UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For quarter ended September 30, 2008
0 - 24968
Commission File Number
THE SINGING MACHINE COMPANY, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 95-3795478
---------------------- -----------------------
(State of Incorporation) (IRS Employer I.D. No.)
6601 Lyons Road, Building A-7, Coconut Creek, FL 33073
------------------------------------------------------
(Address of principal executive offices)
(954) 596-1000
(Issuer's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 Par Value Per Share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirement for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
APPLICABLE ONLY TO ISSUES INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicated by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities and
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
CLASS NUMBER OF SHARES OUTSTANDING
Common Stock, $0.01 par value 32,698,876 as of November 5, 2008
1
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Page No.
--------
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 2008(Unaudited)
and March 31, 2008 3
Consolidated Statements of Operations - Three
months and six months ended September 30, 2008 and 2007(Unaudited) 4
Consolidated Statements of Cash Flows - Six months
ended September 30, 2008 and 2007 (Unaudited) 5
Notes to Consolidated Financial Statements-
September 30, 2008 (Unaudited) 6-13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-17
Item 3. Quantitative and Qualitative Disclosure About Market Risk 17-18
Item 4. Controls and Procedures 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 1A. Risk Factors 18-24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits 24
SIGNATURES 25
2
The Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
September 30, 2008 March 31, 2008
--------------- --------------
(Unaudited) (Audited)
Assets
------
Current Assets
Cash $ 980,067 $ 447,816
Accounts receivable, net of allowances of $80,811 and
$120,899, respectively 7,951,755 1,961,721
Due from factor 128,669 131,451
Inventories, net 9,901,213 3,514,984
Prepaid expenses and other current assets 512,725 412,552
--------------- --------------
Total Current Assets 19,474,429 6,468,524
Property and Equipment, net 794,913 598,280
Other Non-Current Assets 178,320 169,362
--------------- --------------
Total Assets $ 20,447,662 $ 7,236,166
=============== ==============
Liabilities and Shareholders' Equity
------------------------------------
Current Liabilities
Accounts payable $ 9,090,702 $ 1,145,150
Due to related parties - net 6,345,516 616,732
Accrued expenses 590,557 409,415
Short-term loan - bank 153,845 -
Current portion of long-term financing obligation 18,186 -
Customer credits on account 673,292 778,993
Deferred gross profit on estimated returns 216,269 217,812
--------------- --------------
Total Current Liabilities 17,088,367 3,168,102
Long-term Financing Obligation, less current portion 33,342 -
--------------- --------------
Total Liabilities 17,121,709 3,168,102
--------------- --------------
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; 100,000,000 shares authorized;
32,698,876 and 31,758,400 shares issued and outstanding 326,989 317,584
Additional paid-in capital 18,625,987 18,430,612
Accumulated deficit (15,627,023) (14,680,132)
--------------- --------------
Total Shareholders' Equity 3,325,953 4,068,064
--------------- --------------
Total Liabilities and Shareholders' Equity $ 20,447,662 $ 7,236,166
=============== ==============
The accompanying notes are an integral part of these consolidated financial statements.
3
The Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For Three Months Ended For Six Months Ended
------------------------------------ ------------------------------------
September 30, September 30, September 30, September 30,
2008 2007 2008 2007
---------------- ---------------- ---------------- ----------------
Net Sales $ 12,616,396 $ 16,107,967 $ 14,386,742 $ 18,554,067
Cost of Goods Sold 10,595,445 12,915,137 12,163,142 15,021,885
---------------- ---------------- ---------------- ----------------
Gross Profit 2,020,951 3,192,830 2,223,600 3,532,182
---------------- ---------------- ---------------- ----------------
Operating Expenses
Selling expenses 792,542 924,763 1,014,076 1,088,668
General and administrative expenses 996,556 1,132,294 1,918,755 2,092,571
Depreciation and amortization 103,499 61,989 204,660 124,186
---------------- ---------------- ---------------- ----------------
Total Operating Expenses 1,892,597 2,119,046 3,137,491 3,305,425
---------------- ---------------- ---------------- ----------------
Income (Loss) from Operations 128,354 1,073,784 (913,891) 226,757
Other Expenses
Interest expense (25,684) (19,661) (33,000) (24,950)
---------------- ---------------- ---------------- ----------------
Net Income (Loss) $ 102,670 $ 1,054,123 $ (946,891) $ 201,807
================ ================ ================ ================
Income (Loss) per Common Share
Basic $ 0.00 $ 0.04 $ (0.03) $ 0.01
Diluted $ 0.00 $ 0.03 $ (0.03) $ 0.01
Weighted Average Common and Common
Equivalent Shares:
Basic 32,698,876 29,937,618 32,227,250 29,677,218
Diluted 32,698,876 30,290,381 32,227,250 30,029,981
The accompanying notes are an integral part of these consolidated financial statements.
4
The Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For Six Months Ended
-----------------------------------
September 30, September 30,
2008 2007
-----------------------------------
Cash flows from operating activities
Net (Loss) Income $ (946,891) $ 201,807
Adjustments to reconcile net (loss) income to net cash and cash
equivalents provided by (used in) operating activities:
Depreciation and amortization 204,660 124,186
Change in inventory reserve (15,745) (19,748)
Change in allowance for bad debts (40,088) 60,607
Stock compensation 7,280 20,891
Deferred gross profit on estimated sales returns (1,543) 14,960
Changes in assets and liabilities:
(Increase) Decrease in:
Accounts receivable (5,949,946) (11,728,247)
Inventories (6,370,484) (3,097,409)
Prepaid expenses and other current assets (100,173) 88,575
Other non-current assets (8,958) (1,411)
Increase (Decrease) in:
Accounts payable 7,945,552 8,646,427
Accounts payable - related party 5,473,963 3,728,294
Accrued expenses 181,142 81,377
Customer credits on account (105,701) (98,250)
--------------- ----------------
Net cash provided by (used in) operating activities 273,068 (1,977,941)
--------------- ----------------
Cash flows from investing activities
Purchase of property and equipment (401,293) (170,308)
--------------- ----------------
Net cash used in investing activities (401,293) (170,308)
--------------- ----------------
Cash flows from financing activities
Borrowings from (retention by) factor, net 2,782 (239,669)
Proceeds from issuance of stock - 937,671
Net loan proceeds from short-term bank obligation 153,845 -
Net proceeds from long-term financing obligation 51,528 -
Net advances from related parties 452,321 1,929,779
--------------- ----------------
Net cash provided by financing activities 660,476 2,627,781
--------------- ----------------
Change in cash and cash equivalents 532,251 479,532
Cash and cash equivalents at beginning of period 447,816 1,188,900
--------------- ----------------
Cash and cash equivalents at end of period $ 980,067 $ 1,668,432
=============== ================
Supplemental Disclosures of Cash Flow Information:
--------------- ----------------
Cash paid for Interest $ 33,000 $ 24,950
=============== ================
Non-Cash Financing Activities:
--------------- ----------------
Conversion of trade payable to equity $ 197,500 $ 300,000
=============== ================
The accompanying notes are an integral part of these consolidated financial statements.
5
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2008
NOTE 1 - BASIS OF PRESENTATION
OVERVIEW
The Singing Machine Company, Inc., a Delaware corporation (the "Company," "SMC",
"The Singing Machine", "We" or "Us"), and wholly-owned subsidiaries SMC
(Comercial Offshore De Macau) Limitada ("Macau Subsidiary"), SMC Logistics, Inc.
("SMC-L"), SMC-Music, Inc.("SMC-M"), and Singing Machine Holdings Ltd. (a B.V.I.
company) are primarily engaged in the development, marketing, and sale of
consumer karaoke audio equipment, accessories, musical instruments 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.
NOTE 2-SUMMARY OF ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The accompanying consolidated financial statements
include the accounts of The Singing Machine Company, Inc., SMC (Comercial
Offshore De Macau) Limitada ("Macau Subsidiary"), SMC Logistics, Inc. ("SMC-L"),
SMC-Music, Inc. ("SMC-M"), and The Singing Machine Holdings Ltd. (a B.V.I.
company). All inter-company accounts and transactions have been eliminated in
consolidation for all periods presented.
INTERIM CONSOLIDATED FINANCIAL STATEMENTS. The consolidated financial statements
for the three months and six months ended September 30, 2008 and 2007 are
unaudited. In the opinion of management, such consolidated financial statements
include all adjustments (consisting of normal recurring accruals) necessary for
the fair presentation of the consolidated financial position and the
consolidated results of operations. The consolidated results of operations for
the periods presented are not necessarily indicative of the results to be
expected for the full year. The consolidated balance sheet information as of
March 31, 2008 was derived from the audited consolidated financial statements
included in the Company's Annual Report on Form 10-K. The interim consolidated
financial statements should be read in conjunction with that report.
USE OF ESTIMATES. The Singing Machine makes estimates and assumptions in the
ordinary course of business relating to sales returns and allowances, inventory
reserves, warranty reserves, and reserves for promotional incentives that affect
the reported amounts of assets and liabilities and of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period.
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.
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 reduces inventory on hand to its
net realizable value on an item-by-item basis when it is apparent that the
expected realizable value of an inventory item falls below its original cost. A
charge to cost of sales results when the estimated net realizable value of
specific inventory items declines below cost. Management regularly reviews the
Company's inventories for such declines in value.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Macau Subsidiary is the Hong Kong dollar. Such
financial statements are translated to U.S. dollars using year-end rates of
exchange for assets and liabilities, and average rates of exchange for the year
for revenues, costs, and expenses. Net gains and losses resulting from foreign
exchange transactions and translations were not material during the periods
presented.
