-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Pdw7ILnl6VtGeuBJoe4me1UZQReK6ZCRgPdXbklDKbzJWHG7BQc9ggT/BwjbMzf/ EBh0ilsAX3rW9Uc6TmqEdw== 0001116502-01-501367.txt : 20020410 0001116502-01-501367.hdr.sgml : 20020410 ACCESSION NUMBER: 0001116502-01-501367 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SINGING MACHINE CO INC CENTRAL INDEX KEY: 0000923601 STANDARD INDUSTRIAL CLASSIFICATION: PHONOGRAPH RECORDS & PRERECORDED AUDIO TAPES & DISKS [3652] IRS NUMBER: 953795478 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-24968 FILM NUMBER: 1786679 BUSINESS ADDRESS: STREET 1: 6601 LYONS ROAD STREET 2: BLDG A-7 CITY: COCONUT CREEK STATE: FL ZIP: 33073 BUSINESS PHONE: 9545961000 MAIL ADDRESS: STREET 1: 6601 LYONS ROAD BLDG CITY: COCONUT CREEK STATE: FL ZIP: 33073 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 September 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 4,747,620 shares of Common Stock, $.01 par value, issued and outstanding at September 30, 2001. THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY INDEX PART I. FINANCIAL INFORMATION Item 1. Financial Statements: Page No. -------- Consolidated Balance Sheets - September 30, 2001 (Unaudited) and March 31, 2001 .............................................. 3 Consolidated Statement of Operations - Three and six months ended September 30, 2001 and 2000 (Unaudited) ................... 4 Consolidated Statement of Cash Flows - Six months ended September 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 ............................. 10 PART II. OTHER INFORMATION Item 1. Legal Proceedings ............................................... 18 Item 2. Changes in Securities ........................................... 18 Item 3. Defaults Upon Senior Securities ................................. 19 Item 4. Submission of Matters to a Vote of Security Holders ............. 19 Item 5. Other Information ............................................... 19 Item 6. Exhibits and Reports on Form 8-K ................................ 19 SIGNATURES ............................................................... 20 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
September 30, March 31, 2001 2001 ------------ ------------ (unaudited) ASSETS CURRENT ASSETS: Cash $ 2,422,768 $ 1,016,221 Accounts Receivable, net of allowance of $9,812 7,241,745 955,652 Due from Factor -- 933,407 Due from Vendor -- 699,096 Inventories 10,194,450 4,813,461 Interest Receivable -- 7,425 Prepaid Expenses and Other Current Assets 1,137,351 598,487 ------------ ------------ TOTAL CURRENT ASSETS 20,996,314 9,023,749 PROPERTY AND EQUIPMENT, NET 296,823 263,791 OTHER ASSETS: Deposit for Credit Line 256,008 -- Due from related party -- 7,692 Due from officers -- 110,000 Investment in/advances to Unconsolidated Subsidiary 268,537 374,730 Reorganization Intangible - net 231,231 277,047 Deferred tax asset 452,673 452,673 ------------ ------------ TOTAL ASSETS $ 22,501,586 $ 10,509,682 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts Payable 3,691,522 821,684 Accrued Expenses 3,985,182 746,017 Income taxes payable -- 23,320 Loan Payable 569,511 -- Notes Payable -- -- Due to related party 2,491,530 -- ------------ ------------ TOTAL CURRENT LIABILITIES 10,737,745 1,591,021 ------------ ------------ STOCKHOLDERS' EQUITY: Preferred Stock, $1.00 par value; 1,000,000 shares authorized, no shares issued and outstanding -- -- Common Stock, Class A, $.01 par value; 100,000 authorized, no shares issued and outstanding -- -- Common Stock, $.01 par value; 18,900,000 shares authorized; 4,747,620 and 4,359,120 shares issued and outstanding, respectively 47,476 43,590 Additional Paid In Capital 3,701,633 3,324,779 Deferred Guarantee Fees -- (171,472) Retained Earnings 8,014,731 5,721,764 ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 11,763,841 8,918,661 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 22,501,586 $ 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 Six Months Ended ------------------------------ ------------------------------ September 30, September 30, September 30, September 30, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ NET SALES $ 15,749,241 $ 11,786,707 $ 21,272,851 $ 17,855,298 COST OF SALES 10,438,974 8,481,626 14,101,529 13,031,470 ------------ ------------ ------------ ------------ GROSS PROFIT 5,310,267 3,305,081 7,171,322 4,823,828 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 3,069,794 1,506,220 4,877,849 2,546,117 ------------ ------------ ------------ ------------ INCOME FROM OPERATIONS 2,240,472 1,798,861 2,293,473 2,277,711 OTHER INCOME (EXPENSES): Other income 125,379 917 143,230 3,946 Interest expense (34,465) (140,094) (134,037) (203,192) Interest income 28 11,156 2,475 35,215 Factoring fees (40) (33,923) (173) (68,498) ------------ ------------ ------------ ------------ NET OTHER EXPENSES 90,902 (161,944) 11,494 (232,529) INCOME BEFORE INCOME TAX EXPENSE 2,331,374 1,636,917 2,304,967 2,045,182 INCOME TAX EXPENSE 6,000 388,848 12,000 388,848 NET INCOME $ 2,325,374 $ 1,248,069 $ 2,292,967 $ 1,656,334 ============ ============ ============ ============ NET INCOME PER COMMON SHARE Basic $ 0.51 $ 0.29 $ 0.51 $ 0.40 ============ ============ ============ ============ Diluted $ 0.44 $ 0.25 $ 0.44 $ 0.33 ============ ============ ============ ============ WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING Basic 4,517,104 4,251,033 4,454,857 4,157,677 Diluted 5,322,815 5,037,428 5,214,841 4,961,589
See accompanying notes to financial statements. 4 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENT OF CASH FLOWS
Six Months Ended -------------------------------- September 30, September 30, 2001 2000 ----------- ----------- NET CASH USED IN OPERATING ACTIVITIES: $ (301,528) $ (853,117) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (101,973) (177,252) Proceeds from factor 933,407 (255,319) Proceeds from Officer 117,425 -- Deposit for Credit line (256,008) -- Investment/Advances in unconsolidated subsidiary 64,973 -- Due from related parties -- 394,706 ----------- ----------- Net cash provided by (used in) investing activities 752,824 (37,865) CASH FLOW FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock & exercise of warrants and options 380,740 409,163 Line of credit net proceeds 569,511 -- Net proceeds from notes payable -- 599,247 ----------- ----------- Net cash provided by financing activities 950,251 1,008,410 ----------- ----------- Increase in cash and cash equivalents 1,406,547 117,428 Cash and cash equivalents - beginning of period 1,016,221 378,848 ----------- ----------- CASH AND CASH EQUIVALENTS - END OF PERIOD $ 2,422,768 $ 496,276
