SINGING MACHINE CO INC - Quarter Report: 2010 September (Form 10-Q)
SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON,
DC 20549
FORM
10-Q
(Mark
One)
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x
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QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
quarter ended September 30, 2010
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¨
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TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For the
transition period from _____ to ______.
Commission File Number 0 -
24968
(Exact
Name of Registrant as Specified in its Charter)
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DELAWARE
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95-3795478
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(State
of Incorporation )
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(IRS
Employer I.D.
No.)
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6601 Lyons Road, Building
A-7, Coconut Creek, FL 33073
(Address
of principal executive offices)
(954)
596-1000
(Registrant’s
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirement for
the past 90 days. Yes x No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definition of “large accelerated filer”, “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
One)
Large
accelerated filer ¨ Accelerated
filer ¨ Non-accelerated
filer ¨ Smaller
Reporting Company x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No x
PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Indicated
by check mark whether the registrant has filed all documents and reports
required to be filed by Sections 12, 13 or 15(d) of the Securities and Exchange
Act of 1934 subsequent to the distribution of securities under a plan confirmed
by a court. Yes o No o
APPLICABLE
ONLY TO CORPORATE ISSUERS:
Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date:
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CLASS
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NUMBER
OF SHARES OUTSTANDING
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Common
Stock, $0.01 par value
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37,835,793
as of November 12, 2010
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THE
SINGING MACHINE COMPANY, INC. AND SUBSIDIARIES
INDEX
PART I.
FINANCIAL INFORMATION
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Page
No.
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Item
1.
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Financial
Statements
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Consolidated
Balance Sheets – September 30, 2010(Unaudited) and March 31,
2010
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3
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Consolidated
Statements of Operations - Three months and six months ended September 30,
2010 and 2009(Unaudited)
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4
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Consolidated
Statements of Cash Flows - Six months ended September 30, 2010 and 2009
(Unaudited)
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5
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Notes
to Consolidated Financial Statements- September 30, 2010
(Unaudited)
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6-12
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Item
2.
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Management's
Discussion and Analysis of Financial Condition and Results of
Operations
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13-17
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Item
4T.
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Controls
and Procedures
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17
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PART
II. OTHER INFORMATION
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Item
1.
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Legal
Proceedings
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18
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Item
1A.
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Risk
Factors
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18
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Item
2.
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Unregistered
Sales of Equity Securities and Use of Proceeds
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18
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Item
3.
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Defaults
Upon Senior Securities
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18
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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18
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Item
5.
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Other
Information
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18
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Item
6.
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Exhibits
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18
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SIGNATURES
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19
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2
The
Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED
BALANCE SHEETS
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September 30, 2010
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March 31, 2010
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|||||||
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(Unaudited)
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(Audited)
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|||||||
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Assets
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Current
Assets
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||||||||
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Cash
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$ | 1,094,647 | $ | 865,777 | ||||
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Accounts
receivable, net of allowances of $208,638 and
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||||||||
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$185,407,
respectively
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4,106,769 | 983,791 | ||||||
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Due
from factor
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- | 14,987 | ||||||
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Inventories,net
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4,665,720 | 2,804,848 | ||||||
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Prepaid
expenses and other current assets
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82,522 | 118,465 | ||||||
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Total
Current Assets
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9,949,658 | 4,787,868 | ||||||
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Property and
equipment, net
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495,198 | 736,966 | ||||||
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Other
non-current assets
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164,677 | 164,644 | ||||||
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Total
Assets
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$ | 10,609,533 | $ | 5,689,478 | ||||
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Liabilities and Shareholders'
Deficit
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||||||||
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Current
Liabilities
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||||||||
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Accounts
payable
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$ | 4,405,272 | $ | 895,713 | ||||
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Due
to related parties, net
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5,671,181 | 3,033,801 | ||||||
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Accrued
expenses
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485,217 | 227,257 | ||||||
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Short-term
loan - bank
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- | 1,091,828 | ||||||
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Current
portion of long-term financing obligation
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13,640 | 18,186 | ||||||
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Customer
credits on account
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351,903 | 742,009 | ||||||
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Deferred
gross profit on estimated returns
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309,459 | 123,708 | ||||||
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Total
Current Liabilities
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11,236,672 | 6,132,502 | ||||||
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Long-term
financing obligation, less current portion
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- | 4,547 | ||||||
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Total
Liabilities
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11,236,672 | 6,137,049 | ||||||
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Shareholders' Deficit
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||||||||
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Preferred
stock, $1.00 par value; 1,000,000 shares authorized; no shares issued and
outstanding
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- | - | ||||||
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Common
stock, Class A, $.01 par value; 100,000 shares
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||||||||
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authorized;
no shares issued and outstanding
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- | - | ||||||
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Common
stock, $0.01 par value; 100,000,000 shares authorized;
35,835,793 and 37,585,794 shares issued and outstanding
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378,357 | 375,857 | ||||||
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Additional
paid-in capital
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19,104,465 | 19,098,726 | ||||||
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Accumulated
deficit
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(20,109,961 | ) | (19,922,154 | ) | ||||
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Total
Shareholders' Deficit
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(627,139 | ) | (447,571 | ) | ||||
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Total
Liabilities and Shareholders' Deficit
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$ | 10,609,533 | $ | 5,689,478 | ||||
The
accompanying notes are an integral part of these consolidated financial
statements.
3
The
Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED
STATEMENTS OF OPERATIONS
(Unaudited)
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For Three Months Ended
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For Six Months Ended
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|||||||||||||||
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September 30, 2010
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September 30, 2009
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September 30, 2010
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September 30, 2009
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Net
Sales
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$ | 8,357,672 | $ | 6,991,372 | $ | 10,449,299 | $ | 7,805,380 | ||||||||
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Cost
of Goods Sold
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6,664,996 | 5,607,768 | 8,180,730 | 6,707,398 | ||||||||||||
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Gross
Profit
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1,692,676 | 1,383,604 | 2,268,569 | 1,097,982 | ||||||||||||
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Operating
Expenses
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Selling
expenses
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644,921 | 636,031 | 894,010 | 940,172 | ||||||||||||
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General
and administrative expenses
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634,033 | 930,353 | 1,309,609 | 1,790,607 | ||||||||||||
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Depreciation
and amortization
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119,716 | 102,513 | 241,768 | 202,265 | ||||||||||||
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Total
Operating Expenses
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1,398,670 | 1,668,897 | 2,445,387 | 2,933,044 | ||||||||||||
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Income
(Loss) from Operations
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294,006 | (285,293 | ) | (176,818 | ) | (1,835,062 | ) | |||||||||
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Other
Expenses
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Interest
expense
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(2,353 | ) | (27,683 | ) | (10,989 | ) | (30,951 | ) | ||||||||
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Net
Income (Loss)
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$ | 291,653 | $ | (312,976 | ) | $ | (187,807 | ) | $ | (1,866,013 | ) | |||||
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Income
(Loss) per Common Share
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||||||||||||||||
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Basic
and Diluted
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$ | 0.01 | $ | (0.01 | ) | $ | (0.00 | ) | $ | (0.05 | ) | |||||
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Weighted
Average Common and Common Equivalent
Shares:
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||||||||||||||||
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Basic
and Diluted
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37,668,211 | 37,449,332 | 37,627,003 | 37,449,332 | ||||||||||||
The
accompanying notes are an integral part of these consolidated financial
statements.
