As filed with the Securities and Exchange Commission on October 6, 2004
Registration No. 333-109574
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
THE SINGING MACHINE COMPANY, INC.
--------------------------------------------
(Name of Small Business Issuer in Its Charter)
DELAWARE 5065 95-3795478
-------------------------------- ------------------------- ------------------
(State or other jurisdiction (Primary Standard (IRS Employer
of incorporation or organization) Industrial Classification) Identification No.)
--------------
YI PING CHAN, INTERIM CHIEF EXECUTIVE OFFICER,
CHIEF OPERATING OFFICER AND SECRETARY
6601 LYONS ROAD, BLDG. A-7
COCONUT CREEK, FL 33073
(954) 596-1000
(Address and telephone number of Registrant's principal executive offices
and principal place of business)
DARRIN M. OCASIO, ESQ.
SICHENZIA ROSS FRIEDMAN FERENCE LLP
1065 AVENUE OF THE AMERICAS
NEW YORK, NY 10018
(212) 930-9700
(212)-930-9725 - FACSIMILE
(Name, address and telephone number of agent for service)
--------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON
AS PRACTICABLE AFTER THE REGISTRATION STATEMENT BECOMES EFFECTIVE.
If any of the securities being registered on this form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, check the following box: [X]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the Registration Statement is expected to be made pursuant
to Rule 434, check the following box. [_]
CALCULATION OF REGISTRATION FEE
==================================================================================================================
TITLE OF EACH CLASS OF SECURITIES AMOUNT TO BE PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF
TITLE OF EACH CLASS OF SECURITIES AMOUNT TO BE OFFERING PRICE AGGREGATE OFFERING REGISTRATION
TO BE REGISTERED REGISTERED PER SECURITY PRICE FEE
------------------------------------------ ------------- ----------------- ----------------- ------------
Common Stock (1) 1,838,602 $ 0.575(1) $ 1,057,196.15 $ 133.95
Common Stock (2) 40,151 $ 1.21 $ 48,582.71 $ 4.46(4)
Common Stock (3) 1,038,962 $ 4.25 $ 4,405,198.88 $ 356.38(4)
Common Stock (5) 561,039 $ 4.25 $ 2,384,157.50 $ 192.88(4)
Common Stock (6) 207,791 $ 4.25 $ 883,111.75 $ 71.44(4)
Common Stock (7) 311,680 $ 4.25 $ 1,324,640.00 $ 107.16(4)
Common Stock (7) 635,842 $ 4.25 $ 2,702,328.50 $ 218.67(4)
Total 4,634,067
(1) Represents 1,797,917 shares of our common stock issuable upon conversion
of outstanding securities, and an additional 40,685 additional shares that
we are required to registered pursuant to registration rights agreement.
Estimated solely for the purpose of determining the registration fee, in
accordance with Rule 457(c), based on the average high and low prices of
our common stock as reported on the American Stock Exchange on September
27, 2004 ($0.575).
(2) Represents shares of common stock issued to A.G. Edwards & Sons, Inc.
(3) Represents shares of common stock issuable upon exercise of outstanding
convertible debentures held by certain selling stockholders. Pursuant to
Rule 416, there are also being registered such additional number of shares
of common stock as may become issuable pursuant to the anti-dilution
provisions of the debentures.
(4) Previously paid in the Registration Statements that we filed on October 9,
2003, and April 6, 2004.
(5) Represents shares of common stock being issuable upon exercise of
outstanding common stock purchase warrants held by certain selling
stockholders. Pursuant to Rule 416, there are also being registered such
additional number of shares of common stock as may become issuable
pursuant to the anti-dilution provisions of the common stock purchase
warrants.
(6) Represents a good faith estimate of the anticipated maximum number of
shares of common stock which the Registrant may issued to the holders of
the debentures in payment of interest accruing thereon. ===
(7) Represents additional shares that the Registrant's required to register
pursuant to a registration rights agreement. The Registrant has registered
an additional 40,685 shares (described in footnote 1). Under the
registration rights agreement, the Registrant is required to register an
additional 30% of the aggregate amount of shares issuable upon (a)
conversion of the convertible debentures, (b) exercise of the warrants;
(c) interest payments on the debentures and (d) pursuant to the
anti-dilution provision in the debenture.
The Registrant hereby amends this registration statement on such date or dates
as may be necessary to delay its effective date until the registrant shall file
a further amendment which specifically states that this registration statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPETE AND MAY BE CHANGED. WE MAY NOT
SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES
AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL
THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THOSE SECURITIES IN
ANY STATE WHERE THE OFFER OR SALE IS PROHIBITED.
SUBJECT TO COMPLETION, DATED OCTOBER 6, 2004
PROSPECTUS
4,634,067 SHARES OF COMMON STOCK
[GRAPHIC OMITTED]
THE SINGING MACHINE COMPANY, INC.
We are registering for resale an aggregate of 4,634,067 shares of common
stock of The Singing Company, Inc. that have been issued or may be issued to
certain of our stockholders named in this Prospectus and their transferees.
We will not receive any proceeds from the sale of the shares, but we will
receive proceeds from the selling stockholders if they exercise their warrants.
Our common stock is quoted on the American Stock Exchange under the symbol "SMD.
" On September 27, 2004, the closing sales price of our common stock, as
reported on AMEX was $0.575 per share. We are registering approximately 45.90%
of our common stock for resale as determined on a fully diluted basis.
The shares of common stock may be sold from time to time by the selling
stockholders in one or more transactions at fixed prices, at market prices at
the time of sale, at varying prices determined at the time of sale or at
negotiated prices. The selling stockholders and any broker-dealer who may
participate in the sale of the shares may use this Prospectus. See "Plan of
Distribution."
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE "RISK
FACTORS" BEGINNING ON PAGE 1.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities, or determined if
this Prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
THE DATE OF THIS PROSPECTUS IS OCTOBER __, 2004
TABLE OF CONTENTS
Prospectus Summary........................................................... 1
Risk Factors................................................................. 2
Special Note regarding Forward-Looking Statements............................ 9
Use of Proceeds.............................................................. 9
Selling Stockholders......................................................... 10
Plan of Distribution......................................................... 14
Market Price of Common Stock................................................. 16
Dividend Policy.............................................................. 16
Selected Financial Information and Other Data................................ 17
Management's Discussion and Analysis of Financial Condition and
Results of Operations..................................................... 20
Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...................................................... 33
Business..................................................................... 34
Management................................................................... 42
Executive Compensation....................................................... 44
Certain Transactions......................................................... 49
Principal Stockholders....................................................... 50
Description of Securities.................................................... 51
Shares Eligible for Future Sale.............................................. 53
Legal Matters................................................................ 54
Experts...................................................................... 54
Where You Can Find Additional Information.................................... 54
Index to Consolidated Financial Statements...................................F-1
PROSPECTUS SUMMARY
This Summary highlights information contained elsewhere in this
Prospectus. We encourage you to read the entire Prospectus carefully, including
the section entitled "Risk Factors" and the financial statements and the notes
to those financial statements.
COMPANY OVERVIEW
We are engaged in the production and distribution of karaoke audio
software and electronic recording equipment. Our electronic karaoke machines and
audio software products are marketed under the Singing Machine(R), MTV(R),
Nickelodeon(R), Care Bears(R) and Motown(R) brand names. Our corporate offices
are located at 6601 Lyons Road, Building A-7, Coconut Creek, Florida 33073, and
our telephone number is (954) 596- 1000.
THE OFFERING
Common Stock offered by the Selling Stockholders 4,634,067
Common Stock Outstanding Prior to the Offering(1) 9,202,318
Common Stock Outstanding after the Offering(2) 13,836,385
Use of Proceeds We will not receive any
proceeds from the sale
of common stock by the
selling stockholders.
----------
(1) Based on the number of shares actually outstanding as of September 27,
2004. Does not include (a) options to purchase 949,490 shares of our
common stock which are currently outstanding under our 1994 Amended and
Restated Stock Option Plan and our Year 2000 Stock Option Plan, and (b) an
aggregate of 4,634,067 shares which are being registered in this
registration statement, which includes 2,836,879 shares issuable upon
conversion of our outstanding convertible debentures, 591,039 shares
issuable upon exercise of outstanding warrants, 207,791 shares which may
be issued as interest payments on the debentures, 988,307 shares as a good
faith estimate of additional shares that may be issued pursuant to our
obligations under a registration rights agreement and 40,151 shares issued
to AG Edwards.
(2) Assumes the issuance of 4,634,067 shares of our common stock which are
being registered in this registration. Does not include options to
purchase 1,027,530 shares of our common stock which are currently
outstanding under our 1994 and 2000 Year Stock Option Plans.
1
RISK FACTORS
You should carefully consider the following factors and other information
in this Prospectus before deciding to purchase our common stock.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
RISKS ASSOCIATED WITH OUR BUSINESS
WE HAVE SIGNIFICANT WORKING CAPITAL NEEDS AND IF WE ARE UNABLE TO OBTAIN
ADDITIONAL FINANCING, WHEN NEEDED, WE MAY NOT HAVE SUFFICIENT CASH FLOW TO RUN
OUR BUSINESS
As of September 27, 2004, our cash on hand is limited. We need
approximately $1.8 million in working capital in order to finance our operations
over the next three months. We plan on financing our working capital needs from
the collection of accounts receivable, and sales of existing inventory. As of
June 30, 2004, our inventory was valued at $4.8 million. We are currently
finalizing financing from a company that will factor our accounts receivable. We
have reached a factoring agreement in principal with Crestmark Financing in
August 2004. The agreement allows us to receive up to 70% of our eligible
account receivables by pledging these accounts as collateral. The maximum amount
we may receive is $2,500,00. The account receivable is with recourse. The
interest rate on the advance is 2% plus prime rate currently 6.5%. The
maintenance fee is 1% of the invoice face value, which will be posted to the
account when the cash is collected. The minimum fee per month is $9000. See
"Liquidity" beginning on page 30. If we are not able to obtain adequate
financing, when needed, it will have a material adverse effect on our cash flow
and our ability to run our business. If we have a severe shortage of working
capital, we may not be able to continue our business operations and may be
required to file a petition for bankruptcy under Chapter 11 of the U.S.
Bankruptcy Code or enter into some other form of liquidation or reorganization
proceeding.
WE MAY BE DEEMED TO INSOLVENT AND WE MAY GO OUT OF BUSINESS
As of June 30, 2004, our cash position is limited. We are not able to pay
all of our creditors on a timely basis. We are current on approximately 33% of
our accounts payable, which totaled $3.9 million as of June 30, 2004. We are not
current on our accounts payable of $2.6 million to factories in China. If we are
not able to pay our current debts as they become due, we may be deemed to be
insolvent. We may be required to file a petition for bankruptcy under Chapter 11
of the U.S. Bankruptcy Code or enter into some other form of liquidation or
reorganization proceedings.
OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTANTING FIRM RAISED SUBSTANTIAL DOUBT
ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN AS OF MARCH 31, 2004 AND 2003
We received a report dated June 16, 2004 (except for the last paragraph of
note 7 as to which the date is July 14, 2004) from our independent registered
public accounting firm covering the consolidated financial statements for our
fiscal year ended March 31, 2004 that included an explanatory paragraph which
stated that the financial statements were prepared assuming the Singing Machine
would continue as a going concern. This report stated that our operating
performance in fiscal 2004 and our minimal liquidity raised substantial doubt
about our ability to continue as a going concern. If we are not able to raise
additional capital, we may need to curtail or stop our business operations. We
may be required to file a petition for bankruptcy under Chapter 11 of the U.S.
Bankruptcy Code or enter into some other form of liquidation or reorganization
proceedings.
WE ARE IN TECHNICAL DEFAULT OF THE TERMS OF THE CONVERTIBLE DEBENTURES AND THERE
COULD BE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS AND FINANCIAL RESULTS IF WE
ARE DEEMED TO BE IN DEFAULT
We are in technical default of the terms of the $4 million in convertible
debentures that we issued to 6 institutional investors in September 2003. We had
an obligation to have the registration statement registering the securities
underlying the debentures issued to the institutional investors filed and
declared effective by July 1, 2004. As of September 27, 2004, the registration
statement has not been declared effective. As such, under the terms of the
registration rights agreement we are liable to pay liquidated damages in the
amount of $80,000 for each month that the registration statement is not declared
effective. Additionally, the institutional investors could declare us in default
of the convertible debentures and demand repayment of the debentures and all
other amounts due under the transaction documents evidencing their $4 million
investment. In September 2004, one investor demanded repayment of its $300,000
debenture, however has subsequently informed us that it is not seeking repayment
at this time.
2
IF WE ARE UNABLE TO EFFECTIVELY AND EFFICIENTLY IMPLEMENT OUR PLAN TO REMEDIATE
THE MATERIAL WEAKNESSES WHICH HAVE BEEN IDENTIFIED IN OUR INTERNAL CONTROLS AND
PROCEDURES, THERE COULD BE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS OR
FINANCIAL RESULTS
We have identified a number of differences which constitute material
weaknesses in our internal controls and procedures in connection with the audit
of our financial statements for fiscal 2004. The deficiencies in our internal
controls relate to:
o weaknesses in our financial reporting processes as a result of a
lack of adequate staffing in the accounting department,
o accounting for consigned inventory and inventor costing.
We are implementing a number of procedures to correct these weaknesses in
our internal controls. However, no assurances can be given that we will be able
to successfully implement our revised internal controls and procedures or that
our revised controls and procedures will be effective in remedying all of the
identified material weaknesses in our controls and procedures. In addition, we
may be required to hire additional employees, and may experience higher than
anticipated capital expenditures and operating expenses, during our
implementation of these changes. If we are unable to implement these changes
effectively or efficiently there could be a material adverse effect on our
operations or financial results.
A SMALL NUMBER OF OUR CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR
REVENUES, AND THE LOSS OF ONE OR MORE OF THESE KEY CUSTOMERS COULD SIGNIFICANTLY
REDUCE OUR REVENUES AND CASH FLOW
We rely on a few large customers to provide a substantial portion of our
revenues. As a percentage of total revenues, our net sales to our five largest
customers during the fiscal period ended March 31, 2004, 2003 and 2002 were
approximately 53%, 67% and 87%, respectively. In fiscal 2004, three customers
accounted for 20%, 12% and 8% of our net sales. The customers are Arbiter,
Giochi and Best Buy, 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 SIX FACTORIES TO MANUFACTURE AND PRODUCE THE MAJORITY OF OUR
KARAOKE MACHINES FOR FISCAL 2005, AND IF THE RELATIONSHIP WITH THESE FACTORIES
IS DAMAGED OR INJURED IN ANY WAY, IT WOULD REDUCES OUR REVENUES AND
PROFITABILITY
We have worked out a verbal agreement with six factories in China to
produce approximately 95% of our karaoke machines in fiscal 2005. We owe one of
these factories approximately $1.6 million as of September 27, 2004 and have
worked out a payment plan with it. See the "Liquidity" Section. 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 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 2004 and 2003, a number of our customers and distributors
returned karaoke products that they purchased from us. Our total returns
represented 9.4% and 10.4% of our net sales in fiscal 2004 and fiscal 2003,
respectively. In the fourth quarter of fiscal 2004, our customers returned goods
valued at $1.8 million, or 2.5% of our net sales.
3
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 experience lower
sales volume. In our fiscal year ended March 31, 2004, our sales to customers in
the United States decreased because of increased price competition. During
fiscal 2004, we sold 20.2% of our karaoke machines at prices that were equal to
or below cost. We will not be able to stay in business if we continue to sell
our karaoke machines at prices that are at or below cost. 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 selling prices. In fiscal 2004, we gave our customers
$2.1 million of credits on these accounts because the sell-through of our
products was not as strong as we had expected. We also provided our customers
with advertising allowances in the amount of $2.3 million during fiscal 2004 and
$4.1 million during fiscal 2003. 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 Asia for our machine
production, our production lead times range from one to four months. Therefore,
we must commit to production in advance of customers orders. It is difficult to
forecast customer demand because we do not have any scientific or quantitative
method to predict this demand. Our forecasting is based on management's general
expectations about customer demand, the general strength of the retail market
and management's historical experiences. We overestimated demand for our
products in fiscal 2003 and had $25.2 million in inventory as of March 31, 2003.
Because of this excess inventory, we had liquidity problems in fiscal 2004 and
our revenues, net income and cash flow were adversely affected. We had a net
loss of $22.7 million in fiscal 2004, which limited our cash flow.
WE ARE SUBJECT TO THE COSTS AND RISKS OF CARRYING INVENTORY FOR OUR CUSTOMERS
AND IF WE HAVE TOO MUCH INVENTORY, IT WILL AFFECT OUR REVENUES AND NET INCOME
Many of our customers place orders with us several months prior to the
holiday season, but they schedule delivery two or three weeks before the holiday
season begins. As such, we are subject to the risks and costs of carrying
inventory during the time period between the placement or the order and the
delivery date, which reduces our cash flow. As of March 31, 2003, we had $25.2
million in inventory on hand, which impacted our cash flow and liquidity from
operations in fiscal 2004. As of June 30, 2004, our inventory was valued at $4.8
million. It is important that we sell this inventory during fiscal 2005, so we
have sufficient cash flow for operations.
OUR GROSS PROFIT MARGINS HAVE DECREASED OVER THE PAST YEAR AND WE EXPECT
COMPETITIVE MARKET CONDITIONS
Over the past year, our gross profit margins have decreased. In the fiscal
year ended March 31, 2004, our gross profit margin was 2.6% of net sales
compared to 24.4% of net sales in fiscal year ended March 31, 2003. This decline
resulted from the closeout of older models and excessive inventory, price
competition and increased sales by International SMC. Sales made by
International SMC increased from 52% of our sales in fiscal 2003 to 61% in
fiscal 2004. International SMC delivers our karaoke products to customers
directly from factories in China and therefore does not incur costs related to
logistics, handling, warehousing and just in time inventory support. In
contrast, such costs are incurred by our parent company in the United States on
sales from the US. Accordingly, the average sales price per unit realized by
International SMC is significantly lower (due to lower expenses) than that of
our parent company in the United States. We expect further price competition and
a continuing shift of sales volume to International SMC. Accordingly, we expect
that our gross profit margin will decrease in fiscal 2005.
4
OUR SENIOR CORPORATE MANAGEMENT TEAM IS NEW TO THE SINGING MACHINE AND IS
REQUIRED TO DEVOTE SIGNIFICANT ATTENTION TO OUR FINANCING AGREEMENTS AND
SETTLING OUR CLASS ACTION LAWSUITS
Beginning on May 2, 2003, through the present date, four of our executive
officers have resigned. We hired a new Chief Operating Officer, Yi Ping Chan on
April 1, 2003, and a new Chief Financial Officer, Jeff Barocas, on April 9,
2004. Three new directors have joined our Board since October 31, 2003 and one
of them has resigned since that date. Bernard Appel joined our Board effective
as of October 31, 2003, Harvey Judkowitz joined on March 29, 2004 and Joseph
Testa joined in September 8, 2004. Richard Ekstract joined our Board on October
31, 2003 and resigned for personal reasons on June 2, 2004. We are in the
process of searching for a new Chief Executive Officer and new directors. It
will take some time for our new management and our new board of directors to
learn about our business and to develop strong working relationships with each
other and our employees. Our new senior corporate management's ability to
complete this process has been and continues to be hindered by the time that it
needs to devote to other pressing business matters. New management needs to
spend significant time on overseeing our liquidity situation and overseeing
legal matters, such as our class action lawsuit. We cannot assure you that this
major restructuring of our board of directors and senior management and the
accompanying distractions, in this environment, will not adversely affect our
results of operations.
THE SEC IS CONDUCTING AN INFORMAL INVESTIGATION OF THE COMPANY AND IF WE HAVE
DONE SOMETHING THAT DOES NOT COMPLY WITH THE FEDERAL SECURITIES LAWS, WE WILL BE
SUBJECT TO FINES, PENALTIES AND OTHER SANCTIONS BY THE SEC
In August 2003, we were advised that the SEC had commenced an informal
investigation of our company. It appears that the investigation is focused on
the restatement of our financial statements for fiscal years 2002 and 2001;
however, the SEC may be reviewing other issues as well. If the SEC finds that
our company has not fully complied with all applicable federal securities laws,
we could be subject to fines, penalties and other sanctions imposed by the SEC.
OUR LICENSING AGREEMENT WITH MTV NETWORKS IS IMPORTANT TO OUR BUSINESS AND IF WE
WERE TO LOSE OUT MTV LICENSE IT COULD AFFECT OUR REVENUES AND PROFITABILITY
Our license with MTV Networks is important to our business. We generated
11.8% and 32.3% of our consolidated net sales from products sold under the MTV
license in fiscal 2004 and 2003, respectively. Our MTV license was extended
through December 31, 2004. If we were to lose our MTV license, it would have an
adverse effect on our revenues and net income.
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 amount of our sales occur during the second
quarter ended September 30 and the third quarter ended December 31. Sales in our
second and third quarter, combined, accounted for approximately 86% of net sales
in fiscal 2004 and 2003 and 81% of net sales in fiscal 2002.
IF WE ARE UNABLE TO COMPETE IN THE KARAOKE PRODUCTS CATEGORY, OUR REVENUES AND
NET PROFITABILITY WILL BE REDUCED
Our major competitors for karaoke machines and related products are Craig
and Memorex. We believe that competition for karaoke machines is based primarily
on price, product features, reputation, delivery times, and customer support.
Our primary competitors for producing karaoke music are Compass, Pocket Songs,
Sybersound, UAV and Sound Choice. We believe that competition for karaoke music
is based primarily on popularity of song titles, price, reputation, and delivery
times. To the extent that we lower prices to attempt to enhance or retain market
share, we may adversely impact our operating margins. Conversely, if we opt not
to match competitor's price reductions we may lose market share, resulting in
decreased volume and revenue. To the extent our leading competitors reduce
prices on their karaoke machines and music, we must remain flexible to reduce
our prices. If we are forced to reduce our prices, it will result in lower
margins and reduced profitability. Because of intense competition in the karaoke
industry in the United States during fiscal 2004, 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 2005. In addition, we must compete with
all the other existing forms of entertainment including, but not limited to:
motion pictures, video arcade games, home video games, theme parks, nightclubs,
television and prerecorded tapes, CD's and video cassettes.
5
IF WE ARE UNABLE TO DEVELOP NEW KARAOKE PRODUCTS, OUR REVENUES MAY NOT CONTINUE
TO GROW
The karaoke industry is characterized by rapid technological change,
frequent new product introductions and enhancements and ongoing customer demands
for greater performance. In addition, the average selling price of any karaoke
machine has historically decreased over its life, and we expect that trend to
continue. As a result, our products may not be competitive if we fail to
introduce new products or product enhancements that meet evolving customer
demands. The development of new products is complex, and we may not be able to
complete development in a timely manner, or at all. Edward Steele, our former
Chief Executive Officer, has overseen our Product Development for the past
twelve years. Mr. Steele currently serves as a Senior Advisor and Director of
Product Development under a contract which expires on February 28, 2005. We have
not yet identified a successor who will oversee product development if Mr.
Steele were to leave our company. 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 wit 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.
OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD PREVENT
OR DELAY OUR CUSTOMERS' RECEIPT OF INVENTORY
We rely principally on four contract ocean carriers to ship virtually all
of the products that we import to our warehouse facility in Compton, California.
Retailers that take delivery of our products in China rely on a variety of
carriers to import those products. Any disruptions in shipping, whether in
California or China, caused by labor strikes, other labor disputes, terrorism,
and international incidents or otherwise prevent or delay our customers' receipt
of inventory. If our customers do not receive their inventory on a timely basis,
they may cancel their orders or return products to us. Consequently, our
revenues and net income would be reduced.
THE FACTORIES THAT MANUFACTURE OUR KARAOKE PRODUCTS ARE LOCATED IN THE PEOPLE'S
REPUBLIC OF CHINA, SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS. IF
THERE IS ANY PROBLEM WITH THE MANUFACTURING PROCESS, OUR REVENUES AND NET
PROFITABILITY MAY BE REDUCED.
We are dependent upon six factories in the People's Republic of China to
manufacture the majority of our karaoke machines. One of these factories will be
producing approximately 68% of our karaoke products in fiscal 2005. We do not
have written agreements with any of these factories. Our arrangements with these
factories are subject to the risks of doing business abroad, such as import
duties, trade restrictions, work stoppages, and foreign currency fluctuations,
limitations on the repatriation of earnings and political instability, which
could have an adverse impact on our business. Furthermore, we have limited
control over the manufacturing processes themselves. As a result, any
difficulties encountered by our third-party manufacturers that result in product
defects, production delays, cost overruns or the inability to fulfill orders on
a timely basis could adversely affect our revenues, profitability and cash flow.
Also, since we do not have written agreements with any of these factories, we
are subject to additional uncertainty if the factories do not deliver products
to us on a timely basis.
6
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
that our factories use to produce our karaoke products. If our suppliers are
unable to provide our factories with the parts and supplies, the factories 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 are used in
our karaoke machines. If we are unable to anticipate any shortages of parts and
materials in the future, the factories may experience severe production
problems, which would impact our sales.
CONSUMER DISCRETIONARY SPENDING MAY AFFECT KARAOKE PURCHASES AND IS AFFECTED BY
VARIOUS ECONOMIC CONDITIONS AND CHANGES
Our business and financial performance may be damaged more than most
companies by adverse financial conditions affecting our business or by a general
weakening of the economy. Purchases of karaoke machines and music are considered
discretionary for consumers. Our success will therefore be influenced by a
number of economic factors affecting discretionary and consumer spending, such
as employment levels, business, interest rates, and taxation rates, all of which
are not under our control. Additionally, other extraordinary events such as
terrorist attacks or military engagements, which adversely affect the retail
environment may restrict consumer spending and thereby adversely affect our
sales growth and profitability.
WE MAY HAVE INFRINGED THE COPYRIGHTS OF CERTAIN MUSIC PUBLISHERS AND IF WE
VIOLATE FEDERAL COPYRIGHT LAWS, WE WILL BE SUBJECT TO MONETARY PENALTIES
Over the past several years, we have received notices from several music
publishers who have alleged that we did not have the proper copyright licenses
to sell certain songs included in our compact discs with graphics discs
("CDG"s). CDG's are compact discs which contain the musical recordings of the
karaoke songs and graphics which contain the lyrics of the songs. We have
settled or are in the process of settling all of these copyright infringement
issues with these publishers. We have spent approximately $70,000 to settle
these copyright infringement suits in fiscal year 2003 and 2004. These copyright
infringement claims may have a negative effect on our ability to sell our music
products to our customers. If we do not have the proper copyright licenses for
any other songs that are included in our CDG's and cassettes, we will be subject
to additional liability under the federal copyright laws, which could include
settlements with the music publishers and payment of monetary damages.
WE MAY BE SUBJECT TO CLAIMS FROM THIRD PARTIES FOR UNAUTHORIZED USE OF THEIR
PROPRIETARY TECHNOLOGY, COPYRIGHTS OR TRADE SECRETS AND ANY CLAIMS ASSERTED
AGAINST US COULD AFFECT OUR NET PROFITABILITY
We believe that we independently developed the technology used in our
electronic and audio software products and that it does not infringe on the
proprietary rights, copyrights or trade secrets of others. However, we cannot
assure you that we have not infringed on the proprietary rights of third parties
or those third parties will not make infringement violation claims against us.
During fiscal 2000, Tanashin Denki, Ltd., a Japanese company that holds a patent
on a cassette tape drive mechanism alleged that some of our karaoke machines
violated their patents. We settled the matters with Tanashin in December 1999.
Subsequently in December 2002, Tanashin again alleged that some of our karaoke
machines violated their patents. We entered into another settlement agreement
with them in May 2003. In addition to Tanashin, we could receive infringement
claims from other third parties. Any infringement claims may have a negative
effect on our profitability and financial condition.
7
WE ARE EXPOSED TO THE CREDIT RISK OF OUR CUSTOMERS, WHO ARE EXPERIENCING
FINANCIAL DIFFICULTIES, AND IF THESE CUSTOMERS ARE UNABLE TO PAY US, OUR
REVENUES AND PROFITABILITY WILL BE REDUCED
We sell products to retailers, including department stores, lifestyle
merchants, direct mail retailers, which are catalogs and showrooms, national
chains, specialty stores, and warehouse clubs. Some of these retailers, such as
K-Mart, FAO Schwarz and KB Toys, have engaged in leveraged buyouts or
transactions in which they incurred a significant amount of debt, and operated
under the protection of bankruptcy laws. As of September 27, 2004, we are aware
of only two customers, FAO Schwarz and KB Toys, which are operating under the
protection of bankruptcy laws. Deterioration in the financial condition of our
customers could result in bad debt expense to us and have a material adverse
effect on our revenues and future profitability.
A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTERS IN CALIFORNIA OR FLORIDA
COULD IMPACT OUR ABILITY TO DELIVER MERCHANDISE TO OUR STORES, WHICH COULD
ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY
A significant amount of our merchandise is shipped to our customers from
one of our two warehouses, which are located in Compton, California, and Coconut
Creek, Florida. Events such as fire or other catastrophic events, any
malfunction or disruption of our centralized information systems or shipping
problems may result in delays or disruptions in the timely distribution of
merchandise to our customers, which could substantially decrease our revenues
and profitability.
OUR BUSINESS OPERATIONS COULD BE DISRUPTED IF THERE ARE LABOR PROBLEMS ON THE
WEST COAST
During fiscal 2004, approximately 39% of our sales were domestic warehouse
sales, which were made from our warehouses in California and Florida. During the
third quarter of fiscal 2003, the dock strike on the West Coast affected sales
of two of our karaoke products and we estimate that we lost between $3 and $5
million in orders because we couldn't get the containers of these products off
the pier. If another strike or work slow-down occurs and we do not have a
sufficient level of inventory, a strike or work slow-down would result in
increased costs to us and may reduce our profitability.
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE WHICH MAY CAUSE INVESTORS
TO LOSE ALL OR A PORTION OF THEIR INVESTMENT
From June 1, 2003 through September 27, 2004, our common stock has traded
between a high of $6.55 and a low of $0.30. During this period, we have restated
our earnings, lost senior executives and Board members, had liquidity problems,
and incurred a net loss of $22.7 million in fiscal 2004. 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.
8
OUR OBLIGATION TO MAKE SEVERANCE PAYMENTS COULD PREVENT OR DELAY TAKEOVERS
Our employment agreement with Yi Ping Chan and Edward Steele requires us,
under certain conditions, to make substantial severance payments upon
resignation and after a change of control. Mr. Chan is entitled to a severance
payment of $250,000 if he resigns after a change in control. Mr. Steele is
entitled to a severance payment of $125,000 upon resignation or change of
control. These provisions could delay or impede a merger, tender offer or other
transaction resulting in a change in control of the Singing Machine, even if
such a transaction would have significant benefits to our shareholders. As a
result, these provisions could limit the price that certain investors might be
willing to pay in the future for shares of our common stock. See "Executive
Compensation - Employment Agreements" on page 44.
RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
OUR COMMON STOCK MAY BE DELISTED FROM THE AMERICAN STOCK EXCHANGE, WHICH MAY
HAVE A MATERIAL ADVERSE IMPACT ON THE PRICING AND TRADING OF OUR COMMON STOCK
Our common stock is quoted on the American Stock Exchange ("Amex"). The
Amex, as a matter of policy, will consider the suspension of trading in, or
removal from listing of, any stock when, in the opinion of Amex, (i) the
financial condition and/or operating results of an issuer appear to be
unsatisfactory; (ii) it appears that the extent of public distribution or the
aggregate market value of the stock has become so reduced as to make further
dealings on the Amex inadvisable; (iii) the issuer has sold or otherwise
disposed of its principal operating assets; or (iv) the issuer has sustained
losses which are so substantial in relation to its overall operations or its
existing financial condition has become so impaired that it appears
questionable, in the opinion of Amex, whether the issuer will be able to
continue operations and/or meet its obligations as they mature.
As of September 27, 2004, we have not received any notices from AMEX
notifying us that they will delist us. However, we cannot assure you that Amex
will not take any actions in the near future to delist our common stock. If our
common stock were delisted from the Amex, we would trade on the Over-the-Counter
Bulletin Board and the market price for shares or our common stock could
decline. Further, if our common stock is removed from listing on Amex, it may
become more difficult for us to raise funds through the sale of our common stock
or securities convertible into our common stock.
IF WE SELL ANY OF OUR SECURITIES AT A PRICE LOWER THAN $1.41 PER SHARE, THE
CONVERSION PRICE OF OUR DEBENTURES AT $1.41 PER SHARE WILL BE REDUCED AND THERE
WILL BE ADDITIONAL DILUTION TO OUR SHAREHOLDERS
We already had to reset the conversion price from $3.85 per share to $1.41
per share. Given that the closing price for our common stock was $0.575 per
share on September 27, 2004 it is possible that we may again need to sell
additional securities for capital at a price lower than $1.41 per share. If we
sell any securities at a price lower than $1.41 per share, the conversion price
of our debentures currently set at $1.41 per share will be reduced and there
will be more dilution to our shareholders if and when the debentures are
converted into shares of our common stock. If we issue or sell any securities at
a price less than $1.41 per share, the set price will be reduced by an amount
equal to 50% of the difference between the set price and effective purchase
price of such shares.
We have prepared a table, which show the adjustments that will be made to
(i) the conversion price of our convertible debentures and (ii) the number of
shares issued to the debenture holders, if we issue or sell our securities at
the (a) closing price on September 27, 2004, which was $0.575 per share, (b) 50%
of the closing price on September 27, 2004, which is $0.2875 per share and (c)
75% of the closing price on September 27, 2004, which is $0.1438 per share.
PRICE OF SINGING MACHINE ADJUSTED CONVERSION NUMBER OF SHARES ISSUABLE UPON
COMMON STOCK PRICE OF DEBENTURE CONVERSION OF DEBENTURE
------------------------- ------------------- ------------------------------
$ 0.575 $ 1.40 2,857,142
$ 0.2875 $ .85 4,705,882
$ 0.1438 $ 0.78 5,128,205
If the price of our securities continues to decrease, and we continue to
issue or sell our securities at price below $1.41 per share, our obligation to
issue shares upon conversion of the debentures is essentially limitless.
9
When the conversion price reset occurs, the effective conversion price
will decrease, the value of beneficial conversion will increase. The additional
value of beneficial conversion would be recognized as discount on the
convertible debentures.
IF OUR OUTSTANDING DERIVATIVE SECURITIES ARE EXERCISED OR CONVERTED, OUR
EXISTING SHAREHOLDERS WILL SUFFER DILUTION
As of September 27, 2004, there were outstanding stock options to purchase
an aggregate of 949,490 shares of common stock at exercise prices ranging from
$1.30 to $14.30 per share, not all of which are immediately exercisable. The
weighted average exercise price of the outstanding stock options is
approximately $3.95 per share. As of September 27, 2004, there were outstanding
immediately exercisable option to purchase an aggregate of 521,815 shares of our
common stock. There were outstanding stock warrants to purchase 591,040 shares
of common stock at exercise prices ranging from $1.52 to $4.03 per share, all of
which are exercisable. The weighted average exercise price of the outstanding
stock warrants is approximately $3.98 per share. In addition, we have issued
$4,000,000 of convertible debentures, which are convertible into an aggregate of
2,836,879 shares of common stock. To the extent that the aforementioned
convertible securities are exercised or converted, dilution to our stockholders
will occur.
THE $4 MILLION PRIVATE PLACEMENT THAT WE CLOSED IN SEPTEMBER 2003 WILL AFFECT
OUR ABILITY TO RAISE CAPITAL IN THE FUTURE
On September 8, 2003, we closed a private offering in which we issued $4
million of convertible debentures and stock purchase warrants to six
institutional investors. As part of this investment, we agreed to several
limitations on our corporate actions, some of which limit our ability to raise
financing in the future. If we enter into any financing transactions during the
one year period prior to September 8, 2004, we need to offer the institutional
investors the right to participate in such offering in an amount equal to the
greater of (a) the principal amount of the debentures currently outstanding or
(b) 50% of the financing offered to the outside investment group. For example,
if we offer to sell $10 million worth of our securities to an outside investment
group, the institutional investors will have the right to purchase up to $5
million of the offering. This right may affect our ability to attract other
investors if we require external financing to remain in operations. Furthermore,
for a period of 90 days after the effective date of the registration statement
registering shares of common stock issuable upon conversion of the convertible
debentures and the warrants, we cannot sell any securities.
Additionally, we cannot:
o sell any of our securities in any transactions where the exercise
price is adjusted based on the trading price of our common stock at
any time after the initial issuance of such securities; and
o sell any securities which grant investors the right to receive
additional shares based on any future transaction on terms more
favorable than those granted to the investor in the initial
offering.
These limitations are in place until the earlier of February 20, 2006 or
the date on which all the debentures are converted into shares of our common
stock.
10
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS AND INVESTORS MAY
DEPRESS OUR STOCK PRICE
As of September 27, 2004, there were 9,202,318 shares of our common stock
outstanding. Of these shares, approximately 5,954,796 shares are eligible for
sale under Rule 144. We have filed two registration statements registering an
aggregate 3,794,250 of shares of our common stock (a registration statement on
Form S-8 to register the sale of 1,844,250 shares underlying options granted
under our 1994 Stock Option Plan and a registration statement on Form S-8 to
register 1,950,000 shares of our common stock underlying options granted under
our Year 2001 Stock Option Plan). An additional registration statement on Form
S-1, of which this Prospectus is a part, was filed in October 2003, registering
an aggregate of 4,634,067shares of our common stock. The market price of our
common stock could drop due to the sale of large number of shares of our common
stock, such as the shares sold pursuant to the registration statements or under
Rule 144, or the perception that these sales could occur.
OUR STOCK PRICE MAY DECREASE IF WE ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK
Our Certificate of Incorporation authorizes the issuance of 18,900,000
shares of common stock. As of September 27, 2004, we had 9,202,318 shares of
common stock issued. We have an obligation to issue up to:
o 1,540,530 shares issuable under outstanding options and warrants;
and
o 2,836,879 shares upon conversion of the convertible debentures.