See accompanying notes to consolidated financial statements. 5 THE SINGING MACHINE COMPANY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2001 (Unaudited) NOTE 1 - BASIS OF PRESENTATION The accompanying consolidated financial statements of the Company have been prepared in accordance with the instructions to 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. The Financial Accounting Standards Board has recently issued several new accounting pronouncements which may apply to the Company. Statement No. 133 as amended by Statement No. 137 and 138, "Accounting for Derivative Instruments and Hedging Activities" established accounting and reporting standards for derivative instruments and related contracts and hedging activities. This statement is effective for all fiscal quarters and fiscal years beginning after June 15, 2000. The adoption of this pronouncement did not have a material effect on the Company's financial position, results of operations or liquidity. Statement No. 141 "Business Combinations" ("SFAS 141") establishes revised standards for accounting for business combinations. Specifically, the statement eliminates the pooling method, provides new guidance for recognizing intangible assets arising in a business combination, and calls for disclosure of considerably more information about a business combination. This statement is effective for business combinations initiated on or after July 1, 2001. The adoption of this pronouncement on July 1, 2001 did not have a material effect on the Company's financial position, results of operations or liquidity. Statement No. 142 "Goodwill and Other Intangible Assets" ("SFAS 142") provides new guidance concerning the accounting for the acquisition of intangibles, except those acquired in a business combination, which is subject to SFAS 141, and the manner in which intangibles and goodwill should be accounting for subsequent to their initial recognition. Generally, intangible assets with indefinite lives, and goodwill, are no longer amortized; they are carried at lower of cost or market and subject to annual impairment evaluation, or interim impairment evaluation if an interim triggering event occurs, using a new fair market value method. Intangible assets with finite lives are amortized over those lives, with no stipulated maximum, and an impairment test is performed only when a triggering event occurs. This statement is effective for all fiscal years beginning after December 15, 2001. The Company believes that the future implementation of SFAS 142 on April 1, 2002 will not have a material effect on the Company's financial position, results of operations or liquidity. Statement No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" supercedes Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121"). Though it retains the basic requirements of SFAS 121 regarding when and how to measure an impairment loss, SFAS 144 provides additional implementation guidance. SFAS 144 excludes goodwill and intangibles not being amortized among other exclusions. SFAS 144 also supercedes the provisions of APB 30, "Reporting the Results of Operations", pertaining to discontinued operations. Separate reporting of a discontinued operation is still required, but SFAS 144 expands the presentation to include a component of an entity, rather than strictly a business segment as defined in SFAS 131, Disclosures about Segments of an Enterprise and Related Information. SFAS 144 also eliminates the current exemption to consolidation when control over a subsidiary is likely to be temporary. This statement is effective for all fiscal years beginning after December 15, 2001. The Company believes that the future implementation of SFAS 144 on April 1, 2002 will 6 not have a material effect on the Company's financial position, results of operations or liquidity. Certain amounts in the September 30, 2000 interim consolidated financial statements have been reclassified to conform to the September 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 six month period ended September 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 completed a contract selling the 60% interest on September 11, 2001. The transaction resulted in a net loss on investment of $48,912. The purchaser took over operation of the company on September 12, 2001. Payment of the remaining contract price, $90,002, will take place over a four month period of time ending December 31, 2001. The advances and interest remaining at September 30, 2001, in the amount of $ 171,821, will be paid in full over a ten month period and will accrue additional interest over that time. The additional amount due of $6,714 was added after the transaction. 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 $256,008. NOTE 4 - LOANS AND LETTERS OF CREDIT In July 1999, the Company entered into a financing agreement with a financing corporation. The agreement expired 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. 7 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 September 30, 2001, was $569,511. NOTE 5 - EQUITY Stock options and warrants were exercised during the second quarter of fiscal year 2002. 297,100 shares of common stock were issued with proceeds to the Company of $316,288. The total of Stock options and warrants exercised for the six month period ended September 30, 2001 were 388,500 shares with a total proceeds to the Company of $380,740. On August 15, 2001, the directors of the Company were each issued 10,000 common stock options (50,000 options total) at the then current stock price of $6.35. Pursuant to APB no. 25, no compensation expense will be recognized. 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 Company anticipates the purchase level to remain close to this number for fiscal year 2002. The amount due to FLX at September 30, 2001 of $2,491,530 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. 