4
The
Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Unaudited)
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For Six Months Ended
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||||||||
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September 30, 2010
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September 30, 2009
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Cash
flows from operating activities
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Net
Loss
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$ | (187,807 | ) | $ | (1,866,013 | ) | ||
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Adjustments
to reconcile net loss to net cash and cash equivalents provided
by (used in) operating activities:
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||||||||
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Depreciation
and amortization
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241,768 | 202,265 | ||||||
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Inventory
reserve charge
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- | 191,179 | ||||||
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Change
in allowance for bad debts
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23,231 | 91,736 | ||||||
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Stock
based compensation
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8,239 | 7,938 | ||||||
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Deferred
gross profit on estimated returns
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185,751 | (156,854 | ) | |||||
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Changes
in assets and liabilities:
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||||||||
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(Increase)
Decrease in:
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||||||||
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Accounts
receivable
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(2,526,642 | ) | (3,084,916 | ) | ||||
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Inventories
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(1,860,872 | ) | (494,836 | ) | ||||
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Prepaid
expenses and other current assets
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35,943 | 122,882 | ||||||
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Other
non-current assets
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(33 | ) | (390 | ) | ||||
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Increase
(Decrease) in:
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||||||||
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Accounts
payable
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3,509,559 | 1,796,035 | ||||||
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Accounts
payable - related party
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2,637,380 | 605,140 | ||||||
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Accrued
expenses
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257,960 | 75,207 | ||||||
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Customer
credits on account
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(390,106 | ) | 453,533 | |||||
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Net
cash provided by (used in) operating activities
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1,934,371 | (2,057,094 | ) | |||||
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Cash
flows from investing activities
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||||||||
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Purchase
of property and equipment
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- | (38,377 | ) | |||||
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Disposal
of property and equipment
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- | 1,648 | ||||||
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Net
cash used in investing activities
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- | (36,729 | ) | |||||
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Cash
flows from financing activities
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||||||||
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Borrowings
from factor, net
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14,987 | 57,909 | ||||||
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Net
(repayments)proceeds pursuant to factoring facility
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(619,567 | ) | 1,768,830 | |||||
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Net
(repayments)proceeds from short-term bank loan
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(1,091,828 | ) | 1,322,884 | |||||
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Payments
on long-term financing obligation
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(9,093 | ) | (7,577 | ) | ||||
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Net
cash (used in) provided by financing activities
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(1,705,501 | ) | 3,142,046 | |||||
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Change
in cash and cash equivalents
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228,870 | 1,048,223 | ||||||
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Cash
and cash equivalents at beginning of period
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865,777 | 957,163 | ||||||
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Cash
and cash equivalents at end of period
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$ | 1,094,647 | $ | 2,005,386 | ||||
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Supplemental
Disclosures of Cash Flow Information:
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||||||||
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Cash
paid for Interest
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$ | 10,989 | $ | 30,951 | ||||
The
accompanying notes are an integral part of these consolidated financial
statements.
5
THE
SINGING MACHINE COMPANY, INC AND SUBSIDIARIES
September
30, 2010
NOTE
1 – BASIS OF PRESENTATION
OVERVIEW
The
Singing Machine Company, Inc., a Delaware corporation (the "Company," “SMC”,
"The Singing Machine", “we” or “us”), and wholly-owned subsidiaries SMC
(Comercial Offshore De Macau) Limitada (“Macau Subsidiary”), SMC Logistics, Inc.
(“SMC-L”), SMC-Music, Inc.(“SMC-M”), and Singing Machine Holdings Ltd. (a B.V.I.
company) are primarily engaged in the development, marketing, and sale of
consumer karaoke audio equipment, accessories, musical instruments and musical
recordings. The products are sold directly to distributors and retail
customers.
The
preparation of The Singing Machine's financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
revenues and expenses during the period. Future events and their effects cannot
be determined with absolute certainty; therefore, the determination of estimates
requires the exercise of judgment. Actual results inevitably will differ from
those estimates, and such differences may be material to the Company's financial
statements. Management evaluates its estimates and assumptions continually.
These estimates and assumptions are based on historical experience and other
factors that are believed to be reasonable under the circumstances.
NOTE
2-SUMMARY OF ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION.
The accompanying consolidated financial statements include the accounts
of the Company, Macau Subsidiary, SMC-L, SMC-M and The Singing Machine Holdings
Ltd. (a B.V.I. company). All inter-company accounts and transactions
have been eliminated in consolidation for all periods presented.
INTERIM CONSOLIDATED FINANCIAL
STATEMENTS. The consolidated financial statements for the three months
and six months ended September 30, 2010 and 2009 are unaudited. In the opinion
of management, such consolidated financial statements include all adjustments
(consisting of normal recurring accruals) necessary for the fair presentation of
the consolidated financial position and the consolidated results of operations.
The consolidated results of operations for the periods presented are not
necessarily indicative of the results to be expected for the full year. The
consolidated balance sheet information as of March 31, 2010 was derived
from the audited consolidated financial statements included in the Company’s
Annual Report on Form 10-K. The interim consolidated financial statements should
be read in conjunction with that report.
USE OF ESTIMATES. The Singing
Machine makes estimates and assumptions in the ordinary course of business
relating to sales returns and allowances, inventory reserves, warranty reserves,
and reserves for promotional incentives that affect the reported amounts of
assets and liabilities and of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Historically, past changes to these
estimates have not had a material impact on the Company's financial condition.
However, circumstances could change which may alter future
expectations.
COLLECTIBILITY OF ACCOUNTS
RECEIVABLE. The Singing Machine's allowance for doubtful accounts is
based on management's estimates of the creditworthiness of its customers,
current economic conditions and historical information, and, in the opinion of
management, is believed to be an amount sufficient to respond to normal business
conditions. Management sets 100% reserves for customers in bankruptcy and other
reserves based upon historical collection experience. Should business conditions
deteriorate or any major customer default on its obligations to the Company,
this allowance may need to be significantly increased, which would have a
negative impact on operations.
ACCOUNTS RECEIVABLE
FACTORING. The Company’s factoring facility, which was
canceled on June 8, 2010, only financed non-recourse accounts
receivable. Such receivables were considered to have been sold in
accordance with Financial Accounting Standard Board (“FASB”), Accounting
Standard Codification (“ASC”) 860-30, Transfers and Servicing Secured Borrowing
and Collateral. Accordingly, advances received pursuant to the
factoring facility have been netted against the accounts receivable on the
accompanying consolidated balance sheet for March 31, 2010.
RESERVES ON INVENTORIES. The
Singing Machine reduces inventory on hand to its net realizable value on an
item-by-item basis when it is apparent that the expected realizable value of an
inventory item falls below its original cost. A charge to cost of sales results
when the estimated net realizable value of specific inventory items declines
below cost. Management regularly reviews the Company's inventories for such
declines in value.
