Algorhythm Holdings, Inc. (RIME) Earnings Call Transcript & Summary

Good day, everyone, and welcome to today's program, The Singing Machine third quarter earnings call. [Operator Instructions] Please note today's call may be recorded, and I'll be standing by if you should need any assistance. It is now my pleasure to turn the conference over to Brendan Hopkins. Please go ahead.

Good morning, everyone. Thanks for taking the time to join us this morning. We have a quick safe harbor, and then we'll start. Except for historical information contained herein, the statements in this conference call are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause our actual results in future periods to differ materially from forecasted results. With that said, I'd like to turn the call over to Gary Atkinson, CEO of The Singing Machine Company.

Good morning, ladies and gentlemen. This is Gary Atkinson, the company's CEO. I'm also joined by Lionel Marquis, the company's CFO. Lionel's going to get us started. We have a lot to cover today, but before Lionel starts, I want to address probably the biggest question that's on everyone's minds at the moment, and that is the primary reasons for the earnings miss that we reported this morning. Certainly, if we look back at 2019, it was a very, very unusual year for us. We saw a lot of onetime incidents and situations that occurred that certainly are not part of the historical trends that we've seen in the past. So when I look at key factors for what contributed to the miss, and Lionel will get into a lot of these in more detail from a financial perspective. But just from a high level, obviously, we're still dealing with the pending insurance claim on the wet damaged goods that were reported back in the second quarter. We also saw a softer-than-anticipated sell-through for Carpool Karaoke over the holidays. That certainly contributed to the financials that we reported this morning. The other area that we saw over 2019 was just the threat of looming tariffs that pretty much followed us for the entire year, did have an impact on our microphones this year. We also saw a lot of the brick-and-mortar retailers were reporting softer-than-anticipated foot traffic and sell-through at various different retailers. So we've seen already Target has already preannounced some December numbers. They saw slower-than-expected sales in not only toys, but overall electronics and, particularly, audio for them was down. So we've sort of been lumped into some of the issues that retailers had over the December period. But I would say from a high level, those are some of the reasons for what we saw here in the third quarter. But with that being said, I'm going to turn it over to Lionel, who will talk through some of the details, and then I'll jump back in and talk about the outlook for 2020 and beyond.