CONCENTRATION OF CREDIT RISK
The Company maintains cash balances in foreign financial institutions. Such
balances are not insured. The uninsured amounts at September 30, 2008 and March
31, 2008 are $638,086 and $407,376, respectively.
6
INVENTORY
Inventories are comprised of electronic karaoke 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 Singing Machine reduces inventory on hand to
its net realizable value on an item-by-item basis when it is apparent that the
expected realizable value of an inventory item falls below its original cost. A
charge to cost of sales results when the estimated net realizable value of
specific inventory items declines below cost. Management regularly reviews the
Company's investment in inventories for such declines in value.
REVENUE RECOGNITION
Revenue from the sale of equipment, accessories, and musical recordings are
recognized upon the later of: (a) the time of shipment or (b) when title passes
to the customers and all significant contractual obligations have been satisfied
and collection of the resulting receivable is reasonably assured. Revenues from
sales of consigned inventory are recognized upon sale of the product by the
consignee. Net sales are comprised of gross sales net of actual and estimated
future returns, discounts and volume rebates.
STOCK BASED COMPENSATION
The Company began to apply the provisions of Share-Based Payments ("SFAS 123
(R)"), starting on January 1, 2006. SFAS 123 (R) which became effective after
June 15, 2005, replaces SFAS No. 123, Accounting for Stock-Based Compensation,
and supersedes Accounting Principles Board Opinion ("APB") No. 25, Accounting
for Stock Issued to Employees. SFAS 123 (R) requires all share-based payments to
employees including grants of employee stock options, be measured at fair value
and expensed in the consolidated statement of operations over the service period
(generally the vesting period). Upon adoption, the Company transitioned to SFAS
123 (R) using the modified prospective application, whereby compensation cost is
only recognized in the consolidated statements of operations beginning with the
first period that SFAS 123 (R) is effective and thereafter, with prior periods'
stock-based compensation still presented on a pro forma basis. Under the
modified prospective approach, the provisions of SFAS 123 (R) are to be applied
to new employee awards and to employee awards modified, repurchased, or
cancelled after the required effective date. Additionally, compensation cost for
the portion of employee awards for which the requisite service has not been
rendered that are outstanding as of the required effective date shall be
recognized as the requisite service is rendered on or after the required
effective date. The compensation cost for that portion of employee awards shall
be based on the grant-date fair value of those awards as calculated for either
recognition or pro-forma disclosures under SFAS 123. The Company continues to
use the Black-Scholes option valuation model to value stock options. As a result
of the adoption of SFAS 123 (R), the Company recognized a charge of $3,640
(included in selling, general and administrative expenses) for the three months
ended September 30, 2008 associated with the expensing of stock options. For the
three and six months ended September 30, 2008, the stock option expense was
$3,640 and $7,280, respectively. Employee stock option compensation expense in
fiscal years 2008 and 2007 includes the estimated fair value of options granted,
amortized on a straight-line basis over the requisite service period for the
entire portion of the award.
The fair value of each option grant was estimated on the date of the grant using
the Black-Scholes option-pricing model with the assumptions outlined below. For
the quarter ended September 30, 2008, the Company took into consideration
guidance under SFAS 123 (R) and SEC Staff Accounting Bulletin No. 107 (SAB 107)
when reviewing and updating assumptions. The expected volatility is based upon
historical volatility of our stock and other contributing factors. The expected
term is based upon observation of actual time elapsed between date of grant and
exercise of options for all employees. Previously such assumptions were
determined based on historical data.
o For the six months ended September 30, 2008: expected dividend yield
0%, risk-free interest rate of 1.55%, volatility of 67.41% and
expected term of one year.
o For the six months ended September 30, 2007: expected dividend yield
0%, risk-free interest rate of 4.92%, volatility of 90.77% and
expected term of three years.
ADVERTISING
Costs incurred for producing and publishing advertising of the Company, are
charged to operations as incurred. The Company has entered into cooperative
advertising agreements with its major clients that specifically indicated that
the client has to spend the cooperative advertising fund upon the occurrence of
mutually agreed events. The percentage of the cooperative advertising allowance
ranges from 2% to 5% of the purchase. The clients have to advertise the
Company's products in the client's catalog, local newspaper and other
advertising media. The client must submit the proof of the performance (such as
a copy of the advertising showing the Company's products) to the Company to
request for the allowance. The client does not have the ability to spend the
allowance at their discretion. The Company believes that the identifiable
benefit from the cooperative advertising program and the fair value of the
advertising benefit is equal or greater than the cooperative advertising
expense. Advertising expense for the six months ended September 30, 2008 and
2007 was $200,041 and $195,371, respectively.
RESEARCH AND DEVELOPMENT COSTS
All research and development costs are charged to results of operations as
incurred. These expenses are shown as a component of selling, general and
administrative expenses in the consolidated statements of operations. For the
three months ended September 30, 2008 and 2007, these amounts totaled $4,705 and
$1,090, respectively.
For the six months ended September 30, 2008 and 2007, these amounts totaled
$6,654 and $7,975, respectively.
7
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
disclosures of information about the fair value of certain financial instruments
for which it is practicable to estimate that value. For purposes of this
disclosure, the fair value of a financial instrument is the amount at which the
instrument could be exchanged in a current transaction between willing parties,
other than in a forced sale or liquidation.
The carrying amounts of the Company's short-term financial instruments,
including accounts receivable, due from factors, accounts payable, customer
credits on account, accrued expenses and loans payable to related parties
approximates fair value due to the relatively short period to maturity for these
instruments.
RECLASSIFICATIONS
Certain prior period amounts have been reclassified to conform to the current
period presentation.
NOTE 3- INCOME TAXES
The Company follows Statement of Financial Accounting Standards No. 109
"Accounting for Income Taxes" ("SFAS No. 109"). Under the asset and liability
method of SFAS No. 109, deferred tax assets and liabilities are recognized for
the future tax consequences attributed to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax base. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. Under SFAS
No. 109, the effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. If
it is more likely than not that some portion of a deferred tax asset will not be
realized, a valuation allowance is recognized.
Significant management judgment is required in developing The Singing Machine's
provision for income taxes, including the determination of foreign tax
liabilities, deferred tax assets and liabilities and any valuation allowances
that might be required against the deferred tax assets. Management evaluates its
ability to realize its deferred tax assets on a quarterly basis and adjusts its
valuation allowance when it believes that it is more likely that the asset will
not be realized.
As of September 30, 2008 and March 31, 2008, The Singing Machine had gross
deferred tax assets of approximately $2.4 million and $2.5 million,
respectively, against which the Company recorded valuation allowances totaling
approximately $2.4 million and $2.5 million, respectively.
On January 1, 2007 we adopted FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes ("FIN 48"). FIN 48 clarifies the requirements of
SFAS No. 109, Accounting for Income Taxes, relating to the recognition of income
tax benefits. FIN 48 provides a two-step approach to recognizing and measuring
tax benefits when the benefits' realization is uncertain. The first step is to
determine whether the benefit is to be recognized; the second step is to
determine the amount to be recognized: o Income tax benefits should be
recognized when, based on the technical merits of a tax position, the company
believes that if a dispute arose with the taxing authority and were taken to a
court of last resort, it is more likely than not (i.e., a probability of greater
than 50 percent) that the tax position would be sustained as filed; and o If a
position is determined to be more likely than not of being sustained, the
reporting company should recognize the largest amount of tax benefit that is
greater than 50 percent likely of being realized upon ultimate settlement with
the taxing authority.
The adoption of FIN 48 had no impact on these financial statements.
8
NOTE 4- INVENTORIES
Inventories are comprised of the following components:
September 30, March 31,
2008 2008
----------------- ----------------
Finished Goods $ 5,233,520 $ 4,012,969
Inventory in Transit 5,261,351 -
Less: Inventory Reserve (593,658) (497,985)
----------------- ----------------
Net Inventories $ 9,901,213 $ 3,514,984
================= ================
Inventory consigned to customers at September 30, 2008 and March 31, 2008 were
$382,885 and $372,012, respectively.
NOTE 5 - ACCOUNTS RECEIVABLE FACTORING AGREEMENT
The Company executed an agreement with CIT on August 13, 2007 to factor its
receivables. CIT assumes the credit risk on approved accounts (factor risk
accounts). For non-approved accounts, the Company will assume the credit risk
(client risk accounts). The factoring fees, for the client risk accounts, are
..3% of the gross invoice. For the factor risk accounts, the fees are .55% of the
gross invoice. The annual minimum charge is $24,000. CIT does not advance funds
to the Company directly. On October 26, 2007, the Company entered into a four-
party agreement with CIT("Factor"), Standard Chartered Bank (Hong Kong), Limited
("Lender") and Starlight Marketing Limited ("Borrower"), a related party.
According to the agreement, the Company assigns the proceeds from customers to
the Lender, the Lender advances the loans to the Borrower. The Borrower sends
the advance to the Company. Both the Borrower and the Company guarantee the
repayment of the advance. The maximum amount for the advance is approximately
$4.5 million or 85% of the qualified accounts receivable, which ever is higher.
