Algorhythm Holdings Inc (RIME) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to The Singing Machine's third quarter results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded Monday, January 31, 2005. I would now like turn the conference over to Mr. J. Bauer, Chairman of The Singing Machine. Please go ahead, sir.

Thank you, operator, and good morning to everyone. With me this morning are Interim CEO, Y.P. Chan; and CFO, Jeff Barocas. After our prepared remarks, will be available to answer your questions.

As we have stated in previous conference calls, our primary objectives for this current fiscal year are to position the company for a return to sustained profitability and to stabilize the company's balance sheet. This morning, we are pleased to report a profitable third quarter. This was our second consecutive quarter of profitability. We also reported an increase in our working capital and cash positions and reduced inventories. I believe that we have come a very long way toward accomplishing our goals.

Another sign of our progress is that we were able to report our third quarter results only 4 weeks after the end of our quarter instead of the 6 weeks or more that it used to take us to get the numbers out. Our management team has done a fantastic job with our financial reporting function, and the work they have done is clearly bearing fruit. This is only the most visible -- this is only one of the most visible examples of how our commitment to implementing best practices in every aspect of our business is making a dramatic difference at The Singing Machine.

We know that we cannot build the first-class organization we are striving for by just cutting costs. So, even though we reduced total operating costs by 73 percent in the third quarter compared to the prior year, what's just more important is these cuts have been accompanied by significant improvements in how we operate the business. It is clear from the numbers that we are doing a better job than ever before in managing our supply chain, our returns, our inventories and our cash flow. We also have made good progress in getting the most of our product development and sales in marketing dollars. We even have made progress in corporate governance. It has taken us time to find the right people, but I am pleased to report that today, our outside directors are well-qualified, active and committed to the future of The Singing Machine.

We have continued to hone our operations to an even finer edge. We will take advantage of additional cost reductions opportunities in our warehouse and repair operations as well as in our licensing program. At the same time, we are now beginning to add resources in (indiscernible) areas. We have selectively expanded our sales team with the experienced personnel we need to achieve our objective of restoring topline growth beginning in the next fiscal year.

We also have expanded our commitment to staffing the music side of the business, which has long been an area of great opportunity but disappointing performance for the company. At the same time, we're looking beyond the karaoke business to such new digital products, music products and other related merchandise to diversify from the seasonality of our existing business. This strategy will provide more and more stable and smooth revenue basis throughout the year. Karaoke remains a strong consumer electronics category. Our ability to continue to sell our products at a profit despite all of the obstacles we faced this year demonstrates the continued viability of The Singing Machine brand in the marketplace. We are restoring our credibility as a reliable supplier, which is another reason for optimism as we look into the next season.

We previewed several innovative new products at the CS Show in Las Vegas earlier this month. The response among our customers was encouraging. We plan to see the buyers again next month at the Toy Fair in New York. Then the real work begins as we get together on a one-on-one basis with suppliers to set the programs for the coming season. Those of you who have followed us for awhile know that this is the traditional calendar in the consumer electronics industry. I look forward to reporting how things are shaping up for fiscal 2006 on our next conference call.

Now I am going to turn the call over to Jeff to review the results in detail. Jeff?

Thanks, J. I'll begin with the Safe Harbor statement. Please note that this conference call will include forward-looking statements. These statements are based on current expectations, estimates and projections about our business, based in part on assumptions made by management. These statements are not guarantees of future performance and actual results may differ materially. A more detailed discussion of these risks and uncertainties is contained in this morning's press release and Singing Machine's various filings with the SEC.

The statements made during this call are made only as of the date of the call, and we undertake no obligation to update these statements.

I will now briefly review our financial results for the third quarter and first nine months of fiscal 2005. For more detailed financial information, I urge you to read our Form 10-Q that we expect to file in the next 2 weeks.

