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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, 2005
0 - 24968
Commission File Number
THE SINGING MACHINE COMPANY, INC.
(Exact Name Registrant as Specified in its Charter)
DELAWARE 95-3795478
(State of incorporation) (I.R.S. Employer Identification No.)
6601 LYONS ROAD, BUILDING A-7, COCONUT CREEK, FL 33073
(Address of principal executive offices)
(954) 596-1000
(Issuer's telephone number,
including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Title of Each Class Name of Each Exchange on Which Registered
COMMON STOCK AMERICAN STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. |X| Yes |_| No
Indicate by check mark if disclosure of delinquent filers pursuant Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). |_| Yes |X| No
The aggregate market value of the Registrant's voting stock held by
non-affiliates, based upon the closing price for the common stock of $0.76 per
share as reported on the American Stock Exchange on June 7, 2005 was
approximately $7,636,002 (based on 10,047,371 shares outstanding).
APPLICABLE ONLY TO CORPORATE ISSUERS: State the number of shares outstanding of
each of the Issuer's classes of common stock, as of the latest practicable date.
There were 10,047,371 shares of common stock, issued and outstanding at June 7,
2005.
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, 2005
PAGE
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PART I
Item 1. Business 2
Item 2. Properties 6
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 7
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters and Issuer Purchases
of Equity Securities 8
Item 6. Selected Financial Data 8
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 9
Item 7A Quantitative and Qualitative Disclosures About Market Risk 22
Item 8. Financial Statements and Supplementary Data 22
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 22
Item 9A. Controls and Procedures 23
Item 9B. Other Information 23
PART III
Item 10. Directors and Executive Officers of the Registrant 24
Item 11. Executive Compensation 26
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters 31
Item 13. Certain Relationships and Related Transactions 32
Item 14. Principal Accounting Fees and Services 33
PART IV
Item 15. Exhibits, Financial Statement Schedules 33
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements contained in this Annual Report on Form 10-K, including
without limitation, statements containing the words "believes," "anticipates,"
"estimates," "expects," "intends," and words of similar import, constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those reflected in these forward-looking statements. Factors
that might cause such a difference include, but are not limited to, those
discussed in the section entitled "Management's Discussion and Analysis of
Financial Position and Results of Operations - Factors That May Affect Future
Results and Market Price of Stock."
Readers are cautioned not to place undue reliance on these forward- looking
statements, which reflect management's opinions only as of the date hereof. We
undertake no obligation to revise or publicly release the results of any
revisions to these forward- looking statements. Readers should carefully review
the risk factors described in other documents the Company files from time to
time with the Securities and Exchange Commission.
1
PART I
ITEM 1. BUSINESS
OVERVIEW
The Singing Machine Company, Inc. (the "Singing Machine" "we," "us" or "our") is
engaged in the development, production, distribution, marketing and sale of
consumer karaoke audio equipment, accessories and music. We contract for the
manufacture of all electronic equipment products with factories located in
China. We also produce and market karaoke music, including compact disks plus
graphics ("CD+G's"), and audiocassette tapes containing music and lyrics of
popular songs for use with karaoke recording equipment. All of our recordings
include two versions of each song; one track offers music and vocals for
practice and the other track is instrumental only for performance by the
participant. Virtually all of the cassettes sold by us are accompanied by
printed lyrics, and our karaoke CD+G's contain lyrics, which appear on the video
screen. We contract for the reproduction of music recordings with independent
studios. See "Legal Proceedings."
We were incorporated in California in 1982. We originally sold our products
exclusively to professional and semi-professional singers. In 1988, we began
marketing karaoke equipment for home use. In May 1994, we merged into a wholly
owned subsidiary incorporated in Delaware with the same name. As a result of
that merger, the Delaware Corporation became the successor to the business and
operations of the California Corporation and retained the name The Singing
Machine Company, Inc. In July 1994, we formed a wholly owned subsidiary in Hong
Kong, now known as International SMC (HK) Ltd. ("International SMC" or "Hong
Kong subsidiary"), to coordinate our engineering, production, logistic and
finance in China.
In November 1994, we closed an initial public offering of 2,070,000 shares of
our common stock and 2,070,000 warrants. In April 1997, we filed a voluntary
petition for relief under Chapter 11 of the U.S. Bankruptcy Code. On March 17,
1998, our plan of reorganization was approved by the U.S. Bankruptcy Court. On
June 10, 1998, our plan of reorganization had been fully implemented. Our common
stock currently trades on the American Stock Exchange under the symbol "SMD." We
were listed on the AMEX on March 8, 2001. Our principal executive offices are
located in Coconut Creek, Florida.
As used herein, the "Singing Machine," "we," us" and similar terms include The
Singing Machine Company, Inc. and its subsidiary, International SMC, unless the
context indicates otherwise.
PRODUCT LINES
We currently have a product line of 27 different models of karaoke machines plus
10 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 $200 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 2500 recordings, which we license from publishers. Our library of master
recordings covers the entire range of musical tastes including popular hits,
golden oldies, country, rock and roll, Christian, Latin music and rap. We even
have backing tracks for opera and certain foreign language recordings.
MARKETING, SALES AND DISTRIBUTION
Our karaoke machines and music are sold nationally and internationally to a
broad spectrum of customers, primarily through mass merchandisers, department
stores, direct mail catalogs and showrooms, music and record stores, national
chains, specialty stores, and warehouse clubs. Our karaoke machines and karaoke
music are currently sold in such stores as Best Buy, Circuit City, Costco, J.C.
Penney, Kohl's, Radio Shack, and Sam's Club.
In fiscal 2005, approximately 74 % of revenues were to the customers within the
US and 26% of revenues were international sales. Our sales within the US are
primarily made by our in-house sales team and our independent sales
representatives. Our independent sales representatives are paid a commission
based upon sales in their respective territories. We utilize some of our outside
independent sales representatives to help us provide service to our mass
merchandisers and other retailers. The sales representative agreements are
generally one (1) year agreements, which automatically renew on an annual basis,
unless terminated by either party on 30 days' notice. At March 31, 2005, we
worked with 14 independent sales representatives in the United States. Our
international sales are primarily made by our in-house sales representatives and
our independent distributors.
We also market our products at various national and international trade shows
each year. We regularly attend the following trade shows and conventions: the
Consumer Electronics Show each January in Las Vegas; the American Toy Fair each
February in New York and the Hong Kong Electronics Show each October in Hong
Kong.
Our licensing agreements with MTV Networks, Inc. and Nickelodeon, both a
division of Viacom International, Inc and Universal Music Entertainment, Inc.
have also helped us to expand our product name. However, we are depending less
and less on the licensed products as we move forward.
2
DISTRIBUTORSHIP AGREEMENTS
In November 2001, we signed an international distributorship agreement with
Arbiter Group, PLC ("Arbiter"). Arbiter is the exclusive distributor of Singing
Machine(R) karaoke machines and music products in the United Kingdom and a
non-exclusive distributor in all other European countries. The agreement is
subject to an automatic renewal provision. If either party does not give notice
on or before December 1 of year during the term of the agreement, the agreement
will automatically be renewed for another year on the same terms.
In March 2003, we signed an international distributorship agreement with Top-Toy
(Hong Kong) Ltd. Top Toy is the exclusive distributor of Singing Machine(R)
karaoke machines and music products in Denmark, Norway, Sweden, Iceland and
Faeroe Islands. The agreement is for three years, from April 1, 2003 through
March 31, 2006. The agreement contains an automatic renewal provision whereby if
either party does not give notice at least 3 months before March 31, 2006, the
agreement will automatically be renewed for another year on the same terms. We
also have verbal agreements with six other independent distributors who sell our
products throughout Europe
SALES
As a percentage of total revenues, our net sales in the aggregate to our five
largest customers during the fiscal years ended March 31, 2005, 2004, and 2003,
respectively, were approximately 40%, 54% and 67%, respectively. In fiscal 2005,
top three major customers accounted for 9%, 8% and 8% of our net revenues.
Although we have long-established relationships with all of our customers, we do
not have contractual arrangements with any of them. A decrease in business from
any of our major customers could have a material adverse effect on our results
of operations and financial condition.
Sales by customer geographic regions are as follows:
FOR THE FISCAL YEARS ENDED
March 31,
2005 2004 2003
---------------------------------------------------
North America $28,227,140 $43,044,496 $77,696,780
Europe 9,531,632 25,783,789 15,714,846
Others 451,053 1,712,843 2,202,140
---------------------------------------------------
$38,209,825 $70,541,128 $95,613,766
===================================================
RETURNS
Returns of electronic hardware and music products by our customers are generally
not permitted except in approved situations involving quality defects, damaged
goods, goods shipped in error. Our policy is to give credit to our customers for
the returns in conjunction with the receipt of new replacement purchase orders.
Our total returns represented 9.2% and 9.4% of our net sales in fiscal 2005 and
2004, respectively.
LICENSE AGREEMENTS
We entered into our licensing agreement with MTV in November 2000 and have
amended the agreement five times since that date. Our license covers the sale of
MTV products in the United States, Canada and Australia. During fiscal 2004, our
line consisted of nine MTV branded machines and a wide assortment of MTV branded
music. Our license agreement as amended with MTV, expired on August 31, 2004,
however MTV chose to extend the agreement until December 31, 2004. The minimum
guarantee was $300,000, which has been paid in full as of March, 31, 2005. The
agreement was terminated on December 31, 2004. MTV has extended the selling off
period for one existing MTV licensed product to September 30, 2005. The company
has prepaid the royalty in the amount of $30,705 for the entire MTV licensed
inventory in April, 2005, which will be recorded as royalty expense for fiscal
2006. We also have a licensing agreement with MTV for an European country ended
October 31, 2005 with an option to extend until October 31, 2006.
We entered into our licensing agreement with Hard Rock Academy, a division of
Hard Rock Cafe in December 2001. This license agreement allows us to produce and
market a line of karaoke machines and complimentary music that are co-branded
with the Singing Machine and Hard Rock Academy name. The first co- branded
machine was produced during the fourth quarter of fiscal 2003. The agreement
originally contained a minimum guaranteed royalty payment, but in September 2003
Hard Rock agreed to release us from our minimum guaranteed payment obligations
during the remaining term of the license agreement. This agreement expired on
December 31, 2004 and does not contain any automatic renewal provisions.
In February 2003, we entered into a multi-year license agreement with Universal
Music Entertainment to market a line of Motown Original Artist Karaoke machines
and music. This agreement and its subsidiary agreement signed in March 2003,
allow us to be the first to use original artist recordings for our CD+G
formatted karaoke music. Over the term of the license agreement, we are
obligated to make guaranteed minimum royalty payments in the amount of $300,000,
which has been paid in full as of March 31, 2005. The Universal Music
Entertainment license originally expires on March 31, 2006 and does not contain
any automatic renewal provisions. However, the agreement was extended to
December 31, 2006 without additional minimum guarantee payment.
3
We entered into a license agreement with Care Bears in September 2003. Under
this agreement, we are marketing a line of Care Bears branded karaoke machines
and music. Over the term of the license, we are obligated to make guaranteed
minimum royalty payments in the amount of $200,000. This license originally
expires on January 1, 2006 and does not contain any automatic renewal
provisions. In October 2004, we have signed a termination agreement to cease the
license by December 31, 2004. We are obligated to pay minimum royalty payments
in the amount of $200,000, which has been paid in full as of November 20, 2004.
