SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-KSB
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended MARCH 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _______________ to _______________
Commission File Number: 0-24968
THE SINGING MACHINE COMPANY, INC.
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(Name of Registrant as specified in its charter)
DELAWARE 95-3795478
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1551 W. COPANS ROAD, #100, POMPANO BEACH, FL 33064
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number: 954-968-8006
Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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Common Stock
Par Value $.01 per share OTC Bulletin Board
Common Stock Purchase Warrant OTC Bulletin Board
Securities registered pursuant to Section 12(g) of the Act: None
Check whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports) and (2) has been subject to such filing requirements for the past
90 days.
Yes X No ____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year: $5,195,567
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AGGREGATE MARKET VALUE OF THE VOTING STOCK
HELD BY NONAFFILIATES OF THE REGISTRANT
As of June 30, 1996, 2,811,582 shares of Common Stock, par value $.01
per share ("Common Stock"), of the Registrant were outstanding. Based on the
average of the closing bid and asked prices of the Common Stock on the OTC
Bulletin Board ("OTC") as of June 30, 1996 ($0.30), the aggregate market value
of the 1,963,916 shares of the Common Stock held by persons other than officers,
directors and persons known to the Registrant to be the beneficial owner (as
that term is defined under the rules of the Securities and Exchange Commission)
of more than five percent of the Common Stock on that date was approximately
$590,000. By the foregoing statements, the Registrant does not intend to imply
that any of these officers, directors or beneficial owners are affiliates of the
Registrant or that the aggregate market value, as computed pursuant to rules of
the Securities and Exchange Commission, is in any way indicative of the amount
which could be obtained for such shares of Common Stock.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the Registrant has filed all documents
and reports required to be filed by Section 12, 13 or 14(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ____ No ____
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
State the number of shares outstanding of each of the Registrant's
classes of common stock, as of the latest practicable date:
2,811,582 shares of Common Stock, par value $.01
per share, were outstanding as of June 30, 1996
DOCUMENTS INCORPORATED BY REFERENCE
Exhibits contained in Registration Statement
on Form SB-2 (Registration No. 33-81974-A)
filed by the Registrant on July 27, 1994.
Forms 8-K filed by the Registrant on
December 4, 1995 and February 23, 1996.
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TABLE OF CONTENTS
PAGE
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Part I
Item 1. Business................................................... 1
Item 2. Properties.................................................10
Item 3. Legal Proceedings..........................................10
Item 4. Submission of Matters to a Vote of Security Holders........10
Part II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................10
Item 6. Management's Discussion and Analysis of Financial
Condition and Results of Operations......................11
Item 7. Financial Statements and Supplementary Data................22
Item 8. Changes in and disagreements with Accountants on
Accounting and Financial Disclosure......................23
Part III
Item 9. Directors and Executive Officers of the Registrant.........23
Item 10. Executive Compensation.....................................25
Item 11. Security Ownership of Certain Beneficial Owners and
Management...............................................28
Item 12. Certain Relationships and Related Transactions.............29
Item 13. Exhibit and Reports of Form 8-K............................31
Signatures.................................................34
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PART I
Item 1. BUSINESS
GENERAL
The Singing Machine Company, Inc. (the "Company") is engaged in the distribution
and marketing of electronic KARAOKE audio equipment which plays backing tracks
(music without lyrics) of popular songs and records the vocal accompaniment of
professional and amateur singers to those backing tracks. The Company contracts
for the manufacture of all of its electronic equipment products with
manufacturers located in the Far East. The Company also produces and markets
KARAOKE audio software, including CDS, CD and graphics, video tapes and audio
tapes, containing music and lyrics of popular songs for use with KARAOKE
recording equipment. One track of those tapes offers complete music and vocals
for practice and the other track is instrumental only for performance by the
participant. Virtually all audio software sold by the Company is accompanied by
printed lyrics and the Company's KARAOKE video tapes contain lyrics which appear
on the video screen. The Company contracts for the reproduction of its audio
software, which is produced by the Company or by an exclusive independent
producer.
The Company currently has a product line of 11 different models of recording and
playback units incorporating such features as a dual cassette player, graphic
equalizer and high-output stereo amplifier and markets certain of its units
under the popular national brand Memorex(Trademark) as well as its registered
trademark THE SINGING MACHINE(Registered trademark). In addition, the Company
believes that it has one of the larger backing track libraries of music in the
KARAOKE industry consisting of over 2,500 titles.
The Company sells audio software under the trademarks KARAOKE
KASSETTE(Trademark), KARAOKE KOMPACT DISC(Trademark) and KARAOKE VIDEO
KASSETTE(Trademark) and KARAOKE recording and playback units under its
registered trademark THE SINGING MACHINE(Registered trademark). The Company also
licenses its trademark, on a non-exclusive basis, to others for sales around thE
world. The Company believes that it is one of several companies in the KARAOKE
industry in the United States which sells both hardware and software.
BACKGROUND AND FORMATION OF THE COMPANY
The KARAOKE industry began in Japan in the 1970s. In Japanese society,
entertaining is not typically conducted in individual homes, but rather in
restaurants and nightclubs. KARAOKE, which translated literally means "empty
orchestra", is a concept that allows participants to sing words to soundtracks
of popular songs, reading lyrics from video monitors or scripts. The concept is
identical to that employed in the "follow the bouncing ball" segment of the
"Sing Along with Mitch" television program from the 1960s. The instrumental
music, or backing track, is provided by pre-recorded soundtracks on CDs or audio
or video tapes. In Japan, KARAOKE clubs and public establishments became popular
vehicles for social occasions and business entertainment.
The Company was incorporated in California in 1982. The Company originally sold
its products exclusively to professional and semi-professional singers. In 1988,
when Eugene B. Settler, currently a director, was retained as the Company's
President, it began marketing KARAOKE equipment for home use. The Company
believes it was the first to offer KARAOKE electronic recording equipment and
audio software for home use in the United States.
In February 1990 all of the outstanding Common Stock was purchased by Magna
International, Inc. ("Magna"). In March 1990, the Company relocated its offices
from California to South, Florida. In September 1991, Messrs. Paul Wu, Eugene B.
Settler and Edward Steele purchased an option from Magna for 100% of the
Company's then outstanding Common Stock, which option was exercised in May 1994,
by Messrs. Settler and Steele and, Mr. Wu's designees. In September 1992, Magna
and an affiliate thereof agreed to exchange $816,574 of debt owed
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by the Company to Magna and an affiliate thereof for additional shares of the
Company's Common Stock (the "Additional Shares"). That agreement, as amended,
gave Magna the right to require the Company to repurchase the Additional Shares,
on December 31, 1996, for $816,574 plus interest at 8% per annum from September
30, 1994. On November 10, 1994 Magna exchanged the Additional Shares for the
Company's promissory note (the "Magna Note") in the amount of $816,574. In
addition, in May 1994, the Company was merged into a wholly-owned subsidiary of
the Company 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.
STRATEGY
Currently the Company is focusing on its audio equipment operations with the
intention of increasing cash flow, improving operating efficiency, increasing
internal growth and returning to profitability. The Company's intent is to
obtain additional market share through an emphasis on the affordability,
selection and quality of its products.
The Company is also focusing greater sales efforts on mass market retailers,
such as Target and Montgomery Ward, which the Company believes have greater
potential for increased software sales. The Company has historically sold its
software products predominately to chain music stores and music distributors and
believes that the potential in this market has decreased. In order to reduce
expenses, management has limited the development of new products for both audio
equipment and audio software. There can be no assurance that the Company will be
able to successfully implement its strategy.
PRODUCTS
The following table sets forth the approximate amounts and percentages of the
Company's net revenues by product type during the periods shown, excluding
certain ancillary revenues.
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31,
------------------------------------------------------------------------------------------------
1996 1995 1994 1993
-------------------- ---------------------- --------------------- ----------------------
NET PERCENT NET PERCENT NET PERCENT NET PERCENT
REVENUES OF TOTAL REVENUES OF TOTAL REVENUES OF TOTAL REVENUES OF TOTAL
---------- -------- ---------- -------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Audio software $1,255,932 24.9% $3,258,312 56.4% $5,414,215 63.3% $2,823,429 48.8%
Audio equipment 3,795,447 75.1% 2,520,194 43.6% 3,133,508 36.7% 2,966,473 51.2%
</TABLE>
The Company currently offers 11 different models of electronic recording and
playback equipment with retail prices ranging from $30 for basic units to $300
for semi-professional units with CD and graphics player sound enhancement,
graphic equalizers, tape record/playback features and multiple inputs and
outputs for connection to compact disc players and video cassette recorders.
The Company currently offers its audio software in four formats - multiplex
cassettes, CDS, CD and graphics, and video cassette tapes with retail prices
ranging from $3.99 to $14.98. The Company purchases recordings from an
independent producer, and currently has a song library of over 2,500 titles. The
Company's backing track product line covers the entire range of musical tastes
including popular hits, golden oldies, country, standards, rock and roll and
rap. The Company even has backing tracks for opera and certain foreign language
recordings. The Company considers its song library to be of considerable value
and of material importance to its business. See "Notes to Consolidated Financial
Statements No. 6 - Commitments and Contingencies".
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NEW PRODUCT DEVELOPMENT
Management believes that the enhancement and extension of the Company's existing
products and the selective development of new product lines are important to the
Company's continued growth. The Company combines the style and content of its
products to meet customer requirements for quality, product mix and pricing.
Company employees work closely with both retailers and suppliers to identify
trends in consumer preferences and to generate new product ideas. The Company's
employees evaluate new ideas and seek to develop new products and improvements
to existing products to satisfy industry requirements and changing consumer
preferences.
During the fiscal year ended March 31, 1996, the Company introduced 4 new models
of recording equipment, 108 new song titles and 101 new compilations of existing
titles as well as secured the rights to use the brand name Memorex(Trademark).
The Company has also expanded into non-KAROKE audio equipment with the addition
of wireless stereo speakers to its product line.
SALES, MARKETING AND DISTRIBUTION
The Company distributes its products to retailers and wholesale distributors
through two methods: domestic sales, i.e., shipment of products from the
Company's inventory; and direct sales, i.e., shipments directly from the
Company's Hong Kong subsidiary or manufacturers in the Far East, of products
sold by the Company's sales force. Domestic sales, which account for
substantially all of the Company's audio software sales, are made to customers
located throughout the United States from the Company's inventories maintained
at its warehouse facility in Florida, and a warehouse in California, or directly
from U.S. software manufacturers.
DOMESTIC SALES. The Company's strategy of selling products from a domestic
warehouse enables it to provide timely delivery and serve as a "domestic
supplier of imported goods". The Company purchases electronic recording products
overseas for its own account and warehouses the products in a leased facility in
Florida and a warehouse in California. The Company is responsible for costs of
shipping, insurance, customs clearance and duties, storage and distribution
related to such warehouse products and therefore, warehouse sales command higher
sales prices than direct sales. The Company generally sells from its own
inventory in less than container-sized lots to customers. For each of the fiscal
years ended March 31, 1995 and 1996 domestic sales accounted for approximately
96% and 73%, respectively, of the Company's revenues. This decrease is
attributable to the formation of a new international subsidiary. See Item 6 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations".
DIRECT SALES. The formation of a new subsidiary, International SMC (HK) Ltd.
("International") is attributable for the advent of foreign equipment sales in
fiscal year 1996, which accounted for 24% of total revenues. Some products sold
by the Company are shipped directly to its customers from the Far East through
either International or The SMC Singing Machine Company, Ltd., a Hong Kong
trading company ("LTD"). Paul Wu, a director of the Company and a director of a
principal stockholder of the Company, is the Chairman of the Board of LTD. Sales
made through International or LTD are completed by either delivering products to
the customers' common carriers at the shipping point or by shipping the products
to customers' distribution centers, warehouses or stores. Direct sales are made
in large quantities (generally container-sized lots) to customers located in
Italy, England, Canada, Australia and the United States, who pay International
or LTD pursuant to their own international, irrevocable, transferable letters of
credit or on open credit with the Company's suppliers in the Far East. Pursuant
to an agreement with LTD, the Company receives 50% of LTD's net profits as
commissions, for all direct sales originated by the Company. For the fiscal
years ended March 31, 1995 and 1996, approximately 3.8% and 2.5% respectively,
of the Company's revenues were attributable to commissions from LTD. See Item 6
- - "Management's Discussion and Analysis of Financial Condition and Results of
operations".
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The Company relies on its Management's ability to determine the existence and
extent of available markets for its products. Company Management has
considerable marketing and sales backgrounds and devotes a significant portion
of its time to marketing-related activities. The Company achieves both domestic
and direct sales, and markets its hardware and software products, primarily
through its own sales force and approximately 25 independent sales
representatives. The Company's representatives are located in various states and
are paid a commission based upon sales in their respective territories. The
Company's sales representative agreements are generally one year agreements
which automatically renew on an annual basis, unless terminated by either party
on 90 day's notice. The Company works closely with its major customers to
determine marketing and advertising plans.
The Company also markets its products at various national and international
trade shows each year. The Company regularly attends the following trade shows
and conventions: CES ("Consumer Electronics Show") each January in Las Vegas;
Hong Kong Electronics Show each October in Hong Kong; the Hong Kong Toy Fair in
January; and the American Toy Fair each February in New York.
The Company's electronic recording products are marketed under THE SINGING
MACHINE(Registered trademark) or Memorex(Trademark) trademarks, and its audio
software is marketed under the KARAOKE Kassette(Trademark), KARAOKE Kompact
Disc(Trademark) and KARAOKE Video Kassette(Trademark) trademarks, throughout the
United States primarily through department stores, lifestyle merchants, mass
merchandisers, direct mail catalogs and showrooms, music and record stores,
national chains, specialty stores and warehouse clubs. The Company's KARAOKE
machines are currently sold in such stores as Target, Toys R Us, J.C. Penney,
Incredible Universe, Montgomery Ward, Spiegel's Catalog, and Wal-Mart. In
addition, the Company's KARAOKE software customers include Montgomery Ward,
Fingerhut, Target, The Wall, Specs Music, Ames, The Wherehouse Stores and
Musicland.
As a percentage of total revenues, the Company's net sales in the aggregate to
its five largest customers during the fiscal years ended March 31, 1995 and
1996, were approximately 53% and 63%, respectively. Handleman and Montgomery
Ward each accounted for over 10% of the Company's net sales for the year ended
March 31, 1995, representing 34% of total revenues on a combined basis during
that period. Handleman represented 45% of total revenues from software sales for
such period and Montgomery Ward represented 27% of total revenues from hardware
sales. For the fiscal 1996 period J.C. Penney, Montgomery Ward, Fingerhut and
Target each accounted for over 10% of the Company's net sales. Target
represented 43% of total revenues from software sales for fiscal 1996 while J.C.
Penny and Montgomery Ward each represented 21% and Fingerhut represented 16% of
total revenues from hardware sales for such period.
Although the Company has long-established relationships with many of its
customers, it does not have long-term contractual arrangements with any of them.
A decrease in business from any of its major customers could have a material
adverse effect on the Company's results of operations and financial condition.
The Company manages credit policies with respect to its customer base. The
Company has not suffered significant credit losses to date, even during a period
when many major retailers, including customers of the Company, experienced
significant difficulties, including filing for protection under federal
bankruptcy laws. In the cases where a customer of the Company has filed for
protection under federal bankruptcy laws, it has not had a significant impact on
the Company's revenues or other categories of financial performance.
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RETURNS
Returns of electronic hardware products by the Company's customers are generally
not permitted except in approved situations involving quality defects, damaged
goods or goods shipped in error or in an untimely manner. Returned hardware
products are placed in inventory by the Company for future sale and, if
necessary, refurbished. The practice in the prerecorded music industry is to
permit retailers to return or exchange audio software merchandise. In general,
the policy of the Company is to give credit to its distributors for audio
software returned in conjunction with the receipt of new replacement purchase
orders. Any such returns of software are available for resale by the Company.
Separate and apart from its copyright royalty reserves, the Company has
historically established return reserves of from approximately 15% to 22% of
total sales for financial statement reporting purposes. Such reserves also
include reserves for returns resulting from direct sales by LTD. The Company
believes such reserves are consistent with industry standards.
IMPORTING
The Company presently purchases and imports virtually all of its electronic
recording products from four suppliers located in the People's Republic of China
and Hong Kong. In fiscal 1995 and 1996, suppliers in the People's Republic of
China accounted for approximately 64% and 70%, respectively, of the Company's
total product purchases, including virtually all of the Company's hardware
purchases. The Company's primary suppliers of electronic recording products are
located in the Shenzen province of the People's Republic of China.
