10QSB 1 singingmachine10qsb.txt QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-QSB QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 ----------------- 0 - 24968 --------- Commission File Number THE SINGING MACHINE COMPANY, INC. --------------------------------- (Exact Name of Small Business Issuer as Specified in its Charter) Delaware 95-3795478 -------- ---------- (State of Incorporation ) (IRS Employer I.D. No.) 6601 Lyons Road, Building A-7, Coconut Creek, FL 33073 ------------------------------------------------------ (Address of principal executive offices ) (954) 596-1000 -------------- (Issuer's telephone number, including area code) Check whether the Issuer: (1) filed all reports required to be filed by section 13 or 15(d) of the Exchange Act during the past 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 APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes x No APPLICABLE ONLY TO CORPORATE ISSUERS There were 4,450,520 shares of Common Stock, $.01 par value, issued and outstanding at June 30, 2001. THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY INDEX
Page No. PART I. FINANCIAL INFORMATION -------- Item 1. Financial Statements: Consolidated Balance Sheets - June 30, 2001 (Unaudited) and March 31, 2001........................................................................3 Consolidated Statement of Operations - Three months ended June 30, 2001 and 2000 (Unaudited)....................................................4 Consolidated Statement of Cash Flows - Three months ended June 30, 2001 and 2000 (Unaudited)....................................................5 Notes to Consolidated Financial Statements............................................6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................................................9 PART II. OTHER INFORMATION Item 1. Legal Proceedings.....................................................................17 Item 2. Changes in Securities.................................................................17 Item 3. Defaults Upon Senior Securities.......................................................18 Item 4. Submission of Matters to a Vote of Security Holders...................................18 Item 5. Other Information.....................................................................18 Item 6. Exhibits and Reports on Form 8-K......................................................18 SIGNATURES...........................................................................................18
2 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY PART I - FINANCIAL INFORMATION Item I. Financial Statements THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS ASSETS
June 30, March 31, 2001 2001 ------------ ------------ (unaudited) CURRENT ASSETS: Cash $ 43,381 $ 1,016,221 Accounts Receivable, net of allowance Of $9,812 4,910,520 955,652 Due from Factor 202 933,407 Due from Vendor -- 699,096 Inventories 5,021,893 4,813,461 Interest Receivable -- 7,425 Prepaid Expenses and Other Current Assets 768,576 598,487 ------------ ------------ TOTAL CURRENT ASSETS 10,744,572 9,016,324 PROPERTY AND EQUIPMENT, NET 261,638 263,791 OTHER ASSETS: Deposit for Credit Line 254,362 -- Due from related party 7,692 7,692 Due from officers -- 117,425 Investment in/advances to unconsolidated Subsidiary 383,947 374,730 Reorganization Intangible - net 254,139 277,047 Deferred tax asset 452,673 452,673 ------------ ------------ TOTAL ASSETS $ 12,359,024 $ 10,509,682 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts Payable 1,303,853 821,684 Accrued Expenses 518,384 746,017 Income taxes payable -- 23,320 Loan Payable 335,107 -- Notes Payable -- -- Due to related party 1,073,488 -- ------------ ------------ TOTAL CURRENT LIABILITIES 3,230,832 1,591,021 ------------ ------------ STOCKHOLDERS' EQUITY: Common Stock, $.01 par value; 18,900,000 shares authorized; 4,450,520 shares issued and outstanding 44,505 43,590 Additional Paid In Capital 3,388,316 3,324,779 Deferred Guarantee Fees -- (171,472) Retained Earnings 5,695,371 5,721,764 ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 9,128,193 8,918,661 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 12,359,024 $ 10,509,682 ============ ============
See accompanying notes to consolidated financial statements 3 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended June 30, June 30, 2001 2000 ----------- ----------- NET SALES $ 5,523,734 $ 6,068,591 COST OF SALES 3,662,646 4,549,844 ----------- ----------- GROSS PROFIT 1,861,088 1,518,747 ----------- ----------- SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 1,901,996 1,039,897 ----------- ----------- INCOME (LOSS) FROM OPERATIONS (40,908) 478,850 OTHER INCOME (EXPENSES): Other income 15,865 3,029 Interest expense (3,692) (63,098) Interest income 2,475 24,059 Factoring fees (133) (34,575) ----------- ----------- NET OTHER EXPENSES 14,515 (70,585) ----------- ----------- INCOME (LOSS) BEFORE INCOME TAXES (26,393) 408,265 ----------- ----------- INCOME TAX EXPENSE (BENEFIT) -- -- ----------- ----------- NET INCOME (LOSS) $ (26,393) $ 408,265 =========== =========== EARNINGS (LOSS) PER SHARE Basic $ (0.01) $ 0.10 =========== =========== Diluted $ (0.01) $ 0.09 =========== =========== WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING Basic 4,391,968 4,063,296 Diluted 4,391,968 4,660,680
