UNITED STATES
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 quarter ended December 31, 2005
0 - 24968
Commission File Number
THE SINGING MACHINE COMPANY, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
DELAWARE 95-3795478
----------------------- ----------------------
(State of Incorporation ) (IRS Employer I.D. No.)
6601 Lyons Road, Building A-7, Coconut Creek, FL 33073
(Address of principal executive offices)
(954) 596-1000
(Issuer's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large
accelerated filer |_| Accelerated filer |_| Non-accelerated filer |X|.
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes |_| No |X|
APPLICABLE ONLY TO ISSUES INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicated by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities and
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes |_| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
CLASS NUMBER OF SHARES OUTSTANDING
Common Stock, $0.01 par value 10,060,282 as of February 10, 2006
1
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
INDEX
PART I. FINANCIAL INFORMATION
Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheets - December 31, 2005 (Unaudited)
and March 31,2005 3
Consolidated Statements of Operations - Three months and
nine months Ended December 31,2005 and 2004 (Unaudited) 4
Consolidated Statements of Cash Flows - Nine months
Ended December 31, 2005 and 2004 (Unaudited) 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosure About Market Risk 18
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 1A. Risk Factors 19
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits 25
SIGNATURES 26
2
The Singing Machine Company, Inc. and Subsidiary
CONSOLIDATED BALANCE SHEETS
December 31 March 31
2005 2005
------------ ------------
(Unaudited)
Assets
Current Assets
Cash and cash equivalents $ 677,166 $ 617,054
Restricted cash 875,604 870,795
Accounts receivable, less allowances of $212,822 and $117,806,
respectively 4,874,995 1,150,842
Due from factor -- 34,372
Inventories 1,614,720 3,094,937
Prepaid expenses and other current assets 472,220 507,304
------------ ------------
Total Current Assets 8,514,705 6,275,304
Property and Equipment, at cost less accumulated depreciation
of $4,094,639 and $3,579,882, respectively 687,222 1,038,843
Other Non-Current Assets 131,234 354,661
------------ ------------
Total Assets $ 9,333,161 $ 7,668,808
============ ============
Liabilities and Shareholders' Deficit
Current Liabilities
Accounts payable $ 2,973,200 $ 1,466,571
Accrued expenses 881,320 693,776
Borrowing - Factor 1,306,090 --
Customer credits on account 646,852 1,659,324
Deferred gross profit on estimated returns 356,504 396,231
Convertible debentures, net of unamortized discount of $267,263
and $1,615,647, respectively 3,732,737 2,384,353
Subordinated debt-related parties 300,000 600,000
Income tax payable 2,453,576 2,453,576
------------ ------------
Total Current Liabilities 12,650,279 9,653,831
------------ ------------
Shareholders' Deficit
Preferred stock, $1.00 par value; 1,000,000 shares authorized, no
shares issued and outstanding -- --
Common stock, Class A, $.01 par value; 100,000 shares
authorized; no shares issued and outstanding -- --
Common stock, $0.01 par value; 18,900,000 shares authorized;
10,060,282 and 9,769,593 shares issued and outstanding 100,603 97,696
Additional paid-in capital 11,638,723 11,432,463
Accumulated deficit (15,056,444) (13,515,182)
------------ ------------
Total Shareholders' Deficit (3,317,118) (1,985,023)
------------ ------------
Total Liabilities and Shareholders' Deficit $ 9,333,161 $ 7,668,808
============ ============
The accompanying notes are an integral part of these financial statements.
3
The Singing Machine Company, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For Three Months Ended For Nine Months Ended
---------------------------- ----------------------------
Dec 31, 2005 Dec 31, 2004 Dec 31, 2005 Dec 31, 2004
------------ ------------ ------------ ------------
Net Sales $ 9,877,262 $ 14,368,388 $ 31,201,330 $ 36,978,549
Cost of Goods Sold 7,296,801 9,445,203 24,360,625 27,024,880
------------ ------------ ------------ ------------
Gross Profit 2,580,461 4,923,185 6,840,705 9,953,669
Operating Expenses
Advertising 122,355 267,280 313,901 689,074
Commissions 311,293 607,042 619,569 965,705
Compensation 574,249 805,557 1,846,035 2,141,337
Freight and handling 325,074 485,602 618,640 782,746
Selling, general and administrative expenses 1,195,974 1,747,059 3,330,292 4,291,619
------------ ------------ ------------ ------------
Total Operating Expenses 2,528,945 3,912,540 6,728,437 8,870,481
------------ ------------ ------------ ------------
Income from Operations 51,516 1,010,645 112,268 1,083,188
Other Income (Expenses)
Other income 15,516 124,535 105,834 241,806
Interest expense (180,887) (195,942) (410,980) (439,646)
Interest expense - Amortization of discount
on convertible debentures (451,096) (446,194) (1,348,384) (1,190,115)
------------ ------------ ------------ ------------
Net Other Expenses (616,467) (517,601) (1,653,530) (1,387,955)
------------ ------------ ------------ ------------
Net Income (Loss) $ (564,951) $ 493,044 $ (1,541,262) $ (304,767)
============ ============ ============ ============
Income (Loss) per Common Share:
Basic and diluted $ (0.06) $ 0.05 $ (0.15) $ (0.03)
Weighted Average Common and Common
Equivalent Shares:
Basic 10,055,791 9,202,318 9,958,269 8,934,136
Diluted 10,055,791 9,255,651 9,958,269 8,934,136
The accompanying notes are an integral part of these financial statements.
4
The Singing Machine Company, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For Nine Months Ended
--------------------------
Dec 31, 2005 Dec 31, 2004
----------- -----------
Cash flows from operating activities
Net Loss $(1,541,262) $ (304,767)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization 514,757 532,102
Change in inventory reserve (616,735) --
Change in allowance for bad debts 95,016 --
Amortization of discount/deferred fees on convertible debentures 1,553,082 1,190,116
Stock compensation 9,167 293,000
Deferred gross profit on estimated sales returns (39,727) (956,880)
Changes in assets and liabilities:
(Increase) Decrease in:
Accounts receivable (3,819,169) (466,633)
Insurance receivable -- 800,000
Due from manufacturer -- (1,398)
Inventories 2,096,952 3,120,074
Prepaid expenses and other assets 35,084 176,716
Other non-current assets 18,729 198,680
Increase (Decrease) in:
Accounts payable 1,506,629 (3,132,516)
Accrued expenses 187,544 (58,096)
Customer credits on account (1,012,472) (1,351,572)
Current income taxes -- 1,184,342
----------- -----------
Net cash (used in) provided by operating activities (1,012,405) 1,223,168
----------- -----------
Cash flows from investing activities
Purchase of property and equipment (163,137) (757,375)
Restricted cash (4,809) 4,328
----------- -----------
Net cash used in investing activities (167,946) (753,047)
----------- -----------
Cash flows from financing activities
Borrowing from factoring, net 1,340,462 577,994
Bank overdraft -- (62,282)
Proceeds from related party loan -- 240,000
Payment on related party loan (100,000) (240,000)
----------- -----------
Net cash provided by financing activities 1,240,462 515,712
----------- -----------
Increase in cash and cash equivalents 60,112 985,833
Cash and cash equivalents at beginning of period 617,054 356,342
----------- -----------
Cash and cash equivalents at end of period $ 677,166 $ 1,342,175
=========== ===========
Supplemental Disclosures of Cash Flow Information:
Cash paid for Interest $ 129,583 $ 379,375
=========== ===========
Cash paid for Taxes $ -- 50,000
=========== ===========
Non-Cash Financing Activities:
Related party loan paid off with stock $ 200,000 $ --
=========== ===========
The accompanying notes are an integral part of these financial statements.
