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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
0 - 24968
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Commission File Number
THE SINGING MACHINE COMPANY, INC.
---------------------------------
(Exact Name of Small Business Issuer as Specified in its Charter)
Delaware 95-3795478
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(State of Incorporation ) (IRS Employer I.D. No.)
6601 Lyons Road, Building A-7, Coconut Creek, FL 33073
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(Address of principal executive offices )
(954) 596-1000
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(Issuer's telephone number, including area code)
Check whether the Issuer: (1) filed all reports required to be filed by section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports); and (2) has been
subject to such filing requirements for the past 90 days. Yes x No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes x No
APPLICABLE ONLY TO CORPORATE ISSUERS
There were 8,089,027 shares of Common Stock, $.01 par value, issued and
outstanding at June 30, 2002.
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Page No.
--------
Consolidated Balance Sheets - December 31, 2001 (Unaudited)
and March 31, 2001 .............................................. 3
Consolidated Statement of Operations - Three and nine months
ended December 31, 2001 and 2000 (Unaudited) .................... 4
Consolidated Statement of Cash Flows - Nine months ended
December 31, 2001 and 2000 (Unaudited) .......................... 5
Notes to Consolidated Financial Statements ...................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............................. 9
Item 3. Quantitative and Qualitative Disclosure About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................... 16
Item 2. Changes in Securities ........................................... 16
Item 3. Defaults Upon Senior Securities ................................. 17
Item 4. Submission of Matters to a Vote of Security Holders ............. 17
Item 5. Other Information ............................................... 18
Item 6. Exhibits and Reports on Form 8-K ................................ 18
SIGNATURES ............................................................... 19
Exhibit 99.1
Exhibit 99.2
2
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
PART I - FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2002 MARCH 31, 2002
------------- --------------
(unaudited)
ASSETS
------
CURRENT ASSETS
Cash $ 1,465,174 $ 5,520,147
Accounts receivable, net 2,612,215 3,536,903
Due from manufacturer 740,207 488,298
Inventories 12,941,333 9,274,352
Prepaid expenses and other current assets 878,298 982,697
Fixed deposits 1,514,283 513,684
----------- -----------
TOTAL CURRENT ASSETS 20,151,510 20,316,081
----------- -----------
PROPERTY AND EQUIPMENT, NET 1,065,751 574,657
----------- -----------
OTHER ASSETS
Security deposits 152,540 135,624
Reorganization intangible, net 185,416 185,416
Deferred tax asset 452,673 452,673
----------- -----------
TOTAL OTHER ASSETS 790,629 773,713
----------- -----------
TOTAL ASSETS $22,007,890 $21,664,451
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Accounts payable $ 4,259,780 $ 1,846,238
Accrued expenses 505,338 1,289,597
Income tax payable 0 58,542
----------- -----------
TOTAL CURRENT LIABILITIES 4,765,118 3,194,377
----------- -----------
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par value, 1,000,000 shares authorized, no
shares issues and outstanding -- --
Common stock, Class A, $0.01 par value, 100,000 shares authorized, no
shares issued and outstanding -- --
Common stock, $0.01 par value, 18,900,000 shares authorized, 8,089,027
and 8,020,027 shares issued and outstanding 80,890 80,200
Additional paid-in capital 4,683,923 4,602,828
Retained earnings 12,477,959 13,787,046
----------- -----------
TOTAL STOCKHOLDERS' EQUITY 17,242,772 18,470,074
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $22,007,890 $21,664,451
=========== ===========
See accompanying notes to consolidated financial statements
3
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended June 30,
2002 2001
----------- -----------
NET SALES $ 4,151,983 $ 5,523,734
COST OF SALES 3,091,513 3,662,646
----------- -----------
GROSS PROFIT 1,060,470 1,861,088
----------- -----------
OPERATING EXPENSES
Compensation 770,898 459,612
Commissions 110,668 147,784
Advertising 165,765 228,904
Royalty expense 67,830 124,241
Selling, general, & administrative expenses 1,278,352 941,455
----------- -----------
TOTAL OPERATING EXPENSES 2,393,513 1,901,996
----------- -----------
INCOME FROM OPERATIONS (1,333,043) (40,908)
----------- -----------
OTHER INCOME (EXPENSES)
Other Income 13,901 15,732
Interest Expense (1,549) (3,692)
Interest Income 11,604 2,475
----------- -----------
NET OTHER EXPENSES 23,956 14,515
----------- -----------
INCOME BEFORE INCOME TAXES (1,309,087) (26,393)
INCOME TAX EXPENSE -- --
----------- -----------
NET INCOME $(1,309,087) $ (26,393)
=========== ===========
EARNINGS PER SHARE:
Basic $ (0.16) $ (0.01)
=========== ===========
Diluted $ (0.16) $ (0.01)
=========== ===========
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES
OUTSTANDING:
Basic 8,061,277 6,587,952
=========== ===========
Diluted 8,061,277 6,587,952
=========== ===========
See accompanying notes to financial statements
4
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended June 30,
2002 2001
----------- -----------
CASH FLOW FROM OPERATING ACTIVITIES:
Net Income $(1,309,087) $ (26,393)
Adjustments to reconcile net income to net cash provided by (used in) operating
activities
Depreciation and amortization 121,047 32,568
Stock based expenses -- 171,472
Bad debt -- --
Deferred tax benefit -- 22,908
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable 924,688 (3,954,868)
Due from manufacturer (251,909) 699,096
Inventories (3,666,981) (208,432)
Prepaid expenses and other assets 87,483 (170,089)
Increase (decrease) in:
Accounts payable 2,413,542 482,169
Due to manufacturer -- 1,073,488
Accrued expenses (784,259) (227,633)
Income taxes payable (58,542) (23,320)
----------- -----------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (2,524,018) (2,129,034)
----------- -----------
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of property and equipment (612,141) (30,416)
Deposit for credit line (1,000,599) (254,362)
Proceeds from investment in factor -- 933,205
Proceeds from repayment of officer loans -- 117,425
Investment in and advances to unconsolidated subsidiary -- (9,217)
----------- -----------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (1,612,740) 756,635
----------- -----------
CASH FLOW FROM FINANCING ACTIVITIES
Loan proceeds -- 362,955
Loan repayments -- (27,848)
Proceeds from exercise of stock options and warrants 81,785 64,452
----------- -----------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 81,785 399,559
----------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS (4,054,973) (972,840)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 5,520,147 1,016,221
----------- -----------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 1,465,174 $ 43,381
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 1,549 $ 3,692
=========== ===========
Cash paid during the year for income taxes $ 58,542 $ 23,320
=========== ===========
See accompanying notes to consolidated financial statements
5
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying consolidated financial statements of the Company have been
prepared in accordance with the instructions to Form 10-Q and, therefore, omit
or condense certain footnotes and other information normally included in
financial statements prepared in accordance with generally accepted accounting
principles. It is suggested that these consolidated condensed financial
statements should be read in conjunction with the Company's consolidated
financial statements and notes thereto included in the Company's audited
financial statements on the Company's Annual Report on Form 10-KSB for the
fiscal year ended March 31, 2002.