For the third quarter of fiscal 2005, ending December 31, 2004, net income was 496,000, or 5 cents a share diluted. This included a 446,000 non-cash expense related to the amortization of discount on convertible debentures. In comparison, for the third quarter of 2004, The Singing Machine reported a net loss of 10,451,000, or $1.20 per share. The fully-diluted share count for this year's third quarter increased to about 9,256,000 shares from approximately 8.9 million shares a year earlier. This reflects our issuance of 400,000 shares in connection with the settlement of the class-action lawsuit.

Operating profit for this year's third quarter increased to 1,014,000. This compares to an operating loss of 7,632,000 last year. I note that we achieved this $8.7 million improvement in operating profit despite a decline in revenue for the quarter to 14,368,000 from 29,613,000 last year.

Revenue for this year's third quarter was reduced in part by the backup of container ships waiting to unload at ports in Los Angeles and Long Beach last November that affected everyone importing goods from Asia.

This improvement reflects two things -- first, gross margin increased to 34 percent for revenues for this year's third quarter compared to a negative gross margin of 3 percent for the third quarter of fiscal 2004.

Second, total operating expenses decreased by 2,878,000, or 42.4 percent. We achieved cost reductions in every expense category, with the exceptions of commissions, which increased as a result of a new distribution agreement for our karaoke music.

For the nine months ended December 31, 2004 the net loss was 302,000, or 3 cents per share diluted, which includes a 1,190,000 non-cash expense related to the discount on convertible debentures. This compares to a net loss for the first 9 months of fiscal 2004 of 13,425,000, or $1.58 per share.

Operating income rose to 1,086,000 for the first nine months of fiscal 2005. This is an improvement of more than 12 million compared to the operating loss of 11 million that we reported in the same period last year.

Revenues for this year's first nine months was 36,979,000 versus 70,115,000 for the same period a year earlier.

Cash flow from operating activities for the first 9 months of 2005 increased to 1,223,000 compared to a negative 4,998,000 for the first 9 months of last year, an improvement of more than $6.2 million.

Turning to the balance sheet, working capital at December 31, 2004 increased to 1,218,000. Cash and cash equivalents increased to 2.2 million at December 31, 2004 compared to 1.2 million at March 31, 2004. Inventories declined to about 2.8 million at December 31, 2004 from 5.9 million at March 31, 2004 and accounts payable declined by $3.1 million.

Two file notes. Subsequent to the end of the quarter, the Company announced the conversion of approximately $400,000 of subordinated debt through equity. We expect that additional debt to be converted into equity by the end of March. These transactions will be reflected on the company's balance sheet at March 31, 2005.

Secondly, I am pleased to report that we have corrected all material weaknesses as documented in last year's order by former auditors Grant Thornton. I expect it to be reflected in our 10-K for the year ending March 31.

Operator, we are ready for the first question.

(OPERATOR INSTRUCTIONS). Linda Donnelly (ph), the Franklin Management Group.

Could you give us some indication of what your capital expenditures will be for this fiscal year, as well as your depreciation expense?

This is Y.P. Chan here. I think capital expenditure for the coming fiscal year is roughly for about $750,000 in the past (indiscernible). And the coming season will be depending on our product introduced. The capital expenditure could be a range between $500,000 to $1.5 million. That number is yet to be finalized.

And somewhat depreciations are for the past year is approximately $532,000 (ph$).

Alright. And could you elaborate a little bit on the Las Vegas show? You said that you thought it had a very good response to the 7 new products. So can you just give a little elaboration on that?

Yes; we showed two new karaoke products, one of which ties also very much into the possibility of playing DVD films and libraries on the same unit. The other one was an upgraded model of our last year's model, 988, which was a console-type product which sold quite well and which is on the upper end of the more -- a little bit like a semiprofessional unit.

So we showed these 2 models, and we are at the moment discussing this further with some very -- potential customers to see whether we are going to -- which of the models we're going to make. We're probably are going to go ahead with one of the models, which was the most salable and which will give us the most bang for the buck if we're investing. But it's a little bit too early to say right now, but within the next 30 days, we will be making up our minds as to which model we are going to introduce.