See accompanying notes to consolidated financial statements. 4 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Ended June 30, June 30, 2001 2000 ----------- ----------- NET CASH USED IN OPERATING ACTIVITIES $(1,793,927) $ (971,334) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and Equipment (30,416) (4,497) Due from factor 933,205 (261,236) Due from officer 117,425 -- Deposit for Credit line (254,362) -- Investment/Advances Unconsolidated Subsidiary (9,217) -- ----------- ----------- Net cash provided by investing activities 756,635 (265,733) ----------- ----------- CASH FLOW FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock & exercise of warrants and options 64,452 400,518 Net proceeds from notes payable -- 599,247 ----------- ----------- Net cash provided by financing activities 64,452 999,765 ----------- ----------- Decrease in cash and cash equivalents (972,840) (237,302) Cash and cash equivalents - beginning of period 1,016,221 378,848 ----------- ----------- CASH AND CASH EQUIVALENTS - END OF PERIOD $ 43,381 $ 141,546 =========== ===========
See accompanying notes to consolidated financial statements. 5 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 (Unaudited) NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS The accompanying consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-QSB and, therefore, omit or condense certain footnotes and other information normally included in financial statements prepared in accordance with generally accepted accounting principles. It is suggested that these consolidated condensed financial statements should be read in conjunction with the Company's financial statements and notes thereto included in the Company's audited financial statements on Form 10-KSB for the fiscal year ended March 31, 2001. The accounting policies followed for interim financial reporting are the same as those disclosed in Note 1 of the Notes to Financial Statements included in the Company's audited financial statements for the fiscal year ended March 31, 2001, which are included in Form 10- KSB. Certain amounts in the June 30, 2000 interim consolidated financial statements have been reclassified to conform to the June 30, 2001 presentation. In the opinion of management, all adjustments which are of a normal recurring nature and considered necessary to present fairly the financial positions, results of operations, and cash flows for all periods presented have been made. The results of operations for the three month period ended June 30, 2001 are not necessarily indicative of the results that may be expected for the entire fiscal year ending March 31, 2002. The accompanying consolidated condensed financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant inter-company balances and transactions have been eliminated. Assets and liabilities of the foreign subsidiary are translated at the rate of exchange in effect at the balance sheet date; income and expenses are translated at the average rates of exchange prevailing during the year. The related translation adjustment is not material. NOTE 2 - INVESTMENT IN AND ADVANCES TO UNCONSOLIDATED SUBSIDIARY In November 2000, the Company closed on an acquisition of 60% of the ordinary voting shares of a Hong Kong toy company for a total purchase price of $170,000. The Company believed that the acquiree had agreed to extend the effective date to June 2001, but a dispute arose and the Company committed to dispose of the entire investment. Accordingly, pursuant to Statement of Financial Accounting Standards No. 94 "Consolidation of All Majority-Owned Subsidiaries," the Company is treating the control of the subsidiary as temporary and has recorded the investment of $170,000 and advances and interest of $213,947 at cost. The Company intends to enter into a contract to sell the 60% interest at the original cost. 6 NOTE 3 - DEPOSIT FOR CREDIT LINE The Company, through its Hong Kong subsidiary, is negotiating with a major international bank for credit facilities. Pursuant to these negotiations, the Company's subsidiary is required to maintain a separate depository account in the amount of $254,362. NOTE 4 - LOANS AND LETTERS OF CREDIT In July 1999, the Company entered into a financing agreement with a financing corporation. The agreement expires in July 2001. The financing corporation opens letters of credits on behalf of the Company to purchase inventory. Under the terms of the agreement, the Company pays a flat fee negotiated based on each letter of credit and the maximum amount of a single letter of credit cannot exceed $1,000,000. At March 31, 2001, the Company has no letters of credit open with the financing corporation. The factor has agreed under a third party agreement to factor receivables related to these letters of credit and pays the financing corporation directly. This agreement was terminated in April 2001. On May 19, 1999, as amended on February 14, 2000, the Company, through its Hong Kong Subsidiary, obtained a credit facility of $500,000 from a Hong Kong subsidiary of a Belgian bank. This facility is a revolving line of credit based upon drawing down a maximum of 15% of the value of export letters of credit lodged with Belgian Bank. There is no expiration date to this agreement, except that Belgian Bank reserves the right to revise the terms and conditions at the Bank's discretion. The cost of this credit facility is the U.S. Dollar prime rate plus 1.25%. Repayment of principal plus interest shall be made upon negotiation of the export letters of credit, but not later than 90-days after the advance. As of March 31, 2001, there was no outstanding balance on this credit facility. On April 26, 2001, the Company executed a Loan and Security Agreement (the "Agreement") with