SINGING MACHINE CO INC - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

Commission File Number 0 - 24968

THE SINGING MACHINE COMPANY, INC.

(Exact Name of Registrant as Specified in its Charter)

6301 NW 5^th Way, Suite 2900, Fort Lauderdale FL 33309

(Address of principal executive offices)

(954) 596-1000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days. Yes [X] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One)

Large accelerated filer [  ] Accelerated filer [  ] Non-accelerated filer [  ] Smaller Reporting Company [X] Emerging growth company [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

APPLICABLE ONLY TO ISSUES INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

Indicated by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities and Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [  ] No [  ]

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARIES

INDEX

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

The Singing Machine Company, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

See notes to the condensed consolidated financial statements

The Singing Machine Company, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See notes to the condensed consolidated financial statements

The Singing Machine Company, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See notes to the condensed consolidated financial statements

The Singing Machine Company, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the three months ended September 30, 2020 and 2019

(Unaudited)

The Singing Machine Company, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the six months ended September 30, 2020 and 2019

(Unaudited)

See notes to the condensed consolidated financial statements.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

NOTE 1 – BASIS OF PRESENTATION

OVERVIEW

The Singing Machine Company, Inc., a Delaware corporation (the “Company”, “SMC”, “The Singing Machine”) and its three wholly-owned subsidiaries SMC (Comercial Offshore De Macau) Limitada (“Macau Subsidiary”), SMC Logistics, Inc. (“SMC-L”) and SMC-Music, Inc.(“SMC-M”) are primarily engaged in the development, marketing, and sale of consumer karaoke audio systems, accessories, musical instruments and musical recordings. The products are sold by SMC to retailers and distributors for resale to consumers.

NOTE 2 - SUMMARY OF ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

The condensed consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in the condensed consolidated financial statements. The accompanying unaudited financial statements for the three and six months ended September 30, 2020 and 2019 have been prepared in accordance with generally accepted accounting principles applicable to interim financial information and the requirements of Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete consolidated financial statements. In the opinion of management, such condensed consolidated financial statements include all adjustments (consisting of normal recurring accruals) necessary for the fair presentation of the condensed consolidated financial position and the condensed consolidated results of operations. The condensed consolidated results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. The condensed consolidated balance sheet information as of March 31, 2020 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2020. The interim condensed consolidated financial statements should be read in conjunction with that report.

USE OF ESTIMATES

The Singing Machine makes estimates and assumptions in the ordinary course of business relating to sales returns and allowances, warranty reserves, inventory reserves and reserves for promotional incentives that affect the reported amounts of assets and liabilities and of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Future events and their effects cannot be determined with absolute certainty; therefore, the determination of estimates requires the exercise of judgment. Historically, past changes to these estimates have not had a material impact on the Company’s financial condition. However, circumstances could change which may alter future expectations.

COLLECTIBILITY OF ACCOUNTS RECEIVABLE

The Singing Machine’s allowance for doubtful accounts is based on management’s estimates of the creditworthiness of its customers, current economic conditions and historical information, and, in the opinion of management, is believed to be in an amount sufficient to respond to normal business conditions. Management sets 100% reserves for customers in bankruptcy and other reserves based upon historical collection experience.

The Company is subject to chargebacks from customers for cooperative marketing programs, defective returns, return freight and handling charges that are deducted from open invoices and reduce collectability of open invoices. Should business conditions deteriorate or any major customer default on its obligations to the Company, this allowance may need to be significantly increased, which would have a negative impact on operations.

FOREIGN CURRENCY TRANSLATION

The functional currency of the Macau Subsidiary is the Hong Kong dollar. The financial statements of the subsidiary are translated to U.S. dollars using period-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are recorded in the condensed consolidated statement of operations and translations are recorded in a separate component of shareholders’ equity. Any such amounts were not material during the periods presented.

Concentration of Credit Risk

At times, the Company maintains cash in United States bank accounts that are more than the Federal Deposit Insurance Corporation insured amounts. The Company also maintains cash balances in foreign financial institutions. The amounts at foreign financial institutions at September 30, 2020 and March 31, 2020 are approximately $896,000 and $217,000, respectively.

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist of accounts receivable.

INVENTORY

Inventories are comprised primarily of electronic karaoke equipment, microphones and accessories, and are stated at the lower of cost or net realizable value, as determined using the first in, first out method. Inventories also include an estimate for the net realizable value of expected future inventory returns due to warranty and allowance programs. As of September 30, 2020 and March 31, 2020 the estimated amounts for these future inventory returns were approximately $1,114,000 and $1,367,000, respectively. The Company reduces inventory on hand to its net realizable value on an item-by-item basis when it is apparent that the expected realizable value of an inventory item falls below its original cost. A charge to cost of sales results when the estimated net realizable value of specific inventory items declines below cost. Management regularly reviews the Company’s investment in inventories for such declines in value. As of September 30, 2020 and March 31, 2020 the Company had inventory reserves of approximately $905,000 and $434,000, respectively for estimated excess and obsolete inventory.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

DEFERRED FINANCING COSTS

The Company classifies deferred financing costs incurred when obtaining or renewing revolving credit facilities as assets in the accompanying condensed consolidated balance sheets as it is likely that during certain periods during non-peak season there will be no balance due on these credit facilities to offset the deferred financing costs. In June 2020, the Company incurred approximately $74,000 in deferred financing costs associated with the closing of the Crestmark Facility and the IHC Facility which are being amortized over twelve months and were classified as current assets on the accompanying condensed consolidated balance sheets.

