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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, 2003
0 - 24968
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Commission File Number
THE SINGING MACHINE COMPANY, INC.
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(Exact Name Registrant as Specified in its Charter)
Delaware 95-3795478
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(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 $11.00 per
share as reported on the American Stock Exchange on September 30, 2002 was
approximately $89,888,458 (based on 8,171,678 shares outstanding).
ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS: Indicate
whether the Issuer has filed all documents and reports required to be filed by
Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities
under a plan confirmed by a court. |X| Yes |_| No
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 8,171,678 shares of common stock, issued and outstanding at March 31,
2003.
DOCUMENTS INCORPORATED BY REFERENCE
None
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED MARCH 31, 2003
Page
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PART I
Item 1. Business 4
Item 2. Properties 9
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters 10
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 18
Item 8. Financial Statements and Supplementary Date 24
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 24
PART III
Item 10. Directors and Executive Officers 25
Item 11. Executive Compensation 27
Item 12. Security Ownership of Certain Beneficial Owners and Management 31
Item 13. Certain Relationships and Related Transactions 33
Item 14. Controls and Procedures 33
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 34
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. The
Company undertakes 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 "Company," "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 CD 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. We believe we were the first
company to offer karaoke electronic recording equipment and music for home use
in the United States.
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 "Company," "we," us" and similar terms include The
Singing Machine Company, Inc. and its subsidiary, International SMC (HK) Ltd.,
unless the context indicates otherwise.
RECENT DEVELOPMENTS
We faced several challenges during our fiscal year ended March 31,
2003. Although our net sales increased to $95,613,766 in the twelve months ended
March 31, 2003 ("fiscal 2003") compared to net sales of $62,475,753 in the
twelve months ended March 31, 2002 ("fiscal 2002"), our net income decreased to
$1,217,812 or $.15 per share in fiscal 2003 compared with net income of
$6,289,065 in fiscal 2002 or $.88 per share. Several factors contributed to this
decrease in net income, including but not limited to a loss on a guaranteed
sales contract of approximately $2.5 million, an inventory reserve charge of
approximately $3.7 million, higher than expected operating expenses of $21.6
million in fiscal 2003 and an income tax liability expenses of $198,772. A more
detailed explanation of our financial results is contained under "Management's
Discussion and Analysis and Results of Financial Condition" on page 11.
As a result of these factors, our net worth declined to a level which
took us out of compliance with a tangible net worth requirement contained in our
credit facility with our commercial lender, LaSalle Business Credit, LLC
("LaSalle," "commercial lender" or "lender"). In March 2003, our lender notified
us that we were in default of this requirement and that it could accelerate our
loan at any time. Due to the liquidity difficulties associated with the excess
inventory exposure and our lender's notice of default, we have received a going
concern uncertainty paragraph on our audited financial statements for fiscal
2003. While we are endeavoring to sell the excess inventory from last year, to
renegotiate our loan with LaSalle and to seek other sources of financing, we
cannot assure that we will be successful in any of these efforts.
We also made a decision to restate our financial statements for the
fiscal year ended March 31, 2002 and 2001 to increase the accrual for income
taxes. The restatement does not change reported revenue, gross margin or pre-tax
income for fiscal 2002 or fiscal 2001. See "Management's Discussion and Analysis
of Results of Operation and Financial Condition - Restatement" on page 10.
PRODUCT LINES
We currently have a product line of 34 different models of karaoke
machines plus 12 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. Our machines sell at retail prices
ranging from $30 for basic units to $400 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
MARKETING
We rely on management's ability to determine the existence and extent
of available markets for our products. Our management has considerable marketing
and sales background and devotes a significant portion of its time to marketing
related activities. We achieve both domestic and direct sales by marketing our
hardware and music products primarily through our own sales force and various
independent sales representatives. Our representatives are located across the
United States and are paid a commission based upon sales in their respective
territories. 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, 2003, we worked with 18
independent sales representatives. We work closely with our major customers to
determine marketing and advertising plans.
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. We spent approximately $674,925, $181,866 and $55,376 on research and
development in fiscal 2003, 2002 and 2001, respectively. The primary purpose of
our research and development expenses is to develop prototypes and working
samples.
Our karaoke machines and music are marketed under the Singing
Machine(R) trademark throughout the United States, 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, J.C. Penney, Target and Toys R Us.
Our licensing agreements with MTV Networks and Nickelodeon have further
expanded our brand name and our customer base. Through our license with MTV, we
have begun to focus on the 12 to 24 year old market and through our agreement
with Nickelodeon, we have reached an even younger age group between the ages of
3-6. We also expanded our licensed product lines in fiscal 2003 with the
addition of Hard Rock Academy(R) and Motown(R) (Universal Music Entertainment)
agreements. The addition of these agreements will help us to reach demographic
areas covering all ages.
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, 2003, subject to an automatic renewal provision.
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 January 1,
2003 until December 31, 2005.
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, 2003, 2002
and 2001, respectively, were approximately 67%, 87% and 78% respectively. In
fiscal 2003, 2002 and 2001, 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
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accounted for more than 10% of our revenues. Although we have long-established
relationships with all of our customers, we do not have long-term 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.
During the last three years, our revenues from international sales have
increased. Sales by customer geographic regions were as follows:
2003 2002 2001
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United States $76,777,138 $62,333,801 $34,391,540
Asia 21,310 49,314 --
Australia 814,334 -- --
Canada 919,642 47,565 11,420
Central America 96,836 5,756 --
Europe 15,714,846 -- 433,821
Mexico 1,225,111 -- --
South America 44,549 39,317 38,570
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$95,613,766 $62,475,753 $34,875,351
=========== =========== ===========
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 credit
policies are tailored to our customer base. We have not suffered significant
credit losses to date.
DISTRIBUTION
We distribute hardware products to retailers and wholesale distributors
through two methods: shipments of product from inventory (domestic sales), and
shipments of product directly through our Hong Kong subsidiary and manufacturers
in Asia (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 Florida or California.
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. In the fiscal year ended March 31, 2003, approximately 48% of our
consolidated sales were domestic sales.
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 an open account. In the fiscal
year ended March 31, 2003, approximately 52% of our consolidated sales were
direct sales.
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 the Shenzhen Special Economic Zone
and Guangdong Province of the People's Republic of China, who assemble our
karaoke machines. 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 Singing
Machine(R) trademarks, as well as trademarks associated with our merchandise
license agreements.
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, the Company authors 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.
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While our equipment manufacturers purchase our supplies from a small
number of large suppliers, all of the electronic components and raw materials
used by them 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,
although we primarily use six factories to manufacture our karaoke machines and
accessories, and a small number of studios to record our music (including our
in-house production), we do not anticipate that the loss of any single
manufacturer or 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, 2003, 2002 and 2001, warranty claims have not been
material to our results of operations.
MERCHANDISE LICENSE AGREEMENTS
In November 2000, we entered into a multi-year merchandise license
agreement with MTV Networks, a division of Viacom International, Inc., to create
the first line of MTV karaoke machines and compact disks with graphics
("CD+G's") featuring music for MTV's core audience. Under the licensing
agreement, we originally produced two MTV-branded machines for the fiscal 2002
year: (1) a large format karaoke machine with a built in, fully functional
television that enables users to view song lyrics and (2) a small karaoke system
that connects to a television. We also produced exclusive CD+G's featuring music
catering to MTV's core audience, that were distributed with the MTV branded
karaoke machines. We have amended the agreement three times since November 2000.
For fiscal 2004, our line will consist of nine MTV branded machines and a wide
assortment of MTV branded music. Our license covers the sale of MTV products in
the United States, Canada and Australia. In December 2002, we entered into an
amendment, which adjusted some of the financial aspects of the agreement and
added an additional minimum guarantee of royalty payments of $1,500,000. The MTV
license expires on December 31, 2003 and management is currently in negotiations
to extend this agreement beyond that date. We do not believe that the payment of
these guaranteed fees will adversely affect our ongoing operations.
In December 2001, we entered into a multi-year license agreement with
the Nickelodeon division of MTV Networks. Under this license, we originally
created a line of two Nickelodeon branded machines and music for the fiscal 2003
year. This has expanded to five machines, plus a line of Nickelodeon music.
These products are distributed through our established distribution channels.
Over the term of this license agreement, we are obligated to make guaranteed
minimum royalty payments of $450,000. We do not believe that the payment of
these guaranteed fees will adversely affect our ongoing operations. The
Nickelodeon license expires on December 31, 2004.
In December 2002, we entered into a multi-year license agreement with
Hard Rock Academy, a division of Hard Rock Cafe. This agreement allows the
Company to produce and market a line of its karaoke machines and complementary
music through its distribution channels. The first branded machine was
introduced in the fourth quarter of fiscal 2003 and a line of music is currently
under development. Over the term of this license agreement, we are obligated to
make guaranteed minimum royalty payments over a specified period of time in the
total amount of $250,000. We do not believe that the payment of these guaranteed
fees will adversely affect our ongoing operations. The Hard Rock Academy license
expires on December 31, 2005.