FOREIGN
CURRENCY TRANSLATION
The
functional currency of the Macau Subsidiary is the Hong Kong dollar. Such
financial statements are translated to U.S. dollars using year-end rates of
exchange for assets and liabilities, and average rates of exchange for the year
for revenues, costs, and expenses. Net gains and losses resulting from foreign
exchange transactions and translations were not material during the periods
presented.
6
CONCENTRATION
OF CREDIT RISK
The
Company maintains cash balances in foreign financial
institutions. The amounts at September 30, 2010 and March 31, 2010
are $664,648 and $734,908, respectively. At times the Company
maintains cash in United States bank accounts that are in excess of the Federal
Deposit Insurance Corporation (“FDIC”) insured amounts of up to
$250,000. As of September 30, 2010 and March 31, 2010 the amounts
uninsured in United States banks was $179,999 and $0, respectively.
INVENTORY
Inventories
are comprised of electronic karaoke equipment, accessories, electronic musical
instruments, electronic toys and compact discs and are stated at the lower of
cost or market, as determined using the first in, first out method. The Singing
Machine reduces inventory on hand to its net realizable value on an item-by-item
basis when it is apparent that the expected realizable value of an inventory
item falls below its original cost. A charge to cost of sales results when the
estimated net realizable value of specific inventory items declines below cost.
Management regularly reviews the Company's investment in inventories for such
declines in value.
REVENUE
RECOGNITION
Revenue
from the sale of equipment, accessories, and musical recordings are recognized
upon the later of: (a) the time of shipment or (b) when title passes to the
customers and all significant contractual obligations have been satisfied and
collection of the resulting receivable is reasonably assured. Revenues from
sales of consigned inventory are recognized upon sale of the product by the
consignee. Net sales are comprised of gross sales net of actual and estimated
future returns, discounts and volume rebates.
STOCK
BASED COMPENSATION
The
Company began to apply the provisions FASB ASC 718-20, Compensation – Stock
Compensation Awards Classified as Equity (“ASC 718-20”) starting on January 1,
2006. ASC 718-20 requires all share-based payments to employees
including grants of employee stock options, be measured at fair value and
expensed in the consolidated statement of operations over the service period
(generally the vesting period). Upon adoption, the Company transitioned to ASC
718-20 using the modified prospective application, whereby compensation cost is
only recognized in the consolidated statements of operations beginning with the
first period that ASC 718-20 is effective and thereafter, with prior periods'
stock-based compensation still presented on a pro forma basis. Under the
modified prospective approach, the provisions of ASC 718-20 are to be applied to
new employee awards and to employee awards modified, repurchased, or cancelled
after the required effective date. Additionally, compensation cost for the
portion of employee awards for which the requisite service has not been rendered
that are outstanding as of the required effective date shall be recognized as
the requisite service is rendered on or after the required effective date. The
compensation cost for that portion of employee awards shall be based on the
grant-date fair value of those awards as calculated for either recognition or
pro-forma disclosures under ASC 718-20 The Company continues to
use the Black-Scholes option valuation model to value stock
options. For the three and six months ended September 30, 2010, the
stock option expense was $369 and $739, respectively. For the three and six
months ended September 30, 2009, the stock option expense was $3,936 and $7,938,
respectively. Employee stock option compensation expense in fiscal
years 2010 and 2009 includes the estimated fair value of options granted,
amortized on a straight-line basis over the requisite service period for the
entire portion of the award.
The fair
value of each option grant was estimated on the date of the grant using the
Black-Scholes option-pricing model with the assumptions outlined below. For the
quarter ended September 30, 2009, the Company took into consideration guidance
under ASC 718-20 and SEC
Staff Accounting Bulletin No. 107 when reviewing and updating assumptions. The
expected volatility is based upon historical volatility of our stock and other
contributing factors. The expected term is based upon observation of actual time
elapsed between date of grant and exercise of options for all employees.
Previously such assumptions were determined based on historical
data.
|
|
·
|
For
the six months ended September 30, 2010: expected dividend yield 0%,
risk-free interest rate of 0.41%, volatility 268.4% and expected term of
three years.
|
|
|
·
|
For
the six months ended September 30, 2009: expected dividend yield 0%,
risk-free interest rate of 0.57% to 1.41%, volatility 70.22% and 80.07%
and expected term of one year.
|
ADVERTISING
Costs
incurred for producing and publishing advertising of the Company are charged to
operations as incurred. The Company has entered into cooperative advertising
agreements with its major clients that specifically indicated that the client
has to spend the cooperative advertising fund upon the occurrence of mutually
agreed events. The percentage of the cooperative advertising allowance ranges
from 2% to 5% of the clients’ inventory purchases. The clients have to advertise
the Company's products in the client's catalog, local newspaper and other
advertising media. The client must submit the proof of the performance (such as
a copy of the advertising showing the Company’s products) to the Company to
request for the allowance. The client does not have the ability to spend the
allowance at their discretion. The Company believes that the identifiable
benefit from the cooperative advertising program and the fair value of the
advertising benefit is equal or greater than the cooperative advertising
expense. Advertising expense for the six months ended September 30, 2010 and
2009 was $389,496 and $282,369, respectively.
7
RESEARCH
AND DEVELOPMENT COSTS
All
research and development costs are charged to results of operations as incurred.
These expenses are shown as a component of selling, general and administrative
expenses in the consolidated statements of operations. For the six
months ended September 30, 2010 and 2009, these amounts totaled $15,025 and
$39,762, respectively.
FAIR
VALUE OF FINANCIAL INSTRUMENTS
We have
adopted FASB ASC 825, which requires disclosures of information about the fair
value of certain financial instruments for which it is practicable to estimate
that value. For purposes of this disclosure, the fair value of a financial
instrument is the amount at which the instrument could be exchanged in a current
transaction between willing parties, other than in a forced sale or
liquidation.
The
carrying amounts of the Company's short-term financial instruments, including
accounts receivable, due from factors, accounts payable, customer credits on
account, accrued expenses and loans payable to related parties approximates fair
value due to the relatively short period to maturity for these
instruments.
SUBSEQUENT
EVENTS
We
adopted the provisions of FASB ASC 855, Subsequent Events
(“ASC 855”). The
purpose of ASC 855 is to establish a general standard of accounting for the
disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. The
statement outlines the following:
|
|
·
|
The
period after the balance sheet date during which management of a reporting
entity should evaluate events or transactions that may occur for potential
recognition or disclosure in the financial
statements
|
|
|
·
|
The
circumstances under which an entity should recognize events or
transactions occurring after the balance sheet date in its financial
statements
|
|
|
·
|
The
disclosures that an entity should make about events or transactions that
occurred after the balance sheet
date.
|
NOTE
3- INCOME TAXES
The
Company follows FASB ASC 740 10-25, Accounting for Uncertainty in Income Taxes,
which defines a recognition threshold and measurement attribute for financial
statement recognition and measurements of tax positions taken or expected to be
taken in a tax return. As of September 30, 2010 this position did not
result in any adjustment to the Company’s provision for income
taxes.
