Algorhythm Holdings, Inc.: Form 10-K for the period ended Mar 31, 2022

OVERVIEW

We are primarily engaged in the development, marketing, and sale of consumer karaoke audio equipment, accessories and musical recordings.

We are the leading global karaoke and music entertainment company that specializes in the design and production of quality karaoke and music enabled consumer products for adults and children. Our products are among the most widely available karaoke products in the world. Our mission is to “create joy through music.” In order to deliver on this mission, we are focused on the following multi-prong approach:

• In the short-term, improve profitability by optimizing operations and continue to expand gross margins.
• In the mid-to-long-term, continue to grow our global distribution and expand into new product categories that take advantage of our vast distribution relationships and sourcing abilities.

Our Product Portfolio

Our products are sold directly to distributors and retail customers. Our portfolio of owned and licensed brands and products are organized into the following categories:

Karaoke— including our flagship brand Singing Machine, our karaoke line is driven by quality products at affordable price points that we believe deliver great value to our customers. All of our karaoke products are Bluetooth® enabled to allow access to digital music content via our mobile apps available on iOS and Android platforms. We believe our core karaoke line offers best-in-class innovative features that, including but not limited to enables customers to output video to a TV screen, correct singer’s pitch in real-time, stream karaoke content directly to the machine, sing duets, display scrolling lyrics in-time with the song, and play custom karaoke CD+G discs. The Company’s products are sold directly to consumers via its retail channels, ecommerce, its own website, and distributors worldwide. This product category accounted for approximately 82% of our net sales in our fiscal year ended March 31, 2022.

Licensed Products— including brands such as Carpool Karaoke. In 2019, we entered into a 3-year license agreement with CBS® for its Carpool Karaoke brand, made popular by James Corden on The Late Show with James Corden. We launched an innovative Carpool Karaoke Microphone that works specifically in the car. This license agreement with CBS® expires on September 30, 2022. We are actively exploring renewing the license agreement and exploring new licensing opportunities. This product category accounted for approximately 3% of our net sales in our fiscal year ended March 31, 2022.

Microphones and Accessories— we currently offer a line of traditional microphone accessories that are compatible with our karaoke machines. These microphones feature an assortment of colors, come wired or wireless, and may include new features like party lighting and voice changing effects. We are also seeing growth in portable Bluetooth® microphones which are marketed under our Party Machine brand. This product category accounted for approximately 9% of our net sales in our fiscal year ended March 31, 2022.

Singing Machine Kids Youth Electronics— including the brand Singing Machine Kids. Our kids line of products offer fun music entertainment features designed specifically for children. Our kids’ products provide a high-quality introduction to singing and music entertainment for young singers and offer innovative features like voice changing effects, recording, Bluetooth® compatibility, and portability. This product category accounted for approximately 5% of our net sales in our fiscal year ended March 31, 2022.

Music Subscriptions— in conjunction with our premium partner, Stingray Digital, we offer karaoke music subscription services for the iOS and Android platforms as well as a web-based download store and integrated streaming services for our hardware. We currently offer almost 20,000 licensed karaoke songs in the catalog. This product category accounted for approximately 1% of our net sales in our fiscal year ended March 31, 2022.

Product Development and Design

Product development is a key element of our strategic growth plan. We strive to deliver many new, exciting consumer products to market every single year to retain our presence as the market-leader in consumer karaoke products. Strategic product development is done in-house from our corporate headquarters in Fort Lauderdale, FL where we identify new potential categories, features, and price points. Products are created in conjunction with contract product designers and inventors in collaboration with our contract manufacturers in China to deliver products that represent tremendous value to our customers. In addition to new products, we always look for ways to improve existing products to hit more affordable price points or improve features based upon market feedback.

Business Segments

We operate in one principal industry segment across geographically diverse marketplaces, selling our products globally to large, national retailers as well as independent retailers, on our retailer’s websites, and our own direct to consumer website. In North America, our customers include Amazon, Costco, Sam’s Club, Target and Wal-Mart. Our largest international territories are the U.K. and Australia, where we sell through international distributors, representatives. We also sell to select international retail customers in geographic locations where we do not have a direct sales presence.

Suppliers and Manufacturing

We source our products from a variety of contract manufacturers in southern China. We are not dependent on any one supplier as we use many manufacturers (currently over 5) to make our products. We maintain a Hong Kong office that provides us with factory management, sourcing, quality control, engineering, and product development. We buy finished goods from our suppliers and generally do not source raw materials for manufacturing, however in limited circumstances where we develop proprietary hardware and software, we will secure the proprietary circuits and provide to our contract manufacturers for assembly into the final product. While we are not responsible for sourcing raw materials, we rely on our contract manufacturers’ ability to secure injected plastic, wood cabinets, integrated circuits, display panels, speaker drivers, and other components that are necessary for assembly into our final products.

Our goods are produced by our contract manufacturers and are either shipped via ocean vessels to our distribution center in Ontario, California or we utilize a direct import program where our retail customers coordinate to pick up the goods FOB China. The direct import program allows our customers to take advantage of better ocean container rates through bigger volume and allows us to bypass our California warehouse. We maintain a third-party logistics warehouse in Canada where we sell directly to retail customers and independent channels in Canada. Historically, most of our customers pick up goods from our warehouse (freight collect).

Sales and Marketing

Our products are marketed and sold through our direct sales team, working in conjunction with independent sales representatives that provide sales and customer support for our retail customers in North America. Sales are recognized upon transfer of title to our customers and are made utilizing standard credit terms of approximately 60-90 days. Our sales terms indicate that we only accept returns for defective merchandise, however we have accepted overstock returns from our retail partners in the past. Please see risk factor titled “*We are subject to the risk that some of our large customers may return karaoke products that they have purchased from us and if this happens, it would reduce our revenues and profitability” under “*Risk Factors”.

We seek to expand our direct-to-consumer sales, which we believe will increase overall gross margins and also increase brand awareness.

Marketing, promotion and consumer engagement are key elements in the youth electronics, toy, and music categories. Historically, a significant percentage of our promotional spending has been structured as co-op promotion incentives with our large retail partners. We continue to focus our marketing efforts on growing brand awareness among our target consumer demographic, optimizing marketing investments, and executing an integrated marketing strategy. We believe an important component of our future growth is based on speaking to the right customer, with the right content, in the right channel, at the right time. We have implemented online marketing, social media, and digital analytics tools, which allow us to better measure the performance of our marketing activities, learn from our consumers, and receive valuable insights into industry and competitor activities.

Customer service is a critical component of our marketing strategy. We maintain a U.S.-based internal customer service department within our corporate headquarters that responds to customer inquiries, investigates and resolves issues, and is available to assist customers and consumers during business hours.

Competition

The youth electronics, toy, and music industry has many participants, none of which has dominant market share, though certain companies may have disproportionate strength in specific product categories. We compete with a number of different companies in a variety of categories, although there is no single company that competes with us across all of our product categories. Our largest direct competitors are Singsation®, Singtrix®, eKids®, Bonaok, Karaoke USA™, and Ion® Audio.

The primary method of competition in the industry consists of brand positioning, product innovation, quality, price, and timely distribution. Our competitive strengths include our ability to develop innovative new products, speed to market, our relationships with major retailers, and the quality and pricing of our products.

Intellectual Property

We rely on a combination of word and design mark trademarks and trade secrets to protect our intellectual property. In certain circumstances, we will partner with third parties to develop proprietary products, and, where appropriate, we have license agreements related to the use of third-party innovation in our products. The duration of our trademark registrations varies from country to country. However, trademarks are generally valid and may be renewed indefinitely as long as they are in use and/or their registrations are properly maintained.

Customers

Sales to our top five customers together comprised approximately 90% of our net sales in both fiscal years ended March 31, 2022 and March 31, 2021. In our fiscal year ended March 31, 2022, revenues from three of these customers represented greater than 10% of net sales at a percentage of 37%, 18%, and 17% of total net sales. In our fiscal year ended March 31, 2021, revenues from four of these customers represented greater than 10% of net sales at a percentage of 36%, 20%, 13% and 12% of total net sales.

We have no long-term contracts with these customers, and as a result, our success depends heavily on our customers’ willingness to purchase and provide shelf space for our products.

Seasonality

We do experience heightened seasonal demand for our products in our second and third quarters of our fiscal year. In our fiscal year ended March 31, 2022 and our fiscal year ended March 31, 2021, approximately 81% and 86%, respectively, of our net sales shipped in our second and third quarters. However, we continually look for products and new categories to reduce our exposure to seasonality variances.

Regulatory Matters

Each of our products is designed to comply with all applicable mandatory and voluntary safety standards. In the United States, these safety standards are promulgated by federal, state and independent agencies such as the US Consumer Product Safety Commission, ASTM, the Federal Communications Commission, the Food and Drug Administration, the Federal Trade Commission, and various states Attorney Generals and state regulatory agencies. All of our products are independently tested by third party laboratories accepted by the Consumer Product Safety Commission to verify compliance to applicable safety standards. A similar approach is used to design and test products sold internationally.