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
The Singing Machine to be the first to use original artist recordings for our
CD+G formatted karaoke music. The original introduction will be one machine and
six CD+G discs. Over the term of this license agreement, we are obligated to
make guaranteed minimum royalty payments over a specified period of time in the
amount of $300,000. We do not believe that the payment of these guaranteed fees
will adversely affect our ongoing operations. The Universal Music Entertainment
license expires on March 31, 2006.
We distribute all of our licensed products through our established
distribution channels, including Best Buy, Costco, JC Penny, Sam's Club, Target
and Toys R Us. Our distribution network also includes the online versions of
these retail customers.
4
COMPETITION
Our business is highly competitive. Our major competitors for karaoke
machines and related products are Craig, Curtis, Grand Prix and Memorex. We
believe that competition for karaoke machines is based primarily on price,
product features, reputation, delivery times, and customer support. Our primary
competitors for producing karaoke music are Pocket Songs, 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.
We try to stay ahead of our competition by introducing new products
each year and upgrading our existing products. We believe that we were one of
the first companies to introduce CD+G technology to karaoke machines. In fiscal
2004, we will be introducing more than 20 new models of karaoke machines.
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 registered various trademarks with the United States Patent &
Trademark Office for our Singing Machine(R) products and also have common law
rights in these trademarks. We have also registered our trademarks in Germany,
the Benelux countries, Switzerland and the United Kingdom. In fiscal 2003, we
filed an application to obtain a European Community Trademark for the 15
European Community countries and filed registrations in certain Asian countries.
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 more than 3,500 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. 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,
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. The statutory rate is the greater of $0.08 per song for five minutes of
playing time or $0.0155 per minute of playing time or fraction thereof with
respect to each item of music produced and distributed by us. 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. or Electronic Testing Laboratories.
Our production and sale of music products is subject to federal copyright laws.
5
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 the Company.
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
third quarter. A significant portion of our customers place orders in our second
and third quarter in anticipation of such holiday buying. 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 the Company to ship products closer to the time that
retailers expect to sell the products to consumers. These factors increase the
risk that the Company may not be able to meet demand for certain products at
peak demand times, or that the Company's own inventory levels may be adversely
impacted by the need to pre-build products before orders are placed. In fiscal
2003, we overestimated the demand for our products and had $25 million of
inventory as of March 31, 2003.
In fiscal 2003 and 2002, our financing of seasonal working capital grew
in the first quarter and peaked in the second and third quarter, consistent with
the industry taken as a whole. We are currently in the process of seeking to
amend our existing line of credit. If these efforts are unsuccessful, we will
need to seek alternative facilities. To finance seasonal working capital
requirements of our Hong Kong subsidiary, we expect to use short-term foreign
credit lines with a number of banks. Our foreign credit lines total
approximately $5.5 million. For fiscal year 2004, we expect to spend between $10
and $15 million on inventory for domestic stock, in addition to the $25 million
of inventory on hand as of March 31, 2003. However, we may change this amount
depending on business requirements.
BACKLOG
We ship our products in accordance with delivery schedules specified by
our customers, which usually request delivery within three months. 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 toy 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.
EMPLOYEES
As of July 1, 2003, we employed 54 persons, all of whom are full-time
employees, including four executive officers. Fourteen (14) of our employees are
located at International SMC's corporate offices in Hong Kong. There are fifteen
(15) employees located at our California locations in warehousing and
administrative functions. The remaining twenty-five (25) employees are based in
Florida, including the four (4) executive positions; four (4) are
engaged in warehousing and logistics, four (4) are engaged in accounting, and
thirteen (13) are engaged in marketing, sales and administrative functions.
There are no labor agreements with employees and we currently maintain a good
relationship with all employees.
ITEM 2. PROPERTIES
Our corporate headquarters are located in Coconut Creek, Florida in an
18,000 square foot office and warehouse facility. Our four leases for this
office space expire on August 31, 2004. We sublease showroom space at the
International Toy Center in New York City. We have leased 9,393 square feet of
office and showroom space in Hong Kong from which we oversee our 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 two warehouse facilities in southern California. The Compton
facility has 69,000 square feet and the lease expires on February 23, 2008. The
Rancho Dominguez location has 94,650 square feet, predominately warehouse. This
lease expires June 30, 2005. We have also subleased warehouse space in Carson,
California, that we previously leased for warehouse space to an unrelated third
party until the expiration of the lease, January 2004. We intend to consolidate
our operations by October of 2003 and sublease one of the remaining facilities
for the term of its lease.
We believe that the facilities are well maintained, are in substantial
compliance with environmental laws and regulations, and are 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
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.
6
From July 2, 2003 through July 8, 2003, six securities class action
lawsuits were filed against the Singing Machine and certain of its officers and
directors in the United States District Court for the Southern District of
Florida on behalf of all persons who purchased the Singing Machine's securities
during the various class action periods specified in the complaints. We expect
that all of these actions will be consolidated in the United States District
Court for the Southern District of Florida. The complaints that have been filed
allege violations of Section 10(b) and Section 20(a) of the Securities Exchange
Act of 1934 and Rule 10(b)-5. The complaints seek compensatory damages,
attorney's fees and injunctive relief. While the specific factual allegations
vary slightly in each case, the complaints generally allege that defendants
falsely represented the Singing Machine's financial results during the relevant
class periods.
We believe the allegations in these cases are without merit and we
intend to vigorously defend these actions.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders through a
solicitation of proxies or otherwise, during the fourth quarter of the fiscal
year covered by this report.
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." We began trading on the AMEX on March 8, 2001. From January
26, 1996 through March 7, 2001, we traded on the National Association of
Securities Dealers, Inc.'s OTC Bulletin Board under the symbol "SING". Set forth
below is the range of high and low information for our common stock as traded on
the American Stock Exchange during fiscal 2003 and 2002, as reported by
Commodity Systems, Inc. This information contained in this table has been
restated to give effect to our 3-for-2 stock split to stockholders of record on
March 4, 2002.
FISCAL PERIOD HIGH LOW
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
2002:
First Quarter (April 1 - June 30, 2001) $ 4.45 $ 2.90
Second Quarter (July 1 - September 30, 2001) 5.02 3.70
Third Quarter (October 1 - December 31, 2001) 16.19 4.30
Fourth Quarter (January 1 - March 31, 2002) 17.80 12.53
As of July 15, 2003, there were approximately 300 record holders of our
outstanding common stock.
COMMON STOCK
The Company has never declared or paid cash dividends on its common
stock and the Company's Board of Directors intends to continue its policy for
the foreseeable future. Furthermore, the Company's credit facility with LaSalle
Business Credit, Inc. restricts the Company from paying any dividends to its
shareholders, unless it obtains prior written consent from LaSalle. Future
dividend policy will depend upon the Company's earnings, financial condition,
contractual restrictions and other factors considered relevant by the Company's
Board of Directors and will be subject to limitations imposed under Delaware
law.
On March 14, 2002, the Company affected a 3 for 2 stock split for all
shareholders on record as of March 4, 2002.
7
SALE OF UNREGISTERED SECURITIES
During the three-month period ended March 31, 2003, two employees
exercised stock options issued under our 2001 Management Stock Option Plan. The
employees exercised options to acquire an aggregate of 38,500 shares of our
common stock. The names of the option holders, the dates of exercise of the
number of shares purchased, the exercise price and the proceeds received by us
are listed below.
NAME DATE OF EXERCISE NO. OF SHARES EXERCISE PRICE PROCEEDS
Edwin Young 01/21/2003 37,500 2.04 76,500
April Green 02/24/2003 1,000 2.04 2,040
Each of these individuals paid for the shares with cash. The shares
issued to our employees were registered under the Securities Act on a
registration statement on Form S-8. As such, no restrictive legends were placed
on the shares.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth, for the periods indicated, certain
items included in the Company's financial statements located here and in other
filings with the Securities and Exchange Commission and should be read in
conjunction with the financial data set forth below in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related footnotes
(included in Item 8).
