ITEM 1. BUSINESS
OVERVIEW
The Singing Machine Company, Inc. (the "Singing Machine" "we," "us" or "our") is engaged in the development, production, distribution, marketing and sale of consumer karaoke audio equipment, accessories, music and musical instrument. We contract for the manufacture of all electronic equipment products with factories located in China. We also produce and market karaoke music, including compact disks plus graphics ("CD+G's"), and audiocassette tapes containing music and lyrics of popular songs for use with karaoke recording equipment. All of our recordings include two versions of each song; one track offers music and vocals for practice and the other track is instrumental only for performance by the participant. Virtually all of the cassettes sold by us are accompanied by printed lyrics, and our karaoke CD+G's contain lyrics, which appear on the video screen. We contract for the reproduction of music recordings with independent studios.
We 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 engineering, production, logistic and finance in China. In December 2005, we formed a wholly owned subsidiary SMC (Comercial Offshore De Macau) Limidata in Macau, China to process the orders that ship directly from the factories in China. In the future, the Hong Kong subsidiary will only handle the engineering and production in China.
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.
As used herein, the "Singing Machine," "we," us" and similar terms include The Singing Machine Company, International SMC and SMC (Comercial Offshore Do Macau) Limidata, unless the context indicates otherwise.
PRODUCT LINES
We currently have a product line of 21 different models of karaoke machines plus 5 accessories such as microphones, incorporating such features as CD plus graphics player, sound enhancement, echo, tape record/playback features, and multiple inputs and outputs for connection to compact disc players, video cassette recorders, and home theater systems. Our machines sell at retail prices ranging from $30 for basic units to $200 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 2500 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
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, Walmart, Costco, J.C. Penney, Kohl's, Radio Shack, and Sam's Club.
In fiscal 2006, approximately 70 % of revenues were to the customers within the US and 30% of revenues were international sales. Our sales within the US 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. Our international sales are primarily made by our in-house sales representatives and our independent distributors.
As a percentage of total revenues, our net sales in the aggregate to our five largest customers during the fiscal years ended March 31, 2006, 2005, and 2004, respectively, were approximately 55%, 40% and 54%, respectively. In fiscal 2006, top three major customers accounted for 13%, 12% and 11% of our net 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.
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. and Nickelodeon, both a division of Viacom International, Inc and Universal Music Entertainment, Inc. have also helped us to expand our product name. Our new licensing agreement with Bratz and Hi-5 will help us to promote our new product lines to the youth electronics market.
The Singing Machine brand is one of the most recognized karaoke brands in the United States and the Europe. While we continue to focus on our core karaoke business, we are expanding our business into other product category. Our strong product procurement team in Hong Kong and our experienced sales and service team in the North America enable us to compete not only in karaoke market but also in other markets, such as musical instruments, licensed toy products and other consumer electronics products.
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. 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 7.4% and 9.4% of our net sales in fiscal 2006 and 2005, respectively.
DISTRIBUTORSHIP AGREEMENTS
In September 2005, we signed a one-year exclusive distribution agreement with Warner Elektra Atlantic (WEA) Company to distribute our karaoke music products in the United States. Our karaoke music products are placed at major mass merchants, specialty stores and music stores through WEA distribution network. WEA has an option to renew the distribution agreement for another year. The music products are shipped to WEA warehouse at a consignment basis.
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 3 months before March 31, 2006. The agreement was terminated on March 31, 2006. We also have verbal agreements with six other independent distributors who sell our products throughout Europe
LICENSE AGREEMENTS
In February 2003, we entered into a multi-year license agreement with Universal Music Entertainment to market a line of Motown Karaoke machines and music. This agreement and its subsidiary agreement signed in March 2003, allow us to be the first to use original artist recordings for our CD+G formatted karaoke music. Over the term of the license agreement, we are obligated to make guaranteed minimum royalty payments in the amount of $300,000, which has been paid in full as of March 31, 2005. The Universal Music Entertainment license expired on March 31, 2006 and did not contain any automatic renewal provisions. However, the agreement was extended to December 31, 2006 without any additional minimum guarantee payments.
We entered into a license agreement with Nickelodeon, Inc., a division of Viacom International, Inc. in December 2002. Under this agreement, we licensed Nickelodeon branded machines and a wide assortment of music. This license originally expired on December 31, 2004. The company has extended the agreement to December 31, 2005. Over the term of the license agreement, we are obligated to make guaranteed minimum royalty payments in the amount of $450,000, which has been paid in full as of March 31, 2005. The agreement was extended to December 31, 2006.
On December 20, 2005, we entered into a three-year license agreement with Hi-5 to produce and distribute karaoke software, including compact discs with graphics (CDGs) and karaoke music downloadable via the Internet, a variety of karaoke hardware products, and youth-oriented cassette players, CD and DVD players, and clock radios based on the popular "Hi-5" television show. The agreement contains an option to extend for an additional three years.
On May 10, 2006, we entered into a two-year license agreement with MGA Entertainment, Inc. to produce and distribute a variety of karaoke products based on MGA's BRATZ(TM) franchise, one of the world's leading toy lines and girls' lifestyle brands, in North America, Europe and Australia. These karaoke products include a TFT DVD karaoke system, sing-a-long cassette players, deluxe microphones, electronic keyboards and an electronic drum.
TOTAL LICENSE SALES FOR THE FISCAL YEAR ENDED March 31,
2006 2005 2004 ---- ---- ----
MTV 2.1% 17.6% 11.8% Nickelodeon 0.0% 0.5% 5.5% Other Licenses 0.9% 2.5% 3.9% --- ---- ---- Total Licenses Sales 3.0% 20.6% 21.2% === ==== ====
In the future, we might use our own brand or other brands.
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 China 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, 2006, approximately 33% of our sales were sales from our domestic warehouses ("Domestic Sales") and 67% were sales shipped directly from China ("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, domestic 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 China 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.
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 2007, we anticipate that 75% of our karaoke products will be produced by one of these factories, which has agreed to extend financing to us. We believe that the manufacturing capacity of our factories is adequate to meet the demands for our products in fiscal year 2007. However, if our primary factory in China was 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 2007" on page 17. In manufacturing our karaoke related products, these factories use molds and certain other tooling, most of which are owned by the Company. 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) and private labels.
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. In some cases, we also use outside firm to author the CD+G's. 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, 2006, 2005 and 2004, 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 Memorex and other consumer electronics companies. 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.
TRADEMARKS AND PATENTS
We have obtained registered trademarks for The Singing Machine name and the logo 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 intent to use an application for the "Karaoke Vision" mark in the United States. We also filed various trademarks for our products.
In the past few years, we have also obtain two U.S. patents for Karaoke machines.
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 $0.15 per song on each CD that is sold. Similarly, the terms of the licenses vary, but typically are for terms of 2 to 5 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.
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 accepted 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 United States. Therefore, we maintain a quality control program designed to ensure compliance with all applicable US 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 US tariff laws, which provides a favorable category of US import duties. China's NTR status became permanent on January 1, 2002. This substantially reduces the possibility of China losing its NTR status, which would result in increasing costs for us.
SEASONALITY AND SEASONAL FINANCING
Our business is highly seasonal, with consumers making a large percentage of karaoke purchases around the traditional holiday season in our second and third quarter. 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, 2006, we had inventory of 1.7million (net of reserves totaling $1.1 million) compared to inventory of $3.1 million as of March 31, 2005 (net of reserves totaling $1.7 million).
Our financing of seasonal working capital during fiscal 2006 was from selling of the inventory carried over from prior year, factoring the accounts receivables. We financed the purchase of new inventory with our short-term lines of credit in Hong Kong and through factory financing in China.
During fiscal 2007, we plan on financing our inventory purchases by using credit that has been extended to us by the 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.
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. In recent years, a trend toward just-in-time inventory practices in the consumer electronics industry has resulted in fewer advance orders and therefore less backlog of orders for the Company. We believe that backlog orders at any given time may not accurately indicate future sales. We believe that we will be able to fill all of these orders in fiscal year 2007. However, these orders can be cancelled or modified at any time prior to delivery. This backlog does not take into account of any sales ordered by customers directly from our domestic inventory with order turnaround time of one to two weeks. We normally have to keep the minimum inventory in our domestic warehouses for this type of sales.
EMPLOYEES
As of June 30, 2006, we employed 30 persons, all of whom are full-time employees, including two executive officers. Fifteen of our employees are located at International SMC's corporate offices in Hong Kong. The remaining fifteen employees are based in the United States, including two executive positions, two engaged in warehousing and technical support, and eleven in accounting, marketing, sales and administrative functions.
ITEM 1A.
ITEM 1A. RISK FACTORS
Set forth below and elsewhere in this Annual Report on Form 10-K 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.
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 June 30, 2006, our cash on hand is limited. We need approximately $1.1 million in working capital in order to finance our operations over the next three months. We will finance our working capital needs from the collection of accounts receivable, and sales of existing inventory. As of March 31, 2006, our inventory was valued at $1.7 million. See "Liquidity" beginning on page 19. If these sources do not provide us with adequate financing, we may try to seek financing from lenders and investors. If we are not able to obtain adequate financing, when needed, it will have a material adverse effect on our cash flow and our ability to continue as a going concern. If we have a severe shortage of working capital, we may not be able to continue our business operations and may be required to file a petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code or enter into some other form of liquidation or reorganization proceeding.
WE MAY BE DEEMED INSOLVENT AND WE MAY GO OUT OF BUSINESS.
As of March 31, 2006, our cash position is limited and we had negative equity. We are not able to pay all of our creditors on a timely basis. We are not current on our accounts payable of $0.4 million to our factory in China. If we are not able to pay our current debts as they become due, we may be deemed to be insolvent. We may be required to file a petition for bankruptcy under Chapter 11 of the U.S. Bankruptcy Code or enter into some other form of liquidation or reorganization proceedings.
OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS RAISED SUBSTANTIAL DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN AS OF MARCH 31, 2006.
We received a report dated May 26, 2006 from our independent certified public accountants covering the consolidated financial statements for our fiscal year ended March 31, 2006 that included an explanatory paragraph which stated that the financial statements were prepared assuming that the Singing Machine would continue as a going concern. This report stated that our operating performance in fiscal 2006 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.
A SMALL NUMBER OF OUR CUSTOMERS ACCOUNT FOR A SUBSTANTIAL PORTION OF OUR REVENUES, AND THE LOSS OF ONE OR MORE OF THESE KEY CUSTOMERS COULD SIGNIFICANTLY REDUCE OUR REVENUES AND CASH FLOW.
We rely on a few large customers to provide a substantial portion of our revenues. As a percentage of total revenues, our net sales to our five largest customers during the year ended March 31, 2006 and year ended March 31, 2005 were approximately 56% and 40%, respectively. We do not have long-term contractual arrangements with any of our customers and they can cancel their orders at any time prior to delivery. A substantial reduction in or termination of orders from any of our largest customers would decrease our revenues and cash flow.
WE ARE RELYING ON ONE FACTORY TO MANUFACTURE AND PRODUCE THE MAJORITY OF OUR KARAOKE MACHINES FOR FISCAL 2006, AND IF THE RELATIONSHIP WITH THIS FACTORY IS DAMAGED OR INJURED IN ANY WAY, IT WOULD REDUCE OUR REVENUES AND PROFITABILITY.
We have worked out a written agreement with factories in China to produce most of our karaoke machines for fiscal 2007. We owe one factory approximately $0.4 million as of March 31, 2006 and have worked out a verbal payment plan with it. If the factory is unwilling or unable to deliver our karaoke machines to us, our business will be adversely affected. Because our cash on hand is minimal, we are relying on revenues received from the sale of our ordered karaoke machines to provide cash flow for our operations. If we do not receive cash from these sales, we may not be able to continue our business operations.
WE ARE RELYING ON ONE DISTRIBUTOR TO DISTRIBUTE OUR MUSIC PRODUCTS, IF THE DISTRIBUTION AGREEMENT IS TERMINATED, IT WOULD REDUCE OUR REVENUES AND PROFITABILITY.
We are relying on Warner Elektra Atlantic Corporation (WEA) to distribute our music products in fiscal 2006, if the distribution agreement is terminated, our music revenues might decrease as well as our profitability.
WE ARE SUBJECT TO THE RISK THAT SOME OF OUR LARGE CUSTOMERS MAY RETURN KARAOKE PRODUCTS THAT THEY HAVE PURCHASED FROM US AND IF THIS HAPPENS, IT WOULD REDUCE OUR REVENUES AND PROFITABILITY.
In fiscal 2006 and 2005, a number of our customers and distributors returned karaoke products that they had purchased from us. Our customers returned goods valued at $2.4 million, or 7.4% of our net sales in fiscal 2006. Some of the returns resulted from customer's overstock of the products. Although we were not contractually obligated to accept this return of the products, we accepted the return of the products because we valued our relationship with our customers. Because we are dependent upon a few large customers, we are subject to the risk that any of these customers may elect to return unsold karaoke products to us in the future. If any of our customers were to return karaoke products to us, it would reduce our revenues and profitability.
WE ARE SUBJECT TO PRESSURE FROM OUR CUSTOMERS RELATING TO PRICE REDUCTION AND FINANCIAL INCENTIVES AND IF WE ARE PRESSURED TO MAKE THESE CONCESSIONS TO OUR CUSTOMERS, IT WILL REDUCE OUR REVENUES AND PROFITABILITY.
Because there is intense competition in the karaoke industry, we are subject to pricing pressure from our customers. Many of our customers have demanded that we lower our prices or they will buy our competitor's products. If we do not meet our customer's demands for lower prices, we will not sell as many karaoke products. In fiscal year ended March 31, 2006, our sales to customers in the United States decreased because of increased price competition. We are also subject to pressure from our customers regarding certain financial incentives, such as return credits or large advertising or cooperative advertising allowances, which effectively reduce our profit. We gave advertising allowances in the amount of $0.2 million during fiscal 2006 and $0.6 million during fiscal 2005. We have historically offered advertising allowances to our customers because it is standard practice in the retail industry.
WE EXPERIENCE DIFFICULTY FORECASTING THE DEMAND FOR OUR KARAOKE PRODUCTS AND IF WE DO NOT ACCURATELY FORECAST DEMAND, OUR REVENUES, NET INCOME AND CASH FLOW MAY BE AFFECTED.
Because of our reliance on manufacturers in China for our machine production, our production lead times range from one to four months. Therefore, we must commit to production in advance of customers orders. It is difficult to forecast customer demand because we do not have any scientific or quantitative method to predict this demand. Our forecasting is based on management's general expectations about customer demand, the general strength of the retail market and management's historical experiences. We overestimated demand for our products in fiscal 2003 and 2004 and had $5.9 million in inventory as of March 31, 2004. Because of this excess inventory, we had liquidity problems in fiscal 2005 and our revenues, net income and cash flow were adversely affected.
WE ARE SUBJECT TO THE COSTS AND RISKS OF CARRYING INVENTORY FOR OUR CUSTOMERS AND IF WE HAVE TOO MUCH INVENTORY, IT WILL AFFECT OUR REVENUES AND NET INCOME.
Many of our customers place orders with us several months prior to the holiday season, but they schedule delivery two or three weeks before the holiday season begins. As such, we are subject to the risks and costs of carrying inventory during the time period between the placement or the order and the delivery date, which reduces our cash flow. As of March 31, 2006 we had $1.6 million in inventory on hand. It is important that we sell this inventory during fiscal 2007, so we have sufficient cash flow for operations.
OUR GROSS PROFIT MARGINS HAVE DECREASED OVER THE PAST YEAR AND WE EXPECT A COMPETITIVE MARKET.