As of
September 30, 2010 and March 31, 2010, The Singing Machine had gross deferred
tax assets of approximately $4.1 million and $4.0 million, respectively, against
which the Company recorded valuation allowances totaling approximately $4.1
million and $4.0 million, respectively.
As of
September 30, 2010 the Company is subject to U.S. Federal income tax
examinations for the tax years ended March 31, 2007 through March 31,
2010.
NOTE
4- INVENTORIES
Inventories
are comprised of the following components:
|
September 30,
|
March 31,
|
|||||||
|
2009
|
2009
|
|||||||
|
(unaudited)
|
||||||||
|
Finished
Goods
|
$ | 4,412,342 | $ | 5,475,056 | ||||
|
Inventory
in Transit
|
1,557,550 | - | ||||||
|
Less:
Inventory Reserve
|
(936,568 | ) | (745,389 | ) | ||||
|
Net
Inventories
|
$ | 5,033,324 | $ | 4,729,667 | ||||
Inventory
consigned to customers at September 30, 2010 and March 31, 2010 were $353,557
and $353,557, respectively.
8
NOTE
5 - ACCOUNTS RECEIVABLE FACTORING FACILITY
On June
8, 2010 the Company was notified by DBS Bank (Hong Kong) Limited (“DBS” or
“Lender”) that our credit and factoring facilities totaling $13.0M were being
withdrawn effective upon receipt of amounts due on both factoring and accounts
payable financing facilities. As of September 30, 2010, the Company had no
outstanding amounts due to DBS with respect to the financing
facility. Our parent company, The Starlight Group (“Starlight”), has
committed to provide bridge financing until the Company secures a new financing
facility.
The
factoring facility was established on August 28, 2008, pursuant to a three-party
Banking Facility agreement between the Company’s wholly owned subsidiary SMC
(Commercial Offshore De Macau) Limitada (“Borrower”), DBS and Branch Banking and
Trust Company (“BB&T” or “Factor”). The agreement was
comprised of three facilities including a maximum of $7.0 million on 80% of
qualified accounts receivable, a maximum letter of credit facility of $4.0
million for accounts payable financing and a maximum of $2.0 million for the
negotiation of export bills under letter of credit.
Under the
factor agreement, the Factor assumed credit risk on approved accounts (factor
risk accounts). For non-approved accounts, the Company assumed the
credit risk (client risk accounts). The factoring fees were .675% of
the gross invoice for both client risk (recourse) and factor risk (non-recourse)
accounts. As of September 30, 2010 there were no open accounts receivable
assigned to the Factor. As of September 30, 2010 and March 31, 2010
there were outstanding amounts due from BB&T of $0 and $14,987
respectively. These amounts represent excess of customer
payments received by BB&T that had yet to be transferred to
DBS. As of September 30, 2010and March 31, 2010 the outstanding
amount under the factoring facility with DBS was $0 and $619,567 respectively.
This amount represents advances made by DBS on non-recourse receivables and have
been offset against accounts receivable in the accompanying consolidated balance
sheet for March 31, 2010.
9
NOTE
6 - PROPERTY AND EQUIPMENT
A summary
of property and equipment is as follows:
|
USEFUL
|
September 30,
|
March 31,
|
||||||||||
|
LIFE
|
2010
|
2010
|
||||||||||
|
(unaudited)
|
||||||||||||
|
Computer
and office equipment
|
5
years
|
$ | 660,948 | $ | 660,948 | |||||||
|
Furniture
and fixtures
|
5-7
years
|
217,875 | 217,875 | |||||||||
|
Leasehold
improvements
|
* | 151,503 | 151,503 | |||||||||
|
Warehouse
equipment
|
7
years
|
101,521 | 101,521 | |||||||||
|
Molds
and tooling
|
3-5
years
|
1,820,106 | 1,820,106 | |||||||||
| 2,951,953 | 2,951,953 | |||||||||||
|
Less:
Accumulated depreciation
|
(2,456,755 | ) | (2,214,987 | ) | ||||||||
| $ | 495,198 | $ | 736,966 | |||||||||
NOTE
7 - CUSTOMER CREDITS ON ACCOUNT
Customer
credits on account represent customers that have received credits in excess of
their accounts receivable balance. These balances were reclassified for
financial statement purposes as current liabilities until paid or applied to
future purchases.
NOTE
8 – FINANCING
As of
September 30, 2010 and March 31, 2010 the Company owed DBS $0 and $1,091,828
respectively pursuant to an accounts payable financing facility. The proceeds
were used to pay China manufacturing vendors. The accounts payable facility
loans were secured with corporate guarantees from the Company as well as a
guarantee from Starlight.
This
accounts payable financing facility was pursuant to the three-party Banking
Facility agreement discussed in Note 5.
Interest
on letter of credit facilities and discounting charges on accounts receivable
advances were charged at a rate of 1.5% per annum over LIBOR (London Interbank
Offered Rate). The credit facility was secured with corporate
guarantees from the Company as well as a $2.0 million guarantee from Starlight
International Holdings Limited, a related party. This agreement replaced a
previous four-party agreement between the Company, Starlight Marketing Limited
(a related party), Standard Chartered Bank (Hong Kong), Limited and
CIT.
NOTE
9 - COMMITMENTS AND CONTINGENCIES
LEGAL
MATTERS
MGA
ENTERTAINMENT, INC. v. THE SINGING MACHINE COMPANY, INC. (CENTRAL DISTRICT COURT
OF CALIFORNIA, CASE CV 10-03761 DOC (RNBX) )
MGA
Entertainment, Inc. (“MGA”) filed an action against the Company on April 16,
2010 alleging breach of contract, breach of implied covenant of good faith and
fair dealing, and conversion claims relating to two licensing agreements between
the parties entered into on May 10, 2006 and November 21, 2006. The two
licensing agreements involved the manufacture, distribution and marketing of
“Bratz” branded merchandise.
The
Company has responded to the above captioned case and has removed the case to
federal court, case no. CV 10-03761 DOC (RNBX). Based upon legal opinion from
outside Counsel, the Company believes it has defenses to the claims raised by
MGA. However, at the time of this filing, the case is still in early stages of
litigation and the outcome is unknown.
The
Company has also filed a class-action lawsuit on behalf of itself and all
similarly situated licensees against MGA in the Central District Court of
California, case no. CV 10-4536-DOC(RNBX). The Company alleges breach of
contract, failure of consideration for the licensing agreements, and other
claims based on various state and federal laws. Both pending cases between MGA
and SMC were mutually stayed, pending the outcome of the Mattel and MGA
litigation, however on October 26, 2010 the District Court re-opened both cases
sua
sponte.
