NOTE 3 – LIQUIDITY

As of December 31, 2019 theThe Company was in default on the Revolving Credit Facility due to non-compliance with the fixed charge coverage ratio in part due to the loss of margin and expenses associated with the damaged goods discussed above as well as a loss from operations. In November 2019, the Company entered into a Forbearance Agreement with PNC Bank, National Association (“PNC”) whereby PNC “forbears” taking action it would be entitled to under a default through March 31, 2020 at which time we would renegotiate renewal of the Revolving Credit Facility or obtain alternative financing.

As of December 31, 2019 the Company did not meet the required EBITDA hurdle of greater than or equal to $400,000 for the third quarter ended December 31, 2019 and is unlikely to meet the remaining hurdles of the Forbearance Agreement for the fiscal year ending March 31, 2020. As of December 31, 2019 the Revolving Credit Facility has no outstanding balance and there have been no further actions by PNC to exercise any of their options afforded to them as per the terms of the Revolving Credit Facility.

For the nine months ended December 31, 2019, the Company incurredreported a net loss of approximately $1,003,000$207,000 for the three months ended June 30, 2020 as compared to a net incomeloss of approximately $1,473,000$870,000 for the ninethree months ended December 31, 2018.June 30, 2019. In August 2019, a major customer received goods that were significantly water damaged due to excess moisture absorbed in pallets shipped by the factory. As a result we incurred a loss in cash flow of approximately $1,559,000 in revenue and approximately $849,000 in additional out of pocket expenses to retrieve, inspect, warehouse and properly destroy the goods during Fiscal 2020. As of this filing we have we have recovered approximately $2,245,000 from our cargo insurance coverage consisting of settlement of approximately $1,268,000 in insurance claim receivable, approximately $131,000 reflected as gain from damaged goods insurance claim in the condensed consolidated statement of operations for the three months ended June 30, 2020 with the remaining gain on recovery of approximately $846,000 subsequently received in July 2020 which will be recognized as a gain from damaged goods insurance claim in the next quarter ending September 30, 2020. We also secured vendor invoice credits of $390,000 from the factory that caused the damage which is reflected as gain from extinguishment of accounts payable in the condensed consolidated statement of operations for the three months ended June 30, 2020. On June 16, 2020, the Company executed an Intercreditor Revolving Credit Facility on eligible accounts receivable and inventory which replaced a revolving credit facility with PNC bank that was terminated on June 16, 2020. The Company expectssigned a two-year Loan and Security Agreement for a $10,000,000 financing facility (“Crestmark Facility”) with Crestmark Bank (“Crestmark”) on eligible accounts receivable. Further, the Company also executed a two-year Loan and Security Agreement (“IHC Facility”) with Iron Horse Credit (“IHC”) for up to $2,500,000 in inventory financing. The Intercreditor Revolving Loan Facility will expire on June 15, 2022. The Company has adequate cash flowson hand and cash available on its Intercreditor Revolving Credit Facility (approximately $2,600,000 as of the date of this filing) to meet all obligations during this off-peak season. On May 5, 2020, the Company received loan proceeds from operationsCrestmark in the amount of approximately $444,000 under the Paycheck Protection Program (“PPP”). The PPP was established as well as other financing resourcespart of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest may be forgivable to the extent the Company uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. Management is confident that the availability of cash from our Intercreditor Revolving Credit Facility, proceeds from the insurance claim settlement, proceeds from the PPP loan and our projections to reduce excess inventory during the next year will be adequate to satisfy working capitalmeet the Company’s liquidity requirements for at least the next twelve months from the date the accompanying condensed consolidated financial statements are issued. The Company plans to supplement cash flows from operations from several activities and resources including the following:months.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2019

(Unaudited)

There can be no assurances that any of the above actions can be accomplished or that financing will be available on acceptable terms. If the Company is unable to obtain financing or continues to experience sustained losses from operations this would have a material adverse effect on its ability to meet its financial obligations when due.

NOTE 3 -4 – SUMMARY OF ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

The condensed consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in the condensed consolidated financial statements. The accompanying unaudited condensed financial statements for the three and nine months ended December 31,June 30, 2020 and 2019 and 2018 have been prepared in accordance with generally accepted accounting principles applicable to interim financial information and the requirements of Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete consolidated financial statements. In the opinion of management, such condensed consolidated financial statements include all adjustments (consisting of normal recurring accruals) necessary for the fair presentation of the condensed consolidated financial position and the condensed consolidated results of operations. The condensed consolidated results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. The condensed consolidated balance sheet information as of March 31, 20192020 was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K10-K/A for the year ended March 31, 2019.2020. The interim condensed consolidated financial statements should be read in conjunction with that report.

