SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2002 Commission File Number 0-24968 ------- THE SINGING MACHINE COMPANY, INC. --------------------------------- (Exact Name of Registrant as Specified in its Charter) Delaware 95-3795478 -------- ---------- (State of Incorporation) (IRS Employer I.D. No.) 6601 Lyons Road, Building A-7, Coconut Creek, FL 33073 ------------------------------------------------------ (Address of principal executive offices) (954) 596-1000 -------------- (Registrant's telephone number, including area code) Indicate 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. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes [ ] No [X] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [X} No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS There were 8,125,178 shares of Common Stock, $.01 par value, issued and outstanding at December 31, 2002. THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements Page No. -------- Consolidated Balance Sheets - December 31, 2002 (Unaudited) and March 31, 2002 .............................................. 3 Consolidated Statement of Operations - Three and nine months ended December 31, 2002 and 2001 (Unaudited)..................... 4 Consolidated Statement of Cash Flows - Nine months ended December 31, 2002 and 2001 (Unaudited) .......................... 5 Notes to Consolidated Financial Statements ...................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ............................. 11 Item 3. Quantitative and Qualitative Disclosure About Market Risk........ 19 Item 4. Controls and Procedures.......................................... 19 PART II. OTHER INFORMATION Item 1. Legal Proceedings ............................................... 21 Item 2. Changes in Securities and Use of Proceeds........................ 21 Item 3. Defaults Upon Senior Securities ................................. 22 Item 4. Submission of Matters to a Vote of Security Holders ............. 22 Item 5. Other Information ............................................... 22 Item 6. Exhibits and Reports on Form 8-K ................................ 22 SIGNATURES ............................................................... 24 CERTIFICATIONS ............................................................25 EXHIBIT INDEX..............................................................27 2 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY PART I - FINANCIAL INFORMATION ITEM I. FINANCIAL STATEMENTS THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2002 MARCH 31, 2002 ----------------- -------------- (unaudited) ASSETS CURRENT ASSETS Cash and cash equivalents $ 362,927 $ 5,520,147 Accounts receivable, net 19,535,201 3,536,903 Due from manufacturer 753,206 488,298 Inventories 30,016,924 9,274,352 Prepaid expenses and other current assets 2,155,879 982,697 Deposits 517,324 513,684 ----------- ----------- TOTAL CURRENT ASSETS 53,341,461 20,316,081 ----------- ----------- PROPERTY AND EQUIPMENT, NET 1,232,227 574,657 ----------- ----------- OTHER ASSETS Security deposits 180,532 135,624 Reorganization intangible, net 185,416 185,416 Deferred tax asset -- 452,673 ----------- ----------- TOTAL OTHER ASSETS 365,948 773,713 ----------- ----------- TOTAL ASSETS $54,939,636 $21,664,451 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $13,049,506 $ 1,846,238 Accrued expenses 4,173,368 1,289,597 Deferred Revenue 822,106 Loan payable 10,163,088 -- Income tax payable 630,796 58,542 ----------- ----------- TOTAL CURRENT LIABILITIES 28,838,864 3,194,377 ----------- ----------- STOCKHOLDERS' EQUITY Preferred stock, $1.00 par value, 1,000,000 shares authorized, no shares issues and outstanding -- -- Common stock, Class A, $0.01 par value, 100,000 shares authorized, no shares issued and outstanding -- -- Common stock, $0.01 par value, 18,900,000 shares authorized, 8,125,178 and 8,020,027 shares issued and outstanding 81,252 80,200 Additional paid-in capital 4,757,355 4,602,828 Retained earnings 21,262,165 13,787,046 ----------- ----------- TOTAL STOCKHOLDERS' EQUITY 26,100,772 18,470,074 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $54,939,636 $21,664,451 =========== =========== See accompanying notes to consolidated financial statements 3 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended Nine Months Ended December 31, December 31, December 31, December 31, 2002 2001 2002 2001 ------------ ------------ ------------ ------------ NET SALES $ 48,869,776 $ 34,158,513 $ 85,998,383 $ 55,431,595 COST OF SALES 35,438,420 22,719,929 62,090,759 36,821,615 ------------ ------------ ------------ ------------ GROSS PROFIT 13,431,356 11,438,584 23,907,624 18,609,980 ------------ ------------ ------------ ------------ OPERATING EXPENSES Compensation 1,257,519 1,090,838 2,827,823 2,361,797 Commissions 581,800 777,209 1,127,221 1,266,016 Advertising 3,210,330 1,038,056 4,082,940 1,942,442 Royalty expense 1,189,706 1,191,169 2,064,336 1,596,800 Selling, general, and administrative expenses 2,110,769 1,413,371 5,153,503 3,248,749 ------------ ------------ ------------ ------------ TOTAL OPERATING EXPENSES 8,350,124 5,510,643 15,255,823 10,415,804 ------------ ------------ ------------ ------------ INCOME FROM OPERATIONS 5,081,232 5,927,941 8,651,801 8,194,176 ------------ ------------ ------------ ------------ OTHER INCOME (EXPENSES) Other Income 38,628 53,600 196,648 195,741 Interest Expense (117,704) (104,877) (228,597) (143,034) Interest Income -- 17,471 11,943 40,564 ------------ ------------ ------------ ------------ NET OTHER EXPENSES (79,096) (33,806) (20,006) 93,271 ------------ ------------ ------------ ------------ INCOME BEFORE INCOME TAX PROVISION 5,002,156 5,894,135 8,631,795 8,287,447 INCOME TAX PROVISION (1,105,569) (6,000) (1,156,676) (18,000) ------------ ------------ ------------ ------------ NET INCOME $ 3,896,587 $ 5,888,135 $ 7,475,119 $ 8,269,447 ============ ============ ============ ============ EARNINGS PER SHARE: Basic $ .48 $ .80 $ .92 $ 1.20 ============ ============ ============ ============ Diluted $ .44 $ .69 $ .84 $ 1.04 ============ ============ ============ ============ WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING: Basic 8,123,548 7,335,758 8,101,441 6,900,918 ============ ============ ============ ============ Diluted 8,944,027 8,565,861 8,947,897 7,973,514 ============ ============ ============ ============ See accompanying notes to financial statements 4 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Nine Months Ended December 31, 2002 2001 ------------ ------------ CASH FLOW FROM OPERATING ACTIVITIES: Net Income $ 7,475,119 $ 8,269,447 Adjustments to reconcile net income to net cash provided by (used in) operating activities Depreciation and amortization 454,806 209,334 Stock based expenses -- 171,472 Bad debt 3,356 -- Deferred tax benefit 452,673 (73,574) Changes in assets and liabilities: (Increase) decrease in: Accounts receivable (16,001,654) (26,104,253) Due from manufacturer (264,908) 1,379,901 Inventories (20,742,572) (1,900,092) Prepaid expenses and other assets (1,218,091) 261,287 Increase (decrease) in: Accounts payable 11,203,268 5,554,717 Accrued expenses 2,883,772 4,157,472 Deferred Revenue 822,106 -- Income taxes payable 572,254 (23,320) ------------ ------------ NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (14,359,871) (8,097,609) ------------ ------------ CASH FLOW FROM INVESTING ACTIVITIES Purchase of property and equipment (1,112,376) (593,823) Deposit for credit line (3,640) (256,807) Proceeds from investment in factor -- 933,407 Proceeds from repayment of officer loans -- 117,425 Investment in and advances to unconsolidated subsidiary -- 274,702 ------------ ------------ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (1,116,016) 474,904 ------------ ------------ CASH FLOW FROM FINANCING ACTIVITIES Loan proceeds 37,612,713 19,211,494 Loan repayments (27,449,625) (11,644,383) Proceeds from exercise of stock options and warrants 155,579 956,078 ------------ ------------ NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 10,318,667 8,523,189 ------------ ------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (5,157,220) 900,484 CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 5,520,147 1,016,221 ------------ ------------ CASH AND CASH EQUIVALENTS - END OF YEAR $ 362,927 $ 1,916,705 ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for interest $ 228,597 $ 143,034 ============ ============ Cash paid during the year for income taxes $ 73,207 $ 18,000 ============ ============ See accompanying notes to consolidated financial statements 5 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 (Unaudited) NOTE 1 - BASIS OF PRESENTATION The accompanying consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q and, therefore, omit or condense certain footnotes and other information normally included in financial statements prepared in accordance with generally accepted accounting principles. It is suggested that these consolidated condensed financial statements should be read in conjunction with the Company's consolidated financial statements and notes thereto included in the Company's audited financial statements on the Company's Annual Report on Form 10-KSB for the fiscal year ended March 31, 2002. The accounting policies followed for interim financial reporting are the same as those disclosed in Note 1 of the Notes to Financial Statements included in the Company's audited consolidated financial statements for the fiscal year ended March 31, 2002, which are included in Form 10- KSB. The Financial Accounting Standards Board has recently issued several new accounting pronouncements which may apply to the Company. The following statements have been adopted by the Company. Statement No. 141 "Business Combinations" establishes revised standards for accounting for business combinations. Specifically, the statement eliminates the pooling method, provides new