2003 2002* 2001* 2000* 1999*
(as restated) (as restated)
STATEMENT OF OPERATIONS:
Net Sales $95,613,766 $62,475,753 $34,875,351 $19,032,320 $ 9,547,816
Earnings(loss) before income taxes $ 1,416,584 $ 8,184,559 $ 4,188,021 $ 577,686 $ 754,156
Income tax expense (benefit) $ 198,772 $ 1,895,494 $ 491,744 $ 160,299 $ 170,000
Net earnings (loss) $ 1,217,812 $ 6,289,065 $ 3,696,277 $ 737,985 $ 924,156
BALANCE SHEET:
Working capital $13,389,509 $14,577,935 $ 6,956,879 $ 2,985,120 $ 398,503
Current ratio 1.63 3.82 4.37 7.77 1.28
Property, plant and equipment, net $ 1,096,423 $ 574,657 $ 263,791 $ 99,814 $ 16,447
Total assets $38,935,294 $21,403,196 $10,509,682 $ 4,346,901 $ 2,379,335
Shareholders' equity $17,685,364 $16,225,433 $ 8,450,237 $ 3,906,286 $ 964,740
PER SHARE DATA:
Earnings (loss) per common share -
basic $ 0.15 $ 0.88 $ 0.59 $ 0.23 $ 0.37
Earnings (loss) per common share -
diluted $ 0.14 $ 0.79 $ 0.50 $ 0.19 $ 0.36
Cash dividends paid 0.00 0.00 0.00 0.00 0.00
*Certain numbers in these financial statements have been reclassified to conform
with current year presentation.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
OVERVIEW
RESTATEMENT OF FINANCIAL STATEMENTS
In June 2003, management revised its position on taxation of its
subsidiary's income by the United States and by the Hong Kong tax authorities.
With regard to taxation in Hong Kong, the Company's subsidiary had
previously applied for a Hong Kong offshore claim income tax exemption based on
the locality of profits of the Hong Kong subsidiary. Management believed that
the exemption would be approved because the source of all profits of the Hong
Kong subsidiary is from exporting to customers outside of Hong Kong.
8
Accordingly, no provision for income taxes was provided in the consolidated
financial statements as of March 31, 2002 and 2001. However, full disclosure was
previously reflected in the audited financial statements for years ended March
31, 2002 and 2001 of the estimated amount that would be due to the Hong Kong tax
authority should the exemption be denied. Management is continuing its exemption
application process. However, due to the extended period of time that the
application has been outstanding, as well as management's reassessment of the
probability that the application will be approved, management has determined to
restate the 2002 and 2001 consolidated financial statements to provide for such
taxes. The effect of such restatement is to increase income tax expense by
$748,672 and 468,424 in fiscal 2002 and 2001, respectively. However, the Company
can claim United States foreign tax credits in 2002 for these Hong Kong taxes,
which is reflected in the final restated amounts.
With regard to United States taxation of foreign income, the Company
had originally taken the position that the foreign income of the Hong Kong
subsidiary qualified for a deferral under the Internal Revenue Code allowing for
such income to be indefinitely deferred and not taxed in the United States until
such income is repatriated. Full disclosure of the amount and nature of the
indefinite deferral for fiscal year 2002 was reflected in the income tax
footnote of the consolidated financial statements for that year. The Internal
Revenue Code, regulations and case law regarding international income taxation
is quite complex and subject to interpretation. Each case is determined based on
the individual facts and circumstances. Due to certain inter-company loans made
in 2002 and 2003, the profits previously considered to be indefinitely deferred
became partially taxable as "deemed dividends" under section 956 of the Internal
Revenue Code. Although certain arguments against the imposition of a "deemed
dividend" may be asserted, management has determined to restate the fiscal year
2002 consolidated financial statements based on its reassessment of its original
position. The effect of such restatement is to increase income tax expense by
$1,027,545 in fiscal year 2002, which includes the utilization of the foreign
tax credits referred to above.
The net effect of the above two adjustments 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.
Summary
As restated, our income taxes increased from $119,277 in fiscal 2002 to
$1,895,494 and from $23,320 in fiscal 2001 to $491,744 in fiscal 2001 and
consequently our net income decreased correspondingly. The restatement does not
change our reported revenue, gross margin or pre-tax income for fiscal 2002 or
fiscal 2001.
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:
2003 2002* 2001*
Total Revenues 100.0% 100.0% 100.0%
Cost of Sales 75.6% 65.4% 63.5%
Operating expenses 22.7% 21.4% 22.1%
Operating income 1.7% 13.2% 14.4%
Other expenses, net 0.2% 0.1% 2.4%
Income before taxes 1.5% 13.1% 12.0%
Provision (benefit) for income taxes 0.2% 3.0% 1.4%
Income (loss) 1.3% 10.1% 10.6%
* The percentages are based on our restated financial statements for
fiscal 2002 and fiscal 2001.
YEAR ENDED MARCH 31, 2003 COMPARED TO THE 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.
The Company's growth was driven in large part by the addition of International
sales in Europe, Asia, and Australia. This new market area is in its infant
stage and the Company expects continued future growth in this area. We also
generated $30,884,344 million or 32.3% of our net sales from products sold under
the MTV license in fiscal 2003.
9
Strong sales of the Company's licensed merchandise and the introduction
of new karaoke machines and 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 10.2% in fiscal 2002.
Sales in fiscal 2003 were reduced by a charge against sales of $2.5
million as a result of the end of a guaranteed margin agreement with a customer.
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 our
Hong Kong subsidiary 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 margin contract.
International sales were primarily in Europe, Canada and Australia.
Sales to international customers historically maintain lower selling prices, and
thus a lower gross profit margins. The main reason for this is that the sales
are made to distributors in these 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.
The Company also undertook a revaluation of its current inventory. It
was determined that due to liquidation sales, inventory would be sold at a loss;
therefore, a decrease in the value of these specific items was made. The total
amount of the provision for inventory was $3,715,357.
In fiscal 2003, the Company entered into a guaranteed gross margin
contract which completed on January 15, 2003. The Company entered into an
agreement with a retail customer in April 2002 whereby it guaranteed the
customer a minimum gross margin of $3,573,000 from the sale of the Company's
products during the period from September 1, 2002 through January 15, 2003.
Under the agreement, the Company agreed to reimburse the customer for the
difference between the customer's gross margin on sales and the minimum
guarantee. As of the settlement date of the contract, January 15, 2003, the net
loss on the agreement was $2,570,047. The Company also realized the consignment
sales made by this customer at January 15, 2003, in the amount of $2,441,483. As
of March 31, 2003 the total amount due under this agreement has been paid.
OPERATING EXPENSES
Operating expenses were $21,670,501 or 22.7% of total revenues in
fiscal 2003, up from $13,387,533 or 16.1% 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:
(i) increased advertising expenses of $2,654,729 due to increases
with our outside firm, the production of a television
commercial, as well as cooperative advertising with customers,
which is variable based on the level of sales
(ii) the increase in depreciation in the amount of $239,686 due to
the addition of molds for new product additions for fiscal
year 2003,
(iii) compensation expense in the amount of $1,151,012 due to the
addition of key personnel in Florida, in our California
facility and at our Hong Kong subsidiary,
(iv) increased freight and handling charges to customers $869,525
(v) expansion of the California warehouse and its associated
expenses in the amount of $873,919,
(vi) expansion of International SMC's operations and its related
expenses, in the amount of $580,906.
(vii) increases in product development fees for development of
future product $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, show expenses, and other selling expenses.
As a result of the merchandise license agreements and minimum guarantee
requirements, the Company expects royalty expense to increase in fiscal 2004.
Our advertising expense, as discussed in (i) above, increased
$2,654,729 for the fiscal year ended March 31, 2003 as compared to fiscal 2002.
Advertising expense consists of primarily two components: Co-operative
advertising and direct advertising expense. Co-operative advertising is paid
directly to the customer and is based directly on the amount of sales. The
customer has complete discretion as to the use of these funds. Co-operative
advertising expenses accounted for $2,320,705 of the increase in advertising
expenses. In fiscal 2002, the Company embarked on its first television
advertising and continued with the use of print advertising, radio spots,
sponsorships, promotions and other media. The increased costs for our
advertising firm were $334,024 over the prior year.
10
DEPRECIATION AND AMORTIZATION
The Company's depreciation and amortization expenses were $634,142 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
Other expenses were $197,646 for the fiscal year ended March 31, 2003
as compared with net 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 use
of our credit facility with LaSalle during this period. Prior to August 2002,
the Company had cash reserves to fund operations and did not need to borrow on
the revolving credit facility. Our interest income increased from $2,475 during
the fiscal year 2002 to $11,943 during the fiscal year 2003 because we earned
income on our cash balances held by our lender by investing in 24 hour
commercial paper investments. The Company expects interest expense to increase
in fiscal 2004 due to the credit facility accruing interest at the default rate
of prime plus 2.5% (6.75% at March 31, 2003).
INCOME TAX EXPENSE
The Company's tax expense is based on an aggregation of the taxes on
earnings of its Hong Kong and domestic operations. Income tax rates in Hong Kong
are approximately 16%, while the statutory income tax rate in the United States
is 34%. The Company's 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 the
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. The Company's future effective income tax rate will fluctuate based on the
level of earnings of its Hong Kong and domestic operations.
NET INCOME
As a result of the foregoing, the Company's 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.
YEAR ENDED MARCH 31, 2002 COMPARED TO YEAR ENDED MARCH 31, 2001
- ---------------------------------------------------------------
NET SALES
Net sales for the fiscal year ended March 31, 2002 increased 80.2% to
$62,475,753 compared to $34,875,351 for the fiscal year ended March 31, 2001.