While the Company purchases its products from a small number of large suppliers
with whom it maintains close alliances, there are numerous other suppliers from
which the same products could be purchased. The Company provides key suppliers
with design and quality specifications. In return for ongoing business which the
Company provides these suppliers, such suppliers maintain production capacity
for the Company's production needs. To ensure that its high standards of product
quality and that shipping schedules are met by suppliers, pursuant to the terms
of an agreement entered into between the Company and Memcorp, Inc., dated
October 27, 1995, ("Memcorp Administrative Agreement") the Company utilizes
employees of Memcorp Asia in Hong Kong, a subsidiary of Memcorp, Inc., the
licensor of the Memorex(Trademark) brand, as agents. Those agents include
product inspectors who are knowledgeable about the Company's product
specifications and work closely with the suppliers to verify that such
specifications are met. Additionally, key officers of the Company frequently
visit suppliers for quality assurance and to support good working relationships.
The agreement with Memcorp, Inc. ("Memcorp"), is a five year exclusive
arrangement, signed on October 27, 1995, whereby the Company became the
exclusive sub-distributor of KARAOKE hardware products under the "Memorex"
trademark. The sub-distributor agreement requires the Company to pay a
commission fee on all hardware sales utilizing the brand name during the term of
the agreement. In addition to the sub-distributor agreement, the Memcorp
Administrative Agreement provides the Company administrative assistance and the
use of office and warehouse space in Asia as may be required for the purchase,
distribution and sale of products. The Company pays Memcorp a commission fee on
all shipped products for these services.
As part of the consideration for the sub-distributor and administrative
agreements, the Company granted Memcorp an option (the "Memcorp Option"),
exercisable until October 26, 1996, to purchase one million (1,000,000) shares
of the Company's common stock at a price of one dollar ($1) per share. Memcorp
was granted certain registration rights for one year with respect to the shares
underlying the option.
On May 31, 1996, the President of the United States renewed the People's
Republic of China's "Most Favored Nation" ("MFN") treatment for the entry of
goods into the United States for an additional year, beginning July 3, 1996.
Such renewal continues in effect unless disapproved by Congress within sixty
days. In the context of United States tariff legislation, MFN treatment means
that products are subject to favorable duty rates upon entry
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into the United States. If MFN status for China is restricted or revoked in the
future, the Company's cost of goods purchased from Chinese vendors is likely to
increase. A resultant change in suppliers would likely have an adverse effect on
the Company's operations, and possibly, earnings. Although Management believes
such adversity would be short-term as a result of its ability to find
alternative suppliers, it is unlikely that any such suppliers would offer the
same preferred financing terms that are currently offered by FLX (HK) Ltd., a
Hong Kong corporation ("FLX"). Management continues to closely monitor the
situation and has determined that the production capabilities in countries
outside China which have MFN status, and, therefore have favorable duty rates,
would meet the Company's production needs.
MANUFACTURING AND PRODUCTION
The electronic recording devices sold by the Company are manufactured and
assembled by third parties pursuant to design specifications provided by the
Company. The Company's electronic recording devices are assembled by four
factories in the People's Republic of China. See "Notes to Financial Statements
- - No. 7, Related Party Transactions". The finished products are packaged and
labeled under either the Company's registered trademark, THE SINGING
MACHINE(Registered trademark), the Memorex(Trademark) brand name, or under a
customer's private label, such as Radio Shack. Memcorp Asia performs quality
control inspections on the premises of its subcontractor's facilities and also
inspects the Company's various electronic recording products upon their arrival
in the United States.
The Company's products contain electronic components manufactured by other
companies such as Panasonic and Sony. Various subcontractors in the Far East
produce printed circuit boards and audio components in accordance with
specifications of the Company. The electronic components are installed in
cabinets manufactured by FLX and other manufacturers. Tools and dies used in the
production of certain models of the electronic audio equipment sold by the
Company are owned by LTD and may be used by LTD to manufacture other companies'
products. In March 1995, the Company purchased tools and dies for two new models
from LTD for $318,000, which were subsequently sold to International, primarily
in order to have the exclusive right to use such tools and dies.
All of the electronic components and raw materials used by the Company are
available from several sources of supply and the Company does not anticipate
that the loss of any single supplier would have a material long-term adverse
effect on its business, operations or financial condition.
The Company's audio software is produced by an independent producer. After the
selection of songs for inclusion in a particular collection, Company personnel
attempt to contact the publishers of the songs to obtain permission to re-record
the music and print the lyrics. Based on the original musical arrangement, the
independent producer retains singers and musicians to create a re-recording of
the original work. Songs are recorded once with both music and lyrics, to allow
the KARAOKE participant to hear an example of the songs performance, and once
without lyrics to provide a "backing track" to accompany the original singing of
the KARAOKE participant. Collections of such songs are then assembled on master
digital audio tapes. The master tapes are then sent to various subcontractors in
the United States and/or Hong Kong for duplication. The Company reproduces its
original master tapes in three formats: audio cassette tapes; video cassette
tapes; and audio CDs.
WARRANTIES
All of the electronic equipment sold by the Company is warranted against
manufacturing defects for a period of 90 days for labor and one year for parts.
All audio software sold by the Company is similarly warranted for a period of 30
days. During the fiscal years ended March 31, 1995 and 1996, warranty claims
have not been material to the Company's results of operations.
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BACKLOG
At March 31, 1996, the Company had approximately $100,000, net of cancellations,
of unfilled customer orders. The amount of unfilled orders at any particular
time is affected by a number of factors, including scheduling of manufacturing
and shipping of products, which in some instances is dependent on the needs of
the customer.
COMPETITION
The Company's business is highly competitive. In addition, the Company competes
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, CDs and video cassettes. The Company's
financial position depends, among other things, on its ability to keep pace with
such changes and developments and to respond to the requirements of its
customers. Many of the Company's competitors have significantly greater
financial, marketing and operating resources and broader product lines than does
the Company. The Company's major electronic component competitors include:
Pioneer; JVC; Grand Prix; Casio; and Soundesign. The Company's major audio
software competitors are Pocket Songs and Sound Choice.
The Company believes that competition in its markets is based primarily on
price, product performance, reputation, delivery times and customer support. The
Company believes that, due to its proprietary know-how, it has the ability to
develop and produce hardware and software on a cost-effective basis.
TRADEMARKS AND LICENSES
The Company has registered The Singing Machine(Registered trademark) trademark
in the United States, Canada, Austria, Benelux, Germany, France and the United
Kingdom. The Company has also filed registration applications for that trademark
in various other countries, including Australia, Germany, Italy, South Africa,
Spain and Switzerland. The Company also utilizes the common law trademarks
KARAOKE KASSETTE(Trademark), KARAOKE KOMPACT DISC(Trademark) and KARAOKE VIDEO
KASSETTE(Trademark) in connection with the sale of its audio software. The
Company considers these trademarks to be of considerable value and of material
importance to its business.
The Company holds federal and international copyrights to substantially all of
the audio productions comprising its song library. However, since each of those
productions is a re-recording of an original work by others, the Company is
subject to both contractual and statutory licensing agreements with the
publishers who own or control the copyrights of the underlying musical
compositions and is obligated to pay royalties to the holders of such copyrights
for the original music and lyrics of all of the songs in its library that have
not passed into the public domain. Since most audio software distributed by the
Company is accompanied by printed lyrics, the Company is also subject to written
print royalty license agreements. The Company is currently a party to more than
13,000 different written copyright license agreements covering more than 30,000
separate copyright holders.
The Federal Copyright Act (the "Act") creates a compulsory statutory license for
all nondramatic musical works which have been distributed to the public in the
United States. Under the Act, with respect to each work included in an audio
software product distributed by the Company under a compulsory license, the
Company is required to pay a royalty of the greater of $0.0695 per song or
$0.013 per minute of playing time or fraction thereof with respect to each item
of audio software produced and distributed by the Company (the "Statutory
Rate"). Royalties due under compulsory licenses are payable monthly. The Company
currently has compulsory statutory licenses for approximately 125 songs in its
song library.
The majority of the songs in the Company's song library are subject to written
copyright license agreements. The Company's written licensing agreements for
audio software ("mechanical licenses") typically provide for royalties at the
Statutory Rate although some provide for lower royalty rates. Written licenses
typically provide for
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quarterly royalty payments. The Company also has written license agreements for
substantially all of the printed lyrics which are distributed with its audio
software products ("print licenses"), which licenses also typically provide for
quarterly payments of royalties at the Statutory Rate.
The Act allows a deferral of royalty payments for products sold subject to a
right of return. The practice in the recorded music industry is to permit
retailers to return or exchange merchandise. Accordingly, each audio production
sold by the Company is sold subject to a right of return for credit against
future purchases or exchange. Royalties are due with respect to such sales on
the earlier to occur of nine months after the date of distribution or the date
on which the revenue from the sale is recognized in accordance with generally
accepted accounting principles. The Company has reached agreement on a 25%
reserve with a music publisher representing over 22% of its print licenses,
which agreement requires the payment of deferred royalties no later than nine
months after the date of distribution. With regard to the other principal
copyright royalty holders, the Company has deferred, and intends to continue to
defer, approximately 25% of royalty payments for approximately nine months, an
amount and period which the Company believes is appropriate for the KARAOKE
industry.
During the fiscal years ended March 31, 1995 and 1996, the Company made royalty
payments totaling approximately $960,000 and $500,000, respectively, with
respect to audio software units distributed. As of fiscal year ends 1995 and
1996 the Company had accrued for audio royalty payments approximately $940,000
and $600,000, respectively.
In May 1994, the Company requested its principal copyright royalty creditor, the
Harry Fox Agency, Inc. ("HFA"), which represents the majority of copyright
holders for which the Company is obligated to pay royalties, to audit its
records for the period October 1991 through March 1994. On May 22, 1995, the
Company executed a settlement agreement (the "Settlement Agreement") with HFA,
with respect to all non-current royalty obligations and claims for the period
from October 1, 1991 through March 31, 1994 in the amount of $1,030,000. The
Company had accrued approximately $1.0 million in its financial statements for
royalty obligations to HFA, and on February 22, 1995, paid HFA $200,000 to be
applied against the settlement amount. The total amount of settlement payments
made during fiscal 1996 was $432,000, and the balance of approximately $400,000
was anticipated to be paid in monthly installments, through May 1997, of
principal and interest at 8.0% per annum. After a period of default, the Company
entered into an amended payment agreement with HFA, stipulating a lump sum
payment to bring its account current and monthly installments thereafter, and is
current with respect to such agreement as of the date of this filing. As
collateral security for the payment of its obligations under the Settlement
Agreement, the Company has granted HFA a security interest in the Company's
master sound recordings.
With the completion of its negotiations with HFA, the Company has now entered
settlement agreements, totaling approximately $1.2 million, with creditors
representing a majority of its non-current copyright royalty obligations.
Pursuant to those settlement agreements, the Company intends to satisfy all
non-current royalty obligations with the creditors in question by May 1997,
although there is no guarantee that the Company will be able to do so within the
specified time period. As of June 30, 1996, the Company had paid approximately
$800,000 pursuant to those settlement agreements. An audit was performed by HFA
for the period April 1, 1994 through March 31, 1996, the results of which are
still outstanding as of this writing. The Company however, does not anticipate
any material adjustment as a result of such audit.
As a result of the Company's historical copyright royalty reserve practices, the
Company could be subject to various claims for damages under its written
copyright licensing agreements, the Act and common law (the "Claims"). In cases
of copyright infringement, the Act permits the copyright holder to elect to
recover either actual damages, and any additional profits of the infringer, or
statutory damages. Statutory damages under the Act range from $500 to $20,000
for each infringement, and the Act gives the federal courts complete authority
8
<PAGE>
over the size of damage awards. In cases where the copyright owner sustains the
burden of proving, and the court finds, that infringement was committed
wilfully, the court in its discretion may increase the award of statutory
damages to a sum of not more than $100,000 per work infringed. In PEER
INTERNATIONAL CORPORATION V. PAUSA RECORDS, INC., 909 F.2d 1332 (9th Cir. 1990),
the Court of Appeals held that statutory damages are not available for a failure
to pay royalties under a private license agreement since such a failure is not
an act of infringement within the meaning of the Act. The Court in that case
suggested that the only remedy for a failure to pay royalties under a written
license agreement is a common law action to recover the unpaid amounts. However,
there can be no assurance that courts in other jurisdictions will adopt the
holding in Peer.
The Company's executive officer, Mr. Edward Steele, and former president and
current member of the Board of Directors, Mr. Eugene Settler, have agreed to
indemnify the Company against certain claims arising out of the Company's
compulsory, statutory (i.e., non-written) licensing agreements (an
"Indemnifiable Claim") asserted with respect to the period from September 3,
1991 through November 10, 1994 by pledging all of their shares of Common Stock
to the Company. In the event of the assertion of such an Indemnifiable Claim,
the Company may require the return of shares of Common Stock (one-half from each
of Messrs. Steele and Settler) to the Company with a market value collectively
equal to the Indemnifiable Claim. There can be no assurance, however, that the
Company would be able to sell or otherwise dispose of such shares for cash or
raise a sufficient amount from the sale of such shares in order to satisfy the
Indemnifiable Claim. In addition, the Company would continue to bear all other
costs and expenses incurred by, or assessed against, the Company (including
legal) associated with such an Indemnifiable Claim, whether or not such
Indemnifiable Claim is resolved in favor of the Company. The Company has agreed
to release certain shares of Common Stock from the provisions of the pledge and
indemnity agreement during the period beginning December 10, 1995, under certain
circumstances based upon the performance of the Company. No such shares have
been released as of June 30, 1996. The pledge and indemnity agreement will also
terminate as to Messrs. Steele or Settler in the event of their deaths, provided
the Company then maintains life insurance of at least $1,000,000 on each party.
No such insurance is presently in place.
No Claims have been asserted against the Company to date with respect to
copyright infringement. The Company believes that the assertion of any such
Claims is remote, primarily as a result of its actual and proposed satisfaction
of all material past due royalty obligations and the payment agreements which
the Company has negotiated with its principal copyright royalty creditors.
However, there can be no assurance that such Claims will not be asserted or, if
asserted, that such Claims will not have material adverse effect on the
Company's financial position. Furthermore, the Company is not current in the
payment of certain of its current royalty obligations.
The Company also receives income from the sale of rights to certain of its
original KARAOKE master song tapes to an unrelated party. Under the agreement,
such party has the exclusive right to distribute these songs in certain Asian
markets. During the fiscal year ended March 31, 1995, the Company received
income of $279,000 from such sales. The agreement by which the Company received
such income expired on September 1, 1995. Accordingly, the Company did not
receive any income from such source during fiscal 1996.
INFORMATION SYSTEMS
During fiscal 1996, in an effort to reduce overhead expenses, the Company
entered into an agreement with Memcorp, Inc., whereby the Company physically
transferred its mainframe computer system and associated software licenses to
Memcorp, Inc., an electronics distributor located in Hialeah, Florida, at no
cost to Memcorp in exchange for the Company's indefinite continued use of such
system. Via telephonic communications, the Company maintains twenty four hour,
seven day a week access to the system. Under the terms of the agreement, Memcorp
is responsible for all of the system's operating, maintenance and licensing
fees. The system provides current on-line information to assist the Company in
analyzing purchasing patterns which enables it to better
9
<PAGE>
identify product demand. Sales information is maintained and tracked by major
product category and customer. The information system generates analyses of
individual products to support Management in analyzing sales trends and price
sensitivity.
EMPLOYEES
At March 31, 1996, the Company had 14 employees, 6 of whom were engaged in
warehousing and technical support and 8 in marketing and administrative
functions. The total number of employees has been reduced significantly from the
prior year's total of 25 through both layoffs and attrition, as management
pursues cost cutting measurers. None of the employees is represented by a labor
union. The Company believes that its employee relations are adequate.
Item 2. PROPERTIES
As of April 1995, the Company's United States distribution warehouse was
relocated from a 15,162 square foot facility in Boca Raton, Florida to a 29,762
square foot facility in nearby Pompano Beach. In October 1995, the Company's
corporate offices were also relocated to the same facility. The new lease is for
a 62-month term, with two three-year extension options and provides for base
rent, excluding common area maintenance, taxes and insurance of approximately
$138,000 during the first year with fixed increases thereafter.
Although the Company has not entered into any written agreements, it is actively
seeking parties to sublet a portion of its warehouse facility in order to reduce
overhead.