Over the past year, our gross profit margins have generally decreased due to the competition except for fiscal 2005 when we had developed several new models, which were in demand and yielded higher profit margins. We expect that our gross profit margin might decrease under downward pressure in fiscal 2007.
OUR LICENSING AGREEMENT WITH MTV NETWORKS IS IMPORTANT TO OUR BUSINESS AND IF WE WERE TO LOSE OUR MTV LICENSE IT WOULD AFFECT OUR REVENUES AND PROFITABILITY.
Our license with MTV Networks is important to our business. We generated 2.1% and 17.6% of our consolidated net sales from products sold under the MTV license in fiscal 2006 and 2005, respectively. Our MTV license was terminated on December 31, 2004, with an extension to sell certain existing inventory by September 30, 2005. We expect the MTV branded products will be phased out and replaced with SMC brand products going forward.
OUR BUSINESS IS SEASONAL AND THEREFORE OUR ANNUAL OPERATING RESULTS WILL DEPEND, IN LARGE PART, ON OUR SALES DURING THE RELATIVELY BRIEF HOLIDAY SEASON.
Sales of consumer electronics and toy products in the retail channel are highly seasonal, with a majority of retail sales occurring during the period from September through December in anticipation of the holiday season, which includes Christmas. A substantial majority of our sales occur during the second quarter ended September 30 and the third quarter ending December 31. Sales in our second and third quarter, combined, accounted for approximately 87.5%, 86.7% and 87.2% of net sales in fiscal 2006, 2005 and 2004, respectively.
IF WE ARE UNABLE TO COMPETE IN THE KARAOKE PRODUCTS CATEGORY, OUR REVENUES AND NET PROFITABILITY WILL BE REDUCED.
Our major competitors for karaoke machines and related products is 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 2006, 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 2007. In addition, we must compete with all the other existing forms of entertainment including, but not limited to: motion pictures, video arcade games, home video games, theme parks, nightclubs, television, prerecorded tapes, CD's and video cassettes.
IF WE ARE UNABLE TO DEVELOP NEW KARAOKE PRODUCTS, OUR REVENUES MAY NOT CONTINUE TO GROW.
The karaoke industry is characterized by rapid technological change, frequent new product introductions and enhancements and ongoing customer demands for greater performance. In addition, the average selling price of any karaoke machine has historically decreased over its life, and we expect that trend to continue. As a result, our products may not be competitive if we fail to introduce new products or product enhancements that meet evolving customer demands. The development of new products is complex, and we may not be able to complete development in a timely manner. To introduce products on a timely basis, we must:
o accurately define and design new products to meet market needs;
o design features that continue to differentiate our products from those of our competitors;
o transition our products to new manufacturing process technologies;
o identify emerging technological trends in our target markets;
o anticipate changes in end-user preferences with respect to our customers' products;
o bring products to market on a timely basis at competitive prices; and
o respond effectively to technological changes or product announcements by others.
We believe that we will need to continue to enhance our karaoke machines and develop new machines to keep pace with competitive and technological developments and to achieve market acceptance for our products. At the same time, we need to identify and develop other products which may be different from karaoke machines.
OUR PRODUCTS ARE SHIPPED FROM CHINA AND ANY DISRUPTION OF SHIPPING COULD PREVENT OR DELAY OUR CUSTOMERS' RECEIPT OF INVENTORY.
We rely principally on four contract ocean carriers to ship virtually all of the products that we import to our warehouse facility in Compton, California. Retailers that take delivery of our products in China rely on a variety of carriers to import those products. Any disruptions in shipping, whether in California or China, caused by labor strikes, other labor disputes, terrorism, and international incidents may prevent or delay our customers' receipt of inventory. If our customers do not receive their inventory on a timely basis, they may cancel their orders or return products to us. Consequently, our revenues and net income would be reduced.
OUR MANUFACTURING OPERATIONS ARE LOCATED IN THE PEOPLE'S REPUBLIC OF CHINA, SUBJECTING US TO RISKS COMMON IN INTERNATIONAL OPERATIONS. IF THERE IS ANY PROBLEM WITH THE MANUFACTURING PROCESS, OUR REVENUES AND NET PROFITABILITY MAY BE REDUCED.
We are using six factories in the People's Republic of China to manufacture the majority of our karaoke machines. These factories will be producing approximately 98% of our karaoke products in fiscal 2007. Our arrangements with these factories are subject to the risks of doing business abroad, such as import duties, trade restrictions, work stoppages, and foreign currency fluctuations, limitations on the repatriation of earnings and political instability, which could have an adverse impact on our business. Furthermore, we have limited control over the manufacturing processes themselves. As a result, any difficulties encountered by our third-party manufacturers that result in product defects, production delays, cost overruns or the inability to fulfill orders on a timely basis could adversely affect our revenues, profitability and cash flow. Also, since we do not have written agreements with any of these factories, we are subject to additional uncertainty if the factories do not deliver products to us on a timely basis.
WE DEPEND ON THIRD PARTY SUPPLIERS FOR PARTS FOR OUR KARAOKE MACHINES AND RELATED PRODUCTS, AND IF WE CANNOT OBTAIN SUPPLIES AS NEEDED, OUR OPERATIONS WILL BE SEVERELY DAMAGED.
Our growth and ability to meet customer demand depends in part on our capability to obtain timely deliveries of karaoke machines and our electronic products. We rely on third party suppliers to produce the parts and materials we use to manufacture and produce these products. If our suppliers are unable to provide our factories with the parts and supplies, we will be unable to produce our products. We cannot guarantee that we will be able to purchase the parts we need at reasonable prices or in a timely fashion. In the last several years, there have been shortages of certain chips that we use in our karaoke machines. If we are unable to anticipate any shortages of parts and materials in the future, we may experience severe production problems, which would impact our sales.
CONSUMER DISCRETIONARY SPENDING MAY AFFECT KARAOKE PURCHASES AND IS AFFECTED BY VARIOUS ECONOMIC CONDITIONS AND CHANGES.
Our business and financial performance may be damaged more than most companies by adverse financial conditions affecting our business or by a general weakening of the economy. Purchases of karaoke machines and music are considered discretionary for consumers. Our success will therefore be influenced by a number of economic factors affecting discretionary and consumer spending, such as employment levels, business, interest rates, and taxation rates, all of which are not under our control. Additionally, other extraordinary events such as terrorist attacks or military engagements, which adversely affect the retail environment may restrict consumer spending and thereby adversely affect our sales growth and profitability.
WE MAY HAVE INFRINGED THE COPYRIGHTS OF CERTAIN MUSIC PUBLISHERS AND IF WE VIOLATE FEDERAL COPYRIGHT LAWS, WE WILL BE SUBJECT TO MONETARY PENALTIES.
Over the past several years, Singing Machine (like its competitors) has received notices from certain music publishers alleging that the full range of necessary rights in their copyrighted works has not been properly licensed in order to sell those works as part of products known as "compact discs with graphics" ("CDG"s). CDG's are compact discs which contain the musical recordings of karaoke songs and graphics which contain the lyrics of the songs. Singing Machine has negotiated licenses with the complaining parties, or is in the process of settling such claims, with each one of the complaining copyright owners. As with any alleged copyright violations, unlicensed users may be subject to damages under the U.S. Copyright Act. Such damages and claims could have a negative effect on Singing Machine's ability to sell its music products to its customers if left unchecked or unresolved, the reason Singing Machine pursues licenses so diligently.
WE MAY BE SUBJECT TO CLAIMS FROM THIRD PARTIES FOR UNAUTHORIZED USE OF THEIR PROPRIETARY TECHNOLOGY, COPYRIGHTS OR TRADE SECRETS AND ANY CLAIMS ASSERTED AGAINST US COULD AFFECT OUR NET PROFITABILITY.
We believe that we independently developed the technology used in our electronic and audio software products and that it does not infringe on the proprietary rights, copyrights or trade secrets of others. However, we cannot 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.
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 June 30, 2006, we are aware of only three customers, FAO Schwarz, Musicland and KB Toys, which are operating under the protection of bankruptcy laws. Deterioration in the financial condition of our customers could result in bad debt expense to us and have a material adverse effect on our revenues and future profitability.
A DISRUPTION IN THE OPERATION OF OUR WAREHOUSE CENTERS IN CALIFORNIA OR FLORIDA COULD IMPACT OUR ABILITY TO DELIVER MERCHANDISE TO OUR STORES, WHICH COULD ADVERSELY AFFECT OUR REVENUES AND PROFITABILITY.
A significant amount of our merchandise is shipped to our customers from one of our two warehouses, which are located in Compton, California, and Coconut Creek, Florida. Events such as fire or other catastrophic events, any malfunction or disruption of our centralized information systems or shipping problems may result in delays or disruptions in the timely distribution of merchandise to our customers, which could substantially decrease our revenues and profitability.
OUR BUSINESS OPERATIONS COULD BE DISRUPTED IF THERE ARE LABOR PROBLEMS ON THE WEST COAST.
During fiscal 2006, approximately 33% of our sales were domestic warehouse sales, which were made from our warehouses in California and Florida. During the third quarter of fiscal 2003, the dock strike on the West Coast affected sales of two of our karaoke products and we estimate that we lost between $3 and $5 million in orders because we could not get the containers of these products off the pier. If another strike or work slow-down occurs and we do not have a sufficient level of inventory, a strike or work slow-down would result in increased costs to us and may reduce our profitability.
RISKS ASSOCIATED WITH OUR CAPITAL STRUCTURE
THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE WHICH MAY CAUSE INVESTORS TO LOSE ALL OR A PORTION OF THEIR INVESTMENT.
From December 1, 2004 through March 31, 2006, our common stock has traded between a high of $.95 and a low of $0.22. During this period, we had liquidity problems and incurred a net loss of $1.9 million in fiscal 2006 and loss of $3.6 million in fiscal 2005. Our stock price may continue to be volatile based on similar or other adverse developments in our business. In addition, the stock market periodically experiences significant adverse price and volume fluctuations which may be unrelated to the operating performance of particular companies.
IF INVESTORS SHORT OUR SECURITIES, IT MAY CAUSE OUR STOCK PRICE TO DECLINE.
During the past year, a number of investors have held a short position in our common stock. As of June 12, 2006, investors hold a short position in 283,000 shares of our common stock which represents 4.0% of our public float. The anticipated downward pressure on our stock price due to actual or anticipated sales of our stock by some institutions or individuals who engage in short sales of our common stock could cause our stock price to decline. Additionally, if our stock price declines, it may be more difficult for us to raise capital.
OUR COMMON STOCK MAY BE DELISTED FROM THE AMERICAN STOCK EXCHANGE, WHICH MAY HAVE A MATERIAL ADVERSE IMPACT ON THE PRICING AND TRADING OF OUR COMMON STOCK.
The Company has received a non-compliance notice from The American Stock Exchange (the "Amex") on July 18, 2005. The notice indicated that the Company has fallen below the continued listing standards of the Amex and that its listing is being continued pursuant to an extension. Specifically, for the fiscal year ended March 31, 2005, the Company was not in compliance with the minimum shareholders' equity requirement of $2,000,000, and had reported net losses in each of the past two fiscal years, resulting in the Company's non-compliance with Sections 1003(a)(i) and 1003(a)(iv) of the Amex Company Guide. In addition, the Company failed to announce in a press release, as required by Section 610(b) of the Amex Company Guide, that it received an audit opinion which contained a going concern qualification as disclosed in its Form 10-K for fiscal 2005 that was filed on June 29, 2005.
In order to maintain its Amex listing, the Company submitted a plan by August 18, 2005 advising the Amex of actions it will take, which may allow it to regain compliance within a maximum of 18 months and 12 months from July 18, 2005, respectively.
The Exchange has completed its review of The Singing Machine's plan of compliance and supporting documentation and has determined that, in accordance with Section 1009 of the Company Guide, the Plan makes a reasonable demonstration of the Company's ability to regain compliance with the continued listing standards within a maximum of 18 months and 12 months from July 18, 2005, respectively.
The Company must regain compliance with the $4,000,000 minimum shareholders' equity requirement by January 18, 2007. Failure to regain compliance within these time frames likely will result in the Exchange Staff initiating delisting proceedings pursuant to Section 1009 of the Company Guide. Further, if our common stock is removed from listing on Amex, it may become more difficult for us to raise funds through the sales of our common stock or securities.
IF OUR OUTSTANDING DERIVATIVE SECURITIES ARE EXERCISED OR CONVERTED, OUR EXISTING SHAREHOLDERS WILL SUFFER DILUTION.
As of March 31, 2006, there were outstanding stock options to purchase an aggregate of 1,300,110 shares of common stock at exercise prices ranging from $.32 to $11.09 per share, not all of which are immediately exercisable. The weighted average exercise price of the outstanding stock options is approximately $2.42 per share. As of March 31, 2006, there were outstanding immediately exercisable options to purchase an aggregate of 392,161 shares of our common stock. There were outstanding stock warrants to purchase 5,591,040 shares of common stock at exercise prices ranging from $1.41 to $4.03 per share, all of which are exercisable. The weighted average exercise price of the outstanding stock warrants is approximately $0.85 per share..
FUTURE SALES OF OUR COMMON STOCK HELD BY CURRENT STOCKHOLDERS AND INVESTORS MAY DEPRESS OUR STOCK PRICE.
As of June 30, 2006, there were 10,060,282 shares of our common stock outstanding. Of these shares, approximately 960,924 shares are eligible for sale under Rule 144. We have filed two registration statements registering an aggregate 3,794,250 of shares of our common stock (a registration statement on Form S-8 to register the sale of 1,844,250 shares underlying options granted under our 1994 Stock Option Plan and a registration statement on Form S-8 to register 1,950,000 shares of our common stock underlying options granted under our Year 2001 Stock Option Plan). An additional registration statement on Form S-1 was filed in October 2003, registering an aggregate of 2,795,465 shares of our common stock. The market price of our common stock could drop due to the sale of large number of shares of our common stock, such as the shares sold pursuant to the registration statements or under Rule 144, or the perception that these sales could occur.
OUR STOCK PRICE MAY DECREASE IF WE ISSUE ADDITIONAL SHARES OF OUR COMMON STOCK.
Our Certificate of Incorporation authorizes the issuance of 100,000,000 shares of common stock as amended in January 2006. As of June 30, 2006, we had 10,060,282 shares of common stock issued and outstanding and an aggregate of 6,891150 shares issuable under our outstanding options and warrants. As such, our Board of Directors has the power, without stockholder approval, to issue up to 83,048,568 shares of common stock.
According to the Security Purchase Agreement dated on February 21, 2006, the Company is required to issue 12,875,536 shares of common stock to Koncepts International at $0.233 per shares for $3 million investment. The agreement is currently under review by American Stock Exchange (AMEX). The shares are expected to be issued on July 31, 2006 once approval from AMEX has been received.
Any issuance of additional shares of common stock, whether by us to new stockholders or the exercise of outstanding warrants or options, may result in a reduction of the book value or market price of our outstanding common stock. Issuance of additional shares will reduce the proportionate ownership and voting power of our then existing stockholders.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW MAKE IT DIFFICULT FOR A THIRD PARTY TO ACQUIRE OUR COMPANY AND COULD DEPRESS THE PRICE OF OUR COMMON STOCK.
Delaware law and our certificate of incorporation and bylaws contain provisions that could delay, defer or prevent a change in control of our company or a change in our management. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. These provisions of our restated certificate of incorporation include: authorizing our board of directors to issue additional preferred stock, limiting the persons who may call special meetings of stockholders, and establishing advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our corporate headquarters are located in Coconut Creek, Florida in a 7,000 square feet office and warehouse facility. The lease expires on April 30, 2007. The annual rental expense is $87,000.