LONG-LIVED ASSETS

The Company reviews long-lived assets for impairment whenever circumstances and situations change such that there is an indication that the carrying amounts may not be recoverable. If the undiscounted future cash flows attributable to the related assets are less than the carrying amount, the carrying amounts are reduced to fair value and an impairment loss is recognized in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360-10-05, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

LEASES

The Company follows FASB ASC 842, “Leases”. The ASC requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. The standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than twelve months. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. (See Note 6– LEASES).

The Company determines if an arrangement contains a lease at the inception of a contract. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at the commencement date. The liability is equal to the present value of the remaining minimum lease payments. The asset is based on the liability, subject to certain adjustments. Operating leases result in straight-line expense (similar to operating leases under the prior accounting standard) while finance leases result in a front-loaded expense pattern (similar to capital leases under the prior accounting standard). As the interest rate implicit in the Company’s operating leases is not readily determinable, the Company utilizes its incremental borrowing rate to discount the lease payments. The Company utilizes the implicit rate for its finance leases.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost, less accumulated depreciation. Expenditures for repairs and maintenance are charged to expense as incurred. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to their estimated useful lives using accelerated and straight-line methods.

FAIR VALUE OF FINANCIAL INSTRUMENTS

We follow FASB ASC 825, “Financial Instruments”, which requires disclosures of information about the fair value of certain financial instruments for which it is practicable to estimate that value. For purposes of this disclosure, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation.

The carrying amounts of the Company’s short-term financial instruments, including accounts receivable, accounts payable, accrued expenses, refunds due to customers and due to/from related parties approximates fair value due to the relatively short period to maturity for these instruments. The carrying amounts on the subordinated debt to Starlight Marketing Development, Ltd. (related party), finance leases and installment notes approximate fair value due to the relatively short period to maturity and related interest accrued at a rate similar to market rates. The carrying amount on the revolving lines of credit approximate fair value due the relatively short period to maturity and related interest accrued at market rates. The carrying amount on the Payroll Protection Program note payable approximates fair value due the relatively short period to maturity as management intends to apply for total forgiveness of the loan in the current fiscal year.

REVENUE RECOGNITION AND RESERVE FOR SALES RETURNS

The Company recognizes revenue in accordance with FASB ASC 606, “Revenue from Contracts with Customers”. All revenue is generated from contracts with customers. The Company recognizes revenue when the goods are delivered and control of the goods sold is transferred to the customer, in an amount, referred to as the transaction price, that reflects the consideration to which the Company is expected to be entitled in exchange for those goods. The Company determines revenue recognition utilizing the following five steps: (1) identification of the contract with a customer, (2) identification of the performance obligations in the contract (promised goods or services that are distinct), (3) determination of the transaction price, (4) allocation of the transaction price to the performance obligations, and (5) recognition of revenue when, or as, the Company transfers control of the product or service for each performance obligation.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

The Company’s contracts with customers consist of one performance obligation (the sale of the Company’s products). The Company’s contracts have no financing elements, payment terms are less than 120 days and have no further contract asset or liability obligations once control of goods is transferred to the customer. Revenue is recorded in the amount of consideration the Company expects to receive for the sale of these goods.

Costs incurred in fulfilling contracts with customers include administrative costs associated with the procurement of goods are included in general and administrative expenses, in-bound freight costs are included in the cost of goods sold and accrued sales representative commissions are included in selling expenses in the accompanying condensed consolidated statements of operations as our underlying customer agreements are less than one year.

The Company disaggregates revenues by product line and major geographic region as most of its revenue is generated by the sales of karaoke hardware and the Company has no other material business segments (See Note 8 – GEOGRAPHICAL INFORMATION).

While the Company generally does not allow products to be returned, the Company does provide for variable consideration contingent upon the occurrence of uncertain future events. Variable consideration is estimated at the expected value or at the most likely amount depending on the type of consideration. Estimated amounts are included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. The Company estimates variable consideration under our return allowance programs for goods returned to the customer for various reasons, whereby a sales return reserve is recorded based on historic return amounts, specific events as identified and management estimates.

The Company’s reserve for sales returns were approximately $1,723,000 and $1,224,000 as of September 30, 2020 and March 31, 2020, respectively.

Revenue is derived from four different major product lines. Disaggregated revenue from these product lines for the three and six months ended September 30, 2020 and 2019 consisted of the following:

SHIPPING AND HANDLING COSTS

Shipping and handling costs are performed by both the Company and third-party logistics companies. Shipping and handling activities are performed before the customer obtains control of the goods sold to them and are considered activities to fulfill the Company’s promise to transfer the goods. For the three months ended September 30, 2020 and 2019 shipping and handling expenses were approximately $305,000 and $225,000, respectively. For the six months ended September 30, 2020 and 2019 shipping and handling expenses were approximately $388,000 and $314,000, respectively. These expenses are classified as a component of selling expenses in the accompanying condensed consolidated statements of operations.

STOCK BASED COMPENSATION

The Company follows the provisions of the FASB ASC 718-20, “Compensation – Stock Compensation Awards Classified as Equity”. ASC 718-20 requires all share-based payments to employees including grants of employee stock options, be measured at fair value and expensed in the condensed consolidated statements of operations over the service period (generally the vesting period). The Company uses the Black-Scholes option valuation model to value stock options. Employee stock option compensation expense for the three and six months ended September 30, 2020 and 2019 includes the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period for the entire portion of the award. For the three months ended September 30, 2020 and 2019, the stock option expense was approximately $0 and $5,000, respectively. For the six months ended September 30, 2020 and 2019, the stock option expense was $0 and $10,000, respectively.