Insurance

We carry product liability insurance that provides us with $10,000,000 coverage with a minimal deductible. We consult with our insurers to ascertain appropriate liability coverage for our product mix. We believe our current coverage is adequate for our existing business and will continue to evaluate our coverage in the future in line with our expanding sales and product breadth.

Human Capital Resources

We believe that the development, attraction and retention of employees is an important factor to our Company’s success. We offer our employees a wide range of benefits, including 100% paid health benefits for the employee, generous leave, vacation, and personal paid time-off, 12 paid company holidays a year, and flexible work hours to work-from-home. To support the advancement of our employees, we offer training and development programs encouraging advancement from within. As of the filing of this report, we had 32 employees, 17 of which are located at our corporate office and 15 at our logistics center in Ontario, California. During peak shipping season, (July through December), we rely heavily on temporary labor at our logistics warehouse to handle the increased shipment volume.

Environmental Issues

We may be subject to legal and financial obligations under environmental, health and safety laws in the United States and in other jurisdictions where we operate. We are not currently aware of any material environmental liabilities associated with any of our operations.

Recent Developments

Controlled Company

Subsequent to March 31, 2022, and as of the date of this report, Digital Power Lending, LLC (“Digital Power Lending”) beneficially owns and BitNile Holdings, Inc. (“BitNile Holdings”) and Milton C. Ault, III (“Ault,” and collectively with Digital Power Lending and BitNile Holdings, “BitNile”) may be deemed to beneficially own an aggregate of 1,568,849 shares of our common stock or approximately 52.0% of our outstanding shares. Digital Power Lending is a wholly owned subsidiary of BitNile Holdings. Mr. Ault is the Executive Chairman of BitNile Holdings.

As longs as BitNile continues to hold more than 50% of the voting power of our Company, we will be a “controlled company” as defined under Nasdaq Marketplace Rules.

For so long as we are a controlled company under Nasdaq Marketplace Rules, we are permitted to elect to rely on certain exemptions from corporate governance rules, including:

• an exemption from the rule that a majority of our board of directors must be independent directors;
• an exemption from the rule that the compensation of our CEO must be determined or recommended solely by independent directors; and
• an exemption from the rule that our director nominees must be selected or recommended solely by independent directors.

BitNile has indicated that it intends to appoint two directors to our Board of Directors. Upon the appointment of the BitNile nominees, our Board of Directors will increase in size to seven directors, of which less than a majority will be “independent” as defined under Nasdaq Marketplace Rules.

Reverse Stock Split and Nasdaq Listing

On May 23, 2022, the Company effected a reverse stock split of its shares of common stock in a ratio of 1:30. The reverse stock split was affected to meet The Nasdaq Capital Market’s minimum bid price requirement. All information in this Annual Report on Form 10-K has been retroactively adjusted to give effect to this 1-for-30 reverse stock split.

Our common stock was approved for listing on the Nasdaq Capital Market under the symbol “MICS” and began trading on the Nasdaq Capital Market on May 24, 2022.

Public Offering

On May 23, 2022, we consummated a public offering of 1,000,000 shares of our common stock for gross proceeds of $4.0 million prior to deducting underwriting discounts and commissions and other estimated offering expenses of approximately $0.7 million. The offering closed on May 26, 2022. As compensation, we issued to the underwriter in the public offering warrants to purchase up to 100,000 shares of our common stock. The warrants are exercisable six months from the commencement of sales under the public offering, have an exercise price of $5.00 per share and expire five years from the date of issuance.

Stock Redemption Agreement

Prior to August 10, 2021, the Company was partially held by koncepts International Limited (“koncepts”) which was a major shareholder of the Company that owned approximately 49% of our shares of common stock outstanding on a fully diluted basis as of March 31, 2021. The Company was also partly held by Treasure Green Holdings Ltd. (“Treasure Green) which owned approximately 2% of our common stock. In total approximately 51% of the Company’s shares of common stock on a fully diluted basis as of March 31, 2021 were previously owned by koncepts and Treasure Green. koncepts and Treasure Green are owned by Fairy King Prawn Holdings Limited (“Fairy King”), an investment holding company incorporated in the British Virgin Islands, principally owned by the Company’s then Chairman, Philip Lau.

On August 5, 2021, the Company entered into a stock redemption agreement (the “Redemption Agreement”) with koncepts and Treasure Green, pursuant to which the Company redeemed 654,105 shares of common stock of the Company (the “Redeemed Shares”). The closing of the transaction set forth in the Redemption Agreement took place on August 10, 2021, at which time the Redeemed Shares were assigned and transferred back to the Company in consideration of a payment by the Company of approximately $7,162,000 to koncepts and Treasure Green. The Redeemed Shares were retired and returned to the unissued authorized capital of the Company.

Prior to August 10, 2021, we did business with a number of entities that are principally owned by the Company’s former Chairman, Philip Lau, including Starlight R&D Ltd (“SLRD”), Starlight Consumer Electronics USA, Inc., (“SCE”), Cosmo Communications Corporation of Canada, Inc. (“Cosmo”), Winglight Pacific, Ltd (“Winglight”) and Starlight Electronics Company Ltd (“SLE”), among others.

Pursuant to the Redemption Agreement, neither koncepts nor Treasure Green remained shareholders of the Company and SLRD, SCE, Cosmo, Winglight and SLE are no longer related parties.

Available Information

The Company is incorporated under the laws of the State of Delaware and was formed in 1994. Our common stock is traded on the NASDAQ Capital Market under the symbol “MICS”. Our principal executive offices are located at 6301 NW 5th Way, Suite 2900, Fort Lauderdale, FL, and our telephone number is (954) 596-1000. We maintain our corporate website at www.singingmachine.com (http://www.singingmachine.com). Our website also includes corporate governance information, including our Code of Ethics and our Board committee charters. The information contained on our website does not constitute a part of this report.

We file reports with the Securities and Exchange Commission (“SEC”), including an annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports that we file with, or furnish to, the SEC. The SEC maintains an Internet website, www.sec.gov (http://www.sec.gov), that contains reports, proxy and information statements and other information that we file electronically with the SEC.

Set forth below and elsewhere in this Annual Report on Form 10-K and in the other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Annual Report.

RISKS ASSOCIATED WITH OUR BUSINESS

THE COVID-19 PANDEMIC HAS AFFECTED OUR BUSINESS IN MANY DIFFERENT WAYS, AND MAY AMPLIFY THE RISKS AND UNCERTAINTIES FACING OUR BUSINESS WHICH MAY IMPACT OUR BUSINESS AND FINANCIAL RESULTS.

The COVID-19 pandemic has significantly affected U.S. consumer shopping patterns and caused the health of the U.S. and world economy to deteriorate in fiscal year 2022. During our fiscal year ended March 31, 2022, demand for consumer electronics products including home based entertainment and toys remained strong. However, late delivery of key products for the holiday season due to global logistics issues resulted in lost sales and an increase in inventory of approximately $5.5 million greater than planned at the end of our fiscal year ended March 31, 2022. While many of the restrictions and measures initially implemented in response to the pandemic have since been softened or lifted in varying degrees in different locations around the world, and the manufacture and distribution of COVID-19 vaccines during calendar year 2021 and 2022 helped to initiate a recovery from the pandemic, the uncertainty regarding existing and new potential variants of COVID-19 and the success of any vaccines in respect thereof, may in the future cause a reduction in global economic activity or prompt, the re-imposition of certain restrictions and measures. In addition, even if not required by governmental authorities, increases in COVID-19 cases, such as if a new variant emerges, may result in significantly reduced economic activity, which could impact our business and our financial results.

OUR SUPPLY CHAIN MAY BE MATERIALLY ADVERSELY IMPACTED BY THE WORLDWIDE FINANCIAL MARKETS AND GLOBAL EVENTS

We rely upon the facilities of our third-party manufacturers in China to manufacture our products and export our products throughout the world. The COVID-19 pandemic has resulted in significant governmental measures being implemented to control the spread of COVID-19, including, among others, restrictions on manufacturing and the movement of employees in many regions of China during our fiscal year ended March 31, 2021 and continuing into fiscal 2022. In late calendar 2021, the increased demand for consumer electronics products and current economic recovery continued to increase worldwide demand for products using semiconductor “chip” components in the production of most consumer electronics which has resulted in an international shortage of chips available to fulfill demand. As a result, we have experienced longer delivery lead times and some unavailability of these components which have delayed delivery of some of our products. We have also experienced delays in delivery schedules due to new outbreaks of COVID-19 in Southern China that have forced temporary closures of some key shipping ports. The port closures have also led to a temporary shortage of shipping containers which have resulted in significant price increases due to increased demand. While we have seen the easing of COVID-19 restrictions and the impact on our business, we cannot predict the impact of the resurgence of variants of COVID-19 and other factors affecting local and global economies, specifically China.

OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS MAY BE MATERIALLY ADVERSELY AFFECTED BY ANY NEGATIVE IMPACT ON THE GLOBAL ECONOMY AND CAPITAL MARKETS RESULTING FROM THE CONFLICT IN UKRAINE OR ANY OTHER GEOPOLITICAL TENSIONS.

U.S. and global markets are experiencing volatility and disruption following the escalation of geopolitical tensions and the start of the military conflict between Russia and Ukraine. On February 24, 2022, a full-scale military invasion of Ukraine by Russian troops was reported. Although the length and impact of the ongoing military conflict is highly unpredictable, the conflict in Ukraine could lead to market disruptions, including significant volatility in credit and capital markets.

Additionally, Russia’s military interventions in Ukraine have led to sanctions and other penalties being levied by the U.S., European Union and other countries against Russia. Additional potential sanctions and penalties have also been proposed and/or threatened. Russian military actions and the resulting sanctions could adversely affect the global economy and financial markets. In addition, the invasion of Ukraine and the resulting sanctions imposed on Russia have resulted in increased volatility in the financial markets and the markets for certain commodities including oil, which may significantly impact the manufacturers that we rely on, but is not expected to have any direct impact on us.

While the Company has not experienced any direct impact from the conflict in the Ukraine, the extent and duration of the military action, sanctions and resulting market disruptions are impossible to predict, but could be substantial and could adversely affect our operating results as they impact the global economy in the future.

CHANGES IN GOVERNMENT REGULATIONS RELATING TO INTERNATIONAL TARIFFS COULD SIGNIFICANTLY REDUCE OUR REVENUES, PRODUCT COST AND PROFITABILITY.

U.S. government administration and members of the U.S. Congress have made public statements indicating possible significant changes in U.S. trade policy and have taken certain actions that may impact U.S. trade, including imposing tariffs on certain goods imported into the United States. Any changes in U.S. trade policy could trigger retaliatory actions by affected countries, resulting in “trade wars,” and increased costs for goods imported into the United States. All of our products are manufactured and imported from China. However, only our microphone products are currently subject to 7.5% tariffs currently in place. Should the government decide to expand its list of products to include our karaoke products that would subject our products to tariffs in the future, there could be a significant increase in the landed cost of our products. If we are unable to mitigate these increased costs through price increases we could experience reductions in revenues, gross profit margin and results from operations.

A SMALL NUMBER OF OUR CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR REVENUES, AND THE LOSS OF ONE OR MORE OF THESE KEY CUSTOMERS COULD SIGNIFICANTLY REDUCE OUR REVENUES AND CASH FLOW.

We rely on a few large customers to provide a substantial portion of our revenues. Sales to the Company’s top five customers together comprised approximately 90% of our net sales for both of our fiscal years ended March 31, 2022 and 2021. In our fiscal year ended March 31, 2022, revenues from three of these customers represented greater than 10% of net sales at a percentage of 37%, 18%, and 17% of total net sales. In our fiscal year ended March 31, 2021, revenues from four of these customers represented greater than 10% of net sales at a percentage of 36%, 20%, 13% and 12% of total net sales. We do not have long-term contractual arrangements with any of our customers and they can cancel their orders at any time prior to delivery. A substantial reduction in or termination of orders from any of our largest customers would decrease our revenues and cash flow.

WE ARE SUBJECT TO THE RISK THAT SOME OF OUR LARGE CUSTOMERS MAY RETURN KARAOKE PRODUCTS THAT THEY HAVE PURCHASED FROM US AND IF THIS HAPPENS, IT WOULD REDUCE OUR REVENUES AND PROFITABILITY.

In our fiscal years ended March 31, 2022 and 2021, a number of our customers and distributors returned karaoke products that they had purchased from us. Our customers returned goods valued at approximately $3.6 million or 7.5% of our net sales in our fiscal year ended March 31, 2022 and approximately $4.1 million or 9.1% of our net sales in our fiscal year ended March 31, 2021. The return of products is due to a variety of reasons including defective units, customers’ overstock and buyer’s remorse. The primary reason for the 1.6 percentage point decrease in returns was due to a decrease in overstock returns from our major customers. Our factories charge customary repair and freight costs which increase our expenses and reduce profitability. If any of our customers were to increase the volume of their returned karaoke products to us, it would reduce our revenues and profitability.

WE ARE SUBJECT TO PRESSURE FROM OUR CUSTOMERS RELATING TO PRICE REDUCTION AND FINANCIAL INCENTIVES AND IF WE ARE PRESSURED TO MAKE THESE CONCESSIONS TO OUR CUSTOMERS, IT WILL REDUCE OUR REVENUES AND PROFITABILITY.

Because there is intense competition in the karaoke industry, we are subject to pricing pressure from our customers. Many of our customers have demanded that we lower our prices and threatened to buy our competitor’s products. If we do not meet our customer’s demands to lower our regular prices, we will not sell as many karaoke products. We are also subject to pressure from our customers regarding certain financial incentives, such as return credits or large cooperative (“co-op”) promotion incentives, which effectively reduce our net sales and profit. We gave co-op promotion incentives of approximately $1.7 million during our fiscal year ended March 31, 2022 and $2.0 million during our fiscal year ended March 31, 2021. We have historically offered co-op promotion incentives to our customers because it is standard practice in the retail industry.

WE EXPERIENCE DIFFICULTY FORECASTING THE DEMAND FOR OUR KARAOKE PRODUCTS AND IF WE DO NOT ACCURATELY FORECAST DEMAND, OUR REVENUES, NET INCOME AND CASH FLOW MAY BE AFFECTED.

Because of our reliance on manufacturers in China for our machine production, our production lead times range from one to four months. Therefore, we must commit to production in advance of customers’ orders. It is difficult to forecast customer demand because we do not have any scientific or quantitative method to predict this demand. Our forecasting is based on management’s general expectations about customer demand, the general strength of the retail market and management’s historical experiences. In past years we have overestimated demand for our products which led to excess inventory in some of our products and caused liquidity problems that adversely affected our revenues, net income and cash flow.

WE ARE SUBJECT TO THE COSTS AND RISKS OF CARRYING INVENTORY FOR OUR CUSTOMERS AND IF WE HAVE TOO MUCH INVENTORY, IT WILL AFFECT OUR CASH FLOW FOR OPERATIONS.

Many of our customers place orders with us several months prior to the holiday season, but they schedule delivery two or three weeks before the holiday season begins. As such, we are subject to the risks and costs of carrying inventory during the time period between the placement of the order and the delivery date, which reduces our cash flow. As of March 31, 2022 we had approximately $14.2 million in inventory as compared to $5.5 million in inventory as of March 31, 2021. The primary reasons for the increase in inventory is due to late delivery of key products for the holiday season due to global logistics issues resulting in lost sales and an increase in inventory as of March 31, 2022 of approximately $5.5 million with the remaining increase due to new product received and in-transit for a program with one major customer. If we are unable to sell this inventory during fiscal 2023 at historical or greater margins, our cash flow for operations will be negatively impacted.

WE ARE SUBJECT TO INSURANCE RISK OF LOSS FOR GOODS DAMAGED WHILE IN TRANSIT FROM THE MANUFACTURER TO THE CUSTOMER AND OUR WAREHOUSE.

All of our goods are manufactured in China and are transported to customers and our warehouse in California via ocean vessel. As such, we are subject to damages that may occur to these goods when they are in transit to customers or our warehouse. Should substantial damage incur while goods are in transit, we could experience a significant loss of revenue, inventory and incur significant out of pocket expenses associated with destruction of the damaged goods, which could cause a significant loss from operations and reduction in cash flow. During our fiscal year ended March 31, 2020, a major customer received goods that were significantly water damaged due to excess moisture absorbed in pallets shipped by the factory resulting in a loss of approximately $2.4 million. We recovered approximately $2.3 million from our cargo insurance coverage during our fiscal year ended March 31, 2021. During our fiscal years ended March 31, 2022 and 2021 we also secured vendor invoice credits of approximately $0.3 million and $0.4 million, respectively, from the factory and factory’s representative that caused the damage. While we have taken measures to prevent a similar incident in the future, there can be no guarantee that this type of damage or other types of damage could occur in the future. Due the size of the claim, we have obtained insurance coverage for goods that are shipped direct import to our customers whose shipping terms are FOB shipping point and for goods in transit to our California warehouse however, certain exclusions have been added that may prevent insurance coverage of this type of incident in the future.

OUR BUSINESS IS SEASONAL AND THEREFORE OUR ANNUAL OPERATING RESULTS WILL DEPEND, IN LARGE PART, ON OUR SALES DURING THE RELATIVELY BRIEF HOLIDAY SEASON.

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 our second fiscal quarter ending September 30 and our third fiscal quarter ending December 31. Sales in our second and third quarter, combined, accounted for approximately 81% and 86% of net sales in our fiscal years ended March 31, 2022 and, 2021, respectively.

IF WE ARE UNABLE TO COMPETE IN THE KARAOKE PRODUCTS CATEGORY, OUR REVENUES AND NET PROFITABILITY WILL BE REDUCED.

