% of its karaoke products will be produced by these factories in fiscal 2021, which have verbally agreed to extend financing[38] - Products contain electronic components from companies like Panasonic, Sanyo, Toshiba, and Sony, with finished products packaged and labeled under The Singing Machine trademark and private labels[38] - The company utilizes Hong Kong and China-based employees for product inspection and quality assurance to ensure specifications and shipping schedules are met[40][41] COMPETITION The company faces intense competition in both the hardware and digital music markets from rivals with greater resources - The business is highly competitive, with major competitors for karaoke machines including Singsation, Ion Audio, Singtrix, and Karaoke USA, primarily competing on price, product features, reputation, delivery times, and customer support[43] - For download or streaming karaoke music, primary competitors are Youtube, Sybersound, Smule, and Karaoke Anywhere, competing on song title popularity, price, reputation, and delivery times[43] - The company also competes with all other forms of entertainment, and many competitors have significantly greater financial, marketing, and operating resources[44] TRADEMARKS AND PATENTS The company protects its brand with registered trademarks for its name and logos across multiple international regions - The company holds registered trademarks for 'The Singing Machine' name and logo in multiple regions (U S , Canada, Australia, Hong Kong, China, EU, Japan, Mexico, Republic of Korea) and for 'SMC Kids' and its logo in the U S , Canada, Australia, EU, and Republic of Korea[45] - Two U S design patents for karaoke machines (US D505,960 S and US D524,325 S) were obtained in 2003[45] COPYRIGHTS AND LICENSES The company offers licensed karaoke music through a revenue-sharing partnership with Stingray Digital Group - Karaoke music is offered through the Singing Machine Karaoke Download Store, Community, and iPhone/iPad App via a partnership with Stingray Digital Group, which handles all licensing agreements and royalty payments with music publishers[47] - The company shares a revenue split with Stingray on all streamed or downloaded karaoke videos[47] GOVERNMENT REGULATION The company's products must meet safety standards and are subject to potential tariff risks on imports from China - Karaoke machines must meet safety standards (UL/ETL in U S , CE marking in Europe) and are subject to federal copyright laws for music products[48] - All products are manufactured and imported from China; currently, only microphones are subject to a 7.5% tariff Expansion of tariffs to include karaoke products could significantly increase landed costs and reduce revenues and profit margins[49] SEASONALITY AND SEASONAL FINANCING The business is highly seasonal, with sales concentrated in the holiday season, and relies on a new credit facility for financing - The business is highly seasonal, with a large percentage of purchases occurring around the traditional holiday season in the second and third fiscal quarters (ending September 30 and December 31)[50] - This seasonality, combined with production lead times, creates risks of underproduction or overproduction and inventory management challenges[50] - Seasonal working capital financing for Fiscal 2020 was from a Revolving Credit Facility from PNC Bank (terminated June 16, 2020) and vendor extended accounts payable terms A new tri-party Intercreditor Revolving Line of Credit with Crestmark ($10M for receivables) and Iron Horse Credit ($2 5M for inventory) was executed on June 16, 2020, providing up to $12.5 million in financing[52] Inventory Levels (Net of Reserves) | As of | Inventory Amount | | :--- | :--- | | March 31, 2020 | $7.6 million | | March 31, 2019 | $6.0 million | EMPLOYEES As of July 2020, the company employed 32 full-time employees, primarily in the U S - As of July 28, 2020, the company employed 32 full-time employees: 1 administrative employee in Macau and 31 in the U S (3 executive officers, 13 in warehousing/logistics/technical support, and 15 in accounting, marketing, sales, and administration)[54] Item 1A. Risk Factors The company faces significant risks from the COVID-19 pandemic, international tariffs, customer concentration, and operational challenges RISKS ASSOCIATED WITH OUR BUSINESS The company's business is exposed to risks from the COVID-19 pandemic, supply chain disruptions, and customer concentration COVID-19 Pandemic Impact The COVID-19 pandemic poses a significant risk to consumer spending and product demand - The COVID-19 pandemic has significantly affected U S consumer shopping patterns and the economy, potentially leading to prolonged disruptions in consumer spending, lack of product demand, and forced retail store closures[57] Supply Chain Impact Due to COVID-19 The company's reliance on Chinese manufacturing creates significant supply chain risks due to the COVID-19 pandemic - Reliance on third-party manufacturers in China means the supply chain may be materially adversely impacted by COVID-19 governmental measures, potentially causing manufacturing delays or the need for more expensive alternative sources[58] - An outbreak among warehouse staff in California could close the facility, resulting in lost sales and delays in new product offerings[58] Changes in Government Regulations Relating to International Tariffs Potential expansion of tariffs on Chinese imports could significantly increase costs and reduce profitability - All products are manufactured and imported from China; currently, only microphones are subject to a 7.5% tariff Expansion of tariffs to include karaoke products could significantly increase landed costs and reduce