We also showed a new product that we are negotiating for, which is to some extent unrelated to the karaoke business but very much into the musical digital recording area of the market. It's a bit too soon to give some more information at this point because we are negotiating a distribution agreement with the company. So, as we go along, we will give some more updates on this and that will also decide some additional capital expenditures that we will probably make available to this type of product, which would be a wonderful addition to the type of merchandise we're selling right now.

Linda, in addition to what J. said about our new product in the digital music machine, one thing we have done this year so far is we have scaled back the number of products offered in the marketplace, and we took -- now this year, we're probably going to offer about 10 existing products in addition to new one. We package it in such a way that the different what we call shooters (ph) and offered to different (indiscernible) depending on the target market, certainly price point. By doing that, we are able to segmentize our market a little bit better, offer the value proposition that caters specific to that segment, and that will help us to achieve better result, in terms of revenue and also profit margins.

Steve Springer, Target Capital.

Great job and the quarter, guys. Congratulations. You referred to the backup -- Jeff referred to the backup on the West Coast of the shipping containers. I'm wondering if you have any new plans as to how you could reduce those possible problems in the year coming forward?

Yes; there was a backup on container shipments because the very, very heavy shipments from China to the entire marketplace. If you think about what -- when you look at something that is produced here today that is sold in every store, you can bet that 90 percent is coming to be from China. So it has been tremendous pressure on containers, ships available and how to get their products into the country.

I might also add a little bit here that it was not only exactly the back half, which certainly delayed some of our products, but there was also a bit of a problem with our manufacturers in China this year, who could not really secure enough workers to produce the kind of products and merchandise that they had to produce. So we lost on some thought maybe 3-4 weeks, 5 weeks to get them into the country, which means we lost like 1 turn in sales, especially to customers like the larger customers, who -- where 1 month makes a very big difference. And that actually probably took away maybe $4 or $5 million of our sales potential this year. But it is as it is, and we certainly are making more precautions this year again to start our new program as early as possible so to give us enough lead time. So hopefully, we will be able to introduce all the merchandise we want to on a timely fashion, and that is our goal. And we're working very close to that extent.

And Steve, to back up what J. just said -- strategically, one of our strategies is to try to do as much as (indiscernible) business as possible. By doing that, the big lead tier (ph) have a lot more leverage in terms of getting the freighter into the United States, for example. Just a statistic -- for the month of September 2004, (indiscernible) about 90,000 containers in September 2004. So, if we could newly strategic or roll some of these goods to the customer, they help us in terms of logistic supply chain.

(indiscernible) we're looking now, as J. just mentioned before, we're actively looking to introduce new products that diversify us from the seasonality of Christmas.

Could you talk a little bit about how your improved balance sheet, you would expect to change the relationships that you have with some of the large retailers? It's my understanding that in the current fiscal year and this past season, that there was some difficulty in working with some of the large retailers because of their concerns about The Singing Machine's financial condition, which now is much improved. Could you talk about how you see that benefiting the year coming forward?

Steve, Jeff. We have worked very, very diligently in the first 9 months to pay off a lot of the credit balances that we had with the retailers. At the beginning of the year, we had over $2.1 million of monies that we actually owned at (ph) retailers for primarily returned merchandise which they returned on credit. And what we have done is we have either provided them with credits against purchases in this past year, or we have actually, as we generated cash, we've actually disbursed cash to relieve these liabilities. At the end of September, we've actually paid down a lot of these liabilities to the retailers, accounting for $1.3 million of money owed to them.

This has improved our standing with the retailers in addition to the improved balance sheet which we now have that the retailers are feeling a lot more comfortable in dealing with us now that we have survived the worst. And as you can see, we're progressively improving our financial position on a quarterly basis.

Steve, in addition to this, we also have improved our relationship with our suppliers in China very much. We have paid back most of the monies owed to them. Some of them are totally cleared up, and with one supplier, we have a long-standing relationship, and we have an excellent, excellent relationship with all of them.