10
INCOME
TAXES
In a
letter dated July 21, 2008 the Internal Revenue Service (“IRS”) notified the
former foreign subsidiary of an unpaid tax balance on Income Tax Return of a
Foreign Corporation (Form 1120-F) for the period ending March 31, 2003 for
International SMC (HK) Limited (“ISMC (HK)”), a former
subsidiary. According to the notice ISMC (HK) has an unpaid balance
due in the amount of $241,639 that includes an interest assessment of
$74,125. ISMC (HK) was sold in its entirety by the Company on
September 25, 2006 to a British Virgin Islands company
(“Purchaser”). The sale and purchase agreement with the Purchaser of
ISMC (HK) specifies that the Purchaser would ultimately be responsible for any
liabilities, including tax matters. On June 3, 2009 the IRS filed a
federal tax lien in the amount of approximately $170,000 against ISMC (HK) under
ISMC (HK)’s federal Tax ID. Management sought independent legal counsel to
assess the potential liability, if any, on the Company. In a
memorandum from independent counsel, the conclusion based on the facts presented
was that the IRS would not prevail against the Company for collection of the
ISMC (HK) income tax liability based on:
|
|
·
|
The
Internal Revenue Service’s asserted position that the Company is not the
taxpayer.
|
|
|
·
|
The
1120- F tax liability was recorded under the taxpayer identification
number belonging to ISMC and not the Company’s taxpayer identification
number
|
|
|
·
|
The
IRS would be barred from recovery since it failed to assess or issue a
notice of levy within the three year statute of
limitations
|
Based on
the conclusion reached in the legal memorandum, management does not believe that
the Company will have any further liability with regards to this
issue.
LEASES
The
Company has entered into various operating lease agreements for office and
warehouse facilities in Coconut Creek, Florida and City of Industry, California.
The leases expire at varying dates. Rent expense for the six months ended
September 30, 2010 and 2009 was $401,138 and $439,717,
respectively.
In
addition, the Company maintains various warehouse equipment and computer
equipment operating leases.
Future
minimum lease payments under property and equipment leases with terms exceeding
one year as of September 30, 2010 are as follows:
|
Property Leases
|
Equipment Leases
|
|||||||
|
For
year ending
|
||||||||
|
September
30,
|
||||||||
|
2011
|
$ | 395,321 | $ | 2,416 | ||||
|
2012
|
675,460 | - | ||||||
|
2013
|
671,044 | - | ||||||
|
2014
|
57,384 | - | ||||||
| $ | 1,799,209 | $ | 2,416 | |||||
.
NOTE
10 - STOCKHOLDERS' EQUITY
COMMON
STOCK ISSUANCES
During
the six months ended September 30, 2010 and 2009, the Company issued 249,999 and
0 shares of its common stock, respectively.
On August
31, 2010 the Company issued 249,999 shares of its common stock to our Board of
Directors at $.03 per share, pursuant to our annual director compensation
plan.
STOCK
OPTIONS
On June
1, 2001, the Board of Directors approved the 2001 Stock Option Plan (“Plan”),
which replaced the 1994 Stock Option Plan, as amended, (the "1994 Plan"). The
Plan was developed to provide a means whereby directors and selected employees,
officers, consultants, and advisors of the Company may be granted incentive or
non-qualified stock options to purchase common stock of the Company. As of
September 30, 2010, the Plan is authorized to grant options up to an aggregate
of 1,950,000 shares of the Company's common stock and up to 300,000 shares for
any one individual grant in any quarter. As of September 30, 2010, the Company
granted 1,043,895 options under the Year 2001 Plan with 611,380 options still
outstanding, leaving 906,105 options available to be granted. There
were no additional stock options issued during the six months ended September
30, 2010. As of September 30, 2010, the Company has no options still issued and
no options available to be granted under the 1994 Plan, since the 1994 Plan has
expired (after 10 years).
11
The
majority of sales to customers outside of the United States for the three and
six months ended September 30, 2010 and 2009 were made by the Macau
Subsidiary. Sales by geographic region for the period presented are
as follows:
|
FOR THE THREE MONTHS ENDED
|
FOR THE SIX MONTHS ENDED
|
|||||||||||||||
|
September 30,
|
September 30,
|
|||||||||||||||
|
2010
|
2009
|
2010
|
2009
|
|||||||||||||
|
North
America
|
$ | 8,087,092 | $ | 5,302,263 | 10,178,719 | $ | 6,116,271 | |||||||||
|
Europe
|
270,580 | 1,664,806 | 270,580 | 1,664,806 | ||||||||||||
|
Others
|
- | 24,303 | - | 24,303 | ||||||||||||
| $ | 8,357,672 | $ | 6,991,372 | $ | 10,449,299 | $ | 7,805,380 | |||||||||
The
geographic area of sales is based primarily on the location where the product is
delivered.
NOTE 12 – DUE TO RELATED PARTIES,
NET
As of
September 30, 2009 and March 31, 2009 the Company had amounts due to related
parties in the amounts of $5,671,181 and $3,033,801, respectively, consisting
primarily of non-interest bearing trade payables due to Starlight
affiliates.
NOTE
13 – RELATED PARTY TRANSACTIONS
During
the six months ended September 30, 2010 and September 30, 2009 the Company sold
approximately $1,219,000 and $0, respectively to Starlight Electronics at
discounted pricing granted to direct import major distributors. The
average gross profit margin on sales to Starlight Electronics for the six months
ended September 30, 2010 yielded 9%. The product was drop
shipped to Cosmo Communications of Canada (“Cosmo”), the Company’s primary
distributor of its products to Canada. This amount was included as a component
of cost of goods sold in the accompanying consolidated statements of operations.
During
the six months ended September 30, 2010 and September 30, 2009 the Company sold
directly to Cosmo approximately $234,000 and $790,000,
respectively at a gross profit margin of 15.9% and 11.1%,
respectively. Sales to Cosmo were at discounted pricing granted to major
distributors shipped domestically with freight prepaid. This amount
was included as a component of cost of goods sold in the accompanying
consolidated statements of operations.
The
Company purchased products from Starlight Marketing Macao, a subsidiary of
Starlight International Holding Ltd. The purchases from Starlight Marketing
Macao for the six month period ended September 30, 2010 and 2009 were $3,764,672
and $1,982,868 respectively.
During
the six month period ended September 30, 2010 and September 30, 2009 the Company
purchased products from Cosmo in the amount of $182,013 and $328,429,
respectively.
On August
1, 2010, SMC Logistics entered into a service and logistics agreement with
affiliates Starlight Consumer Electronics (USA), Inc. and Cosmo to provide
logistics, fulfillment, and warehousing services for these affiliates’ domestic
sales. The Company received $499,998 and $622,938 in service fees
from these affiliates during the six months ended September 30, 2010 and
September 30, 2009, respectively. For the six months ended September
30, 2010 and 2009, the Company additionally received reimbursements from Cosmo
in the amount of $42,965 and $62,305, respectively for expenses and salaries
incurred by SMC Logistics on behalf of Cosmo.
NOTE
14 – SUBSEQUENT EVENTS
We
evaluated the effects of all subsequent events from the end of the second
quarter ended September 30, 2010 through November 12, 2010, the date we filed
our financial statements with the U.S. Securities and Exchange Commission. There
were no events to report during this evaluation period.