8 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 September 30, 2001 and 2000 were approximately 94% and 76%, respectively. For the six months ending September 30, 2001 and 2000, two (2) major retailers accounted for 79% and 32% 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 50,000 common stock options and 1,656,000 public warrants for the three and six months ended September 30, 2001 were not utilized since the effect was antidilutive; however, those common stock options and public warrants outstanding may dilute future earnings per share. NOTE 9 - SEGMENTS The Company operates in one business segment. Sales during the three months and six months September 30, 2001, were all generated in the United States. 9 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((R)) 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, Target, J.C. Penney and Fingerhut. We had a net profit before estimated income tax of $2,304,967 for the six month period ended September 30, 2001. Our working capital as of September 30, 2001, was approximately $10,258,569. RESULTS OF OPERATIONS REVENUES Revenues for the three months ended September 30, 2001 (the "second quarter") were $15,749,241, an increase of 33% over the second quarter of fiscal 2001. Revenues for the six months ended September 30, 2001 were $21,272,851, an increase of 19% over the first six months of fiscal 2001. The revenue growth was driven by the addition of new products to the Company's core product line. GROSS PROFIT Gross profit for the three month period ended September 30, 2001 was $5,310,267 or 34% of sales compared with $3,305,081 or 28% of sales for the second quarter of the prior year. Gross profit for the six months ended September 30, 2001 and 2000 were $7,171,322, or 33.7% of revenues and $4,823,828, or 27% of revenues, respectively. This favorable increase in the Company's gross profit margin is due to increased purchasing efficiencies and to the increased sale of music products which have higher profit margins than some of our electronic products. It is also due to the elimination of manufacturers agency fees which were a part of product cost in prior years and a different mix of products 10 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses ("SG&A") were $3,069,794 or 20% of total revenues, in the second quarter, up from $1,506,220 or 13% of total revenues, in the second quarter of the prior year. For the six months ended September 30, 2001, SG&A were $4,877,849 or 23% of total revenues, up from $2,546,117 or 14% of total revenues for the six months ended September 30, 2000. The increase in SG&A expenses is primarily due to costs associated with: (1) with opening the Company's Hong Kong office, (2) the Company's first advertising campaign, (3) the amortization of certain guarantee fees and (4) certain expenses associated with increased sales. In December 2000, the Company's wholly-owned subsidiary, International SMC (HK) Ltd. opened a Hong Kong office and incurred SG&A expenses of approximately $283,182. By opening this office, the Company saves the manufacturers agency fees which were paid in prior years. The Hong Kong office has fixed overhead expenses every month, as opposed to per shipment agency fees. The benefit can be seen in the second quarter and will continue to be seen in the third quarter when, historically, the Company has the greatest amount of purchases from the Orient. For the first time in its history, the Company has embarked on a formal advertising campaign, which will use print advertising, radio spots, sponsorships, promotions and other media. The cost of advertising during the second quarter was approximately $470,000. The Company's SG&A expenses also increased by $114,316 due to the accelerated amortization of certain deferred guarantee fees in the first quarter when the loan agreements for which the guarantees were made were terminated. Another factor in these increased SG&A expenses was payroll and its associated expenses which contributed approximately $354,000 in expenses. Other increases in SG&A expenses were variable expenses which are directly related to the increase in sales. These variable expenses include royalty expense, commission expense and warehouse expenses. DEPRECIATION AND AMORTIZATION EXPENSES The Company's depreciation and amortization expenses were $148,684 or .9 % of total revenues in the second quarter, up from $30,449 or .2% in the second quarter of the prior year. For the six months ended September 30, 2001, the Company's depreciation and amortization expenses were $215,123, or 1% of total revenues, up from $59,213, or .3% of total revenues, for the six months ended September 30, 2000. The increase in depreciation and amortization expenses can be attributed to the Company's acquisition of new fixed assets during the last twelve months, which included computers, furniture and other equipment in all of the Company's locations in Florida, California and Hong Kong. The amortization expense also includes the amortization of a fee paid to LaSalle Bank for our line of credit facility. OTHER INCOME AND EXPENSES Other income was $90,902 for the second quarter of fiscal 2002 compared with net expenses of $161,944 for the second quarter of the prior year. Other income was $11,494 for the six months ended September 30, 2001 compared with net expenses of $232,529 for the six months ended September 30, 2000. The Company has begun to generate positive income from these miscellaneous items because it has had a decrease in factoring fees and interest expense. The Company no longer has to pay factoring fees because it terminated its factoring agreement in the first quarter of 2002, when it entered into its credit facility with LaSalle National Bank. Furthermore, the Company has had limited interest expense during the first six months because it has made nominal borrowing under its credit facility with LaSalle. The Company has also begun to generate income from royalty payments received in Hong Kong for the use of Company owned molds by other parties. 