We have also reserved up to 207,791 additional shares for interest payment
on the debentures and 988,207 additional shares that we may issue pursuant to
the anti-dilution provisions contained in the convertible debentures which
relate to price protection protections for the convertible debenture holders. As
such, our Board of Directors has the power, without stockholder approval, to
issue up to 5,117,503 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.
11
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). Any statements about our expectations,
beliefs, plans, objectives, assumptions or future events or performance are not
historical facts and may be forward-looking. These statements are often, but not
always, made through the use of words or phrases such as "anticipate,"
"estimate," "plans," "projects," "continuing," "ongoing," "expects," "management
believes," "we believe," "we intend" and similar words or phrases. Accordingly,
these statements involve estimates, assumptions and uncertainties, which could
cause actual results to differ materially from those expressed in them. Any
forward-looking statements are qualified in their entirety by reference to the
"Risk Factors" contained on pages 2 through 8 of this Prospectus.
Because the factors discussed in this Prospectus could cause actual
results or outcomes to differ materially from those expressed in any
forward-looking statements made by us or on behalf of our company, you should
not place undue reliance on any such forward-looking statements. Further, any
forward-looking statement speaks only as of the date on which it is made, and we
undertake no obligation to update any forward-looking statement or statements to
reflect events or circumstances after the date on which such statement is made
or to reflect the occurrence of unanticipated events. New factors emerge from
time to time, and it is not possible for us to predict which will arise. In
addition, we cannot assess the impact of each factor on our business or the
extent to which any factor, or combination of factors, may cause actual results
to differ materially from those contained in any forward- looking statements.
USE OF PROCEEDS
We will not receive any proceeds from the sale of shares by the selling
stockholders. Although we may receive proceeds if the warrants are exercised,
these proceeds, if any, will be used for working capital purposes or any other
purpose approved by the Board of Directors.
SELLING STOCKHOLDERS
The following table sets forth information as of August 27, 2004 with
respect to the beneficial ownership of our common stock both before and
immediately following the offering by each of the selling stockholders.
Calculation of the percent of outstanding shares owned is based on shares
of our common stock issued and outstanding as of August 27, 2004. Beneficial
ownership is determined in accordance with Rule 13d-3 promulgated by the
Securities and Exchange Commission, and generally includes voting or investment
power with respect to securities. Except as indicated in the footnotes to the
table, we believe each holder possesses sole voting and investment power with
respect to all of the shares of common stock owned by that holder, subject to
community property laws where applicable. In computing the number of shares
beneficially owned by a holder and the percentage ownership of that holder,
shares of common stock underlying options, warrants, debentures or preferred
stock by that holder that are currently exercisable or convertible or are
exercisable or convertible within 60 days after the date of the table are deemed
outstanding. Those shares, however, are not deemed outstanding for the purpose
of computing the percentage ownership of any other person or group.
The terms of the debentures and warrants owned by Omicron Master Trust, SF
Capital Partners, Ltd, Bristol Investment Fund, Ltd., Ascend Offshore Fund,
Ltd., Ascend Partners, LP and Ascend Partners Sapient LP (collectively, the
"Institutional Investors") prohibit conversion of those debentures or exercise
of those warrants to the extent that a conversion of those debentures would
result in the holder, together with its affiliates, beneficially owning in
excess of 4.99% of our outstanding shares of common stock, and to the extent
that exercise of the warrants would result in the holder, together with its
affiliates, beneficially owning in excess of 4.99% of our outstanding shares of
common stock. A holder may waive the 4.99% limitation upon 60 days prior written
notice to us. However, we have registered for resale all of the shares that can
be resold by each selling shareholder, without regard to the conversion or
exercise limitations described herein. After each selling shareholder sells
shares, we will file a prospectus supplement which indicates the number of
shares that each selling shareholder is eligible to sell.
12
Because the 4.99% conversation limitation only affects one of our
investors, Omicron Master Trust, we have prepared the beneficial ownership table
without regard to any exercise or conversion limitations.
SECURITIES OWNED
PRIOR TO OFFERING SHARES OF SECURITIES AFTER OFFERING(11)
------------------------- COMMON STOCK ----------------------------
SHARES OF STOCK BEING OFFERED NUMBER OF PERCENT OF
SHARES PERCENT AMT. DILUTION UNDER THIS SHARES OF COMMON
NAME OF SELLING STOCKHOLDER OF STOCK OF STOCK ADJUSTED PROSPECTUS(3) COMMON STOCK STOCK
----------------------------- -------- -------- --------------- -------------- ------------ ------------
Omicron Master Trust 2,058,764(1) 22.37 617,629(2) 2,806,262(4) 0 *
SF Capital Partners, Ltd. 411,753(1) 4.47 123,526(2) 561,252(5) 0 *
Bristol Investment Fund, Ltd. 247,052(1) 2.68 74,116(2) 336,751(6) 0 *
Ascend Offshore Fund, Ltd. 393,636(1) 4.28 118,091(2) 536,557(7) 0 *
Ascend Partners, LP 47,928(1) * 14,378(2) 65,330(8) 0 *
Ascend Partners Sapient, LP 134,890(1) 1.47 40,467(2) 183,866(9) 0 *
Roth Capital Partners, LLC 103,896(10) 1.13 103,896 103,896(10) 0 *
AG Edwards & Sons, Inc. 40,151 * 40,151 40,151(11) 0 *
--------------
* Less than 1%.
(1) Represents shares of common stock issuable upon conversion of the
debentures and exercise of the warrants, which the Institutional Investors
have the right to acquire within sixty (60) days of September 27, 2004.
(2) Represents shares of common stock issuable upon conversion of the
debentures, exercise of the warrants and shares which may be issued
pursuant to the anti-dilution provision of the debentures to the selling
stockholder.
(3) Represents 130% of the shares issuable upon conversion on the debentures
and exercise of the warrants, shares as well as shares underlying interest
payments on the debentures (collectively, the "Registrable Securities").
Also includes shares issued to Roth and AG Edwards.
(4) Shares offered pursuant to this Prospectus consist of 21,773,050 shares
issuable upon conversion of the debentures; 285,714 shares issuable upon
exercise of warrants; up to 129,870 shares which we may issued as interest
payable on the debentures; and 617,629 shares, an additional 30% of the
registrable securities. Omicron Capital, L.P., a Delaware limited
partnership ("Omicron Capital") serves as investment manager to Omicron
Master Trust, a trust formed under the laws of Bermuda ("Omicron").
Omicron Capital, Inc., a Delaware corporation ("OCI") serves as general
partner of Omicron Capital and Winchester Global Trust Company Limited
("Winchester") serves as the trustee of Omicron. By reason of such
relationships, Omicron Capital and OCI may be deemed to share dispositive
power of the shares of our common stock owned by Omicron and Winchester
may be deemed to share voting and dispositive power over the shares of our
common stock owned by Omicron. Omicron Capital, OCI and Winchester Capital
has delegated authority from the board of directors of Winchester
regarding the portfolio management decisions with respect to the shares of
common stock owned by Omnicron and as of September 27, 2004, Mr. Oliver H.
Morali and Mr. Bruce T. Bernstein, officers of OCI, have delegated
authority from the board of directors of OCI regarding the portfolio
management decisions of Omicron Capital with respect to the shares of
common stock owned by Omicron. By reason of such delegated authority,
Messrs. Morali and Bernstein disclaim beneficial ownership of such shares
of our common stock and neither of such persons has any legal right to
maintain such power with respect to shares of our common stock offered by
Omicron, as those terms as used for purposes of the Securities Exchange
Act of 1934, as amended.
(5) Shares offered pursuant to this Prospectus consist of 354,610 shares
issuable upon conversion of the debentures; 57,143 shares issuable upon
exercise of warrants, up to 25,974 shares which we may issued as interest
payable on the debentures, and 123,526, an additional 30% of the
Registrable Securities. Michael A. Roth and Brian J. Stark are the
founding members and director the management of Staro Asset Management,
L.L.C., a Wisconsin limited liability company ("Staro") which acts as
investment manager and has sole power to direct the management of SF
Capital Partners, Ltd. Through Staro, Messrs. Roth and Stark possess sole
voting and dispositive power over all of the shares owned by SF Capital
Partners, Ltd.
13
(6) Shares offered pursuant to this Prospectus consist of 212,766 shares
issuable upon conversion of the debentures; 34,286 shares issuable upon
exercise of warrants, up to 15,584 shares which we may issued as interest
payable on the debentures, and 74,116 shares, an additional 30% of the
Registrable Securities. Paul Kessler and Diana Derycz-Kessler are the
managing members of Bristol Capital Advisors, LLC, a Delaware limited
liability company ("BCA") which acts as investment manager and has sole
power to direct the management of Bristol Investment Fund, Ltd. Through
BCA, Mr. Kessler and Mrs. Diana Derycz -Kessler possess voting and
dispositive power over the shares owned by Bristol Investment Fund, Ltd.
(7) Shares offered pursuant to this Prospectus consist of 339,007 shares
issuable upon conversion of the debentures; 54,629 shares issuable upon
exercise of warrants, up to 24,831 shares which we may issued as interest
payable on the debentures, and 118,091 shares, an additional 30% of the
Registrable Securities. Ascend Capital, LLC, a Delaware limited liability
company ("Ascend") serves as the investment advisor to Ascend Offshore
Fund, Ltd. ("Ascend Offshore") Malcolm Fairbain serves as the founder and
sole managing member of Ascend Offshore and has the sole power to direct
the management of Ascend Offshore. Through Ascend, Mr. Fairbain possesses
sole voting and dispositive power over all of the shares owned by Ascend
Offshore.
(8) Shares offered pursuant to this Prospectus consist of 41,277 shares
issuable upon conversion of the debentures; 6,651 shares issuable upon
exercise of warrants, up to 3,023 shares which we may issued as interest
payable on the debentures, and 14,378 shares, an additional 30% of the
Registrable Securities. Ascend serves as the investment advisor to Ascend
Partners, LP ("Ascend LP"). Malcolm Fairbain serves as the founder and
sole managing member of Ascend LP and has the sole power to direct the
management of Ascend LP. Through Ascend, Mr. Fairbain possesses sole
voting and dispositive power over all of the shares owned by Ascend LP.
(9) Shares offered pursuant to this Prospectus consist of 116,170 shares
issuable upon conversion of the debentures; 18,720 shares issuable upon
exercise of warrants, up to 8,509 shares which we may issued as interest
payable on the debentures, and 40.467 shares, an additional 30% of the
Registrable Securities. Ascend Capital, LLC, a Delaware limited liability
company ("Ascend") serves as the investment advisor to Ascend Partners
Sapient, LLP, Ltd. ("Ascend Partners). Malcolm Fairbain serves as the
founder and sole managing member of Ascend Partners and has the sole power
to direct the management of Ascend Partners. Through Ascend, Mr. Fairbain
possesses sole voting and dispositive power over all of the shares owned
by Ascend Partners.
(10) Shares offered pursuant to this Prospectus consist of 103,896 shares
issuable upon exercise of warrants. Gordon and Byron Roth share voting and
dispositive power with respect to the share held by Roth Capital.
(11) AG Edwards & Sons, Inc. is a publicly traded company. The current officers
and directors of AG Edwards may be deemed to possess the sole voting and
dispositive power over all the shares owned by AG Edwards & Sons, Inc.
(12) Because the selling stockholders may sell all or some portion of the
shares of common stock beneficially owned by them, only an estimate
(assuming the selling stockholders sell all of the shares offered hereby)
can be given as to the number of shares of common stock that will be
beneficially owned by the selling stockholders after this offering. In
addition, any selling stockholder may have sold, transferred or otherwise
disposed or, or may sell, transfer or otherwise dispose of, at any time or
from time to time since the dates on which they provided the information
regarding the shares beneficially owned by them, all or a portion of the
shares beneficially owned by them in transactions exempt from the
registration requirements of the Securities Act of 1933.
14
CIRCUMSTANCES UNDER WHICH SELLING STOCKHOLDERS ACQUIRED SECURITIES
Set forth below is a summary of the circumstances that led to the issuance
to the selling stockholders of shares of our common stock and the securities,
which are exercisable or convertible into shares of our common stock.
On August 20, 2003, we entered into a Securities Purchase Agreement
("Purchase Agreement") with Omicron Master Trust, SF Capital Partners Ltd.,
Bristol Investment Fund, Ltd., Ascend Offshore Fund, Ltd., Ascend Sapient
Partners, Ltd. and Ascend Partners, LP., for the sale to these investors of 8%
debentures, convertible into shares of our common stock at a conversion price
equal to $3.85 per share, for an aggregate amount of $4 million. We closed this
offering on September 8, 2003. As of September 27, 2004, due to a reduction in
the conversion price the debentures were convertible into 2,836,879 shares of
common stock. The investors also received warrants to purchase up to, in the
aggregate 457,143 shares of our common stock with an exercise price equal to
$4.025 per share. We also agreed to register the resale of the shares issued to
the investors in a registration rights agreements. The debentures, the warrant
agreements, the registration rights agreement and any other e documents relating
to the securities issued to the investors shall sometimes be collectively
referred to as the e transaction documents. e
The debentures mature on February 20, 2006 and they provide for interest
only payments on a quarterly basis, on March 1, June 1, September 1 and December
1. The interest rate was 8% per annum from September 8, 2003 through February 9,
2004, however, in connection with an amendment to the transaction documents we
agreed to increase the interest rate to 8.5% per annum effective as of February
9, 2004. We must make these interest payments in cash. However, if we meet
certain requirements specified in the debentures, we can make the interest
payments by using shares of our common stock. These requirements are that (1) a
registration statement registering the resale of the investor's shares is
effective, (2) our common stock is listed for trading on a principal market,
such as the American Stock Exchange or the NASDAQ National Market (3) there is a
sufficient number of authorized but unissued shares of our common stock
available so that all shares of our common stock could be issued to the
investors under the transaction documents, (4) we are not in default of any of
the terms of the transaction documents and (5) the issuance of the shares to an
investor will not result in the investor owning more than 4.99% of our issued
and outstanding common stock (unless the investor has waived the 4.99%
conversion limitation).
If certain conditions are met after the registration statement is declared
effective, we have the right, but not the obligation to redeem the debentures at
100% of their face value, plus accrued interest. The first condition is that the
closing price of our common stock must exceed the set price of the debentures by
200% for more than 15 consecutive trading days. The set price of the convertible
debentures is $1.41, so the trading price for 15 consecutive trading days must
exceed $2.82 per share. The other conditions are (1) we must have honored all
conversions made by the investors prior to the redemption date, (2) our
registration statement registering the resale of shares is effective, (3) our
common stock is listed for trading on a principal market, such as AMEX or
NASDAQ, (4) we have paid all liquidated damages that are due under the
transaction documents, (5) there is a sufficient number of authorized but
unissued shares of our common stock available to issue to the investors all
shares of our common stock that could be issued to the investors under the
debentures, (6) we are not in default of any of the terms of the transaction
documents, (7) the issuance of the shares to an investor will not result in an
investor owning more than 4.99% of our issued and outstanding common stock
(unless the investor has waived the 4.99% conversion limitation) and (8) we had
not made any public announcements about a pending or proposed change of control
or a fundamental transaction, such as a merger or acquisition, has not occurred
and not been consummated.
The warrants are exercisable for a period of three years from the date
of issuance until September 7, 2006 and the initial exercise price is $4.025 per
share. The conversion price of the debentures and the exercise price of the
warrants are subject to adjustment in the event we issue additional shares of
our common stock or securities convertible into shares of our common stock at a
price per share of common stock less than the conversion price or exercise price
on the basis of a weighted average formula. In addition, the conversion price of
the debentures and exercise price of the warrants are subject to adjustment at
any time as the result of any subdivision, stock split, combination of shares or
capitalization. For example, if we were to declare a 2-for-1 stock split, the
conversion price of the debentures would be reduced by half from $3.85 to $1.93
per share and the exercise price of the warrants would be reduced from $4.025 to
$2.0125 per share.
15
The Institutional Investors and Roth Capital Partners, LLC ("Roth
Capital"), the placement agent in this transaction ("Roth Capital"), were also
given certain registration rights in a registration rights agreement with the
Company. We agreed to register:
[_] an aggregate of 2,836,879 shares issuable upon conversion of the
convertible debentures;
[_] an aggregate of 591,039 shares issuable upon exercise of warrants;
[_] an aggregate of 207,791 shares issuable as interest payments on the
debentures; and
All of these shares are collectively referred to as the "Registrable
Securities." In addition, we agreed that we would register 130% of the
Registrable Securities. As such, we are registering an additional 988,207
shares.
We granted the investors a right of first refusal to participate in our
future offerings of our common stock or equivalent securities for a period of
one year after the effective date of the registration statement. If we enter
into any financing transactions during the one year period after the
registration statement is effective, of which this Prospectus is a part, we need
to offer the institutional investors the right to participate in such offering
in an amount equal to the greater of (a) the principal amount of the debentures
currently outstanding or (b) 50% of the financing offered to the outside
investment group. For example, if we offer to sell $10 million worth of our
securities to an outside investment group, the institutional investors will have
the right to purchase up to $5 million of this offering.
Additionally, we cannot:
[_] sell any of our securities in any transactions which are based on
the trading price of our common stock at any time after the initial
issuance of such securities; or
[_] sell any securities which grant investors the right to receive
additional shares based on future transaction of our company on
terms more favorable than those granted to the investor in the
initial offering.
These limitations are in place until the earlier of February 20, 2006 or
the date on which all the debentures are converted into equity. Furthermore, we
agreed not to sell any capital stock or capital stock equivalents for a period
of 90 days after the effective date of this registration statement.
We are obligated to pay liquidated damages to the investors if an event of
default occurs under the registration rights agreement. An event of default
occurs if:
o we do not give the debenture holders the opportunity to review and
comment on the registration statement prior to filing an amendment
to the registration statement with the SEC;
o if we fail to file a request for acceleration within 5 trading days
after the date that the SEC has notified us that the registration
statement is not subject to further review;
o if we fail to file a pre-effective amendment to the registration
statement within 10 trading days after the receipt of comments by
the SEC; or
o a registration statement ceases to be effective for any reason after
the effectiveness date or the holders are not permitted to utilize
the prospectus for 20 consecutive trading days or an aggregate of 30
consecutive dates during any 12-month period.
16
During each month that we have an event of default, we are obligated to
pay each holder liquidated damages in an amount equal to 2% per month, pro rata
on a daily basis, of (i) the subscription amount paid by such holder pursuant to
the purchase agreement, which was $4 million in the aggregate, and (ii) if the
warrants are "in the money" and then held by the holder, the value of the
outstanding warrants (valued at the difference between the average volume weight
average price during the applicable month and the exercise price multiplied by
the number of shares of common stock the warrants are exercisable into). As of
September 27, 2004, the liquidated damages are $80,000 per month.
We amended the convertible debenture agreements to increase the interest
rate to 8.5% effective as of February 9, 2004 and granted warrants to purchase
an aggregate of 30,000 shares of the Singing Machine's common stock to the
debenture holders on a pro-rata basis. These concessions were in consideration
of the debenture holder's agreements to (i) enter into new subordination
agreements with Milberg Factors, (ii) to waive all liquidated damages due under
the transaction documents through July 1, 2004 and (iii) to extend the effective
date of the Form S-1 registration statement until July 1, 2004. The new warrants
have an exercise price equal to $1.52 per share, the fair market value of the
Company's common stock on February 9, 2004, the date of the grant. The fair
value of these warrants as calculated pursuant to Statement No. 123 is $30,981
and has been expensed as other operating expenses in the accompanying statements
of operations.
In connection with this financing, we paid Roth, as placement agent, cash
compensation of 5.5% of the proceeds raised in this offering and granted it a
warrant to purchase 103,896 shares of our common stock at an exercise price of
$4.025 per share. We agreed to register the resale of the 103,896 shares
underlying the warrant issued to Roth.
We have agreed to register the resale of 40,151 shares issued to AG
Edwards & Sons, Inc. in connection with a settlement agreement that we entered
into with them, effective as of November 17, 2003. AG Edwards served as our
investment advisor from October 8, 2002 through October 8, 2003. See the "Legal
Proceedings" Section.
PLAN OF DISTRIBUTION
The selling stockholders and any of their pledgees, assignees,
transferees, donees and successors-in-interest may, from time to time, sell any
or all of their shares of common stock on any stock exchange, market or trading
facility on which the shares are traded or in private transactions. These sales
may be at fixed or negotiated prices. The selling stockholders may use any one
or more of the following methods when selling shares:
[_] ordinary brokerage transactions and transactions in which the
broker-dealer solicits purchasers;
[_] block trades in which the broker-deal will attempt to sell the
shares as agent but may position and resell a portion of the block
as principal to facilitate the transaction;
[_] purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
[_] an exchange distribution in accordance with the rules of the
applicable exchange;
[_] privately negotiated transactions;
[_] settlement of short sales;
[_] broker-dealers may agree with the selling stockholders to sell a
specified number of such shares at a stipulated price per share;
[_] a combination of any such methods of sale; and
[_] any other method permitted pursuant to applicable law.
If any of the selling stockholders sell or engage in short sales of our
common stock, it could have a negative effect on our stock price. Each of the
selling stockholders will prior to the effectiveness of the registration
statement advise in writing that they have not since the purchase of the
debentures and will not prior to the effectiveness of the registration statement
make a short sale of our common stock. See "Risk Factors - If investors short
our securities, our stock price may decline" on page 2.
17
One of the Institutional Investors, SF Capital Partners, Ltd., is an
affiliate of a broker dealer that is registered with the National Association of
Securities Dealers. In the subscription agreement that it entered into when it
purchased the convertible debentures and warrants in August 2003, SF Capital
Partners represented that it was purchasing these securities in the ordinary
course of business and at that at the time of the purchase it did not have any
agreements directly or indirectly with any persons to distribute those
securities. Broker-dealers engaged by the selling stockholders may arrange for
other brokers-dealers to participate in sales. Broker-dealers may receive
commissions or discounts from the selling stockholders (or, if any broker-dealer
acts as agent for the purchaser of shares, from the purchaser) in amounts to be
negotiated. The selling stockholders do not expect these commissions and
discounts to exceed what is customary in the types of transactions involved.
Broker-dealers may agree to sell a specified number of such shares at a
stipulated price per share, and, to the extent such broker-dealer is unable to
do so acting as agent for us or a selling shareholder, to purchase as principal
any unsold shares at the price required to fulfill the broker-dealer commitment.
Broker-dealers who acquire shares as principal may thereafter resell such shares
from time to time in transactions, which may involve block transactions and
sales to and through other broker-dealers, including transactions of the nature
described above, in the over-the-counter markets or otherwise at pries and on
terms then prevailing at the time of sale, at prices than related to the
then-current market price or in negotiated transactions. In connection with such
resales, broker-dealers may pay to or receive from the purchasers such shares
commissions as described above.
The selling stockholders may also sell shares under Rule 144 under the
Securities Act, if available, rather than under this Prospectus The selling
stockholder may from time to time pledge or grant a security interest in some or
all of the shares of common stock owned by them and, if they default in the
performance of their secured obligations, we will file a supplement to this
Prospectus to list the pledgees and/or secured parties as selling stockholders.
Furthermore, if the selling stockholders assign or transfer their shares of our
common stock, we will file a supplement to this Prospectus to list the pledgees,
transferees and other successors-in interest as selling stockholders.
The selling stockholders and any broker-dealers or agents that are
involved in selling the shares may be deemed to be "underwriters" within the
meaning of the Securities Act in connection with such sales. In such event, any
commissions received by such broker-dealers or agents and any profit on the
resale of the shares purchased by them may be deemed to be underwriting
commissions or discounts under the Securities Act. The selling stockholders have
informed us that none of them have any agreement or understanding, directly or
indirectly, with any person to distribute the common stock.
The selling stockholders, their affiliates and any other persons
participating in the sale or distribution of the shares offered under this
Prospectus will be subject to applicable provisions of the Securities Exchange
Act of 1934, and the rules and regulation under that act, including without
limitation, Regulation M. Regulation M applies to activities of the selling
stockholders and their affiliates that may be considered a "distribution," which
is an offering of securities, whether or not subject to a registration under the
Securities Act of 1933, what is distinguished from ordinary trading transactions
by the magnitude of the offering and the presence of special selling efforts and
selling methods by the selling security holders of their affiliates may cause
the shares offered by those selling stockholders to be considered a distribution
under Regulation M.
If the selling stockholders or their affiliates are considered to be
involved in a "distribution" with respect to shares of our common stock they
will be prohibited from directly or indirectly bidding for, purchasing or
attempting to induce any person to bid for or purchases shares of common stock
offered under this Prospectus during the applicable restricted period, which is
the period beginning on the later of five business day prior to the
determination of the offering price of the shares of common stock offered under
this Prospectus or such time that a person becomes a distribution participant,
and ending upon such person's completion of participation in the distribution.
The provisions described above may restrict certain activities including
stabilizing activities by the selling stockholders and their affiliates or any
other person participating in the sale or distribution of shares offered under
this Prospectus, and may limit the timing of purchases and sales of any of the
shares by the selling stockholders, their affiliates or any other such person.
Furthermore, under Regulation M, persons engaged in a distribution of securities
are prohibited from simultaneously engaging in market making and certain other
activities with respect to such securities for a specified period of time prior
to the commencement of such distributions, subject to specified exceptions or
exemptions. All of these limitations may affect the marketability of the shares
of common stock offered under this Prospectus.
18
We will make copies of this Prospectus available to the selling
stockholders and have informed them of the need for delivery of copies of this
Prospectus to purchasers at or prior to the time of any sale of the shares. We
are required to pay all fees and expenses incurred by our company incident to
the registration of the shares. We have agreed to indemnify the selling
stockholders against certain losses, claims, damages and liabilities, including
liabilities under the Securities Act.
MARKET PRICES OF COMMON STOCK
Our common stock currently trades on the American Stock Exchange under the
symbol "SMD." Set forth below is the range of high and low information for our
common stock as traded on the American Stock Exchange during fiscal 2004 and
fiscal 2003. This information regarding trading on AMEX represents prices
between dealers and does not reflect retail mark-up or markdown or commissions,
and may not necessarily represent actual market transactions.
FISCAL PERIOD HIGH LOW
--------------------------------------------- ------- ------
2004:
First quarter (April 1 - June 30, 2003) $ 7.94 $ 2.85
Second quarter (July 1 - September 30, 2003) 5.03 2.70
Third quarter (October 1 - December 31, 2003) 4.43 1.80
Fourth quarter (January 1 - March 31, 2004) 2.43 1.14
2003:
First quarter (April 1 - June 30, 2002) $16.89 $12.06
Second quarter (July 1 - September 30, 2002 12.74 8.05
Third quarter (October 1 - December 31, 2002) 13.49 8.50
Fourth quarter (January 1 - March 31, 2003) 9.19 5.30
As of September 27, 2004, there were approximately 311 record holders of
our outstanding common stock.
COMMON STOCK
We have never declared or paid cash dividends on our common stock and our
Board of Directors intends to continue its policy for the foreseeable future.
Future dividend policy will depend upon our earnings, financial condition,
contractual restrictions and other factors considered relevant by our Board of
Directors and will be subject to limitations imposed under Delaware law.
On March 14, 2002, we affected a 3-for-2 stock split for all shareholders
on record as of March 4, 2002.
DIVIDEND POLICY
We do not anticipate the declaration or payment of any dividends in the
foreseeable future. We have never declared or paid cash dividends on our common
stock and our Board of Directors intends to continue its policy for the
foreseeable future. Also, we will consider our earnings, financial condition,
contractual restrictions and other factors in deciding whether to issue
dividends in the future. Under Delaware law, we are prohibited from declaring
dividends unless we have legally available surplus, as such term is defined
under Delaware law. Alternatively, if we do not have legally available surplus,
we can pay dividends out of our net profits in the fiscal year in which the
dividend is declared.
SELECTED FINANCIAL INFORMATION AND OTHER DATA
The selected financial information set forth below is derived from, and
should be read in conjunction with, the more detailed financial statements
(including the notes thereto) appearing elsewhere in this Prospectus. See
"Consolidated Financial Statements."
19
INCOME STATEMENT ITEMS
YEAR ENDED MARCH 31,
---------------------------------------------------
2004 2003 2002* 2001* 2000
------- -------- -------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net Sales 70,541 95,614 62,476 34,875 19,032
Cost of Sales 68,722 72,329 40,853 22,159 13,727
Total Operating Expenses 22,013 21,671 13,388 7,689 3,779
Earnings (Loss) From Operations (20,195) 1,614 8,235 5,028 1,526
Net Other (Expenses) Income (1,730) (198) (51) (840) 948
Income Tax (Benefit) Expense (758) 199 1,895 492 160
Net Earnings (Loss) (22,683) 1,218 6,289 3,696 738
Net Earnings (Loss) per common share basic (2.65) 0.15 0.88 0.59 0.23
Net Earnings (Loss) per common share diluted (2.65) 0.14 0.79 0.50 0.19
Shares used in computing net earnings (loss)
per common share - basic 8,556 8,114 7,159 6,292 2,726
Shares used in computing net earnings (loss)
per common share - diluted 8,556 8,931 7,943 7,457 3,342
--------------
* As Restated
THREE MONTHS ENDED SIX MONTHS ENDED NINE MONTHS ENDED YEAR ENDED THREE MONTHS ENDED
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
------------------ ------------------ ------------------ ------------------ ------------------
2003 2002* 2003 2002* 2003 2002* 2004 2003 2004 2003
------- ------- ------- ------- ------- ------ ------- ------ ------- -------
(In Thousands, Except Per Share Data)
Net Sales 7,628 4,297 39,364 36,256 68,054 81,915 70,541 95,614 3,857 7,628
Cost of Sales 5,902 2,991 34,166 27,527 65,457 64,155 68,722 72,329 3,087 5,902
Gross Profit 1,726 1,306 5,198 8,729 2,597 17,760 1,819 23,285 770 1,726
Total Operating
Expenses 3,860 2,639 8,584 5,101 13,615 9,109 22,014 21,671 1,854 3,860
Earnings (Loss)
From Operations (2,134) (1,333) (3,386) 3,628 (11,018) 8,651 (20,195) 1,614 (1,084) (2,134)
Net Other (Expenses)
Income (181) 24 (590) 52 (1,245) (20) (1,730) (198) (435) (181)
Income Tax (Expense)
Benefit (2,315) (118) 1,003 (993) (1,161) (2,675) (759) (199) (2)
Net Earnings (Loss) (4,630) (1,427) (2,973) 2,687 (13,424) 5,956 (22,684) 1,217 (1,519) (2,317)
Net Earnings (Loss)
per common
share basic (0.56) (0.18) (0.35) 0.33 (1.58) 0.74 (2.65) 0.15 (0.17) (0.28)
Net Earnings (Loss)
per common share
diluted (0.56) (0.18) (0.35) 0.30 (1.58) 0.67 (2.65) 0.14 (0.17) (0.28)
Shares used in
computing net
earnings (loss)
per common
share - basic 8,278 8,061 8,389 8,090 8,503 8,101 8,566 8,114 8,787 8,278
Shares used in
computing net
Earnings (loss)
per common share
- diluted 8,278 8,061 8,387 8,889 8,503 8,948 8,566 8,931 8,787 8,278
----------
* As Restated
BALANCE SHEET AND OTHER ITEMS
*As Restated
SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
---------------------- ----------------------- --------------------- -----------------------
2003 2002* 2003 2002* 2004 2003 2004 2003
--------- ----------- ----------- ----------- --------- ---------- ---------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Cash (excluding restricted 1,106 658 236 363 356 268 313,574 86
cash)
Total current assets 46,948 48,764 27,267 53,341 13,162 36,531 11,214 35,075
Working capital 17,536 17,248 8,275 20,740 (1,383) 15,281 (2,670) 13,085
Total Assets 49,995 50,581 29,604 54,940 14,762 38,935 12,635 37,566
Inventory 20,563 31,382 8,029 30,017 5,228 25,194 4,763 25,960
Current liabilities 29,412 31,516 18,992 32,601 14,545 21,250 13,885 21,990
Long term obligations 595 -- 954 -- 0 0 0 --
Total shareholders' equity 19,988 19,065 9,658 22,338 217 17,685 (1,250) 15,576
*As Restated
20
SELECTED QUARTERLY FINANCIAL DATA
QUARTERLY FISCAL 2005
UNAUDITED
3-MONTHS
ENDED
JUNE 30,
2004
------------
Net Sales $ 3,856,872
Gross Profit $ 770,139
Net Loss $ (1,519,510)
Net Loss Per Share (basic & diluted) $ (0.17)
QUARTERLY FISCAL 2004
UNAUDITED UNAUDITED UNAUDITED UNAUDITED
3-MONTHS 3-MONTHS 3-MONTHS 3-MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
2003 2003 2003 2004
------------ ------------- ------------- -----------
Net Sales $ 7,379,866 $ 31,984,251 $ 28,689,622 $ 2,239,279
Gross Profit $ 1,394,036 $ 3,803,539 $ (2,601,126) $(1,109,973)
Net Loss $ (2,317,352) $ (656,669) $ (9,942,122) $(9,258,802)
Net Loss Per Share $ (0.28) $ (0.08) $ (1.14) $ (1.09)
(basic & diluted)
QUARTERLY FISCAL 2003
UNAUDITED UNAUDITED UNAUDITED UNAUDITED
3-MONTHS 3-MONTHS 3-MONTHS 3-MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
2002 2002 2002 2003
------------ ------------- ------------- -----------
Net Sales $ 4,264,203 $ 33,044,306 $ 49,102,372 $ 9,202,885
Gross Profit $ 1,273,322 $ 9,754,954 $ 14,525,191 $(2,268,736)
Net Earnings (loss) $ (1,358,780) $ 4,837,926 $ 3,846,894 $(6,108,228)
Net Earnings (loss)
Per Share (basic) (0.17) 0.60 0.47 (0.75)
Per Share (diluted) (0.18) 0.55 0.48 (0.75)
21
QUARTERLY FISCAL 2002
UNAUDITED UNAUDITED UNAUDITED UNAUDITED
3-MONTHS 3-MONTHS 3-MONTHS 3-MONTHS
ENDED ENDED ENDED ENDED
JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31,
2001* 2001* 2001* 2002
------------ ------------- ------------- -----------
Net Sales $ 5,523,228 $ 15,797,752 $ 34,324,556 $ 6,780,217
Gross Profit $ 1,923,199 $ 5,408,430 $ 11,884,855 $ 2,406,429
Net Earnings (loss) $ (470,447) $ 1,881,321 $ 5,444,081 $ (565,890)
Net Earnings (loss)
Per Share (basic) (0.07) 0.28 0.74 (0.07)
Per Share (diluted) (0.07) 0.25 0.65 (0.07)
*As Restated
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
We had a challenging year in the twelve month period ended March 31, 2004
("fiscal 2004"). During fiscal 2004, we reported a net loss of $22.7 million, or
$2.65 per diluted share, on sales of $70.5 million which compares to net income
of $1.2 million in fiscal 2003 or $.14 per diluted share, on sales of $95.6
million. Sales decreased primarily from increased competition in the United
States and in international markets. In fiscal 2003, we overestimated the demand
for our products and as result had $25 million of excess inventory at year end.
In addition, both our retail customers and our international distributors
carried excess Singing Machine inventory into fiscal 2004, which impacted our
ability to sell into the trade and distribution channels.
Our gross profit decreased to $1.8 million or 2.6% of total revenues in
fiscal 2004 compared to gross profit of $23.3 million or 24.4% of total revenues
in fiscal 2003. Our net loss for fiscal 2004 was $22.7 million, which includes
several unusual operating expenses: litigation expenses severance expenses,
lease termination costs, write off of prepaid royalties, tooling impairment
charges and the settlement will be final if no appeals are filed by the next 30
days, write off of capitalized cost of reorganization intangible.
In July 2003, we made a decision to restate our audited financial
statements for the fiscal years ended March 31, 2002 and March 31, 2001 because
we revised our position on the Hong Kong and U.S. taxation of the income of
International SMC, our Hong Kong subsidiary. See "Restatement" on pages 24. As a
result of this restatement we were named as a defendant in several class action
lawsuits and a derivative lawsuit. The shareholder complaints were consolidated
into one lawsuit in the United States District Court for Southern Florida.
Settlement was approved by the court on July 30, 2004. The court entered an
order approving our settlement agreement with the plaintiffs on August 2, 2004.
See "Legal Proceedings" on page 41. We incurred approximately $706,000 for the
settlement and related expenses, net of reimbursement from our insurance
carrier.
In July 2003, we raised $1 million in subordinated debt financing from an
investment group comprised of an officer, directors and an associate of one of
our directors. On August 19, 2004, LaSalle amended our credit agreement, which
extended the loan until March 31, 2004 and waived the existing condition of
default. On September 8, 2003, we raised $4 million in an offering of 8%
convertible subordinated debentures to six accredited investors. The proceeds of
the debenture were used to pay down our accounts payable, finance operations and
pay down a portion of our loan with LaSalle. On December 31, 2003, we again
violated the tangible net worth requirement and working capital requirements
under our credit agreement with LaSalle. On January 31, 2004, we paid off our
loan with LaSalle and LaSalle released its security interests in our assets and
terminated the credit agreement. We entered into a factoring agreement with
Milberg Factors effective as of February 9, 2004 and terminated this agreement
on July 14, 2004.
22
Despite the reduction in expenses, we still had minimal liquidity during
fiscal 2004. As such, we were forced to sell excess inventory at or below cost.