We entered into a license agreement with Nickelodeon, Inc., a division of Viacom
International, Inc. in December 2002. Under this agreement, we licensed
Nickelodeon branded machines and a wide assortment of music. This license
originally expires on December 31, 2004. The company has extended the agreement
to December 31, 2005. Over the term of the license agreement, we are obligated
to make guaranteed minimum royalty payments in the amount of $450,000, which has
been paid in full as of March 31, 2005.
We distribute all of our licensed products through our established distribution
channels, including Best Buy, Circuit City, Costco, JC Penney, Kohl's, Radio
Shack and Sam's Club. Our distribution network also includes the online versions
of these retail customers.
The following table sets forth the percentage of total sales that have been
generated under the MTV License, our Nickelodeon License and our other licenses
(Care Bears, Hard Rock Academy and Universal Music).
FOR THE FISCAL YEAR ENDED
March 31,
2005 2004 2003
-------------------------------------
MTV 17.6% 11.8% 32.3%
Nickelodeon 0.5% 5.5% 0%
Other Licenses 2.5% 3.9% 0%
-------------------------------------
Total Licenses Sales 20.5% 21.2% 32.3%
=====================================
In the future, we might use our own brand or other brands.
DISTRIBUTION
We distribute hardware products to retailers and wholesale distributors through
two methods: shipment of products from inventory held at our warehouse
facilities in Florida and California (domestic sales), and shipments directly
through our Hong Kong subsidiary and manufacturers in China of products (direct
sales). Domestic sales, which account for substantially all of our music sales,
are made to customers located throughout the United States from inventories
maintained at our warehouse facilities. In the fiscal year ended March 31, 2005,
approximately 36% of our sales were sales from our domestic warehouses
("Domestic Sales") and 64% were sales shipped directly from China ("Direct
Sales").
Domestic Sales. Our strategy of selling products from a domestic warehouse
enables us to provide timely delivery and serve as a domestic supplier of
imported goods. We purchase karaoke machines overseas from certain factories in
China for our own account, and warehouse the products in leased facilities in
Florida and California. We are responsible for costs of shipping, insurance,
customs clearance, duties, storage and distribution related to such products
and, therefore, domestic sales command higher sales prices than direct sales. We
generally sell from our own inventory in less than container-sized lots.
Direct Sales. We ship some hardware products sold by us directly to customers
from China through International SMC, our subsidiary. Sales made through
International SMC are completed by either delivering products to the customers'
common carriers at the shipping point or by shipping the products to the
customers' distribution centers, warehouses, or stores. Direct sales are made in
larger quantities (generally container sized lots) to customers' world wide, who
pay International SMC pursuant to their own international, irrevocable,
transferable letters of credit or on open account.
MANUFACTURING AND PRODUCTION
Our karaoke machines are manufactured and assembled by third parties pursuant to
design specifications provided by us. Currently, we have ongoing relationships
with six factories, located in Guangdong Province of the People's Republic of
China, who assemble our karaoke machines. During fiscal 2006, we anticipate that
50% of our karaoke products will be produced by one of these factories, which
has agreed to extend financing to us. We believe that the manufacturing capacity
of our factories is adequate to meet the demands for our products in fiscal year
2006. However, if our primary factory in China was prevented from manufacturing
and delivering our karaoke products, our operation would be severely disrupted
while alternative sources of supply are located. See "Risk Factors - We are
relying on one factory to manufacture and produce the majority of our karaoke
machines for fiscal 2006" on page 16. In manufacturing our karaoke related
products, these factories use molds and certain other tooling, most of which are
owned by International SMC. Our products contain electronic components
manufactured by other companies such as Panasonic, Sanyo, Toshiba, and Sony. Our
manufacturers purchase and install these electronic components in our karaoke
machines and related products. The finished products are packaged and labeled
under our trademark, The Singing Machine(R).
4
We have obtained copyright licenses from music publishers for all of the songs
in our music library. We contract with outside studios on a work-for hire basis
to produce recordings of these songs. After the songs have been recorded, we
author the CD+G's in our in house studio. We use outside companies to
mass-produce the CD+G's and audiocassettes, once the masters have been
completed.
While our equipment manufacturers purchase our supplies from a small number of
large suppliers, all of the electronic components and raw materials used by us
are available from several sources of supply, and we do not anticipate that the
loss of any single supplier would have a material long-term adverse effect on
our business, operations, or financial condition. Similarly, we use a small
number of studios to record our music (including our in house production), we do
not anticipate that the loss of any single studio would have a material
long-term adverse effect on our business, operations or financial condition. To
ensure that our high standards of product quality and factories meet our
shipping schedules, we utilize Hong Kong based employees of International SMC as
our representatives. These employees include product inspectors who are
knowledgeable about product specifications and work closely with the factories
to verify that such specifications are met. Additionally, key personnel
frequently visit our factories for quality assurance and to support good working
relationships.
All of the electronic equipment sold by us is warranted to the end user against
manufacturing defects for a period of ninety (90) days for labor and parts. All
music sold is similarly warranted for a period of 30 days. During the fiscal
years ended March 31, 2005, 2004 and 2003, warranty claims have not been
material to our results of operations.
COMPETITION
Our business is highly competitive. Our major competitors for karaoke machines
and related products are Craig and Memorex. We believe that competition for
karaoke machines is based primarily on price, product features, reputation,
delivery times, and customer support. We believe that our brand name is well
recognized in the industry and helps us compete in the karaoke machine category.
Our primary competitors for producing karaoke music are Pocket Songs, UAV,
Sybersound and Sound Choice. We believe that competition for karaoke music is
based primarily on popularity of song titles, price, reputation, and delivery
times.
In addition, we compete with all other existing forms of entertainment
including, but not limited to, motion pictures, video arcade games, home video
games, theme parks, nightclubs, television and prerecorded tapes, CD's, and
videocassettes. Our financial position depends, among other things, on our
ability to keep pace with changes and developments in the entertainment industry
and to respond to the requirements of our customers. Many of our competitors
have significantly greater financial, marketing, and operating resources and
broader product lines than we do.
TRADEMARKS
We have obtained registered trademarks for The Singing Machine name and the logo
in which the microphone is used in our name in the United States and in the
European Community. We have also filed trademark applications in Australia and
Hong Kong. In fiscal 2003, we filed intent to use an application for the
"Karaoke Vision" mark in the United States. The application has not been
finalized as of March 31, 2005.
Our trademarks are a significant asset because they provide product recognition.
We believe that our intellectual property is significantly protected, but there
are no assurances that these rights can be successfully asserted in the future
or will not be invalidated, circumvented or challenged.
COPYRIGHTS AND LICENSES
We hold federal and international copyrights to substantially all of the music
productions comprising our song library. However, since each of those
productions is a re-recording of an original work by others, we are subject to
contractual and/or statutory licensing agreements with the publishers who own or
control the copyrights of the underlying musical compositions. We are obligated
to pay royalties to the holders of such copyrights for the original music and
lyrics of all of the songs in our library that have not passed into the public
domain. We are currently a party to many different written copyright license
agreements.
The majority of the songs in our song library are subject to written copyright
license agreements, oftentimes referred to as synchronization licenses. Our
written licensing agreements for music provide for royalties to be paid on each
song. The actual rate of royalty is negotiable, but typically ranges from $0.09
to $0.18 per song on each CD that is sold. Similarly, the terms of the licenses
vary, but typically are for terms of 2 to 5 years. Our written licenses
typically provide for quarterly royalty payments, although some publishers
require reporting on a semi-annual basis.
We currently have compulsory statutory licenses for certain songs in our song
library which are reproduced on audiocassettes. The Federal Copyright Act
creates a compulsory statutory license for all non-dramatic musical works, 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.
5
GOVERNMENT REGULATION
Our karaoke machines must meet the safety standards imposed in various national,
state, local and provincial jurisdictions. Our karaoke machines sold in the
United States are designed, manufactured and tested to meet the safety standards
of Underwriters Laboratories, Inc. ("ULE") or Electronic Testing Laboratories
("ETL"). In Europe and other foreign countries, our products are manufactured to
meet the CE marking requirements. CE marking is a mandatory European product
marking and certification system for certain designated products. When affixed
to a product and product packaging, CE marking indicates that a particular
product complies with all applicable European product safety, health and
environmental requirements within the CE marking system. Products complying with
CE marking are now accepted to be safe in 28 European countries. However, ULE or
ETL certification does not mean that a product complies with the product safety,
health and environmental regulations contained in all fifty states in the United
States. Therefore, we maintain a quality control program designed to ensure
compliance with all applicable US and federal laws pertaining to the sale of our
products. Our production and sale of music products is subject to federal
copyright laws.
The manufacturing operations of our foreign suppliers in China are subject to
foreign regulation. China has permanent "normal trade relations" ("NTR") status
under US tariff laws, which provides a favorable category of US import duties.
China's NTR status became permanent on January 1, 2002. This substantially
reduces the possibility of China losing its NTR status, which would result in
increasing costs for us.
SEASONALITY AND SEASONAL FINANCING
Our business is highly seasonal, with consumers making a large percentage of
karaoke purchases around the traditional holiday season in our second and third
quarter. These seasonal purchasing patterns and requisite production lead times
cause risk to our business associated with the underproduction or overproduction
of products that do not match consumer demand. Retailers also attempt to manage
their inventories more tightly, requiring that we ship products closer to the
time that retailers expect to sell the products to consumers. These factors
increase the risk that we may not be able to meet demand for certain products at
peak demand times, or that our own inventory levels may be adversely impacted by
the need to pre-build products before orders are placed. As of March 31, 2005,
we had inventory of 3.1 million (net of reserves totaling $1.7 million) compared
to inventory of $5.9 million as of March 31, 2004 (net of reserves totaling $6.6
million).
Our financing of seasonal working capital during fiscal 2005 was from selling of
the inventory carried over from prior year. We were able to pay down the overdue
debt to one of our major suppliers in China from $2.1 million to $700 thousand
in fiscal 2005. We financed the purchase of new inventory with our short-term
lines of credit in Hong Kong and through factory financing in China.
During fiscal 2006, we plan on financing our inventory purchases by using credit
that has been extended to us by the factories in China, by using our short term
lines of credit in Hong Kong and with letters of credit that are issued by our
customers to be used as collateral for payment to our vendors.
BACKLOG
We ship our products in accordance with delivery schedules specified by our
customers, which usually request delivery within three months of the date of the
order. In the consumer electronics industry, orders are subject to cancellation
or change at any time prior to shipment. In recent years, a trend toward
just-in-time inventory practices in the consumer electronics industry has
resulted in fewer advance orders and therefore less backlog of orders for the
Company. We believe that backlog orders at any given time may not accurately
indicate future sales. As of June 15, 2005, we had backlog of $22 million
compared to backlog of $32.8 million at the same period in fiscal 2005. We
believe that we will be able to fill all of these orders in fiscal year 2006.
However, these orders can be cancelled or modified at any time prior to
delivery. This backlog does not take into account of any sales ordered by
customers directly from our domestic inventory with order turnaround time of one
to two weeks. We normally have to keep the minimum inventory in our domestic
warehouses for this type of sales.