I may also add that, yes, we have this year experienced a very, very good results with actually nontraditional electronic distributors where we've sold our karaoke equipment, and these people have been extremely successful. They have totally sold out our products, and we're actually discussing with them to add on to a line for this coming season. So we are greatly encouraged at some of the steps that we have taken and also the renewed confidence in our company as a viable supplier exists, is stronger and has been appreciated by those customers. So we certainly look forward to improve the position in all those areas.

On the balance sheet, there's an item on the liability side of income tax payable of $2,453,000. Is that the potential Hong Kong tax liability?

That is correct, Steve.

And could you again just give us a summary of what you view, how you view this? It's my understanding that there is some considerable doubt that this liability will never actually be due. Is that how you see it?

Yes. Let me explain to the audience who did not participate or follow our company last year situation in the past couple year. About 3-4 years ago, we established a wholly-owned subsidiary in Hong Kong called ISMC which has been engaged in engineering, sourcing, quality control and shipping of goods from our supplier in China to the United States or to Europe. And a couple years ago, and under the recommendation of our previous auditor, they said, since all your business comes out of Hong Kong, by Hong Kong tax law, you do not have to pay Hong Kong tax.

So therefore, they helped us to file extension in Hong Kong for the tax exemption. But about 2 years ago, when we engaged a different auditor, the auditor insisted we needed to expense this in our balance sheet as we saw these liabilities are. But since then, in about 3 to 4 year, we have not received any judgment from the Hong Kong IrD (ph) region, including the U.S. IRA (ph) coming back to us said, by the way, you owe this money; you need to pay. So this thing had been going on for 3 to 4 year, and we have not -- again, we're not reaching any decision from the Hong Kong IrD indicating that we have to pay this tax, up to this point. But this item has been expensed in our balance sheet; that's where you see the $2.45 million.

I see. And my last question -- could you talk a little bit about -- first of all, could you give us a breakdown of the percentage of domestic sales versus international sales for the quarter? And could you talk about what your expectations are for the international market -- where you expect to be expanding? And if you could go region by region or continent by continent, that would be helpful.

For the first 9 months in fiscal year 2005, our international business accounted for 26 percent of our total revenue; that's about $9.5 million, and United States accounted for the 74 percent. Compared with the same period last year, our international revenue actually dropped. There was probably (indiscernible) is one of our biggest distributor in Europe had quite a lot of inventory leftover from last year, and this year they were just showing the existing inventory from last year. And then also, because of the critical concern, another major distributor did not purchase from us last year because of the (indiscernible) concern. And that is the reason why you see the revenue drop substantially for these 2 major customers, as we saw the impact our own revenue in international markets.

Looking forward to the coming season, we expect to -- we expect to do business with most of these customers in Italy, Spain, UK, France, Scandinavian countries. We also do business in Australia, we do business in Canada, and we expect to continue our business in this region. At this point, it's too early to tell exactly what the level looks like because it is a little bit premature. I think will probably have more information in the next conference call as our salespeople are now going over with our distributor customers in international markets to firm up the numbers.

And, Steve, to add one more thing, we're negotiating very close to finalizing a deal with the company that will provide us entry into the German market, which could be, down the road, a substantial market. And we also expect to expand our business in Mexico beyond where it has been this year. So in those areas, we do expect some significant increases, hopefully.

Ian Gilson, Granite Financial Group.

How much of the business was FOB Hong Kong in the quarter? And we are coming up to the Chinese New Year, which I think is a little earlier this year. Do we expect to have enough workers coming back after the Chinese New Year to fulfill commitment?

Let me address your Chinese New Year issue. Chinese New Year is coming up by February 9; actually, it's only a couple of days away. Normally, during Chinese New Year, most of the factories in southern China shut down for about 2 weeks to allow the workers to go back to their hometown to celebrate Chinese New Year. Whether they come back or not, that is a question that many, many people wonder. I look at it historically, most of these workers did come back to the factory and continue to work in the factory.