Our major competitors for karaoke machines and related products are Singsation®, Singtrix®, eKids®, Bonaok, Karaoke USA™, Ion® Audio, licensed property karaoke products and other consumer electronics companies. We believe that competition for karaoke machines is based primarily on price, product features, reputation, delivery times, and customer support. To the extent that we lower prices to attempt to enhance or retain market share, we may adversely impact our operating margins. Conversely, if we opt not to match competitor’s price reductions we may lose market share, resulting in decreased volume and revenue. To the extent our leading competitors reduce prices on their karaoke machines, we must remain flexible to reduce our prices. If we are forced to reduce our prices, it will result in lower margins and reduced profitability. Because of intense competition in the karaoke industry in the United States during our fiscal year ended March 31, 2022, we expect that the intense pricing pressure in the low end of the market will continue in the karaoke market in the United States in our fiscal year ending March 31, 2023. In addition, we must compete with all the other existing forms of entertainment including, but not limited to: motion pictures, video arcade games, home video games, theme parks, nightclubs, television, prerecorded tapes, CD’s, and DVD’s and streaming video.

IF WE ARE UNABLE TO DEVELOP NEW KARAOKE PRODUCTS, OUR REVENUES MAY NOT CONTINUE TO GROW.

The karaoke industry is characterized by rapid technological change, frequent new product introductions and enhancements and ongoing customer demands for greater performance. In addition, the average selling price of any karaoke machine has historically decreased over its life, and we expect that trend to continue. As a result, our products may not be competitive if we fail to introduce new products or product enhancements that meet evolving customer demands. The development of new products is complex, and we may not be able to complete development in a timely manner. To introduce products on a timely basis, we must:

• accurately define and design new products to meet market demand;
• design features that continue to differentiate our products from those of our competitors;
• transition our products to new manufacturing process technologies;
• identify emerging technological trends in our target markets;
• anticipate changes in end-user preferences with respect to our customers’ products;
• bring products to market on a timely basis at competitive prices; and
• respond effectively to technological changes or product announcements by others.

We believe that we will need to continue to enhance our karaoke machines and develop new machines to keep pace with competitive and technological developments and to achieve market acceptance for our products. At the same time, we need to identify and develop other products which may be different from karaoke machines.

OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD PREVENT OR DELAY OUR CUSTOMERS’ RECEIPT OF INVENTORY.

We rely principally on four contract ocean carriers to ship substantially all of the products that we import to our warehouse facility in Ontario, California. Retailers that take delivery of our products in China rely on a variety of carriers to import those products. Any disruptions in shipping, whether in California or China, caused by labor strikes, other labor disputes, terrorism, and international incidents may prevent or delay our customers’ receipt of inventory. If our customers do not receive their inventory on a timely basis, they may cancel their orders or return products to us. Consequently, our revenues and net income would be reduced and our results of operations adversely affected.

OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE’S REPUBLIC OF CHINA, SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS. IF THERE IS ANY PROBLEM WITH THE MANUFACTURING PROCESS, OUR REVENUES AND NET PROFITABILITY MAY BE REDUCED.

We currently use five factories in China to manufacture all of our karaoke products. Our arrangements with these factories are subject to the risks of doing business abroad, such as import duties, trade restrictions, work stoppages, and foreign currency fluctuations, limitations on the repatriation of earnings and political instability, which could have an adverse impact on our business. Furthermore, we have limited control over the manufacturing processes. As a result, any difficulties encountered by our third-party manufacturers that result in product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis could adversely affect our revenues, profitability and cash flow. Also, since we do not have written agreements with any of these factories, we are subject to additional uncertainty if the factories do not deliver products to us on a timely basis.

WE DEPEND ON THIRD PARTY SUPPLIERS FOR PARTS FOR OUR KARAOKE MACHINES AND RELATED PRODUCTS, AND IF WE CANNOT OBTAIN SUPPLIES AS NEEDED, OUR OPERATIONS WILL BE SEVERELY DAMAGED.

Our growth and ability to meet customer demand depends in part on our capability to obtain timely deliveries of karaoke machines and our electronic products. We rely on third party suppliers to produce the parts and materials that are used to manufacture and produce these products. If our suppliers are unable to provide our factories with the parts and supplies, they we will be unable to produce our products. Currently there is a worldwide shortage of electronic chips due to the increased demand for semiconductors and we are currently competing with large companies to obtain these parts and could see production and shipment delays. We cannot guarantee that we will be able to purchase the parts we need at reasonable prices or in a timely fashion. If we are unable to anticipate any shortages of parts and materials in the future, we may experience severe production problems and delivery delays, which would impact our sales.

WE DEPEND ON THE ABILITY OF OUR SUPPLIERS TO MANUFACTURE OUR PRODUCTS WITHOUT INFRINGING, MISAPPROPRIATING OF OTHERWISE VIOLATING THE INTELLECTUAL PROPERTY OF PROPRIETARY RIGHTS OF OTHERS IN MANUFACTURING OUR PRODUCTS.

We source our products from a variety of contract manufacturers. We buy finished goods from our suppliers and generally do not source raw materials and parts for manufacturing and assembly into the final product. We rely on our contract manufacturers’ ability to secure injected plastic, wood cabinets, integrated circuits, display panels, speaker drivers, and other components that are necessary for assembly into our final products. While we are not responsible to source raw materials, we rely on these suppliers to have all required licenses or proprietary rights to the materials that are incorporated into the final product. In addition, we rely on the representations of our contract manufacturers that they are using materials and components that meet all necessary legal, safety, and compliance requirements. If our suppliers do not have the proper licenses or rights or are not in compliance with all regulatory requirements, we may be named a party or be subject to claims, including claims of infringement or violating the intellectual property or proprietary rights of third parties with respect to our products.

CONSUMER DISCRETIONARY SPENDING MAY AFFECT KARAOKE PURCHASES AND IS AFFECTED BY VARIOUS ECONOMIC CONDITIONS AND CHANGES.

Purchases of karaoke machines and music are considered discretionary for consumers. Our success will therefore be influenced by a number of economic factors affecting discretionary and consumer spending, such as employment levels, business, interest rates, and taxation rates, all of which are not under our control. Additionally, other extraordinary events such as terrorist attacks or military engagements, which adversely affect the retail environment may restrict consumer spending and thereby adversely affect our sales growth and profitability.

HIGH INFLATION AND UNFAVORABLE ECONOMIC CONDITIONS COULD NEGATIVELY AFFECT OUR OPERATIONS AND RESULTS.

Unfavorable global or regional economic conditions may be triggered by numerous developments beyond our control, including inflation, geopolitical events, health crises such as the COVID-19 pandemic, and other events that trigger economic volatility on a global or regional basis. Those types of unfavorable economic conditions could adversely affect our business and financial results. In particular, a significant deterioration in economic conditions, including economic slowdowns or recessions, increased unemployment levels, inflationary pressures or disruptions to credit and capital markets, could lead to decreased consumer confidence and consumer spending more generally, thus reducing consumer demand for our products. For example, in 2021 and continuing into 2022, the United States has experienced a rapid increase in inflation levels of over 8.6%, which is now at a 40-year historic high. Such heightened inflationary levels may negatively impact consumer disposable income and discretionary spending and, in turn, reduce consumer demand for our products and increase our costs.

WE ARE EXPOSED TO THE CREDIT RISK OF OUR CUSTOMERS, WHO ARE EXPERIENCING FINANCIAL DIFFICULTIES, AND IF THESE CUSTOMERS ARE UNABLE TO PAY US, OUR REVENUES AND PROFITABILITY WILL BE REDUCED.

We sell products to retailers, including national chains, warehouse clubs, department stores, lifestyle merchants, specialty stores, and direct mail catalogs and showrooms. Deterioration in the financial condition of our customers could result in bad debt expense to us and have a material adverse effect on our revenues and future profitability.

A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTER IN CALIFORNIA COULD IMPACT OUR ABILITY TO DELIVER MERCHANDISE TO OUR CUSTOMERS, WHICH COULD ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY.

A significant amount of our merchandise is shipped to our customers from our warehouse located in Ontario, California. Events such as fire or other catastrophic events, any malfunction or disruption of our centralized information systems or shipping problems may result in delays or disruptions in the timely distribution of merchandise to our customers, which could substantially decrease our revenues and profitability.

WE MAY ENCOUNTER DIFFICULTIES ACCESSING CAPITAL

We currently have an Intercreditor Revolving Credit Facility with Crestmark Bank for a $10.0 million facility (decreasing to $5.0 million in off-peak season) on eligible accounts receivable under an evergreen arrangement that terminates upon written notice by the Company and is subject to a termination fee if terminated by the Company anytime other than the annual renewal date of June 11. We also have a $2.5 million facility on eligible inventory with Iron Horse Credit that was to expire on June 11, 2022. However, absent any termination notice given by the Company to IHC, the current financing arrangement automatically renewed for another twelve-month term and is subject to a termination fee if terminated by the Company prior to the twelve-month renewal date. There can be no assurances that we can obtain any new financing or that we will be able to successfully enter into any arrangements upon terms that are acceptable to the Company in the future. Should there be a disruption in the current levels of these markets or a deterioration of our business, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.