USE OF ESTIMATES

The Singing Machine makes estimates and assumptions in the ordinary course of business relating to sales returns and allowances, warranty reserves, inventory reserves and reserves for promotional incentives that affect the reported amounts of assets and liabilities and of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Future events and their effects cannot be determined with absolute certainty; therefore, the determination of estimates requires the exercise of judgment. Historically, past changes to these estimates have not had a material impact on the Company’s financial condition. However, circumstances could change which may alter future expectations.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

COLLECTIBILITYNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020 and 2019

(Unaudited)

COLLECTABILITY OF ACCOUNTS RECEIVABLE

The Singing Machine’s allowance for doubtful accounts is based on management’s estimates of the creditworthiness of its customers, current economic conditions and historical information, and, in the opinion of management, is believed to be in an amount sufficient to respond to normal business conditions. Management sets 100% reserves for customers in bankruptcy and other reserves based upon historical collection experience.

The Company is subject to chargebacks from customers for cooperative marketing programs, defective returns, return freight and handling charges that are deducted from open invoices and reduce collectability of open invoices.

Should business conditions deteriorate or any major customer default on its obligations to the Company, this allowance may need to be significantly increased, which would have a negative impact on operations.

The Company is subject to chargebacks from customers for cooperative promotional programs, defective returns, return freight and handling charges that are deducted from open invoices and reduce collectability of open invoices.

FOREIGN CURRENCY TRANSLATION

The functional currency of the Macau Subsidiary is the Hong Kong dollar. The financial statements of the subsidiary are translated to U.S. dollars using period-end rates of exchange for assets and liabilities, and average rates of exchange for the period for revenues, costs, and expenses. Net gains and losses resulting from foreign exchange transactions are recorded in the condensed consolidated statement of operations and translations are recorded in a separate component of shareholders’ equity. Any such amounts were not material during the periods presented.

Concentration of Credit RiskCONCENTRATION OF CREDIT RISK

At times, the Company maintains cash in United States bank accounts that are more than the Federal Deposit Insurance Corporation insured amounts. The Company also maintains cash balances in foreign financial institutions. The amounts at foreign financial institutions at December 31, 2019June 30, 2020 and March 31, 20192020 are approximately $426,000$70,000 and $211,000,$217,000, respectively.

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist of accounts receivable.

INVENTORY

Inventories are comprised primarily of electronic karaoke equipment, microphones and accessories, and are stated at the lower of cost or net realizable value, as determined using the first in, first out method. Inventories also include an estimate for the net realizable value of expected future inventory returns due to warranty and allowance programs. As of December 31, 2019June 30, 2020 and March 31, 20192020 the estimated amounts for these future inventory returns were approximately $2,444,000$784,000 and $599,000,$1,367,000, respectively. The Company reduces inventory on hand to its net realizable value on an item-by-item basis when it is apparent that the expected realizable value of an inventory item falls below its original cost. A charge to cost of sales results when the estimated net realizable value of specific inventory items declines below cost. Management regularly reviews the Company’s investment in inventories for such declines in value. As of December 31, 2019June 30, 2020 and March 31, 20192020 the Company had inventory reserves of approximately $404,000$467,000 and $254,000approximately $434,000, respectively for estimated excess and obsolete inventory.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2019

(Unaudited)DEFERRED FINANCING COSTS

The Company classifies deferred financing costs incurred when obtaining or renewing revolving credit facilities as assets in the accompanying condensed consolidated balance sheets as it is likely that during certain periods during non-peak season there will be no balance due on these credit facilities to offset the deferred financing costs. In June 2020, the Company incurred approximately $74,000 in deferred financing costs associated with the closing of the Crestmark Facility and the IHC Facility which are being amortized over the term of the agreement and were classified as current assets on the accompanying condensed consolidated balance sheets.

LONG-LIVED ASSETS

The Company reviews long-lived assets for impairment whenever circumstances and situations change such that there is an indication that the carrying amounts may not be recoverable. If the undiscounted future cash flows attributable to the related assets are less than the carrying amount, the carrying amounts are reduced to fair value and an impairment loss is recognized in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360-10-05, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

LEASES

The Company follows FASB ASC 842, “Leases”. The ASC requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. The standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than twelve months. Leases are classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. (See Note 8– LEASES).