5
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - SUMMARY OF ACCOUNTING POLICIES
OVERVIEW
The Singing Machine Company, Inc., a Delaware corporation, and Subsidiary (the
"Company," or "The Singing Machine") are primarily engaged in the development,
marketing, and sale of consumer karaoke audio equipment, accessories, and
musical recordings as well as other consumer electronic products. The products
are sold directly to distributors and retail customers.
The preparation of The Singing Machine's financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
revenues and expenses during the period. Future events and their effects cannot
be determined with absolute certainty; therefore, the determination of estimates
requires the exercise of judgment. Actual results inevitably will differ from
those estimates, and such differences may be material to the Company's financial
statements. Management evaluates its estimates and assumptions continually.
These estimates and assumptions are based on historical experience and other
factors that are believed to be reasonable under the circumstances. For further
information regarding these estimates as well as The Singing Machine Company's
actual results, please refer to the Consolidated Financial Statements and Notes
hereto contained in The Singing Machine's Annual Report on Form 10-K for the
year ended March 31, 2005.
BASIS OF PRESENTATION
The accompanying consolidated financial statements for the nine months ended
December 31, 2005 and 2004 are unaudited but, in the opinion of management,
include all necessary adjustments (consisting of normal, recurring in nature)
for a fair presentation of the financial position, results of operations and
cash flows for the interim periods presented. Interim results are not
necessarily indicative of results for a full year. Therefore, the results of
operations for the nine months ended December 31, 2005 are not necessarily
indicative of operating results to be expected for the year.
The management of the Company believes that a higher degree of judgment or
complexity is involved in the following areas:
COLLECTIBILITY OF ACCOUNTS RECEIVABLE
The Singing Machine's allowance for doubtful accounts is based on management's
estimates of the credit worthiness of its customers, current economic conditions
and historical information, and, in the opinion of management, is believed to be
an amount sufficient to cover uncollectible accounts. 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.
INVENTORIES
The Singing Machine reduces inventories on hand to their net realizable value 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 inventories for
such declines in value.
INCOME TAXES
Significant management judgment is required in developing The Singing Machine's
provision for income taxes, including the determination of foreign tax
liabilities, deferred tax assets and liabilities and any valuation allowances
that might be required against the deferred tax assets. Management evaluates its
ability to realize its deferred tax assets on a quarterly basis and adjusts its
valuation allowance when it believes that it is more likely than not that the
asset will not be realized.
The Company follows Statement of Financial Accounting Standards No. 109
"Accounting for Income Taxes" ("SFAS No. 109"). Under the asset and liability
method of SFAS No. 109, deferred tax assets and liabilities are recognized for
the future tax consequences attributed to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax base. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under SFAS
No. 109, the effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. If
it is more likely than not that some portion of a deferred tax asset will not be
realized, a valuation allowance is recognized.
As of December 31, 2005 and March 31, 2005, The Singing Machine had gross
deferred tax assets of $11.3 million and $10.4 million, against which the
Company recorded valuation allowances totaling $11.3 million and $10.4 million,
respectively.
6
For the nine months ended December 31, 2005 and December 31, 2004, the Company
recorded no tax provision. We received a tax refund of $1.1 million on August
24, 2004, which has been used to pay related party loans 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.
Hong Kong income taxes payable totaled $2.4 million at December 31, 2005 and
March 31, 2005 and is included in the accompanying balance sheets as income
taxes payable.
OTHER ESTIMATES
The Singing Machine makes other estimates in the ordinary course of business
relating to sales returns and allowances, warranty reserves, and reserves for
promotional incentives. Historically, past changes to these estimates have not
had a material impact on the Company's financial condition. However,
circumstances could change which may alter future expectations.
THE FOLLOWING ARE THE COMPANY'S REMAINING ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of The Singing
Machine Company, Inc. and its wholly-owned Hong Kong Subsidiary, International
SMC (HK) Limited ("Hong Kong Subsidiary"). All intercompany accounts and
transactions have been eliminated in consolidation.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Hong Kong Subsidiary is its local currency. The
financial statements of the subsidiary are translated to U.S. dollars using
year-end rates of exchange for assets and liabilities, and average rates of
exchange for the year for revenues, costs, and expenses. Net gains and losses
resulting from foreign exchange transactions are included in the consolidated
statements of operations and were not material during the periods presented. The
effect of exchange rate changes on cash for the nine months ended December 31,
2005 and 2004 were also not material.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three
months or less at the time of purchase to be cash equivalents. Cash and cash
equivalent balances at December 31, 2005 and March 31, 2005 were $677,166 and
$617,054, respectively. Cash balances at December 31, 2005 and March 31, 2005
include approximately $132,921and $379,000, respectively, held in foreign banks
by the Hong Kong Subsidiary. These funds are not covered by depository
insurance.
LONG-LIVED ASSETS
The Company reviews long-lived assets for impairment whenever circumstances and
situations change such that there is an indication that the carrying amounts may
not be recoverable. If the undiscounted future cash flows attributable to the
related assets are less than the carrying amount, the carrying amounts are
reduced to fair value and an impairment loss is recognized in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
SHIPPING AND HANDLING COSTS
Shipping and handling costs are classified as a separate component of operating
expenses and those billed to customers are recorded as revenue in the statement
of operations.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation.
Expenditures for repairs and maintenance are charged to expense as incurred.
Depreciation is provided for in amounts sufficient to relate the cost of
depreciable assets to their estimated useful lives using accelerated and
straight-line methods.
REVENUE RECOGNITION
Revenue from the sale of equipment, accessories, and musical recordings are
recognized upon the later of (a) the time of shipment or (b) when title passes
to the customers and all significant contractual obligations have been satisfied
and collection of the resulting receivable is reasonably assured. Revenues from
sales of consigned inventory are recognized upon sale of the product by the
consignee. Net sales are comprised of gross sales net of actual returns and a
provision for estimated future returns. The provision for estimated sales
returns for the nine months ended December 31, 2005 and 2004 were $1.6 million
and $1.5 million, respectively. The actual returns represent 4.4% and 2.5% of
the net sales for the nine months ended December 31, 2005 and December 31, 2004,
respectively.
7
STOCK BASED COMPENSATION
The Company accounts for warrants and stock options issued after July 1, 2005
under the guidelines of Financial Accounting Standards Board ("FASB") No. 123
(Revised 2004), "Share-Based Payment" ("SFAS 123 (R)"). This Statement revises
the original SFAS No. 123 by eliminating the option to account for employee
stock options under APB No. 25 and generally requires companies to recognize the
cost of employee services received in exchange for awards of equity instruments
based on the grant-date fair value of those options granted. The provisions of
SFAS 123 (R) are effective for the Company's financial statements issued for the
first interim period beginning after June 15, 2005.
The Company continues to account for stock options issued to employees prior to
July 1, 2005 using the intrinsic value method in accordance with the provisions
of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. As such, compensation cost is
measured on the date of grant as the excess of the current market price of the
underlying stock over the exercise price. Such compensation amounts are
amortized over the respective vesting periods of the option grant. The Company
applied the disclosure provisions of Statement of Financial Accounting Standards
("SFAS") No. 148, "Accounting for Stock-Based Compensation- Transition and
Disclosure an amendment of FASB Statement No. 123", which permits entities to
provide pro forma net earnings (loss) and pro forma earnings (loss) per share
disclosures for employee stock option grants as if the fair-valued based method
defined in SFAS No. 123 had been applied to options granted.