The accounting policies followed for interim financial reporting are the same as
those disclosed in Note 1 of the Notes to Financial Statements included in the
Company's audited consolidated financial statements for the fiscal year ended
March 31, 2002, which are included in Form 10- KSB.
The Financial Accounting Standards Board has recently issued several new
accounting pronouncements which may apply to the Company.
The following statements have been adopted by the Company.
Statement No. 141 "Business Combinations" establishes revised standards for
accounting for business combinations. Specifically, the statement eliminates the
pooling method, provides new guidance for recognizing intangible assets arising
in a business combination, and calls for disclosure of considerably more
information about a business combination. This statement is effective for
business combinations initiated on or after July 1, 2001. The adoption of this
pronouncement on July 1, 2001 did not have a material effect on the Company's
financial position, results of operations or liquidity.
Statement No. 142 "Goodwill and Other Intangible Assets" provides new guidance
concerning the accounting for the acquisition of intangibles, except those
acquired in a business combination, which is subject to SFAS 141, and the manner
in which intangibles and goodwill should be accounted for subsequent to their
initial recognition. Generally, intangible assets with indefinite lives, and
goodwill, are no longer amortized; they are carried at lower of cost or market
and subject to annual impairment evaluation, or interim impairment evaluation if
an interim triggering event occurs, using a new fair market value method.
Intangible assets with finite lives are amortized over those lives, with no
stipulated maximum, and an impairment test is performed only when a triggering
event occurs. This statement is effective for all fiscal years beginning after
December 15, 2001. The Company adopted SFAS 142 on April 1, 2002 liquidity.and
accordingly has stopped amortizing the reorganization intangible, which has a
net balance of $185,412 at March 31, 2002.
Statement No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets" supercedes Statement No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121").
Though it retains the basic requirements of SFAS 121 regarding when and how to
measure an impairment loss, SFAS 144 provides additional implementation
guidance. SFAS 144 excludes goodwill and intangibles not being amortized among
other exclusions. SFAS 144 also supercedes the provisions of APB 30, "Reporting
the Results of Operations," pertaining to discontinued operations. Separate
reporting of a discontinued operation is still required, but SFAS 144 expands
the presentation to include a component of an entity, rather than strictly a
business segment as defined in SFAS 131, Disclosures about Segments of an
Enterprise and Related Information. SFAS 144 also eliminates the current
exemption to consolidation when control over a subsidiary is likely to be
temporary. This statement is effective for all fiscal years beginning after
December 15, 2001. The implementation of SFAS 144 on April 1, 2002 did not have
a material effect on the Company's financial position, results of operations or
liquidity.
Statement No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment
of FASB Statement No. 13, and Technical Corrections," updates, clarifies, and
simplifies existing accounting pronouncements. Statement No. 145 rescinds
Statement 4, which required all gains and losses from extinguishment of debt to
be aggregated and, if material, classified as an extraordinary item, net of
related income tax effect. As a result, the criteria in Opinion 30 will now be
used to classify those gains and losses. Statement 64 amended Statement 4, and
is no longer necessary because Statement 4 has been rescinded. Statement 44 was
issued to establish accounting requirements for the effects of transition to the
provisions of the motor Carrier Act of 1980. Because the transaction has been
completed, Statement 44 is no longer necessary. Statement 145 amends Statement
13 to require that certain lease modifications that have economic effects
similar to sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. This amendment is consistent with FASB's goal
requiring similar accounting treatment for transactions that have similar
economic effects. The adoption of SFAS No. 145 did not have a material impact on
the Company's consolidated financial statements.
The following statements will be adopted by the Company as they become
effective.
6
Statement No. 143, "Accounting for Asset Retirement Obligations," requires
entities to record the fair value of a liability for an asset retirement
obligation in the period in which it is incurred. When the liability is
initially recorded, the entity capitalizes a cost by increasing the carrying
amount of the related long-lived asset. Over time, the liability is accreted to
its present value each period, and the capitalized cost is depreciated over the
useful life of the related asset. Upon settlement of the liability, an entity
either settles the obligation for its recorded amount or incurs a gain or loss
upon settlement. The standard is effective for fiscal years beginning after June
15, 2002. The adoption of SFAS No. 143 is not expected to have a material impact
on the Company's financial statements.
Certain amounts in the June 30, 2001 interim consolidated financial statements
have been reclassified to conform to the June 30, 2002 presentation.
In the opinion of management, all adjustments which are of a normal recurring
nature and considered necessary to present fairly the financial positions,
results of operations, and cash flows for all periods presented have been made.
The results of operations for the three month period ended June 30, 2002 are not
necessarily indicative of the results that may be expected for the entire fiscal
year ending March 31, 2003.
The accompanying consolidated condensed financial statements include the
accounts of the Company and its wholly-owned subsidiary. All significant
inter-company balances and transactions have been eliminated. Assets and
liabilities of the foreign subsidiary are translated at the rate of exchange in
effect at the balance sheet date; income and expenses are translated at the
average rates of exchange prevailing during the year. The related translation
adjustment is not material.
NOTE 2 - DEPOSIT FOR LETTER OF CREDIT FACILITY
The Company, through its Hong Kong subsidiary, maintains letter of credit
facilities with two major international banks. The Company's subsidiary is
required to maintain separate deposit accounts at these banks in the amount of
$1,514,283. This amount is included in deposits at June 30, 2002.
NOTE 3 - EQUITY
Stock options and warrants were exercised during the first quarter of fiscal
year 2003. 69,000 shares of common stock were issued with proceeds to the
Company of $81,785.
NOTE 4 - COMMITMENTS
The Company entered into an agreement with a retail customer whereby they
guaranteed the customer a minimum gross margin of $3,573,000 from the sale of
the Company's products during the period from September 1, 2002 through January
15, 2003. Under the agreement, the Company will reimburse the customer for the
difference between the customer's gross margin on sales and the minimum
guarantee. The Company would have a total exposure of $3,537,000, in the event
that there were no sales of the Company's products made by the retail customer
during this period.
On April 15, 2002, the Company entered into a three-year employment agreement
with a new Executive Vice President of Sales and Marketing. The agreement
stipulates a salary and bonuses and a 50% of annual pay severance clause. The
agreement grants 50,000 options to the employee. The employee may elect to
return the first year options to the Company for $100,000. As of the date of the
accompanying audit report, the options have not been issued.
In June 2002, the Board of Directors approved the terms of a consulting
agreement effective on February 28, 2003 with the current CEO when he retires on
that day. The CEO will receive $250,000 per year and will also receive an
appreciation bonus of $200,000 on February 28, 2003.
In May and June 2002, the Company's subsidiary entered into new office leases in
Hong Kong, each for 36 months at an aggregate $13,364 per month.