Item 3. LEGAL PROCEEDINGS
Mr. Eugene Settler was retained by the Company in 1988 as its President and
served in that office until the termination of his employment agreement on
February 22, 1996. Mr. Settler continues to hold the office of Director. As a
result of the Company's termination of his employment agreement it ceased
payments thereunder. Mr. Settler filed a demand for arbitration for a breach of
his employment agreement as required pursuant to the terms of such employment
agreement. The Company has been advised that such arbitration is scheduled for
late September 1996.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5. MARKET FOR COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On November 17, 1995 the Company was informed by The Nasdaq Stock Market, Inc.,
that the common stock of the Company did not meet the minimum bid price of $1.00
per share, and that the Company's net tangible assets did not meet the minimum
requirement of $4,000,000. On January 25, 1996, pursuant to a January 19, 1996
hearing before a Nasdaq Hearing Panel, the Nasdaq Listings Qualifications
Committee ("Committee"), denied the Company's request for an exception to the
minimum bid price requirement. In addition the Committee indicated that the
Company did not meet the minimum quantitative criteria for inclusion on the
Nasdaq SmallCap
10
<PAGE>
Market. Accordingly, effective January 26, 1996, the Company's securities were
delisted from the Nasdaq Stock Market. However, the Company's securities were
immediately eligible to trade on the OTC Bulletin Board.
The Common Stock is currently traded on the OTC Bulletin Board under the symbol
"SING". The following table sets forth, for the fiscal periods indicated, the
high and low bid prices for the Common Stock on the Nasdaq National Market for
the periods prior to January 26, 1996, and the OTC Bulletin Board thereafter, as
adjusted for the fiscal fourth quarter 1995 20% Stock Dividend. The Company's
Common Stock commenced trading on November 10, 1994. Prior thereto, there was no
public market for the Company's Common Stock.
<TABLE>
<CAPTION>
FISCAL 1996 HIGH LOW
-------------------------------------------------- -------------- -------------
<S> <C> <C>
First Quarter..................................... $1.63 $1.50
Second Quarter.................................... 1.50 1.00
Third Quarter..................................... 1.03 0.75
Fourth Quarter (through January 25,1996).......... 0.78 0.50
Fourth Quarter (from January 26, 1996; OTC)(1).... 0.25 0.25
FISCAL 1995 HIGH LOW
-------------------------------------------------- -------------- -------------
Third Quarter (from November 10, 1994)............ $4.48 $2.92
Fourth Quarter ................................... 2.50 1.25
<FN>
----------
(1) Stock quoted on OTC as of January 26, 1996.
</FN>
</TABLE>
As of June 30, 1996, the last reported bid price of the Common Stock on the OTC
Bulletin Board was $0.25 per share. The number of record holders of the Common
Stock at June 30, 1996 was 149, although the Company believes that the number of
beneficial owners of such Common Stock is much greater.
As a result of being delisted from the Nasdaq National Market, stockholders may
find it more difficult to dispose of, or to obtain accurate quotations as to the
market value of, the Company's Common Stock.
The Company has never declared or paid cash dividends on its capital stock and
the Company's Board of Directors intends to continue this policy for the
foreseeable future. Earnings, if any, will be used to finance the development
and expansion of the Company's business. Future dividend policy will depend upon
the Company's earnings, capital requirements, financial condition and other
factors considered relevant by the Company's Board of Directors and will be
subject to limitations imposed under Delaware law and the agreement with the
representatives of the underwriters for the Company's initial public offering
(the "Representatives").
Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION
WITH, AND IS QUALIFIED IN ITS ENTIRETY BY, THE FINANCIAL STATEMENTS AND SELECTED
FINANCIAL INFORMATION INCLUDED ELSEWHERE HEREIN. HISTORICAL RESULTS ARE NOT
NECESSARILY INDICATIVE OF TRENDS IN OPERATING RESULTS FOR ANY FUTURE PERIOD.
11
<PAGE>
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, except
as noted below:
<TABLE>
<CAPTION>
YEAR ENDED MARCH 31
--------------------------------------
1996 1995 1994 1993
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenues:
Equipment sales, net ................. 73.0% 41.9% 35.1% 46.6%
Music sales, net ..................... 24.2 54.2 60.5 44.3
Commission income - related party
and other .......................... 2.8 3.9 4.4 9.1
Total revenues ......................... 100.0% 100.0% 100.0% 100.0%
Cost of Sales (1):
Cost of equipment sales .............. 89.6% 89.9% 77.6% 87.0%
Cost of music sales .................. 110.8 72.5 52.8 50.6
Expenses:
Other operating expenses ............. 13.6 7.8 4.8 4.2
Selling, general and administrative
expenses ........................... 48.2 38.2 18.6 27.1
Depreciation and amortization ........ 4.4 2.1 0.5 1.0
Impairment of long-lived assets ...... 7.8 -- -- --
Operating income (loss) ................ (66.2) (25.1) 16.9 4.7
Other expenses, net .................... (7.9) (12.1) 7.6 6.8
Income (loss) before taxes ............. (74.1) (37.2) 9.2 (2.1)
Provision (benefit) for income taxes ... -- (5.7) 2.0 --
Income (loss) .......................... (74.1) (31.5) 7.2 (2.1)
<FN>
- ----------
(1) Expressed as a percentage of related sales.
</FN>
</TABLE>
GENERAL
For fiscal 1996 and fiscal 1995, the Company's total revenues were approximately
$5.2 million and $6.0 million, respectively. In fiscal 1996 the Company had a
net loss of approximately $3.9 million compared to a net loss of approximately
$1.9 million in fiscal 1995. While total revenues decreased $0.8 million or 14%
from year to year there was an increase in equipment sales of $1.3 million or
51%, which was offset by a decrease in music sales of $2.0 million or 61%. Audio
software historically has a higher gross profit margin than electronic equipment
and, consequently, the decrease in music sales to total revenues had a
significant negative impact on net income.
12
<PAGE>
THE YEAR ENDED MARCH 31, 1996
COMPARED TO YEAR ENDED MARCH 31, 1995 (THE "FISCAL 1995 PERIOD").
The following discussion of fiscal year 1996 is in comparison to the Fiscal 1995
Period which is presented on a pro forma combined basis for the periods from
April 1, 1994 through May 4, 1994 (the "Predecessor Period") and from May 5,
1994 through March 31, 1995 (the "Successor Period"). As a result of the
application of "pushdown" accounting during the Fiscal 1995 Period, the
information with respect to such Fiscal 1995 Period may not necessarily be
comparable with the year ended March 31, 1996.
Total revenues declined by approximately $0.8 million or 14% for the fiscal year
ended March 31, 1996 compared to the $6.0 million reported for the Fiscal 1995
Period. The decline was attributable to decreases in music sales, master tape
sales, and commission income partially offset by sales from the Company's new
Hong Kong subsidiary.
Revenues from equipment sales increased $1.3 million or 52% to approximately
$3.8 million during fiscal 1996 compared to approximately $2.5 million for the
Fiscal 1995 Period. The increase is a result of foreign sales totaling
approximately $1.3 million. The recording of foreign equipment sales is
attributable to sales made by the Company's subsidiary, International SMC (HK)
Ltd. ("International"), formed in April, 1995, which represents 33% of equipment
sales and 24% of total revenues, for fiscal 1996. Previously, the Company,
through related party transactions, recorded commissions earned on foreign
shipments. But for such change in the method of recognizing income from foreign
hardware shipments, the Company's revenues from equipment sales for fiscal 1996
would have been relatively unchanged from the 1995 Period.
Revenues from music sales declined by $2.0 million or 61% to approximately $1.3
million in fiscal 1996 from the approximately $3.3 million recorded during the
Fiscal 1995 Period. The decline in music sales was due to less than expected
sales in certain music formats and master tape sales as well as management's
decision to redirect music sales away from distributors who historically have
high merchandise return rates in favor of mass market retailers. Sales of the
Company's four (4) song music format to a major customer declined by more than
$1.3 million for fiscal 1996. The Company did not report any master tape sales
revenue for fiscal 1996 compared to $279,000 during the Fiscal 1995 Period. The
Company's master tape agreement with an unrelated party expired September 1,
1995, which accounts for this decrease.
Commission income decreased to approximately $130,000 during fiscal 1996
compared to $230,000 during the Fiscal 1995 Period. The decrease of
approximately $100,000 or 43% was primarily because of a decrease in commission
income from a related party. The Company anticipates commission income from a
related party to continue to decline due to the formation of International and
the decision to conduct substantially all foreign sales through International.
Cost of equipment sales for the year ended March 31, 1996, expressed as a
percentage of related sales, was essentially unchanged from the approximate 90%
reported for the Fiscal 1995 Period. The cost of music sales, expressed as a
percentage of music sales, increased from almost 73% in fiscal 1995 to nearly
111% for the current year. Among other items this increase in cost of music
sales includes, approximately $190,000 in adjustments to inventory values based
on changing market conditions and the greater impact of amortization expense on
substantially lower sales volume.
Other operating expenses increased approximately $235,000, or 50%, for fiscal
1996, compared to the Fiscal 1995 Period. The increase was primarily because of
increased warehouse rent and occupancy costs of approximately ($81,000), costs
of outside storage expenses for merchandise ($20,000), cost of freight ($73,000)
and an increase in warehouse salaries ($53,000).
13
<PAGE>
Selling, general & administrative expenses ("SG&A expenses") increased
approximately $200,000 or 9% for fiscal 1996 compared to the Fiscal 1995 Period.
The increase was primarily due to expenses associated with the administration of
the Company's new international subsidiary in Hong Kong of approximately
($170,000), costs associated with product development ($150,000), directors and
officers insurance ($57,000), catalog expense ($38,000), bad debt expense
($31,000), and financial consulting fees ($29,000). These increases were
partially offset by a decrease in expenses related to Bridge Warrant price
adjustments $169,000, and decreases in accounting fees of $100,000 and legal
fees of $61,000, which were incurred in the prior year and related to the
Company's IPO. A quarterly comparison of SG&A expenses indicates reductions in
the majority of categories totaling approximately $500,000 or 57%, including
salaries $78,000, catalog expense $48,000, public relations $20,000, accounting
$127,000 and legal $105,000.
During fiscal 1995, the Company received approximately $380,000 of reimbursed
expense credits from its related party supplier, FLX. The Company received
approximately $150,000 of such credits from FLX during fiscal 1996. Excluding
these credits, selling, general and administrative expenses year to year would
have been essentially unchanged.
The Company continues to take action to reduce its SG&A expenses, which can be
seen in the fourth quarter comparison. The Company believes that the full impact
of staff reductions will be seen in fiscal 1997; product development costs are
being curtailed, computer support expenses have been reduced, rigid restrictions
have been placed on overtime and travel, and discretionary expenditures are
being carefully reviewed and eliminated by management. In addition, although the
Company has not entered into any written agreements, it is actively seeking
parties to sublet a portion of its warehouse facility in order to further reduce
overhead.
Depreciation and amortization expense increased approximately $100,000 or 81% to
$227,000 during the fiscal year ended March 31, 1996. The increase was primarily
due to depreciation expense associated with International's purchase of tools
and dies which are carried on its books at $318,000.
As a result of the significant decline in music sales during fiscal 1996 the
Company reviewed the carrying value of costs in excess of net assets acquired
(goodwill) and trademarks carried on its balance sheet. As a result of this
review the Company recorded a reduction in the carrying value of such assets
relating to music sales in the amount of $405,000 which was charged to
operations. See "Notes to Consolidated Financial Statements No. 1 - Organization
and Summary of Significant Accounting Policies".
Operating loss for fiscal 1996 was approximately $3.4 million compared to a loss
of $1.5 million for the Fiscal 1995 Period. As a percentage of total revenues,
the operating loss increased to 66% for fiscal 1996 from 25% in the prior year.
The decrease in operating income was related to a combination of factors
including the decrease in total revenues, a significant change in sales mix, an
unfavorable accounting adjustment and an increase in selling, general and
administrative expenses. The ratio of higher gross margin music sales to total
revenues decreased to 24% in fiscal 1996 from 54% the prior year. Gross profit,
expressed as a percentage of equipment sales remained the same compared to the
prior year at 10%. Gross profit from equipment sales increased approximately
$140,000 for the same period. This increase was attributable to increased volume
of approximately $1.3 million from the Company's new subsidiary, International,
as well as the elimination of price concessions granted to certain customers
during the Fiscal 1995 Period. Gross profit (loss) from music sales decreased
approximately $1.0 million to (11%) of related sales for the fiscal year ended
March 31,1996, compared to 27%, for the Fiscal 1995 Period. The decline in gross
profit from music sales was primarily because of an increase in returned
merchandise ($355,000), the decline in master tape sales ($279,000), the
inventory valuation adjustments of approximately ($190,000), and the loss of
approximately $1,300,000 in music sales to a major customer of the Company's
four (4) song music format compared to the Fiscal 1995 Period.
14
<PAGE>
Net interest expense decreased approximately $110,000 or 40% for fiscal 1996
compared to the Fiscal 1995 Period. The decrease was primarily due to
non-recurring interest expense associated with bridge financing of approximately
$137,000 in fiscal 1995 and a decrease in interest expense on related party
obligations $69,000, partially offset by interest expense on debt owed to Magna
International ($58,000), and past due royalty obligations to the Harry Fox
Agency, Inc.($33,000).
Loss on sales of accounts receivable was 5% and 7% of total revenues for the
fiscal years 1996 and 1995, respectively. The decrease of approximately $160,000
or 39% was primarily because of a decrease in fees charged by the Company's
factor, negotiated in the third quarter of fiscal 1995, combined with the
decrease in total revenues.
Net loss for fiscal 1996 was approximately $3.9 million, an increase of $2.0
million from the loss of $1.9 million reported for the Fiscal 1995 Period. The
loss for fiscal 1996 was primarily attributable to the 61% decline in high gross
margin music sales, the high level of merchandise returns and the related
reduction in carrying value of goodwill and trademarks. Although projections can
be overly optimistic and purchase orders can be canceled , and such items are no
guarantee of revenue, the Company has projections for fiscal 1997 sales based on
customer inquiries in excess of $10.5 million, of which $8.0 million are
substantiated by purchase orders.
THE YEAR ENDED MARCH 31, 1995 (THE "FISCAL 1995 PERIOD")
COMPARED TO YEAR ENDED MARCH 31, 1994 (THE "FISCAL 1994 PERIOD").
The following discussion of the Fiscal 1995 Period is presented on a pro forma
combined basis for the periods from April 1, 1994 through May 4, 1994 (the
"Predecessor Period") and from May 5, 1994 through March 31, 1995 (the
"Successor Period"). As a result of the application of "pushdown" accounting
during the Fiscal 1995 Period, the information with respect to such Fiscal 1995
Period may not necessarily be comparable with the year ended March 31, 1994.
Total revenues for the Fiscal 1995 Period decreased approximately $2.9 million
or 33% from approximately $8.9 million in the Fiscal 1994 Period. That decrease
was reflected in all three components of total revenue from the Fiscal 1994
Period to the Fiscal 1995 Period: software sales decreased $2.2 million or 40%,
to approximately $3.3 million; equipment sales decreased $0.6 million or 20%, to
$2.5 million; and commission income decreased $0.1 million or 32%, to
approximately $0.2 million. The Company attributes the decrease in total
revenues primarily to substantially weaker than expected sales during the third
quarter holiday season ended December 31, 1994 (the "1994 Quarter"), and a
substantial increase in both actual returns and the Company's reserve (a
$576,000 increase) for potential product returns in the fourth quarter. The
impact of such increase was to reduce total revenues for the fourth quarter.
Total revenues for the 1994 Quarter compared to the three months ended December
31, 1993 (the "1993 Quarter") decreased approximately $1.9 million or 42.2%, to
$2.6 million. That decrease was reflected in the two principal components of
total revenue from the 1993 Quarter: software sales decreased $1.3 million or
53%, to $1.2 million and equipment sales decreased $0.6 million or 31%, to
approximately $1.4 million.
The decrease in software sales is primarily attributable to a decrease in the
Company's sales of its 8 song cassette format. The decrease in commission income
is attributable to a decline in sales for a Hong Kong trading company controlled
by a related party for whom the Company acts as the exclusive sales agent. The
substantial increase to the Company's reserve for product returns resulted from
management's reassessment of such reserves in the fourth quarter. Such
reassessment was primarily as a result of greater than anticipated actual and
forecasted returns of software merchandise (which, as is customary in the
pre-recorded music industry, is generally sold with a right of return for credit
against future purchases). In the period from April 1, 1995 to June 30, 1995,
the Company's largest software customer returned merchandise aggregating in
excess of $200,000 and received a credit for such amount for future purchase
orders.
