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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
Commission File Number 0-24968
THE SINGING MACHINE COMPANY, INC.
(Exact Name of Registrant as Specified in its Charter)
Delaware 95-3795478
-------- ----------
(State of Incorporation ) (IRS Employer I.D. No.)
6601 Lyons Road, Building A-7, Coconut Creek, FL 33073
(Address of principal executive offices)
(954) 596-1000
(Registrant's telephone number, including area code)
Indicate whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PRECEDING FIVE YEARS
Indicate whether the registrant has filed all documents and reports required to
be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a court.
[x] Yes [ ] No
APPLICABLE ONLY TO CORPORATE ISSUERS
There were 8,123,303 shares of Common Stock, $.01 par value, issued and
outstanding at September 30, 2002.
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Page No.
--------
Consolidated Balance Sheets - September 30, 2002 (Unaudited)
and March 31, 2002 .............................................. 3
Consolidated Statement of Operations - Three and six months
ended September 30, 2002 and 2001 (Unaudited).................... 4
Consolidated Statement of Cash Flows - Six months ended
September 30, 2002 and 2001 (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
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................... 16
Item 2. Changes in Securities and Use of Proceeds........................ 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
CERTIFICATIONS
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
September 30, 2002 March 31, 2002
------------------ --------------
(unaudited)
Assets
------
Current Assets
Cash and cash equivalents $ 658,436 $ 5,520,147
Accounts receivable, net 14,383,100 3,536,903
Due from manufacturer 10,767 488,298
Inventories 31,382,386 9,274,352
Prepaid expenses and other current assets 813,130 982,697
Deposits 1,516,666 513,684
----------- -----------
Total Current Assets 48,764,485 20,316,081
----------- -----------
Property and Equipment, Net 1,289,355 574,657
----------- -----------
Other Assets
Security deposits 150,597 135,624
Reorganization intangible, net 185,416 185,416
Deferred tax asset 452,673 452,673
----------- -----------
Total Other Assets 788,686 773,713
----------- -----------
Total Assets $50,842,526 $21,664,451
=========== ===========
Liabilities and Stockholders' Equity
------------------------------------
Current Liabilities
Accounts payable $18,247,003 $ 1,846,238
Accrued expenses 2,261,136 1,289,597
Loan payable 8,043,272 --
Income tax payable 39,649 58,542
----------- -----------
Total Current Liabilities 28,591,060 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,
8,123,303 and 8,020,027 shares issued and outstanding 81,233 80,200
Additional paid-in capital 4,753,548 4,602,828
Retained earnings 17,416,685 13,787,046
----------- -----------
Total Stockholders' Equity 22,251,466 18,470,074
----------- -----------
Total Liabilities and Stockholders' Equity $50,842,526 $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 Six Months Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------ ------------ ------------ ----------------
Net Sales $ 32,976,624 $ 15,749,241 $ 37,128,635 $ 21,272,851
Cost of Sales 23,560,826 10,438,974 26,652,358 14,101,529
------------ ------------ ------------ ------------
Gross Profit 9,415,798 5,310,267 10,476,277 7,171,322
------------ ------------ ------------ ------------
Operating Expenses
Compensation 799,406 811,345 1,570,304 1,270,957
Commissions 434,753 341,016 545,421 488,800
Advertising 706,845 617,653 872,610 846,557
Royalty expense 806,800 281,389 874,630 405,630
Selling, general, & administrative 1,764,382 1,018,391 2,985,564 1,865,905
expenses
------------ ------------ ------------ ------------
Total Operating Expenses 4,512,186 3,069,794 6,848,529 4,877,849
------------ ------------ ------------ ------------
Income from Operations 4,903,612 2,240,473 3,627,748 2,293,473
------------ ------------ ------------ ------------
Other Income (Expenses)
Other Income 144,119 125,339 163,564 143,057
Interest Expense (109,344) (34,465) (122,509) (134,037)
Interest Income 339 28 11,943 2,475
------------ ------------ ------------ ------------
Net Other Expenses 35,114 90,902 52,998 11,495
------------ ------------ ------------ ------------
Income Before Income Tax Provision 4,938,726 2,331,375 3,680,746 2,304,968
Income Tax Provision (51,107) (6,000) (51,107) (12,000)
------------ ------------ ------------ ------------
Net Income $ 4,887,619 $ 2,325,375 $ 3,629,639 $ 2,292,968
============ ============ ============ ============
Earnings per Share:
Basic $ .60 $ .34 $ .45 $ .34
============ ============ ============ ============
Diluted $ .55 $ .29 $ .41 $ .28
============ ============ ============ ============