Effective May 1, 2002, the Company signed a 5-year warehouse lease in California
for $33,970 per month. The Company also subleased out its space in the other
California warehouse for rent income of $12,393 per month through January 31,
2004.
Effective June 1, 2002, the Company signed an additional 27-month lease to
expand its corporate headquarters. The additional rent is $1,987 per month.
7
NOTE 5 - CONCENTRATIONS
The Company derives primarily all of its revenues from retailers of products in
the United States. Financial instruments, which potentially subject the Company
to concentrations of credit risk, consist of accounts receivable. The Company's
allowance for doubtful accounts is based upon management's estimates and
historical experience and reflects the fact that accounts receivable are
concentrated with several large customers whose credit worthiness have been
evaluated be management. At June 30, 2002, 52.4% of accounts receivable were due
from four U.S. customers and two foreign customers. Accounts receivable from two
customers that individually owed over 10% of accounts receivable at June 30,
2002 was 16% and 10%. The Company performs ongoing credit evaluations of its
customers and generally does not require collateral.
Revenues derived from five customers for the quarters ended June 30, 2002 and
2001 were 78% and 97% of revenues, respectively. Revenues derived from two
customers in the first quarter ended June 30, 2002 and 2001, respectively, which
individually purchased greater than 10% of the Company's total revenues, were
39% and 17% in 2002 and 90% and 48% in 2001.
In the fourth quarter of fiscal 2002, a major customer that provided 37% of the
Company's revenue in 2002 converted its purchase method to a consignee basis.
The Company recorded approximately $2,875,000 of sales returns and reversal of
related cost of sales of $2,112,000 in the fourth quarter of fiscal 2002 and the
customer retained the inventory on a consignment basis.
The Company is dependent upon foreign companies for manufacture of all of its
electronic products. The Company's arrangements with manufacturers are subject
to the risk of doing business abroad, such as import duties, trade restrictions,
work stoppages, foreign currency fluctuations, political instability, and other
factors, which could have an adverse impact on its business. The Company
believes that the loss of any one or more of their suppliers would not have a
long-term material adverse effect because other manufacturers with whom the
Company does business would be able to increase production to fulfill their
requirements. However, the loss of certain suppliers in the short-term could
adversely affect business until alternative supply arrangements are secured.
During fiscal 2002 and 2001, manufacturers in the People's Republic of China
(China) accounted for in excess of 95% and 94%, respectively of the Company's
total product purchases, including virtually all of the Company's hardware
purchases. The Company expects purchasing for 2003 to fall within the above
range as well.
Purchases of products derived from three factories based in China during fiscal
2002 were 51%, 39%, and 5% and from two manufacturers based in China during
fiscal 2001 were 80% and 14%, respectively. For the first quarter ended June 30,
2002, purchases of product were derived from five factories based in China.
The Company finances its sales primarily through a loan facility with one
lender. Although management believes there are other sources available, a loss
of the current credit facility could be in the short term, adversely affect
operations until an alternate lending arrangement is secured.
Net sales derived from the Company's Hong Kong based subsidiary aggregated
approximately $1,675,766 for the quarter ended June 30, 2002 and $4,124,242 for
the same period in 2001. The carrying value of net assets held by the Company's
Hong Kong based subsidiary was approximately $1,287,860 at June 30, 2002.
NOTE 6 - EARNINGS PER SHARE
Basic net income (loss) per common share (Basic EPS) excludes dilution and is
computed by dividing net income (loss) available to common stockholder by the
weighted-average number of common shares outstanding for the period. Diluted net
income per share (Diluted EPS) reflects the potential dilution that could occur
if stock options or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the Company. At June 30, 2002 there were 995,475
common stock equivalents outstanding which may dilute future earnings per share.
8
NOTE 7 - SEGMENTS
The Company operates in one segment and maintains its records accordingly. Sales
by customer geographic region were as follows:
June 30,
2002 2001
----------- -----------
United States $ 3,494,039 $ 5,523,734
Asia -- --
Australia 18,135 --
Canada 19,921 --
Central America 183,144 --
Europe 429,496 --
South America 7,248 --
----------- -----------
$ 4,151,983 $ 5,523,734
=========== ===========
NOTE 8 - SUBSEQUENT EVENTS
In July 2002, 33,750 common shares were issued upon exercise of options for
gross proceeds of $2.04 per share or $68,850.
In August 2002, the Company amended its Loan and Security Agreement (the
"Agreement") with a commercial lender (the "Lender").
The Lender will advance up to 70% of the Company's eligible accounts receivable,
plus up to 40% of the eligible inventory, plus up to 40% of the commercial
letters of credit opened for the purchase of eligible inventory, less reserves
of up to $1,200,000 as defined in the agreement.
The outstanding loan limit varies between zero and $25,000,000 depending on the
time of year, as stipulated in the Agreement. The Lender also provides the
Company the ability to issue commercial letters of credit up to $2,500,000,
which shall reduce the loan limits above. The loans bear interest at the
commercial lender's prime rate plus 0.5% and an annual fee equal to 1% of the
maximum loan amount or $250,000 is payable. The term of the loan facility
expires on April 26, 2004 and is automatically renewable for one-year terms. All
amounts under the loan facility are due within 90 days of demand. The loans are
secured by a first lien on all present and future assets of the Company except
for certain tooling located at a vendor in China.
The Agreement contains a financial covenant stipulating a minimum tangible net
worth of $16,000,000 as of June 30, 2002 with escalations as defined in the
Agreement. There was no balance outstanding at June 30, 2002.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Quarterly Report on Form 10- Q,
including without limitation, statements containing the words believes,
anticipates, estimates, expects, and words of similar import, constitute
forward-looking statements. You should not place undue reliance on these
forward-looking statements. Our actual results could differ materially from
those anticipated in these forward-looking statements for many reasons,
including the risks faced by us described below and elsewhere in this Quarterly
Report, and in other documents we file with the Securities and Exchange
Commission.
Readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's opinions only as of the
date hereof. We undertake no obligation to revise or publicly release the
results of any revision to these forward-looking statements.
GENERAL
The Singing Machine Company, Inc. and its wholly owned subsidiary,
International (SMC) HK, Ltd.(the "Company," "we" or "us") engages in the
production, distribution, marketing and sale of consumer karaoke audio
equipment, accessories and music. Our electronic karaoke machines and audio
software products are marketed under The Singing Machine(R) trademark.
Our products are sold throughout the United States, primarily through
department stores, lifestyle merchants, mass merchandisers, direct mail catalogs
and showrooms, music and record stores, national chains, specialty stores and
warehouse clubs.
Our karaoke machines and karaoke software are currently sold in such
retail outlets as Best Buy, Toys R Us, Target and J.C. Penney.
We had a net loss before estimated income tax of $1,309,087 for the
three month period ended June 30, 2002. Our working capital as of June 30, 2002,
was approximately $15,386,392.