15
<PAGE>
Operating loss for the Fiscal 1995 Period was approximately $1.5 million,
compared to operating income of $1.5 million for the Fiscal 1994 Period. As a
percentage of total revenues, operating income (loss) decreased to (25%) in the
Fiscal 1995 Period from 17% in the Fiscal 1994 Period. The decrease in operating
income was attributable to a combination of the decrease in revenues and a
decline in total gross margins resulting from a change in the sales mix, other
unfavorable cost of sales adjustments, an increase in selling, general and
administrative ("SG&A") expense and an increase in depreciation and
amortization. Audio software, including master song tapes, generally has a
higher profit margin than the Company's electronic equipment and the ratio of
audio software sales to total revenues decreased from 61% to 54%. Additionally,
gross margin on equipment and software sales decreased from 22% to 10% and 47%
to 27% from the Fiscal 1994 Period to the Fiscal 1995 Period, respectively. The
decrease in equipment gross margin is attributable, in part, to the Company's
voluntary discounting of certain merchandise to certain major customers during
the 1994 holiday season as a result of its inability to satisfy the orders of
those customers with the specific equipment requested. As a gesture of goodwill,
the Company delivered more expensive merchandise at the same cost to the
customer as the merchandise originally ordered. Furthermore, unfavorable
adjustments relating to shortages in the Company's year end physical inventory
and costs associated with refurbishing returned merchandise also added to the
reduction in equipment gross margin. The decline in audio software gross margin
is attributable to the net effect of an increase in the sales return reserve
($197,000), a decline in master tape sales ($69,000), an increase in sales
discounts ($41,000) and a change in estimated useful lives of certain software
assets ($142,400).
SG&A expense in the Fiscal 1995 Period increased approximately $0.6 million or
38%, to $2.3 million from the Fiscal 1994 Period, primarily as a result of an
increase in legal, accounting, consulting, insurance and other costs associated
with being a public company. In addition, on January 26, 1995, the Company's
Board of Directors declared a voluntary reduction in the exercise prices of the
warrants held by the public (the "Public Warrants"), certain investors (the
"Bridge Warrants") and its underwriters (the "Representative Warrants") to
purchase shares of the Company's Common Stock (the "Exercise Price Reduction").
The reduction in the exercise price of the Bridge Warrants resulted in an
additional SG&A expense of $169,200.
Depreciation and amortization increased approximately $77,000 or 158% in the
Fiscal 1995 Period primarily as a result of the amortization of goodwill and
trademarks. These intangible assets were recorded in conjunction with the
exercise by certain of the Company's directors, in May 1994, of an option to
purchase all the Company's then outstanding common stock.
Net interest expense for the Fiscal 1995 Period increased approximately $15,000.
Interest expense decreased by $233,000 primarily as a result of a decrease in
interest associated with past due royalty obligations $65,000 and satisfaction
of a note payable relating to an inventory purchase $156,000. This decrease was
offset by interest expense associated with inventory financing $62,000, the
amortization of a note payable discount $43,000, the Company's $400,000 bridge
loan effected in July 1994 (the "Bridge Financing") $107,000, and Fiscal 95
Period interest associated with the note payable to Magna $33,000.
Loss on sales of accounts receivable increased approximately $38,000 or 10%, to
$411,000 in the Fiscal 1995 Period, primarily as a result of an increase in the
factor rate due to an increase in the average outstanding collection period of
factored receivables.
Net loss for the Fiscal 1995 Period was approximately $1.9 million, a difference
of $2.5 million from the net income of approximately $0.6 million in the Fiscal
1994 Period. The loss for the Fiscal 1995 Period was primarily attributable to
disappointing operating results for the 1994 Quarter, the fact that the fourth
quarter has historically been the Company's weakest period, and for reasons
discussed related to the costs and expenses above. Net loss for the 1994 Quarter
was nearly $300,000, a difference of approximately $900,000 from the net income
of approximately $600,000 in the 1993 Quarter.
16
<PAGE>
SEASONAL FACTORS
As is typical in the KARAOKE industry, the Company's operations have been
seasonal, with the highest net sales occurring in the second and third quarter
(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.
The Company's results of operations may also fluctuate from quarter to quarter
as a result of the amount and timing of orders placed and shipped to customers,
as well as other factors. The fulfillment of orders can therefore significantly
affect results of operations on a quarter-to-quarter basis.
INFLATION
Inflation has not had a significant impact on the Company's operations. The
Company has historically passed any price increases on to its customers since
prices charged by the Company are generally not fixed by long-term contracts.
POSSIBLE CLAIMS
The Company may be subject to various Claims for damages and other remedies
under its written copyright licensing agreements or pursuant to Title 17 of the
United States Code. The Company is current with respect to compulsory licenses,
granted pursuant to the federal copyright statute. As of June 30, 1996, the
Company had paid approximately $800,000 of its past due royalty obligations and
had negotiated deferred payment agreements with several of its royalty
creditors. Although the Company believes that the assertion of any such Claims
is remote, primarily as a result of its recently completed negotiations for
specific payment agreements with its principal copyright royalty creditors,
there can be no assurance that such Claims will not be asserted or, if asserted,
that such Claims will not have a material adverse effect on the Company's
financial position. See Item 1 - "Business - Trademarks and Licenses."
LIQUIDITY AND CAPITAL RESOURCES
The Company continues to suffer from a lack of liquidity and capital resources
which have affected its ability to conduct business in a profitable manner. The
Company's working capital deficit at March 31, 1996, was approximately ($2.4)
million. While the Company is currently seeking financing for its inventory and
working capital needs there is no guarantee that it will be successful in
obtaining such financing on satisfactory terms, the lack of which could force
the Company to cease operations.
The Company is a party to a factoring agreement, dated June 3, 1992, as amended
December 30, 1994, with Bankers Capital ("Bankers"), a division of Bankers
Leasing Association, Inc., pursuant to which Bankers purchases certain of the
Company's accounts receivable. Under the agreement, Bankers purchases certain
selected accounts receivable from the Company and advances 70% of the face
amount of those receivables to the Company. Bankers retains discretion to
determine which of the Company's accounts receivable it will purchase. Once
Bankers purchases the account receivable of any particular customer of the
Company, all accounts receivable of such customer (whether or not so purchased)
are collected by Bankers and applied first to payment of the particular accounts
receivable purchased by Bankers. As a result of the greater incidence of
returned merchandise by the Company's software customers, Bankers purchases a
lesser percentage of the Company's total accounts receivable relating to
software merchandise than hardware merchandise.
The Company is charged interest on all advances against the purchased accounts
receivable, at an annual rate of 1.5% in excess of the prime rate of interest
charged by Harris Trust and Savings Bank (8.25% on June 30, 1996), until the
receivables subject to the advances are collected. For accounts receivable
purchased by Bankers the
17
<PAGE>
Company will be charged a fee, from 2.0% to 3.0%, depending on the period the
receivable has been outstanding, and receives payment from Bankers of the
remaining 30% of the face amount of the receivable. All receivables which are
not collected within 150 days are charged back to the Company and deducted from
the total advances available to the Company. All of the Company's accounts
receivable, inventories and intangibles are pledged as security under this
agreement. The Company has agreed to pay minimum monthly fees of $10,000 under
the agreement. As of June 30, 1996, the outstanding balance for which the
Company is contingently liable to Bankers, was approximately $480,000. The
agreement with Bankers expires on June 28, 1997.
In September 1992, Magna agreed to exchange $816,574 of debt owed by the Company
to Magna, and an affiliated company of Magna, for additional shares of the
Company's Common Stock (the "Additional Shares"). That agreement, as amended,
gave Magna the right to require the Company to repurchase the Additional Shares,
on December 31, 1996, for $816,574 plus interest at 8% per annum from September
30, 1994. On November 10, 1994, Magna exchanged the Additional Shares for the
Company's promissory note (the "Magna Note") in the amount of $816,574. Payment
of the note was guaranteed by a pledge from Gemco Pacific, Inc., an assignee of
Paul Wu, a director of the Company, of all of its shares of the Company's Common
Stock until the payment and satisfaction of fifty percent of the principal
amount of the note, and fifty percent of such shares until the remaining
principal balance of the note is paid.
The Magna Note was due in two equal installments on November 10, 1995 and May
10, 1996. The Company did not pay either installment. However, the Company did
make partial payments through June 30, 1996 of $275,000, which includes
principal and interest. As a result of the Company's failure to timely pay the
agreed upon installments the remaining balance of the note became due and
payable in full. The default provision of the Magna Note provides for a cure
period of 15 days after written notice has been given to the Company from Magna.
Written notice of default to the Company from Magna has not yet been received,
however, it is not required. The Company is subject to pay any reasonable
attorney's fees incurred by Magna in enforcing the rights of Magna while the
loan is in default. Notice of default has been given to Magna and no wavier of
default has been obtained by the Company. The entire note is classified as a
current obligation on the Company's balance sheet and continues to accrue
interest. Magna has thus far been cooperating with the Company as it attempts to
restructure and has made no demands for payment. At the appropriate time the
Company will attempt to renegotiate the terms on the debt agreement with Magna.
However, there can be no assurance that the Company will be able to successfully
negotiate new terms which will be favorable to the Company, if at all.
On March 31, 1995 and 1996, the Company had accrued on its financial statements
total royalties payable, comprised of audio and written lyric components, of
approximately $1.6 million and $1.1 million, respectively. As of June 30, 1996,
the Company was six quarters delinquent in the payment of its copyright royalty
obligations imposed pursuant to written copyright royalty agreements with
various publishers. Due to its current liquidity problems, the Company can only
meet its other operating obligations by not timely paying such royalty
obligations. However, the Company has had discussions with these publishers to
seek alternative payment terms and has entered into an agreement to pay the
approximate $160,000 balance to HFA by August 30, 1996.
In May 1994, the Company requested its principal copyright royalty creditor, the
Harry Fox Agency, Inc. ("HFA"), which represents the majority of copyright
holders for which the Company was obligated to pay royalties, to audit its
records for the period October 1991 through March 1994. On May 22, 1995, the
Company executed a settlement agreement (the "Settlement Agreement") with HFA,
with respect to all non-current royalty obligations and claims for the period
from October 1, 1991 through March 31, 1994 in the amount of $1,030,000. The
Company had accrued approximately $1.0 million in its financial statements for
royalty obligations to HFA and, on February 22, 1995, paid HFA $200,000 to be
applied against the settlement amount. The total amount of settlement payments
made during fiscal 1996 were $432,000, and the balance of approximately $400,000
is anticipated to be paid in monthly installments, through May 1997, of
principal and interest at 8.0% per annum. After a period of default, the Company
entered into an amended payment agreement
18
<PAGE>
with HFA, stipulating a lump sum payment to bring its account current and
monthly installments thereafter, and is current with respect to such agreement
as of the date of this filing. As collateral security for the payment of its
obligations under the Settlement Agreement, the Company has granted HFA a
security interest in the Company's master sound recordings.
With the completion of its negotiations with HFA, the Company has now entered
settlement agreements, totaling approximately $1.2 million, with creditors
representing a majority of its non-current copyright royalty obligations.
Pursuant to those settlement agreements, the Company intends to satisfy all
non-current royalty obligations with the creditors in question by May 1997,
although there is no guarantee that the Company will be able to do so within the
specified time period. As of June 30, 1996, the Company had paid approximately
$800,000 pursuant to those settlement agreements. An audit was performed by HFA
for the period April 1, 1994 through March 31, 1996, the results of which are
still outstanding as of this writing. The Company does not anticipate any
material adjustments as a result of such audit.
The Company may be subject to various Claims for damages and other remedies
under its written copyright licensing agreements or pursuant to Title 17 of the
United States Code. The Company satisfied its outstanding royalty obligations
with respect to compulsory licenses, granted pursuant to the federal copyright
statute, and has been current thereafter with respect to such compulsory royalty
obligations. Although the Company believes that the assertion of any such claims
is remote, primarily as a result of the completed negotiations for specific
payment agreements with its principal copyright royalty creditors, there can be
no assurance that such Claims will not be asserted or, if asserted, that such
Claims will not have a material adverse effect on the Company's financial
position.
In fiscal 1990, the Company entered into an agreement to sell the rights to
certain of its original KARAOKE master song tapes to an unrelated party. Under
the agreement, such party had the exclusive right to distribute these songs in
certain Asian markets. During the fiscal year ended March 31, 1995, the Company
received income of $279,000 from such sales. The agreement by which the Company
received such income expired on September 1, 1995. Accordingly, the Company did
not receive any income from such source during fiscal 1996.
On July 20, 1994, the Company closed a private financing pursuant to which it
issued secured subordinated promissory notes in an aggregate principal amount of
$400,000, and issued Bridge Warrants to purchase 360,000 shares of Common Stock.
Such notes, together with interest at a rate of 8% per annum, were repaid on
November 18, 1994. The Bridge Warrants were exercisable at a price of $1.20 per
share of Common Stock commencing February 8, 1995 and expire on August 15, 1999.
As of June 30, 1996, 272,250 of such Bridge Warrants had been exercised,
resulting in gross proceeds of $326,000 to the Company.
On November 18, 1994, the Company closed the initial public offering (the "IPO")
of 1,380,000 (1,656,000 as adjusted for the Stock Dividend) shares of Common
Stock and 1,380,000 (1,656,000 as adjusted for the Stock Dividend) Warrants for
an aggregate purchase price of approximately $7,080,000. After giving effect to
the payment of offering expenses and underwriting expenses collectively
estimated at $1,959,000, the Company received approximately $5,121,000 of net
proceeds from such initial public offering. Approximately $1,600,000 of the net
proceeds of the IPO were used to satisfy a portion of certain accounts and notes
payable to FLX (HK) Ltd., a Hong Kong Corporation ("FLX"), and The Singing
Machine Company, Ltd., a Hong Kong trading company ("LTD"). Approximately
$350,000 of the proceeds from the IPO were used for inventory purchases,
$850,000 were used to satisfy past due copyright royalty obligations, $225,000
were used for working capital and $400,000 was applied to satisfy indebtedness
represented by certain outstanding promissory notes issued in connection with
the Bridge Financing. The Company used approximately $1,695,000 of the net
proceeds of the IPO to satisfy certain trade payables to suppliers of materials
and services used in the Company's operations.
19
<PAGE>
As a result of weaker than expected sales for the fiscal year ended March 31,
1995 and the concomitant reduction in cash flow from operations, the Company was
required to use a substantially greater portion of the proceeds from the public
offering for the payment of debt (including obligations to FLX and LTD) and
operating expenses than originally anticipated (approximately 32% compared to
the original estimate of 7.4%). The additional funds used to satisfy trade
payables were deducted from the amounts originally anticipated to be used for
inventory purchases, which have accounted for 6.9% of the net proceeds compared
to the original estimate of 26%.
Since September 1991, FLX and LTD have sold merchandise to the Company under
deferred payment terms. Paul Wu, a director of the Company, is the Chairman of
the Board and a principal stockholder of FLX and LTD. For the fiscal years ended
March 31, 1995 and 1996, the total inventory purchases from FLX and LTD were
approximately $2.3 million and $1.2 million, respectively. In the normal course
of business, the Company enters into negotiations with FLX and LTD, with respect
to the terms and the nature of transactions conducted with those companies. For
the fiscal year ended March 31, 1996, such negotiations resulted in the Company
receiving credits totaling approximately $150,000 from such companies for such
items as refurbishing of defective merchandise by the Company and promotional
and advertising expenses, with a concomitant credit to results of operations.
See Item 12 - "Certain Relationships and Related Transactions".
At March 31, 1996, the Trade payables - related party, which totaled
approximately $500,000, were composed of amounts due with respect to payments
made, by the Company for merchandise received from overseas suppliers. FLX and
LTD have also advanced funds directly to, or on behalf of the Company, with
respect to inventory purchases.
Primarily due to the Company's continued negative cash flow from operations and
as a result of the net losses incurred by the Company for the fiscal years ended
1995 and 1996, the Company does not believe that its current credit facility
with Bankers and its current financing arrangements with FLX and LTD will be
sufficient to meet its cash flow needs for the fiscal year ending March 31,
1997. FLX and LTD had agreed to provide up to $500,000 of inventory financing to
the Company through April 1, 1996. Since April 1, 1995, FLX and LTD have
provided inventory financing to the Company in excess of their $500,000
commitment, but have no obligation to do so in the future and could demand
payment of the Company's outstanding credit at any time as the financing
agreement has now expired. As of June 30, 1996, FLX and/or LTD have not
requested payment nor has the Company made such payment.
As of March 31, 1996, the Company had a working capital deficit of approximately
($2.4 million), compared to positive working capital of $1.2 million for the
prior year. Although the Company had positive cash flow during the Fiscal 1995
Period, such positive cash flow was primarily attributable to the completion of
its initial public offering, the factoring agreement with Bankers and agreements
with FLX and LTD to provide inventory financing.
Although the Company is currently engaged in negotiations with regard to
securing third-party financing to replace or augment the financing arrangements
provided by FLX and LTD, there can be no assurance that such financing will be
available on terms satisfactory to the Company or at all, that FLX and LTD will
continue to provide financing to the Company, or that FLX and LTD will continue
to provide overfunding to the Company and not demand repayment of amounts
financed in excess of their $500,000 commitment. In any such event, the Company
may seek to refinance its obligations with creditors (including the Company's
past due obligations to Magna) or be forced to curtail or cease operations.