However, as most of us know, in the past season, southern China, which has been the major manufacturing base in the past 15 to 20 years, has a shortage of about 2.2 million workers. And most people wonder, why was there 2.2 million shortage when China has 1.3 billion people. But I think that has a lot to do with the fact that the Chinese economic development has really allowed the people in the (indiscernible) who have additional living without coming to the factory and also has a better opportunity for them. And also in the past 10 years, the salary in southern China have not increased substantially, in line with inflation. All these factors contributing to shortage of workers. And one of the things that we plan to do this year is that we inform our customer in detail much earlier and try to get the company much earlier to start production; hopefully 2 months ahead of time instead of waiting until last minute. So that is on your Chinese New Year question.

With respect to the second question, the first question, FOB Hong Kong, our third quarter FOB was $7 million.

7 million?

Yes.

(OPERATOR INSTRUCTIONS). Ethan Sharp (ph), a private investor.

Hi, congratulations on a great quarter, much improved balance sheet. How was retail sell-through of both the karaoke machines and the music during the last quarter of the holiday season?

I think it was a little bit mixed. With some clients and some customers, we had terrific sell-through, and with some others -- actually, some of the larger people that usually are the more traditional people in selling this type of equipment, sales have been -- sell-through hasn't been as good as they expected. But we do not expect any great fallback on that to -- as far as our supplies to them are concerned. And so far, I can say that we have actually received turns which are trailing last year quite a bit, which is encouraging.

So do you have a number for the total amount of returns yet, or not?

No, because they traditionally will come in more also now in February and up to March. But I can say that, compared to last year, definitely the returns have been substantially less.

Ethan, to give you a specific number here and also the roughly estimate is the return so far to this point. After this point, it's probably 10 percent against our total reserve. We expect to have more over the next few weeks. And so far, the number looks pretty good.

We certainly have accounted, I would say, conservatively this year.

Okay, so there weren't that many retail -- mostly, the couple of big retailers that had excess inventory after the holidays?

Some of them have had, yes. I think they also maybe missed a little bit the way they marketed their products this year. We have no control, but clearly, you have to understand that any retailer, especially the large chains who are very much dependent on Christmas sales, could be as objective as possible. Let's put it this way -- they have to have three lines (ph) -- A, D and C, okay? The A line is where the hottest items are being sold right now. A couple years ago, karaoke was there. Today, karaoke is not as hot as it was and is not as important. This last year it was (indiscernible); this year, it was iPods and iPod-related products. These things shift over which we have no control. And, needless to say, the companies decided what products to put where. But as far as our products are concerned, we have not experienced any adverse effect. Rather, there may be not having gotten real results selling the merchandise through as well as they should have. But that is par for the course; there is no way we can control those issues.

Regarding inventory backup in the ports, will you have inventory coming in this fourth quarter that was backed up to the ports? Does, you know, that add the inventory on the balance sheet from what it is at the end of the third quarter?

No. Actually, what happened was the backup in the port caused some delay on our shipping to the retailer. As a result of that, I think (indiscernible) traditionally, for example, some retailer will get 2 turns. During the holiday season, we might only get 1 or 1.5 turns in the selling cycle, which impact our land mail. But that so far, all the inventory that we have at least (indiscernible) been accounted for in our partnership with exceptional return that historical are (indiscernible) our business.

And I would think that -- I would like to (indiscernible) now is that strategically, and indeed, for the past season, what we have done is we intentionally sell short to some of the customer. We also intentionally did not purchase as much inventory as we would have originally due to our liquidity situation and due to our cash flow as well as our anticipation. And these contribute to our (indiscernible) decrease.

Okay, thanks. Regarding the nontraditional karaoke distributors, you indicated that some of the unsuccessful in selling karaoke machines. Can you give us some examples of who those might be, who those are?

Ethan, I think we would like to (indiscernible) would like to keep this customer confidential because we do not want our competitor to call him tomorrow.

Sure, that's understandable. And regarding on the balance sheet -- actually -- on the expenses, increased commissions -- I assume that means increased sales of the karaoke music?