RESULTS OF OPERATIONS
REVENUES
Revenues for the three months ended June 30, 2002 were $4,151,983,
compared to revenues of $5,523,734 for the three months ended June 30, 2001. One
of our major customers, Toys R Us, changed the timing of their initial orders of
products for the year from June of 2002 to August of 2002. For the three months
ended June 30, 2002 sales to Toys R Us were approximately $827,000.
Comparatively, for the same period in fiscal 2002 we had sales to Toys R Us in
the amount of approximately $3,667,000.
GROSS PROFIT
Gross profit for the three-month period ended June 30, 2002 was
$1,060,470 or 25.5% of sales compared with $1,860,088 or 33.7% of sales for the
first quarter of the prior year. Gross margins decreased because of decreased
music sales and lower profit margins on the sale of our karaoke machines in the
first quarter of fiscal 2003 compared to the first quarter of fiscal 2002. Due
to the concept change of music packaging, the Company delayed the launch of a
new music line until August of 2002. This delay dcontributed to the decrease in
our gross profit margin, as music sales historically maintain a higher gross
profit margin than machine sales.
OPERATING EXPENSES
Operating expenses were $2,381,897 or 57.4% of total revenues, in the
first quarter, up from $1,909,996 or 34.4% of total revenues, in the first
quarter of the prior year. The primary factors that contributed to the increase
in operating expenses are:
(i) the increase in depreciation in the amount of $65,937 due to
the addition of molds for new product additions for fiscal
year 2003,
(ii) compensation expense in the amount of $311,286 due to the
addition of key personnel both here and at our Hong Kong
subsidiary,
(iii) expansion of the California warehouse and its associated
expenses in the amount of $80,000,
(iv) expansion of the Hong Kong subsidiary and its related expenses
in the amount of $104,334.
10
DEPRECIATION AND AMORTIZATION EXPENSES
The Company's depreciation and amortization expenses were $121,047
or 2.7 % of total revenues in the first quarter, up from $41,73732,568 or .7% in
the first quarter of the prior year. The increase in depreciation and
amortization expenses can be attributed to the Company's acquisition of new
molds and tooling for our expanded product line.
OTHER INCOME AND EXPENSES
Net income was $23,956, for the first quarter of fiscal 2002 compared
with net income of $14,515 for the first quarter of the prior year. We generated
income of approximately $13,901 from royalty payments received in Hong Kong for
the use of Company owned mold by third parties during the first quarter of 2002
compared with income of approximately $15,732 during the first quarter of fiscal
2001. Our interest expense decreased during the first quarter of fiscal 2002
compared to the first quarter of fiscal 2001 because we had a zero credit
balance under our credit facility with LaSalle during this time period. Our
interest income increased from $2,475 during the first quarter of 2001 to
$11,604 during the first quarter of fiscal 2002 because we earned income on our
cash balances held by our lender by investing in 24 hour commercial paper
investments.
INCOME BEFORE INCOME TAX EXPENSE
The Company's net loss before income taxes was ($1,309,087) for the
first quarter compared with ($26,393) for the first quarter of the previous
year. This decrease in profit is due primarily to the decrease in sales and
increased salaries expense as discussed in the sections above.
INCOME TAX EXPENSE
The Company files separate tax returns for the parent and for the Hong
Kong Subsidiary.
During the first quarter of fiscal 2002, the Company showed a loss in
both the U.S. parent company and International SMC (HK) Ltd., its wholly-owned
Hong Kong subsidiary. As a result of the annualization of these losses, there
was no accrual for income tax included in the first quarter financial
statements.
NET LOSS
As a result of the foregoing, the Company's net loss was ($1,309,087)
for the first quarter compared with ($26,393) for the first quarter of the prior
year.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2002, the Company had cash on hand of $1,465,174 compared
to cash on hand of $5,520,147 at March 31, 2001. The decrease in cash is a
direct result of purchasing inventory earlier in the year as described below. At
June 30, 2002, the Company had current assets of $20,151,510 and total assets of
$22,007,890 compared to current assets of $20,316,081 and total assets of
$21,664,451 at March 31, 2002. This decrease in current assets is the result of
a reclassification of security deposits to other assets. The increase in total
assets is primarily due to the increase in inventories. We increased our
inventory levels as of June 30, 2002, in anticipation of the potential strike by
longshoremen and other dockworkers on the California seaboard and to prepare for
orders received for shipment in the 2nd quarter of fiscal 2003.
Current liabilities increased to $4,765,118 as of June 30, 2002,
compared to $3,194,377 at March 31, 2002. This increase in current liabilities
is primarily due to the accrual of accounts payable for inventory purchases. At
June 30, 2002, the balance of the credit facility with LaSalle Business Credit
was zero.
The Company's stockholders' equity decreased to $17,242,772 as of June
30, 2002 from $18,470,074 as of March 31, 2002, due to the net loss for the
quarter.
Cash flows used in operating activities were $2,524,018 during the
fiscal quarter ended June 30, 2002. Cash flows were used in operating activities
primarily due to the loss for the quarter of $1,309,087, increase in inventory
in the amount of $3,666,981 and amounts due from a manufacturer in the amount of
$251,909. Other uses were due to the decrease in accrued expenses in the amount
of $784,259 and income taxes payable in the amount of $58,542. Cash flows were
provided by operating activities primarily due to an increase in accounts
payable in the amount of $2,413,542 and a decrease in accounts receivable in the
amount of $924,688, and prepaid expenses in the amount of $87,483. These
decreases are a result of the increased inventory purchases and low sales volume
for the fiscal quarter.
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Cash used in investing activities during the fiscal quarter ended June
30, 2002 was $1,612,740. Cash used in investing activities resulted primarily
from the payment of fixed deposits for letter of credit facilities in the amount
of $1,000,599 and the purchase of fixed assets of $612,141. The purchase of
fixed assets consists primarily of the tooling and molds required for production
of new machines for this fiscal year. Tooling and molds are depreciated over
three years.
Cash flows provided by financing activities were $81,785 during the
period ended June 30, 2002. This consisted of proceeds from the exercise of
warrants and options. As the credit line at LaSalle National Bank was zero for
the entire quarter, there were no loan proceeds or repayments.
The Company expects that its capital needs will increase during fiscal
2003. Our capital needs stem primarily from our need to purchase sufficient
levels of inventory for the Christmas season. Our principal sources of capital
in the next twelve months include our operating cash flows, borrowings under our
credit facility with LaSalle and advances made under three letters of credit
issued to our factories. Our credit facility with LaSalle has been amended to
provide us with up to $25 million in financing depending upon the time of the
year. We believe this will help us to meet our capital needs for fiscal 2003.