OUR PRODUCTION COSTS MAY INCREASE IF WE ARE REQUIRED TO MAKE PURCHASES USING THE CHINESE YUAN INSTEAD OF THE U.S. DOLLAR.

The majority of our products are currently manufactured in China. During the fiscal year ended March 31, 2022, the Chinese local currency had no material effect on the Company as all of our purchases are denominated in U.S. currency. However, in the event our purchases are required to be made in Chinese local currency, the Yuan, we will be subject to the risks involved in foreign exchange rates. In the future the value of the Yuan may depend to a large extent on the Chinese government’s policies and China’s domestic and international economic and political developments. As a result, our production costs may increase if we are required to make purchases using the Yuan instead of the U.S. dollar and the value of the Yuan increases over time. Any significant increase in the cost of manufacturing our products would have a material adverse effect on our business and results of operations. We sell our product to Canadian customers some of whom require us to invoice them in Canadian Dollars. We are subject to risks involved in the exchange rate between the Canadian and US dollar. However, the exchange rate has been stable during our fiscal year ended March 31, 2022 and the associated exchange rates did not have a material impact on our financial results. Should the exchange rate between the Canadian and US Dollar become more volatile and sales to Canadian customers increase, there could be a material adverse effect on our business.

OUR PROFIT MARGIN MAY BE DECREASED DUE TO INCREASED PRICES OF RAW MATERIALS, SHIPPING COSTS AND COSTS ASSOCIATED WITH PRODUCTION.

Fluctuation in the price of oil, electronic chip components and shipping costs have and will continue to affect the Company in connection with the sourcing and delivery of raw materials and services. We expect to see increased cost in our finished goods during fiscal year 2023 due to the significant increases in the price of oil, rising inflation, increased cost of trans-oceanic shipping, increased drayage costs, electronic component price increases and increases in the cost of labor related to regulations instituted in China which impact wages related to the cost of production. These issues are common to all companies in the same type of business and if the Company is not able to negotiate lower costs, reduce other expenses, or pass on some or all of these price increases to our customers, our profit margin may be decreased.

OUR SUCCESS DEPENDS LARGELY ON THE CONTINUED SERVICES OF OUR SENIOR MANAGEMENT TEAM AND CERTAIN KEY EMPLOYEES.

We rely on our executive officers and key employees in the areas of business strategy, marketing, sales, services, and general and administrative functions. From time to time, there may be changes in our executive management team or key employees resulting from the hiring or departure of executives or key employees, which could disrupt our business. We do not maintain key-man insurance for any member of our senior management team or any other employee. The loss of one or more of our executive officers or key employees could have a serious adverse effect on our business.

WE PRIMARILY RELY ON TRADE SECRET PROTECTION AND NON-DISCLOSURE AGREEMENTS TO PROTECT OUR PROPRIETARY INFORMATION, WHICH MAY NOT BE EFFECTIVE.

We currently rely on trade secret protection and non-disclosure agreements with our employees, consultants and third-parties to protect our confidential and proprietary information. If we do not protect our intellectual property and other confidential information adequately, competitors may be able to use our proprietary technologies and information and thereby erode any competitive advantages they provide us.

We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent these rights are effectively maintained as confidential. We expect to rely primarily on trade secret and contractual protections for our confidential and proprietary information and we have taken security measures we believe are appropriate to protect this information. These measures, however, may not provide adequate protection for our trade secrets, know-how or other confidential information. We seek to protect our proprietary information by, among other things, entering into confidentiality agreements with employees, consultants and other third parties. These confidentiality agreements may not sufficiently safeguard our trade secrets and other confidential information and may not provide adequate remedies in the event of unauthorized use or disclosure of this information. Enforcing a claim that a party illegally disclosed or misappropriated a trade secret or other proprietary information could be difficult, expensive and time-consuming and the outcome could be unpredictable. In addition, trade secrets or other confidential information could otherwise become known or be independently developed by others in a manner that could prevent legal recourse by us. If any of our trade secrets or other confidential or proprietary information were disclosed or misappropriated or if any such information was independently developed by a competitor, our competitive position could be harmed and our business could suffer.

RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE

FUTURE SECURITIES ISSUANCES COULD RESULT IN SIGNIFICANT DILUTION TO OUR STOCKHOLDERS AND IMPAIR THE MARKET PRICE OF OUR COMMON STOCK.

Future issuances of shares of our common stock could depress the market price of our common stock and result in dilution to existing holders of our common stock. Also, to the extent outstanding options and warrants to purchase our shares of our common stock are exercised or options or other equity-based awards are issued or become vested, there will be further dilution. The amount of dilution could be substantial depending upon the size of the issuances or exercises. Furthermore, we may issue additional equity securities that could have rights senior to those of our common stock.

BECAUSE CERTAIN OF OUR STOCKHOLDERS CONTROL A SIGNIFICANT NUMBER OF SHARES OF OUR COMMON STOCK, THEY MAY HAVE EFFECTIVE CONTROL OVER ACTIONS REQUIRING STOCKHOLDER APPROVAL

As of the date of this report, Digital Power Lending beneficially owns and BitNile Holdings and Ault may be deemed to beneficially own an aggregate of 1568,849 shares of our common stock or approximately 52.0% of our outstanding shares. As a result, these stockholders, acting together, have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership might harm the market price of our common stock by:

• delaying, deferring or preventing a change in corporate control;
• impeding a merger, consolidation, takeover or other business combination involving us; or
• discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us.

AS A “CONTROLLED COMPANY” UNDER THE RULES OF THE NASDAQ CAPITAL MARKET, WE MAY CHOOSE TO EXEMPT OUR COMPANY FROM CERTAIN CORPORATE GOVERNANCE REQUIREMENTS THAT COULD HAVE AN ADVERSE EFFECT ON OUR PUBLIC STOCKHOLDERS.

Subsequent to March 31, 2022 and as of the date of this report, Digital Power Lending beneficially owns and BitNile Holdings and Ault may be deemed to beneficially own an aggregate of 1,568,849 shares of our common stock or approximately 52.0% of our outstanding shares. Digital Power Lending is a wholly owned subsidiary of BitNile Holdings. Mr. Ault is the Executive Chairman of Bitnile Holdings.

As long as BitNile continues to hold more than 50% of the voting power of our Company, we will be a “controlled company” as defined under Nasdaq Marketplace Rules.

For so long as we are a controlled company under Nasdaq Marketplace Rules, we are permitted to elect to rely, and may rely, on certain exemptions from corporate governance rules, including:

• an exemption from the rule that a majority of our board of directors must be independent directors;
• an exemption from the rule that the compensation of our CEO must be determined or recommended solely by independent directors; and
• an exemption from the rule that our director nominees must be selected or recommended solely by independent directors.

As a result, you may not have the same protection afforded to stockholders of companies that are subject to these corporate governance requirements.

BitNile has indicated it intends to appoint two directors to our Board of Directors. Upon the appointment of the BitNile nominees, our Board of Directors will increase in size to seven directors, of which less than a majority will be “independent” as defined under Nasdaq Marketplace Rules.

OUR CERTIFICATE OF INCORPORATION ALLOW FOR OUR BOARD OF DIRECTORS TO CREATE NEW SERIES OF PREFERRED STOCK WITHOUT FURTHER APPROVAL BY OUR STOCKHOLDERS, WHICH COULD ADVERSELY AFFECT THE RIGHTS OF THE HOLDERS OF OUR COMMON STOCK.

Our board of directors has the authority to fix and determine the relative rights and preferences of preferred stock. Our board of directors has the authority to issue up to 1,000,000 shares of our preferred stock without further stockholder approval. As a result, our board of directors could authorize the issuance of a series of preferred stock that would grant to holders of preferred stock the right to our assets upon liquidation, or the right to receive dividend payments before dividends are distributed to the holders of common stock. In addition, our board of directors could authorize the issuance of a series of preferred stock that has greater voting power than our common stock or that is convertible into our common stock, which could decrease the relative voting power of our common stock or result in dilution to our existing stockholders. Although we have no present intention to issue any shares of preferred stock or to create any series of preferred stock, we may create such series and issue such shares in the future.

THE MARKET PRICE OF OUR COMMON STOCK MAY BE ADVERSELY AFFECTED BY SEVERAL FACTORS.

The market price of our common stock could fluctuate significantly in response to various factors and events, including:

In addition, the securities markets have from time-to-time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock.

WE HAVE NOT PAID CASH DIVIDENDS IN THE PAST AND DO NOT EXPECT TO PAY CASH DIVIDENDS IN THE FUTURE. ANY RETURN ON INVESTMENT MAY BE LIMITED TO THE VALUE OF OUR STOCK.