Weighted Average Common and Common
Equivalent Shares
Outstanding:
Basic 8,119,026 6,775,655 8,090,102 6,682,286
============ ============ ============ ============
Diluted 8,881,970 7,984,671 8,899,023 8,066,089
============ ============ ============ ============
See accompanying notes to financial statements
4
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended
September 30,
2002 2001
------------ ------------
Cash Flow from Operating Activities:
Net Income $ 3,629,639 $ 2,292,967
Adjustments to reconcile net income to net cash provided by (used in)
operating activities
Depreciation and amortization 289,134 68,941
Stock based expenses -- 171,472
Bad debt -- --
Deferred tax benefit -- 45,816
Changes in assets and liabilities:
(Increase) decrease in:
Accounts receivable (10,846,197) (6,286,093)
Due from manufacturer 477,531 3,198,318
Inventories (22,108,034) (5,380,989)
Prepaid expenses and other assets 154,594 (538,864)
Increase (decrease) in:
Accounts payable 16,400,765 2,869,838
Accrued expenses 971,539 3,239,166
Income taxes payable (18,893) (23,320)
------------ ------------
Net Cash Provided by (Used in) Operating Activities (11,049,922) (342,748)
------------ ------------
Cash Flow from Investing Activities
Purchase of property and equipment (1,003,832) (101,973)
Deposit for credit line (1,002,982) (256,008)
Proceeds from investment in factor -- 933,407
Proceeds from repayment of officer loans -- 117,425
Investment in and advances to unconsolidated subsidiary -- 106,193
------------ ------------
Net Cash Provided by (Used in) Investing Activities (2,006,814) 799,044
------------ ------------
Cash Flow from Financing Activities
Loan proceeds 21,665,040 3,879,288
Loan repayments (13,621,768) (3,309,777)
Proceeds from exercise of stock options and warrants 151,753 380,740
------------ ------------
Net Cash Provided by (Used in) Financing Activities 8,195,025 950,251
------------ ------------
Increase in Cash and Cash Equivalents (4,861,711) 1,406,547
Cash and Cash Equivalents - Beginning of Period 5,520,147 1,016,221
------------ ------------
Cash and Cash Equivalents - End of Year $ 658,436 $ 2,422,768
============ ============
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for interest $ 57,383 $ 38,157
============ ============
Cash paid during the year for income taxes $ 51,107 $ 23,320
============ ============
See accompanying notes to consolidated financial statements
5
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(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 had 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
6
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.
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.
Statement No. 146, "Accounting for Exit or Disposal Activities" ("SFAS 146")
addresses the recognition, measurement, and reporting of cost that are
associated with exit and disposal activities that are currently accounted for
pursuant to the guidelines set forth in EITF 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to exit an Activity
(including Certain Cost Incurred in a Restructuring)," cost related to
terminating a contract that is not a capital lease and one-time benefit
arrangements received by employees who are involuntarily terminated - nullifying
the guidance under EITF 94-3. Under SFAS 146, the cost associated with an exit
or disposal activity is recognized in the periods in which it is incurred rather
than at the date the Company committed to the exit plan. This statement is
effective for exit or disposal activities initiated after December 31, 2002 with
earlier application encouraged. The adoption of SFAS 146 is not expected to have
a material impact on the Company's financial position or result of operations.
Certain amounts in the September 30, 2001 interim consolidated financial
statements have been reclassified to conform to the September 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 September 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
$1,516,666. This amount is included in deposits at September 30, 2002.
NOTE 3 - LOANS AND LETTERS OF CREDIT
In August 2002, the Company amended its Loan and Security Agreement (the
"Agreement" or "credit facility") 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 $1,000,000 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 credit facility also provides
the Company with the ability to obtain commercial letters of credit of up to
$2,500,000, which reduces the loan limits set forth 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. which is $250,000. The term of
7
the credit facility expires on April 26, 2004 and is automatically renewable for
one-year terms. All amounts under the credit 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 $14,250,000 from September 30, 2002 to October 30, 2002 with
escalations after this point as defined in the Agreement.