We entered into a credit facility with LaSalle in April 2001. This
facility was amended in August of 2002 to increase our credit line. Under this
credit facility, LaSalle will advance up to 70% of the Company's eligible
accounts receivable, plus up to 40% of eligible inventory, plus up to 40% of
commercial letters of credit issued by LaSalle minus reserves as set forth in
the loan documents. The credit facility is subject to loan limits from zero to
$25,000,000 depending on the time of the year, as stipulated in the loan
documents. Advances made under the credit facility bear interest at LaSalle's
prime rate plus .5%. There is also an annual fee of 1% of the loan maximum, or
$250,000. The credit facility expires on April 26, 2004 and is automatically
renewable for one-year terms thereafter. Under the terms of the credit facility,
the Company is required to maintain certain financial ratios and conditions. The
loan contains a clean up period every 12 months where the loan amount must go to
zero for a period of time. The loan is secured by a first lien on all present
and future assets of the Company, except certain tooling located in China.
Our Hong Kong subsidiary, International SMC, maintains a letter of
credit facility with the Hong Kong Shanghai Banking Corporation ("HSBC"). The
facility requires International SMC to maintain a separate deposit account in
the amount of $513,684. This amount is included in deposits at March 31, 2002.
During April and May 2002, HSBC agreed to issue International SMC two
documentary letters of credit to finance its purchases of karaoke machines from
our factories. One letter of credit provides for advances of up to $200,000 per
draw, provided that the total drawings do not exceed $2 million. The other
letter of credit is for $1 million. These letters of credit expire on December
21, 2002 and November 30, 2002, respectively and our factories are the
beneficiaries. In June 2002, International SMC obtained a $1 million documentary
letter of credit from Fortis Bank, formerly known as Belgian Bank, Hong Kong, a
subsidiary of Generale Bank, Belgium. This letter of credit expires on December
6, 2002 and one of our factories is the beneficiary.
International SMC also has use of a $500,000 credit facility from
Fortis Bank. This facility is a revolving line based upon drawing down a maximum
of 15% of the value of export letters of credit held by Fortis Bank. There is no
maturity date except that Fortis Bank reserves the right to revise the terms and
conditions at the Bank's discretion. The cost of this credit facility is the
U.S. Dollar prime rate plus 1.25%. Repayment of principal plus interest shall be
made upon negotiation of the export letters of credit, but not later than ninety
(90) days after the advance. This credit facility is not currently in use and
the terms are being renegotiated.
During the first quarter, we entered into an agreement with a retail
customer, whereby we guaranteed the customer a minimum gross margin of
$3,573,000 from the sale of the Company's products during the period from
September 1, 2002 through January 1, 2003. The agreement also provides that the
Company will deliver the goods to the customer on a consignment basis. Under
this agreement, the Company will reimburse the customer for the difference
between the customer's gross margin on sales and the minimum guarantee. The
Company would have a total exposure of $3,537,000, in the event that there were
no sales of the Company's products made by the retail customer during this
period. The customer has provided the Company with initial sell through
statistics on our product. Based on this information, management believes that
this agreement will not have a material effect on the Company.
As of June 30, 2002, we do not have any material commitments for
capital expenditures, other than (i) our obligation to make certain guaranteed
minimum royalty payments in the amount of $450,000 under our licensing agreement
with Nickelodeon, (ii) our lease for our warehouse space in California and (iii)
our purchases of inventory from certain factories in China. We also have
contractual obligations under our real estates leases in Florida, Hong Kong and
California. Except for the foregoing, we do not have any present commitment that
is likely to result in our liquidity increasing or decreasing in any material
way. In addition, except for the Company's need for additional capital to
finance inventory purchases, the Company knows of no trend, additional demand,
event or uncertainty that will result in, or that is reasonably likely to result
in, the Company's liquidity increasing or decreasing in any material way.
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SEASONAL AND QUARTERLY RESULTS
Historically, the Company's 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 second and third quarter, combined, accounted for
approximately 81% of net sales in fiscal 2002 and 75% of net sales in fiscal
2001.
The Company's 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, as well as other factors. The fulfillment of orders can therefore
significantly affect results of operations on a quarter-to-quarter basis.
INFLATION
Inflation has not had a significant impact on the Company's operations.
The Company has historically passed any price increases on to its customers
since prices charged by the Company are generally not fixed by long-term
contracts.
CRITICAL ACCOUNTING POLICIES
The U.S. Securities and Exchange Commission defines critical accounting
policies as "those that are both most important to the portrayal of a company's
financial condition and results, and require management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain". Preparation of our
financial statements involves the application of several such policies. These
policies include: estimates of accruals for product returns, the realizability
of the deferred tax asset, calculation of our allowance for doubtful accounts
and the Hong Kong income tax exemption.
Accrual for product returns. We regularly receive requests from our
customers for product returns. Our accrual amount is based on historical
experience and is recorded as a reduction of sales and costs of sales and as a
liability equal to the resulting gross profit on the estimated returns. At June
30, 2002, the accrual was approximately $94,000.
Realizability of Deferred Tax Asset. We eliminated our valuation
allowance on the deferred tax asset since we determined that it is more likely
than not that the deferred tax asset will be realized.
Estimate for Doubtful Accounts. We estimate an allowance for doubtful
accounts using the specific identification method since a majority of accounts
receivable are concentrated with several customers whose credit worthiness is
evaluated periodically by us. The allowance was $12,022 at June 30, 2002.
Hong Kong Income Tax Exemption. We estimated that the Hong Kong income
tax to be zero based on our assessment of the probability that the application
for the Hong Kong income tax exemption would be approved.
In addition to the above policies, several other policies, including
policies governing the timing of revenue recognition, are important to the
preparation of our financial statements, but do not meet the definition of
critical accounting policies because they do not involve subjective or complex
judgments.
RISK FACTORS
Set forth below and elsewhere in this Quarterly Report on Form 10-Q and
in the other documents we file with the SEC, including but not limited to our
Annual Report on Form 10-KSB, 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.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
WE RELY ON SALES TO A LIMITED NUMBER OF KEY CUSTOMERS WHICH ACCOUNT FOR A LARGE
PORTION OF OUR NET SALES
As a percentage of total revenues, our net sales to our five largest customers
during the fiscal period ended June 30, 2002 and 2001 were approximately 77.7%
and 97% respectively. In the first quarter of fiscal 2003, two major customers
accounted for 38.5% and 16.9% of our net sales. Although we have
long-established relationships with many of our customers, we do not have
long-term contractual arrangements with any of them. A substantial reduction in
or termination of orders from any of our largest customers could adversely
affect our business, financial condition and results of operations. In addition,
pressure by large customers seeking price reductions, financial incentives,
changes in other terms of sale or requesting that we bear the risks and the cost
of carrying inventory, such as consignment agreements, could adversely affect
our business, financial condition and results of operations. The Company has
significantly broadened their base of customers, decreasing the amount of
reliance on their largest customers. If one or more of our major customers were
to cease doing business with us, significantly reduced the amount of their
purchases from us or returned substantial amounts of our products, it could have
a material adverse effect on our business, financial condition and results of
operations.