a commercial lender (the "Lender"). The Lender will advance up to 75% of the Company's eligible accounts receivable, plus up to 40% of the eligible inventory, plus up to 40% of the commercial letters of credit opened for the purchase of eligible inventory, less reserves of up to $1,200,000 as defined in the agreement. The outstanding loan limit varies between zero and $10,000,000 depending on the time of year, as stipulated in the Agreement. The Lender will also issue or co-sign for commercial letters of credit up to $2,500,000, which shall reduce the loan limits above. The loans bear interest at the commercial lender's prime rate plus 0.5% and an annual fee equal to 1% of the maximum loan amount or $100,000 is payable. The term of the loan facility expires on April 26, 2004 and is automatically renewable for one-year terms. All amounts under the loan facility are due within 90 days of demand. The loans are secured by a first lien on all present and future assets of the Company except for certain tooling located at a vendor in China. The Agreement contains a financial covenant stipulating a minimum tangible net worth of $6,250,000 with escalations as defined in the Agreement. The outstanding balance at June 30, 2001, was $335,107. 7 NOTE 5 - EXERCISE OF STOCK OPTIONS AND WARRANTS AND MODIFICATION Stock options and warrants were exercised during the first quarter of fiscal year 2002. 91,400 shares of common stock were issued with proceeds to the Company of $64,452. On October 26, 2000, the Company extended the expiration of the Company's Public Warrants to November 10, 2001. All other terms and conditions of the Public Warrants shall remain the same (exercise price, manner of exercise, etc.) NOTE 6 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company has an agreement with FLX (a China manufacturer of consumer electronics products) to produce electronic recording equipment based on the Company's specifications. A former director of the Company, is Chairman of the Board and a principal stockholder of FLX. During the fiscal year ended March 31, 2001, the Company purchased approximately 80% of its equipment from FLX. The amount due to FLX at June 30, 2001 of $1,073,488 is included in the related party payable. The Company believes that all of the foregoing transactions with FLX 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. NOTE 7 - MAJOR CUSTOMERS As a percentage of total revenues, the Company's net sales in the aggregate to its five (5) largest customers during the quarters ended June 30, 2001 and 2000 were approximately 97% and 87%, respectively. For the three months ending June 30, 2001 and 2000, two (2) major retailers accounted for 90% and 48% each of total revenues. Because of the seasonality of the Company's sales, these results may be distorted due to the historically low percentage of overall sales during the Company's first fiscal quarter of each year. NOTE 8 - EARNINGS PER SHARE Basic net income (loss) per common share (Basic EPS) excludes dilution and is computed by dividing net income (loss) available to common stockholder by the weighted-average number of common shares outstanding for the period. Diluted net income per share (Diluted EPS) reflects the potential dilution that could occur if stock options or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. The assumed exercise of common stock equivalents was not utilized for the quarter ended June 30, 2001 since the effect was antidilutive. At June 30, 2001, there were 1,560,800 common stock options and warrants outstanding, which may dilute future earnings per share. NOTE 9 - SEGMENTS The Company operates in one business segment. Sales during the three months June 30, 2001, were all generated in the United States. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ------------------------------------------------- FORWARD-LOOKING STATEMENTS Certain statements contained in this Quarterly Report on Form 10- QSB, including without limitation, statements containing the words "believes," "anticipates," "estimates," "expects," and words of similar import, constitute "forward-looking statements." You should not place undue reliance on these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us described below and elsewhere in this Quarterly Report, and in other documents we file with the Securities and Exchange Commission. 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. GENERAL The Singing Machine Company, Inc. and its wholly owned subsidiary, International (SMC) HK, Ltd.("the "Company," "we" or "us") engages in the production and distribution of karaoke audio software and electronic recording equipment. Our electronic karaoke machines and audio software products are marketed under The Singing Machine(TM) trademark. Our products are sold 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. Our karaoke machines and karaoke software are currently sold in such retail outlets as Best Buy, Toys R Us, Wal-Mart, Target, J.C. Penney and Fingerhut. We had a net loss before estimated income tax of $26,393 for the three month period ended June 30, 2001. Our working capital as of June 30, 2001, was approximately $7,513,740. RESULTS OF OPERATIONS REVENUES For the three month period ended June 30, 2001, revenues were $5,523,734 as compared to $6,068,591 for the three months ended June 30, 2000. This is a decrease of 8% from last year. This decrease is due to a delay in production of four products. These products were due to ship in the middle of June and shipping was rescheduled for the first two weeks of July. These products were shipped on their rescheduled dates in July. GROSS PROFIT Gross profit for the three month period ended June 30, 2001 was $1,861,088 or 34% of sales. This shows an increase over the three months ended June 30, 2000, when the gross profit was 25% of sales. This favorable change in gross profit is due to increased purchasing efficiencies. It is also due to the elimination of manufacturers agency fees which were a part of product cost in prior years. 