As of September 30, 2008 and March 31, 2008 the outstanding amount due from the
factor was $128,669 and $131,451, respectively. The amounts represent excess of
customer payments received by the factor over advances made to the Company. The
factoring agreement with CIT expired in August 2008 and the Company gave 60 days
written notice to terminate the agreement.
On August 28, 2008, the Company executed a three-party Banking Facility
agreement between the Company's wholly owned subsidiary SMC (Commercial Offshore
De Macau) Limitada ("Borrower"), DBS Bank (Hong Kong) Limited ("Lender") and
BB&T ("Factor"). According to the agreement, BB&T will serve as the
correspondent factor for the Lender and does not advance funds to the Company
directly. The Company assigns the proceeds from customers to the Lender and the
Lender advances funds to the Borrower. The maximum amount for the advance is
approximately $7.0 million or 80% of the qualified accounts receivable, which
ever is higher. The Factor assumes credit risk on approved accounts (factor risk
accounts). For non-approved accounts, the Company will assume the credit risk
(client risk accounts). The factoring fees will be .45% of the gross invoice for
both client risk and factor risk accounts. This agreement is effective October
16, 2008 and replaces the previous four-party agreement between the Company,
Starlight Marketing Limited (a related party), Standard Chartered Bank (Hong
Kong), Limited and CIT.
NOTE 6 - PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
September 30, March 31,
LIFE 2008 2008
---------- ------------------------------------
(unaudited)
Computer and office and warehouse 5 years
equipment $ 701,184 $ 520,182
Furniture and fixtures 5-7 years 219,415 216,120
Leasehold improvements * 162,114 156,614
Molds and tooling 3 years 1,244,465 1,032,970
------------------------------------
2,327,178 1,925,886
Less: Accumulated depreciation (1,532,265) (1,327,606)
------------------------------------
$ 794,913 $ 598,280
====================================
* Shorter of remaining term of lease or useful life
9
NOTE 7 - CUSTOMER CREDITS ON ACCOUNT
Customer credits on account represent customers that have received credits in
excess of their accounts receivable balance. These balances were reclassified
for financial statement purposes as current liabilities until paid or applied to
future purchases.
NOTE 8 - FINANCING
On February 12, 2008 SMC (Comercial Offshore De Macau) Limitada ("Macau
Subsidiary") entered into a Banking Facilities agreement with Heng Seng Bank
Limited ("Bank"). Under the terms of the agreement, the Macau Subsidiary has
access to $5,100,000 in total facilities including $500,000 for payment of goods
financed under the bank's letters of credit, $3,000,000 for negotiation of
discrepant documents presented under export letters of credit and a factoring
facility to a maximum of $1,600,000. Interest on open balances is due and
payable monthly at a rate of 2% per annum above LIBOR (London Interbank Offered
Rate). The note is secured by a promissory note from the Macau Subsidiary of
$5.8 million and an unlimited written guarantee from the Company. The amount due
to the Bank as of September 30, 2008 and March 31, 2007 were $153,845 and $0
respectively.
On July 16, 2008 SMC Logistics, Inc. ("SMC-L") entered into a financing
arrangement with Westover Financial, Inc. for the purchase of four forklifts for
the California logistics operations. The terms of the agreement required an
initial payment of $18,691 and 36 monthly payments of $1,516. On September 30,
2008 the remaining amount due on this obligation was $51,528 of which $18,186
was due within the next twelve months and the remaining $33,342 due after one
year.
On August 28, 2008, the Company executed a three-party Banking Facility
agreement between the Company's wholly owned subsidiary SMC (Commercial Offshore
De Macau) Limitada ("Borrower"), DBS Bank (Hong Kong) Limited ("Lender") and
BB&T ("Factor"). The agreement provides for credit facilities to a maximum of
$13.0 million consisting of the following:
o Maximum of $7.0 million on 80% of qualified accounts receivable.
o Maximum letter of credit facility of $4.0 million for accounts payable
financing.
o Maximum $2.0 million negotiation of export bills under letter of
credit.
Interest on letter of credit facilities and discounting charges on accounts
receivable advances will be charged at a rate of 1.5% per annum over LIBOR
(London Interbank Offered Rate). The credit facility is secured with corporate
guarantees from the Company as well as a $2.0 million guarantee from Starlight
International Holdings Limited, a related party. BB&T will serve as the
correspondent factor for the Lender for the Company's qualified North American
accounts receivable. BB&T does not advance funds to the Company directly. The
Company assigns the proceeds from customers to the Lender and the Lender
advances funds to the Borrower. The factoring fees will be .45% of the gross
invoice for all factored accounts. This agreement is effective October 16, 2008
and replaces the previous four-party agreement between the Company, Starlight
Marketing Limited (a related party), Standard Chartered Bank (Hong Kong),
Limited and CIT. There were no outstanding obligations on these credit
facilities as of September 30, 2008 and March 31, 2008.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
SYBERSOUND RECORDS, INC. V. UAV CORPORATION; MADACY ENTERTAINMENT L.P., AUDIO
STREAM, INC., TOP TUNES, INC., SINGING MACHINE, INC., BCI ECLIPSE COMPANY, LLC,
AMOS ALTER, DAVID ALTER, EDWARD GOETZ, DENNIS NORDEN, FRANK ROBERTSON, DOUGLAS
VOGT AND RICHARD VOGT (UNITED STATES DISTRICT COURT FOR THE CENTRAL DISTRICT OF
CALIFORNIA, CV05-5861 JFW); (UNITED STATES COURT OF APPEALS FOR THE NINTH
CIRCUIT (USCA DOCKET NO. 06-55221)
The federal court action filed on August 11, 2005 alleged violation of the
Copyright Act and the Lanham Act by the defendants, and claims for unfair
competition under California law. Sybersound was joined in the complaint by
several publisher owners of musical compositions who alleged copyright
infringement against all the defendants except The Singing Machine Company, Inc.
On November 7, 2005, the district court ordered the publisher plaintiffs'
copyright claims severed from the case. The Singing Machine Company, Inc. is not
a party to the severed cases.
In September 2005, the defendants, including The Singing Machine Company, Inc.,
filed multiple motions to dismiss the original complaint. In October 2005,
Sybersound filed a motion for summary judgment. On January 6, 2006, the court
granted the motions of the defendants and denied the plaintiff's motion, thereby
dismissing the case against the defendants, including The Singing Machine
Company, Inc., with prejudice. The plaintiff Sybersound thereafter appealed the
decision to the Ninth Circuit Court of Appeals.
On February 27, 2008 the Ninth Circuit Court of Appeals affirmed the dismissal
against The Singing Machine Company, Inc. and dismissed all claims against the
Company with prejudice. Sybersound had until July 10, 2008 to file a Petition
with the United States Supreme Court to appeal that decision. Sybersound did not
file any such Petition with the United States Supreme Court. Due to Sybersound's
failure to file a timely Petition, the above lawsuit is considered concluded.
10
The Company is also subject to various other legal proceedings and other claims
that arise in the ordinary course of business. In the opinion of management, the
amount of ultimate liability, if any, in excess of applicable insurance
coverage, is not likely to have a material effect on the financial condition,
results of operations or liquidity of the Company. However, as the outcome of
litigation or other legal claims is difficult to predict, significant changes in
the range of possible loss could occur, which could have a material impact on
the Company's operations.
INCOME TAXES
In a letter dated July 21, 2008 the Internal Revenue Service notified the
Company of an unpaid tax balance on Income Tax Return of a Foreign Corporation
(Form 1120-F) for the period ending March 31, 2003 for International SMC (HK)
Limited "ISMC (HK)", a former subsidiary. According to the notice ISMC (HK) has
an unpaid balance due in the amount of $241,639 that includes an interest
assessment of $74,125. ISMC (HK) was sold in its entirety by the Company on
September 25, 2006 to a British Virgin Islands company ("Purchaser"). The sale
and purchase agreement with the Purchaser of ISMC (HK) specifies that the
Purchaser would ultimately be responsible for any liabilities, including tax
matters. Management believes this matter is in the initial discovery stages and
is too preliminary to determine whether this would have an impact on the
Company's financial statements.
NON-COMPLIANCE NOTICE FROM AMEX
On September 16, 2008, the Company received a notice letter from The American
Stock Exchange (the "Amex") indicating that the Company has fallen below the
continued listing standards of the Amex and that its listing is being continued
pursuant to an extension.
For the quarters ended June 30, 2008 and September 30, 2008, the Company was not
in compliance with Section 1003(a)(ii) of the Amex Company Guide with
shareholders' equity of less than $4,000,000 and net losses in three of its four
most recent fiscal years.
In order to maintain its Amex listing, the Company was required to submit a plan
of compliance to the American Stock Exchange by October 23, 2008 advising the
Amex of actions it would take, which may allow it to regain compliance with all
of the Exchange's continued listing standards by March 31, 2009. The Company has
submitted the plan indicating how the Company intends to meet the net equity
requirement of $4,000,000. The Amex will need up to 45 days to review the plan
and make the final decision.
The Listings Qualifications Department at Amex would evaluate the plan,
including any supplemental information provided, and make a determination as to
whether the Company has made a reasonable demonstration in the Plan of an
ability to regain compliance. If the plan is accepted, the Company may be able
to continue its listing during the plan period, during which time it will be
subject to periodic review to determine whether it is making progress consistent
with the Revised Plan. The Company may be subject to delisting proceedings if
the plan is not accepted, or if the plan is accepted but the Company is not in
compliance with all of the Exchange's continued listing standards within the
time frame provided or does not make progress consistent with the plan during
the plan period.