13
OUR LICENSING AGREEMENT WITH MTV IS IMPORTANT TO OUR BUSINESS
We generated $23,354,270, or 37.8% of our net sales, in fiscal 2002
from our sales of MTV licensed merchandise. Management values this license with
MTV and desires to continue this licensing relationship. If the MTV license were
to be terminated or failed to be renewed, our business, financial condition and
results of operations could be adversely affected. However, management believes
that our company has developed a strong brand name in the karaoke industry and
that it will be able to continue to develop and grow its business, even if the
MTV licensing relationship did not exist. The Company and MTV are currently
negotiating an extension of this agreement.
INVENTORY MANAGEMENT AND CONSIGNMENT AGREEMENTS
Because of our reliance on manufacturers in the Far East, our
production lead times are relatively long. Therefore, we must commit to
production in advance of customers orders. If we fail to forecast customers or
consumer demand accurately we may encounter difficulties in filling customer
orders or liquidating excess inventories, or may find that customers are
canceling orders or returning products. Distribution difficulties may have an
adverse effect on our business by increasing the amount of inventory and the
cost of storing inventory. Recently, we have entered into consignment agreements
with two or our customers, which may make it more difficult to manage our
inventory. During the fourth quarter of fiscal 2002, Best Buy began taking our
goods on a consignment basis. In the first quarter of fiscal 2003, we entered
into a consignment and revenue guarantee agreement with a retail customer for
sale of the company's products during the period from September 1, 2002 through
January 1, 2003. Additional changes in retailer inventory management strategies
could make inventory management more difficult. Any of these results could have
a material adverse effect on our business, financial condition and results of
operations.
OUR INABILITY TO COMPETE AND MAINTAIN OUR NICHE IN THE ENTERTAINMENT INDUSTRY
COULD HURT OUR BUSINESS
The business in which we are engaged is highly competitive. Our major
competitors for karaoke machines and related products are Grand Prix, JVC,
Memorex and Pioneer Corp. We believe that competition for karaoke machines is
based primarily on price, product features, reputation, delivery times, and
customer support. Our primary competitors for producing karaoke music are Pocket
Songs and Sound Choice. We believe that competition for karaoke music is based
primarily on popularity of song titles, price, reputation, and delivery times.
We believe that our new product introductions and enhancements of
existing products are material factors for our continued growth and
profitability. In fiscal 2002, we produced 6 new karaoke machines. However, many
of our competitors are substantially larger and have significantly greater
financial, marketing and operating resources than we have. No assurance can be
given that we will continue to be successful in introducing new products or
further enhancing our existing products.
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 and prerecorded
tapes, CD's and video cassettes.
WE ARE SUBJECT TO SEASONALITY, WHICH IS AFFECTED BY VARIOUS ECONOMIC CONDITIONS
AND CHANGES RESULTING IN FLUCTUATIONS IN QUARTERLY RESULTS
Sales of consumer electronics and toy products in the retail channel
are highly seasonal, causing the substantial majority of our sales to occur
during the second quarter ended September 30 and the third quarter ended
December 31. Sales in our second and third quarter, combined, accounted for
approximately 81% of net sales in fiscal 2002 and 75% of net sales in fiscal
2001.
The seasonal pattern of sales in the retail channel requires
significant use of our working capital to manufacture and carry inventory in
anticipation of the holiday season, as well as early and accurate forecasting of
holiday sales. Failure to predict accurately and respond appropriately to
consumer demand on a timely basis to meet seasonal fluctuations, or any
disruption of consumer buying habits during their key period, would harm our
business and operating results.
Additional factors that can cause our sales and operating results to
vary significantly from period to period include, among others, the mix of
products, fluctuating market demand, price competition, new product
introductions by competitors, fluctuations in foreign currency exchange rates,
disruptions in delivery of components, political instability, general economic
conditions, and the other considerations described in this section entitled Risk
Factors.
WE HAVE SIGNIFICANT FUTURE CAPITAL NEEDS WHICH ARE SUBJECT TO THE UNCERTAINTY OF
ADDITIONAL FINANCING
We have amended our credit facility with LaSalle Business Credit to $25
million. In addition, the Company has attained additional financing in Hong
Kong. Management believes that this financing is sufficient for operations
during fiscal 2003. If this amount is not adequate, we may be unable to sustain
our rapid growth, which would have a material adverse effect on our business,
results of operations, and financial condition.
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A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTERS IN CALIFORNIA AND FLORIDA
OR OUR MANUFACTURING OPERATIONS IN CHINA WOULD IMPACT OUR ABILITY TO DELIVERY
MERCHANDISE TO OUR STORES, WHICH COULD ADVERSELY IMPACT OUR REVENUES AND HARM
OUR BUSINESS AND FINANCIAL RESULTS
A significant amount of our merchandise is shipped to our customers
from one of our two warehouses, which are located in Compton, California and
Coconut Creek, Florida. A disruption in the operation of our warehouse centers
in California and Florida or our manufacturing operations in China would impact
our ability to delivery merchandise to our stores, which could adversely impact
our revenues and harm our business and financial results. 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 adversely
impact our revenues and our business and financial results.
OUR BUSINESS OPERATIONS COULD BE SIGNIFICANTLY DISRUPTED IF THE CALIFORNIA
LONGSHOREMEN GO ON STRIKE
During fiscal 2002, approximately 55% of our sales were domestic sales,
which were made from our warehouses in California and Florida. From June 2002 to
August 10, 2002, longshoremen and other dockworkers represented by the
International Longshore and Warehouse Union, have agreed to work without a
contract by consecutive 24-hour periods. Since we import a significant amount of
karaoke electronic recording equipment from the Far East to California, a strike
of these workers would have a material adverse effect on our business, results
of operations and financial condition. The Company has been purchasing and
receiving a significant amount of inventory so that in the event that the strike
occurs, we will have lessened any resulting loss of profit. However, if we have
not received a sufficient level of inventory, a strike would result in increased
costs to our company and may reduce our profitability in fiscal 2003.
OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD HARM
OUR BUSINESS
We rely principally on four contract ocean carriers to ship virtually
all of the products that we import to our warehouse facility in Compton,
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 or otherwise could significantly harm our
business and reputation.
TERRORISM AND THE UNCERTAINTY OF WAR MAY HARM OUR OPERATING RESULTS
The terrorist attacks of September 11, 2001 have had a negative impact
on various regions of the United States and on a wide range of industries.
Terrorist attacks or acts of war may cause damage or disruption to our
facilities, information systems, vendors, employees and customers, which could
significantly impact our revenues and results of operations. In the future,
fears or recession, war and additional acts of terrorism may continue to impact
the economy and could negatively impact our business.