The outstanding balance under the credit facility at September 30, 2002, was
$8,043,272.
NOTE 4 - EQUITY
Stock options and warrants were exercised during the second quarter of fiscal
year 2003. 34,350 shares of common stock were issued with proceeds to the
Company of $70,074. The total of stock options and warrants exercised for the
six month period ended September 30, 2002 were 103,350 shares with a total
proceeds to the Company of $151,859.
On August 15, 2002, 50,000 stock options were granted at the then current stock
price of $8.61 to our executive vice president of sales and marketing as per his
employment contract. On September 11, 2002, the outside directors of the Company
were each issued 30,000 common stock options (90,000 options total) at the then
current stock price of $11.09. Pursuant to APB no. 25, no compensation expense
will be recognized.
NOTE 5 - COMMITMENTS
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
provides for a salary and bonuses and a 50% of annual pay severance clause. The
agreement grants 50,000 options to the employee. After his first year of
employment, the employee may elect to return the first year options to the
Company or one of its representatives for $100,000.
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.
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 inventory is being held by the customer on a consignment basis.
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.
Effective September 1, 2002, the Company signed an additional 24 month lease to
expand its corporate headquarters. The additional rent is $1,980 per month.
NOTE 6 - CONCENTRATIONS
The Company derives the majority 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 September 30, 2002, 51.8% of accounts receivable
were due from three U.S. customers and two foreign customers. Accounts
receivable from three customers that individually owed over 10% of accounts
receivable at September 30, 2002 was 12.9%, 11.0% and 10.3%. The Company
performs ongoing credit evaluations of its customers and generally does not
require collateral.
8
Revenues derived from five customers for the six months ended September 30, 2002
and 2001were 69.4% and 94%. Revenues derived from two customers for the six
months ended September 30, 2002 and 2001, respectively, which individually
purchased greater than 10% of the Company's total revenues, were 32% and 11% for
the six months ended September 30, 2002 and 79% and 32% for the six months ended
September 30, 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. As of September 30, 2002
this customer was still on a consignment basis with all but two products.
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 six months ended September
30, 2002, purchases of product were derived from seven factories based in China.
The Company finances its sales primarily through a credit 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 $29,322,407 for the six months ended September 30, 2002 and
$17,654,747 for the same period in 2001. The carrying value of net assets held
by the Company's Hong Kong based subsidiary was approximately $12,454,151 at
September 30, 2002.
NOTE 7 - 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 September 30, 2002 there were
1,101,125 common stock equivalents outstanding which may dilute future earnings
per share.
NOTE 8 - SEGMENTS
The Company operates in one segment and maintains its records accordingly. Sales
by customer geographic region were as follows:
September 30,
2002 2001
----------- -----------
United States $29,450,108 $21,241,045
Asia -- 24,657
Australia 242,652 --
Canada 19,921 2,250
Central America 68,673 4,789
Europe 6,800,801 --
Mexico 546,480 --
South America -- 110
----------- -----------
$37,128,635 $21,272,851
=========== ===========
NOTE 9 - SUBSEQUENT EVENTS
On November 4, 2002, a customer that provided 5% of the Company's revenue for
the six months ended September 30, 2002 converted its purchase method to a
consignee basis. The Company recorded approximately $858,839 of sales returns
and reversal of related cost of sales of $641,285 in September and the customer
retained the inventory on a consignment basis. This agreement is effective as of
October 30, 2002. No future shipments to this customer will be included in this
consignment agreement.
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, J.C. Penney and Circuit City.
We had net income of $3,629,639 for the six month period ended September 30,
2002. Our working capital as of September 30, 2002, was $20,173,425.
RESULTS OF OPERATIONS
REVENUES
Revenues for the three months ended September 30, 2002 were $32,976,624,
compared to revenues of $15,749,241 for the three months ended September 30,
2001. Revenues for the six months ended September 30, 2002 and 2001 were
$37,128,635 and $21,272,851, respectively. Our revenue increase is due not only
to increased sales to our historical customer base, but also to the addition of
new customers. Our new customers include Circuit City and K-Mart.