12
ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD-LOOKING
STATEMENTS
The
following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes included elsewhere in this quarterly report. This
document contains certain forward-looking statements including, among others,
anticipated trends in our financial condition and results of operations and our
business strategy. (See Part II, Item 1A, "Risk Factors "). These
forward-looking statements are based largely on our current expectations and are
subject to a number of risks and uncertainties. Actual results could differ
materially from these forward-looking statements.
Statements
included in this quarterly report that do not relate to present or historical
conditions are called “forward-looking statements.” Such forward-looking
statements involve known and unknown risks and uncertainties and other factors
that could cause actual results or outcomes to differ materially from those
expressed in, or implied by, the forward-looking statements. Forward-looking
statements may include, without limitation, statements relating to our plans,
strategies, objectives, expectations and intentions. Words such as “believes,”
“forecasts,” “intends,” “possible,” “estimates,” “anticipates,” “expects,”
“plans,” “should,” “could,” “will,” and similar expressions are intended to
identify forward-looking statements. Our ability to predict or project future
results or the effect of events on our operating results is inherently
uncertain. Forward-looking statements should not be read as a guarantee of
future performance or results, and will not necessarily be accurate indications
of the times at, or by which, such performance or results will be
achieved.
Important
factors to consider in evaluating such forward-looking statements include, but
are not limited to: (i) changes in external factors or in our internal budgeting
process which might impact trends in our results of operations; (ii)
unanticipated working capital or other cash requirements; (iii) changes in our
business strategy or an inability to execute our strategy due to unanticipated
changes in the industries in which we operate; and (iv) the effects of adverse
general economic conditions, both within the United States and globally, (v)
vendor price increases and decreased margins due to competitive pricing during
the economic downturn (vi)various competitive market factors that may prevent us
from competing successfully in the marketplace and (vii) other factors described
in the risk factors section of our Annual Report on Form 10-K, this Quarterly
Report on 10-Q, or in our other filings made with the SEC.
Readers
are cautioned not to place undue reliance on these forward-looking statements,
which reflect management's opinions only as of the date hereof. We undertake no
obligation to revise or publicly release the results of any revision to these
forward-looking statements.
OVERVIEW
The
Singing Machine Company, Inc., a Delaware corporation, (the “Singing Machine,”
“we,” “us,” “our” or “the Company”) and our subsidiaries are primarily engaged
in the design, marketing, and sale of consumer karaoke audio equipment,
accessories and musical recordings. The Company’s products are sold directly to
distributors and retail customers. Our electronic karaoke machines and audio
software products are marketed under The Singing Machine(R) and Motown
trademarks.
Our
products are sold throughout North America and Europe, primarily through
department stores, lifestyle merchants, mass merchandisers, direct mail catalogs
and showrooms, music and record stores, national chains, specialty stores and
warehouse clubs.
Our
karaoke machines and karaoke software are currently sold in such major retail
outlets as Costco, Kohl's, J.C. Penney, Toys R Us, and Wal-Mart. Our business
has historically been subject to significant seasonal fluctuations causing our
revenues to vary from period to period and between the same periods in different
fiscal years. Thus, it may be difficult for an investor to project our results
of operations for any given future period. We are uncertain of how
significantly our business will be harmed by a prolonged economic recession but,
we anticipate that continued contraction of consumer spending will negatively
affect our revenues and profit margins.
RESULTS
OF OPERATIONS
The
following table sets forth, for the periods indicated, certain items related to
our consolidated statements of operations as a percentage of net sales for the
three months and six months ended September 30, 2010 and 2009.
13
The
Singing Machine Company, Inc. and Subsidiaries
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
For Three Months Ended
|
For Six Months Ended
|
|||||||||||||||
|
September 30, 2010
|
September 30, 2009
|
September 30, 2010
|
September 30, 2009
|
|||||||||||||
|
Net
Sales
|
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
|
Cost
of Goods Sold
|
79.7 | % | 80.2 | % | 78.3 | % | 85.9 | % | ||||||||
|
Gross
Profit
|
20.3 | % | 19.8 | % | 21.7 | % | 14.1 | % | ||||||||
|
Operating
Expenses
|
||||||||||||||||
|
Selling
expenses
|
7.7 | % | 9.1 | % | 8.6 | % | 12.0 | % | ||||||||
|
General
and administrative expenses
|
7.6 | % | 13.3 | % | 12.5 | % | 22.9 | % | ||||||||
|
Depreciation
and amortization
|
1.4 | % | 1.5 | % | 2.3 | % | 2.6 | % | ||||||||
|
Total
Operating Expenses
|
16.7 | % | 23.9 | % | 23.4 | % | 37.6 | % | ||||||||
|
Income
(Loss) from Operations
|
3.5 | % | -4.1 | % | -1.7 | % | -23.5 | % | ||||||||
|
Other
Income (Expenses)
|
||||||||||||||||
|
Interest
expense
|
0.0 | % | -0.4 | % | -0.1 | % | -0.4 | % | ||||||||
|
Net
Other Expenses (Income)
|
0.0 | % | -0.4 | % | -0.1 | % | -0.4 | % | ||||||||
|
Net
Income (Loss)
|
3.5 | % | -4.5 | % | -1.8 | % | -23.9 | % | ||||||||
QUARTER
ENDED SEPTEMBER 30, 2010 COMPARED TO THE QUARTER ENDED SEPTEMBER 30,
2009
NET
SALES
Net sales
for the quarter ended September 30, 2010 increased to $8,357,672 from
$6,991,372, an increase of $1,366,300 as compared to the same period ended
September 30, 2009. This increase in sales is primarily due to increased demand
and earlier purchasing commitments from North American customers. For the
quarter ended September 30, 2010 sales to international customers decreased by
approximately $1,394,000 as European customers have excess inventory from the
prior year to sell off during the current year. The decrease in
international customer sales was offset by $2,785,000 increase in domestic
customers due to increased demand and earlier purchasing commitments compared to
the same period in the prior year.
GROSS
PROFIT
Our gross
profit for the quarter ended September 30, 2010 increased to $1,692,676 from
$1,383,604 an increase of $309,072 as compared to the same period in the prior
year. This increase is primarily due to the increase in revenue in
the quarter as compared to the same quarter in the prior year. As a
percentage of revenues, our gross profit for the three months ended September
30, 2010 increased to 20.3% from 19.8% for the same period in 2009. The increase
in gross profit as a percentage of revenues was primarily due to the higher mix
of sales to North American customers which typically yields higher profit
margins.
OPERATING
EXPENSES
For the
quarter ended September 30, 2010, total operating expenses decreased to
$1,398,670. This represents a decrease of $270,227 from the same
period’s quarter ended total operating expenses of $1,668,897. This decrease was
primarily due to general administrative expenses associated with expense
reductions implemented by management at the beginning of the current fiscal
year.
General
and administrative expenses decreased $296,320 for the quarter ended September
30, 2010 compared to the quarter ended September 30, 2009. The
decrease was primarily due to an estimated $111,000 decrease in compensation
expense and employee benefits due to reduction in workforce. The
remaining decrease was due to continued management efforts to reduce expenses
commensurate with sales.