Had compensation cost for the Company's stock-based compensation plan been
determined using the fair value method for awards under that plan, consistent
with SFAS No. 123 (R), "Accounting for Stock Based Compensation", the Company's
net earnings (loss) would have been changed to the pro-forma amounts indicated
below for the nine months and three months ended December 31, 2005 and December
31, 2004:
For nine months ended For three months ended
-------------------------------- --------------------------------
December 31, 2005 December 31, 2004 December 31, 2005 December 31, 2004
------------- ------------- ------------- -------------
Net income (loss), as reported $ (1,541,266) $ (304,767) $ (564,951) $ 493,044
Less: Total stock-based employee
compensation expense determined under
fair value based method
$ (423,945) $ (480,838) $ (127,333) $ (164,269)
-------------------------------- --------------------------------
Net income (loss), pro forma $ (1,965,211) $ (785,605) $ (692,284) $ 328,775
================================ ================================
Net income (loss), per share - basic As reported $ (0.15) $ (0.03) $ (0.06) $ 0.05
Pro forma $ (0.20) $ (0.09) $ (0.07) $ 0.04
Net income (loss), per share - diluted As reported $ (0.15) $ (0.03) $ (0.06) $ 0.05
Pro forma $ (0.20) $ (0.09) $ (0.07) $ 0.04
The effect of applying SFAS No. 123 (R) is not likely to be representative of
the effects on reported net earnings (loss) for future years due to, among other
things, the effects of vesting.
For financial statement disclosure purposes and for purposes of valuing stock
options and warrants issued to consultants, the fair market value of each stock
option granted was estimated on the date of grant using the Black-Scholes
Option-Pricing Model in accordance with SFAS No. 123 (R) using the following
weighted-average assumptions:
o For the nine months ended December 31, 2005: expected dividend yield 0%,
risk- free interest rate of 4%, volatility 191.97% and expected term of
three years.
o For the nine months ended December 31, 2004: expected dividend yield 0%,
risk-free interest rate of 4%, volatility 199.15% and expected term of
five years.
o For the three months ended December 31, 2005: expected dividend yield 0%,
risk-free interest rate of 4%, volatility 191.97% and expected term of
three years.
o For the three months ended December 31, 2004: expected dividend yield 0%,
risk- free interest rate of 4%, volatility 199.15% and expected term of
five years.
ADVERTISING
Costs incurred for producing and communicating advertising of the Company, are
charged to operations as incurred. The Company had entered into cooperative
advertising agreements with its major clients that specifically indicated that
the client has to spend the cooperative advertising fund on mutually agreed
events. The percentage of the cooperative advertising allowance ranges from 2%
to 5% of the purchase. The clients have to advertise the Company's products in
the client's catalog, local newspaper and other advertising media. The client
must submit the proof of the performance (such as a copy of the advertising
showing the Registrant's product) to the Company to request for the allowance.
The client does not have the ability to spend the allowance at their discretion.
The Company believes that the identifiable benefit from the cooperative
advertising program and the fair value of the advertising benefit is equal or
greater than the cooperative advertising expense. Advertising expense for the
nine months ended December 31, 2005 and December 31, 2004 was $313,901 and
$689,074 respectively.
8
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to results of operations as
incurred. These expenses are shown as a component of selling, general &
administrative expenses in the consolidated statements of operations. For the
nine months ended December 31, 2005 and December 31, 2004, these amounts totaled
$105,130 and $204,625, respectively.
EARNINGS PER SHARE
In accordance with SFAS No, 128, "Earnings per Share," basic income (loss) per
share is computed by dividing the net income (loss) for the year by the weighted
average number of common shares outstanding. Diluted income (loss) per share is
computed by dividing net income (loss) for the year by the weighted average
number of common shares outstanding including the effect of common stock
equivalents.
For the nine months ended December 31, 2005 and December 31, 2004, 3,972,159 and
4,000,387 common stock equivalents were not included in the computation of
diluted earnings per share as their effect would have been antidilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
disclosures of information about the fair value of certain financial instruments
for which it is practicable to estimate that value. For purposes of this
disclosure, the fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced sale or liquidation.
The carrying amounts of the Company's short-term financial instruments,
including accounts receivable, accounts payable and accrued expenses
approximates fair value due to the relatively short period to maturity for these
instruments.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to the current
period presentation.
NOTE 2 - GOING CONCERN
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, which contemplates continuation of the Company as a going concern.
The Company has experienced recurring losses, has an accumulated deficit and
negative working capital. Our unencumbered assets are limited. We are not able
to meet some short term obligations. These factors, among others, raise
substantial doubt that the Company may be unable to continue operations as a
going concern.
Subsequent to December 31, 2005, we plan to finance our operations as follows:
1) Vendor financing - The Company's key vendors in China have agreed to
manufacture on behalf of the Company, without advanced payments. We have
substantially improved our payment status with vendors during the past year. We
are current with our suppliers, except one factory in China, which has agreed to
a payment plan.
2) Factoring of accounts receivable - The Company has a credit line of $2.5
million from a factor to finance accounts receivable of sales originated in the
United States. The factor advances the Company 70% of eligible invoices
immediately after the product is shipped.
3) Related party loan - We might be able to raise additional short term loans
from a related party if needed.
4) Cost reduction - The Company has reduced significant operating expenses in
this fiscal year. The cost reduction initiatives are part of our intensive
effort to achieve a successful turn around restructuring. The Company plans to
continue its cost cutting efforts in its future operations.
5) Stock - The Company is actively seeking funds from private placements to
finance operations.
6) Debts to equity conversion - The Company is currently working with the
debenture holders to extend the payment term or to convert the debt into the
equity.
There can be no assurances that forecasted results will be achieved or that
additional financing will be obtained. The financial statements do not include
any adjustments relating to the recoverability and classification of asset
amounts or the amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern.
9
NOTE 3 - INVENTORIES
Inventories are comprised of the following components:
DECEMBER 31, MARCH 31,
2005 2005
----------- -----------
Finished Goods $ 2,666,415 $ 4,717,455
Inventory in Transit -- 45,912
Less: Inventory Reserve (1,051,695) (1,668,430)
----------- -----------
Total Inventories $ 1,614,720 $ 3,094,937
=========== ===========
Inventory consigned to customers at December 31, 2005 and March 31, 2005 was
$213,363 and $151,824, respectively.
NOTE 4 - ACCOUNTS RECEIVABLE FACTORING AGREEMENT
On August 4, 2004, the Company started to factor its accounts receivables
through Crestmark Bank in Detroit, Michigan. The agreement allows the Company,
at the discretion of Crestmark, to factor up to 70% of eligible receivables,
with recourse. The total amount of the facility is $2.5 million at December 31,
2005. The Company pays 1% of gross receivables in fees with a $9,000 minimum
maintenance fee per month. The average balance of the line will be subject to
interest payable on a monthly basis at prime plus 2% (9.25% at December 31,
2005). The agreement contains a liquidating damage fee of $171,000 payable for
early termination by the Company as of December 31, 2005.
Crestmark Bank also received a security interest in all of the Company's
accounts receivables and inventory in the United States. The Company's debenture
holders and insider loan holders have subordinated their debt to Crestmark Bank.
On August 2, 2005, Crestmark Bank has increased the borrowing availability by
$190,000 under the factoring agreement. The additional availability is secured
by certificates of deposit in the amount of $190,000, pledged by Yi Ping Chan
(Interim CEO) and Josef Bauer (Chairman of the Board).
As of December 31, 2005, the outstanding amount due to Crestmark bank for
factoring was $1,306,090. The credit availability based on available accounts
receivable was $262,705 as of December 31, 2005.