Good morning, everyone. I will take you through the profit and loss statement and a little bit of -- some of the balance sheet items and concerns that we have. As I go through this, I'll try and highlight some of those larger items that were cause for the miss and identify them as unusual. And where they do apply, where it does apply. So for the quarter just ended Q3 of 2019 versus 2018, we were down -- we did $15.5 million of sales versus $19.4 million in the same quarter in the prior year. That's a $3.9 million downturn. We had our U.K. distributor who was down significantly. I think the U.K. and the Brexit and the economy there has a lot to do with some of the issues he's been having there. But he ended up the year at -- he, the distributor in the U.K. as well as 1 major customer ended up the prior year with significant inventory in stock. So they both ordered less stock for the 2019 season. For the quarter, that contributed to approximately $2.1 million in the drop in revenue. And then there was an additional reserves required in sales for the quarter for overstock as well as the Carpool Karaoke. And this is -- it has to do with what Gary mentioned in terms of the slow Christmas season. The overstock situation is a lot more than what we usually take back. And again, attributed to the troubles that some of the retailers were having, the foot traffic and consumer electronics and toys. The year-to-date 2019, $40.4 million versus $45.6 million last year, and that's a downturn of $5.2 million. Again, the same major customer as well as the U.K. distributor accounted for approximately $3.2 million in the downturn. And the rest of it was primarily caused by the reserves that we had to put together for the anticipated overstock returns from the slow season. Gross profit. We did $4.0 million versus $5.6 million. The $1.6 million was due primarily to the drop in net sales that has explained above. One of the things that dropped was the gross profit percentage, it was 26% for the quarter versus 28.9% in the year before. And that's primarily due to the estimated amount of overstock reserves that we had to put in for estimated returns, especially on Carpool Karaoke and the -- in our core products, some of our heavier margin items that are coming back. The year-to-date numbers on gross profit, $10.7 million 2019 versus $11.2 million is a $500,000 decrease primarily due to the sales drop of -- as we explained above as well as about $100,000 in tariffs on the microphone product that Gary alluded to earlier. The one good thing that did happen is the amount of gross profit that did drop was offset by an increase in profit margin. The Carpool Karaoke product, even though it did not sell well, what we did keep out in the field was at a significantly high margin, and that contributed to the higher profit margin, 26.4% versus 24.6%. And selling expenses for Q3 in 2019 were $3.4 million versus $2.2 million in the year before. It's an increase of approximately $1.2 million. There was approximately $600,000 in unexpected co-op expenses that we were after the -- once the holidays began and the traffic was slow, we were trying to mitigate some of these returns. And we did give some co-op advertising programs to try and move some of that inventory along. And some of that was also to support the Carpool Karaoke product. There's also Carpool Karaoke expenses that we did have in the year before. With regards to royalties and marketing expenses for the introduction of the product, that was approximately $0.3 million, $300,000. $6.6 million year-to-date on selling expenses versus $4.4 million, an increase of $1.9 million. We did a lot of spending on the marketing side for the Carpool Karaoke product and rolling that out as well as royalties that we had to pay out on -- with the CBS contract, that accounted for approximately $800,000 of the increase. So that was what we kind of spent to roll that product out and introduce it. There was additional co-op, as we mentioned earlier, for our core product and Cpk that we hinted out in the third quarter. So programs to try and mitigate some of the returns coming back, and it helped with the slow sell-through. We also had approximately $100,000 in freight cost related to the damaged goods with the insurance claim. That's -- I should mention at this time that the -- overall, in the net income numbers that you're seeing or the net loss numbers you're seeing, approximately $800,000 relates to out-of-pocket costs, freight costs and lost margin from the damaged goods scenario, the damaged goods incident. So hopefully, once the insurance claim to settle, that we will pick up some of that and pick that back up into the bottom line. The question is the timing of the settlement. So that's where we stand at this point. With that, general and administrative expenses, $1.4 million versus $1.5 million in the year before in the quarter, relatively flat. Year-to-date, $5 million in G&A versus $4.2 million, a $0.8 million difference, $800,000 difference. A couple of things there, out-of-pocket damage -- for the damaged goods, out-of-pocket expenses for them, the damaged goods issue was approximately $400,000. And last year, we had a bad debt recovery of approximately $300,000 from Toys "R" Us that we didn't have the benefit of getting this year. So that contributed another $300,000. We also had some increases in freight charges, both in and out. A lot of it due to -- or $109,000 was due to the damaged goods. And there was a few hundred thousand dollars in freight charges, a lot of it associated with the excess returns that were expected to come in. It gave us a loss for the quarter of approximately $900,000 versus a profitable $1.8 million for the quarter last year. I think we've explained that pretty well in the onetime incidences and stuff. It was just a configuration of all things kind of coming together, so onetime actions coming together, onetime kind of a perfect storm-type scenario. And it gave us the loss on the bottom line year-to-date of approximately $1 million versus -- loss versus $1.5 million profit last year, year to date. And again, approximately $800,000 of that loss is directly due to the insurance claim that we have pending in the damaged goods. Our accounts receivable was down from the same point that it was last year, approximately $3 million. We were able to do some dynamic discounting programs and pull in some receivable room -- some receivables a little bit earlier than they were due. And that's helping us with our cash flow situation. The inventory is approximately $2 million higher at this point than what it was at the same point last year. And again, this is due to the estimates we had to put in for the overstock we anticipated coming back. As far as the accounts payable are concerned, those are up by approximately $3.2 million. We are holding money back on the vendor who caused the problem with the damaged goods. And as a safety net, with regards to the insurance, I mean it's our intent not to lose money on this claim, irregardless of what the claims settlement might be. We will need to work out things between the manufacture and ourselves for the difference that we can't maybe collect on the claim, depending on what the offer is on settlement. Those are the major issues on my report for this quarter.