The Company's growth was driven by strong sales of the Company's MTV licensed
merchandise and the introduction of new karaoke machines and music titles. We
generated $23,354,270 million or 37.8% of our net sales from products sold under
the MTV license in fiscal 2002. Our sales of music increased to $6,306,547 or
10.2% of our net sales in fiscal 2002 compared with $3,087,615 or 9% of our net
sales in fiscal 2001.
GROSS PROFIT
Gross profit for the fiscal year ended March 31, 2002 was $21,622,913
or 33% of sales compared to $12,716,300 or 34.5% of sales for the fiscal year
ended March 31, 2001. The decrease in gross margin compared to the prior year is
due to the realization of volume discounts by our largest customers. This was
offset to some degree by reduced prices that we paid our manufacturers for our
karaoke machines because of our increased purchases.
OPERATING EXPENSES
Operating expenses increased to $13,387,533, or 19.7% of sales, for the
year ended March 31, 2002 from $7,688,707, or 19.8% of sales, for the year ended
March 31, 2001. This increase in operating expenses was primarily attributed to
the increase in expenses associated with: (1) the opening of the Company's Hong
Kong office, (2) the Company's first advertising campaign and (3) certain
expenses which are considered variable as they relate directly to the level of
sales.
11
In December 2000, the Company's wholly-owned subsidiary, International
SMC, opened a Hong Kong office. For the fiscal year ended March 31, 2002, this
office incurred SG&A expenses of approximately $1,144,734 compared to $418,618
in the prior year. By opening this office, the Company saved the manufacturers
agency fees, which were paid on each shipment in prior years. The Hong Kong
office has fixed overhead expenses every month, as opposed to per shipment
agency fees. We realized the greatest benefit from our Hong Kong office in the
third quarter of fiscal 2002, when we purchased the largest amount of inventory.
Our advertising expense increased to $2,377,638 for the fiscal year
ended March 31, 2002 compared to $921,359 for the fiscal year ended March 31,
2001. Advertising expense consists of primarily two components: Co-operative
advertising and direct advertising expense. Co-operative advertising is paid
directly to the customer and is based directly on the amount of sales. The
customer has complete discretion as to the use of these funds. Co-operative
advertising expenses accounted for $972,000 of the increase in advertising
expenses. In fiscal 2002, the Company embarked on its first formal advertising
campaign, which used print advertising, radio spots, sponsorships, promotions
and other media. The cost for this advertising campaign was approximately
$484,000 and this is a direct advertising expense.
Other expenses, termed variable expenses, contributed to the increase
in operating expenses. These expenses included royalty expense, sales
commissions, warehouse expenses, and travel. The largest increase can be seen in
royalty expense, which increased approximately $1,713,000 over the prior year,
primarily from the sale of items under the MTV licensing agreement. Our
commissions payable to our independent sales representatives increased by
$457,000 during fiscal 2002, because of increased sales. Our warehouse related
expenses also increased by $478,000. These expenses are due to the increased
importing of the Company's karaoke machines from Hong Kong. Compensation
expenses increased $569,935. We grew from 22 employees at March 31, 2001 to 47
employees at March 31, 2002.
DEPRECIATION AND AMORTIZATION
The Company's depreciation and amortization expenses were $394,456 for
the fiscal year ended March 31, 2002, up from $301,064 in the prior year. The
increase in depreciation and amortization expenses can be attributed to the
Company's acquisition of new fixed assets during fiscal 2002, which included
computers, furniture and other equipment in all of the Company's locations in
Florida, California and Hong Kong. It also included the addition of new molds
for our expanded product line. The amortization expense includes the
amortization of a fee paid to LaSalle Bank for our line of credit facility and
the amortization of remaining deferred guarantee fees related to the factoring
agreement we terminated in April 2001.
OTHER EXPENSES
Other expenses were $50,821 for the fiscal year ended March 31, 2002
compared with net expenses of $839,572 for the fiscal year ended March 31, 2001.
The Company had a large decrease in these miscellaneous items primarily because
of the elimination of factoring fees and a decrease in interest expense
resulting in a net decrease of $543,279. The Company terminated its factoring
agreement in April 2001 and no longer incurs the fees and interest associated
with it. The Company replaced the factoring agreement with a lower cost credit
facility with LaSalle Business Credit in April 2001. The Company has also begun
to generate income from royalty payments received in Hong Kong for the use of
Company owned molds by other parties.
INCOME BEFORE INCOME TAX EXPENSE
The Company's income before income taxes increased 95.4% to $8,184,559
for the fiscal year ended March 31, 2002, compared to $4,188,021 for the fiscal
year ended March 31, 2001. This increase in profit is due primarily to the
increase in sales.
INCOME TAX EXPENSE
Our income tax expense was restated for fiscal 2002. Our accrual for
income taxes is based on primarily two components: (i) taxes of $1,027,545 which
we are paying pursuant to Section 956 of the Internal Revenue Code on an
intercompany loans and (ii) taxes of $748,672 for International SMC's business
operations in Hong Kong. The total income tax expense for fiscal 2002 was
$1,895,494.
NET INCOME
As a result of the foregoing, the Company's net income increased 41.3%
to $6,289,065 for the fiscal year ended March 31, 2002, compared to $3,696,277
for the fiscal year ended March 31, 2001.
12
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2003, the Company had cash on hand of $268,265 compared to
$5,520,147 at March 31, 2002. Our current liabilities increased to $21,249,930
as of March 31, 2003, compared to $5,177,763 at March 31, 2002.
Because we had minimal liquidity as of June 24, 2003 and had defaulted
under a credit agreement with our commercial lender, we received a going concern
qualification from our independent auditors for our financial statements for
fiscal 2003. On March 14, 2003, we received a letter from LaSalle informing us
that we were in violation of a net worth covenant in our credit agreement. In
this letter, LaSalle also advised us that we were in default under the credit
agreement and that it could accelerate the payment of all liabilities due under
this agreement at any time. In June 2003, LaSalle amended the agreement through
July 31, 2003 but did not waive the condition of default. One of the conditions
of this last amendment was that we obtain $2 million in subordinated debt
financing by July 10, 2003.
As of July 10, 2003, we have obtained $1 million in subordinated debt
financing. On or about July 10, 2003, certain officers, directors and an
associate of a director, advanced $1 million to the Company. We have not
finalized the terms of this management loan; however, the Company has immediate
use and access to the $1 million in funding. It is presently expected that the
loan will be a short-term loan, which will be due on or before October 31, 2003.
However, we have not yet determined the interest rate or if any compensation,
such as warrants, will be awarded to the management investment group for their
loan. We are also in the process of finalizing a $1 million loan from an outside
investment group and hope to close this transaction as soon as possible. There
can be no assurance that this financing will be completed on time on the terms
presently contemplated. Although the Company has only raised $1 million of the
required $2 million by the due date, the Company believes that the commercial
lender will continue to support the increased availability under the Amendment.
We are currently in negotiations with LaSalle to restructure the loan
for the remainder of fiscal 2004. We hope that these negotiations will be
successful and that a restructured loan agreement will be in place prior to
August 1, 2003. However, we cannot assure you that these efforts will be
successful. We entered into our credit facility with LaSalle in April 2001 and
have entered into several amendments subsequently. We last amended the credit
facility effective as of June 30, 2003 and it provides that the agreement
expires on July 31, 2003. Under the amended credit facility, LaSalle Bank will,
at its discretion, advance up to 70% of the Company's eligible accounts
receivable, plus up to 20% of eligible inventory, plus us up to 60% of
commercial letters of credit issue by LaSalle minus reserves as set forth in the
loan documents. The loan is secured by a first lien on all present and future
assets of the Company, except specific tooling located in China.
Due to the increased level of inventory and accounts payable as of
March 31, 2003, the Company has an increased need for working capital. As of
March 31, 2003, the Company had current assets of $34.6 million, which consisted
primarily of accounts receivable and inventory; and current liabilities of
approximately $21.2 million. The most significant current liabilities include
(i) approximately $8.4 million in accounts payable, of which approximately $4
million is amounts payable to the Company's factories in China and (ii) $6.8
million outstanding under the Company's credit facility with LaSalle Bank. Over
the past few months, the Company has had discussions with its factories in China
and they have indicated that they are willing to extend the payment dates for
the Company's obligations. The Company also has been negotiating with LaSalle
Bank to increase the credit available to the Company and has identified other
sources of capital.
Our Hong Kong subsidiary, International SMC, has letters of credit
facilities available to finance its inventory purchases. These facilities are
(1) a $2.5 million facility at Hong Kong Shanghai Banking Corporation and (2) a
$1 million facility at Fortis Bank. International SMC also has a short term loan
with the Hong Kong Shanghai Banking Corporation for $2 million which expires in
December 2003. Additionally, one of our directors advanced $400,000 to
International SMC in March 2003. As of July 7, 2003, the balance of $200,000 is
due on October 31, 2003 and bears interest at the rate of 8% per annum.