We have never paid cash dividends on our stock and do not anticipate paying cash dividends on our stock in the foreseeable future. The payment of cash dividends on our stock will depend on our earnings, financial condition and other business and economic factors affecting us at such time as the board of directors may consider relevant. If we do not pay cash dividends, our stock may be less valuable because a return on your investment will only occur if our stock price appreciates.

We entered into an operating lease agreement, effective October 1, 2017, for our 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 $9,700 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 base rent payment is approximately $67,300 per month with a 3% increase every 12 months for the remaining term of the extension.

We believe that our facilities are well maintained, in substantial compliance with environmental laws and regulations, and adequately covered by insurance. We also believe that these leased facilities are not unique and could be replaced, if necessary, at the end of the term of the existing leases.

On September 11, 2020 a complaint was filed against the Company’s SMCL subsidiary and various staffing agencies used by SMCL in a Superior Court of San Bernardino County. The complaint alleges an employee of the Company committed employment practice violations against a former temporary employee not employed by us. Management has investigated the allegation and has engaged an employment attorney to defend the lawsuit. The case is still in discovery and no trial date has been set. The complaint seeks damages estimated to be no less than $500,000 in a money judgment. Management does not believe the claims have merit and does not believe the lawsuit will have a material adverse effect on our financial results.

On April 29, 2022, a complaint was filed by Tunnel IP LLC against the Company in the U.S District Court for the Southern District of Florida. The Complaint alleges that one of the Company’s products, SDL2093, infringes on U.S. Patent No. 7,916,877. On June 24, 2022, Tunnel IP agreed to dismiss all claims against the Company with prejudice.

As of this filing management is not aware of any other legal proceedings other than matters that arise in the ordinary course of business.

The objective of this Management’s Discussion and Analysis of Financial Condition and Results of Operation is to allow investors to view the Company from management’s perspective, considering items that would have a material impact on future operations.

The following discussion summarizes the significant factors affecting our results of operations and financial condition as of and during the years ended March 31, 2022 and 2021 and should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements based upon current plans, expectations and beliefs that involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from those anticipated in or implied by these forward-looking statements as a result of several factors, including those discussed in the section captioned “Risk Factors” included under Part I, Item 1A and elsewhere in this report. See also the section captioned “Disclosure on Forward-Looking Statements” in this report.

OVERVIEW

Our primary objectives for the fiscal year ended March 31, 2022 (“Fiscal 2022”) were to:

• increase our revenues by expanding our product lines and customer base;
• maintain the general and administrative costs while increasing revenue;
• decrease ending inventory on hand;
• improve profitability;

Revenues increased by approximately $1.7 million or approximately 3.7% primarily due to an increase in our two largest customers of approximately $4.2 million who increased the number of products offered offset by decreases in two of our top-five customers who experienced a decrease of approximately $2.5 million in sales of Carpool Karaoke (“CPK”) product. Gross profit margins decreased by approximately 4.0 margin points to 22.8% primarily due a decrease of approximately $3.1 million in sales of high margin yield CPK product which accounted for approximately 3.0 margin points of the decrease offset by reduction in co-op promotion incentives of approximately $0.2 million or approximately 0.7 points as several major customers did not offer their usual holiday campaigns due to supply issues caused by global logistics issues. The remaining decrease of approximately 1.7 points of gross margin was primarily due to unit cost increases to products from increases in raw materials and a significant increase in freight costs due to global logistics issues that were only partially passed on to customers. Operating expenses decreased approximately $0.1 million primarily due a decrease in royalties paid on CPK licensed product of approximately $0.3 million offset by an increase in general and administrative expenses of approximately $0.2 million primarily due to an increase consultation and professional services associated with guidance in investor relations and planning of contemplated one-time capital transactions. Inventory on hand increased by approximately $8.7 million of which approximately $5.4 million was for late delivery of seasonal product due to global logistics difficulties during peak season. The remaining increase in inventory was primarily due to new products purchased by one major customer that partially shipped during the first quarter ended June 30, 2022 with the remaining scheduled to ship during the second quarter ending September 30 2022. Net income decreased by approximately $1.9 million primarily due to an approximately $1.5 million reduction in gross profit margin with the remaining decrease primarily due to reduced net one-time gains.

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, certain income and expense items expressed as a percentage of the Company’s total revenues:

FISCAL YEAR ENDED MARCH 31, 2022 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2021

NET SALES

Net sales for the year ended March 31, 2022 (“Fiscal 2022”) were approximately $47.5 million. This represents an increase of approximately $1.7 million as compared to approximately $45.8 million in the fiscal year ended March 31, 2021 (“Fiscal 2021”). This increase was primarily due an increase in sales to our two largest customers of approximately $4.2 million who increased the number of products offered to its customers and offset by decreases in two of our top-five customers that experienced a decrease of approximately $2.5 million in sales of CPK product.

GROSS PROFIT

Gross profit for Fiscal 2022 was approximately $10.8 million or 22.8% of total revenues compared to approximately $12.3 million or 26.8% of sales for Fiscal 2021, a decrease of approximately $1.5 million as compared to the same period in the prior year. There was a decrease in our gross profit margin of approximately 4.0 margin points which accounted for approximately $2.2 million gross profit margin. This decrease was offset by the gross profit contribution of approximately $0.5 million due to the increase in net sales as explained above and a decrease in co-op promotions of approximately $0.2 million.

Gross profit margin for Fiscal 2022 was 22.8% compared to 26.8% for Fiscal 2021, a decrease of 4.0 margin points. The decrease in CPK sales as discussed above contributed approximately 3.0 margin points of the decrease. There was a gross profit margin increase of approximately 0.7 margin points due to a decrease in promotion incentives of approximately $0.2 million. The remaining 1.7 gross margin point decrease was primarily due to product cost increases in raw materials and a significant increase in freight costs due to global logistics issues that were only partially passed on to customers.

OPERATING EXPENSES

During the fiscal year ended March 31, 2022, our operating expenses decreased from approximately $10.9 million to approximately $10.8 million, a decrease of approximately $0.2 million compared to the same period last year. Selling expenses decreased by approximately $0.4 primarily due to decreased royalty expense of approximately $0.3 million commensurate with the decrease in CPK product sales as explained above. There was an increase in discretionary marketing expense of approximately $0.4 million which included approximately $0.1 million to upgrade our website and develop direct-to consumer business. This increase was offset $0.4 million due to a decrease of approximately $0.3 million in outbound freight as we were able to move one major customer from shipping terms from freight prepaid to freight collect. The decrease in selling expenses of $0.4 million was offset by an increase in general and administrative expenses of approximately $0.2 million primarily due to an increase consultation and professional services associated with guidance in investor relations and planning of contemplated one-time capital transactions.

OTHER INCOME (EXPENSES)

Other income (expenses), net decreased by approximately $1.0 million to approximately $0.2 in other income, net for the fiscal year ended March 31, 2022 compared to approximately $1.2 million in other income, net for the same period ended March 31, 2021. For the fiscal year ended March 31, 2022 there were one-time gains of approximately $0.4 million for the forgiveness of the Paycheck Protection Program loan and a gain of approximately $0.4 million primarily from a vendor settling accounts payable related to a damaged goods incident that occurred in the fiscal year ended March 31, 2020. This compares to the fiscal year ended March 31, 2021 when there were one-time gains associated with the recovery of approximately $1.1 million in out-of-pocket expenses relating to a prior year damaged goods insurance claim and a vendor settling accounts payable of $0.4 million from the factory that caused the damage. There was an additional one-time gain of approximately $0.2 million from Cosmo, a related party, related to payment in fiscal 2021 of prior year sales which were reversed and the related receivable was initially deemed uncollectible and written off in the prior fiscal year.

Interest and amortization expense associated with the financing terms of the Crestmark Bank financing facility and Ironhorse financing facility increased to approximately $0.6 million for the fiscal year ended March 31, 2022 from approximately $0.5 million for the year ended March 31, 2021, an increase of approximately $0.1 million.

INCOME BEFORE INCOME TAX PROVISION

We had income before income tax provision of approximately $0.3 million in Fiscal 2022 compared to income before income tax provision of approximately $2.6 million in Fiscal 2021 for a total decrease in income before income tax provision of approximately $2.3 million. Net income from operations contributed approximately $1.4 million of the decrease due primarily to the decrease in gross profit as explained above. The decrease in other income and expenses, net of $1.2 million as explained above accounted for the remaining decrease in income before income tax provision.

INCOME TAX PROVISION

Significant management judgment is required in developing our provisions for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against deferred tax assets. Management evaluates its ability to realize its deferred tax assets on a quarterly basis and adjusts its valuation allowance when it believes that it is not likely to be realized. On both March 31, 2022 and 2021, we had net deferred tax assets of approximately $0.9 million. The deferred tax assets on March 31, 2022 and 2021 were net of a valuation allowance of approximately $78,000 and approximately $23,000, respectively due to management’s belief that certain tax assets will more than likely expire prior to the Company’s these assets being realized.