The Company determines if an arrangement contains a lease at the inception of a contract. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Right- of-use assets and lease liabilities are recognized at the commencement date. The liability is equal to the present value of the remaining minimum lease payments. The asset is based on the liability, subject to certain adjustments. Operating leases result in straight-line expense (similar to operating leases under the prior accounting standard) while finance leases result in a front-loaded expense pattern (similar to capital leases under the prior accounting standard). As the interest rate implicit in the Company’s operating leases is not readily determinable, the Company utilizes its incremental borrowing rate to discount the lease payments. The Company utilizes the implicit rate for its finance leases.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020 and 2019

(Unaudited)

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost, less accumulated depreciation. Expenditures for repairs and maintenance are charged to expense as incurred. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to their estimated useful lives using accelerated and straight-line methods.

FAIR VALUE OF FINANCIAL INSTRUMENTS

We follow FASB ASC 825, Financial Instruments, which requires disclosures of information about the fair value of certain financial instruments for which it is practicable to estimate that value. For purposes of this disclosure, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation.

The carrying amounts of the Company’s short-term financial instruments, including accounts receivable, accounts payable, accrued expenses, refunds due to customers and due to/from related parties approximates fair value due to the relatively short period to maturity for these instruments. The carrying amounts on the subordinated debt to Starlight Marketing Development, Ltd. (related party) and, finance leases approximate fair value due to the relatively short period to maturity and related interest accrued at a rate similar to market rates. The carrying amount on the revolving linelines of credit approximatesapproximate fair value due to the relatively short period to maturity and related interest accrued at market rates. The carrying amount on the PPP note payable of credit approximate fair value due the relatively short period to maturity as management intends to apply for total forgiveness of the loan in the current fiscal year.

REVENUE RECOGNITION AND RESERVE FOR SALES RETURNS

The Company recognizes revenue in accordance with FASB ASC 606, “Revenue from Contracts with Customers”. All revenue is generated from contracts with customers. The Company recognizes revenue when the goods are delivered and control of the goods sold is transferred to the customer, in an amount, referred to as the transaction price, that reflects the consideration to which the Company is expected to be entitled in exchange for those goods. The Company determines revenue recognition utilizing the following five steps: (1) identification of the contract with a customer, (2) identification of the performance obligations in the contract (promised goods or services that are distinct), (3) determination of the transaction price, (4) allocation of the transaction price to the performance obligations, and (5) recognition of revenue when, or as, the Company transfers control of the product or service for each performance obligation.

The Company’s contracts with customers consist of one performance obligation (the sale of the Company’s products). Revenue is recognized when the goods are delivered and control of the goods sold is transferred to the customer. The Company’s contracts have no financing elements, payment terms are less than 120 days and have no further contract asset or liability obligations once control of goods is transferred to the customer. Revenue is recorded in the amount of consideration the Company expects to receive for the sale of these goods.

The Company selectively participates in a retailer’s co-op promotion initiatives to maximize sales of the Company’s products on the retail floor or to assist in developing consumer awareness of new product launches, by providing marketing fund allowances to our customers. As these co-op promotion initiatives are not a distinct good or service and the Company cannot reasonably estimate the fair value of the benefit it receives from these arrangements, the cost of these allowances at the time they are offered to the customers are recorded as a reduction to net sales. Co-op promotion allowances were approximately $272,000 and $169,000for the three months ended June 30, 2020 and 2019, respectively. Costs incurred in fulfilling contracts with customers include administrative costs associated with the procurement of goods are included in general and administrative expenses, in-bound freight costs are included in the cost of goods sold and accrued sales representative commissions are included in selling expenses in the accompanying condensed consolidated statements of operations.operations as our underlying customer agreements are less than one year.

The Company disaggregates revenues by product line and major geographic region as most of its revenue is generated by the sales of karaoke hardware and the Company has no other material business segments (See NOTE 10)Note 10 – GEOGRAPHICAL INFORMATION).

TheWhile the Company generally does not allow products to be returned, other thanthe Company does provide for variable consideration contingent upon the occurrence of uncertain future events. Variable consideration is estimated at the expected value or at the most likely amount depending on the type of consideration. Estimated amounts are included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. The Company estimates variable consideration under our return allowance programs for goods returned to the customer for various reasons, and accordingly recordswhereby a sales return reserve is recorded based on historic return amounts, specific events as identified and management estimates.

