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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2004
0 - 24968
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Commission File Number
THE SINGING MACHINE COMPANY, INC.
---------------------------------
(Exact Name Registrant as Specified in its Charter)
Delaware 95-3795478
- ------------------------ -----------------------------------
(State of incorporation) (I.R.S. Employer Identification No.)
6601 Lyons Road, Building A-7, Coconut Creek, FL 33073
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(Address of principal executive offices)
(954) 596-1000
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(Issuer's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Title of each class Name of each Exchange on which Registered
- ------------------- -----------------------------------------
Common Stock American Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
None
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
requirements for the past 90 days. [X[ Yes [_] No
Indicate by check mark if disclosure of delinquent filers pursuant Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). [_] Yes [X] No
The aggregate market value of the Registrant's voting stock held by
non-affiliates, based upon the closing price for the common stock of $0.71 per
share as reported on the American Stock Exchange on June 18, 2004 was
approximately $6,249645 (based on 8,802,318 shares outstanding).
APPLICABLE ONLY TO CORPORATE ISSUERS: State the number of shares outstanding of
each of the Issuer's classes of common stock, as of the latest practicable date.
There were 8,802,318 shares of common stock, issued and outstanding at June 18,
2004.
DOCUMENTS INCORPORATED BY REFERENCE
NONE
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
INDEX TO ANNUAL REPORT ON FORM 10-KSB
FOR THE FISCAL YEAR ENDED MARCH 31, 2004
PART I
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 7A Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Date
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Item 9A. Controls and Procedures
PART III
Item 10. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accountant Fees and Services
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
2
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report on Form 10-K, including
without limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," "intends," and words of similar import, constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those reflected in these forward-looking statements. Factors
that might cause such a difference include, but are not limited to, those
discussed in the section entitled "Management's Discussion and Analysis of
Financial Position and Results of Operations - Factors That May Affect Future
Results and Market Price of Stock."
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
revisions to these forward- looking statements. Readers should carefully review
the risk factors described in other documents the Company files from time to
time with the Securities and Exchange Commission.
PART I
ITEM 1. BUSINESS
OVERVIEW
The Singing Machine Company, Inc. (the "Singing Machine" "we," "us" or
"our") is engaged in the development, production, distribution, marketing and
sale of consumer karaoke audio equipment, accessories and music. We contract for
the manufacture of all electronic equipment products with factories located in
Asia. We also produce and market karaoke music, including compact disks plus
graphics ("CD+G's"), and audiocassette tapes containing music and lyrics of
popular songs for use with karaoke recording equipment. All of our recordings
include two versions of each song; one track offers music and vocals for
practice and the other track is instrumental only for performance by the
participant. Virtually all of the cassettes sold by us are accompanied by
printed lyrics, and our karaoke CD+G's contain lyrics, which appear on the video
screen. We contract for the reproduction of music recordings with independent
studios.
We were incorporated in California in 1982. We originally sold our
products exclusively to professional and semi-professional singers. In 1988, we
began marketing karaoke equipment for home use. In May 1994, we merged into a
wholly owned subsidiary incorporated in Delaware with the same name. As a result
of that merger, the Delaware Corporation became the successor to the business
and operations of the California Corporation and retained the name The Singing
Machine Company, Inc. In July 1994, we formed a wholly owned subsidiary in Hong
Kong, now known as International SMC (HK) Ltd. ("International SMC" or "Hong
Kong subsidiary"), to coordinate our production and finance in Asia.
In November 1994, we closed an initial public offering of 2,070,000
shares of our common stock and 2,070,000 warrants. In April 1997, we filed a
voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code. On
March 17, 1998, our plan of reorganization was approved by the U.S. Bankruptcy
Court. On June 10, 1998, our plan of reorganization had been fully implemented.
Our common stock currently trades on the American Stock Exchange under the
symbol "SMD." We were listed on the AMEX on March 8, 2001. Our principal
executive offices are located in Coconut Creek, Florida.
As used herein, the "Singing Machine," "we," us" and similar terms
include The Singing Machine Company, Inc. and its subsidiary, International SMC,
unless the context indicates otherwise.
RECENT DEVELOPMENTS
We had a challenging year in the twelve month period ended March 31,
2004 ("fiscal 2004"). During fiscal 2004, we reported a net loss of $22.7
million, or $2.65 per diluted share, on sales of $70.5 million which compares to
net income of $1.2 million in fiscal 2003 or $.14 per diluted share, on sales of
$95.6 million. Sales decreased primarily from increased competition in the
United States and in international markets.
Our gross profit decreased to $1.8 million or 2.6% of total revenues in
fiscal 2004 compared to gross profit of $23.3 million or 24.4% of total revenues
in fiscal 2003. Gross profit decreased as a result of our need to sell inventory
at lower margins in order to generate cash from operations, increase liquidity
and liquidate prior year excess inventory. During fiscal 2004, we also recorded
inventory provisions totaling approximately $7 million and an impairment charge
for tooling totaling approximately $443,000, both of which also negatively
impacted our gross profit.
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Our net loss for fiscal 2004 was $22.7 million, which includes
inventory write-downs of approximately $7.0 million, as well as non cash
accruals for litigation, severance pay, lease termination and other unusual or
non-recurring expenses in the aggregate amount of $4.6 million. A more detailed
explanation of our financial results is contained under "Management's Discussion
and Analysis of Results of Operations and Financial Condition" on pages 10-20.
PRODUCT LINES
We currently have a product line of 40 different models of karaoke
machines plus 7 accessories such as microphones, incorporating such features as
CD plus graphics player, sound enhancement, echo, tape record/playback features,
and multiple inputs and outputs for connection to compact disc players, video
cassette recorders, and home theater systems. Ten of these karaoke machines are
models that we plan on discontinuing after we sell our excess inventory in
fiscal 2005. Our machines sell at retail prices ranging from $30 for basic units
to $300 for semi-professional units. We currently offer our music in two formats
- - multiplex cassettes and CD+G's with retail prices ranging from $6.99 to
$19.99. We currently have a song library of over 3,500 recordings, which we
license from publishers. Our library of master recordings covers the entire
range of musical tastes including popular hits, golden oldies, country, rock and
roll, Christian, Latin music and rap. We even have backing tracks for opera and
certain foreign language recordings.
MARKETING, SALES AND DISTRIBUTION
Our karaoke machines and music are sold nationally and internationally
to a broad spectrum of customers, primarily through mass merchandisers,
department stores, direct mail catalogs and showrooms, music and record stores,
national chains, specialty stores, and warehouse clubs. Our karaoke machines and
karaoke music are currently sold in such stores as Best Buy, Circuit City,
Costco, J.C. Penney, Kohl's, Radio Shack, and Sam's Club.
In fiscal 2004, approximately 61% of our sales were domestic sales and
39% were international sales. Domestic sales are sales that are made in the
United States and international sales are sales that are made outside of the
United States. Our domestic sales are primarily made by our in-house sales team
and our independent sales representatives. Our independent sales representatives
are paid a commission based upon sales in their respective territories. We
utilize some of our outside independent sales representatives to help us provide
service to our mass merchandisers and other retailers. The sales representative
agreements are generally one (1) year agreements, which automatically renew on
an annual basis, unless terminated by either party on 30 days' notice. At March
31, 2004, we worked with 16 independent sales representatives in the United
States. Our international sales are primarily made by our in-house sales
representatives and our eight independent distributors.
We also market our products at various national and international trade
shows each year. We regularly attend the following trade shows and conventions:
the Consumer Electronics Show each January in Las Vegas; the American Toy Fair
each February in New York and the Hong Kong Electronics Show each October in
Hong Kong.
Our licensing agreements with MTV Networks, Inc., a division of Viacom
International, Inc., Hard Rock Academy, Inc. and Universal Music Entertainment,
Inc. have also helped us to expand our product name.
LICENSE AGREEMENTS
We entered into our licensing agreement with MTV in November 2000 and
have amended the agreement five times since that date. Our license covers the
sale of MTV products in the United States, Canada and Australia. During fiscal
2004, our line consisted of nine MTV branded machines and a wide assortment of
MTV branded music. Our license agreement as amended with MTV, currently expires
on August 31, 2004, subject to MTV's option, at its sole discretion, to extend
the agreement for an additional four month period. The license period contains a
minimum guaranteed royalty payment of $100,000, which is recoupable against
sales throughout the calendar year, unless the license agreement is cancelled.
We entered into our licensing agreement with Hard Rock Academy, a
division of Hard Rock Cafe in December 2001. This license agreement allows us to
produce and market a line of karaoke machines and complimentary music that are
co-branded with the Singing Machine and Hard Rock Academy name. The first
co-branded machine was produced during the fourth quarter of fiscal 2003. The
agreement originally contained a minimum guaranteed royalty payment, but in
September 2003 Hard Rock agreed to release us from our minimum guaranteed
payment obligations during the remaining term of the license agreement. This
agreement expires on December 31, 2005 and does not contain any automatic
renewal provisions.
In February 2003, we entered into a multi-year license agreement with
Universal Music Entertainment to market a line of Motown Karaoke machines and
music. This agreement and its subsidiary agreement signed in March 2003, allow
us to be the first to use original artist recordings for our CD+G formatted
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karaoke music. Over the term of the license agreement, we are obligated to make
guaranteed minimum royalty payments in the amount of $300,000. The Universal
Music Entertainment license expires on March 31, 2006 and does not contain any
automatic renewal provisions.
We entered into a license agreement with Care Bears in September 2003.
Under this agreement, we are marketing a line of Care Bears branded karaoke
machines and music. Over the term of the license, we are obligated to make
guaranteed minimum royalty payments in the amount of $200,000. This license
expires on January 1, 2006 and does not contain any automatic renewal
provisions.
We entered into a license agreement with Nickelodeon, Inc., a division
of Viacom International, Inc. in December 2002. Under this agreement, we
licensed Nickelodeon branded machines and a wide assortment of music. This
license will expire on December 31, 2004 and will not be renewed.
We distribute all of our licensed products through our established
distribution channels, including Best Buy, Circuit City, Costco, JC Penny,
Kohl's, Radio Shack and Sam's Club. Our distribution network also includes the
online versions of these retail customers.
The following table sets forth the percentage of total sales that have
been generated under the MTV License, our Nickelodeon License and our other
licenses (Care Bears, Hard Rock Academy and Universal Music).
FOR THE
FISCAL YEAR
ENDED DECEMBER 31
----------------------------
2004 2003
----- -----
MTV 11.8% 32.3%
Nickelodeon 5.5% 0%
Other Licenses 3.9% 0%
---- ----
Total Licensed Sales 21.2% 32.3%
DISTRIBUTORSHIP AGREEMENTS
In November 2001, we signed an international distributorship agreement
with Arbiter Group, PLC ("Arbiter"). Arbiter is the exclusive distributor of
Singing Machine(R) karaoke machines and music products in the United Kingdom and
a non-exclusive distributor in all other European countries. The agreement
terminates on December 31, 2004, subject to an automatic renewal provision. If
either party does not give notice on or before December 1 of year during the
term of the agreement, the agreement will automatically be renewed for another
year on the same terms.
In March 2003, we signed an international distributorship agreement
with Top-Toy (Hong Kong) Ltd. Top Toy is the exclusive distributor of Singing
Machine(R) karaoke machines and music products in Denmark, Norway, Sweden,
Iceland and Faeroe Islands. The agreement is for three years, from April 1, 2003
through March 31, 2006. The agreement contains an automatic renewal provision
whereby if either party does not give notice at least 3 months before March 31,
2006, the agreement will automatically be renewed for another year on the same
terms.
We also have verbal agreements with six other independent distributors
who sell our products throughout Europe
SALES
As a percentage of total revenues, our net sales in the aggregate to
our five largest customers during the fiscal years ended March 31, 2004, 2003,
and 2002, respectively, were approximately 53%, 67% and 87%, respectively. In
fiscal 2004, three major customers accounted for 20%, 12% and 10% of our net
revenues.
In fiscal 2004, Arbiter, Giochi and Best Buy accounted for more than
10% of our net revenues. Arbiter and Giochi are independent distributors of our
products. In fiscal 2003 and 2002, Best Buy and Toys R Us each accounted for
more than 10% of our revenues. In fiscal 2003 Target and in fiscal 2002 Costco
also accounted for more than 10% of our revenues. Although we have
long-established relationships with all of our customers, we do not have
contractual arrangements with any of them. A decrease in business from any of
our major customers could have a material adverse effect on our results of
operations and financial condition.
5
During the last three years, our revenues from foreign operations have
increased. Sales by customer geographic regions were as follows:
FOR THE
FISCAL YEAR
ENDED MARCH 31
-------------------------------------------
2004 2003 2002
----------- ----------- -----------
North America $43,044,496 $77,696,780 $62,381,366
Latin America 753,399 1,366,496 45,073
Europe 25,783,789 15,714,846 --
Asia/Australia 959,444 835,644 49,314
----------- ----------- -----------
$70,541,128 $95,613,766 $62,475,753
=========== =========== ===========
RETURNS
Returns of electronic hardware and music products by our customers are
generally not permitted except in approved situations involving quality defects,
damaged goods, goods shipped in error or goods that are shipped on a consignment
basis. Our policy is to give credit to our customers for the returns in
conjunction with the receipt of new replacement purchase orders. Our total
returns represented 9.4% and 10.4% of our net sales in fiscal 2004 and 2003,
respectively.
DISTRIBUTION
We distribute hardware products to retailers and wholesale distributors
through two methods: shipment of products from inventory held at our warehouse
facilities in Florida and California (domestic sales), and shipments directly
through our Hong Kong subsidiary and manufacturers in Asia of products (direct
sales). Domestic sales, which account for substantially all of our music sales,
are made to customers located throughout the United States from inventories
maintained at our warehouse facilities. In the fiscal year ended March 31, 2004,
approximately 39% of our sales were sales from our domestic warehouses
("Domestic Sales") and 61% were sales shipped directly from Asia ("Direct
Sales").
Domestic Sales. Our strategy of selling products from a domestic
warehouse enables us to provide timely delivery and serve as a "domestic
supplier of imported goods." We purchase karaoke machines overseas from certain
factories in China for our own account, and warehouse the products in leased
facilities in Florida and California. We are responsible for costs of shipping,
insurance, customs clearance, duties, storage and distribution related to such
products and, therefore, warehouse sales command higher sales prices than direct
sales. We generally sell from our own inventory in less than container-sized
lots.
Direct Sales. We ship some hardware products sold by us directly to
customers from Asia through International SMC, our subsidiary. Sales made
through International SMC are completed by either delivering products to the
customers' common carriers at the shipping point or by shipping the products to
the customers' distribution centers, warehouses, or stores. Direct sales are
made in larger quantities (generally container sized lots) to customers' world
wide, who pay International SMC pursuant to their own international,
irrevocable, transferable letters of credit or on open account.
MANUFACTURING AND PRODUCTION
Our karaoke machines are manufactured and assembled by third parties
pursuant to design specifications provided by us. Currently, we have ongoing
relationships with six factories, located in Guangdong Province of the People's
Republic of China, who assemble our karaoke machines. During fiscal 2005, we
expect that 95% of our karaoke products will be produced by one of these
factories, which has agreed to extend financing to us. We are indebted to this
factory in the amount of $2.4 million and have worked out a payment plan
regarding our outstanding invoice. Additionally, this factory has agreed to
provide us with financing for fiscal year 2005. See "Management's Discussion and
Analysis of Financial Condition - Liquidity" beginning on page 17. We believe
that the manufacturing capacity of our factories is adequate to meet the demands
for our products in fiscal year 2005. However, if our primary factory in China
were prevented from manufacturing and delivering our karaoke products, our
operation would be severely disrupted while alternative sources of supply are
located. See "Risk Factors - We are relying on one factory to manufacture and
produce the majority of our karaoke machines for fiscal 2005" on page 22. In
manufacturing our karaoke related products, these factories use molds and
certain other tooling, most of which are owned by International SMC. Our
products contain electronic components manufactured by other companies such as
Panasonic, Sanyo, Toshiba, and Sony. Our manufacturers purchase and install
these electronic components in our karaoke machines and related products. The
finished products are packaged and labeled under our trademark, The Singing
Machine(R).
6
We have obtained copyright licenses from music publishers for all of
the songs in our music library. We contract with outside studios on a work-for
hire basis to produce recordings of these songs. After the songs have been
recorded, we author the CD+G's in our in house studio. We use outside companies
to mass-produce the CD+G's and audiocassettes, once the masters have been
completed.
While our equipment manufacturers purchase our supplies from a small
number of large suppliers, all of the electronic components and raw materials
used by us are available from several sources of supply, and we do not
anticipate that the loss of any single supplier would have a material long-term
adverse effect on our business, operations, or financial condition. Similarly,
we use a small number of studios to record our music (including our in house
production), we do not anticipate that the loss of any single studio would have
a material long-term adverse effect on our business, operations or financial
condition. To ensure that our high standards of product quality and factories
meet our shipping schedules, we utilize Hong Kong based employees of
International SMC as our representatives. These employees include product
inspectors who are knowledgeable about product specifications and work closely
with the factories to verify that such specifications are met. Additionally, key
personnel frequently visit our factories for quality assurance and to support
good working relationships.
All of the electronic equipment sold by us is warranted to the end user
against manufacturing defects for a period of ninety (90) days for labor and
parts. All music sold is similarly warranted for a period of 30 days. During the
fiscal years ended March 31, 2004, 2003 and 2002, warranty claims have not been
material to our results of operations.
COMPETITION
Our business is highly competitive. Our major competitors for karaoke
machines and related products are Craig and Memorex. We believe that competition
for karaoke machines is based primarily on price, product features, reputation,
delivery times, and customer support. We believe that our brand name is well
recognized in the industry and helps us compete in the karaoke machine category.
Our primary competitors for producing karaoke music are Pocket Songs, UAV,
Sybersound and Sound Choice. We believe that competition for karaoke music is
based primarily on popularity of song titles, price, reputation, and delivery
times.
In addition, we compete with all 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
videocassettes. Our financial position depends, among other things, on our
ability to keep pace with changes and developments in the entertainment industry
and to respond to the requirements of our customers. Many of our competitors
have significantly greater financial, marketing, and operating resources and
broader product lines than we do.
TRADEMARKS
We have obtained registered trademarks for The Singing Machine name and
the logo in which the microphone is used in our name in the United States and in
the European Community. We have also filed trademark applications in Australia
and Hong Kong. In fiscal 2003, we filed an intent to use application for the
mark Karaoke Vision in the United States.
Our trademarks are a significant asset because they provide product
recognition. We believe that our intellectual property is significantly
protected, but there are no assurances that these rights can be successfully
asserted in the future or will not be invalidated, circumvented or challenged.
COPYRIGHTS AND LICENSES
We hold federal and international copyrights to substantially all of
the music productions comprising our song library. However, since each of those
productions is a re-recording of an original work by others, we are subject to
contractual and/or statutory licensing agreements with the publishers who own or
control the copyrights of the underlying musical compositions. We are obligated
to pay royalties to the holders of such copyrights for the original music and
lyrics of all of the songs in our library that have not passed into the public
domain. We are currently a party to many different written copyright license
agreements.
The majority of the songs in our song library are subject to written
copyright license agreements, oftentimes referred to as synchronization
licenses. Our written licensing agreements for music provide for royalties to be
paid on each song. The actual rate of royalty is negotiable, but typically
ranges from $0.09 to $0.18 per song on each CD that is sold. Similarly, the
terms of the licenses vary, but typically are for terms of 2 to 5 years. Our
written licenses typically provide for quarterly royalty payments, although some
publishers require reporting on a semi-annual basis.
We currently have compulsory statutory licenses for certain songs in
our song library which are reproduced on audiocassettes. The Federal Copyright
Act creates a compulsory statutory license for all non-dramatic musical works,
7
which have been distributed to the public in the United States. Royalties due
under compulsory licenses are payable quarterly and are based on the statutory
rate. We also have written license agreements for substantially all of the
printed lyrics, which are distributed with our audiocassettes, which licenses
also typically provide for quarterly payments of royalties at the statutory
rate.
GOVERNMENT REGULATION
Our karaoke machines must meet the safety standards imposed in various
national, state, local and provincial jurisdictions. Our karaoke machines sold
in the United States are designed, manufactured and tested to meet the safety
standards of Underwriters Laboratories, Inc. ("ULE") or Electronic Testing
Laboratories ("ETL"). In Europe and other foreign countries, our products are
manufactured to meet the CE marking requirements. CE marking is a mandatory
European product marking and certification system for certain designated
products. When affixed to a product and product packaging, CE marking indicates
that a particular product complies with all applicable European product safety,
health and environmental requirements within the CE marking system. Products
complying with CE marking are now accepted to be safe in 28 European countries.
However, ULE or ETL certification does not mean that a product complies with the
product safety, health and environmental regulations contained in all fifty
states in the United States. Therefore, we maintain a quality control program
designed to ensure compliance with all applicable US and federal laws pertaining
to the sale of our products. Our production and sale of music products is
subject to federal copyright laws.
The manufacturing operations of our foreign suppliers in China are
subject to foreign regulation. China has permanent "normal trade relations"
("NTR") status under US tariff laws, which provides a favorable category of US
import duties. China's NTR status became permanent on January 1, 2002, following
enactment of a bill authorizing such status upon China's admission to the World
Trade Organization ("WTO") effective as of December 1, 2001. This substantially
reduces the possibility of China losing its NTR status, which would result in
increasing costs for us.
SEASONALITY AND SEASONAL FINANCING
Our business is highly seasonal, with consumers making a large
percentage of karaoke purchases around the traditional holiday season in our
second and third quarter. These seasonal purchasing patterns and requisite
production lead times cause risk to our business associated with the
underproduction or overproduction of products that do not match consumer demand.
Retailers also attempt to manage their inventories more tightly, requiring that
we ship products closer to the time that retailers expect to sell the products
to consumers. These factors increase the risk that we may not be able to meet
demand for certain products at peak demand times, or that our own inventory
levels may be adversely impacted by the need to pre-build products before orders
are placed. As of March 31, 2004, we had inventory of $5.2 million (net of
reserves totaling $6.6 million) compared to inventory of $25.2 million as of
March 31, 2003 (net of reserves totaling $3.7 million). In fiscal 2003, we
overestimated the demand for our products and as result had $25 million of
excess inventory at year end.
Our financing of seasonal working capital during fiscal 2004 was
different from prior years because of the excess inventory that we had on hand
as of March 31, 2003. During fiscal 2004, we purchased approximately $9.1
million of new inventory and the remainder of our sales were from the
liquidation of the excess inventory on hand. We financed the purchase of new
inventory with our short-term lines of credit in Hong Kong and through
financing, with one of our factories in China.
During fiscal 2005, we plan on financing our inventory purchases by
using credit that has been extended to us by one of our factories in China, by
using our short term lines of credit in Hong Kong and with letters of credit
that are issued by our customers to be used as collateral for payment to our
vendors. As of June 30, 2004, we expect to order an aggregate of approximately
$28 million of inventory during fiscal 2005.
BACKLOG
We ship our products in accordance with delivery schedules specified by
our customers, which usually request delivery within three months of the date of
the order. In the consumer electronics industry, orders are subject to
cancellation or change at any time prior to shipment. In recent years, a trend
toward just-in-time inventory practices in the consumer electronics industry has
resulted in fewer advance orders and therefore less backlog of orders for the
Company. We believe that backlog orders at any given time may not accurately
indicate future sales. As of June 20, 2004, we had backlog of $32.8 million
compared to backlog of $33.4 million at the same period in 2003. We believe that
we will be able to fill all of these orders in fiscal year 2005. However, these
orders can be cancelled or modified at any time prior to delivery.
EMPLOYEES
As of March 31, 2004, we employed 40 persons, all of whom are full-time
employees, including three executive officers. Fifteen of our employees are
located at International SMC's corporate offices in Hong Kong. The remaining
twenty five employees are based in the United States, including two executive
positions; ten are engaged in warehousing and technical support, and thirteen in
accounting, marketing, sales and administrative functions.
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ITEM 2. PROPERTIES
Our corporate headquarters are located in Coconut Creek, Florida in an
18,000 square foot office and warehouse facility, of which 7600 square feet has
been subleased. Our four leases for this office space expire on August 31, 2005.
We have leased 9,393 square feet of office and showroom space in Hong Kong from
which we oversee China based manufacturing operations. Our two leases for this
space in the Ocean Center building expire on April 30, 2005 and May 31, 2005,
respectively.
We have one warehouse facility in Compton California. The Compton
warehouse facility has 79,000 square feet and the lease expires on February 23,
2008. We terminated our lease for warehouse space in Rancho Domingeuz,
Caliofnria effective as of May 1, 2004.
We believe that the facilities are well maintained, in substantial
compliance with environmental laws and regulations, and adequately covered by
insurance. We also believe that these leased facilities are not unique and could
be replaced, if necessary, at the end of the term of the existing leases.
ITEM 3. LEGAL PROCEEDINGS
Class Action and Derivative Lawsuit
- -----------------------------------
From July 2, 2003 through October 2, 2003, seven securities class
action lawsuits and a shareholder's derivative action were filed against us and
certain of our officers and directors in the United States District Court for
the Southern District of Florida on behalf of all persons who purchased our
securities during the various class action periods specified in the complaints.
On September 18, 2003, United States District Judge William J. Zlock entered an
order consolidating the seven (7) purported class action law suits and one (1)
purported shareholder derivative action into a single action case styled Frank
Bielansky v. the Company, Salberg & Company, P.A., et al - Case Number: 03-80596
- - CIV - ZLOCK (the "Class Action"). The complaints that were 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.
We entered into a settlement agreement with the plaintiffs in the Class
Lawsuit in March 2004. At a hearing in April 2004, the Court gave preliminary
approval for the settlement and directed that notices be sent to shareholders
pursuant to the Settlement Agreement. The notices advised shareholders of their
rights and responsibilities concerning the settlement. The Court has set a
hearing on July 30, 2004 before Judge Zlock to consider final approval of the
settlement.
Pursuant to the terms of the settlement agreement, we are required to
make a cash payment of $800,000 and Salberg & Company, P.A., our former auditor,
is required to make a payment of $475,000. Our cash payment of $800,000 is
covered by our liability insurance and our insurer has placed this payment in an
escrow account pending final approval of the Settlement. In addition, we are
obligated to issue 400,000 shares of our common stock. The pending settlement
would also obligate us to implement certain corporate governance changes,
including an expansion or our Board of Directors to six members with independent
directors comprising at least 2/3 of the total Board seats.