During fiscal 2004, we sold approximately 20.2% of our inventory at prices at or
below cost. As such, our gross profit percentage decreased to 2.6% of our net
sales. As of March 31, 2004, we did not have any advances outstanding under our
factoring agreement with Milberg; however, we were in violation of the covenants
relating to working capital and tangible net worth. We terminated this factoring
agreement, effective as of July 14, 2004. Because of our limited liquidity, we
received a going concern uncertainty paragraph on our audited financial
statements for fiscal 2004. Although our cash on hand as of July 1, 2004 is
limited, we believe that we will have sufficient cash from operations to fund
our operating requirements for the next three months. After three months, we
expect to begin collecting accounts receivable from the sales of our karaoke
products in the second and third quarters. If there is a need for additional
funds, short term loans will be obtained. We will continue to sell older
inventory models at discounted prices to generate cash as well as continuing to
reduce operating expenses.
23
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain income
and expense items expressed as a percentage of the Company's total revenues:
2004 2003 2002*
----- ----- -----
Total revenues 100.0% 100.0% 100.0%
Cost of sales 97.4% 75.6% 65.4%
Operating expenses 31.2% 22.7% 21.4%
Operating (loss) income (28.6%) 1.7% 13.2%
Other (expenses), income, net (2.5%) (0.2%) (0.1%)
(Loss) Income before taxes (31.1%) 1.5% 13.1%
Provision (benefit) for income taxes 1.1% .2% 3.0%
(Loss) income (32.2%) 1.3% 10.1%
----------
* AS RESTATED.
RESTATEMENT OF FINANCIAL STATEMENTS
In June 2003, management revised its position on taxation of its
subsidiary's income by the United States and by the Hong Kong tax authorities.
With regard to taxation in Hong Kong, our subsidiary had previously
applied for a Hong Kong offshore claim income tax exemption based on the
locality of profits of the Hong Kong subsidiary. Management previously believed
that the exemption would be approved because the source of all profits of the
Hong Kong subsidiary is from exporting to customers outside of Hong Kong.
Accordingly, no provision for income taxes was provided in the consolidated
financial statements as of March 31, 2002 and 2001. However, full disclosure was
previously reflected in the audited financial statements for years ended March
31, 2002 and 2001 of the estimated amount that would be due to the Hong Kong tax
authority should the exemption be denied. Management is continuing its exemption
application process. However, due to the extended period of time that the
application has been outstanding, as well as management's reassessment of the
probability that the application will be approved, management determined to
restate the 2002 and 2001 consolidated financial statements to provide for such
taxes. The effect of such restatement was to increase income tax expense by
$748,672 and $468,424 in fiscal 2002 and 2001, respectively. However, we can
claim United States foreign tax credits in 2002 for these Hong Kong taxes, which
is reflected in the final restated amounts.
With regard to United States taxation of foreign income, we had originally
taken the position that the foreign income of the Hong Kong subsidiary qualified
for a deferral under the Internal Revenue Code allowing for such income to be
indefinitely deferred and not taxed in the United States until such income is
repatriated. Full disclosure of the amount and nature of the indefinite deferral
for fiscal year 2002 was reflected in the income tax footnote of the
consolidated financial statements for that year. The Internal Revenue Code,
regulations and case law regarding international income taxation is quite
complex and subject to interpretation. Each case is determined based on the
individual facts and circumstances. Due to certain inter-company loans made in
2002 and 2003, the profits previously considered to be indefinitely deferred
became partially taxable as "deemed dividends" under section 956 of the Internal
Revenue Code. Although certain arguments against the imposition of a "deemed
dividend" may be asserted, management determined to restate the fiscal year 2002
consolidated financial statements based on its reassessment of its original
position. The effect of such restatement was to increase income tax expense by
$1,027,545 in fiscal year 2002, which includes the utilization of the foreign
tax credits referred to above.
The net effect of the above two adjustments was to decrease net income by
$1,776,217 and $468,424 in fiscal 2002 and 2001. The net effect on net income
per share was to decrease net income per share basic and diluted by $0.25 and
$0.23, respectively in fiscal 2002 and decrease net income per share basic and
diluted by $0.07 and $0.06, respectively in fiscal 2001.
24
FISCAL YEAR ENDED MARCH 31, 2004 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2003
NET SALES
Net sales for the fiscal year ended March 31, 2004 decreased to $70.5
million compared to revenues of $95.6 million in the fiscal year ended March 31,
2003. The decrease in net sales was due to both decreases in unit volume as well
as pricing, due to increases in competition in the United States and
international markets. In fiscal year 2004, 61% of our sales were direct sales,
which represent sales made by International SMC, and 39% were domestic sales,
which represent sales made from our warehouse in the United States.
The sales decreases occurred in all segments of our business. Our total
hardware sales decreased to $67.7 million, in fiscal 2004 compared to total
hardware sales of $87 million in fiscal 2003. The total decrease of hardware
sales of $19.3 million from the previous year sales level is the primary due to
the increasing market competition. Also we had to lower our price in order to
move the overstocked inventory from fiscal year 2003.
In addition, there was a significant decrease in our music sales. Music
sales decreased to $2.8 million, or 4% of net sales, in fiscal 2004, compared to
$9.1 million, or 9.5% of net sales, in fiscal 2003. The decrease in music sales
is also a result of increased competition in this category, both domestically as
well as internationally.
GROSS PROFIT
Gross profit for fiscal 2004 was $1.8 million or 2.6% of total revenues
compared to $23.3 million or 24.4% of sales for fiscal 2003. The decrease in
gross margin compared to the prior year is primarily due to the following
factors: (i) write-down of inventories, (ii) sales made at lower prices to
generate cash from operation, (iii) increased sales by International SMC, which
sales have lower gross profit margins than sales from the U.S. parent company
and (iv) tooling impairment cost of $443,000.
At the end of fiscal 2004, our inventory levels were higher than we
expected. We determined that due to liquidation sales, inventory would be sold
at a loss; therefore, a decrease in the value of specific inventory items was
made to reverse the value of the inventory on hand to its net realizable value.
The total amount of the provision for inventory was $6.6 million in fiscal 2004
compared to a provision of $3.7 million in fiscal 2003.
In addition to the write-down of inventories, due to competitive price
pressure, a significant amount of sales shipped in fiscal 2004 were made at
lower margins than in previous years. In the fourth quarter, we sold $1 million
of inventory with a negative margin of $366,751.
Our product line did not sell as well as our retailers and mass merchants
had expected. As a result, we agreed to give our customers pricing concessions
and allowed them to return inventory to us. We issued over $1 million in
customer credits during the fourth quarter, which reduced our sales and gross
profit margins equally. Our gross margins were also negatively affected by the
return of $1.8 million of additional inventory.
Our decrease in our gross margin percentage in fiscal 2004 compared to
fiscal 2003 was also reduced by the mix of our sales. The percentage of sales
made by our Hong Kong subsidiary increased from 52% of the total sales in fiscal
2003 to 61% in fiscal 2004. Historically, sales made by International SMC
maintain a lower gross profit margin. We reduced the sales price of our products
sold by International SMC because its customers are required to pay for the
shipping, duty and the warranty costs.
Our gross profit may not be comparable to those of other entities, since
some entities include the costs of warehousing, inspection, freight charges and
other distribution costs in their cost of sales. We account for the above
expenses as operating expenses and classify them under selling, general and
administrative expenses
OPERATING EXPENSES
Operating expenses were $22 million or 31.2% of net sales in fiscal 2004
compared to $21.67 million or 22.7% of net sales in fiscal 2003. The primary
factors that contributed to the increase in operating expenses are:
25
o Increased compensation expenses in the amount of $953,000 in fiscal
2004 of which approximately $323,000 was for severance payments to
four former executive officers; and
o Increased selling, general and administrative expenses of $2,706,000
due to:
- increased legal fees in the amount of $1,080,00 of which
approximately $706,000 was for the class action settlement,
and increased consulting fees in the amount of approximately
$370,000 which was related to consulting work performed by our
lender;
- increased rent expenses in the amount of $690,000 due to the
expansion of the warehouse facility in Rancho Dominguez in
fiscal 2003. The increase warehouse space was necessary to
stock the unanticipated unsold inventories in fiscal year 2004
and expenses of $180,000 for early termination of the lease in
Rancho Dominguez, California;
- a write off of the capitalized cost of reorganization of
$185,000;
- increased accounting expenses in the amount of $426,000, which
was due to the additional work needed to restate our financial
statements for the fiscal years ended March 31, 2001 and 2002
and work required on the filing of certain registration
statements; and
- increased bank fees and loan cost in the amount of $271,000,
which was related to the loan agreement with LaSalle bank.
This increase in expenses was offset by decreases in our advertising
expenses and our freight and handling charges in the amount of $2,692,000 and
$689,000, respectively. Advertising expense consists of two components:
co-operative advertising and direct advertising expense. Co-operative
advertising is paid directly to the customer and the allowances are based on the
amount of sales. The customer provides copies of advertising on which these
funds are spent, but has complete discretion as to the use of these funds. As we
believe that there is a separate and identifiable benefit associated with the
co-operative advertising, such amounts are recorded as a component of operating
expenses. Co-operative advertising expenses decreased to $2,340,439 in fiscal
2004 compared to $5,032,367 in fiscal 2003 because our sales decreased. Our
royalty expenses were $2,294,727 in fiscal 2004 compared to $2,257,653 in fiscal
2003. Our royalty expenses in fiscal 2004 included a write-off of $980,000 in
pre- paid royalties under our licensing agreement with MTV.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses were $750,359 for fiscal 2004
compared to $622,298 for fiscal 2003. This increase in depreciation and
amortization expenses can be attributed to our investment in tooling and dies
for the new models, in addition to the acceleration in the depreciation method
used to depreciate tools and dies.
NET OTHER EXPENSES
Net other expenses were $1.73 million in fiscal 2004 compared to $197,646
in fiscal 2003. Net other expenses increased because our interest expense
increased to $1.75 million in fiscal 2004 compared to $406,000 in fiscal 2003.
Our interest expense increased because we recorded $917,853 for the amortization
of the discount and related deferred financing fees on our convertible
debentures and approximately $800,000 relates to interest expense on the LaSalle
loan, interest on the convertible debentures, interest on the insiders loan, and
interest expense incurred at our Hong Kong subsidiary. We expect interest
expense to increase further in fiscal 2005, as we will have a full year's worth
of amortization of the discount on the convertible debentures and related
deferred financing fees.
INCOME BEFORE TAXES
We had a net loss before taxes of $21.9 million in fiscal 2004 compared to
net income of $1.42 million in fiscal 2003.
26
INCOME TAX EXPENSE
Significant management judgment is required in developing our provision
for income taxes, including the determination of foreign tax liabilities,
deferred tax assets and liabilities and any valuation allowances that might be
required against the deferred tax assets. Management evaluates its ability to
realize its deferred tax assets on a quarterly basis and adjusts its valuation
allowance when it believes that it is more likely than not that the asset will
not be realized. At December 31, 2003 and March 31, 2004, we concluded that a
valuation allowance was needed against all of our deferred tax assets, as it was
not more likely than not that the deferred taxes would be realized. At March 31,
2004 and 2003, we had gross deferred tax assets of $8.2 million and $1.9
million, against which we recorded valuation allowances totaling $8.2 million
and $0, respectively.
For the fiscal year ended March 31, 2004, we recorded a tax provision of
$758,505. This occurred because the valuation allowance established against our
deferred tax assets exceeded the amount of the benefit created from carrying
back a portion of the current year's losses. The carry-back of the losses from
the current year resulted in an income tax receivable of $1.1 million, which is
included in refundable tax in the accompanying balance sheets. We have now
exhausted our ability to carry back any further losses and therefore will only
be able to recognize tax benefits to the extent that we has future taxable
income.
Our subsidiary has applied for an exemption of income tax in Hong Kong.
Therefore, no taxes have been expensed or provided for at the subsidiary level.
Although no decision has been reached by the governing body, the parent company
has reached the decision to provide for the possibility that the exemption could
be denied and accordingly has recorded a provision for Hong Kong taxes in fiscal
2003 and 2002. There was no provision for Hong Kong income taxes in fiscal 2004
due to the subsidiary's net operating loss for the year. Hong Kong income taxes
payable totaled $2.4 million at March 31, 2004 and 2003 and is included in the
accompanying balance sheets as income taxes payable.
We effectively repatriated approximately $2.0 million, $5.6 million and
$5.7 million from our foreign operations in 2004, 2003 and 2002, respectively.
Accordingly, these earnings were taxed as a deemed dividend based on U.S.
statutory rates. We have no remaining undistributed earnings of our foreign
subsidiary.
We operate within multiple taxing jurisdictions and are subject to audit
in those jurisdictions. Because of the complex issues involved, any claims can
require an extended period to resolve. In management's opinion, adequate
provisions for income taxes have been made.
NET LOSS/NET INCOME
As a result of the foregoing, we had a net loss of $22.7 million in 2004
compared to net income of $1.2 million in fiscal 2003.
QUARTER ENDED JUNE 30, 2004 COMPARED TO THE QUARTER ENDED JUNE 30, 2003
NET SALES
Net sales for the quarter ended June 30, 2004 were $3,856,872, compared to
net sales of $7,627,975 for the comparative period of 2003. Sales decreased
$3,771,103 or 49.4% from the comparative period. The decrease is a result of a
planned management decision, to defer the launch of our new products until the
quarter ended September 30, 2004. This management decision provided us with the
opportunity to focus on selling existing models in inventory, to generate cash
for operations.
We were notified, by a customer in the quarter ended June 30, 2004 that
they would not continue participating in a promotion program. During the year
ended March 31,2004 and as a result of this promotion program, this customer was
given a credit in the amount of $372,000. As a result of the customer's decision
not to continue participation in this program, the amount previously credited to
their account was reversed during the quarter ended June 30, 2004.
27
GROSS PROFIT
Gross profit for the quarter ended June 30, 2004 was $770,139 or 20.0% of
sales as compared to $1,726,109 or 22.6% of sales for the quarter ended June 30,
2003. The decrease in gross margin percentage compared to the prior year is due
primarily to sales of existing older models that we held in inventory at reduced
costs to generate cash for operations in the first quarter of fiscal 2005. The
sales of these older models at reduced prices resulted in lower profit margins
on these sales. Due to the level of inventory of older model machines of
$4,763,060 at June 30, 2004, we anticipate that the gross profit percentage for
the sale of these models will be lower for the balance of fiscal 2005, compared
to the sales of newer model machines being introduced in the second quarter of
fiscal 2005.
OPERATING EXPENSES
Total operating expenses were $1,854,434 for the quarter ended June 30,
2004, compared to $3,860,347 for the comparative period of 2003. Operating
expenses decreased compared to prior period by 52% or $2,005,913. This decrease
of expenses is a result of two primary factors:
o In fiscal 2004, one of our primary objectives was to reduce our
operating expenses. Total controllable operating expenses decreased
51% from the comparative last year quarter or $1,663,841.
Controllable expenses include selling, general and administrative
and compensation, expense. Selling, general and administrative
expense was reduced by $1,050,861 or 53%, to $929,691, from
$1,980,552. Compensation expense on a comparative basis was reduced
by $612,980 or 47% from $1,299,195 to $686,215.
o In addition, variable selling related expenses advertising,
commissions, freight & handling and royalty, decreased as a percent
of sales from 7.6% to 6.2% of sales. In total, variable expenses
decreased $342,072, from $580,600 in the quarter ended June 30, 2003
to $238,528 in the quarter ended June 30, 2004.
Management anticipates that the controllable operating expense will continue to
be at approximately the same levels as the quarter ended June 30, 2004 for the
balance of the fiscal year.
OTHER EXPENSES
Other expenses were $435,224 for the quarter ended June 30, 2004, compared to
other expense of $180,799 for the quarter ended June 30, 2003. The significant
increase over prior year is the result of amortization of the discount on the
convertible debentures totaling $332,715 compared to zero for the comparative
period of last year. The Company did not close on the convertible debenture
until September 2004, therefore for the comparative period; the amortization on
discount of the convertible debentures was zero. Interest expense decreased for
the quarter ended June 30, 2004 vs. the quarter ended June 30, 2003. For the
quarter ended June 30, 2004 interest expense decreased to $114,200 from
$188,468. The decrease is a result of reduced borrowings, compared to the prior
year.
INCOME TAXES
For the three months ended June 30, 2004, the Company recorded no tax
provision. This occurred because the Company has net operating losses during
this period and has not recorded a benefit for the current period's losses
because realizability is not more likely than not.
FISCAL YEAR ENDED MARCH 31, 2003 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2002
NET SALES
Net sales for the fiscal year ended March 31, 2003 increased 53.0% to
$95.6 million compared to $62.5 million for the fiscal year ended March 31,
2002. Our growth was driven in large part by the addition of international sales
in Europe, Asia, and Australia. We also generated $30.9 million or 32.3% of our
net sales from products sold under the MTV license in fiscal 2003.
Strong sales of our music titles were also driving forces in our revenue
growth for fiscal 2003. In fiscal 2003, our sales of music increased to $8.9
million or 9.3% of sales as compared to $6.3 million or 10.1% of net sales in
fiscal 2002. In fiscal 2004, 52% of our sales were direct sales, which represent
sales made by International SMC, and 48% were domestic sales, which represent
sales made from our warehouse in the U.S.
28
GROSS PROFIT
Gross profit for the fiscal year ended March 31, 2003 was $23.3 million or
24.4% of sales as compared to $21.6 million or 34.6% of sales for the fiscal
year ended March 31, 2002. The decrease in gross margin compared to the prior
year is due primarily to the following factors: (i) increased sales from
International SMC both to domestic and international customers; (ii) a write
down of the value of inventory and (iii) a reduction of sales due to a
guaranteed gross profit agreement with Transworld.
International sales were primarily in Europe, Canada and Australia. Sales
to international customers historically maintain lower selling prices, and thus,
a lower gross profit margin. The main reason for this is that the sales are made
to distributors in those countries and there are no additional variable
expenses. Other variable expenses that are seen in conjunction with U.S. sales
are advertising allowances, handling charges, returns and commissions.
In fiscal 2003, we entered into a guaranteed gross profit agreement with
Transworld, a specialty music retailer. We guaranteed Transworld that it would
earn a minimum gross profit of $3,573,000 from the sale of our karaoke products
during the period between September 1, 2002 through January 15, 2003. Under this
agreement, we agreed to pay Transworld for the difference between the gross
profit earned on its sales of our karaoke products and the minimum guarantee. As
of the settlement date of the contract, Transworld had not realized the minimum
guarantee of gross profit. As such, we had to provide them with a check in the
amount of $2.5 million, which was recorded in the fourth quarter of fiscal 2003
as a reduction to revenue.
At the end of fiscal 2003, our inventory level was much higher than we had
expected. As of March 31, 2003, we had inventory on hand of $25 million. We
determined that due to liquidation sales, inventory would be sold at a loss;
therefore, a decrease in the value of specific inventory items was made to
reduce inventory on hand to its realizable value. The total amount of the
provision for inventory was $3.7 million at March 31, 2003.
Gross profit may not be comparable to those of other entities, since some
entities include the costs of warehousing, inspection, freight charges and other
distribution costs in their cost of sales. We account for the above expenses as
operating expenses and classify them under selling, general and administrative
expenses.
OPERATING EXPENSES
Operating expenses were $21.7 million or 22.7% of total revenues in fiscal
2003 up from $13.4 million or 21.4% of total revenues, in fiscal 2002. The
primary factors that contributed to the increase of approximately $8.3 million
in operating expenses for the fiscal year 2003 are:
o increased advertising expenses of $2.7 million due to increased use
of our outside advertising agency to oversee more advertising
projects for us, the production of a television commercial, as well
as cooperative advertising with customers, which is variable based
on the level of sales ;
o the increase in depreciation in the ======== amount of $240,000 due
to the addition of molds for new product additions for fiscal year
2003;
o compensation expense in the amount of 1.2 million due to the
addition of key personnel in Florida, at our California facility and
at International SMC, which include the executive vice-president of
sales, sales administration, music licensing coordinator, and music
production personnel, as well as warehouse employees and repair
personnel;
o increased freight and handling charges to customers in the amount of
$870,000;
o expansion of the California warehouse and its associated expenses in
the amount of $874,000;
o expansion of International SMC's operations and its related
expenses, in the amount of $581,000; and
o increases in product development fees for the development of future
product in the amount of $571,000.
Other increases in operating expenses were to selling expenses, which are
considered variable. These expenses are based directly on the level of sales and
include royalty expenses and commissions. We also incurred $79,000 of expenses
for catalogue expenses and show expenses. These expenses are not variable and do
not change based on the level of sales. Show expenses are costs that are
associated with the Consumer Electronics Show and Toy Fair, such as promotional
materials, show space and mock up samples.
29
Our advertising expense increased $2.7 million for the fiscal year ended
March 31, 2003 as compared to fiscal 2002. Advertising expense consists of two
components: co-operative advertising and direct advertising expense.
Co-operative advertising is paid directly to the customer and the allowances are
based on the amount of sales. The customer provides copies of advertising on
which these funds are spent, but has complete discretion as to the use of these
funds. As we believe that there is a separate and identifiable benefit
associated with the co- operative advertising, such amounts are recorded as a
component of operating expenses. Co-operative advertising expenses accounted for
$2.3 million of the increase in advertising expenses. In fiscal 2002, we
embarked on our first television advertising and continued with the use of print
advertising, radio spots, sponsorships, promotions and other media. This is
considered direct advertising, whereby we actually contract for advertising of
the product. The increased costs for our advertising firm were $334,024 over the
prior year. The expense for direct advertising is at our discretion and is not
variable based on the level of sales attained. Both of these types of
advertising are direct expenses of the Company.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses were $622,298 for the fiscal
year ended March 31, 2003 as compared to $394,456 for the fiscal year ended
March 31, 2002. The increase in depreciation and amortization expenses can be
attributed to the Company's acquisition of new molds and tooling for our
expanded product line, as well as additional costs for additional computer
equipment and furniture for additional personnel.
OTHER EXPENSES
Net other expenses were $200,000 for the fiscal year ended March 31, 2003
as compared with net other expenses of $50,821 for the fiscal year ended March
31, 2002. Our interest expense increased during the fiscal year ended March 31,
2003 compared to the same period of the prior year primarily due to our
increased borrowings under our credit facility with LaSalle during this period.
Prior to August 2002, we had cash reserves to fund operations and did not need
to borrow under our revolving credit facility. However, in August 2002, we began
borrowing our credit facility with LaSalle. Our interest income decreased from
$16,934 during the fiscal year 2002 to $11,943 during the fiscal year 2003 due
to our interest earning's cash balance is lower than previous year. We expect
interest expense to increase in fiscal 2004 as compared to prior years due to
the credit facility accruing interest at a higher rate, effective as of August
19, 2003 when we entered into the Fourteenth Amendment to our credit facility.
As of December 31, 2003, our credit facility accrued interest at 6.5%, which is
prime plus 2.5%, our former default rate. Since interest is calculated based on
the average monthly balance of the credit facility, we can not reasonably
estimate the degree to which this year's expense will exceed last years. We do
know, however, that the interest spread is 1.75% higher than in the same period
last year.
INCOME TAX EXPENSE
Our tax expense is based on an aggregation of the taxes on earnings of
International SMC and our domestic operations. Income tax rates in Hong Kong are
approximately 16%, while the statutory income tax rate in the U.S. is 34%. Our
effective tax rate in fiscal 2003 was 14% as compared to 23% in fiscal 2002.
This decrease in the effective tax rate is a result of our company generating a
pretax loss in the United States in fiscal 2003, resulting in a tax benefit, as
compared to pretax income in the U.S. in fiscal 2002. Our future effective
income tax rate will fluctuate based on the level of earnings of International
SMC and our domestic operations.
30
NET INCOME
As a result of the foregoing, our net income was $1,217,812 for the fiscal
year ended March 31, 2003 compared to net income of $6,289,065 for fiscal 2002.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2004, we had cash on hand of $313,574 and a bank overdraft of
$55,504 compared to cash on hand of $356,342 and a bank overdraft of $ 62,282 at
March 31, 2004. Our current liabilities decreased to $13,937,515 from
$15,200,581 as of March 31, 2004. We had a working capital deficit of $2,670,548
as of June 30, 2004.
As of June 30, 2004, our current liabilities consist of accounts payable
of $3.9 million, accrued expenses of $2.8 million, customer credits on account
of $1.8 million, a bank overdraft of $55,504, subordinated debt of $1 million,
convertible debenture of $1.8 million, related party notes payable of $40,000
and an income tax payable of $2.6 million. Our most significant account payable
is a $2.4 million obligation to a factory in China. We have agreed to a verbal
payment plan with the factory, which provides that we will begin making payments
in September 2004. The payments will continue through the year-end March 2005.
We are current on approximately 22% of our accounts payable.
As of June 30, 2004, we did not have any advances outstanding under a
factoring agreement with Milberg; however, we were in violation of the covenants
relating to working capital and tangible net worth. We terminated our factoring
agreement with Milberg Factors, effective as of July 14, 2004. We paid a $25,000
fee to terminate this agreement prior to the scheduled expiration date of
February 9, 2006. Milberg has agreed to release its security interest in all our
assets and accounts receivable. We accrued the $25,000 fee as legal expense for
the quarter ended June 30, 2004, which is included as selling, general and
administrative expenses in the accompanying statements of operation.
We are actively seeking financing from other sources to fund operations.
Our Hong Kong subsidiary, International SMC, has credit facilities at Hong
Kong Shanghai Bank and Fortis Bank. The primary purpose of these facilities is
to provide International SMC with access to letters of credit so that it can
purchase inventory for direct shipment of goods into the United States and
international markets. These facilities are secured by a corporate guarantee
from the U.S. parent company and restricted cash on deposit with the lender. The
maximum credit under the facilities is $2.0 million. The balance at June 30,
2004 and March 31, 2004 was $55,505 and $62,282, respectively. The interest rate
is approximately 4% per annum. As of June 30, 2004 there was no availability
under these facilities.
As of June 30, 2004, our cash on hand is limited. Our average monthly
operating costs are approximately $600,000 and we expect that we will need
approximately $1.8 million for working capital during the next three-month
period between October and December. Our primary expenses are normal operating
costs including salaries, payments under the severance agreements for two of our
former executives, lease payments for our warehouse space in Compton, California
and other operating costs.
On June 16, 2004, an executive and beneficial owner of the Singing Machine
advanced us a short-term loan of $40,000, to be used to meet working capital
obligations. The loan is non-interest bearing and was repaid on August 30,
2004.
31
On July 14, 2004, a director, Jay Bauer, advanced us a short-term loan of
$200,000, to be used to meet working capital obligations. The loan bears
interest at 8.75% per annum. The loan was repaid on August 26.
We currently expect to order between $8 and $12 million of new inventory
for domestic stock for the year. During fiscal 2005, we will attempt to
liquidate the excess inventory from fiscal 2004. We believe this inventory is
marketable and saleable; however, there can be no assurances that we will be
able to liquidate this inventory during our upcoming fiscal year.
Cash flows used in operating activities were $67,066 for the quarter ended
June 30, 2004. Cash used in operating activities primarily related to decreases
in accounts payable, accrued expense and customer credits on account of $1.7
million, which was offset by cash flows provided by collection of accounts
receivable.
Cash used in investing activities for the quarter ended June 30, 2004 was
$19,240. Cash used in investing activities resulted from the purchase of fixed
assets in the amount of $19,240. The purchase of fixed assets consists of the
tooling and molds required for production of new machines for this fiscal year.
Cash flows provided by financing activities were $33,223 for the quarter
ended June 30, 2004. This cash inflow was primarily from a loan from a related
party.
During the three-month period between October and December 2004, we plan
on financing our working capital needs from
o Collection of accounts receivable;
o Sales of existing inventory;
o Continued support from factories in China in financing our purchases
of karaoke machines for fiscal 2005; and
o Utilizing credit facilities that are available to International SMC
to finance all direct shipments.
o We are also trying to secure a new factoring agreement so that we
can sell our accounts receivable to the factor to finance our
working capital needs. There can be no assurances that we will be
able to obtain a new factoring agreement.
Our sources of cash for working capital in the longer term, the six-month
period between September and March 2004, are the same as our sources during the
short term. We have received a tax refund of $1.1 million on August 24, 2004,
which has been used to pay the loan from the related parties and the vendors. If
we need additional financing, we intend to approach other financing companies
for financing. 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 our operations.
During fiscal 2005, we will strive to keep our operating costs at a
minimum. In order to reduce the need to maintain inventory in our warehouses in
California and Florida, we intend to generate a larger share of our total sales
through sales directly from International SMC. Sales originating from
International SMC are shipped directly to our customers from the ports in China
and are primarily backed by customer letters of credit. Our customers take title
to the merchandise at their consolidators in China and are responsible for their
shipment, duty, clearance and freight charges to their locations. We will also
assist our customers in the forecasting and management of their inventories of
our product to reduce the amount of required warehouse inventory.
32
We are also planning to finance a significant amount of our working
capital needs with customer issued letters of credit, using International SMC's
credit facility with Hong Kong Bank and relying on financing from one of our
factories in China. We anticipate that total purchases of approximately $28
million that will be financed by the above methods. We currently expect to order
between approximately $8 and $12 million in new inventory, which will be
financed by using International SMC's credit facility and financing from a
Chinese factory.
Customer orders can be cancelled at any time prior to delivery and we
cannot assure you that our customers will complete these purchases. In the event
that we do not sell sufficient products in our second and third quarter, we have
considered other sources of financing, such as trying to secure an additional
credit facility, private offerings and/or a venture capital investment. We
expect that our profit margin for sales of our karaoke products will continue to
be under price pressure, because of the sale of older models. During fiscal
2005, we plan on introducing three new karaoke machines, which will command
higher prices and a higher profit margin. We also will continue to cut its
operating expenses.
We entered into a factoring agreement with Milberg Factors, effective as
of February 9, 2004. Pursuant to the agreement, Milberg, at its discretion,
would advance us the lesser of 80% of our accounts receivable or $3.5 million.
To secure these advances, Milberg received a security interest in all of our
accounts receivable and inventory located in the United States and a pledge of
66 2/3% of the stock in International SMC (HK) Ltd., our wholly-owned
subsidiary. This agreement was effective for an initial term of two years, with
successive automatic renewals unless either party gave notice of termination.
We borrowed approximately $250,000 under the factoring agreement in the
fourth quarter of fiscal 2004 and repaid all outstanding amounts. As of March
31, 2004, we did not have any advances outstanding under the factoring
agreement; however, we were in violation of the covenants relating to working
capital and tangible net worth. We terminated our factoring agreement with
Milberg Factors, effective as of July 14, 2004. We paid a $25,000 fee to
terminate this agreement prior to the scheduled expiration date of February 9,
2006. Milberg has agreed to release its security interest in all our assets and
accounts receivable.
We have reached a factoring agreement in principal with Crestmark
Financing in August 2004. The agreement allows us to receive up to 70% of our
eligible account receivables by pledging these accounts as collateral. The
maximum amount we may receive is $2,500,00. The account receivable is with
recourse. The interest rate on the advance is 2% plus prime rate currently 6.5%.
The maintenance fee is 1% of the invoice face value, which will be posted to the
account when the cash is collected. The minimum fee per month is $9000.
Our Hong Kong subsidiary, International SMC, has access to credit
facilities at Hong Kong Shanghai Bank and Fortis Bank. The primary purpose of
the facilities is to provide International SMC with access to letters of credit
so that it can purchase inventory for direct shipment of goods into the United
States and international markets. The facilities are secured by a corporate
guarantee from our U.S. parent company and restricted cash on deposit with the
lender. The maximum available credit under the facilities is $2.0 million. The
balance at March 31, 2004 and 2003 was $62,282 and $316,646, respectively. The
interest rate is approximately 4% per annum. As of March 31, 2004 there was no
availability under these facilities.
As of September 27, 2004, our cash on hand is limited. Our average monthly
operating costs are approximately $600,000 and we expect that we will need
approximately $1.8 million for working capital during the next three month
period between October and December. Our primary expenses are normal operating
costs including salaries, payments under the severance agreements for two of our
former executives, lease payments for our warehouse space in Compton, California
and other operating costs. For more information about how we will finance our
working capital requirements, see "Working Capital Requirement during the Short
and Long Term" on page 32.
Our commitments for debt and other contractual arrangements are summarized
as follows:
YEARS ENDING MARCH 31
-------------------------------------------------------------------------------------------
Total 2005 2006 2007 2008 2009
------------- -------------- -------------- ------------ ------------ -------------
Merchandise License Guarantee $ 525,000 $ 375,000 $ 150,000 - - -
Property Leases $ 2,657,506 $ 838,792 $ 579,851 $ 495,545 $ 371,659 $ 371,659
Equipment Leases $ 120,263 $ 71,746 $ 19,502 $ 7,969 $ 13,044 $ 8,002
Subordinated Debt-Related Parties $ 1,000,000 - $ 1,000,000 - - -
Convertible Debentures $ 4,000,000 $ 4,000,000 - - - -
33
Each of the contractual agreements (except the equipment leases) provides
that all amounts due under that agreement can be accelerated if we default under
the terms of the agreement. For example, if we fail to make a minimum guaranteed
royalty payment that is required under a Merchandise License Agreement on a
timely basis, the licensor can declare us in default and require that all
amounts due under the Merchandise License Agreement are immediately due and
payable.
Merchandise license guarantee reflects amounts that we are obligated to
pay as guaranteed royalties under our various license agreements. In fiscal
2005, we have guaranteed minimum royalty payments under our license agreements
with Care Bears, MTV, Nickelodeon and Motown (Universal Music).
Property leases represents leases for office and warehouse space in
California, Florida and Hong Kong. Equipment leases represent leases for
forklifts and copy machines.
On September 8, 2003, we issued an aggregate of $4,000,000 of 8%
convertible debentures in a private offering to six accredited investors. The
debentures initially are convertible into 1,038,962 shares of our common stock
at $3.85 per share, subject to adjustment in certain situations. The conversion
price has been reset to $1.41 on July 30, 2004 pursuant to the antidilutions
provisions and the debentures are now convertible into 2,836,879 shares of
common stock. It may have significant impact on the Company's results of
operaton. We also issued an aggregate of 457,143 warrants to the investors. The
exercise price of the warrants is $4.025 per share and the warrants expire on
September 7, 2006. We have an obligation to register the shares of common stock
underlying the debentures and warrants.
On February 9, 2004 we amended our convertible debenture agreements to
increase the interest rate to 8.5% and to grant warrants to purchase an
aggregate of 30,000 shares of our common stock to the debenture holders on a
pro-rata basis. These concessions are in consideration of the debenture holder's
agreements to (i) enter into new subordination agreements with Milberg, (ii) to
waive all liquidated damages due under the transaction documents through July 1,
2004 and (iii) to extend the effective date of the Form S-1 registration
statement until July 1, 2004. The new warrants have an exercise price equal to
$1.52 per share and the fair value of these warrants was estimated by using the
Black-Scholes Option-Pricing Model and totaled $30,981. This amount was expensed
as a component of selling, general and administrative expenses. Pursuant to the
convertible debenture agreements, we were required to register the shares of
common stock underlying the debentures and detachable stock purchase warrants
issued in connection with the debentures. The registration of the common shares
was required to be effective by July 1, 2004.
Because we did not have the registration statement declared effective by
July 14, 2004, we are in technical default of the convertible debenture
agreements. As such, we are accruing liquidated damages in the amount of $80,000
per month. Additionally, the convertible debenture holders could declare us in
default of the convertible debentures and accelerate all payments due under the
convertible debentures, which is the principal amount of $4 million plus any
liquidated damages and other fees that are assessed. We are working to cure our
event of default by filing the registration statement as soon as possible.
Additionally, we are trying to enter into another amendment of the convertible
debentures and transaction documents with the convertible debenture holders
which would extend the filing date for the registration statement and eliminate
all liquidated damages. There can be no assurances that we will be able to enter
into an amendment of the convertible debenture agreements.
EXCHANGE RATES
We sell all of our products in U.S. dollars and pay for all of our
manufacturing costs in either U.S. or Hong Kong dollars. Operating expenses of
the Hong Kong office are paid in Hong Kong dollars. The exchange rate of the
Hong Kong dollar to the U.S. dollar has been fixed by the Hong Kong government
since 1983 at HK$7.80 to U.S. $1.00 and, accordingly, has not represented a
currency exchange risk to the U.S. dollar. We cannot assure you that the
exchange rate between the United States and Hong Kong currencies will continue
to be fixed or that exchange rate fluctuations will not have a material adverse
effect on our business, financial condition or results of operations.
34
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 selling months)
and to a lesser extent the first and fourth quarters of the fiscal year. Sales
in our fiscal second and third quarter, combined, accounted for approximately
86% of net sales in fiscal 2004 and 2003, and 81% of net sales in fiscal 2002.
Our results of operations may also fluctuate from quarter to quarter as a
result of the amount and timing of orders placed and shipped to customers, as
well as other factors. The fulfillment of orders can therefore significantly
affect results of operations on a quarter-to-quarter basis.
INFLATION
Inflation has not had a significant impact on the Company's operations.
The Company has historically passed any price increases on to its customers
since prices charged by the Company are generally not fixed by long- term
contracts.
CRITICAL ACCOUNTING POLICIES
We prepared our consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America. As
such, management is required to make certain estimates, judgments and
assumptions that it believes are reasonable based on the information available.
These estimates and assumptions affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses for the periods presented. The significant accounting
policies which management believes are the most critical to aid in fully
understanding and evaluating our reported financial results included accounts
receivable - allowance for doubtful accounts, reserves on inventory, deferred
tax assets and our Hong Kong income tax exemption.
Collectibility Of Accounts Receivable. The Singing Machine's allowance for
doubtful accounts is based on management's estimates of the creditworthiness of
its customers, current economic conditions and historical information, and, in
the opinion of management, is believed to be an amount sufficient to respond to
normal business conditions. Management sets 100% reserves for customers in
bankruptcy and other reserves based upon historical collection experience.
Should business conditions deteriorate or any major customer default on its
obligations to the Company, this allowance may need to be significantly
increased, which would have a negative impact on operations.
Inventory. The Singing Machine reduces inventory on hand to its net
realizable value based on the expected on an item by item basis when it is
apparent that the expected realizable value of an inventory item falls below its
original cost. A charge to cost of sales results when the estimated net
realizable value of specific inventory items declines below cost. Management
regularly reviews the Company's investment in inventories for such declines in
value.