In the event that we are not able to renegotiate an agreement with
LaSalle, we have considered alternative sources of financing, including but not
limited to inventory and accounts receivable financing and other high risk
financing such as venture capital funds. Without such financing, our ability to
continue our operations is in significant doubt.
During fiscal 2004, we plan on significantly decreasing our capital
expenditures. We currently expect to order $10-$15 million in new inventory for
domestic stock. During fiscal 2004, we will attempt to liquidate the excess
inventory from fiscal 2003. We believe this inventory is highly marketable and
saleable; however, there can be no assurances that we will be able to liquidate
this inventory during our upcoming fiscal year.
The Company's commitments for debt and other contractual arrangements
are summarized as follows:
Years ending March 31,
Total 2004 2005 2006 2007 2008
----- ---- ---- ---- ---- ----
Merchandise
License Guarantee $1,595,000 $1,395,000 $150,000 $50,000 -- --
Property Leases $3,638,771 $1,330,158 $924,338 $517,071 $495,545 $371,659
Equipment Leases $86,016 $46,525 $19,965 $10,322 $7,969 $1,235
13
We should be able to satisfy our liquidity requirements until July 30,
2003 by using credit that has been extended to us under our credit agreement
with LaSalle. However, we are currently in default of the loan and LaSalle could
accelerate the loan at any time. We hope that our renegotiations are successful,
but can not guarantee that this will occur. If we are not able to obtain
adequate financing, we may not be able to continue as a going concern.
Except for the foregoing, we do not have any present commitment that is
likely to result in our liquidity increasing or decreasing in any material way.
In addition, except for the Company's need for additional capital to finance
inventory purchases, the Company knows of no trend, additional demand, event or
uncertainty that will result in, or that is reasonably likely to result in, the
Company's liquidity increasing or decreasing in any material way.
Cash flows used in operating activities were $11,532,761 during the
fiscal year ended March 31, 2003. Cash flows were used in operating activities
primarily due to increases in accounts receivable in the amount of $2,619,778
and inventory in the amount of $19,635,351 during fiscal 2003. We purchased a
higher level of inventory in fiscal 2003 as we had anticipated a higher demand
for our products.
Cash used in investing activities during the fiscal year ended March
31, 2003 was $1,144,064. Cash used in investing activities resulted primarily
from the purchase of fixed assets in the amount of $1,144,064. The purchase of
fixed assets consists primarily of the tooling and molds required for production
of new machines for this fiscal year. Tooling and molds are depreciated over
three years.
Cash flows provided by financing activities were $7,424,943 during the
fiscal year ended March 31, 2003. This consisted of proceeds from the exercise
of warrants and options in the amount of $242,119. The Company also had a short
term loan with a director in the amount of $400,000 during fiscal 2003. The
remainder of cash provided from financing activities was provided by net
borrowings on the credit line at LaSalle National Bank in the amount of
$6,782,824 primarily for the financing of the inventory buildup.
EXCHANGE RATES
We sell all of our products in U.S. dollars and pay for all of our
manufacturing costs in either U.S. or Hong Kong dollars. Operating expenses of
the Hong Kong office are paid in Hong Kong dollars. We cannot assure you that
the exchange rate fluctuations between the United States and Hong Kong
currencies will not have a material adverse effect on our business, financial
condition or results of operations.
SEASONAL AND QUARTERLY RESULTS
Historically, the Company's operations have been seasonal, with the
highest net sales occurring in the second and third quarters (reflecting
increased orders for equipment and music merchandise during the Christmas
selling months) and to a lesser extent the first and fourth quarters of the
fiscal year. Sales in the Company's fiscal second and third quarter, combined,
accounted for approximately 85% of net sales in fiscal 2003, 81% of net sales in
fiscal 2002 and 75% of net sales in fiscal 2001.
The Company's results of operations may also fluctuate from quarter to
quarter as a result of the amount and timing of orders placed and shipped to
customers, as well as other factors. The fulfillment of orders can therefore
significantly affect results of operations on a quarter-to-quarter basis.
INFLATION
Inflation has not had a significant impact on the Company's operations.
The Company has historically passed any price increases on to its customers
since prices charged by the Company are generally not fixed by long-term
contracts.
CRITICAL ACCOUNTING POLICIES
The U.S. Securities and Exchange Commission defines critical accounting
policies as "those that are both most important to the portrayal of a company's
financial condition and results, and require management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain. The management of the
Company believes that a high degree of judgment or complexitiy is involved in
the following areas:
14
COLLECTIBILITY OF ACCOUNTS RECEIVABLE. The Company'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 Company 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 Company'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. At March 31,
2003 and 2002, the Company had net deferred tax assets of $1.9 million and $191
thousand, respectively. Management evaluates its ability to realize its deferred
tax assets on a quarterly basis and adjusts its valuation allowance as
necessary. There is no related valuation allowance at March 31, 2003 and 2002.
The Company's Hong Kong 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 U.S. parent company has reached the decision to provide for the
possibility that the exemption could be denied and accordingly has recorded a
provision in fiscal 2003, 2002, and 2001.
The Company may be deemed to have constructively repatriated
approximately $5.6 million, $5.7 million and $0 from its foreign operations in
2003, 2002 and 2001, respectively. Accordingly, these earnings were taxed as a
deemed dividend based on U.S. statutory rates. No provision has been made for
U.S. taxes on the remaining undistributed earnings of the Company's foreign
subsidiaries of approximately $3.6 million at March 31, 2003 and $1.9 million at
March 31, 2002, as it is anticipated that such earnings would be permanently
reinvested in their respective operations in accordance with section 956 of the
Internal Revenue Code.
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 Company 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.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
This Annual Report contains statements that are forward-looking. These
statements are based on current expectations and assumptions that are subject to
risks and uncertainties. Actual results could differ materially because of
issues and uncertainties such as those listed below, which, among others, should
be considered in evaluating the Company's financial outlook.
WE RECEIVED A GOING CONCERN UNCERTAINTY PARAGRAPH FROM OUR INDEPENDENT AUDITORS
Our consolidated financial statements as of and for the year ended
March 31, 2003 were prepared in conformity with accounting principles generally
accepted in the United States of America, which contemplates continuation of the
Company as a going concern. Our independent auditors have issued a report dated
June 24, 2003 (except for Note 9, as to which the date is July 8, 2003 and Note
15, as to which the date is July 10, 2003) stating that our default under our
credit agreement with LaSalle raises substantial doubt about our ability to
continue as a going concern. We have minimal liquidity as of June 24, 2003, the
date of the audit report, and our commercial lender has declared us in default
under the terms of our credit agreement, which expires on July 31, 2003. For
these reasons, our independent auditors were concerned about our ability to
continue as a going concern. We are attempting to restructure our credit
agreement with our lender. Based upon cash flow projections, the Company
believes the anticipated cash flow from operations will be sufficient to finance
the Company's operating needs until inventory is sold and the receivables
subsequently collected, provided the bank does not call the loan. However, there
can be no assurances that we will achieve our forecasted results and that our
cash flow from operations will be sufficient to finance our operating needs
until our inventory is sold. We are also seeking other sources of long and short
term capital. Because we can give no assurance that we can achieve any of the
foregoing, there is substantial uncertainty about our ability to continue as a
going concern. Because we have a going concern certainty paragraph, it may be
more difficult for us to raise capital.
15
WE HAVE SIGNIFICANT WORKING CAPITAL NEEDS WHICH ARE SUBJECT TO THE UNCERTAINTY
OF ADDITIONAL FINANCING
If we are not able to restructure our credit agreement with our
commercial lender by July 31, 2003, we will need to seek additional funds to
operate our business. Although we have been looking for alternative sources of
capital (in addition to our credit line with our commercial lender), we are not
certain that we will be able to locate and secure such additional financing on a
timely basis and on terms that are acceptable to the Company. We are also trying
to sell our excess inventory to provide us with more cash for operations. If we
do not have adequate financing, it will have a material adverse effect on our
business, results of operation and financial condition and we may need to change
our business strategy or reduce our operations. If we have a severe shortage of
working capital, we may not be able to continue our business operations and may
be required to file a petition for Chapter 11 or enter into some liquidation or
reorganization proceeding. In addition, any issuance of additional equity
securities will dilute the ownership interest of our existing stockholders and
issuance of debt securities may increase the perceived risk of investing in us.