Bankruptcy Filing in Fiscal year 1997
- -------------------------------------
We filed a voluntary petition for relief under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court for the Southern District
of Florida, case number 97-22199-BKC-RBR, on April 11, 1997. On March 17, 1998,
the U.S. Bankruptcy Court confirmed our First Amended Plan of Reorganization. As
of June 10, 1998, our plan has been fully implemented.
Other Matters
- -------------
We are involved in various other litigation and legal matters,
including claims related to intellectual property, product liability which we
are addressing or defending in the ordinary course of business. Management
believes that any liability that may potentially result upon resolution of such
matters will not have a material adverse effect on our business, financial
condition or results of operation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our annual meeting of shareholders was held on February 26, 2004.
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.
9
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
--------- --------
Bernard Appel 7,986,945 52,617
Jay Bauer 7,986,945 52,617
Yi Ping Chan 7,373,655 665,907
Richard Ekstract 7,616,891 422,671
The proposal to approve an amendment to our Year 2001 Stock Option Plan
to allow for the grant of stock awards under the Year 2001 Stock Option Plan was
ratified and approved by the following votes:
Shares Voted Shares Voted Shares Broker
"FOR" "AGAINST" "ABSTAINING" "NON-VOTE"
- ----------- --------- ------------ ----------
1,921,599 1,351,142 45,720 4,721,101
The proposal to approve the appointment of Grant Thornton LLP as
independent accountants for the Company for the year ended March 31, 2004, was
ratified by the following vote:
Shares Voted Shares Voted Shares Broker
"FOR" "AGAINST" "ABSTAINING" "NON-VOTE"
- ----------- --------- ------------ ----------
7,605,366 8,122 2,794 --
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock currently trades on the American Stock Exchange under
the symbol "SMD." Set forth below is the range of high and low information for
our common stock as traded on the American Stock Exchange during fiscal 2004 and
fiscal 2003. This information regarding trading on AMEX represents prices
between dealers and does not reflect retail mark-up or markdown or commissions,
and may not necessarily represent actual market transactions.
FISCAL PERIOD HIGH LOW
2004:
First quarter (April 1 - June 30, 2003) $7.94 $2.85
Second quarter (July 1 - September 30, 2003) 5.03 2.70
Third quarter (October 1 - December 31, 2003) 4.43 1.80
Fourth quarter (January 1 - March 31, 2004) 2.43 1.14
2003:
First quarter (April 1 - June 30, 2002) $16.89 $12.06
Second quarter (July 1 - September 30, 2002 12.74 8.05
Third quarter (October 1 - December 31, 2002) 13.49 8.50
Fourth quarter (January 1 - March 31, 2003) 9.19 5.30
As of July 1, 2004, there were approximately 311 record holders of our
outstanding common stock.
COMMON STOCK
We have never declared or paid cash dividends on our common stock and
our Board of Directors intends to continue its policy for the foreseeable
future. Future dividend policy will depend upon our earnings, financial
condition, contractual restrictions and other factors considered relevant by our
Board of Directors and will be subject to limitations imposed under Delaware
law.
On March 14, 2002, we affected a 3 for 2 stock split for all
shareholders on record as of March 4, 2002.
10
SALES OF UNREGISTERED SECURITIES
Effective as of April 15, 2003, we issued an aggregate of 50,000
options to Jack Dromgold as consideration for services that he had rendered to
us. The options had an exercise price of $7.60 per share and vested in five
equal installments over a five year period beginning on January 1, 2004. We
issued these options to Mr. Dromgold in reliance upon Section 4(2) of the
Securities Act, because he was knowledgeable, sophisticated and had access to
comprehensive information about us. We inadvertently failed to report these
options in the first quarter of fiscal 2004. These options expired in March
2004, ninety days after Mr. Dromgold's resignation from our company.
ITEM 6. SELECTED FINANCIAL DATA
*RESTATED
2004 2003 2002* 2001* 2000
------------ ------------ ------------ ------------ ------------
STATEMENT OF OPERATIONS:
Net Sales $ 70,541,128 $ 95,613,766 $ 62,475,753 $ 34,875,351 $ 19,032,320
Earnings(loss) before income taxes $(21,924,919) $ 1,416,584 $ 8,184,559 $ 4,188,021 $ 577,686
Income tax expense (benefit) 758,505 $ 198,772 $ 1,895,494 $ 494,744 $ 160,299
Net earnings (loss) $(22,683,424) $ 1,217,813 $ 6,289,065 $ 3,696,277 $ 737,985
BALANCE SHEET:
Working capital $ (1,382,929) $ 15,281,023 $ 14,577,935 $ 6,956,879 $ 2,985,120
Current ratio 0.90 1.72 3.82 4.37 7.77
Property, plant and equipment, net $ 983,980 $ 1,096,424 $ 574,657 $ 263,791 $ 99,814
Total assets $ 14,761,572 $ 38,935,294 $ 21,403,196 $ 10,509,682 $ 4,346,901
Shareholders' equity $ 216,814 $ 17,685,364 $ 16,225,433 $ 8,450,237 $ 3,906,286
PER SHARE DATA:
Earnings (loss) per common share
- - basic $ (2.65) $ 0.15 $ 0.88 $ 0.59 $ 0.23
Earnings (loss) per common share
- - diluted $ (2.65) $ 0.14 $ 0.79 $ 0.50 $ 0.19
Cash dividends paid 0.00 0.00 0.00 0.00 0.00
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
OVERVIEW
We had a challenging year in the twelve month period ended March 31,
2004 ("fiscal 2004"). During fiscal 2004, we reported a net loss of $22.7
million, or $2.65 per diluted share, on sales of $70.5 million which compares to
net income of $1.2 million in fiscal 2003 or $.14 per diluted share, on sales of
$95.6 million. Sales decreased primarily from increased competition in the
United States and in international markets. In fiscal 2003, we overestimated
the demand for our products and as result had $25 million of excess inventory at
year end. In addition, both our retail customers and our international
distributors carried excess Singing Machine inventory into fiscal 2004, which
impacted our ability to sell into the trade and distribution channels.
Our gross profit decreased to $1.8 million or 2.6% of total revenues in
fiscal 2004 compared to gross profit of $23.3 million or 24.4% of total revenues
in fiscal 2003. Our net loss for fiscal 2004 was $22.7 million, which includes
several unusual operating expenses: litigation expenses severance expenses,
lease termination costs, write off of prepaid royalties tooling impairment
charges, write off of capitalized cost of reorganization intangible.
11
In July 2003, we made a decision to restate our audited financial
statements for the fiscal years ended March 31, 2002 and March 31, 2001 because
we revised our position on the taxation of the income of International SMC, our
Hong Kong subsidiary. See "Restatement" on pages 12-13. As a result of this
restatement we were named as a defendant in several class action lawsuits and a
derivative lawsuit. The shareholder complains were consolidated into one lawsuit
in the United States District Court for Southern Florida. We entered into a
settlement agreement with the class action plaintiffs in April 2004 and are
waiting for final approval of the settlement on July 30, 2004. See "Legal
Proceedings" on page 9. We incurred approximately $706,000 for the settlement
and related expenses, net of reimbursement from our insurance carrier.
In July 2003, we raised $1 million in subordinated debt financing from
an investment group comprised of an officer, directors and an associate of one
of our directors. On August 19, 2004, LaSalle amended the credit agreement,
which extended the loan until March 31, 2004 and waived the condition of
default. On September 8, 2003, we raised $4 million in an offering of 8%
convertible subordinated debentures to six accredited investors. The proceeds of
the debenture were used to pay down our accounts payable liabilities, finance
operations and pay down a portion of our loan with LaSalle. On December 31,
2003, we again violated the tangible net worth requirement and working capital
requirements under our credit agreement with LaSalle. On January 31, 2004, we
paid off our loan with LaSalle and LaSalle released its security interests in
our assets. We entered into a factoring agreement with Milberg Factors effective
as of February 9, 2004.
Despite the reduction in expenses and the additional capital, we still
had minimal liquidity during fiscal 2004. As such, we were forced to sell excess
inventory at or below cost. During fiscal 2004, we sold approximately 20.2% of
our inventory at prices at or below cost. As such, our gross profit decreased to
2.6% of our net sales. As of March 31, 2004, we did not have any advances
outstanding under our factoring agreement with Milberg; however, we were in
violation of the covenants relating to working capital and tangible net worth.
Because of our limited liquidity, we received a going concern uncertainty
paragraph on our audited financial statements for fiscal 2004. Although our cash
on hand as of July 1, 2004 is limited, we believe that we will have sufficient
cash from operations to fund our operating requirements for the next three
months. After three months, we expect to begin collecting accounts receivable
from the sales of our karaoke products in the second and third quarters. If
there is a need for additional funds, short term loans will be obtained. See
"Liquidity" beginning on page 17. We will continue to sell older inventory
models at discounted prices to generate cash as well as continuing to reduce
operating expenses.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
income and expense items expressed as a percentage of the Company's total
revenues:
2004 2003 2002*
Total revenues 100.0% 100.0% 100.0%
Cost of sales 97.4% 75.6% 65.4%
Operating expenses 31.2% 22.7% 21.4%
Operating (loss) income (28.6%) 1.7% 13.2%
Other (expenses), income, net (2.5%) (0.2%) (0.1%)
(Loss) Income before taxes (31.1%) 1.5% 13.1%
Provision (benefit) for income taxes 1.1% .2% 3.0%
(Loss) income (32.2%) 1.3% 10.1%
*AS RESTATED.
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, our 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, we 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, we 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.
12
The net effect of the above two adjustments is to decrease net income
by $1,776,217 and $468,424 in fiscal 2002 and 2001. The net effect on net income
per share is to decrease net income per share basic and diluted by $0.25 and
$0.23, respectively in fiscal 2002 and decrease net income per share basic and
diluted by $0.07 and $0.06, respectively in fiscal 2001.
FISCAL YEAR ENDED MARCH 31, 2004 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2003
- -------------------------------------------------------------------------------
NET SALES
Net sales for the fiscal year ended March 31, 2004 decreased to $70.5
million compared to revenues of $95.6 million in the fiscal year ended March 31,
2003. The decrease in net sales was due to both decreases in unit volume as well
as pricing, due to increases in competition in the United States and
international markets. In fiscal year 2004, 61% of our sales were direct sales,
which represent sales made by International SMC, and 39% were domestic sales,
which represent sales made from our warehouse in the United States.
The sales decreases occurred in all segments of our business. Our total
hardware sales decreased to $67.7 million, in fiscal 2004 compared to total
hardware sales of $87 million in fiscal 2003. The total decrease of hardware
sales of $19.3 million from the previous year sales level is the primary due to
the increasing market competition. Also we had to lower our price in order to
move the overstocked inventory from fiscal year 2003.
In addition, there was a significant decrease in our music sales. Music
sales decreased to $2.8 million, or 4% of net sales, in fiscal 2004, compared to
$9.1 million, or 9.5% of net sales, in fiscal 2003. The decrease in music sales
is also a result of increased competition in this category, both domestically as
well as internationally.
GROSS PROFIT
Gross profit for fiscal 2004 was $1,818,550 or 2.6% of total revenues
compared to $23,284,731 or 24.4% of sales for fiscal 2003. The decrease in gross
margin compared to the prior year is primarily due to the following factors: (i)
write-down of inventories, (ii) sales made at lower prices to generate cash from
operation, (iii) increased sales by International SMC, the gross profit margin
is lower for the sales shipped from Hong Kong due to the volume discount and
reduction of the warehousing and insurance expenses and (iv) tooling impairment
cost of $443,000.
At the end of fiscal 2004, our inventory levels were much higher than
we expected. We determined that due to liquidation sales, inventory would be
sold at a loss; therefore, a decrease in the value of specific inventory items
was made. The total amount of the provision for inventory was $6.6 million in
fiscal 2004 compared to a provision of $3.7 million in fiscal 2003.
13
In addition to the write-down of inventories, due to competitive price
pressure, a significant amount of sales shipped in current year were made at
lower margins than in previous years. In the fourth quarter, we sold $1 million
of inventory with a negative margin of $366,751 (after applying inventory
valuation reserves).
Our product line did not sell as well as our retailers and mass
merchants had expected. As a result, we agreed to give our customers pricing
concessions and allowed them to return inventory to us. We issued over $1
million in customer credits during the fourth quarter, which reduced our sales
and gross profit margins equally. Our gross margins were also negatively
affected by the return of $1.8 million in inventory.
Our decrease in our gross margin percentage in fiscal 2004 compared to
fiscal 2003 was also reduced by the mix of our sales. The percentage of sales
made by our Hong Kong subsidiary increased from 52% of the total sales in fiscal
2003 to 61% in fiscal 2004. Usually, sales made by International SMC
historically maintain a lower gross profit margin because there are no variable
expenses from these sales. Other variable expenses that are normally included
with sales are advertising allowances, returns and commissions.
Our gross profit may not be comparable to those of other entities,
since some entities include the costs of warehousing, inspection, freight
charges and other distribution costs in their cost of sales. We account for the
above expenses as operating expenses and classify them under selling, general
and administrative expenses
OPERATING EXPENSES
Operating expenses were $22,013,849 or 31.2% of net sales in fiscal
2004 compared to $21,670,501 or 22.7% of net sales in fiscal 2003. The primary
factors that contributed to the increase in operating expenses are:
o Increased compensation expenses in the amount of $953,000 in
fiscal 2004 of which approximately $323,000 was for severance
payments to four former executive officers,
o Increased selling, general and administrative expenses of
$2,706,000 due to
o increased legal fees in the amount of $1,080,000 of
which approximately $706,000 was for the class action
settlement, and increased consulting fees in the
amount of approximately $370,000 which was related to
consulting work performed by our lender,
o increased rent expenses in the amount of $690,000 due
to the expansion of the warehouse facility in Rancho
Dominguez in fiscal 2003. The increase warehouse
space was necessary to stock the unanticipated unsold
inventories in fiscal year 2004 and expenses of
$180,000 for early termination of the lease in Rancho
Dominguez, California
o a write off of the capitalized cost of reorganization
of $185,000,
o increased accounting expenses in the amount of
$426,000, which was due to the additional work needed
to restate our financial statements for the fiscal
years ended March 31, 2001 and 2002 and work required
on the filing of certain registration statements and
o increased bank fees and loan cost in the amount of
$271,000, which was related to the loan agreement
with Lasalle bank.
This increase in expenses was offset by decreases in our advertising
expenses and our freight and handling charges in the amount of $2,692,000 and
$689,000, respectively. Advertising expense consists of two components:
co-operative advertising and direct advertising expense. Co-operative
advertising is paid directly to the customer and the allowances are based on the
amount of sales. The customer provides copies of advertising on which these
funds are spent, but has complete discretion as to the use of these funds. As we
believe that there is a separate and identifiable benefit associated with the
co-operative advertising, such amounts are recorded as a component of operating
expenses. Co-operative advertising expenses decreased to $2,340,439 in fiscal
2004 compared to $5,032,367 in fiscal 2003 because our sales decreased. Our
royalty expenses were $2,294,727 in fiscal 2004 compared to $2,257,653 in fiscal
2003. Our royalty expenses in fiscal 2004 included a write-off of $980,000 in
pre-paid royalties under our licensing agreement with MTV.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses were $750,359 for fiscal
2004 compared to $622,298 for fiscal 2003. This increase in depreciation and
amortization expenses can be attributed to our investment in tooling and dies
for the new models, in addition to the acceleration in the depreciation method
used to write off the useful life of the tools and dies.
14
NET OTHER EXPENSES
Net other expenses were $1,729,620 in fiscal 2004 compared to $197,646
in fiscal 2003. Net other expenses increased because our interest expense
increased to $1.7 million in fiscal 2004 compared to $406,000 in fiscal 2003.
Our interest expense increased because we recorded $917,853 for the amortization
of the discount and related deferred financing fees on our convertible
debentures and approximately $800,000 relates to interest expense on the LaSalle
loan, interest on the convertible debentures, interest on the insiders loan, and
interest expense incurred at our Hong Kong subsidiary. We expect interest
expense to increase further in fiscal 2005, as we will have a full year's worth
of amortization of the discount on the convertible debentures and related
deferred financing fees.
INCOME BEFORE TAXES
We had a net loss before taxes of $21,924,919 in fiscal 2004 compared
to net income of $1,416,584 in fiscal 2003.
INCOME TAX EXPENSE
Significant management judgment is required in developing our provision
for income taxes, including the determination of foreign tax liabilities,
deferred tax assets and liabilities and any valuation allowances that might be
required against the deferred tax assets. Management evaluates its ability to
realize its deferred tax assets on a quarterly basis and adjusts its valuation
allowance when it believes that it is more likely than not that the asset will
not be realized. At December 31, 2003 and March 31, 2004, we concluded that a
valuation allowance was needed against all of our deferred tax assets, as it was
not more likely than not that the deferred taxes would be realized. At March 31,
2004 and 2003, we had gross deferred tax assets of $8.2 million and $1.9
million, against which we recorded valuation allowances totaling $8.2 million
and $0, respectively.
For the fiscal year ended March 31, 2004, we recorded a tax provision
of $758,505. This occurred because the valuation allowance established against
our deferred tax assets exceeded the amount of the benefit created from carrying
back a portion of the current year's losses. The carry-back of the losses from
the current year resulted in an income tax receivable of $1.1 million, which is
included in refundable tax in the accompanying balance sheets. We have now
exhausted our ability to carry back any further losses and therefore will only
be able to recognize tax benefits to the extent that we has future taxable
income.
Our subsidiary has applied for an exemption of income tax in
Hong Kong. Therefore, no taxes have been expensed or provided for at the
subsidiary level. Although no decision has been reached by the governing body,
the parent company has reached the decision to provide for the possibility that
the exemption could be denied and accordingly has recorded a provision for Hong
Kong taxes in fiscal 2003 and 2002. There was no provision for Hong Kong income
taxes in fiscal 2004 due to the subsidiary's net operating loss for the year.
Hong Kong income taxes payable totaled $2.4 million at March 31, 2004 and 2003
and is included in the accompanying balance sheets as income taxes payable.
We effectively repatriated approximately $2.0 million, $5.6 million and
$5.7 million from our foreign operations in 2004, 2003 and 2002, respectively.
Accordingly, these earnings were taxed as a deemed dividend based on U.S.
statutory rates. We have no remaining undistributed earnings of our foreign
subsidiary.
We operate within multiple taxing jurisdictions and are
subject to audit in those jurisdictions. Because of the complex issues involved,
any claims can require an extended period to resolve. In management's opinion,
adequate provisions for income taxes have been made.
NET LOSS/NET INCOME
As a result of the foregoing, we had a net loss of $22.7 million in
2004 compared to net income of $1.2 million in fiscal 2003.
FISCAL YEAR ENDED MARCH 31, 2003 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2002
NET SALES
Net sales for the fiscal year ended March 31, 2003 increased 53.0% to
$95,613,766 compared to $62,475,753 for the fiscal year ended March 31, 2002.
Our growth was driven in large part by the addition of international sales in
Europe, Asia, and Australia. We also generated $30,884,344 million or 32.3% of
our net sales from products sold under the MTV license in fiscal 2003.
Strong sales of our music titles were also driving forces in our
revenue growth for fiscal 2003. In fiscal 2003, our sales of music increased to
$8,894,743 or 9.3% of sales as compared to $6,306,547 or 10.1% of net sales in
fiscal 2002. In fiscal 2004, 52% of our sales were direct sales, which represent
sales made by International SMC, and 48% were domestic sales, which represent
sales made from our warehouse in the United States.
15
GROSS PROFIT
Gross profit for the fiscal year ended March 31, 2003 was $23,284,731
or 24.4% of sales as compared to $21,622,913 or 34.6% of sales for the fiscal
year ended March 31, 2002. The decrease in gross margin compared to the prior
year is due primarily to the following factors: (i) increased sales from
International SMC both to domestic and international customers; (ii) a write
down of the value of inventory and (iii) a reduction of sales due to a
guaranteed gross profit agreement with Transworld.
International sales were primarily in Europe, Canada and Australia.
Sales to international customers historically maintain lower selling prices, and
thus, a lower gross profit margin. The main reason for this is that the sales
are made to distributors in those countries and there are no additional variable
expenses. Other variable expenses that are seen in conjunction with U.S. sales
are advertising allowances, handling charges, returns and commissions.
In fiscal 2003, we entered into a guaranteed gross profit agreement
with Transworld, a specialty music retailer. We guaranteed Transworld that it
would earn a minimum gross profit of $3,573,000 from the sale of our karaoke
products during the period between September 1, 2002 through January 15, 2003.
Under this agreement, we agreed to pay Transworld for the difference between the
gross profit earned on its sales of our karaoke products and the minimum
guarantee. As of the settlement date of the contract, Transworld had not
realized the minimum guarantee of gross profit. As such, we had to provide them
with a check in the amount of $2.5 million, which was recorded in the fourth
quarter of fiscal 2003 as a reduction to revenue.
At the end of fiscal 2003, our inventory level was much higher than we
had expected. As of March 31, 2003, we had inventory on hand of $25 million. We
determined that due to liquidation sales, inventory would be sold at a loss;
therefore, a decrease in the value of specific inventory items was made. The
total amount of the provision for inventory was $3,715,357 at March 31, 2003.
Gross profit may not be comparable to those of other entities, since
some entities include the costs of warehousing, inspection, freight charges and
other distribution costs in their cost of sales. We account for the above
expenses as operating expenses and classify them under selling, general and
administrative expenses.
OPERATING EXPENSES
Operating expenses were $21,670,501 or 22.7% of total revenues in
fiscal 2003 up from $13,387,533 or 21.4% of total revenues, in fiscal 2002. The
primary factors that contributed to the increase of approximately $8.3 million
in operating expenses for the fiscal year 2003 are:
o increased advertising expenses of $2,654,729 due to increased
use of our outside advertising agency to oversee more
advertising projects for us, the production of a television
commercial, as well as cooperative advertising with customers,
which is variable based on the level of sales
o the increase in depreciation in the amount of $239,686 due to
the addition of molds for new product additions for fiscal
year 2003,
o compensation expense in the amount of $1,151,012 due to the
addition of key personnel in Florida, at our California
facility and at International SMC, which include the executive
vice-president of sales, sales administration, music licensing
coordinator, and music production personnel, as well as
warehouse employees and repair personnel.
o increased freight and handling charges to customers in the
amount of $869,525,
o expansion of the California warehouse and its associated
expenses in the amount of $873,919,
o expansion of International SMC's operations and its related
expenses, in the amount of $580,906.
o increases in product development fees for the development of
future product in the amount of $571,370.
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 royalty expenses and commissions. We also incurred $79,000 of
expenses for catalogue expenses and show expenses. These expenses are not
variable and do not change based on the level of sales. Show expenses are costs
that are associated with the Consumer Electronics Show and Toy Fair, such as
promotional materials, show space and mock up samples.
Our advertising expense increased $2,654,729 for the fiscal year ended
March 31, 2003 as compared to fiscal 2002. Advertising expense consists of two
components: co-operative advertising and direct advertising expense.
Co-operative advertising is paid directly to the customer and the allowances are
based on the amount of sales. The customer provides copies of advertising on
which these funds are spent, but has complete discretion as to the use of these
funds. As we believe that there is a separate and identifiable benefit
associated with the co-operative advertising, such amounts are recorded as a
component of operating expenses. Co-operative advertising expenses accounted for
$2,320,705 of the increase in advertising expenses. In fiscal 2002, we embarked
16
on our first television advertising and continued with the use of print
advertising, radio spots, sponsorships, promotions and other media. This is
considered direct advertising, whereby we actually contract for advertising of
the product. The increased costs for our advertising firm were $334,024 over the
prior year. The expense for direct advertising is at our discretion and is not
variable based on the level of sales attained. Both of these types of
advertising are direct expenses of the Company.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses were $622,298 for the fiscal
year ended March 31, 2003 as compared to $394,456 for the fiscal year ended
March 31, 2002. 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, as well as minimal costs for additional computer
equipment and furniture for additional personnel.
OTHER EXPENSES
Net other expenses were $197,646 for the fiscal year ended March 31,
2003 as compared with net other expenses of $50,821 for the fiscal year ended
March 31, 2002. Our interest expense increased during the fiscal year ended
March 31, 2003 compared to the same period of the prior year primarily due to
our increased borrowings under our credit facility with LaSalle during this
period. Prior to August 2002, we had cash reserves to fund operations and did
not need to borrow under our revolving credit facility. However, in August 2002,
we began borrowing our credit facility with LaSalle. Our interest income
decreased from $16,934 during the fiscal year 2002 to $11,943 during the fiscal
year 2003 due to our interest earning's cash balance is lower than previous
year. We expect interest expense to increase in fiscal 2004 as compared to prior
years due to the credit facility accruing interest at a higher rate, effective
as of August 19, 2003 when we entered into the Fourteenth Amendment to our
credit facility. As of December 31, 2003, our credit facility accrued interest
at 6.5%, which is prime plus 2.5%, our former default rate. Since interest is
calculated based on the average monthly balance of the credit facility, we can
not reasonably estimate the degree to which this year's expense will exceed last
years. We do know, however, that the interest spread is 1.75% higher than in the
same period last year.
INCOME TAX EXPENSE
Our tax expense is based on an aggregation of the taxes on earnings of
International SMC and our domestic operations. Income tax rates in Hong Kong are
approximately 16%, while the statutory income tax rate in the United States is
34%. Our effective tax rate in fiscal 2003 was 14% as compared to 23% in fiscal
2002. This decrease in the effective tax rate is a result of our company
generating a pretax loss in the United States in fiscal 2003, resulting in a tax
benefit, as compared to pretax income in the United States in fiscal 2002. Our
future effective income tax rate will fluctuate based on the level of earnings
of International SMC and our domestic operations.
NET INCOME
As a result of the foregoing, our net income was $1,217,812 for the
fiscal year ended March 31, 2003 compared to net income of $6,289,065 for fiscal
2002.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2004, we had cash on hand of $356,342 and current assets
of $13,161,819. Our current assets consist primarily of cash on hand of
$356,342, restricted cash of $874,283, accounts receivable of $3.8 million,
inventories of $5.2 million, an insurance receivable of $800,000 for settlement
of the class action lawsuit and a refundable tax credit of $1.18 million.
As of March 31, 2004, our current liabilities consist of accounts
payable of $3.9 million, accrued expenses of $3.48 million, customer credit on
account of $2.1 million, a bank overdraft of $62,282, subordinated debt of $1
million and an income tax payable of $2.44 million. Our most significant account
payable is a $2.4 million obligation to a factory in China. We have agreed to a
verbal payment plan with the factory, which provides that we will begin making
payments in September 2004. The payments will continue through the year end
March 2005, We are current on approximately 80% of our accounts payable.