NOTE 5 - PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
USEFUL DECEMBER 31, MARCH 31,
LIFE 2005 2005
Computer and office equipment 5 years $ 477,815 $ 507,953
Furniture and fixtures 5-7 years 402,073 351,510
Leasehold improvement * 154,125 103,776
Molds and tooling 3 years 3,747,848 3,655,486
----------- -----------
4,781,861 4,618,725
Less: Accumulated depreciation (4,094,639) (3,579,882)
----------- -----------
$ 687,222 $ 1,038,843
=========== ===========
* Shorter of remaining term of lease or useful life
NOTE 6 - RESTRICTED CASH
The Company, through the Hong Kong Subsidiary, maintains a letter of credit
facility and short term loan with a major international bank. The Hong Kong
Subsidiary was required to pledge as collateral under the facility $875,604 and
$870,795 at December 31, 2005 and March 31, 2005, respectively. This amount is
shown as restricted cash in the accompanying balance sheets. The restricted cash
is not covered by deposit insurance.
10
NOTE 7 - LOANS AND LETTERS OF CREDIT
CREDIT FACILITY
The Hong Kong Subsidiary maintains separate credit facilities at two
international banks. The primary purpose of the facilities is to provide the
Hong Kong Subsidiary with the following abilities:
o Overdraft protection facilities
o Issuance and negotiation of letters of credit
o Trust receipts
o A Company credit card
These facilities are secured by a corporate guarantee from the U.S. Company,
restricted cash on deposit with the lenders and require that the Hong Kong
Subsidiary maintain a minimum tangible net worth of approximately $2 million.
The Hong Kong Subsidiary was in compliance with minimum tangible net worth as of
December 31, 2005. The maximum available credit under the facilities was $1.5
million. As of January 23, 2006, the Hong Kong Subsidiary terminated its credit
facility with HSBC, one of the international banks. A restricted cash deposit of
$609,246 was released by the bank, which was used as collateral for this
facility along with promissory note and cross corporate guarantee. As of
December 31, 2005, the interest rate is approximately 6.6%. At December 31, 2005
and March 31, 2005, there were no outstanding bank overdrafts against the
facilities; the letters of credit issued under these facilities were $0 and
$676,076; the total availability under these facilities was $1.5 million and
$823,924.
RELATED PARTY LOANS
On or about July 10, 2003, an officer, an individual, a director and a former
director of our Company advanced $1 million to our Company pursuant to written
loan agreements. The officer is Yi Ping Chan and the directors were Josef A.
Bauer and Howard Moore. Mr. Moore resigned from our Board, effective as of
October 17, 2003. Additionally, Maureen LaRoche, a business associate of Mr.
Bauer, participated in the financing. The loans are subordinated to the
factoring company and accrued interest at 9.5% per annum. These loans were
originally scheduled to be repaid by October 31, 2003, but were extended past
December 31, 2005. All interest was accrued, and the unpaid amount totaled
approximately $2,375 at December 31, 2005. A portion of the loans and the
accrued interest in the amount of $409,500 has been converted into 563,274
shares of common stock at $0.72 per share on January 5, 2005. In addition,
another portion of the loans in the amount of $200,000 has been converted into
277,778 shares of common stock on May 18, 2005. On November 30, 2005, Maureen
LaRoche was repaid $107,917 ($100,000 principal and $7,917 interest).
On June 27, 2005, the Company received a $200,000 loan from Andrew Shapiro, a
relative of Mr. Bauer who is the Chairman of the Board of Directors. The
interest rate on the loan is 12% per annum and is due on November 30, 2005 or
such later date as mutually agreed between the parties. On November 30, 2005,
Andrew Shapiro was repaid $210,192 in full ($200,000 principal and $10,192
interest).
As of December 31, 2005, $300,000 of principal is outstanding for related party
loans.
NOTE 8 - CUSTOMER CREDITS ON ACCOUNT
Customer credits on account represents credit amounts for customers that have
credits in excess of their accounts receivable balance. These balances were
reclassified for financial statement purposes as current liabilities until paid
or applied to future purchases. In some cases, the Company has refunded the
credit to the customer upon request.
NOTE 9 - CONVERTIBLE DEBENTURES WITH WARRANTS
In September 2003, the Company issued $4 million of 8% Convertible Debentures in
a private offering which are due February 20, 2006 ("Convertible Debentures").
The net cash proceeds received by the Company were $3,745,000 after deduction of
cash commissions and other expenses.
The Convertible Debentures are convertible at the option of the holders and were
initially convertible into 1,038,962 common shares at a conversion price of
$3.85 per common share subject to certain anti-dilution adjustment provisions,
at any time after the closing date. The repayment of the Convertible Debentures
was subordinated to a factoring agreement with Milberg Factors, which was
terminated as of July 14, 2004. On November 8, 2004, the Convertible Debentures
were subordinated to a new factor, Crestmark Bank.
These Convertible Debentures were issued with 457,143 detachable stock purchase
warrants with an exercise price of $4.025 per share. These warrants may be
exercised at any time after September 8, 2003 and before September 7, 2006 and
are subject to certain anti-dilution provisions. The warrants are also subject
to an adjustment provision; whereas the price of the warrants may be changed
under certain circumstances.
11
The Convertible Debentures bear interest at the stated rate of 8% per annum.
Interest is payable quarterly on March 1, June 1, September 1, and December 1.
The interest may be payable in cash, shares of Common Stock, or a combination
thereof subject to certain provisions and at the discretion of the Company.
In accounting for this transaction, the Company allocated the proceeds based on
the relative estimated fair value of the stock purchase warrants and the
convertible debentures. This allocation resulted in a discount on the
convertible debentures of $3.3 million, which is being amortized over the life
of the debt on a straight-line basis to interest expense, which is not
materially different from the effective interest method.
On February 9, 2004, the Company amended its convertible debenture agreements to
increase the interest rate to 8.5% and to grant warrants to purchase an
aggregate of 30,000 shares of the Company's common stock to the debenture
holders on a pro-rata basis. These concessions are in consideration of the
debenture holder's agreements to (i) enter into new subordination agreements
with Milberg, (ii) to waive all liquidated damages due under the transaction
documents through July 1, 2004 and (iii) to extend the effective date of the
Form S-1 registration statement until July 1, 2004. The new warrants have an
exercise price equal to $1.52 per share and the fair value of these warrants was
estimated by using the Black-Scholes Option-Pricing Model and totaled $30,981.
This amount was expensed as a component of selling, general and administrative
expenses during the three months ended December 31, 2003. Pursuant to the
Convertible Debenture agreements, the Company was required to register the
shares of common stock underlying the debentures and detachable stock purchase
warrants issued in connection with the debentures. The registration of the
common shares was required to be effective by July 1, 2004. The Form S-1/A
registration statement was effective on January 21, 2005.
On November 8, 2004, the Company executed a letter agreement with the debenture
holders, whereby the Company agreed to change the interest rate on the debenture
to 9% in exchange for the debenture holders agreeing to (i) execute a
subordination agreement with Crestmark Bank, (ii) waive all liquidated damages
due under the transaction documents through January 7, 2005, and (iii) withdraw
any demand for repayment under the debenture.
According to the anti-dilution adjustment provision, if the Singing Machine
sells shares of its common stock at an effective price less than the Set Price,
the debenture holders are entitled to convert their debentures into shares at a
new conversion price, which equals to the original Set Price minus 75% of the
difference between the Set Price and the new price if the event occurs before
September 8, 2004. On July 30, 2004, the Singing Machine received the court
approval of the Class Action Lawsuit (case# 03-CV-80596). The Singing Machine
issued 400,000 shares to the plaintiff as part of the settlement on September
23, 2004. The market closing price on July 30, 2004 was $0.60 per share. The
event has triggered the conversion price reset for the convertible debentures.