EMPLOYEES
As of March 31, 2005, we employed 31 persons, all of whom are full-time
employees, including two executive officers. Sixteen of our employees are
located at International SMC's corporate offices in Hong Kong. The remaining
fifteen employees are based in the United States, including two executive
positions, two engaged in warehousing and technical support, and eleven in
accounting, marketing, sales and administrative functions.
ITEM 2. PROPERTIES
Our corporate headquarters are located in Coconut Creek, Florida in a 7,000
square feet office and warehouse facility.
We have one warehouse facility in Compton California. The Compton warehouse
facility has 79,000 square feet and the lease expires on February 23, 2008. We
have subleased approximately 40,000 square feet. We terminated our lease for
warehouse space in Rancho Dominguez, California effective as of May 1, 2004.
We have lease 3,579 square feet of office space in Hong Kong from which we
oversee China based manufacturing operations. The lease expires April 30, 2008.
6
We believe that the facilities are well maintained, in substantial compliance
with environmental laws and regulations, and adequately covered by insurance. We
also believe that these leased facilities are not unique and could be replaced,
if necessary, at the end of the term of the existing leases.
ITEM 3. LEGAL PROCEEDINGS
CLASS ACTION AND DERIVATIVE LAWSUIT
From July 2, 2003 through October 2, 2003, seven securities class action
lawsuits and a shareholder's derivative action were filed against us and certain
of our officers and directors in the United States District Court for the
Southern District of Florida on behalf of all persons who purchased our
securities during the various class action periods specified in the complaints.
On September 18, 2003, United States District Judge William J. Zlock entered an
order consolidating the seven (7) purported class action law suits and one (1)
purported shareholder derivative action into a single action case styled Frank
Bielansky v. the Company, Salberg & Company, P.A., et al - Case Number: 03-80596
- - CIV - ZLOCK (the "Class Action"). The complaints that were filed allege
violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of
1934 and Rule 10(b)-5. The complaints seek compensatory damages, attorney's fees
and injunctive relief.
The Company entered into a settlement agreement with the plaintiffs in the Class
Action in March 2004. At a hearing in April 2004, the Court gave preliminary
approval for the settlement and directed that notices be sent to shareholders
pursuant to the Settlement Agreement. The notices advised shareholders of their
rights and responsibilities concerning the settlement. The Court set a hearing
on July 30, 2004 before Judge Zlock to consider final approval of the
settlement. At the hearing, Judge Zlock signed the order giving final approval
to the settlement. The terms of the settlement will be implemented after all
final appeals period have expired.
Pursuant to the terms of the settlement agreement, we are required to make a
cash payment of $800,000 and Salberg & Company, P.A., our former auditor, is
required to make a payment of $475,000. Our cash payment of $800,000 is covered
by our liability insurance and our insurer has placed this payment in an escrow
account. In addition, we are obligated to issue 400,000 shares of our common
stock to the plaintiffs. The settlement obligates us to implement certain
corporate governance changes, including an expansion or our Board of Directors
to six members with independent directors comprising at least 2/3 of the total
Board seats.
As of March 31, 2004, the Company recorded an expense equal to the total
estimated cost of the settlement less the amount expected to be reimbursed by
the Company's insurance carrier. The net charge associated with this matter
totaled approximately $462,000 and was included as a component of selling,
general and administrative expenses for the fiscal year ended March 31, 2004.
The court entered an order approving the settlement agreement on July 30, 2004.
The Company has issued the 400,000 shares to the plaintiffs on November 22,
2004. The cost of the 400,000 shares is $240,000 based on the stock closing
price on September 23, 2004. The remaining balance of the accrued expense in the
amount of $222,000 ($462,000 - $240,000) has been recorded as the reduction of
selling, general and administrative expenses for the fiscal year ended March 31,
2005.
SYBERSOUND VS. SINGING MACHINE
On May 12, 2005, Sybersound Records, Inc., d/b/a Party Tyme Karaoke, filed a
suit in Los Angeles Superior Court, seeking more than $200 million in damages
arising from music piracy by numerous karaoke record manufacturers, including
The Singing Machine Company Inc. The lawsuits allege that Sybersound's
competitors (including The Singing Machine Company, Inc.) have failed,
unlawfully, to license competing karaoke records. In addition, Sybersound claims
competitors have underreported sales to publishers, which has, in turn, undercut
Sybersound's pricing. The lawsuits allege, among other things, wrongful
interference with business, unfair trade practices and unfair competition. The
Singing Machine Company, Inc. believes that this legal action is completely
without merit and we are prepared to defend ourselves vigorously in order to be
vindicated. As of June 28, 2005, this case is in the early stages of litigation
and, thus, it is impossible to determine its outcome.
OTHER MATTERS
We are involved in various other litigation and legal matters, including claims
related to intellectual property, product liability which we are addressing or
defending in the ordinary course of business. Management believes that any
liability that may potentially result upon resolution of such matters will not
have a material adverse effect on our business, financial condition or results
of operation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of stockholders on Monday, November 29, 2004 at 9:30
a.m. at the Marriott Town Center Hotel. Our shareholders approved the election
of Bernard Appel, Josef Bauer, Yi Ping Chan and Harvey Judkowitz as directors to
serve until the next Annual Meeting and until their successors shall be elected
and qualified and ratified the appointment of Berkovits, Lago, & Company LLP as
our independent certified public accountants for the fiscal year ending March
31, 2005.
7
PART II
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock currently trades on the American Stock Exchange under the
symbol "SMD." Set forth below is the range of high and low information for our
common stock as traded on the American Stock Exchange during fiscal 2005 and
fiscal 2004. This information regarding trading on AMEX represents prices
between dealers and does not reflect retail mark-up or markdown or commissions,
and may not necessarily represent actual market transactions.
FISCAL PERIOD HIGH LOW
- ---------------------------------------------- --------- ---------
2005:
First quarter (April 1 - June 30, 2004) $ 1.30 $ .36
Second quarter (July 1 - September 30, 2004) .72 .30
Third quarter (October 1 - December 31, 2004) 1.15 .51
Fourth quarter (January 1 - March 31, 2005) 1.05 .61
2004:
First quarter (April 1 - June 30, 2003) $ 7.94 $ 2.85
Second quarter (July 1 - September 30,2003) 5.03 2.70
Third quarter (October 1 - December 31, 2003) 4.43 1.80
Fourth quarter (January 1 - March 31, 2004) 2.43 1.14
As of June 7, 2005, there were approximately 309 record holders of our
outstanding common stock.
COMMON STOCK
We have never declared or paid cash dividends on our common stock and our Board
of Directors intends to continue its policy for the foreseeable future. Future
dividend policy will depend upon our earnings, financial condition, contractual
restrictions and other factors considered relevant by our Board of Directors and
will be subject to limitations imposed under Delaware law.
ITEM 6. SELECTED FINANCIAL DATA
2005 2004 2003 2002* 2001*
------------ ------------ ------------ ------------ ------------
Statement of Operations:
Net Sales $ 38,209,825 $ 70,541,128 $ 95,613,766 $ 62,475,753 $ 34,875,351
Earnings(loss) before income taxes (3,591,975) (21,924,919) $ 1,416,584 $ 8,184,559 $ 4,188,021
Income tax expense (benefit) $ 0 $ 758,505 $ 198,772 $ 1,895,494 $ 494,744
Net earnings (loss) (3,591,975) (22,683,424) $ 1,217,813 $ 6,289,065 $ 3,696,277
Balance Sheet:
Working capital (3,378,528) (1,382,939) $ 15,281,023 $ 14,577,935 $ 6,956,879
Current ratio 0.65 0.90 1.72 3.82 4.37
Property, plant and equipment, net $ 1,038,843 $ 983,980 $ 1,096,424 $ 574,657 $ 263,791
Total assets $ 7,668,808 $ 15,417,395 $ 38,935,294 $ 21,403,196 $ 10,509,682
Shareholders' equity (1,985,023) $ 216,814 $ 17,685,364 $ 16,225,433 $ 8,450,237
Per Share Data:
Earnings (loss) per common share - basic $ (0.39) $ (2.65) $ 0.15 $ 0.88 $ 0.59
Earnings (loss) per common share - diluted $ (0.39) $ (2.65) $ 0.14 $ 0.79 $ 0.50
Cash dividends paid 0 0 0 0 0
* Restated
8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
OVERVIEW
Our primary objectives for fiscal 2005 were to continue to drive down the
operating costs and to position the company for a return of profitability. Our
gross profit increased to $9.3 million or 24.3% of total revenues for twelve
months ended March 31, 2005 compared to gross profit of $1.8 million or 2.6% of
total revenues for same period last year. The increase of the profit margin was
primarily due to the development of the new product and better sales planning.
Our fixed operating expenses (compensation and selling, general and
administrative expense) in fiscal 2005 decrease to $7.3 million from $14.9
million, a decrease of $7.6 million or 51% compared to prior year. The decrease
of fixed operating expenses was primarily due to the aggressive cost reduction
initiative implemented by the management team. As a result, our net loss
decreased by $19.1 million to $3.6 million in fiscal 2005 from $22.7 million in
fiscal 2004.
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:
2005 2004 2003
-----------------------------------
Total Revenues 100.0% 100.0% 100.0%
Cost of Sales 75.8% 97.4% 75.6%
Operating expenses 28.5% 31.2% 22.7%
Operating (loss) income -4.2% -28.6% 1.7%
Other (expenses), income, net -5.2% -2.5% -0.2%
(Loss) Income before taxes -9.4% -31.1% 1.5%
Provision (benefit) for income taxes 0.0% 1.1% 0.2%
(Loss) Income -9.4% -32.2% 1.3%
FISCAL YEAR ENDED MARCH 31, 2005 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2004
NET SALES
Net sales for the fiscal year ended March 31, 2005 decreased to $38.2 million
compared to revenues of $70.5 million in the fiscal year ended March 31, 2004.
The decrease in net sales was a result of both decreases in unit volume as well
as pricing. The decrease in sales is primarily attributed to:
o We made a decision not to pursue low margin accounts which tie up
cash flow but do not provide enough profit margins;
o Customers concerned of our financial liquidity;
o Customers had high level of inventory on hand from prior year;
o Increase of competition in the United States and international
market.
In fiscal year 2005, 64% of our sales were direct sales, which represent sales
made by International SMC, and 36% were domestic sales, which represents sales
made from our warehouse in the United States.
The sales decrease occurred in all segments of our business. Our total hardware
sales decreased to $35.9 million, in fiscal 2005 compared to total hardware
sales of $67.7 million in fiscal 2004.
Music sales decreased to $2.3 million, or 6% of net sales, in fiscal 2005,
compared to $2.8 million, or 4% of net sales, in fiscal 2004. The decrease in
music sales was a result of increased competition in this category.
GROSS PROFIT
Gross profit for fiscal 2005 was $9.3 million or 24.2% of total revenues
compared to $1.8 million or 2.6% of sales for fiscal 2004. The increase in gross
margin, compared to the prior year, was primarily due to the development of new
products and better sales planning. We developed seven new models in fiscal
2005, which made up $19.0 million in sales or 54% of the hardware sales in
fiscal 2005. Our new products have differentiated us from our competitors and
yield a higher profit margin.
Our gross profit may not be comparable to those of other entities, since some
entities include the costs of warehousing, inspection, freight charges and other
distribution costs in their cost of sales. We account for the above expenses as
operating expenses and classify them under selling, general and administrative
expenses.