GROSS PROFIT
Gross profit for the three-month period ended September 30, 2002 was $9,415,798
or 28.6% of sales compared with $5,310,267 or 33.7% of sales for the second
quarter of the prior year. Gross profit for the six months ended September 30,
2002 was $10,476,277 or 28.2% of sales compared with $7,171,322 or 33.7% of
sales for the six months ended September 30, 2001. The decrease in gross profit
is primarily due to increased sales from our subsidiary and sales to
international customers. Sales to international customers historically maintain
a lower gross profit, but there are no other variable expenses from these sales.
Other variable expenses that are normally included with sales are advertising
allowances, returns and commissions.
OPERATING EXPENSES
Operating expenses were $4,512,186 or 13.7% of total revenues, in the second
quarter, up from $3,069,794 or 19.5% of total revenues, in the second quarter of
the prior year. For the six months ended September 30, 2002 and 2001, operating
expenses were $6,848,529 or 18.4% and $4,877,849 or 22.9%, respectively.
Although operating expenses increased in dollar value, as compared to revenues,
they decreased materially as a percentage of sales.
10
The primary factors that contributed to the increase in operating expenses for
the six months ended September 30, 2002 are:
(i) the increase in depreciation in the amount of $186,170 due to the
addition of molds for new product additions for fiscal year 2003,
(ii) compensation expense in the amount of $299,347 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 $241,648,
(iv) expansion of the Hong Kong subsidiary and its related expenses in the
amount of $367,218.
Other increases in operating expenses were to selling expenses, which are
considered variable. These expenses are based directly on the level of sales and
include: commissions, direct advertising, and royalty expenses. These areas
alone contributed $643,355 to the increase in operating expenses.
DEPRECIATION AND AMORTIZATION EXPENSES
The Company's depreciation and amortization expenses were $300,863 or .8 % of
total revenues for the six months ended September 30, 2002, up from $114,693 or
..5% for the six months ended September 30, 2001. 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
Other income net of other expenses was $35,114, for the second quarter of fiscal
2003 and $52,998 for the six months ended September 30, 2002. We generated
income of approximately $111,841 from royalty payments received in Hong Kong for
the use of Company owned mold by third parties during the first six months of
fiscal 2003 compared with income of approximately $93,904 during the same period
of fiscal 2002. Our interest expense decreased for the six months ended
September 30, 2002 as compared to the same period of the prior year primarily
due to the decreased level of borrowing required under our credit facility with
LaSalle during this period at a significantly lower prime rate. Prior to August
2002, the Company had cash reserves to fund operations and did not need to
borrow on the line. Our interest income increased from $2,475 during the six
months ended September 30, 2001, to $11,943 during the first six months of
fiscal 2003 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 income before income taxes was $3,680,746 for the six months
ended September 30, 2002 compared with $2,304,968 for the same period of the
prior year.
INCOME TAX EXPENSE
The Company files separate tax returns for the parent and for the Hong Kong
Subsidiary.
During the first two quarters of fiscal 2003, the Company showed a loss in the
U.S. parent company and a profit in International SMC (HK) Ltd., its
wholly-owned Hong Kong subsidiary. As a result of the annualization of these
losses, there was no accrual for federal income tax included in the financial
statements. There was an accrual for state income taxes based on these numbers.
NET INCOME
As a result of the foregoing, the Company's net income was $3,629,639 for the
first six months of fiscal 2003 compared with $2,292,968 for the first six
months of the prior year.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2002, the Company had cash on hand of $658,436 compared to
$5,520,147 at March 31, 2002. The decreased cash is a direct result of
purchasing inventory. At September 30, 2002, the Company had current assets of
$48,764,485 and total assets of $50,842,526 compared to current assets of
$20,316,081 and total assets of $21,664,451 at March 31, 2002. The increase in
current assets is the result of increased accounts receivable and inventory to
support sales for the second and third quarter of fiscal 2003. The increase in
total assets is due to the increase in accounts receivable, inventory and fixed
assets.
Current liabilities increased to $28,591,060 as of September 30, 2002, compared
to $3,194,377 at March 31, 2002. This increase in current liabilities is
primarily due to increased accounts payable for inventory purchases. At
11
September 30, 2002, the balance of the credit facility with LaSalle Business
Credit was $8,043,272.