revenues, gross profit margin, and results from operations[59][60] Customer Concentration Risk The company has a high customer concentration, with the three largest customers accounting for 63% of net sales in Fiscal 2020 - Sales to the three largest customers accounted for approximately 63% and 66% of net sales in Fiscal 2020 and 2019, respectively The loss or substantial reduction of orders from any of these key customers could significantly reduce revenues and cash flow[61] Product Returns Risk Product returns increased significantly in Fiscal 2020, primarily due to overstock of licensed and non-licensed goods - Customer returns of karaoke products amounted to approximately $5.4 million (13.1% of net sales) in Fiscal 2020, up from $3 8 million (8 2%) in Fiscal 2019, primarily due to overstock of licensed goods and non-licensed products[62] Pricing Pressure and Financial Incentives Intense industry competition leads to pricing pressure and demands for financial incentives, which can reduce profitability - Intense competition in the karaoke industry leads to pricing pressure from customers and demands for financial incentives like return credits or advertising allowances, which can reduce revenues and profitability[63] Forecasting Demand Difficulty Long production lead times from China make accurate demand forecasting difficult, posing a risk to financial performance - Due to one-to-four-month production lead times from China, the company must commit to production in advance of customer orders, making accurate demand forecasting difficult and potentially affecting revenues, net income, and cash flow if demand is overestimated[64] Inventory Carrying Costs and Risks The company incurs significant costs and risks by carrying inventory for several months before customer delivery - The company carries inventory for several months before customer delivery, incurring risks and costs that reduce cash flow As of March 31, 2020, inventory was approximately $7.6 million[65] Insurance Risk of Loss for Goods Damaged in Transit A significant past loss has resulted in reduced insurance coverage, increasing future risk for transit damage costs - Goods transported from China via ocean vessel are subject to damage in transit A $2.4 million loss occurred in August 2019 due to water damage, though $2 3 million was recovered from cargo insurance and $0 4 million from vendor credits[66] - Due to the size of the claim, the company can no longer afford the same insurance coverage, increasing future risk for transit damage costs[66] Seasonality of Business The company's sales are highly seasonal, with the vast majority occurring during the holiday season in the second and third fiscal quarters - Sales are highly seasonal, with the majority (98% in Fiscal 2020, 94% in Fiscal 2019) occurring in the second and third fiscal quarters (September through December) due to the holiday season[68] Competition Risk Intense competition in the karaoke and broader entertainment industries can lead to reduced margins or market share loss - Intense competition in the karaoke industry, based on price, features, reputation, delivery, and support, can lead to reduced operating margins if prices are lowered or market share loss if prices are not matched[69] - The company also competes with all other forms of entertainment, including motion pictures, video games, and streaming video[69] New Product Development Risk The company must continuously introduce new products to remain competitive in a market with rapid technological change - The karaoke industry is characterized by rapid technological change and decreasing average selling prices, requiring continuous new product introductions and enhancements to remain competitive and meet evolving customer demands[70][71] Shipping Disruption Risk Reliance on ocean carriers from China exposes the company to shipping disruption risks that could reduce revenues - Reliance on contract ocean carriers for importing products from China means disruptions (e g , labor strikes, terrorism) could prevent or delay customer receipt of inventory, leading to order cancellations and reduced revenues[72] Manufacturing Operations in China Risks Manufacturing in China exposes the company to international business risks and limited control over third-party factories - Manufacturing in China subjects the company to international business risks such as import duties, trade restrictions, work stoppages, foreign currency fluctuations, and political instability[73] - Limited control over third-party manufacturing processes and the absence of written agreements with factories create risks of product defects, production delays, cost overruns, or failure to fulfill orders on time[73][75] Third-Party Supplier Dependence The company's operations are vulnerable to disruptions in the supply of parts and materials from third-party suppliers - The company depends on third-party suppliers for parts and materials for its karaoke machines, and inability to obtain these supplies at reasonable prices or in a timely fashion could severely damage operations and sales[76] Consumer Discretionary Spending Risk The company's success is vulnerable to economic factors affecting discretionary consumer spending - Purchases of karaoke machines and music are discretionary, making the company's success vulnerable to economic factors affecting consumer spending, such as employment levels, interest rates, and taxation, as well as extraordinary events[77] Customer Credit Risk Selling to retailers exposes the company to credit risk, which could lead to bad debt expense - Selling products to retailers, including national chains, exposes the company to credit risk Deterioration in customer financial