Singing Machine hits a Sour Note

The Singing Machine Company (AMEX:SMD) announced poor results and red ink. The management group sounds like they are whistling in the graveyard. Read this quote from Tony Handal, C.E.O.

"We are all disappointed over these financial results, which we believe to be largely the result of forces beyond our control. Despite this, we were generally able to maintain our net sales as compared to last year. However, due to shrinking gross margins and higher-than-expected returns, we were not able to sustain profitability.”

Mr. Handel you claim in the same sentence to maintain net sales, yet you report higher-than-expected returns. You may be splitting hairs on accounting definitions but it sounds like you are deluding yourself and therefore shareholders.
Here are a few items that also concern me that you have chosen not to mention.
1. Inventories are up
2. Accounts payable are up
3. Pre-paid expenses are up and huge in relation to the overall balance sheet
4. Due to related parties has doubled and is also huge
5. You have negative cash flow