All right. Thank you, Lionel. So as we look at 2020 and the outlook for the year, I think obviously, we as a management team at Singing Machine, we're disappointed with the results of 2019, obviously. Anybody who's been following the company has seen our track record over the years, has known that we, as a team, generally make money, and we were able to survive hits that we've seen in the past. So coming for 2020, we are looking at forecasting a pretty conservative year. But we are looking to get back to profitability for fiscal 2021. That being said, in terms of being conservative, I mean we are seeing an impact from the coronavirus that has extended Chinese New Year. Obviously, we still produce all of our products in China. So the factories have been delayed getting back to work. But fortunately, anybody who knows the seasonality of the business, knows we're not shipping much product this time of year. So we're not seeing any material impact just yet. We are seeing, if anything, a delay to some product development that we're working on right now. But assuming the virus gets contained here over the next 2, 3 months, we're not anticipating any material impact on production and shipping. And now in terms of the some of the good news that we're seeing for this year, we have already met with all of our major customers. And I can safely say that all of our major retail customers are going to continue to support us for the coming year. We're anticipating approximately about the same in terms of sales with the customers that we're doing business with now. We are going to be looking to cut a lot of promotional and advertising expenses that we incurred in this past year or the coming year just to reduce some of the overhead that we're seeing now and then help us get back on track to profitability. So we believe -- I mean we're still the market leader in the space. The demand for karaoke has not disappeared overnight. It's still there. It's still strong. We are still the #1 brand in all the retail shelf space. So we're not looking at this as a pervasive long-term struggle. I think we're looking at this as this was a bad 2019 that had a lot of onetime sort of uncontrollable impacts that eventually, it just became too many things that we just couldn't withstand. Now in terms of some of the sales efforts that we have for the coming year, one of the things that we're doing is we've not been happy with our Canadian distributor. We believe they've been leaving sales on the table up there. So what we've done in the past few months as we've notified that distributor that we're taking back the territory. So now Singing Machine is directly reaching out to all of the major retail accounts up in Canada. Bernardo and our national Sales Manager are already in talks and have meetings with the major Canadian retailers, and we're getting good feedback and good response. So we're anticipating we can grow the Canadian territory at a higher margin than selling to a distributor for this coming year. We did see very strong sell-through in the Australian territory, particularly the Nordic territory did very, very well. They've already come in and placed reorders for the New Year. European sales did well. As Lionel mentioned, the U.K. sales were down this past year. I think a lot of that is just due to Brexit. And we've also hired a sales representative for the China territory to help start reaching out to some of the major retailers in China. So by no means are we looking at a long-term negative situation here. Again, I think this is a onetime 2019 hit, and we're working now to get back on track and back to profitability for the coming years. So with that all being said, I want to make sure we save time for questions. So let's open it up for any questions that anyone has.

[Operator Instructions] And we'll take our first question from Jason Hirschman with -- a private investor.

I guess someone threw a hit in the sales return on your stock this morning, but don't worry about that. I'm sure it will bounce back. So let me ask you a question actually about the inventory situation at your customers and your distributors today. You mentioned in your comments that the U.K. distributor or one major customer, I think, were high on their inventory. But I'm thinking, going forward, what's your thoughts on the situation across the -- across all your inventories, across all your customers today?

Sure. I can address that. I mean in terms of our U.S.-based customers, I think their inventory levels right now are all very healthy. I mean most of our accounts like Walmart and Target and Amazon, they're all year-round customers. So they're always looking to be in stock. We're not seeing any of those accounts that are particularly over inventoried on any one item. So we're expecting they're all going to come back in and reorder for the spring and for the fall. Obviously, the problems that we had this past year with some of our seasonal accounts at the club stores, they did end up the season higher on inventory than we anticipated. And we don't give guaranteed sales away to any of our customers. But the reality of doing business with these major stores is that when they end up the year heavy on inventory, you either need to -- if you want to continue doing business with them again for the following year, you need to work out a back-end exit strategy for them. And that could be a combination of markdown funding or just simply taking back over stock. And what we elected to do is take back over stock with some of those seasonal accounts. So that's where we're seeing some of these increased return reserves in the numbers that we reported in Q3. But when we look at the -- just at least the North American accounts, we're not seeing any inventory concerns that are there. I think when you look at international accounts, probably with the exception of the U.K., everybody has ended out clean.