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 have subleased approximately 40,000 square feet. The annual rental expense is $525,000 and our sublease income is approximately $240,000 per year.
We have leased 3,579 square feet of office space in Hong Kong from which we oversee China based manufacturing operations. The lease expires April 30, 2008. The annual rental expense is $107,370.
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.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
LEGAL MATTERS
SYBERSOUND RECORDS, INC., D/B/A PARTY TYME KARAOKE V. UAV CORPORATION, D/B/A KARAOKE BAY AND D/B/A STERLING ENTERTAINMENT; MADACY ENTERTAINMENT GROUP, LTD.; AUDIO STREAM, INC. D/B/A KEYNOTE KARAOKE; TOP TUNES, INC.; SINGING MACHINE COMPANY; COMPASS PRODUCTIONS, INC.; BCI ECLIPSE LLC; AND DOES 1 THROUGH 50 INCLUSIVE. (SUPERIOR COURT OF THE STATE OF CALIFORNIA FOR THE COUNTY OF LOS ANGELES, WEST DISTRICT, CASE NO. SC 085498)
On May 12, 2005, Sybersound Records, Inc., a U.S. karaoke product distributor, filed a suit in Los Angeles Superior Court against virtually every one of its competitors (including Singing Machine), seeking actual and punitive damages arising from alleged unfair business practices, unfair competition, and wrongful interference with business relationships. The defendants in the case (including Singing Machine), all of whom cooperated in vigorously defending themselves from what they considered to be baseless charges, filed various motions in the case seeking dismissal on Constitutional and other grounds. Sybersound thereafter moved to dismiss the state court action, a motion which the court granted, and filed a new action against many of the same defendants, including The Singing Machine Company, Inc., in federal court on August 11, 2005 (described below).
SYBERSOUND RECORDS, INC. V. UAV CORPORATION; MADACY ENTERTAINMENT L.P., AUDIO STREAM, INC., TOP TUNES, INC., SINGING MACHINE, INC., BCI ECLIPSE COMPANY, LLC, AMOS ALTER, DAVID ALTER, EDWARD GOETZ, DENNIS NORDEN, FRANK ROBERTSON, DOUGLAS VOGT AND RICHARD VOGT (UNITED STATES DISTRICT COURT FOR THE CENTRAL DISTRICT OF CALIFORNIA, CV05-5861 JFW); (UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT (USCA DOCKET NO. 06-55221)
The new federal court action filed on August 11, 2005 alleged violation the Copyright Act and the Lanham Act by the defendants, and claims for unfair competition under California law. Sybersound was joined in the complaint by several publisher owners of musical compositions who alleged copyright infringement against all the defendants except The Singing Machine Company, Inc. On November 7, 2005, the district court ordered the publisher plaintiffs' copyright claims severed from the case. The Singing Machine Company, Inc. is not a party to the severed cases.
In September, 2005, the defendants, including The Singing Machine Company, Inc., filed multiple motions to dismiss the original complaint. In October, Sybersound filed a motion for summary judgment, as well. On January 6, 2006, the court granted the motions of the defendants and denied the plaintiff's motion, dismissing the case against the defendants, including The Singing Machine Company, Inc., with prejudice. Plaintiff Sybersound thereafter appealed the decision to the Ninth Circuit Court of Appeals. The case is currently under review by the appellate court.
Despite the confidence of The Singing Machine Company, Inc. that the ruling in its favor at the district court level will be affirmed on appeal, it is not possible to predict such outcomes with any degree of certainty.
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.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of stockholders on Tuesday, January 17, 2006 at 9:30 a.m. at Company's executive offices. There were present in person or by proxy 8,864,270 shares of Common Stock, of a total of 10,060,282 shares of Common Stock entitled to vote. At the Annual Meeting, our stockholders voted in favor of the following proposals:
1. The number of shares voted in favor of the election of the following nominees for director is set forth opposite each nominee's name:
Nominee Number of Shares - ---------------- ---------------- Bernard Appel 8,778,680 Josef Bauer 8,771,700 Yi Ping Chan 8,227,980 Marc Goldberg 8,778,680 Stewart Merkin 8,778,680 Harvey Judkowitz 8,778,680
2. 8,132,948 shares were voted in favor of amending the Company's Certificate of Incorporation to increase the number of authorized shares common stock, par value $0.01 per share, from 18,900,000 to 100,000,000 shares.
3. 8,780,542 shares were voted in favor of the appointment of Berkovits, Lago, & Company LLP as the Company's independent auditors for the fiscal year ending March 31, 2006.
PART II
ITEM 5.
ITEM 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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 2006 and fiscal 2005. 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 - --------------------------------------------- ----- ----- 2006: First quarter (April 1 - June 30, 2005) $0.80 $0.55 Second quarter (July 1 - September 30, 2005) 0.67 0.39 Third quarter (October 1 - December 31, 2005) 0.50 0.22 Fourth quarter (January 1 - March 31, 2006) 0.47 0.23
2005: First quarter (April 1 - June 30, 2004) $1.30 $ .36 Second quarter (July 1 - September 30, 2004) .72 .30 Third quarter (October 1 - December 31, 2004) 1.15 .51 Fourth quarter (January 1 - March 31, 2005) 1.05 .61
As of June 30, 2006, there were approximately 317 record holders of our outstanding common stock. Because brokers and other institutions hold many of the shares on behalf of shareholders, we are unable to determine the actual number of shareholders represented by these record holders.
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.
During the fiscal year ended March 31, 2006 and 2005, the Company issued 290,689 and 1,017,275 shares of its common stock.
On November 1, 2005, the Company issued 12,911 shares of common stock to members of the Board of Directors for services provided to the Company for fiscal year 2005, valued at $9,167.
On May 1, 2005, the Company has authorized the issuance of 277,778 shares of common stock for the conversion of a $200,000 related party loan.
On February 21, 2006, we entered into a Securities Purchase Agreement (the "Purchase Agreement") with koncepts International Limited (the "Purchaser") pursuant to which we agreed to sell and issue 12,875,536 shares of common stock, $.01 par value per share (the "Common Shares"), and 3 common stock purchase warrants (the "Warrants") to purchase an aggregate of 5,000,000 shares of our common stock for an aggregate purchase price of $3,000,000, or a per share purchase price of $.233. Subject to additional closing conditions as specified in the Purchase Agreement, the closing of the offering is subject to our successful restructuring of our $4,000,000 principal amount subordinated debenture which came due on February 20, 2006, as well as the approval of the American Stock Exchange and the shareholders of Starlight International Holdings Ltd., parent company of the Purchaser, as per the requirements of Hong Kong Stock Exchange. The parties intend to complete this offering within the next 60 days, assuming all closing conditions are met.
We issued Warrants to purchase (i) 2,500,000 shares of our common stock at an exercise price of $.233 per share for one year from the date of issuance, (ii) 1,250,000 shares of our common stock at an exercise price of $.28 per share for three years from the date of issuance, and (iii) 1,250,000 shares of our common stock at an exercise price of $.35 per share for four years from the date of issuance. The Warrants are subject to adjustment upon the occurrence of specific events, including stock dividends, stock splits, combinations or reclassifications of our common stock or distributions of cash or other assets. Under the terms of the Warrants, in no event shall the Purchaser become the beneficial owner of more than 19.99% of the number of shares of common stock outstanding immediately after giving effect to such issuance.
*All of the above issuances and sales were deemed to be exempt under Rule 506 of Regulation D and Section (2) of the Securities Act of 1933, as amended. No advertising or general solicitation was employed in offering the securities. The offerings and sales were made to a limited number of persons, all of whom were accredited investors, business associates of the Singing Machine or executive officers of the Singing Machine, and transfer was restricted by the Singing Machine in accordance with the requirement of the Securities Act of 1933. In addition to representations by the above-reference persons, we have made independent determinations that 11 of the above-referenced person were accredited or sophisticated investors, and that they were capable of analyzing the merits and risks of their investment, and that they understood the speculative nature of their investment. Furthermore, all of the above-referenced persons were provided with access to our Securities and Exchange Commission filings.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K. The statements of operations data for the years ended March 31, 2006, 2005 and 2004 and the balance sheet data at March 31, 2006 and 2005 are derived from our audited financial statements which are included elsewhere in this Form 10-K. The statement of operations data for the year ended March 31, 2003 and 2002 and the balance sheet data at March 31, 2004, 2003 and 2002 are derived from our audited financial statements which are not included in this Form 10-K. The historical results are not necessarily indicative of results to be expected for future periods.
* Restated
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following discussion should be read in conjunction with the Financial Statements and Notes thereto. Our fiscal year ends March 31. This document contains certain forward-looking statements including, among others, anticipated trends in our financial condition and results of operations and our business strategy. (See Part I, Item 1A, "Risk Factors "). These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially from these forward-looking statements. Important factors to consider in evaluating such forward-looking statements include (i) changes in external factors or in our internal budgeting process which might impact trends in our results of operations; (ii) unanticipated working capital or other cash requirements; (iii) changes in our business strategy or an inability to execute our strategy due to unanticipated changes in the industries in which we operate; and (iv) various competitive market factors that may prevent us from competing successfully in the marketplace.
OVERVIEW
Our primary objectives for fiscal 2006 were:
o restructure the $4 million convertible debts;
o raise additional capital;
o stabilize our revenues;
o continue to drive down the operating costs;
o expand our business into other product categories.
We believe that we have achieved our primary goal in almost every category. Our revenues has been stabilized, the decrease of sales was moderate compared to the decrease of sales in fiscal 2005 and fiscal 2004. Our gross profit margin only decreased by 2% in fiscal 2006 compared to prior year in light of increase of factory labor cost and the raw material. Our fixed operating expenses (compensation and selling, general and administrative expense) in fiscal 2006 decreased to $7.1 million from $7.3 million, a decrease of $0.2 million or 3% compared to prior year. The decrease of fixed operating expenses was primarily due to the continuing cost cutting efforts. We have successfully restructured the $4 million debenture and recorded one time gain of $2.2 million as other income. As a result, our net loss decreased by $1.7 million to $1.9 million in fiscal 2006 from $3.6 million in fiscal 2005.
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:
2006 2005 2004 ----- ----- -----
Total Revenues 100.0% 100.0% 100.0% Cost of Sales 78.1% 75.8% 97.4% Operating expenses 28.6% 28.5% 31.2% Operating (loss) income -6.7% -4.2% -28.6% Other (expenses), income, net 0.10% -5.2% -2.5% (Loss) Income before taxes -5.9% -9.4% -31.1% Provision (benefit) for income taxes 0.0% 0.0% 1.1% (Loss) Income -5.9% -9.4% -32.2%
FISCAL YEAR ENDED MARCH 31, 2006 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2005
NET SALES
One of our primary goals in fiscal 2006 was to stabilize the revenues. Net sales for the fiscal year ended March 31, 2006 was approximately $32.3 million, a decrease of approximately $5.9 million from approximately $38.2 million for fiscal 2005 compared to a decrease of approximately $32.3 million from fiscal 2004 to fiscal 2005. The decrease in net sales was a result of both decreases in unit volume as well as pricing. The decrease in sales is primarily attributed to:
o Customers concerned of our financial liquidity;
o Most of the overstock inventory from prior years has been sold at a very lower price in fiscal 2004 and fiscal 2005, which generated the higher revenues. There were only approximately $2 million of old inventory carried over to fiscal 2006;
o Increase of price competition in the United States and international market.
In fiscal year 2006, 67% of our sales were direct sales, which represent sales made by International SMC, and 33% were domestic sales, which represents sales made from our warehouse in the United States.
The sales decrease occurred in all segments of our business. Our total hardware sales decreased to approximately $30.9 million, in fiscal 2006 compared to total hardware sales of approximately $35.9 million in fiscal 2005.
Music sales decreased to approximately $1.4 million, or 5% of net sales, in fiscal 2006, compared to approximately $2.3 million, or 6% of net sales, in fiscal 2005. The decrease in music sales was a result of increased competition in this category.
GROSS PROFIT
Gross profit for fiscal 2006 was approximately $7.1 million or 21.9% of total revenues compared to approximately $9.3 million or 24.2%of sales for fiscal 2005. The decrease in gross margin, compared to the prior year, was primarily due to increased price competition and the increase of factory labor and raw material cost. The decrease of music sales also had negative effect on the gross margin since music sales yield higher profit margin than our other products.
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 for the fiscal year ended March 31, 2006 decreased from approximately $10.9 million to approximately $9.2 million, a decrease of approximately $1.7 million or 15.1% compared to the same period last year. The decrease in operating expenses consists of a $1.4 million decrease in variable expenses (Advertising, Commission, Freight and Royalty expenses) and a $0.3 decrease in fixed expenses (compensation and general and administration expenses). The variable expenses were decreased proportionally as revenues decreased. The fixed expense decrease of approximately $0.3 million was primarily due to reductions in warehouse expenses and compensation expenses, which were partially off set by an increase of bad debts expense.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses were $688,951 for fiscal 2006 compared to $709,291 for fiscal 2005. This decrease in depreciation and amortization expenses can be attributed to the fact that we produced fewer models with higher volume per model, which increased the economies of scale for our product lines.
NET OTHER INCOME (EXPENSES)
Net other income was $254,172 in fiscal 2006 compared to net other expenses of $1,971,740 in fiscal 2005. Net other expenses decrease was because we recognized approximately $2.2 million one time gain from restructuring of approximately $4 million convertible debts and decrease of interest expense of $62,199.
INCOME BEFORE TAXES
We had a net loss before taxes of $1,905,250 in fiscal 2006 compared to a net loss before taxes of $3,591,975 in fiscal 2005. The decreased net loss was primarily due to approximately $2.2 million gain from debts restructuring.
INCOME TAX EXPENSE
Significant management judgment is required in developing our provisions for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against 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 not likely to be realized. On March 31, 2006 and 2005, we had gross deferred tax assets of approximately $6.4 million and approximately $10.4 million, against which we recorded valuation allowances totaling approximately $6.4 million and approximately $10.4, respectively.
For the fiscal year ended March 31, 2006, we did not record income tax expenses. This occurred because the company had taxable losses for both US operations and Hong Kong operations.
Our subsidiary has applied for an exemption of income tax in Hong Kong. Although no decision has been reached by the governing body, the parent company has decided 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 2006 and fiscal 2005 due to the subsidiary's taxable loss. Hong Kong income taxes payable totaled approximately $2.4 million at March 31, 2006 and 2005 and is included in the accompanying balance sheets as income taxes payable.
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 approximately $1.9 million in fiscal 2006 compared to a net loss of approximately $3.6 million in fiscal 2005. Our decrease in net loss is primarily attributable to $2.2 million one time gain from the restructuring of the $4 million convertible debentures.
FISCAL YEAR ENDED MARCH 31, 2005 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 2004
NET SALES
Net sales for the fiscal year ended March 31, 2005 decreased to approximately $38.2 million compared to revenues of approximately $70.5 million in the fiscal year ended March 31, 2004. The decrease in net sales was a result of both decreases in unit volume as well as pricing. The decrease in sales is primarily attributed to:
o We made a decision not to pursue low margin accounts which tie up cash flow but do not provide enough profit margins;
o Customers concerned of our financial liquidity;
o Customers had high level of inventory on hand from prior year;
o Increase of competition in the United States and international market.
In fiscal year 2005, 64% of our sales were direct sales, which represent sales made by International SMC, and 36% were domestic sales, which represents sales made from our warehouse in the United States.