The Company was previously added to the list of issuers that are not in
compliance with the Amex's continued listing standards, and the Company's
trading symbol SMD remains subject to the extension ".BC" to denote its
noncompliance. This indicator will remain in effect until such time as the
Company has regained compliance with all applicable continued listing standards.
LEASES
The Company has entered into various operating lease agreements for office and
warehouse facilities in Coconut Creek, Florida, City of Industry, California and
Macau. The leases expire at varying dates. Rent expense for the six months ended
September 30, 2008 and 2007 was $141,421 and $123,839 respectively.
In addition, the Company maintains various warehouse equipment and computer
equipment operating leases.
Future minimum lease payments under property and equipment leases with terms
exceeding one year as of September 30, 2008 are as follows:
Property Leases Equipment Leases
-------------------- --------------------
For period ending
2009 $ 587,508 $ 9,888
2010 856,466 9,848
2011 647,205 -
2012 649,080 -
2013 and beyond 725,936 -
-------------------- -------------------
$ 3,466,195 $ 19,736
==================== ====================
11
NOTE 10 - STOCKHOLDERS' EQUITY
COMMON STOCK ISSUANCES
During the six months ended September 30, 2008 and 2007, the Company issued
940,476 and 3,519,820 shares of its common stock, respectively.
On April 1, 2008, the Company issued 940,476 shares of common stock to Starlight
Industrial Holdings, Ltd. for $197,500 ($.21 per share) as payment for certain
payables owed by the Company for tooling.
During the six months ended September 30 2007, the Company issued 162,677 shares
of common stock to various employees, as well as directors, at prices ranging
from $.32 per share to $.93 per share pursuant to employee stock option
agreements.
On September 28, 2007, the Company issued 857,143 shares of common stock to
koncept International Limited, a subsidiary of Starlight for $300,000 ($.350 per
share). The fair value of the shares of $300,000 was used to offset the trade
payable to Starlight Marketing Macao.
On April 16, 2007, 2,500,000 warrants at $0.233 were exercised by koncept
International Limited, a subsidiary of Starlight, and the Company received a
total of $582,500.
EARNINGS PER SHARE
In accordance with SFAS No. 128, "Earnings per Share", basic (loss) earnings per
share are computed by dividing the net (loss) earnings for the year by the
weighted average number of common shares outstanding. Diluted earnings per share
is computed by dividing net earnings for the year by the weighted average number
of common shares outstanding including the effect of common stock equivalents.
For the six months ended September 30, 2008 and 2007, common stock equivalents
to purchase 3,213,215 and 3,131,830 shares of stock were not included in the
computation of diluted earnings per share because the exercise prices were
greater than the average market price of the Company's common stock for the
period.
STOCK OPTIONS
On June 1, 2001, the Board of Directors approved the 2001 Stock Option Plan
(`Plan"), which replaced the 1994 Stock Option Plan, as amended, (the "1994
Plan"). The Plan was developed to provide a means whereby directors and selected
employees, officers, consultants, and advisors of the Company may be granted
incentive or non-qualified stock options to purchase common stock of the
Company. As of September 30, 2008, the Plan is authorized to grant options up to
an aggregate of 1,950,000 shares of the Company's common stock and up to 300,000
shares for any one individual grant in any quarter. As of September 30, 2008,
the Company granted 1,140,180 options under the Year 2001 Plan with 707,665
options still outstanding, leaving 809,820 options available to be granted. As
of September 30, 2008, the Company has 5,550 options still issued and no options
available to be granted under the 1994 Plan, since the 1994 Plan has expired
(after 10 years).
The exercise price of employee common stock option issuances in the quarters
ended September 30, 2008 and 2007 were 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 the years prior to June 15, 2006. The Company adopted
SFAS 123(R) for the reporting period ending after June 15, 2005 and recognized
the fair value of the stock option as part of the general and administration
expenses.
STOCK WARRANTS
As of September 30, 2008, the Company had a total of 2,500,000 stock purchase
warrants outstanding. The exercise price of these warrants range from $0.28 to
$0.35. The expiration date of these warrants range from July 25, 2009 to July
26, 2010.
NOTE 11 - GEOGRAPHICAL INFORMATION
The majority of sales to customers outside of the United States for the six
months ended September 30, 2008 and 2007 were made by the Macau Subsidiary.
Sales by geographic region for the period presented are as follows:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
September 30, September 30,
2008 2007 2008 2007
----------------------------------- -----------------------------------
North America $ 9,386,839 $ 11,454,775 $ 10,615,487 $ 12,813,620
Europe 3,029,757 4,371,227 3,164,896 5,160,647
Others 199,800 281,965 606,359 579,800
----------------------------------- -----------------------------------
$ 12,616,396 $ 16,107,967 $ 14,386,742 $ 18,554,067
=================================== ===================================
The geographic area of sales is based primarily on the location where the
product is delivered.
12
NOTE 12 - DUE TO RELATED PARTIES, NET
As of September 30, 2008 the Company had $6,345,516 due to related parties. This
consists of an interest bearing loan payable of $853,468 to Starlight Marketing
Limited and $5,492,048 in trade payables and expenses due to Starlight
affiliates.
NOTE 13 - RELATED PARTY TRANSACTIONS
On April 1, 2008, the Company issued 940,476 shares of common stock to Starlight
Industrial Holdings, Ltd. for $197,500 ($.21 per share) as payment for certain
payables owed by the Company for tooling.
On May 23, 2008, SMC Logistics entered into a service and logistics agreement
with affiliates Starlight Consumer Electronics (USA), Inc. and Cosmo
Communications (USA) Corporation to provide logistics, fulfillment, and
warehousing services for Starlight and Cosmo's domestic sales. The Agreement is
expected to generate approximately $1.1 million dollars in expense reimbursement
for fiscal year 2009. As of September 30, 2008 the company has received $473,346
in service fees from Starlight and Cosmo which has been used to offset startup
and operating expenses of the logistics operation.
The Company purchased products from Starlight Marketing Macao, a subsidiary of
Starlight International Holding Ltd. The purchases from Starlight for the six
month period ended September 30, 2008 and 2007 were $6,071,189 and $5,050,557,
respectively. In addition, the Company also purchased molds and tooling from
Starlight in the amount of $201,935 and $269,700 in fiscals 2008 and 2007,
respectively, which are included in Property and Equipment in the accompanying
Consolidated Balance Sheets.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes included in the Company's Annual Report on Form
10-K for the year ended March 31, 2008. This document contains certain
forward-looking statements including, among others, anticipated trends in our
financial condition and results of operations and our business strategy. (See
Part II, Item 1A, "Risk Factors "). These forward-looking statements are based
largely on our current expectations and are subject to a number of risks and
uncertainties. Actual results could differ materially from these forward-looking
statements.
Important factors to consider in evaluating such forward-looking statements
include, but are not limited to: (i) changes in external factors or in our
internal budgeting process which might impact trends in our results of
operations; (ii) unanticipated working capital or other cash requirements; (iii)
changes in our business strategy or an inability to execute our strategy due to
unanticipated changes in the industries in which we operate; and (iv) various
competitive market factors that may prevent us from competing successfully in
the marketplace.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which reflect management's opinions only as of the date hereof. We
undertake no obligation to revise or publicly release the results of any
revision to these forward-looking statements.
OVERVIEW
The Singing Machine Company, Inc., a Delaware corporation, and its subsidiaries
(the "Singing Machine," "we," "us" or "ours") are primarily engaged in the
design, marketing, and sale of consumer karaoke audio equipment, accessories,
musical recordings and Bratz licensed electronic products. The Company's
products are sold directly to distributors and retail customers. Our electronic
karaoke machines and audio software products are marketed under The Singing
Machine(R) and Motown trademarks.
Our products are sold throughout North America and Europe, primarily through
department stores, lifestyle merchants, mass merchandisers, direct mail catalogs
and showrooms, music and record stores, national chains, specialty stores and
warehouse clubs.
Our karaoke machines and karaoke software are currently sold in such major
retail outlets as Best Buy, Costco, Kohl's, J.C. Penney, Radio Shack, Wal-Mart
and Sam's Club. Our Bratz products are sold in Toys R Us and Meijers.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain items related
to our consolidated statements of operations as a percentage of net sales for
the three months and six months ended September 30, 2008 and 2007.
13
The Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
For Three Months Ended For Six Months Ended
------------------------------------------------------------
September 30, September 30, September 30, September 30,
2008 2007 2008 2007
------------------------------------------------------------
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of Goods Sold 84.0% 80.2% 84.5% 81.0%
Gross Profit 16.0% 19.8% 15.5% 19.0%
Operating Expenses
Selling expenses 6.3% 5.7% 7.0% 5.9%
General and administrative
expenses 7.9% 7.0% 13.3% 11.3%
Depreciation and amortization 0.8% 0.4% 1.4% 0.7%
Total Operating Expenses 15.0% 13.1% 21.7% 17.9%
Income (Loss) from Operations 1.0% 6.7% -6.2% 1.1%
Other Expenses
Interest expense -0.2% -0.1% -0.2% -0.1%
Net Other Expenses -0.2% -0.1% -0.2% -0.1%
Net Income (Loss) 0.8% 6.6% -6.4% 1.0%
QUARTER ENDED SEPTEMBER 30, 2008 COMPARED TO THE QUARTER ENDED SEPTEMBER 30,
2007
NET SALES
Net sales for the quarter ended September 30, 2008 decreased to $12,616,396 from
$16,107,967, a decrease of $3,491,571 as compared to the same period ended
September 30, 2007. The primary reason for this decrease was a continued delay
of product shipments from Asia which caused us to reschedule sales to the next
quarter. Sales from our Macau subsidiary were especially affected by these
delays as sales decreased by approximately $3,850,000 from the same period ended
September 30, 2007. This decrease was offset by an increase of approximately
$359,000 in revenue from our US operations compared to the same quarter ended
September 30, 2007.