We entered into a factoring agreement with Milberg Factors, effective
as of February 9, 2004. Pursuant to the agreement, Milberg, at its discretion,
will advance us the lesser of 80% of our accounts receivable or $3.5 million.
All receivables submitted to Milberg are subject to a fee equal to 0.8% of the
gross invoice value. The average monthly balance of the line will incur interest
at a rate of prime plus .75%. Other terms of the agreement include minimum fees
of $200,000 per calendar year and include covenants requiring the Singing
Machine to maintain $7.5 million of tangible net worth and $7.5 million of
working capital at all times as defined in the agreement. To secure these
advances, Milberg received a security interest in all of our accounts receivable
and inventory located in the United States and a pledge of 66 2/3% of the stock
in International SMC (HK) Ltd., our wholly-owned subsidiary. This agreement is
effective for an initial term of two years, with successive automatic renewals
unless either party gives notice of termination.
17
We borrowed approximately $250,000 under the factoring agreement in the
fourth quarter of fiscal 2004 and repaid all outstanding amounts. As of March
31, 2004, we did not have any advances outstanding under the factoring
agreement; however, we were in violation of the covenants relating to working
capital and tangible net worth. We terminated our factoring agreement with
Milberg Factors, effective as of July 14, 2004. We paid a $25,000 fee to
terminate this agreement prior to the scheduled expiration date of February 9,
2006. Milberg has agreed to release its security interest in all our assets and
accounts receivable. We are now actively seeking financing from other sources.
Our Hong Kong subsidiary, International SMC, has access to credit
facilities at Hong Kong Shanghai Bank and Fortis Bank. The primary purpose of
the facilities is to provide International SMC with access to letters of credit
so that it can purchase inventory for direct shipment of goods into the United
States and international markets. The facilities are secured by a corporate
guarantee from the U.S. parent company and restricted cash on deposit with the
lender. The maximum available credit under the facilities is $2.0 million. The
balance at March 31, 2004 and 2003 was $62,282 and $316,646, respectively. The
interest rate is approximate 4% per annum. As of March 31, 2004 there was no
availability under these facilities.
As of June 1, 2004, our cash on hand is limited. Our average monthly
operating costs are approximately $600,000 and we expect that we will need
approximately $1.5 million for working capital during the next three month
period between July and September. Our primary expenses are normal operating
costs including salaries, payments under the severance agreements for two of our
former executives, lease payments for our warehouse space in Compton, California
and other operating costs.
On July 14, 2004, a director Jay Bauer has advanced the Company a short
term loan of $200,000, to be used to meet working capital obligations. The loan
bears interest at 8.75% per annum and is due on demand.
Our commitments for debt and other contractual arrangements are
summarized as follows:
YEARS ENDING MARCH 31,
-------------------------------------------------------------------------------------
TOTAL 2005 2006 2007 2008 2009
---------- ---------- ---------- ---------- ---------- ----------
Merchandise License Guarantee $ 525,000 $ 375,000 $ 150,000 -- -- --
Property Leases $2,657,506 $ 838,792 $ 579,851 $ 495,545 $ 371,659 $ 371,659
Equipment Leases $ 120,263 $ 71,746 $ 19,502 $ 7,969 $ 13,044 $ 8,002
Subordinated Debt-related parties $1,000,000 -- $1,000,000 -- -- --
Convertible Debentures $4,000,000 -- $4,000,000 -- -- --
Each of the contractual agreements (except the equipment leases)
provides that all amounts due under that agreement can be accelerated if we
default under the terms of the agreement. For example, if we fail to make a
minimum guaranteed royalty payment that is required under a Merchandise License
Agreement on a timely basis, the licensor can declare us in default and require
that all amounts due under the Merchandise License Agreement are immediately due
and payable.
Merchandise license guarantee reflects amounts that we are obligated to
pay as guaranteed royalties under our various license agreements. In fiscal
2005, we have guaranteed minimum royalty payments under our license agreements
with Care Bears, MTV and Motown (Universal Music).
We have leases for office and warehouse space in California, Florida
and Hong Kong. We have equipment leases for forklifts and copy machines.
On September 8, 2003, we issued an aggregate of $4,000,000 of 8%
convertible debentures in a private offering to six accredited investors. The
debentures initially are convertible into 1,038,962 shares of our common stock
at $3.85 per share, subject to adjustment in certain situations. We also issued
an aggregate of 457,143 warrants to the investors. The exercise price of the
warrants is $4.025 per share and the warrants expire on September 7, 2006. We
have an obligation to register the shares of common stock underlying the
debentures and warrants.
On February 9, 2004 we amended our convertible debenture agreements to
increase the interest rate to 8.5% and to grant warrants to purchase an
aggregate of 30,000 shares of our common stock to the debenture holders on a
pro-rata basis. These concessions are in consideration of the debenture holder's
agreements to (i) enter into new subordination agreements with Milberg, (ii) to
waive all liquidated damages due under the transaction documents through July 1,
2004 and (iii) to extend the effective date of the Form S-1 registration
statement until July 1, 2004. The new warrants have an exercise price equal to
$1.52 per share and the fair value of these warrants was estimated by using the
Black-Scholes Option-Pricing Model and totaled $30,981. This amount was expensed
as a component of selling, general and administrative expenses. Pursuant to the
convertible debenture agreements, we were required to register the shares of
common stock underlying the debentures and detachable stock purchase warrants
18
issued in connection with the debentures. The registration of the common shares
was required to be effective by July 1, 2004. Because we did not have the
registration statement declared effective by July 14, 2004, we are in technical
default of the convertible debenture agreements. As such, we are accruing
liquidated damages in the amount of $80,000 per month. Additionally, the
convertible debenture holders could declare us in default of the convertible
debentures and accelerate all payments due under the convertible debentures,
which is the principal amount of $4 million plus any liquidated damages and
other fees that are assessed. One of the reasons that we are in technical
default is because we have not received all the information that we have
requested from the debenture holders for the registration statement. We are
working to cure our event of default by filing the registration statement as
soon as possible. Additionally, we are trying to enter into another amendment of
the convertible debentures and transaction documents with the convertible
debenture holders which would extend the filing date for the registration
statement and eliminate all liquidated damages. There can be no assurances that
we will be able to enter into an amendment of the convertible debenture
agreements.
WORKING CAPITAL REQUIREMENTS DURING THE SHORT AND LONG TERM
During the three month period between July and September, we plan on
financing our working capital needs from
(i) Collection of accounts receivable;
(ii) Sales of existing inventory;
(iii) Seeking additional financial company for advance in account
receivables.
(iv) Continued support from factories in China in financing our
purchases of karaoke machines for fiscal 2005; and
(iv) Utilizing credit facilities that are available to
International SMC to finance all direct shipments.
Our sources of cash for working capital in the longer term, the six
month period between September and March 2004, are the same as our sources
during the short term. We expect to receive a tax refund of $1.1 million at the
end of September 2004. If we need additional financing we intend to approach
Milberg and request that it modify the terms of its factoring agreement or
permit us to obtain financing from a third party. However, we can not assure
that Milberg will be willing to waive any of the conditions of the factoring
agreement and/or let us seek capital from a third party. If we need to obtain
additional financing and fail to do so, it may have a material adverse effect on
our ability to meet our financial obligations and to continue our operations.
During fiscal 2005, we will strive to keep our operating costs at a
minimum. In order to reduce the need to maintain inventory in our warehouse in
California and Florida, we intend to generate a larger share of our total sales
through sales directly from International SMC. The goods are shipped directly to
our customers from the ports in China and are primarily backed by customer
letters of credit. The customers take title to the merchandise at their
consolidators in China and are responsible for their shipment, duty, clearance
and freight charges to their locations. These sales in which the customer
purchase the good for delivery at a specific destination are referred to as
"FOB" sales. We will also assist our customers in the forecasting and management
of their inventories of our product.
We are also planning to finance a significant amount of our sales with
customer issued letters of credit, using International SMC's credit facility
with Hong Kong Bank and relying on financing from one of our factories in China.
We anticipate that total purchases of approximately $28 million that will be
financed by the above methods. We currently expect to order approximately $8
million in new inventory, which will be financed by using International SMC's
credit facility and financing from a Chinese factory.
However, these purchase orders can be cancelled at any time prior to
delivery and we can not assure you that our customers will complete these
purchases. In the event that we do not sell sufficient products in our second
and third quarter, we have considered other sources of financing, such as trying
to secure an additional credit facility, private offerings and/or a venture
capital investment. We expect that our profit margin for sales of our karaoke
products will continue to be under price pressure, because of the older
competition in the marketplace. During fiscal 2005, we plan on introducing three
new karaoke machines which will command higher prices and a higher profit
margin. The Company also will continue to cut our operating expenses.
We may incur an operating charge in fiscal 2004. In connection with the
settlement of the class action lawsuit, we have agreed to issue approximately
400,000 share of our common stock to the class action plaintiffs. The
convertible debentures and warrants provide that if we issue any additional
securities at a price that is lower than the set price of the debentures and the
warrants, the price of the debentures and warrants will be adjusted accordingly.
However, there is an exception for the stock issued for acquisitions or
strategic investments, the primary purpose of which is not for raise capital. We
believe that the issuance of the securities to the class action plaintiffs may
fall with this exception. We will need to discuss the issue with the
institutional investors to see if they agree with our position. There can be no
assurances that they will agree with our position that the conversion price of
the debentures and the exercise price of the warrants should not be adjusted.
19
Additionally, we are in default of the convertible debenture agreements
and related transaction documents. Under the terms of the convertible
debentures, we are accruing liquidated damages of $80,000 for each month that we
do not have a registration statement filed.
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 Singing Machine's need for additional capital to
finance inventory purchases, the Singing Machine knows of no trend, additional
demand, event or uncertainty that will result in, or that is reasonably likely
to result in, the Singing Machine's liquidity increasing or decreasing in any
material way
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. The exchange rate of the
Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government
since 1983 at HK$7.80 to U.S. $1.00 and, accordingly, has not represented a
currency exchange risk to the U.S. dollar. We cannot assure you that the
exchange rate between the United States and Hong Kong currencies will continue
to be fixed or that exchange rate fluctuations will not have a material adverse
effect on our business, financial condition or results of operations.
SEASONAL AND QUARTERLY RESULTS
Historically, our operations have been seasonal, with the highest net
sales occurring in the second and third quarters (reflecting increased orders
for equipment and music merchandise during the Christmas selling months) and to
a lesser extent the first and fourth quarters of the fiscal year. Sales in our
fiscal second and third quarter, combined, accounted for approximately 86% of
net sales in fiscal 2004 and 2003, and 81% of net sales in fiscal 2002.
Our results of operations may also fluctuate from quarter to quarter as
a result of the amount and timing of orders placed and shipped to customers, 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
We prepared our consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America. As
such, management is required to make certain estimates, judgments and
assumptions that it believes are reasonable based on the information available.
These estimates and assumptions affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses for the periods presented. The significant accounting
policies which management believes are the most critical to aid in fully
understanding and evaluating our reported financial results included accounts
receivable - allowance for doubtful accounts, reserves on inventory, deferred
tax assets and our Hong Kong income tax exemption.
COLLECTIBILITY OF ACCOUNTS RECEIVABLE. The Singing Machine's allowance
for doubtful accounts is based on management's estimates of the creditworthiness
of its customers, current economic conditions and historical information, and,
in the opinion of management, is believed to be an amount sufficient to respond
to normal business conditions. Management sets 100% reserves for customers in
bankruptcy and other reserves based upon historical collection experience.
Should business conditions deteriorate or any major customer default on its
obligations to the Company, this allowance may need to be significantly
increased, which would have a negative impact on operations.
20
RESERVES ON INVENTORIES. The Singing Machine establishes a reserve on
inventory based on the expected net realizable value of inventory on an item by
item basis when it is apparent that the expected realizable value of an
inventory item falls below its original cost. A charge to cost of sales results
when the estimated net realizable value of specific inventory items declines
below cost. Management regularly reviews the Company's investment in inventories
for such declines in value.
INCOME TAXES. Significant management judgment is required in developing
our provision for income taxes, including the determination of foreign tax
liabilities, deferred tax assets and liabilities and any valuation allowances
that might be required against the deferred tax assets. Management evaluates its
ability to realize its deferred tax assets on a quarterly basis and adjusts its
valuation allowance when it believes that it is more likely than not that the
asset will not be realized. At December 31, 2003 and March 31, 2004, we
concluded that a valuation allowance was needed against all of our deferred tax
assets, as it was not more likely than not that the deferred taxes would be
realized. At March 31, 2004 and 2003, we had gross deferred tax assets of $8.2
million and $1.9 million, against which we recorded valuation allowances
totaling $8.2 million and $0, respectively.
For the fiscal year ended March 31, 2004, we recorded a tax provision
of $758,505. This occurred because the valuation allowance established against
our deferred tax assets exceeded the amount of the benefit created from carrying
back a portion of the current year's losses. The carry-back of the losses from
the current year resulted in an income tax receivable of $1.1 million, which is
included in refundable tax in the accompanying balance sheets. we have now
exhausted our ability to carry back any further losses and therefore will only
be able to recognize tax benefits to the extent that it has future taxable
income.
Our subsidiary has applied for an exemption of income tax in Hong Kong.
Therefore, no taxes have been expensed or provided for at the subsidiary level.
Although no decision has been reached by the governing body, the parent company
has reached the decision to provide for the possibility that the exemption could
be denied and accordingly has recorded a provision for Hong Kong taxes in fiscal
2003 and 2002. There was no provision for Hong Kong income taxes in fiscal 2004
due to the subsidiary's net operating loss for the year. Hong Kong income taxes
payable totaled $2.4 million at March 31, 2004 and 2003 and is included in the
accompanying balance sheets as income taxes payable.
We effectively repatriated approximately $2.0 million, $5.6
million and $5.7 from its foreign operations in 2004, 2003 and 2002,
respectively. Accordingly, these earnings were taxed as a deemed dividend based
on U.S. statutory rates. We have no remaining undistributed earnings of
the Company's foreign subsidiary.
We operate within multiple taxing jurisdictions and are subject to
audit in those jurisdictions. Because of the complex issues involved, any claims
can require an extended period to resolve. In management's opinion, adequate
provisions for income taxes have been made.
OTHER ESTIMATES. We makes other estimates in the ordinary course of
business relating to sales returns and allowances, warranty reserves, and
reserves for promotional incentives. Historically, past changes to these
estimates have not had a material impact on our financial condition. However,
circumstances could change which may alter future expectations.
Set forth below and elsewhere in this Annual Report on Form 10-K and in
the other documents we file with the SEC are risks and uncertainties that could
cause actual results to differ materially from the results contemplated by the
forward looking statements contained in this Annual Report.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
RISKS ASSOCIATED WITH OUR BUSINESS
WE HAVE SIGNIFICANT WORKING CAPITAL NEEDS AND IF WE ARE UNABLE TO OBTAIN
ADDITIONAL FINANCING, WHEN NEEDED, WE MAY NOT HAVE SUFFICIENT CASH FLOW TO RUN
OUR BUSINESS
As of July 1, 2004, our cash on hand is limited. We need approximately
$1.5 million in working capital in order to finance our operations over the next
three months. We will finance our working capital needs from the collection of
accounts receivable, and sales of existing inventory. See "Liquidity" beginning
on page 17. As of March 31, 2004, our inventory was valued at $5.2 million. If
these sources do not provide us with adequate financing, we may try to seek
financing from a third party. If we are not able to obtain adequate financing,
when needed, it will have a material adverse effect on our cash flow and our
ability to run our business. 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 bankruptcy under Chapter 11 of the U.S. Bankruptcy Code or enter
into some other form of liquidation or reorganization proceeding.
21
WE MAY BE DEEMED TO INSOLVENT AND WE MAY GO OUT OF BUSINESS
As of March 31, 2004, our cash position is limited. We are not able to
pay all of our creditors on a timely basis. We are current on approximately 80%
of our accounts payable, which total $3.9 million as March 31, 2004. We are not
current on our account payable of $2.4 million to our factory in China. If we
are not able to pay our current debts as they become due, we may be deemed to be
insolvent. We may be required to file a petition for bankruptcy under Chapter 11
of the U.S. Bankruptcy Code or enter into some other form of liquidation or
reorganization proceedings.
OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTANTING FIRM RAISED SUBSTANTIAL DOUBT
ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN AS OF MARCH 31, 2004 AND 2003
We received a report dated June 16, 2004 from our independent certified
public accountants covering the consolidated financial statements for our fiscal
year ended March 31, 2004 that included an explanatory paragraph which stated
that the financial statements were prepared assuming the Singing Machine would
continue as a going concern. This report stated that our operating performance
in fiscal 2004 and our minimal liquidity raised substantial doubt about our
ability to continue as a going concern. If we are not able to raise additional
capital,we may need to curtail or stop our business operations. We may be
required to file a petition for bankruptcy under Chapter 11 of the U.S.
Bankruptcy Code or enter into some other form of liquidation or reorganization
proceedings.
WE ARE IN TECHNICAL DEFAULT OF THE TERMS OF THE CONVERTIBLE DEBENTURES AND
THERE COULD BE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS AND FINANCIAL RESULTS
IF WE ARE DEEMED TO BE IN DEFAULT
We are in technical default of the terms of the $4 million in
convertible debentures that we issued to 6 institutional investors in September
2003. We had an obligation to have the registration statement registering the
securities issued to the institutional investors filed and declared effective by
July 1, 2004. As of July 14, 2004, the registration statement has not been
declared effective. As such, under the terms of the registration rights
agreement we are accruing liquidated damages in the amount of $80,000 for each
month that the registration statement is not declared effective. Additionally,
the institutional investors could declare us in default of the convertible
debentures and demand repayment of the debentures and all other amounts due
under the transaction documents evidencing their $4 million investment.
IF WE ARE UNABLE TO EFFECTIVELY AND EFFICIENTLY IMPLEMENT OUR PLAN TO REMEDIATE
THE MATERIAL WEAKNESSES WHICH HAVE BEEN IDENTIFIED IN OUR INTERNAL CONTROLS AND
PROCEDURES, THERE COULD BE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS OR
FINANCIAL RESULTS
We have identified a number of material weaknesses in our internal
controls and procedures in connection with the audit of our financial statements
for fiscal 2004. See " Controls and Procedures" on page 30. The deficiencies in
our internal controls relate to:
- weaknesses in our financial reporting processes as a result of
a lack of adequate staffing in the accounting department,
- accounting for consigned inventory and inventory costing.
We are implementing a number of procedures to correct these weaknesses
in our internal controls. However, no assurances can be given that we will be
able to successfully implement our revised internal controls and procedures or
that our revised controls and procedures will be effective in remedying all of
the identified material weaknesses in our prior controls and procedures. In
addition, we may be required to hire additional employees, and may experience
higher than anticipated capital expenditures and operating expenses, during our
implementation of these changes. If we are unable to implement these changes
effectively or efficiently there could be a material adverse effect on our
operations or financial results.
A SMALL NUMBER OF OUR CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR
REVENUES, AND THE LOSS OF ONE OR MORE OF THESE KEY CUSTOMERS COULD SIGNIFICANTLY
REDUCE OUR REVENUES AND CASH FLOW
We rely on a few large customers to provide a substantial portion of
our revenues. As a percentage of total revenues, our net sales to our five
largest customers during the fiscal period ended March 31, 2004, 2003 and 2002
were approximately 53%, 67% and 87%, respectively. In fiscal 2004, three
customers accounted for 20%, 12% and 8% of our net sales. The customers are
Arbiter, Giochi and Best Buy respectively. We do not have long-term contractual
arrangements with any of our customers and they can cancel their orders at any
time prior to delivery. A substantial reduction in or termination of orders from
any of our largest customers would decrease our revenues and cash flow.
WE ARE RELYING ON ONE FACTORY TO MANUFACTURE AND PRODUCE THE MAJORITY OF OUR
KARAOKE MACHINES FOR FISCAL 2005, AND IF THE RELATIONSHIP WITH THIS FACTORY IS
DAMAGED OR INJURED IN ANY WAY , IT WOULD REDUCES OUR REVENUES AND PROFITABILITY
We have worked out a verbal agreement with a factory in China to
produce all of our karaoke machines for fiscal 2005. We owe this factory
approximately $2.4 million as of June 30, 2004 and have worked out a payment
plan with it. See "Liquidity" beginning on page 17. If the factory is unwilling
or unable to deliver our karaoke machines to us, our business will be adversely
affected. Because our cash on hand is minimal, we are relying on revenues
received from the sale of our ordered karaoke machines to provide cash flow for
our operations. If we do not receive cash from these sales, we may not be able
to continue our business operations.
WE ARE SUBJECT TO THE RISK THAT SOME OF OUR LARGE CUSTOMERS MAY RETURN KARAOKE
PRODUCTS THAT THEY HAVE PURCHASED FROM US AND IF THIS HAPPENS, IT WOULD REDUCE
OUR REVENUES AND PROFITABILITY
In fiscal 2004 and 2003, a number of our customers and distributors
returned karaoke products that they had purchased from us. Our customers
returned goods valued at $1.8 million, or 2.5% of our net sales in fiscal 2004.
Best Buy, one of our largest customers, returned approximately $2.75 million in
karaoke products that it had not been able to sell during the Christmas season
in fiscal 2003. Best Buy agreed to keep this inventory in its retail stores, but
converted the sale to a consignment sale. Although we were not contractually
obligated to accept this return of the karaoke products in fiscal 2004 or fiscal
2003, we accepted the return of the karaoke products because we valued our
relationship with our customers. Because we are dependent upon a few large
customers, we are subject to the risk that any of these customers may elect to
return unsold karaoke products to us in the future. If any of our customers were
to return karaoke products to us, it would reduce our revenues and
profitability.
WE ARE SUBJECT TO PRESSURE FROM OUR CUSTOMERS RELATING TO PRICE REDUCTION AND
FINANCIAL INCENTIVES AND IF WE ARE PRESSURED TO MAKE THESE CONCESSIONS TO OUR
CUSTOMERS, IT WILL REDUCE OUR REVENUES AND PROFITABILITY
Because there is intense competition in the karaoke industry, we are
subject to pricing pressure from our customers. Many of our customers have
demanded that we lower our prices or they will buy our competitor's products. If
we do not meet our customer's demands for lower prices, we will not sell as many
karaoke products. In our fiscal year ended March 31, 2004, our sales to
customers in the United States decreased because of increased price competition.
During fiscal 2004, we sold 20.2% of our karaoke machines at prices that were
equal to or below cost. We will not be able to stay in business if we continue
to sell our karaoke machines at prices that are at or below cost. We are also
subject to pressure from our customers regarding certain financial incentives,
such as return credits or large advertising or cooperative advertising
allowances, which effectively reduce our selling prices. In fiscal 2004, we gave
22
our customers $2.1 million of credit on account because the sell-through of our
products was not as strong as we had expected. We also gave them advertising
allowances in the amount of $2.3 million during fiscal 2004 and $4.1 million
during fiscal 2003. We have historically offered advertising allowances to our
customers because it is standard practice in the retail industry.
WE EXPERIENCE DIFFICULTY FORECASTING THE DEMAND FOR OUR KARAOKE PRODUCTS AND IF
WE DO NOT ACCURATELY FORECAST DEMAND, OUR REVENUES, NET INCOME AND CASH FLOW MAY
BE AFFECTED
Because of our reliance on manufacturers in Asia for our machine
production, our production lead times range from one to four months. Therefore,
we must commit to production in advance of customers orders. It is difficult to
forecast customer demand because we do not have any scientific or quantitative
method to predict this demand. Our forecasting is based on management's general
expectations about customer demand, the general strength of the retail market
and management's historical experiences. We overestimated demand for our
products in fiscal 2004 and had $25.2 million in inventory as of March 31, 2003.
Because of this excess inventory, we had liquidity problems in fiscal 2004 and
our revenues, net income and cash flow were adversely affected. We had a net
loss of $22.7 million in fiscal 2004 and our cash flow was limited in fiscal
2004.
WE ARE SUBJECT TO THE COSTS AND RISKS OF CARRYING INVENTORY FOR OUR CUSTOMERS
AND IF WE HAVE TOO MUCH INVENTORY, IT WILL AFFECT OUR REVENUES AND NET INCOME
Many of our customers place orders with us several months prior to the
holiday season, but they schedule delivery two or three weeks before the holiday
season begins. As such, we are subject to the risks and costs of carrying
inventory during the time period between the placement or the order and the
delivery date, which reduces our cash flow. As of March 31, 2003, we had $25.2
million in inventory on hand, which impacted our cash flow and liquidity from
operations in fiscal 2004. As of March 31, 2004, our inventory was valued at
$5.2 million, after a $6.6 million reserve had been taken. It is important that
we sell this inventory during fiscal 2005, so we have sufficient cash flow for
operations.
OUR GROSS PROFIT MARGINS HAVE DECREASED OVER THE PAST YEAR AND WE EXPECT
COMPETITIVE MARKET
Over the past year, our gross profit margins have decreased. In the
fiscal year ended March 31, 2004, our gross profit margin was 2.6% of net sales
compared to 24.4% of net sales in fiscal year ended March 31, 2003. This decline
resulted from the closeout of older models and excessive inventory, price
competition and increased sales by International SMC. Sales made by
International SMC increased from 52% of our sale in fiscal 2003 to 61 % in
Fiscal 2004. International SMC delivers our karaoke products to customers
directly from our manufacturer's factories in China and therefore does not
provide logistics, handling, warehousing and just in time inventory support,
which services are provided by our parent company in the United States.
Accordingly, the average sales price per unit realized by International SMC is
significantly lower than that of our parent company in the United States. We
expect further price competition and a continuing shift of sales volume to
International SMC. Accordingly, we expect that our gross profit margin will
decrease in fiscal 2005.
OUR SENIOR CORPORATE MANAGEMENT TEAM IS NEW TO THE SINGING MACHINE AND IS
REQUIRED TO DEVOTE SIGNIFICANT ATTENTION TO OUR FINANCING AGREEMENTS AND
SETTLING OUR CLASS ACTION LAWSUITS
Beginning on May 2, 2003, through the present date, four of our
executive officers have resigned We hired a new Chief Operating Officer, Yi Ping
Chan on April 1, 2003, and a new Chief Financial Officer, Jeff Barocas, on April
9, 2004. Three new directors have joined our Board since October 31, 2004 and
one of them has resigned since that date. Bernard Appel joined our Board
effective as of October 31 and Harvey Judkowitz joined on March 29, 2004.
