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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, 2003
0 - 24968
---------
Commission File Number
THE SINGING MACHINE COMPANY, INC.
---------------------------------
(Exact Name of Small Business Issuer 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
--------------
(Issuer's telephone number, including area code)
Indicate by check mark 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
requirement 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
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No x
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
CLASS NUMBER OF SHARES
OUTSTANDING ON JULY 30, 2003
Common Stock, $0.01 par value 8,300,178
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Page No.
--------
Consolidated Balance Sheets - June 30, 2003 (Unaudited)
and March 31, 2003 .............................................. 3
Consolidated Statements of Operations - Three months
ended June 30, 2003 and 2002 (Unaudited) .................... 4
Consolidated Statements of Cash Flows - Three months ended
June 30, 2003 and 2002 (Unaudited) .............................. 5
Notes to Consolidated Financial Statements ...................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ............................. 12
Item 3. Quantitative and Qualitative Disclosure About Market Risk ....... 16
Item 4. Controls and Procedures ......................................... 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................... 23
Item 2. Changes in Securities ........................................... 23
Item 3. Defaults Upon Senior Securities ................................. 24
Item 4. Submission of Matters to a Vote of Security Holders ............. 24
Item 5. Other Information ............................................... 24
Item 6. Exhibits and Reports on Form 8-K ................................ 24
SIGNATURES ............................................................... 25
Exhibit 99(a)
Exhibit 99(b)
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, MARCH 31,
2003 2003
----------- -----------
(unaudited)
ASSETS
------
CURRENT ASSETS
Cash and cash equivalents $ 86,413 $ 268,265
Restricted Cash 862,122 838,411
Accounts Receivable, less allowances of $171,411
and $405,759, respectively 4,236,488 5,762,944
Due from manufacturer 60,272 1,091,871
Inventories 25,959,760 25,194,346
Prepaid expense and other current assets 1,943,844 1,483,602
Deferred tax asset 1,925,612 1,925,612
----------- -----------
TOTAL CURRENT ASSETS 35,074,511 36,565,051
PROPERTY AND EQUIPMENT, at cost less accumulated
depreciation of $1,648,369 and $1,472,850, respectively 2,149,919 2,026,252
OTHER NON-CURRENT ASSETS 341,530 343,991
----------- -----------
TOTAL PROPERTY, EQUIPMENT AND OTHER ASSETS 2,491,449 2,370,243
----------- -----------
TOTAL ASSETS $37,565,960 $38,935,294
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
Bank overdraft 46,652 316,646
Accounts payable $ 9,785,339 $ 8,486,009
Accrued expenses 1,231,491 1,443,406
Due to related party 200,000 400,000
Notes payable 2,000,000 0
Revolving credit facility 4,903,371 6,782,824
Income taxes payable 3,823,360 3,821,045
----------- -----------
TOTAL CURRENT LIABILITIES 21,990,213 21,249,930
----------- -----------
SHAREHOLDERS' EQUITY
Preferred stock, $1.00 par value; 1,000,000 shares
authorized, no shares issued and outstanding -- --
Common stock, Class A, $.01 par value; 100,000 shares
authorized; no shares issued and outstanding -- --
Common stock, $0.01 par value; 18,900,000 shares
authorized; 8,300,178 and 8,171,678 shares issued and outstanding 83,002 81,717
Additional paid-in capital 5,049,880 4,843,430
Retained earnings 10,442,865 12,760,217
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 15,575,747 17,685,364
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $37,565,960 $38,935,294
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
3
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
THREE MONTHS ENDED
JUNE 30, JUNE 30,
2003 2002
------------- -----------
(as restated)
NET SALES $ 7,627,975 $ 4,296,841
COST OF SALES 5,901,866 2,990,881
------------- -----------
GROSS PROFIT 1,726,109 1,305,960
OPERATING EXPENSES
Advertising 270,770 165,765
Compensation 1,111,579 770,898
Freight & handling 225,866 245,490
Royalty expense 83,964 67,830
Selling, general & administrative expenses 2,168,168 1,389,020
------------- -----------
TOTAL OPERATING EXPENSES 3,860,347 2,639,003
------------- -----------
LOSS FROM OPERATIONS (2,134,238) (1,333,043)
OTHER INCOME (EXPENSES)
Other income 7,669 13,901
Interest expense (188,468) (1,549)
Interest income -- 11,604
------------- -----------
NET OTHER EXPENSES (180,799) 23,956
NET LOSS BEFORE INCOME TAX (2,315,037) (1,309,087)
INCOME TAX EXPENSE 2,315 118,334
NET LOSS $ (2,317,352) $(1,427,421)
============= ===========
LOSS PER SHARE:
Basic & Diluted $ (0.28) $ (0.18)
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT
SHARES OUTSTANDING:
Basic & Diluted 8,278,469 8,061,277
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
4
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
FOR THE QUARTER ENDED JUNE 30,
----------- ------------------
2003 2002 (AS RESTATED)
----------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss $(2,317,352) $(1,309,087)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 175,519 121,047
Changes in assets and liabilities:
(Increase) decrease in:
Restricted cash (23,711) 0
Accounts Receivable 1,526,456 924,688
Due from manufacturer 0 (251,909)
Inventories 266,185 (3,666,981)
Prepaid Expenses and other assets (457,782) 87,483
Increase (decrease) in:
Accounts payable 1,299,330 2,413,542
Accrued expenses (211,914) (784,259)
Bank Overdraft (269,994) 0
Income taxes payable 2,315 (58,542)
----------- -----------
Net Cash used in Operating Activities (10,948) (2,524,018)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (299,186) (612,141)
Deposit for credit line 0 (650)
----------- -----------
Net cash used in Investing Activities (299,186) (612,791)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Net revolving credit facility (1,879,453) 0
Payments on related party loan (200,000) 0
Proceeds from note payable 2,000,000
Proceeds from exercise of stock options and warrants 207,735 81,785
----------- -----------
Net cash provided by Financing Activities 128,282 81,785
----------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS (181,852) (3,055,024)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 268,265 5,520,147
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 86,413 $ 2,465,123
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 188,469 $ 1,549
=========== ===========
Cash paid during the year for income taxes $ 0 $ 58,542
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
5
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - SUMMARY OF ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include
the accounts of The Singing Machine Company, Inc. and its subsidiary (the
"Company", "The Singing Machine"). All significant intercompany transactions and
balances have been eliminated. The unaudited consolidated financial statements
have been prepared in conformity with Rule 10-01 of Regulation S-X of the
Securities and Exchange Commission and therefore do not include information or
footnotes necessary for a complete presentation of financial position, results
of operations and cash flows in conformity with accounting principles generally
accepted in the United States of America. However, all adjustments (consisting
of normal recurring accruals), which, in the opinion of management, are
necessary for a fair presentation of the financial statements, have been
included. Operating results for the period ended June 30, 2003 are not
necessarily indicative of the results that may be expected for the remaining
quarters or the year ending March 31, 2004 due to seasonal fluctuations in The
Singing Machine's business, changes in economic conditions and other factors.