The Company’s reserve for sales returns were approximately $4,546,000$380,000 and $896,000$1,224,000 as of December 31, 2019June 30, 2020 and March 31, 2019,2020, respectively.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31,June 30, 2020 and 2019

(Unaudited)

Revenue is derived from four different major product lines. Disaggregated approximate revenue from these product lines for the three and nine months ended December 31,June 30, 2020 and 2019 and 2018 consisted of the following:

SHIPPING AND HANDLING COSTS

Shipping and handling costs are performed by both the Company and third-party logistics companies. Shipping and handling activities are performed before the customer obtains control of the goods sold to them and are considered activities to fulfill the Company’s promise to transfer the goods. For the three months ended June 30, 2020 and 2019 shipping and handling expenses were approximately $83,000 and $89,000, respectively. These expenses are classified as a component of selling expenses in the accompanying condensed consolidated statements of operations.

STOCK BASED COMPENSATION

The Company follows the provisions of the FASB ASC 718-20, “Compensation – Stock Compensation Awards Classified as Equity”. ASC 718-20 requires all share-based payments to employees including grants of employee stock options, be measured at fair value and expensed in the condensed consolidated statements of operations over the service period (generally the vesting period). The Company uses the Black-Scholes option valuation model to value stock options. Employee stock option compensation expense for the three and nine months ended December 31,June 30, 2020 and 2019 and 2018 includes the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period for the entire portion of the award. For the three months ended December 31,June 30, 2020 and 2019, and 2018, the stock option expense was approximately $5,000$0 and $10,000, respectively. For the nine months ended December 31, 2019 and 2018, the stock option expense was $15,000 and $30,000,$5,000, respectively.

ADVERTISING

Costs incurred for producing and publishing advertising of the Company are charged to operations the first time the advertising takes place. The Company has entered into cooperative advertising agreements with its major customers that specifically indicate that the customer must spend the cooperative advertising fund upon the occurrence of mutually agreed events. The percentage of the cooperative advertising allowance ranges from 1% to 13% of the purchase. The customers must advertise the Company’s products in the customer’s catalog, local newspaper and other advertising media. The customer must submit the proof of the performance (such as a copy of the advertising showing the Company’s products) to the Company to request for the allowance. The customer does not have the ability to spend the allowance at their discretion. The Company believes that the identifiable benefit from the cooperative advertising program and the fair value of the advertising benefit is equal or greater than the cooperative advertising expense. Advertising expense, which is included as a component of selling expenses on the accompanying condensed consolidated statements of operations, for the three months ended December 31, 2019 and 2018 was approximately $2,040,000 and $1,328,000, respectively. Advertising expense for the nine months ended December 31, 2019 and 2018 was approximately $3,820,000 and $2,877,000, respectively. As of December 31, 2019 and March 31, 2019 there was an accrual for cooperative advertising allowances of $1,689,000 and $185,000, respectively. These amounts were a component of accrued expenses in the condensed consolidated balance sheets.

RESEARCH AND DEVELOPMENT COSTS

Research and development costs are charged to results of operations as incurred. These expenses are shown as a component of selling, general and administrative expenses in the condensed consolidated statements of operations.income. For the three months ended December 31,June 30, 2020 and 2019, and 2018, these amounts totaled approximately $13,000 and $27,000, respectively. For the nine months ended December 31, 2019 and 2018, these amounts totaled approximately $36,000 and $64,000$5,000, respectively.

INCOME TAXES

The Company follows the provisions of FASB ASC 740 “Accounting for Income Taxes.” Under the asset and liability method of ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. If it is more likely than not that some portion of a deferred tax asset will not be realized, a valuation allowance is recognized. As of June 30 2020 and March 31, 2020 the Company recognized a valuation reserve of approximately $88,000 for deferred tax assets relating to net operating loss carryforwards that the Company will more than likely not be able to realize prior to their expiration.

The Company analyzes its deferred tax assets and liabilities at the end of each interim period and, based on management’s best estimate of its full year effective tax rate, recognizes cumulative adjustments to its deferred tax assets and liabilities. For the ninethree months ended December 31,June 30, 2020 and 2019 and 2018 we estimated our effective tax rate to be approximately 22%.27.6% and 21.5%, respectively. As of December 31, 2019June 30, 2020, and March 31, 2019,2020, the CompanySinging Machine had grossnet deferred tax assets of approximately $1,053,000$1,365,000 and $758,000,$1,286,000, respectively. The Company recorded an income tax benefit of approximately $240,000$79,000 and an income tax provision of approximately $367,000$239,000 for the three months ended December 31,June 30, 2020 and 2019, and 2018, respectively. The Company recorded an income tax benefit of approximately $295,000 and an income tax provision of $422,000 for the nine months ended December 31, 2019 and 2018, respectively.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31,June 30, 2020 and 2019

(Unaudited)

The Company recognizes a liability for uncertain tax positions. An uncertain tax position is defined as a position in a previously filed tax return or a position expected to be taken in a future tax return that is not based on clear and unambiguous tax law and which is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The Company measures the tax benefits recognized based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. As of December 31, 2019,June 30, 2020, there were no uncertain tax positions that resulted in any adjustment to the Company’s provision for income taxes. The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes. The Company currently has no liabilities recorded for accrued interest or penalties related to uncertain tax provisions.