The sales decrease occurred in all segments of our business. Our total hardware sales decreased to approximately $35.9 million, in fiscal 2005 compared to total hardware sales of approximately $67.7 million in fiscal 2004.
Music sales decreased to approximately $2.3 million, or 6% of net sales, in fiscal 2005, compared to approximately $2.8 million, or 4% of net sales, in fiscal 2004. The decrease in music sales was a result of increased competition in this category.
GROSS PROFIT
Gross profit for fiscal 2005 was approximately $9.3 million or 24.2% of total revenues compared to approximately $1.8 million or 2.6% of sales for fiscal 2004. The increase in gross margin, compared to the prior year, was primarily due to the development of new products and better sales planning. We developed seven new models in fiscal 2005, which made up approximately $19.0 million in sales or 54% of the hardware sales in fiscal 2005. Our new products have differentiated us from our competitors and yield a higher profit margin.
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 for the fiscal year ended March 31, 2005 decreased from approximately $22.0 million to approximately $10.9 million, a decrease of approximately $11.1 million or 50.5% compared to the same period last year. The decrease in operating expenses consists of a decrease in variable expenses and fixed expenses. The variable expenses (Advertising, Commission, Freight and Royalty expenses) were decreased proportionally as revenues decreased. The fixed expense decrease of $7.6 million was primarily due to the following factors:
o Decreases in compensation expenses in the amount of approximately $2.2 million due to business downsizing and staff cuts.
o Decreases in professional fees and legal expenses of approximately $2.1 million due to the completion of a class action lawsuit and management's assumption of additional responsibilities, which were previously performed by outside professionals.
o Decreased rent expense of approximately $870,000 due to the early termination of one of our warehouses in California and the sublease of the existing warehouse space.
o Decreases in defective product repair fees of approximately $796,000 due to our testing line in our California warehouse. We have sent fewer real defective products to the factory for repair in fiscal 2005.
o Decreased product licensing royalty of approximately $1.0 million due to the termination of several licensing agreements. Our dependency on other brands has decreased in the past.
DEPRECIATION AND AMORTIZATION
Our depreciation and amortization expenses were $709,290 for fiscal 2005 compared to $750,359 for fiscal 2004. This decrease in depreciation and amortization expenses can be attributed to the fact that we produced fewer models with higher volume per model, which increased the economies of scale for our product lines.
NET OTHER EXPENSES
Net other expenses were $1,971,740 in fiscal 2005 compared to $1,729,620 in fiscal 2004. Net other expenses increased because our interest expense increased to approximately $2.1 million in fiscal 2005 compared to approximately $1.7 million in fiscal 2004. Our interest expense increased because we recorded approximately $1.6 million for the amortization of the discount on our convertible debentures. The increase in interest expense was partially offset by other income. We expect interest expense to maintain the same level for fiscal 2006.
INCOME BEFORE TAXES
We had a net loss before taxes of $3,591,975 in fiscal 2005 compared to a net loss before taxes of $21,924,919 in fiscal 2004. The decreased net loss was the result of increased profit margins and decreased expenses in every category.
INCOME TAX EXPENSE
Significant management judgment is required in developing our provisions for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against 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 not likely to be realized. On March 31, 2005 and 2004, we had gross deferred tax assets of approximately $10.4 million and $8.2 million, against which we recorded valuation allowances totaling approximately $10.4 million and $8.2, respectively.
For the fiscal year ended March 31, 2005, we did not record income tax expenses. This occurred because the company had taxable losses for both US operations and Hong Kong operations.
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 decided 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 2005 and fiscal 2004 due to the subsidiary's taxable loss. Hong Kong income taxes payable totaled approximately $2.4 million at March 31, 2005 and 2004 and is included in the accompanying balance sheets as income taxes payable.
We effectively repatriated approximately $0, $2.0 million and $5.6 million from our foreign operations in 2005, 2004 and 2003, 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 $3.6 million in 2005 compared to a net loss of $22.7 million in fiscal 2004.
LIQUIDITY AND CAPITAL RESOURCES
On March 31, 2006, we had cash on hand of approximately $0.4 million in addition to approximately $0.3 million of restricted cash compared to cash on hand of approximately $0.6 million and restricted cash of approximately $0.9 million on March 31, 2005. The decrease of cash on hand was primarily due to net loss of the operation.
Cash used by operating activities were approximately $0.4 million for the twelve months ended March 31, 2006. This was primarily due to a net operation loss of approximately $1.9 million and settlement of the customer credit balance of approximately $0.6 million, which was offset by decrease of approximately $2.1 million of old inventory.
Cash provided by investing activities for the twelve months ended March 31, 2006 was approximately $0.4 million. Cash provided by investing activities was from the release of the restricted cash of $0.6 million from a bank in Hong Kong offset by the purchase of tooling and molds in the amount of $0.2 million.
Cash used in financing activities were approximately $0.2 million for the fiscal year ended March 31, 2006, which was due to the payment of insider loan and the increase of cash reserve in the factoring bank.
As of March 31, 2006, our working capital was approximately ($4.3) million. Our current liabilities of approximately $8.1 million include:
o Amount due to one factory of approximately $0.4 million - we have worked out the payment plan with the factory to pay off the balance by the end of this year.
o Customer credit on account of approximately $0.6 million - the amount might be offset by the products or refund.
o Loan payable - $2 million bridge loan from Starlight to pay off the $4 million convertible debentures. The loan will be converted into equity upon closing of Starlight $3 investment.
o Subordinate debt of approximately $0.3 million - $50,000 will be paid upon closing of Starlight investment, the remaining balance will be extended for 3 years.
o Hong Kong income tax payable of approximately $2.5 million (see Income Tax Expense on Page 17 for details) - We do not expect the complete tax payment to come due in the short term. Our tax exemption application is still pending with the Hong Kong tax authority. Even if the outcome is unfavorable, the Company still has the right to appeal, which could take more than a year to settle.
o Current liabilities resulted from normal course of the business of approximately $1.7 million.
As of June 30, 2006, our loan balance with Crestmark Bank was $0. The Company can borrow up to the lesser of the $2.5 million or 70% of the eligible accounts receivable. Per the agreement we are only allowed to factor the sales originating from the warehouses in the United States. The factor company determines the eligible receivables based on their own credit standard, and the accounts' aging. As of June 30, 2006, there approximately $150,000 availability under the Crestmark facility.
As of June 30, 2006, our cash on hand is limited. Our average monthly operating expenses are approximately $400,000 and we need approximately $1.2 million to cover our operating expenses during the next three month period. Our primary expenses are normal operating costs including salaries, lease payments for our warehouse space in Compton, California and other operating costs.
As of March 31, 2006, our commitments for debt and other contractual arrangements are summarized as follows:
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.
WORKING CAPITAL REQUIREMENTS DURING THE SHORT AND LONG TERM
During the next twelve month period, we plan on financing our working capital needs from:
1) Equity investment - The shareholders of Starlight International have approved a $3 million investment. The Company has received $1 million from Starlight in June, 2006 in addition to $2 million received in March, which was used to settle the $4 million convertible debentures.
2) Related Party Loan - We might be able to raise additional short term loan from our new equity holder, who is also one of our suppliers.
3) Vendor financing - Our key vendors in China have agreed to manufacture on behalf of the Company without advanced payments and have extended payment terms to the Company. The terms with the factories are sufficient to cover the factory direct sales, which accounted more than 60% of the total revenues.
4) Factoring of accounts receivable - The Company would factor its accounts receivable for sales originated in the United States.
5) Cost reduction - The Company has reduced significant operating expenses in this fiscal year. The cost reduction initiatives are part of our intensive effort to achieve a successful turn-around restructuring. The Company plans to continue its cost cutting efforts in fiscal 2007.
6) Bank facility - The Company is actively seeking additional banking facilities to finance its domestic purchase.
Our sources of cash for working capital in the long term are the same as our sources during the short term. If we need additional financing, we intend to approach different financing companies or insiders. However, we cannot guarantee that our financing plan will succeed. If we need to obtain additional financing and fail to do so, it may have a material adverse effect on our ability to meet our financial obligations and continue our operations.
During fiscal 2007, we will strive to reduce additional operating costs. In order to reduce the need to maintain inventory in our warehouse in California and Florida, we intend to generate a larger share of our total sales through sales directly from International SMC. The goods are shipped directly to our customers from ports in China and are primarily backed by customer letters of credit. The customers take title to the merchandise at their consolidators in China and are responsible for the shipment, duty, clearance and freight charges to their locations. These sales in which the customer purchases the goods for delivery at a specific destination are referred to as "Direct" sales. We will also help our customers forecast and manage their inventories of our product. We are also planning to finance a significant amount of our sales with customer issued letters of credit, using credit facility with banks in Hong Kong and Macau, and relying on financing from two of our factories in China including our new majority equity owner - Starlight International.
In the event that we do not sell sufficient products in our second and third quarters, 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 the profit margin for sales of our karaoke products will continue to be under price pressure, because of the competitors in the marketplace. During fiscal 2007, we plan on introducing products other than karaoke to fulfill our sales seasonality gap.
Except for the foregoing, we do not have any present commitment that is likely to cause our liquidity to increase or decrease in any material way. In addition, except for the Company's need for additional capital to finance inventory purchases, the Company is not aware of any trend, additional demand, event or uncertainty that will result in, or that is reasonably likely to result in, the Company's liquidity increasing or decreasing in any material way.
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.
SEASONAL AND QUARTERLY RESULTS
Historically, our operations have been seasonal, with the highest net sales occurring in the second and third quarters (reflecting increased orders for equipment and music merchandise during the Christmas selling months) and to a lesser extent the first and fourth quarters of the fiscal year. Sales in our fiscal second and third quarter, combined, accounted for approximately 88%, 86.7% and 87.2% of net sales in fiscal 2006, 2005 and 2004.
Our results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of orders placed and shipped to customers, as well as other factors. The fulfillment of orders can therefore significantly affect results of operations on a quarter-to-quarter basis.
We are currently developing the products and considering trading products other than karaoke category during the slow season to fulfill the revenue shortfall.
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.
RESERVES ON INVENTORIES. The Singing Machine establishes a reserve on inventory based on the expected net realizable value of inventory on an item by item basis when it is apparent that the expected realizable value of an inventory item falls below its original cost. A charge to cost of sales results when the estimated net realizable value of specific inventory items declines below cost. Management regularly reviews the Company's investment in inventories for such declines in value.
INCOME TAXES. Significant management judgment is required in developing our provision for income taxes, including the determination of foreign tax liabilities, deferred tax assets and liabilities and any valuation allowances that might be required against the deferred tax assets. Management evaluates its ability to realize its deferred tax assets on a quarterly basis and adjusts its valuation allowance when it believes that it is more likely than not that the asset will not be realized.
We operate within multiple taxing jurisdictions and are subject to audit in those jurisdictions. Because of the complex issues involved, any claims can require an extended period to resolve. In management's opinion, adequate provisions for potential income taxes in the jurisdictions have been made.
OTHER ESTIMATES. We make other estimates in the ordinary course of business relating to sales returns and allowances, warranty reserves, and reserves for promotional incentives. Historically, past changes to these estimates have not had a material impact on our financial condition. However, circumstances could change which may alter future expectations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and interest rates. We are exposed to market risk in the areas of changes in United States and international borrowing rates and changes in foreign currency exchange rates. In addition, we are exposed to market risk in certain geographic areas that have experienced or remain vulnerable to an economic downturn, such as China. We purchase substantially all our inventory from companies in China, and, therefore, we are subject to the risk that such suppliers will be unable to provide inventory at competitive prices. While we believe that, if such an event were to occur we would be able to find alternative sources of inventory at competitive prices, we cannot assure you that we would be able to do so. These exposures are directly related to our normal operating and funding activities. Historically and as of March 31, 2006, we have not used derivative instruments or engaged in hedging activities to minimize market risk.
INTEREST RATE RISK
As or March 31, 2006, we exposure to market risk resulting from changes in interest rates is immaterial.
FOREIGN CURRENCY RISK
We have a wholly-owned subsidiary in Hong Kong. Sales by these operations made on a FOB China or Hong Kong basis are dominated in U.S. dollars. However, purchases of inventory and Hong Kong operating expenses are typically denominated in Hong Kong dollars, thereby creating exposure to changes in exchange rates. Changes in the Hong Kong dollar/U.S. dollar exchange rates may positively or negatively affect our gross margins, operating income and retained earnings. We do not believe that near-term changes in the exchange rates, if any, will result in a material effect on our future earnings, fair values or cash flows, and therefore, we have chosen not to enter into foreign currency hedging transactions. We cannot assure you that this approach will be successful, especially in the event of a significant and sudden change in the value of the Hong Kong dollar.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplemental data required pursuant to this Item 8 are included in this Annual Report on Form 10-K, as a separate section commencing on page and are incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
CHANGE OF ACCOUNTANTS
On October 15, 2004, Grant Thornton LLP (the "Former Accountant") resigned as the auditors for The Singing Machine Company, Inc. (the "Company"). On October 15, 2004, the Company engaged Berkovits, Lago & Company, LLP (the "New Accountant"), as its independent certified public accountant. The Company's decision to engage the New Accountant was approved by its Audit Committee on October 15, 2004.
The Company did not consult with the New Accountant 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 the Company's financial statements, and no written or oral advice was provided by the New Accountant that was a factor considered by the Company in reaching a decision as to the accounting, auditing or financial reporting issues.
The reports of the Former Accountant on the financial statements of the Company prior to their resignation, did not contain an adverse opinion or disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles, except that the Former Accountant's opinions on the reports expressed substantial doubt with respect to the Company's ability to continue as a going concern.
During the Company's two most recent fiscal years and the subsequent interim period through the date of resignation, there were no reportable events as the term described in Item 304(a)(1)(v) of Regulation S-K, except for:
Management and the Former Accountant, advised to our Audit Committee that during the course of the audits conducted by the former auditor for fiscal 2005, they noted deficiencies in internal controls relating to:
o weakness in our financial reporting process as a result of a lack of adequate staffing in the accounting department, and
o accounting for consigned inventory and inventory costing.
The Former Accountant has advised the Audit Committee that each of these internal control deficiencies constitute a material weakness as defined in Statement of Auditing Standards No. 60. Certain of these internal control weaknesses may also constitute material weaknesses in our disclosure controls. The Company has strengthen its internal controls in those areas as of March 31, 2006.
During the Company's two most recent fiscal years and the subsequent interim period through the date of resignation, there were no disagreements with the Former Accountant on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which, if not resolved to the satisfaction of the Former Accountant 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.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms.
(b) Changes in Internal Controls
There was no change in our internal controls or in other factors that could affect these controls during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information with respect to our executive officers, directors and significant employees as of March 31, 2006.
Name Age Position - ----------------- --- ------------------------------------------------------ Yi Ping Chan 42 Interim CEO, Chief Operating Officer, Director, Secretary Danny Zheng 36 Chief Financial Officer Josef A. Bauer 67 Chairman Harvey Judkowitz 61 Director Bernard Appel 74 Director Marc D. Goldberg 61 Director Stewart A. Merkin 63 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, 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 June 2002. Prior to that, he was Chief Strategist and Interim CFO from January 2000 to June 2002 of a Hong Kong-based IT and business process consulting firm with operations in Hong Kong, China and the US. He also held a senior management position with a Hong Kong-based venture capital and technology holding company with operations in Hong Kong, China and the US. He also worked as a business development analyst for Allied Signal Inc. (now part of Honeywell Corp.) doing joint venture and acquisitions in Japan and China. He also worked as an engineer for International Business Machine Corp. in the USA. 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.