For further information, please refer to the Consolidated Financial Statements
and Notes thereto contained in The Singing Machine's Annual Report on Form 10-K
for the year ended March 31, 2003.
INVENTORIES
Inventories are comprised of electronic karaoke audio equipment,
accessories, and compact discs and are stated at the lower of cost or market, as
determined using the first in, first out method. The following table represents
the major components of inventory at the dates specified.
June 30, 2003 March 31, 2003
------------- --------------
Finished goods $ 27,991,580 $ 27,807,763
Inventory in transit 1,568,870 1,101,940
Less Inventory reserve (3,600,690) (3,715,357)
------------ ------------
Total Inventory $ 25,959,760 $ 25,194,346
============ ============
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year presentation.
STOCK BASED COMPENSATION
The Company accounts for stock options issued to employees using the
intrinsic value method in accordance with the provisions of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. As such, compensation cost is measured
on the date of grant as the excess of the current market price of the underlying
stock over the exercise price. Such compensation amounts are amortized over the
respective vesting periods of the option grant. The Company applied the
disclosure provisions of Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure an amendment
of FASB Statement No. 148", which permits entities to provide pro forma net
earnings (loss) and pro forma earnings (loss) per share disclosures for employee
stock option grants as if the fair-valued based method defined in SFAS No. 123
had been applied to options granted.
Had compensation cost for the Company's stock-based compensation plan
been determined using the fair value method for awards under that plan,
consistent with Statement of Financial Accounting Standards (SFAS) No 123,
"Accounting for Stock Based Compensation" (Statement No. 123), the Company's net
earnings would have been changed to the pro-forma amounts indicated below.
JUNE 30, 2003 JUNE 30, 2002
------------- -------------
Net loss As reported $ (2,317,352) $ (1,427,421)
Pro forma $ (2,518,804) $ (1,456,293
Net loss per share - basic & diluted As reported $ (0.28) $ (0.18)
Pro forma $ (0.30) $ (0.18)
6
The effect of applying Statement No. 123 is not likely to be
representative of the effects on reported net earnings for future years due to,
among other things, the effects of vesting.
For stock options and warrants issued to consultants, the Company
applies the fair value method of accounting as prescribed by SFAS 123. There
were no consulting expenses relating to grants for the quarters ended June 30,
2003 and 2002.
For financial statement disclosure purposes and for purposes of valuing
stock options and warrants issued to consultants, the fair market value of each
stock option granted was estimated on the date of grant using the Black-Scholes
Option-Pricing Model in accordance with SFAS 123 using the following
weighted-average assumptions:
First Quarter 2004: expected dividend yield 0%, risk-free
interest rate of 4%, volatility 79.9% and
expected term of five years.
First Quarter 2003: expected dividend yield 0%, risk-free
interest rate of 6.8%, volatility 42%
and expected term of two years.
RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under SFAS 133. SFAS 149 is generally effective for contracts
entered into or modified after June 30, 2003 (with a few exceptions) and for
hedging relationships designated after June 30, 2003. The Company does not
expect the provisions of SFAS 149 to have a material impact on its financial
position or results of operations.
SFAS No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" ("SFAS 150"). SFAS 150 improves
the accounting for certain financial instruments that, under previous guidance,
issuers could account for as equity. The new Statement requires that those
instruments be classified as liabilities in statements of financial position.
This statement is effective at the beginning of the second quarter of fiscal
2004. The Company does not expect the provisions of SFAS 150 to have a material
impact on its financial position or results of operations.
NOTE 2 - GOING CONCERN
The accompanying unaudited consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America, which contemplate continuation of the Company as a
going concern.
On March 14, 2003, the Company was notified of its violation of the net
worth covenant of its Loan and Security Agreement (the "Agreement") with its
commercial lender and the Company was declared in default under the Agreement.
The lender amended the Agreement on July 31, 2003, extending the loan until
August 20, 2003, but did not waive the condition of default. This condition of
default raises substantial doubt about the Company's ability to continue as a
going concern.
The Company is attempting to restructure and extend its revolving
credit facility. Based upon cash flow projections, the Company believes the
anticipated cash flow from operations will be sufficient to finance the
Company's operating needs until inventory is sold and the receivables
subsequently collected, provided that the bank does not call the loan. There can
be no assurances that forecasted results will be achieved or that additional
financing will be obtained. The financial statements do not include any
adjustments relating to the recoverability and classification of asset amounts
or the amounts and classification of liabilities that might be necessary should
the Company be unable to continue as a going concern.
Although the Company had a larger than normal amount of currently
saleable inventory at June 30, 2003 and March 31, 2003 (based on the Company's
recent sales trends and industry turnover standards), the Company has developed
a fiscal 2004 sales plan that it believes will allow it to sell such inventory
and recover its costs in the normal course of business.
NOTE 3 - RESTATEMENT OF FINANCIAL STATEMENTS FOR THE FISCAL YEARS 2002 AND 2001
In June 2003, management revised its position on taxation of its
subsidiary's income by the United States and by the Hong Kong tax authorities.
7
With regard to taxation in Hong Kong, the Company's subsidiary had
previously applied for a Hong Kong offshore claim income tax exemption based on
the locality of profits of the Hong Kong subsidiary. Management believed that
the exemption would be approved because the source of all profits of the Hong
Kong subsidiary is from exporting to customers outside of Hong Kong.