Actually, Steve (ph), is not exactly the situation. Let me give you what we have been going on there. Last year, actually, 2003, in the December 2003 timeframe, we entered into distribution agreement with one broaders (ph) one division of one broaders. And there is that they are distributing our product (indiscernible) to the different customer retail. We do not have access to (indiscernible). We have to pay more commission to them. And basically, the cost of goods sold remains the same thing, but the commission goes up because we have to pay one brother (ph) extra money to distribute our products.

Okay, but did karaoke music then stay the same or go down, in terms of distribution?

So far, the numbers we have is that the karaoke music was below expectations. And that's one, really, J. Bauer mentioned before. This is the area we need to focus on and make sure we should maximize that distribution as well as our music labeling (ph) moving forward.

We have been reviewing all our options here as we go forward, but all I can say is that we have, finally, a clean slate for the music and of the business, which understands the music, which understands how to market it properly, how to put the things together. And so from that point of view, this has been long in coming. And clearly, I am saying that I've been disappointed, we have been disappointed, so far.

But I do believe that this is going to be a turnaround year here, and that we hopefully will improve this segment of our business for the coming year.

Okay. How is the music selling at retail? Is it doing decently?

Well, I think the music sales in retail in the U.S., similar to our hardware story in eBay (ph), boils down to its placement, promotion and also bundling and price. In some of the retail did well with our music, some did not, because of the 4 factors I just mentioned.

Steve Springer with Target Capital.

I have one last question. It's partly an observation and partly a question. It is clear, J., that you have brought in new people into the company. The balance sheet has been dramatically improved, the expenses have been dramatically reduced, the product strategy has been altered to go more high-end, to exit the lower price points. You're introducing some newer products to get away from the dependence on the -- complete dependence on the karaoke market. You're continuing to expand internationally, and you have also indicated that in your introduction to the call that the accounting metrics that have been put in place -- the practices, the best practices that have been put in place -- have resulted in more rapid reporting, more transparency to shareholders.

All of this is really a dramatic change from what had been going on before and which resulted in the stock price plummeting down to the levels that it reached. So I really -- I think it's a dramatic change, and I am wondering, can you give any guidance going forward or any ideas to what you expect to happen in terms of the topline and the bottom line in the coming fiscal year?

Steve, following our credo, we are not going to give any forward-looking information. We will have a report as things develop in a fashion to the shareholders and during our next conference call, and certainly give an update on everything is happening. I thank you certainly for your comments because they are encouraging and we have put together a wonderful team right now and I think we're all on the same page. All I can say is that certainly, certainly, we have laid the foundation for the company to move forward to expand our product line, which will take time. And it's not going to be happening overnight. But it certainly is reflective that what we're doing is bearing fruit, and I do hope that with the market staying where it is right now and hopefully improving, we will benefit from that. And the company should benefit as we go forward. And we are all greatly encouraged, and we think, of course, all our suppliers, our shareholders (technical difficulty) who have been patient with us, including, of course, especially you. And we thank you for all this confidence. And we have -- I have to thank not just my immediate team around me, but all our employees and our office in Hong Kong, where everybody has done really a fantastic job. It is certainly not a one-man job; it has been working together, getting people on the same page and moving forward. And I'm greatly encouraged that we have a team in place that will hopefully catapult us to next level.

Steve, I want to add to what J. has just said. Even though we're going to stick to our policy and not make any forecast and give guidance, however, we are committed to information transparency and shareholder value. What I mean is, as soon as we have information, we want to release it out to the market and let investors digest and make their own decisions.

Gentlemen, at this time, there are no further questions.

Well, thank you very much. Thank you, all of the participants. And we look forward to staying in touch with you. And always feel free, if you have any questions, we are always available; give us a call. And thanks for your help and your confidence, and we look forward to another good season.

Thank you very much.

Thank you very much.

Ladies and gentlemen, that does conclude the conference call today. We thank you for your participation and ask that you please disconnect your lines.