9
OPERATING EXPENSES
Operating expenses for the fiscal year ended March 31, 2005 decreased from $22.0
million to $10.9 million, a decrease of $11.1 million or 50.5% compared to the
same period last year. The decrease in operating expenses consists of a decrease
in variable expenses and fixed expenses. The variable expenses (Advertising,
Commission, Freight and Royalty expenses) were decreased proportionally as
revenues decreased. The fixed expense decrease of $7.6 million was primarily due
to the following factors:
o Decreases in compensation expenses in the amount of $2.2 million due
to business downsizing and staff cuts.
o Decreases in professional fees and legal expenses of $2.1 million
due to the completion of a class action lawsuit and management's
assumption of additional responsibilities, which were previously
performed by outside professionals.
o Decreased rent expense of $870K due to the early termination of one
of our warehouses in California and the sublease of the existing
warehouse space.
o Decreases in defective product repair fees of $796K due to our
testing line in our California warehouse. We have sent fewer real
defective products to the factory for repair in fiscal 2005.
o Decreased product licensing royalty of $1.0 million due to the
termination of several licensing agreements. Our dependency on other
brands has decreased in the past.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses were $709,290 for fiscal 2005
compared to $750,359 for fiscal 2004. This decrease in depreciation and
amortization expenses can be attributed to the fact that we produced fewer
models with higher volume per model, which increased the economies of scale for
our product lines.
NET OTHER EXPENSES
Net other expenses were $1,971,740 in fiscal 2005 compared to $1,729,620 in
fiscal 2004. Net other expenses increased because our interest expense increased
to $2.1 million in fiscal 2005 compared to $1.7 million in fiscal 2004. Our
interest expense increased because we recorded $1.6 million for the amortization
of the discount on our convertible debentures. The increase in interest expense
was partially offset by other income. We expect interest expense to maintain the
same level for fiscal 2006.
INCOME BEFORE TAXES
We had a net loss before taxes of $3,591,975 in fiscal 2005 compared to a net
loss before taxes of $21,924,919 in fiscal 2004. The decreased net loss was the
result of increased profit margins and decreased expenses in every category.
INCOME TAX EXPENSE
Significant management judgment is required in developing our provisions for
income taxes, including the determination of foreign tax liabilities, deferred
tax assets and liabilities and any valuation allowances that might be required
against deferred tax assets. Management evaluates its ability to realize its
deferred tax assets on a quarterly basis and adjusts its valuation allowance
when it believes that it is not likely to be realized. On March 31, 2005 and
2004, we had gross deferred tax assets of $10.4 million and $8.2 million,
against which we recorded valuation allowances totaling $10.4 million and $8.2,
respectively.
For the fiscal year ended March 31, 2005, we did not record income tax expenses.
This occurred because the company had taxable losses for both US operations and
Hong Kong operations.
Our subsidiary has applied for an exemption of income tax in Hong Kong.
Therefore, no taxes have been expensed or provided for at the subsidiary level.
Although no decision has been reached by the governing body, the parent company
has decided to provide for the possibility that the exemption could be denied
and accordingly has recorded a provision for Hong Kong taxes in fiscal 2003 and
2002. There was no provision for Hong Kong income taxes in fiscal 2005 and
fiscal 2004 due to the subsidiary's taxable loss. Hong Kong income taxes payable
totaled $2.4 million at March 31, 2005 and 2004 and is included in the
accompanying balance sheets as income taxes payable.
We effectively repatriated approximately $0, $2.0 million and $5.6 million from
our foreign operations in 2005, 2004 and 2003, respectively. Accordingly, these
earnings were taxed as a deemed dividend based on U.S. statutory rates. We have
no remaining undistributed earnings of our foreign subsidiary.
We operate within multiple taxing jurisdictions and are subject to audit in
those jurisdictions. Because of the complex issues involved, any claims can
require an extended period to resolve. In management's opinion, adequate
provisions for income taxes have been made.
NET LOSS/NET INCOME
As a result of the foregoing, we had a net loss of $3.6 million in 2005 compared
to a net loss of $22.7 million in fiscal 2004.
10
FISCAL YEAR ENDED MARCH 31, 2004 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2003
NET SALES
Net sales for the fiscal year ended March 31, 2004 decreased to $70.5 million
compared to revenues of $95.6 million in the fiscal year ended March 31, 2003.
The decrease in net sales was due to both decreases in unit volume as well as
pricing, due to increases in competition in the United States and international
markets. In fiscal year 2004, 61% of our sales were direct sales, which
represent sales made by International SMC, and 39% were domestic sales, which
represent sales made from our warehouse in the United States.
The sales decreases occurred in all segments of our business. Our total hardware
sales decreased to $67.7 million, in fiscal 2004 compared to total hardware
sales of $87 million in fiscal 2003. The total decrease of hardware sales of
$19.3 million from the previous year sales level is the primary due to the
increasing market competition. Also we had to lower our price in order to move
the overstocked inventory from fiscal year 2003.
In addition, there was a significant decrease in our music sales. Music sales
decreased to $2.8 million, or 4% of net sales, in fiscal 2004, compared to $9.1
million, or 9.5% of net sales, in fiscal 2003. The decrease in music sales is
also a result of increased competition in this category, both domestically as
well as internationally.
GROSS PROFIT
Gross profit for fiscal 2004 was $1,818,550 or 2.6% of total revenues compared
to $23,284,731 or 24.4% of sales for fiscal 2003. The decrease in gross margin
compared to the prior year is primarily due to the following factors: (i)
write-down of inventories, (ii) sales made at lower prices to generate cash from
operation, (iii) increased sales by International SMC, the gross profit margin
is lower for the sales shipped from Hong Kong due to the volume discount and
reduction of the warehousing and insurance expenses and (iv) tooling impairment
cost of $443,000.
At the end of fiscal 2004, our inventory levels were much higher than we
expected. We determined that due to liquidation sales, inventory would be sold
at a loss; therefore, a decrease in the value of specific inventory items was
made. The total amount of the provision for inventory was $6.6 million in fiscal
2004 compared to a provision of $3.7 million in fiscal 2003.
In addition to the write-down of inventories, due to competitive price pressure,
a significant amount of sales shipped in current year were made at lower margins
than in previous years. In the fourth quarter, we sold $1 million of inventory
with a negative margin of $366,751 (after applying inventory valuation
reserves).
Our product line did not sell as well as our retailers and mass merchants had
expected. As a result, we agreed to give our customers pricing concessions and
allowed them to return inventory to us. We issued over $1 million in customer
credits during the fourth quarter, which reduced our sales and gross profit
margins equally. Our gross margins were also negatively affected by the return
of $1.8 million in inventory.
Our decrease in our gross margin percentage in fiscal 2004 compared to fiscal
2003 was also reduced by the mix of our sales. The percentage of sales made by
our Hong Kong subsidiary increased from 52% of the total sales in fiscal 2003 to
61% in fiscal 2004. Usually, sales made by International SMC historically
maintain a lower gross profit margin because there are no variable expenses from
these sales. Other variable expenses that are normally included with sales are
advertising allowances, returns and commissions.
Our gross profit may not be comparable to those of other entities, since some
entities include the costs of warehousing, inspection, freight charges and other
distribution costs in their cost of sales. We account for the above expenses as
operating expenses and classify them under selling, general and administrative
expenses
OPERATING EXPENSES
Operating expenses were $22,013,849 or 31.2% of net sales in fiscal 2004
compared to $21,670,501 or 22.7% of net sales in fiscal 2003. The primary
factors that contributed to the increase in operating expenses are:
o Increased compensation expenses in the amount of $953,000 in fiscal
2004 of which approximately $323,000 was for severance payments to
four former executive officers,
o Increased selling, general and administrative expenses of $2,706,000
due to
o increased legal fees in the amount of $1,080,000 of which
approximately $706,000 was for the class action settlement, and
increased consulting fees in the amount of approximately $370,000
which was related to consulting work performed by our lender,
o increased rent expenses in the amount of $690,000 due to the
expansion of the warehouse facility in Rancho Dominguez in fiscal
2003. The increase warehouse space was necessary to stock the
unanticipated unsold inventories in fiscal year 2004 and expenses of
$180,000 for early termination of the lease in Rancho Dominguez,
California
o a write off of the capitalized cost of reorganization of $185,000,
11
o increased accounting expenses in the amount of $426,000, which was
due to the additional work needed to restate our financial
statements for the fiscal years ended March 31, 2001 and 2002 and
work required on the filing of certain registration statements and
o increased bank fees and loan cost in the amount of $271,000, which
was related to the loan agreement with Lasalle bank.
This increase in expenses was offset by decreases in our advertising expenses
and our freight and handling charges in the amount of $2,692,000 and $689,000,
respectively. Advertising expense consists of two components: co-operative
advertising and direct advertising expense. Co-operative advertising is paid
directly to the customer and the allowances are based on the amount of sales.
The customer provides copies of advertising on which these funds are spent and
is reimbursed after review of such proof of performance. As we believe that
there is a separate and identifiable benefit associated with the co-operative
advertising, such amounts are recorded as a component of operating expenses.
Co-operative advertising expenses decreased to $2,340,439 in fiscal 2004
compared to $5,032,367 in fiscal 2003 because our sales decreased. Our royalty
expenses were $2,294,727 in fiscal 2004 compared to $2,257,653 in fiscal 2003.
Our royalty expenses in fiscal 2004 included a write-off of $980,000 in pre-paid
royalties under our licensing agreement with MTV.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses were $750,359 for fiscal 2004
compared to $622,298 for fiscal 2003. This increase in depreciation and
amortization expenses can be attributed to our investment in tooling and dies
for the new models, in addition to the acceleration in the depreciation method
used to write off the useful life of the tools and dies.
NET OTHER EXPENSES
Net other expenses were $1,729,620 in fiscal 2004 compared to $197,646 in fiscal
2003. Net other expenses increased because our interest expense increased to
$1.7 million in fiscal 2004 compared to $406,000 in fiscal 2003. Our interest
expense increased because we recorded $917,853 for the amortization of the
discount and related deferred financing fees on our convertible debentures and
approximately $800,000 relates to interest expense on the LaSalle loan, interest
on the convertible debentures, interest on the insiders loan, and interest
expense incurred at our Hong Kong subsidiary. We expect interest expense to
increase further in fiscal 2005, as we will have a full year's worth of
amortization of the discount on the convertible debentures and related deferred
financing fees.
INCOME BEFORE TAXES
We had a net loss before taxes of $21,924,919 in fiscal 2004 compared to net
income of $1,416,584 in fiscal 2003.
INCOME TAX EXPENSE
Significant management judgment is required in developing our provision for
income taxes, including the determination of foreign tax liabilities, deferred
tax assets and liabilities and any valuation allowances that might be required
against the deferred tax assets. Management evaluates its ability to realize its
deferred tax assets on a quarterly basis and adjusts its valuation allowance
when it believes that it is more likely than not that the asset will not be
realized. At December 31, 2003 and March 31, 2004, we concluded that a valuation
allowance was needed against all of our deferred tax assets, as it was not more
likely than not that the deferred taxes would be realized. At March 31, 2004 and
2003, we had gross deferred tax assets of $8.2 million and $1.9 million, against
which we recorded valuation allowances totaling $8.2 million and $0,
respectively.