guidance for recognizing intangible assets arising in a business combination, and calls for disclosure of considerably more information about a business combination. This statement is effective for business combinations initiated on or after July 1, 2001. The adoption of this pronouncement on July 1, 2001 did not have a material effect on the Company's financial position, results of operations or liquidity. Statement No. 142 "Goodwill and Other Intangible Assets" provides new guidance concerning the accounting for the acquisition of intangibles, except those acquired in a business combination, which is subject to SFAS 141, and the manner in which intangibles and goodwill should be accounted for subsequent to their initial recognition. Generally, intangible assets with indefinite lives, and goodwill, are no longer amortized; they are carried at lower of cost or market and subject to annual impairment evaluation, or interim impairment evaluation if an interim triggering event occurs, using a new fair market value method. Intangible assets with finite lives are amortized over those lives, with no stipulated maximum, and an impairment test is performed only when a triggering event occurs. This statement is effective for all fiscal years beginning after December 15, 2001. The Company adopted SFAS 142 on April 1, 2002 liquidity and accordingly has stopped amortizing the reorganization intangible, which had a net balance of $185,412 at March 31, 2002. Statement No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" supercedes Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"). Though it retains the basic requirements of SFAS 121 regarding when and how to measure an impairment loss, SFAS 144 provides additional implementation guidance. SFAS 144 excludes goodwill and intangibles not being amortized among other exclusions. SFAS 144 also supercedes the provisions of APB 30, "Reporting the Results of Operations," pertaining to discontinued operations. Separate reporting of a discontinued operation is still required, but SFAS 144 expands the presentation to include a component of an entity, rather than strictly a business segment as defined in SFAS 131, Disclosures about Segments of an Enterprise and Related Information. SFAS 144 also eliminates the current exemption to consolidation when control over a subsidiary is likely to be temporary. This statement is effective for all fiscal years beginning after December 15, 2001. The implementation of SFAS 144 on April 1, 2002 did not have a material effect on the Company's financial position, results of operations or liquidity. Statement No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," updates, clarifies, and simplifies existing accounting pronouncements. Statement No. 145 rescinds Statement 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Opinion 30 will now be used to classify those gains and losses. Statement 64 amended Statement 4, and is no longer necessary because Statement 4 has been rescinded. Statement 44 was issued to establish accounting requirements for the effects of transition to the provisions of the motor Carrier Act of 1980. Because the transaction has been completed, 6 Statement 44 is no longer necessary. Statement 145 amends Statement 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. This amendment is consistent with FASB's goal requiring similar accounting treatment for transactions that have similar economic effects. The adoption of SFAS No. 145 did not have a material impact on the Company's consolidated financial statements. Statement No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure", amends FASB Statement No. 123, "Accounting for Stock-Based Compensation". In response to a growing number of companies announcing plans to record expenses for the fair value of stock options, Statement 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement 148 amends the disclosure requirements of Statement 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. The Statement also improves the timeliness of those disclosures by requiring that this information be included in interim as well as annual financial statements. In the past, companies were required to make pro forma disclosures only in annual financial statements. The transition guidance and annual disclosure provisions of Statement 148 are effective for fiscal years ending after December 15, 2002, with earlier application permitted in certain circumstances. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The Company adopted the disclosure provisions of Statement 148 for the quarter ended December 31, 2002, but will continue to use the method under APB 25 in accounting for stock options. The adoption of the disclosure provisions of Statement 148 did not have a material impact on the Company's financial position, results of operations or liquidity. The following statements will be adopted by the Company as they become effective. Statement No. 143, "Accounting for Asset Retirement Obligations," requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after June 15, 2002. The adoption of SFAS No. 143 is not expected to have a material impact on the Company's financial statements. Statement No. 146, "Accounting for Exit or Disposal Activities" ("SFAS 146") addresses the recognition, measurement, and reporting of cost that are associated with exit and disposal activities that are currently accounted for pursuant to the guidelines set forth in EITF 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to exit an Activity (including Certain Cost Incurred in a Restructuring)," cost related to terminating a contract that is not a capital lease and one-time benefit arrangements received by employees who are involuntarily terminated - nullifying the guidance under EITF 94-3. Under SFAS 146, the cost associated with an exit or disposal activity is recognized in the periods in which it is incurred rather than at the date the Company committed to the exit plan. This statement is effective for exit or disposal activities initiated after December 31, 2002 with earlier application encouraged. The adoption of SFAS 146 is not expected to have a material impact on the Company's financial position or result of operations. Certain amounts in the December 31, 2001 interim consolidated financial statements have been reclassified to conform to the December 31, 2002 presentation. In the opinion of management, all adjustments, which are of a normal recurring nature and considered necessary to present fairly the financial positions, results of operations, and cash flows for all periods presented have been made. The results of operations for the three-month period ended December 31, 2002 are not necessarily indicative of the results that may be expected for the entire fiscal year ending March 31, 2003. The accompanying consolidated condensed financial statements include the accounts of the Company and its wholly owned subsidiary. All significant inter-company balances and transactions have been eliminated. Assets and liabilities of the foreign subsidiary are translated at the rate of exchange in effect at the balance sheet date; income and expenses are translated at the average rates of exchange prevailing during the year. The related translation adjustment is not material. NOTE 2 - DEPOSIT FOR LETTER OF CREDIT FACILITY The Company, through its Hong Kong subsidiary, maintains letter of credit facilities with three major international 7 banks. The Company's subsidiary is required to maintain separate deposit accounts at these banks in the amount of $517,324. This amount is included in deposits at December 31, 2002. NOTE 3 - LOANS AND LETTERS OF CREDIT In December 2002, the Company amended its Loan and Security Agreement (the "Agreement") with a commercial lender (the "Lender"). The Lender will advance up to 70% of the Company's eligible accounts receivable, plus up to 40% of the eligible inventory, plus up to 40% of the commercial letters of credit opened for the purchase of eligible inventory, less reserves of up to $1,000,000 as defined in the agreement. The outstanding loan limit varies between zero and $25,000,000 depending on the time of year, as stipulated in the Agreement. The Lender also provides the Company the ability to issue commercial letters of credit up to $2,500,000, which shall reduce the loan limits above. The loans bear interest at the commercial lender's prime rate plus 0.5% and an annual fee equal to 1% of the maximum loan amount or $250,000 is payable. The term of the loan facility expires on April 26, 2004 and is automatically renewable for one-year terms. All amounts under the loan facility are due within 90 days of demand. The loans are secured by a first lien on all present and future assets of the Company except for certain tooling located at a vendor in China. The Agreement contains a financial covenant stipulating a minimum tangible net worth of $20,000,000 from October 31, 2002 to December 31, 2002 with escalations after this point as defined in the Agreement. The outstanding balance at December 31, 2002, was $10,163,088. NOTE 4 - EQUITY Stock options and warrants were exercised during the third quarter of fiscal year 2003. 