ADVERTISING

Costs incurred for producing and publishing advertising of the Company are charged to operations the first time the advertising takes place. The Company has entered into cooperative advertising agreements with its major customers that specifically indicate that the customer must spend the cooperative advertising fund upon the occurrence of mutually agreed events. The percentage of the cooperative advertising allowance ranges from 1% to 13% of the purchase. The customers must advertise the Company’s products in the customer’s catalog, local newspaper and other advertising media. The customer must submit the proof of the performance (such as a copy of the advertising showing the Company’s products) to the Company to request the allowance. The customer does not have the ability to spend the allowance at their discretion. The Company believes that the identifiable benefit from the cooperative advertising program and the fair value of the advertising benefit is equal or greater than the cooperative advertising expense. Advertising expense for the three months ended September 30, 2020 and 2019 was approximately $1,094,000 and $1,419,000, respectively. Advertising expense for the six months ended September 30, 2020 and 2019 was approximately $1,415,000 and $1,780,000, respectively As of September 30, 2020 and March 31, 2020 there was an accrual for cooperative advertising allowances of $653,000 and $685,000, respectively. These amounts were a component of accrued expenses in the condensed consolidated balance sheets.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

RESEARCH AND DEVELOPMENT COSTS

Research and development costs are charged to results of operations as incurred. These expenses are shown as a component of selling, general and administrative expenses in the condensed consolidated statements of operations. For the three months ended September 30, 2020 and 2019, these amounts totaled approximately $2,000 and $18,000, respectively. For the six months ended September 30, 2020 and 2019, these amounts totaled $15,000 and $23,000 respectively.

INCOME TAXES

The Company follows the provisions of FASB ASC 740 “Accounting for Income Taxes.” Under the asset and liability method of ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. If it is more likely than not that some portion of a deferred tax asset will not be realized, a valuation allowance is recognized. As of September 30, 2020 and March 31, 2020 the Company recognized a valuation reserve of approximately $88,000 for deferred tax assets relating to net operating loss carryforwards that the Company will more than likely not be able to realize prior to their expiration.

The Company analyzes its deferred tax assets and liabilities at the end of each interim period and, based on management’s best estimate of its full year effective tax rate, recognizes cumulative adjustments to its deferred tax assets and liabilities. For the six months ended September 30, 2020 and 2019 we estimated our effective tax rate to be approximately 25% and 18%, respectively. As of September 30, 2020 and March 31, 2020 the Singing Machine had net deferred tax assets of approximately $677,000 and $1,286,000, respectively. The Company recorded an income tax provision of approximately $821,000 and $184,000 for the three months ended September 30, 2020 and 2019, respectively. The Company recorded an income tax provision of approximately $742,000 for the six months ended September 30, 2020 and an income tax benefit of approximately $55,000 for the six months ended September 30, 2019.

The Company recognizes a liability for uncertain tax positions. An uncertain tax position is defined as a position in a previously filed tax return or a position expected to be taken in a future tax return that is not based on clear and unambiguous tax law and which is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The Company measures the tax benefits recognized based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. As of September 30, 2020, there were no uncertain tax positions that resulted in any adjustment to the Company’s provision for income taxes. The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes. The Company currently has no liabilities recorded for accrued interest or penalties related to uncertain tax provisions.

COMPUTATION OF EARNINGS PER SHARE

Income per common share is computed by dividing net income by the weighted average of common shares outstanding during the period. As of September 30, 2020 and 2019 total potential dilutive shares from common stock options amounted to approximately 2,230,000 and 2,250,000 shares, respectively. These shares were included in the computation of diluted earnings per share for the three and six months ended September 30, 2020 and the three months ended September 30, 2019. These shares were not included in the computation of diluted earnings per share for the six months ended September 30, 2019 because their effect was anti-dilutive.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2019, the FASB issued ASU 2019-12, “Income Taxes” (Topic 740). Among several issues addressed in this ASU, there was one area that may potentially affect the Company’s calculations of interim income tax provision or benefit. The guidance specifies that an entity should apply the annual effective tax rate to the year-to date income or loss as long as the tax benefits for any losses are expected to be realized during the year or would be recognizable as a deferred tax asset at the end of the year eliminating the requirement of a valuation allowance for that interim period. There is specific guidance for circumstances in which an entity incurs a loss on a year-to-date basis that exceeds the anticipated ordinary loss for the year, which is an exception to the general guidance in Subtopic 740-270. This new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We are currently evaluating the potential effects of this updated guidance on our condensed consolidated financial statements and related disclosures.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments—Credit Losses” (Topic 326). This ASU represents a significant change in the current accounting model by requiring immediate recognition of management’s estimates of current expected credit losses. Under the prior model, losses were recognized only as they were incurred, which delayed recognition of expected losses that might not yet have met the threshold of being probable. The amendments in ASU 2016-03 for smaller reporting companies are effective for fiscal years beginning after April 1, 2023 including interim periods within that fiscal year. Early adoption is permitted. We are currently evaluating the potential effects of this updated guidance on our condensed consolidated financial statements and related disclosures.

NOTE 3 - INVENTORIES, NET

Inventories are comprised of the following components:

NOTE 4 – PROPERTY AND EQUIPMENT

A summary of property and equipment is as follows:

Depreciation expense for the three months ended September 30, 2020 and 2019 was approximately $68,000 and $60,000, respectively. Depreciation expense for the six months ended September 30, 2020 and 2019 was approximately $139,000 and $119,000, respectively.