20
<PAGE>
GOING CONCERN
The report by the Company's independent auditors on its 1996 financial
statements express substantial doubt about the Company's ability to continue as
a going concern. The independent auditors attributed this substantial doubt to
substantial net operating losses in the fiscal year ended March 31, 1996 and an
accumulated deficit of approximately $5.7 million. The auditors have further
noted that the Company experienced a substantial decline in sales of music
recordings and other revenues. The Company is currently dependent on the
continued overfunding of inventory financing from FLX and LTD to continue
operations and to allow it to make inventory purchases in advance of the peak
holiday selling season. The Company does not have a line of credit in place to
finance its seasonal needs for inventory purchases. The discontinuance of
overfunding by FLX and LTD, and the unavailability of financing to replace such
overfunding, could result in the Company being forced to curtail or cease its
operations. The financial statements do not include adjustments relating to the
recoverability and classification of the recorded carrying value of assets or
the amounts or classifications of other liabilities that might be necessary
should the Company be unable to successfully negotiate additional inventory
financing and continue as a going concern.
21
<PAGE>
Item 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
HISTORICAL FINANCIAL STATEMENTS
Report of Independent Certified Public Accountants, Millward & Co........F-1
Report of Independent Certified Public Accountants, Ernst & Young LLP....F-2
Balance Sheet at March 31, 1996..........................................F-3
Statements of Operations for the fiscal year ended March 31, 1996 and
the period from May 5 to March 31, 1995 (the Successor Period) and
for the period from April 1 to May 4, 1994 (the Predecessor Period)....F-5
Statements of Shareholders Equity for the fiscal year ended March 31,
1996 and the period from May 5 to March 31, 1995 (the Successor
Period) and for the period from April 1 to May 4, 1994 (the
Predecessor Period)....................................................F-6
Statements of Cash Flows for the fiscal year ended March 31, 1996 and
the period from May 5 to March 31, 1995 (the Successor Period) and
for the period from April 1 to May 4, 1994 (the Predecessor Period)....F-7
Notes to Financial Statements............................................F-9
22
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
The Singing Machine Company, Inc.
Pompano Beach, Florida
We have audited the accompanying consolidated balance sheet of The Singing
Machine Company, Inc. and Subsidiary as of March 31, 1996 and the related
consolidated statements of operations, shareholders' equity and cash flows for
the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the consolidated financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial statements.
An audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall 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 financial position of The Singing Machine
Company, Inc. and Subsidiary at March 31, 1996 and the results of their
operations and their cash flows for the year then ended in conformity with
generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that The Singing Machine Company, Inc. and Subsidiary will continue as a going
concern. As more fully described in Note 2, the Company, has incurred recurring
operating losses and has a net working capital deficiency of $2,427,127 along
with a significant decline in sales volume. In addition, the Company does not
have a line of credit in place to finance its seasonal needs for inventory
purchases. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans as to these matters are also
described in Note 2. The consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the inability of The Singing Machine Company, Inc. and
Subsidiary to continue as a going concern.
Millward & Co. CPAs
Fort Lauderdale, Florida
July 15, 1996
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
The Singing Machine Company, Inc.
We have audited the accompanying statements of operations, sharedholders' equity
and cash flows for the period from May 5, 1994 to March 31, 1995 (the successor
period) and for the period fron April 1, 1994 to May 4, 1994 (the predecessor
period) of the Singing Machine Company, Inc. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in acciordance with generally accepted auditing
standards. Those standards required that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all materials respects, the results of operations and cash flows for the period
from May 5, 1994 to March 31, 1995 (the successor period) and for the period
from April 1, 1994 to May 4, 1994 (the predecessor period) of The Singing
Machine Company, Inc. in conformity with generally accepted accounting
principles.
The financial statements referred to above have been prepared assuming that The
Singing Machine Company, Inc. will continue as a going concern. As more fully
described in Note 2, the Company has incurred recurring operating losses along
with a significant decline in sales volume. In addition, the Company does not
have a line of credit in place to finance its seasonal needs for inventory
purchases. These conditions raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans as to these matters are also
described in Note 2. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability of assets or the
amounts of liabilities that may result from the possible inability of The
Singing Machine Company, Inc. to continue as a going concern.
ERNST & YOUNG LLP
West Palm Beach, Florida
June 20, 1995
F-2
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
March 31, 1996
ASSETS
CURRENT ASSETS:
Cash $ 113
Trade Accounts Receivable, Net of Allowance
for Doubtful Accounts of $17,000 and Sales
Returns and Allowances of $118,000 184,607
Due from Factor 33,833
Due from Officer 30,203
Inventories, Net 2,306,432
Prepaid Expenses and Other Current Assets 83,381
----------
Total Current Assets 2,638,569
----------
PROPERTY AND EQUIPMENT, Net of Accumulated
Depreciation of $168,463 359,775
----------
INTANGIBLE ASSETS:
Investment in Song Library, Net of Accumulated
Amortization of $227,000 1,037,328
Trademarks, Net of Accumulated Amortization
of $73,509 691,762
Cost in Excess of Net Asset Acquired, Net
of Accumulated Amortization of $55,485 523,391
----------
Total Intangible Assets 2,252,481
----------
OTHER ASSETS 19,490
----------
Total Assets $5,270,315
==========
The accompanying notes are an integral part of these statements
F-3
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET (Continued)
March 31, 1996
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Trade Accounts Payable $1,457,159
Trade Accounts Payable to Related Parties 505,634
Accrued Expenses 1,007,437
Royalties Payable 1,134,543
Current Portion of Long-Term Debt 960,923
----------
Total Current Liabilities 5,065,696
LONG-TERM DEBT: 20,878
----------
Total Liabilities 5,086,574
----------
COMMITMENTS AND CONTINGENCIES:
SHAREHOLDERS' EQUITY:
Common Stock, $.01 Par Value; 10,000,000
Shares Authorized; 2,811,582 Shares
Issued and Outstanding 28,116
Additional Paid-In Capital 5,827,169
Accumulated Deficit (5,671,544)
----------
Total Shareholders' Equity 183,741
----------
Total Liabilities and Shareholders' Equity $5,270,315
==========
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
SUCCESSOR PREDECESSOR
----------- -----------
FOR THE PERIOD FROM PERIOD FROM
YEAR MAY 5, APRIL 1,
ENDED 1994 TO 1994 TO
MARCH 31, MARCH 31, MAY 4,
1996 1995 1994
----------- ----------- -----------
REVENUES:
Equipment Sales, Net $ 3,795,447 $ 2,359,056 $ 161,138
Music Sales, Net 1,255,932 3,145,683 112,629
Commission Income - Related Party 130,893 225,041 5,923
Other 13,295 5,502 30
----------- ----------- -----------
Total Revenues 5,195,567 5,735,282 279,720
----------- ----------- -----------
COSTS AND EXPENSES:
Cost of Equipment Sales 3,399,282 2,111,084 154,775
Cost of Music Sales 1,391,588 2,282,804 80,956
Other Operating Expenses 705,496 451,987 19,140
Selling, General and
Administrative Expenses 2,505,437 2,172,268 126,781
Depreciation and Amortization 226,947 121,744 3,743
Impairment of Long-Lived Assets 405,085 - -
----------- ----------- -----------
Total Costs and Expenses 8,633,835 7,139,887 385,395
----------- ----------- -----------
Operating Loss (3,438,268) (1,404,605) (105,675)
----------- ----------- -----------
OTHER (EXPENSES) INCOME:
Interest Expense (172,467) (300,847) (5,156)
Interest Income 8,315 32,935 -
Loss on Sales of Accounts
Receivable (250,818) (400,613) (10,620)
Gain (Loss) on Sale of
Property and Equipment 2,258 (45,434) -
----------- ----------- -----------
Total Other Expenses (412,712) (713,959) (15,776)
----------- ----------- -----------
LOSS BEFORE INCOME TAXES (3,850,980) (2,118,564) (121,451)
BENEFIT FROM INCOME TAXES - (298,000) (44,937)
----------- ----------- -----------
NET LOSS $(3,850,980) $(1,820,564) $ (76,514)
=========== =========== ===========
LOSS PER COMMON SHARE $ (1.38) $ (1.04) $ (0.05)
=========== =========== ===========
WEIGHTED AVERAGE COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING $ 2,806,361 $ 1,748,804 $ 1,436,089
=========== ============ ===========
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK
$.01 PAR VALUE ADDITIONAL TOTAL
-------------------- PAID-IN ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT EQUITY
---------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance at April 1, 1994 883,332 $ 8,833 $ 573,667 $(2,585,594) $(2,003,094)
Net Loss for the Period from
April 1, 1994 to May 4, 1994 - - - (76,514) (76,514)
---------- -------- ---------- ----------- -----------
Balance at May 4, 1994 - Predecessor 883,332 8,833 573,667 (2,662,108) (2,079,608)
Successor
Effects of Change in Ownership:
Elimination of Predecessor's
Net Capital Deficiency and
Pushdown of Purchase Price - - (382,500) 2,662,108 2,279,608
Shares Issued by Public Offering 1,380,000 13,800 5,106,707 - 5,120,507
Proceeds from Bridge Warrants - - 45,000 - 45,000
Stock Dividend 276,000 2,760 (2,760) - -
Reduction of Exercise Price of Warrants - - 169,200 - 169,200
Net Loss for the Period from May 5, 1994
to March 31, 1995 - - - (1,820,564) (1,820,564)
---------- -------- ---------- ----------- -----------
Balance at March 31, 1995 2,539,332 25,393 5,509,314 (1,820,564) 3,714,143
Exercise of Bridge Warrants 272,250 2,723 317,855 - 320,578
Net Loss for the Year Ended March 31, 1996 - - - (3,850,980) (3,850,980)
---------- -------- ---------- ----------- -----------
Balance at March 31, 1996 2,811,582 $ 28,116 $5,827,169 $(5,671,544) $ 183,741
========== ======== ========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
<TABLE>
<CAPTION>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
SUCCESSOR PREDECESSOR
------------ -------------
FOR THE PERIOD FROM PERIOD FROM
YEAR ENDED MAY 5, 1994 APRIL 1, 1994
MARCH 31, TO MARCH 31, TO MAY 4,
1996 1995 1994
----------- ------------ -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(3,850,980) $(1,820,564) $ (76,514)
Adjustments to Reconcile Net Loss to Net
Cash Provided by (Used in) Operations:
Reduction in Exercise Price of Warrants - 169,200 -
Amortization of Goodwill 38,698 35,382 -
Amortization of Trademarks 51,018 46,994 -
Amortization of Discount on Note Payable - 45,000 -
Amortization of Discount on Notes
Payable - Related Party - 39,262 3,738
Amortization of Song Library 124,461 104,306 10,049
Depreciation 137,231 39,364 3,742
Impairment of Long-Lived Assets 405,085 - -
(Gain) Loss on Sale of Property and Equipment (2,780) 45,434 -
Changes in Operating Assets and Liabilities:
Trade Accounts Receivable 915,996 (333,831) 100,759
Due from Factor 274,469 (24,607) (11,335)
Inventories 348,878 (981,096) 164,996
Prepaid Expenses and Other 221,664 (30,216) (37,950)
Income Tax Receivable 211,188 (211,188) -
Deferred Income Taxes - (151,792) -
Trade Accounts Payable 580,252 (238,074) 70,479
Trade Accounts Payable to Related Parties (456,982) (618,777) 35,279
Accrued Expenses 436,866 313,845 12,888
Royalties Payable 373,621 146,795 (220,457)
Income Taxes Payable - (125,063) (44,937)
----------- ----------- -----------
Net Cash Provided by (Used in) Operating Activities (191,315) (3,549,626) 10,737
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of Property and Equipment (64,111) (325,796) -
Proceeds from Sale of Property and Equipment 5,000 - -
Additions to Song Library (71,972) (93,555) (10,617)
Additions to Trademarks - (10,361) -
Due from Officer 447 (5,422) (367)
Other Assets 32,158 227,290 28,509
----------- ----------- -----------
Net Cash Provided by (Used in) Investing Activities (98,478) (207,844) 17,525
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of Notes Payable to Related Parties - (538,902) (50,000)
Proceeds from Promissory Notes - 355,000 -
Repayments of Promissory Notes - (400,000) -
Issuance of Bridge Warrants 320,578 45,000 -
Issuance of Common Stock - 5,120,507 -
Proceeds from Long-Term Debt - 28,549 -
Repayment of Long-Term Debt (771,021) (113,107) (12,073)
----------- ----------- -----------
Net Cash Provided by (Used in) Financing Activities (450,443) 4,497,047 (62,073)
----------- ----------- -----------
Increase (Decrease) in Cash (740,236) 739,577 (33,811)
Cash at Beginning of Period 740,349 772 34,583
----------- ----------- -----------
Cash at End of Period $ 113 $ 740,349 $ 772
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE>
<TABLE>
<CAPTION>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
SUCCESSOR PREDECESSOR
------------ -------------
FOR THE PERIOD FROM PERIOD FROM
YEAR ENDED MAY 5, 1994 APRIL 1, 1994
MARCH 31, TO MARCH 31, TO MAY 4,
1996 1995 1994
----------- ------------ -------------
<S> <C> <C> <C>
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash Paid for Interest $ 103,000 $ 123,000 $ -
=========== =========== ===========
Cash Paid (Received) for Income Taxes $ (211,000) $ 241,000 $ -
=========== =========== ===========
NONCASH FINANCING ACTIVITY:
Long-Term Note Receivable Given for
Certain Past Due Royalty Payments $ 830,000 $ - $ -
=========== =========== ===========
Long-Term Debt Incurred for the
Acquisition of Property and Equipment $ 31,212 $ - $ -
=========== =========== ===========
Long-Term Debt and Accounts Payable
Incurred for Insurance $ 51,350 $ - $ -
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-8
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. ORGANIZATION AND BASIS OF PRESENTATION - The Singing Machine Company, Inc.
and Subsidiary (the Company) is primarily engaged in the production,
distribution and marketing of karaoke music recordings, as well as the
distribution and marketing of electronic karaoke audio equipment and
accessories. The Company also acts as the exclusive commissioned sales agent for
a related party which sells karaoke audio equipment to both unrelated parties
located in the United States and internationally, and to the Company for
distribution within the United States.
In February 1990, Magna International Corp. (Magna) purchased 100% of the
Company's outstanding common stock from its previous shareholders. Due to this
100% change in ownership, this transaction was accounted for as a purchase of
the Company and, accordingly, the purchase price, including Magna's acquisition
indebtedness, which was guaranteed by the Company, was "pushed down" to the
financial statements of the Company as of February 1990 (see Note 7).
On May 5, 1994, certain officers of the Company, and a then unrelated party,
exercised an option to purchase all the outstanding common stock of the Company
from Magna. As a result of this change in ownership, this transaction was
accounted for as a purchase of the Company and, accordingly, the purchase price
has been "pushed down" to the financial statements of the Company as of that
date. Accordingly, the financial results of the Company prior to such date is
considered a "predecessor" company for financial reporting purposes.
On November 18, 1994, the Company closed an initial public offering of its
common stock on Form SB-2.
2. PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
the accounts of The Singing Machine Company, Inc. and its wholly owned foreign
subsidiary. All significant intercompany transactions have been eliminated.
3. USE OF ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
4. FOREIGN CURRENCY TRANSLATION - Local currency is generally considered the
functional currency outside the United States. Assets and liabilities are
translated at the year end exchange rate. Income and expense items are
translated at average rates of exchange prevailing during the year. The related
translation adjustment is not material.
5. INVENTORIES - Inventories are substantially all finished goods, which consist
primarily of electronic karaoke audio equipment and accessories, audio and video
tapes, and compact discs. Inventories are stated at the lower of cost (first-in,
first-out method) or market.
6. PROPERTY AND EQUIPMENT - Property and equipment is recorded at cost less
accumulated depreciation and amortization. Depreciation is provided using an
accelerated method over the estimated useful lives of the related assets.
Leasehold improvements are amortized over the shorter of the estimated useful
lives of the improvements or the term of the related lease.
F-9
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
7. CASH EQUIVALENTS - The Company considers all highly liquid investments with a
maturity of three months or less when purchased to be cash equivalents.
8. INVESTMENT IN SONG LIBRARY - Investment in song library consists of costs
incurred in the production or purchase of master song tapes. Amortization is
computed using the straight-line method over the estimated useful life of ten
years. Amortization expense is included in cost of music sales in the
accompanying statements of operations. Management periodically evaluates the
recoverability of its investment in song library to ensure that there has been
no permanent impairment in its value.