9 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses were $1,901,996 or 34% of total revenues, and $1,039,897 or 17% of total revenues for the three months ended June 30, 2001 and 2000, respectively. The increase in these expenses is partially due to a final expense for the amortization of guarantee fees. This accelerated amortization of $114,316 is due to the termination of the loan agreement for which the guarantee was made. Approximately, $166,000 of the increase is due to the opening of the Hong Kong office of International SMC (HK) Ltd., our wholly owned subsidiary. By opening this office, the Company saves the manufacturers agency fees which were paid in prior years. The office will have fixed overhead expenses every month, as opposed to per shipment agency fees. Therefore the full benefit of maintaining this office will be seen more clearly in our second and third quarters when, historically, the Company has the greatest amount of purchases from the Orient. Another factor in these increased expenses was payroll and its associated expenses which contributed approximately $250,000. Other increases were seen in royalty and commission expenses. DEPRECIATION AND AMORTIZATION EXPENSES The expense for depreciation and amortization was $41,737 for the three months ended June 30, 2001 as compared to $28,763 for the three months ended June 30, 2000. The increase is due primarily to the fixed asset additions of the last twelve months. These additions consisted of computers, furniture and other equipment in our California warehouse. OTHER EXPENSES Other income and expenses decreased by $85,102 from the three months ended June 30, 2000 to the three months ended June 30, 2001. The primary areas of decrease are interest and factoring fees. The Company terminated the factoring agreement in the first quarter and had no accounts receivable factored at that time. The Company's new loan agreement with LaSalle National Bank was in effect, but nominal borrowing was required in the first quarter which resulted in a limited interest expense. INCOME BEFORE INCOME TAX EXPENSE The Company showed a loss of $26,393 for the three months ended June 30, 2001. This loss can be attributed to the fixed costs associated with the opening the Hong Kong office. It can also be partially attributed to the accelerated amortization of guarantee fees, resulting in an additional expense of $114,316, in the selling, general and administrative expenses. INCOME TAX EXPENSE As a result of showing a net loss for the period, no accrual was made for income tax expense and the change in the deferred tax asset was not material. NET INCOME As there was no income tax expense accrual for the three months ended June 30, 2001, the net loss after taxes remained $26,393 as explained above. 10 SEASONALLY AND QUARTERLY RESULTS Historically, our operations have been seasonal, with the highest net sales occurring in the second and third quarters (reflecting increased orders for equipment and music merchandise during the Christmas selling months) and to a lesser extent the first and fourth quarters of the fiscal year. 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. FINANCIAL CONDITION AND LIQUIDITY At June 30, 2001, we had current assets of $10,744,572 and total assets of $12,359,024 compared to current assets of $9,016,324 and total assets of $10,509,682 at March 31, 2001. This increase in current assets and total assets is primarily due to the increase in accounts receivable for sales in the month of June. Current liabilities increased to $3,230,832 as of June 30, 2001, compared to $1,591,021 at March 31, 2001. This increase in current liabilities is because of increased accounts payable and increased purchases of electronic recording equipment from a related party in the month of June. The use of the credit line was primarily to purchase inventory. Accounts payable increased to $1,303,853 as of June 30, 2001 from $821,684 as of March 31, 2001, primarily as a consequence of our increased expenditures to finance our sales efforts. Our stockholders' equity increased from $8,918,661 as of March 31, 2001, to $9,128,193 as of June 30, 2001 due to the exercise of warrants, write off of deferred guarantee fees and the current quarter loss. Cash flows used for operating activities were $1,793,927 during the three months ended June 30, 2001. Cash provided by investing activities during this same period was $756,635 resulting primarily from receipt of $933,205 invested at the factor, $117,425 repayments from officers and a deposit placed for a credit line of $254,362. Cash flows provided by financing activities were $64,452 during the three month period ended June 30, 2001. This consisted of proceeds in the amount of $64,452 from the exercise of warrants and options. CAPITAL RESOURCES The Company has obtained significant financing for continuing operations and growth. In April 2001, the Company entered into a credit facility with LaSalle Business Credit, Inc., which replaced the Company's pre-existing financing arrangements with Main Factors, Inc. and EPK Financial. The Company also has a credit facility with Belgian Bank, which is not currently in use and the terms of which are being renegotiated. LaSalle Bank The Company entered into a new credit facility with LaSalle Business Credit, Inc. (the "Lender" or "LaSalle") in April 2001. Under this credit facility, the Lender will advance up to 75% of the Company's eligible accounts receivable, plus up to 40% of eligible inventory, plus up to 40% of commercial letters of credit issued/guaranteed by the Lender minus reserves as set out in the loan documents. The agreement is subject to loan limits from zero to $10,000,000 depending on the time of the year, as stipulated in the loan documents. 