Accordingly, no provision for income taxes was provided in the consolidated
financial statements as of March 31, 2002 and 2001. However, full disclosure was
previously reflected in the audited financial statements for years ended March
31, 2002 and 2001 of the estimated amount that would be due to the Hong Kong tax
authority should the exemption be denied. Management is continuing its exemption
application process. However, due to the extended period of time that the
application has been outstanding, as well as management's reassessment of the
probability that the application will be approved, management has determined to
restate the 2002 and 2001 consolidated financial statements to provide for such
taxes. The effect of such restatement is to increase income tax expense by
$748,672 and $468,424 in fiscal 2002 and 2001, respectively. However, the
Company can claim United States foreign tax credits in 2002 for these Hong Kong
taxes, which is reflected in the final restated amounts.
With regard to United States taxation of foreign income, the Company
had originally taken the position that the foreign income of the Hong Kong
subsidiary qualified for a deferral under the Internal Revenue Code allowing for
such income to be indefinitely deferred and not taxed in the United States until
such income is repatriated. Full disclosure of the amount and nature of the
indefinite deferral for fiscal year 2002 was reflected in the income tax
footnote of the consolidated financial statements for that year. The internal
revenue code, regulations and case law regarding international income taxation
is quite complex and subject to interpretation. Each case is determined based on
the individual facts and circumstances. Due to certain inter-company loans made
in 2002 and 2003, the profits previously considered to be indefinitely deferred
became partially taxable as "deemed dividends" under section 956 of the Internal
Revenue Code. Although certain arguments against the imposition of a "deemed
dividend" may be asserted, management has determined to restate the fiscal year
2002 consolidated financial statements based on its reassessment of its original
position. The effect of such restatement is to increase income tax expense by
$1,027,545 in fiscal year 2002, which includes the utilization of the foreign
tax credits referred to above.
The net effect of the above two adjustments for the quarter ended June
30, 2002 is to decrease net income by $118,334. The net effect on net income per
share is to decrease net income per share basic and diluted by $0.01 for the
quarter ended June 30, 2002.
NOTE 4 - LOANS AND LETTERS OF CREDIT
CREDIT FACILITY
The Company's Hong Kong Subsidiary maintains separate credit facilities
at two international banks.
The Company maintains a facility with a maximum credit available of
$5.5 million U.S. dollars. The primary purpose of the facilities is to provide
the Subsidiary with the following abilities:
o Overdraft facilities
o Issuance and negotiation of letters of credit, both regular and
discrepant
o Trust receipts
o A Company credit card
The facilities are secured by a corporate guarantee from the U.S.
Company, maintain restricted cash on deposit with the lender and maintain net
worth as outlined in the agreement.
The Company executed a short term loan with an international bank in
May of 2003. The $2,000,000 loan carries interest at a SIBOR (Singapore
Interbank Money Offer Rate) rate plus 2.75%. The rate at June 30, 2003 was
4.02%. The loan must be paid in full by October 31, 2003 and a deposit of
$350,000 must be retained in a restricted depository account with the lender
until such time as the loan is paid in full.
LOAN AND SECURITY AGREEMENT
On April 26, 2001, the Company executed a Loan and Security Agreement
(the "Agreement") with a commercial lender (the "Lender"). On July 31, 2003,
this loan was amended through August 20, 2003. The following is a description of
the terms as amended.
The Lender will advance up to 70% of the Company's eligible accounts
receivable, plus up to 20% of the eligible inventory up to $6,000,000, plus up
to 40% of the commercial letters of credit opened for the purchase of eligible
inventory up to $3 million, less reserves at the discretion of the lender.
8
The outstanding loan limit varies between zero and $10,000,000, as
stipulated in the Agreement. The Lender also provides the Company the ability to
issue commercial letters of credit up to $3,000,000, 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 $100,000 is
payable. 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. This amendment
expires August 20, 2003.
The Agreement contains covenants including a restriction on the payment
of dividends as well as a financial covenant stipulating a minimum tangible net
worth of $30,000,000 as of December 31, 2002 with escalations as defined in the
Agreement. On March 15, 2003, the lender notified the Company that they are in
default of this covenant and the agreement. The balance outstanding at March 31,
2003 was $6,782,824 and was classified as a current liability under revolving
credit facility on the balance sheet. At March 31, 2003, the Company was over
advanced under the agreement by approximately $3 million. The June 30, 2003
amendment gave the Company an additional $4.5 million in availability which gave
the Company working capital and cured the over advance; however, the Amendment
requires the Company to raise $2 million in subordinated debt.
The Company is currently negotiating a restructuring of the agreement
with the lender.
NOTE 5 - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
CLASS ACTION. From July 2, 2003 through August 11, 2003, ten securities
class action lawsuits were filed against The Singing Machine and certain of its
officers and directors in the United States District Court for the Southern
District of Florida on behalf of all persons who purchased The Singing Machine's
securities during the various class action periods specified in the complaints.
The Company expects that all of these actions will be consolidated in the United
States District Court for the Southern District of Florida.
The complaints that have been filed allege violations of Section 10(b)
and Section 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)-5. The
complaints seek compensatory damages, attorney's fees and injunctive relief.
While the specific factual allegations vary slightly in each case, the
complaints generally allege that defendants falsely represented the Company's
financial results for the years ended March 31, 2002 and 2001.
The Company believes that the allegations in these cases are without
merit and the Company intends to vigorously defend these actions. However, as
the outcome of litigation is difficult to predict, significant changes in the
estimated exposures could occur which could have a material affect on the
Company's operations.
In July 2003, a shareholder filed a derivative action against the
Company, its board of directors and senior management purporting to pursue the
action on behalf of the Company and for its benefit. No pre-lawsuit demand to
investigate the allegations or bring action was made on the board of directors.
The Company is named as a nominal defendant in this case.
The Complaint alleges claims for breach of fiduciary duty, abuse of
control, gross mismanagement, waste of corporate assets and unjust enrichment.