According to the Emerging Issue Task Force (EITF) Issue No. 00-27, if the terms
of a contingent conversion option do not permit an issuer to compute the number
of shares that the holder would receive if the contingent event occurs and the
conversion price is adjusted, an issuer should wait until the contingent event
occurs and then compute the resulting number of shares that would be received
pursuant to the new conversion price. The incremental intrinsic value that
resulted from the price reset equals additional shares multiplied by the stock
market price at the issuing date of the debentures, which would be recorded as
discount of convertible debentures and amortized over the remaining life of the
debentures. The new adjusted conversion price of stock is $1.41 [3.85-
(3.85-0.60) X 75%] while the conversion price of the warrants is $1.46. The
amount of $687,638 was recorded as additional discounts of the debentures and
will be amortized for the remaining life of the debentures. As of December 31,
2005, the number of shares issuable upon conversion of the debentures is
2,831,858. Total amortization for the nine months ended December 31, 2005 is
$1,348,384 and the unamortized discount is $267,263.
In connection with the Convertible Debentures, the Company paid financing fees
as follows: 103,896 stock purchase warrants with a fair value of $268,386,
28,571 shares of common stock with a fair value of $141,141, and cash of
$255,000. Total financing fees of $664,527 were recorded as deferred fees and
are being amortized over the term of the debentures.
The unamortized deferred fees are reported in other non-current assets in the
accompanying balance sheets and total $38,566 as of December 31, 2005 and
$243,264 as of March 31, 2005.
Due to a past due interest payment of $210,000, the Company is not in compliance
with the convertible debenture agreement. The entire principal amount of $4
million plus interest is due immediately at the election of the debenture
holders. Additionally, the Company is not in compliance with the debenture
agreements because the Company is below the continued listing standards of the
American Stock Exchange (the "Amex").
NOTE 10 - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
SYBERSOUND
On May 12, 2005, Sybersound Records, Inc., d/b/a Party Tyme Karaoke
("Sybersound"), filed a suit in the 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.
12
On August 10, 2005, Sybersound Records, Inc. filed a voluntary dismissal against
all defendants in the Los Angeles Superior Court.
On August 11, 2005, Sybersound, along with various other publishers, filed a
claim in the United States District Court for the Central District of
California. The lawsuit alleges the following against The Singing Machine
Company, Inc: violation of the Lanham Act, intentional interference with
prospective economic relations, unfair competition, common law unfair
competition, unfair trade practices, rescission and accounting. The Company
believes the claim is without merit. The Company will vigorously defend the
case.
On January 6, 2006, the lawsuit filed in May 2005 by Sybersound Records, Inc.
was dismissed with prejudice by the United States District Court for the Central
District of California.
The Company is also subject to various other legal proceedings and other claims
that arise in the ordinary course of business. In the opinion of management, the
amount of ultimate liability, if any, in excess of applicable insurance
coverage, is not likely to have a material effect on the financial condition,
results of operations or liquidity of the Company. However, as the outcome of
litigation or other legal claims is difficult to predict, significant changes in
the estimated exposures could occur, which could have a material impact on the
Company's operations.
LEASES
The Company has entered into various operating lease agreements for office and
warehouse facilities in Coconut Creek, Florida, Compton, California, and
Kowloon, Hong Kong. The leases expire at varying dates. Rent expense for the
nine months ended December 31, 2005 and December 31, 2004 was $508,981 and
$617,442.97, respectively.
In addition, the Company maintains various warehouse and computer equipment
operating leases.
Future minimum lease payments under property and equipment leases with terms
exceeding one year as of December 31, 2005 are as follows:
Property Lease Equipment Lease
---------- ----------
2006 $ 746,629 $ 3,791
2007 661,675 3,791
2008 79,544 3,791
2009 -- 3,791
2010 -- 316
---------- ----------
$1,487,848 $ 15,480
========== ==========
EMPLOYMENT AGREEMENTS
The Company has an employment contract with one key officer as of December 31,
2005. The agreement provides for base salaries, with annual cost of living
adjustments and travel allowances and expires on March 31, 2006. In the event of
a termination without cause or in the event of a change of control, as defined
in the agreements, the employee would be entitled to a lump sum payment in the
aggregate of $250,000.
MERCHANDISE LICENSE AGREEMENTS
In February 2003, we entered into a multi-year license agreement with Universal
Music Entertainment to market a line of Motown Karaoke machines and music. This
agreement and its subsidiary agreement signed in March 2003, allow us to be the
first to use original artist recordings for our CD+G formatted 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 expires on March
31, 2006 and does not contain any automatic renewal provisions. However, the
agreement was extended to December 31, 2006 without any additional minimum
guarantee payments.
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 expired 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 December 31, 2005. As of December 31, 2005, we are in
the process of renewing our license agreement with Nickelodeon, Inc.
On December 20, 2005, we entered into a three-year license agreement with Hi-5
to produce and distribute karaoke software, including compact discs with
graphics (CDGs) and karaoke music downloadable via the Internet, a variety of
karaoke hardware products, and youth-oriented cassette players, CD and DVD
players, and clock radios based on the popular "Hi-5" television show. The
agreement contains an option to extend for an additional three years.
13
NOTE 11 - SHAREHOLDERS' EQUITY
COMMON STOCK ISSUANCES
During the nine months ended December 31, 2005 and 2004, the Company issued the
following shares of stock:
December 31, Number of shares issued Proceed to company
2005 290,689 $ --
2004 450,000 $ --
On November 1, 2005, the Company issued 12,911 shares of common stock to members
of the Board of Directors for services provided to the Company for fiscal year
2005, valued at $9,167.
On September 19, 2005, Jay Bauer, Chairman of the Board, agreed to convert a
$175,000 related party loan into 243,056 shares of common stock at a price of
$.72 per share. The Application for Additional Shares listing has been submitted
to the American Stock Exchange and is pending approval. As of October 31, 2005,
these shares have not been issued.
On May 1, 2005, the Company has authorized the issuance of 277,778 shares of
common stock for the conversion of a $200,000 related party loan.
On September 23, 2004, the Company issued 400,000 shares to the plaintiffs in a
class action lawsuit.
On May 11, 2004, the Company issued 50,000 shares of common stock to a former
executive for consulting services rendered. The Company expensed the consulting
costs in the three months ended December 31, 2003, the period which services
were provided.
STOCK OPTIONS
On June 1, 2001, the Board of Directors approved the 2001 Stock Option Plan
("Plan"), which replaced the 1994 Stock Option Plan, as amended, (the "1994
Plan"). The Plan was developed to provide a means whereby directors and selected
employees, officers, consultants, and advisors of the Company may be granted
incentive or non-qualified stock options to purchase common stock of the
Company. As of December 31, 2005, the Plan is authorized to grant options up to
an aggregate of 1,950,000 shares of the Company's common stock and up to 300,000
shares for any one individual grant in any fiscal year. As of December 31, 2005,
the Company has granted 1,229,560 options under the Year 2001 Plan, leaving
720,440 options available to be granted. As of December 31, 2005, the Company
has 34,050 options issued and outstanding under its 1994 Plan.
In accordance with SFAS No. 123 (R), for options issued to employees, the
Company applies the intrinsic value method of APB Opinion No. 25 and related
interpretations in accounting for its options issued for the fiscal year
beginning before June 15, 2005.