condition could result in bad debt expense and materially affect revenues and profitability[78] Warehouse Operation Disruption Risk A disruption at the California warehouse could substantially decrease revenues and profitability - A disruption in the operation of the California warehouse center (e g , fire, catastrophic events, system malfunction) could impact timely merchandise delivery to customers, substantially decreasing revenues and profitability[79] Securities and Financial Market Risk The company's financial condition and market disruptions could adversely affect its access to capital - The company's financial condition affected its ability to renew traditional financing with PNC Bank, leading to a new Intercreditor Revolving Line of Credit with Crestmark and Iron Horse Disruptions in these markets or business deterioration could adversely affect capital access[80] Currency Exchange Rate Risk Future purchases in Chinese Yuan could expose the company to foreign exchange rate risks - While purchases are currently denominated in U S currency, a future requirement to purchase in Chinese Yuan could expose the company to foreign exchange rate risks, potentially increasing production costs if the Yuan's value increases[81] Increased Raw Material/Production Pricing Rising raw material, shipping, and labor costs could decrease profit margins if not passed on to customers - Fluctuations in oil prices affect petroleum-based raw materials, and increased trans-oceanic shipping costs and labor costs in China could impact production pricing Inability to negotiate lower costs or pass on increases could decrease profit margins[83] RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE The company's capital structure presents risks including stock option dilution, potential stock price depression, and anti-takeover provisions Stock Option Dilution The exercise of outstanding stock options would dilute existing shareholders - As of March 31, 2020, there were outstanding stock options to purchase 2,230,000 shares of common stock, with a weighted average exercise price of approximately $0.26 per share Exercise of these options would dilute existing shareholders[85] Future Sales of Common Stock Future sales of a large number of shares could depress the stock price - As of July 28, 2020, 38,557,643 shares of common stock were outstanding Future sales of a large number of shares, including those registered under Form S-8 or Rule 144, or the perception of such sales, could depress the stock price[86] Issuance of Additional Shares The Board can issue additional shares without stockholder approval, potentially diluting existing shareholders - The Board of Directors has the power to issue up to 59,212,357 additional shares of common stock without stockholder approval, which could reduce the book value or market price per share and dilute existing shareholders' ownership and voting power[87] Charter Documents and Delaware Law Provisions Anti-takeover provisions could prevent a change in control and depress the stock price - Provisions in Delaware law and the company's charter documents could delay, defer, or prevent a change in control or management, potentially depressing the common stock price[88] Failure to Maintain Effective Internal Controls Ineffective internal controls could adversely impact public disclosures and the stock price - Failure to establish or maintain effective internal controls over financial reporting could adversely impact public disclosures regarding business, financial condition, or results of operations, and negatively affect the common stock price[89] Market Price Fluctuations The common stock price could fluctuate significantly due to various internal and external factors - The market price of common stock could fluctuate significantly due to factors like operating results, loss of strategic relationships, industry developments, economic conditions, government regulations (including tariffs), and period-to-period financial results[90] No Cash Dividends Expected The company does not anticipate paying cash dividends, limiting returns to potential stock price appreciation - The company has never paid cash dividends and does not anticipate doing so in the foreseeable future Any return on investment may be limited to stock price appreciation[91] Item 1B. Unresolved Staff Comments There are no unresolved staff comments - No unresolved staff comments[92] Item 2. Properties The company leases its corporate headquarters in Florida, a warehouse in California, and an office in Macau - Corporate headquarters: Leased 6,500 sq ft office space in Fort Lauderdale, Florida; lease expires March 31, 2024; annual rental expense approximately $0.2 million for Fiscal 2020[93] - Warehouse: Leased 86,000 sq ft in Ontario, California for logistics; lease expires August 31, 2020, with a three-year extension executed on June 15, 2020, expiring August 31, 2023; annual rental expense approximately $0.5 million for Fiscal 2020[94] - Macau office: Leased 424 sq ft office; lease expires April 30, 2021; annual rent expense approximately $19,000 for Fiscal 2020[95] - All leased facilities are believed to be well maintained, in compliance with environmental laws, and adequately insured, with replacements available if necessary[96] Item 3. Legal Proceedings The company is a defendant in a product liability lawsuit, which is not expected to have a material adverse effect - On February 4, 2020, the company was named in a product liability complaint in Missouri, alleging injury from battery acid leakage from a karaoke product[97] - The plaintiff alleges strict product liability, negligence, breach of warranty, and failure to warn against Singing Machine, Target, and Energizer