11 INCOME BEFORE INCOME TAX EXPENSE The Company's net income before income taxes increased 42.4% to $2,331,374 for the second quarter compared with $1,636,917 for the second quarter of the previous year. The Company's net income before income taxes increased 12.7% to $2,304,967 for the six month ended September 30, 2001 compared with $2,045,182 for the six months ended September 30, 2000. This increase in profit is due primarily to the increase in sales. INCOME TAX EXPENSE The Company files separate tax returns for the parent and for the Hong Kong Subsidiary. During the second quarter of fiscal 2002, the Company showed a loss in the U.S. parent company, and a profit in International SMC (HK) Ltd., its wholly-owned Hong Kong subsidiary. As a result of this, the accrual for income tax included only an estimate for alternative minimum tax. No additional tax is estimated to be owed and the change in the deferred tax asset was not material. The Company's Hong Kong subsidiary has applied for a Hong Kong "offshore claim" income tax exemption based on the locality of the profits of the Hong Kong subsidiary. Management believes that since the source of all profits of the Hong Kong subsidiary are from customers outside of Hong Kong it is likely the exemption will be approved. Accordingly, no provision for income taxes on the profits of the Hong Kong subsidiary have been provided in the accompanying consolidated financial statements. In the event the exemption is not approved, the Hong Kong subsidiary profits will be taxed at a flat rate of 16% resulting in an estimated income tax expense for the six months ended September 30, 2001 of approximately $568,000. NET INCOME As a result of the foregoing, the Company's net income increased 86.3% to $2,325,374 for the second quarter compared with $1,248,069 for the second quarter of the prior year. The Company's net income increased 38.4% to $2,292,967 for the six months ended September 30, 2001 compared with $1,656,334 for the six months ended September 30, 2000. SEASONALLY AND QUARTERLY RESULTS Historically, the Company's 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. The Company's results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of orders placed and shipped to customers, as well as other factors. The fulfillment of orders can therefore significantly affect results of operations on a quarter-to-quarter basis. FINANCIAL CONDITION AND LIQUIDITY At September 30, 2001, the Company had current assets of $20,996,314 and total assets of $22,501,586 compared to current assets of $9,023,749 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 September, as well as an increase in inventory for future shipments. Current liabilities increased to $10,737,745 as of September 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 September. The use of the credit line was primarily to purchase inventory. Accounts payable increased to $3,691,522 as of September 30, 2001 from $821,684 as of March 31, 2001, 12 primarily as a consequence of the Company's increased expenditures to finance its sales efforts. The Company's stockholders' equity increased from $8,918,661 as of March 31, 2001, to $11,763,841 as of September 30, 2001 due to the exercise of warrants, the write off of deferred guarantee fees and the current quarter net income. Cash flows used for operating activities were $301,528 during the six months ended September 30, 2001. This amount was primarily the result of increases in accounts receivable, inventory, accounts payable and accrued expenses. These increases are a direct result of the increased volume of sales for the period. Cash provided by investing activities during this same period was $757,824 resulting primarily from receipt of $933,407 previously invested with the Company's factor. Other factors included in this increase included $117,425 received from payments from our officers . Cash used for investing activities consisted of property and equipment in the amount of $101,973 and a $256,008 deposit placed for a credit line. Cash flows provided by financing activities were $950,251 during the six month period ended September 30, 2001. This consisted of proceeds from the exercise of warrants and options and the net amount of borrowing on the line of credit at LaSalle Bank. 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. 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. 13 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. 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 in 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 six months ended September 30, 2001 and 2000, were approximately 94% and 76% 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 14 deterioration in the financial condition of our major customers could have a material adverse effect on our future profitability. 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 ("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 November 2001, the People's Republic of China was admitted to the World Trade Organization ("WTO"), which should help facilitate our business operations in China. However, if the People's Republic of China's membership in the WTO is revoked, restricted or suspended in any way, 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 production capabilities in countries outside China, which have Most Favored Nation status or membership in the WTO, and therefore, have favorable duty rates would meet our production needs. 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." Accordingly, period-to-period comparisons may not necessarily be meaningful and should not be relied on as indicative of future performance. Historically, the first and fourth quarters of our fiscal year have been the least profitable quarter and the second and third have been the most profitable. 