14
INCOME
FROM OPERATIONS
Income
from operations increased $579,299 this quarter, to $294,006 for the three
months ended September 30, 2010 compared to a net loss from operations of
$285,293 for the same period ended September 30, 2009. Increased
sales and gross profit accounted for approximately 53% of the improvement in
income from operations while reductions in operating expenses accounted for the
remaining 47%.
OTHER
INCOME/EXPENSES
Our net
other expenses (interest expense) decreased to $2,353 from $27,683 for the same
period a year ago. The decrease in interest expense was primarily due to the
termination of our financing facilities with DBS bank without negotiating any
replacement financing.
INCOME
TAXES
For the
three months ended September 30, 2010 and 2009, the Company did not record a tax
provision because it expects current year-to-date losses and sufficient future
net losses to offset the income for these periods.
NET
INCOME
For the
three months ended September 30, 2010 net income increased to $291,653 compared
to net loss of $312,976 for the same period a year ago. The increase in net
income was primarily due to increased revenue and resulting gross profit
increase combined with management’s continued efforts to reduce administrative
expenses commensurate with sales volume.
SIX
MONTHS ENDED SEPTEMBER 30, 2010 COMPARED TO THE SIX MONTHS ENDED SEPTEMBER 30,
2009
NET
SALES
Net sales
for the six months ended September 30, 2009 increased to $10,449,299 from
$7,805,380, an increase of $2,643,919 as compared to the same period ended
September 30, 2009. This increase in sales is primarily due to
increased demand and earlier purchasing commitments from North American
customers. For the six months ended September 30, 2010 sales to international
customers decreased by approximately $1,394,000 as European customers have
excess inventory from the prior year to sell off during the current year. The
decrease in international customer sales was offset by approximately $4,062,000
increase in domestic customers due to increased demand and earlier purchasing
commitments compared to the same period in the prior year.
GROSS
PROFIT
Our gross
profit for the six months ended September 30, 2010 increased to $2,268,569 from
$1,097,982, an increase of $1,170,587 as compared to the same period in the
prior year primarily due to the increase in revenue for the comparable periods.
As a percentage of revenues, our gross profit for the six months ended September
30, 2010 increased to 21.7% from 14.1% for the same period in 2009. The increase
of gross profit as a percentage of revenues was primarily to the higher mix of
sales to North American customers which typically yields higher profit
margins. There were no one-time charges to cost of goods sold during
the six months ended September 30, 2010 compared to the same period ended
September 30, 2009 where one-time pricing discounts totaling $235,440 for slow
moving and defective product and a one-time charge of $181,142 to adjust certain
Bratz licensed products and musical instruments to lower of cost or market value
were recognized
OPERATING
EXPENSES
For the
six months ended September 30, 2010, total operating expenses decreased to
$2,445,387 from $2,933,044 for the six months ended September 30, 2009, a
decrease of $487,657. This decrease was primarily due to
management’s continued efforts to reduce administrative expenses and improve
operating efficiencies. General and administrative expenses decreased
approximately $481,000 of which wage reductions and associated employee benefits
due to reduction in workforce accounted for approximately $256,000 of the
decrease. The remaining decrease was due to continued
management efforts to reduce administrative expenses commensurate with
sales.
OTHER
INCOME/EXPENSES
Our net
other expenses (interest expense) decreased to $10,989 from $30,951 for the same
period a year ago. The decrease in interest expense was primarily due to the
termination of our financing facilities with DBS bank without negotiating any
replacement financing.
INCOME
TAXES
For the
six months ended September 30, 2010 and 2009, the Company did not record a tax
provision because it had a net operating loss for the six months ended September
30, 2010 and had sufficient net operation loss from previous periods to offset
the income for the six months ended September 30, 2009.
15
NET
LOSS/INCOME
We
incurred a net loss of $187,807 for the six months ended September 30, 2010
compared to a net loss of $1,866,013 for the same period a year ago. The
$1,678,206 decrease in net loss was primarily due to increased revenue and
resulting gross profit increase combined with management’s continued efforts to
reduce administrative expenses commensurate with sales volume. In addition there
were no one-time charges to cost of goods sold during the six months ended
September 30, 2010 compared to the same period ended September 30, 2009 where
one-time pricing discounts totaling $235,440 for slow moving and defective
product and a one-time charge of $181,142 to adjust certain Bratz licensed
products and musical instruments to lower of cost or market value were
recognized
LIQUIDITY AND CAPITAL
RESOURCES
As of
September 30, 2010, Singing Machine had cash on hand of $1,094,647 as compared
to cash on hand of $2,005,386 as of September 30, 2009. We had a working capital
deficit of $1,287,014 as of September 30, 2010.
Net cash
provided by operating activities was $1,934,371 for the six months ended
September 30, 2010, as compared to $2,057,094 used in operating activities the
same period a year ago. The increase in net cash provided was a
result of the following factors: increase in trade accounts payable and an
increase in related party debt offset by increase in inventory required for
fourth quarter shipments and an increase in accounts receivable due to the
increase in sales.
Net cash
used by investing activities for the six months ended September 30, 2010 was $0
as compared to $36,729 used by investing activities for the same period ended a
year ago. This decrease was caused primarily by $0 capital
expenditures for the current fiscal year.
Net cash
used in financing activities was $1,705,501 for the six months ended September
30, 2010, as compared to cash provided by financing activities of $3,142,046 for
the same period ended a year ago. Our facilities with DBS bank were terminated
on June 8, 2010 and we were required to pay off all outstanding balances during
the six month period ending September 30, 2010 accounting for the significant
increase in funds used by investing activities. During the six months
ended September 30, 2009 we made use of available credit facilities from DBS
bank and reduced our reliance on related party and vendor financing during that
period. Since we have not replaced our financing facility we have
relied on related party and vendor financing as well as offering major customers
additional discounts in exchange for reduced payment terms.
As of
September 30, 2010, our unrestricted cash on hand was $1,094,647. Our average
monthly general and administrative expenses are approximately $211,000. We
expect that we will require approximately $1 million for working capital during
the next three-month period.
During
the next 12 month period, we plan on financing our operation needs
by:
|
|
·
|
Raising
additional working capital;
|
|
|
·
|
Collecting
our existing accounts receivable;
|
|
|
·
|
Selling
existing inventory;
|
|
|
·
|
Vendor
financing;
|
|
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·
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Borrowing
from factoring bank;
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·
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Short
term loans from our majority
shareholder;
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·
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Fees
for fulfillment, delivery and returns services from related
parties.
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Our
sources of cash for working capital in the long term, 12 months and beyond are
essentially the same as our sources during the short term. We are actively
seeking additional financing facilities and capital investments to maintain and
grow our business. If we need to obtain additional financing and fail
to do so, it may have a material adverse effect on our ability to meet our
financial obligations and to continue as a going concern.
INVENTORY
SELL THROUGH
We
monitor the inventory levels and sell through activity of our major customers to
properly anticipate returns and maintain the appropriate level of inventory. We
believe that we have proper return reserves to cover potential returns based on
historical return ratios and information available from the
customers.