Income Taxes. Significant management judgment is required in developing
our provision for income taxes, including the determination of foreign tax
liabilities, deferred tax assets and liabilities and any valuation allowances
that might be required against the deferred tax assets. Management evaluates its
ability to realize its deferred tax assets on a quarterly basis and adjusts its
valuation allowance when it believes that it is more likely than not that the
asset will not be realized. At December 31, 2003 and March 31, 2004, we
concluded that a valuation allowance was needed against all of our deferred tax
assets, as it was not more likely than not that the deferred taxes would be
realized. At March 31, 2004 and 2003, we had gross deferred tax assets of $8.2
million and $1.9 million, against which we recorded valuation allowances
totaling $8.2 million and $0, respectively.
For the fiscal year ended March 31, 2004, we recorded a tax provision of
$758,505. This occurred because the valuation allowance established against our
deferred tax assets exceeded the amount of the benefit created from carrying
back a portion of the current year's losses. The carry-back of the losses from
the current year resulted in an income tax receivable of $1.1 million, which is
included in refundable tax in the accompanying balance sheets. We have received
the tax fund of $1.1 million on August 24, 2004, which has been used to pay the
related parties' loan and the vendors. we have now exhausted our ability to
carry back any further losses and therefore will only be able to recognize tax
benefits to the extent that it has future taxable income.
35
Our subsidiary has applied for an exemption of income tax in Hong Kong.
Therefore, no taxes have been expensed or provided for at the subsidiary level.
Although no decision has been reached by the governing body, the parent company
has reached the decision to provide for the possibility that the exemption could
be denied and accordingly has recorded a provision for Hong Kong taxes in fiscal
2003 and 2002. There was no provision for Hong Kong income taxes in fiscal 2004
due to the subsidiary's net operating loss for the year. Hong Kong income taxes
payable totaled $2.4 million at March 31, 2004 and 2003 and is included in the
accompanying balance sheets as income taxes payable.
We effectively repatriated approximately $2.0 million, $5.6 million and
$5.7 from its foreign operations in 2004, 2003 and 2002, respectively.
Accordingly, these earnings were taxed as a deemed dividend based on U.S.
statutory rates. We have no remaining undistributed earnings of the Company's
foreign subsidiary.
We operate within multiple taxing jurisdictions and are subject to audit
in those jurisdictions. Because of the complex issues involved, any claims can
require an extended period to resolve. In management's opinion, adequate
provisions for income taxes have been made.
Other Estimates. We makes other estimates in the ordinary course of
business relating to sales returns and allowances, warranty reserves, and
reserves for promotional incentives. Historically, past changes to these
estimates have not had a material impact on our financial condition. However,
circumstances could change which may alter future expectations.
Set forth below and elsewhere in this Prospectus and in the other
documents we file with the SEC are risks and uncertainties that could cause
actual results to differ materially from the results contemplated by the forward
looking statements contained in this Annual Report.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
CHANGE OF ACCOUNTANTS IN MARCH 2003
On March 24, 2003, we dismissed Salberg & Company, P.A. ("Salberg &
Company"), as our independent certified public accountant. On March 27, 2003, we
engaged Grant Thornton, LLP ("Grant Thornton"), as our independent registered
public accounting firm. Our decision to change accountants was approved by our
Audit Committee on March 24, 2003.
The report of Salberg & Company on our consolidated financial statements
for fiscal 2002, fiscal 2001 did not contain an adverse opinion or disclaimer of
opinion and was not qualified or modified as to uncertainty, audit scope or
accounting principles. Furthermore, Salberg & Company did not advise us that:
1) internal controls necessary to develop reliable consolidated
financial statements did not exist, or
2) information had come to the attention of Salberg & Company which
made in unwilling to rely upon management's representations or made
it unwilling to be associated with the consolidated financial
statements prepared by management, or
3) the scope of the audit should be expanded significantly, or
information had come to the attention of Salberg & Company that it
has concluded will, or if further investigated might, materially
impact the fairness or reliability of a previously issued audit
report or the underlying consolidated financial statements, or the
consolidated financial statements issued or to be issued covering
the fiscal periods subsequent to March 31, 2002 (including
information that may prevent it from rendering an unqualified audit
report on those consolidated financial statements) or made in
unwilling to rely on management's representations or to be
associated with the consolidated financial statements prepared by
management or,
4) information has come to the attention of Salber & Company that it
has concluded will, or if further investigated might, materially
impact the fairness or reliability of a previously issued audit
report or the underlying consolidated financial statements or the
consolidated financial statements issued or to be issued covering
the fiscal periods subsequent to March 31, 2002 through March 28,
2003, the date of the Form 8-K filing reporting our change in
accountants, that had not been resolved to the satisfaction of
Salberg & Company or which would have prevented Salberg & Company
from rendering an unqualified audit report on such consolidated
financial statements.
36
During our two most recent fiscal years and all subsequent interim periods
through March 24, 2003, there were no disagreements with Salberg & Company on
any matters of accounting principles or practices, financial statement
disclosure or auditing scope or procedure, which, if not resolved to the
satisfaction of Salberg & Company would have caused it to make reference to the
subject matter of the disagreements in connection with its reports on these
financial statements for those periods.
We did not consult with Grant Thornton regarding the application of
accounting principles to a specific transaction, either completed or proposed,
or the type of audit opinion that might be rendered on our financial statements,
and no written or oral advice was provided by Grant Thornton that was a factor
considered by us in reaching a decision as to the accounting, auditing or
financial reporting issues.
RESTATEMENT
In July 2003, we revised our position on the taxation of the income of our
Hong Kong subsidiary by the United States and Hong Kong tax authorities, which
was contained in our audited financial statements for fiscal 2002. We discussed
these issues with Salberg & Company and it agreed to opine on the restated
financial statements. See the "Restatement of Financial Statements" section.
BUSINESS
OVERVIEW
We are engaged in the development, distribution, marketing and sale of
consumer karaoke audio equipment, accessories and music. We contract for the
manufacture of all electronic equipment products with factories located in Asia.
We also produce and market karaoke music, including compact disks plus graphics
("CDG's"), and audiocassette tapes containing music and lyrics of popular songs
for use with karaoke recording equipment. All of our recordings include two
versions of each song; one track offers music and vocals for practice and the
other track is instrumental only for performance by the participant. Virtually
all of the cassettes sold by us are accompanied by printed lyrics, and our
karaoke CDG's contain lyrics, which appear on the video screen. We contract for
the reproduction of music recordings with independent studios.
We were incorporated in California in 1982. We originally sold our
products exclusively to professional and semi-professional singers. In 1988, we
began marketing karaoke equipment for home use. In May 1994, we merged into a
wholly owned subsidiary incorporated in Delaware with the same name. As a result
of that merger, the Delaware Corporation became the successor to the business
and operations of the California Corporation and retained the name The Singing
Machine Company, Inc. In July 1994, we formed a wholly owned subsidiary in Hong
Kong, now known as International SMC (HK) Ltd. ("International SMC" or "Hong
Kong subsidiary"), to coordinate our production and finance in Asia.
In November 1994, we closed an initial public offering of 2,070,000 shares
of our common stock and 2,070,000 warrants. In April 1997, we filed a voluntary
petition for relief under Chapter 11 of the U.S. Bankruptcy Code. On March 17,
1998, our plan of reorganization was approved by the U.S. Bankruptcy Court. On
June 10, 1998, our plan of reorganization had been fully implemented. Our common
stock currently trades on the American Stock Exchange under the symbol "SMD." We
were listed on the AMEX on March 8, 2001. Our principal executive offices are
located in Coconut Creek, Florida.
37
PRODUCT LINES
We currently have a product line of 40 different models of karaoke
machines plus seven accessories such as microphones, incorporating such features
as CD plus graphics player, sound enhancement, echo, tape record/playback
features, and multiple inputs and outputs for connection to compact disc
players, video cassette recorders, and home theater systems. Ten of these
karaoke machines are models that we plan on discontinuing after we sell our
excess inventory in fiscal 2005. Our machines sell at retail prices ranging from
$30 for basic units to $300 for semi-professional units. We currently offer our
music in two formats - multiplex cassettes and CD+G's with retail prices ranging
from $6.99 to $19.99. We currently have a song library of over 3,500 recordings,
which we license from publishers. Our library of master recordings covers the
entire range of musical tastes including popular hits, golden oldies, country,
rock and roll, Christian, Latin music and rap. We even have backing tracks for
opera and certain foreign language recordings.
MARKETING, SALES AND DISTRIBUTION
Our karaoke machines and music are sold nationally and internationally to
a broad spectrum of customers, primarily through mass merchandisers, department
stores, direct mail catalogs and showrooms, music and record stores, national
chains, specialty stores, and warehouse clubs. Our karaoke machines and karaoke
music are currently sold in such stores as Best Buy, Circuit City, Costco, JC
Penney, Kohl's, Radio Shack, and Sam's Club.
In fiscal 2004, approximately 61% of our sales were domestic sales and 39%
were international sales. Domestic sales are sales that are made in the United
States and international sales are sales that are made outside of the United
States. Our domestic sales are primarily made by our in-house sales team and our
independent sales representatives. Our independent sales representatives are
paid a commission based upon sales in their respective territories. We utilize
some of our outside independent sales representatives to help us provide service
to our mass merchandisers and other retailers. The sales representative
agreements are generally one (1) year agreements, which automatically renew on
an annual basis, unless terminated by either party on 30 days' notice. At June
30, 2004 we worked with 16 independent sales representatives in the United
States. Our international sales are primarily made by our in-house sales
representatives and our eight independent distributors.
We also market our products at various national and international trade
shows each year. We regularly attend the following trade shows and conventions:
the Consumer Electronics Show each January in Las Vegas; the American Toy Fair
each February in New York and the Hong Kong Electronics Show each October in
Hong Kong.
Our licensing agreements with MTV Networks, Inc., a division of Viacom
International, Inc., Hard Rock Academy, Inc. and Universal Music Entertainment,
Inc. have also helped us to expand our product name.
LICENSE AGREEMENTS
We entered into our licensing agreement with MTV in November 2000 and have
amended the agreement five times since that date. Our license covers the sale of
MTV products in the United States, Canada and Australia. During fiscal 2004, our
line consisted of nine MTV branded machines and a wide assortment of MTV branded
music. Our license agreement as amended with MTV, currently expires on August
31, 2004, subject to MTV's option, at its sole discretion, to extend the
agreement for an additional four month period. The license period contains a
minimum guaranteed royalty payment of $100,000, which is recoupable against
sales throughout the calendar year, unless the license agreement is cancelled.
We entered into our licensing agreement with Hard Rock Academy, a division
of Hard Rock Cafe in December 2001. This license agreement allows us to produce
and market a line of karaoke machines and complimentary music that are
co-branded with the Singing Machine and Hard Rock Academy name. The first co-
branded machine was produced during the fourth quarter of fiscal 2003. The
agreement originally contained a minimum guaranteed royalty payment, but in
September 2003 Hard Rock agreed to release us from our minimum guaranteed
payment obligations during the remaining term of the license agreement. This
agreement expires on December 31, 2005 and does not contain any automatic
renewal provisions.
In February 2003, we entered into a multi-year license agreement with
Universal Music Entertainment to market a line of Motown Karaoke machines and
music. This agreement and its subsidiary agreement signed in March 2003, allow
us to be the first to use original artist recordings for our CD+G formatted
karaoke music. Over the term of the license agreement, we are obligated to make
guaranteed minimum royalty payments in the amount of $300,000. The Universal
Music Entertainment license expires on March 31, 2006 and does not contain any
automatic renewal provisions.
We entered into a license agreement with Care Bears in September 2003.
Under this agreement, we are marketing a line of Care Bears branded karaoke
machines and music. Over the term of the license, we are obligated to make
guaranteed minimum royalty payments in the amount of $200,000. This license
expires on January 1, 2006 and does not contain any automatic renewal
provisions.
38
We entered into a license agreement with Nickelodeon, Inc., a division of
Viacom International, Inc. in December 2002. Under this agreement, we licensed
Nickelodeon branded machines and a wide assortment of music. This license will
expire on December 31, 2004 and will not be renewed.
We distribute all of our licensed products through our established
distribution channels, including Best Buy, Circuit City, Costco, JC Penney,
Kohl's, Radio Shack and Sam's Club. Our distribution network also includes the
online versions of these retail customers.
The following table sets forth the percentage of total sales that have
been generated under the MTV License, our Nickelodeon License and our other
licenses (Care Bears, Hard Rock Academy and Universal Music).
FOR THE FISCAL YEAR ENDED
DECEMBER 31,
-----------------------------
2004 2003
------------- -------------
MTV 11.8% 32.3%
Nickelodeon 5.5% 0%
Other Licenses 3.9% 0%
------------- -------------
Total Licensed Sales 21.2% 32.3%
============= =============
DISTRIBUTORSHIP AGREEMENTS
In November 2001, we signed an international distributorship agreement
with Arbiter Group, PLC ("Arbiter"). Arbiter is the exclusive distributor of
Singing Machine(R) karaoke machines and music products in the United Kingdom and
a non-exclusive distributor in all other European countries. The agreement
terminates on December 31, 2004, subject to an automatic renewal provision. If
either party does not give notice on or before December 1 of year during the
term of the agreement, the agreement will automatically be renewed for another
year on the same terms.
In March 2003, we signed an international distributorship agreement with
Top-Toy (Hong Kong) Ltd. Top- Toy is the exclusive distributor of Singing
Machine(R) karaoke machines and music products in Denmark, Norway, Sweden,
Iceland and Faeroe Islands. The agreement is for three years, from April 1, 2003
through March 31, 2006. The agreement contains an automatic renewal provision
whereby if either party does not give notice at least three months before March
31, 2006, the agreement will automatically be renewed for another year on the
same terms.
We also have verbal agreements with six other independent distributors who
sell our products throughout Europe
SALES
As a percentage of total revenues, our net sales in the aggregate to our
five largest customers during the fiscal years ended March 31, 2004, 2003, and
2002, respectively, were approximately 53%, 67% and 87%, respectively. In fiscal
2004, three major customers accounted for 20%, 12% and 10% of our net revenues.
In fiscal 2004, Arbiter, Giochi and Best Buy accounted for more than 10%
of our net revenues. Arbiter and Giochi are independent distributors of our
products. In fiscal 2003 and 2002, Best Buy and Toys "R" Us Inc. each accounted
for more than 10% of our revenues. In fiscal 2003 Target and in fiscal 2002
Costco also accounted for more than 10% of our revenues. Although we have
long-established relationships with all of our customers, we do not have
contractual arrangements with any of them. A decrease in business from any of
our major customers could have a material adverse effect on our results of
operations and financial condition.
39
During the last three years, our revenues from foreign operations have
increased. Sales by customer geographic regions were as follows:
FOR THE FISCAL YEAR ENDED MARCH 31,
--------------------------------------------
2004 2003 2002
------------ ------------- -------------
NORTH AMERICA $ 43,044,496 $ 77,696,780 $ 62,381,366
LATIN AMERICA 753,399 1,366,496 45,073
EUROPE 25,783,789 15,714,846 --
ASIA/AUSTRALIA 959,444 835,644 49,314
------------ ------------- -------------
$ 70,541,128 $ 95,613,766 $ 62,475,753
============ ============= =============
RETURNS
Returns of electronic hardware and music products by our customers are
generally not permitted except in approved situations involving quality defects,
damaged goods, goods shipped in error or goods that are shipped on a consignment
basis. Our policy is to give credit to our customers for the returns in
conjunction with the receipt of new replacement purchase orders. Our total
returns represented 9.4% and 10.4% of our net sales in fiscal 2004 and 2003,
respectively.
DISTRIBUTION
We distribute hardware products to retailers and wholesale distributors
through two methods: shipment of products from inventory held at our warehouse
facilities in Florida and California (domestic sales), and shipments directly
through our Hong Kong subsidiary and manufacturers in Asia of products (direct
sales). Domestic sales, which account for substantially all of our music sales,
are made to customers located throughout the United States from inventories
maintained at our warehouse facilities. In the fiscal year ended March 31, 2004,
approximately 39% of our sales were sales from our domestic warehouses
("Domestic Sales") and 61% were sales shipped directly from Asia ("Direct
Sales").
Domestic Sales. Our strategy of selling products from a domestic warehouse
enables us to provide timely delivery and serve as a "domestic supplier of
imported goods." We purchase karaoke machines overseas from certain factories in
China for our own account, and warehouse the products in leased facilities in
Florida and California. We are responsible for costs of shipping, insurance,
customs clearance, duties, storage and distribution related to such products
and, therefore, warehouse sales command higher sales prices than direct sales.
We generally sell from our own inventory in less than container-sized lots.
Direct Sales. We ship some hardware products sold by us directly to
customers from Asia through International SMC, our subsidiary. Sales made
through International SMC are completed by either delivering products to the
customers' common carriers at the shipping point or by shipping the products to
the customers' distribution centers, warehouses, or stores. Direct sales are
made in larger quantities (generally container sized lots) to customers' world
wide, who pay International SMC pursuant to their own international,
irrevocable, transferable letters of credit or on open account.
40
MANUFACTURING AND PRODUCTION
Our karaoke machines are manufactured and assembled by third parties
pursuant to design specifications provided by us. Currently, we have ongoing
relationships with six factories, located in Guangdong Province of the People's
Republic of China, who assemble our karaoke machines. During fiscal 2005, we
expect that 95% of our karaoke products will be produced by one of these
factories, which has agreed to extend financing to us. We are indebted to this
factory in the amount of $2.4 million and have worked out a payment plan
regarding our outstanding invoice. Additionally, this factory has agreed to
provide us with financing for fiscal year 2005. See "Management's Discussion and
Analysis of Financial Condition - Liquidity" beginning on page 28. We believe
that the manufacturing capacity of our factories is adequate to meet the demands
for our products in fiscal year 2005. However, if our primary factory in China
were prevented from manufacturing and delivering our karaoke products, our
operation would be severely disrupted while alternative sources of supply are
located. See "Risk Factors - We are relying on one factory to manufacture and
produce the majority of our karaoke machines for fiscal 2005" on page 3. In
manufacturing our karaoke related products, these factories use molds and
certain other tooling, most of which are owned by International SMC. Our
products contain electronic components manufactured by other companies such as
Panasonic, Sanyo, Toshiba, and Sony. Our manufacturers purchase and install
these electronic components in our karaoke machines and related products. The
finished products are packaged and labeled under our trademark, The Singing
Machine(R).
We have obtained copyright licenses from music publishers for all of the
songs in our music library. We contract with outside studios on a work-for hire
basis to produce recordings of these songs. After the songs have been recorded,
we author the CD+G's in our in house studio. We use outside companies to
mass-produce the CD+G's and audiocassettes, once the masters have been
completed.
While our equipment manufacturers purchase our supplies from a small
number of large suppliers, all of the electronic components and raw materials
used by us are available from several sources of supply, and we do not
anticipate that the loss of any single supplier would have a material long-term
adverse effect on our business, operations, or financial condition. Similarly,
we use a small number of studios to record our music (including our in house
production), we do not anticipate that the loss of any single studio would have
a material long-term adverse effect on our business, operations or financial
condition. To ensure that our high standards of product quality and factories
meet our shipping schedules, we utilize Hong Kong based employees of
International SMC as our representatives. These employees include product
inspectors who are knowledgeable about product specifications and work closely
with the factories to verify that such specifications are met. Additionally, key
personnel frequently visit our factories for quality assurance and to support
good working relationships.
All of the electronic equipment sold by us is warranted to the end user
against manufacturing defects for a period of ninety (90) days for labor and
parts. All music sold is similarly warranted for a period of 30 days. During the
fiscal years ended March 31, 2004, 2003 and 2002, warranty claims have not been
material to our results of operations.
COMPETITION
Our business is highly competitive. Our major competitors for karaoke
machines and related products are Craig and Memorex.
We believe that competition for karaoke machines is based primarily on
price, product features, reputation, delivery times, and customer support. We
believe that our brand name is well recognized in the industry and helps us
compete in the karaoke machine category. Our primary competitors for producing
karaoke music are Pocket Songs, UAV, Sybersound and Sound Choice. We believe
that competition for karaoke music is based primarily on popularity of song
titles, price, reputation, and delivery times.
In addition, we compete with all other existing forms of entertainment
including, but not limited to, motion pictures, video arcade games, home video
games, theme parks, nightclubs, television and prerecorded tapes, CD's, and
videocassettes. Our financial position depends, among other things, on our
ability to keep pace with changes and developments in the entertainment industry
and to respond to the requirements of our customers. Many of our competitors
have significantly greater financial, marketing, and operating resources and
broader product lines than we do.
41
TRADEMARKS
We have obtained registered trademarks for The Singing Machine name and
the logo in which the microphone is used in our name in the United States and in
the European Community. We have also filed trademark applications in Australia
and Hong Kong. In fiscal 2003, we filed an intent to use application for the
mark Karaoke Vision in the United States.
Our trademarks are a significant asset because they provide product
recognition. We believe that our intellectual property is significantly
protected, but there are no assurances that these rights can be successfully
asserted in the future or will not be invalidated, circumvented or challenged.
COPYRIGHTS AND LICENSES
We hold federal and international copyrights to substantially all of the
music productions comprising our song library. However, since each of those
productions is a re-recording of an original work by others, we are subject to
contractual and/or statutory licensing agreements with the publishers who own or
control the copyrights of the underlying musical compositions. We are obligated
to pay royalties to the holders of such copyrights for the original music and
lyrics of all of the songs in our library that have not passed into the public
domain. We are currently a party to many different written copyright license
agreements.
The majority of the songs in our song library are subject to written
copyright license agreements, oftentimes referred to as synchronization
licenses. Our written licensing agreements for music provide for royalties to be
paid on each song. The actual rate of royalty is negotiable, but typically
ranges from $0.09 to $0.18 per song on each CD that is sold. Similarly, the
terms of the licenses vary, but typically are for terms from two years up to
five years. Our written licenses typically provide for quarterly royalty
payments, although some publishers require reporting on a semi-annual basis.
We currently have compulsory statutory licenses for certain songs in our
song library which are reproduced on audiocassettes. The Federal Copyright Act
creates a compulsory statutory license for all non-dramatic musical works, which
have been distributed to the public in the United States. Royalties due under
compulsory licenses are payable quarterly and are based on the statutory rate.
We also have written license agreements for substantially all of the printed
lyrics, which are distributed with our audiocassettes, which licenses also
typically provide for quarterly payments of royalties at the statutory rate.
GOVERNMENT REGULATION
Our karaoke machines must meet the safety standards imposed in various
national, state, local and provincial jurisdictions. Our karaoke machines sold
in the United States are designed, manufactured and tested to meet the safety
standards of Underwriters Laboratories, Inc. ("ULE") or Electronic Testing
Laboratories ("ETL"). In Europe and other foreign countries, our products are
manufactured to meet the CE marking requirements. CE marking is a mandatory
European product marking and certification system for certain designated
products. When affixed to a product and product packaging, CE marking indicates
that a particular product complies with all applicable European product safety,
health and environmental requirements within the CE marking system. Products
complying with CE marking are now presumed to be safe in 28 European countries.
However, ULE or ETL certification does not mean that a product complies with the
product safety, health and environmental regulations contained in all fifty
states in the U.S. Therefore, we maintain a quality control program designed to
ensure compliance with all applicable U.S. and federal laws pertaining to the
sale of our products. Our production and sale of music products is subject to
federal copyright laws.
The manufacturing operations of our foreign suppliers in China are subject
to foreign regulation. China has permanent "normal trade relations" ("NTR")
status under U.S. tariff laws, which provides a favorable category of U.S.
import duties. China's NTR status became permanent on January 1, 2002, following
enactment of a bill authorizing such status upon China's admission to the World
Trade Organization ("WTO") effective as of December 1, 2001. This substantially
reduces the possibility of China losing its NTR status, which would result in
increasing costs for us.
42
SEASONALITY AND SEASONAL FINANCING
Our business is highly seasonal, with consumers making a large percentage
of karaoke purchases around the traditional holiday season in our fiscal second
and third quarters. These seasonal purchasing patterns and requisite production
lead times cause risk to our business associated with the underproduction or
overproduction of products that do not match consumer demand. Retailers also
attempt to manage their inventories more tightly, requiring that we ship
products closer to the time that retailers expect to sell the products to
consumers. These factors increase the risk that we may not be able to meet
demand for certain products at peak demand times, or that our own inventory
levels may be adversely impacted by the need to pre-build products before orders
are placed. As of March 31, 2004, we had inventory of $5.2 million compared to
inventory of $25.2 million as of March 31, 2003. In fiscal 2003, we
overestimated the demand for our products and as result had $25 million of
excess inventory at year end.
Our financing of seasonal working capital during fiscal 2004 was different
from prior years because of the excess inventory that we had on hand as of March
31, 2003. During fiscal 2004, we purchased approximately $9.1 million of new
inventory and the remainder of our sales were from the liquidation of the excess
inventory on hand. We financed the purchase of new inventory with our short-term
lines of credit in Hong Kong and through financing, with one of our factories in
China.
During fiscal 2005, we plan on financing our inventory purchases by using
credit that has been extended to us by one of our factories in China, by using
our short term lines of credit in Hong Kong and with letters of credit that are
issued by our customers to be used as collateral for payment to our vendors. As
of June 30, 2004, we expect to order an aggregate of approximately $28 million
of inventory during fiscal 2005.
BACKLOG
We ship our products in accordance with delivery schedules specified by
our customers, which usually request delivery within three months of the date of
the order. In the consumer electronics industry, orders are subject to
cancellation or change at any time prior to shipment. We believe that backlog
orders at any given time may not accurately indicate future sales. As of
September 27, 2004, we had backlog of $15.1 million compared to backlog of $20.2
million at the same period in 2003. We believe that we will be able to fill all
of these orders in fiscal year 2005. However, these orders can be cancelled or
modified at any time prior to delivery.
EMPLOYEES
As of September 27, 2004, we employed 42 persons, all of whom are
full-time employees, including three executive officers. Fifteen of our
employees are located at International SMC's corporate offices in Hong Kong. The
remaining 27 employees are based in the United States, including two executive
positions; ten are engaged in warehousing and technical support, and twelve in
accounting, marketing, sales and administrative functions.
43
PROPERTIES
Our corporate headquarters are located in Coconut Creek, Florida in an
18,000 square foot office and warehouse facility, of which 7600 square feet has
been subleased. Our four leases for this office space expire on August 31, 2005.
We have leased 9,393 square feet of office and showroom space in Hong Kong from
which we oversee China based manufacturing operations. Our two leases for this
space in the Ocean Center building expire on April 30, 2005 and May 31, 2005,
respectively.
We have one warehouse facility in Compton California. The Compton
warehouse facility has 79,000 square feet and the lease expires on February 23,
2008. We terminated our lease for warehouse space in Rancho Dominguez,
California effective as of May 1, 2004.
We believe that the facilities are well maintained, in substantial
compliance with environmental laws and regulations, and adequately covered by
insurance. We also believe that these leased facilities are not unique and could
be replaced, if necessary, at the end of the term of the existing leases.
LEGAL PROCEEDINGS
CLASS ACTION AND DERIVATIVE LAWSUIT
From July 2, 2003 through October 2, 2003, eight securities class action
lawsuits and two purported shareholders derivative actions were filed against us
and certain of our officers and directors in the United States District Court
("Court") for the Southern District of Florida on behalf of all persons who
purchased our securities during the various class action periods specified in
the complaints. All of these class action lawsuits were consolidated into one
case styled Frank Bielansky, etc. v. Salberg & Company et al., United States
District Court, Southern District of Florida, Case No. 03-80596-CIV-ZLOCH (the
"Class Action") in September 2003.
The complaints allege violations of Section 10(b) and Section 20(a) of the
Securities Exchange Act of 1934 and Rule 10(b)-5 and allege that certain
officers and directors breached their fiduciary duties and the accountant
committed professional malpractice. The complaints seek compensatory damages,
attorney's fees and injunctive relief.
We entered into a settlement agreement with the plaintiffs in the Class
Action in March 2004. The court entered an order approving the settlement
agreement on August 2, 2004. The settlement was declared final by the court.
Pursuant to the terms of the settlement agreement, we are required to make
a cash payment of $800,000 and Salberg & Company, P.A., our former auditor, is
required to make a payment of $475,000. Our cash payment of $800,000 is covered
by our liability insurance and our insurer has placed this payment in an escrow
account to be released. In addition, we issued 400,000 shares of our common
stock in September 2004. The settlement will also obligate us to implement
certain corporate governance changes, including an expansion of our Board of
Directors to six members with independent directors comprising at least 2/3 of
the total Board seats.
BANKRUPTCY FILING IN FISCAL YEAR 1997
We filed a voluntary petition for relief under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court for the Southern District
of Florida, case number 97-22199-BKC-RBR, on April 11, 1997. On March 17, 1998,
the U.S. Bankruptcy Court confirmed our First Amended Plan of Reorganization. As
of June 10, 1998, our plan has been fully implemented.
OTHER MATTERS
We are involved in various other litigation and legal matters, including
claims related to intellectual property, product liability which we are
addressing or defending in the ordinary course of business. Management believes
that any liability that may potentially result upon resolution of such matters
will not have a material adverse effect on our business, financial condition or
results of operation.
44
In September 2003, we had a disagreement with AG Edwards & Sons, Inc., an
investment banker ("AG Edwards") regarding our investment banking agreement with
it. We believed that AG Edwards had waived its right of first refusal to assist
us in raising capital in a private offering and retained Roth Capital Partners,
LLC to raise $4 million in the convertible debenture offering. However, AG
Edwards did not believe that it had waived its right of first refusal and took
the position that we had breached the terms of our investment banking agreement
with it. Although we believe that our position is correct and AG Edwards had
waived its right of first refusal, for business reasons we decided to settle
this potential claim. We entered into a settlement agreement with AG Edwards on
November 17, 2003 in which we agreed to pay the sum of $181,067 over a six month
period. We were deemed to have paid $94,355 of this amount by issuing 40,151
shares of our common stock to AG Edwards.
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND SIGNIFICANT EMPLOYEES
The following table sets forth certain information with respect to our
executive officers, directors and significant employees as of September 27,
2004.
NAME Age Position
----------------- --- -------------------------------------
Yi Ping Chan 40 Interim CEO, Chief Operating Officer,
Director, Secretary
Jeff Barocas 40 Chief Financial Officer
Josef A. Bauer 65 Chairman
Harvey Judkowitz 58 Director
Bernard Appel 72 Director
Yi Ping Chan has served as our Chief Operating Officer from May 2, 2003
and as our Interim Chief Executive Officer since October 17, 2003. Prior to this
appointment, Mr. Chan was a consultant to Singing Machine. Mr. Chan was a
founder and general partner of MaxValue Capital Ltd., a Hong Kong-based
management consulting and investment firm, and co-founder and director of E
Technologies Ltd., Hong Kong, which specialized in health care technology
transfer from April 1996 to March 2003. Prior to that, he was Chief Strategist
and Interim Chief Financial Officer from January 2000 to June 2002 of a Hong
Kong-based IT and business process consulting firm with operations in Hong Kong,
China and the U.S. He also held a senior management position with a Hong
Kong-based venture capital and technology holding company with operations in
Hong Kong, China and the U.S. Mr. Chan earned an MBA in 1994 and a MSEE in 1990
from Columbia University, and a BSEE with Magna Cum Laude in 1987 from
Polytechnic University, New York.
Jeff Barocas has served as our Chief Financial Officer from April 9, 2004
through the present date. Prior to joining our company, Mr. Barocas was Chief
Financial Officer at Biometrics Security Technology, Inc., a Florida based
security software developer where he was responsible for all administrative
functions, purchasing, financial and SEC reporting and new business development
for Latin America and the Caribbean. From 1996 to 2002, he was Chief Financial
Officer at Quipp, Inc., a Florida based manufacturer of automated capital
equipment for the newspaper industry. From 1986 to 1995, he was Chief Financial
Officer at London International US Holdings, a Sarasota, Florida consumer
products and medical products company where he managed all financial,
information systems and material procurements activities.
Josef A. Bauer has served as a director from October 15, 1999. Mr. Bauer
previously served as a director of the Singing Machine from February 1990 until
September 1991 and from February 1995 until July 1997, when we began our Chapter
11 proceeding. Mr. Bauer presently serves as the Chief Executive Officer of the
following three companies: Banisa Corporation, a privately owned investment
company, since 1975; Trianon, a jewelry manufacturing and retail sales companies
since 1978 and Seamon Schepps, also a jewelry manufacturing and retail sales
company since 1999.).
Bernard S. Appel has served as a director since October 31, 2003. He spent
34 years at Radio Shack, beginning in 1959. At Radio Shack, he held several key
merchandising and marketing positions and was promoted to the positions of
President in 1984 and to Chairman of Radio Shack and Senior Vice President of
Tandy Corporation in 1992. Since 1993 through the present date, Mr. Appel has
operated the private consulting firm of Appel Associates, providing companies
with merchandising, marketing and distribution strategies, creative line
development and domestic and international procurement.
45
Harvey Judkowitz has served as a director since March 29, 2004 and is the
Chairman of our Audit Committee. He is licensed as a Certified Public Accountant
in New York and Florida. From 1988 to the present date, Mr. Judkowitz has
conducted his own CPA practices. He currently serves as the Chairman and Chief
Executive Officer of UniPro Financial Services, a diversified financial services
company. He also sits on the Board of Directors and serves as the Chair of the
Audit Committee of the following public companies: Global Business Services,
Inc., Pony Express USA, Intelligent Motor Cars, Inc. and Kirshner Entertainment
& Technologies, Inc. He currently serves as the Interim Chief Financial Officer
of Kirshner Entertainment & Technologies, Inc.
BOARD COMMITTEES
We have an audit committee, an executive compensation/stock option
committee and a nominating committee. As of September 27, 2004, the audit
committee consists of Messrs. Judkowitz, Appel and Bauer. The Board has
designated Mr. Judkowitz as the "audit committee financial expert," as defined
by Item 401(h) of Regulation S-K of the Securities Exchange Act of 1934. The
Board has determined that Harvey Judkowitz and Bernard Appel are "independent
directors" within the meaning of the listing standards of the American Stock
Exchange. The audit committee recommends the engagement of independent auditors
to the board, initiates and oversees investigations into matters relating to
audit functions, reviews the plans and results of audits with our independent
auditors, reviews our internal accounting controls, and approves services to be
performed by our independent auditors. The executive compensation/stock option
committee consists of Messrs. Judkowitz, Appel and Bauer.
The executive compensation/stock option committee considers and authorizes
remuneration arrangements for senior management and grants options under, and
administers our employee stock option plan. The entire Board of Directors
operates as a nominating committee. The nominating committee is responsible for
reviewing the qualifications of potential nominees for election to the Board of
Directors and recommending the nominees to the Board of Directors for such
election.
CODE OF ETHICS
We have adopted a Code of Business Conduct and Ethics, which is applicable
to all directors, officers and employees of the Singing Machine, including our
principal executive officer, our principal financial officer, our principal
accounting officer or controller or other persons performing similar functions.
The Code of Ethics is available on our website at www.singingmachine.com and is
filed as Exhibit 14.1 to our Annual Report on Form 10-K for the fiscal year
ended March 31, 2004. We intend to post amendments to our Code of Ethics (to the
extent applicable to our chief executive officer, principal financial officer,
principal accounting officer or controller or other persons performing similar
functions) on our website.
DIRECTOR'S COMPENSATION
During fiscal 2004, our employee directors did not receive any additional
or special compensation for serving as directors. During fiscal 2004, our
compensation package for our non-employee directors consisted of grants of stock
options and reimbursement of costs and expenses associated with attending our
Board meetings. Our three non-employee directors during fiscal 2003 were Josef
A. Bauer, Bernard Appel and Richard Ekstract. Effective as of February 26, 2004,
we granted each of our non-employee directors options under our Year 2001 Stock
Option Plan to purchase 20,000 shares of our common stock. The options have an
exercise price of $1.30 per share and vest over a three year period beginning on
February 26, 2005. These options expire five years after their vesting date.
o During fiscal 2005, we will implement the following compensation
policy for our directors.
o Each non-employee director will receive an annual retainer of
$10,000, with $7,500 to be paid in cash and $2,500 to be paid in
stock, based at the closing price of our common stock on the date of
the annual shareholder's meeting or any other date selected by the
Board.
46
o Each non-employee director will also receive an initial stock option
grant for 20,000 shares upon joining our Board of Directors and each
continuing non-employee director will receive an annual stock option
grant for 20,000 shares for each additional year served on the Board
which will be awarded on the anniversary date of the Board member's
initial grant.
o Each non-employee director will be reimbursed for all reasonable
expenses incurred in attending Board meetings and will receive a fee
of $500 for each Board or committee meeting attended.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
To our knowledge, based solely on a review of the copies of such reports
furnished to the Company and written representations that no other reports were
required, the Company believes that during the year ended March 31, 2004, its
officers, directors and 10% shareholders complied with all Section 16(a) filing
requirements except for the following transactions. Mr. Bauer and Mr. Steele
each filed two Form 4's late in which reported on transaction in each late Form
4. Mr. Steele also filed three amendment to his Form 4 filings to correct
typographical errors. Mr. Ekstract file four Form 4's late in which he reported
5 transactions late. Mr. Chan filed one Form 4 late in which he failed to report
one transaction. The Company's former officers and a former director (Jack
Dromgold, April Green and Howard Moore) each filed one Form 4 late which
reported on transaction in each late Form 4 and Mr. Dahl, a former officer,
filed his Form 3 late.