Brands[97][98] - The matter is being defended by the company's product liability insurance counsel, and management does not expect a material adverse effect on financial condition, results of operations, or cash flows[98] Item 4. Mine Safety Disclosures This item is not applicable to the company - Not applicable[100] PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's stock trades on the OTCQX, has never paid dividends, and has outstanding options under its equity compensation plans Market Information The company's common stock trades on the OTCQX under the symbol "SMDM" and had 188 record holders as of July 2020 - The Company's common stock trades on the OTCQX under the symbol "SMDM"[102] - As of July 28, 2020, there were approximately 188 record holders of the company's outstanding common stock[103] Common Stock High and Low Sales Prices (Fiscal 2020 & 2019) | FISCAL PERIOD | HIGH ($) | LOW ($) | | :--- | :--- | :--- | | Fiscal 2020: | | | | First quarter | 0.44 | 0.26 | | Second quarter | 0.34 | 0.22 | | Third quarter | 0.31 | 0.24 | | Fourth quarter | 0.26 | 0.10 | | Fiscal 2019: | | | | First quarter | 0.47 | 0.33 | | Second quarter | 0.44 | 0.31 | | Third quarter | 0.40 | 0.28 | | Fourth quarter | 0.44 | 0.29 | DIVIDENDS The company has never paid cash dividends and intends to continue this policy for the foreseeable future - The company has never declared or paid cash dividends on its common stock and its Board of Directors intends to continue this policy for the foreseeable future[104] EQUITY COMPENSATION PLAN INFORMATION As of March 31, 2020, the company had outstanding options under both security holder-approved and non-approved equity plans Equity Compensation Plan Information as of March 31, 2020 | ISSUANCE UNDER EQUITY PLAN CATEGORY | NUMBER OF SECURITIES TO BE ISSUED UPON EXERCISE OF OUTSTANDING OPTIONS, WARRANTS AND RIGHTS | WEIGHTED AVERAGE EXERCISE PRICE OF OUTSTANDING OPTIONS, WARRANTS AND RIGHTS ($) | NUMBER OF SECURITIES REMAINING AVAILABLE FOR FUTURE COMPENSATION PLANS (EXCLUDING SECURITIES IN COLUMN (A)) | | :--- | :--- | :--- | :--- | | Equity Compensation Plans approved by Security Holders | 580,000 | 0.06 | 0 | | Equity Compensation Plans Not approved by Security Holders | 1,650,000 | 0.33 | 0 | RECENT SALES OF UNREGISTERED SECURITIES The company issued unregistered common stock to a former director and its Board of Directors in Fiscal 2020 - On August 30, 2019, the company issued 60,000 shares of common stock to a former director who exercised stock options at an average exercise price of $0.17 per share[106] - On June 12, 2019, the company issued 32,890 shares of common stock to its Board of Directors at $0.38 per share, as part of the annual director compensation plan for Fiscal 2020[108] - These issuances were deemed exempt under Rule 506 of Regulation D and/or Section 4(2) of the Securities Act, made to a limited number of accredited or sophisticated investors[109] PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS There were no purchases of equity securities by the issuer and affiliated purchasers - There were no purchases of equity securities by the issuer and affiliated purchasers[111] Item 6. Selected Financial Data As a smaller reporting company, the registrant is not required to provide the information for this item - The company is a smaller reporting company and is not required to provide selected financial data[112] Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Fiscal 2020 saw an 11% revenue decrease and a net loss of $2.9 million, driven by lower sales and higher operating expenses OVERVIEW Fiscal 2020 revenues decreased by 11%, but gross margins improved, while operating expenses and net loss increased significantly - Primary objectives for Fiscal 2020 included maintaining revenues by expanding product lines and customer base, decreasing general and administrative costs, decreasing ending inventory, and improving profitability[115] - Revenues decreased by approximately $5.1 million (11%) in Fiscal 2020, primarily due to reduced holiday foot traffic and lower-than-expected sales of the new Carpool Karaoke product[115] - Gross profit margins increased by 1.5 percentage points to 26.8%, mainly due to the high margin yield of the Carpool Karaoke product[115] - Operating expenses increased by approximately $0.8 million, primarily due to one-time losses from water-damaged goods and increased marketing spending for the Carpool Karaoke product[115] - Net loss increased by approximately $3.5 million, driven by increased operating expenses and one-time losses[115] RESULTS OF OPERATIONS The company's operating results shifted from income to a loss in Fiscal 2020, with a net loss margin of -6.8% Income and Expense Items as a Percentage of Total Revenues | Item | 2020 | 2019 | | :--- | :--- | :--- | | Total Revenues | 100.0% | 100.0% | | Cost of Sales | 73.2% | 74.7% | | Operating Expenses | 34.5% | 23.1% | | Operating (Loss) Income | -7.7% | 2.2% | | Other (Expenses), net | -0.6% | -0.6% | | (Loss)Income before Tax | -8.3% | 1.6% | | Benefit from (provision for) Income Taxes | 1.5% | -0.2% | | Net (Loss) Income | -6.8% | 1.4% | NET SALES Net sales decreased by 10.9% in Fiscal 2020 due to reduced distributor purchases and a loss from water-damaged goods - The decrease in net sales was primarily due to reduced purchases by UK and Canada distributors ($2 1M and $1 4M, respectively) due to prior year overstock, a $1.6M loss from water-damaged goods, and $1 1M and $0 7M less purchases/returns from two major domestic customers[118] - These decreases were partially offset by a $1.5 million increase in sales to one major customer where products were offered in brick-and-mortar stores in Fiscal 2020, compared