GROSS PROFIT
Our gross profit for the quarter ended September 30, 2008 decreased to
$2,020,951 from $3,192,830, a decrease of $1,171,879 as compared to the same
period in the prior year. This decrease is primarily due to the decrease in
revenue in the quarter ended September 30, 2008 compared to the same quarter in
the prior year. As a percentage of revenues, our gross profit for the three
months ended September 30, 2008 decreased to 16.0% from 19.8% for the same
period in 2007. The decrease of gross profit as a percentage of revenues was
primarily due lower gross profit margins from shipments of Bratz products
compared to the same period last year.
OPERATING EXPENSES
For the quarter ended September 30, 2008, total operating expenses decreased to
$1,892,597. This represents a decrease of $226,449 over last year's same quarter
ended total operating expenses of $2,119,046. This decrease was primarily due to
reimbursement by related parties of approximately$473,000 for general and
administration expenses related to logistics services to them by the Company.
This reimbursement was offset by startup and increased staffing costs for our
logistics operation and an increase in depreciation on tools and new business
system equipment purchased during the past year.
14
Factors contributing to the increase of operating expenses are as follows:
1) Selling expenses decreased $132,221 which was primarily due decreases in
commission expense from decreased sales and decreased royalty expense due from
decreased sales of licensed products. These decreases were somewhat offset by
increased freight costs from our logistics operation.
2) General and administrative expenses decreased $135,738 which was primarily
due to reimbursement by related parties of approximately$473,000 for general and
administration expenses related to logistics services to them by the Company.
This reimbursement was offset by startup expense, additional rent and increased
staffing costs for our logistics operation.
3) Depreciation expense increased $41,510 due to the depreciation of tools and a
new business system purchased during the past year.
INCOME FROM OPERATIONS
Income from operations decreased $945,430 this quarter, to $128,354 for the
three months ended September 30, 2008 from $1,073,784 for the same period ended
September 30, 2007. The decrease was primarily due to the decrease in net sales
compared to the same period in the prior year. In addition, we experienced
additional operating costs associated with the startup of the logistics services
for related parties.
OTHER INCOME/EXPENSES
Our net other expenses (interest expense) increased to $25,684 from $19,661 for
the same period a year ago. The increase of interest expenses was primarily due
to the increase in financing required for a portion of the delayed inventory
required for next quarter shipments.
INCOME TAXES
For the three months ended September 30, 2008 and 2007, the Company did not
record a tax provision because it expects current year-to-date losses and
sufficient future net losses to offset the income for these periods.
NET INCOME
For the three months ended September 30, 2008 net income decreased to $102,670
from $1,054,123 for the same period a year ago. The decrease of net income was
primarily due to the decrease in revenues from the same period in the prior year
and startup costs and increased operating expenses for our logistics operation.
SIX MONTHS ENDED SEPTEMBER 30, 2008 COMPARED TO THE SIX MONTHS ENDED SEPTEMBER
30, 2007
NET SALES
Net sales for the six months ended September 30, 2008 decreased to $14,386,742
from $18,554,067, a decrease of $4,167,325 as compared to the same period ended
September 30, 2007. The primary reason for this decrease was a continued delay
of product shipments from Asia which caused us to reschedule sales to the next
quarter. Sales from our Macau subsidiary were especially affected by these
delays as sales decreased by approximately $4,100,000 from the same period ended
September 30, 2007. .
GROSS PROFIT
Our gross profit for the six months ended September 30, 2008 decreased to
$2,223,600 from $3,532,182, a decrease of $1,308,582 as compared to the same
period in the prior year primarily due to the decrease in revenue for the
comparable periods. As a percentage of revenues, our gross profit for the six
months ended September 30, 2008 decreased to 15.5% from 19.0% for the same
period in 2007. The decrease of gross profit as a percentage of revenues was
similar to the one for three months ended September 30, 2008.
OPERATING EXPENSES
For the six months ended September 30, 2008, total operating expenses decreased
to $3,137,491 from $3,305,425 for the six months ended September 30, 2007, a
decrease of $167,934. The decrease of operating expenses is the same as for the
three month period.
OTHER INCOME/EXPENSES
Our net other expenses increased to $33,000 (interest expense) from $24,950
(interest expense) for the same period a year ago.
INCOME TAXES
For the six months ended September 30, 2008 and 2007, the Company did not record
a tax provision because it had a net operating loss for the six months ended
September 30, 2008 and had sufficient net operation loss from previous periods
to offset the income for the six months ended September 30, 2007.
15
NET LOSS/INCOME
We incurred a net loss $946,891 for the six months ended September 30, 2008
compared to a net profit of $201,807 for the same period a year ago. The
increase of net income was primarily due to the decrease in revenues and startup
costs and operating expenses for our logistics operation.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2008, Singing Machine had cash on hand of $980,067 as
compared to cash on hand of $1,668,432 as of September 30, 2007. We had working
capital of $2,386,062 as of September 30, 2008.
Net cash provided by operating activities was $273,068 for the six months ended
September 30, 2008, as compared to $1,977,941 used by operating activities the
same period a year ago. The increase in net cash provided was a result of the
following factors: increase of accounts payable to Hong Kong and related party
suppliers and decreased accounts receivable due to decreased sales. These
increases to cash provided from operations were offset by an increase in
inventory in preparation for the upcoming season and a drop in net income due to
reduced sales during the comparable period.
Net cash used by investing activities for the six months ended September 30,
2008 was $401,293 as compared to $170,308 used by investing activities for the
same period ended a year ago. This increase was caused primarily by the purchase
of additional tools and a business computer system.
Net cash provided by financing activities was $660,476 for the six months ended
September 30, 2008, as compared to $2,627,781 for the same period ended a year
ago. There were no warrants or options exercised during the six months ended
September 30, 2008 compared to the same period in 2007 when we recognized
proceeds of $614,381 from the exercise of stock options and 2,500,000 warrants
exercised by Starlight, a related party. These proceeds were offset by an
increase in related party loans.
As of September 30, 2008, our unrestricted cash on hand was $980,067. Our
average monthly general and administrative expenses are approximately $330,000.
We expect that we will require approximately $1 million for working capital
during the next three-month period.
During the next 12 month period, we plan on financing our operation needs by:
o Raising additional working capital;
o Collecting our existing accounts receivable;
o Selling existing inventory;
o Vendor financing;
o Borrowing from factoring bank;
o Short term loans from our majority shareholder;
o Fees for fulfillment, delivery and returns services from related
parties.
Our sources of cash for working capital in the long term, 12 months and beyond,
are essentially the same as our sources during the short term. We are actively
seeking additional financing facilities and capital investments to maintain and
grow our business. If we need to obtain additional financing and fail to do so,
it may have a material adverse effect on our ability to meet our financial
obligations and to continue as a going concern.
Our commitments for debt and other contractual obligations as of September 30,
2008 are summarized as follows:
Total Less than 1 year 1 - 3 years 3 - 5 years Over 5 years
-----------------------------------------------------------------------------------------------
Property Leases $ 3,466,195 $ 587,508 $ 2,152,751 $ 725,936 $ -
Equipment Leases 19,736 9,888 9,848 - -
Short-Term Bank Loan 153,845 153,845
Equipment Financing Arrangement 51,528 18,186 33,342
Licensing Agreement 242,000 242,000 - -
Loan Payable-Related Party 1,069,053 1,069,053 - - -
-----------------------------------------------------------------------------------------------
Total $ 5,002,357 $ 2,080,480 $ 2,195,941 $ 725,936 $ -
===============================================================================================
16
INVENTORY SELL THROUGH
We monitor the inventory levels and sell through activity of our major customers
to properly anticipate returns and maintain the appropriate level of inventory.
We believe that we have proper return reserves to cover potential returns based
on historical return ratios and information available from the customers.
SEASONAL AND QUARTERLY RESULTS
Historically, our operations have been seasonal, with the highest net sales
occurring in our fiscal second and third quarters (reflecting increased orders
for equipment and music merchandise during the Christmas holiday season) and to
a lesser extent the first and fourth quarters of the fiscal year. Sales in our
fiscal second and third quarter, combined, accounted for approximately 87.8% and
94% of net sales in fiscal 2008 and 2007, respectively.
Our results of operations may also fluctuate from quarter to quarter as a result
of the amount and timing of orders placed and shipped to customers, as well as
other factors. The fulfillment of orders can therefore significantly affect
results of operations on a quarter-to-quarter basis.
We are currently developing and considering selling products other than those
within the karaoke category during the slow season to fulfill the revenue
shortfall.
INFLATION
Inflation has not had a significant impact on The Singing Machine's operations.