Richard Ekstract jointed our Board on October 31, 2003 and resigned for personal
reasons on June 2, 2004. We are in the process of searching for a new Chief
Executive Officer and new directors. It will take some time for our new
management and our new board of directors to learn about our business and to
develop strong working relationships with each other and our employees. Our new
senior corporate management's ability to complete this process has been and
continues to be hindered by the time that it needs to devote to other pressing
business matters. New management needs to spend significant time on overseeing
our liquidity situation and overseeing legal matters, such as our class action
lawsuit. We cannot assure you that this major restructuring of our board of
directors and senior management and the accompanying distractions, in this
environment, will not adversely affect our results of operations.
THE SEC IS CONDUCTING AN INFORMAL INVESTIGATION OF THE COMPANY AND IF WE HAVE
DONE SOMETHING ILLEGAL, WE WILL BE SUBJECT TO FINES, PENALTIES AND OTHER
SANCTIONS BY THE SEC
In August 2003, we were advised that the SEC had commenced an informal
investigation of our company. It appears that the investigation is focused on
the restatement of our financial statements in fiscal 2002 and 2001; however,
the SEC may be reviewing other issues as well. If the SEC finds that our company
23
has not fully complied with all applicable federal securities laws, we could be
subject to fines, penalties and other sanctions imposed by the SEC.
WE ARE NAMED AS A DEFENDANT IN A CLASS ACTION LAWSUIT RELATING TO THE
RESTATEMENT OF OUR FINANCIAL STATEMENTS FOR FISCAL 2002 AND FISCAL 2001, WHICH
IF DETERMINED ADVERSELY TO US, COULD RESULT IN THE IMPOSITION OF DAMAGES AGAINST
US AND HARM OUR BUSINESS AND FINANCIAL CONDITION
We are named as a defendant in a class action lawsuit which arose from
the restatement of our financial statements for fiscal 2002 and 2001. In this
lawsuit, the plaintiffs allege that our executive officers and our company
violated Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934
and Rule 10(b)-5. The plaintiffs seek compensatory damages, attorney's fees and
injunctive relief. While the specific factual allegations vary slightly in each
case, the complaints generally allege that our officers falsely represented the
Company's financial results during the relevant class periods. In March 2004, we
have entered into a settlement agreement with the class action plaintiffs. See
"Business - Legal Matters." This settlement is subject to approval by the court
and the shareholders who are members of the class action lawsuit at a hearing
which will be held on July 30, 2004.
If this settlement agreement is not approved by the court and members
of the class action lawsuit, we will need to expend additional times and
resources on resolving this matter, whether through continued settlement
discussions or through litigation. If a significant monetary judgment is
rendered against us, we are not certain that we will have the ability to pay
such a judgment. Any losses resulting from these claims could adversely affect
our profitability and cash flow.
OUR LICENSING AGREEMENT WITH MTV NETWORKS IS IMPORTANT TO OUR BUSINESS AND IF WE
WERE TO LOSE OUT MTV LICENSE IT WOULD AFFECT OUR REVENUES AND PROFITABILITY
Our license with MTV Networks is important to our business. We
generated 11.8% and 32.3% of our consolidated net sales from products sold under
the MTV license in fiscal 2004 and 2003, respectively. Our MTV license was
extended until July 30, 2004 with options for MTV to renew for an additional
four months period through December 31, 2004. If we were to lose our MTV
license, it would have an effect on our revenues and net income.
OUR BUSINESS IS SEASONAL AND THEREFORE OUR ANNUAL OPERATING RESULTS WILL DEPEND,
IN LARGE PART, ON OUR SALES DURING THE RELATIVELY BRIEF HOLIDAY SEASON
Sales of consumer electronics and toy products in the retail channel
are highly seasonal, with a majority of retail sales occurring during the period
from September through December in anticipation of the holiday season, which
includes Christmas. A substantial majority of our sales occur during the second
quarter ended September 30 and the third quarter ended December 31. Sales in our
second and third quarter, combined, accounted for approximately 86% of net sales
in fiscal 2004, and 2003 and 81% of net sales in fiscal 2002.
IF WE ARE UNABLE TO COMPETE IN THE KARAOKE PRODUCTS CATEGORY, OUR REVENUES AND
NET PROFITABILITY WILL BE REDUCED
Our major competitors for karaoke machines and related products are
Craig 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 Compass, 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 to attempt to enhance or
retain market share, we may adversely impact our operating margins. Conversely,
if we opt not to match competitor's price reductions we may lose market share,
resulting in decreased volume and revenue. To the extent our leading competitors
reduce prices on their karaoke machines and music, we must remain flexible to
reduce our prices. If we are forced to reduce our prices, it will result in
lower margins and reduced profitability. Because of intense competition in the
karaoke industry in the United States during fiscal 2004, we expect that the
intense pricing pressure in the low end of the market will continue in the
karaoke market in the United States in fiscal 2005. 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.
IF WE ARE UNABLE TO DEVELOP NEW KARAOKE PRODUCTS, OUR REVENUES MAY NOT CONTINUE
TO GROW
The karaoke industry is characterized by rapid technological change,
frequent new product introductions and enhancements and ongoing customer demands
for greater performance. In addition, the average selling price of any karaoke
machine has historically decreased over its life, and we expect that trend to
continue. As a result, our products may not be competitive if we fail to
introduce new products or product enhancements that meet evolving customer
demands. The development of new products is complex, and we may not be able to
24
complete development in a timely manner, or at all. Edward Steele, our former
Chief Executive Officer, has overseen our Product Development for the past
twelve years. Mr. Steele currently serves as a Senior Advisor and Director of
Product Development under a contract which expires on February 28, 2005. We have
not yet identified a successor who will oversee product development if Mr.
Steele were to leave our company. To introduce products on a timely basis, we
must:
o accurately define and design new products to meet market
needs;
o design features that continue to differentiate our products
from those of our competitors;
o transition our products to new manufacturing process
technologies;
o identify emerging technological trends in our target markets;
o anticipate changes in end-user preferences with respect to our
customers' products;
o bring products to market on a timely basis at competitive
prices; and
o respond effectively to technological changes or product
announcements by others.
We believe that we will need to continue to enhance our karaoke
machines and develop new machines to keep pace with competitive and
technological developments and to achieve market acceptance for our products.
OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD PREVENT
OR DELAY OUR CUSTOMERS' RECEIPT OF INVENTORY
We rely principally on four contract ocean carriers to ship 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 prevent or delay our
customers' receipt of inventory. If our customers do not receive their inventory
on a timely basis, they may cancel their orders or return products to us.
Consequently, our revenues and net income would be reduced.
OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE'S REPUBLIC OF CHINA,
SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS. IF THERE IS ANY
PROBLEM WITH THE MANUFACTURING PROCESS, OUR REVENUES AND NET PROFITABILITY MAY
BE REDUCED.
We are dependent upon six factories in the People's Republic of China
to manufacture the majority of our karaoke machines. These factories will be
producing approximately 95% of our karaoke products in fiscal 2005. We do not
have written agreements with any of these factories. Our arrangements with these
factories are subject to the risks of doing business abroad, such as import
duties, trade restrictions, work stoppages, and foreign currency fluctuations,
limitations on the repatriation of earnings and political instability, which
could have an adverse impact on our business. Furthermore, we have limited
control over the manufacturing processes themselves. As a result, any
difficulties encountered by our third-party manufacturers that result in product
defects, production delays, cost overruns or the inability to fulfill orders on
a timely basis could adversely affect our revenues, profitability and cash flow.
Also, since we do not have written agreements with any of these factories, we
are subject to additional uncertainty if the factories do not deliver products
to us on a timely basis.
WE DEPEND ON THIRD PARTY SUPPLIERS FOR PARTS FOR OUR KARAOKE MACHINES AND
RELATED PRODUCTS, AND IF WE CANNOT OBTAIN SUPPLIES AS NEEDED, OUR OPERATIONS
WILL BE SEVERELY DAMAGED
Our growth and ability to meet customer demand depends in part on our
capability to obtain timely deliveries of karaoke machines and our electronic
products. We rely on third party suppliers to produce the parts and materials 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.
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. Additionally, other extraordinary events such as
terrorist attacks or military engagements, which adversely affect the retail
environment may restrict consumer spending and thereby adversely affect our
sales growth and profitability.
25
WE MAY HAVE INFRINGED THE COPYRIGHTS OF CERTAIN MUSIC PUBLISHERS AND IF WE
VIOLATE FEDERAL COPYRIGHT LAWS, WE WILL BE SUBJECT TO MONETARY PENALTIES
Over the past several years, we have received notices from several
music publishers who have alleged that we did not have the proper copyright
licenses to sell certain songs included in our compact discs with graphics discs
("CDG"s). CDG's are compact discs which contain the musical recordings of the
karaoke songs and graphics which contain the lyrics of the songs. We have
settled or are in the process of settling all of these copyright infringement
issues with these publishers. We have spent approximately $70,000 to settle
these copyright infringement suits in fiscal year 2003 and 2004. These copyright
infringement claims may have a negative effect on our ability to sell our music
products to our customers. If we do not have the proper copyright licenses for
any other songs that are included in our CD+G's and cassettes, we will be
subject to additional liability under the federal copyright laws, which could
include settlements with the music publishers and payment of monetary damages.
WE MAY BE SUBJECT TO CLAIMS FROM THIRD PARTIES FOR UNAUTHORIZED USE OF THEIR
PROPRIETARY TECHNOLOGY, COPYRIGHTS OR TRADE SECRETS AND ANY CLAIMS ASSERTED
AGAINST US COULD AFFECT OUR NET PROFITABILITY
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.
During fiscal 2000, Tanashin Denki, Ltd., a Japanese company that holds a patent
on a cassette tape drive mechanism alleged that some of our karaoke machines
violated their patents. We settled the matters with Tanashin in December 1999.
Subsequently in December 2002, Tanashin again alleged that some of our karaoke
machines violated their patents. We entered into another settlement agreement
with them in May 2003. In addition to Tanashin, we could receive infringement
claims from other third parties. Any infringement claims may have a negative
effect on our profitability and financial condition.
WE ARE EXPOSED TO THE CREDIT RISK OF OUR CUSTOMERS, WHO ARE EXPERIENCING
FINANCIAL DIFFICULTIES, AND IF THESE CUSTOMERS ARE UNABLE TO PAY US, OUR
REVENUES AND PROFITABILITY WILL BE REDUCED
We sell products to retailers, including department stores, lifestyle
merchants, direct mail retailers, which are catalogs and showrooms, national
chains, specialty stores, and warehouse clubs. Some of these retailers, such as
K-Mart, FAO Schwarz and KB Toys, have engaged in leveraged buyouts or
transactions in which they incurred a significant amount of debt, and operated
under the protection of bankruptcy laws. As of June 1, 2004, we are aware of
only two customers, FAO Schwarz and KB Toys, which are operating under the
protection of bankruptcy laws. Deterioration in the financial condition of our
customers could result in bad debt expense to us and have a material adverse
effect on our revenues and future profitability.
A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTERS IN CALIFORNIA OR FLORIDA
COULD IMPACT OUR ABILITY TO DELIVER MERCHANDISE TO OUR STORES, WHICH COULD
ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY
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 substantially decrease our revenues
and profitability.
OUR BUSINESS OPERATIONS COULD BE DISRUPTED IF THERE ARE LABOR PROBLEMS ON THE
WEST COAST
During fiscal 2004, approximately 39% of our sales were domestic
warehouse 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 occurs and we
do not have a sufficient level of inventory, a strike or work slow-down would
result in increased costs to us and may reduce our profitability.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE WHICH MAY CAUSE INVESTORS
TO LOSE ALL OR A PORTION OF THEIR INVESTMENT
From June 1, 2003 through June 1, 2004, our common stock has traded
between a high of $6.55 and a low of $0.65. During this period, we have restated
our earnings, lost senior executives and Board members, had liquidity problems,
and incurred a net loss of $22.7 million in fiscal 2004. Our stock price may
continue to be volatile based on similar or other adverse developments in our
business. In addition, the stock market periodically experiences significant
adverse price and volume fluctuations which may be unrelated to the operating
performance of particular companies.
26
IF INVESTORS SHORT OUR SECURITIES, IT MAY CAUSE OUR STOCK PRICE TO DECLINE
During the past year, a number of investors have held a short position
in our common stock. As of July 7, 2004, investors hold a short position in
252,000 shares of our common stock which represents 4.1% of our public float.
The anticipated downward pressure on our stock price due to actual or
anticipated sales of our stock by some institutions or individuals who engage in
short sales of our common stock could cause our stock price to decline.
Additionally, if our stock price declines, it may be more difficult for us to
raise capital.
OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS
Our employment agreement with Yi Ping Chan requires us, under certain
conditions, to make substantial severance payments to him if he resigns after a
change of control. As of March 31, 2004, Mr. Chan is entitled to severance
payments of $250,000. These provisions could delay or impede a merger, tender
offer or other transaction resulting in a change in control of the Singing
Machine, 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.
See "Executive Compensation - Employment Agreements" on page 33.
RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
- -------------------------------------------
OUR COMMON STOCK MAY BE DELISTED FROM THE AMERICAN STOCK EXCHANGE, WHICH MAY
HAVE A MATERIAL ADVERSE IMPACT ON THE PRICING AND TRADING OF OUR COMMON STOCK
Our common stock is quoted on the American Stock Exchange ("Amex"). The
Amex, as a matter of policy, will consider the suspension of trading in, or
removal from listing of, any stock when, in the opinion of Amex, (i) the
financial condition and/or operating results of an issuer appear to be
unsatisfactory; (ii) it appears that the extent of public distribution or the
aggregate market value of the stock has become so reduced as to make further
dealings on the Amex inadvisable; (iii) the issuer has sold or otherwise
disposed of its principal operating assets; or (iv) the issuer has sustained
losses which are so substantial in relation to its overall operations or its
existing financial condition has become so impaired that it appears
questionable, in the opinion of Amex, whether the issuer will be able to
continue operations and/or meet its obligations as they mature.
As of June 30, 2004, we have not received any notices from AMEX
notifying us that they will delist us. However, we cannot assure you that Amex
will not take any actions in the near future to delist our common stock. If our
common stock were delisted from the Amex, we would trade on the Over-the-Counter
Bulletin Board and the market price for shares or our common stock could
decline. Further, if our common stock is removed from listing on Amex, it may
become more difficult for us to raise funds through the sale of our common stock
or securities convertible into our common stock.
IF OUR OUTSTANDING DERIVATIVE SECURITIES ARE EXERCISED OR CONVERTED, OUR
EXISTING SHAREHOLDERS WILL SUFFER DILUTION
As of March 31, 2004, there were outstanding stock options to purchase
an aggregate of 1,027,530 shares of common stock at exercise prices ranging from
$1.30 to $14.30 per share, not all of which are immediately exercisable. The
weighted average exercise price of the outstanding stock options is
approximately $3.95 per share. As of March 31, 2004, there were outstanding
immediately exercisable option to purchase an aggregate of 912,168 shares of our
common stock. There were outstanding stock warrants to purchase 591,040 shares
of common stock at exercise prices ranging from $1.52 to $4.03 per share, all of
which are exercisable. The weighted average exercise price of the outstanding
stock warrants is approximately $3.98 per share. In addition, we have issued
$4,000,000 of convertible debentures, which are initially convertible into an
aggregate of 1,038,962 shares of common stock. To the extent that the
aforementioned convertible securities are exercised or converted, dilution to
our stockholders will occur.
THE $4 MILLION PRIVATE PLACEMENT THAT WE CLOSED IN SEPTEMBER 2003 WILL AFFECT
OUR ABILITY TO RAISE CAPITAL IN THE FUTURE
On September 8, 2003, we closed a private offering in which we issued
$4 million of convertible debentures and stock purchase warrants to six
institutional investors. As part of this investment, we agreed to several
limitations on our corporate actions, some of which limit our ability to raise
financing in the future. If we enter into any financing transactions during the
one year period prior to September 8, 2004, we need to offer the institutional
investors the right to participate in such offering in an amount equal to the
greater of (a) the principal amount of the debentures currently outstanding or
(b) 50% of the financing offered to the outside investment group. For example,
if we offer to sell $10 million worth of our securities to an outside investment
group, the institutional investors will have the right to purchase up to $5
million of the offering. This right may affect our ability to attract other
investors if we require external financing to remain in operations. Furthermore,
for a period of 90 days after the effective date of the registration statement
registering shares of common stock issuable upon conversion of the convertible
debentures and the warrants, we cannot sell any securities.
27
Additionally, we can not:
o sell any of our securities in any transactions where the
exercise price is adjusted based on the trading price of our
common stock at any time after the initial issuance of such
securities.
o sell any securities which grant investors the right to receive
additional shares based on any future transaction on terms
more favorable than those granted to the investor in the
initial offering
These limitations are in place until the earlier of February 20, 2006
or the date on which all the debentures are converted into shares of our common
stock.
IF WE SELL ANY OF OUR SECURITIES AT A PRICE LOWER THAN $3.85 PER SHARE, THE
CONVERSION PRICE OF OUR DEBENTURES AT $3.85 PER SHARE WILL BE REDUCED AND THERE
WILL BE ADDITIONAL DILUTION TO OUR SHAREHOLDERS
Given that our common stock is trading at a price of $0.50 per share as
of June 30, 2004, it is possible that we may need to sell additional securities
for capital at a price lower than $3.85 per share. If we sell any securities at
a price lower than $3.85 per share, the conversion price of our debentures
currently set at $3.85 per share will be reduced and there will be more dilution
to our shareholders if and when the debentures are converted into shares of our
common stock. If we issue or sell any securities at a price less than $3.85 per
share prior to September 8, 2004, the set price of the debentures will be
reduced by an amount equal to 75% of the difference between the set price and
the effective purchase price for the shares If such dilutive issuances occur
after September 8, 2004 but before the earlier of February 20, 2006 or when all
the debentures are converted into shares of our common stock, the set price will
be reduced by an amount equal to 50% of the difference between the set price and
effective purchase price of such shares. So, if we sold 1 million shares of our
common stock on June 30, 2004 for a price of $0.50 per share, the set price of
the debentures would be reduced by $2.51 to $1.34 and the aggregate number of
shares of our common stock that would be issued upon conversion of the
debentures would be increased from 1,038,962 shares to 2,985,075 shares. If the
price of our securities continues to decrease, and we continue to issue or sell
our securities at price below $3.85 per share, our obligation to issue shares
upon conversion of the debentures is essentially limitless.
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS AND INVESTORS MAY
DEPRESS OUR STOCK PRICE
As of March 31, 2004, there were 8,752,318 shares of our common stock
outstanding. Of these shares, approximately 5,954,796 shares are eligible for
sale under Rule 144. 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 register 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). An additional registration statement on Form
S-1, of which this Prospectus is a part, was filed in October 2003, registering
an aggregate of 2,795,465 shares of our common stock. 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.
OUR STOCK PRICE MAY DECREASE IF WE ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK
Our Certificate of Incorporation authorizes the issuance of 18,900,000
shares of common stock. As of March 31, 2004, we had 8,752,318 shares of common
stock issued and outstanding and an aggregate of 1,681,570 shares issuable under
our outstanding options and warrants. We also have an obligation to issue up to
1,038,962 shares upon conversion of our debentures and have reserved 207,791
additional shares for interest payment on the debentures. As such, our Board of
Directors has the power, without stockholder approval, to issue up to 7,282,359
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 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.
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ITEM 7A. 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 interest 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 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
March 31, 2004, we have not used derivative instruments or engaged in hedging
activities to minimize market risk.
INTEREST RATE RISK
As or March 31, 2004, we do not have any exposure to market risk
resulting from changes in interest rates. We have $4 million in convertible
notes, which have a fixed interest rate of 8.5% effective as of February 9,
2004.
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 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The financial statements and supplemental data required pursuant to
this Item 8 are included in this Annual Report on Form 10-K, as a separate
section commencing on page F-1 and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
CHANGE OF ACCOUNTANTS IN MARCH 2003
On March 24, 2003, we dismissed Salberg & Company, P.A. ("Salberg &
Company"), as our independent certified public accountant. On March 27, 2003, we
engaged Grant Thornton, LLP ("Grant Thornton"), as our independent registered
public accounting firm. Our decision to change accountants was approved by our
Audit Committee on March 24, 2003.
The report of Salberg & Company on our consolidated financial
statements for fiscal 2002, fiscal 2001 did not contain an adverse opinion or
disclaimer of opinion and was not qualified or modified as to uncertainty, audit
scope or accounting principles. Furthermore, Salberg & Company did not advise us
that:
1) internal controls necessary to develop reliable consolidated
financial statements did not exist, or
2) information had come to the attention of Salberg & Company
which made in unwilling to rely upon management's
representations or made it unwilling to be associated with the
consolidated financial statements prepared by management, or
3) the scope of the audit should be expanded significantly, or
information had come to the attention of Salberg & Company
that it has concluded will, or if further investigated might,
materially impact the fairness or reliability of a previously
issued audit report or the underlying consolidated financial
statements, or the consolidated financial statements issued or
to be issued covering the fiscal periods subsequent to March
31, 2002 (including information that may prevent it from
rendering an unqualified audit report on those consolidated
financial statements) or made in unwilling to rely on
management's representations or to be associated with the
consolidated financial statements prepared by management or,
29
4) information has come to the attention of Salberg & Company
that it has concluded will, or if further investigated might,
materially impact the fairness or reliability of a previously
issued audit report or the underlying consolidated financial
statements or the consolidated financial statements issued or
to be issued covering the fiscal periods subsequent to March
31, 2002 through March 28, 2003, the date of the Form 8-K
filing reporting our change in accountants, that had not been
resolved to the satisfaction of Salberg & Company or which
would have prevented Salberg & Company from rendering an
unqualified audit report on such consolidated financial
statements.
During our two most recent fiscal years and all subsequent interim
periods through March 24, 2003, there were no disagreements with Salberg &
Company on any matters of accounting principles or practices, financial
statement disclosure or auditing scope or procedure, which, if not resolved to
the satisfaction of Salberg & Company would have caused it to make reference to
the subject matter of the disagreements in connection with its reports on these
financial statements for those periods.
We did not consult with Grant Thornton regarding the application of
accounting principles to a specific transaction, either completed or proposed,
or the type of audit opinion that might be rendered on our financial statements,
and no written or oral advice was provided by Grant Thornton that was a factor
considered by us in reaching a decision as to the accounting, auditing or
financial reporting issues.
RESTATEMENT
In July 2003, we revised our position on the taxation of the income of
our Hong Kong subsidiary by the United States and Hong Kong tax authorities,
which was contained in our audited financial statements for fiscal 2002. We
discussed these issues with Salberg & Company and it agreed to opine on the
restated financial statements. See "Restatement of Financial Statements" - Page
21.
ITEM 9A. 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 ("Evaluation") of the effectiveness of the design and
operation of our disclosure controls and procedures, as defined in Rule
13a-15(f) or Rule 15d-15(f) under the Securities Exchange Act of 1934, within 90
days of the filing date of this report (the "Evaluation Date"). In the course of
the Evaluation, we identified significant material weaknesses in our internal
disclosure controls and procedures.
Management and Grant Thornton, have advised our Audit Committee that
during the course of the audit, they noted deficiencies in internal controls
relating to:
o weakness in our financial reporting process as a result of a
lack of adequate staffing in the accounting department, and
o accounting for consigned inventory and inventory costing.
Grant Thornton has advised the Audit Committee that each of these
internal control deficiencies constitute a material weakness as defined in
Statement of Auditing Standards No. 60. Certain of these internal control
weaknesses may also constitute material weaknesses in our disclosure controls.
We have performed substantial additional procedures designed to ensure that
these internal control deficiencies did not lead to material misstatements in
our consolidated financial statements and to enable the completion of Grant
Thornton's audit of our consolidated financial statements, notwithstanding the
presence of the internal control weaknesses noted above. Based on these
additional procedures, the Chief Executive Officer and Chief Financial Officer
have concluded that as of the Evaluation Date our disclosure controls and
procedures are effective except as described above, to ensure that the
information required to be disclosed by us in reports that we file or submit
under the Securities Exchange Act of 1934 are recorded, processed, summarized
and reported within the time periods specified in Securities and Exchange
Commission rules and forms.
We have not yet been able to implement any substantial corrective
actions as of the date of this Annual Report on Form 10-K. We intend to
implement changes promptly to address these issues, and will consider
implementation of the following corrective actions as well as additional
procedures:
1. Retention of outside professional advisors to evaluate our
existing internal controls and disclosure controls and make
suggestions for implementation;
2. Retention of additional personnel in finance positions;
3. Review and revision of our procedure for reporting consigned
inventory and inventory costing;
4. Use of significant outside resources to supplement our
employees in the preparation of the consolidated financial
statements and other reports filed or submitted under the
Securities Exchange Act of 1934.
We will continue to evaluate the effectiveness of its disclosure
controls and internal controls and procedures on an ongoing basis, and will take
further action as appropriate.
30
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to our
executive officers, directors and significant employees as of March 31, 2004.
Name Age Position
- ---- --- --------
Yi Ping Chan 40 Interim CEO, Chief Operating Officer, Director,
Secretary
April J. Green* 40 Chief Financial Officer
John Dahl* 30 Executive Vice President of Finance
Josef A. Bauer 65 Chairman
Harvey Judkowitz 58 Director
Bernard Appel 72 Director
Richard Ekstract* 72 Director
*Each of these persons has resigned subsequent to March 31, 2004.
Yi Ping Chan has served as our Chief Operating Officer from May 2, 2003
and as our Interim Chief Executive Officer since October 17, 2003. Prior to this
appointment, Chan was a consultant to Singing Machine. Mr. Chan was a founder
and general partner of MaxValue Capital Ltd., a Hong Kong-based management
consulting and investment firm, and co-founder and director of E Technologies
Ltd., Hong Kong, which specialized in health care technology transfer from April
1996 to March 2003. Prior to that, he was Chief Strategist and Interim CFO from
January 2000 to June 2002 of a Hong Kong-based IT and business process
consulting firm with operations in Hong Kong, China and the US. He also held a
senior management position with a Hong Kong-based venture capital and technology
holding company with operations in Hong Kong, China and the US. Mr. Chan earned
an MBA in 1994 and a MSEE in 1990 from Columbia University, and a BSEE with
Magna Cum Laude in 1987 from Polytechnic University, New York.