SEASONAL
AND QUARTERLY RESULTS
Historically,
our operations have been seasonal, with the highest net sales occurring in our
second and third fiscal quarters (reflecting increased orders for equipment and
music merchandise during the Christmas holiday season) and to a lesser extent
the first and fourth quarters of the fiscal year. Sales in our second and third
fiscal quarters, combined, accounted for approximately 89.0% and 92.0% of net
sales in fiscal 2010 and 2009, respectively.
Our
results of operations may also fluctuate from quarter to quarter as a result of
the amount and timing of orders placed and shipped to customers, as well as
other factors. The fulfillment of orders can therefore significantly affect
results of operations on a quarter-to-quarter basis.
We are
currently developing and considering selling products other than those within
the karaoke category during the slow season to fulfill the revenue
shortfall.
16
INFLATION
Inflation
has not had a significant impact on our operations. We generally have
adjusted our prices to track changes in the Consumer Price Index since prices we
charge are generally not fixed by long-term contracts.
OFF-BALANCE
SHEET ARRANGEMENTS
We do not
have any off balance sheet arrangements that are reasonably likely to have a
current or future effect on our financial condition, revenues, results of
operations, liquidity or capital expenditures.
CRITICAL
ACCOUNTING POLICIES
We
prepared our consolidated financial statements in accordance with accounting
principles generally accepted in the United States of America. As such,
management is required to make certain estimates, judgments and assumptions that
it believes are reasonable based on the information available. These estimates
and assumptions affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses for the periods presented. The significant accounting policies which
management believes are the most critical to aid in fully understanding and
evaluating our reported financial results include: accounts receivable allowance
for doubtful accounts, reserves on inventory, deferred tax assets and our Macau
income tax exemption.
COLLECTIBILITY
OF ACCOUNTS RECEIVABLE. Our allowance for doubtful accounts is based on
management's estimates of the creditworthiness of our customers, current
economic conditions and historical information, and, in the opinion of
management, is believed to be an amount sufficient to respond to normal business
conditions. Management sets 100% reserves for customers in bankruptcy and other
reserves based upon historical collection experience. Should business conditions
deteriorate or any major customer default on its obligations to the Company,
this allowance may need to be significantly increased, which would have a
negative impact on operations.
RESERVES
ON INVENTORIES. We establish a reserve on inventory based on the expected net
realizable value of inventory on an item-by-item basis when it is apparent that
the expected realizable value of an inventory item falls below its original
cost. A charge to cost of sales results when the estimated net realizable value
of specific inventory items declines below cost. Management regularly reviews
the Company's investment in inventories for such declines in value.
INCOME
TAXES. Significant management judgment is required in developing our provision
for income taxes, including the determination of foreign tax liabilities,
deferred tax assets and liabilities and any valuation allowances that might be
required against the deferred tax assets. Management evaluates its ability to
realize its deferred tax assets on a quarterly basis and adjusts its valuation
allowance when it believes that it is more likely than not that the asset will
not be realized.
We
operate within multiple taxing jurisdictions and are subject to audit in those
jurisdictions. Because of the complex issues involved, any claims can require an
extended period to resolve. In management's opinion, adequate provisions for
potential income taxes in the jurisdiction have been made.
USE OF OTHER ESTIMATES. We
make other estimates in the ordinary course of business relating to sales
returns and allowances, warranty reserves, and reserves for promotional
incentives. Historically, past changes to these estimates have not had a
material impact on our financial condition. However, circumstances could change
which may alter future expectations.
(a) Evaluation of
Disclosure Controls and Procedures. As of the end of the period covered
by this report, we conducted an evaluation, under the supervision and with the
participation of our chief executive officer and chief financial officer of our
disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule
15d-15(e) of the Exchange Act). Based upon this evaluation, our chief executive
officer and chief financial officer concluded that our disclosure controls and
procedures are effective to ensure that information required to be disclosed by
us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Commission's rules and forms and is accumulated and communicated to the
Company’s management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required
disclosure.
(b) Changes in
Internal Controls. We reported certain material weaknesses in our
internal controls over financial reporting in our annual report on Form 10-K for
the year ended March 31, 2010. The Company is still in the process of
addressing these material weaknesses and will continue to update the Exchange as
to our remediation progress.
17
MGA
Entertainment, Inc. (“MGA”) filed an action against the Company on April 16,
2010 alleging breach of contract, breach of implied covenant of good faith and
fair dealing, and conversion claims relating to two licensing agreements between
the parties entered into on May 10, 2006 and November 21, 2006. The two
licensing agreements involved the manufacture, distribution and marketing of
“Bratz” branded merchandise.
The
Company has responded to the above captioned case and has removed the case to
federal court, case no. CV 10-03761 DOC (RNBX). Based upon legal opinion from
outside Counsel, the Company believes it has defenses to the claims raised by
MGA. However, at the time of this filing, the case is still in early stages of
litigation and the outcome is unknown.
The
Company has also filed a class-action lawsuit on behalf of itself and all
similarly situated licensees against MGA in the Central District Court of
California, case no. CV 10-4536-DOC(RNBX). The Company alleges breach of
contract, failure of consideration for the licensing agreements, and other
claims based on various state and federal laws. Both pending cases between MGA
and SMC were mutually stayed, pending the outcome of the Mattel and MGA
litigation, however on October 26, 2010 the District Court re-opened both cases
sua
sponte.
ITEM
1A. RISK FACTORS
RISKS
ASSOCIATED WITH OUR BUSINESS
CURRENT
LEVELS OF SECURITIES AND FINANCIAL MARKET VOLATILITY ARE
UNPRECEDENTED.
The
capital and credit markets have been experiencing volatility and disruption for
more than 12 months. In recent months, the volatility and disruption has reached
unprecedented levels. In some cases, the markets have produced downward pressure
on stock prices and credit availability for certain issuers. We believe these
credit market disruptions have likely decreased our ability to access debt and
equity financing. If current levels of market disruption and volatility continue
or worsen, there can be no assurance that we will not experience an adverse
effect, which may be material, on our ability to access capital and on our
business, financial condition and results of operations.
RISKS
ASSOCIATED WITH OUR CAPITAL STRUCTURE
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None
We are
not currently in default upon any of our senior securities.
None.
None.
31.1
Certification of Gary Atkinson, Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.*
31.2
Certification of Carol Lau, Interim Chief Financial Officer pursuant
to Rule 13a-14(a) of the Securities Exchange Act of 1934, as
amended.*
32.1
Certifying Statement of the Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act.*
32.2
Certifying Statement of the Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act.*
* Filed
herewith
18
SIGNATURES
Pursuant
to the requirements of the Securities and Exchange Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
THE
SINGING MACHINE COMPANY, INC.
|
Date: November
12, 2010
|
By:
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/s/ Gary Atkinson
|
|
Gary
Atkinson
|
||
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Chief
Executive Officer
|
||
|
/s/ Carol Lau
|
||
|
Carol
Lau
|
||
|
Interim
Chief Financial Officer
|
19