The Singing Machine Company, Inc.

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The Singing Machine Company, Inc.

6601 Lyons Road
Building A-7
Coconut Creek, Florida 33073
U.S.A.
Telephone: (954) 596-1000
Fax: (954) 596-2000
Web site: http://www.singingmachine.com

Public Company
Incorporated: 1982
Employees: 54
Sale: $95.6 million (2002)
Stock Exchanges: American
Ticker Symbol: SMD
NAIC: 334310 Audio and Video Equipment Manufacturing; 512240 Audio and Video Equipment Manufacturing

The Singing Machine Company, Inc. develops and distributes karaoke machines and music for home use. Its karaoke machines are manufactured under contract in China and are sold in North America, Europe, and Asia. Most of the nearly 3,000 songs the company uses with its machines are mixed and produced at its Florida studios. Singing Machine was one of the first in the industry to target consumers rather than businesses for its products. Its success has partly stemmed from effective cross-marketing deals, which allow it to distribute its karaoke machines under the MTV, Nickelodeon, Hard Rock Academy, and Motown brand names, as well as under its own label. Singing Machine does the bulk of its sales in the United States during the holiday season at mass retailers, including Wal-Mart, Toys "R" Us, Best Buy, and Sears. After a string of phenomenal years in which the company annually achieved record sales and profits, Singing Machine fell on harder times. After the company was forced in 2003 to restate earnings for the fiscal years of 2001, 2002, and 2003, shareholders filed suit, alleging that the company had materially misrepresented its financial bona fides.

Early Years: 1982–87

Legend has it that karaoke—a Japanese word meaning "empty orchestra"—was invented in the Japanese city of Kobe in the early 1970s when a band failed to show up for its nightclub act. In an attempt to keep the crowd occupied, the club's owner played tapes of music without vocals and handed around a microphone that members of the audience used to sing along. The impromptu entertainment was a hit, and a cultural phenomenon was born. By the mid-1970s, several Japanese audio companies had begun producing karaoke machines and the musical tapes to go along with them.

Karaoke found its way to the United States in the early 1980s, as karaoke bars sprang up in major cities. While karaoke gained adherents among some Americans, the activity was nowhere near as popular as it was in Japan, where it had become "a way of life," according to Transpacific. However, karaoke did catch the eye of some state-side investors who saw in it a business opportunity. One such pioneer was Earl Glick, the head of Hal Roach Studios Inc. in Hollywood, who had become enchanted with the concept of karaoke while he was vacationing on a cruise ship. Roach Studios, the producers of the Laurel and Hardy and Li'l Rascals movies, was a venerable Hollywood institution.

Glick launched The Singing Machine as a Roach Studios subsidiary in 1982. Soon thereafter, he met with Ahihiko Kurobe, an executive with Nikkodo, one of the leading karaoke machine companies in Japan. Glick and Kurobe agreed to team up, with Nikkodo manufacturing karaoke devices for Singing Machine, which would become the first American company striving to reach the American karaoke market. (Singing Machine would later terminate this production contract with Nikkodo and instead directly contract out the manufacture of its karaoke machines to Asian factories.) Like other karaoke equipment producers, Singing Machine pitched its products not to individual karaoke users but to the karaoke bars and nightclubs that were beginning to gain popularity. The machines were technically sophisticated and quite expensive, with Singing Machine's early models typically costing over $2,000. The company also began to produce the taped background music that the machines played, which involved acquiring licenses from record labels and artists, and then hiring musicians to re-record the original songs without vocals.

Although the market for Singing Machine's products was relatively small, the company performed well in its early years. By 1987, Singing Machine had sold 30,000 machines and expanded its line to include five types, ranging in price from $250 to $2,300, and a library of 1,500 different background tracks on both tape and compact disc. However, Singing Machine's parent company was stretched too thin. Roach Studios had aggressively entered new markets in the 1980s but had overextended itself. In 1987, Roach Studios sold Singing Machine to a group of entertainment and toy industry investors for $1.75 million.