1,875 shares of common stock were issued with proceeds to the Company of $3,825. The total of stock options and warrants exercised for the nine month period ended December 31, 2002 were 105,151 shares with a total proceeds to the Company of $155,684. On December 31, 2002, 187,000 stock options were granted to various employees of the Company under the Stock Option Plan of 2001 at the then current stock price of $9.00 per share. Pursuant to APB no. 25, no compensation expense will be recognized. NOTE 5 - COMMITMENTS On April 15, 2002, the Company entered into a three-year employment agreement with a new Executive Vice President of Sales and Marketing. The agreement stipulates a salary and bonuses and a 50% of annual pay severance clause. The agreement grants 50,000 options to the employee. The employee may elect to return the first year options to the Company for $100,000. In May and June 2002, the Company's subsidiary entered into new office leases in Hong Kong, each for 36 months at an aggregate $13,364 per month. Effective May 1, 2002, the Company signed a 5-year warehouse lease in California for $33,970 per month. The Company also subleased out its space in the other California warehouse for rent income of $12,393 per month through January 31, 2004. Effective June 1, 2002, the Company signed an additional 27-month lease to expand its corporate headquarters. The additional rent is $1,987 per month. Effective September 1, 2002, the Company signed an additional 24 - month lease to expand its corporate headquarters. The additional rent is $1,980 per month. As of November 13, 2002, the Company amended its merchandise license agreement to license a name, trade name, and logo of a music oriented television network. The term of the agreement remained unchanged, expiring on December 31, 2003. The Company pays a royalty rate of a percentage of sales of the licensed or branded merchandise, as defined in the amended agreement. The original agreement required a minimum royalty of $686,250, which minimum was met with sales and was paid by the Company as of March 31, 2002. The current amendment places a new guaranteed minimum royalty of $1,500,000. This guaranteed minimum is recoupable 8 against royalties of sales for the period January 1, 2003 through December 31, 2003 only. The guarantee is payable as follows: $500,000 on or before December 27, 2002; $333,334 on or before June 1, 2003; $333,333 on or before September 1, 2003; and $333,333 on or before December 1, 2003 As of December 31, 2002, the initial $500,000 had been paid and is included in prepaid expenses. Effective December 23, 2002, the Company signed a 30-month lease for additional warehouse space in California for $44,947 per month commencing January 1, 2003. NOTE 6 - CONCENTRATIONS The Company derives the majority of its revenues from retailers of products in the United States. Financial instruments, which potentially subject the Company to concentrations of credit risk, consist of accounts receivable. The Company's allowance for doubtful accounts is based upon management's estimates and historical experience and reflects the fact that accounts receivable are concentrated with several large customers whose credit worthiness have been evaluated by management. At December 31, 2002, approximately 50% of accounts receivable were due from two U.S. customers. Accounts receivable from two customers that individually owed over 10% of accounts receivable at December 31, 2002 was 25% and 25%. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. Revenues derived from five customers for the nine months ended September 30, 2002 and 2001 were 73.1% and 98%. Revenues derived from three customers for the nine months ended December 31, 2002, which individually purchased greater than 10% of the Company's total revenues, were 23.1%, 17.9% and 17.6% for the nine months ended December 31, 2002 and two customers 66% and 36% for the nine months ended December 31, 2001. In the fourth quarter of fiscal 2002, a major customer that provided 37% of the Company's revenue in 2002 converted its purchase method to a consignee basis. The Company recorded approximately $2,875,000 of sales returns and reversal of related cost of sales of $2,112,000 in the fourth quarter of fiscal 2002 and the customer retained the inventory on a consignment basis. As of December 31, 2002 this customer was still on a consignment basis with all but two products. The Company is dependent upon foreign companies for manufacture of all of its electronic products. The Company's arrangements with manufacturers are subject to the risk of doing business abroad, such as import duties, trade restrictions, work stoppages, foreign currency fluctuations, political instability, and other factors, which could have an adverse impact on its business. The Company believes that the loss of any one or more of their suppliers would not have a long-term material adverse effect because other manufacturers with whom the Company does business would be able to increase production to fulfill their requirements. However, the loss of certain suppliers in the short-term could adversely affect business until alternative supply arrangements are secured. During fiscal 2002 and 2001, manufacturers in the People's Republic of China (China) accounted for in excess of 95% and 94%, respectively of the Company's total product purchases, including virtually all of the Company's hardware purchases. The Company expects purchasing for 2003 to fall within the above range as well. Purchases of products derived from three factories based in China during fiscal 2002 were 51%, 39%, and 5% and from two manufacturers based in China during fiscal 2001 were 80% and 14%, respectively. For the nine months ended December 31, 2002, purchases of product were derived from seven factories based in China. The Company finances its sales primarily through a loan facility with one lender. Although management believes there are other sources available, a loss of the current credit facility could be in the short term, adversely affect operations until an alternate lending arrangement is secured. Net sales derived from the Company's Hong Kong based subsidiary aggregated approximately $45,415,402 for the nine months ended December 31, 2002 and $27,485,628 for the same period in 2001. The carrying value of net assets held by the Company's Hong Kong based subsidiary, net of inter-company balances, was approximately ($6,270,855) at December 31, 2002. NOTE 7 - EARNINGS PER SHARE Basic net income (loss) per common share (Basic EPS) excludes dilution and is computed by dividing net income (loss) available to common stockholder by the weighted-average number of common shares outstanding for the 9 period. Diluted net income per share (Diluted EPS) reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. At December 31, 2002 there were 1,286,250 common stock equivalents outstanding which may dilute future earnings per share. NOTE 8 - SEGMENTS The Company operates in one segment and maintains its records accordingly. Sales by customer geographic region for the nine months ended December 31, 2002, were as follows: December 31, 2002 2001 ----------- ----------- United States $70,809,392 $55,300,710 Asia 21,310 49,314 Australia 529,020 -- Canada 696,073 37,344 Central America 61,046 4,789 Europe 12,978,811 -- Mexico 902,731 122 South America -- 39,316 ----------- ----------- $85,998,383 $55,431,595 =========== =========== NOTE 9 - SUBSEQUENT EVENTS The Company entered into an agreement with a retail customer whereby they guaranteed the customer a minimum gross margin of $3,573,000 from the sale of the Company's products during the period from September 1, 2002 through January 15, 2003. Under the agreement, the Company will reimburse the customer for the difference between the customer's gross margin on sales and the minimum guarantee. The Company would have a total exposure of $3,537,000, in the event that there were no sales of the Company's products made by the retail customer during this period. In accordance with the Securities and Exchange Commission Staff Accounting Bulletin 101, "Revenue Recognition", the Company has not recognized any revenues or related cost of sales at December 31, 2002. Any revenues or related cost of sales will be recognized at January 15, 2003 ("settlement date"), since the ultimate net sales are not determinable until that date. In accordance with the Emerging Issues Task Force ("EITF") Issue 01-9, the guarantee is considered a reduction of sales. As of the settlement date of the contract, the decrease in sales is $2,570,047, bringing net sales under this agreement to ($167,737) and net loss on the agreement to ($1,594,113). As of this date, an initial amount of $1,500,000 has been paid against the amount due under the settlement. The remaining amount is payable in four equal payments of $267,511 on April 25, July 25 and October 25, 2003 and January 25, 2004. 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Certain statements contained in this Quarterly Report on Form 10- Q, including without limitation, statements containing the words believes, anticipates, estimates, expects, and words of similar import, constitute forward-looking statements. You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described below and elsewhere in this Quarterly Report, and in other documents we file with the Securities and Exchange Commission. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. GENERAL The Singing Machine Company, Inc. and its wholly owned subsidiary, International (SMC) HK, Ltd.