The Singing Machine generally has adjusted its prices to track changes in the
Consumer Price Index since prices charged by Singing Machine are generally not
fixed by long-term contracts.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off balance sheet arrangements that are reasonably likely to
have a current or future effect on our financial condition, revenues, results of
operations, liquidity or capital expenditures.
CRITICAL ACCOUNTING POLICIES
We prepared our consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. As such,
management is required to make certain estimates, judgments and assumptions that
it believes are reasonable based on the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses for the periods presented. The significant accounting policies which
management believes are the most critical to aid in fully understanding and
evaluating our reported financial results include: accounts receivable allowance
for doubtful accounts, reserves on inventory, deferred tax assets and our Macau
income tax exemption.
COLLECTIBILITY OF ACCOUNTS RECEIVABLE. The Singing Machine's allowance for
doubtful accounts is based on management's estimates of the creditworthiness of
its customers, current economic conditions and historical information, and, in
the opinion of management, is believed to be an amount sufficient to respond to
normal business conditions. Management sets 100% reserves for customers in
bankruptcy and other reserves based upon historical collection experience.
Should business conditions deteriorate or any major customer default on its
obligations to the Company, this allowance may need to be significantly
increased, which would have a negative impact on operations.
RESERVES ON INVENTORIES. The Singing Machine establishes a reserve on inventory
based on the expected net realizable value of inventory on an item-by-item basis
when it is apparent that the expected realizable value of an inventory item
falls below its original cost. A charge to cost of sales results when the
estimated net realizable value of specific inventory items declines below cost.
Management regularly reviews the Company's investment in inventories for such
declines in value.
INCOME TAXES. Significant management judgment is required in developing our
provision for income taxes, including the determination of foreign tax
liabilities, deferred tax assets and liabilities and any valuation allowances
that might be required against the deferred tax assets. Management evaluates its
ability to realize its deferred tax assets on a quarterly basis and adjusts its
valuation allowance when it believes that it is more likely than not that the
asset will not be realized.
We operate within multiple taxing jurisdictions and are subject to audit in
those jurisdictions. Because of the complex issues involved, any claims can
require an extended period to resolve. In management's opinion, adequate
provisions for potential income taxes in the jurisdiction have been made.
USE OF 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.
17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our financial position,
results of operations or cash flows due to adverse changes in financial and
commodity market prices and rates. We are exposed to market risk in the areas of
changes in United States and international borrowing rates and changes in
foreign currency exchange rates. In addition, we are exposed to market risk in
certain geographic areas that have experienced or remain vulnerable to an
economic downturn, such as China. We purchase substantially our entire inventory
from companies in China, and, therefore, we are subject to the risk that such
suppliers will be unable to provide inventory at competitive prices. While we
believe that, if such an event were to occur, we would be able to find
alternative sources of inventory at competitive prices, we cannot assure you
that we would be able to do so. These exposures are directly related to our
normal operating and funding activities. Historically and as of September 30,
2008, we have not used derivative instruments or engaged in hedging activities
to minimize market risk.
INTEREST RATE RISK
As of September 30, 2008, our exposure to market risk resulting from changes in
interest rates is immaterial.
FOREIGN CURRENCY RISK
We have a wholly-owned subsidiary in Macau. Sales by this operation made on a
FOB China or Hong Kong basis are denominated in U.S. dollars. However, purchases
of inventory and Macau operating expenses are typically denominated in either
Hong Kong dollars or the Macau currency ("MOP"), thereby creating exposure to
changes in exchange rates. Changes in the Hong Kong dollar, U.S. dollar or MOP
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 be assured that this approach
will be successful, especially in the event of a significant and sudden change
in the value of the MOP or Hong Kong dollar.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. As of the end of the
period covered by this report, we conducted an evaluation, under the supervision
and with the participation of our chief executive officer and chief financial
officer of our disclosure controls and procedures (as defined in Rule 13a-15(e)
and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our chief
executive officer and chief financial officer concluded that our disclosure
controls and procedures are effective to ensure that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the Commission's rules and forms and is accumulated and communicated to the
Company's management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.
(b) Changes in Internal Controls. There was no change in our internal control
over financial reporting identified in connection with the evaluation required
by paragraph (d) of Rules 13a-15 or 15d-15 under the Exchange Act that occurred
during the end of the period covered by this report that has materially
affected, or is reasonably likely to materially affect our internal control over
financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 1A. RISK FACTORS
FACTORS THAT MAY AFFECT OUR FUTURE RESULTS AND THE MARKET PRICE OF OUR STOCK
RISKS ASSOCIATED WITH OUR BUSINESS
WE HAVE ENTERED INTO AN AGREEMENT WITH THE STARLIGHT GROUP TO MANAGE THEIR
LOGISTICS AND FULFILLMENT SERVICES IN THE UNITED STATES. IF WE ARE UNABLE TO
PERFORM UNDER THIS AGREEMENT, IT COULD NEGATIVELY IMPACT OUR REVENUES AND CASH
FLOW.
On May 23, 2008 we entered into a services agreement to receive orders,
warehouse, and ship all of the Starlight Group's United States domestic goods.
The value of this contract is approximately $1.1 million dollars per year. If we
are unable to perform the duties under this contract, it could negatively impact
our revenue and cash flow.
THE MUSIC INDUSTRY HAS BEEN EXPERIENCING A CONTINUED DECLINE OF COMPACT DISC
(CD) SALES. OUR KARAOKE CD SALES COULD DECLINE FURTHER IN THE FUTURE.
Due to the expansion of the music download business, the sales of Compact Discs
(CD) have been declining in recent years. Our karaoke CD sales have been
declining since 2004 and may continue to decline in the future. Music revenue
accounts for less than 1% of our total revenues for the six months ended
September 30, 2008.
18
A SMALL NUMBER OF OUR CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR
REVENUES, AND THE LOSS OF ONE OR MORE OF THESE KEY CUSTOMERS COULD SIGNIFICANTLY
REDUCE OUR REVENUES AND CASH FLOW.
We rely on a few large customers to provide a substantial portion of our
revenues. As a percentage of total revenues, our net sales to our five largest
customers during the year ended March 31, 2008 and year ended March 31, 2007
were approximately 62% and 57%, respectively. We do not have long-term
contractual arrangements with any of our customers and they can cancel their
orders at any time prior to delivery. A substantial reduction in or termination
of orders from any of our largest customers would decrease our revenues and cash
flow.
WE ARE RELYING ON ONE FACTORY TO MANUFACTURE AND PRODUCE THE MAJORITY OF OUR
KARAOKE MACHINES FOR FISCAL 2009, AND IF THE RELATIONSHIP WITH THIS FACTORY IS
DAMAGED OR INJURED IN ANY WAY, IT WOULD REDUCE OUR REVENUES AND PROFITABILITY.
We have worked out a written agreement with a factory in China to produce most
of our karaoke machines for fiscal 2009. If the factory is unwilling or unable
to deliver our karaoke machines to us, our business will be adversely affected.
Because our cash on hand is minimal, we are relying on revenues received from
the sale of our ordered karaoke machines to provide cash flow for our
operations. If we do not receive cash from these sales, we may not be able to
continue our business operations.
WE ARE RELYING ON ONE DISTRIBUTOR TO DISTRIBUTE OUR MUSIC PRODUCTS, IF THE
DISTRIBUTION AGREEMENT IS TERMINATED, IT WOULD REDUCE OUR REVENUES AND
PROFITABILITY.
We are relying on an exclusive distributor to distribute our music products in
fiscal 2009. If the distribution agreement is terminated, our music revenues
might decrease as well as our profitability.
WE ARE SUBJECT TO THE RISK THAT SOME OF OUR LARGE CUSTOMERS MAY RETURN KARAOKE
PRODUCTS THAT THEY HAVE PURCHASED FROM US AND IF THIS HAPPENS, IT WOULD REDUCE
OUR REVENUES AND PROFITABILITY.
In fiscal 2008 and 2007, a number of our customers and distributors returned
karaoke products that they had purchased from us. Our customers returned goods
valued at $2.9 million or 8.6% of our net sales in fiscal 2008. Some of the
returns resulted from customer's overstock of the products. Although we were not
contractually obligated to accept return of the products, we accepted the
returns because we value our relationship with our customers. Because we are
dependent upon a few large customers, we are subject to the risk that any of
these customers may elect to return unsold karaoke products to us in the future.
If any of our customers were to return karaoke products to us, it would reduce
our revenues and profitability.
WE ARE SUBJECT TO PRESSURE FROM OUR CUSTOMERS RELATING TO PRICE REDUCTION AND
FINANCIAL INCENTIVES AND IF WE ARE PRESSURED TO MAKE THESE CONCESSIONS TO OUR
CUSTOMERS, IT WILL REDUCE OUR REVENUES AND PROFITABILITY.
Because there is intense competition in the karaoke industry, we are subject to
pricing pressure from our customers. Many of our customers have demanded that we
lower our prices or they will buy our competitor's products. If we do not meet
our customer's demands for lower prices, we will not sell as many karaoke
products. In the fiscal year ended March 31, 2008, our sales to customers in the
United States decreased because of increased price competition. We are also
subject to pressure from our customers regarding certain financial incentives,
such as return credits or large advertising or cooperative advertising
allowances, which effectively reduce our profit. We gave advertising allowances
of approximately $458,099 during fiscal 2008 and $200,000 during fiscal 2007. We
have historically offered advertising allowances to our customers because it is
standard practice in the retail industry.