EXECUTIVE COMPENSATION
The following table sets forth certain compensation information for the
fiscal years ended March 31, 2004, 2003 and 2002 with regard to (i) Yi Ping
Chan, our Interim Chief Executive Officer and Chief Operating Officer, from
October 17, 2003 through the present date, (ii) Robert Weinberg, our Chief
Executive Officer from July 23, 2003 through October 17, 2003 and (iii) Edward
Steele, our Chief Executive Officer from June 1991 through July 23, 2003, and
each of our other executive officers whose compensation exceeded $100,000 on an
annual basis (the "Named Officers"):
47
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM COMPENSATION
------------------------------ --------------------------------
OTHER SECURITIES
NAME OF INDIVIDUAL AND ANNUAL UNDERLYING ALL OTHER
PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION(1) OPTIONS/SAR'S COMPENSATION(2)
----------------------------- ----- ---------- --------- --------------- ------------- --------------
Yi Ping Chan 2004 $ 247,470(4) -- $ 6,000 52,800 $ 12,180
Interim Chief Executive
Officer and
Chief Operating Officer(3)
Edward Steele 2004 $ 378,809(4) -- $ 6,000 10,000 $ 17,949
Former Chief Executive 2003 $ 382,352 -- $ 8,671 30,000 $ 17,969
Officer (5) 2002 $ 364,145 $ 192,133 $ 8,258 15,000 $ 17,908
April J. Green 2004 $ 127,642 -- $ 3,600 4,380 $ 5,094
Chief Financial Officer(6) 2003 $ 122,200 $ 25,000 $ 3,900 20,000 $ 13,551
2002 $ 88,825 $ 25,000 $ 3,900 30,000 $ 7,091
John Dahl 2004 $ 78,834 -- $ 1,200 50,000 $ 350
Senior Vice President of
Finance(7)
John Klecha 2004 $ 41,480 -- $ 1,000 0 $ 189,911(9)
Former Chief Operating 2003 $ 300,117 -- $ 6,555 24,000 $ 13,264
Officer (8) 2002 $ 286,111 $ 157,200 $ 6,242 15,000 $ 11,725
Jack Dromgold 2004 $ 183,266(4) -- $ 4,500 50,000 $ 110,622(11)
Former Vice President of 2003 $ 210,277 $ 50,000 $ 51,067 100,000 $ 154,072(12)
Sales
and Marketing(10) 2002 -- -- -- -- --
Robert Weinberg 2004 $ 57,692 -- 3,000(14) -- --
Former Chief Executive
Officer(13)
----------
(1) The amounts disclosed in this column for fiscal 2004, 2003 and 2002
include automobile expense allowances.
(2) Includes matching contributions under our 401(k) savings plan, medical
insurance pursuant to the executive's employment agreement and other
expenses described herein.
(3) Mr. Chan became our Interim Chief Executive Officer on October 17, 2004.
(4) Effective as of August 1, 2003, Mr. Chan, Mr. Dromgold and Mr. Steele
agreed to take 15% of their annual compensation in the form of stock for a
nine month period until March 31, 2004 (except Mr. Steele's agreement was
for an 8 month period until February 28, 2004 when his employment
agreement expired). During their respective time periods, Mr. Chan, Mr.
Dromgold and Mr. Steele received compensation in the amount of $20,125,
$17,535 and $63,136 in shares of the Singing Machine's common stock. The
average trading that was used to calculate the number of shares that would
be issued to each officer was $3.85 per share.
(5) Mr. Steele served as our Chief Executive Officer from September 1991
through July 23, 2003. He currently serves as our Senior Advisor and
Director of Product Development.
(6) Ms. Green served as our Chief Financial Officer from March 15, 2002
through April 9, 2004.
48
(7) Mr. Dahl served as our Senior Vice President of Finance from October 22,
2003 through April 13, 2003.
(8) Mr. Klecha served as our Chief Operating Officer from June 28, 1999
through May 2, 2003.
(9) Amounts paid to Mr. Klecha pursuant to his separation an release agreement
were $183,703 and $36,204 for medical insurance and matching 401(k)
contributions.
(10) Mr. Dromgold joined us on April 15, 2002 and resigned on December 16,
2003.
(11) Amounts paid to Mr. Dromgold pursuant to his separation and release
agreement were $104,640 and our matching 401(k) contributions and medical
insurance were $4,582.
(12) Includes relocation expenses of $45,529, our matching contribution of
$8,543 under our 401(k) savings plan and medical insurance at a $100,000
value contributed to option granted to Mr. Dromgold and $60,565 paid to
Mr. Dromgold pursuant to his separation and release agreement.
(13) Mr. Weinberg served as our Chief Executive Officer from July 23, 2003 to
October 12, 2004.
(14) Represents three months of rent paid for Mr. Weinberg's apartment in
Florida.
OPTION GRANTS IN FISCAL 2004
The following table sets forth information concerning all options granted
to our officers and directors during the year ended March 31, 2004. No stock
appreciation rights ("SAR's") were granted.
POTENTIAL REALIZABLE VALE AT
SHARES TOTAL OPTIONS ASSUMED ANNUAL RATES OF STOCK PRICE
UNDERLYING GRANTED TO APPRECIATION FOR OPTION TERM
OPTIONS EMPLOYEES IN EXERCISE PRICE EXPIRATION -----------------------------------
GRANTED (1) FISCAL YEAR PER SHARE DATE 5% 10%
---------- ------------- -------------- ------------- -------------- ----------------
Yi Ping Chan 52,800 3.3% $ 1.97 12/18/14 $ 169,431 $ 269,791
Edward Steele 10,000 .6% $ 1.97 12/18/14 $ 32,089 $ 51,097
April J. Green 4,380 .3% $ 1.97 12/18/14 $ 14,055 $ 22,380
John Dahl 50,000 3.1% $ 1.97 12/18/14 $ 160,446 $ 255,484
John Klecha -- -- -- -- -- --
Jack Dromgold 50,000 3.1% $ 7.60 Cancelled(3) -- --
Robert Weinberg -- -- -- -- -- --
--------------
(1) All of these options were granted under a Year 2001 Stoc Option Plan. The
Options granted to Mr. Steele, Ms. Green, Mr. Dahl and Mr. Dromgold vest
in five equal installments over a period of five years, beginning on
December 13, 2004 (except Mr. Dromgold's vesting began on April 15, 2004).
Mr. Chan's options vest in (except Mr. Chan's options vest in 3 equal
installments over a 3 year period).
(2) The dollar amounts under these columns are the result of calculations
based on the market price on the date of grant at an assumed annual rate
of appreciation over the maximum term of the option at 5% and 10% as
required by applicable regulations of the SEC and, therefore, are not
intended to forecast possible future appreciation, if any of the common
stock price. Assumes all options are exercised at the end of their
respective terms. Actual gains, if any, on stock option exercises depend
on the future performance of the common stock.
(3) Mr. Dromgold received a grant of 50,000 options on April 15, 2003. These
options expired on March 18, 2004, ninety days after Mr. Dromgold resigned
from our company.
49
AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED MARCH 31, 2004 AND OPTION
VALUES
The following table sets forth information as to the exercise of stock
options during the fiscal year ended March 31, 2004 by our officers listed in
our Summary Compensation Table and the fiscal year-end value of unexercised
options.
NUMBER OF VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS AT
AT FISCAL YEAR END FISCAL YEAR END (2)
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME OF INDIVIDUAL UPON EXERCISE REALIZED (1) UNEXERCISABLE UNEXERCISABLE
-------------------- --------------- ------------ ------------------- -----------------------
Yi Ping Chan -- -- 50,000/152,800 0/0
Edward Steele -- -- 322,500/10,000 0/0
April Green -- -- 30,000/19,380 0/0
John Dahl -- -- 0/50,000 0/0
John Klecha -- -- 0/0 0/0
Jack Dromgold -- -- 0/0 0/0
Robert Weinberg -- -- 0/0 0/0
EMPLOYMENT AGREEMENTS
YI PING CHAN. Effective as of May 2, 2003, we entered into a three year
employment agreement with Yi Ping Chan, our current Chief Operating Officer. Mr.
Chan is entitled to receive an annual salary equal to $250,000 per year, plus
bonuses and increases in his annual salary at the sole discretion of our Board
of Directors. We agreed to grant Mr. Chan options to purchase 150,000 shares of
our common stock of which 50,000 options will vest each year and to reimburse
him for moving expenses of up to $40,000. We granted Mr. Chan options to
purchase 150,000 shares of our common stock, in July 2003. In the event of a
termination of his employment following a change of control, Mr. Chan would be
entitled to a lump sum payment of 100% of the amount of his total compensation
in the twelve months preceding such termination. During the term of his
employment agreement and for a period of two years after his termination for
cause and one year if he is terminated without cause, Mr. Chan cannot directly
or indirectly compete with our company in the karaoke industry in the United
States.
EDWARD STEELE. On February 27, 2004, we extended our employment agreement
with Edward Steele for another year. Mr. Steele will serve as the Director of
Product Development for a one year period to expire on February 28, 2005. Under
his employment agreement, Mr. Steele is entitled to receive annual compensation
of $250,000 per year; however, Mr. Steele has agreed to take a 20% pay cut so
his base salary is $200,000 per year. The agreement also provides for
discretionary bonuses. In the event of a termination of his employment following
a change of control, Ms. Steele would be entitled to a lump sum payment of 50%
of the amount of his total compensation in the twelve months preceding such
termination. During the term of his employment agreement and for a period of one
year after his termination for cause, Mr. Steele cannot directly or indirectly
compete with our company in the karaoke industry in the United States.
SEPARATION AND CONSULTING AGREEMENTS
APRIL J. GREEN. Ms. Green resigned as our Chief Financial Officer
effective as of April 9, 2004. In connection with her resignation, we entered
into a separation and release agreement with Ms. Green. Under this agreement, we
agreed to provide Ms. Green with a severance payment equal to $115,519, which
consisted of (1) salary payments in the amount of $100,000, (ii) a COBRA
reimbursement payment equal to $6,600 and (iii) payments for accrued vacation
time equal to $4,153 over a nine month period. In exchange, Ms. Green agreed to
release the Singing Machine from any liability in connection with the
termination of her employment.
JOHN DAHL. Mr. Dahl resigned as our Senior Vice President of Finance
effective as of April 13, 2004. In connection with his resignation, we entered
into a separation and release agreement with Mr. Dahl. Under this agreement, we
agreed to provide Mr. Dahl with a severance payment equal to $51,050, which
consisted of (i) salary payments in the amount of $39,000, (ii) moving expenses
equal to $11,000 and (iii) COBRA reimbursement payments equal to $1,050 over a
five month period. In exchange, Mr. Dahl agreed to release the Singing Machine
from any liability in connection with the termination of his employment.
50
JACK DROMGOLD. Mr. Dromgold resigned as our Executive Vice President of
Sales, effective as of December 16, 2003. In connection with his resignation, we
entered into a separation and release agreement with him. Under this agreement,
we agreed to provide Mr. Dromgold with a payment equal to $161,939, which
consisted of (i) $50,000 in cash to be paid on December 16, 2003 (ii) $109,281
to be paid over a six month period and (iii) three months of COBRA reimbursement
payments. In exchange, Mr. Dromgold agreed to release the Singing Machine from
any liability in connection with the termination of his employment. We also
entered into a consulting agreement with Mr. Dromgold on December 16, 2003 to
provide us with consulting relating to our sales and marketing efforts for a
sixty day period. We amended this agreement on April 27, 2004 and issued 50,000
shares of our common stock to Mr. Dromgold.
JOHN KLECHA. Mr. Klecha resigned as our Chief Operating Officer and
President, effective as of May 2, 2003. In connection with his resignation, we
entered into a separation and release agreement. Under this agreement, we agreed
to provide Mr. Klecha with a severance payment equal to $183,707, which
consisted of (i) salary and auto allowance through May 31, 2003, (ii) four weeks
of accrued vacation time, (iii) four months of salary and automobile allowance
payments and (iv) seven months COBRA reimbursement payments. In exchange, Mr.
Klecha agreed to release the Singing Machine from any liability in connection
with the termination of his employment.
EQUITY COMPENSATION PLANS AND 401(K) PLAN
We have two stock option plans: our 1994 Amended and Restated Stock Option
Plan ("1994 Plan") and our Year 2001 Stock Option Plan ("Year 2001 Plan"). Both
the 1994 Plan and the Year 2001 Plan provide for the granting of incentive stock
options and non-qualified stock options to our employees, officers, directors
and consultants As of September 27, 2004, we had 330,300 options issued and
outstanding under our 1994 Plan and 619,190 options are issued and outstanding
under our Year 2001 Plan.
The following table gives information about equity awards under our 1994
Plan and the Year 2001 Plan.
WEIGHTED-AVERAGE NUMBER OF SECURITIES
NUMBER OF SECURITIES EXERCISE PRICE OF REMAINING AVAILABLE FOR EQUITY
TO BE ISSUED UPON OUTSTANDING COMPENSATION PLANS
EXERCISE OF OUTSTANDING OPTIONS, WARRANTS (EXCLUDING SECURITIES IN
PLAN CATEGORY OPTION, WARRANTS AND RIGHTS AND RIGHTS COLUMN (A))
------------------------------ --------------------------- ----------------- -------------------------------
Equity Compensation Plans
approved by
Security Holders 949,490 $ 3.95 1,268,810
Equity Compensation Plans
Not approved by
Security Holders 0 0 0
1994 PLAN
Our 1994 Plan was originally adopted by our Board of Directors in May 1994
and it was approved by our shareholders on June 29, 1994. Our shareholders
approved amendments to our 1994 Plan in March 1999 and September 2000. The 1994
Plan reserved for issuance up to 1,950,000 million share of our common stock
pursuant to the exercise of options granted under the Plan. As of March 31,
2003, we had granted all the options that are available for grant under our 1994
Plan. As of March 31, 2004, we have 358,700 options issued and outstanding under
the 1994 Plan and all of these options are fully vested as of March 31, 2004.
YEAR 2001 PLAN
On June 1, 2001, our Board of Directors approved the Year 2001 Plan and it
was approved by our shareholders at our special meeting held September 6, 2001.
The Year 2001 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. The Year 2001 Plan authorizes an aggregate of 1,950,000 shares of the
Company's common stock and a maximum of 450,000 shares to any one individual in
any one fiscal year. The shares of common stock available under the Year 2001
Plan are subject to adjustment for any stock split, declaration of a stock
dividend or similar event
51
The Year 2001 Plan is administered by our Stock Option Committee
("Committee"), which consists of two or more directors chosen by our Board. The
Committee has the full power in its discretion to (i) grant options under the
Year 2001 Plan, (ii) determine the terms of the options (e.g., vesting, exercise
price), (iii) to interpret the provisions of the Year 2001 Plan and (iv) to take
such action as it deems necessary or advisable for the administration of the
Year 2001 Plan.
Options granted to eligible individuals under the Year 2001 Plan may be
either incentive stock options ("ISO's"), which satisfy the requirements of Code
Section 422, or nonstatutory options ("NSO's"), which are not intended to
satisfy such requirements. Options granted to outside directors, consultants and
advisors may only be NSO's. The option exercise price will not be less than 100%
of the fair market value of the Company's common stock on the date of grant.
ISO's must have an exercise price greater to or equal to the fair market value
of the shares underlying the option on the date of grant (or, if granted to a
holder of 10% or more of our common stock, an exercise price of at least 110% of
the under underlying shares fair market value on the date of grant). The maximum
exercise period of ISO's is ten years from the date of grant (or five years in
the case of a holder with 10% or more of our common stock). The aggregate fair
market value (determined at the date the option is granted) of shares with
respect to which an ISO are exercisable for the first time by the holder of the
option during any calendar year may not exceed $100,000. If that amount exceeds
$100,000, our Board of the Committee may designate those shares that will be
treated as NSO's.
Options granted under the Year 2001 Plan are not transferable except by
will or applicable laws of descent and distribution. Except as expressly
determined by the Committee, no option shall be exercisable after thirty (30)
days following an individual's termination of employment with the Company or a
subsidiary, unless such termination of employment occurs by reason of such
individual's disability, retirement or death. The Committee may in its sole
discretion, provide in a grant instrument that upon a change of control (as
defined in the Year 2001 Plan) that all outstanding option issued to the grantee
shall automatically, accelerate and become full exercisable. Additionally, the
obligations of the Company under the Year 2001 Plan are binding on (1) any
successor corporation or organization resulting from the merger, consolidation
or other reorganization of the Company or (2) any successor corporation or
organization succeeding to all or substantially all of the assets and business
of the Company. In the event of any of the foregoing, the Committee may, at its
discretion, prior to the consummation of the transaction, offer to purchase,
cancel, exchange, adjust or modify any outstanding options, as such time and in
such manner as the Committee deems appropriate.
401(K) PLAN
Effective January 1, 2001, we adopted a voluntary 401(k) plan. All
employees with at least one year of service are eligible to participate in our
401(k) plan. In fiscal 2002, we made a matching contribution of 100% of salary
deferral contributions up to 3% of pay, plus 50.369% of salary deferral
contributions from 3% to 5% of pay for each payroll period. The amounts charged
to earnings for contributions to this plan and administrative costs during the
years ended March 31, 2004, 2003 and 2002 totaled approximately $55,402, $61,466
and $41,733, respectively.
CERTAIN TRANSACTIONS
On July 14, 2004, Josef A. Bauer, a director, advanced a short-term loan
of $200,000 to us which we are to use to meet our working capital obligations.
The interest rate on the loan is 8.5% per annum and the loan is payable on
demand. On August 26, 2004, we repaid Mr. Buaer a total of $202,109, including
$2,109 in interest.
In June 2004, Edward Steele, former officer and director, advanced $40,000
to us. The loan was interest fee and paid in full on August 30, 2004.
On or about July 10, 2003, certain officers and directors of our company
advanced $1 million to our company pursuant to written loan agreements. The
officer was Yi Ping Chan and the directors were Josef A. Bauer and Howard Moore.
Mr. Moore resigned from our Board, effective as October 17, 2003. Additionally,
Maureen LaRoche, a business associate of Mr. Bauer, participated in the
financing. These loans bear interest at the rate of 9.5% per annum. These loans
were subordinated to Milberg's factoring agreement, which we terminated
effective as of July 14, 2004. The Board has not yet determined when these loans
will be repaid.
52
On or about March 4, 2003, Josef A. Bauer, a director, advanced $400,000
to International SMC pursuant to a letter agreement, which used the funds to
make an advance to a vendor for the purchase of raw materials for the production
of our machines. We were to repay Mr. Bauer's loan in two months on or about May
4, 2003 and the loan bore interest at the rate of 8% per annum. We repaid
$200,000 on the loan on or about May 4, 2003 and the remaining balance was paid
on or about October 10, 2003.
We believe that of all of these related party transactions described above
are on terms that are as favorable as terms that we could have obtained from
unrelated third parties.
PRINCIPAL STOCKHOLDERS
The following table set forth as of September 27, 2004, certain
information concerning beneficial ownership of our common stock by:
o all directors of the Singing Machine;
o all executive officers of the Singing Machine; and
o persons known to own more than 5% of our common stock.
Unless otherwise indicated, the address for each person is The Singing
Machine Company, Inc., 6601 Lyons Road, Building A-7, Coconut Creek, Florida
33073. As of September 27, 2004, we had 9,202,318 shares of our common stock
issued and outstanding.
As used herein, the term beneficial ownership with respect to a security
is defined by Rule 13d-3 under the Securities Exchange Act of 1934 as consisting
of sole or shared voting power (including the power to vote or direct the vote)
and/or sole or shared investment power (including the power to dispose or direct
the disposition of) with respect to the security through any contract,
arrangement, understanding, relationship or otherwise, including a right to
acquire such power(s) during the next 60 days. Unless otherwise noted,
beneficial ownership consists of sole ownership, voting and investment rights.
SHARES OF PERCENT OF
COMMON STOCK COMMON STOCK
------------ ------------
Yi Ping Chan
Interim Chief Executive Officer and Chief
Operating Officer 67,652(1) *
Jeff Barocas
Chief Financial Officer 0 *
Joseph Bauer
Chairman 1,065,471(2) 11.58%
Bernard Appel
Director 0 *
Harvey Judkowitz
Director 0 *
John Klecha 810,811(3) 8.81%
Edward Steele 1,050,510(4) 11.42%
Former Officer and Director
Wellington Management Company, LLP 939,400(5) 10.21%
All Directors and Executive Officers as a Group 1,118,162(6) 12.15%
53
----------
* Less than 1%.
(1) Includes 50,000 shares issuable upon the exercise of stock options that
are exercisable within 60 days of September 27, 2004.
(2) Includes 11,197 shares held by Mr. Bauer individually, 200,000 shares held
by Mr. Bauer's wife, 180,374 shares held by Mr. Bauer and his wife
jointly, 369,400 shares held by Mr. Bauer's pension account, 274,500
shares held in Mr. Bauer Family United Partnership and 30,000 share
issuable upon the exercise of stock options that can be exercisable within
60 days of September 27, 2004.
(3) All of the information presented in this item with respect to Mr. Klecha's
beneficial ownership were extracted solely from his Amendment No. 2 to his
Schedule 13D filed on October 20, 2003.
(4) Includes 503,200 shares which are held by Mr. Steele directly, 209,810
shares which are held by Mr. Steele's wife and 342,500 shares issuable
upon the exercise of stock options that are exercisable within 60 days of
September 27, 2004.
(5) The address of Wellington Management Company, LLP is 75 State Street,
Boston, Massachusetts. All of the information presented in this item with
respect to this beneficial ownership was extracted solely from their
Schedule 136 filed on February 12, 2004.
(6) Includes 80,000 shares issuable upon the exercise of stock options that
are exercisable within 60 days of September 27, 2004.
DESCRIPTION OF SECURITIES
We are authorized to issue:
o 18,900,000 shares of common stock;
o 100,000 shares of Class A common stock; and
o 1,000,000 shares of convertible preferred stock.
As of September 27, 2004, we have 9,202,318 shares of our common stock
issued and outstanding and no shares of Class A common stock or convertible
preferred stock are issued and outstanding.
COMMON STOCK
We are authorized to issue up to 18,900,000 shares of our common stock,
par value $0.01 per share. The holders of our common stock are entitled to one
vote for each share held of record on all matters to be voted on by
stockholders. There is no cumulative voting with respect to the election of
directors, with the result that the holders of more than 50% of the shares voted
for the election of directors can elect all of the directors. The holders of our
common stock are entitled to receive dividends when, as and if declared by the
Board of Directors out of funds legally available. In the event of liquidation,
dissolution or winding up of the Company, the holders of our common stock are
entitled to share ratably in all assets remaining available for distribution to
them after payment of liabilities and after provision has been made for each
class of stock, if any, having preference over the common stock. Holders of
shares of common stock, as such, have no conversion, preemptive or other
subscription rights, and, except as noted herein, there are no redemption
provisions applicable to the common stock. All of the outstanding shares of
common stock are validly issued, fully paid and nonassessable.
CLASS A COMMON STOCK
Our Certificate of Incorporation authorizes the issuance of 100,000 shares
of Class A Common Stock, par value $0.01 per share. In connection with our
public offering in 1994, all issued shares of our Class A common stock were
converted into shares of our common stock. We do not plan on issuing any shares
of our Class A common stock and will delete this provision from our Certificate
of Incorporation when we file the next amendment to our Certificate of
Incorporation, which will be at our next shareholder's meeting.
54
CONVERTIBLE PREFERRED STOCK
Our Board of Directors has the authority, without further action by our
stockholders, to issue up to 1,000,000 shares of our preferred stock, par value
$1.00 per share, in one or more series and to fix the rights, preferences,
privileges and restrictions thereof. In April 1999, we authorized the issuance
of 1,000,000 shares of our convertible preferred stock in connection with a
private offering of our units. All of these shares of convertible preferred
stock were converted into shares of our common stock automatically on April 1,
2000.
We do not plan on issuing any shares of our convertible preferred stock in
the near future and will delete this provision from our Certificate of
Incorporation when we file the next amendment to our Certificate of
Incorporation, which will be at our next shareholder's meeting.
ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS OF OUR ARTICLES OF INCORPORATION,
BYLAWS AND DELAWARE LAW
Certain provisions of our amended certificate of incorporation, bylaws and
Delaware law, which are summarized below, may be deemed to have an anti-takeover
effect and may delay, defer or prevent a tender offer or takeover attempt that a
stockholder might consider in its best interest, including those attempts that
might result in a premium over the market price for the shares held by
stockholders.
CUMULATIVE VOTING
Our amended certificate of incorporation does not permit our stockholders
the right to cumulate votes in the election of directors.
SPECIAL MEETING OF STOCKHOLDERS
Our bylaws provided that special meetings of our stockholders may only be
called by (1) resolution of the Board or the president or (2) the president or
the secretary upon the written request (stating the purpose of the meeting) of a
majority of the directors then in office or the holders of a majority of the
outstanding shares entitled to vote.
AUTHORIZED BUT UNISSUED SHARES
The authorized but unissued shares of common stock are available for
future issuance without stockholder approval. These additional shares may be
utilized for a variety of corporate purposes, including public or private
offerings to raise capital, corporate acquisitions and employee benefit plans.
The existence of authorized but unissued shares of common stock could render
more difficult or discourage an attempt to obtain control of us, by means of a
proxy contest, tender offer, merger or otherwise.
LIMITATIONS ON LIABILITY AND INDEMNIFICATION MATTERS
We have adopted provisions in our amended certificate of incorporation and
bylaws that limit the liability of our directors to the fullest extent permitted
by the by the Delaware General Corporation Law. Pursuant to such provisions, no
director will be liable to the Company or its stockholders for monetary damages
for breaches of certain fiduciary duties as a director of the Company. The
limitation of liability will not affect a director's liability for (1) a breach
of the director's duty of loyalty to the Company or its stockholders, (2) an act
or omission not in good faith or that involves intentional misconduct or a
knowing violation of the law, (3) any unlawful distributions, or (4) a
transaction from which the director receives an improper personal benefit. The
limitation of liability also will not affect the availability of equitable
remedies such as injunctive relief or rescission.
Our amended certificate of incorporation and bylaws require us to
indemnify our officers and directors to the fullest extent permitted by Delaware
law. We have entered into indemnification agreements with each of our directors
and executive officers. These agreements, among other things, indemnify our
directors and executive officers for certain expenses, judgments, fines and
settlement amounts incurred by them in any action or proceeding, including any
action by or in the right of the Company, arising out of the person's services
as a director or executive officer of the Company or any other company or
enterprise to which the person provides services at our request. We believe that
these provisions and agreements are necessary to attract and retain qualified
directors and executive officers.
55
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to our directors, officers and controlling person based on
the foregoing provisions, we have been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
and is, therefore, unenforceable.
DELAWARE LAW
Under Delaware law, a corporation may not engage in any "business
combination" (as defined in the Delaware General Corporation Law) with an
"interested stockholder" for three years after such stockholder becomes an
interested stockholder. An interested stockholder is any person who is the
beneficial owner of 15% or more of the outstanding voting stock of the
corporation. A corporation may enter into a business combination with an
interested stockholder if:
(a) the Board of Directors approves either the business combination or
the transaction which resulted in the stockholder becoming an
interested stockholder before the date on which the stockholder
becomes an interested stockholder;
(b) upon consummation of the transaction resulting in the stockholder
reaching the 15% threshold, the stockholder owned 85% of the
outstanding voting shares at the time the transaction commenced,
excluding those shares held by directors who are also officers or
employee stock plans in which the participants do not have the right
to determine confidentially whether shares subject to the plan will
be tendered in a tender or exchange offer; or
(c) on or subsequent to becoming an interested stockholder, the business
combination is approved by the Board of Directors and is authorized
at a meeting by the affirmative vote of at least two-thirds of the
outstanding voting stock not owned by the interested stockholder.
TRANSFER AGENT
The transfer agent for our common stock is Continental Stock Transfer &
Trust Co., 2 Broadway, New = York, New York 10004.
SHARES ELIGIBLE FOR FUTURE SALE
As of September 27, 2004, we have 9,202,318 shares of our common stock
issued and outstanding. If the 4,634,067 shares registered in this Prospectus
are issued, we will have 13,836,385 shares issued and outstanding. Of these
shares, all of the 4,634,067 shares registered in this offering will be freely
tradeable without restriction or further registration under the Securities Act,
unless such shares are purchased by "affiliates" as that term is defined in Rule
144 under the Securities Act. Shares that cannot be traded without restriction
are referred to as "restricted securities" as that term is defined in Rule 144
under the Securities Act. As of September 27, 2004, approximately 7,776,789 (of
our 9,202,318 issued and outstanding shares) are eligible for sale under Rule
144. Restricted securities may be sold in the public market only if registered
of if they qualify for an exemption from registration under Rule 144 of the
Securities Act.
RULE 144
In general, under Rule 144 as currently in effect, a person (or group of
person whose shares are aggregated), including affiliates of the Company, who
have beneficially owned shares of our common stock for at least one year would
be entitled to sell within any three-month period, an amount of restricted
securities that does not exceed the greater of:
[_] One percent of the number of shares of common stock then outstanding
(approximately 88,063 shares as of September 27, 2004; or
[_] the average weekly trading volume in the common stock during the
four calendar weeks preceding the filing of a notice on Form 144
with respect to such sale.
56
Sales under Rule 144 are also subject to certain manner of sale provisions
and notice requirements and to the availability of current public information
about us.
RULE 144(K)
Under Rule 144(k), a person who is not deemed to have been one of our
affiliates at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years,
including the holding period of any prior owner other than an affiliate, is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144.
No prediction can be made as to the effect, if any that market sales of
the Company's common stock, or the availability of the common stock for sale,
will have on the market price of the common stock prevailing from time to time.
Nevertheless, sales of a significant number of shares of the Company's common
stock in the public market, or the perception that such sales could occur, could
adversely affect the market price of the common stock and impair our future
ability to raise capital through an offering of equity securities. See "Risk
Factors - Future sales of our common stock may depress our stock price."
LEGAL MATTERS
The validity of the securities being offered hereby will be passed upon by
Sichenzia Ross Friedman Ference LLP, New York, NY.
EXPERTS
Our financial statements for the years ended March 31, 2004 and 2003
appearing in this Prospectus and registration statement have been audited by
Grant Thornton LLP, as our independent registered public accounting firm, as set
forth in their report appearing elsewhere herein, and are included in reliance
upon the report given on the authority of the firm as experts in accounting and
auditing. Our financial statements for the year ended March 31, 2002 appearing
in this Prospectus and registration statement have been audited by Salberg &
Company, P.A., as independent registered public accounting firm, as set forth in
their report appearing elsewhere herein, and are included in reliance upon the
report given on the authority of the firm as experts in accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 pursuant to the Securities Act of 1933, as amended, with
respect to the offer, issuance and sale of 6,298,178 shares of our common stock.
This Prospectus does not contain all of the information set forth in the
registration statement. For further information with respect to us, and the
shares of our common stock to be sold in this offering, we make reference to the
registration statement.
You may read and copy all or any portion of the registration statement or
any other information, which we filed at the SEC's public reference rooms in
Washington, D.C. The address for the SEC's public reference room in Washington,
D.C. is Judiciary Plaza, 450 Fifth Street, N.W., Washington, DC 20549. You can
request copies of these documents, upon payment of a duplicating filing fee, by
writing to the SEC. Please call the Securities and Exchange Commission at
1-800-SEC-0330 for further information on the operation of the public reference
rooms. Our SEC filings are also available to you free or charge at the SEC's web
site at http://www.sec.gov.
57
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm......................F-2
Report of Independent Registered Public Accounting Firm......................F-3
Consolidated Balance Sheets..................................................F-4
Consolidated Statements of Operations........................................F-5
Consolidated Statement of Cash Flows.........................................F-7
Consolidated Statements of Stockholders' Equity..............................F-9
Notes to Consolidated Financial Statements..................................F-10
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
The Singing Machine Company, Inc.
We have audited the accompanying consolidated balance sheets of The Singing
Machine Company, Inc. and subsidiary (the "Company") as of March 31, 2004 and
2003, and the related consolidated statements of operations, shareholders'
equity and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and financial statement schedule based
on our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of The Singing
Machine Company, Inc. and subsidiary as of March 31, 2004 and 2003 and the
consolidated results of their operations and their consolidated cash flows for
the years then ended, in conformity with accounting principles generally
accepted in the United States of America.
We have also audited Schedule II of The Singing Machine Company, Inc. and
subsidiary for the year ended March 31, 2004. In our opinion, this schedule,
when considered in relation to the basic consolidated financial statements taken
as a whole, presents fairly, in all material respects, the information therein.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed more fully in Note 2 to the
financial statements and as of June 16, 2004, the Company has minimal liquidity.
Additionally and as of March 31, 2004, the Company was in violation of the
tangible net worth covenant of its factoring agreement. This continuing
condition of minimal liquidity and the lack of adequate external financing
raises substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to increasing liquidity are also described
in Note 2 to the financial statements. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ Grant Thornton LLP
Miami, Florida
June 16, 2004 (except for the last
paragraph of Note 7, as to which
the date is July 14, 2004)
F-2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders:
The Singing Machine Company, Inc.
and Subsidiary
We have audited the accompanying consolidated statement of operations, changes
in stockholders' equity, and cash flows for the year ended March 31, 2002 of The
Singing Machine Company, Inc., and Subsidiary. These consolidated financial
statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with the Standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes, examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations and
cash flows of The Singing Machine Company, Inc. and Subsidiary for the year
ended March 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
As more fully described in Note 3 of the fiscal 2004, 2003 and 2002 consolidated
financial statements, subsequent to the issuance of the Company's 2002 and 2001
consolidated financial statements and our report thereon dated May 23, 2002,
management determined to restate the 2002 and 2001 consolidated financial
statements to reflect a change in their position regarding taxation of certain
corporate income and a resulting increase in the income tax provision for years
2002 and 2001. In our related report, we expressed an unqualified opinion. Our
opinion on the revised consolidated financial statements, as expressed herein,
remains unqualified.
/S/ SALBERG & COMPANY, P.A.
BOCA RATON, FLORIDA
MAY 23, 2002 (EXCEPT FOR NOTE 3 AS TO WHICH THE DATE IS JULY 14, 2003)
F-3
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
JUNE 30 MARCH 31 MARCH 31,
2004 2004 2003
------------ ------------ ------------
(UNAUDITED)
ASSETS
Current Assets
Cash and cash equivalents $ 313,574 $ 356,342 $ 268,264
Restricted Cash 863,968 874,283 838,411
Accounts Receivable, less allowances of $98,000
and $406,000, respectively 2,020,834 3,806,166 5,762,944
Due from manufacturers 228,169 134,964 1,091,871
Inventories 4,763,060 5,228,060 25,194,346
Prepaid expense and other current assets 1,112,962 783,492 1,449,505
Insurance receivable 800,000 800,000 --
Refundable tax 1,111,401 1,178,512 --
Deferred tax asset -- -- 1,925,612
------------ ------------ ------------
TOTAL CURRENT ASSETS 11,213,968 13,161,819 36,530,953
PROPERTY AND EQUIPMENT, at cost less accumulated
depreciation of $2,567,000 and $1,473,000, respectively 869,782 983,980 1,096,424
OTHER ASSETS
Other non-current assets 551,070 615,773 1,307,917
------------ ------------ ------------
TOTAL ASSETS $ 12,634,820 $ 14,761,572 $ 38,935,294
============ ============ ============
LIABILITIES AND SHAREHOLDERS' (DEFICIT)/EQUITY
Current Liabilities
Bank overdraft $ 55,504 $ 62,282 $ 316,646
Accounts payable 3,852,160 3,995,852 7,553,007
Accrued expenses 2,796,912 3,481,905 1,443,406
Customer credits on account 1,806,784 2,111,484 933,002
Convertible debentures, net of unamortized discount
of $2,554,511 1,778,204 1,445,489 --
Subordinated debt-related parties 1,000,000 1,000,000 400,000
Revolving credit facilities -- -- 6,782,824
Note payable - related party 40,000 -- --
Income taxes payable 2,554,952 2,447,746 3,821,045
------------ ------------ ------------
TOTAL CURRENT LIABILITIES 13,884,516 14,544,758 21,249,930
SHAREHOLDERS' (DEFICIT)/EQUITY
Preferred stock, $1.00 par value; 1,000,000 shares
authorized, no shares issued and outstanding -- -- --
Common stock, Class A, $.01 par value; 100,000
shares authorized; no shares issued and outstanding -- -- --
Common stock, $0.01 par value; 18,900,000 shares
authorized; 8,752,318 and 8,171,678 shares issued
and outstanding, respect 88,023 87,523 81,717
Additional paid-in capital 10,104,998 10,052,498 4,843,430
Accumulated (deficit)/retained earnings (11,442,717) (9,923,207) 12,760,217
------------ ------------ ------------
TOTAL SHAREHOLDERS' (DEFICIT)/EQUITY (1,249,696) 216,814 17,685,364
------------ ------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY $ 12,634,820 $ 14,761,572 $ 38,935,294
============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED
FINANCIAL STATEMENTS.