(the "Company", "we" or "us") engages in the production, distribution, marketing and sale of consumer karaoke audio equipment, accessories and music. Our electronic karaoke machines and audio software products are marketed under The Singing Machine(C) trademark. Our products are sold throughout the United States, primarily through department stores, lifestyle merchants, mass merchandisers, direct mail catalogs and showrooms, music and record stores, national chains, specialty stores and warehouse clubs. Our karaoke machines and karaoke software are currently sold in such retail outlets as Best Buy, Toys R Us, Target, J.C. Penney and Circuit City. We had a net income before tax of $8,631,795 for the nine-month period ended December 31, 2002. RESULTS OF OPERATIONS REVENUES Revenues for the three months ended December 31, 2002 were $48,869,776, compared to revenues of $34,158,513 for the three months ended December 31, 2001. Revenues for the nine months ended December 31, 2002 and 2001 were $85,998,383 and $55,431,595, respectively. Our revenue increase for the nine months of 55.1% is due to increased sales and the introduction of new products and services. We also obtained several significant new national retail customers in our third quarter ended December 31, 2002. GROSS PROFIT Gross profit for the three-month period ended December 31, 2002 was $13,431,356 or 27.5% of sales compared with $11,438,584 or 33.7% of sales for the second quarter of the prior year. Gross profit for the nine months ended December 31, 2002 was $23,907,624 or 27.8% of sales compared with $18,609,980 or 33.6% of sales for the nine months ended December 31, 2001. The decrease in gross profit is primarily due to increased sales from our subsidiary and sales to international customers. Our international sales were primarily in Europe, Canada and Australia. Sales to international customers historically maintain a lower gross profit because there are no other variable expenses from these sales. Other variable expenses that are normally included with sales are advertising allowances, returns and commissions. OPERATING EXPENSES Operating expenses were $8,350,124 or 17.1% of total revenues, in the third quarter, up from $5,510,643 or 16.1% of total revenues, in the third quarter of the prior year. For the nine months ended December 31, 2002 and 2001, operating expenses were $15,255,823 or 17.7% of total revenues and $10,415,804 or 18.8%of total revenues, respectively. The primary factors that contributed to the increase of approximately $1,532,132 in operating expenses for the nine months ended December 31, 2002 are: 11 (i) the increase in depreciation in the amount of $188,713 due to the addition of molds for new product additions for fiscal year 2003, (ii) compensation expense in the amount of $466,026 due to the addition of key personnel in Florida, in our California facility and at our Hong Kong subsidiary, (iii) expansion of the California warehouse and its associated expenses in the amount of $701,789, (iv) expansion of the Hong Kong subsidiary and its related expenses, in the amount of $340,710. (v) increases in product development fees for development of future product $300,454. Other increases in operating expenses were to selling expenses, which are considered variable. These expenses are based directly on the level of sales and include commissions, direct and co-operative advertising, and royalty expenses. These areas alone contributed $2,469,239 to the increase in operating expenses. DEPRECIATION AND AMORTIZATION EXPENSES The Company's depreciation and amortization expenses were $466,561 or .6 % of total revenues for the nine months ended December 31, 2002, up from $236,032 or ..7% for the nine months ended December 31, 2001. The increase in depreciation and amortization expenses can be attributed to the Company's acquisition of new molds and tooling for our expanded product line, as well as minimal costs for additional computer equipment and furniture for additional personnel. OTHER INCOME AND EXPENSES Other expense net of other income was $79,076, for the third quarter of fiscal 2003 compared to other expenses net of other income of $33,806 for the third quarter of fiscal 2002. Other expenses net of other income for the nine months ended December 31, 2003 were $20,006 compared to income of $93,271 for the nine months ended December 31, 2001. Our interest expense increased during the nine months ended December 31, 2002 compared to the same period of the prior year primarily due to our increased use of our credit facility with LaSalle during this period. Prior to August 2002, the Company had cash reserves to fund operations and did not need to borrow on the line. Our interest income increased from $2,475 during the nine months ended December 31, 2001, to $11,943 during the first nine months of fiscal 2003 because we earned income on our cash balances held by our lender by investing in 24 hour commercial paper investments. INCOME BEFORE INCOME TAX EXPENSE The Company's net income before income taxes was $8,631,795 for the nine months ended December 31, 2002 compared with $8,287,447 for the same period of the prior year. INCOME TAX EXPENSE The Company files separate tax returns for the parent and for the Hong Kong Subsidiary. During the first three quarters of fiscal 2003, the Company showed a profit in both the U.S. parent company and in International SMC (HK) Ltd., its wholly-owned Hong Kong subsidiary. As a result of the annualization of this profit, the U.S. parent company has used up its net operating loss carryforwards. The Company had a deferred tax benefit at March 31, 2002 of $452,673 that had been taken in prior years. Now that the net operating losses have been depleted, the Company must expense this benefit. The computed provision for income taxes at December 31, 2002 was $704,003. This includes accruals for both federal and state income taxes. This provision plus the expense of the tax benefit make up the income tax expense of $1,156,676. The Hong Kong subsidiary has applied for an income tax exclusion based on the nature of its income. The claim for this exemption is still pending with Inland Revenue of Hong Kong; therefore, no accrual is made for Hong Kong income taxes. NET INCOME As a result of the foregoing, the Company's net income was $7,475,119 for the first nine months of fiscal 2003 compared with $8,269,447 for the first nine months of the prior year. 12 LIQUIDITY AND CAPITAL RESOURCES At December 31, 2002, the Company had cash on hand of $362,927 compared to $5,520,147 at March 31, 2002. The decreased cash is a direct result of increased inventory levels and accounts receivables. At December 31, 2002, the Company had current assets of $53,341,462 and total assets of $54,939,636 compared to current assets of $20,316,081 and total assets of $21,664,451 at March 31, 2002. The increase in current assets is the result of increased accounts receivable from sales of the third quarter and increased inventory levels. Increases in accounts receivable are common for this quarter of our fiscal year, due to the high volume of sales. The receivables created in the fiscal third quarter are subsequently collected in the fiscal fourth quarter. Due to overall economic conditions, sales in the third quarter were not as high as expected. Although sales of the Company's product on a retail level were high, anticipated reorders from customers were not received during the third quarter. The lack of reorders decreased the Company's liquidity, as the Company now has a higher than expected level of inventory. This inventory is new, saleable inventory that the Company expects will sell within the next six to nine months. The increase in total assets is due to the increase in accounts receivable, inventory and fixed assets. Current liabilities increased to $28,838,865 as of December 31, 2002, compared to $3,194,377 at March 31, 2002. This increase in current liabilities is primarily due to increased accounts payable for inventory purchases and usage of the credit facility with LaSalle Business Credit. At December 31, 2002, the balance of the credit facility with LaSalle Business Credit was $10,163,088. The Company's stockholders' equity increased to $26,100,772 as of December 31, 2002 from $18,470,074 as of March 31, 2002, due primarily to the net income for the first three fiscal quarters. Cash flows used in operating activities were $14,359,871 during the nine months ended December 31, 2002. Cash flows were used in operating activities primarily due to the increase in inventory in the amount of $20,742,572, accounts receivable in the amount of $16,001,654 and an income tax payable accrual of $572,254 The increased inventory was partially offset by the increase in accounts payable, which funded this inventory. Cash used in investing activities during the nine months ended December 31, 2002 was $1,116,016. Cash used in investing activities resulted primarily from the purchase of fixed assets in the amount of $1,112,376. The purchase of fixed assets consists primarily of the tooling and molds required for production of new machines for this fiscal year. Tooling and molds are depreciated over three years. Cash flows provided by financing activities were $10,318,667 during the nine months ended December 31, 2002. This consisted of proceeds from the exercise of warrants and options in the amount of $155,579. The remainder of cash provided from financing activities was provided by net borrowings on the credit line at LaSalle National Bank in the amount of $10,163,088. Due to the increased level of inventory and accounts payable as of December 31, 2002, the Company has an increased need for working capital. As of December 31, 2002, the Company had current assets of $53.3, which consisted primarily of accounts receivable and inventory; and current liabilities of approximately $28.8 million. The most significant current liabilities include (i) approximately $13 million in accounts payable, of which approximately $9 million is amounts payable to the Company's factories in China and (ii) $10 million outstanding under the Company's credit facility with LaSalle Bank. Over the past few months, the Company has had discussions with its factories in China and they have indicated that they are willing to extend the payment dates for the Company's obligations. The Company also has been negotiating with LaSalle Bank to increase the credit available to the Company. Under the Company's credit facility with LaSalle Bank, the Company has a 45-day clean-up period between March 15, 2003 and April 30, 2003 in which the Company is required to have a zero balance (i.e., the Company can not borrow any money under its credit facility during this time period). Given the Company's current liquidity situation, the Company is requesting that LaSalle change this clean-up period to a later time period, such as May 15, 2003 - June 30, 2003. The Company's primary credit facility is with LaSalle Bank., which the Company entered into in April 2001. Under this credit facility, LaSalle Bank will advance up to 75% of the Company's eligible accounts receivable, plus up to 40% of eligible inventory, plus us up to 40% of commercial letters of credit issue by LaSalle minus reserves as set forth in the loan documents. The credit facility is subject to loan limits from zero to $25 million, depending on the time of the year, as stipulated in the loan documents. The credit facility expires on April 26, 2004 and is automatically renewable for one-year terms thereafter. Under the terms of the credit facility, the Company is required to maintain certain financial ratios and conditions. The loan contains a clean up period every 12 months where the loan amount must go to zero for a period of time. The loan is secured by a first lien on all present and future assets of the Company ,except tooling located in China. 