COMPUTATION OF EARNINGS (LOSS)LOSS PER COMMON SHARE

Income (loss)Loss per common share is computed by dividing the net income (loss)loss by the weighted average of common shares outstanding during the period. As of December 31,June 30, 2020 and 2019 and 2018 total potential dilutive shares from common stock options amounted to approximately 2,250,0002,230,000 and 2,350,0002,310,000 shares, respectively. These shares were not included in the computation of diluted earnings per share for the three and nine months ended December 31,June 30, 2020 and 2019 because their effect was anti-dilutive. These shares were included in the computation of diluted earnings per share for the three and nine months ended December 31, 2018.

ADOPTION OF NEW ACCOUNTING STANDARDS

In February 2016, the FASB issued ASU 2016-02, Topic 842, as amended, “Leases”. The ASU requires lessees to recognize leases on the balance sheet and disclose key information about leasing arrangements. The new standard establishes a right-of-use model (ROU) that requires a lessee to recognize a ROU asset and lease liability on the balance sheet for all leases with a term longer than twelve months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement. On April 1, 2019, the Company adopted the new lease standard using the optional transition method under which comparative financial information will not be restated and continue to apply the provisions of the previous lease standard in its disclosures for the comparative periods. (See Note 7– LEASES).

The Company determines if an arrangement contains a lease at the inception of a contract. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at the commencement date. The liability is equal to the present value of the remaining minimum lease payments. The asset is based on the liability, subject to certain adjustments. Operating leases result in straight-line expense (similar to operating leases under the prior accounting standard) while finance leases result in a front-loaded expense pattern (similar to capital leases under the prior accounting standard). As the interest rate implicit in the Company’s operating leases is not readily determinable, the Company utilizes its incremental borrowing rate to discount the lease payments. The Company utilizes the implicit rate for its finance leases.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2019, the FASB issued ASU 2019-12, “Income Taxes(Topic 740).Among several issues addressed in this ASU, there was one area that may potentially affect the Company’s calculations of interim income tax provision or benefit. The guidance specifies that an entity should apply the annual effective tax rate to the year-to date income or loss as long as the tax benefits for any losses are expected to be realized during the year or would be recognizable as a deferred tax asset at the end of the year eliminating the requirement of a valuation allowance for that interim period. There is specific guidance for circumstances in which an entity incurs a loss on a year-to-date basis that exceeds the anticipated ordinary loss for the year, which is an exception to the general guidance in Subtopic 740-270. This new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. We are currently evaluating the potential effects of this updated guidance on our condensed consolidated financial statements and related disclosures.

In June 2016, the FASB issued ASU 2016-13, “Financial“Financial Instruments—Credit Losses” (Topic(Topic 326). This ASU represents a significant change in the current accounting model by requiring immediate recognition of management’s estimates of current expected credit losses. Under the prior model, losses were recognized only as they were incurred, which delayed recognition of expected losses that might not yet have met the threshold of being probable.The amendments in ASU 2016-03 for smaller reporting companies are effective for fiscal years beginning after April 1, 2023 including interim periods within that fiscal year. Early adoption is permitted. We are currently evaluating the potential effects of this updated guidance on our condensed consolidated financial statements and related disclosures.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2019

(Unaudited)

NOTE 45 - INVENTORIES, NET

Inventories are comprised of the following components:

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020 and 2019

(Unaudited)

NOTE 56 – PROPERTY AND EQUIPMENT

A summary of property and equipment is as follows:

Depreciation expense for the three months ended December 31,June 30, 2020 and 2019 and 2018 was approximately $77,000$71,000 and $64,000, respectively. Depreciation expense for the nine months ended December 31, 2019 and 2018 was approximately $196,000 and $200,000,$59,000, respectively.