Danny Zheng has been part of the Singing Machine management team since April 2004 and has served as financial controller and principal accounting officer. Danny is a certified public accountant licensed by the state of Delaware. He has more than 10 years of hands-on controllership experience. He held controller and VP finance positions with various private and public companies. Previously, he was also employed by a New York regional CPA firm as tax consultant for 4 years. Danny was also served as general manager from 1999 to 2002 for PC Ware International Miami branch, a Taiwan based computer manufacturer. He was responsible for its distribution, marketing and finance operation in six countries throughout Latin America. He also served as director of operation for PC Micro, a joint venture computer manufacturer in Manaus, Brazil from 1999 to 2002. Danny earned a B.S. degree in accounting from Nankai University in China.
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 company 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.
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 has served as the Chairman and CEO of UniPro Financial Services, a diversified financial services company until company was sold in September, 2005. He presently is the Chairman of AHM Financial Services Inc., a start up management company.
Marc Goldberg has served as a director since December 1, 2004. He has been President since 1995 of SuMa Partners, Ltd., a human resources, labor relations and employee communication consulting firm. In addition to his consulting practice, he has more than twenty-five years of applied expertise in organizational effectiveness, change management and performance improvement in Fortune 500 and emerging companies. Prior to founding SuMa Partners, Mr. Goldberg was Vice President, Human Resources at Mobile Telecommunication Technologies. He also served as an organization design consultant for The Mescon Group, Inc., Vice President, Human Resources at Contel Business Systems/Executone, Inc., and Manager, Human Resources at GE Integrated Communication Services. He obtained his J.D. and his Bachelor of Arts in Sociology from Boston University, and is certified as a Senior Professional in Human Resources (SPHR) and as a Business Manager(CBM).
Stewart Merkin has served as a director since December 1, 2004. Mr. Merkin, founding partner of the Law Office of Stewart A. Merkin, has been practicing law in Miami, Florida since 1974. His core legal practice areas include corporate and securities law, as well as mergers and acquisitions and international transactions. He was awarded both J.D. and M.B.A. degrees from Cornell University, as well as a B.S. from The Wharton School, University of Pennsylvania. He has been admitted to the Florida and New York State Bar since 1972 and 1973 respectively.
BOARD COMMITTEES
We have an audit committee, an executive compensation/stock option committee and a nominating committee.
As of June 30, 2006, the audit committee consists of Messrs. Judkowitz (Chairman), Appel and Merkin. 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 Messrs. Judkowitz, Merkin and 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.
As of June 30, 2006, the executive compensation/stock option committee consists of Messrs. Goldberg (Chairman), Judkowitz 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.
As of June 30, 2006, the nominating committee consists of Messrs. Appel (Chairman), Bauer, Merkin and Chan. 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.
Nomination of Directors
As provided in its charter and our company's corporate governance principles, the Nominating Committee is responsible for identifying individuals qualified to become directors. The Nominating Committee seeks to identify director candidates based on input provided by a number of sources, including (1) the Nominating Committee members, (2) our other directors, (3) our stockholders, (4) our Chief Executive Officer or Chairman, and (5) third parties such as professional search firms. In evaluating potential candidates for director, the Nominating Committee considers the entirety of each candidate's credentials.
Qualifications for consideration as a director nominee may vary according to the particular areas of expertise being sought as a complement to the existing composition of the Board of Directors. However, at a minimum, candidates for director must possess:
o high personal and professional ethics and integrity;
o the ability to exercise sound judgment;
o the ability to make independent analytical inquiries;
o a willingness and ability to devote adequate time and resources to diligently perform Board and committee duties; and
o the appropriate and relevant business experience and acumen.
In addition to these minimum qualifications, the Nominating Committee also takes into account when considering whether to nominate a potential director candidate the following factors:
o whether the person possesses specific industry expertise and familiarity with general issues affecting our business;
o whether the person's nomination and election would enable the Board to have a member that qualifies as an "audit committee financial expert" as such term is defined by the Securities and Exchange Commission (the "SEC") in Item 401 of Regulation S-K;
o whether the person would qualify as an "independent" director under the listing standards of the American Stock Exchange;
o the importance of continuity of the existing composition of the Board of Directors to provide long term stability and experienced oversight; and
o the importance of diversified Board membership, in terms of both the individuals involved and their various experiences and areas of expertise.
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 this Annual Report on Form 10-K. We intend to post amendments to or waives from 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 2006, our compensation package for our non-employee directors consisted of grants of stock options, cash payment and reimbursement of costs and expenses associated with attending our Board meetings. Our five non-employee directors during fiscal 2006 were Messrs. Bauer, Appel, Judkowitz, Goldberg and Merkin.
During fiscal 2006, we have implemented the following compensation policy for our directors.
o An initial grant of 20,000 SMD stock options with an exercise price determined as the closing price on the day of joining the board. The options will vest in one year and expire in ten years while they are board members or 90 days once they are no longer board members.
o An annual cash payment of $7,500 will be made for each completed full year of service or prorated for a partial year. The payment will be made as of March 31.
o An annual stock grant of stock equivalent in value to $2,500 for each completed full year of service or prorated for a partial year. The stock price at grant will be determined at the closing price on the day of the Annual Shareholder Meeting. The actual grant will be made on or before March 31.
o An annual grant of 20,000 SMD stock options with an exercise price determined as the closing price on the day of the Annual Shareholder Meeting. If the Annual Meeting is held less than 6 months after the board member first joined the board he or she will not receive another option grant.
o Independent board members will receive a $500 fee for each board meeting and annual meeting they attend. Committee meetings and telephone board meetings will be compensated with a $200 fee.
o All expenses will be reimbursed for attending board, committee and annual meetings or when their presence at a location away from home is requested.
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, 2006, its officers, directors and 10% shareholders complied with all Section 16(a) filing.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain compensation information for the fiscal years ended March 31, 2006, 2005 and 2004 with regard to (i) Yi Ping Chan, our Interim Chief Executive Officer and Chief Operating Officer, from October 17, 2003 through the present date, and each of our other executive officers whose compensation exceeded $100,000 on an annual basis (the "Named Officers"):
(1) The amounts disclosed in this column for fiscal 2006, 2005 and 2004 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. Steele served as our Chief Executive Officer from September 1991 through July 23, 2003. He serves as our Senior Advisor and Director of Product Development since then. Mr. Steele resigned on July 18, 2005. His fiscal 2006 salary includes $125,000 severance payment.
(4) Mr. Danny Zheng joined our company on April 19, 2004 as financial controller and became our Chief Financial Officer on April 5, 2005.
(5) Effective as of August 1, 2003, Mr. Chan 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 and Mr. Steele received compensation in the amount of $20,125 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.
OPTION GRANTS IN FISCAL 2006
The following table sets forth information concerning all options granted to our officers and directors during the year ended March 31, 2006. No stock appreciation rights ("SAR's") were granted.
(1) All of these options were granted under a Year 2001 Stock Option Plan. The Options granted to Mr. Judkowitz, Mr. Bauer, Mr. Goldberg, Mr. Merkin and Mr. Appel vest in one year, on March 31, 2006 according to director compensation policy. The Options granted to Mr. Chan and Mr. Zheng vested in three years.
(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. Steele received a grant of 50,000 options on May 9, 2005. These options will expire on October 18, 2005 ninety days after Mr. Steele resigned from our company.
AGGREGATED OPTION EXERCISES IN FISCAL YEAR ENDED MARCH 31, 2006 AND OPTION VALUES
The following table sets forth information as to the exercise of stock options during the fiscal year ended March 31, 2006 by our officers listed in our Summary Compensation Table and the fiscal year-end value of unexercised options.
EMPLOYMENT AGREEMENTS
There is no employment contract with executive officers of the Company as of July 14, 2006.
SEPARATION AND CONSULTING AGREEMENTS
Edward Steele resigned as Senior Advisor and Director of Product Development on July 18, 2005. In connection with his resignation, we entered into a separation and release agreement with Mr. Steele. Under this agreement, we agreed to provide Mr. Steele with a severance payment equal to $134,194, which consisted of (i) auto allowance in the amount of $3,250, (ii) a COBRA reimbursement payment equal to $3,060, (iii) payment for accrued vacation time equal to $2,884 and (v) severance payments in the amount of $125,000. In exchange, Mr. Steele agreed to release the Singing Machine from any liability in connection with the termination of his employment.
Mr. Barocas resigned as our Chief Financial Officer effective March 31, 2005. In connection with his resignation, we entered into a separation and release agreement with Mr. Barocas. Under this agreement, we agreed to provide Mr. Barocas with a severance payment equal to $50,157, which consisted of (i) salary payment in the amount of $13,846, (ii) auto allowance in the amount of $554, (iii) a COBRA reimbursement payment equal to $1,142, (iv) payment for accrued vacation time equal to $5,769 and (v) severance payments in the amount of $28,846.15. In exchange, Mr. Barocas 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 March 31, 2006, we had 20,550 options issued and outstanding under our 1994 Plan and 1,279,560 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.
YEAR 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, 2006, we have 20,550 options issued and outstanding under the 1994 Plan and all of these options are fully vested as of March 31, 2006.
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. At March 31, 2006, we have granted 1,279,560 options under the Year 2001 Plan, 371,611 of which are fully vested.
The Year 2001 Plan is administered by our Stock Option Committee ("Committee"), which consists of two or more directors chosen by our Board. The Committee has the full power in its discretion to (i) grant options under the Year 2001 Plan, (ii) determine the terms of the options (e.g. - vesting, exercise price), (iii) to interpret the provisions of the Year 2001 Plan and (iv) to take such action as it deems necessary or advisable for the administration of the Year 2001 Plan.
Options granted to eligible individuals under the Year 2001 Plan may be either incentive stock options ("ISO's"), which satisfy the requirements of 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 10 years from the date of grant (or five years in the case of a holder with 10% or more of our common stock). The aggregate fair market value (determined at the date the option is granted) of shares with respect to which an ISO are exercisable for the first time by the holder of the option during any calendar year may not exceed $100,000. If that 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. We made a matching contribution of 100% of salary deferral contributions up to 3% of pay, plus 50% of salary deferral contributions from 3% to 5% of pay for each payroll period. The amounts charged to earnings for contributions to this plan and administrative costs during the years ended March 31, 2006, 2005 and 2004 totaled approximately $39,572, $30,025 and $55,402, respectively.
REPORT OF THE EXECUTIVE COMPENSATION/STOCK OPTION COMMITTEE ON EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION PHILOSOPHY
The Executive Compensation Committee believes that the Singing Machine must maintain short and long-term executive compensation plans that enable us to attract and retain well-qualified executives. Furthermore, we believe that our compensation plans must also provide a direct incentive for our executives to create shareholder value.
In furtherance of this philosophy, the compensation of our executives generally consists of three components: base salary, annual cash incentives and long-term performance-based incentives.
BASE SALARIES
During fiscal 2006, we had an employment agreement with one executive officer. The base salary of each of our executive officers was determined based on comparison to executives with similar responsibilities at other public companies: The persons that served as executive officers during fiscal 2006 are listed below.
Eddie Steele, who served as our Chief Executive Officer from September 1991 through August 3, 2004 and as our Director of Product Development from August 3, 2004 through July 18, 2005.
Yi Ping Chan, who has served as our Chief Operating Officer since May 2, 2003 and Interim Chief Executive Officer since October 17, 2003 through the present date.
Danny Zheng who has served as our Financial Controller from April 19, 2004 to April 3, 2005 and served as our Chief Financial Officer from April 4, 2005 through the present date.
INCENTIVE CASH BONUSES
Generally, we award cash bonuses to our management employees and other employees, based on their personal performance in the past year and overall performance of our company. During fiscal 2006, we awarded a $12,000 bonus to Mr. Zheng, our Chief Financial Officer.
LONG TERM COMPENSATION - STOCK OPTION GRANTS
We have utilized stock options to motivate and retain executive officers and other employees for the long-term. We believe that stock options closely align the interests of our executive officers and other employees with those of our stockholders and provide a major incentive to building stockholder value. Options are typically granted annually, and are subject to vesting provisions to encourage officers and employees to remain employed with the Company.
During fiscal 2006, we granted an aggregate of 330,000 options to our senior executive officers. All options grants in fiscal 2006 were made under our Year 2001 Stock Option Plan. See "Executive Compensation -Option Grants in Last Fiscal Year" on pages 26 for information about the number of options granted to each individual. Each of the option grants was at a price that was equal to the closing price of our common stock on the date of grant.
RELATIONSHIP BETWEEN OUR COMPENSATION POLICIES AND CORPORATE PERFORMANCE
We believe that our executive compensation policies correlate with our corporate performance. Our stock options are usually granted at a price equal to or above the fair market value of our common stock on the date of grant. As such, our officers only benefit from the grant of stock options if our stock price appreciates. Generally, we try to tie bonus payments to our financial performance. However, if an individual has made significant contributions to our company, we will provide them with a bonus payment for their efforts even if our company's financial performance has not been strong.
COMPENSATION OF CHIEF EXECUTIVE OFFICER
Effective as of October 17, 2003, Yi Ping Chan became our Interim Chief Executive Officer. Mr. Chan's salary is $250,000 per year, as set forth in his employment agreement. In July 2003, Mr. Chan agreed to accept 15% of his salary during the nine-month period between July 1, 2003 through March 31, 2004 in the form of stock rather than cash. We also agreed to grant Mr. Chan options to purchase 150,000 shares of our common stock, at an exercise price of $5.60 per share, of which 50,000 options vest each year and to reimburse him for moving expenses of up to $40,000. Mr. Chan has voluntarily cancelled the 150,000 options on May 10, 2006.
We did not grant any cash bonuses to Mr. Chan in fiscal 2006.
We awarded stock options to Mr. Chan in December 2003. We awarded Mr. Chan options to purchase 52,800 shares of our common stock at an exercise price of $1.97 per share. We awarded 80,000 stock options to Mr. Chan at exercise price of $0.60 on May 9, 2005. These options were granted under our Year 2001 Stock Option Plan and were granted at a price that was equal to closing price of our common stock on the date of grant. Mr. Chan's options vest at a rate of one-third per year over a period of three years.
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
The graph below compares the performance of the Singing Machine's common stock with the American Stock Market Index ("AMEX Index") and the Dow Jones - Consumer Electronics Index ("Dow Jones-CSE"), during the period beginning March 31, 2000 through March 31, 2005. The graph assumes the investment of $100 on March 31, 2000 in the Singing Machine's common stock, in the AMEX Index and the Dow Jones-CSE Index. Total shareholder return was calculated on the basis that in each case all dividends were reinvested.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth as of June 30, 2006, 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.
o persons known to own more than 5% of our common stock;
We had 10,060,282 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.
* Less than 1%.
(1) Includes as to the person indicated the following outstanding stock options to purchase shares of the Company's Common Stock issued
under the 1994 and 2001 Stock Option Plans , which will be vested and exercisable within 60 days of June 30, 2006: 61,867 options held by Yi Ping Chan; 30,533 options held by Danny Zheng; 79,827 options held by Joseph Bauer; 40,000 options held by Bernard Appel; 40,000 options held by Harvey Judkowitz; 20,000 options held by Marc Goldberg and 20,000 options held by Stewart Merkin.