For the fiscal year ended March 31, 2004, we recorded a tax provision of
$758,505. This occurred because the valuation allowance established against our
deferred tax assets exceeded the amount of the benefit created from carrying
back a portion of the current year's losses. The carry-back of the losses from
the current year resulted in an income tax receivable of $1.1 million, which is
included in refundable tax in the accompanying balance sheets. We have now
exhausted our ability to carry back any further losses and therefore will only
be able to recognize tax benefits to the extent that we has future taxable
income.
Our subsidiary has applied for an exemption of income tax in Hong Kong.
Therefore, no taxes have been expensed or provided for at the subsidiary level.
Although no decision has been reached by the governing body, the parent company
has reached the decision to provide for the possibility that the exemption could
be denied and accordingly has recorded a provision for Hong Kong taxes in fiscal
2003 and 2002. There was no provision for Hong Kong income taxes in fiscal 2004
due to the subsidiary's net operating loss for the year. Hong Kong income taxes
payable totaled $2.4 million at March 31, 2004 and 2003 and is included in the
accompanying balance sheets as income taxes payable.
We effectively repatriated approximately $2.0 million, $5.6 million and $5.7
million from our foreign operations in 2004, 2003 and 2002, respectively.
Accordingly, these earnings were taxed as a deemed dividend based on U.S.
statutory rates. We have no remaining undistributed earnings of our foreign
subsidiary.
We operate within multiple taxing jurisdictions and are subject to audit in
those jurisdictions. Because of the complex issues involved, any claims can
require an extended period to resolve. In management's opinion, adequate
provisions for income taxes have been made.
12
NET LOSS/NET INCOME
As a result of the foregoing, we had a net loss of $22.7 million in 2004
compared to net income of $1.2 million in fiscal 2003.
LIQUIDITY AND CAPITAL RESOURCES
On March 31, 2005, we had cash on hand of $0.6 in addition to $0.9 million of
restricted cash and no bank overdrafts compared to cash on hand of $0.4 million
and restricted cash of $0.9 million and a bank overdraft of $0.1 million on
March 31, 2004. The increase of cash on hand was primarily due to increases in
cash provided by operating activities, partially offset by decreases in cash
used in investment activities.
Cash flows provided by operating activities were $1.1 million for the twelve
months ended March 31, 2005. This was the result of better inventory planning
and the selling off of overstocked inventory. Cash provided by operating
activities was primarily attributed to decreases in inventory, receipt of a
federal tax refund and insurance payment, partially offset by decreases of
accounts payable, accrued expenses and customer credit on account.
o Accounts payable decreases were the result of management's
commitment to reduce overdue accounts payable invoices with our
major supplier in China;
o Accrued expenses decreased as a result of a class action settlement
in the amount of $1.1 million, of which $800,000 was paid by our
insurance company and $240,000 was paid with 400,000 shares of
common stock. We also paid approximately $200,000 for music
royalties and $1.4 million in other expenses.
o Customer credit on account decreased because the Company paid off
some of the customer credit balance or applied the credit balances
to new orders.
Cash used in investing activities for the twelve months ended March 31, 2005 was
$0.7 million. Cash used in investing activities was for the purchase of tooling
and molds for the production of new karaoke machines for this fiscal year.
Cash flows used by financing activities were $0.1 million for the fiscal year
ended March 31, 2005. This cash outflow was primarily due to cost of paying off
a bank overdraft.
As of March 31, 2005, our working capital was ($3.4) million. Our current
liabilities of $9.6 million include:
o Amount due to one factory of $0.7 million - we have worked out the
payment plan with the factory to pay off the balance by the end of
this year.
o Customer credit on account of $1.7 million - the amount of $0.7
million is due to one customer, of which $0.5 million credit balance
was settled by shipments in June 2005, the remaining amount might be
offset by the products or refund.
o Convertible debentures of $2.4 million - The debentures expire in
February 2006, we might be able to pay off a portion of the
debenture before or on the maturity date.
o Subordinate debt of $0.6 million - The additional $0.2 million was
converted into common stock in May 2005.
o Hong Kong income tax payable of $2.5 million (see Income Tax Expense
on Page 12 for details) - We do not expect the complete tax payment
to come due in the short term. Our tax exemption application is
still pending with the Hong Kong tax authority. Even if the outcome
is unfavorable, the Company still has the right to appeal, which
could take more than a year to settle.
o Current liabilities resulted from normal course of the business of
$1.7 million.
As of June 15, 2005, our loan balance with Crestmark Bank was $0.3 million. The
Company can borrow up to the lesser of the $2.5 million or 70% of the eligible
accounts receivable. Per the agreement we are only allowed to factor the sales
originating from the warehouses in the United States. The factor company
determines the eligible receivables based on their own credit standard, and the
accounts' aging. As of June 15, 2005, there was no availability under the
Crestmark facility due to low sales volume during the slow selling season.
Our Hong Kong subsidiary, International SMC, has access to credit facilities at
the Hong Kong Shanghai Bank and Fortis Bank. The primary purpose of the
facilities is to provide International SMC with access to letters of credit so
that it can purchase inventory for direct shipment of goods into the United
States and international markets. The facilities are secured by a corporate
guarantee from the U.S. parent company and restricted cash on deposit with the
lender. The maximum available credit under the facilities is $1.5 million. The
balance as of March 31, 2005 and 2004 was $0 and $62,282, respectively. The
interest rate is approximate 4% per annum. As of June 15, 2005, the availability
from these facilities was $0.8 million
As of June 15, 2005, our cash on hand is limited. Our average monthly operating
expenses are approximately $450,000 and we need approximately $1.4 million to
cover our operating expenses during the next three month period. Our primary
expenses are normal operating costs including salaries, lease payments for our
warehouse space in Compton, California and other operating costs.
As of March 31, 2005, our commitments for debt and other contractual
arrangements are summarized as follows:
13
Less than Over
Total 1 year 1 - 3 years 3 - 5 years 5 years
------------------------------------------------------------------------
Property Leases 2,134,065 808,429 1,325,636 -- --
Equipment Leases 18,321 3,791 7,581 6,949 --
Subordinated Debt - Related Party 600,000 600,000 -- -- --
Convertible Debentures 4,000,000 4,000,000 -- --
Interest payments 417,000 417,000 -- --
------------------------------------------------------------------------
Total $7,169,386 $5,829,220 $1,333,217 $ 6,949 $ --
------------------------------------------------------------------------
Each of the contractual agreements (except the equipment leases) provide that
all amounts due under that agreement can be accelerated if we default under the
terms of the agreement.
WORKING CAPITAL REQUIREMENTS DURING THE SHORT AND LONG TERM
During the next twelve month period, we plan on financing our working capital
needs from:
o The collection of accounts receivable;
o Sales of existing inventory;
o Financial companies willing to makes advances on accounts
receivable;
o Short term insider loans;
o The Continued support of factories in China that finance our
purchases of karaoke machines for fiscal 2006; and
o The utilization of credit facilities that are available to
International SMC to finance all direct shipments.
Our sources of cash for working capital in the long term are the same as our
sources during the short term. If we need additional financing, we intend to
approach different financing companies or insiders. However, we cannot guarantee
that our financing plan will succeed. If we need to obtain additional financing
and fail to do so, it may have a material adverse effect on our ability to meet
our financial obligations and continue our operations.
During fiscal 2006, we will strive to reduce additional operating costs. In
order to reduce the need to maintain inventory in our warehouse in California
and Florida, we intend to generate a larger share of our total sales through
sales directly from International SMC. The goods are shipped directly to our
customers from ports in China and are primarily backed by customer letters of
credit. The customers take title to the merchandise at their consolidators in
China and are responsible for the shipment, duty, clearance and freight charges
to their locations. These sales in which the customer purchases the goods for
delivery at a specific destination are referred to as "Direct" sales. We will
also help our customers forecast and manage their inventories of our product. We
are also planning to finance a significant amount of our sales with customer
issued letters of credit, using International SMC's credit facility with Hong
Kong Bank and relying on financing from one of our factories in China.
In the event that we do not sell sufficient products in our second and third
quarters, we have considered other sources of financing, such as trying to
secure an additional credit facility, private offerings and/or a venture capital
investment. We expect that the profit margin for sales of our karaoke products
will continue to be under price pressure, because of the competitors in the
marketplace. During fiscal 2006, we plan on introducing products other than
karaoke to fulfill our sales seasonality gap.
Except for the foregoing, we do not have any present commitment that is likely
to cause our liquidity to increase or decrease in any material way. In addition,
except for the Company's need for additional capital to finance inventory
purchases, the Company is not aware of any 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.
EXCHANGE RATES
We sell all of our products in U.S. dollars and pay for all of our manufacturing
costs in either U.S. or Hong Kong dollars. Operating expenses of the Hong Kong
office are paid in Hong Kong dollars. The exchange rate of the Hong Kong dollar
to the U.S. dollar has been fixed by the Hong Kong government since 1983 at
HK$7.80 to U.S. $1.00 and, accordingly, has not represented a currency exchange
risk to the U.S. dollar. We cannot assure you that the exchange rate between the
United States and Hong Kong currencies will continue to be fixed or that
exchange rate fluctuations will not have a material adverse effect on our
business, financial condition or results of operations.
14
SEASONAL AND QUARTERLY RESULTS
Historically, our operations have been seasonal, with the highest net sales
occurring in the second and third quarters (reflecting increased orders for
equipment and music merchandise during the Christmas selling months) and to a
lesser extent the first and fourth quarters of the fiscal year. Sales in our
fiscal second and third quarter, combined, accounted for approximately 86.7%,
87.2% and 85.6% of net sales in fiscal 2005, 2004 and 2003.
Our results of operations may also fluctuate from quarter to quarter as a result
of the amount and timing of orders placed and shipped to customers, as well as
other factors. The fulfillment of orders can therefore significantly affect
results of operations on a quarter-to-quarter basis.
We are currently developing the products and considering trading products other
than karaoke category during the slow season to fulfill the revenue shortfall.
INFLATION
Inflation has not had a significant impact on the Company's operations. The
Company has historically passed any price increases on to its customers since
prices charged by the Company are generally not fixed by long-term contracts.
CRITICAL ACCOUNTING POLICIES
We prepared our consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. As such,
management is required to make certain estimates, judgments and assumptions that
it believes are reasonable based on the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses for the periods presented. The significant accounting policies which
management believes are the most critical to aid in fully understanding and
evaluating our reported financial results included accounts receivable -
allowance for doubtful accounts, reserves on inventory, deferred tax assets and
our Hong Kong income tax exemption.
COLLECTIBILITY OF ACCOUNTS RECEIVABLE. The Singing Machine's allowance for
doubtful accounts is based on management's estimates of the creditworthiness of
its customers, current economic conditions and historical information, and, in
the opinion of management, is believed to be an amount sufficient to respond to
normal business conditions. Management sets 100% reserves for customers in
bankruptcy and other reserves based upon historical collection experience.
Should business conditions deteriorate or any major customer default on its
obligations to the Company, this allowance may need to be significantly
increased, which would have a negative impact on operations.
RESERVES ON INVENTORIES. The Singing Machine establishes a reserve on inventory
based on the expected net realizable value of inventory on an item by item basis
when it is apparent that the expected realizable value of an inventory item
falls below its original cost. A charge to cost of sales results when the
estimated net realizable value of specific inventory items declines below cost.
Management regularly reviews the Company's investment in inventories for such
declines in value.