NOTE 5 – BANK FINANCING

Intercreditor Revolving Credit Facility Crestmark Bank and Iron Horse Credit

On June 16, 2020, the Company executed an Intercreditor Revolving Credit Facility on eligible accounts receivable and inventory which replaced the Company’s previous revolving credit facility with PNC Bank which was terminated on June 16, 2020. The Company signed a two-year Loan and Security Agreement for a $10.0 million financing facility with Crestmark Bank (“Crestmark Facility”) on eligible accounts receivable. The outstanding loan balance cannot exceed $10.0 million during peak selling season between July 1 and December 31and is reduced to a maximum of $5.0 million between January 1 and July 31. Costs associated with closing of the Intercreditor Revolving Credit Facility of approximately $74,000 are deferred and will be amortized over one year. During the three and six months ended September 30, 2020 the Company incurred amortization expense of approximately $18,000 and $21,000, respectively associated with the amortization of deferred financing costs from the Intercreditor Revolving Credit Facility.

Under the Crestmark Facility:

The Crestmark Facility is secured by a perfected security interest in all assets including a first security interest in Accounts Receivable and Inventory. Notwithstanding the foregoing, Crestmark shall subordinate its first security interest in inventory to IHC as agreed between all parties. The Crestmark Facility bears interest at the Wall Street Journal Prime Rate plus 5.50% with a floor of 8.75%. Interest and Maintenance Fees shall be calculated on the higher of the actual average monthly loan balance from the prior month or a minimum average loan balance of $2,000,000. For the three and six months ended September 30, 2020 the Company recorded interest expense of approximately $51,000.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

The Crestmark Facility expires on June 15, 2022. As of September 30, 2020, the Company had an outstanding balance of approximately $134,000 on the Crestmark Facility.

In addition, the Company executed a two-year Loan and Security Agreement with Iron Horse Credit (“IHC Facility”) for up to $2,500,000 in inventory financing.

Under the IHC Facility:

The IHC Facility is secured by a perfected security interest in the Company’s inventory. The IHC Facility bears interest at 1.292% per month or 15.51% annually. Interest shall be calculated on the higher of the actual average monthly loan balance from the prior month or a minimum average loan balance of $1,000,000. Interest expense for the three and six months ended September 30, 2020 was approximately $54,000 and $62,000, respectively. The IHC Facility expires on June 15, 2022. As of September 30, 2020, there was an outstanding balance of $1,022,000.

Revolving Credit Facility PNC Bank

On June 22, 2017, the Company renewed the existing revolving credit facility (the “PNC Revolving Credit Facility”) with PNC Bank, National Association (“PNC”) for an additional three years which was terminated on June 16, 2020 and replaced by the Intercreditor Revolving Credit Facility with Crestmark and IHC. In September 2019, the Company defaulted on the PNC Revolving Credit Facility due to non-compliance with the fixed charge coverage ratio requirement. In November 2019, the Company entered into a Forbearance Agreement with PNC whereby PNC delayed taking action they would have been be entitled to under a default through March 31, 2020. The Company remained in default of the Forbearance Agreement up until termination of the Revolving Credit Facility on June 16, 2020 at which time the Company executed the Intercreditor Revolving Credit Facility with Crestmark and IHC. As of September 30, 2020, and March 31, 2020 there were no amounts due on the PNC Revolving Credit Facility. During the three months ended September 30, 2020 and 2019 the Company incurred interest expense of approximately $0 and $32,000, respectively, on amounts borrowed against the PNC Revolving Credit Facility. During the six months ended September 30, 2020 and 2019 the Company incurred interest expense of approximately $0 and $33,000, respectively on amounts borrowed against the PNC Revolving Credit Facility.

Note Payable Payroll Protection Plan

On May 5, 2020, the Company received loan proceeds from Crestmark in the amount of approximately $444,000 under the Paycheck Protection Program (“PPP”). The PPP was established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest may be forgivable to the extent the Company uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness may be reduced if the borrower terminates employees or reduces salaries during the eligible period. The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments until a forgiveness application has been accepted and reviewed by the SBA, and the SBA has provided Crestmark with the loan forgiveness amount. For the three months ended September 30, 2020 and 2019 the Company incurred interest expense of approximately $1,000 and $0, respectively. For the six months ended September 30, 2020 and 2019 the Company incurred interest expense of approximately $2,000 and $0, respectively. As of September 30, 2020 there was an outstanding balance on the PPP note payable of approximately $444,000. The Company currently expects to apply for forgiveness of the entire loan balance.

Installment Notes Payable

On June 18, 2019, the Company entered into a financing arrangement with Dimension Funding, LLC (“Dimension”) to finance an entire ERP System project over a term of 60 months at a cost of approximately $365,000. As of September 30, 2020, the Company executed three installment notes totaling approximately $365,000 for payments issued to the project vendor. The installment notes have 60-month terms with interest rates of 7.58%, 8.55% and 9.25%, respectively. The installment notes are payable in monthly installments of $7,459 which include principal and interest. As of September 30, 2020, and March 31, 2020 there was an outstanding balance on the installment notes of approximately $312,000 and $346,000, respectively. For the three months ended September 30, 2020 and 2019 the Company incurred interest expense of approximately $7,000. For the six months ended September 30, 2020 and 2019 the Company incurred interest expense of approximately $14,000 and $7,000, respectively.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

Subordinated Debt/Note Payable to Related Party

In conjunction with the Crestmark Facility and IHC Facility there is a subordination agreement on related party debt due to Starlight Marketing Development, Ltd. of approximately $803,000. On June 1, 2020 the remaining amount due on the subordinated debt of approximately $803,000 was converted to a note payable (“subordinated note payable”) which bears interest at 6%. As part of the agreement to convert the subordinated debt to a note payable it was agreed that interest expense would be accrued at the same 6% interest rate on the unpaid principal retroactively from the date that previously scheduled payments had been missed. During the three months ended September 30, 2020 and 2019 interest expense was approximately $12,000 and $0, respectively on the subordinated note payable and the related party subordinated debt. During the six months ended September 30, 2020 and 2019 interest expense was approximately $24,000 and $2,000, respectively on the subordinated note payable and the related party subordinated debt.