to internet fulfillment only in Fiscal 2019[118] Net Sales Comparison (Fiscal 2020 vs. 2019) | Metric | Fiscal 2020 ($) | Fiscal 2019 ($) | Change ($) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | Net Sales | 41,418,304 | 46,482,998 | (5,064,694) | -10.9% | GROSS PROFIT Gross profit margin increased by 1.5 percentage points, driven by high-margin sales of the new Carpool Karaoke product - The $0.8 million decrease in gross profit was due to a $1 3 million decrease from lower net sales, partially offset by a $0 5 million increase from improved profit margin[120] - The 1.5 percentage point increase in gross profit margin was primarily driven by a $1 7 million (2 6 margin points) increase from sales of the new licensed Carpool Karaoke product, which yielded average gross profit margins of 61.7%[121] Gross Profit Comparison (Fiscal 2020 vs. 2019) | Metric | Fiscal 2020 ($) | Fiscal 2019 ($) | Change ($) | Change (pp) | | :--- | :--- | :--- | :--- | :--- | | Gross Profit | 11,095,081 | 11,773,199 | (678,118) | - | | Gross Margin | 26.8% | 25.3% | - | +1.5 | OPERATING EXPENSES Operating expenses increased by $3.6 million due to higher selling expenses, administrative costs, and bad debt expense - Selling expenses increased by $2.1 million due to higher advertising allowances ($0 7M), increased freight expense ($0 7M, including for returned/damaged goods), discretionary marketing for Carpool Karaoke ($0 3M), and royalty expense for Carpool Karaoke ($0 3M)[123] - General and administrative expenses increased by $0.8 million, primarily due to $0.7 million in out-of-pocket expenses for warehousing, inspection, and destruction of water-damaged goods, and $0 1 million in increased credit insurance for J C Penney[124] - Bad debt expense increased by $0.8 million, primarily due to $0 4 million from two customer bankruptcies in Fiscal 2020, compared to a $0 4 million recovery from Toys R Us bankruptcy claims in Fiscal 2019[125] Operating Expenses Comparison (Fiscal 2020 vs. 2019) | Expense Category | Fiscal 2020 ($) | Fiscal 2019 ($) | Change ($) | | :--- | :--- | :--- | :--- | | Total Operating Expenses | 14,339,853 | 10,724,245 | +3,615,608 | | Selling expenses | 7,203,991 | 5,117,235 | +2,086,756 | | General and administrative expenses | 6,564,422 | 5,790,019 | +774,403 | | Bad debt expense (recovery) | 302,333 | (442,671) | +745,004 | (LOSS) INCOME BEFORE INCOME TAX BENEFIT (PROVISION) Pre-tax results decreased by $4.3 million, primarily due to a one-time charge for water-damaged goods and lower sales - The $4.3 million decrease was due to a one-time charge of approximately $1.1 million in Fiscal 2020 associated with the loss on water-damaged goods (fully recovered by July 28, 2020) and the remaining $3 2 million decrease from lower sales and increased operating expenses[128] Pre-Tax Income Comparison (Fiscal 2020 vs. 2019) | Metric | Fiscal 2020 ($) | Fiscal 2019 ($) | Change ($) | | :--- | :--- | :--- | :--- | | (Loss) Income Before Income Tax Benefit (Provision) | (3,498,814) | 791,027 | (4,289,841) | INCOME TAX BENEFIT (PROVISION) The company recognized an income tax benefit of $0.6 million in Fiscal 2020, compared to a provision in the prior year - The company recognized an income tax benefit of approximately $0.6 million in Fiscal 2020, compared to a provision of $0 2 million in Fiscal 2019[131] - Net deferred tax assets were approximately $1.3 million in Fiscal 2020 (net of a $0 1 million valuation allowance) compared to $0 8 million in Fiscal 2019[130] Income Tax Benefit (Provision) Comparison (Fiscal 2020 vs. 2019) | Metric | Fiscal 2020 ($) | Fiscal 2019 ($) | | :--- | :--- | :--- | | Income Tax Benefit (Provision) | 641,814 | (159,480) | | Effective Tax Rate | 18.1% | 20.1% | NET INCOME The company reported a net loss of $2.9 million in Fiscal 2020, a significant decline from the prior year's net income Net Income Comparison (Fiscal 2020 vs. 2019) | Metric | Fiscal 2020 ($) | Fiscal 2019 ($) | | :--- | :--- | :--- | | Net Income | (2,857,000) | 631,547 | LIQUIDITY AND CAPITAL RESOURCES Cash increased slightly due to operating and financing activities, while working capital stood at $4.3 million - The $0.1 million increase in cash was primarily due to $0 4 million from operating activities and $0 2 million from financing activities, offset by $0 5 million used for fixed asset purchases[135] - Cash provided by operating activities was $0.4 million in Fiscal 2020, influenced by a net loss of $2 9 million, increased insurance receivable ($1 3M), and increased inventory ($1 8M), offset by increases in accounts payable ($4 2M), accrued expenses ($0 7M), refunds due to customers ($0 8M), and amounts due to related parties ($0 7M)[136] - Cash used by investing activities was $0.5 million in Fiscal 2020, mainly for a new business reporting system ($0 3M) and molds/tooling for new karaoke models ($0 2M)[138] - Cash provided by financing activities was $0.2 million in Fiscal 2020, from installment notes ($0 4M) offset by payments on bank term notes and financed leases ($0 2M)[139] - Working capital as of March 31, 2020, was approximately $4.3 million[140] Cash on Hand Comparison (Fiscal 2020 vs. 2019) | As of | Cash on Hand ($) | | :--- | :--- | | March 31, 2020 | 345,200 | | March 31, 2019 | 211,408 | WORKING CAPITAL REQUIREMENTS DURING THE SHORT AND LONG TERM Working capital needs will be financed through vendor financing and a new Intercreditor Revolving Credit Facility - Working capital needs for the next twelve months will be financed primarily through vendor financing (covering ~50% of Fiscal 2021 revenues) and a new Intercreditor Revolving Credit Facility with Crestmark ($10M on receivables) and Iron Horse Credit ($2 5M on inventory), providing