April Green served as our Chief Financial Officer from March 15, 2002
through April 9, 2004. She joined our company in June 1999 as our controller and
was promoted to the position of Director of Finance & Administration in January
1, 2000. She resigned as our Chief Financial Officer on April 9, 2004 and was
replaced by Jeff Barocas, our new Chief Financial Officer. See "New Chief
Financial Officer" on page 29 and "Separation Agreements" in exhibit 10.9. Prior
to joining us, Ms. Green held various positions of increasing responsibility
with Monogram International, a large, Florida-based novelty and toy company from
February 1993 to June 1999. At Monogram, Ms. Green rose from Staff Accountant to
Controller. Prior to June 1999, she served in a variety of financial positions
in the automotive industry in the Tampa area. Ms. Green is a Certified Public
Accountant, a member of the American Institute of Certified Public Accountants
(AICPA) and a member of the AWSCPA (American Woman's Society of CPA's).
John Dahl served as our Senior Vice-President of Finance from November
1, 2003 through April 13, 2004, when he resigned from this position. See
"Separation Agreements" in exhibit 10.11. Prior to joining us, Mr. Dahl served
as a consultant with American Express Tax Services from May 1999 through
December 2003. While Mr. Dahl was working with American Express, he was engaged
as a consultant on our account by LaSalle Business Credit, our prior lender.
Prior to March 1999, Mr. Dahl attended law school at Northern Illinois
University from September 1996 through May 1999.
Josef A. Bauer has served as a director from October 15, 1999. Mr.
Bauer previously served as a director of the Singing Machine from February 1990
until September 1991 and from February 1995 until July 1997, when we began our
Chapter 11 proceeding. Mr. Bauer presently serves as the Chief Executive Officer
of the following three companies: Banisa Corporation, a privately owned
investment company, since 1975; Trianon, a jewelry manufacturing and retail
sales companies since 1978 and Seamon Schepps, also a jewelry manufacturing and
retail sales company since 1999.).
Bernard S. Appel has served as a director since October 31, 2003. He
spent 34 years at Radio Shack, beginning in 1959. At Radio Shack, he held
several key merchandising and marketing positions and was promoted to the
positions of President in 1984 and to Chairman of Radio Shack and Senior Vice
President of Tandy Corporation in 1992. Since 1993 through the present date, Mr.
Appel has operated the private consulting firm of Appel Associates, providing
companies with merchandising, marketing and distribution strategies, creative
line development and domestic and international procurement.
Richard Ekstract served as a director from October 31, 2003 through
June 2, 2004. Since 1959, Mr.Ekstract has created, financed and launched more
than twenty periodicals about the consumer electronics industry, including Audio
Times, Consumer Electronics Monthly, Consumer Electronics Show Daily, Autosound
and Communications, Satellite Retailing, Video Business, Video Review, TWICE,
CARS, and License! From January 1999 through February 2001, Mr. Ekstrakt was the
31
managing partner of License Magazine, which was sold to Advanstar
Communications. From March 2001 through the present date, Mr. Ekstract has
served as the Managing Partner of Cottage & Gardens, LLC, a magazine providing
advice to consumers on a range of topics, including decorating, gardening,
homemaking and crafts. Mr. Ekstract was also founder and chairman of the Home
Office Association of America where he served as Chairman from March 1990
through January 1999.
Harvey Judkowitz has served as a director since March 29, 2004 and is
the Chairman of our Audit Committee. He is licensed as a Certified Public
Accountant in New York and Florida. From 1988 to the present date, Mr. Judkowitz
has conducted his own CPA practices. He currently serves as the Chairman and CEO
of UniPro Financial Services, a diversified financial services company. He also
sits on the Board of Directors and serves as the Chair of the Audit Committee of
the following public companies: Global Business Services, Inc., Pony Express
USA, Intellligent Motor Cars, Inc. and Kirshner Entertainment & Technologies,
Inc. He currently serves as the Interim Chief Financial Officer of Kirshner
Entertainment & Technologies, Inc.
NEW CHIEF FINANCIAL OFFICER
Effective as of April 9, 2004, we hired Jeff Barocas to serve as our
Chief Financial Officer. Prior to joining our company, Mr. Barocas was CFO at
Biometrics Security Technology, Inc., a Florida based security software
developer where he was responsible for all administrative functions, purchasing,
financial and SEC reporting and new business development for Latin America and
the Caribbean. From 1996 to 2002, he was CFO at Quipp, Inc., a Florida based
manufacturer of automated capital equipment for the newspaper industry. From
1986 to 1995, he was CFO at London International US Holdings, a Sarasota,
Florida consumer products and medical products company where he managed all
financial, information systems and material procurements activities. He is 56
years old.
BOARD COMMITTEES
We have an audit committee, an executive compensation/stock option
committee and a nominating committee. As of July 10, 2004, the audit committee
consists of Messrs. Judkowitz, Appel and Bauer. As of July 10, 2004, the audit
committee consists of Messrs. Judkowitz, Appel and Bauer. The Board has
designated Mr. Judkowitz as the "audit committee financial expert," as defined
by Item 401(h) of Regulation S-K of the Securities Exchange Act of 1934. The
Board has determined that Harvey Judkowitz and Bernard Appel are "independent
directors" within the meaning of the listing standards of the American Stock
Exchange. The audit committee recommends the engagement of independent auditors
to the board, initiates and oversees investigations into matters relating to
audit functions, reviews the plans and results of audits with our independent
auditors, reviews our internal accounting controls, and approves services to be
performed by our independent auditors. The executive compensation/stock option
committee consists of Messrs. Judkowitz, Appel and Bauer. The executive
compensation/stock option committee considers and authorizes remuneration
arrangements for senior management and grants options under, and administers our
employee stock option plan. The entire Board of Directors operates as a
nominating committee. The nominating committee is responsible for reviewing the
qualifications of potential nominees for election to the Board of Directors and
recommending the nominees to the Board of Directors for such election.
CODE OF ETHICS
We have adopted a Code of Business Conduct and Ethics, which is
applicable to all directors, officers and employees of the Singing Machine,
including our principal executive officer, our principal financial officer, our
principal accounting officer or controller or other persons performing similar
functions. The Code of Ethics is available on our website at
www.singingmachine.com and is filed as Exhibit 14.1 to this Annual Report on
Form 10-K. We intend to post amendments to or waives from our Code of Ethics (to
the extent applicable to our chief executive officer, principal financial
officer, principal accounting officer or controller or other persons performing
similar functions) on our website.
DIRECTOR'S COMPENSATION
During fiscal 2004, our employee directors did not receive any
additional or special compensation for serving as directors. During fiscal 2004,
our compensation package for our non-employee directors consisted of grants of
stock options and reimbursement of costs and expenses associated with attending
our Board meetings. Our three non-employee directors during fiscal 2003 were Jay
Bauer, Bernard Appel and Richard Ekstract. Effective as of February 26, 2004, we
granted each of our non-employee directors options under our Year 2001 Stock
Option Plan to purchase 20,000 shares of our common stock. The options have an
exercise price of $1.30 per share and vest over a three year period beginning on
February 26, 2005. These options expire five years after their vesting date.
During fiscal 2005, we will implement the following compensation policy
for our directors.
32
o Each non-employee director will receive an annual retainer of
$10,000, with $7,500 to be paid in cash and $2,500 to be paid
in stock, based at the closing price of our common stock on
the date of the annual shareholder's meeting or any other date
selected by the Board.
o Each non-employee director will also receive an initial stock
option grant for 20,000 shares upon joining our Board of
Directors and each continuing non-employee director will
receive an annual stock option grant for 20,000 shares for
each additional year served on the Board which will be awarded
on the anniversary date of the Board member's initial grant.
o Each non-employee director will be reimbursed for all
reasonable expenses incurred in attending Board meetings and
will receive a fee of $500 for each Board or committee meeting
attended.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
To our knowledge, based solely on a review of the copies of such
reports furnished to the Company and written representations that no other
reports were required, the Company believes that during the year ended March 31,
2004, its officers, directors and 10% shareholders complied with all Section
16(a) filing requirements except for the following transactions. Mr. Bauer and
Mr. Steele each filed two Form 4's late in which reported on transaction in each
late Form 4. Mr. Steele also filed three amendment to his Form 4 filings to
correct typographical errors. Mr. Ekstract file four Form 4's late in which he
reported 5 transactions late. Mr. Chan filed one Form 4 late in which he failed
to report one transaction. The Company's former officers and a former director
(Jack Dromgold, April Green and Howard Moore) each filed one Form 4 late which
reported on transaction in each late Form 4 and Mr. Dahl, a former officer,
filed his Form 3 late.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain compensation information for the
fiscal years ended March 31, 2004, 2003 and 2002 with regard to (i) Yi Ping
Chan, our Interim Chief Executive Officer and Chief Operating Officer, from
October 17, 2003 through the present date, (ii) Robert Weinberg, our Chief
Executive Officer from July 23, 2003 through October 17, 2003 and (iii) Edward
Steele, our Chief Executive Officer from June 1991 through July 23, 2003, and
each of our other executive officers whose compensation exceeded $100,000 on an
annual basis (the "Named Officers"):
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM COMPENSATION
SECURITIES
NAME OF INDIVIDUAL AND PRINCIPAL OTHER ANNUAL UNDERLYING ALL OTHER
POSITION YEAR SALARY BONUS COMPENSATION(1) OPTIONS / SAR'S COMPENSATION(2)
- -------- ---- ------ ------- --------------- --------------- ---------------
Yi Ping Chan 2004 $247,470(4) -- $ 6,000 52,800 $ 12,180
Interim Chief Executive Officer and
Chief Operating Officer(3)
Edward Steele 2004 $378,809(4) -- $ 6,000 10,000 $ 17,949
Former Chief Executive Officer(5) 2003 $382,352 -- $ 8,671 30,000 $ 17,969
2002 $364,145 $192,133 $ 8,258 15,000 $ 17,908
April J. Green 2004 $127,642 -- $ 3,600 4,380 $ 5,094
Chief Financial Officer(6) 2003 $122,200 $ 25,000 $ 3,900 20,000 $ 13,551
2002 $ 88,825 $ 25,000 $ 3,900 30,000 $ 7,091
John Dahl 2004 $ 78,834 -- $ 1,200 50,000 $ 350
Senior Vice President of Finance(7)
John Klecha 2004 $ 41,480 -- $ 1,000 0 $189,911(9)
Former Chief Operating Officer(8) 2003 $300,117 -- $ 6,555 24,000 $ 13,264
2002 $286,111 $157,200 $ 6,242 15,000 $ 11,725
Jack Dromgold 2004 $183,266(4) -- $ 4,500 50,000 $110,622(11)
Former Vice President of Sale and 2003 $210,277 $ 50,000 $ 51,067 100,000 $154,072(12)
Marketing(10) 2002 -- -- -- -- --
Robert Weinberg 2004 $ 57,692 -- $ 3,000(14) -- --
Former Chief Executive Officer(13)
33
(1) The amounts disclosed in this column for fiscal 2004, 2003 and 2002
include automobile expense allowances.
(2) Includes matching contributions under our 401(k) savings plan, medical
insurance pursuant to the executive's employment agreement and other
expenses described herein.
(3) Mr. Chan became our Interim Chief Executive Officer on October 17,
2004.
(4) Effective as of August 1, 2003, Mr. Chan, Mr. Dromgold and Mr. Steele
agreed to take 15% of their annual compensation in the form of stock
for a nine month period until March 31, 2004 (except Mr. Steele's
agreement was for an 8 month period until February 28, 2004 when his
employment agreement expired). During their respective time periods,
Mr. Chan, Mr. Dromgold and Mr. Steele received compensation in the
amount of $20,125, $17,535 and $63,136 in shares of the Singing
Machine's common stock. The average trading that was used to calculate
the number of shares that would be issued to each officer was $3.85 per
share.
(5) Mr. Steele served as our Chief Executive Officer from September 1991
through July 23, 2003. He currently serves as our Senior Advisor and
Director of Product Development.
(6) Ms. Green served as our Chief Financial Officer from March 15, 2002
through April 9, 2004.
(7) Mr. Dahl served as our Senior Vice President of Finance from October
22, 2003 through April 13, 2003.
(8) Mr. Klecha served as our Chief Operating Officer from June 28, 1999
through May 2, 2003.
(9) Amounts paid to Mr. Klecha pursuant to his separation and release
agreement were $183,703 and $36,204 for medical insurance and matching
401(K) contributions.
(10) Mr. Dromgold joined us on April 15, 2002 and resigned on December 16,
2003.
(11) Amounts paid to Mr. Dromgold pursuant to his separation and release
agreement were $104,640 and our matching 401(k) contributions and
medical insurance were $4,582.
(12) Includes relocation expenses of $45,529, our matching contribution of
$8,543 under our 401(k) savings plan and medical insurance at a
$100,000 value contributed to option granted to Mr. Dromgold and
$60,565 paid to Mr. Dromgold pursuant to his separation and release
agreement.
(13) Mr. Weinberg served as our Chief Executive Officer from July 23, 2003
to October 12, 2004.
(14) Represents 3 months of rent paid for Mr. Weinberg's apartment in
Florida.
OPTION GRANTS IN FISCAL 2004
The following table sets forth information concerning all options
granted to our officers and directors during the year ended March 31, 2004. No
stock appreciation rights ("SAR's") were granted.
SHARES TOTAL OPTIONS POTENTIAL REALIZABLE VALUE AT
UNDERLYING GRANTED TO ASSUMED ANNUAL RATES OF STOCK PRICE
OPTIONS EMPLOYEES IN EXERCISE PRICE APPRECIATION FOR OPTION TERM(2)
NAME GRANTED(1) FISCAL YEAR PER SHARE EXPIRATION DATE 5% 10%
- ------------------ ---------- ----------- --------- --------------- -------------- ------------
Yi Ping Chan 52,800 3.3% $1.97 12/18/14 $169,431 $269,791
Edward Steele 10,000 .6% $1.97 12/18/14 $32,089 $51,097
April J. Green 4,380 .3% $1.97 12/18/14 $14,055 $22,380
John Dahl 50,000 3.1% $1.97 12/18/14 $160,446 $255,484
John Klecha -- -- -- -- -- --
Jack Dromgold 50,000 3.1% $7.60 Cancelled(3) -- --
Robert Weinberg -- -- -- -- -- --
(1) All of these options were granted under a Year 2001 Stock Option Plan.
The Options granted to Mr. Steele, Ms. Green, Mr. Dahl and Mr. Dromgold
vest in five equal installments over a period of five years, beginning
on December 13, 2004 (except Mr. Dromgold's vesting began on April 15,
2004). Mr. Chan's options vest in (except Mr. Chan's options vest in 3
equal installments over a 3 year period).
34
(2) The dollar amounts under these columns are the result of calculations
based on the market price on the date of grant at an assumed annual
rate of appreciation over the maximum term of the option at 5% and 10%
as required by applicable regulations of the SEC and, therefore, are
not intended to forecast possible future appreciation, if any of the
common stock price. Assumes all options are exercised at the end of
their respective terms. Actual gains, if any, on stock option exercises
depend on the future performance of the common stock.
(3) Mr. Dromgold received a grant of 50,000 options on April 15, 2003.
These options expired on March 18, 2004, ninety days after Mr. Dromgold
resigned from our company.
AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED MARCH 31, 2004 AND OPTION
VALUES
The following table sets forth information as to the exercise of stock
options during the fiscal year ended March 31, 2004 by our officers listed in
our Summary Compensation Table and the fiscal year-end value of unexercised
options.
NUMBER OF
UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT FISCAL IN-THE-MONEY OPTIONS AT
YEAR END FISCAL YEAR END(2)
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME OF INDIVIDUAL UPON EXERCISE REALIZED(1) UNEXERCISABLE UNEXERCISABLE
------------------ ------------- ----------- ------------- -------------
Yi Ping Chan -- -- 50,000/152,800 0/0
Edward Steele -- -- 322,500/10,000 0/0
April J. Green -- -- 30,000/19,380 0/0
John Dahl -- -- 0/50,000 0/0
John Klecha -- -- 0/0 0/0
Jack Dromgold -- -- 0/0 0/0
Robert Weinberg -- -- 0/0 0/0
EMPLOYMENT AGREEMENTS
YI PING CHAN. Effective as of May 2, 2003, we entered into a three year
employment agreement with Yi Ping Chan, our current Chief Operating Officer. Mr.
Chan is entitled to receive an annual salary equal to $250,000 per year, plus
bonuses and increases in his annual salary at the sole discretion of our Board
of Directors. We agreed to grant Mr. Chan options to purchase 150,000 shares of
our common stock of which 50,000 options will vest each year and to reimburse
him for moving expenses of up to $40,000. We granted Mr. Chan options to
purchase 150,000 shares of our common stock, in July 2003. In the event of a
termination of his employment following a change of control, Mr. Chan would be
entitled to a lump sum payment of 100% of the amount of his total compensation
in the twelve months preceding such termination. During the term of his
employment agreement and for a period of two years after his termination for
cause and one year if he is terminated without cause, Mr. Chan cannot directly
or indirectly compete with our company in the karaoke industry in the United
States.
EDDIE STEELE. On February 27, 2004, we extended our employment
agreement with Eddie Steele for another year. Mr. Steele will serve as the
Director of Product Development for a one year period to expire on February 28,
2005. Under his employment agreement, Mr. Steele is entitled to receive annual
compensation of $250,000 per year; however, Mr. Steele has agreed to take a 20%
pay cut so his base salary is $200,000 per year. The agreement also provides for
discretionary bonuses. In the event of a termination of his employment following
a change of control, Ms. Steele would be entitled to a lump sum payment of 50%
of the amount of his total compensation in the twelve months preceding such
termination. During the term of his employment agreement and for a period of one
year after his termination for cause, Mr. Steele cannot directly or indirectly
compete with our company in the karaoke industry in the United States.
SEPARATION AND CONSULTING AGREEMENTS
APRIL GREEN. Ms. Green resigned as our Chief Financial Officer
effective as of April 9, 2004. In connection with her resignation, we entered
into a separation and release agreement with Ms. Green. Under this agreement, we
agreed to provide Ms. Green with a severance payment equal to $115,519, which
consisted of (1) salary payments in the amount of $100,000, (ii) a COBRA
reimbursement payment equal to $6,600 and (iii) payments for accrued vacation
time equal to $4,153 over a nine month period. In exchange, Ms. Green agreed to
release the Singing Machine from any liability in connection with the
termination of her employment.
JOHN DAHL. Mr. Dahl resigned as our Senior Vice President of Finance
effective as of April 13, 2004. In connection with his resignation, we entered
into a separation and release agreement with Mr. Dahl. Under this agreement, we
agreed to provide Mr. Dahl with a severance payment equal to $51,050, which
consisted of (i) salary payments in the amount of $39,000, (ii) moving expenses
equal to $11,000 and (iii) COBRA reimbursement payments equal to $1,050 over a
five month period. In exchange, Mr. Dahl agreed to release the Singing Machine
from any liability in connection with the termination of his employment.
35
JACK DROMGOLD. Mr. Dromgold resigned as our Executive Vice President of
Sales, effective as of December 16, 2003. In connection with his resignation, we
entered into a separation and release agreement with him. Under this agreement,
we agreed to provide Mr. Dromgold with a payment equal to $161,939, which
consisted of (i) $50,000 in cash to be paid on December 16, 2003 (ii) $109,281
to be paid over a six month period and (iii) three months of COBRA reimbursement
payments. In exchange, Mr. Dromgold agreed to release the Singing Machine from
any liability in connection with the termination of his employment. We also
entered into a consulting agreement with Mr. Dromgold on December 16, 2003 to
provide us with consulting relating to our sales and marketing efforts for a
sixty day period. We amended this agreement on April 27, 2004 and issued 50,000
shares of our common stock to Mr. Dromgold.
JOHN KLECHA. Mr. Klecha resigned as our Chief Operating Officer and
President, effective as of May 2, 2003. In connection with his resignation, we
entered into a separation and release agreement. Under this agreement, we agreed
to provide Mr. Klecha with a severance payment equal to $183,707, which
consisted of (i) salary and auto allowance through May 31, 2003, (ii) four weeks
of accrued vacation time, (iii) four months of salary and automobile allowance
payments and (iv) seven months COBRA reimbursement payments. In exchange, Mr.
Klecha agreed to release the Singing Machine from any liability in connection
with the termination of his employment.
EQUITY COMPENSATION PLANS AND 401(K) PLAN
We have two stock option plans: our 1994 Amended and Restated Stock
Option Plan ("1994 Plan") and our Year 2001 Stock Option Plan ("Year 2001
Plan"). Both the 1994 Plan and the Year 2001 Plan provide for the granting of
incentive stock options and non-qualified stock options to our employees,
officers, directors and consultants As of March 31, 2004, we had 358,700 options
issued and outstanding under our 1994 Plan and 668,830 options are issued and
outstanding under our Year 2001 Plan.
The following table gives information about equity awards under our
1994 Plan and the Year 2001 Plan.
Number of securities
Number of securities Weighted-average remaining available for
to be issued upon exercise price of future issuance under
exercise or outstanding equity compensation plans
outstanding options, options, warrants (excluding securities in
Plan Category warrants and rights and rights column (a))
- ------------- ------------------- ---------- -----------
Equity Compensation Plans 1,027,530 $3.95 784,195
approved by Security
holders
Equity Compensation Plans 0 0 0
Not approved by Security
Holders
1994 PLAN
Our 1994 Plan was originally adopted by our Board of Directors in May
1994 and it was approved by our shareholders on June 29, 1994. Our shareholders
approved amendments to our 1994 Plan in March 1999 and September 2000. The 1994
Plan reserved for issuance up to 1,950,000 million share of our common stock
pursuant to the exercise of options granted under the Plan. As of March 31,
2003, we had granted all the options that are available for grant under our 1994
Plan. As of March 31, 2004, we have 358,700 options issued and outstanding under
the 1994 Plan and all of these options are fully vested as of March 31, 2004.
YEAR 2001 PLAN
On June 1, 2001, our Board of Directors approved the Year 2001 Plan and
it was approved by our shareholders at our special meeting held September 6,
2001. The Year 2001 Plan was developed to provide a means whereby directors and
selected employees, officers, consultants, and advisors of the Company may be
granted incentive or non-qualified stock options to purchase common stock of the
Company. The Year 2001 Plan authorizes an aggregate of 1,950,000 shares of the
Company `s common stock and a maximum of 450,000 shares to any one individual in
any one fiscal year. The shares of common stock available under the Year 2001
Plan are subject to adjustment for any stock split, declaration of a stock
dividend or similar event. At March 31, 2004, we have granted 423,980 options
under the Year 2001 Plan, 26,668 of which are fully vested.
36
The Year 2001 Plan is administered by our Stock Option Committee
("Committee"), which consists of two or more directors chosen by our Board. The
Committee has the full power in its discretion to (i) grant options under the
Year 2001 Plan, (ii) determine the terms of the options (e.g. - vesting,
exercise price), (iii) to interpret the provisions of the Year 2001 Plan and
(iv) to take such action as it deems necessary or advisable for the
administration of the Year 2001 Plan.
Options granted to eligible individuals under the Year 2001 Plan may be
either incentive stock options ("ISO's"), which satisfy the requirements of Code
Section 422, or nonstatutory options ("NSO's"), which are not intended to
satisfy such requirements. Options granted to outside directors, consultants and
advisors may only be NSO's. The option exercise price will not be less than 100%
of the fair market value of the Company's common stock on the date of grant.
ISO's must have an exercise price greater to or equal to the fair market value
of the shares underlying the option on the date of grant (or, if granted to a
holder of 10% or more of our common stock, an exercise price of at least 110% of
the under underlying shares fair market value on the date of grant). The maximum
exercise period of ISO's is 10 years from the date of grant (or five years in
the case of a holder with 10% or more of our common stock). The aggregate fair
market value (determined at the date the option is granted) of shares with
respect to which an ISO are exercisable for the first time by the holder of the
option during any calendar year may not exceed $100,000. If that amount exceeds
$100,000, our Board of the Committee may designate those shares that will be
treated as NSO's.
Options granted under the Year 2001 Plan are not transferable except by
will or applicable laws of descent and distribution. Except as expressly
determined by the Committee, no option shall be exercisable after thirty (30)
days following an individual's termination of employment with the Company or a
subsidiary, unless such termination of employment occurs by reason of such
individual's disability, retirement or death. The Committee may in its sole
discretion, provide in a grant instrument that upon a change of control (as
defined in the Year 2001 Plan) that all outstanding option issued to the grantee
shall automatically, accelerate and become full exercisable. Additionally, the
obligations of the Company under the Year 2001 Plan are binding on (1) any
successor corporation or organization resulting from the merger, consolidation
or other reorganization of the Company or (2) any successor corporation or
organization succeeding to all or substantially all of the assets and business
of the Company. In the event of any of the foregoing, the Committee may, at its
discretion, prior to the consummation of the transaction, offer to purchase,
cancel, exchange, adjust or modify any outstanding options, as such time and in
such manner as the Committee deems appropriate.
401(K) PLAN
Effective January 1, 2001, we adopted a voluntary 401(k) plan. All
employees with at least one year of service are eligible to participate in our
401(k) plan. In fiscal 2002, we made a matching contribution of 100% of salary
deferral contributions up to 3% of pay, plus 50.369% of salary deferral
contributions from 3% to 5% of pay for each payroll period. The amounts charged
to earnings for contributions to this plan and administrative costs during the
years ended March 31, 2004, 2003 and 2002 totaled approximately $55,402, $61,466
and $41,733, respectively.
REPORT OF THE EXECUTIVE COMPENSATION/STOCK OPTION COMMITTEE ON
EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION PHILOSOPHY
The Executive Compensation Committee believes that the Singing Machine
must maintain short and long-term executive compensation plans that enable us to
attract and retain well-qualified executives. Furthermore, we believe that our
compensation plans must also provide a direct incentive for our executives to
create shareholder value.
In furtherance of this philosophy, the compensation of our executives
generally consists of three components: base salary, annual cash incentives and
long-term performance-based incentives.
BASE SALARIES
During fiscal 2004, we had employment agreement with five of our
executive officers. We also employed one person as our Chief Executive officer
for a period of approximately 2 1/2 months without an employment agreement. The
base salaries of each of our executive officers was determined based on
comparison to executives with similar responsibilities at other public
companies: The persons that served as executive officers during fiscal 2004 are
listed below.
37
Eddie Steele, who served as our Chief Executive Officer from September
1991 through August 3, 2004 and as our Director of Product Development
from August 3, 2004 through the present date.
Yi Ping Chan, who has served as our Chief Operating Officer since May
2, 2003 and Interim Chief Executive Officer since October 17, 2003
through the present date.