13 Our Hong Kong subsidiary, International SMC, has three letters of credit facilities available to finance its inventory purchases. These facilities are (1) a $2 million facility at Hang Sang Bank, (ii) a $2.5 million facility at Hong Kong Shanghai Banking Corporation and (ii) a $1 million facility at Fortis Bank The Company intends to satisfy its capital and liquidity requirements over the next ninety (90) days by (i) relying on credit extended to it from its factories in China, (ii) working with LaSalle Bank to increase the credit available to the Company under its credit facility, (iii) drawing on letters of credit with banks in Hong Kong to finance purchases of inventory, (iv) using cash collected from accounts receivable and (v) securing a $2 million credit facility with a financial institution in the Far East within the next two weeks. The Company's long-term plans for its capital and liquidity requirements are the same as its short-term plan. Additionally, the Company believes that it will have decreased levels of inventory purchases during the next six to nine months, utilizing inventory already on hand. The Company believes that its cash, cash equivalents, combined with financing obtained from LaSalle, its Hong Kong lenders and/or another financial institution, will be adequate to meet its capital need for at least the next 9 to 12 months. As of January 31, 2003, the Company's material commitments for capital expenditures are its obligations to (i) repay $4.3 under its credit facility with LaSalle Bank by March 15, 2003, (ii) pay $2,570,047 under a guaranteed sales contract with a retail customer (as described below), (iii) make certain guaranteed minimum royalty payments in the amount of (a) $1.5 million over the next year under its licensing agreement with MTV, which expires on December 31, 2003 and $450,000 under its licensing agreement with Nickelodeon, which expires on December 31, 2004, and (iv) make lease payments totaling approximately $85,000 per month for warehouse space in California until June 2005 and (v) capital expenditures in the amount of approximately $1.2 million for mold, furniture and fixtures during fiscal 2004. The Company has other contractual obligations under its real estates leases in Florida and Hong Kong. In April 2002, the Company entered into an agreement with a retail customer whereby it guaranteed the customer a minimum gross margin of $3,573,000 from the sale of the Company's products during the period from September 1, 2002 through January 15, 2003. Under the agreement, the Company will reimburse the customer for the difference between the customer's gross margin on sales and the minimum guarantee. The Company would have a total exposure of $3,537,000, in the event that there were no sales of the Company's products made by the retail customer during this period. In accordance with the Securities and Exchange Commission Staff Accounting Bulletin 101, "Revenue Recognition", the Company has not recognized any revenues or related cost of sales at December 31, 2002. Any revenues or related cost of sales will be recognized at January 15, 2003 ("settlement date"), since the ultimate net sales are not determinable until that date. In accordance with the Emerging Issues Task Force ("EITF") Issue 01-9, the guarantee is considered a reduction of sales. As of the settlement date of the contract, the decrease in sales is $2,570,047, bringing net sales under this agreement to ($167,737) and net loss on the agreement to ($1,594,113). As of this date, an initial amount of $1,500,000 has been paid against the amount due under the settlement. The remaining amount is payable in four equal payments of $267,511 on April 25, July 25 and October 25, 2003 and January 25, 2004. SEASONAL AND QUARTERLY RESULTS Historically, the Company's operations have been seasonal, with the highest net sales occurring in the second and third quarters (reflecting increased orders for equipment and music merchandise during the Christmas selling months) and to a lesser extent the first and fourth quarters of the fiscal year. The Company's results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of orders placed and shipped to customers, as well as other factors. The fulfillment of orders can therefore significantly affect results of operations on a quarter-to-quarter basis. INFLATION Inflation has not had a significant impact on the Company's operations. The Company has historically passed any price increases on to its customers since prices charged by the Company are generally not fixed by long-term contracts. CRITICAL ACCOUNTING POLICIES The U.S. Securities and Exchange Commission defines critical accounting policies as "those that are both most important to the portrayal of a company's financial condition and results, and require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain". Preparation of our financial statements involves the application of several such 14 policies. These policies include: estimates of accruals for product returns, the realizability of the deferred tax asset, calculation of our allowance for doubtful accounts and the Hong Kong income tax exemption. Accrual for product returns. We regularly receive requests from our customers for product returns. Our accrual amount is based on historical experience and is recorded as a reduction of sales and costs of sales and as a liability equal to the resulting gross profit on the estimated returns. At December 31, 2002, the accrual was approximately $1,253,104. Estimate for Doubtful Accounts. We estimate an allowance for doubtful accounts using the specific identification method since a majority of accounts receivable are concentrated with several customers whose credit worthiness is evaluated periodically by us. The allowance was $3,356 at December 31, 2002. Hong Kong Income Tax Exemption. We estimated that the Hong Kong income tax to be zero based on our assessment of the probability that the application for the Hong Kong income tax exemption would be approved. In addition to the above policies, several other policies, including policies governing the timing of revenue recognition, are important to the preparation of our financial statements, but do not meet the definition of critical accounting policies because they do not involve subjective or complex judgments. RISK FACTORS Set forth below and elsewhere in this Quarterly Report on Form 10-Q and in the other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward looking statements contained in this Quarterlyl Report. FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK WE HAVE SIGNIFICANT FUTURE CAPITAL NEEDS WHICH ARE SUBJECT TO THE UNCERTAINTY OF ADDITIONAL FINANCING As of December 31, 2002, we had current assets of $53.3 million, consisting primarily of inventory and accounts receivable and current liabilities of $28,838,864. We have developed a plan to satisfy our short-term and long-term capital needs. See "Management Discussion and Analysis of Financial Condition - Liquidity" on page 14 of this Quarterly Report. We believe that we will be able to secure adequate financing pursuant to this plan. However, if we do not obtain sufficient financing, our business operations and financial condition will be adversely affected. If the Company does not have adequate financing, it may not be able to purchase sufficient inventory for fiscal 2004 and this may reduce sales and net income during fiscal 2004. Furthermore, the Company may have to scale back its business operations in Florida, California and the Far East if it does not have adequate financing. WE RELY ON SALES TO A LIMITED NUMBER OF KEY CUSTOMERS, WHICH ACCOUNT FOR A LARGE PORTION OF OUR NET SALES As a percentage of total revenues, our net sales to our five largest customers during the fiscal period ended December 31, 2002 and 2001 were approximately 73.1% and 98% respectively. In the third quarter of fiscal 2003, two major customers accounted for 32.5% and 23.5% of our net sales. Although we have long-established relationships with many of our customers, we do not have long-term contractual arrangements with any of them. A substantial reduction in or termination of orders from any of our largest customers could adversely affect our business, financial condition and results of operations. In addition, pressure by large customers seeking price reductions, financial incentives, changes in other terms of sale or requesting that we bear the risks and the cost of carrying inventory, such as consignment agreements, could adversely affect our business, financial condition and results of operations. The Company has significantly broadened its base of customers, decreasing the amount of reliance on their largest customers. If one or more of our major customers were to cease doing business with us, significantly reduced the amount of their purchases from us or returned substantial amounts of our products, it could have a material adverse effect on our business, financial condition and results of operations. WE MAY HAVE SIGNIFICANT RETURNS, MARKDOWNS AND PURCHASE ORDER CANCELLATIONS As is customary in the consumer electronics industry, the Company has, on occasion, (i) permitted certain customers to return slow-moving items for credit, (ii) provided price protection to certain customers by making price reductions effective as to certain products then held by customers in inventory and (ii) accepted customer cancellations of purchase orders issued to the Company. The Company expects that it will continue to be required to make such accommodations in the future. Any significant increase in the amount of returns, markdowns or purchaser order cancellations could have a material adverse effect on the Company's results of operations. 