up to $1.5 million in available borrowings as of the filing date[140][141] Current Liabilities as of March 31, 2020 | Current Liability Category | Amount ($) | | :--- | :--- | | Accounts payable | 5.0 million | | Accrued expenses | 1.5 million | | Due to related parties | 0.5 million | | Refunds due to customers | 0.8 million | | Reserve for sales returns | 1.2 million | | Current operating lease liabilities | 0.3 million | | Current installment notes and capital lease payments | 0.1 million | EXCHANGE RATES The company primarily transacts in U.S. dollars, with stable exchange rates for its limited foreign currency expenses - All products are sold in U S dollars, and manufacturing costs are paid in U S or Hong Kong dollars Macau office expenses are in Hong Kong dollars or Macau Pataca[142] - Exchange rates for HKD and MOP to USD have been relatively stable, but future fluctuations could materially affect business, financial condition, or results of operations[142] SEASONAL AND QUARTERLY RESULTS Operations are highly seasonal, with approximately 98% of net sales in Fiscal 2020 occurring during the holiday season - Operations are seasonal, with the highest net sales in the second and third fiscal quarters (September-December) due to holiday purchasing, accounting for approximately 98% and 94% of net sales in Fiscal 2020 and 2019, respectively[143] INFLATION Inflation has not significantly impacted operations as the company can pass price increases to customers - Inflation has not significantly impacted operations, as the company historically passes price increases on to customers due to non-fixed long-term contracts[145] OFF BALANCE SHEET ARRANGEMENTS The company has no off-balance sheet arrangements - The company has no off-balance sheet arrangements[146] CRITICAL ACCOUNTING POLICIES AND ESTIMATES Critical accounting policies include allowances for accounts receivable, inventory reserves, and revenue recognition - Critical accounting policies and estimates include accounts receivable allowance for doubtful accounts, reserves on inventory, and revenue recognition and reserve for sales returns[147] ACCOUNTS RECEIVABLE AND COLLECTIBILITY The allowance for doubtful accounts is based on management estimates and historical information - Allowance for doubtful accounts is based on management's estimates of customer creditworthiness, economic conditions, and historical information, with 100% reserves for bankrupt customers[148] - The company is subject to customer chargebacks for cooperative marketing, defective returns, and freight, which reduce collectibility of open invoices Credit insurance was purchased for J C Penney in Fiscal 2020[148] RESERVES ON INVENTORIES Inventory reserves are established when the expected net realizable value falls below its original cost - Inventory reserves are established when the expected net realizable value of an item falls below its original cost, resulting in a charge to cost of sales[149] Inventory Reserves | As of | Inventory Reserve Amount ($) | | :--- | :--- | | March 31, 2020 | 400,000 | | March 31, 2019 | 300,000 | REVENUE RECOGNITION AND RESERVE FOR SALES RETURNS Revenue is recognized upon delivery and control transfer, with reserves established for estimated sales returns - Revenue is recognized in accordance with FASB ASC 606 when goods are delivered and control is transferred to the customer, reflecting the expected consideration[150] - The company's contracts typically involve one performance obligation (sale of products) with payment terms less than 120 days and no financing elements[151] - Variable consideration for sales returns is estimated based on historical amounts, specific events, and management estimates, with a sales return reserve recorded at the time of sale[154][155] Sales Returns and Reserve (Fiscal 2020 vs. 2019) | Metric | Fiscal 2020 ($) | Fiscal 2019 ($) | | :--- | :--- | :--- | | Sales Returns Received | 5,400,000 | 3,800,000 | | Sales Return Reserve | 1,200,000 | 900,000 | INCOME TAXES Deferred tax assets and liabilities are recognized for temporary differences, with a valuation allowance if realization is not probable - Deferred tax assets and liabilities are recognized for future tax consequences of temporary differences, measured using enacted tax rates A valuation allowance is recognized if realization of a deferred tax asset is not probable[158] - The company recognizes a liability for uncertain tax positions if it is more likely than not that the position will be sustained, measuring the benefit based on the largest likely realized amount[158][306] OTHER ESTIMATES Other business estimates have not historically had a material impact on the company's financial condition - Other estimates in the ordinary course of business include sales returns and allowances, warranty reserves, and promotional incentives Historically, changes to these estimates have not materially impacted financial condition[159] ADOPTION OF NEW ACCOUNTING STANDARDS The company adopted the new lease accounting standard, Topic 842, on April 1, 2019 - On April 1, 2019, the company adopted ASU 2016-02, Topic 842, 'Leases', using the optional transition method, requiring lessees to recognize right-of-use (ROU) assets and lease liabilities on the balance sheet for leases longer than twelve months[160] RECENT ACCOUNTING PRONOUNCEMENTS The company is currently evaluating the impact of new accounting standards for income taxes and credit losses - The company is evaluating ASU 2019-12, 'Income Taxes (Topic 740)', effective for fiscal years beginning after December 15, 2020, which may affect interim income tax provision calculations[161] - The company is also evaluating ASU 2016-13, 'Financial Instruments—Credit