INCOME TAXES. Significant management judgment is required in developing our
provision for income taxes, including the determination of foreign tax
liabilities, deferred tax assets and liabilities and any valuation allowances
that might be required against the deferred tax assets. Management evaluates its
ability to realize its deferred tax assets on a quarterly basis and adjusts its
valuation allowance when it believes that it is more likely than not that the
asset will not be realized. At March 31, 2005 and 2004, we concluded that a
valuation allowance was needed against all of our deferred tax assets, as it was
not likely that the deferred taxes would be realized. At March 31, 2005 and
2004, we had gross deferred tax assets of $10.4 million and $8.2 million,
against which we recorded valuation allowances totaling $10.4 million and $8.2,
respectively.
For the fiscal years ended March 31, 2005 and March 31, 2004, the Company
recorded a tax provision of $0 and $758,505, respectively. We have received the
tax refund of $1.1 million on August 24, 2004, which has been used to pay
related parties' loan and the vendors. The Company has now exhausted its ability
to carry back any further losses and therefore will only be able to recognize
tax benefits to the extent that it has future taxable income.
The Company's subsidiary has applied for an exemption of income tax in Hong
Kong. Therefore, no taxes have been expensed or provided for at the subsidiary
level. Although no decision has been reached by the governing body, the parent
company has reached the decision to provide for the possibility that the
exemption could be denied and accordingly has recorded a provision for Hong Kong
taxes in fiscal 2003 and 2002. There was no provision for Hong Kong income taxes
in fiscal 2004 and fiscal 2005 due to the subsidiary's net operating losses.
Hong Kong income taxes payable totaled $2.4 million at March 31, 2005 and 2004
and is included in the accompanying balance sheets as income taxes payable.
The Company effectively repatriated approximately $0, $2.0 million and $5.6
million from its foreign operations in 2005, 2004 and 2003, respectively.
Accordingly, these earnings were taxed as a deemed dividend based on U.S.
statutory rates. The Company has no remaining undistributed earnings of the
Company's foreign subsidiary.
15
We operate within multiple taxing jurisdictions and are subject to audit in
those jurisdictions. Because of the complex issues involved, any claims can
require an extended period to resolve. In management's opinion, adequate
provisions for income taxes have been made.
We make other estimates in the ordinary course of business relating to sales
returns and allowances, warranty reserves, and reserves for promotional
incentives. Historically, past changes to these estimates have not had a
material impact on our financial condition. However, circumstances could change
which may alter future expectations.
Set forth below and elsewhere in this Annual Report on Form 10-K and in the
other documents we file with the SEC are risks and uncertainties that could
cause actual results to differ materially from the results contemplated by the
forward looking statements contained in this Annual Report.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
RISKS ASSOCIATED WITH OUR BUSINESS
WE HAVE SIGNIFICANT WORKING CAPITAL NEEDS AND IF WE ARE UNABLE TO OBTAIN
ADDITIONAL FINANCING, WHEN NEEDED, WE MAY NOT HAVE SUFFICIENT CASH FLOW TO RUN
OUR BUSINESS.
As of June 7, 2005, our cash on hand is limited. We need approximately $1.3
million in working capital in order to finance our operations over the next
three months. We will finance our working capital needs from the collection of
accounts receivable, and sales of existing inventory. See "Liquidity" beginning
on page 13. As of March 31, 2005, our inventory was valued at $3.1 million. If
these sources do not provide us with adequate financing, we may try to seek
financing from a third party. If we are not able to obtain adequate financing,
when needed, it will have a material adverse effect on our cash flow and our
ability to run our business. If we have a severe shortage of working capital, we
may not be able to continue our business operations and may be required to file
a petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code or enter
into some other form of liquidation or reorganization proceeding.
WE MAY BE DEEMED INSOLVENT AND WE MAY GO OUT OF BUSINESS.
As of March 31, 2005, our cash position is limited. We are not able to pay all
of our creditors on a timely basis. We are current on approximately 50% of our
accounts payable, which total $1.5 million as March 31, 2005. We are not current
on our account payable of $0.7 million to our factory in China. If we are not
able to pay our current debts as they become due, we may be deemed to be
insolvent. We may be required to file a petition for bankruptcy under Chapter 11
of the U.S. Bankruptcy Code or enter into some other form of liquidation or
reorganization proceedings.
OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS RAISED SUBSTANTIAL DOUBT
ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN AS OF MARCH 31, 2005.
We received a report dated June 24, 2005 from our independent certified public
accountants covering the consolidated financial statements for our fiscal year
ended March 31, 2005 that included an explanatory paragraph which stated that
the financial statements were prepared assuming the Singing Machine would
continue as a going concern. This report stated that our operating performance
in fiscal 2005 and our minimal liquidity raised substantial doubt about our
ability to continue as a going concern. If we are not able to raise additional
capital, we may need to curtail or stop our business operations. We may be
required to file a petition for bankruptcy under Chapter 11 of the U.S.
Bankruptcy Code or enter into some other form of liquidation or reorganization
proceedings.
A SMALL NUMBER OF OUR CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR
REVENUES, AND THE LOSS OF ONE OR MORE OF THESE KEY CUSTOMERS COULD SIGNIFICANTLY
REDUCE OUR REVENUES AND CASH FLOW.
We rely on a few large customers to provide a substantial portion of our
revenues. As a percentage of total revenues, our net sales to our five largest
customers during the fiscal period ended March 31, 2005, 2004 and 2003 were
approximately 40%, 53% and 67% respectively. In fiscal 2005, three customers
accounted for 9%, 8% and 8% of our net sales. We do not have long-term
contractual arrangements with any of our customers and they can cancel their
orders at any time prior to delivery. A substantial reduction in or termination
of orders from any of our largest customers would decrease our revenues and cash
flow.
WE ARE RELYING ON ONE FACTORY TO MANUFACTURE AND PRODUCE THE MAJORITY OF OUR
KARAOKE MACHINES FOR FISCAL 2005, AND IF THE RELATIONSHIP WITH THIS FACTORY IS
DAMAGED OR INJURED IN ANY WAY, IT WOULD REDUCE OUR REVENUES AND PROFITABILITY.
We have worked out a written agreement with a factory in China to produce most
of our karaoke machines for fiscal 2006. We owe this factory approximately $0.7
million as of June 15, 2005 and have worked out a verbal payment plan with it.
See "Liquidity" beginning on page 13. If the factory is unwilling or unable to
deliver our karaoke machines to us, our business will be adversely affected.
Because our cash on hand is minimal, we are relying on revenues received from
the sale of our ordered karaoke machines to provide cash flow for our
operations. If we do not receive cash from these sales, we may not be able to
continue our business operations.
16
WE ARE RELYING ON ONE DISTRIBUTOR TO DISTRIBUTE OUR MUSIC PRODUCTS, IF THE
DISTRIBUTION AGREEMENT IS TERMINATED, IT WOULD REDUCE OUR REVENUES AND
PROFITABILITY.
We are relying on Warner Brother Publication to distribute our music products in
fiscal 2005, if the distribution agreement is terminated, our music revenues
might decrease as well as our profitability.
WE ARE SUBJECT TO THE RISK THAT SOME OF OUR LARGE CUSTOMERS MAY RETURN KARAOKE
PRODUCTS THAT THEY HAVE PURCHASED FROM US AND IF THIS HAPPENS, IT WOULD REDUCE
OUR REVENUES AND PROFITABILITY.
In fiscal 2005 and 2004, a number of our customers and distributors returned
karaoke products that they had purchased from us. Our customers returned goods
valued at $3.5 million, or 9% of our net sales in fiscal 2005. Some of the
returns were resulted from the customer's overstock of the products. Although we
were not contractually obligated to accept this return of the products in fiscal
2005 or fiscal 2004, we accepted the return of the products because we valued
our relationship with our customers. Because we are dependent upon a few large
customers, we are subject to the risk that any of these customers may elect to
return unsold karaoke products to us in the future. If any of our customers were
to return karaoke products to us, it would reduce our revenues and
profitability.
WE ARE SUBJECT TO PRESSURE FROM OUR CUSTOMERS RELATING TO PRICE REDUCTION AND
FINANCIAL INCENTIVES AND IF WE ARE PRESSURED TO MAKE THESE CONCESSIONS TO OUR
CUSTOMERS, IT WILL REDUCE OUR REVENUES AND PROFITABILITY.
Because there is intense competition in the karaoke industry, we are subject to
pricing pressure from our customers. Many of our customers have demanded that we
lower our prices or they will buy our competitor's products. If we do not meet
our customer's demands for lower prices, we will not sell as many karaoke
products. In our fiscal year ended March 31, 2005, our sales to customers in the
United States decreased because of increased price competition. We are also
subject to pressure from our customers regarding certain financial incentives,
such as return credits or large advertising or cooperative advertising
allowances, which effectively reduce our profit. We gave advertising allowances
in the amount of $0.6 million during fiscal 2005 and $2.3 million during fiscal
2004. We have historically offered advertising allowances to our customers
because it is standard practice in the retail industry.
WE EXPERIENCE DIFFICULTY FORECASTING THE DEMAND FOR OUR KARAOKE PRODUCTS AND IF
WE DO NOT ACCURATELY FORECAST DEMAND, OUR REVENUES, NET INCOME AND CASH FLOW MAY
BE AFFECTED.
Because of our reliance on manufacturers in China for our machine production,
our production lead times range from one to four months. Therefore, we must
commit to production in advance of customers orders. It is difficult to forecast
customer demand because we do not have any scientific or quantitative method to
predict this demand. Our forecasting is based on management's general
expectations about customer demand, the general strength of the retail market
and management's historical experiences. We overestimated demand for our
products in fiscal 2003 and 2004 and had $5.9 million in inventory as of March
31, 2004. Because of this excess inventory, we had liquidity problems in fiscal
2005 and our revenues, net income and cash flow were adversely affected
WE ARE SUBJECT TO THE COSTS AND RISKS OF CARRYING INVENTORY FOR OUR CUSTOMERS
AND IF WE HAVE TOO MUCH INVENTORY, IT WILL AFFECT OUR REVENUES AND NET INCOME.
Many of our customers place orders with us several months prior to the holiday
season, but they schedule delivery two or three weeks before the holiday season
begins. As such, we are subject to the risks and costs of carrying inventory
during the time period between the placement or the order and the delivery date,
which reduces our cash flow. As of March 31, 2004, we had $5.9 million in
inventory on hand, which impacted our cash flow and liquidity from operations in
fiscal 2005. As of March 31, 2005, our inventory was valued at $3.1 million,
after a $1.7 million reserve had been taken. It is important that we sell this
inventory during fiscal 2006, so we have sufficient cash flow for operations.
OUR GROSS PROFIT MARGINS HAVE DECREASED OVER THE PAST YEAR AND WE EXPECT
COMPETITIVE MARKET.
Over the past year, our gross profit margins have generally decreased due to the
competition except for fiscal 2005 since we have developed the several new
models, which yield higher profit margin. We expect that our gross profit margin
might decrease under downward pressure in fiscal 2006.
WE MAY BE UNABLE TO SUCCESSFULLY DEFEND OURSELVES IN THE SYBERSOUND LAWSUIT AND
OUR CASH FLOW COULD BE AFFECTED. THE COST TO DEFEND OURSELVES MAY BE SUBSTANTIAL
AND OUR NET PROFITABILITY MAY BE AFFECTED.