Jack Dromgold, who served as our Senior Vice President of Sales from
April 15, 2002 through December 16, 2003.
April Green, who served as our Chief Financial Officer from March 15,
2002 through April 9, 2004.
John Dahl, who served as our Vice President of Finance from October 22,
2003 through April 13, 2004.
Robert Weinberg served as our Chief Executive Officer from August 3,
2003 through October 17, 2003. We did not have an employment agreement
with Mr. Weinberg for his services as our Chief Executive Officer.
INCENTIVE CASH BONUSES
Generally, we award cash bonuses to our management employees and other
employees, based on their personal performance in the past year and overall
performance of our company. During fiscal 2004, we did not award any cash
bonuses to any of our executive officers because our financial performance was
weak. We had an operating loss of $22.6 million.
LONG TERM COMPENSATION - STOCK OPTION GRANTS
We have utilized stock options to motivate and retain executive
officers and other employees for the long-term. We believe that stock options
closely align the interests of our executive officers and other employees with
those of our stockholders and provide a major incentive to building stockholder
value. Options are typically granted annually, and are subject to vesting
provisions to encourage officers and employees to remain employed with the
Company.
During fiscal 2004, we granted an aggregate of 167,180 options to our
senior executive officers. All options grants in fiscal 2004 were made under our
Year 2001 Stock Option Plan. See "Executive Compensation -Option Grants in Last
Fiscal Year" on pages 34-35 for information about the number of options granted
to each individual. Each of the option grants was at a price that was equal to
the closing price of our common stock on the date of grant.
RELATIONSHIP BETWEEN OUR COMPENSATION POLICIES AND CORPORATE PERFORMANCE
We believe that our executive compensation policies correlate with our
corporate performance. Our stock options are usually granted at a price equal to
or above the fair market value of our common stock on the date of grant. As
such, our officers only benefit from the grant of stock options if our stock
price appreciates. Generally, we try to tie bonus payments to our financial
performance. However, if an individual has made significant contributions to our
company, we will provide them with a bonus payment for their efforts even if our
company's financial performance has not been strong.
COMPENSATION OF CHIEF EXECUTIVE OFFICER
During fiscal 2004, we had three different individuals serving in the
position as Chief Executive Officer. Edward Steele served as our Chief Executive
Officer for approximately four months during fiscal 2004 from April 1, 2004
through August 3, 2004. His base salary for the period between June 1, 2003
through June 1, 2004 as contained in his employment agreement was $385,875 per
year. During this time period, Mr. Steele received salary payments equal to
$128,625. In July 2003, Mr. Steele agreed to accept 15% of his salary during the
eight month period between July 1, 2003 through February 28, 2004 in the form of
stock rather than cash. Although Mr. Steele resigned as the Chief Executive
Officer on August 3, 2003, he remains with our company and is employed as our
Director of Product Development.
38
Robert Weinberg served as our Chief Executive Officer for a period of
approximately two months from August 3, 2003 through October 17, 2003, when he
resigned for personal reasons. We did not have an employment agreement with Mr.
Weinberg. Mr. Weinberg received $53,000 for his two months as our CEO. Because
Mr. Weinberg lived in New Jersey, we agreed to pay him for the cost of renting
an apartment in South Florida when he visited our company's headquarters. We did
not grant any options or cash bonuses to Mr. Weinberg during his tenure as our
Chief Executive Officer.
Effective as of October 17, 2003, Yi Ping Chan became our Interim Chief
Executive Officer. Mr. Chan's salary is $250,000 per year, as set forth in his
employment agreement. In July 2003, Mr. Chan agreed to accept 15% of his salary
during the nine-month period between July 1, 2003 through March 31, 2004 in the
form of stock rather than cash. We also agreed to grant Mr. Chan options to
purchase 150,000 shares of our common stock, at an exercise price of $5.60 per
share, of which 50,000 options vest each year and to reimburse him for moving
expenses of up to $40,000.
We did not grant any cash bonuses to Mr. Chan in fiscal 2004 because
our financial performance did not justify cash bonuses to any of our employees.
We had a net operating loss of $ 22.6 million in fiscal 2004.
We awarded stock options to Mr. Chan in December 2003. We awarded Mr.
Chan options to purchase 52,800 shares of our common stock at an exercise price
of $1.97 per share. These options were granted under our Year 2001 Stock Option
Plan and were granted at a price that was equal to closing price of our common
stock on the date of grant. Mr. Chan's options vest at a rate of one-third per
year over a period of three years.
THE EXECUTIVE COMPENSATION COMMITTEE
Harvey Judkowitz, Chairman
Bernard Appel
Jay Bauer
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of our Executive Compensation Committee as of in the fiscal
year ended March 31, 2004 were Messrs. Appel, Bauer and Ekstract. Howard Moore
and Robert Weinberg served as members of the Compensation Committee for
approximately seven months in fiscal 2004 from April 1, 2004 through April 17,
2004. None of the members of the Compensation Committee in fiscal 2004 were or
are current officers or employees of the Singing Machine or any of its
subsidiaries (except Mr. Weinberg, a former member of our Compensation
Committee, served as our Chief Executive Officer from a two month period from
August 3 through October 17, 2003). None of these persons have served on the
board of directors or on the compensation committee of any other entity that has
an executive officer serving on our board of directors or on our Compensation
Committee.
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
The graph below compares the performance of the Singing Machine's
common stock with the American Stock Market Index ("AMEX Index") and the Dow
Jones - Consumer Electronics Index ("Dow Jones-CSE"), during the period
beginning March 31, 1999 through March 31, 2004. The graph assumes the
investment of $100 on March 31, 1999 in the Singing Machine's common stock, in
the AMEX Index and the Dow Jones-CSE Index. Total shareholder return was
calculated on the basis that in each case all dividends were reinvested.
[PERFORMANCE GRAPH OMITTED]
1999 2000 2001 2002 2003 2004
---- ---- ---- ---- ---- ----
THE SINGING MACHINE COMPANY, INC. 100.00 225.00 256.00 852.80 375.47 62.40
DOW JONES CONSUMER ELECTRONICS INDEX 100.00 219.40 131.81 109.14 69.68 112.51
AMEX MARKET INDEX 100.00 141.41 119.30 118.32 113.00 159.70
39
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table set forth as of June 15, 2004, certain information
concerning beneficial ownership of our common stock by:
-all directors of the Singing Machine,
-all executive officers of the Singing Machine.
-persons known to own more than 5% of our common stock;
Unless otherwise indicated, the address for each person is The Singing
Machine Company, Inc., 6601 Lyons Road, Building A-7, Coconut Creek, Florida
33073. As of June 15, 2003, we had 8,806,264 shares of our common stock issued
and outstanding.
As used herein, the term beneficial ownership with respect to a
security is defined by Rule 13d-3 under the Securities Exchange Act of 1934 as
consisting of sole or shared voting power (including the power to vote or direct
the vote) and/or sole or shared investment power (including the power to dispose
or direct the disposition of) with respect to the security through any contract,
arrangement, understanding, relationship or otherwise, including a right to
acquire such power(s) during the next 60 days. Unless otherwise noted,
beneficial ownership consists of sole ownership, voting and investment rights.
NAME SHARES OF COMMON STOCK PERCENT OF COMMON STOCK
- ---- ---------------------- -----------------------
Y.P. Chan
Interim CEO and Chief Operating Officer 67,652(1) *
Jeff Barocas
Chief Financial Officer 0 *
Joseph Bauer
Chairman 981,804(3) 11.15%
Bernard Appel
Director 0 *
Harvey Judkowitz
Director 0 *
John Klecha
Director 810,811(4) 9.20%
Wellington Management
Company, LLP 939,400(5) 10.67%
All Directors and
Executive Officers
as a Group 1,049,456(6) 11.85%
*Less than 1%.
(1) Includes 500,000 shares issuable upon the exercise of stock options
that are exercisable within 60 days of June 15, 2004.
(2) Includes 30,000 shares issuable upon the exercise of stock options that
are exercisable within 60 days of June 15, 2004.
(3) Includes 11,197 shares held by Mr. Bauer individually, 200,000 shares
held by Mr. Bauer's wife, 180,374 shares held by Mr. Bauer and his wife
jointly, 369,400 shares held by Mr. Auer's pension account, 217,500
shares held in Mr. Bauer Family United Partnership and 3,333 share
issuable upon the exercise of stock options that can be exercisable
within 60 days of June 15, 2004.
40
(4) All of the information presented in this item with respect to Mr.
Klecha's beneficial ownership were extracted solely from his Amendment
No. 2 to his Schedule 13D filed on October 20, 2003.
(5) The address of Wellington Management Company, LLP is 75 State Street,
Boston, Massachusetts. All of the information presented in this item
with respect to this beneficial ownership was extracted solely from
their Schedule 136 filed on February 12, 2004.
(6) Includes 53,333 shares issuable upon the exercise of stock options that
are exercisable within 60 days of June 15, 2004.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On July 14, 2004, Jay Bauer notified us that he intends to advance us a
short-term loan of $200,000 to be used to meet working capital obligations.
On or about July 10, 2003, certain officers and directors of our
company advanced $1 million to our company pursuant to written loan agreements.
The officer was Yi Ping Chan and the directors were Jay Bauer and Howard Moore.
Additionally, Maureen LaRoche, a business associate of Mr. Bauer, participated
in the financing. These loans bear interest at the rate of 9.5% per annum. These
loans were subordinated to Milberg's factoring agreement, which we terminated
effective as of July 14, 2004. The Board has not yet determined when these loans
will be repaid.
On or about March 4, 2003, Jay Bauer, one of our directors advanced
$400,000 to International SMC pursuant to a letter agreement, which used the
funds to make an advance to a vendor for the purchase of raw materials for the
production of our machines. We were to repay Mr. Bauer's loan in two months on
or about May 4, 2003 and the loan bore interest at the rate of 8% per annum. We
repaid $200,000 on the loan on or about May 4, 2003 and the remaining balance
was paid on or about October 10, 2003.
ITEM 14.
The following is a summary of the fees billed to the Singing Machine by
Grant Thornton, LLP for professional services rendered for the fiscal years
ended March 31, 2004 and 2003:
FEE CATEGORY FISCAL 2004 FISCAL 2003
------------ ----------- -----------
Audit Fees $180,532 $130,767
Audit-Related Fees 37,100
Tax Fees 103,958 56,261
All Other Fees 5,041
--------- --------
Total Fees $326,631 $187,028
======== ========
Audit Fees. Consists of fees billed for professional services rendered
for the audit of the Singing Machine's consolidated financial statements and
review of the interim consolidated financial statements included in quarterly
reports and services that are normally provided by Grant Thornton LLP in
connection with statutory and regulatory filings or engagements.
Audit-Related Fees. Consists of fees billed for assurance and related
services that are reasonably related to the performance of the audit or review
of the Singing Machine's consolidated financial statements and are not reported
under "Audit Fees." These services include employee benefit plan audits,
accounting consultations in connection with acquisitions, attest services that
are not required by statute or regulation, and consultations concerning
financial accounting and reporting standards.
Tax Fees. Consists of fees billed for professional services for tax
compliance, tax advice and tax planning. These services include assistance
regarding federal, state and international tax compliance, tax audit defense,
customs and duties, mergers and acquisitions, and international tax planning.
All Other Fees. Consists of fees for products and services other than
the services reported above. In fiscal 2004, these services included general
business meetings between Grant Thornton and executives and directors of The
Singing Machine.
POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT
SERVICES OF INDEPENDENT AUDITORS
The Audit Committee's policy is to pre-approve all audit and
permissible non-audit services provided by the independent auditors. These
services may include audit services, audit-related services, tax services and
other services. Pre-approval is generally provided for up to one year and any
pre-approval is detailed as to the particular service or category of services
41
and is generally subject to a specific budget. The independent auditors and
management are required to periodically report to the Audit Committee regarding
the extent of services provided by the independent auditors in accordance with
this pre-approval, and the fees for the services performed to date. The Audit
Committee may also pre-approve particular services on a case-by-case basis.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Exhibits
3.1 Certificate of Incorporation of the Singing Machine filed with the
Delaware Secretary of State on February 15, 1994 and amendments through
April 15, 1999 (incorporated by reference to Exhibit 3.1 in the Singing
Machine's registration statement on Form SB-2 filed with the SEC on
March 7, 2000).
3.2 Certificate of Amendment of the Singing Machine filed with the Delaware
Secretary of State on September 29, 2000 (incorporated by reference to
Exhibit 3.1 in the Singing Machine's Quarterly Report on Form 10-QSB
for the period ended September 30, 1999 filed with the SEC on November
14, 2000).
3.3 Certificates of Correction filed with the Delaware Secretary of State
on March 29 and 30, 2001 correcting the Amendment to our Certificate of
Incorporation dated April 20, 1998 (incorporated by reference to
Exhibit 3.11 in the Singing Machine's registration statement on Form
SB-2 filed with the SEC on April 11, 2000).
3.4 Amended By-Laws of the Singing Machine Singing Machine (incorporated by
reference to Exhibit 3.14 in the Singing Machine's Annual Report on
Form 10-KSB for the year ended March 31, 2001 filed with the SEC on
June 29, 2001).
4.1 Form of Certificate Evidencing Shares of Common Stock (incorporated by
reference to Exhibit 3.3. of the Singing Machine's registration
statement on Form SB-2 filed with the SEC on March 7, 2000). File No.
333-57722)
10.1 Factoring Agreement dated February 9, 2004 between Milberg Factors,
Inc. and the Singing Machine. (incorporated by reference to Exhibit
10.1 in the Singing Machine's Quarterly Report on Form 10-Q filed with
the SEC on February 17, 2004, File No. 000-24968).
10.2 Security Agreement for Goods and Chattels dated February 9, 2004
between Milberg Factors, Inc. and the Singing Machine. incorporated by
reference to Exhibit 10.2 in the Singing Machine's Quarterly Report on
Form 10-Q filed with the SEC on February 17,2004, File No. 000-24968).
10.3 Security Agreement for Inventory dated February 9, 2004 between Milberg
Factors, Inc. and the Singing Machine (incorporated by reference to
Exhibit 10.3 in the Singing Machine's Quarterly Report on Form 10-Q
filed with the SEC on February 17, 2004, File No. 000-24968).
10.4 Second Amendment to the Transaction Documents dated February 9, 2004
between Omicron Master Trust, SF Capital Partners, Ltd, Bristol
Investment Fund, Ltd., Ascend Offshore Fund, ltd., Ascend Partners, LP,
Ascend Partners Sapient L.P. and the Singing Machine (incorporated by
reference to Exhibit 10.4 in the Singing Machine's Quarterly Report on
Form 10-Q filed with the SEC on February 17, 2004, File No. 000-24968).
10.5 Form of Subordination Agreement executed by institutional Investors.
(Incorporated by reference to Exhibit 10.18 of the Singing Machine's
Amendment No. 1 to its registration statement on Form S-1 filed with
SEC on April, 2004)
10.6 Employment Agreement dated February 27, 2004 between the Singing
Machine and Eddie Steele.*
10.7 Employment Agreement dated May 2, 2003 between the Singing Machine and
Yi Ping Chan. (incorporated by reference to Exhibit 10.20 of the
Singing Machine's Annual Report on Form 10-KSB/A filed with the SEC on
July 23, 2003, File No. 000-24968).
10.8 Separation and Release Agreement effective as of May 2, 2003 between
the Singing Machine and John Klecha (incorporated by reference to
Exhibit 10.1 of the Singing Machine's Annual Report on Form 8-K filed
with the SEC on July 17, 2003, File No. 000-24968).
10.9 Separation and Release Agreement effective as of April 9, 2004 between
the Singing Machine and April Green.*
42
10.10 Separation and Release Agreement dated December 16,2003 between the
Singing Machine and Jack Dromgold.*
10.11 Separation and Release Agreement effective as of April 12, 2004 between
the Singing Machine and John Dahl.*
10.12 Industrial Lease dated March 1, 2002, by and between AMP Properties,
L.P. and the Singing Machine for warehouse space in Compton, California
(incorporated by reference to Exhibit 10.20 of the Singing Machine's
Annual Report on Form 10-KSB/A filed with the SEC on July 23, 2002,
File No. 000-24968).
10.13 Amended and Restated 1994 Management Stock Option Plan (incorporated by
reference to Exhibit 10.6 to the Singing Machine's registration
statement on Form SB-2 filed with the SEC on March 28, 2001, File No.
333-59684).
10.14 Year 2001 Stock Option Plan (incorporated by reference to Exhibit 10.1
of the Singing Machine's registration statement on Form S-8 filed with
the SEC on September 13, 2002, File No. 333-99543).
10.15 Securities Purchase Agreement dated as of August 20, 2003 by and among
the Singing Machine and Omicron Master Trust, SF Capital Partners,
Ltd., Bristol Investment Fund, Ltd., Ascend Offshore Fund, Ltd., Ascend
Partners, LP and Ascend Partners Sapient, LP (collectively, the
"Investors") (filed as Exhibit 10.1 to the Singing Machine's
Registration Statement filed with the SEC on October 9, 2003, File No.
333-109574).
10.16 Amendment dated September 5, 2003 to Securities Purchase Agreement
between the Singing Machine and the Investors (filed as Exhibit 10.2 to
the Singing Machine's Registration Statement filed with the SEC on
October 9, 2003, File No. 333-109574).
10.17 Form of Debenture Agreement issued by the Singing Machine to each of
the Investors (filed as Exhibit 10.3 to the Singing Machine's
Registration Statement filed with the SEC on October 9, 2003, File No.
333-109574).
10.18 Form of Warrant Agreement issued by the Singing Machine to the
Investors (filed as Exhibit 10.4 to the Singing Machine's Registration
Statement filed with the SEC on October 9, 2003, File No. 333-109574).
10.19 Warrant Agreement between the Singing Machine and Roth Capital
Partners, LLC (filed as Exhibit 10.5 to the Singing Machine's
Registration Statement filed with the SEC on October 9, 2003, File No.
333-109574).
10.20 Registration Rights Agreement between the Singing Machine and each of
the Investors and Roth Capital Partners, LLC (filed as Exhibit 10.5 to
the Singing Machine's Registration Statement filed with the SEC on
October 9, 2003, File No. 333-109574).
10.21 Domestic Merchandise License Agreement dated November 1, 2000 between
MTV Networks, a division of Viacom International, Inc. and the Singing
Machine (incorporated by reference to Exhibit 10.3 of the Singing
Machine's Quarterly Report on Form 10-Q for the quarter ended December
31, 2002, filed with the SEC on February 14, 2003, File No. 000-24968).
10.22 Amendment dated January 1, 2002 to Domestic Merchandise License
Agreement between MTV Networks, a division of Viacom International,
Inc. and the Singing Machine (incorporated by reference to Exhibit 10.4
of the Singing Machine's Quarterly Report on Form 10-Q for the quarter
ended December 31, 2002, filed with the SEC on February 14, 2003, File
No. 0000-24968).
10.23 Second Amendment as of November 13, 2002 to Domestic Merchandise
License Agreement between MTV Networks, a division of Viacom
International, Inc. and the Singing Machine (incorporated by reference
to Exhibit 10.5 of the Singing Machine's Quarterly Report on Form 10-Q
for the quarter ended December 31, 2002, filed with the SEC on February
2003, File No. 000-24968).
10.24 Third Amendment as of February 26, 2003 to Domestic Merchandise License
Agreement between MTV Networks, a division of Viacom International,
Inc. and the Singing Machine (incorporated by reference to Exhibit
10.10 of the Singing Machine's Annual Report on Form 10-K for the
fiscal year ended March 31, 2003, filed with the SEC on July 17, 2003,
File No. 000-24968).
43
10.25 Amendment to Domestic Licensing Agreement dated November 15, 2002
between the Singing Machine and MTV Networks, a division of Viacom
International, Inc. (incorporated by reference to Exhibit 10.5 in the
Singing Machine's Quarterly Report on Form 10-Q filed with the SEC on
February 17, 2004, File No. 000-24968).
10.26 Fifth Amendment to Domestic Licensing Agreement dated December 23, 2003
between the Singing Machine and MTV Networks, a division of Viacom
International, Inc. (incorporated by reference to Exhibit 10.6 in the
Singing Machine's Quarterly Report on Form 10-Q filed with the SEC on
February 17, 2004, File No. 000-24968).
10.27 Sales Agreement effective as of December 9, 2003 between the Singing
Machine and CPP Belwin, Inc. and its affiliates (incorporated by
reference to Exhibit 10.7 in the Singing Machine's Quarterly Report on
Form 10-Q filed with the SEC on February 17, 2004, File No. 000-24968).
10.28 Distribution Agreement dated April 1, 2003 between the Singing Machine
and Arbiter Group, PLC.*
10.29 Loan Agreements dated August 13, 2003 in the aggregate amount of $1
million between the Company and each of Josef Bauer, Howard Moore &
Helen Moore Living Trust, Maureen G. LaRoche and Yi Ping Chan.*
10.30 Letter dated March 4, 2003 from Jay Bauer to the Singing Machine
regarding a $400,000 loan.*
14.1 Code of Ethics*
21.1 List of Subsidiaries*
23.1 Consent of Grant Thornton, LLP*
23.2 Consent of Salberg & Co.*
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002*
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002*
32.1 Certification of the Chief Executive Officer pursuant to U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002*
32.2 Certification of the Chief Financial Officer pursuant to U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002*
- ---------
*Filed herewith
Reports on Form 8-K
On February 17, 2004, we filed a Current Report on Form 8-K pursuant to
Item 7 (Financial Statements and Exhibits) and Item 9 (Regulation FD Disclosure)
reporting our results for the nine months ended December 31, 2003.
On February 26, 2004, we filed a Current Report on Form 8-K pursuant to
Item 5 (Other Events and Required FD Disclosure). Announcing the results of our
shareholder's meeting held on February 26, 2004.
44
SIGNATURES
In accordance with the requirements of Section 13 and 15(d) of the Securities
Exchange Act of 1934, The Singing Machine Company, Inc. has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE SINGING MACHINE COMPANY, INC.
Dated: July 14, 2004 By: /s/ Yi Ping Chan
-----------------
Yi Ping Chan
Interim Chief Executive Officer
(Principal Executive Officer)
In accordance with the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of The Singing
Machine Company, Inc. and in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE
- --------- -------- ----
/s/ Yi Ping Chan Interim Chief Executive Officer July 14, 2004
- --------------------
Yi Ping Chan
/s/ Jeff Barocas Chief Financial Officer (Principal July 14, 2004
- -------------------- Financial and Accounting Officer)
Jeff Barocas
/s/ Josef A. Bauer Director July 14, 2004
- --------------------
Josef A. Bauer
/s/ Bernard Appel Director July 14, 2004
- --------------------
Bernard Appel
/s/ Harvey Judkowitz Director July 14, 2004
- --------------------
Harvey Judkowitz
45
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2004
THE SINGING MACHINE COMPANY, INC.
AND SUBSIDIARY
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm F-2
Independent Auditors' Report F-3
Consolidated Balance Sheets F-4
Consolidated Statements of Operations F-5
Consolidated Statement of Cash Flows F-6
Consolidated Statements of Stockholders' Equity F-7
Notes to Consolidated Financial Statements F-8
F-1
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
The Singing Machine Company, Inc.
We have audited the accompanying consolidated balance sheets of The Singing
Machine Company, Inc. and subsidiary (the "Company") as of March 31, 2004 and
2003, and the related consolidated statements of operations, shareholders'
equity and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and financial statement schedule based
on our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The Singing
Machine Company, Inc. and subsidiary as of March 31, 2004 and 2003 and the
consolidated results of their operations and their consolidated cash flows for
the years then ended, in conformity with accounting principles generally
accepted in the United States of America.
We have also audited Schedule II of The Singing Machine Company, Inc. and
subsidiary for the year ended March 31, 2004. In our opinion, this schedule,
when considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly, in all material respects, the information therein.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed more fully in Note 2 to the
financial statements and as of June 16, 2004, the Company has minimal liquidity.
Additionally and as of March 31, 2004, the Company was in violation of the
tangible net worth covenant of its factoring agreement. This continuing
condition of minimal liquidity and the lack of adequate external financing
raises substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to increasing liquidity are also described
in Note 2 to the financial statements. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ Grant Thornton LLP
Miami, Florida
June 16, 2004 (except for the last
paragraph of Note 7, as to which
the date is July 14, 2004)
F-2
Independent Auditors' Report
Board of Directors and Shareholders:
The Singing Machine Company, Inc.
and Subsidiary
We have audited the accompanying consolidated statement of operations, changes
in stockholders' equity, and cash flows for the year ended March 31, 2002 of The
Singing Machine Company, Inc., and Subsidiary. These consolidated financial
statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with the Standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes, examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
The Singing Machine Company, Inc. and Subsidiary for the year ended March 31,
2002, in conformity with accounting principles generally accepted in the United
States of America.
As more fully described in Note 3 of the fiscal 2004, 2003 and 2002 consolidated
financial statements, subsequent to the issuance of the Company's 2002 and 2001
consolidated financial statements and our report thereon dated May 23, 2002,
management determined to restate the 2002 and 2001 consolidated financial
statements to reflect a change in their position regarding taxation of certain
corporate income and a resulting increase in the income tax provision for years
2002 and 2001. In our related report, we expressed an unqualified opinion. Our
opinion on the revised consolidated financial statements, as expressed herein,
remains unqualified.
/s/ SALBERG & COMPANY, P.A.
Boca Raton, Florida
May 23, 2002 (except for Note 3 as to which the date is July 14, 2003)
F-3
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
March 31, March 31,
2004 2003
------------ -----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 356,342 $ 268,264
Restricted Cash 874,283 838,411
Accounts Receivable, less allowances of
$98,000 and $406,000, respectively 3,806,166 5,762,944
Due from manufacturers 134,964 1,091,871
Inventories, net 5,228,060 25,194,346
Prepaid expense and other current assets 783,492 1,449,505
Insurance receivable 800,000 --
Refundable tax 1,178,512 --
Deferred tax asset -- 1,925,612
------------ -----------
TOTAL CURRENT ASSETS 13,161,819 36,530,953
PROPERTY AND EQUIPMENT, at cost less
accumulated depreciation of $2,871,000 and
$1,473,000, respectively 983,980 1,096,424
OTHER ASSETS
Other non-current assets 615,773 1,307,917
------------ -----------
TOTAL ASSETS $ 14,761,572 $38,935,294
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Bank overdraft $ 62,282 $ 316,646
Accounts payable 3,995,852 7,553,007
Accrued expenses 3,481,905 1,443,406
Customer credits on account 2,111,484 933,002
Convertible debentures, net of
unamortized discount of $2,554,511 1,445,489 0
Subordinated debt-related parties 1,000,000 400,000
Revolving credit facilities -- 6,782,824
Income taxes payable 2,447,746 3,821,045
------------ -----------
TOTAL CURRENT LIABILITIES 14,544,758 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;
8,752,318 and 8,171,678 shares
issued and outstanding 87,523 81,717
Additional paid-in capital 10,052,498 4,843,430
Accumulated (deficit)/retained earnings (9,923,207) 12,760,217
------------ -----------
TOTAL SHAREHOLDERS' EQUITY 216,814 17,685,364
------------ -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 14,761,572 $38,935,294
============ ===========
The accompanying notes are an integral part of these financial statements.