WE EXPERIENCE DIFFICULTY FORECASTING THE DEMAND FOR OUR KARAOKE PRODUCTS AND IF
WE DO NOT ACCURATELY FORECAST DEMAND, OUR REVENUES, NET INCOME AND CASH FLOW MAY
BE AFFECTED.
Because of our reliance on manufacturers in China for our machine production,
our production lead times range from one to four months. Therefore, we must
commit to production in advance of customers orders. It is difficult to forecast
customer demand because we do not have any scientific or quantitative method to
predict this demand. Our forecasting is based on management's general
expectations about customer demand, the general strength of the retail market
and management's historical experiences. We overestimated demand for our
products in fiscal 2003 and 2004 and had $5.9 million in inventory as of March
31, 2004. Because of this excess inventory, we had liquidity problems in fiscal
2005 and our revenues, net income and cash flow were adversely affected.
WE ARE SUBJECT TO THE COSTS AND RISKS OF CARRYING INVENTORY FOR OUR CUSTOMERS
AND IF WE HAVE TOO MUCH INVENTORY, IT WILL AFFECT OUR REVENUES AND NET INCOME.
Many of our customers place orders with us several months prior to the holiday
season, but they schedule delivery two or three weeks before the holiday season
begins. As such, we are subject to the risks and costs of carrying inventory
during the time period between the placement or the order and the delivery date,
which reduces our cash flow. As of September 30, 2008 we had $9.9 million in
inventory on hand, as compared to $3.5 million in inventory at September 30,
2007. It is important that we sell this inventory during fiscal 2009, so we have
sufficient cash flow for operations.
19
OUR GROSS PROFIT MARGINS HAVE DECREASED OVER THE PAST YEAR AND WE EXPECT A
COMPETITIVE MARKET.
Over the past year, our gross profit margins have generally decreased due to the
competition except for fiscal 2005 when we had developed several new models,
which were in demand and yielded higher profit margins. We expect that our gross
profit margin might decrease under downward pressure in fiscal 2009 because of
currency fluctuations, increasing labor costs and the increasing cost of
petroleum based raw materials and services which are affecting the entire market
segment.
OUR BUSINESS IS SEASONAL AND THEREFORE OUR ANNUAL OPERATING RESULTS WILL DEPEND,
IN LARGE PART, ON OUR SALES DURING THE RELATIVELY BRIEF HOLIDAY SEASON.
Sales of consumer electronics and toy products in the retail channel are highly
seasonal, with a majority of retail sales occurring during the period from
September through December in anticipation of the holiday season, which includes
Christmas. A substantial majority of our sales occur during our second quarter
ending September 30 and third quarter ending December 31. Sales in our second
and third quarter, combined, accounted for approximately 87.0% and 94.0% of net
sales in fiscal 2008 and 2007 respectively.
IF WE ARE UNABLE TO COMPETE IN THE KARAOKE PRODUCTS CATEGORY, OUR REVENUES AND
NET PROFITABILITY WILL BE REDUCED.
Our major competitors for karaoke machines and related products are Memorex and
GPX. We believe that competition for karaoke machines is based primarily on
price, product features, reputation, delivery times, and customer support. Our
primary competitors for producing karaoke music are Compass, Pocket Songs,
Sybersound, UAV and Sound Choice. We believe that competition for karaoke music
is based primarily on popularity of song titles, price, reputation, and delivery
times. To the extent that we lower prices to attempt to enhance or retain market
share, we may adversely impact our operating margins. Conversely, if we opt not
to match competitor's price reductions we may lose market share, resulting in
decreased volume and revenue. To the extent our leading competitors reduce
prices on their karaoke machines and music; we must remain flexible to reduce
our prices. If we are forced to reduce our prices, it will result in lower
margins and reduced profitability. Because of intense competition in the karaoke
industry in the United States during fiscal 2008, we expect that the intense
pricing pressure in the low end of the market will continue in the karaoke
market in the United States in fiscal 2009. In addition, we must compete with
all the other existing forms of entertainment including, but not limited to:
motion pictures, video arcade games, home video games, theme parks, nightclubs,
television, prerecorded tapes, CD's, and video cassettes.
IF WE ARE UNABLE TO DEVELOP NEW KARAOKE PRODUCTS, OUR REVENUES MAY NOT CONTINUE
TO GROW.
The karaoke industry is characterized by rapid technological change, frequent
new product introductions and enhancements and ongoing customer demands for
greater performance. In addition, the average selling price of any karaoke
machine has historically decreased over its life, and we expect that trend to
continue. As a result, our products may not be competitive if we fail to
introduce new products or product enhancements that meet evolving customer
demands. The development of new products is complex, and we may not be able to
complete development in a timely manner. To introduce products on a timely
basis, we must:
o accurately define and design new products to meet market needs;
o design features that continue to differentiate our products from those
of our competitors;
o transition our products to new manufacturing process technologies;
o identify emerging technological trends in our target markets;
o anticipate changes in end-user preferences with respect to our
customers' products;
o bring products to market on a timely basis at competitive prices; and
o respond effectively to technological changes or product announcements
by others.
We believe that we will need to continue to enhance our karaoke machines and
develop new machines to keep pace with competitive and technological
developments and to achieve market acceptance for our products. At the same
time, we need to identify and develop other products which may be different from
karaoke machines.
20
OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD PREVENT
OR DELAY OUR CUSTOMERS' RECEIPT OF INVENTORY.
We rely principally on four contract ocean carriers to ship virtually all of the
products that we import to our warehouse facility in City of Industry,
California. Retailers that take delivery of our products in China rely on a
variety of carriers to import those products. Any disruptions in shipping,
whether in California or China, caused by labor strikes, other labor disputes,
terrorism, and international incidents may prevent or delay our customers'
receipt of inventory. If our customers do not receive their inventory on a
timely basis, they may cancel their orders or return products to us.
Consequently, our revenues and net income would be reduced.
OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE'S REPUBLIC OF CHINA,
SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS. IF THERE IS ANY
PROBLEM WITH THE MANUFACTURING PROCESS, OUR REVENUES AND NET PROFITABILITY MAY
BE REDUCED.
We are using eight factories in the People's Republic of China to manufacture
our karaoke machines. These factories will be producing nearly all of our
karaoke products in fiscal 2009. Our arrangements with these factories are
subject to the risks of doing business abroad, such as import duties, trade
restrictions, work stoppages, and foreign currency fluctuations, limitations on
the repatriation of earnings and political instability, which could have an
adverse impact on our business. Furthermore, we have limited control over the
manufacturing processes. As a result, any difficulties encountered by our
third-party manufacturers that result in product defects, production delays,
cost overruns or the inability to fulfill orders on a timely basis could
adversely affect our revenues, profitability and cash flow. Also, since we do
not have written agreements with any of these factories, we are subject to
additional uncertainty if the factories do not deliver products to us on a
timely basis.
WE DEPEND ON THIRD PARTY SUPPLIERS FOR PARTS FOR OUR KARAOKE MACHINES AND
RELATED PRODUCTS, AND IF WE CANNOT OBTAIN SUPPLIES AS NEEDED, OUR OPERATIONS
WILL BE SEVERELY DAMAGED.
Our growth and ability to meet customer demand depends in part on our capability
to obtain timely deliveries of karaoke machines and our electronic products. We
rely on third party suppliers to produce the parts and materials we use to
manufacture and produce these products. If our suppliers are unable to provide
our factories with the parts and supplies, we will be unable to produce our
products. We cannot guarantee that we will be able to purchase the parts we need
at reasonable prices or in a timely fashion. In the last several years, there
have been shortages of certain chips that we use in our karaoke machines. If we
are unable to anticipate any shortages of parts and materials in the future, we
may experience severe production problems, which would impact our sales.
CONSUMER DISCRETIONARY SPENDING MAY AFFECT KARAOKE PURCHASES AND IS AFFECTED BY
VARIOUS ECONOMIC CONDITIONS AND CHANGES.
Our business and financial performance may be damaged more than most companies
by adverse financial conditions affecting our business or by a general weakening
of the economy. Purchases of karaoke machines and music are considered
discretionary for consumers. Our success will therefore be influenced by a
number of economic factors affecting discretionary and consumer spending, such
as employment levels, business, interest rates, and taxation rates, all of which
are not under our control. Additionally, other extraordinary events such as
terrorist attacks or military engagements, which adversely affect the retail
environment may restrict consumer spending and thereby adversely affect our
sales growth and profitability.
WE MAY HAVE INFRINGED THE COPYRIGHTS OF CERTAIN MUSIC PUBLISHERS AND IF WE
VIOLATE FEDERAL COPYRIGHT LAWS, WE WILL BE SUBJECT TO MONETARY PENALTIES.
Over the past several years, the Singing Machine (like its competitors) has
received notices from certain music publishers alleging that the full range of
necessary rights in their copyrighted works has not been properly licensed in
order to sell those works as part of products known as "compact discs with
graphics" ("CDG"s). CDG's are compact discs which contain the musical recordings
of karaoke songs and graphics which contain the lyrics of the songs. Singing
Machine has negotiated licenses with the complaining parties, or is in the
process of settling such claims, with each one of the complaining copyright
owners. As with any alleged copyright violations, unlicensed users may be
subject to damages under the U.S. Copyright Act. Such damages and claims could
have a negative effect on Singing Machine's ability to sell its music products
to its customers. This is the reason the Singing Machine pursues licenses so
diligently.