WE MAY NOT BE ABLE TO SUSTAIN OR MANAGE OUR RAPID GROWTH
We experienced rapid growth in net sales and net income in the last
year. Our net sales for the fiscal year ended March 31, 2002 increased 80.2% to
$61.8 million compared to $34.3 million for the fiscal year ended March 31,
2002. Similarly, our net income increased to $8.06 million for fiscal 2002
compared to $4.6 million for fiscal 2001. As a result, comparing our
period-to-period operating results may not be meaningful, and results of
operations from prior periods may not be indicative of future results. We cannot
assure you that we will continue to experience growth in, or maintain our
present level of, net sales or net income.
Our growth strategy calls for us to continuously develop and diversify
our karaoke products by (i) developing new karaoke machines and music products,
(ii) entering into additional license agreements (iii) expanding into
international markets, (iv) developing new retail customers in the United States
and (v) obtaining additional financing. Our growth strategy will place
additional demands on our management, operational capacity and financial
resources and systems. To effectively manage future growth, we must continue to
expand our operational, financial and management information systems and train,
motive and manage our work force.
In addition, implementation of our growth strategy is subject to risks
beyond our control, including competition, market acceptance of new products,
changes in economic conditions, our ability to maintain our licensing agreements
with MTV and Nickelodeon and our ability to finance increased levels of accounts
receivable and inventory necessary to support our sales growth, if any.
Accordingly, we cannot assure you that our growth strategy will be implemented
successfully.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE
Market prices of the securities of companies in the toy and
entertainment industry are often volatile. The market prices of our common stock
may be affected by many factors, including:
- unpredictable consumer preferences and spending trends;
15
- operating results that vary from the expectations of investors and
securities analysts;
- the actions of our customers and competitors (including new product
line announcements and introduction;
- changes in our pricing policies, the pricing policies of our
competitors and general pricing trends in the consumer and
electronics and toy markets;
- regulations affecting our manufacturing operations in China;
- other factors affecting the entertainment and consumer electronics
industries in general; and
- sales of our common stock into the public market.
In addition, the stock market periodically has experienced significant
price and volume fluctuations which may have been unrelated to the operating
performance of particular companies.
OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE'S REPUBLIC OF CHINA,
SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS
We are dependent upon six factories in the People's Republic of China
to manufacture all of our electronic products. Our arrangements with these
factories are subject to the risks of doing business abroad, such as import
duties, trade restrictions, work stoppages, foreign currency fluctuations,
limitations on the repatriation of earnings, political instability, and other
factors which could have an adverse impact on our business. Furthermore, we have
limited control over the manufacturing processes themselves. As a result, any
difficulties encountered by the 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 business, financial condition and
results of operations. We believe that the loss of any one or more of our
manufacturers would not have a long-term material adverse effect on us because
other manufacturers with whom we do business would be able to increase
production to fulfill our requirements. However, the loss of certain of our
manufacturers, could, in the short-term, adversely affect our business until
alternative supply arrangements were secured.
WE MAY HAVE SIGNIFICANT RETURNS, MARKDOWNS AND PURCHASE ORDER CANCELLATIONS
As is customary in the consumer electronics industry, the Company has,
on occasion, (i) permitted certain customers to return slow-moving items for
credit, (ii) provided price protection to certain customers by making price
reductions effective as to certain products then held by customers in inventory
and (ii) accepted customer cancellations of purchase orders issued to the
Company. The Company expects that it will continue to be required to make such
accommodations in the future. Any significant increase in the amount of returns,
markdowns or purchaser order cancellations could have a material adverse effect
on the Company's results of operations.
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 we
use to manufacture and produce these products. If our suppliers are unable to
provide our factories with the parts and supplies, we will be unable to produce
our products. We cannot guarantee that we will be able to purchase the parts we
need at reasonable prices or in a timely fashion. In the last several years,
there have been shortages of certain chips that we use in our karaoke machines.
We, however, anticipated this shortage and instructed our factories to purchase
the chips in advance. If we are unable to anticipate any shortages of parts and
materials in the future, we may experience severe production problems, which
would impact our sales.
CONSUMER DISCRETIONARY SPENDING MAY AFFECT KARAOKE PURCHASES AND IS AFFECTED BY
VARIOUS ECONOMIC CONDITIONS AND CHANGES
Our business and financial performance may be damaged more than most
companies by adverse financial conditions affecting our business or by a general
weakening of the economy. 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. Adverse economic changes affecting these factors may
restrict consumer spending and thereby adversely affect our growth and
profitability.
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WE MAY BE INFRINGING UPON THE COPYRIGHTS OF THIRD PARTIES
Each song in our catalog is licensed to us for specific uses. Because
of the numerous variations in each of our licenses for copyrighted music, there
can be no assurance that we have complied with scope of each of our licenses and
that our suppliers have complied with these licenses. Additionally, third
parties over whom we exercise no control may use our sound recordings in such a
way that is contrary to our license agreement and by violating our license
agreement we may be liable for contributory copyright infringement. Any
infringement claims may have a negative effect on our ability to sell products.
WE HAVE SIGNIFICANT RELIANCE ON LARGE RETAILERS WHICH ARE SUBJECT TO CHANGES IN
THE ECONOMY
We sell products to retailers, including department stores, lifestyle
merchants, direct mail retailers which are catalogs and showrooms, national
chains, specialty stores, and warehouse clubs. Certain of such retailers have
engaged in leveraged buyouts or transactions in which they incurred a
significant amount of debt, and some are currently operating under the
protection of bankruptcy laws. Despite the difficulties experienced by retailers
in recent years, we have not suffered significant credit losses to date.
Deterioration in the financial condition of our customers could have a material
adverse effect on our future profitability.
OUR NET INCOME MAY BE REDUCED IF OUR HONG KONG SUBSIDIARY DOES NOT RECEIVE AN
EXEMPTION FOR OFFSHORE INCOME TAX
Our Hong Kong subsidiary has applied for a Hong Kong "offshore claim"
income tax exemption based on the locality of the profits of the Hong Kong
subsidiary. Management believes that since the source of all profits of the Hong
Kong subsidiary are from exporting to customers outside of Hong Kong, it is
likely that the exemption will be approved. Accordingly, no provision for
foreign income taxes has been provided in the Company's financial statements. In
the event the exemption is not approved, the Hong Kong subsidiary's profits will
be taxed at a flat rate of 16% resulting in an income tax expense of
approximately $725,000 and $460,000 for fiscal 2002 and 2001.
OUR BUSINESS OPERATIONS COULD BE SIGNIFICANTLY DISRUPTED IF WE LOSE MEMBERS OF
OUR MANAGEMENT TEAM
Our success depends to a significant degree upon the continued
contributions of our executive officers, both individually and as a group.
Although we have entered into employment contracts with Edward Steele, our Chief
Executive Officer; John Klecha, our President, Chief Operating Officer; and Jack
Dromgold, our Executive Vice President of Sales and Marketing, the loss of the
services of any of these individuals could prevent us from executing our
business strategy. We cannot assure you that we will be able to find appropriate
replacements for Edward Steele, John Klecha or Jack Dromgold, if the need should
arise, and any loss or interruption of Mr. Steele, Mr. Klecha or Mr. Dromgold's
services could adversely affect our business, financial condition and results of
operations. Mr. Steele will be retiring in February 2003; however, we expect to
retain him as a consultant on product development for a period of at least
one-year after his retirement.
OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS.
Our employment agreements with Eddie Steele, John Klecha, April Green
and Jack Dromgold require us, under certain conditions, to make substantial
severance payments to them if they resign after a change of control. These
provisions could delay or impede a merger, tender, offer or other transaction
resulting in a change in control of the Company, even if such a transaction
would have significant benefits to our shareholder. As a result, these
provisions could limit the price that certain investors might be willing to pay
in the future for shares of our common stock.
WE MAY BE SUBJECT TO CLAIMS FROM THIRD PARTIES FOR UNAUTHORIZED USE OF THEIR
PROPRIETARY TECHNOLOGY, COPYRIGHTS OR TRADE SECRETS
We believe that we independently developed the technology used in our
electronic and audio software products and that it does not infringe on the
proprietary rights, copyrights or trade secrets of others. However, we cannot
assure you that we have not infringed on the proprietary rights of third parties
or those third parties will not make infringement violation claims against us.
Any infringement claims may have a negative effect on our ability to manufacture
our products.
YOUR INVESTMENT MAY BE DILUTED
If additional funds are raised through the issuance of equity
securities, your percentage ownership in our equity will be reduced. Also, you
may experience additional dilution in net book value per share, and these equity
securities may have rights, preferences, or privileges senior to those of yours.
RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS MAY DEPRESS OUR
STOCK PRICE
As of June 30, 2002, there were 8,089,027 shares of our common stock
outstanding. We have filed two registration statements registering an aggregate
4,792,234 of shares of our common stock (a registration statement on Form S-3
registering the resale of 2,947,984 shares or our common stock and a
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registration statement on Form S-8 to registering the sale of 1,844,250 shares
underlying options granted under our 1994 Stock Option Plan). We also intend to
file a registration statement on Form S-8 to register 1,950,000 shares of our
common stock underlying options granted under our Year 2001 Stock Option Plan.
The market price of our common stock could drop due to the sale of large number
of shares of our common stock, such as the shares sold pursuant to the
registration statements or under Rule 144, or the perception that these sales
could occur.
ADVERSE EFFECT ON STOCK PRICE FROM FUTURE ISSUANCES OF ADDITIONAL SHARES
Our Certificate of Incorporation authorizes the issuance of 18,900,000
million shares of common stock. As of June 30, 2002, we had 8,089,027 shares of
common stock issued and outstanding and an aggregate of 995,475 outstanding
options and warrants. As such, our Board of Directors has the power, without
stockholder approval, to issue up to 9,815,498 shares of common stock.
Any issuance of additional shares of common stock, whether by us to new
stockholders or the exercise of outstanding warrants or options, may result in a
reduction of the book value or market price of our outstanding common stock.
Issuance of additional shares will reduce the proportionate ownership and voting
power of our then existing stockholders.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY MAKE IT DIFFICULT FOR A
THIRD PARTY TO ACQUIRE OUR COMPANY AND COULD DEPRESS THE PRICE OF OUR COMMON
STOCK.
Delaware law and our certificate of incorporation and bylaws contain
provisions that could delay, defer or prevent a change in control of our company
or a change in our management. These provisions could also discourage proxy
contests and make it more difficult for you and other stockholders to elect
directors and take other corporate actions. These provisions of our restated
certificate of incorporation include: authorizing our board of directors to
issue additional preferred stock, limiting the persons who may call special
meetings of stockholders, and establishing advance notice requirements for
nominations for election to our board of directors or for proposing matters that
can be acted on by stockholders at stockholder meetings.
We are also subject to certain provisions of Delaware law that could
delay, deter or prevent us from entering into an acquisition, including the
Delaware General Corporation Law, which prohibits a Delaware corporation from
engaging in a business combination with an interested stockholder unless
specific conditions are met. The existence of these provisions could limit the
price that investors are willing to pay in the future for shares of our common
stock and may deprive you of an opportunity to sell your shares at a premium
over prevailing prices.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company does not hold any investments in market risk sensitive
instruments. Accordingly, the Company believes that it is not subject to any
material risks arising from changes in interest rates, foreign currency exchange
rates, commodity prices, equity prices or other market changes that affect
market risk instruments
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceeding, nor to the
knowledge of management are any legal proceedings threatened against the
Company. From time to time, the Company may be involved in litigation relating
to claims arising out of operations in the normal course of business.
ITEM 2. CHANGES IN SECURITIES
(a) Not Applicable.
(b) Not Applicable.
(c) During the three month period ended June 30, 2002, one employee exercised
stock options issued under our 1994 Amended and Restated Management Stock Option
Plan. The employee exercised options to acquire an aggregate of 16,500 shares of
our common stock. The names of the option holder, the dates of exercise, the
number of shares purchased, the exercise price and the proceeds received by the
Company are listed below.
Date of No. of Exercise
Name Exercise Shares Price Proceeds
- ---------- ----------- --------- ---------- -----------
Alicia Haskamp 04/06/02 16,500 $2.04 $33,660
18
Ms. Haskamp paid for the shares with cash. Ms. Haskamp exercised her options in
reliance upon Section 4(2) of the Securities Act of 1933, because she was
knowledgeable, sophisticated and had access to comprehensive information about
the Company. The shares issued to our employees were registered under the
Securities Act on a registration statement on Form S-8. As such, no restrictive
legends were placed on the shares.
During the three month period ended June 30, 2002, one warrant holder exercised
their warrants to acquire an aggregate of 52,500 shares of our common stock. The
name of the warrant holder, the date of exercise, the number of shares
purchased, the exercise price and the proceeds received by the Company are
listed below.
Date of No. of Exercise
Name Exercise Shares Price Proceeds
- ---------- ----------- --------- ---------- ----------
FRS Investments 05/17/02 52,500 $0.9167 $ 48,125
FRS paid for its shares with cash. FRS exercised its warrants in reliance upon
Section 4(2) of the Securities Act of 1933, because it was knowledgeable,
sophisticated and had access to comprehensive information about the Company. The
Company placed legends on the certificates stating that the securities were not
registered under the Securities Act and set forth the restrictions on their
transferability and sale. We have registered these shares for resale on a
registration statement on Form S-3.
(d) Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certifying Statement of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
99.2 Certifying Statement of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
The Company did not file any Report on Form 8-K during the three months ended
June 30, 2002.
19
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE SINGING MACHINE COMPANY, INC.
/s/ April J. Green
-----------------------------
April J. Green
Chief Financial Officer
(On behalf of Registrant and
Chief Accounting Officer)
August 14, 2002
20
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
99.1 Certifying Statement of the Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes- Oxley Act of 2002
99.2 Certifying Statement of the Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002