NOTE 67 – BANK FINANCING

Intercreditor Revolving Credit Facility Crestmark Bank and Iron Horse Credit

On June 22, 2017,16, 2020, the Company renewedexecuted an Intercreditor Revolving Credit Facility on eligible accounts receivable and inventory which replaced the existingCompany’s previous revolving credit facility (the “Revolving Credit Facility”) with PNC Bank which was terminated on June 16, 2020. The Company signed a two-year Loan and Security Agreement for an additional three years expiringa $10.0 million financing facility with Crestmark Bank on July 15, 2020.eligible accounts receivable. The outstanding loan balance cannot exceed $15,000,000$10.0 million during peak selling season between AugustJuly 1 and December 31 (with the ability of the Company to request an additional $5,000,000 of availability during peak selling season if required) and31and is reduced to a maximum of $7,500,000$5.0 million between January 1 and July 31. At December 31, 2019 and March 31, 2019,Costs associated with closing of the outstanding balance was approximately $0 and $0, respectively, on the Revolving Credit Facility. As of December 31, 2019, there was approximately $15,000,000 available to borrow on theIntercreditor Revolving Credit Facility assuming complianceof approximately $74,000 are deferred and are being amortized over the term of the agreement. During the three months ended June 30, 2020 the Company incurred amortization expense of approximately $3,000 associated with the limits and covenants as discussed below. Usage underamortization of deferred financing costs from the Intercreditor Revolving Credit Facility shall not exceedFacility.

Under the sum of the following (the “Borrowing Base”):Crestmark Facility:

The Revolving Credit Facility includes the following sub-limits:

The Revolving CreditCrestmark Facility must complyis secured by a security interest in all assets including a first security interest in Accounts Receivable and Inventory. Notwithstanding the foregoing, Crestmark shall subordinate its first security interest in inventory to IHC as agreed between all parties. The Crestmark Facility bears interest at the Wall Street Journal Prime Rate plus 5.50% with a floor of 8.75%. Interest and Maintenance Fees shall be calculated on the following quarterly financial covenantshigher of the actual average monthly loan balance from the prior month or a minimum average loan balance of $2,000,000. There was no interest expense on the Crestmark Facility for the three months ended June 30, 2020 and 2019. The Crestmark Facility expires on June 15, 2022. There was no outstanding balance on the Crestmark Facility as of June 30, 2020.

In addition, the Company also executed a two-year Loan and Security Agreement with IHC for up to avoid default:$2,500,000 in inventory financing. Under the IHC Facility:

The IHC Facility is secured by a perfected security interest in the Company’s inventory. The IHC Facility bears interest at 1.292% per month or 15.51% annually. Interest shall be calculated on the higher of the actual average monthly loan balance from the prior month or a minimum average loan balance of $1,000,000. Interest expense for the three months ended June 30, 2020 and 2019 was approximately $8,000 and $0, respectively. The IHC Facility expires on June 15, 2022. As of June 30, 2020 and March 31, 2020 there was an outstanding balance of $1,400,000 and $0, respectively.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31,June 30, 2020 and 2019

(Unaudited)

As of December 31,Revolving Credit Facility PNC Bank

On June 22, 2017, the Company renewed the existing revolving credit facility (the “PNC Revolving Credit Facility”) with PNC Bank, National Association (“PNC”) for an additional three years which was terminated on June 16, 2020 and replaced by the Intercreditor Revolving Credit Facility with Crestmark and IHC. In September 2019 the Company remained in defaultdefaulted on the PNC Revolving Credit Facility due to non-compliance with the fixed charge coverage ratio in part due to the loss of margin and related expenses associated with the damaged goods received by one major customer in August, 2019.requirement. In November 2019, the Company entered into a Forbearance Agreement with PNC whereby PNC “forbears”delayed taking action it would have been be entitled to under a default through March 31, 2020 and would continue forbearance actions provided the2020. The Company continued to meet compliance with certain conditions (See Note 2 – LIQUIDITY).

As of December 31, 2019 the Company did not meet the required conditionsremained in default of the Forbearance Agreement and is unlikely to meet the remaining hurdles of the Forbearance Agreement for the fiscal year ending March 31, 2020. As of December 31, 2019 the Revolving Credit Facility has no outstanding balance and there have been no further actions by PNC to exercise any of their options afforded to them as per the terms of the Revolving Credit Facility.