The Company's stockholders' equity increased to $22,251,466 as of September 30,
2002 from $18,470,074 as of March 31, 2002, due primarily to the net income for
the quarter.
Cash flows used in operating activities were $11,049,922 during the six months
ended September 30, 2002. Cash flows were used in operating activities primarily
due to the increase in inventory in the amount of $22,108,034, accounts
receivable in the amount of $10,846,197 and an income tax payable accrual of
$18,893. Cash flows were provided by operating activities due to the increase in
accrued expenses in the amount of $971,539, an increase in accounts payable in
the amount of $16,400,765, a decrease in amounts due from a manufacturer in the
amount of $477,531 and a decrease in prepaid expenses and other assets in the
amount of 154,594. The increased inventory was partially offset by the increase
in accounts payable which funded this inventory.
Cash used in investing activities during the six months ended September 30, 2002
was $2,006,814. Cash used in investing activities resulted primarily from the
payment of fixed deposits for letter of credit facilities in the amount of
$1,002,982 and the purchase of fixed assets of $1,003,832. 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 a
three year period.
Cash flows provided by financing activities were $8,195,025 during the six
months ended September 30, 2002. This consisted of proceeds from the exercise of
warrants and options in the amount of $151,753. The remainder of cash provided
from financing activities was provided by net borrowings on the credit line at
LaSalle National Bank in the amount of $8,043,272.
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. 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 $516,666. The facility also required a $1,000,000 deposit to be restricted in
our regular operating account. This amount is included in deposits at September
30, 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.
12
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. As of September 30, 2002
this customer was still on a consignment basis with all but two products. As of
February 28, 2003, we expect that this consignment agreement will only apply to
the Company's music products and will exclude all of the Company's karaoke
machines.
The Company entered into an agreement with a retail customer in April 2002,
which was amended in July 2002, whereby it 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. Under this agreement, the
Company will reimburse the customer for the difference between the customer's
gross margin on sales and the minimum guarantee. Accordingly, the maximum amount
the Company may be committed to pay is $3,537,000. 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 inventory
held by the customer is on a consignment basis. In September 2002, the customer
provided the Company with initial sell through statistics on its products. Based
on this information received, the Company intends to renegotiate this agreement
and believes that based on the renegotiation, there will be no material impact
to the Company. However, if the Company is not able to renegotiate this
agreement, the Company's total exposure under this agreement would be a maximum
of $3,537,000.
On November 4, 2002, a customer that provided 5% of the Company's revenue for
the six months ended September 30, 2002 converted its purchase method to a
consignee basis. The Company recorded approximately $858,839 of sales returns
and reversal of related cost of sales of $641,285 in September and the customer
retained the inventory on a consignment basis. No future shipments to this
customer will be included in this consignment agreement. This agreement expires
on February 1, 2003. The Company does not believe that this agreement will have
a material effect on the Company.
As of September 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.
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.
The Company's results of operations may also fluctuate from quarter to quarter
as a result of the amount nd 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.
13
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
September 30, 2002, the accrual was approximately $802,213.
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 $0 at September 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 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 September 30, 2002 and 2001 were
approximately 69.4% and 94% respectively. In the second quarter of fiscal 2003,
two major customers accounted for 42.1% 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 its 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.
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. As of September 30, 2002, we have entered into
consignment agreements with three of our customers. Additionally, 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.
14
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
In August 2002, we increased our credit facility with LaSalle Business
Credit to $25 million. In addition, the Company has attained additional
financing in Hong Kong. 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.
A disruption in the operation of our warehouse centers in California and Florida
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. 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 disrupted if there are labor problems on the
West Coast
During fiscal 2002, approximately 55% of our sales were domestic sales,
which were made from our warehouses in California and Florida. We anticipated
the potential labor problems on the West Coast in the second quarter of fiscal
2002 and increased the amount of inventory that we held in our California
warehouses. As such, the work-slow-by the West Coast longshoremen in October
2002 did not significantly impact our operations. However, if another strike or
work slow-down were to occur and we have not received a sufficient level of
15
inventory, a strike or work slow-down 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.