WE ARE CURRENTLY IN DEFAULT UNDER OUR CREDIT AGREEMENT WITH OUR COMMERCIAL
LENDER
On March 14, 2003, we received a letter from LaSalle informing us that
we were in breach of our credit agreement as a result of our failure to maintain
the minimum tangible net worth requirement. In this letter, LaSalle also advised
us that it could accelerate the payment of all liabilities due under the credit
agreement at any time. Additionally, we have not satisfied a requirement in the
last amendment to our credit agreement that we obtain $2 million in subordinated
debt financing by 10, 2003. As of July 12, 2003, LaSalle has not filed a lawsuit
against us to accelerate the payment of any liabilities due under the credit
agreement. If LaSalle were to exercises its right to foreclose on our assets,
primarily our accounts receivable and inventory, this action might disrupt our
current business operations. If LaSalle were to liquidate a significant amount
of our inventory at one time, it might be more difficult for us to place
inventory with other retailers. We would also need to find financing from a
third party and there are no assurances that we will be able to do so.
WE ARE NAMED AS A DEFENDANT IN SEVERAL CLASS ACTION LAWSUITS
From July 2, 2003 through July 8, 2003, six securities class action
lawsuits were filed against our company 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 the Singing Machine's securities
during the various class action periods specified in the complaints. While the
specific factual allegations vary slightly in each case, the complaints
generally allege that defendants falsely represented the Singing Machine's
financial results during the relevant class periods.
While we believe that the allegations in the complaint are without
merit, an unfavorable resolution of pending litigation could have a material
adverse effect on our financial condition. Litigation may result in substantial
costs and expenses and significantly divert the attention of the Singing
Machine's management regardless of the outcome. There can be no assurance that
the Singing Machine will be able to achieve a favorable settlement of pending
litigation or obtain a favorable resolution of litigation if it is not settled.
In addition, current litigation could lead to increased costs or interruptions
of normal business operations of the Singing Machine.
WE RELY ON SALES TO A LIMITED NUMBER OF KEY CUSTOMERS, WHICH ACCOUNT FOR A LARGE
PORTION OF OUR NET SALES
As a percentage of total revenues, our net sales to our five largest
customers during the fiscal period ended March 31, 2003, 2002 and 2001 were
approximately 67%, 77% and 87% respectively. In fiscal 2003, three major
customers accounted for 21%, 17% and 15% of our net sales. Although we have
long-established relationships with many of our customers, we do not have
long-term contractual arrangements with any of them. A substantial reduction in
or termination of orders from any of our largest customers could adversely
affect our business, financial condition and results of operations. In addition,
pressure by large customers seeking price reductions, financial incentives,
changes in other terms of sale or requesting that we bear the risks and the cost
of carrying inventory, such as consignment agreements, could adversely affect
our business, financial condition and results of operations. The Company has
significantly broadened its base of customers, decreasing the amount of reliance
on their largest customers. If one or more of our major customers were to cease
doing business with us, significantly reduced the amount of their purchases from
us or returned substantial amounts of our products, it could have a material
adverse effect on our business, financial condition and results of operations.
16
WE MAY HAVE SIGNIFICANT RETURNS, MARKDOWNS AND PURCHASE ORDER CANCELLATIONS
As is customary in the consumer electronics industry, the Company has,
on occasion, (i) permitted certain customers to return slow-moving items for
credit, (ii) provided price protection to certain customers by making price
reductions effective as to certain products then held by customers in inventory
and (ii) accepted customer cancellations of purchase orders issued to the
Company. The Company expects that it will continue to be required to make such
accommodations in the future. Any significant increase in the amount of returns,
markdowns or purchaser order cancellations could have a material adverse effect
on the Company's results of operations.
OUR LICENSING AGREEMENTS ARE IMPORTANT TO OUR BUSINESS
We value all of our merchandise license agreements and feel that if any
of them were to be terminated or fail to be renewed, our business, financial
condition and results of operations could be adversely affected. Our license
with MTV is particular important to our business. We generated $30,884,344
million or 32.3% of our net sales from products sold under the MTV license in
fiscal 2003. However, management believes that our company has developed a
strong brand name in the karaoke industry and that it will be able to continue
to develop and grow its business, even if the merchandise license agreements did
not exist.
INVENTORY MANAGEMENT AND CONSIGNMENT ARRANGEMENTS
Because of our reliance on manufacturers in Asia for our machine
production, our production lead times are relatively long. Therefore, we must
commit to production in advance of customers orders. If we fail to forecast
customers or consumer demand accurately we may encounter difficulties in filling
customer orders or liquidating excess inventories, or may find that customers
are canceling orders or returning products. Distribution difficulties may have
an adverse effect on our business by increasing the amount of inventory and the
cost of storing inventory. As of March 31, 2003, we had $25 million in
inventory. We will attempt to liquidate this excess inventory during fiscal
2004. We believe that this entire inventory is highly marketable and saleable;
however, there can be no assurances that we will be able to liquidate this
inventory during our upcoming fiscal year.
As of March 31, 2003, we had one remaining consignment agreement with a
customer. Only one product line is included in this consignment agreement, our
music. The Company does not believe that any changes to this arrangement will
have a material adverse effect on our business, financial condition and results
of operations.
OUR INABILITY TO COMPETE AND MAINTAIN OUR NICHE IN THE ENTERTAINMENT INDUSTRY
COULD HURT OUR BUSINESS
The business in which we are engaged is highly competitive. Our major
competitors for karaoke machines and related products are Craig, Curtis, Grand
Prix and Memorex. We believe that competition for karaoke machines is based
primarily on price, product features, reputation, delivery times, and customer
support. Our primary competitors for producing karaoke music are Pocket Songs,
Sybersound, UAV and Sound Choice. We believe that competition for karaoke music
is based primarily on popularity of song titles, price, reputation, and delivery
times. To the extent that we lower prices for to attempt to enhance or retain
market share, we may adversely impact our operating margins. Conversely, if we
opt not to match competitor's price reductions we may lose market share,
resulting in decreased volume and revenue.
We believe that our new product introductions and enhancements of
existing products are material factors for our continued growth and
profitability. In fiscal 2003, we produced new lines of karaoke machines.
However, many of our competitors have significantly greater financial, marketing
and operating resources than we have. No assurance can be given that we will
continue to be successful in introducing new products or further enhancing our
existing products. In addition, we must compete with all the other existing
forms of entertainment including, but not limited to: motion pictures, video
arcade games, home video games, theme parks, nightclubs, television and
prerecorded tapes, CD's and video cassettes.
17
WE ARE SUBJECT TO SEASONALITY, WHICH IS AFFECTED BY VARIOUS ECONOMIC CONDITIONS
AND CHANGES RESULTING IN FLUCTUATIONS IN QUARTERLY RESULTS
Sales of consumer electronics and toy products in the retail channel
are highly seasonal, causing the substantial majority of our sales to occur
during the second quarter ended September 30 and the third quarter ended
December 31. Sales in our second and third quarter, combined, accounted for
approximately 85.6% of net sales in fiscal 2003, 81% of net sales in fiscal 2002
and 75% of net sales in fiscal 2001.
The seasonal pattern of sales in the retail channel requires
significant use of our working capital to manufacture and carry inventory in
anticipation of the holiday season, as well as early and accurate forecasting of
holiday sales. Failure to predict accurately and respond appropriately to
consumer demand on a timely basis to meet seasonal fluctuations, or any
disruption of consumer buying habits during their key period, would harm our
business and operating results. In fiscal 2003, we overestimated the demand for
our product and held $25 million of inventory as of March 31, 2003. Our
increased inventory levels led to a shortage in our available working capital
and our current liquidity crisis. Additional factors that can cause our sales
and operating results to vary significantly from period to period include, among
others, the mix of products, fluctuating market demand, price competition, new
product introductions by competitors, fluctuations in foreign currency exchange
rates, disruptions in delivery of components, political instability, general
economic conditions, and the other considerations described in this section
entitled Risk Factors.
A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTERS IN CALIFORNIA AND FLORIDA
WOULD IMPACT OUR ABILITY TO DELIVERY MERCHANDISE TO OUR STORES, WHICH COULD
ADVERSELY IMPACT OUR REVENUES AND HARM OUR BUSINESS AND FINANCIAL RESULTS
A significant amount of our merchandise is shipped to our customers
from one of our three warehouses, which are located in Compton, California,
Rancho Dominguez, California and Coconut Creek, Florida. Events such as fire or
other catastrophic events, any malfunction or disruption of our centralized
information systems or shipping problems may result in delays or disruptions in
the timely distribution of merchandise to our customers, which could adversely
impact our revenues and our business and financial results.
OUR BUSINESS OPERATIONS COULD BE DISRUPTED IF THERE ARE LABOR PROBLEMS ON THE
WEST COAST
During fiscal 2003, approximately 48% of our sales were domestic sales,
which were made from our warehouses in California and Florida. During the third
quarter of fiscal 2003, the dock strike on the West Coast affected sales of two
of our karaoke products and we estimate that we lost between $3 and $5 million
in orders because we couldn't get the containers of these products off the pier.