(2) Includes 126,913 shares held individually by Mr. Bauer, 323,216 held by Mr. Bauer's wife, 224,374 held jointly by Mr. Bauer and his wife, 369,400 shares held by Mr. Bauer's pension account, 245,500 shares held in Mr. Bauer's Family LTD Partnership and 79,827 issuable upon the exercise of stock options that can be exercisable within 60 days of June 30, 2006.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On or about July 10, 2003, an officer and two directors of our Company advanced $1 million to our Company pursuant to written loan agreements. The officer is Yi Ping Chan and the directors were Josef A. Bauer and Howard Moore. Mr. Moore resigned from our Board, effective as of October 17, 2003. Additionally, Maureen LaRoche, a business associate of Mr. Bauer, participated in the financing. The loans are subordinated to the factoring company and accrued interest at 9.5% per annum. These loans were originally scheduled to be repaid by October 31, 2003, but were extended past March 31, 2006. All interest was accrued, and the unpaid amount totaled approximately $9,500. A portion of the loans and the accrued interest in the amount of $409,500 has been converted into 563,274 shares of common stock at $0.72 per share on January 5, 2005. In addition, another portion of the loans in the amount of $200,000 has been converted into 277,778 shares of common stock on May 18, 2005. On November 30, 2005, Maureen LaRoche was repaid $107,917 ($100,000 principle and $7,917 interest). The balance of related party loan as of March 31, 2006 was $300,000. According Starlight Security Purchase Agreement dated on February 21, 2006, the company might use $50,000 from $3 million investment to retire part of the loans. The remainder of the loan will be extended for 3 years at an interest rate of 5.5%.
On June 27, 2005, the Company received a $200,000 loan from Andrew Shapiro, a relative of Mr. Bauer. The interest rate on the loan is 12% per annum and is due on November 30, 2005 or such later date as mutually agreed between the parties.
On June 2, 2006, the Company received a $200,000 loan from Andrew Shapiro, a relative of Mr. Bauer. The interest rate on the loan is 8% per annum and is due on June 20, 2006 or such later date as mutually agreed between the parties. The loan was repaid on June 30, 2006 with interest.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following is a summary of the fees billed to the Singing Machine by Berkovits, Lago & Co, LLP and Grant Thornton, LLP for professional services rendered for the fiscal years ended March 31, 2006 and 2005:
Fee Category Fiscal 2006 Fiscal 2005 ----------- ----------- Audit Fees $155,193 $289,790 Tax Fees $ 0 $ 33,543 All Other Fees $ 1,500 $ 12,938 -------- -------- Total Fees $156,693 $336,271 ======== ========
Audit Fees - Consists of fees billed for professional services rendered for the audit of the Singing Machine's consolidated financial statements and review of the interim consolidated financial statements included in quarterly reports and services that were provided by Berkovits, Lago & Co, LLP and Grant Thornton LLP in connection with statutory and regulatory filings or engagements.
Tax Fees - Consists of fees billed for professional services for tax compliance, tax advice and tax planning. These services include assistance regarding federal, state and international tax compliance, tax audit defense, customs and duties, mergers and acquisitions, and international tax planning.
All Other Fees - Consists of fees for products and services other than the services reported above. In fiscal 2005, these services included general business meetings between auditors, and executives and directors of The Singing Machine.
Out of the total fiscal 2006 and fiscal 2005 audit and other fees, $151,943 and $86,219 were billed by Berkovits, Lago and Co., LLP, respectively.
POLICY ON AUDIT COMMITTEE PRE-APPROVAL OF AUDIT AND PERMISSIBLE NON-AUDIT SERVICES OF INDEPENDENT AUDITORS
The Audit Committee's policy is to pre-approve all audit and permissible non-audit services provided by the independent auditors. These services may include audit services, audit-related services, tax services and other services. Pre-approval is generally provided for up to one year and any pre-approval is detailed as to the particular service or category of services and is generally subject to a specific budget. The independent auditors and management are required to periodically report to the Audit Committee regarding the extent of services provided by the independent auditors in accordance with this pre-approval, and the fees for the services performed to date. The Audit Committee may also pre-approve particular services on a case-by-case basis.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES EXHIBITS
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)
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 institutional 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)
10.6 Employment Agreement dated February 27, 2004 between the Singing Machine and Eddie Steele. (incorporated by reference to the Singing Machine's Annual Report on Form 10-K for the fiscal year ended March 31, 2005)
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 the Singing Machine's Annual Report on Form 10-K for the fiscal year ended March 31, 2005)
10.10 Separation and Release Agreement dated December 16,2003 between the Singing Machine and Jack Dromgold. (incorporated by reference to the Singing Machine's Annual Report on Form 10-K for the fiscal year ended March 31, 2005)
10.11 Separation and Release Agreement effective as of April 12, 2004 between the Singing Machine and John Dahl. (incorporated by reference to the Singing Machine's Annual Report on Form 10-K for the fiscal year ended March 31, 2005)
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).
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 the Singing Machine's Annual Report on Form 10-K for the fiscal year ended March 31, 2005)
10.29 Loan Agreements dated August 13, 2003 in the aggregate amount of $1 million between the Company and each of Josef Bauer, Howard Moore & Helen Moore Living Trust, Maureen G. LaRoche and Yi Ping Chan.(incorporated by reference to the Singing Machine's Annual Report on Form 10-K for the fiscal year ended March 31, 2005)
10.30 Letter dated March 4, 2003 from Jay Bauer to the Singing Machine regarding a $400,000 loan. (incorporated by reference to the Singing Machine's Annual Report on Form 10-K for the fiscal year ended March 31, 2005)
10.31 Securities Purchase Agreement dated February 21, 2006, by and between The Singing Machine Company, Inc. and koncepts International Limited. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on February 27, 2006)
10.32 Registration Rights Agreement dated February 21, 2006, by and between The Singing Machine Company, Inc. and koncepts International Limited. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on February 27, 2006)
10.33 One Year Stock Purchase Warrant of The Singing Machine Company, Inc. dated February 21, 2006. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on February 27, 2006)
10.34 Three Year Stock Purchase Warrant of The Singing Machine Company, Inc. dated February 21, 2006. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on February 27, 2006)
10.35 Four Year Stock Purchase Warrant of The Singing Machine Company, Inc. dated February 21, 2006. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on February 27, 2006)
10.36 Bridge Loan Agreement dated March 8, 2006, by and between The Singing Machine Company, Inc. and Ever Solid Limited. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on March 14, 2006)
10.37 Collateral Security Agreement dated March 8, 2006, by and between The Singing Machine Company, Inc. and Ever Solid Limited. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on March 14, 2006)
10.38 Bridge Note of The Singing Machine Company, Inc. dated March 8, 2006. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on March 14, 2006)
10.39 Settlement Agreement and Release dated as of March 5, 2006 by and among The Singing Machine Company, Inc. and the holders of the Company's $4,000,000 principal amount 8% Convertible Debentures. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on March 14, 2006)
10.40 Settlement Agreement dated April 27, 2006, by and between The Singing Machine Company, Inc. and Abacus Advisors Group LLC. (incorporated by reference to the Singing Machine's Current Report on Form 8-K filed with the SEC on May 3, 2006)
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32.1 Certification of the Chief Executive Officer pursuant to U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
32.2 Certification of the Chief Financial Officer pursuant to U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
* Filed herewith
SIGNATURES
In accordance with the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, The Singing Machine Company, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE SINGING MACHINE COMPANY, INC.
Dated: July 14, 2006 By: /s/ YI PING CHAN ---------------------------------------- Interim Chief Executive Officer (Principal Executive Officer)
In accordance with the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of The Singing Machine Company, Inc. and in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE - -------------------------- ---------------------------------- --------------
/s/ YI PING CHAN Chief Executive Officer July 14, 2006 - -------------------------- (Principal Executive Officer) Yi Ping Chan
/s/ Danny Zheng Chief Financial Officer (Principal July 14, 2006 - -------------------------- Financial and Accounting Officer) Danny Zheng
/s/ JOSEF A. BAUER Director July 14, 2006 - -------------------------- Josef A. Bauer
/s/ BERNARD APPEL Director July 14, 2006 - -------------------------- Bernard Appel
/s/ HARVEY JUDKOWITZ Director July 14, 2006 - -------------------------- Harvey Judkowitz
/s/ MARC GOLDBERG Director July 14, 2006 - -------------------------- Marc Goldberg
/s/ STEWART MERKIN Director July 14, 2006 - -------------------------- Stewart Merkin
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
Reports of Independent Registered Public Accounting Firms 37 Consolidated Balance Sheets 39 Consolidated Statements of Operations 40 Consolidated Statements of Stockholders' Equity (Deficit) 41 Consolidated Statements of Cash Flows 42 Notes to Consolidated Financial Statements 43
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of The Singing Machine Company, Inc.
We have audited the accompanying consolidated balance sheets of The Singing Machine Company, Inc. and it's Subsidiaries (the "Company") as of March 31, 2006 and 2005, and the related consolidated statements of operations, shareholders' deficit, 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 consolidated financial statements based on our audits.
We conducted our audits 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 financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of March 31, 2006 and 2005, and the results of its operations and its 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 Company for the years ended March 31, 2006 and 2005. 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 consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company's inability to obtain outside long term financing and recurring losses from operations raise substantial doubt about the Company's ability to continue as a going concern. Management's plans are also described in Note 2 to the consolidated financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Berkovits, Lago & Company, LLP
Fort Lauderdale, Florida May 26, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders The Singing Machine Company, Inc.
We have audited the accompanying consolidated statements of operations and cash flows of The Singing Machine Company, Inc. and subsidiary (the "Company") for the year ended March 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit.
We conducted our audit in accordance with 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. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of their operations and their consolidated cash flows of The Singing Machine Company, Inc. and subsidiary for the year ended March 31, 2004, 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 consolidated 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 and the fifth paragraph of Note 3, as to which the date is September 20, 2004)
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these financial statements.
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these financial statements.
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
The accompanying notes are an integral part of these financial statements.
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these financial statements.
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") is primarily engaged in the development, marketing, and sale of consumer karaoke audio equipment, accessories, musical instrument 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.
THE MANAGEMENT OF THE COMPANY BELIEVES THAT THE FOLLOWING ACCOUNTING POLICIES REQUIRE A HIGH DEGREE OF JUDGMENT OR COMPLEXITY:
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.
The Company follows Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" ("SFAS No. 109"). Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. If it is more likely than not that some portion of a deferred tax asset will not be realized, a valuation allowance is recognized.
As of March 31, 2006 and 2005, The Singing Machine had gross deferred tax assets of $6.4 million and $10.4 million, against which the Company recorded valuation allowances totaling $6.4 million and $10.4, respectively.
For the fiscal years ended March 31, 2006 and March 31, 2005, the Company recorded no tax provision. We received a tax refund of $1.1 million on August 24, 2005, which was used to pay related party loans and the vendors. The Company has now exhausted its ability to carry back any further losses and therefore will only be able to recognize tax benefits to the extent that it has future taxable income.
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 2004 and 2002. There was no provision for Hong Kong income taxes in fiscal 2005 and fiscal 2006 due to the subsidiary's net operating losses.
Hong Kong income taxes payable totaled $2.4 million at March 31, 2006 and 2005 and is included in the accompanying balance sheets as income taxes payable.
OTHER ESTIMATES. The Singing Machine makes other estimates in the ordinary course of business relating to sales returns and allowances, warranty reserves, and reserves for promotional incentives. Historically, past changes to these estimates have not had a material impact on the Company's financial condition. However, circumstances could change which may alter future expectations.
THE FOLLOWING ARE THE COMPANY'S REMAINING ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of The Singing Machine Company, Inc. and its wholly-owned Hong Kong Subsidiary, International SMC (HK) Limited ("Hong Kong Subsidiary"). All intercompany accounts and transactions have been eliminated in consolidation.
FOREIGN CURRENCY TRANSLATION
The functional currency of the Hong Kong Subsidiary is its local currency. The financial statements of the subsidiary are translated to U.S. dollars using year-end rates of exchange for assets and liabilities, and average rates of exchange for the year for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are included in the consolidated statements of operations and were not material during the periods presented. The effect of exchange rate changes on cash at March 31, 2006, 2005 and 2004 were also not material.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents. Cash and cash equivalent balances at March 31, 2006 and March 31, 2005 were $423,548 and $617,054, respectively.
CONCENTRATION OF CREDIT RISK
Occasionally the Company maintains cash balances in foreign financial institutions. Such balances are not insured. The uninsured amounts at March 31, 2006 and 2005 approximate $251,108 and $379,000 respectively.
INVENTORIES
Inventories are comprised of electronic karaoke equipment, accessories, and compact discs and are stated at the lower of cost or market, as determined using the first in, first out method.
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 years March 31, 2004, the Company recorded an impairment charge totaling $442,989 on certain tooling. The 2004 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 and all significant contractual obligations have been satisfied and collection of the resulting receivable is reasonably assured. Revenues from sales of consigned inventory are recognized upon sale of the product by the consignee. Net sales are comprised of gross sales net of a provision for actual and estimated future returns, discounts and volume rebates. The provision for actual and estimated sales returns for fiscal years ended March 31, 2006, 2005 and 2004 was $2.4 million, $3.6 million and $6.7 million, respectively. The total returns represents 7.4%, 9.3% and 9.4% of the net sales for fiscal year ended March 31, 2006, 2005 and 2004, respectively.
STOCK BASED COMPENSATION
Effective June 15, 2005, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payments ("SFAS 123 (R)"), which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees. SFAS 123 (R) requires all share-based payments to employees including grants of employee stock options, be measured at fair value and expensed in the consolidated statement of operations over the service period (generally the vesting period). Upon adoption, the Company transitioned to SFAS 123 (R) using the modified prospective application, whereby compensation cost is only recognized in the consolidated statements of operations beginning with the first period that SFAS 123 (R) is effective and thereafter, with prior periods' stock-based compensation still presented on a pro forma basis. Under the modified prospective approach, the provisions of SFAS 123 (R) are to be applied to new employee awards and to employee awards modified, repurchased, or cancelled after the required effective date. Additionally, compensation cost for the portion of employee awards for which the requisite service has not been rendered that are outstanding as of the required effective date shall be recognized as the requisite service is rendered on or after the required effective date. The compensation cost for that portion of employee awards shall be based on the grant-date fair value of those awards as calculated for either recognition or pro-forma disclosures under SFAS 123. The Company continues to use the Black-Scholes option valuation model to value stock options. As a result of the adoption of SFAS 123 (R), the Company recognized a charge of $13,307 (included in selling, general and administrative expenses) in the year ended March 31, 2006 associated with the expensing of stock options. Employee stock option compensation expense in 2006 includes the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period for the entire portion of the award.
Reported and pro forma net income (loss) and earnings (loss) per share are as follows:
The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option-pricing model with the assumptions in the table below. During fiscal year 2006, the Company took into consideration guidance under SFAS 123 (R) and SEC Staff Accounting Bulletin No. 107 (SAB 107) when reviewing and updating assumptions. The expected volatility is based upon historical volatility of our stock and other contributing factors. The expected term is based upon observation of actual time elapsed between date of grant and exercise of options for all employees. Previously such assumptions were determined based on historical data.
Fiscal 2006: expected dividend yield 0%, risk- free interest rate between 4% to 4.86%, volatility between 91% and 104% and expected term of three to five years.
Fiscal 2005: expected dividend yield 0%, risk- free interest rate of 4%, volatility between 110% and 199% and expected term of three to five years.
Fiscal 2004: expected dividend yield 0%, risk- free interest rate of 4%, volatility between 80% and 110% and expected term of three years.