15 OUR LICENSING AGREEMENT WITH MTV IS IMPORTANT TO OUR BUSINESS We generated $23,354,270, or 37.8% of our net sales, in fiscal 2002 from our sales of MTV licensed merchandise. Management values this license with MTV and desires to continue this licensing relationship. If the MTV license were to be terminated or fail to be renewed, our business, financial condition and results of operations could be adversely affected. However, management believes that our company has developed a strong brand name in the karaoke industry and that it will be able to continue to develop and grow its business, even if the MTV licensing relationship did not exist. Our licensing agreement with MTV expires on December 31, 2003. INVENTORY MANAGEMENT AND CONSIGNMENT ARRANGEMENTS Because of our reliance on manufacturers in the Far East for our machine production, our production lead times are relatively long. Therefore, we must commit to production in advance of customers orders. If we fail to forecast customers or consumer demand accurately we may encounter difficulties in filling customer orders or liquidating excess inventories, or may find that customers are canceling orders or returning products. Distribution difficulties may have an adverse effect on our business by increasing the amount of inventory and the cost of storing inventory. As of December 31, 2002, we had $30 million in inventory. We will attempt to liquidate this excess inventory during fiscal 2004. We believe that all of this inventory is highly marketable and saleable; however, there can be no assurances that we will be able to liquidate this inventory during our upcoming fiscal year. As of December 31, 2002, we had consignment agreements with three of our customers. It is more difficult to manage our inventory when our products are sold on consignment. Two of these consignment agreements expired on February 1, 2003. We expect that our remaining consignment agreement will expire on February 28, 2003 for most of the products sold by this retail customer (our music sales with this customer will still remain on consignment). Additionally, changes in retailer inventory management strategies could make inventory management more difficult. Any of these results could have a material adverse effect on our business, financial condition and results of operations. OUR INABILITY TO COMPETE AND MAINTAIN OUR NICHE IN THE ENTERTAINMENT INDUSTRY COULD HURT OUR BUSINESS The business in which we are engaged is highly competitive. Our major competitors for karaoke machines and related products are Grand Prix, JVC, Memorex and Pioneer Corp. We believe that competition for karaoke machines is based primarily on price, product features, reputation, delivery times, and customer support. Our primary competitors for producing karaoke music are Pocket Songs and Sound Choice. We believe that competition for karaoke music is based primarily on popularity of song titles, price, reputation, and delivery times. We believe that our new product introductions and enhancements of existing products are material factors for our continued growth and profitability. In fiscal 2002, we produced 6 new karaoke machines. However, many of our competitors are substantially larger and have significantly greater financial, marketing and operating resources than we have. No assurance can be given that we will continue to be successful in introducing new products or further enhancing our existing products. In addition, we must compete with all the other existing forms of entertainment including, but not limited to: motion pictures, video arcade games, home video games, theme parks, nightclubs, television and prerecorded tapes, CD's and video cassettes. WE ARE SUBJECT TO SEASONALITY, WHICH IS AFFECTED BY VARIOUS ECONOMIC CONDITIONS AND CHANGES RESULTING IN FLUCTUATIONS IN QUARTERLY RESULTS Sales of consumer electronics and toy products in the retail channel are highly seasonal, causing the substantial majority of our sales to occur during the second quarter ended September 30 and the third quarter ended December 31. Sales in our second and third quarter, combined, accounted for approximately 81% of net sales in fiscal 2002 and 75% of net sales in fiscal 2001. The seasonal pattern of sales in the retail channel requires significant use of our working capital to manufacture and carry inventory in anticipation of the holiday season, as well as early and accurate forecasting of holiday sales. Failure to predict accurately and respond appropriately to consumer demand on a timely basis to meet seasonal fluctuations, or any disruption of consumer buying habits during their key period, would harm our business and operating results. As economic conditions fluctuate, retail environments adjust their buying patterns accordingly in order to 16 decrease their position in inventory on hand. Although the sales of the Company's product were high, on a retail level, for the nine months ended December 31, 2002, the sales of other product lines not affiliated with consumer electronics were not. This had a direct effect on the decreased amount of reorders received by the Company in the fiscal third quarter of 2003. Additional factors that can cause our sales and operating results to vary significantly from period to period include, among others, the mix of products, fluctuating market demand, price competition, new product introductions by competitors, fluctuations in foreign currency exchange rates, disruptions in delivery of components, political instability, general economic conditions, and the other considerations described in this section entitled Risk Factors. A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTERS IN CALIFORNIA AND FLORIDA WOULD IMPACT OUR ABILITY TO DELIVERY MERCHANDISE TO OUR STORES, WHICH COULD ADVERSELY IMPACT OUR REVENUES AND HARM OUR BUSINESS AND FINANCIAL RESULTS A significant amount of our merchandise is shipped to our customers from one of our two warehouses, which are located in Compton, California and Coconut Creek, Florida. Events such as fire or other catastrophic events, any malfunction or disruption of our centralized information systems or shipping problems may result in delays or disruptions in the timely distribution of merchandise to our customers, which could adversely impact our revenues and our business and financial results. OUR BUSINESS OPERATIONS COULD BE DISRUPTED IF THERE ARE LABOR PROBLEMS ON THE WEST COAST During fiscal 2002, approximately 55% of our sales were domestic sales, which were made from our warehouses in California and Florida. During the third quarter of fiscal 2003, the dock strike on the West Coast affected sales of two of our karaoke products and we lost approximately $3 million in orders because we couldn't get these product off the pier. If another strike or work slow-down were to occur and we do not have a sufficient level of inventory, a strike or work slow-down would result in increased costs to our company and may reduce our profitability. OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD HARM OUR BUSINESS We rely principally on four contract ocean carriers to ship virtually all of the products that we import to our warehouse facility in Compton, California. Retailers that take delivery of our products in China rely on a variety of carriers to import those products. Any disruptions in shipping, whether in California or China, caused by labor strikes, other labor disputes, terrorism, and international incidents or otherwise could significantly harm our business and reputation. WE MAY NOT BE ABLE TO SUSTAIN OR MANAGE OUR RAPID GROWTH We experienced rapid growth in net sales and net income in the last year. Our net sales for the fiscal year ended March 31, 2002 increased 80.2% to $61.8 million compared to $34.3 million for the fiscal year ended March 31, 2002. Similarly, our net income increased to $8.06 million for fiscal 2002 compared to $4.6 million for fiscal 2001. As a result, comparing our period-to-period operating results may not be meaningful, and results of operations from prior periods may not be indicative of future results. We cannot assure you that we will continue to experience growth in, or maintain our present level of, net sales or net income. Our growth strategy calls for us to continuously develop and diversify our karaoke products by (i) developing new karaoke machines and music products, (ii) entering into additional license agreements (iii) expanding into international markets, (iv) developing new retail customers in the United States and (v) obtaining additional financing. Our growth strategy will place additional demands on our management, operational capacity and financial resources and systems. To effectively manage future growth, we must continue to expand our operational, financial and management information systems and train, motive and manage our work force. In addition, implementation of our growth strategy is subject to risks beyond our control, including competition, market acceptance of new products, changes in economic conditions, our ability to maintain our licensing agreements with MTV and Nickelodeon and our ability to finance increased levels of accounts receivable and inventory necessary to support our sales growth, if