11 The loan of funds under this agreement bears interest at the lender's prime rate plus .5%. There is also and annual fee of 1% of the loan maximum, or $100,000. The term of the agreement runs through April 26, 2004 and is automatically renewable for one-year terms thereafter. The facility contains a covenant on minimum tangible net worth that the Company must maintain. The loan contains a 90 days repayment on demand in the event of default, and allows for a clean up period every 12 months where the loan amount must go to zero for a period of time. The loan is secured by a first lien on all present and future assets of the Company, except certain tooling located in China. The Company has no present commitment that is likely to result in its liquidity increasing or decreasing in any material way. In addition, the Company knows of no trend, additional demand, event or uncertainty that will result in, or that is reasonably likely to result in, the Company's liquidity increasing or decreasing in any material way. The Company has no material commitments for capital expenditures. The Company knows of no material trends, favorable or unfavorable, in the Company's capital resources. The Company has no additional outstanding credit lines or credit commitments in place and has no additional current need for financial credit. In next few months, the Company may obtain additional credit facilities for its Hong Kong subsidiary, but this will not have a significant impact on its liquidity. Belgian Bank Effective February 14, 2000, the Company, through its Hong Kong subsidiary, obtained a credit facility of $500,000 (US) from Belgian Bank, Hong Kong, a subsidiary of Generale Bank, Belgium. This facility is a revolving line based upon drawing down a maximum of 15% of the value of export letters of credit held by Belgian Bank. There is no maturity date except that Belgian Bank reserves the right to revise the terms and conditions at the Bank's discretion. The cost of this credit facility is the U.S. Dollar prime rate plus 1.25%. Repayment of principal plus interest shall be made upon negotiation of the export letters of credit, but not later than ninety (90) days after the advance. This credit facility is not currently in use and the terms are being renegotiated. Credit Facilities that were Terminated in April 2001 Main Factors The Company was a party to a factoring agreement, dated June 16, 1999, and amended December, 1999 and April, 2000, with Main Factors, Inc. (Main Factors). The Company terminated this arrangement with Main Factors in April 2001, when it entered into a credit facility with LaSalle. Under the factoring agreement, Main Factors purchased certain selected accounts receivable from the Company and advanced 75% - 85% of the face value of those receivables to the Company. The accounts receivable were purchased by Main Factors without recourse and Main Factors therefore performed an intensive credit review prior to the purchase of the receivables. The Company was charged a fixed percentage fee of the invoice, which could decrease on volume. The purchase of receivables of the Company by Main Factors was absolute and was a true sale of receivables. Main Factors has placed no maximum limit on the amount of the Company's receivables it would purchase. John Klecha, the Company's Chief Operating Officer and Chief Financial Officer, personally guaranteed this factoring agreement. 12 EPK Financial Corporation The Company entered into an agreement with EPK Financial Corporation (EPK) whereby EPK would open letters of credit with the Company's factories to import inventory for distribution to the Company's customers. The Company terminated this arrangement with EPK in April 2001, when it entered into a credit facility with LaSalle. During fiscal 2001 and the first quarter of fiscal 2002, the Company did not use its credit facility with EPK. RISK FACTORS Set forth below and elsewhere in this Quarterly Report and in the other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward looking statements contained in this Quarterly Report. Factors That May Affect Future Results and Market Price of Stock Our inability to compete and maintain our niche in the entertainment industry could hurt our business The business in which we are engaged is highly competitive. In addition, we must compete with all the other existing forms of entertainment including, but not limited to, motion pictures, video arcade games, home video games, theme parks, nightclubs, television and prerecorded tapes, CD's and video cassettes. Competition 0in the karaoke industry is based primarily on price, product performance, reputation, delivery times, and customer support. We believe that our new product introductions and enhancements of existing products are material factors for our continuing growth and profitability. Many of our competitors