ADVERTISING
Costs incurred for producing and publishing advertising of the Company, are charged to operations as incurred. The Company had entered into cooperative advertising agreements with its major clients that specifically indicated that the client has to spend the cooperative advertising fund on mutually agreed events. The percentage of the cooperative advertising allowance ranges from 2% to 5% of the purchase. The clients have to advertise the Company's products in the client's catalog, local newspaper and other advertising media. The client must submit the proof of the performance (such as a copy of the advertising showing the Company's products) to the Company to request for the allowance. The client does not have the ability to spend the allowance at their discretion. The Company believes that the identifiable benefit from the cooperative advertising program and the fair value of the advertising benefit is equal or greater than the cooperative advertising expense. Advertising expense for the years ended March 31, 2006, 2005 and 2004 was $168,739, $597,821 and $2,340,439, 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, 2006, 2005 and 2004, these amounts totaled $132,282, $239,242 and $302,144, respectively.
EARNINGS PER SHARE
In accordance with SFAS No, 128, "Earnings per Share," basic (loss) earnings per share are computing by dividing the net (loss) earnings for the year by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net earnings for the year by the weighted average number of common shares outstanding including the effect of common stock equivalents.
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 November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 151, "Inventory Costs - an amendment of ARB No. 43, Chapter 4" (SFAS 151), effective for inventory costs incurred during fiscal years beginning after June 15, 2005. This Statement amends the guidance in Accounting Research Bulletin (ARB) No. 43, Chapter 4, "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage). Paragraph 5 of ARB No. 43, Chapter 4, previously stated that "...under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and re-handling costs may be so abnormal as to require treatment as current period charges...." SFAS 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal..." In addition, SFAS 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Company adopted SFAS 151 as of April 1, 2005. The effect of the adoption of SFAS 151 was not material.
In December 2004, FASB issued Statement of Financial Accounting Standards No. 153, "Exchanges of Non monetary Assets - an amendment of APB Opinion No. 29" (SFAS 153), effective for non monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. This Statement amends Accounting Principles Board (APB) Opinion No. 29 to eliminate the exception for non monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non monetary assets that do not have commercial substance. A non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The Company adopted SFAS 153 as of January 1, 2005. The effect of the adoption of SFAS 153 was not material.
In December 2004, FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" (SFAS 123 (revised 2004), effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. This Statement is a revision of FASB Statement No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related implementation guidance. SFAS 123 (revised 2004) eliminates the alternative to use APB Opinion No. 25's intrinsic value method of accounting that was provided in Statement 123 as originally issued. Under APB Opinion No. 25, issuing stock options to employees generally resulted in recognition of no compensation cost. SFAS 123 (revised 2004) requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). Recognition of that compensation cost helps users of financial statements to better understand the economic transactions affecting an entity and to make better resource allocation decisions. The Company adopted SFAS 123 (revised 2004) for the fiscal quarter ending after June 15, 2005. The effect of the adoption of SFAS 123 (revised 2004) is not material.
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.
The Company has experienced recurring losses, has an accumulated deficit and negative working capital. Our unencumbered assets are limited and we are not able to meet some short term obligations. These factors, among others, raise substantial doubt that the Company may be able to continue operations as a going concern.
Subsequent to March 31, 2006, we plan to finance our operations as follows:
1) Equity investment - The shareholders of Starlight International (Starlight) have approved a $3 million investment in the Company's common stock. The Company has received a $1 million (non interest bearing advance) from Starlight in June, 2006 in addition to the $2 million (interest bearing loan) received in March, which was used to settle the $4 million convertible debentures.
2) Related Party Loan - We might be able to raise additional short term loan from Starlight, who is also one of our suppliers.
3) Vendor financing - Our key vendors in China have agreed to manufacture on behalf of the Company without advanced payments and have extended payment terms to the Company. The terms with the factories are sufficient to cover the factory direct sales, which accounted more than 60% of the total revenues.
4) Factoring of accounts receivable - The Company would factor its accounts receivable for sales originated in the United States.
5) Cost reduction - The Company has reduced significant operating expenses in this fiscal year. The cost reduction initiatives are part of our intensive effort to achieve a successful turn-around restructuring. The Company plans to continue its cost cutting efforts in the fiscal 2007.
6) Bank facility - The Company is actively seeking additional banking facilities to finance its domestic purchase.
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.
NOTE 3 - INVENTORIES
Inventories are comprised of the following components:
MARCH 31, MARCH 31, 2006 2005 ----------- ----------- Finished Goods $ 2,637,277 $ 4,717,455 Inventory in Transit 146,904 45,912 Less: Inventory Reserve (1,096,123) (1,668,430) ----------- ----------- Total Inventories $ 1,688,058 $ 3,094,937 =========== ===========
Inventory consigned to customers 2006 and March 31, 2005 was $176,750 and $151,824, respectively.
NOTE 4 - ACCOUNTS RECEIVABLE FACTORING AGREEMENT
On August 4, 2004, the Company entered into a 3 year factoring agreement with Crestmark Bank, Detroit, Michigan. The agreement allows the Company, at the discretion of Crestmark, to factor its outstanding receivables, with recourse, up to a maximum of the lesser of $2.5 million or 70% of eligible accounts receivable. The Company pays 1% of gross receivables in fees with a $9,000 minimum maintenance fee per month. The average balance of the line will be subject to interest payable on a monthly basis at prime plus 2% (10% at March 31, 2006). The agreement contains a liquidated damage fee, which equals to $9,000 multiply remaining months of the contract term for early termination by the Company.
Crestmark Bank also received a security interest in all of the Company's accounts receivables and inventory in the United States. The related party loan holders have subordinated their debt to the Crestmark Bank debt.
As of March 31, 2006 and 2005, the outstanding amount due from Crestmark bank for factoring was $134,281 and $34,372, respectively. The amount represents excess of customer payments received by Crestmark Bank over advances made to the Company.
NOTE 5 - PROPERTY AND EQUIPMENT
A summary of property and equipment is as follows:
USEFUL MARCH 31, MARCH 31, LIFE 2006 2005 --------- ----------- ------------ Computer and office equipment 5 years $ 516,456 $ 507,953 Furniture and fixtures 5-7 years 364,026 351,510 Leasehold improvement * 154,125 103,776 Molds and tooling 3 years 2,725,080 2,601,400 ----------- ----------- 3,759,687 3,564,639 Less: Accumulated depreciation (3,246,072) (2,525,796) ----------- ----------- $ 513,615 $ 1,038,843 =========== ===========
* Shorter of remaining term of lease or useful life
NOTE 6 - RESTRICTED CASH
The Company, through the Hong Kong Subsidiary, maintains a letter of credit facility and short term loan with a major international bank. The Hong Kong Subsidiary was required to maintain a separate deposit account in the amount $268,405 and $870,795 at March 31, 2006 and 2005, respectively. This amount is shown as restricted cash in the accompanying balance sheets. The restricted cash is not covered by the bank's deposit insurance.
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
o Trust receipts
o A Company credit card
These facilities are secured by a corporate guarantee from the U.S. Company, restricted cash on deposit with the lenders and require that the Hong Kong subsidiary maintain a minimum tangible net worth of approximately $2 million. International SMC was in compliance with minimum tangible net worth as of March 31, 2006. The maximum available credit under the facilities is $1.5 million. The interest rate is approximately 6%. At March 31, 2006 and March 31, 2005, there were no borrowings against the facilities. The Hong Kong Subsidiary terminated its credit facility with HSBC and Fortis Bank on January 23, 2006 and May 1, 2006, respectively. The Company is currently seeking a banking facility in Macau to meet its export needs.
LOAN PAYABLE
On March 10, 2006, the Company borrowed $2 million from a subsidiary of Starlight International to pay off the $4 million convertible debentures (see Note 10 and Note 11). The bridge loan will be converted into equity upon closing of Starlight $3 million investment.
RELATED PARTY LOANS
On or about July 10, 2003, an officer and two directors of our Company advanced $1 million to our Company pursuant to written loan agreements. The officer is Yi Ping Chan and the directors were Josef A. Bauer and Howard Moore. Mr. Moore resigned from our Board, effective as of October 17, 2003. Additionally, Maureen LaRoche, a business associate of Mr. Bauer, participated in the financing. The loans are subordinated to the factoring company and accrued interest at 9.5% per annum. These loans were originally scheduled to be repaid by October 31, 2003, but were extended past March 31, 2006. All interest was accrued, and the unpaid amount totaled approximately $14,250. A portion of the loans and the accrued interest in the amount of $409,500 has been converted into 563,274 shares of common stock at $0.72 per share on January 5, 2005. In addition, another portion of the loans in the amount of $200,000 has been converted into 277,778 shares of common stock on May 18, 2005. On November 30, 2005, Maureen LaRoche was repaid $107,917 ($100,000 principle and $7,917 interest). The balance of related party loan as of March 31, 2006 was $300,000. According the Security Purchase Agreement with Starlight dated on February 21, 2006, the company might use $50,000 of $3 million investment to retire a portion of the loan. The remainder of the loan will be extended for 3 years at an interest rate of 5.5%.
On June 27, 2005, the Company received a $200,000 loan from Andrew Shapiro, a relative of Mr. Bauer. The interest rate on the loan is 12% per annum and is due on November 30, 2005. The loan was repaid on November 29, 2005 with interest.
On June 2, 2006, the Company received a $200,000 loan from Andrew Shapiro, a relative of Mr. Bauer. The interest rate on the loan is 8% per annum and is due on June 20, 2006 or such later date as mutually agreed between the parties. The loan was repaid on June 30, 2006 with interest.
NOTE 8 - CUSTOMER CREDITS ON ACCOUNT
Customer credits on account represent customers that have received credits in excess of their accounts receivable balance. These balances were reclassified for financial statement purposes as current liabilities until paid or applied to future purchases.
NOTE 9 - CONVERTIBLE DEBENTURES WITH WARRANTS
In September 2003, the Company issued $4 million of 8% Convertible Debentures in a private offering which were due February 20, 2006 ("Convertible Debentures"). The net cash proceeds received by the Company were $3,745,000 after deduction of cash commissions and other expenses.
The Convertible Debentures are convertible at the option of the holders and were initially convertible into 1,038,962 common shares at a conversion price of $3.85 per common share subject to certain anti-dilution adjustment provisions, at any time after the closing date. The repayment of the Convertible Debentures was subordinated to a factoring agreement with Milberg Factors (Milberg), which was terminated as of July 14, 2004.
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 the effective interest method.
On February 9, 2004, the Company amended its convertible debenture agreements to increase the interest rate to 8.5% and to grant warrants to purchase an aggregate of 30,000 shares of the Company's common stock to the debenture holders on a pro-rata basis. These concessions are in consideration of the debenture holder's agreements to (i) enter into new subordination agreements with Milberg, (ii) to waive all liquidated damages due under the transaction documents through July 1, 2004 and (iii) to extend the effective date of the Form S-1 registration statement until July 1, 2004. The new warrants have an exercise price equal to $1.52 per share and the fair value of these warrants was estimated by using the Black-Scholes Option-Pricing Model and totaled $30,981. This amount was expensed as a component of selling, general and administrative expenses during the three months ended December 31, 2003. Pursuant to the Convertible Debenture agreements, the Company was required to register the shares of common stock underlying the debentures and detachable stock purchase warrants issued in connection with the debentures. The registration of the common shares was required to be effective by July 1, 2004. The Form S-1 registration statement was effective on January 21, 2005.
On November 8, 2004, the Company executed a letter agreement with the debenture holders, whereby the Company agreed to change the interest rate on the debenture to 9% in exchange for the debenture holders agreeing to (i) execute a subordination agreement with Crestmark Bank, (ii) waive all liquidated damages due under the transaction documents through January 7, 2005, and (iii) withdraw any demand for repayment under the debenture.
According to the anti-dilution adjustment provision, if the Singing Machine sells shares of its common stock at an effective price less than the agreed to price in the agreement, the debenture holders are entitled to convert their debentures into shares at a new conversion price, which equals to the original set price minus 75% of the difference between the Set Price and the new price if the event occurs before September 8, 2004. On July 30, 2004, the Singing Machine received the court approval of the Class Action Lawsuit (case# 03-CV-80596). The Singing Machine issued 400,000 shares to the plaintiff as part of the settlement on September 23, 2004. The market closing price on July 30, 2004 was $0.60 per share. The event has triggered the conversion price reset for the convertible debentures.
According to the Emerging Issue Task Force (EITF) Issue No. 00-27, if the terms of a contingent conversion option do not permit an issuer to compute the number of shares that the holder would receive if the contingent event occurs and the conversion price is adjusted, an issuer should wait until the contingent event occurs and then compute the resulting number of shares that would be received pursuant to the new conversion price. The incremental intrinsic value that resulted from the price reset equals additional shares multiplied by the stock market price at the issuing date of the debentures, which would be recorded as discount of convertible debentures and amortized over the remaining life of the debentures. The new adjusted conversion price of stock is $1.41 [3.85- (3.85-0.60) X 75%] while the conversion price of warrant is $1.46. As of July 30, 2004, the number of shares issuable upon conversion of debenture is 2,831,858. The amount of $687,638 was recorded as additional discounts of the debentures and will be amortized for the remaining life of the debentures. Total amortization expense for March 31, 2006 is $1,615,642.
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 financing fees has been fully amortized as of March 31, 2006.
NOTE 10 - NET GAIN ON RETIREMENT OF CONVERTIBLE DEBENTURES
On March 10, 2006, the holders of the Company's 8% convertible debentures agreed to accept $2,000,000 in full payment of principal and unpaid interest due them on the convertible debentures.
This agreed upon final payment resulted in a net gain of $2,253,725 which has been reflected under other income in the accompanying consolidated statement of operations for the fiscal year ended 2006.
The funds to complete this transaction were provided by a $2 million bridge loan from Ever Solid Ltd., a subsidiary of Starlight International Holding Ltd. The $2 million bridge loan was recorded as loan payable in the balance sheets as of March 31, 2006. The Company also agreed to reset the price of 457,143 warrants issued to the debenture holders from $1.41 to $0.85. The warrants are to expire on September 7, 2006. The Company has recorded the fair value of the price reset in the amount of $6,000 to financing expense for the year ended March 31, 2006.
The funds for the retirement of the obligation were advanced by Starlight pursuant to a Stock Purchase Agreement.
NOTE 11 - SECURITY PURCHASE AGREEMENT
On February 21, 2006, we entered into a Securities Purchase Agreement (the "Purchase Agreement") with koncepts International Limited (the "Purchaser") pursuant to which the Company agreed to sell and issue 12,875,536 shares of common stock, $.01 par value per share (the "Common Shares"), and 3 common stock purchase warrants (the "Warrants") to purchase an aggregate of 5,000,000 shares of common stock for an aggregate purchase price of $3,000,000, or a per share purchase price of $.233. Subject to additional closing conditions as specified in the Purchase Agreement, the closing of the offering is subject to the Company's successful restructuring of $4,000,000 principal amount subordinated debenture which came due on February 20, 2006, as well as the approval of the American Stock Exchange and the shareholders of Starlight International Holdings Ltd., parent company of the Purchaser, as per the requirements of Hong Kong Stock Exchange. The parties intend to complete this offering within the next 60 days, assuming all closing conditions are met.
The Company issued Warrants to purchase (i) 2,500,000 shares of our common stock at an exercise price of $.233 per share for one year from the date of issuance, (ii) 1,250,000 shares of our common stock at an exercise price of $.28 per share for three years from the date of issuance, and (iii) 1,250,000 shares of our common stock at an exercise price of $.35 per share for four years from the date of issuance. The Warrants are subject to adjustment upon the occurrence of specific events, including stock dividends, stock splits, combinations or reclassifications of our common stock or distributions of cash or other assets. Under the terms of the Warrants, in no event shall the Purchaser become the beneficial owner of more than 19.99% of the number of shares of common stock outstanding immediately after giving effect to such issuance.