F-4
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
YEARS ENDED MARCH 31, THREE MONTHS ENDED JUNE 30,
-------------------------------------------- ----------------------------
2004 2003 2002 2004 2003
------------ ------------ ------------ ------------ ------------
(as restated)
(Note 3)
NET SALES $ 70,541,128 $ 95,613,766 $ 62,475,753 $ 3,856,872 $ 7,627,975
COST OF SALES
Cost of Goods Sold 68,279,589 72,329,035 40,852,840 3,086,733 5,901,866
Impairment of Tooling 442,989 -- -- -- --
------------ ------------ ------------ ------------ ------------
GROSS PROFIT 1,818,550 23,284,731 21,622,913 770,139 1,726,109
OPERATING EXPENSES
Advertising 2,340,439 5,032,367 2,377,638 69,589 270,770
Commissions 1,024,883 997,529 1,294,543 45,520 --
Compensation 5,048,831 4,095,176 2,486,547 686,215 1,299,195
Freight & Handling 1,423,082 2,112,435 1,242,910 90,688 225,866
Royalty Expense 2,294,727 2,257,653 1,862,116 32,731 83,964
Selling, general & administrative expenses 9,881,887 7,175,341 4,123,779 929,691 1,980,552
------------ ------------ ------------ ------------ ------------
TOTAL OPERATING EXPENSES 22,013,849 21,670,501 13,387,533 1,854,434 3,860,347
------------ ------------ ------------ ------------ ------------
(LOSS) INCOME FROM OPERATIONS (20,195,299) 1,614,230 8,235,380 (1,084,295) (2,134,238)
OTHER INCOME (EXPENSES)
Other income 22,116 196,537 215,840 11,700 7,669
Stock based guarantee fees -- -- (171,472) -- --
Interest and amortizatoin expense (1,752,952) (406,126) (112,123) (446,915) (188,468)
Interest income 1,216 11,943 16,934 -- --
------------ ------------ ------------ ------------ ------------
NET OTHER EXPENSES (1,729,620) (197,646) (50,821) (435,215) (180,799)
------------ ------------ ------------ ------------ ------------
(LOSS) INCOME BEFORE PROVISION FOR INCOME TAXES (21,924,919) 1,416,584 8,184,559 (1,519,510) (2,315,037)
PROVISION FOR INCOME TAXES 758,505 198,772 1,895,494 -- 2,315
------------ ------------ ------------ ------------ ------------
NET (LOSS) INCOME $(22,683,424) $ 1,217,812 $ 6,289,065 $ (1,519,510) $ (2,317,352)
============ ============ ============ ============ ============
(LOSS) EARNINGS PER COMMON SHARE:
Basic $ (2.65) $ 0.15 $ 0.88 $ (0.17) $ (0.28)
Diluted $ (2.65) $ 0.14 $ 0.79 $ (0.17) $ (0.28)
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES:
Basic 8,566,116 8,114,330 7,159,142 8,787,483 8,278,469
Diluted 8,566,116 8,931,385 7,943,473 8,787,483 8,278,469
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-5
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CASH FLOWS
UNAUDITED
FOR THREE MONTHS ENDING
FOR YEAR ENDING MARCH 31 JUNE 30
------------------------------------------ --------------------------
2004 2003 2002 2004 2003
------------ ----------- ----------- ----------- -----------
(as restated)
(Note 3)
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) earnings $(22,683,424) $ 1,217,812 6,289,065 $(1,519,510) $(2,317,352)
Adjustments to reconcile net (loss) earnings to
net cash provided by (used in) operating
activities
Depreciation and amortization 750,359 622,298 394,456 133,437 175,519
Impairment of tooling and Intangible 628,405 -- -- -- --
Provision for inventory 2,865,789 3,715,357 -- -- --
Provision for bad debt (159,676) 393,737 45,078 -- --
Amortization of discount/deferred fees on
convertible debentures 909,891 -- -- 332,715 --
Stock compensation expense 632,451 -- 171,472 -- --
Deferred taxes 1,925,612 (1,734,194) -- -- --
Changes in assets and liabilities:
Accounts Receivable 2,116,454 (2,626,074) (2,626,329) 1,785,332 1,526,456
Due from manufacturer 956,908 (603,573) 210,798 (132,589) --
Inventories 17,100,497 (19,635,351) (4,460,891) 1,160,206 266,185
Prepaid expenses and other assets 666,013 (1,020,895) (352,373) (329,471) (457,782)
Insurance receivable (800,000) -- -- -- --
Other non-current assets 1,204,630 (426,494) (91,631) 64,703 --
Accounts payable (3,557,155) 5,706,769 1,364,158 (799,516) 1,299,330
Accrued expenses 2,038,499 153,809 199,445 (631,993) (211,914)
Customer credits on account 1,178,482 933,002 -- (304,700) --
Current income taxes (2,551,811) 1,779,117 1,811,439 174,317 2,315
----------- ----------- ----------- ----------- -----------
Net cash provided by (used in)
operating activities 3,221,924 (11,524,680) 2,954,687 (67,066) 282,757
------------ ----------- ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (1,266,321) (1,144,064) (613,691) (19,240) (299,186)
Proceeds from investment in factor -- -- 933,407 -- --
Proceeds from repayment of related
party loans -- -- 125,117 -- --
Restricted cash (35,872) (324,727) (513,684) 10,315 (23,711)
Investment in and advances in
unconsolidated subsidiary -- -- 298,900
----------- ----------- ----------- ----------- -----------
Net cash (used in) provided by
investing activities (1,302,193) (1,468,791) 230,049 (8,925) (322,897)
----------- ----------- ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings from revolving credit facilities 28,863,712 47,825,725 21,856,653 -- (1,879,453)
Repayments to revolving credit
facilities (35,646,536) (41,042,901) (21,856,653) -- --
Proceeds from issuance of convertible
debentures 4,000,000 -- -- -- --
Bank Overdraft (254,364) 316,645 -- (6,777) (269,994)
Payment of fees related to convertible
debt (255,000) -- -- -- --
Proceeds from subordinated debt-related
parties, net 600,000 400,000 1,319,190 -- --
Proceeds from note payable -- -- -- 40,000 2,000,000
Payment on related party loan -- -- -- -- (200,000)
Proceeds from exercise of stock
options and warrants 860,535 242,119 -- -- 207,735
----------- ----------- ----------- ----------- -----------
Net cash (used in) provided by
finanancing activities (1,831,653) 7,741,588 1,319,190 33,223 (141,712)
----------- ----------- ----------- ----------- -----------
INCREASE(DECREASE) IN CASH AND CASH EQUIVALENTS 88,078 (5,251,883) 4,503,926 (42,768) (181,852)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 268,264 5,520,147 1,016,221 356,342 268,265
------------ ----------- ----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 356,342 $ 268,264 $ 5,520,147 $ 313,574 $ 86,413
============ =========== =========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
CASH PAID FOR THE YEAR ENDING MARCH 31, 2004
Interest $ 995,101 $ 406,126 $ 112,123 $ 120,625 $ 188,469
============ =========== =========== =========== ===========
Income Taxes $ 1,388,804 $ 153,849 $ 102,415 $ -- $ --
============ =========== =========== =========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL
STATEMENTS.
F-6
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
PREFERRED STOCK COMMON STOCK DEFERRED
-------------------------- --------------------------- PAID IN RETAINED GUARANTEE
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS FEES TOTAL
------------ ------------ ------------ ------------ ------------ ------------ ------------ -------------
BALANCE AT
MARCH 31, 2001,
RESTATED -- -- 6,538,680 65,387 3,302,982 5,253,340 (171,472) 8,450,237
Net earnings -- -- -- -- -- 6,289,065 -- 6,289,065
Exercise of
warrants -- -- 581,100 5,811 584,239 -- -- 590,050
Exercise of
employee
stock
options -- -- 900,525 9,005 720,135 -- -- 729,140
Fractional
share
adjustment
pursuant
to 3:2
stock split -- -- (278) (3) (4,528) -- -- (4,531)
Amortization
of deferred
guarantee fees -- -- -- -- -- -- 171,472 171,472
------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
BALANCE AT
MARCH 31,
2002, RESTATED -- -- 8,020,027 80,200 4,602,828 11,542,405 -- 16,225,433
Net earnings -- -- -- -- -- 1,217,812 -- 1,217,812
Exercise of
warrants 52,500 525 47,600 -- 48,125
Exercise of
employee stock
options -- -- 99,151 992 193,002 -- -- 193,994
------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
BALANCE AT
MARCH 31, 2003 8,171,678 81,717 4,843,430 12,760,217 -- 17,685,364
Net loss -- -- -- -- -- (22,683,424) -- (22,683,424)
Exercise of
employee stock
options -- -- 448,498 4,485 1,076,885 -- -- 1,081,370
Warrants issued
in connection
with
convertible
debenture
admendment -- -- -- -- 30,981 -- -- 30,981
Financing fees
paid with
warrants -- -- -- -- 268,386 -- -- 268,386
Warrants issued
in connection
with and
beneficial
conversion
feature of
co-vertible
debentures -- -- -- -- 3,312,362 -- -- 3,312,362
Issuance of
common stock 132,142 1,321 520,454 -- -- 521,775
------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
BALANCE AT
MARCH 31, 2004 -- $ -- 8,752,318 $ 87,523 $ 10,052,498 $ (9,923,207) $ -- $ 216,814
Net loss
(Unaudited) -- -- -- (1,519,510) -- (1,519,510)
Shares issued
for consulting
service 50,000 500 52,500 -- -- 53,000
(Unaudited) ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
BALANCE AT
JUNE 30, 2004
(UNAUDITED) 8,802,318 88,023 10,104,998 (11,442,717) -- (1,249,696)
F-7
THE SINGING MACHINE COMPANY, INC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF ACCOUNTING POLICIES
OVERVIEW
The Singing Machine Company, Inc., a Delaware corporation, and Subsidiary
(the "Company," or "The Singing Machine") are primarily engaged in the
development, marketing, and sale of consumer karaoke audio equipment,
accessories, and musical recordings. The products are sold directly to
distributors and retail customers.
The preparation of The Singing Machine's financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial
statements and revenues and expenses during the period. Future events and their
effects cannot be determined with absolute certainty; therefore, the
determination of estimates requires the exercise of judgment. Actual results
inevitably will differ from those estimates, and such differences may be
material to the Company's financial statements. Management evaluates its
estimates and assumptions continually. These estimates and assumptions are based
on historical experience and other factors that are believed to be reasonable
under the circumstances. These estimates and The Singing Machine's actual
results are subject to the risk factors listed in Quantitative and Qualitative
Disclosure About Market Risk section.
The management of the Company believes that a higher degree of judgment or
complexity is involved in the following areas:
UNAUDITED INTERIM RESULTS. The accompanying balance sheet as of June 30,
2004 and the statements of operations and cash flows for the three months ended
June 30, 2003 and 2004 are unaudited. In the opinion of management, these
statements have been prepared on the same basis as the audited financial
statements and include all adjustments, consisting only of normal recurring
adjustments, necessary for the fair presentation of the results for these
periods. The data disclosed in the notes to the financial statements for these
periods and through the date of this filing are also unaudited.
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.
INVENTORY. 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.
INCOME TAXES. Significant management judgment is required in developing
The Singing Machine's provision for income taxes, including the determination of
foreign tax liabilities, deferred tax assets and liabilities and any valuation
allowances that might be required against the deferred tax assets. Management
evaluates its ability to realize its deferred tax assets on a quarterly basis
and adjusts its valuation allowance when it believes that it is more likely than
not that the asset will not be realized. At December 31, 2003 and March 31,
2004, the Company concluded that a valuation allowance was needed against all of
the Company's deferred tax assets, as it was not more likely than not that the
deferred taxes would be realized. At June 30, 2004, March 31, 2004 and 2003, The
Singing Machine had gross deferred tax assets of $8.7, $8.2 million and $1.9
million, against which the Company recorded valuation allowances totaling $8.7,
$8.2 million and $0, respectively.
For the fiscal year ended March 31, 2004, the Company recorded a tax
provision of $758,505. This occurred because the valuation allowance established
against the Company's deferred tax assets exceeded the amount of the benefit
created from carrying back a portion of the current year's losses. The
carry-back of the losses from the current year resulted in an income tax
receivable of $1.1 million, which is included in refundable tax in the
accompanying balance sheets. We have received the tax fund of $1.1 million on
August 24, 2004, which has been used to pay the related parties' loan and the
vendors. The Company has now exhausted its ability to carry back any further
losses and therefore will only be able to recognize tax benefits to the extent
that it has future taxable income.
F-8
For the three months ended June 30, 2004, the Company recorded no tax
provision. This occurred because the Company has net operating losses during
this period and has not recorded a benefit for the current period's losses
because realizability is not more likely than not.
The Company's subsidiary has applied for an exemption of income tax in
Hong Kong. Therefore, no taxes have been expensed or provided for at the
subsidiary level. Although no decision has been reached by the governing body,
the parent company has reached the decision to provide for the possibility that
the exemption could be denied and accordingly has recorded a provision for Hong
Kong taxes in fiscal 2003 and 2002. There was no provision for Hong Kong income
taxes in fiscal 2004 due to the subsidiary's net operating loss for the year.
Hong Kong income taxes payable totaled $2.4 million at March 31, 2004 and
2003 and is included in the accompanying balance sheets as income taxes payable.
The Company effectively repatriated approximately $2.0 million, $5.6
million and $5.7 million from its foreign operations in 2004, 2003 and 2002,
respectively. Accordingly, these earnings were taxed as a deemed dividend based
on U.S. statutory rates. The Company has no remaining undistributed earnings of
the Company's foreign subsidiary.
The Company operates within multiple taxing jurisdictions and is subject
to audit in those jurisdictions. Because of the complex issues involved, any
claims can require an extended period to resolve. In management's opinion,
adequate provisions for income taxes have been made.
OTHER ESTIMATES. The Singing Machine makes other estimates in the ordinary
course of business relating to sales returns and allowances, warranty reserves,
and reserves for promotional incentives. Historically, past changes to these
estimates have not had a material impact on the Company's financial condition.
However, circumstances could change which may alter future expectations.
THE FOLLOWING ARE THE COMPANY'S REMAINING ACCOUNTING POLICIES.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of The Singing
Machine Company, Inc. and its wholly-owned Hong Kong Subsidiary, International
SMC (HK) Limited ("Hong Kong Subsidiary"). All intercompany accounts and
transactions have been eliminated in consolidation.
STOCK SPLITS
On March 15, 2002, the Company affected a 3 -for -2 stock split. All share
and per share data have been retroactively restated in the accompanying
consolidated financial statements to reflect the split.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Hong Kong Subsidiary is the local currency.
The financial statements of the subsidiary are translated to U.S. dollars using
year-end rates of exchange for assets and liabilities, and average rates of
exchange for the year for revenues, costs, and expenses. Net gains and losses
resulting from foreign exchange transactions are included in the consolidate
statements of operations and were not material during the periods presented. The
effect of exchange rate changes on cash at March 31, 2004, 2003 and 2002 were
also not material.
F-9
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of
three months or less at the time of purchase to be cash equivalents. Cash
balances at March 31, 2004 and 2003 include approximately $140,000 and $73,000,
respectively, held in foreign banks by the Hong Kong Subsidiary.
COMPREHENSIVE EARNINGS
Other comprehensive earnings (loss) is defined as the change in equity of
a business enterprise during a period from transactions and other events and
circumstances from non-owner sources, including foreign currency translation
adjustments and unrealized gains and losses on derivatives designated as cash
flow hedges. For the years ended March 31, 2004, 2003 and 2002 comprehensive
earnings (loss) was equal to net earnings (loss).
INVENTORIES
Inventories are comprised of electronic karaoke audio equipment,
accessories, and compact discs and are stated at the lower of cost or market, as
determined using the first in, first out method. Inventory consigned to
customers at March 31, 2004 and 2003 was $300,914 and $56,695, respectively.
F-10
The following table represents the major components of inventory at March
31.
2004 2003
------------- -------------
Finished Goods $ 5,106,710 $ 24,092,406
Inventory in Transit 121,350 1,101,940
------------- -------------
Total Inventories $ 5,228,060 $ 25,194,346
============= =============
LONG-LIVED ASSETS
The Company reviews long-lived assets for impairment whenever
circumstances and situations change such that there is an indication that the
carrying amounts may not be recoverable. If the undiscounted future cash flows
attributable to the related assets are less than the carrying amount, the
carrying amounts are reduced to fair value and an impairment loss is recognized
in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." During the year ended March 31, 2004, the Company recorded
an impairment charge totaling $442,989 on certain tooling. The charge was the
result of the Company's decision to discontinue certain inventory models.
SHIPPING AND HANDLING COSTS
Shipping and handling costs are classified as a separate component of
operating expenses and those billed to customers are recorded as revenue in the
statement of operations.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation
and amortization. Expenditures for repairs and maintenance are charged to
expense as incurred. Depreciation is provided for in amounts sufficient to
relate the cost of depreciable assets to their estimated useful lives using
accelerated and straight-line methods.
REVENUE RECOGNITION
Revenue from the sale of equipment, accessories, and musical recordings
are recognized upon the later of (a) the time of shipment or (b) when title
passes to the customers, all significant contractual obligations have been
satisfied and collection of the resulting receivable is reasonably assured.
Revenues from sales of consigned inventory are recognized upon sale of the
product by the consignee. Net sales are comprised of gross sales net of a
provision for actual and estimated future returns, discounts and volume rebates.
DUE FROM MANUFACTURER
The Hong Kong Subsidiary operates as an intermediary to purchase karaoke
hardware from factories located in China on behalf of the Company. Certain
manufacturers credited the Company for the return of inventory to the factory
for rework. One manufacturer also credited the Company for volume incentive
rebates on purchases in fiscal 2003. The balance due from these manufacturers as
of March 31, 2004 and 2003 was $134,964 and $1,091,871, respectively and will be
applied to future purchases of inventory.
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.
F-11
STOCK BASED COMPENSATION
The Company accounts for stock options issued to employees using the
intrinsic value method in accordance with the provisions of Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. As such, compensation cost is measured
on the date of grant as the excess of the current market price of the underlying
stock over the exercise price. Such compensation amounts are amortized over the
respective vesting periods of the option grant. The Company applied the
disclosure provisions of Statement of Financial Accounting Standards ("SFAS")
No. 148, "Accounting for Stock-Based Compensation- Transition and Disclosure an
amendment of FASB Statement No. 123", which permits entities to provide pro
forma net earnings (loss) and pro forma earnings (loss) per share disclosures
for employee stock option grants as if the fair-valued based method defined in
SFAS No. 123 had been applied to options granted.
Had compensation cost for the Company's stock-based compensation plan been
determined using the fair value method for awards under that plan, consistent
with SFAS No. 123, "Accounting for Stock Based Compensation", the Company's net
earnings (loss) would have been changed to the pro-forma amounts indicated below
for the years ended March 31:
FOR THE FISCAL YEAR ENDED MARCH 31,
-------------------------------------------------------------
2004 2003 2002
-------------------- ------------------ -----------------
Net (loss) earnings, as reported $ (22,683,424) $ 1,217,812 $ 6,289,065
Deducts: Total stock-based employee
compensation expensed determined
under fair value based $ (723,058) $ (1,740,624) $ (115,489)
method, net of tax
Net (loss) earning, pro forma $ (23,406,482) $ (522,812) $ 6,173,576
Net (loss) earnings per share - basic As reported $ (2.65) $ 0.15 $ 0.88
Pro forma $ (2.73) $ (0.06) $ 0.86
Net (loss) earnings per share - diluted As reported $ (2.65) $ 0.14 $ 0.79
Pro forma $ (2.73) $ (0.06) $ 0.78
The effect of applying SFAS No. 123 is not likely to be representative of
the effects on reported net earnings (loss) for future years due to, among other
things, the effects of vesting.
For financial statement disclosure purposes and for purposes of valuing
stock options and warrants issued to consultants, the fair market value of each
stock option granted was estimated on the date of grant using the Black- Scholes
Option-Pricing Model in accordance with SFAS No. 123 using the following
weighted-average assumptions:
o Fiscal 2004: expected dividend yield 0%, risk- free interest rate of
4%, volatility between 80% and 110% and expected term of three
years.
o Fiscal 2003: expected dividend yield 0%, risk- free interest rate of
4%, volatility 71% and expected term of three years.
o Fiscal 2002: expected dividend yield 0%, risk- free interest rate of
6.08% to 6.81%, volatility 42% and expected term of two years.
ADVERTISING
Costs incurred for producing and communicating advertising of the Company,
are charged to operations as incurred. The Company has cooperative advertising
arrangements with its vendors and accrues the cost of advertising as a selling
expense, calculated on the related revenues. Advertising expense for the years
ended March 31, 2004, 2003 and 2002 was $2,340,439, $5,032,367 and $2,377,638,
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 &
administrative expenses in the consolidated statements of operations. For the
years ended March 31, 2004, 2003 and 2002, these amounts totaled $302,144,
$674,925 and $181,866, respectively.
F-12
EARNINGS PER SHARE
In accordance with SFAS No. 128, "Earnings per Share", basic (loss)
earnings per share is computed by dividing the net (loss) earnings for the year
by the weighted average number of common shares outstanding. Diluted (loss)
earnings per share is computed by dividing net (loss) earnings by the weighted
average number of common shares outstanding including the effect of common stock
equivalents.
The following table presents a reconciliation of basic and diluted (loss)
earnings per share:
2004 2003 2002
------------- ------------ ------------
(as restated)
Net (loss) earnings $(22,683,424) $ 1,217,812 $ 6,289,065
(Loss) earnings available to common shareholders $(22,683,424) $ 1,217,812 $ 6,289,065
Weighted average shares outstanding - basic 8,566,116 8,114,330 7,159,142
(Loss) earnings per share - basic $ (2.65) $ 0.15 $ 0.88
(Loss) earnings available to common shareholders $(22,683,424) $ 1,217,812 $ 6,289,065
Weighted average shares outstanding - basic 8,566,116 8,114,330 7,159,142
Effect of dilutive securities:
Stock options/Warrants -- 817,055 784,331
Convertible debentures -- -- --
------------ ------------ ------------
Weighted average shares outstanding - diluted 8,566,116 8,931,385 7,943,473
Earnings per share - diluted $ (2.65) $ 0.14 $ 0.79
============ ============ ============
In 2004, 2003 and 2002, 2,657,532, 90,000 and 0 common stock equivalents
were not included in the computation of diluted (loss) earnings per share as
their effect would have been antidilutive.
FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosures of information about the fair value of certain financial
instruments for which it is practicable to estimate that value. For purposes of
this disclosure, the fair value of a financial instrument is the amount at which
the instrument could be exchanged in a current transaction between willing
parties, other than in a forced sale or liquidation.
The carrying amounts of the Company's short-term financial instruments,
including accounts receivable, accounts payable and accrued expenses
approximates fair value due to the relatively short period to maturity for these
instruments.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the
current year presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities (and Interpretation of ARB No. 51)" ("FIN 46"). FIN
46 addresses consolidation by business enterprises of certain variable interest
entities, commonly referred to as special purpose entities. The adoption of FIN
46 did not have a material effect on the Company's financial condition, results
of operations, or cash flows.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No.
133 on Derivative Instruments with Characteristics of both Liabilities and
Equity." This statement amends and clarifies accounting for derivatives
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities under SFAS No. 133. This statement is
effective for contracts entered into or modified after June 30, 2003, except as
for provisions that relate to SFAS No. 133 implementation issues that have been
effective for fiscal quarters that began prior to June 15, 2003, which should
continue to be applied in accordance with their respective dates. The adoption
of SFAS No. 149 did not have a material impact on the Company's financial
condition, results of operations, or cash flows.
F-13
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." This Statement
establishes standards for classifying and measuring certain financial
instruments that embody obligations of the issuer and have characteristics of
both liabilities and equity and is effective financial instruments entered into
or modified after May 31, 2003; otherwise effective at the beginning of the
first interim period beginning after June 15, 2003, except for mandatorily
redeemable financial instruments of nonpublic entities which are subject to the
provisions of this Statement for the first fiscal period beginning after
December 15, 2003 the adoption of SFAS No. 150 did not have a material impact on
the Company's financial condition, results of operations, or cash flows.
NOTE 2 - GOING CONCERN
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America, which contemplate continuation of the Company as a going concern.
On February 9, 2004, the Company entered into a factoring agreement with
Milberg Factors, Inc. and as of March 31, 2004, the Company was in violation of
the minimum required tangible net worth and working capital covenants of the
agreement. Subsequent to March 31, 2004, the agreement was terminated.
The Company anticipates generating cash flow from the following, until the
September selling season:
o Collection of existing Accounts Receivable. At March 31, 2004 the
Company had Accounts Receivable (net of allowances) $3,806,166.
o Sale of existing inventory. A March 31, 2004, the Company had
inventory totaling $5,228,060.
o Receipt of federal tax refund. The Company has tax refund of $1.1
million as a result of a net loss carry back. It is anticipated that
the refund will be received in September or October 2004.
Sales will be financed using the following methods:
o Vendor Financing. The Company's key vendors in China have agreed to
manufacture on behalf of the Company, without advanced payments.
o A significant amount of committed customer orders have been sold
under customer letters of credit terms. The customers letters of
credit will be used as collateral to provide advances to our
vendors. The customers will pay and take title of the karaoke
machines in China as the karaoke machines are shipped. This will
generate immediate funds to pay the vendors and generate additional
cash flows.
o As stated above a tax refund of $1.1 million dollars is anticipated
to be received in September or October. These funds will also be
used to pay the Company's vendors.
o For customers whose terms of sale are with open terms, the Company
will also use a factoring arrangement, either with Milberg or some
other financial institution.
In June 2004, a beneficial owner of the Company advanced a short-term loan
of $40,000 to the Company. The loan is interest fee and is due on demand.
On July 14, 2004, a director, Josef A. Bauer, advanced the Company a short
term loan of $200,000, to be used to meet working capital obligations. The loan
bears interest at 8.75% per annum and is due on demand.
There can be no assurances that forecasted results will be achieved or
that additional financing will be obtained. The financial statements do not
include any adjustments relating to the recoverability and classification of
asset amounts or the amounts and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern.
F-14
NOTE 3 - RESTATEMENT OF FINANCIAL STATEMENTS FOR THE FISCAL YEARS 2002 AND 2001
In June 2003, management revised its position on taxation of its
subsidiary's income by the United States and by the Hong Kong tax authorities.
With regard to taxation in Hong Kong, the Company's subsidiary had
previously applied for a Hong Kong offshore claim income tax exemption based on
the locality of profits of the Hong Kong subsidiary. Management believed that
the exemption would be approved because the source of all profits of the Hong
Kong subsidiary is from exporting to customers outside of Hong Kong.
Accordingly, no provision for income taxes was provided in the consolidated
financial statements as of March 31, 2002 and 2001. However, full disclosure was
previously reflected in the audited financial statements for years ended March
31, 2002 and 2001 of the estimated amount that would be due to the Hong Kong tax
authority should the exemption be denied. Management is continuing its exemption
application process. However, due to the extended period of time that the
application has been outstanding, as well as management's reassessment of the
probability that the application will be approved, management has determined to
restate the 2002 and 2001 consolidated financial statements to provide for such
taxes. The effect of such restatement is to increase income tax expense by
$748,672 and $468,424 in fiscal 2002 and 2001, respectively. However, the
Company can claim United States foreign tax credits in 2002 for these Hong Kong
taxes, which is reflected in the final restated amounts.
With regard to United States taxation of foreign income, the Company had
originally taken the position that the foreign income of the Hong Kong
subsidiary qualified for a deferral under the Internal Revenue Code allowing for
such income to be indefinitely deferred and not taxed in the United States until
such income is repatriated. Full disclosure of the amount and nature of the
indefinite deferral for fiscal year 2002 was reflected in the income tax
footnote of the consolidated financial statements for that year. The internal
revenue code, regulations and case law regarding international income taxation
is quite complex and subject to interpretation. Each case is determined based on
the individual facts and circumstances. Due to certain inter-company loans made
in 2002 and 2003, the profits previously considered to be indefinitely deferred
became partially taxable as "deemed dividends" under section 956 of the Internal
Revenue Code. Although certain arguments against the imposition of a "deemed
dividend" may be asserted, management has determined to restate the fiscal year
2002 consolidated financial statements based on its reassessment of its original
position. The effect of such restatement is to increase income tax expense by
$1,027,545 in fiscal year 2002, which includes the utilization of the foreign
tax credits referred to above.
The net effect of the above two adjustments is to decrease net income by
$1,776,217 and $468,424 in fiscal 2002 and 2001. The net effect on net income
per share is to decrease net income per share basic and diluted by $0.25 and
$0.23, respectively in fiscal 2002 and decrease net income per share basic and
diluted by $0.07 and $0.06, respectively in fiscal 2001.
F-15
In September, 2004, the management revised the cash flow for the period
ending June 30, 2003, September 30, 2003 and December 31, 2003. The amendments
are related to the reclassification of the "Restrict Cash" and "Bank Overdraft".
There is no effect to the Statement of Operations. The following table shows the
reclassification of the cash flow:
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
COMPRESSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
FOR PERIOD ENDING
-----------------------------------------------------------------------------
06/30/03 06/30/03 09/30/03 09/30/03 12/31/03
-------- -------- -------- -------- --------
AS REPORTED AS AMENDED AS REPORTED AS AMENDED AS REPORTED
----------- ---------- ----------- ---------- -----------
Cash flows from operating activities
Net Income $ (2,317,352) $ (2,317,352) $ (2,974,021) $ (2,974,021) $(13,424,622)
Net Cash Used in Operating Activities (10,948) 282,757 (4,678,328) (4,380,280) (4,998,092)
------------ ------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used in Investing Activities (299,186) (322,897) (157,178) (186,370) (434,065)
------------ ------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash provided by Financing Activities 128,282 (141,712) 5,673,244 5,404,388 5,399,850
------------ ------------ ------------ ------------ ------------
DECREASE IN CASH AND CASH EQUIVALENTS (181,852) (181,852) 837,738 837,738 (32,307)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 268,265 268,265 268,265 268,265 268,265
------------ ------------ ------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 86,413 $ 86,413 $ 1,106,003 $ 1,106,003 $ 235,958
============ ============ ============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 188,469 $ 188,469 $ 350,192 $ 350,192 $ 591,817
============ ============ ============ ============ ============
Cash paid during the year for income taxes $ -- $ -- $ 205,000 $ 205,000 $ 205,000
============ ============ ============ ============ ============
FOR PERIOD ENDING
-----------------
12/31/03
--------
AS AMENDED
----------
Cash flows from operating activities
Net Income $(13,424,622)
Net Cash Used in Operating Activities (4,998,092)
------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used in Investing Activities (462,067)
------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash provided by Financing Activities 5,427,852
------------
DECREASE IN CASH AND CASH EQUIVALENTS (32,307)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 268,265
------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 235,958
============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for interest $ 591,817
============
Cash paid during the year for income taxes $ 205,000
============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
NOTE 4 - ACCOUNTS RECEIVABLE FACTORING AGREEMENT
On February 9, 2004, the Company entered into a factoring agreement with
Milberg Factors, Inc. ("Milberg") of New York City. The agreement allows the
Company, at the discretion of Milberg, to factor its outstanding receivables
without recourse up to a maximum of the lesser of $3.5 million or 80% of
eligible accounts receivable, less certain reserves determined by Milberg. The
Company will pay .8% of gross receivables in fees and the average balance of the
line will be subject to interest on a monthly basis at prime plus .75% with a
minimum rate not to decrease below 4.75%. The agreement contains minimum
aggregate charges in any calendar year of $200,000, limits on incurring any
additional indebtedness and the Company must maintain tangible net worth and
working capital above $7.5 million. Milberg also received a security interest in
all of the Company's accounts receivable and inventory located in the United
States and a pledge of 66 2/3% of the Hong Kong Subsidiary. For the year ending
March 31, 2004, the Company incurred $141,455 in related charges which are
included in selling, general and administrative expenses in the accompanying
statements of operations.
No accounts were factored for the three months ended June 30, 2004 and for
the years ended March 31, 2004. As of March 31, 2003, the Company was in
violation of the minimum tangible net worth and working capital requirements and
subsequent to March 31, 2004, the agreement was terminated.
F-16
NOTE 5 - PROPERTY AND EQUIPMENT
A summary of property and equipment at March 31, 2004 and 2003 is as
follows:
USEFUL
LIVES 2004 2003
----------- ------------ -------------
Computer and office equipment 5 years $ 465,810 $ 313,222
Furniture and fixtures 5 - 7 years 381,164 341,777
Leasehold improvements * 103,776 110,841
Molds and tooling 3 years 2,903,822 1,803,435
------------ -------------
3,854,572 2,569,274
Less: accumulated depreciation (2,870,592) (1,472,850)
------------ -------------
Total net property and equipment $ 983,980 $ 1,096,424
============ =============
* Shorter of remaining term of lease or useful life
NOTE 6 - RESTRICTED CASH
The Company, through the Hong Kong Subsidiary, maintains a letter of
credit facility and short term loan with a major international bank. The Hong
Kong Subsidiary is required to maintain a separate deposit account in the amount
of $874,283 and $838,411 at March 31, 2004 and 2003, respectively. This amount
is shown as restricted cash at March 31, 2004 and 2003.
NOTE 7 - LOANS AND LETTERS OF CREDIT
CREDIT FACILITY
The Hong Kong Subsidiary maintains separate credit facilities at two
international banks. The primary purpose of the facilities is to provide the
Subsidiary with the following abilities:
o Overdraft protection facilities ;
o Issuance and negotiation of letters of credit, both regular and
discrepant ;
o Trust receipts; and
o A Company credit card .
The facilities ARE SECURED BY A CORPORATE GUARANTEE FROM THE U.S. COMPANY,
RESTRICTED CASH ON DEPOSIT WITH THE LENDER AND REQUIRE THAT THE COMPANY MAINTAIN
A MINIMUM TANGIBLE NET WORTH. THE MAXIMUM AVAILABLE CREDIT UNDER THE FACILITIES
IS $2.0 MILLION. THE BALANCE AT MARCH 31, 2004 AND 2003 WAS $62,282 AND
$316,646, RESPECTIVELY. THE INTEREST RATE IS APPROXIMATELY 4%. AT MARCH 31,
2004, THE COMPANY DOES NOT HAVE ANY AVAILABILITY UNDER THESE FACILITIES.
On April 26, 2001, the Company executed a Loan and Security Agreement with
a commercial lender, which as amended was due to expire on March 31, 2004. As of
January 31, 2004 the loan was paid in full, the facility was terminated and the
UCC filings were released.
RELATED PARTY LOANS
On July 10, 2003, the Company obtained $1 million in subordinated debt
financing from a certain officer, directors and an associate of a director. The
loans accrue interest at 9.5% per annum and as of March 31, 2004, all interest
was accrued and unpaid and totaled approximately $71,000. These loans were
originally scheduled to be repaid by October 31, 2003 and are now due on demand.
F-17
On July 14, 2004, a director, Josef A. Bauer has advanced the Company a
short term loan of $200,000, to be used to meet working capital obligations. The
loan bears interest at 8.75%. The loan was repaid along with interest on August
26, 2004.
In June 2004, a beneficial owner of the Company advanced $40,000 to the
Company. The loan is interest free. The loan was repaid on August 30, 2004.
NOTE 8 - CONVERTIBLE DEBENTURES WITH WARRANT
In September 2003, the Company issued $4 million of 8% Convertible
Debentures in a private offering which are due February 20, 2006 ("Convertible
Debentures"). The net cash proceeds received by the Company were $3,745,000
after deduction of cash commissions and other expenses.
The Convertible Debentures are subordinated to Milberg and were originally
convertible at the option of the holders into 1,038,962 common shares at a
conversion price of $3.85 per common share, subject to certain anti-dilution
adjustment provisions, at any time after the closing date.
These Convertible Debentures were issued with 457,143 detachable stock
purchase warrants with an exercise price of $4.025 per share. These warrants may
be exercised at anytime after September 8, 2003 and before September 7, 2006 and
are subject to certain anti-dilution provisions. The warrants are also subject
to an adjustment provision; whereas the price of the warrants may be changed
under certain circumstances.
The Convertible Debentures bear interest at the stated rate of 8% per
annum. Interest is payable quarterly on March 1, June 1, September 1, and
December 1. The interest may be payable in cash, shares of Common Stock, or a
combination thereof subject to certain provisions and at the discretion of the
Company.
In accounting for this transaction, the Company allocated the proceeds
based on the relative estimated fair value of the stock purchase warrants and
the convertible debentures. This allocation resulted in a discount on the
convertible debentures of $3.3 million, which is being amortized over the life
of the debt on a straight-line basis to interest expense, which is not
materially different from effective interest method. Total amortization for
fiscal year ended March 31, 2004 totaled $757,851 and the unamortized discount
totaled $2,554,511 at March 31, 2004.
On February 9, 2004, the Company amended its convertible debenture
agreements to increase the interest rate to 8.5% and to grant warrants to
purchase an aggregate of 30,000 shares of the Company's common stock to the
debenture holders on a pro-rata basis. These concessions are in consideration of
the debenture holder's agreements to (i) enter into new subordination agreements
with Milberg, (ii) to waive all liquidated damages due under the transaction
documents through July 1, 2004 and (iii) to extend the effective date of the
Form S-1 registration statement until July 1, 2004. The new warrants have an
exercise price equal to $1.52 per share and the fair value of these warrants was
estimated by using the Black-Scholes Option-Pricing Model and totaled $30,981.
This amount was expensed as a component of selling, general and administrative
expenses. Pursuant to the Convertible Debenture agreements, the Company was
required to register the shares of common stock underlying the debentures and
detachable stock purchase warrants issued in connection with the debentures. The
registration of the common shares was required to be effective by July 1, 2004.
As the related Form S-1 registration statement was not effective on July 1,
2004, the Company is required to pay liquidating damages in the amount of
$80,000 per month until the registration statement becomes effective and is in
technical default of the Convertible Debenture agreements and related
transaction documents. Additionally, the institutional investors could declare
us in default of the convertible debentures and demand repayment of the
debentures and all other amounts due under the transaction documents evidencing
their $4 million investment. In September 2004, one investor demanded repayment
of its $300,000 debenture.
In connection with the Convertible Debentures the Company paid financing
fees as follows: 103,896 stock purchase warrants, with a fair value of $268,386,
28,571 shares of common stock with a fair value of $141,141, and cash of
$255,000. Total financing fees of $664,527 were recorded as deferred fees and
are being amortized over the term of the debentures.
The unamortized deferred fees are reported in other non-current assets in
the accompanying balance sheets and total $512,487.