9. COSTS IN EXCESS OF NET ASSETS ACQUIRED AND TRADEMARKS - Costs in excess of
net assets acquired (goodwill) and trademarks, arising from the "push-down"
accounting applied to the exercise of the purchase option described above, have
been amortized using the straight-line method over 20 years. The carrying value
of goodwill and trademarks are reviewed if the facts and circumstances suggest
that it may be impaired. If this review indicates that the goodwill and
trademarks will not be recoverable, as determined based on the estimated
undiscounted cash of the entity acquired over the remaining amortization period,
the Company's carrying value of the goodwill and trademarks is reduced by the
estimated shortfall of cash flows. As of March 31, 1996, the carrying value of
goodwill and trademarks was reviewed by the Company and based upon the outcome
of such review, the Company has recorded a reduction in the carrying value of
such assets relating to music sales in the amount of $405,085. The Company
continues to actively sell music products; however, the Company has experienced
a sixty percent reduction in music sales and a corresponding reduction in cash
flows associated with these sales. Accordingly, the portion of the goodwill and
trademarks that the Company estimates related to the reduction of music sales
has been charged to operations. In addition, the Company has revised the
estimated useful life of these assets to ten years for fiscal years beginning
April 1, 1996. Amortization expense charged to operations for the fiscal years
ended March 31, 1996 and 1995 amounted to $89,716 and $82,380, respectively.
10. INCOME TAXES - The Company accounts for income taxes pursuant to Financial
Accounting Standards Board (FASB) Statement No. 109, "Accounting for Income
Taxes". Deferred income taxes at the end of each period are determined based on
the difference between the financial statement and tax basis of assets and
liabilities and loss carry-forwards using the enacted tax rates for the years in
which the taxes are expected to be paid or recovered.
11. REVENUE RECOGNITION - Revenue from the sale of equipment and music are
recognized upon shipment and are reported net of returns and allowances.
Commission income is recognized as earned.
During fiscal 1990, the Company entered into an agreement with an unrelated
company to sell the rights to certain of its master song tapes. The agreement,
as amended, provides the unrelated company with the exclusive right to
distribute these songs in certain Asian markets, as defined, through September
1, 1995. For the fiscal 1996 and 1995 periods, the Company recognized music
sales revenues of $0 and $279,000, respectively, under this agreement.
12. LOSS PER COMMON SHARE - Loss per common share is calculated based on the
weighted average number of common shares and dilutive common stock equivalents
outstanding during the period. For the fiscal 1996 and 1995 periods, the effect
of the common stock equivalents would be antidilutive and has not been included
in the calculation.
F-10
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
13. FINANCIAL ACCOUNTING STANDARDS NO. 121 (FAS NO. 121) - In March 1995, the
FASB issued FAS No. 121 "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of". This statement, which is effective for
the Company's financial statements for its 1997 fiscal year, requires that
long-lived assets and certain intangibles to be held and used by the Company be
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. If the estimated
undiscounted cash flows that are expected to result from the use of the asset
are less than the carrying amount of the asset, an impairment loss is recorded
equal to the excess of the carrying amount over the fair value of the assets.
The Company has reviewed for impairment of its long-lived assets in its fiscal
1996 year (see item 9 above) and will review for impairment using the
methodology prescribed by FAS No. 121 in fiscal 1997.
NOTE 2 - GOING CONCERN
The accompanying consolidated financial statements have ben prepared assuming
that the Company will continue as a going concern. As shown in the accompanying
consolidated financial statements, the Company incurred net losses of $3,659,552
for the year ended March 31, 1996 and there is an accumulated deficit of
$5,480,116 and a working capital deficiency of $2,427,127 at March 31, 1996. In
addition, the Company does not have a line of credit in place to finance its
seasonal needs for purchases of inventory. Management of the Company believes
that it has instituted certain initiatives, including an enhanced sales focus
and cost reductions, that will result in returning the Company to profitable
operations in fiscal 1997, although there can be no assurance that this can
happen. In addition, management of the Company is in the process of negotiating
unsecured inventory financing from its related party suppliers and others that
will finance the purchase of inventory at levels necessary to support its
business plan. The consolidated financial statements do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the possible inability of the Company to continue as a going
concern.
NOTE 3 - SALE OF RECEIVABLES WITH RECOURSE
The Company sells certain trade accounts receivable, subject to full recourse
provisions, pursuant to a factoring agreement, as amended. At March 31, 1996,
the outstanding balance of such receivables for which the Company is
contingently liable was approximately $700,000. Accrued expenses include
reserves for estimated returns and allowances of $65,000 at March 31, 1995.
The Company received proceeds of approximately $3,191,000 and $3,990,000 in the
fiscal 1996 period and fiscal 1995, respectively, upon the sale of trade
accounts receivable under this agreement, and incurred approximately $251,000
and $411,000 in losses upon the sale of such accounts, respectively. All of the
Company's accounts receivables, inventories and intangibles are pledged as
collateral under this agreement, and the factor holds back 30% of the approved
receivable face amount as security (70% for a certain customer). Minimum factor
fees were $3,000 per month through December 31, 1994 and $10,000 per month
thereafter.
F-11
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 4 - PROPERTY AND EQUIPMENT
A summary of property and equipment as of March 31, 1996 is as follows:
Estimated
Useful
Lives
(YEARS)
Computer Equipment 5 $ 60,139
Recording Equipment 5 15,671
Office and Warehouse Equipment 7 94,114
Leasehold Improvements 11 40,827
Tools and Dies 5 317,486
---------
528,237
Less Accumulated Depreciation (168,463)
---------
$ 359,774
=========
Depreciation and amortization expense on property and equipment for the fiscal
1996 period and fiscal 1995 is approximately $137,231 and $43,000, respectively.
NOTE 5 - LONG TERM DEBT
A summary of long term debt as of March 31, 1996 is as follows:
Note payable, bearing interest monthly at 8%, due in equal
principal and interest payments in November 1995 and May 1996.
Collateralized by a pledge of 256,666 shares of common stock
held by the designee of a director. $ 541,574 (1)
Note payable, bearing interest at 8%, due in monthly principal
and interest payments of $26,250 through April 1997.
Collateralized by investment in song library. 400,653 (1)
Notes payable, bearing interest at 15.61%, due in monthly
principal and interest payments of $387 through October 2000.
Collateralized by office equipment with a net book value of
$14,800 at March 31, 1996. 14,657
(1) As of June 1996, the Company is in default on this note.
F-12
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 5 - LONG TERM DEBT (CONTINUED)
Note payable, bearing interest at 20.82%, due in monthly
principal and interest payments of $589 through August 1998.
Collateralized by office equipment with a net book value of
$13,843 at March 31, 1996. $ 13,333
Note payable, non-interest bearing, due in monthly principal
payments of approximately $3,864 through June 1996. 11,584
---------
981,801
Less current maturities (960,923)
---------
$ 20,878
=========
Aggregate annual maturities on the above long-term debt is as follows:
1997 $ 960,923
1998 8,624
1999 5,894
2000 4,145
2001 2,215
---------
$ 981,801
=========
NOTE 6 - COMMITMENTS AND CONTINGENCIES
On April 1, 1995, the Company entered into a lease for an office and warehouse
facility for a term of 62 months. Pursuant to the terms of the lease, the
Company must pay maintenance, insurance and real estate taxes. The Company also
leases various equipment under operating leases which expire through fiscal
2000. Total rent expense was approximately $170,000 and $103,000 in the fiscal
1996 and fiscal 1995 periods, respectively. Future minimum lease commitments
under noncancelable operating leases are as follows:
YEAR ENDING MARCH 31:
---------------------
1997 $ 139,286
1998 144,858
1999 150,652
2000 156,678
2001 26,113
---------
$ 617,587
=========
F-13
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 6 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company is required to pay certain royalties related to the sale of
substantially all of its music and lyrics based upon prescribed and negotiated
rates. Royalty expense amounted to approximately $409,000 and $974,000 for the
fiscal 1996 and 1995 periods, respectively, and is included in cost of music
sales in the accompanying statements of operations. The Company is not current
in the payment of certain of its royalty obligations to various royalty
creditors. Management has accrued for all such liability in the accompanying
balance sheet.
On May 22, 1995, the Company entered into a note payable with its primary
royalty creditor for the payment of royalty obligations and past due interest
due through March 31, 1994. The note payable requires various payments through
April 15, 1997 and provides for monthly interest payments at 8% and is
collateralized by a security interest in the Company's song library. The Company
is in default on this note agreement.
As a result of its proposed satisfaction of a portion of all past due royalty
obligations, management believes that it is remote that any claims which could
be asserted under its written copyright licensing agreements or pursuant to
United States federal copyright regulations will be asserted. However, the
ultimate outcome of this uncertainty and its effect on the financial statements
cannot be determined at this time.
On July 20, 1994, certain of the Company's shareholders agreed to indemnify the
Company against certain claims asserted with respect to the period from
September 3, 1991 through November 10, 1994, arising out of the Company's
compulsory statutory licensing agreements, by pledging all of their shares of
common stock (360,000 shares) to the Company. In the event of the assertion of
such claim, the Company may require the return of shares of common stock to the
Company with a market value equal to such claim, excluding any expenses that may
be incurred by or assessed against the Company. The Company has agreed to
release certain shares of common stock from the provisions of the pledge and
indemnity agreement during the period beginning 13 months after November 10,
1994 under certain circumstances based upon the performance of the Company. The
pledge and indemnity agreement will also terminate in the event of a pledgor's
death, provided the Company then maintains adequate insurance on such pledgor.
On July 1, 1992, the Company entered into a contract, as amended, with an
unrelated party to produce 1,200 master song tapes to be delivered to the
Company by December 31, 1997. At March 31, 1996, the remaining amount of the
commitment was $315,150, and $344,850 of songs had been delivered.
The Company entered into an agreement, as amended, with a consultant to provide
certain financial advisory services for an advisory fee of $3,000 per month
through November 18, 1996.
NOTE 7 - RELATED PARTY TRANSACTIONS
At March 31, 1996, the amount due from officer bears interest monthly at 9% and
is due on March 31, 1997.
The Company acts as the exclusive sales agent for a Hong Kong trading company
controlled by a director, who is also the director of a significant shareholder
of the company (a director). The Company receives commission income from such
company based upon 50% of the net profits, as defined, related to sales arranged
by the company. The Company has repurchased from unrelated parties, based in the
United States, certain electronic karaoke audio equipment and accessories which
were sold directly by this related party.
F-14
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 7 - RELATED PARTY TRANSACTIONS (CONTINUED)
During the fiscal 1996 and 1995 periods, the Company purchased, under deferred
payment terms, certain karaoke audio equipment and accessories from Far East
companies (Related Party Suppliers) controlled by a director. Upon delivery of
such equipment in the United States, the Company executes documents of
acceptance in favor of a bank in the Far East, which are guaranteed by the
director. The director has also advanced funds directly to, or on behalf of, the
Company with respect to such equipment purchases. Amounts outstanding under
documents of acceptances or owed directly to these Related Party Suppliers incur
interest at 8.0% - 9.5% per annum from the date of shipment to the Company.
In the fiscal 1996 and 1995 periods, equipment purchases from the Related Party
suppliers were approximately $1,200,000 and $2,357,000, respectively; and
approximately $40,000 and $109,000, respectively, of interest expense was
incurred related to these purchases. During the fiscal 1995 period, the Company
entered into an agreement with the above noted director which provided inventory
financing, through April 1, 1995, of up to $2,200,000 (inclusive of amounts owed
directly, and amounts guaranteed under documents of acceptances). On May 4,
1995, the agreement was renegotiated whereby the director provided inventory
financing through April 1, 1996 of up to $500,000. The Company has not
negotiated any new agreement with this related supplier. At March 31, 1996,
amounts owed directly to the director and amounts owed under documents of
acceptances, guaranteed by the director, aggregated approximately $439,000.
These amounts are included in trade accounts payable to related parties.
On March 29, 1995, the Company purchased tools and dies for two models from a
company controlled by a director for $318,000 in order to have the exclusive
right to use them in connection with the manufacture of electronic equipment by
unrelated suppliers.
During the fiscal 1995 period, the Company repaid approximately $489,000 in
notes payable, including imputed interest at 10%, to an affiliate of Magna.
Additionally, during the fiscal 1995 period, the Company repaid an approximately
$100,000 note payable to a related party supplier. The note provided for monthly
interest payments at 6%. During the fiscal 1995 period, approximately $48,000 of
interest expense on notes payable to related parties is included in the
accompanying statements of operations.
On September 3, 1991, Magna sold an option, to certain officers and another then
unrelated party of the Company, to purchase all of the then outstanding common
shares of the Company (883,332 shares) for $200,000 in cash. Pursuant to this
option agreement (the "Option"), dividends could not be paid to Magna, and the
management, voting rights and profits, if any, of the Company inured to the
benefit of the option holders. The Option could not be exercised until certain
indebtedness to Magna and another related party was repaid. Prior to December
31, 1994, all amounts due to former owners for which certain shares of the
Company's common stock were pledged, were paid in full and the shares were
released from escrow. Subsequently on May 5, 1994, the Option was exercised for
no additional consideration. As a result of this 80% change in ownership (see
Note 9), this transaction was accounted for as a purchase of the Company and,
accordingly, the purchase price has been "pushed down" to the financial
statements of the Company, as of May 5, 1994. Accordingly, the financial results
of the Company prior to such date is considered a "predecessor" company for
financial reporting purposes.
F-15
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 8 - SHAREHOLDERS' EQUITY
On July 26, 1994, the Company's Board of Directors authorized a 1 for 1.87476
reverse stock split distribution for voting common shareholders of record on
such date. Prior to such stock split, the Company's Board of Directors
authorized a new class of nonvoting common stock. The Company then exchanged
124,992 then issued an outstanding shares of voting common stock for 83,333
shares of such nonvoting common stock. The nonvoting common stock automatically
converted into voting common stock on a share-for-share basis on the effective
date of the Company's initial public offering, described below. Retroactive
effect has been given to this stock split.
Effective May 3, 1994, the Company adopted a stock option plan (the Plan), which
provides for the granting of both incentive and nonqualified stock options to
key personnel, including officers, directors, consultants and advisors of the
Company, based upon the determination of the Board of Directors. The Plan was
amended on June 29, 1994, and incentive stock options were granted under the
Plan to purchase 293,700 shares of the Company's common stock at an exercise
price of $3.00 to $5.50. The incentive stock options expire in 1999 and 2004.
At March 31, 1996, 155,000 of these options are currently exercisable, and the
remaining 138,700, held by three individuals, become exercisable in maximum
increments of 20,000 each year through June 29, 1996. Additional incentive or
nonqualified stock options may be granted to purchase up to 186,300 shares of
the Company's common stock. At March 31, 1996, 480,000 shares or common stock
have been reserved for issuance under the Plan.
On November 18, 1994, the Company closed the initial public offering of
1,380,000 shares of its common stock and 1,380,000 warrants (the Public
Warrants) for an aggregate purchase price of approximately $7,080,000. After
giving effect to the payment of offering expenses and under-writing expenses of
approximately $1,959,000, the Company received approximately $5,121,000 of net
proceeds from such initial public offering. The Public Warrants entitle the
registered holders to purchase one share of common stock and were initially
exercisable at a price of $6 per share. As a result of the stock split declared
by the Board of Directors and the further reductions of the exercise price by
the Company, described below, the exercise price of the Public Warrants was
reduced to $3.60 per share and the number of shares underlying the Public
Warrants was increased to 1,656,000. The Public Warrants may be exercised at
anytime beginning November 10, 1995 and continuing thereafter until November 10,
1999.
Also, included in the offering were 120,000 warrants issued to the Company's
underwriters (the Representatives Warrants). The Representative's Warrants
entitle the registered holders to purchase one share of the Company's common
stock and a warrant to purchase an additional share of common stock. The
exercise price of the warrants for common stock, the underlying warrants, and
the common stock subject to issuance pursuant to the underlying Public Warrants
was initially $7.50, $.13 and $9.00 respectively. These prices were reduced as a
result of the stock split, described below, to $4.50, $.08 and $5.40,
respectively, and the number of shares of both common stock and warrants was
increased from 120,000 to 144,000, respectively. The warrants become exercisable
November 10, 1995 and continuing thereafter until November 10, 1999.
On January 26, 1995, the Company's Board of Directors declared a 20% stock split
effective in the form of a dividend, to all holders of record as of February 6,
1995. The officers, certain directors and holders of 883,332
F-16
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 8 - SHAREHOLDERS' EQUITY (CONTINUED)
restricted shares of common stock of the Company voluntarily waived their pro
rata portion of the stock split, and accordingly, the ultimate shares issued
constituted an approximate 12% distribution of shares. In conjunction with the
split, and pursuant to certain anti-dilutive provisions in the warrant
agreements, as defined, the Company increased the shares underlying all
outstanding warrants and reduced the exercise price of the warrants. The Company
further reduced the exercise price of the warrants as an inducement for the
holders to exercise. This additional reduction reduced the exercise price of the
Bridge Warrants below the fair market value of the Company's common stock and,
accordingly, resulted in additional expense of $169,200 which is included in
selling, general and administrative expense on the accompanying statement of
operations for the successor period.