If another strike or work slow-down were to occur and we do not have a
sufficient level of inventory, a strike or work slow-down would result in
increased costs to our company and may reduce our profitability.
OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD HARM
OUR BUSINESS
We rely principally on four contract ocean carriers to ship virtually
all of the products that we import to our warehouse facility in Compton,
California. Retailers that take delivery of our products in China rely on a
variety of carriers to import those products. Any disruptions in shipping,
whether in California or China, caused by labor strikes, other labor disputes,
terrorism, and international incidents or otherwise could significantly harm our
business and reputation.
WE MAY NOT BE ABLE TO SUSTAIN OR MANAGE OUR RAPID GROWTH
We experienced rapid growth in net sales and net income over the last
few years. Our net sales for the fiscal year ended March 31, 2003 increased 53%
to $95.6 million compared to $62.5 million for the fiscal year ended March 31,
2002. Our net income for fiscal 2003 was $1.2 million compared to $6.3 million
for fiscal 2002. As a result, comparing our period-to-period operating results
may not be meaningful, and results of operations from prior periods may not be
indicative of future results. We cannot assure you that we will continue to
experience growth in, or maintain our present level of, net sales or net income.
Our growth strategy calls for us to continuously develop and diversify
our karaoke products by (i) developing new and innovative karaoke machines and
music products, (ii) entering into additional license agreements (iii) expanding
into international markets, (iv) developing new retail customers in the United
States and (v) obtaining additional financing. Our growth strategy will place
additional demands on our management, operational capacity and financial
resources and systems. To effectively manage future growth, we must continue to
expand our operational, financial and management information systems and train,
motivate and manage our work force.
18
In addition, implementation of our growth strategy is subject to risks
beyond our control, including competition, market acceptance of new products,
changes in economic conditions, our ability to maintain our licensing agreements
with MTV and Nickelodeon and our ability to finance increased levels of accounts
receivable and inventory necessary to support our sales growth, if any.
Accordingly, we cannot assure you that our growth strategy will be implemented
successfully.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE
Market prices of the securities of companies in the toy and
entertainment industry are often volatile. The market prices of our common stock
may be affected by many factors, including:
- - our ability to resolve our present liquidity crisis, by extending our credit
facility with LaSalle or by finding alternative sources of financing,
- - our ability to resell our excess inventory as of March 31, 2003;
- - unpredictable consumer preferences and spending trends;
- - the actions of our customers and competitors (including new product line
announcements and introduction;
- - changes in our pricing policies, the pricing policies of our competitors and
general pricing trends in the consumer and electronics and toy markets;
- - regulations affecting our manufacturing operations in China;
- - other factors affecting the entertainment and consumer electronics industries
in general; and
- - sales of our common stock into the public market.
In addition, the stock market periodically has experienced significant price and
volume fluctuations which may have been unrelated to the operating performance
of particular companies.
OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE'S REPUBLIC OF CHINA,
SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS
We are dependent upon six factories in the People's Republic of China
to manufacture all of our electronic products. Our arrangements with these
factories are subject to the risks of doing business abroad, such as import
duties, trade restrictions, work stoppages, and foreign currency fluctuations,
limitations on the repatriation of earnings, political instability, and other
factors, which could have an adverse impact on our business. Furthermore, we
have limited control over the manufacturing processes themselves. As a result,
any difficulties encountered by the third-party manufacturers that result in
product defects, production delays, cost overruns or the inability to fulfill
orders on a timely basis could adversely affect our business, financial
condition and results of operations. We believe that the loss of any one or more
of our manufacturers would not have a long-term material adverse effect on us
because other manufacturers with whom we do business would be able to increase
production to fulfill our requirements. However, the loss of certain of our
manufacturers, could, in the short-term, adversely affect our business until
alternative supply arrangements were secured.
WE DEPEND ON THIRD PARTY SUPPLIERS FOR PARTS FOR OUR KARAOKE MACHINES AND
RELATED PRODUCTS, AND IF WE CANNOT OBTAIN SUPPLIES AS NEEDED, OUR OPERATIONS
WILL BE SEVERELY DAMAGED
Our growth and ability to meet customer demand depends in part on our
capability to obtain timely deliveries of karaoke machines and our electronic
products. We rely on third party suppliers to produce the parts and materials we
use to manufacture and produce these products. If our suppliers are unable to
provide our factories with the parts and supplies, we will be unable to produce
our products. We cannot guarantee that we will be able to purchase the parts we
need at reasonable prices or in a timely fashion. In the last several years,
there have been shortages of certain chips that we use in our karaoke machines.
We, however, have anticipated this shortage and have made commitments to our
factories to purchase chips in advance. If we are unable to anticipate any
shortages of parts and materials in the future, we may experience severe
production problems, which would impact our sales.
19
CONSUMER DISCRETIONARY SPENDING MAY AFFECT KARAOKE PURCHASES AND IS AFFECTED BY
VARIOUS ECONOMIC CONDITIONS AND CHANGES
Our business and financial performance may be damaged more than most
companies by adverse financial conditions affecting our business or by a general
weakening of the economy. Purchases of karaoke machines and music are considered
discretionary for consumers. Our success will therefore be influenced by a
number of economic factors affecting discretionary and consumer spending, such
as employment levels, business, interest rates, and taxation rates, all of which
are not under our control. Adverse economic changes affecting these factors may
restrict consumer spending and thereby adversely affect our growth and
profitability.
WE MAY BE INFRINGING UPON THE COPYRIGHTS OF THIRD PARTIES
Each song in our catalog is licensed to us for specific uses. Because
of the numerous variations in each of our licenses for copyrighted music, there
can be no assurance that we have complied with scope of each of our licenses and
that our suppliers have complied with these licenses. Additionally, third
parties over whom we exercise no control may use our sound recordings in such a
way that is contrary to our license agreement and by violating our license
agreement we may be liable for contributory copyright infringement. Any
infringement claims may have a negative effect on our ability to sell products.
WE HAVE SIGNIFICANT RELIANCE ON LARGE RETAILERS, WHICH ARE SUBJECT TO CHANGES IN
THE ECONOMY
We sell products to retailers, including department stores, lifestyle
merchants, direct mail retailers, which are catalogs and showrooms, national
chains, specialty stores, and warehouse clubs. Certain of such retailers have
engaged in leveraged buyouts or transactions in which they incurred a
significant amount of debt, and some are currently operating under the
protection of bankruptcy laws. Despite the difficulties experienced by retailers
in recent years, we have not suffered significant credit losses to date.
Deterioration in the financial condition of our customers could have a material
adverse effect on our future profitability.
OUR BUSINESS OPERATIONS COULD BE SIGNIFICANTLY DISRUPTED IF WE LOSE MEMBERS OF
OUR MANAGEMENT TEAM
Our success depends to a significant degree upon the continued
contributions of our executive officers, both individually and as a group.
Although we have entered into employment contracts with Edward Steele, our Chief
Executive Officer; Yi Ping. Chan, our Chief Operating Officer, April Green, our
Chief Financial Officer and Jack Dromgold, our Executive Vice President of Sales
and Marketing, the loss of the services of any of these individuals could
prevent us from executing our business strategy. We cannot assure you that we
will be able to find appropriate replacements for Edward Steele or Jack
Dromgold, if the need should arise, and any loss or interruption of Mr. Steele
or Mr. Dromgold's services could adversely affect our business, financial
condition and results of operations.
OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS.
Our employment agreements with Eddie Steele, Yi Ping Chan, April Green
and Jack Dromgold require us, under certain conditions, to make substantial
severance payments to them if they resign after a change of control. These
provisions could delay or impede a merger, tender, offer or other transaction
resulting in a change in control of the Company, even if such a transaction
would have significant benefits to our shareholders. As a result, these
provisions could limit the price that certain investors might be willing to pay
in the future for shares of our common stock.
WE MAY BE SUBJECT TO CLAIMS FROM THIRD PARTIES FOR UNAUTHORIZED USE OF THEIR
PROPRIETARY TECHNOLOGY, COPYRIGHTS OR TRADE SECRETS
We believe that we independently developed the technology used in our
electronic and audio software products and that it does not infringe on the
proprietary rights, copyrights or trade secrets of others. However, we cannot
assure you that we have not infringed on the proprietary rights of third parties
or those third parties will not make infringement violation claims against us.
Any infringement claims may have a negative effect on our ability to manufacture
our products.
YOUR INVESTMENT MAY BE DILUTED
If additional funds are raised through the issuance of equity
securities, your percentage ownership in our equity will be reduced. Also, you
may experience additional dilution in net book value per share, and these equity
securities may have rights, preferences, or privileges senior to those of yours.