On March 10, 2006, the Company borrow $2 million from a subsidiary of Starlight International to pay off the $4 million convertible debentures (see Note 11). The bridge loan will be converted into equity upon closing of Starlight $3 million investment.
On June 15, 2006, the shareholders of Starlight approved the Purchase Agreement, the Company received $1,000,000 cash payment from Purchaser on June 20, 2006. The Company will issue 12,875,536 shares of common stock to the Purchaser upon receiving the approval from the American Stock Exchange on or around July 31, 2006.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
LEGAL MATTERS
SYBERSOUND RECORDS, INC., d/b/a Party Tyme Karaoke v. UAV CORPORATION, d/b/a KARAOKE BAY and d/b/a STERLING ENTERTAINMENT; MADACY ENTERTAINMENT GROUP, LTD.; AUDIO STREAM, INC. d/b/a KEYNOTE KARAOKE; TOP TUNES, INC.; SINGING MACHINE COMPANY; COMPASS PRODUCTIONS, INC.; BCI ECLIPSE LLC; and DOES 1 THROUGH 50 inclusive. (SUPERIOR COURT OF THE STATE OF CALIFORNIA FOR THE COUNTY OF LOS ANGELES, WEST DISTRICT, CASE NO. SC 085498)
On May 12, 2005, Sybersound Records, Inc., a U.S. karaoke product distributor, filed a suit in Los Angeles Superior Court against virtually every one of its competitors (including Singing Machine), seeking actual and punitive damages arising from alleged unfair business practices, unfair competition, and wrongful interference with business relationships. The defendants in the case (including Singing Machine), all of whom cooperated in vigorously defending themselves from what they considered to be baseless charges, filed various motions in the case seeking dismissal on Constitutional and other grounds. Sybersound thereafter moved to dismiss the state court action, a motion which the court granted, and filed a new action against many of the same defendants, including The Singing Machine Company, Inc., in federal court on August 11, 2005.
SYBERSOUND RECORDS, INC. V. UAV CORPORATION; MADACY ENTERTAINMENT L.P., AUDIO STREAM, INC., TOP TUNES, INC., SINGING MACHINE, INC., BCI ECLIPSE COMPANY, LLC, AMOS ALTER, DAVID ALTER, EDWARD GOETZ, DENNIS NORDEN, FRANK ROBERTSON, DOUGLAS VOGT AND RICHARD VOGT (UNITED STATES DISTRICT COURT FOR THE CENTRAL DISTRICT OF CALIFORNIA, CV05-5861 JFW); (UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT (USCA DOCKET NO. 06-55221)
The new federal court action filed on August 11, 2005 alleged violation the Copyright Act and the Lanham Act by the defendants, and claims for unfair competition under California law. Sybersound was joined in the complaint by several publisher owners of musical compositions who alleged copyright infringement against all the defendants except The Singing Machine Company, Inc. On November 7, 2005, the district court ordered the publisher plaintiffs' copyright claims severed from the case. The Singing Machine Company, Inc. is not a party to the severed cases.
In September, 2005, the defendants, including The Singing Machine Company, Inc., filed multiple motions to dismiss the original complaint. In October, Sybersound filed a motion for summary judgment, as well. On January 6, 2006, the court granted the motions of the defendants and denied the plaintiff's motion, dismissing the case against the defendants, including The Singing Machine Company, Inc., with prejudice. Plaintiff Sybersound thereafter appealed the decision to the Ninth Circuit Court of Appeals. The case is currently under review by the appellate court.
NON-COMPLIANCE NOTICE FROM AMEX
The Company has received a non-compliance notice from The American Stock Exchange (the "Amex") on July 18, 2005. The notice indicated that the Company has fallen below the continued listing standards of the Amex and that its listing is being continued pursuant to an extension. Specifically, for the fiscal year ended March 31, 2005, the Company was not in compliance with the minimum shareholders' equity requirement of $2,000,000, and had reported net losses in each of the past two fiscal years, resulting in the Company's non-compliance with Sections 1003(a)(i) and 1003(a)(iv) of the Amex Company Guide. In addition, the Company failed to announce in a press release, as required by Section 610(b) of the Amex Company Guide, that it received an audit opinion which contained a going concern qualification as disclosed in its Form 10-K for fiscal 2005 that was filed on June 29, 2005.
In order to maintain its Amex listing, the Company submitted a plan by August 18, 2005 advising the Amex of actions it will take, which may allow it to regain compliance within a maximum of 18 months and 12 months from July 18, 2005, respectively.
The Exchange has completed its review of The Singing Machine's plan of compliance and supporting documentation and has determined that, in accordance with Section 1009 of the Company Guide, the Plan makes a reasonable demonstration of the Company's ability to regain compliance with the continued listing standards within a maximum of 18 months and 12 months from July 18, 2005, respectively.
The Company must regain compliance with the $4,000,000 minimum shareholders' equity requirement by January 18, 2007. Failure to regain compliance within these time frames likely will result in the Exchange Staff initiating delisting proceedings pursuant to Section 1009 of the Company Guide. Further, if our common stock is removed from listing on Amex, it may become more difficult for us to raise funds through the sales of our common stock or securities.
The Company is also subject to various other legal proceedings and other claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability, if any, in excess of applicable insurance coverage, is not likely to have a material effect on the financial condition, results of operations or liquidity of the Company. However, as the outcome of litigation or other legal claims is difficult to predict, significant changes in the range of possible loss could occur, which could have a material impact on the Company's operations.
LEASES
The Company has entered into various operating lease agreements for office and warehouse facilities in Coconut Creek, Florida, Compton, California, and Kowloon, Hong Kong. The leases expire at varying dates. Rent expense for fiscal 2006, 2005 and 2004 was $632,586, $673,148 and $1,542,041, 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, 2006 are as follows:
Property Lease Equipment Lease -------------- --------------- Years ending March 31: 2007 $ 733,302 $ 3,791 2008 532,696 3,791 2009 35,790 3,791 2010 -- 3,159 ---------- ------- $1,301,788 $14,532 ========== =======
MERCHANDISE LICENSE AGREEMENTS
In February 2003, we entered into a multi-year license agreement with Universal Music Entertainment to market a line of Motown Karaoke machines and music. This agreement and its subsidiary agreement signed in March 2003, allow us to be the first to use original artist recordings for our CD+G formatted karaoke music. Over the term of the license agreement, we are obligated to make guaranteed minimum royalty payments in the amount of $300,000, which has been paid in full as of March 31, 2005. The Universal Music Entertainment license expires on March 31, 2006 and extended to December 31, 2006.
We entered into a license agreement with Nickelodeon, Inc., a division of Viacom International, Inc. in December 2002. Under this agreement, we licensed Nickelodeon branded machines and a wide assortment of music. This license originally expired on December 31, 2004. The company has extended the agreement to December 31, 2006. Over the term of the license agreement, we are obligated to make guaranteed minimum royalty payments in the amount of $450,000, which has been paid in full as of December 31, 2005.
On December 20, 2005, we entered into a three-year license agreement with Hi-5 to produce and distribute karaoke software, including compact discs with graphics (CDGs) and karaoke music downloadable via the Internet, a variety of karaoke hardware products, and youth-oriented cassette players, CD and DVD players, and clock radios based on the popular "Hi-5" television show. The agreement contains an option to extend for an additional three years.
On May 10, 2006, we entered into a two-year license agreement with MGA Entertainment, Inc. to produce and distribute a variety of karaoke products based on MGA's BRATZ(TM) franchise, one of the world's leading toy lines and girls' lifestyle brands, in North America, Europe and Australia. These karaoke products include a TFT DVD karaoke system, sing-a-long cassette players, deluxe microphones, electronic keyboards and an electronic drum.
NOTE 13 - STOCKHOLDERS' DEFICIT
COMMON STOCK ISSUANCES
During the fiscal year ended March 31, 2006 and 2005, the Company issued 290,689 and 1,017,275 shares of its common stock, respectively.
On November 1, 2005, the Company issued 12,911 shares of common stock to members of the Board of Directors for services provided to the Company for fiscal year 2005, valued at $9,167.
On May 1, 2005, the Company has authorized the issuance of 277,778 shares of common stock for the conversion of a $200,000 related party loan.
On January 5, 2005, the Company has authorized the issuance of 563,274 shares of common stock for the conversion of a $400,000 related party loan and a $9,500 interest payment. The conversion rate is $0.72 per share, which is based on the 5 days average stock closing price prior to December 20, 2004.
On September 23, 2004 the Company issued 400,000 shares of common stock to the plaintiffs in lieu of the class action lawsuit settlement. (See Note-10 "Legal Matters")
On May 11, 2004, the Company issued 50,000 shares of common stock to a former executive for consulting services rendered. The Company expensed the consulting costs in fiscal 2004, the period for which services were provided.
On April 1, 2004, the Company adjusted its common stock by 4,001 shares due to a prior year 3 to 2 stock split .
EARNINGS PER SHARE
In accordance with SFAS No. 128, "Earnings per Share", basic (loss) earnings per share are computed by dividing the net (loss) earnings for the year by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing net earnings for the year by the weighted average number of common shares outstanding including the effect of common stock equivalents. The following table presents a reconciliation of basic (loss) earnings per share and diluted earnings per share:
For fiscal 2006, 2005 and 2004, 1,133,201, 4,674,338 and 2,657,532 common stock equivalents were not included in the computation of diluted earnings per share as their effect would have been antidilutive for fiscal years ended March 31, 2006, 2005 and 2004.
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, 2006, the Plan is authorized to grant options up to an aggregate of 1,950,000 shares of the Company's common stock and up to 300,000 shares for any one individual grant in any fiscal year. As of March 31, 2006, the Company had granted 1,279,560 options under the Year 2001 Plan, leaving 670,440 options available to be granted. As of March 31, 2006, the Company had 343,050 options issued and 20,550 outstanding under its 1994 Plan.
The exercise price of employee common stock option issuances in 2006, 2005 and 2004 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 prior to June 15, 2006. The Company adopted SFAS 123(R) for the reporting period ending after June 15, 2005 and recognized the fair value of the stock option as part of the selling, general and administration expense. A summary of the options issued as of the presented period and changes during the years is presented below.
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 the periods presented:
The following table summarizes information about employee stock options outstanding at March 31, 2006 :
STOCK WARRANTS
As of March 31, 2006, the Company had a total of 591,040 stock purchase warrants outstanding. Of the total, 457,143 warrants were issued in September 2004 to investors in connection with the $4 million debenture offering (see Note 9) 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 expense. 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 9). 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 2005 was $2.67.
On July 30, 2005, the exercise price for 457,143 warrants issued to the debentures' holder has been adjusted from $4.05 to $1.46 pursuant to antidilution provision (see Note 9). On March 10, 2006, the exercise price for 457,143 has been changed from $1.46 to $0.85 (see Note 9).
NOTE 14 - INCOME TAXES
The Company files separate tax returns for the parent and for the Hong Kong Subsidiary. The income tax expense (benefit) for federal, foreign, and state income taxes in the consolidated statement of operations consisted of the following components for 2006, 2005 and 2004:
2006 2005 2004 ----------- ----------- ------------ Current: U.S. Federal $ 550,839 $ -- $(1,071,709) Foreign (129,090) -- -- State 74,870 -- (95,398) Deferred (496,619) 1,925,612 ----------- ----------- ----------- $ -- $ -- $ 758,505 =========== =========== ===========
The United States and foreign components of income (loss) before income taxes are as follows:
2006 2005 2004 ------------ ------------ ------------
United States $ (1,167,592) $ (2,943,847) $(21,362,610) Foreign (737,659) (648,128) (562,309) ------------ ------------ ------------ $ (1,905,251) $ (3,591,975) $(21,924,919) ============ ============ ============
The actual tax expense differs from the "expected" tax expense for the years ended March 31, 2006, 2005 and 2004 (computed by applying the U.S. Federal Corporate tax rate of 34 percent to income before taxes) as follows:
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows:
At March 31, 2006, the Company has federal tax net operating loss carryforwards in the amount of approximately $11.1 million which expire beginning in the year 2019. In addition, state tax net operating loss carryforwards in the amount of approximately $9.8 million expire beginning in 2009.
NOTE 15 - SEGMENT INFORMATION
The Company operates in one segment and maintains its records accordingly. The majority of sales to customers outside of the United States are made by the Hong Kong Subsidiary. Sales by geographic region for the period presented are as follows:
FOR THE FISCAL YEARS ENDED March 31, 2006 2005 2004 ----------- ----------- ----------- North America $22,458,950 $28,227,140 $43,044,496 Europe 9,655,939 9,531,632 25,783,789 Others 190,671 451,053 1,712,843 ----------- ----------- ----------- $32,305,560 $38,209,825 $70,541,128 =========== =========== ===========
The geographic area of sales is based primarily on the location where the product is delivered.
NOTE 16 - 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, 2006, 2005 and 2004 totaled $39,571, $30,027 and $55,402, respectively. The amounts are included as a component of compensation expense in the accompanying statements of operations. The Company does not provide any post employment benefits to retirees.
NOTE 17 - 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, 2006, 47% of accounts receivable were due from three customers: two from the U.S. and one from an International Customer. Accounts receivable from customers that individually owed over 10% of total accounts receivable was 31% at March 31, 2006. Accounts receivable from customers that individually owed over 10% of total accounts receivable were 12% and 10% at March 31, 2005. The Company performs ongoing credit evaluations of its customers and generally does not require collateral.
Revenues derived from five customers in 2006, 2005 and 2004 were 56%, 40% and 54% of total revenues, respectively. Revenues derived from top three customers in 2006, 2005 and 2004 as percentage of the total revenue were 13%, 12% and 11%; 9%, 8% and 9%; and 20%, 12% and 10%, respectively. The loss of any of these customers can have an adverse impact on the financial position of the Company.
Net sales derived from the Hong Kong Subsidiary aggregated $21.9 million in 2006, $26.9 million in 2005 and $43.1 million in 2004.
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 2006, 2005 and 2004, manufacturers in the People's Republic of China ("China") accounted for approximately 98%, 96% and 96% respectively; of the Company's total product purchases, including all of the Company's hardware purchases.
The Company is primary relying on one US factoring company in the United States. The loss of the facility might have an adverse effect on the Company's business.
NOTE 18 - 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 2006, 2005 and 2004 are set forth in the following table:
NOTE 19 - SUBSEQUENT EVENTS
On May 10, 2006, we entered into a two-year license agreement with MGA Entertainment, Inc. to produce and distribute a variety of karaoke products based on MGA's BRATZ(TM) franchise, one of the world's leading toy lines and girls' lifestyle brands, in North America, Europe and Australia. These karaoke products include a TFT DVD karaoke system, sing-a-long cassette players, deluxe microphones, electronic keyboards and an electronic drum.
On June 2, 2006, the Company received a $200,000 loan from Andrew Shapiro, a relative of Mr. Bauer. The interest rate on the loan is 8% per annum and is due on June 20, 2006 or such later date as mutually agreed between the parties. The loan was repaid on June 30, 2006 with interest.
On June 15, 2006, the shareholders of Starlight has approved the Purchase Agreement, the Company received $1,000,000 cash payment from Purchaser on June 20, 2006. The Company will issue 12,875,536 shares of common stock to the Purchaser upon receiving the approval from the American Stock Exchange.
SUPPLEMENTAL DATA SCHEDULE II