In connection with the Intercreditor Revolving Credit Facility the Company was required to subordinate the subordinated note payable. Both the Crestmark Facility and IHC Facility agreements allow for the repayment of the subordinated note payable provided any amounts borrowed against these credit facilities are paid in full, the Company maintains a 1 : 1 debt coverage ratio and exhibits sufficient cash liquidity to support on-going operations. There is no set schedule with regards to repayment of the note and as such the subordinated note payable has been classified as a non-current liability as of September 30, 2020 and March 31, 2020 on the consolidated balance sheets. As of September 30, 2020 and March 31, 2020 the remaining amount due on the subordinated debt was approximately $803,000.

NOTE 6 - COMMITMENTS AND CONTINGENCIES

INSURANCE CLAIM SETTLEMENT – DAMAGED GOODS INCIDENT

As of this filing we have recovered approximately $2,336,000 from our cargo insurance coverage which settled approximately $1,268,000 in insurance claim receivable with the remaining proceeds reflected in other income and (expenses) as a gain from damaged goods insurance claim in the condensed consolidated statement of operations. For the three and six months ended September 30, 2020 the gain from damaged goods insurance claim was approximately $937,000 and $1,068,000, respectively.

LEGAL MATTERS

Management is not aware of any legal proceedings other than matters that arise in the ordinary course of business.

LEASES

Operating Leases

We have operating lease agreements for offices and a warehouse facility in Florida, California and Hong Kong expiring in various years through 2024.

We entered into an operating lease agreement, effective October 1, 2017, for the corporate headquarters located in Fort Lauderdale, Florida where we lease approximately 6,500 square feet of office space. The lease expires on March 31, 2024. The base rent payment is approximately $8,800 per month, subject to annual adjustments.

We entered into an operating lease agreement, effective June 1, 2013, for 86,000 square feet of warehouse space in Ontario, California for our logistics operations. On June 15, 2020 we executed a three-year lease extension which will expire on August 31, 2023. The renewal base rent payment is $65,300 with a 3% increase every 12 months for the remaining term of the extension.

We entered into an operating lease agreement, effective May 1, 2018, for 424 square feet of office space in Macau. The rent is fixed at approximately $1,600 per month for the duration of the lease which expires on April 30, 2021. The lease provides for a renewal option to extend the lease.

Lease expense for our operating leases is recognized on a straight-line basis over the lease terms.

Finance Leases

On May 25, 2018 and June 4, 2018, we entered into two long-term capital leasing arrangements with Wells Fargo Equipment Finance (“Wells Fargo”) to finance the leasing of two used forklift vehicles in the amount of approximately $44,000. The leases require monthly payments in the amount of $1,279 per month over a total lease term of 36 months which commenced on June 1, 2018. The agreement has an effective interest rate of 4.5% and the Company has the option to purchase the equipment at the end of the lease term for one dollar. As of September 30, 2020 and March 31, 2020, the remaining amounts due on these capital leasing arrangements was approximately $10,000 and $18,000, respectively. For the three months ended September 30, 2020 and 2019 the Company incurred interest expense of $109 and $239, respectively. For the six months ended September 30, 2020 and 2019 the Company incurred interest expense of $263 and $513, respectively.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

Supplemental balance sheet information related to leases as of September 30, 2020 is as follows:

Supplemental statement of operations information related to leases for the three and six months ended September 30, 2020 is as follows:

Scheduled maturities of operating and finance lease liabilities outstanding as of September 30, 2020 are as follows:

NOTE 7 - STOCK OPTIONS

During the six months ended September 30, 2020 and 2019 the Company issued 0 and 100,000 stock options, respectively at an exercise price of $0 and $.38 to directors as compensation for their service.

The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option-pricing model with the assumptions outlined below. The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is based upon observation of actual time elapsed between date of grant and exercise of options for all employees.

A summary of stock option activity for the six months ended September 30, 2020 is summarized below:

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

The following table summarizes information about employee stock options outstanding at September 30, 2020:

* Total number of options outstanding as of September 30, 2020 includes 1,080,000 options issued to five current and two former directors as compensation and 1,150,000 options issued to key employees that were not issued from the Plan.

NOTE 8 - GEOGRAPHICAL INFORMATION

Sales to customers outside of the United States for the three and six months ended September 30, 2020 and 2019 were primarily made by the Macau Subsidiary in US dollars. Sales by geographic region for the periods presented are as follows:

The geographic area of sales was based on the location where the product is delivered.

NOTE 9 –RELATED PARTY TRANSACTIONS

All transactions listed below are related to the Company as they are all with affiliates of our Chairman of the Board, Mr. Phillip Lau.

DUE TO/FROM RELATED PARTIES

On September 30, 2020 and March 31, 2020, the Company had amounts due to related parties in the amounts of approximately $244,000 and $502,000, respectively for services provided by these companies and licensing fees for use of pedestal model molds and tools owned by the parent company. On September 30, 2020 and March 31, 2020, the Company had $0 and $100,000 due from a related party for goods sold to this company.

TRADE

During the three months ended September 30, 2020 and 2019 the Company sold approximately $0 and $778,000, respectively to Winglight Pacific, Ltd. (“Winglight”), a related party, at a discounted price similar to prices granted to major direct import customers shipped internationally with freight prepaid. The average gross profit margin on sales to Winglight for the three months ended September 30, 2020 and 2019 was NA and 23.9%, respectively. The product was shipped to Cosmo Communications of Canada (“Cosmo”), another related company and the Company’s primary distributor of its products to Canada at that time. These amounts were included as a component of net sales in the accompanying condensed consolidated statements of operations.