New Challenges: 1988–97

A pivotal moment for the young company took place in 1988, when Edward Steele joined Singing Machine. Steele, a veteran executive from the toy industry, had become fascinated with karaoke machines after seeing their popularity in Asian bars. In 1989, Steele acquired a significant stake in the company and began to chart its course for future growth. Steele believed that karaoke had broad appeal in the United States but that Singing Machine had been misguided when it sought to follow a Japanese marketing model and rely almost exclusively on sales to bars and nightclubs. Rather, Steele believed, karaoke must be brought directly to American consumers. "You can sell a lot more machines to the population than to karaoke clubs," a company executive would later tell the Miami Herald.

To implement Steele's vision of marketing directly to consumers, the company aggressively expanded its product line to include cheaper and less sophisticated machines that individuals could afford to buy and use at home. An early iteration of this idea was Singing Machine's $49 dual cassette recorder, which could tape a singer on one side using pre-recorded music on the other. Nevertheless, the company did not abandon its original market of bars and nightclubs but continued to oversee the manufacture and marketing of high-end machines designed for those venues.

The early 1990s proved the viability of Steele's foresight. Domestic karaoke machine sales exploded from $75 million in 1990 to $590 million by 1992, and consumer awareness of karaoke had risen to 80 percent by the latter year. However, with the karaoke market expanding, more competitors entered the field. By 1992, sixty-five different American companies were engaged in the manufacture of karaoke hardware (machines), software (tapes and CDs), and accessories. Fortunately for Singing Machine, the company had a solid foothold since it had entered the sector early.

Singing Machine's two-pronged strategy of targeting both institutional customers and individual consumers did not yield immediate results. The company's earnings were erratic. In an attempt to raise capital, fund expansion, and smooth operations, Singing Machine opted to become a public company in 1994. An initial stock offering of 1.2 million shares netted the company $4.7 million. Steele, who had assumed the post of chief executive officer, retained a 9.5 percent stake in the company.

Singing Machine's position looked secure after its stock offering. The company significantly expanded the array of products available to consumers to include eighteen different models of karaoke machines marketed under four trademarks—The Singing Machine, Karaoke Kassette, Karaoke Compact Disc, and Karaoke Video Kassette. In 1995, the company also launched its own version of the latest karaoke technology—compact discs with graphics (CD+G). When played in a karaoke machine, this compact disc scrolled the lyrics of the song in time with the music, making it easier for singers to follow along.

Despite these positive developments, Singing Machine faced significant obstacles in the wake of its stock offering. The karaoke equipment sector had become even more crowded as a range of companies recognized karaoke's growth potential. "Every major multimedia, electronics, and software company in the United States is involved with this newest entertainment medium," an industry analyst told the Orlando Sentinel in 1994.

Singing Machine responded to these new threats on different fronts. In an attempt to boost its sales by making its machines stand out from the competition's on store shelves, the company reached an agreement with Memcorp, Inc., which allowed Singing Machine to use the Memorex trademark on its electronic karaoke equipment. Singing Machine also sought to drive sales with greater retail penetration. In 1995, the company reached key agreements with Camelot Music Stores and Radio Shack that allowed Singing Machine to test products in Camelot stores and display its latest catalogue in over 6,000 Radio Shack outlets. Singing Machine also looked to its own operational efficiencies to improve its bottom line. In 1995, the company formed a wholly owned, Hong Kong-based subsidiary, International SMC (Hong Kong) Ltd. With this new unit, Singing Machine anticipated that it could book 100 percent of its Far East merchandise sales, which would increase its revenues by an estimated $2.5 million. (With its existing arrangement, Singing Machine could only attribute a percentage of its Asian sales as commission revenue from direct sales.)

Company Perspectives:

We at The Singing Machine plan to keep you "up-to-date" on the latest karaoke happenings. As you may or may not know karaoke is everywhere. It can be found in a small neighborhood restaurant in Nebraska, a large club in New York City, a high school graduation party in Portland, and even on the big screen in Hollywood. It is all over and sooner or later, it will somehow be a part of your life! It's great to know that in a day and age where television and video games dominate our children's time, there is a "family-oriented" alternative … karaoke.