During April 1995, 272,250 Bridge Warrants were exercised resulting in proceeds
to the Company of $326,000.
NOTE 9 - INCOME TAXES
On September 3, 1991, the Company underwent a change of ownership (as defined by
Internal Revenue Code Section 382). This change limits the Company's ability to
utilize its approximately $4,057,000 of net operating loss carryforwards (NOL's)
as of March 31, 1996 to $14,000 per year (these NOL's expire from 2003 to 2007).
At March 31, 1996, the Company has net operating loss carryforwards of
approximately $5,000,000, (which are not subject to the above limitations) that
expire through 2011. A valuation allowance of approximately $1,753,000 has been
recognized to offset primarily all of the deferred tax assets related to these
carryforwards.
The components of the benefits from income taxes are as follows:
<TABLE>
<CAPTION>
SUCCESSOR PREDECESSOR
-------------------------------- --------------------------------
PERIOD FROM MAY 5, 1994 PERIOD FROM APRIL 1, 1994
YEAR ENDED MARCH 31, 1996 TO MARCH 31, 1995 TO MAY 4, 1994
------------------------------- -------------------------------- --------------------------------
CURRENT DEFERRED TOTAL CURRENT DEFERRED TOTAL CURRENT DEFERRED TOTAL
--------- -------- -------- -------- --------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Federal $ - $ - $ - $(82,063) $(184,267) $(266,330) $(29,937) $(12,800) $(42,737)
State - - - - (31,670) (31,670) - (2,200) (2,200)
--------- -------- -------- -------- --------- --------- -------- --------- ---------
$ - $ - $ - $(82,063) $(215,937) $(298,000) $(29,937) $(15,000) $(44,937)
========= ======== ======== ======== ========= ==================== ======== ========
</TABLE>
F-17
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 9 - INCOME TAXES (CONTINUED)
The differences between the statutory United States federal income tax rate and
the effective tax rate for successor and predecessor are as follows:
<TABLE>
<CAPTION>
SUCCESSOR PREDECESSOR
-------------- -------------
PERIOD FROM PERIOD FROM
YEAR ENDED MAY 5, 1994 TO APRIL 1, 1994
MARCH 31, 1996 MARCH 31, 1995 MAY 4, 1994
-------------- -------------- -------------
<S> <C> <C> <C>
Statutory rate (34)% (34)% (34)%
State income tax effect, net of
federal benefit - (3) (3)
Changes in valuation allowance 34 22 -
Realization of net operating
loss carryforwards - - -
------ ------ ------
Effective rate - % (15)% (37)%
====== ====== ======
</TABLE>
At March 31, 1996, the components of the cumulative effect of temporary
differences in the deferred income tax liability and income tax asset balances
are as follow:
MARCH 31, 1996
----------------------------------------
CURRENT LONG-TERM
TOTAL ASSET ASSET
---------- --------- -----------
Assets:
Net operating loss carryforwards $1,799,000 $ 14,000 $ 1,785,000
Reserves for bad debts, sales
returns and warranties 147,000 147,000 -
Liabilities:
Investment in song library (193,000) (25,000) (168,000)
----------- --------- -----------
1,753,000 136,000 1,617,000
Valuation allowance (1,753,000) (136,000) (1,617,000)
----------- --------- -----------
Net deferred tax assets $ - $ - $ -
=========== ========= ===========
The net change in the valuation allowance during the fiscal 1996 periods was
$239,000.
F-18
<PAGE>
THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1996
NOTE 10 - CONCENTRATIONS OF CREDIT RISK AND MAJOR CUSTOMERS
The Company derives primarily all of its equipment and music sales revenues from
distributors and retailers of such products in the United States. Financial
instruments which potentially subject the Company to concentrations of credit
risk consist principally of cash and accounts receivable. The credit risk
associated with cash is considered low due to the credit quality of the
depository institution. The Company's allowance for doubtful accounts is based
upon management's estimates and historical experience. The Company performs
ongoing credit evaluations of its customers and generally does not require
collateral.
During the fiscal 1996 and 1995 periods 63% and 53%, respectively, of the
Company's total revenues were derived from sales to five customers. Sales
derived from customers who individually purchased greater than 10% of total
revenues were as follows:
1996 1995
-------------------------
J.C. Penney 18% -
Handleman Company, Inc. - 23%
Montgomery Ward 16% 11%
Fingerhut 12% -
Target 10% -
NOTE 11 - FOURTH QUARTER ADJUSTMENTS (UNAUDITED)
The following is a summary of certain year end adjustments that are considered
material in the aggregate to the results of the fourth quarter.
FISCAL FISCAL
1996 1995
-------- --------
Reduction of exercise price of
Bridge Warrants $ - $169,200
Inventory write-down 371,000 154,300
Reserve for sales returns - 224,600
Write-off of deferred costs - 142,400
Impairment of long-lived assets 405,085 -
-------- --------
$776,085 $690,500
======== ========
F-19
<PAGE>
Item 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Item 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The following are the directors of the Company, their respective ages, the year
in which each was elected a director and, where applicable, the office of the
Company held by the director. Each director elected will hold office for a one
year term or until their respective successors have been duly elected and
qualified:
SERVED AS
DIRECTOR
NAME AGE SINCE OFFICE
- ------------------- --------- ----------- -----------------------------------
Edward Steele 67 1991 Chief Executive Officer, President,
Chief Financial Officer, Secretary
and Director
Eugene B. Settler 60 1991 Director
Paul Wu 66 1991 Director
Josef A. Bauer 59 1995 Director
Edward Steele joined the Company in 1988 and has served as the Company's Chief
Executive Officer, Chief Financial Officer and as a director since September
1991. As of February 29, 1996, Mr. Steele also assumed the offices of President
and Secretary of the Company. From October 1988 to September 1991, Mr. Steele
was responsible for the development of the Company's electronic hardware
products in the Far East and was the Company's sales director. Prior to joining
the Company, Mr. Steele served in executive capacities at a number of companies
in the toy and electronics fields, including as Managing Director in charge of
worldwide sales of Concept 2000, a manufacturer of consumer electronics, from
1971 to 1978; as President of Wicely Corp., a distributor of electronic toys and
consumer electronics, from 1978 to 1983; and as President of Justin Products
Corp., an electronic toy manufacturer, from 1983 to 1988.
Eugene B. Settler joined the Company as President in 1988 and served in that
office until the termination of his employment agreement on February 22, 1996.
Mr. Settler continues to hold the office of Director, as he has since September
1991. Prior to joining the Company, Mr. Settler served as Director of Sales and
Marketing for CBS-Epic Records from 1968 to 1971, as Executive Vice President of
Marketing for RCA Records from 1971 to 1973, and as Vice President of Marketing
of TMC Music Corp. from 1973 to 1974. Mr. Settler was President of Request
Records from 1976 to 1981 and Executive Vice President of IJE, Inc. (Kid Stuff
Records) from 1981 to 1987.
Paul Wu has been a director of the Company since September 1991 and was the
Chairman of the Board of Directors from September 1991 to February 1995. Mr. Wu
is a private investor and has been engaged in the electronics business in the
Far East and the United States. Since 1979, Mr. Wu has been the Chairman of the
Board and a principal stockholder of FLX (HK) Ltd., a Hong Kong corporation
("FLX"), which manufactures
23
<PAGE>
consumer electronics. Mr. Wu has also been the Chairman and a principal
stockholder of The SMC Singing Machine Co., Ltd., a Hong Kong corporation
("LTD"), since 1991, which is a trading company for consumer electronics. Mr. Wu
is also a director of Gemco Pacific, Inc., a principal stockholder of the
Company.
Josef A. Bauer was appointed to the Board of Directors on February 3, 1995.
Since 1992, Mr. Bauer has been a managing director and principal stockholder of
Dero Research Ltd. in Hong Kong, which serves as a manufacturer's representative
for the sale of telephone and electronic products. From 1970 to 1993, Mr. Bauer
served as managing director and was a principal stockholder of Dero Research
Corporation in Tokyo, Japan, which was engaged in the design, engineering and
manufacture of automobile audio equipment. He served as a director from 1991 to
1994, of AmeriData Technologies, Inc., a publicly traded computer products and
service company. In December 1994, Mr. Bauer was elected to the Board of
Directors of Go-Video, Inc., a publicly traded video electronics manufacturer
and distributor. Mr. Bauer has also served as president of Banisa Corporation, a
privately owned investment company, since 1975. Mr. Bauer is also President of
Magna (a position he has held since 1989) and was formerly a director of the
Company from February 1990 until September 1991. See Item 12 - "Certain
Relationships and Related Transactions."
The Company has agreed, until November 10, 1999, that the representatives
("Representatives") of the underwriters for the Company's initial public
offering which closed on November 18, 1994, may designate a nominee to the Board
of Directors, reasonably acceptable to the Company, or have a representative
attend all Board Meetings. No such nominee has yet been designated. The
officers, certain directors and certain stockholders of the Company have agreed
to vote their shares for the election of such nominee.
The Company's directors serve for a term of one year, or until their successors
shall have been elected and qualified. The Company has in place an employment
agreement with its Chief Executive Officer, Mr. Steele. See Item 10 - "Executive
Compensation, Employment Agreements".
DIRECTORS' FEES
The Company currently reimburses each director for expenses incurred in
connection with his attendance at each meeting of the Board of Directors or a
committee on which he serves. In addition, non-employee directors are paid a fee
of $750 for each board or committee meeting attended and are entitled to receive
2,500 common stock options per year. No such options were issued for fiscal
1996..
BOARD COMMITTEES
On February 3, 1995, the Board of Directors appointed Audit and Executive
Compensation/Stock Option Committees. The Audit Committee consists of Messrs.
Steele, Wu and Bauer and the Executive Compensation/Stock Option Committee
consists of Messrs. Settler, Wu and Bauer. 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 the Company's independent auditors, reviews the Company's
internal accounting controls, and approves services to be performed by the
Company's independent auditors. The Executive Compensation/Stock Option
Committee considers and authorizes remuneration arrangements for senior
management and grants options under, and administers, the Company's 1994 Amended
and Restated Management Stock Option Plan. The entire board of directors
operates as a nominating committee.
24
<PAGE>
BOARD AND BOARD COMMITTEE MEETINGS
During the fiscal year ended March 31, 1996, there were two meetings of the
Board of Directors. The board members also communicate on a regular basis during
the normal course of the business of the Company. The Audit and Executive
Compensation/Stock Option Committees of the Board did not meet during the year.
All directors attended at least 75% of the meetings of the Board.
EXECUTIVE OFFICERS
The following were the executive officer and a certain key employee of the
Company as of March 31, 1996, their respective ages, the office of the Company
held by each and the year in which each was first elected an officer. The
executive officer will hold office until the next annual meeting of the Board of
Directors or until his respective successors have been duly elected and
qualified.
OFFICER'S NAME AGE OFFICE OFFICER SINCE
- ------------------- ----------- ----------------------------- --------------
Edward Steele 67 Chief Executive Officer, September 1991
President, Chief Financial
Officer and Secretary
Howard Miller 55 General Manager August 1991
Howard Miller, a certified public accountant, had been the General Manager of
the Company since August 1991 until his resignation effective May 31, 1996. From
January 1989 to August 1991, Mr. Miller was a self-employed accountant. Prior to
1989 Mr. Miller held various executive financial positions with companies
engaged in the manufacturing, aviation and marine freight industries.
For information regarding Mr. Steele, see description above.
Item 10. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table sets forth the annual and long-term compensation paid to or
accrued for the executive officers of the Company whose annual compensation
exceeded $100,000 during the Company's last two fiscal years.
25
<PAGE>
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
FOR THE FISCAL YEARS ENDED MARCH 31, 1996 AND 1995
LONG TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
-------------------------------------------------- -----------------
NAME AND OTHER ANNUAL OPTIONS
PRINCIPAL POSITION YEAR SALARY(1) BONUS COMPENSATION(2) (NO. OF SHARES)
- ------------------ ---- --------- ----- --------------- ---------------
<S> <C> <C> <C> <C> <C>
Edward Steele 1996 $ 145,731 $-0- $8,617 -0-
Chief Executive Officer 1995 150,000 -0- 10,300 75,000
Eugene B. Settler 1996 140,841 -0- 11,803 -0-
President 1995 150,000 -0- 12,000 75,000
<FN>
- ----------
(1) Mr. Steele enacted a 15% voluntary pay reduction as of September 1995, in light of the Company's poor
financial performance.
(2) Includes $3,600 and $6,954, in automobile allowance for Messrs. Steele and Settler, respectively .
</FN>
</TABLE>
EMPLOYMENT AGREEMENTS
The Company executed an employment agreement with Mr. Steele which commenced as
of October 1, 1994 and is scheduled to terminate on March 31, 1997. Pursuant to
Mr. Steele's employment agreement, he is entitled to received base compensation
of $150,000 per year, which amount automatically increases during the second and
third fiscal years by the greater of 5% or the annual increase in the Consumer
Price Index. The agreement also provides for bonuses based on a percentage of a
bonus pool tied to the annual pre-tax net income (as defined in the agreement)
of the Company. No such bonuses were paid for the 1996 or 1995 fiscal years. Mr.
Steele would receive 45% of the bonus pool. In the event of a termination of his
employment following a change-in-control, Mr. Steele would be entitled to a
lump-sum payment of 300% of the amount of his total compensation in the twelve
months preceding such termination. During the term of his employment agreement
and for a period of two years after his termination for cause or his voluntary
termination of his employment agreement, Mr. Steele could not directly or
indirectly compete with the Company in the KARAOKE industry in the United
States.
The Company had also entered into an employment agreement with Mr. Settler,
which was terminated by the Company on February 22, 1996. As a result of the
termination, the Company ceased payments thereunder. Mr. Settler has filed a
complaint which, under the terms of the employment agreement, is to be settled
via binding arbitration. The Company has been advised that such proceeding is
scheduled for late September, 1996.
26
<PAGE>
STOCK OPTION GRANTS IN LAST FISCAL YEAR
There were no stock options granted to the Company's executive officers during
the fiscal year ended March 31, 1996.
The following table sets forth information regarding stock options granted to
the Company's executive officers during the fiscal year ended March 31, 1995 and
the potential value of such options at the end of their terms, assuming certain
levels of stock price appreciation:
<TABLE>
<CAPTION>
GRANTS IN FISCAL YEAR 1995
INDIVIDUAL GRANTS(1)
-----------------------------------------------------------------------
PERCENT OF TOTAL
SHARES UNDERLY- OPTIONS GRANTED TO
ING OPTIONS EMPLOYEES IN FISCAL EXERCISE EXPIRATION
NAME GRANTED (#) YEAR PRICE DATE
---- --------------- ------------------- -------- ----------
<S> <C> <C> <C> <C>
Edward Steele.................... 75,000 34.3% $5.50 6/29/99
Eugene B. Settler................ 75,000 34.3% $5.50 6/29/99
<FN>
- ---------------------------------
(1) All options are incentive stock options granted pursuant to the
Company's Plan and have a term of five years. These options were
granted on June 29, 1994. 20,000 of such options for each of Messrs.
Steele and Settler were immediately exercisable with the balance
becoming exercisable in increments of 20,000 shares per year.
</FN>
</TABLE>
STOCK OPTION EXERCISES AND HOLDINGS
The following table provides certain information concerning the unexercised
options to purchase shares of Common Stock held by the Company's executive
officers as of March 31, 1996. No stock options were exercised by any executive
officer of the Company during fiscal 1996.
<TABLE>
<CAPTION>
LONG-TERM INCENTIVE PLANS
AWARDS IN LAST FISCAL YEAR
VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
OPTIONS AT 3/31/96 3/31/96
(#) ($)(1)
----------------------------- ----------------------------
SHARES ACQUIRED VALUE
NAME ON EXERCISE(#) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- -------------- -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Edward Steele........ 0 0 40,000 35,000 (1) (1)
Eugene B. Settler.... 0 0 40,000 35,000 (1) (1)
<FN>
- ---------------------
(1) No executive of the Company held any "in the money" options in which
the fair market value of the Common Stock exceeded the option exercise
price as of March 31, 1996.
</FN>
</TABLE>
27
<PAGE>
Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of June 30, 1996, the shares of Common Stock
beneficially owned by each director of the Company, each executive officer of
the Company named in the Summary Compensation Table under the caption "Item 10 -
Executive Compensation", each person known to the Company to own more than 5% of
the outstanding shares of Common Stock and all directors and executive officers
as a group.