Prior the Forbearance Agreement interest on the Revolving Line of Credit was accrued at .75% per annum over PNC’s announced prime rate with an option for the Company to elect the 1, 2 or 3 month fully absorbed PNC LIBOR Rate plus 2.75% per annum with a default rate of 2% over the applicable rate. Upon execution of the Forbearance Agreement there was a pricing rate increase of .5% on the ..75% per annum rate and the PNC LIBOR Rate plus 2.75% (See Note 2 – LIQUIDITY). There is an unused facility fee equal to ..375% per annum on the unused portionup until termination of the Revolving Credit Facility on June 16, 2020 at which will be calculatedtime the Company entered into the Intercreditor Revolving Credit Facility with Crestmark and IHC. At June 30, 2020 and March 31, 2020 there were no amounts due on the basis of a 360 day year for the actual number of days elapsed and will be payable quarterly in arrears. During the three months ended December 31, 2019 and 2018 the Company incurred interest expense of approximately $86,000 and $100,000, respectively, on amounts borrowed against the Revolving Credit Facility. During the nine months ended December 31, 2019 and 2018, the Company incurred interest expense of approximately $119,000 and $155,000, respectively on amounts borrowed against thePNC Revolving Credit Facility. During the three months ended December 31, 2019 and 2018, the Company incurred an unused facility fee of approximately $10,000 and $8,000, respectively on the unused portion of the Revolving Credit Facility. During the nine months ended December 31, 2019 and 2018, the Company incurred an unused facility fee of approximately $30,000 and $23,000, respectively on the unused portion of the Revolving Credit Facility.

The Revolving Line of Credit is secured by first priority security interests in all of the named borrowers’ tangible and intangible assets as well as first priority security interests of 100% of member or ownership interests of any of its domestic existing or newly formed subsidiaries and first priority lien on up to 65% of the borrowers’ foreign subsidiary’s existing or subsequently formed or acquired foreign subsidiaries. The Revolving Credit Facility is also secured by a related-party debt subordination agreement with Starlight Marketing Development, Ltd. in the amount of approximately $803,000. Costs associated with renewal of the Revolving Credit Facility of approximately $40,000 were deferred and are being amortized over the term of the agreement. During the three months ended December 31, 2019 and 2018, the Company incurred amortization expense of approximately $3,000 associated with the amortization of deferred financing costs from the original Revolving Credit Facility. During the nine months ended December 31, 2019 and 2018 the Company incurred amortization expense of approximately $10,000 associated with the amortization of deferred financing costs from the original Revolving Credit Facility.

Subordinated Related Party Debt

The subordination agreement was amended reducing the amount of related party subordinated debt to the remaining amount due of approximately $815,000. Provision has also been made to allow repayment of the remaining $815,000 in quarterly installments of $123,000 including interest accrued at 6% per annum commencing September 30, 2017 and ending on the debt maturity date of June 30, 2019. There are no provisions to continue accruing interest on the outstanding principal amount due as of June 30, 2019. Payments of $123,000 are only permitted upon receipt of the Company’s quarterly compliance certificate; the Company having met the mandatory pay-down of the Revolving Credit Facility to $1,000,0002020 and average excess availability for the prior 30 days (after subtraction of third party trade payables 30 days or more past due) of no less than $1,000,000 after giving effect to the payment. As part of the Conditions to Installment Payment of the subordinated debt, payments not made under this note that cannot be made as a result of the foregoing prohibition, including payments after the scheduled maturity date, shall not be deemed an Event of Default and can be made as soon as the Company is able to demonstrate that it meets the liquidity requirements defined above. Quarterly installment payments of $123,000 due on the last day of each fiscal quarter have not been made since September 2017 due to the Company not meeting these requirements; a payment of $123,000 which includes principal and interest, was not made during the three months ended December 31, 2019. A payment of $25,000 was made in August 2019 with approximately $12,500 paying down the principal and approximately $12,500 paying interest due. During the three months ended December 31, 2019 and 2018, the Company incurred interest expense of approximately $0 and $7,000$1,000, respectively, on amounts borrowed against the related party subordinated debt. DuringPNC Revolving Credit Facility.

Note Payable Payroll Protection Plan

On May 5, 2020, the nineCompany received loan proceeds from Crestmark in the amount of approximately $444,000 under the Paycheck Protection Program (“PPP”). The PPP was established as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest may be forgivable to the extent the Company uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness may be reduced if the borrower terminates employees or reduces salaries during the eligible period. The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments until a forgiveness application has been accepted and reviewed by the SBA, and the SBA has provided Crestmark with the loan forgiveness amount. For the three months ended December 31,June 30, 2020 and 2019 and 2018, the Company incurred interest expense of approximately $1,000 and $0, and $20,000, respectively onrespectively. The Company currently expects to apply for forgiveness of the related party subordinated debt.entire loan balance.