All right. Just a follow-up then on those seasonal accounts that -- or those club accounts that you saw a little bit more difficulty with. Were they doing anything differently this past season than they did in previous years? Is this -- was that the reason of less foot traffic?

Well, I think, yes, so when we look at the club stores and what was different this year, I think there's 2 things we can point to. One was, they, both the club stores, I'm talking specifically Costco and Sam's Club, they were running items that had already been in the chain for a number of years. So I would say that at least Costco and Sam's were running on the same item for the last 4 years. And I think you start to see a fatigue at the club level where these members who are shopping, they've probably seen the same item year in and year out, and people who have the appetite for karaoke have already probably purchased that product in the past. And I think that contributed to some of the slower sell-through. So I don't think that there's suddenly a less demand for karaoke. I think if anything, we're still seeing karaoke as a very popular activity that's all over social media and popular culture. But I think we face the issue of just fatigue on items that had already been in the chain for a number of years. So we are looking this year to refresh with completely new items at all the club stores to bring that sort of freshness back.

Okay. And just one more question. I know that the coronavirus issue is extremely difficult to predict. But it sounds like given your ordering patterns and seasonality that as long as the situation is resolved, so the production can get back to normal within the next, say, 2 to 3 months, you guys wouldn't be noticeably disrupted, except for perhaps some new product development.

Yes. I think you've categorized that pretty accurately. I mean like you said, it's a big uncertainty at this time. We're monitoring it every day with the factories. I know that they're having a tough time right now getting labor to come back to the factory. I know China has put a lot of travel restrictions in place. So workers are having a tough time getting back to work. But again, like you mentioned, we're not shipping anything right now anyway. So it hasn't impacted us. And assuming the virus gets contained, we're not anticipating that it will impact us in the long run.

Okay. One final question. I appreciate you answering all these questions this morning. In terms of the Carpool Karaoke product, obviously, a little softer than perhaps one would have hoped. I suppose there is a -- there's going to be a change to the sort of the sales approach or maybe the pricing for this coming holiday season there.

Yes. I mean it's not an item that we're going to give up on. I mean and I think, if anything, the mistake that I made was, I was too aggressive too soon in how strong the demand would be for it. But I do believe it is still a strong item and a strong category. It's well-reviewed online. I think part of this -- the approach for this year is we are going to drop the MSRP retail from 59 down to 49. We also have room in the margin to hit promotion to 39. The retailers that did well with it was Amazon and Best Buy. Best Buy, particularly, they supported it with a big floor standing display in all of the stores, and they did really well with it at 49. The retailers that did not do well with it are the ones that haven't been supporting it with any sort of in-store displays. So another -- if you go to a Target, you see it just hanging on a JPEG by itself with no promotional support, and it just didn't perform well. But -- so I think part of the strategy this year is getting the retailers to commit to bringing it in with bigger displays to really highlight the features that are behind it. And just as an aside, we still think this category is a real category because we were at the Consumer Electronics Show, back in January, we saw another company that debuted a similar product. So basically, karaoke in the car, we've seen Tesla with their new OS that has karaoke built into the car. We've heard that's doing very, very well. And we've seen also Yamaha has announced they're developing a chip for karaoke in the car. So there's a lot of, I think, activity in that space. And it's obvious people sing in their car. So if anything, maybe we're just a little bit early to it. We did still sell at the end of the day. We sold over 50,000 to 60,000 units this last year. It fell short of expectations because of how high our expectations were. But all things considered, it's still sold through and it's well reviewed. So we're going to continue to support it into the future. But obviously, treat it with a bit more caution than we would have earlier in last year.

[Operator Instructions] And it appears that we have no questions at this time.

Okay. All right. Well, I appreciate everybody spending the time this morning to listen in on the third quarter earnings. If anybody has any additional questions after this, feel free to reach out to Brendan or myself. And we look forward to getting the company back on track here in the coming new fiscal year. And we'll speak with all of you for the year-end report. So thank you, everybody.

This does conclude today's conference. You may disconnect your lines, and have a good day.