SHARES
BENEFICIALLY PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED CLASS
- ----------------------------------------- --------------- ----------------
Gemco Pacific, Inc.(1) 256,666 9.1%
500 Hennessy Road
Causeway, Hong Kong
Edward Steele (6) 245,000(2) 8.7
1551 W. Copans Road, #100
Pompano Beach, Florida 33064
Eugene B. Settler 242,000(2) 8.6
1551 W. Copans Road, #100
Pompano Beach, Florida 33064
Ford Harvest Ltd. 183,333 6.5
500 Hennessy Road
Causeway, Hong Kong
Paul Wu 75,000(3) 2.7
985 Rexdale Blvd.
Rexdale, Ontario M9W 1R9
Josef A. Bauer 22,500(4) *
820 Park Avenue
New York, NY 10021
All directors and executive officers 584,500(5) 20.8%
as a group (4 persons)
- ---------------------------------------
* Less than 1%
(1) Mr. Wu is a director of Gemco Pacific, Inc. ("Gemco"). Mr. Wu disclaims
beneficial ownership of the shares owned by Gemco. All 256,666 of such
shares have been pledged by Gemco to Magna International, Inc.
("Magna") to secure payment of an $816,574 promissory note of the
Company to Magna.
(2) Includes immediately exercisable options to purchase 60,000 shares of
Common Stock.
(3) Includes immediately exercisable options to purchase 75,000 shares of
Common Stock.
(4) Consists of immediately exercisable warrants to acquire such shares.
Does not include 256,666 shares pledged to Magna by Gemco to secure an
outstanding obligation of the Company to Magna. Mr. Bauer is President
of Magna.
(5) Includes immediately exercisable options to purchase 195,000 shares of
Common Stock and immediately exercisable warrants to acquire 22,500
shares of Common Stock.
(6) Mr. Steele disclaims beneficial ownership of 6,500 shares owned by his
wife, Ms. Joan Steele.
28
<PAGE>
The Company's affiliates at the time of the initial public offering, including
its officers and directors, agreed for a two year period commencing November 18,
1994, to vote all of their shares of Common Stock or other voting securities of
the Company in the same proportion as the votes cast by non-affiliates voting
shares of the same class or series, with respect to (a) any liquidation of the
Company, or (b) any merger or consolidation in which the Company is not the
surviving corporation or any sale of all or substantially all of its assets.
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file reports of
ownership and changes in ownership of such securities with the Securities and
Exchange Commission. Officers, directors and greater than ten-percent beneficial
owners are required by applicable regulations to furnish the Company with copies
of all Section 16(a) forms they file. The Company is not aware of any beneficial
owner of more than ten percent of its Common Stock.
Based solely upon a review of the copies of the forms furnished to the Company,
the Company believes that all filing requirements applicable to its officers and
directors were complied with during the 1996 fiscal year.
POSSIBLE CHANGE IN CONTROL
The Company's principal executive officer, Mr. Steele, and its former president
and current director, Mr. Settler, have agreed to indemnify the Company against
certain claims related to compulsory copyright obligations (an "Indemnifiable
Claim") asserted with respect to the period from September 3, 1991 through
November 10, 1994 by pledging all of their shares of Common Stock to the
Company. In the event of the assertion of an Indemnifiable Claim, the Company
may require the return of shares of Common Stock (one-half from each of Messrs.
Steele and Settler) to the Company with a market value collectively equal to the
Indemnifiable Claim. As a result of that indemnification, the Company could
reacquire up to approximately 6.5% of its outstanding shares of Common Stock
(assuming 2,811,582 shares of Common Stock outstanding as of June 30, 1996) from
each of Messrs. Steele and Settler.
Gemco had pledged all 256,666 of its shares of the Company's common stock to
Magna to secure payment of an $816,574 promissory note (the Magna Note) of the
Company to Magna. Josef A. Bauer, a director of the Company, is President of
Magna. The Company is currently in default with regard to the remaining balance
of $541,574. As a result of such default, Magna could acquire approximately 9.1%
of the Company's outstanding Common Stock if it pursues legal remedy.
Item 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On September 3, 1991, in consideration for $200,000, Magna, the then owner of
all of the issued and outstanding shares of the Company's Common Stock, entered
into an option agreement (the "Option Agreement") with Wedge Corp., a Florida
corporation ("Wedge"), to sell Wedge's designee 100% of the Company's Common
Stock. The stockholders of Wedge were Paul Wu, Edward Steele and Eugene B.
Settler (the "Optionees"). In connection with the grant of the option, Wedge
agreed to pledge all of the shares subject to the option to Magna as security
for the Company's satisfaction of various loans from Magna and an affiliate of
Magna. On May 5, 1994, the option was exercised for no additional consideration,
and Magna transferred 883,332 shares of the Company's Common Stock to Messrs.
Settler and Steele and Mr. Wu's designees, Gemco Pacific, Inc. ("Gemco") and
Ford Harvest Ltd. The 256,666 shares held by Gemco are held by Magna as security
for the loans from Magna and an affiliate of Magna. Mr. Wu is a director of
Gemco. Magna has not provided any material services to the Company since
September 3, 1991. Josef A. Bauer, President of Magna, was elected to the
Company's Board of Directors on February 3, 1995.
29
<PAGE>
In September 1992, Magna and an affiliate thereof agreed to exchange $816,574 of
debt owed by the Company to Magna and an affiliate thereof for additional shares
of the Company's Common Stock (the "Additional Shares"). That agreement, as
amended, gave Magna the right to require the Company to repurchase the
Additional Shares, on December 31, 1996, for $816,574 plus interest at 8% per
annum from September 30, 1994. On November 10, 1994 Magna exchanged the
Additional Shares for the Company's promissory note in the amount of $816,574.
Payment of the note was guaranteed by a pledge from Gemco Pacific, Inc., an
assignee of Paul Wu, a director of the Company, of all of its shares of the
Company's Common Stock until the payment and satisfaction of fifty percent of
the principal amount of the note, and fifty percent of such shares until the
remaining principal balance of the note is paid.
The Company has an agreement with FLX to produce electronic recording equipment,
based on the Company's specifications. The Company acts as exclusive agent for
LTD and receives commission income from such company based upon 50% of the net
profits, as defined, related to sales arranged by the Company for LTD. Paul Wu,
a director of the Company, is the Chairman of the Board and a principal
stockholder of FLX and LTD. During the fiscal years ended March 31, 1996 and
1995, the Company purchased approximately $1.2 million and $2.3 million,
respectively, in equipment from FLX and LTD and received approximately $130,000
and $230,000, respectively, in commission income from LTD. See Item 6 -
"Managements Discussion and Analysis of Financial Condition and Results of
Operations".
On May 4, 1992, the Company sold all of its tools and dies used in the
production of electronic recording equipment to LTD for approximately $344,000,
resulting in a gain to the Company of approximately $202,000. In March 1995, the
Company purchased tools and dies for two new models from LTD for $318,000.
The Company believes that all of the foregoing transactions with FLX and LTD
have been on terms no less favorable to the Company than could have been
obtained from unaffiliated third parties in arms-length transactions under
similar circumstances.
Approximately $1.6 million of the net proceeds of the Company's initial public
offering in November 1994 were used to satisfy certain accounts and note payable
to FLX and LTD. Paul Wu, a director of the Company, is an officer, director and
principal stockholder of FLX and LTD. The accounts payable are composed of
amounts due with respect to payments made, or guaranteed, by FLX and LTD in
connection with the issuance of documents of acceptance ("D/As") by the Company
for merchandise received from overseas suppliers. The Company purchases
electronic recording products for its own account from manufacturers in the Far
East. Upon delivery of such merchandise in the United States, the Company
executes D/As in favor of a bank in the Far East with respect to payment for
that merchandise. FLX and LTD have guaranteed the Company's obligations to those
banks. In addition, FLX and LTD have also advanced funds directly to, or on
behalf of the Company, with respect to inventory purchases.
Mr. Wu, as Chairman of FLX and LTD, had agreed that FLX and LTD would continue
to provide up to $500,000 of inventory financing in the form of loans to, or on
behalf of, the Company, or the provision of D/As on the Company's behalf through
April 1, 1996. Since April 1, 1995, FLX and LTD have provided inventory
financing to the Company in excess of their $500,000 commitment, but have no
obligation to do so in the future and could demand payment of the Company's
outstanding credit at any time as the financing agreement has now expired. As of
June 30, 1996, there has been no such demand for payment. However, there are no
assurances that FLX and LTD will not demand payment in the future.
30
<PAGE>
On a case-by-case basis with respect to certain purchase orders, and subject to
his discretion, Mr. Bauer has agreed, directly or through a company controlled
by Mr. Bauer, to provide inventory financing in the form of letters of credit on
the Company's behalf. In exchange, the Company has agreed to reimburse Mr. Bauer
for all expenses incurred with respect to such letters of credit and to pay a
commission of four percent on the face amount of the letter of credit. In July
1995, Mr. Bauer funded letters of credit aggregating $130,000 for the Company's
benefit and has provided no further funding to date.
The Company's principal executive officer, Mr. Steele, and its former president
and current director, Mr. Settler, have agreed to indemnify the Company against
certain Indemnifiable Claims asserted with respect to the period from September
3, 1991 through November 10, 1994 by pledging all of their shares of Common
Stock to the Company. In the event of the assertion of any Indemnifiable Claim,
the Company may require the return of shares of Common Stock (one-half from each
of Messrs. Steele and Settler) to the Company with a market value collectively
equal to the Indemnifiable Claim. There can be no assurance, however, that the
Company would be able to sell or otherwise dispose of such shares for cash in
order to satisfy the Indemnifiable Claim. In addition, the Company would
continue to bear all other costs and expenses incurred by, or assessed against,
the Company (including legal) associated with such an Indemnifiable Claim,
whether or not such Indemnifiable Claim is resolved in favor of the Company. The
Company has agreed to release certain shares of Common Stock from the provisions
of the pledge and indemnity agreement during the period beginning 13 months
after November 10, 1994 under certain circumstances based upon the performance
of the Company. No such shares have been released as of June 30, 1996. The
pledge and indemnity agreement will also terminate as to Messrs. Steele or
Settler in the event of their death, provided the Company then maintains life
insurance of at least $1,000,000 on each party. No such insurance is presently
in place.
The Company has agreed that, for a period of two years from November 18, 1994
without the consent of the Representatives from the Company's initial public
offering in November 1994, it shall not redeem any of its securities or pay any
dividends, or make any other cash distributions in respect of its securities, in
excess of the amount of the Company's current or retained earnings recognized
from and after the closing date.
Item 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibit No. Description
<S> <C>
1(a) Form of Underwriting Agreement between the Company and the Representatives(5)
1(b) Form of Selected Dealers Agreement(3)
3(a) Certificate of Incorporation of the Company, including amendment to be filed with the Secretary of
State of Delaware(1)
3(b) By-Laws of the Company(1)
4(a) Form of Warrant issued in connection with July, 1994 private offering(1)
4(b) Warrant Agreement and related Warrant Certificate to be issued in connection with the public offering
by the Company on November 18, 1994(6)
4(c) Underwriter's Warrant issued to the Underwriters on November 18, 1994(6)
*10(a) Employment Agreement between the Company and Edward Steele, dated November 18, 1994(6)
*10(b) Employment Agreement between the Company and Eugene B. Settler, dated November 18, 1994(6)
*10(c) Employment Agreement between the Company and Howard Miller, dated November 18, 1994(6)
10(d) Agreement dated February 28, 1994 between the Company and Magna International Corp.(1)
*10(e) 1994 Amended and Restated Management Stock Option Plan(1)
31
<PAGE>
10(f) Financial Consulting Agreement between the Company and the Representatives, dated November 18,
1994(3)
10(g) Consulting Agreement between the Company and Genesis Partners, Inc., dated December 9, 1993, as
amended September 2, 1994 and October 20, 1994(4)
10(h) Agreement of Merger dated February 28, 1994, among with Company, The Singing Machine
Company, Inc., a California corporation, and Magna International Corp.(1)
10(i) Supply, Support and Distributorship Agreement dated as of January 1, 1994, between the Company
and FLX (HK) Ltd.(1)
10(j) Supply, Support and Distributorship Agreement dated as of January 1, 1994, between the Company
and The SMC Singing Machine Co., Ltd.(1)
10(k) Accounts Receivable Agreement, dated June 15, 1992, between the Company and Bankers Capital, as
amended September 22, 1994 and December 30, 1994(2)
10(l) Letter Agreement, dated May 4, 1994, among the Company, Paul Wu, Edward Steele and Eugene B.
Settler(1)
10(m) Letter Agreement, dated May 4, 1994, among the Company, Edward Steele and Eugene B. Settler(1)
10(n) Indemnity and Stock Pledge Agreement, dated July 20, 1994, among Eugene B. Settler, Edward Steele
and the Company(1)
10(o) Agreement dated June 29, 1994 among the Company, Magna International Corp., Edward Steele,
Eugene B. Settler and Gemco Pacific, Inc.(1)
10(p) Trademark certificates(2)
10(q) Form of Subscription Agreement evidencing registration rights(3)
10(r) Letter Agreement, dated March 27, 1995, among the Company and Paul Wu(7)
10(s) Letter Agreement, dated May 15, 1995, between the Company and The Harry Fox Agency, Inc.(8)
10(t) Security Agreement, dated May 22, 1995, between the Company and The Harry Fox Agency, Inc.(8)
10(u) Draft form of Indemnity and Contribution Agreement by and among Eugene B. Settler, Edward Steele
and Gemco(9)
10(v) Sub-distribution agreement between the Company and Memcorp, Inc., dated October 27, 1995(10)
10(w) Administrative agreement between the Company and Memcorp, Inc., dated October 27, 1995(10)
10(x) Option agreement to purchase one million shares between the Company and Memcorp, Inc., dated
October 27, 1995(10)
<FN>
- ----------
* Compensatory Plan or Management Contract
(1) Incorporated by reference to the Company's Registration Statement on Form SB-2 (Registration No.
33-81974-A) (the "Registration Statement") as filed on July 27, 1994.
(2) Incorporated by reference to the Amendment No. 1 to the Registration Statement as filed on September 28,
1994.
(3) Incorporated by reference to the Amendment No. 3 to the Registration Statement as filed on October 21,
1994.
(4) Incorporated by reference to the Amendment No. 4 to the Registration Statement as filed on November 4,
1994.
(5) Incorporated by reference to the Amendment No. 5 to the Registration Statement as filed on November 8,
1994.
(6) Incorporated by reference to the Post-Effective Amendment No. 1 to the Registration Statement as filed on
December 13, 1994.
(7) Incorporated by reference to the Post-Effective Amendment No. 4 to the Registration Statement as filed on
March 29, 1995.
(8) Incorporated by reference to the Company's Report on Form 8-K dated June 5, 1995.
32
<PAGE>
(9) Incorporated by reference to the Company's Annual Report on Form 10-KSB for the fiscal year ended March 31,
1995 dated June 28, 1995.
(10) Incorporated by reference to the Company's Quarterly Report on Form 10-QSB for the quarter ended September
30, 1995 dated November 13, 1995.
</FN>
</TABLE>
(b) Reports on Form 8-K.
The Company filed two reports on Form 8-K during the year ended
March 31, 1996. The Company filed one Item 4 Form 8-K on December 4,
1995, and one Item 6 Form 8-K on February 23, 1996.
33
<PAGE>
SIGNATURES
In accordance with the requirements of Section 13 and 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized1.
THE SINGING MACHINE COMPANY, INC.
By: /s/ EDWARD STEELE
-------------------------------------------
Edward Steele, Chief Executive Officer, President,
Treasurer, Secretary and Director (Principal
Executive, Financial and Accounting Officer)
Dated: August 12, 1996
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 Company and in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE
- --------- -------- ----
/s/ EDWARD STEELE Chief Executive Officer, President, August 12, 1996
- --------------------- Treasurer, Secretary and Director
Edward Steele (Principal Executive, Financial and
Accounting Officer)
Director
- ---------------------
Eugene B. Settler
/s/ PAUL WU Director August 12, 1996
- ---------------------
Paul Wu
/s/ JOSEF A. BAUER Director August 12, 1996
- ---------------------
Josef A. Bauer
34
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1996
<PERIOD-START> APR-01-1995
<PERIOD-END> MAR-31-1996
<CASH> 113
<SECURITIES> 0
<RECEIVABLES> 383,643
<ALLOWANCES> (135,000)
<INVENTORY> 2,306,432
<CURRENT-ASSETS> 2,638,569
<PP&E> 528,238
<DEPRECIATION> (168,463)
<TOTAL-ASSETS> 5,270,315
<CURRENT-LIABILITIES> 5,065,696
<BONDS> 0
0
0
<COMMON> 28,116
<OTHER-SE> 155,625
<TOTAL-LIABILITY-AND-EQUITY> 5,270,315
<SALES> 5,051,379
<TOTAL-REVENUES> 5,195,567
<CGS> 4,790,870
<TOTAL-COSTS> 8,633,835
<OTHER-EXPENSES> 248,560
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 164,152
<INCOME-PRETAX> (3,850,980)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,850,980)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,850,980)
<EPS-PRIMARY> (1.38)
<EPS-DILUTED> (1.38)
</TABLE>