We are currently defending ourselves in a lawsuit filed by Sybersound Records,
Inc., d/b/a Party Tyme Karaoke, which seeks damages of more than $200 million.
If we cannot successfully defend ourselves and are forced to pay the judgment
our cash flow could be affected. Alternatively, the cost of successfully
defending ourselves may also be great and may adversely affect our net
profitability.
17
OUR LICENSING AGREEMENT WITH MTV NETWORKS IS IMPORTANT TO OUR BUSINESS AND IF WE
WERE TO LOSE OUR MTV LICENSE IT WOULD AFFECT OUR REVENUES AND PROFITABILITY.
Our license with MTV Networks is important to our business. We generated 17.6%
and 11.8% of our consolidated net sales from products sold under the MTV license
in fiscal 2005 and 2004, respectively. Our MTV license was terminated on
December 31, 2004, with an extension to sell certain existing inventory by
September 31, 2005. We expect the MTV branded products will be phased out and
replaced with SMC brand products going forward.
OUR BUSINESS IS SEASONAL AND THEREFORE OUR ANNUAL OPERATING RESULTS WILL DEPEND,
IN LARGE PART, ON OUR SALES DURING THE RELATIVELY BRIEF HOLIDAY SEASON.
Sales of consumer electronics and toy products in the retail channel are highly
seasonal, with a majority of retail sales occurring during the period from
September through December in anticipation of the holiday season, which includes
Christmas. A substantial majority of our sales occur during the second quarter
ended September 30 and the third quarter ended December 31. Sales in our second
and third quarter, combined, accounted for approximately 86.7%, 87.2% and
85.6%of net sales in fiscal 2005, 2004 and 2003, respectively.
IF WE ARE UNABLE TO COMPETE IN THE KARAOKE PRODUCTS CATEGORY, OUR REVENUES AND
NET PROFITABILITY WILL BE REDUCED.
Our major competitors for karaoke machines and related products are Craig and
Memorex. We believe that competition for karaoke machines is based primarily on
price, product features, reputation, delivery times, and customer support. Our
primary competitors for producing karaoke music are Compass, Pocket Songs,
Sybersound, UAV and Sound Choice. We believe that competition for karaoke music
is based primarily on popularity of song titles, price, reputation, and delivery
times. To the extent that we lower prices to attempt to enhance or retain market
share, we may adversely impact our operating margins. Conversely, if we opt not
to match competitor's price reductions we may lose market share, resulting in
decreased volume and revenue. To the extent our leading competitors reduce
prices on their karaoke machines and music, we must remain flexible to reduce
our prices. If we are forced to reduce our prices, it will result in lower
margins and reduced profitability. Because of intense competition in the karaoke
industry in the United States during fiscal 2005, we expect that the intense
pricing pressure in the low end of the market will continue in the karaoke
market in the United States in fiscal 2006. 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, prerecorded tapes, CD's and video cassettes.
IF WE ARE UNABLE TO DEVELOP NEW KARAOKE PRODUCTS, OUR REVENUES MAY NOT CONTINUE
TO GROW.
The karaoke industry is characterized by rapid technological change, frequent
new product introductions and enhancements and ongoing customer demands for
greater performance. In addition, the average selling price of any karaoke
machine has historically decreased over its life, and we expect that trend to
continue. As a result, our products may not be competitive if we fail to
introduce new products or product enhancements that meet evolving customer
demands. The development of new products is complex, and we may not be able to
complete development in a timely manner. To introduce products on a timely
basis, we must:
o accurately define and design new products to meet market needs;
o design features that continue to differentiate our products from those of
our competitors;
o transition our products to new manufacturing process technologies;
o identify emerging technological trends in our target markets;
o anticipate changes in end-user preferences with respect to our customers'
products;
o bring products to market on a timely basis at competitive prices; and
o respond effectively to technological changes or product announcements by
others.
We believe that we will need to continue to enhance our karaoke machines and
develop new machines to keep pace with competitive and technological
developments and to achieve market acceptance for our products. At the same
time, we need to identify and develop other products which may be different from
karaoke machines.
OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD PREVENT
OR DELAY OUR CUSTOMERS' RECEIPT OF INVENTORY.
We rely principally on four contract ocean carriers to ship virtually all of the
products that we import to our warehouse facility in Compton California.
Retailers that take delivery of our products in China rely on a variety of
carriers to import those products. Any disruptions in shipping, whether in
California or China, caused by labor strikes, other labor disputes, terrorism,
and international incidents may prevent or delay our customers' receipt of
inventory. If our customers do not receive their inventory on a timely basis,
they may cancel their orders or return products to us. Consequently, our
revenues and net income would be reduced.
18
OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE'S REPUBLIC OF CHINA,
SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS. IF THERE IS ANY
PROBLEM WITH THE MANUFACTURING PROCESS, OUR REVENUES AND NET PROFITABILITY MAY
BE REDUCED.
We are using nine factories in the People's Republic of China to manufacture the
majority of our karaoke machines. These factories will be producing
approximately 95% of our karaoke products in fiscal 2006. Our arrangements with
these factories are subject to the risks of doing business abroad, such as
import duties, trade restrictions, work stoppages, and foreign currency
fluctuations, limitations on the repatriation of earnings and political
instability, which could have an adverse impact on our business. Furthermore, we
have limited control over the manufacturing processes themselves. As a result,
any difficulties encountered by our third-party manufacturers that result in
product defects, production delays, cost overruns or the inability to fulfill
orders on a timely basis could adversely affect our revenues, profitability and
cash flow. Also, since we do not have written agreements with any of these
factories, we are subject to additional uncertainty if the factories do not
deliver products to us on a timely basis.
WE DEPEND ON THIRD PARTY SUPPLIERS FOR PARTS FOR OUR KARAOKE MACHINES AND
RELATED PRODUCTS, AND IF WE CANNOT OBTAIN SUPPLIES AS NEEDED, OUR OPERATIONS
WILL BE SEVERELY DAMAGED.
Our growth and ability to meet customer demand depends in part on our capability
to obtain timely deliveries of karaoke machines and our electronic products. We
rely on third party suppliers to produce the parts and materials we use to
manufacture and produce these products. If our suppliers are unable to provide
our factories with the parts and supplies, we will be unable to produce our
products. We cannot guarantee that we will be able to purchase the parts we need
at reasonable prices or in a timely fashion. In the last several years, there
have been shortages of certain chips that we use in our karaoke machines. If we
are unable to anticipate any shortages of parts and materials in the future, we
may experience severe production problems, which would impact our sales.
CONSUMER DISCRETIONARY SPENDING MAY AFFECT KARAOKE PURCHASES AND IS AFFECTED BY
VARIOUS ECONOMIC CONDITIONS AND CHANGES.
Our business and financial performance may be damaged more than most companies
by adverse financial conditions affecting our business or by a general weakening
of the economy. Purchases of karaoke machines and music are considered
discretionary for consumers. Our success will therefore be influenced by a
number of economic factors affecting discretionary and consumer spending, such
as employment levels, business, interest rates, and taxation rates, all of which
are not under our control. Additionally, other extraordinary events such as
terrorist attacks or military engagements, which adversely affect the retail
environment may restrict consumer spending and thereby adversely affect our
sales growth and profitability.
WE MAY HAVE INFRINGED THE COPYRIGHTS OF CERTAIN MUSIC PUBLISHERS AND IF WE
VIOLATE FEDERAL COPYRIGHT LAWS, WE WILL BE SUBJECT TO MONETARY PENALTIES.
Over the past several years, we have received notices from several music
publishers who have alleged that we did not have the proper copyright licenses
to sell certain songs included in our compact discs with graphics discs
("CDG"s). CDG's are compact discs which contain the musical recordings of the
karaoke songs and graphics which contain the lyrics of the songs. We have
settled or are in the process of settling all of these copyright infringement
issues with these publishers. We have spent approximately $70,000 to settle
these copyright infringement suits in fiscal year 2004 and 2005. These copyright
infringement claims may have a negative effect on our ability to sell our music
products to our customers. If we do not have the proper copyright licenses for
any other songs that are included in our CD+G's and cassettes, we will be
subject to additional liability under the federal copyright laws, which could
include settlements with the music publishers and payment of monetary damages.
See " Legal Proceedings."
WE MAY BE SUBJECT TO CLAIMS FROM THIRD PARTIES FOR UNAUTHORIZED USE OF THEIR
PROPRIETARY TECHNOLOGY, COPYRIGHTS OR TRADE SECRETS AND ANY CLAIMS ASSERTED
AGAINST US COULD AFFECT OUR NET PROFITABILITY.
We believe that we independently developed the technology used in our electronic
and audio software products and that it does not infringe on the proprietary
rights, copyrights or trade secrets of others. However, we cannot assure you
that we have not infringed on the proprietary rights of third parties or those
third parties will not make infringement violation claims against us. During
fiscal 2000, Tanashin Denki, Ltd., a Japanese company that holds a patent on a
cassette tape drive mechanism alleged that some of our karaoke machines violated
their patents. We settled the matters with Tanashin in December 1999.
Subsequently in December 2002, Tanashin again alleged that some of our karaoke
machines violated their patents. We entered into another settlement agreement
with them in May 2003. In addition to Tanashin, we could receive infringement
claims from other third parties. Any infringement claims may have a negative
effect on our profitability and financial condition.
19
WE ARE EXPOSED TO THE CREDIT RISK OF OUR CUSTOMERS, WHO ARE EXPERIENCING
FINANCIAL DIFFICULTIES, AND IF THESE CUSTOMERS ARE UNABLE TO PAY US, OUR
REVENUES AND PROFITABILITY WILL BE REDUCED.
We sell products to retailers, including department stores, lifestyle merchants,
direct mail retailers, which are catalogs and showrooms, national chains,
specialty stores, and warehouse clubs. Some of these retailers, such as K-Mart,
FAO Schwarz and KB Toys, have engaged in leveraged buyouts or transactions in
which they incurred a significant amount of debt, and operated under the
protection of bankruptcy laws. As of June 15, 2005, we are aware of only two
customers, FAO Schwarz and KB Toys, which are operating under the protection of
bankruptcy laws. Deterioration in the financial condition of our customers could
result in bad debt expense to us and have a material adverse effect on our
revenues and future profitability.
A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTERS IN CALIFORNIA OR FLORIDA
COULD IMPACT OUR ABILITY TO DELIVER MERCHANDISE TO OUR STORES, WHICH COULD
ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY.
A significant amount of our merchandise is shipped to our customers from one of
our two warehouses, which are located in Compton, California, and Coconut Creek,
Florida. Events such as fire or other catastrophic events, any malfunction or
disruption of our centralized information systems or shipping problems may
result in delays or disruptions in the timely distribution of merchandise to our
customers, which could substantially decrease our revenues and profitability.
OUR BUSINESS OPERATIONS COULD BE DISRUPTED IF THERE ARE LABOR PROBLEMS ON THE
WEST COAST.
During fiscal 2005, approximately 36% of our sales were domestic warehouse
sales, which were made from our warehouses in California and Florida. During the
third quarter of fiscal 2003, the dock strike on the West Coast affected sales
of two of our karaoke products and we estimate that we lost between $3 and $5
million in orders because we couldn't get the containers of these products off
the pier. If another strike or work slow-down occurs and we do not have a
sufficient level of inventory, a strike or work slow-down would result in
increased costs to us and may reduce our profitability.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE WHICH MAY CAUSE INVESTORS
TO LOSE ALL OR A PORTION OF THEIR INVESTMENT.