Losses' (Topic 326), effective for smaller reporting companies for fiscal years beginning after April 1, 2023, which requires immediate recognition of estimated current expected credit losses[162] Item 7A. Quantitative and Qualitative Disclosures About Market Risk As a smaller reporting company, the registrant is not required to provide the information for this item - The company is a smaller reporting company and is not required to provide quantitative and qualitative disclosures about market risk[163] Item 8. Financial Statements and Supplementary Data The financial statements and supplemental data are included in a separate section of this report - The financial statements and supplemental data are included as a separate section, commencing on page F-1 (page 54 of the document)[164] Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure There were no changes in or disagreements with accountants on accounting and financial disclosure - No changes in and disagreements with accountants on accounting and financial disclosure[165] Item 9A. Controls and Procedures Management concluded that the company's disclosure controls and internal control over financial reporting were effective Evaluation of Disclosure Controls and Procedures The CEO and CFO concluded that the company's disclosure controls and procedures were effective - The Chief Executive Officer and Chief Financial Officer evaluated and concluded that the company's disclosure controls and procedures were effective[165] Management's Annual Report on Internal Control over Financial Reporting Management assessed internal controls using the COSO framework and concluded they were effective - Management is responsible for establishing and maintaining adequate internal control over financial reporting and assessed its effectiveness using the COSO framework (2013)[167] - The Chief Executive Officer and Chief Financial Officer concluded that internal control over financial reporting was effective as of the year covered by this Annual Report[169] Changes in Internal Controls No material changes were made to internal controls during the quarter ended March 31, 2020 - There were no changes in the company's internal controls over financial reporting during the quarter ended March 31, 2020, that materially affected or were reasonably likely to materially affect them[170] Item 9B. Other Information There is no other information to report under this item - None[172] PART III Item 10. Directors, Executive Officers and Corporate Governance The company's leadership includes its executive officers and a board of directors with audit, compensation, and nominating committees Directors and Executive Officers The company is led by CEO Gary Atkinson, VP Bernardo Melo, and CFO Lionel Marquis, along with a five-member board - Gary Atkinson has served as CEO since May 2012, leading the company to seven consecutive years of profitability and sales growth[176] - Bernardo Melo has been VP Global Sales and Marketing since 2008, overseeing sales, operations of the music division, and customer service[177] - Lionel Marquis was appointed CFO in May 2012, with 25 years of experience as Controller/CFO for manufacturing and distribution companies[178] Executive Officers and Directors as of March 31, 2020 | Name | Age | Position | | :--- | :--- | :--- | | Gary Atkinson | 38 | CEO | | Bernardo Melo | 43 | VP Global Sales and Marketing | | Lionel Marquis | 67 | CFO | | Phillip Lau | 72 | Chairman | | Harvey Judkowitz | 75 | Director | | Joseph Kling | 90 | Director | | Peter Hon | 79 | Director | | Yat Tung Lau | 41 | Director | BOARD COMMITTEES The board operates with an audit committee, a compensation committee, and a nominating committee - The company has an audit committee, a compensation committee, and a nominating committee[184] - The audit committee consists of Messrs Judkowitz (Chairman) and Kling, with Mr Judkowitz qualifying as an 'audit committee financial expert' and both as 'independent directors'[185] - The compensation committee consists of Messrs Judkowitz, Kling, and Philip Lau, responsible for senior management remuneration and stock option plan administration[186] - The nominating committee consists of Messrs Philip Lau and Yat Tung Lau, responsible for reviewing and recommending director nominees[187] NOMINATION OF DIRECTORS Director candidates are identified and evaluated based on ethics, judgment, independence, and relevant experience - The Nominating Committee identifies director candidates based on input from committee members, other directors, shareholders, CEO/Chairman, and third-party search firms[188] - Minimum qualifications for director candidates include high personal and professional ethics, sound judgment, independent analytical inquiries, willingness to devote adequate time, and relevant business experience and acumen[189] FAMILY RELATIONSHIPS The Chairman, a Director, and the CEO have family relationships - Chairman Philip Lau is the father of Director Yat Tung Lau and the uncle of CEO Gary Atkinson[191] CODE OF ETHICS The company has adopted a Code of Business Conduct and Ethics for all directors, officers, and employees - The company has adopted a Code of Business Conduct and Ethics applicable to all directors, officers, and employees, available on its website[192] COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT Several directors filed late Section 16(a) forms during the fiscal year - All Section 16(a) forms required to be filed during the year ended March 31, 2020, were believed to be timely filed, except for one transaction each by Messrs Harvey Judkowitz, Peter Hon, Yat-Tung Lau, Philip Lau, and Joseph Kling, who filed Form 5 in lieu of a timely Form 4[194] Item 11. Executive Compensation