The complaint alleges that the individual defendants breached their fiduciary
duties and engaged in gross mismanagement by allegedly ignoring indicators of
the lack of control over the Company's accounting and management practices,
allowing the Company to engage in improper conduct and otherwise failing to
carry out their duties and obligations to the Company. The plaintiff's seek
damages for breach of fiduciary duties, punitive and compensatory damages,
restitution, and bonuses or other incentive-based or equity based compensation
received by the CEO and CFO under the Sarbanes-Oxley Act of 2002.
The Company believes that the allegations in this derivative lawsuit
are without merit and intends to vigorously defend this action.
OTHER MATTERS. The Company is also subject to various other legal
proceedings and other claims that arise in the ordinary course of its business.
In the opinion of management, the amount of ultimate liability, if any, in
excess of applicable insurance coverage, is not likely to have a material effect
on the financial condition, results of operations or liquidity of the Company.
However, as the outcome of litigation or other legal claims is difficult to
predict, significant changes in the estimated exposures could occur, which could
have a material impact on the Company's operations.
9
NOTE 6 - STOCKHOLDERS' EQUITY
COMMON STOCK ISSUANCES
During the first quarter of fiscal 2004 and 2003, the Company issued
the following shares of stock upon exercise of outstanding options and warrants.
- ------------- ------------------------------ --------------------------
June 30, Number of Shares Issued Proceeds to Company
- ------------- ------------------------------ --------------------------
2004 128,500 $207,735
- ------------- ------------------------------ --------------------------
2003 69,000 $81,785
- ------------- ------------------------------ --------------------------
EARNINGS PER SHARE
In accordance with Statement of Financial Accounting Standards No. 128,
"Earnings per Share," basic earnings per share are computed by dividing the net
earnings for the period by the weighted average number of common shares
outstanding. Diluted earnings per share is computed by dividing net earnings by
the weighted average number of common shares outstanding including the effect of
common stock equivalents.
The following table presents a reconciliation of basic and diluted
earnings per share:
JUNE 30,
2003 2002
(as restated)
Net loss $(2,317,352) $(1,427,421)
Loss available to common shares $(2,317,352) $(1,427,421)
Weighted average shares outstanding -
basic & diluted 8,278,469 8,061,277
Loss per share - Basic & Diluted $ (0.28) $ (0.18)
For the quarter ended June 30, 2003 and 2002, 637,681 and 784,331
common stock equivalents were excluded from the computation of diluted earnings
per share because their effect was antidilutive.
NOTE 7 - SEGMENT INFORMATION
The Company operates in one segment and maintains its records
accordingly. The majority of sales to customers outside of the United States are
made by the Company's Subsidiary. Sales by geographic region for the quarters
ended June 30 were as follows:
SALES 2003 2002
United States $3,863,002 $3,494,039
France
1,018,046 --
Italy
792,720 --
United Kingdom 1,532,065 429,496
Other 422,142 373,306
---------- ----------
Consolidated Net Sales $7,627,975 $4,296,841
========== ==========
The geographic area of sales is based primarily on the location where the
product is delivered.
NOTE 8 - SUBSEQUENT EVENTS
As of July 10, 2003, the Company obtained $1 million in subordinated debt
financing from a certain officer, directors and an associate of a director. The
Company has not finalized the terms of this loan; however, the Company has
immediate use and access to the $1 million of funding.
As of July 28, 2003, an unrelated party posted a $1 million standby letter of
credit as further collateral on the revolving credit facility. The consideration
to be paid in return for this has not been finalized.
10
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.
OVERVIEW
The Singing Machine Company, Inc., a Delaware corporation, and Subsidiary (the
"Company", or "The Singing Machine") are primarily engaged in the production,
marketing, and sale of consumer karaoke audio equipment, accessories, and
musical recordings. The products are sold directly to distributors and retail
customers. 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, Circuit City, Costco, Toys R Us, Target and J.C. Penney.
We had a net loss after estimated tax expense of $2,317,352 for the three month
period ended June 30, 2003. Our working capital as of June 30, 2003, was
approximately $14 million.
RESTATEMENT OF FINANCIAL STATEMENTS
In June 2003, management revised its position on taxation of its subsidiary's
income by the United States and by the Hong Kong tax authorities.
With regard to taxation in Hong Kong, the Company's subsidiary had previously
applied for a Hong Kong offshore claim income tax exemption based on the
locality of profits of the Hong Kong subsidiary. Management believed that the
exemption would be approved because the source of all profits of the Hong Kong
subsidiary is from exporting to customers outside of Hong Kong.
Accordingly, no provision for income taxes was provided in the consolidated
financial statements as of March 31, 2002 and 2001. However, full disclosure was
previously reflected in the audited financial statements for years ended March
31, 2002 and 2001 of the estimated amount that would be due to the Hong Kong tax
authority should the exemption be denied. Management is continuing its exemption
application process. However, due to the extended period of time that the
application has been outstanding, as well as management's reassessment of the
probability that the application will be approved, management has determined to
restate the 2002 and 2001 consolidated financial statements to provide for such
taxes. The effect of such restatement is to increase income tax expense by
$748,672 and 468,424 in fiscal 2002 and 2001, respectively. However, the Company
can claim United States foreign tax credits in 2002 for these Hong Kong taxes,
which is reflected in the final restated amounts.
With regard to United States taxation of foreign income, the Company had
originally taken the position that the foreign income of the Hong Kong
subsidiary qualified for a deferral under the Internal Revenue Code allowing for
such income to be indefinitely deferred and not taxed in the United States until
such income is repatriated. Full disclosure of the amount and nature of the
indefinite deferral for fiscal year 2002 was reflected in the income tax
footnote of the consolidated financial statements for that year. The Internal
Revenue Code, regulations and case law regarding international income taxation
is quite complex and subject to interpretation. Each case is determined based on
the individual facts and circumstances. Due to certain inter-company loans made
in 2002 and 2003, the profits previously considered to be indefinitely deferred
became partially taxable as "deemed dividends" under section 956 of the Internal
Revenue Code.
11
Although certain arguments against the imposition of a "deemed dividend" may be
asserted, management has determined to restate the fiscal year 2002 consolidated
financial statements based on its reassessment of its original position. The
effect of such restatement is to increase income tax expense by $1,027,545 in
fiscal year 2002, which includes the utilization of the foreign tax credits
referred to above.