From June 1, 2004 through June 1, 2005, our common stock has traded between a
high of $1.00 and a low of $0.33. During this period, we have lost senior
executives and Board members, had liquidity problems, and incurred a net loss of
$3.6 million in fiscal 2005. Our stock price may continue to be volatile based
on similar or other adverse developments in our business. In addition, the stock
market periodically experiences significant adverse price and volume
fluctuations which may be unrelated to the operating performance of particular
companies.
IF INVESTORS SHORT OUR SECURITIES, IT MAY CAUSE OUR STOCK PRICE TO DECLINE.
During the past year, a number of investors have held a short position in our
common stock. As of May 15, 2005, investors hold a short position in 205,000
shares of our common stock which represents 2.6% of our public float. The
anticipated downward pressure on our stock price due to actual or anticipated
sales of our stock by some institutions or individuals who engage in short sales
of our common stock could cause our stock price to decline. Additionally, if our
stock price declines, it may be more difficult for us to raise capital.
OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS.
Our employment agreement with Yi Ping Chan requires us, under certain
conditions, to make substantial severance payments to him if he resigns after a
change of control. As of March 31, 2005, Mr. Chan is entitled to severance
payments of $250,000. These provisions could delay or impede a merger, tender
offer or other transaction resulting in a change in control of the Singing
Machine, even if such a transaction would have significant benefits to our
shareholders. As a result, these provisions could limit the price that certain
investors might be willing to pay in the future for shares of our common stock.
See "Executive Compensation - Employment Agreements" on page 28.
RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
OUR COMMON STOCK MAY BE DELISTED FROM THE AMERICAN STOCK EXCHANGE, WHICH MAY
HAVE A MATERIAL ADVERSE IMPACT ON THE PRICING AND TRADING OF OUR COMMON STOCK.
Our common stock is quoted on the American Stock Exchange ("Amex"). The Amex, as
a matter of policy, will consider the suspension of trading in, or removal from
listing of, any stock when, in the opinion of Amex, (i) the financial condition
and/or operating results of an issuer appear to be unsatisfactory; (ii) it
appears that the extent of public distribution or the aggregate market value of
the stock has become so reduced as to make further dealings on the Amex
inadvisable; (iii) the issuer has sold or otherwise disposed of its principal
operating assets; or (iv) the issuer has sustained losses which are so
substantial in relation to its overall operations or its existing financial
condition has become so impaired that it appears questionable, in the opinion of
Amex, whether the issuer will be able to continue operations and/or meet its
obligations as they mature.
20
As of June 7, 2005, we have not received any notices from AMEX notifying us that
they will delist us. However, we cannot assure you that Amex will not take any
actions in the near future to delist our common stock. If our common stock were
delisted from the Amex, we would trade on the Over-the-Counter Bulletin Board
and the market price for shares or our common stock could decline. Further, if
our common stock is removed from listing on Amex, it may become more difficult
for us to raise funds through the sale of our common stock or securities
convertible into our common stock.
IF OUR OUTSTANDING DERIVATIVE SECURITIES ARE EXERCISED OR CONVERTED, OUR
EXISTING SHAREHOLDERS WILL SUFFER DILUTION.
As of March 31, 2005, there were outstanding stock options to purchase an
aggregate of 1,041,610 shares of common stock at exercise prices ranging from
$.75 to $14.30 per share, not all of which are immediately exercisable. The
weighted average exercise price of the outstanding stock options is
approximately $3.67 per share. As of March 31, 2005, there were outstanding
immediately exercisable option to purchase an aggregate of 775,831 shares of our
common stock. There were outstanding stock warrants to purchase 591,040 shares
of common stock at exercise prices ranging from $1.46 to $4.03 per share, all of
which are exercisable. The weighted average exercise price of the outstanding
stock warrants is approximately $1.91 per share. In addition, we have issued
$4,000,000 of convertible debentures, which are convertible into an aggregate of
2,831,858 shares of common stock. To the extent that the aforementioned
convertible securities are exercised or converted, dilution to our stockholders
will occur.
THE $4 MILLION PRIVATE PLACEMENT THAT WE CLOSED IN SEPTEMBER 2003 WILL AFFECT
OUR ABILITY TO RAISE CAPITAL IN THE FUTURE.
On September 8, 2003, we closed a private offering in which we issued $4 million
of convertible debentures and stock purchase warrants to six institutional
investors. As part of this investment, we agreed to several limitations on our
corporate actions, some of which limit our ability to raise financing in the
future. If we enter into any financing transactions prior to January 21, 2006,
we need to offer the institutional investors the right to participate in such
offering in an amount equal to the greater of (a) the principal amount of the
debentures currently outstanding or (b) 50% of the financing offered to the
outside investment group. For example, if we offer to sell $10 million worth of
our securities to an outside investment group, the institutional investors will
have the right to purchase up to $5 million of the offering. This right may
affect our ability to attract other investors if we require external financing
to remain in operations. Furthermore, for a period of 90 days after the
effective date of the registration statement registering shares of common stock
issuable upon conversion of the convertible debentures and the warrants, we
cannot sell any securities.
Additionally, we cannot:
o sell any of our securities in any transactions where the exercise price is
adjusted based on the trading price of our common stock at any time after
the initial issuance of such securities.
o sell any securities which grant investors the right to receive additional
shares based on any future transaction on terms more favorable than those
granted to the investor in the initial offering
These limitations are in place until the earlier of February 20, 2006 or the
date on which all the debentures are converted into shares of our common stock.
IF WE SELL ANY OF OUR SECURITIES AT A PRICE LOWER THAN $0.60 PER SHARE, THE
CONVERSION PRICE OF OUR DEBENTURES AT $1.41 PER SHARE WILL BE REDUCED AND THERE
WILL BE ADDITIONAL DILUTION TO OUR SHAREHOLDERS.
Given that our common stock is trading at a price of $0.60 per share as of June
15, 2005, it is possible that we may need to sell additional securities for
capital at a price lower than $0.60 per share. If we sell any securities at a
price lower than $0.60 per share, the conversion price of our debentures
currently set at $1.41 per share will be reduced and there will be more dilution
to our shareholders if and when the debentures are converted into shares of our
common stock. The set price will be reduced by an amount equal to 50% of the
difference between the set price and effective purchase price of such shares.
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS AND INVESTORS MAY
DEPRESS OUR STOCK PRICE.
As of March 31, 2005, there were 9,769,593 shares of our common stock
outstanding. Of these shares, approximately 960,924 shares are eligible for sale
under Rule 144. We have filed two registration statements registering an
aggregate 3,794,250 of shares of our common stock (a registration statement on
Form S-8 to register the sale of 1,844,250 shares underlying options granted
under our 1994 Stock Option Plan and a registration statement on Form S-8 to
register 1,950,000 shares of our common stock underlying options granted under
our Year 2001 Stock Option Plan). An additional registration statement on Form
S-1, of which this Prospectus is a part, was filed in October 2003, registering
an aggregate of 2,795,465 shares of our common stock. The market price of our
common stock could drop due to the sale of large number of shares of our common
stock, such as the shares sold pursuant to the registration statements or under
Rule 144, or the perception that these sales could occur.
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OUR STOCK PRICE MAY DECREASE IF WE ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK.
Our Certificate of Incorporation authorizes the issuance of 18,900,000 shares of
common stock. As of March 31, 2005, we had 9,769,593 shares of common stock
issued and outstanding and an aggregate of 1,632,650 shares issuable under our
outstanding options and warrants. We also have an obligation to issue up to
2,831,858 shares upon conversion of our debentures and have reserved 207,791
additional shares for interest payment on the debentures. As such, our Board of
Directors has the power, without stockholder approval, to issue up to 4,458,108
shares of common stock.
Any issuance of additional shares of common stock, whether by us to new
stockholders or the exercise of outstanding warrants or options, may result in a
reduction of the book value or market price of our outstanding common stock.
Issuance of additional shares will reduce the proportionate ownership and voting
power of our then existing stockholders.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAKE IT DIFFICULT FOR A
THIRD PARTY TO ACQUIRE OUR COMPANY AND COULD DEPRESS THE PRICE OF OUR COMMON
STOCK.
Delaware law and our certificate of incorporation and bylaws contain provisions
that could delay, defer or prevent a change in control of our company or a
change in our management. These provisions could also discourage proxy contests
and make it more difficult for you and other stockholders to elect directors and
take other corporate actions. These provisions of our restated certificate of
incorporation include: authorizing our board of directors to issue additional
preferred stock, limiting the persons who may call special meetings of
stockholders, and establishing advance notice requirements for nominations for
election to our board of directors or for proposing matters that can be acted on
by stockholders at stockholder meetings.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our financial position,
results of operations or cash flows due to adverse changes in financial and
commodity market prices and interest rates. We are exposed to market risk in the
areas of changes in United States and international borrowing rates and changes
in foreign currency exchange rates. In addition, we are exposed to market risk
in certain geographic areas that have experienced or remain vulnerable to an
economic downturn, such as China. We purchase substantially all our inventory
from companies in China, and, therefore, we are subject to the risk that such
suppliers will be unable to provide inventory at competitive prices. While we
believe that, if such an event were to occur we would be able to find
alternative sources of inventory at competitive prices, we cannot assure you
that we would be able to do so. These exposures are directly related to our
normal operating and funding activities. Historically and as of March 31, 2005,
we have not used derivative instruments or engaged in hedging activities to
minimize market risk.
INTEREST RATE RISK
As or March 31, 2005, we do not have any exposure to market risk resulting from
changes in interest rates. We have $4 million in convertible notes, which have a
fixed interest rate of 9% effective as of November 8, 2004.
FOREIGN CURRENCY RISK
We have a wholly-owned subsidiary in Hong Kong. Sales by these operations made
on a FOB China or Hong Kong basis are dominated in U.S. dollars. However,
purchases of inventory and Hong Kong operating expenses are typically
denominated in Hong Kong dollars, thereby creating exposure to changes in
exchange rates. Changes in the Hong Kong dollar/U.S. dollar exchange rates may
positively or negatively affect our gross margins, operating income and retained
earnings. We do not believe that near-term changes in the exchange rates, if
any, will result in a material effect on our future earnings, fair values or
cash flows, and therefore, we have chosen not to enter into foreign currency
hedging transactions. We cannot assure you that this approach will be
successful, especially in the event of a significant and sudden change in the
value of the Hong Kong dollar.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY 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
On October 15, 2004, Grant Thornton LLP (the "Former Accountant") resigned as
the auditors for The Singing Machine Company, Inc. (the "Company"). On October
15, 2004, the Company engaged Berkovits, Lago & Company, LLP (the "New
Accountant"), as its independent certified public accountant. The Company's
decision to engaged the New Accountant was approved by its Audit Committee on
October 15, 2004.
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The reports of the Former Accountant on the financial statements of the Company
for each of the two most recent fiscal years, 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, except that the Former Accountant's opinion in
its report on the Company's financial statements expressed substantial doubt
with respect to the Company's ability to continue as a going concern for the
last two fiscal years.
During the Company's two most recent fiscal years and the subsequent interim
period through the date of resignation, there were no reportable events as the
term described in Item 304(a)(1)(v) of Reg