are substantially larger and have significantly greater financial, marketing and operating resources than we have. No assurance can be given that we will continue to be successful in introducing new products or further enhancing existing products. We rely on sales to key customers which subjects us to risk As a percentage of total revenues, our net sales to our five largest customers during the fiscal quarter ended June 30, 2001 and 2000, were approximately 97% and 87% respectively. During fiscal year 2002, we further intend to broaden our base of customers. Although we have long-established relationships with many of our customers, we do not have long-term contractual arrangements with any of them. A decrease in business from any of our major customers could have a material adverse effect on our results of operations and financial condition. We have significant reliance on large retailers which are subject to changes in the economy We sell products to retailers, including department stores, lifestyle merchants, direct mail retailers which are catalogs and showrooms, national chains, specialty in stores, and warehouse clubs. Certain of such retailers have engaged in leveraged buyouts or transactions in which they incurred a significant amount of debt, and some are currently operating under the protection of bankruptcy laws. Despite the difficulties experienced by retailers in recent years, we have not suffered significant credit losses to date. A deterioration in the financial condition of our major customers could have a material adverse effect on our future profitability. 13 We are subject to the risks of doing business abroad We are dependent upon foreign companies for manufacture of all of our electronic products. Our arrangements with manufacturers are subject to the risks of doing business abroad, such as import duties, trade restrictions, work stoppages, foreign currency fluctuations, political instability, and other factors which could have an adverse impact on our business. We believe that the loss of any one or more of our suppliers would not have a long-term material adverse effect on us, because other manufacturers with whom we do business would be able to increase production to fulfill our requirements. However, the loss of certain of our suppliers, could, in the short-term, adversely affect our business until alternative supply arrangements were secured. During fiscal 2001 and 2000, suppliers in the People's Republic of China accounted for in excess of 94% and 88%, respectively of our total product purchases, including virtually all of our hardware purchases. The Company expects purchasing for fiscal 2002 to fall within the above range as well. In 2000, the People's Republic of China gained "Most Favored Nation" treatment for entry of goods into the United States for an additional year. In the context of United States tariff legislation, MFN treatment means that products are subject to favorable duty rates upon entry into the United States. IF MFN status for China is restricted or revoked in the future, our cost of goods purchased from Chinese vendors is likely to increase. A resultant change in suppliers would likely have an adverse effect on our operations and, possibly, earnings, although management believes such adversity would be short-term as a result of its ability to find alternative suppliers. We continue to closely monitor the situation and have determined that the production capabilities in countries outside China, which have MFN status and, therefore, have favorable duty rates, would meet our production needs. It must also be noted that at the present time, China is applying for membership into the World Trade Organization ("WTO"). This application is meeting with great favor from many of the WTO's other members. If this membership is approved, China will no longer require MFN status for US trade. The decision on membership will be submitted to the Ministerial Conference in Doha, Qatar in November of 2001. We have significant future capital needs which are subject to the uncertainty of additional financing We may need to raise significant additional funds to fund our rapid sales growth and/or implement other business strategies. If adequate funds are not available on acceptable terms, or at all, we may be unable to sustain our rapid growth, which would have a material adverse effect on our business, results of operations, and financial condition. We are subject to seasonality which is affected by various economic conditions and changes resulting in fluctuations in quarterly results We have experienced, and will experience in the future, significant fluctuations in sales and operating results from quarter to quarter. This is due largely to the fact that a significant portion of our business is derived from a limited number of relatively large customer orders, the timing of which cannot be predicted. Furthermore, as is typical in the karaoke industry, the quarters ended September 30 and December 31 will include increased revenues from sales made during the holiday season. Additional factors that can cause our sales and operating results to vary significantly from period to period include, among others, the mix of products, fluctuating market demand, price competition, new product introductions by competitors, fluctuations in foreign currency exchange rates, disruptions in delivery of components, political instability, general economic conditions, and the other considerations described in this section entitled "Risk Factors." 