The net effect of the above two adjustments for the quarter ended June 30, 2002
is to decrease net income by $118,334. The net effect on net income per share is
to decrease net income per share basic and diluted by $0.01 for the quarter
ended June 30, 2002.
QUARTER ENDED JUNE 30, 2003 COMPARED TO THE QUARTER ENDED JUNE 30, 2002
- -----------------------------------------------------------------------
NET SALES
Net sales for the quarter ended June 30, 2003 increased 77.5% to $7,627,975
compared to $4,296,841 for the quarter ended June 30, 2002. The increase in the
Company's sales for this quarter is due to the acquisition of new customers in
Europe, as well as increased sales to existing customers. Sales in European
countries increased $2.6 million over the same period in the prior year. The
Company believes that sales in this segment will continue to increase over the
remaining fiscal year.
GROSS PROFIT
Gross profit for the quarter ended June 30, 2003 was $1,726,109 or 22.6% of
sales as compared to $1,305,960 or 32.2% of sales for the quarter ended June 30,
2002. The decrease in gross margin percentage compared to the prior year is due
primarily to increased sales from our Hong Kong subsidiary to international
customers. International sales were primarily in Europe for the quarter. Sales
to international customers historically maintain lower selling prices, and thus
a lower gross profit margin. Due to the increased inventory levels at June 30,
2003, which was carried from the prior year, the Company anticipates that the
gross profit percentage for the remainder of the fiscal year will fall below
last year.
OPERATING EXPENSES
Operating expenses were $3,860,347 or 50.6% of total revenues for the quarter
ended June 30, 2003. The expenses increased over prior year by $1,221,344, but,
as a percentage of sales, decreased from 61.4% at June 30, 2002. This decreased
percentage is a result of a higher revenue base over which to spread operating
fixed costs. The primary factors that contributed to the increase of
approximately $1.2 million in operating expenses for the quarter ended June 30,
2003 are:
(i) increased advertising expenses of $105,000, due primarily to increased
sales
(ii) compensation and related expenses in the amount of $341,000.
(iii) Increased expenses of $300,000 due to the increased need for space to
hold our high level of inventory in California.
(iv) Increased accounting and legal fees of $214,000
(v) Various other smaller expenses contributed to the remainder of the
increase.
As a result of the merchandise license agreements and minimum guarantee
requirements, the Company expects royalty expense to increase in fiscal 2004.
OTHER EXPENSES
Other expenses were $180,799 for the quarter ended June 30, 2003, as compared
with net other income of $23,956 at June 30, 2002. Our interest expense increase
is due to the increased use of our credit facility at the default rate of
interest during this period. For the quarter ended June 2002, the Company had
cash reserves to fund operations and did not need to borrow on the revolving
credit facility. The Company expects interest expense to continue to increase
for the remainder of fiscal 2004 due to the credit facility accruing interest at
the default rate of prime plus 2.5% (6.75% at June 30, 2003).
INCOME TAX EXPENSE (BENEFIT)
The Company's tax expense is based on an aggregation of the taxes on earnings of
its Hong Kong and domestic operations on an annualized basis. Income tax rates
in Hong Kong are approximately 16%, while the statutory income tax
12
rate in the United States is 34%. The Company's effective tax rate during the
first quarter of fiscal 2004 was 0% as compared to 19% during the first quarter
of fiscal 2003. This decrease in the effective tax rate is a result of estimated
tax benefits for fiscal 2004 resulting from estimated United States pretax loss
for fiscal 2004 offset by estimated tax expense related to the estimated Hong
Kong pretax income for fiscal 2004. As the effective tax rates are based on
estimates, the Company's future effective income tax rate will fluctuate based
on the changes in the estimates
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
At June 30, 2003, the Company had cash on hand of $86,413 and a bank overdraft
of $46,652 compared to cash on hand of $268,265 and a bank overdraft of $316,646
at March 31, 2003. Our current liabilities increased to $21,990,213 as of June
30, 2003, compared to $21,249,930 at June 30, 2002.
Because we had minimal liquidity as of June 30, 2003 and had defaulted under a
credit agreement with our commercial lender, we received a going concern
paragraph from our independent auditors for our financial statements for fiscal
2003. On March 14, 2003, we received a letter from LaSalle informing us that we
were in violation of a net worth covenant in our credit agreement. In this
letter, LaSalle also advised us that we were in default under the credit
agreement and that it could accelerate the payment of all liabilities due under
this agreement at any time. In July 2003, LaSalle amended the agreement through
August 20, 2003 but did not waive the condition of default.
As of July 10, 2003, we obtained $1 million in subordinated debt financing from
a certain officer, directors and an associate of a director. As of July 28,
2003, an unrelated party posted a $1 million standby letter of credit as further
collateral on the revolving credit facility. It is presently expected that these
will be short-term loans, which will be due on or before October 31, 2003.
However, we have not yet determined the interest rate or if any compensation,
such as warrants, will be awarded to the unrelated party and management
investment group for these loans.
We are currently in negotiations with LaSalle to restructure the loan for the
remainder of fiscal 2004. We hope that these negotiations will be successful and
that a restructured loan agreement will be in place prior to August 21, 2003.
However, we cannot assure you that these efforts will be successful. We entered
into our credit facility with LaSalle in April 2001 and have entered into
several amendments subsequently. We last amended the credit facility effective
as of July 31, 2003 and it provides that the agreement expires on August 20,
2003. Under the amended credit facility, LaSalle Bank will, at its discretion,
advance up to 70% of the Company's eligible accounts receivable, plus up to 20%
of eligible inventory, plus us up to 60% of commercial letters of credit issue
by LaSalle minus reserves as set forth in the loan documents. The loan is
secured by a first lien on all present and future assets of the Company, except
specific tooling located in China.