NOTE 12 - SEGMENT INFORMATION
The Company operates in one segment and maintains its records accordingly. The
majority of sales to customers outside of the United States are made by the Hong
Kong Subsidiary. Sales by geographic region for the period presented are as
follows:
FOR THE NINE MONTHS ENDED FOR THE THREE MONTHS ENDED
December 31, December 31,
2005 2004 2005 2004
----------- ----------- ----------- -----------
North America $21,438,505 $27,386,433 $ 6,596,397 $ 9,306,588
Europe 9,572,154 9,111,894 3,184,424 4,848,992
Others 190,671 480,222 96,441 212,808
----------- ----------- ----------- -----------
$31,201,330 $36,978,549 $ 9,877,262 $14,368,388
=========== =========== =========== ===========
The geographic area of sales is based primarily on the location where the
product is delivered.
14
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 filed with the Securities and Exchange Commission.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's opinions only as of the date hereof. We
undertake no obligation to revise or publicly release the results of any
revision to these forward-looking statements.
OVERVIEW
The Singing Machine Company, Inc., a Delaware corporation, and its subsidiary
(the "Singing Machine," "we," or "us") are primarily engaged in the design,
marketing, and sale of consumer karaoke audio equipment, accessories, and
musical recordings. The Company's products are sold directly to distributors and
retail customers. Our electronic karaoke machines and audio software products
are marketed under The Singing Machine(R) and Motown trademarks.
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 major
retail outlets as Best Buy, Costco, Kohl's, J.C. Penney, Radio Shack and Sam's
Club.
The following table sets forth, for the periods indicated, certain items related
to our consolidated statements of operations as a percentage of net revenues for
the three months and nine months ended December 31, 2005 and 2004.
Three Months Ended Three Months Ended Nine Months Ended Nine Months Ended
------------------ ------------------ ----------------- -----------------
12/31/05 12/31/04 12/31/05 12/31/04
-------- -------- -------- --------
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of Goods Sold 73.9% 65.7% 78.1% 73.1%
Gross Profit 26.1% 34.3% 21.9% 26.9%
Operating Expenses
Advertising 1.2% 1.9% 1.0% 1.9%
Commissions 3.2% 4.2% 2.0% 2.6%
Compensation 5.8% 5.6% 5.9% 5.8%
Freight & Handling 3.3% 3.4% 2.0% 2.1%
Selling, general and administrative expenses 12.1% 12.1% 10.7% 11.6%
Total Operating Expenses 25.6% 27.2% 21.6% 24.0%
Income from Operations 0.5% 7.1% 0.4% 2.9%
Other Income (Expenses)
Other income 0.2% 0.9% 0.3% 0.7%
Interest expense -1.8% -1.4% -1.3% -1.2%
Interest expense - Amortization of discount
on convertible debentures -4.6% -3.1% -4.3% -3.2%
Net Other Expenses -6.2% -3.6% -5.3% -3.7%
Income (Loss) Before Income Taxes -5.7% 3.5% -4.9% -0.8%
Income Taxes Expense 0.0% 0.0% 0.0% 0.0%
Net Income (Loss) -5.7% 3.5% -4.9% -0.8%
15
QUARTER ENDED DECEMBER 31, 2005 COMPARED TO THE QUARTER ENDED DECEMBER 31, 2004
NET SALES
Net sales for the quarter ended December 31, 2005 decreased to $9,877,262 from
$14,368,388, a decrease of $4,491,126 as compared to the same period ended
December 31, 2004. This decrease can be attributed to the decrease in music
sales as well as a decrease in our direct hardware sales from Hong Kong. The
decrease of music sales resulted from the transition of our exclusive music
distributor. As of February 10, 2006, we finalized the distribution agreement
with WEA. As a result, we have received more music sales than anticipated in our
4th quarter that will be shipped prior to fiscal year ending March 31, 2006. For
the quarter ended March 31, 2004, the music sales were $131,000. The decrease of
hardware sales in the amount of $3.5 million resulted from our financial
constraints.
GROSS PROFIT
Our gross profit for the quarter ended December 31, 2005 decreased to $2,580,461
from $4,923,185, a decrease of $2,342,724 as compared to the same period in the
prior year. As a percentage of revenues, our gross profit for the three months
ended December 31, 2005 decreased to 26.1% from 34.3% for the same period in
2004. The decrease of gross profit as a percentage of revenues was primarily due
to:
1) a decrease in music sales, which yields higher profit margins than
our other products;
2) an increase of manufacturing costs, which is a result of energy
price increases as well as the labor cost increases in China.
OPERATING EXPENSES
For the three months ended December 31, 2005, total operating expenses decreased
to $2,528,945 from $3,912,540 for the three months ended December 31, 2004, a
decrease of $1,383,595. As a percentage of net revenues, our operating expenses
decreased to 25.6% from 27.2% for the same period a year ago. Management has
consistently reduced its operating expenses. This decrease of operating expenses
is primarily due to the following factors:
1) Advertising expenses decreased to $122,355 from $267,280 for the same period
a year ago due to a reduction of unnecessary advertising allowances;
2) Freight expenses decreased to $325,074 from $485,602 for the same period a
year ago as a proportion to the decrease in revenues;
3) Selling, general and administrative expenses decreased to $1,195,974 from
$1,747,059 for the same period a year ago primarily due to reduction in royalty
fees, accounting fees, rent expense, temporary labor and others. In January
2006, we subleased 30,000 square feet of additional space of our California
warehouse, which will reduce our monthly rental expense by $18,000.
4) The compensation expense decreased to $574,249 from $805,557 due to the
corporate restructuring, which resulted in an elimination of several under
performing positions while improving the overall efficiency of the Company.
Our management will continue to implement cost cutting efforts in order to
further reduce operating expenses for the remaining period of the current fiscal
year.
OTHER INCOME/EXPENSES
Our other net expenses increased to $616,467 from $517,601 for the same period a
year ago. The increase is primarily due to the decrease of the other income for
the three months ending December 31, 2005. For the three months ending December
31, 2004, the Company recorded a one time credit balance write off as other
income in the amount of $124,830.
INCOME TAXES
For the three months ended December 31, 2005 and 2004, the Company did not
record a tax provision because it expects sufficient future net losses to offset
the income for these periods.
NET INCOME
The net income decreased to a net loss of $564,954 from net income of $493,044
for the same period a year ago. The decrease of profit was primarily due to the
decrease of the revenues and the profit margins.
NINE MONTHS ENDED DECEMBER 31, 2005 COMPARED TO THE NINE MONTHS ENDED DECEMBER
31, 2004
NET SALES
Net sales decreased to $31,201,330 from $36,978,549 a decrease of $5,777,219 or
15.6% for the nine months ended December 31, 2005 as compared to the same period
in prior year. The decrease in sales for the nine month period is the same as
for the three months period above.
GROSS PROFIT
Gross profit decreased to $6,840,705 from $9,953,669 a decrease of $3,112,964 or
31.3% for the nine months ended December 31, 2005 as compared to the same period
ended in prior year. The reason for the decrease is the same as those for three
months ended December 31, 2005.
16
OPERATING EXPENSES
Total operating expenses decreased to $6,728,437 from $8,870,481 a decrease of
$2,142,044 or 24.1% for the nine months ended December 31, 2005 as compared to
the same period in prior year. As a percentage of the net revenues, the
operating expenses decreased to 21.6% from 24%. The decrease in the operating
expenses as percentage is primarily due to the reduction of expenses in all
categories as following:
1) Advertising expenses decreased to $313,901 from $689,074 a year ago due to a
reduction of unnecessary advertising allowances;
2) Salary expenses decreased to $1,846,035 from $2,141,337 a year ago due to the
corporate restructuring.
3) Selling, general and administrative expenses decreased to $3,330,292 from
$4,291,619 for the same period a year ago primarily due to reduction in
professional fees, bad debt expense, warehouse rental, royalty fees and others.
OTHER INCOME/EXPENSES
Net other expenses increased to $1,653,530 from $1,387,955 an increase of
$265,575 or 19.1% for the nine months ended December 31, 2005 as compared to the
same period ended in prior year. The increase is primarily due to an increase of
the amortization of the discount on convertible debentures. The increase of
discounts on convertible debentures was a result of recalculating the fair value
of the conversion feature after a conversion price reset.
INCOME TAXES
For the nine months ended December 31, 2005 and 2004, the Company did not record
tax provisions since it incurred net losses.
NET LOSS
Net loss increased to $1,541,262 from $304,767 for the nine months ended
December 31, 2005 compared to the same period in the prior year. The net loss
increase was primarily due to a decrease of the revenues, a decrease of the
profit margin and an increase of non-cash interest expenses related to the
amortization of the discounts on convertible debentures. For the nine months
ended December 31, 2005, the interest expense related to the discount on the
convertible debentures was $1.3 million compared to $1.2 million in the same
period last year.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2005, Singing Machine had cash on hand of $677,166 in
addition to $875,604 of restricted cash, as compared to cash on hand of $617,054
and restricted cash of $870,795 as of March 31, 2005. We had a working capital
deficit of $4,135,574 as of December 31, 2005. Two major items contributing to
the working capital deficit are the $4 million convertible debentures and the
$2.4 million accrued for Hong Kong income tax.
Net cash used by operating activities was $1,012,405 for the nine months ended
December 31, 2005, as compared to $1,223,168 provided by operating activities
the same period a year ago. The cash used in operating activities was primarily
due to the increase of the accounts receivable, the settlement of customer
credit on accounts and partially offset by increase of the accounts payable and
decrease of the inventory.
Net cash used in investing activities for the nine months ended December 31,
2005 was $167,946, as compared to $753,047 for the same period ended a year ago.
Cash used in investing activities primarily resulted from the purchase of
tooling equipment and molds used in the production of new karaoke machines.
Net cash provided by financing activities was $1,240,462 for the nine months
ended December 31, 2005, as compared to $515,712 for the same period ended a
year ago. The net cash provided by financing activities was primarily due to an
advance of $1,340,462 from our factoring bank.
The Company has a factoring agreement with Crestmark Bank, pursuant to which the
Company may borrow 70% of eligible accounts receivable up to $2.5 million. The
agreement stipulates that we are only allowed to factor sales originating from
our warehouses in the United States. The factoring company determines the
eligible receivables based on their own credit standard, and the accounts'
aging. As of December 31, 2005, the credit availability under this agreement is
$262,705.
Our Hong Kong subsidiary, International SMC, has a credit facility at Fortis
Bank. The primary purpose of this facility is to provide International SMC with
access to letters of credit so that it can purchase inventory for sale in the
United States and international markets. International SMC also depends on the
facility to negotiate letters of credit with its customers. The facility is
secured by a corporate guarantee from the U.S. parent company and restricted
cash on deposit with lenders. The maximum credit under the facilities was
$500,000 as of December 31, 2005. The interest rate is approximately 6.85% per
annum. As of December 31, 2005, the available credit under these facilities was
$64,000.
As of December 31, 2005, our unrestricted cash on hand was $677,166. Our average
monthly fixed operating costs are approximately $450,000, which includes
employee compensation and selling, general & administration expenses. We expect
that we will require approximately $1.35 million for working capital during the
next three-month period.
17
During the three-month period between January and March 2006, we plan on
financing our working capital needs by:
o Collecting our existing accounts receivable;
o Selling existing inventory;
o Borrowing from our factoring agreement;
o Borrowing from our credit facilities;
o Raising additional working capital.
The convertible debentures in the amount of $4 million are due on February 20,
2006. We will not be able to meet the payment requirement with our cash.
Therefore, we are seeking to extend the payment due date, to convert the debts
to equity or to raise new capital to settle the payment. If we fail to reach an
agreement with the debenture holders, it may have a material adverse effect on
our operation.
Our sources of cash for working capital in the long term, 12 months and beyond,
are the same as our sources during the short term. We are actively seeking
additional financing facilities and capital investments to maintain and grow our
business. If we need to obtain additional financing and fail to do so, it may
have a material adverse effect on our ability to meet our financial obligations
and to continue as a going concern.
Our commitments for debt and other contractual obligations as of December 31,
2005 are summarized as follows:
-------------------------------------------------------------------------
Total Less than 1 year 1 - 3 years 3 - 5 years Over 5 years
-------------------------------------------------------------------------
Property Leases 1,487,848 $ 746,629 $ 697,465 $ 43,754 $ --
Equipment Leases 15,478 3,791 11,372 316 --
Subordinated Debt - Related Party 300,000 300,000 -- -- --
Convertible Debentures 4,000,000 4,000,000 -- -- --
Interest payments 212,375 212,375 -- -- --
-------------------------------------------------------------------------
Total $6,015,701 $5,262,795 $ 708,837 $ 44,070 $ --
=========================================================================
INVENTORY SELL THROUGH
We monitor the inventory levels and sell through activity of our major customers
to properly anticipate returns and maintain the appropriate level of inventory.
As of February 10, 2006, we expect only two customers to return $400,000 of
overstock inventory. We have proper return reserves to cover these potential
returns.
SEASONAL AND QUARTERLY RESULTS
Historically, our operations have been seasonal, with the highest net sales
occurring in our fiscal second and third quarters (reflecting increased orders
for equipment and music merchandise during the Christmas holiday season) 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 87% and
86% of net sales in fiscal 2005 and 2004, respectively. By contrast, our highest
levels of returned merchandise occurred in the first and fourth quarter since
customers usually returned defective or overstock inventory subsequent to the
Christmas holiday season. Approximately 84% of the total returns were received
in the first and fourth quarter combined in fiscals 2005 and 2004.
Our results of operations may also fluctuate from quarter to quarter as a result
of the amount and timing of orders placed and shipped to customers, as well as
other factors. The fulfillment of orders can therefore significantly affect
results of operations on a quarter-to-quarter basis.
INFLATION
Inflation has not had a significant impact on The Singing Machine's operations.
Singing Machine has historically passed any price increases on to its customers
since prices charged by Singing Machine are generally not fixed by long-term
contracts.
CRITICAL ACCOUNTING POLICIES
For the three months ended December 31, 2005 there were no significant changes
to our accounting polices from those reported in our Annual Report on Form 10-K
for the fiscal year ended March 31, 2005.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our financial position,
results of operations or cash flows due to adverse changes in financial and
commodity market prices and rates. We are exposed to market risk in the areas of
changes in United States and international borrowing rates and changes in
foreign currency exchange rates. In addition, we are exposed to market risk in
certain geographic areas that have experienced or remain vulnerable to an
economic downturn, such as China. We purchase substantially our entire 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 December 31,
2005, we have not used derivative instruments or engaged in hedging activities
to minimize market risk.
18
FOREIGN CURRENCY RISK
We have a wholly owned subsidiary in Hong Kong. Sales by our Hong Kong
subsidiary made on an 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 either the Hong Kong dollar or U.S. dollar
exchange rates may positively or negatively affect our gross margins, operating
income and retained earnings. We do not believe that near-term changes in the
exchange rates, if any, will result in a material effect on our future earnings,
fair values or cash flows, and therefore, we have chosen not to enter into
foreign currency hedging transactions. We cannot assure you that this approach
will be successful, especially in the event of a significant and sudden change
in the value of the Hong Kong dollar.