F-18
If the Singing Machine sells shares of its common stock at an effective
price less than Set Price, the debentures' holders are entitled to covert their
debentures into shares at a new conversion price, which equals to the original
set price minus 50% of the difference between the Set Price and the new price if
the event occurs before 9/8/04. On July 30, 2004, the Singing Machine received
the court approval of the Class Action Lawsuit (case# 03- CV-80596) and as a
result issued 400,000 shares to the plaintiff as part of the settlement on
September 27, 2004. The market closing price on July 30, 2004 was $0.60 per
share. The event has triggered the conversion price reset for the convertible
debentures. The debentures are now convertible at a conversion rate of $1.41 and
are convertible into 2,836,879 shares of common stock.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
CLASS ACTION From July 2, 2003 through October 2, 2003, seven securities
class action lawsuits and a shareholder's derivative action were filed against
the Company and certain of its officers and directors in the United States
District Court for the Southern District of Florida on behalf of all persons who
purchased the Company's securities during the various class action periods
specified in the complaints. On September 18, 2003, United States District Judge
William J. Zlock entered an order consolidating the seven (7) purported class
action law suits and one (1) purported shareholder derivative action into a
single action case styled Frank Bielansky v. the Company, Salberg & Company,
P.A., et al - Case Number: 03-80596 - CIV - ZLOCK (the "Class Action"). Salberg
& Company, P.A. is our former independent auditor. The complaints that were
filed allege violations of Section 10(b) and Section 20(a) of the Securities
Exchange Act of 1934 and Rule 10(b)-5. The complaints seek compensatory damages,
attorney's fees and injunctive relief.
The Company entered into a settlement agreement with the plaintiffs in the
Class Action in March 2004. At a hearing in April 2004, the Court gave
preliminary approval for the settlement and directed that notices be sent to
shareholders pursuant to the settlement agreement. The notices advised
shareholders of their rights and responsibilities concerning the settlement. We
entered into a settlement agreement with the plaintiffs in the Class Action in
March 2004.
Pursuant to the terms of the settlement agreement, the Company is required
to make a cash payment of $800,000 and Salberg & Company, P.A., our former
auditor, is required to make a payment of $475,000. Our cash payment of $800,000
is covered by our liability insurance and our insurer has placed this payment in
an escrow account pending final approval of the Settlement. In addition, the
Company is obligated to issue 400,000 shares of its common stock and may also
provide other non-cash consideration. The pending settlement would also obligate
the Company to implement certain corporate governance changes, including an
expansion of its Board of Directors to six members with independent directors
comprising at least 2/3 of the total Board seats.
As of March 31, 2004, the Company recorded an expense equal to the total
estimated cost of the settlement less the amount expected to be reimbursed by
the Company's insurance carrier. The net charge associated with this matter
totaled approximately $462,000 and is included as a component of selling,
general and administrative expenses in the accompanying statements of
operations.
The court entered an order approving the settlement agreement on July 30,
2004. The Company has issued the 400,000 thousand shares to the plaintiffs on
September 27, 2004 and $800,000 was placed in escrow for the benefit of the
plaintiffs.
F-19
OTHER MATTERS. In August 2003, we were advised that the Securities and
Exchange Commission had commenced an informal inquiry of our company. We are
cooperating fully with the SEC staff. It appears that the investigation is
focused on the restatement of our audited financial statements for fiscal 2002
and 2001. We have been advised that an informal inquiry should not be regarded
as an indication by the SEC or its staff that any violations of law have
occurred or as a reflection upon any person or entity that may have been
involved in those transactions.
The Company entered into a settlement agreement with an investment banker
on November 17, 2003. Pursuant to this agreement, the Company agreed to pay the
sum of $181,067 over a five month period and issue to the investment banker
40,151 shares of stock with a fair value of $94,355. As of the date of the
settlement agreement, the Company expensed the total amount of the settlement,
which is included as selling, general and administrative expenses in the
accompanying statements of operations. As of March 31, 2004, the unpaid balance
totaled $72,427 and is included in accounts payable in the accompanying balance
sheets.
F-20
The Company is also subject to various other legal proceedings and other
claims that arise in the ordinary course of its business. In the opinion of
management, the amount of ultimate liability, if any, in excess of applicable
insurance coverage, is not likely to have a material effect on the financial
condition, results of operations or liquidity of the Company. However, as the
outcome of litigation or other legal claims is difficult to predict, significant
changes in the estimated exposures could occur, which could have a material
impact on the Company's operations.
LEASES
The Company has entered into various operating lease agreements for office
and warehouse facilities in Coconut Creek, Florida, Compton, California, Rancho
Dominguez, California and Kowloon, Hong Kong. The leases expire at varying
dates. Rent expense for fiscal 2004, 2003 and 2002 was $1,542,041, $901,251 and
$333,751, respectively.
In addition, the Company maintains various warehouse and computer
equipment operating leases.
Future minimum lease payments under property and equipment leases with
terms exceeding one year as of March 31, 2004 are as follows:
PROPERTY LEASE EQUIPMENT LEASES
-------------- ----------------
Year ending March 31:
2005 $ 838,792 $ 71,746
2006 579,851 19,502
2007 495,545 7,969
2008 371,659 13,044
2009 371,659 8,002
-------------- ----------------
$ 2,657,506 $ 120,263
============== ================
EMPLOYMENT AGREEMENTS
The Company has employment contracts with three key officers and one
employee as of March 31, 2004. These agreements provide for base salaries, with
annual cost of living adjustments and travel allowances and expire through March
31, 2006. In the event of a termination for cause or in the event of a change of
control, as defined in the agreements, the employees would be entitled to a lump
sum payment in the aggregate of $533,000.
The Company entered into a separation and release agreement with an
executive on December 19, 2003. The agreement provided for the individual to
receive $161,939 in settlement of the Company's contract. The amount of the
settlement was expensed as compensation as of the date of the agreement.
The Company entered into a separation and release agreement with an
executive on April 6, 2004. The agreement provided for the individual to receive
$115,519 in settlement of the Company's contract. The amount has been expensed
as compensation at March 31, 2004, at which time the amount settled was probable
and estimatable.
The Company entered into a separation and release agreement with an
executive on April 12, 2004. The agreement provided for the individual to
receive $51,050 in settlement of the Company's contract. The amount has been
expensed as compensation at March 31, 2004, at which time the amount settled was
probable and estimatable
MERCHANDISE LICENSE AGREEMENTS
The Company entered into a licensing agreement with MTV in November 2000
and have amended the agreement five times since that date. This license covers
the sale of MTV products in the United States, Canada and Australia. During
fiscal 2004, the Company's product line consisted of nine MTV branded machines
and a wide assortment of MTV branded music. The license agreement as amended
with MTV currently expires on August 31, 2004, subject to MTV's option, at its
sole discretion, to extend the agreement for additional four month period. Each
of the license periods contains a minimum guarantee royalty payment of $200,000,
which is recoupable against sales throughout the calendar year, unless the
license agreement is cancelled. The remaining future minimum payment is $200,000
as of March 31, 2004.
F-21
In February 2003, the Company entered into a multi-year license agreement
with Universal Music Entertainment to market a line of Motown Karaoke machines
and music. This agreement and its subsidiary agreement signed in March 2003,
allow the Company to be the first to use original artist recordings for our CD+G
formatted karaoke music. Over the term of the license agreement, the Company is
obligated to make guaranteed minimum royalty payments over a specified period of
time in the amount of $300,000. The Universal Music Entertainment license
expires on March 31, 2006 and does not contain any automatic renewal provisions.
The remaining future minimum payment is $175,000 as of March 31, 2004.
The Company entered into a license agreement with Care Bears in September
2003. Under this agreement, the Company licensed Care Bears branded machines and
electronic products. This license expires on January 1, 2006. Over the term of
the license agreement, the Company is obligated to make guaranteed minimum
royalty payments over a specific period of time in the amount of $200,000. The
remaining future minimum payment is $175,000 as of March 31, 2004
NOTE 10 - STOCKHOLDERS' EQUITY
COMMON STOCK ISSUANCES
During the fiscal ended March 31, 2004, the Company issued 580,640 shares
of its common stock. Of these shares, 28,571 were issued in lieu of a cash
payment of commission and closing costs relating to the Convertible Debentures.
Certain executives received 63,420 shares of common stock in lieu of a portion
of their cash compensation and bonuses for fiscal 2004. The fair value of this
stock, $290,464 was charged to compensation expense. 40,151 shares of stock were
issued in lieu of a settlement with an investment banker, at an estimated fair
value of $94,355. The remaining 448,498 shares of stock issued were through the
exercise of vested stock options.
During fiscal 2004, 2003 and 2002, the Company issued the following shares
of stock upon exercise of outstanding options and warrants.
NUMBER OF SHARES
ISSUED PROCEEDS TO COMPANY
---------------- -------------------
2004 580,640 $ 860,535
2003 151,651 $ 242,119
2002 1,481,347 $ 1,314,659
GUARANTEE FEES
During the year ended March 31, 2000, the Company issued 525,000 shares of
common stock to two officers of the Company in exchange for guarantees related
to the Company's factor agreement, and letter of credit agreement. These
guarantee fees totaled $590,625 and were amortized over a period of 31 months.
For the year ended March 31, 2002, $171,472 of deferred fees were charged to
operations. There were no remaining deferred guarantee fees at March 31, 2002.
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 (loss)
earnings per share is computed by dividing net (loss) earnings for the year by
the weighted average number of common shares outstanding including the effect of
common stock equivalents.
In 2004, 2003 and 2002, 2,657,532, 90,000 and 0 common stock equivalents,
respectively, were not included in the computation of diluted (loss) earnings
per share as their effect would have been antidilutive.
For the fiscal year ended March 31, 2004, there were 1,618,570 common
stock options and warrants outstanding with exercise prices between $1.30 and
$14.30. In addition, there was a potential 1,038,962 shares that may be issued
in connection with the Convertible Debentures if certain conditions exist.
However, the Convertible Debentures are now convertible into 2,836,879 shares of
common stock because of a reset conversion price.
F-22
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 March 31, 2004, the Plan is authorized to grant options up to an
aggregate of 1,950,000 shares of the Company's common stock and up to 300,000
shares for any one individual in any fiscal year. As of March 31, 2004, the
Company had granted 922,470 options under the Year 2001 Plan, leaving 1,027,530
options available to be granted. As of March 31, 2004, the Company had 358,700
options issued and outstanding under its 1994 Plan.
In accordance with SFAS No. 123, for options issued to employees, the
Company applies the intrinsic value method of APB Opinion No. 25 and related
interpretations in accounting for its options issued. The following table sets
forth the issuances of stock options for fiscal 2004, 2003 and 2002.
The exercise price of employee common stock option issuances in 2004, 2003
and 2002 was equal to the fair market value on the date of grant. Accordingly,
no compensation cost has been recognized for options issued under the Plan in
these years. A summary of the options issued as of March 31, 2004, 2003 and 2002
and changes during the years is presented below.
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER OF EXERCISE NUMBER OF EXERCISE NUMBER OF EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------------------- ----------------------- -----------------------
FISCAL YEAR 2004 2003 2002
Stock Options:
Balance at beginning of period 1,543,250 $ 4.43 1,094,475 $ 2.11 2,433,300 $ 1.31
Granted 423,980 $ 2.66 567,000 $ 7.88 82,800 $ 3.92
Exercised (448,500) $ 1.91 (143,725) $ 1.63 (1,406,625) $ 0.87
Forfeited (491,200) $ 6.75 (4,500) $ 2.04 (15,000) $ 2.04
--------- --------- ----------
Balance at end of period 1,027,530 $ 3.95 1,513,250 $ 4.43 1,094,475 $ 2.11
========= ========= ==========
Options exercisable at end of period
630,168 $ 4.48 976,250 $ 2.45 647,738 $ 2.11
========= ========= ==========
Weighted average fair value of $ 2.63 $ 8.19 $ 1.54
options granted during the period
The following table summarizes information about employee stock options
and warrants outstanding at March 31, 2004:
NUMBER WEIGHTED AVERAGE NUMBER
OUTSTANDING REMAINING WEIGHTED AVERAGE EXERCISABLE WEIGHTED AVERAGE
AT MARCH 31, 2004 CONTRACTUAL LIFE EXERCISE PRICE AT MARCH 31, 2003 EXERCISE PRICE
----------------- ---------------- ---------------- ----------------- ----------------
$1.30 - $1.97 288,330 8.43 $ 1.73 20,001 $ 1.30
$2.04 373,700 2.39 $ 2.04 373,000 $ 2.04
$3.83 -$7.26 215,000 7.20 $ 5.66 91,667 $ 5.67
$9.00 -$14.30 150,500 6.47 $ 10.47 145,500 $ 10.43
----------------- -----------------
1,027,530 630,168
================= =================
F-23
STOCK WARRANTS
During fiscal year 2004, the Company issued a total of 591,040 stock
purchase warrants as follows. In September, 2003, 457,143 of the warrants were
issued to investors in connection with the $4 million debenture offering (see
Note 8) and 103,896 warrants were issued to the respective investment banker.
The estimated fair value of the warrants issued to the investors in the amount
of $1,180,901 was recorded as a discount on the debentures and the estimated
fair value of the warrants issued to the investment banker in the amount of
$268,386 has been record as deferred fees. Both amounts are being amortized over
the term of the debentures. In February 2004, the Company issued an additional
30,001 warrants to the investors in connection with a settlement agreement (see
Note 8). The estimated fair value of these warrants totaled $30,981, which was
expensed as component of selling, general and administrative expenses. The
weighted average fair value of warrants issued during fiscal 2004 and
outstanding as of March 31, 2004 was $2.67.
As of March 31, 2004, 591,040 stock purchase warrants were outstanding and
exercisable with a weighted average exercise price of $3.98. The range of
exercise prices was between $1.52 and $4.03 per common share.
NOTE 11 - INCOME TAX
The Company files separate tax returns for the parent and for the Hong
Kong Subsidiary. The income tax expense (benefit) for federal, foreign, and
state income taxes in the consolidated statement of earnings consisted of the
following components for 2004, 2003 and 2002:
2004 2003 2002
------------ ------------ ------------
(as restated)
Current:
U.S. Federal $ (1,071,709) $ 663,816 $ 1,027,545
Foreign -- 1,230,650 748,672
State (95,398) 38,500 119,277
Deferred $ 1,925,612 $ (1,734,194) $ --
------------ ------------ ------------
$ 758,505 $ 198,772 $ 1,895,494
============ ============ ============
The United States and foreign components of earnings (loss) before income
taxes are as follows:
2004 2003 2002
------------- ------------- -----------
UNITED STATES $ (21,362,610) $ (5,952,129) $ 3,669,341
FOREIGN (562,309) 7,368,713 4,515,218
------------- ------------- -----------
$ (21,924,919) $ 1,416,584 $ 8,184,559
============= ============= ===========
THE ACTUAL TAX EXPENSE DIFFERS FROM THE "EXPECTED" TAX EXPENSE FOR THE
YEARS ENDED MARCH 31, 2004, 2003 AND 2002 (COMPUTED BY APPLYING THE U.S. FEDERAL
CORPORATE TAX RATE OF 34 PERCENT TO INCOME BEFORE TAXES) AS FOLLOWS:
2004 2003 2002
------------ ------------ -------------
(AS RESTATED)
EXPECTED TAX EXPENSE (BENEFIT) $ (7,454,472) $ 481,880 $ 2,782,750
(426,796) (43,204) 78,723
STATE INCOME TAXES, NET OF FEDERAL
INCOME TAX BENEFIT
PERMANENT DIFFERENCES 5,830 69,114 --
DEEMED DIVIDEND 410,513 1,011,628 1,027,545
CHANGE IN VALUATION ALLOWANCE 8,160,924 -- (1,059,089)
TAX RATE DIFFERENTIAL ON
FOREIGN EARNINGS 92,781 (1,326,368) (812,739)
OTHER (30,274) 5,723 (121,696)
------------ ------------ -------------
ACTUAL TAX EXPENSE $ 758,505 $ 198,772 $ 1,895,494
============ ============ =============
F-24
THE TAX EFFECTS OF TEMPORARY DIFFERENCES THAT GIVE RISE TO SIGNIFICANT
PORTIONS OF DEFERRED TAX ASSETS AND LIABILITIES AT MARCH 31, 2004 AND 2003 ARE
AS FOLLOWS:
2004 2003
------------- ------------
DEFERRED TAX ASSETS:
INVENTORY DIFFERENCES $ 2,309,487 $ 1,491,021
STATE NET OPERATING LOSS CARRYFORWARD 502,417 171,019
FEDERAL NET OPERATING LOSS CARRYFORWARD 2,425,186 --
HONG KONG NET OPERATING LOSS CARRYFORWARD 98,404 --
HONG KONG FOREIGN TAX CREDIT 2,447,746 --
AMT CREDIT CARRYFORWARD 70,090 --
BAD DEBT RESERVE 33,323 137,958
RESERVE FOR SALES RETURNS 161,726 110,303
CHARITABLE CONTRIBUTIONS 58,037 --
AMORTIZATION OF REORGANIZATION INTANGIBLE 68,981 28,076
------------- ------------
TOTAL GROSS DEFERRED ASSETS 8,175,397 1,938,377
LESS VALUATION ALLOWANCE (8,160,924) --
DEFERRED TAX LIABILITY -- 1,938,37
7
DEPRECIATION (14,473) (12,765)
------------- ------------
NET DEFERRED TAX ASSET $ (0.00) $ 1,925,612
============= ============
NOTE 12 - SEGMENT INFORMATION
The Company operates in one segment and maintains its records accordingly.
The majority of sales to customers outside of the United States are made by the
Hong Kong Subsidiary. Sales by geographic region for the year ended March 31
were as follows:
2004 2003 2002
------------ ------------ -------------
United States $ 41,729,879 $ 76,777,138 $ 62,333,801
Asia -- 21,310 49,314
Australia 959,444 814,334 --
Canada 1,314,617 919,642 47,565
Europe 25,783,789 15,714,846 --
Latin America 753,399 1,366,496 45,073
------------ ------------ -------------
$ 70,541,128 $ 95,613,766 $ 62,475,753
============ ============ =============
The geographic area of sales is based primarily on the location where the
product is delivered.
NOTE 13 - EMPLOYEE BENEFIT PLANS
The Company has a 401(k) plan for its employees to which the Company makes
contributions at rates dependent on the level of each employee's contributions.
Contributions made by the Company are limited to the maximum allowable for
federal income tax purposes. The amounts charged to operations for contributions
to this plan and administrative costs during the years ended March 31, 2004,
2003 and 2002 totaled $55,402, $61,466 and $41,733, respectively and are
included as a component of compensation expenses in the accompanying statements
of operations. The Company does not provide any post employment benefits to
retirees.
F-25
NOTE 14 - CONCENTRATIONS OF CREDIT RISK, CUSTOMERS, SUPPLIERS, AND FINANCING
The Company derives primarily all of its revenues from retailers of
products in the U.S. Financial instruments, which potentially subject the
Company to concentrations of credit risk, consist of accounts receivable. The
Company's allowance for doubtful accounts is based upon management's estimates
and historical experience and reflects the fact that accounts receivable are
concentrated with several large customers whose credit worthiness have been
evaluated by management. At March 31, 2004, 65% of accounts receivable were due
from three customers: two from the U.S. and one from an International Customer.
Accounts receivable from three customers that individually owed over 10% of
accounts receivable at March 31, 2004 was 31%, 24% and 10%. Accounts receivable
from four customers that individually owed over 10% of accounts receivable at
March 31, 2003 was 22%, 19%, 15% and 11%. The Company performs ongoing credit
evaluations of its customers and generally does not require collateral.
Revenues derived from five customers in 2004, 2003 and 2002 were 54%, 67%
and 87% of revenues, respectively. Revenues derived from three customers in 2004
,2003, and 2002, respectively, which individually purchased greater than 10% of
the Company's total revenues, were 20%, 12% and 10% in 2004, 21%, 17% and 15% in
2003, 37%, 28%, and 10% in 2002.
The Company is dependent upon foreign companies for the manufacture of all
of its electronic products. The Company's arrangements with manufacturers are
subject to the risk of doing business abroad, such as import duties, trade
restrictions, work stoppages, foreign currency fluctuations, political
instability, and other factors, which could have an adverse impact on its
business. The Company believes that the loss of any one or more of their
suppliers would not have a long-term material adverse effect because other
manufacturers with whom the Company does business would be able to increase
production to fulfill their requirements. However, the loss of certain suppliers
in the short-term could adversely affect business until alternative supply
arrangements are secured.
During fiscal years 2004, 2003 and 2002, manufacturers in the People's
Republic of China ("China") accounted for approximately 96%, 94% and 95%,
respectively, of the Company's total product purchases, including all of the
Company's hardware purchases.
Net sales derived from the Hong Kong Subsidiary aggregated $43.1 million
in 2004, $49.3 million in 2003 and $27.2 million in 2002. The carrying value of
net assets held by the Company's Hong Kong based subsidiary was $ 14.4 million
at March 31, 2004.
F-26
NOTE 15 - QUARTERLY FINANCIAL DATA - UNAUDITED
The following financial information reflects all normal recurring
adjustments that are, in the opinion of management, necessary for a fair
statement of the results of the interim periods. The quarterly unaudited results
for the years 2004 and 2003 are set forth in the following table:
BASIC DILUTED
EARNINGS EARNINGS
NET EARNINGS (LOSS) (LOSS)
SALES GROSS PROFIT (LOSS) PER SHARE PER SHARE
------------------- ------------------ ------------------- ------------- -------------
2004
First quarter $ 7,627,975 $ 1,726,109 $ (2,317,352) $ (0.28) $ (0.28)
Second quarter 31,984,251 3,803,539 (656,669) (0.08) (0.08)
Third quarter 28,689,623 (2,601,125) (10,450,601)(1) (1.20) (1.20)
Fourth quarter 2,239,279 (1,109,973) (9,258,802)(2) (1.09) (1.09)
------------------- ------------------ ------------------- ------------- -------------
Total $ 70,541,128 $ 1,818,550 $ (22,683,424) $ (2.65) $ (2.65)
=================== ================== =================== ============= =============
2003
First quarter $ 4,264,203 $ 1,273,322 $ (1,358,780) $ (0.17) $ (0.17)
Second quarter 33,044,306 9,754,954 4,837,926 0.60 0.54
Third quarter 49,102,372 14,525,191 3,846,894 0.47 0.43
Fourth quarter 9,202,885 (2,268,736) (6,108,228) (0.75) (0.66)
------------------- ------------------ ------------------- ------------- -------------
Total $ 95,613,766 $ 23,284,731 $ 1,217,812 $ 0.15 $ 0.14
=================== ================== =================== ============= =============
(1) Includes additional inventory write-downs totaling $4.8 million and
deferred tax valuation allowance adjustment in the amount of $1.9 million.
(See note 1 for details)
(2) Includes additional inventory write-downs totaling $1.7 million.
[Balance of page intentionally left blank] mi
F-27
SUPPLEMENTAL DATA
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
BALANCE AT CHARGED TO CREDITED TO BALANCE AT
BEGINNING OF COSTS AND REDUCTION TO COSTS AND END OF
DESCRIPTION PERIOD EXPENSES FOR WRITE OFF EXPENSES PERIOD
------------------------------------ ----------- ------------- ------------ ------------ -------------
Year ended March 31, 2004
Reserves deducted from
assets to which they apply:
Allowance for doubtful accounts $ 405,759 $ 70,788 $ (148,074) $ (230,464) $ 98,009
Deferred tax valuation allowance $ - $ 8,160,924 $ $ $ 8,160,924
Year ended March 31, 2003
Reserves deducted from assets
to which they apply:
Allowance for doubtful accounts $ 12,022 $ 412,055 $ - $ (18,318) $ 405,759
Deferred tax valuation allowance $ - $ - $ - $ - $ -
Year ended March 31, 2002
Reserves deducted from assets
to which they apply:
Allowance for doubtful accounts $ 9,812 $ 45,078 $ (42,868) $ - $ 12,022
Deferred tax valuation allowance $ - $ - $ - $ - $ -
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth various expenses, which will be incurred in
connection with the registration of our securities. Other than the SEC
Registration Fee, the amounts set forth below are estimates:
SEC Registration Fee $ 947
Printing & Engraving Expenses $ 5,000
Legal Fees and Expenses $25,000
Accounting Fees and Expenses $30,000
Transfer Agent Fees $ 1,000
-------
TOTAL $60,947
=======
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
As a Delaware corporation, we are subject to the Delaware General
Corporation Law. Section 102(b)(7) of Delaware law enables a corporation in its
certificate of incorporation to eliminate or limit personal liability of members
of its Board of Directors for monetary damages for breach of a director's
fiduciary duty of care. Article 10 of our Certificate of Incorporation provides
that a director shall not be personally liable to us or our stockholders for
monetary damages for breach of fiduciary duty as a director, except for
liability (i) for any breach of the director's duty of loyalty to us or our
stockholders, (ii) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) under Section 174 of
the General Corporation Law of Delaware or (iv) for any transaction from which
the director derived an improper personal benefit and contains a comparable
provision. Under Section 174 of Delaware law, directors are subject to personal
liability if they declare dividends or have the corporate buy back, acquire or
purchase shares of its common stock in circumstances which are not permitted by
Delaware law. Under Delaware law, directors can not declare dividends unless the
company has legally available surplus, as such term is defined under Delaware
law, or the dividends are declared out of net profits in the fiscal year in
which the dividend is declared. Directors can not authorize the acquisition,
purchase or redemption of shares of a company's common stock unless such
transaction is authorized by the company's articles of incorporation.
58
Section 145 of Delaware law permits a corporation organized under Delaware
law to indemnify directors and officers with respect to any matter in which the
director or officer acted in good faith and in a manner he reasonably believed
to be in or not opposed to the best interests of the company, and with respect
to any criminal action or proceeding, he had no reasonable cause to believe his
conduct was unlawful. Article VI of our Bylaws provides that our officers,
directors, employees or agent shall be indemnified to the full extent permitted
by Delaware law. Article VI also provides that we may advance expenses to a
director prior to the final disposition of the action. However, if required
under Delaware law, we may require an officer or director to give us an
undertaking in advance of the final disposition that he will repay all amounts
so advanced, if it shall ultimately be determined that such officer or director
is not entitled to be indemnified under our by-laws or otherwise.
The above discussion of Delaware law and our certificate of incorporation
and bylaws is not intended to be exhaustive and is qualified in its entirety by
our certificate of incorporation, bylaws and Delaware law.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
The following table sets forth our sale of securities during the last
three years, which securities were not registered under the Securities Act of
1933, as amended. Except as described in paragraph 23, no underwriters were
employed with respect to the sale of any of the securities listed below.
1. During fiscal 2000, six employees exercised options to acquire 118,250
stock options. All of these options were granted to our employees on December 8,
1999. The names of the employees, the number of shares purchased and the
proceeds to us are listed below:
NUMBER OF PROCEEDS
SHARES PURCHASE TO THE DATE OF
NAME ACQUIRED PRICE COMPANY EXERCISE
---------------------------- -------------- ------------ ------------ --------------
Melody Rawski 7,500 $ .29 $ 2,150 12/30/99
John Steele 7,500 $ .29 $ 2,150 01/04/00
John Klecha 75,000 $ .29 $ 21,500 01/18/00
Terry Marco 7,500 $ .29 $ 2,150 01/25/00
Terri Phillips 3,750 $ .29 $ 1,075 02/16/00
Adolph Nelson 2,250 $ .29 $ 645 03/15/00
Jorge Otaegui 2,250 $ .29 $ 645 08/02/00
Each of the employees paid for the options with cash. Each employee's
exercise of the option was made in reliance on Section 4(2) of the Securities
Act. Each employee represented that he/she had no need for liquidity in his/her
investment and had adequate financial resources to withstand a total loss of
their investment. A legend was placed on the certificates stating that the
securities were not registered under the Securities Act and set forth the
restrictions on their transferability and sale.
2. During fiscal 2000, eleven warrant holders exercised their warrants to
acquire 195,000 shares of our common stock. Each of these warrant holders
acquired their warrants in our private offering of units that closed on May 12,
1999. The names of the warrant holders, the date of exercise, the number of
shares purchased, the exercise price and the proceeds received by us are listed
below.
PROCEEDS
DATE OF NO. OF EXERCISE TO THE
NAME EXERCISE SHARES PRICE COMPANY
------------------------ ------------- ----------- ----------- --------------
Benchmark Capital 4/26/00 24,000 $ 1.33 $ 32,000
Sebastian Angelico 5/03/00 6,000 $ 1.33 $ 8,000
Josef Bauer 5/15/00 12,000 $ 1.33 $ 16,000
Albert Wardi 5/22/00 3,000 $ 1.33 $ 4,000
Wolcot Capital Inc. 5/24/00 6,000 $ 1.33 $ 128,000
Wendy Blauner 5/24/00 6,000 $ 1.33 $ 8,000
Jon Blauner 5/24/00 6,000 $ 1.33 $ 8,000
John Klecha 9/25/00 6,000 $ 1.33 $ 8,000
Bank Sal. Oppenheim 10/27/00 60,000 $ 1.33 $ 80,000
Sil Venturi 12/01/00 6,000 $ 1.33 $ 8,000
Aton Trust 12/01/00 60,000 $ 1.33 $ 80,000
59
Each of these warrant holders exercised their warrants in reliance upon
Section 4(2) of the Securities Act of 1933, because each of the holders was
knowledgeable, sophisticated and had access to comprehensive information about
us. We placed legends on the certificates stating that the securities were not
registered under the Securities Act and set forth the restrictions on their
transferability and sale.
3. During fiscal 2000, certain of our outside consultants exercised
warrants to acquire an aggregate of 483,000 shares that were issued to them. The
names of the consultants, the date of issuance of the warrants, the date of
exercise, the number of warrants, exercise price and proceeds are listed below.
DATE OF DATE OF NO. OF EXERCISE
NAME ISSUANCE EXERCISE WARRANTS PRICE PROCEEDS
-------------------------------------------- ----------- ------------- ------------- ----------- --------------
Portfolio Research Associates 6/08/99 5/17/00 114,000 $ .92 $ 104,500
Jack Robbins 4/1/5/99 5/24/00 125,000 $ .67 $ 75,000
Jack Robbins 4/15/99 5/24/00 125,000 $ 1.005 $ 112,500
Union Atlantic 2/08/99 11/01/00 30,000 $ .67 $ 20,000
Each of these consultants exercised their warrants in reliance upon
Section 4(2) of the Securities Act of 1933, because each of the holders was
knowledgeable, sophisticated and had access to comprehensive information about
us. We placed legends on the certificates stating that the securities were not
registered under the Securities Act and set forth the restrictions on their
transferability and sale.
4. In May 2000, we obtained two working capital loans in the amount of
$100,000 and $500,000 from Maureen La Rouche and Josef A. Bauer. The loans were
for a period of eight months and bore interest at the rate of 15% per annum. As
consideration for extending the loans, we issued 7,500 warrants to Ms. La Rouche
and 37,500 warrants to Mr. Bauer, on May 25, 2000. Each warrant allowed the
holder to purchase one share of our common stock at an exercise price of $2.18
per share. The warrants expire on May 25, 2003.
5. On September 5, 2000, we issued 37,500 warrants to Neal Berkman for
services rendered to our Company. Mr. Berkman a principal at Berkman and
Associates, a firm that provides investor relation services to us. The warrants
had an exercise price of $2.04 per share and 18,750 warrants vested on December
1, 2001 and the remaining 18,750 on December 1, 2002. The warrants expired on
December 1, 2006. We issued these warrants to Mr. Berkman in reliance upon
Section 4(2) of the Securities Act, because Mr. Berkman was knowledgeable,
sophisticated and had access to comprehensive information about us.
6. On September 5, 2000, we issued an aggregate of 625,500 options to our
employees, as consideration for services they had rendered to us. We issued
these options to our employees in reliance upon Section 4(2) of the Securities
Act, because our employees were knowledgeable, sophisticated and had access to
comprehensive information about us.
NO. OF EXERCISE
NAME OPTIONS PRICE
-------------------------------------- ------------ -----------
Brian Cino 15,000 $ 2.04
April Green 30,000 $ 2.04
Alicia Haskamp 45,000 $ 2.04
John Klecha 270,000 $ 2.04
Terry Marco 45,000 $ 2.04
Marion McElligott 10,000 $ 2.04
Jamilla Miller 4,500 $ 2.04
Howard Moore 37,500 $ 2.04
Adolph Nelson 3,750 $ 2.04
Jorge Otaeugi 4,500 $ 2.04
Terry Phillips 7,500 $ 2.04
Melody Rawski 15,000 $ 2.04
Edward Steele 300,000 $ 2.04
John Steele 75,000 $ 2.04
Richard Torrelli 3,500 $ 2.04
Edwin Young 75,000 $ 2.04
60
For each employee, officer or director, fifty percent of their options are
exercisable on December 1, 2001 and 50% on December 1, 2002. The options all
expire on December 1, 2006.
7. On September 5, 2000, we issued an aggregate of 75,000 options to our
current directors and one previous director for their services to us during the
preceding year. We issued these options to our directors in reliance upon
Section 4(2) of the Securities Act, because our directors were knowledgeable,
sophisticated and had access to comprehensive information about us.
NO. OF EXERCISE
NAME OPTIONS PRICE
-------------------------- ---------- -----------
Josef Bauer 15,000 $ 2.04
Edward Steele 15,000 $ 2.04
John Klecha 15,000 $ 2.04
Howard Moore 15,000 $ 2.04
Alan Schor 15,000 $ 2.04
These options are immediately exercisable and expire on September 5, 2006.
8. On March 13, 2001, we issued 30,000 options to Robert Weinberg and
15,000 options to John DeNovi. Mr. Weinberg received his grant of options
because he was joining our Board of Directors and Mr. DeNovi because he was
joining our company as an employee The exercise price of these options is $3.27
per share and the expiration date is March 13, 2006. Half of Mr. Weinberg's
options vest on December 1, 2001 and the remainder vest on December 1, 2002.
Half of Mr. DeNovi's options vest on March 13, 2002 and the remainder vest on
March 13, 2003. We issued these options to Mr. Weinberg and Mr. DeNovi in
reliance upon Section 4(2) of the Securities Act, because each of them was
knowledgeable, sophisticated and had access to comprehensive information about
us.
9. During fiscal 2002, thirteen employees, one director and one former
director exercised stock options issued under our 1994 Amended and Restated
Management Stock Option Plan. The names of the option holders, the dates of
grant, the dates of exercise, the number of shares purchased, the exercise price
and the proceeds received by us are listed below.
DATE OF DATE OF NO. OF EXERCISE
NAME GRANT EXERCISE SHARES PRICE PROCEEDS
-------------------------------------------- ------------- ------------- ----------- ---------- -----------
Adolph Nelson 12/08/99 04/30/01 2,250 $ .29 $ 645
John Steele 12/08/99 04/30/01 7,500 $ .29 $ 2,150
Teresa Marco 12/08/99 05/01/01 7,500 $ .29 $ 2,150
Terry Philips 12/08/99 05/01/01 2,250 $ .29 $ 645
Brian Cino 12/08/99 05/02/01 5,100 $ .29 $ 1,462
John Klecha 12/08/99 05/30/01 75,000 $ .29 $ 21,500
Melody Rawski 12/08/99 06/14/01 7,500 $ .29 $ 2,150
Terry Phillips 12/08/99 07/11/01 2,250 $ .29 $ 645
April Green 06/25/99 07/11/01 150 $ .66 $ 166
Brian Cino 12/08/99 07/15/01 1,200 $ .29 $ 344
April Green 06/25/99 07/11/01 300 $ 1.11 $ 332
John Steele 12/02/99 07/24/01 15,000 $ 0.29 $ 16,600
Josef Bauer 09/05/00 08/16/01 15,000 $ 2.04 $ 30,600
April Green 06/25/99 08/16/01 300 $ 1.11 $ 332
Edward Steele 12/08/99 09/28/01 262,500 $ .29 $ 75,250
Edward Steele 12/08/99 09/28/01 7,500 $ 2.04 $ 15,300
April Green 06/25/99 10/02/01 1,500 $ 1.11 $ 1,660
April Green 06/25/99 10/31/01 1,500 $ 1.11 $ 1,660
John Steele 06/25/99 11/06/01 15,000 $ 1.11 $ 16,600
Brian Cino 12/08/98 11/13/01 525 $ .29 $ 151
April Green 06/25/99 11/13/01 1,500 $ 1.11 $ 1,660
Teresa Marco 06/25/99 11/13/01 15,000 $ 1.11 $ 16,600
John Steele 09/25/00 12/07/01 7,500 $ 2.04 $ 15,300
61
DATE OF DATE OF NO. OF EXERCISE
NAME GRANT EXERCISE SHARES PRICE PROCEEDS
-------------------------------------------- ------------- ------------- ----------- ---------- -----------
April Green 06/25/99 12/07/01 1,050 $ 1.11 $ 1,162
Melody Rawski 09/25/00 12/18/01 7,500 $ 2.04 $ 15,300
April Green 09/05/00 12/18/01 3,000 $ 2.04 $ 6,120
Edwin Young 09/05/00 12/28/01 37,500 $ 2.04 $ 76,500
Adolph Nelson 09/25/00 12/28/01 1,875 $ 2.04 $ 3,825
Edward Steele 12/08/99 01/03/02 262,500 $ .287 $ 75,250
Edward Steele 06/25/99 01/03/02 45,000 $ 1.107 $ 49,800
Edward Steele 09/05/00 01/03/02 15,000 $ 2.04 $ 30,600
Alicia Haskamp 09/05/00 01/03/02 6,000 $ 2.04 $ 12,240
M. McElligott 09/05/00 02/06/02 3,750 $ 2.04 $ 7,650
Brian Cino 12/09/98 02/06/02 675 $ .287 $ 193.50
Brian Cino 09/05/00 02/06/02 1,350 $ 2.04 $ 2,754
Jorge Otaeugi 12/09/98 02/06/02 2,250 $ .29 $ 645
Jorge Otaeugi 09/05/00 02/06/02 2,250 $ 2.04 $ 4,590
John Steele 09/05/00 02/06/02 7,500 $ 2.04 $ 15,300
Terry Phillips 09/05/00 02/19/02 450 $ 2.04 $ 918
Alan Schor 09/05/00 02/19/02 7,500 $ 2.04 $ 15,300
Robert Torrelli 09/05/00 03/07/02 150 $ 2.04 $ 306
John DeNovi 03/13/01 03/07/02 2,550 $ 3.27 $ 8,330
John Steele 09/05/00 03/14/02 22,500 $ 2.04 $ 45,900
Terry Phillips 09/05/00 03/22/02 900 $ 2.04 $ 1,836
Each person paid for theirs shares with cash. Each person exercised their
options in reliance upon Section 4(2) of the Securities Act of 1933, because
he/she was knowledgeable, sophisticated and had access to comprehensive
information about us. The shares issued to these optionees were registered under
the Securities Act on a registration statement on Form S-8. The shares issued to
employees who were not affiliates did not contain any restrictive legends. The
shares issued to our executive officers and our directors contained a control
legend. Control legends were contained on the shares issued to Edward Steele,
our Chief Executive Officer and a director, John Klecha, our Chief Operating
Officer and a director and Josef Bauer, our director.