15 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, copyrights or trade secrets We believe that we independently developed the technology used in our electronic and audio software products and that it does not infringe on the proprietary rights, copyrights or trade secrets of others. However, we cannot assure you that we have not infringed on the proprietary rights of third parties or those third parties will not make infringement violation claims against us. Any infringement claims may have a negative effect on our ability to manufacture our products. We may be infringing upon the copyrights of third parties Each song in our catalog is licensed to us for specific uses. Because of the numerous variations in each of our licenses for copyrighted music, there can be no assurance that we have complied with scope of each of our licenses. Additionally, third parties over whom we exercise no control may use our sound recordings in such a way that is contrary to our license agreement and by violating our license agreement we may be liable for contributory copyright infringement. Any infringement claims may have a negative effect on our ability to sell 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 Edward Steele, our Chief Executive Officer and John Klecha, our President, Chief Operating Officer, Chief Financial Officer, Treasurer and Secretary, and the loss of the services of either of these individuals could prevent us from executing our business strategy. 16 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. 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 September 30 2001, there were 4,747,620 shares of our common stock outstanding,. We have filed two registration statements to register an aggregate of 3,194,823 shares of our common stock ( a registration statement on Form S-3 to register the resale of 1,965,323 shares or our common stock and a registration statement on Form S-8 to register the sale of 1,229,500 shares underlying options granted under our 1994 Stock Option Plan). We also intend to file a registration statement on Form S-8 to register 1,300,000 shares of our common stock underlying options granted under our Year 2001 Stock Option Plan. The market price of our common stock could drop due to the sale of large number of shares of our common stock, such as the shares sold pursuant to the registration statements or under Rule 144, or the perception that these sales could occur. 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 September 30, 2001, we had 4,747,620 shares of common stock issued and outstanding and an aggregate of 1,308,900 outstanding options and warrants. As such, our Board of Directors has the power, without stockholder approval, to issue up to 12,843,488 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. 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 September 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 184,800 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 ---------- ----------- --------- ---------- ----------- Terry Phillips 7/11/01 1,500 $ .43 $ 645 April Green 7/11/01 100 $1.66 $ 166 Brian Cino 7/15//01 800 $ .43 $ 344 April Green 7/11/01 200 $1.66 $ 332 John Steele 7/24/01 10,000 $ .43 $16,600 Josef Bauer 8/16/01 10,000 $3.06 $30,600 April Green 8/16/01 200 $1.66 $ 332 Edward Steele 9/28/01 175,000 $ .43 $75,250 Edward Steele 9/28/01 5,000 $3.06 $15,300 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. Bauer and Mr. Edward Steele. During the three month period ended September 30, 2001, three warrant holders exercised their warrants to acquire an aggregate of 94,000 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. Date of No. of Exercise Name Exercise Shares Price Proceeds ---------- ----------- --------- ---------- ---------- Itamar Zac Jones 7/15/01 4,000 $ 2.00 $ 8,000 Josef Bauer 8/16/01 10,000 $ 2.00 $20,000 Josef Bauer 8/16/01 25,000 $ 3.25 $81,250 Josef Bauer 8/16/01 50,000 $ 1.00 $50,000 Maureen LaRoche 8/16/01 5,000 $ 3.25 $16,250 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 18 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. We have registered these shares for resale on a registration statement on Form S-3. On August 15, 2001, the Company issued an aggregate of 50,000 options to its directors pursuant to an annual grant of options to persons who had served on the Board during the previous year. Each of the following directors received 10,000 options: Eddie Steele, John Klecha, Josef Bauer, Howard Moore and Robert Weinberg . The exercise price of the options is $6.35 per share and the options expire on August 14, 2006. The options are exercisable immediately. We issued these options to our directors in reliance upon Section 4(2) of the Securities Act, because our directors are knowledgeable, sophisticated and have access to comprehensive information about the Company. (d) Not applicable. Item 3. DEFAULTS UPON SENIOR SECURITIES Not applicable Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS On August 16, 2001, the Company held its Annual Meeting of Stockholders. The stockholders of record at July 12, 2001 were provided with a Proxy Statement pursuant to Section 14(a) of the Securities Exchange Act of 1934 as filed July 10, 2001. This Proxy statement detailed four proposals which were brought to vote at the August 16 meeting. The outcome of these proposals as well as details of each vote follows. Proposal 1 - Election of Directors. The following five directors were elected to serve until the next Annual Meeting of Shareholders and until their successors shall be elected and qualified: Broker For Against Withheld Abstentions Non-Votes --- ------- -------- ----------- ---------- Edward Steele 3,803,510 0 3,070 0 552,540 John Klecha 3,803,510 0 3,070 0 552,540 Josef Bauer 3,803,510 0 3,004 0 552,606 Howard Moore 3,803,510 0 3,004 0 552,606 Robert Weinberg 3,803,510 0 3,004 0 552,606 Proposal 2 - To approve the year 2001 Stock Option Plan: Broker For Against Withheld Abstentions Non-Votes --- ------- -------- ----------- ---------- 2,414,541 92,549 3,490 848,192 Proposal 3 - To approve the Company's Cash Bonus Performance Plan: Broker For Against Withheld Abstentions Non-Votes --- ------- -------- ----------- ---------- 2,296,275 210,279 0 4,026 961,992 Proposal 4 - To ratify the selection of Salberg & Company, P.A., as the Company's independent certified public accountants for the fiscal year end March 31, 2002: Broker For Against Withheld Abstentions Non-Votes --- ------- -------- ----------- ---------- 3,813,010 1,290 0 2,280 542,540 19 Item 5. OTHER INFORMATION The Company's wholly-owned subsidiary, International SMC (HK) Ltd. sold 600,000 shares or 60% of the issued and outstanding shares of Toy Concepts International Limited, a Hong Kong company, to Kingsky Technology Limited, a Hong Kong company, effective as of September 12, 2001. The sale was not a material disposition, and did not require that the Company file a Form 8-K. The sales price for the Toy Concept's shares was $120,003, with $30,000 received on September 30, 2001 and the balance of the purchase price being paid in full by December 30, 2001. Over the past year, the Company had advanced an aggregate of approximately $200,000 to Toy Concepts, which it has agreed to repay, along with accrued interest, pursuant to a payment schedule ending on June 30, 2002. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 2.1 Stock Purchase Agreement dated September 11, 2001 between International SMC (HK) Limited, as the vendor, and Kingsky Technology Limited, as the purchaser. (b) Reports on Form 8-K The Company did not file any reports on Form 8-K in the three months ended September 30, 2001. 20 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: November 13, 2001 By: /s/ John F. Klecha ------------------------------------------- John F. Klecha President, Chief Financial Officer, Chief Operating Officer, Treasurer and Secretary (Principal Financial and Accounting Officer) 21 EX-2.1 3 ex2-1.txt STOCK PURCHASE AGRREEMENT DATED SEPT. 11 ,2001 EXHIBIT 2.1 Dated the 11th day of September 2001 ******************************** AGREEMENT ******************************** Messrs. Quan & Co., Solicitors, 1601-2, 16th Floor, Hang Shing Building, 363-373 Nathan Road, Kowloon, Hong Kong Ref.: 0816/01/DQ THIS AGREEMENT is made the 11th day of September, 2001 BETWEEN (1) The person whose name and address are set out in the 1st Schedule hereto (hereinafter called "the Vendor"); (2) The person whose name and address are set out in the 1st Schedule hereto (hereinafter called "the Purchaser"); and (3) All those persons who respective names and addresses are set out in the 1st Schedule hereto (hereinafter collectively called "the Purchaser Guarantors"). WHEREAS: - (A) TOY CONCEPTS INTERNATIONAL LIMITED (hereinafter called "the Company") is incorporated in Hong Kong (Certificate of Incorporation No.441231) as a private company limited by shares with an authorized capital of HK$1,000,000.00 divided into 1,000,000 shares of HK$1.00 each, of which 1,000,000 shares have been issued and fully paid up as at the date hereof. (B) The Vendor is the registered holder of the number of shares in the Company as are set out opposite its name in the Ist Schedule which is attached hereto (hereinafter called "the Sale Shares"). (C) The Vendor has agreed to sell and the Purchaser has agreed to purchase the Sale Shares on the terms and conditions hereinafter mentioned. NOW IT IS HEREBY AGREED as follows: - 1. Subject to the terms of this Agreement, the Vendor will sell and the Purchaser will purchase the Sale Shares for a consideration of HONG KONG DOLLARS NINE HUNDRED AND THIRTY SIX THOUSAND ONLY (HK$936,000.00) together with all rights attached or accruing thereto as at the date of completion and the said consideration shall be paid by the Purchaser to the Vendor in the following manner: - (i) a cashier order in the sum of HK$234,000.00 drawn in favor of the Vendor shall be delivered to T.S. Tong & Co., Solicitors for the Vendor (hereinafter called "the Vendor's Solicitors") as deposit upon the signing of this Agreement; and (ii) the balance of the said consideration for the Sale Shares being HK$702,000.00 shall be paid to the Vendor by four installments by way of four post-dated cheques drawn in favour of the Vendor and particulars of the said post-dated cheques are set out in the 2nd Schedule attached hereto. 2. Notwithstanding the aforesaid, the Purchaser agrees to deliver the four post-dated cheques as mentioned in Clause I above to the Vendor's Solicitors upon Completion. Besides, the Purchaser agrees that if the Purchaser should make default in the payment of any of the said four installments or any part thereof on the due date, the remaining balance of the unpaid consideration shall immediately become due and payable and the Vendor shall have the right to commence legal proceedings to recover the said remaining balance of the unpaid consideration and other damages, if any, without notice. 3. (a) Completion of the sale and purchase of the Sale Shares (hereinafter called "Completion") shall take place on 12th September 2001 ("Completion Date") at a place to be designated by the Vendor, or at such date or place as may be mutually agreed by the parties hereto when the following business will be simultaneously transacted: - (i) The Vendor shall deliver to the Purchaser or Messrs. Quan & Co., the Purchaser's solicitors (hereinafter called the "Purchaser's Solicitors") the following: - (1) instrument of transfer and contract notes in favour of the Purchaser and/or its nominee in respect of the Sale Shares all duly executed by the Vendor; (2) original share certificate in respect of the Sale Shares. (3) written resignations of Edward STEELE, John KLECHA and Maria Alice HASKAMP CARQUEJA as directors of the Company with immediate effect with acknowledgment that they have no claim or right of action against the Company for compensation for loss of office termination of employment or otherwise; (4) duly signed written resolutions of the Company to the following effect: - (aa) approving the transfer of the Sale Shares to the Purchaser and/or its nominees and the registration of the appropriate share transfer subject to the same being duty stamped; and (bb) appointing three persons as may be nominated by the Purchaser as directors and approving the resignations of the said Edward STEELE, John KLECHA and Maria Alice HASKAMP CARQUEJA as directors of the Company. (5) written instructions to the bankers of the Company to change authorized signatories of the Company's bank accounts, if any, and (6) all the documents as set out in the 4th Schedule hereto. 4. (a) The Purchaser hereby acknowledges that the Vendor has advanced a sum of HK$1,560,000.00 to the Company and the Purchaser agrees to repay the said sum to the Vendor and the accrued interest by eleven installments by way of eleven post-dated cheques drawn in favour of the Vendor as set out in the 3rd Schedule which is attached hereto. (b) The Purchaser agrees to deliver the eleven post-dated cheques as mentioned in Clause 4(a) above to the Vendor's Solicitors upon Completion. Besides, the Purchaser agrees that if the Purchaser should make default in the payment of any of the said eleven installments or any part thereof on the due date, the remaining balance of the unpaid sum(s) and the unpaid accrued interest shall immediately become due and payable and the Vendor shall have the right to commence legal proceedings to recover the said balance of the unpaid sum(s) and the unpaid accrued interest and other damages, if any, without notice. 