However, Singing Machine's situation did not improve. After renegotiating the terms of its financing agreement with Banker's Capital, the company reported a net loss of $152,000 on sales of about $5.9 million in fiscal year 1995. The following year did not bring better results, as revenue dropped and losses widened. The company pledged to reduce expenditures, cut employees, and initiate new programs to drive sales. Singing Machine abruptly fired its president, Eugene Settler, in 1996, and Steele took over Settler's administrative functions in addition to his own as CEO. Nevertheless, these steps could not halt Singing Machine's downward spiral. In 1997, the company filed for protection from its creditors under the provisions of Chapter 11. Steele remained optimistic about Singing Machine's prospects, though. "The pressure is now off," he said in an April 18, 1997 press release. "Chapter 11 will give us the opportunity to put into place a comprehensive restructuring plan." Singing Machine emerged from Chapter 11 in 1998.

Restructuring and Growth: 1998–2002

The cornerstone of Singing Machine's post-Chapter 11 restructuring plan was to improve retail penetration. In the early 1990s the company had made some headway in pitching its machines to individual consumers, but it had struggled to gain access to the types of stores that could generate the volume of sales it required. Its main retail customers were PACE Membership Warehouse and Handelman, not the retail giants that could make or break a brand. In 1997, Steele brought in John Klechna as Singing Machine's chief operating officer, and Klechna immediately turned his attention to this problem. "We basically had to beg, borrow, and steal to get retail programs in at the ground level and convince retail buyers that it's a dynamic category," Klecha told the Miami Herald in 2000.

By 1999, Singing Machine had distribution agreements with Best Buy, Sears, and JC Penney, and in the following year the company reached crucial agreements to bring its products to Toys "R" Us and Wal-Mart.

Once it had secured these retail agreements, Singing Machine focused on building its customer base. Despite its growing popularity in the United States—by 2000 the domestic karaoke market was estimated at more than $200 million—karaoke still retained associations from its past as a nightlife activity for adults. Singing Machine saw the future of karaoke in younger consumers and cast about for ways to draw them to its products, as well as convince their parents that karaoke was family-oriented fun.

To fulfill this strategy, Singing Machine reached an agreement with MTV—"that perennial arbiter of all things youthful," as Cable World dubbed the network—in 2001. In exchange for royalties of $650,000 over three years, Singing Machine received the right to market a line of MTV-branded karaoke machines and to get input from MTV's creative staff in designing the two initial models and creating the song lists that were sold with the karaoke machines. The deal was an unequivocal triumph for Singing Machine. "Since their introduction … our MTV-branded karaoke systems have grown to become the most successful products in our history," Klechna (who had assumed the post of president in 2001) said in a January 8, 2002 company press release.

Hoping to build on the success of its MTV deal, Singing Machine signed a multi-year domestic merchandise licensing agreement with Nickelodeon, a unit of Viacom International Inc. Under the terms of the deal, Singing Machine would produce a line of Nickelodeon-branded karaoke machines and software featuring music for the television network's core audience. While its relationship with MTV was intended to draw teenage and young adult consumers, with the Nickelodeon product line, Singing Machine sought to appeal to an even younger demographic—pre-schoolers and pre-teens, whom the company believed represented tremendous growth potential.

Singing Machine did not want to overlook its original consumers either, and used its cross-branding strategy to shore up its position with older karaoke fans. In 2002, the company signed a three-year agreement with Hard Rock Academy, a division of the trendy Hard Rock Café, to produce a line of Hard Rock branded machines and music software. Later that year, the company entered a similar agreement with Universal Music Group to produce Motown Originals software and karaoke machines, which Singing Machine directed at baby boomer consumers who wanted to reconnect with the Motown music of their youth.