Installment Notes Payable

On June 18, 2019, the Company entered into a financing arrangement with Dimension Funding, LLC (“Dimension”) to finance the entire ERP System project over a term of 60 months at a cost of approximately $365,000. As of December 31, 2019June 30, 2020 the Company executed three installment notes totaling approximately $365,000 for payments issued to the project vendor. The installment notes have 60 month terms with interest rates of 7.58%, 8.55% and 9.25%, respectively. The installment notes are payable in monthly installments of $7,459 which include principal and interest. As of June 30, 2020 and March 31, 2020 there was an outstanding balance on the installment notes of approximately $328,000 and $346,000, respectively. For three months ended June 30, 2020 and 2019 the Company incurred interest expense of approximately $7,000 and $0 respectively.

Subordinated Debt/Note Payable to Related Party

In conjunction with the PNC Revolving Credit Facility there was a subordination agreement on related party debt due to Starlight Marketing Development, Ltd. of approximately $803,000. On June 1, 2020 the remaining amount due on the subordinated debt of approximately $803,000 was converted to a note payable (“subordinated note payable”) which bears interest at 6%. As part of the agreement to convert the subordinated debt to a note payable it was agreed that interest expense would be accrued at the same 6% interest rate on the unpaid principal retroactively from the date that previously scheduled payments had been missed. During the three months ended June 30, 2020 and 2019 interest expense was approximately $12,000 and $2,000, respectively on the subordinated note payable and the related party subordinated debt, respectively.

In connection with the Intercreditor Revolving Credit Facility the Company was required to subordinate the subordinated note payable. Both Crestmark and IHC facility agreements allow for the repayment of the subordinated note payable provided any amounts borrowed against these credit facilities are paid in full, the Company maintains a 1 : 1 debt coverage ratio and exhibits sufficient cash liquidity to support on-going operations. There is no set schedule with regards to repayment of the note and as such the subordinated note payable has been classified as a non- current liability as of June 30, 2020 and March 31, 2020 on the condensed consolidated balance sheets. As of June 30, 2020 and March 31, 2020 the remaining amount due on the subordinated debt was approximately $803,000 and $815,000, respectively.$803,000.

Bank Term Note

The Company repaid the final $125,000 installment of a term loan with PNC which originated in fiscal year 2018.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2019

(Unaudited)

NOTE 78 - COMMITMENTS AND CONTINGENCIES

LEGAL MATTERS

As of August 19, 2020 management is not aware of any legal proceedings other than matters that arise in the ordinary course of business.

THE SINGING MACHINE COMPANY, INC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2020 and 2019

(Unaudited)

LEASES

Operating Leases

We have operating lease agreements for offices and a warehouse facility in Florida, California and Hong KongMacau expiring in various years through 2024.

We entered into an operating lease agreement, effective October 1, 2017, for the corporate headquarters located in Fort Lauderdale, Florida where we lease approximately 6,500 square feet of office space. The lease expires on March 31, 2024. The base rent payment is approximately $8,800 per month, subject to annual adjustments.

We entered into an operating lease agreement, effective June 1, 2013, for 86,000 square feet of warehouse space in Ontario, California for our logistics operations. The lease expires on August 31, 2020 (original lease term of 87 months). The base rent payment is approximately $43,700

per month for the remaining term of the lease. On June 15, 2020 we executed a three-year lease extension which will expire on August 31, 2023. The lease providesrenewal base rent payment will be $65,300 with a 3% increase every 12 months for a renewal option to extend the leaseremaining term for 5 years atof the fair market value at the time of renewal.extension.

We entered into an operating lease agreement, effective May 1, 2018, for 424 square feet of office space in Macau, Hong Kong.Macau. The rent is fixed at approximately $1,600 per month for the duration of the lease which expires on April 30, 2021. The lease provides for a renewal option to extend the lease.

Lease expense for our operating leases is recognized on a straight-line basis over the lease terms.

Finance Leases

On May 25, 2018 and June 4, 2018, we entered into two long-term capital leasing arrangements with Wells Fargo Equipment Finance (“Wells Fargo”) to finance the leasing of two used forklift vehicles in the amount of approximately $44,000. The leases require monthly payments in the amount of $1,279 per month over a total lease term of 36 months which commenced on June 1, 2018. The agreement has an effective interest rate of 4.5% and the Company has the option to purchase the equipment at the end of the lease term for one dollar. As of June 30, 2020 and March 31, 2020 the remaining amounts due on these capital leasing arrangements was approximately $14,000 and $18,000, respectively. For the three months ended June 30, 2020 and 2019 the Company incurred interest expense of $154 and $274, respectively.

Supplemental balance sheet information related to leases as of December 31, 2019June 30, 2020 is as follows:follows: