As filed with the Securities and Exchange Commission on April 1, 2004
Registration No. 333-109574
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
Amendment No. 1 to
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
THE SINGING MACHINE COMPANY, INC.
(Name of Small Business Issuer in Its Charter)
DELAWARE 5065 95-3795478
(State or other jurisdiction (Primary Standard (IRS Employer
of incorporation or organization) Industrial Classification) Identification No.)
----------------------
Yi Ping Chan, Interim Chief Executive Officer,
Chief Operating Officer and Secretary
6601 Lyons Road, Bldg. A-7
Coconut Creek, FL 33073
(954) 596-1000
(Address and telephone number of Registrant's principal executive offices
and principal place of business)
Laura M. Holm
Adorno & Yoss, P.A.
700 S. Federal Highway, Suite 200
Boca Raton, FL 33432
(Name, address and telephone number of agent for service)
----------------------
Approximate Date of Commencement of Proposed Sale to the Public: As
soon as practicable after the Registration Statement becomes effective.
If any of the securities being registered on this form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box:[X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering.[ ]
If this form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule
462(d) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [ ]
If delivery of the Registration Statement is expected to be made
pursuant to Rule 434, check the following box. [ ]
CALCULATION OF REGISTRATION FEE
TITLE OF EACH CLASS OF PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
SECURITIES TO BE AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING REGISTRATION
REGISTERED REGISTERED SECURITY PRICE FEE
---------------------------------------------------------------------------------------------------------
Common Stock(1) 40,151(1) $1.21(1) $ 48,582.71(1) $ 4.46(1)
Common Stock(2) 1,038,962 $4.25(3) $4,405,198.88(3) $356.38(3)
Common Stock(4) 561,039 $4.25(3) $2,384,157.50(3) $192.88(3)
Common Stock(5) 207,791 $4.25(3) $ 883,111.75(3) $ 71.44(3)
Common Stock(6) 311,680 $4.25(3) $1,324,640.00(3) $107.16(3)
Common Stock(7) 635,842 $4.25(3) $2,702,328.50(3) $218.67(3)
------------- -------
Total 2,795,465 $955.79
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(1) Estimated solely for the purpose of determining the registration fee, in
accordance with Rule 457(c), based on the average high and low prices of
our common stock as report on the American Stock Exchange on March 31, 2004
($1.21).
(2) Represents shares of common stock issuable upon exercise of outstanding
convertible debentures held by certain selling stockholders. Pursuant to
Rule 416, there are also being registered such additional number of shares
of common stock as may become issuable pursuant to the anti-dilution
provisions of the debentures at the conversion price of $3.85 per share.
(3) Previously paid in the Registration Statement that was filed on October 9,
2003.
(4) Represents shares of common stock being issuable upon exercise of
outstanding common stock purchase warrants held by certain selling
stockholders. Pursuant to Rule 416, there are also being registered such
additional number of shares of common stock as may become issuable pursuant
to the anti-dilution provisions of the common stock purchase warrants.
(5) Represents the anticipated maximum number of shares of common stock which
may be issued to the holders of the debentures in payment of interest
accruing thereon, based upon the value of the interest which the Company is
obligated to pay for a maximum period of 30 months on an aggregate
principal amount of $4,000,000 at the conversion rate of $3.85 per share.
(6) Represents a good faith estimate of the number of shares which are issuable
pursuant to certain anti-dilution provisions of the convertible debentures.
(7) Represents the number of shares issuable upon (a) conversion of the
convertible debentures, (b) exercise of the warrants, (c) as interest
payments on the debentures, (d) pursuant to the anti-dilution provisions of
the debentures, multiplied by 130%, which amount the registrant is
obligated to register for resale under its agreements with the holders of
the debentures and warrants.
The registrant hereby amends this registration statement on such date or dates
as may be necessary to delay its effective date until the registrant shall file
a further amendment which specifically states that this registration statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
The information in this Prospectus is not compete and may be changed. We may not
sell these securities until the registration statement filed with the Securities
and Exchange Commission is effective. This Prospectus is not an offer to sell
these securities and it is not soliciting an offer to buy those securities in
any state where the offer or sale is prohibited.
Subject to Completion, Dated April 1, 2004
PROSPECTUS
2,795,465 Shares of Common Stock
THE SINGING MACHINE COMPANY, INC.
[GRAPHIC OMITTED]
We are registering for resale an aggregate of 2,795,465 shares of common stock
of The Singing Company, Inc. that have been issued or may be issued to certain
of our stockholders named in this Prospectus and their transferees.
We will not receive any proceeds from the sale of the shares, but we will
receive proceeds from the selling stockholders if they exercise their warrants.
Our common stock is quoted on the American Stock Exchange under the symbol
"SMD". On March 31, 2004, the closing sales price of our common stock, as
reported on AMEX was $1.17 per share.
The shares of common stock may be sold from time to time by the selling
stockholders in one or more transactions at fixed prices, at market prices at
the time of sale, at varying prices determined at the time of sale or at
negotiated prices. The selling stockholders and any broker-dealer who may
participate in the sale of the shares may use this Prospectus. See "Plan of
Distribution."
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS"
BEGINNING ON PAGE 7.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities, or determined if
this Prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this Prospectus is April 1, 2004
TABLE OF CONTENTS
Prospectus Summary...................................................... 1
Risk Factors............................................................ 2
Special Note regarding Forward-Looking Statements....................... 10
Use of Proceeds......................................................... 10
Selling Stockholders.................................................... 10
Plan of Distribution.................................................... 15
Market Price of Common Stock............................................ 16
Dividend Policy......................................................... 17
Selected Financial Information and Other Data........................... 18
Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................... 21
Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.................................................... 33
Business................................................................ 34
Management.............................................................. 41
Executive Compensation.................................................. 43
Certain Transactions.................................................... 48
Principal Stockholders.................................................. 49
Description of Securities............................................... 51
Shares Eligible for Future Sale......................................... 53
Legal Matters........................................................... 54
Experts................................................................. 54
Where You Can Find Additional Information............................... 54
Index to Consolidated Financial Statements.............................. F-1
Part II. Information Not Required In Prospectus........................II-1
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PROSPECTUS SUMMARY
This Summary highlights information contained elsewhere in this
Prospectus. It does not contain all of the information that you should consider
before investing in our common stock. We encourage you to read the entire
Prospectus carefully, including the section entitled "Risk Factors" and the
financial statements and the notes to those financial statements.
COMPANY OVERVIEW
We are engaged in the production and distribution of karaoke audio
software and electronic recording equipment. Our electronic karaoke machines and
audio software products are marketed under the Singing Machine(R), MTV(R),
Nickelodeon(R), Hard Rock Academy(R), Care Bears(R) and Motown(R) brand names.
Our corporate offices are located at 6601 Lyons Road, Building A-7, Coconut
Creek, Florida 33073, and our telephone number is (954) 596-1000.
THE OFFERING
Common Stock offered by the
Selling Stockholders....................... 2,795,465
Common Stock Outstanding
Prior to the Offering(1)................... 8,752,320
Common Stock Outstanding
after the Offering(2)...................... 11,547,785
Use of Proceeds............................ We will not receive any
proceeds from the sale of
common stock by the selling
stockholders.
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(1)Based on the number of shares actually outstanding as of March 1, 2004.
Does not include (a) options to purchase 1,120,120 shares of our common
stock which are currently outstanding under our 1994 Amended and Restated
Stock Option Plan and our Year 2000 Stock Option Plan, and (b) an aggregate
of 2,795,465 shares which are being registered in this registration
statement, which includes 1,038,962 shares issuable upon conversion of our
outstanding convertible debentures, 561,039 shares issuable upon exercise
of outstanding warrants, 207,791 shares which may be issued as interest
payments on the debentures, 311,680 shares that may be issuable pursuant to
anti-dilution provisions in the debentures, 635,842 shares as a good
faith estimate of additional shares that may be issued pursuant to our
obligations under a registration rights agreement and 40,151 shares issued
to AG Edwards.
(2)Assumes the issuance of 2,795,465 shares of our common stock which are
being registered in this registration statement, which includes 1,038,962
shares issuable upon conversion of our outstanding convertible debentures,
561,039 shares issuable upon exercise of outstanding warrants, 207,791
shares which may be issued as interest payments on the debentures, 311,680
shares that may be issuable pursuant to anti-dilution provisions in the
debentures, 635,842 shares as a good faith estimate of additional shares
that may be issued pursuant to our obligations under a registration rights
agreement and 40,151 shares issued to AG Edwards.
1
RISK FACTORS
You should carefully consider the following factors and other
information in this Prospectus before deciding to purchase our common stock.
RISKS RELATED TO THE COMPANY'S BUSINESS AND OPERATIONS
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 March 1, 2004, our cash on hand is limited. During the next three months,
we plan on financing our working capital needs from the collection of accounts
receivable and using the funds that are advanced to us by Milberg under our
factoring agreement. We also plan on obtaining working capital from the sale of
our inventory. As of December 31, 2003, our inventory was valued at $8 million.
If these sources do not provide us with adequate financing, we may try to seek
financing from a third party; however, we will have to obtain consent from
Milberg prior to obtaining any other financing. If we are not able to obtain
adequate financing, when needed, it will have a material adverse effect on our
cash flow and our ability to run our business. If we have a severe shortage of
working capital, we may not be able to continue our business operations and may
be required to file a petition for bankruptcy under Chapter 11 of the U.S.
Bankruptcy Code or enter into some other form of liquidation or reorganization
proceeding.
WE MAY BE DEEMED TO INSOLVENT AND WE MAY GO OUT OF BUSINESS
As of March 1, 2004, our cash position is limited. We are not able to pay all of
our creditors on a timely basis. We are not current on approximately $2.7
million of outstanding accounts payable, which represents accounts payable to
two factories in China. If we are not able to pay our current debts as they
become due, we may be deemed to be insolvent and we may not be able to continue
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 proceeding..
OUR INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS RAISED SUBSTANTIAL DOUBT ABOUT OUR
ABILITY TO CONTINUE AS A GOING CONCERN AS OF MARCH 31, 2003
We received a report dated June 24, 2003 (except for Note 9, as to which the
date is July 8, 2003 and Note 15, as to which the date is July 10, 2003) from
our independent certified public accountants covering the consolidated financial
statements for our fiscal year ended March 31, 2003 that included an explanatory
paragraph which stated that the financial statements were prepared assuming the
Company would continue as a going concern. This report stated that a
then-existing default under our credit agreement with LaSalle Business Credit
raised substantial doubt about our ability to continue as a going concern.
We paid our loan with LaSalle in full effective as of January 31, 2004 and
terminated the agreement. We replaced the LaSalle credit facility by entering
into a factoring agreement with Milberg Factors, Inc., effective as of February
9, 2004. Pursuant to the agreement, Milberg, at its discretion, will advance the
Company with the lesser of 80% of our eligible accounts receivable or $3.5
million. We do not know if this factoring agreement will provide us with
sufficient capital. If the agreement with Milberg does not provide sufficient
capital, or we are unable to obtain additional financing, we may have a
liquidity problem and this would affect our ability to continue our business
operations, and accordingly our independent certified public accountants may
again raise substantial doubt about our ability to continue as a going concern
as of March 31, 2004.
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, PROFITABILITY AND CASH FLOW
We rely on a few large customers to provide a substantial portion of our
revenues. As a percentage of total revenues, our net sales to our five largest
customers during the fiscal period ended March 31, 2003, 2002 and 2001 were
approximately 67%, 77% and 87% respectively. In fiscal 2003, three major
customers accounted for 21%, 17% and 15% of our net sales. We do not have
long-term contractual arrangements with any of our customers and they can cancel
2
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, profitability and cash flow.
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 February 2002, one of our largest customers, Best Buy returned approximately
$2.75 million in karaoke products to us that it had not been able to sell during
the Christmas season. Best Buy kept this inventory in its retail stores, but
converted the sales to consignment sales. Although we were not contractually
obligated to accept this return of the karaoke products, we did this because we
valued our relationship with Best Buy. 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 REDUCTIONS,
FINANCIAL INCENTIVES AND OTHER RISKS THAT FORCE US TO BEAR THE RISKS AND COSTS
OF CARRYING INVENTORY, 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 the nine months ended December 31, 2003, our sales to customers in
the United States decreased because of increased price competition. We sold many
of our karaoke machines to these U.S. customers at prices near or below cost. We
are also subject to the risk that our customers might demand certain financial
incentives, such as large advertising or cooperative advertising allowances,
which effectively reduce our selling prices. Additionally, 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 of the order and the delivery date, which reduces
our cash flow.
OUR GROSS PROFIT MARGINS HAVE DECREASED OVER THE PAST YEAR AND WE EXPECT THE
TREND TO CONTINUE
Over the past year, our gross profit margins have decreased. In the nine months
ended December 31, 2003, our gross profit margin was 4.6% compared to 21.7% in
the nine months ended December 31, 2002. This decline resulted from price
competition and a shift in customer orders from our parent company in the United
States to our Hong Kong subsidiary, International SMC. International SMC
delivers our karaoke products to customers directly from our manufacturer's
factories in China and therefore does not provide logistics, handling,
warehousing and just in time inventory support, which services are provided by
our parent company in the United States. Accordingly, the average sales price
per unit realized by International SMC is significantly lower than that of our
parent company in the United States. We expect further price competition and a
continuing shift of sales volume to International SMC. Accordingly, we expect
that our gross profit margin will decrease in fiscal 2004.
OUR SENIOR CORPORATE MANAGEMENT TEAM IS NEW TO THE SINGING MACHINE AND IS
REQUIRED TO DEVOTE SIGNIFICANT ATTENTION TO OUR FINANCING AGREEMENTS AND
SETTLING OUR CLASS ACTION LAWSUITS.
Beginning on May 2, 2003, through the present date, we have had two Chief
Executive Officers and a Chief Operating Officer resign. We are currently in
negotiations with our Chief Financial Officer and Senior Vice President of
Finance regarding their resignations from our company. Additionally, four out of
the five directors serving on our Board on May 2, 2003 have resigned since that
date. We hired a new Chief Operating Officer, Yi Ping Chan on March 31, 2003,
and appointed three new directors, Bernard Appel and Richard Ekstract, on
October 31, 2003 and Harvey Judkowitz On March 29, 2004. We are in the process
of searching for a new Chief Executive Officer. It will take some time for our
new management and our new board of directors to learn about our business and to
develop strong working relationships with each other and our employees. In
particular, coordination between various divisions of our Company have not been
systematized and morale has suffered as a consequence. Our new senior corporate
management's ability to complete this process has been and continues to be
hindered by the time that it needs to devote to other pressing business matters.
New management needs to spend significant time on overseeing our liquidity
situation and overseeing legal matters, such as our class action lawsuit. We
cannot assure you that this major restructuring of our board of directors and
senior management and the
3
accompanying distractions, in this environment, will not adversely affect our
results of operations.
THE SEC IS CONDUCTING AN INFORMAL INVESTIGATION OF THE COMPANY AND IF WE HAVE
DONE SOMETHING ILLEGAL, WE WILL BE SUBJECT TO FINES, PENALTIES AND OTHER
SANCTIONS BY THE SEC
In August 2003, we were advised that the SEC had commenced an informal
investigation of our company. It appears that the investigation is focused on
the restatement of our financial statements in fiscal 2002 and 2001; however,
the SEC may be reviewing other issues as well. If the SEC finds that our company
has not fully complied with all applicable federal securities laws, we could be
subject to fines, penalties and other sanctions imposed by the SEC.
WE ARE NAMED AS A DEFENDANT IN A CLASS ACTION LAWSUIT RELATING TO THE
RESTATEMENT OF OUR FINANCIAL STATEMENTS FOR FISCAL 2002 AND FISCAL 2001, WHICH
IF DETERMINED ADVERSELY TO US, COULD RESULT IN THE IMPOSITION OF DAMAGES AGAINST
US AND HARM OUR BUSINESS AND FINANCIAL CONDITION
We are named as a defendant in a class action lawsuit which arose from the
restatement of our financial statements for fiscal 2002 and 2001. In this
lawsuit, the plaintiffs allege that our executive officers and our company
violated Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934
and Rule 10(b)-5. The plaintiffs seek compensatory damages, attorney's fees and
injunctive relief. While the specific factual allegations vary slightly in each
case, the complaints generally allege that our officers falsely represented the
Company's financial results during the relevant class periods. In March 2004, we
have entered into a settlement agreement with the class action plaintiffs. See
"Business - Legal Matters" on page 53. This settlement is subject to approval by
the court and the shareholders who are members of the class action lawsuit.
If this settlement agreement is not approved by the court and members of the
class action lawsuit, we will need to expend additional times and resources on
resolving this matter, whether through continued settlement discussions or
through litigation. If a significant monetary judgment is rendered against us,
we are not certain that we will have the ability to pay such a judgment. Any
losses resulting from these claims could adversely affect our profitability and
cash flow.
OUR LICENSING AGREEMENT WITH MTV NETWORKS IS IMPORTANT TO OUR BUSINESS AND IF WE
WERE TO LOSE OUT MTV LICENSE IT WOULD AFFECT OUR REVENUES AND PROFITABILITY
Our license with MTV Networks is important to our business. We generated
$30,884,344 or 32.3% of our consolidated net sales from products sold under the
MTV license in fiscal 2003. During the nine months ended December 31, 2003, we
generated only $8.3 million or 12.2% of our consolidated net sales under this
MTV license agreement. Our MTV license was extended until April 30, 2004 with
options for MTV to renew for two additional periods through December 31, 2004;
however, MTV can terminate the license agreement for certain reasons over the
course of the calendar year 2004. If we were to lose our MTV license, it would
have an effect on our revenues and net income.
WE EXPERIENCE DIFFICULTY FORECASTING THE DEMAND FOR OUR KARAOKE PRODUCTS AND IF
WE ARE NOT ACCURATELY FORECAST DEMAND, OUR REVENUES, NET INCOME AND CASH FLOW
MAY BE AFFECTED
Because of our reliance on manufacturers in Asia for our machine production, our
production lead times range from one to four months. Therefore, we must commit
to production in advance of customers orders. It is difficult to forecast
customer demand because we do not have any scientific or quantitative method to
predict this demand. Our forecasting is based on management's general
expectations about customer demand, the general strength of the retail market
and management's historical experiences. As of December 31, 2003, we had $14.2
million in inventory against which a $6.2 million reserve has been taken We will
attempt to liquidate this inventory over the next six months. However, if we are
unable to sell this inventory, our revenues, cash flow and profitability will be
reduced.
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
4
Christmas. A substantial majority of our sales occur during the second quarter
ended September 30 and the third quarter ended December 31. Sales in our second
and third quarter, combined, accounted for approximately 85.6% of net sales in
fiscal 2003, 81% of net sales in fiscal 2002 and 75% of net sales in fiscal
2001.
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. In addition, we must compete with all the
other existing forms of entertainment including, but not limited to: motion
pictures, video arcade games, home video games, theme parks, nightclubs,
television and prerecorded tapes, CD's and video cassettes.
IF WE ARE UNABLE TO DEVELOP NEW KARAOKE PRODUCTS, OUR REVENUES MAY NOT CONTINUE
TO GROW
The karaoke industry is characterized by rapid technological change, frequent
new product introductions and enhancements and ongoing customer demands for
greater performance. In addition, the average selling price of any karaoke
machine has historically decreased over its life, and we expect that trend to
continue. As a result, our products may not be competitive if we fail to
introduce new products or product enhancements that meet evolving customer
demands. The development of new products is complex, and we may not be able to
complete development in a timely manner, or at all. During the past twelve
years, Edward Steele, our former Chief Executive Officer, oversaw new product
development. Mr. Steele will be retiring from our company on February 28, 2004
and we have not yet identified a successor who will oversee new product
development. To introduce products on a timely basis, we must:
- accurately define and design new products to meet market needs;
- design features that continue to differentiate our products from those of our
competitors;
- transition our products to new manufacturing process technologies;
- identify emerging technological trends in our target markets;
- anticipate changes in end-user preferences with respect to our customers'
products;
- bring products to market on a timely basis at competitive prices; and
- respond effectively to technological changes or product announcements by
others.
We believe that we will need to continue to enhance our karaoke machines and
develop new machines to keep pace with competitive and technological
developments and to achieve market acceptance for our products.
OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD PREVENT
OR DELAY OUR CUSTOMERS' RECEIPT OF INVENTORY
We rely principally on four contract ocean carriers to ship virtually all of the
products that we import to our warehouse facilities in Compton and Rancho
Dominguez, California. Retailers that take delivery of our products in China
rely on a variety of carriers to import those products. Any disruptions in
shipping, whether in California or China, caused by labor strikes, other labor
disputes, terrorism, and international incidents or otherwise prevent or delay
our customers' receipt of inventory. If our customers do not receive their
inventory on a timely basis, they may cancel their orders or return products to
us. Consequently, our revenues and net income would be reduced.
5
OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE'S REPUBLIC OF CHINA,
SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS. IF THERE IS ANY
PROBLEM WITH THE MANUFACTURING PROCESS, OUR REVENUES AND NET PROFITABILITY MAY
BE REDUCED.
We are dependent upon six factories in the People's Republic of China to
manufacture all of our electronic products. Our arrangements with these
factories are subject to the risks of doing business abroad, such as import
duties, trade restrictions, work stoppages, 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.
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 CD+G's. We have settled or are in the
process of settling all of these copyright infringement issues with these
publishers. 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.
6
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 4, 2004, we are aware of only two
customers, FAO Schwarz and KB Toys, which are operating under the protection of
bankruptcy laws. In fiscal 2003, FAO Schwarz and KB Toys represented less than
1% of our revenues and we expect that revenues from this account will be less
than 2% of our revenues in fiscal 2004. Despite the difficulties experienced by
retailers in recent years, we have not suffered significant credit losses to
date. Deterioration in the financial condition of our customers could 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 three warehouses, which are located in Compton, California, Rancho
Dominguez, California and Coconut Creek, Florida. Events such as fire or other
catastrophic events, any malfunction or disruption of our centralized
information systems or shipping problems may result in delays or disruptions in
the timely distribution of merchandise to our customers, which could
substantially decrease our revenues and profitability.
OUR BUSINESS OPERATIONS COULD BE DISRUPTED IF THERE ARE LABOR PROBLEMS ON THE
WEST COAST
During fiscal 2003, approximately 48% of our sales were domestic sales, which
were made from our warehouses in California and Florida. During the third
quarter of fiscal 2003, the dock strike on the West Coast affected sales of two
of our karaoke products and we estimate that we lost between $3 and $5 million
in orders because we couldn't get the containers of these products off the pier.
If another strike or work slow-down occurs and we do not have a sufficient level
of inventory, a strike or work slow-down would result in increased costs to us
and may reduce our profitability.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE WHICH MAY CAUSE INVESTORS
TO LOSE ALL OR A PORTION OF THEIR INVESTMENT
From March 1, 2002 through March 1, 2004, our common stock has traded between a
high of $19.05 and a low of $1.14. During this period, we have restated our
earnings, lost senior executives and Board members, had liquidity problems and
defaulted on our line of credit with LaSalle. 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 February 9, 2004, investors hold a short position in 400,000
shares of our common stock which represents 6.56% 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.
7
OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS
Our employment agreements with Yi Ping Chan, April Green, Jack Dromgold and John
Dahl require us, under certain conditions, to make substantial severance
payments to them if they resign after a change of control. As of December 31,
2003, Mr. Chan, Ms. Green and Mr. Dahl are entitled to severance payments of
$250,000, $73,600, and $75,000, respectively. These provisions could delay or
impede a merger, tender offer or other transaction resulting in a change in
control of the Company, even if such a transaction would have significant
benefits to our shareholders. As a result, these provisions could limit the
price that certain investors might be willing to pay in the future for shares of
our common stock. See "Executive Compensation - Employment Agreements" on page
45.
RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
IF OUR OUTSTANDING DERIVATIVE SECURITIES ARE EXERCISED OR CONVERTED, OUR
EXISTING SHAREHOLDERS WILL SUFFER DILUTION
As of December 31, 2003, there were outstanding stock options to purchase an
aggregate of 1,120,120 shares of common stock at exercise prices ranging from
$1.97 to $14.00 per share, not all of which are immediately exercisable. The
weighted average exercise price of the outstanding stock options is
approximately $4.81 per share. As of March 1, 2004, there were outstanding
immediately exercisable warrants to purchase an aggregate of 561,039 shares of
our common stock, the resale of which is covered in this Prospectus. In
addition, we have issued $4,000,000 of convertible debentures, which are
initially convertible into an aggregate of 1,038,962 shares of common stock, the
resale of which is covered by this Prospectus. To the extent that the
aforementioned convertible securities are exercised or converted, dilution to
our stockholders will occur.
THE $4 MILLION PRIVATE PLACEMENT THAT WE CLOSED IN SEPTEMBER 2003 WILL AFFECT
OUR ABILITY TO RAISE CAPITAL IN THE FUTURE
On September 8, 2003, we closed a private offering in which we issued $4 million
of convertible debentures and stock purchase warrants to six institutional
investors. As part of this investment, we agreed to several limitations on our
corporate actions, some of which limit our ability to raise financing in the
future. If we enter into any financing transactions during the one year period
after the registration statement, of which this Prospectus is a part, is
effective 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, we cannot sell any securities.
Additionally, we can not:
- 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.
- 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 equity.
IF WE SELL ANY OF OUR SECURITIES AT A PRICE LOWER THAN $3.85 PER SHARE, THE
CONVERSION PRICE OF OUR DEBENTURES AT $3.85 PER SHARE WILL BE REDUCED AND THERE
WILL BE ADDITIONAL DILUTION TO OUR SHAREHOLDERS
Given that our common stock is trading at a price of $1.17 per share as of
March 31, 2004, it is possible that we may need to sell additional securities
for capital at a price lower than $3.85 per share. If we sell any securities at
a price lower than $3.85 per share, the conversion price of our debentures
currently set at $3.85 per share will be reduced and there will be more dilution
to our shareholders if and when the debentures are converted into shares of our
common stock. If we issue or sell any securities at a price less than $3.85 per
share prior to September 8, 2004, the set price of the debentures will be
reduced by an amount equal to 75% of the difference between the set price and
the effective purchase price for the shares If such dilutive issuances occur
after September 8, 2004 but before the earlier of February 20, 2006 or when all
the debentures are converted into shares of our common stock, the set price will
8
be reduced by an amount equal to 50% of the difference between the set price and
effective purchase price of such shares. So, if we sold 1 million shares of our
common stock on April 1, 2004 for a price of $1.22 per share, the set price
of the debentures would be reduced by $2.24 to $1.61 and the aggregate number of
shares of our common stock that would be issued upon conversion of the
debentures would be increased from 1,038,962 shares to 2,484,472 shares.
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS AND INVESTORS MAY
DEPRESS OUR STOCK PRICE
As of December 31, 2003, there were 8,752,320 shares of our common stock
outstanding. Of these shares, approximately 5,954,796 shares are eligible for
sale under Rule 144. We have filed two registration statements registering an
aggregate 3,794,250 of shares of our common stock (a registration statement on
Form S-8 to register the sale of 1,844,250 shares underlying options granted
under our 1994 Stock Option Plan and a registration statement on Form S-8 to
register 1,950,000 shares of our common stock underlying options granted under
our Year 2001 Stock Option Plan). An additional registration statement on Form
S-1, of which this Prospectus is a part, was filed in October 2003, registering
an aggregate of 2,795,465 shares of our common stock. The market price of our
common stock could drop due to the sale of large number of shares of our common
stock, such as the shares sold pursuant to the registration statements or under
Rule 144, or the perception that these sales could occur.
OUR STOCK PRICE MAY DECREASE IF WE ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK
Our Certificate of Incorporation authorizes the issuance of 18,900,000 shares of
common stock. As of March 1, 2004, we had 8,752,320 shares of common stock
issued and outstanding and an aggregate of 1,681,159 shares issuable under our
outstanding options and warrants. We also have an obligation to issue up to
1,038,962 shares upon conversion of our debentures and have reserved 207,791
additional shares for interest payment on the debentures. As such, our Board of
Directors has the power, without stockholder approval, to issue up to 7,219,768
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.
We are also subject to certain provisions of Delaware law that could delay,
deter or prevent us from entering into an acquisition, including the Delaware
General Corporation Law, which prohibits a Delaware corporation from engaging in
a business combination with an interested stockholder unless specific conditions
are met. The existence of these provisions could limit the price that investors
are willing to pay in the future for shares of our common stock and may deprive
you of an opportunity to sell your shares at a premium over prevailing prices.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus contains forward-looking statements within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"). Any statements about our
expectations, beliefs, plans, objectives, assumptions or future events or
9
performance are not historical facts and may be forward-looking. These
statements are often, but not always, made through the use of words or phrases
such as "anticipate," "estimate," "plans," "projects," "continuing," "ongoing,"
"expects," "management believes," "we believe," "we intend" and similar words or
phrases. Accordingly, these statements involve estimates, assumptions and
uncertainties, which could cause actual results to differ materially from those
expressed in them. Any forward-looking statements are qualified in their
entirety by reference to the "Risk Factors" contained on pages 2 through 8 of
this Prospectus.
Because the factors discussed in this Prospectus could cause actual
results or outcomes to differ materially from those expressed in any
forward-looking statements made by us or on behalf of our company, you should
not place undue reliance on any such forward-looking statements. Further, any
forward-looking statement speaks only as of the date on which it is made, and we
undertake no obligation to update any forward-looking statement or statements to
reflect events or circumstances after the date on which such statement is made
or to reflect the occurrence of unanticipated events. New factors emerge from
time to time, and it is not possible for us to predict which will arise. In
addition, we cannot assess the impact of each factor on our business or the
extent to which any factor, or combination of factors, may cause actual results
to differ materially from those contained in any forward-looking statements.
USE OF PROCEEDS
We will not receive any proceeds from the sale of shares by the selling
stockholders. Although we may receive proceeds if the warrants are exercised,
these proceeds, if any, will be used for working capital purposes or any other
purpose approved by the Board of Directors.
SELLING STOCKHOLDERS
The following table sets forth information as of March 1, 2004 with
respect to the beneficial ownership of our common stock both before and
immediately following the offering by each of the selling stockholders.
Calculation of the percent of outstanding shares owned is based on
shares of our common stock issued and outstanding as of March 1, 2004.
Beneficial ownership is determined in accordance with Rule 13d-3 promulgated by
the Securities and Exchange Commission, and generally includes voting or
investment power with respect to securities. Except as indicated in the
footnotes to the table, we believe each holder possesses sole voting and
investment power with respect to all of the shares of common stock owned by that
holder, subject to community property laws where applicable. In computing the
number of shares beneficially owned by a holder and the percentage ownership of
that holder, shares of common stock underlying options, warrants, debentures,
notes or preferred stock by that holder that are currently exercisable or
convertible or are exercisable or convertible within 60 days after the date of
the table are deemed outstanding. Those shares, however, are not deemed
outstanding for the purpose of computing the percentage ownership of any other
person or group.
The terms of the debentures and warrants owned by Omicron Master Trust,
SF Capital Partners, Ltd, Bristol Investment Fund, Ltd., Ascend Offshore Fund,
Ltd., Ascend Partners, LP and Ascend Partners Sapient LP prohibit conversion of
those debentures or exercise of those warrants to the extent that a conversion
of those debentures would result in the holder, together with its affiliates,
beneficially owning in excess of 4.99% of our outstanding shares of common
stock, and to the extent that exercise of the warrants would result in the
holder, together with its affiliates, beneficially owning in excess of 4.99% of
our outstanding shares of common stock. A holder may waive the 4.99% limitation
upon 60 days prior written notice to us. Also, these limitations do not preclude
a holder from converting or exercising a debenture or warrant and selling shares
underlying that debenture or warrant in stages over time where each stage does
not cause the holder and its affiliates to beneficially own shares in excess of
the limitation amounts. In light of the limitations contained in the debentures
and warrants, the number of shares shown in the table as beneficially owned by
each holder of those debentures and warrants prior to this offering has been
limited to 4.99% of the share of our common stock outstanding as of the date of
the table. However, we have registered for resale all of the shares that can be
resold by each selling shareholder, without regard to the conversion or exercise
limitations described herein.
After each selling shareholder sells shares, we will file a prospectus
supplement which indicates the number of shares that each selling shareholder is
eligible to sell.
10
SECURITIES OWNED SHARES OF SECURITIES AFTER OFFERING(11)
PRIOR TO OFFERING COMMON STOCK -----------------------------
------------------------- BEING OFFERED NUMBER OF PERCENT OF
SHARES OF PERCENT OF UNDER THIS SHARES OF COMMON
NAME OF SELLING STOCKHOLDER STOCK(1) STOCK PROSPECTUS (2) COMMON STOCK STOCK
--------------------------- --------- ---------- --------------- ------------ ----------
Omicron Master Trust 434,034 4.99 1,637,662(3) 0 *
SF Capital Partners, Ltd. 187,013 2.15 327,521(4) 0 *
Bristol Investment Fund, Ltd. 112,208 1.29 196,520(5) 0 *
Ascend Offshore Fund, Ltd. 178,785 2.05 313,122(6) 0 *
Ascend Partners Sapient, LP 61,266 * 107,301(7) 0 *
Ascend Partners, LP 21,768 * 38,124(8) 0 *
Roth Capital Partners, LLC 103,896 1.18 135,064(9) 0 *
AG Edwards & Sons, Inc. 40,151 * 40,151(10) 0 *
--------------
* Less than 1%.
(1) The debentures and warrants contractually limit the selling stockholder's
right to convert the debentures or exercise of the warrants, as the case
may be, to the extent such selling stockholder's beneficial ownership
exceeds 4.99% of the Company's then issued and outstanding shares of common
stock. Represents shares of common stock issuable upon conversion of the
debentures and exercise of the warrants, which the holders have the right
to acquire within sixty (60) days of November 15, 2003. Excludes Roth
Capital Partners, LLC ("Roth") and A.G. Edwards & Sons, Inc. ("A.G.
Edwards").
(2) Listed shares represent shares issuable upon conversion of the debentures
and exercise of the warrants (without regard to any exercise or conversion
limitations), shares which we may issue as payment of interest on
debentures or pursuant to certain anti-dilution provisions of the
debentures (collectively, the "Registrable Securities"). Also includes an
additional 30% of the Registrable Securities, which we are required to
register pursuant to a registration rights agreement, as well as the shares
issued to Roth and AG Edwards.
(3) Shares offered pursuant to this Prospectus consist of 649,351 shares
issuable upon conversion of the debentures; 285,714 shares issuable upon
exercise of warrants; up to 129,870 shares which we may issued as interest
payable on the debentures; 194,805 shares we may issue under the
anti-dilution provisions of the debentures and 377,922 shares, an
additional 30% of the registrable securities. Omicron Capital, L.P., a
Delaware limited partnership ("Omicron Capital") serves as investment
manager to Omicron Master Trust, a trust formed under the laws of Bermuda
("Omicron"). Omicron Capital, Inc., a Delaware corporation ("OCI") serves
as general partner of Omicron Capital and Winchester Global Trust Company
Limited ("Winchester") serves as the trustee of Omicron. By reason of such
relationships, Omicron Capital and OCI may be deemed to share dispositive
power of the shares of our common stock owned by Omicron and Winchester may
be deemed to share voting and dispositive power over the shares of our
common stock owned by Omicron. Omicron Capital, OCI and Winchester Capital
has delegated authority from the board of directors of Winchester regarding
the portfolio management decisions with respect to the shares of common
stock owned by Omnicron and as of September 15, 2003, Mr. Oliver H. Morali
and Mr. Bruce T. Bernstein, officers of OCI, have delegated authority from
the board of directors of OCI regarding the portfolio management decisions
of Omicron Capital with respect to the shares of common stock owned by
Omicron. By reason of such delegated authority, Merssrs. Morali and
Bernstein disclaim beneficial ownership of such shares of our common stock
and neither of such persons has any legal right to maintain such power with
respect to shares of our common stock offered by Omicron, as those terms as
used for purposes of the Securities Exchange Act of 1934, as amended.
(4) Shares offered pursuant to this Prospectus consist of 129,870 shares
issuable upon conversion of the debentures; 57,143 shares issuable upon
exercise of warrants, up to 25,974 shares which we may issued as interest
payable on the debentures, 38,952 shares we may issue under the
anti-dilution provisions of the debentures and 75,582 shares, an additional
30% of the Registrable Securities. Michael A. Roth and Brian J. Stark are
the founding members and director the management of Staro Asset Management,
L.L.C., a Wisconsin limited liability company ("Staro") which acts as
investment manager and has sole power to direct the management of SF
Capital Partners, Ltd. Through Staro, Messrs. Roth and Stark possess sole
voting and dispositive power over all of the shares owned by SF Capital
Partners, Ltd.
(5) Shares offered pursuant to this Prospectus consist of 77,922 shares
issuable upon conversion of the debentures; 34,286 shares issuable upon
exercise of warrants, up to 15,584 shares which we may issued as interest
11
payable on the debentures, 23,377 shares we may issue under the
anti-dilution provisions of the debentures and 45,351 shares, an additional
30% of the Registrable Securities. Paul Kessler and Diana Derycz-Kessler
are the managing members of Bristol Capital Advisors, LLC, a Delaware
limited liability company ("BCA") which acts as investment manager and has
sole power to direct the management of Bristol Investment Fund, Ltd..
Through BCA, Mr. Kessler and Mrs. Diana Derycz Kessler possess voting and
dispositive power over the shares owned by Bristol Investment Fund, Ltd.
(6) Shares offered pursuant to this Prospectus consist of 124,156 shares
issuable upon conversion of the debentures; 54,629 shares issuable upon
exercise of warrants, up to 24,831 shares which we may issued as interest
payable on the debentures, 37,247 shares we may issue under the
anti-dilution provisions of the debentures and 72,259 shares, an additional
30% of the Registrable Securities. Ascend Capital, LLC, a Delaware limited
liability company ("Ascend") serves as the investment advisor to Ascend
Offshore Fund, Ltd. ("Ascend Offshore") Malcolm Fairbain serves as the
founder and sole managing member of Ascend Offshore and has the sole power
to direct the management of Ascend Offshore. Through Ascend, Messr.
Fairbain possesses sole voting and dispositive power over all of the shares
owned by Ascend Offshore.
(7) Shares offered pursuant to this Prospectus consist of 42,546 shares
issuable upon conversion of the debentures; 18,720 shares issuable upon
exercise of warrants, up to 8,509 shares which we may issued as interest
payable on the debentures, 12,764 shares we may issue under the
anti-dilution provisions of the debentures and 24,762 shares, an additional
30% of the Registrable Securities. Ascend Capital, LLC, a Delaware limited
liability company ("Ascend") serves as the investment advisor to Ascend
Partners Sapient, LLP, Ltd. ("Ascend Partners). Malcolm Fairbain serves as
the founder and sole managing member of Ascend Partners and has the sole
power to direct the management of Ascend Partners. Through Ascend, Messr.
Fairbain possesses sole voting and dispositive power over all of the shares
owned by Ascend Partners.
(8) Shares offered pursuant to this Prospectus consist of 15,117 shares
issuable upon conversion of the debentures; 6,651 shares issuable upon
exercise of warrants, up to 3,023 shares which we may issued as interest
payable on the debentures, 4,535 shares we may issue under the
anti-dilution provisions of the debentures and 8,798 shares, an additional
30% of the Registrable Securities. Ascend serves as the investment advisor
to Ascend Partners, LP ("Ascend LP"). Malcolm Fairbain serves as the
founder and sole managing member of Ascend LP and has the sole power to
direct the management of Ascend LP. Through Ascend, Messr. Fairbain
possesses sole voting and dispositive power over all of the shares owned by
Ascend LP.
(9) Shares offered pursuant to this Prospectus consist of 103,896 shares
issuable upon exercise of warrants and 31,168 shares, an additional 30% of
the Registrable Securities.
(10) AG Edwards & Sons, Inc. is a publicly traded company. The current officers
and directors of AG Edwards may be deemed to possess the sole voting and
dispositive power over all the shares owned by AG Edwards & Sons, Inc.
(11) Because the selling stockholders may sell all or some portion of the shares
of common stock beneficially owned by them, only an estimate (assuming the
selling stockholders sell all of the shares offered hereby) can be given as
to the number of shares of common stock that will be beneficially owned by
the selling stockholders after this offering. In addition, any selling
stockholder may have sold, transferred or otherwise disposed or, or may
sell, transfer or otherwise dispose of, at any time or from time to time
since the dates on which they provided the information regarding the shares
beneficially owned by them, all or a portion of the shares beneficially
owned by them in transactions exempt from the registration requirements of
the Securities Act of 1933.
CIRCUMSTANCES UNDER WHICH SELLING STOCKHOLDERS ACQUIRED SECURITIES
Set forth below is a summary of the circumstances that led to the
issuance to the listed selling stockholders of shares of our common stock and
the securities, which are exercisable or convertible into shares of our common
stock.
On August 20, 2003, we entered into a Securities Purchase Agreement
("Purchase Agreement") with Omicron Master Trust, SF Capital Partners Ltd.,
Bristol Investment Fund, Ltd., Ascend Offshore Fund, Ltd., Ascend Sapient
Partners, Ltd. and Ascend Partners, LP., for the sale to these investors of 8%
debentures, convertible into shares of our common stock at a conversion price
equal to $3.85 per share, for an aggregate amount of $4 million. We closed this
offering on September 8, 2003. As of March 1, 2004, the debentures are
convertible into 1,038,962 shares of our common stock. The investors also
received warrants to purchase up to, in the aggregate 457,143 shares of our
common stock with an exercise price equal to $4.025 per share. We also agreed to
register the resale of the shares issued to the investors in a registration
12
rights agreements. The debentures, the warrant agreements, the registration
rights agreement and any other documents relating to the securities issued to
the investors shall sometimes be collectively referred to as the transaction
documents.
The debentures mature on February 20, 2006 and accrue interest at the
rate of 8% per annum, and they provide for interest only payments on a quarterly
basis, at our option, in cash or in shares of common stock. In order to use
shares of our common stock to make the interest payments, we must meet certain
requirements specified in the debentures. These requirements are that (1) a
registration statement registering the resale of the investor's shares is
effective, (2) our common stock is listed for trading on a principal market,
such as the American Stock Exchange or the NASDAQ National Market (3) there is a
sufficient number of authorized but unissued shares of our common stock
available so that all shares of our common stock could be issued to the
investors under the transaction documents, (4) we are not in default of any of
the terms of the transaction documents and (5) the issuance of the shares to an
investor will not result in the investor owning more than 4.99% of our issued
and outstanding common stock (unless the investor has waived the 4.99%
conversion limitation).
If certain conditions are met after the registration statement is
declared effective, we have the right, but not the obligation to redeem the
debentures at 100% of their face value, plus accrued interest. The first
condition is that the closing price of our common stock must exceed the set
price of the debentures by 200% for more than 15 consecutive trading days. As of
March 1, 2004, the set price is $3.85, so the trading price for 15 consecutive
trading days must exceed $7.70 per share. The other conditions are (1) we must
have honored all conversions made by the investors prior to the redemption date,
(2) our registration statement registering the resale of shares is effective,
(3) our common stock is listed for trading on a principal market, such as AMEX
or NASDAQ, (4) we have paid all liquidated damages that are due under the
transaction documents, (5) there is a sufficient number of authorized but
unissued shares of our common stock available to issue to the investors all
shares of our common stock that could be issued to the investors under the
debentures, (6) we are not in default of any of the terms of the transaction
documents, (7) the issuance of the shares to an investor will not result in an
investor owning more than 4.99% of our issued and outstanding common stock
(unless the investor has waived the 4.99% conversion limitation) and (8) we had
not made any public announcements about a pending or proposed change of control
or a fundamental transaction, such as a merger or acquisition, has not occurred
and not been consummated.
The warrants are exercisable for a period of three years from the date
of issuance until September 7, 2006 and the initial exercise price is $4.025 per
share. The conversion price of the debentures and the exercise price of the
warrants are subject to adjustment in the event we issue additional shares of
our common stock or securities convertible into shares of our common stock at a
price per share of common stock less than the conversion price or exercise price
on the basis of a weighted average formula. In addition, the conversion price of
the debentures and exercise price of the warrants are subject to adjustment at
any time as the result of any subdivision, stock split, combination of shares or
capitalization. For example, if we were to declare a 2-for-1 stock split, the
conversion price of the debentures would be reduced by half from $3.85 to $1.93
per share and the exercise price of the warrants would be reduced from $4.025 to
$2.0125 per share.
We will account for this transaction in accordance with the Emerging
Issues Task Force Consensus on Issue 00-27 ("EITF 00-27"). The fair value of the
stock purchase warrants, as determined by a third party, will be allocated from
the proceeds of the debt issuance and recorded as a debt discount to be
amortized over the life of the debt to interest expense. We will then calculate
the effective conversion price of the debt to determine whether any beneficial
conversion feature exists. The results of the application of EITF 00-27 could
have a material impact on our financial results.
The investors and Roth Capital Partners, LLC ("Roth Capital"), the
placement agent in this transaction ("Roth Capital"), were also given certain
registration rights in a registration rights agreement with the Company. We
agreed to register:
o an aggregate of 1,038,962 shares issuable upon conversion of the
convertible debentures,
o an aggregate of 561,039 shares issuable upon exercise of warrants,
o an aggregate of 207,791 shares issuable as interest payments on the
debentures;
o an aggregate of 311,680 shares of common stock issuable pursuant to
the weighted average anti-dilution provisions of the debentures.
13
All of these shares are collectively referred to as the "Registrable
Securities." In addition, we agreed that we would register 130% of the
Registrable Securities. As such, we are registering an additional 635,842
shares. In total, we are registering 2,755,314 shares for resale by the selling
stockholders.
We granted the investors a right of first refusal to participate in our
future offerings of our common stock or equivalent securities for a period of
one year after the effective date of the registration statement. If we enter
into any financing transactions during the one year period after the
registration statement is effective, of which this Prospectus is a part, 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 this offering.
Additionally, we can not:
o sell any of our securities in any transactions which are based on
the trading price of our common stock at any time after the initial
issuance of such securities or
o sell any securities which grant investors the right to receive
additional shares based on future transaction of our company 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 equity. Furthermore,
we agreed not to sell any capital stock or capital stock equivalents for a
period of 90 days after the effective date of this registration statement.
We amended the convertible debenture agreements to increase the
interest rate to 8.5% effective as of February 9, 2004 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 our new lender, (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, the fair market value of the
Company's common stock on February 9, 2004, the date of the grant. The fair
value of these warrants as calculated pursuant to Statement No. 123 is $30,981
and has been expensed as other operating expenses in the accompanying statements
of operations.
In connection with this financing, we paid Roth, as placement agent,
cash compensation of 5.5% of the proceeds raised in this offering and granted it
a warrant to purchase 103,896 shares of our common stock at an exercise price of
$4.025 per share. We agreed to register the resale of the 103,896 shares
underlying the warrant issued to Roth.
We have also agreed to register the resale of 40,151 shares issued to
AG Edwards & Sons, Inc. in connection with a settlement agreement that we
entered into with them, effective as of November 17, 2003. AG Edwards served as
our investment advisor from October 8, 2002 through October 8, 2003. See "Legal
Proceedings" on page 45.
This brings the grand total of shares being registered for resale under
this prospectus to 2,795,465.
PLAN OF DISTRIBUTION
The selling stockholders and any of their pledgees, assignees,
transferees, donees and successors-in-interest may, from time to time, sell any
or all of their shares of common stock on any stock exchange, market or trading
facility on which the shares are traded or in private transactions. These sales
may be at fixed or negotiated prices. The selling stockholders may use any one
or more of the following methods when selling shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits purchasers;
o block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block
as principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
14
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately negotiated transactions;
o settlement of short sales;
o broker-dealers may agree with the selling stockholders to sell a
specified number of such shares at a stipulated price per share;
o a combination of any such methods of sale; and
o any other method permitted pursuant to applicable law.
If any of the selling stockholders sell or engage in short sales of our
common stock, it could have a negative effect on our stock price. Each of the
selling stockholders will prior to the effectiveness of the registration
statement advise in writing that they have not since the purchase of the
debentures and will not prior to the effectiveness of the registration statement
make a short sale of our common stock. See "Risk Factors - If investors short
our securities, our stock price may decline" on page 7.
The selling stockholders may also sell shares under Rule 144 under the
Securities Act, if available, rather than under this Prospectus. Broker-dealers
engaged by the selling stockholders may arrange for other brokers-dealers to
participate in sales. Broker-dealers may receive commissions or discounts from
the selling stockholders (or, if any broker-dealer acts as agent for the
purchaser of shares, from the purchaser) in amounts to be negotiated. The
selling stockholders do not expect these commissions and discounts to exceed
what is customary in the types of transactions involved. Broker-dealers may
agree to sell a specified number of such shares at a stipulated price per share,
and, to the extent such broker-dealer is unable to do so acting as agent for us
or a selling shareholder, to purchase as principal any unsold shares at the
price required to fulfill the broker-dealer commitment. Broker-dealers who
acquire shares as principal may thereafter resell such shares from time to time
in transactions, which may involve block transactions and sales to and through
other broker-dealers, including transactions of the nature described above, in
the over-the-counter markets or otherwise at pries and on terms then prevailing
at the time of sale, at prices than related to the then-current market price or
in negotiated transactions. In connection with such resales, broker-dealers may
pay to or receive from the purchasers such shares commissions as described
above.
The selling stockholder may from time to time pledge or grant a
security interest in some or all of the shares of common stock owned by them
and, if they default in the performance of their secured obligations, we will
file a supplement to this Prospectus to list the pledgees and/or secured parties
as selling stockholders. Furthermore, if the selling stockholders assign or
transfer their shares of our common stock, we will file a supplement to this
Prospectus to list the pledgees, transferees and other successors-in interest as
selling stockholders.
The selling stockholders and any broker-dealers or agents that are
involved in selling the shares may be deemed to be "underwriters" within the
meaning of the Securities Act in connection with such sales. In such event, any
commissions received by such broker-dealers or agents and any profit on the
resale of the shares purchased by them may be deemed to be underwriting
commissions or discounts under the Securities Act. The selling stockholders have
informed us that none of them have any agreement or understanding, directly or
indirectly, with any person to distribute the common stock.
The selling stockholders, their affiliates and any other persons
participating in the sale or distribution of the shares offered under this
Prospectus will be subject to applicable provisions of the Securities Exchange
Act of 1934, and the rules and regulation under that act, including without
limitation, Regulation M. Regulation M applies to activities of the selling
stockholders and their affiliates that may be considered a "distribution," which
is an offering of securities, whether or not subject to a registration under the
Securities Act of 1933, what is distinguished from ordinary trading transactions
by the magnitude of the offering and the presence of special selling efforts and
selling methods by the selling security holders of their affiliates may cause
the shares offered by those selling stockholders to be considered a distribution
under Regulation M.
If the selling stockholders or their affiliates are considered to be
involved in a "distribution" with respect to shares of our common stock they
will be prohibited from directly or indirectly bidding for, purchasing or
15
attempting to induce any person to bid for or purchases shares of common stock
offered under this Prospectus during the applicable restricted period, which is
the period beginning on the later of five business day prior to the
determination of the offering price of the shares of common stock offered under
this Prospectus or such time that a person becomes a distribution participant,
and ending upon such person's completion of participation in the distribution.
The provisions described above may restrict certain activities
including stabilizing activities by the selling stockholders and their
affiliates or any other person participating in the sale or distribution of
shares offered under this Prospectus, and may limit the timing of purchases and
sales of any of the shares by the selling stockholders, their affiliates or any
other such person. Furthermore, under Regulation M, persons engaged in a
distribution of securities are prohibited from simultaneously engaging in market
making and certain other activities with respect to such securities for a
specified period of time prior to the commencement of such distributions,
subject to specified exceptions or exemptions. All of these limitations may
affect the marketability of the shares of common stock offered under this
Prospectus.
We will make copies of this Prospectus available to the selling
stockholders and have informed them of the need for delivery of copies of this
Prospectus to purchasers at or prior to the time of any sale of the shares. We
are required to pay all fees and expenses incurred by our company incident to
the registration of the shares. We have agreed to indemnify the selling
stockholders against certain losses, claims, damages and liabilities, including
liabilities under the Securities Act.
MARKET PRICES OF COMMON STOCK
Our common stock currently trades on the American Stock Exchange under
the symbol "SMD." We began trading on the AMEX on March 8, 2001. From January
26, 1996 through March 7, 2001, we traded on the National Association of
Securities Dealers, Inc.'s OTC Bulletin Board under the symbol "SING". Set forth
below is the range of high and low information for our common stock as traded on
the American Stock Exchange for fiscal 2002, 2003 and the nine months ended
December 31, 2003, as reported by Commodity Systems, Inc. This information
regarding trading on AMEX represents prices between dealers and does not reflect
retail mark-up or markdown or commissions, and may not necessarily represent
actual market transactions. This information contained in this table has been
restated to give effect to our 3-for-2 stock split to stockholders of record on
March 4, 2002.
FISCAL PERIOD HIGH LOW
------------- ---- ---
2004:
First Quarter (April 1 - June 30, 2003) $7.94 $2.85
Second Quarter (July 1 - September 30, 2003) $5.03 $2.70
Third quarter (October 1 - December 31, 2003) $13.49 $2.15
Fourth quarter (January 1 - March 31, 2004) $ 2.43 $2.14
2003:
First quarter (April 1 - June 30, 2002) $16.89 $12.06
Second quarter (July 1 - September 30, 2002) 12.74 8.05
Third quarter (October 1 - December 31, 2002) 13.49 8.50
Fourth quarter (January 1 - March 31, 2003) 9.19 5.30
2002:
First Quarter (April 1 - June 30, 2001) $ 4.45 $ 2.90
Second Quarter (July 1 - September 30, 2001) 5.02 3.70
Third Quarter (October 1 - December 31, 2001) 16.19 4.30
Fourth Quarter (January 1 - March 31, 2002) 17.80 12.53
As of March 31, 2004, our closing price was $1.17 per share. As of February 27,
2004, there were 295 record holders of our outstanding common stock. On March
14, 2002, we effected a 3-for-2 stock split for all stockholders of record on
March 4, 2002.
16
DIVIDEND POLICY
We do not anticipate the declaration or payment of any dividends in the
foreseeable future. We have never declared or paid cash dividends on our common
stock and our Board of Directors intends to continue its policy for the
foreseeable future. Furthermore, our factoring agreement with Milberg restricts
us from paying any dividends to our shareholders, unless we obtain prior written
consent from Milberg. Also, we will consider our earnings, financial condition,
contractual restrictions and other factors in deciding whether to issue
dividends in the future. Under Delaware law, we are prohibited from declaring
dividends unless we have legally available surplus, as such term is defined
under Delaware law. Alternatively, if we do not have legally available surplus,
we can pay dividends out of our net profits in the fiscal year in which the
dividend is declared.
17
SELECTED FINANCIAL INFORMATION AND OTHER DATA
The selected financial information set forth below is derived from, and
should be read in conjunction with, the more detailed financial statements
(including the notes thereto) appearing elsewhere in this Prospectus. See
"Consolidated Financial Statements."
INCOME STATEMENT ITEMS
YEAR ENDED MARCH 31,
2003 2002* 2001* 2000 1999
------ ------ ------ ------ -----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net Sales 95,614 62,476 34,875 19,032 9,548
Cost of Sales 72,329 40,853 22,159 13,727 7,029
Total Operating Expenses 21,671 13,388 7,689 3,779 1,545
Earnings (Loss) From Operations 1,614 8,235 5,028 1,526 974
Net Other (Expenses) Income (198) (51) (840) 948 220
Income Tax (Benefit) Expense 199 1,895 492 160 170
Net Earnings (Loss) 1,218 6,289 3,696 738 924
Net Earnings (Loss) per common 0.15 0.88 0.59 0.23 0.37
share basic
Net Earnings (Loss) per common 0.14 0.79 0.50 0.19 0.36
share diluted
Shares used in computing net 8,114 7,159 6,292 2,726 2,475
earnings (loss) per common share -
basic
Shares used in computing net 8,931 7,943 7,457 3,342 2,592
earnings (loss) per common share -
diluted
----------
*As Restated
THREE MONTHS ENDED SIX MONTHS ENDED NINE MONTHS ENDED
------------------ ---------------- -----------------
JUNE 30, SEPTEMBER 30, DECEMBER 31,
2003 2002* 2003 2002* 2003 2002*
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net Sales 7,628 4,292 39,364 36,256 68,054 81,915
Cost of Sales 5,902 2,990 34,166 27,527 65,457 64,155
Total Operating Expenses 3,860 2,639 8,548 5,101 13,615 9,109
Earnings (Loss) From Operations (2,134) (1,333) (3,387) 3,628 (11,019) 8,652
Net Other (Expenses) Income (181) 24 590 52 (1,245) (20)
Income Tax (Benefit) Expense 2,315 1,309 1,003 993 1,161 2,675
(118)
Net Earnings (Loss) (2,317) (1,191) 2,974 2,688 (13,425) 5,957
Net Earnings (Loss) per common (0.28) (0.35) (1.58)
share basic (0.18)15) (0.33) 0.74
Net Earnings (Loss) per common (0.28) (0.35) (1.58)
share diluted (0.18)15) (0.30) 0.67
Shares used in computing net 8,278 8,061 8,389 8,090 8,503
earnings (loss) per common share 8,101
- basic
Shares used in computing net 8,278 8,061 8,387 8,889 8,503 8,948
earnings (loss) per common share
- diluted
----------
*As Restated
18
BALANCE SHEET AND OTHER ITEMS
YEAR ENDED MARCH 31,
2003 2002* 2001* 2000 1999
---- ----- ----- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Cash (excluding restricted cash) 268 5,520 1,016 379 49
Total current assets 36,565 19,947 9,016 3,789 1,813
Working capital 15,315 14,770 7,425 399 13,084
Total Assets 38,936 21,403 10,510 4,347 2,379
Inventory 25,194 9,274 4,813 1,487 410
Current liabilities 21,450 5,178 1,591 441 1,415
Long term obligations 0 0 0 -- --
Total shareholders' equity 17,685 16,225 8,918 3,900 965
----------
*As Restated
JUNE 30, SEPTEMBER 30, DECEMBER 31,
2003 2002* 2003 2002* 2003 2002*
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Cash (excluding restricted 86 21,465 1,106 658 236 363
cash)
Total current assets 35,075 20,152 46,948 48,764 27,267 53,341
Working capital 13,085 13,522 17,536 17,248 8,275 20,740
Total Assets 37,566 21,747 49,995 50,581 29,604 54,940
Inventory 25,960 12,941 20,563 31,382 8,029 30,017
Current liabilities 21,990 6,630 29,412 31,516 18,992 32,601
Long term obligations -- -- 595 -- 954 --
Total shareholders' equity 15,576 15,116 19,988 19,065 9,658 22,338
----------
*As Restated
19
SELECTED QUARTERLY FINANCIAL DATA
QUARTERLY FISCAL 2004
UNAUDITED UNAUDITED UNAUDITED
3 MONTHS 3 MONTHS 3 MONTHS
ENDED ENDED ENDED
JUNE 30, 2003 SEPTEMBER 30, 2003 DECEMBER 31, 2003
Net Sales $7,379,866 $31,984,251 $28,689,622
Gross Profit $1,394,036 $3,803,539 ($2,601,126)
Net Loss ($2,317,352) ($656,669) ($9,942,122)
Net Loss Per Share
(basic & diluted) $(0.28) $(0.08) $(1.14)
QUARTERLY FISCAL 2003
UNAUDITED UNAUDITED UNAUDITED UNAUDITED
3 MONTHS 3 MONTHS 3 MONTHS 3 MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2002 SEPTEMBER 30, 2002 DECEMBER 31, 2002 MARCH 31, 2003
------------- ------------------ ----------------- --------------
Net Sales $ 4,264,203 $ 33,044,306 $ 49,102,372 $ 9,202,885
Gross Profit $ 1,273,322 $ 9,754,954 $ 14,525,191 $ (2,268,736)
Net Earnings (loss) $ (1,358,780) $ 4,837,926 $ 3,846,894 $ (6,108,228)
Net Earnings (loss)
Per Share (basic) (0.17) 0.60 0.47 (0.75)
Per Share (diluted) (0.18) 0.55 0.48 (0.75)
QUARTERLY FISCAL 2002
UNAUDITED UNAUDITED UNAUDITED UNAUDITED
3 MONTHS 3 MONTHS 3 MONTHS 3 MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, 2001* SEPTEMBER 30, 2001* DECEMBER 31, 2001* MARCH 31, 2002
------------- ------------------ ----------------- --------------
Net Sales $ 5,523,228 $ 15,797,752 $ 34,324,556 $ 6,780,217
Gross Profit $ 1,923,199 $ 5,408,430 $ 11,884,855 $ 2,406,429
Net Earnings (loss) $ (470,447) $ 1,881,321 $ 5,444,081 $ (565,890)
Net Earnings (loss)
Per Share (basic) (0.07) 0.28 0.74 (0.07)
Per Share (diluted) (0.07) 0.25 0.65 (0.07)
----------
*As Restated
20
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We are engaged in the development, production, distribution, marketing
and sale of consumer karaoke audio equipment, accessories and music. We also
produce and market karaoke music, including CD plus graphics ("CD+G's"), and
audiocassette tapes containing music and lyrics of popular songs for use with
karaoke recording equipment. We sell our products under our Singing Machine(R)
trademark and with have licensing agreements with MTV Networks, Nickelodeon,
Hard Rock Academy, The Joester Loria Group ("Care Bears") and Universal Music
Entertainment ("Motown").
We faced several challenges during our fiscal year ended March 31,
2003. Although our net sales increased to $95,613,766 in the twelve months ended
March 31, 2003 ("fiscal 2003") compared to net sales of $62,475,753 in the
twelve months ended March 31, 2002 ("fiscal 2002"), our net income decreased to
$1,217,812 or $.15 per share in fiscal 2003 compared with net income of
$6,289,065 in fiscal 2002 or $.88 per share. Several factors contributed to this
decrease in net income, including but not limited to a loss on a guaranteed
gross profit agreement of approximately $2.5 million, an inventory reserve
charge of approximately $3.7 million, higher than expected operating expenses of
$21.6 million in fiscal 2003 and income tax expense of $198,772.
In fiscal 2003, we entered into a guaranteed gross profit agreement
with Transworld Entertainment Company ("Transworld"), a specialty music
retailer. We guaranteed Transworld that it would earn a minimum gross profit of
$3,573,000 from the sale of our karaoke products during the period between
September 1, 2002 through January 15, 2003. Under this agreement, we agreed to
pay Transworld the difference between the gross profit earned on its sales of
our karaoke products and the minimum guarantee. When our guaranteed profit
agreement with Transworld expired on January 15, 2004, Transworld had not
realized the minimum guarantee of gross profit and we paid them $2.5 million,
which was recorded in the fourth quarter of fiscal 2003 as a reduction of
revenue.
At the end of fiscal 2003, our inventory level was much higher than we
had expected. As of March 31, 2003, we had inventory on hand of $25 million. We
determined that due to liquidation sales, inventory would be sold at a loss;
therefore, a decrease in the value of these specific items was made. The total
amount of the provision for inventory was $3,715,357.
As a result of these factors, our net worth declined to a level which
took us out of compliance with a tangible net worth requirement contained in our
credit facility with LaSalle. In March 2003, LaSalle notified us that we were in
default of this requirement and that it could accelerate our loan at any time.
Due to the liquidity difficulties associated with the excess inventory exposure
and LaSalle's notice of default, we received a going concern uncertainty
paragraph on our audited financial statements for fiscal 2003. In their report
dated June 24, 2003, our independent certified public accountants stated that
our event of default under our credit agreement with LaSalle raised substantial
doubt about our ability to continue as a going concern. At December 31, 2003, we
again violated the tangible net worth covenant of the agreement. We paid off the
loan on January 31, 2004, terminated the agreement and LaSalle released their
security interest in our assets.
Since June 24, 2003, the date of the audit report, we have taken
several steps to increase our liquidity. In July 2003, we raised $1 million in
subordinated debt financing from an investment group composed of Yi Ping Chan,
our Chief Operating Officer, Jay Bauer, a director, Howard Moore, a former
director and Maureen LaRoche, an associate of Mr. Bauer and secured a $1 million
standby letter of credit from an unrelated third party. See "Certain Related
Transactions" on page 48. In August 2003, LaSalle extended our credit facility
until March 31, 2004. Effective as of September 8, 2003, we raised $3.75 million
in net proceeds in a private offering from certain institutional investors.
These funds were submitted directly to LaSalle to pay down our outstanding line
of credit. For more information about this private offering, please see "Selling
Stockholders - Circumstances in which Selling Stockholders Acquired the Shares"
on page 13.
We also made a decision to restate our financial statements for the
fiscal year ended March 31, 2002 and 2001 to increase the accrual for income
taxes. The restatement did not change reported revenue, gross margin or pre-tax
income for fiscal 2002 or fiscal 2001.
21
RESTATEMENT OF FINANCIAL STATEMENTS FOR FISCAL 2002 AND 2001
In June 2003, our management revised its position on taxation of the
income of International SMC (H.K.) Ltd., our Hong Kong subsidiary, by the United
States and by the Hong Kong tax authorities for the reasons stated below.
With regard to taxation in Hong Kong, International SMC had previously
applied for a Hong Kong offshore claim income tax exemption based on the
locality of its profits in China. Management believed, based on advice from its
then Hong Kong based independent certified public accountants, who audited the
wholly-owned subsidiary for Hong Kong statutory purposes, that the exemption
would be approved because the source of all profits of International SMC was
from exporting to customers outside of Hong Kong. Accordingly, no provision for
income taxes was provided in the consolidated financial statements as of March
31, 2002 and 2001. However, full disclosure was previously reflected in the
audited financial statements for the fiscal years ended March 31, 2002 and 2001
of the estimated amount that would be due to the Hong Kong tax authority should
the exemption be denied. In June 2003, we revised our position on the taxation
of the income of International SMC because we received different advice from our
new independent certified public accountants. We dismissed our former
independent certified public accountant on March 24, 2003 and engaged our new
independent certified public accountants effective as of March 27, 2003.
Management is continuing its exemption application process. However,
due to the extended period of time that the application has been outstanding, as
well as management's reassessment of the probability that the application will
be approved, management has decided to restate the 2002 and 2001 consolidated
financial statements to provide for such taxes. The effect of such restatement
is to increase income tax expense by $748,672 and $468,424 in fiscal 2002 and
2001, respectively. However, we can claim United States foreign tax credits in
2002 for these Hong Kong taxes, which is reflected in the final restated
amounts.
With regard to United States taxation of foreign income, in fiscal 2002
and 2003 we had taken the position that the foreign income of International SMC
was not taxable under the Internal Revenue Code (Section 956) until such income
is repatriated, or brought back into the United States as taxable income. The
basis of this position was primarily due to the fact that the amount of income
in question was very low and fully repaid within a reasonable time after the
original loan dates as allowable under Section 956, thus a deemed dividend had
not occurred. It was expected that this income would remain in Hong Kong. Full
disclosure of the amount and nature of the indefinite deferral for the income of
International SMC for fiscal year 2002 was reflected in the income tax footnote
of the consolidated financial statements for that year. Our new independent
certified public accountants questioned this treatment and management decided to
restate the income tax expense to treat the advances as deemed dividends. The
effect of such restatement is to increase income tax expense by $1,027,545 in
fiscal year 2002, which includes the utilization of the foreign tax credits
referred to above.
The net effect of the above two adjustments for the quarter and nine
months ended December 31, 2002 is to decrease net income by $576,060 and
$1,517,983, respectively. The net effect on net income per share is to decrease
net income per share basic and diluted by $0.07 and $0.06 for the quarter and
$0.18 and $0.17 for the nine months ended December 31, 2002.
SUMMARY
The net effect of the above two adjustments is to decrease our net
income by $1,776,217 and $468,424 in fiscal 2002 and 2001. The net effect on
basic and diluted earnings per share is a decrease of $0.25 and $0.23,
respectively for fiscal 2002; decrease of $0.07 and $0.06, respectively for the
fiscal year 2001, and increase $0.01 and $0.01, respectively for the three
months ended June 30, 2002.
As restated, our income taxes increased from $119,277 in fiscal 2002 to
$1,895,494 and from $23,320 in fiscal 2001 to $491,744 and consequently our net
income decreased correspondingly. The restatements do not change our reported
revenue, gross margin or pre-tax income for fiscal 2002 or fiscal 2001.
22
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain
income and expense items expressed as a percentage of the Company's total
revenues:
Nine Months Ended Fiscal Year Ended March 31,
December 31, 2003 2003 2002 2001
Total Revenues 100.0% 100.0% 100.0% 100.0%
Cost of Sales 96.1% 75.6% 65.4% 63.5%
Operating expenses 19.3% 22.7% 21.4% 22.1%
Operating income -15.4% 1.7% 13.2% 14.4%
Other expenses, net 1.9% 0.2% 0.1% 2.4%
Income before taxes -17.3% 1.5% 13.1% 12.0%
Provision (benefit) for income taxes 1.7% 0.2% 3.0% 1.4%
Income (loss) -19.0% 1.3% 10.1% 10.6%
NINE MONTHS ENDED DECEMBER 31, 2003 COMPARED TO
NINE MONTHS ENDED DECEMBER 31, 2002
Net Sales
Net sales for the nine months ended December 31, 2003 decreased 16.9%
to $68,053,739 as compared to $81,915,443 for the nine months ended December 31,
2002. Sales to international customers increased $14.6 million over the same
period in the prior year, as sales in the United States decreased $33.7 million.
New customers and increased purchases by existing customers contributed to the
increase in the European market. Our sales in the United States decreased
primarily because of the increased competition in this market. Approximately
$5.6 million of this decrease is from the music sector of our business. We lost
one significant customer and had reduced sales in two other major retailers. A
portion of the decreased sales in the United States can be attributed to
advertising allowances accrued for customers. Advertising allowances consist of
co-operative advertising, marketing development funds and specific advertising.
These allowances are variable and are negotiated every year and since there is
no separate and identifiable benefit to the company, such amounts are recorded
as a reduction of sales
Gross Profit
Gross profit for the nine months ended December 31, 2003 was $2,596,449
or 3.8% of sales as compared to $17,760,348 or 21.7% of sales for the nine
months ended December 31, 2002.
The decrease in gross profit during the nine months ended December 31,
2003 is a result of:
- Competitive pricing pressure on machine pricing
- Sales of excess inventory at significantly reduced prices
- A 31% decline in the sales of higher margin music
- A reserve against the value of inventory on hand at December 31, 2003, in the
amount of $4,998,126 for our anticipated recovery value
- An impairment charge for tools in the amount of $508,480
- Increased sales from International SMC to international and domestic
customers. These sales usually carry lower gross margins, as the customer pays
for the ocean freight and clearance of the goods.
- Increased expense of the guaranteed minimum royalty on our MTV license of
$998,000.
23
Even though we have taken a reserve that we believe is sufficient to
cover any losses against the value of inventory, there can be no assurance that
we will be able to recover its remaining value through sales of the products.
Any additional reduction that may be necessary may have a material impact in
future periods. As we continue to reduce the amount of inventory in our
warehouses, we anticipate gross margins to remain low.
Operating Expenses
Operating Expenses increased over the same period in the prior year to
$13.6 million from $11.5 million. The primary reasons for the increase in
operating expenses are as follows:
i) Increases in total cash and stock compensation of $724,895
ii) Increases in bad debt expense and at the wholly-owned Hong Kong subsidiary
of $392,000
iii) Increases with respect to the need to warehouse the excess inventory
carried over from March 2003 totaling $492,119
iv) Increases paid for legal and accounting fees totaling $626,185
v) Increased costs related to the amendments required to secure the financing
from LaSalle and related consulting costs totaling $432,223
vi) Increases in bad debts for the domestic operations attributable to the KB
Toys and FAO bankruptcy filings of $263,289
vii) Increase in charitable contributions, insurance and fixing fees associated
with the production of music and customer service totaling $304,134
viii) Offset by a decrease to direct advertising $697,119 and decreases in
freight to customers of $452,092
Other Expenses
Other expenses were $1,245,424 for the nine months ended December 31,
2003 compared to net other expenses of $20,006 at December 31, 2002. Our
interest expense increased by $965,944 during the nine months ended December 31,
2003 compared to interest expense in the same period of the prior year. Our
interest expense increased due to the increased use of our credit facility at a
higher interest rate than the prior year, as well as the amortization of
deferred expenses associated with the convertible debentures. The remaining
$259,474 is attributable to other miscellaneous expenses such as exchange
differences.
Income Taxes
Significant management judgment is required in developing our provision
for income taxes, including the determination of foreign tax liabilities,
deferred tax assets and liabilities and any valuation allowances that might be
required against the deferred tax assets. At December 31, 2003, we concluded
that a valuation allowance was needed against all of our deferred tax assets, as
it is not more likely than not that the deferred taxes will be realized. For the
nine months ended December 31, 2003, we recorded a tax provision of $1.2
million. This occurred because the valuation allowance established against the
deferred tax asset exceeded the amount of the benefit created from carrying back
a portion of the current period losses. The carry-back of the losses from the
current period resulted in an income tax receivable of $1.2 million, which is
included in prepaid and other current assets in the accompanying balance sheets.
We have now exhausted its ability to carry back any further losses and therefore
will not be able to recognize tax benefits on future losses including its
expected fourth quarter loss.
International SMC, has applied for an exemption of income tax in Hong
Kong. Therefore, no taxes have been expensed or provided for at the subsidiary
level. Although the governing body has reached no decision to date, the U.S.
parent company has reached the decision to provide for the possibility that the
exemption could be denied and accordingly has recorded a provision in fiscal
2004, 2003, 2002, and 2001. For the nine months ended December 31, 2003, a
provision of $424,763 was recorded at the Hong Kong statutory rate of 17.5%.
Current Hong Kong taxes payable on the earnings of International SMC totaled
$2.9 million at December 31, 2003.
24
We operate within multiple taxing jurisdictions and is subject to audit
in those jurisdictions. Because of the complex issues involved, any claims can
require an extended period to resolve. In management's opinion, adequate
provisions for income taxes have been made.
Net Loss (Earnings)
As a result of the forgoing, our net loss for the nine months ended
December 31, 2003 was $13,424,622 compared with net income of $5,957,136 for the
nine months ended December 31, 2002.
FISCAL YEAR ENDED MARCH 31, 2003 COMPARED
WITH FISCAL YEAR ENDED MARCH 31, 2002
Net Sales
Net sales for the fiscal year ended March 31, 2003 increased 53.0% to
$95,613,766 compared to $62,475,753 for the fiscal year ended March 31, 2002.
Our growth was driven in large part by the addition of international sales in
Europe, Asia, and Australia. We also generated $30,884,344 million or 32.3% of
our net sales from products sold under the MTV license in fiscal 2003.
Strong sales of our music titles were also driving forces in our
revenue growth for fiscal 2003. In fiscal 2003, our sales of music increased to
$8,894,743 or 9.3% of sales as compared to $6,306,547 or 10.2% in fiscal 2002.
Gross Profit
Gross profit for the fiscal year ended March 31, 2003 was $23,284,731
or 24.4% of sales as compared to $21,622,913 or 34.6% of sales for the fiscal
year ended March 31, 2002. The decrease in gross margin compared to the prior
year is due primarily to the following factors: (i) increased sales from
International SMC both to domestic and international customers; (ii) a write
down of the value of inventory and (iii) a reduction of sales due to a
guaranteed gross profit agreement with Transworld.
International sales were primarily in Europe, Canada and Australia.
Sales to international customers historically maintain lower selling prices, and
thus, a lower gross profit margin. The main reason for this is that the sales
are made to distributors in those countries and there are no additional variable
expenses. Other variable expenses that are seen in conjunction with U.S. sales
are advertising allowances, handling charges, returns and commissions.
In fiscal 2003, we entered into a guaranteed gross profit agreement
with Transworld, a specialty music retailer. We guaranteed Transworld that it
would earn a minimum gross profit of $3,573,000 from the sale of our karaoke
products during the period between September 1, 2002 through January 15, 2003.
Under this agreement, we agreed to pay Transworld for the difference between the
gross profit earned on its sales of our karaoke products and the minimum
guarantee. As of the settlement date of the contract, Transworld had not
realized the minimum guarantee of gross profit. As such, we had to provide them
with a check in the amount of $2.5 million, which was recorded in the fourth
quarter of fiscal 2003 as a reduction to revenue.
At the end of fiscal 2003, our inventory level was much higher than we
had expected. As of March 31, 2003, we had inventory on hand of $24 million. We
determined that due to liquidation sales, inventory would be sold at a loss;
therefore, a decrease in the value of specific inventory items was made. The
total amount of the provision for inventory was $3,715,357.
Gross profit may not be comparable to those of other entities, since
some entities include the costs of warehousing, inspection, freight charges and
other distribution costs in their cost of sales. We account for the above
expenses as operating expenses and classify them under selling, general and
administrative expenses.
Operating Expenses
Operating expenses were $21,670,501 or 22.7% of total revenues in
fiscal 2003, up from $13,387,533 or 16.1% of total revenues, in fiscal 2002. The
primary factors that contributed to the increase of approximately $8.3 million
in operating expenses for the fiscal year 2003 are:
25
o increased advertising expenses of $2,654,729 due to increased use of
our outside advertising agency to oversee more advertising projects for
us, the production of a television commercial, as well as cooperative
advertising with customers, which is variable based on the level of
sales
o the increase in depreciation in the amount of $239,686 due to the
addition of molds for new product additions for fiscal year 2003,
o compensation expense in the amount of $1,151,012 due to the addition of
key personnel in Florida, at our California facility and at
International SMC, which include the executive vice-president of sales,
sales administration, music licensing coordinator, and music production
personnel, as well as warehouse employees and repair personnel.
o increased freight and handling charges to customers in the amount of
$869,525,
o expansion of the California warehouse and its associated expenses in
the amount of $873,919,
o expansion of International SMC's operations and its related expenses,
in the amount of $580,906.
o increases in product development fees for the development of future
product in the amount of $571,370.
Other increases in operating expenses were to selling expenses, which
are considered variable. These expenses are based directly on the level of sales
and include royalty expenses and commissions. We also incurred $79,000 of
expenses for catalogue expenses and show expenses. These expenses are not
variable and do not change based on the level of sales. Show expenses are costs
that are associated with the Consumer Electronics Show and Toy Fair, such as
promotional materials, show space and mock up samples.
As a result of the merchandise license agreements and minimum guarantee
requirements, we expect royalty expense to increase in fiscal 2004. Our
agreement with MTV contains a minimum guaranteed royalty payment of $1.5 million
by December 31, 2003. Because we will not meet this minimum guaranteed royalty
payment, we have expensed additional royalty expense and will continue to do so
until December 31. We expect a minimum of $500,000 of royalty expense over last
year.
Our advertising expense increased $2,654,729 for the fiscal year ended
March 31, 2003 as compared to fiscal 2002. Advertising expense consists of two
components: co-operative advertising and direct advertising expense.
Co-operative advertising is paid directly to the customer and is based directly
on the amount of sales. The customer provides copies of advertising on which
these funds are spent, but has complete discretion as to the use of these funds.
These funds are placed in a general budget with the customer and used for weekly
advertising and promotions. Co-operative advertising expenses accounted for
$2,320,705 of the increase in advertising expenses. In fiscal 2002, we embarked
on our first television advertising and continued with the use of print
advertising, radio spots, sponsorships, promotions and other media. This is
considered direct advertising, whereby we actually contract for advertising of
the product. The increased costs for our advertising firm were $334,024 over the
prior year. The expense for direct advertising is at our discretion and is not
variable based on the level of sales attained. Both of these types of
advertising are direct expenses of the Company.
Depreciation and Amortization
Our depreciation and amortization expenses were $634,142 for the fiscal
year ended March 31, 2003 as compared to $394,456 for the fiscal year ended
March 31, 2002. The increase in depreciation and amortization expenses can be
attributed to the Company's acquisition of new molds and tooling for our
expanded product line, as well as minimal costs for additional computer
equipment and furniture for additional personnel.
Other Expenses
Net other expenses were $197,646 for the fiscal year ended March 31,
2003 as compared with net other expenses of $50,821 for the fiscal year ended
March 31, 2002. Our interest expense increased during the fiscal year ended
March 31, 2003 compared to the same period of the prior year primarily due to
our increased borrowings under our credit facility with LaSalle during this
period. Prior to August 2002, we had cash reserves to fund operations and did
not need to borrow under our revolving credit facility. However, in August 2002,
we began borrowing our credit facility with LaSalle. Our interest income
increased from $2,475 during the fiscal year 2002 to $11,943 during the fiscal
year 2003 because we earned interest income on cash balances in our disbursement
account, at LaSalle, by investing in 24 hour commercial paper investments. We
expect interest expense to increase in fiscal 2004 as compared to prior years
due to the credit facility accruing interest at a higher rate, effective as of
August 19, 2003 when we entered into the Fourteenth Amendment to our credit
facility. As of December 31, 2003, our credit facility accrued interest at 6.5%,
which is prime plus 2.5%, our former default rate. Since interest is calculated
based on the average monthly balance of the credit facility, we can not
reasonably
26
estimate the degree to which this year's expense will exceed last years. We do
know, however, that the interest spread is 1.75% higher than in the same period
last year.
Income Tax Expense
Our tax expense is based on an aggregation of the taxes on earnings of
International SMC and our domestic operations. Income tax rates in Hong Kong are
approximately 16%, while the statutory income tax rate in the United States is
34%. Our effective tax rate in fiscal 2003 was 14% as compared to 23% in fiscal
2002. This decrease in the effective tax rate is a result of our company
generating a pretax loss in the United States in fiscal 2003, resulting in a tax
benefit, as compared to pretax income in the United States in fiscal 2002. Our
future effective income tax rate will fluctuate based on the level of earnings
of International SMC and our domestic operations.
Net Income
As a result of the foregoing, our net income was $1,217,812 for the
fiscal year ended March 31, 2003 compared to net income of $6,289,065 for fiscal
2002.
FISCAL YEAR ENDED MARCH 31, 2002 COMPARED
TO FISCAL YEAR ENDED MARCH 31, 2001
Net Sales
Net sales for the fiscal year ended March 31, 2002 increased 80.2% to
$62,475,753 compared to $34,875,351 for the fiscal year ended March 31, 2001.
Our growth was driven by strong sales of our MTV licensed merchandise and the
introduction of new karaoke machines and music titles. We generated $23,354,270
million or 37.8% of our net sales from products sold under the MTV license in
fiscal 2002. Our sales of music increased to $6,306,547 or 10.2% of our net
sales in fiscal 2002 compared with $3,087,615 or 9% of our net sales in fiscal
2001.
Gross Profit
Gross profit for the fiscal year ended March 31, 2002 was $21,622,913
or 35% of sales compared to $12,716,300 or 36% of sales for the fiscal year
ended March 31, 2001. The decrease in gross margin compared to the prior year is
due to the realization of volume discounts by our largest customers. These
volume discounts were calculated based on the amount of purchases we received
from the customer and were subject to written agreements with them. Our largest
customers purchased a greater dollar amount of goods in fiscal 2002, but on a
percentage basis the discounts given to our largest customers in fiscal 2002 and
fiscal 2001 stayed relatively constant at 1.5% and 1%. The volume discounts were
offset to some degree by reduced prices that we paid our factories for our
karaoke machines because of our increased purchases. As our customers receive
volume rebates, we in turn receive volume incentive rebates from our factories
based on the amount of purchases made from them during certain time periods. We
negotiated these volume discounts with our factories in our purchasing
agreements in May 2002, when we began placing our orders for fiscal 2002.
Gross profit may not be comparable to those of other entities, since
some entities include the costs of warehousing, inspection, freight out and
other distribution costs in their cost of sales. We account for the above
expenses as operating expenses and classified them under selling, general and
administrative expenses
Operating Expenses
Operating expenses increased to $13,387,533, or 21% of sales, for the
year ended March 31, 2002 from $7,688,707, or 22% of sales, for the year ended
March 31, 2001. This increase in operating expenses was primarily attributed to
the increase in expenses associated with: (1) the opening of our Hong Kong
office, (2) our first advertising campaign and (3) certain expenses which are
considered variable as they relate directly to the level of our sales.
In December 2000, International SMC opened a Hong Kong office. For the
fiscal year ended March 31, 2002, this office incurred SG&A expenses of
approximately $1,144,734 compared to $418,618 in the prior year. By opening this
office, we saved the manufacturers agency fees, which were paid on each shipment
in prior years. Prior to opening the office, we had incurred an agency fee of
3-5% of each shipment of goods from Hong Kong paid to an outside company. The
outside agency was responsible for maintaining shipping files and coordinating
shipment of our products for this fee. By opening our own office in Hong Kong ,
our employees provided the services that had previously been provided by our
agent. We had fixed overhead expenses every month, as opposed to per shipment
agency fees. We realized the greatest benefit from our Hong Kong office in the
third quarter of fiscal 2002, when we purchased the largest amount of inventory.
27
Our advertising expense increased to $2,377,638 for the fiscal year
ended March 31, 2002 compared to $921,359 for the fiscal year ended March 31,
2001. Advertising expense consists of primarily two components: co-operative
advertising and direct advertising expense. Co-operative advertising is paid
directly to the customer and is based directly on the amount of sales. These
funds are placed in a general budget with the customer and used for weekly
advertising expenses and promotions. The customer has complete discretion as to
the use of these funds and provided us with proof of how the advertising money
is spent. Co-operative advertising expenses accounted for $972,000 of the
increase in advertising expenses. In fiscal 2002, we embarked on our first
formal advertising campaign, which used print advertising, radio spots,
sponsorships, promotions and other media. We contracted with an advertising
agency, who coordinated this effort. In the past, we relied only on our
customer's co-operative advertising. The cost for this formal advertising
campaign was approximately $484,000 and this is a direct advertising expense.
Other expenses, termed variable expenses, contributed to the increase
in operating expenses. These expenses included royalty expense, sales
commissions, warehouse expenses, and travel. The largest increase can be seen in
royalty expense, which increased approximately $1,713,000 over the prior year,
primarily from the sale of items under the MTV licensing agreement. Our
commissions payable to our independent sales representatives are based on sales
volume and increased by $457,000 during fiscal 2002, because of increased sales.
Our warehouse related expenses also increased by $478,000. These expenses are
due to the increased importing of our karaoke machines from Hong Kong.
Compensation expenses increased $569,935. We grew from 22 employees at March 31,
2001 to 47 employees at March 31, 2002.
Depreciation and Amortization
Our depreciation and amortization expenses were $394,456 for the fiscal
year ended March 31, 2002, up from $301,064 in the prior year. The increase in
depreciation and amortization expenses can be attributed to our acquisition of
new fixed assets during fiscal 2002, which included computers, furniture and
other equipment in all of our locations in Florida, California and Hong Kong. It
also included the addition of new molds for our expanded product line. The
amortization expense includes the amortization of a fee paid to LaSalle for our
line of credit facility and the amortization of remaining deferred guarantee
fees related to the factoring agreement we terminated in April 2001.
Other Expenses
Net other expenses were $50,821 for the fiscal year ended March 31,
2002 compared with net other expenses of $839,572 for the fiscal year ended
March 31, 2001. We had a large decrease in these miscellaneous items primarily
because of the elimination of factoring fees and a decrease in interest expense
resulting in a net decrease of $543,279. Our interest expense decreased because
we terminated our factoring agreement in April 2001 and replaced it with a lower
cost credit facility with LaSalle Business Credit. The LaSalle agreement accrues
interest at prime plus .75%, which is the same interest paid under the factoring
agreement. The LaSalle agreement enables us to borrow on all eligible
receivables and inventory pursuant to the agreement with no additional fees. We
also began to generate income from royalty payments received in Hong Kong for
the use of certain of our molds for karaoke machines by certain third party
customers of our manufacturers. We allow our factories to rent our molds to
their customers with our written approval. The rental fee for these molds are
paid to us in the form of royalty payments and are calculated based on the
number of units produced from our molds. We will use this income to offset other
expenses, including the development of molds.
Income Before Income Tax Expense
Our income before income taxes increased 95.4% to $8,184,559 for the
fiscal year ended March 31, 2002, compared to $4,188,021 for the fiscal year
ended March 31, 2001. This increase in profit is due primarily to the increase
in sales.
Income Tax Expense
Our income tax expense was restated for fiscal 2002. Our accrual for
income taxes is based on primarily two components: (i) taxes of $1,027,545 which
we are paying pursuant to Section 956 of the Internal Revenue Code on an
intercompany loan and (ii) taxes of $748,672 for International SMC's business
operations in Hong Kong. The total income tax expense for fiscal 2002 was
$1,895,494. For more information about these taxes, please see "Management's
Discussion and Analysis of Financial Condition - Restatement" on page 22.
Net Income
As a result of the foregoing, our net income increased 41.3% to
$6,289,065 for the fiscal year ended March 31, 2002, compared to $3,696,277 for
the fiscal year ended March 31, 2001.
28
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003, we had cash on hand of $235,958 and a bank
overdraft of $85,236 compared to cash on hand of $268,265 and a bank overdraft
of $316,646 at March 31, 2003. Our current assets consist predominantly of
accounts receivable and inventory. Our accounts receivable increased to
$14,729,176 for the nine months ended December 31, 2003 due to the amount of
sales that occurred in November and December, as well as some customer terms
which exceed 45 days.
Our inventory has been steadily decreasing since March 31, 2003,
because we are shipping goods to our customers and have taken write downs for
our inventory in the aggregate amount of $4,559,143 since March 31, 2003. As of
December 31, 2003, we had $8 million in inventory, net of a provision for loss
of $6,195,197 compared to $25 million as of March 31, 2003.
Our current liabilities decreased to $18,911,314 as of December 31,
2003, compared to $21,249,930 at March 31, 2003. Current liabilities consist of
accounts payable of $5,329,648, accrued expenses of $2,587,567, accrual for
income taxes of $2,872,509, subordinated debt of $1 million, bank overdraft of
$85,136 and the revolving credit facilities of $7,115,114. The revolving credit
facilities were composed of our borrowing under the LaSalle agreement of
$2,474,386 and borrowings under credit facilities at HSBC and Fortis Banks in
Hong Kong in the amount of $4,640,728.
Approximately $2.7 million or 51% of our accounts payable are due to
two factories in China. This amount is aged beyond the terms originally set by
the factories. We have been in contact with these factories regarding these
amounts and have discussed informal payment plans with them. We intend to enter
into written payment plans with these factories, but cannot ensure that this
will occur. As of March 1, 2004, none of the factories have taken any legal
actions against us to collect the amounts that are due and outstanding. If these
factories pursue any claims against us, it could have a material effect on our
operations. The remainder of accounts payable of $2.6 million are within terms
set by our vendors.
During fiscal 2003, we had a credit facility with LaSalle Business
Credit, LLC. Under this agreement, LaSalle advanced funds to us based on our
eligible accounts receivable and inventory. The loan was secured by a first lien
on all of present and future assets, except specific tooling located in China.
During fiscal 2004, the maximum amount that we were permitted to borrow under
the credit facility was $7.5 million.
International SMC has access to credit facilities at Hong Kong Shanghai
Bank and Fortis Bank. The primary purpose of the facilities is to provide the
Subsidiary with the following abilities:
o overdraft protection facilities
o issuance and negotiation of letters of credit, both regular and discrepant
o trust receipts
o A company credit card
The facilities are secured by a corporate guarantee from the U.S.
Company, restricted cash on deposit with the lender and require that the Company
maintain a minimum tangible net worth. The maximum available credit under the
facilities is $5.5 million. The balance at December 31, 2003 and 2002 was
$4,640,728 and $0, respectively.
Because we had minimal liquidity and had defaulted under our credit
agreement with LaSalle, we received a going concern paragraph from our
independent certified public accountants for our audited financial statements
for fiscal 2003. On March 14, 2003, we were notified by LaSalle that we were in
violation of the tangible net worth covenant in our credit facility and were
declared in default. LaSalle amended the credit facility on August 19, 2003 in a
fourteenth amendment, which extended the loan until March 31, 2004 and the
condition of default was waived. On December 31, 2003, we again violated the
tangible net worth requirement and working capital requirement of our credit
facility with LaSalle.
On January 31, 2004, we paid this loan in full, terminated this credit
facility and LaSalle released its security interest in our assets.
On February 9, 2004, we executed a factoring agreement with Milberg
Factors, Inc. Pursuant to the agreement, Milberg, at its discretion, will
advance the
29
Company the lesser of 80% of our accounts receivable or $3.5 million. All
receivables submitted to Milberg are subject to a fee equal to 0.8% of the gross
invoice value. The average monthly balance of the line will incur interest at a
rate of prime plus .75%. Other terms of the agreement include minimum fees of
$200,000 per calendar year and include covenants requiring the Company to
maintain $7.5 million of tangible net worth and $7.5 million of working capital
at all times as defined in the agreement. To secure these advances, Milberg
received a security interest in all of our accounts receivable and inventory
located in the United States and a pledge of 66 2/3% of the stock in
International SMC (HK) Ltd., our wholly-owned subsidiary. This agreement is
effective for an initial term of two years, with successive automatic renewals
unless either party gives notice of termination.
Although this credit line is not equivalent to our previous lines, we
believe that advances under this credit facility, as well as collection of our
outstanding accounts receivable, will allow us enough available cash flow to
continue operations until August 2004 and prepare for the upcoming fiscal year.
We have been receiving collections of accounts receivable since the termination
of our LaSalle agreement, which have served as working capital and enabled us to
pay our obligations.
In order to further increase our liquidity, we are selling our excess
inventory and reducing our cost structure. As of February 11, 2004, we have
orders on hand of about $2.5 million and had already shipped over $1.0 million,
which is ahead of our projected target for most of the old inventory. Our goal
is to sell $3 to $4 million of old inventory by March 31, 2004. However, we can
not provide you with any assurances that we will be able to sell this inventory.
We have taken several steps to decrease our costs. Since June 2003, we
have had two rounds of lay-offs at our Company. In January 2004, our senior
executive officers agreed to take 20% salary reductions and other employees also
agreed to salary reductions. Additionally, we have also subleased some of our
warehouse space in California and Florida and hope to sublease out more.
We do not intend to enter into any additional material commitments for
the Company in the near future. We will be incurring only normal course of
business expenses such as: rent, utilities, salaries and related expenses,
accounting, legal, bank charges, interest, office supplies, and other expenses
that may become necessary as they relate to repairs and maintenance of our
leased facilities and computer equipment. We will also incur expenses for any
outstanding operating leases that are currently in place (see commitment table
below).
We intend to finance our business in fiscal 2005 through:
(i) Continued support from our Chinese factories in financing our purchases and
entering into agreements for payment of old receivables;
(ii) Selling the remainder of our inventory on hand;
(iii) Continuing to reduce costs;
(iv) Using our credit facility with Milberg Factors; and
(v) Utilizing credit facilities that are available to International SMC to
finance all direct shipments.
In order to reduce the need to maintain inventory in United States
locations in fiscal 2005, we intend to generate a larger share of our total
sales through FOB sales from International SMC. These sales are shipped directly
to our customers from the ports in China and are primarily backed by letters of
credit. The customers take title to the merchandise at their consolidators in
China and are responsible for their shipment, duty, clearance and freight
charges to their locations. We will also assist our customers in the forecasting
and management of their inventories of our product.
If we need additional financing during our peak selling season, we
intend to approach Milberg. If Milberg is not willing to provide us with
additional financing, we will need to seek additional capital from other
sources. However, we can not assure that we will be able to obtain additional
financing or that the terms will be acceptable to us. If we need to obtain
additional financing and fail to do so, it may have a material adverse effect on
our ability to meet our financial obligations and continue to operate.
30
DEBT AND CONTRACTUAL OBLIGATIONS
Our commitments for debt and other contractual arrangements as of
December 31, 2003 are summarized as follows:
Years ending March 31,
---------------------------------------------------------------------------------------------------------------------
Total 2004 2005 2006 2007 2008
---------------------------------------------------------------------------------------------------------------------
Merchandise License Guarantee $1,595,000 $1,395,000 $150,000 $50,000 -- --
---------------------------------------------------------------------------------------------------------------------
Property Leases $3,638,771 $1,330,158 $924,338 $517,071 $495,545 $371,659
---------------------------------------------------------------------------------------------------------------------
Equipment Leases $86,016 $46,525 $19,965 $10,322 $7,969 $1,235
---------------------------------------------------------------------------------------------------------------------
Revolving Credit Facilities $7,115,114 $7,115,114 -- -- -- --
---------------------------------------------------------------------------------------------------------------------
Subordinated Debt-related parties $1,000,000 $1,000,000
---------------------------------------------------------------------------------------------------------------------
Convertible Debentures $4,000,000 -- -- $4,000,000 -- --
---------------------------------------------------------------------------------------------------------------------
*Each of the contractual agreements provides that all amounts due under
that agreement can be accelerated if we default under the terms of the
agreement. For example, if we fail to make a minimum guaranteed royalty payment
that is required under a Merchandise License Agreement on a timely basis, the
Licensor can declare us in default and require that all amounts due under the
License Agreement are immediately due and payable.
Merchandise license guarantee reflects amounts that we are obligated to
pay as guaranteed royalties under our various license agreements. In fiscal
2003, we had guaranteed minimum royalty payments under our license agreements
with MTV Networks, Nickelodeon, Hard Rock Academy and Motown (Universal Music).
In fiscal 2004, we have guaranteed minimum royalty payments under the license
agreement with MTV and Motown (Universal Music).
We have leases for property in Rancho Dominguez and Compton California,
as well as in Coconut Creek, Florida. We have equipment leases for forklifts and
copy machines. Our revolving credit facility represents our credit facility with
LaSalle Business Credit, LLC, which was terminated as of January 31, 2004.
On September 8, 2003, we issued an aggregate of $4,000,000 of 8%
convertible debentures in a private offering to six accredited investors. The
debentures initially are convertible into 1,038,962 shares of common stock at
$3.85 per share, subject to adjustment in certain situations. We also issued an
aggregate of 457,143 warrants to the investors. The exercise price of the
warrants is $4.025 per share and the warrants expire on September 7, 2006. We
have an obligation to register the shares of common stock underlying the
debentures and warrants and filed a registration statement on Form S-1 to
register the shares on October 9, 2003.
Effective as of February 9, 2004, we amended the convertible debenture
agreements to increase the interest rate to 8.5% per annum effective as of
February 9, 2004, and granted 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 were in consideration of the debenture holder's agreements to
(i)enter into new subordination agreements with the Company's new lender,
Milberg Factors, (ii) to waive all liquidated damages due under the convertible
debentures and related 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, the fair
market value of the Company's common stock on February 9, 2004, the date of the
grant.
SOURCES AND USES OF CASH
Cash flows used in operating activities were $4,998,092 for the nine
months ended December 31, 2003. Cash flows were used in operating activities
primarily due to increases in accounts receivable in the amount of $9.4 million,
decreases in accounts payable of $3.2 million and decreases in existing
inventory of $12.2 million, as well as the loss for the period and other
non-cash expenses such as the tooling impairment and provision for inventory
losses. The decreases in existing inventory were the result of sales of our
inventory and a write down in the value of the inventory.
Cash used in investing activities for the nine months ended December
31, 2003 was $434,065. Cash used in investing activities resulted from the
purchase of fixed assets in the amount of $434,065. The purchase of fixed assets
consists of the tooling and molds required for production of new machines for
this fiscal year. Tooling and molds are depreciated over three years.
31
Cash flows provided by financing activities were $5,399,851 for the
nine months ended December 31, 2003. This consisted of proceeds from the
exercise of options in the amount of $981,972. We also issued convertible
debentures with detachable stock purchase warrants. This transaction resulted in
a gross increase in cash of $4 million. We received subordinated debt from
related parties of $1 million in July of 2003 and paid $400,000 to a director
who had previously loaned money to our Company on a short term basis. The
remainder of cash provided from financing activities was provided by net
repayments on the credit line at LaSalle National Bank in the amount of
$4,308,438 and borrowings on the credit lines in Hong Kong in the amount of
$4,640,728 to fund ongoing operations.
EXCHANGE RATES
We sell all of our products in U.S. dollars and pay for all of our
manufacturing costs in either U.S. or Hong Kong dollars. Operating expenses of
the Hong Kong office are paid in Hong Kong dollars. We cannot assure you that
the exchange rate fluctuations between the United States and Hong Kong
currencies will not have a material adverse effect on our business, financial
condition or results of operations.
SEASONAL AND QUARTERLY RESULTS
Historically, our operations have been seasonal, with the highest net
sales occurring in the second and third quarters (reflecting increased orders
for equipment and music merchandise during the Christmas selling months) and to
a lesser extent the first and fourth quarters of the fiscal year. Sales in our
fiscal second and third quarter, combined, accounted for approximately 85% of
net sales in fiscal 2003, 81% of net sales in fiscal 2002 and 75% of net sales
in fiscal 2001.
Our results of operations may also fluctuate from quarter to quarter
primarily as a result of the amount and timing of orders placed and shipped to
customers. 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 our operations. We have
historically passed any price increases on to its customers since prices charged
by us are generally not fixed by long-term contracts.
CRITICAL ACCOUNTING POLICIES
The U.S. Securities and Exchange Commission defines critical accounting
policies as "those that are both most important to the portrayal of a company's
financial condition and results, and require management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain. Our management
believes that a high degree of judgment or complexity is involved in the
following areas:
Collectibility of Accounts Receivable. Our allowance for doubtful
accounts is based on management's estimates of the creditworthiness of its
customers, current economic conditions and historical experience, and, in the
opinion of management, is believed to be an amount sufficient to respond to
normal business conditions. Management sets 100% reserves for customers in
bankruptcy and other reserves based upon historical collection experience.
Should business conditions deteriorate or any major customer default on its
obligations to our Company, this allowance may need to be significantly
increased, which would have a negative impact on operations.
Reserves on Inventories. We establish a reserve on inventory based on
the expected net realizable value of inventory on an item-by-item basis when it
is apparent that the expected realizable value of an inventory item falls below
its original cost. A charge to cost of sales results when the estimated net
realizable value of specific inventory items declines below cost. Management
regularly reviews our investment in inventories for such declines in value.
Income Taxes. Significant management judgment is required in developing
the Company's provision for income taxes, including the determination of foreign
tax liabilities, deferred tax assets and liabilities and any valuation
allowances that might be required against the deferred tax assets. At December
31, 2003, we concluded that a valuation allowance was needed against all of our
deferred tax assets, as it is not more likely than not that the deferred taxes
will be realized. For the nine months ended December 31, 2003, we recorded a tax
provision of $1.2 million. This occurred because the valuation allowance
established against the deferred tax asset exceeded the amount of the benefit
created from carrying back a portion of the current period losses. The
carry-back of the losses from the current period resulted in an income tax
receivable of $1.2 million, which is included in prepaid and other current
assets in the accompanying balance sheets. We have now exhausted its ability to
carry back any further losses and therefore will not be able to recognize tax
benefits on future losses including its expected fourth quarter loss.
32
International SMC, has applied for an exemption of income tax in Hong
Kong. Therefore, no taxes have been expensed or provided for at the Subsidiary
level. Although the governing body has reached no decision to date, the U.S.
parent company has reached the decision to provide for the possibility that the
exemption could be denied and accordingly has recorded a provision in fiscal
2004, 2003, 2002, and 2001. For the nine months ended December 31, 2003, a
provision of $424,763 was recorded at the Hong Kong statutory rate of 17.5%.
Current Hong Kong taxes payable on the earnings of our Hong Kong subsidiary
totaled $2.9 million at December 31, 2003.
We operate within multiple taxing jurisdictions and is subject to audit
in those jurisdictions. Because of the complex issues involved, any claims can
require an extended period to resolve. In management's opinion, adequate
provisions for income taxes have been made.
Other Estimates. We make other estimates in the ordinary course of
business relating to sales returns and allowances, warranty reserves, and
reserves for promotional incentives. Historically, past changes to these
estimates have not had a material impact on our financial condition. However,
circumstances could change which may alter future expectations.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our financial
position, results of operations or cash flows due to adverse changes in
financial and commodity market prices and interest rates. We are exposed to
market risk in the areas of changes in United States and international borrowing
rates and changes in foreign currency exchange rates. In addition, we are
exposed to market risk in certain geographic areas that have experienced or
remain vulnerable to an economic downturn, such as China. We purchase
substantially all our inventory from companies in China, and, therefore, we are
subject to the risk that such suppliers will be unable to provide inventory at
competitive prices. While we believe that, if such an event were to occur we
would be able to find alternative sources of inventory at competitive prices, we
cannot assure you that we would be able to do so. These exposures are directly
related to our normal operating and funding activities. Historically and as of
December 31, 2003, we have not used derivative instruments or engaged in hedging
activities to minimize market risk.
INTEREST RATE RISK
Our exposure to market risk resulting from changes in interest rates
relates primarily to debt under our credit facility with LaSalle. Under our
credit facility, our interest rate is LaSalle's prime rate plus 2.5% per annum
("current interest rate"). As of December 31, 2003, our outstanding balance
under our credit facility was $2,474,386 and we are accruing interest at the
prime plus 2.5% per annum. This loan was paid in full on January 30, 2004. We do
not believe that near-term changes in the interest rates, if any, will result in
a material effect on our future earnings, fair values or cash flows. On
September 8, 2003, we issued convertible notes in the amount of $4 million, the
fixed interest rate as of February 9, 2004 is 8.5% per annum.
FOREIGN CURRENCY RISK
We have a wholly-owned subsidiary in Hong Kong. Sales by these
operations made on a FOB China or Hong Kong basis are dominated in U.S. dollars.
However, purchases of inventory and Hong Kong operating expenses are typically
denominated in Hong Kong dollars, thereby creating exposure to changes in
exchange rates. Changes in the Hong Kong dollar/U.S. dollar exchange rates may
positively or negatively affect our gross margins, operating income and retained
earnings. We do not believe that near-term changes in the exchange rates, if
any, will result in a material effect on our future earnings, fair values or
cash flows, and therefore, we have chosen not to enter into foreign currency
hedging transactions. We cannot assure you that this approach will be
successful, especially in the event of a significant and sudden change in the
value of the Hong Kong dollar.
33
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
On March 24, 2003, we dismissed Salberg & Company, P.A. ("Salberg &
Company"), as our independent certified public accountant. On March 27, 2003, we
engaged Grant Thornton, LLP ("Grant Thornton"), as our independent certified
public accountant. Our decision to change accountants was approved by its Audit
Committee on March 24, 2003.
The report of Salberg & Company on our consolidated financial
statements for fiscal 2002, fiscal 2001 did not contain an adverse opinion or
disclaimer of opinion and was not qualified or modified as to uncertainty, audit
scope or accounting principles. Furthermore, Salberg & Company did not advise us
that:
1) internal controls necessary to develop reliable consolidated
financial statements do not exist, or
2) information has come to the attention of Salberg & Company which
made in unwilling to rely upon management's representations or made
it unwilling to be associated with the consolidated financial
statements prepared by management, or
3) the scope of the audit should be expanded significantly, or
information has come to the attention of Salberg & Company that they
have concluded will, or if further investigated might, materially
impact the fairness or reliability of a previously issued audit
report or the underlying consolidated financial statements, or the
consolidated financial statements issued or to be issued covering
the fiscal periods subsequent to March 31, 2002 (including
information that may prevent it from rendering an unqualified audit
report on those consolidated financial statements) or made in
unwilling to rely on management's representations or to be
associated with the consolidated financial statements prepared by
management or,
4) information has come to the attention of Salberg & Company that they
have concluded will, or if further investigated might, materially
impact the fairness or reliability of a previously issued audit
report or the underlying consolidated financial statements or the
consolidated financial statements issued or to be issued covering
the fiscal periods subsequent to March 31, 2002 through March 28,
2003, the date of the Form 8-K filing reporting our change in
accountants, that had not been resolved to the satisfaction of
Salberg & Company or which would have prevented Salberg & Company
from rendering an unqualified audit report on such consolidated
financial statements.
During our two most recent fiscal years and all subsequent interim
periods through March 24, 2003, there were no disagreements with Salberg &
Company on any matters of accounting principles or practices, financial
statement disclosure or auditing scope or procedure, which, if not resolved to
the satisfaction of Salberg & Company would have caused it to make reference to
the subject matter of the disagreements in connection with its reports on these
financial statements for those periods.
We did not consult with Grant Thornton regarding the application of
accounting principles to a specific transaction, either completed or proposed,
or the type of audit opinion that might be rendered on our financial statements,
and no written or oral advice was provided by Grant Thornton that was a factor
considered by us in reaching a decision as to the accounting, auditing or
financial reporting issues.
RESTATEMENT
In July 2003, we revised our position on the taxation of the income of
our Hong Kong subsidiary by the United States and Hong Kong tax authorities,
which was contained in our audited financial statements for fiscal 2002. We
discussed these issues with Salberg & Company and it agreed to opine on the
restated financial statements. See "Restatement of Financial Statements" - Page
22.
BUSINESS
OVERVIEW
We are engaged in the development, production, distribution, marketing
and sale of consumer karaoke audio equipment, accessories and music. We contract
for the manufacture of all electronic equipment products with factories located
in Asia. We also produce and market karaoke music, including CD plus graphics
34
("CD+G's"), and audiocassette tapes containing music and lyrics of popular songs
for use with karaoke recording equipment. All of our recordings include two
versions of each song; one track offers music and vocals for practice and the
other track is instrumental only for performance by the participant. Virtually
all of the cassettes sold by us are accompanied by printed lyrics, and our
karaoke CD+G's contain lyrics, which appear on the video screen. We contract for
the reproduction of music recordings with independent studios. We operate our
business in one reportable segment over multiple geographical regions
world-wide.
We were incorporated in California in 1982. We originally sold our
products exclusively to professional and semi-professional singers. In 1988, we
began marketing karaoke equipment for home use.
In May 1994, we merged into a wholly owned subsidiary incorporated in
Delaware with the same name. As a result of that merger, the Delaware
Corporation became the successor to the business and operations of the
California Corporation and retained the name The Singing Machine Company, Inc.
In July 1994, we formed a wholly owned subsidiary in Hong Kong, now known as
International SMC coordinate our production and finance in Asia.
In November 1994, we closed an initial public offering of 2,070,000
shares of our common stock and 2,070,000 warrants. In April 1997, we filed a
voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code. On
March 17, 1998, the U.S. Bankruptcy Court approved our plan of reorganization.
On June 10, 1998, our plan of reorganization had been fully implemented. Our
common stock currently trades on the American Stock Exchange under the symbol
"SMD." We were listed on the AMEX on March 8, 2001. Our principal executive
offices are located in Coconut Creek, Florida.
PRODUCT LINES
We currently have a product line of 34 different models of karaoke
machines plus 12 accessories such as microphones, incorporating such features as
CD plus graphics player, sound enhancement, echo, tape record/playback features,
and multiple inputs and outputs for connection to compact disc players, video
cassette recorders, and home theater systems. Our machines sell at retail prices
ranging from $30 for basic units to $400 for semi-professional units. We
currently offer our music in two formats - multiplex cassettes and CD+G's with
retail prices ranging from $6.99 to $19.99. We currently have a song library of
over 3,500 recordings, which we license from publishers. Our library of master
recordings covers the entire range of musical tastes including popular hits,
golden oldies, country, rock and roll, Christian, Latin music and rap. We even
have backing tracks for opera and certain foreign language recordings.
MARKETING, SALES AND DISTRIBUTION
MARKETING
We rely on management's ability to determine the existence and extent
of available markets for our products. We achieve both domestic and direct sales
by marketing our hardware and music products primarily through our own sales
force and various independent sales representatives. Our representatives are
located across the United States and are paid a commission based upon sales in
their respective territories. The sales representative agreements are generally
one (1) year agreements, which automatically renew on an annual basis, unless
terminated by either party on 30 days' notice. At March 1, 2004, we worked with
18 independent sales representatives. We work closely with our major customers
to determine marketing and advertising plans.
We market our products at various national and international trade
shows each year. We regularly attend the following trade shows and conventions:
the Consumer Electronics Show each January in Las Vegas; the American Toy Fair
each February in New York and the Hong Kong Electronics Show each October in
Hong Kong. We spent approximately $674,925, $181,866 and $55,376 on research and
development in fiscal 2003, 2002 and 2001, respectively. The primary purpose of
our research and development expenses is to develop prototypes and working
samples.
Our karaoke machines and music are marketed under the Singing Machine
(R) trademark throughout the United States, and sold primarily to mass
merchandisers, department stores, direct mail catalogs and showrooms, music and
record stores, national chains, specialty stores, and warehouse clubs. Our
karaoke machines and karaoke music are currently sold in such stores as Best
Buy, Circuit City, J.C. Penney, Target and Toys R Us. We utilize some of outside
independent sales representatives to help us provide service to our mass
merchandisers and other retailers.
35
Our licensing agreements with MTV Networks and Nickelodeon have further
expanded our brand name and our customer base. Through our license with MTV, we
have begun to focus on the 12 to 24 year old market and through our agreement
with Nickelodeon; we have reached an even younger age group between the ages of
3-6. We also expanded our licensed product lines in fiscal with the addition of
Hard Rock Academy(R) and Motown(R) (Universal Music Entertainment) agreements.
We believe that the addition of these agreements will help us to reach
demographic areas covering all ages.
In November, 2001, we signed an international distributorship agreement
with Arbiter Group, PLC ("Arbiter").
Arbiter is the exclusive distributor of the Singing Machine(R) karaoke machines
and music products in the United Kingdom and a non-exclusive distributor in all
other European countries. The agreement terminates on December 31, 2004, because
we renewed the agreement for another year. The agreement contains an automatic
renewal provision, whereby if either party does not give notice on or before
December 1 of a year during the term of the agreement, the agreement will
automatically be renewed for another year on the same terms.
In March 2003, we signed an international distributorship agreement
with Top-Toy (Hong Kong) Ltd. Top-Toy is the exclusive distributor of Singing
Machine (R) karaoke machines and music products in Denmark, Norway, Sweden,
Iceland and Faeroe Islands. The agreement is for three years, from April 1, 2003
until March 31, 2006. . The agreement contains an automatic renewal provision,
whereby if either party does not give notice at least 3 months before March 31,
2006, the agreement will automatically be renewed for another year on the same
terms.
SALES
As a percentage of total revenues, our net sales in the aggregate to
our five largest customers during the fiscal years ended March 31, 2003, 2002
and 2001, respectively, were approximately 67%, 87% and 78% respectively. In
fiscal 2003, 2002 and 2001, Best Buy and Toys R Us each accounted for more than
10% of our revenues. In fiscal 2003 Target and in fiscal 2002 Costco also
accounted for more than 10% of our revenues. Although we have established
relationships with our top five largest customers, we do not have long-term
contractual arrangements with any of them. A decrease in business from any of
our major customers could have a material adverse effect on our results of
operations and financial condition.
During the last three years, our revenues from international sales have
increased. Sales by customer geographic regions were as follows:
FISCAL YEAR ENDED MARCH 31,
2003 2002 2001
------------- ------------ -------------
United States $ 76,777,138 $ 62,333,801 $ 34,391,540
Asia 21,310 49,314 --
Australia 814,334 -- --
Canada 919,642 47,565 11,420
Central America 96,836 5,756 --
Europe 15,714,846 -- 433,821
Mexico 1,225,111 -- --
South America 44,549 39,317 38,570
$ 95,613,766 $ 62,475,753 $ 34,875,351
============== ============= ==============
As is customary in the consumer electronics industry, we have, on
occasion, (i) permitted certain customers to return slow-moving items for
credit, (ii) provided price protection to certain customers by making price
reductions effective as to certain products then held by customers in inventory
and (ii) accepted customer cancellations of purchase orders issued to the
Company. We expect that we will continue to be required to make such
accommodations in the future. Any significant increase in the amount of returns,
markdowns or purchaser order cancellations could have a material adverse effect
on our revenues and profitability.
DISTRIBUTION
We distribute hardware products to retailers and wholesale distributors
through two methods: shipments of product from inventory (domestic sales), and
36
shipments of product directly through our Internatioional SMC subsidiary and
manufacturers in Asia (direct sales). Domestic sales, which account for
substantially all of our music sales, are made to customers located throughout
the United States from inventories maintained at our warehouse facilities in
Florida or California.
Domestic Sales. Our strategy of selling products from a domestic
warehouse enables us to provide timely delivery and serve as a "domestic
supplier of imported goods." We purchase karaoke machines overseas from certain
factories in China for our own account, and warehouse the products in leased
facilities in Florida and California. We are responsible for costs of shipping,
insurance, customs clearance, duties, storage and distribution related to such
products and, therefore, warehouse sales command higher sales prices than direct
sales. We generally sell from our own inventory in less than container-sized
lots. In the fiscal year ended March 31, 2003, approximately 48% of our
consolidated sales were domestic sales.
Direct Sales. We ship some hardware products sold by us directly to
customers from Asia through International SMC, our subsidiary. Sales made
through International SMC are completed by either delivering products to the
customers' common carriers at the shipping point or by shipping the products to
the customers' distribution centers, warehouses, or stores. Direct sales are
made in larger quantities (generally container sized lots) to customers world
wide, who pay International SMC pursuant to their own international,
irrevocable, transferable letters of credit or on an open account. In the fiscal
year ended March 31, 2003, approximately 52% of our consolidated sales were
direct sales.
MANUFACTURING AND PRODUCTION
Our karaoke machines are manufactured and assembled by third parties
pursuant to design specifications provided by us. Currently, we have ongoing
relationships with six factories, located in the Shenzhen Special Economic Zone
and Guangdong Province of the People's Republic of China, who assemble our
karaoke machines and related products. In manufacturing our karaoke machines and
related products, these factories use molds and certain other tooling, most of
which are owned by International SMC. Our products contain electronic components
manufactured by other companies such as Panasonic, Sanyo, Toshiba, and Sony. Our
manufacturers purchase and install these electronic components in our karaoke
machines and related products. The finished products are packaged and labeled
under our Singing Machine(R) trademarks.
We believe that we have obtained copyright licenses from music
publishers for all of the songs in our music library. We contract with outside
studios on a work-for hire basis to produce recordings of these songs. After the
songs have been recorded, we author the CD+G's in our in-house studio. We use
outside companies to mass-produce the CD+G's and audiocassettes, once the
masters have been completed.
While our equipment manufacturers purchase our supplies from a small
number of large suppliers, all of the electronic components and raw materials
used by them are available from several sources of supply, and we do not
anticipate that the loss of any single supplier would have a material long-term
adverse effect on our business, operations, or financial condition. Similarly,
although we primarily use six factories to manufacture our karaoke machines and
accessories, and a small number of studios to record our music (including our
in-house production), we do not anticipate that the loss of any single
manufacturer or single studio would have a material long-term adverse effect on
our business, operations or financial condition. To ensure that our high
standards of product quality and factories meet our shipping schedules, we
utilize Hong Kong based employees of International SMC as our representatives.
These employees include product inspectors who are knowledgeable about product
specifications and work closely with the factories to verify that such
specifications are met. Additionally, key personnel frequently visit our
factories for quality assurance and to support good working relationships.
All of the electronic equipment sold by us is warranted to the end user
against manufacturing defects for a period of ninety (90) days for labor and
parts. All music sold is similarly warranted for a period of 30 days. During the
fiscal years ended March 31, 2003, 2002 and 2001, warranty claims have not been
material to our results of operations.
MERCHANDISE LICENSE AGREEMENTS
In November 2000, we entered into a multi-year merchandise license
agreement with MTV Networks, a division of Viacom International, Inc., to create
the first line of MTV karaoke machine and compact disks with graphics ("CD+G's")
featuring music for MTV's core audience. Under the licensing agreement, we
originally produced two MTV-branded machines for the fiscal 2002 year. Since
November 2000, we have amended the agreement five times. For fiscal 2004, our
line consisted of nine MTV branded machines and a wide assortment of MTV branded
music. Our
37
license covers the sale of MTV products in the United States, Canada and
Australia.
On January 7, 2004, we entered into the fifth amendment of its
licensing agreement with MTV Networks. The amendment reduced the minimum royalty
guarantee for calendar 2003 from $1.5 million to $1.3 million. The amendment
also extended the expiration date of the original agreement to April 30, 2004,
with options to extend for an additional two periods until December 31, 2004 at
the discretion of MTV. In accordance with this amendment, each of the three
license periods contain minimum guarantee royalty payments of $100,000 each for
a total of $300,000 if all extensions are exercised. Each of the minimum
guaranteed royalty payments is recoupable against sales throughout the calendar
year, unless the contract is cancelled.
In December 2001, we entered into a multi-year license agreement with
the Nickelodeon division of MTV Networks. Under this license, we originally
created a line of two Nickelodeon branded machines and music for the fiscal 2003
year. This has expanded to five machines, plus a line of Nickelodeon music.
These products are distributed through our established distribution channels.
Over the term of this license agreement, we are obligated to make guaranteed
minimum royalty payments of $450,000. We do not believe that the payment of
these guaranteed fees will adversely affect our ongoing operations. The
Nickelodeon license expires on December 31, 2004 and does not contain any
automatic renewal provisions.
In December 2002, we entered into a multi-year license agreement with
Hard Rock Academy, a division of Hard Rock Cafe. This agreement allows us to
produce and market a line of its karaoke machines and complementary music
through its distribution channels. The first branded machine was introduced in
the fourth quarter of fiscal 2003 and a line of music is currently under
development. During the first nine months of this agreement, made $100,000 in
minimum guaranteed royalty payments. In September 2003, we amended this
agreement and Hard Rock agreed to release us from our minimum guaranteed payment
obligations during the remaining term of the license agreement. The Hard Rock
Academy license expires on December 31, 2005 and does not contain any automatic
renewal provisions.
In February 2003, we entered into a multi-year license agreement with
Universal Music Entertainment to market a line of Motown karaoke machines and
music. This agreement and its subsidiary agreement signed in March 2003, allow
us to be the first to use original artist recordings for our CD+G formatted
karaoke music. The original introduction will be one machine and six CD+G discs.
Over the term of this license agreement, we are obligated to make guaranteed
minimum royalty payments over a specified period of time in the amount of
$300,000. We do not believe that the payment of these guaranteed fees will
adversely affect our ongoing operations. The Universal Music Entertainment
license expires on March 31, 2006 and does not contain any automatic renewal
provisions.
We distribute all of our licensed products through our established
distribution channels, including Best Buy, Costco, JC Penny, Sam's Club, Target
and Toys R Us. Our distribution network also includes the online versions of
these retail customers.
The following table sets forth the percentage of total sales that have
been generated under each of our MTV License, our Nickelodeon license and our
other licenses (Hard Rock Academy and Universal Music).
LICENSED SALES AS A PERCENTAGE OF TOTAL SALES
For the Nine Months Ended For the Fiscal Year Ended
December 31 March 31,
2003 2003 2002 2001
--------------------------------------------------------------------------------------
MTV 14% 33% 39% 0%
Nickelodeon 6% 3% 0% 0%
Other Licenses 2% 1% 0% 0%
Total Licensed Sales 22% 37% 39% 0%
COMPETITION
Our business is highly competitive. Our major competitors for karaoke
machines and related products are Craig, Curtis, Grand Prix and Memorex. We
38
believe that competition for karaoke machines is based primarily on price,
product features, reputation, delivery times, and customer support. Our primary
competitors for producing karaoke music are Pocket Songs, UAV, Sybersound and
Sound Choice. We believe that competition for karaoke music is based primarily
on popularity of song titles, price, reputation, and delivery times.
In addition, we compete with all other existing forms of entertainment
including, but not limited to, motion pictures, video arcade games, home video
games, theme parks, nightclubs, television and prerecorded tapes, CD's, and
videocassettes. Our financial position depends, among other things, on our
ability to keep pace with changes and developments in the entertainment industry
and to respond to the requirements of our customers. Many of our competitors
have significantly greater financial, marketing, and operating resources and
broader product lines than we do.
TRADEMARKS
We have registered The Singing Machine name and the logo in which the
microphone is used in our name with the United States Patent & Trademark Office
("USPTO") for our Singing Machine(R) products. We also registered these
trademarks in the United States and in Germany, the Benelux countries,
Switzerland and the United Kingdom. In fiscal 2003, we filed an intent to use
applications with the USPTO for KaraokeVision. We also filed one application to
obtain a European Community Trademark for the Singing Machine name and logo in
the 15 European Community countries and also filed registrations in Australia,
China and Hong Kong.
Our trademarks are a significant asset because they provide product
recognition. We believe that our intellectual property is significantly
protected, but there are no assurances that these rights can be successfully
asserted in the future or will not be invalidated, circumvented or challenged.
COPYRIGHTS AND LICENSES
We hold federal and international copyrights to substantially all of
the music productions comprising our song library. However, since each of those
productions is a re-recording of an original work by others, we are subject to
contractual and/or statutory licensing agreements with the publishers who own or
control the copyrights of the underlying musical compositions. We are obligated
to pay royalties to the holders of such copyrights for the original music and
lyrics of all of the songs in our library that have not passed into the public
domain. We are currently a party to more than 3,500 different written copyright
license agreements.
The majority of the songs in our song library are subject to written
copyright license agreements, oftentimes referred to as synchronization
licenses. Our written licensing agreements for music provide for royalties to be
paid on each song. The actual rate of royalty is negotiable, but typically
ranges from $0.09 to $0.18 per song on each CD+G or cassette that is sold. Our
written licenses typically provide for quarterly royalty payments, although some
publishers require reporting on a semi-annual basis. Upon negotiation of the
license agreements, we usually pay a small fixing fee, based on the number of
songs we estimate to sell. These fees are expensed directly to general expenses.
In most instances, we also pay a small advance. The advances are amortized over
the shorter of (a) the life of the license or (b) the units sold.
We currently have compulsory statutory licenses for certain songs in
our song library, which are reproduced on audiocassettes. The Federal Copyright
Act creates a compulsory statutory license for all non-dramatic musical works,
which have been distributed to the public in the United States. Royalties due
under compulsory licenses are payable quarterly and are based on the statutory
rate. The statutory rate is the greater of $0.08 per song for five minutes of
playing time or $0.0155 per minute of playing time or fraction thereof with
respect to each item of music produced and distributed by us. We also have
written license agreements for substantially all of the printed lyrics, which
are distributed with our audiocassettes, which licenses also typically provide
for quarterly payments of royalties at the statutory rate.
GOVERNMENT REGULATION
Our karaoke machines must meet the safety standards imposed in various
national, state, local and provincial jurisdictions. These safety standards
regulate the electrical transmission from our karaoke machines and our laser
disks contained within our karaoke machines are subject to approval from the
Federal Communications Commission and the Food & Drug Administration. Our
karaoke machines sold in the United States are designed, manufactured and tested
to meet the safety standards of Underwriters Laboratories, Inc. ("ULI") or
Electronic Testing Laboratories ("ETL"). By meeting the ULE or ETL standards, we
are deemed to meet the safety requirements in all states in the United States.
In Europe and other foreign countries, the C.E. standard is
39
required. Our production and sale of music products is subject to federal
copyright laws.
The manufacturing operations of our foreign suppliers in China are
subject to foreign regulation. China has permanent "normal trade relations"
("NTR") status under US tariff laws, which provides a favorable category of US
import duties. China's NTR status became permanent on January 1, 2002, following
enactment of a bill authorizing such status upon China's admission to the World
Trade Organization ("WTO") effective as of December 1, 2001. This substantially
reduces the possibility of China losing its NTR status, which would result in
increasing costs for us.
SEASONALITY AND SEASONAL FINANCING
Our business is highly seasonal, with consumers making a large
percentage of karaoke purchases around the traditional holiday season in our
third quarter. A significant portion of our customers place orders in our second
and third quarter in anticipation of such holiday buying. These seasonal
purchasing patterns and requisite production lead times cause risk to our
business associated with the underproduction or overproduction of products that
do not match consumer demand. Retailers also attempt to manage their inventories
more tightly, requiring that we ship products closer to the time that retailers
expect to sell the products to consumers. These patterns of building-up
inventory are consistent with other companies in the toy and electronics
industries.
These factors increase the risk that we may not be able to meet demand
for certain products at peak demand times, or that our own inventory levels may
be adversely impacted by the need to pre-build products before orders are
placed. In fiscal 2003, we overestimated the demand for our products and had $25
million of inventory as of March 31, 2003.
In fiscal 2003 and 2002, our financing of seasonal working capital grew
in the first quarter and peaked in the second and third quarter, consistent with
the industry taken as a whole. As of February 1, 2004, we had ordered and
received only $11 million in inventory for domestic stock. However, due to
factors such as changes in economic conditions, market demands, competitors
production and customer needs, this amount could increase before the end of our
current fiscal year ended March 31, 2004. To finance the seasonal working
capital requirements of International SMC, we expect to use short-term foreign
credit lines with a number of banks. International SMC's working capital is
predominantly driven by letters of credit, as the shipments are F.O.B China.
During fiscal 2003, International SMC had access to two credit facilities at the
Hong Kong Shanghai Banking Corporation and Fortis Bank. See "Liquidity" on page
28 and Note 6 on page F-8.
On February 9, 2004, we executed a factoring agreement with Milberg
Factors, Inc. Pursuant to the agreement, Milberg, at its discretion, will
advance the Company the lesser of 80% of our accounts receivable or $3.5
million. All receivables submitted to Milberg are subject to a fee equal to 0.8%
of the gross invoice value. The average monthly balance of the line will incur
interest at a rate of prime plus .75%. Other terms of the agreement include
minimum fees of $200,000 per calendar year, $7.5 million tangible net worth and
$7.5 million working capital. To secure these advances, Milberg received a
security interest in all of our accounts receivable and inventory located in the
United States and a pledge of 66 2/3% of the stock in International SMC (HK)
Ltd, our wholly-owned subsidiary. This agreement is effective for an initial
term of two years, with successive automatic renewals unless either party gives
notice of termination.
Although this credit line is not equivalent to our previous lines, we
believe that advances under this credit facility, as well as collection of our
outstanding accounts receivable, will allow us enough available cash flow to
continue operations until August 2004 and prepare for the upcoming fiscal year.
We have been receiving collections of accounts receivable since the termination
of our LaSalle agreement, which have served as working capital and enabled us to
pay our obligations.
BACKLOG
We ship our products in accordance with delivery schedules specified by
our customers, which usually request delivery within three months. In the
consumer electronics industry, orders are subject to cancellation or change at
any time prior to shipment. In recent years, a trend toward just-in-time
inventory practices in the toy industry has resulted in fewer advance orders and
therefore less backlog of orders for us. We believe that backlog orders at any
given time may not accurately indicate future sales. In order to support
customers with just in time inventory practice, many companies in the consumer
electronics industry takes an active role in the inventory planning for their
customers. These electronic companies will monitor the inventory held by their
customers. If a customer's inventory falls below a certain level, the company
40
will automatically re-order and ship the inventory to their customers. In order
to utilize this method of inventory control, it is necessary to have stock of
the product which can be shipped to the customer with little notice.
EMPLOYEES
As of March 1, 2004, we employed 45 persons, all of whom are full-time
employees, including 3 executive officers. Fourteen of our employees are located
at International SMC's corporate offices in Hong Kong. The remaining 31 of our
employees are based in the United States; 3 are executive positions; 13 are
engaged in warehousing and technical support, and the remaining 15 in
accounting, marketing, sales and administrative functions.
PROPERTIES
Our corporate headquarters are located in Coconut Creek, Florida in an
18,000 square foot office and warehouse facility. Our four leases for this
office space expire on August 31, 2004. We sublease showroom space at the
International Toy Center in New York City. We have leased 9,393 square feet of
office and showroom space in Hong Kong from which we oversee our China based
manufacturing operations. Our two leases for this space in the Ocean Center
building expire on April 30, 2005 and May 31, 2005, respectively.
We have two warehouse facilities in southern California. The Compton
facility has 69,000 square feet and the lease expires on February 23, 2008. The
Rancho Dominguez location has 94,650 square feet, predominately warehouse and
the lease expires on June 30, 2005. We will attempt to consolidate our
operations and move all of our warehousing operations to either facility by
subleasing either the Compton or Rancho Dominguez facility for the remaining
term of its lease. As of March 1, 2004, we have not been successful in
subleasing all of our warehouse space in these facilities; however, we have
entered into a sublease for a portion of the warehouse space in our Rancho
Dominguez facility.
We believe that the facilities are well maintained, are in substantial
compliance with environmental laws and regulations, and are adequately covered
by insurance. We also believe that these leased facilities are not unique and
could be replaced, if necessary, at the end of the term of the existing leases.
LEGAL PROCEEDINGS
We filed a voluntary petition for relief under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court for the Southern District
of Florida, case number 97-22199-BKC-RBR, on April 11, 1997. On March 17, 1998,
the U.S. Bankruptcy Court confirmed our First Amended Plan of Reorganization. As
of June 10, 1998, our plan had been fully implemented.
From July 2, 2003 through October 2, 2003, seven securities class
action lawsuits and a shareholder's derivative action were filed against us and
certain of our officers and directors in the United States District Court for
the Southern District of Florida on behalf of all persons who purchased our
securities during the various class action periods specified in the complaints.
On September 18, 2003, United States District Judge William J. Zlock entered an
order consolidating the seven (7) purported class action law suits and one (1)
purported shareholder derivative action into a single action case styled Frank
Bielansky v. Salberg & Company, P.A., et al - Case Number: 03-80596 - CIV -
ZLOCK (the "Class Action"). The complaints that were filed allege violations of
Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934 and Rule
10(b)-5. The complaints seek compensatory damages, attorney's fees and
injunctive relief. While the specific factual allegations vary slightly in each
case, the complaints generally allege that our officers falsely represented our
financial results during the relevant class periods. We believe the allegations
in these cases are without merit and we intend to vigorously defend these
actions.
We entered into a settlement agreement with the plaintiffs of the Class
Action Lawsuit in March 2004. This settlement is subject to document and final
approval by the Court. On April 24, 2004, the Court is set to hear a motion for
preliminary approval of the settlement. If granted, the Court will direct that
notices be given to the shareholders who are members of the Class Action Lawsuit
about their rights to participate in the settlement or to opt out.
The terms of the settlement include a cash payment equal to $1,325,000,
which includes $850,000 to be paid by our company and $475,000 to be paid by
Salberg & Company, P.A., our former auditor. We expect that our portion of the
cash payment will be covered by our liability insurance. The settlement also
obligates us to implement certain corporate governance changes, including an
expension of our Board of Directors to six memebers, with independent directors
comprising at least 2/3 of the total Board seats, and may include other non-cash
consideration.
We entered into a separation and release agreement with an executive on
December 19, 2003. The agreement provided for the individual to receive $159,281
in settlement of his contract with us. The amount has been expensed as
compensation at December 31, 2003.
We entered into a settlement agreement with an investment banker, AG
Edwards, on November 17, 2003. Pursuant to this agreement, we will pay the sum
of $181,067 over a six month period and have issued to the investment banker
40,151 shares of stock with a fair value of $94,355.
41
We amended our convertible debenture agreements to increase the
interest rate to 8.5% effective as of February 9, 2004 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 the our new lender, (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, the fair market value of the
Company's common stock on February 9, 2004, the date of the grant. The fair
value of these warrants as calculated pursuant to Statement No. 123 is $30,981
and has been expensed as other operating expenses in the accompanying statements
of operations.
We are also subject to various other legal proceedings and other claims
that arise in the ordinary course of its business. In the opinion of management,
the amount of ultimate liability, if any, in excess of applicable insurance
coverage, is not likely to have a material effect on the financial condition,
results of operations or liquidity of the Company. However, as the outcome of
litigation or other legal claims is difficult to predict, significant changes in
the estimated exposures could occur, which could have a material impact on the
Company's operations.
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES
The following table sets forth certain information with respect to our
executive officers and directors as of March 1, 2004.
NAME AGE POSITION
---- --- --------
Yi Ping Chan 39 Chief Executive Officer, Chief Operating Officer,
Secretary and Director
April J. Green 40 Chief Financial Officer
John Dahl 31 Senior Vice-President of Finance
Josef A. Bauer 65 Director
Bernard Appel 71 Director
Richard Ekstract 72 Director
Harvey Judkowitz 59 Director
Alicia Haskamp 56 Managing Director of International SMC
YI PING CHAN has served as our Chief Operating Officer since May 2,
2003. Prior to this appointment, Chan was a consultant to Company from March 31,
2003 through May 2, 2003. He was a founder of MaxValue Capital Ltd., a Hong
Kong-based management consulting and investment firm, and co-founder of E
Technologies Ltd., Hong Kong, which specialized in health care technology
transfer from April 1996 to March 2003. Prior to that, he was Chief Strategist
and Interim CFO from January 2000 to June 2002, of a Hong Kong-based IT and
business process consulting firm with operations in Hong Kong, China and the US.
He also held a senior management position with a Hong Kong-based venture capital
and technology holding company with operations in Hong Kong, China and the US
from 1997 to December 1999. Mr. Chan earned an MBA in 1994 and a MSEE in 1990
from Columbia University, and a BSEE, in 1987 from Polytechnic University, New
York.
APRIL GREEN has served as our Chief Financial Officer since March 15,
2002. Ms. Green joined our company in June 1999 as our controller and was
promoted to the position of Director of Finance & Administration in January 1,
2000. Prior to joining us, Ms. Green held various positions of increasing
responsibility with Monogram International, a Florida-based novelty and toy
company from February 1993 to June 1999. At Monogram, Ms. Green rose from Staff
Accountant to Controller. Prior to February 1993, she served in a variety of
financial positions in the automotive industry in the Tampa area. Ms. Green is a
Certified Public Accountant, a member of the American Institute of Certified
Public Accountants (AICPA) and a member of the AWSCPA (American Woman's Society
of CPA's).
We are currently in negotiations with Ms. Green regarding her
resignation as our Chief Financial Officer. See "Management - Employment and
Other Agreements."
JOHN DAHL has served as our Senior Vice-President of Finance since
November 1, 2003. Prior to joining us, Mr. Dahl served as a consultant with
American Express Tax Services from May 1999 through December 2003. While Mr.
42
Dahl was working with American Express, he was engaged as a consultant on our
account by LaSalle. Prior to March 1999, Mr. Dahl attended law school at
Northern Illinois University from September 1996 through May 1999. We are
currently in negotiations with Mr. Dahl regarding his resignation as our Senior
Vice President of Finance. See "Management's Employment and Other Agreements."
JOSEF A. BAUER has served as a director since October 15, 1999. Mr.
Bauer previously served as a director of the Company from February 1990 until
September 1991 and from February 1995 until July 1997, when we began our Chapter
11 proceeding. Mr. Bauer presently serves as the Chief Executive Officer of the
following three companies: Banisa Corporation, a privately owned investment
company, since 1975; Trianon, a jewelry manufacturing and retail sales companies
since 1978 and Seamon Schepps, also a jewelry manufacturing and retail sales
company since 1999.
BERNARD S. APPEL has served as a director since October 31, 2003. He
spent 34 years at Radio Shack, beginning in 1959. At Radio Shack, he held
several key merchandising and marketing positions and was promoted to the
positions of President in 1984 and to Chairman of Radio Shack and Senior Vice
President of Tandy Corporation in 1992. Since 1993 through the present date, Mr.
Appel has operated the private consulting firm of Appel Associates, providing
companies with merchandising, marketing and distribution strategies, creative
line development and domestic and international procurement.
RICHARD EKSTRACT has served as a director since October 31, 2003. Since
1959, Mr.Ekstract has created, financed and launched more than twenty
periodicals about the consumer electronics industry, including Audio Times,
Consumer Electronics Monthly, Consumer Electronics Show Daily, Autosound and
Communications, Satellite Retailing, Video Business, Video Review, TWICE, CARS,
and License! From January 1999 through February 2001, Mr. Ekstrakt was the
managing partner of License Magazine, which was sold to Advanstar
Communications. From March 2001 through the present date, Mr. Ekstract has
served as the Managing Partner of Cottage & Gardens, LLC, a magazine providing
advice to consumers on a range of topics, including decorating, gardening,
homemaking and crafts. Mr. Ekstract was also founder and chairman of the Home
Office Association of America where he served as Chairman from March 1990
through January 1999.
HARVEY JUDKOWITZ has served as a director since March 29, 2004 and is
the Chairman of our Audit Committee. He is licensed as a Certified Public
Accountant in New York and Florida. From 1988 to the present date, Mr. Judkowitz
has conducted his own CPA practice. He currently serves as the Chairman and CEO
of UniPro Financial Services, a diversified financial services company. He also
sits on the Board of Directors and serves as the Chair of the Audit Committee of
the following public companies: Global Business Services, Inc., Pony Express
USA, Intelligent Motor Cars, Inc. and Kirshner Entertainment & Technologies,
Inc. He currently serves as the Interim Chief Financial Officer of Kirshner
Entertainment & Technologies, Inc.
ALICIA HASKAMP has served as the Managing Director of International
SMC, our Hong Kong subsidiary since December 2000 through the present date.
Prior to this time from October 1998 through Decembet 2000, Ms. Haskamp served
as the Director of U.S. operations for Ulysse Nardin, S.A., a Swiss company
engaged in the manufacture, distribution and sale of specialty watches.
Our directors serve for a term of one year, or until their successors
shall have been elected and qualified. Our executive officers are appointed and
serve at the discretion of the Board of Directors.
FAMILY RELATIONSHIPS
There are no relationships between our current executive officers and
directors. However, Alicia Haskamp is the widow of Walter Haskamp, who served as
a director of our company from July 16, 1998 through July 1999.
BOARD COMMITTEES
We have an audit committee, an executive compensation/stock option
committee and a nominating committee. The audit committee consists of Messrs.
Judkowitz, Ekstract and Appel. The audit committee recommends the engagement of
independent certified public accountants to the board, initiates and oversees
investigations into matters relating to audit functions, reviews the plans and
results of audits with our independent certified public accountants, reviews our
internal accounting controls, and approves services to be performed by our
independent certified public accountants. The executive compensation/stock
option committee consists of Messrs. Judkowitz, Ekstract and Appel. The
executive compensation/stock option committee considers and authorizes
remuneration arrangements for senior management and grants options under, and
administers our employee stock option plan. The entire Board of Directors
operates as a nominating committee. The nominating committee is responsible for
reviewing the qualifications of potential nominees for election to the Board of
Directors and recommending the nominees to the Board of Directors for such
election.
DIRECTOR'S COMPENSATION
It is the general policy of the Board that compensation for our
independent directors should be a mix of cash and equity-based compensation. Our
independent directors are those directors that meet the definition of
independence contained in the American Stock Exchange listing requirements. We
pay each independent director an annual director's fee of $10,000, which may be
payable in cash or stock at the election of the Company. We also reimburse each
director for the costs of attending each of our Board meetings. As of April 1,
2004, our independent directors are Jay Bauer, Bernard Appel, Richard Ekstract
and Harvey Judkowitz. We do not compensate our employee directors for their
service on our Board. As of April 1, 2004, our only employee director is Yi Ping
Chan.
In addition, it is our policy to grant options to each of our
independent directors for each year of service on our Board. Each independent
director will receive a grant of 10,000 options from our Year 2001 Stock Option
43
Plan for each year of service on our Board. The exercise price of the options
will be equal to the fair market value of our common stock on the day before our
annual or special shareholders meeting. The options will be exercisable for a
period of five years after the vesting date. During fiscal 2002, we granted each
of our three outside director options under our Year 2001 Plan to purchase a
total of 10,000 shares at an exercise price of $11.09 per share.
EXECUTIVE COMPENSATION
The following table sets forth certain compensation information for the
fiscal years ended March 31, 2003, 2002, and 2001 with regard to Edward Steele,
our Chief Executive Officer during fiscal 2003, 2002 and 2001, and each of our
other executive officers whose compensation exceeded $100,000 on an annual basis
(the "Named Officers"):
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM COMPENSATION
----------------------------------------- ------------------------------------------------------
SECURITIES
NAME OF INDIVIDUAL OTHER RESTRICTED UNDERLYING/
AND ANNUAL STOCK OPTIONS/ LTIP ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1) AWARD(S) SAR'S PAYOUTS COMPENSATION(2)
------------------ ---- --------- ---------- -------------- ---------- ---------- ------- ---------------
Edward Steele 2003 $ 382,352 $ 0 $ 8,671 0 30,000 0 $ 17,969
CEO(3) 2002 $ 364,145 $ 192,133 $ 8,258 0 15,000 0 $ 17,908
2001 $ 320,865 $ 256,289 $ 7,938 0 315,000 0 $ 10,515
John Klecha 2003 $ 300,117 $ 0 $ 6,555 0 24,000 $ 13,264
President, COO(4) 2002 $ 286,111 $ 157,200 $ 6,242 0 15,000 0 $ 11,725
2001 $ 255,777 $ 205,031 $ 6,000 0 300,000 0 $ 6,007
April Green 2003 $ 122,200 $ 25,000 $ 3,900 0 20,000 0 $ 13,551
CFO (5) 2002 $ 88,825 $ 25,000 $ 3,900 0 30,000 0 $ 7,091
2001 $ 83,658 $ 17,000 $ 3,900 0 7,500 0 $ 3,321
Jack Dromgold 2003 $ 210,277 $ 50,000(7) $ 5,538 0 100,000 0 $ 154,072(8)
Executive Vice
President, Sales &
Marketing (6)
----------
(1) The amounts disclosed in this column for fiscal 2003, 2002 and 2001
include automobile expense allowances, which are provided pursuant to
the executive's employment agreements.
(2) Includes the Company's matching contributions under its 401(k) savings
plan and medical insurance pursuant to the executive's employment
agreements.
(3) Mr. Steele resigned as our Chief Executive Officer and as a director
effective as of August 3, 2003.
(4) Mr. Klecha resigned as our President and Chief Operating Officer
effective as of May 2, 2003.
(5) Ms. Green has served as our Chief Financial Officer since March 15,
2002. She served as the Director of Finance and Administration from
January 1, 2000 through March 14, 2002 and as our controller from June
1999 through December 2000.
(6) Mr. Dromgold joined our company on April 15, 2002.
(7) Mr. Dromgold received $50,000 as a signing bonus when he joined our
company pursuant to his employment agreement.
(8) Includes relocation expenses of $45,529, the Company matching
contributions of $8,543 under its 401(k) savings plan and medical
insurance and a $100,000 value attributed to options granted to Mr.
Dromgold. After one year of employment, Mr. Dromgold had the right to
sell 50,000 options that were granted to him under his employment
agreement back to the Company at a price of $100,000. Mr. Dromgold did
not elect to exercise this right during fiscal 2003 and the Company
extended this right for another year.
44
OPTION GRANTS IN FISCAL 2003
The following table sets forth information concerning all options
granted to our officers and directors during the year ended March 31, 2003. No
stock appreciation rights ("SAR's") were granted.
POTENTIAL REALIZABLE
PERCENTAGE VALUE AT ASSUMED
OF TOTAL ANNUAL RATES OF STOCK
SHARES OPTIONS EXERCISE PRICE APPRECIATION
UNDERLYING GRANTED TO PRICE FOR OPTION TERM(2)
OPTIONS EMPLOYEES IN PER EXPIRATION ---------------------
NAME GRANTED(1) FISCAL YEAR SHARE DATE 5% 10%
------------- ---------- ------------ --------- ---------- ---------- ---------
Edward Steele 30,000(3) 5.25% $ 14.30 7/15/08 $ 118,525 $ 261,908
John Klecha 24,000(3) 4.28% $ 14.30 7/15/08 $ 94,800 $ 209,520
Jack Dromgold 50,000(4) 8.76% $ 8.61 8/14/07 $ 92,775 $ 199,795
50,000(5) $ 9.00 12/31/08 $ 124,327 $ 274,730
April Green 20,000(5) 3.50% $ 9.00 12/31/08 $ 49,731 $ 109,891
----------
(1) All options were granted pursuant to the Year 2001 Stock Option
Plan. Option exercise prices were at the market when granted.
(2) The dollar amounts under these columns are the result of
calculations based on the market price on the date of grant at an
assumed annual rate of appreciation over the maximum term of the
option at 5% and 10% as required by applicable regulations of the
SEC and, therefore, are not intended to forecast possible future
appreciation, if any of the common stock price. Assumes all
options are exercised at the end of their respective terms. Actual
gains, if any, on stock option exercises depend on the future
performance of the common stock.
(3) All of these options vested on June 12, 2002, the date of grant.
(4) Half of these options, 25,000 vested on April 15, 2003 and the
remaining 25,000 vest on April 15, 2004.
(5) Twenty percent of the options are exercisable on January 1, 2004
and 20% exercisable each January 1st thereafter with the last 20%
becoming exercisable on January 1, 2008. These options expire with
varying expiration dates from December 31, 2009 through December
31, 2013.
AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED MARCH 31, 2003 AND
OPTION VALUES
The following table sets forth information as to the exercise of stock
options during the fiscal year ended March 31, 2003 by our officers listed in
our Summary Compensation Table and the fiscal year-end value of unexercised
options.
45
VALUE OF
NUMBER OF UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FISCAL YEAR END FISCAL YEAR END(2)
-----------------------------------
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME OF INDIVIDUAL UPON EXERCISE REALIZED UNEXERCISABLE UNEXERCISABLE
------------------ --------------- -------- ------------- -------------
Edward Steele 0 0 352,500/0 $2,251,050/0
John Klecha 0 0 382,500/0 $2,502,330/0
Jack Dromgold 0 0 25,000/75,000 $0/0
April Green 1,000 $3,940 26,000/20,000 $128,440/0
----------
(1) Value realized is based on the difference between the closing
price of our common stock on the date of exercise and the option
exercise prices times the number of outstanding options.
(2) Value of unexercised options equals $6.98, the average of the high
and low trading prices on March 31, 2003, less the option exercise
price multiplied by the number of shares exercisable or
unexercisable.
EMPLOYMENT AND OTHER AGREEMENTS
YI PING CHAN. Effective as of May 2, 2003, we entered into a three-year
employment agreement with Yi Ping Chan, our Chief Operating Officer. Mr. Chan is
entitled to receive an annual salary equal to $250,000 per year, plus bonuses
and increases in his annual salary, at the sole discretion of the Company's
Board of Directors. In July 2003, Mr. Chan agreed to accept 15% of his salary
during nine-month period between July 1, 2003 through March 31, 2004 in the form
of stock rather than cash. We also agreed to grant Mr. Chan options to purchase
150,000 shares of the Company's common stock, of which 50,000 options will vest
each year and to reimburse him for moving expenses of up to $40,000. In the
event of a termination of his employment following a change of control, Mr. Chan
would be entitled to a lump sum payment of 100% of the amount of his total
compensation in the twelve months preceding such termination. During the term of
his employment agreement and for a period of two year after his termination for
cause and one year if he is terminated without cause Mr. Chan cannot directly or
indirectly compete with our company in the karaoke industry in the United
States.
APRIL GREEN. On March 15, 2002, we entered into a three-year employment
agreement with April Green, our Chief Financial Officer. Pursuant to Ms. Green's
employment agreement, she is entitled to receive base compensation of $122,200
per year, which amount automatically increases during the second and third years
by not less than the greater of 5% or the annual increase in the consumer price
index. The agreement also provides for discretionary bonuses based on a
percentage of the Company's current bonus pool. In the event of a termination of
her employment following a change of control, Ms. Green would be entitled to a
lump sum payment of 50% of the amount of her total compensation in the twelve
months preceding such termination. During the term of her employment agreement
and for a period of two years after her termination for cause and one year if
terminated without cause, Ms. Green cannot directly or indirectly compete with
our company in the karaoke industry in the United States.
We are currently in negotiations with Ms. Green regarding her
resignation as our Chief Financial Officer. We are planning to enter into a
separation and release agreement with Ms. Green which provides for her to
provide us with consulting services for a 20-day period after her resignation
date and a severance payment equal to approximately $115,000, which will be paid
to Ms. Green over an eight month period. As of April 1, 2004, we have not
finalized the terms of this separation and release agreement.
JOHN DAHL. On October 22, 2003, we entered into a three-year employment
agreement with John Dahl, our Senior Vice President of Finance, commencing on
November 3, 2003 and expiring on November 2, 2005. Mr. Dahl is entitled to
receive an annual salary equal to $150,000 per year, plus bonuses and increases
in his annual salary, at the sole discretion of our Board of Directors. We also
agreed to grant Mr. Dahl options to purchase 50,000 shares of our common stock,
which will be vested in accordance with the applicable stock option agreement.
As of December 1, 2003, we have not granted these options to Mr. Dahl. We also
agreed to pay Mr. Dahl $50,000 as a signing bonus and for his moving expenses.
In the event of a termination of his employment following a change of
control, Mr. Dahl would be entitled to a lump sum payment of 50% of the amount
of his total compensation in the twelve months preceding such termination.
During the term of his employment agreement and for a period of two year after
his termination for cause and one year if terminated without cause, Mr. Dahl
cannot directly or indirectly compete with our company in the karaoke industry
in the United States.
We are currently in negotiations with Mr. Dahl regarding his
resignation as our Senior Vice President of Finance. We have not finalized any
agreements with Mr. Dahl as of April 1, 2004.
46
EDDIE STEELE. On February 27, 2004, we extended our employment
agreement with Eddie Steele for another year to expire on February 28, 2005. Mr.
Steele has been an executive officer of our company since September 1991. Mr.
Steele will serve as our Director of Product Development for the next year. Mr.
Steele is entitled to receive base compensation of $250,000 per year; however,
Mr. Steele has agreed to take a 20% pay cut, so his base salary will be
$200,000. The agreement also provides for discretionary bonuses. In the event of
a termination of his employment following a change of control, Mr. Steele would
be entitled to a lump sum payment of 50% of the amount of his total compensation
in the twelve months preceding such termination. During the term of his
employment agreement and for a period of one year after his termination for
cause, Mr. Steele cannot directly or indirectly compete with our company in the
karaoke industry in the United States. Edward Steele joined the Company in 1988
and has served as an executive officer since September 1991.
JOHN KLECHA. Mr. Klecha was employed as our Chief Operating Officer
pursuant to an employment agreement dated July 1, 2000. Mr. Klecha's employment
agreement was to expire on May 31, 2003 and would automatically extend for an
additional year, until May 31, 2004, unless either party gave written notice at
least sixty days prior to the end of the three-year term. We gave Mr. Klecha
notice that we would not renew his employment agreement in February 2003. Mr.
Klecha resigned as our Chief Operating Officer and President, effective as of
May 2, 2003, but remained as an employee until May 31, 2003. In connection with
his resignation, we entered into a separation and release agreement. Under this
agreement, we agreed to provide Mr. Klecha with a payment equal to $183,707,
which consisted of (i) salary and auto allowance through May 31, 2003, (ii) four
weeks of accrued vacation time, (iii) four months of salary and automobile
allowance payments and (iv) seven months COBRA reimbursement payments. In
exchange, Mr. Klecha agreed to release the Company from any liability in
connection with termination of employment.
JACK DROMGOLD. Mr. Dromgold was employed as our Executive
Vice-president of Sales pursuant to an employment agreement dated April 15,
2002. Mr. Dromgold's resigned his position effective December 19, 2003, but
remained as a consultant to the company until February 15, 2004. In connection
with his resignation, we entered into a separation and release agreement. Under
this agreement, we agreed to provide Mr. Dromgold with payments equal to
$164,598 which consisted of (i) salary through June 30, 2004, (ii) $50,000 in
cash on the resignation date, and (iii) three months COBRA reimbursement
payments. We also entered into a two month consulting agreement with him. In
return for this and upon registration of the shares underlying the agreement, he
will receive common stock with a market value of $50,000. In exchange, Mr.
Klecha agreed to release the Company from any liability in connection with
termination of employment. As of April 1, 2004, we have not issued these shares
to Mr. Dromgold.
EQUITY COMPENSATION PLANS AND 401(K) PLAN
The Company has two stock option plans: the 1994 Amended and Restated
Stock Option Plan ("1994 Plan") and the Year 2001 Stock Option Plan ("Year 2001
Plan"). Both the 1994 Plan and the Year 2001 Plan provide for the granting of
incentive stock options and non-qualified stock options to our employees,
officers, directors and consultants As of February 1, 2004, we had 358,700
options issued and outstanding under our 1994 Plan and 761,420 options are
issued and outstanding under our Year 2001 Plan.
The following table gives information about equity awards under our
1994 Plan and the Year 2001 Plan as of February 1, 2004.
--------------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE NUMBER OF SECURITIES REMAINING
ISSUED UPON EXERCISE EXERCISE PRICE OF AVAILABLE FOR FUTURE ISSUANCE UNDER
OR OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, EQUITY COMPENSATION PLANS
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS (EXCLUDING SECURITIES IN COLUMN (A))
--------------------------------------------------------------------------------------------------------------------------
Equity Compensation
Plans approved by 1,120,120 $4.81 1,188,580
Security holders
--------------------------------------------------------------------------------------------------------------------------
Equity Compensation Plans
Not approved by Security 0 0 0
Holders
--------------------------------------------------------------------------------------------------------------------------
47
1994 PLAN
Our 1994 Plan was originally adopted by our Board of Directors in May
1994 and it was approved by our shareholders on June 29, 1994. Our shareholders
approved amendments to our 1994 Plan in March 1999 and September 2000. The 1994
Plan reserved for issuance up to 1,950,000 million share of our common stock
pursuant to the exercise of options granted under the Plan. As of March 31,
2003, we had granted all the options that are available for grant under our 1994
Plan. As of March 1, 2004, we had 358,700 options issued and outstanding under
the 1994 Plan and all of these options are fully vested as of March 31, 2003.
YEAR 2001 PLAN
On June 1, 2001, our Board of Directors approved the Year 2001 Plan and
our shareholders at a special meeting held September 6, 2001 subsequently
approved it. The Year 2001 Plan was developed to provide a means whereby
directors and selected employees, officers, consultants, and advisors of the
Company would be granted incentive or non-qualified stock options to purchase
common stock of the Company. The Year 2001 Plan authorizes an aggregate of
1,950,000 shares of the Company's common stock and a maximum of 450,000 shares
to any one individual in any one fiscal year. The shares of common stock
available under the Year 2001 Plan are subject to adjustment for any stock
split, declaration of a stock dividend or similar event. At March 1, 2004, we
have granted 821,420 options under the Year 2001 Plan, 216,233 of which are
fully vested.
The Year 2001 Plan is administered by our Stock Option Committee
("Committee"), which consists of two or more directors chosen by our Board. The
Committee has the full power in its discretion to (i) grant options under the
Year 2001 Plan, (ii) determine the terms of the options (e.g. - vesting,
exercise price), (iii) to interpret the provisions of the Year 2001 Plan and
(iv) to take such action as it deems necessary or advisable for the
administration of the Year 2001 Plan.
Options granted to eligible individuals under the Year 2001 Plan may be
either incentive stock options ("ISO's"), which satisfy the requirements of
Internal Revenue Code Section 422, or non-statutory options ("NSO's"), which are
not intended to satisfy such requirements. Options granted to outside directors,
consultants and advisors may only be NSO's. The option exercise price will not
be less than 100% of the fair market value of the Company's common stock on the
date of grant. ISO's must have an exercise price greater to or equal to the fair
market value of the shares underlying the option on the date of grant (or, if
granted to a holder of 10% or more of our common stock, an exercise price of at
least 110% of the under underlying shares fair market value on the date of
grant). The maximum exercise period of ISO's is 10 years from the date of grant
(or five years in the case of a holder with 10% or more of our common stock).
The aggregate fair market value (determined at the date the option is granted)
of shares with respect to which an ISO are exercisable for the first time by the
holder of the option during any calendar year may not exceed $100,000. If that
amounts exceeds $100,000, our Board of the Committee may designate those shares
that will be treated as NSO's.
Options granted under the Year 2001 Plan are not transferable except by
will or applicable laws of descent and distribution. Except as expressly
determined by the Committee, no option shall be exercisable after thirty (30)
days following an individual's termination of employment with the Company or a
subsidiary, unless such termination of employment occurs by reason of such
individual's disability, retirement or death. The Committee may in its sole
discretion, provide in a grant instrument that upon a change of control (as
defined in the Year 2001 Plan) that all outstanding option issued to the grantee
shall automatically, accelerate and become full exercisable. Additionally, the
obligations of the Company under the Year 2001 Plan are binding on (1) any
successor corporation or organization resulting from the merger, consolidation
or other reorganization of the Company or (2) any successor corporation or
organization succeeding to all or substantially all of the assets and business
of the Company. In the event of any of the foregoing, the Committee may, at its
discretion, prior to the consummation of the transaction, offer to purchase,
cancel, exchange, adjust or modify any outstanding options, as such time and in
such manner as the Committee deems appropriate.
48
401(K) PLAN
Effective January 1, 2001, we adopted a voluntary 401(k) plan. All
employees with at least one year of service are eligible to participate in our
401(k) plan. In fiscal 2002, we made a matching contribution of 100% of salary
deferral contributions up to 3% of pay, plus 50% of salary deferral
contributions from 3% to 5% of pay for each payroll period. The amounts charged
to earnings for contributions to this plan and administrative costs during the
years ended March 31, 2003, 2002 and 2001 totaled $61,466, $41,733 and $8,682,
respectively.
CERTAIN TRANSACTIONS
On or about July 10, 2003, certain officers and directors of our
company advanced $1 million to our company pursuant to written loan agreements.
The officer was Yi Ping Chan and the directors were Jay Bauer and Howard Moore.
Additionally, Maureen LaRoche, a business associate of Mr. Bauer, participated
in the financing. This loan bears interest at the rate of 9.5% per annum. It is
presently expected that the loan will be repaid after March 31, 2004, as the
debt is subordinated to our agreement with Milberg Factors, Inc.
When our outside Board members approved this transaction, they approved
the interest rate on the loan and also approved granting additional
compensation, such as warrants, to the investment group, if an investment bank
provided a fairness opinion on the issuance of the additional consideration.
Under Delaware law, the members of our Board of Directors have the authority to
approve additional compensation to the investment group. If we retain an
investment banking firm, we will accept recommendations from it on the type and
amount of additional compensation that should be granted to the investment
group. We expect that any additional compensation would probably be warrants,
because unlike the issuance of stock, warrants with an exercise price equal to
the fair market value on the date of grant, do not have a direct impact on our
statement of operations. However, we will remain open to any suggestions from
our investment banking firm on the amount and type of compensation that would be
acceptable for this transaction.
On about March 4, 2003, Jay Bauer, one of our directors advanced
$400,000 to International SMC pursuant to a letter agreement, which used the
funds to make an advance to a vendor for the purchase of raw materials for the
production of our machines. We were to repay Mr. Bauer's loan in two months on
or about May 4, 2003 and the loan bore interest at the rate of 8% per annum. We
repaid $200,000 on the loan on or about May 4, 2003 and the remaining balance
was paid on or about October 10, 2003.
On July 1, 1999, we loaned $55,000 to each of Eddie Steele and John
Klecha to purchase 2 units in our private placement. In May and June 1999, we
raised $1,100,000 in a private offering. Our company needed the capital because
we had just emerged from our Chapter 11 filing. We sold 40 units to 17 investors
at an offering price of $27,500 per unit. Each unit consisted of 20,000 shares
of the Company's convertible preferred stock and warrants to purchase 4,000
shares of the Company's common stock . These loans bore interest at the rate of
9% per annum and were due on June 28, 2001. Mr. Klecha and Mr. Steele repaid
these loans and all accrued interest in June 2001.
In June 1999, we arranged a credit facility with Main Factors Inc.,
whereby Main Factors purchased certain of our accounts receivable. To secure the
credit facility, John Klecha, our Chief Operating Officer and Chief Financial
Officer at that time, provided his personal payment guaranty. In July 1999, we
entered into an agreement with EPK Financial Corporation ("EPK") whereby EPK
provided letters of credit to our factories to import inventory for distribution
to our customers. To secure the EPK facility, Edward Steele and John Klecha each
provided their personal guarantees. In consideration for providing their
personal guarantees of these credit facilities, we issued 200,000 shares of our
common stock to Mr. Steele and 150,000 shares of our common stock to Mr. Klecha
in June 1999. Both agreements with Main Factors and EPK were terminated in April
2001. We issued the shares to Mr. Steele and Mr. Klecha in reliance upon Section
4(2) of the Securities Act of 1933, because each of them was knowledgeable,
sophisticated and had access to comprehensive information about us. We placed
legends on the certificates stating that the securities were not registered
under the Securities Act and set forth the restrictions on their transferability
We amortized the value of these deferred guarantee fees over a two year period,
which was completed in the first quarter of fiscal 2002.
PRINCIPAL STOCKHOLDERS
The following table set forth as of March 1, 2004, certain information
concerning beneficial ownership of our common stock by:
o all directors of the Company,
49
o all executive officers of the Company.
o persons known to own more than 5% of our common stock;
Unless otherwise indicated, the address for each person is The Singing
Machine Company, Inc., 6601 Lyons Road, Building A-7, Coconut Creek, Florida
33073. As of March 1, 2004, we had 8,752,320 shares of our common stock issued
and outstanding.
As used herein, the term beneficial ownership with respect to a
security is defined by Rule 13d-3 under the Securities Exchange Act of 1934 as
consisting of sole or shared voting power (including the power to vote or direct
the vote) and/or sole or shared investment power (including the power to dispose
or direct the disposition of) with respect to the security through any contract,
arrangement, understanding, relationship or otherwise, including a right to
acquire such power(s) during the next 60 days. Unless otherwise noted,
beneficial ownership consists of sole ownership, voting and investment rights.
The following table set forth as of March 1, 2004, certain information
concerning beneficial ownership of our common stock by:
o all directors of the Company,
o all executive officers of the Company.
o persons known to own more than 5% of our common stock;
Unless otherwise indicated, the address for each person is The Singing
Machine Company, Inc., 6601 Lyons Road, Building A-7, Coconut Creek, Florida
33073. As of March 1, 2004, we had 8,752,320 shares of our common stock issued
and outstanding.
As used herein, the term beneficial ownership with respect to a
security is defined by Rule 13d-3 under the Securities Exchange Act of 1934 as
consisting of sole or shared voting power (including the power to vote or direct
the vote) and/or sole or shared investment power (including the power to dispose
or direct the disposition of) with respect to the security through any contract,
arrangement, understanding, relationship or otherwise, including a right to
acquire such power(s) during the next 60 days. Unless otherwise noted,
beneficial ownership consists of sole ownership, voting and investment rights.
SHARES OF PERCENTAGE OF
NAME COMMON STOCK COMMON STOCK
--------------------------------------------------- ------------ -------------
Y.P. Chan 67,652(1) *
Chief Executive Officer and Chief Operating Officer
April Green 31,050(2) *
Chief Financial Officer
John Dahl 0 *
Senior Vice President of Finance
Joseph Bauer 975,572(3) 11.14%
Director
Bernard Appel 0 *
Director
2,000 *
Richard Ekstract
Director
Eddie Steele 1,169,596(4) 12.84%
Former Chief Executive Officer And Director(5)
John Klecha 810,811(5) 9.26%
Former Officer and Director(6)
Wellington Management Company, LLP(7) 939,400(6) 10.73%
All Directors and Executive Officers as a Group 1,076,274(7) 12.12%
50
----------
*Less than 1%.
(1) Includes 50,000 shares issuable upon the exercise of stock options that are
exercisable within 60 days of March 1, 2004.
(2) Includes 30,000 shares issuable upon the exercise of stock options that are
exercisable within 60 days of March 1, 2004.
(3) Includes 17,596 shares which are held by Mr. Bauer directly, 360,000 shares
held by Mr. Bauer's pension plan, 179,600 shares held by the Bauer Family
Limited Partnership, 200,000 shares held by Mr. Bauer's wife, 193,975
shares held by Mr. Bauer and his wife directly and 20,000 shares issuable
upon the exercise of stock options that are exercisable within 60 days of
March 1, 2004.
(4) Effective as of August 3, 2003, Mr. Steele resigned as our Chief Executive
Officer and as a director. Mr. Steele will continue to be an employee of
the Company until February 28, 2004. Includes 152,910 shares held by Mr.
Steele's wife and 352,500 shares issuable upon the exercise of stock
options that are exercisable within 60 days of March 1, 2004.
(5) Mr. Klecha resigned as Chief Operating Officer effective as of May 2, 2003
and as a director effective as of July 28, 2003.
(6) The address of Wellington Management Company, LLP is 78 State Street,
Boston, Massachusetts 02109. All of the information presented in this item
with respect to this beneficial owner was extracted solely from their
Scheduled 13G filed on February 12, 2004.
(7) Includes 100,000 shares issuable upon the exercise of stock options that
are exercisable within 60 days of March 1, 2004/
DESCRIPTION OF SECURITIES
We are authorized to issue:
o 18,900,000 shares of common stock,
o 100,000 shares of Class A common stock, and
o 1,000,000 shares of convertible preferred stock.
As of March 1, 2004, we have 8,752,320 shares of our common stock
issued and outstanding and no shares of Class A common stock or convertible
preferred stock are issued and outstanding.
COMMON STOCK
We are authorized to issue up to 18,900,000 shares of our common stock,
par value $0.01 per share. The holders of our common stock are entitled to one
vote for each share held of record on all matters to be voted on by
stockholders. There is no cumulative voting with respect to the election of
directors, with the result that the holders of more than 50% of the shares voted
for the election of directors can elect all of the directors. The holders of our
common stock are entitled to receive dividends when, as and if declared by the
Board of Directors out of funds legally available. In the event of liquidation,
dissolution or winding up of the Company, the holders of our common stock are
entitled to share ratably in all assets remaining available for distribution to
them after payment of liabilities and after provision has been made for each
class of stock, if any, having preference over the common stock. Holders of
shares of common stock, as such, have no conversion, preemptive or other
subscription rights, and, except as noted herein, there are no redemption
provisions applicable to the common stock. All of the outstanding shares of
common stock are validly issued, fully paid and nonassessable.
51
CLASS A COMMON STOCK
Our Certificate of Incorporation authorizes the issuance of 100,000
shares of Class A Common Stock, par value $0.01 per share. In connection with
our public offering in 1994, all issued shares of our Class A common stock were
converted into shares of our common stock. We do not plan on issuing any shares
of our Class A common stock and will delete this provision from our Certificate
of Incorporation when we file the next amendment to our Certificate of
Incorporation, which will be at our next shareholder's meeting.
CONVERTIBLE PREFERRED STOCK
Our Board of Directors has the authority, without further action by our
stockholders, to issue up to 1,000,000 shares of our preferred stock, par value
$1.00 per share, in one or more series and to fix the rights, preferences,
privileges and restrictions thereof. In April 1999, we authorized the issuance
of 1,000,000 shares of our convertible preferred stock in connection with a
private offering of our units. All of these shares of convertible preferred
stock were converted into shares of our common stock automatically on April 1,
2000.
We do not plan on issuing any shares of our convertible preferred stock
in the near future and will delete this provision from our Certificate of
Incorporation when we file the next amendment to our Certificate of
Incorporation, which will be at our next shareholder's meeting.
ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS OF OUR ARTICLES OF INCORPORATION,
BYLAWS AND DELAWARE LAW
Certain provisions of our amended certificate of incorporation, bylaws
and Delaware law, which are summarized below, may be deemed to have an
anti-takeover effect and may delay, defer or prevent a tender offer or takeover
attempt that a stockholder might consider in its best interest, including those
attempts that might result in a premium over the market price for the shares
held by stockholders.
CUMULATIVE VOTING
Our amended certificate of incorporation does not permit our
stockholders the right to cumulate votes in the election of directors.
SPECIAL MEETING OF STOCKHOLDERS
Our bylaws provided that special meetings of our stockholders may only
be called by (1) resolution of the Board or the president or (2) the president
or the secretary upon the written request (stating the purpose of the meeting)
of a majority of the directors then in office or the holders of a majority of
the outstanding shares entitled to vote.
AUTHORIZED BUT UNISSUED SHARES
The authorized but unissued shares of common stock are available for
future issuance without stockholder approval. These additional shares may be
utilized for a variety of corporate purposes, including public or private
offerings to raise capital, corporate acquisitions and employee benefit plans.
The existence of authorized but unissued shares of common stock could render
more difficult or discourage an attempt to obtain control of us, by means of a
proxy contest, tender offer, merger or otherwise.
LIMITATIONS ON LIABILITY AND INDEMNIFICATION MATTERS
We have adopted provisions in our amended certificate of incorporation
and bylaws that limit the liability of our directors to the fullest extent
permitted by the by the Delaware General Corporation Law. Pursuant to such
provisions, no director will be liable to the Company or its stockholders for
monetary damages for breaches of certain fiduciary duties as a director of the
Company. The limitation of liability will not affect a director's liability for
(1) a breach of the director's duty of loyalty to the Company or its
stockholders, (2) an act or omission not in good faith or that involves
intentional misconduct or a knowing violation of the law, (3) any unlawful
distributions, or (4) a transaction from which the director receives an improper
personal benefit. The limitation of liability also will not affect the
availability of equitable remedies such as injunctive relief or rescission.
Our amended certificate of incorporation and bylaws require us to
indemnify our officers and directors to the fullest extent permitted by Delaware
52
law. We have entered into indemnification agreements with each of our directors
and executive officers. These agreements, among other things, indemnify our
directors and executive officers for certain expenses, judgments, fines and
settlement amounts incurred by them in any action or proceeding, including any
action by or in the right of the Company, arising out of the person's services
as a director or executive officer of the Company or any other company or
enterprise to which the person provides services at our request. We believe that
these provisions and agreements are necessary to attract and retain qualified
directors and executive officers.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to our directors, officers and controlling person based on
the foregoing provisions, we have been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
and is, therefore, unenforceable.
DELAWARE LAW
Under Delaware law, a corporation may not engage in any "business
combination" (as defined in the Delaware General Corporation Law) with an
"interested stockholder" for three years after such stockholder becomes an
interested stockholder. An interested stockholder is any person who is the
beneficial owner of 15% or more of the outstanding voting stock of the
corporation. A corporation may enter into a business combination with an
interested stockholder if:
(a) the Board of Directors approves either the business combination or
the transaction which resulted in the stockholder becoming an
interested stockholder before the date on which the stockholder
becomes an interested stockholder;
(b) upon consummation of the transaction resulting in the stockholder
reaching the 15% threshold, the stockholder owned 85% of the
outstanding voting shares at the time the transaction commenced,
excluding those shares held by directors who are also officers or
employee stock plans in which the participants do not have the
right to determine confidentially whether shares subject to the
plan will be tendered in a tender or exchange offer; or
(c) on or subsequent to becoming an interested stockholder, the
business combination is approved by the Board of Directors and is
authorized at a meeting by the affirmative vote of at least
two-thirds of the outstanding voting stock not owned by the
interested stockholder.
TRANSFER AGENT
The transfer agent for our common stock is Continental Stock Transfer &
Trust Co., 2 Broadway New York, New York 10004.
SHARES ELIGIBLE FOR FUTURE SALE
As of March 1 2004, we have 8,752,320 shares of our common stock issued
and outstanding. If the 2,795,465 shares registered in this Prospectus are
issued, we will have 11,551,785 shares issued and outstanding. Of these shares,
all of the 2,795,465 shares registered in this offering will be freely tradeable
without restriction or further registration under the Securities Act, unless
such shares are purchased by "affiliates" as that term is defined in Rule 144
under the Securities Act. Shares that cannot be traded without restriction are
referred to as "restricted securities" as that term is defined in Rule 144 under
the Securities Act. As of March 1, 2004, approximately 5,954,796 shares are
eligible for sale under Rule 144. Restricted securities may be sold in the
public market only if registered of if they qualify for an exemption from
registration under Rule 144 of the Securities Act.
RULE 144
In general, under Rule 144 as currently in effect, a person (or group
of person whose shares are aggregated), including affiliates of the Company, who
have beneficially owned shares of our common stock for at least one year would
be entitled to sell within any three-month period, an amount of restricted
securities that does not exceed the greater of:
o 1% of the number of shares of common stock then outstanding
(approximately 87,563 shares as of March 1, 2004; or
53
o the average weekly trading volume in the common stock during the four
calendar weeks preceding the filing of a notice on Form 144 with
respect to such sale.
Sales under Rule 144 are also subject to certain manner of sale
provisions and notice requirements and to the availability of current public
information about us.
RULE 144(K)
Under Rule 144(k), a person who is not deemed to have been one of our
affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years,
including the holding period of any prior owner other than an affiliate, is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.
No prediction can be made as to the effect, if any that market sales of
the Company's common stock, or the availability of the common stock for sale,
will have on the market price of the common stock prevailing from time to time.
Nevertheless, sales of a significant number of shares of the Company's common
stock in the public market, or the perception that such sales could occur, could
adversely affect the market price of the common stock and impair our future
ability to raise capital through an offering of equity securities. See "Risk
Factors - Future sales of our common stock may depress our stock price."
LEGAL MATTERS
The validity of the securities being offered hereby will be passed upon
by Adorno & Yoss, P.A., 700 S. Federal Highway, Suite 200, Boca Raton, Florida
33432.
EXPERTS
Our financial statements for the year ended March 31, 2003 appearing in
this Prospectus and registration statement have been audited by Grant Thornton
LLP, as independent certified public accountants, as set forth in their report
appearing elsewhere herein, and are included in reliance upon the report given
on the authority of the firm as experts in accounting and auditing. Our
financial statements for the years ended March 31, 2002 and 2001 appearing in
this Prospectus and registration statement have been audited by Salberg &
Company, P.A., as independent certified public accountants, as set forth in
their report appearing elsewhere herein, and are included in reliance upon the
report given on the authority of the firm as experts in accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a
registration statement on Form S-1 pursuant to the Securities Act of 1933, as
amended, with respect to the offer, issuance and sale of 2,795,465 shares of our
common stock. This Prospectus does not contain all of the information set forth
in the registration statement. For further information with respect to us, and
the shares of our common stock to be sold in this offering, we make reference to
the registration statement.
You may read and copy all or any portion of the registration statement
or any other information, which we filed at the SEC's public reference rooms in
Washington, D.C., New York, New York, and Chicago, Illinois. The address for the
SEC's public reference room in Washington, D.C. is Judiciary Plaza, 450 Fifth
Street, N.W., Washington, DC 20549. You can request copies of these documents,
upon payment of a duplicating filing fee, by writing to the SEC. Please call the
Securities and Exchange Commission at 1-800-SEC-0330 for further information on
the operation of the public reference rooms. Our SEC filings are also available
to you free or charge at the SEC's web site at http://www.sec.gov.
54
THE SINGING MACHINE COMPANY, INC.
INDEX TO FINANCIAL STATEMENTS
UNAUDITED FINANCIAL STATEMENTS FOR THE
NINE MONTHS ENDED DECEMBER 31, 2003 AND 2002
Consolidated Balance Sheets - December 31, 2003 (Unaudited) and March 31, 2003
Consolidated Statements of Operations - Nine Months Ended December 31, 2003
and 2002 (Unaudited)
Consolidated Statements of Cash Flows . - Nine Months Ended December 31, 2003
and 2002 (Unaudited)
Notes to Consolidated Financial Statements
AUDITED FINANCIAL STATEMENTS AS OF MARCH 31, 2003 AND 2002 AND THE FISCAL
YEARS ENDED MARCH 31, 2003, 2002 AND 2001
Independent Certified Public Accountants' Reports
Consolidated Balance Sheets as of March 31, 2003 and 2002
Consolidated Statements of Earnings for the Years Ended March 31, 2003, 2002
and 2001
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended
March 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the Years ended March 31, 2003, 2002
and 2001
Notes to Consolidated Financial Statements as of March 31, 2003, 2002 and 2001
F-1
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, MARCH 31,
2003 2003
------------ ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 235,958 $ 268,265
Restricted Cash 866,413 838,411
Accounts Receivable, less allowances of $816,235 and $405,759
respectively 14,729,176 5,762,944
Due from manufacturer 1,112,200 1,091,871
Inventories, net 8,029,371 25,194,346
Prepaid expense and other current assets 2,294,377 1,483,602
Deferred tax asset -- 1,925,612
------------ ------------
TOTAL CURRENT ASSETS 27,267,495 36,565,051
PROPERTY AND EQUIPMENT, at cost less accumulated depreciation of
$2,567,480 and $1,472,850 respectively 1,365,687 2,026,252
OTHER ASSETS
Other non-current assets 970,464 343,991
------------ ------------
TOTAL ASSETS $ 29,603,646 $ 38,935,294
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Bank overdraft $ 85,236 $ 316,646
Accounts payable 5,331,470 8,486,009
Accrued expenses 2,587,579 1,443,406
Subordinated debt-related parties 1,000,000 400,000
Revolving credit facilities 7,115,114 6,782,824
Income taxes payable 2,872,509 3,821,045
------------ ------------
TOTAL CURRENT LIABILITIES 18,991,908 21,249,930
------------ ------------
LONG TERM LIABILITIES
Convertible debentures, net of unamortized discount of $3,046,000 954,210 --
------------ ------------
TOTAL LIABILITIES 19,946,118 21,249,930
SHAREHOLDERS' EQUITY
Preferred stock, $1.00 par value; 1,000,000 shares authorized, no
shares issued and outstanding -- --
Common stock, Class A, $.01 par value; 100,000 shares authorized; no
shares issued and outstanding -- --
Common stock, $0.01 par value; 18,900,000 shares authorized;
8,752,320 and 8,171,678 shares issued and outstanding 87,523 81,717
Additional paid-in capital 10,234,410 4,843,430
Retained earnings (664,405) 12,760,217
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 9,657,528 17,685,364
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 29,603,646 $ 38,935,294
============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-2
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
December 31, December 31,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(as restated) (as restated)
NET SALES $ 28,689,623 $ 45,659,446 $ 68,053,739 $ 81,915,443
COST OF SALES
Cost of goods sold 30,782,268 36,628,126 64,948,809 64,155,095
Impairment of tooling 508,480 -- 508,480 --
------------ ------------ ------------ ------------
GROSS PROFIT (2,601,125) 9,031,320 2,596,449 17,760,348
OPERATING EXPENSES:
Compensation 1,097,327 1,257,519 3,552,718 2,827,823
Freight & handling 523,177 944,169 1,153,353 1,605,445
Selling, general & administrative expenses 3,410,116 1,748,400 8,908,899 4,675,279
------------ ------------ ------------ ------------
TOTAL OPERATING EXPENSES 5,030,620 3,950,088 13,614,971 9,108,547
------------ ------------ ------------ ------------
(LOSS) EARNINGS FROM OPERATIONS (7,631,744) 5,081,232 (11,018,521) 8,651,801
OTHER INCOME (EXPENSES):
Other income 32,098 38,628 (50,882) 196,648
Interest expense (687,178) (117,704) (1,194,541) (228,597)
Interest income -- -- -- 11,943
------------ ------------ ------------ ------------
NET OTHER (EXPENSES) INCOME (655,079) (79,076) (1,245,422) (20,006)
NET (LOSS) EARNINGS BEFORE INCOME TAX (8,286,825) 5,002,156 (12,263,944) 8,631,795
INCOME TAX EXPENSE 2,163,776 1,681,629 1,160,678 2,674,659
------------ ------------ ------------ ------------
NET (LOSS) EARNINGS $(10,450,601) $ 3,320,527 $(13,424,622) $ 5,957,136
============ ============ ============ ============
(LOSS) EARNINGS PER SHARE:
Basic $ (1.20) $ 0.41 $ (1.58) $ 0.74
Diluted $ (1.20) $ 0.37 $ (1.58) $ 0.67
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT SHARES OUTSTANDING:
Basic 8,729,818 8,123,548 8,503,065 8,101,441
Diluted 8,729,818 8,944,027 8,503,065 8,947,897
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-3
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
FOR THE NINE MONTHS ENDED
DECEMBER 31,
------------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES (restated)
Net (loss) earnings $(13,424,622) $ 7,475,119
Adjustments to reconcile net (loss) earnings to net cash used in
operating activities
Depreciation and amortization 1,165,687 454,806
Impairment of tooling 508,480
Provision for inventory 4,996,685 --
Provision for bad debt 410,476 --
Amortization of discount on convertible debentures 444,584 --
Stock compensation expense 511,299 --
Deferred tax benefit 1,925,612 452,673
Changes in assets and liabilities:
(Increase) decrease in:
Accounts Receivable (9,376,708) (15,998,298)
Due from manufacturer (20,329) (264,908)
Inventories 12,168,290 (20,742,572)
Prepaid Expenses and other assets (858,011) (1,218,091)
Increase (decrease) in:
Accounts payable (3,154,539) 11,203,268
Accrued expenses 653,540 3,705,878
Income taxes payable (948,536) 572,254
------------ ------------
Net Cash Used in Operating Activities (4,998,092) (14,359,871)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (434,065) (1,112,376)
------------ ------------
Net cash used in Investing Activities (434,065) (1,112,376)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings from revolving credit facilities 27,777,630 37,612,713
Repayments to revolving credit facilities (27,445,340) (27,449,625)
Proceeds from issuance of convertible debentures 4,000,000 --
Bank Overdraft (231,410) --
Restricted cash (28,002) (3,640)
Payment of financing fees related to convertible debentures (255,000) --
Proceeds from subordinated debt-related parties, net 600,000 --
Proceeds from exercise of stock options and warrants 981,972 155,579
------------ ------------
Net cash provided by Financing Activities 5,399,850 10,315,027
------------ ------------
DECREASE IN CASH AND CASH EQUIVALENTS (32,307) (5,157,220)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 268,265 5,520,147
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 235,958 $ 362,927
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
CASH PAID FOR THE NINE MONTHS ENDED DECEMBER 31, 2003
Interest $ 591,817 $ 228,597
============ ============
Income Taxes $ 1,388,102 $ 73,207
============ ============
NON-CASH FINANCING ACTIVITIES
Stock based compensation $ 511,299 $ --
============ ============
Discounts for warrants issued in connection with and beneficial $ 3,494,274 $ --
conversion feature of convertible debentures
============ ============
Financing fees in connection with convertible debenture issuance,
paid in stock and warrants 409,527 --
============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-4
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - SUMMARY OF ACCOUNTING POLICIES
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include the
accounts of The Singing Machine Company, Inc. and International SMC (H.K.) Ltd.,
its wholly-owned subsidiary (the "Company", "The Singing Machine"). All
significant intercompany transactions and balances have been eliminated. The
unaudited consolidated financial statements have been prepared in conformity
with Rule 10-01 of Regulation S-X of the Securities and Exchange Commission and
therefore do not include information or footnotes necessary for a complete
presentation of financial position, results of operations and cash flows in
conformity with accounting principles generally accepted in the United States of
America. However, all adjustments (consisting of normal recurring accruals),
which, in the opinion of management, are necessary for a fair presentation of
the financial statements, have been included. Operating results for the period
ended December 31, 2003 are not necessarily indicative of the results that may
be expected for the remaining quarter or the year ending March 31, 2004 due to
seasonal fluctuations in The Singing Machine's business, changes in economic
conditions and other factors. For further information, please refer to the
Consolidated Financial Statements and Notes thereto contained in The Singing
Machine's Annual Report on Form 10-K for the year ended March 31, 2003.
INVENTORIES
Inventories are comprised of electronic karaoke audio equipment, accessories,
and compact discs and are stated at the lower of cost or market, as determined
using the first in, first out method. The following table represents the major
components of inventory at the dates specified.
December 31, 2003 March 31, 2003
----------------- --------------
Finished goods $ 13,463,330 $ 27,807,763
Inventory in transit 1,200,221 1,101,940
Provision for losses (6,634,180) (3,715,357)
------------ ------------
Total Inventory $ 8,029,371 $ 25,194,346
============ ============
Although management has taken a provision, which they estimate, based on recent
contacts with customers, to be a sufficient reserve for potential losses on
disposal of existing inventory, the Company's sales are highly seasonal and unit
sales and their related selling prices during peak seasons may not meet
expectations. Therefore, management's estimates could differ significantly from
actual outcome and have a material impact on future operations. The Company also
made the decision to discontinue certain models from their line. A reserve was
taken against the remaining inventories of these discontinued items to enable
the items to be sold through alternate sales arenas, such as through liquidation
facilities. Management believes that at September 30, 2003, there was not
sufficient evidence warranting an additional reserve against inventory at that
time, as the peak selling season had just begun and there were no indications
that the inventory would not be sold.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to the current
period presentation.
F-5
STOCK BASED COMPENSATION
The Company accounts for stock options issued to employees using the intrinsic
value method in accordance with the provisions of Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. As such, compensation cost is measured on the date of grant as
the excess of the current market price of the underlying stock over the exercise
price, if any. 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 ("Statement") No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment
of Statement No. 123", "Accounting for Stock Based Compensation", 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 Statement 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, pursuant to
Statement No. 123, the Company's net (loss) earnings would have been changed to
the pro-forma amounts indicated below.
FOR THE THREE MONTHS ENDED DECEMBER 31, FOR THE NINE MONTHS ENDED DECEMBER 31,
2003 2002 2003 2002
------------------ ------------------- ----------------- -------------------
Net (loss) earnings As reported $(10,450,601) $3,320,527 $(13,424,622) $5,957,136
Pro forma $(10,653,283) $3,291,655 $(14,032,668) $5,870,518
Net (loss) earnings per share - As reported $(1.20) $0.41 $(1.58) $0.74
basic
Pro forma $(1.22) $0.41 $(1.65) $0.72
Net (loss) earnings per share As reported $(1.20) $0.37 $(1.58) $0.67
-diluted
Pro forma $(1.22) $0.37 $(1.65) $0.66
Stock-based compensation -- -- 511,933 --
For stock options and warrants issued to non-employees, the Company applies the
fair value method of accounting pursuant to Statement 123. Due to a change in
status of a former employee, an expense of $220,835 was charged to compensation
expense in August 2003.
For financial statement disclosure purposes and for purposes of valuing stock
options and warrants issued to non-employees, 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 Statement No. 123 using the following
weighted-average assumptions:
Third Quarter 2004: expected dividend yield 0%, risk-free interest rate of 2.5%,
volatility 110.05% and expected term of five years. Third Quarter 2003: expected
dividend yield 0%, risk-free interest rate of 6.8%, volatility 42% and expected
term of two years.
RECENT ACCOUNTING PRONOUNCEMENTS
Statement No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" amends and clarifies accounting for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities under Statement 133. Statement 149 is generally effective for
contracts entered into or modified after June 30, 2003 (with a few exceptions)
and for hedging relationships designated after June 30, 2003. The provisions of
Statement 149 did not have a material impact on the Company's financial position
or results of operations.
Statement No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" improves the accounting for
certain financial instruments that, under previous guidance, issuers could
account for as equity. The new Statement requires that those instruments be
classified as liabilities in statements of financial position. This statement is
effective for instruments entered into or modified after May 31, 2003. The
provisions of Statement 150 did not have a material impact on the Company's
financial position or results of operations.
F-6
NOTE 2 - GOING CONCERN
The accompanying unaudited consolidated financial statements have been prepared
in conformity with accounting principles generally accepted in the United States
of America, which contemplate continuation of the Company as a going concern
(See Management Discussion and Analysis - Liquidity and Capital Resources).
On March 14, 2003, the Company was notified of its violation of the tangible net
worth covenant of its Loan and Security Agreement (the "Agreement") with its
commercial lender and the Company was declared in default under the Agreement.
The lender amended the Agreement on August 19, 2003. Pursuant to this fourteenth
amendment the loan was extended until March 31, 2004 and the condition of
default was waived.
As of December 31, 2003, the Company again violated the tangible net worth and
working capital covenants of the Agreement. As of January 31, 2004 the loan was
paid in full, the facility was terminated and the UCC filings were released.
NOTE 3 - RESTATEMENT OF FINANCIAL STATEMENTS FOR THE FISCAL YEARS 2002 AND 2001
In June 2003, management revised its position on taxation of the income of
International SMC (H.K.) Ltd., its wholly-owned subsidiary, by the United States
and by the Hong Kong tax authorities for the reasons stated below.
With regard to taxation in Hong Kong, International SMC had previously applied
for a Hong Kong offshore claim income tax exemption based on the locality of its
profits. Management believed that the exemption would be approved because the
source of all profits of International SMC is from exporting to customers
outside of Hong Kong. Accordingly, no provision for income taxes was provided in
the consolidated financial statements as of March 31, 2002 and 2001. However,
full disclosure was previously reflected in the audited financial statements for
years ended March 31, 2002 and 2001 of the estimated amount that would be due to
the Hong Kong tax authority should the exemption be denied. Management is
continuing its exemption application process. However, due to the extended
period of time that the application has been outstanding, as well as
management's reassessment of the probability that the application will be
approved, management has determined to restate the 2002 and 2001 consolidated
financial statements to provide for such taxes. The effect of such restatement
is to increase income tax expense by $748,672 and $468,424 in fiscal 2002 and
2001, respectively. However, the Company can claim United States foreign tax
credits in 2002 for these Hong Kong taxes, which is reflected in the final
restated amounts.
With regard to United States taxation of foreign income, the Company had
originally taken the position that the foreign income of the Hong Kong
subsidiary was not taxable under the Internal Revenue Code (Section 956) until
such income is repatriated, or brought back into the United States as taxable
income. It was expected that this income would remain in Hong Kong. Full
disclosure of the amount and nature of the indefinite deferral for fiscal year
2002 was reflected in the income tax footnote of the consolidated financial
statements for that year. The internal revenue code, regulations and case law
regarding international income taxation is quite complex and subject to
interpretation. Each case is determined based on the individual facts and
circumstances. Due to certain inter-company loans, relating to inventory
purchases, made in 2002 and 2003, the profits previously considered to be
indefinitely deferred became partially taxable as "deemed dividends" under
section 956 of the Internal Revenue Code. Although certain arguments against the
imposition of a "deemed dividend" may be asserted, management has determined to
restate the fiscal year 2002 consolidated financial statements based on its
reassessment of its original position. The effect of such restatement is to
increase income tax expense by $1,027,545 in fiscal year 2002, which includes
the utilization of the foreign tax credits referred to above.
The net effect of the above two adjustments for the quarter and nine months
ended December 31, 2002 is to decrease net income by $576,060 and $1,517,983,
respectively. The net effect on net income per share is to decrease net income
per share basic and diluted by $0.07 and $0.06 for the quarter and $0.18 and
$0.17 for the nine months ended December 31, 2002.
NOTE 4 - IMPAIRMENT OF TOOLING
Pursuant to Statement No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", the Company recorded a loss on impairment of tooling. In
December 2003, and as a result of the Company's decision to discontinue certain
models, management estimated that the amounts recoverable on certain tooling
through future operations, on an undiscounted basis, were below their book
values. An expense of $508,480 was charged to operations for this impairment.
F-7
NOTE 5 - PROVISION FOR INCOME TAX
Significant management judgment is required in developing the Company's
provision for income taxes, including the determination of foreign tax
liabilities, deferred tax assets and liabilities and any valuation allowances
that might be required against the deferred tax assets. At December 31, 2003,
the Company concluded that a valuation allowance was needed against all of the
Company's deferred tax assets, as it is not more likely than not that the
deferred taxes will be realized. For the three months ended December 31, 2003,
the Company recorded a tax provision of $2.2 million. This provision was created
because the valuation allowance established against the deferred tax asset
exceeded the amount of the benefit created from carrying back a portion of the
current period losses. The carry-back of the losses from the current period
resulted in an income tax receivable of $1.2 million, which is included in
prepaid and other current assets in the accompanying balance sheets.
The Company's wholly-owned subsidiary, has applied for an exemption of income
tax in Hong Kong. Therefore, no taxes have been expensed or provided for at the
Subsidiary level. Although the governing body has reached no decision to date,
the U.S. parent company has reached the decision to provide for the possibility
that the exemption could be denied and accordingly has recorded a provision in
fiscal 2004, 2003, 2002, and 2001. For the nine months ended December 31, 2003,
a provision of $424,763 was recorded at the Hong Kong statutory rate of 17.5%.
Accrued Hong Kong taxes payable on the current and prior earnings of the
Company's Hong Kong subsidiary totaled $2.9 million at December 31, 2003.
The Company operates within multiple taxing jurisdictions and is subject to
audit in those jurisdictions. Because of the complex issues involved, any claims
can require an extended period to resolve. In management's opinion, adequate
provisions for income taxes have been made.
NOTE 6 - LOANS AND LETTERS OF CREDIT
CREDIT FACILITY
The Company's Hong Kong Subsidiary maintains separate credit facilities at two
international banks. The primary purpose of the facilities is to provide the
Subsidiary with the following abilities:
o Overdraft protection facilities
o Issuance and negotiation of letters of credit, both regular and discrepant
o Trust receipts
o A Company credit card
The facilities are secured by a corporate guarantee from the U.S. Company,
restricted cash on deposit with the lender and require that the Company maintain
a minimum tangible net worth. The maximum available credit under the facilities
is $5.5 million. The balance at December 31, 2003 and 2002 was $4,640,728 and
$0, respectively.
LOAN AND SECURITY AGREEMENT
On April 26, 2001, the Company executed a Loan and Security Agreement (the
"Agreement") with a commercial lender (the "Lender"), which as amended on August
19, 2003, was due to expire on March 31, 2004. At December 31, 2003 and 2002 the
amount outstanding was $2,474,386 and $10,163,088, respectively. As of January
31, 2004 the loan was paid in full, the facility was terminated and the UCC
filings were released.
SUBORDINATED DEBT
As of July 10, 2003, the Company obtained $1 million in subordinated debt
financing from a certain officer, directors and an associate of a director. The
loans are accruing interest at 9.5% per annum and paid quarterly. These loans
were originally scheduled to be paid back by October 31, 2003; however, the
notes have since been subordinated to the Company's credit facility and the
total amount outstanding of $1 million will not be repaid until either the
subordination is released by the Company's lender or the credit facility is
closed.
F-8
NOTE 7 - 8% 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 subordinated to the Company's Lender and are
convertible at the option of the holders into 1,038,962 Common Shares at the
conversion rates referred to below, subject to certain anti-dilution adjustment
provisions, at any time after the closing date. Each Convertible Debenture may
be convertible into common shares, at a conversion price of $3.85 per Common
Share. of the registration statement.
The Convertible Debentures are subordinated to the Company's Lender and are
convertible at the option of the holders into 1,038,962 Common Shares at the
conversion rates referred to below, subject to certain anti-dilution adjustment
provisions, at any time after the closing date. Each Convertible Debenture may
be convertible into common shares, representing an initial conversion price of
$3.85 per Common Share.
These Convertible Debentures were issued with 457,143 detachable stock purchase
warrants with an exercise price of $4.025 per share. These warrants may be
exercised at anytime after September 8, 2003 and before September 7, 2006 and
are subject to certain anti-dilution provisions. The warrants are also subject
to an adjustment provision; whereas the price of the warrants may be changed
under certain circumstances.
The Convertible Debentures bear interest at the stated rate of 8% per annum.
Interest is payable quarterly on March 1, June 1, September 1, and December 1.
The interest may be payable in cash, shares of Common Stock, or a combination
thereof subject to certain provisions and at the discretion of the Company. On
February 9, 2004 the stated rate of interest was raised to 8.5%.
In accounting for this transaction, the Company allocated $1.2 million of the
proceeds to the estimated fair value of the stock purchase warrants and $2.3
million as the estimated fair value of the beneficial conversion feature. These
amounts resulted in a discount in the convertible debentures of $3.5 million,
which is being amortized over the life of the debt on a straight-line basis to
interest expense. Total amortization for the nine months ended December 31, 2003
was $444,584.
In connection with the Convertible Debentures the Company paid financing fees as
follows: 103,896 stock purchase warrants, with a fair value of $264,671, 28,571
shares of common stock with a fair value of $141,141, and cash of $255,000.
Total financing fees of $660,812 were recorded as deferred fees and are being
amortized over the term of the debentures on a straight-line basis. The
unamortized deferred fees are reported in other non-current assets in the
accompanying balance sheets.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
CLASS ACTION. From July 2003 through August 2003, eight securities class action
lawsuits were filed against the Company and certain of its officers and
directors in the United States District Court for the Southern District of
Florida on behalf of all persons who purchased The Singing Machine's securities
during the various class action periods specified in the complaints. These
complaints have all been consolidated into one action styled Bielansky, et al.
v. Salberg & Co., et al., Case No. 03-80596-ZLOCH (the Shareholder Action).
The complaints in the Shareholder Action allege violations of Section
10(b) and Section 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)-5
promulgated there under. These complaints seek compensatory damages, attorney's
fees and injunctive relief.
In July 2003, a shareholder filed a derivative action against the Company, its
board of directors and senior management purporting to pursue the action on
behalf of the Company and for its benefit. No pre-lawsuit demand was made on the
board of directors for them to investigate the allegations or to bring action.
The Company is named as a nominal defendant in this case. This case has been
consolidated into the "Shareholder Action" identified above.
This derivative complaint alleges claims for breach of fiduciary duty, abuse of
control, gross mismanagement, waste of corporate assets and unjust enrichment.
The complaint alleges that the individual defendants breached their fiduciary
F-9
duties and engaged in gross mismanagement by allegedly ignoring indicators of
the lack of control over the Company's accounting and management practices,
allowing the Company to engage in improper conduct and otherwise failing to
carry out their duties and obligations to the Company. The plaintiffs seek
damages for breach of fiduciary duties, punitive and compensatory damages,
restitution, and bonuses or other incentive-based or equity based compensation
received by the CEO and CFO under the Sarbanes-Oxley Act of 2002
The court in the Shareholder Action has directed plaintiffs' counsel to file one
amended consolidated complaint no later than November 14, 2003.
The Company intends to vigorously defend the Shareholder Action. As the outcome
of litigation is difficult to predict, significant changes in the estimated
exposures could occur which could have a material affect on the Company's
operations.
A second shareholder derivative suit was filed in October 2003, which makes
generally the same allegations. The second derivative suit has not been served
on the Company or on any of its current or former officers and directors. This
suit was transferred to the same judge to whom the Shareholder Action was
assigned and has been consolidated into the Shareholder Action.
OTHER MATTERS. In August 2003, we were advised that the Securities and Exchange
Commission had commenced an informal inquiry of our company. We are cooperating
fully with the SEC staff. It appears that the investigation is focused on the
restatement of our audited financial statements for fiscal 2002 and 2001. We
have been advised that an informal inquiry should not be regarded as an
indication by the SEC or its staff that any violations of law have occurred or
as a reflection upon any person or entity that may have been involved in those
transactions.
The Company entered into a separation and release agreement with an executive on
December 19, 2003. The agreement provided for the individual to receive $159,281
in settlement of the Company's contract. The amount has been expensed as
compensation at December 31, 2003.
The Company entered into a settlement agreement with an investment banker on
November 17, 2003. Pursuant to this agreement, the Company will pay the sum of
$181,067 over a six month period and has issued to the investment banker 40,151
shares of stock with a fair value of $94,355.
The Company amended its convertible debenture agreements to increase the
interest rate to 8.5% effective as of February 9, 2004 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 the Company's new lender, (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, the fair market value of the
Company's common stock on February 9, 2004, the date of the grant. The fair
value of these warrants as calculated pursuant to Statement No. 123 is $30,981
and has been expensed as other operating expenses in the accompanying statements
of operations.
The Company is also subject to various other legal proceedings and other claims
that arise in the ordinary course of its business. In the opinion of management,
the amount of ultimate liability, if any, in excess of applicable insurance
coverage, is not likely to have a material effect on the financial condition,
results of operations or liquidity of the Company. However, as the outcome of
litigation or other legal claims is difficult to predict, significant changes in
the estimated exposures could occur, which could have a material impact on the
Company's operations.
NOTE 9 - STOCKHOLDERS' EQUITY
COMMON STOCK ISSUANCES
During the nine months ended December 31, 2003, the Company issued 580,642
shares of its common stock. Of these shares, 28,571 were issued in lieu of a
cash payment of commission and closing costs relating to the Convertible
Debentures. Certain executives received 63,420 shares of common stock in lieu of
a portion of their cash compensation and bonuses for fiscal 2004. The fair value
of this stock, $290,165 was charged to compensation expense. 40,151 shares of
stock were issued in lieu of a settlement with an investment banker, at an
estimated fair value of $94,355. The remaining 448,500 shares of stock issued
were through the exercise of vested stock options. There were no shares of
common stock issued in the nine months ended December 31, 2002.
F-10
EARNINGS PER SHARE
In accordance with Statement No. 128, "Earnings per Share," basic earnings per
share are computed by dividing the net earnings for the period by the weighted
average number of common shares outstanding. Diluted earnings per share is
computed by dividing net earnings by the weighted average number of common
shares outstanding including the effect of common stock equivalents.
The following table presents a reconciliation of basic and diluted earnings per
share:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2003 2002 2003 2002
(as restated) (as restated)
Net (loss) income $(10,450,601) $ 3,320,527 $(13,424,622) $ 5,957,136
Loss available to common shares $(10,450,601) $ 3,320,527 $(13,424,622) $ 5,957,136
Weighted average shares outstanding - basic 8,729,818 8,123,548 8,503,065 8,101,441
Weighted average shares outstanding - diluted 8,729,818 8,944,027 8,503,065 8,947,897
Loss per share - Basic $ (1.20) $ 0.41 $ (1.58) $ 0.74
============ ============ ============ ============
Loss per share -Diluted $ (1.20) $ 0.37 $ (1.58) $ 0.67
============ ============ ============ ============
For the three months and nine months ended December 31, 2003, 1,120,120 common
stock equivalents were excluded from the calculation of diluted earnings per
share, as there was a net operating loss for the periods and their effects would
have been antidilutive. For the three months and nine months ended December 31,
2002, 90,000 and 0 common stock equivalents were not included in the computation
of diluted earnings per share because their effect was antidilutive.
For the nine months ended December 31, 2003, there were 1,120,120 common stock
options outstanding with exercise prices between $1.97 and $14.30. In addition,
there is a potential 1,038,962 shares that may be issued in connection with the
Convertible Debentures if certain conditions exist. (See Note 7.)
NOTE 10 - 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
Company's wholly-owned Subsidiary. Sales by geographic region for the quarters
ended December 31 were as follows:
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2003 2002 2003 2002
SALES: ------------ ------------ ------------ ------------
United States $ 19,847,863 $ 41,028,985 $ 41,184,176 $ 72,402,914
Australia 582,385 286,368 892,964 529,020
Canada 307,182 706,476 832,007 733,801
Europe 8,687,809 6,178,010 26,497,706 12,998,917
Other 210,407 29,945 708,343 100,143
Less: Allowances (946,023) (2,570,338) (2,061,457) (3,243,907)
------------ ------------ ------------ ------------
Consolidated Net Sales $ 28,689,623 $ 45,659,446 $ 68,053,739 $ 83,520,888
============ ============ ============ ============
The geographic area of sales is based primarily on the location where the
product is delivered.
F-11
NOTE 11 - SUBSEQUENT EVENTS
On January 7, 2004, the Company entered into the fifth amendment of its
licensing agreement with MTV Networks. The amendment reduced the minimum royalty
guarantee for calendar 2003 from $1.5 million to $1.3 million. The amendment
also extended the expiration date of the original agreement to April 30, 2004,
with options to extend for an additional two periods until December 31, 2004 at
the discretion of MTV. In accordance with this amendment, each of the three
license periods contain minimum guarantee royalty payments of $100,000 each for
a total of $300,000 if all extensions are exercised Each of the minimum
guaranteed royalty payments is recoupable against sales throughout the calendar
year, unless the contract is cancelled.
On February 9, 2004, the Company entered into a factoring agreement with Milberg
Factors, Inc. ("Milberg") of New York City. The agreement allows the Company, at
the discretion of Milberg, to borrow against its outstanding receivables up to a
maximum of the lesser of $3.5 million or 80% of the purchase price. The Company
will pay .8% of gross receivables in fees and the average balance of the line
will be subject to interest on a monthly basis at prime plus .75% with a minimum
rate not to decrease below 4.75%. The agreement contains minimum aggregate
charges in any calendar year of $200,000, limits on incurring any additional
indebtedness and the Company must maintain tangible net worth and working
capital above $7.5 million. Milberg also received a security interest in all of
the Company's accounts receivable and inventory located in the United States and
a pledge of 66 2/3 of the stock of International SMC, our Hong Kong subsidiary.
F-12
[GRANT THORNTON LETTERHEAD]
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
Board of Directors
The Singing Machine Company, Inc.
We have audited the accompanying consolidated balance sheet of The Singing
Machine Company, Inc. and subsidiary (the "Company") as of March 31, 2003 and
the related consolidated statements of earnings, shareholders' equity and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and financial statement schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The Singing
Machine Company, Inc. and subsidiary as of March 31, 2003 and the consolidated
results of their operations and their consolidated cash flows for the year then
ended, in conformity with accounting principles generally accepted in the United
States of America.
We have also audited Schedule II of The Singing Machine Company, Inc. and
subsidiary for the year ended March 31, 2003. In our opinion, this schedule,
when considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly, in all material respects, the information therein.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 2 to the financial
statements, on March 14, 2003, the Company was notified of its violation of the
net worth covenant of its Loan and Security Agreement (the "Agreement") with its
commercial lender (the "Lender") and the Company was declared in default under
the Agreement. As of June 24, 2003, the Company has minimal liquidity. In June
2003, this Lender amended the Agreement through July 31, 2003 but did not waive
the condition of default (see Note 9). This continuing condition of default
raises substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to increasing liquidity and restructuring
the Agreement are also described in Note 2 to the financial statements. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ Grant Thornton LLP
Miami, Florida
June 24, 2003 (except for Note 9, as to which the date is July 8, 2003 and Note
15, as to which the date is July 10, 2003)
F-13
Independent Auditors' Report
Board of Directors and Shareholders:
The Singing Machine Company, Inc.
and Subsidiary
We have audited the accompanying consolidated balance sheet of The Singing
Machine Company, Inc., and Subsidiary as of March 31, 2002, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for the years ended March 31, 2002 and 2001. These consolidated financial
statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of The Singing Machine
Company, Inc. and Subsidiary as of March 31, 2002, and the results of their
operations and their cash flows for the years ended March 31, 2002 and 2001 in
conformity with accounting principles generally accepted in the United States of
America.
As more fully described in Note 3 of the fiscal 2003, 2002 and 2001 consolidated
financial statements, subsequent to the issuance of the Company's 2002 and 2001
consolidated financial statements and our report thereon dated May 23, 2002,
management determined to restate the 2002 and 2001 consolidated financial
statements to reflect a change in their position regarding taxation of certain
corporate income and a resulting increase in the income tax provision for years
2002 and 2001. In our related report, we expressed an unqualified opinion. Our
opinion on the revised consolidated financial statements, as expressed herein,
remains unqualified.
/s/ SALBERG & COMPANY, P.A.
SALBERG & COMPANY, P.A.
Boca Raton, Florida
May 23, 2002 (except for Note 3 as to which the date is July 14, 2003)
F-14
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
MARCH 31,
--------------------------
2003 2002
----------- -----------
ASSETS (AS RESTATED)
(NOTE 3)
CURRENT ASSETS
Cash and cash equivalents $ 268,265 $ 5,520,147
Restricted cash 838,411 513,684
Accounts receivable, less allowance for doubtful accounts of $405,759
in 2003 and $12,022 in 2002 5,762,944 3,536,903
Due from manufacturer 1,091,871 488,298
Inventories 25,194,346 9,274,352
Prepaid expenses and other current assets 1,449,505 422,314
Deferred tax asset 1,925,612 191,418
Deposits 34,097 --
----------- -----------
TOTAL CURRENT ASSETS 36,565,051 19,947,116
PROPERTY AND EQUIPMENT, at cost less accumulated depreciation of
$1,472,850 in 2003 and $846,915 in 2002 1,096,423 574,657
OTHER ASSETS
Other non-current assets 1,273,820 881,423
----------- -----------
TOTAL OTHER ASSETS 1,273,820 881,423
----------- -----------
TOTAL ASSETS $38,935,294 $21,403,196
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Bank overdraft 316,646 --
Accounts payable $ 8,486,009 $ 1,846,238
Accrued expenses 1,443,406 1,289,597
Due to related party 400,000 --
Revolving credit facility 6,782,824 --
Income taxes payable 3,821,045 2,041,928
----------- -----------
TOTAL CURRENT LIABILITIES 21,249,930 5,177,763
----------- -----------
SHAREHOLDERS' EQUITY
Preferred stock, $1.00 par value; 1,000,000 shares authorized,
no shares issued and outstanding -- --
Common stock, Class A, $.01 par value; 100,000 shares
authorized; no shares issued and outstanding -- --
Common stock, $0.01 par value; 18,900,000 shares authorized;
8,171,678 and 8,020,027 shares issued and outstanding 81,717 80,200
Additional paid-in capital 4,843,430 4,602,828
Retained earnings 12,760,217 11,542,405
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 17,685,364 16,225,433
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $38,935,294 $21,403,196
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-15
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE YEARS ENDED
----------------------------------------------
MARCH 31, MARCH 31, MARCH 31,
2003 2002 2001
------------ ------------ ------------
(AS RESTATED) (AS RESTATED)
(NOTE 3) (NOTE 3)
NET SALES $ 95,613,766 $ 62,475,753 $ 34,875,351
COST OF SALES 72,329,035 40,852,840 22,159,051
------------ ------------ ------------
GROSS PROFIT 23,284,731 21,622,913 12,716,300
OPERATING EXPENSES
Advertising 5,032,367 2,377,638 921,359
Commissions 997,529 1,294,543 837,222
Compensation 3,637,559 2,486,547 1,916,612
Freight & Handling 2,112,435 1,242,910 882,610
Royalty Expense 2,257,653 1,862,116 148,643
Selling, general & administrative expenses 7,632,958 4,123,779 2,982,261
------------ ------------ ------------
------------ ------------
TOTAL OPERATING EXPENSES 21,670,501 13,387,533 7,688,707
------------ ------------ ------------
EARNINGS FROM OPERATIONS 1,614,230 8,235,380 5,027,593
OTHER INCOME (EXPENSES)
Other income 196,537 215,840 32,617
Interest income 11,943 16,934 50,242
Interest expense (406,126) (112,123) (424,104)
Stock based guarantee fees -- (171,472) (267,029)
Factoring fees -- -- (231,298)
------------ ------------ ------------
NET OTHER EXPENSES (197,646) (50,821) (839,572)
EARNINGS BEFORE INCOME TAX 1,416,584 8,184,559 4,188,021
PROVISION FOR INCOME TAX 198,772 1,895,494 491,744
------------ ------------ ------------
NET EARNINGS $ 1,217,812 $ 6,289,065 $ 3,696,277
============ ============ ============
EARNINGS PER COMMON SHARE:
Basic $ 0.15 $ 0.88 $ 0.59
Diluted $ 0.14 $ 0.79 $ 0.50
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES:
Basic 8,114,330 7,159,142 6,291,792
Diluted 8,931,385 7,943,473 7,457,173
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-16
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
PREFERRED STOCK COMMON STOCK
MOUNT DEFERRED
PAID IN RETAINED GUARANTEE
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS FEES TOTAL
Balance at March 31, 2000 1,000,000 $ 1,000,000 4,541,430 $ 45,414 $1,703,910 $ 1,557,063 $ (400,101) $ 3,906,286
Net earnings, as restated -- -- -- -- -- 3,696,277 -- 3,696,277
Conversion of preferred
stock (1,000,00) (1,000,000) 1,500,000 15,000 985,000 -- -- --
Exercise of warrants -- -- 570,000 5,700 574,300 -- -- 580,000
Exercise of Employee
stock options -- -- 2,250 23 622 -- -- 645
Cancellation of shares -- -- (75,000) (750) 750 -- -- --
Warrants issued for
services and as loan fees -- -- -- -- 38,400 -- -- 38,400
Amortization of deferred
guarantee fees -- -- -- -- -- -- 228,629 228,629
---------- ------------ ---------- --------- ----------- ------------ ----------- ------------
Balance at March 31, 2001 -- -- 6,538,680 65,387 3,302,982 5,253,340 (171,472) 8,450,237
Net earnings, as restated -- -- -- -- -- 6,289,065 -- 6,289,065
Exercise of warrants -- -- 581,100 5,811 584,239 -- -- 590,050
Exercise of Employee
stock options -- -- 900,525 9,005 720,135 -- -- 729,140
Fractional share
adjustment pursuant to
3:2 stock split -- -- (278) (3) (4,528)) -- -- (4,531)
Amortization of deferred
guarantee fees -- -- -- -- -- -- 171,472 171,472
---------- ------------ ---------- --------- ----------- ------------ ----------- ------------
Balance at March 31, 2002 -- -- 8,020,027 80,200 4,602,828 11,542,405 -- 16,225,433
Net earnings, as restated -- -- -- -- -- 1,217,812 -- 1,217,812
Exercise of warrants -- -- 52,500 525 47,600 -- -- 48,125
Exercise of Employee
stock options -- -- 99,151 992 193,002 -- -- 193,994
---------- ------------ ---------- --------- ----------- ------------ ----------- ------------
Balance at March 31, 2003 -- $ -- 8,171,678 $ 81,717 $4,843,430 $12,760,217 $ -- $17,685,364
========== ============ ========== ========= =========== ============ =========== ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
F-17
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED MARCH 31,
----------------------------------------------
2003 2002 2001
------------ ------------ ------------
(AS RESTATED) (AS RESTATED)
(NOTE 3) (NOT 3)
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 1,217,812 $ 6,289,065 $ 3,696,277
Adjustments to reconcile net earnings to net cash (used in)
provided by operating activities:
Depreciation and amortization 622,298 394,456 301,064
Stock based expenses -- 171,472 267,029
Bad debt 393,737 45,078 85,302
Provision for inventory losses 3,715,357 -- --
Deferred tax benefit (1,734,194) -- --
Changes in assets and liabilities:
(Increase) decrease in:
Accounts Receivable (2,619,778) (2,626,329) (312,916)
Due from manufacturer (603,573 210,798 (699,096)
Inventories (19,635,351) (4,460,891) (3,326,255)
Prepaid Expenses and other assets (1,453,685) (444,004) (394,176)
Increase (decrease) in:
Accounts payable 6,639,771 1,364,158 467,491
Accrued expenses 153,809 199,445 672,342
Income taxes payable 1,779,117 1,811,439 479,750
------------ ------------ ------------
Net Cash (Used in) Provided by Operating Activities (11,524,680) 2,954,687 1,236,812
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (1,144,064) (613,691) (373,409)
Proceeds from investment in factor -- 933,407 --
Proceeds from repayment of related party loans -- 125,117 386,261
Investment in and Advances in unconsolidated subsidiary -- 298,900 (374,730)
------------ ------------ ------------
Net cash (used in) provided by Investing Activities (1,144,064) 743,733 (361,878)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from borrowings on revolving credit facility 47,825,725 21,856,653 600,000
Repayments on revolving credit facility (41,042,901) (21,856,653) (600,000)
Bank Overdraft 316,646 -- --
Restricted cash (324,727) (513,684) --
Proceeds from related party loan 400,000 -- --
Proceeds from exercise of stock options and warrants 242,119 1,319,190 580,645
Due from factor -- -- (818,206)
------------ ------------ ------------
Net cash provided by (used in) Financing Activities 7,416,862 1,319,190 (237,561)
------------ ------------ ------------
(DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (5,251,882) 4,503,926 637,373
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 5,520,147 1,016,221 378,848
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 268,265 $ 5,520,147 $ 1,016,221
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION
Cash paid during the year for interest $ 406,126 $ 112,123 $ 424,104
============ ============ ============
Cash paid during the year for income taxes $ 153,849 $ 102,415 $ 11,994
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
F-18
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF ACCOUNTING POLICIES
OVERVIEW
The Singing Machine Company, Inc., a Delaware corporation, and
Subsidiary (the "Company", or "The Singing Machine") are primarily engaged in
the production, marketing, and sale of consumer karaoke audio equipment,
accessories, and musical recordings. The products are sold directly to
distributors and retail customers.
The preparation of The Singing Machine's financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial
statements and revenues and expenses during the period. Future events and their
effects cannot be determined with absolute certainty; therefore, the
determination of estimates requires the exercise of judgment. Actual results
inevitably will differ from those estimates, and such differences may be
material to the Company's financial statements. Management evaluates its
estimates and assumptions continually. These estimates and assumptions are based
on historical experience and other factors that are believed to be reasonable
under the circumstances. These estimates and The Singing Machine's actual
results are subject to the risk factors listed in Quantitative and Qualitative
Disclosures About Market Risk Section of the Form 10-K for the year ended March
31, 2003.
The management of the Company believes that a higher degree of judgment
or complexity is involved in the following areas:
COLLECTIBILITY OF ACCOUNTS RECEIVABLE. The Singing Machine's allowance
for doubtful accounts is based on management's estimates of the creditworthiness
of its customers, current economic conditions and historical information, and,
in the opinion of management, is believed to be an amount sufficient to respond
to normal business conditions. Management sets 100% reserves for customers in
bankruptcy and other reserves based upon historical collection experience.
Should business conditions deteriorate or any major customer default on its
obligations to the Company, this allowance may need to be significantly
increased, which would have a negative impact on operations.
RESERVES ON INVENTORIES. The Singing Machine establishes a reserve on
inventory based on the expected net realizable value of inventory on an item by
item basis when it is apparent that the expected realizable value of an
inventory item falls below its original cost. A charge to cost of sales results
when the estimated net realizable value of specific inventory items declines
below cost. Management regularly reviews the Company's investment in inventories
for such declines in value.
INCOME TAXES. Significant management judgment is required in developing
The Singing Machine's provision for income taxes, including the determination of
foreign tax liabilities, deferred tax assets and liabilities and any valuation
allowances that might be required against the deferred tax assets. At March 31,
2003 and 2002, The Singing Machine had net deferred tax assets of $1.9 million
and $191 thousand, respectively. Management evaluates its ability to realize its
deferred tax assets on a quarterly basis and adjusts its valuation allowance
when it believes that it is more likely than not that the asset will not be
realized. There is no related valuation allowance at March 31, 2003 and 2002.
The Company's Subsidiary has applied for an exemption of income tax in
Hong Kong. Therefore, no taxes have been expensed or provided for at the
Subsidiary level. Although no decision has been reached by the Hong Kong
governing body, the Company has reached the decision to provide for the
possibility that the exemption could be denied and accordingly has recorded a
provision in fiscal 2003, 2002, and 2001.
The Company constructively repatriated approximately $5.6 million, $5.7
million and $0 from its foreign operations in 2003, 2002 and 2001, respectively.
Accordingly, these earnings were treated as a deemed dividend and were taxed
using U.S. statutory rates. No provision has been made for U.S. taxes on the
remaining undistributed earnings of the Company's foreign subsidiary of
approximately $3.6 million at March 31, 2003 and $1.9 million at March 31, 2002,
as it is anticipated that such earnings would be permanently reinvested in their
operations.
F-19
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company operates within multiple taxing jurisdictions and is
subject to audit in those jurisdictions. Because of the complex issues involved,
any claims can require an extended period to resolve. In management's opinion,
adequate provisions for income taxes have been made.
OTHER ESTIMATES. The Singing Machine makes other estimates in the
ordinary course of business relating to sales returns and allowances, and
reserves for promotional incentives. Historically, past changes to these
estimates have not had a material impact on the Company's financial condition.
However, circumstances could change which may alter future expectations.
THE FOLLOWING ARE THE COMPANY'S REMAINING ACCOUNTING POLICIES.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of The Singing
Machine Company, Inc. and its wholly-owned Hong Kong Subsidiary, International
SMC (HK) Limited ("Hong Kong Subsidiary"). All intercompany accounts and
transactions have been eliminated in consolidation.
STOCK SPLITS
On March 15, 2002, the Company effected a 3 for 2 stock split. All share and per
share data have been retroactively restated in the accompanying consolidated
financial statements to reflect the split.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Company's Hong Kong Subsidiary is the local
currency. The financial statements of the subsidiary are translated to United
States dollars using year-end rates of exchange for assets and liabilities, and
average rates of exchange for the year for revenues, costs, and expenses. Net
gains and losses resulting from foreign exchange transactions are included in
the consolidated statements of earnings and were not material during the periods
presented. The effect of exchange rate changes on cash at March 31, 2003, 2002
and 2001 were not material.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three
months or less at the time of purchase to be cash equivalents. Cash balances at
March 31, 2003 and 2002 include approximately $73,000 and $154,000,
respectively, held in foreign banks by the Hong Kong Subsidiary.
COMPREHENSIVE EARNINGS
Other comprehensive earnings (loss) is defined as the change in equity of a
business enterprise during a period from transactions and other events and
circumstances from non-owner sources, including foreign currency translation
adjustments and unrealized gains and losses on derivatives designated as cash
flow hedges. For the years ended March 31, 2003, 2002 and 2001 comprehensive
earnings was equal to net earnings.
INVENTORIES
Inventories are comprised of electronic karaoke audio equipment, accessories,
and compact discs and are stated at the lower of cost or market, as determined
using the first in, first out method. Inventory reserves were $3,715,357 and $0
for March 31, 2003 and 2002, respectively. Inventory consigned to one customer
at March 31, 2003 and 2002 was $56,695 and $2,020,172, respectively. The
following table represents the major components of inventory at March 31.
2003 2002
------------ ------------
Finished goods $ 27,807,763 $ 7,476,237
Inventory in transit 1,101,940 1,798,115
Less Inventory reserve (3,715,357) --
------------ ------------
Total Inventory $ 25,194,346 $ 9,274,352
============ ============
F-20
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 operational expense
and those billed to customers are recorded as revenue on the statement of
earnings.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation and
amortization. Expenditures for repairs and maintenance are charged to expense as
incurred. Depreciation is provided for in amounts sufficient to relate the cost
of depreciable assets to their estimated useful lives using accelerated and
straight-line methods.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current
year presentation.
DUE TO RELATED PARTY
On March 4, 2003, one of the Company's directors advanced $400,000 to the
Company's Hong Kong subsidiary, which used the funds to pay a debt with a trade
creditor. The Company was to repay this loan by May 4, 2003 and the loan bore
interest at the rate of 8% per annum. The Company repaid $200,000 of the loan on
May 4, 2003 and the director has agreed to extend the remaining balance until
October 31, 2003.
REVENUE RECOGNITION
Revenue from the sale of equipment, accessories, and musical recordings are
recognized upon the later of (a) the time of shipment or (b) when title passes
to the customers, all significant contractual obligations have been satisfied
and collection of the resulting receivable is reasonably assured. Revenues from
sales of consigned inventory are recognized upon sale of the product by the
consignee. Net sales are comprised of gross sales net of a provision for actual
and estimated future returns, discounts and volume rebates.
DUE FROM MANUFACTURER
The Company's Hong Kong Subsidiary operates as an intermediary to purchase
karaoke hardware from factories located in China on behalf of the Company. A
manufacturer affiliated with a former director of the Company credited the
Company for returns of machines to the factory for rework. The manufacturer also
credited the Company for volume incentive rebates on purchases in fiscal 2003.
The balance as of March 31, 2003 was $1,091,871. Volume incentive rebates are
recorded as a reduction to the cost of goods sold for the period reported.
For the fiscal year ended March 31, 2003, the balance of due from manufacturers
consisted of returns of products to the manufacturer in the amount of $2.4
million, purchases of product in the amount of $1.8, volume incentive rebates in
the amount of $208,797 and other expenses such as legal fees, in the amount of
260,000; which were paid on behalf of the manufacturer.
STOCK BASED COMPENSATION
The Company accounts for stock options issued to employees using the intrinsic
value method in accordance with the provisions of Accounting Principles Board
("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. As such, compensation cost is measured on the date of grant as
the excess of the current market price of the underlying stock over the exercise
price. Such compensation amounts are amortized over the respective vesting
periods of the option grant. The Company applied the disclosure provisions of
Statement of Financial Accounting Standards 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
F-21
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 Statement of Financial Accounting Standards (SFAS) No 123,
"Accounting for Stock Based Compensation" (Statement No. 123), the Company's net
earnings would have been changed to the pro-forma amounts indicated below for
the years ended March 31:
2003 2002 2001
--------------------- -------------------- -------------
(AS RESTATED) (AS RESTATED
Net earnings As $ 1,217,812 $ 6,289,065 $ 3,696,277
reported
Deduct: Total stock-based employee compensation
expense determined under fair value based
method, net of tax 1,740,624 115,489 --
-------------------- ------------------- -------------
Net earnings (loss) Pro forma $ (522,812) $ 6,173,576 $ 3,696,277
Net earnings per share - basic As (0.15) $ 0.88 $ 0.59
reported
Pro forma $ (0.06) $ 0.86 $ 0.59
Net earnings per share - diluted As $ (0.14) $ 0.79 $ 0.50
reported
Pro forma $ (0.06) $ 0.78 $ 0.50
Stock based employee compensation -- -- --
The effect of applying Statement No. 123 is not likely to be
representative of the effects on reported net earnings for future years due to,
among other things, the effects of vesting.
For stock options and warrants issued to consultants, the Company
applies the fair value method of accounting as prescribed by SFAS 123.
Accordingly, consulting expense of $38,400 was charged to operations in 2001.
There was no consulting expense relating to grants in 2003 and 2002.
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 123 using the following
weighted-average assumptions:
o Fiscal 2003: expected dividend yield 0%, risk-free interest rate of
4%, volatility 71% and expected term of three years.
o Fiscal 2002: expected dividend yield 0%, risk-free interest rate of
6.08% to 6.81%, volatility 42% and expected term of two years.
o Fiscal 2001: no options were issued; therefore there would be no
change in net earnings
NET SALES
Net sales as reported are calculated by reducing gross sales by the
amounts of any returns, discounts and allowances applicable to those gross
sales.
COST OF SALES
Cost of sales includes the actual cost of the product sold. Other costs
related to the warehousing, storage, shipping and handling of product are
expensed under the category Selling, General and Administrative expenses.
Warehousing, storage charges, product inspection, packing materials are
warehouse expenses, which are included in selling, general and administrative
expenses. . Freight and handling of product is a selling expense.
F-22
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ADVERTISING
Costs incurred for producing and communicating advertising of the Company, are
charged to operations as incurred. The Company has cooperative advertising
arrangements with its vendors and accrues the cost of advertising as a selling
expense. The expense is calculated based on the contractual obligation as a
percentage of the customer's revenue. The Company's customers send proof of
advertising dollars spent in the form of copies of advertisements placed on
behalf of the Company. Advertising expense for the years ended March 31, 2003,
2002 and 2001 was $5,032,367, $2,377,638 and $921,359, respectively.
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to the results of operations
when they are incurred. These expenses are shown in the selling, general &
administrative expenses on the consolidated statements of earnings. For the
years ended March 31, 2003, 2002 and 2001, the amounts expensed were $674,925,
$181,866 and $55,376, respectively.
EARNINGS PER SHARE
In accordance with Statement of Financial Accounting Standards No. 128,
"Earnings per Share", basic earnings per share is computed by dividing the net
earnings for the period by the weighted average number of common shares
outstanding. Diluted earnings per share is computed by dividing net earnings by
the weighted average number of common shares outstanding including the effect of
common stock equivalents.
The following table presents a reconciliation of basic and diluted earnings
per share:
2003 2002 2001
---------- ---------- ----------
(AS RESTATED) (AS RESTATED)
Net earnings $1,217,812 $6,289,065 $3,696,277
Income available to common shares $1,217,812 $6,289,065 $3,696,277
Weighted average shares outstanding - basic 8,114,330 7,159,142 6,291,792
Earnings per share - Basic $ 0.15 $ 0.88 $ 0.59
========== ========== ==========
Income available to common shares $1,217,812 $6,289,065 $3,696,277
Weighted average shares outstanding - basic 8,114,330 7,159,142 6,291,792
Effect of dilutive securities:
Stock options 817,055 784,331 1,127,555
Warrants -- -- 37,826
---------- ---------- ----------
Weighted average shares outstanding - diluted 8,931,385 7,943,473 7,457,173
Earnings per share - Diluted $ 0.14 $ 0.79 $ 0.50
========== ========== ==========
In 2003, 2002 and 2001, 90,000, 0 and 2,529,000 common stock equivalents (as
restated for the 3 for 2 stock split) with exercise prices greater than $10.66
in fiscal 2003 and $4.11 in fiscal 2001 were not included in the computation of
diluted earnings per share as their effect would have been antidilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards 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, accrued expenses, revolving
credit facility and income taxes payable, approximate fair value due to the
relatively short period to maturity for these instruments.
F-23
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of." SFAS No. 144 retained substantially all of the requirements of
SFAS No. 121 while resolving certain implementation issues. SFAS No. 144 is
effective for fiscal years beginning after December 15, 2001. The impact of
adopting SFAS No. 144 was not material.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections."
Under Statement No. 4, all gains and losses from extinguishments of debt were
required to be aggregated and, if material, classified as an extraordinary item,
net of related income tax effect. This Statement eliminates Statement No. 4 and
as a result, gains and losses from extinguishment of debt should be classified
as extraordinary items only if they meet the criteria in Accounting Principles
Board Opinion 30, "Reporting the Results of Operations - Reporting the Effects
of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." Additionally, this Statement
amends SFAS No. 13, "Accounting for Leases," such that lease modifications that
have economic effects similar to sale-leaseback transactions be accounted for in
a similar manner as a sale- leaseback. This Statement is generally effective for
financial statements issued on or after May 15, 2002. The impact of adopting
SFAS No. 145 was not material to the Company.
In July 2002, the FASB issued Statement No. 146, "Accounting for Restructuring
Costs," ("SFAS 146"). SFAS 146 applies to costs associated with an exit activity
(including restructuring) or with a disposal of long-lived assets. Those
activities can include eliminating or reducing product lines, terminating
employees and contracts and relocating plant facilities or personnel. SFAS 146
is effective prospectively for exit or disposal activities initiated after
December 31, 2002, with earlier adoption encouraged. The adoption of this
standard did not a material impact on the financial statements.
In December 2002, the FASB issued Statement No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure an amendment of FASB
Statement No. 123" ("SFAS 143"). SFAS 148 amends FASB Statement No. 123,
"Accounting for Stock-Based Compensation", to provide alternative methods of
transition for an entity that voluntarily changes to the fair value based method
of accounting for stock-based employee compensation and to require prominent
disclosures about the effects on reported net earnings of an entity's accounting
policy decisions with respect to stock-based employee compensation. SFAS 148
also amends APB Opinion No. 28, "Interim Financial Reporting," to require
disclosures about those effects in interim financial information. The Singing
Machine currently accounts for its stock-based compensation awards to employees
and directors, under accounting prescribed by Accounting Principles Board
Opinion No. 25 and provides the disclosures required by SFAS No. 148. The
Singing Machine currently intends to continue to account for its stock-based
compensation awards to employees and directors using the intrinsic value method
of accounting as prescribed by Accounting Principles Board Opinion No. 25.
In December 2002, the FASB issued Interpretation 45 (FIN 45), Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. For a guarantee subject to FASB
Interpretation 45, a guarantor is required to:
o measure and recognize the fair value of the guarantee at inception
(for many guarantees, fair value will be determined using a present
value method); and
o provide new disclosures regarding the nature of any guarantees, the
maximum potential amount of future guarantee payments, the current
carrying amount of the guarantee liability, and the nature of any
recourse provisions or assets held as collateral that could be
liquidated and allow the guarantor to recover all or a portion of its
payments in the event guarantee payments are required.
Thedisclosure requirement of this Interpretation is effective for financial
statements for fiscal years ending after December 15, 2002 and did not have
a material effect on the Company's financial statements. The initial
recognition and measurement provision are effective prospectively for
guarantees issued or modified on or after January 1, 2003 and the Company
does not believe that the adoption of these provisions will have a material
impact on the Company's financial statements.
F-24
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities (and Interpretation of ARB No. 51)" ("FIN 46").
FIN 46 addresses consolidation by business enterprises of certain variable
interest entities, commonly referred to as special purpose entities. The
adoption of FIN 46 did not have a material effect on the Company's financial
statement presentation or disclosure.
NOTE 2 - GOING CONCERN
The accompanying consolidated financial statements have been prepared
in conformity with accounting principles generally accepted in the United States
of America, which contemplate continuation of the Company as a going concern.
On March 14, 2003, the Company was notified of its violation of the net
worth covenant of its Loan and Security Agreement (the "Agreement") with its
commercial lender and the Company was declared in default under the Agreement.
The lender amended the Agreement on June 30, 2003, extending the loan until July
31, 2003, but did not waive the condition of default. This condition of default
raises substantial doubt about the Company's ability to continue as a going
concern.
The Company is attempting to restructure and extend its revolving
credit facility. Based upon cash flow projections, the Company believes the
anticipated cash flow from operations will be sufficient to finance the
Company's operating needs until inventory is sold and the receivables
subsequently collected, provided that the bank does not call the loan. 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.
Although the Company had a larger than normal amount of currently
saleable inventory at March 31, 2003 (based on the Company's recent sales trends
and industry turnover standards), the Company has developed a fiscal 2004 sales
plan that it believes will allow it to sell such inventory and recover the
majority of its costs in the normal course of business. The Company has reduced
selling prices on certain inventory items and accordingly, in the fourth quarter
of fiscal 2003, the Company has taken a provision for loss against this
inventory.
NOTE 3 - RESTATEMENT OF FINANCIAL STATEMENTS FOR THE FISCAL YEARS 2002 AND 2001
In June 2003, management revised its position on taxation of its subsidiary's
income by the United States and by the Hong Kong tax authorities.
With regard to taxation in Hong Kong, the Company's subsidiary had previously
applied for a Hong Kong offshore claim income tax exemption based on the
locality of profits of the Hong Kong subsidiary. Management believed that the
exemption would be approved because the source of all profits of the Hong Kong
subsidiary is from exporting to customers outside of Hong Kong. Accordingly, no
provision for income taxes was provided in the consolidated financial statements
as of March 31, 2002 and 2001. However, full disclosure was previously reflected
in the audited financial statements for years ended March 31, 2002 and 2001 of
the estimated amount that would be due to the Hong Kong tax authority should the
exemption be denied. Management is continuing its exemption application process.
However, due to the extended period of time that the application has been
outstanding, as well as management's reassessment of the probability that the
application will be approved, management has determined to restate the 2002 and
2001 consolidated financial statements to provide for such taxes. The effect of
such restatement is to increase income tax expense by $748,672 and $468,424 in
fiscal 2002 and 2001, respectively. However, the Company can claim United States
foreign tax credits in 2002 for these Hong Kong taxes, which is reflected in the
final restated amounts.
With regard to United States taxation of foreign income, the Company had
originally taken the position that the foreign income of the Hong Kong
subsidiary was not taxable under the Internal Revenue Code until such income is
repatriated. Full disclosure of the amount and nature of the indefinite deferral
for fiscal year 2002 was reflected in the income tax footnote of the
consolidated financial statements for that year. The internal revenue code,
regulations and case law regarding international income taxation is quite
complex and subject to interpretation. Each case is determined based on the
individual facts and circumstances. Due to certain inter-company loans made in
2002 and 2003, the profits previously considered to be indefinitely deferred
became partially taxable as "deemed dividends" under section 956 of the Internal
Revenue Code. Although certain arguments against the imposition of a "deemed
dividend" may be asserted, management has determined to restate the fiscal year
2002 consolidated financial statements based on its reassessment of its original
F-25
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
position. The effect of such restatement is to increase income tax expense by
$1,027,545 in fiscal year 2002, which includes the utilization of the foreign
tax credits referred to above.
The net effect of the above two adjustments is to decrease net income by
$1,776,217 and $468,424 in fiscal 2002 and 2001. The net effect on net income
per share is to decrease net income per share basic and diluted by $0.25 and
$0.23, respectively in fiscal 2002 and decrease net income per share basic and
diluted by $0.07 and $0.06, respectively in fiscal 2001.
NOTE 4 - ACCOUNTS RECEIVABLE AND FACTOR AGREEMENT
During 2001, the Company sold certain trade accounts receivable, primarily
without recourse, pursuant to a factoring agreement. The sale of these accounts
receivable is treated as a sale under SFAS 140. The Company terminated the
factoring agreement in April 2001 upon obtaining a new Loan and Security
Agreement with a commercial lender. (See Note 8) For the year ending March 31,
2001, the Company incurred $429,509 in factoring fees and interest. The portion
representing factor interest expense was $198,208 of the $429,506. The transfer
of the receivables was treated as a sale since they were transferred without
recourse and the Company surrendered effective control of such transferred
accounts. The account proceeds from investment in factor contains the amount
received from the factoring company for their purchase of the Company's accounts
receivable. This is characterized as a financing activity, since factoring is an
activity used to raise short term financing capital and the cash raised does not
result from transactions or other events that enter into the determination of
net income. In 2001, the account due from factor contained the amount of cash
left in the factors accounts, at the option of the Company, since the factor
offered a higher interest than could be obtained elsewhere. Thus it was
considered an investing activity. The proceeds in 2002 represent a return of
this investment from the factor.
During 2000, two officers of the Company entered into guarantee agreements
related to the factor agreement resulting in deferred guarantee fees of
$400,101, which was being amortized over the term of the factor agreement, which
expired on December 31, 2001. Upon termination of the factor agreement, the
unamortized deferred guarantee fees of $171,472 were charged to operations as
amortization in fiscal 2002.
NOTE 5 - SALE OF UNCONSOLIDATED SUBSIDIARY
In November 2000, the Company closed on an acquisition of 60% of the ordinary
voting shares of a Hong Kong toy company for a total purchase price of $170,000.
The Company believed that the acquiree had agreed to extend the effective date
to June 2001, but a dispute arose and the Company committed to dispose of the
entire investment. Accordingly, pursuant to Statement of Financial Accounting
Standards No. 94 "Consolidation of All Majority-Owned Subsidiaries," the Company
treated the control of the subsidiary as temporary and recorded the investment
of $170,000 and advances of $220,661 at cost. The Company completed a contract
selling the 60% interest on September 11, 2001. The transaction resulted in a
net loss on investment of $48,912 included in selling, general, and
administrative expenses. The advances due at March 31, 2002 were $75,831 and
were included in prepaid and other current assets. There were no advances due at
March 31, 2003.
NOTE 6 - PROPERTY AND EQUIPMENT
A summary of property and equipment at March 31, 2003 and 2002 is as follows:
USEFUL LIVES 2003 2002
------------ ------------ -----------
Computer and office equipment 5 years $ 313,221 $ 230,025
Furniture and fixtures 5 - 7 years 341,777 106,164
Leasehold improvements * 110,841 62,483
Molds and tooling 3 years 1,803,434 1,022,900
------------ -----------
2,569,273 1,421,572
Less: accumulated depreciation (1,472,850) (846,915)
------------ -----------
Total net property and equipment $ 1,096,423 $ 574,657
============ ===========
* Shorter of remaining term of lease or useful life
F-26
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - RESTRICTED CASH
The Company, through its Hong Kong subsidiary, maintains a letter of credit
facility and short term loan with a major international bank. The Company's
subsidiary is required to maintain a separate deposit account in the amount of
$838,411 and $513,684 at March 31, 2003 and 2002, respectively. This amount is
shown as restricted cash at March 31, 2003 and 2002.
NOTE 8 - LOANS AND LETTERS OF CREDIT
CREDIT FACILITY
The Company's Hong Kong Subsidiary maintains separate credit facilities at two
international banks. The maximum credit available under these agreements is $5.5
million U.S. dollars. The primary purpose of the facilities is to provide the
Subsidiary with the following abilities:
o Overdraft facilities
o Issuance and negotiation of letters of credit, both regular
and discrepant
o Trust receipts
o A Company credit card
The facilities do not have an expiration date, but are considered short term
debt. Interest on these facilities range from prime plus 2 to prime plus 2.5. At
March 31, the interest rate associated with these lines was 6.25% to 6.5%. The
outstanding amount on these facilities at March 31, 2003, was $0 and there was
no availability.
LOAN AND SECURITY AGREEMENT
On April 26, 2001, the Company executed a Loan and Security Agreement
(the "Agreement") with a commercial lender (the "Lender"). This loan was last
amended on June 30, 2003. The following is a description of the terms as
amended.
The Lender will advance up to 70% of the Company's eligible accounts
receivable, plus up to 20% of the eligible inventory up to $6,000,000, plus up
to 40% of the commercial letters of credit opened for the purchase of eligible
inventory up to $3 million, less reserves at the discretion of the lender.
The outstanding loan limit varies between zero and $10,000,000, as
stipulated in the Agreement. The Lender also provides the Company the ability to
issue commercial letters of credit up to $3,000,000, which shall reduce the loan
limits above. The loans bear interest at the commercial lender's prime rate plus
0.5% and an annual fee equal to 1% of the maximum loan amount or $100,000 is
payable. All amounts under the loan facility are due within 90 days of demand.
The loans are secured by a first lien on all present and future assets of the
Company except for certain tooling located at a vendor in China. This amendment
expires July 31, 2003.
The Agreement contains covenants including a restriction on the payment
of dividends as well as a financial covenant stipulating a minimum tangible net
worth of $30,000,000 as of December 31, 2002 with escalations as defined in the
Agreement. On March 15, 2003, the lender notified the Company that they are in
default of this covenant and the agreement. The balance outstanding at March 31,
2003 was $6,782,824 and was classified as a current liability under revolving
credit facility on the balance sheet. At March 31, 2003, the Company was over
advanced under the agreement by approximately $3 million. The June 30, 2003
amendment gave the Company an additional $4.5 million in availability which gave
the Company working capital and cured the over advance; however, the Amendment
requires the Company to raise $2 million in subordinated debt. Although the
Company has only raised $1 million of the required $2 million by the due date,
the Company believes that the commercial lender will continue to support the
increased availability under the Amendment.
The Company is currently negotiating a restructuring of the agreement
with the lender.
F-27
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - COMMITMENTS AND CONTINGENCIES
LEASES
The Company has entered into various operating lease agreements for
office and warehouse facilities in Coconut Creek, Florida, Compton, California,
Rancho Dominguez, California, New York, New York and Kowloon, Hong Kong. The
leases expire at varying dates. Rent expense for fiscal 2003, 2002 and 2001 was
$901,251, $333,751 and 142,472, respectively.
In addition, the Company maintains various warehouse and computer
equipment operating leases.
Future minimum lease payments under property and equipment leases with
terms exceeding one year as of March 31, 2003 are as follows:
PROPERTY LEASES EQUIPMENT LEASES
--------------- ----------------
Year ending March 31:
2004 $ 1,330,158 $ 46,525
2005 924,338 19,965
2006 517,071 10,322
2007 495,545 7,969
2008 371,659 1,235
-------------- ----------------
$ 3,638,771 $ 86,016
============== ================
Each lease contains a provision for increase based on the Consumer
Price Index. The amounts reflected above represent payments in effect at the end
of the fiscal year, based on the index at inception of the lease. These changes
have historically been immaterial and as such are not estimated in future
minimum lease payments above.
GUARANTEES
The Company's Subsidiary guarantees the revolving credit facility at the
lender by a pledge of 66 2/3% of its common stock. The Company also in turn
guarantees all lines of credit of the Subsidiary.
EMPLOYMENT AGREEMENTS
The Company has employment contracts with four key officers as of March 31,
2003. The agreements provide for base salaries, with annual cost of living
adjustments and travel allowances. The agreements also provide for aggregate
Board approved performance bonuses of up to 10% of net earnings before those
performance bonuses, interest, and taxes. During fiscal 2003, 2002 and 2001, the
bonus percentages were 0%, 5% and 10%, respectively.
MERCHANDISE LICENSE AGREEMENTS
On November 1, 2000, as amended on November 29, 2001, as amended on December
27, 2002, the Company entered into a merchandise license agreement to license a
name, trade name, and logo of a music oriented television network. The term of
the agreement is from November 1, 2000 to December 31, 2003. However, shipment
of related products did not begin until after March 31, 2001. Accordingly, none
of the minimum royalty was charged to operations as of March 31, 2001. The
Company pays a royalty rate of a percentage of stipulated sales, as defined in
the agreement, with $686,250 guaranteed minimum royalties for the term, payable
on a scheduled basis as stipulated in the agreement. The initial minimum royalty
guarantee was paid in fiscal year 2002. The new amendment places an additional
guarantee for calendar year 2003 of $1,500,000, payable on a scheduled basis as
follows: $500,000 on the signing of the amendment, December 27, 2002, $333,333
on June 30, 2003, $333,333 on September 30, 2003 and $333,334 on December 31,
2003. Royalty reports are due on a quarterly basis under the terms of the
agreement and the following table represents a summary of the agreement:
PREPAID
TOTAL BALANCE ACCRUED EXPENSE
EXPENSE AT MARCH 31 AT MARCH 31
------------ -------------- ---------------
2003 $ 1,411,403 $ 355,931 $ 0
2002 $ 1,388,813 $ 0 $ 126,170
2001 $ 0 $ 50,000 $ 0
On December 1, 2001, the Company entered into an additional agreement with a
division of above licensor for additional license properties and products. The
license term is January 1, 2002 to December 31, 2004 with an initial stipulated
F-28
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
ship date of August 15, 2002. The agreement stipulates a royalty rate as a
percentage of net sales (defined as gross sales less discounts, allowances and
damaged goods returns not to exceed 8% of gross sales), payable quarterly, with
a guaranteed minimum royalty for the license term of $450,000 payable as
follows: $25,000 on execution of agreement, $85,000 on or before September 1,
2002, $85,000 on or before December 1, 2002, $85,000 on or before March 1, 2003,
$85,000 on or before June 1, 2003, and $85,000 on or before September 1, 2003
and the following table represents a summary of the agreement:
PREPAID
TOTAL BALANCE ACCRUED EXPENSE
EXPENSE AT MARCH 31 AT MARCH 31
------------ -------------- ---------------
2003 $ 127,778 $ 152,222 $ 0
2002 $ 0 $ 25,000 $ 0
2001 $ 0 $ 0 $ 0
In December 2002, the Company entered into an agreement with a division
of a music and memorabilia restaurant and entertainment chain. The license term
is January 1, 2003 to December 31, 2005. The Company pays a royalty rate of a
percentage of stipulated sales, as defined in the agreement, with a $250,000
guaranteed minimum royalties for the term, payable on a scheduled basis as
follows: $25,000 on signing of the contract and payments of $25,000 at the end
of each calendar quarter starting March 31, 2003 and ending September 30, 2004,
with a final payment of $50,000 due on December 31, 2004 and the following table
represents a summary of the agreement:
PREPAID
TOTAL BALANCE ACCRUED EXPENSE
EXPENSE AT MARCH 31 AT MARCH 31
------------ -------------- ---------------
2003 $ 16,656 $ 33,344 $ 0
2002 $ 0 $ 0 $ 0
2001 $ 0 $ 0 $ 0
In February 2003, the Company entered into an agreement with a large music and
entertainment conglomerate. The license term is April 1, 2003 to March 31, 2006.
The Company pays a royalty rate of a percentage of stipulated sales, as defined
in the agreement, with a $300,000 guaranteed minimum royalties for the term,
payable on a scheduled basis as follows: $25,000 on signing of the contract,
$50,000 on June 30, 2003 and payments of $25,000 at the end of each calendar
quarter starting September 30, 2003 and ending September 30, 2005 and the
following table represents a summary of the agreement:
PREPAID
TOTAL BALANCE ACCRUED EXPENSE
EXPENSE AT MARCH 31 AT MARCH 31
------------ -------------- ---------------
2003 $ 0 $ 25,000 $ 0
2002 $ 0 $ 0 $ 0
2001 $ 0 $ 0 $ 0
Guaranteed royalty payments are non-refundable and not recoupable against
other license agreements with the same licensor.
SIGNIFICANT ESTIMATES
The Company records an accrual for product returns in the normal course of
business. The accrual is estimated based on historical experience and is
recorded as a liability equal to the gross profit on estimated returns. At March
31, 2003 and 2002, the accrual for product returns was $324,422 and $118,488
respectively and are included in accrued expenses on the consolidated balance
sheets.
The Company estimates an allowance for doubtful accounts using the specific
identification method since a majority of accounts receivable are concentrated
with several customers. The allowance for doubtful accounts was $405,759 and
$12,022 at March 31, 2003 and 2002, respectively.
LEGAL MATTERS
CLASS ACTION. From July 2, 2003 through July 8, 2003, six securities class
action lawsuits were filed against The Singing Machine and certain of its
officers and directors in the United States District Court for the Southern
District of Florida on behalf of all persons who purchased The Singing Machine's
securities during the various class action periods specified in the complaints.
The Company expects that all of these actions will be consolidated in the United
States District Court for the Southern District of Florida.
F-29
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The complaints that have been filed allege violations of Section 10(b) and
Section 20(a) of the Securities Exchange Act of 1934 and Rule 10(b)-5. The
complaints seek compensatory damages, attorney's fees and injunctive relief.
While the specific factual allegations vary slightly in each case, the
complaints generally allege that defendants falsely represented the Company's
financial results for the years ended March 31, 2002 and 2001.
The Company believes that the allegations in these cases are without merit and
the Company intends to vigorously defend these actions. However, as the outcome
of litigation is difficult to predict, significant changes in the estimated
exposures could occur which could have a material affect on the Company's
operations.
OTHER MATTERS. The Company is also subject to various other legal proceedings
and other claims that arise in the ordinary course of its business. In the
opinion of management, the amount of ultimate liability, if any, in excess of
applicable insurance coverage, is not likely to have a material effect on the
financial condition, results of operations or liquidity of the Company. However,
as the outcome of litigation or other legal claims is difficult to predict,
significant changes in the estimated exposures could occur, which could have a
material impact on the Company's operations.
NOTE 10 - STOCKHOLDERS' EQUITY
AMENDMENT TO AUTHORIZED SHARES
During September 2000, the Company filed an amendment to its Articles of
Incorporation decreasing the authorized shares of the Company's common stock to
18,900,000 shares and 100,000 Class A common shares.
STOCK SPLIT
On March 15, 2002, the Company effected a 3 for 2 stock split. All share and
per share data have been retroactively restated in the accompanying consolidated
financial statements to reflect the split.
PREFERRED STOCK AND WARRANTS
During April 1999, the Company issued a private placement memorandum, pursuant
to Rule 506 of Regulation D of the 1933 Securities Act, as amended, to offer a
minimum of 40 units and a maximum of 50 units of stock and warrants. Each unit
consisted of 30,000 shares of the Company's 9% non-voting convertible preferred
stock and 6,000 common stock purchase warrants. The purchase price for each unit
was $ 27,500. Each share of preferred stock was convertible, at the option of
the holder, into one share of the Company's common stock at any time after
issuance, and was to automatically convert into one share of common stock on
April 1, 2000. All preferred shares automatically converted on April 1, 2000.
Each warrant entitles the holder to purchase one share of the Company's common
stock at $1.33 per share. The warrants expire three years from the private
placement memorandum date. Through June 1999, the maximum number of 50 units had
been sold and $1,375,000 gross funds were raised ($1,331,017 after related
costs), at which time the offer was closed. During 2000, 2001, and 2002, 24,000,
201,000, and 75,000 warrants were converted for $32,000, $268,000, and $100,000,
respectively leaving no warrants outstanding at March 31, 2002.
COMMON STOCK ISSUANCES
During fiscal 2003, 2002 and 2001, the Company issued the following shares of
stock upon exercise of outstanding options and warrants.
NUMBER OF PROCEEDS
SHARES ISSUED TO COMPANY
------------- ---------------
2003 151,651 $ 242,119
2002 1,481,347 $ 1,314,659
2001 572,250 $ 580,645
F-30
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GUARANTEE FEES
During the year ended March 31, 2000, the Company issued 525,000 shares
of common stock to two officers of the Company in exchange for guarantees
related to the Company's factor agreement, and letter of credit agreement. These
guarantee fees totaled $590,625 and were amortized over a period of 31 months.
For the years ended March 31, 2002 and 2001 $171,472 and $228,629, respectively,
of deferred fees were charged to operations, respectively. There were no
remaining deferred guarantee fees at March 31, 2002.
During the year ended March 31, 2001, the Company issued 37,500 common
stock options for services and 45,000 common stock warrants to two investors as
loan fees. The fair market value of the options totaling $38,400 was charged to
operations. There were no transactions made in fiscal 2002 and 2003.
STOCK OPTIONS
On June 1, 2001, the Board of Directors approved the 2001 Stock Option Plan,
which replaced the 1994 Stock Option Plan, as amended, (the "Plan"). The Plan
was developed to provide a means whereby directors and selected employees,
officers, consultants, and advisors of the Company may be granted incentive or
non-qualified stock options to purchase common stock of the Company. As of March
31, 2003, the Plan is authorized to grant options up to an aggregate of
1,950,000 shares of the Company's common stock and up to 300,000 shares for any
one individual in any fiscal year. As of March 31, 2003, the Company had granted
745,200 options under the Year 2001 Plan, leaving 1,204,800 options available to
be granted.
In accordance with SFAS 123, for options issued to employees, the Company
applies the intrinsic value method of APB Opinion No. 25 and related
interpretations in accounting for its options issued. The following table sets
forth the issuances of stock options for fiscal 2003, and 2002.
The exercise price of common stock option issuances in 2003 and 2002 was equal
to the fair market value on the date of grant. Accordingly, no compensation cost
has been recognized for options issued under the Plan in 2003 or 2002. A summary
of the options issued as of March 31, 2003, 2002 and 2001 and changes during the
years is presented below:
NUMBER OF WEIGHTED WEIGHTED WEIGHTED
OPTIONS AVERAGE NUMBER OF AVERAGE NUMBER OF AVERAGE
AND EXERCISE OPTIONS AND EXERCISE OPTIONS AND EXERCISE
WARRANTS PRICE WARRANTS PRICE WARRANTS PRICE
--------- -------- ----------- -------- ----------- --------
2003 2002 2001
--------------------- ---------------------- ----------------------
Balance at Beginning of Period 1,094,475 $ 2.11 2,433,300 $ 1.31 1,593,300 $ 0.67
Granted 574,926 $ 7.88 82,800 $ 3.92 1,245,750 $ 2.01
Exercised (151,651) $ 1.63 (1,406,625) $ 0.87 (371,250) $ 0.84
Forfeited (4,500) $ 2.04 (15,000) $ 2.04 (34,500) $ 0.92
---------- ---------- ---------
Balance at End of Period 1,513,250 $ 4.43 1,094,475 $ 2.11 2,433,300 $ 1.31
========== ========== =========
Options Exercisable at End of Period 976,250 $ 2.45 647,738 $ 2.11 1,435,050 $ 0.70
========== ========== =========
Weighted Average Fair Value of
Options Granted During the Period $ 4.90 $ 1.54 $ 0.85
The following table summarizes information about employee stock options and
consultant warrants outstanding at March 31, 2003:
WEIGHTED
AVERAGE
REMAINING
RANGE OF NUMBER OUTSTANDING CONTRACTUAL WEIGHTED AVERAGE NUMBER EXERCISABLE WEIHTED AVERAGE
EXERCISE PRICE AT MARCH 31, 2003 LIFE EXERCISE PRICE AT MARCH 31, 2003 EXERCISE PRICE
--------------------- ------------------ ---------------- ----------------- ------------------- ----------------
$ 1.11 58,500 1.24 $ 1.11 58,500 $ 1.11
$ 2.04 785,300 3.67 $ 2.04 785,300 $ 2.04
$3.27 - $ 4.23 102,450 3.20 $ 3.83 102,450 $ 3.83
$5.60 - $ 7.26 190,000 5.69 $ 6.70 0 $ 0.00
$8.61 - $11.09 377,000 6.76 $ 9.45 30,000 $ 11.09
------------------ ------------------
1,513,250 976,250
================== ==================
F-31
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 - INCOME TAXES
The Company files separate tax returns for the parent and for the Hong Kong
Subsidiary. The income tax expense (benefit) for federal, foreign, and state
income taxes in the consolidated statement of earnings consisted of the
following components for 2003, 2002 and 2001:
2003 2002 2001
----------- ----------- -----------
(AS RESTATED) (AS RESTATED)
Current:
U.S. Federal $ 663,816 $ 1,027,545 $ 21,320
Foreign 1,230,650 748,672 468,424
State 38,500 119,277 2,000
Deferred (1,734,194) -- --
----------- ----------- -----------
$ 198,772 $ 1,895,494 $ 491,744
=========== =========== ===========
The United States and foreign components of earnings (loss) before income
taxes are as follows:
FOR THE YEAR ENDED MARCH 31,
------------------------------------------
2003 2002 2001
----------- ----------- -----------
United States $(5,952,129) $ 3,669,341 $ 1,311,899
Foreign 7,368,713 4,515,218 2,876,122
----------- ----------- -----------
$ 1,416,584 $ 8,184,559 $ 4,188,021
=========== =========== ===========
The actual tax expense differs from the "expected" tax expense for the years
ended March 31, 2003, 2002 and 2001 (computed by applying the U.S. Federal
Corporate tax rate of 34 percent to income before taxes) as follows:
2003 2002 2001
----------- ----------- -----------
(AS RESTATED) (AS RESTATED)
Expected tax expense $ 481,880 $ 2,782,750 $ 1,423,927
State income taxes, net of Federal income tax benefit (43,204) 78,723 --
Foreign earnings constructively distributed to the U.S. 1,011,628 1,027,545 --
Change in valuation allowance -- (1,059,089) (609,857)
Tax rate differential on undistributed foreign earnings (1,326,368) (812,739) (517,702)
Other permanent differences 74,836 (121,696) 195,376
----------- ----------- -----------
Actual Tax Expense $ 198,772 $ 1,895,494 $ 491,744
=========== =========== ===========
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities at March 31, 2003 and 2002 are
as follows:
2003 2002
----------- -----------
(AS RESTATED)
Deferred tax assets:
Inventory differences $ 1,491,021 $ --
State net operating loss carryforward 171,019 89,315
Bad debt reserve 137,958 4,087
Reserve for sales returns 110,303 55,886
Stock based expenses -- 13,056
Amortization of reorganization intangible 28,076 36,400
----------- -----------
Total Gross Deferred Assets 1,938,377 198,744
DEFERRED TAX LIABILITY:
Depreciation (12,765) (7,326)
----------- -----------
Net Deferred Tax Asset $ 1,925,612 $ 191,418
=========== ===========
The Company believes that it is more likely than not that the deferred tax
asset will be realized; therefore, no valuation allowance is required.
F-32
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - CONCENTRATIONS OF CREDIT RISK, CUSTOMERS, SUPPLIERS, AND FINANCING
The Company derives primarily all of its revenues from retailers of
products in the United States. Financial instruments, which potentially subject
the Company to concentrations of credit risk, consist of accounts receivable.
The Company's allowance for doubtful accounts is based upon management's
estimates and historical experience and reflects the fact that accounts
receivable are concentrated with several large customers whose credit worthiness
have been evaluated by management. At March 31, 2003, 67% of accounts receivable
were due from four customers: two from the U.S. and two International Customers.
Accounts receivable from four customers that individually owed over 10% of
accounts receivable at March 31, 2003 was 22%, 19%, 15% and 11%. The Company
performs ongoing credit evaluations of its customers and generally does not
require collateral.
Revenues derived from five customers in 2003, 2002 and 2001 were 67%,
87% and 78% of revenues, respectively. Revenues derived from three customers in
2003 and 2002, and two customers in 2001, respectively, which individually
purchased greater than 10% of the Company's total revenues, were 21%, 17% and
15% in 2003, 37%, 28%, and 10% in 2002 and 32% and 23% in 2001.
The Company is dependent upon foreign companies for the manufacture of
all of its electronic products. The Company's arrangements with manufacturers
are subject to the risk of doing business abroad, such as import duties, trade
restrictions, work stoppages, foreign currency fluctuations, political
instability, and other factors, which could have an adverse impact on its
business. The Company believes that the loss of any one or more of their
suppliers would not have a long-term material adverse effect because other
manufacturers with whom the Company does business would be able to increase
production to fulfill their requirements. However, the loss of certain suppliers
in the short-term could adversely affect business until alternative supply
arrangements are secured.
During fiscal years 2003, 2002 and 2001, manufacturers in the People's
Republic of China (China) accounted for approximately 94%, 95% and 94%
respectively of the Company's total product purchases, including all of the
Company's hardware purchases.
The Company finances its sales primarily through a loan facility with
one lender. (See Note 7) Although management believes there are other sources
available, a loss of the current credit facility could be in the short term,
adversely affect operations until an alternate lending arrangement is secured.
This loan, as amended, expires on July 31, 2003.
Net sales derived from the Company's Hong Kong based subsidiary
aggregated $49,268,836 in 2003, $27,176,000 in 2002 and $12,595,800 in 2001. The
carrying value of net assets held by the Company's Hong Kong based subsidiary
was $14,932,175 at March 31, 2003.
NOTE 13 - 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
Company's Subsidiary. Sales by customer geographic region for the years ended
March 31 were as follows:
SALES: 2003 2002 2001
------------ ------------ ------------
United States $ 76,777,138 $ 62,333,801 $ 34,391,540
Asia 21,310 49,314 --
Australia 814,334 -- --
Canada 919,642 47,565 11,420
Central America 96,836 5,756 --
Europe 15,714,846 -- 433,821
Mexico 1,225,111 -- --
South America 44,549 39,317 38,570
------------ ------------ ------------
Consolidated Net Sales $ 95,613,766 $ 62,475,753 $ 34,875,351
============ ============ ============
LONG LIVED ASSETS:
United States operations $ 570,065 $ 311,590
Hong Kong operations $ 1,800,191 $ 1,144,503
Eliminations (13) (13)
------------
Consolidated long-lived assets $ 2,370,243 $ 1,456,080
============
The geographic area of sales is based primarily on the location where the
product is delivered.
F-33
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - EMPLOYEE BENEFIT PLANS
The Company has a 401(k) plan for its employees to which the Company makes
contributions at rates dependent on the level of each employee's contributions.
Contributions made by the Company are limited to the maximum allowable for
federal income tax purposes. The amounts charged to earnings for contributions
to this plan and administrative costs during the years ended March 31, 2003,
2002 and 2001 totaled $61,466, $41,733 and $8,682, respectively. The Company
does not provide any post employment benefits to retirees.
NOTE 15 - SUBSEQUENT EVENTS
As of July 10, 2003, the Company obtained $1 million in subordinated
debt financing from certain officers, directors and an associate of a director.
The loan incurs interest at a rate of 9.5% per annum. These loans are
subordinated to the Company's revolving credit facility and as such may not be
repaid until such time as the credit facility is paid in full. The loan
subordination has been transferred to the Company's new factoring agreement and
the loans are not expected to be paid back before March 31, 2004.
F-34
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUPPLEMENTAL DATA
SCHEDULE I
QUARTERLY FINANCIAL DATA (UNAUDITED)
The following financial information reflects all normal recurring adjustments
that are, in the opinion of management, necessary for a fair statement of the
results of the interim periods. The quarterly results for the years 2003 and
2002 are set forth in the following table with the assumption that the
restatement of income tax was evenly distributed over each quarter:
BASIC DILUTED
EARNINGS EARNINGS
NET EARNINGS (LOSS) PER (LOSS) PER
SALES GROSS PROFIT (LOSS) SHARE SHARE
------------ ------------ ------------ ----------- -----------
2003
First quarter $ 4,264,203 $ 1,273,322 $ (1,358,780) $ (0.17) $ (0.17)
Second quarter 33,044,306 9,754,954 4,837,926 0.6 0.54
Third quarter 49,102,372 14,525,191 3,846,894 0.47 0.43
Fourth quarter 9,202,886 (2,268,736)(1) (6,108,228) (0.75) (0.66)
Total $ 95,613,766 $ 23,284,730 $ 1,217,812 $ 0.15 $ 0.14
2002 (As Restated)
First quarter $ 5,573,228 $ 1,923,199 $ (470,447) $ (0.07) $ (0.07)
Second quarter 15,797,752 5,408,430 1,881,321 0.28 0.25
Third quarter 34,324,556 11,884,855 5,444,081 0.74 0.65
Fourth quarter 6,780,217 2,406,428 (565,890) (0.07) (0.04)
Total $ 62,475,753 $ 21,622,913 $ 6,289,065 $ 0.88 $ 0.79
--------
(1) In the fourth quarter of 2003, the Company took expenses relating to a loss
on a guaranteed margin contract, $2.5 million and a reserve for inventory
loss of $3.7 million. The guaranteed margin contract reduced sales and the
reserve for inventory loss reduced cost of sales.
(2) This table makes the assumption that the restatement of income tax was
evenly distributed over each quarter.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO REDUCTION TO CREDITED TO BALANCE AT
BEGINNING OF COSTS AND ALLOWANCE FOR COSTS AND END OF
DESCRIPTION PERIOD EXPENSES WRITE OFF EXPENSES PERIOD
--------------------------------------- ------------ ---------- ------------- ----------- ----------
Year Ended March 31, 2003
Reserves deducted from assets to which
they apply:
Allowance for doubtful accounts $ 12,022 $ 412,055 $ -- $ (18,318)(1) $ 405,759
Inventory reserves -- $3,715,357 -- $ -- $3,715,357
Year Ended March 31, 2002
Reserves deducted from assets to which
they apply:
Allowance for doubtful accounts $ 9,812 $ 45,078 $ (42,868) $ -- $ 12,022
Inventory reserves $ -- $ -- $ -- $ -- $ --
Year Ended March 31, 2001
Reserves deducted from assets to which
they apply:
Allowance for doubtful accounts $ -- $ 85,302 $ (75,490) $ -- $ 9,812
Inventory reserves $ -- $ -- $ -- $ -- $ --
----------
(1) Recoveries of amounts previously written off against the reserve.
F-35
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth various expenses, which will be incurred
in connection with the registration of our securities. Other than the SEC
Registration Fee, the amounts set forth below are estimates:
SEC Registration Fee............................. $947.37
Printing & Engraving Expenses.................... $5,000.00
Legal Fees and Expenses.......................... $25,000.00
Accounting Fees and Expenses..................... $30,000.00
Transfer Agent Fees . . ......................... $ 1,000.00
----------
TOTAL:................. $60,947.37
==========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
As a Delaware corporation, we are subject to the Delaware General
Corporation Law. Section 102(b)(7) of Delaware law enables a corporation in its
certificate of incorporation to eliminate or limit personal liability of members
of its Board of Directors for monetary damages for breach of a director's
fiduciary duty of care. Article 10 of our Certificate of Incorporation provides
that a director shall not be personally liable to us or our stockholders for
monetary damages for breach of fiduciary duty as a director, except for
liability (i) for any breach of the director's duty of loyalty to us or our
stockholders, (ii) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) under Section 174 of
the General Corporation Law of Delaware or (iv) for any transaction from which
the director derived an improper personal benefit and contains a comparable
provision. Under Section 174 of Delaware law, directors are subject to personal
liability if they declare dividends or have the corporate buy back, acquire or
purchase shares of its common stock in circumstances which are not permitted by
Delaware law. Under Delaware law, directors can not declare dividends unless the
company has legally available surplus, as such term is defined under Delaware
law, or the dividends are declared out of net profits in the fiscal year in
which the dividend is declared. Directors can not authorize the acquisition,
purchase or redemption of shares of a company's common stock unless such
transaction is authorized by the company's articles of incorporation.
Section 145 of Delaware law permits a corporation organized under
Delaware law to indemnify directors and officers with respect to any matter in
which the director or officer acted in good faith and in a manner he reasonably
believed to be in or not opposed to the best interests of the company, and with
respect to any criminal action or proceeding, he had no reasonable cause to
believe his conduct was unlawful. Article VI of our Bylaws provides that our
officers, directors, employees or agent shall be indemnified to the full extent
permitted by Delaware law. Article VI also provides that we may advance expenses
to a director prior to the final disposition of the action. However, if required
under Delaware law, we may require an officer or director to give us an
undertaking in advance of the final disposition that he will repay all amounts
so advanced, if it shall ultimately be determined that such officer or director
is not entitled to be indemnified under our by-laws or otherwise.
The above discussion of Delaware law and our certificate of
incorporation and bylaws is not intended to be exhaustive and is qualified in
its entirety by our certificate of incorporation, bylaws and Delaware law.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
The following table sets forth our sale of securities during the last
three years, which securities were not registered under the Securities Act of
1933, as amended. Except as described in paragraph 23, no underwriters were
employed with respect to the sale of any of the securities listed below.
1. During fiscal 2000, six employees exercised options to acquire
118,250 stock options. All of these options were granted to our employees on
December 8, 1999. The names of the employees, the number of shares purchased and
the proceeds to us are listed below:
II-1
NUMBER OF PURCHASE PROCEEDS TO DATE OF
NAME SHARES ACQUIRED PRICE THE COMPANY EXERCISE
---- --------------- -------- ----------- --------
Melody Rawski 7,500 $.29 $ 2,150 12/30/99
John Steele 7,500 $.29 $ 2,150 01/04/00
John Klecha 75,000 $.29 $21,500 01/18/00
Terry Marco 7,500 $.29 $ 2,150 01/25/00
Terri Phillips 3,750 $.29 $ 1,075 02/16/00
Adolph Nelson 2,250 $.29 $ 645 03/15/00
Jorge Otaegui 2,250 $.29 $ 645 08/02/00
Each of the employees paid for the options with cash. Each employee's
exercise of the option was made in reliance on Section 4(2) of the Securities
Act. Each employee represented that he/she had no need for liquidity in his/her
investment and had adequate financial resources to withstand a total loss of
their investment. A legend was placed on the certificates stating that the
securities were not registered under the Securities Act and set forth the
restrictions on their transferability and sale.
2. During fiscal 2000, eleven warrant holders exercised their warrants
to acquire 195,000 shares of our common stock. Each of these warrant holders
acquired their warrants in our private offering of units that closed on May 12,
1999. The names of the warrant holders, the date of exercise, the number of
shares purchased, the exercise price and the proceeds received by us are listed
below.
DATE OF NO. OF EXERCISE PROCEEDS TO THE
NAME EXERCISE SHARES PRICE COMPANY
---- -------- ------ -------- ---------------
Benchmark Capital 4/26/00 24,000 $1.33 $ 32,000
Sebastian Angelico 5/03/00 6,000 $1.33 $ 8,000
Josef Bauer 5/15/00 12000 $1.33 $ 16,000
Albert Wardi 5/22/00 3,000 $1.33 $ 4,000
Wolcot Capital Inc. 5/24/00 6,000 $1.33 $128,000
Wendy Blauner 5/24/00 6,000 $1.33 $ 8,000
Jon Blauner 5/24/00 6,000 $1.33 $ 8,000
John Klecha 9/25/00 6,000 $1.33 $ 8,000
Bank Sal. Oppenheim 10/27/00 60,000 $1.33 $ 80,000
Sil Venturi 12/01/00 6,000 $1.33 $ 8,000
Aton Trust 12/01/00 60,000 $1.33 $ 80,000
Each of these warrant holders exercised their warrants in reliance upon
Section 4(2) of the Securities Act of 1933, because each of the holders was
knowledgeable, sophisticated and had access to comprehensive information about
us. We placed legends on the certificates stating that the securities were not
registered under the Securities Act and set forth the restrictions on their
transferability and sale.
3. During fiscal 2000, certain of our outside consultants exercised warrants
to acquire an aggregate of 483,000 shares that were issued to them. The names of
the consultants, the date of issuance of the warrants, the date of exercise, the
number of warrants, exercise price and proceeds are listed below.
Date of Date of No. of Exercise
Name Issuance Exercise Warrants Price Proceeds
---- -------- -------- --------- ------- --------
Portfolio
Research
Associates 6/08/99 5/17/00 114,000 $.92 $104,500
Jack Robbins 4/1/5/99 5/24/00 125,000 $.67 $ 75,000
Jack Robbins 4/15/99 5/24/00 125,000 $1.005 $112,500
Union Atlantic 2/08/99 11/01/00 30,000 $.67 $ 20,000
Each of these consultants exercised their warrants in reliance upon Section 4(2)
of the Securities Act of 1933, because each of the holders was knowledgeable,
sophisticated and had access to comprehensive information about us. We placed
legends on the certificates stating that the securities were not registered
under the Securities Act and set forth the restrictions on their transferability
and sale.
4. In May 2000, we obtained two working capital loans in the amount of
$100,000 and $500,000 from Maureen La Rouche and Josef Bauer. The loans were for
II-2
a period of eight months and bore interest at the rate of 15% per annum. As
consideration for extending the loans, we issued 7,500 warrants to Ms. La Rouche
and 37,500 warrants to Mr. Bauer, on May 25, 2000. Each warrant allowed the
holder to purchase one share of our common stock at an exercise price of $2.18
per share. The warrants expire on May 25, 2003.
5. On September 5, 2000, we issued 37,500 warrants to Neal Berkman for
services rendered to our Company. Mr. Berkman a principal at Berkman and
Associates, a firm that provides investor relation services to us. The warrants
had an exercise price of $2.04 per share and 18,750 warrants vested on December
1, 2001 and the remaining 18,750 on December 1, 2002. The warrants expired on
December 1, 2006. We issued these warrants to Mr. Berkman in reliance upon
Section 4(2) of the Securities Act, because Mr. Berkman was knowledgeable,
sophisticated and had access to comprehensive information about us.
6. On September 5, 2000, we issued an aggregate of 625,500 options to
our employees, as consideration for services they had rendered to us. We issued
these options to our employees in reliance upon Section 4(2) of the Securities
Act, because our employees were knowledgeable, sophisticated and had access to
comprehensive information about us.
NO. OF EXERCISE
NAME OPTIONS PRICE
---- ------- --------
Brian Cino 15,000 $2.04
April Green 30,000 $2.04
Alicia Haskamp 45,000 $2.04
John Klecha 270,000 $2.04
Terry Marco 45,000 $2.04
Marion McElligott 10,000 $2.04
Jamilla Miller 4,500 $2.04
Howard Moore 37,500 $2.04
Adolph Nelson 3,750 $2.04
Jorge Otaeugi 4,500 $2.04
Terry Phillips 7,500 $2.04
Melody Rawski 15,000 $2.04
Eddie Steele 300,000 $2.04
John Steele 75,000 $2.04
Richard Torrelli 3,500 $2.04
Edwin Young 75,000 $2.04
For each employee, officer or director, fifty percent of their options
are exercisable on December 1, 2001 and 50% on December 1, 2002. The options all
expire on December 1, 2006.
7. On September 5, 2000, we issued an aggregate of 75,000 options to
our current directors and one previous director for their services to us during
the preceding year. We issued these options to our directors in reliance upon
Section 4(2) of the Securities Act, because our directors were knowledgeable,
sophisticated and had access to comprehensive information about us.
NO. OF EXERCISE
NAME OPTIONS PRICE
---- ------- --------
Josef Bauer 15,000 $2.04
Edward Steele 15,000 $2.04
John Klecha 15,000 $2.04
Howard Moore 15,000 $2.04
Alan Schor 15,000 $2.04
These options are immediately exercisable and expire on September 5,
2006.
8. On March 13, 2001, we issued 30,000 options to Robert Weinberg and
15,000 options to John DeNovi. Mr. Weinberg received his grant of options
because he was joining our Board of Directors and Mr. DeNovi because he was
joining our company as an employee The exercise price of these options is $3.27
per share and the expiration date is March 13, 2006. Half of Mr. Weinberg's
options vest on December 1, 2001 and the remainder vest on December 1, 2002.
Half of Mr. DeNovi's options vest on March 13, 2002 and the remainder vest on
March 13, 2003. We issued these options to Mr. Weinberg and Mr. DeNovi in
reliance upon Section 4(2) of the Securities Act, because each of them was
knowledgeable, sophisticated and had access to comprehensive information about
us.
II-3
9. During fiscal 2002, thirteen employees, one director and one former
director exercised stock options issued under our 1994 Amended and Restated
Management Stock Option Plan. The names of the option holders, the dates of
grant, the dates of exercise, the number of shares purchased, the exercise price
and the proceeds received by us are listed below.
DATE OF DATE OF NO. OF EXERCISE
NAME GRANT EXERCISE SHARES PRICE PROCEEDS
---- -------- --------- ------ -------- --------
Adolph Nelson 12/08/99 04/30/01 2,250 $.29 $ 645
John Steele 12/08/99 04/30/01 7,500 $.29 $ 2,150
Teresa Marco 12/08/99 05/01/01 7,500 $.29 $ 2,150
Terry Philips 12/08/99 05/01/01 2,250 $.29 $ 645
Brian Cino 12/08/99 05/02/01 5,100 $.29 $ 1,462
John Klecha 12/08/99 05/30/01 75,000 $.29 $21,500
Melody Rawski 12/08/99 06/14/01 7,500 $.29 $ 2,150
Terry Phillips 12/08/99 07/11/01 2,250 $.29 $ 645
April Green 06/25/99 07/11/01 150 $.66 $ 166
Brian Cino 12/08/99 07/15/01 1,200 $.29 $ 344
April Green 06/25/99 07/11/01 300 $1.11 $ 332
John Steele 12/02/99 07/24/01 15,000 $0.29 $16,600
Josef Bauer 09/05/00 08/16/01 15,000 $2.04 $30,600
April Green 06/25/99 08/16/01 300 $1.11 $ 332
Edward Steele 12/08/99 09/28/01 262,500 $.29 $75,250
Edward Steele 12/08/99 09/28/01 7,500 $2.04 $15,300
April Green 06/25/99 10/02/01 1,500 $1.11 $ 1,660
April Green 06/25/99 10/31/01 1,500 $1.11 $ 1,660
John Steele 06/25/99 11/06/01 15,000 $1.11 $16,600
Brian Cino 12/08/98 11/13/01 525 $.29 $ 151
April Green 06/25/99 11/13/01 1,500 $1.11 $ 1,660
Teresa Marco 06/25/99 11/13/01 15,000 $1.11 $16,600
John Steele 09/25/00 12/07/01 7,500 $2.04 $15,300
April Green 06/25/99 12/07/01 1,050 $1.11 $ 1,162
Melody Rawski 09/25/00 12/18/01 7,500 $2.04 $15,300
April Green 09/05/00 12/18/01 3,000 $2.04 $ 6,120
Edwin Young 09/05/00 12/28/01 37,500 $2.04 $76,500
Adolph Nelson 09/25/00 12/28/01 1,875 $2.04 $ 3,825
Eddie Steele 12/08/99 01/03/02 262,500 $.287 $75,250
Eddie Steele 06/25/99 01/03/02 45,000 $1.107 $49,800
Eddie Steele 09/05/00 01/03/02 15,000 $2.04 $30,600
Alicia Haskamp 09/05/00 01/03/02 6,000 $2.04 $12,240
M. McElligott 09/05/00 02/06/02 3,750 $2.04 $ 7,650
Brian Cino 12/09/98 02/06/02 675 $.287 $193.50
Brian Cino 09/05/00 02/06/02 1,350 $2.04 $ 2,754
Jorge Otaeugi 12/09/98 02/06/02 2,250 $.29 $ 645
Jorge Otaeugi 09/05/00 02/06/02 2,250 $2.04 $ 4,590
John Steele 09/05/00 02/06/02 7,500 $2.04 $15,300
Terry Phillips 09/05/00 02/19/02 450 $2.04 $ 918
Alan Schor 09/05/00 02/19/02 7,500 $2.04 $15,300
Robert Torrelli 09/05/00 03/07/02 150 $2.04 $ 306
John DeNovi 03/13/01 03/07/02 2,550 $3.27 $ 8,330
John Steele 09/05/00 03/14/02 22,500 $2.04 $45,900
Terry Phillips 09/05/00 03/22/02 900 $2.04 $ 1,836
Each person paid for theirs shares with cash. Each person exercised
their options in reliance upon Section 4(2) of the Securities Act of 1933,
because he/she was knowledgeable, sophisticated and had access to comprehensive
information about us. The shares issued to these optionees were registered under
II-4
the Securities Act on a registration statement on Form S-8. The shares issued to
employees who were not affiliates did not contain any restrictive legends. The
shares issued to our executive officers and our directors contained a control
legend. Control legends were contained on the shares issued to Eddie Steele, our
Chief Executive Officer and a director, John Klecha, our Chief Operating Officer
and a director and Josef Bauer, our director.
10. During fiscal 2002, six warrant holders exercised their warrants to
acquire an aggregate of 75,000 shares of our common stock. All of these persons
acquired their warrants in the Company's private offering of units on May 12,
1999. The names of the warrant holders, the dates of exercise the number of
shares purchased, the exercise price and the proceeds received by us are listed
below.
DATE OF DATE OF NO. OF EXERCISE
NAME GRANT EXERCISE SHARES PRICE PROCEEDS
---- --------- --------- ------ --------- --------
Entropy Holdings 05/12/99 04/30/01 15,000 $1.33 $ 20,000
Itamar Zac Jones 05/12/99 07/15/01 6,000 $1.33 $ 8,000
Anthony Broy 05/12/99 10/31/01 6,000 $1.33 $ 8,000
Eddie Steele 05/12/99 01/03/02 12,000 $1.33 $ 16,000
Fred Merz 05/12/99 02/19/02 6,000 $1.33 $ 8,000
John Klecha 05/12/99 03/19/02 30,000 $1.33 $ 40,000
Each of the warrant holders paid for their shares with cash. Each of
these warrant holders exercised their warrants in reliance upon Section 4(2) of
the Securities Act of 1933, because each of these holders was knowledgeable,
sophisticated and had access to comprehensive information about us. We placed
legends on the certificates stating that the securities were not registered
under the Securities Act and set forth the restrictions on their transferability
and sale.
11. During fiscal 2002, four consultants exercised their warrants to
acquire an aggregate of 243,600 shares of our common stock. The names of the
warrant holders, the dates of issuance of the warrant, the number of shares
purchased, the exercise price and the proceeds received by us are listed below.
Date of Date of No. of Exercise
Name Issuance Exercise Shares Price Proceeds
---- --------- -------- ------ ----- --------
SISM Research 5/21/99 11/02/01 15,000 $1.33 $ 20,000
FRS Investments 7/08/99 12/31/01 30,000 $.92 $ 27,500
FRS Investments 7/08/99 04/30/01 15,000 $.92 $ 13,750
FRS Investments 7/08/99 03/04/02 30,000 $0.917 $ 27,500
Edward Borelli 7/08/99 10/29/01 143,100 $.92 $131,175
Clarion Finanz AG 4/14/99 11/08/01 10,500 $.92 $ 92,125
Each of the consultants paid for their shares with cash. Each of these
warrant holders exercised their warrants in reliance upon Section 4(2) of the
Securities Act of 1933, because each of these holders was knowledgeable,
sophisticated and had access to comprehensive information about us. We placed
legends on the certificates stating that the securities were not registered
under the Securities Act and set forth the restrictions on their transferability
and sale.
12. On August 15, 2001, we issued an aggregate of 75,000 options to its
directors pursuant to an annual grant of options to persons who had served on
the Board during the previous year. Each of the following directors received
15,000 options: Eddie Steele, John Klecha, Josef Bauer, Howard Moore and Robert
Weinberg. The exercise price of the options is $4.25 per share and the options
expire on August 14, 2006. The options are exercisable immediately. We issued
these options to our directors in reliance upon Section 4(2) of the Securities
Act, because our directors are knowledgeable, sophisticated and have access to
comprehensive information about us.
13. On August 16, 2001, Josef Bauer and Maureen LaRoche, Mr. Bauer's
assistant, exercised warrants to acquire an aggregate of 90,000 shares of our
common stock. Mr. Bauer and Ms. LaRoche acquired these warrants on May 15, 2000
when they advanced working capital to our company in May 2000. The dates of
exercise the number of shares purchased, the exercise price and the proceeds
received by us are listed below.
II-5
DATE OF NO. OF EXERCISE
NAME EXERCISE SHARES PRICE PROCEEDS
---- -------- ------ -------- --------
Josef Bauer 8/16/01 15,000 $1.34 $20,000
Josef Bauer 8/16/01 37,500 $2.17 $81,250
Josef Bauer 8/16/01 75,000 $.67 $50,000
Maureen LaRoche 8/16/01 7,500 $2.17 $16,250
Mr. Bauer and Ms. LaRoche paid for their shares with cash and exercised
their warrants in reliance upon Section 4(2) of the Securities Act of 1933,
because each was knowledgeable, sophisticated and had access to comprehensive
information about us. We placed legends on the certificates stating that the
securities were not registered under the Securities Act and set forth the
restrictions on their transferability and sale.
14. On November 30, 2001, Neil Berkman exercised options to acquire
37,500 shares of our common stock at a purchase price of $2.04 per share. Mr.
Berkman acquired these warrants for financial consulting services that he
rendered to us. Mr. Berkman paid for his shares with cash and exercised their
warrants in reliance upon Section 4(2) of the Securities Act of 1933, because he
was knowledgeable, sophisticated and had access to comprehensive information
about us. We placed legends on the certificates stating that the securities were
not registered under the Securities Act and set forth the restrictions on their
transferability and sale.
15. On December 28, 2001, Josef Bauer exercised 15,000 stock options
acquired under our Year 2001 Stock Option Plan at an exercise price of $2.04 per
share. Mr. Bauer received a grant of these options on September 5, 2000. Mr.
Bauer exercised his options in reliance upon Section 4(2) of the Securities Act
of 1933, because he was knowledgeable, sophisticated and had access to
comprehensive information about us. We placed legends on the certificates
stating that the securities were not registered under the Securities Act and set
forth their restrictions on transferability and sale.
16. During fiscal 2003, five employees and a director exercised stock
options issued under our 1994 Amended and Restated Management Stock Option Plan.
All of these options were granted on September 5, 2000. The employees and
director exercised options to acquire an aggregate of 91,225 shares of our
common stock. The names of the option holder, the dates of exercise, the number
of shares purchased, the exercise price and the proceeds received by us are
listed below.
DATE OF NO. OF EXERCISE
NAME EXERCISE SHARES PRICE PROCEEDS
---- -------- ------ -------- --------
Alicia Haskamp 04/06/02 16,500 $2.04 $33,660
Howard Moore 07/12/02 33,750 $2.04 $68,850
Terri Phillips 07/31/02 600 $2.04 $ 1,224
Adolph Nelson 12/19/02 1,875 $2.04 $ 3,825
Edwin Young 01/21/03 37,500 $2.04 $76,500
April Green 02/24/03 1,000 $2.04 $ 2,040
Each employee and director paid for the shares with cash. Each employee
and director exercised his/her options in reliance upon Section 4(2) of the
Securities Act of 1933, because he/she was knowledgeable, sophisticated and had
access to comprehensive information about us. We registered all the stock
underlying the options granted under our 1994 Plan on a registration statement
on Form S-8. The shares issued to employees who were not affiliates did not
contain any restrictive legends. The shares issued to our executive officer and
our director contained a control legend. Control legends were contained on the
shares issued to April Green, our Chief Financial Officer, and Howard Moore, our
director.
17. During the three month period ended June 30, 2002, one warrant
holder, FRS Investments, Inc. ("FRS") exercised its warrants to acquire an
aggregate of 52,500 shares of our common stock. FRS received the warrant grant
on July 8, 1999 in connection with consulting services rendered to us. The date
of exercise, the number of shares purchased, the exercise price and the proceeds
received by us are listed below.
DATE OF NO. OF EXERCISE
NAME EXERCISE SHARES PRICE PROCEEDS
---- -------- ------ -------- --------
FRS Investments 05/17/02 52,500 $0.9167 $48,125
FRS paid for its shares with cash. FRS exercised its warrants in
reliance upon Section 4(2) of the Securities Act of 1933, because it was
knowledgeable, sophisticated and had access to comprehensive information about
the us. We placed legends on the certificates stating that the securities were
not registered under the Securities Act and set forth the restrictions on their
transferability and sale.
II-6
18. On December 31, 2002, we issued an aggregate of 187,000 options to
our employees, as consideration for services they had rendered to us. We issued
these options to our employees in reliance upon Section 4(2) of the Securities
Act, because our employees were knowledgeable, sophisticated and had access to
comprehensive information about us.
NAME NO. OF OPTIONS ISSUED PRICE
---- --------------------- -----
Frank Abell 6,000 $9.00
Jennifer Barnes 5,000 $9.00
Dan Becherer 10,000 $9.00
Almina Brady-Dykes 6,000 $9.00
Elizabeth Canela 3,000 $9.00
Tammy Chestnut 1,000 $9.00
Belinda Cheung 500 $9.00
Danny Cheung 1,000 $9.00
Jeffrey Chiu 1,000 $9.00
Brian Cino 3,000 $9.00
John DeNovi 10,000 $9.00
Teresa Garcia 15,000 $9.00
April Green 20,000 $9.00
Alicia Haskamp 18,000 $9.00
Michelle Ho 3,000 $9.00
Wilson Ho 1,000 $9.00
Dale Hopkins 10,000 $9.00
Irene Ko 3,000 $9.00
Bill Lau 4,500 $9.00
Dora Lee 3,000 $9.00
Nataly Lessard 6,000 $9.00
Gigi Leung 500 $9.00
Marian McElligott 15,000 $9.00
Adolph Nelson 2,000 $9.00
Rick Ng 500 $9.00
Cathy Novello 4,000 $9.00
Jennifer O'Kuhn 2,000 $9.00
Jorge Otaegui 2,000 $9.00
Terri Phillips 3,000 $9.00
Melody Rawski 5,000 $9.00
Asante Sellers 1,000 $9.00
Stacy Sethman 5,000 $9.00
John Steele 10,000 $9.00
Richard Torrelli 1,000 $9.00
Nicolas Venegas 2,000 $9.00
Vicky Xavier 2,500 $9.00
Ho Man Yeung 500 $9.00
Yen Yu 1,000 $9.00
For each employee, twenty percent (20%) of their options are
exercisable on January 1, 2004 and 20% exercisable each January 1st thereafter
with the last 20% becoming exercisable on January 1, 2008. The options expire 5
years after they become exercisable with varying expiration dates from December
31, 2009 through December 31, 2013.
19. During the three month period ended June 30, 2003, four employees
exercised stock options issued under our 1994 Amended and Restated Management
Stock Option Plan. The employees exercised options to acquire an aggregate of
128,500 shares of our common stock. All of the options were granted on September
5, 2000, except John Klecha received the grant for 58,500 options at $1.11 on
June 25, 1999. The names of the option holder, the dates of exercise, the number
of shares purchased, the exercise price and the proceeds received by us are
listed below.
II-7
NO. OF OPTIONS EXERCISE EXERCISE
NAME EXERCISED PRICE DATE PROCEEDS
---- -------------- -------- -------- --------
John Steele 30,000 $2.04 04/9/03 $61,200
Allen Schor 7,500 $2.04 04/9/03 $15,300
Alicia Haskamp 7,500 $2.04 04/18/03 $15,300
Alicia Haskamp 10,000 $2.04 04/01/03 $20,400
John Klecha 58,500 $1.11 04/22/03 $64,935
John Klecha 15,000 $2.04 04/22/03 $30,600
All of the above issuances were paid for with cash. The above employees
exercised their options in reliance upon Section 4(2) of the Securities Act of
1933, because each was knowledgeable, sophisticated and had access to
comprehensive information about our company. We registered all the stock
underlying the options granted under our 1994 Plan on a registration statement
on Form S-8. The shares issued to our employees who were not affiliates did not
contain any restrictive legends. The shares issued to our executive officer
contained a control legend. Control legends were contained on the shares issued
to John Klecha, our Chief Operating Officer and director.
20. On August 1, 2003, we issued 14, 492 and 11,594 shares of its
common stock to Jack Dromgold and John Steele as bonus payments, respectively.
Mr. Dromgold was guaranteed a $50,000 bonus in cash under his employment
agreement, but he agreed that we could pay his bonus with shares of our common
stock. Mr. John Steele was entitled to an $80,000 bonus under his employment
agreement, but he agreed to take a $40,000 bonus which would be paid with our
common stock. Our average trading price for the five days preceding August 1,
2003 of $3.45 was used to calculate the number of shares that would be issued to
Mr. Dromgold and Mr. Steele. We issued these shares to Mr. Dromgold and Mr.
Steele in reliance upon Section 4(2) of the Securities Act, because each of them
was knowledgeable, sophisticated and had access to comprehensive information
about our company. We placed restrictive legends on the certificates stating
that the securities were not registered under the Securities Act and set forth
their restrictions on transferability and sale.
21. On August 1, 2003, Yi Ping Chan, Jack Dromgold and Eddie Steele
agreed to take 15% of their annual compensation in the form of stock. The salary
reductions for Mr. Chan and Mr. Dromgold covered a nine month period from August
1, 2003 through March 31, 2004 and the salary reduction for Mr. Steele covered
an eight month period from August 1, 2003 through February 28, 2004. The average
trading price of our common stock for the five days preceding August 1, 2003 of
$3.45 was used to calculate the number of shares that would be issued to Mr.
Chan, Mr. Dromgold and Mr. Steele. Mr. Chan agreed to take a salary reduction of
$3,125 per month for an aggregate of $28,125 over a nine month period , which
would be paid with 8,153 shares of our common stock. Mr. Dromgold agreed to take
a salary reduction of $1,948 per month for an aggregate of $17,535 over a nine
month period, which would be paid with 5,082 shares of our common stock. Mr.
Steele agreed to take a salary reduction of $7,892 per month for an aggregate of
$63,136 over a eight month period, which would be paid with 18,300 shares of our
common stock. We issued these shares to Mr. Chan, Mr. Dromgold and Mr. Steele in
reliance upon Section 4(2) of the Securities Act, because each of them was
knowledgeable, sophisticated and had access to comprehensive information about
our company. We placed restrictive legends on the certificates stating that the
securities were not registered under the Securities Act and set forth their
restrictions on transferability and sale.
22. On August 1, 2003, we issued 2,899 shares of our common stock to
Jay Bauer and Howard Moore for services that they had rendered on our Board
during fiscal 2003. The value of these shares was equal to $10,000, based on the
five day average trading price of our common stock during the five day period
preceding August 1, 2003, which was $4.60. We issued these shares to Mr. Bauer
and Mr. Moore in reliance upon Section 4(2) of the Securities Act, because each
of them was knowledgeable, sophisticated and had access to comprehensive
information about our company. We placed restrictive legends on the certificates
stating that the securities were not registered under the Securities Act and set
forth their restrictions on transferability and sale
23. On September 8, 2003, we issued an aggregate of $4,000,000 of 8%
convertible debentures in a private offering to six accredited investors. The
debentures initially are convertible into shares of common stock at a price of
$3.85 per share, subject to adjustment in certain situations. Each investor also
received warrants equal to 40% of the subscription amount divided by $3.50. The
exercise price of the warrants is $4.025 per share and the warrants expire on
September 7, 2006. We have an obligation to register the shares of common stock
underlying the debenture and warrants, which we are satisfying by filing this
registration statement. The names of the investors, the amount of the debentures
and the number or warrants issuable to each investor are set forth below.
II-8
AMOUNT OF
NAME DEBENTURES NO. OF WARRANTS
---- ---------- ---------------
Omnicron Master Trust $2,500,000 285,714
SF Capital Partners, Ltd $500,000 57,143
Bristol Investment Fund, Ltd. $300,000 34,286
Ascend Offshore Fund, Ltd. $478,000 54,629
Ascend Partners, LP $58,200 6,651
Ascend Partners Sapient LP $163,800 18,720
We issued these shares to these persons in reliance upon Section 4(2)
of the Securities Act, because the investors were knowledgeable, sophisticated
and had access to comprehensive information about us. We placed legends on the
debentures and the warrant agreements stating that the securities were not
registered under the Securities Act and set forth the restrictions on their
transferability and sale. We used Roth Capital as our placement agent and they
received a commission equal to 5.5% of the proceeds and a warrant to purchase
103,896 shares or our common stock. We agreed to register the shares underlying
Roth's warrant in a registration statement.
24. On November 17, 2003, we agreed to issue 40,151 shares of our
common stock to AG Edwards & Sons pursuant to a settlement agreement. In
September 2003, we had a disagreement with AG Edwards & Sons, regarding the
total amount of fees that were payable under our investment banking agreement
with them. We entered into a settlement agreement with them effective as of
November 17, 2003 in which we agreed to pay them the aggregate sum of $181,067
in five equal installments beginning on November 17, 2003 and ending on March
15, 2005. We also agreed to issue 40, 151 shares of our common stock to them and
to register these shares for resale in this Prospectus. We issued the shares to
AG Edwards in reliance upon Section 4(2) of the Securities Act, because it was
knowledgeable, sophisticated and had access to comprehensive information about
us. We placed legends on the stock certificates stating that the shares were not
registered under the Securities Act and set forth the restrictions on their
transferability and sale.
25. On December 19, 2003, we issued an aggregate of 221,920 options to
our employees, as consideration for services they had rendered to us. We issued
these options to our employees in reliance upon Section 4(2) of the Securities
Act, because our employees were knowledgeable, sophisticated and had access to
comprehensive information about us.
NAME NUMBER OF OPTIONS EXERCISE PRICE
------------------ ----------------- ---------------
Frank Abell 1,320 $ 1.97
Josef Bauer 2,740
Dan Becherer 4,910 $ 1.97
Almina Brady-Dykes 1,320 $ 1.97
Pam Broyles 500 $ 1.97
Elizabeth Canela 660 $ 1.97
Yi Ping Chan 52,800 $ 1.97
Belinda Cheung 110 $ 1.97
Jeffrey Chiu 220 $ 1.97
Brian Cino 660 $ 1.97
John Dahl 50,000 $ 1.97
April Green 4,380 $ 1.97
Alicia Haskamp 24,600 $ 1.97
Jeff Ho 5,000 $ 1.97
Michelle Ho 5,660 $ 1.97
Wilson Ho 220 $ 1.97
Irene Ko 660 $ 1.97
Rose Labadessa 5,000 $ 1.97
Bill Lau 5,990 $ 1.97
Doral Lee 5,660 $ 1.97
Nataly Lessard 1,320 $ 1.97
Marian McElligott 3,290 $ 1.97
II-9
Alyssa Malamud 1,000 $ 1.97
Bernardo Melo 4,000 $ 1.97
Rick Ng 110 $ 1.97
Dennis Norden 8,000 $ 1.97
Cathy Novello 880 $ 1.97
Jennifer O'Kuhn 440 $ 1.97
Jorge Otaegui 440 $ 1.97
John Petko 1,500 $ 1.97
Terri Phillips 660 $ 1.97
Melody Rawski 1,100 $ 1.97
Evelyn Romero 500 $ 1.97
Kristi Ronyak 1,000 $ 1.97
Rafael Ros 1,200 $ 1.97
Stacy Sethman 1,100 $ 1.97
Edward Steele 10,000 $ 1.97
John Steele 12,200 $ 1.97
Nicolas Venegas 440 $ 1.97
Ho Man Yeung 110 $ 1.97
Yen Yu 220 $ 1.97
These options vest in three equal installments over a period of three
years, beginning on December 17, 2004. The options expire three years after the
vesting date.
26. On January 23, 2004, we issued an aggregate of 32,000 options to
our employees, as consideration for services they had rendered to us. We issued
these options to our employees in reliance upon Section 4(2) of the Securities
Act, because our employees were knowledgeable, sophisticated and had access to
comprehensive information about us. The names of the employees, the number of
options and the exercise price of the options is listed below.
NAME NUMBER OF OPTIONS EXERCISE PRICE
---- ----------------- --------------
Dennis Nordeen 17,000 $1.60
John Steele 15,000 $1.60
For each employee, 20% of their options vest on January 23, 2005 and
20% are exercisable on each January 23 thereafter with the last 20% becoming
exercisable on January 23, 2010. The options expire 5 years after the date on
which they first become exercisable with varying expiration dates of January 22,
2010 through January 22, 2015.
27. On February 6, 2004, we issued an aggregate of 41,560 options to
our employees, as consideration for their agreement to reduce their respective
salaries. We issued these options to our employees in reliance upon Section 4(2)
of the Securities Act, because our employees were knowledgeable, sophisticated
and had access to comprehensive information about us. The names of the
employees, the number of options and the exercise price of the options is listed
below.
NAME NUMBER OF OPTIONS EXERCISE PRICE
---- ----------------- --------------
Jeffrey Li-Chieh Ho 7,000 $1.54
Stacy Blair Sethman 3,500 $1.54
Bernardo Melo 6,000 $1.54
John Petko 5,640 $1.54
Rosalina Labadessa 6,000 $1.54
Marian McElligott 6,400 $1.54
Frank Abell 7,170 $1.54
For each employee, half of these options become exercisable on August
6, 2004 and the remaining half vest on February 5, 2005. The options expire 5
years after the date on which they become exercisable with an expiration dates
of August 5, 2008 and February 5, 2009.
28. Effective as of February 9,2004, we issued an aggregate of 30,000
warrants to the investors that had purchased debentures in our $4 million
private offering. We agreed to the debenture holders in exchange for their
agreement 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. We issued the warrants to the debenture holders in
reliance on Section 4(2) of the Securities Act, because each of the debenture
holders was knowledgeable, sophisticated and had access to comprehensive
information about the Company. The new warrants have an exercise price equal to
$1.52 per share, the fair market value of the Company's common stock on February
9, 2004, the date of the grant. We placed restrictive legends on the warrants
stating that the securities were not registered under the Securities Act and set
forth their restrictions on transferability and sale.
29. On February 26, 2004, we issued an aggregate of 60,000 options to
our three non-employee directors. Jay Bauer, Bernard Appel and Richard Ekstract
each received 20,000 options. The exercise price of the options is equal to
$1.30 per share, the fair market value on the date of grant. The options vest in
three equal installments beginning on February 27, 2004 and expire three years
after the vesting date, provided that each person continues to serve on our
Board of Directors. If any of these persons were to resign from our Board, all
vested options would terminate six months after the director's resignation date.
We issued these options to Mr. Bauer, Mr. Appel and Mr. Ekstract in reliance
upon Section 4(2) of the Securities Act, because each of them was knowledgeable,
sophisticated and had access to comprehensive information about our company. We
placed restrictive legends on the options stating that the securities were not
registered under the Securities Act and set forth their restrictions on
transferability and sale.
Exhibit No. Description of Exhibit
----------- ----------------------
3.1 Certificate of Incorporation of the Company filed with the Delaware
Secretary of State on February 15, 1994 and amendments through April
15, 1999 (incorporated by reference to Exhibit 3.1 in the Company's
registration statement on Form SB-2 filed with the SEC on March 7,
2000, File No. 333-57722).
3.2 Certificate of Amendment of the Company filed with the Delaware
Secretary of State on September 29, 2000 (incorporated by reference to
Exhibit 3.1 in the Company's Quarterly Report on Form 10-QSB for the
period ended September 30, 1999 filed with the SEC on November 14, 2000
File No. 000-24968).
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3.3 Certificates of Correction filed with the Delaware Secretary of State
on March 29 and 30, 2001 correcting the Amendment to our Certificate of
Incorporation dated April 20, 1998 (incorporated by reference to
Exhibit 3.11 in the Company's registration statement on Form SB-2 filed
with the SEC on April 11, 2000, File No. 333-57722 ).
3.4 Amended By-Laws of the Company (incorporated by reference to Exhibit
3.14 in the Company's Annual Report on Form 10-KSB for the year ended
March 31, 2001 filed with the SEC on June 29, 2001, File No.
000-24968).
4.1 Form of Certificate Evidencing Shares of Common Stock (incorporated by
reference to Exhibit 3.3. of the Company's registration statement on
Form SB-2 filed with the SEC on March 7, 2000, File No. 333-57722)
5.1 Opinion of Adorno & Yoss, P.A.*
10.1 Loan Agreements dated August 13, 2003 in the aggregate amount of $1
million between the Company and each of Josef Bauer, Howard Moore &
Helen Moore Living Trust, Maureen G. LaRoche and Yi Ping Chan.
10.2 Settlement Agreement dated September 17, 2003 between AG Edwards &
Sons, Inc. and the Company, Inc.
10.1 Securities Purchase Agreement dated as of August 20, 2003 by and among
the Company and Omicron Master Trust, SF Capital Partners, Ltd.,
Bristol Investment Fund, Ltd., Ascend Offshore Fund, Ltd., Ascend
Partners, LP and Ascend Partners Sapient, LP (collectively, the
"Investors") (filed as Exhibit 10.1 to the Company's Registration
Statement filed with the SEC on October 9, 2003, File No. 333-109574).
10.2 Amendment dated September 5, 2003 to Securities Purchase Agreement
between the Company and the Investors (filed as Exhibit 10.2 to the
Company's Registration Statement filed with the SEC on October 9, 2003,
File No. 333-109574).
10.3 Form of Debenture Agreement issued by the Company to each of the
Investors (filed as Exhibit 10.3 to the Company's Registration
Statement filed with the SEC on October 9, 2003, File No. 333-109574).
10.4 Form of Warrant Agreement issued by the Company to the Investors (filed
as Exhibit 10.4 to the Company's Registration Statement filed with the
SEC on October 9, 2003, File No. 333-109574).
10.5 Warrant Agreement between the Company and Roth Capital Partners, LLC
(filed as Exhibit 10.5 to the Company's Registration Statement filed
with the SEC on October 9, 2003, File No. 333-109574).
10.6 Registration Rights Agreement between the Company and each of the
Investors and Roth Capital Partners, LLC (filed as Exhibit 10.5 to the
Company's Registration Statement filed with the SEC on October 9, 2003,
File No. 333-109574).
10.7 Domestic Merchandise License Agreement dated November 1, 2000 between
MTV Networks, a division of Viacom International, Inc. and the Company
(incorporated by reference to Exhibit 10.3 of the Company's Quarterly
Report on Form 10-Q for the quarter ended December 31, 2002, filed with
the SEC on February 14, 2003, File No. 000-24968).
10.8 Amendment dated January 1, 2002 to Domestic Merchandise License
Agreement between MTV Networks , a division of Viacom International,
Inc. and the Company (incorporated by reference to Exhibit 10.4 of the
Company's Quarterly Report on Form 10-Q for the quarter ended December
31, 2002, filed with the SEC on February 14, 2003, File No.
0000-24968).
10.9 Second Amendment as of November 13, 2002 to Domestic Merchandise
License Agreement between MTV Networks, a division of Viacom
International, Inc. and the Company (incorporated by reference to
Exhibit 10.5 of the Company's Quarterly Report on Form 10-Q for the
quarter ended December 31, 2002, filed with the SEC on February 2003,
File No. 000-24968).
10.10 Third Amendment as of February 26, 2003 to Domestic Merchandise License
Agreement between MTV Networks, a division of Viacom International,
Inc. and the Company (incorporated by reference to Exhibit 10.10 of the
Company's Annual Report on Form 10-K for the fiscal year ended March
31, 2003, filed with the SEC on July 17, 2003, File No. 000-24968).
10.11 Amendment to Domestic Licensing Agreement dated November 15, 2002
between the Company and MTV Networks, a division of Viacom
International, Inc. (incorporated by reference to Exhibit 10.5 in the
Company's Quarterly Report on Form 10-Q filed with the SEC on February
17, 2004, File No. 000-24968).
10.12 Fifth Amendment to Domestic Licensing Agreement dated December 23, 2003
between the Company and MTV Networks, a division of Viacom
International, Inc. (incorporated by reference to Exhibit 10.6 in the
Company's Quarterly Report on Form 10-Q filed with the SEC on February
17, 2004, File No. 000-24968).
10.13 Sales Agreement effective as of December 9, 2003 between the Company
and CPP Belwin, Inc. and its affiliates (incorporated by reference to
Exhibit 10.7 in the Company's Quarterly Report on Form 10-Q filed with
the SEC on February 17, 2004, File No. 000-24968).
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10.14 Factoring Agreement dated February 9, 2004 between Milberg Factors,
Inc. and the Company. (incorporated by reference to Exhibit 10.1 in the
Company's Quarterly Report on Form 10-Q filed with the SEC on February
17, 2004, File No. 000-24968).
10.15 Security Agreement for Goods and Chattels dated February 9, 2004
between Milberg Factors, Inc. and the Company. incorporated by
reference to Exhibit 10.2 in the Company's Quarterly Report on Form
10-Q filed with the SEC on February 17,2004, File No. 000-24968).
10.16 Security Agreement for Inventory dated February 9, 2004 between Milberg
Factors, Inc. and the Company (incorporated by reference to Exhibit
10.3 in the Company's Quarterly Report on Form 10-Q filed with the SEC
on February 17, 2004, File No. 000-24968).
10.17 Second Amendment to the Transaction Documents dated February 9, 2004
between Omicron Master Trust, SF Capital Partners, Ltd, Bristol
Investment Fund, Ltd., Ascend Offshore Fund, ltd., Ascend Partners, LP,
Ascend Partners Sapient L.P. and the Company (incorporated by reference
to Exhibit 10.4 in the Company's Quarterly Report on Form 10-Q filed
with the SEC on February 17, 2004, File No. 000-24968).
10.18 Form of Subordination Agreement executed by institutional Investors*
10.19 Employment Agreement dated February 27, 2004 between the Company and
Eddie Steele.*
10.20 Employment Agreement dated June 1, 2000 between the Company and
John Klecha (incorporated by reference to Exhibit 10.1 of the Company's
registration statement on Form SB-2 filed with the SEC on March 28,
2001 Report on Form 8-K filed with the SEC March 28, 2001, File No.
333-57722).
10.21 Separation and Release Agreement effective as of May 2, 2003 between
the Company and John Klecha (incorporated by reference to Exhibit 10.1
of the Company's Annual Report on Form 8-K filed with the SEC on July
17, 2003, File No. 000-24968).
10.22 Employment Agreement dated March 15, 2002 between the Company and April
Green (incorporated by reference to Exhibit 10.21 of the Company's
Annual Report on Form 10-KSB/A filed with the SEC on July 23, 2002,
File No. 000-24968 ).
10.23 Employment Agreement dated April 14, 2002 between the Company and Jack
Dromgold (incorporated by reference to Exhibit 10.20 of the Company's
Annual Report on Form 10-KSB/A filed with the SEC on July 23, 2003,
File No. 000-24968).
10.24 Employment Agreement dated May 2, 2003 between the Company and Yi Ping
Chan. (incorporated by reference to Exhibit 10.20 of the Company's
Annual Report on Form 10-KSB/A filed with the SEC on July 23, 2003,
File No. 000-24968)
II-12
Exhibit No. Description of Exhibit
----------- ----------------------
10.25 Industrial Lease dated March 1, 2002, by and between AMP Properties,
L.P. and the Company for warehouse space in Compton, California
(incorporated by reference to Exhibit 10.20 of the Company's Annual
Report on Form 10-KSB/A filed with the SEC on July 23, 2002, File No.
000-24968).
10.26 Loan and Security Agreement dated April 2000 between LaSalle Business
Credit, Inc. and the Company (incorporated by reference to Exhibit 3.1
in the Company's Quarterly Report on Form 10-QSB for the period ended
September 30, 1999 filed with the SEC on November 14, 2000, File No.
000-24968).
10.27 First through Fourth Amendment to Loan and Security Agreement dated
October 1, 2001 through February 28, 2002 between LaSalle Business
Credit, Inc. and the Company (incorporated by reference to Exhibits
10.11 through 10.14 of the Company's Annual Report on Form 10-KSB/A
filed with the SEC on July 23 , 2003, File No. 000-24968).
10.28 Fifth Amendment to Loan and Security Agreement dated August 13, 2002
between LaSalle Business Credit, Inc. and the Company (incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2002 filed with the SEC on
November 14, 2002, File No. 000-24968).
10.29 Sixth Amendment to Loan and Security Agreement dated November 28, 2001
between LaSalle Business Credit, Inc. and the Company (incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report on Form
10-Q for the quarter ended December 31, 2002, filed with the SEC on
February 14, 2003, File No. 000-24968).
10.30 Seventh through Tenth Amendment to Loan and Security Agreement dated
February 2-, 2003 through March 28, 2003 between LaSalle Business
Credit, Inc. and the Company, In (incorporated by reference to Exhibits
10.1 through 10.5 to the Form 8-K filed with the SEC on May 21, 2003,
File No. 000-24968).
10.31 Eleventh Amendment to Loan and Security Agreement dated February 28,
2003 between LaSalle Business Credit, Inc. and the Company, Inc.
(incorporated by reference to Exhibit 10.1 of the Company's Current
Report on Form 8-K filed with the SEC on June 4, 2003, File No.
000-24968).
10.32 Twelfth Amendment to Loan and Security Agreement dated February 28,
2003 between LaSalle Business Credit, Inc. and the Company, Inc.
(incorporated by reference to Exhibit 10.1 of the Company's Current
Report on Form 8-K filed with the SEC on July 7, 2003, File No.
000-24968).
10.33 Thirteenth Amendment to Loan and Security Agreement dated August 1,
2003 between LaSalle Business Credit, LLC and the Company (incorporated
by reference to Exhibit 10.1 of the Company's Current Report on Form
8-K filed with the SEC on August 1, 2003, File No. 000-24968).
10.34 Fourteenth Amendment to the Loan and Security Agreement dated August
28, 2003 between LaSalle Business Credit, LLC and the Company
(incorporated by reference to Exhibit 10.1 of the Company's Current
Report on Form 8-K filed with the SEC on August 28, 2003, File No.
000-24968).
II-13
Exhibit No. Description of Exhibit
----------- ----------------------
10.35 Amended and Restated 1994 Management Stock Option Plan (incorporated by
reference to Exhibit 10.6 to the Company's registration statement on
Form SB-2 filed with the SEC on March 28, 2001, File No. 333-59684).
10.36 Year 2001 Stock Option Plan (incorporated by reference to Exhibit 10.1
of the Company's registration statement on Form S-8 filed with the SEC
on September 13, 2002, File No. 333-99543).
10.37 Company's Amended Bankruptcy Plan of Reorganization dated December 17,
1997 and Bankruptcy Court's Order Confirming the Plan of Reorganization
(incorporated by reference to Exhibit 10.5 of the Company's
registration statement on Form SB-2 filed with the SEC on March 7,
2000, File No. 333- 57722).
16.1 Letter regarding Change in Former Accountants (incorporated by
reference to Exhibit 16.1 attached to the Company's Current Report on
Form 8-K filed on March 27, 2003).
21.1 List of Subsidiaries (incorporated by reference to Exhibit 21.1 in the
Company's Annual Report on Form 10-K for the fiscal year ended March
31, 2003 filed with the SEC on July 17, 2003, File No. 000-24968).
23.1 Consent of Grant Thornton, LLP*
23.2 Consent of Salberg & Company, P.A.*
23.3 Consent of Adorno & Yoss, P.A. (contained in Exhibit 5.1)
*Filed herewith.
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration
statement to:
(i) Include any Prospectus required by Section 10(a)(3)
of the Securities Act;
(ii) Reflect in the Prospectus any facts or events which,
individually or together, represent a fundamental
change in the information in the registration
statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered
(if the total dollar value of securities offered
would not exceed that which was registered) and any
deviation from the low or high end of the estimated
maximum offering range may be reflected in the form
of Prospectus filed with the Securities and Exchange
Commission pursuant to Rule 424(b) if, in the
aggregate, the change in volume and price represents
no more than a 20% change in the maximum aggregate
offering price set forth in the "Calculation of the
Registration Fee" table in the effective registration
statement; and
(iii) Include any additional or changed material
information on the plan of distribution.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, as amended, treat each such
post-effective amendment as a new registration statement
relating to the securities offered therein, and the offering
of the securities at that time to be the initial bona fide
offering thereof.
(3) To remove from registration by means of a post-effective
amendment any of the securities being registered which remain
unsold at the termination of the offering.
(4) For purposes of determining any liability under the Securities
Act of 1933, as amended, treat the information omitted from
the form of Prospectus filed as part of this registration
statement in reliance upon Rule 430A, and contained in a form
of Prospectus filed by the small business issuer under Rule
424(b)(1) or (4) or 497(h) under the Securities Act as part of
this registration statement as of the time the Commission
declares it effective.
(5) For determining any liability under the Securities Act, treat
each post-effective amendment that contains a form of
Prospectus as a new registration statement for the securities
offered in the registration statement, and that offering of
the securities at the time as the initial bona fide offering
of those securities.
II-14
Insofar as indemnification for liabilities arising under the Securities Act of
1933, as amended, may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the foregoing provisions, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Securities Act of 1933, as amended, and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the Registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question of whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933, as amended, and will be governed by the final
adjudication of such issue.
II-15
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant has
duly caused this Amendment No. 1 to the Registration Statement on Form S-1, to
be signed on its behalf by the undersigned, thereunto duly authorized in the
City of Coconut Creek, Florida, on March 2, 2004.
THE SINGING MACHINE COMPANY, INC.
Dated: March 31, 2004 By: /s/ Yi Ping Chan
--------------------
Yi Ping Chan, Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
----- ----
/s/ Yi Ping Chan Chief Executive Officer and March 31, 2004
----------------
Chief Operating Officer
(Principal Executive Officer)
/s/ April Green Chief Financial Officer March 31, 2004
---------------
(Principal Financial Officer)
/s/ John Dahl Senior Vice President of
-------------
March __, 2004
Finance
/s/ Josef A. Bauer Director March 31, 2004
------------------
Josef A. Bauer
/s/Bernard Appel Director March 31, 2004
----------------
Bernard Appel
/s/ Richard Ekstract Director March 31, 2004
--------------------
/s/ Harvey Judkowitz Director March 31, 2004
--------------------
Harvey Judkowitz
II-16
INDEX TO EXHIBITS
Exhibit No. Description of Exhibit
----------- ----------------------
5.1 Opinion re: Legality of the Securities Being Registered
10.18 Form of Subordination Agreement dated February 9, 2004 signed by
Omnicron, Master Trust, SF Capital Partners, Ltd. Bristol Investment
Fund, Ltd., Ascend Offshore Fund, Ltd., Ascent Partners LP, Ascent
Partners Sapient, LP, and the Company
23.1 Consent of Grant Thornton, LLP
23.2 Consent of Salberg & Company, P.A.
23.3 Consent of Adorno & Yoss, P.A. (contained in Exhibit 5.1)