During the three months ended September 30, 2020 and 2019 the Company sold approximately $0 and $168,000, respectively of product directly to Cosmo from its California warehouse facility. These amounts were included as a component of net sales in the accompanying condensed consolidated statements of operations.

On July 30, 2020, the Company and Cosmo reached agreement that Cosmo would no longer be the Company’s Canadian distributor and the Company became the sole and exclusive distributor of the Company’s products in Canada. As part of the agreement, the companies executed a Purchase and Sales agreement whereby the Company acquired all of Cosmo’s karaoke inventory for approximately $685,000.

During the six months ended September 30, 2020 and 2019 the Company sold approximately $0 and $852,000, respectively to Winglight at a discounted price similar to prices granted to major direct import customers shipped internationally with freight prepaid. The average gross profit margin on sales to Winglight for the six months ended September 30, 2020 and 2019 was NA and 23.7%, respectively. The product was shipped to Cosmo. These amounts were included as a component of net sales in the accompanying condensed consolidated statements of operations.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

During the six months ended September 30, 2020 and 2019 the Company sold approximately $0 and $239,000, respectively of product directly to Cosmo from its California warehouse facility. These amounts were included as a component of net sales in the accompanying condensed consolidated statements of operations.

The Company incurred service expenses from Starlight Electronics Co, Ltd, (“SLE”) a related party. The services from SLE were approximately $90,000 for the three months ended September 30, 2020 and 2019. The services from SLE for the six months ended September 30, 2020 and 2019 were approximately $181,000 and $191,000 respectively. These amounts were included as a component of general and administrative expenses in the accompanying condensed consolidated statements of operations.

NOTE 10 – RESERVE FOR SALES RETURNS

A return program for defective goods is negotiated with each of our wholesale customers on a year-to-year basis. Customers are allowed to return defective goods within a specified period of time after shipment (between 6 and 9 months). The Company does make occasional exceptions to this return policy and accordingly records a sales return reserve based on historic return amounts, specific exceptions as identified and management estimates.

The Company records a sales reserve for its return goods programs at the time of sale for estimated sales returns that may occur. The liability for defective goods is included in the reserve for sales returns on the condensed consolidated balance sheets.

Changes in the Company’s reserve for sales returns are presented in the following table:

NOTE 11 – REFUNDS DUE TO CUSTOMERS

As of September 30, 2020 and March 31, 2020 the amount of refunds due to customers was approximately $121,000  and $807,000, respectively. Refunds due to customers at September 30, 2020 were primarily due to one major customer for overstock returns. Refunds due to customers at March 31, 2020 were primarily due to one major customer which reflects approximately $1,691,000 of chargebacks less approximately $1,181,000 that the customer had deducted on payment remittances to the Company as of March 31, 2020. The remaining $297,000 was primarily due to amounts due to two major customers for overstock returns.

NOTE 12 - EMPLOYEE BENEFIT PLANS

The Company has a 401(k) plan for its employees to which the Company makes contributions at rates dependent on the level of each employee’s contributions. Contributions made by the Company are limited to the maximum allowable for federal income tax purposes. The amounts charged to operations for contributions to this plan and administrative costs during the three months ended September 30, 2020 and 2019 totaled approximately $20,000 and $18,000, respectively. The amounts charged to operations for contributions to this plan and administrative costs during the six months ended September 30, 2020 and 2019 totaled approximately $34,000 and $32,000, respectively. The amounts are included as a component of general and administrative expense in the accompanying condensed consolidated statements of operations. The Company does not provide any post-employment benefits to retirees.

NOTE 13 - CONCENTRATIONS OF CREDIT AND SALES RISK

The Company derives a majority of its revenues from retailers of products in the United States. The Company’s allowance for doubtful accounts is based upon management’s estimates and historical experience and reflects the fact that accounts receivable are concentrated with several large customers. At September 30, 2020, 93% of accounts receivable were due from four customers in North America that individually owed over 10% of total accounts receivable. At March 31, 2020, 82% of accounts receivable were due from three customers in North America that individually owed over 10% of total accounts receivable.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2020 and 2019

(Unaudited)

The Company generates most of its revenue from retailers of products in the United States with a significant amount of sales concentrated with several large customers the loss of which could have an adverse impact on the financial position of the Company. For the three months ended September 30, 2020, there were three customers who individually accounted for 10% or more of the Company’s gross sales. Revenue derived from these customers as a percentage of gross sales were 44%, 21%, and 12% respectively. For the three months ended September 30, 2019, there were three customers who individually accounted for 10% or more of the Company’s gross sales. Revenue derived from these customers as a percentage of gross sales were 36%, 13% and 11%, respectively.

For the six months ended September 30, 2020, there were three customers who individually accounted for 10% or more of the Company’s gross sales. Revenue derived from this customer as a percentage of gross sales were 40%, 20% and 15%, respectively. For the six months ended September 30, 2019, there were two customers who individually accounted for 10% or more of the Company’s gross sales. Revenue derived from these customers as a percentage of gross sales were 43% and 10%, respectively.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes included elsewhere in this quarterly report. This document contains certain forward-looking statements including, among others, anticipated trends in our financial condition and results of operations and our business strategy. (See Part II, Item 1A, “Risk Factors “). These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially from these forward-looking statements.

Statements included in this quarterly report that do not relate to present or historical conditions are called “forward-looking statements.” Such forward-looking statements involve known and unknown risks and uncertainties and other factors that could cause actual results or outcomes to differ materially from those expressed in, or implied by, the forward-looking statements. Forward-looking statements may include, without limitation, statements relating to our plans, strategies, objectives, expectations and intentions. Words such as “believes,” “forecasts,” “intends,” “possible,” “estimates,” “anticipates,” “expects,” “plans,” “should,” “could,” “will,” and similar expressions are intended to identify forward-looking statements. Our ability to predict or project future results or the effect of events on our operating results is inherently uncertain. Forward-looking statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved.