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,
2001. 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;
- 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
16
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, have anticipated this shortage and have made commitments to our
factories to purchase 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.
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.
17
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 September 30, 2002, there were 8,123,303 shares of our common
stock outstanding. We have filed three registration statements registering an
aggregate 6,742,234 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, a
registration statement on Form S-8 to registering the sale of 1,844,250 shares
underlying options granted under our 1994 Stock Option Plan and 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 September 30, 2002, we had 8,123,303
shares of common stock issued and outstanding and an aggregate of 1,101,125
outstanding options and warrants. As such, our Board of Directors has the power,
without stockholder approval, to issue up to 9,675,572 shares of common stock.
18
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
Item 4. Controls and Procedures
Within 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our principal
executive officer and principal financial officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information required to be included in our periodic
SEC reports. It should be noted that the design of any system of controls is
based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions, regardless of how remote.
In addition, we reviewed our internal controls, and there have been no
significant changes in our internal controls or in other factors that could
significantly affect those controls subsequent to the date of their last
evaluation.
19
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 September 30, 2002, one employee and one
director exercised stock options granted under one of the Company's stock option
plans. The employees exercised options to acquire an aggregate of 34,350 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
- ---------- ----------- --------- ---------- -----------
Howard Moore 07/12/02 33,750 $2.04 $68,850
Terri Phillips 07/31/02 600 $2.04 $ 1,224
Mr. Moore and Ms. Phillips paid for their shares with cash. Both Mr. Moore and
Ms. Phillips exercised their options in reliance upon Section 4(2) of the
Securities Act of 1933, because they are 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 of Ms.
Phillips. A control legend was placed on Mr. Moore's shares as he is a member of
the Company's Board of Directors.
(d) Not applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
The Annual Meeting of Stockholders of the Company was held on September 12,
2002. Proxies for the meeting were solicited pursuant to Regulation 14A of the
Securities Exchange Act of 1934 and there was no solicitation in opposition to
that of management. All of management's nominees for directors as listed in the
proxy statement were elected with the number of votes cast for each nominee as
follows:
Shares Voted Votes
"FOR" Withheld
------------ ---------
Edward Steele 7,579,999 36,283
John Klecha 7,580,019 36,263
Josef Bauer 7,586,714 29,568
Howard Moore 7,098,069 518,213
Robert Weinberg 7,586,719 29,563
The proposal to appoint Salberg & Company, P.A., as independent
accountants for the Company for the year ended March 31, 2003, was ratified by
the following vote:
Shares Voted Shares Voted Shares Broker
"FOR" "AGAINST" "ABSTAINING" "NON-VOTE"
----- -------- ----------- ----------
7,605,366 8,122 2,794 ___
Item 5. OTHER INFORMATION
Not applicable.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Fifth Amendment dated August 13, 2002 to Loan and Security
Agreement dated April 26, 2001 by and between LaSalle Business
Credit, Inc. and the Company.
10.2 First Amendment and Allonge to that Certain Demand Note dated
April 26, 2001 executed by rhe Company in favor of LaSalle
Business Credit, Inc. in the original principal amount of
$10,000.00.
20
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
(b) Reports on Form 8-K
The Company did not file any Report on Form 8-K during the three months ended
September 30, 2002.
21
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.
By: /s/ April J. Green
----------------------------------------
April J. Green
Chief Financial Officer
(On behalf of Registrant and
Chief Accounting Officer)
Dated: November 14, 2002
22
CERTIFICATIONS
I, Edward Steele, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Singing Machine
Company, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 /S/ Edward Steele
-----------------
Edward Steele
Chief Executive Officer
23
CERTIFICATIONS
I, April J Green, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Singing Machine
Company, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002 /S/ April J Green
-----------------
April J Green
Chief Financial Officer
(Principal Financial Officer)
24
EXHIBIT INDEX
Exhibit No. Description
10.1 Fifth Amendment dated August 13, 2002 to Loan and Security
Agreement dated April 26, 2001 by and between LaSalle
Business Credit, Inc. and the Company.
10.2 First Amendment and Allonge to that Certain Demand Note
dated April 26, 2001 executed by The Singing Machine
Company, Inc. in favor of LaSalle Business Credit, Inc. in
the original principal amount of $10,000,000.00
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
25