F-4
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
MARCH 31, MARCH 31, MARCH 31,
2004 2003 2002
------------ ------------ ------------
(as restated)
(Note 3)
NET SALES $ 70,541,128 $ 95,613,766 $ 62,475,753
COST OF SALES
Cost of Goods Sold 68,279,589 72,329,035 40,852,840
Impairment of Tooling 442,989 -- --
------------ ------------ ------------
GROSS PROFIT 1,818,550 23,284,731 21,622,913
OPERATING EXPENSES
Advertising 2,340,439 5,032,367 2,377,638
Commissions 1,024,883 997,529 1,294,543
Compensation 5,048,831 4,095,176 2,486,547
Freight & Handling 1,423,082 2,112,435 1,242,910
Royalty Expense 2,294,727 2,257,653 1,862,116
Selling, general &
administrative expenses 9,881,887 7,175,341 4,123,779
------------ ------------ ------------
TOTAL OPERATING EXPENSES 22,013,849 21,670,501 13,387,533
------------ ------------ ------------
(LOSS) INCOME FROM OPERATIONS (20,195,299) 1,614,230 8,235,380
OTHER INCOME (EXPENSES)
Other income 22,116 196,537 215,840
Stock based guarantee fees -- -- (171,472)
Interest expense (1,752,952) (406,126) (112,123)
Interest income 1,216 11,943 16,934
------------ ------------ ------------
NET OTHER EXPENSES (1,729,620) (197,646) (50,821)
------------ ------------ ------------
(LOSS) INCOME BEFORE
PROVISION FOR INCOME TAXES (21,924,919) 1,416,584 8,184,559
PROVISION FOR INCOME TAXES 758,505 198,772 1,895,494
------------ ------------ ------------
NET (LOSS) INCOME $(22,683,424) $ 1,217,812 $ 6,289,065
============ ============ ============
(LOSS) EARNINGS PER COMMON SHARE:
Basic $ (2.65) $ 0.15 $ 0.88
Diluted $ (2.65) $ 0.14 $ 0.79
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT SHARES:
Basic 8,566,116 8,114,330 7,159,142
Diluted 8,566,116 8,931,385 7,943,473
The accompanying notes are an integral part of these financial statements.
F-5
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR YEAR ENDING MARCH 31,
------------------------------------------
2004 2003 2002
------------ ------------ ------------
(as restated)
(Note 3)
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) earnings $(22,683,424) $ 1,217,812 $ 6,289,065
Adjustments to reconcile
net (loss) earnings to
net cash provided by
(used in) operating activities
Depreciation and amortization 750,359 622,298 394,456
Impairment of tooling
and Intangible 628,405 -- --
Provision for inventory 2,865,789 3,715,357 --
Provision for bad debt (159,676) 393,737 45,078
Amortization of discount/
deferred fees on
convertible debentures 909,891 -- --
Stock compensation expense 632,451 -- 171,472
Deferred taxes 1,925,612 (1,734,194) --
Changes in assets and liabilities:
Accounts Receivable 2,116,454 (2,626,074) (2,626,329)
Due from manufacturer 956,908 (603,573) 210,798
Inventories 17,100,497 (19,635,351) (4,460,891)
Prepaid expenses and other assets 666,013 (1,020,895) (352,373)
Insurance receivable (800,000) -- --
Other non-current assets 1,204,630 (426,494) (91,631)
Accounts payable (3,557,155) 5,706,769 1,364,158
Accrued expenses 2,038,499 153,809 199,445
Customer credits on account 1,178,482 933,002 --
Current income taxes (2,551,811) 1,779,117 1,811,439
------------ ------------ ------------
Net cash provided by (used in)
operating activities 3,221,924 (11,524,680) 2,954,687
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (1,266,321) (1,144,064) (613,691)
Proceeds from investment in factor 0 -- 933,407
Proceeds from repayment of
related party loans 0 -- 125,117
Investment in and advances in
unconsolidated subsidiary 0 -- 298,900
------------ ------------ ------------
Net cash (used in) provided by
financing activities (1,266,321) (1,144,064) 743,733
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings from revolving
credit facilities 28,863,712 47,825,725 21,856,653
Repayments to revolving
credit facilities (35,646,536) (41,042,901) (21,856,653)
Proceeds from issuance of
convertible debentures 4,000,000 -- --
Bank Overdraft (254,364) 316,645 --
Restricted cash (35,872) (324,727) (513,684)
Payment of fees related to
convertible debt (255,000) -- --
Proceeds from subordinated
debt-related parties, net 600,000 400,000 1,319,190
Proceeds from exercise of
stock options and warrants 860,535 242,119 --
------------ ------------ ------------
Net cash (used in) provided by
financing activities (1,867,525) 7,416,861 805,506
------------ ------------ ------------
INCREASE(DECREASE) IN CASH AND
CASH EQUIVALENTS 88,078 (5,251,883) 4,503,926
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD 268,264 5,520,147 1,016,221
------------ ------------ ------------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 356,342 $ 268,264 $ 5,520,147
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION:
CASH PAID FOR THE YEAR ENDING
MARCH 31, 2004
Interest $ 943,018 $ 406,126 $ 112,123
============ ============ ============
Income Taxes $ 1,388,804 $ 153,849 $ 102,415
============ ============ ============
NON-CASH FINANCING ACTIVITIES
Discounts for warrants
issued in connection with
and beneficial conversion
feature of convertible
debentures $ 3,312,362 $ -- $ --
============ ============ ============
Financing fees in connection
with convertible debentures
issuance, paid in stock
and warrants $ 409,527 $ -- $ --
============ ============ ============
Warrants issued in connection
with convertible debentures
admendment $ 30,981 $ -- $ --
============ ============ ============
The accompanying notes are an integral part of these financial statements.
F-6
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
PREFERRED STOCK COMMON STOCK DEFERRED
--------------- ------------------------ PAID IN RETAINED GUARANTEE
SHARES AMOUN SHARES AMOUNT CAPITAL EARNINGS FEES TOTAL
------ -------- --------- ----------- ------------ ------------ ------------ ------------
Balance at
March 31, 2001,
restated -- -- 6,538,680 65,387 3,302,982 5,253,340 (171,472) 8,450,237
Net earnings -- -- -- -- -- 6,289,065 -- 6,289,065
Exercise of warrants 581,100 5,811 -- 584,239 -- 590,050
Exercise of employee
stock options -- -- 900,525 9,005 720,135 -- -- 729,140
Fractional share
adjustment pursuant
to 3:2 stock split -- -- (278) (3) (4,528) -- -- (4,531)
Amortization of
deferred guarantee
fees -- -- -- -- -- -- 171,472 171,472
---- -------- --------- ----------- ------------ ------------ ------------ ------------
Balance at
March 31, 2002,
restated -- -- 8,020,027 80,200 4,602,828 11,542,405 -- 16,225,433
Net earnings -- -- -- -- -- 1,217,812 -- 1,217,812
Exercise of warrants -- -- 52,500 525 47,600 -- -- 48,125
Exercise of employee
stock options -- -- 99,151 992 193,002 -- -- 193,994
---- -------- --------- ----------- ------------ ------------ ------------ ------------
Balance at
March 31, 2003 -- -- 8,171,678 81,717 4,843,430 12,760,217 -- 17,685,364
Net loss -- -- -- -- (22,683,424) -- (22,683,424)
Exercise of employee
stock options -- -- 448,498 4,485 1,076,885 -- -- 1,081,370
Warrants issued in
connection with
convertible
debenture
admendment -- -- -- -- 30,981 -- -- 30,981
Financing fees paid
with warrants -- -- -- -- 268,386 -- -- 268,386
Warrants issued in
connection with and
beneficial
conversion
feature of
convertible
debentures -- -- -- -- 3,312,362 -- -- 3,312,362
Issuance of
common stock -- -- 132,142 1,321 520,454 -- -- 521,775
---- -------- --------- ----------- ------------ ------------ ------------ ------------
Balance at
March 31, 2004 -- $ -- 8,752,318 $ 87,523 $ 10,052,498 $ (9,923,207) $ -- $ 216,814
==== ======== ========= =========== ============ ============ ============ ============
The accompanying notes are an integral part of these financial statements
F-7
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF ACCOUNTING POLICIES
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.
The preparation of The Singing Machine's financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial
statements and revenues and expenses during the period. Future events and their
effects cannot be determined with absolute certainty; therefore, the
determination of estimates requires the exercise of judgment. Actual results
inevitably will differ from those estimates, and such differences may be
material to the Company's financial statements. Management evaluates its
estimates and assumptions continually. These estimates and assumptions are based
on historical experience and other factors that are believed to be reasonable
under the circumstances. These estimates and The Singing Machine's actual
results are subject to the risk factors listed in Quantitative and Qualitative
Disclosure About Market Risk section.
The management of the Company believes that a higher degree of judgment
or complexity is involved in the following areas:
COLLECTIBILITY OF ACCOUNTS RECEIVABLE. The Singing Machine's allowance
for doubtful accounts is based on management's estimates of the creditworthiness
of its customers, current economic conditions and historical information, and,
in the opinion of management, is believed to be an amount sufficient to respond
to normal business conditions. Management sets 100% reserves for customers in
bankruptcy and other reserves based upon historical collection experience.
Should business conditions deteriorate or any major customer default on its
obligations to the Company, this allowance may need to be significantly
increased, which would have a negative impact on operations.
RESERVES ON INVENTORIES. The Singing Machine establishes a reserve on
inventory based on the expected net realizable value of inventory on an item by
item basis when it is apparent that the expected realizable value of an
inventory item falls below its original cost. A charge to cost of sales results
when the estimated net realizable value of specific inventory items declines
below cost. Management regularly reviews the Company's investment in inventories
for such declines in value.
INCOME TAXES. Significant management judgment is required in developing
The Singing Machine's provision for income taxes, including the determination of
foreign tax liabilities, deferred tax assets and liabilities and any valuation
allowances that might be required against the deferred tax assets. Management
evaluates its ability to realize its deferred tax assets on a quarterly basis
and adjusts its valuation allowance when it believes that it is more likely than
not that the asset will not be realized. At December 31, 2003 and March 31,
2004, the Company concluded that a valuation allowance was needed against all of
the Company's deferred tax assets, as it was not more likely than not that the
deferred taxes would be realized. At March 31, 2004 and 2003, The Singing
Machine had gross deferred tax assets of $8.2 million and $1.9 million, against
which the Company recorded valuation allowances totaling $8.2 million and $0,
respectively.
For the fiscal year ended March 31, 2004, the Company recorded a tax
provision of $758,505. This occurred because the valuation allowance established
against the Company's deferred tax assets exceeded the amount of the benefit
created from carrying back a portion of the current year's losses. The
carry-back of the losses from the current year resulted in an income tax
receivable of $1.1 million, which is included in refundable tax in the
accompanying balance sheets. The Company has now exhausted its ability to carry
back any further losses and therefore will only be able to recognize tax
benefits to the extent that it has future taxable income.
The Company's subsidiary has applied for an exemption of income tax in
Hong Kong. Therefore, no taxes have been expensed or provided for at the
subsidiary level. Although no decision has been reached by the governing body,
the parent company has reached the decision to provide for the possibility that
the exemption could be denied and accordingly has recorded a provision for Hong
Kong taxes in fiscal 2003 and 2002. There was no provision for Hong Kong income
taxes in fiscal 2004 due to the subsidiary's net operating loss for the year.
F-8
Hong Kong income taxes payable totaled $2.4 million at March 31, 2004 and 2003
and is included in the accompanying balance sheets as income taxes payable.
The Company effectively repatriated approximately $2.0 million, $5.6
million and $5.7 million from its foreign operations in 2004, 2003 and 2002,
respectively. Accordingly, these earnings were taxed as a deemed dividend based
on U.S. statutory rates. The Company has no remaining undistributed earnings of
the Company's foreign subsidiary.
The Company operates within multiple taxing jurisdictions and is
subject to audit in those jurisdictions. Because of the complex issues involved,
any claims can require an extended period to resolve. In management's opinion,
adequate provisions for income taxes have been made.
OTHER ESTIMATES. The Singing Machine makes other estimates in the
ordinary course of business relating to sales returns and allowances, warranty
reserves, and reserves for promotional incentives. Historically, past changes to
these estimates have not had a material impact on the Company's financial
condition. However, circumstances could change which may alter future
expectations.
THE FOLLOWING ARE THE COMPANY'S REMAINING ACCOUNTING POLICIES.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of The
Singing Machine Company, Inc. and its wholly-owned Hong Kong Subsidiary,
International SMC (HK) Limited ("Hong Kong Subsidiary"). All intercompany
accounts and transactions have been eliminated in consolidation.
STOCK SPLITS
On March 15, 2002, the Company affected a 3 for 2 stock split. All
share and per share data have been retroactively restated in the accompanying
consolidated financial statements to reflect the split.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Hong Kong Subsidiary is the local
currency. The financial statements of the subsidiary are translated to United
States dollars using year-end rates of exchange for assets and liabilities, and
average rates of exchange for the year for revenues, costs, and expenses. Net
gains and losses resulting from foreign exchange transactions are included in
the consolidate statements of operations and were not material during the
periods presented. The effect of exchange rate changes on cash at March 31,
2004, 2003 and 2002 were also not material.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of
three months or less at the time of purchase to be cash equivalents. Cash
balances at March 31, 2004 and 2003 include approximately $140,000 and $73,000,
respectively, held in foreign banks by the Hong Kong Subsidiary.
COMPREHENSIVE EARNINGS
Other comprehensive earnings (loss) is defined as the change in equity
of a business enterprise during a period from transactions and other events and
circumstances from non-owner sources, including foreign currency translation
adjustments and unrealized gains and losses on derivatives designated as cash
flow hedges. For the years ended March 31, 2004, 2003 and 2002 comprehensive
earnings (loss) was equal to net earnings (loss).
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. Inventory consigned to
customers at March 31, 2004 and 2003 was $300,914 and $56,695, respectively. The
following table represents the major components of inventory at March 31.
2004 2003
------------ ------------
Finished goods $ 11,687,856 $ 27,807,763
Inventory in transit 121,350 1,101,940
Less: Inventory reserves (6,581,146) (3,715,357)
------------ ------------
Total Inventories, net $ 5,228,060 $ 25,194,346
============ ============
F-9
LONG-LIVED ASSETS
The Company reviews long-lived assets for impairment whenever
circumstances and situations change such that there is an indication that the
carrying amounts may not be recoverable. If the undiscounted future cash flows
attributable to the related assets are less than the carrying amount, the
carrying amounts are reduced to fair value and an impairment loss is recognized
in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." During the year ended March 31, 2004, the Company recorded
an impairment charge totaling $442,989 on certain tooling. The charge was the
result of the Company's decision to discontinue certain inventory models.
SHIPPING AND HANDLING COSTS
Shipping and handling costs are classified as a separate component of
operating expenses and those billed to customers are recorded as revenue in the
statement of operations.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated
depreciation and amortization. Expenditures for repairs and maintenance are
charged to expense as incurred. Depreciation is provided for in amounts
sufficient to relate the cost of depreciable assets to their estimated useful
lives using accelerated and straight-line methods.
REVENUE RECOGNITION
Revenue from the sale of equipment, accessories, and musical recordings
are recognized upon the later of (a) the time of shipment or (b) when title
passes to the customers, all significant contractual obligations have been
satisfied and collection of the resulting receivable is reasonably assured.
Revenues from sales of consigned inventory are recognized upon sale of the
product by the consignee. Net sales are comprised of gross sales net of a
provision for actual and estimated future returns, discounts and volume rebates.
DUE FROM MANUFACTURER
The Hong Kong Subsidiary operates as an intermediary to purchase
karaoke hardware from factories located in China on behalf of the Company.
Certain manufacturers credited the Company for the return of inventory to the
factory for rework. One manufacturer also credited the Company for volume
incentive rebates on purchases in fiscal 2003. The balance due from these
manufacturers as of March 31, 2004 and 2003 was $134,964 and $1,091,871,
respectively and will be applied to future purchases of inventory.
CUSTOMER CREDITS ON ACCOUNT
Customer credits on account represent customers that have received
credits in excess of their accounts receivable balance. These balances were
reclassified for financial statement purposes as current liabilities until paid
or applied to future purchases.
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 ("SFAS")
No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure an
amendment of FASB Statement No. 123", 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.
F-10
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 SFAS No. 123, "Accounting for Stock Based Compensation", the
Company's net earnings (loss) would have been changed to the pro-forma amounts
indicated below for the years ended March 31:
FOR THE FISCAL YEAR ENDED MARCH 31,
---------------------------------------
2004 2003 2002
------------ ---------- ----------
Net (loss) earnings, as reported ($22,683,424) $1,217,812 $6,289,065
Deducts: Total stock-based employee
compensation expensed determined
under fair value based method,
net of tax ($723,058) ($1,740,624) ($115,489)
------------ ----------- ----------
Net (loss) earning, pro forma ($23,406,482) ($522,812) $6,173,576
Net (loss) earnings per share - basic As reported ($2.65) $0.15 $0.88
Pro forma ($2.73) ($0.06) $0.86
Net (loss) earnings per share - diluted As reported ($2.65) $0.14 $0.79
Pro forma ($2.73) ($0.06) $0.78
The effect of applying SFAS No. 123 is not likely to be representative
of the effects on reported net earnings (loss) for future years due to, among
other things, the effects of vesting.
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 No. 123 using the following
weighted-average assumptions:
Fiscal 2004: expected dividend yield 0%, risk-free interest
rate of 4%, volatility between 80% and 110% and expected term of three
years.
Fiscal 2003: expected dividend yield 0%, risk-free interest
rate of 4%, volatility 71% and expected term of three years.
Fiscal 2002: expected dividend yield 0%, risk-free interest
rate of 6.08% to 6.81%, volatility 42% and expected term of two years.
ADVERTISING
Costs incurred for producing and communicating advertising of the
Company, are charged to operations as incurred. The Company has cooperative
advertising arrangements with its vendors and accrues the cost of advertising as
a selling expense, calculated on the related revenues. Advertising expense for
the years ended March 31, 2004, 2003 and 2002 was $2,340,439, $5,032,367 and
$2,377,638, respectively.
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to results of operations
as incurred. These expenses are shown as a component of selling, general &
administrative expenses in the consolidated statements of operations. For the
years ended March 31, 2004, 2003 and 2002, these amounts totaled $302,144,
$674,925 and $181,866, respectively.
EARNINGS PER SHARE
In accordance with SFAS No. 128, "Earnings per Share", basic (loss)
earnings per share is computed by dividing the net (loss) earnings for the year
by the weighted average number of common shares outstanding. Diluted (loss)
earnings per share is computed by dividing net (loss) earnings by the weighted
average number of common shares outstanding including the effect of common stock
equivalents.
F-11
The following table presents a reconciliation of basic and diluted
(loss) earnings per share:
2004 2003 2002
------------ ---------- ----------
(as restated)
Net (loss) earnings $(22,683,424) $1,217,812 $6,289,065
(loss) earnings available to common shareholders $(22,683,424) $1,217,812 $6,289,065
Weighted average shares outstanding - basic 8,566,116 8,114,330 7,159,142
(Loss) earnings per share - Basic $ (2.65) $ 0.15 $ 0.88
(Loss) earnings available to common shareholders $(22,683,424) $1,217,812 $6,289,065
Weighted average shares outstanding - basic 8,566,116 8,114,330 7,159,142
Effect of dilutive securities:
Stock options/Warrants 0 817,055 784,331
Convertible debentures 0 -- --
------------ ---------- ----------
Weighted average shares outstanding - diluted 8,566,116 8,931,385 7,943,473
Earnings per share - Diluted $ (2.65) $ 0.14 $ 0.79
============ ========== ==========
In 2004, 2003 and 2002, 2,657,532, 90,000 and 0 common stock
equivalents were not included in the computation of diluted (loss) earnings per
share as their effect would have been antidilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosures of information about the fair value of certain financial
instruments for which it is practicable to estimate that value. For purposes of
this disclosure, the fair value of a financial instrument is the amount at which
the instrument could be exchanged in a current transaction between willing
parties, other than in a forced sale or liquidation.
The carrying amounts of the Company's short-term financial instruments,
including accounts receivable, accounts payable and accrued expenses
approximates fair value due to the relatively short period to maturity for these
instruments.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities (and Interpretation of ARB No. 51)" ("FIN 46").
FIN 46 addresses consolidation by business enterprises of certain variable
interest entities, commonly referred to as special purpose entities. The
adoption of FIN 46 did not have a material effect on the Company's financial
condition, results of operations, or cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
No. 133 on Derivative Instruments with Characteristics of both Liabilities and
Equity." This statement amends and clarifies accounting for derivatives
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. This statement is
effective for contracts entered into or modified after June 30, 2003, except as
for provisions that relate to SFAS No. 133 implementation issues that have been
effective for fiscal quarters that began prior to June 15, 2003, which should
continue to be applied in accordance with their respective dates. The adoption
of SFAS No. 149 did not have a material impact on the Company's financial
condition, results of operations, or cash flows.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." This
Statement establishes standards for classifying and measuring certain financial
instruments that embody obligations of the issuer and have characteristics of
both liabilities and equity and is effective financial instruments entered into
or modified after May 31, 2003; otherwise effective at the beginning of the
first interim period beginning after June 15, 2003, except for mandatorily
redeemable financial instruments of nonpublic entities which are subject to the
provisions of this Statement for the first fiscal period beginning after
December 15, 2003 The adoption of SFAS No. 150 did not have a material impact on
the Company's financial condition, results of operations, or cash flows.
NOTE 2 - GOING CONCERN
The accompanying 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 February 9, 2004, the Company entered into a factoring agreement
with Milberg Factors, Inc. and as of March 31, 2004, the Company was in
violation of the minimum required tangible net worth and working capital
covenants of the agreement. Subsequent to March 31, 2004, the agreement was
terminated.
F-12
The Company anticipates generating cash flow from the following, until
the September selling season:
o Collection of existing Accounts Receivable. At March 31, 2004 the
Company had Accounts Receivable (net of allowances) $3,806,166.
o Sale of existing inventory. A March 31, 2004, the Company had
Inventory (net of reserves) $5,228,060.
o Receipt of federal tax refund. The Company has a tax refund of $1.1
million as a result of net loss carry back. It is anticipated that
the refund will be received in September or October 2004.
Sales will be financed using the following methods:
o Vendor Financing. The Company's key vendors in China have agreed to
manufacture on behalf of the Company, without advanced payments.
o A significant amount of committed customer orders (discussed in
Backlog) have been sold under customer letters of credit terms. The
customers letters of credit will be used as colateral to provide
advances to our vendors. The customers will pay and take title of the
karaoke machines in China as the karaoke machines are shipped. This
will generate immediate funds to pay the vendors and generate
additional cash flows.
o As stated above a tax refund of $1.1 million dollars is anticipated
to be received in September or October. These funds will also be used
to pay the Company's vendors.
o For customers whose terms of sale are with open terms, the Company
will also use a factoring arrangement, either with Milberg or some
other financial institution.
On July 14, 2004, a director Jay Bauer has advanced the Company a short
term loan of $200,000, to be used to meet working capital obligations. The loan
bears interest at 8.75% per annum and is due on demand.
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.
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.
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.
F-13
The net effect of the above two adjustments is to decrease net income
by $1,776,217 and $468,424 in fiscal 2002 and 2001. The net effect on net income
per share is to decrease net income per share basic and diluted by $0.25 and
$0.23, respectively in fiscal 2002 and decrease net income per share basic and
diluted by $0.07 and $0.06, respectively in fiscal 2001.
NOTE 4 - ACCOUNTS RECEIVABLE FACTORING AGREEMENT
On February 9, 2004, the Company entered into a factoring agreement
with Milberg Factors, Inc. ("Milberg") of New York City. The agreement allows
the Company, at the discretion of Milberg, to factor its outstanding receivables
without recourse up to a maximum of the lesser of $3.5 million or 80% of
eligible accounts receivable, less certain reserves determined by Milberg. The
Company will pay .8% of gross receivables in fees and the average balance of the
line will be subject to interest on a monthly basis at prime plus .75% with a
minimum rate not to decrease below 4.75%. The agreement contains minimum
aggregate charges in any calendar year of $200,000, limits on incurring any
additional indebtedness and the Company must maintain tangible net worth and
working capital above $7.5 million. Milberg also received a security interest in
all of the Company's accounts receivable and inventory located in the United
States and a pledge of 66 2/3% of the Hong Kong Subsidiary. For the year ending
March 31, 2004, the Company incurred $141,455 in related charges which are
included in selling, general and administrative expenses in the accompanying
statements of operations.
No accounts were factored for the year ended March 31, 2004 and as of
March 31, 2004, the Company was in violation of the minimum tangible net worth
and working capital requirements. Subsequent to March 31, 2004, the agreement
was terminated.
NOTE 5 - PROPERTY AND EQUIPMENT
A summary of property and equipment at March 31, 2004 and 2003 is as
follows:
USEFUL LIVES 2004 2003
------------ ----------- -----------
Computer and office equipment 5 years $ 465,810 $ 313,222
Furniture and fixtures 5 - 7 years 381,164 341,777
Leasehold improvements * 103,776 110,841
Molds and tooling 3 years 2,903,822 1,803,435
----------- -----------
3,854,572 2,569,274
Less: accumulated depreciation (2,870,592) (1,472,850)
----------- -----------
Total net property and equipment $ 983,980 $ 1,096,424
=========== ===========
- ----------
* Shorter of remaining term of lease or useful life
NOTE 6 - RESTRICTED CASH
The Company, through the Hong Kong Subsidiary, maintains a letter of
credit facility and short term loan with a major international bank. The Hong
Kong Subsidiary is required to maintain a separate deposit account in the amount
of $874,283 and $838,411 at March 31, 2004 and 2003, respectively. This amount
is shown as restricted cash at March 31, 2004 and 2003.