Important factors to consider in evaluating such forward-looking statements include, but are not limited to: (i) changes in external factors or in our internal budgeting process which might impact trends in our results of operations; (ii) unanticipated working capital or other cash requirements; (iii) changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the industries in which we operate; and (iv) the effects of adverse general economic conditions, both within the United States and globally, (v) vendor price increases and decreased margins due to competitive pricing during the economic downturn (vi)various competitive market factors that may prevent us from competing successfully in the marketplace and (vii) other factors described in the risk factors section of our Annual Report on Form 10-K, this Quarterly Report on 10-Q, or in our other filings made with the SEC.

Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements.

OVERVIEW 

The Singing Machine Company, Inc., a Delaware corporation (the “Company”, “SMC”, “The Singing Machine”) and its three wholly-owned subsidiaries SMC (Comercial Offshore De Macau) Limitada (“Macau Subsidiary”), SMC Logistics, Inc. (“SMC-L”) and SMC-Music, Inc.(“SMC-M”) are primarily engaged in the development, marketing, and sale of consumer karaoke audio systems, accessories, musical instruments and musical recordings. The products are sold by SMC to retailers and distributors for resale to consumers.

Our products are sold throughout North America, Europe and Australia primarily through major mass merchandisers and warehouse clubs, on-line retailers and to a lesser extent department stores, lifestyle merchants, direct mail catalogs and showrooms, music and record stores, and specialty stores.

Representative customers include Amazon, Best Buy, BJ’s Wholesale, Costco, Sam’s Club, Target, and Wal-Mart. Our business has historically been subject to seasonal fluctuations causing our revenues to vary from quarter to quarter and between the same periods in different fiscal years. Our products are manufactured for the most part based on the purchase indications of our customers. We are uncertain of how significantly our business would be harmed by a prolonged economic recession, but we anticipate that continued contraction of consumer spending would negatively affect our revenues and profit margins.

Sales of consumer electronics and toy products in the retail channel are highly seasonal, with a majority of retail sales occurring during the period from September through December in anticipation of the holiday season, which includes Christmas. A substantial majority of our sales occur during the second quarter ending September 30 and the third quarter ending December 31. Sales in our second and third quarter, combined, accounted for approximately 98% and 94% of net sales in fiscal 2020 and 2019, respectively.  

The COVID-19 pandemic has significantly affected U.S. consumer shopping patterns and caused the health of the U.S. economy to deteriorate. We cannot foresee whether the outbreak of COVID-19 will be effectively contained, nor can we predict the severity and duration of its impact on our business and our financial results. If the outbreak of COVID-19 is not effectively and timely controlled, our business operations, financial condition, and liquidity may be materially and adversely affected as a result of prolonged disruptions in consumer spending, a lack of demand for our products, forced retail store closures and other factors that we cannot foresee. The extent to which COVID-19 will impact our business and our financial results will depend on future developments which are highly uncertain and cannot be predicted.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, certain items related to our consolidated statements of operations as a percentage of net sales for the three and six months ended September 30, 2020 and 2019:

The Singing Machine Company, Inc. and Subsidiaries

CONDENDSED CONSOLIDATED STATEMENTS OF OPERATIONS

QUARTER ENDED SEPTEMBER 30, 2020 COMPARED TO THE QUARTER ENDED SEPTEMBER 30, 2019

NET SALES

Net sales for the quarter ended September 30, 2020 increased to approximately $23,188,000 from $20,082,000 an increase of approximately $3,106,000 as compared to the same period ended September 30, 2019. Sales of our Carpool Karaoke The Mic (“CPK”) product increased by approximately $1,098,000 during the three months ended September 30, 2020 compared to the same period ended September 30, 2019. During the three months ended September 30, 2019, we received notification from a major customer that several containers of goods from multiple vessels purchased direct import by the customer had arrived severely water damaged which resulted in estimated customer chargebacks and a reduction of sales of approximately $1,534,000 for this one-time prior year incident. The remaining increase in sales of approximately $474,000 was primarily due to increased internet product demand from two major customers during the three months ended September 30, 2020.

GROSS PROFIT

Gross profit for the quarter ended September 30, 2020 increased to approximately $6,725,000 from $5,642,000 an increase of approximately $1,083,000 as compared to the same period in the prior year. The increase in CPK product sales contributed approximately $638,000 to the increase in gross profit. The one-time damaged goods incident during the three months ended September 30, 2019 contributed approximately $286,000 of the variance in gross profit with the remaining increase due to the gross profit on the mix of products sold.

Gross profit margin for the three months ended September 30, 2020 was 29.0% compared to 28.1% for the three months ended September 30, 2019. The increase in CPK product sales which yield substantially more gross profit margin than our traditional product accounted for approximately 0.7 margin points of the 0.9 gross profit margin point increase with the remaining 0.2 increase in margin points attributed to the mix of products sold.

OPERATING EXPENSES

For the quarter ended September 30, 2020, total operating expenses decreased to approximately $4,287,000 compared to approximately $4,783,000 from the same period in the prior year. This represents a decrease in total operating expenses of approximately $496,000 from the quarter ended September 30, 2019. Selling expenses decreased by approximately $111,000, primarily due reduced discretionary marketing expenses associated with CPK product of approximately $200,000 and offset by increased royalty expense on CPK product of approximately $148,000 due to the increase in sales. The remaining decrease was primarily due to reductions in advertising allowance programs for the holidays.