Executive compensation includes salaries and bonuses, with a CEO to median employee pay ratio of 2.4:1 SUMMARY COMPENSATION TABLE The CEO and CFO received salaries, while the VP of Global Sales & Marketing received a salary and bonus in Fiscal 2020 Summary Compensation Table (Fiscal 2020 & 2019) | Name and Principal Position | Year | Salary ($) | Bonus ($) | TOTAL COMP ($) | | :--- | :--- | :--- | :--- | :--- | | Gary Atkinson, CEO | 2020 | 150,000 | - | 150,000 | | | 2019 | 150,000 | - | 150,000 | | Lionel Marquis, CFO | 2020 | 149,153 | - | 149,153 | | | 2019 | 142,952 | - | 142,952 | | Bernardo Melo, VP Global Sales & Marketing | 2020 | 157,200 | 70,771 | 227,971 | | | 2019 | 157,200 | 110,747 | 267,947 | NARRATIVE DISCLOSURE TO SUMMARY COMPENSATION TABLE Executive officers do not have employment contracts but have change-in-control agreements providing severance benefits - Mr Atkinson and Mr Marquis did not have employment contracts and received annual salaries of $150,000 and $149,153 (Fiscal 2020) respectively[199] - Mr Melo did not have an employment contract and received an annual salary of $157,200 for Fiscal 2020 and 2019[201] - Executive officers have change-in-control agreements entitling them to accrued compensation, a lump sum payment (one year's salary if executive terminates, 1 5 years' salary plus bonus if company terminates), and full vesting of outstanding stock options and equity awards upon termination following a change in control[202][205] OPTION GRANTS IN FISCAL 2020 No specific option grants in Fiscal 2020 are detailed in this section - No specific option grants in Fiscal 2020 are detailed in this section, but the subsequent table shows outstanding awards[202] OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END Executive officers held numerous unexercised stock options with various expiration dates and exercise prices at fiscal year-end Outstanding Equity Awards at Fiscal Year-End (March 31, 2020) | Name and Principal Position | Number of Securities Underlying Unexercised Options () Exercisable | Option Exercise Price ($) | Option Expiration Date | | :--- | :--- | :--- | :--- | | Gary Atkinson, CEO | 120,000 | 0.06 | 10/29/2020 | | | 150,000 | 0.21 | 7/1/2023 | | | 50,000 | 0.24 | 3/31/2026 | | | 100,000 | 0.47 | 5/3/2027 | | Lionel Marquis, CFO | 120,000 | 0.06 | 10/29/2020 | | | 100,000 | 0.21 | 7/1/2023 | | | 15,000 | 0.24 | 3/31/2026 | | | 50,000 | 0.47 | 5/3/2027 | | Bernardo Melo, VP Sales | 200,000 | 0.06 | 10/29/2020 | | | 250,000 | 0.21 | 7/1/2023 | | | 25,000 | 0.17 | 6/30/2025 | | | 100,000 | 0.32 | 8/10/2026 | | | 200,000 | 0.47 | 5/3/2027 | CHIEF EXECUTIVE PAY RATIO DISCLOSURE The CEO to median employee pay ratio for Fiscal 2020 was 2.4 to 1 - The median employee was determined using the quarterly average number of active full-time employees and a subcontractor for Fiscal 2020, excluding Mr Atkinson, and included wages, cash bonuses, contractor payments, and fair market value of stock option awards[204] CEO to Median Employee Pay Ratio (Fiscal 2020) | Metric | Amount ($) | | :--- | :--- | | Mr. Atkinson's total annual compensation | 150,000 | | Median employee's total annual compensation | 53,159 | | Ratio of Chief Executive Officer to median employee | 2.4 : 1 | DIRECTOR COMPENSATION Non-employee directors received compensation in the form of cash fees, stock awards, and option awards - Compensation for non-employee directors in Fiscal 2020 included initial grants of 20,000 stock options, an annual cash payment of $7,500, an annual stock grant equivalent to $2,500, an annual grant of 20,000 stock options, and fees for board/committee meetings[212][214] Director Compensation (Fiscal 2020) | Name | Fees Earned or Paid in Cash ($) | Stock Awards ($) | Option Awards ($) | Total ($) | | :--- | :--- | :--- | :--- | :--- | | Peter Hon | 500 | 2,500 | 4,002 | 7,002 | | Harvey Judkowitz | 9,750 | 2,500 | 4,001 | 16,251 | | Phillip Lau | 250 | 2,500 | 4,002 | 6,752 | | Yat Tung Lau | - | 2,500 | 4,002 | 6,502 | | Joseph Kling | 9,500 | 2,500 | 4,001 | 16,001 | YEAR 2001 PLAN The Year 2001 Stock Option Plan has expired, and no further options can be issued under it - The Year 2001 Plan, approved by the Board in 2001 and shareholders in 2001, authorized 1,950,000 shares for incentive or non-qualified stock options to directors, employees, officers, consultants, and advisors[213] - As of March 31, 2020, 940,000 options had been granted under the plan, with 580,000 remaining outstanding and fully vested The plan has since expired, and no further options can be issued[215] - Options granted under the plan are generally not transferable and are exercisable for 30 days following termination of employment, unless due to disability, retirement, or death[216] 401(K) PLAN The company maintains a 401(k) plan with matching contributions for eligible employees - Effective January 1, 2001, the company adopted a voluntary 401(k) plan for employees with at least one year of service[217] - The company makes a matching contribution of 100% of salary deferral contributions up to 3% of pay, plus 50% of salary deferral contributions from 3% to 5% of pay[217] 401(k) Contributions and Administrative Costs | Fiscal Year Ended | Amount Charged to Earnings ($) | | :--- | :--- | | March 31, 2020 | 63,000 | | March 31, 2019 | 70,000 | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The largest beneficial owner holds 51.0% of common stock, while officers and directors as a group own 6.5% Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters As of August 2020, Fairy King Prawn Holdings Limited is the largest beneficial owner with 51.0% of common stock - Beneficial ownership includes common stock subject to convertible securitie