any. Accordingly, we cannot assure you that our growth strategy will be implemented successfully. THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE 17 Market prices of the securities of companies in the toy and entertainment industry are often volatile. The market prices of our common stock may be affected by many factors, including: -unpredictable consumer preferences and spending trends; -operating results that vary from the expectations of investors and securities analysts; - the actions of our customers and competitors (including new product line announcements and introduction; - changes in our pricing policies, the pricing policies of our competitors and general pricing trends in the consumer and electronics and toy markets; -regulations affecting our manufacturing operations in China; -other factors affecting the entertainment and consumer electronics industries in general; and -sales of our common stock into the public market. In addition, the stock market periodically has experienced significant price and volume fluctuations which may have been unrelated to the operating performance of particular companies. OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE'S REPUBLIC OF CHINA, SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS We are dependent upon six factories in the People's Republic of China to manufacture all of our electronic products. Our arrangements with these factories are subject to the risks of doing business abroad, such as import duties, trade restrictions, work stoppages, and foreign currency fluctuations, limitations on the repatriation of earnings, political instability, and other factors, which could have an adverse impact on our business. Furthermore, we have limited control over the manufacturing processes themselves. As a result, any difficulties encountered by the third-party manufacturers that result in product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis could adversely affect our business, financial condition and results of operations. We believe that the loss of any one or more of our manufacturers would not have a long-term material adverse effect on us because other manufacturers with whom we do business would be able to increase production to fulfill our requirements. However, the loss of certain of our manufacturers, could, in the short-term, adversely affect our business until alternative supply arrangements were secured. WE DEPEND ON THIRD PARTY SUPPLIERS FOR PARTS FOR OUR KARAOKE MACHINES AND RELATED PRODUCTS, AND IF WE CANNOT OBTAIN SUPPLIES AS NEEDED, OUR OPERATIONS WILL BE SEVERELY DAMAGED Our growth and ability to meet customer demand depends in part on our capability to obtain timely deliveries of karaoke machines and our electronic products. We rely on third party suppliers to produce the parts and materials we use to manufacture and produce these products. If our suppliers are unable to provide our factories with the parts and supplies, we will be unable to produce our products. We cannot guarantee that we will be able to purchase the parts we need at reasonable prices or in a timely fashion. In the last several years, there have been shortages of certain chips that we use in our karaoke machines. We, however, have anticipated this shortage and have made commitments to our factories to purchase chips in advance. If we are unable to anticipate any shortages of parts and materials in the future, we may experience severe production problems, which would impact our sales. CONSUMER DISCRETIONARY SPENDING MAY AFFECT KARAOKE PURCHASES AND IS AFFECTED BY VARIOUS ECONOMIC CONDITIONS AND CHANGES Our business and financial performance may be damaged more than most companies by adverse financial conditions affecting our business or by a general weakening of the economy. Purchases of karaoke machines and music are considered discretionary for consumers. Our success will therefore be influenced by a number of economic factors affecting discretionary and consumer spending, such as employment levels, business, interest rates, and taxation rates, all of which are not under our control. Adverse economic changes affecting these factors may restrict consumer spending and thereby adversely affect our growth and profitability. 18 WE MAY BE INFRINGING UPON THE COPYRIGHTS OF THIRD PARTIES Each song in our catalog is licensed to us for specific uses. Because of the numerous variations in each of our licenses for copyrighted music, there can be no assurance that we have complied with scope of each of our licenses and that our suppliers have complied with these licenses. Additionally, third parties over whom we exercise no control may use our sound recordings in such a way that is contrary to our license agreement and by violating our license agreement we may be liable for contributory copyright infringement. Any infringement claims may have a negative effect on our ability to sell products. WE HAVE SIGNIFICANT RELIANCE ON LARGE RETAILERS, WHICH ARE SUBJECT TO CHANGES IN THE ECONOMY We sell products to retailers, including department stores, lifestyle merchants, direct mail retailers, which are catalogs and showrooms, national chains, specialty stores, and warehouse clubs. Certain of such retailers have engaged in leveraged buyouts or transactions in which they incurred a significant amount of debt, and some are currently operating under the protection of bankruptcy laws. Despite the difficulties experienced by retailers in recent years, we have not suffered significant credit losses to date. Deterioration in the financial condition of our customers could have a material adverse effect on our future profitability. OUR NET INCOME MAY BE REDUCED IF OUR HONG KONG SUBSIDIARY DOES NOT RECEIVE AN EXEMPTION FOR OFFSHORE INCOME TAX Our Hong Kong subsidiary has applied for a Hong Kong "offshore claim" income tax exemption based on the locality of the profits of the Hong Kong subsidiary. Management believes that since the source of all profits of the Hong Kong subsidiary are from exporting to customers outside of Hong Kong, it is likely that the exemption will be approved. Accordingly, no provision for foreign income taxes has been provided in the Company's financial statements. In the event the exemption is not approved, the Hong Kong subsidiary's profits will be taxed at a flat rate of 16% resulting in an income tax expense of approximately $725,000 and $460,000 for fiscal 2002 and 2001. OUR BUSINESS OPERATIONS COULD BE SIGNIFICANTLY DISRUPTED IF WE LOSE MEMBERS OF OUR MANAGEMENT TEAM Our success depends to a significant degree upon the continued contributions of our executive officers, both individually and as a group. Although we have entered into employment contracts with Edward Steele, our Chief Executive Officer; John Klecha, our President, Chief Operating Officer; and Jack Dromgold, our Executive Vice President of Sales and Marketing, the loss of the services of any of these individuals could prevent us from executing our business strategy. Mr. Klecha's employment agreement expires on May 31, 2003. We are currently in negotiations with Mr. Klecha regarding his employment with our company after May 31, 2003. We cannot assure you that we will be able to find appropriate replacements for Edward Steele, John Klecha or Jack Dromgold, if the need should arise, and any loss or interruption of Mr. Steele, Mr. Klecha or Mr. Dromgold's services could adversely affect our business, financial condition and results of operations. OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS. Our employment agreements with Eddie Steele, John Klecha, April Green and Jack Dromgold require us, under certain conditions, to make substantial severance payments to them if they resign after a change of control. These provisions could delay or impede a merger, tender, offer or other transaction resulting in a change in control of the Company, even if such a transaction would have significant benefits to our shareholder. As a result, these provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock. WE MAY BE SUBJECT TO CLAIMS FROM THIRD PARTIES FOR UNAUTHORIZED USE OF THEIR PROPRIETARY TECHNOLOGY, COPYRIGHTS OR TRADE SECRETS We believe that we independently developed the technology used in our electronic and audio software products and that it does not infringe on the proprietary rights, copyrights or trade secrets of others. However, we cannot assure you that we have not infringed on the proprietary rights of third parties or those third parties will not make infringement violation claims against us. Any infringement claims may have a negative effect on our ability to manufacture our products. YOUR INVESTMENT MAY BE DILUTED If additional funds are raised through the issuance of equity securities, your percentage ownership in our equity will be reduced. Also, you may experience additional dilution in net book value per share, and these equity 19 securities may have rights, preferences, or privileges senior to those of yours. RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS MAY DEPRESS OUR STOCK PRICE As of December 31, 2002, there were 8,125,178 shares of our common stock outstanding. We have filed three registration statements registering an aggregate 6,742,234 of shares of our common stock (a registration statement on Form S-3 registering the resale of 2,947,984 shares or our common stock, a registration statement on Form S-8 to registering the sale of 1,844,250 shares underlying options granted under our 1994 Stock Option Plan and a registration statement on Form S-8 to register 1,950,000 shares of our common stock underlying options granted under our Year 2001 Stock Option Plan). The market price of our common stock could drop due to the sale of large number of shares of our common stock, such as the shares sold pursuant to the registration statements or under Rule 144, or the perception that these sales could occur. ADVERSE EFFECT ON STOCK PRICE FROM FUTURE ISSUANCES OF ADDITIONAL SHARES Our Certificate of Incorporation authorizes the issuance of 18,900,000 million shares of common stock. As of December 31, 2002, we had 8,125,178 shares of common stock issued and outstanding and an aggregate of 1,336,250 outstanding options and warrants. As such, our Board of Directors has the power, without stockholder approval, to issue up to 9,438,572 shares of common stock. Any issuance of additional shares of common stock, whether by us to new stockholders or the exercise of outstanding warrants or options, may result in a reduction of the book value or market price of our outstanding common stock. Issuance of additional shares will reduce the proportionate ownership and voting power of our then existing stockholders. PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY MAKE IT DIFFICULT FOR A THIRD PARTY TO ACQUIRE OUR COMPANY AND COULD DEPRESS THE PRICE OF OUR COMMON STOCK. Delaware law and our certificate of incorporation and bylaws contain provisions that could delay, defer or prevent a change in control of our company or a change in our management. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. These provisions of our restated certificate of incorporation include: authorizing our board of directors to issue additional preferred stock, limiting the persons who may call special meetings of stockholders, and establishing advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings. We are also subject to certain provisions of Delaware law that could delay, deter or prevent us from entering into an acquisition, including the Delaware General Corporation Law, which prohibits a Delaware corporation from engaging in a business combination with an interested stockholder unless specific conditions are met. The existence of these provisions could limit the price that investors are willing to pay in the future for shares of our common stock and may deprive you of an opportunity to sell your shares at a premium over prevailing prices. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company does not hold any investments in market risk sensitive instruments. Accordingly, the Company believes that it is not subject to any material risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk instruments ITEM 4. CONTROLS AND PROCEDURES Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. 20 In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of their last evaluation. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is not a party to any material legal proceeding, nor to the knowledge of management are any legal proceedings threatened against the Company. From time to time, the Company may be involved in litigation relating to claims arising out of operations in the normal course of business. ITEM 2. CHANGES IN SECURITIES (a) Not Applicable. (b) Not Applicable. (c) On December 31, 2002, we issued an aggregate of 187,000 options to our employees, as consideration for services they had rendered to us. We issued these options to our employees in reliance upon Section 4(2) of the Securities Act, because our employees were knowledgeable, sophisticated and had access to comprehensive information about us. Name Number of Options Exercise Price - ---- ----------------- -------------- Frank Abell 6,000 $9.00 Jennifer Barnes 5,000 $9.00 Dan Becherer 10,000 $9.00 Almina Brady-Dykes 6,000 $9.00 Elizabeth Canela 3,000 $9.00 Tammy Chestnut 1,000 $9.00 Belinda Cheung 500 $9.00 Danny Cheung 1,000 $9.00 Jeffrey Chiu 1,000 $9.00 Brian Cino 3,000 $9.00 John DeNovi 10,000 $9.00 Teresa Garcia 15,000 $9.00 April Green 20,000 $9.00 Alicia Haskamp 18,000 $9.00 Michelle Ho 3,000 $9.00 Wilson Ho 1,000 $9.00 Dale Hopkins 10,000 $9.00 Irene Ko 3,000 $9.00 Bill Lau 4,500 $9.00 Dora Lee 3,000 $9.00 Nataly Lessard 6,000 $9.00 Gigi Leung 500 $9.00 Marian McElligott 15,000 $9.00 Adolph Nelson 2,000 $9.00 Rick Ng 500 $9.00 Cathy Novello 4,000 $9.00 Jennifer O'Kuhn 2,000 $9.00 Jorge Otaegui 2,000 $9.00 Terri Phillips 3,000 $9.00 Melody Rawski 5,000 $9.00 Asante Sellers 1,000 $9.00 Stacy Sethman 5,000 $9.00 John Steele 10,000 $9.00 Richard Torrelli 1,000 $9.00 Nicolas Venegas 2,000 $9.00 Vicky Xavier 2,500 $9.00 Ho Man Yeung 500 $9.00 Yen Yu 1,000 $9.00 21 For each employee, twenty percent (20%) of their options are exercisable on January 1, 2004 and 20% exercisable each January 1st thereafter with the last 20% becoming exercisable on January 1, 2008. The options expire 5 years after they become exercisable with varying expiration dates from December 31, 2009 through December 31, 2013. During the three month period ended December 31, 2002, one employee exercised stock options issued under our 1994 Amended and Restated Management Stock Option Plan. The employee exercised options to acquire an aggregate of 1,875 shares of our common stock. The name of the option holder, the date of exercise, the number of shares purchased, the exercise price and the proceeds received by the Company are listed below. Date of No. of Exercise Name Exercise Shares Price Proceeds - ------------- -------- ------- -------- -------- Adolph Nelson 12/19/02 1,875 $2.04 $ 3,825 Mr. Nelson paid for his shares with cash. Mr. Nelson exercised his options in reliance upon Section 4(2) of the Securities Act of 1933, because he is are knowledgeable, sophisticated and had access to comprehensive information about the Company. The shares issued to our employees were registered under the Securities Act on a registration statement on Form S-8. As such, no restrictive legends were placed on the shares of Mr. Nelson. (d) Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS Not applicable. ITEM 5. OTHER INFORMATION In February 2003, the Board requested that Mr. Steele remain as Chief Executive Officer and Chairman of the Board for another year, until February 28, 2004. Mr. Steele will be employed under the terms of his employment agreement dated March 1, 1998 and an amendment effective as of May 5, 2000. In a press release dated February 1, 2002 and in subsequent SEC filings, the Company had announced that Mr. Steele would be retiring as the Chief Executive Officer on February 28, 2003. John Klecha will remain employed as the Chief Operating Officer and President of the Company until May 31, 2003, which is the expiration date of his employment agreement with the Company. The Board is currently in negotiations with Mr. Klecha regarding his employment with the Company after May 31, 2003. Further, in January 2003, the Board commenced a search process to identify talented senior level executives to join the Company. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Sixth Amendment dated December 27, 2002 to Loan and Security Agreement dated April 26, 2001 by and between LaSalle Business Credit, Inc. and the Company. 10.2 Sublease dated December 2002 between Nakamichi America Corporation and the Company for warehouse space in Rancho Dominguez, California. 10.3 Domestic Merchandise License Agreement dated November 1, 2000 between MTV Networks, a division of Viacom International, Inc. and the Company (portions of this Exhibit 10.3 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission). 10.4 Amendment dated January 1, 2002 to Domestic Merchandise License Agreement between MTV Networks, a division of Viacom International, Inc. and the Company (portions of this Exhibit 10.4 22 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission). 10.5 Second Amendment as of November 13, 2002 to Domestic Merchandise License Agreement between MTV Networks, a division of Viacom International, Inc. and the Company (portions of this Exhibit 10.5 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission). 99.1 Certifying Statement of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certifying Statement of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K The Company did not file any Report on Form 8-K during the three months ended December 31, 2002. 23 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE SINGING MACHINE COMPANY, INC. Dated February 14, 2003 By: /s/ April J. Green -------------------------------------------- April J. Green Chief Financial Officer (On behalf of Registrant and Chief Accounting Officer) 24 CERTIFICATIONS I, Edward Steele, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Singing Machine Company, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 / S / Edward Steele Edward Steele Chief Executive Officer 25 CERTIFICATIONS I, April J Green, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Singing Machine Company, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 / S / April J Green April J Green Chief Financial Officer (Principal Financial Officer) 26 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.1 Sixth Amendment dated December 27, 2002 to Loan and Security Agreement dated April 26, 2001 by and between LaSalle Business Credit, Inc. and the Company. 10.2 Sublease dated December 27, 2002 between Nakamichi American Corporation and the Company for warehouse space in Rancho Dominguez, California. 10.3 Domestic Merchandise License Agreement dated November 1, 2000 between MTV Networks, a division of Viacom International, Inc. and the Company (portions of this Exhibit 10.3 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission). 10.4 Amendment dated January 1, 2002 to Domestic Merchandise License Agreement between MTV Networks, a division of Viacom International, Inc. and the Company (portions of this Exhibit 10.4 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission). 10.5 Amendment dated November 13, 2002 to Domestic Merchandise License Agreement between MTV Networks, a division of Viacom International, Inc. and the Company (portions of this Exhibit 10.5 have been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission). 99.1 Certifying Statement of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002 99.2 Certifying Statement of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002 27