ITEM 4. CONTROLS AND PROCEDURES
(a) As of the end of the period covered by this quarterly report, management
concluded its evaluation of the effectiveness of the design and operation of the
Company's disclosure controls and procedures. As of the end of the period, our
Chief Executive Officer and our Chief Financial Officer concluded that we
maintain disclosure controls and procedures that are effective in providing
reasonable assurance that information required to be disclosed in our reports
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to the Company's
management, including our Chief Executive Officer and our Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.
(b) During the evaluation referred to in Item 4(a) above, we have identified no
change in our internal control over financial reporting that occurred during our
last fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable
ITEM 1A. RISK FACTORS
FACTORS THAT MAY AFFECT OUR FUTURE RESULTS AND THE MARKET PRICE OF OUR 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 February 10, 2005, our cash on hand is limited. We need approximately
$1.35 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. As of December 31,
2005, our inventory was valued at $1.6 million. See "Liquidity" beginning on
page 17. 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 continue as a going concern. 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 December 31, 2005, our cash position is limited and we had negative
equity. We are not able to pay all of our creditors on a timely basis. We are
not current on our accounts payable of $0.4 million to our factory in China and
$210,000 interest payment to the debenture holders. 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 that 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.
19
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 nine months ended December 31, 2005 and year ended March
31, 2005 were approximately 60% and 40%, respectively. We do not have long-term
contractual arrangements with any of our customers and they can cancel their
orders at any time prior to delivery. A substantial reduction in or termination
of orders from any of our largest customers would decrease our revenues and cash
flow.
WE ARE RELYING ON ONE FACTORY TO MANUFACTURE AND PRODUCE THE MAJORITY OF OUR
KARAOKE MACHINES FOR FISCAL 2006, 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 $0.4
million as of December 31, 2005 and have worked out a verbal payment plan with
it. If the factory is unwilling or unable to deliver our karaoke machines to us,
our business will be adversely affected. Because our cash on hand is minimal, we
are relying on revenues received from the sale of our ordered karaoke machines
to provide cash flow for our operations. If we do not receive cash from these
sales, we may not be able to continue our business operations.
WE ARE 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 Elektra Atlantic Corporation (WEA) to distribute our
music products in fiscal 2006, 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 resulted from 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 December 31, 2005 we had $1.6 million in
inventory on hand. As of March 31, 2005, our inventory was valued at $3.1
million, after a $1.3 million reserve had been taken. It is important that we
sell this inventory during fiscal 2006, so we have sufficient cash flow for
operations.
20
OUR GROSS PROFIT MARGINS HAVE DECREASED OVER THE PAST YEAR AND WE EXPECT A
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 several new models,
which are in demand and yield higher profit margins. We expect that our gross
profit margin might decrease under downward pressure in fiscal 2006.
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 30, 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 ending 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;
21
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.
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.
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.
22
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 February 10, 2006, we are aware of only
three customers, FAO Schwarz, Musicland 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 could not 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.
RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
WE MAY BE UNABLE TO MEET THE REQUIREMENTS TO SATISFY THE $4 MILLION HELD IN
DEBENTURES BY FEBRUARY 20, 2006. IF WE FAIL TO DO SO, THIS MAY HAVE AN ADVERSE
IMPACT ON OUR BUSINESS.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE WHICH MAY CAUSE INVESTORS
TO LOSE ALL OR A PORTION OF THEIR INVESTMENT.
From December 1, 2004 through December 31, 2005, our common stock has traded
between a high of $.95 and a low of $0.22. During this period, we 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 January 10, 2006, investors hold a short position in 238,000
shares of our common stock which represents 2.0% 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 February 10, 2006, 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 "Employment Agreements" on page 13.
23
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.
The Company has received a non-compliance notice from The American Stock
Exchange (the "Amex") on July 18, 2005. The notice indicated that the Company
has fallen below the continued listing standards of the Amex and that its
listing is being continued pursuant to an extension. Specifically, for the
fiscal year ended March 31, 2005, the Company was not in compliance with the
minimum shareholders' equity requirement of $2,000,000, and had reported net
losses in each of the past two fiscal years, resulting in the Company's
non-compliance with Sections 1003(a)(i) and 1003(a)(iv) of the Amex Company
Guide. In addition, the Company failed to announce in a press release, as
required by Section 610(b) of the Amex Company Guide, that it received an audit
opinion which contained a going concern qualification as disclosed in its Form
10-K for fiscal 2005 that was filed on June 29, 2005.
In order to maintain its Amex listing, the Company should submit a plan by
August 18, 2005 advising the Amex of actions it will take, which may allow it to
regain compliance within a maximum of 18 months and 12 months from July 18,
2005, respectively. The Listings Qualifications Department will evaluate the
plan, and make a determination as to whether the Company has made a reasonable
demonstration in the plan of an ability to regain compliance. If the plan is
accepted, the Company may be able to continue its listing during the plan period
of up to 18 months, during which time it will be subject to periodic review to
determine whether it is making progress consistent with the plan. If the plan is
rejected, the Company may not be able to continue its listing in the Amex. We
would trade on the Over-the-Counter Bulletin Board and the market price for
shares of our common stock could decline.
The Company submitted a plan to The American Stock Exchange on August 18, 2005
advising the Amex of actions it will take, which may allow it to regain
compliance within a maximum of 18 months and 12 months from July 18, 2005,
respectively. The Exchange has completed its review of The Singing Machine's
plan of compliance and supporting documentation and has determined that, in
accordance with Section 1009 of the Company Guide, the Plan makes a reasonable
demonstration of the Company's ability to regain compliance with the continued
listing standards within a maximum of 18 months and 12 months from July 18,
2005, respectively.
The Company must regain compliance with the $2,000,000 minimum shareholders'
equity requirement by July 18, 2006, and must be in compliance with all of the
Exchange's continued listing standards by January 18, 2007. Failure to regain
compliance within these time frames likely will result in the Exchange Staff
initiating delisting proceedings pursuant to Section 1009 of the Company Guide.
Further, if our common stock is removed from listing on Amex, it may become more
difficult for us to raise funds through the sales of our common stock or
securities.
IF OUR OUTSTANDING DERIVATIVE SECURITIES ARE EXERCISED OR CONVERTED, OUR
EXISTING SHAREHOLDERS WILL SUFFER DILUTION.
As of December 31, 2005, there were outstanding stock options to purchase an
aggregate of 1,263,610 shares of common stock at exercise prices ranging from
$.60 to $14.30 per share, not all of which are immediately exercisable. The
weighted average exercise price of the outstanding stock options is
approximately $2.42 per share. As of December 31, 2005, there were outstanding
immediately exercisable options to purchase an aggregate of 549,261 shares of
our common stock. There were outstanding stock warrants to purchase 591,040
shares of common stock at exercise prices ranging from $1.41 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.
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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.
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS AND INVESTORS MAY
DEPRESS OUR STOCK PRICE.
As of February 10, 2006, there were 10,060,282 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.
OUR STOCK PRICE MAY DECREASE IF WE ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK.
Our Certificate of Incorporation authorizes the issuance of 100,000,000 shares
of common stock as amended in January 2006. As of February 10, 2006, we had
10,060,282 shares of common stock issued and outstanding and an aggregate of
2,253,650 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 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
We are not currently in default upon senior securities
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable
ITEM 6. EXHIBITS
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act
32.1 Certifying Statement of the Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act
32.2 Certifying Statement of the Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE SINGING MACHINE COMPANY, INC.
Dated February 14, 2006 By: /s/ YI PING CHAN
--------------------------------------------
Interim Chief Executive Officer and
Chief Operating Officer (Principal Executive
Officer)
Dated: February 14, 2006 By: /s/ DANNY ZHENG
--------------------------------------------
Chief Financial Officer (Principal Financial
Officer)
26