General and administrative expenses decreased by approximately $393,000 to approximately $1,842,000 for the three months ended September 30, 2020 compared to approximately $2,235,000 for the same period ended September 30, 2019. There were one-time expenses incurred during the three months ended September 30, 2019 including approximately $219,000 in out-of-pocket expenses associated with the damaged goods incident and approximately $135,000 in accounts receivable insurance for J C Penney that did not reoccur during the three months ended September 30, 2020. The remaining decrease was primarily due to a reduction in travel and entertainment expenses associated with COVID-19 limitations.

INCOME FROM OPERATIONS

There was income from operations of approximately $2,439,000 for the three months ended September 30, 2020 compared to income from operations of approximately $859,000 for the three months ended September 30, 2019. The increase in income from operations of approximately $1,580,000 was primarily due to the increase in gross profit and reduction in operating expenses as explained above.

OTHER INCOME (EXPENSES)

Other income and (expenses) increased by approximately $841,000 to approximately $790,000 in other income, net for the three months ended September 30, 2020 compared to approximately $51,000 in other expenses for the same period ended September 30, 2019 primarily due to the recovery of approximately $937,000 in out-of-pocket expenses relating to a prior year damaged goods insurance claim. This increase in other income was offset by an increase in interest expense and amortization of deferred financing costs of approximately $96,000 associated with the financing terms of the Crestmark Facility and IHC Facility.

INCOME TAXES

For the three months ended September 30, 2020 and 2019 the Company recognized an income tax provision of approximately $821,000 and $184,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 25.2% and 18.3%, respectively.

NET INCOME

For the three months ended September 30, 2020 there was net income of approximately $2,408,000 compared to net income of approximately $624,000 for the same period a year ago. The increase in net income was primarily due to the same reasons discussed in Income from Operations, Other Income (Expenses) and Income Taxes.

SIX MONTHS ENDED SEPTEMBER 30, 2020 COMPARED TO THE SIX MONTHS ENDED SEPTEMBER 30, 2019

NET SALES

Net sales for the six months ended September 30, 2020 increased to approximately $26,511,000 from $24,891,000 an increase of approximately $1,620,000 as compared to the same period ended September 30, 2019. Sales of our CPK product increased by approximately $939,000 during the six months ended September 30, 2020 compared to the same period ended September 30, 2019. During the six months ended September 30, 2019, we received notification from a major customer that several containers of goods from multiple vessels purchased direct import by the customer had arrived severely water damaged which resulted in estimated customer chargebacks and a reduction of sales of approximately $1,534,000 for this prior year one-time incident. These increases in net sales were offset by a reduction in sales of approximately $826,000 to J C  Penney due to their pending bankruptcy.

GROSS PROFIT

Gross profit for the six months ended September 30, 2020 increased to approximately $7,959,000 from approximately $6,630,000 an increase of approximately $1,329,000 as compared to the same period in the prior year. The increase in CPK product sales as indicated in Net Sales contributed approximately $542,000 increase in gross profit margin. The one-time damaged goods incident during the six months ended September 30, 2019 contributed approximately $296,000 of the variance in gross profit with the remaining increase attributed to the mix of products sold.

Gross profit margin for the six months ended September 30, 2020 was 30.0% compared to 26.6% for the six months ended September 30, 2019. The increase in CPK product sales which yield substantially more gross profit margin than our traditional product accounted for approximately 0.4 of the 3.4 gross profit margin point increase with the remaining increase in margin points attributed to the mix of products sold.

OPERATING EXPENSES

For the six months ended September 30, 2020, total operating expenses increased to approximately $6,292,000 compared to approximately $6,873,000 from the same period in the prior year. This represents a decrease in total operating expenses of approximately $581,000 from the six months ended September 30, 2019. Selling expenses decreased by approximately $200,000, primarily due to reduced discretionary marketing expense of approximately $343,000 associated with the CPK product and offset by an increase of royalty expenses of approximately $130,000 due to the increase in CPK product sales.

General and administrative expenses decreased by approximately $401,000 to approximately $3,205,000 for the six months ended September 30, 2020 compared to approximately $3,606,000 for the same period ended September 30, 2019. There were one-time expenses incurred during the three months ended September 30, 2019 including approximately $219,000 in out-of-pocket expenses associated with the damaged goods incident and approximately $135,000 in accounts receivable insurance for J C Penney that did not reoccur during the three months ended September 30, 2020. There was a decrease in travel and entertainment of approximately $153,000 due to canceled trade shows and other limitations associated with COVID-19. These increases in general and administrative expenses were offset  by an increase in outside computer services associated with the implementation of our new ERP system.

INCOME (LOSS) FROM OPERATIONS

There was income from operations of approximately $1,668,000 for the six months ended September 30, 2020 compared to a loss from operations of approximately $243,000 for the six months ended September 30, 2019. The increase in income from operations of approximately $1,911,000 was primarily due to the increase in gross profit and reduction in operating expenses as explained above.

OTHER INCOME (EXPENSES)

Other income and (expenses) increased by approximately $1,333,000 to approximately $1,276,000 in other income, net for the six months ended September 30, 2020 compared to approximately $57,000 in other expenses for the same period ended September 30, 2019 primarily due to the recovery of approximately $1,068,000 in out-of-pocket expenses relating to a prior year damaged goods insurance claim and a vendor extinguishing accounts payable of $390,000 from the factory that caused the damage. This increase in other income was offset by an increase in interest expense and amortization of deferred financing costs of approximately $125,000 associated with the financing terms of the Crestmark Facility and IHC Facility.

INCOME TAXES

For the six months ended September 30, 2020 and 2019 the Company recorded an income tax provision of approximately $742,000 and an income tax benefit of approximately $55,000, respectively, due to management’s best estimate of the Company’s full year effective tax rate of approximately 25.2% and 18.3%, respectively.