However, Singing Machine's growth strategy involved more than licensing agreements. In 2001, the company hired the advertising and public relations firm DK 13 & Partners to step up its marketing efforts. Recognizing that karaoke's potential outside the United States and Asia was virtually untapped, the company entered a distribution agreement with London-based Arbiter Group PLC, a leading distributor of consumer electronics products to major retailers in the United Kingdom and throughout Europe. "We believe that our opportunity in Europe rivals our opportunity on this side of the Atlantic," Klechna said in a company press release on November 28, 2001.

Key Dates:

1982:: Singing Machine is incorporated as a subsidiary of Hal Roach Studios Inc.
1987:: An investor group acquires Singing Machine.
1990:: The company moves its headquarters from California to Boca Raton, Florida.
1994:: Singing Machine becomes a public company.
1995:: The company forms International SMC (Hong Kong) Ltd.
1997:: Singing Machine seeks Chapter 11 protection.
2000:: Singing Machine signs a merchandise licensing agreement with cable television channel MTV.
2001:: Singing Machine enters into a distribution agreement with Arbiter Group plc.
2002:: Singing Machine signs a licensing agreement with Viacom International Inc. to create a line of Nickelodeon branded karaoke machines and software.
2003:: Singing Machine restates its earnings for the previous three fiscal years; a class action shareholder suit is filed against the company.

The company's post-bankruptcy efforts were successful. Singing Machine's revenue shot up from $6 million in fiscal year 1997 to $9.5 million in fiscal year 1999 and to $19 million the following year. The company's sales grew at an annual average rate of 83 percent between 1999 and 2001, when revenue reached $59 million. In 2002, the company's revenue grew another 80 percent to exceed $61 million. Equally impressive was the jump in earnings, which rose an average of 136 percent a year to top $9 million in 2001. Business Week named Singing Machine its top "Hot Growth" company in 2002. "We're really on the tip of the iceberg of where this can go," an ebullient Klechna told the Miami Herald on April 14, 2003.

Rebuilding: 2003 and Beyond

However, Singing Machine's fortunes changed dramatically in 2003, when the company was forced by its auditors to restate its earnings for fiscal years 2001, 2002, and 2003 because of a tax issue with its Hong Kong subsidiary. The subsidiary generated most of the company's profit, yet Singing Machine had not paid any foreign income tax because it assumed it would get an exemption from the Hong Kong tax authority, since all of its profits were generated from exporting to customers outside Hong Kong. Within one day of the announcement, Singing Machine's share price fell 38 percent.

On the heels of this bad news came reports that Singing Machine's prospects were not quite as rosy as they once appeared. In 2002, Klechna had overseen an agreement in which Singing Machine agreed to sell to a major retail customer on consignment (and thus not get paid until the karaoke machines were sold). The customer pulled out of the deal at the last minute, leaving Singing Machine with a backlog of inventory worth $2.6 million. To compound this problem, the company performed poorly that holiday season—the period that typically accounted for nearly 80 percent of its annual sales. This in turn caused Singing Machine's inventory to balloon even more. Saddled with so much unsold merchandise, Singing Machine's debt climbed. By the end of 2002, the company owed some of its creditors $8.5 million, and its net worth had fallen to $26 million, which violated a covenant of a loan agreement with La Salle National Bank that required the company to maintain a minimum net worth of $30 million. This stream of bad news prompted shareholders to file a class action lawsuit against Singing Machine for making material misrepresentations to the market between 2001 and 2003. The company's auditors expressed substantial doubt about its ability to continue as a going concern.

Singing Machine took steps to allay doubts about its future. After the consignment debacle came to light, Klechna stepped down as president and COO and was replaced as COO by Y.P. Chan. In July 2003, Steele resigned as CEO. Robert Weinberg was named CEO and president, and Howard Moore assumed Steele's position as chairman of the board of directors. The company remained optimistic that it could get itself back on track. "We made a couple of mistakes last year; we're paying for it," Chan told the Miami Herald on July 1, 2003. "The company has grown substantially the last five years. Along with the growth, we have had growing pains."