Due to the increased levels of inventory and accounts payable as of June 30,
2003, the Company has an increased need for working capital. As of June 30,
2003, the Company had current assets of $35.1 million, which consisted primarily
of accounts receivable and inventory; and current liabilities of approximately
$21.9 million. Our inventory levels remained relatively stable at approximately
$26 million between March 31 and June 30, 2003. Despite sales of approximately
$7.6 million during our first quarter, our inventory levels increased because
58% of our sales were direct sales made from International SMC and some
purchases were received in the first quarter. The most significant current
liabilities include (i) approximately $9.8 million in accounts payable, of which
approximately $4.8 million is amounts payable to the Company's factories in
China and (ii) $4.9 million outstanding under the Company's credit facility with
LaSalle Bank. Over the past few months, the Company has had discussions with its
factories in China and they have indicated that they are willing to extend the
payment dates for the Company's obligations. The Company also has been
negotiating with LaSalle Bank to increase the credit available to the Company
and has identified other sources of capital.
Our Hong Kong subsidiary, International SMC, has letters of credit and other
various credit facilities available to finance its inventory purchases.
International SMC also has a short term loan with the Hong Kong Shanghai Banking
Corporation for $2 million which is due by October 31, 2003. Additionally, one
of our directors advanced $400,000 to International SMC in March 2003. As of
June 30, 2003, the remaining balance of the loan was $200,000 and is due on
October 31, 2003, bearing interest at the rate of 8% per annum.
In the event that we are not able to renegotiate an agreement with LaSalle, we
have considered alternative sources of financing, including but not limited to
inventory and accounts receivable financing and other high risk financing such
as venture capital funds. Without such financing, our ability to continue our
operations is in significant doubt.
During fiscal 2004, we plan on significantly decreasing our capital
expenditures. We currently expect to order $8-$12 million in new inventory for
domestic stock. During fiscal 2004, we will attempt to liquidate the excess
inventory from fiscal 2003. We believe this inventory is highly marketable and
saleable; however, there can be no assurances that we will be able to liquidate
this inventory during our upcoming fiscal year.
13
The Company's commitments for debt and other contractual arrangements are
summarized as follows:
- --------------------------------------- -------------- -----------------------------------------------------------------
Years ending March 31,
- --------------------------------------- -------------- -----------------------------------------------------------------
Total 2004 2005 2006 2007 2008
- --------------------------------------- -------------- -------------- ------------ ------------ ------------ -----------
Merchandise License Guarantee $1,595,000 $1,395,000 $150,000 $50,000 -- --
- --------------------------------------- -------------- -------------- ------------ ------------ ------------ -----------
Property Leases $3,638,771 $1,330,158 $924,338 $517,071 $495,545 $371,659
- --------------------------------------- -------------- -------------- ------------ ------------ ------------ -----------
Equipment Leases $86,016 $46,525 $19,965 $10,322 $7,969 $1,235
- --------------------------------------- -------------- -------------- ------------ ------------ ------------ -----------
We should be able to satisfy our liquidity requirements until August 20, 2003 by
using credit that has been extended to us under our credit agreement with
LaSalle. However, we are currently in default of the loan and LaSalle could
accelerate the loan at any time. We hope that our renegotiations are successful,
but can not guarantee that this will occur. If we are not able to obtain
adequate financing, we may not be able to continue as a going concern.
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.
Cash flows used in operating activities were $10,949 for the quarter ended June
30, 2003. Cash flows were used in operating activities primarily due to
decreases in accounts receivable in the amount of $1.5 million and increases in
accounts payable of $1.3 million
Cash used in investing activities for the quarter ended June 30, 2003 was
$299,186. Cash used in investing activities resulted from the purchase of fixed
assets in the amount of $299,186. The purchase of fixed assets consists of the
tooling and molds required for production of new machines for this fiscal year.
Tooling and molds are depreciated over five years.
Cash flows provided by financing activities were $128,282 for the quarter ended
June 30, 2003. This consisted of proceeds from the exercise of options in the
amount of $207,735. The Company also had a short term loan with a director with
a balance of $200,000 at June 30, 2003 and a short term note with a bank for $2
million. 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
$1.9 million to fund ongoing operations.
EXCHANGE RATES
We sell all of our products in U.S. dollars and pay for all of our manufacturing
costs in either U.S. or Hong Kong dollars. Operating expenses of the Hong Kong
office are paid in Hong Kong dollars. We cannot assure you that the exchange
rate fluctuations between the United States and Hong Kong currencies will not
have a material adverse effect on our business, financial condition or results
of operations.
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 the
Company's fiscal second and third quarter, combined, accounted for approximately
85% of net sales in fiscal 2003, 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.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
WE RECEIVED A GOING CONCERN PARAGRAPH FROM OUR INDEPENDENT AUDITORS
14
We received a going concern paragraph from our independent auditors for
the fiscal year ended March 31, 2003. We have minimal liquidity as of June 24,
2003, the date of the audit report, and our commercial lender declared us in
default under the terms of our credit agreement, on March 14, 2003. For these
reasons, our independent auditors were concerned about our ability to continue
as a going concern. We are attempting to restructure our credit agreement with
our lender. Effective as of July 31, 2003, our lender extended our credit
agreement until August 20, 2003, but did not waive any of the current events of
default.. Based upon cash flow projections, the Company believes the anticipated
cash flow from operations and most importantly, the expected net proceeds from
future earnings will be sufficient to finance the Company's operating needs
until inventory is sold and the receivables subsequently collected. However,
there can be no assurances that we will achieve our forecasted results and that
our cash flow from operations will be sufficient to finance our operating needs
until our inventory is sold. We are also seeking other sources of long and short
term capital. Because we can give no assurance that we can achieve any of the
foregoing, there is substantial uncertainty about our ability to continue as a
going concern. Because we have a going concern qualification, it may be more
difficult for us to raise capital.
WE HAVE SIGNIFICANT WORKING CAPITAL NEEDS WHICH ARE SUBJECT TO THE UNCERTAINTY
OF ADDITIONAL FINANCING
If we are not able to restructure our credit agreement with our
commercial lender by August 20, 2003, we will need to seek additional funds to
operate our business. Although we have been looking for alternative sources of
capital (in addition to our credit line with our commercial lender), we are not
certain that we will be able to locate and secure such additional financing on a
timely basis and on terms that are acceptable to the Company. We are also trying
to sell our excess inventory to provide us with more cash for operations. If we
do not have adequate financing, it will have a material adverse effect on our
business, results of operation and financial condition and we may need to change
our business strategy or reduce our operations. If we have a severe shortage of
working capital, we may not be able to continue our business operations and may
be required to file a petition for Chapter 11 or enter into some liquidation or
reorganization proceeding. In addition, any issuance of additional equity
securities will dilute the ownership interest of our existing stockholders and
issuance of debt securities may increase the perceived risk of investing in us.