5. The Vendor warrants and undertakes to the Purchaser that the following matters are true and accurate s at the date hereof and will remain true and accurate as at Completion:- (a) The Sale Shares constitute 6/10 of the issued share capital of the Company and there is no option, pre- emption rights or other rights to acquire, and no mortgage, charge, pledge, lien or other form of security or encumbrance on, over or affecting the Sale Shares or any of them or any of the unissued share capital of the Company (if any) and there is no agreement or commitment to give or create any of the foregoing, and no claims have been made by any person entitled or claiming to be entitled to any of the foregoing, and the Vendor is the legitimate rightful and lawful owner of the Sale Shares and is entitled to sell and transfer the Sale Shares and pass the full legal and beneficial ownership thereof to the Purchaser without encumbrances or charges on the term set out in this Agreement. (b) All the information given in the recitals hereto is true and correct in all respects. 6. (a) The Vendor hereby agrees that upon the compliance with all the terms of this Agreement by the Purchaser, the Purchaser shall be entitled to all the money receivable of contracts/sales orders made prior to the 12th September 2001 and the Vendor shall not make any claim arising therefrom. and the Purchaser shall also be entitled to all money which are in the Company's bank account(s) as at the 12th September 2001. (b) The Vendor undertakes with the Purchaser that its will hold the Purchaser fully, and effectively indemnified and at all time keep it fully and effectively indemnified by payment in cash on demand in respect of any depletion in or reduction in value of the assets of or any increase in the liabilities of or deprivation of any taxation or other relief by the Company occasioned by or resulting from a breach of any of the warranties, representations and undertakings contained in this Agreement. (c) The liability of the Vendor in respect of any breach of the warranties and any terms and conditions of this Agreement shall be limited as provided in the following sub-clauses of this Clause:- (i) The Vendor shall be under no liability in respect of a breach of any, of the warranties or any terms and conditions of this Agreements unless it shall have received written notice from the Purchaser prior to the lst anniversary of the date of this Agreement giving details of the relevant claim and any such claim shall (if not previously satisfied, settled or withdrawn) be deemed to have been waived or withdrawn at the expiration of one month after the Ist anniversary of the date of this Agreement unless proceedings in respect thereof shall then already have been commenced against the Vendor. (ii) The aggregate liability of the Vendor in respect of any claim for breach of any of the warranties or any terms and conditions of this Agreement shall be limited to the consideration as referred to in Clause 1 above actually received by the Vendor hereunder. 7. (a) Each of the Purchaser Guarantors hereby guarantees, unconditionally and irrevocably as primary obligor, to the Vendor the due observance and performance by the Purchaser of all the agreements, obligations, commitments and undertakings contained in this Agreement ("Purchaser's Guaranteed Obligations") on the part of the Purchaser to be observed and performed and each of the Purchaser Guarantors undertakes and agrees that he will indemnify the Vendor and keep the Vendor fully indemnified on a full indemnity basis in respect of all losses, costs, expenses and damage whatsoever which may be sustained by the Vendor by reason of or in consequence of any failure of the Purchaser to carry out any such Purchaser's Guaranteed Obligations. (b) The guarantee and indemnity provided by each of the Purchaser Guarantors in this Clause 7 shall be a continuing guarantee and indemnity and shall cover all Purchaser's Guaranteed Obligations notwithstanding the liquidation, incapacity or any change in the constitution of the Purchaser or any settlement of account or variation or modification of this Agreement or any indulgence or waiver given by any party hereto or other matter whatsoever until the last claim whatsoever by the Vendor against the Purchaser has been satisfied in full, (c) Should any Purchaser's Guaranteed Obligations, which if valid or enforceable would be the subject of the guarantee and indemnity in this Clause 7, be or become wholly or in part invalid or unenforceable against the Purchaser by reason of any defect in or insufficiency or want of powers of the Purchaser or irregular or improper purported exercise thereof or breach or want of authority by any person purporting to act on behalf of the Purchaser or because any of the rights have become barred by reason of any legal limitation, disability, incapacity or any other fact or circumstance whether or not always known to the Vendor, each of the Purchaser Guarantors shall nevertheless be liable to the Vendor notwithstanding the avoidance or invalidity of any term or condition of this Agreement whatsoever including (without limitation) avoidance under any enactment relating to liquidation in respect of that Purchaser's Guaranteed Obligations as if the same were wholly valid and enforceable. (d) The guarantee and indemnity provided by each of he Purchaser Guarantors in this Clause 7 may be enforced against him by the Vendor at any time without first instituting legal proceedings against the Purchaser in the first instance or joining in the Purchaser as a party or parties in the same proceedings against him. (e) The obligations and liability of the Purchaser Guatantors under this Agreement shall be joint and several. 