20
RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS MAY DEPRESS OUR
STOCK PRICE
As of March 31, 2003, there were 8,171,678 shares of our common stock
outstanding. We have filed two registration statements registering an aggregate
3,794,250 of shares of our common stock (a registration statement on Form S-8 to
registering the sale of 1,844,250 shares underlying options granted under our
1994 Stock Option Plan and a registration statement on Form S-8 to register
1,950,000 shares of our common stock underlying options granted under our Year
2001 Stock Option Plan). The market price of our common stock could drop due to
the sale of large number of shares of our common stock, such as the shares sold
pursuant to the registration statements or under Rule 144, or the perception
that these sales could occur.
ADVERSE EFFECT ON STOCK PRICE FROM FUTURE ISSUANCES OF ADDITIONAL SHARES
Our Certificate of Incorporation authorizes the issuance of 18,900,000
million shares of common stock. As of March 31, 2003, we had 8,171,678 shares of
common stock issued and outstanding and an aggregate of 1,513,250 outstanding
options and warrants. As such, our Board of Directors has the power, without
stockholder approval, to issue up to 9,215,072 shares of common stock.
Any issuance of additional shares of common stock, whether by us to new
stockholders or the exercise of outstanding warrants or options, may result in a
reduction of the book value or market price of our outstanding common stock.
Issuance of additional shares will reduce the proportionate ownership and voting
power of our then existing stockholders.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY MAKE IT DIFFICULT FOR A
THIRD PARTY TO ACQUIRE OUR COMPANY AND COULD DEPRESS THE PRICE OF OUR COMMON
STOCK.
Delaware law and our certificate of incorporation and bylaws contain
provisions that could delay, defer or prevent a change in control of our company
or a change in our management. These provisions could also discourage proxy
contests and make it more difficult for you and other stockholders to elect
directors and take other corporate actions. These provisions of our restated
certificate of incorporation include: authorizing our board of directors to
issue additional preferred stock, limiting the persons who may call special
meetings of stockholders, and establishing advance notice requirements for
nominations for election to our board of directors or for proposing matters that
can be acted on by stockholders at stockholder meetings.
We are also subject to certain provisions of Delaware law that could
delay, deter or prevent us from entering into an acquisition, including the
Delaware General Corporation Law, which prohibits a Delaware corporation from
engaging in a business combination with an interested stockholder unless
specific conditions are met. The existence of these provisions could limit the
price that investors are willing to pay in the future for shares of our common
stock and may deprive you of an opportunity to sell your shares at a premium
over prevailing prices.
ITEM 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 rates. We are exposed to market risk
in the areas of changes in United States and international borrowing rates and
changes in foreign currency exchange rates. In addition, we are exposed to
market risk in certain geographic areas that have experienced or remain
vulnerable to an economic downturn, such as China. We purchase substantially all
of our inventory from companies in China, and, therefore, we are subject to the
risk that such suppliers will be unable to provide inventory at competitive
prices. While we believe that, if such an event were to occur we would be able
to find alternative sources of inventory at competitive prices, we cannot assure
you that we would be able to do so. These exposures are directly related to our
normal operating and funding activities. Historically and as of March 31, 2003,
we have not used derivative instruments or engaged in hedging activities to
minimize market risk.
INTEREST RATE RISK:
Our exposure to market risk resulting from changes in interest rates
relates primarily to debt under our credit facility with LaSalle. Under our
credit facility, our interest rate is LaSalle's prime rate plus 1/2 of 1% per
annum ("current interest rate"). As of March 31, 2003, we are accruing interest
at the default rate, which is the current interest rate under the credit
agreement plus 2.5% per annum. We do not believe that near-term changes in the
interest rates, if any, will result in a material effect on our future earnings,
fair values or cash flows.
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, The Singing Machine Company, Inc. (the "Company")
dismissed Salberg & Company, P.A. (the "Former Accountant"), as its independent
certified public accountant. On March 27, 2003, the Company engaged Grant
Thornton LLP (the "New Accountant"), as its independent certified public
accountant. The Company's decision to change accountants was approved by its
Audit Committee on March 24, 2003.
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The report of the Former Accountant on the financial statements of the
Company for the two most recent fiscal years and all subsequent interim periods,
did not contain an adverse opinion or disclaimer of opinion and was not
qualified or modified as to uncertainty, audit scope or accounting principles
for the two most recent fiscal years and all subsequent interim periods.
Furthermore, the Former Accountant has not advised the Company that:
1) internal controls necessary to develop reliable financial
statements do not exist, or
2) information has come to the attention of the Former Accountant
which made it unwilling to rely upon management's
representations or made it unwilling to be associated with the
financial statement prepared by management, or
3) the scope of the audit should be expanded significantly, or
information has come to the attention of the Former Accountant
that they have concluded will, or if further investigated
might, materially impact the fairness or reliability of a
previously issued audit report or the underlying financial
statements, or the 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 financial statements) or
made in unwilling to rely on management's representations or
to be associated with the financial statements prepared by
management or,
4) information has come to the attention of the Former Accountant
that they have concluded will, or if further investigated
might, materially impact the fairness or reliability of a
previously issued audit report or the underlying financial
statements or the financial statements issued or to be issued
covering the fiscal periods subsequent to March 31, 2002
through the date of this Form 8-K that has not been resolved
to the Former Accountant's satisfaction or which would have
prevented the Former Accountant from rendering an unqualified
audit report on such financial statements.
During the Company's two most recent fiscal years and all subsequent
interim periods, there were no disagreements with the Former Accountant on any
matters of accounting principles or practices, financial statement disclosure or
auditing scope or procedure, which, if not resolved to the satisfaction of the
Former Accountant 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.
The Company did not consult with the New Accountant 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 the
Company's financial statements, and no written or oral advice was provided by
the New Accountant that was a factor considered by the Company in reaching a
decision as to the accounting, auditing or financial reporting issues.
RESTATEMENT
In June 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 and
2001. We discussed these issues with Salberg & Company, P.A. and it agreed to
opine on the restated financial statements.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to our
executive officers and directors as of March 31, 2003.
Name Age Position
Edward Steele 73 Chief Executive Officer & Chairman
Yi Ping Chan 38 Chief Operating Officer, Secretary
Jack S. Dromgold 59 Executive Vice-president of Sales & Marketing
April J. Green 39 Chief Financial Officer
Josef A. Bauer 65 Director
Howard W. Moore 72 Director
Robert J. Weinberg 54 Director
John F. Klecha 52 Director
Edward Steele has served as the Chief Executive Officer and as a
director of the Company from September 1991 through the present date. He also
served as our President from September 1991 through March 2001 and oversaw our
reorganization in our Chapter 11 proceeding which began in April 1997 and was
completed in June 1998. From October 1988 to September 1991, Mr. Steele was our
sales director and was responsible for the development of our electronic
hardware products in Asia. Prior to joining us, Mr. Steele served in executive
capacities at a number of companies in the toy and electronics fields, including
as managing director in charge of worldwide sales of Concept 2000, a
manufacturer of consumer electronics from 1971 to 1978; as President of Wicely
Corp., a distributor of electronic toys and consumer electronics from 1978 to
1983; and as President of Justin Products Corp., an electronic toy manufacturer
from 1983 to 1988.
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Yi Ping Chan has served as our Chief Operating Officer from May 2,
2003. Prior to this appointment, Chan was a consultant to Singing Machine. Mr.
Chan was a founder of MaxValue Capital Ltd., a Hong Kong-based management
consulting and investment firm, and co-founder 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, 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. From 1994 to 1997, Mr. Chan was
Business Development Manager for AlliedSignal Inc. (now part of Honeywell
International, Inc.) and Knorr-Bremse Far East Ltd., where he focused on joint
ventures and acquisitions in China and Japan. Earlier, he was Senior Associate
Engineer for IBM in New York, and began his career as a member of the technical
staff of TRW Corporation in Redondo Beach, California. Under IBM sponsorship,
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. Mr.
Chan is a member of the Young Entrepreneurs' Organization, serving as a board
member of the Hong Kong chapter in 2002 and 2003. He also served as a
development advisor and associate for the Global Chinese Business Initiative at
the Wharton School, University of Pennsylvania from 1998 to 2001
Jack Dromgold has served as our Executive Vice President of Sales and
Marketing since April 16, 2002. Prior to joining us, Mr. Dromgold served as Vice
President of Sales for Hasbro Games from 1993 through April 2002. Mr. Dromgold
is a 35-year veteran of the toy and game industry and has been involved in the
development of sales programs to support the launch of many new products over
the years.
April Green has served as our Chief Financial Officer since March 15,
2002 through the present date. Ms. Green joined our company in June 1999 as our
controller and was promoted to the position of Director of Finance &
Administration in January 1, 2000. 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 February
1993, 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 Klecha has served as a director of our company since October 10,
1997. Mr. Klecha served as our President from March 2001 through May 2, 2003, as
our Chief Operating Officer from March 2001 through May 2, 2003 and as our Chief
Financial Officer, Secretary and Treasurer from October 10, 1997 through April
15, 2002. Mr. Klecha joined our company to assist us from emerging from our
Chap