WE ARE CURRENTLY IN DEFAULT UNDER OUR CREDIT AGREEMENT WITH OUR COMMERCIAL
LENDER
On March 14, 2003, we received a letter from LaSalle informing us
that we were in breach of our credit agreement as a result of our failure to
maintain the minimum tangible net worth requirement. In this letter, LaSalle
also advised us that it could accelerate the payment of all liabilities due
under the credit agreement at any time. As of August 12, 2003, LaSalle has not
filed a lawsuit against us to accelerate the payment of any liabilities due
under the credit agreement. If LaSalle were to exercises its right to foreclose
on our assets, primarily our accounts receivable and inventory, this action
might disrupt our current business operations. If LaSalle were to liquidate a
significant amount of our inventory at one time, it might be more difficult for
us to place inventory with other retailers. We would also need to find financing
from a third party and there are no assurances that we will be able to do so.
WE ARE NAMED AS A DEFENDANT IN SEVERAL CLASS ACTION LAWSUITS
We are involved in a number of litigation matters. An unfavorable
resolution of pending litigation could have a material adverse effect on our
financial condition. Litigation may result in substantial costs and expenses and
significantly divert the attention of the Singing Machine's management
regardless of the outcome. There can be no assurance that the Singing Machine
will be able to achieve a favorable settlement of pending litigation or obtain a
favorable resolution of litigation if it is not settled. In addition, current
litigation could lead to increased costs or interruptions of normal business
operations of the Singing Machine.
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 March 31, 2003, 2002 and 2001 were
approximately 67%, 77% and 87% respectively. In fiscal 2003, three major
customers accounted for 21%, 17% and 15% 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
15
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.
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.
OUR LICENSING AGREEMENTS ARE IMPORTANT TO OUR BUSINESS
We value all of our merchandise license agreements and feel that if any
of them were to be terminated or fail to be renewed, our business, financial
condition and results of operations could be adversely affected. Our license
with MTV is particular important to our business. We generated $30,884,344
million or 32.3% of our net sales from products sold under the MTV license in
fiscal 2003. 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 merchandise license agreements did
not exist.
INVENTORY MANAGEMENT AND CONSIGNMENT ARRANGEMENTS
Because of our reliance on manufacturers in Asia for our machine
production, 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 March 31, 2003, we had $25 million in
inventory. We will attempt to liquidate this excess inventory during fiscal
2004. We believe that this entire inventory is highly marketable and saleable;
however, there can be no assurances that we will be able to liquidate this
inventory during our upcoming fiscal year.
As of June 30, 2003, we had one remaining consignment agreement with a
customer. Only one product line is included in this consignment agreement, our
music. The Company does not believe that any changes to this arrangement will
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 Craig, Curtis, Grand
Prix and Memorex. 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,
Sybersound, UAV and Sound Choice. We believe that competition for karaoke music
is based primarily on popularity of song titles, price, reputation, and delivery
times. To the extent that we lower prices for to attempt to enhance or retain
market share, we may adversely impact our operating margins. Conversely, if we
opt not to match competitor's price reductions we may lose market share,
resulting in decreased volume and revenue.
We believe that our new product introductions and enhancements of
existing products are material factors for our continued growth and
profitability. In fiscal 2003, we produced new lines of karaoke machines.
However, many of our competitors 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
16
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 85.6% of net sales in fiscal 2003, 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. In fiscal 2003, we overestimated the demand for
our product and held $25 million of inventory as of March 31, 2003. Our
increased inventory levels led to a shortage in our available working capital
and our current liquidity crisis. 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.
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 three warehouses, which are located in Compton, California,
Rancho Dominguez, 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 2003, approximately 48% of our sales were domestic sales,
which were made from our warehouses in California and Florida. During the third
quarter of fiscal 2003, the dock strike on the West Coast affected sales of two
of our karaoke products and we estimate that we lost between $3 and $5 million
in orders because we couldn't get the containers of these products off the pier.
If another strike or work slow-down were to occur and we do not have a
sufficient level of inventory, a strike or work slow-down would result in
increased costs to our company and may reduce our profitability.
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 over the last
few years. Our net sales for the fiscal year ended March 31, 2003 increased 53%
to $95.6 million compared to $62.5 million for the fiscal year ended March 31,
2002. Our net income for fiscal 2003 was $1.2 million compared to $6.3 million
for fiscal 2002. 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 and innovative 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,
motivate and manage our work force.
17
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
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:
- -our ability to resolve our present liquidity crisis, by extending our credit
facility with LaSalle or by finding alternative sources of financing,
- -our ability to resell our excess inventory as of March 31, 2003;
- -unpredictable consumer preferences and spending trends;
- -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, and 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 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
18
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.
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 Yi Ping Chan, our Chief
Operating Officer, April Green, our Chief Financial 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 also intend to enter into an employment agreement with our new CEO, Robert
Weinberg. We cannot assure you that we will be able to find appropriate
replacements for Robert Weinberg, Yi Ping Chan, April Green or Jack Dromgold, if
the need should arise, and any loss or interruption of Mr. Weinberg, Mr. Chan,
Ms. Green or Mr. Dromgold's services could adversely affect our business,
financial condition and results of operations.
OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS.
Our employment agreements with Yi Ping Chan, 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 shareholders. 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.