10. During fiscal 2002, six warrant holders exercised their warrants to
acquire an aggregate of 75,000 shares of our common stock. All of these persons
acquired their warrants in the Company's private offering of units on May 12,
1999. The names of the warrant holders, the dates of exercise the number of
shares purchased, the exercise price and the proceeds received by us are listed
below.
DATE OF DATE OF NO. OF EXERCISE
NAME GRANT EXERCISE SHARES PRICE PROCEEDS
------------------------- ------------ ------------- ---------- ---------- -----------
Entropy Holdings 05/12/99 04/30/01 15,000 $ 1.33 $ 20,000
Itamar Zac Jones 05/12/99 07/15/01 6,000 $ 1.33 $ 8,000
Anthony Broy 05/12/99 10/31/01 6,000 $ 1.33 $ 8,000
Edward Steele 05/12/99 01/03/02 12,000 $ 1.33 $ 16,000
Fred Merz 05/12/99 02/19/02 6,000 $ 1.33 $ 8,000
John Klecha 05/12/99 03/19/02 30,000 $ 1.33 $ 40,000
Each of the warrant holders paid for their shares with cash. Each of these
warrant holders exercised their warrants in reliance upon Section 4(2) of the
Securities Act of 1933, because each of these holders was knowledgeable,
sophisticated and had access to comprehensive information about us. We placed
legends on the certificates stating that the securities were not registered
under the Securities Act and set forth the restrictions on their transferability
and sale.
11. During fiscal 2002, four consultants exercised their warrants to
acquire an aggregate of 243,600 shares of our common stock. The names of the
warrant holders, the dates of issuance of the warrant, the number of shares
purchased, the exercise price and the proceeds received by us are listed below.
DATE OF DATE OF NO. OF EXERCISE
NAME ISSUANCE EXERCISE SHARES PRICE PROCEEDS
---------------------- ----------- ------------ ------------ ----------- -------------
SISM Research 5/21/99 11/02/01 15,000 $ 1.33 $ 20,000
FRS Investments 7/08/99 12/31/01 30,000 $ .92 $ 27,500
FRS Investments 7/08/99 04/30/01 15,000 $ .92 $ 13,750
FRS Investments 7/08/99 03/04/02 30,000 $ 0.917 $ 27,500
Edward Borelli 7/08/99 10/29/01 143,100 $ .92 $ 131,175
Clarion Finanz AG 4/14/99 11/08/01 10,500 $ .92 $ 92,125
62
Each of the consultants paid for their shares with cash. Each of these
warrant holders exercised their warrants in reliance upon Section 4(2) of the
Securities Act of 1933, because each of these holders was knowledgeable,
sophisticated and had access to comprehensive information about us. We placed
legends on the certificates stating that the securities were not registered
under the Securities Act and set forth the restrictions on their transferability
and sale.
12. On August 15, 2001, we issued an aggregate of 75,000 options to its
directors pursuant to an annual grant of options to persons who had served on
the Board during the previous year. Each of the following directors received
15,000 options: Edward Steele, John Klecha, Josef Bauer, Howard Moore and Robert
Weinberg. The exercise price of the options is $4.25 per share and the options
expire on August 14, 2006. The options are exercisable immediately. We issued
these options to our directors in reliance upon Section 4(2) of the Securities
Act, because our directors are knowledgeable, sophisticated and have access to
comprehensive information about us.
13. On August 16, 2001, Josef Bauer and Maureen LaRoche, Mr. Bauer's
assistant, exercised warrants to acquire an aggregate of 90,000 shares of our
common stock. Mr. Bauer and Ms. LaRoche acquired these warrants on May 15, 2000
when they advanced working capital to our company in May 2000. The dates of
exercise the number of shares purchased, the exercise price and the proceeds
received by us are listed below.
DATE OF NO. OF EXERCISE
NAME EXERCISE SHARES PRICE PROCEEDS
-------------------------- ----------- ---------- ----------- ------------
Josef Bauer 8/16/01 15,000 $ 1.34 $ 20,000
Josef Bauer 8/16/01 37,500 $ 2.17 $ 81,250
Josef Bauer 8/16/01 75,000 $ .67 $ 50,000
Maureen LaRoche 8/16/01 7,500 $ 2.17 $ 16,250
Mr. Bauer and Ms. LaRoche paid for their shares with cash and exercised
their warrants in reliance upon Section 4(2) of the Securities Act of 1933,
because each was knowledgeable, sophisticated and had access to comprehensive
information about us. We placed legends on the certificates stating that the
securities were not registered under the Securities Act and set forth the
restrictions on their transferability and sale.
14. On November 30, 2001, Neil Berkman exercised options to acquire 37,500
shares of our common stock at a purchase price of $2.04 per share. Mr. Berkman
acquired these warrants for financial consulting services that he rendered to
us. Mr. Berkman paid for his shares with cash and exercised their warrants in
reliance upon Section 4(2) of the Securities Act of 1933, because he was
knowledgeable, sophisticated and had access to comprehensive information about
us. We placed legends on the certificates stating that the securities were not
registered under the Securities Act and set forth the restrictions on their
transferability and sale.
15. On December 28, 2001, Josef A. Bauer exercised 15,000 stock options
acquired under our Year 2001 Stock Option Plan at an exercise price of $2.04 per
share. Mr. Bauer received a grant of these options on September 5, 2000. Mr.
Bauer exercised his options in reliance upon Section 4(2) of the Securities Act
of 1933, because he was knowledgeable, sophisticated and had access to
comprehensive information about us. We placed legends on the certificates
stating that the securities were not registered under the Securities Act and set
forth their restrictions on transferability and sale.
16. During fiscal 2003, five employees and a director exercised stock
options issued under our 1994 Amended and Restated Management Stock Option Plan.
All of these options were granted on September 5, 2000. The employees and
director exercised options to acquire an aggregate of 91,225 shares of our
common stock. The names of the option holder, the dates of exercise, the number
of shares purchased, the exercise price and the proceeds received by us are
listed below.
63
DATE OF NO. OF EXERCISE
NAME EXERCISE SHARES PRICE PROCEEDS
----------------------- ------------- ---------- ---------- ------------
Alicia Haskamp 04/06/02 16,500 $ 2.04 $ 33,660
Howard Moore 07/12/02 33,750 $ 2.04 $ 68,850
Terri Phillips 07/31/02 600 $ 2.04 $ 1,224
Adolph Nelson 12/19/02 1,875 $ 2.04 $ 3,825
Edwin Young 01/21/03 37,500 $ 2.04 $ 76,500
April Green 02/24/03 1,000 $ 2.04 $ 2,040
Each employee and director paid for the shares with cash. Each employee
and director exercised his/her options in reliance upon Section 4(2) of the
Securities Act of 1933, because he/she was knowledgeable, sophisticated and had
access to comprehensive information about us. We registered all the stock
underlying the options granted under our 1994 Plan on a registration statement
on Form S-8. The shares issued to employees who were not affiliates did not
contain any restrictive legends. The shares issued to our executive officer and
our director contained a control legend. Control legends were contained on the
shares issued to April Green, our Chief Financial Officer, and Howard Moore, our
director.
17. During the three month period ended June 30, 2002, one warrant holder,
FRS Investments, Inc. ("FRS") exercised its warrants to acquire an aggregate of
52,500 shares of our common stock. FRS received the warrant grant on July 8,
1999 in connection with consulting services rendered to us. The date of
exercise, the number of shares purchased, the exercise price and the proceeds
received by us are listed below.
NO. OF
DATE OF EXERCISE
NAME EXERCISE SHARES PRICE PROCEEDS
-------------------- ----------- ---------- ------------ ------------
FRS Investments 05/17/02 52,500 $ 0.9167 $ 48,125
FRS paid for its shares with cash. FRS exercised its warrants in reliance
upon Section 4(2) of the Securities Act of 1933, because it was knowledgeable,
sophisticated and had access to comprehensive information about the us. We
placed legends on the certificates stating that the securities were not
registered under the Securities Act and set forth the restrictions on their
transferability and sale.
18. On December 31, 2002, we issued an aggregate of 187,000 options to our
employees, as consideration for services they had rendered to us. We issued
these options to our employees in reliance upon Section 4(2) of the Securities
Act, because our employees were knowledgeable, sophisticated and had access to
comprehensive information about us.
NO. OF
NAME OPTIONS ISSUED PRICE
--------------------------------------- ------------------ ---------
Frank Abell 6,000 $ 9.00
Jennifer Barnes 5,000 $ 9.00
Dan Becherer 10,000 $ 9.00
Almina Brady-Dykes 6,000 $ 9.00
Elizabeth Canela 3,000 $ 9.00
Tammy Chestnut 1,000 $ 9.00
Belinda Cheung 500 $ 9.00
Danny Cheung 1,000 $ 9.00
Jeffrey Chiu 1,000 $ 9.00
Brian Cino 3,000 $ 9.00
John DeNovi 10,000 $ 9.00
Teresa Garcia 15,000 $ 9.00
April Green 20,000 $ 9.00
Alicia Haskamp 18,000 $ 9.00
Michelle Ho 3,000 $ 9.00
Wilson Ho 1,000 $ 9.00
Dale Hopkins 10,000 $ 9.00
64
NO. OF
NAME OPTIONS ISSUED PRICE
--------------------------------------- ------------------ ---------
Irene Ko 3,000 $ 9.00
Bill Lau 4,500 $ 9.00
Dora Lee 3,000 $ 9.00
Nataly Lessard 6,000 $ 9.00
Gigi Leung 500 $ 9.00
Marian McElligott 15,000 $ 9.00
Adolph Nelson 2,000 $ 9.00
Rick Ng 500 $ 9.00
Cathy Novello 4,000 $ 9.00
Jennifer O'Kuhn 2,000 $ 9.00
Jorge Otaegui 2,000 $ 9.00
Terri Phillips 3,000 $ 9.00
Melody Rawski 5,000 $ 9.00
Asante Sellers 1,000 $ 9.00
Stacy Sethman 5,000 $ 9.00
John Steele 10,000 $ 9.00
Richard Torrelli 1,000 $ 9.00
Nicolas Venegas 2,000 $ 9.00
Vicky Xavier 2,500 $ 9.00
Ho Man Yeung 500 $ 9.00
Yen Yu 1,000 $ 9.00
For each employee, twenty percent (20%) of their options are exercisable
on January 1, 2004 and 20% exercisable each January 1st thereafter with the last
20% becoming exercisable on January 1, 2008. The options expire 5 years after
they become exercisable with varying expiration dates from December 31, 2009
through December 31, 2013.
19. Effective as of April 15, 2003, we issued an aggregate of 50,000
options to Jack Dromgold as consideration for services that he had rendered to
us. The options had an exercise price of $7.60 per share and vested in five
equal installments over a five year period beginning on January 1, 2004. We
issued these options to Mr. Dromgold in reliance upon Section 4(2) of the
Securities Act, because he was knowledgeable, sophisticated and had access to
comprehensive information about us. We inadvertently failed to report these
options in the first quarter of fiscal 2004. These options expired in March
2004, ninety days after Mr. Dromgold's resignation from our company.
20. During April 2003, four employees exercised stock options issued under
our 1994 Amended and Restated Management Stock Option Plan. The employees
exercised options to acquire an aggregate of 128,500 shares of our common stock.
All of the options were granted on September 5, 2000, except John Klecha
received the grant for 58,500 options at $1.11 on June 25, 1999. The names of
the option holder, the dates of exercise, the number of shares purchased, the
exercise price and the proceeds received by us are listed below.
NO. OF EXERCISE EXERCISE
NAME OPTIONS EXERCISED PRICE DATE PROCEEDS
-------------------- ----------------------- ----------- ------------- ------------
John Steele 30,000 $ 2.04 04/9/03 $ 61,200
Allen Schor 7,500 $ 2.04 04/9/03 $ 15,300
Alicia Haskamp 7,500 $ 2.04 04/18/03 $ 15,300
Alicia Haskamp 10,000 $ 2.04 04/01/03 $ 20,400
John Klecha 58,500 $ 1.11 04/22/03 $ 64,935
John Klecha 15,000 $ 2.04 04/22/03 $ 30,600
All of the above issuances were paid for with cash. The above employees
exercised their options in reliance upon Section 4(2) of the Securities Act of
1933, because each was knowledgeable, sophisticated and had access to
comprehensive information about our company. We registered all the stock
underlying the options granted under our 1994 Plan on a registration statement
on Form S-8. The shares issued to our employees who were not affiliates did not
contain any restrictive legends. The shares issued to our executive officer
contained a control legend. Control legends were contained on the shares issued
to John Klecha, our Chief Operating Officer and director.
65
21. On August 1, 2003, we issued 14, 492 and 11,594 shares of its common
stock to Jack Dromgold and John Steele as bonus payments, respectively. Mr.
Dromgold was guaranteed a $50,000 bonus in cash under his employment agreement,
but he agreed that we could pay his bonus with shares of our common stock. Mr.
John Steele was entitled to an $80,000 bonus under his employment agreement, but
he agreed to take a $40,000 bonus which would be paid with our common stock. Our
average trading price for the five days preceding August 1, 2003 of $3.45 was
used to calculate the number of shares that would be issued to Mr. Dromgold and
Mr. Steele. We issued these shares to Mr. Dromgold and Mr. Steele in reliance
upon Section 4(2) of the Securities Act, because each of them was knowledgeable,
sophisticated and had access to comprehensive information about our company. We
placed restrictive legends on the certificates stating that the securities were
not registered under the Securities Act and set forth their restrictions on
transferability and sale.
22. On August 1, 2003, Yi Ping Chan, Jack Dromgold and Edward Steele
agreed to take 15% of their annual compensation in the form of stock. The salary
reductions for Mr. Chan and Mr. Dromgold covered a nine month period from August
1, 2003 through March 31, 2004 and the salary reduction for Mr. Steele covered
an eight month period from August 1, 2003 through February 28, 2004. The average
trading price of our common stock for the five days preceding August 1, 2003 of
$3.45 was used to calculate the number of shares that would be issued to Mr.
Chan, Mr. Dromgold and Mr. Steele. Mr. Chan agreed to take a salary reduction of
$3,125 per month for an aggregate of $28,125 over a nine month period , which
would be paid with 8,153 shares of our common stock. Mr. Dromgold agreed to take
a salary reduction of $1,948 per month for an aggregate of $17,535 over a nine
month period, which would be paid with 5,082 shares of our common stock. Mr.
Steele agreed to take a salary reduction of $7,892 per month for an aggregate of
$63,136 over an eight month period, which would be paid with 18,300 shares of
our common stock. We issued these shares to Mr. Chan, Mr. Dromgold and Mr.
Steele in reliance upon Section 4(2) of the Securities Act, because each of them
was knowledgeable, sophisticated and had access to comprehensive information
about our company. We placed restrictive legends on the certificates stating
that the securities were not registered under the Securities Act and set forth
their restrictions on transferability and sale.
23. On August 1, 2003, we issued 2,899 shares of our common stock to Josef
A. Bauer and Howard Moore for services that they had rendered on our Board
during fiscal 2003. The value of these shares was equal to $10,000, based on the
five day average trading price of our common stock during the five day period
preceding August 1, 2003, which was $4.60. We issued these shares to Mr. Bauer
and Mr. Moore in reliance upon Section 4(2) of the Securities Act, because each
of them was knowledgeable, sophisticated and had access to comprehensive
information about our company. We placed restrictive legends on the certificates
stating that the securities were not registered under the Securities Act and set
forth their restrictions on transferability and sale.
24. On September 8, 2003, we issued an aggregate of $4,000,000 of 8%
convertible debentures in a private offering to six accredited investors. The
debentures initially are convertible into shares of common stock at a price of
$3.85 per share, subject to adjustment in certain situations. Each investor also
received warrants equal to 40% of the subscription amount divided by $3.50. The
exercise price of the warrants is $4.025 per share and the warrants expire on
September 7, 2006. We have an obligation to register the shares of common stock
underlying the debenture and warrants, which we are satisfying by filing this
registration statement. The names of the investors, the amount of the debentures
and the number or warrants issuable to each investor are set forth below.
AMOUNT OF NO. OF
NAME DEBENTURES WARRANTS
-------------------------------------- ---------------- ------------
Omnicron Master Trust $ 2,500,000 285,714
SF Capital Partners, Ltd $ 500,000 57,143
Bristol Investment Fund, Ltd. $ 300,000 34,286
Ascend Offshore Fund, Ltd. $ 478,000 54,629
Ascend Partners, LP $ 58,200 6,651
Ascend Partners Sapient LP $ 163,800 18,720
We issued these shares to these persons in reliance upon Section 4(2) of
the Securities Act, because the investors were knowledgeable, sophisticated and
had access to comprehensive information about us. We placed legends on the
debentures and the warrant agreements stating that the securities were not
registered under the Securities Act and set forth the restrictions on their
transferability and sale. We used Roth Capital as our placement agent and they
received a commission equal to 5.5% of the proceeds and a warrant to purchase
103,896 shares or our common stock. We agreed to register the shares underlying
Roth's warrant in a registration statement.
66
25. On November 17, 2003, we agreed to issue 40,151 shares of our
common stock to AG Edwards & Sons pursuant to a settlement agreement. In
September 2003, we had a disagreement with AG Edwards & Sons,
regarding the total amount of fees that were payable under our investment
banking agreement with them. We entered into a settlement agreement with them
effective as of November 17, 2003 in which we agreed to pay them the aggregate
sum of $181,067 in five equal installments beginning on November 17, 2003 and
ending on March 15, 2005. We also agreed to issue 40, 151 shares of our common
stock to them and to register these shares for resale in this Prospectus. We
issued the shares to AG Edwards in reliance upon Section 4(2) of the Securities
Act, because it was knowledgeable, sophisticated and had access to comprehensive
information about us. We placed legends on the stock certificates stating that
the shares were not registered under the Securities Act and set forth the
restrictions on their transferability and sale.
26. On December 19, 2003, we issued an aggregate of 221,920 options to our
employees, as consideration for services they had rendered to us. We issued
these options to our employees in reliance upon Section 4(2) of the Securities
Act, because our employees were knowledgeable, sophisticated and had access to
comprehensive information about us.
67
NUMBER OF EXERCISE
NAME OPTIONS PRICE
-------------------------------------- -------------- -----------
Frank Abell 1,320 $ 1.97
Josef Bauer 2,740
Dan Becherer 4,910 $ 1.97
Almina Brady-Dykes 1,320 $ 1.97
Pam Broyles 500 $ 1.97
Elizabeth Canela 660 $ 1.97
Yi Ping Chan 52,800 $ 1.97
Belinda Cheung 110 $ 1.97
Jeffrey Chiu 220 $ 1.97
Brian Cino 660 $ 1.97
John Dahl 50,000 $ 1.97
April Green 4,380 $ 1.97
Alicia Haskamp 24,600 $ 1.97
Jeff Ho 5,000 $ 1.97
Michelle Ho 5,660 $ 1.97
Wilson Ho 220 $ 1.97
Irene Ko 660 $ 1.97
Rose Labadessa 5,000 $ 1.97
Bill Lau 5,990 $ 1.97
Doral Lee 5,660 $ 1.97
Nataly Lessard 1,320 $ 1.97
Marian McElligott 3,290 $ 1.97
Alyssa Malamud 1,000 $ 1.97
Bernardo Melo 4,000 $ 1.97
Rick Ng 110 $ 1.97
Dennis Norden 8,000 $ 1.97
Cathy Novello 880 $ 1.97
Jennifer O'Kuhn 440 $ 1.97
Jorge Otaegui 440 $ 1.97
John Petko 1,500 $ 1.97
Terri Phillips 660 $ 1.97
Melody Rawski 1,100 $ 1.97
Evelyn Romero 500 $ 1.97
Kristi Ronyak 1,000 $ 1.97
Rafael Ros 1,200 $ 1.97
Stacy Sethman 1,100 $ 1.97
Edward Steele 10,000 $ 1.97
john Steele 12,200 $ 1.97
Nicolas Venegas 440 $ 1.97
Ho Man Yeung 110 $ 1.97
Yen Yu 220 $ 1.97
These options vest in three equal installments over a period of three
years, beginning on December 17, 2004. The options expire three years after the
vesting date.
27. On January 23, 2004, we issued an aggregate of 32,000 options to our
employees, as consideration for services they had rendered to us. We issued
these options to our employees in reliance upon Section 4(2) of the Securities
Act, because our employees were knowledgeable, sophisticated and had access to
comprehensive information about us. The names of the employees, the number of
options and the exercise price of the options is listed below.
NUMBER OF EXERCISE
NAME OPTIONS PRICE
-------------------------------------- -------------- -----------
Dennis Nordeen 17,000 $ 1.60
John Steele 15,000 $ 1.60
68
For each employee, 20% of their options vest on January 23, 2005 and 20%
are exercisable on each January 23 thereafter with the last 20% becoming
exercisable on January 23, 2010. The options expire 5 years after the date on
which they first become exercisable with varying expiration dates of January 22,
2010 through January 22, 2015.
28. On February 6, 2004, we issued an aggregate of 41,560 options to our
employees, as consideration for their agreement to reduce their respective
salaries. We issued these options to our employees in reliance upon Section 4(2)
of the Securities Act, because our employees were knowledgeable, sophisticated
and had access to comprehensive information about us. The names of the
employees, the number of options and the exercise price of the options is listed
below.
NUMBER OF EXERCISE
NAME OPTIONS PRICE
---------------------------------- -------------- -----------
Jeffrey Li-Chieh Ho 7,000 $ 1.54
Stacy Blair Sethman 3,500 $ 1.54
Bernardo Melo 6,000 $ 1.54
John Petko 5,640 $ 1.54
Rosalina Labadessa 6,000 $ 1.54
Marian McElligott 6,400 $ 1.54
Frank Abell 7,170 $ 1.54
For each employee, half of these options become exercisable on August 6,
2004 and the remaining half vest on February 5, 2005. The options expire 5 years
after the date on which they become exercisable with an expiration dates of
August 5, 2008 and February 5, 2009.
29. Effective as of February 9,2004, we issued an aggregate of 30,000
warrants to the investors that had purchased debentures in our $4 million
private offering. We agreed to the debenture holders in exchange for their
agreement to (i) enter into new subordination agreements with Milberg, (ii) to
waive all liquidated damages due under the transaction documents through July 1,
2004 and (iii) to extend the effective date of the Form S-1 registration
statement until July 1, 2004. We issued the warrants to the debenture holders in
reliance on Section 4(2) of the Securities Act, because each of the debenture
holders was knowledgeable, sophisticated and had access to comprehensive
information about the Company. The new warrants have an exercise price equal to
$1.52 per share, the fair market value of the Company's common stock on February
9, 2004, the date of the grant. We placed restrictive legends on the warrants
stating that the securities were not registered under the Securities Act and set
forth their restrictions on transferability and sale.
30. On February 26, 2004, we issued an aggregate of 60,000 options to our
three non-employee directors. Josef A. Bauer, Bernard Appel and Richard Ekstract
each received 20,000 options. The exercise price of the options is equal to
$1.30 per share, the fair market value on the date of grant. The options vest in
three equal installments beginning on February 27, 2004 and expire three years
after the vesting date, provided that each person continues to serve on our
Board of Directors. If any of these persons were to resign from our Board, all
vested options would terminate six months after the director's resignation date.
We issued these options to Mr. Bauer, Mr. Appel and Mr. Ekstract in reliance
upon Section 4(2) of the Securities Act, because each of them was knowledgeable,
sophisticated and had access to comprehensive information about our company. We
placed restrictive legends on the options stating that the securities were not
registered under the Securities Act and set forth their restrictions on
transferability and sale.
69
Exhibit Index
3.1 Certificate of Incorporation of the Singing Machine filed with the
Delaware Secretary of State on February 15, 1994 and amendments through
April 15, 1999 (incorporated by reference to Exhibit 3.1 in the Singing
Machine's registration statement on Form SB-2 filed with the SEC on March
7, 2000).
3.2 Certificate of Amendment of the Singing Machine filed with the Delaware
Secretary of State on September 29, 2000 (incorporated by reference to
Exhibit 3.1 in the Singing Machine's Quarterly Report on Form 10-QSB for
the period ended September 30, 1999 filed with the SEC on November 14,
2000).
3.3 Certificates of Correction filed with the Delaware Secretary of State on
March 29 and 30, 2001 correcting the Amendment to our Certificate of
Incorporation dated April 20, 1998 (incorporated by reference to Exhibit
3.11 in the Singing Machine's registration statement on Form SB-2 filed
with the SEC on April 11, 2000).
3.4 Amended By-Laws of the Singing Machine Singing Machine (incorporated by
reference to Exhibit 3.14 in the Singing Machine's Annual Report on Form
10-KSB for the year ended March 31, 2001 filed with the SEC on June 29,
2001).
4.1 Form of Certificate Evidencing Shares of Common Stock (incorporated by
reference to Exhibit 3.3. of the Singing Machine's registration statement
on Form SB-2 filed with the SEC on March 7, 2000). File No. 333-57722).
5.1 Opinion from Counsel
10.1 Factoring Agreement dated February 9, 2004 between Milberg Factors, Inc.
and the Singing Machine. (incorporated by reference to Exhibit 10.1 in the
Singing Machine's Quarterly Report on Form 10- Q filed with the SEC on
February 17, 2004, File No. 000- 24968).
10.2 Security Agreement for Goods and Chattels dated February 9, 2004 between
Milberg Factors, Inc. and the Singing Machine. incorporated by reference
to Exhibit 10.2 in the Singing Machine's Quarterly Report on
Form 10-Q filed with the SEC on February 17,2004, File No. 000-24968).
10.3 Security Agreement for Inventory dated February 9, 2004 between Milberg
Factors, Inc. and the Singing Machine (incorporated by reference to
Exhibit 10.3 in the Singing Machine's Quarterly Report on Form 10- Q filed
with the SEC on February 17, 2004, File No. 000-24968).
10.4 Second Amendment to the Transaction Documents dated February 9, 2004
between Omicron Master Trust, SF Capital Partners, Ltd, Bristol Investment
Fund, Ltd., Ascend Offshore Fund, ltd., Ascend Partners, LP, Ascend
Partners Sapient L.P. and the Singing Machine (incorporated by reference
to Exhibit 10.4 in the Singing Machine's Quarterly Report on Form 10-Q
filed with the SEC on February 17, 2004, File No. 000- 24968).
10.5 Form of Subordination Agreement executed by institutiona Investors.
(Incorporated by reference to Exhibit 10.18 of the Singing Machine's
Amendment No. 1 to its registration statement on Form S-1 filed with SEC
on April, 2004, File No. 333-109574).
10.6 Employment Agreement dated February 27, 2004 between the Singing Machine
and Edward Steele (incorporated by reference to Exhibit 10.6 of the
Singing Machine's Annual Report on Form 10-K for fiscal 2004 filed with
the SEC on July 15, 2004, File No. 000-24968).
70
10.7 Employment Agreement dated May 2, 2003 between the Singing Machine and Yi
Ping Chan. (incorporated by reference to Exhibit 10.20 of the Singing
Machine's Annual Report on Form 10-KSB/A filed with the SEC on July 23,
2003, File No. 000-24968).
10.8 Separation and Release Agreement effective as of May 2, 2003 between the
Singing Machine and John Klecha (incorporated by reference to Exhibit 10.1
of the Singing Machine's Annual Report on Form 8-K filed with the SEC on
July 17, 2003, File No. 000-24968).
10.9 Separation and Release Agreement effective as of April 9 2004 between the
Singing Machine and April Green (incorporated by reference to Exhibit 10.9
of the Singing Machine's Annual Report on Form 10-K for fiscal 2004 filed
with the SEC on July 15, 2004, File No. 000-24968).
10.10 Separation and Release Agreement dated December 16,2003 between the
Singing Machine and Jack Dromgold (incorporated by reference to Exhibit
10.10 of the Singing Machine's Annual Report on Form 10-K for fiscal 2004
filed with the SEC on July 15, 2004, File No. 000-24968).
10.11 Separation and Release Agreement effective as of April 12, 2004 between
the Singing Machine and John Dahl (incorporated by reference to Exhibit
10.11 of the Singing Machine's Annual Report on Form 10-K for fiscal 2004
filed with the SEC on July 15, 2004, File No. 000-24968).
10.12 Industrial Lease dated March 1, 2002, by and between AMP Properties, L.P.
and the Singing Machine for warehouse space in Compton, California
(incorporated by reference to Exhibit 10.20 of the Singing Machine's
Annual Report on Form 10-KSB/A filed with the SEC on July 23, 2002, File
No. 000-24968).
10.13 Amended and Restated 1994 Management Stock Option Plan (incorporated by
reference to Exhibit 10.6 to the Singing Machine's registration statement
on Form SB-2 filed with the SEC on March 28, 2001, File No. 333-59684).
10.14 Year 2001 Stock Option Plan (incorporated by reference to Exhibit 10.1 of
the Singing Machine's registration statement on Form S-8 filed with the
SEC on September 13, 2002, File No. 333-99543).
10.15 Securities Purchase Agreement dated as of August 20, 2003 by and among the
Singing Machine and Omicron Master Trust, SF Capital Partners, Ltd.,
Bristol Investment Fund, Ltd., Ascend Offshore Fund, Ltd., Ascend
Partners, LP and Ascend Partners Sapient, LP (collectively, the
"Investors") (filed as Exhibit 10.1 to the Singing Machine's Registration
Statement filed with the SEC on October 9, 2003, File No. 333- 109574).
10.16 Amendment dated September 5, 2003 to Securities Purchase Agreement between
the Singing Machine and the Investors (filed as Exhibit 10.2 to the
Singing Machine's Registration Statement filed with the SEC on October 9,
2003, File No. 333-109574).
10.17 Form of Debenture Agreement issued by the Singing Machine to each of the
Investors (filed as Exhibit 10.3 to the Singing Machine's Registration
Statement filed with the SEC on October 9, 2003, File No. 333- 109574).
10.18 Form of Warrant Agreement issued by the Singing Machine to the Investors
(filed as Exhibit 10.4 to the Singing Machine's Registration Statement
filed with the SEC on October 9, 2003, File No. 333-109574).
10.19 Warrant Agreement between the Singing Machine and Roth Capital Partners,
LLC (filed as Exhibit 10.5 to the Singing Machine's Registration Statement
filed with the SEC on October 9, 2003, File No. 333- 109574).
10.20 Registration Rights Agreement between the Singing Machine and each of the
Investors and Roth Capital Partners, LLC (filed as Exhibit 10.5 to the
Singing Machine's Registration Statement filed with the SEC on October 9,
2003, File No. 333-109574).
71
10.21 Domestic Merchandise License Agreement dated November 1, 2000 between MTV
Networks, a division of Viacom International, Inc. and the Singing Machine
(incorporated by reference to Exhibit 10.3 of the Singing Machine's
Quarterly Report on Form 10-Q for the quarter ended December 31, 2002,
filed with the SEC on February 14, 2003, File No. 000-24968).
10.22 Amendment dated January 1, 2002 to Domestic Merchandise License Agreement
between MTV Networks, a division of Viacom International, Inc. and the
Singing Machine (incorporated by reference to Exhibit 10.4 of the Singing
Machine's Quarterly Report on Form 10-Q for the quarter ended December 31,
2002, filed with the SEC on February 14, 2003, File No. 0000-24968).
10.23 Second Amendment as of November 13, 2002 to Domestic Merchandise License
Agreement between MTV Networks, a division of Viacom International, Inc.
and the Singing Machine (incorporated by reference to Exhibit 10.5 of the
Singing Machine's Quarterly Report on Form 10-Q for the quarter ended
December 31, 2002, filed with the SEC on February 2003, File No.
000-24968).
10.24 Third Amendment as of February 26, 2003 to Domestic Merchandise License
Agreement between MTV Networks, a division of Viacom International, Inc.
and the Singing Machine (incorporated by reference to Exhibit 10.10 of the
Singing Machine's Annual Report on Form 10-K for the fiscal year ended
March 31, 2003, filed with the SEC on July 17, 2003, File No. 000-24968).
10.25 Amendment to Domestic Licensing Agreement dated November 15, 2002 between
the Singing Machine and MTV Networks, a division of Viacom International,
Inc. (incorporated by reference to Exhibit 10.5 in the Singing Machine's
Quarterly Report on Form 10-Q filed with the SEC on February 17, 2004,
File No. 000-24968).
10.26 Fifth Amendment to Domestic Licensing Agreement dated December 23, 2003
between the Singing Machine and MTV Networks, a division of Viacom
International, Inc. (incorporated by reference to Exhibit 10.6 in the
Singing Machine's Quarterly Report on Form 10-Q filed with the SEC on
February 17, 2004, File No. 000-24968).
10.27 Sales Agreement effective as of December 9, 2003 between the Singing
Machine and CPP Belwin, Inc. and its affiliates (incorporated by reference
to Exhibit 10.7 in the Singing Machine's Quarterly Report on Form 10-Q
filed with the SEC on February 17, 2004, File No. 000-24968).
10.28 Distribution Agreement dated April 1, 2003 between the Singing Machine and
Arbiter Group, PLC (incorporated by reference to Exhibit 10.28 of the
Singing Machine's Annual Report on Form 10-K for fiscal 2004 filed with
the SEC on July 15, 2004, File No. 000-24968).
10.29 Loan Agreements dated August 13, 2003 in the aggregate amount of $1
million between the Company and each of Josef A. Bauer, Howard Moore &
Helen Moore Living Trust, Maureen G. LaRoche and Yi Ping Chan
(incorporated by reference to Exhibit 10.28 of the Singing Machine's
Annual Report on Form 10-K for fiscal 2004 filed with the SEC on July 15,
2004, File No. 000-24968).
10.30 Letter dated March 4, 2003 from Josef A. Bauer to the Singing Machine
regarding a $400,000 loan (incorporated by reference to Exhibit 10.30 of
the Singing Machine's Annual Report on Form 10-K for fiscal 2004 filed
with the SEC on July 15, 2004, File No. 000-24968).
14.1 Code of Ethics (incorporated by reference to Exhibit 14. of the Singing
Machine's Annual Report on Form 10-K for fiscal 2004 filed with the SEC on
July 15, 2004, File No. 000-24968).
21.1 List of Subsidiaries (incorporated by reference to Exhibit 21.1 of the
Singing Machine's Annual Report on Form 10-K for fiscal 2004 filed with
the SEC on July 15, 2004, File No. 000-24968).
23.1 Consent of Grant Thornton LLP.
23.2 Consent of Salberg & Co.
72
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement to:
(i) Include any Prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) Reflect in the Prospectus any facts or events which,
individually or together, represent a fundamental change in
the information in the registration statement. Notwithstanding
the foregoing, any increase or decrease in volume of
securities offered (if the total dollar value of securities
offered would not exceed that which was registered) and any
deviation from the low or high end of the estimated maximum
offering range may be reflected in the form of Prospectus
filed with the Securities and Exchange Commission pursuant to
Rule 424(b) if, in the aggregate, the change in volume and
price represents no more than a 20% change in the maximum
aggregate offering price set forth in the "Calculation of the
Registration Fee" table in the effective registration
statement; and
(iii) Include any additional or changed material information on the
plan of distribution.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, as amended, treat each such post-effective amendment as
a new registration statement relating to the securities offered therein, and the
offering of the securities at that time to be the initial bona fide offering
thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the termination of
the offering.
(4) For purposes of determining any liability under the Securities Act
of 1933, as amended, treat the information omitted from the form of Prospectus
filed as part of this registration statement in reliance upon Rule 430A, and
contained in a form of Prospectus filed by the small business issuer under Rule
424(b)(1) or (4) or 497(h) under the Securities Act as part of this registration
statement as of the time the Commission declares it effective.
(5) For determining any liability under the Securities Act, treat each
post-effective amendment that contains a form of Prospectus as a new
registration statement for the securities offered in the registration statement,
and that offering of the securities at the time as the initial bona fide
offering of those securities.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended, may be permitted to directors, officers and controlling
persons of the Registrant pursuant to the foregoing provisions, or otherwise,
the Registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Securities Act of 1933, as amended, and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the Registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question of whether
such indemnification by it is against public policy as expressed in the
Securities Act of 1933, as amended, and will be governed by the final
adjudication of such issue.
73
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
Registrant has duly caused this Amendment No. 2 to the Registration Statement on
Form S-1, to be signed on its behalf by the undersigned, thereunto duly
authorized in the City of Coconut Creek, Florida, on October 6, 2004.
THE SINGING MACHINE COMPANY, INC.
Dated: October 6, 2004 By: /s/ YI PING CHAN
-------------------------------
Yi Ping Chan
Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated.
SIGNATURE TITLE DATE
-------------------------------------- ---------------------------------------------- ---------------
/s/ YI PING CHAN Chief Executive Officer and Chief Operating October 6, 2004
--------------------------------------
Yi Ping Chan
/s/ JEFF BAROCAS Chief Financial Officer October 6, 2004
-------------------------------------- (Principal Financial Officer)
Jeff Barocas
/s/ JOSEF A. BAUER Director October 6, 2004
--------------------------------------
Josef A. Bauer
/s/ HARVEY JUDKOWITZ Director October 6, 2004
--------------------------------------
Harvey Judkowitz