In Fiscal 2022 we recognized an income tax provision of approximately $0.1 million compared to an income tax provision of approximately $0.5 million in Fiscal 2021. The Company’s effective tax rate for the fiscal year ended March 31, 2022 was approximately 20.0% as compared to 17.4% for Fiscal 2021.

We operate within multiple taxing jurisdictions and are subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve. In management’s opinion, adequate provisions for income taxes have been made.

NET INCOME

As a result of the foregoing, we had net income of approximately $0.2 million and $2.2 million for Fiscal 2022 and Fiscal 2021, respectively.

LIQUIDITY AND CAPITAL RESOURCES

On March 31, 2022, we had cash on hand of approximately $2.3 million as compared to cash on hand of approximately $0.4 million on March 31, 2021. The increase of cash on hand of approximately $1.9 million was primarily due to approximately $4.0 million provided by financing activities and offset by approximately $2.0 million in net cash used in operating activities. As of March 31, 2022, our working capital was approximately $7.8 million.

During the next twelve-month period, we plan on financing our working capital needs primarily from:

1) Vendor financing – All our key vendors in China have agreed to manufacture on behalf of the Company without advanced payments and have extended payment terms to the Company. The terms with the factories are sufficient to cover the factory direct import sales which are expected to account for approximately 60% of the total revenues in the fiscal year ending March 31, 2023.

2) Credit Facility - We currently have an Intercreditor Revolving Credit Facility with Crestmark Bank for a $10.0 million facility (decreasing to $5.0 million in off-peak season) on eligible accounts receivable under an evergreen arrangement that terminates upon written notice by the Company and is subject to a termination fee if terminated by the Company anytime other than the annual renewal date of June 11. We also have a $2.5 million facility on eligible inventory with Iron Horse Credit that was to expire on June 11, 2022. However, absent any termination notice given by the Company to IHC, the current financing arrangement automatically renewed for another twelve-month term and is subject to a termination fee if terminated by the Company prior to the twelve-month renewal date. Approximately $4.0 million of borrowings are available under all our credit facilities as of the date of this filing .

3) Equity Raise – On May 23, 2022, we entered into an underwriting agreement (the “Underwriting Agreement”) with Aegis Capital Corp., who acted as the sole underwriter (the “Underwriter”), in a firm commitment underwritten public offering (the “Offering”) pursuant to which the Company sold to the Underwriter 1,000,000 shares (the “Shares”) of common stock, par value $0.01 per share (the “Common Stock”) for gross proceeds of $4.0 million prior to deducting underwriting discounts and commissions and other estimated offering expenses. After underwriter discounts, commissions and other estimated offering expenses of approximately $0.7 million we received approximately $3.3 million to be used as working capital. The offering closed on May 26, 2022.

The Company believes that its cash on hand, working capital (net of cash), cash expected to be generated from its operating forecast, along with the availability of cash from its credit facilities, will be adequate to meet the Company’s liquidity requirements for at least twelve months from the filing of this annual report .

Cash used in operating activities in Fiscal 2022 was approximately $2.0 million. There was an increase in inventory of approximately $8.4 million of which approximately $3.7 million was additional inventory due to product that was delivered too late for seasonal shipments as a result of global logistics difficulties, approximately $3.3 million was new product purchased for one major customer that was in-transit with the remaining increase primarily due to CPK inventory to be re-launched during the upcoming fiscal year. There was an increase in accounts receivable of approximately $0.6 million due to later than usual shipments due to global logistics issues. These decreases in cash used in operations were offset by an increase in amounts due from banks of approximately $4.5 million due to cash required to pay vendors for the additional inventory and an increase in accounts payable of approximately $2.5 million primarily due to new seasonal goods in-transit.

Cash provided by operating activities in Fiscal 2021 was approximately $0.2 million. There was net income of approximately $2.1 million. There was a decrease in inventory of approximately $2.1 million primarily due to increased demand for our CPK product through social media awareness and increased demand for our home-based entertainment products during the COVID pandemic which allowed us to sell through most of the excess inventory from the prior fiscal year. There was a decrease in insurance receivable of approximately $1.3 million associated with the recovery of a pending insurance claim associated with water damaged goods in the prior fiscal year. These increases in cash provided by operations were offset by a reduction in accounts payable of approximately $3.2 million primarily due to the payment of significant amounts held back from the factory that caused the damaged goods issue in the prior fiscal year upon receipt of the related insurance claim proceeds. There was an increase in amounts due from banks of approximately $2.2 million due to excess cash collected over amounts due on the lines of credit associated with the operating cash generated from the reduction in inventory. There was a decrease in refunds due to customers of approximately $0.7 million associated with the settlement of the unpaid portion of chargebacks for damaged goods due to one customer from the prior fiscal year.

Cash used in investing activities for Fiscal 2022 and Fiscal 2021 was approximately $0.1 million and $0.2 million, respectively primarily for the purchase of molds and tooling for new karaoke models.

Net cash provided by financing activities for Fiscal 2022 was approximately $4.0 million. We received loan proceeds from our inventory line of credit of approximately $2.4 million. In August 2021, the Company received net proceeds of approximately $1.8 million from the execution of private placement and stock redemption agreements as summarized in the next two paragraphs. These financing activities were offset by a payment of $150,000 on the subordinated related party debt, with the remaining offset primarily due to payments made on scheduled installments on installment notes and finance leases.

In August 2021, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with large institutional investors and a strategic investor for private placement of (i) 550,000 shares of its common stock (the “Shares”) together with common warrants to purchase up to 550,000 shares of common stock for an exercise price of $10.50 per share, and (ii) 561,111 pre-funded warrants (“Pre-Funded Warrants”) with each Pre-Funded Warrant exercisable for one share of common stock at an exercise price of $0.01 per share, together with Common Warrants to purchase up to 561,111 shares of common stock at an exercise price of $10.50 per share (the “Private Placement”). The closing of the Private Placement took place on August 10, 2021, when the Shares, Common Warrants, and Pre-Funded Warrants were delivered to the purchasers and funds, in the amount of approximately $9,800,000, were received by the Company. Approximately $7,200,000 of the funds received were used to repurchase shares of the Company pursuant to that certain Redemption Agreement discussed below. The Company received an increase in working capital of approximately $1,800,000 of working capital after settlement of expenses associated with closing of these transactions.

In August, 2021, the Company entered into a stock redemption agreement (the “Redemption Agreement”) with koncepts International Limited (“koncepts”) and Treasure Green Holdings, Ltd. (“Treasure Green”), pursuant to which the Company agreed to redeem 654,105 shares of common stock of the Company (the “Redeemed Shares”). The closing of the transactions set forth in the Redemption Agreement took place on August 10, 2021, at which time the Redeemed Shares were assigned and transferred back to the Company in consideration of a payment of approximately $7,200,000 to koncepts and Treasure Green. The Redeemed Shares were retired and returned to the unissued authorized capital of the Company Net cash provided by financing activities for Fiscal 2021 was approximately $0.1 million. We received loan proceeds from Crestmark in the amount of approximately $0.4 million under the Paycheck Protection Program. We received additional proceeds from our inventory line of credit of approximately $0.1 million. These proceeds were offset by principal payments made on subordinated related party debt of $0.3 million and payments on financed leases and installment notes of approximately $0.1 million.

We currently have an Intercreditor Revolving Credit Facility with Crestmark Bank for a $10.0 million facility (decreasing to $5.0 million in off-peak season) on eligible accounts receivable under an evergreen arrangement that terminates upon written notice by the Company and is subject to a termination fee if terminated by the Company anytime other than the annual renewal date of June 11. We also have a $2.5 million facility on eligible inventory with Iron Horse Credit that was to expire on June 11, 2022. However, absent any termination notice given by the Company to IHC, the current financing arrangement automatically renewed for another twelve-month term and is subject to a termination fee if terminated by the Company prior to the twelve-month renewal date.

As of this filing, we have borrowed approximately $2.5 million on the IHC Facility, which is the maximum loan amount allowed on eligible inventory and approximately $0.0 million on our Crestmark Facility which will make available up to $10.0 million of eligible accounts receivable as the next twelve months progress as long as the loan is in place. As of this filing the Company has approximately $1.0 million currently available from these two credit facilities based on eligible inventory with IHC and eligible accounts receivable with Crestmark.

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 Small Business Administration (“SBA”). For the year ended March 31, 2021 the Company incurred interest expense of approximately $4,000. In June 2021 the Company received notification from the SBA that the loan had been forgiven in its entirety. For the fiscal year ended March 31, 2022, a gain of approximately $448,000 (including principal and interest) from the forgiveness of the loan was included in other income (expenses), net in the accompanying consolidated statements of income.