NOTE 7 - LOANS AND LETTERS OF CREDIT
CREDIT FACILITY
The Hong Kong Subsidiary maintains separate credit facilities at two
international banks. The primary purpose of the facilities is to provide the
Subsidiary with the following abilities:
o Overdraft protection facilities
o Issuance and negotiation of letters of credit, both regular and
discrepant
o Trust receipts
o A Company credit card
F-14
The facilities are secured by a corporate guarantee from the U.S.
Company, restricted cash on deposit with the lender and require that the Company
maintain a minimum tangible net worth. The maximum available credit under the
facilities is $2.0 million. The balance at March 31, 2004 and 2003 was $62,282
and $316,646, respectively. The interest rate is approximately 4%. At March 31,
2004, the company does not have any availability under these facilites.
LOAN AND SECURITY AGREEMENT
On April 26, 2001, the Company executed a Loan and Security Agreement
with a commercial lender, which as amended was due to expire on March 31, 2004.
As of January 31, 2004 the loan was paid in full, the facility was terminated
and the UCC filings were released.
SUBORDINATED DEBT
On July 10, 2003, the Company obtained $1 million in subordinated debt
financing from a certain officer, directors and an associate of a director. The
loans accrue interest at 9.5% per annum and as of March 31, 2004, all interest
was accrued and unpaid and totaled approximately $71,000. These loans were
originally scheduled to be repaid by October 31, 2003; however, the loans have
since been subordinated to Milberg and the total amount outstanding of $1
million will not be repaid until either the subordination is released by
Milberg or the factoring agreement is terminated.
LOAN FROM DIRECTOR
On July 14, 2004, a director Jay Bauer has advanced the Company a short
term loan of $200,000, to be used to meet working capital obligations. The loan
bears interest at 8.75% per annum and is due on demand.
NOTE 8 - CONVERTIBLE DEBENTURES WITH WARRANT
In September 2003, the Company issued $4 million of 8% Convertible
Debentures in a private offering which are due February 20, 2006 ("Convertible
Debentures"). The net cash proceeds received by the Company were $3,745,000
after deduction of cash commissions and other expenses.
The Convertible Debentures are subordinated to Milberg and are
convertible at the option of the holders into 1,038,962 common shares at a
conversion price of $3.85 per common share, subject to certain anti-dilution
adjustment provisions, at any time after the closing date.
These Convertible Debentures were issued with 457,143 detachable stock
purchase warrants with an exercise price of $4.025 per share. These warrants may
be exercised at anytime after September 8, 2003 and before September 7, 2006 and
are subject to certain anti-dilution provisions. The warrants are also subject
to an adjustment provision; whereas the price of the warrants may be changed
under certain circumstances.
The Convertible Debentures bear interest at the stated rate of 8% per
annum. Interest is payable quarterly on March 1, June 1, September 1, and
December 1. The interest may be payable in cash, shares of Common Stock, or a
combination thereof subject to certain provisions and at the discretion of the
Company.
In accounting for this transaction, the Company allocated the proceeds
based on the relative estimated fair value of the stock purchase warrants and
the convertible debentures. This allocation resulted in a discount on the
convertible debentures of $3.3 million, which is being amortized over the life
of the debt on a straight-line basis to interest expense, which is not
materially different from effective interest method. Total amortization for
fiscal year ended March 31, 2004 totaled $757,851 and the unamortized discount
totaled $2,554,511 at March 31, 2004.
On February 9, 2004, the Company amended its convertible debenture
agreements to increase the interest rate to 8.5% and to grant warrants to
purchase an aggregate of 30,000 shares of the Company's common stock to the
debenture holders on a pro-rata basis. These concessions are in consideration of
the debenture holder's agreements to (i) enter into new subordination agreements
with Milberg, (ii) to waive all liquidated damages due under the transaction
documents through July 1, 2004 and (iii) to extend the effective date of the
Form S-1 registration statement until July 1, 2004. The new warrants have an
exercise price equal to $1.52 per share and the fair value of these warrants was
estimated by using the Black-Scholes Option-Pricing Model and totaled $30,981.
This amount was expensed as a component of selling, general and administrative
expenses. Pursuant to the Convertible Debenture agreements, the Company was
required to register the shares of common stock underlying the debentures and
detachable stock purchase warrants issued in connection with the debentures. The
registration of the common shares was required to be effective by July 1, 2004.
As the related Form S-1 registration statement was not effective on July 1,
2004, the Company is required to pay liquidating damages in the amount of
$80,000 per month until the registration statement becomes effective and is in
technical default of the agreement.
In connection with the Convertible Debentures the Company paid
financing fees as follows: 103,896 stock purchase warrants, with a fair value of
$268,386, 28,571 shares of common stock with a fair value of $141,141, and cash
of $255,000. Total financing fees of $664,527 were recorded as deferred fees and
are being amortized over the term of the debentures on a straight-line basis.
F-15
The unamortized deferred fees are reported in other non-current assets in the
accompanying balance sheets and total $512,487.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
CLASS ACTION From July 2, 2003 through October 2, 2003, seven
securities class action lawsuits and a shareholder's derivative action were
filed against the Company 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 Company's securities during the various class
action periods specified in the complaints. On September 18, 2003, United States
District Judge William J. Zlock entered an order consolidating the seven (7)
purported class action law suits and one (1) purported shareholder derivative
action into a single action case styled Frank Bielansky v. the Company, Salberg
& Company, P.A., et al - Case Number: 03-80596 - CIV - ZLOCK (the "Class
Action"). Salberg & Company, P.A. is our former independent auditor. The
complaints that were 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.
The Company entered into a settlement agreement with the plaintiffs in
the Class Action in March 2004. At a hearing in April 2004, the Court gave
preliminary approval for the settlement and directed that notices be sent to
shareholders pursuant to the settlement agreement. The notices advised
shareholders of their rights and responsibilities concerning the settlement. The
Court has set a hearing on July 30, 2004 before Judge Zlock to consider final
approval of the Settlement.
Pursuant to the terms of the settlement agreement, the Company is
required to make a cash payment of $800,000 and Salberg & Company, P.A., our
former auditor, is required to make a payment of $475,000. Our cash payment of
$800,000 is covered by our liability insurance and our insurer has placed this
payment in an escrow account pending final approval of the Settlement. In
addition, the Company is obligated to issue 400,000 shares of its common stock
and may also provide other non-cash consideration. The pending settlement would
also obligate the Company to implement certain corporate governance changes,
including an expansion of its Board of Directors to six members with independent
directors comprising at least 2/3 of the total Board seats.
As of March 31, 2004, the Company recorded an expense equal to the
total estimated cost of the settlement less the amount expected to be reimbursed
by the Company's insurance carrier. The net charge associated with this matter
totaled approximately $462,000 and is included as a component of selling,
general and administrative expenses in the accompanying statements of
operations.
OTHER MATTERS. In August 2003, we were advised that the Securities and
Exchange Commission had commenced an informal inquiry of our company. We are
cooperating fully with the SEC staff. It appears that the investigation is
focused on the restatement of our audited financial statements for fiscal 2002
and 2001. We have been advised that an informal inquiry should not be regarded
as an indication by the SEC or its staff that any violations of law have
occurred or as a reflection upon any person or entity that may have been
involved in those transactions.
The Company entered into a separation and release agreement with an
executive on December 19, 2003. The agreement provided for the individual to
receive $161,939 in settlement of the Company's contract. The amount of the
settlement was expensed as compensation as of the date of the agreement.
The Company entered into a separation and release agreement with an
executive on April 6, 2004. The agreement provided for the individual to receive
$115,519 in settlement of the Company's contract. The amount has been expensed
as compensation at March 31, 2004, at which time the amount settled was probable
and estimatable.
The Company entered into a separation and release agreement with an
executive on April 12, 2004. The agreement provided for the individual to
receive $51,050 in settlement of the Company's contract. The amount has been
expensed as compensation at March 31, 2004, at which time the amount settled was
probable and estimatable.
The Company entered into a settlement agreement with an investment
banker on November 17, 2003. Pursuant to this agreement, the Company agreed to
pay the sum of $181,067 over a five month period and issue to the investment
banker 40,151 shares of stock with a fair value of $94,355. As of the date of
the settlement agreement, the Company expensed the total amount of the
settlement, which is included as selling, general and administrative expenses in
the accompanying statements of operations. As of March 31, 2004, the unpaid
balance totaled $72,427 and is included in accounts payable in the accompanying
balance sheets.
F-16
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.
LEASES
The Company has entered into various operating lease agreements for
office and warehouse facilities in Coconut Creek, Florida, Compton, California,
Rancho Dominguez, California and Kowloon, Hong Kong. The leases expire at
varying dates. Rent expense for fiscal 2004, 2003 and 2002 was $1,542,041,
$901,251 and $333,751, respectively.
In addition, the Company maintains various warehouse and computer
equipment operating leases.
Future minimum lease payments under property and equipment leases with
terms exceeding one year as of March 31, 2004 are as follows:
PROPERTY LEASES EQUIPMENT LEASES
--------------- ----------------
Year ending March 31:
2005 $ 838,792 $ 71,746
2006 579,851 19,502
2007 495,545 7,969
2008 371,659 13,044
2009 371,659 8,002
---------- --------
$2,657,506 $120,263
========== ========
EMPLOYMENT AGREEMENTS
The Company has employment contracts with three key officer and one
employee as of March 31, 2004. The agreements provide for base salaries, with
annual cost of living adjustments and travel allowances and expire through March
31, 2006. In the event of a termination for cause or in the event of a change of
control, as defined in the agreements, the employees would be entitled to a lump
sum payment in the aggregate of $533,000.
MERCHANDISE LICENSE AGREEMENTS
We entered into a licensing agreement with MTV in November 2000 and
have amended the agreement five times since that date. This license covers the
sale of MTV products in the United States, Canada and Australia. During fiscal
2004, the Company's product line consisted of nine MTV branded machines and a
wide assortment of MTV branded music. The license agreement as amended with MTV
currently expires on August 31, 2004, subject to MTV's option, at its sole
discretion, to extend the agreement for additional four month period. Each of
the license periods contains a minimum guarantee royalty payment of $200,000,
which is recoupable against sales throughout the calendar year, unless the
license agreement is cancelled. The remaining future minimum payment is $200,000
as of March 31, 2004.
In February 2003, the Company entered into a multi-year license
agreement with Universal Music Entertainment to market a line of Motown Karaoke
machines and music. This agreement and its subsidiary agreement signed in March
2003, allow the Company to be the first to use original artist recordings for
our CD+G formatted karaoke music. Over the term of the license agreement, the
Company is obligated to make guaranteed minimum royalty payments over a
specified period of time in the amount of $300,000. The Universal Music
Entertainment license expires on March 31, 2006 and does not contain any
automatic renewal provisions. The remaining future minimum payment is $175,000
as of March 31, 2004.
The Company entered into a license agreement with Care Bears in
September 2003. Under this agreement, the Company licensed Care Bears branded
machines and electronic products. This license expires on January 1, 2006. Over
the term of the license agreement, the Company is obligated to make guaranteed
minimum royalty payments over a specific period of time in the amount of
$200,000. The remaining future minimum payment is $175,000 as of March 31, 2004
F-17
NOTE 10 - STOCKHOLDERS' EQUITY
COMMON STOCK ISSUANCES
During the fiscal ended March 31, 2004, the Company issued 580,640
shares of its common stock. Of these shares, 28,571 were issued in lieu of a
cash payment of commission and closing costs relating to the Convertible
Debentures. Certain executives received 63,420 shares of common stock in lieu of
a portion of their cash compensation and bonuses for fiscal 2004. The fair value
of this stock, $290,464 was charged to compensation expense. 40,151 shares of
stock were issued in lieu of a settlement with an investment banker, at an
estimated fair value of $94,355. The remaining 448,498 shares of stock issued
were through the exercise of vested stock options.
During fiscal 2004, 2003 and 2002, the Company issued the following
shares of stock upon exercise of outstanding options and warrants.
Number of Shares Issued Proceeds to Company
2004 580,640 $860,535
2003 151,651 $242,119
2002 1,481,347 $1,314,659
GUARANTEE FEES
During the year ended March 31, 2000, the Company issued 525,000 shares
of common stock to two officers of the Company in exchange for guarantees relaed
to the Company's factor agreement, and letter of credit agreement. These
guarantee fees totaled $590,625 and were amortized over a period of 31 months.
For the years ended March 31, 2002, $171,472 of deferred fees were charged to
operations. There were no remaining deferred guarantee fees at March 31, 2002.
EARNINGS PER SHARE
In accordance with SFAS No. 128, "Earnings per Share", basic (loss)
earnings per share are computed by dividing the net (loss) earnings for the year
by the weighted average number of common shares outstanding. Diluted (loss)
earnings per share is computed by dividing net (loss) earnings for the year by
the weighted average number of common shares outstanding including the effect of
common stock equivalents.
In 2004, 2003 and 2002, 2,657,532, 90,000 and 0 common stock
equivalents were not included in the computation of diluted (loss) earnings per
share as their effect would have been antidilutive.
For the fiscal year ended March 31, 2004, there were 1,618,570 common stock
options and warrants outstanding with exercise prices between $1.30 and $14.30.
In addition, there is a potential 1,038,962 shares that may be issued in
connection with the Convertible Debentures if certain conditions exist.
STOCK OPTIONS
On June 1, 2001, the Board of Directors approved the 2001 Stock Option
Plan (`Plan"), which replaced the 1994 Stock Option Plan, as amended, (the
"1994 Plan"). The Plan was developed to provide a means whereby directors and
selected employees, officers, consultants, and advisors of the Company may be
granted incentive or non-qualified stock options to purchase common stock of the
Company. As of March 31, 2004, the Plan is authorized to grant options up to an
aggregate of 1,950,000 shares of the Company's common stock and up to 300,000
shares for any one individual in any fiscal year. As of March 31, 2004, the
Company had granted 922,470 options under the Year 2001 Plan, leaving 1,027,530
options available to be granted. As of March 31, 2004, the Company had 358,700
options issued and outstanding under its 1994 Plan.
In accordance with SFAS No. 123, for options issued to employees, the
Company applies the intrinsic value method of APB Opinion No. 25 and related
interpretations in accounting for its options issued. The following table sets
forth the issuances of stock options for fiscal 2004, 2003 and 2002.
The exercise price of employee common stock option issuances in 2004,
2003 and 2002 was equal to the fair market value on the date of grant.
Accordingly, no compensation cost has been recognized for options issued under
the Plan in these years. A summary of the options issued as of March 31, 2004,
2003 and 2002 and changes during the years is presented below
Weighted Weighted Weighted
Average Average Average
Number of Exercise Number of Exercise Number of Exercise
Options Price Options Price Options Price
--------- -------- --------- --------- --------- ---------
Fiscal Year 2004 2003 2002
Stock Options:
Balance at
beginning of period 1,543,250 $4.43 1,094,475 $2.11 2,433,300 $1.31
Granted 423,980 $2.66 567,000 $7.88 82,800 $3.92
Exercised (448,500) $1.91 (143,725) $1.63 (1,406,625) $0.87
Forfeited (491,200) $6.75 (4,500) $2.04 (15,000) $2.04
--------- --------- ----------
Balance at end of period 1,027,530 $3.95 1,513,250 $4.43 1,094,475 $2.11
========= ========= ==========
Options exercisable at
end of period 630,168 $4.48 976,250 $2.45 647,738 $2.11
========= ========= ==========
Weighted average
fair value of
options granted
during the period $2.63 $8.19 $1.54
F-18
The following table summarizes information about employee stock options
and warrants outstanding at March 31, 2004:
Weighted Average
Number Outstanding at Remaining Weighted Average Number Exercisable Weighted Average
Range of Exercise Price March 31, 2004 Contractual Life Exercise Price at March 31, 2003 Exercise Price
- ----------------------- --------------------- ---------------- ---------------- ------------------ ----------------
$1.30 - $1.97 288,330 8.43 $1.73 20,001 $1.30
$2.04 373,700 2.39 $2.04 373,000 $2.04
$3.83 -$7.26 215,000 7.20 $5.66 91,667 $5.67
$9.00 -$14.30 150,500 6.47 $10.47 145,500 $10.43
--------- -------
1,027,530 630,168
========= =======
STOCK WARRANTS
During fiscal year 2004, the Company issued a total of 591,040 stock
purchase warrants as follows. In September, 2003, 457,143 of the warrants were
issued to investors in connection with the $4 million debenture offering (see
Note 10) and 103,896 warrants were issued to the respective investment banker.
The estimated fair value of the warrants issued to the investors in the amount
of $1,180,901 was recorded as a discount on the debentures and the estimated
fair value of the warrants issued to the investment banker in the amount of
$268,386 has been record as deferred fees. Both amounts are being amortized over
the term of the debentures. In February 2004, the Company issued an additional
30,001 warrants to the investors in connection with a settlement agreement (see
note 10). The estimated fair value of these warrants totaled $30,981, which was
expensed as component of selling, general and administrative expenses. The
weighted average fair value of warrants issued during fiscal 2004 and
outstanding as of March 31, 2004 was $2.67.
As of March 31, 2004, 591,040 stock purchase warrants were outstanding
and exercisable with a weighted average exercise price of $3.98. The range of
exercise prices was between $1.52 and $4.03 per common share.
NOTE 11 - INCOME TAX
The Company files separate tax returns for the parent and for the Hong
Kong Subsidiary. The income tax expense (benefit) for federal, foreign, and
state income taxes in the consolidated statement of earnings consisted of the
following components for 2004, 2003 and 2002:
2004 2003 2002
----------- ----------- ----------
(as restated)
Current:
U.S. Federal $(1,071,709) $ 663,816 $1,027,545
Foreign -- 1,230,650 748,672
State (95,398) 38,500 119,277
Deferred 1,925,612 (1,734,194) --
----------- ----------- ----------
$ 758,505 $ 198,772 $1,895,494
=========== =========== ==========
The United States and foreign components of earnings (loss) before
income taxes are as follows:
2004 2003 2002
------------ ----------- ----------
United States $(21,362,610) $(5,952,129) $3,669,341
Foreign (562,309) 7,368,713 4,515,218
------------ ----------- ----------
$(21,924,919) $ 1,416,584 $8,184,559
============ =========== ==========
F-19
The actual tax expense differs from the "expected" tax expense for the
years ended March 31, 2004, 2003 and 2002 (computed by applying the U.S. Federal
Corporate tax rate of 34 percent to income before taxes) as follows:
2004 2003 2002
----------- ----------- -----------
(as restated)
Expected tax expense (benefit) $(7,454,472) $ 481,880 $ 2,782,750
State income taxes, net of Federal income tax benefit (426,796) (43,204) 78,723
Permanent differences 5,830 69,114 --
Deemed Dividend 410,513 1,011,628 1,027,545
Change in valuation allowance 8,160,924 -- (1,059,089)
Tax rate differential on foreign earnings 92,781 (1,326,368) (812,739)
Other (30,274) 5,723 (121,696)
----------- ----------- -----------
Actual tax expense $ 758,505 $ 198,772 $ 1,895,494
=========== =========== ===========
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities at March 31, 2004 and 2003 are
as follows:
2004 2003
----------- -----------
Deferred tax assets:
Inventory differences $ 2,309,487 $ 1,491,021
State net operating loss carryforward 502,417 171,019
Federal net operating loss carryforward 2,425,186 --
Hong Kong net operating loss carryforward 98,404 --
Hong Kong foreign tax credit 2,447,746 --
AMT credit carryforward 70,090 --
Bad debt reserve 33,323 137,958
Reserve for sales returns 161,726 110,303
Charitable contributions 58,037 --
Amortization of reorganization intangible 68,981 28,076
----------- -----------
Total Gross Deferred Assets 8,175,397 1,938,377
Less valuation allowance (8,160,924) --
Deferred tax liability -- 1,938,377
Depreciation (14,473) (12,765)
----------- -----------
Net Deferred Tax Asset $ (0.00) $ 1,925,612
=========== ===========
NOTE 12 - 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 Hong Kong Subsidiary. Sales by geographic region for the year ended
March 31 were as follows:
2004 2003 2002
----------- ----------- -----------
United States 41,729,879 $76,777,138 $62,333,801
Asia -- 21,310 49,314
Australia 959,444 814,334 --
Canada 1,314,617 919,642 47,565
Europe 25,783,789 15,714,846 --
Latin America 753,399 1,366,496 45,073
----------- ----------- -----------
$70,541,128 $95,613,766 $62,475,753
=========== =========== ===========
The geographic area of sales is based primarily on the location where the
product is delivered.
F-20
NOTE 13 - EMPLOYEE BENEFIT PLANS
The Company has a 401(k) plan for its employees to which the Company
makes contributions at rates dependent on the level of each employee's
contributions. Contributions made by the Company are limited to the maximum
allowable for federal income tax purposes. The amounts charged to operations for
contributions to this plan and administrative costs during the years ended March
31, 2004, 2003 and 2002 totaled $55,402, $61,466 and $41,733, respectively and
are included as a component of compensation expenses in the accompanying
statements of operations. The Company does not provide any post employment
benefits to retirees.
NOTE 14 - CONCENTRATIONS OF CREDIT RISK, CUSTOMERS, SUPPLIERS, AND FINANCING
The Company derives primarily all of its revenues from retailers of
products in the United States. Financial instruments, which potentially subject
the Company to concentrations of credit risk, consist of accounts receivable.
The Company's allowance for doubtful accounts is based upon management's
estimates and historical experience and reflects the fact that accounts
receivable are concentrated with several large customers whose credit worthiness
have been evaluated by management. At March 31, 2004, 65% of accounts receivable
were due from three customers: two from the U.S. and one from an International
Customer. Accounts receivable from three customers that individually owed over
10% of accounts receivable at March 31, 2004 was 31%, 24% and 10%. Accounts
receivable from four customers that individually owed over 10% of accounts
receivable at March 31, 2003 was 22%, 19%, 15% and 11%. The Company performs
ongoing credit evaluations of its customers and generally does not require
collateral.
Revenues derived from five customers in 2004, 2003 and 2002 were 54%,
67% and 87% of revenues, respectively. Revenues derived from three customers in
2004 ,2003, and 2002, respectively, which individually purchased greater than
10% of the Company's total revenues, were 20%, 12% and 10% in 2004, 21%, 17% and
15% in 2003, 37%, 28%, and 10% in 2002.
The Company is dependent upon foreign companies for the 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 years 2004, 2003 and 2002, manufacturers in the People's
Republic of China (China) accounted for approximately 96%, 94% and 95%,
respectively, of the Company's total product purchases, including all of the
Company's hardware purchases.
Net sales derived from the Hong Kong Subsidiary aggregated $43.1
million in 2004, $49.3 million in 2003 and $27.2 million in 2002. The carrying
value of net assets held by the Company's Hong Kong based subsidiary was $14.4
million at March 31, 2004.
NOTE 15 - QUARTERLY FINANCIAL DATA - UNAUDITED
The following financial information reflects all normal recurring
adjustments that are, in the opinion of management, necessary for a fair
statement of the results of the interim periods. The quarterly unaudited results
for the years 2004 and 2003 are set forth in the following table:
Basic Diluted
Earnings Earnings
Net Earnings (Loss) Per (Loss) Per
Sales Gross Profit (Loss) Share Share
----------- ------------ ------------ ------ ------
2004
First quarter $ 7,627,975 $ 1,726,109 $ (2,317,352) $(0.28) $(0.28)
Second quarter 31,984,251 3,803,539 (656,669) (0.08) (0.08)
Third quarter 28,689,623 (2,601,125) (10,450,601) (1.20) (1.20)
Fourth quarter 2,239,279 (1,109,973) (9,258,802) (1.09) (1.09)
----------- ------------ ------------ ------ ------
Total $70,541,128 $ 1,818,550 $(22,683,424) $(2.65) $(2.65)
=========== ============ ============ ====== ======
2003
First quarter $ 4,264,203 $ 1,273,322 $ (1,358,780) $(0.17) $(0.17)
Second quarter 33,044,306 9,754,954 4,837,926 0.60 0.54
Third quarter 49,102,372 14,525,191 3,846,894 0.47 0.43
Fourth quarter 9,202,885 (2,268,736) (6,108,228) (0.75) (0.66)
----------- ------------ ------------ ------ ------
Total $95,613,766 $ 23,284,731 $ 1,217,812 $ 0.15 $ 0.14
=========== ============ ============ ====== ======
F-21
Supplemental Data
Schedule II
VALUATION AND QUALIFYING ACCOUNTS
Balance at Charged to Reduction Credited to Balance at
Beginning of Costs and to for Costs and End of
Description Period Expenses Write off Expenses Period
----------- ---------- ---------- ----------- ----------- ----------
Year ended March31, 2004
Reserves deducted from assets to which they apply:
Allowance for doubtful accounts $ 405,759 $ 72,864 $ (148,074) $ (232,540) $ 98,009
Inventory reserves $3,715,357 $7,047,197 $(4,181,408) $6,581,146
Year ended March31, 2003
Reserves deducted from assets to which they apply:
Allowance for doubtful accounts $ 12,022 $ 412,055 $ -- $ (18,318) $ 405,759
Inventory reserves $ -- $3,715,357 $ -- $ -- $3,715,357
Year ended March 31, 2002
Reserves deducted from assets to which they apply:
Allowance for doubtful accounts $ 9,812 $ 45,078 $ (42,868) $ -- $ 12,022
Inventory reserves $ -- $ -- $ -- $ -- $ --
F-22
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
10.6 Employment Agreement dated February 27, 2004 between the Singing
Machine and Eddie Steele.
10.9 Separation and Release Agreement effective as of April 9, 2004 between
the Singing Machine and April Green.
10.10 Separation and Release Agreement dated December 16,2003 between the
Singing Machine and Jack Dromgold.
10.11 Separation and Release Agreement effective as of April 12, 2004 between
the Singing Machine and John Dahl.
10.28 Distribution Agreement dated April 1, 2003 between the Singing Machine
and Arbiter Group, PLC.
10.29 Loan Agreements dated August 13, 2003 in the aggregate amount of $1
million between the Company and each of Josef Bauer, Howard Moore &
Helen Moore Living Trust, Maureen G. LaRoche and Yi Ping Chan.
10.30 Letter dated March 4, 2003 from Jay Bauer to the Singing Machine
regarding a $400,000 loan.
14.1 Code of Ethics
21.1 List of Subsidiaries
23.1 Consent of Grant Thornton, LLP
23.2 Consent of Salberg & Co.
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification of the Chief Executive Officer pursuant to U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
32.2 Certification of the Chief Financial Officer pursuant to U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002