14 Accordingly, period-to-period comparisons may not necessarily be meaningful and should not be relied on as indicative of future performance. Historically, the first quarter of our fiscal year, the three months ended June 30, have been the least profitable quarter. Our proprietary technology may not be sufficiently protected Our success depends on our proprietary technology. We rely on a combination of contractual rights, patents, trade secrets, know-how, trademarks, non-disclosure agreements and technical measures to establish and protect our rights. We cannot assure you that we can protect our rights to prevent third parties from using or copying our technology. We may be subject to claims from third parties for unauthorized use of their proprietary technology We believe that we independently developed our technology and that it does not infringe on the proprietary rights or trade secrets of others. However, we cannot assure you that we have not infringed on the technologies of third parties or those third parties will not make infringement violation claims against us. Any infringement claims may have a negative effect on our ability to manufacture our products. Consumer discretionary spending may affect karaoke purchases and is affected by various economic conditions and changes Our business and financial performance may be damaged more than most companies by adverse financial conditions affecting our business or by a general weakening of the economy. Purchases of karaoke audio software and electronic recording equipment are considered discretionary for consumers. Our success will therefore be influenced by a number of economic factors affecting discretionary and consumer spending, such as employment levels, business, interest rates, and taxation rates, all of which are not under our control. Adverse economic changes affecting these factors may restrict consumer spending and thereby adversely affect our growth and profitability. We depend on third party suppliers, and if we cannot obtain supplies as needed, our operations will be severely damaged We rely on third party suppliers to produce the parts and materials we use to manufacture our products. If our suppliers are unable to provide us with the parts and supplies, we will be unable to produce our products. We cannot guarantee that we will be able to purchase the parts we need at reasonable prices or in a timely fashion. If we are unable to purchase the supplies and parts we need to manufacture our products, we will experience severe production problems, which may possibly result in the termination of our operations. Our business operations could be significantly disrupted if we lose members of our management team Our success depends to a significant degree upon the continued contributions of our executive officers, both individually and as a group. Although we have entered into employment contracts with Messrs. Steele and Klecha, the loss of the services of either of these individuals could prevent us from executing our business strategy. See "Management-Directors and Executive Officers" for a listing of our executive officers. Your investment may be diluted If additional funds are raised through the issuance of equity securities, your percentage ownership in our equity will be reduced. Also, you may experience additional dilution in net book value per share, and these equity securities may have rights, preferences, or privileges senior to those of yours. 15 Our ability to manage growth could hurt our business To manage our growth, we must implement systems, and train and manage our employees. We may not be able to implement these action items in a timely manner, or at all. Our inability to manage growth effectively could have a material adverse effect on our business operating results, and financial conditions. There can be no assurance that we will achieve our planned expansion goals, manage our growth effectively, or operate profitably. Risks Associated with our Capital Structure Future sales of our common stock held by current stockholders may depress our stock price As of June 30 2001, there were 4,450,520 shares of our common stock outstanding, of which approximately 1,198,883 were restricted securities as that term is defined by Rule 144 under the Securities Act of 1933. The restricted securities will be eligible for public sale only if registered under the Securities Act or sold in accordance with Rule 144. The market price of our common stock could drop due to the sale of large number of shares of our common stock, such as the shares sold under this prospectus or under Rule 144, or the perception that these sales could occur. We have filed a registration statement on Form S-8 to register the sale of up to 1,229,500 shares of our common stock underlying stock options granted and to be granted under our stock option plan. Additionally, we intend to file a registration statement to register for resale approximately 1.3 million shares of our common stock. These factors could also make it more difficult to raise funds through future offerings of common stock. Adverse Effect on Stock Price from Future Issuances of Additional Shares Our Certificate of Incorporation authorizes the issuance of 18,900,000 million shares of common stock. As of June 30, 2001, we had 4,450,520 shares of common stock issued and outstanding and an aggregate of 1,626,000 outstanding options and warrants and 1,656,000 public warrants. As such, our Board of Directors has the power, without stockholder approval, to issue up to 11,167,480 shares of common stock. Any issuance of additional shares of common stock, whether by us to new stockholders or the exercise of outstanding warrants or options, may result in a reduction of the book value or market price of our outstanding common stock. Issuance of additional shares will reduce the proportionate ownership and voting power of our then existing stockholders. Provisions in our charter documents and Delaware law may make it difficult for a third party to acquire our company and could depress the price of our common stock. Delaware law and our certificate of incorporation and bylaws contain provisions that could delay, defer or prevent a change in control of our company or a change in our management. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors and take other corporate actions. These provisions of our restated certificate of incorporation include: authorizing our board of directors to issue additional preferred stock, limiting the persons who may call special meetings of stockholders, and establishing advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings. 16 We are also subject to certain provisions of Delaware law that could delay, deter or prevent us from entering into an acquisition, including the Delaware General Corporation Law, which prohibits a Delaware corporation from engaging in a business combination with an interested stockholder unless specific conditions are met. The existence of these provisions could limit the price that investors are willing to pay in the future for shares of our common stock and may deprive you of an opportunity to sell your shares at a premium over prevailing prices. 17 PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS The Company is not a party to any material legal proceeding, nor to the knowledge of management, are any legal proceedings threatened against the Company. From time to time, the Company may be involved in litigation relating to claims arising out of operations in the normal course of business. Item 2. CHANGES IN SECURITIES (a) Not Applicable. (b) Not Applicable. (c) During the three month period ended June 30, 2001, six employees exercised stock options issued under our 1994 Amended and Restated Management Stock Option Plan. The employees exercised options to acquire an aggregate of 71,400 shares of our common stock. The names of the option holders, the dates of exercise the number of shares purchased, the exercise price and the proceeds received by the Company are listed below. Date of No. of Exercise Name Exercise Shares Price Proceeds ---- -------- ------ ----- -------- Adolph Nelson 4/30/01 1,500 $.43 $ 645 John Steele 4/30/01 5,000 $.43 $ 2,150 Teresa Marco 5/01/01 5,000 $.43 $ 2,150 Terry Philips 5/01/01 1,500 $.43 $ 645 Brian Cino 5/02/01 3,400 $.43 $ 1,462 John Klecha 5/30/01 50,000 $.43 $21,500 Melody Rawski 6/14/01 5,000 $.43 $ 2,150 Each of these employees paid for the shares with cash. Each of the employees exercised their options in reliance upon Section 4(2) of the Securities Act of 1933, because each of them was knowledgeable, sophisticated and had access to comprehensive information about the Company. The shares issued to our employees were registered under the Securities Act on a registration statement on Form S-8. As such, no restrictive legends were placed on the shares, except a control legend was placed on the shares that were issued to Mr. Klecha. During the three month period ended June 30, 2001, two warrant holders exercised their warrants to acquire an aggregate of 20,000 shares of our common stock. The names of the warrant holders, the dates of exercise the number of shares purchased, the exercise price and the proceeds received by the Company are listed below. 18 Date of No. of Exercise Name Exercise Shares Price Proceeds ---- -------- ------ ----- -------- Entropy Holdings 04/30/01 10,000 $ 2.00 $20,000 FRS Investments 04/30/01 10,000 $ 1.375 $13,750 Each of the warrant holders paid for their shares with cash. Each of these warrant holders exercised their warrants in reliance upon Section 4(2) of the Securities Act of 1933, because each of these holders was knowledgeable, sophisticated and had access to comprehensive information about the Company. The Company placed legends on the certificates stating that the securities were not registered under the Securities Act and set forth the restrictions on their transferability and sale. (d) Not applicable. Item 3. DEFAULTS UPON SENIOR SECURITIES Not applicable Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS Not applicable. Item 5. OTHER INFORMATION None. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Loan and Security Agreement made as of April 26, 2001 between The Singing Machine Company, Inc. and LaSalle Business Credit, Inc. 10.2 $10,000,000 Demand Note executed as of April 26, 2001 by the Singing Machine Company, Inc. 10.3 Trademark Security Agreement made as of April 26, 2001 by The Singing Machine Company, Inc. in favor of LaSalle Business Credit, Inc. for U.S. trademarks. 10.4 Trademark Security Agreement made as of April 26, 2001 by The Singing Machine Company, Inc. in favor of LaSalle Business Credit, Inc. for Canadian trademarks. (b) Reports on Form 8-K The Company did not file any reports on Form 8-K in the three months ended June 30, 2001. 19 SIGNATURES Pursuant to the requirements of the Securities 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. Dated: August 13, 2001 By: /s/ John F. Klecha --------------------------- John F. Klecha President, Chief Financial Officer, Chief Operating Officer, Treasurer and Secretary 20