19
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, 2003, there were 8,300,178 shares of our common stock
outstanding. We have filed two registration statements registering an aggregate
3,794,250 of shares of 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 June 30, 2003, we had 8,300,178 shares of
common stock issued and outstanding and an aggregate of 1,417,250 outstanding
options and warrants. As such, our Board of Directors has the power, without
stockholder approval, to issue up to 9,182,572 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 DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our financial
position, results of operations or cash flows due to adverse changes in
financial and commodity market prices and rates. We are exposed to market risk
in the areas of changes in United States and international borrowing rates and
changes in foreign currency exchange rates. In addition, we are exposed to
market risk in certain geographic areas that have experienced or remain
vulnerable to an economic downturn, such as China. We purchase substantially all
of our inventory from companies in China, and, therefore, we are subject to the
risk that such suppliers will be unable to provide inventory at competitive
prices. While we believe that, if such an event were to occur we would be able
to find alternative sources of inventory at competitive prices, we cannot assure
you that we would be able to do so. These exposures are directly related to our
normal operating and funding activities. Historically and as of June 30, 2003,
we have not used derivative instruments or engaged in hedging activities to
minimize market risk.
INTEREST RATE RISK:
Our exposure to market risk resulting from changes in interest rates
relates primarily to debt under our credit facility with LaSalle. Under our
credit facility, our interest rate is LaSalle's prime rate plus 1/2 of 1% per
annum ("current interest rate"). As of June 30, 2003, we are accruing interest
at the default rate, which is the current interest rate under the credit
agreement plus 2.5% per annum. We do not believe that near-term changes in the
interest rates, if any, will result in a material effect on our future earnings,
fair values or cash flows.
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FOREIGN CURRENCY RISK:
We have a wholly owned subsidiary in Hong Kong. Sales by these
operations made on a FOB China or Hong Kong basis are dominated in U.S. dollars.
However, purchases of inventory and Hong Kong operating expenses are typically
denominated in Hong Kong dollars, thereby creating exposure to changes in
exchange rates. Changes in the Hong Kong dollar/U.S. dollar exchange rates may
positively or negatively affect our gross margins, operating income and retained
earnings. We do not believe that near-term changes in the exchange rates, if
any, will result in a material effect on our future earnings, fair values or
cash flows, and therefore, we have chosen not to enter into foreign currency
hedging transactions. We cannot assure you that this approach will be
successful, especially in the event of a significant and sudden change in the
value of the Hong Kong dollar.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation (the "Evaluation") of the effectiveness of the design
and operation of our disclosure controls and procedures, as defined in Rules
13a-14(c) and 15d-15(c) under the Securities Exchange Act of 1934, within 90
days of the filing date of this report (the "Evaluation Date").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.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From July 2, 2003 through August 11, 2003, ten securities class action
lawsuits were filed against the Singing Machine and certain of its officers and
directors in the United States District Court for the Southern District of
Florida on behalf of all persons who purchased the Singing Machine's securities
during the various class action periods specified in the complaints. We expect
that all of these actions will be consolidated into one case the United States
District Court for the Southern District of Florida. The complaints that have
been filed allege violations of Section 10(b) and Section 20(a) of the
Securities Exchange Act of 1934 and Rule 10(b)-5. The complaints seek
compensatory damages, attorney's fees and injunctive relief. While the specific
factual allegations vary slightly in each case, the complaints generally allege
that defendants falsely represented the Singing Machine's financial results
during the relevant class periods.
We believe the allegations in these class action lawsuits are without
merit and we intend to vigorously defend these actions.
In July 2003, a shareholder filed a derivative action against the
Company, its board of directors and senior management purporting to pursue the
action on behalf of the Company and for its benefit. No pre-lawsuit demand to
investigate the allegations or bring action was made on the board of directors.
The Company is named as a nominal defendant in this case.
The Complaint alleges claims for breach of fiduciary duty, abuse of
control, gross mismanagement, waste of corporate assets and unjust enrichment.
The complaint alleges that the individual defendants breached their fiduciary
duties and engaged in gross mismanagement by allegedly ignoring indicators of
the lack of control over the Company's accounting and management practices,
allowing the Company to engage in improper conduct and otherwise failing to
carry out their duties and obligations to the Company. The plaintiff's seek
damages for breach of fiduciary duties, punitive and compensatory damages,
restitution, and bonuses or other incentive-based or equity based compensation
received by the CEO and CFO under the Sarbanes-Oxley Act of 2002.
We believe the allegations in this derivative lawsuit are without merit
and we intend to vigorously defend this action.
ITEM 2. CHANGES IN SECURITIES
(a) Not Applicable.
(b) Not Applicable.
(c) During the three month period ended June 30, 2003, four employees exercised
stock options issued under our 1994 Amended and Restated Management Stock Option
Plan. The employee exercised options to acquire an aggregate of 128,500 shares
of our common stock. The names of the option holder, the grant date of the
options, the dates of exercise, the number of shares purchased, the exercise
price and the proceeds received by the Company are listed below.
NO. OF
OPTIONS EXERCISE EXERCISE
NAME GRANT DATE EXERCISED PRICE DATE PROCEEDS
John Steele 9/5/2000 30,000 2.0400 4/9/2003 61,200
Allen Schor 9/5/2000 7,500 2.04 4/9/2003 15,300
Alicia Haskamp 9/5/2000 7,500 2.04 4/18/2003 15,300
Alicia Haskamp 9/5/2000 10,000 2.04 4/1/2003 20,400
John Klecha 9/5/2000 58,500 1.11 4/22/2003 64,935
John Klecha 6/25/1999 15,000 2.04 4/22/2003 30,600
All of the above issuances were paid for with cash. The above employees
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.
22
(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
31(a) Certifying Statement of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act
31(b) Certifying Statement of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act
32(a) Certifying Statement of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act
32(a) Certifying Statement of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act
(b) Reports on Form 8-K
The Company filed the following Current Reports on Form 8-K during the
quarterly period ended June 30, 2003:
Date of Report Items Reported Financial Statements Filed
- -------------- -------------- --------------------------
May 6, 2003 Item 5 None
May 22, 2003 Item 5 None
June 5, 2003 Item 5 None
June 30, 2003 Item 5 None
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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.
Dated August 14, 2003
By: /s/ April J. Green
-------------------------------------------
April J. Green
Chief Financial Officer
(On behalf of Registrant and
Chief Accounting Officer)
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EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
31(a) Certifying Statement of the Chief
Executive Officer as adopted
pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
31(b) Certifying Statement of the Chief
Executive Officer as adopted
pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
32(a) 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
32(b) 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