8. Notwithstanding anything contained in this Agreement to the contrary, the Purchaser's obligations and the obligations of the Purchaser Guarantors under this Agreement shall survive Completion and shall continue thereafter in full force and effect until all such obligations have been fulfilled. 9. As from the date of this Agreement up to the date of completion, if there is any event which results or may result in the Vendor failing or incapable to fulfill any of the representations or warranties contained herein the Vendor must immediately inform the Purchaser of the same. 10. None of the parties hereto shall prior to the date of completion divulge to any third parties (except to their respective professional advisers) any information regarding the existence or subject matter of this Agreement without the prior written agreement of the other parties such agreement not to be unreasonably withheld. 11. If either party hereto shall desire to give to or serve on the other party and/or the Directors and/or the legal personal representatives of any such person any notice claim or demand hereunder or in connection therewith, the same shall be sufficiently given or served if sent by post to him at his address stated herein or last known to the party giving the notice claim or demand. 12. Each party shall, be liable to pay their own legal cost in the preparation approval and execution of this Agreement. 13. (a) The stamp duty payable on the bought and sold notes and instruments of transfer executed in respect of the Sale Shares shall be borne by the Purchaser. (b) In the event that the Stamp Office requires any document(s), account(s) and/or balance sheet(s) of the Company for the purpose of assessing the amount of stamp duty payable, the expenses of arranging for the production of such document(s), account(s) and/or balance sheet(s) shall be borne by the Purchaser. 14. This Agreement is governed by and construed in accordance with the laws of Hong Kong and each of the parties hereto agree to submit to the non-exclusive jurisdiction of the courts of Hong Kong as regards any claim or matter arising under this Agreement. IN WITNESS whereof the parties hereto have executed this Agreement on the day and year first above written. THE 1st SCHEDULE ABOVE REFERRED TO Name of Vendor Address Number of Sale Shares - -------------- ------- --------------------- INTERNATIONAL SMC 1, Unit 6, Mirror Tower, 600,000 (HK) LIMITED 61 Mody Road, Kowloon. Hong Kong Name of Purchaser Address Number of Sale Shares - ---------------- ------- --------------------- KINGSKY 721 Peninsula Centre, 600,000 TECHNOLOGY LIMITED 67 Mody Road, Kowloon, Hong Kong Name of Purchaser Guarantor Nationality Passport No. Address - --------------------------- ----------- ----------- ------- (1) WU Sheng-SHI Taiwan M14536552 5&6 floor, 83 Shi- Ning North Road, Taipei (2) Gerald PENN U.S.A. 11033228 1361 Broadway Shi-B31 Hewlett, NY 11557 (3) Robert Lawrence WITKIN U.S.A. 700832626 511 Burlington Road Freehold, NJ 07728 THE 2ND SCHEDULE ABOVE REFERRED TO ---------------------------------- Particulars of four post-dated cheques -------------------------------------- Date Amount - ---- ------ 30/09/2001 HK$234,000.00 31/10/2001 HK$156,000.00 30/11/2001 HK$156,000.00 30/12/2001 HK$156,000.00 THE 3RD SCHEDULE ABOVE REFERRED TO Accrued Interest Total Sum Date Loan Amount Repayable Repayable Repayable - ---- -------------------- ---------------- ---------- 31/8/2001 HK$234,000.00 HK$17,224.11 HK$251,224.11 30/9/2001 HK$312,000.00 HK$14,168.32 HK$326,168.32 31/10/2001 HK$78,000.00 HK$11,195.67 HK$89,195.67 30/11/2001 HK$78,000.00 HK$10,001.10 HK488,001.10 31/12/2001 HK$78,000.00 HK$9,473.26 HK$87,473.26 31/1/2002 HK$78,000.00 HK$8,612.05 HK$88,001.10 28/2/2002 HK$117,000.00 HK$7,000.77 HK$124,000.77 31/3/2002 HK$117,000.00 HK$6,459.04 HK$123,459.04 30/4/2002 HK$156,000.00 HK$5,000.55 HK$161,000.55 31/5/2002 HK$156,000.00 HK$3,444.82 HK$159,444.82 30/6/2002 HK$156,000.00 HK$1,666.85 HK$157,666.85 --------------- ------------ --------------- HK$1,560,000.00 HK$94,246.54 HK$1,654,246.54 THE 4TH SCHEDULE ABOVE REFERRED TO ---------------------------------- 1. A Green Box; 2. A statutory book with registers of Directors, Secretaries, Members, Transfers and Charges and Minutes of Directors' and Members' meetings; 3. Certificate of Incorporation ion name of E-Fair Industrial Limited ( Written in Chinese - unable to type in); 4. Certificate of Incorporation on Change of Name in name of Toy Concept International Limited (Written Chinese - unable to type in); 5. 16 copies of Memorandum and Articles of Association; 6. An expired Business Registration Certificate for the year 1993/1994; 7. Share Certificate book with 9 duly cancelled share certificates nos. 1 to 9 and 18 blank share certificates; 8. Directors' Report and Financial Statements for the years ended 31st March 2000 and 2001; 9. Common Seal in name of E-Fair Industrial Limited; 10. Company Chop in name of E-Fair Industrial Limited; 11. Declaration of Trust dated 17th April 2001 executed by Mr. Ip Chi Hung in favour of Robert Lawrence Witkin; 12. Letter of Wishes; and 13. Letter of Indemnity dated 17th April 2001. SEALED with the COMMON SEAL of ) KINGSKY TECHNOLOGY LIMITED ) and signed by Mr. Wu Sheng-Shi, ) /S/ Wu Sheng-Shi its Director - - - - - - - - - ) in the presence of:- ) Derek B.K. Quan Solicitor HKSAR ) SIGNED, SEALED and DELIVERED by ) WU Sheng-Shi (holder of Taiwanese ) /S/ Wu Sheng-Shi Passport No. M14536552 in the ) presence of:- ) Derek B.K. Quan Solicitor HKSAR ) SIGNED, SEALED and DELIVERED by ) Gerald PENN (holder of U.S.A. ) /S/ Gerald Penn Passport No. 111033228 in the ) presence of:- ) Derek B.K. Quan Solicitor HKSAR ) SIGNED, SEALED and DELIVERED by ) Robert Lawrence WITKIN (holder of ) /S/ Robert Lawrence Witkin U.S.A. Passport No. 700832626 ) in the presence of:- ) /S/ William H. Passaic Notary Public of New Jersey My commission Expires February 9, 2006 SEALED with the COMMON SEAL of ) INTERNATIONAL SMC (HK) ) LIMITED and signed by Maria Alice ) HASKAMP CARQUEJA, a director in ) the presence of:- ) /S/ Iu Ting Kwok Solicitor T.S. Tong & Co. Hong Kong SAR RECEIVED on the day and year first above ) ) written of and from the Purchaser the sum of ) ) HK$234,000.00 being deposit (as referred to in ) ) Clause 1(i) above) paid by the Purchaser to the ) ) Vendor. ) -----END PRIVACY-ENHANCED MESSAGE-----