In August 2019, a major customer received goods that were significantly water damaged due to excess moisture absorbed in pallets shipped by the factory. As a result, we incurred a loss in cash flow of approximately $1.6 million in lost revenue and approximately $0.8 million in additional out of pocket expenses to retrieve, inspect, warehouse and properly destroy the goods in the prior fiscal year. As of this filing we have we recovered approximately $2.3 million from our cargo insurance coverage which settled approximately $1.3 million in insurance claim receivable with the remaining proceeds reflected in other income and (expenses) as a gain from damaged goods insurance claim in the consolidated statement of income for the fiscal year ended March 31, 2021. For the fiscal year ended March 31, 2022 we secured vendor invoice credits of approximately $0.2 million from the manufacturer’s representative of the factory that caused the damage. For the fiscal year ended March 31, 2021 there was a gain from damaged goods insurance claim of approximately $1.1 and we secured vendor invoice credits of approximately $0.4 million from the factory that caused the damage which is reflected as gain from extinguishment of accounts payable in the consolidated statements of income.

EXCHANGE RATES

We sell most of our products in U.S. dollars with some sales to certain Canadian customers in Canadian Dollars and pay for all of our manufacturing costs in either U.S. or Hong Kong dollars. We are subject to risks involved in the exchange rate between the Canadian and US dollar, however, even though the exchange rate has fluctuated between $1.23 to $1.29 CAD to the U.S. Dollar during peak selling and collection season in Fiscal 2022 sales volume sold in Canadian dollars was not significant and the associated exchange rates did not have a material impact on the Company’s financial results. Operating expenses of the Macau office are paid in either Hong Kong dollars or Macau Pataca (MOP). The exchange rate of the Hong Kong dollar to the U.S. dollar has been relatively stable at approximately HK $7.75 to U.S. $1.00 since 1983 and, accordingly, has not represented a currency exchange risk to the U.S. dollar. The exchange rate of the MOP to the U.S. dollar is approximately MOP $8.00 to U.S. $1.00. While exchange rates have been stable for several years, we cannot assure you that the exchange rate between the United States, Macau, Hong Kong and Canadian currencies will continue to be stable and exchange rate fluctuations may have a material effect on our business, financial condition or results of operations.

SEASONAL AND QUARTERLY RESULTS

Historically, our operations have been seasonal, with the highest net sales occurring in the second and third quarters (reflecting increased orders for equipment and music merchandise during the Christmas selling months) and to a lesser extent the first and fourth quarters of the fiscal year. Sales in our fiscal second and third quarter, combined, accounted for approximately 81% and 86% of net sales in Fiscal 2022 and Fiscal 2021, respectively.

Our results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of orders placed and shipped to customers. We may experience quarter to quarter fluctuations in product landed cost as the cost of shipping containers, drayage port delay charges and other logistics related costs increase as peak shipping season arrives. The fulfillment of orders can therefore significantly affect results of operations on a quarter-to-quarter basis.

During 2021 and continuing into 2022, the United States has experienced a rapid increase in inflation levels of over 8.6%, which is now at a 40-year historic high. Such heightened inflationary levels may negatively impact consumer disposable income and discretionary spending and, in turn, reduce consumer demand for our products and increase our costs and could significantly affect results of operations on a quarter-to-quarter basis.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

We prepared our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. As such, management is required to make certain estimates, judgments and assumptions that it believes are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. The significant accounting policies which management believes are the most critical to aid in fully understanding and evaluating our reported financial results included accounts receivable allowance for doubtful accounts, reserves on inventory, revenue recognition and reserve for sales returns and income taxes.

ACCOUNTS RECEIVABLE AND COLLECTIBILITY

The Singing Machine’s accounts receivable consist of amounts due from customers in the ordinary course of business. Accounts receivable are carried at cost, net of allowances for uncollectible amounts. Provisions for losses are charged to operations in amounts sufficient to maintain an allowance for losses at a level considered adequate to cover probable losses inherent in the Company’s 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 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. 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. The Company is subject to chargebacks from customers for co-op promotion incentives, defective returns, return freight and handling charges that are deducted from open invoices and reduce collectability of open invoices.

RESERVES ON INVENTORIES

The Singing Machine establishes a reserve on inventory based on the expected net realizable value of inventory 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 due to excess supply on-hand, slow-moving product and end-of-life product. On March 31, 2022 and 2021 the Company had inventory reserves of approximately $0.4 million and $0.6 million, respectively.

REVENUE RECOGNITION AND RESERVE FOR SALES RETURNS

The Company recognizes revenue in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, “Revenue from Contracts with Customers”. All revenue is generated from contracts with customers. The Company recognizes revenue when 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 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 consolidated statements of income as our underlying customer agreements are less than one year.

The Company selectively participates in a retailer’s co-op promotion incentives to maximize sales of the Company’s products on the retail floor or to assist in developing consumer awareness of new product launches, by providing marketing fund allowances to our customers. As these co-op promotion incentives are not a distinct good or service and the Company cannot reasonably estimate the fair value of the benefit it receives from these arrangements, the cost of these allowances at the time they are offered to the customers are recorded as a reduction to net sales. For the fiscal years ended March 31, 2022 and 2021, co-op promotion incentives were approximately $1.7 million and $2.0 million, respectively.

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 12 – SEGMENT INFORMATION).

While the Company generally does not contractually provide for overstock returns, 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 from the customer for various reasons, whereby a sales return reserve is recorded based on historic return amounts, specific events as identified and management estimates.

For the fiscal years ended March 31, 2022 and 2021 the Company received sales returns of approximately $3.6 million and $4.1 million, respectively. The return of products is due to a variety of reasons including defective units, customers’ overstock and buyer’s remorse. The primary reason for the decrease of approximately $0.5 million in returns was primarily due a decrease in overstock returns from major customers.

The Company’s reserve for sales returns were approximately $1.0 million as of March 31, 2022 and 2021 (See Note 16 – RESERVE FOR SALES RETURNS).

INCOME TAXES

We operate within multiple taxing jurisdictions and are subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve. In management’s opinion, adequate provisions for potential income taxes in the jurisdictions have been made. 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. 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.

OTHER ESTIMATES

We make other estimates in the ordinary course of business relating to sales returns and allowances, warranty reserves, and reserves for promotional incentives. Historically, past changes to these estimates have not had a material impact on our financial condition. However, circumstances could change which may alter future expectations.

RECENT ACCOUNTING PRONOUNCEMENTS

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 are effective for our fiscal year beginning 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 consolidated financial statements and related disclosures.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.

(a) Management’s Report on Disclosure Controls and Procedures

Our management, under the supervision and with the participation of our Principal Executive Officer (our Chief Executive Officer) and Principal Financial Officer (our Chief Financial Officer), has evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2022, the end of our fiscal year covered by this report. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or person performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Management recognizes that any disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2022, that consider remediation efforts commenced by the Company as a result of the material weaknesses noted during the assessment of the effectiveness of the Company’s internal controls over financial reporting as of and for the year ended March 31, 2021, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures are effective.

(b) Management’s Annual Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. This rule defines internal control over financial reporting as a process designed by, or under the supervision of Company management to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Management has assessed the effectiveness of our internal control over financial reporting using the components established in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

A system of internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A material weakness is any deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our company’s annual or interim financial statements will not be prevented or detected on a timely basis.

Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our internal control over financial reporting was effective as of the year covered by this Annual Report.

Remediation of Prior Year Material Weakness in Internal Control over Financial Reporting

For the year ended March 31, 2021, we identified a material weakness in the consolidated financial statements close process which failed to detect errors which could have been material in the accounting for inventory cutoff and the inventory valuation of estimated returns. Specifically, the Company had a deficient process to close the consolidated financial statements and prepare comprehensive and timely account analysis, due in part to a new accounting software system, which resulted in certain adjusting journal entries.

We implemented a new Enterprise Resource Planning (“ERP”) software system during the fiscal year ended March 31, 2021 and during the closing process discovered that the system was not applying the First-In-First Out (“FIFO”) layering formula correctly to returned goods received. While we have identified the specific FIFO costing formula that the system must use for returning goods the curing of this defect in the accounting software system was still in progress as of March 31, 2021. In addition, due to significant personnel turnover in our California warehouse facility and the implementation of a new ERP software system there were some communication and training issues regarding the staging and receiving areas of the warehouse during the end of year physical inventory that caused a material weakness in properly observing inventory cutoff.

We have remediated the FIFO calculation material weakness by manually calculating the FIFO cost of each item in the inventory (including returned product) at the end of each quarter, comparing the manually calculated inventory valuation to the perpetual inventory valuation from our accounting software system and recording any difference in cost of goods sold in the consolidated financial statements. We expect the returned goods valuation defect in the accounting software system to be remediated during the fiscal year ending March 31, 2023 and will continue to manually calculate the inventory valuation at the end of each quarter until such time that any differences between the manual calculation and accounting system calculation are deemed immaterial.

We have remediated the inventory cutoff weakness with proper training of new personnel involved with the inventory and specifically addressed procedures prior to the physical inventory conducted for the fiscal year ended March 31, 2022.

(c) Changes in Internal Controls

Other than the remediation of the prior year material weakness, there were no other changes in the Company’s internal controls over financial reporting during the quarter ended March 31, 2022, that materially affected, or were reasonably likely to materially affect the Company’s internal control over financial reporting.

Auditor Attestation

This Annual Report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management’s report in this Annual Report.