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 be sure 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.
21
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 catalogs and showrooms, national chains, specialty stores, and
warehouse clubs. Some of these retailers have engaged in leveraged buyouts or
transactions in which they incurred a significant amount of debt, and operated
under the protection of bankruptcy laws. Deterioration in the financial
condition of our customers could result in bad debt expense to us and have a
material adverse effect on our revenues and future profitability.
A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTERS IN CALIFORNIA OR FLORIDA
COULD IMPACT OUR ABILITY TO DELIVER MERCHANDISE TO OUR CUSTOMERS, WHICH COULD
ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY.
A significant amount of our merchandise is shipped to our customers from one of
our two warehouses, which are located in City of Industry, 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 2008, approximately 49.0% of our sales were domestic warehouse
sales, which were made from our warehouses in California and Florida. During the
third quarter of fiscal 2003, the dock strike on the West Coast affected sales
of two of our karaoke products and we estimate that we lost between $3 and $5
million in orders because we could not get the containers of these products off
the pier. If another strike or work slow-down occurs and we do not have a
sufficient level of inventory, a strike or work slow-down would result in
increased costs to us and may reduce our profitability.
CURRENCY EXCHANGE RATE RISK
During fiscal year 2008, the Chinese local currency has had no material effect
on the value of the US dollar as Chinese local currency is pegged to the US
dollar.
INCREASED RAW MATERIAL/PRODUCTION PRICING
The fluctuations in the price of oil has and will continue to affect the Company
in connection the sourcing and utilizing petroleum based raw materials and
services. The cost of trans-oceanic shipping, plastic and the like are driving
up the price our suppliers charge us for finished goods. Also, the there have
been a series of labor related regulations instituted in China which impact
wages and thus the cost of production which may result in our suppliers
demanding higher prices for our finished goods. This issue is common to all
companies in the same type of business and if the Company is not able to
negotiate lower costs, or reduce other expenses, or pass on some or all of these
price increases to our customers, our profit margin may be decreased.
RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE WHICH MAY CAUSE INVESTORS
TO LOSE ALL OR A PORTION OF THEIR INVESTMENT.
From December 1, 2004 through September 30, 2008, our common stock has traded
between a high of $1.60 and a low of $0.12. During this period, we had liquidity
problems and incurred a net loss of $1.9 million in fiscal 2006 and loss of $3.6
million in fiscal 2005. Our stock price may continue to be volatile based on
similar or other adverse developments in our business. In addition, the stock
market periodically experiences significant adverse price and volume
fluctuations which may be unrelated to the operating performance of particular
companies.
IF INVESTORS SHORT OUR SECURITIES, IT MAY CAUSE OUR STOCK PRICE TO DECLINE.
During the past year, a number of investors have held a short position in our
common stock. As of September 30, 2008, investors held a short position of
approximately 25,900 shares of our common stock which represented 0.1% of our
public float. The anticipated downward pressure on our stock price due to actual
or anticipated sales of our stock by some institutions or individuals who engage
in short sales of our common stock could cause our stock price to decline.
Additionally, if our stock price declines, it may be more difficult for us to
raise capital
OUR COMMON STOCK MAY BE DELISTED FROM THE AMERICAN STOCK EXCHANGE, WHICH MAY
HAVE A MATERIAL ADVERSE IMPACT ON THE PRICING AND TRADING OF OUR COMMON STOCK.
On September 16, 2008, we received notice from The American Stock Exchange (the
"Amex") that we had fallen below the continued listing standards of the Amex and
that its listing is being continued pursuant to an extension. Specifically, for
the quarter ended June 30, 2008, we were not in compliance with Section
1003(a)(ii) of the Amex Company Guide with shareholders' equity of less than
$4,000,000 and net losses in three of its four most recent fiscal years. The
Company was required to respond to Amex by October 23,2008 has submitted the
plan indicating how the Company intends to meet the net equity requirement of
$4,000,000. The Amex will need up to 45 days to review the plan and make the
final decision. The Listings Qualifications Department at Amex will evaluate the
plan, including any supplemental information provided, and make a determination
as to whether the Company has made a reasonable demonstration in the Plan of an
ability to regain compliance. If the plan is accepted, the Company may be able
to continue its listing during the plan period, during which time it will be
subject to periodic review to determine whether it is making progress consistent
with the Revised Plan. The Company may be subject to delisting proceedings if
the plan is not accepted, or if the plan is accepted but the Company is not in
compliance with all of the Exchange's continued listing standards within the
time frame provided or does not make progress consistent with the plan during
the plan period.
22
IF OUR OUTSTANDING DERIVATIVE SECURITIES ARE EXERCISED OR CONVERTED, OUR
EXISTING SHAREHOLDERS WILL SUFFER DILUTION.
As of September 30, 2008, there were outstanding stock options to purchase an
aggregate of 713,215 shares of common stock at exercise prices ranging from
$0.32 to $9.00 per share, not all of which are immediately exercisable. The
weighted average exercise price of the outstanding stock options is
approximately $.84 per share. As of September 30, 2007, there were outstanding
and immediately exercisable options to purchase an aggregate of 1,184,155. There
were outstanding stock warrants to purchase 2,500,000 shares of common stock at
exercise prices ranging from $.28 to $.35 per share, all of which are
exercisable. The weighted average exercise price of the outstanding stock
warrants is approximately $0.315 per share.
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS AND INVESTORS MAY
DEPRESS OUR STOCK PRICE.
As of November 5, 2008 there were 32,698,876 shares of our common stock
outstanding. We have filed three registration statements registering an
aggregate 3,827,586 of shares of our common stock (a post effective amended
registration statement on Form S-8 to register 33,336 shares issued to our Board
of Directors pursuant to their Compensation Plan, 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 was filed in October 2003, registering an aggregate of 2,795,465 shares of
our common stock. The market price of our common stock could drop due to the
sale of large number of shares of our common stock, such as the shares sold
pursuant to the registration statements or under Rule 144, or the perception
that these sales could occur.
OUR STOCK PRICE MAY DECREASE IF WE ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK.
Our Certificate of Incorporation authorizes the issuance of 100,000,000 shares
of common stock as amended in January 2006. As of September 30, 2008 we had
32,698,876 shares of common stock issued and outstanding and an aggregate of
3,213,215 shares issuable under our outstanding options and warrants. As such,
our Board of Directors has the power, without stockholder approval, to issue up
to 64,087,909 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.
IF WE FAIL TO MAINTAIN EFFECTIVE INTERNAL CONTROLS OVER FINANCIAL REPORTING, THE
PRICE OF OUR COMMON STOCK MAY BE ADVERSELY AFFECTED.
Our internal controls over financial reporting have weaknesses and conditions
that need to be addressed, the disclosure of which may have an adverse impact on
the price of our common stock. We are required to establish and maintain
appropriate internal controls over financial reporting. Failure to establish
those controls, or any failure of those controls once established, could
adversely impact our public disclosures regarding our business, financial
condition or results of operations. In addition, our management's assessment of
internal controls over financial reporting has identified weaknesses and
conditions that need to be addressed in our internal controls over financial
reporting or other matters that may raise concerns for investors. Any actual or
perceived weaknesses and conditions that need to be addressed in our internal
controls over financial reporting, disclosure of our management's assessment of
our internal controls over financial reporting or disclosure of our public
accounting firm's attestation to or report on management's assessment of our
internal controls over financial reporting may have an adverse impact on the
price of our common stock.
23
THE MARKET PRICE OF OUR COMMON STOCK MAY BE ADVERSELY AFFECTED BY SEVERAL
FACTORS.
The market price of our common stock could fluctuate significantly in response
to various factors and events, including:
o our ability to execute our business plan;
o operating results below expectations;
o loss of any strategic relationship;
o industry developments;
o economic and other external factors; and
o period-to-period fluctuations in its financial results.
In addition, the securities markets have from time to time experienced
significant price and volume fluctuations that are unrelated to the operating
performance of particular companies. These market fluctuations may also
materially and adversely affect the market price of our common stock.
WE HAVE NOT PAID CASH DIVIDENDS IN THE PAST AND DO NOT EXPECT TO PAY CASH
DIVIDENDS IN THE FUTURE. ANY RETURN ON INVESTMENT MAY BE LIMITED TO THE VALUE OF
OUR STOCK.
We have never paid cash dividends on our stock and do not anticipate paying cash
dividends on our stock in the foreseeable future. The payment of cash dividends
on our stock will depend on our earnings, financial condition and other business
and economic factors affecting us at such time as the board of directors may
consider relevant. If we do not pay cash dividends, our stock may be less
valuable because a return on your investment will only occur if our stock price
appreciates.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
We are not currently in default upon any of our senior securities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
31.1 Certification of Anton Handal, Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.*
31.2 Certification of Carol Lau, Interim Chief Financial Officer pursuant to
Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.*
32.1 Certifying Statement of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act.*
32.2 Certifying Statement of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act.*
* Filed herewith
24
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE SINGING MACHINE COMPANY, INC.
Date: November 14, 2008 By: /s/ Anton H. Handal
-------------------
Anton H. Handal
Chief Executive Officer
/s/ Carol Lau
--------------
Carol Lau
Interim Chief Financial Officer
25